Question Tag: Lease Accounting

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  • 20 Marks

AAA – May 2022 – L3 – Q2 – Assurance Engagements

Discuss due diligence processes and provide IFRS 16 guidance on lease recognition, measurement, and disclosure.

Pegrace Nigeria Limited (PNL), your audit client, is a national hotel group with substantial cash resources. Its accounting functions are well managed and the group’s accounting policies are rigorously applied. The company’s financial year-end is December 31.

The company has been seeking to acquire a construction company for some time in order to bring in-house the building and refurbishment of hotels and related leisure facilities, like swimming pools, volleyball courts, and restaurants. The management has recently identified Robin Construction Company Limited (RCCL) as a potential target and has urgently requested that you undertake a limited due diligence review.

Further to the preliminary talks between the management of RCCL and PNL, you were provided with the following brief on Robin Construction Company Limited:

  1. The Chief Executive, Managing Director, and Finance Director are all family members and major shareholders. The company has an established reputation for quality constructions.
  2. Due to a recession in the building business, the company has been operating at its overdraft limit for the last 18 months and has been close to breaching debt obligations on several occasions.
  3. Robin’s accounting policies are generally less prudent than those of Pegrace (assets are depreciated over longer estimated useful lives).
  4. Contract revenue is recognized on the percentage of completion method, measured by reference to costs incurred to date. Provisions are made for loss-making contracts.
  5. The company’s management team includes a qualified and experienced quantity surveyor, whose main responsibilities are:
    • Supervising quarterly physical counts at major construction sites;
    • Comparing costs to date against quarterly rolling budgets; and
    • Determining profits or losses, by contract, at each financial year-end.
  6. Labour force is provided under subcontracts. During construction, the regulatory body visited the site and discovered non-compliance with site health and safety regulations.

In February 2021, Robin received a claim that a site on which it built a housing development in Banana Estate was not properly drained and is now sinking. Residents are demanding rectification and asking for payment or damages. Robin has referred the matter to its legal counsel and denied all liability, as the site preparation was subcontracted to Sahara Services Company Limited. No provisions have been made in respect of the claims, nor has any disclosure been made.

The auditor’s report on Robin’s financial statements for the year ended December 31, 2020, was signed, without modification, in March 2021.

Required:

a. Prepare a document to give the explanatory meaning of the term ‘due diligence’ and subsequently discuss items to investigate in a due diligence exercise. (12 Marks)

b. Advise on how to recognize, measure, present, and disclose leases as required by IFRS 16. (8 Marks)

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  • 20 Marks

CR – Nov 2020 – L3 – Q5 – Leases (IFRS 16)

Discuss lease classification, loan liability derecognition under IFRS 9, and tax offsetting rules under IAS 12.

Muzana Limited owns tractors used for farming purposes and sometimes enters into lease arrangements with other agricultural companies. A particular tractor when leased out by Muzana is for 8 years. The useful economic life of each tractor is estimated at 10 years while the fair value of each tractor is estimated at N26 million. The present value of minimum lease payments in the lease arrangement is N28 million. Lease payments are made to Muzana by the lessee on a monthly basis and has a purchase option at the end of the lease term to acquire the machine for N2.2 million. A similar fairly used machine in the market will cost the buyer N2.5 million. Following the transition to IFRS 16, the management of Muzana have classified this lease as an operating lease in its year-end financial statements.

In order to expand its operations, Muzana accessed the Agricultural Loan Credit Programme set up by the government of Nigeria. In the year 2016, Muzana was granted a 5-year interest free loan of N100 million. At year end September 30, 2019, Muzana had been able to set aside N100 million in a special trust to be used for no other purpose than to pay off the loan in full on its due date in 2020. The management of Muzana are currently preparing their year-end 2019 financial statements and have derecognised the loan liability due to the fact that funds have been set aside in full to satisfy the loan payment in 2020.

Muzana Limited have just concluded a meeting with its tax consultant. The amounts due to the state tax authorities in the current year is N2.3 million. Muzana also has a tax credit of N1.8 million due from the Federal government in the current year. The tax consultant has advised Muzana that these amounts can be offset in their year-end financial statements to show only a tax liability of N500,000.

