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Acc207 July Semester 2015 Question 1 This question consists of two (2) parts, Part A and B. You are required to answer both parts. Part A On 1 January 2011, Chan Trading Pte Ltd entered into a lease agreement to lease a piece of equipment from Wong Leasing Pte Ltd. The terms of the agreement included: Non-cancellable lease term of four years, with no renewal or purchase option; and Lease rental of $10,000 per year to be paid by Chan Trading Pte Ltd on 31 December of each of the four years, commencing 31 December 2011. The lease rental was calculated and mutually agreed upon based on a 5% rate of return to Wong Leasing Pte Ltd. The equipment was new on 1 January 2011, had a fair market value of $42,000 and was expected to have an estimated useful life of five years. At the end of the lease term, the equipment was to be returned to Wong Leasing Pte Ltd. There was no mention of residual value. Required: Demonstrate the accounting for leases by doing the following: (a) Apply the concept of lease classification criterion and determine whether it is a finance lease or not? (3 marks) (b) Compute the present value of the minimum lease payments treating it as an ordinary annuity. (2 marks) (c) Compute the annual depreciation charge on the leased equipment. (1 mark) (d) Prepare the amortization schedule for the period from 1 January 2011 to 31 December 2014. (6 marks) Page 3 of 11 July Semester 2015 Part B Assume the same fact as Question 1 Part A with the exception that each annual lease payment was to be made on 1 January (instead of 31 December), commencing with the first payment on 1 January 2011 (instead of 31 December 2011). Assume the implicit rate charged remained at 5%. Required: Demonstrate the accounting for leases by doing the following: (a) Apply the concept of lease classification criterion, determine whether it is a finance lease or not? (3 marks) (b) Compute the present value of the minimum lease payments treating it as an annuity due instead of ordinary annuity. (3 marks) (c) Compute the annual depreciation charge on the leased equipment. (1 mark) (d) Prepare the amortization schedule for the period from 1 January 2011 to 1 January 2014. (6 marks) Note: Journal entries are not necessary. Question 2 (a) Compare and contrast the three methods of valuation derived from the discounting model: discounted dividends, discounted abnormal earnings (or abnormal ROE) and discounted cash flows. Note: Detailed description of each method is not required, focus on the differences. Do not include multiple valuations, e.g. price to earnings (P/E) method here. (21 marks) (b) Identify and discuss two (2) possible reasons why price to earnings (P/E) method is often the preferred method used by both the brokerage firm and in merger and takeover deals. (4 marks) Page 4 of 11 July Semester 2015 Question 3 XYZ Ltd was incorporated on 2 January 2011 to undertake research and development in a new field of science. On the same day, the company approves a remuneration plan to grant its CEO options to purchase 1,000,000 of the company's ordinary shares at $0.30 per share (the exercise price). These options will vest on 1 January 2013 if the CEO remains in the employment of the company until then. The options are exercisable from 1 January 2014 to 31 December 2015. Given that the company is a new start-up in a new industry, it may be argued that the fair value of the equity instrument cannot be estimated reliably. The company thus measures that share options at their intrinsic value, the difference between the fair value of the shares and its exercise price, as provided by FRS 102. Assume that the company adopts a 31 December accounting year end. Assume further that, based on the net tangible asset backing per share, the fair value of the shares are estimated as follows: As at 1 March 2011: $0.30 per share As at 31 December 2011: $0.42 per share As at 31 December 2012: $0.45 per share As at 31 December 2013: $0.50 per share The company's share is quoted on the stock exchange of Singapore. The CEO exercised 200,000 of the options on 31 December 2014 when the market price was $0.60 per share and exercised the remainder of 800,000 of the options on 31 December 2015 when the market price is $0.80 per share. Required: Demonstrate the accounting for the above by providing the journal entries for the period from 31 December 2011 to 31 December 2015. Note: Journal narration is not necessary, but you are to show workings to support number used in the journals entries (25 marks) Question 4 Below are the summarized financial statements for the years to 31 March 2012 and 2011 of ABC Ltd, a company that produces hard play equipment. During the past few years its performance has been criticized by investors and analysts as a number of key ratios have been below that of the equivalent industry averages. At the end of 2011, in an attempt to improve performance and produce better results, the directors of the ABC Ltd entered into a phase of restructuring. The restructuring programme has involved disposal of surplus assets, reducing employee numbers, outsourcing product construction and streaming the products offered. ACC207 Copyright 2015 SIM University Page 5 of 11 Examination - July Semester 2015 The directors of ABC Ltd believe that the restructuring programme has been successful at addressing the previous criticism and has improved the company's performance. Extracts from the statement of comprehensive income for the year ended 31 March: Revenue Cost of sales Gross profit Operating expense Profit from operation Finance costs Profit before tax Income tax Profit after tax 2012 $'000 5492 -3384 2108 -864 1244 -196 1048 -308 740 2011 $'000 5608 -3148 2460 -1432 1028 -408 620 -232 388 Extracts from the statement of financial position as at 31 March: 2012 $'000 Non-current assets Property, plant and equipment Intangibles 2012 $'000 4200 2011 $'000 5040 112 128 4312 Current assets Inventories Trade and other receivables Bank Non-current liabilities 10% loan note Current liabilities Trade payables Taxation Restructuring provision Total Liabilities & Equity 5168 688 664 492 568 84 20 Total Assets Equity Ordinary $1 share capital Capital reserve Retained earnings 2011 $'000 1436 5748 1080 6248 1600 800 1096 1036 464 696 3732 1960 800 3200 844 372 0 580 260 248 1216 5748 1088 6248 Page 6 of 11 July Semester 2015 Extracts from statement of changes in equity for the year ended 31 March 2012: Retained earnings in $'000 Balance as at 1 April 2011 696 740 Add profit for the year Less dividend paid Balance as at 31 March 2012 -400 1036 The following ratios have been calculated for ABC Ltd for the year ended 31 March 2011 Return on capital employed 19.9% Gross profit margin 43.9% Operating profit margin 18.3% Current ratio 0.99:1 Quick ratio 0.54:1 Inventory days 57 days Receivable days 37 days Payable days 67 days Gearing (debt over debt + equity) 62% Interest cover 2.5 times Additional information: (i) ABC Ltd disposed of its surplus assets during the year ended 31 March 2012 for $750,000. The carrying values of these assets on the date of disposal were $438,000. The resulting gain was recorded within operating incomes. (ii) At the end of 2011 ABC Ltd provided for the costs of the restructuring at an estimated $248,000. These costs were included in its operating expenses. The costs of the restructuring incurred during 2012 actually amounted to $260,000 (iii) The directors were pleased with the performance of ABC Ltd during the year to 31 March 2012 and on 20 April 2012, a final dividend of $840,000 was declared. Required: (a) Compute the ratios for the year ended 31 March 2012 equivalent to those provided above for 2011. (10 marks) ACC207 (b) Interpret the ratios from (a) and analyse the financial performance and financial position of ABC Ltd for the two years ended 31 March 2012 and 31 March 2011. Note: Your answer should consider the effects of restructuring. (15 marks)