Question 2 (75 marks) Moonlight Ltd ("Moonlight') is in the business of designing, manufacturing and supplying various types of glass products for decoration, architecture and residence uses. Thomas Lo, the accountant, is responsible for preparing the financial statements using the financial information below. Trial balance at 31 December 2019 Debit $000 2,700 Credit $000 950,000 433,000 246,300 222,300 4,500 142,000 14.700 360,000 120,000 210,900 300,000 Production machine Property, plant and equipment - at cost - Accumulated depreciation - 1 January 2019 Inventories - 31 December 2019 Accounts receivable Provision for bad debts Accounts payable Bank overdraft Ordinary share capital Preference share capital Retained profits - 1 January 2019 6% convertible debentures Current tax Deferred tax Revenue Provision for warranty cost Bank overdraft interest Interest income Cost of sales Selling and distribution costs General and administrative costs Debenture interests paid Fixed bank deposits Preference dividends paid Dividends paid 1,400 1,600 6,600 1,054,000 5,100 3,600 3,100 645,000 142.000 137,000 15,000 150,000 20,000 117,000 2,653,900 2,653,900 The following notes are also relevant: The total number of ordinary shares outstanding at 31 December 2018 was 27,000,000 shares. Moonlight made a new issue of 3,000,000 shares at its full market price of $3.80 on 1 March 2019 followed by a rights issue of one new for every four existing shares held on 1 August 2019. The exercise price of the rights issue was $1.20 and the average market price immediately preceding the rights issue was $3.60. The total number of preference shares outstanding at 31 December 2018 was 120,000,000. There was no change in the preference shares during the year. Preference shareholders are entitled to fixed amount of dividends each year. ACT B332F Group Assignment V2 1. 2. The 6% convertible debentures were issued on 1 May 2018. Debenture interest is payable half-yearly in artears on 1 November and 1 May. Each $1,000 convertible debenture can be converted for 200 ordinary shares any time after 31 December 2022 3. On 2 January 2019, Moonlight leased a production machine for 6 years with an option to renew for another 2 years under the same terms. At the inception of the lease, the management has expressed intention to renew the lease. The fair value of the machine is $15,500,000. Moonlight is required to make equal annual rental payment of $2,700,000 commencing 2 January 2019. The lease has an implicit interest rate of 10% and the useful life of the leased asset is 10 years. Moonlight adopted a straight-line depreciation for the leased machinery. Moonlight also paid $10,000 in negotiating and signing the lease agreement, and $245,000 initial direct cost as installation and machine testing cost. Moonlight has performed the following entries in relation to the lease: Dr. Production machine Dr. Cost of sales Cr. Bank $2,700,000 255,000 $2,755,000 3. On 2 January 2019, Moonlight leased a production machine for 6 years with an option to renew for another 2 years under the same terms. At the inception of the lease, the management has expressed intention to renew the lease. The fair value of the machine is $15,500,000. Moonlight is required to make equal annual rental payment of $2,700,000 commencing 2 January 2019. The lease has an implicit interest rate of 10% and the useful life of the leased asset is 10 years. Moonlight adopted a straight-line depreciation for the leased machinery. Moonlight also paid $10,000 in negotiating and signing the lease agreement, and $245,000 initial direct cost as installation and machine testing cost. Moonlight has performed the following entries in relation to the lease: Dr. Production machine Dr. Cost of sales Cr. Bank $2,700,000 255,000 $2,755,000 Moonlight leased a luxury car for the use of the Managing Director under a 12-month non-cancelable lease on 1 June 2019. Moonlight made an initial payment of $29,520 upon signing the lease followed by 11 equal monthly payment of $12,000 commencing 1 July 2019. According to the lease agreement, Moonlight has exclusive use of the car during the lease term. The lessor will be responsible for the repair and maintenance of the car. The lease is non-cancellable and the lease transaction qualifies for using the simplified lease accounting model under HKFRS 16. The accounting staff had charged all the lease payments as general and administrative expenses. Moonlight annual incremental borrowing rate is 10%. 5. Moonlight's accounting policy is to provide depreciation on non-current assets based on year-end figures. Property, plant and equipment (PPE) are depreciated over 10 years on a straight-line basis. There were no additions or disposals of PPE during the year. Depreciation on PPE is charged to cost of sales. 