1. Accounting for lease by lessee.

Dogberry Security Services wins a five year contract in a late x1 to provide routine police services to Messinas municipal government. Rather than buy all the equipment it needs, it decides to lease some of it. Polease, a vehicle dealer, offers to lease to Dogberry an armored van for the transport of prisoners. The van has a fair value of 39,925 and is expected to yield economic benefits evenly over its five-year life. Under the terms of the proposed lease, Dogberry will pay Polease 10,000 at the end of each of the five years which indicates an implicit interest rate in the lease of 8%(39,925/10,000 = 3.9925 =PVA (8%, 5 payments)). At the end of the lease term, Dogberry will return the vehicle to Polease. There is no transfer-of-title clause or bargain purchase option in the lease contract. Dogberrys management is concerned about the financial implications of Poleases offer. They ask you to determine the financial statement impact of the lease under two assumptions-that its classified as (i) an operating lease and (ii) a financial lease. Dogberry plans to sign the lease contract on 1/1x2. The company has a 31 December financial year-end. Required (a) What is the effect of the lease on Dogberrys accounts at the start of x2 when the contract is signed if the lease is: (i) an operating lease? (ii) a finance lease? (b) How should Dogberry account for the lease in its x2 and x3 accounts (income statement and end-year balance sheet) if lease is: (i) an operating lease? (ii) A finance lease? (C) Is the lease an operating lease or finance lease under IAS? Give reasons for your answer.

Answer: Check figures (b)(ii) Interest expense, x3 2650

2. Effect of cost flow assumptions on income and tax The Svejk Company is a wholesaler of the bear tankards. The table below shows the companys purchases and sales of its (1 litre) Pilsener Special tankard Purchases 31/12/x5 During x6: February April July August October Total 31/12x6 Sales Balance in inventory 500 at 4/tankard

300 at 5 600 at 7 700 at 5.5 800 at 7.5 500 at 6 1500 1,400 600 at?

Required (a) Calculate the x6 inventory for this product line under FIFO, LIFO and WAC costflow assumptions. Assume the company uses a perpetual system to keep track of inventory quantities and values. Compare the results. Which method yields the highest gross profit and why? (b) Assume all three methods are permitted for tax purposes. Would Svejks income tax liability for x6 be greater or less if it used LIFO rather than FIFO- and by how much? Assume a 40% tax rate. (c) On investigating Svejks accounting systems, you discover that it uses a perpetual inventory system to keep track of inventory quantities but uses a periodic system to establish the costs of tankards sold during the year. (Under the periodic systems, COGS is calculated at year-end: thus purchases made (and other costs incurred) after that last sale dater are included in the COGS calculation.) Recalculate the x6 gross profit for the Pilsener Special product line under FIFO, LIFO and WAC cost-flow assumptions. Compare the resulting gross profit figures with this you calculated in (a) Why does gross profit differ between (a) and (c) under LIFO and WAC? Under what circumstances would you expect a company to choose the system outlines in (C)? Answer: check figures (a) WAC gross profit 3,375 (b) LIFO gross profit 2,350