OUM Business School

BBFA2303
Intermediate Financial Accounting II

Copyright © Open University Malaysia (OUM)

 BBFA2303
INTERMEDIATE
FINANCIAL
ACCOUNTING II
Dr Lee Teck Heang
Assoc Prof Dr Ong Tze San

Copyright © Open University Malaysia (OUM)

Project Directors: Prof Dato’ Dr Mansor Fadzil
Prof Dr Wardah Mohamad
Open University Malaysia

Writer: Dr Lee Teck Heang

Universiti Tunku Abdul Rahman

Assoc Prof Dr Ong Tze San

Universiti Putra Malaysia

Moderators: Mara Ridhuan Che Abdul Rahman

Universiti Kebangsaan Malaysia

Azlina Abd Aziz

Baldev Singh
Open University Malaysia

Developed by: Centre for Instructional Design and Technology

Open University Malaysia

First Edition, July 2007

Second Edition, July 2011
Third Edition, August 2014
Copyright © Open University Malaysia (OUM), August 2014, BBFA2303
All rights reserved. No part of this work may be reproduced in any form or by any means
without the written permission of the President, Open University Malaysia (OUM).

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Copyright Open University
University Malaysia
Malaysia (OUM)
(OUM)
Table of Contents
Course Guide ix–xiv

Topic 1 Accounting for Financial Liabilities 1

1.1 Debt Instruments (MFRS 139) 2
1.1.1 Bonds 2
1.1.2 Amortisation of Premium and Discount 3
1.1.3 Retirement of Bonds at Maturity 4
1.1.4 Disclosure Requirements 4
1.1.5 Long-term Loans 4
1.2 Hybrid Instruments 5
1.2.1 Convertible Bonds 5
1.2.2 Redeemable Preference Shares 6
Summary 14
Key Terms 15
Self-test 1 16
Self-test 2 16

Topic 2 Leases 17
2.1 The Nature of Leases 18
2.1.1 Types of Leases 19
2.1.2 Difference between Lease and Hire Purchase 26
2.2 The Accounting Treatment of an Operating Lease 27
2.2.1 Operating Lease – The LesseeÊs Book 27
2.2.2 Operating Lease – The LessorÊs Book 27
2.3 The Accounting Treatment of a Finance Lease 28
2.3.1 Finance Lease – The LesseeÊs Book 28
2.3.2 Finance Lease – The LessorÊs Book 34
2.3.3 Accounting Treatment of Indirect Costs 34
2.4 Sale and Leaseback 36
2.4.1 Sale and Leaseback – Finance Lease 36
2.4.2 Sale and Leaseback – Operating Lease 38
2.5 Disclosure and Presentation 40
2.5.1 Finance Lease – In the Financial Statement 40
of the Lessee
2.5.2 Finance Lease – In the Financial Statement 41
of the Lessor
2.5.3 Operating Lease – In the Financial Statement 42
of the Lessee

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iv  TABLE OF CONTENTS

2.5.4 Operating Lease – In the Financial Statement 42

of the Lessor
Sumarry 45
Key Terms 45
Self-test 1 46
Self-test 2 47

Topic 3 Investments in Equity and Debt Securities 49

3.1 Equity and Debt Investments 50
3.2 Reporting Investments 52
3.2.1 Trading Securities 53
3.2.2 Available-for-Sale Securities 53
3.2.3 Held-to-Maturity Securities 53
3.3 Short-term Investment versus Long-term Investment 54
3.3.1 Short-term Investment 54
3.3.2 Long-term Investment 55
Summary 55
Key Terms 56
Self-test 1 56
Self-test 2 56

Topic 4 Investment Properties 57

4.1 Recognition 58
4.2 Measurement 58
4.2.1 Fair Value Model 59
4.2.2 Cost Model 60
4.3 Transfers 60
4.4 Disposal 60
4.5 Disclosures 61
Summary 62
Key Terms 63
Self-Test 1 63
Self-Test 2 63

Topic 5 Introduction to Group Accounts 64

5.1 Application FRS3 65
5.1.1 Regulatory Framework 65
5.1.2 Business Combination 66
5.2 Basic Parent-subsidiary Structure 67
5.3 Consolidation at Acquisition Date 69
5.4 Goodwill 69
5.5 Minority Interest 70

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 TABLE OF CONTENTS  v

Summary 70
Key Terms 71
Self-Test 1 72
Self-Test 2 72

Topic 6 Intangible Assets 73

6.1 Characteristics and Qualities of Intangible Assets 74
6.2 Research and Development 75
6.3 Purchased Goodwill 77
6.4 Other Intangible Assets 78
6.4.1 Intangible Asset with Finite Useful Life 78
6.4.2 Intangible Asset with Indefinite Useful Life 78
6.4.3 Internally Generated Brands, Mastheads, 78
Titles and Others
Summary 78
Key Terms 79
Self-test 1 79
Self-test 2 80

Topic 7 Impairment 81
7.1 Impairment, Retirement and Disposal 82
7.1.1 Impairment 82
7.1.2 Retirement and Disposal 84
7.2 Disclosure Requirements 85
7.3 Property, Plant and Equipment 88
7.4 Recognition of Fixed Assets 89
7.5 Initial Measurement 90
7.5.1 Acquired Assets for Cash or Cash Equivalent 90
7.5.2 Self-Constructed Fixed Asset 92
7.5.3 Exchange Fixed Asset 94
7.6 Subsequent Expenditure 96
7.7 Subsequent Measurement 99
Summary 104
Key Terms 105
References 105
Self-test 1 105
Self-test 2 107

Topic 8 Company Reconstruction 109

8.1 Business Reconstruction 110
8.2 Internal Reconstruction (Capital Reduction) 112
8.3 Return of Surplus Capital 113
8.4 Reduction of Capital Not Represented by Available Assets 116

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vi  TABLE OF CONTENTS

Summary 127
Key Terms 128
Self-test 1 128
Self-test 2 130

Topic 9 Comprehensive Cases 133

9.1 Preparation of Simple Group Balance Sheet on 133
Acquisition Date
9.2 Preparation of Published Financial Statement 135
9.3 Financial Statement Analysis 137
9.4 Integrity and Ethics in Preparing and Reporting 141
Financial Information

Answers 143

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COURSE GUIDE

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Copyright © Open University Malaysia (OUM)
 COURSE GUIDE  ix

COURSE GUIDE DESCRIPTION

You must read this Course Guide carefully from the beginning to the end. It tells
you briefly what the course is about and how you can work your way through
the course material. It also suggests the amount of time you are likely to spend in
order to complete the course successfully. Please keep on referring to the Course
Guide as you go through the course material as it will help you to clarify
important study components or points that you might miss or overlook.

INTRODUCTION
BBFA2303 Intermediate Financial Accounting II is one of the courses offered by
the OUM Business School at Open University Malaysia (OUM). This course is
worth 3 credit hours and should be covered over 15 weeks.

COURSE AUDIENCE
This is a core major course for all students undergoing Bachelor of Accounting.

As an open and distance learner, you should be acquainted with learning

independently and being able to optimise the learning modes and environment
available to you. Before you begin this course, please ensure that you have the
right course material, and understand the course requirements as well as how the
course is conducted.

STUDY SCHEDULE
It is a standard OUM practice that learners accumulate 40 study hours for every
credit hour. As such, for a three-credit hour course, you are expected to spend
120 study hours. Table 1 gives an estimation of how the 120 study hours could be
accumulated.

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x  COURSE GUIDE

Table 1: Estimation of Time Accumulation of Study Hours

Study
Study Activities
Hours
Briefly go through the course content and participate in initial discussion 3
Study the module 60
Attend 3 to 5 tutorial sessions 10
Online participation 12
Revision 15
Assignment(s), Test(s) and Examination(s) 20
TOTAL STUDY HOURS ACCUMULATED 120

COURSE OUTCOMES
By the end of this course, you should be able to:
1. Apply approved accounting standards to account for the various categories
of financial liabilities, leases, investments and intangibles;
2. Explain the need for impairments and describe the requirements of
approved accounting standards in respect of impairments;
3. Compute impairment losses for property, plant and equipment and
intangibles including goodwill;
4. Describe the regulatory requirements for preparing group accounts and
explain the rationale for preparing group accounts;
5. Prepare a consolidated balance sheet on acquisition date for a simple group
structure involving only direct holding in subsidiaries in accordance with
approved accounting standards;
6. Account for capital reconstruction; and
7. Evaluate the importance of ethics in financial reporting process.

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 COURSE GUIDE  xi

COURSE SYNOPSIS
This course is divided into nine topics. The synopsis for each topic is listed as
follows:

Topic 1 deals with accounting for financial liabilities. It covers debt instruments
and hybrid instruments. Part I of debt instruments discusses bonds, amortisation
of bond at maturity, disclosure requirements and long-term loans. Part II of
hybrid instruments consists of convertible bonds and redeemable preference
shares.

Topic 2 discusses the accounting for leases; such as operating leases, finance
leases and sales and leaseback transaction.

Topic 3 explores investments in equity and debt securities. The application of

MFRS 129 will be further explored here.

Topic 4 covers investment properties. The application of MFRS 140 is

demonstrated here.

Topic 5 outlines the introduction to group accounts. Two standards which are
MFRS 3 and MFRS 127 will be introduced here. The subtopics include regulatory
framework of group accounts (requirement for consolidation and exemption
from consolidation), basic parent-subsidiary structure, consolidation at
acquisition date, goodwill and minority interest.

Topic 6 introduces intangible assets which include (i) research and development;
(ii) purchased goodwill; and (iii) other intangible assets.

Topic 7 deals with impairments. This includes property, plant and equipment.

Topic 8 elaborates capital reconstruction. It further discusses issues such as the

general impact of business reconstruction on a company and the relevant
accounting treatments under these circumstances.

Topic 9 includes comprehensive case study so that learners can encapsulate their
learning from the earlier topics for this course. This topic is designed to enable
learners answering comprehensive examination questions.

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xii  COURSE GUIDE

TEXT ARRANGEMENT GUIDE

Before you go through this module, it is important that you note the text
arrangement. Understanding the text arrangement will help you to organise your
study of this course in a more objective and effective way. Generally, the text
arrangement for each topic is as follows:

Learning Outcomes: This section refers to what you should achieve after you
have completely covered a topic. As you go through each topic, you should
frequently refer to these learning outcomes. By doing this, you can continuously
gauge your understanding of the topic.

Self-Check: This component of the module is inserted at strategic locations

throughout the module. It may be inserted after one sub-section or a few sub-
sections. It usually comes in the form of a question. When you come across this
component, try to reflect on what you have already learnt thus far. By attempting
to answer the question, you should be able to gauge how well you have
understood the sub-section(s). Most of the time, the answers to the questions can
be found directly from the module itself.

Activity: Like Self-Check, the Activity component is also placed at various

locations or junctures throughout the module. This component may require you
to solve questions, explore short case studies, or conduct an observation or
research. It may even require you to evaluate a given scenario. When you come
across an Activity, you should try to reflect on what you have gathered from the
module and apply it to real situations. You should, at the same time, engage
yourself in higher order thinking where you might be required to analyse,
synthesise and evaluate instead of only having to recall and define.

Summary: You will find this component at the end of each topic. This component
helps you to recap the whole topic. By going through the summary, you should
be able to gauge your knowledge retention level. Should you find points in the
summary that you do not fully understand, it would be a good idea for you to
revisit the details in the module.

Key Terms: This component can be found at the end of each topic. You should go
through this component to remind yourself of important terms or jargon used
throughout the module. Should you find terms here that you are not able to
explain, you should look for the terms in the module.

References: The References section is where a list of relevant and useful

textbooks, journals, articles, electronic contents or sources can be found. The list
can appear in a few locations such as in the Course Guide (at the References

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 COURSE GUIDE  xiii

section), at the end of every topic or at the back of the module. You are
encouraged to read or refer to the suggested sources to obtain the additional
information needed and to enhance your overall understanding of the course.

PRIOR KNOWLEDGE
No prior knowledge required.

ASSESSMENT METHOD
Please refer to myINSPIRE.

REFERENCES
Omar, R., Hassan, H., Sulaiman, A. J., & Mohamad, L. (Eds.). Accounting
principles. Malaysia: McGraw-Hill.
Lazar, L., Arshad, R., & Choo. (2006). Financial reporting an introduction.
Malaysia: McGraw-Hill.
Lerner, J. L., & Cashin, J. M. (1998). Schaum's outline of theory and problems of
principles of accounting I (5th ed.). Black Lick, OH USA: McGraw-Hill.
Ng, E. (2009). A practical guide to financial reporting standards (Malaysia).
Singapore: CCH.
Relevant financial reporting standard.
Stice, E. K., Stice, J. D., & Skousen, K. F. (2004). Intermediate accounting (15th
ed.). New York: Thompson South-Western.
Tan, L. (2000). Financial accounting & reporting in Malaysia: Volume 1 (2nd ed.).
Malaysia: PAAC.
Tan, L. (2000). Financial accounting & reporting in Malaysia: Volume 2 (2nd ed.).
Malaysia: PAAC.
Tan, L. (2005). Consolidated financial statement (4th ed.). Malaysia: PAAC.

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University Malaysia
Malaysia (OUM)
(OUM)
xiv  COURSE GUIDE

TAN SRI DR ABDULLAH SANUSI (TSDAS) DIGITAL

LIBRARY
The TSDAS Digital Library has a wide range of print and online resources for the
use of its learners. This comprehensive digital library, which is accessible
through the OUM portal, provides access to more than 30 online databases
comprising e-journals, e-theses, e-books and more. Examples of databases
available are EBSCOhost, ProQuest, SpringerLink, Books24x7, InfoSci Books,
Emerald Management Plus and Ebrary Electronic Books. As an OUM learner,
you are encouraged to make full use of the resources available through this
library.

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Topic  Accounting for

1 Financial
Liabilities
LEARNING OUTCOMES
By the end of this topic, you should be able to:
1. Define liability;
2. Identify five types of debt instruments (MFRS 139); and
3. Identify two types of hybrid instruments.

 INTRODUCTION
According to Malaysian Accounting Standards Board (MASB), the term liability
is defined as "a present obligation of an entity arising from past events, the
settlement of which is expected to result in the outflow from the entity of
resources embodying economic benefits."

Long-term financial liabilities, such as term loans and bonds, arise from entityÊs
financing decision. They are normally raised to finance and part-finance the long-
term assets of the entity. Long term financial liabilities form the long term capital
employed by the entity in its operation and investments together with the equity.
These liabilities are long-term liabilities because they cannot be payable within
one year, the duration is longer than a year.

What else awaits you in this first topic? You will learn more on bonds
amortisation of premium and discount, retirements of bonds at maturity,
disclosure requirements and long term loans. Last but not least, you will be
introduced to two types of hybrid instruments: convertible bonds and
redeemable preference shares.

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2  TOPIC 1 ACCOUNTING FOR FINANCIAL LIABILITIES

1.1 DEBT INSTRUMENTS (MFRS 139)

There are five types of debt instruments (MFRS 139) namely bonds, amortisation of
premium and discount, retirements of bonds at maturity, disclosure requirements
and long term loans.

1.1.1 Bonds
Do you know that a corporate bond is normally called a loan stock? What does it
mean?

Corporate bond or loan stock is a long-term debt instrument issued by a

company to raised funds. The company that issues the bond recognises it
as a long-term debt which must be reflected on the balance sheet.

There are two situations that need bonds to be issues: They are:
(a) When a bond is issued at par and if there is no other features involved, it is
normally a straightforward matter.
(b) If the bonds are not issued at par (at discount) or bonds convertible into
ordinary shares, the accounting principles can be complex.

These two are further explained as follows:

(a) Bonds Issued at Par

The interest expense on the bond is simply the amount based on the coupon
rate specified on the bond indenture. For example, a company wishes to
issue a RM10,000,000 bond at its par value. The bond matures in five years.
If the market rate of interest is 10%, thus the coupon rate is equal to 10%, so
the present value of the bond is RM10,000,000.

(b) Bonds Issued at Discount

When a bond is issued at discount this means it is issued for less than its
par value. For example, assume that XYZ Bhd intends to issue a
RM50,000,000 par value bond with a coupon rate of 6%, matures in five
years. If the market interest rate is 10% and the present value is:

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 TOPIC 1 ACCOUNTING FOR FINANCIAL LIABILITIES  3

Bond value = PVIFA (10%, 5)  [0.06  RM50m] + PVIF (10%, 5)

 [RM50m]
= 3.7908  RM3,000,000 + 0.62092  RM50,000,000
= RM11,372,400 + RM31,046,000
= RM42, 418,400.

SELF-CHECK 1.1

1. Define corporate bond.

2. Describe two views of how bond premiums or discounts shall be
presented.

1.1.2 Amortisation of Premium and Discount

If the interest expense on bonds in each period is to reflect the effective
borrowing cost of the issuer, then the effective interest rate method (present
value amortisation method) shall be used. Using the same XYZ Bhd case, the
amortisation schedule is shown in Table 1.1.
Table 1.1: Amortisation Schedule for XYZ Bhd

Year Beginning Interest rate Coupon Discount Ending

carrying 10% (b)= interest amortised carrying
value of 10%  (a) payable (c) (d) = (b) – value of
bond (a) (c) bond (e) =
(a) + (d)
RM RM RM RM RM
1 42,418,400 4,241,840 3,000,000 1,241,840 43,660,240
2 43,660,240 4,366,024 3,000,000 1,366,024 45,026,264
3 45,026,264 4,502,626 3,000,000 1,502,626 46,528,890
4 46,528,890 4,652,889 3,000,000 1,652,889 48,181,779
5 48,181,779 4,818,221 3,000,000 1,818,221 50,000,000
22,581,600 15,000,000 7,581,600

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4  TOPIC 1 ACCOUNTING FOR FINANCIAL LIABILITIES

1.1.3 Retirement of Bonds at Maturity

MFRS139 prescribes that an entity may remove its financial liability from its
balance sheet. A bond or a term loan may be retired or extinguished.

On the date of retirement, the difference between cash paid and the net carrying
value if the debt is gain or loss arising on the debt extinguished. For example,
Net carrying value of a bond: RM10 million
Cash paid to extinguish the bond: RM9 million

A gain arises on retirement is RM1 million. If the cash paid was RM12 million, a
net loss is RM2 million.

1.1.4 Disclosure Requirements

There are currently two views of how bond premiums or discounts shall be
presented. First, is that the bond liability shall be presented at its par value, while
the discount and premium is presented separately on the balance sheet. The
presentation of the bond at its par value showed the legal liability of the issuer.

Secondly, is to offset the discount or premium against or to the par value of the
bond so that the net carrying value of the bond is presented on the face of the
balance sheet. For a discount, a reduction to the par value arises in the offset;
while for the premium, an addition to the par value arises.

1.1.5 Long-term Loans

Accounting for a term loan is straightforward. At the draw down date of the
loan, the net proceeds or cash received (at its face value), is the amount that shall
be recorded as liability, and no premium or discount is involved. For example, if
a company received RM10 million on the draw down date of term loan, the
journal entry would be:

Dr Cash account RM10,000,000

Cr Long-term loan account RM10,000,000
(To record receipt of term loan)

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 TOPIC 1 ACCOUNTING FOR FINANCIAL LIABILITIES  5

If the company carries 9% of an interest rate = RM10,000,000  0.09 = RM900,000

Dr Term loan interest expense RM900,000

Cr Cash or Interest payable RM900,000
(To recognise term loan interest expense for the year)

1.2 HYBRID INSTRUMENTS

There are two types of hybrid instruments namely convertible bonds and
redeemable preference shares.

1.2.1 Convertible Bonds

Firstly, what does a convertible bond mean?

A convertible bond is a bond issued by a corporation that, unlike a regular

bond, gives the bondholder the option to trade in the bond for shares in
the company that issued it.

This gives the bondholder both a fixed-income investment with coupon

payments as well as the potential to benefit from an increase in the company's
share price. The additional value of the conversion option, however, will mean
that the coupon payment on the bond will be lower than that of an equivalent
bond with no conversion option.

A convertible bond issue (like other bonds), will state the maturity and the coupon
on the bond. A convertible bond also has information about the conversion option or
how many shares will be received for the bond if it is converted.

For example, take a convertible bond that sells for RM1,000. It has an annual
coupon of 7% and can be converted into 100 shares at any time. Each year, the
bondholder will receive RM70 (RM1,000  7%) as long as the bond has not been
converted into shares. If the bondholder was to convert the bond into shares, he
or she would no longer receive the coupon payment (interest) and the value of
the investment would move with the price of the stock.

Based on the number of shares that will be received upon conversion and the
price paid for the bond, the effective share purchase price can be calculated. In
the stated example, the effective price that the bondholder pays for the shares
would be the price paid divided by the amount of shares received or RM10
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6  TOPIC 1 ACCOUNTING FOR FINANCIAL LIABILITIES

(RM1,000/100). The investor will only convert the bond into shares if the current
share price is higher than the effective share purchase price.

An investor would, however, convert a bond into shares if the share value rose to
RM20. He or she would receive 100 shares and the market value of the shares
would be RM2,000.

On the other hand, if the share price was RM5, an investor would keep the bond
and receive the payments on the bond because if converted, the market value of
the shares would be only RM500.

1.2.2 Redeemable Preference Shares

To safeguard and protect the interest of trade payables, redemption of shares
must be done in accordance with the requirement of the law. Generally, it is
more likely for a company to redeem its preference shares than ordinary shares.

To facilitate share redemption, company should either issue new shares to

provide the required funds or there must be sufficient distributable profits to be
transferred to the capital redemption reserve fund. When there is premium
payable on redemption, it is the normal accounting practice in Malaysia to use
the retained profit after share premium account has been fully utilised.

The accounting treatment of share redemption involves three sections as shown

in Figure 1.1.

Figure 1.1: Three sections of share redemption

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 TOPIC 1 ACCOUNTING FOR FINANCIAL LIABILITIES  7

Let us look at each section of share redemption in detail as follows:

(a) Redemption at Par Value by Issuing New Shares

In order to maintain the capital structure of the company when redemption
takes place, the directors may issue new shares with a total value
equivalent to the shares redeemed. The new fund is purportedly raised to
provide for the required cash in share redemption.

The following accounting entries are to be taken up when the company

issues new shares to pay for the redemption:

Dr Preference shares
Cr Redemption of preference shares

(Being nominal value of the preference shares transferred out for

redemption)

Dr Bank
Cr Application and allotment

(Being money received from applicants of the new issue of shares)

Dr Application and allotment

Cr Ordinary share capital

(Being allotment of shares to successful applicants)

Dr Redemption of preference shares

Cr Bank

(Being payment made to redeem preference shares)

When the redemption is totally financed by issuing new ordinary shares, the
retained profits of the company will not be affected. This is because there is no
transfer of the retained profits to the capital redemption reserve fund. Hence, in
the balance sheet, retained profit will be same amount before or even after the
redemption of shares takes place. Let us take a look at Example 1.1.

Example 1.1:
The following balance sheet was extracted from Kepong Berhad as at 31
March 2010. All the companyÊs preference shares will be redeemed at par on 1
April 2010. It was further agreed upon that the redemption to be fully financed by
the new issue of 300,000 ordinary shares at RM1.00 each.

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8  TOPIC 1 ACCOUNTING FOR FINANCIAL LIABILITIES

Kepong Berhad
Balance Sheet as at 31 March 2010

Assets RM

Land and building 1,200,000

Bank 450,000
1,650,000
Share capital
500,000 ordinary shares at RM1.00 each paid-up fully 500,000
300,000 6% preference shares at RM1.00 each paid-up fully 300,000
Retained profits 850,000
1,650,000

Show the journal entries to record the above redemption.

Solution:

RM RM
Dr Preference shares 300,000
Cr Redemption of preference shares 300,000
(Being nominal value of the preference shares transferred out for redemption)

RM RM
Dr Bank 300,000
Cr Application and allotment 300,000
(Being money received from applicants for the new issue of shares)

RM RM
Dr Application and allotment 300,000
Cr Ordinary share capital 300,000
(Being allotment of shares to successful applicants)

RM RM
Dr Redemption of preference shares 300,000
Cr Bank 300,000
(Being payment made to redeem preference shares)

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 TOPIC 1 ACCOUNTING FOR FINANCIAL LIABILITIES  9

As explained earlier, if the redemption is fully financed by issuing new

ordinary shares, the retained profit will be unchanged. The balance sheet
for Example 1.1 will look as follows after the redemption:

Kepong Berhad
Balance Sheet as at 1 April 2010
Assets RM
Land and building 1,200,000
Bank 450,000
1,650,000
Share capital
800,000 ordinary shares at RM1.00 each paid up fully 800,000
Retained profits 850,000
1,650,000

(b) Redemption at Par Value Out of Profits

Now, let us move on to the second section of share redemption. Apart from
issuing new shares to finance the redemption, the company is also allowed
to redeem its shares by setting aside its reserves to a non-distributable
reserve account.

If a company redeem its shares at par value out of its profit, an amount
equal to the nominal value of the shares redeemed must be transferred
from the profit and loss appropriation account to the redemption reserve
account. This redemption reserve is a non-distributable reserve. After the
transfer, the available retained profits for dividend distribution are
reduced.

Furthermore, the company has to ensure that it has sufficient cash to pay
the redeemed shareholders if it has chosen to finance the redemption fully
through internal funds.

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10  TOPIC 1 ACCOUNTING FOR FINANCIAL LIABILITIES

The following journal entries are required when redemption is done out of
retained profits:

Dr Preference shares
Cr Redemption of preference shares
(Being nominal value of the preference shares transferred out for
redemption)

Dr Profit and loss appropriation

Cr Capital redemption reserve
(Being transfer of profit and loss appropriation account to capital
redemption reserve)

Dr. Redemption of preference shares

Cr. Bank
(Being payment made to redeem preference shares)

Let us look at Example 1.2. It uses similar information as Example 1.1 but
here, the directors have decided to redeem the preference shares out of the
companyÊs profits.

Example 1.2:
The following balance sheet was extracted from Kepong Berhad as at 31 March
2010. The company decided to redeem all its preference shares at par on 1
April 2010. It was further agreed upon that the redemption be wholly financed
by the new issue of 300,000 ordinary shares at RM1.00 each.
Kepong Berhad
Balance Sheet as at 31 March 2010
Assets RM
Land and building 1,200,000
Bank 450,000
1,650,000
Share capital
500,000 ordinary shares at RM1.00 each paid-up fully 500,000
300,000 6% preference shares at RM1.00 each paid-up 300,000
fully
Retained profits 850,000
1,650,000

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 TOPIC 1 ACCOUNTING FOR FINANCIAL LIABILITIES  11

Show the book entries to record the above transactions.

