University of Rwanda

College of business and economics

Gikondo&Huye&Rusizi and NYAGATARE Campus

CPA COACHING PROGRAM

Intermediate level.

I1. Financial Reporting

Prepared by: BAFE

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Table of Contents
CHAPTER 1: THE REGULATORY FRAMEWORK ................................................................................................... 5
CHAPTER II: RELEVENT IASs AND IFRSs ............................................................................................................... 9
I.1. IAS 16: PPE (Property plant and equipment) ............................................................................................................ 9
I.2. IAS 23 BOROWING COSTS ................................................................................................................................. 16
I.3. IFRS 16 LEASE ...................................................................................................................................................... 20
I.4. IAS 20 – Accounting for Government Grants and Disclosure of Government Assistance ..................................... 32
I.5. INVESTMENT PROPERTY (IAS 40) ................................................................................................................... 35
I.6. IFRS 15: Revenue from contract with customers .................................................................................................... 38
I.7. FINANCIAL INSTRUMENTS............................................................................................................................... 45
I.7.1. IFRS 9: FINANCIAL INSTRUMENTS: RECOGNITION AND MEASUREMENT INITIAL
RECOGNITION ........................................................................................................................................................ 49
I.7.2. IFRS 7 – FINANCIAL INSTRUCTMENTSL: DISCLOSURES .................................................................... 50
I.8. IAS 12: INCOME TAX {ACCOUNTING FOR DEFERRED TAX ...................................................................... 51
I.9. IAS 37: PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS ..................................... 58
I.10. Inventories (IAS 2. ................................................................................................................................................ 60
I.11. IFRS 5 Non-current held for sale and discontinued operation .............................................................................. 62
I.12. IAS 33 Earnings per share ..................................................................................................................................... 65
I.13. IAS 10: Event after reporting date ......................................................................................................................... 71
I.14. IAS 38: INTANGIBLE ASSETS .......................................................................................................................... 73
CHAPTER III: Published financial statement ................................................................................................................... 80
TOPIC IV: FINANCIAL STATEMENTS OF VARIOUS TYPES OF ORGANISATIONS ........................................... 82
III.1. FARMING ............................................................................................................................................................ 82
III.2. INSURANCE FIRMS .......................................................................................................................................... 83
III.3. BANK ................................................................................................................................................................... 87
CHAPTER V: BANKRUPTCY AND LIQUIDATION OF COMPANIES OVERVIEW OF INSOLVENCY
AND BANKRUPTCY ...................................................................................................................................................... 88
CHAPTER VI:(GROUP ACCOUNTS), SUBSIDIARIES, ASSOCIATES AND JOINTLY CONTROLED
ENTITY............................................................................................................................................................................. 92
A. Consolidated financial statement .......................................................................................................................... 93
B. Steps in consolidation ........................................................................................................................................... 94
C. Consolidated statement of financial position ...................................................................................................... 102
D. Consolidated income statement .......................................................................................................................... 105
E. Consolidated cash flow ....................................................................................................................................... 108
CHAPTER VII: ANALYSIS OF FINANCIAL STATEMENT/ RATIO ANALYSIS ................................................... 113
CHAP VIII: EFFECT OF CHANGE IN FOREIGN EXCHANGE ................................................................................ 124
CHAPTER IX: OPERATING SEGMENT (IFRS 8) ...................................................................................................... 131
CHAPTER X: BRANCH ACCOUNTING ..................................................................................................................... 133
CHAPTER XI. Accounting for consignment .................................................................................................................. 143
CHAPTER XII: PULIC SECTOR................................................................................................................................... 150

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I1.2 EXAM INSTRUCTION

GENERAL INSTRUCTIONS OF FINANCIAL REPORTING EXAM ARE:

1. Time allowed: 3 hours 15 Minutes.

2. The examination has two section: A, B
3. Section A has 3 compulsory questions and Section B has 2 questions of which one
must be attempted.
4. Pass rate is: 50 marks
5. And any other instructions as deemed necessary

WHAT TO DO DURING THE EXAM

 You must read the question very carefully and identify the instructional verbs used,
remember there may be more than one thing to answer within each requirement. You
must use the mark allocation to work out how much depth you need to go into in your
answer.
 Make sure that you are answering the question set not the one that you would like to
answer.
 Remember that the exam has 4 questions in total and section A is compulsory. Section
A has 80% of total marks, thus, make sure that much of your time is used to section
A
 Start with the question you are in a position to maximize on the marks
 Remember that the strategy you put in place must be decided in the first 10
minutes reading time.
 To pass, you don’t need to balance figures like try to check if total assets agree with
total equity and liability. Some students spend much time trying to balance financial
position. Advice is to show all of your workings and post figures on the face of
financial statements. You can check balances only if you have surplus time

Managing your time effectively and identifying easy marks available

You must make sure that you are using your exam time efficiently, to identify any questions
that you can easily tackle and plan the order in which you will answer those questions.

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FINANCIAL REPORTING WILL HELP STUDENTS:

1) To understand different IASs and IFRSs

2) To understand how to prepare the financial statements of companies and groups of
companies in accordance with IFRS, component of financial statements are
 Statements of comprehensive income
 Statement of financial position
 Statement of change in equity and
 Statement of cash flow

3) To discuss, explain and apply the methods of accounting for business combinations
and
4) To interpret financial statements

Summary of topic of financial reporting

1. Conceptual framework for financial reporting

2. Relevant international standards and international financial reporting standards
3. Preparation of separate financial statements (Company account)
4. Groups and business combinations
5. Interpretation of financial statements
6. Public sector-IPSAS

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CHAPTER 1: THE REGULATORY FRAMEWORK
The Conceptual Framework states that qualitative characteristics are the attributes that make
the information provided in financial statements useful to users

The international Accounting Standards Board (IASB)

The IASB develops IFRS standards. The main objectives of the IFRS foundation are to raise
the standards of financial reporting and eventually bring about global harmonization of
accounting standards.
The international accounting standards boards (IASB) is an independent, privately funded
body that develops and approve IFRS standards.

Prior to 2003, standards were issued as international accounting standards (IAS Standard). In
2003 IFRS 1 was issued and all new standards are now designated as IFRS standards. The
members of the IASB come from several countries and have a variety of back ground, with a
mix of auditors, preparers of financial statement, users of financial statement and academics.

The IFRS Foundation

The IFRS Foundation (formally called the international accounting standards committee
foundation or IASCF) is not for profit, private sector body that oversees the IASB.

The objectives of the IFRS foundation, summarized from its document IFRS foundation
constitution are to:
Develop a single set of high quality, understandable, enforceable and globally accepted IFRS
standards through its standards-setting body the IASB

Promote the use and rigorous application of those standards;

Take account of the financial reporting needs of emerging and small and medium-sized
entities (SMEs); and
Bring about convergence of rational accounting standards and IFRS standards to high quality
solution

Due process (How IFRSs are developed)

International Financial Reporting Standards (IFRSs) are developed through an international
consultation process, the "due process", which involves interested individuals and
organizations from around the world.
The due process comprises six stages, with the Trustees having the opportunity to ensure
compliance at various points throughout:
1. Setting the agenda
2. Planning the project
3. Developing and publishing the discussion paper
4. Developing and publishing the exposure draft
5. Developing and publishing the standard
After the standard is issued an effective date is set for its application

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Benefits and Drawbacks of accounting standards

Accounting standards are the authoritative statements used in accounting and preparation of
financial statements.
Accounting standards can be defined as an internally consistent set of rules controlling the
measurement and disclosure of information in financial statements in other words, agreed
criteria, in accordance with usage, the law or a professional body, on what is ``sound''
practice in a given situation.

Benefits
• They provide useful working rules for professional accountants
• Increase improvement of the quality of work of accountants
• Helps accountants resist possibility of influence by directors to use suspected
accounting policies
• Ensures users get complete and clearer information that is consistency
• They assist financial information to be comparable
• Ensures that financial statements provide the true economic reality of an organization
•
Drawbacks
• Standards can be rigid and bureaucratic
• Standards may reduce professional judgment of accountancy
• They may make users completely believe that financial statements are unquestionable
• There may be political influence in their development
• The more the standards the more the cost

Difference between IASs and IFRSs

A series of accounting standards, known as the International Accounting Standards, were

released by the IASC between 1973 and 2000, and were ordered numerically. The series
started with IAS 1, and concluded with the IAS 41, in December 2000.
At the time when the IASB was established, they agreed to adopt the set of standards that
were issued by the IASC, i.e. the IAS 1 to 41, but that any standards to be published after that
would follow a series known as the International Financial Reporting Standards (IFRS).
One of the major differences is that the series of standards in the IAS were published by the
International

Accounting Standards Committee (IASC) between 1973 and 2001, whereas, the standards for
the IFRS were published by the International Accounting Standards Board (IASB), starting
from 2001.

When the IASB was established in 2001, it was agreed to adopt all IAS standards, and name
future standards as IFRS. One major implication worth noting, is that any principles within
IFRS that may be contradictory, will definitely supersede those of the IAS. Basically, when
contradictory standards are issued, older ones are usually disregarded.

IN SUMMARY

• IAS stands for International Accounting Standards, while IFRS refers to International
Financial Reporting Standards.
• IAS standards were published between 1973 and 2001, while IFRS standards were
published from 2001 onwards

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 • IAS standards range from 1 to 41. As per now we have 17 IFRSs. To see the list of all
standards, you can refer to this link http://www.ifrs.org/issued-standards/list-of-
standards/
• IAS standards were issued by the IASC, while the IFRS are issued by the IASB,
which succeeded the IASC.
• Principles of the IFRS take precedence if there’s contradiction with those of the IAS,
and these results in the IAS principles being dropped.

THE QUALITATIVE CHARACTERISTICS OF FINANCIAL INFORMATION

The qualitative characteristics of financial information

The conceptual framework states that qualitative characteristics are the attributes that make
the information provided in financial statement useful to user.

The two fundamental qualitative characteristics are relevance and faithful representation.
Enhancing qualitative characteristic are comparability, verifiability, timeliness and
understandability.

Faithful representation. Financial reports represent economic phenomena in words and

numbers. To be useful, financial information must not only represent relevant phenomena but
must faithfully represent the substance of the phenomena that it purports to represent’ To be a
faithful representation, information must be complete, neutral and free from error.

Relevance

Financial information is relevant if it is capable of making a difference in the decisions made

by users. Information may be capable of making a difference in a decision even if some users
choose not to take advantage of it or are already aware of it from other sources
Financial information is capable of making a difference in decisions if it has predictive value,
confirmatory value or both.

Financial information has predictive value if it can be used as an input to processes employed
by users to predict future outcomes. Financial information need not be a prediction or
forecast to have predictive value. Financial information with predictive value is employed by
users in making their own predictions

Main Qualitative characteristics of financial information

Understandability: an essential quality of the information provided in the financial

statements is that it is readily understandable by users. For these reason users are assumed to
have a reasonable knowledge of business and economic activities and accounting.
Relevance: information has the quality of being relevant when it influences the economic
decisions of users by helping them evaluate past, present or future events or confirming or
correcting their past evaluations. The relevance of information is affected by its nature and
materiality.
Reliability: Information is useful when it is free from material error and bias and can be
depended upon by users to represent faithfully that which it purports to represent or could
reasonably be expected to represent. To be reliable then the information should:
• Be represented faithfully,
• Be accounted for and presented in accordance with their substance and economic
reality and not merely their legal form,
• Be neutral i.e. free from bias, includes some degree of caution especially where
uncertainties surround some events and transactions (prudence),
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 • Be complete i.e. must be within the bounds of materiality and cost. An omission can
cause information to be false.

Comparability: users must be able to compare the financial statements of an enterprise

through time in order to identify trends in its financial position and performance. Users must
also be able to compare the financial statements of different accounting policies, changes in
the various policies and the effect of these changes in the accounts. Compliance with
accounting standards also helps achieve this comparability.

Elements of Financial Statements

Financial statements need to reflect the effects of transactions and other events on the
reporting entity‘s financial performance and financial position. This involves a high degree
of classification and aggregation. Order is imposed on this process by specifying and
defining the classes of items – the elements – that encapsulate the key aspects of the effects
of those transactions and other events. The main elements and their definitions are as
follows:

Assets – a resource controlled by an entity as a result of past events from which future
economic benefits are expected to flow. Assets are broken down between current assets and
non-current assets (formerly known as fixed assets).

Liabilities – present obligations of the entity arising from past events, settlement of which is
expected to result in an outflow of resources embodying economic benefits. Liabilities are
broken down between current liabilities and non-current liabilities.
Equity – the residual interest in the assets of the entity after deducting all its liabilities.
Incomes– increases in economic benefits in the form of inflows of assets or decreases of
liabilities that result in increases in equity.
Expenses – decreases in economic benefits in the form of outflows of assets or
incurrence of liabilities that result in decreases in equity

Recognition of the elements of financial statements

Only items that meet the definition of an asset, a liability or equity are recognized in the
statement of financial position. Similarly, only items that meet the definition of income or
expenses are recognized in the statement(s) of financial performance. However, not all items
that meet the definition of one of those elements are recognized.
Recognition: the process of capturing for inclusion in the statement of financial position or
statement(s) of profit or loss and other comprehensive income an item that meets the
definition of one of the elements of financial statements- an asset, a liability, equity, income,
or expenses.
An asset or liability should be recognized if it will be both relevant and provide users the
financial statement with a faithful representation of the transaction of the transactions of that
entity, the conceptual framework takes these fundamental qualitative characteristics along
with the definitions of the elements of the financial statements as the key component of
recognition.

De-recognition is the removal of all or part of a recognized asset or liability from an entity’s
statement of financial position.

De-recognition normally occurs when that item is disposed or no longer meets the definition
of an asset or liability.

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CHAPTER II: RELEVENT IASs AND IFRSs

I.1. IAS 16: PPE (Property plant and equipment)

Definition: Property, plant and equipment are tangible items that are held for use in the
production or supply of goods or services, for rental to others, or for administrative
purposes; and are expected to be used during more than one period

Recognition

Condition necessary to recognize assets in the books of account.

IAS 16 states that the cost of an item of property, plant and equipment shall be
recognized as an asset if, and only if:

 It is probable that future economic benefits associated with the item will flow to the
entity; and
 The cost of the item can be measured reliably.

Measurement

Initial Measurement

IAS 16 state that Property, plant and equipment that qualifies for recognition as an asset
shall initially be measured at its cost.

The cost of an item of property, plant and equipment shall be comprised by:

i. The Purchase Price less trade discounts and rebates

ii. Import duties and non-refundable purchase taxes
iii. Any costs that are directly attributable to bringing the asset to the
iv. Location and condition necessary for the asset to be used as intended, for example:

 Initial delivery and handling costs

 Site preparation costs
 Installation and assembly costs
 Professional fees
 Costs of testing whether the asset is functioning properly
(after deducting the sales proceeds of any samples produced
during testing)
iv. The estimated initial costs of dismantling and removing the item and
restoring the site, if such an obligation is placed on the entity (legally or
constructively)
N.B:
(a) Administration and other general overheads are not included in the cost of the
asset.
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 (b) Likewise, the following are also excluded: training costs, advertising and
promotional costs and costs incurred while an asset, capable of being used as
intended, is yet to be brought into use, is left idle or is operating below full
capacity.
(c) In the case of self-constructed assets, the following are excluded from the cost
of the asset:
 Abnormal amounts of wasted material, labour or other resources]
 In certain circumstances, IAS 23 allows part of the borrowing cost to be
capitalized.
(d) If payment is deferred beyond normal credit terms, the difference between the
cash price equivalent and the total payment is recognized as interest over the
period of credit (unless such interest is capitalized in accordance with IAS
23).

Cost of acquired assets acquired in exchange for another asset;

If an asset is acquired in exchange for another asset, the acquired asset is

measured at its fair value unless the exchange lacks commercial substance
or the fair value cannot be measured reliably. If this is the case, the
acquired asset should be measured at the carrying value of the asset given
up (carrying amount being equal to cost less accumulated depreciation and
impairment losses).

Question.1.

On 01 January 2016 T.s Limited has acquired an item of plant. The details of this
acquisition are:
Details Amount Amount
Frw Frw
List price of plant 240,000
Trade discount applicable to T. Ltd 12.5%
Ancillary costs:
Shipping and handling costs 2,750
Pre-production testing 12,500
Maintenance contract for three years 24,000
Site preparation costs:
Electrical cable installation 14,000
Concrete reinforcement 4,500
Own labor costs 7,500
26,000
 T.s Ltd paid for the plant (excluding the ancillary costs) within
four weeks and thus received a 3% early settlement discount.
 An error was made in installing the electrical cable. This error
cost RWF 6,000 and is included in the RWF14, 000 figure.
 The plant is expected to last for 10 years. At the end of this period, there
will be compulsory costs of RWF18,000 to dismantle the plant and
restore the site. (Ignore discounting).

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 Required:
1. What is the initial cost of the plant that should be recognized in the Statement of
Financial Position for the year ended 31 December 2016?

Subsequent Measurement.

Subsequently after initial measurement of PPE the entity shall choose either:
(a) Cost model or
(b) Revaluation model.

(a) Cost model: This is where the entity adopts to carry their assets at cost less any
accumulated depreciation and any accumulated impairment losses.

Method of computing depreciation

i. Straight line method

ii. Fixed Percentage on Diminishing Balance (Reducing balance method)

(b) Revaluation model

This is where the entity carry its asset at a revalued amount. Revalued amount is its fair
value at the date of the revaluation less any subsequent accumulated depreciation and
subsequent accumulated impairment losses:

If an item of PPE is revalued, then the entire class of PPE to which the assets belongs shall
be revalued.
If an asset is revalued upwards:
Dr Assets
Cr: Revaluation surplus
(Being recognition of the increase in the value of the asset.)

If an asset is revalued downwards:

Dr: Revaluation loss/expense
Cr: Assets
(With the decrease in the value of the asset.)
However, if the revaluation gain reverses a previous revaluation loss, which was
recognised as an expenses, then gain should be recognized in the income statement (but
only to the extent of the previous loss of the same asset). Any excess over the amount of the
original loss goes to the revaluation surplus.

Furthermore, if Revaluation loss reserves a previous revaluation surplus, the decrease

should be debited directly to the revaluation surplus to the extent of any credit balance
existing in the revaluation surplus in respect of the asset.
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Example:
On 31/12/2017 Kigali mountain ltd had motor vehicle with carrying value of Frw 25 million.
On 31/12/2014 the motor vehicle had a carrying value equivalent to Frw 15 Million.
Furthermore, Included in the property, plant and equipment of Kigali mountain ltd for the
year ended 31/12/2017 is the building with the carrying amount of Frw 80 million, this
building had a carrying value as at 31/12/2016 of Frw 100 million.
Due to significant change in the price of the assets, on 31/12/2017 Kigali Mountain revalue
some of the assets: as follow:
The motor vehicle was revalued at Frw 5 million while the building was revalued at Frw
125 million. All assets of Kigali mountain ltd are measured at Revaluation model.
Required: Prepare the journal entries to reflect the above transaction in the book of account
of Kigali Mountain.

Example 2;

MUSHYA Tea company ltd is tea factory located in GICUMBI District and it was
established 10 years ago. The financial year of MUSHAYA tea ltd ended 31 December.

On 30/06/2010, company acquired Airplane to facilitate the transport of tea from factory to
foreign market. The airplane was acquired at total of Frw 204 Million with an estimated use
useful life of 10 years. Included in the cost of airplane is a substantial overhaul of Frw 4
million which will be required every 2 years due to airplane’s engine. The overhaul will
increase the economic benefits of the airplane.

On 1 January 2011, the Company acquired land and building to extend its investment at the
value of Frw 400 million (including land of Frw 40 million). Due to extended investment
MUSHYA tea ltd decided to import new machinery from USA. The machinery was
purchased and arrived in GICUMBI on 31 December 2011, invoice price of the machine was
952,380.952 USD. The installation cost was Frw 40 million. The building and machinery are
depreciated at the rate of 10% and 5% respectively.

On 01 January 2013, MUSHYA tea ltd opted to restate the assets at their current market
value and the assets was revalued as follow:

The airplane was revalued to Frw 180 million and there was no change in the useful life of
the airplane. Land and building was revalued at Frw 280 million (land at value of Frw 60
million). The machinery was revalued at the value of Frw 700 million.
The ruling exchange rate of BNR as at 31 December 2011 was 1 USD= Frw 840.

Required:
1. Prepare the extract financial statement for the year ended 31st December 2013.
2. Assume that the revaluation was carried out at 30 June 2013 and there was no
overhaul cost for the engine of airplane. Prepare the extract financial statement of
MUSHYA Tea company ltd.

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Answer

AIRPLANE

Acquisition date: 30 June 2010

Initial cost excluding overhaul cost; 204 million-4million=200 million

Useful life of 10 years

N.B: Revaluation took place on 01 January 2013 i.e 2.5 years after acquisition

Information to be reflected in Extract Financial statements is computed as follows:

Frw 000
Initial cost 200,000
Accumulated depreciation (50,000)
NBV as at 30 June 2013 150,000
Revalued amount 180,000
Revaluation surplus 30,000

Dr: Motor vehicle Frw 20,000

Cr: Reserve Frw 20,000
Being recognition of revaluation upward

Amount to reclassified in retained earnings

IAS 16 state that

The revaluation surplus included in equity in respect of an item of property, plant and
equipment may be transferred directly to retained earnings when the asset is derecognised.
This may involve transferring the whole of the surplus when the asset is retired or disposed
of.

However, some of the surplus may be transferred as the asset is used by an entity. In such a
case, the amount of the surplus transferred would be the difference
between depreciation based on the revalued carrying amount of the asset and depreciation
based on the asset’s original cost. Transfers from revaluation surplus to retained earnings are
not made through profit or loss

Deprecation based on cost 20,000

Deprecation based on revalued amount 24,000

Amount to be reclassified to retained earnings 24,000-20,000=4,000

Dr Reserves Frw 4,000

Cr Retained earnings Frw 4,000

Compute depreciation for the year ended 31 December 2013

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7.5 years is obtained as follows: 10years-2.5 years

N.B: you may be given a scenario where revaluation took place half way the year, if so, the
depreciation for first months before revaluation must be computed based on initial cost while
depreciation for months after revaluation is based on revalued amount and remaining years

Overhaul costs

The company will require an overhaul cost for every two years, from 30 June 2010. The
estimated value of this overhaul is Frw 4 million.

The capitalized overhaul cost as at 30 June 2010 was Frw 4million which will be written off
within two years i.e till 30 June 2012. The new overhaul was incurred on 01 July 2012 and
will be used till 30 June 2014.

In 2013, we need only to compute depreciation of this overhaul as its related capitalization
took place in 2012.

In 2012 there was a depreciation charge of 6 months i.e 4,000/4*6/12 for this new overhaul
cost, therefore, the NBV as at 31 December 2013 is

Land and Building

Acquisition date: 01 January 2011

Initial cost: 400 million (where 40 million is for land)

Depreciation rate on building: 10%

Revaluation date: 01 January 2013

Reporting date: 31 December 2013

Frw 000
Land and building (Cost) 400,000
Less cost of land (40,000)
Cost of building 360,000
Accumulated depreciation as at 30 June 2013 (72,000)

NBV of building as at 30 June 2013 288,000

Revalued amount of building (280m-60 m) 220,000
Revaluation deficit on building 68,000
Revaluation surplus on land 60m-40m 20,000

Depreciation of building for the year ended 31 December 2013

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Machinery

Machinery was imported on 31 December 2011

Invoice price; 952,380.952 USD
Installation costs: 40 million
Depreciation rate: 5%
Exchange as at 31 December 2011: 1USD=Frw 840

Frw 000
Invoice price 952,380.952 USD x 840 800,000
Installation costs 40,000
Total initial cost 840,000
Accumulated depreciation as at 30 June 2013 (42,000)
840,000*5%*1
NBV as 30 June 2013 798,000
Revalued amount 700,000
Revaluation deficit 98,000

Extract Statement of profit or loss account

Frw 000
Expenditure
Depreciation of Airplane and engine 24,000+2,000 26,000
Depreciation of building 22,000
Revaluation deficit on building (note 1 below 68,000
Depreciation of machinery 35,000
Revaluation deficit on machinery (note 1 98,000
below

Other comprehensive income

Revaluation surplus on airplane (note 1 below 20,000
Revaluation surplus on land (note 1 below 20,000

Note 1: Revaluation surplus and deficit

IAS 16 State that:

If an asset’s carrying amount is increased as a result of a revaluation, the increase shall be

recognized in other comprehensive income and accumulated in equity under the heading of
revaluation surplus.
However, the increase shall be recognized in profit or loss to the extent that it reverses a
revaluation decrease of the same asset previously recognized in profit or loss

If an asset’s carrying amount is decreased as a result of a revaluation, the decrease shall be

recognized in profit or loss.

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However, the decrease shall be recognized in other comprehensive income to the extent of
any credit balance existing in the revaluation surplus in respect of that asset. The decrease
recognized in other comprehensive income reduces the amount accumulated in equity under
the heading of revaluation surplus

Extract statement of financial position

Frw 000
Assets
Airplane and its engine 156,000+1,000
Land and building 258,000
Machinery 665,000
Equity
Revaluation reserves 20,000+20,000-4,000 36,000

De-recognition

IAS 16 prescribes that the carrying amount of an item of property, plant and equipment shall
be derecognized on disposal; or when no future economic benefits are expected from its
use or disposal.

The gain or loss arising from de-recognition of an item of property, plant and equipment
shall be included in profit or loss when the item is derecognized.

The gain or loss from de-recognition is calculated as the net disposal proceeds (usually
income from sale of item) less the carrying amount of the item.
Tangible and intangible assets

The difference between tangible assets and intangible assets:

Tangible asset: Those with physical substance i.e we can see or touch them.
Example: building, machinery, cars, furniture etc.

Intangible assets: Those without physical substance but are valuable for the business.
E.g. patents, copyrights etc. Such assets are called intangible assets.

I.2. IAS 23 BOROWING COSTS

Definition: Borrowing costs are interest and other costs incurred by an entity in
connection with the borrowing of funds.

Accounting treatment of borrowing costs

Borrowing costs shall be recognised as an expense in the period in which they are
incurred, except to the extent that they are capitalised.

Borrowing costs that are directly attributable to the acquisition,

construction or production of a qualifying asset shall be capitalised as part of
the cost of that asset.
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A qualifying asset is an asset that necessarily takes a substantial period of time to
get ready for its intended use or sale.

Borrowing costs that can be capitalized shall be determined as follow:

Borrowing costs-investment income earned on temporary investment of

unused funds

N.B: The amount of borrowing costs capitalised during a period shall not exceed
the amount of borrowing costs incurred during that period.
The capitalisation of borrowing costs as part of the cost of a qualifying asset
shall commence when:

(a) expenditures for the asset are being incurred;

(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.
Suspension and cessation of borrowing costs

1.
Capitalisation of borrowing costs shall be suspended during extended periods in
which active development is interrupted.

2.
Capitalisation of borrowing costs shall cease when substantially all the activities
necessary to prepare the qualifying asset for its intended use or sale are
complete
Example of borrowing cost that can be capitalised

i. Interest on bank overdraft, short and long term borrowings

ii. Amortization of discounts or premium relating to borrowing
iii. Amortization of auxiliary costs incurred in connection with arrangements of
borrowings.
iv. Finance charges in respect of finance leases recognized in accordance with IAS 17.

Example 1.
On the 1st June 2010, SAH. Limited commenced construction of a new factory
that is expected to take 3 years to complete. It is being financed entirely by a 3-
year term loan of RWF 6 million (taken out at the start of construction). Due to a
substantial hazards caused by heavy rain, the active construction of factory was
suspended for 2 months from 1st August 2010.
The loan carries a fixed interest rate of 9% per annum and issue costs of 1.5% of
the loan value were incurred on the loan. During the year, RWF57, 000 had been
earned from the temporary investment of these borrowings.
The company’s year-end is 31st December.

17
Required: How much interest must be capitalized under IAS 23 for the year
ended 31st December 2010.

Example 1
Borrowing cost =6,000x9%=540
The loan was taken on 01 June 2010; during the year, only 7 months are applicable
But due to suspension of active development of assets for two months, the borrowing costs
that will be capitalized is for 5 months instead of 7 months, then
The remaining borrowing costs of two months will be reported in P/L (this interest relate to
period when operations were suspended)
Issue costs
The loan if for 3 years, then issue costs for one year is computed as follows
The issue cost to be capitalized for the year ended December 2010:

Total borrowing cost =225+12.5=237.5

Less investment income (57)
Amount to be capitalized =180.5

18
Example 2:
On 1/1/2010 XY Ltd borrowed Frw 30, 000,000 to finance the production of two projects both of
which were expected to take a year to build. Production started during the year 2011. The loan
facility was drawn down on 1/1/2011 and was utilized as follows, with the remaining funds
invested temporarily.

Project
Period A B
Frw Frw
1st January 2011- 30th June 2011 5,000,000 10,000,000
1st July 2011-31st December 2011 5,000,000 10,000,000
10,000,000 20,000,000
Interest on borrowings was nine percent per annum (9% p.a) and idle funds can be invested to earn
an interest of seven percent (7% p.a).
Required:
a) Calculate the amount of borrowing cost to be capitalized
b) Calculate the total cost of the asset A and B as it would be represented in the financial
statement.

