Assignment:
SCENARIO BACKGROUND
Ukhozi Airlines is a brand new airline aiming to target a very specific market; working parents who have to travel short-haul for business purposes. The unique selling point of the airlines is that it caters specifically for these people by offering a number of services that take into account their family situation.
An article appeared in a local newspaper after a recent interview with the company's founder, Denise Anderson.
Read Dailynews.pdf
DAILY NEWS
Ukhozi takes to the sky
Now you can bring your family along when working those long hours abroad. The new kid in town in the airline industry is the medium-sized luxury airline called Ukhozi. Its founder, Denise Anderson, is a former executive of a listed company.
Like many jetsetters, in the past she spent at least 50 percent of her working week in the air. The airline was conceived when she flew with her three-year-old son two years ago. When she walked into the business lounge with a three-year-old boy, you could have sworn that she was carrying a hand grenade. There was just this inexplicable fear in everyone's eyes. The idea of the "family business class" hit her.
Ukhozi is a Zulu name for an eagle. Zulu is one of the languages Denise learned during her travels to South Africa.
The airline's specialty is family business. On its planes, it provides a family room (which has space for four people) and a private bathroom. While the target market was originally working mothers, the family room has become very popular with honeymooners.
Setting up the company required a lot of upfront investment. The company invested in two buildings, one in Paris, and one in London. Two planes have been acquired. There was also a lot of initial investment in computers and software.
During the interview we had last week, Denise responded to the company's enormous set-up costs by saying, "Nothing ventured, nothing gained." We asked her if it was risky to launch such a luxury product during the current slump in the industry.
Denise said that her biggest challenge has been to find financiers for the two planes acquired during the Paris Airline Exhibition. It was easy to raise finance for the two buildings, but the renovation costs were very high. She says these costs were necessary to bring the buildings to the right standard. The market value of Paris buildings has increased by 10 percent. The cost of training staff on computer systems has been reasonable so far.
When we asked Denise if there has been anything surprising about her adventure, she indicated her surprise in the number of fathers who have brought their children along while on business. "All my stereotypes have been challenged, and to be fair, that's good, since my business is about breaking down barriers."
Training the new assets clerk
You are the head office accountant of Ukhozi Airlines. Christine Adams was recently appointed as assets clerk of Ukhozi. You'll be assisting Christine with any questions she has in order to provide on-the-job training. Christine also needs some assistance in organizing the assets file left behind by the previous assets clerk.
You have received an email from Christine, who is currently busy familiarizing herself with Ukhozi's assets system.
"Hi there,
I've left the assets file that the previous assets clerk prepared on your desk for you to look through. I identified some significant accounting issues that require your intput. Before you start looking through it, I have a question for you.
We have purchased two passenger aircraft from Going, and have apitalized some costs to the cost of the asset. I would like to know if this is in compliance with IAS 16.
Also, we had to transport our planes to base airports before they could be used commercially. Can this cost be included too?
Many thanks,
Christine Adams
PS. Good luck with the file."
1. What cost cannot be capitalized to the cost of Ukhozi's aircraft under IAS 16?
a. Purchase price
b. Refundable taxes
c. Costs to transport planes to base airport before commercial use
d. Non-refundable taxes.
2. Which training costs can also be capitalized to the cost of Ukhozi's aircraft?
a. Cargo and baggage handling
b. Flight crew and pilots
c. Management
d. None of the above.
The assets file
The first document you look at is a copy of an internal memo to Ukhozi's management.
M E M O
TO: All management staff
FROM: Denise Anderson
Re. Purchase of land and development of play center
The piece of land we acquired last year close to our London Airport base has been put to good use!
We've just finished construction of the Ukhozi Airlines play center and mini theme park. These facilities are designed primarily as a day care center for the children of our customers-many parents complete round-trips within a day, and can now leave their kids to play under the supervision of our trained childcare attendants for up to 10 hours.
We expect the play center to operate for the next 10 years, at which point the airport authority has plans for expansion. We'll have to dismantle this structure at that point and relocate it.
It is estimated that it will cost Ukhozi Airlines €2 million to dismantle the building and €5 million to build, but we think it's a worthwhile price to pay in order to offer our customers this unique service.
Would all managers please circulate this information across their teams?
Thanks, Denise
3. How should Ukhozi account for the expected dismantling cost of the play center?
a. Expense it when they initially recognize the building.
b. Expense it in the future when they incur the expenditure.
c. Capitalize it in the future when they incur the expenditure.
d. Capitalize its present value to the cost of the building during construction.
MEMO related to aircraft parts
- The wings of the plane have to be maintained every two year, and if the wings are found to be below aviation standards, they are replaced.
- The body of the plane has a useful life of 20 years.
- Ukhozi has signed an agreement with Going to upgrade the EBF systems every three years.
- Yhe seats of the plane have to be refurbished every four years.
- Each of these items is significant in relation to total cost and meets the recognition criteria.
4. Having read the MEMO, what is the appropriate accounting treatment for the aircraft?
a. Recognize and depreciate the plane over the life of the body of the plane.
b. Recognize the plane as the only asset and depreciate it over the average useful life of all the components.
c. Recognize each significant component as a separate asset and depreciate it over its specific useful life.
d. Recognize the body of the plane separately from other components, and depreciate both parts separately over their average useful life.
