NANYANG TECHNOLOGICAL UNIVERSITY

NANYANG BUSINESS SCHOOL

AC1104 - ACCOUNTING II
Semester 2, 2023/2024

Seminar 9: (1) Debt Financing; and

(2) Events after the Reporting Period

A) Pre-seminar preparation

a) Required reading: refer to course outline

b) Be prepared for the discussion questions

B) Self study

a) Illustration 1

b) NCKL illustrations 1 to 13, plus case study (pages 539 to 549), and illustrations
1 to 2 (pages 157 to 158)

C) Discussion questions

Q1 SI & Q5 ChocoLand

AC1104 S9 - 1
Illustration 1 (K-Five)

K-Five Company sells and installs home security systems. It also provides a 24-hour
monitoring service for a fee and guarantees a response time of within 10 minutes of the alarm
sounding. K-Five closes its accounts annually on 31 December.

A Purchase Contract

On 1 January 2009, K-Five signed a non-cancellable 3-year purchase contract with Alarm-S
Company, a renowned manufacturer of home alarm systems, which requires all of its retailers
to enter into 3-year contracts. The contract requires K-Five to purchase at least 500 sets of
Model #300 home alarm systems at $600 per set during each of the first two years and 1,000
sets at $500 per set during the third year of the contract. Assume all the alarm sets were
delivered to K-Five at the end of the financial year, with terms Cash on Delivery (COD).

During the years 2009 and 2010, Alarm-S faced intense market competition (from other
manufacturers) and at the same time managed to achieve significant economies of scale. In
November 2010, Alarm-S announced that, from January 2011, new 3-year contracts entered
into for Model #300 home alarm systems will be priced at $450 per set. K-Five anticipates that
it may have to reduce its prices accordingly to remain competitive.

An Unfortunate Incident

During 2010, only one instance occurred in which K-Five failed to respond to an alarm within
their guaranteed 10-minute. Unfortunately, this incident occurred at the home of an elderly
couple and resulted in the husband, Mr Soo, suffering a severe heart attack which required a
month’s hospitalization.

Mr Soo has since filed a suit for recovery of medical expenses incurred ($60,000), loss of
jewellery ($50,000), and pain and suffering endured ($190,000).

A confidential note from K-Five’s legal counsel, Mr Law, advises the following course of
action:

Make an offer to pay the medical expenses in full and 20% of the indicated value of the
jewellery. (When pressed for further details, Mr Law thinks that there is 30% chance of Mr
Soo accepting this offer.)

Should the above offer be rejected, K-Five is to challenge the legal suit in a court of law which
will be heard sometime in late 2011. When this happens, it is anticipated that the judgment
could be against K-Five, and the amount awarded is likely (95% probability) to be in the region
of $100,000, with a slim chance (5% probability) of full payment as per Mr Soo’s claims.

AC1104 S9 - 2
Additionally, K-Five has an insurance coverage under Insure Company, but the maximum
payout is limited to $80,000 per client suit. Insure’s payment policy is to reimburse K-Five
upon presentation of relevant receipts.

Required

The managing director of K-Five Company is a certified public accountant but has not been
keeping up with the recent developments in financial reporting due to his heavy work load. He
has expressed that all explanations and advice, in relation to the requests below, be supported
by conceptual reasoning and authoritative references to the Financial Reporting Standards
(International) issued by Accounting Standards Council Singapore (ASC).

a) With regard to the purchase commitment, explain whether K-Five Company has a
liability (state the amount, if applicable) for the financial years ended 31 December 2009
and 31 December 2010.

b) Advise K-Five Company on the accounting treatment for the legal suit for the financial
year ended 31 December 2010, and show the journal entries (if any) with supporting
computations.

c) If just prior to the date the 2010 financial statements are authorised for issue you are told
that Mr Soo has accepted the offer, and payment will be made much later, explain how
this additional information will affect your answer to part (b) above.

Illustration 2 (Qiji)

Qiji Pte Ltd’s (Qiji) 2023 December year-end financial statements were authorised for issue on
1 March 2024. Towards the end of February 2024, the Director of Qiji discovered that one of
the managers had misappropriated cash of $15 million, which represents a material amount of
the company’s assets. Further investigation indicates that the money was stolen in December
2023

Determine the accounting issue and discuss any necessary adjustment is required in 2023.

AC1104 S9 - 3
Suggested solution to illustration 1 (K-Five)

(a)
- On the day of signing contract and at the end of financial year 2009: No JE.

