Expert Answer :2 QUESTION 1 70 marks You are Leslie Canton, the r

Solved by verified expert :2QUESTION 1 70 marksYou are Leslie Canton, the recently appointed group financial manager of Sizacom Ltd. Sizacom Ltdis listed on the JSE Securities Exchange South Africa and is the owner and operator of a cellulartelecommunications network in South Africa. The Group Financial Director of Sizacom Ltd, Mr JamesParfitt, sent you the following memorandum:TO: Leslie Canton, Group financial managerFROM: James Parfitt, Group Financial DirectorDATE: 15 January 2004SUBJECT: Various accounting issues – financial year ended 31 December 2003At the board meeting last week, Ms Tania Sookha, an independent, non-executive director, raisedquestions about a number of issues, which are described below. Ms Sookha is a recent appointee toour board who wants to ascertain whether these issues are being appropriately addressed as part ofour current year-end procedures.1 Customer acquisition costsThis matter relates to the two types of cell phone users that Sizacom Ltd has, namely contractcustomers and prepaid customers.(a) Contract customersThe contract customers sign their contracts with service providers who act as agents for Sizacom Ltdin the sale of airtime. In terms of their contracts, these customers pay a fixed monthly amount foraccess to the Sizacom network. They are billed monthly in advance for the access fee and monthly inarrears for airtime usage (outgoing calls).All contracts are for a period of 24 months and the customer may not cancel the contract during thisinitial 24-month period. After that period, customers may continue with the original contract, whichthey may cancel at any time with notice of one month, or alternatively sign a new non-cancellable 24-month contract (a renewal contract). Many customers choose the second option (a renewal contract)because the service providers offer discounted cellular phone handset upgrades as an incentive forentering into a new contract. The service providers are able to offer the discounted cellular phonehandsets using the customer acquisition bonus described below.When a contract is signed, irrespective of whether it is a first-time contract or a renewal contract,Sizacom Ltd pays an acquisition bonus of R1 500 to the relevant service provider. These acquisitioncosts are recognised as non-current assets and amortised over a period of 24 months.(b) Prepaid customersThe prepaid customers purchase their “starter packs” and airtime vouchers from retailers such asgarage shops, supermarkets and general dealers. Customers initially register for this service bypurchasing a “starter pack”, which includes a SIM card and an airtime voucher, and from then onprepay for their airtime by purchasing vouchers of various denominations from the retailers. SizacomLtd sells the vouchers to retailers at a discount to their face value.For every “starter pack” purchased, Sizacom Ltd pays a customer acquisition bonus of R1 000 to therelevant retailer. However, the retailer is only entitled to the customer acquisition bonus once the SIMcard has been activated. These customer acquisition costs are also recognised as non-currentassets but are amortised over a period of 18 months.32 Defined benefit fundA report from Sizacom Ltd’s actuaries, relating to the Sizacom Ltd Pension Fund, a defined benefitfund, was tabled at the board meeting. The report contained the following information:31 December2003 2002R’000 R’000Plan assetsMarket value – beginning of year 25 900 25 000Contingency reserve – beginning of year (2 590) (2 500)Employer contributions 3 300 3 000Employee contributions 3 300 3 000Expected return on plan assets 2 900 4 200Pension payments (5 300) (5 000)Actuarial loss (2 800) (4 300)Movement in contingency reserve (140) (90)24 570 23 310Market value – end of year 27 300 25 900Contingency reserve – end of year (2 730) (2 590)Defined benefit obligationBalance – beginning of year 28 180 28 000Current service cost 3 520 3 200Interest cost 3 000 2 980Pension payments (5 300) (5 000)Actuarial (gain)/loss 500 (1 000)Balance – end of year 29 900 28 180Other informationExpected average remaining working life of planparticipants20 years20 yearsThe actuaries’ report indicated that all amounts, other than the contingency reserve, were determinedon the basis of AC 116, Employee benefits. The contingency reserve is an amount set aside in theactuarial determination of contribution rates to cover unforeseen future occurrences.Sizacom Ltd’s annual financial statements for the year ended 31 December 2002 included thefollowing notes:Accounting policiesDefined benefit plansIf net cumulative unrecognised actuarial gains or losses at the end of a financial year exceed thegreater of• 10% of the present value of the defined benefit obligation at that date, and• 10% of the fair value of the plan assets at that date,the excess is recognised on a straight-line basis over the expected average remaining working life ofemployees in the plan.Sizacom Ltd Pension FundUnrecognised net actuarial losses of R3,1 million (2001: gains of R200 000) are included in the deficiton the defined benefit plan.3 Black empowerment transactionOn 1 January 2003, Sizacom Ltd issued 10 million ordinary shares to Dludla (Pty) Ltd, a blackempowerment investor, for R50 million. In addition, Dludla (Pty) Ltd is entitled to a bonus payment on31 December 2007 if the return on a notional investment in Sizacom Ltd shares for the period from41 January 2003 to 31 December 2007 exceeds 15% per annum, compounded annually. In terms ofthe agreement, the bonus payment will be calculated as follows:B = (P – Y) * 5 000 000Where: BPY===Bonus paymentWeighted average share price of Sizacom Ltd for the month of December 2007Share price of Sizacom Ltd on 1 January 2003, inflated by 15% per annum,compounded annually and adjusted for dividend paymentsAccording to the original proposal from Flag Bank Ltd, who structured the above deal, the fair value ofthe bonus payment element at 1 January 2003 was R3 million. Last week Flag Bank Ltd informed methat the fair value of the bonus payment element at 31 December 2003 amounted to R3,5 million.REQUIRED(a) Prepare a report to the Group Financial Director of Sizacom Ltd, in which you• evaluate, with reasons, the recognition and measurement of customer acquisition costs;and• recommend changes to these practices where appropriate. (25)(b) Discuss the current income tax and deferred tax implications of the customer acquisition costsfor Sizacom Ltd. (10)(c) Prepare journal entries to record the movement in the defined benefit liability or asset arisingfrom the Sizacom Ltd Pension Fund in the financial statements of Sizacom Ltd for the yearended 31 December 2003. Show all supporting workings. Narrations are not required. (11)(d) Prepare a reconciliation of the defined benefit liability / asset as disclosed in the annualfinancial statements of Sizacom Ltd at 31 December 2003 to the plan assets and definedbenefit obligations of Sizacom Ltd Pension Fund at that date. (8)(e) Discuss, with reasons, the appropriate recognition and measurement of the potential bonuspayment to Dludla (Pty) Ltd in the annual financial statements of Sizacom Ltd for the yearended 31 December 2003. (16)