Answer:

Borrowing cost

A B
Frw 000 Frw 000
Borrowing cost 10,000*9%=900 20,000*9%=1,800
Less Investment income 5,000*7%*6/12= (175) 10,000*7%*6/12= (350)
Borrowing cost to be 725 1,450
capitalized (a)

Total cost of assets

A B
Frw 000 Frw 000
Expenditure incurred 10,000 20,000
Borrowing costs 725 1,450
Total cost 10,725 21,450

Example from past paper:

Borrowing cost is computed as follows

Frw 000
Borrowing costs 800,000*15%=120,000

Investment income is computed as follows

19
 Frw
From 1 July to 30 November 2017 600,000*10%*5/12 25,000
Invested amount is 800-600
From 1 Dec 2017 to 28 Feb 2018 200*10%*3/12 5,000

Unused amount is 800-200-400=200

Total investment income 30,000

Amount to be capitalised is the difference between borrowing cost and investment income earned
on used amount that was temporary invested

Amount to be capitalized is computed as follows

Frw
Borrowing costs 120,000
Less investment income as above (30,000)
Amount to be capitalized as at 30 June 2018 90,000

I.3. IFRS 16 LEASE

The IASB published IFRS 16 (Lease).

IASB promulgated that new lease amendment under IFRS 16 will comes into effect on and after 1st
January 2019. i.e it is now being applied by companies.

Objectives of this standard

The objective is to ensure that lessees and lessors provide relevant information in a manner that
faithfully represents those transactions.
This information gives a basis for users of financial statements to assess the effect that leases have
on the financial position, financial performance and cash flows of an entity.

Definition:
Lease is an agreement whereby the lessor conveys to the lessee, in return for rent, the right to use
an asset for an agreed period of time. The lessor remains the owner but lessee has a right to use the
equipment for agreed rentals to be paid over a period

Finance lease: is an agreement that transfer substantially all the risks and rewards incidental to
ownership of an asset. Title may or may not eventually be transferred.

Operating lease

This is an agreement does not conveys the right to control the use of an identified asset for a
period of time

20
Minimum lease payments

These are payments over the lease term that the lease is or can be required to make excluding
contingent, rent, costs for services and taxes to be paid by and reimbursed to the lessor.

1.IDENTIFYING WHETHER A CONTRACT IS A LEASE OR NOT

At inception of a contract, an entity should assess whether the contract is, or contains, a lease. A
contract is, or contains, a lease if the contract gives the right to control the use of an identified asset
(‘underlying asset’) for a period of time in exchange for consideration.
The right to control the use of an identified asset can be split into:

i. The right to obtain substantially all of the economic benefits from use of an identified asset and
ii. The right to direct the use of an identified asset.
Below are some important criteria used to identify whether a contract is a lease or not.
(a) The contract shall have an identified assets
(b) The customer (Lessee) has the right to obtain substantially all of the economic
benefits from use of the assets throughout the period of contract.
(c) At inception of contract, the manner in which the asset will be used must be
predetermined.
(d) The customer shall have the right to operate the asset throughout the period of
contract and the supplier has no right to change or affect those operating
instructions.
(e) The customer shall design the way that predetermines how and for what purpose
the asset will be used throughout the period of use (Contract).
Example:
Company A enters into a fixed three-year contract with a stadium operator (Supplier) to use a space
in a stadium to sell its goods. The contract states the amount of space and that the space may be
located at any one of several entrances of the stadium. The Supplier has the right to change the
location of the space allocated to Company A at any time. There are minimal costs to the Supplier
associated with changing the space. Company A uses a kiosk (that Company A owns) to sell its
goods that can be moved easily. There are many areas in the stadium that are available and would
meet the specification for the space in the contract
The contract does not contain a lease because there is no identified asset. Company A controls its
own kiosk. The contract is for space in the stadium, and this space can be changed at the
discretion of the Supplier. The Supplier has the substantive right to substitute the Space Company
A used because:

a) The Supplier has the practical ability to change the space used at any time without
Company A’s approval.
b) The Supplier would benefit economically from substituting the space

IFRS 16 introduces a single lessee accounting model and requires a lessee to recognise assets and
liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low
value. A lessee is required to recognise a right-of-use asset representing its right to use the
underlying leased asset and a lease liability representing its obligation to make lease payments.

Leases previously classified as operating lease

21
The lessee shall:

a) Recognize a lease liability at the date of initial application for leases previously classified as
an operating lease applying IAS 17. The lessee shall measure that lease liability at the
present value of the remaining lease payments, discounted using the lessee’s incremental
borrowing rate at the date of initial application

b) Recognize a right-of-use asset at the date of initial application for leases previously
classified as an operating lease applying IAS 17. The lessee shall choose, on a lease-by-
lease basis, to measure that right-of-use asset at either:

 its carrying amount as if the Standard had been applied since the commencement date, but
discounted using the lessee’s incremental borrowing rate at the date of initial application; or
 An amount equal to the lease liability, adjusted by the amount of any prepaid or accrued
lease payments relating to that lease recognized in the statement of financial position
immediately before the date of initial application

Exclusion from IFRS 16.

i. Leases of intangible assets
Not all assets rented shall be accounted under IFRS 16. Instead IFRS 16 excludes rights for
intangible assets such as motion picture films, video recordings, plays, manuscripts, patents and
copyrights. These rights should be accounted for under IAS 38. For leases of other intangible
assets, entities (lessees only) may choose to apply IAS 38 or IFRS 16.
ii.Short-term leases
Entities may elect not to apply recognition requirements of IFRS 16 for short-term leases. A short-
term lease is a lease that, at the commencement date, has a lease term of 12 months or less and does
not contain a purchase option.
When this recognition exemption is applied, lease payments are recognised as an expense over the
lease term on straight-line basis or another systematic basis (IFRS 16.6).
iii. Low-value assets
Entities may elect not to apply recognition requirements of IFRS 16 for leases for which the
underlying asset is of low value. The value of the underlying asset should be assessed by reference
to a new asset regardless of the age of the asset being leased. Paragraph IFRS 16.B6 states that
leases of cars do not qualify as leases of low-value assets because a new car would typically not be
of low value.
Examples of low-value assets given by IFRS 16.
Tablets, PCs, small items of office furniture and telephones.
Basis for Conclusions to IFRS 16 explain that, when developing the exemption for low-value
assets, IASB had in mind leases of underlying assets with a value, when new, in the order of
magnitude of $5,000 or less. Although this threshold is not included in the standard, it is often used
as a valid guidance for determining whether an asset is of low value.

An assessment of whether an asset is of low value should also be made irrespective of the
materiality levels for a given entity, so large and small entities are expected to reach the same
conclusions about whether a particular underlying asset is of low value.

Accounting for short-term lease and lease for assets of low value

22
If a lessee elects not to apply due to either short-term leases or leases for which the underlying
asset is of low value, the lessee shall recognise the lease payments associated with those leases as
an expense on either a straight-line basis over the lease term or another systematic basis. The lessee
shall apply another systematic basis if that basis is more representative of the pattern of the lessee’s
benefit.

Measurement of lease in the books of Lessee

Initial measurement
Initial measurement of the right-of-use asset

At the commencement date, a lessee shall measure the right-of-use asset at cost. The cost of
the right-of-use asset shall comprise

 At the commencement date, a lessee shall measure the lease liability at the present value of
the lease payments that are not paid at that date. The lease payments shall be discounted
using the interest rate implicit in the lease, if that rate can be readily determined. If that rate
cannot be readily determined, the lessee shall use the lessee’s incremental borrowing rate
 any lease payments made at or before the commencement date, less any lease
incentives received
 any initial direct costs incurred by the lessee; and
 An estimate of costs to be incurred by the lessee in dismantling and removing
the underlying asset, restoring the site on which it is located or restoring the underlying
asset to the condition required by the terms and conditions of the lease, unless those costs
are incurred to produce inventories. The lessee incurs the obligation for those costs either at
the commencement date or as a consequence of having used the underlying asset during a
particular period

Subsequent Measurement of right-of-use asset

After the commencement date, a lessee shall measure the right-of-use asset applying a cost model

Cost model

To apply a cost model, a lessee shall measure the right-of-use asset at cost less any accumulated
depreciation and any accumulated impairment losses; and

However, the lessee may not adopt cost model if

a) If a lessee applies the fair value model in IAS 40 Investment Property to its investment
property, the lessee shall also apply that fair value model to right-of-use assets that meet the
definition of investment property in IAS 40

b) If right-of-use assets relate to a class of property, plant and equipment to which

the lessee applies the revaluation model in IAS 16, a lessee may elect to apply that
revaluation model to all of the right-of-use assets that relate to that class of property, plant
and equipment

Subsequent measurement of the lease liability

After the commencement date, a lessee shall measure the lease liability by

23
 a) Increasing the carrying amount to reflect interest on the lease liability;
b) Reducing the carrying amount to reflect the lease payments made; and
c) Re-measuring the carrying amount to reflect any reassessment or lease modifications , or to
reflect revised in-substance fixed lease payments as detailed below

Reassessment of the lease liability

After the commencement date, a lessee shall re-measure the lease liability to reflect changes to
the lease payments. A lessee shall recognise the amount of the re-measurement of the lease liability
as an adjustment to the right-of-use asset.

However, if the carrying amount of the right-of-use asset is reduced to zero and there is a further
reduction in the measurement of the lease liability, a lessee shall recognise any remaining amount
of the re-measurement in profit or loss

Lessee shall re-measure the lease liability by discounting the revised lease payments using a
revised discount rate, if either:
 if there is a change in the lease term, a lessee shall determine the revised lease payments on
the basis of the revised lease term; or
 If there is a change in the assessment of an option to purchase the underlying asset, assessed
considering the events and circumstances described in paragraphs 20⁠–⁠21 in the context of a
purchase option. A lessee shall determine the revised lease payments to reflect the change
in amounts payable under the purchase option

Measurement of lease in the books of Lessor

Lease classification

A lessor shall classify each of its leases as either an operating lease or a finance lease

How to classify a lease as finance lease or as operating lease

A lease is classified as a finance lease if it transfers substantially all the risks and rewards
incidental to ownership of an underlying asset. A lease is classified as an operating lease if it does
not transfer substantially all the risks and rewards to ownership of an underlying asset.

Recognition and measurement

At the commencement date, a lessor shall recognise assets held under a finance lease in its
statement of financial position and present them as a receivable at an amount equal to the net
investment in the lease

How net investment in the lease measured

The lessor shall use the interest rate implicit in the lease to measure the net investment in the lease.
In the case of a sublease, if the interest rate implicit in the sublease cannot be readily determined,
an intermediate lessor may use the discount rate used for the head lease (adjusted for any initial
direct costs associated with the sublease) to measure the net investment in the sublease

24
At the commencement date, the lease payments included in the measurement of the net investment
in the lease comprise the following payments for the right to use the underlying asset during
the lease term that are not received at the commencement date

 fixed payments less any lease incentives payable

 variable lease payments that depend on an index or a rate, initially measured using the
index or rate as at the commencement date

 any residual value guarantees provided to the lessor by the lessee, a party related to the
lessee or a third party unrelated to the lessor that is financially capable of discharging the
obligations under the guarantee
 payments of penalties for terminating the lease, if the lease term reflects the lessee
exercising an option to terminate the lease

Subsequent measurement

A lessor shall recognize finance income over the lease term, based on a pattern reflecting a constant
periodic rate of return on the lessor’s net investment in the lease

A lessor shall apply the lease payments relating to the period against the gross investment in the
lease to reduce both the principal and the unearned finance income

Operating lease the books of lessor

A lessor shall recognise lease payments from operating leases as income on either a straight-line
basis or another systematic basis.
A lessor shall recognise costs, including depreciation, incurred in earning the lease income as an
expense

Examples

Books of the lessee

1. Lease paid in arrears

ILLUSTRATION 1.

AMEKI Ltd acquire an assets under a finance lease for a cash price of Frw 10,900, the asset with
an expected useful life of 5 years, the lease is for five years, with annual payment of Frw 3000 in
arrears. The implicit interest is 12%.

Calculate the value at which the asset will be initially recorded in the accounts.

ILLUSTRATION 2.

ABC Ltd initiates the leasing of equipment from XYZ Ltd on 1st Jan 2008. The equipment had
unexpected useful life of 3 years. It was to revert back to the lessor on the expiry of the lease
agreement on 31st Dec 2010.The fair value of the equipment at the inception of the lease was
Frw.13.5 million. Three payments are due to the lessor at an amount of Frw. 5 million p.a
beginning 31st Dec 2008. An additional sum of Frw. 1 million is paid annually by the lessee for
25
insurance. ABC Ltd guarantees a Frw. 1 million residue value on 31st Dec 2010 to the lessor
ABC Ltd incremental borrowing rate is 10% and XYZ Ltd implicit rate is unknown. The salvage
value of the equipment was Frw.100, 000.

Required

i. Relevant journal entries to record the above transactions in the book of ABC Ltd.

ii. Prepare the balance sheet extract as at 31st Dec 2008 to 31st Dec 2010.

Answer
Date of lease commencement 1/01/2008
Lease term: 3 Years
Fair value of assets: Frw 13.5 million
Lease rentals: Frw 5 million
Insurance expense payable by the lessee: Frw 1 Million
Guaranteed residual value; Frw 1 milion
Discount factor 10%
Residual value: 100,000
Present value of lease rentals

Present value of guaranteed residual

value
Present value of gross investment 13,186
Cash price of asset 13,500
The lowest between the two should be picked, therefore the lower is Present value of investment
i.e 13,185

Journal entries
Dr: Right of use an asset Frw 18,186
Cr: Lease obligation Frw 18,186
Being recognition of lease at inception

Dr: Depreciation expense (P/L) Frw 4,362

Cr Accumulated depreciation Frw 4,362
Being recognition of depreciation in the books of lessee for right of use an asset
Period Opening balance Interest 10% Lease rentals Closing balance
Frw 000 Frw 000 Frw 000 Frw 000
31 Dec 2008 13,185 1,318.5 5,000 9,504
31 Dec 2009 9,504 950 5,000 5,454
31 Dec 2010 5,454 545 5,000+1,000 0

Dr: Interest expense-(P/L) 1,318.5

Cr: Lease obligation Frw 1,318.5
Being recognition of finance cost on lease obligation
Dr: Lease obligation Frw 5,000
Cr: Bank Frw 5,000
Being payment of lease rentals

26
Extract profit or loss
2008 2009 2010
Frw 000 Frw 000 Frw 000
Depreciation 4,362 4,362 4,362
Interest 1,318.5 950 545
Insurance 1,000 1,000 1,000

Extract statement of financial position

2008 2009 2010
Frw 000 Frw 000 Frw 000
Right of use asset 13,185 13,185 13,185
Accumulated (4,362) (8,724) (13,086)
depreciation
NBV of right use asset 8,823 4,461 100 (residual value)

Non-current liability
Lease obligation 5,454 - -
Current liability
Lease obligation 9,504-5,454=4,050 5,454-0=5,454 -

LLUSTRATION 3.

On 1/1/2010 Bujumbura ltd a wine merchant owned by Qatar in Ivory Coast buys a small
bottling & levelling machine from Bagbor ltd co. under finance lease. The cash price of the
machine was Frw.7, 710,000 while the amount to be paid was Frw.10, 000,000.The agreement
required an immediate repayment of Frw.2, 000,000 with balance being settled in four equal
annual instalments commencing 1/12/2010.The interest charge was 15% p.a calculated on the
remaining balance of the liability during each accounting period

Required:

a) Loan amortisation schedule and the interest using the actuarial method

Amortization of interest by using sum of digit method

Illustration 4.
Company Z Limited acquired a machine by way of a lease agreement. The fair value of
the machine was RWF 15,000. Estimated life of the machine is 4 years.
The terms of the lease are: Annual lease rental of RWF 5, 000 payable in arrears each year for 4
years.
Required: Advice Z ltd on how the above machine shall be recorded in the books of account.

The interest rate was not given, therefore, the interest should be amortized using sum of digit
method

Fair value of machine 15,000

Estimated life of the machine 4 years
Lease rentals 5,000

27
Total lease rentals 5,000*4=20,000
Fair value of asset (15,000)
Interest ` 5,000

Interest for Year one

Interest for year two 1,500
Interest for year three 1,000
Interest for year four
5,000

Amortization of lease obligation

Period Opening balance Interest Lease payment Closing balance
Frw Frw Frw Frw
Y1 15,000 2,000 5,000 12,000
Y2 12,000 1,500 5,000 8,500
Y3 8,500 1,000 5,000 4,500
Y4 4,500 500 5,000 0

Extract statement of P/L

Y1 Y2 Y3 Y4
Interest 2,000 1,500 1,000 5,00
Depreciation 3,750 3,750 3,750 3,750
15,000/4

Extract statement of financial position

Y1 Y2 Y3 Y4
Frw Frw Frw Frw
Leased asset 15,000 15,000 15,000 15,000
Accumulated 3,750 7,500 11,250 15,000
depreciation
NBV 11,250 7,500 3,750 0

Non-current
liability
Lease obligation 8,500 4,500 - -
Current liability
Lease obligation 12,000- 8,500-4,500=3,500 4,000 -
8,500=3,500

Lease paid in Advance

Illustration 5

28
MK ltd enters into a finance lease on 01st January 2010, the leased equipment has a cash price of
Frw 80million. Its useful life is estimated at 5 years. The terms of the lease are as follow; Lease
term is 5 years, annual payment is Frw 20 million in advance, implicit interest rate is 12% per
annum.

Required: show how MK Ltd shall treat the above transaction in the financial statement for the
year ended 31st December 2010

Commencement of the lease: 01/01/2010

Cash price of asset: 80 million
Lease term: 5 years
Annual payment: Frw 20 million in advance, i.e first payment was made on 01/01/2010
Interest rate: 12%

Opening balance Interest 12% Lease payment Closing balance

Frw 000 Frw 000 Frw 000 Frw 000
A B=(A-C)*12% C D=A+B-C
31/12/2010 80,000 7,200 20,000 67,200
31/12/2011 67,200 5,664 20,000 52,864
31/12/2012 52,864 3,944 20,000 36,808
31/12/2013 36,808 2,017 20,000 18,825
31/12/2014 18,825 - 20,000 -

Statement of Profit or Loss

Dec 2010 Dec 2011 Dec 2012 Dec 2013 Dec 2015
Frw 000 Frw 000 Frw 000 Frw 000 Frw 000
Depreciation 16,000 16,000 16,000 16,000 16,000
Interest expense 7,200 5,664 3,944 2,017 -

Statement of financial position

Dec 2010 Dec 2011 Dec 2012 Dec 2013 Dec 2015
Frw 000 Frw 000 Frw 000 Frw 000 Frw 000
Leased asset 80,000 80,000 80,000 80,000 80,000
Accumulated 16,000 32,000 48,000 64,000 80,000
depreciation
NBV 64,000 48,000 32,000 16,000 0

Non-Current
liability
Lease 67,200- 52,864- 36,808- - -
obligation 20,000=47,200 20,000=32,864 20,000=16,808
Current
liability
Lease 20,000 20,000 20,000 20,000 -
obligation

Sale and lease back

29
In a sale and leaseback transaction, an asset is sold by a vendor and then the same asset is
leased back to the same vendor.

If an entity (the seller-lessee) transfers an asset to another entity (the buyer-lessor) and leases that
asset back from the buyer-lessor, both the seller-lessee and the buyer-lessor shall account for the
transfer contract lease

Assessing whether the transfer of the asset is a sale, an entity shall apply the requirements for
determining when a performance obligation is satisfied in IFRS 15 to determine whether the
transfer of an asset is accounted for as a sale of that asset.

Transfer of the asset is a sale if the transfer of an asset by the seller-lessee satisfies the
requirements of IFRS 15 to be accounted for as a sale of the asset:

 The seller-lessee shall measure the right-of-use asset arising from the leaseback at the
proportion of the previous carrying amount of the asset that relates to the right of use
retained by the seller-lessee. Accordingly, the seller-lessee shall recognise only the amount
of any gain or loss that relates to the rights transferred to the buyer-lessor

 The buyer-lessor shall account for the purchase of the asset applying applicable Standards,
and for the lease applying the lessor accounting requirements in this Standard.

Exercises
i. Distinguish between finance lease and operating lease
ii. On 1st January 2009, Kigali mountain ltd leased a machine from general
machines ltd, it was the responsibility of Kigali mountain ltd to repair the
machine. Kigali Mountain ltd was to make instalment lease payments of
Frw 14,000,000 every six months on 30th June and 31st December. The
first payment was made on 30 June 2009. The fair value of the machine was
Frw 60,000,000 with an estimated useful life of 3 years. The interest rate
implicit in the lease was 10% per six months.

Required:
i. Extract of the financial statement of comprehensive income for the year ended
31st December 2010 and 2009.
ii. Extract of financial position as at 30th June 2010 and 2009.

Revision question on lease

Question three of Dec 2019

30
Scenario 3

Commencement of lease 1/01/2018

Lease term 5 years
Interest rate 10%
PV of lease payment 350 million
Lease rentals 92 million p.a in arrears
Use of life of leased plant 7 years
Dr: Leased plant Frw 350 million
Cr: Lease liability Frw 350 million
Recognition of leased plant

Amortization of lease liability

Opening balance Interest 10% Lease payment Closing balance

Frw 000 Frw 000 Frw 000 Frw 000
31 Dec 2018 350,000 35,000 92,000 293,000
31 Dec 2019 293,000 29,300 92,000 230,300

Extract statement of P/L for the year ended 31 Dec 2018

Frw 000
Expenses
Depreciation 70,000
Interest 35,000

Statement of financial position as at 31 Dec 2018

Frw 000
Asset
Leased asset 350,000
Acc. depreciation (70,000)
NBV 280,000

Non-current liability
Lease obligation 230,300
Current liability
Lease obligation 293,000-230,300 62,700

Exercise :

Kigali Mountain entered into a contract with MUSANZE wine ltd for using its machinery within a
period of 10 years. Commencement date is 01st January 2001. Kigali Mountain will pay initial
direct cost of Frw 20,000, Musanze wine ltd will provide Lease incentives of Frw 5,000. The
contract stipulates that K M Ltd shall pay upfront lease payment for the year 2001 equivalent to
Frw 50,000. Kigali mountain was informed that there is new IFRS 16 which come into effect from
01st January 2019, and he believe that this contract will be accounted for under this new IFRS. The
discount rate applicable is 5%.

31
Required: As professional accountant, you are required to advise K M ltd how the above contract
will be presented in the financial statement for the year ended 31st December 2001, 2002 and 2003.
Refer to answer

I.4. IAS 20 – Accounting for Government Grants and Disclosure of Government

Assistance

Government Grants: Are assistance by government in the form of transfers of

resources to an entity in return for past or future compliance with certain
conditions relating to the operating activities of the entity.

Government assistance: Is action by government designed to provide an

economic benefit specific to an entity or range of entities qualifying under certain
criteria.

Grants related Assets:

These are grants whose primary conditions are that an entity qualifying for them
should purchase, construct or otherwise acquire non-current assets.
Grants related to income:

Are grants other than those related to assets: e.g. grants to pay operating expenses
or particular project/ contract

Forgivable loans: These are loans which the lender undertakes to waive
repayment with certain prescribed conditions.

An entity should not recognize government grants until it has reasonable

assurance that the entity will comply with any conditions attached to the grant and
the entity will actually receive the grant.
For a forgivable loan, it should be treated in the same way as a government grant.
When there’s a reasonable assurance that the entity will need the relevant term
and for the forgiveness.

Accounting treatment for Government grants relating to asset:

There are two methods by which the government grants can be accounted for:
1. Capital approach: Deduct the grant in arriving at the carrying amount
of the asset
2. Income approach: Show the grant as a deferred credit in the
Statement of Financial Position, amortizing it to the Statement of
Comprehensive Income over the life of the asset to which it relates:

Income Approach (Setting up the grant as deferred income)

1. On receipt of government grant Dr.
bank/ cash a/c
Cr. Grant a/c
32
 2. For acquisition of the asset Dr.
Asset a/c
Cr. Cash a/c
3. To record dep. to reduce the grant receipt Dr.
Grant a/c
Cr. P&L a/c

Capital Approach
1. On receipt of government grant: Dr.
Cash a/c
Cr. Grant a/c

2. To record the acquisition Dr.

Asset a/c
Cr. Cash a/c
3. To record the reduction of grant Dr.
Grant a/c
Cr. Asset a/c
With the amount used less grant received
Example: A company receives a 20% grants towards the cost of a new item which costs
Frw 100,000 and has a useful life of four years and a nil residue value.
The expected profit of the company is Frw. 50,000 per annum before accounting for
depreciation in each year.
Required: Profit & loss account extract and statement of financial position extracts by:
a) Deducting the grant in arriving at the carrying amount of the asset. (Capital
Approach)
b) Set up the grant as a deferred income (Income approach).

Answer
Capital approach
On receipt of grant
Dr: Bank Frw 20,000 i. (20%*100,000)
Cr: Grant Frw 20,000
On acquisition of asset
Dr: Asset 100,000
Cr: Bank/cash Frw 100,000
On reduction of grant
Dr: Grant Frw 20,000
Cr: Asset 20,000
Depreciation =80,000/4=20,000

Extract Profit or loss account

Y1 Y2 Y3 Y4
Profit before 50,000 50,000 50,000 50,000
depreciation
Depreciation (20,000) (20,000) (20,000) (20,000)

33
Operating profit 30,000 30,000 30,000 30,000
Balance sheet
Y1 Y2 Y3 Y4
Frw 000 Frw 000 Frw 000 Frw 000
Asset 80 80 80 80
Acc depreciation (20) (40) (60) (80)
NBV 60 40 20 0

Income approach
On receipt of grant
Dr: Bank Frw 20,000
Cr: Grant Frw 20,000
On acquisition of asset
Dr: Asset Frw 100,000
Cr: Bank Frw 100,000

Dr: Depreciation expenses P/L Frw 25,000

Cr: Acc. Depreciation Frw 25,000

Dr: Grant Frw 5,000

Cr: Other income (p/l) Frw 5,000

Extract statement of profit and loss account

Y1 Y2 Y3 Y4
Frw Frw Frw Frw
Profit before 50,000 50,000 50,000 50,000
depreciation
Depreciation (25,000) (25,000) (25,000) (25,000)
Add: Other income 5,000 5,000 5,000 5,000
(Grant)
Operating profit 30,000 30,000 30,000 30,000

Balance sheet
Y1 Y2 Y3 Y4
Frw 000 Frw 000 Frw 000 Frw 000
Asset 100 100 100 100
Acc depreciation (25) (50) (75) (100)
NBV 75 50 25 -
Liability
Non-current
liability
Government grant 20-5-5=10 10-5=5 5-5=0 -
Current liability
Grant 5 5 5-
15 10 5

Presentation of grants related to income

Grants related to income are presented as part of profit or loss, either separately or under a general
heading such as ‘Other income’; alternatively, they are deducted in reporting the related expense
34
I.5. INVESTMENT PROPERTY (IAS 40)

Investment property is property land or a building or part of a building or both held by the
owner or by the lessee under a finance lease) to earn rentals or for capital appreciation or both.
The following shall not be considered or taken as investment property.
(a) Biological assets related to agricultural activity
(b) Mineral rights and reserves

Investment property shall be recognised as an asset when, and only if:

(a) It is probable that the future economic benefits that are associated with the investment
property will flow to the entity; and

(b) The cost of the investment property can be measured reliably.

Recognition of investment property

Initial measurement

An investment property shall be measured initially at its cost.

Subsequent measurement

Subsequently the Standard permits entities to choose either;

i. Fair value model, under which an investment property is measured, after initial
measurement, at fair value with changes in fair value recognised in profit or loss.
In estimating fair value, the entity should consider a number of factors and sources:
(a) Current prices in an active market for properties of a different nature,
condition or location, adjusted to reflect those differences
(b) Recent prices of similar properties on less active markets, adjusted to reflect
changes in economic conditions
(c) Discounted cash flow projections based on reliable estimates of future cash flows.

ii. Cost model. The cost model is specified in IAS 16 and requires an investment property to be
measured after initial measurement at depreciated cost (less any accumulated impairment losses).

The fair value: is the price at which the property could be exchanged between
knowledgeable, willing parties in an arm’s length transaction.

Illustration.

ABACUS ltd is a company incorporated in 2000. During the year ended 2010 the company has
plan to expand its investment. On 30th June 2010 the company has acquired the buildings for Frw
260,000,000 and motor vehicle for Frw 100,000,000, the building was used for the office purpose.
35
On 30th June 2014 the company has took the option to rent the building. On that date, the fair
value of the building was estimated at Frw 150,000,000 and on the same date company revalue its
motor vehicle at Frw 60,000,000.
The building are depreciate at the rate of 20%, and motor vehicle at 10%
On 31st December 2014 the fair value of building was estimated at Frw 170, 000,000

Required: prepare the extract financial statement for the year ended 31 December 2014

Answer

From 30 June 2010, The building met criteria of being recorded in accordance with IAS 16
Frw 000
Cost of building 260,000
Accumulated depreciation 260,000*20%*4=208,000
NBV as at 30 June 2014 52,000
Fair value as at 30 June 2014 150,000
Revaluation gain 98,000

Dr: Asset Frw 98,000

Cr: Revaluation reserve Frw 98,000
From 30 June 2014, The building will be accounted for in accordance with IAS 40, The initial cost
of this building will be Frw 150,000,000. The building is measured using fair value model

Gain on fair value as at reporting date

Frw 000
Fair value as at 30 June 2014 150,000
Fair value as at 31 Dec 2014 170,000
Gain on fair value 20,000

Dr: Building Frw 20,000

Cr: Other income Frw 20,000
Depreciation to be charged in P/L, will be computed as follows

Motor vehicle
Frw 000
Initial cost 100,000
Accumulated depreciation 100,000*10%*4=(40,000)
NBV 60,000
Revalued amount 60,000

NBV as at 31 December 2014, 60,000-3,000=57,000

Extract statement of total comprehensive income for the year ended 31 December 2014
Frw 000
Other income
Gain on fair value 20,000
Expense
Depreciation of building 26,000

36
Depreciation of motor vehicle 8,000

Other comprehensive income

Revaluation surplus on building 98,000

Extract statement of financial position as at 31 December 2014

Frw 000
Assets
Building 170,000
Motor vehicle 60,000-3,000 57,000

Equity
Reserve 20,000

Transfers;

An entity shall transfer a property to, or from, investment property when, and only when, there is a
change in use. A change in use occurs when the property meets, or ceases to meet, the definition of
investment property and there is evidence of the change in use

a) Transfer from investment property to owner occupied property i.e. commencement of

owner occupation. The fair value of the property at the date of change is determined and
used for subsequent accounting under IAS 16
b) Transfer from investment property to inventories i.e commencement of development with
a view to sale. The fair value of the property at the date of change is determined and used
for subsequent accounting under IAS 2 Inventories.
c) Transfer from owner occupied property to investment property i.e end of owner
occupation. If the investment property is to be carried at fair value, the entity should apply
IAS 16 up to the date of change in use.

