QUESTION 2 (12 MARKS)

Background

Creative Hardwares Pty Ltd (CHPL) is a national hardware retailer that is listed on the Australian Securities Exchange (ASX). CHPL introduced a new executive compensation plan (ECP) on 1 July 2019. The plan allows for cash bonuses to be paid to executive directors under the following terms and conditions:

A bonus will be paid if the company's earnings per share (EPS) exceed 'normal' EPS.

'Normal' EPS has been agreed to be $0.65 per share.

The bonus is calculated to be 12.5% of any profit generated in excess of that required to result in an EPS of $0.65.

The draft financial statements for the year ended 30 June 2020 show an EPS of $0.922 per share and a bonus payable under the ECP of $108,800.

Additional information

On 1 December 2019, CHPL entered into an agreement with Apex Investment Pty Ltd (Apex Investment) to lease a property to Apex Investment. The terms of the agreement are as follows:

The period of the lease is 20 years.

The consideration payable to CHPL at the inception of the lease is $2.5 million.

The interest rate implicit in the lease is 7.5%.

CHPL signed an unconditional agreement to repurchase the property after six years for a fixed amount of $3.43 million.

At the request of the executive directors of CHPL, the property has been derecognised from the statement of financial position and a profit of $1.5 million has been recognised in the statement of comprehensive income. The $1.5 million profit was calculated by comparing the $1 million carrying value of the property prior to disposal with the consideration received.

Prior to derecognition, the property was being depreciated on a straight line basis at 5% per annum, based on an initial cost of $1.4 million.

Required:

You are employed as a senior auditor by RCD Chartered Accountants (RCD).

(a) Determine whether or not the correct accounting treatment has been adopted by CHPL in relation to the transaction between the company and Apex Investment. If you determine that the accounting treatment adopted is not correct, advise on the correct accounting treatment. (5 marks)

(b) Explain why the directors may have been motivated to adopt the accounting treatment that has been adopted. (3 marks)

(c) Determine whether the directors have acted unethically and what (if any) impact this would have on you, as auditor of CHPL. (4 marks)