QUESTION 1 (60 marks) Hydrocraft Ltd is a manufacturing company in the deep-sea exploration sector and the entity has a 31 December financial year end. The entity is the only entity in the country that specializes in the manufacture of deep-sea vessels (submersibles) for their customers, namely private tourist entities. The deep-sea vessels are manufactured using specialized machines and it usually takes approximately 24 months to manufacture each deep-sea vessel.

Hydrocraft Ltd embarked on the manufacture of a deep-sea vessel for a client who ordered a vessel for their company, which takes tourists to visit the Titanic wreckage at the bottom of the Atlantic Ocean. As soon as the order was received on 1 January
2023, Hydrocraft Ltd started manufacturing the vessel.

In order to manufacture the inventory item (deep-sea vessel), a new specialized machine, Machine C, was required, which Hydrocraft Ltd decided to lease from a third party. Details of the lease agreement are as follows:

• Five annual fixed lease installments are due at the end of December each year.

• The lease installments will increase by 10% each year as per the table below:

Due date Leaseinstallment
31December2023 80000
31December 2024 88000
31December 2025 96800
31December 2026 106480
31December 2027 117128

• The implicit rate applicable to the lease is 7% per annum.

• Machine C has an unguaranteed residual value at the end of the lease term of R15 842. The lessee is not expected to make a payment for this at the end of the lease.

• Machine C had a fair value of R396 000 at the start of the lease term on 1 January 2023.

• The machine was modified by the third party prior to the start of the lease to be specifically suited for the manufacturing of deep-sea vessels created by Hydrocraft Ltd.
• At the end of the lease, ownership of the machine reverts to the lessor however Hydrocraft Ltd has a right to continue with the lease for another three years for R25 000 per annum. The market-related rent for a similar specialized machine would cost approximately R112 000 per annum, at that time.
• The machine has an expected economic and useful life of 5 years.

• The first installment was paid on 31 December 2023 as per the agreement.

• Costs incurred in negotiating and securing the lease agreement amounted to R3 450 which were paid in cash on 1 January 2023 once the lease contract was entered into and finalized.

Hydrocraft Ltd continuously used Machine C throughout the financial year to manufacture the deep-sea vessel and therefore the machine was never left idle.

The accountant of Hydrocraft Ltd accounted for the lease and lease related costs in the current financial year as follows along with an explanation as to how it was calculated:

Date Journal Details Dr Cr   Explanation
    R R  
1    Jan Indirect lease costs 3450   Expensingofthe initial
2023 (P/L)       indirectcostofthe lease.
  Bank (SFP)   3450  
(Accounting for the indirect costs to secure the lease)  
31Dec Lease expense(P/L) 100850   Expense calculated by
2023     straight-lining the total of
Bank (SFP)   80000
      the lease payments and
  Leaseliability (SFP)   20850 the unguaranteed residual

Additional information:

• Hydrocraft Ltd’s policy is to depreciate all machinery using a straight-line basis over its useful life and depreciate their right-of-use assets in accordance with the depreciation requirements of IAS 16, using the cost model.
• SARS grants the same wear and tear allowance for Machine C i.e. 5 years.

• The lease payments are deductible for tax purposes when paid.

• The company tax rate is 27% for all financial years.


1.1 Briefly discuss how you would classify the lease (i.e., operating or finance lease) in the accounting records of the lessor at the start of the lease. As part of your justification (amongst as many other factors as you can mention as per IFRS 16), calculate and comment on the present value of minimum lease payments.
• Structure you answer neatly using relevant headings where possible.

• Use only the information given in the question.

• Round off calculations to the nearest Rand.

(15 marks)

1.2 Briefly discuss whether or not the accountant’s treatment of the lease is correct, in the accounting records of Hydrocraft, in terms of IFRS 16. Also briefly discuss how it should be measured (initially and subsequently) if you do not agree with the accountant’s treatment. No calculations are required as part of your answer.
• Structure your discussion neatly using relevant headings where possible. (15 marks)

1.3 Assume that the lease is a finance lease. Prepare the general journal entries of Hydrocraft Ltd for the year ended 31 December 2023, in accordance with the International Financial Reporting Standards (IFRS), using only the information given in the question. Make reference to your calculations in 1.1.
• Round off answers to the nearest Rand.