Any difference at that date, between the carrying amount of the property under IAS 16 and its fair
value, is treated in the same way as a revaluation in accordance with IAS 16.
That is gains will be credited to a revaluation reserves and losses will be charged to the statement
of comprehensive income Transfer from inventories to investment property through the
commencement of an operating lease to another party.

Here any difference between the fair value of the property and its carrying amount at that date
should be recognized in profit or loss.

Example:
Kigali Mountain Ltd purchased a property on 1st January 2009 for Frw 3,000,000. KM
Ltd intended to renovate the property and let the building to a government department,
due to locate in the area under its decentralisation programme. A further Frw 600,000
was spent over the next 11 months in getting the building ready for letting. No lease had
been signed by the government department. The building was ready for tenant
occupation on 1st December 2009.

37
The valuation of the completed property on 31st December 2009 was Frw 4,000,000.
However, due to unforeseen budgetary difficulties, the government shelved its
decentralisation plan and the property remained unoccupied.

In February 2010, the property was valued at Frw 4,200,000 and KM Ltd decided
immediately to relocate its head office to this property. KM Ltd secured tenants for its
old headquarters. The book value of that head office was Frw 3,000,000 and the market
value at the date of letting in February 2010 was Frw 3,600,000.
The valuations of both properties were provided by independent qualified valuers.

Required:

How should KM Ltd account for these property movements under IAS 40 and IAS 16,
assuming the company implements the Fair Value Model and the Revaluation Model,
respectively?

Answer
Dr: Property Frw 3,000,000
Cr: Bank Frw 3,000,000
Being recognition of acquired property

Dr: Property Frw 600,000

Cr: Bank Frw 600,000
Recognition of additional costs incurred to make property ready for use
At 31 Dec 2009
Dr: Property Frw 400,000
Cr: Gain-other income (P/L) Frw 400,000
Being revaluation gain on property valuation

In February 2010
Dr: Property Frw 200,000
Cr: Gain-P/L Frw 200,000
Being gain on property valuation
The company decided to relocate its head office to this property, therefore, the property does no longer meet criteria of
IAS 40, and instead it will be accounted for under IAS 16. The initial cost to be recorded under IAS 40 is Frw
4,200,000

The old headquarters was rented and therefore will be accounted for in accordance with IAS 40
At date of transfer, the book value of old headquarter was Frw 3,000,000 and Market value was Frw 3,600,000
Dr: Asset Frw 600,000
Cr: Revaluation surplus Frw 600,000
Being revaluation gain on asset
The initial cost of this asset under IAS 40, will be Frw 3,600,000

I.6. IFRS 15: Revenue from contract with customers

38
IFRS 15 Revenue from contracts with customers is concerned with the recognition of revenues
arising from fairly common transactions.

– The sale of goods

– The rendering of services
– The use by others of entity assets yielding interest, royalties and dividends

Generally revenue is recognised when the entity has transferred promised goods or services to the
customer. The standard sets out five steps for the recognition process

Revenue is income arising in the ordinary course of an entity's activities and it may be called
different names, such as sales, fees, interest, dividends or royalties.

IFRS 15 replaces both IAS 18 Revenue and IAS 11 Construction contracts. It is effective for
reporting periods beginning on or after 1 January 2017. Its core principle is that revenue is
recognised to depict the transfer of goods or services to a customer in an amount that reflects the
consideration to which the entity expects to be entitled in exchange for those goods or services.

Under IFRS 15 the transfer of goods and services is based upon the transfer of control, rather than
the transfer of risks and rewards as in IAS 18.

Control of an asset is described in the standard as the ability to direct the use of, and obtain
substantially all of the remaining benefits from, the asset.

IFRS 15 applies to all contracts with customers except:

i. Leases within the scope of IFRS 16
ii. Insurance contracts within the scope of IAS 4
iii. Financial instruments and other contractual rights and obligations within the scope of IFRS
9, IFRS 10, IFRS 11, IAS 27 or IAS 28.
iv. Non-monetary exchanges between entities in the same line of business

Key definitions

Income – Increases in economic benefits during the accounting period in the form of inflows or
enhancements of assets or decreases of liabilities that result in an increase in equity, other than
those relating to contributions from equity participants.

Revenue - Income arising in the course of an entity’s ordinary activities.

Contract – An agreement between two or more parties that creates enforceable rights and
obligations
Contract asset – An entity’s right to consideration in exchange for goods or services that the entity
has transferred to a customer when that right is conditioned on something other than the passage of
time (for example the entity’s future performance)

Receivable – An entity’s right to consideration that is unconditional – ie only the passage of time is
required before payment is due

Contract liability – An entity’s obligation to transfer goods or services to a customer for which the
entity has received consideration (or the amount is due) from the customer.

Customer – A party that has contracted with an entity to obtain goods or services that are an
output of the entity’s ordinary activities in exchange for consideration.
39
Performance obligation – A promise in a contract with a customer to transfer to the customer
either: (a) A good or service (or a bundle of goods or services) that is distinct; or
(b) A series of distinct goods or services that are substantially the same and that have the same
pattern of transfer to the customer.

Transaction price – The amount of consideration to which an entity expects to be entitled in

exchange for transferring promised goods or services to a customer, excluding amounts collected
on behalf of third parties

Stand-alone selling price – The price at which an entity would sell a promised good or service
separately to a customer

N.B: Revenue does not include sales taxes, value added taxes or goods and service taxes which are
only collected for third parties, because these do not represent an economic benefit flowing to the
entity.

Recognition and measurement of revenue

Under IFRS 15 revenue is recognized and measured using a five step model

1. Identify the contract with the customer

(a)The parties have approved the contract and are committed to carrying it out.
(b) Each party’s rights regarding the goods and services to be transferred can be
identified.
(c)The payment terms for the goods and services can be identified
(d) The contract has commercial substance
(e)It is probable that the entity will collect the consideration to which it will be
entitled
2. Identify the separate performance obligation
A contract includes promises to provide goods or services to a customer. Those promises are
called performance obligations

3. Determine the transaction price

4. Allocate the transaction price to the performance obligations: Where a contract contains
more than one distinct performance obligation a company allocates the transaction price to
all separate performance obligations in proportion to the stand-alone selling price of the
good or service underlying each performance obligation.

If the good or service is not sold separately, the company would estimate its stand-alone
selling price

5. Recognize revenue when (or as) a performance obligation is satisfied: The entity satisfies a
performance obligation by transferring control of a promised good or service to the
customer.

Contract costs

40
 The incremental costs of obtaining a contract (such as sales commission) are recognised as an
asset if the entity expects to recover those costs.

Costs that would have been incurred regardless of whether the contract was obtained are
recognised as an expense as incurred.

Costs incurred in fulfilling a contract, unless within the scope of another standard (such as IAS
2 Inventories, IAS 16 Property, plant and equipment or IAS 38 Intangible assets) are
recognised as an asset if they meet the following criteria:

(a) The costs relate directly to an identifiable contract (costs such as labour, materials,
management costs)
(b) The costs generate or enhance resources of the entity that will be used in satisfying (or
continuing to satisfy) performance obligations in the future; and
(c) The costs are expected to be recovered Costs recognised as assets are amortised on a
systematic basis consistent with the transfer to the customer of the goods or services to
which the asset relates.

Performance obligations satisfied at a point in time

A performance obligation not satisfied over time will be satisfied at a point in time. This will be
the point in time at which the customer obtains control of the promised asset and the entity satisfies
a performance obligation.

Some indicators of the transfer of control are:

(a) The entity has a present right to payment for the asset.
(b) The customer has legal title to the asset.
(c) The entity has transferred physical possession of the asset.
(d) The significant risks and rewards of ownership have been transferred to the customer.
(e) The customer has accepted the asset

Performance obligation satisfied over time

A performance obligation satisfied over time meets the criteria in Step 5 above and, if it entered
into more than one accounting period, would previously have been described as a long-term
contract.

Methods of measuring the amount of performance completed to date encompass output methods
and input methods.

Output methods recognise revenue on the basis of the value to the customer of the goods or
services transferred. They include surveys of performance completed, appraisal of units produced
or delivered etc.

Input methods recognise revenue on the basis of the entity’s inputs, such as labour hours,
resources consumed, and costs incurred. If using a cost-based method, the costs incurred must
contribute to the entity’s progress in satisfying the performance obligation.

These contracts are generally construction contracts, and it is possible that you will see this term
used as the old standard, IFRS 11 used it.

1. Computation of Profit
41
 Description Amount
Contract price x Percentage of completion to date xxxxx
Less cost of sales (xxxx)
(Estimated total cost x percentage of completion to date)
Profit for the year xxx

Computation of cost for sales for the year for long-term contract

Estimated total cost x Percentage of completion xxx

Less cost of sales recognized in previous period (xxx)
Cost of sales for the year xxx

Revenue for the period for performance obligation exceeding one year

Contract price x percentage of completion xxx

Less revenue recognized in previous period (xxx)
Revenue for the period xxx

Contract asset & Contract liability.

Contract assets is Presented separately under current asset while contract liability is presented
separately under current liability

Description Amount
Cost incurred to date xxx
Recognized profit xxx
Less recognized loss (xxx)
Less progressive invoices ( Progressive Billings) (xxx)
Contract asset & Liability xxx

Receivable or payable
At each reporting period, the entity must compare the progressive invoices with cash received. If
progressive billing exceed cash received, the difference is presented separately under current asset
while if progressive billing is less than cash received the difference must be presented separately
under current liability.

Example 1:
Contract where performance obligations are satisfied over time
Suppose that a contract started on 1 January 2015, with an estimated completion date of 31
December 2016.

42
The final contract price is Frw 1,500,000. The following data relates to the first year, to 31
December 2015:
(a) Costs incurred amounted to Frw 600,000.
(b) Certificates of work completed have been issued, to the value of Frw 750,000.
(c) It is estimated with reasonable certainty that further costs to completion in 2016 will be
Frw 600,000.
What is the contract profit in 2015, and what entries would be made for the contract at 31
December 2015?

Answer:

Profit for the year

Description Amount
Frw
Contract price x Percentage of completion to date 1,500,000*50%=
750,000
Cost of sales 1,200,000*50%=600,000
Less Estimated total cost x percentage of
completion to date
Profit for the year 150,000
Contract assets

Description Amount
Frw
Cost incurred to date 600,000
Recognized profit 150,000
Less recognized loss 0
Less progressive invoices ( Progressive Billings) 0

Example 2

P Co has the following construction contract (performance obligations satisfied over time) in
progress as at 31 December 2018.

Description Amount
Frw
Total contract price 750,000
Costs incurred to date 225,000
Estimated costs to completion 340,000
Progress payments invoiced and received 290,000
43
Answer

Description Amount
Contract price x Percentage of completion to date 750,000*40%=300,000
Less Cost of sales 565,000*40%=226,000
(Estimated total cost x percentage of completion to date)
Profit for the year 74,000

Contract assets

Description Amount
Frw
Cost incurred to date 225,000
Recognized profit 74,000
Less recognized loss 0
Less progressive invoices ( Progressive Billings) (290,000)
Contract assets 9,000

Contract making loss

Example 3

P Co has the following construction contract (performance obligations satisfied over time) in
progress as at 31 December 2019:

Description Amount
Frw
Total contract price 550,000
Costs incurred to date 225,000
Estimated costs to completion 340,000
Progress payments invoiced and 290,000
received

Answer

Determine if the contract is making loss:

Description Amount
Frw
Contract price 550,000
Estimated total cost 225,000+340,000 565,000
44
 Estimated loss (15,000)

Determine Profit or loss for the period

Description Amount
Frw
Contract price x Percentage of completion to date 550,000*40%=220,000
Cost of sales (Balancing figure) (235,000)
Loss (15,000)
Contract Liability

Description Amount
Frw
Cost incurred to date 225,000
Recognized profit (15,000)
Less recognized loss 0
Less progressive invoices ( Progressive Billings) (290,000)
Contract liability (80,000)

I.7. FINANCIAL INSTRUMENTS

The following standards are relevant:

IAS 32: Financial instruments presentation

IFRS 9; financial instruments
IFRS 7: Disclosure

IAS 32: Presentation

A financial instrument is a contract that gives rise to a financial asset of one entity and a
financial liability or equity instrument of another.
45
Financial asset:

A financial asset I any asset that is:

(i) Cash;
(ii) An equity instrument of another entity;
(iii) A contractual right: To receive cash or another financial asset from another entity; or To
exchange financial assets or financial liabilities with another entity under conditions that are
potentially favourable to the entity; or A contract that will or may be settled in the entity’s own
equity instruments and is:

Financial liability:

Any liability that is a contractual obligation:

i. To deliver cash or another financial asset to another entity; or
ii. To exchange financial assets or financial liabilities with another entity under conditions that
are potentially unfavourable to the entity; or

Derivatives: is a financial instruments or other contract with the following characteristics

 The value changes in response to change in a specified interest rate, financial instrument
price, commodity price, foreign exchange rate

 It requires no initial net investment or an initial net investment that is smaller than would be
required for other types of contracts that would be expected to have a similar response to
changes in market factors.

 It is settled at a future date

Equity instrument:

It a contract that evidences a residual interest in the assets of an entity after deducting all of its
liabilities.

Examples of financial assets include:

(a) Trade receivables

(b) Options
(c) Shares (when held as an investment)
Examples of financial liabilities include:

(a) Trade payables

(b) Debenture loans payable
(c) Redeemable preference (non-equity) shares.

PRESENTATION:
46
The issuer of a financial instrument shall classify the instrument, or its component parts, on initial
recognition as a financial liability, a financial asset or an equity instrument in accordance with the
substance of the contractual arrangement and the definitions of a financial liability, a financial
asset and an equity instrument

Compound financial instrument: This refers to the financial instrument with liability and equity
component

IAS 32 requires the following for compound financial instrument

The issuer of a non-derivative financial instrument shall evaluate the terms of the financial
instrument to determine whether it contains both a liability and an equity component. Such
components shall be classified separately as financial liabilities, financial assets or equity
instruments. Use the following steps to separate liability component with equity component

(a) Calculate the value of the liability component

(b) Deduct this from the instrument as a whole to leave a residual value for the equity element

Illustration.

BAHIMBA Company issues 2,000 convertible bonds at the start of 2002. The bonds have a three
year term, and are issued at par with a face value of Frw. 1,000 per bond, giving total proceeds of
Frw 2, 000,000. Interest is payable annually in arrears at a nominal annual interest rate of 6%.
Each bond is convertible at any time up to maturity into 250 ordinary shares. When the bonds are
issued, the prevailing market interest rate for similar debt without convers on optic is 9%.

Required
What is the value of the equity component in the bond?

Answer

Calculate the liability component first. This is valued at the Present Value of cash flows associated
with the convertible debt, discounted at the market rate for similar bonds with no conversion rights.

The difference between this Present Value and the net proceeds constitute the equity element.

Cash flows are interest and principal amount

Period Cash flow Discount factor PV

Frw 000 Frw 000 Frw 000
Y1 120 0.917 110
Y2 120 0.842 101
Y3 120+2000=2,120 0.772 1,637
Liability component 1,848
Equity component (Balancing figure) 152
Net proceed 2,000

Dr: Bank Frw 2,000

Cr: Equity Frw 152
47
Cr: Liability Frw 1,848

At the end of the year, the liability would be;

Opening balance Interest charge 9% Payment Closing balance

Frw 000 Frw 000 Frw 000 Frw 000
Y1 1,848 166 120 1,894
Y2 1,894 170 120 1,944
Y3 1,944 175 2,000+120 -

Extract statement of Profit or loss

Y1 Y2 Y3
Frw 000 Frw 000 Frw 000
Interest 120 120 120

Statement of financial position for the year ended …

Frw 000
Non-current liability
6% loan stock 1,894
Equity
SHARE Option 152

Illustration 2
Convertible Debt

A company issues Frw. 20m of 4% convertible loan notes at par on 1 January 2009. The loan
notes are redeemable for cash or convertible into equity shares on the basis of 20 shares per
Frw.100 of debt at the option of the loan note holder on 31 December 2011. Similar but non-
convertible loan notes carry an interest rate of 9%.

Required;

Show how these loan notes should be accounted for in the financial statements at 31
December 2009.

Interest, Dividends, Loss and gains

Interest, dividends, losses and gains relating to a financial instrument or a component that
is a financial liability shall be recognised as income or expense in profit or loss.
Distributions to holders of an equity instrument shall be recognised by the entity directly
in equity. Transaction costs of an equity transaction shall be accounted for as a deduction
from equity

48
I.7.1. IFRS 9: FINANCIAL INSTRUMENTS: RECOGNITION AND
MEASUREMENT INITIAL RECOGNITION

When financial instrument should be recognized

An entity shall recognise a financial asset or a financial liability in its statement of financial
position when, and only when, the entity becomes party to the contractual provisions of the
instrument

De-recognition.

De-recognition is the removal of a previously recognized financial instrument from an

entity's statement of financial position.

An entity should derecognize a financial asset when:

a) The contractual rights to the cash flows from the financial asset expire; or

b) It transfers substantially all the risks and rewards of ownership of the financial asset to another
party.
An entity should derecognize a financial liability when it is extinguished i.e., when the
obligation specified in the contract is discharged or cancelled or expires.

Measurement of financial instruments

Initial measurement - IFRS 9

Initially, Financial or financial liability shall be measured at its fair value plus or minus, in the case
of a financial asset or financial liability not at fair value through profit or loss, transaction
costs that are directly attributable to the acquisition or issue of the financial asset or financial
liability.

Subsequent measurement -IFRS 9

After initial recognition, IFRS 9 requires an entity to measure financial assets to either.
i. Amortized cost or
ii. Fair value through other comprehensive income
iii. Fair value through profit or loss account:

A financial asset is measured at amortized cost if both of the following conditions are met:

a) The asset is held within a business model whose objective is-to hold assets in order to
collect contractual cash flows

b) The contractual terms of the financial asset give rise on specified dates to cash flows that are
solely payments of principal and interest on the principal amount outstanding.

49
A financial asset or liability shall be measured at fair value through profit or loss meets either of
the following conditions:

a) It is classified as held for trading.

A financial instrument is classified as held for trading if it is acquired or incurred principally for
the purpose of selling or repurchasing.

Financial liability shall subsequently be measured at amortized cost except financial liabilities at
fair value through profit or loss. Such liabilities, including derivatives that are liabilities, shall be
subsequently measured at fair value

Amortized cost
Assets held at amortized cost is measured using the effective interest method.
Amortized cost of a financial asset or financial liability is the amount at which the financial asset
or liability is measured at initial recognition minus principal repayments, plus or minus the
cumulative amortization of any difference between that initial amount and the maturity amount,
and minus any write- down for impairment or un-collectability.

LLUSTRATION.

Amortised Cost
On 1 January 2001 Abacus Co purchases a debt instrument for its fair value of Frw 1,000. The
debt instrument is due to mature on 31 December 2005. The instrument has a principal amount of
Frw 1,250 and the instrument carries fixed interest at 4.72% that is paid annually. The effective
rate of interest is 10%.
Required: How should Abacus Co account for the debt instrument over its five-year term?
Opening balance Interest @10% Payment Closing
Frw Frw Frw Frw
Dec 2001 1,000 100 59 1,041
Dec 2002 1,041 104 59 1,086
Dec 2003 1,086 107 59 1,134
Dec 2004 1,134 113 59 1,188
Dec 2005 1,188 119 59+1,250 0

I.7.2. IFRS 7 – FINANCIAL INSTRUCTMENTSL: DISCLOSURES

IFRS 7 requires companies to disclose financial instruments by their class. Entity shall group
financial instruments into classes that are appropriate to the nature of the information disclosed and
that take into account the characteristics of those financial instruments. An entity shall provide
sufficient information to permit reconciliation to the line items presented in the statement of
financial position

An entity shall disclose information that enables users of its financial statements to evaluate the
significance of financial instruments for its financial position and performance
In the financial position the entity shall disclose the category of financial assets and liabilities

The carrying amounts of each of the following categories, as specified in IFRS 9, shall be disclosed
either in the statement of financial position or in the notes

50
In the statement of comprehensive income, the entity shall disclose income and expenses that arise
due to financial assets or liability at fair value through profit/loss and those through other
comprehensive income

I.8. IAS 12: INCOME TAX {ACCOUNTING FOR DEFERRED TAX

In accounting for income taxes the main concerns will be;

i. Accounting for current corporation tax: Tax assessed on the taxable profits for the
years at corporation tax rates.
ii. Accounting for future tax consequences (deferred tax).
This is a provision for tax effect on the benefits being enjoyed currently but which are
likely to review in the future e.g. a provision where high capital allowance in the initial
years of an asset are replaced with high depreciation charge in the later years of an
asset.

The differences between accounting profits and taxable profits is caused by.
i. Permanent difference or
ii. Temporary difference

(a) Permanent difference: Are differences that arise from the items that are considered in one
calculation but excluded in the other i.e. items of income and expenses being included in
accounting profits but are excluded from taxable profits. They do not reverse in any period
therefore they do not give rise to deferred tax.

They usually arise from the following.

a) Certain types of income recognized in determining the accounting profits but
no assessed pretax purposes e.g. gains on disposed of capital assets, windfall
gains, donations and grants especially if not related to business.
b) Certain types of expenditure recognized is determination of accounting profits
but are not allowed as expenses for tax purposes e.g. entertainment allowance not
related to business from expenditure, loss on disposal of capital assets etc.
(b) Temporary differences: They reverse on the foresee period and therefore they give rise to
deferred tax (future tax consequences)
IAS 12 (Revised) defines temporary differences as differences between the carrying amount of
assets or liabilities in the statement of financial position and then tax base that are not of a
permanent nature.

Temporary Difference = Carrying amount of assets or liabilities Less Tax base of assets or
liabilities

Carrying amount= Cost-accumulated depreciation

If the assets has impaired the carrying amount is obtained after deducting the
impairment.

Tax base= Cost-accumulated Capital allowance

51
Tax base of an asset

This is the amount that will be deductible for tax purposes against any factors taxable economic
benefit that will flow to the enterprise when it recovers the carrying amount of that asset. In other
words, this is the amount on which future capital allowances will be based

Type of Temporary Differences

The temporary differences that arise may either be: -

(a) Taxable temporary differences

(b) deductible temporary differences

1. Taxable Temporary Difference

There are differences that will result in taxable amounts in the future when the carrying amounts of
the assets are recovered or the liabilities are settled. They give rise to deferred tax liability
balances at the year end. This occurs when carrying amount of asset is high than its tax base
They arise when,
(i) The carrying amounts of assets exceed their tax base or depreciation is less than their capital
allowance
(ii) The carrying amounts of liabilities are less than their tax bases

Deferred tax liabilities are amounts of income taxes payable in future periods in respect of taxable
temporary differences

This is obtained by taking taxable temporary difference multiply with tax rate

Deductible temporary differences

They are temporary differences that will result in amounts that are tax deductible in the future
when the carrying amounts of assets are recovered or the liabilities are settled.

Deductible temporary differences arise when;

(a) The carrying amounts of liabilities exceed their tax bases
(b) Carry forward of unused tax losses
(c) Carry forward of unused tax loss and credits: A deferred tax asset shall be recognised for
the carry forward of unused tax losses and unused tax credits to the extent that it is
probable that future taxable profit will be available against which the unused tax losses and
unused tax credits can be utilised

Deferred tax assets are amounts of income taxes recoverable in future periods in respect of
Deductible temporary differences. Deferred tax assets =Temporary difference*Tax rate

52
Example:

BT Ltd. purchased an item of machinery for RWF2, 000,000 on 1st January 2008. It
had an estimated life of eight years and an estimated residual value of RWF400, 000.
The machine is depreciated on a straight line basis. The tax authorities do not allow
depreciation as a deductible expense. Instead, a tax expense of 40% of the cost
of this type of asset can be claimed against income tax in the year of purchase and 20%
per annum (on a reducing balance basis) of its tax base thereafter. The rate of income
tax can be taken as 25%.

In respect of the above item of machinery, calculate the deferred tax charge

Answer

Year one

Step one: Compute carrying amount

Frw 000
Cost 2,000
(200)

Carrying amount 1,800

Step two: Compute tax base as follows

Frw 000
Cost of asset 2,000
(800)
Tax base 1,200

Step three: Compute temporary difference

Frw 000
Carrying amount 1,800
Tax base 1,200
Taxable temporary difference 600

Step Four: Compute Differed tax

TTD 600
Tax rate 25%
Differed tax liability 150

Dr: Income tax Frw 150

Cr: Differed tax liability Frw 150

Extract statement of P/L

Expenses

53
Income tax Frw 150

Extract statement of financial position

Liability

Non-current liability

Deferred tax Frw 150

Year –two

Carrying amount

Frw 000
Cost 2,000
Accumulated depreciation (400)
NBV 1,600

Tax base

Frw 000
Cost 2,000
(1,040)

Tax base 960

Temporary difference
Frw 000
Carrying amount 1,600
Tax base 960
TTD 640
Compute deferred tax liability
Frw 000
TTD 640
Tax rate 25%
Deferred tax liability 160

Dr: Income tax Frw 10

Cr: Deferred tax liability Frw 10

Extract statement of P/L

Expenses
Income tax Frw 10

54
Extract statement of financial position
Liability
Non-current liability
Deferred tax Frw 160
Year three
Carrying amount
Frw 000
Cost 2,000
Accumulated depreciation (600)
NBV 1,400
1,232
Tax base 768
TTD 632
Deferred tax liability 158
As you can see, there is a decrease in deferred tax liability from Frw 160 to Frw 158, the double
entry will be

Dr: Deferred tax liability Frw 2

Cr: Income tax Frw 2

Example:

A company purchased an asset costing Frw 1,500 at the end of 2008 the carrying amount is Frw
1,000. The cumulative depreciation for tax purposes is Frw.900 and the current tax rate is 25%.
Required;
Compute the deferred tax liability for the asset

Revalued assets

Under IAS 16 assets may be revalued. If this affects the taxable profit for the current period, the
tax base of the asset changes and no temporary difference arises.
If, however (as in some countries), the revaluation does not affect current taxable profits, the tax
base of the asset is not adjusted.
Consequently, the taxable flow of economic benefits to the entity as the carrying value of the asset
is recovered will differ from the amount that will be deductible for tax purposes.
The difference between the carrying amount of a revalued asset and its tax base is a temporary
difference and gives rise to a deferred tax liability or asset.

Example

At 31 December 2009, the carrying value of property plant and equipment was Frw 88 million and
it tax base was Frw 54 million. The carrying value of Frw 88 million includes a surplus of Frw 12
million that arose as result of a property revaluation on 31 December 2009.

55
This revaluation had no effect on the tax base of the property. The property had not previously
been revalued. The tax rate is 25%

The deferred tax liability at 31 December 2008 was Frw 4 million. This liability relates to
temporary difference for property, plant and equipment.

Required: Compute deferred tax for the year ended 31 December 2009

Answer

Frw 000
Carrying amount 88,000
Tax base 54,000
Temporary difference 34,000
Tax rate 25%
Deferred tax liability 34,000*25% 8,500

Included in the difference is the amount which arose from revaluation

Thus, deferred tax on the revaluation is computed as follows: 12,000*25%=3,000

At 31 December 2009

Frw 000
Deferred tax liability 8,500
Balance b/d (4,000)
Increase in liability 4,500

The journal entry

Dr: revaluation reserve Frw 3,000
Dr: P/L (Tax charge) Frw 1,500
Cr: Deferred tax account Frw 4,500

Effect of Leasing on deferred tax:

If a company entered into a finance lease, the temporary difference is determined by comparing
annual lease rentals and Depreciation of that asset (after adding Finance charge to depreciation.)

If lease rentals is high than summation of depreciation and finance costs, the difference will be
deductible temporary difference and vice versa

Example:
ST Limited entered into a finance lease arrangement on 1st January 2010. The lease rental for the
year was RWF6, 000. The Statement of Comprehensive Income was charged with depreciation of
RWF2, 910 and a finance cost of RWF2, 274. The tax rate is 25%.
Temporary difference
Frw
Depreciation and finance charge 2,910+2,274 5,184
Lease rentals (6,000)
Deductible temporary difference 816
Tax rate 25%
Deferred tax asset 204
56
Dr: Deferred tax account Frw 204
Cr: P/L Income tax Frw 204

Effect of unrealized inventory profit on deferred tax:

In consolidated accounts, an un-realized inventory profit has deferred tax implications.

An unrealized inventory profit adjustment reduces the consolidated profit but has no
effect on taxable profit. A temporary difference arises, which will reverse in the next
year as the inventory is sold and the unrealized profit is realized.

The carrying amount of inventory is obtained after deducting the unrealized profit on
stock and the tax base is the total value of stock inclusive of unrealized profit, therefore,
the unrealized profit becomes deductible temporary difference.

Illustration on tax 1.