Required: a. Explain how the lease arrangement should be classified in Muzana‘s 2018 year-end financial statements? (7 Marks) b. Advise the management of Muzana, based on IFRS 9 derecognition rules, if the loan liability can be recognised in their year-end September 30, 2019 financial statements. (7 Marks) c. Explain if the advise provided by the tax consultant is consistent with the offsetting rules under IAS 12 Income Taxes? (6 Marks)

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  • 7 Marks

FR – NOV 2016 – L2 – Q6a – Leases (IFRS 16)

Question tests understanding of the two types of leases under IAS 17 and their key differences.

Identify the TWO kinds of leases stipulated in IAS 17 and compare in tabular form with at least FIVE differences.

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  • 6 Marks

FR – April 2022 – L2 – Q2b – Financial Reporting Standards and Their Applications

Prepare extracts for the Statement of Financial Position and Statement of Profit or Loss for Kundugu Ltd in 2020 and 2021, accounting for a lease agreement under IFRS 16.

b) Kundugu Ltd (Kundugu) is a manufacturing company located in the Savannah Region. The reporting date of Kundugu is 31 December, and the company reports under International Financial Reporting Standards (IFRSs). Kundugu intends to expand its production to take advantage of emerging economic activities in the new region.

On 1 January 2020, the company entered into a lease agreement for production equipment with a useful economic life of 8 years. The lease term is for four years, and Kundugu agrees to pay annual rent of GH¢50,000 commencing on 1 January 2020 and annually thereafter. The interest rate implicit in the lease is 7.5%, and the lessee’s incremental borrowing rate is 10%. The present value of lease payments not yet paid on 1 January 2020 is GH¢130,026. Kundugu paid legal fees of GH¢1,000 to set up the lease.

Required:
Prepare extracts for the Statement of Financial Position and Statement of Profit or Loss for 2020 and 2021, showing how Kundugu should account for this transaction. (6 marks)

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  • 7 Marks

FR – Nov 2019 – L2 – Q2c – Financial Reporting Standards and Their Applications

Calculation and accounting entries for lease under IFRS 16 in the financial statements of Asawase Ltd.

On 1 August 2018, Asawase Ltd entered into an agreement to acquire a motor vehicle. The terms of the agreement were that the vehicle would be leased for five years from the date of inception, subject to a deposit of GH¢19,972 and five annual payments of GH¢6,500 in advance, commencing on 1 August 2018. The fair value of the vehicle and the present value of the lease payments were GH¢48,000 at inception. The interest rate implicit in the lease is 8%.

Required:
In accordance with IFRS 16: Leases, show with appropriate calculations, the accounting entries required to record the transaction in the financial statements for the year ended 31 July 2019. (7 marks)

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  • 20 Marks

FR – Nov 2021 – L2 – Q3 – Preparation of Financial Statements

This question focuses on the preparation of a Statement of Profit or Loss and Other Comprehensive Income and a Statement of Financial Position for Neeta Ltd, incorporating revaluations, deferred tax, and lease accounting.

Neeta Ltd is a manufacturing company located in the Western Region. The trial balance of Neeta Ltd as at 31 March 2020 is as follows:

Trial Balance GH¢’000 GH¢’000
Revenue (Note i) 164,000
Production costs 90,000
Distribution costs 8,000
Administrative expenses 26,000
Inventory at 31 March 2019 19,710
Interest paid on interest-bearing borrowings 3,000
Income tax (Note iii) 100
Dividends paid on equity shares 5,000
Property, Plant and Equipment (PPE) (Note iv) 77,000
Provision for depreciation on PPE at 31 March 2019 22,610
Trade receivables 53,000
Cash and cash equivalents 33,000
Trade payables 12,000
Long term interest-bearing borrowings 50,000
Lease rentals (Note v) 20,000
Deferred tax (Note iii) 7,000
Share capital 50,000
Retained earnings at 31 March 2019 29,000
Totals 334,710 334,710

Additional information:

i) On 1 April 2019, Neeta Ltd sold goods to a customer for a price of GH¢12.1 million. The terms of the sale allowed the customer extended credit, and the price was payable by the customer in cash on 31 March 2021. Neeta Ltd included the GH¢12.1 million in revenue for the current year and the corresponding entry in trade receivables. A discount rate that is appropriate for the risks in this transaction is 10%.

ii) The carrying value of inventory at 31 March 2020 was GH¢25 million.

iii) The estimated income tax on the profits for the year to 31 March 2020 is GH¢1.5 million. During the year, GH¢1.3 million was paid in full as the final settlement of income tax on the profits for the year ended 31 March 2019. The statement of financial position as at 31 March 2019 had included GH¢1.4 million in respect of this liability.

