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					  UNIVERSITY OF KWAZULU-NATAL

     SCHOOL OF ACCOUNTING


FINAL EXAMINATIONS : OCTOBER 2008


     ADVANCED ACCOUNTING



     PRACTICE PAPER 1 - 2008

      SUGGESTED SOLUTIONS
QUESTION 1: SUGGEST SOLUTION


(a)     Memorandum dealings with intangibles

To:     Audit Committee Members
Re:     Intangible Assets
From:   I. N. Season
Date:   15 January 20.5

The main considerations relating to the recognition of intangible assets in the group financial
statements of Winter Ltd have been outlined below for your information.

The internally generated brand name of Summer Ltd is an intangible asset: It is a non-monetary
asset that arises in terms of a legal right and therefore should be recognised in the group financial
statements if the fair value can be reliably measured. In preparing the 20.3 group financial
statements, the fair value could not be reliably measured and therefore the initial accounting was
determined on a provisional basis which implied that the brand name was not recognised and
goodwill increased accordingly. The information was available in 20.4 (within 12 months of the
date of acquisition), and therefore the 20.3 comparative figures should be restated to take into
account the reduction of goodwill relating to the separate recognition of the intangible asset as
well as the amortisation of the intangible asset and the reversal of the amortisation of goodwill for
20.3. The intangible asset should be measured initially as its fair value of R800 000 and should
subsequently be amortised over its useful life of eight years.

The exclusivity contract is also an intangible asset: It arises from a contractual right and should be
recognised initially at fair value. The cost to the group of the exclusivity contract (R200K, i.e. fair
value at date acquired by the group) should be amortised over the useful life of 29 months (1
August 20.3 to 31 December 20.5). An impairment loss should be recognised at 31 December 20.4
in order to ensure that the carrying amount of the intangible asset does not exceed it recoverable
amount of R60 000.

Note: The term recognition implies that discussion relating to disclosure issues would be
inappropriate.

Comment re intangibles for remainder of question

Where the question has asked (directly or indirectly) for the accounting for intangible in the 20.4
financial statements, any amounts relating to 20.3 should be calculated using the valuation that
became available in 20.4. This is appropriate in terms of the requirement that changes be made to
provisional amounts from the acquisition date, and that the comparative figures thus be restated.
The consolidated entries, reconciliation of intangibles etc., have therefore been done in exactly the
same way as if the information had always been available.




                                                  1
QUESTION 1: SUGGEST SOLUTION continued

(b)     Journal Entries

Workings
Analysis of equity – Summer Ltd

                                                              100%              60%              40%
At acquisition:
Share capital                                                  1 000
Share premium                                                  9 000
Revaluation reserve                                          340 000
Revaluation reserve                                          100 000
Deferred tax - Revaluation reserve                          (30 000)
Retained income                                              670 000
Intangible asset – Exclusivity contract                      200 000
Deferred tax – Exclusivity contract                         (60 000)
Intangible asset – Brand                                     800 000
Deferred tax – Brand                                       (240 000)
                                                           1 790 000      1 074 000          716 000
Cost at 1 August 20.3                                                     1 440 000
Goodwill                                                                    366 000

Since acquisition up to b.o.y:
Retained income (830 000 – 670 000)                          160 000            96 000        64 000
Intangible amortisation (wkgs 2)                            (76 150)          (45 690)      (30 460)
Deferred tax on amort. of intangibles (76 150 x 30%)          22 845            13 707         9 138
                                                           1 896 695                         758 678

Current year:
Profits ((970 000 – 830 000) + 100 000 dividend pd)          240 000                           96 000
Intangibles amortisation (wkgs 2)                          (182 759)                        (73 104)
Deferred tax (182 759 x 30%)                                  54 828                           21 931
Impairment – Exclusivity contract (82 758 – 60 000)         (22 758)                          (9 103)
Deferred tax ( 22 758 * 30%)                                   6 827                            2 731
                                                           1 992 833      1 195 700          797 133