Tea factory ltd is estimating a differed tax liability as at 31st May 2010 and has provided the
following information;
(1) Property plant and equipment has a cost and revalued amount of Frw 100 million and
accumulated depreciation of frw 18 million. The total capital allowance on property, plant and
equipment amount to frw 30 million. Assume that the temporary difference due to revaluation
of property, plant and equipment amount to frw 2 million
(2) The total inventory was carried out at frw 20 million which was the net realizable value. The
costs of inventory was Frw 22 million. There was unrealized profit of frw 1 million that had
not been deducted from the inventory on consolidation.
(3) The receivable amount to frw 30 million after making a provision of frw 2 million for a
doubtful debt.
The Deferred tax liability as at 1st June 2009 was frw 8.5 million
The company estimated the tax for the year 2010 of frw 10 million and the corporation tax rate is
30%

Required;

Compute the deferred tax liability as at 31st May 2010 and the charge to the income statement for
the year ended 31st May 2010.

57
 IAS 37: PROVISIONS, CONTINGENT LIABILITIES AND
I.9.
CONTINGENT ASSETS

The objective of this Standard 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 enable users to understand their nature, timing and amount.

IAS 37 prescribes the accounting and disclosure for all provisions, contingent liabilities and
contingent assets, except:

(b) Those resulting from executory contracts, except where the contract is onerous. Executory
Contracts are contracts under which neither party has performed any of its obligations nor both
parties have partially performed their obligations to an equal extent;

(c) Those covered by another Standard.

Provisions

A provision is a liability of uncertain timing or amount.

Contingent liabilities

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

Contingent assets

A contingent asset is a possible asset 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.

An entity shall not recognise a contingent asset.

Recognition of provision

A provision should be recognised when, and only when:

(a) An entity has a present obligation (legal or constructive) as a result of a past event;
(b) It is probable (ie more likely than not) that an outflow of resources embodying economic
benefits will be required to settle the obligation; and
(c) A reliable estimate can be made of the amount of the obligation. The Standard notes that it is
only in extremely rare cases that a reliable estimate will not be possible.

If these condition are not met, the entity should not recognize a provision
58
In rare cases it is not clear whether there is a present obligation. In these cases, a past event is
deemed to give rise to a present obligation if, taking account of all available evidence, it is more
likely than not that a present obligation exists at the balance sheet date.

Measurement

The amount recognised as a provision shall be the best estimate of the expenditure required to
settle the present obligation at the balance sheet date.

How do we record provisions?

When a business first set up a provision, the full amount of the provision should be debited to
statement of profit or loss and credited to the statement financial provision as follows.

Dr: Expenses (statement of profit or loss) xxx

Cr: Provisions (statement of financial position) xxx

In subsequent years, adjustments may be needed to the amount of the provision. The procedure to
be followed is as follow.
 Calculate the new provision required
 Compare it with the existing balance on the provision account (the balance
b/f from the previous accounting period).
 Calculate increase or decrease required

If a higher provision is required, the following entries are passed:

Dr: Expenses (statement of profit of profit or loss) xxx

Cr: Provisons (statement of financial position) xxx
With the amount of increase.

If a lower provision is needed, now than before:

Dr: Provisions (statement of financial position) xxx

Cr: Expenses (statement of profit or loss) xxx
With the amount of the decrease.

Accounting treatment of contingent liability and contingent assets

An entity shall not recognize a contingent liability or contingent assets instead the contingent
liabilities and contingent assets must be disclosed in the statement of financial position
Contingent assets usually arise from unplanned or other unexpected events that give rise to the
possibility of an inflow of economic benefits to the entity. An example is a claim that an entity is
pursuing through legal processes, where the outcome is uncertain

59
I.10. Inventories (IAS 2.

Inventories shall be measured at the lower of cost and net realisable value

Net realisable value: is the estimated selling price in the ordinary course of business less the
estimated costs of completion and the estimated costs necessary to make the sale.

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.

The standards applies to all inventories except

 Work in progress arising under construction contracts
 Financial instrument
 Biological assets

Example 1:

Kigali mountain ltd had an inventory on hand at 31st December 2020: Frw 351,700,
which include the following:
a. A printer for sales office. This was purchased for Frw 4,000 in May 2004. The
invoice had been posted to purchases.
b. Inventory costing and included at Frw 2,000 (Selling price Frw 2,800). This
was damaged on 15th November 2004 while being moved in the stores. It will
cost Frw 600 to repair this item and then it will be sold for Frw 2,500
c. Also included at Frw 3,200 were goods supplied free of charge by a supply as a
means of promoting a new product. The normal purchase price of these will be
Frw 4,500 and are expected to retail for Frw, 6,300.
Required: What was the value of inventory as at 31 December 2020
Example 3
For operational reasons, an entity could not carry out its annual stock take until five days after
the year-end. At this date, stock on the premises was RWF20 million at cost. Between
the year-end and the stock take, the following transactions were identified:
a. Normal sales at a mark-up on cost of 30%, RWF1,560,000
b. Sales on a sale or return basis at a margin of 20%, RWF930,000
c. Goods received at cost, RWF780,000

Answer

Frw 000
Cost of inventory as at stock take 20,000
Add: Normal sales at mark-up 1,200,000
Add: Sales on a sale or return basis 744,000
80%
Less: Cost of goods purchased subsequently to (780,000)
the year end
Value of inventory as at reporting date 21,164,000

60
Example 4

XY Ltd has a consignment of goods worth Frw 20,000 purchased three weeks before the
year-end. Those goods were subsequently damaged in an accident. The original estimated
selling price of these goods was Frw 27,000. However, in order to make the goods ready for
sale, remedial work costing Frw 4,500 needs to be carried out, after which the goods will be
sold for Frw 23,000.

Answer

Cost of inventory 20,000

NRV (Selling price less cost to sale ) 23,000-4,500 18,500

Good should be included in financial statements at Frw 18,500

61
I.11. IFRS 5 Non-current held for sale and discontinued operation

A non-current asset should be classified as held for sale if its carrying amount
will be recovered principally through a sale transaction rather than through
continued use.

The assets shall be classified as held for sale if and only the following condition are satisfied.

i. The asset must be available for sale in its present condition

ii. Management are committed to a plan to sell the assets

iii. There is an active plan to locate buyer

iv. The asset is being actively marketed

v. the sale is expected to be completed with 12 months of its classification as

held for sale

vi. It is highly unlikely that the plan will be significantly changed or

withdrawn Measurement and presentation of non-current assets held
for sale.

Measurement

i. Non-current assets held for sale should be measured at the lower of their carrying
amount and fair value less cost to sell.

ii. Non-current assets held for sale shall be presented separately on the face of
statement of financial position and should not be depreciated

iii. On presentation on statement of financial position, they will qualify as current

assets under rules of IAS 1.

62
Illustration 1:

On 1st January 20x1, john’s pizza company bought a chicken processing machine for
Frw.200, 000. It has an expected useful life of 10 years and a nil residual value. On
December 20x2, after 2 years of using the assets, john’s company decides to sell the machine
and starts action to locate a buyer.

The machines are in short supply so john’s is confident that the machine to dismantle the
machine and market it available to the buyer.

The fair value of the machine as at 31 December 20x2 was Frw 150,000 and cost to sale
was estimated to be Frw 5000

Required:

At what value should the machine be stated in john’s company statement of

financial position?

Solution:

NBV: 200,000-(200,000/10)*2=160,000
Fair value less cost to sale =150,000-5,000=145,000

The machine should be presented separately of the face of financial statement at Frw
145,000 (The low of carrying amount and Fair value less costs to sale). The impairment loss
of Frw.15, 000 incurred in writing down the machine to fair value less costs to sell will be
charged to the income statement.

A discontinued operating is a component of an entity that has either been disposed of or

is classified as held for sale and

Represent a separate major line of business or geographical area of operations

 Is part of single co-ordinated plan to dispose of a separate major line

of business or geographical area of operation or
 Is a subsidiary acquired exclusively for resale

63
Illustration
Valentine produced cards and sold roses. However, halfway through the year ended 31st
march 20x6, the rose business was closed and assets sold of incurring losses on disposal of
non-current assets of Frw76,000 and redundancy costs of Frw37,000. The directors
reorganized the continuing business at a cost of Frw98,000. Trading results may be
summarized as follows
Frw 000 Frw 000
Turnover 650 320
Cost of sales 320 150
Administration 120 110
Distribution 60 90
Other trading information is as follows:
Interest payable 17
Tax 31
Required:

Draft the income statement for the year ended 31st march 20x6.

64
I.12. IAS 33 Earnings per share

Earnings per share (EPS) refer to the portion of a company's profit allocated to each share
of common stock. Earnings per share serves as an indicator of a company's profitability
towards the common stock.

The calculation of the earnings figure effectively becomes:

Earnings=Profit-Tax-Non-controlling interest-Preference dividend

N.B: if the preference dividend are cumulative, the total amount of dividend shall be
deducted from profit while if the preference dividend are non-cumulative, only the dividend
paid during the period are to be considered in computation of EPS.

CHANGES IN CAPITAL STRUCTURE

If the capital structure of a company changes it also affect the weighted average
shares.
There are a number of possible causes for such a change. The most common are:
1. Issue of shares at their full market price
2. A Capitalisation or Bonus issue
3. A Rights Issue
4. Share Exchange

1. Issue of Shares at Full Market Price

Rule =New shares should be included in the EPS calculation, weighted on a time basis.
Do not adjust previous year’s EPS
2. Bonus or Capitalisation Issue

Bonus shares occurs when an entity issue shares to existing

shareholders for free i.e no additional costs, hence the number of
shares increase without correspondent increase in resources.

Rule = Bonus shares are deemed to be issued on the 1st day of the
earliest period being reported (usually, the 1st day of the
comparative year). The effect will be as if the bonus shares
had always been in issue. Thus; no time weighting and
Adjust previous years EPS,

The previous EPS is adjusted by multiplying current EPS with the

bonus factor.

65
Example: Kigali Business Company Ltd (KBC) had an issued ordinary shares of 40,000 as at
31/12/2016. During the year ended 31/12/2017 the company issued a bonus shares of 1 for 4 shares
held, the issue was completed on 31st March 2016 and it was financed through capitalization of
reserves. KBC has a 10% non-cumulative preference shares of 200,000 of Frw 10 per share. Due to
cash flow problems KBC paid only 90% of preference dividend. KBC ltd issued additional ordinary
shares of 20,000 on 30/10/2017 to increase the liquidity position subsequently to the issue. The profit
after tax was Frw 2,400,000.

During the year ended 31st December 2016 KBC had reported EPS of 10.

Required: Compute the EPS for the year ended 31/12/2017 and compute the restated EPS of 2016.

Calculate weighted number of shares

Shares in issue as at 1/01/2017 40,000

Bonus shares issued on 31 March 2016 10,000
Shares issued on 30/10/2017 3,333
53,333

Adjusting profit after tax

Profit after tax 2,400,000
Less: Preference dividend (180,000)
Profit available to owners 2,220,000

Working 1: Preference dividend

Value of preference shares

Dividend
The dividend are non-cumulative, therefore only
dividend paid should be considered which is
90%

Adjusting previous EPS

4/5 is a bonus factor

3. Rights Issue

A right issue refers to the right given to existing shareholders in prorate to their shareholding
at the time of issue, the exercise price is often less that the market price of share.
Rule = Calculate the “Theoretical Ex Rights Price” Weight shares on a time basis
Adjust previous years EPS: Previous EPS*TERP/cum right Price

66
The Theoretical Ex-Rights: Price is the price the shares will have, in theory, after the rights
issue occurs.
Cum Rights Price: is the market price of the shares immediately before the rights issue takes
place.

Example: ABC Ltd had earnings (for EPS) of RWF396,000 in 2010 and RWF360,000 in 2009
At the start of 2010, it had 3,600,000 shares in issue
On the 1st July 2010, the company made a 1 for 4 for .50rwf rights issue. The “cum rights”
price was RWF1. What is the EPS for 2010 and adjust the EPS for 2009.

Answer
Calculate Theoretical Ex-Right Price
Shares Unity price Value
4 1 4
1 0.5 0.5
5 4.5

Right issue shares

issued on 1 July 2010

Compute weighted number of shares as follows

Shares in issue 2,000,000

at the
beginning of
the year* note
1
After right 2,250,000
issue
Total weighted 4,250,000
shares

Note: When shares are issued using right issue, the existing shares in issue should be
adjusted for the effect of Theoretical Ex-Right issue price

Adjust previous EPS as shown below

Previous EPS

Adjustment

67
Example 2

Extracts from the balance sheet of RDN as at 1st April 2005 are:
RWF’000 RWF’000
Ordinary shares of 0.25 each 4,000
8% Preference shares 1,000
Reserves
Share premium 700
Capital redemption reserve 1,300
Revaluation reserve 90
Retained earnings 750
2,840
7,840
10% convertible loans 2,000

The following draft income statement has been prepared for the year to 31st March 2006:
RWF’000 RWF’000
Profit before interest and tax 1,800
Loan interest (200)
Profit before tax 1,600
Taxation
Provision for 2006 300
Deferred tax 390
(690)
910
Dividends paid: Ordinary 320
Preference 80
(400)
510

(i) A bonus issue of 1 new share for every 8 ordinary shares held was made on 7th September 2005

(ii) A fully subscribed rights issue of 1 new share for every 5 ordinary shares held at a price of 50
cents each was made on 1st January 2006. Immediately prior to the issue, the market price of
RDN’s ordinary shares was RWF1.40 each

(iii) The EPS was correctly reported in last year’s accounts at 8 cents

Required: Compute EPS to be included in the Financial statement for the year ended 31st Much 2016
and Restate the EPS as reported in prior period.

68
 4. Share Exchange

Shares issued to acquire a subsidiary are deemed to be issued on the first day of the
period for which profits of new subsidiary are included in group earnings,
therefore, the shares issued in exchange for acquisition of subsidiary are weighted
on time period from the date of acquisition.

FULLY DILUTED EARNINGS PER SHARE

Fully diluted earnings per share occurs when the existing earnings will be required
to be spread over a greater number of shares in future as a result of the exercise of
existing rights to share at some future date.
Factors which result into diluted EPS
(a)
Share warrants and options
(b)
(c)
Contingently issuable shares
Convertible debt.

(a) Share warrant.

Share warrants and options allow the holder to buy shares in the future,
usually at a price below the fair value

Example: ENST Ltd has earnings for 2007 of RWF1,200,000 and 5 million
ordinary shares. It has 1 million share options with an exercise price of RWF3. The
average fair value of an ordinary share during the year was RWF4.

Prepare basic EPS

Ordinary shares 5,000,0000

Earning 1,200,000
EPS

Prepare diluted EPS

Number of share option 1,000,000
Value of share option 1,000,000*Frw 3 Frw 3,000,000
Shares that would have been issued at full
market price to earn the same amount
Share That will result into dilution 1,000,000-750,000=250,000

(b) CONVERTIBLE BONDS/LOAN STOCK

These are financial instruments which the holder usually has an option to convert the
bond into ordinary shares at some future date.
Basic earnings are increased by the net of tax interest saved on conversion, whilst the basic
number of shares is increased by the expected increase in ordinary shares.

69
 (c) DILUTIVE / ANTI-DILUTIVE POTENTIAL ORDINARY SHARES

Potential ordinary shares should be treated as dilutive only when the actual conversion to
ordinary shares would have the effect of decreasing net profit or increasing a net loss per
share from continuing operations. The effects of anti-dilutive potential ordinary shares
are to be ignored in calculating diluted earnings per share.

Example

The company has provided you with the following information

Profit for the year attributable to ordinary Frw 12 million

shareholders
Ordinary shares 20 million
Average fair value of one ordinary shares Frw 7.5

Additional information

a) Share option: 5 million with exercise price of Frw 6

b) Convertible preference shares: 800,000 entitled to a cumulative dividend of Frw 8
per share. Each is convertible to two ordinary shares.
c) 2% convertible bond: nominal amount Frw 100 million. Each Frw 1,000 bond is
convertible to 40 ordinary shares
d) Tax rate: 40%

Required: Determine the basic Earnings per Share and Diluted EPS

Answer

Ordinary shares 20,000,000

Profit for the year (note 1) 12,000,000
Basic EPS

Calculate incremental earning

Increase in Increase in EPS
earning shares
Frw 000 000
Share option - 1,000 -
Convertible 6,400 1,600 4
preference shares
Convertible bond 1,200 4,000 0.3

Number of share option 5,000,000

Value of share option 5,000,000*6=30,000,000
Shares that would have been issued at full market price
and yield the same amount

Calculate diluted earnings per share

Net profit Ordinary shares EPS

000 000
As reported 12,000 20,000 0.6
Options - 1,000
70
 Net profit Ordinary shares EPS
12,000 21,000 0.57
Convertible bond 1,200 4,000
13,200 25,000 0.53
Preference shares 6,400 1,600
19,600 26,600 0.74

Increase in earnings due to dividend =800*8=6,400

Increase in earnings arising on interest on convertible bond=100,000*2 %*( 1-40%) =1,200

Convertible preference shares will not result into dilution of shares as conversion results into
increase in EPS, Therefore,

I.13. IAS 10: Event after reporting date

It is commonly known that all available information must be taken into consideration when
preparing the financial statements. i.e The financial statement must include and provide all
information existed up to the date of preparation. There is a time difference between the date
when the financial statements are prepared and the date when financial statement are issued
for authorization. The events that occur between the date of preparing financial statement and
the date when financial statements are issued for authorization may help in the preparation of
financial statement or may provide relevant information to the financial statement that had
already prepared.

Definition

Events after the reporting date are those events, both favorable and unfavorable, that occur
between the reporting date and the date financial statements are authorized for issue. Those
events may be Adjusting events or non-adjusting events,

Adjusting Events

These are events that provide evidence of conditions that existed at the statement of financial
position date. If those events are identified, the financial statements should be adjusted to
reflect these events.

Example of adjusting events

 The settlement, after the Statement of Financial Position date, of a court case that
confirms that the entity had a present obligation at the Statement of Financial Position
date. The entity will accordingly adjust any previously recognized provision or create a
new one.
 The receipt of information after the Statement of Financial Position date indicating
that an asset was impaired at the Statement of Financial Position date,
 The bankruptcy of a customer after the Statement of Financial Position date
 The sale of inventories after the Statement of Financial Position date may give
evidence about their net realizable value at the Statement of Financial Position date
 The determination after the Statement of Financial Position date of the cost of assets
purchased, or proceeds of assets sold, before the year-end.
 The discovery of fraud or errors that show the financial statements are incorrect.

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Non-Adjusting Events

These are events that portrait indicative conditions that arose after the Statement of Financial
Position date. Whenever, those events are identified, the entity should not adjust its financial
statements to reflect these events as those events doesn’t affect the financial statement.
However, those information may be relevant to the users of financial statement i.e the events
could influence the economic decisions of users. Therefore, IAS 10 suggests that if those
events are material, they should be disclosed in the notes by detailing:

(a) The nature of the event; and

(b) An estimate of its financial effect, or a statement that such an estimate cannot be made

Examples non-adjusting events:

 A major business combination after the year end or the disposal of a major subsidiary
 Announcing a plan to discontinue an operation
 Major purchases of assets, disposals of assets, expropriation of major assets by government
or classification of assets as held for sale
 Destruction of a major production plant by fire
 Announcing or commencing a major restructuring
 Major ordinary share transactions after the year-end (other than bonus issues, share splits
or reverse share splits, which must be adjusted for)
 Abnormally large change in asset prices or foreign exchange rates after the year-end
 Changes in tax rates/laws
 Commencing major litigation arising solely out of events that occurred after the Statement
of Financial Position date

Dividend

If an entity declares dividends to holders of equity instruments after the reporting period, the
entity shall not recognize those dividends as a liability at the end of the reporting period

GOING CONCERN CONSIDERATIONS UNNDER IAS 10

If there is evidence that may cast the entity’s ability to continue as a going concern, the
financial statement for that period shall not be prepared on a going concern basis, or if it is
management’s intention to liquidate or cease trading, or no realistic alternative exists to
continue the operations, the accounts should be prepared on a “break-up basis”. In addition,
disclosures prescribed by IAS 1 under such circumstances should also be complied with.

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I.14. IAS 38: INTANGIBLE ASSETS

In accordance with IAS 38, intangible assets are defined as an identifiable non-monetary
asset without physical substance. Such as Patents, Goodwill, Copyright, computer
software, License.

The following shall not be considered as intangible asset

(i) Intangible assets that are within the scope of another standard
(ii) Financial assets, as defined in IAS 39 Financial Instruments:
(iii) Mineral rights and expenditure on the exploration and extraction of oil, gas, minerals,

Accounting treatment

IAS 38 state that, when intangible asset are identified and the entity has control over the
benefits from that assets, it must be recognized as assets. Before recognition in the books of
account, the following shall be fulfilled.

i. It is probable that future economic benefits attributable to the asset will flow to the
organization, and
ii. The cost of the asset can be measured reliably

Recognition of internally generated intangible assets

N.B: Before recognition of internally generated intangible asset, the entity must be able
to separate Research phase and development phase.

RESEARCH

Research is original and planned investigation undertaken with the prospect of gaining new
scientific or technical knowledge and understanding.

Research expenditure must be recognized as an expense in the Income Statement when it is

incurred, i.e. it cannot be capitalized.

IAS 38 provides examples of research activities:

(a) Activities aimed at obtaining new knowledge

(b) The search for alternatives for materials, devices, products, processes, systems or
services
(c) The design or evaluation of possible alternatives for new or improved materials,
devices, products, processes, systems or services.

Treatment of cost incurred in research phase

No intangible asset arising from research (or from the research phase of an internal project)
shall be recognized.

Expenditure on research (or on the research phase of an internal project) shall be recognized
as an expense when it is incurred.

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DEVELOPMENT

Development is the process whereby the entity apply research findings or other knowledge to
design for the production of new or substantially improved materials, devices, products,
processes, systems or services before the start of commercial production or use.

An intangible asset arising from development shall be recognized as asset if, and only if, an
entity can demonstrate all of the following:

(a) Probable future economic benefits will be generated by the asset

(b) Intention to complete and use or sell the asset
(c) Resources exist to complete the development and to use/sell the asset
(d) Ability to use or sell the asset
(e) Technical feasibility of completing the asset so that it will be available for use or sale.
(f) Expenditure attributable to the development of the asset can be measured reliable.

N.B: there circumstance where an entity cannot distinguish research phase and development
phase. If so, then the entire expenditure is classified as research.

1. Initial recognition

Intangible asset shall initially be recognized at its cost or fair value of intangible assets being
received.

The cost of separately acquired intangible assets comprises:

 Purchase price (including irrecoverable taxes / duties less discounts and rebates) and
 Directly attributable costs of preparing the asset for use (these can include items such
as professional fees, costs of testing and employees’ benefits).

However, the following costs cannot be included:

 Costs of introducing new products / services such as advertising

 Costs of conducting new business
 Administration costs
 Costs incurred while an asset that is ready for use is awaiting deployment
 Initial operating losses incurred from an operation.

Note: if the intangible asset is acquired in an acquisition, then the fair value of the asset at the
date of acquisition is used in accounting for the business combination.

2.MEASUREMENT OF INTANGIBLE ASSETS AFTER RECOGNITION

After initial recognition, an intangible asset should be valued using either:

(a) Cost Model, or
(b) Revaluation Model

ACQUISITION BY GOVERNMENT GRANT

There may be situations where an intangible asset may be acquired free of charge, through a
government assistance/grant, e.g. licences for Radio/TV stations.
The entity may choose to recognise both the intangible asset and the grant initially at fair
value. This would be in accordance with IAS 20.
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Alternatively, the entity can recognise the asset initially at a nominal amount plus any
expenditure that is directly attributable to preparing the asset for its intended use.

Example 1

Kigali Mountain Ltd. develops and manufactures computer software. The company has 4
projects in hand on 30th June 2009; S1, S2 & S3 and S4. The details for each are as follows:

S1 S2 S3 S4
000 000 000 000
Frw Frw Frw Frw
Deferred development expenditure at 1st July 2008 1,080 1,500 - 2,000
Development expenditure incurred in year ended 30 th June 2009
Wages and salaries 180 - 120 200
Materials 30 - 24 750
Other expenses 9 - 18 250

Additional information
Project S1
All expenditure on this project was capitalised until 30th June 2008 as the conditions
necessary for capitalisation, as laid down by IAS 38, were present. However, during the
current year, the future profitability of the project became doubtful due to previously
unforeseen competitive pressures.
Project S2

All expenditure on this project was incurred and deferred prior to the current year.
Commercial production began in September 2008. Actual and estimated sales from year end
30th June 2009 to 30th June 2012 are as follows:

30th June 2009 800,000 units

30th June 2010 2,400,000 units
30th June 2011 3,600,000 units
30th June 2012 400,000 units

The directors believe it to be imprudent to defer any expenditure beyond 30th June 2012.

Project S3

This project only commenced in the year under review and appears to satisfy the criteria for
deferral.
Project S4
The cost incurred during the year 2008 cover the research and development cost, however, the
entity cannot separate the cost incurred on research and cost incurred to develop the software.
The amount was capitalized as the entity believe that the software will increase the future
economic benefit. The cost incurred during the year ended 30th June 2009, relates to the
development activities and the active activities was completed during the year. The entity
expect that software 4 can be used within 3 years.
REQUIREMENT:
Show how the above 4 projects would affect the financial statements of Kigali mountain Ltd.
for the year ended 30th June 2009
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Answer

Project S1

As at reporting date, the condition necessary for deferral is no longer applicable because
future profitability of the project became doubtful. Therefore, balance brought forward at the
beginning of the year and all expenditure incurred during the year must be written off

Journal entries

Dr: P/L (Dvp expenditure written off) Frw 1,080

Cr: Capital development expenditure Frw 1,080
Being deferred development expenditure written off

Dr: Expense (wages, materials, other expenses) P/L Frw 219

Cr: Bank Frw 219
Being recognition of cost incurred during the year

Project S2

The project was completed and put it into use in September 2008, therefore, the amortization
should be computed and charged in P/L

Project S3

The project started during the year and met criteria for deferral, therefore, the related cost
should be capitalized as follows

Dr: Capital development expenditure Frw 162

Cr: Bank Frw 162
Being recognition of development expenditure

Project S4

IAS 38 state that if the entity cannot separate Research cost and development cost, all cost
must be expensed not capitalized.

Therefore, the cost incurred in 2008 must be written off.

Journal entries
Dr: P/L (Dvp expenditure written off) Frw 2,000
Cr: Capital development expenditure Frw 2,000
Being deferred development expenditure written off

The cost incurred during the year must be capitalized as the condition for deferral are
satisfied. Amortization for these costs must be applied from 2009 up to three years

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Dr: Capital development expenditure Frw 1,200
Cr: Bank Frw 1,200
Being recognition of development expenditure

Amortization

Extract statement of profit and loss account for the year ended 30 June 2009

Frw 000
Expenses
Development cost written off incurred on S1 1,080
Development cost written off incurred on S4 2,000
Wages & salaries, Materials and other expenses 219
Amortization of project S2 and S4 567

Extract statement of financial position as at 31 December 2009

Frw 000 Frw 000 Frw 000

Development expenditure
S2 1,500 (167) 1,333
S3 162 1,62
S4 1,200 (4,00) 9,00

ASSETS WITH BOTH TANGIBLE AND INTANGIBLE ELEMENTS

IAS 38 recognizes that some intangible assets may be contained in or on a physical substance
such as a compact disc (in the case of computer software), legal documentation (in the case of
a license or patent) or film.

It must then be determined whether an asset that incorporates both intangible and tangible
elements should be treated under IAS 16 Property, Plant and Equipment or under IAS 38
Intangible Assets.

In order to resolve this issue, the entity must use judgment to assess which element is more
significant. For example, computer software for a computer-controlled machine tool that
cannot operate without that specific software is an integral part of the related hardware and it
is treated as Property, Plant and Equipment. The same applies to the operating system of a
computer.

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INTERIM FINANCIAL REPORTING IAS 34

INTRODUCTION

IAS 34 recognizes the usefulness of timely and reliable interim financial reporting in
improving the ability of investors, creditors and others to understand an entity’s capacity to
generate earnings and cash flows and its financial condition and liquidity. The standard does
not oblige entities to publish interim financial reports.

However, entities whose debt or equity securities are publicly traded are often required by
governments, stock exchanges, accountancy bodies, etc to publish interim financial reports. If
interim financial reports are published and purport to comply with IFRSs, then IAS 34
governs their content. Each financial report, annual or interim, is evaluated on its own for
conformity to IFRSs. If an entity’s interim financial report is described as complying with
IFRSs, it must comply with all of the requirements of IAS 34.

The interim period is a financial period shorter than a full financial year. The interim financial
report means a financial report containing either a full set of financial statements (in
accordance with IAS 1) or a set of condensed financial statements (as outlined in IAS 34) for
an interim period

MINIMUM COMPONENTS OF AN INTERIM FINANCIAL REPORT

An interim report may consist of a condensed version of the full financial statements and
should include an explanation of the events and transactions that are significant to an
understanding of the interim financial statements. At a minimum, they should include:

 Condensed statement of financial position

 Condensed statement of comprehensive income
 Condensed statement showing either:
o All changes in equity; or
o Changes in equity other than those arising from capital
transactions with owners and distributions to owners
 Condensed cash flow statement; and
 Selected explanatory notes

If the entity publishes a set of condensed financial statements in its interim financial report,
those condensed statements should include, at a minimum each of the headings and subtotals
that were included in its most recent annual financial statements, together with selected
explanatory notes as outlined by IAS 34.

