Solved by verified expert :ACCT 352
Intermediate Accounting III
Fall
2012 – Case 2
Alta Velocidad
Esperanza de L’Argentina, S.A.
Alta
Velocidad Esperanza de L’Argentina, Sociedad Anónima (AVE),
a high-speed railway operatordomiciled in Rio
Norte, Argentina, is a Foreign Private Issuer as defined by the U.S. Securities
and Exchange Commission. AVE currently files Form 20-F annually with the
Commission in which it reconciles its calendar year financial reporting to U.S.
GAAP from Argentine GAAP. Rather than waiting
until
2012 when Argentina switches to IFRS, AVE is considering early adoption of
IFRS. This would allow AVE to take advantage of SEC Release No. 33-8879. Under
such a plan, AVE would be eligible to file financial statements with the
Commission prepared in accordance with International Financial Reporting
Standards (IFRS) as issued by the International Accounting Standards Board
(IASB) without reconciliation to generally accepted accounting
principles (GAAP) as used in the United States.
Conmuchas
Dudas, AVE Chief Financial Officer, has hesitated making the move to IFRS
because she is unsure what impact, if any, IFRS adoption will have on the
company’s financial position. Ms. Dudas has asked you to determine if there is
a difference in the accounting treatment between U.S. GAAP and IFRS for the
following transaction:
On
April 1, 2011, AVE, entered into a non-cancelable agreement with Gastos
Financieros Reál (GFR), to lease five new high-speed locomotives for a period
of eight years. The economic life of this type of powered rolling stock is 11
years on average, assuming no residual value. However, there is a significant
market for second-hand locomotives that allows AVE to estimate what the
expected residual value of the locomotives might be. Ms. Dudas projects that this
amount will be 20% of the fair value on April 1, 2011.
The
lease term will commence once the locomotives have been delivered to AVE’s
train depot and have been accepted by an independent inspection company that
will test whether the powered cars meet the minimum conditions. This is
expected to take place on the same day as the lease signing — April 1, 2011.
At
the beginning of each month, AVE will pay a total monthly lease payment of
US$120,000 for the five locomotives. AVE’s incremental monthly borrowing rate
is 0.447%. In an uncustomary display of candor,
GFR
disclosed the monthly implicit interest rate on this lease to be 0.460%.
At
the expiration of the lease agreement, AVE has the option to buy the
locomotives at an exercise price of 17% of the fair value determined at the
beginning of the lease. On April 1, 2011, the total fair value of the five
high-speed locomotives was estimated at US$10.5 million.
According to plan, AVE
took possession of the new locomotives on April 1, 2011, when the bullet train
engines were delivered, tested and found to be in conformity with
specifications.
Ms.Dudas would like you to recommend the
proper classification of the lease under bothU.S. GAAP and IFRS. As
part of your research, she expects you to develop thenecessary journal
entries for the first month of the lease. If capitalization is recommended, she
would like to know what the impact would be on AVE’s classified balance sheet
at fiscal yearend (December 31st).
Finally, based on your analysis of the lease agreement, Conmuchas would like to
know whether you recommend AVE pursue early adoption of IFRS or wait until 2012
when IFRS becomes mandatory for publicly-traded Argentine corporations. AVE has
a healthy balance sheet and is currently a “darling” of Wall Street bond
traders.
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