ACC 406 STUDY MODULE GUIDE

MODULE OUTLINE: PUBLIC

SECTOR ACCOUNTING AND
FINANCE “B” ACC406
Preamble

The module aims to equip the students with the ability to:
 Understand financial reporting in the public sector
 Understand and apply International Public Sector Financial
Reporting Standards (IPSAS) to public sector financial reporting

Module content

International Public Sector Accounting Standards

 IPSAS 1 Presentation of Financial Statements (IAS 1)

 IPSAS 2 Cash flow Statements (IAS 7)
 IPSAS 3 Accounting policies, Changes in Accounting Estimates
and Errors (IAS 8)
 IPSAS 5 Borrowing Costs (IAS 23)
 IPSAS 9 Revenue from Exchange Transactions (IAS 18)
 IPSAS11 Construction Contacts (IAS 11)
 IPSAS12 Inventories (IAS 2)
 IPSAS13 Leases (1AS 17)
 IPSAS16 Investment Property (IAS 40)
 IPSAS17 Property, Plant & Equipment (IAS 16)
 IPSAS19 Provisions, Contingent Liabilities and Contingent Assets
(IAS 37)
 IPSAS23 Revenue from Non-Exchange Transactions (Taxes &
Transfers) (N/A)
 IPSAS24 Presentation of Budget Information in Financial
Statements (N/A)
 IPSAS31 Intangible Assets (IAS 38)
 IPSAS32 Service Concessions Arrangements: Grantor (IFRIC 12)

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Financial Reporting

 Preparation of Statutory Financial Statements:

- Cash Flow Statements
- Consolidated Revenue Fund
- Value Added Statements
- Statement of Assets and Liabilities
- Preparation of Statutory Financial Statements in Local
Authorities
- Preparation of Revenue and Expenditure Accounts

Recommended Reading list

1. International Public Sector Accounting Standards

2. The Urban Councils Act Chapter 29:15
3. The Rural Councils Act Chapter 29:14

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Table of Contents
MODULE OUTLINE: PUBLIC SECTOR ACCOUNTING AND FINANCE “B” ACC406 ..... 1
Preamble ...................................................................................................................................... 1
Module content ............................................................................................................................ 1
International Public Sector Accounting Standards .................................................................. 1
Financial Reporting ................................................................................................................. 2
Recommended Reading list ..................................................................................................... 2
CHAPTER 1 : BACKGROUND ................................................................................................... 15
1.0 Introduction ..................................................................................................................... 15
1.1 The convergence process: Process for Reviewing and Modifying IASB Documents ........ 15
1.2 IPSAS and Related IAS/IFRS ............................................................................................. 18
CHAPTER 2: PRESENTATION OF FINANCIAL STATEMENTS (IPSAS 1) ......................... 21
2.1 The objective of IPSAS 1 .................................................................................................... 21
2.2 Purpose of financial statements ........................................................................................... 22
2.2.1 Uses of Financial Statements ........................................................................................ 23
2.2.2 Definition of Elements of Financial Statements ........................................................... 23
2.3 Responsibility for financial statements................................................................................ 25
2.4 Components of the financial statements .............................................................................. 25
2.4.1 Additional information about the entity’s outputs and outcomes................................. 25
2.4.3 Additional information about the entity’s compliance with legislative, regulatory, or
other externally-imposed regulations. ................................................................................... 26
2.5 Overall considerations for the financial statements ........................................................ 26
2.5.1 Fair presentation and compliance with IPSAS ............................................................. 26
2.5.2 Going concern............................................................................................................... 27
2.5.3 Consistency of presentation .......................................................................................... 27
2.5.4 Materiality .................................................................................................................... 27
2.5.4.1 Attributes of Materiality .................................................................................................... 28
2.5.4.2 Aggregation ....................................................................................................................... 28
2.5.5 Offsetting ...................................................................................................................... 28
2.5.6 Comparative information .............................................................................................. 28
2.5.7 Reporting period ........................................................................................................... 28
2.5.8 Timeliness ..................................................................................................................... 29
2.6 Revenue and capital ............................................................................................................. 29
2.6.1 Defining revenue and capital transactions .................................................................... 29

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2.6.1.1 Revenue expenditure ......................................................................................................... 29

2.6.1.2 Capital expenditure ............................................................................................................ 30
2.6.2 Importance of the capital/revenue distinction .............................................................. 30
2.7 The statement of financial performance .............................................................................. 31
2.7.1 Terminology ................................................................................................................. 31
2.7.2 The purpose of the statement of financial performance ............................................... 31
2.7.3 Format of the statement of financial performance........................................................ 32
2.7.3.1 Illustrative format from IPSAS 1....................................................................................... 33
2.7.3.2 Comparison to a sole trader income statement .................................................................. 34
2.7.4 Determining revenue to be included in the statement of financial performance .......... 36
2.7.4 Determining expenses to be included in the statement of financial performance ........ 37
2.8 Statement of financial position ............................................................................................ 38
2.8.1 The purpose of the statement of financial position....................................................... 38
2.8.2 Format of the statement of financial position ............................................................... 38
2.8.2.1 Illustrative statement from IPSAS 1 .................................................................................. 40
2.8.3 The structure of the statement of financial position ..................................................... 42
2.9 Statement of changes in equity ............................................................................................ 43
2.9.1 Illustrative format from IPSAS 1.................................................................................. 44
2.10 Other IPSAS 1 requirements ............................................................................................. 46
2.10.1 Notes to the financial statements ................................................................................ 46
2.10.1.1 Accounting policies ......................................................................................................... 46
2.10.1.2 Accounting estimates ....................................................................................................... 47
2.10.2 Other disclosures required by IPSAS 1 ...................................................................... 48
2.11 Discussion Question .......................................................................................................... 48
Question 1 .............................................................................................................................. 48
Question 2 .............................................................................................................................. 49
Question 3 .............................................................................................................................. 49
Question 4 .............................................................................................................................. 51
Question 5 .............................................................................................................................. 51
Question 6 .............................................................................................................................. 52
Question 7 .............................................................................................................................. 54
Question 8 .............................................................................................................................. 56
Question 9 .............................................................................................................................. 57
CHAPTER 3: IPSAS 2 Cash flow Statements (IAS 7) ............................................................... 60

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3.0 Introduction ......................................................................................................................... 60

3.1 Objective of the Cashflow Statement .................................................................................. 61
3.2 Key definitions .................................................................................................................... 61
3.3 Presentation of the cash flow statement .............................................................................. 62
3.4 Format of the cash flow statement ....................................................................................... 63
3.4.1 Cash flows from operating activities ............................................................................ 63
3.4.1.1 The indirect method ........................................................................................................... 64
3.4.1.2 The direct method .............................................................................................................. 65
3.4.1.3 Comparison of direct and indirect methods ....................................................................... 67
3.4.2 Cash flows from investing activities ............................................................................ 72
3.4.3 Financing Activities ...................................................................................................... 75
3.5 Other issues.......................................................................................................................... 78
3.5.1 Net or gross? ................................................................................................................. 78
3.5.2 Taxation ........................................................................................................................ 78
3.5.3 Interest and dividends ................................................................................................... 79
3.5.4 Unwinding the discount on provisions ......................................................................... 79
3.5.5 Foreign currency ........................................................................................................... 80
3.5.6 Non-cash transactions ................................................................................................... 80
3.5.7 Additional disclosures .................................................................................................. 80
3.6 Discussion Questions ........................................................................................................... 81
Question 1 .............................................................................................................................. 81
Question 2 .............................................................................................................................. 83
Question 3 .............................................................................................................................. 84
Question 4 .............................................................................................................................. 85
Question 5 .............................................................................................................................. 86
Question 6 .............................................................................................................................. 88
CHAPTER 4 : ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES
AND ERRORS (IPSAS 3) ............................................................................................................ 91
4.0 Introduction ......................................................................................................................... 91
4.1 Accounting Policies ............................................................................................................. 91
4.1.1 Selection and Application of Accounting Policies ....................................................... 91
4.1.2 Changes in Accounting Policies ................................................................................... 92
4.1.2.1 Retrospective Application ................................................................................................. 93
4.1.2.2 Disclosure Requirements............................................................................................. 93

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4.2 Changes in Accounting Estimates ....................................................................................... 94

4.2.1 Prospective adjustment ................................................................................................. 94
4.2.2 Disclosure Requirements .............................................................................................. 95
4.3 Errors ................................................................................................................................... 95
4.3.1 Retrospective adjustment .............................................................................................. 95
4.3.2 Disclosure Requirements ............................................................................................. 96
4.4 Summary ......................................................................................................................... 96
4.5 Discussion Questions ...................................................................................................... 97
Question 1 .............................................................................................................................. 97
Question 2 .............................................................................................................................. 98
CHAPTER 5: BORROWING COSTS (IPSAS 5) ........................................................................ 99
5.0 Introduction ......................................................................................................................... 99
5.1 Definitions ........................................................................................................................... 99
5.2 Borrowing Costs—Benchmark Treatment ........................................................................ 100
5.3 Borrowing Costs—Alternative Treatment......................................................................... 100
5.3.1 Borrowing Costs Eligible for Capitalization .............................................................. 100
5.3.2 Difficulties in determining borrowing costs ............................................................... 101
5.3.3 Determination of borrowing costs to be captalised- Dedicated borrowing ................ 101
5.3.4 Determination of borrowing costs to be captalised- undedicated/general borrowing 102
5.3.5 Determination of borrowing costs to be captalised- Difficult scenarios ............... 102
5.4 Commencement of Capitalization ..................................................................................... 103
5.5 Suspension of Capitalization ............................................................................................. 104
5.6 Cessation of Capitalization ................................................................................................ 104
5.7 Disclosure Requirements ................................................................................................... 104
5.8 Discussion Questions ......................................................................................................... 105
Question 1 ............................................................................................................................ 105
Question 2 ............................................................................................................................ 106
CHAPTER 6: REVENUE FROM EXCHANGE TRANSACTIONS (IPSAS 9) ....................... 107
6.0 Introduction ....................................................................................................................... 107
6.1 Scope of IPSAS 9: Revenue from exchange transactions ................................................. 108
6.1.1 Revenue from rendering of Services .......................................................................... 109
6.1.2 Revenue from provision of goods .............................................................................. 109
6.1.3 Revenue from the use by others of entity assets ......................................................... 109
6.2 Definitions ......................................................................................................................... 109

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6.3 Revenue recognition .......................................................................................................... 110

6.3.1 Custodial inflows ........................................................................................................ 110
6.3.2 Financing inflows ....................................................................................................... 110
6.4 Measurement of Revenue .................................................................................................. 111
6.4.1 Consideration in the form of cash and cash equivalence............................................ 111
6.4.1.1 Deferred inflow of cash and cash equivalence ................................................................ 111
6.4.2 Consideration in the form of barter exchange ............................................................ 111
6.4.3 Identification of the Transaction..................................................................................... 112
6.4.4 Recognition criteria of revenue from rendering of Services ...................................... 112
6.4.4.1 Reliable Estimate of revenue ........................................................................................... 113
6.4.4.2 Probable inflow of economic benefits/ service potential................................................. 113
6.4.4.3 Stage of completion method ............................................................................................ 113
6.4.5 Recognition criteria of revenue from sale of Goods................................................... 114
6.4.5.1 Transfer of significant risks and rewards of ownership of the goods .............................. 115
6.4.5.1 Probable inflow of economic benefits or service potential ............................................. 116
6.4.6 Recognition criteria of revenue from Interest, Royalties and Dividends ................... 116
6.5 Disclosure Requirements ................................................................................................... 117
6.6 Class discussion ................................................................................................................. 118
Question 1 ............................................................................................................................ 118
Question 2 ............................................................................................................................ 118
Question 3 ............................................................................................................................ 118
Question 4 ............................................................................................................................ 118
Question 5 ............................................................................................................................ 119
CHAPTER 7: IPSAS 11 -CONSTRUCTION CONTRACTS .................................................... 121
7.0 Introduction ....................................................................................................................... 121
7.1 Definitions ......................................................................................................................... 122
7.2 Scope of IPSAS 11 ............................................................................................................ 122
7.3 Combining and Segmenting Construction Contracts ........................................................ 123
7.4 Contract Revenue .............................................................................................................. 123
7.4.1 Variable revenue ......................................................................................................... 124
7.4.1.1 Variation .......................................................................................................................... 124
7.4.1.2 Claims .............................................................................................................................. 125
7.4.1.3 Incentive .......................................................................................................................... 125
7.5 Contract Costs.................................................................................................................... 125

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7.5.1 Direct contract costs ................................................................................................... 126

7.5.2 Related costs ............................................................................................................... 126
7.5.3 Directly chargeable costs ............................................................................................ 126
7.5.4 Costs relating to future activity .................................................................................. 127
7.5.5 Recognition of Expected Deficits ............................................................................... 127
7.6 Recognition of Contract Revenue and Expenses ............................................................... 127
7.6.1 Fixed price contracts ................................................................................................... 128
7.6.2 Cost plus or Cost based contracts ............................................................................... 128
7.7 Stage of completion ........................................................................................................... 128
7.8 Change in circumstances ................................................................................................... 129
7.9 Changes in Estimates ......................................................................................................... 130
7.10 Disclosure Requirements ................................................................................................. 130
7.11 Class discussion ........................................................................................................... 131
Question 1 ............................................................................................................................ 131
Question 2 ............................................................................................................................ 132
Question 3 ............................................................................................................................ 132
Question 4 ............................................................................................................................ 133
CHAPTER 8: INVENTORIES (IPSAS 12) ................................................................................ 135
8.0 Introduction ....................................................................................................................... 135
8.1 Scope of IPSAS 12 ............................................................................................................ 136
8.2 Definitions ......................................................................................................................... 137
8.3 Inventories ......................................................................................................................... 137
8.4 Measurement of Inventories .............................................................................................. 138
8.5 Cost of Inventories............................................................................................................. 139
8.5.1 Costs of Purchase........................................................................................................ 139
8.5.2 Costs of Conversion.................................................................................................... 139
8.5.3 Other Costs ................................................................................................................. 139
8.5.4 Excluded costs ............................................................................................................ 139
8.5.5 Cost of Inventories of a Service Provider ................................................................... 140
8.5.6 Cost of Agricultural Produce Harvested from Biological assets ................................ 140
8.5.7 Techniques for the Measurement of Cost ................................................................... 140
8.5.8 Cost Formulas ............................................................................................................. 141
8.5.8.1 Net Realizable Value ....................................................................................................... 141
8.5.9 Distributing Goods at No Charge or for a Nominal Charge ....................................... 141

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8.5.10 Recognition as an Expense ....................................................................................... 141

8.6 Disclosure Requirements ................................................................................................... 142
8.7 Discussion Questions ......................................................................................................... 142
Question 1 ............................................................................................................................ 142
Question 2 ............................................................................................................................ 143
Question 3 ............................................................................................................................ 144
Question 4 ............................................................................................................................ 144
Question 5 ............................................................................................................................ 144
CHAPTER 9: LEASES (IPSAS 13) ............................................................................................ 146
9.0 Introduction ....................................................................................................................... 146
9.1 Definitions ......................................................................................................................... 146
9.2 Scope of IPSAS 13 ............................................................................................................ 150
9.3 Classification of Leases ..................................................................................................... 150
9.3.1 Changes to lease conditions/provisions ...................................................................... 152
9.3.2 Lease on land and Buildings ....................................................................................... 152
9.3.2.1 Unreliable allocation........................................................................................................ 152
9.3.2.2 Immaterial land component ............................................................................................. 153
9.3.2.3 Leases interests are for investment .................................................................................. 153
9.4 Leases and Other Contracts ............................................................................................... 153
9.5 Accounting for operating leases ........................................................................................ 153
9.6 Accounting for finance leases............................................................................................ 154
9.6.1 Finance leases with payments in advance .................................................................. 157
9.6.1.1 Worked example: payments in advance .......................................................................... 157
9.6.2 Finance leases: Other methods of allocating finance costs ........................................ 159
9.7 Disclosure requirements .................................................................................................... 161
9.7.1 Operating leases:......................................................................................................... 161
9.7.2 Finance leases: ............................................................................................................ 161
9.8 Class Discussion ................................................................................................................ 162
Question 1 ............................................................................................................................ 162
Question 2 ............................................................................................................................ 162
Question 3 ............................................................................................................................ 163
Question 4 ............................................................................................................................ 164
CHAPTER 10 .............................................................................................................................. 167
IPSAS 14: EVENTS AFTER THE REPORTING DATE .......................................................... 167

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10.1 Introduction ..................................................................................................................... 167

10.2 Provisions of IPSAS 14 ................................................................................................... 167
10.3 Event after the reporting Date ......................................................................................... 168
10.4 Recognition and measurement: Adjusting events ........................................................... 168
10.5 Recognition and measurement: Non-adjusting events .................................................... 169
10.6 IPSAS 14 – Other considerations .................................................................................... 170
10.6.1 Dividends .................................................................................................................. 170
10.6.2 Going concern........................................................................................................... 171
10.6.3 Restructuring ............................................................................................................ 171
10.7 Disclosure ........................................................................................................................ 172
10.8 Class discussion ............................................................................................................... 172
Question 1 ............................................................................................................................ 172
Question 2 ............................................................................................................................ 173
Question 3 ............................................................................................................................ 173
CHAPTER 11 .............................................................................................................................. 175
IPSAS 16 Investment Property .................................................................................................... 175
11.1 Definition ......................................................................................................................... 175
11.1.1 Investment property .................................................................................................. 175
11.1.2 Owner occupied ........................................................................................................ 176
11.2 Accounting treatment for investment properties ............................................................. 177
11.2.1 Initial recognition ..................................................................................................... 177
11.2.2 Subsequent measurement ......................................................................................... 177
11.3 Disclosure requirements .................................................................................................. 178
11.3.1 Further disclosure requirements for properties held under the fair value model: .... 178
11.3.2 Further disclosure requirements for properties held under cost model: ................... 179
11.4 Discussion Questions ....................................................................................................... 179
Question 1 ............................................................................................................................ 179
Question 2 ............................................................................................................................ 179
Question 3 ............................................................................................................................ 180
CHAPTER 12 .............................................................................................................................. 182
IPSAS 17: PLANT, PROPERTY & EQUIPMENT .................................................................... 182
12.0 Introduction ..................................................................................................................... 182
12.1 Definitions ....................................................................................................................... 182
12.2 Recognition ...................................................................................................................... 182

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12.3 Presentation in the statement of financial position .......................................................... 182

12.4 Measurement of property, plant and equipment: initial treatment .................................. 183
12.4.1 Non-exchange transactions ....................................................................................... 183
12.5 Valuation of property, plant and equipment: initial treatment: subsequent treatment .... 184
12.6 Accounting for revaluations ............................................................................................ 185
12.7 Classes of assets............................................................................................................... 186
12.7.1 Heritage assets .......................................................................................................... 186
12.7.1.1 Characteristics of heritage assets ................................................................................... 187
12.7.1.2 Valuation of heritage assets ........................................................................................... 187
12.7.1.3 Disclosure requirements for heritage assets .............................................................. 187
12.7.2 Infrastructure assets .................................................................................................. 188
12.8 Depreciation..................................................................................................................... 188
12.8.1 Key definition: Depreciation .................................................................................... 188
12.8.2 Which assets are depreciated? .................................................................................. 189
12.8.3 Calculating depreciation ........................................................................................... 189
12.8.3.1 Changes in expected life ................................................................................................ 191
12.9 Subsequent expenditure ................................................................................................... 191
12.10 Derecognition ................................................................................................................ 192
12.11 Disclosure requirements ................................................................................................ 193
12.11.1 Further disclosures for revalued PPE ..................................................................... 194
12.12 Class Discussion ............................................................................................................ 195
Question 1 ............................................................................................................................ 195
Question 2 ............................................................................................................................ 195
Question 3 ............................................................................................................................ 195
CHAPTER 13 .............................................................................................................................. 197
IPSAS 19: Provisions, Contingent Liabilities and Contingent Assets ........................................ 197
13.0 Introduction ..................................................................................................................... 197
13.1 Scope of IPSAS 19 .......................................................................................................... 197
13.2 IPSAS 19 Key definitions................................................................................................ 198
13.2.1 Provision ................................................................................................................... 198
13.2.2 Contingent liability ................................................................................................... 198
13.2.3 Contingent asset ........................................................................................................ 199
13.3 Recognition of provisions ................................................................................................ 199
13.4 Recognition of contingent liabilities................................................................................ 199

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13.5 Recognition of contingent assets ..................................................................................... 200

13.6 Measurement ................................................................................................................... 200
13.6.1 Future events............................................................................................................. 201
13.6.2 Expected disposal of assets....................................................................................... 201
13.6.3 Reimbursements ....................................................................................................... 201
13.7 Changes in provisions ...................................................................................................... 202
13.8 Use of provisions ............................................................................................................. 202
13.8.1 Future operating net deficits ..................................................................................... 202
13.8.2 Onerous contracts ..................................................................................................... 202
13.8.3 Restructuring ............................................................................................................ 203
13.8.4 Sale or transfer of operations .................................................................................... 204
13.9 Disclosure requirements .................................................................................................. 204
13.9.1 For a provision: ......................................................................................................... 204
13.9.2 For a contingent liability, assuming the expected outflow is not remote: ................ 204
13.10 Revision Questions ........................................................................................................ 205
Question 1 ............................................................................................................................ 205
Question 2 ............................................................................................................................ 205
Question 3 ............................................................................................................................ 206
Question 4 ............................................................................................................................ 206
Question 5 ............................................................................................................................ 206
Question 6 ............................................................................................................................ 207
Question 7 ............................................................................................................................ 207
Question 8 ............................................................................................................................ 207
Question 9 ............................................................................................................................ 207
Question 10 .......................................................................................................................... 208
Question 11 .......................................................................................................................... 208
CHAPTER 14 .............................................................................................................................. 209
IPSAS 23 Revenue from Non-Exchange Transactions ............................................................... 209
14.1 Non-exchange transactions .............................................................................................. 209
14.0 Overview ......................................................................................................................... 209
14.2 IPSAS 23 Revenue from Non-Exchange transactions .................................................... 210
14.3 Recognition ...................................................................................................................... 210
14.4 Measurement ................................................................................................................... 212
14.5 Revenue from taxes ......................................................................................................... 212

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14.6 Transfers .......................................................................................................................... 214

14.6.1 Grants........................................................................................................................ 215
14.6.2 Fines.......................................................................................................................... 215
14.6.3 Bequests .................................................................................................................... 216
14.6.4 Gifts and donations ................................................................................................... 216
14.6.5 Debt forgiveness ....................................................................................................... 216
14.6.6 Services in-kind ........................................................................................................ 216
14.7 Disclosure ........................................................................................................................ 217
14.8 Revision Questions .......................................................................................................... 217
Question 1 ............................................................................................................................ 217
Question 2 ............................................................................................................................ 218
Question 3 ............................................................................................................................ 218
Question 4 ............................................................................................................................ 218
Question 5 ............................................................................................................................ 219
Question 6 ............................................................................................................................ 219
Question 7 ............................................................................................................................ 219
Question 8 ............................................................................................................................ 220
CHAPTER 15 .............................................................................................................................. 221
IPSAS 31: Intangible Assets........................................................................................................ 221
15.0 Introduction ..................................................................................................................... 221
15.1 Key definition: Intangible asset ....................................................................................... 221
15.2 Recognition and measurement of intangible assets ......................................................... 221
15.3 Measurement ................................................................................................................... 222
15.3.1 Key definition: Fair value ......................................................................................... 222
15.4 Types of intangible assets ................................................................................................ 222
15.4.1 Internally generated intangible assets: development costs ....................................... 223
15.4.2 Accounting treatment for internally generated intangible assets .............................. 224
15.5 Other intangible assets - measurement ............................................................................ 224
15.6 Other intangible assets - amortisation ............................................................................. 226
15.7 Subsequent expenditure ................................................................................................... 227
15.8 Other intangible assets – de-recognition ......................................................................... 227
15.9 Intangible assets - disclosures.......................................................................................... 227
15.10 Revision Questions ........................................................................................................ 228
Question 1 ............................................................................................................................ 228

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Question 2 ............................................................................................................................ 229

CHAPTER 16. ............................................................................................................................. 230
IPSAS 32 Service Concession Arrangements: Grantor ............................................................... 230
16.0 Overview ......................................................................................................................... 230
16.1 Key definitions: ............................................................................................................... 230
16.2 Objective of IPSAS 32 .................................................................................................... 231
16.3 Key provisions of IPSAS 32............................................................................................ 231
16.4 Grantor accounting .......................................................................................................... 232
16.5 Illustration – Grantor accounting ..................................................................................... 233
16.6 Revision Questions .......................................................................................................... 234
Question 1 ............................................................................................................................ 234
CHAPTER 17 .............................................................................................................................. 235
IPSAS 24: Presentation of Budget Information in Financial Statements .................................... 235
17.0 Overview of IPSAS 24 .................................................................................................... 235
17.2 IPSAS 24 requirements ................................................................................................... 235
17.3 Key definitions ................................................................................................................ 236
17.4 The nature of budgets ...................................................................................................... 236
17.5 Financial statement presentation ..................................................................................... 237
17.6 Non-comparable budget and financial statements ........................................................... 238
17.7 Original and final budgets ............................................................................................... 238
17.8 Differences between budgeted and actual amounts ......................................................... 239
17.9 Disclosure requirements .................................................................................................. 239
17.10 Summary........................................................................................................................ 240

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CHAPTER 1 : BACKGROUND
1.0 Introduction
It is extremely safe to make the assumption that you are already familiar with the requirements of
IAS/IFRS, you should for all intentions and purposes find the following list helpful in order to
see which IAS/IFRS each IPSAS is based on. Note that there are varying degrees of differences
between an IPSAS and its equivalent IAS/IFRS, hopefully you will appreciate the differences
between the IPSAS and the IAS/IFRS as we go through the course of the moduleere.

1.1 The convergence process: Process for Reviewing and Modifying

IASB Documents
The IPSASB develops IPSAS to address public sector financial reporting issues in two different
ways, by addressing public sector financial reporting issues:
(a) that have not been comprehensively or appropriately dealt with in existing IFRS issued
by the International Accounting Standards Board (IASB);
(b) for which there is no related IFRS; and
(c) By developing IPSAS that are converged with IFRS by adapting them to the public
sector context.

The IPSASB has a formal procedure that it follows when considering IASB documents for
convergence. This is set out in the IPSASB’s 2008 publication Process for Reviewing and
Modifying IASB Document8 and is summarised in the following diagram:

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 Step 1: Are there public sector issues that warrant a departure?

In determining whether public sector issues warrant a departure from an IASB document, the
IPSASB will consider if applying the requirements of the IASB document would:

 Mean that the objectives of public sector financial reporting would not be adequately met.

 Mean that the qualitative characteristics of public sector financial reporting would not be
adequately met.
 Require undue cost or effort.

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If public sector issues do not warrant a departure, IPSASB style and terminology changes will be
made to the IASB document (see step 4).

 Step 2: Should a separate public sector project be initiated?

If the assessment under Step 1 leads to the conclusion that departures from the IASB document
are warranted, the IPSASB will next consider whether to initiate a separate public sector project.
If the identified public sector issue is not dealt with at all in an IASB document, it is likely that a
separate public sector project will be initiated. For example, the IPSASB had to initiate a project
on impairments of non-cash-generating assets (culminating in IPSAS 21, which we will look at
later in this course of this module) since the IASB document on impairments (IAS 36) only deals
with cash-generating assets.

If the consideration of Step 2 identifies public sector issues that warrant a separate public
sector project, a project brief would be prepared for the IPSASB’s approval and the project
would follow the standard-setting due process.

In other situations, the IASB document may deal with an issue but may not address public sector
circumstances, or if it does, does not do so adequately.

If the public sector issues can be addressed within a document that is converged with the
related IASB document, go to Step 3.

 Step 3: Modify IASB document

In Step 3, modifications are made to the relevant IASB document in order to produce an IPSAS
(for example, modifications were made to IAS 1 Presentation of Financial Statements in order to
produce IPSAS 1 Presentation of Financial Statements).

Several parameters have been set for the extent of modification on an IASB document. For
example:

Recognition and measurement requirements may be modified if doing so would result in the
objectives or qualitative characteristics of public sector financial reporting being better met, or
there would be undue cost or effort in applying the requirements.

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Deletions from, or other amendments to, an IASB document could be replaced by an alternative
that better achieves the objective of public sector financial reporting. Guidance and examples
may be added to provide public sector context.

 Step 4: Make IPSASB style and terminology changes to IASB documents

In many cases, the style and terminology of an IPSASB document that is converged with a
related IASB document will require changes resulting from considerations including:

 Inclusion of a boxed rubric at the front of each IPSAS, identifying the material that
constitutes the IPSAS and the documents that provide the context in which the IPSAS
should be read.
 Deletion of definitions in IASB documents that have no public sector context.
 References to an IASB document for which an equivalent IPSAS has not been issued will
be replaced with ‘the relevant international or national accounting standard dealing with
the topic discussed’.
 Terminology changes to better reflect the public sector scope of the documents (for
example ‘business’ would be replaced with ‘entity’ or ‘operation’.)

Each IPSAS should be accompanied by a Basis for Conclusions which focusses on modifications
to the IASB document. Note that this does not form part of the IPSAS.

1.2 IPSAS and Related IAS/IFRS

Table 1-1 below therefore shows the IPSAS and the IAS/IFRS that it is based
on

Table 1-1:IPSAS and Related IAS/IFRS

Based
IPSAS on:

IPSAS Presentation of Financial

1 Statements IAS 1

IPSAS
2 Cash Flow Statements IAS 7

IPSAS
3 Accounting Policies, Changes in IAS 8
Accounting Estimates and Errors

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IPSAS
4 The Effects of Changes in Foreign IAS 21
Exchange Rates

IPSAS
5 Borrowing Costs IAS 23

IPSAS Revenue from Exchange

9 Transactions IAS 18

IPSAS Financial Reporting in

10 Hyperinflationary IAS 29
Economies

IPSAS
11 Construction Contracts IAS 11

IPSAS
12 Inventories IAS 2

IPSAS
13 Leases IAS 17

IPSAS
14 Events After the Reporting Date IAS 10

IPSAS
16 Investment Property IAS 40

IPSAS
17 Property, Plant and Equipment IAS 16

IPSAS
18 Segment Reporting IAS 14

IPSAS Provisions, Contingent Liabilities

19 and IAS 37
Contingent Assets

IPSAS
20 Related Party Disclosures IAS 24

IPSAS 21 Impairment of Non-Cash-Generating IAS 36

Assets

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IPSAS 22 Disclosure of Financial Information

About N/A
the General Government Sector

IPSAS 23 Revenue from Non-Exchange N/A

Transactions (Taxes and Transfers)

IPSAS 24 Presentation of Budget Information

in N/A
Financial Statements

IPSAS
25 Employee Benefits IAS 19

IPSAS 26 Impairment of Cash-Generating

Assets IAS 36

IPSAS
27 Agriculture IAS 41

IPSAS 28 Financial Instruments: Presentation IAS 32

IPSAS 29 Financial Instruments: Recognition

and IAS 39
Measurement

IPSAS 30 Financial Instruments: Disclosures IFRS 7

IPSAS
31 Intangible Assets IAS 38

IPSAS 32 Service Concession Arrangements: IFRIC1 12

Grantor

1
International Financial Reporting Interpretation Committee

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IPSAS 33 First-time Adoption of Accrual Basis IFRS 1

IPSASs

IPSAS 34 Separate Financial Statements IAS 27

IPSAS 35 Consolidated Financial Statements IAS 27

IAS
IPSAS 36 Investments in Associates and Joint 28/31
Ventures

IPSAS IAS
37 Joint Arrangements 28/31

IPSAS 38 Disclosure of Interests in Other

Entities IAS
27/28/31

CHAPTER 2: PRESENTATION OF
FINANCIAL STATEMENTS
(IPSAS 1)
2.1 The objective of IPSAS 1

The objective of IPSAS 1 is to prescribe the manner in which general purpose financial
statements should be presented to ensure comparability both with the entity’s financial
statements of previous periods and with the financial statements of other entities.

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To achieve this objective, IPSAS 1 sets out overall considerations for the presentation of
financial statements, guidance for their structure, and minimum requirements for the content of
financial statements prepared under the accrual basis of accounting.

The recognition, measurement, and disclosure of specific transactions and other events are dealt
with in other IPSAS, which we will be covering as we progress through this module.

2.2 Purpose of financial statements

According to IPSAS 1, the objective of financial statements is to provide information about the;

 financial position;
 financial performance; and
 cash flows of an entity that is useful to a wide range of users in making and evaluating
decisions about the allocation of resources and to demonstrate accountability of the
entity for the resources entrusted to it.

The organisation can do this by providing:

- Information about the sources, allocation, and uses of financial resources

- Information about how the organisation financed its activities and met its cash
requirements
- Information that is useful in evaluating the organisation’s ability to finance its activities
and to meet its liabilities and commitments

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- Information about the financial condition of the organisation and changes in it

- Aggregate information useful in evaluating the organisation’s performance in terms of
service costs, efficiency, and accomplishments.

2.2.1 Uses of Financial Statements

 Financial statements can have a predictive role, providing information useful in
predicting the level of resources required for continued operations and the associated
risks and uncertainties.

 Financial statements may also provide users with information about whether resources
were obtained and used in accordance with the legally adopted budget and with legal and
contractual requirements.

In order to achieve the objectives the financial statements of an organisation should provide
information about the organisations’:

i. Assets
ii. Liabilities
iii. Net assets (capital/equity)
iv. Revenue
v. Expenses
vi. Cash flows.

Supplementary information, including non-financial information, may be reported alongside the

financial statements in order to provide a more comprehensive picture of the organisation’s
activities during the period.

2.2.2 Definition of Elements of Financial Statements

These elements, with their respective definitions are:
1. Assets
An asset is a resource, with the ability to provide an inflow of service potential or economic
benefits that an entity presently controls, and which arises from a past event.

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2. Liabilities
A liability is a present obligation that arises from a past event where there is little or no realistic
alternative to avoid an outflow of service potential or economic benefits from the entity.

3. Revenue
Revenue is;
(a) inflows during the current reporting period, which increase the net assets of an entity
other than:
(i) ownership contributions and
(ii) increases in deferred inflow; and
(b) inflows during the current reporting period that result from decreases in deferred inflows.

4. Expenses
Expenses are;
(a) outflows during the current reporting period which decrease the net assets of an entity
other than;
(i) ownership distributions; and
(ii) increases in deferred outflows; and
(b) outflows during the current reporting period that result from decreases in deferred
outflows.

5. Deferred inflows
This is an inflow of service potential or economic benefits provided to the entity for use in a
specified future reporting period that results from a non-exchange transaction and increases the
net assets.
6. Deferred outflows
This is an outflow of service potential or economic benefits provided to another entity or party
for use in a specified future reporting period that results from a non-exchange transaction and
decreases net assets.
7. Ownership contributions
These are inflows of resources to an entity, contributed by external parties that establish or
increase an interest in the net assets of the entity.

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8. Ownership distributions
These are outflows of resources from the entity, distributed to external parties that return or
reduce an interest in the net assets of the entity.

2.3 Responsibility for financial statements

The responsibility for the preparation and presentation of financial statements varies within and
across jurisdictions but may include the individual who leads the entity (e.g. chief executive) or
the head of the central finance agency or other senior official such as the accountant-general.

2.4 Components of the financial statements

Information is presented in a complete set of financial statements comprises of:

i. a Statement of Financial Position;

ii. a Statement of Financial Performance;

iii. a Statement of Changes in Net assets/Equity

iv. a Cash Flow Statement

v. Notes (comprising of a summary of significant accounting policies and other

explanatory notes).
vi. ****When the entity makes publicly available it’s approved budget, a
comparison of budget and actual amounts, either as a separate additional
financial statement or as a budget column in the financial statements, is also
needed.

2.4.1 Additional information about the entity’s outputs and outcomes

In addition, entities are encouraged (but not required) to present additional information to assist
users in assessing the performance of the entity, and its stewardship of assets, as well as making
and evaluating decisions about the allocation of resources. This additional information may
include details about the entity’s outputs and outcomes in the form of;
(a) Performance indicators;

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(b) Statements of Service Performance;

(c) Program reviews; and
(d) Other reports by management about the entity’s achievements over the reporting period.

2.4.3 Additional information about the entity’s compliance with legislative,

regulatory, or other externally-imposed regulations.
Entities are also encouraged to disclose information about compliance with legislative,
regulatory, or other externally-imposed regulations.

2.5 Overall considerations for the financial statements

2.5.1 Fair presentation and compliance with IPSAS
Financial statements shall present fairly the financial position, financial performance, and cash
flows of an entity. Fair presentation requires the faithful representation of the effects of
transactions, other events, and conditions in accordance with the definitions and recognition
criteria for assets, liabilities, revenue, and expenses set out in IPSAS.

In virtually all circumstances, a fair presentation is achieved by compliance with applicable

IPSASs. A fair presentation also requires an entity to:

(i) Select and apply accounting policies in accordance with IPSAS 3:Accounting
Policies, changes in accounting estimates and errors,
IPSAS 3 sets out a hierarchy of authoritative guidance that management considers, in the
absence of a standard that specifically applies to an item.
(a) Present information, including accounting policies, in a manner that provides relevant,
reliable, comparable, and understandable information.

(b) Provide additional disclosures when compliance with the specific requirements in IPSAS
is insufficient to enable users to understand the impact of particular transactions, other
events, and conditions on the entity’s financial position and financial performance.

