Case data:

Saunas4U Pty Ltd is a business that manufactures and sells kit saunas that can be built in home workshops across Australia as well as custom built saunas. The business was established in 2010 and has grown to a large proprietary company with four directors, Chris and Helen Knight and David and Yvonne Jorgensen. The business operates from a large factory in Melbourne, is registered for Goods and Services Tax (GST) and has a financial year ending 30 June. When commencing the business 1 July 2010, Saunas4U Pty Ltd was not able to purchase a building to manufacture the saunas in and instead rented a factory. As the business has grown they would now like to purchase their own land and buildings to operate the business in. They are currently looking at 2 options. Option 1 would involve additional costs relating to legal fees of $2,200 (GST Inclusive) to register the business as the owners of the land, $1,300 (GST Inclusive) to conduct a safety inspection of the machinery, $5,500 (GST Inclusive) to rewire the building as the existing al cables no longer work, $4,400 (GST Inclusive) for one year building insurance. Option 1 would involve purchasing the following assets for $400,000 (GST Exclusive) on 1 July 2020. Option 1 Fair value of assets Land $100,000 Building $350,000 Machinery $30,000 Total $480 000 Option 2 would involve continuing to rent a factory but at larger premises. The owners have recently located a suitable place and negotiated a possible contract at a cost of $120,000 (GST Exclusive) per year for five years. The building is expected to have a useful life of twenty years and an estimated residual value of $15, 666.67. The machinery is expected to have a useful life of 5 years and be used for 10,000 hours and an estimated residual value of $800. The machine is expected to be used 1,500 hours in first year, 2,200 hours in year 2, 2,500 in year 3, 2,000 in year 4 and 1,800 in year 5. Saunas4U Ltd adopts the cost model for measuring non-current assets. The business has seen a huge increase in demand for its products due to the pandemic affecting Australia in recent months. The owners have recently discussed with the CFO the possibility of changing to the revaluation model for measuring non-current assets. With the increase in demand of the businesses products, it was decided to employ 2 additional staff. This will also require the payroll team to ensure employee benefits are correctly set up for the new staff. It was determined that new staff would earn $2,800 per week and will incur the following deductions: PAYG withholding tax $853, employer superannuation payment of 9.5%, payroll tax of 4.25%, WorkCover 2%, employee contribution to superannuation $100 and employee contributions for insurance fees of $25. One of the downfalls of the pandemic on the company is some debtors are now having difficulty paying their debt. In the past the business used the direct write off method. The CFO has discussed already with the owners about moving to the allowance method of accounting for bad debts. Two of the owners were debating the merits of percentage of net credit sales method and the ageing of debtors method. On 1 July 2020, Saunas4U Pty, signs an agreement with HomeDecor to provide 10 weekly lessons on how to build a sauna on You tube and 10 kit saunas. The contract price for this amounted to $16,500 (GST Inclusive), on credit terms n/30 for the kit saunas and how to videos. This amount also includes one free service of the saunas to be performed twelve months after the delivery of the sauna kits to HomeDecor. The standalone price for the 10 weekly You tube lessons is $11,000 (GST Inclusive), while standalone price for the 10 kit saunas is 15,400 (GST Inclusive). The twelve month service fee for the saunas is usually $1,100 (GST Inclusive). HomeDecor paid the full amount on 20 July 2020 for the sauna kits and You tube lessons. The sauna kits were delivered in 25 July 2020. By 31 December 2020, 6 You tube lessons were conducted.

Questions:

Explain why the owners of Saunas4U Pty Ltd, would like to change the method of measuring noncurrent assets during the pandemic. Discuss how changing the measurement of noncurrent assets from the cost model to the revaluation model influences the usefulness of financial information with reference to the fundamental qualitative characteristics of information prescribed by the Conceptual Framework for financial reporting.

The owners would also like to consider option 2, i.e., renting a factory for 5 years at $120,000 per year rather than buying land, building and machinery as per option 1. However, they are concerned that this will affect their ability to obtain future credit as the contract to rent the factory will need to be recorded as a liability. Advise the owners whether the rent contract of $600,000 should be treated as liability. If not, recommend how the rent should be treated and recognised in the financial statements. Justify your answers with reference to the applicable Conceptual Framework definitions and/or recognition criteria.