Solution:
RM RM
Dr Preference shares 300,000
Cr Redemption of preference shares 300,000
(Being nominal value of the preference shares transferred out for
redemption)

RM RM
Dr Bank 300,000
Cr Application and allotment 300,000
(Being money received from applicants for the new issue of shares)

RM RM
Dr Application and allotment 300,000
Cr Ordinary share capital 300,000
(Being allotment of shares to successful applicants)

RM RM
Dr Redemption of preference shares 300,000
Cr Bank 300,000
(Being payment made to redeem preference shares)

When company finances the redemption through companyÊs profits, the

balance sheet after the redemption will be different as RM300,000 will be
transferred out from profits to the capital redemption reserve account:

Kepong Berhad
Balance Sheet as at 1 April 2010
Assets RM
Land and building 1,200,000
Bank 150,000
1,350,000
Share capital
500,000 ordinary shares at RM1.00 each paid up fully 500,000
Retained profits 550,000

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12  TOPIC 1 ACCOUNTING FOR FINANCIAL LIABILITIES

Capital redemption reserve 300,000

1,350,000

(c) Redemption at Par Value Partly From New Issue of Shares and Partly From
Profits
Now, we have come to the last section of share redemption. When a
company decides to redeem its shares, it may find it very costly to finance
the redemption solely by issuing new shares. At the same time, the
company may not have sufficient internal funds or profits to redeem them
fully. Hence, it is therefore very common for a company to finance the
redemption partly from the new issue of shares and partly from its profits.

The journal entries for this approach are a combination of the first two
entries that we have discussed earlier.

Again, by using similar information in Example 1.1, let us suppose the

directors decided to redeem the 300,000, 6% preference shares by partly
issuing 180,000 ordinary shares of RM1 each at par and partly by using
appropriation account balance as per Example 1.3.

Example 1.3:
The following balance sheet was extracted from Kepong Berhad as at 31 March
2010. The company decided to redeem all its preference shares at par on 1 April
2010. It was further agreed upon that the redemption be wholly financed by the
new issue of 300,000 ordinary shares at RM1.00 each.

Kepong Berhad
Balance Sheet as at 31 March 2010
Assets RM
Land and building 1,200,000
Bank 450,000
1,650,000
Share capital
500,000 ordinary shares at RM1.00 each paid-up fully 500,000
300,000 6% preference shares at RM1.00 each paid-up 300,000
fully
Retained profits 850,000
1,650,000
Show the book entries to record the above transactions.

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 TOPIC 1 ACCOUNTING FOR FINANCIAL LIABILITIES  13

Solution:

RM RM
Dr Preference shares 300,000
Cr Redemption of preference shares 300,000

(Being nominal value of the preference shares transferred out for redemption)

RM RM
Dr Bank 180,000
Cr Application and allotment 180,000
(Being money received from applicants of the new issue of shares)

RM RM
Dr Application and allotment 180,000
Cr Ordinary share capital 180,000
(Being allotment of shares to successful applicants)

RM RM
Dr Profit and loss appropriation 120,000
Cr Capital redemption reserve 120,000
(Being transfer of profit and loss appropriation account to
capital redemption reserve not covered by new issue of shares)

RM RM
Dr Redemption of preference shares 300,000
Cr Bank 300,000
(Being payment made to redeem preference shares)

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14  TOPIC 1 ACCOUNTING FOR FINANCIAL LIABILITIES

The balance sheet as at 1 April 2010 for Kepong Berhad after the redemption
will look as follows:

Kepong Berhad
Balance Sheet as at 1 April 2010
Assets RM
Land and building 1,200,000
Bank 330,000
1,530,000
Share capital
600,000 ordinary shares at RM1.00 each paid up fully 680,000
Retained profits 730,000
Capital redemption reserve 120,000
1,530,000

ACTIVITY 1.1

Differentiate between convertible bonds and redeemable preference

shares.

 Liability is defined as "a present obligation of an entity arising from past

events, the settlement of which is expected to result in the outflow from the
entity of resources embodying economic benefits."

 Five types of debt instruments (MFRS 139) are bonds, amortisation of

premium and discount, retirements of bonds at maturity, disclosure
requirements and long term loans.

 Bond is a long-term debt instrument issued by a company to raised funds.

Bonds are issued at par and discount.

 If the interest expense on bonds in each period is to reflect the effective

borrowing cost of the issuer, then the effective interest rate method (present
value amortisation method) shall be used.

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 TOPIC 1 ACCOUNTING FOR FINANCIAL LIABILITIES  15

 A bond or a term loan may be retired or extinguished. On the date of

retirement, the difference between cash paid and the net carrying value if the
debt is gain or loss arising on the debt extinguished.

 There are currently two views of how bond premiums or discounts shall be
presented:
(i) The bond liability shall be presented at its par value, while the discount
and premium is presented separately on the balance sheet.
(ii) To offset the discount or premium against or to the par value of the
bond so that the net carrying value of the bond is presented on the face
of the balance sheet.

 Accounting for a term loan is straightforward. At the draw down date of the
loan, the net proceeds or cash received, at its face value, is the amount that
shall be recorded as liability, and no premium or discount is involved.

 Two types of hybrid instruments are convertible bonds and redeemable

preference shares.

 A convertible bond is a bond issued by a corporation that, unlike a regular

bond, gives the bondholder the option to trade in the bond for shares in the
company that issued it.

 To safeguard and protect the interest of trade payables, redemption of shares

must be done in accordance with the requirement of the law.

 Generally, it is more likely for a company to redeem its preference shares

than ordinary shares.

Amortisation of premium and discount Hybrid

At par Instrument
Bonds Long-term loans
Convertible bond Redeemable preference shares
Disclosure requirements Retirements of bonds at maturity
Discount

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16  TOPIC 1 ACCOUNTING FOR FINANCIAL LIABILITIES

Ribena Co. issued a RM500,000, 10-year bonds at a premium. Prior to maturity,

when the carrying value of the bonds is RM508,000, the company retires the
bonds at 102. Prepare the entry to record the redemption of the bonds.

Sniper Inc. has successfully developed a new spreadsheet program. To produce

and market the program, the company needed RM2 million of additional
financing. On January 1, 2013, Sniper Inc. borrowed money as follows:

Sniper Inc issued RM500,000, 11%, 10-year convertible bonds. The bonds sold at
face value and pay semi-annual interest on January 1 and July 1. Each RM1,000
bond is convertible into 30 shares of SniperÊs RM20 par value common stock. You
are required to prepare journal entries for:
(a) The issuance of the bonds on January 1, 2009.
(b) Interest expense on July 1 and December 31, 2013.
(c) The payment of interest on January 1, 2014.
(d) The conversion of all bonds into common stock on January 1, 2014, when
the market value of the common stock was RM67 per share.

Copyright © Open University Malaysia (OUM)

 Topic  Leases
2
LEARNING OUTCOMES
By the end of this topic, you should be able to:
1. Discuss the nature of leases;
2. Differentiate between operating lease and finance lease;
3. Prepare account for operating leases and finance leases in the books of
a lessee and a lessor;
4. Prepare journal entries for sales and leaseback transactions; and
5. Apply the disclosure requirement for leases.

 INTRODUCTION
Do you know that in Britain and the United States, customers are allowed to
lease their vehicles and properties? Upon signing the lease agreement, customers
will need to pay the instalments. How do you differentiate between leasing and
hire purchase? The answer is in the following paragraph.

What leasing is? Leasing is a source of finance which allows a company to

acquire expensive assets through instalment payments. Basically, a lease is an
agreement in which the owner of an asset (lessor) agrees to give the tenant
(lessee) the right to use the asset for a stated period of time in return for a series
of payments.

This topic outlines the accounting treatment of leasing transactions under MFRS
117. MFRS 117 is a government standard for leases, applicable from or after 1
October 2006. It introduces you to the fundamental principles of MFRS 117,
which include the recognition, measurement and presentation of leases in the
books of a lessee and a lessor.

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2.1 THE NATURE OF LEASES

Let us start this subtopic by looking at Figure 2.1.

Figure 2.1: A few important questions on lease

What are the answers to these questions? The answers to these questions will be
discussed in Subtopic 2.1.1 and Subtopic 2.1.2.

Let us go back to leases. As stated before, in the Malaysian context, accounting for
leases is outlined in MFRS 117. The following is the definition for lease as stated in
MFRS 117.

Lease is an agreement where the lessor conveys to the lessee in return for a
payment or series of payments the right to use an asset for an agreed
period of time.
MFRS 117

In simple terms, a lease is a legal contract between the owner and the tenant of an
asset. The lessor, who has the legal title to the asset, allows the asset to be used by
the lessee, who does not have the legal title to the asset, for a stipulated period in
return for a series of payments.

What are the principles of lease? The principles of lease are shown in Figure 2.2.

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 TOPIC 2 LEASES  19

Figure 2.2: Principles of lease

Source: Jones & Rivett (1998)

ACTIVITY 2.1
1. List the assets in a company which were acquired through leasing
arrangements. Post your answer in myVLE and compare it with
those of your classmates.
2. In your opinion, why do companies lease assets instead of buying
them?

2.1.1 Types of Leases

For accounting purposes, a lease can be classified into two categories:
(a) Operating lease; and
(b) Finance lease.

According to Paragraph 7 of MFRS 117, the classification of a lease is based on

the extent to which risks and rewards incidental to the ownership of a leased
asset rests in the hands of the lessor or the lessee.

Paragraph 7 of MFRS 117 explains that risks include the possibility of losses from
idle capacity or technological obsolescence and of variations in return due to
changing economic conditions.

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20  TOPIC 2 LEASES

On the other hand, rewards may come from profitable operations over the assetÊs
economic life and through gains from the appreciation in the value of realisation
of a residual value.

A lease is considered a finance lease when the risks and rewards of the leased
asset are transferred substantially from the lessor to the lessee. However, the title
(legal ownership) of the asset may or may not be eventually transferred to the
lessee. The lease will be considered an operating lease if risks and rewards are
not substantially transferred from the lessor to the lessee.

Therefore, a finance lease is a transaction to borrow monies to buy an asset,

whereas an operating lease is merely renting an asset.

Figure 2.3 shows you an illustration of an operating lease and a finance lease using
the principle of „risks and rewards‰ as a determinant criterion of classification.

Figure 2.3: Operating lease and finance lease

Source: Weygandt, Kieso & Kimmel (2002)

Figure 2.3 shows an operating lease in which the lessee leases the car from the
lessor for one month, after which the car will be returned to the lessor. The lessee
does not have to make any other payment besides the one-month rental of
RM3,000. This is an operating lease because the lessee is merely renting the car
from the lessor. The risks and rewards of ownership are not transferred to the
lessee. The risks and rewards rest with the lessor. The lessor is responsible for the
risk of loss in the value of the car due to wear and tear, usage and passage of time.

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 TOPIC 2 LEASES  21

In finance lease, the lessee leases a photocopying machine for its entire useful life
and is required to pay a monthly rental of RM1,000. In addition, the lessee is
responsible for the costs of maintaining, repairing and insuring the asset. This is
considered a finance lease because the maintenance costs are borne by the lessee,
indicating that the risks and rewards have been transferred from the lessor to the
lessee. The fact that the entire useful life of the machine lies with the lessee also
shows that the lessee will have to bear the risk of obsolescence of the
photocopying machine.

According to Paragraph 10 of MFRS 117, whether a lease is a finance lease or an

operating lease depends on the substance of the transaction rather than the form
of the contract.

The following situations (found in Paragraph 10 of MFRS 117), would give rise to
a lease being classified as a finance lease:
(a) The lease transfers ownership of the asset to the lessee by the end of the
lease term;
(b) The lessee has the option to purchase the asset at a price which is expected
to be sufficiently lower than the fair value at the date the option becomes
exercisable such that, at the inception of the lease, it is reasonably certain
that the option will be exercised;
(c) The lease term is for the major part of the economic life of the asset even if
the title is not transferred (it is suggested 75% or more as a guide in
Paragraph 10 of MASB 10);
(d) At the inception of the lease, the value of the minimum lease payments
amounts to at least substantially all of the fair value of the assets (it is
suggested 90% as a guide in Paragraph 10 of MASB 10); and
(e) The leased assets are of a specialised nature, such that only the lessee can
use them without major modifications being made.

The following Figure 2.4 shows you how a lease qualifies as finance lease, as
explained in Paragraph 10 of MFRS 117.

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Figure 2.4: The classification of lease as a finance lease

Source: MASB 10 (Appendix 2, p. 21)

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 TOPIC 2 LEASES  23

Let us refer to Example 2.1 to understand how the application of Paragraph 10 of

MFRS 117 works.

Example 2.1:

Super Max Sdn Bhd is a major construction company in Kajang. Super MaxÊs Sdn
Bhd financial year ends 31 December. In view of expansion, the company
recently entered into two leasing contracts, for a piling machine and mobile
fitting equipment.

The details of the contracts are as follows:

(a) Pilling Machine

On 1 January 2013, Super Max Sdn Bhd (lessee) entered into a lease
agreement with Easylease Bhd (lessor) for a piling machine. The fair value
of the machine is RM20 million. Super Max Sdn Bhd is required to pay six
instalments of RM4 million, payable in advance, from 1 January 2013 to 1
January 2018. Based on the lease agreement, the cost of repairing and
maintaining will be borne by Super Max Sdn Bhd. Easy lease is not
responsible for any damages.

Super Max Sdn Bhd will be given the option to purchase the machine at the
end of the lease term at a nominal price of RM10. The lease agreement
stipulates that this is a non-cancellable lease. It is estimated that the
machine will have a useful life of seven years. The interest rate implicit in
the lease is 10%.

(b) Fitting Equipment

On 1 July 2013, Super Max Sdn Bhd (lessee) entered into a contract with
Maju Lease Bhd (lessor) to lease fitting equipment. Super Max Sdn Bhd is
required to make four payments of RM150,000 per annum, payable in
advance, from 1 July 2013 to 1 July 2016.

Based on the terms and conditions of the lease contract, both parties (lessor and
lessee) are allowed to terminate the contract. However, they are required to give
three monthsÊ notice to the other party. Maju Lease is responsible for maintaining
the fitting equipment throughout the lease term. It is also required to inspect the
equipment every month. The machine has an estimated lifespan of 15 years with
a fair value of RM1.2 million. The interest rate implicit in the lease is 10%.

Required
Explain and justify whether each lease is a finance or operating lease.

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24  TOPIC 2 LEASES

Solution:

Piling Machine
Paragraph 10 of MFRS 117 stipulates the conditions that determine whether the
asset should be treated as an operating or finance lease. In the case of the piling
machine, it is a finance lease for the following reasons:

(a) The lease term is 86%(6/7  100%) of the useful life of the asset;

(b) An option to purchase the asset at a nominal price of RM1 at the end of the
lease term. It is reasonably certain that the company will exercise the
option. Therefore, ownership is transferred at the end of the lease term;

(c) It is a non-cancellable lease; and

(d) The present value of the minimum lease payment is more than
90% of the fair value of the asset.
Note:
Present value of the minimum lease payments is:
Present value = RM4 million + RM4 million/(1+0.10)1 + RM4million/(1
+ 0.10)2+ RM4 million/(1+0.10)3 + RM4
million/(1+0.10)4 + RM4million/(1+0.10)5
= RM19.16 million
An alternative approach to determine the present value is:
Present value = RM4 million  Present value factor for six periods
= RM4 million + (RM4 million  3.7908)
= RM19.16 million
Fair value is RM20 million. Therefore, the present value of the minimum
lease payment is 95.8% of the fair value of the asset:
= RM19.16 million/RM20 million  100% = 95.8% >90%

(e) The lessee is responsible for repairing and maintaining the asset, indicating
that the risks and rewards lie with the lessee.

Fitting Equipment

(a) The lease is an operating lease for the following reasons:

(b) The lease term is 27% (4 years/15 years  100% = 27%) of the useful life of
the asset;

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(c) The lease is cancellable by either party giving three monthsÊ notice; and

(d) The present value of the minimum lease payment is less than 90% of the
fair value of the asset.
Note:
Present value = RM150,000 + RM150,000/(1 + 0.10)1+ RM150,000/
(1 + 0.10)2 + RM150,000/(1 + 0.10)3
= RM523,035
An alternative approach to determine the present value is:
Present value = RM150,000  Present value factor for four periods
= RM150,000 + (RM150,000  2.4869)
= RM523,035
Fair value = RM1.2 million
Therefore, the present value of the minimum lease payment is 52% of the
fair value of the asset:
= RM523,035/ RM1,200,000  100%
= 43.5% < 90%

As for Paragraph 11 of MFRS 117, it explains that there are indicators of

situations which, individually or in combination, could also lead to a lease being
classified as finance lease, such as:
(a) If the lessee cancels the lease, the lessorÊs losses associated with the
cancellation of the lease are borne by the lessee;
(b) Gains or losses from the fair value of the residual fall on the lessee (for
example, in the form of a rent rebate equalling most of the sales proceeds at
the end of the lease); and
(c) The lessee has the ability to continue the lease for a secondary period at a
rent which is substantially lower the market rent.

ACTIVITY 2.2
Discuss with your classmates the meaning of the following terms:
(a) Risks and rewards;
(b) Operating lease; and
(c) Finance lease.

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SELF-CHECK 2.1

Why „risks and rewards‰ is used as a basis to determine whether a

leased asset is classified as an operating or a finance lease?

2.1.2 Difference between Lease and Hire Purchase

What is the difference between lease and hire purchase? Firstly, let us look at hire
purchase definition.

A hire purchase is a type of finance lease in which the user is given an

option to buy the asset at a nominal sum at the end of the contract.

However, there is no significant difference in terms of economic effects between a

hire purchase and a finance lease since the risks and rewards of ownership are
transferred to the users.

The difference between a hire purchase and a lease contract lies in connection
with the following tax implications on the capital allowance:
(a) The lessor in the finance lease will be allowed to claim the capital allowance
instead of the lessee; and
(b) The lessee in the hire purchase will be allowed to claim the capital
allowance instead of the lessor.

SELF-CHECK 2.2

What is the difference between a hire purchase and a lease?

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 TOPIC 2 LEASES  27

2.2 THE ACCOUNTING TREATMENT OF AN

OPERATING LEASE
Let us look at operating lease from the perspectives of the lessee and the lessor in
this subtopic.

2.2.1 Operating Lease – The Lessee’s Book

In the book of a lessee, lease payment in an operating lease is recognised as an
expense on a straight-line basis over the lease term; unless another systematic basis
is representative of the time pattern of the userÊs benefit (MFRS 117, Para 33).

2.2.2 Operating Lease – The Lessor’s Book

The asset held under an operating lease will be recorded in the book of the lessor
as a fixed asset and it will be duly depreciated. The lease income (i.e. rental
received) should be recognised as income on a straight-line basis over the lease
term, unless another systematic basis is more representative of the time pattern in
which the userÊs benefit derived from the leased asset is diminished (MFRS 117,
Para 50).

Let us look at Example 2.2 to understand more on this matter.

Example 2.2:

Blue Hawk Sdn Bhd makes plastic toys in Subang. Its financial year ends
31 December. In an attempt to penetrate the European market, on 1 January 2013,
the company entered into an operating lease with Smart Tech Sdn Bhd to lease 10
machines for five years in order to increase production. Blue Hawk Sdn Bhd is
required to pay Smart Tech Sdn Bhd rental of RM100,000 per annum. The fair
value of the five machines is RM800,000. It is estimated that the machines have a
useful life of 10 years. It is also stated in the contract that the lessor, Smart Tech
Sdn Bhd, is responsible for maintaining the machines during the lease period.

Required
Prepare the journal entries to record the leasing transactions in the books of the
lessor and the lessee.

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Solution:

Books of Blue Hawk Sdn Bhd (Lessee)

1 January 2013
Dr Cr
(RM) (RM)
Dr Lease rental expense 100,000
Cr Bank 100,000
(To record the lease rental payment)

Books of Smart Tech Sdn Bhd (The lessor)

Dr Bank 100,000
Cr Lease rental income 100,000
(To record the lease rental received)
Dr Profit and Loss – Depreciation 80,000
Cr Accumulated Depreciation
(800,000/10 years) 80,000
(To record the depreciation expense)

2.3 THE ACCOUNTING TREATMENT OF A

FINANCE LEASE
Now let us learn finance lease based on the lesseeÊs book, finance lease based on
the lessorÊs book and accounting treatment of indirect costs.

2.3.1 Finance Lease – The Lessee’s Book

There are three important elements concerning the lesseeÊs book. They are:

(a) Measurement of Leased Asset

According to Paragraph 20 of MFRS 117, the lessee should recognise finance
leases as assets and liabilities in its balance sheet. The amount recognised
should be the fair value of the leased assets.

However, if it is lower, then it should be recognised at the present value of

the minimum lease payment. In calculating the present value of the

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 TOPIC 2 LEASES  29

minimum lease payment, the discount factor is the interest rate implicit in the
lease, if not, the lesseeÊs incremental borrowing rate should be used.

The journal entry to recognise leased assets in the lesseeÊs book will be:

Dr (RM) Cr (RM)
Dr Lease assets XX
Cr Lease liabilities/Lease creditors XX

Let us look at Example 2.3.

Example 2.3:

Sungai Emas Sdn Bhd entered into a finance lease agreement for a machine
with a renowned leasing company in Kuala Lumpur on 1 January 2013.

The contract has the following terms and conditions:

(a) The lessee is required to pay five-yearly instalments of RM120,000;
(b) The first instalment commence on 1 January 2013;
(c) The machine has a fair value of RM600,000 on 1 January 2013;
(d) Sungai Emas Sdn Bhd is required to bear all maintenance costs;
(e) The lease is not cancellable; and
(f) The incremental borrowing rate is 10% per annum.

Required

Calculate the amount that Sungai Emas Sdn Bhd should record at the
inception of the lease and prepare the journal entry of the transaction.

Solution:

Based on Paragraph 20 of MFRS 117, a finance lease is recognised as an asset

and a liability at the fair value of the leased property, or if lower, the present
value of the minimum lease payment.

The fair value is RM600,000.

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The present value of the minimum lease payment is:

Present value = 120,000 + 120,000/(1 + 0.10)1 + 120,000/(1 + 0.10)2 +
120,000/(1+0.10)3 + 120,000/(1 + 0.10)4 = 500,388

An alternative approach to determine the present value is:

Present value = 120,000  Present value factor for 5 years
= 120,000 + (120,000  3.1699)
= 500,388

Therefore, the lease asset and lease creditor will be recorded at RM500,388 at
the inception of the lease.
The journal entry is:
Dr (RM) Cr (RM)
Dr Lease assets 500,388
Cr Lease liability 500,388

(b) Depreciation of the Leased Asset

According to Paragraph 27 of MFRS 117, the leased asset should be
depreciated over the useful life of the asset if it is a finance leased to the
lessee.

However, if there is no reasonable certainty that the lessee will obtain

ownership by the end of the lease term, the asset should be fully
depreciated over the lease term or its useful life, whichever is shorter.

(c) Instalment of Lease Payment

Lease payments are to be apportioned between the finance charge and the
reduction of outstanding liability. The finance charge should be allocated to
periods during the lease term, so as to produce a constant periodic rate of
interest on the remaining balance of the liability for each period (MFRS 117,
Para 25).

The journal entry for the rental payment in the lesseeÊs book will be:

Dr (RM) Cr (RM)
Dr Lease liability/creditor XX
Dr Finance charge (P&L) XX
Cr Bank XX

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 TOPIC 2 LEASES  31

There are two main methods of allocating the finance charge. They are:
(i) The actuarial method; and
(ii) The sum-of digits.

Example 2.4 illustrates these principles. You are advised to pay more
attention to this example.

Example 2.4:

Aksons Sdn Bhd is a retailer in Ipoh selling household products. On 1 January

2013, the company entered into a finance lease contract for equipment with a
leasing company in Kuala Lumpur. Aksons Sdn Bhd is required to pay eight
yearly instalments of RM20,000 per year. The first rental fee is payable in
advance on 1 January 2013. The last payment will be on 1 January 2014. The
lease is non-cancellable and Aksons Sdn Bhd is responsible for repairing and
maintaining the lease asset. The fair value of the equipment as at 1 January is
RM103,212. It is assumed that the present value of the minimum lease payment
is equal to the fair value of the machine.

Based on the contract, at the end of the lease period, the title for the
equipment will be transferred to Aksons Sdn Bhd for a nominal sum of
RM1. It is quite certain that the company will exercise the purchase option at
the end of the lease period. The useful life of the machine is 10 years with a
residual value of RM500. The incremental borrowing rate is 15% per annum.

Required
(a) Prepare the journal entry in the lesseeÊs account to record the
transaction at the inception of the lease.
(b) Compute the depreciation of the lease asset for 2013.
(c) Compute the allocation of the finance charge in each period using:
(i) The actuarial method; and
(ii) The sum-of-digit method.

(d) Show all the journal entries for 2014, assuming the allocation of finance
charge is based on the actuarial method.

Solution:
(a) The lessee should be recognised as a finance lease. The lessee should
recognise a lease asset and a lease creditor in the balance sheet. The

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32  TOPIC 2 LEASES

amount should be RM103,212 since the fair value is equal to the

present value.

The journal entry in the lesseeÊs book is:

Dr (RM) Cr (RM)
Dr Lease Asset 103,212
Cr Lease creditor 103,212
(b) Since ownership will be transferred to the lessee, the machine should
be depreciated over the useful life of the asset. For 2013, the
depreciation charge would be:
(RM103,212 – RM500)/1 year = RM10,271.20

(c) Calculation of interest charge using the actuarial method is as follows:

Payment Interest Principal Closing

Year
Made 15% Repayment Balance
2010 20,000 – 20,000 83,212
2011 20,000 12,480 7,520 75,692
2012 20,000 11,352 8,648 67,044
2013 20,000 10,056 9,944 57,100
2014 20,000 8,564 11,436 45,664
2015 20,000 6,848 13,152 32,512
2016 20,000 4,876 15,124 17,388
2017 20,000 2,612 17,388 –
Total 160,000 56,788 103,212

Calculation of interest charge using the sum-of-digit method is as follows:

Note:
The effective financing period is seven years as the first payment was
payable in advance on 1 January 2013. The sum of digit is 28 (1 + 2 + 3 + 4 +
5 + 6 + 7)

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Interest allocation is as follows:

Year RM
2013 7/28  56,788 14,197
2014 6/28  56,788 12,169
2015 5/28  56,788 10,141
2016 4/28  56,788 8,113
2017 3/28  56,788 6,084
2018 2/28  56,788 4,056
2019 1/28  56,788 2,028
2020 NIL 56,788

Payment Interest Principal Closing

Year
Made 15% Repayment Balance
2013 20,000 – 20,000 83,212
2014 20,000 14,197 5,803 77,409
2015 20,000 12,169 7,831 69,578
2016 20,000 10,141 9,859 59,719
2017 20,000 8,113 11,887 47,832
2018 20,000 6,084 13,916 33,916
2019 20,000 4,056 15,944 17,972
2020 20,000 2,028 17,972 –
160,000 56,788 103,212

(d) Year 2014

Dr (RM) Cr (RM)
Dr Lease creditor 7,520
Dr Finance charge (P&L) 12,480
Cr Bank 20,000
(To record the payment of leased instalment)

Dr Depreciation 10,271.20
Cr Accumulated Depreciation 10,271.20
(To record the depreciation expense)

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2.3.2 Finance Lease – The Lessor’s Book

Previously, we have looked at the lesseeÊs book. Now, let us look at the lessorÊs
book. There are two important elements concerning the lessorÊs book. They are:

(a) Recognition of Sales/Receivable

Based on Paragraph 36 of MFRS 117, lessors should recognise assets held
under a finance lease in their balance sheet and present them as receivable
at an amount equal to the net investment in the lease.

