Expert Answer :2 QUESTION 1 40 marks Africa Ltd is a diversified

Solved by verified expert :2QUESTION 1 40 marksAfrica Ltd is a diversified company with a 31 December financial year end. The company isincorporated in South Africa and listed on the JSE Ltd. The group has applied InternationalFinancial Reporting Standards (IFRS) since 1 January 2000 and is not a first time adopter ofIFRS in 2005.Kenya LtdAfrica Ltd acquired 40% of the ordinary shares of Kenya Ltd on 1 November 2005 forR10 million. On that date Africa Ltd considered all the assets and liabilities of Kenya Ltd tobe 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 inKenya Ltd that could be exercised at any time on or after 1 November 2005. The option hadnot yet been exercised by 31 December 2005, and Africa Ltd has no intention of doing so inthe foreseeable future. The option had a cost and fair value of nil on 1 November 2005 and afair 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 thecompany’s production function and they accordingly decided to sell the company’sown machinery. The machinery was withdrawn from use immediately and advertisedfor sale. At that date the fair value was R17 million.• On 1 October 2005, before the outsourcing decision, the net book value of themachinery was R18 million, comprising a cost of R30 million and accumulateddepreciation of R12 million. The latter included the current year’s depreciation to1 October 2005.• On 1 November 2005, the date of acquisition by Africa Ltd, the fair value wasR21 million.• On 31 December 2005 the machinery had a fair value of R20 million, as a result of achange in market conditions during December 2005.• During the period 1 October 2005 to 31 December 2005 expected selling costsremained fixed at R500 000.• Although the machinery had not yet been sold by 31 December 2005, the directors ofboth Kenya Ltd and Africa Ltd remain committed to the plan to sell the machinery.Machinery owned by Africa Ltd itselfMachine 1Africa 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 forR2 million. Machine 1 had a revised remaining useful life of seven years at 31 December2005.3Machine 2Machine 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 lifeas 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 Ltdexpected the dismantling costs to amount to R4 million. During 2005 these costs wererevised to R4,5 million.• The obligation to incur the dismantling costs in terms of the government regulationsarose on 1 January 2004.• If the machine is not dismantled at the end of its useful life a fine is payable which willamount 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 3Machine 3 was ordered from France on 1 May 2005 in terms of a non-cancellable order andwas delivered to Africa Ltd on 1 July 2005 at a cost of €4 million. The amount owing to thesupplier was settled in cash on 10 July 2005. Africa Ltd installed and tested the machineduring 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) topurchase €4 million, for delivery on 10 July 2005. Africa Ltd designated this FEC as a cashflow hedge of the changes in the spot exchange rate for the period 1 May 2005 to30 June 2005. For the period 1 July 2005 to 10 July 2005, Africa Ltd designated the FEC asa fair value hedge of the forward exchange rate in the creditor. The hedge met all thecriteria 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)R1 May 2005 –1 July 2005 (518 272)10 July 2005 (280 000)Accounting policies and additional information• The following exchange rates applied:Date SpotrateForward to10 July 20051€ = R 1€ = R1 May 2005 8,55 8,651 July 2005 8,50 8,5210 July 2005 8,58 N/A31 December 2005 8,80 N/A4• 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 otherwiseindicated.• All items of machinery are assumed to have a residual value of nil unless otherwiseindicated.• The group calculates the effect of changes in the estimates of residual values, usefullives and dismantling costs with effect from the beginning of the year in which therevised estimate is made.• There was no impairment of assets.• The group’s accounting policy is to remove the gains or losses recognised directly inequity in respect of cash flow hedges and include them in the initial carrying amount ofthe 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 Marks(a) Discuss the appropriate recognition, measurement and presentation (andinclude amounts where appropriate) of the machinery owned by Kenya Ltdin the 2005 consolidated annual financial statements of Africa Ltd. Thediscussion must include the recognition, measurement and presentation ofany adjustments in the consolidated annual financial statements to themachinery owned by Kenya Ltd from the acquisition date to the year end.13(b) Prepare journal entries to record the purchase of Machine 3 and to recordthe FEC from the date of inception to the date of settlement by applyingthe appropriate hedge accounting principles.16(c) Based on the information provided, calculate the depreciation expenserelating to machinery that will be disclosed in the notes to the 2005consolidated annual financial statements of Africa Ltd. Ignorecomparatives.11TOTAL MARKS 40