Reference no: EM13490570

Gateway Ltd ('Gateway') is a South African company listed on the Johannesburg Securities Exchange. The company develops, manufactures and markets a range of navigation, communication and information devices and applications, which are enabled by means of global positioning system (GPS) technology.

The company's mission is 'innovation and versatility through adversity' and it has continued to generate healthy margins despite the recent financial crisis and the impact it has had on the discretionary spending of its customer base.

The company operates in two markets:

• Fitness products:

• The main products include touch-screen outdoor handsets with integrated digital cameras, wireless workout courses and fitness watches designed for casual runners to elite tri-athletes; and

Marine products:

High-definition radar and transceiver systems for boats of all sizes.

The fitness products are mainly sold through a network of independent dealers and distributors in three geographical areas, namely South Africa, the Middle East and North America, and account for approximately 50% of Gateway's revenue. The marine products are sold primarily to government agencies in Africa and the Middle East and account for 40% of Gateway's revenue (the remaining 10% consists of interest and dividend income).

Each geographical area reports to the relevant managing directors of the fitness and marine markets on that market's products. The two managing directors report financial and operating information of each market separately to Gateway's chief executive officer, who has been identified as the chief operating decision maker for the purpose of evaluating the performance and allocation of resources to the fitness and marine markets. There are no inter-market transfers or sales.

The board of directors of Gateway decided not to present segmental information in accordance with International Financial Reporting Standard (IFRS) 8, Operating Segments, in the company's annual financial statements for the financial year ended 31 December 2010. The reason for the directors' decision was that they are of the opinion that the company has only one segment, namely 'the development, manufacture and marketing of a range of navigation, communication and information devices and applications'. Therefore, as this aggregated information is already presented in the annual financial statements, no additional segmental information needs to be provided.
You are completing your training contract as a trainee accountant with Gateway. You are assisting Gateway's chief financial officer, a qualified CA(SA), with the finalisation of the annual financial statements of Gateway for the year ended 31 December 2010.
The annual financial statements are to be presented to Gateway's Audit Committee on Monday, 28 March 2011.
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Additional information

