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Calculation Of Finance Lease Straight Line Method Finance Charge Accounting Essay

Total lease payment = 5*6000= 30000 (Less) Market Price of asset = 22000 8000 Allocation of finance charge: = Finance charge = 8000/5 = 1600 No: of years Depreciation: = Market Value =22000/5= 4400 Useful life Liability Schedule:

Years

Liability at Beginning

Finance charge

Total

Payment

Liability at end

1

22000
1600
23600
6000
17600

2

17600
1600
19200
6000
13200

3

13200
1600
14800
6000
8800

4

8800
1600
10400
6000
4400

5

4400
1600
6000
6000

Stage of completion (Surveyor’s method)

Years

Recognised Previous Year

Recognised Current Year

1

500000*32/100=160000
NIL
160000

2

500000*68/100=340000
160000
180000

3

500000*100/100=500000
340000
160000

Profit Table

Year

1

2

3

Revenue

160000
180000
160000

(Less) Cost

60000
105000
135000

Profit

100000

75000

25000

PART A

STATEMENT OF COMPREHENSIVE INCOME FOR AL SHARQIAH LLC FOR THE YEAR ENDING DECEMBER 31ST 2009

PARTICLARS
AMOUNT(OMR)
AMOUNT(OMR)
Sales
178800
Add -Construction Revenue
160000

Net sales

338800

Less-Cost of Goods sold

Opening stock
12500
Add – Purchases
80000
Add -Carriage Inward
1200
Less-Closing Stock
(21000)
Less-Return Outward
(1200)
Add -Construction Cost
60000

(131500)

Gross Profit

207300

Less-Indirect Expenses

Bad Debts
1000
Carriage Outward
800
Electricity Expenses
2400
Rent
5000
Insurance Premium
3000
Repairs and Maintenance of Furniture
1500
Building Repairs
2000
Finance Charge
1600
Depreciation
4400
Salaries
12000

33700

Net Profit

173600

Question (B) (Working)

Calculation of finance lease (Sum Of Digit)

Finance charge:

Total lease payment = 5*6000= 30000
(Less) Market Price of asset = 22000

8000

Allocation of finance charge:

Sum of digits= 5+4+3+2+1=15
Year

Total
1
5/15*8000
2667
2
4/15*8000
2133
3
3/15*8000
1600
4
2/15*8000
1067
5
1/15*8000
533

Depreciation:

= Market Value =22000/5= 4400
Useful life

Liability Schedule:

Years

Liability at Beginning

Finance charge

Total

Payment

Liability at End

1

22000
2667
24667
6000
18667

2

18667
2133
20800
6000
14800

3

14800
1600
16400
6000
10400

4

10400
1067
11467
6000
5467

5

5467
533
6000
6000

Stage Of Completion:

Percentage of Completion:

Year
1
2
3

60000 300000
165000 300000
300000 300000
20%
55%
100%

Schedule:

Years

Recognised Previous Year

Recognised Current Year

1

500000*20/100=100000
NIL
100000

2

500000*55/100=275000
100000
175000

3

500000*100/100=500000
275000
225000

Profit:

Year

1

2

3

Revenue

100000
175000
225000

(Less) Cost

60000
105000
135000

Profit

40000

70000

90000

PART B

STATEMENT OF COMPREHENSIVE INCOME FOR AL SHARQIAH LLC FOR THE YEAR ENDING DECEMBER 31ST 2009

PARTICLARS
AMOUNT(OMR)
AMOUNT(OMR)
Sales
178800
Add -Construction Revenue
100000

Net sales

278800

Less-Cost of Goods sold

Opening stock
12500
Add – Purchases
80000
Add -Carriage Inward
1200
Less-Closing Stock
(21000)
Less-Return Outward
(1200)
Add -Construction Cost
60000

(131500)

Gross Profit

147300

Less-Indirect Expenses

Bad Debts
1000
Carriage Outward
800
Electricity Expenses
2400
Rent
5000
Insurance Premium
3000
Repairs and Maintenance of Furniture
1500
Building Repairs
2000
Finance Charge
1067
Depreciation
4400
Salaries
12000

(33167)

Net Profit

114133

Question (C)

The net profit figures are different in A and B since the method used for calculating the finance lease in A is straight line method and for determining the stage of completion is surveyors method for construction contracts whereas in B sum of digits is used to calculate finance lease and costs is used for calculating stage of completion of construction contracts.
Cost method for calculating the stage of completion for construction contract is more accurate since it gives a clear picture of the revenue and costs that the company has incurred currently rather than estimating the revenue and cost using the surveyor’s method since in this method the stage of completion is estimated by the surveyor which may not be accurate and may vary year to year.
Calculation of finance charge using straight line method is much simpler as it is very easy to calculate the finance charge and the amount remains the same throughout the calculation (finance charge). Whereas sum of digits provides a more accurate answer but is little complex.
At the end it can be concluded by saying that calculation of finance lease using sum of digits and calculation of stage of completion using cost method gives us a true as well as a clear picture of the company’s performance.

Question (D)

Finance Lease (IAS 17)

Lease is an agreement signed by two or more parties where the lessor gives a payment or series of payment to the lessee to use an asset for an agreed time period.
There are two types of lease finance and operating. Finance lease is lease where all the risks and rewards of an asset are transferred. Operating lease is a lease other than finance lease.

Methods for calculating finance lease:

Actuarial Method:

It is said to be the most accurate method of calculating finance charge but on the same time it is also includes complex calculations.