Where and/or should an entity depart from the requirements of an IPSAS, it must disclose:

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- That management has concluded that the financial statements present fairly the entity’s
financial position, financial performance, and cash flows;
- That it has complied with applicable IPSASs, except that it has departed from a particular
requirement to achieve a fair presentation;

(c) The title of the Standard from which the entity has departed, the nature of the departure,
including the treatment that the Standard would require, the reason why that treatment
would be so misleading in the circumstances that it would conflict with the objective of
financial statements set out in this Standard, and the treatment adopted; and

(d) For each period presented, the financial impact of the departure on each item in the
financial statements that would have been reported in complying with the requirement.

2.5.2 Going concern

Financial statements shall be prepared on a going concern basis unless there is an intention to
liquidate the entity or to cease operating, or if there is no realistic alternative but to do so.

When financial statements are not prepared on a going concern basis, that fact shall be disclosed,
together with the basis on which the financial statements are prepared and the reason why the
entity is not regarded as a going concern.

2.5.3 Consistency of presentation

The presentation and classification of items in the financial statements shall be retained from one
period to the next unless:
i. It is apparent, that another presentation or classification would be more appropriate
having regard to the criteria for the selection and application of accounting policies in
IPSAS 3; or
ii. An IPSAS requires a change in presentation.

2.5.4 Materiality
By definition, Omissions or misstatements of items are material if they could, individually or
collectively, influence the decisions or assessments of users made on the basis of the financial
statements.

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Assessing whether an omission or misstatement could influence decisions of users, and so be

material, requires consideration of the characteristics of those users. Users are assumed to have a
reasonable knowledge of the public sector and economic activities and accounting, and a
willingness to study the information with reasonable diligence. Therefore, the assessment needs
to take into account how users with such attributes could reasonably be expected to be influenced
in making and evaluating decisions.

2.5.4.1 Attributes of Materiality

Materiality depends on the nature and size of the omission or misstatement judged in the
surrounding circumstances. The nature or size of the item, or a combination of both, could be the
determining factor.

2.5.4.2 Aggregation
Each material class of similar items shall be presented separately in the financial statements.
Items of a dissimilar nature or function shall be presented separately, unless they are immaterial.

2.5.5 Offsetting
Assets and liabilities, and revenue and expenses, should not be offset unless required or
permitted by an IPSAS.

2.5.6 Comparative information

Except when an IPSAS permits or requires otherwise, comparative information should be
disclosed in respect of the previous period for all amounts reported in the financial statements as
well as comparative information for narrative and descriptive information when it is relevant to
an understanding of the current period’s financial statements

2.5.7 Reporting period

IPSAS 1 requires that financial statements be presented at least annually. When an entity’s
reporting date changes and the annual financial statements are presented for a period longer or
shorter than one year, an entity shall disclose in addition to the period covered by the financial
statements:
(i) The reason for using a longer or shorter period; and
(ii) The fact that comparative amounts for certain statements such as the statement of
financial performance, statement of changes in net assets/equity, cash flow statement, and
related notes are not entirely comparable

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2.5.8 Timeliness
The usefulness of financial statements is impaired if they are not made available to users within a
reasonable period after the reporting date. An entity should be in a position to issue its financial
statements within six months of the reporting date.

2.6 Revenue and capital

Before we proceed further with studying the IPSAS 1 requirements for the preparation of the
financial statements, we need to understand the distinction between capital and revenue, since
this underpins the IPSAS requirements.

2.6.1 Defining revenue and capital transactions

By now you must be comfortable with the definitions of elements in the Financial Statements
provided in the Conceptual Framework.

2.6.1.1 Revenue expenditure

Just as well, you are already aware of the definitions of revenue and expenditure in the private
sector. In the public sector, revenue expenditure can be understood as current expenditure. That
is, items that will be used in delivering the organisation’s objectives in the current accounting
period.

Income will include income made available to the organisation to fund expenditure during the
year. This could include taxes collected, grant income to fund activities and fees charged for
services delivered.

Whilst, expenses will include costs associated with delivering the objectives of the organisation.
For example, costs related to service delivery.

That said, ‘revenue expenditure’ will therefore relate to costs that are incurred to generate a
benefit within an accounting period and will thus be found in the Statement of Financial
Performance.

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2.6.1.2 Capital expenditure

Capital expenditure transactions are those transactions which relate to Statement of Financial
Position (i.e. balance sheet) items. They will include transactions that affect both physical and
finance capital. Where;

 Physical capital is the net non-current assets of the organization ; and

 Finance capital is the sum of the resources used to acquire the physical capital.

Thus capital transactions can be best understood as the ongoing investment in the organisation.

According to the accounting equation, Capital = Assets – Liabilities. The physical capital of an
organisation can therefore be said to consist of:
Non-current assets Plus: current assets Less: current liabilities

Less: non-current liabilities.

Finance capital in the private sector will refer to Shareholders Funds/Investments. In the public
sector, we will naturally not have shareholders’ investments in the same way as we do in the
private sector. We will, however, show any investment in the organisation that has been made by
the tax payer (for example, if assets were given to an organisation when it was set up). We will
also reflect any funds carried forward to future periods including any surplus or deficit that the
organisation has made.

2.6.2 Importance of the capital/revenue distinction

The distinction between revenue and capital items is important in the public and the private
sector. In the private sector, it is important because shareholders will not want to see their
investment used to fund on-going revenue expenditure. It is therefore important that
shareholders’ funds maintain their capital value and they should not be used to fund a loss or to
be distributed as dividends to shareholders. The revenue reserves, however, can be distributed to
shareholders.

In the public sector, it is important because of the variety of funding sources utilised by the
public sector organisations. Funding given to an organisation will usually have some conditions

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attached to it. For example, the SADC Regional Development Fund may give a grant to build a
new road so the organisation will be required to show that this grant was used for that purpose
and to treat it appropriately in the accounts.

It is important to distinguish between capital and revenue expenditure in order to treat the costs
appropriately.

Organisations may also be funded by raising money from tax payers. The authority to raise this
money is usually granted by the legislature and may only be used for specific purposes. The
money raised must be spent in accordance with these conditions. In some instances, this will
include capital expenditure but it may not, so it is important to distinguish between different
types of expenditure.

These conditions differ from the private sector where income earned can usually be used as the
directors of the organisation deem fit.

Capital expenditure in both the public and private sector can be financed by borrowing (although
in some instances, certain public sector organisations mostly may not have the legal power to
borrow money).

2.7 The statement of financial performance

The statement of financial performance summarises the revenue and expenditure (and therefore
the surplus/deficit) of an entity over an accounting period.

2.7.1 Terminology
IPSAS 1 does note that other titles are permitted for this statement, including “income
statement” and “profit and loss statement”. To add further confusion, you may have heard the
statement referred to as a “statement of comprehensive income”, which is a statement prepared
by private sector companies who are following IAS/IFRS.

2.7.2 The purpose of the statement of financial performance

You should already be familiar with the accruals or matching concept. This concept means that
we compare revenues and expenses during an accounting period and any difference is reported as
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a surplus (i.e. revenues are greater than expenses) or a deficit (i.e. expenses are greater than
revenues). The fact that particular revenues are related to particular expenses means that we need
to ensure that these are matched to each other in the same statement.

The statement of financial performance is therefore an accruals-based statement that presents

expenses and revenues in a particular format to show the users of the accounts whether the
organisation has generated a surplus or incurred a deficit for the accounting period. It is also
important that this is presented in a systematic way and in the right amount of detail, as we shall
see as we look at typical formats of the statement.

2.7.3 Format of the statement of financial performance

As a minimum, the face of the statement of financial performance shall include line items that
present the following amounts for the period:

- Revenue;
- Finance costs;
- Share of the surplus or deficit of associates and joint ventures accounted for using the
equity method;
- Pre-tax gain or loss recognised on the disposal of assets or settlement of liabilities
attributable to discontinuing operations; and
- Surplus or deficit.

An analysis of expenses using the classification based on either the nature or function of expense
within the entity is also required to be presented by the entity either on the face of the financial
statement or in the notes.

Additional line items, headings, and subtotals shall be presented on the face of the statement of
financial performance when such presentation is relevant to an understanding of the entity’s
financial performance.

When items of revenue and expense are material, their nature and amount shall be disclosed
separately. Circumstances that would give rise to the separate disclosure of items of revenue and
expense include:

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 Write-downs of inventories to net realisable value or of property, plant, and equipment

to recoverable amount or recoverable service amount as appropriate, as well as
reversals of such write-downs;
 Restructurings of the activities of an entity and reversals of any provisions for the
costs of restructuring;
 Disposals of items of property, plant, and equipment;
 Privatisations or other disposals of investments;
 Discontinuing operations;
 Litigation settlements; and
 Other reversals of provisions.

2.7.3.1 Illustrative format from IPSAS 1

Let’s look at the illustrative format of the statement of financial performance as included in
IPSAS 1. No doubt you are already familiar with the format of a basic sole trader or company
income statement from your previous accountancy studies, so in this section we will consider
how the Statement of Financial Performance for a public sector entity following IPSAS 1 may
differ from the equivalent statement that you are already familiar with.

Public Sector Entity – Statement of Financial performance for the year ended
December 31 20YY, illustrating classification of expenses by NATURE

20XY 20XX
Revenue
Taxes X X
Fees, fines, penalties, licences X X
Transfers from other government entities X X
Other
Revenue X X

Total
revenue X X

Expenses

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Wages, salaries and employee benefits (X) (X)

Grants and other transfer payments (X) (X)
Supplies and consumables used (X) (X)
Depreciation and amortisation expense (X) (X)
Impairment of property, plant and equipment (X) (X)
Other
expenses (X) (X)
Finance
costs (X) (X)

Total
expenses (X) (X)

Share of surplus of associates X X

Surplus/(deficit) for the period X X

Attributable
to: Owners of the controlling entity X X
Minority interest X X

X X

2.7.3.2 Comparison to a sole trader income statement

The basic format of the statement of financial performance deducts the expenditure incurred
from the revenue generated in a given period, giving a net surplus or deficit. A surplus is
generated if revenue exceeds expenditure, and a deficit is generated if expenditure exceeds
revenue. This terminology is used instead of profit/loss which is associated with private
enterprises such as sole traders.

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An entity should present, either on the face of the statement of financial performance or in the
notes, a sub-classification of total revenue and expenses. Revenue should be classified in a
‘manner appropriate to the entity’s operations’. See above format for the type of categories that
could be used. Expenditure should be classified either by the nature of expenses or their
function within the entity, as appropriate to the entity.

Nature – The illustrative format categorises expenditure by the nature of the expense. This
analysis details the type of expenditure (e.g. wages, depreciation etc).

Function - Expenses are categorised according to their function i.e. according to the programme
or purpose for which they were incurred. For example, health, education etc. Entities classifying
expenses by function should disclose additional information on the nature of expenses.

IPSAS 1 also gives an illustrative statement of financial performance with expenses

classified by function as follows:
Public Sector Entity – Statement of Financial performance for the
year ended December 31 20XY, illustrating classification of
expenses by FUNCTION

20XY 20XX
Revenue
Taxes X X
Fees, fines, penalties, licences X X
Transfers from other government entities X X
Other
revenue X X

Total
revenue X X

Expenses
General public services (X) (X)
Defence (X) (X)
Public order and safety (X) (X)

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Education (X) (X)

Health (X) (X)
Social
protection (X) (X)
Housing and community amenities (X) (X)
Recreational, cultural and religion (X) (X)
Economic
affairs (X) (X)
Environmental protection (X) (X)
Other
expenses (X) (X)
Finance
costs (X) (X)

Total
expenses (X) (X)

Share of surplus of associates X X

Surplus/(deficit) for the period X X

Attributab
le to: Owners of the controlling entity X X
Minority interest X X

X X

2.7.4 Determining revenue to be included in the statement of financial

performance
All items of revenue and expense recognised in a period should be included in the determination
of surplus or deficit, unless an IPSAS requires otherwise (for example, revaluation gains on the
revaluation of property in accordance with IPSAS 17 Property, Plant and Equipment).

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The sub-classifications of revenue must be presented either on the face of the statement or in the
notes. Classification will depend on the nature of the entity’s operations but might include:

- Fees and charges to recipients of services

- Fines and penalties
- Charges for licenses, permits, permissions etc.
- Sales
- Taxes
- Gains on the sale of non-current assets
- Grants and transfers from government bodies
- Donations

NB. Note that we will look at the rules for recognising revenue in more detail later in this course
when we cover IPSAS 9 and IPSAS 23.

2.7.4 Determining expenses to be included in the statement of financial

performance
In the preceding section you were reminded about the distinction between non-current and
current expenditure. We can now look at the way in which items of current expenditure are
included and presented in a statement of financial performance.

Examples of current expenditure are:

- salaries, wages and employee benefits;

- grants to other bodies;
- supplies and consumables;
- depreciation and other charges for assets;
- transport costs;
- financing costs, and;
- losses on the sale of non-current assets.

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Public sector organisations vary greatly in the type of current expenses incurred and the
statement of financial performance should provide sufficient detail for the reader to see how
much has been spent on each of the major areas of expenditure. For example, a university will
usually incur large expenses for salaries as the organisation will have a large number of staff.
This might need to be sub-divided to provide the necessary level of detail, so there might be a
distinction between academic staff and support staff.

The organisation should select the most appropriate format for presenting its expenses, i.e. by
nature or by function, depending on which format provides the most relevant information to the
users of the accounts. Of course, there is nothing to stop an organisation presenting both types of
information if it chooses to, or presenting the information in one way on the statement and an
alternative way in notes to the statement. The standard gives this choice, but whichever form of
presentation is used, it is essential that the classification fairly presents the organisation’s
performance.

2.8 Statement of financial position

IPSAS 1 states that it is acceptable to refer to it as a balance sheet or statement of assets and
liabilities. For consistency in these sections, we will always use the term statement of financial
position.

2.8.1 The purpose of the statement of financial position

The statement of financial position is one of the primary statements produced by public sector
organisations and should be considered alongside the statement of financial performance and the
cash flow statement.

2.8.2 Format of the statement of financial position

IPSAS 1 does not require a particular format for the statement of financial position but it does
list the following which must be presented as separate line items:

(a) Property, plant, and equipment;

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(b) Investment property;

(c) Intangible assets;

(d) Financial assets (excluding amounts shown under (e), (g), (h) and (i));

(e) Investments accounted for using the equity method;

(f) Inventories;

(g) Recoverables from non-exchange transactions (taxes and transfers);

(h) Receivables from exchange transactions;

(i) Cash and cash equivalents;

(j) Taxes and transfers payable;

(k) Payables under exchange transactions;

(l) Provisions;

(m) Financial liabilities (excluding amounts shown under (j), (k) and (l));

(n) Minority interest, presented within net assets/equity; and

(o) (o) Net assets/equity attributable to owners of the controlling entity.

Additional line items, headings, and sub-totals shall be presented on the face of the statement of
financial position when such presentation is relevant to an understanding of the entity’s financial
position.

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2.8.2.1 Illustrative statement from IPSAS 1

The following statement of financial position is an illustrative format taken from an appendix in
IPSAS 1. Note that it is illustrative only and is used to clarify the content of the standard. A
statement of financial position does not need to look exactly like this one, but does need to
adhere to minimum disclosure requirements detailed in IPSAS 1.

Public Sector Entity – Statement of Financial Position as at December 31

20XX

20XY 20XX

ASSETS

Current assets X X

Cash and cash equivalents X X

Receivables X X

Inventories X X

Prepayments X X

Other current assets X X

X X

Non-current assets

Receivables X X

Investments in associates X X

Other financial assets X X

Infrastructure, plant and equipment X X

Land and buildings X X

Intangible assets X X

Other non-financial assets X X

X X

Total assets X X

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LIABILITIES

Current liabilities

Payables X X

Short-term borrowings X X

Current portion of long-term borrowings X X

Short-term provisions X X

Employee benefits X X
Superannuation X X

X X

Non-current liabilities

Payables X X

Long-term borrowings X X

Long-term provisions X X

Employee benefits X X

Superannuation X X

X X

Total liabilities X X

Net assets

NET ASSETS/EQUITY

Capital contributed by other government entities X X

Reserves X X

Accumulated surpluses/(deficits) X X

Minority interest X X

Total net assets/equity X X

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2.8.3 The structure of the statement of financial position

Assets have been defined as resources controlled by an entity as a result of past events and from
which future economic benefits or service potential are expected to flow to the entity

An asset shall be classified as current when it satisfies any of the following criteria:

(a) It is expected to be realised in, or is held for sale or consumption in, the entity’s normal
operating cycle;
(b) It is held primarily for the purpose of being traded;
(c) It is expected to be realized within twelve months after the reporting date; or
(d) It is cash or a cash equivalent (as defined in IPSAS 2), unless it is restricted from being
exchanged or used to settle a liability for at least twelve months after the reporting date.

All other assets shall be classified as non-current. Liabilities have similar distinction between
current and non-current. A liability shall be classified as current when it satisfies any of the
following criteria:

(a) It is expected to be settled in the entity’s normal operating cycle;

(b) It is held primarily for the purpose of being traded;

(c) It is due to be settled within twelve months after the reporting date;
or
(d) The entity does not have an unconditional right to defer settlement of the liability for at
least twelve months after the reporting date.

All other liabilities shall be classified as non-current.

Capital

In the public sector there is not always a close equivalent to share capital or shareholders equity.
In an accruals accounting environment however, where the value of all assets and liabilities are
being shown, the difference between the two (i.e. net assets) needs to be shown.

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This may be made up of several different elements such as accumulated surpluses, reserves and
capital contributed by government.

Accumulated surpluses would be increased each year by any surplus made and reported in the
statement of financial performance (or reduced by any deficit incurred in the year).

Other reserves may be the result of funds being set aside for a particular purpose (e.g. a reserve
for the repair of buildings) or they may result from double entry bookkeeping such as in the
revaluation of assets where the asset account is debited to show the increase in its value and the
revaluation reserve is credited (and therefore increases).

When an organisation is identified as a separate entity and is preparing separate accounts for the
first time, if it has been provided with assets and working capital by government, this will need
to be reflected in the accounts. This is generally how an account for capital contributed by
government might be created and this will remain unchanged until a change in the funding
arrangement is made (i.e. when government decides to provide more capital funding or requires
any of it to be repaid).

2.9 Statement of changes in equity

The statement of changes in equity (sometimes known as the statement of changes in net
assets) reconciles the equity figure (and its constituent parts) from the figure at the beginning of
the accounting period to that at the end of the accounting period. The figure at the end of the
accounting period will be the one found on the statement of financial position.

The statement of changes in equity for a public sector organisation details the transactions that
have affected the capital and reserves accounts and shows how the opening balance has been
adjusted to produce the closing balance. This can be shown as a table with each capital and
reserve account shown as separate columns:

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Statement of changes in equity for year to 31 December 20XY

Contributed Revaluation Accumulated Total
capital reserve surpluses

$’000 $’000 $’000 $’000

Bal at 31 December 20XX 5,000 1,000 2,000 8,000

Capital contributed by Gvt 200 - - 200
Revaluation of tangible - 200 - 200
assets
Impairment of intangible - (150) - (150)
assets

Net surplus - - 500 500

Bal at 31 December 20XY 5,200 1,050 2,500 8,750

This statement clarifies for the user how the various accounts have been affected by particular
transactions or events, especially if the balance has moved as a result of several transactions. For
example, the revaluation reserve has not moved much between 31 December 20XX and 31
December 20XY (i.e. a total movement of 5%) but there has been a large upward movement as a
result of a positive revaluation and a slightly smaller downward movement because of
impairments of other assets. These movements are not evident from the information in the
statement of financial position but they are easy to identify in this statement.

2.9.1 Illustrative format from IPSAS 1

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Public Sector Entity – Statement of changes in net equity for the year
ended December 31 2016

Contri Othe Transl Accumul Tot

buted r ation ated al
reser reserv surpluse
capital ves e s/
(deficits)

Balance at
December 31 X X (X) X X
2017
Changes in
accounting (X) (X)
Policy

Restated balance X X (X) X X

Changes in net
equity for
2016
Gain on property X X
revaluation
Loss on
revaluation of (X) (X)
investments
Exchange
differences on (X) (X)
translating foreign
operations

Net revenue
recognised X (X) X
directly in net
assets/equity
Surplus for the X X

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period

Total recognised
revenue X (X) X X
and expense for
the
period

Balance at
December 31 X X (X) X X
2016

2.10 Other IPSAS 1 requirements

2.10.1 Notes to the financial statements
The notes to the financial statements of an entity should:

a) Present information about the basis of preparation of the financial statements and the
specific accounting policies selected and applied for significant transactions and other
events;

b) Disclose the information required by IPSASs that is not presented elsewhere in the
financial statements; and

c) Provide additional information which is not presented on the face of the financial
statements but is necessary for fair presentation.

2.10.1.1 Accounting policies

Accounting policies are the ways in which accounting principles are applied by an entity, and
they therefore determine how events are reflected in the financial statements. In other words,

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where there is some freedom for an entity to choose how to treat an item, the way it chooses to
do so will be its accounting policy for that item. For example, an entity can chose different
methods of valuing inventory and the chosen method will be one of their accounting policies.

The policies chosen and applied by a company must be consistent with the requirements of
accounting standards.

The following must be disclosed in the summary of accounting policies:

1. The measurement basis (or bases) used in preparing the financial statements;

2. The extent to which the entity has applied any transitional provisions in any IPSAS; and

3. The other accounting policies used that are relevant to an understanding of the financial
statements.

2.10.1.2 Accounting estimates

Because of uncertainties that are inherent in business activities, it is not always possible to
measure all items in the financial statements precisely. Estimates, therefore, may be needed for
items such as accruals, the allowance for receivables, the useful economic life of assets, etc.
Estimation techniques are the methods adopted by the entity to arrive at the estimated monetary
amounts for elements of the financial statements.

Entities must therefore disclose in the notes information about (a) the key assumptions
concerning the future, and (b) other key sources of estimation uncertainty at the reporting date,
that have a significant risk of causing a material adjustment to the carrying amounts of assets and
liabilities within the next financial year. In respect of those assets and liabilities, the notes shall
include details of:

1. Their nature; and

2. Their carrying amount as at the reporting date.

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2.10.2 Other disclosures required by IPSAS 1

The following must be disclosed:

1. The domicile and legal form of the entity, and the jurisdiction within which it operates;

2. A description of the nature of the entity’s operations and principal activities;

3. A reference to the relevant legislation governing the entity’s operations;

4. The name of the controlling entity and the ultimate controlling entity of the economic
entity (where applicable); and

5. If it is a limited life entity, information regarding the length of its life.

2.11 Discussion Question

Question 1
(a) You are auditing ABC Primary School and the Headmistress has asked for help in
categorising the following items as revenue or capital:

i. Purchase of a minibus for school use.

ii. Bus fares from students.
iii. Cost of fuel used by the minibus
iv. Annual grant towards the school running costs.
v. Rent collected from a community group for use of the gymnasium.
vi. Costs associated with building the gymnasium.
vii. Costs associated with redecorating the school cafeteria.
viii. Proceeds from a second-hand book sale to raise money for the school.

(b) Explain how the distinction between capital and revenue is reflected in the financial
statements of a public sector organisation.

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Question 2
Determine the amounts to be shown in the statement of financial performance for the year ended
31 December 2017 for a government trading activity (selling goods produced by prisoners) in
respect of the following items and prepare the revenue section of the statement of financial
performance for the year ended 31 December 2017:

(a) During the year, $53,000 was received from private donations...
This included $3,000 that a donor notified the government trading organisation of. However, the
bank transfer failed as the donor input the account details incorrectly and at the end of the year a
replacement bank transfer had not yet been made by the donor.
(b) During the year, sales to customers amount to $1.35m. One of the customers has returned
goods that were faulty and has asked for a refund. The goods had been sold to the
customer for $12,000.
(c) A grant from government of $0.6m is received in twelve equal monthly instalments
commencing 31 January 2017 and at the year end the December instalment had not been
received.
(d) In addition to the sales shown in (b), the accounts show net revenue on the sale of
Christmas cards of $27,000. This is made up of $35,000 in sales less an $8,000 fee paid
to a private agency to distribute the cards.

Question 3
The following records have been taken from the trial balance of National Museum of Zimbabwe
for the year ended 31 December 2017.

$’000 $’000
Buildings 6,342
Buildings accumulated depreciation 2,162
Inventories at 31 December 2017 1,223
Receivables 100
Short term investments 90
Cash 420
Payables 369
Long term loans 400

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Accumulated surpluses 840

Staff costs 1,250
Electricity 30
Office stationery etc 15
Insurance 345
Bank interest charges 5
Investment income 20
Reserves 142
Revenue from admission charges 376
Grant for staff training 40
Donations 25
Other revenue 46
Government grant for operating expenses 1,400
Capital contributed by government 4,000
9,820 9,820

Further information:
(a) Depreciation has still to be accounted for. The museum depreciates its assets over 40
years using the straight line basis.
(b) On 1 October 2017 the Museum was given permission to take on a long term loan of
$400,000 in order to acquire some artefacts of national significance. The loan liability has
been recognised in the trial balance. The loan interest is payable when the loan itself is to
be repaid at the end of ten years and the interest rate to be applied is 8%. The artefacts
have not yet been purchased.
(c) The insurance expenditure included in the trial balance has been paid for the period from
1 January 2017 to 28 February 2018.
(d) A pay increase was announced in December 2017 and is to be applied from 1 November
2017. The cost of the increase for 2017 is $60,000, but this was not paid to employees
until January 2018.

Required
Prepare financial statements for National Museum of Zimbabwe for the year ended 31 December
2017.

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Question 4
How do you think the following items would appear in the statement of financial position?
Suggest which category the item should appear in and what the amount should be at the end of
the financial year.

(a) The balance on the receivables account was $25,000 on 1 January. During the year,
income of $175,000 was generated of which $40,000 was paid immediately in cash. A
further $125,000 was received from receivables and $2,000 was identified as being a bad
debt as the company owing the money has ceased trading.

(b) The balance on the vehicles account on 1 January was $85,000 and accumulated
depreciation on vehicles was $40,000. During the year a new vehicle was purchased for
$12,000 and another vehicle was sold which had cost $8,000 and had been depreciated by
$5,000. The depreciation charge in the statement of financial performance was $11,000.

(c) A surplus of $78,000 has been reported in the statement of financial performance and it
has been agreed that 50% of this should be transferred to the buildings repair reserve.
Opening balances were $140,000 on the buildings repair reserve and $(16,000) on the
accumulated surplus / (deficit) account. During the year, $37,000 was spent on replacing
central heating systems and this is to be charged to the buildings repair reserve.

(d) A long term loan was arranged on 1 January for $15,000. During the year payments were
made of $1,500, half of which were for interest charges.

Question 5
You are in the process of auditing the accounts of Midlands Institute of Science, a government
owned college which specialises in engineering courses. The Dean of the Faculty of Mechanical
Engineering has written to you asking for some clarification of items in the most recently
available published accounts. His email included the following questions, all of which relate to
the statement of financial position in the accounts to 31 December 2017:

(a) I noticed that the machinery figure under non-current assets was $30,000 last year but I
know we had ten pieces of machinery and each one costs $7,000 according to my 2017
catalogue. Why is the figure in the statement so low?

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(b) The retained surpluses figure is $100,000 but we only have $20,000 in the bank. Does
that mean we spent nearly all the surplus?

(c) The intangible assets / patents figure has gone down from $50,000 to $45,000. I assume
this relates to the patents for the new designs my colleagues patented last year. I do not
understand why this would go down in value as we still have full rights to these patents.
Required
Write a memo providing a response to these questions from the Dean of Mechanical
Engineering in a suitable format.

Question 6
The following records have been taken from the pre-adjustment trial balance of the General
Administration Agency for the year ended 31 December 2016.
$’000 $’000
Buildings 5,900
Buildings accumulated depreciation 1,650
IT assets 1,234
IT assets accumulated depreciation 587
Inventories at 31 December 2016 888
Receivables 90
Short term investments 100
Cash 540
Payables 470
Long term loans 250
Accumulated surpluses 1,240
Staff costs 1,155
Electricity and office expenses 40
Bank interest charges 5
Insurance 240
General reserves 80
Revenue from charges to service users 425
Grant for software upgrades 75

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Donations 120
Other revenue 125
General grant for operating activities 1,670
Capital contributed by government 3,500
10,192 10,192

Further information:

i. Depreciation has still to be accounted for. The agency depreciates its buildings over 40
years using the straight line basis, and its IT assets using the reducing balance basis at a
rate of 35%. The Agency’s software upgrades are not treated as non-current assets but are
charged as an expense in the year.

ii. The long term loan is to be repaid at the end of five years and the interest rate to be
applied is 5%. No interest has so far been paid on this loan for 2016.

iii. The insurance expenditure includes a prepayment of $15,000 for the period up to 28
February 2017.

iv. A pay increase was announced on 1 January 2017 and it is to be applied retrospectively
from 1 December 2016. The cost of the increase for 2016 is $25,000.

v. On 16 January 2017, a fire destroyed $400,000 of the inventories.

vi. On 31 January 2017, a letter was received stating that a company that owed the Agency
$2,000 had ceased trading and it is unlikely that the Agency will receive any of the
money owed to it.

vii. On the last day of the year, the government transferred $300,000 additional capital to the
agency. This has not been included in the above trial balance.

Required
Prepare a Financial Statements in a form prescribed by IPSAS 1 for the General Administration
Agency for the year ended 31 December 2016.

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Question 7
The following information has been taken from the records of the New Technology Agency for
the year ended 31 December 2016. The Agency is part of the Ministry of Tertiary and Higher
Education.

$’000 $’000
IT assets 2,840
IT assets accumulated depreciation 1,350
Buildings 13,570
Buildings accumulated depreciation 3,800
Staff costs 2,660
Office expenses 90
Bank interest charges 20
Insurance 550
Loan interest 10
Grant for staff training 170
Donations 280
Other revenue 290
General grant for operating activities 3,840
Inventories at 31 December 2016 2040
Receivables 210
Short term investments 230
Cash 1,240
Payables 1,090
Long term loans 580
Accumulated surpluses 2,850
General reserves 180
Revenue from charges to service users 980
Capital contributed by government 8,050

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23,460 23,460

Further information:

1 Depreciation has still to be accounted for. The agency depreciates its buildings over 45
years using the straight line basis, and its IT assets using the reducing balance basis at a
rate of 30%.

2 The long term loan is to be repaid at the end of five years and the interest rate to be
applied is 4%.

3 The office expenses amount includes $12,000 for electricity. A further $3,000 of
electricity expenses is to be accrued.

4 At the end of 2016, $25,000 insurance expenses had been prepaid.

5 On 10 January 2017, inspection of the inventories revealed that $50,000 of information

leaflets which had been printed in June 20X6 contained errors. All these leaflets will have
to be scrapped.

6 On 15 January 2017, a company that owed the Agency $5,000 ceased trading. It is
unlikely that the Agency will receive any of the money owed to it.

7 On 31 December 2016, a number of unprocessed invoices for consultancy services were

found in the drawer of the payables ledger manager who had left the organization during
the year. The invoices all related to the year ending 31 December 2016 and amounted to
$30,000.

8 No capital was received or repaid to government during the year.

Required

Prepare a Financial Statements for the New Technology Agency for the year ended 31 December
2016.

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Question 8
The following records have been taken from the trial balance of the Essential Services Agency
for the year ended 31 December 2017.

$’000 $’000
Buildings 18,500
Buildings accumulated depreciation 6,300
Equipment 4,150
Equipment accumulated depreciation 1,590
Insurance 300
General reserves 100
Revenue from charges to service users 1,100
Training grant 220
Donations and fundraising income 350
Other revenue 175
General grant for operating activities 3,520
Capital contributed by government 8,785
Inventories at 1 January 2017 540
Receivables 120
Short term investments 380
Cash 120
Payables 880
Long term loans (5%) 400
Staff costs 1,650
General expenses 935
Bank interest charges 15
Loan interest paid 10
Accumulated surpluses 3,300
26,720 26,720
Further information:

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1. The agency depreciates its buildings over 45 years using the straight line basis, and its
equipment using the reducing balance basis at a rate of 25% per year. The depreciation
for 2017 has still to be accounted for

2. The insurance expenditure includes a prepayment of $15,000 for the period up to 28

February 2018.

3. A pay increase was announced in January 2018 and is to be applied from 1 December
2017. The cost of the increase for 2017 is $20,000.

4. Inventories at 31 December 2017 were $340,000. On 10 January 2018, a storm destroyed

$150,000 of the inventories. The Agency charges inventory used during the year to
general expenses.

5. On 15 December 2017 a company that owed the Agency $25,000 went bankrupt. It is
unlikely that the amount owing will be recovered.

6. At the end of 2017, there was an outstanding instalment of the general grant of $250,000
that had not yet been received by the Agency.

Required

Prepare a Financial Statements for the Essential Services Agency for the year ended 31
December 2017.

Question 9
Objective Test Questions

1. The definition of revenue given in IPSAS 1 Presentation of Financial Statements is:

(a) The gross inflow of economic benefits or service potential during the reporting period
when those inflows result in an increase in net assets/equity, including increases relating
to contributions from owners.

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(b) Decreases in economic benefits or service potential during the reporting period in the
form of outflows or consumption of assets or incurrences of liabilities that result in
decreases in net assets/equity, other than those relating to distributions to owners.

(c) The gross inflow of economic benefits or service potential during the reporting period
when those inflows result in an increase in net assets/equity, other than increases relating
to contributions from owners.

(d) Increases in economic benefits or service potential during the reporting period in the form
of outflows or consumption of assets or incurrences of liabilities that result in decreases
in net assets/equity, other than those relating to distributions to owners.

2. In which section of the statement of financial position should employment taxes that
are due for settlement in 15 months' time be presented, according to IPSAS1
Presentation of financial statements?

(a) Current liabilities

(b) Current assets

(c) Non-current liabilities

(d) Non-current assets

3. IPSAS 1 Presentation of Financial Statements lists information which all entities are
required to include in their financial statements. Which of the following does not
have to be disclosed in an organisation’s financial statements?

(a) Information about key sources of estimation uncertainty at the reporting date.

(b) Information about inputs and outputs of the entity in the form of key performance
indicators.

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(c) The domicile and legal form of the entity, and the jurisdiction within which it
operates.

(d) A reference to the relevant legislation governing the entity’s operations.

4. Are the following statements true or false, according to IPSAS 1 Presentation of

Financial Statements?

(i) An assessment of materiality needs to take into account how users could
reasonably be expected to be influenced in making and evaluating decisions.

(ii) When assessing materiality it should not be assumed that users have a reasonable
knowledge of the public sector and economic activities and accounting.

Statement (i) Statement (ii)

(a) True True
(b) False False
(c) True False
(d) False True

5. IPSAS 1 Presentation of Financial Statements lists the minimum balances which must be
shown as separate line items on the statement of financial position. Which of the
following does not have to be shown as a separate line item of the face of the statement
of financial position?

(a) Accumulated surplus/deficit

(b) Inventories

(c) Minority interest

(d) Provisions

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CHAPTER 3: IPSAS 2 Cash flow

Statements (IAS 7)
3.0 Introduction
Information about the cash flows of an entity is useful in providing users of financial statements
with information for both accountability and decision-making purposes. Cash flow information
allows users to ascertain how;
 a public sector entity raised the cash it required to fund its activities, and
 the manner in which that cash was used.

In making and evaluating decisions about the allocation of resources, such as the sustainability of
the entity’s activities, users require an understanding of the timing and certainty of cash flows.

Cash and liquidity are a different concept to profit or surplus. It is possible for an entity reporting
a profit or surplus to have liquidity problems if it does not effectively manage the flow of cash.
Cash is about the liquidity of an entity and hence cash flows concern the change in that liquidity.
In the public sector cash management is not just about surviving; it is about the process of
utilising cash resources to their optimal effect.

For a stakeholder to be able to assess the effectiveness of a public sector entity, in the same way
that an investor would assess a business, it is important that information is included in the
financial statements not only on the entity's performance and financial position but also on its
cash flows. When used alongside a statement of financial position, for example, a cash flow
statement provides users with information on the changes in net assets of the entity. An entity
may have a strong financial position and good performance during the period, but may also have
suffered significant cash outflows.

IPSAS 1 Presentation of Financial Statements sets out the content of an entity's financial
statements and includes the requirement for a cash flow statement to be presented. The detailed
requirements of the presentation of the cash flow statement are the subject of IPSAS 2 Cash
Flow Statements.

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3.1 Objective of the Cashflow Statement

The objective of IPSAS 2 is to provide information about the historical changes in cash and cash
equivalents of an entity. The cash flow statement identifies the:

- sources of cash inflows

- items on which cash was expended during the reporting period

Historical cash flow information is often used as an indicator of the amount, timing, and
certainty of future cash flows. Information about the cash flows of an entity is useful in assisting
users to predict:

 the future cash requirements of the entity

 its ability to generate cash flows in the future

 its ability to fund changes in the scope and nature of its activities.

A cash flow statement also allows a user to assess the accountability of an entity by examining
the details of the cash inflows and cash outflows during the reporting period.

A cash flow statement, when used in conjunction with other financial statements, provides
information that enables users to evaluate the changes in net assets/equity of an entity, its
financial structure (including its liquidity and solvency), and its ability to affect the amounts and
timing of cash flows in order to adapt to changing circumstances and opportunities.

It also enhances the comparability of the reporting of operating performance by different entities,
because it eliminates the effects of using different accounting treatments for the same
transactions and other events.

3.2 Key definitions

We will consider the definitions of cash and cash equivalents.

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Cash
Cash comprises cash in hand and on-demand deposits.

Cash equivalents
Short-term, highly liquid investments that are readily convertible into known amounts of cash
and which are subject to an insignificant risk of changes in value.

