WORKBOOK DPA40093 FINANCIAL ACCOUNTING 4

DPA40093 FINANCIAL ACCOUNTING 4 NOOR DASREENA SHUKRIA ABDUL SHUKUR WORKBOOK

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Authors NOOR DASREENA SHUKRIA ABDUL SHUKUR POLITEKNIK KUCHING SARAWAK MINISTRY OF HIGHER EDUCATION KM22, JALAN MATANG, 93050 KUCHING, SARAWAK. Phone No. : (082) 845596/7/8 Fax No. : (082) 845023 E-mail : [email protected] Website : http://www.poliku.edu.my/ Copyright © 2023 Politeknik Kuching Sarawak eISBN: 978-967-2953-78-4 All rights reserved. No parts of this publication may be copied, stored in form or by any means, electronic, mechanical, photocopying and recording or otherwise or by any means for reproduced without the prior permission of Politeknik Kuching Sarawak. Published by: Politeknik Kuching Sarawak Ministry Of Higher Education

This workbook, DPA40093 – Financial Accounting 4 is prepared mainly for Diploma Accountancy, Politeknik Kuching Sarawak. The contents are based on existing financial accounting books, the main references stated in the syllabus, MFRSs and my teachings notes. Therefore, any mistakes or errors are unintentional and will be corrected from time to time. I hope that to some extent this workbook will help the teaching and learning process run smoothly and the students are reminded to use this workbook together with the main references stated in the course outline to gain deeper understanding. It is my sincere wish that students especially in Polytechnics and other students in higher institutions may find this book useful and valuable aid to understand this subject. I hope that student and academicians will get benefit from this publication and this book will contribute to the advancement of audit education and learning in Malaysia. Education is the passport to the future, therefore as a student, you need to prepare yourself gradually for the real world. Noor Dasreena Shukria Abdul Shukur, A.M(M) Politeknik Kuching Sarawak 2023

All praise to Allah SWT whose help and guidance has sustains us to bring this book to completion. I sincerely hope that this book will be a valuable aid and reference to all especially students of Commerce Department throughout all polytechnics in Malaysia. I also wish to express our grateful thanks to all parties who involve in the publication process directly or indirectly. There are a lot of moral support and guidance given to me during the publication and also suggestions and encouragements. My heartfelt appreciations to the director of Politeknik Kuching Sarawak; En. Hikmatullah Hajid Ahmad Khan, Head of Commerce Department; Pn Normala Jaya, Programme Coordinator Diploma Accountancy; Pn Khatijah Ibrahim, and to all my colleagues at Commerce Department of Politeknik Kuching Sarawak whose always been helpful and supportive during the publication of this book. Most of all, special thanks to my family’s members especially both my parents, Abdul Shukur Abdullah and Daisy Zakiah Noorazyze Abd Rahim, who never stop giving their supports and encouragement in getting this book published. Without their blessings, this book will never be completed. Finally, I wish to express my deepest gratitude to everybody who’s always helpful. Without cooperation and support from all parties involved, none of this will ever come true. Hopefully this book may become valuable and useful reference to gain more knowledge in this world and hereafter. Noor Dasreena Shukria Abdul Shukur, A.M(M) Politeknik Kuching Sarawak 2023

ABSTRACT WORKBOOK DPA40093 FINANCIAL ACCOUNTING 4 by NOOR DASREENA SHUKRIA ABDUL SHUKUR DPA40093 FINANCIAL ACCOUNTING 4 is a workbook aimed at students and lecturers who are taking and teaching this course respectively. This workbook is written in simple English to enable students to obtain an understanding the accounting standards as stated. Designed in line with the latest syllabus prescribe in Malaysian Polytechnic, its covers five essential topics. All topics discussed within the necessary scope and depth relevant with diploma student level. Each topic consists at least eight (8) questions to enhance the understanding of each student and all the questions will be discussed in the classroom. Topic 1 will cover Lease: MFRS 16 but only from the perspective of Lessee as that is described in the syllabus. Topic 2 present about Accounting Policies, Changes in Accounting Estimates and Errors: MFRS 108. Topic 3 describes the Borrowing Costs: MFRS 123, whereas Topic 4 addresses the Impairment of Assets: MFRS 136. Topic 5 deals with the Comprehensive Financial Statement for Company: MFRS 101. The author aims that this workbook will really helps to smooth the teaching and learning process in the classroom. Keywords: Financial Statements, Leases, Accounting Policies, Accounting Estimates, Correction of Errors, Borrowing Costs, Impairment of Assets.

DPA40093 FINANCIAL ACCOUNTING 4 TOPIC PAGE TOPIC 1 LEASES: MFRS 16 1 TOPIC 2 ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS: MFRS 108 25 TOPIC 3 BORROWING COSTS: MFRS 123 50 TOPIC 4 IMPAIRMENT OF ASSETS: MFRS 136 73 TOPIC 5 COMPREHENSIVE FINANCIAL STATEMENT-COMPANY: MFRS 101 104

DPA40093 FINANCIAL ACCOUNTING 4 1 TOPIC 1 LEASES: MFRS 16

DPA40093 FINANCIAL ACCOUNTING 4 2 INTRODUCTION Every organization needs assets to run business smoothly. Assets owned by organization are mainly classified into two groups, non-current assets (tangible and intangible) and current assets. There are few ways to acquire non-current assets mainly for plant, property and equipment to be used in the business. Normally, all organization prefer to acquire assets either by cash or credit. But if the organization does not have enough cash or having difficulties in getting loan for credit terms, the organization can just rent the assets from another company. For example, an airline company may just rent an airplane from another company instead of purchase it because it is less costly. This activity is called leasing. Leasing assets commonly related to information technology, transportation, construction and agriculture. Why choose to lease an asset: a. Information technology assets become obsolete in short period of time and organization must quickly adapt to the changes. b. Transportation assets such as airplanes requires huge financial commitment, hence by leasing, it can help to reduce the burden. c. Construction company also will use different types of vehicles or equipment for different contract and work ship. d. Agriculture often use different types of assets for the corps such as paddy field will only use upon harvesting the paddy. Therefore, leasing the asset minimizes the possibility that some assets might become idle or obsolete. LEARNING OUTCOMES At the end of this topic, students should be able to: 1.1 Explain the definition of leases 1.2 Provide the records for right of use assets and lease liabilities in the books of the lessee. 1.3 Show the presentation of Leases in the Financial Statements.

