Acct 3101 Ruby Tradition Ltd. Auditing

Contents:

1.0 Introduction:        2

2.0 Proposal 1:        2

2.1 Determination of impact of Proposal 1 as perceived by the directors:        2

2.2 Classification of proposed issue of preference share:        3

3.0 Proposal 2:        4

3.1 Determination of impact of proposal 2 perceived by lender bank Ltd.:        4

3.2 Classification of proposed leasing agreement relating to land and building:        4

4.0 Conclusion:        5

5.0 References:        6

5.0 Appendix:        6

5.1 Proposal 1        6

5. 2Proposal 2        7

1.0 Introduction:

Ruby Traditions Ltd had presented two proposals for fund proposed expansion, the first proposal is issue 200,000 preference share into the public. The second proposal is sale and leaseback of land and building. Since two proposal have their individual features, therefore the recorded journal entries for each proposal are also different during the period.

In the following paragraphs, two of the proposals are analysed individually and then conclude with the most suitable proposal to meet the current requisite of the company. In the first proposal analysis, the impacts should be highlighted and the preference share should be classified in accordance with AASB. In the second proposal analysis, relevant journal entries will be recorded in compliance with AASB standard, And detailed explanation on the classification of proposed leasing agreement

2.0 Proposal 1:

2.1 Determination of impact of Proposal 1 as perceived by the directors:

Preference share refers to stock which are paid for ordinary share. One of key benefit of owning preference share is that shareholders receive the dividend prioritize than common shareholders. Moreover, if the company goes bankrupt, the preference shareholders are able to claim greater amount than common shareholders. However, one of major difference between preference share and common share is that preference shares do not obtain any voting rights. Therefore, the director does not need get any opinion from preference shareholders when arrives with policymaking decision. This may result director treating preference shareholder differently to other shareholders, because preference shareholder has less influence on decision making.

In addition, Preference shareholders normally guaranteed to receive a fixed amount of dividend from the company’s earning, which is different to common shareholder who received divided based on the company’s growth and profit during the year.

Issue preference shares to the public will also have considerable impact on director on managing or coordinating the relationship between shareholders. This is because preference shareholders are also considered as the owner of the company. Therefore, when preference shares increasingly issued to the public, the number of owners will also increase accordingly. The increase number of shareholders may result in intensification of conflicts.

2.2 Classification of proposed issue of preference share:

In compliance with the AASB 132, the preference share can be treated as equity. These preference share should be firstly calculated as part of equity component by definition being the residual.

Since it is equity in nature, it allows the company to lower the debt to equity ratio than issue debt. As the preference shares become part of net worth of the company, it also allows Ruby Tradition Ltd to increase its borrowing capacity.

In addition, the preference shares are cumulative preferred shares, which allows undeclared dividend to accumulated until the day they are paid. From then company standpoint, this may signify that company are allowed to defer the dividend paid to preference shareholder to the next account year, if the company is facing financial difficult during the current accounting year, this benefit will help Ruby Tradition Ltd to overcome the pressure from tight cash flow. Moreover, preference share is redeemable share, which means the company has the right to repurchase share at the market price, and then reissue at a lower rate than 6%, as a result decrease the cost of capital.

The preference share which Ruby tradition issues is called convertible preference share, which offers shareholders a more flexible option in between of receiving cash payment of $50 per share or receives a set number of ordinary shares at the end of 10 years.  

Ruby tradition Ltd issue the preference at par value of $50 per share. Once the companies collect cash, asset and equity should be recognised, relevant journal entries should be recorded. (See appendix)

3.0 Proposal 2:

3.1 Determination of impact of proposal 2 perceived by lender bank Ltd.:

In proposal 2, Ruby traditions Ltd had disposed the land and building to Lender Bank Ltd, and also made a leaseback offer to Lender Bank Ltd. This means, the company has transfer risks and ownership of the asset to Lender bank Ltd, and becomes the lessee when leaseback the property. During the period of leaseback, Lender Bank Ltd still retains substantially all the risks and rewards and may provide insurance or maintenance of the building to the company. In the prospective of Lender Bank Ltd, the company has to recognise the land and building as the asset of the company, this also need to indicate on the balance sheet. Moreover, the building which presented in balance sheet has to depreciated according to Lender bank Ltd’ depreciation policy. Most importantly, Lender Bank Ltd should be able to claim greater tax benefit of the leased asset due to the nature of operating lease.

3.2 Classification of proposed leasing agreement relating to land and building:

According AASB 17 the propose leasing agreement should be classified as operating lease:

To recognise as the operating lease, there are number of criteria which need to comply with:

• There is no indication of ownership transferring to Lender Bank Ltd at the end of 10 years lease.
• Lender Bank Ltd does not have any option to repurchase back the land and building after the 10 years lease term – no bargain purchase option
• The present value of the minimum lease payment, did not exceeds 90% of the $4,000,000 value of the building, compute as follow: N=10, PMT=1,300,000, I=8%, RV=1,250,120.

From the Lessee’s standpoint, this type of expense is recognised on a straight line basis over the 10 years leasing period. The lessee should recognise the P&L immediately when the selling price of the building is less or equal to the fair value over the period. [AASB17:Par 61].

The sale-lease back arrangement of Ruby Tradition allows the company to increase the liquidity for the company due to large inflow of cash from disposal of asset, and with relatively smaller amount of outflow for rental payments. By implementing the off balancing method, the company should have a slight increase in debt ratio from rental payment, and an increase in the current asset due to the cash flow from sale.