Sum of Digits Method:

It is a method which is easier to apply than the actuarial method. It is widely used because of its simplicity and accuracy. The finance charge is allocated in a reducing scale to the accounting period.

Straight-line method:

In this method the finance charge is allocated equally over the number of years of the lease. This method is generally not used since it is used only for immaterial leases. It is the simplest method among all the methods but is not very accurate. The finance charge remains the same throughout the lease.

Disclosers

Finance Lease:

Cost related for acquiring assets for the purpose of finance lease
Accounting policy for finance lease.
Total rentals received for an accounting period.
Total investment.

Operating Lease:

Accounting policy for the operating lease.
Depreciation charges and amounts of assets held for operating leases.
Total rentals received for an accounting period.

Construction Contracts (IAS11)

Construction contract is a contract that is specifically negotiated for the construction of an asset or combination of assets that are closely interrelated or interdependent in terms of their design, technology, function etc.
There are two types of contracts. Fixed-price contract is a contract where the contractor fixes a fixed price for the contract, which in some case is subject to cost appreciation clauses. Cost-plus contract are those where the contractor is paid for the allowable costs plus a percentage of these costs or a fixed fee.

Objective

This standard prescribes the accounting treatment of costs and revenue related to construction contract. Since the date at which the contract is entered into and the date the activity is completed usually fall in different accounting period.

Methods for calculating stage of completion:

Cost Method:

It is a method where the percentage of completion is calculated using the cost incurred each year divided by the number of years. This method gives a clear picture of the revenue and profit as it is based on real figures.

Surveyor Method:

It is a method where the percentage of completion is calculated using the percentage of completion given by the surveyor. This method is not considered to be accurate since the data given by the surveyor might not always be exactly the same as it is supposed to be.

Physical completion Method:

It is a method where the percentage of completion is calculated by dividing the year upon total number of years in a percentage form. It is not much accurate as compared to cost method.

Disclosure

Amount of revenue recognized
Method used to calculate revenue
Method used to find the stage of completion
Advance received
Total cost incurred and estimated profit

Event after the balance sheet date (IAS 10)

Objective

This accounting standard requires financial statements to reveal all the conditions that have been existed at the date of balance sheet. A time period of two months is given after the year end if the financial statements need to be adjusted before it is authorized by the directors and auditors.
There are two types of events that are considered in this standard:

Adjusting Events:

These are events where the information becomes available that gives evidence of the conditions that existed at the date of balance sheet. The entity is supposed to adjust the amounts recognized in the financial statements of the company to show adjusting events after the balance sheet date.
Example:
A fraud happened on 20th May 2009 and was only discovered in 25th January 2010. (Year ending 2009)
The accounting treatment according to IAS 10 prescribes it to be adjusted in the financial statements.

Non-Adjusting Events:

These are events that take place after the date of balance sheet date but not existed at the date of balance sheet date. These events are so material that non-disclosure would highly affect the users of these financial statements and have a proper understanding of the financial position.
Example:
A fire broke out in the store on 20th January 2010 destroying all the goods worth $10000. (Year ending 2009)
The accounting treatment for this case according to IAS 10 would be to disclose by a note in the balance sheet and it need not be adjusted in the financial position.

Provisions, Contingent liability and Contingent Assets (IAS 37)

Objective

The main feature of this standard is to ensure that appropriate recognition criteria and measurement bases are applied and sufficient information is disclosed in the notes to enable the users to understand their nature, timing and amount.

Provisions

These are those liabilities which have an uncertain timing and amount. Examples are legal obligations, retailer’s policies to refund customers and warranty obligations.
Principles for recognition of provisions:
If an entity has a present legal or constructive obligation as a result of past events.
Transfer of economic benefits will be required to settle obligations are probable.
An amount for the obligation can be estimated.

Contingent Liability

It may be a possible obligation that might arise from past events and its existence will only be confirmed on the occurrence or non-occurrence of uncertain future events not wholly controlled by the entity. Or it might even be a present obligation that might arise from past events but has not yet been recognised.

Disclosure

A contingent liability must be disclosed by a way of note if the economic benefits are possible or remote. If it is probable it must be recognised in the books of accounts.

Contingent Assets

It is a possible asset that arises from past events and whose existence will only be confirmed by the occurrence of one or more uncertain future events not wholly controlled by the entity.

Disclosure

A contingent asset is required to be disclosed by the way of note if the inflow of economic benefit is probable or possible. If the inflows of economic benefit are remote it has to be ignored.

Table showing treatment of contingent liabilities and assets

Chances

Contingent Liability

Contingent Assets

Remote

Disclose in note
Ignore

Possible

Disclose in note
Disclose in note

Probable

Recognise
Disclose in note
Remote: It means that it is very rare that the event will take place
Possible: It means that there is a chance of the event to take place.
Probable: It means that the event will most likely take place.

Contingent Liability

Remote: If the chances of a contingent liability are remote it means that the chance of the event is very rare and has to be disclosed as a note.
Possible: If the chances of the contingent liability is possible it means that there are chance of the event to happen as well as not happen therefore in this case it has to be disclosed as a note.
Probable: If the chances of the contingent liability are probable it means that the event is most likely to happen and needs to be recognized in the books of accounts.

Contingent Assets

Remote: If the chances of a contingent asset are remote it means that the chance of the event is very rare and has to be ignored.
Possible: If the chances of the contingent asset is possible it means that there are chance of the event to happen as well as not happen therefore in this case it has to be disclosed as a note.
Probable: If the chances of the contingent asset are probable it means that the event is most likely to happen and needs to be disclosed as a note in the books of accounts.


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