When a parent company that records its investment using the cost method during a fiscal year sells a portion of its investment, explain the correct accounting for any differences between selling price and recorded values.View Solution:
When a parent company that records its investment using the

Techno Builders has acquired a 70% interest in the equity of a foreign company, Prefabco, whose functional currency is the FC. Although Prefabco began operations in June 2008 when 1 FC equaled $1.95, Techno did not acquire its interest until March 31, 2011, when 1 FC equaled $2.08. Techno paid 400,000 FC for its interest in Prefabco when the subsidiary’s condensed pre-closing trial balance was as follows: Prefabco had net income and dividends, declared at year-end and paid in the first quarter of the next year, subsequent to Techno s acquisition as follows along with selected rates of exchange: Required Prepare a schedule to determine the balance in Techno’s account ‘‘Investment in Prefabco’’ as of year-end 2013 and also prepare all of the entries that would be necessary to eliminate the investment account in a worksheet to consolidate the parent company and its subsidiary for the year 2013. Techno uses the simple equity method to account for its interest in the subsidiary.

(a) Accounting practices for fixed assets and depreciation can be said to have developed in a piecemeal manner. The introduction of FRS 11 ‘Impairment of Fixed Assets’ has meant that a standard on the measurement of fixed assets was required to provide further guidance in this area. FRS 15 ‘Tangible Fixed Assets’ deals with the measurement and valuation issue.

Required

Describe why it was important for a new accounting standard to be issued on the measurement of fixed assets.

(b) Aztech, a public limited company manufactures and operates a fleet of small aircraft. It draws up its financial statements to 31 March each year,

Aztech also owns a small chain of hotels (carrying value of £16 million), which are used in the sale of holidays to the public. It is the policy of the company not to provide depreciation on the hotels as they are maintained to a high standard and the economic lives of the hotels are long (20 years remaining life). The hotels are periodically revalued and on 31 March 2000, their existing use value was determined to be £20 million, the replacement cost of the hotels was £16 million and the open market value was £19 million. One of the hotels included above is surplus to the company’s requirements as at 31 March 2000. This hotel had an existing use value of £3 million, a replacement cost of £2 million and an open market value of £2.5 million, before expected estate agents and solicitors fees of £200 000. Aztech wishes to revalue the hotels as at 31 March 2000. There is no indication of any impairment in value of the hotels.

The company has recently finished manufacturing a fleet of five aircraft to a new design. These aircraft are intended for use in its own fleet for domestic carriage purposes. The company commenced construction of the assets on 1 April 1998 and wishes to recognise them as fixed assets as at 31 March 2000 when they were first utilised. The aircraft were completed on 1 January 2000 but their exterior painting was delayed until 31 March 2000.

The costs (excluding finance costs) of manufacturing the aircraft were £28 million and the company has adopted a policy of capitalising the finance costs of manufacturing the aircraft. Aztech had taken out a three year loan of £20 million to finance the aircraft on 1 April 1998. Interest is payable at 10% per annum but is to be rolled over and paid at the end of the three year period together with the capital outstanding. Corporation tax is 30%.

During the construction of the aircraft, certain computerised components used in the manufacture fell dramatically in price. The company estimated that at 31 March 2000 the net realisable value of the aircraft was £30 million and their value in use was £29 million.

The engines used in the aircraft have a three year life and the body parts have an eight year life; Aztech has decided to depreciate the engines and the body parts over their different useful lives on the straight line basis from 1 April 2000. The cost of replacing the engines on 31 March 2003 is estimated to be £15 million. The engine costs represent thirty per cent of the total cost of manufacture.

The company has decided to revalue the aircraft annually on the basis of their market value. On 31 March 2001, the aircraft have a value in use of £28 million, a market value of £27 million and a net realisable value of £26 million. On 31 March 2002, the aircraft have a value in use of £17 million, a market value of £18 million and a net realisable value of £18.5 million. There is no consumption of economic benefits in 2002 other than the depreciation charge. Revaluation surpluses or deficits are apportioned between the engines and the body parts on the basis of their year end carrying values before the revaluation.

Required:

(i) Describe how the hotels should be valued in the financial statements of Aztech on 31 March 2000 and explain whether the current depreciation policy relating to the hotels is acceptable under FRS 15 ‘Tangible Fixed Assets’.

(ii) Show the accounting treatment of the aircraft fleet in the financial statements on the basis of the above scenario for the financial years ending on:

(a) 31 March 2000.

(b) 31 March 2001, 2002.

(c) 31 March 2003 before revaluation.

Candidates should use FRS 15 ‘Tangible Fixed Assets’ in answering all parts of the above question.

Fairmont Golf issued fixed rate debt when interest rates were 6 percent. Rates have since risen to 7 percent. Using the values reported on the financial statements would most likely cause an analyst to

a. overestimate Fairmont’s economic liabilities.

b. underestimate Fairmont’s economic liabilities.

c. underestimate Fairmont’s interest coverage ratio.

Willowbrook Fitness Center purchased a new step machine for $8,250. The apparatus is expected to last four years and have a residual value of $750. What will the depreciation expense be for each year under the straight-line method?