Back It Up Corporation Case Study

As per the requirement, I have assessed the financial statements of Back It Up corporation. I have identified the following issues:

Issue 1: Accounting for the Lease

Grant has recorded its lease as operating lease. Whereas, in essence, it is apparently a finance lease. IAS !7, Leases says that a lease is a finance lease where,

The lease transfers ownership of the asset to the lessee by the end of the lease term
The lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than fair value at the date the option becomes exercisable that, at the inception of the lease, it is reasonably certain that the option will be exercised
The lease term is for the major part of the economic life of the asset, even if title is not transferred
The inception of the lease, the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset
The lease assets are of a specialised nature such that only the lessee can use them without major modifications being made

Most of above mentioned features are present in this lease. This is because the lease is for 80% life of the asset. The executory costs which are kind of cost of sales are borne by the leasing company. The Present value of minimum rental payments is $68776.4 amounts to at least substantially all of the fair value of the leased asset minus its residual value at the end of the lease. Then, the lease term is also for the major part of the economic life of the asset. Therefore, the financial statements should be revised to adjust the effect of finance lease.

The result of the adjustment would be that the income statement need to be debited with the interest expense of 68776.4*10%= 6877.64 and the remaining amount would be considered as the principle repayment of the finance lease. An asset and corresponding lease liability should also be incorporated in the balance sheet.

Issue 2: Preferred Shares

The preferred shares issues by the company are retractable. According to IAS 32, presentation of the financial instruments, these preferred shares should be treated as liability and not the equity and the relevant dividend payment would be treated as the finance cost instead of dividend payments. A key definition of financial assets according to IAS 32 is, any asset that is:

• Cash
• An equity instrument of another entity
• A contractual right
• To receive cash or another financial asset from another entity; or
• To exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity; or
• A contract that will or may be settled in the entity’s own equity instruments and is:
• A non-derivative for which the entity is or may be obliged to receive a variable number of the entity’s own equity instruments

This would affect both balance sheet and income statement. The company would need to reclassify the retractable shares as liability instead of equity. Then, the dividends paid would be treated as interest cost that would decrease the income by $4000 (2000 x $2). The equity would decrease by $20000 (2000*10) while the liabilities would increase by the same amount.

Issue 3:Loyalty Program

The company is also initiating a loyalty program. The locality programs come under the ambit of IFRIC 13. It says, that when an entity“grants loyalty award credits shall allocate some of the proceeds of the initial sale to the award credits as a liability (its obligation to provide the awards). In effect, the award is accounted for as a separate component of the sale transaction. The amount of proceeds allocated to the award credits is measured by reference to their fair value, that is, the amount for which the award credits could have been sold separately.The entity shall recognize the deferred portion of the proceeds as revenue only when it has fulfilled its obligations. It may fulfil its obligations either by supplying the awards itself or by engaging (and paying) a third party to do so.” (IFRIC 13 — Customer Loyalty Programmes)

The company is going to award a discount of $500. This would be for the sales of $500*100= $50000. The company should defer portion of its revenue for a value that can be assigned to the sales on the basis of the reward points. More information is needed in this regard to calculate the amount of revenue that can be deferred as whole $500,000 cannot be differed.

Issue 4: Post-retirement benefits

Post-retirement benefits should be treated according to IAS 19 Employee benefits. According to this standards, the current service cost should be treated as expense instead of the contributions to the plan. Moreover, the interest cost of the liability would also be treated as expense. The cost would be reduced by the return on the plan assets. The net asset or liability will arise equal to the difference of plan assets or liabilities which would be accounted for in the balance sheet. Actuarial gains and losses would also be accounted for but they are not available for now and considering the fact that the pension plan is setup just two months prior to year-end, they may not be material as well. However, more information is needed in this regard.

Currently the company has accounted for $87000 expense whereas the actual expense is the current service cost which is 95000. Therefore, the income statement would be further credited by 6260 (95000-1740-87000). Whereas, in the balance sheet, there would be a liability shown equal to the difference of plan assets and plan liabilities of 6260 (95000-88740).

Issue 5: Long-term Note Receivable

The company would receive 5 payments of 4000 each for the note receivable and the company has accounted for the note using the face value of the note. This is not the case. The note receivable should be valued by discounting the payments by using the appropriate discount rate. Then the present value of the note receivable should be accounted for in the balance sheet instead of the face value.

Issue 6: Future Tax Liability

The value of the future tax assets is uncertain. It is assumed that there would be a strong growth in profits in the coming years, but what if it did not materialize. The possibility of any future losses and expected applicable tax rate should be evaluated before creating a deferred tax asset. However, the deferred tax asset should be created on the basis of prevailing tax rates at the moment.

Issue 7: Provision of Income Tax

The provision for income tax is made on the basis of tax paid in the current year. However, there could be other differences that can impact the provision of income tax.

I hope this report would help you a lot in answering your questions. Please inform me if I can be of any other help

References

IAS 17 — Leases. (2018). Iasplus.com. Retrieved 24 June 2018, from https://www.iasplus.com/en/standards/ias/ia

IAS 32 — Financial Instruments: Presentation. (2018). Iasplus.com. Retrieved 24 June 2018, from https://www.iasplus.com/en/standards/ia

IFRIC 13 — Customer Loyalty Programmes. (2018). Iasplus.com. Retrieved 25 June 2018, from https://www.iasplus.com/en/standards/ifric

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