Answered step-by-stepStanley was recently appointed as the accountant for Hunter Ltd....
Stanley was recently appointed as the accountant for Hunter Ltd. His previous employer, King Ltd, had adopted fair value for the valuation of its properties. He was surprised to learn Hunter Ltd uses the cost model for its properties.
Keen to demonstrate his expertise, Stanley approached the senior management of Hunter Ltd and suggested that they should consider adopting fair value for the valuation of their properties.
Based on his analysis, Stanley presented the following table to senior management to show the effect of adopting the fair value model on the company's financials, effective from 1 July 2023:
Hunter Ltd Summarised Statement of Financial Position As at 1 July 2023 | ||
| Cost Model | Revaluation | |
| $M | $M | |
| Other assets | 100 | 100 |
| Properties (net) | 80 | 120 |
| Total assets | 180 | 220 |
| Liability | 60 | 60 |
| Equity | 120 | 160 |
| Total liabilities and equity | 180 | 220 |
Hunter Ltd uses the straight-line depreciation method for its properties. The remaining useful life of the properties is 20 years on 1 July 2023. The residual value is negligible.
Profit before interest and taxes (EBIT) is expected to be $30 million for the financial year ended 30 June 2024 under the cost model.
Hunter Ltd's senior management are paid a fixed salary plus a bonus payment if return on assets (ROA) exceeds 15%. ROA is calculated as EBIT/total assets at the beginning of the year.
Required
- Calculate the effect of the revaluation of properties on depreciation expense and profit before interest and taxes (EBIT) for the financial year ended 30 June 2024.
2. Explain why senior management of Hunter Ltd might not be in favour of adopting the revaluation model for properties.
Answer & Explanation
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