‘Short-term’ is usually interpreted to mean 3 months or less. An essential element of a cash

equivalent is that it is held for the purpose of meeting short-term cash commitments as they fall
due and not for long-term investment purposes. To meet the definition of a cash equivalent, the
item should be “readily convertible” which suggests that it has a short maturity of, say, three
months or less from the date of acquisition. Cash equivalents may therefore include:

 Short term deposits;

 Loan notes;

 Bank deposit accounts; and

 Government securities.

Bank borrowings normally form part of an entity's financing activities. However, where bank
overdrafts are repayable on demand they form an integral part of the entity’s cash management.
In these circumstances, bank overdrafts are included a part of cash and cash equivalents.

3.3 Presentation of the cash flow statement

IPSAS 2 requires the provision of information about the historical changes in cash and cash
equivalents of an entity by means of a cash flow statement that classifies cash flows during the
period from operating, investing, and financing activities:

 Operating activities - The activities of the entity that are not investing or financing
activities.

 Investing activities - The acquisition and disposal of long-term assets and other
investments not included in cash equivalents.

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 Financing activities - Activities that result in changes in the size and composition of the
contributed capital and borrowings of the entity.

3.4 Format of the cash flow statement

PRO FORMA CASH FLOW STATEMENT

Cash flows from operating activities

Cash flows from investing activities

Cash flows from financing activities

Net increase/decrease in cash and cash equivalents

Cash and cash equivalents at beginning of year

Cash and cash equivalents at end of year

3.4.1 Cash flows from operating activities

The cash flows from an entity's operating activities can be presented using two methods:

 The direct method, which discloses the major classes of gross cash receipts and
payments; or

 The indirect method, where the entity starts with the net surplus or deficit for the

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period and adjusts it for non-cash transactions, deferrals or accruals of past or future
operating cash receipts or payments and items of revenue or expense that will form
part of the entity's investing and financing cash flows.

3.4.1.1 The indirect method

Under the indirect method, you start with an accruals based surplus or deficit figure and then
remove the impact of all the accruals based adjustments, such as depreciation, and movements in
working capital, to work back to the cash generated by operating activities. The adjustments for
movements in inventories, trade receivables and payables are to reverse out the effect of accruals
accounting.

The standard way to approach the indirect method is to start with net surplus/deficit for the
period and make the following adjustments:

 Add: depreciation

 Add: loss made on non-current asset disposal

 Less: profit made on non-current asset disposal

 Adjust for working capital

- Less: increase in inventories

- Add: decrease in inventories

- Less: increase in receivables

- Add: decrease in receivables

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- Add: increase in payables

- Less: decrease in payables

IPSAS 2 includes the following illustration of the indirect method:

Source: IPSAS 2

3.4.1.2 The direct method

Use of the direct method is encouraged by IPSAS 2 but ensure that you are able to use both
methods.

The direct method shows the major flows of gross cash receipts and gross cash payments. It
therefore shows information which may be useful in estimating future cash flows. Entities
reporting cash flows from operating activities using the direct method are also encouraged to
provide a reconciliation of the surplus/deficit from ordinary activities with the net cash flow from
operating activities, as part of the cash flow statement or in the notes to the financial statements.
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IPSAS 2 includes the following illustration of the direct method:

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Source: IPSAS 2

3.4.1.3 Comparison of direct and indirect methods

Both methods have relative merits and disadvantages and effectively the merits of one method
are the disadvantages of the other.

Direct method merits:

- Shows actual operating cash receipts and payments for each major item of cash flow
from operations.

- Useful for readers of the financial statements as it gives them information not
available with indirect method.

- Knowledge of the specific sources of cash receipts and purpose for which cash
payments were made this period may be useful in assessing future cash flows.

Indirect method merits:

- Highlights the difference between the surplus before tax and net cash flow from
operating activities.

- Reconciliation gives an indication of the quality of the organisation’s earnings i.e.

how quickly surplus is turned into cash.

The total net cash flows from operations will be the same under either method; and

The remainder of the cash flow statement (cash flows from investing and financing
activities) is the same regardless of whether the direct or indirect method is used in the
first section.

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Worked example: Direct and indirect methods

Extracts from the draft financial statements of Delta Trading Agency for the year ended 31
December 2017 are set out below:
Extract from the statement of financial performance

$ $

Revenue 250,000

Cost of sales: Opening inventories 30,000

Purchases 218,000

Closing inventories (52,000)

(196,000)

Gross profit 54,000

Other operating expenses* (21,600)

Surplus from operations 32,400

*Other operating expenses includes depreciation of $11,000 and employee costs of $8,000.

Extract from the statement of financial position

31/12/17 31/12/16
$ $

Trade receivables 68,000 23,000

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Trade payables 21,600 42,800

Required

Calculate the cash flow from operating activities using

(a) The direct method

(b) The indirect method

Solution to worked example

$
(a)Direct method

Receipts

Cash receipts from service users (W1) 205,000

205,000

Payments

Cash payment to suppliers (W2) (241,800)

Cash payments to employees (8,000)

(249,800)

Net cash flows from operating activities (44,800)

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(W1) Cash receipts from service users

Revenue 250,000
Plus: trade receivables at 31/12/16 23,000
Less: trade receivables at 31/12/17 (68,000)
205,000

(W2) Cash payments to suppliers

Purchases 218,000
Plus: trade payables at 31/12/X8 42,800
Less: trade payables at 31/12/X9 (21,600)
239,200
Other operating expenses 21,600
Less: depreciation (as not cash) (11,000)
Less: employee costs (separate line item) (8,000)
241,800

$
(b) Indirect method

Surplus 32,400

Add: depreciation 11,000

Less: increase in inventories (52,000 – 30,000) (22,000)

Less: increase in receivables (68,000 – 23,000) (45,000)

Less: decrease in payables (21,600 – 42,800) (21,200)

Net cash flow from operating activities (44,800)

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ow attempt the following Question. This is slightly more challenging than the worked example
because:

You have not been given a purchases figure, so you will need to work it out by
adjusting operating expenses for opening and closing inventories.

There are finance costs and interest received balances to deal with. In accordance
with the examples given in IPSAS 2, finance costs and interest received are included
within the operating cash flows section of the cash flow statement. There are finance
costs payable and interest receivable balances at the beginning and end of the year,
so:

- Only include cash finance costs paid and interest received in the direct method

- Adjust for the movement in finance costs payable along with trade payables in the
indirect method, and the movement in interest receivables along with trade
receivables.

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3.4.2 Cash flows from investing activities

Cash flows arising from investing activities are important as they provide information on the level of
investment that an entity has made in assets that it will hold and use in its business on an on-going
basis. Only expenditures that result in a recognised asset in the Statement of Financial Position are
eligible for classification as investing activities.

Examples of cash flows arising from investing activities include:

 Cash paid to acquire, or a receipt from the sale of, an item of property, plant or equipment;

 Cash paid to acquire, or a receipt from the sale of, an intangible asset such as a brand or
trademark;

 Cash paid to acquire, or a receipt from the sale of, a separate entity, such as a controlled
entity;

 Cash paid to acquire, or a receipt from the sale of, an equity or debt instrument in another
entity, such as a joint venture or associate; and

 Cash given as an advance or loan to another entity, or the repayment of such items by the
other entity.

Cash inflows or outflows arising from the sale or acquisition of an entity should be shown as a net
figure and identified separately in the cash flow statement. It is important to remember that when an
asset is sold, not only will there be a cash inflow from the proceeds of the sale but the entity will also
make a surplus or deficit on the transaction. The surplus or deficit itself is not a cash flow and
therefore does not form part of the cash flow statement. It is the cash proceeds received on the sale
that are reported in the cash flow statement.

Worked example: Cash flows from investing activities

A school’s statement of financial position had a total net book value of property, plant and equipment
(PPE) of $7,600,000 at the beginning of the financial year and $8,600,000 at the end of the financial

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year.

During the year, the following transactions occurred:

1) A new science block was built. At the end of the year, $16,000 payments to the builders
were outstanding. There were no capital payables at the start of the year.

2) A new minibus was acquired on the first day of the year by finance lease and is included
in the closing PPE balance at its fair value of $20,000 less one year’s depreciation. The
lease term requires five annual payments of $4,500.

3) The total depreciation charge for the year was $700,000.

4) A part of the school’s sports fields was sold to a property developer during the year. The
land was held in the books at $160,000 and was sold at a profit of $18,000. By the end of
the year, half of the disposal proceeds had been received and half were received shortly
after the year-end.

Required
Prepare the cash flows from investing activities for the school’s cash flow statement (to the nearest
$000).

Solution to worked example

There are two cash flows to include within cash flows from investing activities: purchase of PPE and
proceeds from sale of PPE.
$’000

Purchase of PPE (W1) (1,824)

Proceeds from sale of PPE (W2) 89

Net cash flow on investing activities (1,735)

Working 1: Cash outflow from purchase of PPE

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The easiest way to approach this calculation is to recreate the PPE ledger account:

PPE
$’000 $’000
Bal b/d 7,600 Depreciation 700
Disposal 160
Balancing figure -
additions 1,860 Bal c/d 8,600
9,460 9,460
The balancing figure of $1,860,000 gives us the additions to PPE but this is still an accruals based
figure and we need the actual cash paid.

This needs to be adjusted as follows:

$’000
Additions per ledger (accruals basis) 1,860
Less closing capital payable (note 1) (16)
Less finance leased asset (note 2) (20)

Additions to PPE on a cash basis 1,824

Note the finance leased asset is adjusted for because this acquisition did not result in a cash outflow to
purchase the asset. The cash flow is the annual lease payment, which is accounted for in operating
activities (the finance cost element) and financing activities (the principal element).

Working 2: Cash inflow from disposal of PPE

$’000

Book value of land disposed of 160

Plus profit on disposal 18

Disposal proceeds 178

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Received in the year (half) 89

3.4.3 Financing Activities

Financing activities change the amount and composition of an entity's contributed capital and
borrowings. Such activities are included under a separate heading in the cash flow statement because
this analysis provides useful information on the amount of cash generated by the entity that will be
needed to service its financing activities. Examples of financing activities are:

 Cash proceeds received from issuing debt instruments, such as debentures, bonds or long-
term borrowings;

 Cash paid to repay debt instruments; and

 The principal (capital) element in finance lease payments made during the period

 Cash proceeds received from additional capital from other government entities and cash
paid to repay capital to other government entities.

It is important to remember that it is cash movements that are reflected in the cash flow statement.
Therefore non-cash financing changes, such as taking out a new finance lease or converting debt into
equity, will not be included.

Cash movements must be presented on a gross basis, as shown in the illustration below.

Illustration: Gross presentation of cash flows.

On 1 January 2017 an entity takes out a $500,000 loan due to be repaid in 2022. The entity also
repays $250,500 of borrowings it had undertaken in previous financial periods.

Each cash flow will be presented gross in the financing activities section of the cash flow statement.

Proceeds from borrowings $500,000

Repayments of borrowings ($250,500)
Cash flows from financing activities $249,500

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The repayment of borrowings is shown as a negative amount since it is a cash outflow.

Worked example: Cash flows from financing activities

A government agency’s Statement of Financial Position included the following capital and liabilities
as at 31 December 2017 and 2016:

2017 2016
$’000 $’000
LIABILITIES
Current liabilities
Payables 89 47
Finance lease liability 6 -
Bank overdraft 34 23
129 70
Non-current liabilities
Loan from Central Treasury Department 250 -
Bank loan - 150
Finance lease liability 21 -
271 150
NET ASSETS/EQUITY
Capital contributed by government 1,300 1,000
Revaluation reserve 340 340
Retained surplus 56 12
1,696 1,352

The finance lease liability relates to a finance lease taken out on 1 January 2017 for a new emergency
vehicle. The lease requires 5 annual payments of $8,000 in arrears on 31 December each year, and the
fair value of the vehicle is $32,000.

The bank overdraft is repayable on demand.

Required
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Prepare the cash flows from financing section of the agency’s cash flow statement for the year-ended
31 December 2017

Solution to worked example

There are four cash flows to be included in the financing section:

1. The cash inflow from additional capital received from other government entities during
the year: $300,000

2. The cash inflow from the Central Treasury Department loan: $250,000

3. The cash outflow to repay the bank loan: $150,000

4. The cash outflow relating to the principal element of the finance lease payment. This
will need to be calculated since we know the total payment ($8,000) but not the
principal amount.

We will therefore need to do a sum of digits calculation for year 1 only as follows:
$’000

Fair value of asset 32

Total lease payments (5 x $8,000) 40

Total financing cost 8

Sum of digits (1+2+3+4+5) 15

Year 1 finance cost 5/15 x $8,000 3

Therefore year 1 principal ($8,000-$3,000) 5

Note that the movement in trade payables would have been adjusted for within the operating cash
flows section of the cash flow statement and hence no adjustment is made in the financing section.

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The bank overdraft is part of cash and cash equivalents as it is repayable on demand and hence the
increase in the overdraft will be reflected in the overall increase or decrease in the agency’s cash for
the year.

Therefore, the cash flow from financing section of the agency’s cash flow statement for the year-
ended 31 December 2017 will appear as follows
$’000

Capital contributed by other government entities 300

Proceeds from borrowings 250

Repayment of borrowings (150)

Principal element of finance leases (5)

Cash flows from financing activities 395

3.5 Other issues

3.5.1 Net or gross?
The separate line items set out under the required cash flow headings should represent the major
classes of gross cash receipts and payments arising for each of the activities.

Cash flows which relate to a customer rather than to the entity may be reported on a net basis under
the relevant cash flow heading. Items shown net may include, for example, the collection of taxes by
one level of government for another level of government. Cash flows may also be presented on a net
basis where the related inflow and outflow occurs within a short space of time, the cash flows are
large and the maturity dates are short (within three months). An example is the purchase and sale of
the same investment.

3.5.2 Taxation
Although public sector entities are generally exempt from taxes on net surpluses, entities may operate

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under tax equivalent regimes where taxes are levied in the same way as they are on private sector
entities.

We therefore need to think about how to treat taxation in the cash flow statement. There are two
points to note:
 Although taxes that are based on the net surplus/deficit may relate to items throughout the
cash flow statement, it may not be practicable to identify separately the elements of tax
which relate to each of the three components of the cash flow statement. As a result, tax
will normally be reported as part of an entity's operating activities, although it may be split
between the relevant headings where it is practicable to do so.

 The cash flow in relation to tax should be separately identified in the cash flow statement
and where it has been allocated between the different headings, a total should be disclosed.

3.5.3 Interest and dividends

IPSAS 2 permits some flexibility in the classification of some cash flows.

Cash flows from interest and dividends received and paid shall each be disclosed separately. Each
shall be classified in a consistent manner from period to period as either operating, investing, or
financing activities.

Interest paid (for example on overdrafts, loans and finance leases) and interest and dividends received
are usually classified as operating cash flows for a public financial institution. However, there is no
consensus on the classification of these cash flows for other entities.

**NB. For the purposes of your exam, assume that all interest paid and received is to be
included within the operating cash flows section unless told otherwise.

3.5.4 Unwinding the discount on provisions

Note that finance costs arising from the unwinding of discounts on provisions are not a cash flow and

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hence are not included within the interest paid cash flow under the direct method. Under the indirect
method, any movement in provision, regardless of whether due to unwinding or actual changes, is
adjusted as a movement in working capital along with the movements in receivables, inventories and
payables.

3.5.5 Foreign currency

Where cash flows arise in a foreign currency they should be translated into the entity's functional
currency at the exchange rate on the date that the cash flow occurred. The average exchange rate for
the period may be used as an approximation to the actual exchange rate although an entity is not
permitted to use the rate at the end of the reporting period to translate foreign currency cash flows.

Where an entity has a foreign controlled entity, its cash flows should be translated to the functional
currency at the exchange rates on the dates that the cash flows occurred.

3.5.6 Non-cash transactions

Investing and financing transactions that do not impact on cash, for example the conversion of debt to
equity, should not be included in the cash flow statement. The effect of such transactions should be
disclosed elsewhere in the financial statements as appropriate.

3.5.7 Additional disclosures

An entity should disclose the components of cash and cash equivalents and provide a reconciliation
between this and the corresponding items in the statement of financial position.

If an entity has any significant cash and cash equivalent balances that are restricted in some way and
therefore are not available for use by the entity this should be explained. This might occur for
example in a consolidated cash flow statement where a controlled entity operates in a country where
exchange controls or other legal restrictions apply.

Other disclosures are encouraged where such additional information is relevant to users in their
understanding of an entity's financial statements. Additional useful disclosures may include, for
example:

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 The amount of an entity's undrawn borrowings that may be available for future operating
activities and to settle capital commitments.

 The aggregate amounts of the cash flows from each of operating, investing, and financing
activities related to interests in joint ventures reported using proportionate consolidation.

3.6 Discussion Questions

Question 1
The following information has been extracted from the accounts of government trading agency:

Statement of financial position at 31 March

2017 2016
$’000 $’000
ASSETS
Current assets
Inventories 365 332
Receivables 153 320
Short term investments 24 35
542 687
Non-current assets

Property, plant and equipment 1,585 1,407

Total assets 2,127 2,094

LIABILITIES

Current liabilities
Payables 159 237
Interest payable 7 4
Bank overdraft 115 230
281 471

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Non-current liabilities
Long term borrowings 192 185
Total liabilities 473 656
Net assets 1,654 1,438

NET ASSETS/EQUITY
Capital and reserves 1,654 1,438
Total net assets/equity 1,654 1,438

Statement of financial performance for year ended 31 March 2017

$’000
Revenue 2,625
Operating expenses (2,156)
Interest received 17
Finance costs (35)
Surplus for the year 451

Additional Information

(i) Included within operating expenses is depreciation of $27,000, profit on disposal of an

assets of $25,000 and employee costs of $367,000.

(ii) Trade receivables includes interest receivable, as follows:

31 March 2016 $4,000

31 March 2017 $3,000

Required
Prepare the cash flow from operating activities for the agency for the year ended 31 March 2018 using
the:

(a) Direct method

(b) Indirect method

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Question 2
A hospital’s statement of financial position had a total carrying amount of property, plant and
equipment (PPE) of $8,350,000 at the beginning of the financial year and $9,924,000 at the end of
the financial year.

During the year, the following transactions occurred:

1) A new radiography unit was built during the year. The construction cost of the unit is
included in the closing PPE balance above, but adjustment is still required for the
following:

- Borrowing costs of $12,000 directly attributable to constructing the unit have been
included within finance costs in the statement of financial performance instead of being
capitalised in accordance with IPSAS 5.

- Repairs and maintenance work on the hospital cardiology unit were carried out by the
same construction firm and as a result the repairs and maintenance cost of $8,000 has
been accidentally included within the closing PPE balance.

2) The depreciation charge for the year was $845,000.

3) A surplus ambulance was sold at a loss of $2,000 during the year. The ambulance had
originally cost the hospital $20,000 and had been depreciated for 2 years at 20% reducing
balance per year. The proceeds of disposal were received shortly after the year-end. There
were no capital receivables at the start of the year.

4) Capital payables at the beginning and end of the year were $56,000 and $89,000
respectively.

Required
Prepare the cash flows from investing activities for the hospital’s cash flow statement to the
nearest

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Question 3
A hospital’s statement of financial position included the capital and liabilities as at 31 December
2016 and 2017:
2017 2016
$’000 $’000
LIABILITIES
Current liabilities
Payables 145 133
Finance lease liability 9 8
Bank overdraft 78 -
232 141
Non-current liabilities
Loan from Department of Health 344 35
Bank loan 30 120
Finance lease liability 22 31
396 186
NET ASSETS/EQUITY
Capital contributed by government 600 500
Retained surplus 26 34
626 534

The finance lease liability relates to a finance lease taken out on 1 January 2016 for a new x-ray
machine. The lease requires 5 annual payments of $12,000 in arrears on 31 December each year, and
the fair value of the machine is $46,000.

Required

Prepare the cash flows from financing activities for the hospital’s cash flow statement for the year
to 31 December 2017 to the nearest $’000.

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Question 4
Youth Housing Association has prepared its statement of financial performance and statement of
financial position for the year-ended 31 December 2017, and must now prepare its cash flow
statement for the year.

Youth Housing Association: Statement of financial position as at 31 December:

2017 2016
$’000 $’000
ASSETS
Current assets
Receivables 854 738
Cash and cash equivalents 1,662 57
2,516 795
Non-current assets
Land, buildings and equipment 7,894 8,475
Total assets 10,410 9,270

LIABILITIES
Current liabilities
Payables 104 121
Non-current liabilities
Long term borrowings 160 260
Total liabilities 264 381
Net assets 10,146 8,889
NET ASSETS/EQUITY

Capital contributed by government 8,133 8,133

Accumulated surpluses 2,013 756
Total net assets/equity 10,146 8,889

Youth Housing Association: Statement of financial performance for the year-ended 31

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December 2017 (Summary)

$’000
Revenue
Transfers from other government entities 560
Fees and charges 2,345
2,905
Expenses
Wages, salaries and employee benefits (986)
Depreciation (457)
Other expenses (186)
Loss on disposal of asset (4)
Finance costs (15)
(1,648)
Surplus for the period 1,257
Additional information:
(i) Two new maintenance vehicles were acquired during the year.

(ii) During the year, housing stock valued at $202,000 in the accounts was sold to tenants, resulting in
the $4,000 loss on disposal reported in the statement of financial performance.

(iii)Payables included interest payable of $3,000 as at 31 December 2017. There was no interest
payable at the beginning of the year.

(iv) All receivables relate to fees and charges and all payables relate to other expenses.

Required
(a) Prepare the cash flow statement for Youth Housing Association for the year ended 31
December 2017 in accordance with the requirements of IPSAS 2 Cash Flow Statements, using
the direct method.

(b) Prepare the reconciliation of net cash flows from operating activities to surplus for Youth
Housing Association for the year ended 31 December 2017 (indirect method).

Question 5
The Statements of Financial Position for Hava Hospital as at 31 December 2016 and 2017 are as
follows:

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2017 2016
$’000 $’000
ASSETS
Current assets
Inventories 41 23
Receivables 593 560
Cash and cash equivalents 46 12
680 595

Non-current assets
Property, plant and equipment 2,878 2,680
Total assets 3,558 3,275

LIABILITIES
Current liabilities
Payables 323 301
Finance lease liability 8 -
331 301
Non-current liabilities
Long term borrowings 275 250
Finance lease liability 36 -
311 250
Total liabilities 642 551

Net assets 2,916 2,724

NET ASSETS/EQUITY

Capital contributed by government 2,550 2,500

Revaluation reserve 499 258
Accumulated surpluses / (deficit) (133) (34)
Total net assets/equity 2,916 2,724

Additional information:

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(i) The total depreciation charge for the year was $98,000.

(ii) On 1 July 2017, the hospital purchased a new MRI scanner by finance lease. The lease is for
five years. Ten payments of $6,000 are to be made in arrears every 6 months commencing 31
December 2017. The fair value of the scanner is $48,000.

(iii)On 1 February 2017, the hospital repaid $125,000 of its long term bank borrowings. Later in
the year, it had to take out a new long term bank loan in order to finance some of its non-
current asset acquisitions.

(iv) The statement of financial performance reported a profit on disposal of $6,000 relating to the
sale of a piece of land during the year. The land was held in the financial statements at
valuation of $30,000, and there was a balance of $4,000 in the revaluation reserve relating to
the land.

(v) The receivables balance as at 31 December 2016 includes $12,000 disposal proceeds
following disposal of a vehicle during the year-ended 31 December 2016

Required
a) Prepare the cash flow statement for Hava Hospital for the year ended 31 December 2017
using the indirect method.

b) Explain the merits of both the indirect method and the direct method.

Question 6
The statements of financial position for National University as at 31 December 2016 and 2017 are as
follows:
2017 2016
$’000 $’000
ASSETS
Current assets
Receivables: student fees and charges 17 4
Receivables: government funding 168 48
Cash and cash equivalents 109 57
294 109

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Non-current assets
Property, plant and equipment 3,865 3,849
Total assets 4,159 3,958

LIABILITIES
Current liabilities
Payables 690 652
Employee wages 26 34

716 686
Non-current liabilities
Long term borrowings 115 100
Provision for legal claim 104 100
219 200
Total liabilities 935 886
Net assets 3,224 3,072
NET ASSETS/EQUITY

Capital contributed by government 2,500 2,500

Revaluation reserve 450 450
Accumulated surpluses 274 122
Total net assets/equity 3,224 3,072

The university’s statement of financial performance for the year-ended 31 December 2017 was as
follows:
2017
$’000
Revenue
Transfers from other government entities 5,748
Student fees and charges 1,293
7,041
Expenses
Wages, salaries and employee benefits (4,034)
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Depreciation (256)
Other expenses (2,609)
Interest received 4
Profit on disposal of asset 20
Finance costs - loan interest (10)
Finance costs - unwinding of discount on provision (4)
10
Surplus for the period 152

Additional information:
(i) Trade payables at the end of the year includes $25,000 payable to an equipment supplier.
There were no capital payables at the start of the year.

(ii) The university’s long-term borrowings consist of amounts borrowed from the central
government education ministry. At the start of the year the university borrowed an additional
$30,000, and towards the end of the year repaid some of the amounts borrowed in the prior
year.

(iii)Some of the engineering department’s equipment was sold during the year at profit of
$20,000. The equipment was held at its historical cost of $230,000 less accumulated
depreciation. The asset had been depreciated for 4 years under the university’s standard rate of
25% reducing balance per year.

Required
a) Prepare the cash flow statement for National University for the year ended 31 December
2017 in accordance with the requirements of IPSAS 2, using the direct method.

b) Prepare the reconciliation of net cash flows from operating activities to surplus for
National University for the year ended 31 December 2017 (indirect method).

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CHAPTER 4 : ACCOUNTING
POLICIES, CHANGES IN
ACCOUNTING ESTIMATES AND
ERRORS (IPSAS 3)
4.0 Introduction
IPSAS 3 prescribes the criteria for selecting and changing accounting policies, together with the
accounting treatment and disclosure of changes in accounting policies, changes in accounting
estimates, and corrections of errors.

This International Public Sector Accounting Standard (IPSAS) is drawn primarily from International
Accounting Standard (IAS) 8 (Revised December 2003), “Accounting Policies, Changes in
Accounting Estimates and Errors” published by the International Accounting Standards Board
(IASB). Extracts from IAS 8 are reproduced in the standard with the permission of the International
Accounting Standards Committee Foundation (IASCF).

4.1 Accounting Policies

Accounting policies are the specific principles, bases, conventions, rules and practices applied by an
entity in preparing and presenting financial statements.

The Standard specifies the hierarchy of IPSASB’s pronouncements, and authoritative and non-
mandatory guidance, to be considered when selecting accounting policies to apply in the preparation
of financial statements.

4.1.1 Selection and Application of Accounting Policies

When an IPSAS specifically applies to a transaction, other event or condition, the accounting policy
or policies applied to that item shall be determined by applying the Standard and considering any
relevant Implementation Guidance issued by the IPSASB for the Standard.

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However, in the absence of an IPSAS that specifically applies to a transaction, other event or
condition, management shall use its judgment in developing and applying an accounting policy that
results in information that is:
- Relevant to the decision-making needs of users; and
- Reliable, in that the financial statements:
- Represent faithfully the financial position, financial performance and cash flows of the entity;
- Reflect the economic substance of transactions, other events and conditions and not merely the
legal form;
- Are neutral i.e., free from bias;
- Are prudent; and
- Are complete in all material respects.

In selecting accounting policies, management shall refer to, and consider the applicability of, the
following sources in descending order:
(a) The requirements and guidance in IPSASs dealing with similar and related issues; and
(b) The definitions, recognition and measurement criteria for assets, liabilities, revenue and
expenses described in other IPSASs.
(c) The most recent pronouncements of other standard-setting bodies and accepted public or
private sector practices to the extent.

An entity shall select and apply its accounting policies consistently for similar transactions, other
events and conditions, unless an IPSAS specifically requires or permits categorization of items for
which different policies may be appropriate.

4.1.2 Changes in Accounting Policies

Users of financial statements need to be able to compare the financial statements of an entity over
time to identify trends in its financial position, performance and cash flows, therefore an entity shall
change an accounting policy only if the change:
(a) Is required by an IPSAS; or
(b) Results in the financial statements providing reliable and more relevant information about the
effects of transactions, other eventsand conditions on the entity’s financial position, financial
performance or cash flows.

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Changes in accounting policy include;

- A change.from one basis of accounting to another basis of accounting
- A change in the accounting treatment, recognition or measurement of a transaction, event or
condition
.
The following are not changes in accounting policies:
(a) The application of an accounting policy for transactions, other events or conditions that differ
in substance from those previously occurring; and
(b) The application of a new accounting policy for transactions, other events or conditions that did
not occur previously or that were immaterial.

4.1.2.1 Retrospective Application

An entity is required (where practicable) to account for changes in accounting policies
retrospectively.

When a change in accounting policy is applied retrospectively, the entity shall adjust the opening
balance of each affected component of net assets/equity for the earliest period presented and the other
comparative amounts disclosed for each prior period presented as if the new accounting policy had
always been applied except to the extent that it is impracticable to determine either the period specific
effects or the cumulative effect of the change.

When it is impracticable to determine the period specific effects of changing an accounting policy on
comparative information for one or more prior periods presented, the entity shall apply the new
accounting policy to the carrying amounts of assets and liabilities as at the beginning of the earliest
period for which retrospective application is practicable, which may be the current period, and shall
make a corresponding adjustment to the opening balance of each affected component of net
assets/equity for that period.

4.1.2.2 Disclosure Requirements

(i) The nature of the change in accounting policy;
(ii) The reasons why applying the new accounting policy provides reliable and more relevant
information;

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(iii)For the current period and each prior period presented, to the extent practicable, the amount of
the adjustment for each financial statement line item affected;
(iv) The amount of the adjustment relating to periods before those presented, to the extent
practicable; and
(v) If retrospective application is impracticable for a particular prior period, or for periods before
those presented, the circumstances that led to the existence of that condition and a description
of how and from when the change in accounting policy has been applied.

Financial statements of subsequent periods need not repeat these disclosures.

4.2 Changes in Accounting Estimates

As a result of the uncertainties inherent in delivering services, conducting trading or other activities,
many items in financial statements cannot be measured with precision but can only be estimated.

Estimation involves judgments based on the latest available, reliable information. For example,
estimates may be required, of:
- Tax revenue due to government;
- Bad debts arising from uncollected taxes;
- Inventory obsolescence;
- The fair value of financial assets or financial liabilities;
- The useful lives of, or expected pattern of consumption of future economic benefits or service
potential embodied in depreciable assets, or the percentage completion of road construction;
Warranty obligations.

An estimate may need revision if changes occur in the circumstances on which the estimate was
based or as a result of new information or more experience.

When it is difficult to distinguish a change in an accounting policy from a change in an

accounting estimate, the change is treated as a change in an accounting estimate.

4.2.1 Prospective adjustment

A change in an accounting estimate shall be recognized prospectively by including it in surplus or
deficit in:

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(a) The period of the change, if the change affects the period only; or
(b) The period of the change and future periods, if the change affects both.
And to the extent that the change has an effect on assets, liabilities and equity.

4.2.2 Disclosure Requirements

An entity shall disclose the nature and amount of a change in an accounting estimate that has an effect
in the current period or is expected to have an effect on future periods, except for the disclosure of the
effect on future periods when it is impracticable to estimate that effect.

If the amount of the effect in future periods is not disclosed because estimating it is impracticable, the
entity shall disclose that fact.

4.3 Errors
Errors can arise in respect of the;
- Recognition;
- Measurement;
- Presentation or
- Disclosure of elements of financial statements.

Potential current period errors discovered in that period are corrected before the financial statements
are authorized for issue. However, material errors are sometimes not discovered until a subsequent
period, and these prior period errors are corrected in the comparative information presented in the
financial statements for that subsequent period

4.3.1 Retrospective adjustment

An entity shall correct material prior period errors retrospectively in the first set of financial
statements authorized for issue after their discovery by:
(i) Restating the comparative amounts for prior period(s) presented in which the error occurred;
or
(ii) If the error occurred before the earliest prior period presented, restating the opening balances
of assets, liabilities and net assets/equity for the earliest prior period presented.

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A prior period error shall be corrected by retrospective restatement except to the extent that it is
impracticable to determine either the period specific effects or the cumulative effect of the error. In
this instance, the entity shall restate the opening balances of assets, liabilities and net assets/equity for
the earliest period for which retrospective restatement is practicable (which may be the current
period).

4.3.2 Disclosure Requirements

An entity shall disclose the following:
(i) The nature of the prior period error;
(ii) For each prior period presented, to the extent practicable, the amount of the correction for each
financial statement line item affected;
(iii)The amount of the correction at the beginning of the earliest prior period presented; and
(iv) If retrospective restatement is impracticable for a particular prior period, the circumstances
that led to the existence of that condition and a description of how and from when the error has
been corrected.

Financial statements of subsequent periods need not repeat these disclosures.

4.4 Summary
 IPSAS 3 prescribes a hierarchy for choosing accounting policies:
- IPSASs, taking into account any relevant implementation guidance;
- In the absence of a directly applicable IPSAS, look at the requirements and guidance in
IPSASs dealing with similar and related issues; and the definitions, recognition and
measurement criteria for assets, liabilities, revenue and expenses described in other
IPSASs; and
- management may also consider the most recent pronouncements of other standard-
setting bodies, and accepted public and private sector practices.
 Apply accounting policies consistently to similar transactions.
 Make a change in accounting policy only if it is required by an IPSAS, or it results in reliable
and more relevant information.
 If a change in accounting policy is required by an IPSAS, follow that pronouncement’s
transition requirements. If none are specified, or if the change is voluntary, apply the new
accounting policy retrospectively by restating prior periods. If restatement is impracticable,

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include the cumulative effect of the change in net assets/equity. If the cumulative effect cannot
be determined, apply the new policy prospectively.
 Changes in accounting estimates (for example, change in useful life of an asset) are accounted
for in the current period, or the current and future periods (no restatement).
 In the situation a distinction between a change in accounting policy and a change in
accounting estimate is unclear, the change is treated as a change in an accounting estimate.
 All material prior period errors should be corrected retrospectively in the first set of financial
statements authorized for issue after their discovery, by restating comparative prior period
amounts or, if the error occurred before the earliest period presented, by restating the opening
statement of financial position.

4.5 Discussion Questions

Question 1
Consider whether each of the following scenarios involves a change in accounting policy or
a change in accounting estimate:
a) Interest incurred in connection with the purchase of a non-current asset was previously
written off as an expense and charged to the statement of financial performance. In the
future, the organisation plans to capitalise such expenses. This change will bring the
treatment of interest on the purchase of non-current assets in line with other
organisations operating in the sector, allowing users to make more meaningful
comparison between the financial statements produced.
b) An organisation has previously shown certain overheads within the transport expenses
line in the statement of financial performance. It now proposes to show these overheads
within administrative expenses.
c) Previously depreciation on vehicles was charged at 30% using the reducing balance
method. The organisation now plans to depreciate vehicles on a straight line basis over
four years, as this better reflects the consumption of economic benefits.

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Question 2
Shortly after its 31 December 2017 year end, the Environmental Agency discovered material errors in
its 2016 accounts, which meant that operating expenses of $132 800 had been completely omitted
from the prior year accounts owing to a mistake by the new senior accountant. The 2017 surplus was
$110 088 and accumulated surpluses as at 31 December 2016 as in the published 2016 accounts were
$376 301.

Required
Explain how the error will affect accumulated surpluses in the 2017 financial statements according to
IPSAS 3.

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CHAPTER 5: BORROWING
COSTS (IPSAS 5)
5.0 Introduction
The objective of IPSAS 5: Borrowing Costs is to prescribe the accounting treatment for borrowing
costs. This International Public Sector Accounting Standard (IPSAS) is drawn primarily from
International Accounting Standard (IAS) 23, “Borrowing Costs” published by the International
Accounting Standards Boa5rd (IASB).

This Standard prescribes the accounting treatment for borrowing costs. This Standard generally
requires the immediate expensing of borrowing costs. However, the Standard permits, as an allowed
alternative treatment, the capitalization of borrowing costs that are directly attributable to the
acquisition, construction or production of a qualifying asset.

5.1 Definitions
(1) Borrowing costs are interest and other expenses incurred by an entity in connection with the
borrowing of funds.
Borrowing costs may include:
(i) Interest on bank overdrafts and short-term and long-term borrowings;
(ii) Amortization of discounts or premiums relating to borrowings;
(iii) Amortization of ancillary costs incurred in connection with the arrangement of
borrowings;
(iv) Finance charges in respect of finance leases; and
(v) Exchange differences arising from foreign currency borrowings to the extent that they
are regarded as an adjustment to interest costs.

(2) Qualifying asset is an asset that necessarily takes a substantial period of time to get ready for
its intended use or sale.
Examples of qualifying assets are;
- office buildings;

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- hospitals;
- infrastructure assets such as roads, bridges and power generation facilities, and
- inventories that require a substantial period of time to bring them to a condition ready for use or
sale.
The following are not qualifying assets;
- Other investments, and those assets that are routinely produced over a short period of time;
- Assets that are ready for their intended use or sale when acquired

5.2 Borrowing Costs—Benchmark Treatment

Borrowing costs should be recognized as an expense in the period in which they are incurred under
the benchmark treatment, regardless of how the borrowings are applied.

5.3 Borrowing Costs—Alternative Treatment

Borrowing costs should be recognized as an expense in the period in which they are incurred, except
to the extent that they are capitalized.

Borrowing costs that are directly attributable to the acquisition, construction or production of a
qualifying asset should be capitalized as part of the cost of that asset on condition that it is probable
that they will result in future economic benefits or service potential to the entity and the costs can be
measured reliably. IPSAS 5 spells out borrowing costs eligible for capitalization.

