Financial Accounting

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Question 3

Olive Ltd entered into a non-cancellable three-year lease agreement with Yew Bank plc on 1st January 2013. The lease is for an item of machinery that, at the inception of the lease, has a fair value of £829,000. The machinery is expected to have an economic life of four years, after which time it will be worthless.

There are three annual payments of £325,000, payable on 31st December. The first payment was made on 31st December 2013. Included in the £325,000 is an amount of £25,000 which covers insurance and maintenance of the machinery.

There is an option that Olive Ltd will be able to exercise at the end of the third year, wherein Olive can make a one-off payment of £100,000 to rent the machine for 2016 followed by ‘peppercorn’ rents of 1p per year for twenty years or until the machine is scrapped. The option does not provide insurance or maintenance.

Required:

- Assuming that there is a 100% probability that the directors will exercise the option, determine the present value of the minimum lease payments given an implicit rate of interest of 10 per cent and discuss if the lease should be treated as a finance lease. (5 marks)

- Discuss how the directors of Olive Ltd could argue that the lease is an operating lease.(3 marks)

- Assuming that the lease is an operating lease, show how the directors will account for and disclose the payments. (3 marks)

- Assuming that the lease is a finance lease and the option is exercised, show how Olive would account for the lease for the four years to 31st December 2016. The machinery is to be depreciated on a straight line basis. (10 marks)

- Show how Olive would account for the lease for the year to 31st December 2013assuming that IAS17 is reissued using the ‘right of use’ approach. Assume that that there is a 40% chance that the directors will exercise the option. (6 marks)

- Discuss whether IAS17 Leases should be based on the ‘right to use’ approach.(6 marks)

(Total 33 marks)

Question 4

Cheesewater plc has the following draft income statement for the year to 31st December 2013:

[pic 4]

Additional Information.

- On 1st January 2013 there were 4million fully paid up ordinary shares of 25p each and 250,000 10% cumulative preference shares of £1 each.

- On the 1st January 2013 there were 5,000 £100 convertible bonds in issue. Interest of 7% is payable in two equal semi-annual payments. Holders of the convertible bonds can exchange each £100 bond for 200 ordinary shares. On 1st July 2013 1,000 bond holders converted.

- Finance charges shown in the income statement represent bond interest and preference share dividends.

- On 1st April 2013 there was a rights issue of one new share for every four held. 1million new shares were issued raising £1.5million. On 31st March 2013 Cheesewater shares were trading at £2 each.

- On 1st October 2013 there was a 1 for 3 bonus issue. All shares in issue at the time were eligible for this bonus.

- Company Income tax is charged at 28%.

- The basic published earnings per share figure for 2012 was 4p.

Required:

- Calculate the earnings per share for 2013 (12 marks)

- Calculate the 2012 earnings per share figure that would be shown in the 2013 financial statements (3 marks)

- Calculate the fully diluted earnings per share for 2013 (10 marks)

- Discuss the importance of the earnings per share figure for equity valuation (8 marks)

(Total 33marks)

SectionB – Answer ONE of the three questions in this section

Question 5

How useful is an ‘information system’ approach when setting financial accounting standards?

(34 marks)

Question 6

Discuss the significance of the efficient markets hypothesis to your understanding of financial reporting.

(34 marks)

Question 7

Compare and contrast IAS earnings and Economic Value Added and discuss the empirical evidence on the relative information content of these measures of performance. (34 marks)

DB

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