The journal entry to record for this transaction is as follows:

Dr (RM) Cr (RM)
Dr Lease Debtor XX
Cr Sale XX
(b) Recognition of Rental Income
According to Paragraph 40 of MFRS 117, the recognition of income should
be done based on a pattern reflecting a constant periodic rate of return on
the lessorÊs net investment outstanding in respect of the finance lease.

The journal entry to record for this transaction is as follows:

Dr (RM) Cr (RM)
Dr Bank XX
Cr Lease Debtor XX
Cr Profit and Loss – Interest income XX

SELF-CHECK 2.3

What are the two main methods commonly used in allocating the
finance charge?

2.3.3 Accounting Treatment of Indirect Costs

Paragraph 46 of MFRS 117 states that initial direct costs incurred by lessors in
negotiating and arranging a lease, such as commissions and legal fees, should be
written off immediately as expenses or allocated over the lease term.

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This is shown in the following Example 2.5.

Example 2.5:
CIMA Leasing Sdn Bhd entered into an agreement to provide RM407,230 to
Waterfront Sdn Bhd to purchase an expensive imported machine on
1 January 2013. Based on the agreement, Waterfront Sdn Bhd is required to pay
a deposit of RM100,000 on 1 January 2013. It is also required to pay ten
instalments of RM50,000 from 1 January 2014 to 1 January 2023. The interest rate
implicit throughout the lease term is 8% per annum.

Based on the contract, the title to the asset will be transferred to Waterfront Sdn
Bhd at the end of the lease period. Besides, the contract stipulates that
Waterfront Sdn Bhd is responsible for repairing and maintaining the leased
asset. The estimated useful life of the asset is 15 years with a scrap value of
RM5,000. To facilitate the contract, CIMA Leasing Sdn Bhd has engaged a
lawyer and legal fees of RM5,000 was incurred.
Required
Prepare the journal entries in the book of the lessor, related to the lease
transaction, for the year 2013.
Solution:
Books of CIMA Leasing Sdn Bhd (lessor)
Dr Cr
(RM) (RM)
Dr Lease Debtor 407,230
Cr Bank/Sales 407,230
(To record the receivable)

Dr Bank 100,000
Cr Lease Debtor 100,000
(To record the lease payment received)

Dr Lease Debtor 32,578.40

Cr Profit and Loss – Interest
income
(407,230  8%) 32,578.40
(To record the interest income)

Dr Profit and Loss – Indirect costs 5,000

Cr Bank 5,000
(To record the indirect costs)

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2.4 SALE AND LEASEBACK

According to Paragraph 58 of MFRS 117, a sale and leaseback transaction
involves the sale of an asset by the vendor (owner) and the leasing of the same
asset back to the vendor (owner). The sale and leaseback may amount to an
operating lease or a finance lease.

ACTIVITY 2.3

Why do companies enter into sale and leaseback transactions?

2.4.1 Sale and Leaseback – Finance Lease

When a sale and leaseback is a finance lease, it means the transaction does not
transfer significant risks and benefits to the buyer, but merely provides finance to
the lessee.

According to Paragraph 59 of MFRS 117, any excess of sales proceeds over the
carrying amount should not be immediately recognised as income in the financial
statements of a seller. Instead, it should be deferred and amortised over the lease term.

Example 2.6:

Wonderful Sdn Bhd bought a machine costing RM1 million on 1 January 2005 from
Japan. The machine is estimated to have a useful life of 10 years. It is the company
policy to depreciate the machine using the straight-line method over its useful life.

On 1 January 2010, in view of financial difficulty, the company entered into a sale
and leaseback arrangement with a finance company to raise funds. The machine
was sold at the fair value of RM600,000 with an immediate leaseback of a finance
lease for five years. Wonderful Sdn Bhd is required to make five annual rental
payments of RM130,000 from 1 January. The first payment was made on 1 January
2010. Interest is to be allocated using the sum-of digits method.

Required
Prepare the journal entries for the books of Wonderful Sdn Bhd for 2010.

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Solution:
Dr Cr
(RM) (RM)
Dr Bank 600,000
Accumulated Depreciation
(1,000,000/10  5 years) 500,000
Cr Machine 1,000,000
Cr Deferred Gain 100,000
(To record the sale of machine)
Dr Machine 600,000
Cr Lease creditor 600,000
(To record the lease asset and liability)
Dr Lease Creditor 130,000
Cr Bank 130,000
(To record the payment of the lease instalment)
Dr Profit and Loss – Interest expense 20,000
Cr Lease creditor 20,000
(To record the interest portion of the lease payment)
Dr Profit and Loss – Depreciation expense
(600,000/5 years) 120,000
Cr Accumulated Depreciation 120,000
(To record the depreciation of the leased asset)
Dr Deferred Gain (100,000/5 years) 20,000
Cr Profit and Loss 20,000
(To record the realisation of the deferred gain)

Take note of the following:

Total interest charge for the lease period:
RM
Total rental/instalment to be paid 650,000
Fair value of the asset (600,000)
Interest charge over the lease 50,000

Interest expense for the year 2010 = (4/10  50,000)

= 20,000
The effective financing period is 4 years as the first payment was made in
advance on 1 January 2010. The sum of digit is 10 (1 + 2 + 3 + 4).

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2.4.2 Sale and Leaseback – Operating Lease

According to Paragraph 61 of MFRS 117, if the leaseback is an operating lease
and it is clear that the transaction is established at fair value, then any gain or loss
should be recognised immediately.

If the sale price is below the fair value, any profit and loss should be recognised
immediately. Unless the loss is compensated by future lease payment below
market price, then it should be deferred and amortised in proportion to the lease
payments over the period for which the asset is expected to be used.

If the sale price is above fair value, the excess over fair value should be
deferred and amortised over the period for which the asset is expected to be used.

The situations in Paragraph 61 of MASB 10 are summarised in Table 2.1.

Table 2.1: Situations in Paragraph 61 of MASB 10

Carrying Carrying
Carrying Amount
Amount Less Amount Above
Equal to Fair Value
Than Fair Value Fair Value
Sale price Established at Fair Value (Paragraph 61)

Profit No profit Recognise profit Not applicable

immediately
Loss No loss Not applicable Recognise loss
immediately
Sale Price Below Fair Value (Paragraph 61)
Profit No profit Recognise profit No profit
immediately (Note 1)
Loss not compensated by Recognise loss Recognise loss (Note 1)
future lease payments at immediately immediately
below market price
Loss compensated by future Defer and amortise Defer and (Note 1)
lease payments at below loss amortise loss
market price

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 TOPIC 2 LEASES  39

Sale Price Above Fair Value (Paragraph 61)

Profit Defer and amortise Defer and Defer and
profit amortise profit amortise profit
(Note 2)
Loss No loss No loss (Note 1)

Note 1: These parts of the table represent circumstances that would have been dealt
with under Paragraph 63 of the Standard. Paragraph 63 requires the carrying
amount of an asset to be written down to fair value where it is subject to a
sale and leaseback.

Note 2: The profit would be the difference between fair value and sale price as the
carrying amount would have been written down to fair value in accordance
with Paragraph 63.

Let us look at Example 2.7.

Example 2.7:
Maxwell Sdn Bhd, a furniture maker in Klang, bought a machine from Taiwan
costing RM150,000 on 1 January 2007. The machine has a useful life of 10 years.
Based on the company policy, the machine is to be depreciated using the straight-
line method over its useful life. On 1 January 2010, the company entered into a
sale and leaseback arrangement with a leasing company in order to raise funds to
ease tight cash flow. The machine was sold at a fair value of RM120,000 and is
leased back as an operating lease. Maxwell Sdn Bhd is required to pay lease
rental of RM12,000 per annum. Based on the contract, the leasing company is
responsible for all repairing and maintaining costs.
Required
Prepare the journal entries for the books of Maxwell Sdn Bhd for 2010.
Solution:
Dr Cr
(RM) (RM)
Dr
Bank 120,000
Dr Accumulated Depreciation
[(150,000/10 years)  3 years] 45,000
Cr
Machine 150,000

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40  TOPIC 2 LEASES

Cr Profit and Loss-Gain 15,000

(To record the sale of the machine)

Dr Lease rental expense 12,000

Cr Bank 12,000
(To record the payment of lease instalment)

2.5 DISCLOSURE AND PRESENTATION

In this final subtopic, we will look in detail at four elements which relate closely
to what we have just learned. These elements are:
(a) Finance lease – in the financial statement of the lessee;
(b) Finance lease – in the financial statement of the lessor;
(c) Operating lease – in the financial statement of the lessee; and
(d) Operating lease – in the financial statement of the lessor.

2.5.1 Finance Lease – In the Financial Statement of

the Lessee
MFRS 123 stipulates that the lessee is required to make the following disclosures
in the note of accounts of the financial statements for finance leases:

(a) For each class of assets, the net carrying amount at the balance sheet date;

(b) A reconciliation between the total of minimum lease payments at the

balance sheet date and their present value. In addition, an enterprise should
disclose the total of minimum lease payments at the balance sheet date and
their present value, for each of the following periods:
(i) Not later than one year;
(ii) Later than one year and not later than five years; and
(iii) Later than five years.

(c) Contingent rents recognised in income for the period;

(d) The total of future minimum sublease payments expected to be received

under non-cancellable subleases at the balance sheet date; and

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 TOPIC 2 LEASES  41

(e) A general description of the lesseeÊs significant leasing arrangements

including (but not limited), to the following:
(i) The basis on which contingent rent payments are determined;
(ii) The existence and terms of renewal or purchase options and
escalation clauses; and
(iii) Restrictions imposed by lease arrangements, such as those concerning
dividends, additional debt and further leasing.

2.5.2 Finance Lease – In the Financial Statement of

the Lessor
MFRS 123 stipulates that the lessor is required to make the following disclosures
in the note of accounts of financial statements for finance leases:

(a) A reconciliation between the total gross investment in the lease at the
balance sheet date and the present value of minimum lease payments
receivable at the balance sheet date. In addition, an enterprise should
disclose the total gross investment in the lease and the present value of
minimum lease payments receivable at the balance sheet date for each of
the following periods:
(i) Not later than one year;
(ii) Later than one year and not later than five years; and
(iii) Later than five years.

(b) Unearned finance income;

(c) The unguaranteed residual values accruing to the benefit of the lessor;

(d) The accumulated allowance for uncollectible minimum lease payments

receivable;

(e) Contingent rents recognised in income; and

(f) A general description of the lessorÊs significant leasing arrangements.

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42  TOPIC 2 LEASES

2.5.3 Operating Lease – In the Financial Statement of

the Lessee
MFRS 123 stipulates that the lessee is required to make the following disclosures
in the note of accounts of financial statements for operating leases:

(a) The total of future minimum lease payments under non-cancellable

operating leases for each of the following periods:
(i) Not later than one year;
(ii) Later than one year and not later than five years; and
(iii) Later than five years.

(b) The total of future minimum sublease payments expected to be received

under non-cancellable subleases at the balance sheet date;

(c) Lease and sublease payments recognised in income for the period, with
separate amounts for minimum lease payments, contingent rents, and
sublease payments; and

(d) A general description of the lesseeÊs significant leasing arrangements

including (but not limited), to the following:
(i) The basis on which contingent rent payments are determined;
(ii) The existence and terms of renewal or purchase options and
escalation clauses; and
(iii) Restrictions imposed by lease arrangements, such as those concerning
dividends, additional debt and further leasing.

2.5.4 Operating Lease – In the Financial Statement of

the Lessor
MFRS 123 stipulates that the lessor is required to make the following disclosures
in the note of accounts of financial statements for operating leases:

(a) For each class of assets, the gross carrying amount, the accumulated
depreciation and accumulated impairment losses at the balance sheet date:
(i) The depreciation recognised in income for the period;
(ii) Impairment losses recognised in income for the period; and
(iii) Impairment losses reversed in income for the period.

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 TOPIC 2 LEASES  43

(b) The future minimum lease payments under non-cancellable operating

leases in the aggregate and for each of the following periods:
(i) Not later than one year;
(ii) Later than one year and not later than five years; and
(iii) Later than five years.

(c) Total contingent rents recognised in income; and

(d) A general description of the lessorÊs significant leasing arrangements.

The following Example 2.8 is taken from the notes of the accounts of the annual
report of a Malaysian company. It illustrates the accounting policy for leases and
disclosure practice based on MFRS 117 on lease liabilities and commitments.

Example 2.8:

Malaysian Airline System Berhad

Year ended 31 March 2009
Extract from notes to accounts

Significant Accounting Policies

Leases

(a) Finance Lease – The Group as Lessee

Assets acquired by way of hire purchase or finance lease are stated at an
amount equal to the lower of their fair values and the present value of the
minimum lease payments at the inception of the leases, less accumulated
depreciation and impairment losses. The corresponding liability is included
in the balance sheet as borrowing in calculating the present value of the
minimum lease payments, the discount factor used is the interest rate
implicit in the lease, when it is practicable to determine; otherwise, the
companyÊs incremental borrowing rate is used. Any initial direct costs are
also added to the carrying amount of such assets.

Lease payments are apportioned between the finance costs and the
reduction of outstanding liability. Finance costs, which represent the
difference between the total leasing commitments and the fair value of the
assets acquired, are recognised in the profit or loss over the term of the
relevant lease so as to produce a constant periodic rate of charge on the
remaining balance of the obligations for each accounting period.

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44  TOPIC 2 LEASES

The depreciation policy for leased assets is in accordance with depreciable

aircraft, property, plant and equipment as described in
Note 2.4 (e).

(b) Operating Lease – The Group as Lessee

Operating lease payments are recognised as an expense on a straight-line
basis over the term of the relevant lease. In the case of a lease of land and
buildings, the minimum lease payments or the up-front payments made are
allocated, whenever necessary, between the land and the building elements
in proportion to the relative fair values for leasehold interests in the land
element and buildings element of the lease at the inception of the lease. The
upfront payment represents prepaid lease payments and are amortised on a
straight-line basis over the lease term.

Finance lease liabilities

Group Group
2009 2008
RMÊ000 RMÊ000

Future lease payments:

Not later than one year 47,035 14,225
Later than one year and not later than five 196,383 52,451
years
Later than five years 374,150 82,344
Total minimum future lease payments 617,568 149,020
Less: Future finance charges (130,819) (28,368)
Present value of finance lease liabilities 486,749 120,652

ACTIVITY 2.4
Find out how leases are presented and disclosed in annual audited accounts
from the website of Bursa Malaysia at http://www.klse.com.my.

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 TOPIC 2 LEASES  45

 A lease is an agreement whereby the lessor conveys to the lessee, in return

for a payment or series of payments and the right to use an asset for an
agreed period of time.

• Leases are governed by MFRS 117.

• A lease can be categorised as an operating lease or a finance lease.

• The criterion in distinguishing between an operating lease and a finance

lease is whether the risks and rewards incidental to ownership of a leased
asset have been transferred.

 A lease is classified as a finance lease if it transfers substantially all the risks

and rewards incidental to ownership.

 A lease is classified as an operating lease if it does not transfer substantially

all the risk and rewards incidental to ownership.

• The accounting treatment of operating leases and finance leases relates

closely to sale and leaseback transactions.

 According to Paragraph 58 of MFRS 117, a sale and leaseback transaction

involves the sale of an asset by the vendor (owner) and the leasing of the
same asset back to the vendor (owner). The sale and leaseback may amount
to an operating lease or a finance lease.

 Finally, this topic outlines the presentation and disclosure of different types
of leases under the requirement of MFRS 117.

Actuarial method Lease term

Fair value Lessee
Finance lease Lessor
Incremental borrowing rate Minimum lease payment
Interest rate Non-cancellable lease
Lease Operating lease
Leaseback Sum-of digits

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46  TOPIC 2 LEASES

1. (a) Aceland Sdn Bhd is a company that produces equipment for

construction firms. The cost of producing one equipment is RM100
million. The market price is RM150 million. The expected useful life of
the equipment is 30 years.

Mah Sing Sdn Bhd, a developer in Kuala Lumpur, entered into an

agreement to lease the equipment from Aceland Sdn Bhd. According
to the agreement, Mah Sing Sdn Bhd will lease the equipment for 12
years at an annual rental of RM5 million payable on 1 January. The
interest rate implicit to the lease is 10%. At the end of the 12 years,
Mah Sing Sdn Bhd will return the equipment to Aceland Sdn Bhd.
This means that the title to the equipment will not be transferred.
Aceland Sdn Bhd will be responsible for repairing and maintaining
the machine during the lease period.

(b) On 1 January 2010, Fun Land Sdn Bhd entered into a leasing
agreement with Bob Sdn Bhd for a specialised machine. Following are
the terms and conditions:
(i) The fair value of the machine is RM800,000;
(ii) The machine has an estimated useful life of 11 years;
(iii) Fun Land Sdn Bhd is required to pay a deposit of RM40,000 and
nine yearly payments of RM110,000;
(iv) The deposit should be paid on 1 January 2010 and the nine
yearly payments commence on 1 January 2011;
(v) The interest rate implicit to the lease is 10%;
(vi) Fun Land Sdn Bhd is responsible for the cost of maintaining the
machine; and
(vii) The title to the machine will be transferred to Fun Land Sdn Bhd
at the end of the lease term.

Required
Explain and justify whether the leasing arrangement is an operating lease
or a finance lease.

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 TOPIC 2 LEASES  47

2. On 1 January 2005, Super Max Sdn Bhd bought a machine costing RM1
million from Thailand. The machine has an estimated useful life 10 years. It
is depreciated on the straight-line basis over its useful life.

In view of financial difficulty, on 1 January 2010, Super Max Sdn Bhd

entered into a sale and leaseback (finance lease) arrangement with Jaya
Leasing Sdn Bhd where the machine was sold at a fair value of RM800,000.
Super Max Sdn Bhd is required to pay an annual rental of RM170,000,
payable in advance for a period of five years. The first instalment
commences on 1 January 2010 and the last will be on 1 January 2014.
Interest is to be allocated using the sum-of-digits method.

Required
Prepare the journal entries for the books of Super Max for 2010.

1. On 1 January 2005, XYZ Sdn Bhd purchased a machine costing RM1 million
from an established company in Malaysia. The machine has a useful life of
15 years with a scrap value of RM10,000. It is depreciated using the
straight-line method.

On 1 January 2010, the company entered into a sale and leaseback

arrangement with Southern Finance Sdn Bhd where the machine was sold
at a market value of RM600,000. XYZ Sdn Bhd leased back the machine in
an operating lease for eight years. XYZ Sdn Bhd is required to pay a
monthly rental of RM7,500, payable on 1 January every year. The first
payment was made on 1 January 2010 and the last will be made on 1
January 2017.

Required
Prepare the journal entries for the books of XYZ Sdn Bhd for 2010.

2. Silver Hawk Sdn Bhd entered into a lease contract with Maju Jaya Sdn Bhd
for specialised equipment on 1 January 2010. The purchase price of the
machine is RM460,000 if Silver Hawk were to buy the asset in the market.

Following are the terms and conditions of the contract:

(a) Silver Hawk Sdn. Bhd. is required to pay five yearly instalments of
RM100,000, payable on 1 January every year. The first instalment was
paid on 1 January 2010 and the last instalment will be on 1 January
2014.

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48  TOPIC 2 LEASES

(b) The economic useful life of the machine is six years and Silver Hawk
Sdn Bhd will have the option to buy the machine at the end of the
lease term at a nominal sum of RM1. It is certain that the company
will accept the offer.
(c) Insurance and maintenance costs are to be borne by Silver Hawk Sdn Bhd.

Required
Explain the difference between a finance lease and an operating lease. In the
stated situation, explain and justify whether it is a finance lease or an
operating lease.

Jones, M., & Rivett, D. (1998). Workshop notes for AAS17 accounting for leases.
Australia: Australian Society of CPAs.
Lembaga Piawaian Perakaunan Malaysia. (2011). FRS 117 Leases. Retrieved from
http://frf.org.my/images/masb150411/FRS117reprint_14Feb2011.pdf
Lembaga Piawaian Perakaunan Malaysia. (2000). MASB 10 leases. Retrieved from
http://www.masb.org.my/images/stories/archive/PERS/!masb10.pdf
Weygandt, J., Kieso, D., & Kimmel. P. (2002). Accounting principles. United
States of America: Wiley.

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Topic  Investments in
3 Equity and
Debt
Securities
LEARNING OUTCOMES
By the end of this topic, you should be able to:
1. Explain the accounting for investment in debt and equity securities;
2. Describe three categories of securities; and
3. Distinguish between short-term and long-term investment.

 INTRODUCTION
There are some reasons why a corporation invests in equity and debt securities.
These reasons are due to these three primary reasons:
(a) To have excess cash;
(b) Investment is such a significant revenue source; and
(c) They have strategic goals such as gaining control of a competitor or moving
into a new line of business.

Corporations purchase investments in debt or shares securities depending for the

reasons stated previously. Here are the explanations of the reasons. A
corporation may have excess cash that it does not need for the immediate
purchase of operating assets. Excess cash may result from economic cycles. When
investing excess cash for short periods of time, corporations invest in low-risk,
highly liquid securities. It is basically not wise to invest short-term excess cash in
shares of common shares because shares investments can experience rapid price

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50  TOPIC 3 INVESTMENTS IN EQUITY AND DEBT SECURITIES

changes. If the price of the shares declined after a short-term excess cash
investment, and cash is needed again, shares investment should be forced to sell
at a loss.

Some companies purchase investments to generate earnings from investment

income. For example, bankÊs earnings mostly come from lending money, but they
also generate earnings by investing in debts.

Companies also invest for a strategic reason. A company can exercise some
influence over a customer or supplier by purchasing a significant, but not
controlling interest in that company in a related industry in which it wishes to
establish a presence.

ACTIVITY 3.1
Try to figure out where to report short and long-term investments in
the balance sheet.

3.1 EQUITY AND DEBT INVESTMENTS

Companies record investments in debt securities when they purchase bonds,
receive or accrue interest, and sell the bonds. Gains or losses are reported on the
sale of bonds in the „other revenues and gains‰ or „other expenses and losses‰
sections in income statement.

Meanwhile, equity or stock investments record investments in common stock

when they purchase the shares, receive dividends and sell the shares. When
ownership is less than 20% and 50%, the equity method should be used. When
ownership is more than 50%, companies prepare consolidated financial
statements. Let us look at some examples which demonstrate these situations.

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 TOPIC 3 INVESTMENTS IN EQUITY AND DEBT SECURITIES  51

(a) Holding Less Than 20% (Using Cost Method)

Example 3.1:
On July 2012, Shine Corp acquires 1000 shares (10% ownership) of Finnie Corp
common shares. Shine pays RM40 per share plus brokerage fees of RM500. The
entry:
Dr Share Investment RM40,500
Cr Cash RM40,500
(To record purchase of shares)

Shine received dividend of RM2 per share

Dr Cash (1000  RM2) RM2,000

Cr Dividend Revenue RM2,000
(To record receipt of cash dividend)

When a company sells shares investment, it recognises gain or loss between the
net proceeds from the sale (sales price – brokerage fees) and the cost of shares.
Assume Shine receives net proceeds of RM39,500 on the sales of FinnieÊs shares
because the shares cost RM40,500. Shine incurred loss.

Dr Cash RM39,500
Dr Loss on sale of share investments RM1,000
Cr Share Investment RM40,500

(b) Holdings Between 20% and 50% (Using Equity Method)

Example 3.2:
Assume that Vic Corp acquires 30% of the common shares of Beck Company for
RM120,000 on January 2012. Vic records:

Jan 1 Dr Share Investment RM120,000

Cr Cash RM120,000
(to record purchase of Beck common shares)

Then for 2012, Beck reports net income of RM100,000 and declares to pay
RM40,000 cash dividend. Vic records:
(a) Its share of BeckÊs income, RM30,000 (30%  RM100,000); and
(b) The reduction in the investment account for dividend received, RM12,000
(RM40,000  30%).

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52  TOPIC 3 INVESTMENTS IN EQUITY AND DEBT SECURITIES

Dec 2012 Dr Share Investment RM30,000

Cr Revenue from investment RM30,000
(to record 30% equity in BeckÊs 2012 net income)

Dec 2012 Dr Cash RM12,000

Dr Share Investment RM12,000
(to record dividends received)

(c) Holding More Than 50%

A company that owns more than 50% of the common shares of another
entity is called as the parent company. The company whose share the
parent company owns is called the subsidiary company, because of its
shares ownership, the parent company has a controlling interest in the
subsidiary.

When a company owns more than 50% of the common shares of another
company, it usually prepares consolidated financial statement. These
statements present the total revenues and expenses of the subsidiary
companies. It indicates the magnitude and scope of operations of the
companies under common control.

3.2 REPORTING INVESTMENTS

There are three categories of securities as explained in Table 3.1.

Table 3.1: Three Categories of Securities

Category Description
Trading Brought and held primarily for sale in the near term to generate
Securities income on short-term price differences.
Available-for- Held with the intent of selling them sometime in the future.
Sale Securities

Held-to-Maturity Debt securities that the investor has the intent and ability to hold
Securities to maturity.

Debt and equity are classified into the stated securities in Table 3.1 for valuation
and reporting purposes.

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 TOPIC 3 INVESTMENTS IN EQUITY AND DEBT SECURITIES  53

3.2.1 Trading Securities

Companies hold trading securities with the intention of selling them in a short
period (usually less than a month). Trading means frequent buying and selling.
Companies report trading securities at fair value and report changes from cost as
part of net income. The changes are reported as unrealised gains and losses
because the securities have not been sold.

The unrealised gain or loss is the difference between the total cost of trading
securities and their total fair value. Companies classify trading securities as
current assets. If the total cost of the trading securities is greater than total fair
value, an unrealised loss has occurred. In this case, the adjusting entry is a debit
to Unrealised Loss – Income and a credit to market Adjustment – Trading.
Companies report the unrealised loss under „other expenses and losses‰ in the
income statement.

3.2.2 Available-for-Sale Securities

As indicated, companies hold available-for-sale securities with the intention for
selling these investments sometime in the future. If the intent is to sell the
securities within the next year or operating cycle, the investor classifies the
securities as current assets in the balance sheet. Otherwise, it is classified as long-
term assets in the investments section of balance sheet. Companies report
available-for-sale securities at fair value.

3.2.3 Held-to-Maturity Securities

What does a held-to-maturity investment is? A held-to-maturity investment is
the investment made by a company which it intends to hold till maturity while it
has the capacity to honour such intention. Only debt securities can be classified
as held-to-maturity because they have a definite maturity. On the other hand,
equity securities have no maturity and hence, they cannot be classified as held-
to-maturity.

A held-to-maturity investment is reported on balance sheet at its amortised cost.

Amortised cost is the carrying amount of the financial asset determined by
reducing the initial investment by the amount of principal repayments and any
impairment losses recognised and adjusting it for amortisation of discount or
premium using the effective rate of interest method. Interest income is recognised
on held-to-maturity investments using the effective rate of interest method.

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SELF-CHECK 3.1

Indicate how debt investment is reported in the financial statement.

3.3 SHORT-TERM INVESTMENT VERSUS

LONG-TERM INVESTMENT
Lastly, let us look at the comparison between short-term investment and long-
term investment.

3.3.1 Short-term Investment

Do you know that short-term investments are also known as marketable
securities? What do short-term investments mean?

