DEPARTMENT OF ACCOUNTING

FINANCIAL ACCOUNTING 311

ASSESSMENT 3 ** 18 June 2020

MARKS: 53 ** TIME: 95 minutes

Internal examiners:
HC Verster / M Pollock / S Aboo Baker Ebrahim / J Sturdy

External examiner:
J wa Kalonji

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Question Topic Marks

1 Property, plant and equipment, investment
property, intangible assets, income taxes
and impairment loss 32
2 Lessees 21
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QUESTION 1 (32 marks, 58 minutes)

Ri-lax Limited operates in the leisure and tourism industry. Ri-lax Limited is a
South African company with a February year-end. It has two significant assets, namely
an office building in Pretoria and the Lalamove luxury train. The following information
is available for the year ended 29 February 2020:

1. Accounting policies

1.1 Owner-occupied land is accounted for in accordance with the revaluation model.
Revaluations are performed every two years by an independent sworn valuer.
Any revaluation surplus realises on the sale of the asset.

1.2 Investment property is accounted for in accordance with the fair value model.

1.3 All other property, plant and equipment are accounted for in accordance with
the cost model and are depreciated on a straight-line basis over their estimated
useful lives. Owner occupied land and buildings are disclosed as separate
classes of assets.

1.4 All intangible assets are accounted for in accordance with the cost model and
are amortised on a straight-line basis over their estimated useful lives.

1.5 Deferred tax is recognised for all temporary differences using the statement of
financial position method and is based on the tax rates that have been enacted
or substantially enacted by the reporting date.

2. Pretoria land and commercial building

Ri-lax Limited owns a small commercial building in Pretoria, from which they
operate. The land was revalued for the first time on 28 February 2019.

Ri-lax Limited decided to move its offices to the new Waterfall Office Park in
Midrand. On 1 November 2019, Ri-lax Limited moved into their new office
building in Midrand. Ri-lax Limited held the Pretoria building for capital
appreciation purposes from 1 November 2019. The following information
regarding the Pretoria office is available:
Land Building
R R
Purchase price (1 March 2017) 1 500 000 1 900 000
Fair value (28 February 2019) 1 530 000 2 200 000
Fair value (1 November 2019) 1 525 000 2 150 000
Fair value (28 February 2020) 1 550 000 2 160 000
Tax building deduction (no apportionment) - 20 years

The useful life of the Pretoria commercial building is 20 years and the residual
value is estimated at R300 000. The commercial building was available for use
as intended by management on 1 March 2017.
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3. Lalamove luxury train

Lalamove is a luxury train operated by Ri-lax Limited, running routes between

Cape Town, Johannesburg and Victoria Falls. Historically, approximately 60%
of Lalamove Limited’s passengers have been non-South African residents.
However, the number of non-resident passengers have steadily declined. This
decline has not been compensated for by an increase in the number of South
African resident passengers.

Ri-lax Limited acquired the train on 1 March 2013 from the manufacturer at a
cost of R62 million. The train had an estimated useful life of ten years, after
which Ri-lax Limited expects to purchase a new train. At initial recognition, Ri-
lax Limited estimated the residual value of the train to be R12 million. The
estimated residual value remained unchanged for all previous financial years,
but the residual value estimate still needs to be revised on 29 February 2020.
The company still intends to sell the train on 28 February 2023. The costs of
selling the second-hand trains are negligible.

The carrying amount of the train has not been reduced for any amounts other
than the annual depreciation charge, which is calculated at the end of each
financial year.

Prior to finalising the financial statements of the company for the year ended
29 February 2020, executive management had to present budgets for the next
three financial years to the board of directors of Ri-lax Limited. Assume the cash
flows are at the end of each year and a discount rate of 15% per annum (before
tax) is deemed appropriate.

The following budgets were approved by the Board for the Lalamove operation:

Year to
29 Feb 28 Feb 28 Feb 28 Feb
2020 2021 2022 2023
Actual Budgeted Budgeted Budgeted
R’000 R’000 R’000 R’000

Cash revenue 15 000 14 800 15 500 20 400

Cash operating costs (11 000) (10 800) (8 500) (10 200)
Net cash in/(out)flow 4 000 4 000 7 000 10 200
Finance cost (5 000) (5 000) (5 000) (5 000)
Pre-tax (loss)/profit (1 000) (1 000) 2 000 5 200

The above budget does not include the sale of the train on 28 February 2023.
Assume the present value on 29 February 2020 of the cash flow upon disposal
of a ten-year-old train is R14 000 000.

4. Raising the Ri-lax brand

Ri-lax Limited legally registered the Ri-lax brand about ten years ago. The brand
includes various products, including the luxury train and other related leisure
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products. Even though the popularity of the Lalamove luxury train has declined
the popularity other leisure products they offer have increased significantly and
exceeded the company’s wildest expectations.

In order to establish a fair value for the Ri-lax brand, the expertise of Bestguess
Inc, the internationally renowned London-based intangible asset valuators, was
employed. The current fair value of the brand will support the fact that it is
probable that future economic benefits will flow to Ri-lax Limited.

Bestguess Inc valued the Ri-lax brand at R23 million. Ri-lax Limited included
the Ri-lax brand at R23 million in Ri-lax Limited’s statement of financial position
as at 29 February 2020, with a corresponding (R23 million) increase in profits
from operations for the year ended 29 February 2020.