As at 31 March 2020, the carrying amounts of the net assets of Neeta Ltd exceeded their tax base by GH¢28 million. This information is before taking account of the Property revaluation (see Note iv below). The rate of income tax is 30%.

iv) Details of Property, Plant and Equipment are as follows:

Component of PPE Cost (GH¢’000) Accumulated depreciation at 31 March 2019 (GH¢’000) Carrying Amount at 31 March 2019 (GH¢’000)
Land 22,000 0 22,000
Buildings 28,000 5,600 22,400
Plant and Equipment 27,000 17,010 9,990
Total 77,000 22,610 54,390

The estimated useful economic life (at the date of purchase) of PPE components are:

  • Land: Infinite life
  • Building: 50 years
  • Plant and Equipment: 4 years

On 1 April 2019, the property’s open market value was GH¢60 million, including GH¢32 million relating to the building. The directors wish to reflect this revaluation in the financial statements, but no entries regarding the revaluation have been made. The directors do not want to make an annual transfer of excess depreciation to retained earnings. The original estimate of the useful economic life of the building is still considered valid. No assets were fully depreciated at 31 March 2020. All the depreciation is to be charged to the cost of sales.

v) On 1 April 2019, Neeta Ltd leased a large group of machines used in the production process. The lease was for 4 years, and the annual rental (payable in advance) was GH¢20 million. The lessee has not elected to apply the recognition exemption under IFRS 16 leases. The interest rate implicit in the lease can be taken as 9% per year.

Required:

a) Prepare the Statement of Profit or Loss and Other Comprehensive Income for Neeta Ltd for the year ended 31 March 2020.
(10 marks)

b) Prepare the Statement of Financial Position for Neeta Ltd as at 31 March 2020.
(10 marks)

(Total: 20 marks)

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  • 6 Marks

FR – Nov 2016 – L2 – Q2a – Financial Reporting Standards and Their Applications

Prepare financial statement extracts showing how the lease transaction of Asokwa Ltd should be treated for the year ended 31 December 2014.

You are employed as the Financial Accountant for Asokwa Ltd. Asokwa Ltd leased a new piece of equipment from Amakom Ltd for three years commencing on 30 September 2014. The fair value of the equipment is GH¢70,000. A deposit of GH¢4,000 was payable on 30 September 2014 followed by six half-yearly payments of GH¢13,500, payable in arrears, and commencing on 31 March 2015. Asokwa Ltd allocates finance charges on a sum of the period digits basis.

Required:
Prepare financial statement extracts showing how the lease transaction of Asokwa Ltd should be treated for the year ended 31 December 2014.

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  • 10 Marks

CR – Nov 2023 – L3 – Q3a – IFRS 16: Leases

Financial reporting treatment for a lease agreement, including CPI-based increases and variable lease payments for Avoka Grains Plantation.

On 1 January 2022, Avoka Grains Plantation Plc (Avoka) acquired a combined harvester from Awulley Farm Technologies for a lease term of 5 years with instalments payable annually in advance. The useful life of the harvester was estimated at 5 years. Avoka paid the first instalment of GH¢60 million on 1 January 2022.

However, subsequent lease payments are subject to increase/decrease in line with the consumer price index (CPI). At the lease inception, Avoka estimated that CPI would increase by 10% annually. However, CPI increased by 14% in 2022, and consequently GH¢68.4 million was paid on 1 January 2023 as the second instalment. At 31 December 2022, Avoka estimated that the annual increase in CPI would continue to be 14% in future years.

Avoka is also required to pay a usage fee of GH¢0.3 per acre of harvest in excess of 30 million units per annum from the machine. At the lease inception, Avoka planned to use the harvester to achieve 40 million acres of harvest each year during the lease term. During 2022, Avoka harvested 40 million acres of grains and accordingly, an amount of GH¢3 million was also paid along with the second instalment. Avoka’s incremental borrowing rate is 11% per annum.