Short-term investments are securities held by a company that are readily

marketable and intended to be converted into cash within the next year or
operating cycle; whichever that does not meet both criteria is classified as
long-term investments.

In the definition, there are two important criteria mentioned. They are further
explained in Table 3.2.
Table 3.2: Two Important Criteria of Short-Term Investment

Criteria Definition
Readily An investment is readily marketable when it can be sold easily
Marketable whenever the need for cash arises.
Intent to Convert It means that management intends to sell the investment within
next year or operating cycle, whichever longer.

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 TOPIC 3 INVESTMENTS IN EQUITY AND DEBT SECURITIES  55

3.3.2 Long-term Investment

Do you know that companies generally report long-term investments in a
separate section of the balance sheet immediately below „current asset‰? Long-
term investments in available-for-sale securities are reported at fair value.
Investments in common shares accounted for under the equity method are
reported at their equity value.

 A company invests in equity and debt securities due to:

‒ To have excess cash;
‒ Investment is such a significant revenue source; and
‒ They have strategic goals such as gaining control of a competitor or
moving into a new line of business.

 Companies record investments in debt securities when they purchase bonds,

receive or accrue interest, and sell the bonds.

 There are three categories of securities namely trading securities, available-

for-sale securities and held-to maturity securities.

 In trading securities, companies hold trading securities with the intention of

selling them in a short period (usually less than a month).

 As for available-for-sale securities, companies hold available-for-sale securities

with the intention for selling these investments sometime in the future.

 As for held-to-maturity securities, it is the investment made by a company which

it intends to hold till maturity while it has the capacity to honour such intention.

 The difference between short-term investment and long-term investment is

that short-term investment is securities held by a company that are readily
marketable and intended to be converted into cash within the next year or
operating cycle while long-term investment is available-for-sale securities
which are reported at fair value.

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56  TOPIC 3 INVESTMENTS IN EQUITY AND DEBT SECURITIES

Available-for-sale securities Parent company

Brokerage Securities
Controlling interest Short-term investment
Debt securities Subsidiary company
Held-to maturity securities Trading securities
Long-term investment

Jean Co acquired 5% of the 400,000 shares of common stock of Rowater Co at a

total cost of RM6 per share on 18 May 2013. On 30 August, Rowater declared and
paid RM75,000 dividend. On 31 December, Rowater reported net income of
RM244,000 for the year.

Prepare the journal entries for 2013 for Jean Co.

Scott Inc obtained significant influence over North Co by buying 40% of North
Co 60,000 outstanding shares of common stock at a cost of RM12 per share on 1
January 2013. On 15 April, North Co declared and paid a cash dividend of
RM45,000. On 31 December, North Co reported a net income of RM120,000 for
the year.

Prepare the journal entries for 2013 for Scott Inc.

Copyright © Open University Malaysia (OUM)

Topic  Investment
4 Properties

LEARNING OUTCOMES
By the end of this topic, you should be able to:
1. Define investment property and its types;
2. Describe how to measure investment properties;
3. Discuss how investment property can be transferred;
4. Describe investment property disposal; and
5. Summarise investment property disclosures.

 INTRODUCTION
What does investment property mean? MFRS 140 defines investment property as
"land or a building or part of a building or land and building held (by the owner
or under finance lease) to earn rentals or for capital appreciation or both...‰.

In this topic, you will learn more on investment property as we go through its
definition, types, measurement, transfer, disposal and disclosure.

ACTIVITY 4.1
If you have a building or land, would you invest it for future
incomes? Why?

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58  TOPIC 4 INVESTMENT PROPERTIES

4.1 RECOGNITION
How do identify an investment property? Investment property can be recognised
as an asset if:
(a) It is probable that future economic benefits associated with the investment
property will flow to the entity; and
(b) The purchase price to the investment property can be measured reliably.

There are three types of investment propertyas summarised in Table 4.1.

Table 4.1: Three Types of Investment Property

Types Description
Owner-Occupied Building that is owner-occupied can be classified as investment
Property property only if the owner-occupied portion is significant.
Ancillary Services If the ancillary services provided is insignificant then the entity
Provided may treat the property as investment property.
Intra-Group Rental Property rented to members of the group can be classified as
investment property in the individual financial statements.

However, maintenance costs measured daily are not recognised, such as house
maintenance. On the other hand, subsequent costs for replacement of parts of the
property are recognised if the expenditure meets the recognition criteria.

ACTIVITY 4.2
In your own opinion, do you think investing in land and buildings is
worth it?

4.2 MEASUREMENT
Initially, all investment properties are measured at cost. This includes transaction
cost. The cost of purchased investment property consists of the purchase price
and any direct attributable expenditure such as legal fees. Let us look at one
example.

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 TOPIC 4 INVESTMENT PROPERTIES  59

Example 4.1:

DEF Bhd acquired a 30% equity interest in the share capital of MNO Sdn Bhd.
The agreed purchase consideration is as follows:
(a) An issue of 5 million DEFÊs ordinary shares of RM1 valued at RM3 each;
and
(b) The balance in cash of RM5 million.
Legal fees and other acquisition charges amounted to RM18,000.

Required:
(i) Determine the investment cost in the equity shares of MNO Sdn Bhd.
(ii) Show the journal entries.

Solution:

(i) Purchase price

Fair value of shares issued: 5 million  RM3 RM15,000,000

Cash paid RM 5,000,000
RM20,000,000
Legal fees and other acquisition charges RM 18,000
Investment cost RM20,018,000

(ii) Journal entries

Dr Investment in MNO Sdn Bhd RM20,018,000

Cr Share capital of RM1 each RM5,000,000
Cr Share premium RM10,000,000
Cr Cash RM5,018,000

4.2.1 Fair Value Model

The fair value of investment property should reflect the actual market state and
circumstances as of the balance sheet date, not as any future date. It is required to
apply fair value model up until the disposal of the asset or until there is a change
in use.

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60  TOPIC 4 INVESTMENT PROPERTIES

The recognition of a gain or loss arising from a change in fair value of investment
should be in the income statement as of its arose period. Fair value is not
recoverable amount.

4.2.2 Cost Model

After initial recognition, cost model should measure all of its investment
properties at cost less any accumulated depreciation and any accumulated
impairment losses.

4.3 TRANSFERS
Transfer from or to investment property are allowed only when there is a change
in use and evidenced by:
(a) Transfer from investment property to owner-occupied property on
commencement of owner-occupation;
(b) Transfer from investment property to inventories on commencement of
development with view to sale;
(c) Transfer from owner-occupied property to investment property at the end
of the owner-occupation;
(d) Transfer from inventories to investment property at the commencement of
an operating lease; and
(e) Transfer from property in the course of construction or development to
investment property at the end of construction or development.

4.4 DISPOSAL
An investment property should be derecognised or removed from the balance
sheet on disposal or when the investment property is withdrawn from use
permanently and no future economic benefits are expected from its disposal.

From the difference between the net disposal proceeds and the carrying amount
of the asset we can determine the gain or loss arising from the disposal or
retirement and this should be recognised as income or expense in the income
statement.

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 TOPIC 4 INVESTMENT PROPERTIES  61

4.5 DISCLOSURES
The comparative information is required for all disclosures. For both fair value
and cost model, an entity should disclose the following information;

(a) If it applies to the fair value model, in any circumstances, property interests
held under operating leases are classified and accounted for as an
investment property.

(b) When it is difficult to classify, the criteria used to differentiate investment

property from owner-occupied property and from property Âheld for saleÊ
in the ordinary course of business rental income from investment property.

(c) The methods and assumptions applied in determining the fair value of
investment property including a statement of determination of fair value
was supported by market evidence or heavily because of the nature of the
property and lack of comparable market dates.

(d) The fair value of investment property extents based on a valuation by an

independent valuer who holds a recognised and relevant professional
qualification and has experiences in the location and category of the
investment property being valued. If there is no valuation, the fact should
be disclosed.

(e) The amounts recognised in profit or loss for:

(i) Rental income from investment property
(ii) Direct operating expenses (inlcuding maintenance and repairs)
incurred from investment property that generate rental income during
the period
(iii) Direct operating expenses (including maintenance and repairs)
incurred from investment property that do not generate rental income
during the period.

(f) The amount of restrictions on the realisability of investment property or the

remittance of income and proceeds of disposal

(g) Contractual obligations to construct, purchase or develop investment

property or for repairs, maintenance or enhancement.

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62  TOPIC 4 INVESTMENT PROPERTIES

 Investment property is property (land or a building or part of a building or

both) held (by the owner or by the lessee under finance lease) to earn rentals
or for capital appreciation or both.

 There are three types of investment properties namely owner-occupied

property, ancillary services provided and intra-group rental.

 Owner-occupied property – building that is owner-occupied can be classified

as investment property only if the owner-occupied portion is significant.

 Ancillary services provided – if the ancillary services provided is insignificant

then the entity may treat the property as investment property.

 Intra-group rental – property rented to members of the group can be

classified as investment property in the individual financial statements.

 All investment properties are measured at cost including transaction cost. We

can use fair value model and cost model to measure investment properties.

 Transfer from or to investment property are allowed only when there is a

change in use and evidenced by for example, transfer from investment
property to owner-occupied property on commencement of owner-
occupation.

 An investment property should be derecognised or removed from the

balance sheet on disposal or when the investment property is withdrawn
from use permanently and no future economic benefits are expected from its
disposal.

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 TOPIC 4 INVESTMENT PROPERTIES  63

Ancillary services Measurement

Appreciation Operating lease
Disclosure Properties
Disposal Transfer
Investment properties

On 1 January 2013, Sparta Co acquired a property for investment purpose. The

cost of the building was RM10 million and the economic life was estimated to be
50 years. By the end of year 2013, the fair value of the building was RM11.5
million. The fair value on 31 December 2014 was RM10.8 million.

Prepare journal entries for year 2013 and 2014 if the company decided to adopt
the fair value model to account for this property.

JS Bhd acquired land and building for RM24 million on 1 July 2013. Legal and
other expenses incurred amounted to RM1 million. The building has ten floors
and nine of them were rented to its subsidiary and one floor was used by JS Bhd.
The fair value of the property as at 31 December 2013 was RM29 million an at 31
December 2014, RM27 million. The economic life of the property was determined
as 20 years. JS Bhd has adopted the fair value model.

Discuss the accounting treatment for JS Bhd. The financial year end is 31
December.

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Topic  Introduction
5 to Group
Accounts
LEARNING OUTCOMES
By the end of this topic, you should be able to:
1. Explain regulatory framework;
2. Describe business combination;
3. Identify the structure of a group business;
4. Discuss the consolidated financial statement; and
5. Summarise goodwill and minority interest.

 INTRODUCTION
Do you know that a group can be defined as a parent and all of its subsidiaries?
A parent company (a holding company), owns one or more subsidiaries. FRS 3 is
about business combinations. Business combination happens when an entity
acquires all the net assets of another entity, or acquires the equity shares. The
acquisition can be paid for by cash, cash equivalents or other assets or issue of
equity instruments or a combination of those. It can lead to a parent-subsidiary
relationship in which a consolidated financial statement needs to be prepared.

ACTIVITY 5.1

When you first heard about business combination, what comes to

your mind? How would you defines business combination?

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 TOPIC 5 INTRODUCTION TO GROUP ACCOUNTS  65

5.1 APPLICATION FRS3

There are two applications of FRS 3. They are regulatory framework and
business combination.

5.1.1 Regulatory Framework

Purchase method is used for all business combinations. Under purchase
combinations, the view is based on the acquirer. The acquirer should recognise
the assets acquired, all liabilities and contingent liabilities assumed, including
those that were not recognised by the acquiree. Purchase method involves:
(a) Identify the acquirer;
(b) Measure cost of business combination; and
(c) Allocate the cost of business combinations to the various assets and
liabilities of the acquiree.

The date the acquirer takes control is the acquisition date which purchase
method is applicable.

(a) Requirement for Consolidation

According to Section 169 of the Companies Act 1965, the requirements of
financial statement of a company and of consolidated financial statements
of a company with a subsidiary (or subsidiaries). Subsection 169 (15) stated
that a company must present in an annual general meeting, a balance sheet
and an income statement, and where applicable, a consolidated balance
sheet and consolidated income statement that in respect give a true and fair
view of the state of affairs and of the results of the business of the company,
and when applicable, of the group.

Section 168 of Companies Act 1965 requires that the financial years of
subsidiary companies must coincide with the financial year of the holding
company. Provided that:

(a) Within two years after it becomes a subsidiary of the holding

company, its financial year must coincide with the financial year of
the holding company; and

(b) Has obtained approval from the Commisioner of Companies

authorising any subsidiary to continue to have or to adopt a financial
year which does not coincide with that of the holding company.

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66  TOPIC 5 INTRODUCTION TO GROUP ACCOUNTS

(b) Exemption from Consolidation

Relief from requirement as to form and content of the financial statements
must first be approved by the Commisioner of Companies, and may be
granted in limited circumstances, such as those provided under Section
169A (3) of Companies Act 1965, as follows:
(i) That compliance with the ActÊs requirements would render the
accounts and consolidated accounts misleading or inappropriate to
the circumstances of the company; or
(ii) Compliance with the ActÊs requirements would impose unreasonable
burden on the company or any officer of the company.

In practice, this provision is hardly ever made use of in availing exemption

for consolidated accounts or exemption of a particular subsidiary from the
consolidated accounts. Most companies rely on the specific exemptions as
provided in the Ninth Schedule or approved accounting standards.

5.1.2 Business Combination

What does business combination mean?

Business combination is an entity either acquires control or the net assets of

another entity.

There are three main business combinations. They are explained in Table 5.1.
Table 5.1: Three Types of Business Combinations

Types Description
Amalgamation It is a process of two or more companies combine their business
together and form a new company. When the new company is
formed, all the assets and liabilities from old companies will be
acquired and the old companies are liquidated (wound up). Cash,
shares and/or debentures can be used as purchase consideration.
For example, A Sdn Bhd + B Sdn Bhd = AB Sdn Bhd

Absoprtion It is a process of dominant company acquired the assets and

liabilities of another company. The company being acquired is
liquidated (wound up) at the end of the process. Cash, shares
and/or debentures can be used as purchase consideration.
For example, A Sdn Bhd + B Sdn Bhd = A Sdn Bhd

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 TOPIC 5 INTRODUCTION TO GROUP ACCOUNTS  67

Takeover It is a process of acquiring control in another company by the

investor. To gain control, the investor will acquire the majority of
the voting shares of the targeted company. The parent and
subsidiary company relationship will be formed where the
controlling company is the parent company and the acquired
company is the subsidiary of the controlling company. The acquired
company (subsidiary) does not need to be wound up. By the end of
the process, the parent and its subsidiary or subsidiaries form a
group.

SELF-CHECK 5.1

Describe three types of main business combinations.

ACTIVITY 5.2

Give two examples of a business combination that exists in Malaysia.

Name these companies.

5.2 BASIC PARENT-SUBSIDIARY STRUCTURE

Parent-subsidiary relationship arises when one entity obtains control over
another entity. This has been defined by FRS 127 Consolidated and Separate
Financial Statements as follows:
(a) A parent is "an entity that has one or more subsidiaries";
(b) A subsidiary is "an entity including an unincorporated entity such as a
partnership that is control by another entity (known as a parent)"; and
(c) Control is "the power to govern the financial and operating policies of an
entity so as to obtain benefits from its activities."

In addition, as defined by Companies Act 1965 (Section 5), a subsidiary company is:
(a) One in which the investor company:
(i) Controls the composition of the board of directors of the investee
company; or
(ii) Controls more than half the voting power of the investee company; or

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68  TOPIC 5 INTRODUCTION TO GROUP ACCOUNTS

(iii) Holds more than half of the issued share capital (excluding preference
shares).
(b) A subsidiary is a subsidiary of the investor company.

Let us look at Figure 5.1 and Figure 5.2 as examples.

ABC
Nominee of
Bhd 51%
ABC Bhd

20%
Subsidiary Bhd
20%
11%

Investee Bhd

Figure 5.1: ABC Sdn BhdÊs subsidiaries

Figure 5.1 defines that more than half of the criterion is calculated by adding ABC
BhdÊs 20%, with nominee 20% and Subsidiary BhdÊs 11% to give a total of 51%.

Now let us look at Figure 5.2. What does it show?

ABC Sdn
51% Bhd 51%

XX Sdn Bhd YY Sdn Bhd

51% 51%

I Sdn Bhd J Sdn Bhd

Figure 5.2: Mixed group

Figure 5.2 shows that I Sdn Bhd and J Sdn Bhd are subsidiaries of ABC Sdn Bhd,
although ABC Sdn Bhd does not hold any shares directly.

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 TOPIC 5 INTRODUCTION TO GROUP ACCOUNTS  69

5.3 CONSOLIDATION AT ACQUISITION DATE

The financial statements should be issued under the name of the legal parent as a
continuation of the financial statements of the legal subsidiary. Therefore:
(a) Assets and liabilities of the legal subsidiary are at pre-combination carrying
value but that of the legal parent at fair value.
(b) Retained profits and other equity amounts will include all pre-combination
retained profits and other equity balances of the legal subsidiary and post-
acquisition of the legal parent; and
(c) Equity instruments of the legal subsidiary will include all those pre-
combination, plus those subsequently issued by the legal subsidiary.

5.4 GOODWILL
What does goodwill mean?

Goodwill is where the cost of business combination exceeds the fair value
of the assets less liabilities (including all contingent liabilities).

The excess termed as goodwill. Goodwill should be recognised as an asset and

measure it at cost initially. Goodwill will be tested for impairment annually or
frequently if goodwill is identified to have impairment.

However, if the liabilities and contingent liabilities are exceeding the cost of
combination, it is known as negative goodwill. If there is negative goodwill, the
acquirer should:
(a) Re-assess the identification and measurement of the acquireeÊs identifiable
assets, liabilities and contingent liabilities; and
(b) Measure the cost of the combination; and
(c) Immediately recognise any excess remaining after the reassessment in
income statement.

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70  TOPIC 5 INTRODUCTION TO GROUP ACCOUNTS

5.5 MINORITY INTEREST

At a certain time, some of the equity instrument owners of the legal subsidiary
would not exchange their equity instruments for the equity instruments of the
legal parent. These equity owners are treated as minority shareholders and have
an interest in the results and net assets of the legal subsidiary.

The holding company may not acquire all the voting shares of the acquire
company, in which case the subsidiary is not a wholly-owned subsidiary. When
the holding company does not have 100% control, then the members of the
subsidiary other than the holding company are collectively referred to as
minority shareholders. The interest of the minority shareholders in the operation
or the net assets of the subsidiary is termed "minority interest." Minority interest
is considered as equity.

In the consolidated balance sheet, the minority shareholdersÊ interest in the net
assets of the subsidiary are identified and presented as equity but separately
from the parentÊs equity. In other words, in the consolidated statement of
financial position the net assets of both the holding and subsidiary are combined
and the net assets of the subsidiary attributable to minority shareholders are
disclosed separately.

Minority interest is recognised on acquisition date either as:

Option 1: At fair value of the shares held by the minority shareholders; or
Option 2: Equal to the proportion share of the fair value of the net assets of the
subsidiary.

 Regulatory framework uses purchase method,

 Business combination is an entity which acquires either control or the net

assets of another entity.

 There are three main business combinations ‒ amalgamation, absorption and

takeover.

 The parent-subsidiary relationship arises when one entity obtains control

over another entity. It has three important elements which are parent, control
and subsidiary.

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 TOPIC 5 INTRODUCTION TO GROUP ACCOUNTS  71

 A parent is an entity that has one or more subsidiaries.

 A subsidiary is an entity including an unincorporated entity such as a

partnership that is control by another entity (known as a parent).

 Control is the power to govern the financial and operating policies of an

entity so as to obtain benefits from its activities.

 There are two methods of consolidation acquisition or purchase method.

 The acquirer is the party that has control over the operating and financial
policies of the acquiree.

 In certain circumstances, acquirer is hard to identify.

 The cost of business combination comprises the fair value of consideration

given and any costs directly attributable to the business combination.

 Goodwill is where the cost of business combination exceeds the fair value of
the assets less liabilities (including all contingent liabilities). The excess is the
term goodwill. Goodwill should be recognised as an asset and measure it at
cost initially.

 The interest of the minority shareholders in the operation or the net assets of
the subsidiary is termed "minority interest." Minority interest is considered as
equity.

Acquiree Control
Acquirer Goodwill
Acquisition Minority interest
Business combination Parent
Combination Subsidiary

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72  TOPIC 5 INTRODUCTION TO GROUP ACCOUNTS

On 1 January 2013, KK Bhd acquired 80% of the issued ordinary shares of RA Co

by issuing 1 million shares in KK Bhd and RM2.2 million zero interest bond
redeemable in a yearÊs time. Incidental costs incurred in acquiring the shares was
RM500,000. The current market interest rate is 10%. Fair value of one ordinary
share of KK Bhd on 1 January 2013 was RM4.20.

Calculate the cost of business combination.

Ki Bhd acquired 100% of the issued share capital of Ko on 1 July 2013 for RM 2
million. Fair value of net assets of Ko was RM1.6 million. The fair value of a piece
of land of Ko, with carrying value of RM250,000, was estimated at RM420,000.
This land was included in the RM1.6 million. On 2 February 2014 the valuerÊs
report indicated that the fair value of the land on 1 July 2013 was RM580,000.

Compute the goodwill.

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Topic  Intangible
6 Assets
LEARNING OUTCOMES
By the end of this topic, you should be able to:
1. Describe the application of MFRS 138;
2. Identify the characteristics and qualities of intangible assets;
3. Differentiate the methods of measuring intangible assets; and
4. Distinguish between research and development and purchased
goodwill; and
5. Identify other types of intangible assets.

 INTRODUCTION
MFRS 138 covers intangibles that are acquired and developed. All intangibles
assets acquired or developed are recognised at cost initially. Their economic life
is established as finite or indefinite. Example of intangibles that is inherent such
as brand and goodwill. These will be explained further in this topic as we go
through the characteristics and qualities of intangible asset, methods on how to
measure it, the difference between research and development and purchased
goodwill and other types of intangible assets.

ACTIVITY 6.1
Without looking at the notes, what are intangible assets that might be
possessed by you?

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74  TOPIC 6 INTANGIBLE ASSETS

6.1 CHARACTERISTICS AND QUALITIES OF

INTANGIBLE ASSETS
How do we define intangible assets? Intangible assets can be defined:
(a) If it is probable ‒ future economic benefits that are attributable to the asset
will flow to the enterprise; and
(b) The cost of the asset can reliably be measured.

What are the characteristics of intangible assets? Under accounting principle,

assets should be recognised and measurable. However sometimes, the asset can
be recognised but the cost cannot be measured.

An intangible asset can be recognised as an asset if it meets the definition of

intangible assets which is an identifiable non-monetary asset without physical
substance.

How about the qualities of intangible assets? There are three qualities of
intangibles as explained in Table 6.1.
Table 6.1: Three Qualities of Intangible Assets

Qualities Description
Identifiability Separable (capable of being separated or removed from the entity,
licensed, entered or exchanged and arise from contractual or other
legal rights).
Control Entity has the power to obtain future economic benefits flowing
from the underlying resource and restrict others from having
access to those benefits.
Future Economic Arise from sale of products or services, cost saving or renting of
Benefits the asset.

An intangible asset is normally measured at cost. It is recognised when there is:

(a) Separate Acquisition

The price paid to acquire a separate intangible assets reflects the economic
benefits embodied in the asset and fulfill the first criteria. The costs
comprise:
(i) Purchase price (include any incidental costs); and
(ii) Any direct attributable cost of preparing the asset for intended use.

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Any expenditure incurred after the asset has been brought into condition
necessary for it to be operating in a manner intended by a management, is
not an asset but an expense. If it involves credit terms, the difference
between total payment and cash price equivalent is the interest expense.

(b) Part of Business Combination

In business combination, the acquirer should recognise at the date of
acquisition separately from goodwill; an intangible asset of the acquiree if
the assetÊs fair value can be measured realiably irrespective of whether the
asset was recognised by the acquiree. Intangible assetsÊ costs are at fair
value; hence, the acquirer should recognise in-process research and
development project of the acquiree if it meets the definition of intangible
and its fair value can be measured realiably.

(c) Acquisition by Way of a Government Grant

Intangible assets are acquired free of charge or for any nominal
consideration, by way of a government grant and measured initially at fair
value.

(d) Exchange of AssetsC

The cost of the intangible is measured at fair value. If the exchange
transaction lacks commercial substance or the fair value of neither the asset
received nor given up can be measured realiably, the acquired asset will be
measured at the carrying amount of the asset given up. TIVITY 6.1

6.2 RESEARCH AND DEVELOPMENT

Intangible that is developed by an entity such as research and development.
What does research mean?

Research is defined as the original and planned investigation undertaken

with the prospect of gaining new scientific or technical knowledge and
understanding.

Included in research activities:

(a) Aim to obtain new knowledge;
(b) Search of applications of research findings or other knowledge;
(c) Search for product or alternatives of process; and
(d) Design or formulation of possible new product.

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What does development mean?

Development is defined as the application of research findings or other

knowledge into a plan or design for the production of new or substantially
improved material, devices, products, processes, systems or services before
the start of commercial production or use.

Included in development activities:

(a) The design, construction and testing pre-production prototypes and
models;
(b) The design of tools, moulds, jigs and dies involving new technology;
(c) The design, construction and operation of a pilot plant that is not of a scale
economically feasible for commercial production; and
(d) The assessment of commercial viability of a product or process prior to
commencement of commercial production or use.

Development Cost
All costs incurred from the date when the intangibles asset first meets the
recognition criteria. Expenditure that was recognised as expense cannot be
reinstated. Examples of directly attributable cost are:
(a) Costs of materials and services consumed;
(b) Personnel costs; salaries, wages and other employment related costs;
(c) Fees to register a legal right; and
(d) Amortisation of patents and licenses that are used to generate the
intangible asset.

However, selling or administration costs, general overheads, inefficiencies and

staff trainings are excluded.

ACTIVITY 6.2

Is goodwill a type of intangible asset? Discuss.

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6.3 PURCHASED GOODWILL

When does purchased goodwill arise? Purchased goodwill arises when a
business acquires another as a going concern and the combination is accounted
for as an acquisition. It includes goodwill arising on consolidation and on the
acquisition of an unincorporated business. When consolidation is under the
acquisition method of accounting, the fair value of the consideration given for the
shares of a company acquired is allocated amongst the identifiable net assets
acquired, with purchased goodwill (positive or negative) emerging as the
difference. Let us look at Example 6.1.

Example 6.1:

JAN Bhd acquired a 100% equity interest of FEB Bank Bhd for a consideration
of RM200 million. The consideration was arrived at based on a maintainable
profit of RM20 million multiplied by a price-to-earnings ratio of 10.

FEB is a commercial bank and its net intangible assets at acquisition date were
at a fair value of RM80 million. It is generally believed that an arbitrary value
for a banking licence is around RM100 million.

Requires:
Calculate the goodwill arising on acquisition of FEB Bank Bhd on assumptions of:
(a) An identifiable intangible asset.
(b) Is not an identifiable intangible asset.