Intangibles – Summer
                                          Brand            Exclusivity                   Total
                                                            Contract
Useful life                              96 months           29 months
Cost                                            800 000             200 000                 1 000 000
Amortisation for 20.3                  (5/96)  (41 667)    (5/29)  (34 483)                  (76 150)
                                                758 333             165 517                   923 850
Amortisation for 20.4                (12/96) (100 000)    (12/29) (82 759)                  (182 759)
                                                658 333              82 758                   741 091




                                                  2
QUESTION 1: SUGGEST SOLUTION continued


Journal Entries
Dr. Share capital                                                     1   000
    Share premium                                                     9   000
    Revaluation reserve (340 + 70)                                  410   000
    Retained income                                                 670   000
    Intangible assets (200 000 + 800 000)                         1 000   000
    Goodwill                                                        366   000
    Cr.    Investment                                                           1 440 000
            Deferred tax – Intangibles                                            300 000
            Minority interest – B/S                                               716 000
Acquisition of subsidiary

Dr. Retained income                                                 64 000
     Cr.   Minority interest – B/S                                                64 000
Allocation minority share of post-acquisition retained income

Dr. Retained income                                                 31 983
    Minority interest – B/S                                         21 322
    Deferred tax – B/S                                              22 845
    Cr.   Accumulated amortisation – Intangibles                                  76 150
Post-acquisition adjustment – Intangible amortisation

Dr. Minority interest – I/S                                         38 455
    Cr.    Minority interest – B/S                                                38 455
Minority interest in 20.4 profit (96–73,104+21,931-9,103+2.731)

Dr. Intangible amortisation (wkgs 2)                               182 759
     Cr.   Accumulated amortisation                                              182 759
Current year amortisation intangibles

Dr. Deferred tax – B/S                                              54 828
    Cr.    Deferred tax – I/S                                                     54 828
182 760 x 30% - Deferred tax on current year amortisation

Dr. Intangible impairment                                           22 758
     Cr.   Accumulated impairment                                                 22 758
Impairment of exclusivity contract

Dr. Deferred tax – B/S                                               6 827
    Cr.    Deferred tax – I/S                                                      6 827
22 758 x 30% - Deferred tax on impairment

Dr. Minority interest – B/S                                         40 000
    Dividends received                                              60 000
    Cr.    Dividends declared / Retained income                                  100 000
Elimination of 20.4 inter-company dividend




                                                  3
QUESTION 1: SUGGEST SOLUTION continued

(c)      Reconciliation

                                                                       20.4                 20.3
                                                                       R’000                R’000
Balance at 1 January                                                     1 764                840 (1)
Acquisition subsidiary (118:e(i)) – Summer                                         -        1 000
Acquisition trademark (118:e(i)) – Autumn                                          -          320 (2)
Amortisation recognised                                                    (279) (5)         (188) (3)
Foreign currency translation reserve                                         88 (1)          (208) (1)
Reclassification joint venture to associate                                (312) (6)
Impairment losses – Summer Ltd                                              (23) (7)
                                                                          1 238 (8)         1 764   (4)




(See workings above for calculation of Summer intangibles)

1     Workings – Spring Ltd                                       £’000          Exch         R’000
                                                                                 rate
      1.1.2002         NBV £80K x 8/10                                   64
      2002             Amortisation                                     (8)
      31.12.2002       Balance                                           56            15         840
                       Amortisation                                     (8)            13        (104)
                       FCTR                                                                      (208)
      31.12.20.3       Balance                                           48            11          528
                       Amortisation                                     (8)            12         (96)
                       FCTR                                                                         88
      31.12.20.4       Balance                                          40             13          520

