• 14 Marks

CR – May 2018 – L3 – SB – Q4b – Presentation of Financial Statements (IAS 1)

Discuss accounting issues and treatments for factoring and sale-leaseback transactions, applying the substance over form principle.

Waasimi entered into the following transactions during the year ended March 31, 2018:

In March 2018, Waasimi factored some of its trade receivables to Asejere, a finance house. Based on selected account balances, Asejere paid Waasimi 80% of its book value. The agreement was that Asejere would administer the collection of the receivables and remit a residual amount to Waasimi depending upon how quickly individual customers paid. Any balance not collected by Asejere after six months will be refunded to Asejere by Waasimi.

On April 1, 2017, Waasimi’s freehold building had a carrying amount of N15 million and an estimated remaining useful life of 20 years. On this date, Waasimi sold the building to Gbajumose for a price of N24 million and entered into an agreement with Gbajumose to lease back the building for an annual rental of N2.6 million for a period of five years.

The auditors of Waasimi have commented that in their opinion the building had a market value of N20 million at the date of its sale and to rent an equivalent building under similar terms to the agreement between Waasimi and Gbajumose would cost N1,600,000 per annum. Assume finance cost of 10% per annum.

Required:

i. Briefly explain the major accounting issues involved in the above transactions using the principles of substance over form. (5 Marks)

ii. State the appropriate accounting treatments of the various elements identified. (6 Marks)

iii. State the classes of charges to be incurred and their appropriate accounting treatments. (3 Marks)

i. Major accounting issues involved in the two transactions using the principles of substance over form:

  • Factoring: This is a common method for entities to release liquidity from their trade receivables. The issue is whether the trade receivables have been sold, or if the income from the finance house for their “sale” should be treated as a short-term loan. The main “substance issue” with this type of transaction is to identify which party bears the risk relating to the asset. If the risk lies with the finance house (Asejere), the trade receivables should be removed from the statement of financial position. In this case, it is clear that Waasimi still bears the risk related to slow and non-payment of trade receivables. The residual payment by Asejere depends on how quickly the receivables are collected; the longer it takes, the less the residual payment. Any balance uncollected by Asejere after six months will be refunded by Waasimi, reflecting the non-payment risk.
  • Sales and Leaseback of Freehold Building: This is a sales and leaseback transaction. The substance was that Waasimi needed a loan; otherwise, an asset cannot be sold and leased back immediately. It implies that the excess purchase consideration of ₦4 million (₦24m – ₦20m) is “in substance” a loan rather than sales proceeds (legal form) that is being repaid through the excess (₦1 million per annum) of the rent payments. The lease should be treated as an “Operating Lease,” so the property should be considered sold and derecognized.

ii. Appropriate accounting treatment

  • Factoring: Cash received from Asejere (80% of the selected receivables) should be treated as a current liability (a short-term loan). The difference between the gross trade receivables and the amount received from Asejere (plus any amount directly from the credit customers) should be recognized in the statement of profit or loss.
  • Sale of Freehold Property: The sale of the property should be recorded at its fair value (₦20 million). The profit on disposal would be ₦5 million (₦20 million – ₦15 million). The excess of ₦4 million (₦24 million – ₦20 million) should be treated as a loan (Non-current liability).

iii. Classes of charges to be incurred

  • Factoring:
    • Administrative expenses in the form of factoring charges for Asejere collecting receivables.
    • Finance cost reflecting the time taken to collect the receivables.
    • Impairment of trade receivables (bad debts).
  • Sale of Freehold Property:
    • The total rental payment of ₦2.6 million should be split into three elements as follows:
      • Property rental cost: ₦1.6 million
      • Finance cost (10% of ₦4 million): ₦0.4 million
      • Capital repayment of the loan: ₦0.6 million
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