- FY 31/12/2010
DR Loss on purchase commitment $50,000
CR Provision for loss on purchase commitment $50,000
(Being recognising a liability for an onerous contract in 2010)

- When K-Five receives the Alarm in 2011:

DR Inventory $450,000
DR Provision for loss on purchase commitment $50,000
CR Cash $500,000

(b)

DR Legal suit expense $98,000

CR Provision for legal suit $98,000
(Being recognising a liability for the legal suit)

DR Reimbursement receivable $80,000

CR Legal suit expense $80,000
(Being reimbursement due from Insure Company)

(c)

DR Provision for legal suit $28,000

CR Reimbursement receivable $10,000
CR Legal suit expense $18,000
(Being adjusting for excess provision for legal suit & reimbursable amount)

Suggested solution to illustration 2 (Qiji)

The company's director discovered the misappropriation of cash in February 2024, which was
after the financial year-end but before the 2023 financial statements were authorised for issue.
This situation involves events that occurred after the reporting period as stated in SFRS(I) 1-10.
The misappropriation of cash is considered an adjusting event as it happened before the end of
the financial year in 2023. This means that the asset value was overstated by $15 million at the
end of the financial year 2023. As this amount is material, Qiji must make an adjustment to its
2023 financial statements by recognising a cash loss.

AC1104 S9 - 4
Question 1 (SI)

Stark Industries Ltd (SI) is in the business of producing and selling fitness products and
equipment. Its financial year end date is 31 of December. In the financial year 2015, SI was
involved in the following lawsuits:

Case A: In early December 2015, SI was sued by a customer, Dr. Bruce Banner as a result of
an unintended effect of one of its products named Hulk, a type of fitness supplement that was
meant to enhance the growth of the muscles. Dr. Banner claimed that after taking Hulk, his skin
had gradually turned into a strange shade of green. He asked for a compensation of $500,000
plus any legal fees incurred. Mr. Tony Stark, CEO of SI, consulted with his attorney, Ms.
Pepper Potts and estimated that there was a 20% probability that Dr. Banner would accept a
settlement offer of $200,000. If Dr. Banner declined the settlement offer, then there was a 10%
probability that SI would have to pay the amount required by Dr. Banner plus any legal fees
incurred, an 80% probability that they would pay $250,000 plus legal fees incurred, and a 10%
probability that they would pay $100,000 plus legal fees. The legal fees that Dr. Banner had
incurred were $50,000. SI had an insurance policy against customer lawsuits. Ms. Potts
estimated that for this case, there was a 70% chance that the insurance company would agree to
reimburse the compensation paid by SI, and a 30% chance that the company would decline any
reimbursement claim. As at 31 December 2015, SI was still waiting for Dr. Banner’s response
on the settlement offer. If Dr. Banner declines the offer, the court trial will be held in early
2016.

Case B: On 15 December 2015, SI filed a lawsuit against a former employee, Bucky Barnes
for illegally using the experiment results that he obtained while working at SI for development
of his own product. Ms. Potts estimates that there is a 50% probability that Stark Industries
would win the lawsuit and get a compensation of $300,000. The lawsuit is still pending as at
the end of 2015.

Case C: SI’s customer S.H.I.E.L.D Ltd (SHL), a fitness equipment retailer, sued SI on 15
March 2015 for defective exercise equipment produced. Ms. Potts at the time believed that the
claim made by SHL was highly controversial and therefore it was difficult to estimate the result
of the lawsuit. On 2 December 2015, however, the court trial was over and SI paid SHL
$600,000.

Other events that SI encountered during the financial year 2015 are as follows:

Case D: On 21 June 2015, SI ordered 1,000 units of metal parts from Asgard Ltd (Asgard) for
one of its fitness equipment products, Hammer. The contract price was $100 per unit. On 15
August 2015, the market price of the metal parts fell to $80 per unit. Mr. Stark called Mr. Thor,
CEO of Asgard, and persuaded him to adjust the contract price to $90 successfully. The metal
parts were then delivered to SI on 15 November 2015.

