QUESTION 4 a A noncurrent asset which has never been revalue

QUESTION 4 a) A non-current asset (which has never been revalued) has a carrying amount of a straight-line basis, with a remaining £100,000. The asset is being depreciated on useful life of three years and a residual value of £10,000. The asset is expected to three years and then to be sold for £10,000. Disposal costs are expected to be negligible. At present, the asset could be sold for £50,000. Disposal costs would be £2,000. generate net cash inflows of £20,000 per year for the next Required: Assuming a discount rate of 10% and that all cash flows occur at the end of the year concerned, determine the asset\'s value in use. (i) (i) Perform an impairment test for the above non-current asset explaining the appropriate procedure, calculate any impairment loss arising and explain how this should be accounted for (double entry). (iüi) Calculate the amount of depreciation that should be charged in relation to the asset for each of the next three years, assuming that the straight-ine method will continue to be used and the residual value remains unchanged. 12 marks Explain what treasury shares are, what the benefits of holding them are, and what the accounting treatment is for the purchase and resale of treasury shares according to the cost method. b) 8 marks Total 20 marks

Solution

a) (i) Value in use is calculated as sum of disounted expected cash flows to be generated from the asset during the period of its use. Given 20,000 for eery year as cash flows to be discounted at 10% present value factor. The calculation is as follows:

Discount Factor = 1/1.1, 1/(1.1)^2, 1/(1.1)^3

(ii) An asset is said to be impaired when its carrying amount exceeds its recoverable amount. Recoverable amount is calculated as higher of the following:

a) Fair value less costs and b) Value in Use

So value in use is already calculated above as 58,819.70. Now Fair value less costs to sell is computed as following:

= 50,000-2,000

= 48,000.

Here Fair value is considered as the market value given in the question as 50,000.

So now the receoverable amount is higher of fair value less costs to sell and value in use. So receoverable amount will 58,819.70.( 58,819.70> 48,000).

Since carrying amount of the asset 1,00,000 exceeded recoverable amount of 58,819.70, impairment exists. Impaiment loss is calculated by deducting recoverable amount from its carrying amount i.e

The entry for impairment loss will be:

Impairment loss A/c(P&L Expense).....Dr 41,180.30

To Asset/Accumulated Impairment losses ( SFP) 41,180.30

(iii)

b). Treasury Shares are the shares that are bought back by the company, reducing the number of shares outstanding on the open market. It is nothing but buyback or repurchase of own shares by the company.

Advantages of holding treasury shares:

1. Due to buback, it wont result in increase in value of the company but will result in change in number of outstanding shares. This will increases the value of the shares.

2. It will increases the investors confidence that the company is having excess cash. A company having excess cash will definitely running well financially. This will motivates the investors to buy these shares.

3. Holding treasury shares will benefits the company by providing an incentive to the employees in the name of ESOP (Employee stock option schems).

4. Holding treasury shares will helps in gaining control in form of voting power or to change in % of ownership by reissuing at any time.

Accounting treatment under cost method:

Under cost method, purchase of treasury shares will be recorded at actual cost of purchase not at par value by debiting treasury stock account. Later at the time of sale , treasury stock will be credited for cost at which they are purchased.

For example, shares having par value of $ 10 each, the company purchased back 100 shares at $ 15 each. the compamny later resold 100 shares at $ 20 each.

Accounting entries will be as follows:

If the amount received is lesser than cost of treasury stock, then that difference will be debited as discount on capital account.

Computaion of Value in Use
Year	Cash Flows	PV Factor@ 10%	Discounted Cash Flows
1	20,000.00	0.99	19,801.98
2	20,000.00	0.98	19,605.92
3	20,000.00	0.97	19,411.80
	60,000.00		58,819.70