SBR Course notes

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Syllabus A: Fundamental Ethical And Professional Principles 3
Syllabus A1. Professional Behaviour & Compliance With Accounting Standards 3

Syllabus B: THE FINANCIAL REPORTING FRAMEWORK 9

Syllabus B1. The Applications Of An Accounting Framework 9

Syllabus C: REPORTING THE FINANCIAL PERFORMANCE OF ENTITIES 41

Syllabus C1. Performance reporting 41

Syllabus C2. Non-current Assets 59

Syllabus C3. Financial Instruments 122

Syllabus C4. Leases 165

Syllabus C5. Employee Benefits 188

Syllabus C6. Income taxes 200

Syllabus C7. Provisions, contingencies and events after the reporting date 212

Syllabus C8. Share based payment 221

Syllabus C9. Fair Value Measurement 244

Syllabus C10. Reporting requirements of small and medium-sized entities (SMEs) 248

Syllabus C11. Other Reporting Issues 258

Syllabus D: FINANCIAL STATEMENTS OF GROUPS OF ENTITIES 268

Syllabus D1. Group accounting including statements of cash flows 268

Syllabus D2. Associates And Joint Arrangements 340

Syllabus D3: Foreign transactions and entities 350

Syllabus E: Interpret Financial Statements For Different Stakeholders 361

Syllabus E1: Analysis and interpretation of financial information and measurement of performance 361

Syllabus F: THE IMPACT OF CHANGES AND POTENTIAL CHANGES IN ACCOUNTING

REGULATION 394
Syllabus F1. Discussion of issues in financial reporting 394

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 Syllabus A: FUNDAMENTAL ETHICAL AND
PROFESSIONAL PRINCIPLES

Syllabus A1. Professional Behaviour & Compliance With

Accounting Standards

Syllabus A1a) Appraise and discuss the importance of ethical and professional behaviour
in complying with accounting standards and corporate reporting requirements.

Giving Advice

When giving advice be aware of:

1) Your own professional competence and that company directors must keep up to
date with IFRS developments

The issues that may threaten this are:

• Insuf cient time
• Incomplete, restricted or inadequate information
• Insuf cient experience, training or education
• Inadequate resources

2) Your own objectivity

The issues that may threaten this are:

• Financial interests (pro t-related bonuses /share options)
• Inducements to encourage unethical behaviour

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In fact ACCA’s Code of Ethics and Conduct identi es that accountants must not be
associated with reports, returns, communications where they believe that the
information:

• Contains a materially misleading statement

• Contains statements or information furnished recklessly
• Has been prepared with bias, or
• Omits or obscures information required to be included where such omission or obscurity
would be misleading

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 Ethical and professional issues

Accounting professionals are expected to be:

1. highly competent
2. reliable
3. objective
4. high degree of professional integrity.

A professional’s good reputation is one of their most important assets.

Accountancy as a profession has accepted its overriding need to act in the best interest
of the public.

This can create an ethical/professional dilemma.

As accountants also have professional duties to their employer and clients.

Where these duties are in contrast to the public interest, then the ethical conduct of the
accountant should be in favour of the public interest.

This can create problems particularly on an audit, whereby you provide a service for the
client, yet may have to make public information which is detrimental to the company but in
the public interest.

There is a very ne line between acceptable accounting practice and management’s

deliberate misrepresentation in the nancial statements.

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 The nancial statements must meet the following criteria:

• Technical compliance:
Generally accepted accounting principles (GAAP) used.

• Economic substance:
The economic substance of the event that has occurred must be represented
(over and above GAAP)

• Full disclosure and transparency:

Suf cient disclosures made

Management often seeks loopholes in nancial reporting standards that allow them to
adjust the nancial statements as far as is practicable to achieve their desired aim.

These adjustments amount to unethical practices when they fall outside the bounds of
acceptable accounting practice.

In most cases conformance to acceptable accounting practices is a matter of personal

integrity.

Reasons for such behaviour often include

1. market expectations
2. personal realisation of a bonus
3. maintenance of position within a market sector

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 Syllabus A1b) Assess and discuss the consequences of unethical behaviour by
management in carrying out their responsibility for the preparation of corporate reports

ACCA has a Framework for Ethical Decision Making

1) Understand the Real Issue

2) Any Ethical threats?

These would be:
Self-Interest
Self-Review
Advocacy
Familiarity
Intimidation

3) Are the Ethical threats signi cant?

Think about materiality, seniority of people involved and the amount of judgement needed

4) Can safeguards reduce these threats to an acceptable level?

5) Can you look yourself in the mirror afterwards?

Accountants need to act professionally and in the current conditions have even more of a
duty to present fair, accurate and faithfully represented information.

It can be argued that accountants should have the presentation of truth, in a fair and
accurate manner, as a goal.

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 Consequences Of Not Upholding Ethical Principles

One of the more obvious consequences is professional disciplinary

proceedings against unethical members

The results can be serious…

• Fines / Prison
• No longer being able to be a Director
• Expelled from your professional body

Social Responsibility

Looking after society and the environment costs .... no question... but in today's world,
thankfully, it also brings in sales

Companies are now often called 'corporate citizens'. With that comes social responsibility.

Not taking CSR seriously will damage your chances of investment and risk losing sales

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 Syllabus B: THE FINANCIAL REPORTING
FRAMEWORK

Syllabus B1. The Applications Of An Accounting

Framework
Syllabus B1a) Discuss the importance of a conceptual framework in underpinning the
production of accounting standards.

Framework - Basics and Arguments

The IASB framework is not a standard nor does it override any standards

De nition

It sets out the concepts which underlie the accounts. It means that basic principles do not
have to re-debated for every new standard.

It is..
‘a constitution, a coherent system of interrelated objectives and fundamentals which
can lead to consistent standards and which prescribe the nature, function and limits
of nancial accounting and nancial statements’

What’s its purpose?

The IASB’s Framework for the Preparation and Presentation of Financial Statements
describes the basic concepts by which nancial statements are prepared:

• Serves as a guide in developing accounting standards.

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• Serves as a guide to resolving accounting issues that are not addressed directly in a
standard.
(In fact IAS 8 requires management to consider the de nitions, recognition criteria, and
measurement concepts for assets, liabilities, income, and expenses in the Framework.)

What does it ‘look’ like?

It includes the following:

1. The objective of nancial statements

2. Underlying assumptions
3. Qualitative characteristics of good information
4. Elements of FS
5. Recognition of Elements
6. Measurement of Elements
7. Concepts of Capital

More on these in other sections

Arguments for a conceptual framework

• It may seem a very theoretical document but it has highly practical aims.

• Without a framework then standards would be developed without consistency and also
the same basic principles would be continually examined. Perhaps even sometimes with
differing conclusions.

• The IASB therefore becomes the architect of nancial reporting with a framework as
solid foundations upon which everything else relies.

• Also without such a framework then a rules based system tends to come in instead. The
rules get added to as situations arise and nally become cumbersome and unadaptable.

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• It also prevents political lobbyists from changing pressurising changes in standards as
the principles have already been agreed upon.

So a conceptual framework basically provides a framework for:

1. what should be brought into the accounts

2. when it should be brought into the accounts and
3. at how much it should be measured

Arguments against a conceptual framework

• Financial Statements are prepared for many different users - can one set of principles be
agreed by all?

• Perhaps different users need different information and hence different measurement
bases and principles

• Even with framework principles - standards go through a huge analysis process, for
example the revenue recognition exposure draft has now been re-exposed!

GAAP & the framework

In some ways the framework tries to codify the current GAAP into new standards - or
at least current thinking

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 Syllabus B1b) Discuss the objectives of financial reporting including disclosure of
information that can be used to help assess management’s stewardship of the entity’s
resources and the limitations of financial reporting.

Chapter 1: The Objective of Financial Reporting

This chapter sets out:

The objective of general purpose nancial reporting
Information needed
Who the primary users of nancial reports are.

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 Stewardship
Users need information to help them assess management’s stewardship.
This chapter states that users need information to help them assess management’s
stewardship so that they can hold management to account for resources entrusted to their
care.
This assessment in turn helps users make decisions about providing resources to the
entity, which is the objective of general purpose nancial reporting.

Users of nancial reports

Users are investors, lenders and other creditors.
Those users must rely on nancial reports for much of the nancial information they need.

Limitations of Financial Reporting

Users cannot require reporting entities to provide information directly to them, so must rely
on general purpose nancial reports
However, these cannot provide all of the information needed.
Information from other sources is needed, for example, general economic conditions and
expectations, political events and industry/company outlooks.

• Financial accounts are not designed to show the value of an entity; but they help users
estimate it
• Different users have different needs
Standards try to meet the needs of the maximum number of primary users.
(However, an entity can include additional information for a particular subset of primary
users)
• Management need not rely on general purpose nancial reports because it is able to
obtain the nancial information it needs internally.
• Regulators and the public may also nd general purpose nancial reports useful.
However, those reports are not primarily directed to these other groups.
• Financial reports are based on estimates and judgements
The Conceptual Framework establishes the concepts that underlie those estimates
The Conceptual Framework’s vision of ideal nancial reporting is unlikely to be achieved

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 in full, because it takes time to understand, accept and implement new ways of analysing
transactions and other events.