AC1104 S9 - 5
Case E: On 1 September 2015, Hydra Ltd (Hydra) announced its intention to pursue a
takeover of SI. Hydra held no shares of SI as at 1 September 2015. If Hydra were to gain
control over SI, it would need to acquire 51% of SI’s outstanding shares. In response to the
takeover intention, SI immediately adopted a “poison pill” i.e., it offered the existing
shareholders the right to purchase its shares at a 50% discount of the market price. Hydra was
excluded from this policy because it was not an existing shareholder. SI’s announcement was
made on 2 September 2015. On 1 October 2015, shares were distributed and 90% of the
existing shareholders exercised this right to acquire SI shares at $10 each, which is 50% of the
market price on the distribution date. Each shareholder who exercised the right purchased
shares equal to the number of shares they owned before this new issuance. The total number of
shares outstanding before the distribution was 1,000,000. The share price declined to $15 per
share after the rights were exercised.

Required

(i) Provide journal entries (if any) for the three lawsuits that Stark Industries Ltd was
involved in (Case A, Case B and Case C) from 15 March 2015 to 31 December 2015.
Show all supporting computations.

(ii) Provide journal entries for the purchase of the metal parts from Asgard Ltd. (Case D)
from 21 June 2015 to 15 November 2015 (if any).

(iii) Provide journal entries for the poison pill adopted by Stark Industries Ltd in Case E
above, from 1 September 2015 to 1 October 2015 (if any). Show all supporting
computations.

(iv) Refer to Case E above. Explain why Stark Industries Ltd’s response to Hydra Ltd’s
takeover intention is a “poison pill” and explain how it works. Support your argument
with computations. Limit your verbal explanation to three sentences maximum.
Adapted from Q3 of AC1102 Sem 2 Exam 2015/2016
Key ans: (i) Case A: legal suit expense $288,000; (ii) Dr Loss on purchase commitment $10,000;
(iii) No JE on 2 Sep 2015

Question 2 (CL)

Central Laptop Ltd (CL) is a company incorporated in Singapore. Its principal activity is to sell
its home brand laptops in Singapore. CL prepares its financial statements in accordance with
the Singapore Financial Reporting Standards (International) and its financial year ends on 31
December. CL’s 2014 financial statements were issued on 28 February 2015.

Below are the relevant extracts from CL’s draft financial statements as at 31 December 2014.

Current Liabilities: $200,000

Non-Current Liabilities: $300,000
Retained Earnings: $200,000
Net Sales from home brand laptops: $900,000
AC1104 S9 - 6
As the auditor of CL, you have discovered some omitted transactions in the financial year 2014
as listed below:

(a) CL provides two-year product warranty for all home brand laptops that it sells. Based
on CL’s past records, the estimated total warranty costs for the laptops sold in 2014
would be 2% of the net sales. During the financial year 2014, CL incurred warranty
costs of $6,000 in cash. Half of the remaining warranty is expected to be settled in
financial year 2015. CL’s accountant omitted all the transactions related to the product
warranty.

(b) On 24 August 2014, one of the CL home brand laptops exploded and caused a fire in a
customer’s premise. The customer then filed a lawsuit against CL on 11 November
2014. According to the company’s lawyer on 15 December 2014, the probabilities to
compensate the customer with $50,000 and $30,000 would be 50% each. On 3
February 2015, CL made an out-of-court settlement by paying a sum of $35,000.

(c) Another customer filed a lawsuit against CL and claimed that he was injured by an
overheating CL home brand laptop on 15 January 2015. According to the company’s
lawyer on 1 February 2015, CL was likely to compensate this customer with an
estimated amount of $10,000.

Required

(i) Determine the appropriate accounting treatment(s) for the situations in items (a) to (c)
with reference to SFRS(I) 1-37 Provisions, Contingent Liabilities and Contingent Assets
and any other relevant Singapore Financial Reporting Standards.

(ii) Provide all the relevant journal entries for the situations in items (a) to (c) above.

(iii) Determine the closing balances of current liabilities, non-current liabilities and retained
earnings for the financial year 2014, after taking into account requirement (ii) above.
Q2 of AC1102 Sem 2 Exam 2014/2015
Key ans: (ii)(a) DR Warranty Expense $180,000, (c) No journal entry; (iii) Current Liabilities $241,000

Question 3 (Flyhigh)

Flyhigh Ltd sells iFly computer notebooks with a 90-day warranty against manufacturing
defects. Its annual average sales is approximately 1,500 units. Based on the previous claims
experience, 80% of the units sold will have no defects, 15% will have minor defects and 5%
will have major defects. For the sale of 1,500 units, the average cost of rectifying the
manufacturing defects of iFly computer notebooks is estimated to be $90 per unit for minor
defects and $120 per unit for major defects.

