Part B

You are provided with the information below on Busy Body Marine Pty Ltd (BBM), an entity that makes, distributes and repairs marine engines. The end of the reporting period is June 30.

Extracts from the Statement of Financial Position dated 30 June 2014

Current Liabilities

Provision for Warranties$540,000

Non-Current Liabilities

Provision for Warranties$320,399

Non-Current Assets

Plant & Equipment - At Cost$8,000,000

Accumulated Depreciation$2,400,000

Carrying Amount$5,600,000

Plant & Equipment has a useful life of 10 years and is depreciated on a straight line basis

Note 36 to the Statement

Busy Body Marine Pty Ltd is engaged in litigation with various fishing fleets who believe their engines have not been properly serviced. This includes the allegations that the wrong synthetic motor oil was used by Busy Body Marine during servicing. Busy Body Marine denies the allegations as it made all necessary enquiries with the national distributor of the equipment before using the motor oil. As of the day of authorizing the financial statements for issue, Busy Body Marine is unable to estimate the financial effect, if any, of any costs or damages that may be payable to the plaintiffs.

The Provision for Warranties at 30 June 2014 was calculated using the following assumptions (and there was no balance carried forward from the prior year)

During the year ended 30 June 2015, the following occurred:

1. In relation to the warranty provision at 30 June 2014, $400,000 was paid out of the provision. Of the amount paid, $300,000 was for products with minor defects and $100,000 was for products with major defects, all of which related to amounts that had been expected to be paid in the 2015 financial year.
2. In calculating its warranty provision for 30 June 2015, BBM made the following adjustments to the assumptions used for the prior year

Estimated cost of repairs - products with minor defects

2,000,000$

Estimated cost of repairs - products with major defects

$12,000,000

Expected % of products sold during FY14 having NO defects in FY15

80%

Expected % of products sold during FY14 having MINOR defects in FY15

15%

Expected % of products sold during FY14 having MAJOR defects in FY15

5%

Expected timing of settlement of warranty payments - those with MINOR defects

All in FY15

Expected timing of settlement of warranty payments - those with MAJOR defects

40% in FY15; 60% in FY16

Discount rate

6% p.a. but the effect of discouting for FY15 is considered immaterial

Estimated cost of repairs - products with MINOR defects

No change

Estimated cost of repairs - products with MAJOR defects

10,000,000$

Expected % of products sold during FY14 having NO defects in FY15 85% Expected % of products sold during FY14 having MINOR defects in FY15 12% Expected % of products sold during FY14 having MAJOR defects in FY15 3% Expected timing of settlement of warranty payments - those with MINOR defects All in FY16 Expected timing of settlement of warranty payments - those with MAJOR defects 20% in FY16; 80% in FY17

Discount rate

No change. The effect of discouting for FY16 is considered immaterial

1. BBM determined that part of its plant & machinery needed an overhaul - a piece of plant would need to be replaced in about June 2016 at an estimated cost of $500,000. The carrying amount of this piece of plant at 30 June 2014 was $280,000. Its original cost was $400,000.
2. BBM was unsuccessful in its defense of the maintenance/motor oil case and was ordered to pay $1,500,000 to the plaintiffs. As at 30 June 2015 BBM had paid $800,000
3. BBM commenced litigation against one of its advisers for negligent advice given on the original installation of the piece of plant referred to in 3 above. In April 2015 the court found in favor of BBM. The hearing for damages had not been scheduled as at the date the financial statements for 2015 were authorized for issue. BBM estimated it would receive about $425,000.
4. BBM signed an agreement with Bent Bank to the effect that BBM would guarantee a loan made by Bent Bank to BBM's subsidiary Little BBM Pty Ltd. Little BBMs loan with Bent Bank was $3,200,000 as at 30 June 2015 and Little BBM was in a strong financial position at that date.

Instructions

Answer the questions below regarding Busy Body Marine Pty Ltd (BBM) remembering the company has to comply with AASB 137 and other accounting standards.