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 Syllabus B1c) Discuss the qualitative characteristics of useful financial information
including disclosure

Chapter 3: Qualitative Characteristics of Useful

Financial Information

Main Principle

Financial information is useful when it is relevant and represents faithfully what it purports
to represent.

The usefulness of nancial information is enhanced if it is comparable, veri able, timely

and understandable.

Fundamental characteristics:

1. Relevance
Relevant information makes a difference in the decisions made by users.
Therefore it must have a predictive value, con rmatory value, or both. The predictive
value and con rmatory value of nancial information are interrelated.
Materiality is an entity-speci c aspect of relevance. It is based on the nature and/or
size of the item relative to the nancial report.

2. Faithful representation
General purpose nancial reports represent economic phenomena in words and
numbers.
To be useful, nancial information must not only be relevant, it must also represent
faithfully the phenomena it purports to represent.
This maximises the underlying characteristics of completeness, neutrality and freedom
from error.

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 Enhancing characteristics:
1. Comparability (including consistency)
2. Timeliness
3. Reliable information
4. Veri ability
Helps to assure users that information represents faithfully the economic phenomena
that it purports to represent.
It implies that knowledgeable observers could reach a general consensus (although

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 not necessarily absolute agreement) that the information does represent faithfully the
economic phenomena.
5. Understandability
Enables users with a reasonable knowledge to comprehend the information.

Understandability is enhanced when the information is:

• Classi ed
• Characterised
• Presented clearly and concisely

However, relevant information should not be excluded solely because it may be too
complex.

Two constraints that limit the information provided in useful nancial reports:

1. Materiality
Information is material if its omission or misstatement could in uence the decisions
that users make on the basis of an entity’s nancial information.
Materiality is not a matter to be considered by standard-setters but by preparers and
their auditors.

2. Cost-bene t
The bene ts of providing nancial reporting information should justify the costs of
providing that information.

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 Faithful Representation

Accounts must represent faithfully the phenomena it purports to represent

Faithful representations means

1. Substance over form

Faithful representation means capturing the real substance of the matter.

2. Represents the economic phenomena

Faithful means an agreement between the accounting treatment and the economic
phenomena they represent.
The accounts are veri able and neutral.

3. Completeness, Neutrality & Veri ability

Examples

Sell and buy back = Loan

An entity may sell some inventory to a nance house and later buy it back at a price based
on the original selling price plus a pre-determined percentage. Such a transaction is really
a secured loan plus interest. To show it as a sale would not be a faithful representation of
the transaction.

Convertible Loans
Another example is that an entity may issue convertible loan notes.

Management may argue that, as they expect the loan note to be converted into equity, the
loan should be treated as equity.

They would try to argue this as their gearing ratio would then improve. However, it is
recorded as a loan as primarily this is what it is.

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As noted previously, simply following rules in accounting standards can provide for
treatment which is essentially form over substance.

Whereas, users of accounts want the substance over form.

The concept behind faithful representation should enable creators of nancial statements
to faithfully represent everything through measures and descriptions above and beyond
that in the accounting standard if necessary.

Limitations to Faithful Representation

1. Inherent uncertainties
2. Estimates
3. Assumptions

Prudence

Watch the video HERE

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 Syllabus B1d) Evaluate the principles of recognition, derecognition and measurement,
including measurement uncertainty and materiality

Measurement Uncertainty And Relevance

Too many measurement techniques?

What makes a good measurement method?

• Its cost should be justi ed by the bene ts of reporting that information to users
• It should be the minimum necessary to provide relevant information
• It should mean infrequent changes (any necessary changes clearly explained)
• The same method for initial and subsequent measurement (for comparability and
consistency purposes)

The existing Conceptual Framework worryingly provides very little guidance on

measurement

Why not use one measurement basis for everything?

It may not provide the most relevant information to users - (although many call for the use
of current values to provide the most relevant information)

What methods do IFRSs therefore use?

Fair value, historical cost, present value and net realisable value.

Why?
Different information from different measurement bases may be relevant in different
circumstances.

So what's wrong with this?

Different measurement bases may mean the totals in nancial statements have little
meaning.

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 Using 'Current Value'
Pro t orientated businesses turn has market input values (inventory for example) into
market output values (sales of nished products)

Therefore current market values should play a key role in measurement.

This would be the most relevant measure of assets and liabilities for nancial reporting
purposes. (in these circumstances)

Mixed Measurement Approach

The IASB favour a mixed measurement approach - the most relevant method is selected.

Investors feel that this approach is consistent with how they analyse nancial statements

Maybe its problems of mixed measurement are outweighed by the greater relevance
achieved.

• IFRS 9 requires the use of cost in some cases and fair value in other cases
• IFRS 15 essentially applies cost allocation

Measurement Uncertainty
Measurement uncertainty of an item should be considered when assessing whether a
particular measurement basis provides relevant information.

However, most measurement is uncertain and requires estimation.

For example, recoverable value for impairment, depreciation estimates and fair value
measures at level 2 and 3 under IFRS 13.

The IASB thinks that the level of measurement uncertainty that makes information lack
relevance depends on the circumstances and can only be decided when developing
particular standards.
Cash- ow-based measurement can be used to customise measurement bases, which can
result in more relevant information but it may also be more dif cult for users to understand.
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 As a result the Exposure Draft does not identify those techniques as a separate category.

Areas of debate about measurement include:

1. Entry and exit values
2. Entity speci c values
3. Deprival values
4. Entity's business model

For example, property can be measured at historical cost or fair value depending upon the
business model.

The IASB believes that when selecting a measurement basis, the amount is more relevant
if the way in which an asset or a liability contributes to future cash ows is considered. The
IASB considers that the way in which an asset or a liability contributes to future cash ows
depends, in part, on the nature of the business activities.

Historic Cost
Seems to be the easiest but what about...
• Deferred payments
• Impairments
• Depreciation estimates
• Exchanges of assets

Current Values
Current values have a variety of alternative valuation methods.

These include:
• Market value (least ambiguous)
• Value in Use
• Ful lment Value

In the main, the details of how these different measurement methods are applied, are set
out in each accounting standard.

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 Chapter 3—Financial Statements And The Reporting
Entity

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 Chapter 4—The Elements Of Financial Statements -
Assets & Liabilities

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An asset is a present economic resource controlled by the entity as a result of past events.
An economic resource is a right that has the potential to produce economic bene ts.

This section discusses three aspects of those de nitions:

Rights
These come from obligation of others (eg they owe you cash/goods/services)
These also come when there's no obligation of others (eg Use of Property)
These come from contract (eg Leasing an object)
Conceptually, the economic resource is the set of rights, not the physical object.
There may be a dispute over a right. Until that uncertainty is resolved—for example, by a
court ruling—it is uncertain whether an asset exists

Potential to produce economic bene ts

No need to be certain, or even likely, just that in one circumstance, it would produce
economic bene ts

However, low probability might affect decisions about whether the asset is recognised and
how it is measured.
The economic resource is the present right that contains that potential, not the future
economic bene ts
Paying for an object isn't conclusive proof it's an asset and vice-versa. Eg Government
granted rights

Control
Control links an economic resource to an entity.
It helps to identify the economic resource. Eg You control a share of a property so the
asset is that share not the entire property
Control means the present ability to direct the use of the economic resource including
preventing others from doing so.
It usually comes from legal rights but not always. Eg A right to use (not patented) know-
how if it can keep it secret
Control is also indicated by exposure to signi cant variations in bene ts, but it is only one
factor

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A liability is a present obligation of the entity to transfer an economic resource as a
result of past events.

For a liability to exist, three criteria must all be satis ed:

Obligation
Something you have no practical ability to avoid.
You can owe it even to society - you don't need to know their identity
Just because you have a liability of 100 doesn't mean the other party has an asset of 100
Eg. some IFRS contain different recognition criteria for liabilities and assets

They're normally from contracts but can just be from customary practices, published
policies or speci c statements. This is called a ‘constructive obligation’.
The obligation may be conditional (eg options in a contract) - here a liability exists only if
there's no practical ability to avoid it
You can't argue that liquidation is a practical way to avoid something - as you are deemed
to be a going concern
No practical ability to avoid means when avoiding it you'd be signi cantly worse off than
not avoiding it

Transfer of an economic resource

This, again, does not have to be probable, only that, in at least one circumstance, it would
require the entity to transfer an economic resource.

Instead of paying sometimes the following happen:

(a) settle the obligation by negotiating a release from the obligation;
(b) transfer the obligation to a third party; or
(c) replace that obligation to transfer an economic resource with another obligation by
entering into a new transaction.

Here, an entity has the obligation to transfer an economic resource until it has settled,
transferred or replaced that obligation.

