PC Week7 Draft - Case project week 7 PDF

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MEMOTo: Tim BrownFrom: Marianna KitsSubject: Financial issuesLease of refrigeratorsIssueJJI Leases heavy-duty refrigerators from Carlin. The issue here how the lease should be classified as operating lease or capital Lease.AnalysisPer IFRS 16 if the lease term is longer than one year and lease is no...

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MEMO To: Tim Brown From: Marianna Kits Subject: Financial issues

Lease of refrigerators Issue JJI Leases heavy-duty refrigerators from Carlin. The issue here how the lease should be classified as operating lease or capital Lease. Analysis Per IFRS 16 if the lease term is longer than one year and lease is not low-value, then the requirement is to recognize this lease as an asset. JJI lease does not qualify as a short-term or low-value lease. The lease Fair value is 132k and the lease term is for six years. JJI should classify the lease as financial lease in the financial statement. Initial Measurement: IFRS 16.23 -28 “At the commencement date, a lessee shall recognise a right-of-use asset and a lease liability. “ The ROU asset is recognized at cost which includes: the initial measurement of the lease liability any lease payments made at or before the commencement date, less any lease incentives received  any initial direct costs incurred by the lessee  an estimate of costs to be incurred by the lessee at the termination of the lease to dismantle and remove the ROU asset or restore it to the condition required under the terms of the lease. The lease liability is initially measured at the present value of all future payments.  

Components for measuring a lease liability: Fixed payments: - Annual lease payments are 22,000 and payable at the beginning of the period Variable payments – 20,000 penalty if the purchase option is not exercised. Bargain purchase option – JJI has the option of purchasing the refrigerators for fair market value. Also, there is an intention from JJI to purchase the refrigerators. Guaranteed residual value – There is none. Termination penalties – There are none. As the rate implicit in the lease is know (10%), that is the rate used for discounting. See Excel file for PV calculation. PV

$105,397.3 1 To record assets

105.397.31-22,000

83,397.31 To record liability

Subsequent measurement of ROU Asset The cost model or the revaluation model could be used based on IFRS 16.30-38 The cost model is more common, and the asset is measured as cost less depreciation and any accumulated impairment losses. Assets depreciate over the lease term if there is no certainty to obtain ownership and the assets must be depreciated over the useful life if there is a BPO. JJI has BPO option and must apply useful life of assets. Depreciation for the year is $11,710.81 Subsequent measurement of Liability JJI also should recognize interest expenses on the lease obligation. The balance of the lease obligation at the end of prior year, less the current year lease payment, multiplied by the interest rate used to capitalize the lease. Recommendation Based on analysis above the lease is classified as financial lease and JJI need to reverse lease payments from income statement and record ROU asset at 105,397.31 and liability at 83,397.31 cost. Also, depreciation and interest should be recognized deriving from the calculation presented in the excel file.

Juice Jets Issue: The Juice Jets that were purchases a few years ago do not cover operating costs. The issue is whether the carrying value of Juice Jets should be written down as a result of the indicators of impairment. IAS 36 should be consulted to analyze whether the assets are impaired. The asset is impaired when an entity is unable to recover the carrying amount of the asset. Under IFRS, test for impairment is required when entity has indicators of impairment and also annually for selected assets. The following process should be executed for Impairment test and write-down: 1. Asset grouping: All 10 Juice Jets is one group that generates independent cash flow. 2. Impairment test requirements: Annual impairment test required for selects assets (goodwill and intangibles) and for all other assets when indication of impairment exists. As of today, we have following indicators: declining performance – ten Juice Jets do not sell enough juice to cover operating costs. Current market value is 250, 000 that is significantly lower than NBV 400,000

3. Recoverable amount The recoverable amount is the higher of: a) Fair value less cost of disposal b) Value in use Fair value less cost of disposal = 250,000 (no disposal cost given) Value in use = PV (10%, $85,000, $90,000)

PV= 378,099.79 Value in use is higher. The recoverable amount is 378,099.79 c) Impairment test and loss Recoverable amount = 378,099.79 Carrying value = 400,000 Recommendation: Based on the analysis above the assets are impaired and need to be written down to 378,099.79. JJI should book Impairment loss and credit the asset account for 21,900.21. The depreciation charge of the asset should be adjusted for the future periods.