DPA40093 FINANCIAL ACCOUNTING 4 3 DEFINITION OF LEASES Accordingly, to Oxford Dictionary of Accounting, lease has been defined as ‘a contract between the owner of a specific asset, the lessor, and another party, the lessee, allowing the latter to hire the asset. Income Tax Leasing Regulation 1986 define leasing as ‘all types of agreement are made in return for the use of assets. Based on MFRS 16, a lease is a contract, or part of a contract, that conveys to the customer (lessee) the right to use an asset (the underlying asset) for a period of time in exchange for consideration. A lease exists when customer controls the use of the identified asset throughout the period of use. This is when the customer has the right to: a. obtain substantially all of the economic benefits from the use of the identified asset throughout the period of use; and b. direct the use of the identified asset throughout that period. Once, the customer gets to control the use of the asset under leasing, the customer will be the lessee, while a lessor is the owner of the asset who gives the right to control the use of the asset in exchange for the payments received. In other word, the lessor retains the right of ownership but the lessee acquires the right to use the asset for a specific period of time in return for payment. MFRS 16 deals with recognition, measurement, presentation and disclosure of leases in the books of the lessor and lessee. IDENTIFYING A LEASE MFRS 16, Leases gives three considerations in identifying whether a lease exists as follows: a. Whether there exits an identified asset with the right to use. An identified asset must exist in a contract, whether explicitly or implicitly specified. Most cases in leases contract, the asset will typically be stated explicitly. An asset can be either explicitly specified in a contract or implicitly specified at the time it is made available for use by the lessee. b. Whether customer has the right to obtain substantially all of the economic benefits from the use of the identified asset throughout the period of use. Customer has the right to obtain substantially all of the economics benefits of an assets either directly, such as by having exclusive use of the asset throughout the period or indirectly, such as by having a right to sublease the asset. c. Whether a customer has the right to direct the use of the identified asset throughout the period of use. If the customer can how and for what purpose the asset is used throughout the period of use, then the right to use will exist.

DPA40093 FINANCIAL ACCOUNTING 4 4 Control is conveyed where the customer (lessee) has both the right to direct the identified asset’s use and to obtain substantially all the economic benefits from that use. Example 1: Mr Lim enters into a 5-year contract with Mr Moon to transport a specified quantity of goods. Mr Moon uses rail cars of a particular specification and has a large pool of similar rail cars that can be used to fulfil the contract requirements. The rail cars and engines are stored at Mr Moon’s premises when they are not being used to transport goods. Costs associated with substituting the rail cars are minimal for Mr Moon. Determine whether the arrangement contains a lease Example 2: Madam Tim enters into a 5 years contract with Mr Messi, a ship owner, for the use of an identified ship. Madam Tim decides whether and what cargo will be transported; when and to which ports the ship will sail throughout the period of use, subject to restrictions specified in the contract. These restrictions prevent Madam Tim from sailing the ship into waters at a high risk of piracy or carrying explosive materials as cargo. Mr Messi operates and maintains the ship and is responsible for safe passage. Determine whether the contract above contain a lease. Tips:

DPA40093 FINANCIAL ACCOUNTING 4 5 ACCOUNT FOR THE RIGHT OF USE ASSETS AND LEASE LIABILITIES IN THE RECORDS OF THE LESSEE. This syllabus will only cover the accounting treatment for lessee. Lessee is the customer; lessee is the party who gets to use the assets. MFRS 16 applied single accounting method. a. Assets and liabilities are recorded for all leases with a term of more than 12 months, unless the underlying asset is of low value in the Statement of Financial Positions and; b. Depreciation of lease assets is shown separately from finance cost (interest) on lease liabilities in the Statement of Profit or Loss and Other Comprehensive Income. At the commencement date, a lessee shall measure the right-of-use asset at cost. The cost includes: a. Amount of initial measurement of lease liability b. Any lease payment made at or before the commencement, less incentives received c. Any initial direct cost d. An estimate of dismantling and restoration costs. Lessee shall measure the lease liability at the present value of the lease payments that are not paid at the date. The lease payments shall be discounted using the interest rate implicit in a lease in the lease, if that rate can be readily determined. If that rate cannot be readily determined, the lessee shall use the lessee’s incremental borrowing rate. The lease payments included in the measurement of the lease liability comprise the following payments for the right to use underlying asset during the lease term are not paid at the commencement date: a. Fixed payments b. Variables lease payments c. Amounts expected to be payable by the lessee under residual value guarantees. d. Exercise price of purchase option if the lessee is reasonably certain to exercise that option. e. Payments of penalties for terminating the lease, if the lease term reflects the lessee exercising an option to terminate the lease. After the commencement date, the subsequent measurements for the right-of-use assets are as follows: a. A lessee shall measure the right-of-use applying cost model at cost a. Less any accumulated depreciation and any impairment losses b. Adjusted for any measurement of the lease liability A lessee should recognise finance cost (interest), unless the costs are included in another asset.