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 Present obligation as a result of past events
This means:
(a) the entity has already obtained economic bene ts or taken an action; and
(b) as a consequence, the entity will or may have to transfer an economic resource that it
would not otherwise have had to
The enactment of legislation is not in itself suf cient to give an entity a present obligation.
Similarly, an entity’s customary practice becomes an obligation only when it has obtainined
economic bene ts (or took an action) and so now has to transfer an economic resource
that it would not otherwise have had to
A present obligation can exist even if a transfer is only enforceable in the future. Eg. a
contractual liability to pay cash may exist now even if the contract does not require a
payment until a future date.
If an entity has entered into a contract with an employee, there's no present obligation to
pay the salary until it has received the employee’s services. (Before then the contract is
executory)

De nition of Equity
Equity is the residual interest in the assets of the entity after deducting all its liabilities

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 Chapter 4—The Elements Of Financial Statements -
Units of Account

Watch the video HERE

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 Chapter 5: Recognition

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So we recognise Assets / Liabilities / Income / Expense when it is RELEVANT to do so and
in doing so the item is FAITHFULLY REPRESENTED

An item may not be RELEVANT if it has a very low probability of bringing in bene ts

An item may not be RELEVANT if it has a very high existence uncertainty

An item may not be FAITHFULLY REPRESENTED if it's measurement is highly uncertain

Everything is principle based. Different circumstances will need different levels of

probability etc

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 Chapter 5: De-Recognition

Transferred Component
The assets / Liabilities that have been transferred to another party - these are normally
derecognised - and Income / expenses shown

Retained Component
Any assets / liabilities left over - these are not derecognised and no Income / expenses
shown

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 Strange Situations

... where we don't derecognise

1. Asset transferred but retains exposure to signi cant variations in bene ts
2. Asset transferred to an agent of yours (holding it for you)
3. Asset transferred and, at the same time, entered into another transaction that results in
rights or obligations to reacquire the asset.
Eg a forward contract, a written put option, or a purchased call option

Modi ed Contracts

1. Only eliminates existing rights or obligations, normal derecognition rules apply

2. Only adds new rights or obligations, either show as new Assets and Liabilities or...
as part of the same unit of account as the existing rights and obligations
(whichever gives best Faithful Representation)
3. Both eliminates existing rights/obligations and adds new ones
Potentially so big a modi cation that in substance, the modi cation replaces the old
asset or liability with a new asset or liability.
So, derecognise the original asset or liability, and recognise the new asset or liability.

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 Chapter 6: Measurement

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We all like a bit of Simpli cation, right?

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Chapter 6: Measurement - Factors to Consider

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 Reporting Of Items In The Soci And Oci

The performance of a company is reported in the statement of pro t or loss

and other comprehensive income

The statement of pro t or loss is the primary source of information about an entity’s
nancial performance

Therefore, all income and expenses are, in principle, included in that statement.

However, in developing Standards, the Board may decide in exceptional circumstances

that income or expenses are to be included in OCI

(when doing so would result in the statement of pro t or loss providing more relevant
information, or providing a more faithful representation of nancial performance)

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 What gets recycled?

In principle, OCI items are reclassi ed into the statement of pro t or loss in a future period

(Again when doing so results in the statement of pro t or loss providing more relevant
information, or providing a more faithful representation of nancial performance)

However, if there is no clear basis for identifying the period (or amount) in which
reclassi cation would have that result the Board may, in developing Standards, decide that
no reclassi cation is allowed

Recycled means - gains or losses are rst recognised in the OCI and then in a later
accounting period also recognised in the P/L.

What gets recycled:

• The re-translation of a Sub’s goodwill and net assets. (IAS 21)

First - exchange differences are recognised in OCI (and OCE reserve)
Then - when the sub is disposed of - The OCE reserve is emptied and reclassi ed to
P&L - to form part of the pro t on disposal.

• The effective portion of gains and losses on hedging instruments in a cash ow

hedge under IFRS 9

What doesn't get re-cycled?

• Revaluations' gains and losses (IAS 16) - these go the OCI (and OCE reserve)
On disposal - they are not re-cycled to the P/L - instead there's a transfer in the SO`CIE,
from the OCE into RE.

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• FVTOCI items (IFRS 9) - Gains/losses on these go to OCI (and OCE reserve) but
again on disposal no re-cycling to P/L just a reserves transfer

Note: With no reclassi cation the earnings per share will never fully include the gains on
the sale of PPE and FVTOCI investments.

• Remeasurements of a net de ned bene t liability or asset recognised in

accordance with IAS 19

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Syllabus C: REPORTING THE FINANCIAL
PERFORMANCE OF ENTITIES
Syllabus C1. Performance reporting

Syllabus C1a) Discuss and apply the criteria that must be met before an entity can recognise
revenue.

Criteria for IFRS 15

The following must be ok (at inception) before IFRS 15 can be used

1. Both parties have enforceable rights / obligations

2. Contract approved - (as long as both parties cannot unilaterally terminate)

3. Payment terms agreed (not necessarily xed payments)

4. Commercial substance to the contract

5. Customer can (probably) and intends to pay

These are re-assesses later if not met at inception

IFRS15 applies to all contracts except for:

• Lease Contracts

• Insurance Contracts

• Financial instruments and other contractual rights/obligations within the scope of lAS
39/lFRS 9, lFRS 10, lFRS 11, lAS 27 and lAS 28

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• Non-monetary exchanges between entities within the same business to facilitate
sales

Lets say a bank gives you a mortgage (Financial liability) and some other services to do
with the property

The mortgage would be IFRS 9

And the other services probably IFRS 15

Basically if another standard deals with the issue - use that standard!

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 Syllabus C1b) Discuss and apply the criteria for recognition of contract revenue and contract costs
including contract modi cations.

Revenue Recognition - IFRS 15 - introduction

When & how much to Recognise Revenue?

Here you need to go through the 5 step process…

1. Identify the contract(s) with a customer

2. Identify the performance obligations in the contract

3. Determine the transaction price

4. Allocate the transaction price to the performance obligations in the contract

5. Recognise revenue when (or as) the entity satis es a performance obligation

Before we do that though, let’s get some key de nitions out of the way..

Key de nitions

• Contract

An agreement between two or more parties that creates enforceable rights and
obligations.

• Income

Increases in economic bene ts during the accounting period in the form of

increasing assets or decreasing liabilities

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• Performance obligation

A promise in a contract to transfer to the customer either:

- a good or service that is distinct; or

- a series of distinct goods or services that are substantially the same and that have
the same pattern of transfer to the customer.

• Revenue

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

• 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.

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 Revenue Recognition - IFRS 15 - 5 steps

Ok let’s now get into a bit more detail…

Step 1: Identify the contract(s) with a customer

• The contract must be approved by all involved

• Everyone’s rights can be identi ed

• It must have commercial substance

• The consideration will probably be paid

Step 2: Identify the separate performance obligations in the contract

This will be goods or services promised to the customer

These goods / services need to be distinct and create a separately identi able
obligation

• Distinct means:

The customer can bene t from the goods/service on its own AND

The promise to give the goods/services is separately identi able (from other promises)

• Separately identi able means:

No signi cant integrating of the goods/service with others promised in the contract

The goods/service doesn’t signi cantly modify another good or service promised in the
contract.

The goods/service is not highly related/dependent on other goods or services promised

in the contract.

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 Step 3: Determine the transaction price

How much the entity expects, considering past customary business practices

• Variable Consideration
If the price may vary (eg. possible refunds, rebates, discounts, bonuses, contingent
consideration etc) - then estimate the amount expected

• However variable consideration is only included if it’s highly probable there won’t
need to be a signi cant revenue reversal in the future (when the uncertainty has been
subsequently resolved)

• However, for royalties from licensing intellectual property - recognise only when the
usage occurs

Step 4: Allocate the transaction price to the separate performance obligations

If there’s multiple performance obligations, split the transaction price by using

their standalone selling prices. (Estimate if not readily available)

• How to estimate a selling Price

- Adjusted market assessment approach

- Expected cost plus a margin approach
- Residual approach (only permissible in limited circumstances).

• If paid in advance, discount down if it’s signi cant (>12m)

Step 5: Recognise revenue when (or as) the entity satis es a performance
obligation

Revenue is recognised as control is passed, over time or at a point in time.

• What is Control
It’s the ability to direct the use of and get almost all of the bene ts from the asset.

This includes the ability to prevent others from directing the use of and obtaining the
bene ts from the asset.

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 • Bene ts could be:

- Direct or indirect cash ows that may be obtained directly or indirectly

- Using the asset to enhance the value of other assets;

- Pledging the asset to secure a loan

- Holding the asset.

• So remember we recognise revenue as asset control is passed (obligations satis ed)

to the customer

This could be over time or at a speci c point in time.

Examples (of factors to consider) of a speci c point in time:

1. The entity now has a present right to receive payment for the asset;

2. The customer has legal title to the asset;

3. The entity has transferred physical possession of the asset;

4. The customer has the signi cant risks and rewards related to the ownership of the
asset; and

5. The customer has accepted the asset.

Contract costs - that the entity can get back from the customer

These must be recognised as an asset (unless the subsequent amortisation would be

less 12m), but must be directly related to the contract (e.g. ‘success fees’ paid to
agents).

Examples would be direct labour, materials, and the allocation of overheads - this
asset is then amortised

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 Revenues - Presentation in nancial statements

Show in the SFP as a contract liability, asset, or a receivable, depending on

when paid and performed

i.e.. Paid upfront but not yet performed would be a contract liability

Dr Cash

Cr Contract Liability

i.e.. Paid later but already performed

Dr Receivable

Cr Revenue (see below)

Performed but not paid would be a contract receivable or asset

1. A contract asset if the payment is conditional (on something other than time)

2. A receivable if the payment is unconditional

Contract assets and receivables shall be accounted for in accordance with IFRS 9.

Disclosures

All qualitative and quantitative information about:

• its contracts with customers;

• the signi cant judgments in applying the guidance to those contracts; and

• any assets recognised from the costs to ful l a contract with a customer.

