RUA Limited (RUA), a company which prepares its financial statements to 31 December each year, is involved
Question:
RUA Limited (RUA), a company which prepares its financial statements to 31 December each year, is involved in mining and exploration. Before the financial statements for the year ended 31 December 2003 can be finalized, a number of outstanding issues need to be resolved.
Issue 1 On 1 January 2003, RUA was granted a license to commence mining for silver.
As a condition of being granted the license, RUA is obliged to restore the mountainside to its original state when the mining license expires in six years’ time. The directors of RUA estimate that the total cost of restoration will be €120,000,000 of which 80% will be incurred when mining ceases and the remainder during mining. Mining commenced on 1 January 2003. RUA’s cost of capital is 10% and the risk-free rate is 4%. The directors of RUA are proposing to provide for the restoration costs over the next six years based upon projected production at the mine.
Issue 2 RUA purchased a private jet on 1 January 2003 at a cost of €24,000,000. The jet is to be used for transporting company executives to and from the various locations where the company is conducting mining and exploration work. Air regulations require the jet to be overhauled every three years, and it is estimated that each overhaul will cost
€ 1,500,000. RUA is proposing to charge depreciation on a straight-line basis over the jet’s useful economic life of 12 years. Furthermore, it is proposed to create an annual provision of €500,000 to meet the overhaul costs every three years. Issue 3. In 2001, RUA incurred development expenditure amounting to €5,000,000.
This expenditure was expensed in the statement of comprehensive income for the year ended 31 December 2001 as the conditions for capitalization had not been met. However the uncertainties that led to write-off were resolved during the year ended 31 December 2003 and the directors of RUA are proposing to reverse the original write-off and capital-_ issue the expenditure in the financial statements for the year ended 31 December 2003.
Issue 4 RUA carried out a joint contract with COLUMBUS Limited (COLUMBUS).
Under the terms of the contract, RUA is liable for penalties if certain restoration work is not completed satisfactorily. RUA has a separate agreement with COLUMBUS that enables the company to recover 50% of any penalties incurred from COLUMBUS. At 31 December 2003 the directors of RUA estimate that penalties of €5,000,000 will become payable but are uncertain how this should be reflected in the financial statements for the year ended 31 December 2003.
Issue 5 In February 2004, a customer commenced legal action against RUA alleging that drilling work completed in September 2003 had not been carried out in accordance with the terms of the contract. The directors of RUA intend to defend the allegations vigorously and RUA’s legal advisors estimate that the company has a 75% chance of successfully defending the claim. If the customer is successful, penalties and legal fees are expected to amount to €1,000,000. If RUA wins the case, non- -recoverable legal fees of
€25,000 will have been incurred. The directors of RUA are proposing to omit reference to the legal action in the financial statements for the year ended 31 December 2003 as the writ was not issued until February 2004.
Issue 6 In order to provide funds for exploration work, bills receivable amounting to
€4,000,000 were discounted on 1 December 2003. These are due for maturity on 1 November 2004. The directors of RUA are uncertain whether it is necessary to disclose this in the financial statements for the year ended 31 December 2003.
Requirement Prepare a memorandum addressed to the finance director of RUA explaining how each of the issues should be treated in the financial statements for the year ended 31 December 2003.
Step by Step Answer:
International Financial Accounting And Reporting
ISBN: 9780903854726
2nd Edition
Authors: Ciaran Connolly