DPA40093 FINANCIAL ACCOUNTING 4 6 THE PRESENTATION OF LEASES IN THE FINANCIAL STATEMENTS Lessee must present the lease in the Statement of Financial Position, Statement of Profit or Loss and Other Comprehensives Income and Statement of Cash Flow. This syllabus will only cover the presentation of leases for lessee on Statement of Financial Position and Statement of Profit or Loss and other Comprehensives Income. In the statement of Financial Positions, lessee may present the right-to-use assets as NonCurrent item separately from other assets. The same approach is applied to lease liability with the presentation or disclosure to be made accordingly to Non-Current and Current components. All the expenses related to the lease will be presented in Statement of Profit or Loss and Other Comprehensive Income such as depreciation expenses and finance costs. PAYMENT OF ANNUAL PAYMENT FOR LEASE There are two types of annual payment in the lease term, either payment in arrears or payment in advance. Payment in arrears refer to the annual lease payment at the end of the year. Example 3: Maxim Bhd enters into of a 5 years lease of plant on 1 January 2019. The annual rentals are RM115,000, with the first instalment paid on 31 December 2019. The present value of minimum lease payments is RM560,000 and the interest rate implicit in a lease is 5% per annum. You are required: a. Explain how the above lease would be accounted for the year ending 31 December 2019. b. Prepare a schedule of lease payment. c. Prepare an extract of the statement of profit or loss and statement of financial position for 2019-2020. Solution:

DPA40093 FINANCIAL ACCOUNTING 4 7 Steps for payment in arrears. Step 1: Calculate the right-to-use asset based on present value of the annual payment. Use present value annuity (PVOA/PVIFA) table. Look at the interest rate implicit in a lease. If not given, use the borrowing interest rate. Right-of-use asset = Present value of the lease liability (if given), or Annual lease payment x PVIFA (n,i) Step 2: Calculate the depreciation the Right of Use Asset (if lease term = useful life, use either one, but if lease term is different from useful life, choice the short period).

DPA40093 FINANCIAL ACCOUNTING 4 8 Step 3: Prepare the schedule of lease payment Schedule of lease payment for payment in arrears (Payment in arrears refer to the annual lease payment at the end of the year) Year end Balance b/f Finance cost Outstanding balance Instalment Balance c/f (A) (B) (C) (D) (E) A= Right-of-use asset B = A x interest rate C = A + B D = annual payment E = C – D Step 4: Prepare the journal entry for year 1 Debit Credit RM RM 1. Record the ROU Asset (Step 1) Right-of-Use Asset Lease Liability 2. Record the depreciation expense (step 2) Depreciation expenses Accumulated depreciation 3. Record the finance costs (step 3) Finance cost (refer to B) Lease liability 4. Record the annual payment Lease liability Bank

DPA40093 FINANCIAL ACCOUNTING 4 9 Prepare the journal entry for year 2 Debit Credit RM RM 1. Record the depreciation expense (step 2) Depreciation expenses Accumulated depreciation 2. Record the finance costs (step 3) Finance cost (refer to B) Lease liability 3. Record the annual payment Lease liability Bank Step 5: Prepare Extract Statement of Profit or Loss and Statement of Financial Position. Syarikat ______________________ Extract Statement of profit or loss and other comprehensive income for the year ended Expenses RM RM Depreciation expenses Finance costs Other expenses paid by lessee Syarikat _________________ Extract Statement of financial position as at NON-CURRENT ASSETS RM RM Right-to-use Asset (-) accumulated depreciation CARRYING AMOUNT NON-CURRENT LIABILITIES Lease liability (based on the balance c/f following year) CURRENT LIABILITIES Lease liability (balance c/f current year – balance c/f following year) or (Total Liabilities – Total Non-Current Liabilities) TOTAL LIABILITIES (BALANCE C/F CURRENT YEAR)

DPA40093 FINANCIAL ACCOUNTING 4 10 Payment in advance refer to the annual lease payment done at the beginning of the year. Example 4: On 1 January 2019 Calic Bhd took out a 5-year finance lease on a new equipment with a fair value of RM362,400. The lease agreement required the annual payments of RM85,000. The first payment was to be made on 1 January 2019. The interest rate implicit in a lease was 9% per year. You are required: a. Explain how the above lease would be accounted for the year ending 31 December 2019 b. Prepare a schedule of lease payment c. Prepare an extract of the statement of profit or loss and statement of financial position for 2019- 2020. Solution: Steps for payment in advance Step 1: Calculate the present value of the unpaid annual payments. And then calculate the right-of-use asset. Use present value annuity table (PVOA/PVIFA). Look at the interest rate implicit in a lease. If not given, use the borrowing interest rate. Lease liability = PV of the unpaid annual payment (n-1) Right-of-use asset = first annual payment + Lease liability

DPA40093 FINANCIAL ACCOUNTING 4 11 Step 2: Calculate the depreciation of the Right of Use Asset (if lease term = useful life, use either one, but if lease term is different from useful life, choice the short period) Step 3: Prepare the schedule of lease payment Schedule of lease payment for payment in advance (Payment in advance refer to the annual lease payment done at the beginning of the year) Year end Balance b/f Instalment Outstanding balance Finance cost Balance c/f (A) (B) (C) (D) (E) A = Right-of-Use Asset B = annual payment C = A – B D = C x interest rate E = C + D

DPA40093 FINANCIAL ACCOUNTING 4 12 Step 4: Prepare the journal entry Debit Credit 1. RM RM 2. Record the ROU Asset (Step 1) Right-of-Use Asset Bank (because payment in advance) Lease Liability (PV of the unpaid lease liability) 2. Record the depreciation expense (step 2) Depreciation expenses Accumulated depreciation 3. Record the finance costs (step 3) Finance cost (refer to B) Lease liability Prepare journal for year 2 Debit Credit RM RM 1. Record the annual payment Lease liability Bank 2. Record the depreciation expense (step 2) Depreciation expenses Accumulated depreciation 3. Record the finance costs (step 3) Finance cost (refer to B) Lease liability