Required:
Advise Avoka Plc on the financial reporting treatment for the above in the financial statements for the year ended 31 December 2022.
(10 marks)

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  • 20 Marks

AAA – May 2022 – L3 – Q2 – Assurance Engagements

Discuss due diligence processes and provide IFRS 16 guidance on lease recognition, measurement, and disclosure.

Pegrace Nigeria Limited (PNL), your audit client, is a national hotel group with substantial cash resources. Its accounting functions are well managed and the group’s accounting policies are rigorously applied. The company’s financial year-end is December 31.

The company has been seeking to acquire a construction company for some time in order to bring in-house the building and refurbishment of hotels and related leisure facilities, like swimming pools, volleyball courts, and restaurants. The management has recently identified Robin Construction Company Limited (RCCL) as a potential target and has urgently requested that you undertake a limited due diligence review.

Further to the preliminary talks between the management of RCCL and PNL, you were provided with the following brief on Robin Construction Company Limited:

  1. The Chief Executive, Managing Director, and Finance Director are all family members and major shareholders. The company has an established reputation for quality constructions.
  2. Due to a recession in the building business, the company has been operating at its overdraft limit for the last 18 months and has been close to breaching debt obligations on several occasions.
  3. Robin’s accounting policies are generally less prudent than those of Pegrace (assets are depreciated over longer estimated useful lives).
  4. Contract revenue is recognized on the percentage of completion method, measured by reference to costs incurred to date. Provisions are made for loss-making contracts.
  5. The company’s management team includes a qualified and experienced quantity surveyor, whose main responsibilities are:
    • Supervising quarterly physical counts at major construction sites;
    • Comparing costs to date against quarterly rolling budgets; and
    • Determining profits or losses, by contract, at each financial year-end.
  6. Labour force is provided under subcontracts. During construction, the regulatory body visited the site and discovered non-compliance with site health and safety regulations.

In February 2021, Robin received a claim that a site on which it built a housing development in Banana Estate was not properly drained and is now sinking. Residents are demanding rectification and asking for payment or damages. Robin has referred the matter to its legal counsel and denied all liability, as the site preparation was subcontracted to Sahara Services Company Limited. No provisions have been made in respect of the claims, nor has any disclosure been made.

The auditor’s report on Robin’s financial statements for the year ended December 31, 2020, was signed, without modification, in March 2021.

Required:

a. Prepare a document to give the explanatory meaning of the term ‘due diligence’ and subsequently discuss items to investigate in a due diligence exercise. (12 Marks)

b. Advise on how to recognize, measure, present, and disclose leases as required by IFRS 16. (8 Marks)

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  • 20 Marks

CR – Nov 2020 – L3 – Q5 – Leases (IFRS 16)

Discuss lease classification, loan liability derecognition under IFRS 9, and tax offsetting rules under IAS 12.

Muzana Limited owns tractors used for farming purposes and sometimes enters into lease arrangements with other agricultural companies. A particular tractor when leased out by Muzana is for 8 years. The useful economic life of each tractor is estimated at 10 years while the fair value of each tractor is estimated at N26 million. The present value of minimum lease payments in the lease arrangement is N28 million. Lease payments are made to Muzana by the lessee on a monthly basis and has a purchase option at the end of the lease term to acquire the machine for N2.2 million. A similar fairly used machine in the market will cost the buyer N2.5 million. Following the transition to IFRS 16, the management of Muzana have classified this lease as an operating lease in its year-end financial statements.

In order to expand its operations, Muzana accessed the Agricultural Loan Credit Programme set up by the government of Nigeria. In the year 2016, Muzana was granted a 5-year interest free loan of N100 million. At year end September 30, 2019, Muzana had been able to set aside N100 million in a special trust to be used for no other purpose than to pay off the loan in full on its due date in 2020. The management of Muzana are currently preparing their year-end 2019 financial statements and have derecognised the loan liability due to the fact that funds have been set aside in full to satisfy the loan payment in 2020.

Muzana Limited have just concluded a meeting with its tax consultant. The amounts due to the state tax authorities in the current year is N2.3 million. Muzana also has a tax credit of N1.8 million due from the Federal government in the current year. The tax consultant has advised Muzana that these amounts can be offset in their year-end financial statements to show only a tax liability of N500,000.