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 Incremental Costs Of Obtaining A Contract

These are recognised as an asset (if they are expected to be recovered from
the customer)

• Incremental means these costs ONLY occurred due to the contract eg Sales
commission
• If amortisation of these costs would be

Example

1. Due diligence on a potential customer = Expense

(Incurred whether even if we don't take on the customer)
2. Commissions to sales employees = Asset and amortised
(Incurred only for the customer contract & recovery expected through future sales)

Costs To Ful l A Contract

First, be careful these aren't just normal costs dealt under their own standard (eg IAS 2
Inventories, IAS 16 PPE & IAS 38 Intangibles)

Otherwise we again recognise these as an asset if they:

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1. Relate directly to the contract
2. Generate resources we are going to use when we sell
3. Are expected to be recovered

Examples to show as assets include:

Direct labour and Materials

Allocations of depreciation or insurance
Anything explicitly chargeable to the customer
Subcontractor costs

Examples to expense include:

General and administrative costs (not explicitly chargeable to the customer)

Wasted materials, labour and other resources

Costs relating to satis ed or partially satis ed performance obligations (past performance)

must be expensed also

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 Syllabus C1c) Evaluate and apply the recognition and measurement of revenue including
performance obligations satis ed over time, sale with a right of return, repurchase agreements,
consignment arrangements, warranties, variable consideration, principal versus agent considerations
and non-refundable up- front fees.

Speci c IFRS 15 Scenarios

Sale With A Right Of Return

Here we mean the Customer has the right to receive:

1. A refund
2. Credit
3. A different product in exchange

(Please note the right to get for example a different colour or size isn't a return here)

Accounting treatment for Right to Return items

1. Reduce Revenue by the expected value of returns

2. Instead Dr Revenue Cr Refund liability

(Inventory of expected return items excluded from cost of sales)

In subsequent periods, the vendor updates its expected levels of returns, adjusting the
measurement of the refund liability and the associated inventory asset.

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Warranties

Assurance Warranties

These (normally free) warranties simply provide assurance the product complies with
agreed-upon speci cations

These are just bundled into the revenue for the product and a provision for the warranty
costs is made using IAS 37 as normal

Service Warranties

These (normally paid for) warranties provides a service in addition to the assurance.

These are normally:

1. Not required by law
2. For longer periods

These warranties are therefore separate performance obligations

Example

A customer buys an item for $100,000, with a one-year standard warranty that speci es
the equipment will comply with the agreed-upon speci cations and will operate as
promised for a one-year period from the date of purchase.

She also buys an extra $2,000 two-year warranty commencing after the expiry of the
standard one- year warranty.

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There are two warranties in this contract:
1. assurance-type warranty — for rst year after purchase
2. service-type warranty — for two years after expiry of the initial standard warranty.

The service-type warranty and is accounted for as a separate performance obligation.

Deferred revenue of $2,000 is recognised until the performance obligation is satis ed.

The assurance-type warranty is accounted for using IAS 37 Provisions

Non-Refundable Upfront Fees

When the upfront fee received is just an advance payment for future services, recognised
as revenue when those future services are provided.

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Principal vs. Agent

The Principal controls the good before transfer to the customer

The Agent does not control the good before transfer to the customer. So the following
normally are indicators you're an agent

• Another party is primarily responsible for ful lling the contract

• You don't take inventory risk before or after a customer order
• You don't set prices
• You receive commission only
• You take no credit risk for the amount receivable

Accounting treatment for Principal

Show gross revenue and cost of sales

Accounting treatment for Agent

Show commission only as revenue

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 Exam Standard Illustrations

Illustration 1 - Agent or not?

An entity negotiates with major airlines to purchase tickets at reduced rates

It agrees to buy a speci c number of tickets and must pay even if unable to resell them.

The entity then sets the price for these ticket for its own customers and receives cash
immediately on purchase

The entity also assists the customers in resolving complaints with the service provided
by airlines. However, each airline is responsible for ful lling obligations associated with
the ticket, including remedies to a customer for dissatisfaction with the service.

How would this be dealt with under IFRS 15?

Step 1: Identify the contract(s) with a customer

This is clear here when the ticket is purchased

Step 2: Identify the performance obligations in the contract

This is tricky - is it to arrange for another party provide a ight ticket - or is it - to provide
the ight ticket themselves?

Well - look at the risks involved. If the ight is cancelled the airline pays to reimburse,

If the ticket doesn't get sold - the entity loses out

Look at the rewards - the entity can set its own price and thus rewards

On balance therefore the entity takes most of the risks and rewards here and thus
controls the ticket - thus they have the obligation to provide the right to y ticket

Step 3: Determine the transaction price

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This is set by the entity

Step 4: Allocate the transaction price to the performance obligations in the

contract

The price here is the GROSS amount of the ticket price (they sell it for)

Step 5: Recognise revenue when (or as) the entity satis es a performance
obligation

Recognise the revenue once the ight has occurred

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Illustration 2 - Loyalty discounts

An entity has a customer loyalty programme that rewards a customer with one
customer loyalty point for every $10 of purchases.

Each point is redeemable for a $1 discount on any future purchases

Customers purchase products for $100,000 and earn 10,000 points

The entity expects 9,500 points to be redeemed, so they have a stand-alone selling
price $9,500

How would this be dealt with under IFRS 15?

Step 1: Identify the contract(s) with a customer

This is when goods are purchased

Step 2: Identify the performance obligations in the contract

The promise to provide points to the customer is a performance obligation along with,
of course, the obligation to provide the goods initially purchased

Step 3: Determine the transaction price

$100,000

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Step 4: Allocate the transaction price to the performance obligations in the
contract

The entity allocates the $100,000 to the product and the points on a relative stand-
alone selling price basis as follows:

So the standalone selling price total is 100,000 + 9,500 = 109,500

Now we split this according to their own standalone prices pro-rata

Product $91,324 [100,000 x (100,000 / 109,500]

Points $8,676 [100,000 x 9,500 /109,500]

Step 5: Recognise revenue when (or as) the entity satis es a performance
obligation

Of course the products get recognised immediately on purchase but now lets look at
the points..

Let’s say at the end of the rst reporting period, 4,500 points (out of the 9,500) have
been redeemed

The entity recognises revenue of $4,110 [(4,500 points ÷ 9,500 points) × $8,676] and
recognises a contract liability of $4,566 (8,676 – 4,110) for the unredeemed points

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 Syllabus C2. Non-current Assets

Syllabus C2a) Discuss and apply the recognition, derecognition and measurement of non-current
assets including impairments and revaluations.

Initial Recognition of PPE

When should we bring PPE into the accounts?

When the following 3 tests are passed:

1. When we control the asset

2. When it’s probable that we will get future economic bene ts

3. When the asset’s cost can be measured reliably

What gets included in ‘Cost’

1. Directly attributable costs to get it to work and where it needs to be

eg. site preparation, delivery and handling, installation, related professional fees for
architects and engineers

2. Estimated cost of dismantling and removing the asset and restoring the site.

This is:
Dr PPE
Cr Liability

All at present value

This will need discounting and the discount unwound:

Dr interest (with unwinding of discount)
Cr liability

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3. Borrowing costs

If it is an asset that takes a while to construct.

Interest at a market rate must be recognised or imputed.

Let's look at the Future obligated costs in detail..

Future obligated costs

Dr PPE
Cr Liability

at present value

• The present value is calculated by discounting down at the rate given in the exam

eg. 100 in 2 years time at 10% = 100/1.10/1.10 = 82.6

• So the double entry would be:

Dr PPE 82.6
Cr Liability 82.6

However the LIABILITY needs unwinding..

• Unwinding of discount

Dr Interest
Cr Liability

Use the original discount rate (so here 10%)

10% x 82.6 = 8.26

Dr Interest 8.26
Cr Liability 8.26

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 IAS 16 Depreciation

The depreciable amount (cost less prior depreciation, impairment, and

residual value) should be allocated on a systematic basis over the asset’s
useful life

Residual Value & UEL

• Should be reviewed at least at each nancial year-end

• if expectations differ from previous estimates, any change is accounted

for prospectively as a change in estimate.

Which Method of Depreciation should be used?

It should re ect the pattern in which the asset’s economic bene ts are consumed
by the enterprise

How often should depreciation methods be reviewed?

• At least annually

• If the pattern of consumption changes, the depreciation method should be changed

prospectively as a change in estimate.

Accounting treatment

Depreciation should be charged to the income statement

Depreciation begins when the asset is available for use and continues until the asset
is de-recognised

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 Signi cant parts are depreciated separately

• If the cost model is used each part of an item of PPE with a signi cant cost (in
relation to the total cost) must be depreciated separately

• Parts which are regularly replaced - depreciate separately.

The replacement cost is then added to the asset cost when recognition criteria are met.

The carrying amount of the replaced parts is de-recognised

Major Inspections for faults (e.g. Aircraft)

The inspection cost is added to the asset cost when recognition criteria are met

If necessary, the estimated cost of a future similar inspection may be used as an

indication of what the cost of the existing inspection component was when the item was
acquired or constructed

An asset with a component included with a different UEL:

This could be something like Land and buildings - basically you should take the land
value away from the total cost and then depreciate the remainder over the UEL of the
building.