1 Gateway has a functional currency of rand (R).
2 Investments
2.1 Bear Ltd debentures
• Gateway acquired 2 000 Bear Ltd ('Bear') 10% debentures of R1 000 each on 1 January 2009 at a price of R968,98 each. The debentures are redeemable at par on 31 December 2012. Even though Gateway has the intention of holding these instruments until their maturity (or conversion) date, it has elected to classify the investments as available-for-sale in accordance with International Accounting Standard (IAS) 39, Financial Instruments: Recognition and Measurement.
The following applies to the debentures:
Date
Fair value of each debenture
Market-related
interest rate
(the effective
interest rate)
R
%
1 January 2009
968,98
11,0
31 December 2009
464,58
13,0
31 December 2010
991,38
10,5
• Bear defaulted on the coupon payment due on 31 December 2009 because of liquidity problems which arose during December 2009 and which became public knowledge only with the default of the company's coupon payment.
• As these liquidity problems are likely to continue into the foreseeable future, Gateway considered the debentures to be impaired. On 5 January 2010 (prior to authorising Gateway's 2009 annual financial statements), Gateway and Bear agreed to restructure the remaining cash flows. Consequently the annual coupon receipt was reduced to R50 per debenture (amounting to a total reduced coupon receipt of R100 000) at 31 December 2010 and the capital amount due on 31 December 2012 was reduced to R500 per debenture (amounting to a total reduced capital outstanding of R1 million).
• On 31 December 2010 Bear paid the reduced coupon of R50 per debenture owing on that date. On the same date the company announced that it had resolved its liquidity problems thanks to a recapitalisation by its parent company during 2010. It would accordingly resume payment of the original coupon of R100 per debenture (R200 000 in total) on 31 December 2011 and committed itself to redeeming the debentures at their original par value of R1 000 per debenture (R2 million in total) on 31 December 2012.
• The value of Gateway's investment in Bear Ltd debentures at 31 December 2010 would have been R1 965 700 if carried at amortised cost and if no impairment loss had been recognised in the past.
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3 Manufacturing equipment
3.1 Decision to construct a new machine (machine Z)
• On 20 December 2009 the directors of Gateway approved a decision to construct a new production machine. The construction of the machine was to be outsourced to Channel Plc ('Channel'), but ownership of the machine would vest in Gateway throughout the construction, assembly and testing period.
• Channel is a company based in the United Kingdom (UK) and therefore has a functional currency of pounds sterling (£). It is a world leader in the construction of specialised equipment of this nature.
• Gateway is able to view the specification of raw materials available from Channel, assemble them and integrate its own components into the design by means of computer-aided design software. This means that the company is able to construct a virtual prototype of its machine. This process design is delivered through a free web service and will inform the ultimate construction of the machine by Channel.
• The directors of Gateway are also aware of environmentally friendly components which are produced by Green Technologies Plc ('Green Tech') and which would be suitable for construction of a new production machine. These components would help to reduce Gateway's carbon footprint over time. Green Tech has a functional currency of £.
3.2 Construction of machine Z by Channel
On 1 January 2010 Gateway entered into the contract with Channel, in terms of which Channel would -
• construct, install and test the machine on Gateway's premises for a fixed price of £3 600 000, to be paid in two instalments:
o An advance payment of £2 500 000 on 1 February 2010; and
o The balance of £1 100 000 on the date that the machine is ready for use;
• commence construction once the environmentally friendly components have been received from Green Tech;
• as part of constructing the machine, be responsible for transporting the environmentally friendly components from their port of departure into South Africa to Gateway's premises; and
• have completed the testing of the machine's readiness for use by 31 October 2010.
The payments to Channel were funded by means of a loan of £3 600 000 negotiated and drawn down fully on 1 February 2010. The loan (together with any interest owing) was repaid in full on 31 December 2010 and bore interest at a market-related rate of 5,8% per annum. Gateway was able to invest surplus funds in a UK bank account for a period of nine months at a rate of 2,5% per annum. Capital and interest on the invested surplus funds is receivable on maturity. If Channel had funded the loan in South Africa, it would have incurred net financing cost (interest cost less interest income on surplus funds) of R2 612 980.
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3.3 Cost schedule of Channel
Channel provided Gateway with the following cost schedule:
Costs
Cost incurred
Profit margin
Total amount
Notes
£
£
£
Raw materials (excluding the components purchased from Green Tech)
2 300 000
200 000
2 500 000
Incurred on 1 February 2010
Transportation costs of components purchased from Green Tech
20 000
20 000
Incurred on 15 February 2010
Labour costs and overheads to construct, assemble and test
machine Z
980 000
100 000
1 080 000
Incurred evenly over the period 15 February 2010 to 31 October 2010
3 300 000
300 000
3 600 000
3.4 Components imported from Green Tech
On 1 January 2010 Gateway placed a non-cancellable order with Green Tech to purchase the environmentally friendly components. The components were shipped and risks and rewards transferred on 1 February 2010 and arrived at Gateway's premises on 15 February 2010. The cost of the components, amounting to £450 000, was paid on 1 February 2010 as per the order agreement.
3.5 Further information related to manufacturing equipment
• Gateway applies the cost model to manufacturing equipment.
• Machine Z is a qualifying asset in terms of IAS 23, Borrowing Costs.
• Machine Z was ready for use on 31 October 2010. At that date the machine was expected to have a useful life of ten years, with a residual value of R8 million.
• Gateway started using machine Z in its production processes on 1 December 2010.
• The company's policy is to include foreign exchange gains or losses only on foreign loans in financing costs.
• The impact of discounting creditors is immaterial.
• The following exchange rates were applicable:
Date
Spot rate 1£ : R
1 January 2010
11,950
1 February 2010
12,280
15 February 2010
12,164
31 October 2010 and 1 November 2010
11,960
31 December 2010
11,000
Average:
• 1 February 2010 to 31 October 2010
• 15 February 2010 to 31 October 2010
• 1 November 2010 to 31 December 2010
12,120
12,062
11,480
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4 Fleet vehicles of Gateway
The financial accountant of Gateway prepared the following depreciation schedule for the fleet vehicles (you may assume that the calculations are correct):
Fleet vehicles
R
Cost
2 500 000
Accumulated depreciation and impairment losses
(450 000)
Carrying amount at beginning of the year
2 050 000
Depreciation: 1 January to 30 June 2010 [(2 500 000 - 250 000)/5 x 6/12]
(225 000)
There is no limitation on the recognition of deferred tax assets, as the company is expected to make sufficient taxable profit into the foreseeable future against which deductible temporary differences can be utilised.
The fleet of vehicles was purchased on 1 January 2009. Depreciation is provided at 20% per annum using the straight-line method. The residual value was originally estimated and continues to be estimated at R250 000. The South African Revenue Service allows a 20% allowance per year, which is not apportioned on a time basis for a portion of the year.
On 1 July 2010 the fleet vehicles were sold and leased back for R2 million (their fair value) in terms of a finance lease agreement. At the end of the 42-month term of the sale and leaseback agreement, ownership will be transferred to Gateway. The original estimated useful life of the asset remained unchanged. Lease instalments amounting to R58 068 are payable monthly in arrears and started on 31 July 2010, at a nominal interest rate of 11,5% per annum.
The only entries that were passed in respect of this transaction were as follows:
Debit
Credit
R
R
Bank
2 000 000
Lease liability
2 000 000
Receipt of cash on sale and leaseback
Lease liability (R58 068 x 6)
348 408
Bank
348 408
Lease instalment paid