Tutorial 1

Jane Lazar & Huang (4th ed.)

Chapter 1
Regulatory and Conceptual Framework
 Question 4
a) On 1 January x5, Teng owns a freehold building that has a
carrying amount of RM15 million and has an estimated
remaining life of 40 years. On this date, it sells the building
to Financial Providers for a price of RM20 million and
enters into an agreement to rent the building for an
annual rental of RM2.5 million for a period of five years.
The auditors have commented that in their opinion the
building has a market value of RM16 million only and the
rent for a similar building will only cost RM1 million.
Required:
Discuss how the above transaction should be accounted
for in the books of Teng for the year ended 31 December
x5.
 Question 4
Answer:
Teng has sold the building to Financial Providers.
On examining the proceeds it looks like Teng sold
the building at fair value of RM16 million and
borrowed RM4 million. A loan of RM4 million is
to be disclosed by Teng.
Of the rental paid fair rental of RM1 million
charged as expense and the balance of RM1.5
million will comprise interest and repayment of
loan.
 Question 4
b) Teng also buys five identical plots of development land for RM12 million in
x1. On 1 January x2, Teng sells three of the plots to an investment company,
AME for a total sum of RM15 million. This price is based on 75% of the fair
value of the RM20 million as determined by an independent surveyor at the
date of sale. One of the terms of the sale is that Teng will repurchase the
plots of land for the full fair price of RM20 million any time until December
x4. Also included in the agreement is the term on 1 January x2 AME has the
option to require Teng to repurchase the land for RM20 million.

AME seeks a return of 10% per annum on all its investments.

Required:
Describe the substance of the above transaction and prepare the extracts of
the statement of profit or loss and statement of financial position of Teng for
the year ended 31 December x2.
 Question 4
Answer:
This is a sale and buy back arrangement. Teng has
effectively borrowed RM15 million. The difference between
the RM20 million and RM15 million is the interest for three
years.
Teng has to accrue the annual interest using effective
interest rate on the carrying value of the loan. Interest is
charged as finance cost and the accrued interest is added
to the loan. In the first year, Teng will charge 10% on RM15
million of RM1.5 million as interest. The loan will have a
carrying value of RM15 million plus RM1.5 million of
RM16.5 million at 31.12.x2. In the second year interest
accrued will be 10% on RM16.5 million of RM1.65 million.
Extracts of the statement of profit or loss and statement of
financial position of Teng for the year ended 31 December x2:
Statement of Profit and Loss:
Expenses
Interest on loan RM1,500,000

Statement of Financial Position:

Non Current Liabilities
Loan from AME RM15,000,000
Interest RM1,500,00
Carrying Value RM16,500,000
 Question 5
a) The overriding requirement of a companys financial
statements is that they should represent faithfully the
underlying transactions and events that have occurred.
Therefore, transactions and events have to be accounted
for in terms of their substance rather than their legal
form.

Required:
Describe why it is important that substance rather than
legal form is used to account for transactions, and describe
how financial statements can be adversely affected if the
substance of transactions is not recorded.
 Question 5
Answer:
Substance over form mean that transactions and events are
to be reported as to the commercial or economic reality and
not strictly according to legal form.
The key point of the concept is that a transaction should not
be recorded in such a manner as to hide the true intent of the
transaction, which would mislead the readers of a company's
financial statements.
Thus, someone intent on hiding the true intent of a transaction
could structure it to just barely meet GAAP rules, which would
allow that person to record the transaction in a manner that hides
its true intent.
Example: Company C hides debt liabilities in related entities, so
that the debt does not appear on its balance sheet.
 Question 5
b) On 1 July x6, Wood Wonders has in inventory of unseasoned cut timber
valued at RM36 million. The timber will be sold in three years time when it is
fully seasoned. Wood Wonders enters into an agreement with TT Financiers
to sell the timber for RM40 million with the understanding that Wood
Wonders will buy back the timber in three years time (on 30 June x9) for
RM48 million. Wood Wonders intends to sell the timber for RM60 million on
the same date it repurchases from TT Financiers. The current interest rate is
6.4%. The year-end of Wood Wonders is 30 June.

Required
Assuming that the transactions take place as expected, prepare extracts of
the statement of profit and loss for the years to 30 June x7, x8, and x9 and the
statement of financial position at those dates to reflect the recording of the
transactions based on:
i. Their legal form, and
ii. Their substance
 Question 5
Answer:
Legal Form:
Statement of profit or loss for the year ended 30th June
X7 X8 X9
RMm RMm RMm
Sales 40 0 0
Cost of sales (36) 0 0
Profit 4 0 0

Statement of financial position as at 30th June

X7 X8 X9
RMm RMm RMm
Inventory 0 0 0
 Question 5
Answer (contd.):
Substance:
Statement of profit or loss for the year ended 30th June
X7 X8 X9
RMm RMm RMm
Sales 0 0 60
Cost of sales (0) (0) (36)
Gross Profit 0 0 24
Interest (2.56) (2.72) (2.72*)
6.4% x RM40m 6.4% x RM42.56m
th
Statement of financial position as at 30 June RM48m RM45.28
X7 X8 X9
RMm RMm RMm
Inventory 36 36 0
Loan (plus interest) 42.56 45.28 0
* rounded
 Question 7
As at the end of the financial year 31 December x5. Sunny Sdn
Bhds trade receivables has a balance of RM12 million net,
after RM3 million of trade receivables are sold for
RM2.9million to Country Financier on 20 December x5. The
difference of RM100,000 is charged as finance cost. Sunny Sdn
Bhd has to refund to Country Financier any amounts relating
to trade receivables that remain uncollected by Country
Financier after a period of three months.

Required
Advise Sunny Sdn Bhd on the proper accounting treatment of
the trade receivables that are sold. Substantiate your answer.
 Question 7
Answer:
The accounts receivable of RM3 million were
discounted on a recourse basis. This means that
Sunny bears the risk on the receivables (such as
slow payment or even default). In substance, Sunny
has borrowed RM3 million and the RM100,000 is
the interest for the borrowing. The accounts
receivable should be restated at RM12 million plus
RM3 million and a loan of RM3 million.
 Question 8
In April x2, Tripper sold inventory that has a carrying amount (cost) of RM6
million to Cashflow, a finance house for RM10 million. The fair value of the
inventory is RM10 million over its cost. The inventory will remain in Trippers
premises and will be ready for sale in four years time. The contract allow
Tripper to repurchase the inventory at any time at a price of RM10 million
plus interest at 10% per annum compounded from 1 April x2. Storage cost of
the inventory will be borne by Tripper, and the current years storage cost is
RM600,000 which is included in the accounts receivables of Tripper. If Tripper
does not repurchase the inventory, Cashflow will pay the accumulated storage
cost on 31 March x6. Tripper has received the cash and the sale is included in
Trippers sales revenue.

Required
Explain how the above transactions should be treated in Trippers financial
statements for the year ended 31 March x3.
 Question 8
Answer:
The proceeds of RM10 million cannot be taken as sales revenue as the
substance of the transaction appears to be a loan of RM10 million
secured on inventory. This is because Tripper has control over the
inventory being able to buy back the inventory any time. Other factors
to look at are:
Sale price was below fair value --- not at arms length
Storage costs borne by Tripper
Repurchase price is based on sale price plus 10% compound
interest rather than fair market price.
Cashflow is not a finance house and may not be able to bring the
inventory to market.
Tripper has to recognise a loan of RM10 million. Interest of 10% is to
be charged as expense along with storage cost.