• Illustration

Buy House for 100,000.

The land has a value of 40,000.
UEL of building is 10 years

• Solution:

The value of the building itself is: 100,000 - 40,000 = 60,000

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Depreciation would be:
Land 40,000 - zero depreciation
Building 60,000 / 10 years = 6,000

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 PPE - After Initial recognition

After the initial recognition there are 2 choices:

Cost model

• Cost less accumulated depreciation and impairment

• Depreciation should begin when ready for use not wait until actually used

Revaluation model

Fair value at the date of revaluation less depreciation

• If we follow the revaluation model - how often should we revalue?

Revaluations should be carried out regularly

For volatile items this will be annually, for others between 3-5 years or less if deemed
necessary.

• Ok and which assets get revalued?

If an item is revalued, its entire class of assets should be revalued

• And to what value?

Market value normally is fair value.

Specialised properties will be revalued to their depreciated replacement cost.

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Accounting treatment of a Revaluation

An increase in the revalued amount (above depreciated historic cost)

Any increase above depreciated historic cost is credited to equity under the heading
"revaluation surplus" (and shown in the OCI)

DR Asset
CR equity - “revaluation surplus”

An increase in the revalued amount (up to depreciated historic cost)

is taken to the income statement.

DR Assets
CR I/S

A decrease down to Historic cost

Any decrease down to depreciated historic cost is taken to the revaluation reserve (and
OCI) as a debit.

DR equity - “revaluation surplus”

CR Assets

A decrease below historic cost

Any decrease below depreciated historic cost is debited to the income statement

DR Income statement
CR Assets

Disposal of a Revalued Asset

The revaluation surplus in equity - IS NOT transferred to the income statement - it just
drops into RE.

It will, therefore, only show up in the statement of changes in equity.

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Let´s make no mistake about this - the revaluation adjustments can be very
tricky.

when you revalue upwards:

1. the asset will increase .... therefore

2. the depreciation will increase ... and hence

3. the expenses will increase ...

4. This means smaller pro ts and smaller retained earnings just because of the
revaluation!

Shareholders will not be impressed by this as retained earnings are where they are
legally allowed to get their dividends from.

Because of this, a transfer is made out of the revaluation reserve and into retained
earnings every year with the extra depreciation caused by the previous revaluation.

This, though, then causes more problems if the asset is subsequently impaired etc. -
but worry not - the COW has the answer!

This is what you do in a tricky looking revaluation question:

1. Calculate the Depreciated Historic Cost

This is basically what the asset would have been worth had nothing (revaluations/
impairments) occurred in the past.

We do this because anything above this gure is a genuine revaluation and so goes to
the RR.

Similarly anything below this is a genuine impairment and goes to the income
statement.

2. Calculate the NBV just before the Revaluation or Impairment in question

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3. Now calculate the difference between step 2 and the new NBV (the amount to
be revalued or impaired to).

This will be the debit or credit to the asset.

The other side of the entry will depend on the depreciated historic cost calculated in
step 1.

I know all that sounds tricky - so let’s look at an illustration:

Illustration

An asset is bought for 1,000 (10yr UEL).

2 years later it is revalued to 1,000.
One year after that it is impaired to 400.

What is the double entry for this impairment?

1. Calculate the Depreciated Historic Cost

DHC would be 1,000 less 3 years of depreciation = 700

2. Calculate the NBV just before the Impairment

NBV at date of impairment = 1000 NBV one year earlier.

So 1,000 less depreciation of (1,000 / 8) = 125 = 875

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3. Now calculate the difference between step 2 and the amount to be impaired to

Impair to 400.

So from 875 to 400 - credit Asset 475

4. Accounting treatment

Dr RR with any amount above the DHC of 700. So 875-700 = 175

Dr I/S with any amount below DHC of 700. So 700-400 = 300

Dr I/S 300
Dr RR 175
Cr PPE 475

Illustration

1/1/20x2 an asset has a carrying amount of 140 and a remaining UEL of 7 years. No
residual value. The asset is revalued to 60 on 1/1/20x3.

On 1/120x5 the asset is revalued to 110

1. Calculate the Depreciated Historic Cost

DHC would be 140 - depreciation (140 / 7 years x 3 years) = 80

2. Calculate the NBV just before the Revaluation

The asset is revalued to 60 on 1/1/20x3.

So 60 less depreciation of (60 / 6 x 2) = 40

3. Now calculate the difference between step 2 and the amount to be revalued to

On 1/120x5 the asset is revalued to 110

So from 40 to 110 - DR Asset 70

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4. Accounting treatment

Cr RR with any amount above the DHC of 80. So 110-80 = 30

Cr I/S with any amount below DHC of 80. So 80-40 = 40

Dr PPE 70
Cr I/S 40
Cr RR 30

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Review Page

1. PPE costs $1,000, has installation costs of $100, dismantling fee with a present value of
$50 and some losses expected at rst while operators get used to the system of $50. At
what Value should the PPE be in the accounts initially?

2. The PPE above has a 10 yr. UEL but is not used for the rst year. How much is
depreciation and from when?

3. A piece of PPE has a dismantling fee in 2 years of $1,000 and the discount rate is 10%.
What entries would be put in the accounts for this in year 1?

4. What is the best method for depreciation? Reducing balance or straight line?

5. An item of PPE is bought for 1,000 and has a 10 yr. UEL. What is the NBV in 3 years
time?

6. The PPE above is then revalued 1,050. How is this increase accounted for?

7. What would the depreciation charge be for the following year?

8. At the end of that year what is the NBV?

9. What is the Depreciated Historic Cost?

10. It is now revalued down to 400. How is this fall accounted for?

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Exam Standard Question

A piece of property, plant and equipment (PPE) cost $12 million on 1 May 2008. It is being
depreciated over 10 years on the straight-line basis with zero residual value.

On 30 April 2009, it was revalued to $13 million and on 30 April 2010, the PPE was
revalued to $8 million.

The whole of the revaluation loss had been posted to the statement of comprehensive
income and depreciation has been charged for the year.

Make any adjustments necessary for the year ended 30 April 2010

Answer
At 30 April 2009, a revaluation gain of ($13m – $12m – depreciation $1·2m) $2·2 million
would be recorded in equity for the PPE. At 30 April 2010, the carrying value of the PPE
would be $13m – depreciation of $1·44m i.e. $11·56m.

Thus there will be a revaluation loss of $11·56m – $8m i.e. $3·56m. Of this amount $1·96m
will be charged against revaluation surplus in reserves and $1·6 million will be charged to
profit or loss.

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 Componentisation

Various components of an asset to be identi ed and depreciated separately if

they have differing patterns of bene ts.

If a signi cant component is expected to wear out quicker than the overall asset, it is
depreciated over a shorter period.

Then any restoring or replacing is capitalised.

This approach means different depreciation periods for different components.

Examples are land, roof, walls, boilers and lifts.

So the depreciation re ects the effect of a future restoration or replacement.

A challenging process due to..

• Dif culties valuing components

because it is unusual for the various component parts to be valued, so..

1. Involve company personnel in the analysis

2. Applying component accounting to all assets

3. How far the asset should be broken down into components

4. Any measure used to determine components is subjective

5. Asset registers may need to be rewritten

6. Breaking down assets needs ‘materiality', setting a de minimis limit

• When a component is replaced or restored

The old component is de-recognised to avoid double-counting and the new component
recognised.

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• Where it is not possible to determine the carrying amount of the replaced part
of an item of PPE

Best estimates are required.

A possibility is:

Use the replacement cost of the component, adjusted for any subsequent
depreciation and impairment

• A revaluation

Apportion over the signi cant components.

• When a component is replaced

1. The carrying value of the component replaced should be charged to the income
statement

2. The cost of the new component recognised in the statement of nancial position

Transition to IFRS

Use the ‘fair value as deemed cost’ for the asset:

The fair value is then allocated to the different signi cant parts of the asset

Componentisation adds to subjectivity.

The additional depreciation charge can be signi cant.

Accountants and other professionals must use their professional judgment when
establishing signi cance levels, assessing the useful lives of components and
apportioning asset values over recognised components.

Discussions with external auditors will be key one during this process

IAS 36 Impairments

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 A company cannot show anything in its accounts higher than what they’re
actually worth

“What they’re actually worth” is called the “Recoverable Amount”

So no asset can be in the accounts at MORE than the recoverable amount.

Less is ne, just not more.

So, assets need to be checked that their NBV is not greater than the RA.

If it is then it must be impaired down to the RA

So how do you calculate a Recoverable Amount?

There are 2 things an entity can do with an asset

1. Sell it or

2. Use it

It will obviously choose the one which is most bene cial

So, you'll choose the higher of the following

• FV-CTS

(Fair value less costs to sell)

• VIU

(Value in use)

So the higher of the FV - CTS and VIU is called the Recoverable amount

Illustration

In the accounts an item of PPE is carried at 100.

It’s FV-CTS is 90 and its VIU is 80.

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• This means the recoverable amount is 90 (higher of FV-CTS and VIU)

• And that the PPE (100) is being carried at higher than the RA, which is not allowed,
and so an impairment of 10 down to the RA is required in the accounts (100 - 90)

Recognition of an Impairment Loss

An impairment loss should be recognised whenever RA is below carrying amount.

The impairment loss is an expense in the income statement

Adjust depreciation for future periods.