(a) The balance of the warranty provision as at 30 June 2014 is given above. Establish how it was calculated and show your workings.

(b) Find the balance of the warranty provision as at 30 June 2015. Show all your workings.

(c) Calculate the prospective change in depreciation required as a result of the shortened useful life of the piece of plant. Show all your workings.

(d) Determine whether the unpaid amount owing as a result of the maintenance/motor oil case is a liability or a provision and give your reasons.

(e) Determine whether the receipt of damages for the negligent advice meets the definition of an asset or a contingent asset and give your reasons.

(f) Determine whether the bank guarantee meets the definition of a provision or a contingent liability and give your reasons. (Ignore AASB 139 in this regard.)

As you may not find a lot of information on the mechanics of provision in text books, here is some guidance to assist your preparation. 1. When you work out the provision for warranty expenses at 30 June 2014 you need to break up your calculation into 2 parts (i) The impact your business should see in FY 15 (This is called the current portion of the liability)

(ii) The impact your business should see in FY16 (This is the non-current part). Do not forget to PV this portion for an appropriate number of years (for you to work out how many) 2. There are several ways to get to the provision at the end of 30 June 2015, but whatever calculation you use please remember that in FY15 the business would have charged a certain value of repairs against the provision as successful claims were made. This will have pushed down the provision. You then need to rebuild it to a number that is made up ofa. The impact your business should see in FY 16 (current portion of the liability) b. The impact your business should see in FY17 (non-current part). Do not forget to PV this portion for an appropriate number of years (for you to work out how many)

Appendix - Example of Bond Liability measurement

> IFRS: Non-Current (Financial) Liabilities are increased by the proceeds net of issuance costs.

> US GAAP: Liabilities are increased without netting off the issuance costs. An asset called Bond Issue Costs is recognised and then amortised, generating a bond issue cost expense.

Assume bonds were issued at par for $100 Million.

3% issuance costs were paid to an investment bank.

Trust bank accounts have been used to process monies.

The effect of accounting under IFRS and US GAAAP will be:

IFRS:

Debit Bank with net proceeds of $97M

Credit Bond Liability with$97M....issuance cost has been netted off the bond liability

US GAAP

Debit Bond Issue Costs (Asset) with $3M (...this capitalised cost will be amortised progressively (e.g. monthly) against Bond Issue Cost Expense)

Debit Bank with net proceeds of$97M

Credit Bond Liability with$100M

LETTS LOOK AT DEBT CONTRACTED FOR 5 YEARS AND ACCOUNTED FOR UNDER THE EFFECTIVE INTEREST METHOD

NOW LET'S USE THE STRAIGHT LINE METHOD ON THE SAME DATA

End Year 2: DebitInterest expense$104,250[being 5% * ($2.1M - $15,000)] Debit Bond Liability$15,750 Credit Bank$120,000 (no change year to year as it is contracted)

> Note that the bonds in the above example of premium bonds will amortisedownto $2M (equal to face value) just before redeeming at maturity. > If the bonds however had been issued at a discount (instead of a premium) the journals over the life of the bonds would have amortisedthe bonds up to $2M face value at maturity before redeeming.

> Pre tax earnings is periodically reduced by interest expense, which is calculated as being equal to the Par value of the bond multiplied by coupon rate plus or minus the amortisation of the discount or premium. There is no "effective interest rate or yield" used in the calculation. > Using 2000 $1000 denominated bonds issued at a premium of $50 and paying 6% annual coupon driving a market rate of interest at issuance of 5%. > Assume no issuance costs Allowable under US GAPP (but not IFRS) - Upon issue the effect of accounting will be DebitBank$2.1M Credit Bond Liability$2.0M Credit Premium on Bond Liability$0.1M (this is a liability. A discount would be an asset) - After 1 year (assuming no accruals for end of financial period) DebitInterest expense$100,000 [(6% * 2000 * $1000 Par) - ($100,000 / 5 years)] Debit Premium on Bond Liab $20,000 This is the amortisation of the premium Credit Bank$120,000 (being 6% * 2000 * $1000 Par)

