You are the senior accountant at Pern Limited (Pern). Pern is a JSE listed company and the financial year end is 30 June 2022.
You are in the process of completing the recording and financial statement presentation and disclosure of the lease transactions for the financial year. Detailed below is a summary of the only lease transaction:
- Date of inception, 1 October 2021.
- Position of Pern to the lease, lessee.
- Lease payment, R1 000 per month in arrears.
- Lease term, 2 years.
- Rate implicit in the lease, 10% per annum.
- Description of asset leased, Printer and Copier Machine.
- IFRS 16 classification, operating lease.
The financial manager has requested that you take full responsibility for the processing of all respective transaction above, as well as any presentation and disclosure of the transaction in the financial statements.
Additional information:
- You can ignore the effects of inflation on the lease payments stated above.
- You can ignore the effects of taxation.
- Pern’s WACC rate is 15%.
| 1.1 | Calculate the value of the right of use asset and lease liability at inception of the lease. You will need to prepare an amortisation schedule for the lease to calculate its present value. |
| 1.2 | Prepare the journal entries to account for the lease for the financial year ended 30 June 2022. Narrations are not required. Please round the initial value of the lease liability and right of use asset to the nearest whole number. |
TJM (Pty) Limited (TJM) is a small-medium sized company with operations only in South Africa. They manufacture a variety of plastic and glass based products.
You have been requested to review the Weighted Average Cost of Capital (WACC) calculation of TJM. Below is a breakdown of the calculation:
| Ordinary Shares Currently the authorised share capital of TJM is 100 000 shares, of which 50 000 have been issued. The share price of Delmoro Limited (DL), which is a similar company listed on the JSE, is R37.50. DL has operations globally and TJM is significantly smaller than DL. CAPM (Capital Asset Pricing Model) was supposed to be employed to calculate the rate of return; however, the risk free rate cannot be obtained. The expected return on the market was estimated as 15% and the Beta of DL is 0.8. However, TJM’s return on equity is 13%, and that has been used in the calculation. |
| Debentures There are 50 000 debentures in issue with a book value of R30 each. The coupon rate on the debentures is 15%. It was noted that, to attract new debenture holders, the required return would need to be 22.5% at a price of R35 each. |
| Lease Liability TJM has a lease liability on its manufacturing plant. The lease liability value on the face of the statement of financial position is R1.5million. The rate implicit in the lease is 25% and if the lease were to be refinanced, the rate implicit in the lease would be 27.5%. |
| Accounts Payable The creditors ledger has been discounted using the rate implicit in all contracts of 5%. |
| Deferred Tax The value in the balance sheet has been used and the rate used is the tax rate used to calculate deferred tax. |
| Source | Market Value (R) | Rate | Weighting |
| Ordinary Shares | 3 750 000 | 13% | 6.5% |
| Debentures | 1 500 000 | 15% | 3% |
| Lease Liability | 1 500 000 | 25% | 5% |
| Accounts Payable | 100 000 | 5% | 0.67% |
| Deferred Tax | 650 000 | 28% | 2.43% |
| Total | 7 500 000 | ||
| WACC | 17.6% |
Side Note:
WACC is a measure of financial returns for financial capital providers. According to King IV, there is a need to consider all providers of capital, not just financial.
| 2.1 | Identify and discuss what rate should be used as the risk free rate for TJM. Your answer must provide a source reference about where the rate has been obtained from. |
| 2.2 | Critically evaluate the WACC calculation provided. Calculations are not required. |
| 2.3 | With reference to the side note, discuss the appropriateness of using WACC as a measure for calculating the viability of investments in the context of King IV and ESG practices. |
HXM Limited (HXM) is listed on the JSE. The company is in the process of investing in a new project. As the treasury manager, you have been tasked with using the information provided below to recommend whether proceed with the investment in the project.
Original Cost – R2.5million Revenue – R250 000 per annum
Variable Costs – R100 000 per annum
Fixed Costs – R50 000 (rental of the factory space currently under use) Depreciation – R312 500
Useful life – 8 years
SARS Allowance – 5 years
Net cash flow expected after 5 years – R150 000 after tax as at the end of year 5. CPI – 6%
WACC:
| Source | Market Value (R) | Rate |
| Ordinary Shares | 500 000 | 15% |
| Preference Shares | 750 000 | 17.5% |
| Debenture | 1 000 000 | 20% after tax |
Additional Information:
- The tax rate is 28%
Any assessed loss can be used on other projects
| 3.1 | Using first principles, derive the formula that can be used to calculate the terminal value for the project. |
| 3.2 | Calculate the present value of the terminal value of the project. |
| 3.3 | Calculate the Net Present Value of the project. |
LDF Limited (LDF) is a company listed on the JSE. LDF’s financial year end is 30 June 2022. As the financial manager, you are in the process of clearing the misstatements detected by the auditors. The reason you are clearing these misstatements is so that an unqualified opinion can be obtained.
Below is an extract of the auditors schedule of misstatements:
| Reference | Type | Description |
| AM 1 | Factual | Plant has not been depreciated for the past 5 years. |
The buildings were purchased on 28 February 2016 and were available for use immediately. The cost of the plant was R25million and the residual value is estimated to be R3.5million. The useful life is estimated at 15 years. On 31 December 2021, an actuarial valuation of the plant was obtained and LDF should have processed a revaluation. This was not done. The net replacement cost of the asset was estimated to be R20million. LDF uses the revaluation model per IAS 16 as its accounting policy for all of its PPE. LDF has elected to use the net replacement value method to account for revaluations and the straight-line basis to account for depreciation.
Revaluation vs cost model
International Financial Reporting Standards, IFRS, allow for the use of the revaluation and cost models. Both are on the extremes of how to measure the value of a transaction. The reason this exists it to balance the interests of all parties that contribute towards the development of IFRS. The International Accounting Standards Board (IASB) aims to balance all interests. The extremes in measuring a transaction fall under two possible methods namely, neoliberalism and stewardship.
Additional Information:
- Full IFRS is adopted by LDF.
- The effects of taxation and deferred taxation can be ignored.
- The residual value of the plant is estimated to be zero.
| 4.1 | With reference to Revaluation vs Cost Model, discuss how the IASB has balanced the views of its stakeholders with the way in which IAS 16 has been developed. The context of your discussion must be with reference to neoliberalism and stewardship in terms of its accounting definitions. |
| 4.2 | Describe what is meant by the “agency theory” in the context of accounting and commerce. |
| 4.3 | Prepare the correcting journals to fully account for the plant. Narrations are not required. |
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The calculations of the value of the right of use asset and lease liability at inception of the lease is performed as follows……
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