4 Prochain, a public limited company, operates in the fashion industry and has a financial

The company sells its products in department stores throughout the world. Prochain insists on creating its own selling

areas within the department stores which are called ‘model areas’. Prochain is allocated space in the department store

where it can display and market its fashion goods. The company feels that this helps to promote its merchandise.

Prochain pays for all the costs of the ‘model areas’ including design, decoration and construction costs. The areas are

used for approximately two years after which the company has to dismantle the ‘model areas’. The costs of

dismantling the ‘model areas’ are normally 20% of the original construction cost and the elements of the area are

worthless when dismantled. The current accounting practice followed by Prochain is to charge the full cost of the

‘model areas’ against profit or loss in the year when the area is dismantled. The accumulated cost of the ‘model areas’

shown in the balance sheet at 31 May 2006 is $20 million. The company has estimated that the average age of the

‘model areas’ is eight months at 31 May 2006. (7 marks)

Prochain acquired 100% of a sports goods and clothing manufacturer, Badex, a private limited company, on 1 June

2005. Prochain intends to develop its own brand of sports clothing which it will sell in the department stores. The

shareholders of Badex valued the company at $125 million based upon profit forecasts which assumed significant

growth in the demand for the ‘Badex’ brand name. Prochain had taken a more conservative view of the value of the

company and estimated the fair value to be in the region of $108 million to $112 million of which

$20 million relates to the brand name ‘Badex’. Prochain is only prepared to pay the full purchase price if profits from

the sale of ‘Badex’ clothing and sports goods reach the forecast levels. The agreed purchase price was $100 million

plus a further payment of $25 million in two years on 31 May 2007. This further payment will comprise a guaranteed

payment of $10 million with no performance conditions and a further payment of $15 million if the actual profits

during this two year period from the sale of Badex clothing and goods exceed the forecast profit. The forecast profit

on Badex goods and clothing over the two year period is $16 million and the actual profits in the year to 31 May

2006 were $4 million. Prochain did not feel at any time since acquisition that the actual profits would meet the

forecast profit levels. (8 marks)

After the acquisition of Badex, Prochain started developing its own sports clothing brand ‘Pro’. The expenditure in theperiod to 31 May 2006 was as follows:

The costs of the production and launch of the products include the cost of upgrading the existing machinery

($3 million), market research costs ($2 million) and staff training costs ($1 million).

Currently an intangible asset of $20 million is shown in the financial statements for the year ended 31 May 2006.

(6 marks)

Prochain owns a number of prestigious apartments which it leases to famous persons who are under a contract of

employment to promote its fashion clothing. The apartments are let at below the market rate. The lease terms are

short and are normally for six months. The leases terminate when the contracts for promoting the clothing terminate.

Prochain wishes to account for the apartments as investment properties with the difference between the market rate

and actual rental charged to be recognised as an employee benefit expense. (4 marks)

Assume a discount rate of 5·5% where necessary.

Required:

Discuss how the above items should be dealt with in the financial statements of Prochain for the year ended

31 May 2006 under International Financial Reporting Standards.

(25 marks)