6. At 31 December 2019, Moonlight decided to measure its PPE using the revaluation model and has engaged a qualified professional valuer to perform the valuation. At 16 February 2019, the management received confirmation that the fair value of the machine cost should be revalued upward by $16 million at 31 December 2019. The revaluation gain does not affect the tax base of the PPE. 7. A provision for current year tax of $7.8 million was required for the year ended 31 December 2019. The balance on current tax account in the trial balance represented the under/over provision of the tax liability the year before. At 31 December 2019, the taxable and deductible temporary differences were $38,000,000 and $29,000,000 respectively. 30% of the deferred tax asset were expected to reverse in the next 12 ACT B332F Group Assignment V2 months. These figures did not include the tax effects arising on the revaluation of PPE in note 6. 8. Moonlight has the practice of offering a 12-month warranty to the products sold. According to the terms and conditions specified in the sales contract, Moonlight undertakes to remedy, by repair or replacement, manufacturing defects that become apparent within 24-months from the date of sale. Past experience indicated the following: (1) Repair costs depend on the extent of the defects: $6 million in case all products will suffer minor defects and $20 million in case all products will suffer major defects; (ii) Moonlight estimated that 60% of the products will suffer no defects. 30% products will suffer minor defects, and 10% products will suffer major defects. vill suffer major defects (iii) Assume all cash flows happen at the end of each year. Ignore time value of money of warranty cost. 9. Assume corporate tax rate is 20%. Required: Prepare the following financial statements for Moonlight in accordance with the legal and professional requirements in Hong Kong (ignore notes to the accounts and express all your answers in thousand dollars): (a) Statement of profit or loss and other comprehensive income for the year ended 31 December 2019. (22 marks) (b) Statement of changes in equity for the year ended 31 December 2019. (10 marks) (c) Statement of financial position of Moonlight as at 31 December 2019. (29 marks) (d) Compute basic earnings per share (EPS) and Diluted EPS of Moonlight for the year ended 31 December 2019. Explain the usefulness of EPS disclosure in the financial statements. (14 marks) Question 2 (75 marks) Moonlight Ltd ("Moonlight') is in the business of designing, manufacturing and supplying various types of glass products for decoration, architecture and residence uses. Thomas Lo, the accountant, is responsible for preparing the financial statements using the financial information below. Trial balance at 31 December 2019 Debit $000 2,700 Credit $000 950,000 433,000 246,300 222,300 4,500 142,000 14.700 360,000 120,000 210,900 300,000 Production machine Property, plant and equipment - at cost - Accumulated depreciation - 1 January 2019 Inventories - 31 December 2019 Accounts receivable Provision for bad debts Accounts payable Bank overdraft Ordinary share capital Preference share capital Retained profits - 1 January 2019 6% convertible debentures Current tax Deferred tax Revenue Provision for warranty cost Bank overdraft interest Interest income Cost of sales Selling and distribution costs General and administrative costs Debenture interests paid Fixed bank deposits Preference dividends paid Dividends paid 1,400 1,600 6,600 1,054,000 5,100 3,600 3,100 645,000 142.000 137,000 15,000 150,000 20,000 117,000 2,653,900 2,653,900 The following notes are also relevant: The total number of ordinary shares outstanding at 31 December 2018 was 27,000,000 shares. Moonlight made a new issue of 3,000,000 shares at its full market price of $3.80 on 1 March 2019 followed by a rights issue of one new for every four existing shares held on 1 August 2019. The exercise price of the rights issue was $1.20 and the average market price immediately preceding the rights issue was $3.60. The total number of preference shares outstanding at 31 December 2018 was 120,000,000. There was no change in the preference shares during the year. Preference shareholders are entitled to fixed amount of dividends each year. ACT B332F Group Assignment V2 1. 