AC1104 S9 - 7
On 1 December 2010, Flyhigh sold 100 units of iFly computer notebooks during the IT Fair
held in Suntec City, bringing in a total cash sale of $250,000. The unit cost of each iFly
computer notebook is $1,000.

Required

(i) Is warranty cost a contingent liability? Discuss.

(ii) Provide appropriate accounting treatment(s) with journal entries for transactions on 1
December 2010 and support your answers with the relevant Financial Reporting
Standards (International) and any other relevant accounting principles.
Q1a of AA102 Sem 2 Exam 2010/2011
Key ans: Provision for warranty cost $1,950

Question 4 (Dovan)

Dovan Pte Ltd (Dovan) is in the business of selling oil paintings. Its Head Office is in Kallang
and its accounting year end is 30 September. In 2009, Dovan decided to expand its business in
Singapore and signed a three-year rental agreement commencing on 1 October 2009 with the
Jurong Shopping Mall. A three-month rental deposit was paid upon signing the rental
agreement. Monthly rental of $10,000 is to be paid in advance on the first day of each month.
In the event that the rental agreement is prematurely terminated by Dovan, the penalty imposed
will be the rental for the remaining rental period, subject to a minimum of three-month rental.
Under the rental agreement, the shop cannot be sublet to another user.
In 2011, Dovan relocated the business from Jurong to its Head Office in Kallang and decided to
terminate the rental agreement with effect from 1 November 2011.

Required

Advise Dovan on the appropriate accounting treatment upon the premature termination of the
rental agreement in compliance with the relevant Singapore Financial Reporting Standards
(International). Provide the necessary journal entries, if applicable.
Q1b of AA102 Sem 1 Exam 2011/2012
Key ans: Onerous contract, loss $110,000

Question 5 (ChocoLand)

ChocoLand Pte Ltd (ChocoLand), a listed company on Singapore exchange, manufactures both
confectionary and some equipment related to the production of confectionary. The company is
based in Singapore and prepares its financial statements according to the Singapore Financial
Reporting Standards. ChocoLand’s financial year end is 31 December. Below are the relevant
extracts from its financial statements as at 31 December 2012.

AC1104 S9 - 8
 Current Liabilities
Provision for warranties $270,000

Non-current liabilities
Provision for warranties $180,000

Non-current assets
Plant and equipment
At Cost $20,000,000
Accumulated depreciation $6,000,000
Carrying amount $14,000,000

Plant and equipment, which were acquired at the same time, has an estimated useful life of 10
years, zero salvage value and is depreciated on a straight-line basis.

Note 36 – Contingent liabilities:

ChocoLand is engaged in litigation with various parties in relation to allergic reactions to traces
of peanuts alleged to have been found in packets of jelly beans. ChocoLand strenuously denies
the allegations and, as at the date of authorising the financial statements for issue, is unable to
estimate the financial effect, if any, of any costs or damages that may be payable to the
plaintiffs.

ChocoLand provides a two-year warranty for all the equipment it sells. The provision for
warranties as at 31 December 2012 was calculated using the following assumptions (assume
that there is no balance carried forward from the prior year):

Estimated cost of repairs if all equipment sold have minor defects $1,000,000
Estimated cost of repairs if all equipment sold have major defects $6,000,000
Expected % of equipment sold during the FY 12 having no defects in FY 13 80%
Expected % of equipment sold during the FY 12 having minor defects in FY13 15%
Expected % of equipment sold during the FY 12 having major defects in FY13 5%
Expected timing of settlement of warranty payments - those with minor defects All in FY 2013
40% in FY 2013,
Expected timing of settlement of warranty payments - those with major defects
60% in FY 2014

AC1104 S9 - 9
During the financial year ended 31 December 2013, the following occurred:

(1) In relation to the provision for warranties of $450,000 as at 31 December 2012,

$200,000 was paid out of the provision. Of the amount paid, $150,000 was for products
with minor defects and $50,000 was for products with major defects, all of which
related to amounts that had been expected to be paid in 2013 financial year^. No journal
entry has been provided for these payments.

^Warranties that were not settled in the financial year 2013 are expected to be settled in
the financial year 2014.

