Reference no: EM132563524

Hire Purchase

Serena is recently appointed as the new accountant of Skyscraper ( SP) Bhd. The company is in the process of purchasing a new machine that cost RM5 million. Mrs Jean, the chief financial officer informed Serena that the company has insufficient cash to finance the purchase and provided her with two options:

Option 1: To finance the purchase of the machine by issuing RM5 million, six-year, zero interest-bearing note to the seller on 1 July 2019. The expected interest rate for the note is 5.5%. The company is expected to pay off the note in five RM1 million instalments, at every financial year end. The company employs effective interest method.

Option 2: To finance the purchase under the hire purchase agreement. The company is expected to pay a deposit of RM500,000. The hire purchase is expected to commence on 1 July 2018 for 5 years. The expected interest rate charge is 5% and the company uses sum-of-the-year digits method to amortise the interest. The company uses gross method to account for the hire purchase.

The partial statement of financial position of Skyscraper Property Bhd as at 31 December 2018 is as follows:

                                RM000

Non-current assets 50,000

Current assets 30,000

                     80,000

Equity 30,000

Non-current liabilities (loans and borrowings) 30,000

Current liabilities (no loan and borrowings included) 20,000

                                                                     80,000

Additional information:

1) The company closes its account at 31 December every year.

2) It is estimated that the useful life of the machine is ten years with no residual value.

3) Both loans are expected to be classified under non-current liabilities.

4) The calculation for present value annuity factor should be rounded to whole number.

CASE INSTRUCTIONS:

(Round all answers to whole number)

Question (i) Identify any problem experienced by Serena?

Question (ii) Compare the two options by preparing the pro forma statement of financial position for the year 2019. Assume all the elements in the pro forma statement of financial position will increase by 10% in 2019.

Question (iii) Justify which options should be undertaken by SP Bhd.