Solutions:
Identifiable Not Identifiable
RM million RM million
Purchase consideration 200 200
Less: Allocated to identifiable net
assets:
Fair value of net tangible assets 80 80
Fair value of banking licences 100 -
Fair value of net assets acquired 180 80
Goodwill on acquisition 20 120

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6.4 OTHER INTANGIBLE ASSETS

Let us look at other intangible assets namely intangible asset with finite useful
life, intangible asset with indefinite useful life and others intangible assets.

6.4.1 Intangible Asset with Finite Useful Life

The intangible asset is amortised and amortisation begins when the asset is
available for use. The amortisation change is expensed off in the income
statement or included in the carrying amount of another asset. The amortisation
period and method used by an enterprise must be reviewed at the end of each
financial year.

6.4.2 Intangible Asset with Indefinite Useful Life

Intangible assets with indefinite useful lives are not amortised but assessed for
impairment annually and whenever there is an indication that the asset is
impaired. The useful life is also reviewed manually. A change from indefinite to
finite life is accounted for as a change in accounting estimate. A change may
indicate that the asset may be impaired.

6.4.3 Internally Generated Brands, Mastheads, Titles

and Others
Brands, mastheads, publishing titles, customer lists and items similar in
substance that are internally generated should not be recognised as assets.

 MFRS 138 covers the accounting for intangible assets that are not dealt with
specifically in another standard.

 Intangible assets can be defined:

‒ If it is probable that the future economic benefits that are attributable to
the asset will flow to the enterprise.
‒ The cost of the asset can be reliably measured.

 The characteristics of intangible assets are recognised and measureable.

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 The qualities of intangible assets are identifiability, control and future

economic benefits.

 Usually, the fair value of intangible assets can be measured reliably.

 Research is defined as the original and planned investigation undertaken

with the prospect of gaining new scientific or technical knowledge and
understanding.

 Development is defined as the application of research findings or other

knowledge into a plan or design for the production of new or substantially
improved material, devices, products, processes, systems or services before
the start of commercial production or use.

 All research costs are charged to expense.

 Development cost is to be expensed off except those that meet capitalisation

criteria.

 Purchased goodwill arises when a business acquires another as a going

concern and the combination is accounted for as an acquisition.

 Other types of intangible assets are intangible asset with finite useful life,
intangible asset with indefinite useful life, internally generated brands,
mastheads and titles.

Characteristics Purchased goodwill

Intangible asset Prototypes
Research and development Qualities

KOR Football club, acquires a player, Lee, from QPR. The contract was for five
years at the end of which he is free to leave the club. During the five years he can
be transferred by KOR Football club to other clubs. Unfortunately, during the
first six months of year 2013 LeeÊs knee was injured and he could not play.

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During year 2013, the club incurred the following costs:

RM
(a) Transfer fees 5,000,000
(b) Operational costs 2,000,000
(c) Medical cost of Lee 500,000
(d) Massive advertising campaign to launch the player 1,000,000

Which of the above items can be capitalised as an intangible asset?

On 1 January 2013, XXX acquired an identifiable intangible asset for RM250,000.

The economic life was established at five years and the entity adopted the
revaluation model. The fair value of the asset on 31 December 2013 approximated
closely the carrying value. The assetÊs fair value on 31 December 2014 was
RM240,000. However, on 31 December 2015 fair value of the asset could not be
determined.

Explain the treatment for the above statements.

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 Topic  Impairment
7
LEARNING OUTCOMES
By the end of this topic, you should be able to:
1. Demonstrate how to calculate impairment, retirement and disposal of
tangible property, plant and equipment;
2. Summarise disclosure requirements;
3. Define property, plant and equipment;
4. Discuss the criteria for the recognition of fixed assets;
5. Summarise the components of the costs for initial measurement;
6. Demonstrate the techniques to calculate subsequent expenditure; and
7. Practice the subsequent measurement techniques.

 INTRODUCTION
Let us look at our lives. Perhaps, after working for few years, we will have some
money to buy a car. Then, later on, we might buy a house. These are two
examples of the non-current assets an individual may own, instead of cash.

In this topic, we will discuss impairment, retirement and disposal on property,

plant and equipment, which is referred to as non-current assets or fixed assets.
Non-current assets have a relatively long economic life and can be classified
according to their „tangibility‰. A tangible item is something we can touch. Thus,
property, plant and equipment are tangible non-current assets.

Examples of tangible of non-current assets are those with physical form such as
land, warehouse, factory, motor vehicles, machinery, delivery equipment, cash
registers, office furniture, fittings and so on. Accounting for property, plant and
equipment has a significant impact on enterpriseÊs operations because an item of
expenditure can either represent an asset or an expense.
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The accounting standards for property, plant and equipment are covered in
MASB 15 and MFRS 116. MFRS 116 is applied for annual periods from or after 1
January 2006.

7.1 IMPAIRMENT, RETIREMENT AND

DISPOSAL
In the following subtopics, we will discuss three important elements namely
impairment, retirement and disposal.

7.1.1 Impairment
Various factors, such as those internal (obsolescence or physical damage to
assets) or external (economic or legal environment), can cause diminution in the
value of an asset. This drastic change in value is an impairment loss. The
following is the definition for diminution.

Diminution = The process of decreasing or diminishing.

When does impairment loss arise? Impairment loss arises when the carrying
amount of an asset exceeds its recoverable amount. Paragraph 64 to 72 of MASB
15 and MFRS 136 deal with issues in connection with impairment loss.

Let us look at the descriptions of a few important terms (shown in Table 7.1),
which will be used later in this course.
Table 7.1: A Few Important Terms of Impairment

Terms Descriptions
Recoverable Amount Recoverable amount is the higher assetÊs net selling price and
its value in use.
Value in use The present value of estimated future cash flows expected to
arise from the continuing use of an asset and from its disposal
at the end of its useful life.
Net selling price The amount obtainable from the sale of an asset in an armÊs
length transaction between knowledgeable, willing parties,
less the costs of disposal.

When there are indications of impairment, we should compare the carrying value
of the asset with its recoverable amount. There are times when the recoverable

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amount of the property, plant or equipment is below the net carrying amount.
When this happens, the asset should be assessed on its recoverable amount. We
need to immediately recognise the amount of reduction as an expense and charge
it in the current yearÊs profit and loss account.

When do we need to do the impairment test? Paragraph 64 of MASB 15 states that:

„An enterprise should assess at each balance sheet date whether there is
any indication that an asset may be impaired. If any such indication exists,
the enterprise should estimate the recoverable amount of the asset.‰

The accounting treatment of an impairment loss will depend on whether the

asset value is carried at cost or revalued amount:

(a) Assets Carried at Cost

The impairment loss should be recognised as an expense in the income
statement immediately.

(b) Assets Carried at Revalued Amount

The impairment loss should be treated as a decrease in revaluation surplus
to the extent the impairment loss does not exceed the amount held in the
revaluation reserve of that asset.

Let us look at Example 7.1 which demonstrates how to calculate the impairment loss.

Example 7.1:
A machine has a carrying amount of RM100,000. Its realisable value is RM60,000 and
the value in use is RM75,000. Determine any impairment loss.
Solution:
The recoverable amount is RM75,000 and the machine is considered impaired.

The impairment loss of RM25,000 (RM100,000 – RM75,000) should be recognised

immediately by writing down the carrying amount to RM75,000.

An impairment loss should be recognised in the income statement for assets carried
at cost and treated as a revaluation decrease for assets carried at revalued amount.

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7.1.2 Retirement and Disposal

Do you know that we should eliminate the property, plant and equipment from
the account upon the disposal or retirement of an asset? For fully depreciated
property, plant and equipment which continue to be in use, we should retain
these assets in their accounts with RM1 to show their benefit to the enterprise.

When we dispose of property, plant and equipment, take note that one of the
following situations shown in Figure 7.1 will arise:

Figure 7.1: Situations which arise after disposing of property, plant and equipment

Gain or loss upon disposal should be recognised in the income statement in the
year of disposal.

When property, plant and equipment retire from active use, the assets held
should be valued lower than the net carrying amount and net realisable value,
and any loss should be recognised immediately in the income statement. Let us
look at another example in Example 7.2.

Example 7.2:
On 1 January 2005, Streamline Sdn Bhd acquired machinery costing RM300,000.
It is the company policy to depreciate the machine on the straight-line method
over 10 years. It is also the company policy to charge full year depreciation in the
year of purchase and none in the year of disposal. There was no residual value at
the end of the useful life.

The company sold the machine for RM120,000 in 2010.

In 2010, a machine retired from active use. It has a net book value of RM10,000.
The estimated net realisable value of the equipment is RM2,000.

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Required:
(a) Calculate the disposal gain or loss for the machinery; and
(b) Show the journal entries to record the transactions.

Solution:
(a) Net carrying amount = RM300,000 – [(RM300,000/ 10) × 5 years]
= RM150,000
Disposal Loss = RM120,000 – RM150,000
= RM30,000

(b) The journal entry

Dr (RM) Cr (RM)
Dr Bank 120,000
Dr Accumulated Depreciation 150,000
Dr Income Statement – Loss on disposal 30,000
Cr Machinery 300,000
(Disposal of machinery)

Dr (RM) Cr (RM)
Dr Income Statement – written down value 8,000
Cr Equipment 8,000
(Retirement of equipment from active use)

7.2 DISCLOSURE REQUIREMENTS

Based on MASB 15 and MFRS 116, the financial statements shall disclose (for
each class of property, plant and equipment) the following:

(a) The measurement bases used for determining the gross carrying amount;

(b) The depreciation methods used;

(c) The useful lives or the depreciation rates used;

(d) The gross carrying amount and the accumulated depreciation (aggregated
with accumulated impairment losses) at the beginning and end of the
period;

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(e) A reconciliation of the carrying amount at the beginning and end of the
period showing:
(i) Additions;
(ii) Disposals;
(iii) Acquisitions through business combinations;
(iv) Increases or decreases during the period resulting from revaluations
under Paragraphs 34, 43 and 44 and from impairment losses
recognised or reversed directly in equity as required under
Paragraphs 64 to 58 (if any);
(v) Impairment losses recognised in income statement during the period
(if any);
(vi) Impairment losses reversed in income statement during the period (if
any);
(vii) Depreciation;
(viii) The net exchange differences arising from the translation of the
financial statements of a foreign entity; and
(ix) Other movements.

Comparative information is not required for the reconciliation in (e).

(f) Monetary or non-monetary compensation recognised for impairment or

lost items of property, plant and equipment should be disclosed separately.

Let us look at the following example which is taken from the notes of the
accounts of an annual report of a Malaysian company. It illustrates the
accounting policy for property, plant and equipment and the disclosure practice
based on FRS 116 for property, plant and equipment.

Example 7.3:

CAB CAKARAN CORPORATION BERHAD

Year ended 30 September 2009
Extract from notes to accounts

Significant Accounting Policies

Property, plant and equipment are stated at cost or valuation less accumulated
depreciation and accumulated impairment. Land and buildings stated at valuation
are revalued at regular intervals of at least once every five years by the directors
based on the valuation reports of independent professional valuers based on market

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value using comparison and cost methods of valuation with additional valuations in
the intervening years where market conditions indicate that the carrying value of
revalued assets differ materially from the market values.

An increase in the carrying amount arising from revaluation of property, plant

and equipment is credited to the revaluation reserve account as revaluation
surplus. Any deficit arising from revaluation is charged against the revaluation
reserve account to the extent of a previous surplus held in the revaluation reserve
account for the same asset.

In all other cases, a decrease in carrying amount is charged to the income

statement. An increase in revaluation directly related to a previous decrease in
the carrying amount for that same asset that was recognised as an expense, is
credited to income statements to the extent that it offsets the previously recorded
decrease. Upon disposal of revalued assets or crystalisation of deferred tax
liabilities on revalued assets, the amounts in revaluation reserve accounts
relating to such assets are transferred to retained profit accounts.

The carrying amount of property, plant and equipment is reviewed at each

balance sheet date to determine whether there is any indication of impairment.
An impairment loss is recognised whenever the carrying amount of an item of
property, plant and equipment exceeds its recoverable amount. The impairment
loss is charged to the income statement unless it reverses a previous revaluation,
in which case it is treated as a revaluation decrease.

Freehold land and construction-in-progress are not depreciated. Leasehold land

is amortised over the lease period of 12, 52, 54, 63, 66, 96 and 880 years. All other
property, plant and equipment are depreciated on the straight-line method in
order to write off the cost of each asset to its residual value over its estimated
useful life.

The annual depreciation rates are as follows:

Buildings 5 to 96 years
Plant, machinery and equipment 2% – 50%
Electrical installation 10% & 12%
Office equipment 10% – 50%
Furniture, fixtures and fittings 10% – 50%
Motor vehicles 10% – 50%
Renovation 2% – 15%
Pasaraya equipment 10%
Warehouse 10%
Source: http://announcements. bursamalaysia.com/

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ACTIVITY 7.1
Find out how property, plant and equipment are presented and
disclosed in annual audited accounts from the website of Bursa Malaysia
at http://www.klse.com.my

7.3 PROPERTY, PLANT AND EQUIPMENT

What do property, plant and equipment mean? MASB 15 and MFRS 116 define
property, plant and equipment as follows:

Property, plant and equipment refer to the assets that are held by an
enterprise for use in the production of goods and services, for rental to
others, or for administrative or maintenance purposes; and are expected to
be used during more than one reporting period.
(MASB 15 and MFRS 116)

Based on the above definition of property, you should understand that plant and
equipment are tangible assets used in normal business operations. They are also
reminded that tangible assets come in physical form and are expected to provide
services over several accounting periods.

ACTIVITY 7.2

1. You have learnt what the term „tangible asset‰ means. What about
„intangible assets‰? List two examples of intangible assets.

2. Give an example for each of the following:

(a) Property;
(b) Plant; and
(c) Equipment.

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7.4 RECOGNITION OF FIXED ASSETS

An item of property, plant or equipment should be recognised as an asset when:
(a) It is probable that future economic benefits associated with the asset will
flow to the enterprise; and
(b) The cost of the asset to the enterprise can be measured reliably.

Property, plant and equipment are often a major portion of the total assets of an
enterprise. Therefore, they are important in the presentation of its financial
position. Let us look at Figure 7.2 which shows you two distinct criteria needed
for recognition of fixed asset.

Figure 7.2: Criteria for recognition of fixed assets

These two criteria are further explained as follows:

(a) Future Economic Flow to the Enterprise

The first criterion for recognition is met when future economic benefit to
the enterprise can be determined with a degree of certainty. Therefore, risks
and rewards in relation to the ownership of the asset are passed to the
enterprise from the onset.

(b) The Existence of an External Transaction

The second criterion for recognition of acquired assets is easily met because
of the existence of an external transaction. In the case of a self-constructed
asset, a reliable measurement of the cost of construction is readily available.

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7.5 INITIAL MEASUREMENT

According to the MASB 15 and MFRS 116, an item of property, plant or equipment
which qualifies for recognition as an asset should initially be measured at cost. There
are three components of the costs for initial measurement namely acquired assets for
cash or cash equivalent, self-constructed fixed asset and exchange fixed asset.

7.5.1 Acquired Assets for Cash or Cash Equivalent

The initial cost of a fixed asset should comprise:
(a) Import duties;
(b) Purchase price;
(c) Taxes; and
(d) Any directly attributable costs incurred to bring the asset to working
condition for its intended use.

Purchase price should deduct any trade or cash discount, irrespective of whether
or not the discount is taken. Therefore, only cash price equivalent is recorded. Let
us look at Figure 7.3 which shows you some examples of directly attributable costs.

Figure 7.3: Directly attributable costs

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Now let us look at Example 7.4.

Example 7.4:
Zazy Sdn Bhd bought specialised machinery from Taiwan. The invoice price was
RM350,000. Zazy Sdn Bhd is given a discount of 2% by the seller if the company
manages to pay within 45 days. The company has incurred the following
payments for the machinery:
Machinery-Related Expenses RM
Import duties and taxes 7,000
Delivery charges 3,000
Installation charges 12,000
Inspection costs 4,000
Pre-production costs 8,000

Required:
Determine the initial historical cost of the machinery.

Solution:
The components of the historical initial cost of the machinery are tabulated in
Table 7.2 below.
Table 7.2: Components of the Historical Initial Cost of the Machinery

Items RM
Invoice price of machinery 350,000
Less 2% cash discount (irrespective of whether the discount is taken) (7,000)
343,000
Import duties and taxes 7,000
Delivery and transport costs 3,000
Installation charges 12,000
Historical cost of the machinery 365,000

However, we should not include administrative and general overhead expenses in

the cost of a fixed asset. Similarly, start-up and related pre-production costs should
be excluded, unless they are necessary to bring the asset to its working condition.

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ACTIVITY 7.3

Discuss with your classmates the following questions:

(a) What do you understand by the term „maintenance costs‰?
(b) Can maintenance charges be part of the cost of an asset? Give your
reasons.

7.5.2 Self-Constructed Fixed Asset

Firstly, what does self-constructed fixed asset mean?

A self-constructed fixed asset is property, plant or equipment constructed

or built by an enterprise for its own use instead of buying a ready-made
asset.

The cost of a self-constructed fixed asset is determined using the same principles
for an acquired asset. The cost of a self-constructed fixed asset includes all
expenses necessary to bring it to good working condition. The normal costs
incurred are:
(a) Direct material;
(b) Direct labour; and
(c) Overhead.

Material and labour costs are directly related to the asset, while overhead
incurred is based on the amount allocated to the asset.

The cost of a self-constructed fixed asset should not include internal profit and
costs arising from delays, idle capacity or industrial disputes in the course of its
construction.

In any situation, we have to ensure that the initial cost capitalised for a self-
constructed fixed asset does not exceed its estimated recoverable amount. Let us
look at Example 7.5.

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Example 7.5:
Mega Sdn Bhd built a factory. The costs incurred were as follows:
Items RM
ContractorsÊ costs 1,000,000
Direct materials purchased 800,000
Labour used in construction 600,000
Architects and engineers fees 400,000
General administrative costs allocated 300,000
Overhead – directly attributable 460,000

Estimate of unused materials at the construction site worth RM200,000 will be

used in the construction of a warehouse next to the factory. Ten percent of the
direct labour used was attributable to the cost inefficiencies caused by a labour
strike. The contractorsÊ costs include RM100,000 spent on rectification. It is
determined by the accountant of the company that the recoverable amount of the
factory could be RM10,000,000.

Required:
Determine the historical cost of the factory building.

Solution:
Items RM RM
Direct materials 800,000
Less: Unused material (200,000) 600,000
Labour 600,000
Less: Cost inefficiencies (60,000) 540,000
Overhead – directly attributable 460,000
Architects and engineers fees 400,000
ContractorsÊ cost 1,000,000
Less: Rectification costs (100,000) 900,000
Total cost 2,900,000

Now, let us compare the asset costs (RM2,900,000) with the recoverable amount
(RM10,000,000). Therefore, only RM10,000,000 will be capitalised and the balance
of RM1,000,000 will be expensed off in the income statement.

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7.5.3 Exchange Fixed Asset

The company may acquire property, plant and equipment via non-monetary
consideration, by giving one or more assets in exchange for another. For
example, you trade in your old car for a new one.

When we exchange one asset for another, the asset we acquire may or may not be
similar to the one we had.

(a) Similar Asset

What does similar asset mean?

A similar asset is asset used for the same purpose in the same line of
business and has similar fair values.

In this situation, we should measure the asset acquired based on the carrying
amount of the asset given up, so there is no gain or loss recognised. Let us look
at Example 7.6.

Example 7.6:
Speed Sdn Bhd trades-in a used Nissan Serena, a multipurpose van, for a
new Proton Waja. The Nissan Serena was bought at RM140,000; the
carrying amount is RM56,000 and the market value is RM64,000 at the time
of the trade-in. The new Proton Waja has a market value of RM60,000.
Required:
(a) Determine the cost of the Proton Waja; and
(b) Show the journal entry to record the transaction.
Solution:
(a) This is a case of exchanging „similar assets‰. In accordance with the
provision of MASB 15, we measure the new Proton Waja car based on
the carrying amount of the used Nissan Serena multipurpose van,
which is RM56,000.
(b) The journal entry:
Dr (RM) Cr (RM)
Dr Motor vehicle (Proton Waja) 56,000
Dr Accumulated Depreciation 84,000
Cr Motor vehicle (Nissan Serena) 140,000

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(b) Dissimilar Asset

If we acquire an item of property, plant or equipment with a dissimilar item,
we should measure the asset acquired at its fair value. This is equivalent to
the fair value of the asset given up adjusted by the amount of any cash or
cash equivalents transferred. Let us look at Example 7.7.

Example 7.7:
In line with its business expansion, Sunshine Transport Sdn Bhd trades-in a
used lorry for a new BMW. The lorry was bought for RM100,000; the
carrying amount is RM40,000 and the market value of RM54,000 at the time
of the trade-in. The new BMW has a market value of RM150,000.
Required:
(a) Determine the cost of the BMW; and
(b) Show the journal entry to record the transaction.
Solution:
(a) This is a case of exchanging „dissimilar assets‰. In accordance with
the provision of MASB 15, the new BMW should be measured based
on the fair value of the asset received, that is RM150,000.
(b) The journal entry:
Dr (RM) Cr (RM)
Dr Motor vehicle (BMW) 150,000
Dr Accumulated Depreciation 60,000
Cr Motor vehicle (Lorry) 100,000
Cr Gain on disposal 14,000
Cr Cash 96,000

SELF-CHECK 7.1

1. Why do we record asset initially at cost?

2. Why should costs capitalised not exceed the recoverable amount of
the asset?

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7.6 SUBSEQUENT EXPENDITURE

Do you know that subsequent expenditure is expenditure incurred on an asset
after the date of acquisition, exchange or construction? In fact, we will incur
subsequent expenditure throughout the lifespan of such assets, as illustrated in
Figure 7.4.

Figure 7.4: Things to consider after purchasing a new car

Questions we need to ask ourselves:

(a) Should we capitalise the expenditure as part of the cost of the asset?
(b) Should we treat it as revenue expenditure and charge against revenue as
and when incurred?

Here is a rule of thumb that we should apply on this matter:

Subsequent expenditure on property, plant and equipment is recognised as an

asset when the expenditure improves the condition of the asset beyond its
originally-assessed standard of performance.

According to MASB 15 [Para 28], examples of improvements which result in

increased future economic benefits include:
(a) Modification of an item of plant to extend its useful life, including an
increase in its capacity;

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 TOPIC 7 IMPAIRMENT  97

(b) Upgrading machine parts to achieve a substantial improvement in the

quality of output;
(c) Adoption of new production processes to enable a substantial reduction in
previously-assessed operating costs; and
(d) Upgrading of a component of the asset that has been treated separately for
depreciation purposes such as hotel furniture and fixtures, as well as
fittings. Under this situation, the expenditure incurred in replacing or
renewing the component is accounted for the acquisition of a separate asset
and the replaced asset is written off.

We should assess the expenditure on repairs or maintenance of property, plant

and equipment since these are made to restore or maintain the asset.

If the subsequent expenditure is recognised as an asset, this will affect the

amount of depreciation. The following formula can be used to calculate the
depreciation of an asset after the subsequent expenditure:

*Net Carrying Amount + Subsequent Expenditure – Residual Value

Remaining Useful Life
* Net Carrying Amount = Book value – Accumulated depreciation

Let us look at Example 7.8 which shows you how to use the formula.

Example 7.8:
Peach Tree Sdn Bhd, a manufacturer in Klang, bought machinery at a cost of
RM210,000 from Korea in 2005. The residual value was estimated at RM10,000.

It is the companyÊs policy to depreciate the machinery on a straight-line method

over 10 years and charge full year depreciation in the year of purchase and none
in the year of disposal.

The following subsequent expenditures were incurred in 2010:

(a) In view of excessive usage, an important component of the machinery was
damaged and the company replaced it with a similar component at a cost of
RM25,000;
(b) The machine requires annual servicing and the cost in 2010 was RM15,000;
and
(c) The company incurred RM50,000 for a major overhaul, which increased the
output capacity by 40%.

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Required:
(a) How should each of the subsequent expenditures be accounted for?
(b) Calculate the depreciation for the year ended 31 Dec 2010.

Solution:
(a) The cost of replacing a similar component and annual service should be
expensed. The cost of major overhaul should be capitalised as asset.

Net Carrying Amount + Subsequent Expenditure - Residual

Depreciation Value
(b)
=
Remaining Useful Life
= RM110,000 + RM50,000 –
RM10,000
10 – 5
= RM30,000

Net Carrying Amount = Book Value – Accumulated Depreciation

= RM210,000 – (RM200,000/10 – 5)
= RM110,000

SELF-CHECK 7.2

Why do companies prefer to record asset at market value?

ACTIVITY 7.4
Take out a piece of paper and do the following:
(a) Jot down expenditures you will incur after purchasing a car.
(b) Identify the more important ones and compare them with the
others. Explain.

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7.7 SUBSEQUENT MEASUREMENT

Normally, property, plant and equipment are recorded as historical costs and
will depreciate over their useful life. However, there is one exception to this; no
depreciation is charged for freehold land. As the net book value of the non-
current asset may be different from the fair value, the non-current asset will not
reflect the true value or market value of the business.

For example, a building which is five years old may have a carrying value of
RM800,000, whereas the market value might be RM1,600,000 due to its strategic
location and regular maintenance. As such, should this company disclose the
building at the market value or continue to record at cost less accumulated
depreciation?

If we follow historical cost accounting strictly, the building should be disclosed at

cost less accumulated depreciation. However, many enterprises would prefer to
disclose at market value less depreciation. For decision-making purposes, we
should use the fair value.

With reference to MASB 15: Property, Plant and Equipment, the benchmark
treatment is that property, plant and equipment should be recorded at cost less
accumulated depreciation. Similar treatment is also applied in FRS 116. It is
referred to as the „Cost Model‰ [Para 30].

MASB 15 also provides that revaluation should be made with sufficient

regularity such that the carrying amount does not differ materially from that
which would be determined using fair value at the balance sheet [Para 34].
Under paragraph 31 of MFRS 116, it is regarded as the „Revaluation Model‰.

If the enterprise wants to revalue its property, plant or equipment, then the
following rules are applicable:

(a) The non-current assets are shown at fair value, which for:
(i) Land and building is normally at the market value; and
(ii) Plant and equipment at their market value or depreciated replacement
cost (MASB 15, Para 36) (MFRS 116, Para 35).

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(b) Once revaluation has been done by a valuer, regular revaluation should be
carried out every three or five years (MASB 15, Para 37) (MFRS 116, Para 35).

(c) When an item of property, plant and equipment is revalued, the entire class
of property, plant and equipment to which that asset belongs should be
revalued (Para 39) (MFRS 116, Para 36).

Upon an initial revaluation, MASB 15 and MFRS 116 require that an increase in
net carrying amount (revaluation surplus) should be credited directly to equity
and a decrease in net carrying amount should be charged directly as an expense.

However, upon a subsequent revaluation, MASB 15 and MFRS 116 require that a
revaluation increase should be recognised as income to the extent that it reserves
a revaluation decrease of the same asset previously recognised as an expense
[Para 43].

Conversely, a decrease in revaluation should be charged directly against any

related revaluation surplus to the extent that decreases do not exceed the amount
held in the revaluation surplus in respect of the same asset.