Here's some boring de nitions for you:

• Fair value
The amount obtainable from the sale of an asset in a bargained transaction between
knowledgeable, willing parties.

• Value in use
The discounted present value of estimated future cash ows expected to arise from:

- the continuing use of an asset, and from

- its disposal at the end of its useful life

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 Recoverable Amount in more detail

Fair Value Less Costs to Sell

• If there is a binding sale agreement, use the price under that agreement less costs of
disposal

• If there is an active market for that type of asset, use market price less costs of
disposal.

Market price means current bid price if available, otherwise the price in the most recent
transaction

• If there is no active market, use the best estimate of the asset's selling price less
costs of disposal (direct added costs only (not existing costs or overhead))

Let's look at VIU in more detail..

The future cash ows:

• Must be based on reasonable and supportable assumptions

(the most recent budgets and forecasts)

• Budgets and forecasts should not go beyond ve years

• The cash ows should relate to the asset in its current condition

– future restructuring to which the entity is not committed and expenditures to improve
the asset's performance should not be anticipated

• The cash ows should not include cash from nancing activities, or income tax

• The discount rate used should be the pre-tax rate that re ects current market
assessments of the time value of money and the risks speci c to the asset

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Identifying an Asset That May Be Impaired

At each balance sheet date, review all assets to look for any indication that an asset
may be impaired.

If there is an indication that an asset may be impaired, then you must calculate the
asset’s recoverable amount... to see if it is below carrying value

if it is - then you must impair it

Illustration

Asset has carrying value of 100

It has a FV-CTS of 90

It has a VIU of 95

It's recoverable amount is therefore the higher of the 2 = 95 and this is below the
carrying value in the books (100) and so needs impairment of 5.

What are the indicators of impairment?

1. Losses / worse economic performance

2. Market value declines

3. Obsolescence or physical damage

4. Changes in technology, markets, economy, or laws

5. Increases in market interest rates

6. Loss of key employees

7. Restructuring / re-organisation

Just to confuse you a little bit more, we do not JUST check for impairment when there
has been an indicator (listed above).

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We also check the following ANNUALLY regardless of whether there has been an
impairment indicator or not:

1. an intangible asset with an inde nite useful life

2. an intangible asset not yet available for use

3. goodwill acquired in a business combination

Reversal of an Impairment Loss

First of all you need to think about WHY the impairment has been reversed..

1. Discount Rate Changes

Here, no reversal is allowed. So if the discount rate lowers and thus improves the VIU,
this is not considered to be a reversal of an impairment.

2. Other

The increased carrying amount due to reversal should not be more than what the
depreciated historical cost would have been if the impairment had not been recognised

3. Accounting treatment

Reversal of an impairment loss is consistent with the original treatment of the

impairment in terms of whether recognised as income in the income statement or OCI.

Reversal of an impairment loss for goodwill is prohibited.

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 Cash Generating Units

Sometimes individual assets do not generate cash in ows so the calculation

of VIU is impossible

In such a case then the asset will belong to a larger group that does generate cash.

This is called a cash generating unit (CGU) and it is the carrying value of this which is
then tested for impairment

Recoverable amount should then be determined for the asset's cash-generating unit
(CGU)

CGU - A restaurant

For example, the tables in a restaurant do not generate cash.

They do belong to a larger CGU though (the restaurant itself).

It is the restaurant that is then tested for impairment

The carrying amount of the CGU is made up of the carrying amounts of all the assets
directly attributed to it.

Added to this will be assets that are not directly attributed such as head of ce and a
portion of goodwill.

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Illustration

A subsidiary was acquired, which included 3 cash generating units and the goodwill for
the whole subsidiary was 40m

Each CGU would be allocated part of the 40 according to the carrying amount of the
assets in each CGU as follows:

CGU 1 2 3

NBV 200 200 400

Goodwill 10 10 20

A CGU to which goodwill has been allocated (like the 3 above) shall then be tested for
impairment at least annually by comparing the carrying amount of the unit, including the
goodwill, with the recoverable amount of the CGU

If the carrying amount of the unit exceeds the recoverable amount of the unit, the entity
must recognise an impairment loss (down to the unit’s RA)

Order of Impairment

But the problem is what do you impair rst - the assets or the goodwill in the unit?

The impairment loss is allocated in the following order:

1. Reduce any goodwill allocated to the CGU

2. Reduce the assets of the unit pro rata

Note: The carrying amount of an asset should not be reduced below its own
recoverable amount

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Illustration

The following carrying amounts were recorded in the books of a restaurant immediately
prior to the impairment:

Goodwill 100

Property, plant and equipment 100

Furniture and xtures 100

The fair value less costs to sell of these assets is $260m whereas the value in use is
$270m

Required: Show the impact of the impairment

Solution

Recoverable amount is 270 - so the CV of the CGU needs to be reduced from 300 to
270 = 30

This 30 reduces goodwill down to 70

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Review Page

1. When do you check for impairment?

2. What is recoverable amount?

3. If RA is higher than the carrying amount what do you do?

4. If RA is lower than the carrying amount what do you do?

5. What if the asset that is being checked for impairment is not a cash generating unit what
must you do?

6. What are steps for calculating the correct impairment to goodwill when the proportionate
method is used?

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 Exam Standard Question

A subsidiary company had purchased computerised equipment for $4 million on 31

October 2006 to improve the manufacturing process.

Whilst re-organising the group, Ghorse had discovered that the manufacturer of the
computerised equipment was now selling the same system for $2·5 million. The projected
cash ows from the equipment are:

Year ended 31 October

2008 $1·3
2009 $2·2
2010 $2·3
The residual value of the equipment is assumed to be zero.

The company uses a discount rate of 10%. The directors think that the fair value less costs
to sell of the equipment is $2 million. The directors of Ghorse propose to write down the
non-current asset to the new selling price of $2·5 million.

The company’s policy is to depreciate its computer equipment by 25% per annum on the
straight line basis. (5 marks)

Solution

At each balance sheet date, Ghorse should review all assets to look for any indication that
an asset may be impaired, i.e. where the asset’s carrying amount ($3 million) is in excess
of the greater of its net selling price and its value in use.

IAS36 has a list of external and internal indicators of impairment. If there is an indication
that an asset may be impaired, then the asset’s recoverable amount must be calculated
(IAS36 paragraph 9).

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The recoverable amount is the higher of an asset’s fair value less costs to sell (sometimes
called net selling price) and its value in use which is the discounted present value of
estimated future cash ows expected to arise from:

(i) the continuing use of an asset, and from

(ii) its disposal at the end of its useful life

If the manufacturer has reduced the selling price, it does not mean necessarily that the
asset is impaired. One indicator of impairment is where the asset’s market value has
declined signi cantly more than expected in the period as a result of the

passage of time or normal usage. The value-in-use of the equipment will be $4·7 million.

Cash Discounted at 10%

$m
2008 1·2
2009 1·8
2010 1·7
––––
Value in use – 4·7
––––

The fair value less costs to sell of the asset is estimated at $2 million. Therefore, the
recoverable amount is $4·7 million which is higher than the carrying value of $3 million
and, therefore, the equipment is not impaired

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 Syllabus C2b) Discuss and apply the accounting requirements for the classi cation and
measurement of non-current assets held for sale.

Assets Held for Sale

How do we deal with items in our accounts which we are no longer going to
use, instead we are going to sell them

So, think about this for a moment.. Why does this matter to users?

Well, the accounts show the business performance and position, and you expect to see
assets in there that they actually are looking to continue using.

Therefore their values do not have to be shown at their market value necessarily (as
your intention is not to sell them)

Here, though, everything changes… we are going to sell them.

So maybe market value is a better value to use, but they haven’t been sold yet, so
showing them at MV might still not be appropriate as this value has not yet been
achieved

So these are the issues that IFRS 5 tried, in part, to deal with and came up with the
following solution..

Accounting Treatment

1. Step 1 - Calculate the Carrying Amount...

Bring everything up to date when we decide to sell

This means:

- charge the depreciation as we would normally up to that date or

- revalue it at that date (if following the revaluation policy)

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2. Step 2 - Calculate FV - CTS

Now we can get on with putting the new value on the asset to be sold..

Measure it at Fair Value less costs to sell (FV-cts).

This is because, if you think about it, this is the what the company will receive.

HOWEVER, the company hasn’t actually made this sale yet and so to revalue it now to
this amount would be showing a pro t that has not yet happened

3. Step 3 - Value the Assets held for sale

IFRS 5 says the new value should actually be…

...The lower of carrying amount (step 1) and FV-CTS (step 2)

4. Step 4 - Check for an Impairment

Revaluing to this amount might mean an impairment (revaluation downwards) is

needed.

This must be recognised in pro t or loss, even for assets previously carried at revalued
amounts.

Also, any assets under the revaluation policy will have been revalued to FV under step
1.

Then in step 2, it will be revalued downwards to FV-cts.

Therefore, revalued assets will need to deduct costs to sell from their fair value and this
will result in an immediate charge to pro t or loss.

Subsequent increase in Fair Value?

• This basically happens at the year-end if the asset still has not been sold

A gain is recognised in the p&l up to the amount of all previous impairment losses.

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Non-depreciation

Non-current assets or disposal groups that are classi ed as held for sale shall not be
depreciated.