DPA40093 FINANCIAL ACCOUNTING 4 13 Step 5: Prepare Extract Statement of Profit or Loss and Statement of Financial Position. Syarikat ________________ Extract Statement of profit or loss and other comprehensive income for the year ended Expenses RM RM Depreciation expenses Finance costs Other expenses paid by lessee Syarikat Lessee Extract Statement of financial position as at NON-CURRENT ASSETS RM RM Right-to-use Asset (-) accumulated depreciation CARRYING AMOUNT NON-CURRENT LIABILITIES Lease liability (Balance outstanding following year)) or Total Liabilities – Total Current Liabilities) CURRENT LIABILITIES Lease liability (instalment) TOTAL LIABILITIES (BALANCE C/F CURRENT YEAR)

DPA40093 FINANCIAL ACCOUNTING 4 14 SEPARATING LEASE AND NON-LEASE COMPONENTS For a contract that contains a lease component and additional lease and non-lease components, such as the lease of an asset and the provision of a maintenance service, lessees shall allocate the consideration payable on the basis of the relative standalone prices, which shall be estimated if observable prices are not readily available. A lessee may elect, by class of underlying asset, not to separate non-lease components from lease components and instead account for all components as a lease. Any termination option will include in the Right-to-use Assets based on present value for the year. Example 5: Maju Construction Bhd signed an agreement on 1 January 2019 to lease an equipment to Berjaya Bhd. The following information relates to the agreement as follows: a. Berjaya Bhd has a responsibility to pay the installation cost RM1,000. b. Berjaya will also receive RM300 one-off incentives from MBSB. c. The lessee incremental borrowing rate is 14% but the lessor’s implicit rate is 12% and is known by lessee. d. The term of the non-cancellable lease is 6 years with no renewal option. The equipment has an estimated economic life of 8 years. e. The fair value of the equipment on 1 January 2019 is RM380,000. f. Berjaya Bhd has an option to purchase the equipment for RM50,000 upon the termination of the lease. g. Lessee and lessor both use the straight-line depreciation method for all assets and the effective interest rate method to amortize the lease interest. h. The agreement requires equal annual payments of RM81,385 to be paid to lessor at the end of every year starting 31 December 2019. You are required to: i. Calculate the minimum lease payment and the deprecation expenses. ii. Prepare a schedule of lease payment iii. Prepare all related journal entries for the lessee for year 2019 and 2020. iv. Build the extract Financial Statements for 2019 and 2020. Solution:

DPA40093 FINANCIAL ACCOUNTING 4 15 Steps as follows. Step 1: Calculate the present value of the lease liability include with the termination option. Calculate lease liability = PV of lease liability (if given), or annual payment (PVIFA) + termination option (PVIF) Calculate ROU Asset = ROU Assets + Direct Cost - Incentives received Step 2: Depreciate the Right of Use Asset (if there is a termination option, based on the asset useful life).

DPA40093 FINANCIAL ACCOUNTING 4 16 Step 3: Prepare the schedule of lease payment Schedule of lease payment for payment in arrears (Payment in arrears refer to the annual lease payment at the end of the year) Year end Balance b/f Finance cost Outstanding balance Instalment Balance c/f Step 4: Prepare the journal entry for year 1 Debit Credit RM RM 1. Record the ROU Asset (Step 1) Right-of-Use Asset Lease Liability 2. Record the direct costs paid by lessee ROU Asset Bank 3. Record the incentives received Bank ROU-Asset 4. Record the depreciation expense (step 2) Depreciation expenses Accumulated depreciation 5. Record the finance costs (step 3) Finance cost (refer to B) Lease liability 6 Record the annual payment Lease liability Bank

DPA40093 FINANCIAL ACCOUNTING 4 17 Prepare the journal entry for year 2 Debit Credit RM RM 1. Record the depreciation expense (step 2) Depreciation expenses Accumulated depreciation 2. Record the finance costs (step 3) Finance cost (refer to B) Lease liability 3 Record the annual payment Lease liability Bank Step 5: Prepare Extract Statement of Profit or Loss and Statement of Financial Position. Syarikat Lessee Extract Statement of profit or loss and other Comprehensive Income for the year ended Expenses RM RM Depreciation expenses Finance costs Other expenses paid by lessee Syarikat Lessee Extract Statement of financial position as at Non-Current Assets RM RM Right-to-use Asset (-) accumulated depreciation CARRYING AMOUNT Non-Current Liabilities Lease liability (based on the balance c/f following year) Current Liabilities Lease liability (balance c/f current year – balance c/f following year) or (Total Liabilities – Total Non-Current Liabilities) TOTAL LIABILITIES (BALANCE C/F CURRENT YEAR)

DPA40093 FINANCIAL ACCOUNTING 4 18

DPA40093 FINANCIAL ACCOUNTING 4 19 CHECK YOUR OUTCOMES QUESTION 1 a. Define the meaning of lease and lessee. b. List down TWO (2) advantages of leases. c. Outline FOUR (4) considerations in identify a contract contains a lease. d. Explain the definition of economic benefits and control from MFRS 16 Leases. e. Zharif want to rent some space in the warehouse for storing his goods. He’d like to enter into a 3-year rental contract. The owner of that warehouse offers 2 options to him: i. He will occupy a certain area of XY cubic meters, but the specific place will be determined by the owner of the warehouse, based on actual usage of the warehouse and free storage. ii. He will occupy the unit n. 13 of XY cubic meters in the sector A of that warehouse. This place is assigned to him and no one can change it during the duration of the contract. Which option contains lease agreement? Explain your answers. QUESTION 2 a. InTech Business Solutions (“InTech”) enters into a contract with Expert Communications (“Expert”) for the use of an identified server for three years. Expert delivers and installs the server at InTech’s office based on InTech’s instructions, and provides repair and maintenance services for the server, as needed, throughout the contract. Expert can substitute the server only in the case of a malfunction. InTech makes decisions with respect to the data to store on the server and which area of its operations the server will support. InTech has the ability to change how and for what purpose the server is used throughout the contract. Is this containing lease agreement? Explain your answers.

