Solution to Assignment 2

Marvel Limited requires a generator for its factory in Karachi. The following information is
relevant for the acquisition.
1. Marvel Limited issued a special Bond (2018) of Rs. 10,000,000 carrying a coupon rate of 12%
per annum on 1st January 2014. The bond will mature after 5 years. The loan will be used to
buy a new generator and to pay the related expenses, with the remaining amount to be
invested in company’s business.
1.1.14 Cash 10,000,000
12% Bond (2018) 10,000,000

2. Marvel Limited placed order to buy a new generator with General Electric (GE) in USA on 1st
July 2014. The generator is estimated to have a useful life of 6 years and NIL residual value.
Marvel had to pay Rs. 6,000,000 (in equivalent US$) in advance to GE with the order.
1.7.14 Generator 6,000,000
Cash 6,000,000

3. On 1st August 2014, the Company paid Rs. 1,500,000. It included adjustable sales tax of Rs.
300,000 and Rs. 1,000,000 spent to build a concrete foundation to house the generator.
Remaining amount related to freight inwards. The foundation has expected life of 20 years.
1.8.14 Generator (freight + foundation) 1,200,000
Sales Tax Receivable 300,000
Cash 1,500,000

4. On 1st November 2014, the local government approached the company and offered to
provide a grant of Rs. 500,000 1,500,000 (corrected) if the company installs a sound-
reducing canopy on the generator and use it throughout the period of use of the generator.
The management decided to treat the grant as deferred grant revenue and amortize it over
the useful life.
5. The directors of the company agreed and ordered a canopy with a useful life of 5 years that
will cost Rs. 1,000,000 and NIL residual value. It was further agreed that in order to receive
the grant, the generator will not be used until the canopy is installed.
6. Installation was complete on 31st December 2014 with further cost of Rs. 50,000 incurred
and paid on labor and miscellaneous expenses related to installation of the generator. The
canopy was also paid for and installed on 31st December 2014.
31.12.14 Generator (Canopy) 1,000,000
Generator (Misc. Exp.) 50,000
Cash 1,050,000

31.12.14 Generator (Capitalization of interest) 420,000

Financial Charges (Interest expense) 780,000
Bond Interest Payable (12%) 1,200,000
Borrowing Cost = (6,000,000 x 12% 6/12) + (1,200,000 x 12% x 5/12) = 420,000
Alternatively, you can also record BC as (10,000,000 x 12% x 6/12= 600,000) because the activities on
generator started on July 1st on a specific loan of 10,000,000
7. The grant of Rs. 1,500,000 was received on 31st December 2014. The company started using
the generator from 1st January 2015.
31.12.14 Cash 1,500,000
Deferred Grant Revenue 1,500,000

The Cost of Generator is: (This is a memorandum account i.e. only used for depreciation
calculation)
Generator:
Paid to GE 6,000,000
Freight 200,000
Misc. Expenses 50,000
Borrowing Cost 420,000 6,670,000 Life = 6 years
Foundation 1,000,000 Life = 20 years
Canopy 1,000,000 Life = 5 years
Cost of Asset 8,670,000

The generator is used from 1st January 2015 therefore both depreciation of asset and
amortization of deferred grant revenue will start in 2015.

Year 2015
31.12.15 Depreciation Expense 1,361,667
Accumulated Depreciation 1,361,667
31.12.15 Financial Charges 1,200,000
Bond Interest Payable (12%) 1,200,000
31.12.15 Deferred Grant Revenue 300,000
Grant Revenue 300,000

8. On 15th December 2016, the company revised the estimate of total useful life of the
generator to be 11 years. As one year has passed, remaining life will be 10 years. The life of
canopy and foundation will remain the same as the earlier estimates.
31.12.16 Depreciation Expense 805,833
Accumulated Depreciation 805,833
31.12.16 Financial Charges 1,200,000
Bond Interest Payable (12%) 1,200,000
31.12.16 Deferred Grant Revenue 300,000
Grant Revenue 300,000
Life of Canopy is 5 years, and there is no change.
Year 2017
31.12.16 Depreciation Expense 805,833
Accumulated Depreciation 805,833
31.12.16 Financial Charges 1,200,000
Bond Interest Payable (12%) 1,200,000
31.12.16 Deferred Grant Revenue 300,000
 Grant Revenue 300,000

9. On 5thJanuary 2018, a small fire broke up. The damage to generator was minimal and
repairs costing Rs. 50,000 were sufficient. The canopy was completely damaged and had to
be replaced by a new canopy costing 1,200,000. The new canopy had a useful life of 6 years.
5.1.18 Repairs 50,000
Accounts Payable / Cash 50,000
5.1.18 Loss on Canopy 400,000
Accumulated Depreciation (canopy) 600,000
Generator (de-recognizing canopy) 1,000,000
5.1.18 Generator (new canopy) 1,200,000
Accounts Payable / Cash 1,200,000

10. To assess the damage a survey was conducted that revealed that market value of a similar
generator is Rs. 4,960,000 with no change in useful life. Canopy and Foundation was found
to have no change in value or life. The generator was revalued on 15th January 2018.
5.1.18 Accumulated Depreciation (generator) 513,333
Surplus on Revaluation 513,333
31.12.18 Depreciation Expense 870,000
Accumulated Depreciation 870,000
31.12.18 Surplus on Revaluation 64,167
Retained Earnings 64,167
31.12.18 Revaluation Reserve 449,166
Surplus on Revaluation 449,166
31.12.18 Finance Charge 1,200,000
Bond Interest Payable 1,200,000

As surplus on revaluation arose in January, and depreciation is to be charged in December,

the part related to amortization of surplus is directly performed from the surplus itself, and
the remaining balance of surplus transferred in the revaluation reserve (part of equity).
31.12.18 Grant Revenue (amortization on 6 years) 100,000
Deferred Grant 100,000
Year 2019
31.12.19 Depreciation Expense 870,000
Accumulated Depreciation 870,000
31.12.19 Revaluation Reserve (last year surplus was transferred) 64,167
Retained Earnings 64,167
31.12.19 Grant Revenue (amortization on 6 years) 100,000
Deferred Grant 100,000

11. On 1st January 2020, the generator was exchanged with a newer model available in the local
market. Marvel Limited had to pay Rs. 2,000,000 and give the old generator in exchange for
the new model. The new model has a list price of Rs. 6,000,000 but usually sells at a
discount of 10%. The new generator has a build-in canopy and old canopy will be scrapped.
12. Cost of dismantling the old generator will be Rs. 200,000. The cost of installing the new
model will be Rs. 250,000. Both costs would be paid by Marvel Limited from own sources.
1.1.20 Accumulated Depreciation 3,463,333
Revaluation Reserve 385,000
New Generator 5,400,000
New Generator (dismantling of old) 200,000
New Generator (installation of new) 250,000
Old Generator 6,670,000
Cash 2,000,000
P&L 1,028,333

If you find any error, let me know so that I can correct it.