(2) In calculating its provision for warranties for 31 December 2013, ChocoLand made the
following adjustments to the assumptions used for the prior year:

Estimated cost of repairs if all equipment sold have minor defects No change
Estimated cost of repairs if all equipment sold have major defects $5,000,000
Expected % of equipment sold during the FY 13 having no defects in FY14 85%
Expected % of equipment sold during the FY 13 having minor defects in FY14 12%
Expected % of equipment sold during the FY 13 having major defects in FY14 3%
Expected timing of settlement of warranty payments - those with minor defects All in FY 2014
20% in FY 2014,
Expected timing of settlement of warranty payments - those with major defects
80% in FY 2015

(3) During the end of 2013, significantly advanced machinery for the production of
confectionary and related products was available in the market for purchase. At 31
December 2013 ChocoLand estimated the recoverable amount of its plant and
machinery in accordance with SFRS(I) 1-36 Impairment of Assets. The value-in-use of
its plant and equipment was estimated to be $9,000,000 whereas its fair value less costs
of disposal was found to be $8,825,000.

(4) On 1 June 2013, ChocoLand discussed the peanut allergy suit with its legal
representative. The legal representative pointed out that it is probable that $170,000 will
be awarded to plantiffs in damages. In August 2013, the court ordered ChocoLand to
pay $150,000 to the plantiffs. On 31 December 2013, ChocoLand paid $80,000 to
plantiffs. No journal entries have been recorded relating to the peanut allergy case.

(5) ChocoLand had commenced litigation against one of its advisers for neglect advice
given on the original installation of machinery. The company argues that they suffered a
significant loss in revenues as the company’s operations were delayed by 3 months. In
August 2013, the court found in favour of ChocoLand. The hearing for damages had not
been scheduled as at the date the financial statements for 2013 were authorised for issue.
ChocoLand estimated that it would receive about $350,000.

AC1104 S9 - 10
Required

(i) Compute the provision for warranties as at 31 December 2012. This should agree with
the financial statements provided in the question.

(ii) Provide relevant journal entries for item (1) above.

(iii) Calculate the warranty expense for the financial year ended 31 December 2013 and
provide the relevant journal entries. Also, compute the total provision for warranties, as
well as the amounts to be classified as current and non-current liability, as at 31
December 2013.

(iv) Provide all the necessary journal entries, if any, related to the plant and equipment for
the year-ended 31 December 2013. Calculate the depreciation expense for the plant and
equipment for the year-ended 31 December 2014.

(v) Determine the appropriate accounting treatment for the situation above in item (4) and
provide your reasons. Prepare necessary journal entries, if any, for the events taking
place in item (4) above from 1 June 2013 to 31 December 2013.

(vi) Determine the appropriate accounting treatment for the situation above in item (5) above
and provide your reasons. Prepare necessary journal entries, if any.
Q3 of Sem 1 Exam AY2014/2015
Key ans: (i) Current liabilities $270,000; (ii) Dr Provision for warranties $200,000;
(iii) Dr Warranty expense $270,000; (iv) Dr Depreciation expenses $2M, Impairment loss $3M;
(v) Provision; and (vi) Contingent asset

Question 6 (XL)

XL Limited (XL) is a distributor of Pear computers (Pear). Each Pear is sold for $1,200.
Included in the selling price of the Pear is a product warranty which provides assurance
against manufacturing defects for a period of 12 months from the date of sale. Customers can
increase the warranty period by an additional 12 months if they purchase an extended
warranty for $100 upon purchase of Pear. However, customers purchase the extended warranty
after their purchase of Pear, the stand-alone selling price of the extended warranty is $200. The
purchase cost of the Pear to XL is $800. XL estimates that its expenses on each product
assurance warranty and extended warranty to be $80 and $60 respectively. XL complies with
SFRS(I) 15 Revenue from Contracts with Customers and SFRS(I) 1-37 Provisions, Contingent
Liabilities and Contingent Assets.

Required

(i) On 30 September 20x1, Mr A purchases a Pear computer together with an extended

warranty from XL. Prepare the necessary journal entries to record the sale and the
relevant costs to XL. (round off to the nearest dollar)

AC1104 S9 - 11
(ii) With reference to requirement (i) above, how would the allocation of the transaction
price be different if in addition to the warranty for manufacturing defects, the product
warranty entitles the buyer to one free computer optimisation service within the 12-
month product warranty period? Assume that the stand-alone selling price of the
optimisation service is $100 and all customers are expected to utilise the optimisation
service. No journal entries are required. (round off to the nearest dollar)
Q2 of Sem 1 Exam AY2018/2019
Key ans: (i) CR Revenue $1,118, DR Warranty Expense $80; (ii) Sale of Computer $1,040

- END -

AC1104 S9 - 12