Where an entity adopts the allowed alternative treatment, that treatment should be applied consistently
to all borrowing costs that are directly attributable to the acquisition, construction or production of all
qualifying assets of the entity.

5.3.1 Borrowing Costs Eligible for Capitalization

The borrowing costs that are directly attributable to the acquisition, construction or production of a
qualifying asset are those borrowing costs that would have been avoided if the outlays on the
qualifying asset had not been made.

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When an entity borrows funds specifically for the purpose of obtaining a particular qualifying asset,
the borrowing costs that directly relate to that qualifying asset can be readily identified.

5.3.2 Difficulties in determining borrowing costs

It may be difficult to identify a direct relationship between particular borrowings and a
qualifying asset and to determine the borrowings that could otherwise have been avoided. Such
a difficulty occurs, for example;
- when the financing activity of an entity is co-ordinated centrally.
- when an economic entity uses a range of debt instruments to borrow funds at varying
rates of interest,
- the use of loans denominated in or linked to foreign currencies,
- when the economic entity operates in highly inflationary economies

As a result, the determination of the amount of borrowing costs that are directly attributable to the
acquisition of a qualifying asset is difficult and the Question of judgment is required.

5.3.3 Determination of borrowing costs to be captalised- Dedicated borrowing

(1) To the extent that funds are borrowed specifically for the purpose of obtaining a qualifying
asset, the amount of borrowing costs eligible for capitalization on that asset should be
determined as the actual borrowing costs incurred on that borrowing during the period less any
investment income on the temporary investment of those borrowings.

(2) The financing arrangements for a qualifying asset may result in an entity obtaining borrowed
funds and incurring associated borrowing costs before some or all of the funds are used for
outlays on the qualifying asset. In such circumstances, the funds are often temporarily invested
pending their outlay on the qualifying asset.

In determining the amount of borrowing costs eligible for capitalization during a period, any
investment income earned on such funds is deducted from the borrowing costs incurred.

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5.3.4 Determination of borrowing costs to be captalised- undedicated/general

borrowing
To the extent that funds are borrowed generally and used for the purpose of obtaining a qualifying
asset, the amount of borrowing costs eligible for capitalization should be determined by applying a
‘capitalization rate’ to the outlays on that asset.

The capitalization rate should be the weighted average of the borrowing costs applicable to the
borrowings of the entity that are outstanding during the period (excluding other borrowings made
by the entity specifically for the purpose of obtaining a qualifying asset). The amount of
borrowing costs capitalized during a period should not exceed the amount of borrowing costs incurred
during that period.

5.3.5 Determination of borrowing costs to be captalised- Difficult scenarios

(i) When the financing activity of an entity is co-ordinated centrally.
Only those borrowing costs applicable to the borrowings of the entity may be capitalized.
(a) Where a controlled entity receives an interest-free capital contribution or capital grant
No borrowing costs are incurred and consequently entity will not capitalize any such costs.

(b) When a controlling entity transfers funds at partial cost to a controlled entity
The controlled entity may capitalize that portion of borrowing costs which it itself has incurred. In the
financial statements of the economic (controlling) entity, the full amount of borrowing costs can be
capitalized to the qualifying asset, provided that appropriate consolidation adjustments have been
made to eliminate those costs capitalized by the controlled entity.

(c) When a controlling entity has transferred funds at no cost to a controlled entity
Controlled entity doesn’t incur any borrowing costs as such none should be captalised

(ii) When an economic entity uses a range of debt instruments to borrow funds at varying
rates of interest,
In some circumstances, it is appropriate to include all borrowings of the controlling entity and its
controlled entities when computing a weighted average of the borrowing costs; in other
circumstances, it is appropriate for each controlled entity to use a weighted average of the borrowing
costs applicable to its own borrowings.

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(iii) The use of loans denominated in or linked to foreign currencies

Apply IPSAS 4: The Effects of Changes in Foreign Exchange Rates
(iv) When the economic entity operates in highly inflationary economies
Apply IPSAS 10: Financial Reporting in Hyperinflationary Economies

5.4 Commencement of Capitalization

The capitalization of borrowing costs as part of the cost of a qualifying asset should commence when:
(a) Outlays for the asset are being incurred;
Outlays on a qualifying asset include only those outlays that have resulted in payments of cash,
transfers of other assets or the assumption of interest bearing liabilities.
(b) Borrowing costs are being incurred; and
(c) Activities that are necessary to prepare the asset for its intended use or sale are in
progress.

The average carrying amount of the asset during a period, including borrowing costs previously
capitalized, is normally a reasonable approximation of the outlays to which the capitalization rate is
applied in that period.

The activities necessary to prepare the asset for its intended use or sale encompass more than the
physical construction of the asset. They include technical and administrative work prior to the
commencement of physical construction, such as the activities associated with obtaining permits.

However, such activities exclude the holding of an asset when no production or development that
changes the asset’s condition is taking place. For example, borrowing costs incurred while land is
under development are capitalized during the period in which activities related to the development are
being undertaken.
**NB However, borrowing costs incurred while land acquired for building purposes is held
without any associated development activity do not qualify for capitalization.

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5.5 Suspension of Capitalization

Capitalization of borrowing costs should be suspended during extended periods in which active
development is interrupted, and expensed.
Borrowing costs may be incurred during an extended period in which the activities necessary to
prepare an asset for its intended use or sale are interrupted. Such costs are costs of holding partially
completed assets and do not qualify for capitalization.
However, capitalization of borrowing costs is not normally suspended;
- during a period when substantial technical and administrative work is being carried out.
- when a temporary delay is a necessary part of the process of getting an asset ready for its
intended use or sale. For example, capitalization continues during an extended period needed for
inventories to mature or an extended period during which high water levels delay construction
of a bridge, if such high water levels are common during the construction period in the
geographic region involved.

5.6 Cessation of Capitalization

Capitalization of borrowing costs should cease when substantially all the activities necessary to
prepare the qualifying asset for its intended use or sale are complete.

An asset is normally ready for its intended use or sale when the physical construction of the asset is
complete even though routine administrative work might still continue. If minor modifications, such
as the decoration of a property to the purchaser’s or user’s specification, are all that is outstanding,
this indicates that substantially all the activities are complete.

When the construction of a qualifying asset is completed in parts and each part is capable of
being used while construction continues on other parts, capitalization of borrowing costs should
cease when substantially all the activities necessary to prepare that part for its intended use or
sale are completed.

5.7 Disclosure Requirements

The financial statements should disclose:
(a) The accounting policy adopted for borrowing costs;
(b) The amount of borrowing costs capitalized during the period; and

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(c) The capitalization rate used to determine the amount of borrowing costs eligible for
capitalization (when it was necessary to apply a capitalization rate to funds borrowed
generally).
(d) Transitional Provisions

When the adoption of this Standard constitutes a change in accounting policy, an entity is encouraged
to adjust its financial statements in accordance with IPSAS 3, “Accounting Policies, Changes in
Accounting Estimates and Errors.”

Alternatively, entities following the allowed alternative treatment should capitalize only those
borrowing costs incurred after the effective date of this Standard which meet the criteria for
capitalization.

5.8 Discussion Questions

Question 1
On 1 July 2017 an organisation began a $2.2m construction project for a building. It is expected that
the building will be completed by the end of June 2019. During the year ended 30 June 2018, the
following payments were made to the contractor:
Payment date $’000s
1 July 2017 200
30 Sept 2017 600
31 March 2018 1,200
30 June 2018 200
Total 2,200

The organisation’s borrowings for the year ending 30 June 2018 were as follows:
(i) 10% four-year loan with simple interest payable annually which relates specifically to the
project. Debt outstanding on 30 June 2017 amounted to $700,000 and there were no
movements during the year. Interest of $65,000 was incurred on these borrowings during the
year, and interest income of $20,000 was earned on these funds while they were held in
anticipation of payments.

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(ii) 12.5% 10-year loan with simple interest payable annually. Debt outstanding at 1 July 2017
amounted to $1,000,000 and remained unchanged during the year. The debt does not relate to
any specific project.
(iii)10% 10-year loan with simple interest payable annually. Debt outstanding at 1 July 2017
amounted to $1,500,000 and remained unchanged during the year. The debt does not relate to
any specific project.
(iv) The organisation’s policy is to capitalise all borrowing costs that meet the IPSAS 5
requirements.

Required
Calculate the amount of borrowing costs to be capitalised for the year ending 30 June 2017.

Question 2
On 1 January 2016 a government agency borrowed $1.5 million to finance the production of two
assets, both of which were expected to take a year to build. Production started during 2016. The
loan facility was drawn down on 1 January 2016 and was utilised as follows, with the remaining funds
invested temporarily

Asset A ($000) Asset B ($000)

1 January 2016 250 500
1 July 2016 250 500

The loan rate was 9% and the agency can invest surplus funds at 7%.
The agency’s policy is to capitalise all borrowing costs that meet the IPSAS 5 requirements.

Required
Ignoring compound interest, calculate the borrowing costs which may be capitalised for each of the
assets and consequently the cost of each asset as at 31 December 2016.

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CHAPTER 6: REVENUE FROM

EXCHANGE TRANSACTIONS
(IPSAS 9)
6.0 Introduction
This International Public Sector Accounting Standard (IPSAS) is drawn primarily from International
Accounting Standard (IAS) 18 (revised 1993), “Revenue”. The objective of this Standard is to
prescribe the accounting treatment of revenue arising from exchange transactions and events.

The primary issue in accounting for revenue is determining when to recognize revenue. Revenue is
recognized when it is probable that future economic benefits or service potential will flow to the
entity and these benefits can be measured reliably.

This Standard identifies the circumstances in which these criteria will be met and therefore, revenue
will be recognized. It also provides practical guidance on the application of these criteria.

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Revenue is considered to be arising from the following exchange transactions and events:
(a) The rendering of services;
(b) The sale of goods; and
(c) The use by others of entity assets yielding interest, royalties and dividends.

6.1 Scope of IPSAS 9: Revenue from exchange transactions

IPSAS 9 does not deal with revenue arising from non-exchange transactions. Public sector entities
may derive revenues from exchange or non-exchange transactions.

An exchange transaction is one in which the entity receives assets or services, or has liabilities
extinguished, and directly gives approximately equal value (primarily in the form of goods, services
or use of assets) to the other party in exchange.

In distinguishing between exchange and non-exchange revenues, substance rather than the form of the
transaction should be considered. Examples of non-exchange transactions include revenue from the
use of sovereign powers (for example, direct and indirect taxes, duties, and fines), grants and
donations.

This Standard does not deal with revenues;

(a) Addressed in other International Public Sector Accounting Standards, including:
(i) Lease agreements (see IPSAS 13, “Leases”);
(ii) Dividends arising from investments which are accounted for under the equity method
(see IPSAS 7, “Accounting for Investments in Associates”); and
(iii)Gains from the sale of property, plant and equipment (which are dealt with in IPSAS
17, “Property, Plant and Equipment”),
(b) Arising from insurance contracts of insurance entities;
(c) Arising from changes in the fair value of financial assets and financial liabilities or their
disposal (guidance on accounting for financial instruments can be found in International
Accounting Standard (IAS) 39, “Financial Instruments: Recognition and Measurement”);
(d) Arising from changes in the value of other current assets;
(e) Arising from natural increases in herds, and agricultural and forest products; and
(f) Arising from the extraction of mineral ores.

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6.1.1 Revenue from rendering of Services

The rendering of services typically involves the performance by the entity of an agreed task over an
agreed period of time. The services may be rendered within a single period or over more than one
period. Examples of services rendered by public sector entities for which revenue is typically received
in exchange may include the;
- provision of housing;
- management of water facilities;
- management of toll roads; and
- management of transfer payments.

Some agreements for the rendering of services are directly related to construction contracts, for
example, those for the services of project managers and architects. Revenue arising from these
agreements is not dealt with in this Standard but is dealt with in accordance with the requirements for
construction contracts as specified in International Public Sector Accounting Standard (IPSAS) 11,
“Construction Contracts.”

6.1.2 Revenue from provision of goods

Goods includes goods produced by the entity for the purpose of sale, such as publications, and goods
purchased for resale, such as merchandise or land and other property held for resale.

6.1.3 Revenue from the use by others of entity assets

The use by others of entity assets gives rise to revenue in the form of:
(a) Interest—charges for the use of cash or cash equivalents or amounts due to the entity;
(b) Royalties—charges for the use of long-term assets of the entity, for example, patents,
trademarks, copyrights and computer software; and
(c) Dividends or equivalents—distributions of surpluses to holders of equity investments in
proportion to their holdings of a particular class of capital.

6.2 Definitions
The following terms are used in this Standard with the meanings specified:
(i) Exchange transactions are transactions in which one entity receives assets or services, or has
liabilities extinguished, and directly gives approximately equal value (primarily in the form of
cash, goods,services, or use of assets) to another entity in exchange.

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(ii) Fair value is the amount for which an asset could be exchanged, or a liability settled, between
knowledgeable, willing parties in an arm’s length transaction.
(iii)Non-exchange transactions are transactions that are not exchange transactions. In a non-
exchange transaction, an entity either receives value from another entity without directly
giving approximately equal value in exchange, or gives value to another entity without directly
receiving approximately equal value in exchange.
(iv) Revenue is the gross inflow of economic benefits or service potential during the reporting
period when those inflows result in an increase in net assets/equity, other than increases
relating to contributions from owners .

6.3 Revenue recognition

Revenue includes only the gross inflows of economic benefits or service potential received and
receivable by the entity on its own account.

6.3.1 Custodial inflows

Amounts collected as agent of the government or another government organization or on behalf of
other third parties, for example the collection of telephone, road insurance, ZBC television and radio
licences and electricity payments by the post office on behalf of entities providing such services, are
not economic benefits or service potential which flow to the entity and do not result in increases in
assets or decreases in liabilities. Therefore, they are excluded from revenue.

Similarly, in a custodial or agency relationship, the gross inflows of economic benefits or service
potential will have to exclude amounts collected on behalf of the principal and which do not result in
increases in net assets/equity for the entity. The amounts collected on behalf of the principal are not
revenue. Instead, revenue is the amount of any commission received or receivable for the collection or
handling of the gross flows.

6.3.2 Financing inflows

Financing inflows, notably borrowings, do not meet the definition of revenue because they result in an
equal change in both assets and liabilities and have no impact upon net assets/equity. Financing
inflows are taken directly to the statement of financial position and added to the balances of assets and
liabilities.

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6.4 Measurement of Revenue

Revenue should be measured at the fair value of the consideration received or receivable.

The amount of revenue arising on a transaction is usually determined by agreement between the entity
and the purchaser or user of the asset or service. It is measured at the fair value of the consideration
received or receivable taking into account the amount of any trade discounts and volume rebates
allowed by the entity.

6.4.1 Consideration in the form of cash and cash equivalence

In most cases, the consideration is in the form of cash or cash equivalents and the amount of revenue
is the amount of cash or cash equivalents received or receivable.

6.4.1.1 Deferred inflow of cash and cash equivalence

However, when the inflow of cash or cash equivalents is deferred, the fair value of the consideration
may be less than the nominal amount of cash received or receivable. For example, an entity may
provide interest free credit to a customer or accept a note receivable bearing a below-market interest
rate as consideration for the sale of goods. When the arrangement effectively constitutes a financing
transaction, the fair value of the consideration is determined by discounting all future receipts using
an imputed rate of interest. The imputed rate of interest is the more clearly determinable of either:
(a) The prevailing rate for a similar instrument of an issuer with a similar credit rating; or
(b) A rate of interest that discounts the nominal amount of the instrument to the current cash sales
price of the goods or services.

The difference between the fair value and the nominal amount of the consideration is recognized as
interest revenue.

6.4.2 Consideration in the form of barter exchange

When goods or services are exchanged or swapped for goods or services which are of a similar nature
and value, the exchange is not regarded as a transaction which generates revenue. This is often the
case with commodities like oil or milk where suppliers exchange or swap inventories in various
locations to fulfill demand on a timely basis in a particular location.

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When goods are sold or services are rendered in exchange for dissimilar goods or services, the
exchange is regarded as a transaction which generates revenue. The revenue is measured at the fair
value of the goods or services received, adjusted by the amount of any cash or cash equivalents
transferred.

When the fair value of the goods or services received cannot be measured reliably, the revenue is
measured at the fair value of the goods or services given up, adjusted by the amount of any cash or
cash equivalents transferred.

6.4.3 Identification of the Transaction

The recognition criteria in this Standard are usually applied separately to each transaction. However,
in certain circumstances, it is necessary to apply the recognition criteria to the separately identifiable
components of a single transaction in order to reflect the substance of the transaction. For example,
when the price of a product includes an identifiable amount for subsequent servicing, that amount is
deferred and recognized as revenue over the period during which the service is performed.

Conversely, the recognition criteria are applied to two or more transactions together when they are
linked in such a way that the effect cannot be understood without reference to the series of
transactions as a whole. For example, an entity may sell goods and, at the same time, enter into a
separate agreement to repurchase the goods at a later date, thus negating the substantive effect of the
transaction; in such a case, the two transactions are dealt with together.

6.4.4 Recognition criteria of revenue from rendering of Services

When the outcome of a transaction involving the rendering of services can be estimated reliably,
revenue associated with the transaction should be recognized by reference to the stage of completion
of the transaction at the reporting date. The outcome of a transaction can be estimated reliably when
all the following conditions are satisfied:
(a) The amount of revenue can be measured reliably;
(b) It is probable that the economic benefits or service potential associated with the transaction
will flow to the entity;
(c) The stage of completion of the transaction at the reporting date can be measured reliably; and

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(d) The costs incurred for the transaction and the costs to complete the transaction can be
measured reliably.

6.4.4.1 Reliable Estimate of revenue

An entity is generally able to make reliable estimates after it has agreed to the following with the
other parties to the transaction:
- Each party’s enforceable rights regarding the service to be provided and received by the
parties;
- The consideration to be exchanged; and
- The manner and terms of settlement.

It is also usually necessary for the entity to have an effective internal financial budgeting and
reporting system. The entity reviews and, when necessary, revises the estimates of revenue as the
service is performed. The need for such revisions does not necessarily indicate that the outcome of the
transaction cannot be estimated reliably.

6.4.4.2 Probable inflow of economic benefits/ service potential

Revenue is recognized only when it is probable that the economic benefits or service potential
associated with the transaction will flow to the entity. However, when an uncertainty arises about the
collectability of an amount already included in revenue, the uncollectable amount, or the amount in
respect of which recovery has ceased to be probable, is recognized as an expense, rather than as an
adjustment of the amount of revenue originally recognized.

6.4.4.3 Stage of completion method

The stage of completion of a transaction may be determined by a variety of methods. An entity uses
the method that measures reliably the services performed. Depending on the nature of the transaction,
the methods may include:
(a) Surveys of work performed;
(b) Services performed to date as a percentage of total services to be performed; or
(c) The proportion that costs incurred to date bear to the estimated total costs of the transaction.

Only costs that reflect services performed to date are included in costs incurred to date. Only costs
that reflect services performed or to be performed are included in the estimated total costs of the
transaction.

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The recognition of revenue by reference to the stage of completion of a transaction is often referred to
as the percentage of completion method.

Under this method, revenue is recognized in the reporting periods in which the services are rendered.
For example, an entity providing property valuation services would recognize revenue as the
individual valuations are completed. The recognition of revenue on this basis provides useful
information on the extent of service activity and performance during a period. 2IPSAS 11:
Construction Contracts, also requires the recognition of revenue on this basis.

For practical purposes, when services are performed by an indeterminate number of acts over a
specified time frame, revenue is recognized on a straight line basis over the specified time frame
unless there is evidence that some other method better represents the stage of completion. When a
specific act is much more significant than any other acts, the recognition of revenue is postponed until
the significant act is executed.

When the outcome of the transaction involving the rendering of services cannot be estimated
reliably, revenue should be recognized only to the extent of the expenses recognized that are
recoverable.

As the outcome of the transaction cannot be estimated reliably, no surplus is recognized. When the
outcome of a transaction cannot be estimated reliably and it is not probable that the costs incurred will
be recovered, revenue is not recognized and the costs incurred are recognized as an expense. When
the uncertainties that prevented the outcome of the contract being estimated reliably no longer exist,
revenue is recognized according to the stage of completion method.

6.4.5 Recognition criteria of revenue from sale of Goods

Revenue from the sale of goods should be recognized when all the following conditions have been
satisfied:

2
The requirements of that Standard are generally applicable to the recognition of revenue and the associated expenses
for a transaction involving the rendering of services.

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(a) The entity has transferred to the purchaser the significant risks and rewards of ownership of
the goods;
(b) The entity retains neither continuing managerial involvement to the degree usually associated
with ownership nor effective control over the goods sold;
(c) The amount of revenue can be measured reliably;
(d) It is probable that the economic benefits or service potential associated with the transaction
will flow to the entity; and
(e) The costs incurred or to be incurred in respect of the transaction can be measured reliably.

6.4.5.1 Transfer of significant risks and rewards of ownership of the goods

The assessment of when an entity has transferred the significant risks and rewards of ownership to the
purchaser requires an examination of the circumstances of the transaction. In most cases, the transfer
of the risks and rewards of ownership coincides with the transfer of the legal title or the passing of
possession to the purchaser. This is the case for most sales.
However, in certain other cases, the transfer of risks and rewards of ownership occurs at a different
time from the transfer of legal title or the passing of possession.

If the entity retains significant risks of ownership, the transaction is not a sale and revenue is not
recognized. An entity may retain a significant risk of ownership in a number of ways. Examples of
situations in which the entity may retain the significant risks and rewards of ownership are:
(a) When the entity retains an obligation for unsatisfactory performance not covered by normal
warranty provisions;
(b) When the receipt of the revenue from a particular sale is contingent on the derivation of
revenue by the purchaser from its sale of the goods (for example, where a government
publishing operation distributes educational material to schools on a sale or return basis);
(c) When the goods are shipped subject to installation and the installation is a significant part of
the contract which has not yet been completed by the entity; and
(d) When the purchaser has the right to rescind the purchase for a reason specified in the sales
contract and the entity is uncertain about the probability of return.

If an entity retains only an insignificant risk of ownership, the transaction is a sale and revenue is
recognized. For example, a seller may retain the legal title to the goods solely to protect the

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collectability of the amount due. In such a case, if the entity has transferred the significant risks and
rewards of ownership, the transaction is a sale and revenue is recognized.

Another example of an entity retaining only an insignificant risk of ownership may be a sale when a
refund is offered if the purchaser is not satisfied. Revenue in such cases is recognized at the time of
sale provided the seller can reliably estimate future returns and recognizes a liability for returns based
on previous experience and other relevant factors.

6.4.5.1 Probable inflow of economic benefits or service potential

Revenue is recognized only when it is probable that the economic benefits or service potential
associated with the transaction will flow to the entity. In some cases, this may not be probable until
the consideration is received or until an uncertainty is removed.

When an uncertainty arises about the collectability of an amount already included in revenue, the
uncollectable amount, or the amount in respect of which recovery has ceased to be probable, is
recognized as an expense, rather than as an adjustment of the amount of revenue originally
recognized.

6.4.6 Recognition criteria of revenue from Interest, Royalties and Dividends

Revenue arising from the use by others of entity assets yielding interest, royalties and dividends
should be recognized when:
(a) It is probable that the economic benefits or service potential associated with the transaction
will flow to the entity; and
(b) The amount of the revenue can be measured reliably.

Revenue should be recognized using the following accounting treatments:

(i) Interest should be recognized on a time proportion basis that takes into account the effective
yield on the asset;
(ii) Royalties should be recognized as they are earned in accordance with the substance of the
relevant agreement; and
(iii)Dividends or their equivalents should be recognized when the shareholder’s or the entity’s
right to receive payment is established.

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Interest revenue includes the amount of amortization of any discount, premium or other difference
between the initial carrying amount of a debt security and its amount at maturity.

When unpaid interest has accrued before the acquisition of an interest-bearing investment, the
subsequent receipt of interest is allocated between pre-acquisition and post-acquisition periods; only
the post-acquisition portion is recognized as revenue.

Dividends are recognized as revenue unless they clearly represent a recovery of part of the cost of the
equity securities.

Royalties, such as petroleum royalties, accrue in accordance with the terms of the relevant agreement
and are usually recognized on that basis unless, having regard to the substance of the agreement, it is
more appropriate to recognize revenue on some other systematic and rational basis.

In all cases, revenue is recognized only when it is probable that the economic benefits or service
potential associated with the transaction will flow to the entity.

6.5 Disclosure Requirements

An entity should disclose:
(a) The accounting policies adopted for the recognition of revenue including the methods adopted
to determine the stage of completion of transactions involving the rendering of services;
(b) The amount of each significant category of revenue recognized during the period including
revenue arising from:
(i) The rendering of services;
(ii) The sale of goods;
(iii) Interest;
(iv) Royalties; and
(v) Dividends or their equivalents; and
(c) The amount of revenue arising from exchanges of goods or services included in each
significant category of revenue.

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6.6 Class discussion

Question 1
An entity sells goods to a customer for $100,000 less a trade discount of $10,000. Due to the volume
of trade with this customer there is a further discount of $5,000. Payment will be made in cash. Credit
terms are 30 days. Requirement How much revenue will be recognised?

Question 2
An entity sells goods to a customer for $100,000 less a trade discount of $5,000 on one year’s interest
free credit. Requirement Assuming the applicable discount rate is 10%, how much revenue should be
recognised immediately?

Question 3
On 1 January 2016 The Post and Communications Department signs a four year fixed-price contract
to provide services for a customer. The contract value is $550,000. At 31 December 2016 the contract
is thought to be 30% complete. Costs to complete the contract cannot be reliably estimated and costs
incurred to date of $152,000 are recoverable from the customer.

Requirement
What is the revenue to be recognised in the statement of financial performance for the year ended 31
December 2016?

Question 4
On 1 July 2017 The Midlands Regional IT Providers (a trading body run by the Gweru City Council)
handed over to a client a new computer system. The contract price for the supply of the system and
after-sales support for 12 months was $800,000. Midlands Regional IT Providers estimates the cost of
the after-sales support at $120,000 and it normally marks up such costs by 50% when tendering for
support contracts.
Required
What is the revenue Midlands Regional IT Providers should recognise in its financial statements for
the financial year ended 31 December 2017?

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Question 5
Zimbabwe Tourism Authority, a public sector body, has entered into the following transactions in the
year ending 31 December 2017.
1) A six month contract to undertake awareness training for the cross border development agencies
over the period 1 September 2017 to 28 February 2018. The value of services performed to date
amounts to $45,000 out of a total contract value of $60,000. All costs are expected to be recoverable.
2) Sold some tourism merchandise for $15,000 to the Zimbabwe Airports Authority. This authority
has the right to return any unsold merchandise before the 30 April 2018 for a full refund.
3) Provided advertising and marketing support to the Sports Council costing $4,450 relating to a fixed
price $20,000 contract covering the period 1 December 2017 to 31 March 2018. Due to fluctuating
advertising costs, the expected total cost cannot be reliably measured at the year end. However
Zimbabwe Tourism Authority is certain that the Sports Council will pay the costs incurred to date.
4) Sold some Zimbabwe heritage publications on the 1 November 2017 to China Tourism
Agency for $106,152. Payment is not due until 1 May 2018 and China Tourism Agency
cannot return the books.

Required
How much revenue should be recognised in UK Tourism’s financial statements for the year-
ended 31 December 2017?
For item (4) assume a discount rate of 1% per month (12.7% per year compound). No other
transactions require discounting.

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CHAPTER 7: IPSAS 11 -
CONSTRUCTION CONTRACTS
7.0 Introduction
This International Public Sector Accounting Standard (IPSAS) is drawn primarily from International
Accounting Standard (IAS) 11 (revised 1993), “Construction Contracts” published by the
International Accounting Standards Board (IASB).

The objective of this Standard is to prescribe the accounting treatment of costs and revenue associated
with construction contracts. The Standard:
 Identifies the arrangements that are to be classified as construction contracts
 Provides guidance on the types of construction contracts that can arise in the public sector; and
 Specifies the basis for recognition and disclosure of contract expenses and, if
 relevant, contract revenues.

Because of the nature of the activity undertaken in construction contracts, the date at which the
contract activity is entered into and the date when the activity is completed usually fall into different
reporting periods.

In many jurisdictions, construction contracts entered into by public sector entities will not specify an
amount of contract revenue. Rather, funding to support the construction activity will be provided by
an appropriation or similar allocation of general government revenue, or by aid or grant funds. In
these cases, the primary issue in accounting for construction contracts is the allocation of construction
costs to the reporting period in which the construction work is performed and the recognition of
related expenses.

In some jurisdictions, construction contracts entered into by public sector entities may be established
on a commercial basis or a non-commercial full or partial cost recovery basis. In these cases, the
primary issue in accounting for construction contracts is the allocation of both contract revenue and
contract costs to the reporting periods in which construction work is performed.

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7.1 Definitions
(i) Construction contract is a contract, or a similar binding arrangement, specifically negotiated
for the construction of an asset or a combination of assets that are closely interrelated or
interdependent in terms of their design, technology and function or their ultimate purpose or
use.

(ii) Contractor is an entity that performs construction work pursuant to a construction contract.

(iii) Cost plus or cost based contract is a construction contract in which the contractor is
reimbursed for allowable or otherwise defined costs and, in the case of a commercially-based
contract, an additional percentage of these costs or a fixed fee, if any.
(iv) Fixed price contract is a construction contract in which the contractor agrees to a fixed
contract price, or a fixed rate per unit of output, which in some cases is subject to cost
escalation clauses.

7.2 Scope of IPSAS 11

For the purposes of IPSAS 11, construction contracts include:
(a) Contracts for the rendering of services which are directly related to the construction of the
asset, for example, those for the services of project managers and architects; and
(b) Contracts for the destruction or restoration of assets, and the restoration of the environment
following the demolition of assets.
(c) Arrangements that are binding on the parties to the arrangement, but which may not take the
form of a documented contract. Such binding arrangements could include (but are not limited
to;
(i) a ministerial direction;
(ii) a cabinet decision;
(iii) a legislative direction (such as an Act of Parliament); or
(iv) a memorandum of understanding.

A commercial contract will specify that revenue to cover the constructor’s construction costs as
agreed and generate a profit margin will be provided by the other parties to the contract.

However, a public sector entity may also enter into a non-commercial contract to construct an asset
for another entity in return for full or partial reimbursement of costs from that entity or other parties.

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In some cases, the cost recovery may encompass payments by the recipient entity and specific
purpose construction grants or funding from other parties.

In many jurisdictions, where one public sector entity constructs assets for another public sector entity
the cost of construction activity is not recovered directly from the recipient. Rather, the construction
activity is funded indirectly by way of a general appropriation or other allocation of general
government funds to the contractor, or from general purpose grants from third party funding agencies
or other governments. These are classified as fixed price contracts for the purpose of this Standard.

7.3 Combining and Segmenting Construction Contracts

When a contract covers a number of assets, the construction of each asset should be treated as a
separate construction contract when:
(a) Separate proposals have been submitted for each asset;
(b) Each asset has been subject to separate negotiation and the contractor and customer have been
able to accept or reject that part of the contract relating to each asset; and
(c) The costs and revenues of each asset can be identified.

A group of contracts, whether with a single customer or with several customers, should be treated as a
single construction contract when:
(a) The group of contracts is negotiated as a single package;
(b) The contracts are so closely interrelated that they are, in effect, part of a single project with an
overall margin, if any; and
(c) The contracts are performed concurrently or in a continuous sequence.

A contract may provide for the construction of an additional asset at the option of the customer or
may be amended to include the construction of an additional asset. The construction of the additional
asset should be treated as a separate construction contract when:
(a) The asset differs significantly in design, technology or function from the asset or assets
covered by the original contract; or
(b) The price of the asset is negotiated without regard to the original contract price.

7.4 Contract Revenue

Contract revenue should comprise:

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(a) The initial amount of revenue agreed in the contract; and

(b) Variations in contract work, claims and incentive payments to the extent that:
(i) It is probable that they will result in revenue; and
(ii) They are capable of being reliably measured.

Contract revenue is measured at the fair value of the consideration received or receivable. Both the
initial and ongoing measurement of contract revenue are affected by a variety of uncertainties that
depend on the outcome of future events. The estimates often need to be revised as events occur and
uncertainties are resolved.

Where a contract is a cost plus or cost based contract, the initial amount of revenue may not be stated
in the contract. Instead, it may need to be estimated on a basis consistent with the terms and
provisions of the contract, such as by reference to expected costs over the life of the contract.

7.4.1 Variable revenue

In addition, the amount of contract revenue may increase or decrease from one period to the next. For
example:
(a) A contractor and a customer may agree to variations or claims that increase or decrease
contract revenue in a period subsequent to that in which the contract was initially agreed;
(b) The amount of revenue agreed in a fixed price, cost plus or cost based contract may increase
as a result of cost escalation or other clauses;
(c) The amount of contract revenue may decrease as a result of penalties arising from delays
caused by the contractor in the completion of the contract; or
(d) When a fixed price contract involves a fixed price per unit of output, contract revenue
increases or decreases as the number of units is increased or decreased.

7.4.1.1 Variation
A variation is an instruction by the customer for a change in the scope of the work to be performed
under the contract. A variation may lead to an increase or a decrease in contract revenue. Examples of
variations are changes in the specifications or design of the asset and changes in the duration of the
contract. A variation is included in contract revenue when:
(a) It is probable that the customer will approve the variation and the amount of revenue arising
from the variation; and
(b) The amount of revenue can be reliably measured.

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7.4.1.2 Claims
A claim is an amount that the contractor seeks to collect from the customer or another party as
reimbursement for costs not included in the contract price. A claim may arise from, for example,
customer caused delays, errors in specifications or design, and disputed variations in contract work.
The measurement of the amounts of revenue arising from claims is subject to a high level of
uncertainty and often depends on the outcome of negotiations.
Therefore, claims are only included in contract revenue when:
(a) Negotiations have reached an advanced stage such that it is probable that the customer will
accept the claim; and
(b) The amount that it is probable will be accepted by the customer can be measured reliably.

7.4.1.3 Incentive
Incentive payments are additional amounts paid to the contractor if specified performance standards
are met or exceeded. For example, a contract may allow for an incentive payment to the contractor for
early completion of the contract. Incentive payments are included in contract revenue when:
(a) The contract is sufficiently advanced that it is probable that the specified performance
standards will be met or exceeded; and
(b) The amount of the incentive payment can be measured reliably.

7.5 Contract Costs

Contract costs should comprise:
(a) Costs that relate directly to the specific contract;
(b) Costs that are attributable to contract activity in general and can be allocated to the contract on
a systematic and rational basis; and
(c) Such other costs as are specifically chargeable to the customer under the terms of the contract.

Where it is intended at inception of the contract that contract costs are to be fully recovered from the
parties to the construction contract, any expected excess of total contract costs over total contract
revenue for the contract is recognized as an expense immediately.

Examples of contract costs which are excluded are:

(a) Contract costs that relate to future activity on the contract, such as costs of materials that have
been delivered to a contract site or set aside for use in a contract but not yet installed, used or

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applied during contract performance, unless the materials have been made specially for the
contract; and
(b) Payments made to subcontractors in advance of work to be performed under the subcontract.

7.5.1 Direct contract costs

Costs that relate directly to a specific contract include:
(a) Site labour costs, including site supervision;
(b) Costs of materials used in construction;
(c) Depreciation of plant and equipment used on the contract;
(d) Costs of moving plant, equipment and materials to and from the contract site;
(e) Costs of hiring plant and equipment;
(f) Costs of design and technical assistance that are directly related to the contract;
(g) The estimated costs of rectification and guarantee work, including expected warranty costs; and
(h) Claims from third parties.

These costs may be reduced by any incidental revenue that is not included in contract revenue, for
example revenue from the sale of surplus materials at the end of the contract.

7.5.2 Related costs

Costs that may be attributable to contract activity in general and can be allocated to specific contracts
include:
(a) Insurance;
(b) Costs of design that are not directly related to a specific contract; and
(c) Construction overheads.

Such costs are allocated using methods that are systematic and rational and are applied consistently to
all costs having similar characteristics. The allocation is based on the normal level of construction
activity.

7.5.3 Directly chargeable costs

Costs that are specifically chargeable to the customer under the terms of the contract may include
some general administration costs and development costs for which reimbursement is specified in the
terms of the contract.

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Costs that cannot be attributed to contract activity or cannot be allocated to a contract are excluded
from the costs of a construction contract. Such costs include:
(a) General administration costs for which reimbursement is not specified in the contract;
(b) Selling costs;
(c) Research and development costs for which reimbursement is not specified in the contract; and
(d) Depreciation of idle plant and equipment that is not used on a particular contract.

However, costs that relate directly to a contract and which are incurred in securing the contract are
also included as part of the contract costs if they can be separately identified and measured reliably
and it is probable that the contract will be obtained. When costs incurred in securing a contract are
recognized as an expense in the period in which they are incurred, they are not included in contract
costs when the contract is obtained in a subsequent period.

7.5.4 Costs relating to future activity

A contractor may have incurred contract costs that relate to future activity on the contract. Such
contract costs are recognized as an asset provided it is probable that they will be recovered. Such costs
represent an amount due from the customer and are often classified as contract work in progress.

7.5.5 Recognition of Expected Deficits

In respect of construction contracts in which it is intended at inception of the contract that contract
costs are to be fully recovered from the parties to the construction contract, when it is probable that
total contract costs will exceed total contract revenue, the expected deficit should be recognized as an
expense immediately.

7.6 Recognition of Contract Revenue and Expenses

When the outcome of a construction contract can be estimated reliably, contract revenue and contract
costs associated with the construction contract should be recognized as revenue and expenses
respectively by reference to the stage of completion of the contract activity at the reporting date.

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An expected deficit on a construction contract to which should be recognized as an expense

immediately.