DPA40093 FINANCIAL ACCOUNTING 4 20 b. Assume InTech and Expert entered into a contract for network services. Per the contract, Expert will supply a specified quality of network services for a two-years period. To meet the quality level specified, Expert installs and configures the servers at InTech’s office space. That is, Expert determines the speed and quality of the local area network using the servers. Expert has the ability to continuously update or reconfigure the servers when needed to ensure that the quality of network services is met. InTech does not operate the servers or make any significant decisions about their use. Is this containing lease agreement? Explain your answers. QUESTION 3 The following lease arrangements are to be executed between Red Sand Bhd and Blue Sea Bhd on 1 January 2021: Red Sand is to lease the drilling machine belonging to Blue Sea Bhd. The lease term is for 4 years and cannot be cancelled. Red Sand Bhd is to make annual payments of RM22,000 at the end of every year beginning 31 December 2021. At the end of the lease, the drilling machine is required to be returned to Blue Sea Bhd. The drilling machine has a fair value of RM100,000 and an estimated economic life of 6 years. The interest rate implicit in a lease is 7% You are required to: a. Prepare a schedule of lease payment b. Prepare the accounting treatment upon the initial recognition of the lease and the subsequently recognize the lease for 2021. c. Build the extract Financial Statements for 2021 and 2022.

DPA40093 FINANCIAL ACCOUNTING 4 21 QUESTION 4 Green Land Bhd leases a piece of office furniture from Black Pebbles Bhd on 1 January 2021. The lease agreement are as follows: The lease term is for 4 years and cannot be cancelled. Green Land Bhd is to make annual payments of RM3,000, beginning 1 January 2021. At the end of the lease, the office furniture is required to be returned to Black Pebbles Bhd. The office furniture has a fair value of RM10,000 and an estimated economic life of 6 years. The interest rate implicit in a lease of the leases is 8%. You are required to: a. Prepare a schedule of lease payment b. Prepare the accounting treatment upon the initial recognition of the lease and the subsequently recognize the lease for 2021. c. Build the extract Financial Statements for 2021 and 2022. QUESTION 5 On 1 January 2020, Amni Bhd entered into a lease agreement to lease a specified machine from Mesra Bhd. The terms of the agreement included: i. Non-cancellable lease term for five years, with no option to buy the machine at the end of the lease term. The initial cost is RM4,000. ii. Lease rental of RM37,000 per year to be paid beginning of the year, commence on 1 January 2020. iii. The lease rental was calculated and the mutually agreed upon based on 10% rate of return to Mesra Bhd. The machine is expected to have an estimated useful life of five years using straight line method. The fair value of the machine at the commencement date is RM155,000. You are required to: a. Calculate the minimum lease payment and the deprecation expenses. b. Prepare a schedule of lease payment c. Prepare all related journal entries for the lessee for year 2020 and 2021. d. Build the extract Financial Statements for 2020 and 2021.

DPA40093 FINANCIAL ACCOUNTING 4 22 QUESTION 6 On 1 January 2020, Jemah Bhd entered into a lease agreement to lease a specified machine from Nice Bhd. The terms of the agreement included: i. Non-cancellable lease term for five years, with no option to buy the machine at the end of the lease term. The incentives received is RM4,000 ii. Lease rental of RM38,000 per year to be paid at the end of the year, commence on 31 December 2020. iii. The lease rental was calculated and the mutually agreed upon based on 8% rate of return to Nice Bhd. The machine is expected to have an estimated useful life of five years using straight line method. The fair value of the machine at the commencement date is RM155,000. You are required to: a. Calculate the minimum lease payment and the deprecation expenses. b. Prepare a schedule of lease payment c. Prepare all related journal entries for the lessee for year 2020 and 2021. d. Build the extract Financial Statements for 2020 and 2021. QUESTION 7 Kandos Bhd leased an identified IT equipment from ITC Solution Bhd under a 4-year, noncancellable contract starting 1 July 2019. Term of the lease requires payments of RM85,000 each year starting from 30 June 2020. The estimated useful life of the leased asset is 5 years with the residual value of RM30,000. Both companies use straight line method for all equipment. The residual value of the IT equipment at the end of the lease term was RM50,000 and ITC Solution Bhd guarantees that 75% of the residual value can be realised by Kandos Bhd at the end of lease term. The market value of the leased asset at the inception date was RM330,500. Interest rate implicit in a lease is 9% You are required to: a. Show all the necessary calculation on lease liability and depreciation expenses. b. Prepare a schedule of lease payment for the first 3 years c. Prepare the related journal entries for first 2 years. d. Prepare the extract Financial Statements for the first 2 years.

DPA40093 FINANCIAL ACCOUNTING 4 23 QUESTION 8 Willy Bhd signs an agreement on 1 October 2019 to lease an electronic equipment from Gary Bhd. The lease disallow cancellation and is 5-year term with no renewal option. The title of the equipment will be passed to Willy Bhd at the end of the lease period. The agreement requires Willy to make an annual rental payment of RM20,000 beginning 30 September 2020. There is an initial cost of RM2,500 that has to be borne by Willy Bhd. Interest rate of the lease is 10% per annum. The equipment has an estimated economic life of 5 years. The fair value of the equipment on 1 October 2019 is RM90,000. Willy Bhd uses straight line method to depreciate its assets. Based on this situation, you are required to: a. Calculate the present value of minimum lease payments that needs to be paid by Willy Bhd. b. Construct a schedule of lease payment for the first 2 years. c. Prepare the journal entries for Willy Bhd to record the leasing activities for first and second year of the lease. d. Construct the extract Financial Statements for the first 2 years. QUESTION 9 Doofy Berhad is a leasing company that enters into a 5-year lease (that does not allow cancellation) for a specified equipment to Kausar Bhd on 1 January 2019. The equipment has an estimated useful of 6 years and a fair value of RM1,800,000 at the commencement date of the lease. In addition, the leased equipment is of a specialized nature such as Kausar Bhd can use the equipment without major modifications. The lease term contains the followings: i. Rental payments of RM200,000 payable at the beginning of each 6-month period, throughout the lease term. ii. It is expected that Doofy Bhd will realize RM100,000 from selling the asset at the expiration of the agreement but is not guaranteed by Kausar Bhd. iii. The incremental borrowing rate is 8%. iv. Kausar Bhd uses straight line method to depreciate its assets. Residual value of the asset is expected to be RM60,000.