2     R800 000 x 40% = R320 000
3     R800 000 x 40% x 3/12 x 10% (Autumn) + 104 000 (Spring)
      86 150 (Summer) = R188 150
4     R528 000 (Spring) +R923 850 (Summer) + R320 000 –
      R8 000 (Autumn) = R1 763 850
5     96 000 (Spring) + 182 759 (Summer) = R278 759
6     R800 000 x 40% - 8 000 = R312 000
7     R200 000 x 12/29 – R60 000 = R22 758 (R82 758 – R60 000)
8     R520 000 (Spring) + 741 091 – 22 758 (Summer) = R1238 333


(d) Equity accounted earnings – 20.4 Autumn

Increase in retained earnings (2 590 – 2 190)                                                 400   000
Plus: Dividend declared                                                                       250   000
                                                                                              650   000
Plus: Reversal of depreciation after tax (50 000 * 70%)                                        35   000
Plus: Fair value adjustment relating to investment property after tax
       (860 000 – 800 000) x 85%                                                               51 000
Profit of Autumn Ltd adjusted for differences in group policies (IAS 28:26)                   736 000

Group Share of adjusted profit (40%)                                                           294 400
Less: Impairment loss on goodwill                                                             (70 000)
Equity accounted profits                                                                       224 400

                                                 4
QUESTION 1: SUGGEST SOLUTION continued


(d) Equity accounted earnings – 20.4 Autumn (Alternative solution)

Increase in retained earnings (2 590 – 2 190)                                            400   000
Plus: Dividend declared                                                                  250   000
                                                                                         650   000
Plus: Reversal of depreciation after tax (50 000 * 70%)                                   35   000
Plus: Fair value adjustment relating to investment property after tax
       (860 000 – 800 000) x 70%                                                          42 000
Profit of Autumn Ltd adjusted for differences in group policies (IAS 28:26)              727 000

Group Share of adjusted profit (40%)                                                      290 800
Less: Impairment loss on goodwill                                                        (70 000)
Equity accounted profits                                                                  220 800




(e) Extract from group cash flow statement

                                                                              20.4       20.3
Cash flows from operating activities                                           1 258,4      862
Dividends received (wkgs 1)                                                    (686,4)     (589)
Dividends paid (wkgs 2)
Comment
Cash flows include 100% of the parent and subsidiary‟s proportion of
Proportionately consolidated joint venture and none associates

1   Dividends received
    Winter                                                                      1 500      1 200
    Spring (£12 000 x 12; £10 000 x 14)                                           144        140
    Summer                                                                         20         30
    Autumn 20.3: R50 000 x 40%; 20.4: nil                                           -         20
    Less: Inter-company dividends
    Spring (£36 000 x 80% x 12; £30 000 x 80% x 14)                           (345,6)      (336)
    Summer (R100 000 x 60%; R200 000 x 60%)                                      (60)      (120)
    Autumn (-R180 000 x 40%)                                                        -       (72)
                                                                              1 258,4        862
2   Dividends paid
    Winter                                                                        560          500
    Spring (£36 000 x 20% x 12; £30 000 x 20% x 14)                              86,4            9
    Summer (R100 000 x 40%; R200 000 x 40%)                                        40           80
                                                                                686,4          589




                                                 5
QUESTION 2 : SUGGESTED SOLUTION


Requirement 1

Calculation of current tax expense
                                                                                      R‟000
Profit before tax       (w1)                                                          6 229
Add: Depreciation (300 +80 + 190 + 75)                                                  645
Less: Tax allowances
        -       factory building                                                       (225)
        -       old plant (1 900/5)                                                    (380)
        -       new plant (1 800/5)                                                    (360)
Add: Government grant                                                                   500
        Preference dividend                                                             220
Less: Prior year sales overstated                                                      (744)
Taxable income                                                                        5 885

Tax at 30%                                                                            1 765,5


Calculation of deferred tax
                                             Carrying       Tax         Temp              Deferred
                                             Amount         Base        Differences       Tax bal
Balance at 1 January 20.5 (given)                                            2 074        725,9 Cr
Restate due to error                                                          (744)       260,4 Dr
                                                                             1 330         465,5
Balances at 31 December 20.5
Factory buildings                                6 000(a)    3 375(b)       2 625
Administration buildings                         2 800(c)