7.6.1 Fixed price contracts

In the case of a fixed price contract, the outcome of a construction contract can be estimated reliably
when all the following conditions are satisfied:
(a) Total contract revenue, if any, can be measured reliably;
(b) It is probable that the economic benefits or service potential associated with the contract will
flow to the entity;
(c) Both the contract costs to complete the contract and the stage of contract completion at the
reporting date can be measured reliably; and
(d) The contract costs attributable to the contract can be clearly identified and measured reliably
so that actual contract costs incurred can be compared with prior estimates.

7.6.2 Cost plus or Cost based contracts

In the case of a cost plus or cost based contract, the outcome of a construction contract can be
estimated reliably when all the following conditions are satisfied:
(a) It is probable that the economic benefits or service potential associated with the contract will
flow to the entity; and
(b) The contract costs attributable to the contract, whether or not specifically reimbursable, can
be clearly identified and measured reliably.

7.7 Stage of completion

The recognition of revenue and expenses by reference to the stage of completion of a contract is often
referred to as the percentage of completion method. Under this method, contract revenue is matched
with the contract costs incurred in reaching the stage of completion, resulting in the reporting of
revenue, expenses and surplus/deficit which can be attributed to the proportion of work completed.

This method provides useful information on the extent of contract activity and performance during a
period. Under the percentage of completion method, contract revenue is recognized as revenue in the
statement of financial performance in the reporting periods in which the work is performed. Contract
costs are usually recognized as an expense in the statement of financial performance in the reporting
periods in which the work to which they relate is performed.

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The stage of completion of a contract may be determined in a variety of ways. The entity uses the
method that measures reliably the work performed. Depending on the nature of the contract, the
methods may include:
(a) The proportion that contract costs incurred for work performed to date bear to the estimated total
contract costs;
(b) Surveys of work performed; or
(c) Completion of a physical proportion of the contract work.

Progress payments and advances received from customers often do not reflect the work performed.

7.8 Change in circumstances

The outcome of a construction contract can only be estimated reliably when it is probable that the
economic benefits or service potential associated with the contract will flow to the entity. However,
when an uncertainty arises about the collectability of an amount already included in contract revenue,
and already recognized in the statement of financial performance, the uncollectable amount or the
amount in respect of which recovery has ceased to be probable is recognized as an expense rather than
as an adjustment of the amount of contract revenue.

Where contract costs which are to be reimbursed by parties to the contract are not probable of being
recovered, they are recognized as an expense immediately. Examples of circumstances in which the
recoverability of contract costs incurred may not be probable and in which contract costs may need to
be recognized as an expense immediately include contracts:
(a) Which are not fully enforceable, that is, their validity is seriously in question;
(b) The completion of which is subject to the outcome of pending litigation or legislation;
(c) Relating to properties that are likely to be condemned or expropriated;
(d) Where the customer is unable to meet its obligations; or
(e) Where the contractor is unable to complete the contract or otherwise meet its obligations under the
contract.

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7.9 Changes in Estimates

The percentage of completion method is applied on a cumulative basis in each reporting period to the
current estimates of contract revenue and contract costs. Therefore, the effect of a change in the
estimate of contract revenue or contract costs, or the effect of a change in the estimate of the outcome
of a contract, is accounted for as a change in accounting estimate (see IPSAS 3, “Accounting Policies,
Changes in Accounting Estimates and Errors”).

7.10 Disclosure Requirements

An entity should disclose:
(a)The amount of contract revenue recognized as revenue in the period;
(b) The methods used to determine the contract revenue recognized in the period; and
(c)The methods used to determine the stage of completion of contracts in progress.

An entity should disclose each of the following for contracts in progress at the reporting date:
(a) The aggregate amount of costs incurred and recognized surpluses (less recognized deficits)
to date;
(b) The amount of advances received; and
(c) The amount of retentions.

Retentions are amounts of progress billings which are not paid until the satisfaction of conditions
specified in the contract for the payment of such amounts or until defects have been rectified.

Progress billings are amounts of contract revenue billed for work performed on a contract whether or
not they have been paid by the customer.

Advances are amounts of contract revenue received by the contractor before the related work is
performed.

An entity should present:

(a) The gross amount due from customers for contract work as an asset; and
(b) The gross amount due to customers for contract work as a liability.

The gross amount due from customers for contract work is the net amount of:

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(i) Costs incurred plus recognized surpluses; less

(ii) The sum of recognized deficits and progress billings for all contracts in progress for which
costs incurred plus recognized surpluses to be recovered by way of contract revenue (less
recognized deficits) exceeds progress billings.

The gross amount due to customers for contract work is the net amount of:
(i) Costs incurred plus recognized surpluses; less
(ii) The sum of recognized deficits and progress billings for all contracts in progress for
which progress billings exceed costs incurred plus recognized surpluses to be recovered
by way of contract revenue (less recognized deficits).

7.11 Class discussion

Question 1
The Construction Agency entered into a three year contract to construct a pipeline for a neighbouring
country. The contract value was $9 million. At the end of the first year, the following figures were
extracted from the accounting records of The Construction Agency:

Contract: $’000
Certified value of work completed 3,000
Corresponding costs 2,400
Estimate of further costs to completion 4,100
Progress payments received 2,500
Costs incurred to date 2,700

Required
a. What is the total expected surplus on the contract?
b. What amounts will be included in the statement of financial performance at the end of year 1?
c. What is the gross amount due from the contract customer?

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Question 2
The Transport Agency entered into a contract to construct an asset on behalf of a company. The value
of work certified in the current year was $750,000. Costs incurred in completing this certified work
were $575,000. During the year the agency paid out $600,000 in respect of this contract, and invoiced
its customer for $700,000 all of which was received by the end of the accounting period.

The contract is expected to take 3 years to complete and it is expected that a further $200,000 of costs
will be incurred. The total value of the contract is $1,200,000. The outcome of the contract is
reasonably certain.

Required
Show the statement of financial performance and statement of financial position entries for the above
contract in the Transport Agency’s financial statements for the current year.

Question 3
Agency A has a contract with a total fixed price of $50,000. The contract is for three years.
Costs are incurred as follows:

Years: $
Year 1 15,000
Year 2 15,000
Year 3 10,000

Payments on account made by the customer are as follows:

Years: $
Year 1 20,000
Year 2 20,000
Year 3 10,000

No profit should be recognised until year 2. Profits recognised should be calculated on the basis of %
of costs incurred.

Required
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Calculate the figures to be taken to the statement of financial performance and statement of financial
position of Agency A in each of the 3 years.

Question 4
The following trial balance was extracted from the accounting records of Learnmore School as at 31
December 2017:
$ $
Sale of school uniforms and books 345,000
Funding grants 1,010,000
Other operating expenses 255,000
Loan interest paid 2,250
Rental income 89,000
Wages and salaries 847,040
Income from adult education courses (note 5) 205,000
Capital contributed by government 275,000
Buildings – at valuation 450,000
Land - at valuation 200,000
Fixtures, fittings and equipment 567,000
Accumulated depreciation: buildings (at 1 Jan 2017) 30,000
: fixtures, fittings and equipment (at 1 Jan 2017) 250,000
Provision (note 3) 38,000
Bank 173,400
Current asset investments 30,000
Trade receivables and payables 38,460 75,150
Long term bank loan 112,000
Retained earnings (at 1 Jan 2017) 39,000
Revaluation reserve 95,000
2,563,150 2,563,150
Additional information:
i. It is the school’s policy to hold land and buildings at revalued amount. A valuation of land and
buildings during the year revealed that land was worth $230,000 and buildings $475,000.
ii. No depreciation charge has yet been accounted for.

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(ii) The school’s policy is to depreciate buildings straight line over their useful economic life of
60 years, of which 47 was remaining as at 1 January 2017.
(iii)Equipment is depreciated using the reducing balance basis at 20% per year.
(iv) The provision relates to an on-going discrimination claim by a former teacher. Shortly before
the end of the current financial year, the ex-teacher agreed to settle his claim in exchange for
total compensation of $45,000 and a bank transfer for the full amount was made on 31
December 2017, thus marking the end of the case. No entries have yet been made to the
accounts.
(v) During the year, a pupil was injured during a rugby match. The pupil’s parents have begun
legal proceedings, and the school’s legal advisors believe that the school will eventually have
to pay compensation of $500,000. Due to a backlog in the national courts system, the case is
unlikely to be resolved in court until the end of 2020. The country’s central treasury
department recommends that all provisions are discounted at 3% per year. No amounts have
yet been included in the trial balance.
(vi) The school provides evening courses to adults in the local area, and these are fully funded by
fees charged to adults. Of the total income of $205,000 shown in the trial balance, $106,000
relates to the September – December 2017 term and the remainder relates to fees paid in
advance for the January – April 2018 term.
(vii) On 15 August 2017, the National Languages Agency made a bank transfer of $29,000
to the school. This is included in the funding grants balance in the trial balance.
(viii) The grant was made to the school for improving learning outcomes for students whose
first language is not English, and has been given on the condition that it is used to employ a
specially trained language teacher. A suitably qualified teacher was employed for this project
from 1 September 2017, and the total salary cost for the teacher up to 31 December 2017 was
$8,000.

Under the terms of the grant, the money can only be used as stipulated, and the school is required to
include a note in its audited general purpose financial statements detailing how the grant money was
spent. The agreement requires the grant to be spent as specified by 31 August 2018 or be returned to
the agency.
(ix) On 1 July 2017, the school entered into a 24 month operating lease on a photocopying
machine. The machine was received on the same day and immediately went into use. The
leasing company has given the school free rental for the first 6 months of the lease, with
payments of $2,000 per month to commence on 1 January 2018 for each of remaining 18
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months of the lease. As no payments were made during the year, the school’s accountant has
made no entry into the accounts for the lease.
Required:
(a) Explain, with reference to the relevant IPSAS, how items 5 and 6 above should be treated in the
school’s financial statements for the year-ended 31 December 2017.
(b) Prepare the school’s statement of financial performance for the year-ended 31 December 2017
and the statement of financial position at that date.

CHAPTER 8: INVENTORIES (IPSAS

12)
8.0 Introduction
This International Public Sector Accounting Standard (IPSAS) is drawn primarily from International
Accounting Standard (IAS) 2 (revised 2003), “Inventories” published by the International Accounting
Standards Board (IASB). Extracts from IAS 2 are reproduced in the publication of the International

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Public Sector Accounting Standards Board (IPSASB) of the International Federation of Accountants
(IFAC) with the permission of the International Accounting Standards Committee Foundation
(IASCF).
The objective of this Standard is to prescribe the accounting treatment for inventories. A primary
issue in accounting for inventories is the amount of cost to be recognized as an asset and carried
forward until the related revenues are recognized. This Standard provides guidance on the
determination of cost and its subsequent recognition as an expense, including any write-down to net
realizable value. It also provides guidance on the cost formulas that are used to assign costs to
inventories.

8.1 Scope of IPSAS 12

All inventories except:
(i) Work in progress arising under construction contracts, including directly related service
contracts
(ii) Financial instruments;
(iii)Biological assets related to agricultural activity and agricultural produce at the point of harvest
(iv) Work in progress of services to be provided for no or nominal consideration directly in return
from the recipients.

This Standard does not apply to the measurement of inventories held by:
(a) Producers of agricultural and forest products, agricultural produce after harvest, and minerals
and mineral products, to the extent that they are measured at net realizable value in accordance
with well-established practices in those industries.

When such inventories are measured at net realizable value, changes in that value are recognized in
surplus or deficit in the period of the change.

(b) Commodity broker-traders who measure their inventories at fair value less costs to sell. When
such inventories are measured at fair value less costs to sell, changes in fair value less costs to
sell are recognized in surplus or deficit in the period of the change.

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8.2 Definitions
1. Current replacement cost is the cost the entity would incur to acquire the asset on the reporting
date.
2. Exchange transactions are transactions in which one entity receives assets or services, or has
liabilities extinguished, and directly gives approximately equal value (primarily in the form of
cash, goods, services, or use of assets) to another entity in exchange.
3. Fair value is the amount for which an asset could be exchanged, or a liability settled, between
knowledgeable, willing parties in an arm’s length transaction.

4. Inventories are assets:

(a) In the form of materials or supplies to be consumed in the production process;
(b) In the form of materials or supplies to be consumed or distributed in the rendering of services;
(c) Held for sale or distribution in the ordinary course of operations; or
(d) In the process of production for sale or distribution.

5. Net realizable value is the estimated selling price in the ordinary course of operations less the
estimated costs of completion and the estimated costs necessary to make the sale, exchange or
distribution.
6. Non-exchange transactions are transactions that are not exchange transactions. In a non-
exchange transaction, an entity either receives value from another entity without directly
giving approximately equal value in exchange, or gives value to another entity without directly
receiving approximately equal value in exchange.

8.3 Inventories
(i) Inventories encompass goods purchased and held for resale including, for example,
merchandise purchased by an entity and held for resale, or land and other property held for
sale.

(ii) Inventories also encompass finished goods produced, or work in progress being produced, by
the entity.
(iii)Inventories also include materials and supplies awaiting use in the production process and
goods purchased or produced by an entity, which are for distribution to other parties for no

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charge or for a nominal charge; for example, educational books produced by a health authority
for donation to schools.

In many public sector entities inventories will relate to the provision of services rather than goods
purchased and held for resale or goods manufactured for sale. In the case of a service provider,
inventories include the costs of the service for which the entity has not yet recognized the related
revenue

Inventories in the public sector may include:

(a) Ammunition;
(b) Consumable stores;
(c) Maintenance materials;
(d) Spare parts for plant and equipment other than those dealt with in Standards on Property, Plant
And Equipment;
(e) Strategic stockpiles (for example, energy reserves);
(f) Stocks of unissued currency;
(g) Postal service supplies held for sale (for example, stamps);
(h) Work in progress, including:
- Educational/training course materials; and
- Client services (for example, auditing services) where those services are sold at arm’s length
prices; and
- Land/property held for sale.

8.4 Measurement of Inventories

Inventories shall be measured at the lower of cost and net realizable value, except where inventories
are acquired through a non-exchange transaction, their cost shall be measured at their fair value as at
the date of acquisition.

Inventories shall be measured at the lower of cost and current replacement cost where they are held
for:
i. Distribution at no charge or for a nominal charge; or
ii. Consumption in the production process of goods to be distributed at no charge or for a nominal
charge.

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8.5 Cost of Inventories

The cost of inventories shall comprise all costs of purchase, costs of conversion and other costs
incurred in bringing the inventories to their present location and condition.

8.5.1 Costs of Purchase

The costs of purchase of inventories comprise the;
- purchase price;
- import duties and other taxes (other than those subsequently recoverable by the entity from
the taxing authorities); and
- transport, handling and other costs directly attributable to the acquisition of finished goods,
materials and supplies.
Trade discounts, rebates and other similar items are deducted in determining the costs of purchase.

8.5.2 Costs of Conversion

The costs of converting work-in-progress inventories into finished goods inventories are incurred
primarily in a manufacturing environment. The costs of conversion of inventories include costs
directly related to the units of production, such as direct labour.

They also include a systematic allocation of fixed and variable production overheads that are incurred
in converting materials into finished goods.

8.5.3 Other Costs

Other costs are included in the cost of inventories only to the extent that they are incurred in bringing
the inventories to their present location and condition.

8.5.4 Excluded costs

Examples of costs excluded from the cost of inventories and recognized as expenses in the period in
which they are incurred are:
i. Abnormal amounts of wasted materials, labor, or other production costs;
ii. Storage costs, unless those costs are necessary in the production process before a further
production stage;
iii. Administrative overheads that do not contribute to bringing inventories to their present location
and condition; and

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iv. Selling costs.

8.5.5 Cost of Inventories of a Service Provider

To the extent that service providers have inventories, they measure them at the costs of their
production.

The cost of inventories of a service provider does not include surplus margins or non-attributable
overheads that are often factored into prices charged by service providers.

8.5.6 Cost of Agricultural Produce Harvested from Biological assets

In accordance with the relevant international or national accounting standard dealing with agriculture,
inventories comprising agricultural produce that an entity has harvested from its biological assets may
be measured on initial recognition at their fair value less estimated point-of sale costs at the point of
harvest. This is the cost of the inventories at that date for application of this Standard.

8.5.7 Techniques for the Measurement of Cost

Techniques for the measurement of the cost of inventories, such as;
i. the standard cost method; or
ii. the retail method, may be used for convenience if the results approximate cost.

Standard costs take into account normal levels of materials and supplies, labour, efficiency and
capacity utilization. They are regularly reviewed and, if necessary, revised in the light of current
conditions.

Inventories may be transferred to the entity by means of a non-exchange transaction. For example, an
international aid agency may donate medical supplies to a public hospital in the aftermath of a natural
disaster. Under such circumstances, the cost of inventory is its fair value as at the date it is acquired.

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8.5.8 Cost Formulas

The cost of inventories of items that are not ordinarily interchangeable and goods or services
produced and segregated for specific projects shall be assigned by using specific identification of their
individual costs.

Specific identification of costs means that specific costs are attributed to identified items of inventory.
This is an appropriate treatment for items that are segregated for a specific project, regardless of
whether they have been bought or produced.

The cost of inventories, shall be assigned by using the first-in, first-out (FIFO) or weighted average
cost formulas. An entity shall use the same cost formula for all inventories having a similar nature and
use to the entity. For inventories with a different nature or use, different cost formulas may be
justified.

8.5.8.1 Net Realizable Value

The cost of inventories may not be recoverable if those inventories are damaged, if they have become
wholly or partially obsolete, or if their selling prices have declined. The cost of inventories may also
not be recoverable if the estimated costs of completion or the estimated costs to be incurred to make
the sale, exchange or distribution have increased.

8.5.9 Distributing Goods at No Charge or for a Nominal Charge

A public sector entity may hold inventories whose future economic benefits or service potential are
not directly related to their ability to generate net cash inflows. These types of inventories may arise
when a government has determined to distribute certain goods at no charge or for a nominal amount.
In these cases, the future economic benefits or service potential of the inventory for financial
reporting purposes is reflected by the amount the entity would need to pay to acquire the economic
benefits or service potential if this was necessary to achieve the objectives of the entity or else an
estimate of replacement cost will need to be made.

8.5.10 Recognition as an Expense

When inventories are sold, exchanged or distributed the carrying amount of those inventories shall be
recognized as an expense in the period in which the related revenue is recognized. If there is no

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related revenue, the expense is recognized when the goods are distributed or related service is
rendered.

The amount of any write-down of inventories and all losses of inventories shall be recognized as an
expense in the period the write-down or loss occurs. The amount of any reversal of any write-down of
inventories shall be recognized as a reduction in the amount of inventories recognized as an expense
in the period in which the reversal occurs.

For a service provider, the point when inventories are recognized as expenses normally occurs when
services are rendered, or upon billing for chargeable services.

Some inventories may be allocated to other asset accounts, for example, inventory used as a
component of self-constructed property, plant or equipment. Inventories allocated to another asset in
this way are recognized as an expense during the useful life of that asset.

8.6 Disclosure Requirements

47. The financial statements shall disclose:
i. The accounting policies adopted in measuring inventories, including the cost formula used;
ii. The total carrying amount of inventories and the carrying amount in classifications appropriate
to the entity;
iii. The carrying amount of inventories carried at fair value less costs to sell;
iv. The amount of inventories recognized as an expense during the period;
v. The amount of any write-down of inventories recognized as an expense in the period
vi. The amount of any reversal of any write-down that is recognized in the statement of financial
performance in the period
vii. The circumstances or events that led to the reversal of a writedown of inventories
viii. The carrying amount of inventories pledged as security for liabilities.

8.7 Discussion Questions

Question 1
Required
Which of the following can be included as part of the cost of inventories?

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Question 2
On 31 December 2016 a public sector organisation held 180 boxes of bond paper valued at $18.00
each. Transactions during the year 2017 were as follows:
Purchases Boxes $/ box
10 January 120 18.95
28 February 200 19.20
11 April 130 20.35
29 June 250 20.40
24 July 300 20.75
14 November 200 21.25
24 December 100 21.80

Boxes of paper were taken out of the inventory stores and used as follows:
Boxes
13 January 110
2 March 190
21 April 90
2 May 140
21 August 320
19 December 120

Required
Use the information above to value the inventory at the end of the year on both the weighted average
and FIFO methods.
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Question 3
Manufacturing costs in 2016 for inventory held at the year-end are $60 million. All goods held at the
year-end were sold in January 2017, for $50 million. The selling costs incurred for the goods sold in
January 2017 were $4 million. At what value should inventory be held on the SOFP as at 31 Dec
2016?

Question 4
How would you value the following items of inventory?
Medical supplies were bought by a hospital pharmacy for sale to private patients. The following items
were in stock on 31 December 2017:
(a) 150 bottles of Drug A which cost $3 per bottle and which is normally sold at $3.50 per bottle.
New regulations mean that the drug has to be put into new containers which cost $0.75 each.
(b) 10 litres of Drug B which costs $50 per litre and normally sells at $6 per 100ml. A check of
individual items revealed that 2 litres of the drug is now past its use by date.
(c) 500 bandages which cost $2 each and are normally sold to patients at cost.

Question 5
A local supermarket has donated several tonnes of tinned food to a food bank run by a local authority.
The food will be distributed free of charge to local families in need. The food cost the supermarket
$14,000.

At the date when the food was delivered to the bank, the total fair value was $13,200. The current
replacement cost at the reporting date is $12,600. If the food bank was to sell each item of food
individually at normal retail prices to local residents, the total net realisable value would be $16,500.
Required:
Assuming that all the food is still held in inventory at the year-end, at how much would the authority
value the food under IPSAS 12 Inventories?

Question 5

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A hospital is preparing its financial statements for the year-ended 31 December 2017 and needs
calculate the total value of inventory as at the year-end. A count of all inventories gave a total value of
$387,000 but the hospital’s accountant was unsure of the treatment of the following:

a. 3,000 vaccination kits donated to the hospital by an international aid charity shortly before the
year-end have been included at a value of $1, as the accountant felt that since the kits had not
cost the hospital anything, this nominal amount would be a reasonable basis to include them in
the accounts. Upon checking the website of the company that makes the kits, it appears that their
value is $4.50 each.
b. The valuation includes $9,000 of medicines which were found to be out of date during the
inventory count. These medicines will need to be disposed of. There will be no cost incurred
during the disposal.
c. One of the hospital’s medicines is produced in-house, and the 1,220 bottles of this medicine held
at the year-end have been included in the year-end valuation at $6.50/bottle. This valuation has
been calculated by the accountant as follows:
- Raw materials per item $3.00
- Labour per item $2.00
- Pharmacy overhead per item $1.50
The hospital’s management accountancy department had calculated earlier in the year that the
standard overhead to be attributed to each bottle produced should be 80 cents, but the accountant
decided to increase this to $1.50 in the closing inventory valuation because fire damage in the
pharmacy during the year had led to a short-term increase in overhead costs, and the accountant is
keen that some of these costs are deferred until next year by increasing the inventory valuation.
d. The hospital has a large liquid oxygen storage tank which it uses to refill the portable oxygen
tanks used in various patient treatments. The accountant remembers that the oxygen is usually
valued on a weighted average cost basis but couldn’t remember how to do the calculation so it is
currently valued at nil. The accountant provides you with the following information:
- The prior year-end valuation was a total of 3,500 kilograms (kg) at 71cents/kg.
- During the year, two deliveries were received from the liquid oxygen supplier. 15,500 kg were
received on 1 April at a cost of 83cents per kg and a further 13,300 kg were received on 1
September at a price of 87cents per kg.
- Oxygen was taken from the bulk tank on 3 occasions during the year to refill all of the
hospital’s portable tanks. Dates and quantities were as follows:
April: 4,900 kg
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12 June: 6,300 kg
27 September: 7,050 kg
- As in previous years, the auditors have agreed that the oxygen held in portable tanks is not
material so no valuation is needed.
Required
Calculate the closing inventory valuation to be included in the hospital’s statement of financial
position as at 31 December 2017.

CHAPTER 9: LEASES (IPSAS 13)

9.0 Introduction
This International Public Sector Accounting Standard is drawn primarily from International
Accounting Standard (IAS) 17 (revised 2003), “Leases” published by the International Accounting
Standards Board (IASB). Extracts from IAS 17 are reproduced in standard of the International Public
Sector Accounting Standards Board of the International Federation of Accountants with the
permission of IASB.

9.1 Definitions
Because the transaction between a lessor and a lessee is based on a lease agreement between them, it
is appropriate to use consistent definitions. The application of these definitions to the differing
circumstances of the lessor and lessee may result in the same lease being classified differently by
them.

i. Lease
An agreement whereby the lessor conveys to the lessee in return for a payment or series of payments
the right to use an asset for an agreed period of time.

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i. Hire Purchase Contracts

The definition of a lease includes contracts for the hire of an asset which contain a provision giving
the hirer an option to acquire title to the asset upon the fulfillment of agreed conditions. These
contracts are sometimes known as hire purchase contracts.

ii. Initial direct costs

Costs that are directly attributable to negotiating and arranging a lease, except for such costs incurred
by manufacturer or trader lessors.

IPSAS 13 requires lessors to include the initial direct costs incurred in negotiating a finance lease in
the initial measurement of finance lease receivables. For operating leases, such initial direct costs are
added to the carrying amount of the leased asset and recognized over the lease term on the same basis
as the lease revenue. This treatment does not apply to manufacturer or trader lessors. Manufacturer or
trader lessors recognize this type of costs as an expense when the gain or loss is recognized.

iii. Commencement of the lease term

The date from which the lessee is entitled to Question its right to use the leased asset”.

It is the date of initial recognition of the lease (i.e. the recognition of the assets, liabilities, revenue or
expenses resulting from the lease, as appropriate).
iv. Inception of the lease
The earlier of the date of the lease agreement and the date of commitment by the parties to the
principal provisions of the lease.
As at this date:
(a) A lease is classified as either an operating or a finance lease; and
(b) In the case of a finance lease, the amounts to be recognized at the commencement of the lease
term are determined.

If the lease is adjusted for changes in the lessor’s costs between the inception of the lease and the
commencement of the lease term, the effect of any such changes is deemed to have taken place at the
inception
(iv) Contingent rent

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That portion of the lease payments that is not fixed in amount but is based on the future amount of a
factor that changes other than the passage of time (e.g., percentage of future sales, amount of future
use, future price indices, future market rates of interest).
(v) Economic life
Is either:
(a) The period over which an asset is expected to yield economic benefits or service potential to
one or more users; or
(b) The number of production or similar units expected to be obtained from the asset by one or
more users.

(vi) Fair value

The amount for which an asset could be exchanged, or a liability settled, between knowledgeable,
willing parties in an arm’s length transaction.
(vii) Finance lease
A lease that transfers substantially all the risks and rewards incidental to ownership of an asset. Title
may or may not eventually be transferred.
NB
(viii) Guaranteed residual value
That part of the residual value that is guaranteed by the lessee or by a party related to the lessee (the
amount of the guarantee being the maximum amount that could, in any event, become payable); and
For a lessor, that part of the residual value that is guaranteed by the lessee or by a third party
unrelated to the lessor that is financially capable of discharging the obligations under the guarantee.

(ix) Implicit interest rates

The discount rate that, at the inception of the lease, causes present value of the gross investments to be
equal to the sum of (i) the fair value of the leased asset and (ii) any initial direct costs of the lessor.

(x) Lease term

The non-cancelable period for which the lessee has contracted to lease the asset together with any
further terms for which the lessee has the option to continue to lease the asset, with or without further
payment, when at the inception of the lease it is reasonably certain that the lessee will Question the
option.
(xi) The lessee’s incremental borrowing rate of interest

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The rate of interest the lessee would have to pay on a similar lease or, if that is not determinable, the
rate that, at the inception of the lease, the lessee would incur to borrow over a similar term, and with a
similar security, the funds necessary to purchase the asset.

(xii) Minimum lease payments

The payments over the lease term that the
lessee is, or can be, required to make, excluding contingent rent, costs for services and, where
appropriate, taxes to be paid by and reimbursed to the lessor, together with:
(a) For a lessee, any amounts guaranteed by the lessee or by a party related to the lessee; or
(b) For a lessor, any residual value guaranteed to the lessor by:
- The lessee;
- A party related to the lessee; or
- An independent third party unrelated to the lessor that is financially capable of discharging the
obligations under the guarantee.

However, if the lessee has an option to purchase the asset at a price that is expected to be sufficiently
lower than the fair value at the date the option becomes exercisable for it to be reasonably certain, at
the inception of the lease, that the option will be Questiond, the minimum
lease payments comprise the minimum payments payable over the lease term to the expected date of
Question of this purchase option and the payment required to Question it.

(xiii) Net investment

It is the gross investment in the lease discounted at the interest rate implicit in the lease.

(xiv) Non-cancelable lease

It is a lease that is cancelable only:
- Upon the occurrence of some remote contingency;
- With the permission of the lessor;
- If the lessee enters into a new lease for the same or an equivalent asset with the same lessor; or
- Upon payment by the lessee of such an additional amount that, at inception of the lease,
continuation of the lease is reasonably certain.
(xv) Operating lease
Is a lease other than a finance lease.
(xvi) Unearned finance revenue
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Is the difference between:

a) The gross investment in the lease; and
b) The net investment in the lease.
(xvii) Useful life
It is the estimated remaining period, from the commencement of the lease term, without limitation by
the lease term, over which the economic benefits or service potential embodied in the asset are
expected to be consumed by the entity.

9.2 Scope of IPSAS 13

IPSAS 13 applies to all leases other than:
i. Leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources; and
ii. Licensing agreements for such items as motion picture films, video recordings, plays,
manuscripts, patents and copyrights.

And moreover, this Standard shall not be applied as the basis of measurement for:
i. Property held by Lessees that is accounted for as investment property (see International Public
Sector Accounting Standard IPSAS 16, “Investment Property”);
ii. Investment property provided by lessors under operating leases (see IPSAS 16);
iii. Biological assets held by lessees under finance leases (see the relevant international or national
accounting standard dealing with agriculture); or
iv. Biological assets provided by lessors under operating leases (see the relevant international or
national accounting standard dealing with agriculture).

9.3 Classification of Leases

The classification of leases adopted in IPSAS 13 is based on the extent to which risks and rewards
incidental to ownership of a leased asset lie with the lessor or the lessee. At the inception of the lease.
Risks include;
- the possibilities of losses from idle capacity;
- technological obsolescence; or
- changes in value because of changing economic conditions.

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Rewards may be represented by;

- the expectation of service potential or profitable operation over the asset’s economic life; and
- the gain from appreciation in value; or
- realisation of a residual value.

A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to
ownership.

A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards
incidental to ownership.

Whether a lease is a finance lease or an operating lease depends on the substance of the transaction
rather than the form of the contract. Although the following are examples of situations that
individually or in combination would normally lead to a lease being classified as a finance lease, a
lease does not need to meet all these criteria in order to be classified as a finance lease:

(a) The lease transfers ownership of the asset to the lessee by the end of the lease term;
(b) The lessee has the option to purchase the asset at a price that is expected to be sufficiently lower
than the fair value at the date the option becomes exercisable for it to be reasonably certain, at
the inception of the lease, that the option will be Questiond;
(c) The lease term is for the major part of the economic life of the asset even if title is not
transferred;
(d) At the inception of the lease the present value of the minimum lease payments amounts to at
least substantially all of the fair value of the leased asset;
(e) The leased assets are of such a specialized nature that only the lessee can use them without
major modifications; and
(f) The leased assets cannot easily be replaced by another asset.

Other indicators that individually or in combination could also lead to a lease being classified as a
finance lease are:
(a) If the lessee can cancel the lease, the lessor’s losses associated with the cancellation are borne
by the lessee;

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(b) Gains or losses from the fluctuation in the fair value of the residual accrue to the lessee (for
example in the form of a rent rebate equaling most of the sales proceeds at the end of the
lease); and
(c) The lessee has the ability to continue the lease for a secondary period at a rent that is
substantially lower than market rent.
If it is clear from other features that the lease does not transfer substantially all risks and rewards
incidental to ownership, the lease is classified as an operating lease.

9.3.1 Changes to lease conditions/provisions

Lease classification is made at the inception of the lease. If at any time the lessee and the lessor agree
to change the provisions of the lease, other than by renewing the lease, in a manner that would have
resulted in a different classification of the lease if the changed terms had been in effect at the
inception of the lease, the revised agreement is regarded as a new agreement over its term. However,
changes in estimates (for example, changes in estimates of the economic life or the residual value of
the leased property) or changes in circumstances (for example, default by the lessee), do not give rise
to a new classification of a lease for accounting purposes.

9.3.2 Lease on land and Buildings

Leases of land and buildings are classified as operating or finance leases in the same way as leases of
other assets. However, a characteristic of land is that it normally has an indefinite economic life and,
if title is not expected to pass to the lessee by the end of the lease term, the lessee normally does not
receive substantially all of the risks and rewards incidental to ownership, in which case the lease of
land will be an operating lease.

The land and buildings elements of a lease of land and buildings are considered therefore separately
for the purposes of lease classification. The minimum lease payments are allocated between the land
and buildings elements in proportion to the relative fair values of the leasehold interests in the land
and buildings elements of the lease.

9.3.2.1 Unreliable allocation

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If the lease payments cannot be allocated reliably between these two elements, the entire lease is
classified as a finance lease, unless it is clear that both elements are operating leases, in which case
the entire lease is classified as an operating lease.

9.3.2.2 Immaterial land component

For a lease of land and buildings in which the amount that would initially be recognized for the land
element is immaterial, the land and buildings may be treated as a single unit for the purpose of lease
classification and classified as a finance or operating lease. In such a case, the economic life of the
buildings is regarded as the economic life of the entire leased asset.

9.3.2.3 Leases interests are for investment

Separate measurement of the land and buildings elements is not required when the lessee’s interest in
both land and buildings is classified as an investment property in accordance with IPSAS 16 and the
fair value model is adopted. If it does, the property interest is accounted for as if it were a finance
lease and, in addition, the fair value model is used for the asset recognized.

9.4 Leases and Other Contracts

A contract may consist solely of an agreement to lease an asset. However, a lease may also be one
element in a broader set of agreements with private sector entities through public private partnerships.
Where an arrangement contains an identifiable operating lease or finance lease as defined in this
Standard, the provisions of this Standard are applied in accounting for the lease component of the
arrangement.
Accounting Standards, or in the absence thereof, other relevant international and/or national
accounting standards.

9.5 Accounting for operating leases

Accounting for an operating lease is the easier of the two, so we can deal with this first. The basic
requirement is that the operating lease payments should be recorded as an expense in the statement of
financial performance on a straight line basis, unless another systematic basis is representative of the
time pattern of the user’s benefit.

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The principle is because the risks and rewards have not been transferred to the organisation that is
using the asset, the payments should be recorded in a similar way to expenses such as rental
payments. The accounting entry then is in most cases simply a debit to the appropriate operating
expenses account and a credit to the cash account for the annual lease payments.
The fact that the standard requires this to be on a straight line basis adds a slight complication in some
cases. For example, an operating lease may involve the payments:
Year Payment
1 $10,000

2 $25,000

3 $25,000

If we want to account for this on a straight line basis, the annual expense should be $20 000 (i.e. total
payments of $60 000 over three years).
In year 1, the statement of financial performance should show an expense of $20 000 and the
accounting entries will be:
DR Operating lease expenses $20,000
CR Cash $10,000
CR Payables $10,000
This means that we match the cost of $20,000 with the benefit received from the use of the asset,
since the benefit received from using the asset is the same in all three years, regardless of the fact that
we paid less for year 1.

$20,000 will be recognised in year two by reducing, in part, the liability recorded in year one:
Dr Operating lease expenses $20,000
Dr Payables $5,000
Cr Cash $25,000
In the third and final year the same accounting entries will be put through as in year two, thus fully
accounting for the liability.

9.6 Accounting for finance leases

Finance leases can be much more complicated to account for. The key difference from the accounting
for an operating lease is that assets acquired under a finance lease should be treated as assets in the

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statement of financial position along with assets actually owned by the organisation. This entry is
balanced initially by a liability in the statement of financial position of an equal amount.

This initial amount should be equal to the fair value of the leased asset or the present value of the
minimum lease payments if that is lower.

Present values take into account the timing of a payment, reducing future payments depending on how
far into the future they occur using an appropriate discount rate.

For example, let us assume that a government enterprise enters into a five year lease arrangement for
computer equipment. The assets are expected to have a useful life of five years and the organisation
will be responsible for all maintenance of the equipment. The fair value of the computers is $75 000
and annual payments are $20 000. To account for this fully, we need to complete four steps which we
will now look at in order.
Step 1 Record the asset and the associated liability
This will be at the fair value of the assets.
DR Non-current assets $75,000
CR Non-current liabilities $75,000
This shows the user of the statement of financial position that the organisation has use of assets worth
$75,000 and these will be included along with any owned non-current assets.
Step 2 Depreciate the asset
As we are including the computers along with our other assets they should be depreciated in the same
way as the owned assets. Assuming straight line depreciation the entries would be:
$75 000/5 years = $15,000
DR Operating expenses $15,000
CR Accumulated depreciation $15,000
This means after one year that the organisation will show an asset with a net book value of $60 000
(i.e. non-current asset cost of $75,000 less one year’s depreciation of $15,000).
Note that the asset should always be depreciated over the shorter of the useful economic life and lease
term.
Step 3. Split the payment into a finance charge and a reduction in the outstanding liability
You may have noticed that the total payments are more than the fair value that we have just shown
under non-current assets, i.e. total payments are $100,000 and the fair value is $75,000. The
difference between the two is effectively a finance charge and that is how IPSAS 13 requires it to be
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recorded. Each time a payment of $20,000 is recorded this will need to be split into two, i.e. part of
the $20,000 will be shown as a reduction in the outstanding liability on the statement of financial
position and the remainder shown as finance charge in the statement of financial performance.