DPA40093 FINANCIAL ACCOUNTING 4 24 You are required to: a. Show all the necessary calculation on lease liability and depreciation expenses b. Construct a schedule of lease payment for the first 2 years. c. Prepare the related journal entries for the year 2019 in Kausar Bhd. d. Build the extract Financial Statements for the first 2 years QUESTION 10 Lion Bhd enters into a five-year lease of a building which has a remaining useful life of 30 years on 1 January 2019. Lease payments are RM50,000 per annum, payable at the beginning of each year starting from 1 January 2019. At the commencement date, Lion Bhd paid initial direct costs of RM10,000 and received lease incentives of RM5,000. There is no transfer of the asset at the end of the lease and no purchase option. The interest rate implicit in a lease is not determinable but the lessee’s incremental borrowing rate is 5%. You are required to: a. Show all the necessary calculation on lease liability and depreciation expenses b. Construct a schedule of lease payment for the first 2 years. c. Prepare the related journal entries for the year 2019 and 2020 in Lion Bhd. d. Build the extract Financial Statements for the first 2 years

DPA40093 FINANCIAL ACCOUNTING 4 25 TOPIC 2 ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS: MFRS 108

DPA40093 FINANCIAL ACCOUNTING 4 26 INTRODUCTION The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions. Financial statements should be understandable, relevant, reliable and comparable. In order for the financial statements to be comparable, the accounting policies selected should be applied consistently. There are many different bases, methods, rules or practices in accounting for items of the elements of financial statements. For example, there are few methods in valuing inventories and depreciation methods for plant, property and equipment. DEFINITION OF ACCOUNTING POLICIES Accordingly, to Oxford Accounting Dictionary, accounting policies is defined as the specific accounting bases adopted and consistently followed by an organization in the preparation of its financial statements. These bases will have been determined by the organization to be the most appropriate for presenting fairly its financial results and operations. Accounting policies are rules and guidelines that are selected by a company for use in preparing and presenting its financial statements. LEARNING OUTCOMES At the end of this topic, students should be able to: 2.1 Provide the explanation on Accounting Policies 2.2 Provide the explanation on Changes in Accounting Estimates and Error 2.3 Provide the explanation on the relevant accounting treatments 2.4 Summarize the presentation and disclosure required in the Extract of Financial Statements.

DPA40093 FINANCIAL ACCOUNTING 4 27 In Malaysia, companies are required to disclose their accounting policies in their annual accounts. Based on MFRS 108, accounting policies are the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements. MFRS 108 shall be applied in selecting and applying: a. changes in accounting policies, b. changes in accounting estimates and c. corrections of prior period errors. SELECTION OF ACCOUNTING POLICIES MASB have issued numerous accounting standards to cover a large number of elements of financial statements, such as MRFS 102: Inventories, MFRS 116: Plant, property and Equipment, MRFS 138: Intangible assets and many more. For example, when an entity acquired a property for operations under leasing agreement, then the entity has to apply the requirements of MFRS 16: Leases but if the entity acquired the property for operations by cash, then the entity has to apply the requirement MFRS 116: Property, Plant and Equipment. Nevertheless, if the entity acquired property that is not used for its operations, then the entity must adopt MFRS 140: Investment Properties. ABSENCE OF SPECIFIC STANDARDS OR INTERPRETATION Although there are numerous reporting standards and interpretation are being issued, there could be situations where there is no specific applicable standard or interpretation. In the absence of a standard or interpretation, management of the entity is to use its judgement in developing and applying an accounting policy that results in information that is: a. Relevant to the economic decision-making needs of users and b. Reliable in that the financial statements; i. Represent faithfully the financial position, financial performance and cash flows of the entity. ii. Reflect the economic substance of transactions, other events and conditions and not merely the legal form iii. Are neutral that is free from bias iv. Are prudent and v. Are complete in all material respect

DPA40093 FINANCIAL ACCOUNTING 4 28 CONSISTENCY OF ACCOUNTING POLICIES In accounting, consistency requires that an entity or company's financial statements follow the same accounting principles, methods, practices and procedures from one accounting period to the next. In other word, consistency states that, once that entity adopt an accounting principle or method, that entity should continue to follow it consistently in future accounting periods. Example, if Syarikat Haze Berhad adopt to depreciate vehicles using straight line method, Syarikat Haze Berhad must use straight line from one accounting period to the next accounting period. This main purpose for consistency is to enable the users of the financial statements to compare the financial statements of an entity over time to identify trends in its financial position, financial performance and cash flows. CHANGES IN ACCOUNTING POLICIES Consistency does allow an entity or a company to make a change to a more preferred accounting method. However, the change and its effects must be clearly disclosed for the benefit of the users of the financial statements. An entity is only allowed to change its accounting policy under one of the following two circumstances: a. Initial application of a standard or interpretation Changes is required by a standard or an interpretation. b. Voluntary change The change results in the financial statements providing reliable and more relevant information about the effects of transactions, other events or conditions ACCOUNTING TREATMENT FOR CHANGES IN ACCOUNTING POLICIES Accounting policies are the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements. An entity shall change an accounting policy only if the changes: a. is required by a MFRS; or b. results in the financial statements providing reliable and more relevant information about the effects of transactions, other events or conditions on the entity’s financial position, financial performance or cash flows. The accounting treatment for change in accounting policy is called as retrospectively. a. Adjustment is done as if the new accounting policy has always been applied before b. Adjustment to the opening balance of retained earnings.