- up to DHC (1 800 – 50)                         1 750         -            exempt
- above DHC (bal figure)                         1 050         -            1 050

Old plant (1 140 – 190)                           950         -               950
New plant (1 800 – 800 – 75)                      925         -
            (1 800 – 360) tax                               1 440            (515)
Grant receivable                                  300         -               300

Balance at 31 December 20.5                                                 4 410         1 323 Cr
                                                                            ====

[NB – „DHC‟ means depreciated historical cost)
(a)    6 300 – 300 depr            = 6 000
(b)    3 600 – 225 tax allow       = 3 375
(c)    2 800 – 80 depr             = 2 800




                                                   6
QUESTION 2 : SUGGESTED SOLUTION

Calculation of deferred tax expense for 20.5

Deferred tax balance - b.o.y.                                                  465,5 Cr
Deferred tax balance - e.o.y.                                                  1 323,0 Cr
Net movement                                                                   857,5 Cr

Change in rate   - adjust revaluation surplus
                   (i.e. def tax on CA above DHC at b.o.y)
                   (630 + 504) x 5%                                              56,7 Dr
                 - affects correction of error
                    5% x 744                                                    37,2 Cr
                 - affects income statement – temp diffs                        47,0 Dr
Due to revaluation (1 890 + 576) x 30%                                         739,8 Cr
Temp difference (dr I/S) (balancing figure)                                    184,2 Cr


 Deferred tax expense          (I/S)     = 184,2 – 47
                                          = 137,2

Requirement 2

PRECIOUS LIMITED
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED
31 DECEMBER 20.5

                                Share        Share          Revaluation    Retained         Total
                                Capital      Premium        Reserve        Earnings         ____
Balance
1 January 20.5                  6 400        1 200           794,3 (a)     3 100          11 494,3
Correction of error                                                        ( 520,8)(b)      (520,8)
                              _____         _____           _____         _______        ________
Restated balances              6 400        1 200            794,3         2 579,2        10 973,5

Net gains not recognised
in the income statement                                    1 782,90                         1 782,90

- Revaluation surplus                                      1 726,2(c)                       1 726,2
- Transfer from deferred tax (Req 1)                          56,7                             56,7

Share buy-back                   (600)      (1 200)                          (360)        (2 160)
Net profit for the period                                                   3 996,8 (W2)   3 996,8
Ordinary dividends                                                         (2 000)        (2 000)
                              _____          _____         ______          _____         _______
                               5 800             -         2 577,2          4 216        12 593,2

(a)     (690 + 532) x 65%
(b)     (318 + 426) x 70%
(c)     Factory          6 300 – 4 410 = 1 890
        Admin            2 880 – 2 304 = 576
        Revaluation                       2 466
        After deferred tax (70%)        1 726,20




                                                       7
QUESTION 2 : SUGGESTED SOLUTION


Requirement 3

PRECIOUS LIMITED
NOTES TO THE FINANCIAL STATEMENTS

1.     PROPERTY, PLANT AND EQUIPMENT

                                                  Buildings             Plant        Total
       1 January 20.5
       Carrying amount                            6 714       (a)       1 140        7 854

       Valuation/Cost                             7 262       (b)       1 900        9 162
       Accumulated depreciation                    (548)      (c)        (760)      (1 308)

       Revaluation (1 890 + 576)                  2 466                     -         2 466
       Additions                                      -                 1 800         1 800
       Government grant                               -                  (800)         (800)
       Depreciation (300 + 80)                     (380)                 (265)         (645)
                                                  _____                 _____        _____
       31 December 20.5
       Carrying amount                            8 800                 1 875       10 675

       Valuation/cost                             9 180       (d)       2 900       12 080
       Accumulated depreciation                    (380)      (e)      (1 025)      (1 405)