Only upon disposal of the asset, can the revaluation surplus be transferred to the
income statement as realised gain. Let us look at Example 7.9.

Example 7.9:
SSL Sdn Bhd, a developer in Kuala Selangor, bought three blocks of commercial
buildings in Kuala Lumpur and Selangor on 1 January 2010. They are situated in
Kepong, Selayang and Rawang. In compliance with the accounting standard, it is
the companyÊs practice to revalue the buildings every five years. The following
data relate to the three blocks of buildings:
Building Cost Revalued Amount
1.1.2010 1.1.2011 1.1.2016 1.1.2021
RM (Â000) RM (Â000) RM (Â000) RM (Â000)
Kepong 800 1,000 1,300 960
Selayang 800 600 570 970
Rawang 600 900 700 Sold for 740

Required:
Show the journal entries to record the above transactions.

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Solution:
Building in Kepong
Debit Credit
Date Item
RM(Â000) RM (Â000)
1.1.2011 Dr Building A 200
Cr Revaluation surplus 200

1.1.2016 Dr Building A 300

Cr Revaluation surplus 300

1.1.2021 Dr Revaluation surplus 340

Cr Buildings A 340

Building in Selayang
Debit Credit
Date Item
RM(Â000) RM (Â000)
1.1.2011 Dr Income statement 200
Cr Building B 200

1.1.2016 Dr Income statement 30

Cr Building B 30

1.1.2021 Dr Building B 400

Cr Income statement 230
Cr Revaluation surplus 170

Building in Rawang
Debit Credit
Date Item
RM(Â000) RM (Â000)
1.1.2011 Dr Building C 300
Cr Revaluation surplus 300

1.1.2016 Dr Revaluation surplus 200

Cr Building C 200

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1.1.2021 Dr Bank 740

Cr Building C 700
Cr Income statement (gain on disposal) 40

Dr Revaluation surplus 100

Cr Income statement 100

To record the effects of the revaluation, MASB 15 [Para 38] and MFRS 116
provides the following two methods:
(a) Restated proportionately with the change in the gross carrying amount of
the asset so that the carrying amount of the asset after revaluation equals its
revalued amount.
(b) Eliminated against the gross carrying amount of the asset and the net
amount restated to the revalued amount of the asset.

Let us look at Example 7.10 which demonstrates this matter.

Example 7.10:
On 1 May 2005, Superman Sdn Bhd had machinery costing RM250,000 and
accumulated depreciation of RM50,000. The machinery was purchased two
years ago and was depreciated on the straight-line method over 10 years.

On that date, the machinery was revalued upward because current prices had
increased substantially. The basis of the revaluation was based on the
replacement cost and the relevant data were as follows:

Descriptions RM
Replacement cost of a similar or equivalent new machine 400,000)
Less depreciation for two years (80,000)
Depreciated replacement cost 320,000)

Required:
(a) Calculate the surplus arising on the revaluation and show the journal
entry under each of the two methods of recording revaluation of assets.
(b) Present the machinery account under each of the two methods.

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Solution:
(a) Revaluation surplus = Net revalued amount – Net book value
= RM320,000 – RM200,000
= RM120,000
Journal entry:
Method 1
Dr (RM) Cr (RM)
Dr Machinery account 150,000
Cr Accumulated depreciation 30,000
Cr Revaluation reserve 120,000

Method 2
Dr (RM) Cr (RM)
Dr Accumulated depreciation 50,000
Cr Machinery account 70,000
Cr Revaluation reserve 120,000

(b) Presentation of machinery

Items Method 1 Method 2
Machinery, at valuation 400,000 320,000
Less: Accumulated depreciation (80,000) –
Net carrying amount 320,000 320,000

ACTIVITY 7.5
The price for renting a house in Damansara Utama usually is about
twice that for a house in Rawang.
In your opinion, why is this so?

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 An impairment loss refers to drastic change in value. It arises when the

carrying amount of an asset exceeds its recoverable amount.

 The accounting treatment of an impairment loss will depend on whether the

asset value is carried at cost or revalued amount.

 Property, plant and equipment should be eliminated from the account upon
the disposal or retirement of an asset.

 When property, plant and equipment retire from active use, the assets held
should be valued lower than the net carrying amount and net realisable
value, and any loss should be recognised immediately in the income
statement.

 The accounting policy for property, plant and equipment and the disclosure
practice are stated in MFRS 116. Among the requirements are the
measurement bases used for determining the gross carrying amount, the
depreciation methods used, the useful lives or the depreciation rates used
and others.

 Property, plant and equipment are defined as assets that are held by an
enterprise for use in the production of goods and services, for rental to others
or for administrative or maintenance purposes; and are expected to be used
during more than one reporting period.

 An item of property, plant and equipment should be recognised as an asset

when it is probable that future economic benefits associated with the asset
will flow to the enterprise and the cost of the asset to the enterprise can be
measured reliably.

 The property, plant or equipment which qualifies for recognition as an asset

should initially be measured at its cost. There are three components of the
costs for initial measurement namely acquired assets for cash or cash
equivalent, self-constructed fixed asset and exchange fixed asset.

 Subsequent expenditure can only be capitalised when it is probable that

future economic benefits, in excess of the originally assessed standard of
performance of the existing asset, will flow to the enterprise.

 All other subsequent expenditure should be recognised as an expense in the

period in which it incurred.

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Carrying amount Net selling price

Cost Property, plant and equipment
Depreciation Recoverable amount
Disclosure Residual value
Equipment Retirement and disposal
Fair value Subsequent expenditure
Fixed assets Useful life
Impairment Value in use
Impairment loss

Malaysia Accounting Standards Board (MASB). (2000). MASB Standard 15:

Property, plant and equipment. Retrieved from (http://www.masb.org.my/
images/stories/archive/PERS/!masb15.pdf
Malaysia Accounting Standards Board (MASB). (n. d.). Financial Reporting Standard
116. Retrieved from http://www.masb.org.my/index.php?option
=com_content&view=article&id=141:frs116-pg3&catid=6:masb-exclude-private

1. Florida Sdn Bhd acquired machinery from Taiko Bhd, a Japanese subsidiary
in Malaysia. The following expenditures were incurred:
Items RM
Invoice price of machinery 150,000
Trade discount given 3%
Delivery and handling costs 7,000
Maintenance charges per year 2,000

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Installation charges 10,000

General administrative costs 3,000

Required:
Calculate the initial amount this machinery should be valued.

2. Mika Sdn Bhd has incurred the following costs for the construction of a
factory:
Items RM
Land cost 500,000
Legal fees and stamp duty for purchase of land 14,000
Cost of demolishing old building on the land 50,000
Cost of clearing and levelling the land 50,000
Architect fees 55,000
Piling and foundation works 200,000
Legal fees for agreement with building contractor 3,000
Construction cost 480,000
Plumbing and wiring 200,000
1,552,000

Required:
Determine separately the amount to be recorded as the cost of land and of
the factory building.

3. Super Max Sdn Bhd started its business on 1 January 2004. The company
bought two machines in 2006, costing RM50,000 each. It is the company
policy to depreciate the machinery at the rate of 10% per annum, using the
straight-line method. It is also the company policy to provide full year
depreciation in the year of purchase and none for the year of disposal.

In 2010, one of the machines bought in 2006 was sold for RM15,000 on
credit to Wong Sdn Bhd. At the same time, another machine was modified
to increase the quality of its output. The cost of modification was RM20,000.
The useful life of this machine after the modification was estimated to be 13
years.

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Required:
Prepare the following accounts for 2010:
(a) Machinery account;
(b) Accumulated depreciation account; and
(c) Machinery disposal account.

1. Mikuyo Sdn Bhd has a multi-purpose van worth RM270,000. Its policy is to
charge full yearÊs depreciation in the year of acquisition and none in the
year of disposal. The residual value at the end of its useful life is RM20,000.
In 2010, the accumulated depreciation for the van before the current year
provision is RM100,000.

During the year, major repairs were made costing RM60,000 due to a severe
accident. The multi-purpose van was also installed with an advanced alarm
system costing RM15,000. The vanÊs remaining useful life is expected to be
three years.

Required:
(a) How would you treat the expenses incurred in 2010?
(b) Calculate the depreciation charge for 2010.

2. Triple A Rice Sdn Bhd bought a machine on 1 July 2005 at a cost of

RM80,000. The machine had an estimated residual value of RM8,000 and a
useful life of eight years. The company sold it for RM25,000 on 31
December 2010, the last day of its accounting year. Triple A Rice Sdn Bhd
incurred dismantling costs and costs of transporting the machine to the
buyerÊs factory, amounting to RM3,000. The company uses the straight-line
method of depreciation.

Required:
What was the gain or loss upon disposal of the machine?

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3. SR Medical Centre in Kuala Lumpur bought medical equipment costing

RM400,000 on 1 January 2005. The estimated useful life of the equipment
was five years. On 1 January 2009, it was revalued at RM300,000. Following
an inspection, the equipment is expected to last another three years. On 1
January 2010, the equipment was disposed of for RM120,000. The
accumulated depreciation is to be eliminated on revaluation.

Required:
Write up the necessary ledger accounts.

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Topic  Company
8 Reconstruction
LEARNING OUTCOMES
By the end of this topic, you should be able to:

1. Define business reconstruction;

2. Differentiate between internal reconstruction and external
reconstruction;
3. Describe internal reconstruction (capital reduction);
4. Discuss return of surplus capital;
5. Summarise reduction of capital not represented by available assets;
and
6. Analyse external reconstruction.

 INTRODUCTION
In this topic, you will learn about company reconstruction. Before we proceed,
please read the excerpt from World Trade Organization (WTO) website which
describes WTO Secretariat Report on policy statement by the Government of
Malaysia.

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The Secretariat's Report: Summary

TRADE POLICY REVIEW BODY: MALAYSIA

Report by the Secretariat - Summary Observations

Economic Environment

„In the second half of 1997, Malaysia was struck by the Asian financial crisis,
which contributed to a severe deterioration in its economic performance in 1998.
This deterioration occurred despite apparently strong economic fundamentals
(including full employment, low inflation, a high national saving rate, a prudent
fiscal position, and a reasonably sound banking system).‰

„Initially, Malaysia responded to the crisis by tightening financial policies, but

with the further worsening of the economic situation, the Government
changed its policy stance towards the end of 1998, cutting interest rates and
raising government spending in order to stimulate the economy.‰

Source: http://www.wto.org/english/tratop_e/tpr_e/tp180_e.htm

Let us reflect for awhile on the statements. This release illustrates the economic
crisis which happened in Malaysia around 1997. The press release shows how the
crisis affected us, specifically companies. Even if you had not been greatly
affected by the crisis, maybe some people you know have.

How bad was the impact of the economic crisis on companies? For most
companies, they faced serious financial difficulties. Some of those which were
badly hit had to undergo reconstruction.

In this topic, we will learn about business reconstruction undertaken by

companies in financial difficulty. We will also discuss the general impacts of
business reconstruction on companies and the relevant accounting treatment in
these circumstances.

8.1 BUSINESS RECONSTRUCTION

Before we go to the definition of business reconstruction, let us take awhile to
understand what it means in accounting terms. In accounting terms, business
reconstruction refers to a formal process which results in major changes to the
capital structure of the company. During the restructuring process, companies
can either go for internal or external reconstruction. Let us look at Table 8.1
which shows the differences between internal and external reconstruction.

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Table 8.1: Differences between Internal and External Reconstruction

Internal Reconstruction External Reconstruction

 The company may opt to return its  The company brings in outsiders to
share capital which is no longer revive the business. This is done by
required by the company to its setting up a new company to take
shareholders. over all the assets and liabilities of
 The company cancels its uncalled the old company.
share capital which it no longer
requires
 It cancels its share capital which can
no longer be represented by the
available assets.
 A company is said to have share
capital that is no longer represented
by the available assets when it has
accumulated losses which are more
than its paid-up capital.

We will look at internal and external reconstruction in details in the next subtopic.

A company with hefty accumulated losses and faces difficulty in discharging its
obligation to repay its debts may not be able to continue its operations without
going through a series of reforms. Under these circumstances, the company can
opt to wind up or undertake a reconstruction scheme.

Now, let us take a look at the meaning of business reconstruction. Can you guess
what it is?

Business reconstruction means a revamp of the companyÊs capital structure

by reducing its share capital which has been eroded by trading losses or
forming a new company to take over the financially ailing company.

A company undertaking reconstruction scheme must fulfil two conditions:

(a) Have evidence of making profits in the near future; and
(b) Be able to pay dividends to its shareholders.

Shareholders are the owners of a company. They usually bear the major losses
when a company needs to opt for business reconstruction. Depending on the
agreed reconstruction scheme, ordinary shareholders would be the most affected

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party compared to preference shareholders, followed by debenture holders and

the least affected would be the trade payables of the company. This is because the
shareholders of the company would be more willing to absorb the companyÊs
losses than any other outside party such as trade payables.

8.2 INTERNAL RECONSTRUCTION (CAPITAL

REDUCTION)
We have differentiated between internal and external reconstruction in the
previous Table 8.1. Now, let us learn more on internal reconstruction, also known
as capital reduction.

A company may undertake internal reconstruction or capital reduction if:

(i) It is authorised by the articles of associations;
(ii) Approved by a special resolution by the shareholders; and
(iii) Confirmed by the court.

All these conditions must be met before internal reconstruction can be

undertaken by the company.

The court will also look into the impact of internal reconstruction on all the
shareholders and trade payables before it gives the green light to the application
for internal reconstruction by a company. The court will not approve the internal
reconstruction scheme if it finds that it is not „fair and reasonable‰ to the
companyÊs shareholders or trade payables.

Section 64 of the Companies Act 1965 requires the rights of trade payables to be
fully protected before the court can confirm the reduction scheme. The trade
payablesÊ consent must be obtained or the company must ensure that its debts
have been discharged or secured. If a creditor believes that a proposed reduction
scheme does not meet the requirements stated by the law, he or she may object to
the reduction scheme by applying to the court to prevent the transaction from
proceeding.

A company may undertake a reduction of capital by the following ways:

(a) Return capital that is no longer required by the company to its
shareholders;
(b) Cancel uncalled capital that is no longer required by the company; or
(c) Cancel capital that is no longer represented by available assets.

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ACTIVITY 8.1

How do you think the position of trade payables will be affected by

internal reconstruction or capital reduction? Discuss with your
classmates.

8.3 RETURN OF SURPLUS CAPITAL

In this subtopic, we will discuss return of surplus capital. What is meant by
return of surplus capital? Let us find out the answer.

A company may consider reducing the par value of its shares when the company
is unable to identify any profitable opportunities for investment. In this case, the
companyÊs surplus cash resource is refunded to the shareholders under a capital
reduction scheme.

The rationale behind this move is that the cash resources of the company do not
yield a good return on capital for its shareholders. It is a financial decision which
is made when a company undertakes a capital reduction scheme. No matter how
easy the decision can be made based on financial analysis from the companyÊs
point of view; all formalities required by the law must be fulfilled in the return of
surplus capital.

It is stated clearly in the Companies Act 1965 that the trade payablesÊ interest
must be protected and they have the right to oppose the capital reduction scheme
if they feel the scheme is detrimental to their position.

The capital reduction scheme can be undertaken by reducing or writing off the
uncalled capital on the companyÊs issued capital. For example, a company with
500,000 ordinary shares at RM1.00 each issued and paid up to RM0.75 per share
may be reduced to RM0.75 each and fully paid. There is no refund of capital by
cash under this scheme as it only involves reduction of the uncalled capital and
no refund of cash for the capital that has already been paid.

Apart from this, the capital reduction scheme may also be undertaken by
returning the excess capital that is no longer required by the company. For
example, a company with 500,000 shares at RM1.00 each issued and fully paid
can be reduced to RM0.65 each. The difference of RM0.35 per share that has
already been paid is refunded to the shareholders in cash.

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Let us look at Example 8.1. This example illustrates the capital reduction scheme
by reducing the uncalled capital. Read the question carefully and try to answer
the questions without looking at the solution.

Example 8.1:
Bali Sdn Bhd was incorporated with an authorised share capital of RM900,000
shares of RM1.00 each. So far, the company has issued 750,000 ordinary shares
to its members which were paid up to RM0.85 each. The company has not
called up the final call of RM0.15 due to lack of potential investment plans in
the company. The directors of the company finally decided to reduce the
companyÊs share capital to RM0.85 each, as the uncalled capital may not be
needed in the near future. The trade payables and shareholders of the company
were consulted before the reduction scheme was undertaken. All formalities
under the requirements of the law were strictly followed by Bali Sdn Bhd.

Prepare journal entries to reflect the capital reduction scheme undertaken by

Bali Sdn Bhd.

Solution:

RM RM
Dr Share capital 112,500
Cr Capital reduction account 112,500

(Being amount written off share capital)

RM RM
Dr Capital reduction account 112,500
Cr Uncalled capital account 112,500

(Being uncalled capital written off)

After recording the above journal entries in the book of Bali Sdn Bhd, the
issued and paid up capital column in the balance sheet will be shown as
„750,000 ordinary shares at RM0.85 each, fully paid up‰.

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Next, let us see Example 8.2. This example illustrates the capital reduction
scheme by returning excess capital in cash.

Example 8.2:
Magchew Sdn Bhd issued 350,000 ordinary shares at RM1.00 each, fully paid up, to
its members when the company was incorporated 10 years ago. The company has
accumulated a large amount of cash because it has been unable to identify any
good investment opportunities over the years. The directors of the company finally
decided to refund 50% the companyÊs share capital to its shareholders so that they
can make use of the refunds for better investment opportunities. The trade
payables have not objected to the restructuring scheme as they have been very
happy with the companyÊs payment pattern over the years. The shareholders
welcomed the plan very much when it was proposed. All formalities under the
requirements of the law were strictly followed by the company.

Prepare journal entries to reflect the capital reduction scheme undertaken by

Magchew Sdn Bhd.

Solution:
RM RM
Dr Share capital 175,000
Cr Capital reduction account 175,000
(Being amount written off for share capital)

RM RM
Dr Capital reduction account 175,000
Cr Bank 175,000
(Being refund made to the existing shareholders)
Or

RM RM
Dr Share capital 175,000
Cr Bank 175,000
(Being repayment of share capital under capital reconstruction scheme)

After the above journal entries in the book of Magchew Sdn Bhd, the
issued and paid up capital column in the balance sheet will be shown as
„350,000 ordinary shares at RM0.50 each, fully paid up‰.

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8.4 REDUCTION OF CAPITAL NOT

REPRESENTED BY AVAILABLE ASSETS
Do you know that the capital of the company may be gradually eroded by the
companyÊs trading losses? In this case, the available assets of the company may
no longer correctly reflect the capital of the company. This situation is more
apparent for companies during an economic downturn. The ordinary
shareholders may not be able to recover the full amount of their share capital in
the event of winding up because the available assets would have been fully used
up to repay the liabilities of the company, leaving the shareholders to bear the
accumulated losses incurred by the company.

When the company has accumulated a large amount of losses, it can choose to do
nothing and let the losses further erode the capital. It can also wind up under the
requirement of the law or revamp its capital structure to bring the business back
to a more stable position.

The third option mentioned is only feasible if the management team of the
company is optimistic that reconstruction can bring about positive results for the
company. This may include taking positive actions to turn around the ailing
business, revaluing its assets to realisable values and writing off accumulated
losses. If additional funds are required in order to carry out the necessary
measures, the company may issue new shares. The capital reduction scheme may
reduce the net worth of the company at the beginning of the scheme.

However, once the capital reduction scheme is carried out successfully, the
management of the company can focus its efforts on turning around the business
without the burden of further accumulated losses and liabilities. The main
objective of the scheme is to ensure that the loss in capital is absorbed by various
parties such as shareholders, preference shareholders, debenture holders and
trade payables of the company in a proper manner.

In order to determine the amount of capital to be reduced and the basis to allocate
the losses, the directors must, firstly, determine the total amount to be written off. At
the same time, the rights of the trade payables must also be considered. The directors
must always bear in mind that the trade payables may object to the capital reduction
scheme if they find it unacceptable. The capital reduction scheme will not be
approved by the court without support from the trade payables.

Therefore, the directors must be able to convince the trade payables to accept the
proposed scheme. The ordinary shareholders are the ones who will absorb the
major losses in the event of capital reduction. By having reduction in the nominal

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 TOPIC 8 COMPANY RECONSTRUCTION  117

value of the shares under the capital reduction scheme, the shareholders may
receive lower dividends from the company in the future.

However, the shareholders will benefit from the capital reduction scheme if it
generates positive results for the business of the company as a whole. Let us look
at Example 8.3. Read the question carefully and try to answer the questions
without looking at the solution.

Example 8.3:
Dee Bee See Sdn Bhd was set up 30 years ago and has been profitable until the
late 1990s when it was badly affected by the economic crisis. Despite several
extreme measures taken by the top management, the company was unable to
turn the business around and accumulated a large amount of losses over the
years starting from 1999. The following is the balance sheet of Dee Bee See Sdn
Bhd as at 31 December 2013:

Dee Bee See Sdn Bhd

Balance sheet
as at 31 December 2013
RM RM
Non-current assets:
Patent and trademarks 200,000
Goodwill 160,000
Preliminary expenses 80,000
Land and building 1,000,000
Furniture and fittings 80,000
1,520,000

Current assets:
Inventories 220,000
Trade receivables 260,000
480,000

Current liabilities:
Trade payables (280,000)
Bank overdraft (300,000)
(580,000)

Net current assets (100,000)

1,420,000

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118  TOPIC 8 COMPANY RECONSTRUCTION

Share capital:
Ordinary shares at RM4.00 each paid-up fully 2,000,000
6% preference shares at RM4.00 each paid-up fully 400,000
Reserves 980,000
1,420,000

In order to revive the company in 2013, the management decided to implement

a capital reduction scheme with the following approved terms:
(a) The ordinary shares of RM4.00 each will be reduced to RM1 each and the
6% preference shares of RM4.00 each will be reduced to RM2 each.
(b) The patents, trademarks, goodwill and preliminary expenses are to be
fully written off.
(c) The share premium account is to be used for the capital reduction scheme.
(d) The land and building will be revalued to a fair value of RM772,000.
(e) Half of the furniture and fittings will be sold for RM60,000 in cash.
(f) The inventories will be written off by RM60,000.
(g) The accumulated losses will be written off.
(h) The cost of reconstruction amounting to RM12,000 will be paid from the
proceeds received from the disposal of furniture and fittings.
(i) Reserves include share premium of RM220,000 and accumulated losses of
1,200,000.

Required:
(a) Prepare journal entries to record the above transactions.
(b) Draw up the revised balance sheet immediately after the capital
reduction scheme undertaken by Dee Bee See Sdn. Bhd.
Solution:
(i)
RM RM
Dr 6% preference share capital 200,000
Cr Capital reduction account 200,000
(Being 6% preference shares of RM4.00 each reduced to RM2 each)
RM RM
Dr Ordinary share capital 1,500,000
Cr Capital reduction account 1,500,000
(Being ordinary shares of RM4.00 each reduced to RM1 each)

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 TOPIC 8 COMPANY RECONSTRUCTION  119

RM RM
Dr Capital reduction account 440,000
Cr Patent and trade marks 200,000
Goodwill 160,000
Preliminary expenses 80,000

(Being the amount written off for various assets)

RM RM
Dr Share premium 220,000
Cr Capital reduction account 220,000
(Being accumulated loss written off)

RM RM
Dr Capital reduction account 228,000
Cr Land and building 228,000
(Being loss on revaluation of land and building)

RM RM
Dr Cash on hand 60,000
Cr Furniture and fittings 40,000
Capital reduction account 20,000

(Being loss on revaluation of land and building)

RM RM
Dr Capital reduction account 60,000
Cr Inventories 60,000
(Being write-off of inventories)

RM RM
Dr Capital reduction account 1,200,000
Cr Income statement 1,200,000
(Being accumulated loss written off)

RM RM
Dr Capital reduction account 12,000
Cr Cash on hand 12,000
(Being expenses of re-organisation)

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120  TOPIC 8 COMPANY RECONSTRUCTION

(ii)
Dee Bee See Sdn. Bhd.
Revised Balance Sheet
as at 31 December 2013
RM RM
Non-current assets:
Land and building 193,000
Furniture and fittings 10,000
203,000
Current Assets:
Inventories 40,000
Trade receivables 65,000
Cash on hand 12,000
117,000
Current liabilities:
Trade payables (70,000)
Bank overdraft (75,000)
(145,000)

Net current assets (28,000)

75,000

Authorised capital:
900,000 ordinary shares at RM0.25 each
200,000 6% preference shares at RM0.50 each
Share capital
Ordinary shares at RM0.25 each paid-up fully 125,000
6% preference shares at RM0.50 each paid-up fully 50,000
175,000

8.4 EXTERNAL RECONSTRUCTION

We have learned about internal reconstruction or capital reduction in Subtopic
8.2. We have also learnt a bit about external reconstruction and differentiated
between them. Now, we let us learn more on external reconstruction.

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 TOPIC 8 COMPANY RECONSTRUCTION  121

Normally, when undertaking business reconstruction, a company starts with

internal reconstruction. This is because internal reconstruction is much easier to
initiate and monitor. It is also less costly compared to external reconstruction.

However, external reconstruction is more popular among family-owned

companies. It merely involves setting up a new company to take over all the
assets and liabilities of the old company. The basic concept is similar to
amalgamation.

The purchase consideration given to the old company is usually in the form of
shares in the new company. Although the shareholders of the new company may
be exactly the same as the shareholders of the old company, it may appear to the
public as if it is a new establishment as the new company may have a new
management team and a new name.

As in amalgamation, external reconstruction represents a sale of business to a

newly formed company. Therefore, there are two aspects of the accounting
treatments to be dealt with in external reconstruction. They are:
(a) The winding up of the affairs of the old company; and
(b) The opening of the relevant books in the new company.

In accounting treatment, the book of the old company is closed by transferring all
assets and liabilities to a realisation and reconstruction account. This account will
then be offset against the share capital and reserves account.

On the other hand, the books of the new company are opened by recognising all
the assets and liabilities taken over and followed by crediting to the respective
share capital and reserves accounts.

Let us look at Example 8.4 which illustrates the accounting treatment of an

external reconstruction.

Example 8.4:
After several years of making losses, the management of Seng Heng Sdn Bhd
has decided to carry out a restructuring plan in 2014. Since all the shareholders
of the company are family members, they decided to set up a new company to
take over all the assets and liabilities of Seng Heng Sdn Bhd. The new
company, Soon Hiang Sdn Bhd, is to be formed with an authorised capital of
800,000 ordinary shares of RM1.00 each and 200,000, 9% preference shares of
RM1.00 each. Some debentures with 10% interest will also be issued in the
course of the restructuring.