DPA40093 FINANCIAL ACCOUNTING 4 29 RETROSPECTIVE APPLICATION MFRS 108 defines retrospective application as ‘applying a new policy to transactions, other events and condition as if the policy had always been applied’. An entity shall: a. adjust the opening balance of each affected component of equity for the earliest prior period presented and b. the other comparative amounts disclosed for each prior period presented as if the new accounting policy had always been applied. Example for changes in accounting policies such as: a. MFRS123: Expenses vs. Capitalize of borrowing cost b. MFRS102: FIFO vs. Weighted average method c. MFRS 138: Expenses vs. Capitalize R&D costs Example 1: In 2020, Syarikat Maju Bhd change the valuation of inventory from FIFO to Weighted average. The effect of the change is a decreased in the opening inventory 2020 amounting RM14,000. The retained earnings as at 1 January 2020 is RM148,500. Show the relevant journal entry and adjusted Statement of Changes in Equity (Retained earnings) as at 1 January 2020. Solution:

DPA40093 FINANCIAL ACCOUNTING 4 30 Example 2: In 2017, AA Company purchased a hydroelectric generator financed by a long-term loan. A certain interest rate is charged to the loan. In the early years, the company capitalized the interest expenses incurred. However, beginning Jan 2020, management decided to change the policy; from capitalization to expense for proper matching. The interest cost on loan for the purchase of the hydroelectric generator is RM10,000 and has been expensed. Below is the Statement of Retained Earnings for the year ended 31 December 2020: RM Beginning retained earnings 20,000 Profit for the year 112,000 Ending retained earnings 132,000 You are required to prepare the Adjusted Statement of Changes in Equity (Retained earnings) for the year ended 31 December 2020. Solution:

DPA40093 FINANCIAL ACCOUNTING 4 31 SUMMARIZE THE PRESENTATION AND DISCLOSURE REQUIRED IN THE EXTRACT OF FINANCIAL STATEMENTS FOR ACCOUNTING POLICIES A full disclosure of the change and an explanation of its effects on the items of the financial statements must be given in the notes of the account. Financial statements of subsequent periods need not repeat these disclosures. Following are the needs for disclosure: a. the nature of the change b. the reasons why applying the new accounting policy provides reliable and more relevant information. c. For the current period and each prior period presented, the amount of the adjustment d. The amount of the adjustment relating to periods before those presented and e. If retrospective application is impracticable, an explanation and description of how the change in accounting policy was applied. EXPLANATION ON CHANGES IN ACCOUNTING ESTIMATES AND THE ACCOUNTING TREATMENT As a result of the uncertainties inherent in business activities, many items in financial statements cannot be measured with precision but can only be estimated. Estimation involves judgement based on the latest available, reliable information. For example, estimates may be required for: a. Bad debts b. Inventory obsolescence c. The fair value of financial assets or financial liabilities d. The useful lives of depreciable assets e. Warranty obligations. A change in accounting estimate is an adjustment of the carrying amount of an asset or liability, or related expense, resulting from reassessing the expected future benefits and obligations associated with that asset or liability. Changes in accounting estimates are reported prospectively by including it is Statement of Profit or Loss and Other Comprehensive Income as follows: a. The period of the change, if the change effects that period only; or b. The period of the change and future periods, if the change affects both If a change in an accounting estimate gives rise to changes in assets and liabilities, or relates to an item of equity, it is recognized by adjusting the carrying amount of the related asset, liability, or equity item in the period of the change. Companies should not adjust previously reported results for changes in estimates.

DPA40093 FINANCIAL ACCOUNTING 4 32 PROSPECTIVE APPLICATION A prospective application involves applying the changes to the current and future period and adjusting the comparative information from the earliest date practicable. Prospective application requires NO CHANGE in previously reported results. Example 3: Provision for doubtful debts to be increased from 3% to 5% for year 2021. The current value for accounts receivable is RM145,000 and the provision for doubtful debts is RM6,780. Show the relevant journal entry. Solution:

DPA40093 FINANCIAL ACCOUNTING 4 33 Example 4: Group G bought a building on 1 January 2010 for RM300,000 which has useful life of 20 years with no scrap value. After 5 years, the Board of Directors revised the useful life of the asset and agreed to extend the useful life to 30 years and with scrap value of RM2,000. Show the relevant journal entry. Solution: SUMMARIZE THE PRESENTATION AND DISCLOSURE REQUIRED IN THE EXTRACT OF FINANCIAL STATEMENTS FOR ACCOUNTING CHANGES When an entity has a change in accounting estimates, the following disclosures are required: a. the nature and amount of a change in an accounting estimate that has an effect in the current period or is expected to have an effect in future periods or b. If the amount of the effect in future periods is not disclosed because estimating it is impracticable, an entity shall disclose that fact.

DPA40093 FINANCIAL ACCOUNTING 4 34 EXPLANATION ON ERRORS AND THE ACCOUNTING TREATMENT A change in accounting estimates does not relate to prior periods and is not the correction of an error. Errors can arise in respect of the recognition, measurement, presentation or disclosure of elements of financial statements. Types of errors: a. Mathematical of errors (casting error in inventory, incorrect total, balance of the account b. Misclassification of expenses (expenses wrongly debited to asset account, borrowing costs not capitalized) c. Misuse of facts or an oversight (deferred tax expenses) d. Fraud (theft of money or stocks) e. Any changes in accounting policy against GAAP All materials errors must be corrected but financial statements do not comply with MFRS if they contain materials errors or immaterial errors that are made intentionally to achieve a particular presentation of an entity's financial position, financial performance or cash flows. Potential current period errors discovered in that period are corrected before the financial statements are authorized for issue. However, material errors are sometimes not discovered until a subsequent period, and these prior period errors are corrected in the comparative information presented in the financial statements for that subsequent period. This is known as prior period errors. Record correction of errors from prior periods as an adjustment to the beginning balance of retained earnings in the current period. Entity shall correct material errors of prior period errors retrospectively in the first set of financial statements authorized for issue after their discovery of the errors by: a. Restating the comparative amounts for the prior period(s) presented in which the error incurred; or b. If the error occurred before the earlier prior period presented, restating the opening balances of assets, liabilities and equity for the earliest prior period presented.