5. Which factors should be considered in determining an appropriate depreciation method?
a. The impact it will have on profit and the nature of the asset.
b. The market value of the asset and the nature of the asset.
c. The pattern of consumption of economic benefits and the nature of the asset.
d. The income tax regulation and the pattern of assumption of the economic benefits.
A letter from the operations manager
In our earlier discussions, you indicated that the depreciation method should reflect expected consumption of future economic benefits.
Note that the safety regulations require that the engine be replaced after 10,000 flying hours. It is estimated that the plane will fly the following hours each year:
Year 1: 1,000
Year 2: 2,500
Year 3: 2,500
Year 4: 2,500
Year 5: 1,500
The cost of the engine is €6,000,000. The residual value of a 5-year-old engine which has been used for 10,000 flying hours on the date the asset was recognized was estimated to be €1,000,000.
6. Explain the most appropriate method of depreciation for the engines on the Ukhozi aircraft.
7. What is the depreciation charge for the engines that Ukhozi should recognize in year 1?
a. 1.000.000
b. 500.000
c. 600.000
d. 400.000
8. In year 2, the residual value of the engine that operations manager mentions in his letter has doubled to € 2.000.000. Should Ukhozi revise the depreciable amount given the change in residual value?
a. No, because the expected consumption of economic benefits has not changes.
b. No, depreciable mount should only be determined once, and that is at the date of acquisition.
c. Yes, because the expected consumption of the economic benefits has changed, with an adjustment to depreciation already recognized.
d. Yes, because the expected consumption of the economic benefits has changed, but historical depreciation should not be adjusted.
9. Ukhozi has not used one of its computers for the entire year, but only for six months of the year. As a result, only six months' depreciation has been charged in the current year. Computers are depreciated on a straight-line basis. Is this treatment appropriate?
a. This is correct, as depreciation reflects consumption of economic benefits.
b. This is correct, as the asset is temporally idle and should be depreciated on a pro-rata basis.
c. This is incorrect, no depreciation should be recognized since the asset is only used for half a year.
d. This is incorrect, depreciation of the asset does not cease when the asset is temporarily idle.
Another problem
The financial director indicated that Ukhozi intends to revalue the Paris property, which can be done very nicely in terms of its value. The London property will be left untouched, as the industry experts tell that the UK market has flattened out lately.
10. Which of these statements is appropriate:
a. Ukhozi's properties shall be carried at cost less accumulated depreciation and any accumulated impairment losses (cost method).
b. Ukhozi's properties shall be carried at a revalued amount, being its fair value at the date of revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses (revaluation method).
c. IAS 16 allows both the cost method and the revaluation method described in option 1 and 2 for Ukhozi's properties.
d. IAS 16 allows both the cost method and the revaluation method described in option 1 and 2 for Ukhozi's properties but the chosen accounting policy should be applied consistently to the entire class of PP&E.
MEMO regarding buildings
The building in Paris was acquired for €20 million. It is expected to have a useful life of 30 years. The market value of an equivalent 30-years-old building is originally estimated to be €5million,but is revised to around €6 million based on current market conditions. The market value of the Paris building will be about €21million.
The London building was acquired for €35 million. It is expected to have a useful life of 30 years. The market value of an equivalent 30-years-old building is estimated to be €5 million.
11. Calculate the carrying amount of the Paris building at the end of year 1 under the cost model using the straight-line method.
a. €19.333.334
b. €19.466.667
c. €19.500.000
d. €19.533.333
12. Calculate the surplus on the revaluation if the market value increases to €21,45 million and the residual value increases to €6 million.
a. €1.450.000
b. €1.916.666
c. €1.950.000
d. €1.965.000
13. Since the building has not been sold, is it appropriate to recognize the revaluation surplus in other comprehensive income?
a. Yes, generally.
b. No, in profit and loss.
c. No, in the retained earnings.
d. Yes, but only if it's the first revaluation.
14. About the building in Paris remember that the market value is €21,45 million - an increase since the asset was acquired. The residual value has increased to €6 million. What is the appropriate depreciation charge in relation to the Paris building during year 2?
a. €500.000
b. €739.655
c. €532.758
d. €722.414
15. Once Ukhozi realized they would also have to revalue the London building, they considered releasing the revaluation surplus accumulated in equity as the properties were used or sold. Which of the following statements is correct?
a. The revaluation surplus may be released to profit or loss as the asset is depreciated.
b. The revaluation surplus may be released to profit or loss as the asset is sold.
c. The revaluation surplus may be transferred directly to retained earnings as the asset is depreciated or sold.
d. The revaluation surplus should be taken into account in determining the profit or loss on disposal.
16. The second airplane has not been used to its full capacity. Ukhozi must write down the value of the second airplane? (remember that the company uses the cost model for airplanes). What should you advise to do?
a. Do nothing, as it is normal for some assets not to be fully utilized.
b. Do nothing, as there is no need to test the asset for impairment under the cost model.
c. No impairment loss is recognized unless the airplane is to be taken out of use to be sold.
d. Asses the airplane for impairment. If it is impaired, recognize the impairment loss in profit or loss.