The simplest way to do this would be on a straight line basis, i.e. split the finance charge equally over
the life of the asset ($25,000 (being the excess of payment value compared to the fair value of the
asset) / 5 years (life of the lease term) = $5,000 p.a.). However, as the liability reduces, it would be
reasonable to expect the finance charge to reduce as well. For this reason IPSAS 13 requires the
finance charge to be allocated to periods in a way that produces a constant rate of interest on the
remaining balance of the liability. It can be quite complicated to calculate this rate of interest so the
standard allows an approximation to be used to simplify the calculation.

One commonly used approach is the sum of digits method. This can be applied to the example above
to split the $20,000 annual payment between a finance charge and a reduction in the liability. We do
this by using the number of years involved in the lease as a basis for weighting the finance charge in
each year, with year 1 being given the highest weighting:
Year Weight
1 5
2 4
3 3
4 2
5 1
Total 15
The sum of all the weightings is 15 and we allocate 5/15 to year 1, 4/15 to year 2 and so on. The
finance charge in year 1 will therefore be 5/15 x $25,000 = $8,333. This means that the remaining
$11,667 of the annual payment will be shown as a reduction in the liability.
DR Finance charge $8,333
DR Non-current liabilities: finance lease $11,667
CR Cash $20,000

Step 4. Split the outstanding liability between current liabilities and non-current liabilities
The liability has now been reduced to $63,333 (i.e. $75,000 – $11,667). This amount is partly due to
be paid within the next year and partly due to be paid in more than one year. If the statement of

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financial position distinguishes between current and non-current liabilities the $63,333 should be
allocated accordingly.
To do that, we need to work out the split in the payment for year 2. The finance charge in year 2 will
be 4/15 x $25,000 = $6,666 This means that the reduction in the liability in year 2 will be $13,333
(i.e. $20,000 – $6,666).
DR Non-current liabilities: finance lease $13,333
CR Current liabilities: finance lease $13,333 This results in the statement of financial position at the
end of year 1 showing the following information:
Non-current assets (NBV) $60,000
Current liabilities: finance lease $13,333
Non-current liabilities: finance lease $50,000
Note that, although initially the asset and the liability relating to the lease were the same amount (i.e.
the fair value of $75 000), at the end of year 1 they can be different if, as in this case, the rate of
depreciation is not the same as the rate of reduction of the liability.

We can show the reduction in the liability in a table

Year Liability Interest Principal Payment Liability
b/f c/f
$ $ $ $ $
1 75,000 8,333 11 667 20,000 63,333
2 63,333 6,666 13,333 20,000 50,000
3 50,000 5,000 15,000 20,000 35,000
4 35,000 3,333 16,667 20,000 1333
5 18,333 1,666 18,333 20,000 0

9.6.1 Finance leases with payments in advance

In the examples above, we assumed that the lease payments were made at the end of the year. This
meant that we needed to accrue a full year’s interest when splitting the lease payment into interest and
principal. If the lease payment is actually made in advance, the pattern in which interest is accrued
will be different, and this should be taken into account in the way that interest is calculated and
accrued.

9.6.1.1 Worked example: payments in advance

A government agency leased a piece of plant and machinery from ABC Plc on 1 January 2017. The
fair value of the leased machinery is $100,000 and the lease term is three years.
Payments of $40,210 are made on the first day of each financial year.

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Using the sum of digits method, show how the amounts are taken to the statement of financial
performance and the statement of financial position for the year-ended 31 December 2017. Use
straight line depreciation.

Solution to worked example

The agency makes each of the three annual lease payments on the first day of the year. Therefore, in
the third (i.e. final) year of the lease, there is no liability to the leasing company (as the final payment
has been made on the first day of the year) and hence no finance cost needs to be recognised for the
last year of the lease.
Therefore, when spreading the finance cost across the years of the lease no allocation is needed for
year 3.
Step 1: Capitalise asset
We need to debit non-current assets with the fair value of $100,000, with the other side of the entry
being a credit to liabilities.

The depreciation calculation is the same whether the payment is in advance or arrears, i.e.:
$100,000 = $33,333
3 years
Step 3: Split the payment into a finance charge and a reduction in the liability
Total lease payments (3 x $40,210) $120,630
Fair value of asset $100,000
Total finance cost $20,630
As no finance cost is needed for year 3, we need to eliminate the final year from our sum of digits
calculation, i.e. 1 + 2 = 3
Year 1 2/3 x $20,630 = $13,753
Year 2 1/3 x $20,630 = $6,877
Year 3 No finance cost

Step 4: Split the outstanding liability between payables and non-current liabilities
We can now use these finance cost amounts to calculate the closing liability on the statement of
financial position.

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Note that this table is set out differently to the payments in arrears example because the payment
happens on the first day of the year (hence the immediate reduction in the initial balance by the annual
lease payment).
Therefore, the finance cost for the year has to be accrued as it is not paid to the leasing company until
the first day of the next financial year.

Year Liability b/f Payment Balance after payment Interest Liability c/f
$ $ $ $ $
1 100,000 (40,210) 59,790 13,753 73,543
2 73,543 (40,210) 33,333 6,877 40,210
3 40,210 (40,210) 0 0 0

The total closing liability at the end of Year 1 has to include the interest that has accrued during the
year but will not be paid off until day 1 of the next financial year (i.e. a total liability of $73 543). Of
this, the current liability amount is the whole of next year’s lease payment (as it is due immediately
after the end of the current financial year). Non-current liabilities are the remainder, i.e. $33 333.
Therefore, the following amounts will be taken to the financial statements:

Statement of financial performance for the year ended 31 December 2017 (extract) $
Expenses
Depreciation expense (33,333)
Finance costs (13,753)

Statement of financial position for the year ended 31 December 2017 (extract) $
Non-current assets (NBV) 66,667
Non-current liabilities 33,333
Current liabilities 40,210

9.6.2 Finance leases: Other methods of allocating finance costs

The standard does not mention the sum of digits method, or any other specific method of allocating
the finance costs. The key issue is that the expense each year should reflect the outstanding liability
during that period at a constant rate of interest. As the liability reduces, the finance cost should also
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reduce. It is clear from the examples above that the sum of digits method achieves this objective, but
in a very simplified way.

A further method that would meet the requirements of IPSAS 13 is the actuarial method. This
involves using a specified percentage as the basis for determining the interest expense in each period.
The method for computing this specified percentage is complex and outside the scope of your studies.

Worked example: Actuarial method

A government enterprise enters into a five year lease arrangement for computer equipment. The assets
are expected to have a useful life of five years and the organisation will be responsible for all
maintenance of the equipment. The fair value of the computers is $75,000 and annual payments are
$20,000.

Solution to worked example

Using the actuarial method, and applying an effective interest rate of 10.42%, the following pattern of
interest expenses would result (allowing for roundings):
Opening liability Finance cost Reduction in Closing liability
10.42% liability
$ $ $ $
75,000 7,815 12,185 62,815
62,815 6,545 13,455 49,360
49,360 5,143 14,857 34,504
34,504 3,595 16,405 18,099
18,099 1,901 18,099 0
25,000 75,000

The finance cost is determined by multiplying the opening liability by the interest rate of 10.42%
(assuming a single payment at the end of the year). So in year 1, this is $75,000 x 10.42% = $7,815.
In the final year, the figures have been modified slightly to ensure that the total finance costs over the
life of the lease come to the required $25,000. Using the actuarial method this adjustment may be
needed unless the interest rate is specified to several decimal places to avoid rounding differences.
We can see how the figures calculated are similar to the sum of digit calculations in the previous
example. As with the sum of digits method, the finance cost reduces each year in line with the
reduction in the liability, thus complying with the requirements of IPSAS 13.
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9.7 Disclosure requirements

9.7.1 Operating leases:
Lessees must disclose:
(a) The total of future minimum lease payments under non-cancellable operating leases for each of the
following periods:
(i) Not later than one year;
(ii) Later than one year and not later than five years; and
(iii) Later than five years;
(b) The total of future minimum sublease payments expected to be received under non-cancellable
subleases at the reporting date;
(c) Lease and sublease payments recognised as an expense in the period, with separate amounts for
minimum lease payments, contingent rents, and sublease payments; and
(d) A general description of the lessee’s significant leasing arrangements including, but not limited to,
the following:
(i) The basis on which contingent rent payments are determined;
(ii) The existence and terms of renewal or purchase options and escalation clauses; and
(iii) Restrictions imposed by lease arrangements, such as those concerning return of surplus, return of
capital contributions, dividends or similar distributions, additional debt, and further leasing.

9.7.2 Finance leases:

Lessees must disclose:
(a) For each class of asset, the net carrying amount at the reporting date;
(b) A reconciliation between the total of future minimum lease payments at the reporting date, and
their present value;
(c) In addition, an entity shall disclose the total of future minimum lease payments at the reporting
date, and their present value, for each of the following periods:
(i) Not later than one year;
(ii) Later than one year and not later than five years; and
(iii) Later than five years;
(d) Contingent rents recognised as an expense in the period;

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(e) The total of future minimum sublease payments expected to be received under non-cancellable
subleases at the reporting date; and
(f) A general description of the lessee’s material leasing arrangements including, but not limited to,
the following:
(i) The basis on which contingent rent payable is determined;
(ii) The existence and terms of renewal or purchase options and escalation clauses; and
(iii) Restrictions imposed by lease arrangements, such as those concerning return of surplus, return of
capital contributions, dividends or similar distributions, additional debt, and further leasing.

9.8 Class Discussion

Question 1
The Organic Farming Agency leased a piece of plant and machinery from Millers Ltd on 1 January
2017. The fair value of the leased machinery is $82,000 and in return for five years use of the asset,
the agency agreed to pay Millers Ltd $20,000 per year on the last day of the year.

Required
Show the amounts taken to the statement of financial performance and the statement of financial
position for the year-ended 31 December 2017 using the sum of digits method.

Question 2
A government farming agency leased a piece of plant and machinery from Millers Ltd on 1 January
2017. The fair value of the leased machinery is $82,000 and in return for five years use of the asset,
the agency agreed to pay Millers Ltd $20,000 per year on the first day of the year.

Required
Show the amounts taken to the statement of financial performance and the statement of financial
position for the year-ended 31 December 2017 using the sum of digits method.

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Question 3
A government farming agency leased a piece of plant and machinery from Millers Ltd on 1 January
2017. The fair value of the leased machinery is $82,000 and in return for five years use of the asset,
the agency agreed to pay Millers Ltd $20,000 per year on the last day of the year.

Required
Show the amounts taken to the statement of financial performance and the statement of financial
position for the year-ended 31 December 2017 using the actuarial method using an effective interest
rate of 7%.
Class Discussion
Question 1
The Organic Farming Agency leased a piece of plant and machinery from Millers Ltd on 1 January
2017. The fair value of the leased machinery is $82,000 and in return for five years use of the asset,
the agency agreed to pay Millers Ltd $20,000 per year on the last day of the year.

Required
Show the amounts taken to the statement of financial performance and the statement of financial
position for the year-ended 31 December 2017 using the sum of digits method.

Question 2
A government farming agency leased a piece of plant and machinery from Millers Ltd on 1 January
2017. The fair value of the leased machinery is $82,000 and in return for five years use of the asset,
the agency agreed to pay Millers Ltd $20,000 per year on the first day of the year.

Required
Show the amounts taken to the statement of financial performance and the statement of financial
position for the year-ended 31 December 2017 using the sum of digits method.

Question 3
A government farming agency leased a piece of plant and machinery from Millers Ltd on 1 January
2017. The fair value of the leased machinery is $82,000 and in return for five years use of the asset,
the agency agreed to pay Millers Ltd $20,000 per year on the last day of the year.

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Required
Show the amounts taken to the statement of financial performance and the statement of financial
position for the year-ended 31 December 2017 using the actuarial method using an effective interest
rate of 7%.

Question 4
The following trial balance has been extracted from the records of the Improvements Agency for the
year ended 31 December 2017.
Debit Credit
$’000 $’000

Land 3,000
Buildings 12,550
Equipment 1,800
Cash 1
Buildings accumulated depreciation 1,600
Equipment accumulated depreciation 300
Staff costs 925
General expenses 420
Bank interest charges 4
Grants for operating activities 5,900
Inventories at 31 December 2017 85
Other revenue 750
Receivables 125
Revenue from consultancy activities 900
Short term investments 80
Payables 350
Bank 320
General reserves 1,200
Capital contributed by government 6,650
Revaluation reserve 1,200
Accumulated surpluses 240
Suspense account (notes 3 and 5) 220
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19,310 19,310
Further information:
1. The land balance includes a car park held at $500,000 which the agency no longer requires and
which was rented out to a neighbouring private sector company commencing on the first day of
the financial year. The agency’s policy is to account for investment properties under the
revaluation method.
2. The agency revalues land and buildings as permitted by IPSAS 17 and performs a full valuation at
the end of every year. Land and buildings were revalued as at 31 December 2017 and the
following increases were found, which have not been included in the trial balance:
 Buildings were found to have increased in value to $13m during the year.
 Land was found to have increased in value to $3.8m during the year, of which $650,000
relates to the car park discussed in point 1, above.
3. On 1st January 2017 a vehicle was acquired by finance lease. The fair value of the vehicle is
$30,000, and the terms of the lease require the agency to make 3 annual lease payments of
$13,000 commencing 31 December 2017. The annual lease payment for 2017 has been debited to
the suspense account, but no other entries have been made in relation to the leased asset.
4. Depreciation has still to be accounted for.
 Equipment is depreciated using the straight line method over five years after allowing for a
residual value of $150,000. All equipment held was acquired on or after 1 January 2013.
 Buildings are to be depreciated over their total useful economic life of 50 years, of which 37
years remain as at 1 January 2017.
 Leased vehicles are to be depreciated over their lease term.
5. A payment was made into the agency’s bank account in November for $233,000, but the
accountant did not know what this was for, so it was initially credited to a suspense account.
Subsequent investigations revealed that this was a grant for creating new internet-based services.
6. At the end of 2017, there was an outstanding instalment of General Grant of $80,000 that had not
yet been received by the Agency.
Required
From the information above, prepare the;
a) Statements of Financial Performance and
b) Statement of Net Assets for the Improvements Agency for the year ended 31 December
2017, and a statement of financial position at that date.

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CHAPTER 10
IPSAS 14: EVENTS AFTER THE
REPORTING DATE
10.1 Introduction

In assessing entity performance, pertinent information sometimes arises following the cut-off date for
which financial statements are prepared that may have important implications for the financial
position and performance in the year just ended. The end of the reporting period is a cut-off date and
events that happen after this point in time should not generally be recognised in the financial
statements of the period just ended.
However, information that comes to light after the end of the reporting period may provide additional
information about events that actually occurred before the end of the reporting period and it is then
appropriate to take it into account.
Financial statements should reflect the most up to date facts about events that existed at the end of the
reporting period. It is sometimes difficult to establish whether an event happening after the end of the
reporting period is new information about an existing event or a new event.

Users should be informed of significant events occurring after the end of the reporting period such as
the impacts of government reorganisations. The provision of such information required by IPSAS 14
Events after the Reporting Date will help users to understand the impact on future results.

10.2 Provisions of IPSAS 14

The objective of IPSAS 14 is to provide guidance as to how to deal with events that occur after the
end of the reporting period, but before the date on which the financial statements are authorised for
issue. These are described as events after the end of the reporting period.

The standard prescribes:

 when an entity should adjust its financial statements for events after the reporting date
 the disclosures that an entity should give about the date when the financial statements were
authorised for issue, and about events after the reporting date.
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IPSAS 14 also requires that an entity should not prepare its financial statements on a going concern
basis if events after the reporting date indicate that the going concern assumption is not appropriate.

10.3 Event after the reporting Date

Events after the reporting date are those events, both favourable and unfavourable, that occur between
the reporting date and the date when the financial statements are authorised for issue. Two types of
events can be identified:
 Adjusting events - events that provide evidence of conditions that existed at end of the
reporting period
 Non-adjusting events - events that are indicative of conditions that arose after the end of the
reporting period.
In order to determine which events satisfy the definition of events after the reporting date, it is
necessary to identify both the reporting date and the date on which the financial statements are
authorised for issue.

The reporting date is the last day of the reporting period to which the financial statements relate.

The date of authorisation for issue is the date on which the financial statements have received
approval from the individual or body with the authority to finalise those statements for issue.

For example, the date of the Accounting Officer’s authorisation for issue of the financial statements is
normally the same as the date of the Certificate and Report of the Auditor General. This is because, in
line with IPSAS 14, it is only after the Auditor General has certified the accounts that they can no
longer be adjusted for events after the reporting date.

The standards distinguish between events that occur during this period, which should be adjusted for
in the financial statements (adjusting events) and those that should instead only be disclosed (non-
adjusting events).

10.4 Recognition and measurement: Adjusting events

Adjusting events provide evidence of conditions that exist at the end of the reporting period.
An entity should adjust the amounts recognised in the financial statements to reflect any adjusting
events that have been identified.

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The following are examples of adjusting events.

 The settlement of an outstanding court case that was provided for, or disclosed as a contingent
liability, at the end of the reporting period. The provision at the end of the reporting period
should be amended to reflect the actual settlement figure as this provides additional evidence
as to the amount of the provision as required by IPSAS 19 Provisions, contingent liabilities
and contingent assets. If a contingent liability was initially disclosed at the end of the reporting
period, the provision should now be recognised, since the settlement provides information that
a present obligation which can be reliably measured existed at the end of the reporting period.
 Information received after the end of the reporting period about the value or recoverability of
an asset recognised at the end of the reporting period. This might be evidence that the net
realisable value for inventories was lower than estimated, in which case the inventories figure
should be written down accordingly.
 The finalisation of staff bonuses that were payable at the year-end.
 The discovery of fraud or errors which show that amounts recognised or information disclosed
at the end of the reporting period were incorrect.

10.5 Recognition and measurement: Non-adjusting events

Non-adjusting events are those that are indicative of conditions that arose after the end of the
reporting period.

An entity shall not adjust the amounts recognised in its financial statements to reflect non-adjusting
events after the reporting date.

Non-adjusting events should instead be disclosed where the outcome of such events would influence
the economic decisions made by users of the financial statements. Where the disclosure of such an
event is required, the entity should provide details of the nature of the event and an estimate of its
financial effect, or state that such an estimate cannot be made.

The following are examples of non-adjusting events:

 The major purchase or disposal of assets such as property, plant and equipment.
 The destruction of assets caused by a fire occurring after the end of the reporting period.
 The announcement of major government reorganisation.
 A significant fluctuation in foreign exchange rates that would affect amounts reflected in the
financial statements.

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 Entering into major commitments or providing a significant guarantee.

 The commencement of litigation following an event that happened after the end of the
reporting period.

10.6 IPSAS 14 – Other considerations

IPSAS 14 makes specific reference to dividends, going concern and restructuring. We will consider
each in turn.

10.6.1 Dividends
Dividends may arise in the public sector when, for example:
 a Government Business Enterprise (GBE) has outside ownership interests to whom it issues
dividends
 a public sector organisation controls and consolidates the financial statements of an
organisation that has outside ownership interests to whom it pays dividends.
In addition, some public sector entities adopt models that require them to pay income distributions to
their controlling body, such as central government departments.
(Note that in jurisdictions which have adopted IPSAS, Government Business Enterprises report under
IFRS. The accounting treatment, however, is the same under IPSAS and IFRS.)

If dividends on shares have been proposed or declared after the end of the reporting period they do not
meet the definition of a liability and therefore cannot be recognised as a liability at the end of the
reporting period.
To be recognised as a liability the entity should have an obligation at the end of the reporting period.
The obligation to pay the dividend only arises when it has been declared, so it is at the declaration
date that a liability should be recognised.

Where dividends have been proposed or declared after the end of the reporting period, this should be
disclosed in the notes to the financial statements.

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10.6.2 Going concern

Financial statements are usually prepared on what is described as the ‘going concern’ basis. This
assumes that the entity will continue to operate for the foreseeable future.
Where the ‘going concern’ assessment changes after the end of the reporting period, this will need to
be disclosed and will normally affect other aspects of the presentation of the financial statements.

IPSAS 14 provides public sector specific guidance. In the public sector, the assessment of going
concern is likely to be of more relevance for individual organisations than for a government as a
whole.

In assessing whether the going concern assumption is appropriate for an individual organisation
within government, those responsible for the preparation of the financial statements, and/or the
governing body, need to consider a wide range of factors. Those factors will include the current and
expected performance of the entity, any announced and potential restructuring of organisational units,
the likelihood of continued government funding and if necessary, potential sources of replacement
funding.

In the case of entities whose operations are substantially budget-funded, going concern issues
generally only arise if the government announces its intention to cease funding the entity. If the going
concern assumption is no longer appropriate, IPSAS 14 requires an entity to reflect this in its financial
statements. The impact of such a change will depend upon the particular circumstances of the entity,
for example, whether operations are to be transferred to another government entity, sold, or
liquidated, which will determined if a change in the value of the assets and liabilities is required.
Disclosure of the change in the basis of preparation should be provided in accordance with IPSAS 1
Preparation of financial statements.

10.6.3 Restructuring
Where a restructuring is announced after the reporting date and meets the definition of a non-
adjustable event, the appropriate disclosures are made in accordance with IPSAS 14.

Guidance on the recognition of provisions associated with restructuring is found in IPSAS 19. Simply
because a restructuring involves the disposal of a component of an entity, this does not in itself bring

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into question the entity’s ability to continue as a going concern. However, where a restructuring
announced after the reporting date means that an entity is no longer a going concern, the nature and
amount of assets and liabilities recognised may change.

10.7 Disclosure
Disclosure is required for all material non-adjusting events after the reporting date because non-
disclosure could influence the economic decisions of users taken on the basis of the financial
statements. Accordingly, entities must disclose the following for each material category of non-
adjusting event after the reporting date:
 The nature of the event; and
 An estimate of its financial effect, or a statement that such an estimate cannot be made.
Note that no such disclosures are required for adjusting events because they have already been
reflected in the financial statements.

In addition to disclosures that may arise from information on non-adjusting events after the end of the
reporting period, an entity should also disclose the date when the financial statements were authorised
for issue and who provided that authorisation.
This date is important because events that occurred after it are not recognised or disclosed in the
financial statements.
If subsequent information comes to light after the end of the reporting period, about conditions that
existed at the end of the reporting period, the original disclosures should be updated to reflect this new
information.

10.8 Class discussion

Question 1
A central government department’s draft financial statements for the year ended 31 December 2017
were completed on 30 May 2018, signed by the Accounting Officer on 7 June 2018, and laid before
Parliament on 5 July 2018. The following events occurred after the end of the reporting period
(assume all amounts are significant to the entity).
i. Notification was received on 18 January 2018 that a customer owing $100,000 as at 31 December
2017 went into liquidation during December 2017. The financial statements already include a
specific allowance of $20,000 for this customer and the entity does not make general provisions.
ii. The entity announces a major reorganisation on 6 April 2018.

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iii. Confirmation on 28 May 2018 from the entity's insurer that they will pay $500,000 for inventories
that were destroyed in a fire on 24 December 2017. The entity had claimed $650,000 and included
this as a receivable in the financial statements.
Required:
Recommend the proper treatment for these events in accordance with IPSAS 14

Question 2
You are provided with the following information;

(a) Receivables at 31 December 2017 are $64,000. On 20 January 2018 a major debtor was declared
bankrupt. It is now expected that although the receivable owed $25,000 on 31 December 2017
the organisation will only receive $2,500.
(b) A fire shortly after the reporting date has destroyed inventory valued at $3,000. The total value
of inventory held at 31 December 2017 was $600,000.
Required
Explain how the following items should be treated in the financial statements of a government trading
activity for the year ended 31 December 2017

Question 3
The Environment Agency is in the process of preparing its financial statements for the year-ended 31
December 2017. Its trial balance at that date is as follows:

$’000 $’000
Land 553
Buildings 1,520
Equipment 800
Motor vehicles 132
Acc depreciation at 31 December 2017: – buildings 870
- equipment 492
- motor vehicles 64
Salaries, wages and employee benefits 2,352
General operating expenses 2,460

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Depreciation charge for the year (note 2) 160

Bank interest received 4
General grant for operating activities 4,038
Fees and charges 900
Receivables 564
Payables 280
Inventories at 1 January 2017 54
Bank 33
General reserves 215
Provision (note 6) 200
Capital contributed by government 900
Accumulated surpluses 633
Suspense account (note 1) 34
8,629 8,629

Additional Information
(1) As permitted by IPSAS 17, the agency has decided to revalue its land to reflect fair value. An
independent valuer has reported that land has increased in value by $115,000 since it was
originally purchased but this has not yet been adjusted for in the trial balance.
(2) The depreciation charge for the year for all depreciable assets held at the start of the year has
been calculated and included in the draft trial balance above, but the following have not been
taken into account:
 The suspense account relates to the purchase of a motor vehicle on 24 December 2017.
 Some obsolete equipment was disposed of on the last day of the year for $56,000 but as the
disposal proceeds were not received until 4th January 2018, the accountant has made no
entries in the accounts. The machinery disposed of had originally cost $90,000 on 1 April
2014.
 The agency’s policy is to depreciate equipment and motor vehicles straight line over 5 years
with no residual value. The agency accounts for a full year of depreciation in the year of
acquisition and none in the year of disposal.
(3) During the year ended 31 December 2017 operating expenses of $430,000 were paid and
recorded within general operating expenses. These expenses related to the financial year ended
December 2016 and should have been accrued for that year. On 19 January 2018, the agency

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was informed that an organisation who owed the agency $120,000 had been declared bankrupt
in late December 2017, and the debt is now unlikely to be paid.4)
(4) The agency’s policy is to value inventory using the first in first out (FIFO) method. Inventory
was counted on 31 December 2017 and was found to consist of 5,540 barrels of minerals used
to neutralise polluted lakes. Included within general operating expenses are three purchases of
the minerals as follows:
 1 February 2,500 barrels at $89 / barrel
 3 July 2,500 barrels at $98 / barrel
 18 September 2,500 barrels at $105 / barrel.
5) The provision relates to an unfair dismissal legal case which was is due to be resolved on 31
December 2018. The agency’s policy is to discount provisions using a discount rate of 2% and
there have been no changes in the expected outcomes of the case during the year.
Required
Prepare the Environment Agency’s statement of financial performance and statement of
changes in equity for the year ended 31 December 2017, and its statement of financial position
as at 31 December 2017.

CHAPTER 11
IPSAS 16 Investment Property
IPSAS 16 prescribes the accounting treatment for investment properties and related disclosure
requirements.

11.1 Definition
It is very important that you know the definition of an investment property for your exam so that you
are able to correctly classify property owned by a government organisation as investment properties
(IPSAS 16) or owner-occupied property plant, and equipment (thus following IPSAS 17 rules).

11.1.1 Investment property

Investment property is property (land or a building – or part of a building – or both) held to earn
rentals or for capital appreciation or both, rather than for:
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(a) Use in the production or supply of goods or services or for administrative purposes; or
(b) Sale in the ordinary course of operations.

Some examples of public sector assets that would be regarded as investment properties by
IPSAS 16 include:
 Property that is leased out to external parties under an operating lease on a commercial basis.
 An office building which is currently vacant but is held to be leased out under one or more
operating leases on a commercial basis to external parties.

An investment property is not any of the following:

 A building used in the production or supply of goods and services (which would be an owner
occupied property and therefore covered by IPSAS 17 Property, plant and equipment). Note
that a property might be used for both service provision and to earn rentals/capital appreciation
so the key to determining the treatment is to consider whether the service/goods provision is
significant to the rental arrangement.
 Held for resale in the ordinary course of business, for example by a public sector organisation
that builds and sells affordable housing (which would be covered by IPSAS 12 Inventories).
This also applies to a property previously used as an investment property which is now being
held pending sale.
 Being constructed for future use by a third party (which would be covered by IPSAS 11
Construction contracts)
 An investment property currently under construction by the entity (which would also be
covered by IPSAS 17 and recognised as an asset under construction)
 Property leased to another entity under a finance lease.
 Property which is primarily held to provide a social service. For example, homes owned by a
housing association will generate rental cash flows, but they are not rented out on a
commercial basis.

11.1.2 Owner occupied

Property held (by the owner or by the lessee under a finance lease) for use in the production or supply
of goods or services or for administrative purposes.
The property may consist of land, land and buildings, buildings, or part of a building.

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Some examples of public sector assets that would be regarded as investment properties by IPSAS 16
include:
 Land held by a hospital for capital appreciation which may be sold at a beneficial time in the
future.
 Land held for a currently undetermined future use.

11.2 Accounting treatment for investment properties

11.2.1 Initial recognition
Investment properties are initially measured at its cost. If the investment property has not been
acquired through an arm’s length negotiation, then the property is measured at fair value.

The costs of a purchased investment property include the purchase price and any directly attributable
expenditure. Examples of this type of expenditure would include professional fees and property
transfer taxes.
The standard includes costs that are specifically not to be included in the cost of an investment
property. Examples would include start-up costs, operating losses and abnormal amounts of wasted
material or labour.

11.2.2 Subsequent measurement

Investment properties may subsequently be recognised by one of two methods (depending on the
entity’s accounting policies):
 Cost model: recognising the investment properties in exactly the same way as under IPSAS
17 Property, plant and equipment, except that an additional disclosure of the fair value of the
properties must be made.
 Fair value model: recognising the investment properties at fair value, with any movement in
the fair value of the asset resulting in a gain or loss being recognised directly in the statement
of financial performance.

The same model must be applied to all of an organisation’s investment properties.

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11.3 Disclosure requirements

An entity must disclose the following in relation to its investment properties:
(a) Whether it applies the fair value or the cost model.
(b) If it applies the fair value model, whether, and in what circumstances, property interests held
under operating leases are classified and accounted for as investment property.
(c) When classification is difficult, the criteria it uses to distinguish investment property from owner-
occupied property and from property held for sale in the ordinary course of operations.
(d) The methods and significant assumptions applied in determining the fair value of investment
property, including a statement whether the determination of fair value was supported by market
evidence or was more heavily based on other factors (which the entity shall disclose) because of the
nature of the property and lack of comparable market data.
(e) The extent to which the fair value of investment property (as measured or disclosed in the
financial statements) is based on a valuation by an independent valuer who holds a recognised and
relevant professional qualification and has recent experience in the location and category of the
investment property being valued. If there has been no such valuation, that fact shall be disclosed.
(f) The amounts recognised in surplus or deficit for:
(i) Rental revenue from investment property;
(ii) Direct operating expenses (including repairs and maintenance) arising from investment property
that generated rental revenue during the period; and
(iii) Direct operating expenses (including repairs and maintenance) arising from investment property
that did not generate rental revenue during the period.
(g) The existence and amounts of restrictions on the realisability of investment property or the
remittance of revenue and proceeds of disposal.
(h) Contractual obligations to purchase, construct or develop investment property or for repairs,
maintenance or enhancements.

11.3.1 Further disclosure requirements for properties held under the fair value
model:
In addition to the requirements above, entities that apply the fair value model must show a
reconciliation between the opening and closing carrying amounts of investment property, which is
required to include the following:
(a) Additions

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(b) Disposals
(c) Net gains or losses from fair value adjustments
(d) Transfers to/from inventories and owner-occupied property

11.3.2 Further disclosure requirements for properties held under cost model:
(a) The depreciation methods used;
(b) The useful lives or the depreciation rates used;
(c) The gross carrying amount and the accumulated depreciation (aggregated with accumulated
impairment losses) at the beginning and end of the period;
(d) A reconciliation of the carrying amount of investment property at the beginning and end of the
period, showing details including additions, disposals, depreciation, impairment losses and transfers
to/from owner occupied properties.
(e) The fair value of investment property.

11.4 Discussion Questions

Question 1
Required
Are the following assets investment properties under the IPSAS 16 definition?
• A government owns a hostel that it manages through its general property management agency. The
ancillary services provided to residents in the hostel are significant to the arrangement as a whole.
• A hospital owns a building, part of which is used for administration and part is leased out as
apartments on a commercial basis.

Question 2
Required
For the following organisations, identify the accounting entries that would be required at the year-end
to report the investment properties in accordance with IPSAS 16.
(a) Organisation A uses the fair value model to account for its investment properties. Organisation
A owns an investment property which is currently held in their accounts at fair value of $1m.

At the end of the year the fair value of the property is $1.1m.

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(b) At the end of the following accounting period, the fair value of Organisation A’s properties
was $900,000.
(c) Organisation B uses the cost model to account for investment properties. At the end of the
previous reporting period the properties had a carrying value of $1m. The company charges
depreciation on investment properties using 20% reducing balance. The fair value of the
properties at the end of the current period is $1.1m

Question 3
The following is the trial balance for St Andrews Senior School as at 31 December 2017:
$’000s $’000s
Buildings 10,550
Land 2,000
Equipment 1,800
Buildings accumulated depreciation 1,600
Equipment accumulated depreciation 300
Cash 1
Donations and fundraising income 400
Staff costs 925
General expenses 420
Bank interest charges (overdraft only) 4
General grant for operating activities 4,250
Inventories at 1 Jan 2017 85
Other revenue 120
Receivables 125
Revenue from consultancy activities 1,260
Short term investments 80
Payables 528
Training grant 120
Bank overdraft 450
General reserves 920
Long term loans (3.5% - note 2) 500
Capital contributed by government 150
Accumulated surpluses 5,072
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Revaluation reserve 150

Suspense account (CR) 170
15.990 15,990
Additional information:
1. St Andrews is extending its premises with the creation of a new science block. In order to do
this it has purchased new land at a cost of $20,000 and undertaken building work at a cost of
$150,000. All amounts had been paid by the end of the year but no entries have yet been made
for in the accounts. The new science block went into use on 31 December 2017.
2. The long term loan balance at the start of the year was $400,000. A further $100,000 was drawn
down on 30 June 2017 specifically to fund the new science block. This was immediately paid
over to the building contractor as an advance payment towards the $150,000 total building cost.

No entries have yet been made for the annual interest cost of the loan, which is due to be paid on 1
January 2018 to the loan provider.

The school’s policy is to capitalise all finance costs as permitted by IPSAS 5.

3. During the year, some surplus land was disposed of. The only transaction that has been recorded
is the sale proceeds from selling the surplus land and this has been credited to the suspense
account. The land disposed of was held in the school’s books at $150,000, and had previously
been revalued upwards by $35,000.
4. Depreciation has not yet been accounted for. Buildings are to be depreciated over a 30 year
period based on the straight line method and equipment is to be depreciated over a 10 year
period, also using the straight line method. The depreciation policy is to charge a full year in the
year of acquisition and none in the year of disposal.
5. Inventories at 31 Dec 2017 were $340,000.
Required
From the information above:
(a) Prepare the property, plant and equipment disclosure note as required by IPSAS 17 for St
Andrews School’s year-ended 31 December 2017.
(b) Prepare the statements of financial performance and changes in equity for St Andrews School
for the year ended 31 December 2017 and a statement of financial position at that date.
All figures should be rounded to the nearest $’000.

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CHAPTER 12
IPSAS 17: PLANT, PROPERTY &
EQUIPMENT
12.0 Introduction
IPSAS 17 sets out the accounting treatment for property, plant and equipment (PPE). The main issues
covered by the standard include:
 the recognition of non-current tangible assets (such as land and buildings, equipment, and
vehicles) , heritage assets, infrastructure assets
 the determination of carrying amounts
 depreciation
 de-recognition
 disclosure.

12.1 Definitions
 Property, plant and equipment are tangible assets held for use in the production or supply of
goods and services, which are expected to be used for more than one period.
 Tangible assets are those that have a physical substance.
 The carrying amount is the amount at which an asset is recognised in the statement of financial
position, after deducting any accumulated depreciation or impairment losses.

12.2 Recognition
An item of property, plant and equipment is to be recognised as an asset when:
 it is probable that future economic benefits will flow to the entity; and
 the cost of the asset can be measured reliably.

12.3 Presentation in the statement of financial position

Property, plant and equipment is usually included within non-current assets in the statement of
financial position, on the basis that they are expected to be used for more than one period.

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Where an item of property, plant and equipment is being held pending sale, it would be included
within current assets.

12.4 Measurement of property, plant and equipment: initial treatment

Initially, property, plant and equipment are measured at cost.
Cost includes:
 the purchase price, including any import duties and other taxes
 any costs directly attributable to bring the asset to the location and condition for its intended
use
 the estimated costs of dismantling and removing the asset at the end of its useful life

Attributable costs which can be included in the cost of the asset include:
 costs of site preparation
 initial delivery and handling costs
 installation and assembly costs
 costs of testing the asset
 professional fees.

Borrowing costs incurred during the construction of an asset may also be capitalised if they meet the
strict criteria laid down in IPSAS 5 Borrowing Costs

Costs which cannot be included in the cost of the asset include:

 administration and other general overhead costs
 costs incurred while an item capable of operating in a manner intended by management has
yet to be brought into use or is operated at less than full capacity
 abnormal amounts of wasted labour and materials (for self-constructed assets)
 costs of relocation/reorganisation of operations

12.4.1 Non-exchange transactions

If a non-current asset is acquired in a non-exchange transaction, it means that it is received without
the recipient giving equal value in exchange; for example if a piece of medical equipment asset is
donated to a hospital by the government of a donor country.

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Assets acquired in a non-exchange transaction are measured at their fair value3 as at the date of
acquisition.

For example, if a book publisher donates some textbooks to a school, the school will recognise these
books at the amount that it would have otherwise cost them to buy these books (i.e. the publisher’s list
price), even though the actual cost to the school is nil.

