Solution
Robert answered on
Dec 23 2021
1
Q1 a) The lease can be characterized as financial lease because it satisfies the most
important condition for the this, that the risks and rewards for the lease object will be
transfe
ed to the lessee after the expiry of the lease term. The lessee takes care of the
maintenance of the object and uses the object for its entire useful life. Therefore, the
The lessee, during the lease term, has the right to use the object being lease object, in
an unhindered way during the period of the financial lease contract holds valid, to
derive benefits from the object, as well as to bear all the risks and costs that could
arise from the ownership right, although he/she is not the owner of the object in the
formal and legal sense.
) Total finance charge = (30,000*4) - 95,100
= 24,900
Total
cost EMI Interest Principal
Principal
outstanding
95,100
30,000
9,510
20,490
74,610
74,610
30,000
7,461
22,539
52,071
52,071
30,000
5,207
24,793
27,278
27,278
30,000
2,728
27,272
-
Depreciation Schedule
Year Value Depreciation
Net book
value
1 95,100 19,020 76,080
2 76,080 19,020 57,060
3 57,060 19,020 38,040
4 38,040 19,020 19,020
5 19,020 19,020 0
The value in the fifth year is 19,020. And after 5 years it becomes zero.
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c) In the income statement, depreciation as well as interest expenses will be recorded
as follows. Since we don not have tax rate we assume zero tax.
Year Depreciation Interest Tax charges
After - tax
expenses
1
19,020
9,510
-
28,530
2
19,020
7,461
-
26,481
3
19,020
5,207
-
24,227
4
19,020
2,728
-
21,748
5
19,020
-
-
19,020
In the balance sheet the asset value will be recorded net of depreciation and a
co
esponding amount of debt will be recorded as liability. This will be reduced
according to the principal amount repaid every year.
Year Net book value
1 76,080
2 57,060
3 38,040
4 19,020
5 0
d) The concept of “substance over form” in lease accounting concept means that themore
important aspect of transactions is their economic substance rather than simply their
legal form. It is important from the perspective of true and fair presentation of the
company affairs.
Year Liabilities
1 74,610
2 52,071
3 27,278
4 0
5
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This concept encourages the using judgment to prepare the financial statements so
that all the transactions and events that happen can be related to by the investors. They
should make sense and should be presented in a way that accurately reflects their true
purpose and essence. It does not intend to undermine the legal aspects of transactions
and events but the makers of financial statements need a lot of understanding to
choose information that is more useful and relevant information to the users of
financial statement and discard the one that is less impactful.
Various accounting standards use this concept. For instance IAS 17 which is about
Leases and the related transactions mandated the preparers of financial statements to
give priority to the substance of lease contracts and transactions when assessing the
a
angements to identify the type of lease for the purpose of accounting.
In IAS 18, which talks about Revenue measurement and recognition, it is expected
that the accountants consider the economic rationale of the sale agreements in
determining if the sale occu
ed or not. For instance, when an entity plans to sell its
inventory and the buy back the same after a period of time at a higher price, which is
to compensate for the time value of money; this may be recorded as two separate
transactions on paper. So sale is one and buy back is another, though the object being
exchanged is same. So in economic terms, no sale has occu
ed. In essence, it can be
seen as a financing deal, in which the seller get loan in place of inventory and repaired
it with interest. Here, inventory can be considered a collateral.
Therefore the concept of “Substance over legal form” is critical in terms of faithful
epresentation of information and adds to reliability of financial statements. The
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preparers of the financial statements are given the responsibility to judge as to what is
the economic rationale and hence the reality of transactions and events which are to
e recorded in the financial statements.
Q2. a) Liquidity ratio is a group of financial metrics which is used in determining a
company's capability of paying off the short-terms obligations it has. The greater the
value of this ratio, the greater is the margin of safety of the company to meet its short-
term debt obligations. Generally, cu
ent ratio of around 2 is considered an indicator
of good liquidity. The liquidity position of X is good considering it is at the expected
level. However, for the company Y, it trails behind X. Though it is not low as a
whole, but in comparison to X it is weak. The acid ratio is also higher for X when
compared to Y. This ratio tells about the company‟s short term investments and cash
position, leaving out the inventories from cu
ent assets. Excess cash could be an
indication of lesser investment, although it does add to liquidity. The trade-off
etween the two has to be decided by the management.
Based on these parameters, it can be said that X has a better liquidity position than Y.
Long term debt paying ratios help in giving a general idea of the debt load a company
has. Also, it gives an idea about the equity and debt mix in the capital structure of a
company. Debt ratios are useful in determining the level of financial...