Page 16 - CIMA MCS Workbook May 2019 - Day 2 Suggested Solutions

CIMA MAY 2019 – MANAGEMENT CASE STUDY

CHAPTER TEN

TASK 1 – BUSINESS EXPANSION PLANS

Suggested solution

From: Finance Manager
To: FD
Date: Today

BRIEFING NOTE

Purchase of additional premises
The purchase of additional premises for use in the business would be accounted for in accordance
with IAS 16 Property, plant and equipment (IAS 16).

IAS 16 requires that the C$2m cost of new premises purchased should be capitalised. The
capitalised cost should also include any additional direct costs incurred to acquire the premises,
such as legal and professional fees incurred when purchasing the premises.

The capitalised cost should be depreciated over the expected useful life of the asset. For
premises, this would normally be depreciated on a straight‐line basis, so that the same charge is
made in the statement of profit or loss each year.

The purchase of additional premises would require a significant cash outflow, which Jord Homes
could probably finance based upon the most recent financial statements. This would be classified
as ‘investing activities’ cash outflow in a statement of cash flows.

It may also be possible to raise loan finance to pay for the premises, which would limit the initial
cash outflow, but which would incur annual finance charges and require regular loan repayments
over an agreed period of time. The loan liability would be classified between current and non‐
current elements in the statement of financial position. The receipt of the loan would be classified
as a cash inflow within ‘financing activities’, with the periodic loan repayments classified as
‘financing activities’ cash outflows for each year they are incurred.

Build a factory extension

As with the purchase of additional premises, the construction of an asset for own use would be
accounted for in accordance with IAS 16 Property, plant and equipment (IAS 16).

As there will be increased factory space, this would be regarded as enhancement of an asset
which will probably lead to increased future economic benefits. Therefore, the additional costs
incurred should be capitalised and depreciated over the estimated time period those costs are
expected to generate future economic benefits. If a contractor is engaged to construct the
extension, the costs incurred will be relatively easy to confirm e.g. from invoices etc. submitted by
the contractor. In the event that Jord Homes was going to construct the extension, it should
capitalise direct labour costs based upon e.g. salary records and time sheets, along with direct
materials and other direct costs incurred on the construction.

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