The recognition and measurement principle should be the same as those used in the main
financial statements. Additional line items or notes should be included if their omission would
render the interim reports misleading. Basic and diluted earnings per share should be
presented on the face of a Statement of Comprehensive Income for an interim period. If,
however, an entity chooses to publish a complete set of financial statements in its interim
financial report, the form and content of those statements must conform to IAS 1 for a
complete set of financial statements

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SELECTED EXPLANATORY NOTES

The following information must be included, as a minimum, in the notes to the interim
accounts (assuming they are material and not included elsewhere in the interim financial
statements):

 A statement that the same accounting policies used for the interim report were used
for the most recent annual financial statements. If the policies have changed a
description of the nature and effect of the change must be given.
 Explanatory comments about the seasonality or cyclicality of interim operations.
 The nature and amount of items that are unusual because of their nature, size or
incidence.
 The nature and amount of changes in estimates of amounts reported in prior interim
periods of the current financial year and if those changes have a material effect in
the current interim period.
 Issuances, repurchases and repayments of debt and equity securities.
 Dividends paid.
 Segment revenue and segment results for business or geographical segments,
whichever is the primary basis of segment reporting (only disclose segment
reporting in interim accounts if it is required in the full annual accounts).
 Material events after the end of the interim period that have not been reflected in the
interim accounts.
 The effect of changes in the composition of the entity during the interim period e.g.
business combinations.
 Changes in contingent liabilities or contingent assets since the last annual statement of
financial position date

Interim reports should include interim financial statements as follows:

 Statement of Financial Position at the end of the current interim period and a
comparative Statement of Financial Position at the end of the immediately preceding
financial year.
 Statement of Comprehensive Income for the current interim period, and the
cumulative year to-date figures with comparative Statements of Comprehensive
Income for the comparable interim periods (current and year-to-date) of the
immediately preceding financial year.
 Statement showing changes in equity cumulatively for the current financial year-to
date, with a comparative statement for the comparable year-to-date period of the
immediately preceding financial year.
 Cash flow statement cumulatively for the current financial year-to-date, with a
comparative statement for the comparable year-to-date period of the immediately
preceding financial year

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CHAPTER III: Published financial statement
IAS 1 — Presentation of Financial Statements

OVERVIEW

IAS 1 Presentation of Financial Statements sets out the overall requirements for financial
statements, including how they should be structured, the minimum requirements for their
content and overriding concepts such as going concern, the accrual basis of accounting and
the current/noncurrent distinction. The standard requires a complete set of financial
statements to comprise a statement of financial position, a statement of profit or loss and other
comprehensive income, a statement of changes in equity and a statement of cash flows.

Objective of financial statements:

The objective of general purpose 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 economic decisions. To meet that objective, financial statements
provide information about an entity's:

Assets
 Liabilities
 Equity
 Income and expenses, including gains and losses
 Contributions by and distributions to owners
 Cash flows
Components of financial statements

A complete set of financial statements should include:

1. A statement of financial position (balance sheet) at the end of the period

2. A statement of comprehensive income for the period (or an income statement and a
statement of comprehensive income)
3. A statement of changes in equity for the period A statement of cash flows for the
period
4. Statement of cash flows
Notes, comprising a summary of accounting policies and other explanatory notes

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The statement of profit or loss and other comprehensive income

Format: Statement of profit or loss and other comprehensive income for the year ended 31
December 2019
Frw 000 Frw 000
Revenue xxx
Cost of sales (xxx)
Gross profit xxx
Other income xxx
Expenses
Distribution costs xxx
Administrative expense xxx
Other expense xxx
Finance cost xxx
(xxx)
Profit before tax xxx
Income tax expense (xxx)
Profit for the year xxx
Other comprehensive income
Gain on property revaluation xxx
Total comprehensive income xxx

Format of balance sheet statement of financial position

Rwunguko ltd statement of financial position As at 31 December 2017

Details Frw 000 Frw 000

Assets
Noncurrent assets
Property, plant and equipment xxxx
Other intangible assets xxxx
Investments xxxx
Goodwill xxxx
Asset held for sale
Available-for-sale financial assets xxxx
Current assets
Inventories xxxx
Trade receivables xxxx
Other current assets xxxx
Cash and cash equivalents xxxx
xxx
Total asset
Equity and liabilities
Share capital xxxx
Share premium xxxx
Retained earnings xxxx
Other reserves xxxx
Noncurrent liabilities
Debentures xxxx
Deferred tax xxxx
Long term provision xxxx
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Finance lease xxxx
Total Non-current liability xxx
Current liabilities
Trade and other payables xxxx
Unpaid tax xxxx
Bank overdraft xxxx
xxx
Total equity and liabilities xxxx

Statement of change in equity

Share Share Revaluation Retained Total

capital premium surplus earnings

Bal b/d xxx xxx xxx xxx xxx

Change in accounting (xxx) (xxx)

policy
Restated balance xxx xxx xxx xxx xxx

Change in equity for the

year
Dividends (xxx) (xxx)

Revaluation surplus xxx xxx

Profit for the year xxx xxx

Issue of share capital xxx xxx - - xxx

Balance as at year end xxx xxx xxx xxx xxx

TOPIC IV: FINANCIAL STATEMENTS OF VARIOUS TYPES

OF ORGANISATIONS

III.1. FARMING
Agricultural activity is the management by an entity of the biological transformation
and harvest of biological assets for sale or for conversion into agricultural produce or into
additional biological assets
Agricultural produce - is the harvested product of the entity’s biological assets.
A biological asset - is a living animal or plant.
Biological transformation -comprises the processes of growth, degeneration,
production, and procreation that cause qualitative or quantitative changes in a biological
asset
Recognition and measurement
An entity shall recognise a biological asset or agricultural produce when and only when:
a) The entity controls the asset as a result of past events;
b) It is probable that future economic benefits associated with the asset will flow to the entity
c) The fair value or cost of the asset can be measured reliably

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Initial recognition
Measurement
 Biological assets within the scope of IAS 41 are measured on initial recognition and
at subsequent reporting dates at fair value less estimated costs to sell, unless fair value
cannot be reliably measured.
 Agricultural produce is measured at fair value less estimated costs to sell at the point of
harvest.
 The gain on initial recognition of biological assets at fair value less costs to sell,
and changes in fair value less costs to sell of biological assets during a period,
are included in profit or loss.
 All costs related to biological assets that are measured at fair value are recognised as
expenses when incurred, other than costs to purchase biological assets.

Futures/ Characteristics of farm accounting

i. Inter-activity transfers
Dr. Expense’s a/c (input)
Cr. Revenue a/c (output).
Generally a farm is employed with different economic activities e.g. poultry, fishing, crops,
dairy cattle etc. As a result the output of one economic activity may be used by another
economic activity as an input. To account for this, the output of the farmer activity should
be treated as an income for that respective activity and as an expense for the latter activity.
ii. Dominance of barter transactions/ payments in kind;
Dr. Wages/ revenue a/c,
Cr. Revenue a/c.
The transactions relating to agriculture are not controlled by money. In many cases payments
are made in kind.

In order to account for this opportunity such as payments in kind should be quantified in
money terms of adjustments be made in respective accounts. e.g. if the workers received
milk, then liters of milk so given would be valued at selling price an amount be treated as
revenue in livestock account and the same amount treated as wages in crop account.
iii. Related items
In Family Labour: This is usually provided for free. It should be valued at market price
and treated as capital i.e. the double entry would be: Dr. Wages/ General P&L account

Cr. Capital a/c

iv. Family consumption
The family may consume some of the products. The products consumed should be valued
at market price and treated as both revenue as well as drawings i.e. Dr. Drawings

Cr. Sales a/c / Revenues

III.2. INSURANCE FIRMS

Insurance is a form of contract or agreement under which one party undertakes to indemnify
another party the losses suffered due to specified causes in consideration for a fixed sum of
money known as a premium. The party undertaking to indemnify another is called the insurer;
whereas the party paying the premiums in order to receive indemnity is called the insured. The
document containing the terms of the insurance contract is known as a policy.
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Insurance is generally classified into two:
i) Life assurance
ii) General insurance
Also the category of insurance can be classified according to the types of risks like:
Fire insurance
ii) Marine insurance
iii) Motor vehicle / accident insurance
Life Assurance
Life assurance guarantees that, on the policy holder (or the insured) attaining a certain age
or on his death, he will receive a certain amount of money paid to him/related family by the
insurer.
Some of the commonly used terms in the insurance are:

ii. Annuity: This is an annual payment, which a life insurance office

guarantees to pay regularly as long as one lives in consideration
of a lump sum received at the beginning. It is almost the reverse
of a live policy contract.

The amount payable depends upon the age of the person concerned
(called an annuitant) and the prevailing rate of interest. The regular
payment (annuity) is an expense, whereas the lump sum received
at the beginning is called ‘consideration for annuities granted’ and
is income.

iii. Whole life policy: is a policy, which matures on the policy holder attaining
a certain age or on his death, whichever is earlier.
iv. Bonus is the share of profit that the policyholder gets from the insurance
company.
v. Reversionary bonus is that which is payable only on the maturity of the
policy.
vi. Bonus in reduction of premium is bonus which is payable in cash but the
policyholder has opted not to accept it in cash, and instead offset this
against premiums due from him.
vii. Reinsurance means insurance taken by an insurance company in order to
cover itself against a large risk.
viii. Retrocession is where an insurance company reinsures one property with
more than one Reinsurance Company.
ix. Commission on reinsurance ceded: when a company reinsures some of
the risk, the company will receive a commission from the reinsuring firm,
such is known as commission on reinsurance ceded and is income.
x. Commission on reinsurance accepted: when our insurance company
decides to accept reinsurance premiums from another insurance company
because the other insurance company decided to reinsure its business with
us, we have to pay a commission to the other insurance company. Such is
known as commission on reinsurance accepted and is an expense.
xi. Surrender value is the amount that a policyholder can get immediately in
cash back from the life assurance company if he stops paying premiums. It
is the present cash value of the policy.

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xii. Claim: means the amount payable due to the death of the policyholder it is
called a ‘claim by death’. If the claim is paid upon the policyholder
attaining the age mentioned in the policy, it is known as claims by
maturity (or survivance)
Annual accounts for insurance companies:

1. A revenue A/C and

2. Statement of profit and loss account
3. Statement of financial position.

Statement of Profit or loss for the year ended 201xx

Amou
Description nt
Premiums received less premiums paid for
reinsurance. xxx
Consideration for annuities granted. xxx
xxx
Other incomes
Interest received less withholding tax xxx
Dividend received less withholding tax xxx

Rent income xxx

Fines for getting lapsed policies revived xxx
Total income xxx
Expenses
Claims including claims, less claims recovered and
recoverable from reinsurance companies xxx
Annuities paid and due xxx
Bonus paid in cash. xxx
Bonus utilized in reduction of premium xxx
xxx
Other expense
Commissions to agents xxx
Salaries xxx
Travelling expenses xxx
Directors fees xxx
Auditors fees xxx
Bad debts xxx
Rent for all offices occupied xxx
Printing and stationery xxx
xxx
Total expenses xxx
Profit or loss for the period xxx
Retained earnings bal b/d xxx
Retained earnings bal c/d xxx

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 Balance sheet as at…………..
Items Amount
Non-current assets
Property plant and equipment xxx
Loans: On mortgages xxx
Investments: In government
securities, in securities where the
xxx
interest is guaranteed by the
government
Bonds, debentures xxx
Current assets
Outstanding premiums xxx
Accrued interests, dividends and rent. xxx
Amounts due from other insurers. xxx
Bills receivable xxx
Bank xxx
Cash xxx
xxx
Total assets xxx
Equity
Share capital xxx
Retained Profit and loss xxx
Revaluation reserves xxx
Non-current liabilities
Debentures and long term loans xxx
Current liabilities
Accrued expenses xxx
Bills payable xxx
Claims outstanding – whether
xxx
accepted or intimated
Annuities due xxx
Premiums received in advance xxx
Sums dues to other insurance
xxx
companies
xxx
Total equity & Liabilities xxx

86
III.3. BANK
Bank means a company which carries on, or proposes to carry on, banking business in
Kenya but does not include the Central Bank;

Banking business means -

a. The accepting from members of the public of money on deposit repayable on
demand or at the expiry of a fixed period or after notice;
b. The accepting from members of the public of money on current account and
payment on and acceptance of cheques; and
c. The employing of money held on deposit or on current account, or any part
of the money, by lending, investment or in any other manner for the account
and at the risk of the person so employing the money.

Bank Accounts

Profit and loss account for the year ended (date)

Income Amount
Interest on advances (loan, overdrafts, etc) xxx
Interest on government securities xxx
Interest on placement and bank balances (with other) xxx
Less: xxx
Interest paid on deposits (fixed and savings) xxx
Interest paid on borrowings from other bank xxx
Net interest income xxx
Other income
Dividend income xxx
Fee and commission on income xxx
Discounts on bills purchased xxx
Net gain arising from foreign currency dealings xxx
Other expenses xxx
Fee and commission expense xxx
Impairment charge on loans and advance xxx
Net losses arising from foreign currency dealings xxx
General admin. Expenses:
Staff costs xxx
Depreciation and amortization xxx
Auditor’s remuneration xxx
Other operating expenses xxx
Profit before tax xxx
Taxation (xxx)
Transfer to reserves (xxx)
Dividends to shareholders (xxx)
Retained profit for the year xxx
Retained profit bal b/d xxx
Retained profit bal c/d xxx

87
Statement of financial position as at 201xx
Balance sheet as at (date)

Items Amounts
Assets
Cash and balances with central bank xxx
Balances due from other bank xxx
Financial assets at fair value through other
comprehensive income xxx
Financial assets at fair value through profit or loss xxx
Loans and advances to customers xxx
Bills discounted and purchased xxx
Accrued: Interest and other sundry debtors xxx
Property, plant and equipment xxx
Total assets xxx
Equity
Share capital xxx
Retained profits xxx
Other reserves xxx
Liabilities
Deposit from banks and other financial institutions xxx
Deposit from customers xxx
Bills payable xxx
Tax payable xxx
Interest payable xxx
Other payable xxx
Deferred tax Xxx
Long term debt Xxx
Total equity & Liabilities Xxx

CHAPTER V: BANKRUPTCY AND LIQUIDATION OF COMPANIES OVERVIEW

OF INSOLVENCY AND BANKRUPTCY

Introduction

A company which cannot generate sufficient funds from its operation will face financial
difficulties know as financial distress

Insolvency is defined as a condition in which a company is unable to meet debts as they

mature, then when creditors are not paid, they obviously attempt to protect their financial
interests in hope of reducing the possibility of loss. They may seek recovery from the
distressed company in several ways: repossessing assets, filing lawsuits, foreclosing on loans,
and so on

Causes of business failure

A company’s intrinsic value is the present value of its expected future free cash flows. There
are many factors that can cause this value to decline. These factors include
 General economic conditions,
 Industry trends, and

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  Company’s specific problems such as shifting consumer tastes, obsolescent
technology, and changing demographics in existing retail locations. Financial factors,
such as too much debt and unexpected increases in interest rates, can also cause
business failures.

Signals of a financial distress

Financial distress is surprisingly hard to define precisely. This is true partly because of the
variety of events befalling firms under financial distress. The list of events is almost endless,
but here are some examples:

 Dividend reductions
 Plant closings
 Losses
 Layoffs
 CEO resignations

Strategies for solving financial distress

What happens in financial distress? There are many responses to financial distress that a firm
can make. These include one or more of the following turnaround strategies.
 Asset expansion policies
 Operational contraction policies
 Financial policies
 External control activity
 Changes in managerial control
 Wind up company (liquidation)

COMPANY LIQUIDATION

Meaning and modes of liquidation

Meaning of liquidation: To liquidate means to turn an asset into cash. Liquidation is ‘the
process of law whereby a company is wound up to terminate its corporate life’. It is also
referred to (either alternatively or concurrently) in some jurisdictions as winding up and/or
dissolution.

In accounting, liquidation means termination of the firm as a going concern. If a company

cannot meet its liabilities a liquidator will be appointed to realise (sell) the assets of the
company and the proceeds, net of transactions costs, are distributed to the creditors in order
of established priority.

If there is any surplus in hand, then it is to be distributed to its shareholders. Usually, assets
are not adequate to fully satisfy creditor claims. In this case, creditors share according to the
terms of the general assignment.

Modes of liquidation

1. Voluntary liquidation

When the members and creditors decide to wind up the company without the intervention of
the court, it is known as voluntary winding up of a company. It could be in the following
circumstances:
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 i. If the period fixed for the duration of company has been expired or an event on
occurrence of which the company is to be wound up has occurred and company in
general meeting has passed an ordinary resolution requiring the company to be
wound up.
ii. If the company passes a special resolution that it may be wound up voluntarily.

2. Compulsory liquidation

A compulsory winding up occurs by an order of the court made on a petition filed by the
company, its creditors or shareholders etc. Neither a voluntary nor an involuntary petition
automatically creates a bankruptcy case.
After passing a resolution for the voluntary winding up, the court may, at any time, make an
order that voluntary winding up shall continue but subject to such supervision court and with
such liberty for creditors, contributories or others to apply to the court, and generally on such
terms and conditions as the court think fit.

A court rejects voluntary petitions if the action is considered detrimental to the creditors.

Involuntary petitions also can be rejected unless evidence exists to indicate that the debtor is
not actually able to meet obligations as they come due. Merely being slow to pay is not
sufficient.

Accounting treatment of liquidation

The end of going concern

A basic assumption of accounting is that a business is considered a going concern unless the
evidence to the contrary is discovered. As a result, assets such as inventory, land, buildings,
and equipment are traditionally reported based on historical cost rather than net realizable
value. Unfortunately, not all companies prove to be going concerns. Bankruptcy courts
administer liquidations in the interests of a corporation’s creditors and shareholders. The
intent in liquidation is to maximize the net amount recovered from disposal of the debtor’s
assets. Bankruptcy courts appoint accountants, attorneys, or experienced business managers
as trustees to administer the liquidation.

Liquidation process

The steps involved in the liquidation of a company depends on whether the liquidation is a
decision from the Court or it was a declaration from creditors or a voluntary liquidation from
the shareholders.

There are common steps to be considered and they include:

1. Preparation of a statement of affairs and a list of creditors: a statement of affairs as of

the most recent date possible; and a list of creditors with full names, addresses and to
whose attention notices of the creditors meeting must be sent by the management of
the company to the Liquidator
2. Appointment of a liquidator: he/she may be appointed by the court and approved by
the creditors.
3. Sale of the assets. The liquidator will sell the non-cash assets to transform them into
cash

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 4. Settlement of debts. The liquidator will publish, in an appointed newspaper, notice to
the creditors that they should submit any proof of debts. In addition, the liquidator
must send notice in writing to all persons appearing from the company’s books and
records to be creditors (including contingent creditors) inviting them to file a claim
against the company within the allocated time period. After the period by which
creditors must submit their claims has expired the liquidator will arrange for the
settlement of all of the company’s outstanding liabilities.
5. After settlement of the company’s debts, the liquidator will return the capital and
surplus assets, if any, to the shareholders.

Trustee accounting and reporting

(1) Statement of affairs

In addition to the legal statement of affairs, which consists of responses to questions

regarding a debtor’s financial condition, the other report with the same name is the
accounting statement of affairs. The accounting statement of affairs is the basic
accounting report made at the beginning of the liquidation process. It is a balance sheet of
a potentially liquidating concern rather than of a going concern.

The primary purpose of statement of affairs is to approximate the estimated amounts

available to each class of claims. It thereby assists all concerned parties in reaching a
decision as to what insolvency action is preferable.

The statement of affairs presents

the book values of the debtor company’s balance sheet accounts,
the estimated fair market values of the assets,
the order of the claims, and
the estimated deficiency to the general unsecured creditors.

(2) Trustee accounting

Upon accepting the assets, the trustee usually establishes a set of accounting records to
account for the receivership

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CHAPTER VI :( GROUP ACCOUNTS), SUBSIDIARIES,
ASSOCIATES AND JOINTLY CONTROLED ENTITY
IV.1. Key terms to note
Consolidated financial statements: the financial statements of a group presented as those
of a single economic entity.
Subsidiary: an entity that is controlled by another entity (known as the parent)
Parent: an entity that has one or more subsidiaries

Power: refer to the existing rights that give the current ability to direct the relevant activities
of the investee
Group – This is the parent and all its subsidiaries

Example 2: If company A acquired 80% in company B, then A is parent company and B is

a subsidiary company of A

Non-controlling interest (NCI) – It is that portion of net assets of a subsidiary attributable

to equity interest which are not owned directly or indirectly through subsidiaries by the
parent.
In the above example I: NCI is 20%

Example 2: Vodacom ltd acquired 30,000 shares in Aircom, the number of shares listed in
Aircom are 40,000.
Required; determine the group structure
Percentage of control = (30000/40000)*100= 75% and NCI is 25%

Control: the power to govern the financial and operating policies of an entity so as to
obtain benefits from its activities

Control is usually based on ownership of more than 50% of voting power, but other forms of
control are possible.

Four other situations where control can exist are when the parent has power to:
i. Over more than half the voting rights by virtue of an agreement with other investors.
ii. To govern the financial and operating policies of an entity under statute or an
agreement
iii. To appoint or remove the majority of the members of the board of directors
iv. To cast the majority of votes at a meeting of the board of directors

IV.2. Types of Investment

Required treatment
Investment Criteria Percentage in group accounts
Subsidiary Control Above 50% Full consolidation
Equity method of
Associate Significant influence ≥20X<50 (20-49.999%) Accounting
Equity method of
Contractual Accounting or
Joint venture arrangement 50% proportion
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 consolidation
Investment which is Asset held for creation As for single company
none of the above of wealth Below 20% accounts as per IFRS 9

III.2.1 Subsidiary

A. Consolidated financial statement

The parent company is required to prepare consolidated financial statement when it obtains
the control from the investee
Exemption from preparing Groups accounts (Consolidated financial statement)

A parent need not to prepare consolidated financial statement if and only

the following condition are satisfied.

a) The parent is itself a wholly-owned subsidiary or it is partially owned subsidiary of

another entity and its owners including those not otherwise entitled to vote have been
informed about, and do not object to, the parent not presenting consolidated financial
statements.
b) Its debts or equity instrument are not publicly treaded
c) It is not in the process of issuing securities in public securities markets
d) The ultimate or intermediate parent publish consolidated financial statement that
comply with international financial reporting standards.
Date of inclusion or exclusion
The results of subsidiary undertaking are included in the consolidated
financial statement from:
The date of acquisition i.e the date on which the investor obtain the control

The subsidiary is excluded in the consolidated financial stamen from:

The date of disposal i.e the date when the investor lose control

Different reporting date

In most cases the group companies will prepare accounts to the same reporting date. One
or more of subsidiaries may, however, prepare accounts to a different reporting date from
the parent

In such cases the subsidiary may prepare additional financial statement to the reporting
date of all the rest group, for consolidation purposes. If this is not possible, the
subsidiary’s accounts may still be used for the consolidation provided that the gaps
between the reporting dates is three months or less. But the significant transaction that
occur between the parent reporting date and that of subsidiary should be adjust and
Accounted for.

Different Accounting policies

The accounting policy of parent and its subsidiary shall be the same, however, if they
are not the same appropriate adjustments are made to that group member’s financial
statements in preparing the consolidated financial statements to ensure conformity
with the group’s accounting policies

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 B. Steps in consolidation

1) Determine the group structure by identifying the percentage of control

and Percentage of NCI
2) Eliminate intercompany balances and transactions and intercompany debts
3) Determine the Goodwill arising on the acquisition of subsidiary
4) Calculate non-controlling interest
5) Calculate consolidated retained earnings: : take the total retained earnings
of parents at the date of preparing financial statement (figures are taken
form SOFP plus post acquisition subject to other adjustments
6) Prepare consolidated balance sheet and consolidated profit or loss account
by :Add line by line the assets, liabilities, incomes and expenses of parent
and subsidiary
Equity;
i. Share capital. Use the share capital of parent company only in
SOFP
ii. Share premium; use the share premium of parent company only in
SOFP
iii. Other reserves: take the reserves of parent company plus post
iv. acquisition reserves from subsidiaries

Step 3 is detailed below: Good will computation

Goodwill is computed using either full good will or proportionate goodwill method

i. Full goodwill method

Amoun
t
Description Frw
Fair value of consideration transferred xxx
Add: Fair value of non-controlling interest xxx
Total (A) xxx
Less: Fair value of net assets
Share capital xxx
Share premium xxx
Retained earnings (Pre-acquisition profit) xxx
Other resrves (Pre-acquisition profit) xxx
Fair vale adjustment (Note): e.g. Plant and
equipment xxx
Total net assets (B) (xxx)
Good will at acquisition (A-B) xxx
Less impairment of good will if any (xxx)
Net Good will to be reported in SOFP xxxx

ii. Partial/proportionate method

Amount
Description Frw
Fair value of consideration transferred xxx
Less: Fair value of net assets
Share capital xxx
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 Share premium xxx
Retained earnings (Pre-acquisition profit) xxx
Other reserves (Pre-acquisition reserves) xxx
Fair vale adjustment; eg. Plant and equipment.
(Note)1 xxx
Total net assets (B*% of control) (xxx)
Good will at acquisition (A-B) xxx
Less impairment of good will if any (xxx)
Net Good will to be reported in SOFP xxx

Note 1. Fair value adjustment

When holding company acquires investment n subsidiary, the assets of the subsidiary
should always be stated at the fair value. When this happens, there are two options to be
adopted: a. the subsidiary may opt to incorporate revaluation adjustment in the books of
accounts. Thus;

i. With an upward revaluation

Debit: Property Plant Equipment (PPE) Account
Credit: Revaluation reserve Account
ii. With a downward
revaluation

Debit: Revaluation reserve

Credit: PPE Account

The revaluation reserve is a pre-acquisition reserve because the revaluation adjustment

takes place at the date of acquisition. The balance of the revaluation reserve created should
be eliminated by transfer to the cost of control account and Non-controlling Interest (NCI)
account.
ii. Depreciation adjustments
Whenever there is a fair value adjustment, a depreciation adjustment on revaluation
must be made as from the date of acquisition up to the date of consolidation.
The depreciation adjustment affects the profits of the subsidiary and therefore those
profits must be adjusted for depreciation before the Non-controlling interest share. Thus,
those profits must be adjusted for depreciation before the Non-controlling interest share.
Thus, with the depreciation adjustment on revaluation,
If upward revaluation;
Debit: Retained earnings (understatement in depreciation)
Credit: PPE account
If on downward revaluation:
Debit: PPE account
Credit: Retained earnings (excess depreciation)

Example on fair value of considerations and goodwill computation

The consideration paid by the parent for the shares in the subsidiary can take different
forms. For example. The parent could pay cash for the subsidiary. However, the parent could
pay a combination of cash as well as shares in itself, or perhaps just shares in itself to acquire
95
the subsidiary or parent company may promise to make future payment known as deferred
consideration.
The calculation of goodwill must be based on the fair value of the consideration transferred.
For cash, this is straightforward; it is simply the amount of cash paid. But what about shares?
The fair value of shares is the market price on the date of acquisition.

Example

Gakwandi ltd has acquired all of the share capital of Maguende ltd (12,000 Frw 1,000 shares)
by issuing 5 of its own Frw 1,000 shares for every 4 shares in Maguende Ltd. The market
value of Gakwandi ltd’s shares was Frw 6,000 at the date of acquisition. The fair value of the
net assets of Maguende ltd at the date of acquisition was Frw 75 million.

Required: Compute the fair value of consideration paid by Gakwandi ltd

Answer

Answer: Fair value of consideration is

Double entry:

Dr: Investment 90 million

Cr: Share capital

Cr: Share premium

Goodwill will be computed as follows

Frw Million
Fair value of consideration transferred 90
Less net assets acquired (75)
Goodwill 15

Goodwill attributable to NCI

Total goodwill is recognized in the statement of financial position, we can calculate goodwill
attributable to the NCI and goodwill attributable to parent as follows

Example:

Gakwandi ld acquired 90% of Magwende ltd for Frw 10,000,000. At this date the fair value
of Gakwandi ltd’s net assets are Frw 8,000,000 and fair value of the NCI is Frw 1,000,000.

Calculate goodwill.

