QUESTION 1
Africa Ltd is a diversified company with a 31 December financial year end. The company is incorporated in South Africa and listed on the JSE Ltd. The group has applied International Financial Reporting Standards (IFRS) since 1 January 2000 and is not a first time adopter of IFRS in 2005.
Kenya Ltd
Africa Ltd acquired 40% of the ordinary shares of Kenya Ltd on 1 November 2005 for R10 million. On that date Africa Ltd considered all the assets and liabilities of Kenya Ltd to be fairly valued, with the exception of Kenya Ltd's machinery.
On the same date Africa Ltd also acquired an option for a further 40% equity interest in Kenya Ltd that could be exercised at any time on or after 1 November 2005. The option had not yet been exercised by 31 December 2005, and Africa Ltd has no intention of doing so in the foreseeable future. The option had a cost and fair value of nil on 1 November 2005 and a fair value of R800 000 on 31 December 2005.
The following pertains to the machinery of Kenya Ltd:
• On 1 October 2005, the directors of Kenya Ltd approved a decision to outsource the company's production function and they accordingly decided to sell the company's own machinery. The machinery was withdrawn from use immediately and advertised for sale. At that date the fair value was R17 million.
• On 1 October 2005, before the outsourcing decision, the net book value of the machinery was R18 million, comprising a cost of R30 million and accumulated depreciation of R12 million. The latter included the current year's depreciation to 1 October 2005.
• On 1 November 2005, the date of acquisition by Africa Ltd, the fair value was R21 million.
• On 31 December 2005 the machinery had a fair value of R20 million, as a result of a change in market conditions during December 2005.
• During the period 1 October 2005 to 31 December 2005 expected selling costs remained fixed at R500 000.
• Although the machinery had not yet been sold by 31 December 2005, the directors of both Kenya Ltd and Africa Ltd remain committed to the plan to sell the machinery.
Machinery owned by Africa Ltd itself
Machine 1
Africa Ltd acquired Machine 1 on 1 January 2004 at a cost of R63 million. At acquisition, Machine 1 was expected to have a residual value of R3 million.
During the 2005 financial year, nine-year-old machines similar to Machine 1 were selling for R2 million. Machine 1 had a revised remaining useful life of seven years at 31 December 2005.
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Machine 2
Machine 2 was acquired on 1 January 2004 at a cost of R40 million. Africa Ltd does not expect the machine to have a residual value at the end of its useful life as government regulations require this type of machine to be dismantled at that time. The following applies to the end of its useful life:
• On 1 January 2004, based on estimates made by independent consultants, Africa Ltd expected the dismantling costs to amount to R4 million. During 2005 these costs were revised to R4,5 million.
• The obligation to incur the dismantling costs in terms of the government regulations arose on 1 January 2004.
• If the machine is not dismantled at the end of its useful life a fine is payable which will amount to 200% of what the estimated dismantling costs would have been.
• Taking into account the risks associated with the obligation to dismantle the asset, Africa Ltd has determined a fair rate of interest to be 15% (before tax) and 10,5% (after tax).
Machine 3
Machine 3 was ordered from France on 1 May 2005 in terms of a non-cancellable order and was delivered to Africa Ltd on 1 July 2005 at a cost of €4 million. The amount owing to the supplier was settled in cash on 10 July 2005. Africa Ltd installed and tested the machine during the period 1 July 2005 to 31 July 2005 (the date that the machine was ready for use) at a cost of R200 000. Production using the machine commenced on 1 September 2005.
On 1 May 2005, Africa Ltd entered into a forward foreign exchange contract (FEC) to purchase €4 million, for delivery on 10 July 2005. Africa Ltd designated this FEC as a cash flow hedge of the changes in the spot exchange rate for the period 1 May 2005 to 30 June 2005. For the period 1 July 2005 to 10 July 2005, Africa Ltd designated the FEC as a fair value hedge of the forward exchange rate in the creditor. The hedge met all the criteria of IAS 39, Financial instruments: recognition and measurement (AC 133), par. 88. The fair value of the FEC was as follows:
Date AsFsaeitr/( vliaalbuieli ty)
R
1 May 2005 -
1 July 2005 (518 272)
10 July 2005 (280 000)
Accounting policies and additional information
• The following exchange rates applied:
Date Spot
rate
Forward to
10 July 2005
1€ = R 1€ = R
1 May 2005 8,55 8,65
1 July 2005 8,50 8,52
10 July 2005 8,58 N/A
31 December 2005 8,80 N/A
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• The group accounting policy for property, plant and equipment is the cost model.
• Machinery is depreciated on a straight-line basis over ten years unless otherwise indicated.
• All items of machinery are assumed to have a residual value of nil unless otherwise indicated.
• The group calculates the effect of changes in the estimates of residual values, useful lives and dismantling costs with effect from the beginning of the year in which the revised estimate is made.
• There was no impairment of assets.
• The group's accounting policy is to remove the gains or losses recognised directly in equity in respect of cash flow hedges and include them in the initial carrying amount of the related asset or liability when that asset or liability is recognised.
• All companies in the group have a 31 December financial year end.
• Ignore value added tax (VAT).
REQUIRED
(a) Discuss the appropriate recognition, measurement and presentation (and include amounts where appropriate) of the machinery owned by Kenya Ltd in the 2005 consolidated annual financial statements of Africa Ltd. The discussion must include the recognition, measurement and presentation of any adjustments in the consolidated annual financial statements to the machinery owned by Kenya Ltd from the acquisition date to the year end.
(b) Prepare journal entries to record the purchase of Machine 3 and to record the FEC from the date of inception to the date of settlement by applying the appropriate hedge accounting principles.
(c) Based on the information provided, calculate the depreciation expense relating to machinery that will be disclosed in the notes to the 2005 consolidated annual financial statements of Africa Ltd.