When is an asset recognised as held for sale?

• Management is committed to a plan to sell

• The asset is available for immediate sale

• An active programme to locate a buyer is initiated

• The sale is highly probable, within 12 months of classi cation as held for sale

• The asset is being actively marketed for sale at a sales price reasonable in relation
to its fair value

Abandoned Assets

The assets need to be disposed of through sale. Therefore, operations that are
expected to be wound down or abandoned would not meet the de nition. Therefore
assets to be abandoned would still be depreciated.

Balance sheet presentation

Presented separately on the face of the balance sheet in current assets

• Subsidiaries Held for Disposal

IFRS 5 applies to accounting for an investment in a subsidiary held only with a view to
its subsequent disposal in the near future.

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• Subsidiaries already consolidated now held for sale

The parent must continue to consolidate such a subsidiary until it is actually disposed
of. It is not excluded from consolidation and is reported as an asset held for sale under
IFRS 5.

So subsidiaries held for sale are accounted for initially and subsequently at FV-CTS of
all the net assets not just the amount to be disposed of.

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 Held for sale disposal group

This is where we sell more than a single asset, in fact it may be a whole
company

A 'disposal group' is a group of assets, possibly with some associated liabilities, which
an entity intends to dispose of in a single transaction.

Any impairment losses reduce the carrying amount of the disposal group in the order of
allocation required by IAS 36

A disposal group with reversal of impairment losses

Normally the rule here is that an impairment under IFRS 5 can only be reversed up to
as much as a previous impairment.

A disposal group may take up the advantage of some assets within the group using up
the unused Impairment losses on other assets.

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Illustration

Disposal Asset 1 Asset 2 Asset 3

group assets
Previous (100) (20) (30)
impairment
NBV 80 90 100

Here the total nbv is 270.

If by the year end the FV-CTS is now:

Asset 1: 150,
Asset 2: 100
Asset 3: 150

Asset 1 it can be revalued to 150, increase of 70 as previous impairment was 100

Asset 2 can be revalued to 100, an increase of 10 as previous impairment was 20

Asset 3 could normally not be revalued to 150, an increase of 50 but only to 130 as it’s
previous impairment was only 30

However, it can also use any unused impairments of the other assets in it's disposal
group such as 10 from asset 2 and a further 10 from asset 1, and so can be revalued
up to 150.

What if the asset or disposal group is not sold within 12 months?

1. Normally, returns to PPE at the amount it would have been at had it not gone to
held for sale.

2. Check for impairment.

3. Or, keep in HFS if delay is caused by circumstances outside the control of the entity
e.g.

Buyer unexpectedly imposes transfer conditions which extend beyond a year

Or the market demand has collapsed.

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Review Page

1. When a company decides to sell one of its assets what must it do to that asset rst?

2. At what value is a HFS asset held initially in the SFP?

3. Where is this value shown on the SFP?

4. What happens if this asset is still not sold at the year end and has decreased in value?

5. What happens if this asset is still not sold at the year end and has Increased in value?

6. What is the rule for reversal of impairment losses for HFS assets?

7. What is special about disposal groups when looking at reversal of impairment losses

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 Exam Question Page

Ghorse identi ed two manufacturing units, Cee and Gee, which it had decided to dispose
of in a single transaction. These units comprised non-current assets only.

One of the units, Cee, had been impaired prior to the nancial year end on 30 September
2007 and it had been written down to its recoverable amount of $35 million.

The criteria in IFRS5, ‘Non-current Assets Held for Sale and Discontinued Operations’, for
classi cation as held for sale, had been met for Cee and Gee at 30 September 2007. The
following information related to the assets of the cash generating units at 30 September
2007:

Depreciated
FV-CTS IFRS 5 Value
Historic Cost

Cee 50 35 35

Gee 70 90 70

The fair value less costs to sell had risen at the year end to $40 million for Cee and $95
million for Gee.

The increase in the fair value less costs to sell had not been taken into account by Ghorse.

Solution

The two manufacturing units are deemed to be a disposal group under IFRS5 ‘Non-current
Assets Held for Sale and Discontinued Operations’ as the assets are to be disposed of in a
single transaction.

Any impairment loss will reduce the carrying amount of the non-current assets in the
disposal group in the order of allocation required by IAS36 ‘Impairment of Assets’

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 Immediately before the initial classi cation of the asset as held for sale, the carrying
amount of the asset will be measured in accordance with applicable IFRSs.

On classi cation as held for sale, disposal groups are measured at the lower of carrying
amount and fair value less costs to sell. Impairment must be considered both at the time of
classi cation as held for sale and subsequently.

On classi cation as held for sale, any impairment loss will be based on the
difference between the adjusted carrying amounts of the disposal group and fair value less
costs to sell.
Any impairment loss that arises by using the measurement principles in IFRS5 must be
recognised in pro t or loss (IFRS5 paragraph 20).

Thus Ghorse should not increase the value of the disposal group above $105 million at 30
September 2007 as this is the carrying amount of the assets measured in accordance with
applicable IFRS immediately before being classi ed as held for
sale (IAS36 and IAS16).

After classi cation as held for sale, the disposal group will remain at this value as this is
the lower of the carrying value and fair value less costs to sell, and there is no impairment
recorded as the recoverable amount of the disposal group is in excess of the carrying
value.

At a subsequent reporting date the disposal group should be measured at fair value less
costs to sell. However, IFRS5 (paragraphs 21–22) allows any subsequent increase in fair
value less costs to sell to be recognised in pro t or loss to the extent that it is not in excess
of any impairment loss recognised in accordance with IFRS5 or previously with IAS36.

Thus any increase in the fair value less costs to sell can be recognised as follows at 31

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October 2007:

$m
Fair value less costs to sell – Cee 40
Fair value less costs to sell – Gee 95

This gives a total of 135, compared to the carrying value (105) - meaning a potential
increase of 30

However an increase can only be as much as a previous impairment, which only occurred
in Cee (50 – 35) 15

Therefore, the carrying value of the disposal group can increase by $15 million and pro t
or loss can be increased by the same amount, where the fair value rises. Thus the value of
the disposal group will be $120 million.

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 Syllabus C2c) Discuss and apply the accounting treatment of investment properties including
classi cation, recognition, measurement and change of use.

Investment property

A building (or land) owned but not used - just an investment

The building is not used it just makes cash by:

1. its FV going up (capital appreciation) or

2. from rental income

It might not even belong to the entity it could even be just on an operating lease.

This is still an IP (if the FV model is used)

This allows leased land (which is normally an operating lease) to be classi ed as

investment property.

Land held for indeterminate future use is an investment property where the entity has
not decided that it will use the land as owner occupied or for short-term sale

Accounting treatment for the Rental Income

1. Add it to the income statement

2. Easy! (Even for a gonk like you!) :p

Accounting treatment for the FV increase

The difference in FV each year goes to the I/S

Double easy - double gonky

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No depreciation is needed because it's not used :)

Give me examples of what can be Investment Properties cowy.

ok you asked for it:

1. Land held for long-term capital appreciation rather than short-term sale

2. Land held for a currently undetermined future use

This basically means they haven't yet decided what to do with the land

3. A building owned but leased to a third party under an operating lease

4. A building which is vacant but is held to be leased out under an operating lease

5. Property being constructed or developed for future use as an investment property

Ok smarty pants - what ISN'T an Investment property?

• Property intended for sale in the ordinary course of business

(It's stock!)

• Owner-occupied property

• Property leased to another entity under a nance lease

• Property being constructed for third parties

Parts of property

These can be investment properties if the different sections can be sold or leased
separately.

Mais oui, monsier/madame

For example, company owns a building and uses 4 oors and rents out 1. The
latter can be an IP while the rest is treated as normal PPE

Can it still be an IAS 40 Investment property if we are involved in the building still
by giving services to it?

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Si Claro hombre/mujer - It´’s still an IAS 40 Investment property if the supply is small
and insigni cant.

If it’s a signi cant part of the deal with the tenant then the property becomes an
IAS 16 property.

What if my subsidiary uses it but I don’t?

Right ok - now your questions are getting on my nerves… but still - it’s an IAS 40
Investment property in your own individual accounts - because you personally are not
using it.

However, in the group accounts it´s an IAS 16 property because someone in the group
is using it.

..now enough of the questions already.. get back to facebook ..

When can we bring an Investment Property into the accounts?

As with everything else, an investment property should be recognised when:

1. It is probable that the future economic bene ts will ow; and

2. The cost of the investment property can be measured reliably.

Cool - and at how much do we show it at initially?

Initially measured at cost.

This includes:

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1. Purchase price

2. Directly attributable costs, for example transaction costs (professional fees,

property transfer taxes

This does not include:

1. Start-up costs

2. Operating losses incurred before the investment property achieves the planned
level of occupancy

3. Abnormal amounts of wasted labour, material or other resources incurred in

constructing or developing the property

NB

If the property is held under a lease then you must show it initially at the lower of:

• Fair value and

• The present value of the minimum lease payments

Ok so how do we value it after the initial cost?

You choose between two models:

1. The IAS 16 cost model

2. The fair value model

The policy chosen should be applied consistently to all of the entity’s investment
property.

If the property is held under an operating lease the fair value model must be adopted.

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 Cost model

Basically as per IAS 16. The property is measured at cost less depreciation and
impairment losses (the fair value should still be disclosed though).