Required: a. Explain how the lease arrangement should be classified in Muzana‘s 2018 year-end financial statements? (7 Marks) b. Advise the management of Muzana, based on IFRS 9 derecognition rules, if the loan liability can be recognised in their year-end September 30, 2019 financial statements. (7 Marks) c. Explain if the advise provided by the tax consultant is consistent with the offsetting rules under IAS 12 Income Taxes? (6 Marks)

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  • 7 Marks

FR – NOV 2016 – L2 – Q6a – Leases (IFRS 16)

Question tests understanding of the two types of leases under IAS 17 and their key differences.

Identify the TWO kinds of leases stipulated in IAS 17 and compare in tabular form with at least FIVE differences.

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  • 6 Marks

FR – April 2022 – L2 – Q2b – Financial Reporting Standards and Their Applications

Prepare extracts for the Statement of Financial Position and Statement of Profit or Loss for Kundugu Ltd in 2020 and 2021, accounting for a lease agreement under IFRS 16.

b) Kundugu Ltd (Kundugu) is a manufacturing company located in the Savannah Region. The reporting date of Kundugu is 31 December, and the company reports under International Financial Reporting Standards (IFRSs). Kundugu intends to expand its production to take advantage of emerging economic activities in the new region.

On 1 January 2020, the company entered into a lease agreement for production equipment with a useful economic life of 8 years. The lease term is for four years, and Kundugu agrees to pay annual rent of GH¢50,000 commencing on 1 January 2020 and annually thereafter. The interest rate implicit in the lease is 7.5%, and the lessee’s incremental borrowing rate is 10%. The present value of lease payments not yet paid on 1 January 2020 is GH¢130,026. Kundugu paid legal fees of GH¢1,000 to set up the lease.

Required:
Prepare extracts for the Statement of Financial Position and Statement of Profit or Loss for 2020 and 2021, showing how Kundugu should account for this transaction. (6 marks)

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  • 7 Marks

FR – Nov 2019 – L2 – Q2c – Financial Reporting Standards and Their Applications

Calculation and accounting entries for lease under IFRS 16 in the financial statements of Asawase Ltd.

On 1 August 2018, Asawase Ltd entered into an agreement to acquire a motor vehicle. The terms of the agreement were that the vehicle would be leased for five years from the date of inception, subject to a deposit of GH¢19,972 and five annual payments of GH¢6,500 in advance, commencing on 1 August 2018. The fair value of the vehicle and the present value of the lease payments were GH¢48,000 at inception. The interest rate implicit in the lease is 8%.

Required:
In accordance with IFRS 16: Leases, show with appropriate calculations, the accounting entries required to record the transaction in the financial statements for the year ended 31 July 2019. (7 marks)

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  • 20 Marks

FR – Nov 2021 – L2 – Q3 – Preparation of Financial Statements

This question focuses on the preparation of a Statement of Profit or Loss and Other Comprehensive Income and a Statement of Financial Position for Neeta Ltd, incorporating revaluations, deferred tax, and lease accounting.

Neeta Ltd is a manufacturing company located in the Western Region. The trial balance of Neeta Ltd as at 31 March 2020 is as follows:

Trial Balance GH¢’000 GH¢’000
Revenue (Note i) 164,000
Production costs 90,000
Distribution costs 8,000
Administrative expenses 26,000
Inventory at 31 March 2019 19,710
Interest paid on interest-bearing borrowings 3,000
Income tax (Note iii) 100
Dividends paid on equity shares 5,000
Property, Plant and Equipment (PPE) (Note iv) 77,000
Provision for depreciation on PPE at 31 March 2019 22,610
Trade receivables 53,000
Cash and cash equivalents 33,000
Trade payables 12,000
Long term interest-bearing borrowings 50,000
Lease rentals (Note v) 20,000
Deferred tax (Note iii) 7,000
Share capital 50,000
Retained earnings at 31 March 2019 29,000
Totals 334,710 334,710

Additional information:

i) On 1 April 2019, Neeta Ltd sold goods to a customer for a price of GH¢12.1 million. The terms of the sale allowed the customer extended credit, and the price was payable by the customer in cash on 31 March 2021. Neeta Ltd included the GH¢12.1 million in revenue for the current year and the corresponding entry in trade receivables. A discount rate that is appropriate for the risks in this transaction is 10%.

ii) The carrying value of inventory at 31 March 2020 was GH¢25 million.

iii) The estimated income tax on the profits for the year to 31 March 2020 is GH¢1.5 million. During the year, GH¢1.3 million was paid in full as the final settlement of income tax on the profits for the year ended 31 March 2019. The statement of financial position as at 31 March 2019 had included GH¢1.4 million in respect of this liability.