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Answer

Frw
A) Goodwill attributable to parent Frw 000
Fair value of Consideration 10,000
Less fair value of assets attributable to parent Frw 8,000*90% (7,200)
Goodwill attributable to parent (A) 2,800
B) Goodwill attributable to NCI

Fair value of NCI 1,000

Fair value of net assets attributable to NCI (10% x 8m (800)
Goodwill attributable to NCI (B) 200

Total goodwill (A+B)=2,800+200 3,000

Example for partial method of goodwill

On 1 January 2019 Bufumari ld acquired 90% of Biriho ltd for Frw 10,000,000. At this date
the fair value of Biriho ltd’s net assets are Frw 8,000,000

Required: Compute goodwill

It is clear that the fair value of non-controlling interest was not provided and there is no way
to compute it, in this case, proportionate method of goodwill is appropriate

Goodwill is computed as follows

Frw 000
Goodwill attributable to parent
Fair value of Consideration 10,000
Less fair value of assets attributable to (7,200)
parent Frw 8,000*90%
Goodwill at acquisition 2,800

Step 5 is detailed below: Group retained earnings

Description Amount/ Frw

Parent retained earnings xxx
Add: Post acquisition profit from subsidiary xxx
Add: Post acquisition profit from Associate or joint venture if any xxx
Add: Extra depreciation from Unrealized profit on assets sold between xxx
the entity
Add: Negative good will xxx
Less: unrealized profit on stock (xxx)
Less: impairment of goodwill (xxx)
Less: Extra accumulated depreciation on fair value adjustment from the (xxx)
date of acquisition
Adjust for any other information which may be given xxx
Retained earnings bal C/F xxx

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Non-controlling interest balance is computed as follows

Description Amount in
Frw
NCI balance at acquisition xxx
Add: Post acquisition profit from subsidiary ( Apply % of NCI) xxx
Add post acquisition reserves from subsidiary/ies) ( Apply % of NCI) xxx
Add: Extra depreciation from Unrealized profit on assets sold by xxx
parent to subsidiary (Apply % of NCI)
Add: Negative good will (If full good method is used) xxx
Less: unrealized profit on goods sold by Subsidiary to parent and still (xxx)
held in stock ( Apply % of NCI)
Less: impairment of good will (if full goodwill is used) ( Apply % of (xxx)
NCI)
Less: Extra depreciation on fair value adjustment from the date of (xxx)
acquisition ( Apply % of NCI)
Non-controlling interest bal C/F xxx

Step 2: Group adjustment is detailed below

Treatment of intercompany transaction

1. Unrealized profit on stock

i) When parent sold goods to subsidiary
Dr: Group retained earnings xxx
Cr: Group inventory xxx
ii) When subsidiary sold goods to parent company
Dr: Group retained earnings with Parent share xxx
Dr: NCI (non-controlling interest) with NCI xxx
Cr: Group inventory xxx

2. Unrealized profit on Assets sold between inter entity

i) When the parent company transfer the assets to subsidiary

Treatment of unrealized profit on disposal
Dr: Group retained earnings xxx
Cr: Group assets xxx

Treatment of extra depreciation

Dr: Group assets a/c xxx

Cr: Group retained earnings a/c xxx
Cr: NCI (Non-controlling interest) xxx

ii) When the subsidiary transfer the assets to the parent company

Treatment of unrealized profit on disposal

Dr: Group retained earnings (With parent share xxx)
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Dr: NCI (Non-controlling interest) with NCI share xxx
Cr: Group assets xxx

Treatment of extra depreciation

Dr: Group assets a/c xxx
Cr: Group retained earnings xxx

Intercompany debt at reporting date

The receivable and payable arised between group companies shall be eliminated in full

Dr: Payable xxx

Cr. Receivable xxx
Being elimination of intercompany debt

Example

Assume that Pleasant co own 80% shares of Sweet co. Then suppose that pleasant has
receivable of Frw 40 million and sweet has receivables of Frw 30million in their balance
sheet
Include in the receivables of pleasant is Frw 5 million owed by sweet. Remember
again that consolidation means presenting the results of two companies as if they were one.
Do we then simply add together Frw 40 million and Frw 30 million to arrive at the
figure for consolidated receivables? We cannot simply do this, because Frw 5millions of the
receivables is owed within the group. This amount is irrelevant when we consider what the
group as whole is owed.

Further suppose the pleasant has payables of Frw 50millions and sweet has payable
of Frw 45 Million. We already know that Frw 5 millions of sweet ‘payables are a balance
owed to pleasant. If we just added the figures together, we would not reflect fairly the amount
the group owes to the outside world. The outside world does not care what these companies
owe to each other-that is an internal for the group.

Cancellation of like items

 To arrive at a fair picture, we eliminate both the receivables of Frw 5million

in pleasant books and the payable of Frw 5 million in sweet books. Only then
we consolidate by adding together.
 Consolidate receivables = Frw 40 million + Frw 30 million – Frw 5 million
=Frw 65 million
 Consolidated payable =Frw 50 million + Frw 45 million –Frw5 million = frw
90 million

III.2.2. Investment in Associate Company

Investment in associate: this occurs when the investor has significant influence over the
investee

Significant Influence: this is the power to participate in the financial and operating
policies of the investee which is not control nor joint venture
Existence of significant influence is evidence in one or more of the following ways
(a) Representation on the board of directors of the investee
(b) Participation in the policy making decision
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 (c) Material transaction between investor and investee
(d) Interchange of managerial personnel
(e) Provisional of essential technical information Accounting
for the investment in Associate

The investment in associate shall be accounted for using the equity method of
accounting
The equity method of accounting: is a method of accounting whereby the investment is
initially recognized at costs and adjusted thereafter for the post acquisition change in the
investee’s share.

Description Amount in Frw

Cost of investment xxx
Add: Post acquisition profit attributable to the investor xxx
Less: unrealized profit on stock (Downstream transaction) (xxx)
Less: unrealized profit on assets sold (Downstream transaction ) (xxx)
Less: impairment of good will (xxx)
Net investment in associate xxx

Upstream' and 'downstream' transactions

Upstream transactions: occurs where subsidiary company sold goods or assets to the parent
company for example, sales of assets from an associate to the investor. 'Downstream
transaction: occurs where parent company sold goods or asset to the subsidiary company,
for example, sales of assets from the investor to an associate. Profits and losses resulting
from 'upstream' and 'downstream' transactions between an investor (including its
consolidated subsidiaries) and an associate are eliminated to the extent of the investor's
interest in the associate. This is very similar to the procedure for eliminating intra-group
transactions between a parent and a subsidiary. The important thing to remember is that only
the group's share is eliminated.
The double entry is as follows, where A% is the parent's holding 25% in the associate, and
PUP is the provision for unrealised profit.

For upstream transactions (associate sells to parent/subsidiary) where the parent

holds the inventories.
Debit: Retained earnings of parent
P UP ×25%
Credit: Group inventories PUP ×25%

For downstream transactions, (parent/subsidiary sells to associate)

where the associate holds the inventory

Debit: Retained earnings of parent

Pup x 25%
Credit: Investment in associate
PUP x 25%
.

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ILLUSTRATION

Downstream Transaction

A Co, a parent with subsidiaries, holds 25% of the equity shares in B Co. During the
year, A Co makes sales of Frw 1,000,000 to B Co at cost plus a 25% mark-up. At the
year-end, B Co has all these goods still in inventories.

Solution

A Co has made an unrealised profit of Frw 200,000 (1,000,000 × 25/125) on its sales
to the associate.
The group's share of this is 25%, ie Frw 50,000. This must be eliminated.

The double entry is:

Dr: A. Retained earning a/c Frw 50,000
Cr: Investment in associates (B) Frw 50,000

If the sale had been from the associate B to A, i.e. an upstream transaction, the double
entry would have been.
DEBIT A: Retained earnings Frw 50,000
CREDIT A: Inventories Frw 50,000
III.2.3. IAS 31-JOINTLY CONTROLLED ENTITY
Joint venture is form of business combination where the acquirer obtains joint control
of the acquire Therefore the acquirer obtains 50% shareholding in the acquiree.
Venturer; A party to a joint venture and has joint control over that joint venture.
Investor in a joint venture: A party to a joint venture and does not have joint
control over that joint venture.
The types of joint ventures are:
(i) Jointly Controlled Operations
Jointly controlled operations involve the use of assets and other resources of the
venturers rather than the establishment of a separate entity. Each venturer uses its own
assets, incurs its own expenses and liabilities, and raises its own finance
(ii) Jointly Controlled Assets
Jointly controlled assets involve the joint control, and often the joint ownership, of
assets dedicated to the joint venture. Each venturer may take a share of the output
from the assets and each bears a share of the expenses incurred.
(iii) Jointly Controlled Entities
A jointly controlled entity is a corporation, partnership, or other entity in which two or
more venturers have an interest, under a contractual arrangement that establishes joint
control over the entity. Each venturer usually contributes cash or other resources to the
jointly controlled entity.

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Accounting for interest in joint venture

Under IAS 31, there are two methods of accounting for interest in joint venture.

a) Proportionate consolidation method (the benchmark treatment)

Under this method, the assets, liabilities, equity, incomes and expenses of the joint
venture are combined with venturers assets, liabilities, equity, incomes and expenses.

Under this method, two reporting formats of presentation of consolidated financial

statement may be adopted.
Use the Line by line reporting format
Where the items of the financial statements of the venturer are combined on a line
by line basis with the share of the joint venture items of assets, liabilities, equity,
income and expenses

b) Equity method of consolidation (allowed alternative treatment)

This is the allowed alternative treatment under IAS 31 and the benchmark treatment
under IAS 38 (investment in associates). Therefore, under this method the interest in
joint venture is accounted for as if it were an investment in associate.

C. Consolidated statement of financial position

Frw
Non-current assets
Property, plant and equipment X+Y
Good will obtained in acquisition of Y W1
Other investment like trade investment X+Y
Current assets
Inventories X+Y-UP
Account receivable X+Y-Intercompany debt
Cash X+Y
Other current assets X+Y
Total assets
Equity & liabilities
Share capital X
Share premium X
Retained earning X+Y
Shareholders worth
Non-controlling interest W2
Non-current liabilities
Loan X+Y
Finance lease X+Y
Current liabilities
Trade payables X+Y-intercompany debt
Unpaid tax X+Y
Equity & liabilities

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Example
Example: You are provided with the following statement of financial position for
MUHONGOZI and Rwunguko ltd statement of financial position as at 31 st October
2010

MUHONGOZI Ltd Rwunguko ltd

Frw 000 Frw 000
Non-current assets
Plant 325 70
Fixtures 200 50
Investment (shares in Rwunguko at cost) 200 -

Current assets
Inventory at cost 220 70
Receivables 145 105
Bank 100 0
Total assets 1,190 295
Equity
Frw 1 ordinary share 700 170
retained earnings 215 50
Current liabilities
Payables 275 55
Bank overdraft 0 20
Total equity and liabilities 1,190 295

The following information is also available

i. MUHONGOZI purchased 70% of the issued ordinary share capital of
RWUNGUKO four years ago, when the retained earnings of RWUNGUKO
were Frw 20,000.
ii. For the purpose of the acquisition, plant and equipment in RWUNGUKO with a
book value of Frw 50,000 was revalued to its fair value of Frw 60,000. The
revaluation was not recorded in the accounts of RWUNGUKO, depreciation is
charged at 20% using straight line method.
iii. MUHONGOZI sold goods to RWUNGUKO at mark-up of 25%. At 31st
October 2010 the inventory of RWUNGUKO included frw45,000 of goods
purchased from MUHONGOZI
iv. RWUNGUKO owes MUHONGOZI Frw 35,000 for goods purchased and
MUHONGOZI owes RWUNGUKO Frw 15,000
v. It is the group policy to value non-controlling interest at fair value and the market
price of the shares of non-controlling shareholders just before the acquisition was
Frw 1.5.
vi. The good will arising at acquisition was impaired by 20 %

Required

Prepare consolidated statement of financial position as at 31st October 2010

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Answer

Frw 000

Non-current assets
Plant 325+70+10-8 397
Fixtures 200+50 250
Investment (shares in Rwunguko at 200-200 0
cost)
Goodwill W1 61.2
Current assets
Inventory at cost 220+70-9 281
Receivables 145+105-35-15 200
Bank 100
Total assets 1,289.2
Equity
Frw 1 ordinary share 700
retained earnings W2 209.4
Non-controlling interest W3 79.8
Current liabilities
Payables 275+55-35-15 280
Bank overdraft 0+20 20
Total equity and liabilities 1,289.2
Goodwill
Frw Frw
Fair value of consideration transferred 200
Net assets
Share capital 170
Retained earnings 20
Fair value adjustment 60-50 10
(200*70%) (140)
Goodwill at acquisition attributable to 60
parent
Impairment 20%*60 (12)
Goodwill balance Attributable to parent A 48
Goodwill attributable to NCI
Fair value of Non-controlling interest 76.5

Net assets attributable to NCI 200*30% (60)

Goodwill at acquisition 16.5
Impairment 20%*16.5 (3.3)
Goodwill balance B 13.2
Total goodwill A+B 61.2

Group retained earnings

Frw 000
Parent retained earnings 215
Post-acquisition profit from subsidiary (50-20)*70% 21
104
Less impairment (12)
Depreciation on fair value adjustment 10*20%*4years*70% (5.6)
Unrealized profit on stock 45*25/125 (9)
209.4

Non-controlling interest as at 31 Oct 2010

Frw 000
NCI at acquisition 76.5
Post-acquisition profit (50-20)*30% 9
Less depreciation on fair value adjustment 10*20%*4years*30% (2.4)
Impairment (refer to goodwill (3.3)
NCI balance c/d 79.8

Depreciation on fair value adjustment =10*20%*4=8

Dr. Group retained earnings 8*70% 5.6
Dr. NCI 8*30%
Cr. Assets 8

Unrealized profit on stock =45*25/125=9

Dr. Group retained earning Frw 9
Cr. Inventory Frw 9

D. Consolidated income statement

The results and the operations of the associate are not included in the group consolidated
income statement. It is only group share of the associate profit before taxation and group
share of associate tax that are accounted for.

Example:

X Company ltd acquired 60% of Y company ltd

The following is a suggested layout (for an income statement for a company having
subsidiaries as well as associates.
Consolidated income statement for the year ended 30th June TTT

Sales revenue X+Y (A)

Cost of sales X+Y (B)
Gross profit C=A-B
Distribution costs X+Y (D)
Administrative expenses X+Y (E)
Interest payable and similar charges X+Y (F)
Profit before taxation G=C-D-E-F
Taxation X+Y (H)
Profit after tax I=G-H
Share of profit after tax from associates PAT of associates* % acquired (J)
Total profit for the year K=I+J
Profit attributable to
Non-controlling interest R
Parent K-R

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Example
Bagwize ltd acquired 75% of the ordinary shares of Mugwize ltd on that company’s
incorporation in 2013.The summarized statements of profits or loss of the two
companies for the year ending 31 December 2016
Bagwize ltd Mugwize Ltd
Frw 000 Frw 000
Revenue 75,000 38,000
Cost of sales 30,000 20,000
Gross profit 45,000 18,000
Administrative expenses 14,000 8,000
Profit before taxation 31,000 10,000
Income taxes 10,000 2,000
Frofit for the year 21,000 8,000
Movement on retained earnings
Retained earnings brought 87,000 17,000
forward
Profit for the year 21,000 8,000
Retained earnings bal c/d 108,000 25,000

Additional information

Mugwize ltd sold goods worth Frw 5 million at a gross margin of 40% to Bagwize ltd. 50%
of these goods remained in Bagwize Ltd’s inventories at 31 December 2016

Required

Prepare consolidated statement of profit or loss and movement on retained earnings for the
group

Answer

Frw 000
Revenue 75,000 + 38,000-5,000 108,000
Cost of sales 30,000+20,000-5,000+1,000 46,000
Gross profit 62,000
Administrative expenses 14,000+8,000 22,000
Profit before taxation 40,000
Income taxes 10,000+2,000 12,000
Profit for the year 28,000
Profit attributable to:
Parent 26,250
Non-controlling interest 1,750 (W1)

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 Movement on retained earnings
Profit for the year 26,250
Retained earnings bal b/d 87,000 + 17,000*75% 99,750
Bal c/d 126,000

W1: Non-controlling interest for the year

Frw 000
Profit after tax 8,000*25% 2,000
Unrealized profit on stock 1,000*25% (250)
1,750

W2: Provision for unrealized profit: 5 Million x 40%x50% = 1,000

Note: Acquisitions of subsidiary during the year

If subsidiary is acquired during the year, only the post-acquisition element of statement of the
profit or loss balances is included on consolidation

Example

Baguize ltd acquires 60% of the equity of Mugwize ltd on 1 April 2015. The statement of
profit or loss of the two companies for year ended 31 December 2015 are set out below

Baguize ltd Mugwize ltd

Frw 000 Frw 000
Revenue 170,000 80,000
Cost of sales 65,000 36,000
Gross profit 105,000 44,000
Administrative expenses 43,000 12,000
Profit before tax 62,000 32,000
Incomes taxes 23,000 8,000
Profit for the year 39,000 24,000
Retained earnings brought 81,000 40,000
forward
Retained earnings carried 108,000 58,000
forward

Additional information
During the year Baguize Ltd sold goods which had cost Frw 10 million to Mugwize Ltd for
Frw 14 million. At the end of the year, only a quarter of these goods has been sold by
Mugwize Ltd.

Required: Prepare the consolidated statement of profit or loss and movements on retained
earnings

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Answer

Baguize ltd
Frw 000
Revenue 170,000+80,000*9/12-14,000 216,000
Cost of sales 65,000+36,000*9/12-14,000+3,000 (81,000)
Gross profit 135,000
Administrative expenses 43,000+12,000*9/12 52,000
Profit before tax 83,000
Incomes taxes 23,000+8,000*9/12 29,000
Profit for the year 54,000
Non–controlling interest 7,200
Parent 46,800
Retained earnings brought forward 81,000
Retained earnings carried forward 127,800

Working 1
Non-controlling interest
Frw
Profit after tax
7,200

Unrealized profit: =3,000

E. Consolidated cash flow

Statement of cash flow: Is a statement which summarize the cash and cash equivalent
generated by an entity (cash inflow) and cash outflow spent by that entity for a specific
period.

Key terms
 Cash comprises cash on hand and demand deposits. Bank overdrafts, because
they can be repayable on demand, are often included as a component of cash.
 Cash equivalents are short term, highly liquid investments that are readily
convertible to known amounts of cash and which are subject to an
insignificant risk of changes in value.
 They are held to meet short-term cash commitments rather than for
investments and usually have a maturity of three months or les
 Cash flows are inflows and out flows of cash and cash equivalents

Cash and cash equivalent presented in statement of cash flow are classified into:
 Operating Activities
 Investing Activities
 Financing Activities

Operating activities

Operating activities: are the main revenue producing activities of the entity. The cash flow
from operating activities is a key indicator of the extent to which the operations of the entity
has generated cash to:
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  Repay loans
 Maintain the operating capability
 Pay dividends
 Make new investments

Examples of Cash Flows from Operating Activities

 Cash receipts from sale of goods and the rendering of services

 Cash payments to suppliers
 Cash payments to employees
 Cash payments/refunds of income tax
 Cash receipts from royalties, fees, commissions and other revenue

Investment activities

Investment activities refer to the acquisition and disposals of long-term assets and other
investments

Examples of Cash Flows from Investing Activities

 Cash payments to acquire property, plant and equipment and intangibles

 Cash receipts from sales of property, plant and equipment and intangibles
 Cash payments to acquire an investment in shares or loans in other entities
 Cash receipts from sale of investments
 Cash advances and loans made to other parties (non-financial institutions)
 Cash receipts from the repayment of advances and loans made to other parties
(again nonfinancial institutions)

Financing activities

Financing activities are activities that are result in changes in the size and composition of the
contributed equity capital and borrowing of entity
Examples of Cash Flows from Financing Activities
 Cash proceeds from issuing shares
 Cash payments to owners to buy back shares
 Cash proceeds from issuing debentures, loans, notes, bonds,
mortgages, etc. (d) Cash repayments of amounts borrowed
 Cash payment reducing the liability relating to a finance lease

PRESENTATION OF STATEMENT OF CASH FLOW

The statement of cash flow can be reported by using either:

 Direct method: disclose major classes of gross cash receipt and gross cash
payment
 Indirect method: Net profit or loss is adjusted for the effect of transaction of
non-cash nature, any deferral or accrual of past or future operating cash receipt
or payment, and item of income or expense associated with investing or
financing cash flows.
DIRECT METHOD

 The direct method discloses information not available elsewhere in the

financial statement which could be of use estimating future cash flow.

109
 However, the indirect method is simpler, more widely used and more likely to
examined.
 There are different ways in which the information about gross cash receipts
and payment can be obtained. The most obvious way is simply to extract the
information from the accounting records.
 A proforma for the directing method is given below.

Frw 000 Frw 000

Cash flow from operating activities
Cash receipts from customers xxx
Cash paid to suppliers and employees (xxx)
Cash generated from operation xxx
Interest paid (xxx)
Income tax paid (xxx)
Net cash from operating activities xxx

Using the indirect method

This method is undoubtedly easier from the point of view of the preparer of the statement of
the cash flow.

The net profit or loss for the period is adjusted for the following.
 Changes during the period in inventory, operating receivables and payable
 Non-cash items, eg depreciation, provision, profit/losses on the sales of assets
 Other items, the cash flows from which should be classified under investing or
financing activities

A format of indirect method, this method may be more common in the exam

Frw
Profit before tax (statement of profit or loss ) xxx
Add depreciation xxx
Add impairment and amortization xxx
Interest expenses xxx
Loss(gain) on sale of non-current assets xxx/(xxx)
Less investment income (xxx)
Less share of profit from associate (xxx)
Working capital change
(Increase)/ decrease in inventories (xxx)/xxx
(Increase)/ decrease in receivables (xxx)/xxx
Increase/ (decrease) in payable xxx/(xxx)
Cash generated from operations xxx
Interest paid (xxx)
Income taxes paid (xxx)
Net cash flows from operating activities xxx
Investment activities
Cash paid to acquire non-current assets (xxx)
Cash paid to acquire investment in subsidiary (xxx)
Dividend received from Associate company Xxx

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 Investment income Xxx
Cash paid to acquire of intangible asset
Cash flow from investment activities
Financing activities
Cash from new shares issued Xxx
Dividend paid to owners (xxx)
Dividend paid to non-controlling interest (xxx)
Finance lease paid (Xxx)
Loan paid or received (xxx)/xxx
Cash flow from financing activities (xxx)/xxx
Cash and cash equivalent for the period (xxx)/xxx
Cash and cash equivalent at the beginning xxx/(xxx)
Cash and cash equivalent at the end Xxx/(xxx)

Workings: below are some of the working that can help you to work on statement of
cash flow

Property, plant and equipment

Frw Frw
Bal b/d (NBV) xxx Disposal xxx
Leased assets xxx Depreciation for year xxx
Revaluation surplus xxx
Assets from new subsidiary xxx
Additional assets acquired Balancing figure xxx Bal c/d (NBV) xxx
xxx xxx

Note: Depreciation should not be included in credit side of PPE is the opening and closing
balance are at costs
You may be given that the entity disposed asset but you are not given its NBV/cost in that
case the balance may appear in credit side and will represent net book value of asset disposed

If you are not given depreciation for the year, you may use accumulated depreciation account

Accumulated depreciation account

Frw Frw
Depreciation on disposed assets xxx Bal b/d xxx
Depreciation on assets from subsidiary xxx
Depreciation for the yea (Balancing xxx
figure)
Bal c/d xxx xxx
xxx

Intangible assets
Frw Amortization and impairment xxx
Bal b/d xxx
Good will from new subsidiary xxx
Bal c/d xxx

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In this account you may get balancing figure in debit side, if so the balance will be new
intangible assets acquired. If balancing figure is in credit side, it represent impairment and
amortization

Tax liability account

Frw Frw
Tax paid (balancing figure) xxx Current tax bal b/d xxx
Deferred tax bal b/d xxx
Deferred tax bal c/d xxx Tax from subsidiary acquired xxx
Current tax bal c/d xxx Income tax as per P/L xxx
xxx xxx

Investment in associates
Frw Frw
Bal b/d xxx Dividend received (balance) xxx
Profit share from associate as per P/L xxx Bal c/d xxx
xxx xxx
Equity account
Frw Frw
Share capital bal b/d xxx
Share premium bal b/d xxx
Share capital bal c/d xxx Share exchange to acquire subsidiary xxx
Share premium bal c/d xxx Bonus share xxx
Shares issued on cash (Bal) xxx
xxx xxx
Retained earnings account
Frw Frw
Dividend paid to owners xxx Bal b/d xxx
Profit for the year attributable to parent xxx
Transfer to reserves xxx Reclassified reserves xxx
Bal c/d xxx
xxx xxx

Non-controlling interest account

Dividend paid to NCI Frw Frw
Bal b/d xxx
NCI from new subsidiary acquired xxx
Profit as per P/L attributable to NCI xxx
Bal c/d xxx
xxx xxx

Lease account
Frw Frw
Lease paid (Balancing figure) Bal b/d as per NCL xxx
Bal b/d as per CL xxx
Leased assets xxx
Bal c/d xxx Leased assets transferred from new subs xxx
xxx xxx

112
CHAPTER VII: ANALYSIS OF FINANCIAL STATEMENT/ RATIO ANALYSIS

Ratio analysis is one of the most powerful tools to gauge the performance of the company.
Ratios are mathematical indicators and are calculated by dividing one variable by another,
such as sales divided by number of stores or sales divided by operating profit. Ratio analysis
is helpful when predicting future business performance. Ratios are most relevant when they
are analysed in conjunction with similar companies or previous periods.
Purpose of Analysis
The primary object of analysis of accounts is to provide information. Analysis which does not
serve this purpose is useless
The type of information to be provided depends on the nature and circumstances of the
business and the terms of reference. By the latter we mean the specific instructions given by
the person wanting the enquiry to the person making it. Of course, if the person making the
enquiry is also the person who will make use of the information thus obtained, he will be
aware of the particular points for which he is looking

INTERESTED PARTIES

Debenture Holders

These are interested in both the long- and short-term position of the company. In the long
term they are interested in the company’s ability to repay the sums lent by them

Trade Payables

A trade creditor will rely on trade references or personal knowledge when forming an
opinion on the advisability of granting or extending credit to a company

In particular, he will note the following:

 Working capital position or ability of company to pay debts when they fall due.
 Ease with which current assets can be converted into cash.
 Prior claims to company’s assets in the event of a liquidation, i.e. secured loans or
overdrafts.
 Earnings record and expansion programme.

Bankers

Before making a loan or granting an overdraft, the bank would consider:

 The nature and purpose of the loan.

 The duration of the loan (bankers prefer the short- or medium-term loan to those
for longer periods).
 The arrangements for repayment.
 The prospects of repayment.
 Security and prior rights to the assets of the company on liquidation.
 Financial policies of the company, and calibre of management.

Shareholders

The average shareholder is interested in the future dividends he will receive. Future profits
are of secondary importance, so long as they are adequate to provide the dividend

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Financial ratios can be divided into five categories
 Profitability and return
 Long-term solvency and stability
 Short-term solvency and stability
 Efficiency (turnover ratios)
 Shareholders’ investment ratios
 Shareholders’ investment ratios

Example:

To illustrate the calculation of ratios, the following statements of financial position and
statement of profit or loss figures will be used.

KANEZA LTD STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED

31 DECEMBER 2018

Notes 2018 2017

Frw 000 Frw 000
Revenue 1 3,095,576 1,909,051
Operating profit 1 359,501 244,229
Interest 2 17,371 19,127
Profit before tax 342,130 225,102
Income tax 74,200 31,272
Profit for the year 267,930 193,830

KANEZA STATEMENT OF FIANANCIAL POSITION AS AT 31 DECEMBER 2018

N 2018 2017
o
te
s
Frw 000 Frw 000 Frw 000 Frw 000
Assets
Non-current assets
Tangible non-current 802,180 656,071
assets
Current assets
Inventories 64,422 86,550
Receivables 3 1,002,701 853,441
Cash at bank and 1,327 68,363
in hand
1,068,450 1,008,354
Total assets 1,870,630 1,664,425
Equity and
liabilities
Ordinary shares 5 210,000 210,000
Frw 10 each
Share premium 48,178 48,178
account
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Retained earnings 630,721 393,791
888,899 651,969
Non-current
liabilities
10% loan notes 100,000 100,000
2014/2019
Current liabilities 4 881,731 912,456
Total equity and 1,870,630 1,664,425
liabilities

Notes to the financial statements

1. Sales revenue and profit

2018 2017
Frw 000 Frw 000
Sales revenue 3,095,576 1,909,051
Cost of sales 2,402,609 1,441,950
Gross profit 692,967 467,101
Administrative expense 333,466 222,872
Operating profit 359,501 244,229
Depreciation charged 151,107 120,147
1. Interest
2018 2017
Frw 000 Frw 000
Payable on bank overdraft and loans 8,115 11,909
Payable on loans 10,000 10,000
18,115 21,909
Receivable on short-term deposits 744 2,782
Net payable 17,371 19,127

Receivables

2018 2017
Frw 000 Frw 000
Amount falling due within one year
Trade receivables 884,559 760,252
Payments and accrued income 97,022 45,729
981,581 805,981
Amount falling due after more than
one year
Trade receivables 21,120 47,460
Total receivables 1,002,701 853,441

Current liabilities

2018 2017
Frw 000 Frw 000
Trade payables 627,018 545,340
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 Accruals and deferred 81,279 280,464
income
Income taxes 108,000 37,200
Other taxes 65,434 49,452
881,731 912,456

PBIT, profit before interest and tax. This is the amount of profit which the company
earned before having to pay profit to the providers of loan capital
PBIT is therefore:

 The profit before taxation plus

 Interest charges on long term loan

Published account do not always give sufficient detail on interest payable to determine
how much interest on long-term finance. We will assume in our example that the whole
of the interest payable (RWF18, 115,000 note 2) relate to long-term finance.

Profitability ratios

Gross profit margin: Gross profit margin calculates the ratio of gross profit to sales.
Gross profit refers to the margin that company charges above cost of goods sold.
Formula

Net profit margin

Net profit margin ratio evaluates the company’s ability to generate earnings after taxes
Formula

Asset turnover

Asset turnover is a measure of how well the assets of a business are being used to
generate sales. For examples, if two companies each have capital employed of Frw 100
million and company A makes sale of Frw 400 million per annum whereas company B
makes sales of only Frw 200 million per annum, company A is making a higher revenue
from the same amount of assets (twice as much asset turnover as company B) and this
will help A to make a higher return on capital employed than B.

Formula:

FORMULA TO LEARN

Profit margin x assets turnover =ROCE

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 Based on the example above,

Profit margin Asset turnover ROCE

201
8
201
7

In this example, the company’s improvement in ROCE between 2017 and 2018 is
attributable to a higher assets turnover. Indeed, the profit margin has fallen a little but the
higher assets turnover has more than compensated for this.

It is also worth commenting on the change in sales revenues from one year to the next.
You may already have noticed that KANEZA achieved sales growth of over 60% from
Frw 1,900 million to Frw 3,100 million between 2017 and 2018 this is very strong growth
and this is certainly one of the most significant items in the statement of financial
position.

Return on capital employed (ROCE)

ROCE=

Capital employed = shareholders’ equity plus long-term liabilities (or total assets less
current liabilities)

Referring to our example

2018 2017
In our 1,870,630- 1,664,425-
example, 881,731=988,899,000 912,456=751,969,000
Capital
employed

These total figures are total assets less current liabilities figures for 2018 and 2017 in the
statement of financial position. Therefore,

2018 2017
ROC
E

The higher the ratio, more favourable it is for the company

What does a company’s ROCE tell us? What should we be looking for? There are three
comparisons that can be made.