The increase in property, plant and equipment (debit) creates the need for a credit entry to revenue in
the statement of financial performance. This represents revenue from a non-exchange transaction,
which we will look at further iin this module guide.

12.5 Valuation of property, plant and equipment: initial treatment:

subsequent treatment

After acquisition of PPE, an entity may choose either the cost model or the revaluation model as its
accounting policy.
Cost model
Using the cost model, the asset is carried at its historical cost less any accumulated depreciation and
impairment losses.
Revaluation model
Using the revaluation model, the asset is carried in the statement of financial position at a re-valued
amount:
‘After recognition as an asset, an item of property, plant and equipment whose fair value can be
measured reliably shall be carried at a revalued amount, being its fair value at the date of the
revaluation, less any subsequent accumulated depreciation, and subsequent impairment losses.
Revaluation shall be made with sufficient regularity to ensure that the carrying amount does not differ
materially from that which would be determined using fair value at the reporting date.’ (IPSAS 17,
paragraph 44)

3
Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing
parties in an arm’s length transaction.

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For some public sector assets, it may be difficult to establish their market value because of the
absence of market transactions for these assets. Some public sector organisations may have significant
holdings of such assets. In such circumstances, the fair value may be established by reference to other
items with similar characteristics, in similar circumstances and location.

If there is no market-based evidence of fair value because of the specialised nature of an asset, the
organisation may need to estimate fair value using one of the following bases:
 Reproduction cost: In some cases, an asset’s reproduction cost will be the best indicator of its
replacement cost. For example, in the event of loss, a parliament building may be rebuilt rather
than replaced with alternative accommodation, because of its significance to the community.
 Depreciated replacement cost: In many cases, the depreciated replacement cost of an asset
can be established by reference to the buying price of a similar asset with similar remaining
service potential in an active and liquid market.
 Service unit approach: Under this approach, the present value of the remaining service
potential of the asset is used as the basis for valuation.

When an item of PPE is re-valued, the entire class of assets to which it belongs must be re-valued.
Classes are groups of similar assets, for example land, buildings, machinery, vehicles, fixtures and
fittings.
Frequency of revaluation depends on the changes in fair value. Where only insignificant changes in
fair value are experienced, it may be appropriate to revalue these assets every three or five years.

12.6 Accounting for revaluations

Revaluations are dealt with as follows:
 any increase in value is credited to a revaluation reserve
 any reduction in value is recognised as an expense in the statement of financial performance
(although a decrease which reverses part or all of a previous increase for the same asset class
is debited to the revaluation reserve).

When an item of property, plant and equipment is revalued, any accumulated depreciation at the date
of the revaluation is treated in one of the following ways:
 restated proportionately with the change in the gross carrying amount of the asset so that the
carrying amount of the asset after revaluation equals the revalued amount. This method is

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often used when an asset is revalued by means of applying an index to its depreciated
replacement cost
 eliminated against the gross carrying amount of the asset and the net amount restated to the
revalued amount of the asset. This method is often used for buildings.

12.7 Classes of assets

A class of property, plant and equipment is a grouping of assets of a similar nature or function in an
entity’s operation. The following are examples of separate classes that may apply in a public sector
organisation:
 land
 operational buildings
 roads
 machinery
 electricity transmission networks
 ships
 aircraft
 specialised military equipment
 motor vehicles
 furniture and fixtures
 office equipment
 oil rigs.

12.7.1 Heritage assets

Public sector organisations, unlike private companies, may acquire, inherit or receive through a
donation certain assets that are not necessarily required for service provision. They are, however,
assets that the organisation would want to retain, usually because these assets have some cultural or
other unique significance.

IPSAS 17 does not require an entity to recognise heritage assets that would otherwise meet the
definition and recognition criteria of property, plant and equipment.
If an entity does recognise heritage assets, it must apply the disclosure requirements of the standard
and may, but is not required to, apply the measurement requirements of the standard.

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12.7.1.1 Characteristics of heritage assets

The following are the main characteristics of heritage assets, which distinguish them from other assets
held by an organisation:

 their value in cultural, environmental, educational and historical terms is unlikely to be fully
reflected in a financial value based purely on a market price
 legal and/or statutory obligations may impose prohibitions or severe restrictions on disposal by
sale
 they are often irreplaceable and their value may increase over time even if their physical
condition deteriorates
 it may be difficult to estimate their useful lives, which in some cases could be several hundred
years.

12.7.1.2 Valuation of heritage assets

The valuation of heritage assets can be difficult, especially when they are not used primarily for
providing services or when they have been acquired at no cost.
Some heritage assets have service potential other than their heritage value (for example, a historic
building being used for office accommodation). In these cases, they may be recognised and measured
on the same basis as other items of property, plant and equipment.

For other heritage assets, their service potential is limited to their heritage characteristics, for
example, monuments and ruins. The existence of alternative service potential can affect the choice of
measurement base. In some cases, heritage assets may be held in the statement of financial position
with a value of nil.

12.7.1.3 Disclosure requirements for heritage assets

IPSAS 17 requires the following disclosure in respect of heritage assets:
 the measurement basis used
 the depreciation method used
 the gross carrying amount
 the accumulated depreciation at the end of the period
 a reconciliation of the carrying amounts at the beginning and end of the period showing
components thereof.

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12.7.2 Infrastructure assets

Public sector organisations may incur considerable expenditure on large assets such as road networks,
sewers, power supply systems, etc. These are commonly described as infrastructure assets and usually
display some or all of the following characteristics:

 they are part of a system or network

 they are specialised in nature and do not have alternative uses
 they are immovable
 they may be subject to constraints on disposal.

Infrastructure assets meet the definition of property, plant and equipment and should therefore be
accounted for in accordance with IPSAS 17. So, although the standard acknowledges that this distinct
group of assets exists, it does not require any particular accounting treatment for these that is any
different to other property, plant and equipment.

Other standards, such as IPSAS 11 Construction contracts, also refer to infrastructure assets when
discussing application of the standard in particular situations, but again these standards tend not to
require different treatment in respect of infrastructure assets.

12.8 Depreciation
This is the measure of the cost or re-valued amount of the economic benefits of the non-current asset
that have been consumed during the period. The process involves matching the cost of using the asset
with the benefits derived from it.

12.8.1 Key definition: Depreciation

The systematic allocation of the depreciable amount of an asset over its life.
Depreciation is the accounting mechanism for ensuring that the accounting period bears the relevant
expense of utilising a non-current asset.

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Each part of an item of property, plant and equipment with a cost that is significant in relation to the
total cost of the item shall be depreciated separately.

Depreciation is consistent with the matching and accruals principles. Note that ‘loss in value’ does not
necessarily mean the same as a reduction in the potential selling price of the asset, which is a common
misconception.

Depreciation has also been referred to as a measure of the cost or valuation of the asset that has been
consumed during the accounting period. Consumption in this sense is said to be a using up or
reduction in the useful economic life of the asset, however caused.

12.8.2 Which assets are depreciated?

IPSAS 17 requires that all non-current assets be depreciated with only one or two exceptions. Assets
that must be depreciated are those that:
 have an expected life of more than one accounting period
 have a limited useful life, and
 are held for use in the production or supply of goods and services.

An exception to the requirement to depreciate is land as this normally has an unlimited life and as
such is not normally depreciated. However, there are exceptions to this, for example a quarry will be
depreciated as this will lose value over time.

12.8.3 Calculating depreciation

When determining the amount to be written off, it is necessary to consider useful economic life and
residual value. The depreciable amount of an asset is to be allocated on a systematic basis over its
useful life.
Key definitions: Useful life (of PPE)
Either:
(a) The period over which an asset is expected to be available for use by an entity; or
(b) The number of production or similar units expected to be obtained from the asset by an entity.
Residual value

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The estimated amount that an entity would currently obtain from disposal of the asset, after deducting
the estimated costs of disposal, if the asset were already of the age and in the condition expected at the
end of its useful life.
Depreciable amount
The cost of an asset, or other amount substituted for cost, less is residual value.
Depreciation method
The depreciation method selected should reflect the pattern by which the economic benefits are
consumed. This will allow the loss in value of the asset to be allocated over several accounting
periods.

Depreciation methods include the straight-line method, the diminishing (reducing) balance method,
and the units of production (output) method.

An entity chooses the depreciation method which best reflects the pattern in which the asset's
economic benefits or its service potential are consumed. The depreciation method used should be
reviewed each year.

Where a change in estimated life occurs, the carrying value of the asset should be depreciated over its
remaining useful life. Also, the depreciation charge should be adjusted for current and future periods
if the estimated residual value is changed.

Ledger accounts
Here is a quick reminder of the ledger accounts for accounting for property, plant and equipment.
Non-current asset cost
Each category (for example premises, computers, fixtures and fittings, motor vehicles) of non-current
asset must have a separate account. Assets are recorded at cost when initially purchased. The total of
all assets in the same class is shown in the statement of financial position.
The entry for acquiring a non-current asset will be:
Dr Asset account
Cr Bank or supplier (payable)
Accumulated depreciation
You should have a separate accumulated depreciation account for each category of non-current asset.
Keep this account separate from the non-current asset cost (or subsequent valuation) account.

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Depreciation charges for the year are debited to the statement of financial performance and credited to
the accumulated depreciation account.
The entry for annual depreciation will be:
Dr Depreciation expense (statement of financial performance)
Cr Accumulated depreciation account
The total on the accumulated depreciation account is shown in the statement of financial position.

12.8.3.1 Changes in expected life

The expected useful life of each asset is a matter of judgement, and in some situations it may be
necessary to reassess an asset’s useful life. This will have an impact on the depreciation charge in
future periods. The depreciation charge after the useful life has been changed is determined by
dividing the net book value of the asset by the remaining life.

12.9 Subsequent expenditure

The main recognition principle of IPSAS 17 applies to subsequent expenditure on assets, i.e.
recognition can only occur when:
 it is probable that future economic benefits will flow to the entity; and
 the cost of the asset can be measured reliably.

Therefore, the costs of day-to-day servicing of assets are not included within assets and are instead
recognised within expenses. Subsequent expenditure can only be capitalised if it results in the
enhancement of an asset beyond its original state.

For example, replacing broken windows in a building would be recognised in expenses, but building a
new extension would be capitalised within assets, since this represents additional economic benefits
that the building can now provide.

Treatment of subsequent costs which meet the recognition criteria

The cost of any improvement to a non-current asset is added to the non-current asset cost account.
This will give an increased net book value (i.e. increased cost less accumulated depreciation to date),
and this is the basis for the depreciation for future periods. The depreciation charge is calculated by
dividing the new net book value by the remaining life of the asset.

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12.9.1 Other types of subsequent expenditure

Parts of some items of property, plant, and equipment may require replacement at regular intervals.
For example, a road may need resurfacing every few years, a furnace may require relining after a
specified number of hours of use, or aircraft interiors such as seats and galleys may require
replacement several times during the life of the airframe. Such expenditure, where it meets the basic
recognition criteria, may be capitalised.

A condition of continuing to operate an item of property, plant, and equipment (for example, an
aircraft) may be performing regular major inspections for faults regardless of whether parts of the
item are replaced. When each major inspection is performed, its cost is recognised in the carrying
amount of the item of property, plant, and equipment as a replacement if the recognition criteria are
satisfied. Any remaining carrying amount of the cost of previous inspection (as distinct from physical
parts) is derecognised.

12.10 Derecognition

IPSAS 17 raises some issues that should be considered when dealing with the derecognition of assets
- for example removing them from the statement of financial position when they are disposed of.
The carrying amount of an item of property, plant and equipment shall be derecognised:
 on disposal; or
 when no future economic benefits or service potential is expected from its use or disposal.

The gain or loss arising from the derecognition of an item of property, plant and equipment shall be
included in surplus or deficit when the item is derecognised (unless IPSAS 13 requires otherwise on a
sale and leaseback agreement).

However, an entity that, in the course of its ordinary activities, routinely sells items of property, plant
and equipment that it has held for rental to others shall transfer such assets to inventories at their
carrying amount when they cease to be rented and become held for sale. The proceeds from the sale
of such assets shall be recognised as revenue in accordance with IPSAS 9 Revenue from Exchange
Transactions.

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The disposal of an item of property, plant and equipment may occur in a variety ways (for example by
sale, by entering into a finance lease or by donation). In determining the date of disposal of an item,
an entity applies the criteria in IPSAS 9 for recognising revenue from the sale of goods. IPSAS 13
Leases applies to disposal by a sale and leaseback.

If, under the recognition principle, an entity recognises in the carrying amount of an item of property,
plant and equipment the cost of a replacement for part of the item, then it derecognises the carrying
amount of the replaced part regardless of whether the replaced part had been depreciated separately. If
it is not practicable for an entity to determine the carrying amount of the replaced part, it may use the
cost of the replacement as an indication of what the cost of the replaced part was at the time it was
acquired or constructed.

The gain or loss arising from the derecognition of an item of property, plant and equipment is the
difference between the net disposal proceeds and the carrying amount of the item. The consideration
receivable on disposal of an item of property, plant and equipment is recognised initially at its fair
value.

If payment for the item is deferred, the consideration received is recognised initially at the cash price
equivalent. The difference between the nominal amount of the consideration and the cash price
equivalent is recognised as interest revenue in accordance with IPSAS 9, reflecting the effective yield
on the receivable.

12.11 Disclosure requirements

IPSAS 17 contains a long list of disclosure requirements for property, plant and equipment.
The key disclosures are as follows:
 The measurement bases used
 Depreciation methods used
 The useful lives or depreciation rates used
 The gross carrying amount and accumulated depreciation at the beginning and end of the
period
 A reconciliation of the carrying amount at the beginning and end of the period showing:
- revaluations
- additions

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- disposals
- depreciation for the period
- any other changes.

In addition, the following must be disclosed for each class of asset:

(a) The existence and amounts of restrictions on title, and property, plant, and equipment
pledged as securities for liabilities;
(b) The amount of expenditures recognised in the carrying amount of an item of property,
plant, and equipment in the course of its construction;
(c) The amount of contractual commitments for the acquisition of property, plant, and
equipment; and
(d) If it is not disclosed separately on the face of the statement of financial performance, the
amount of compensation from third parties for items of property, plant, and equipment
that were impaired, lost or given up that is included in surplus or deficit.

12.11.1 Further disclosures for revalued PPE

If a class of property, plant, and equipment is stated at revalued amounts, the following shall be
disclosed:
(a) The effective date of the revaluation;
(b) Whether an independent valuer was involved;
(c) The methods and significant assumptions applied in estimating the assets’ fair values;
(d) The extent to which the assets’ fair values were determined directly by reference to
observable prices in an active market or recent market transactions on arm’s length terms,
or were estimated using other valuation techniques;
(e) The revaluation surplus, indicating the change for the period and any restrictions on the
distribution of the balance to shareholders or other equity holders;
(f) The sum of all revaluation surpluses for individual items of property, plant, and equipment
within that class; and
(g) The sum of all revaluation deficits for individual items of property, plant, and equipment
within that class.

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12.12 Class Discussion

Question 1
Year 1: Agency A buys a tangible non-current asset for $155,000, financed by long term loan. The
residual value of the asset after a useful economic life of 6 years is estimated to be $35,000.
Year 2: The asset is revalued and is estimated to have a value of $150,000 with no residual value.
Year 3: The asset is sold for $100,000
It is the policy of Agency A to depreciate assets on a straight line basis, providing a full year’s
depreciation charge in the year of acquisition and none in the year of disposal.
Required
Prepare the ledger accounts for the non-current asset, accumulated depreciation, revaluation reserve
and disposal.

Question 2
Year 1: Agency B buys a tangible non-current asset for $75,000. The asset is financed by a long-term
loan and the useful economic life of the asset is estimated to be 5 years.
Year 2: The asset is revalued and is estimated to have a value of $80,000
Year 3: The asset is sold for $65,000.
It is the policy of Agency B to depreciate assets on a straight line basis providing a full year’s
depreciation charge in the year of acquisition and none in the year of disposal.

Required
Prepare the accounting entries required for the asset in each of the three years.

Question 3
The following balances are an extract from Agency C’s trial balance at 31 December 2017:
$ Dr $ Cr
Land and Buildings – at previous revaluation 118,000
Plant and Machinery – at cost 76,350
Accumulated depreciation: buildings (at 1 Jan 2017) 24,500
Accumulated depreciation: plant and machinery (at 1 Jan 2017) 15,400

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The following information is available for non-current assets:

(i) Land is valued at $20,000 and is considered to have an infinite useful economic life.
(ii) Buildings are revalued regularly in line with IPSAS 17. They have been valued at $105,000 as at
31 December 2017. Depreciation is to be charged based on the year-end value.
(iii)Buildings are depreciated on a straight line basis over their estimated useful economic life. At 1
January 2017 their useful economic life was estimated to be 20 years.
(iv) Plant and machinery with original cost of $15,000 was disposed of during 2017. Accumulated
depreciation on this asset at 1 January 2017 was $7,500. The asset was sold for $9,000. No entries
have been made for this diposal.
(v) Plant and machinery is depreciated using the reducing balance method at 15%.
(vi) Assets are not depreciated in the year of disposal.

Required
Prepare the IPSAS 17 disclosure note for tangible non-current assets.

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CHAPTER 13
IPSAS 19: Provisions, Contingent
Liabilities and Contingent Assets
13.0 Introduction
The life of an entity is full of uncertainties regarding future events and management is therefore
required to make informed estimates on the outcome of such events. For example: will there be
sufficient demand for a service in the future; will all the receivables be collected?

The creation of a provision has traditionally provided entities with an opportunity to smooth results.
For example, in periods where performance has exceeded expectations an entity might be tempted to
make what has been commonly referred to as a “rainy day” provision. The provision set up in
prosperous times would be released in periods when results were below expectations.

As a consequence, IPSAS 19 Provisions, Contingent Liabilities and Contingent Assets was introduced
to restrict an entity's ability to make large “general” provisions which can have a significant impact on
the reported results of an entity. IPSAS 19 provides guidance on the type of provisions that should be
made and on the general principles surrounding recognition.

The objective of IPSAS 19 is to ensure that appropriate recognition criteria and measurement bases
are applied to provisions, contingent liabilities and contingent assets and that sufficient information is
disclosed in the notes to the financial statements to enable users to understand their nature, timing and
amount.

13.1 Scope of IPSAS 19

 IPSAS 19 does not apply to provisions and contingent liabilities arising from social benefits
provided by an entity for which it does not receive a consideration that is approximately equal
to the value of the goods and services provided, directly in return from the recipients of those
benefits.

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Social benefits refer to goods, services, and other benefits provided in the pursuit of the social policy
objectives of a government. These benefits may include:
 the delivery of health, education, housing, transport, and other social services to the
community, as in many cases there is no requirement for the beneficiaries of these services to
pay an amount equivalent to the value of these services; and
 payment of benefits to families, the aged, the disabled, the unemployed, veterans, and others
as governments at all levels may provide financial assistance to individuals and groups in the
community to access services to meet their particular needs, or to supplement their income.

 IPSAS 19 does not apply to executory contracts unless they are onerous.
An onerous contract is a contract for the exchange of assets or services in which the unavoidable costs
of meeting the obligations under the contract exceed the economic benefits or service potential
expected to be received under it.
 Also, IPSAS 19 does not apply to specific types of provisions, contingent liabilities and
contingent assets which are already dealt with in another standard, for example construction
contracts as covered in IPSAS 11 Construction Contracts.

13.2 IPSAS 19 Key definitions

There are some key definitions in IPSAS 19 that we need to learn before we consider the accounting
treatment.

13.2.1 Provision
A provision is a liability of uncertain timing or amount.
Provisions are distinguished from other liabilities such as payables and accruals because there is
uncertainty about the timing or amount of the future expenditure required in settlement.

13.2.2 Contingent liability

A contingent liability is:
(a) A possible obligation that arises from past events, and whose existence will be confirmed only
by the occurrence or non-occurrence of one or more uncertain future events not wholly within
the control of the entity; or
(b) A present obligation that arises from past events, but is not recognised because:
(i) It is not probable that an outflow of resources embodying economic benefits or service
potential will be required to settle the obligation; or

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(ii) The amount of the obligation cannot be measured with sufficient reliability.

A contingent liability arises where there is significant uncertainty about a number of aspects regarding
the liability. A contingent liability arises where an event that occurred in the past may lead to the
entity having a liability in the future, but the financial impact of the event will only be confirmed by
the outcome of some future event not wholly within the entity's control.

The giving of a guarantee to another entity that is in financial difficulty is likely to be a contingent
liability, unless the likelihood of making a payment under the guarantee is remote. A liability that
does not meet the provision recognition criteria, for example because the amount of the obligation
cannot be measured reliably, is a contingent liability.

13.2.3 Contingent asset

A contingent asset is a potential asset that arises from past events but whose existence can only be
confirmed by the outcome of future events not wholly within the entity's control.

An example of a contingent asset would be where a hospital (the reporting entity) is in the process of
taking a drugs supplier to court in a claim for damages caused by inadequate labelling on the drugs.

13.3 Recognition of provisions

IPSAS 19 states that a provision should be recognised when all of the following are true:
1) an entity has a present legal or constructive obligation as a result of a past event;
2) it is probable that an outflow of resources (economic benefits or service potential) will be
required to settle the obligation; and
3) a reliable estimate can be made of the amount of the obligation.
Unless all conditions are met, no provision should be recognised.

13.4 Recognition of contingent liabilities

An entity should not recognise a contingent liability in the financial statements.
Disclosure may be required depending on the likelihood of a settlement being made.

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 If the settlement of the obligation is not probable and not remote then a brief description of the
nature of the contingent liability should be disclosed along with an estimate of its financial
effect, an indication of the uncertainties that exist and the possibility of any reimbursement.
 If the settlement of the obligation is remote no disclosure is required.

Contingent liabilities may develop in a way not initially expected. Therefore, they are assessed
continually to determine whether an outflow of economic benefits or service potential has become
probable. If it becomes probable that an outflow of future economic benefits or service potential will
be required for an item previously dealt with as a contingent liability, a provision is recognised in the
financial statements of the period in which the change in probability occurs (except in the extremely
rare circumstances where no reliable estimate can be made).

For example, a local government entity may have breached an environmental law, but it remains
unclear whether any damage was caused to the environment. Where, subsequently it becomes clear
that damage was caused and remediation will be required, the entity would recognise a provision
because an outflow of economic benefits is now probable.

13.5 Recognition of contingent assets

Contingent assets should not be included in the financial statements.
Where the inflow of economic benefits is probable, the financial statements should disclose:
 a brief description of the nature of the contingent asset
 where practicable, an estimate of the financial effect.

13.6 Measurement
The amount to be included should be a best estimate of the expenditure required to settle the present
obligation at the end of the reporting period. This is the amount an entity would rationally pay to
settle the obligation or to transfer it to a third party.

Management will generally be required to make a number of judgements to arrive at a best estimate
for a provision. Judgements should be supplemented by experience of similar transactions and where
appropriate by advice from independent experts. The outcome of events that occur after the end of the
financial year should be taken into account in making estimates.

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13.6.1 Future events

It is possible that the amount required to settle an obligation will be dependent on a number of future
events. For example, where it is expected that there will be technological advances that will reduce,
say, future clean-up costs, the expected effect of these future events should be taken into account in
assessing the provision.

The effect of possible new legislation that may affect the amount of an existing obligation of a
government or an individual public sector entity is taken into consideration in measuring that
obligation, when sufficient objective evidence exists that the legislation is virtually certain to be
enacted.

13.6.2 Expected disposal of assets

Gains from the expected disposal of assets should not be taken into account in measuring a provision.
IPSAS 19 does not override other standards, so such gains should be dealt with under the relevant
standard.

13.6.3 Reimbursements
In some cases, an entity may be able to look to another party, such as an insurance company or a
supplier under a warranty, for reimbursement of all or part of the entity's expenditure to settle a
provision. The entity generally retains the contractual obligation to settle the provision, even if the
other party fails to make the reimbursement. For example, a government agency may have legal
liability to an individual as a result of misleading advice provided by its employees. However, the
agency may be able to recover some of the expenditure from professional indemnity insurance.

IPSAS 19 requires that the reimbursement should be recognised only when it is virtually certain that
the amount will be received. If it is only probable that a reimbursement will be received then the
amount is considered to be a contingent asset and will be disclosed.

If an asset in respect of the reimbursement can be recognised then it should be reported as a separate
asset in the statement of financial position and not netted against any outstanding provision. The
recognition of any reimbursement asset is restricted to the amount of the related provision. In the

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statement of financial performance, the expense relating to a provision may be presented net of the
amount recognised for a reimbursement.

13.7 Changes in provisions

Because provisions are inherently uncertain amounts, IPSAS 19 requires them to be reviewed at the
end of the reporting period and adjusted to reflect the most up to date information about the estimate.
If at the end of the reporting period it is assessed that a transfer of economic benefits or service
potential is no longer probable, the provision should be reversed.

13.8 Use of provisions

A provision should be used only for expenditure for which the provision was original recognised.
Setting expenditures against a provision that was originally recognised for another purpose would
conceal the impact of two different events.

13.8.1 Future operating net deficits

Provisions are not recognised for net deficits from future operating activities. This is because net
deficits from future operating activities do not meet the definition of liabilities and the general
recognition criteria for provisions.

An expectation of net deficits from future operating activities may indicate that assets used in these
activities may be impaired and should be tested for impairment in accordance with the appropriate
IPSAS.

13.8.2 Onerous contracts

An onerous contract is a contract for the exchange of assets or services in which the unavoidable costs
of meeting the obligations under the contract exceed the economic benefits or service potential
expected to be received under it.

An example of an onerous contract is an operating lease signed in the past by a government

department to rent a building which is now no longer needed. The lease becomes onerous if it cannot

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be cancelled or sublet, i.e. there are obligations (rent payments) which exceed the service potential of
the building.

An onerous contract can be recognised as a provision.

The signing of the contract is the past event which leads to a present obligation, and a probable
outflow of benefits. A reliable estimate of this amount could be made.
When making a best estimate of the provision for an onerous contract the entity should take into
account an estimate of any likely income that will be received under the contract.

13.8.3 Restructuring
A restructuring is a programme that is planned and controlled by management, and materially changes
either:
- the scope of an entity’s activities; or
- the manner in which those activities are carried out.
Examples of restructuring would include:
 Termination or disposal of an activity or service;
 Closure of a branch office;
 Changes in management structure
A provision for restructuring costs is recognised only when the general recognition criteria for
provisions are met.
 A constructive obligation to restructure an entity only arises when:
 A detailed formal plan has been made.
This should include identifying the area of the business and location that is going to be restructured,
an estimate of the number of employees that will be affected, the likely cost of the restructuring and
the estimated time scales involved
 the organisation has raised a valid expectation that it will carry out the restructuring by starting
the restructuring or by making an announcement about the restructuring plan to those who will
be affected.
Time scales should be mentioned as part of this announcement, or the entity should have started to
carry out the restructuring. Evidence that a restructuring plan has commenced might be the removal or
dismantling of assets at the affected location. If an announcement has been made then commencement

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of the plan should be within a short period of time to reduce the likelihood of significant changes
being made.

A restructuring provision should only include direct expenditure arising from the restructuring. Costs
which relate to the future activities of the entity should not be provided for as part of the restructuring,
for example relocating or retraining continuing staff.

13.8.4 Sale or transfer of operations

No obligation arises as a consequence of the sale or transfer of an operation until the entity is
committed to the sale or transfer, that is, there is a binding agreement.

13.9 Disclosure requirements

A number of disclosures are required in relation to provisions, contingent liabilities and contingent
assets.

13.9.1 For a provision:

 A full reconciliation should be presented, clearly identifying movements during the period.
These might include revisions of the estimate, utilisation of the provision or a release of part
of the provision.
 An explanation should be provided for each class of provision, detailing what the provision is
for, the expected timing of outflows, an indication of uncertainties over timing or amount of
expected outflows and whether any reimbursement has been recognised.
 The above disclosures should be provided where an entity elects to recognise provisions for
social benefits for which it does not receive consideration that is approximately equal to the
value of the goods and services provided directly in return from recipients of those benefits.

13.9.2 For a contingent liability, assuming the expected outflow is not remote:
 A brief description should be provided for each class of contingent liability. This should
include an estimate of the financial effect, an indication of any uncertainties and the likelihood
of any reimbursements being forthcoming.

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Where a contingent asset is disclosed because the receipt of economic benefits is probable, the entity
should briefly explain the nature of the contingent asset and where practicable the financial effect of
such an asset.

If information about a contingent liability or asset is not disclosed on practicability grounds then this
fact should be disclosed.

If the disclosure of information surrounding a provision, contingent liability or contingent asset would
be seriously prejudicial to an entity, then the general nature of the item should be disclosed with an
explanation of why no additional disclosure has been made. This is expected to be extremely rare in
practice, although it may be appropriate in circumstances where there are legal proceedings in
progress, the outcome of which could be affected by the disclosure of the estimated settlement.

13.10 Revision Questions

Question 1
During 2016, a provincial government gives a guarantee of certain borrowings of a private sector
operator providing public services for a fee, whose financial condition at that time is sound. During
2017, the financial condition of the operator deteriorates and, on 30 November 2017, the operator files
for protection from its creditors.

Required
Analyse the above scenario and recommend how it should be treated in the financial statements for
the year ending:
(a) 31 December 2016
(b) 31 December 2017

Question 2
A Government Medical Laboratory provides diagnostic ultrasound scanners to both public sector and
private hospitals on a full cost recovery basis. The equipment is provided with a warranty under
which hospitals are covered for the cost of defects that become apparent during the first year after
purchase. If minor defects were to occur in all scanners sold, repair costs of $1 million would be
incurred. If major defects were to occur in all scanners sold, repair costs of $4 million would be

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incurred. Past experience and future expectations indicate that 75% of scanners will have no defect,
20% will have minor defects and 5% will have major defects.

Required
What is the expected value of the cost repairs?

Question 3
During January 2016, a hospital became involved in a complex legal case and its legal advisors have
advised the hospital that they are likely to have to pay $1m compensation in 3 years’ time once the
case is finalised by the courts. The hospital’s policy is to discount provisions using a rate of 2.2%.

Required
Show the entries required for the provision in the financial statements as at 31 December 2016 and
2017.

Question 4
Midlands Medical Trust is in the middle of a legal case. The Trust’s lawyer has advised the trust that
it is likely to have to pay compensation of $50,000. The Trust’s policy is to discount provisions at a
rate of 2.2%. The case is expected to be settled in four years’ time.

Required
(a) Calculate the provision’s value on the statement of financial position for this year and complete
the journal entries needed to account for the provision
(b) Calculate the value by which the provision will be unwound next year and show the journal
entries.

Question 5
A transport agency has received a claim from a road-user for a damaged vehicle caused by a pothole
in the road. The entity's legal advisors believe that it is probable that a settlement will need to be made
of $10,000 in favour of the road-user. However, in their opinion it is also probable that a counterclaim
by the entity against their contractor for contributory negligence would successfully recover the
damages.
Required

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How would this be accounted for in the entity’s financial statements?

Question 6
Refer back to the information on Midlands Medical Trust from Question 5. It is year 2. The lawyers
for Midlands Medical Trust have been reviewing the outstanding legal cases. They have decided that
their initial estimate for the provision of $50,000 was over prudent given recent court cases. They
believe that a more reasonable settlement figure based upon the range of possible outcomes is
$40,000. The solicitors still anticipate that the case will be settled within the same timescales.
Required
Show the accounting entries required in year 2 for the provision.

Question 7
A local authority entered into a 10 year lease of a building. The annual rent under the lease agreement
is $36,000. The local authority has decided to relocate its head office with five years still to run on the
original lease. The local authority is permitted to sublet the building and believes that although market
rentals have decreased it should be able to sublet the building for the full five years. The expected
rental is $24,000 per annum.
Required
How would this be accounted for in the entity’s financial statements?

Question 8
A hospital laundry operates from a building that the hospital (the reporting entity) has leased under an
operating lease. During December 2017, the laundry relocates to a new building. The lease on the old
building continues for the next four years; it cannot be cancelled. The hospital has no alternative use
for the building and the building cannot be re-let to another user.

Required
Analyse the above scenario and recommend how it should be treated in the financial statements for
the year ending 31 December 2017.

Question 9
An entity has a formal restructuring plan in place and has raised a valid expectation that this will take
place by starting to implement the plan or by announcing its main features to those affected.

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Required
Can this be recognised as a provision? Why?

Question 10
Required
Can the following be recognised as provisions?
1. An entity offers warranties at the time of sale under which it agrees to make good, repair or replace
any items that develop manufacturing defects within three years.
2. Entity X guarantees certain borrowings of Entity Y, whose financial condition is sound.
3. An entity plans to repair certain of its assets next year.

Question 11
Midlands Town Council is being sued by a former employee for unfair dismissal. The council’s legal
advisors expect the council to lose the case and have advised that in similar recent cases the courts
have decided on compensation of around $100,000.

Required
(a) Determine whether this meets the IPSAS 19 criteria for recognising a provision.
(b) What accounting entry will be required?
(c) What accounting entry will be required in the following financial year when the case goes to
court and the judge determines that compensation of $125,000 should be paid?
(d) Ignoring the outcome in part c), what would happen instead if in the following year the
employee withdraws their claim against the council?

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CHAPTER 14
IPSAS 23 Revenue from Non-
Exchange Transactions
14.1 Non-exchange transactions
Non-exchange transactions are transactions that are not exchange transactions. In a non-exchange
transaction, an entity either receives value from another entity without directly giving approximately
equal value in exchange, or gives value to another entity without directly receiving approximately
equal value in exchange.

After considering such transactions, the IPSAS Board developed a standard to prescribe the financial
reporting requirements of revenue arising from non-exchange transactions. The standard, IPSAS 23,
was issued in December 2006.

14.0 Overview
One of the main characteristics of public sector entities as a whole is that:
 a major part of their revenue is received as taxation or other mandatory payments by citizens
or companies, rather than being paid in exchange for good and services. Many public sector
bodies also receive donations or grants:
 a major part of their expenditure involves making payments or providing services for no fee, a
nominal amount, or an amount which will not recover costs. These may include payments to
relieve poverty, debt forgiveness and other social expenditures.
 These ‘non-exchange transactions’, in which the parties do not make exchanges of
approximately equal value, are a characteristic feature of public sector financial reporting.
Non-exchange transactions arise rarely if at all in the private sector, and consequently there is
no IFRS covering non-exchange transactions.

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14.2 IPSAS 23 Revenue from Non-Exchange transactions

The objective of IPSAS 23 Revenue from non-exchange transactions (Taxes and Transfers) is to set
out requirements for the financial reporting of non-exchange revenue.
IPSAS 23 applies to revenues from the following transactions and events:
 taxes, from whatever source
 other non-exchange revenue (called ‘transfers' in the standard), such as grants, fines, bequests,
gifts, donations, goods and services in-kind.
IPSAS 23 does not apply to:
 revenue from exchange transactions
 entity combinations
 changes in fair value of financial instruments and other assets
 agriculture assets.
In a non-exchange transaction an entity (or an individual) receives assets either without directly
paying for them, or without paying for them in full (ie at a subsidised price).
.

14.3 Recognition
The same principles apply to the recognition of revenue from non-exchange transactions as to other
revenue. Revenue collected on behalf of third parties (including other government organisations) is
not counted as part of the entity’s revenue. Revenue is recognised when:
 it is probable that future economic benefits or service potential will flow to the entity
 the amount of revenue can be measured reliably.

The principle underlying the recognition of revenue from non-exchange transactions is that if an
entity receives an asset in a non-exchange transaction it recognises revenue of the same amount,
provided that the asset can be measured reliably.

In the case of a public sector entity, assets arising from non-exchange transactions can take a number
of forms including:
 cash and cash receivable;
 other assets or receivables which provide economic benefit; and
 assets or assets receivable which have service potential.

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Under accruals accounting, the public sector entity will recognise revenue when it directly exercises
control over these resources, or has reliable information on enforceable claims on these resources.

Non-exchange revenue will typically include:

 donations;
 surrenders of taxes;
 accounts receivable based on invoices, for example for fines levied on offenders, or for
settlement of tax balances;
 accounts receivable from contracts or binding agreements, including grants from another level
of government or from international donors, and;
 estimates of taxes due based on estimates of the economic activity which gives rise to a
requirement to pay tax.

Revenue should only be recognised when control has passed to the receiving entity, on the basis of
information which is sufficiently reliable.

Pledges, promises or announcements of intention to pay are not generally regarded as sufficient to
ensure an enforceable claim and thus control of an asset.

There are three important situations where assets received are not reflected as non-exchange revenue.
1. Contributions from owners:
These are disclosed separately and are not part of revenue. These occur when a ‘contributing’ entity
provides and designates funding or other assets as being a permanent contribution, establishing a
financial interest in the net assets/equity of the receiving entity.
2. Advance receipts:
An entity may receive an asset, generally cash, in advance of the period for which it was intended.
Such advance receipts relate generally to taxes but IPSAS 23 also gives an example of annual
contributions received in the preceding year. In line with standard accruals principles, these advance
receipts are treated as a liability until the taxable or other event triggering recognition occurs, and
only at that point is revenue recognised.
3. Assets with linked obligations:

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The receipt of assets may give rise to a present obligation, in the form of a duty to act or perform in a
certain way. In some cases this will indicate that the asset has been exchanged for acceptance of an
obligation, and normal accounting for exchange transactions should be followed.

In other cases it is more helpful to treat the asset as being received as a non-exchange transaction, but
to recognise a balancing liability in respect of the obligation. For example, a grant may have been
provided by a donor agency to improve and maintain a train way system. If such a condition is set, the
recipient has an obligation to spend the money in this way and therefore a liability exists to incur such
expenditure or to return the money received. This is described in more detail later.

14.4 Measurement
In line with standard requirements for recognition of revenue, it is necessary that the asset received
and controlled by the entity can be measured reliably.