End Year 2 (no different than the end of year 1): DebitInterest expense$100,000 Debit Premium on Bond Liab $20,000 Credit Bank$120,000

> Note that the initial bond liability is really $2.1M ($2.0M + $0.1M premium) no different in total than the effective interest method. > The $2.1M amortises down to $2M face value at maturity before redemption but the pattern is different to the effective interest method. > If bond had been issued at a discount the amortisation would have driven the carrying amount of the liability up to $2M at maturity.

MPA 804 Accounting Theory - S2 2017 - Melbourne Polytechnic There are 2 parts to the assignment. Both parts are mandatory. Each carries 15 grade points for a total of 30 grade points. You are to do the assignment as a group of 3 and advise the lecturer of the group members before the mid semester break. The work is all to be completed on a Word document and submitted to the lecturer in class on Monday 25 September. If you have spreadsheet calculations you need to present then they should be cut and pasted into the Word document. Please also submit a copy to turnitin by 8pm on 25 September - Part A - Theory question of 1500 words (minimum) and 2000 words maximum (excluding in-text referencing, appendices, bibliography and cover page), and Part B - Practical and theoretical exercises on liabilities, contingent liabilities, contingent assets, provisions and other matters. Part A Describe and analyse the different ways that elements of financial reporting, as defined in the IASB Conceptual Framework, can be measured by listed companies. You are not constrained in this analysis to any one country or set of national accounting standards. Of course Australia is under International Financial Reporting Standards but your research could identify examples of companies operating under U.S. GAAP, Chinese National Accounting Standards or some other regulations/guidelines that illustrate what you want to discuss. In completing this assignment, you are required to: a. Quote examples of measurement methodologies from company annual reports. b. Clearly reference your sources. c. In explaining how a company has measured an element, explain how the measurement method provided decision-useful information and what you understand decision-useful information to be. d. Provide a critical analysis of the techniques the selected company has used and why a technique deployed may be more useful or practical than another method. As an example, two techniques have been appended that show how bond liabilities and interest expense are reported and measured in Australia and the USA. The first technique is called The Effective Interest Method and the other is called the Straight Line Method. The Effective Interest Method is permitted under both IFRS and US GAAP. The Straight Line method is only permitted under US GAAP. If you were writing on example on bond liabilities you could get into a discussion on these different techniques and whether one provides more decision useful information than the other. Or you may conclude that neither technique is very satisfactory and the bond liability should be reported in the balance sheet at market value because if the company wanted to redeem the debt by buying back the securities in the open market it would have to pay fair value (and that would be based on a current trading price for the bond) 1|Page MPA 804 - S2 2017 - Assignment Instructions Part B You are provided with the information below on Busy Body Marine Pty Ltd (BBM), an entity that makes, distributes and repairs marine engines. The end of the reporting period is June 30. Extracts from the Statement of Financial Position dated 30 June 2014 Current Liabilities Provision for Warranties $540,000 Non-Current Liabilities Provision for Warranties $320,399 Non-Current Assets Plant & Equipment - At Cost $8,000,000 Accumulated Depreciation $2,400,000 Carrying Amount $5,600,000 Plant & Equipment has a useful life of 10 years and is depreciated on a straight line basis Note to the Statement: Busy Body Marine Pty Ltd is engaged in litigation with various fishing fleets who believe their engines have not been properly serviced. This includes the allegations that the wrong synthetic motor oil was used by Busy Body Marine during servicing. Busy Body Marine denies the allegations as it made all necessary enquiries with the