 The change in ROCE from one year to the next can be examined. In this
example, there has been an increase in ROCE by about 4% from its 2017
level.
 The ROCE being earned by other companies, if this information is available,
can be compared with the ROCE of this company. Here the information is not
available.
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  A comparison of the ROCE with current market borrowing rates may be
made.
 What would be the cost of extra borrowing to the company if it needed more loans, and is
it earning a ROCE which suggests it could make profits to make such borrowing
worthwhile?
 Is the company making a ROCE which suggests that it is getting value for money from
its current borrowing?
 Companies are in a risk business and commercial borrowing rates are a good independent
benchmark against which company performance can be judged.
In this examples, if we suppose that current market interest rates says, for medium-term
borrowing from banks, is around 10%, then company’s accrual ROCE of 36% in 2018
would not seen low. On the contrary, it might seen high

Return on Equity

Referring to our example, the ROE is calculated as follows

2018 2017
ROE
29.7%

The higher the ratio, more favorable it is for the company.

Liquidity, gearing /leverage and working

Liquidity and working capital ratios include

 Current ratio
 Quick ratio
 Receivable collection period
 Payables payment period
 Inventory turnover
 Debt and gearing /leverage ratio include
 Debt ratio
 Gearing ratio/leverage
 Interest cover
Long term solvency: debt and gearing ratios
Long term solvency ratios is of important because
 When a company is heavily in debt, banks and other potential lenders may be
unwilling to advance further funds.
 When a company is earning only a modest profit before interest and tax and
has a heavy debt burden, there will be very little profit left over for
shareholders after the interest charge have been paid. And so if interest rates
were to up (on bank overdrafts and so on) or the company were to borrow
even more, it might soon be incurring interest charges in excess of PBIT. This
might eventually lead to the liquidation of the company.

Three important ratios to look at while analyzing the solvency ratios of a company:
 The debt ratio,
 Gearing ratio and
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  Interest cover

Debt ratio

The debt ratio is the ratio of a company’s total debts to its assets.

 Assets consist of non-current assets at their statement of financial position

value, plus current assets.
 Debts consist of all payables, whether they are due within one year or after
more than one year. you can ignore long-term provision
 There is no absolute guide to the maximum safe debt ratio but, as very general
guide, you might regard 50% as a safe limit to debt. In practice, may
companies operate successfully with a higher debt ratio than this, but 50% is
nonetheless a helpful benchmark. In addition, if the debt ratio is over 50% and
getting worse, the company’s debt position will be worth looking at more
carefully. Referring to our example, Debt ratio is computed as follow

2018 2017

How do we interpret the result above,?

 In this case, the debt ratio is quit mainly high, mainly because of the large
amount of current liabilities. However the debt ratio has fallen from 61% to
52% between 2017and 20188, and so the company appears to be improving its
debt position.

Gearing /leverage

Gearing and leverage is concerned with a company‘s long term capital structure we can
think of a company as consisting of non-current assets and net current assets (ie working
capital ,which is current assets minus current liabilities). These assets must be financed by
long-term capital of the company, which is either
1. Shareholder’s equity
2. Long term debt

The gearing ratio can be calculated as follow.

Like as for the debt ratio there is no absolute limit to what a gearing ratio ought to be. A
company with a gearing ratio of more than 50% is said to be highly geared, whereas low
gearing means a gearing ratio of less than 50 %.

Many companies are highly geared but if a highly geared company raises its level of
gearing even more, it is likely to have problems borrowing in the future.
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 However, it could lower its gearing by boosting its shareholder’ capital, either with
retained profits or by a new share issues.
Leverage is the term used to describe the converse of gearing ie the proportion of total
assets financed by equity and which may be called the equity to assets ratio. It is
calculated as follows,

Or

In the example of KANEZA, we find that the company, although having high debt ratio
because of its current liabilities, has a low gearing ratio. Leverage is therefore high.

2017 2018

Gearing 10% 10%

ration

Leverage

Interest cover

The interest cover ratio shows a company is earning enough PBIT to pay its interest costs
comfortably or whether its interest cost are high in relation to the size of its profits , so
that a fall in PBIT would then have a significant effect on profits available for ordinary
shareholders

Interest coverage=

An interest cover of two times or less would be low, and it should really exceed three
times before the company’s interest cost are to be considered within acceptable limits.
Consider the three companies below.

Company A Company B Company C

Frw Million Frw Million Frw Million
PBIT 40 40 40
Interest 10 25 30
PBT 30 15 10
Taxation 9 5 3
Profit after tax 21 10 7

Interest cover

Co A Co B Co B
PBIT/Interest
charge =1.6 times =1.33 times

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Both B and C have a low interest cover, which is a warning to ordinary shareholders that
their profits are highly vulnerable, in percentage terms, to even small changes in PBIT

The liquidity ratio and working capital turnover ratios are used to test Company’s
liquidity, length of cash cycle and investment in working capital.

Liquidity ratios: Current ratio and quick ratio

The standard test of liquidity is the current ratio; it can be obtained from the statement of
financial position

Current ratio

The ideas behind this is that a company should have enough current assets that give a
promise of ‘cash to come’ to meet its future commitment to pay off its current liabilities.
A current ratio in excess of 1 should be expected. Otherwise, there would be the prospect
that the company might be unable to pay its debt on time.

The quick ratio, or acid test ratio, is calculated

QUCK RATIO: =

The quick should ideally be at least 1 for companies with a slow inventory turnover. For
companies with a fast inventory turnover, a quick ratio can be comfortably less than 1
without suggesting that the company should be in cash flow trouble.
It often theorized that an acceptable current ratio is 1.5 and acceptable quick ratio is 0.8,
but these should only be used as a guide. Different business operates in very different
way.

Efficiency ratio: control of receivables and inventories

Receivables collection period: Measure the average length of time it takes for company
collect cash from debtors.

The estimated average receivables collection period is calculated as:

Note: The revenue figure from the statement of profit or loss is often used instead of
credit sales.

Inventory turnover period

This ratio: Indicates the average number of days that items of inventory are held for
The inventory period is calculated as

Inventory period

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Generally, the higher inventory turnover is better, but several aspects of inventory-
holding policy have to be balanced
 Lead time
 Seasonal fluctuations in orders
 Alternative uses of warehouse space
 Bulk buying discount
Payables payment period
Account payables payment is ideally calculated by the formula:

It is rare to find purchases disclosed in published accounts and so a cost sale serves as an
approximation. The payment period often helps to assess a company’s liquidity. An
increase is often a sign lack of long-term finance or poor management of current assets,
resulting in the use of extended credit from suppliers, increased bank overdraft and so on

Investment ratios

Investment ratios: Are ratios used by investors to assess the merits of their particular
investments

Dividend Yield

This is the actual dividend payable for a year, including both interim and final, expressed
as a percentage of the quoted share price. It is calculated as:

The dividend yield is a measure of the income return on an investment, and ignores
retained profits. Normally, the higher the dividend yield on ordinary shares, the greater
the risk, though this is not always true. Preference shares tend to have a higher dividend
yield than ordinary shares, mainly to offset the fact that there is little scope for capital
appreciation.

Dividend

This ratio represents the extent to which the distributable profits compare with the
dividend payable. Distributable profits represent the profits after corporation tax and any
other appropriations have been deducted. It is calculated in the following way

When computing Dividend cover for ordinary shareholder’s Distributable profit is

computed as follows

Profit after tax xxx

Less Preference dividend xxx
Available for ordinary xxx

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 Earning Yield

This is the profits available for distribution to the ordinary shareholders, expressed as a
percentage of the quoted market value of the ordinary share capital. It is computed as
follows:

The earnings yield gives the true rate of return on an investment, assuming that all the profits
available for distribution are paid out as dividends. In the majority of cases a proportion of
the profits is retained, and it is the dividend yield that enables an investor to determine his
income

Price Earnings Ratio (or P/E Ratio) This is the number of times the earnings per ordinary
share will divide into the quoted price for the share. The formula is:

LIMITATIONS OF RATIO ANALYSIS

It must be emphasized that accounting ratios are only a means to an end, and not an end in
themselves. By comparing the relationship between figures, only trends or significant
features are highlighted. The real art in interpreting accounts lies in defining the reason for
the features and fluctuations. In order to do this effectively, the interested party may need
further information and a deeper insight into the business’s affairs. The following points
should also be borne in mind:

 The date to which the accounts are drawn up. Accurate information can only be
obtained from up-to-date figures. Seasonal trends should not be forgotten, as at the
end of the peak season the business presents the best picture of its affairs.
 The position as shown by the Statement of Financial Position. The arrangement of
certain matters can be misleading and present a more favourable position, i.e. making
the effort to collect debts just before the year-end in order to show more cash and
lower receivables than is usual; ordering goods to be delivered just after the year-end
so that stocks and payables can be kept as low as possible.
 Management interim accounts should be examined wherever possible to obtain a
clearer idea of trends.
 Comparison with similar businesses should also be made

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CHAP VIII: EFFECT OF CHANGE IN FOREIGN EXCHANGE
The purpose of IAS 21The Effects of Changes in Foreign Exchange Rates is to outline the
following issues:
 The definition of functional and presentation currencies
 Accounting for an entities individual transactions in a foreign
currency
 Translation of the financial statements of a foreign subsidiary

UNCTIONAL AND PRESENTATION CURRENCIES

The functional currency is the currency of the primary economic environment where the
entity operates. In most cases, the functional currency is the currency of the country in which
the entity is situated and in which it carries out most of its transactions. In essence, it is the
currency an entity uses in its day-to-day transactions.

IAS 21 states that the following factors should be considered when determining the
functional currency of an entity:

 The currency that mainly influences sales prices for goods and services (i.e. the
currency in which prices are denominated and settled)
 The currency of the country whose competitive forces and regulations mainly
determine the sales price of goods and service
 The currency that mainly influences labour, material and other costs of providing
goods and services
 The currency in which funding from issuing debt and equity is generated
 The currency in which receipts from operating activities are usually retained
The first three points are seen as the primary factors in determining an entities functional
currency.

Furthermore, if an entity is a foreign operation (i.e. a subsidiary, associate, joint venture or

branch whose activities are based in a country or currency other than those of the reporting
entity), the following factors must also be considered:

 Whether the activities of the foreign operation are carried out as an extension of the
parent, rather than with a significant measure of autonomy/independence.
 Whether transactions with the parent are a high or low proportion of the foreign
operations activities
 Whether cash flows from the foreign operation directly affect the cash flows of the
parent and are readily available for remittance to it
 Whether cash flows from the activities of the foreign operation are sufficient to
service existing debt obligations without funds being made available by the parent

ACCOUNTING FOR INDIVIDUAL TRANSACTIONS

When an entity enters into a contract where the consideration is denominated in a foreign
currency, it will be necessary to translate that foreign currency into the entity’s functional
currency for inclusion in its accounts.

Examples of such foreign transactions include:

 Importing of raw materials

 Importing non-current assets
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When translating the foreign currency transaction, the exchange rate used should be either:
 The spot exchange rate on the date the transaction occurred (the spot rate is the
exchange rate for immediate delivery); or
 For practical reasons, an average rate over a period of time, providing the exchange
rate has not fluctuated significantly
When cash settlement occurs, the settled amount should be translated using the spot rate on
the settlement date. If the exchange rate has altered between the transaction date and the
settlement date, there will be an exchange difference.

These exchange differences must be recognised as part of the profit or loss for the period in
which they arise.

Translation rule

The treatment of any foreign items remaining in the statement of financial position will
depend on whether they are classified as monetary of non-monetary items. Monetary Items
are defined as money /cash and assets and liabilities to be received or paid in fixed or
determinable amounts. Examples include cash, receivables, payables, loans, deferred tax,
pensions and provisions.

The main characteristic of non-monetary items is the absence of a right to receive a fixed or
determinable amount of money. They represent other items in the statement of financial
position that are not monetary items and include things like property plant and equipment,
inventory, investments, prepayments, goodwill, intangibles and inventory.

The rule for the treatment of these foreign items at the reporting date is as follows:

Monetary items: Re-translate using the closing rate of exchange (i.e. the spot exchange rate
at the reporting date)

Non-monetary items: Do not re-translate Non-monetary items measured at cost less

depreciation are translated and recorded at the exchange rate at the date of their acquisition
Items measured at fair value less depreciation should be translated and recorded at the
exchange rate at the date of revaluation

Exchange differences arising on the re-translation of monetary items at the reporting date
must be recognised as part of the profit or loss for the period in which they arise.

Similarly, exchange differences arising on the subsequent settlement of these monetary items
after the reporting date should be recognised as part of the profit or loss for the period in
which they arise.

Example

Pot Ltd. purchases specialised machinery for use in its production process from a foreign
supplier on 18th September. The machine cost US $300,000 and was paid for in full one
month later. The year end is 31st December. The relevant exchange rates are:

18th September RWF1 = US$4.0

5th December RWF1 = US$4.8

At the date of the transaction

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Answer

US $300,000/4=Frw 75,000

Dr: PPE Frw 75,000

Cr: Payable Frw 75,000

At the date of settlement

US $300,000/4.8=Frw 62,500

Dr: Payables Frw 75,000

Cr: Gain Frw 12,500
Cr: Cash Frw 62,500

TRANSLATING THE FINANCIAL STATEMENTS OF FOREIGN OPERATION

Where a subsidiary entity’s functional currency differs from the presentation currency of its
parent, its financial statements must be translated into the parent’s presentation currency prior
to consolidation.

There are a number of different methods that can be used to deal with the translation of a
foreign subsidiary. The method below outlines one such approach.

The following exchange rates should be used in the translation:

Income Statement / Statement of Comprehensive Income:

Income: average rate for the year

Expenses: average rate for the year

Note that the average rate for the year is used for expediency. Ideally, each item of income
and expenditure should be translated at the rate in existence for each transaction. But if there
has been no significant variance over the period, the average rate can be used.
Statement of Financial Position:

Assets & Liabilities: closing rate (i.e. the rate at the reporting date)
Share Capital: historic rate (i.e. the rate at the date of acquisition)
Pre-Acquisition reserves: historic rate
Post –Acquisition reserves: Balancing figure

Exchange differences arise because items are translated at different points in time at different
rates of exchange, for example, the profit or loss for the year forms part of the entity’s overall
retained earnings in the Statement of Financial Position. But, the profit or loss for the year is
arrived at by using the average rate, whereas the reserves figure as a whole in the Statement
of Financial Position does not use the average rate at all.

The calculation of the exchange difference can be calculated as follows:

Opening net assets at this year’s closing rate xxx

Opening net assets at last year’s closing rate (xxx)
Profit for year at closing rate xxx
Profit for year at average rate (xxx)
Total exchange gain/loss Xxx/(xxx)

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Translation of Good will when subsidiary’s functional currency is not the same as
Presentation currency of the reporting entity

Example

On 1st June 2010, Home Limited acquired 80% of Faraway Inc., whose functional currency
is the US $. The financial statements at 31st May 2011 are as follows:

Statement of comprehensive Income

Home Foraway
Frw US$
Revenue 25,000 35,000
Operating costs (15,000) (26,250)
Profit before tax 10,000 8,750
Tax 8,000 (7,450)
Profit for the year 2,000 1,300

Statement of financial position

Home Foraway
Frw Frw
Investment in Foraway 5,000
Non-current assets 10,000 3,000
Current assets 5,000 2,000
20,000 5,000
Share capital 6,000 1,500
Retained earning 4,000 2,500
Liabilities 10,000 1,000

Neither entity recognised any components of other comprehensive income in their individual
accounts in the period.

The following information is applicable:

1. At the date of acquisition, the fair value of the net assets of Faraway were US$6,000.
The increase in the fair value is attributable to land that remains carried by Faraway at
its historical cost.
2. Goodwill is translated at the closing rate.
3. During the year, Home sold goods on cash terms for RWF1,000 to Faraway.
4. On the 1st May 2011, Home lent Faraway RWF400. The liability is measured by
Faraway at the historic rate
5. The non-controlling interest is valued using the proportion of net assets method.
6. Exchange rates to the RWF
US$
1/06/2010 1.5
Average rate 1.75
1/05/2011 1.9
31/05/2011 2

REQUIREMENT:

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Prepare the group statement of financial position, income statement and statement of
comprehensive income at 31st May 2011.

Answer

Group structure

Home

80%

Foraway

Intercompany Loan

Foraway has recorded the loan at its historic amount. The monetary liability must be
translated at the closing rate, with any gain/Loss arising being included in the I/S for the year.

Initially the loan would have been recorded at Frw 400*1.9=$760

The liability at the end of the year is Frw 400*2= $800

Thus, there will be a loss of $40

Dr I/S foraway $40

Cr Loan $40

Revaluation at the Date of Acquisition

At acquisition, the fair value of Foraway’s net assets was $6,000, therefore, the revaluation is
computed as follow:

US$
Share capital 1,500
Retained earnings (2,500-1,300) 1,200
2,700
Fair Value increase (Balancing figure) 3,300
Net assets at acquisition 6,000
The fair value increase is in respect of Land

Dr: PPE $3,300

Cr: Reserve $3,300

Translate the statement of Comprehensive income of Subsidiary

Description Amount in US$ Rate Amount in Frw

Revenue 35,000 1.75 20,000
Operating costs 26,250 1.75 (15,000)
Loss on loan 40 1.75 (23)
translation
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Profit before tax 8,710 4,977
Tax 7,450 1.75 (4,257)
Profit 1,260 720

Calculate Goodwill Arising on Acquisition

Steps to follow

Calculate goodwill in foreign currency

Translate goodwill using exchange rate ruling at acquisition date
Translate goodwill at the closing rate at year end
The difference represents either a gain or loss and is shown in reserves

Then, let’s put the above step into practice

US$ Rate Frw

Cost of Investment 7,500 1.5 5,000
Proportionate net 6,000*80%=(4,800)
assets at Acquisition
Good will at 2,700 1.5 1,800
acquisition
Exchange Loss 450
(Balancing figure)
Good will at year end 2,700 2 1,350

Translate the statement of financial position

US$ Rate Frw

Non-Current assets 6,300 2 3,150
3,300+3,000
Current assets 2,000 2 1,000
Total Assets 8,300 4,150
Share capital 1,500 1.5 1,000
Fair value increase 3,300 1.5 2,200
Pre-acquisition reserves 1,200 1.5 800
Post-Acquisition 1,260 (370)
reserves (Bal fig)
Liabilities 1,000+40 1,040 2 520
8,300 4,150

Prepare the Consolidated statement of comprehensive income and SOFP

Statement of comprehensive Income

Frw
Revenue 25,000+20,000-1,000 44,000
Operating cost 15,000+15,000-1,000 (29,000)
Gross profit 15,000
Exchange loss (23)

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Profit before tax 14,977
Tax 8,000+4,257 12,257
Profit after tax 2,720
Other comprehensive income
Exchange loss on goodwill (450)
Exchange loss on net assets (1,090)
Total comprehensive income 1,080
Profit attributable to
Parent 2,720-144 2,576
NCI

Total Comprehensive income

attributable to
Parent 2,576-450-(1,090*80%) 1,254
NCI 144-(1,090*20%) (74)

Consolidated statement of financial position

Frw
Non-current assets 10,000+3,150 13,150
Good will 1,350
Current Assets 5,000+1,000 6000
Total assets 20,500
Share capital 6,000
Retained earning 3,254
Non-controlling interest 726
Liability 10,000+520 10,520
Total equity and Liability 20,500

Translating net assets

Closing net assets at closing (8,300-1,040)/2 3,630

rate
Opening net assets at opening (1,500+3,300+1,200)/1.5 (4,000)
rate
Profit for the year at average (1,300-40)/1.75 (720)
rate
Exchange Loss (1,090)

Group retained earning

` Frw
Parent 4,000
Post acquisition profit 370*0.8 (296)
Exchange loss on good will -450
3,254
NCI
Frw
At acquisition (6,000*20%)/1.5 800
Post-acquisition 370*20% (74)
726

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Reserve

Exchange loss on translation of Assets 1,090*0.8=872

CHAPTER IX: OPERATING SEGMENT (IFRS 8)

INTRODUCTION.

The company may have several major activities in different location or might have
different operations for which their risks and opportunities differ significantly. The
entities operations/components shall be disclosed in the notes to the financial statement, to
facilitate the users get information about the performance, nature and financial effects of
separate operations/activities.
When the information of different segments are combined and reported as consolidated figure
in financial statements, some major information may not be discovered by users of
information. Hence, investment decision could not accurately be taken in absence of those
information.

IFRS 8: Applies only to those entities whose equity or debt securities are publicly traded
or those which are in the process of issuing shares or debt security in public security
markets. Other companies may opt to disclose information of operating segment in financial
statements, but by complying with the requirement set in IFRS 8.

Definition:

Operating segment is the component of an entity:

i. That engages in business activities from which it may earn revenues and incur
expenses
ii. Whose operating results are regularly reviewed by the entity’s chief operating
decision maker to make decisions about resources to be allocated to the segment and
assess its performance?
iii. For which discrete financial information is available.

REPORTABLE SEGMENTS

Even though operating segment has information necessary for decision making, not all
segments qualify as reportable segment.
IFRS 8, state the criteria that guide the entities to classify reportable and non-reportable
segment. The reportable segment must have the following criteria;
i. Its reported revenue, from both external customers and intersegment sales or
transfers, is 10% or more of the combined revenue (internal and external) of all
operating segments; OR
ii. Its reported assets is 10% or more of the combined assets of all operating
segments.
iii. The absolute measure of its reported profit or loss is 10% or more of the greater,
in absolute amount, of
(a) The combined reported profit of all operating segments that did not report a
loss and
(b) The combined reported loss of all operating segments that reported a loss; or

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 iv. Its assets are 10% or more of the combined assets of all operating segments.

N.B: If the total revenue attributable to all operating segments (as identified by
applying the alternative quantitative thresholds criteria, above) constitutes less than
75% of the entity’s total revenue as per its financial statements, the entity should look
for additional operating segments until it is satisfied that at least 75% of the entity’s
revenue is captured through such segmental reporting.

The entity shall set its own criteria in identifying the additional operating segments as
reportable segments (for the purposes of meeting the 75% threshold), those criteria
shall be established based on the nature of the company and sorely nature of segment.
The company shall continue to identify more segment even if they do not met the
alternative quantitative thresholds test until at least 75% of the entity’s revenue is
included in reportable segment.

Example:

a) Rulindo investment group Ltd operates in the tourism industry, but some of its
subsidiaries operate in Communication, Health and farming.

The management of RIG Ltd identified reportable segment as Mobile Ltd, Radio FM, G Clinic
and Gashora farm Ltd.
For the purpose of preparing segment reports, the following details were extracted from the
income statement for the year ended 31 December 2020.
Total Revenue Intersegment revenue
Frw 000 Frw 000
Mobile Ltd 4,000 2,300
Radio 1,800 1,200
G Clinic 1,400 900
Gashora farm Ltd 80 30
Unallocated 3,000

Required:
Prepare a segment report for RIG Ltd that would be presented in the notes to the financial
statements for the year ended 31 December 2020

Answer

Rulindo Investemnt Group Ltd segment report for the year ended 31 December 2020

Mobile Radio G Clinic Gashora Unallocated Combined

Frw 000 Frw 000 Frw 000 Frw 000 Frw 000 Frw 000
Total revenue 4,000 1,800 1,400 80 3,000 10,280
Intersegment (2,300) (1,200) (900) (30) - (4,430)
sales
External sales 1,700 600 500 50 3,000 5,850

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 CHAPTER X: BRANCH ACCOUNTING
A branch is a segment of or a component of a business situated/ located in the same town, in
the same country or different country with the head office. Branches do not have share capital
or contributed capital. They are owned by the businesses which establish them. There are
there types of branches:
a. Dependent branches: These are branches which don’t maintain their own accounting
records. They are maintained in the Head Office.
b. Independent branches: Are branches that maintain their own accounting records like any
other independent business only that they do not have share capital or contributed capital;
instead they have what is referred to as head office current account which shows the net
investment by the head office in the branch.
c. Foreign branches: Are branches which operate in other countries other than the country of
the head office (main business). They may be either dependent or independent branches

1. Dependent branch

There are two alternative ways of invoicing/ recording goods sent to branches. These are:
i. At cost
ii. At cost plus mark up
iii. At selling price: The method used to record the goods sent to branches determines the
records maintained by the head office.
Journal Entries
1. Goods sent to branch
Dr. Branch stock a/c
Cr. Goods sent to branch a/c
2. Returns of goods to head office by branch
Dr. Goods sent to branch a/c
Cr. Branch stock a/c
3. Sales made by the branch
Dr. Cashbook cash/ bank a/c or debtors a/c
Cr. Branch stock a/c
4. Goods stolen at the branch
Dr. Good’s stolen account/ goods lost/ abnormal loss a/c
Cr. Branch stock a/c
5. Goods returned by customers
Dr. Branch stock a/c
Cr. Branch debtors’ a/c
6. Cash stolen in the branch
Dr. Cash stolen a/c
Cr. Branch stock a/c
7. Reduction of price of goods in the branch
Dr. P&L account/ cost stock a/c
Cr. Branch stock a/c
8. Transfer of goods from one branch to another branch
Dr. Branch stock a/c of the receiving branch
Cr. Branch stock a/c of the sending branch
9. Balancing the goods sent to Branch a/c
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 The balance in this account represents goods sent to the branch and that remained in the
branch for sale. This balance should be transferred to the purchase account.
Dr. Goods sent to branch a/c
Cr. Purchases a/c
10. Branch closing stock Any closing stock in the branch should be shown as a balance
carried down (Bal c/d) on the credit side of the branch stock a/c
The balance which remains in the branch stock account is the branch gross profit.
Therefore, branch stock a/c where goods are sent to the branch as cost acts as a
branch trading account.

Ledger Accounts Maintained Where Goods Are Sent At Cost plus Mark Up or At
Selling Price.

Other than the Head Office sending the goods to branch at cost, it may add a profit to the cost
and send the goods at cost plus profit. The profit is usually a certain percentage on the cost
of goods. (mark-up) or a certain percentage on the selling price of the goods (margin). When
recording it is important to split the invoice price into cost and profit. This profit charged is
recorded separately into an account referred to as branch mark-up account/ branch adjustment
account/ provision for unrealized profit account. This account is used to determine the
realized gross profit and the unrealized profit on branch closing stock at the end of the period.
The ledger accounts maintained include:
i. Branch stock account
ii. Goods sent to branch account
iii. Branch mark-up account
iv. Branch debtors account
v. Branch creditors account
vi. Branch expenses account
vii. Branch profit and loss account

Possible transaction between the branch and head office

1. Goods sent to branch
Dr. Branch stock a/c – at invoice price
Cr. Goods sent to branch at cost
Cr. Branch mark-up a/c – with mark-up
2. Goods returned to head office by the branch
Dr. Goods sent to branch at cost
Dr. Mark-up a/c – with mark-up of goods returned
Cr. Branch stock a/c – at total invoice price
3. Sale of goods by branch
Dr. Branch debtors account / cashbook
Cr. Branch stock account
4. Returns of goods by branch debtors to the branch
Dr. Branch stock a/c
Cr. Branch debtors
5. Returns of goods by branch debtors direct to head office
Dr. Goods sent – at cost
Dr. Branch mark-up a/c – mark-up
Cr. Branch debtors – total value
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6. Increase in price of goods at the branch
Dr. Branch stock a/c
Cr. Branch mark-up with the increase
7. Transfer of goods to other branches
Dr. Branch mark-up a/c – at mark-up
Cr. Branch stock a/c – at invoice price
8. Receipt of goods from other branches
Dr. Branch stock a/c – at invoice price
Cr. Branch mark-up – at mark-up
9. Goods stolen at the branch
Dr. Goods’ stolen a/c at cost
Dr. Branch markup - at mark-up
Cr. Branch stock a/c – at invoice price
10. Cash sale stolen
Dr. Cash stolen a/c
Cr. Branch stock a/c
11. Reduction in price/ mark down of goods in the branch: If price of goods is reduced at
the branch, it is important to determine whether the new selling price is still above the
cost of the good or it is below the cost of the goods. If the new selling price is still
above the cost or at cost, the reduction is only an elimination of the profit that could
have been earned on such goods thus with the reduction.
Dr. Branch mark-up a/c
Cr. Branch stock a/c
If the price of goods is reduced below the cost, then
a. With the reduction from the original selling price to the cost of the goods.
Dr. Branch mark-up a/c
Cr. Branch stock a/c
(This is an elimination of the profit that would have been earned on sale of the goods)
b. With the reduction from cost to the new selling price which is below the cost,
Dr. P&L a/c
Cr. Branch stock a/c (This is a loss to the company) \
12. Balancing the goods sent to branch account
The balancing figure in the goods sent to branch account should be transferred to the
purchases account/ goods available for sale a/c.
Dr. Goods sent to branch a/c
Cr. Purchases account/ goods available for sale.
13. Balancing the branch stock a/c
Where goods are sent to the branch at selling price, the closing stock in the branch is
not given and it is determined as a balance carried down.
Where it is given, it should be shown as a balance carried down on the credit side of the
branch stock account. Then, the branch stock account may or may not balance. If
it does not balance, and the balancing figure is on the debit side, the balance is
taken as a normal stock difference which may arise as a result of the branch
selling goods at a price higher than the invoice price thus with this difference;

135
 Dr. Branch stock a/c
Cr. Branch mark-up a/c
If it does not balance, and the balancing figure is on the credit side, this balance may be
either a normal or abnormal loss.
If it is a normal loss:
Dr. Branch mark-up a/c
Cr. Branch stock a/c
If it is an abnormal loss
Dr. Branch mark-up a/c - with mark-up
Dr. Abnormal loss a/c - cost
Cr. Branch stock a/c - at invoice value price.