       (a)     4 410 Factory + 2 304 Admin = 6 714
       (b)     (4 140 + 690) + (1 900 + 532) = 7 262
       (c)     (210 x 2) + (64 x 2) = 548
       (d)     (4 410 + 1 890) + (2 304 + 576) = 9 180
       (e)     300 + 80 = 380
       (f)     190 + 75 = 265 (W1)



Requirement 4

Earnings (R‟000)
Net profit for the period (W2)                                                   3 996,8

WANS (thousands)
                                                                    Total        Weighted
1 January 20.5
No. of ordinary shares 6 400/2                                      3 200        3 200
Share buy-back (3 mths)                                              (300)         (75)
                                                                                 3 125

Basic earnings per share                                                         127,9 cents




                                              8
QUESTION 2 : SUGGESTED SOLUTION

WORKINGS
                                                                      R000‟s
1.   Calculation of profit before tax

     Profit (given)                                                   6 850
     Depreciation - factory buildings (6 300/21 yrs)                   (300)
                    - administration buildings (2 880/36 yrs)           (80)
                    - old plant (10% x 1 900)                           (190)
                    - new plant ((1 800 – 800 grant) x 10% x 9/12)      (75)
     Government grant                                                  (500)
     Prior year error (318 + 426)                                       744
     Preference dividends – finance cost (12% x 2 000 x 11/12)         (220)
                                                                      6 229

2.   Net profit for the period

     Profit before tax (wkg 1)                                        6 229
     Taxation - current (Req 1)                                      (1 765,5)
               - deferred (Req 1) (184,2 – 47)                         (137,2)
     STC – on share buy-back                                             (52)
            - on pref div (220 x 12½%)                                   (27,5)
            - on ordinary dividends                                     (250)
                                                                      3 996,8




                                                 9
QUESTION 3 : SUGGESTED SOLUTION

PART A

1.   In terms of the statement on Business Combinations, the excess of the cost of acquisition
     over the acquirer‟s interest in the fair value of identifiable assets, liabilities and contingent
     liabilities is described as goodwill (or “negative” goodwill if the opposite is true).

     Cost of the acquisition:
     o According to IFRS3, the R5,8 million contingent adjustment should be included in the cost
        of acquisition (ie. added to the „up-front‟ payment of R14,2 million) as
           -     adjustment appears to be probable (in terms of the due diligence exercise), and
           -     the amount can be measured reliably (all of the R5,8 million will be payable)
           -     the amounts of R3,0m (payable in a year) and R2,8m (payable after two years)
                 should be measured at their present value

     o       The R10 million of the R14,2 million should reflect the fair value of the 2 million shares
             issued as part purchase consideration

     o       The stipulation that Midland may be required to make subsequent payments should its
             share price fall below the issue price, will not affect the cost of acquisition as:
               -     in terms of IFRS3, such payments do not affect the cost of acquisition; the fair
                     value of the additional payment is offset by an equal reduction in the value
                     attributed to the shares initially issued.

     o       The professional consultants‟ fees of R265 000 are costs that are directly attributable to
             the acquisition of Island and should therefore be added to the cost of acquisition

     o       The share issue costs of R152 000 are an integral part of the equity issue transaction and
             is not included in the cost of the business combination. Such costs reduce the proceeds
             from the equity issue.


     Fair value of identifiable assets and liabilities:

         o    The directors‟ proposed recognition of the long-established and sought-after franchise
              to the „Spiga‟ chain of Italian-food restaurants as an intangible asset at its fair value (if
              appropriately determined) of R 3,0 million is acceptable. IFRS3 accepts that assets and
              liabilities of the acquiree may have existed at date of acquisition but may not have been
              previously recognised by the acquiree. Intangible assets of the acquiree are recognized
              only if it meets the definition of an intangible asset and its fair value can be measured
              reliably.

         o    The creation of a provision for future reorganisation and integration costs is not
              acceptable. These do not give rise to a present obligation arising from a past event
              and result merely from the acquirer‟s intentions and future intentions. This provision
              can only be recognized if Island Ltd had, at the acquisition date, an existing liability for
              restructuring recognized in accordance with IAS 37 (provision and contingencies).
              Island Ltd does not appear to have made such a provision.