national distributor of the equipment before using the motor oil. As of the day of authorizing the financial statements for issue, Busy Body Marine is unable to estimate the financial effect, if any, of any costs or damages that may be payable to the plaintiffs. The Provision for Warranties at 30 June 2014 was calculated using the following assumptions (and there was no balance carried forward from the prior year) Estimated cost of repairs - products with $ minor defects Estimated cost of repairs - products with $ major defects Expected % of products sold during FY14 having NO defects in FY15 Expected % of products sold during FY14 having MINOR defects in FY15 Expected % of products sold during FY14 having MAJOR defects in FY15 Expected timing of settlement of warranty payments - those with MINOR defects 2,000,000 12,000,000 80% 15% 5% All in FY15 Expected timing of settlement of warranty payments - those with MAJOR defects 40% in FY15; 60% in FY16 Discount rate 6% p.a. but the effect of discounting for FY15 is considered immaterial 2|Page MPA 804 - S2 2017 - Assignment Instructions During the year ended 30 June 2015, the following occurred: 1. In relation to the warranty provision at 30 June 2014, $400,000 was paid out of the provision. Of the amount paid, $300,000 was for products with minor defects and $100,000 was for products with major defects, all of which related to amounts that had been expected to be paid in the 2015 financial year. 2. In calculating its warranty provision for 30 June 2015, BBM made the following adjustments to the assumptions used for the prior year. Estimated cost of repairs - products with MINOR defects Estimated cost of repairs - products with MAJOR defects Expected % of products sold during FY14 having NO defects in FY15 Expected % of products sold during FY14 having MINOR defects in FY15 Expected % of products sold during FY14 having MAJOR defects in FY15 Expected timing of settlement of warranty payments - those with MINOR defects Expected timing of settlement of warranty payments - those with MAJOR defects No change $ 10,000,000 85% 12% 3% All in FY16 20% in FY16; 80% in FY17 No change. The effect of discounting for FY16 is considered immaterial Discount rate 3. BBM determined that part of its plant & machinery needed an overhaul - a piece of plant would need to be replaced in about June 2016 at an estimated cost of $ 500,000. The carrying amount of this piece of plant at 30 June 2014 was $280,000. Its original cost was $400,000. 4. BBM was unsuccessful in its defense of the maintenance/motor oil case and was ordered to pay $1,500,000 to the plaintiffs. As at 30 June 2015 BBM had paid $800,000 5. BBM commenced litigation against one of its advisers for negligent advice given on the original installation of the piece of plant referred to in 3 above. In April 2015 the court found in favor of BBM. The hearing for damages had not been scheduled as at the date the financial statements for 2015 were authorized for issue. BBM estimated it would receive about $425,000. 6. BBM signed an agreement with Bent Bank to the effect that BBM would guarantee a loan made by Bent Bank to BBM's subsidiary Little BBM Pty Ltd. Little BBMs loan with Bent Bank was $3,200,000 as at 30 June 2015 and Little BBM was in a strong financial position at that date. Instructions Answer the questions below regarding Busy Body Marine Pty Ltd (BBM) remembering the company has to comply with AASB 137 and other accounting standards. (a) The balance of the warranty provision as at 30 June 2014 is given above. Establish how it was calculated and show your workings. 3|Page MPA 804 - S2 2017 - Assignment Instructions (b) Find the balance of the warranty provision as at 30 June 2015. Show all your workings. (c) Calculate the prospective change in depreciation required as a result of the shortened useful life of the piece of plant. Show all your workings. (d) Determine whether the unpaid amount owing as a result of the maintenance/motor oil case is a liability or a provision and give your reasons. (e) Determine whether the receipt of damages for the negligent advice meets the definition of an asset or a contingent asset and give your reasons. (f) Determine whether the bank guarantee meets the definition of a provision or a contingent liability and give your reasons. (Ignore AASB 139 in this regard.) As you may not find a lot of information on the mechanics of provision in text books, here is some guidance to assist your preparation. 