Revenue Recognition Issue JJI signed an agreement with The Tasty Spoon, received 250,000 up-front non-refundable fees and recognized those as revenue. The issue is: when 250,000 should be recognized in the financial statement. Also, The Tasty Spoon has option to return juices. The issue is if revenue from the concentrated juice should be recognized on a shipment day or on different time. Analysis As under IFRS 15 (a) the parties to the contract have approved the contract (in writing, orally or in accordance with other customary business practices) and are committed to perform their respective obligations; MET. The Tasty Spoon signed an agreement with JJI which granting exclusive right to the Smooth treats recipes for purposes of providing these drinks in its restaurants. The agreement is for 3 year term with renewal option for 5 years. (b) the entity can identify each party's rights regarding the goods or services to be transferred; MET. JJI provides to Tasty Spoon five recipes and ships JJI concentrated juice. Also, we need to find if these obligations are distinct? IFRS15.36 The goods and services are distinct when the following two criteria met. 1. Good/service is capable of being distinct – customer can benefit from good/service on its own. 2. Separately identifiable from other goods/services in the contract Per contract the Smoothreates recipes can be only used with JJI recipes. The Tasty Spoon can not use other juices with JJI recipes or use JJI juices with their own recipes. The Tasty Spoon can not benefit separately from recipes or juices. These two performance obligations (recipes and concentrated juice) are not distinct. As a result, these performance obligations cannot be separated and they are not distinct. The contract is to be treated as 1 single performance obligation. (c) the entity can identify the payment terms for the goods or services to be transferred;

Tasty Spoon paid non-refundable fee of 250,000. The appendix does not provide information for concentrated juice pricing. We assume the agreement identifies the price for juices and these criteria MET. (d) the contract has commercial substance (ie the risk, timing or amount of the entity's future cash flows is expected to change as a result of the contract); When Juices ship to the Tasty Spoon the risk and reward had not been transferred because the restaurant has the right to return the goods for tree months. This measure will be met after the term of return expires or when JJI will get notification from Tasty Spoon of the juice use. (e) it is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer. In evaluating whether collectability of an amount of consideration is probable, an entity shall consider only the customer's ability and intention to pay that amount of consideration when it is due. The amount of consideration to which the entity will be entitled may be less than the price stated in the contract if the consideration is variable because the entity may offer the customer a price concession (see paragraph 52). MET. The Tasty Spoon already paid 250,000 of non-refundable fee to JJI. Also, according to agreement, payments are to be made on the 10th of each month for the juice from the previous month. Recommendation Non-Refundable Fee As pe IFRS 15.22 non-refundable fee should be recognized as revenue only if “-The entity has no remaining performance obligations and all, or substantially all, of the promised consideration has been received and is non-refundable; or - The contract is terminated, and consideration received is non-refundable. “ Until one of the events above occurs 250,000 must be recognized as a liability. Then, because this fee is related to the transfer goods ( upfront pay for the juice)and is being recognized when the goods are provided in the future, the five-step model should be applied.

Revenue from the juice: No revenue should be recognized on the delivery date, as there’s a right of return and there’s no historical evidence based on which JJI can conclude that It’s highly probable that reversal of revenue will not occur. JJI will have historical data in the future that will allow to estimate the percentage of refunds. At this time JJI maybe able to recognize the revenue when The Tasty Spoon provides the use of juice data if JJI will find that information as accurate and reliable.

Notice of reassessment In situation when the company disagrees with a reassessment the company is entitled to file a notice of objection during 90 day period after the mailing date of the notice of reassessment. The notice of objection should have a reason why the taxpayer disagrees with the

reassessment. Also, JJI will need to present the supporting documents that prove the amount in your objection. The CRA is required to review the assessment and notify the taxpayer in writing about the result. If JJI will not agree with a new result from CRA the company has 90 days from mailing date from CRA replay to may appeal to the Tax Court of Canada...