Question 1 (30 marks)You work for a construction company that specializes in building office towers. On the first ofFebruary 2019 (1/2/19) your company signed a contract with a customer to build an officetower on land that the customer owns. The two parties agreed that the building would cost$15 million and that the building would be ready for occupancy within 3 years of to signing thecontract. If this deadline is achieved, the customer will pay $2 million. The company’s financialyear ends on the 31st of December. The company’s manager is a bit concerned about the bonuspayment, as ...
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Question 1 (30 marks)You work for a construction company that specializes in building office towers. On the first ofFebruary 2019 (1/2/19) your company signed a contract with a customer to build an officetower on land that the customer owns. The two parties agreed that the building would cost$15 million and that the building would be ready for occupancy within 3 years of to signing thecontract. If this deadline is achieved, the customer will pay $2 million. The company’s financialyear ends on the 31st of December. The company’s manager is a bit concerned about the bonuspayment, as the timeline to complete the building is quite tight and it is possible that delays,such as weather, disruptions in the supply chain etc. could delay completion of the project.The construction company estimated the building will cost $10m in total. The company usuallymeasures income from these sorts of projects on the basis of the proportion of expected totalcosts that have actually been incurred.The customer agrees to pay $5 million at the start of the contract, to be followed by two moreprogress payments of the same amount, 12 months and 24 months later. The bonus will bepaid when the building is ready for occupancy, if this happens within the contracted timeframe.Assume that by 31/12/19, the company estimates that it has completed 25% of the project.The delay was due to an unusually wet year and unexpected problems with the ground causingproblems with the foundations. The company had actually paid for $2.5 million in wages andmaterials in this year.Assume that by 31/12/20 the company estimates it has completed 70% of the project, becauseit had spent a total of approximately $7 million on materials and labour etc. By this point, theexternal structures, such as walls, windows and roof were completed. Most of the remainingwork would be inside the weather-proof building. In early February 2020, the client advises thecompany that it wishes to modify the contract by changing floorcoverings, internal walls foroffice spaces, and air-conditioning systems. These had all been included in the originalcontract. The client just wants to vary the specific items (such as changing from carpet to woodfloors). Your company and the client agreed to increase the sales price by another $1.5 millionin total. Your manager estimates these changes will cost the company another $800,000. Thedeadline for the project was extended by 3 months. Your manager was very happy with theextension of time. She is very confident the project will be completed on time.By 31/12/21 the company estimated it had completed 90% of the work.The building was completed to the satisfaction of the client by the end of March 2022. Thebonus was received in early April 2022.RequiredYour manager wants advice on the following issues. You need to justify your responses byreferencing the standard and other relevant documents.11403 GROUP ASSIGNMENT PAGE 2 OF 3a) Does AASB 15 apply to this contract? (1 mark)b) When should revenue be recognised? At the end of the contract or over the life of thecontract? (2 marks)c) At the commencement of the contract, how should the company treat the bonus of$2m? Should it be included in revenue? (2 marks)d) Based on AASB 15, what would the company’s initial estimate of profit be on the datethe contract was signed? (5 marks)e) Your manager is not sure how to account for the contract modification that occurredin March 2020. Advise her. (Be careful. If you just recite the standard, but do notprovide an answer, such as ‘the modification should be accounted for as …’ yourmanager is highly likely to be upset. Your colleagues suggest you really don’t wantthis.) (5 marks)f) Prepare journal entries for all the relevant years. If you make assumptions, you mustidentify them. (15 marks)Question 2 (30 marks)Terra Corporation enters into a contract with Jupiter Ltd. to provide a system that managesthe customers' portfolio for 3 years. The average customer term is 5 years. Terra will nottransfer the system to Jupiter, but it will provide the system and the services included in thecontract while it is still valid. The contract is renewable for subsequent one-year periods.Terra incurred the following costs to obtain the contract:a) $15,000 commission for the sales representatives.b) $5,000 legal fees paid externallyc) $8,000 flight and accommodation costs to deliver the proposal.d) $25,000 Bonus to sales supervisors in the first yearAfter a month testing, Jupiter decided to sign the contractRequired:i. Your manager wants advice on how to account for these expenditures under Australianaccounting standards in each of the relevant years. You must justify your treatment byreferring to specific paragraphs in the standards. You must also state any assumptionsyou make. (15 marks)ii. Present the journal entries (if any) for each expenditure. (15 marks)Question 3 (30 marks)Your manager has trouble sleeping at night and so read Illustrative Examples to AASB 9Financial Instruments. Unfortunately, the material on pages 4 and 5 of that document got stuckin his mind and he could not sleep, trying to work out why the standard setters would comeup with this particular rule. It upset him that he could not work out what the standard setterswere trying to do.Required11403 GROUP ASSIGNMENT PAGE 3 OF 3Conduct some research into this example and develop a short report (no more than a page)explaining what the standard setters were concerned about and why they developed this rule.Comment on whether this approach will reduce or increase the potential for earningsmanagement.Question 4 (50 marks)Turbo Ltd. enters into a 15-year lease of a whole a building, with an option to extend for fiveyears. Lease payments are $65,000 per year during the initial term and $75,000 per year duringthe optional period, all payable at the beginning of each year. To obtain the lease, Turbo paidinitial direct costs of $35,000, of which $15,000 relates to a payment to a former tenantoccupying one of the floors of the building and $20,000 as a commission for the real estateagent that arranged the lease. As an incentive to Turbo for entering into the lease, America Ltd(the lessor) made the following payments to Turbo: $20,000 for the real estate and $11,000for leasehold improvements.At the commencement date, Turbo concludes that it is not reasonably certain to exercise theoption to extend the lease and, therefore, determines that the lease term is 15 years.The interest rate implicit in the lease is not readily determinable. Turbo’s incrementalborrowing rate is 6.9 per cent per annum, which reflects the rate at which Turbo could borrowan amount similar to the value of the right-of-use asset, in the same currency, for a 15-yearterm, and with similar collateral. Your manager indicated that the leasehold improvement willnot be included in the cost base of the right-of-use asset. Unfortunately, the manager did notsay how this payment should be treated.a. Calculate the initial amount the lease liability will be measured at. (5 marks)b. Calculate the initial amount the right-of-use asset will be measured at. (5 marks)c. Prepare a table which shows the amortization of the lease liability over its life. (5 marks)d. Prepare journal entries for the commencement date and for the next 3 lease payments.You must state any assumptions you make. (10 marks)e. Prepare journal entries for the leasehold incentives. Justify your treatments. (10 marks)f. Your manager thinks there may be an opportunity to engage in earnings managementin relation to the leasehold improvements. Prepare a brief report stating whether ornot there is an opportunity for earnings management and explain clearly how thiswould occur. You will also need to provide arguments to show this would not breachaccounting rules. (15 marks)
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