                                                     10
QUESTION 3 : SUGGESTED SOLUTION Continued


      o   The fair value of the 15% Debentures of Island should be measured at the present
          values of amounts to be disbursed in meeting the liability using the incremental
          borrowing rate of 10%. The fair value can be arrive at as follows:
          -     interest payments
                -     At 15% over 4 years is R390 000 pa
                -     PV factor of annuity for 4 years at 10% is 3.169
                -     Present value of payments 390 000 x 3.169              R 1 235 900
          -     capital payment in 4 years - 2 600 000 x 0,683                 1 775 800
          -     Fair value of debentures                                       3 011 700

      o   The financial assets of Island comprising marketable securities should be measured at
          its fair value of R2,7 million.

      o   The directors are justified in recognising the deferred tax asset arising from the existing
          assessed loss of Island Ltd at date of acquisition provided that the criteria for the
          recognition thereof (in terms of its recoverability) have been satisfied. The deferred tax
          so arising will affect the amount to be recognised as goodwill on the acquisition of
          Island Limited.

      o   Midland Ltd should recognize a deferred tax asset in respect of its „own‟ assessed loss
          of R1,2 million on 1 July 20.3. It will however, not take it into account in determining
          the goodwill/negative goodwill, i.e. it is not considered in the accounting for the
          business combination). Raising such a deferred tax asset will be accounted for in profit
          or loss.

      o   It must be remembered that the deferred tax effect of restating (or recognising for the
          first time) the identifiable assets and liabilities to fair values must be taken into account
          in determining the goodwill at acquisition. This is because temporary differences
          arising on initial recognition in a transaction which is a business combination is not
          „exempt‟ from deferred tax in terms of IAS 12.


2.   Pro-forma journal entry to effect consolidation at date of acquisition:

           Share capital and reserves                                            7 100 000
           Franchise - Island brand                                              3 000 000
           Financial assets -Marketable securities                                 700 000
           Goodwill (balancing figure)                                         12 004 863
                 Deferred tax [30%(3 000 (brand) + 700 (MS) -
                  411.7 (deb) – 2 000 (loss)]                                     (386 490)
                 Debentures (3011.7-2600)                                         (411 700)
                 Minority shareholders [25%(7 100 + 3 000 + 700 –
                  386.49 – 411.7)]                                              (2 500 453)
                 Investment in Island
                  [(14 200 + 3 000(0,9091) + 2 800(0,8264) + 265)]             (19 506 220)
           To eliminate the fair equity of the subsidiary acquired against the
           investment in subsidiary account at acquisition date.




                                                 11
QUESTION 3 : SUGGESTED SOLUTION Continued


PART B

1.   Adjustment to purchase consideration

     o   Midland would have adjusted the initial purchase consideration by the present value of
         the total „contingency‟ payment of R5,8 million at the date of acquisition as, at that date,
         the adjustment was both probable and capable of being measured reliably.
     o   In terms of IFRS 3 however, such estimates are revised subsequently if the future events
         do not occur, or the estimate needs to be revised.
     o   The cost of the business acquisition is therefore revised downwards by R5 041 220 (the
         PV of R3 million and R2,8 million) during the 20.4 year.
     o   There is therefore a consequential effect on the goodwill recognised at acquisition (there
         will be a decrease in the amount recognised as goodwill).
     o   The group should disclose information regarding this adjustment recognized in the 20.4
         year (so as to enable users to evaluate its financial effect) and to evaluate the change in
         goodwill (in the goodwill reconciliation note).