Assets acquired through non-exchange transactions are measured at their fair value at the date of
acquisition. Revenue is valued at the amount of the increase in assets, less any associated liability
attached to the asset.

Many such assets are in the form of cash received immediately or within a short period, and
establishment of fair values will be straightforward. As with all receivables, questions of collectability
due to disputes and delays in payments may need to be addressed.

Liabilities relating to present obligations also need to be valued. Where non-performance of the
obligation would in principle require the asset to be returned, these are generally valued at an amount
equal to the asset value. The liability will be reduced when the event or events occur to discharge the
obligation and these will also trigger revenue recognition.

14.5 Revenue from taxes

IPSAS 23 requires a public sector entity to recognise an asset in respect of taxes when the taxable
event occurs and the asset recognition criteria (including control, expectation of future economic
benefits or service potential, and reliable measurement) are met.

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Taxes are a major source of revenue for many governments and public sector entities. IPSAS 23
includes a definition of taxes as follows:
“Economic benefits or service potential compulsorily paid or payable to public sector entities, in
accordance with laws and/or regulations, established to provide revenue to the government. Taxes
do not include fines or other penalties imposed for breaches of the law.”

The taxable event is the event that the government, legislature, or other authority has determined will
be subject to taxation.

The taxable event will vary according to the type of tax levied and IPSAS 23 provides a list of typical
cases as follows:
 Income tax - earning of assessable income during the taxation period by the taxpayer
 Value added tax - undertaking of taxable activity during the taxation period by the taxpayer
 Goods and services tax - purchase or sale of taxable goods or services during the taxation
period
 Customs duty - movement of dutiable goods or services across the customs boundary
 Death duty - death of a person owning taxable assets
 Property tax - passing of the date on which the tax is levied, or the period for which the tax is
levied, if the tax is levied on a periodic basis.

IPSAS 23 requires that assets arising from taxation transactions be measured at their fair value as at
the date of acquisition. Assets arising from taxation transactions are measured at the best estimate of
the inflow of resources to the entity.

IPSAS 23 describes key features of taxation issues in many jurisdictions which may serve to delay
settlement of tax and make the level of settlement uncertain and may require the development of
statistical models or other estimation approaches. These include the long periods allowed for filing of
returns, failures to file returns by the due date, complexities in tax law and inherent problems in
gathering relevant information.

Due to the need for governments to maintain cash flows from tax receipts, it is normal for tax
authorities to require payments in advance, particularly from self-employed persons and businesses.
IPSAS 23 makes it very clear that the very significant volume of advance tax receipts encountered in

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many jurisdictions should not be recognised as revenue until the tax is properly due. Governments
applying accruals accounting should recognise tax revenue in line with the taxable events, applying
tax rates to taxable income or assets.

The tax area is one where many (perhaps most) governments face significant practical difficulties in
producing reliable estimates of total tax due and the likely level of bad debts. In many jurisdictions
governments will not be able to estimate these even after collection processes have been completed;
they may only be able to objectively and reliably measure the net amount of taxes collected.

Furthermore, governments will often face additional constraints from limitations in the systems used
to collect and account for tax receipts (whether their own or systems used by other entities collecting
tax on behalf of government), which may not provide sufficient information on the period to which
tax receipts relate.

For the reasons set out above, many governments either do not account for tax revenue on an accruals
basis, or provide accruals information which is limited due to difficulties in producing reliable
estimates. IPSAS 23 recognises the difficulties and requires disclosure of information on ‘missing’ tax
revenue.

14.6 Transfers
IPSAS 23 defines transfers as inflows of future economic benefits or service potential from non-
exchange transactions, other than taxes.

IPSAS 23 applies the same recognition principles to other non-exchange revenue, that is, a public
sector entity recognises an asset when the asset recognition criteria (including control, expectation of
future economic benefits or service potential and reliable measurement) are met. Revenue is only
recognised to the extent that a gain from the asset value is not reduced by an associated liability.

Transfers include grants, fines, bequests, gifts, donations, debt forgiveness, and goods and services in-
kind. All these items have the common attribute that they transfer resources from one entity to another
without providing approximately equal value in exchange, and are not taxes as defined in IPSAS 23.

We shall consider each type of transfer in turn.

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14.6.1 Grants
Although grants are not defined in IPSAS 23, they represent a significant type of revenue from non-
exchange transactions. Grants are frequently provided from one level of government to another or
from donor agencies to governments.

Grants are often provided with limitations (‘stipulations’) on how money should be spent or assets
utilised. The standard separates such stipulations into:
 Conditions
where the money must be spent as specified or returned to the donor (in other words a
performance obligation); and
 Restrictions
where there is a more general requirement to spend the money in a specified area but not to
return it if this is not achieved.

This distinction may not always be clear cut and it is necessary to consider the substance of the
stipulation and not merely its form. This might take into account:
 the likelihood of enforcement;
 prior experience with the donor;
 the extent of specification of detailed requirements; and
 the degree of monitoring by the donor.

Where the recipient entity considers that the donor has imposed conditions they will set up a liability
for the obligation, generally to the value of the money received, which will be reduced as the
conditions are satisfied (by spending the money or through other actions) in accordance with the
agreement.

There is no such requirement for grants with restrictions, and revenue is recognised immediately.

14.6.2 Fines
Fines are levies on individuals or entities for breaches of the law. Fines are recognised in the period in
which the fine is imposed.

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14.6.3 Bequests
Bequests are instructions in a deceased person’s will to transfer cash or other assets to an entity.
Bequests are recognised when the nature of the bequest is known and it has been established that the
estate is sufficient to meet all claims. As with grants, bequests may contain stipulations as to how the
money or assets are to be spent or utilised.

14.6.4 Gifts and donations

Gifts and donations are voluntary transfers of cash or other assets to an entity. Gifts and donations are
generally recognised on receipt of the cash or other asset.

The accounting entry is to debit the asset (cash or other asset such as property, plant and equipment)
and credit revenue. Where the asset is not cash, for example the donation of a house or work of art to
a government entity, the asset and revenue will be recognised at fair value.

Pledges to give in the future are not generally recognised as they are not controlled by the entity, but
may warrant disclosure as a contingent asset. As with grants and bequests, gifts and donations may be
subject to stipulations as to how the money or assets are to be spent or utilised.

14.6.5 Debt forgiveness

Lenders may waive their right to collect a debt owed by a public sector entity, thus effectively
cancelling the debt. In such a case the entity has an increase in net assets/equity and treats the amount
forgiven as revenue from a non-exchange transaction.

14.6.6 Services in-kind

Services in-kind are voluntary services provided to an entity by an individual or individuals. Such
services may include free technical assistance from other governments or international organisations,
voluntary work in schools and hospitals or community services performed by convicted offenders.
The standard provides that entities may, but are not required to, recognise services in-kind as revenue
and expenditure where the amount can be measured, is material and its inclusion enhances the

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presentation of the financial statements. Disclosure of the nature of significant in-kind services in all
cases is encouraged.

14.7 Disclosure
IPSAS 23 requires disclosure of the following:
 the accounting policies for the recognition of revenue from non-exchange transactions,
including for major classes, the basis of assessing fair value
 information about the nature of taxes which cannot be measured reliably and are therefore not
recognised
 the nature and types of major classes of bequests, gifts and donations
 the amount of revenue from taxation, split by major classes
 the amount of other revenue/transfers from non-exchange transactions, split by major classes
 the amount of receivables recognised in respect of revenue from non-exchange transactions
 the amount of liabilities associated with amounts received with conditions and from advance
payments as well as liabilities forgiven
 the amount of assets subject to restrictions.

The disclosure of information about services in-kind is encouraged.

14.8 Revision Questions

Question 1
The principle of revenue recognition in IPSAS 23 is that an entity recognises revenue from non-
exchange transactions if it receives an asset which can be measured reliably, subject to exceptions for
contributions from owners, advance receipts and present obligations.
Required
Which ONE of the following receipts would constitute revenue for the year ended December 2017?
(i) A receipt in December 2017 for property tax for the year 2018.
(ii) A receipt from another government body which must be repaid after ten years and on which
annual interest will be charged.
(iii) A receipt for a grant which has the condition that it must be spent on specific designated
projects or returned to the donor.
(iv) A donation from a local resident towards local services.

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Question 2
A national government makes a cash transfer of $50 million to a state government housing agency,
specifying that it must use the cash transfer either to support its existing social housing objectives or
towards new objectives which are in line with national housing priorities.
If this objective is not satisfied, the recipient entity must return the cash to the national government.

Required
How would this be accounted for in the housing entity’s financial statements?

Question 3
The national government (transferor) transfers 200 hectares of land in a major city to a university
(reporting entity) for the establishment of a university campus. The transfer agreement specifies that
the land is to be used for a campus, but does not specify that the land is to be returned if not used for a
campus.

Required
How should the university account for the transaction?

Question 4
The national government (transferor) grants $10 million to a provincial government (reporting entity)
to be used to improve and maintain mass transit systems. Specifically, the money is required to be
used as follows:
 40% for existing railroad and tramway system modernisation
 40% for new railroad or tramway systems
 20% for rolling stock purchases and improvements.

Under the terms of the grant, the money can only be used as stipulated, and the provincial government
is required to include a note in its audited general purpose financial statements detailing how the grant
money was spent. The agreement requires the grant to be spent as specified in the current year or be
returned to the national government.

Required

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How should the provincial government account for the transaction?

Question 5
A major corporation is found guilty of polluting a river. As a penalty, it is required to clean up the
pollution and to pay a fine of $5 million to a government entity. The company is in sound financial
condition and is capable of paying the fine. The company has announced that it will not appeal the
case.

Required
How should the government entity account for the fine?

Question 6
The national government (transferor) lent a local government (reporting entity) $20 million to enable
the local government to build a water treatment plant. After a change in policy, the national
government decides to forgive the loan. There are no stipulations attached to the forgiveness of the
loan. The national government writes to the local government and advises it of its decision; it also
encloses the loan documentation, which has been annotated to the effect that the loan has been
waived.

Required
How should the local government account for the forgiving of the loan?

Question 7
Donations On the evening of 31December 2017, a local television station conducts a fundraising
appeal for a public hospital (reporting entity). The annual reporting date of the public hospital is 31
December. Television viewers telephone or e-mail, promising to send donations of specified amounts
of money. At the conclusion of the appeal, $2 million has been pledged. The pledged donations are
not binding on those making the pledge. Experience with previous appeals indicates approximately
75% of pledged donations will be made.

Required
How should the public hospital account for the pledged donations?

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Question 8
Bequest A 25-year old recent graduate of a public university names the university (reporting entity) as
the primary beneficiary in her will. This is communicated to the university. The graduate is unmarried
and childless and has an estate currently valued at $500,000.

Required
How should the university account for the bequest?

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CHAPTER 15
IPSAS 31: Intangible Assets
15.0 Introduction
IPSAS 31 Intangible Assets, specifies the criteria that determine when an intangible non-current asset
can be recognised, how to measure its carrying value and explains disclosure requirements. Examples
of intangible assets in the public sector include:
 Airport landing rights
 Licences to operate radio and television stations
 Licences to operate mobile telecommunications networks
The standard’s objective is to provide guidance on the treatment of intangible assets not dealt with in
other standards, and therefore many types of assets are outside of its scope, including:
 Financial assets (IPSAS 28)
 Assets arising from employee benefits (IPSAS 25)
 Intangible assets held for sale in the ordinary course of business (IPSAS 11 and IPSAS 12)

15.1 Key definition: Intangible asset

An identifiable non-monetary asset without physical substance
An asset is identifiable if it either:
(a)Is separable, i.e., is capable of being separated or divided from the entity and sold, transferred,
licensed, rented, or exchanged, either individually or together with a related contract,
identifiable asset or liability, regardless of whether the entity intends to do so; or
(b) Arises from binding arrangements (including rights from contracts or other legal rights),
regardless of whether those rights are transferable or separable from the entity or from other
rights and obligations.

15.2 Recognition and measurement of intangible assets

The recognition of an item as an intangible asset requires an entity to demonstrate that the item meets
the recognition criteria are as follows – both must be met in order for an intangible asset to be
recognised:

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(a) It is probable that the expected future economic benefits or service potential that are attributable to
the asset will flow to the entity; and
(b) The cost or fair value of the asset can be measured reliably.

Internally generated goodwill cannot be recognised as an intangible asset as it does not meet the
recognition criteria: it is not an identifiable resource (i.e. it is not separate and does not arise from
binding arrangements) and it cannot be reliably measured at cost.

15.3 Measurement
If the recognition criteria are met, then the asset will initially be measured at cost. Cost includes the
purchase price of the asset, including import duties, non-refundable purchase taxes and any directly
attributable cost of preparing the asset for its intended use. Directly attributable costs include
professional fees and testing costs and exclude administrative overheads and cost incurred while an
asset is capable of operating but has yet to be brought into use.

This is a similar principle to what we saw with regards the initial recognition of property, plant and
equipment under IPSAS 17.

A public sector entity may acquire an intangible asset through a non-exchange transaction (for
example donation of a pharmaceuticals patent to university) The initial cost at acquisition will then be
its fair value.

15.3.1 Key definition: Fair value

The amount for which an asset could be exchanged, or a liability settled, between knowledgeable,
willing parties in an arm’s length transaction.

15.4 Types of intangible assets

For the purposes of our studies intangible assets can be broken down into two main categories:
 Internally generated (development costs), which is essentially where an entity is incurring
costs on developing a new product, materials or system

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 Other (separately acquired) intangibles: this would include copyrights and patents, brands,
licenses and franchises.

Common examples of items encompassed by these broad headings are computer software, patents,
copyrights, motion picture films, lists of users of a service, acquired fishing licences, acquired import
quotas, and relationships with users of a service.

Some public sector entities may have intangible heritage assets, such as the rights to use the likeness
of a significant public person on postage stamps or collectible coins. IPSAS 31 does not require an
entity to recognise intangible heritage assets but if it does so, it must apply the measurement
requirements of the standard.

15.4.1 Internally generated intangible assets: development costs

IPSAS 31 makes an important distinction between research costs and development costs. The
significance of the distinction is that research costs must be charged as an expense to the statement of
financial performance, whereas development costs, where they meet the recognised criteria, are
capitalised and recognised as an intangible non-current asset on the statement of financial position.

Key definitions:
1. Research is original and planned investigation undertaken with the prospect of gaining new
scientific or technical knowledge and understanding.

2. Development is the application of research findings or other knowledge to a plan or design for
the production of new or substantially improved materials, devices, products, processes,
systems or services before the start of commercial production or use.

A public sector entity must be able to demonstrate all of the following six criteria in order to
recognise development expenditure as an asset:

o The technical feasibility of completing the intangible asset so that it will be available for use
or sale;
o Its intention to complete the intangible asset and use or sell it
o Its ability to use or sell the intangible asset;
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o How the intangible asset will generate probable future economic benefits or service potential.
Among other things, the entity can demonstrate the existence of a market for the output of
the intangible asset or the intangible asset itself or, if it is to be used internally, the
usefulness of the intangible asset;
o The availability of adequate technical, financial and other resources to complete the
development and to use or sell the intangible asset; and
o Its ability to measure reliably the expenditure attributable to the intangible asset during its
development.

15.4.2 Accounting treatment for internally generated intangible assets

Research costs: Written off as incurred to the statement of financial performance (expenses).
Development costs: Written off as incurred to the statement of financial performance, unless it meets
all the criteria outlined above for capitalisation.

The costs to be capitalised comprise all directly attributable costs necessary to create, produce and
prepare the asset to be capable of operating in the manner intended by management. This will include
costs of materials, employee benefits and amortisation of patents/licences used to generate the asset
and will exclude selling, administrative and other general overhead expenditure unless it can be
directly attributed to preparing the asset for use. Expenditure on training staff to use the asset and
initial operating deficits / inefficiencies before the asset achieves planned performance should also be
excluded.

The directly attributable costs to be capitalised are measured from the date when the asset first meets
the recognition criteria. Expenditure previously recognised as an expense may not be reinstated.

If the cost is to be capitalised, then recognise the development cost as an intangible asset and applying
the matching principle, amortise over its useful life once commercial production or the intended
benefits commence.

15.5 Other intangible assets - measurement

Initial recognition
Assets in the other (separately acquired) class of intangibles will be recognised initially at cost.
Subsequent recognition

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Subsequent to initial recognition, an entity may choose the cost model or the revaluation model, but if
it chooses the revaluation model then all other assets in the class should also be accounted for using
the same model, unless there is no active market for those assets.

Cost model
After initial recognition, an intangible asset should be carried at its cost less accumulated amortisation
and impairment losses.
Revaluation model
After initial recognition, an intangible asset should be carried at a revalued amount (fair value at the
date of revaluation less any subsequent accumulated amortisation).
Fair value must be determined by reference to an active market.
The revaluation model can only be applied under the following circumstances:
 The fair value must be able to be measured reliably with reference to an active market in that
type of asset.
 The entire class of intangible assets of that type must be revalued at the same time.
 If an intangible asset in a class of revalued intangible assets cannot be revalued because there
is no active market for this asset, the asset should be carried at its cost less any accumulated
amortisation and impairment losses.
 Revaluations should be made with such regularity that the carrying amount does not differ
from that which would be determined using fair value at the statement of financial position
date.
The guidelines state that there will not usually be an active market in an intangible asset; therefore the
revaluation model will usually not be available. For example, although copyrights, publishing rights
and film rights can be sold, each has a unique sale value and hence there is no active market where
identical assets are bought and sold. In such cases, revaluation to fair value would be inappropriate. A
fair value might be obtainable, however, for assets such as fishing rights or quotas or taxi cab
licences.
The treatment of revaluations of intangible assets is the same as you learnt for property, plant and
equipment under IPSAS 17 earlier :
 Increases are credited directly to the revaluation surplus (reserve) unless it reverses a
revaluation decrease of the same asset previously recognised in surplus or deficit.
 Decreases are recognised in surplus or deficit except to the extent of any credit balance in the
revaluation surplus (reserve) in respect of the asset.

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15.6 Other intangible assets - amortisation

IPSAS 31 requires that intangible assets are amortised over their useful economic life.
This is reasonably straightforward for, say, a 10 year fishing licence as the useful life is finite and
easy to determine.

However, other assets may have lives which are not easily determined ( for example brand names),
i.e. there is no foreseeable limit to the period over which the asset is expected to generate cash flows
for the entity. This is known as an indefinite useful life.
i) Amortisation of assets with a finite useful life
An intangible asset with a finite useful life should be amortised over its expected useful life.
 Amortisation should start when the asset is available for use.
 Amortisation should cease at the date that the asset is derecognised.
 The amortisation method used should reflect the pattern in which the asset’s future economic
benefits are consumed. If such a pattern cannot be predicted reliably, the straight-line method
should be used.
 The amortisation charge for each period should normally be recognised in the statement of
financial performance as an expense.
The residual value of an intangible asset with a finite useful life is assumed to be zero, unless a third
party is committed to buying the intangible asset at the end of its useful life or unless there is an active
market for that type of asset (so that its expected residual value can be measured) and it is probable
that there will be a market for the asset at the end of its useful life.
It may be difficult to establish the useful life of an intangible asset, and judgment will be needed.
The amortisation period and the amortisation method used for an intangible asset with a finite useful
life should be reviewed at each financial year end.
ii) Amortisation of assets with an indefinite useful life

An intangible asset with an indefinite useful life should not be amortised.

In accordance with IPSAS 21 and IPSAS 26, an entity is required to test an intangible asset with an
indefinite useful life for impairment by comparing its recoverable amount with its carrying amount:
 Annually, and
 Whenever there is an indication that the intangible asset may be impaired.

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15.7 Subsequent expenditure

The standard states that the nature of intangibles is such that there can be no additions to, or
replacement of parts, in the same way that can occur for tangible assets. Therefore, most subsequent
expenditure is likely to maintain the expected future economic benefits of the existing asset rather
than represent an intangible asset which meets the recognition criteria.

15.8 Other intangible assets – de-recognition

An intangible asset should be eliminated from the statement of financial position when it is disposed
of, or when there is no further expected economic benefit from its future use.

On disposal, the gain or loss arising from the difference between the net disposal proceeds and the
carrying amount of the asset should be taken to the statement of comprehensive income as a gain or
loss on disposal (that is, treated as income or expense).
Any remaining balance relating to the asset within the revaluation reserve in the statement of financial
position should be transferred to retained earnings.
This treatment is no different from that for property, plant and equipment as specified by IPSAS 17.

15.9 Intangible assets - disclosures

IPSAS 31 has extensive disclosure requirements for intangible assets.
For each class of intangible assets, disclosure is required of the following, distinguishing between
internally generated assets and other intangible assets:
(a) Whether the useful lives are indefinite or finite and, if finite, the useful lives or the amortisation
rates used;
(b) The amortisation methods used for intangible assets with finite useful lives;
(c) The gross carrying amount and any accumulated amortisation (aggregated with accumulated
impairment losses) at the beginning and end of the period;
(d) The line item(s) of the statement of financial performance in which any amortisation of intangible
assets is included;
(e) A reconciliation of the carrying amount at the beginning and end of the period showing:
(i) Additions, indicating separately those from internal development and those acquired separately;
(ii) Assets classified as held for sale or included in a disposal group classified as held for sale in
accordance with the relevant international or national accounting standard dealing with non-current
assets held for sale and discontinued operations and other disposals;

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(iii) Increases or decreases during the period resulting from revaluations under paragraphs 74, 84 and
85 (if any); Impairment losses recognised in surplus or deficit during the period in accordance with
IPSAS 21 or IPSAS 26 (if any);
(v) Impairment losses reversed in surplus or deficit during the period in accordance with IPSAS 21 or
IPSAS 26 (if any);
(vi) Any amortisation recognised during the period;
(vii) Net exchange differences arising on the translation of the financial statements into the
presentation currency, and on the translation of a foreign operation into the presentation currency of
the entity; and
(viii) Other changes in the carrying amount during the period.

More detailed disclosures are required in relation to:

 Assets with indefinite useful lives;
 Any individual intangible asset that is material to the financial statements;
 Intangible assets acquired in non-exchange transactions;
 Intangible assets with restricted titles/pledged as security, and;
 Contractual commitments for the acquisition of intangible assets.
Intangible assets measured after recognition using the revaluation model are subject to further
disclosure requirements, including the date of revaluation and the carrying amount of revalued
intangible assets.

An entity is encouraged, but not required, to disclose the following information:

(a) A description of any fully amortised intangible asset that is still in use; and
(b) A brief description of significant intangible assets controlled by the entity but not recognized as
assets because they did not meet the recognition criteria in this Standard.

15.10 Revision Questions

Question 1
The IT Agency has incurred research and development costs of $300,000 during the year ended 31
December 2017. The $300,000 included $50,000 in respect of development of a software programme
which has since been abandoned and $250,000 in respect of development costs on an accounting
package which is expected to come into service next year.

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Required
Explain how the IT agency should account for the $300,000.

Question 2
The University of Midlands has a wholly-owned company, DXP, which has recently significantly
increased its investment in research and development in order to produce higher value added goods.
The Director of Finance of DXP is keen to know whether any of the costs incurred can be treated as
capital expenditure and recognised in the statement of financial position. The costs incurred in year
were as follows:
1. $100,000 was spent on the salary costs of a team working on the development of a new
manufacturing technology. The new technology is in its final stages of testing and expected to come
into use next financial year. The technology is expected to result in savings in production costs for the
company of around $25 000 per year, and will have a useful economic life of 5 years.
2. $150,000 was spent on the development of a ground-breaking quality control process. The project
is in its early stages, but the project manager is confident it will lead to cost savings. He forecasts that
the new process will be ready for implementation in between 5 and 10 years. The Director of Finance,
whilst being excited by the cost saving forecasts produced by the project manager, is concerned that
the time horizon for the development of the product is too long and believes the organisation should
focus its resources on projects that are closer to implementation.
3. The final project under development was a collaboration between three different departments
within the company and two of the company’s customers who sell DXP’s products in the UK retail
market. The aim of the project is to further integrate their logistics management systems. The
managers of the project are expecting the integration to take place in two years’ time and have the full
backing of the Board of all three companies and a commitment to providing the financial and other
resources needed to achieve a successful completion.
To date, the project managers have decided not to monitor the costs of the project because the breadth
of input from different staff made this too complicated, and would be an unwanted distraction from
the main tasks of the project.

Required
Explain whether each of the costs above can be treated as capital expenditure in the statement of
financial position.

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CHAPTER 16.
IPSAS 32 Service Concession
Arrangements: Grantor
16.0 Overview
A service concession arrangement (SCA) is an arrangement (usually contractual) whereby a private
sector entity provides assets and related services that give the public access to major economic and
social facilities. Examples include roads, schools and telecommunication networks.

Within such arrangements there are two parties, a concession operator (normally a private sector
entity) and a grantor (a public sector entity), who is the party that grants the service arrangement. The
operator is compensated for its services over the period of the arrangement and in return has the
obligation to provide public services. At the end of the arrangement the residual interest in any assets
constructed or transferred as part of the arrangement (for example the motorways, bridges or
telecommunication networks) is controlled by the grantor, not the operator.

16.1 Key definitions:

(i) Service concession arrangement
A service concession arrangement is a binding arrangement between a grantor and an operator in
which:
(a) The operator uses the service concession asset to provide a public service on behalf of the grantor
for a specified period of time; and
(b) The operator is compensated for its services over the period of the service concession
arrangement.
(ii) Operator
An operator is the entity that uses the service concession asset to provide public services subject to the
grantor’s control of the asset.
(iii)Grantor
A grantor is the entity that grants the right to use the service concession asset to the operator.

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For example, a government department may enter into an SCA with a private sector construction
company whereby the private company agrees to construct and operate a new motorway for a period
of 25 years. In this case, the operator is the private sector construction company and the grantor is the
government department. Note the operator might be compensated directly by the government
department (for example through monthly payments) or may be compensated indirectly by being
permitted to charge tolls to motorists who use the new motorway.

The outsourcing of an entity’s internal services is not a service concession (for example building
maintenance and employee restaurant facilities), as these do not involve the construction or transfer of
assets.

SCAs have many of the characteristics of a finance lease contract (such as the transfer of a non-
current asset) but also include an executor contract.

16.2 Objective of IPSAS 32

The objective of IPSAS 32 is to prescribe the accounting treatment for service concession
arrangements by the grantor, a public sector entity.

16.3 Key provisions of IPSAS 32

The key issue for both grantors and operators of SCAs is who recognises the SCA asset on their
Statement of Financial Position. The legal owner of the asset will always be the operator, but as you
will remember from our studies of finance leases, legal ownership is not the only consideration when
deciding who recognises the asset. IPSAS 32 provides two control tests:
1. The grantor controls or regulates what services the operator must provide with the
infrastructure/service concession asset, to whom it must provide them, and at what price; and
2. The grantor controls - through ownership, beneficial entitlement or otherwise - any significant
residual interest in the infrastructure/service concession asset at the end of the term of the
arrangement.
If both of these tests are met then the grantor recognises the SCA asset. The asset might have been
provided by the operator or it might be an existing asset of the grantor. So in theory the private sector
operator in any given arrangement will treat the SCA in a consistent manner in their IFRS financial
statements to the public sector grantor in their IPSAS financial statements.

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16.4 Grantor accounting

The grantor’s treatment of an SCA which meets the two control tests is similar to the principles
underling a lessee’s treatment of a finance lease. Where these two tests are met, the grantor will
initially recognise the asset at fair value, with a liability for the corresponding amount.

The nature of the liability, and the accounting treatment after initial recognition, depends on how the
operator is compensated for providing the infrastructure/service concession asset and the related
services.

The grantor makes payments The grantor gives the

to the operator operator the right to charge
service users (e.g. road tolls)
Nature of liability The grantor recognises a The grantor recognises a
financial liability, reflecting its performance obligation,
obligation to make payments to reflecting its obligation to make
the operator. the infrastructure/service
concession asset available to the
operator.

Accounting treatment after Payments made to the operator The performance obligation is
initial recognition are allocated into three reduced as access to the
elements: infrastructure/service
 payment for services; concession asset is provided.
 a finance charge; and
 an element that reduces The grantor recognises the
the finance liability. reduction in the performance
obligation as revenue is
generated over the service
concession arrangement term.

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Where the grantor makes payments to the operator, and also gives the operator the right to charge
service users, the grantor will recognise both a financial liability and a performance obligation, and
will account for these liabilities separately.
You can see in the table above that accounting treatment after initial recognition is the same as for
finance leases where the SCA requires that the grantor makes payments to the operator.

However, where the SCA remunerates the operator by giving it the right to charge service users, the
treatment is rather different, because the grantor has no financial liability to the operator but instead
must recognise a performance obligation.

16.5 Illustration – Grantor accounting

A private sector organisation agrees to construct and operate a section of motorway. The fair value of
the infrastructure/service concession asset is $300 million. The service concession arrangement runs
for 30 years and will commence at the start of Year 2. The infrastructure/service concession asset is
made available for use at the end of Year 1.

The entity will generate revenue from tolls charged to users of the road. The estimated useful
economic life of the infrastructure/service concession asset is 40 years.

Assuming performance of the service concession arrangement is as estimated the financial statements
will contain the following:

Year 1 Statement of financial position

Property, plant and equipment $300 million

Performance obligation $300 million.

Year 2 Statement of financial position

Property, plant and equipment $292.5 million ($300m - 1/40)

Performance obligation $290 million ($300m – 1/30).

Year 2 Statement of financial performance

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Revenue $10 million

Depreciation $7.5 million

16.6 Revision Questions

Question 1
(a) The Eastern Health Authority enters into a service concession arrangement for the provision of
a new hospital and related services. The authority will make annual payments to the operator
over the 20-year period of the arrangement, after which time ownership of the hospital will
pass to the Eastern Health Authority.
(b) As part of its policy of encouraging active lifestyles among residents, Ferntree Municipal
Authority enters into a service concession arrangement whereby a private sector company will
build a brand new swimming pool and sports complex for use by local residents on land
owned by the authority. The authority is not required to make any payments to the operator as
the operator will recoup all of its costs by charging local residents to use the facilities during
the 25 year period of the arrangement, with any increases in fees requiring the approval of the
authority.

Required
Explain how the grantor will account for the SCA in each of the above scenarios.

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CHAPTER 17
IPSAS 24: Presentation of
Budget Information in Financial
Statements
17.0 Overview of IPSAS 24
Most governments publish their financial budgets. The budget documents are often widely distributed
and promoted and reflect the financial characteristics of the government’s plans for the forthcoming
period.

The budget is a key tool for financial management and control and is the central component of the
process that provides for government and parliamentary (or similar) oversight of the finances of
public sector operations.

The reporting by a government of actual results against such approved budgets is an essential part of
the accountability process.

IPSAS 24 sets out reporting requirements for governments and other public sector entities to meet the
need for accountability in the public sector.

17.2 IPSAS 24 requirements

IPSAS 24 requires a comparison of budget amounts and the actual amounts to be included in the
financial statements of entities which are required to, or elect to, make publicly available their
approved budget(s) and for which they are, therefore, held publicly accountable. IPSAS 24 also
requires disclosure of an explanation of the reasons for material differences between the budget and
actual amounts.

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IPSAS 24 aims to ensure that public sector entities demonstrate accountability and enhance the
transparency of their financial statements by showing how they have complied with the approved
budget(s) for which they are held publicly accountable.

IPSAS 24 applies to all entities which are required to, or choose to, make their approved budgets
publicly available.

17.3 Key definitions

Here are some definitions which we need to be aware of in order to understand IPSAS 24:
(i) Accounting basis - The basis ( accruals basis or cash basis) used in the preparation of
financial statements.
(ii) Actual amount - Amounts that result from execution of the budget (the delivery of services
funded from the budget). In some jurisdictions, budget out-turn, budget execution or similar
terms may be used with the same meaning as actual or actual amount.
(iii) Annual budget - An approved budget for one year. It does not include published forward
estimates or projections for periods beyond the budget period.
(iv) Approved budget - The expenditure authority derived from laws, appropriation bills,
government ordinances and other decisions related to the anticipated revenue or receipts for
the budgetary period.
(v) Budgetary basis - The basis accruals basis, cash basis or other basis) used in the budget.
(vi) Comparable basis - The actual amounts presented on the same accounting basis, same
classification basis, for the same entities and for the same period as the approved budget.
(vii) Final budget - The original budget adjusted for all reserves, carry over amounts,
transfers, allocations, supplemental appropriations, and other authorised legislative or similar
authority, changes applicable to the budget period.
(viii) Multi-year budget - An approved budget for more than one year. It does not include
published forward estimates or projections for periods beyond the budget period.
(ix) Original budget - The initial approved budget for the budget period.

17.4 The nature of budgets

An approved budget reflects the revenues or receipts expected to arise in the budget period based on
current plans and expected economic conditions. A budget is not, in principle, simply a forecast of

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expected income and expenditure but frequently sets a formal legal limit within which an entity must
operate.

Budgets may be set to cover some or all of the following:

 Expenditure
 Income
 Cash flows
 Components of the statement of financial position.

IPSAS 24 is written in the context of budgets being set for income and expenditure. Budgets are
generally set for a period of one year but may cover longer periods (multi-year budgets). Multi-year
budgets may or may not be easily divisible into annual figures for comparison with actual annual
financial results.

IPSAS 24 does not prescribe the form, approval process, period, legal status, adjustment process or
other requirements of a budget.

17.5 Financial statement presentation

A comparison of the budget amounts and actual amounts should be presented, either as a separate
additional financial statement or as additional columns in the financial statements.

The choice of presentation may depend on how similar the form of the budget is to the required
financial information to be presented.

The use of additional budget columns in the financial statements is only allowed where the financial
statements and the budget are prepared on a comparable basis. A comparable basis means the same
basis of accounting (whether cash, accruals, or other), for the same entities and reporting period, and
adoption of the same classification structure.

The standard stresses the importance of comparability. The inclusion of budget figures which are not
directly comparable to the financial statement figures would be meaningless and confusing.

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17.6 Non-comparable budget and financial statements

When the budget and financial statements are not prepared on a comparable basis (for example, where
financial statements are prepared on an accruals basis but budgets are prepared on a cash basis), a
separate statement must be presented. IPSAS 24 suggests “Statement of Comparison of Budget and
Actual Amounts” as a title.

This statement must follow the budget basis of reporting and may therefore be presented on a
different basis of accounting from the financial statements. An explanation needs to be given of the
differences in bases.
Where the budget and financial statements are not prepared on a comparable basis, the actual amounts
presented on a comparable basis to the budget in the Statement of Comparison should be reconciled to
the amounts in the financial statements, identifying separately any basis, timing and entity differences.

This information is required in order to demonstrate to a reader that the actual figures in the budget
comparison are derived from the accounting records which underlie the official financial statements.
The reconciliation can be presented either on the face of the statement of comparison or in the notes to
the financial statements. The reconciliation may be split into basis differences, where the accounting
basis is different (for example cash and accrual), timing differences, when the budget period differs
from the period reflected in the financial statements or entity differences, when the budget omits
certain entities included in the financial statements.

17.7 Original and final budgets

Both the original and final budget amounts should be shown, with an explanation of whether changes
from the original budget to the final budget are a consequence of reallocation within the budget or
other factors. The explanation can be shown in the notes to the financial statements or in a separate
report, with a cross reference to the report in the notes to the financial statements.

This requirement is particularly relevant where changes to budgets require a formal and public
approval process. The explanation of differences between original and final budgets is considered
important in terms of accountability and provides useful input for analysis of the financial effects of
changing economic conditions and of policy shifts.

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17.8 Differences between budgeted and actual amounts

Material differences between the budget and actual amounts need to be explained, either by way of
note disclosure or in a separate report issued alongside the financial statements, with a cross reference
in the notes.

The explanation might be given in management discussion and analysis, operations review or other
public report.

This requirement is one of the most significant in terms of accountability, as it confirms, or otherwise,
the robustness of the entity’s budget process and may identify unexpected or unusual items of income
or expenditure of which the public should be aware. Explanations need not be in great detail but
should be sufficient to describe the nature and reasons for significant differences.

Where budgets are prepared in great detail, amounts will need to be aggregated for presentation in
financial statements to avoid information overload. Readers of financial statements are not helped by
excessive detail although such detail may be important in controlling expenditure at the operational
level.

17.9 Disclosure requirements

The notes to the financial statements should explain the budgetary basis and classification basis
adopted in the approved budget.

There may be differences between the accounting basis used in preparation and presentation of the
budget and the accounting basis used in the financial statements, for example the budget may be on a
cash or modified cash basis. Formats and classifications may also differ, for example the budget may
be based on the economic classification of expenses (for example employee costs, costs of goods and
services, etc.) rather than the functional one (for example health, education, etc.), or be linked to
performance outcome objectives.

The notes should state the period of the approved budget.

Generally, the period will match that of the financial statements, but if not, for example with
multiyear budgets, this fact will need to be disclosed to make the statements understandable.

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The notes should give details of the entities included in the approved budget. While the financial
statements may include all resources controlled by an entity on a consolidated basis, approved
budgets may not cover all such entities, for example entities operating on a commercial or market
basis. Disclosure of the entities included in the budget is necessary for an understanding of the
difference in scope.

The disclosure of comparative information for the previous year in respect of the requirements of the
standard is not required. A comparison of the budget amount and actual amount is only required for
the period to which the financial statements relate.

17.10 Summary
The accounting standards covered in this Module Guide are all complex and in real life situations can
result in significant time and expense to apply. Ensure that you are able to explain the basic
requirements of each accounting standard and be able to identify significant issues arising in a
scenario given in the exam. Attempting the exam standard question which follows will give you an
idea of the way in which these standards could be examined.

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Compiled By Majory T Nyazema (2018 – 2019)