DPA40093 FINANCIAL ACCOUNTING 4 35 Example 5: In year 2019, EFG Bhd found that the ending inventory as at 30 April 2018 was overstated by RM200,000. Below are the Extract Statement of Changes in Equity (Retained earnings) for the year ended 2019. 2019 (RM) Beginning Retained Earnings (RE) 227,000 Profit for the year 105,000 Ending balance RE 332,000 You are required to prepare the journal entries and adjusted Statement of Changes in Equity (Retained Earnings) Solution:

DPA40093 FINANCIAL ACCOUNTING 4 36 Prospective application will be used for: a. current period error: the entity is to restate the opening balances of assets, liabilities and equity for the earliest period. b. cumulative effect of the errors: the entity shall restate the comparative information to correct the error prospectively from the earliest date. Example 6: The management of Yihoo Bhd has acquired and recorded equipment on 1 January 2020 at the cost of RM120,000. During the acquisition of the equipment, the company have to bear RM4,000 as installation charges. The account assistant directly recorded the installation charges as maintenance expenses. The company policy is to depreciate all its assets at 10% on cost. However before closing the account on 31 December 2020, the accountant discovered this error. Show the relevant journal entries for the correction of error and deprecation expenses for 2020. Solution:

DPA40093 FINANCIAL ACCOUNTING 4 37 SUMMARIZE THE PRESENTATION AND DISCLOSURE REQUIRED IN THE EXTRACT OF FINANCIAL STATEMENTS FOR ERRORS The following disclosures are required: a. the nature of the prior period error; b. for each prior period presented, to the extent practicable, the amount of the correction: i. for each financial statement line item affected; and ii. if FRS 133 applies to the entity, for basic and diluted earnings per share; c. the amount of the correction at the beginning of the earliest prior period presented; and d. if retrospective restatement is impracticable for a particular prior period, the circumstances that led to the existence of that condition and a description of how and from when the error has been corrected. Financial statements of subsequent periods need not repeat these disclosures. COMPREHENSIVE EXAMPLE The extract balance of Megatrone Bhd related to above situation before the year ended as follow: Extract Trial Balance as at 30 June 2020 DEBIT (RM) CREDIT (RM) Retained earnings 230,000 Factory 150,000 Accumulated depreciation for factory 61,600 Account payables 53,500 Utilities expenses 9,800 Accounts receivables 68,000 Provision for doubtful debts 2,040 Opening inventories 34,200 An accountant in Megatrone Bhd has detected few changes made by the management without his consent before the year ended 30 June 2020. Among the changes are the following: 1. Factory which had been purchased on at a cost of RM150,000 (estimated useful life during purchased is 15 years which residual value of RM18,000) has been depreciated using straight line method. Early this year, after 7 years of the useful life, the management decided to withdraw the residual value.

DPA40093 FINANCIAL ACCOUNTING 4 38 2. Payment for utilities expenses for current year amounted to RM4,500 have been wrongly debited as payment to payable accounts. 3. Provision for doubtful debts to be increase from 3% to 5% this year. 4. The management decided to change the valuing inventory from Weighted Average to FIFO beginning of this year. Since change in the valuation is related to accounting policy, therefore, the accountant has to revalue the last year closing inventory and it has been understated by RM5,800. You are required to: a. Figure out the journal entries to record the changes. b. Summarize the following: i. Extract Statement of Profit or Loss and Other Comprehensive Income for the year ended 30 June 2020 ii. Extract Statement of Changes in Equity for Retained Earnings for the year ended 30 June 2020 iii. Extract Statement of Financial Positions as at 30 June 2020 Solution: a. Journal entries

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DPA40093 FINANCIAL ACCOUNTING 4 40 b. Summarize the following: i. Extract Statement of Profit or Loss and Other Comprehensive Income for the year ended 30 June 2020 ii. Extract Statement of Changes in Equity for Retained Earnings for the year ended 30 June 2020

DPA40093 FINANCIAL ACCOUNTING 4 41 iii. Extract Statement of Financial Positions as at 30 June 2020

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DPA40093 FINANCIAL ACCOUNTING 4 43 CHECK YOUR OUTCOMES QUESTION 1 a. Define accounting policies and consistency from MFRS 108 perspective. b. Elaborate the meaning of prior period error and current period error. c. Express the meaning of Retrospective application and Prospective application. d. Provide TWO (2) examples of changes in accounting estimates. e. List any THREE (3) types of errors under MFRS108. QUESTION 2 State whether each situation is a change in policies, changes in accounting estimates, prior period error or current period errors and the application method to be use. a. At the end of 2021 an audit revealed that the corporation’s allowance for doubtful debts accounts was too small and should be increased to 3.3%. b. The company switched from an average-cost to a FIFO inventory valuation method during the current year. c. In computing the depreciation in 2020 for equipment, an error was made which overstated income in that year RM50,000. The error was discovered in 2021. d. In 2021, the company changed its method of depreciating plant assets from the doubledeclining balance method to the straight-line method. e. The entity has not depreciated its hotel building as it maintains it very well. The hotel building was constructed at a cost of RM3,000,000 million in 2019 and its scrap value was estimated at RM20,000. This was discovered by the accountant in year 2021. f. During the current year, Year 2021, it was discovered that one of the senior staffs had sold some of the investments of the company two years ago and banked the proceeds into his own account. g. ABC Berhad acquired a new brand cost RM100,000 on 1 January 2018. The useful life was determined as indefinite. On 1 January 2021, ABC Berhad reviewed the economic life and determined it has remaining of 4 years. h. The current year’s warranty provision is calculated by providing for 1% of the current year sales, rather than 2% based on last year warranty claims amounting to 1% sales.