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122  TOPIC 8 COMPANY RECONSTRUCTION

Below is the balance sheet of Seng Heng Sdn Bhd as at 31 December 2013:

Seng Heng Sdn Bhd

Balance Sheet
as at 31 December 2013

RM RM
Non-current assets:
Plant and machinery 188,000
Furniture and fittings 50,000
Office equipment 21,000
259,000
Current assets:
Inventories 118,000
Trade receivables 65,000
Cash 40,000
223,000

Current liabilities:
Trade payables (67,000)
Bank overdraft (123,000)
(190,000)
Net current assets 33,000
292,000
Authorised capital:
500,000 ordinary shares at RM1.00 each
150,000 9% preference shares at RM1.00 each

Share capital:
Ordinary shares at RM1.00 each paid up fully 600,000
9% preference shares at RM1.00 each paid up fully 150,000
Accumulated losses (458,000)
292,000

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 TOPIC 8 COMPANY RECONSTRUCTION  123

The reconstruction scheme was agreed to by all the parties on the following
terms:
(i) RM100,000 10% debentures in Soon Hiang Sdn Bhd will be issued to repay
the bank overdraft and the remaining balance is to be settled by cash.
(ii) The trade payables are offered 10% debentures but only RM50,000 are
taken up and the remaining is settled by cash.
(iii) Soon Hiang will issue eight 9% preference shares at RM1.00 each for
every ten preference shares in Seng Heng Sdn Bhd.
(iv) The ordinary shareholders will be given five ordinary shares in Soon
Hiang Sdn Bhd for every 15 shares they hold in Seng Heng Sdn Bhd.
(v) Seng Heng Sdn Bhd is to be wound up following the reconstruction plan.
(vi) Plant and machinery and furniture and fittings are revalued at
RM210,000 and RM56,000 respectively.
(vii) All other assets except for cash are taken over at their book values.

Required:
(a) Compute the purchase considerations paid to Seng Heng Sdn Bhd.
(b) Prepare journal entries to close the books of Seng Heng Sdn Bhd.
(c) Prepare journal entries to open the books of Soon Hiang Sdn Bhd.
(d) Prepare the balance sheet of Soon Hiang Sdn Bhd as at 31 December
2013.

Solution:

(a) Purchase consideration = Fair value of net assets acquired

RM
By way of issuing 10% debentures
– Bank overdraft 100,000
– Trade payables 50,000
By way of issuing 9% preference shares of RM1.00 each
– Four for every five shares held (8  150,000/10) 120,000
By way of issuing ordinary shares of RM1.00 each
– One for every three shares held (5  600,000/15) 200,000
Purchase consideration 470,000

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124  TOPIC 8 COMPANY RECONSTRUCTION

RM
Plant and machinery 210,000
Furniture and fittings 56,000
Equipment 21,000
Inventories 118,000
Trade receivables 65,000
Net assets acquired 470,000

Therefore, Soon Hiang Sdn Bhd needs to pay RM470,000 in taking over Seng
Heng Sdn Bhd.

(b) In the books of Seng Heng Sdn Bhd

RM RM
Dr Soon Hiang Sdn Bhd 470,000
Cr Realisation and reconstruction account 470,000
(Being purchase consideration on reconstruction)

RM RM
Dr Realisation and reconstruction account 442,000
Cr Plant and machinery 188,000
Furniture and fittings 50,000
Equipment 21,000
Inventories 118,000
Trade receivables 65,000
(Being assets taken over by Soon Hiang Sdn Bhd)

RM RM
Dr Trade payables 17,000
Bank overdraft 23,000
Cr Cash account 40,000
(Being liabilities settled by cash)

RM RM
Dr Trade payables 50,000
Bank overdraft 100,000
Cr Sundry membersÊ account 150,000
(Being liabilities taken over by Soon Hiang Sdn Bhd)

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 TOPIC 8 COMPANY RECONSTRUCTION  125

RM RM
Dr Realisation and reconstruction account 28,000
Cr Sundry membersÊ account 28,000

(Being profit on sale of business)

RM RM
Dr Ordinary share capital 600,000
9% preference share capital 150,000
Profit and loss 458,000
Cr Sundry membersÊ account 292,000

(Being transfer of capital and reserves)

RM RM
Dr Ordinary shares in Soon Hiang Sdn Bhd 200,000
9% preference shares in Soon Hiang 120,000
Sdn Bhd
10% debentures in Soon Hiang Sdn Bhd 150,000
Cr Soon Hiang Sdn Bhd 470,000
(Being purchase consideration received)

RM RM
Dr Sundry membersÊ account 470,000
Ordinary shares in Soon Hiang Sdn Bhd 200,000
9% preference shares in Soon Hiang Sdn 120,000
Cr Bhd
10% debentures in Soon Hiang Sdn Bhd 150,000

(Being distribution of ordinary shares, preference shares and debentures)

(c) In the books of Soon Hiang Sdn Bhd

RM RM
Dr Business purchase 470,000
Cr Seng Heng Sdn Bhd account 470,000
(Being purchase consideration for business take over)

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126  TOPIC 8 COMPANY RECONSTRUCTION

RM RM
Dr Plant and machinery 210,000
Furniture and fittings 56,000
Equipment 21,000
Inventories 118,000
Debtor 65,000

Cr Business purchase 470,000

(Being assets and liabilities taken over by Soon Hiang Sdn Bhd)

RM RM
Dr Seng Heng Sdn Bhd 470,000
Cr Ordinary shares capital 200,000
9% preference shares 120,000
10% debentures 150,000

(Being issues of ordinary shares, preference shares and debentures to

Soon Hiang Sdn Bhd)

(d)

Soon Hiang Sdn Bhd

Balance Sheet
as at 31 December 2013

RM RM

Non-current assets:
Plant and machinery 210,000
Furniture and fittings 56,000
Office equipment 21,000
287,000

Current assets:
Inventories 118,000
Trade receivables 65,000
183,000
470,000

Authorised capital:
800,000 ordinary shares at RM1.00 each
200,000 9% preference shares at RM1.00 each

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 TOPIC 8 COMPANY RECONSTRUCTION  127

Share capital
Ordinary shares at RM1.00 each paid up fully 200,000
9% preference shares at RM1.00 each paid up fully 120,000
10% debentures 150,000
470,000

 Company reconstruction is a very hot topic, especially during recession.

Companies facing heavy financial losses may choose to stay in business by
revamping their capital structure. Without any reconstruction plan, a
company may have to wind up.

 In accounting terms, business reconstruction refers to a formal process which

results in major changes to the capital structure of the company. During the
restructuring process, companies can either go for internal or external
reconstruction.

 There are two types of business reconstruction, namely internal

reconstruction and external reconstruction.

 Internal reconstruction deals with positive steps to revive the business, write
off accumulated losses by reducing capital and revalue its assets to reflect fair
value.

 External reconstruction takes place when a new company is formed to take

over a financially failing company.

 In internal reconstruction or capital reduction, the shares among the

shareholders may be cancelled against their wish. A reduction of capital may
not necessarily involve payments to the shareholders when their shares are
cancelled.

 A company may consider reducing the par value of its shares when the
company is unable to identify any profitable opportunities for investment. In
this case, the companyÊs surplus cash resource is refunded to the
shareholders under a capital reduction scheme.

 The company may reduce its capital which is no longer represented by its
available assets if the management believes that the company can be turned
around by the reconstruction scheme.

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128  TOPIC 8 COMPANY RECONSTRUCTION

 The accounting entries for business reconstruction normally involve

some journal entries to record the capital reduction scheme. Meanwhile, an
external reconstruction scheme involves the closing of the books of the old
firm and the opening of books for the new firm.

 Under the requirements of the Companies Act, 1965, all reconstruction

schemes must be approved by the court and agreed to by all the
stakeholders. This is to protect the well-being of all the related parties in the
event of reconstruction.

Business reconstruction Internal reconstruction

Capital reduction Reconstruction
External reconstruction Return of surplus capital

1. Crystal Sdn Bhd has issued 1,000,000 ordinary shares of RM1.00 each. The
shares were fully paid up on application. Over the years, the company has
accumulated a large amount of losses which have to be written off during a
restructuring process. The company has, therefore, decided to reduce the
capital to RM0.50 each after having obtained approval from the trade
payables and the relevant authorities. All formalities under the
requirements of the law were strictly followed by Crystal Sdn Bhd.

Prepare journal entries to reflect the capital reduction scheme undertaken

by Crystal Sdn. Bhd.

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 TOPIC 8 COMPANY RECONSTRUCTION  129

2. The following is the balance sheet of Sure Win Sdn Bhd as at 31 December
2010.

Sure Win Sdn. Bhd.

Balance Sheet
as at 31 December 2010

RMÊ000 RMÊ000

Non-current assets:
Land and building 2,000
Motor vehicles 540
Furniture and fittings 210
Office equipment 200
2,950

Current assets:
Inventories 300
Trade receivables 230
Cash at bank 370
900

Current liabilities:
Trade payables (320)
Bank overdraft (610)
(930)

Net current assets (30)

2,920
Authorised capital:
5,000,000 ordinary shares at RM1.00 each
1,000,000 6% preference shares at RM1.00 each

Share capital:
Ordinary shares at RM1.00 each paid-up fully 4,000
6% preference shares at RM1.00 each paid-up fully 800

Accumulated losses (1,880)

2,920

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130  TOPIC 8 COMPANY RECONSTRUCTION

The company was advised to carry out an internal restructuring activity to

write off the heavy accumulated losses. The management of the company
decided to carry out several financial and non-financial measures to revive
the company. The financial restructuring included a capital reduction
scheme with the following terms:
(a) The ordinary shares of RM1.00 each are to be reduced to RM0.60 each
and the 6% preference shares of RM1.00 each are to be reduced to
RM0.75 each.
(b) The land and building are to be revalued at RM2,080,000.
(c) The bank overdraft is to be settled by realising motor vehicles at book
value and the remaining balance is to be paid out by the cash at bank.
(d) The accumulated losses are to be fully written off.

Required:
(i) Prepare journal entries to record the above transactions.
(ii) Draw up the revised balance sheet immediately after the capital
reduction scheme undertaken by Sure Win Sdn Bhd.

1. Worldwide Sdn Bhd is a cash-rich enterprise. Its paid-up capital consists of

650,000 ordinary shares at RM0.50 each. The company is no longer able to
identify any good investment opportunity. Therefore, the directors of the
company agreed to reduce 50% of the companyÊs share capital and return
the cash to its shareholders. The trade payables did not object to the
decision. All formalities under the requirements of the law were strictly
followed by Worldwide Sdn Bhd.

Prepare journal entries to reflect the capital reduction scheme undertaken

by Worldwide Sdn Bhd.

2. A new company, Massive Sdn Bhd, was set up to take over the financially
ailing company, Superflow Sdn Bhd. Massive Sdn Bhd was formed with an
authorised capital of 900,000 ordinary shares of RM0.10 each and 500,000
8% preference shares of RM0.50 each.

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 TOPIC 8 COMPANY RECONSTRUCTION  131

Below is the balance sheet of Superflow Sdn Bhd as at 30 June 2010.

Superflow Sdn. Bhd.

Balance Sheet
as at 30 June 2010
RM RM
Non-current assets:
Land and building 450,000
Furniture and fittings 50,000
Computers 15,000
515,000
Current assets:
Inventories 88,000
Trade receivables 61,000
Cash at bank 4,000
153,000
Current liabilities:
Trade payables (144,000)
Bank overdraft (454,000)
(598,000)
Net current assets (445,000)
70,000
Authorised capital:
500,000 ordinary shares at RM1.00 each
150,000 6% preference shares at RM1.00 each
Share capital:
Ordinary shares at RM1.00 each paid up fully 500,000
6% preference shares at RM1.00 each paid up fully 150,000
Accumulated losses (580,000)
70,000

Superflow was taken over on the following terms:

(i) RM450,000 8% debentures were issued to partially repay bank
overdraft and the remaining was settled by cash.
(ii) A small group of trade payables were offered 8% debentures and
RM50,000 was accepted by certain trade payables while the balance
will be transferred to Massive Sdn Bhd subject to normal terms of
payment.

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132  TOPIC 8 COMPANY RECONSTRUCTION

(iii) All preference shareholders were offered 8% preference shares at

RM0.50 each in Massive Sdn Bhd.
(iv) The ordinary shareholders were given one ordinary share at RM0.10
each in Massive Sdn Bhd for every two shares held in Superflow Sdn
Bhd.
(v) Land and building were revalued to RM480,000.
(vi) All other assets except for cash were taken over at their book
values.
(vii) Superflow Sdn Bhd was to be wound up after the reconstruction plan.
(viii) The reconstruction plan was completed on 30 June 2010.

Required:
(a) Compute the purchase considerations paid to Superflow Sdn Bhd.
(b) Prepare journal entries to close the books of Superflow Sdn Bhd.
(c) Prepare journal entries to open the book of Massive Sdn Bhd.
(d) Prepare the balance sheet of Massive Sdn Bhd as at 30 June 2010.

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Topic  Comprehensive
9 Cases

LEARNING OUTCOMES
By the end of this topic, you should be able to:
1. Apply the knowledge from earlier topics; and
2. Solve the comprehensive examination questions.

 INTRODUCTION
This last topic is designed for you to encapsulate your learning from the earlier
topics. There are various samples of examination questions and suggested
answers that will be presented for you to analyse.

9.1 PREPARATION OF SIMPLE GROUP

BALANCE SHEET ON ACQUISITION DATE
Let us look two sample questions in this first subtopic on how to prepare balance
sheet on acquisition date.

Question 9.1:

You are analysing the potential purchase of 100% Giant Hypermarket by your
company, Tesco Hypermarket. Information is provided as follows:

Your company, Tesco Hypermarket pays in cash RM200,000 for Giant

Hypermarket and the cash is obtained via long-term loan from the bank.

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134  TOPIC 9 COMPREHENSIVE CASES

Tesco
Hypermarket Giant Hypermarket
Historical Value Historical Value Fair Value

Assets RM'000 RM'000 RM'000

Current Assets 80 60 65
Land 100 40 60
Plants, net 80 30 30
Equipment, net 70 20 30
Cash 60 10 10
Total assets 390 160 195
Liabilities and Equity
Current liabilities 240 60 60
Shareholders' equity 150 100

Total Liabilities and equity 390 160

Required:
Prepare a consolidated balance sheet as well as the inter company transaction.

Question 9.2:

On December 31, Year 1, Synergy Corp purchases 100% of Micron Company by

exchanging 10,000 shares of its common stock (RM5 par value, RM77 market
value) for all of the common stock of Micron.

On the date of acquisition, the book value of Micron is RM620,000. Synergy is

willing to pay the market price of RM770,000 because it feels that MicronÊs
property, plant and equipment (PP&E) is undervalued by RM20,000, it has an
unrecorded trademark worth RM30,000 and intangible benefits of the business
combination (corporate synergies, market position and the like) are valued at
RM100,000.

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 TOPIC 9 COMPREHENSIVE CASES  135

The purchase price is, therefore, allocated as follows:

Purchase price 770,000

Book value of Micron 620,000
Excess 150,000
Excess allocated to – Useful life Annual
deprec/amort.
Undervalued PP&E 20,000 10 2,000
Trademark 30,000 5 6,000
Goodwill 100,000 Indefinite -0-
150,000

The four consolidation entries are:

(a) Replace RM620,000 of the investment account with the book value of the
assets acquired. If less than 100% of the subsidiary is owned, the credit to
the investment account is equal to the percentage of the book value owned
and the remaining credit is to a liability account, minority interest.
(b) Replace RM150,000 of the investment account with the fair value
adjustments required to fully record MicronÊs assets at fair market value.
(c) Eliminate the investment income recorded by Synergy and replace that
account with the income statement of Micron. If less than 100% of the
subsidiary is owned, the investment income reported by the Synergy is
equal to its proportionate share and an additional expense for the balance is
reported for the minority interest in MicronÊs earnings.
(d) Record the depreciation of the fair value adjustment for MicronÊs PP&E and
the amortisation of the trademark. Note that there is no amortisation of
goodwill under current GAAP.

9.2 PREPARATION OF PUBLISHED

FINANCIAL STATEMENT
This subtopic gives you one sample of examination question on how to prepare
published financial statements.

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136  TOPIC 9 COMPREHENSIVE CASES

Question 9.3:

Given below is the trial balance of TaoBao Bhd as at 31 December 2013.

Debit (RMÊ000) Credit (RMÊ000)

Sales 4,000
Cost of sales 1,000
Inventory 200
Administrative expenses 800
Distribution expenses 600
Dividends received 50
Interest expenses 40
Tax paid 440
10% debentures (secured on land) 300
Short-term loans 100
Cash at bank 35
Trade receivables 150
Trade payables 140
Land (cost) 1,000
Property (cost) 2,000
Plant and machinery (cost) 500
Equipment (cost) 400
Accumulated depreciation
Property 400
Plant and machinery 300
Equipment 100
Intangibles 100
Ordinary shares or RM1.00 each 1,000
7.2% preference shares of RM1 each 600
Share premium 100
Retained profit 1 Jan 2013 1,482.6
Investment 1,250
Interim dividends paid
Preference share 21.6
Ordinary share 36
8,572.6 8,572.6

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 TOPIC 9 COMPREHENSIVE CASES  137

Additional information:
(a) Administration and distribution expenses include:
RMÊ000
DirectorÊs remuneration 200
Audit charge 100
Depreciation: Property 50
Plant 100
Equipment 50
(b) Interest expenses are made up of:
Debenture interest 30
Interest on short-term loan 10
(c) Tax expense for the year is RM510,000.
(d) The directors declared the final dividend of preference share and ordinary
share 7.2% on 20 February 2014. The financial statements were approved
for issue on 20 March 2014.
(e) On 31 December 2013 land was revalue to RM3,000,000. The directors want
to incorporate this value in the accounts.
(f) The market value of the quoted shares at 31 December 2013 was
RM1,500,000.

Required:

Prepare the statement of comprehensive income for the year ended 31 December
2013 and the statement of financial position as at 31 December 2013.

9.3 FINANCIAL STATEMENT ANALYSIS

Now let us look at how to do the financial statement analysis through Question
9.4 and Question 9.5.

Question 9.4:

Following are Ogawa CorporationÊs income statement and balance sheet in RM

millions.

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138  TOPIC 9 COMPREHENSIVE CASES

Income Statement
2013
Net revenue 41,444
Cost of goods sold 33,892
Gross margin 7,552
SG&A 3,544
Depreciation 464
Total operating expenses 4,008
Operating income 3,544
Interest expense 180
Income before tax 3,364
Tax provision 1,079
Net Income 2,285

Balance Sheet
2012 2013
Assets
Cash & cash equivalents 4,317 4,232
Short-term investments 2054 1500
Account receivable, net 3,635 2,586
Inventories 327 306
Total current assets 10,333 8,624
PP&E, net 1,517 913
Investments 6,770 5,267
Other non-currents assets 391 366
Total assets 19,011 15,170

Liabilities & stockholder equity

Accounts payable 7,316 5,989
Accrued and other 3,580 2,944
Total current liabilities 10,896 8,933
Long-term debt 750 630
Other non-current liabilities 1,085 734
Total liabilities 12,731 10,297
Stockholder's equity: 6,280 4,873
Total liabilities & stockholder equity 19,011 15,170

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 TOPIC 9 COMPREHENSIVE CASES  139

(a) Using the above information, calculate the following ratios for 2013:
(i) Current ratio
(ii) Quick ratio
(iii) Account receivable turnover ratio
(iv) Days in accounts receivable
(v) Inventory turnover ratio
(vi) Days supply in inventory
(vii) Account payable turnover ratio
(viii) Days in accounts payable
(ix) Conversion period
(x) Net trade cycle (days)

(b) Comment on the changes to OmegaÊs liquidity risk

(c) Indicate the effect of the following actions on Acid ratio and current ratio.
Indicate whether the effect is to increase (I), decrease (D) or if it has no
effect (NE). Consider each action independently of others.
Current Ratio Acid Ratio
Cash receipt from issuing new stock
Write down inventory
Provision more bad debt
Pay supplier faster
Sell account receivable at nominal value

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140  TOPIC 9 COMPREHENSIVE CASES

Question 9.5:
The following data are taken from the records of Hiliran Sdn Bhd:

Hiliran Sdn Bhd

Comparative Balance Sheet As At December 31

2010 2011
(RM) (RM)
Assets:
Cash 38,000 23,000
Account receivable 11,000 15,000
Inventory 220,000 195,000
Property, plant and equipment 70,000 70,000
Total assets 339,000 303,000

Liabilities and shareholder's funds:

Current liabilities 52,000 36,000
Non-current liabilities 175,000 170,000
Shareholders' funds 112,000 97,000
Total liabilities and shareholders' funds 339,000 303,000

Hiliran Sdn Bhd

Comparative Income statement for the years ended December 31
2010 2011
(RM) (RM)
Sales 463,000 345,000
Cost of goods sold 240,00 182,000
Gross margin 223,000 163,000
Operating expenses 133,000 121,000
Interest expenses 15,000 10,000
Income tax 30,000 12,000
Net income 45,000 20,000

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 TOPIC 9 COMPREHENSIVE CASES  141

Required:

(a) Using the above information, compute the following ratios for the two
years:
(i) Gross profit margin.
(ii) Net profit margin before tax.
(iii) Return on capital employed.
(iv) Return on shareholdersÊ funds.
(v) Long-term debt to equity ratio.
(vi) Current ratio.
(vii) Quick ratio.
(viii) Inventory turnover.
(ix) Receivable turnover.
(x) Average collection period.
(xi) Average inventory holding period.
(xii) Non-current assets turnover.

(b) Based on the ratios computed in (a) above, comment on the profitability,
management efficiency, liquidity and solvency of the company over the
two-year period.

(c) Discuss any other information that may enhance your analysis of the
performance of the company.

9.4 INTEGRITY AND ETHICS IN PREPARING

AND REPORTING FINANCIAL
INFORMATION
Lastly, let us look at two sample questions which depict on integrity and ethics in
preparing and reporting financial information.

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142  TOPIC 9 COMPREHENSIVE CASES

Question 9.6:

At a recent conference on corporate social responsibility, one speaker (Mr. Chan

Yong Fung) argued that professional codes of ethics for accountants were not as
useful as some have claimed because:
"They assume professional accountants to be rules-driven, when in fact
most professionals are more driven by principles that guide and underpin
all aspects of professional behaviour, including professional ethics."

When quizzed from the audience about his views on the usefulness of
professional codes of ethics, Mr. Chan suggested that the costs of writing,
implementing, disseminating and monitoring ethical codes outweighed their
usefulness. He said that as long as professional accountants personally observe
the highest values of probity and integrity then there is no need for detailed
codes of ethics.

Required:
(a) Critically evaluate Mr. Chan's views on codes of professional ethics. Use
examples of ethical codes, where appropriate, to illustrate your answer.
(b) With reference to Mr. Chan's comments, explain what is meant by
"integrity" and assess its importance as an underlying principle in corporate
governance.
(ACCA Paper P1, 2007)

Question 9.7:

ABB Inc, operates a chain of department stores. Two years ago, the directors of
ABB Inc. approved a large scale remodelling. Linda, assistant accountant, was
asked to prepare the financial statement and she and management person were
offered bonus based on profitability of the company. Linda discovered huge
outdated stocks. She discuss with her colleagues, the finding is ignore reporting
the outdated stocks. Since reporting will affect the profit and their income.

Required:
(a) According to the standards of ethical conduct for practitioners of
management accounting and financial management, would it be ethical for
Linda not to report the stocks as obsolete?
(b) Would it be easy for Linda to take the ethical action in this situation?

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 ANSWERS  143

Answers
TOPIC 1: ACCOUNTING FOR FINANCIAL LIABILITIES

Self-Test 1
There is a loss on redemption: the cash paid, RM510,000 (RM500,000 102%), is
greater than the carrying value of RM508,000. The entry is;
Dr Bonds payable 500,000
Premium on Bonds Payable 8,000
Loss on bond redemption 2,000
Cr Cash 510,000
(To record redemption of bonds at 102)

Self-Test 2
(a) 2013
Jan 1 Dr Cash 500,000
Cr Bonds payable 500,000
(To record issue of 11%, 10-year convertible bonds at face value)
(b) 2013
July 1 Dr Bond interest expense 27,500
Cr Cash (RM500,000 x 0.055) 27,500
(to record payment of semi annual interest)
2013
Dec 31 Dr Bond interest expense 27,500
Cr Bond interest payable 27,500
(to record accrual of semi annual bond interest)
(c) 2014
Jan 1 Dr Bond interest payable 27,500
Cr Cash 27,500
(to record payment of accrued interest)
(d) 2014
Jan 1 Dr Bonds payable 500,000
Cr Common stock 300,000*
Paid-in capital in excess of par value 200,000
(to record conversion of bonds into common stock)
*RM500,000 / RM1,000 = 500 bonds; 500  30 = 15,000 shares; 15,000  RM20 =
RM300,000)

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144  ANSWERS

TOPIC 2: LEASES

Self-Test 1
1. (a) The lease is classified as an operating lease for the following reasons:
(i) The lease term covers 48% of the useful life of the assets.
Note:
12 years / 30 years  100% = 40%

(ii) The present value of the minimum lease payment is

25% of the fair value of the asset.
Note:
The present value of the minimum lease payment is:
= RM5 million  Present value factor for 12 periods
= RM5 million + (RM5 million  6.4951)
= RM37.48 million
Fair value = RM150 million

Therefore, the present value of the minimum lease payment is

25% of the fair value:
= RM37.48 million / RM150 million  100%
= 25%

(iii) The ownership (i.e. title) of the machine will not be transferred to
Aceland Sdn Bhd (lessee).

(iv) Mah Sing Sdn Bhd (lessor) is responsible for repairing and
maintaining the machine, indicating that the risks and rewards
are not transferred to the lessee.

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 ANSWERS  145

(b) The lease is classified as a finance lease for the following reasons:
(i) The lease periods cover 90% of the useful life of the asset.
Note:
9 years / 10 years  100% = 90%

(ii) The ownership of the asset is transferred to the lessee at the end
of the lease term.

(iii) The present value of the minimum lease payment is 99.7% of the
fair value of the asset.
Note:
The present value of the minimum lease payments is:
= RM 300,000 + RM110, 000  Present value factor for 9 periods.
= RM300,000 + RM110,000 + (RM110,000 × 5.3349)
= RM996,839

Fair value = RM1 million

Therefore, the present value of the payment is 99.7% of the
fair value of the asset
= RM996,839/RM1,000,000  100%
= 99.7%
(iv) The lessee is responsible for repairing and maintaining the asset.