• Dates are required.

• Narrations are not required.

• Ignore only VAT.

(20 marks)

1.4 Discuss in terms of IAS23 Borrowing Costs, whether or not the lease finance cost will be able to be capitalised to the cost of the inventory item (deep-sea vessel). Provide reasons to support your answer. No calculations are required. (10 marks)

QUESTION 2 (27 marks) Sofia Limited is a national airlines company that offers long-term employee benefits to their employees. One of the employee benefits available to pilots and air hostesses is the defined benefit pension plan which will allow the eligible employees to receive monthly pension payouts once they are retired until their deaths. The following information relates to the financial year ended 31 December 2023:


Current service costs 5 400 000

Pension benefits paid to former employees (Note 2) 14 000 000

Contributions paid by the employer to the fund (Note 2) 25 300 000

Past service costs curtailment (Note 1) 18 000 000

Net present value (NPV) of the pension obligation on 1 January


Net present value (NPV) of the pension obligation on 31 December
2023 (as per the actuary after taking into account the curtailment in Note 1)

95 500 000

89 200 000

Fair value of the plan assets on 1 January 2023 102 000 000

Fair value of the plan assets on 31 December 2023 107 000 000

Additional information:

Note 1:

The terms of the defined benefit plan were amended and as a result the benefits payable will be reduced by R18 000 000 with effect from 31 December 2023. Employees were contacted with regards to this amendment, and they did not object to the change.

Note 2:

The contributions and benefits were paid on the last day of the financial year i.e. on

31 December 2023.

Note 3:

The market interest rate on high-quality corporate bonds was 12% for the financial year ended 31 December 2023.


Prepare extracts to the Statement of Profit and Loss and Other Comprehensive Income of Sofia Ltd for the year ended 31 December 2023, in accordance with IAS 19, using all the information given in the question.
• Comparative figures are not required.

• Show and reference all your calculations and workings clearly.

• Round all amounts to the nearest Rand.(27 marks)

QUESTION 3 (13 marks) Skyscraper Ltd is an entity in the hospitality industry and runs a hotel franchise called OysterTM. Skyscraper Ltd constructed a new OysterTM hotel during the 2023 financial year on land that the entity already owned. To construct the hotel, Skyscraper Ltd made use of existing finance facilities already obtained by the entity. The construction began on 1 January 2023 and was completed on 30 September 2023.

The construction of the hotel cost R21 600 000 in total and the expenditure was incurred evenly throughout the 9-month period (i.e. the average expenditure over the
9 month period has therefore half the total).

Skyscraper Ltd’s general borrowings consisted of the following as at 1 January 2023:

Type of borrowing Effective interest rate on the


Amount of the borrowing
Loan with Pearl Bank 9% p.a. R10000 000
Debentures 13.5%p.a. R8000 000

There were no additions nor any repayments regarding any of the borrowings during the year.

During February 2023, the construction was halted for the entire month since Skyscraper needed to do some substantial technical and administrative activities regarding the construction before recommencing construction activities on 1 March

You can assume that no borrowing costs were capitalised during the year and therefore there will be no borrowing costs on borrowing costs.

The Financial Manager at Skyscraper Ltd requires your assistance to determine the amount of borrowing costs that can be capitalized to the cost of hotel.


Assist the Financial Manager of Skyscraper Ltd to calculate the amount of net borrowing costs that should be capitalised in terms of IAS 23 to the cost of the hotel.
• Ignore all taxation.

• Round off all amounts/rates to two decimal places, if necessary. (13 marks)

Answers to Above Questions on Financial Reporting

Answer 1: The classification the lease (i.e., operating or finance lease) in the accounting records of the lessor at the start of the lease is performed as follows:


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