Page 17 - CIMA MCS Workbook May 2019 - Day 2 Suggested Solutions

SUGGESTED SOLUTIONS

IAS 16 therefore requires that the C$1m cost of constructing the extension should be capitalised
and then depreciated over the useful live of the asset.

The cash flow aspect of constructing an extension to the building will be similar to that for
purchase of additional premises. However, it is likely that the cash outlay will be staggered over
several months as construction work progresses. Building the extension also has the advantage
that it is expected to incur a lower total cash outlay, if the estimates are reliable.

Rent a warehouse

To determine whether an agreement contains a lease, IFRS 16 leases (IFRS 16) provides the
following definition of a lease; ‘a lease is a contract that conveys the right to control an identified
asset for a specified period of time in exchange for consideration’. This definition excludes an
asset of low value and any agreement of twelve months or less.

Control enables the user to decide how to use the asset, which may be subject to conditions that
do not unduly hinder its unrestricted use. For example, a lease to hire a specific vehicle may state
that it cannot be used for rallying or racing, or that it cannot be taken out of the country. In the
case of a warehouse, it may specify that, for example, that cannot be used as an indoor sports
arena because there it does not contain any changing or showering facilities. Control of an asset
also implies that you are able to stop or restrict others from using the asset without your
knowledge or consent.

If an agreement meets the definition of a lease, as would seem to be the case here, IFRS 16
requires that a right‐of‐use asset and right‐of‐use obligation should be recognised in the financial
statements. The obligation will be based upon the present value of payments discounted at the
rate implicit within the agreement. The obligation will then be subject to an annual finance charge
which will increase the obligation, but which will be reduced by the amount of the annual
repayment. The liability outstanding at each reporting date should then be split and classified as
either a current or non‐current liability.

The right‐of‐use asset will be based upon the initial present value of the lease obligation, plus any
direct, incremental, costs incurred to enter into the agreement. In the case of leased premises,
which could be lawyers and surveyors fees as part of entering into the lease agreement. It follows
that initial recognition of the right‐of‐use asset may not be at the same value as initial recognition
of the right‐of‐use obligation. The right‐of‐use asset, like any other asset used in the business for
more than one accounting period, will be subject to an annual depreciation charge.

The benefit of leasing the warehouse is that it spreads the cash outlay over the lease period,
rather than being incurred up‐front. However, at the end of the lease period, control of the asset
will revert to the owner, whereas with the other two possibilities, Jord Homes will have
ownership of either an additional asset or an enhanced asset. Lease payments would be classified
as cash outflows under the heading ‘finance activities’.

Finance Manager

KAPLAN PUBLISHING 101