5. Additional information

5.1 Assume a corporate tax rate of 28% and that 80% of capital gains are taxable.

5.2 Ignore Value Added Tax (VAT).

5.3 Assume that all amounts are material.

REQUIRED:

Answer the following questions in terms of International Financial Reporting

Standards (IFRS):

a. Journalise only the land (refer to point 2) in Pretoria (including the deferred tax
movements), in the accounting records of Ri-lax Limited for the year ended
29 February 2020. (10½)

NOTE: - Journal narrations are not required.

- Round all calculated amounts to the nearest Rand.
- Show all your calculations.
- Show each deferred tax movement in a separate journal entry.

b. Calculate the deferred tax balance only for the building in Pretoria (refer to
point 2) on 29 February 2020. Clearly indicate if it is a deferred tax asset or
liability. (5½)

NOTE: - Round all calculated amounts to the nearest Rand.

- Show all your calculations.
- Ignore the tax implications of land.

TURNOVER THE PAGE FOR THE REST OF THE REQUIRED PART

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c. Calculate the impairment loss of the Lalamove luxury train (refer to point 3) on
29 February 2020. (10)

NOTE: - Round all calculated amounts to the nearest Rand.

- Show all your calculations.
- Assume the recoverable amount is the value in use.

d. Discuss whether or not the accounting treatment of the Ri-lax brand (refer to
point 4) adopted by Ri-lax Limited is in accordance with International Financial
Reporting Standards (IFRS). Your discussion should refer to the definition and
recognition criteria of an intangible asset in terms of IAS 38, Intangible Assets.
(6)

QUESTION 2 (21 marks, 38 minutes)

Nako Limited manufactures machinery. The company is listed on the JSE Limited and
has a 30 June reporting date.

1. Lease of plant

On 1 July 2016, the commencement date, Nako Limited commenced leasing a

plant from African Rentals Limited in terms of a lease contract for a non-cancellable
period of five years. The contract is a lease in terms of IFRS 16, Leases. The plant
was available for use as intended by management in Nako Limited’s manufacturing
process on 1 July 2016. The lease contract does not make provision for a
purchase option.

The fair value of the plant at the commencement of the lease was R173 850. The
lease payment of R37 500 is payable annually in arrears with the first instalment
payable on 30 June 2017.

Nako Limited and African Rentals Limited agreed, at commencement date, that
the residual value guarantee of the plant is R50 000. If the fair value of the plant at
the end of the lease term is less than R50 000, Nako Limited will be expected to
pay an amount equal to the difference between R50 000 and the fair value of the
plant to African Rentals Limited.

At commencement date, the estimated fair value of the plant at the end of the lease
term amounted to R57 500.

On 1 July 2016, Nako Limited paid a deposit of R51 846 to secure the lease. On
1 July 2016, Nako Limited also paid R5 000 to their externally appointed legal
advisors for the preparation of the lease contract. African Rentals Limited agreed
to partially reimburse Nako Limited for these costs incurred, as a lease incentive,
and paid a total amount of R4 000 to Nako Limited on 1 July 2016.

There were no changes in the residual value and useful life of the plant. There was
also no indication of impairment of the plant.
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Nako Limited has knowledge of all of the information provided above and correctly
calculated an interest rate implicit in the lease of 10% per annum.

Right-of-use assets related to plant are accounted for in accordance with the cost
model of IAS 16, Property, Plant and Equipment. Depreciation on plant is written
off on the straight-line basis over the estimated useful life of eight years.

2. Lease of office furniture

On 1 July 2016 (commencement date), Nako Limited also entered into a non-
cancellable lease agreement to lease office furniture (low value assets) from Global
Limited for a non-cancellable period of five years. The contract is a lease in terms
of IFRS 16, Leases.

There is an option to extend the lease for a further two years (i.e. to a total of seven
years). At the commencement of the lease, Nako Limited did not have a significant
economic incentive to extend the lease and there is still uncertainty if Nako Limited
will exercise this option to extend the lease agreement for the additional two-year
period. The benefit of the office furniture to Nako Limited remained unchanged
throughout the lease term.
The lease payments are payable annually in arrears with the first instalment payable
on 30 June 2017:
• Years 1 – 3: R60 000 per year
• Years 4 – 5: R36 000 per year
• Years 6 – 7 (extended): R24 000 per year

10% of each monthly instalment is allocated to cover maintenance costs incurred

and paid for by the lessor. This amount is in line with the cost for similar maintenance
services rendered by third parties.
Nako Limited elected to apply the recognition exemption (simplified accounting
method) in respect of low value assets to this lease contract.

Nako Limited accounts for the lease and non-lease components separately.

3. Additional information

Assume that all amounts payable and receivable have been paid and received
timeously.

REQUIRED:

Journalise the above transactions (including cash transactions) of Nako Limited for the
year ended 30 June 2017 in accordance with International Financial Reporting
Standards (IFRS).
NOTE: - Journal narrations are not required, but journals must be dated.
- Journal entries in respect of tax implications are not required.
- Round all calculated amounts to the nearest R1 and all percentages to
the nearest full percentage.
- Show all your calculations.