As at 31 March 2020, the carrying amounts of the net assets of Neeta Ltd exceeded their tax base by GH¢28 million. This information is before taking account of the Property revaluation (see Note iv below). The rate of income tax is 30%.

iv) Details of Property, Plant and Equipment are as follows:

Component of PPE Cost (GH¢’000) Accumulated depreciation at 31 March 2019 (GH¢’000) Carrying Amount at 31 March 2019 (GH¢’000)
Land 22,000 0 22,000
Buildings 28,000 5,600 22,400
Plant and Equipment 27,000 17,010 9,990
Total 77,000 22,610 54,390

The estimated useful economic life (at the date of purchase) of PPE components are:

  • Land: Infinite life
  • Building: 50 years
  • Plant and Equipment: 4 years

On 1 April 2019, the property’s open market value was GH¢60 million, including GH¢32 million relating to the building. The directors wish to reflect this revaluation in the financial statements, but no entries regarding the revaluation have been made. The directors do not want to make an annual transfer of excess depreciation to retained earnings. The original estimate of the useful economic life of the building is still considered valid. No assets were fully depreciated at 31 March 2020. All the depreciation is to be charged to the cost of sales.

v) On 1 April 2019, Neeta Ltd leased a large group of machines used in the production process. The lease was for 4 years, and the annual rental (payable in advance) was GH¢20 million. The lessee has not elected to apply the recognition exemption under IFRS 16 leases. The interest rate implicit in the lease can be taken as 9% per year.

Required:

a) Prepare the Statement of Profit or Loss and Other Comprehensive Income for Neeta Ltd for the year ended 31 March 2020.
(10 marks)

b) Prepare the Statement of Financial Position for Neeta Ltd as at 31 March 2020.
(10 marks)

(Total: 20 marks)

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  • 6 Marks

FR – Nov 2016 – L2 – Q2a – Financial Reporting Standards and Their Applications

Prepare financial statement extracts showing how the lease transaction of Asokwa Ltd should be treated for the year ended 31 December 2014.

You are employed as the Financial Accountant for Asokwa Ltd. Asokwa Ltd leased a new piece of equipment from Amakom Ltd for three years commencing on 30 September 2014. The fair value of the equipment is GH¢70,000. A deposit of GH¢4,000 was payable on 30 September 2014 followed by six half-yearly payments of GH¢13,500, payable in arrears, and commencing on 31 March 2015. Asokwa Ltd allocates finance charges on a sum of the period digits basis.

Required:
Prepare financial statement extracts showing how the lease transaction of Asokwa Ltd should be treated for the year ended 31 December 2014.

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  • 10 Marks

CR – Nov 2023 – L3 – Q3a – IFRS 16: Leases

Financial reporting treatment for a lease agreement, including CPI-based increases and variable lease payments for Avoka Grains Plantation.

On 1 January 2022, Avoka Grains Plantation Plc (Avoka) acquired a combined harvester from Awulley Farm Technologies for a lease term of 5 years with instalments payable annually in advance. The useful life of the harvester was estimated at 5 years. Avoka paid the first instalment of GH¢60 million on 1 January 2022.

However, subsequent lease payments are subject to increase/decrease in line with the consumer price index (CPI). At the lease inception, Avoka estimated that CPI would increase by 10% annually. However, CPI increased by 14% in 2022, and consequently GH¢68.4 million was paid on 1 January 2023 as the second instalment. At 31 December 2022, Avoka estimated that the annual increase in CPI would continue to be 14% in future years.

Avoka is also required to pay a usage fee of GH¢0.3 per acre of harvest in excess of 30 million units per annum from the machine. At the lease inception, Avoka planned to use the harvester to achieve 40 million acres of harvest each year during the lease term. During 2022, Avoka harvested 40 million acres of grains and accordingly, an amount of GH¢3 million was also paid along with the second instalment. Avoka’s incremental borrowing rate is 11% per annum.

Required:
Advise Avoka Plc on the financial reporting treatment for the above in the financial statements for the year ended 31 December 2022.
(10 marks)

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