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a i) ask for the matters to be considered in the audit of adder group
The answer key mentions the following
“Therefore the groups profit is materially overstated and the total Assets and liabilities are materially understated. an adjustment should be recommended to management where by the asset would be reinstated, measured at fair value with a finance lease liability established and the apparent profit moved to the statement of financial position and recognised as deferred income”
Instead of the above paragraph is it correct if we say that the asset should be measured at lower of fair value or present value of minimum lease payments? Why it is stated at fair value rather than compared with the minimum lease payment to find whichever is lower?
Also can we say as a matter to be considered that an effective interest rate has to be calculated to amortize the finance charge over the lease period?
Is it also correct to say that the minimum lease payment for the next year has to be shown as a current liability as a matter to be considered?
Where we have a sale and finance lease back, any profit on the sale should be deferred and spread over the life of the lease (or the estimated remaining useful life of the asset if less)
From the information given in the question we are not able to determine the present value of the minimum lease payments
this is what they have done:
Dr Cash
Cr Assets
Cr Profitsand this is what they should have done
Dr Cash
Cr Finance Lease Obligationso it’s an easy exercise to reverse the first and arrive at the second
“Also can we say as a matter to be considered that an effective interest rate has to be calculated to amortize the finance charge over the lease period?”
We’re told the interest rate (in general terms ) as “paying a rental based on the market rate of interest plus 2%”
We can go no further down that route
i believe the nub of the question is to determine whether your accounting knowledge on sale and lease-back transactions is as good as it was when you sat P2 and then asking you to “explain the audit evidence …”
I think that answers your questions!
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