- 14 Marks
Question
LB Ltd is a construction contract company involved in building commercial properties. Its current policy for determining the percentage of completion of its contracts is based on the proportion of cost incurred to date compared to the total expected cost of the contract.
One of LB Ltd’s contracts has an agreed price of GHS 500 million and estimated total costs of GHS 400 million. The cumulative progress of this contract is:
| Year ended | 30 September 2011 | 30 September 2012 |
|---|---|---|
| Costs incurred | 160 | 290 |
| Work certified and billed | 150 | 320 |
| Billing received | 140 | 300 |
Based on the above, LB Ltd prepared and published its financial statements for the year ended 30 September 2011. Relevant extracts are:
STATEMENT OF PROFIT OR LOSS
| Description | GHSm |
|---|---|
| Revenue | 200 |
| Cost of sales | (160) |
| Profit ((100 x 160/400)) | 40 |
STATEMENT OF FINANCIAL POSITION
| Description | GHSm |
|---|---|
| Current assets: Amounts due from customers | |
| Contract costs to date | 160 |
| Profit recognised | 40 |
| Total assets | 200 |
| Progress billings | (150) |
| Net assets | 50 |
| Contract receivables (150-140) | 10 |
LB Ltd has received some adverse publicity in the financial press for taking its profit too early in the contract process, leading to disappointing profits in the later stages of contracts. Most of LB Ltd’s competitors take profit based on the percentage of completion as determined by the work certified compared to the contract price.
Required:
(i) Assuming LB Ltd changes its method of determining the percentage of completion of contracts to that used by its competitors, and that this would represent a change in an accounting estimate, calculate equivalent extracts of profit or loss and statement of financial position for the year ended 30 September 2012. (7 marks)
(ii) Explain why the above represents a change in accounting estimate rather than a change in accounting policy. (2 marks)
c)
LB Ltd also sells building materials to other contractors from its warehouse and is considering setting up another retail branch in a different part of the country.
The directors have been told that the branch can be run directly through the head office or set up as a separate entity, but are not sure how the accounting will work.
Required:
Explain to the directors how this transaction should be treated in the books of LB Ltd.
(5 marks)
Answer
(i) Based on the value of work certified, the contract is 64% complete ((320 / 500) x 100) at 30 September 2012. Extracts for 2012 are:
LB LTD
STATEMENT OF PROFIT OR LOSS (EXTRACTS) FOR THE YEAR ENDED 30TH SEPTEMBER 2012
| Description | GH¢ million |
|---|---|
| Revenue ((500 x 64%) – 200) | 120 |
| Cost of sales ((400 x 64%) – 160) | (96) |
| Profit ((100 x 64%) – 40) | 24 |
LB LTD
STATEMENT OF FINANCIAL POSITION (EXTRACTS) AS AT 30TH SEPTEMBER 2012
| Description | GH¢ million |
|---|---|
| Current assets | |
| Amounts due from customers | |
| – Contract costs to date | 290 |
| – Profit recognized (100 x 64%) | 64 |
| Total assets | 354 |
| Progress billings | (320) |
| Net assets | 34 |
| Contract receivables (320 – 300) | 20 |
(ii)
Accounting policies are the rules, principles, and practices adopted by an entity in preparing its financial statements. They should be based upon IFRSs or other financial reporting standards.
Accounting estimates are the measurements and valuations arrived at by an entity in applying accounting policies to specific items and transactions.
In the case of LB Ltd, the accounting policy is in accordance with IAS 11 Construction Contracts. Revenue and costs are recognized according to the stage of completion of the contract. LB’s current means of estimating the stage of completion is based on the proportion of cost to date to total cost.
Although the question refers to it as LB’s ‘current policy,’ this is an accounting estimate, because it is LB’s method of applying the accounting policy. A different measurement basis, based on the same accounting policy, is to estimate stage of completion based on the value of work certified. In transferring from one to the other, LB is making a change of accounting estimate.
c)
If a branch is accounted for through the head office, tight control can be maintained. Inventory is normally transferred to the branch at selling price, and the following accounts are maintained in the head office ledger:
- Branch inventory control account – goods transferred recorded at selling price.
- Branch mark-up account.
- Goods sent to branch account – goods transferred recorded at cost price.
The branch inventory account will be debited when goods are sent to the branch and credited when they are sold. At the end of the period, after adjusting for unsold inventory, the mark-up account will show the gross profit of the branch.
Under this system, branch expenses are usually paid centrally from the head office.
A branch which is set up as a separate entity will keep its own full accounting records and pay its own expenses. Initial assets will be transferred to the branch from head office, and transactions between the branch and the head office will go through a branch current account in the head office ledger, representing net investment in the branch, and a head office current account in the branch ledger, representing the capital provided by head office. At the end of the period, these two accounts will be reconciled.
Goods will be transferred to the branch at cost or at a small mark-up, so that the branch can add its own mark-up. At the end of the period, adjustments will have to be made for any goods or cash in transit and for any unrealized profit in inventory, where goods have been transferred to the branch at an amount above cost price.
- Topic: Financial Reporting Standards and Their Applications
- Series: NOV 2015
- Uploader: Dotse