2. Based on the information in the question, the lease is classified as a finance

lease. The lessor should capitalise the asset. The following is the journal
entries for the year 2005.
Dr Cr
RM RM
Fixed asset – Machinery
1,000,000
Cash – Initial deposit 300,000
Lease creditor 700,000
(To record machine acquired on finance lease)
Dr Cr
RM RM
Finance charges 55,000
Lease creditor 125,000
Cash (6 months  RM30,000) 180,000
(To record lease payment)

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146  ANSWERS

Dr Cr
RM RM
Depreciation 50,000
Accumulated depreciation 50,000
(RM1 million/10 years  ½)
(To record depreciation for six months)

Dr Cr
RM RM
Bank
Accumulated depreciation 400,000
Machine 250,000 500,000
Gain 150,000
(To record the sale of machine)

Dr Cr
RM RM
Machine 400,000
Lease creditor 400,000
(To record lease asset and liability

Dr Cr
RM RM
Lease creditor 85,000
Cash 85,000
(To record the payment of the lease instalment)

Dr Cr
RM RM
Profit and loss – Interest charges 10,000
Lease creditor 10,000
(To record the interest portion of the lease payment)

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 ANSWERS  147

Note:
Total interest charged for the lease period:
RM
Total rental/instalment to be paid 425,000
Fair value of the asset 400,000
Interest charged over the lease 25,000

Interest expense for 2005 = (4/10  RM 25,000) = 10,000

Dr Cr
RM RM
Profit and loss – Depreciation 80,000
Accumulated depreciation 80,000
(To record the depreciation)

Note:
RM400,000/5 years = RM80,000
Dr Cr
RM RM
Deferred gain 30,000
Profit and loss 30,000

Note
RM150,000/5 years = RM30,000

Self-Test 2
1. Dr Cr
(RM) (RM)
Bank 600,000
Accumulated depreciation
[(RM1 million – 10,000 /15 years)  5 years] 330,000
Machine 1,000,000
Profit and loss 70,000
(To record the sale of the machine)

Lease rental expense (7,500  12) 90,000

Bank 90,000
(To record the payment of lease instalment)

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148  ANSWERS

2. The basis for differentiating between an operating lease and a finance lease
depends largely on whether the risks and rewards incidental to the
ownership of a leased asset are transferred from the lessor to the lessee. A
finance lease is a lease that transfers substantially the risks and rewards
incidental to the ownership of an asset from the lessor to the lessee. On the
other hand, when a lease is an operating lease, the risks and rewards of the
asset are not transferred to the lessee, who is merely renting the asset.

Accounting Treatment for Operating Lease

In the book of a lessee, lease payment for an operating lease is recognised as
an expense in the income statement on a straight-line basis over the lease
term, unless another systematic basis is representative of the time pattern of
the userÊs benefits (MASB 10, Para 28) and (FRS 117, Para 33). On the other
hand, the asset held under an operating lease will be recorded in the book
of the lessor as a fixed asset and it will be duly depreciated. The lease
income (i.e. rental received) should be recognised as income on a straight-
line basis over the lease term, unless another systematic basis is more
representative of the time pattern in which the userÊs benefit derived from
the leased asset is diminished (MASB 10, Para 49) and (FRS 117, Para 50).

Accounting Treatment for Finance Lease

According to paragraph 15 of MASB10 and paragraph 20 of FRS 117, lessees
should recognise finance leases as assets and liabilities in their balance sheet. The
amount recognised should be the fair value of the leased assets or, if lower, at the
present value of the minimum lease payment. Based on paragraph 35 of MASB
10 and paragraph 36 of FRS 117, lessors should recognise assets held under a
finance lease in their balance sheet and present them as receivable at an amount
equal to the net investment in the lease.

Based on the information given, the lease is a finance lease for the following
reasons:
(i) The lease term is 83% of the useful life of the asset.
Note: 5 years /6 years  100%
(ii) The present value of the minimum lease payment is more than 90% of
the fair value of the asset.

Note:
Present value of the minimum lease payment is:

Present value = RM100,000 + RM100,000/(1 + 0.05)1+ RM100,000/(1 + 0.05)2 +

RM100,000/(1 + 0.05)3 + RM100,000/(1 + 0.05)4
= RM454,600

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 ANSWERS  149

An alternative approach to determine the present value is:

Present value = RM100,000  Present value factor for 5 periods.
= RM100,000 + (RM100,000  3.5460)
= RM454,600
Fair value (i.e. cash price) is RM500,000
Therefore, the present value of the minimum lease payment is 91% of the
fair value of the asset:
= RM454,600/RM460,000  100%
= 98.8%
(i) The lessee is responsible for repairing and maintaining the asset,
indicating that the risks and rewards lie with the lessee.
(ii) An option to purchase the asset at the end of the lease term at a
nominal sum.

TOPIC 3: INVESTMENT IN EQUITY AND DEBT

SECURITIES

Self-Test 1
2013
May 18 Dr Stock investments (400,000  5% x RM6) 120,000
Cr Cash 120,000
(to record purchase of 20,000 shares of Rowater Co stock)

Aug 30 Dr Cash 3,750

Cr Dividend Revenue (75,000 x 5%) 3,750
(to record receipt of cash dividend)

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Self-Test 2
2013
Jan 1 Dr Stock investment (60,000 x 40% x RM12) 288,000
Cr Cash 288,000
(to record purchase of 24,000 shares of North CoÊs stock)

Aug 15 Dr Cash 18,000

Cr Stock Investment (RM45,000 x 40%) 18,000
(to record receipt of cash dividend)

Dec 31 Dr Stock investment (RM120,000 x 40%) 48,000

Cr Revenue from Investment in North Co. 48,000
(to record 40% equity in North coÊs net income)

TOPIC 4: INVESTMENT PROPERTY

Self-Test 1
2013
Jan 1 Dr Investment property 10,000,000
Cr Cash or liability 10,000,000

Dec 31 Dr Investment property 1,500,000

Cr income statement 1,500,000

2014
Dec 31 Dr Income statement 700,000
Cr Investment property 700,000

Self-Test 2
JS Bhd
On 1 July 2013, the property can be classified as investment property as only an
insignificant portion of the property is owner-occupied. The asset is recognised at
RM25 million.

On 31 December 2013, the difference of RM4 million between the fair value of
RM29 millions and carrying value of RM25 millions is recognised in the income
statement.

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 ANSWERS  151

On 31 December 2014, the difference of RM2 million between the fair value of
RM27 million and carrying value of RM29 million is recognised in the income
statement as a loss. The building is not depreciated.

TOPIC 5: INTRODUCTION TO GROUP ACCOUNTS

Self-Test 1
Business Combination
RM
Shares (1,000,000 x 4.20) 4,200,000
Bond (present value) (2,000,000 x 0.91) 2,000,000
Incidental costs 500,000
Cost of business combination 6,700,000

Self-Test 2
Goodwill
RMÊ000
Cost of business combination 2,000
Fair value of net assets 1,600
Goodwill 400

Adjustment to goodwill:
Goodwill 400
Fair value adjustment (580,000 – 420,000) (160)
Goodwill 240

TOPIC 6: INTANGIBLE ASSETS

Self-Test 1
(a) Transfer fees can be capitalised.
(b) Operational costs are not to be capitalised.

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152  ANSWERS

(c) Medical costs are expensed off.

(d) Massive advertising campaign is not allowed to be capitalised.

Self-Test 2
The carrying amount of the asset on 31 December 2013 would be RM250,000 –
RM50,000. Amortisation charge for year 2014 would be another RM50,000 and the
carrying amount would be RM150,000 (RM250,000 – RM100,000). As the fair
value on 31 December 2014 was RM240,000 there was a revaluation surplus of
RM90,000 which should be credited to equity, the revaluation reserve.

In year 2015 amortisation charge will be RM240,000/3 years = RM80,000. The

carrying value on 31 December 2015 will be RM240,000 – RM80,000 = RM
160,000.

As the fair value cannot be determined, the deemed carrying value will be
RM160,000 and the asset is assessed for impairment. Amortisation for year 2016
will be RM80,000 if there is no impairment.

TOPIC 7: IMPAIRMENT

Self-Test 1
1. RM
Invoice price of machinery 150,000
Less: Trade discount (4,500)
145,500
Delivery and handling costs 7,000
Installation charges 10,000
Total 162,500

2. Cost of land:
RM
Land cost 500,000
Legal fees and stamp duty for purchase of land 14,000
Cost of demolishing old building on the land 50,000
Cost of clearing and levelling the land 50,000
614,000

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 ANSWERS  153

Cost of Factory:
Architect fees RM
Piling and foundation works 55,000
Legal fees for agreement with building contractor 200,000
Construction cost 3,000
Plumbing and wiring 480,000
200,000
938,000

3. Machinery Account
2010 Bal b/f 100,000 2010 Disposal 50,000
Bank 20,000 Bal c/f 70,000
120,000 120,000

Accumulated Depreciation Account

2010 Machinery 2010 Bal b/d 60,000
Disposal 30,000
Bal c/f 33,077 Depreciation – Income
statement 3,077
63,077 63,077

Machinery Disposal
2010 Machinery 50,000 2010 Accumulated depreciation 30,000
Wong Sdn Bhd 15,000
Loss in disposal 5,000
50,000 50,000

Self-Test 2
1. (a) Write off RM60,000 and capitalise RM15,000
(b) Depreciation charge for 2010

Net Carrying Amount * + Subsequent Expenditure – Residual Value

=
Remaining Useful Life

= RM270,000 – RM100,000 + RM15,000 – RM20,000

3 years
= RM55,000

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 154  ANSWERS

RM (80,000 – 8,000)
2. Annual depreciation =
8 years
= RM9,000

It is assumed that in 2005 only a half yearÊs depreciation was charged

because the asset was purchased six months into the year.

RM RM
Machine at cost 80,000
Depreciation – 2005 4,500
Depreciation – 2006, 2007, 2008, 2009, 2010 45,000
Accumulated depreciation (49,500
)
Net carrying amount at the date of disposal 30,500
(31/12/2010)
Sale price 25,000
Cost incurred in making the sale (3,000)
Net selling price (22,000
)
Loss on disposal 8,500

This loss will be shown as an expense in the income statement.

3. Medical Equipment
1.1.2005 Cash 400,000 1.1.2008 Accumulated
depreciation 240,000
1.1.2009 Revaluation surplus 140,000 1.1.2010 Disposal 300,000
540,000 540,000

Accumulated Depreciation
1.1.2008 Medical equipment 240,000 31.12.2005 Depreciation 80,000
31.12.2006 Depreciation 80,000
31.12.2007 Depreciation 80,000
240,000 240,000

1.1.2010 Disposal 200,000 31.12.2008 Depreciation 100,000

31.12.2009 Depreciation 100,000
200,000 200,000

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 ANSWERS  155

Disposal of Medical Equipment

1.1.2010 Medical equipment 300,000 1.1.2010 Accumulated 200,000
depreciation
Gain on disposal 20,000 Cash 120,000
320,000 320,000

Revaluation Reserve
Medical
1.1.2010 Income statement 140,000 1.1.2008 equipment 140,000

TOPIC 8: COMPANY RECONSTRUCTION

Self-Test 1
1. Crystal Berhad
RM RM
Dr. Share capital 500,000
Cr. Capital reduction account 500,000

(Being amount written off for share capital)

RM RM
Dr. Capital reduction account 500,000
Cr. Income statement 500,000

(Being accumulated losses written off)

2. Sure Win Sdn Bhd

RM'000 RM'000
Dr. 6% preference share capital 200
Cr. Capital reduction account 200

(Being 6% preference shares of RM1.00 each reduced to RM0.75 each)

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156  ANSWERS

RM'000 RM'000
Dr. Ordinary share capital 1,600
Cr. Capital reduction account 1,600

(Being ordinary shares of RM1.00 each reduced to RM0.60 each)

RM'000 RM'000
Dr. Bank overdraft 610
Cr. Motor vehicles 540
Cash at bank 70

(Being settlement of bank overdraft)

RM'000 RM'000
Dr. Land and building 80
Cr. Capital reduction account 80

(Being revaluation of asset)

RM'000 RM'000
Dr. Capital reduction account 1,880
Cr. Income statement 1,880

(Being accumulated losses written off)

(b)
Sure Win Sdn Bhd
Revised balance sheet
as at 31 December 2010
RM'000 RM'000
Non-current assets:
Land and building 2,080
Furniture and fittings 210
Office equipment 200
2,490
Current assets:
Inventories 300
Trade receivables 230
Cash at bank 300
830

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 ANSWERS  157

Current liabilities:
Trade payables (320)

Net current assets 510

3,000
Authorised capital:
5,000,000 ordinary shares at RM1.00 each
1,000,000 6% preference shares at RM1.00 each

Share capital:
Ordinary shares at RM0.60 each paid up fully 2,400
6% preference shares at RM0.75 each paid up fully 600

3,000

Self-Test 2
1. Worldwide Sdn Bhd
RM RM
Dr. Share capital 162,500
Cr. Capital reduction account 162,500

(Being amount written off for share capital)

RM RM
Dr. Capital reduction account 162,500
Cr. Bank 162,500

(Being refund made to the existing shareholders)

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158  ANSWERS

2. (a) Purchase consideration = Fair value of net assets acquired

RM
8% debentures
- Bank overdraft 450,000
- Trade payables 50,000
8% preference shares of RM0.50 each 75,000
Ordinary shares of RM0.10 each
- One for every two shares held (1  500,000 / 2) 25,000
Purchase consideration 600,000

RM
Land and building 480,000
Furniture and fittings 50,000
Computers 15,000
Inventories 88,000
Trade receivables 61,000
Less: trade payables (94,000)
Net assets acquired 600,000

Therefore, Massive Sdn Bhd needs to pay RM600,000 in taking over

Superflow Sdn Bhd.

(b) In the books of Superflow Sdn Bhd

RM RM
Dr. Massive Sdn Bhd 600,000
Cr. Realisation and reconstruction 600,000
account

(Being purchase consideration on reconstruction)

RM RM
Dr. Realisation and reconstruction 570,000
account
94,000
Trade payables
Cr. Land and building 450,000
Furniture and fittings 50,000
Computers 15,000
Inventories 88,000
Trade receivables 61,000

(Being assets and liabilities taken over by Massive Sdn Bhd)

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 ANSWERS  159

RM RM
Dr. Trade payables 50,000
Bank overdraft 450,000
Cr. Sundry membersÊ account 500,000

(Being liabilities settled by Massive Sdn Bhd)

RM RM
Dr. Bank overdraft 4,000
Cr. Cash account 4,000

(Being bank overdraft settled by cash)

RM RM
Dr. Realisation and reconstruction 30,000
account
Cr. Sundry membersÊ account 30,000

(Being profit on sales of business)

RM RM
Dr. Ordinary share capital 500,000
6% preference share capital 150,000
Cr. Profit and loss 580,000
Sundry membersÊ account 70,000

(Being transfer of capital and reserves)

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160  ANSWERS

RM RM
Dr. Ordinary shares in Massive Sdn Bhd 25,000
8% preference shares in Massive 75,000
Sdn Bhd
8% debentures in Massive Sdn Bhd 500,000
Cr. Massive Sdn Bhd 600,000

(Being purchase consideration received)

RM RM
Dr. Sundry membersÊ account 600,000
Cr. Ordinary shares in Massive Sdn 25,000
Bhd
8% preference shares in 75,000
Massive Sdn Bhd
8% debentures in Massive Sdn 500,000
Bhd

(Being distribution of ordinary shares, preference shares and debentures)

(c) In the books of Massive Sdn Bhd

RM RM
Dr. Business purchase 600,000
Cr. Superflow Sdn Bhd account 600,000

(Being purchase consideration for business take over)

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 ANSWERS  161

RM RM
Dr. Land and building 480,000
Furniture and fittings 50,000
Computers 15,000
Inventories 88,000
Debtor 61,000
Cr. Trade payables 94,000
Business purchase 600,000

(Being assets and liabilities taken over by Massive Sdn Bhd)

RM RM
Dr. Superflow Sdn Bhd 600,000
Cr. Ordinary shares capital 25,000
8% preference shares 75,000
8% debentures 500,000

(Being issues of ordinary shares, preference shares and debentures to Superflow

Sdn Bhd)

(d)
Massive Sdn Bhd
Balance sheet
as at 30 June 2010
RM RM
Non-current assets:
Land and building 480,000
Furniture and fittings 50,000
Computers 15,000
545,000
Current assets:
Inventories 88,000
Trade receivables 61,000
149,000
Current liabilities:
Trade payables (94,000)

Net current assets 55,000

600,000

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162  ANSWERS

Authorised capital:
900,000 ordinary shares at RM0.10 each
500,000 8% preference shares at RM0.50 each

Share capital:
Ordinary shares at RM0.10 each paid up fully 25,000
8% preference shares at RM0.50 each paid up fully 75,000
8% debenture 500,000

600,000

TOPIC 9: COMPREHENSIVE CASES

Question 9.1
Assets RMÊ000
Current assets 145
Land 160
Buildings, net 110
Equipment, net 100
Cash 70
Goodwill 65*
Total assets 650

Liabilities and Equity

Current liabilities 300
Long-term liabilities 200
Shareholders' equity 150
Total liabilities and equity 650
*Goodwill computation: RMÊ000
Payment..................................................................... 200
Fair value of net assets acquired (195-60) ............. 135
65

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 ANSWERS  163

Question 9.2
During Year 2, Micron earns RM150,000 and pays no dividends. The investment,
accounted for under the equity method, has a balance on SynergyÊs book at
December 31, Year 2 as follows:

Beginning balance (31/12/Y1) RM770,000

Investment income 150,000
Dividends (0)
Amortisation of excess (above) (8,000)
Ending balance (31/12/Y2) 912,000

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164  ANSWERS

Question 9.3
TaoBao Bhd
Statement of comprehensive income for the year ended 31 December 2013

Notes RMÊ000 RMÊ000

Sales 4,000
Cost of sales (1,000)
Gross profit 3,000
Administrative expenses 800
Distribution expenses 600 (1,400)
Operating profit 1,600
Finance cost (40)
Dividend income (gross) 50
Profit before tax 1 1,610
Taxation 2 (510)
1,100

Basic earnings per share (cent) 3 105.68

Dividends per share - ordinary
(15 cent less tax 28%) 4 10.8 cent

TaoBao Bhd
Statement of changes in equity for the year ended 31 December 2013

Share Share Revalu. Acc. Total

Capital Premium Reserve Profit
1.1.2013 1,600 100 nil 1,396.6 3,096.6
On revaluation 2,000 2,000
Net profit for the year 1,100 1,100
Dividends
Interim
Preference (21.6) (21.6)
Ordinary (36) (36)
Proposed
Preference (21.6) (21.6)
Ordinary (72) (72)
31.12.2013 1,600 100 2,000 2,345.4 6,045.4

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TaoBao Bhd
Statement of financial position as at 31 December 2013

Notes RMÊ000 RMÊ000

Share Capital 5
Ordinary shares of RM1.00 each 1,000
10% Preference shares of RM1.00 each 600
1,600
Reserves 6
Share premium 100
Asset revaluation reserves 2,000
Profit and loss balance 2,345.4 4,445.4
6,045.4

Non-Current Liabilities
10% debentures (secured on land) 300
Deferred taxation 140

Current Liabilities
Trade payables 140
Tax payable 16
Dividends payable 93.6
Short term loans 100 349.6
6,835
Non-Current Assets
Property, plant & equipment 7 5,100
Intangibles assets 100
investment 8 1,250
6,450
Current Assets
Inventory 200
Trade receivables 150
Bank 35 385
6,835

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TaoBao Bhd
Statement of income & expenses for the year ended 31 December 2013

RMÊ000

Revaluation surplus 2,000

Net profit for the year 1,100
Total recognised gains 3,100

Notes to account:

1. Profit before tax is arrived at after charging:

RMÊ000
DirectorsÊ remuneration 200
Audit fees 100
Depreciation
Property 50
Plant 100
Equipment 50
Debenture interest 30
Interest on short-term loan 10
And crediting
Gross dividend income 50

2. Taxation charge for the year

RMÊ000
Tax charge 470
Increase in deferred tax 40
510
3. Earnings per share (EPS)

EPS is calculated by dividing profit attributable to ordinary shareholders of

RM1,056,800 by 1,000,000 shares.

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4. Dividends

Dividends Gross Dividend Amount of Dividend

Per Share Net of Tax (28%)
Cent RM
Preference
Interim 5 21,600
Final 5 21,600
Ordinary
Interim 5 36,000
Final 10 72,000

5. Share capital

RMÊ000
Authorised capital
xxx ordinary shares of RM1 each xxx
xxx 10% preference shares of RM1 each xxx
xxx

Issued and fully paid up

Ordinary shares of RM1 each 1,000
10% preference shares of RM1 each 600
1,600

6. Reserves

Share Revalu. Profit Total

Premium Reserve & Loss
1.1.2013 100 nil 1,396.6 3,096.6
On revaluation 2,000 2,000
Net profit for the year 948.8 948.8
31.12.2013 100 2,000 2,345.4 4,445.4

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7. Property, plant and equipment

Cost/valuation Land Property Plant Equip Total

1.1.2013 1,000 2,000 500 400 3,900
Valuation 2,000
31.12.2013 3,000 2,000 500 400 5,900

Acc. Depreciation
1.1.2013 350 200 50 600
Charge for the year 50 100 50 200
31.12.2013 400 300 100 800
Net Book Value 3,000 1,600 200 300 5,100

8. Long-term investment

Investments are in equity shares of quoted companies. The market value is

RM1,500,000

Question 9.4

(a)
(i) Current ratio 0.948329662
(ii) Quick ratio 0.918318649
(iii) Account receivable turnover ratio 13.32390291
(iv) Days in accounts receivable 27.01911012
(v) Inventory turnover ratio 107.0837283
(vi) Days supply in inventory 3.361855305
(vii) Account payable turnover ratio 5.09
(viii) Days in accounts payable 70.66269326
(ix) Conversion period 30.38096543
(x) Net trade cycle (days) -40.28172783

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(b)
 Net days in working capital are negative, meaning the company gets
more credit from its suppliers than it gives its customers. We observe a
difference of 40 days in between the credit received and given. This
difference enables the company to profit from this difference.
 However Liquidity ratio 0.97 is less than the benchmark 2.
 Overall the company's liquidity seems to be average.

(c)
Current Ratio Acid Ratio
Cash receipt from issuing new stock I I
Write down inventory D NE
Provision more bad debt D D
Pay supplier faster D D
Sell account receivable at nominal value NE NE

Question 9.5

Answer:
(a)
Marks=12 RATIOS 2010 2011
(i) Gross profit margin 223/463 = 48% 163/345 = 47%
(ii) Net profit margin before tax 75/463 =16% 32/345 = 9.3%
(iii) Return on capital employed 40% 20.6%
(iv) Return on shareholder funds 31% 15.7%
(v) Long-term debt to equity ratio 1.56 : 1 1.75 : 1
(vi) Current ratio 5:1 6.5 : 1
(vii) Quick ratio 0.9 : 1 1.1 : 1
(viii) Inventory turnover 1.1x 0.9x
(ix) Receivable turnover 42x 23x
(x) Average collection period 8.6 days 15 days
(xi) Average inventory holding 331 days 405 days
period
(xii) Non-current assets turnover 6.6x 5x

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(b)
• Profitability: Net profit margin decreased even though GP margin
stable, net profit margin down because of fall in sales.
• Efficiency: Collection longer, over stocking and poor inventory
management, less productivity of fixed assets.
• Liquidity: Current ratio is based on huge inventory holding and quick
ratio confirms that liquidity may be just about minimum safety level.
• Solvency: Ratio 5 shows increasing dependence on borrowings, highly
geared, may show high risk of inadequate cash cover to service loan
payment and interest charges from the liquidity ratios computed.

(c)
• What is the nature of the business?
• How long has it been trading?
• Is it competitive?
• Product lines carried.
• Economic conditions.
• Segment served.
• Margins earned in this business.

Question 9.6

(a) Mr. Chan's views on codes of professional ethics:

Mr. Chan adopts a sceptical stance with regard to codes of ethics. There are
arguments both supporting and challenging his views.

Supporting Mr. Chan's opinion:

Professional codes of ethics have a number of limitations, some of which
Professor Cheung referred to. Because they contain descriptions of
situations that accountants might encounter, they can convey the (false)
impression that professional ethics can be reduced to a set of rules
contained in a code (as pointed out by Mr. Chan). This would be a mistaken
impression, of course, as the need for personal integrity is also emphasised.

Ethical codes do not and cannot capture all ethical circumstances and
dilemmas that a professional accountant will encounter in his or her career
and this reinforces the need for accountants to understand the underlying
ethical principles of probity, integrity, openness, transparency and fairness.
Some may argue that regional variations in cultural, social and ethical

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norms mean that such codes cannot capture important differences in

emphasis in some parts of the world. The moral "right" can be prescribed in
every situation.

Finally, professional codes of ethics are not technically enforceable in any

legal manner although sanctions exist for gross breach of the code in some
jurisdictions. Individual observance of ethical codes is effectively voluntary
in most circumstances.

Against Mr. Chan's opinion:

There are a number of arguments for codes of professional ethics that
challenge Professor Cheung's views. Firstly, professional codes of ethics
signal the importance, to accountants, of ethics and acting in the public
interest in the professional accounting environment. They are reminded,
unambiguously and in "black and white". For example, that as with other
professions, accounting exists to serve the public good and public support
for the profession is likely to exist only as long as the public interest is
supported over and above competing interests. The major international
codes underpin national and regional cultures with internationally expected
standards that, the codes insist, supersede any national ethical nuances.

The IFAC (2003) code states (in clause 4), "the accountancy profession
throughout the world operates in an environment with different cultures
and regulatory requirements. The basic intent of the Code, however, should
always be respected." The codes prescribe minimum standards of behaviour
expected in given situations and give specific examples of potentially
problematic areas in accounting practice. In such situations, the codes make
the preferred course of action unambiguous.

A number of codes of ethics exist for professional accountants. Prominent

among these is the IFAC code. This places the public interest at the heart of
the ethical conduct of accountants. The ACCA code discusses ethics from
within a principles-based perspective. Other countries' own professional
accounting bodies have issued their own codes of ethics in the belief that
they may better describe the ethical situations in those countries.

(b) Integrity
Meaning of "integrity":
Integrity is generally understood to describe a person of high moral virtue.
A person of integrity is one who observes a steadfast adherence to a strict
moral or ethical code notwithstanding any other pressures on him or her to
act otherwise. In professional life, integrity describes the personal ethical
position of the highest standards of professionalism and probity. It is an
underlying and underpinning principle of corporate governance and it is

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required that all those representing shareholder interests in agency

relationships both possess and exercise absolute integrity at all times. To fail
to do so is a breach of the agency trust relationship.

Importance of integrity in corporate governance:

Integrity is important in corporate governance for several reasons. Codes of
ethics do not capture all ethical situations and the importance of the virtue of
the "actor" rather than the ethics of the action is therefore emphasised. Any
profession (such as accounting) relies upon a public perception of competence
and integrity and in this regard, accounting can perhaps be compared with
medicine. As an underlying principle, integrity provides a basic ethical
framework to guide an accountant's professional and personal life.

Finally, integrity underpins the relationships that an accountant has with

his or her clients, auditors and other colleagues. Trust is vital in the normal
conduct of these relationships and integrity underpins this.

Question 9.7

(a) Failure to report the obsolete nature of the inventory would violate the
Standards of Ethical Conduct as follows:

Competence
• Perform duties in accordance with relevant technical standards.
• Prepare complete reports using reliable information.
• By failing to write down the value of the obsolete inventory, Linda
would not be preparing a complete report using reliable information. In
addition, generally accepted accounting principles (GAAP) require the
write-down of obsolete inventory.

Integrity
• Avoid conflicts of interest.
• Refrain from activities that prejudice the ability to perform duties
ethically.
• Refrain from subverting the legitimate goals of the organisation.
• Refrain from discrediting the profession.

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(b) Members of the management team, of which Linda is a part, are responsible
for both operations and recording the results of operations. Since the team
will benefit from a bonus, increasing earnings by ignoring the obsolete
inventory is clearly a conflict of interest. Linda would also be concealing
unfavourable information and subverting the goals of the organisation.
Furthermore, such behaviour is a discredit to the profession.

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