1. When you work out the provision for warranty expenses at 30 June 2014 you need to break up your calculation into 2 parts (i) The impact your business should see in FY 15 (This is called the current portion of the liability) (ii) The impact your business should see in FY16 (This is the non-current part). Do not forget to PV this portion for an appropriate number of years (for you to work out how many) 2. There are several ways to get to the provision at the end of 30 June 2015, but whatever calculation you use please remember that in FY15 the business would have charged a certain value of repairs against the provision as successful claims were made. This will have pushed down the provision. You then need to rebuild it to a number that is made up of a. The impact your business should see in FY 16 (current portion of the liability) b. The impact your business should see in FY17 (non-current part). Do not forget to PV this portion for an appropriate number of years (for you to work out how many) 4|Page MPA 804 - S2 2017 - Assignment Instructions Appendix - Example of Bond Liability measurement > IFRS: Non-Current (Financial) Liabilities are increased by the proceeds net of issuance costs. > US GAAP: Liabilities are increased without netting off the issuance costs. An asset called Bond Issue Costs is recognised and then amortised, generating a bond issue cost expense. Assume bonds were issued at par for $100 Million. 3% issuance costs were paid to an investment bank. Trust bank accounts have been used to process monies. The effect of accounting under IFRS and US GAAAP will be: IFRS: Debit Bank with net proceeds of $97M Credit Bond Liability with $97M....issuance cost has been netted off the bond liability US GAAP Debit Bond Issue Costs (Asset) with $3M (...this capitalised cost will be amortised progressively (e.g. monthly) against Bond Issue Cost Expense) Debit Bank with net proceeds of Credit Bond Liability with $97M $100M LETTS LOOK AT DEBT CONTRACTED FOR 5 YEARS AND ACCOUNTED FOR UNDER THE EFFECTIVE INTEREST METHOD 5|Page MPA 804 - S2 2017 - Assignment Instructions End Year 2: Debit Interest expense Debit Bond Liability Credit Bank $104,250 [being 5% * ($2.1M - $15,000)] $15,750 $120,000 (no change year to year as it is contracted) > Note that the bonds in the above example of premium bonds will amortise down to $2M (equal to face value) just before redeeming at maturity. > If the bonds however had been issued at a discount (instead of a premium) the journals over the life of the bonds would have amortised the bonds up to $2M face value at maturity before redeeming. NOW LET'S USE THE STRAIGHT LINE METHOD ON THE SAME DATA > Pre tax earnings is periodically reduced by interest expense, which is calculated as being equal to the Par value of the bond multiplied by coupon rate plus or minus the amortisation of the discount or premium. There is no \"effective interest rate or yield\" used in the calculation. > Using 2000 $1000 denominated bonds issued at a premium of $50 and paying 6% annual coupon driving a market rate of interest at issuance of 5%. > Assume no issuance costs Allowable under US GAPP (but not IFRS) - Upon issue the effect of accounting will be Debit Bank $2.1M Credit Bond Liability $2.0M Credit Premium on Bond Liability $0.1M (this is a liability. A discount would be an asset) - After 1 year (assuming no accruals for end of financial period) Debit Interest expense $100,000 [(6% * 2000 * $1000 Par) - ($100,000 / 5 years)] Debit Premium on Bond Liab $20,000 This is the amortisation of the premium Credit Bank $120,000 (being 6% * 2000 * $1000 Par) 6|Page MPA 804 - S2 2017 - Assignment Instructions End Year 2 (no different than the end of year 1): Debit Interest expense $100,000 Debit Premium on Bond Liab $20,000 Credit Bank $120,000 > Note that the initial bond liability is really $2.1M ($2.0M + $0.1M premium) no different in total than the effective interest method. > The $2.1M amortises down to $2M face value at maturity before redemption but the pattern is different to the effective interest method. > If bond had been issued at a discount the amortisation would have driven the carrying amount of the liability up to $2M at maturity. 7|Page MPA 804 - S2 2017 - Assignment Instructions