2. The 6% convertible debentures were issued on 1 May 2018. Debenture interest is payable half-yearly in artears on 1 November and 1 May. Each $1,000 convertible debenture can be converted for 200 ordinary shares any time after 31 December 2022 3. On 2 January 2019, Moonlight leased a production machine for 6 years with an option to renew for another 2 years under the same terms. At the inception of the lease, the management has expressed intention to renew the lease. The fair value of the machine is $15,500,000. Moonlight is required to make equal annual rental payment of $2,700,000 commencing 2 January 2019. The lease has an implicit interest rate of 10% and the useful life of the leased asset is 10 years. Moonlight adopted a straight-line depreciation for the leased machinery. Moonlight also paid $10,000 in negotiating and signing the lease agreement, and $245,000 initial direct cost as installation and machine testing cost. Moonlight has performed the following entries in relation to the lease: Dr. Production machine Dr. Cost of sales Cr. Bank $2,700,000 255,000 $2,755,000 3. On 2 January 2019, Moonlight leased a production machine for 6 years with an option to renew for another 2 years under the same terms. At the inception of the lease, the management has expressed intention to renew the lease. The fair value of the machine is $15,500,000. Moonlight is required to make equal annual rental payment of $2,700,000 commencing 2 January 2019. The lease has an implicit interest rate of 10% and the useful life of the leased asset is 10 years. Moonlight adopted a straight-line depreciation for the leased machinery. Moonlight also paid $10,000 in negotiating and signing the lease agreement, and $245,000 initial direct cost as installation and machine testing cost. Moonlight has performed the following entries in relation to the lease: Dr. Production machine Dr. Cost of sales Cr. Bank $2,700,000 255,000 $2,755,000 Moonlight leased a luxury car for the use of the Managing Director under a 12-month non-cancelable lease on 1 June 2019. Moonlight made an initial payment of $29,520 upon signing the lease followed by 11 equal monthly payment of $12,000 commencing 1 July 2019. According to the lease agreement, Moonlight has exclusive use of the car during the lease term. The lessor will be responsible for the repair and maintenance of the car. The lease is non-cancellable and the lease transaction qualifies for using the simplified lease accounting model under HKFRS 16. The accounting staff had charged all the lease payments as general and administrative expenses. Moonlight annual incremental borrowing rate is 10%. 5. Moonlight's accounting policy is to provide depreciation on non-current assets based on year-end figures. Property, plant and equipment (PPE) are depreciated over 10 years on a straight-line basis. There were no additions or disposals of PPE during the year. Depreciation on PPE is charged to cost of sales. 6. At 31 December 2019, Moonlight decided to measure its PPE using the revaluation model and has engaged a qualified professional valuer to perform the valuation. At 16 February 2019, the management received confirmation that the fair value of the machine cost should be revalued upward by $16 million at 31 December 2019. The revaluation gain does not affect the tax base of the PPE. 7. A provision for current year tax of $7.8 million was required for the year ended 31 December 2019. The balance on current tax account in the trial balance represented the under/over provision of the tax liability the year before. At 31 December 2019, the taxable and deductible temporary differences were $38,000,000 and $29,000,000 respectively. 30% of the deferred tax asset were expected to reverse in the next 12 ACT B332F Group Assignment V2 months. These figures did not include the tax effects arising on the revaluation of PPE in note 6. 8. Moonlight has the practice of offering a 12-month warranty to the products sold. According to the terms and conditions specified in the sales contract, Moonlight undertakes to remedy, by repair or replacement, manufacturing defects that become apparent within 24-months from the date of sale. Past experience indicated the following: (1) Repair costs depend on the extent of the defects: $6 million in case all products will suffer minor defects and $20 million in case all products will suffer major defects; (ii) Moonlight estimated that 60% of the products will suffer no defects. 30% products will suffer minor defects, and 10% products will suffer major defects. vill suffer major defects (iii) Assume all cash flows happen at the end of each year. Ignore time value of money of warranty cost. 9. Assume corporate tax rate is 20%. Required: Prepare the following financial statements for Moonlight in accordance with the legal and professional requirements in Hong Kong (ignore notes to the accounts and express all your answers in thousand dollars): (a) Statement of profit or loss and other comprehensive income for the year ended 31 December 2019. (22 marks) (b) Statement of changes in equity for the year ended 31 December 2019. (10 marks) (c) Statement of financial position of Moonlight as at 31 December 2019. (29 marks) (d) Compute basic earnings per share (EPS) and Diluted EPS of Moonlight for the year ended 31 December 2019. Explain the usefulness of EPS disclosure in the financial statements. (14 marks)