QUESTION 1 (25 Marks: 45 minutes) Hold – on Limited is a breakfast cereal produc

Question

QUESTION 1 (25 Marks: 45 minutes)
Hold – on Limited is a breakfast cereal producer and distributor company that has recently acquired a very reputable and popular brand of cereal. Through the company’s market research, the brand is expected to derive enormous value for the company, especially as the company has now opted to not only sell the brand of cereal locally, but internationally to South Africa, Botswana and Mozambique as well. The company has a sophisticated and functional distribution and logistics network to assist with the distribution of this cereal.
As part of the production of this new brand of breakfast cereal, the company purchased a machine for N$ 1 200 000 cash. The machine was delivered on the same day as the payment was made. It is expected to be used over a five year period to produce the already profitable brand of cereal. At the end of the five years, it is expected that the machine will be scrapped and thus has a zero residual value.
Required:
Discuss with reference to the Conceptual Framework, how the purchase of the machine should be recognized and measured. Your answer should include a discussion as to whether the machine should be recognized as either an asset or an expense. (15 marks)

Explanation / Answer

The purchases made by a business organisation may be divided on the basis of its nature as follows

1) purchase of recurring items

2) purchase of non recurring items

Any amount expended on recurring items are called as expenses and shown in profit and loss account. Because they occur continuously at regular intervals they are called as recurring expenses.

For example:- Rent, power, purchase of raw materials etc.

Any anount received on recurring items are called as incomes and shown in profit and loss account.

For example:- Sale of finished products, interest income etc.

At the same time amount expended on non recurring items are called as Assets. Because the expenditure will not incurr in near by future i.e with in one year.

For example:- Machinery. It will be purchased at one time and for using more than one year. So it is an asset.

In the given question a machine was purchased for using more 5 years, which is an non recurring expenditure and so, it is an asset.

The value at which it was purchased was $1,200,000, should be added with all the incedental expenses incurred to instal the machine upto the machine becomes ready to use. In the givegiven question these incidental expenses were not given.

So, the value of machine = $ 1,200,000 ( should be recognised as an asset )

Next, the valueof machine, net off scrap value shall ne divided by the number if useful life of asset i.e Depreciation. It is the assets nature to demolish as the time passes. In other words it is called as wear and tear of an fixed asset like machinery. It will be calculated for every year, over the life period of the asset. As, this depreciation is an non cash expenditure and recurs every year at regural intervals, this depreciation shall be shown as recurring expenditure under profit and loss account.

In the given question the amount of depreciation to be shown under profit and loss account:-

Depreciation =

(value of asset - scrap value)÷ no. of years usefull life of asset

= (1,200,000 - 0) ÷ 5 years = 240,000 per year, this is the value of depreciation

So, as a conclussion for the given question " whether the machine should be recognised as asset or expense "

the machine should be recognised as asset at the value of purchases and depreciation shall be charged to profit and loss account as recurring expenditure.

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