2.   Subsequent cash payment to seller

     o   The purpose of the subsequent payment of R1,0 million during 20.4 is to compensate the
         seller of the Island shares for a reduction in the value of the purchase consideration, ie.
         in the value of the Midland shares that have been issued in exchange.
     o   In this case, there is no increase in the cost of acquisition.
     o   There is consequently no adjustment to goodwill.
     o   The R2,0 payment represents a reduction in the value attributed to the shares initially
         issued.


PART C

The key issue is when and how to recognise the R1.3 million revenue that will flow from the
franchise agreement between Island Limited and Mr. Pastroni. It is necessary at the outset to
acknowledge that the payment for the total initial franchise fee of R1.3 million paid to Island
Limited is actually for 3 separate service components, i.e.:
-       the grant of the franchise rights;
-       the supply to the franchisee of the „Spiga‟ brand fixtures and equipment and the
        customized computer system; and
-       the provision of initial services (in respect of pre-opening advertising, training of personnel
        and final inspections).

It is therefore apparent that the franchise transaction embodies elements of both the rendering of
services (the grant of the rights and the provision of initial services) and the sale of goods (the
supply to the franchisee of the „Spiga‟ brand fixtures and equipment and the customized computer
system).

IAS 18 requires revenue to be recognised – for the rendering of services - by reference to the
stage of completion of the transaction, which is also referred to as the percentage of completion
method. The revenue from the franchise transaction should therefore be proportionally recognised
on fulfillment of each of the 3 identifiable service components.



                                                  12
QUESTION 3 : SUGGESTED SOLUTION Continued


The payment of R1.3 million for the three services components was received on 30 November 20.4
– the date of the signing of the franchise agreement. This therefore meets the probability criteria
that economic benefits associated with the transaction will flow to Island Limited.

It is submitted that as at 31 December 20.4, the requirements of the first 2 service components
have been fulfilled. No revenue relating to the provision of initial services may be recognised
during the 20.4 year as these services were only substantially completed during January 20.4.

As regards the supply to the franchisee of the „Spiga‟ brand fixtures and equipment and the
customized computer system:
-      delivery was completed and title taken by year-end (risks and rewards had passed and
       there were no indications of continued managerial involvement by Island Limited)
-      revenue and costs (R360 000) were measurable
-      economic benefits received (on 30 November 20.4).
Therefore the fair value of these assets will be recognised as revenue for the 20.4 year.

The problem though, is of allocating the total revenue of R1.3 million to each of the 3 stages
(service components). This may be solved as follows:
-       the revenue on the „Spiga‟ brand fixtures and equipment and the customized computer
        system will be the fair value (say the cost of R360 000 plus normal mark-up) of the assets
        sold;
-       the revenue on the provisions of the initial services will be R120 000 plus a reasonable
        mark-up in terms of Island Limited Ltd‟s pricing strategy/policy;
-       the balance of the R1.3 million total revenue may be allocated to the grant of the franchise
        rights (assume this will amount to Rx).

Regarding the grant of the franchise rights
-      revenue earned – rights effective 30 November 204
-      revenue measurable as discussed above
-      direct costs not applicable – sale of a franchise right
-      economic benefits received.

An amount of R90 000 (75 000 – 60 000) x 6) of the initial franchise fee allocated to the grant of
the franchise rights (i.e. Rx) should be deferred and amortised to income over the term of the
franchise agreement. This is because the fixed continuing fees of R60 000 per annum will not be
adequate to cover the costs and a reasonable profit on future continuing services.

Therefore the revenue attributable to the grant of the franchise rights will be Rx less R90 000,
which will be recognised during the 20.4 year.

As stated earlier, no revenue relating to the initial services (which was substantially completed only
in January 20.5) will be recognised during the 20.4 year.

Further, no amount of revenue from the fixed annual continuing fees will accrue during the 20.4
year as Mr Pastoni opened for business on 25 January 20.5, the date from which this revenue in
substance accrues. The 5% turnover-based continuing fee revenue will accrue to Island Limited
from the 20.5 year when the franchisee commenced business.




                                                  13