14. Balancing the branch mark-up a/c

The mark-up on branch closing stock/ unrealized profit on branch closing stock should
be determined and be shown as a balance carried down on the debit side of the
branch mark-up a/c. The branch mark-up a/c is then balanced and the balancing
figure represents the branch gross profit realized during the period.

Example
Kigali best food company ltd (KBFC Ltd) deals in food processing products. The head
office is in Kigali and there are two branches in main town of Kigali. All
purchases are made by the head office and goods are charged to branches at cost
plus 25%. The following information relates to GISHUSHU branch for the year
ended 31/12/2018.
Details Amount Frw
000
Opening balance as at 01/01/2018 Branch inventory (Invoice price) 300,000
Branch debtors 450,000
st
Closing balances as at 31 December 2018 250,000
Branch inventory (Invoice price)
Transaction for the year
Good sent by head office to branch (Invoice price) 2,500,000
Good returned by branch to head office (Invoice price) 200,000
Cash sales 800,0000
Credit sales 2,700,000
Return from customers to the branch 100,000
Discount allowed 30,000
Bad debts written off 20,000
Branch expense 500,000
Goods stolen at branch 30,000
Cash stolen at branch not included in other sales 15,000
Cash received from branch debtors 2,450,000

136
 Required
Prepare.
i. Branch inventory account
ii. Branch mark-up account
iii. Branch debtors account
iv. Branch trading, profit or loss account

2. INDEPENDENT BRANCHES

These are branches which maintain their own books of accounts. They operate as
independent businesses only that they do not have share capital or contributed capital.
Instead they have what we call Head Office current account which shows the amount the
branch owes the Head Office. In some cases, these branches transacts with the Head Office.
Such transactions include:
i. Receipt of goods from Head Office
ii. Expenses of branch paid by Head Office
iii. Branch customer paying to Head Office etc.
Such transactions are recorded in an account called/ referred to as the current account.
Where the Head Office has several branches, a current account is maintained for each branch.
The current account maintained by Head Office is referred to as branch current account and
the current account maintained by branch is referred to as Head Office current account.
Possible transactions between branch and head office Books of the Head Office

Books maintained by Head office.

i. Goods sent to branch

Dr. Branch current account
Cr. Goods sent to branch account at invoice price.
ii. Goods returned to Head Office.
Dr. Goods sent to branch account
Cr. Branch current account
iii. Cash received from branch
Dr. Cashbook
Cr. Branch current account
iv. Cash remitted to branch
Dr. Branch current account
Cr. Cashbook
v. Branch expense paid by Head Office
Dr. Branch current account
Cr. Cashbook
vi. Head Office expense paid by branch
Dr. Appropriate expense account / Profit and Loss account
Cr. Branch current account
vii. Branch creditors paid by Head Office
Dr. Branch current account
Cr. Cashbook
137
 viii. Head Office creditor paid by branch
Dr. Creditors account
Cr. Branch current account
ix. Branch debtor paying direct to Head Office
Dr. Cashbook
Cr. Branch current account
x. Head Office debtor paying direct to branch
Dr. Branch current account
Cr. Debtor account
xi. At the end of accounting period the branch profit/ loss should be transferred to Head
Office books
Dr. Branch current account
Cr. Head Office income statement
Books to be maintained by branch
1. Goods received from Head Office
Dr. Goods received account
Cr. Head Office current account
2. Returns of goods to Head Office
Dr. Head Office current account
Cr. Goods received account
3. Cash remitted to Head Office
Dr. Head Office current account
Cr. Cashbook
4. Cash received from Head Office
Dr. Cash account
Cr. Head Office current account.
5. Branch expense paid by Head Office
Dr. Appropriate expense account/ Profit and Loss account
Cr. Head Office current account
6. Head Office expense paid by branch
Dr. Head Office current account
Cr. Cashbook
7. Branch creditor paid by Head Office
Dr. Creditors account
Cr. Head Office current account
8. Head Office creditors paid by branch
Dr. Head Office current account
Cr. Cashbook
9. Branch debtor paying direct to Head Office
Dr. Head Office current account
Cr. Debtors account
10. Head Office debtor paying direct to branch
Dr. Cashbook cash/ bank account
Cr. Head Office current account
11. To transfer branch profit
Dr. Income statement
138
 Cr. Head Office current account
As can be observed from above entries all transactions must pass through the current
account thus the current accounts will have equal business but on opposite sides it but at
the end of the period. Sometimes the current account balances may fail to agree due to
the following reasons:
i. Errors made when recording
ii. Goods in transit
iii. Cash in transit Errors should be corrected.

Goods in transit
These should be recorded in either the branch books or the Head Office books but not in
both books.
If recorded in branch books:
Dr. Goods in transit account
Cr. Head Office current account
If recorded in Head Office books
Dr. Goods in transit account
Cr. Branch current account
Cash in transit
These should be recorded in either the branch books or Head Office books not in both
books.
If recorded in branch books:
Dr. Cash in transit account
Cr. Head Office current account
If recorded in Head Office books
Dr. Cash in transit
Cr. Branch current account
The Head Office may have a policy of maintaining the fixed asset ledger such that all
fixed assets in the Head Office and in the branch are recorded in the Head Office books.
In this case,
i. When the branch acquires a fixed asset:
In the books of branch
Dr. Head Office current account
Cr. Cashbook (cash/ bank account)/ creditors (credit) account (In the branch books)
In the Head Office books
Dr. Asset account
Cr .Branch current account
ii. With the depreciation expense on such assets
In the branch books
Dr. Depreciation expense account/ Profit and Loss account
Cr. Head Office current account
In the Head Office books
Dr. Branch current account
Cr. Provision for depreciation account.

139
Financial Statements of Independent Branches
At the end of the accounting period, the independent branches will prepare a trial balance
from which the financial statements will be prepared. A combined / consolidated financial
statement will be prepared for the business as a whole. The financial statements are prepared
the same way as for other businesses except for the following terms:
i. Goods sent to the branch
These are reported as values by the Head Office but are not included in the sales of the
enterprise as a whole.
ii. Goods received from Head Office
These forms part of goods available for sale in the branch but should be excluded in the
goods available for sale for the business as a whole.
iii. Goods in transit
Goods in transit are not part of the closing stock of neither the Head Office nor the
branch but are part of closing stock of the enterprise as whole / combined
business.
iv. Provision for unrealized profit
Unrealized profit arises where the Head Office sends goods to the branch at cost plus
profit and the goods remains in the stocks of the branch at the end of the period.
Such profits held up in closing stock is considered unrealized until the goods are
sold by the branch. The unrealized profit on closing stock should be provided for
i.e.
Dr. Head Office Profit and Loss account
Cr. Branch current account
v. Current account
The branch current account balance represents the Head Office investment in the
branch, thus should be carried as an asset of the head office but not for the
enterprise as a whole. Head Office current account balance represents the amount
the branch owes the Head Office thus should be carried as a liability of the branch
but not for the enterprise as a whole.
3. FOREIGN BRANCHES.

These are branches situated in foreign countries other than the country of the Head Office.
An entity may carry out foreign activities in two ways:
i. It may have foreign currency transactions
ii. It may have a foreign operation

a) Foreign currency transaction

These are transactions which are dominated in foreign currency.

They may include:
a. Buying or selling of goods denominated in foreign currency
b. Acquisition or disposal of assets denominated in foreign currency
c. Borrowing or lending of funds in foreign currency IAS 21 requires a foreign currency
transaction to be initially recognized all in the books using the functional currency of the
entity.
Functional currency is the currency of the primary economic environment in which an
entity operates. This means that the foreign currency transaction must be translated using the
foreign currency exchange rate prevailing as at the date the foreign currency transaction takes
place.

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Nonmonetary items are those assets and liabilities appearing on the balance sheet that are
not cash, or cannot be readily converted into cash.
Generally, nonmonetary assets include fixed assets such as property, plant and equipment
as well as intangible items such as goodwill.
Monetary assets A monetary item is an asset or liability carrying a value in francs that will
not change in the future (such as cash and accounts receivable) and monetary liabilities
(such as notes and accounts payable) that have a fixed exchange value unaffected by inflation
or deflation.
At the year end, monetary items which remain unsettled should be retranslated using the rate
as at the date the statement of financial position is prepared i.e. closing rate.
Any exchange difference resulting from the translation and the retranslation should be
reported to the income statement during the period it arises. Exchange difference is the
difference arising from translating a given number of units of one currency at different
exchange rates.
b) Foreign Operations
This is a branch, subsidiary, associate or joint ventures whose activities are carried out in a
foreign country other than the country of the reporting entity.
In order to incorporate the results (the operating results) of a foreign operation. With those of
the reporting entity, the financial statement of the foreign operation must be translated to the
currency of the reporting entity. There are two methods used in the translation of the
financial statements of the foreign operation.
i. Temporal method/ functional currency method
ii. Presentation method/ net investment method.
Temporal / Functional Currency Method
This method is applied where the foreign operation is the same as the operation of the
reporting entity. The foreign operation is the same as that of the operation of the reporting
entity where:
i. The foreign operation does not operate with a significant degree of autonomy i.e. the
foreign operation operates as an extension of the reporting entity.
ii. The cash flows of the foreign operation directly affect the cash flows of the reporting
entity.
iii. Transactions between the foreign operation and the reporting entity are of high
proportion.
Under this method, foreign currency are translated as follow:
i. Monetary items of the foreign operation are translated at closing rate.
ii. Non-monetary items that are carried at fair value/ revalued amount are translated at
exchange rates as at the date the items were revalued.
iii. Non-monetary items that are carried at cost are translated at exchange rates which
were prevailing as at the date of acquisition (Historical rate).
iv. Depreciation is translated at exchange rates used to translate the related assets
(Historical rate).
v. Incomes and expense are translated at exchange rate prevailing as at the date of
transaction (spot rate) or an average rate may be used where the exchange rates
does not fluctuate greatly.
vi. Any exchange difference is reported to the income statement as a gain or a loss.
Presentation Currency/ Net Investment Method
This method is applicable when the foreign operation operates with a significant degree of
autonomy and cash flows of the foreign operation have no direct effect to the operations of
the reporting entity.
This method is applied as follows:
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 i. Both monetary and non-monetary items are translated at closing rate.
ii. Revenues and expenses are translated at rates using average
Format for independent branch
Details Head office Branch Combined
Sales Xxx Xxx xxx
Goods transferred to branch Xxx - -
Total revenue Xxx Xxx Xxx
Cost of goods sold
Opening stock Xxx (at Xxx (at cost)
Xxx (at cost invoice price)
Purchases Xxx Xxx xxx
Goods transferred from Head office Xxx (at -
invoice price)
Closing stock (xxx) at cost (Xxx) at (xxx) at cost
invoice price
Cost of goods sold (xxx) (xxx) (xxx)
Gross profit Xxx Xxx Xxx
Other income
Gain on disposal Xxx - Xxx
Decrease in allowance for UP XX -
Total income Xxx Xxx xxx
Expenses
Depreciation Xxx Xxx Xxx
Increase in allowance for UP xxx -
Other expenses Xxx Xxx Xxx
Total expenses (xxx) (xxx) (xxx)
Net profit Xxx Xxx xxx

Statement of financial position:

Head office Branch Combined
Non-current assets
Property, plant and equipment Xxx Xxx xxx
Intangible Xxx Xxx xxx
Furniture and fittings Xxx Xxx xxx
Investment in branch /Current account balance Xxx - -
Less unrealized profit (xxx) - -
Total non-current assets xxx xxx xxx
Current assets
Account receivables Xxx Xxx Xxx
Inventory Xxx Xxx Xxx
Goods in transit less UP on these goods Xxx - xxx
Cash in transit Xxx - xxx
Cash at bank Xxx Xxx xxx
Total assets Xxx Xxx Xxx
Equity and liabilities
share capital Xxx - Xxx
Head office current account - xxx -
Retained earning Xxx Xxx Xxx
Non-current liabilities
10%Loan note Xxx - Xxx
Current liabilities
Trade payables Xxx Xxx Xxx
Bank overdraft Xxx Xxx
Accrued expenses Xxx Xxx Xxx
Total equity and liabilities Xxx Xxx xxx

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CHAPTER XI. Accounting for consignment
Consignment occurs when the business has no retail premises in a given location and hire an
agent to operate on its behalf. The business send goods to the agent and the agent sell those
received goods at an agreed commission. In that case the business that send goods is known
as consignor and the agent is called consignee.

Goods Consignee
Consignor transferred

Accounting treatment

The consignor will send goods on consignment to consignee. The consignee will then sell
those goods on behalf of the consignor and normally retain a portion of the proceeds as a
commission. He/she may incur additional costs on behalf of consignor such as shipping costs,
storage costs, handling costs. If so, depending on the MoU (Memorandum of understanding)
or agreement, these cost can be deducted from proceeds before transferring the net amount to
the consignor.

The legal ownership of those goods remain with the consignor until the goods are sold. The
stock which remains unsold at reporting date, should be included in the inventory of the
consignor and the consignee shall disclose in the notes value of goods held on behalf of the
consignor.

The net amount which are not yet transferred to the consignor shall be included as liability in
the financial statement of the consignee. The same amount shall be included as receivable in
the books of account of consignor.

Features of consignment

a) Objects: Goods are sent by the consignor to the consignee with an

objective of sale at a profit.
b) Ownership: In consignment, the consignee does not buy the goods. He
merely undertakes to sell them on behalf of the consignor. Hence, the
ownership in the goods remains with consignor till it is sold by the
consignee.
c) Relationship: The relationship between the consignor and the consignee
is that of a principal and an agent, and not of a debtor and creditor. An
agent becomes in debited for amounts realized on behalf of the principal.
d) Risk: the consignor should bear all the risks connected with the goods
until they are sold.
e) Expenses: as consignment is not a sale, whatever the consignee does is
on behalf of the consignor. Thus, the consignor should reimburse all

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 legitimate expenses incurred by the consignee for selling and receiving
the goods.
f) Stock of goods: Any stock remaining unsold with the consignee belongs
to the consignor.
g) Commission: the consignee agrees to sell the goods for an agreed rate of
commission. He or she is therefore, allowed to deduct his commission
due from the sale proceeds.
h) Possession: goods will be in the possession of consignee until they sold
on behalf of the consignor.
i) Repossession: the consignor can repossess the goods from the consignee
at any time.
j) Profit or loss: since the consignee acts on behalf of the consignor, the
profit or loss on sale of goods belongs to the consignor.

Difference between sale and consignment

Sale transaction Consignment

The property in goods is transferred to the The property is transferred to the buyer only
buyer immediately when goods are sold by the consignee.
The ownership of goods remains with the
consignor when goods are transferred to the
consignee by the consignor.
The risk attached to the goods passes with The risk attaching to the goods does not pass
ownership to the buyer to the consignee who acts as an agent. If there
is any damage or loss to the goods it is borne
by consignor provided the consignee has taken
reasonable care of the goods and the damage
or loss is not due to his negligence
The relationship of consignor and consignee is the relationship of buyer and seller is governed
that of a principal and an agent as in a contract by the Sale of Goods Act
of agency
. Unsold goods on consignment are the Goods sold on sale basis are normally not
property of the consignor and may be returned returnable unless there is some defect in them.
if not saleable in the market

Account Sales

This is a summary of the transactions of the consignee. It is a means of conveying

information to the consignor and shows the gross proceeds of sale of the goods, expenses
incurred by the consignee, commission due and the net amount owing to the consignor.
Account sales shall be prepared using the following format

Account Sales as received from B&B Co of 60 bottles’ soft drinks for the sales made on
consignment for the period from May to June 2020

Particulars Frw Frw

Gross sales proceeds
Cash sales xxx
Credit sales xxx
Total sales proceeds xxx
Other receipts such as xxx
insurance realization from
damaged stock
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Total receipts xxx
Less: Amount to be deducted
Advance sent xxx
Expense paid to be reimbursed xxx
Commission receivable Xxx
Total deductions (xxx)
Gross amount due Xxx
Less Bad debt (if it is for (xxx)
consignor’s responsibility)
Net amount due Xxx
Less: Amount still to be (xxx)
collected (balance due from
consignment debtors)
Cash due xxx
Less amount sent (along with (xxx)
account sales)
Net cash due xxx

NOTES:

Other receipts: Amount to be paid by consignee may include the amounts received on
account of sale for insurance realisations from damaged stocks and sale of salvaged stock.
These realisations would not form revenue for consignment business. Hence, they cannot be
included in the normal sale proceeds. But since the consignee has to account for these
realisations also he includes them in the account sales.
Bad debts: If the consignee has to bear the bad debt loss (del credere commission) such a
deduction cannot be made since the amount is to be given by the consignee and he cannot
reduce the amounts due saying someone did not pay up.

Balance due from consignment debtors: The amount due to be received by the consignor
would be the amount left over after setting off the advances, commissions, expenses to be
reimbursed, from the total receipts. The total receipts includes both cash receipts as well as
collections in relation to credit sales. This implies that the Net amount due to be sent to the
consignor may not be available with the consignee in cash.

Accounting and reporting of consignment business

1. Accounts related to consignment arrangement

The objective of consignor in making accounts relating to consignment is two-fold:

a) To ascertain the results (profit/loss) of consignment and incorporate them in his P&L
Account.
b) To make final settlement with the consignee.

To achieve these objectives, he prepares respectively two accounts:

1. ‘Consignment Account’ and

2. Consignee Account’

The consignor and the consignee keep their own books of accounts. The consignor may send
goods to many consignees. Also, a consignee may act as agent for many consignors.
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Therefore, it is appropriate that a separate consignment account as well as consignee account
be prepared in respect of every consignment to enable both of them to know profit or loss on
each consignment.

 When goods are dispatched on consignment no entry can be made in the Sales A/c as
this is not a sale, and, until the goods are sold, they remain the legal property of the
consignor. For the same reason the consignee’s personal account cannot be debited
with the value of the goods consigned. He is not a debtor until the goods are sold.
 As an agent, the consignee is not liable to pay for the goods received on
consignment. Therefore, he makes no entry in his financial books on such receipts.
As, however, he is liable to account for the goods received, he keeps as adequate
record in an appropriate memorandum book. Apart from this his only concern is to
record the expenses he has incurred, the sales, his commission and his financial
relationship with the consignor.

2. Expenses on consignment

(a) Non-recurring expenses

Non-recurring expenses are the expenses which do not arise repeatedly for a particular
consignment. They are incurred for bringing goods to the warehouse of the consignee.
Such expenses are generally incurred on the consignment as a whole, partly by the
consignor and partly by the consignee. The consignor usually incurs expenses, such as
packing, cartage, loading charges, freight, etc., on sending the goods to the consignee.
But the consignee usually incurs expenses, such as customs duty, clearing charges, etc.,
on receiving the goods from the consignor.

(b) Recurring expenses

Recurring expenses are the indirect expenses incurred repeatedly on the same
consignment. They are incurred after the goods have reached the consignee’s place or
warehouse. Advertising, discount on bills, commission on collection of cheques,
travelling expenses of salesman, bad debts, etc., are some examples of recurring expenses
incurred by the consignor whereas warehouse rent and insurance, sales promotion, etc.,
are the examples of recurring expenses incurred by the consignee

Main books to use to account for consignment transaction

The consignment account.

This reflect the profit or loss for the consignment transaction. All incomes earned on
consignment will be recorded in this account and all expenses incurred on consignment will
be recorded here.

The consignee account:

This account reflect the debtor or creditor account for the consignee i.e this account will
show the amount that the consignee is due to pay over the consignor or vice-versa.

The consignment inventory account:

This account record all movement of stock.

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Records in the books of consignee

Generally, the consignee shall not maintain the inventory account as the goods belong to the
consignor. The only account that shall be kept by consignee is:

Consignor account:

This account shall be used to record all proceeds collected by the consignee on behalf of the
consignor, net of any expenses that he consignee is permitted to deduct such as commissions
or other direct costs on sales as it may be agreed by both.

The commission received will be recorded in the appropriate account in the G/L and it must
be representing in the P/L for that period.

Transaction Double entries

Goods sent on consignment Dr Consignment
Cr Goods sent on consignment
Goods returned by the consignee Dr Good sent on consignment
Cr Consignment a/c
Expenses incurred by consignor while Dr Consignment a/c
dispatching goods Cr Bank
Expenses incurred by consignee Dr Consignment a/c
Cr Consignee a/c
Commission payable to the consignee Dr Consignment a/c
Cr Consignee a/c
Recording Account sales (del credere Dr Consignee
commission is paid to consignee or if in Cr Consignment
contract he agrees to collect the credit sales
Normal loss [normal loss of stock of No entry
consignment (damaged stock, obsolete stock)
which was not insured
Insurance claim received for normal stock loss Dr Bank
Cr Consignment
Abnormal loss [abnormal stock loss credited Dr Bank/Insurance company
to consignment A/c (fire loss, burglary loss, Dr Profit and Loss
stolen in transit] Cr Consignment (Total loss
Bad debts borne by consignor Dr Consignment
Cr Consignee
Bad debts borne by consignee No entry in the consignor’s books
Remittance by (Payment from) consignee in Dr Bank/Bills receivable
full settlement by cheque or accepting Bill Cr Consignee
When Bill Receivable is discounted by Dr Bank a/c (Bills minus discount
Consignor Dr Consignment a/c (discount)
Cr Bills Receivable a/c (Total bills
Profit on the consignment is transferred to the Dr Consignment
P&L A/c Cr Profit and loss
Loss on the consignment is transferred to the Dr Profit and loss
P&L A/c Cr Consignment
For closing stock on consignment Dr Consignment stock a/c
Cr Consignment a/c

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Note: The discount on bills may be accounted for in one of two ways: • As a normal
operating expenses item and charged against the profit and loss account; or • As a special
expense item related to the consignment and therefore charged to consignment a/c

Consignment
account
Opening stock Xxx From consignee a/c
Good sent on consignment xxx
Cash (expenses of consignor) Xxx Cash sale Xxx
Consignee a/c (expenses of xxx Credit sale xxx
consignee)
Consignee a/c (Commission) Xxx Own purchase Xxx
Consignee a/c (bad debts) Xxx Closing stock Xxx
P&L A/C (If profit) Xxx P&L (If loss) xxx

Consignee a/c
Cash sales xxx Consignment a/c (Expenses of xxx
consignee)
Credit sales xxx Bills receivable a/c(full bill) xxx
Own purchase xxx Bank/cash (Advance paid to Xxx
consignor)
Consignment a/c (Consignee’s xxx
commission
Consignment a/c (If any bad xxx
debts)
Bank/Cash a/c (for final xxxx
payment)
Bal c/f xxx

Journal entries in the books of the consignee

Transactions Double entries

Goods sent from consignor No entry
Expense paid by the consignor No entry
Commission received Dr: Consignor
Cr: Commission received
Expenses paid on behalf of the consignor Dr Consignor
Cr Bank
Discount allowed to customers Dr Consignor
Cr Debtor
Bad debt born by consignor Dr Consignor
Cr debtors
Bad debt born by the consignee personally Dr Bad debt (P/L)
(when del credere commission was paid to the Cr debtors
consignee)
Cash sales Dr Cash/bank
Cr Consignor
Credit sales Dr Debtors
Cr consignor
Payment to the consignor by cheque or bill Dr Consignor
Cr Bank/Bill payable
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Example:

Wills of London, whose financial year ends on 31 December, consigned goods to Adams, his
agent in Canada. All transactions were started and completed in 19X8.

a. January 16: Wills consigned goods costing £500 to Adams

b. February 28: Wills paid carriage to Canada, £50 Adams, the consignee, sends
an account sale on 31 July when all goods have been sold. It shows:
c. Sales amounted to £750
d. Adams’s expenses were: Import duty, £25 Distribution expenses, £30
e. Commission had been agreed at 6 per cent of sales. This amounted to £45
f. Adams paid balance owing £650. Solution: Entries in the books of the
consignor (Wills’ books)

Consignment
account
Good sent on consignment 500 Sales 750

Carriage 50
Import duties 25
Distribution expenses 30
Commission expense 45
Profit on consignment (to be 100 750
transferred to P/L A/c
750
Consignee a/c
Import duties 25

Sales 750 Distribution expenses 30

Commission expense 45
Bank 650
750 750

Good sent on
consignment a/c

Consignment a/c 500

149
The double entry in the books of the consignee

Consignor a/c

Bank 750
Import duty 25
Distribution expense 30
Commission fees 45
Bank (Transfer) 650
750 750

Consignee a/c
Import duties 25

Sales 750 Distribution expenses 30

Commission expense 45
Bank 650
750 750

CHAPTER XII: PULIC SECTOR

Chapter VII: Finical statement of public sector entities
Benefit of public sector entities
1. It improve accountability, transparency and disclosure of government activities
2. It enable the government and the public to assess the performance of the public sector
entities
3. It will improve the reliability of account and boost the confidence of external
agencies
4. It will facilitate the comparability among the entities and the government
5. It will reduce the misuse of public funds
6. It will improve the consistency in preparation and reporting of financial information

Cash basis: under this principle the transaction is recognized only when cash is received or
paid
Accrual accounting: the expenditures are recognized when they are incurred not when cash
is paid and incomes are recognized when they are earned not when cash is received
Modified cash basis: the transaction are recognized when cash is paid or received, in
addition the invoices outstanding at year end are recorded as account payables/account
receivables

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Examples of IPSAS
IPSAS3: Accounting policies, changes in accounting estimates and errors
Accounting policy must be applied consistently and changes are to be applied retrospectively
in financial statement, adjusting the opening balances.
IPSAS 5: Borrowing costs
Borrowing costs: these are interest and other expenses incurred in connection to the
borrowed funds
Accounting treatment of borrowing costs
Borrowing cost shall be recognized as expenses in the period in which they are incurred
unless they are capitalized,
Borrowing cost that are directly attributable to the acquisition, construction, development of
non-current assets shall be capitalized as cost of assets
IPSAS 7 Investment in Associates
Associates Company is an entity in which the investor has significant influence that is neither
the controlled entity nor the joint venture
The standard require the associate company to be account for using the equity method of
accounting: under this method the investment is initially recognized at costs and adjusted
thereafter for the post acquisition change of the investor’s share in the investee.
IPSAS8: INTERST IN JOINT VENTURE
Joint venture is a binding arrangement whereby the two or more parties are to undertake an
activity that is subjected to joint control
Types of Joint venture
Jointly controlled operation: this refer to the use of the assets and other resources of the
ventures rather than establishing the corporation
Jointly controlled assets: this refer to the joint control of the assets, joint ownership of these
assets contributed for the purpose of joint venture
Jointly controlled entities: This involves the establishment of the corporation, partnership or
other entity in which the ventures has an interest
IPSA 11 Construction contract
The cost and revenue from construction contract are recognized only when the result from
construction can be estimated reliably, and the stage of completion can be computed.
IPSAS 13. Leases
Lease refer to the agreement which transfer substantially the right to use an asset to the lessee
in return for a payment.

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Accounting treatment for Finance lease
Books of the lessee
The lessee shall recognize the leased assets in the statement of financial position under
noncurrent assets and recognize the obligation under finance lease which must be split into
noncurrent liability and current liability.
The lessee shall recognize the interest and depreciation in the statement of Profit or loss a/c
Books of the lessor:
The lessor shall only recognize the lease payment receivable under a finance lease as an
assets in the statement of financial position, and lessor must recognize the interest income in
the statement of Profit or loss a/c
Account treatment of Operating lease
Books of the lessee
Lease rental payment are recorded as expense in the profit or loss account
Books of the lessor
Lease rental received are recognized as other income in the statement of profit or loss a/c
IPSA 14. Event after the reporting period
Events after the reporting period are those events, favourable and unfavourable that occurs
between the end of the reporting period and the date when the financial statements are
authorised for issue.
Two types of events can be identified i.e.
1. Events that provide evidence of conditions that existed at the end of the reporting period
(adjusting events after the reporting period); and
2. Events that are indicative of conditions that arose after the reporting period (non adjusting
events after the reporting period.
Disclosure: Non-Adjusting Events
If non-adjusting events after the reporting period are material, non-disclosure could influence
the economic decisions that users make on the basis of the financial statements.
Typical examples of material non-adjusting events after the reporting period that disclosure
would be expected are;
1. A major combination of entities or disposing of a major subsidiary;
2. A plan to discontinue an operation or a major restructuring of an operation;
3. Major purchase of assets or the destruction of a major asset by fire/storm
4. Major share transactions;
5. Abnormally large changes in assets prices or foreign exchange rates;
6. Changes in tax rates or tax laws that have a major impact on an operation
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IPSAS 19

Definition

IPSAS 17 defines Property, Plant and Equipment as tangible items that are held for use in the
production, supply of goods or services, for rental to others, or for administrative purposes
and are expected to be used during more than one reporting period
Applicability and exceptions
IPSAS 17 must be applied by public entities that prepares and present financial statements
under accrual basis except for Heritage assets. The standard does not apply to biological
assets and Mineral rights and mineral reserves.
The standard does not require entities to recognize heritage assets
Infrastructure assets
The ownership of infrastructure assets is not confined to entities in the public sector. The
infrastructure assets that meets the definition of property, plant and equipment should be
accounted for in accordance with IPSAS 17
Condition necessary to recognize assets under IPSAS 17
The cost of an item of property, plant and equipment shall be recognized in accordance with
IPSAS 17 if
 It is probable that future economic benefits or service potential associated with the item
will flow to the entity
 The cost or fair value of the item can be measured reliably
IPSAS 19: Provision, Contingent assets and contingent liabilities
A provision is a liability of uncertain amount
Contingent asset/liabilities is a possible assets or obligation that arises from the past events
and whose existence will be confirmed by uncertain future events not wholly within the
control of the entity.
A provision should be recognized if it is probable that the future outflow of cash will be
required to settle the obligation, and the amount can be estimated reliably
The entity shall not recognize the contingent asset or contingent liabilities but these are
disclosed in note to the account

Thank you!!

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