Fair value model

All investment properties should be measured at fair value at the end of each reporting
period.

Changes in fair value added to / subtracted from the asset and the other side
recognised in the income statement.

No depreciation is therefore ever recognised.

Change in use

This bit deals with when we decide say to use it as a normal property instead of renting
it out or vice-versa etc.

Examples

1. We occupy and start to use the investment property

All owner-occupied property falls under IAS 16 - cost less depreciation and
impairment losses.

If the FV model was being used then the FV at change of use date is the deemed
cost for future accounting.

2. Start developing an investment property with the intention of selling it when

nished

The property is to be sold in the normal course of business and should therefore
be reclassi ed as inventory and accounted for under IAS 2 Inventories.

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 3. Start developing an investment property with the intention of letting it out
when nished

The property should continue to be held as an investment property under IAS 40.

4. We were using the building but now we are going to let it out when nished

Transfer to investment properties and account under IAS 40.

When we transfer it though (if FV model) we revalue it.

Any revaluation here goes to the Revaluation reserve and OCI as normal (not the
income statement as under IAS 40).

5. A property that was originally held as inventory has now been let to a third
party.

Transfer from inventory to investment properties.

Here when the transfer is made, we revalue (if FV model) to FV and any
difference goes to the income statement.

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 Review Page

1. How much interest can be capitalised on an asset which takes 3 weeks to build?

2. How much interest can be added to the cost of an asset when using a speci c loan

3. How much interest can be added to the cost of an asset when using general funds?

4. What is an Investment Property?

5. How is an IP using the FV model accounted for?

6. Can 1 oor of a building be an IP?

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Exam Question Page

Grange acquired a plot of land on 1 December 2008 in an area where the land is expected
to rise significantly in value if plans for regeneration go ahead in the area.

The land is currently held at cost of $6 million in property, plant and equipment until
Grange decides what should be done with the land.

The market value of the land at 30 November 2009 was $8 million but as at 15 December
2009, this had reduced to $7 million as there was some uncertainty surrounding the
viability of the regeneration plan.

Solution

The land should be classified as an investment property. Although Grange has not decided
what to do with the land, it is being held for capital appreciation.

IAS 40 ‘Investment Property’ states that land held for indeterminate future use is an
investment property where the entity has not decided that it will use the land as owner
occupied or for short-term sale.

The fall in value of the investment property after the year-end will not affect its year-end
valuation as the uncertainty relating to the regeneration occurred after
the year-end.

Dr Investment property $6 million

Cr PPE $6 million

Dr Investment property $2 million

Cr Profi t or loss $2 million

No depreciation will be charged

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 Syllabus C2d) Discuss and apply the accounting treatment of intangible assets including the criteria
for recognition and measurement subsequent to acquisition.

What is an intangible asset

What is an Intangible asset?

Well, according to IAS 38, it’s an identi able non-monetary asset without physical
substance, such as a licence, patent or trademark.

The three critical attributes of an intangible asset are:

1. Identi ability

2. Control (power to obtain bene ts from the asset)

3. Future economic bene ts

Whooah there partner, what´s identi able mean??

Well it just means the asset is one of 2 things:

1. It is SEPARABLE, meaning it can be sold or rented to another party on its own

(rather than as part of a business) or

2. It arises from contractual or other legal rights.

It is the lack of identi ability which prevents internally generated goodwill being
recognised. It is not separable and does not arise from contractual or other legal rights.

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Examples

• Employees can never be recognised as an asset; they are not under the control of
the employer, are not separable and do not arise from legal rights

• A taxi licence can be an intangible asset as they are controlled, can be sold/
exchanged/transferred and arise from a legal right
(The intangible doesn’t have to be separable AND arise from a legal right, just one or
the other is enough).

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 When can you recognise an IA and for how much?

Well it's the old reliably measurable and probable again!

In posher terms...

1. When it is probable that future economic bene ts attributable to the asset will ow
to the entity

2. The cost of the asset can be measured reliably

So at how much should we show the asset at initially?

Well thick pants - it’s obviously brought in at cost!! Aaarh but what is cost I hear you
whisper in my big oppy cow-like ears.. well it’s

Purchase price plus directly attributable costs

Remember that directly attributable means costs which otherwise would not have
been paid, so often staff costs are excluded.

Let’s now look at some speci c issues that come up often in the exam:

• IA acquired as part of a business combination

Well this time, the intangible asset (other than goodwill ) should initially be recognised
at its fair value.

If the FV cannot be ascertained then it is not reliably measurable and so cannot be

shown in the accounts.

In this case by not showing it, this means that goodwill becomes higher.

• Research and Development Costs

Research costs are always expensed in the income statement

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Development costs are capitalised only after technical and commercial feasibility of the
asset for sale or use have been established.

This means that the enterprise must intend and be able to complete the intangible
asset and either use it or sell it and be able to demonstrate how the asset will generate
future economic bene ts.

If entity cannot distinguish between research and development - treat as research and
expense

• Research and Development Acquired in a Business Combination

Recognised as an asset at cost, even if a component is research.

Subsequent expenditure on that project is accounted for as any other research and
development cost

• Internally Generated Brands, Mastheads, Titles, Lists

Should not be recognised as assets - expense them as there is no reliable measure

• Computer Software

If purchased: capitalise as an IA
Operating system for hardware: include in hardware cost

If internally developed: charge to expense until technological feasibility, probable

future bene ts, intent and ability to use or sell the software, resources to complete the
software, and ability to measure cost.

Always expense the following:

1. Internally generated goodwil

2. Start-up, pre-opening, and pre-operating costs

3. Training cost

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4. Advertising and promotional cost, including mail order catalogues

5. Relocation costs

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 Intangible Assets - Future Measurement

So we can use either historic cost or revaluation.

Historic Cost (and amortise)

Generally intangible assets should be amortised over their useful economic life.

1. If has a useful economic life

Amortise over UEL

Residual values should be assumed to be nil, except in the rare circumstances

when an active market exists or there is a commitment by a third party to
purchase the asset at the end of its useful life.

2. If has an inde nite UEL

Check for impairment every year

There should also be an annual review to see if the inde nite life assessment is
still appropriate.

Revaluation (and amortise)

This model can only be adopted if an active market exists for that type of asset.

Revaluing Intangibles is hard, because there is no physical substance, and so a

reliable measure is tricky.

1. There MUST be an active market

2. The item MUST be unique

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So what’s an ‘active market’?

• Firstly I should mention that these are rare, but may exist for certain licences and
production quotas

• These, though, are markets where the products are unique, always trading and prices
available to public

Examples where they might exist:

1. Milk quotas

2. Stock exchange seats

3. Taxi medallions

These two tests make it very dif cult for any intangibles to be revalued so the historic
cost choice is by far the most common.

If the revaluation model is adopted, revaluation surpluses and de cits are accounted for
in the same way as those for PPE

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 Research and development

Research is expensed, Development is often an asset.

Research

Research is investigation to get new knowledge and understanding

All goes to I/S

Development

Under IAS 38, an intangible asset must demonstrate all of the following criteria:

(use pirate as a memory jogger)

1. Probable future economic bene ts

2. Intention to complete and use or sell the asset

3. Resources (technical, nancial and other resources) are adequate and available
to complete and use the asset

4. Ability to use or sell the asset

5. Technical feasibility of completing the intangible asset (so that it will be available
for use or sale)

6. Expenditure can be measured reliably

Once capitalised they should be amortised.

Amortisation begins when commercial production has commenced.

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Once capitalised they should be amortised

The cost of the development expenditure should be amortised over the useful life.

Therefore, the cost of the development expenditure is matched against the revenue it
produces.

Amortisation must only begin when the asset is available for use (hence matching the
income and expenditure to the period in which it relates).

It is an expense in the income statement:

Dr Amortisation expense (I/S)

Cr Accumulated amortisation (SFP)

It must be reviewed at the year-end to check it still is an asset and not an expense.

If the criteria are no longer met, then the previously capitalised costs must be written off
to the statement of pro t or loss immediately.

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Review Page

1. What does identi able mean?

2. What happens if an IA is bought as part of a subsidiary, but its value cannot be

measured reliably?

3. When acquiring a sub which has some research costs - how are these treated in the
group accounts initially?

4. What options are available for the accounting treatment of Intangibles?

5. Which option is rare and why?

6. Should all intangibles be amortised?

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Exam Question Page

H is acquiring S.

S has several marketing-related intangible assets that are used primarily in marketing or
promotion of its products.

These include trade names, internet domain names and non-competition agreements.
These are not currently recognised in S’s nancial statements

How should these be treated?

Solution

Intangible assets should be recognised on acquisition under IFRS3 (Revised).

These include trade names, domain names, and non-competition agreements. Thus these
assets will be recognised and goodwill effectively reduced.

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Review Page

1. Where do you put income from a revenue grant?

2. What are the choices for a capital grant?

3. What if the grant is for land?

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Exam Question Page

Norman has obtained a signi cant amount of grant income for the development of hotels
in Europe.

The grants have been received from government bodies and relate to the size of the hotel
which has been built by the grant assistance.

The intention of the grant income was to create jobs in areas where there was signi cant
unemployment.

The grants received of $70 million will have to be repaid if the cost of building the hotels is
less than $500 million. (4 marks)

Solution

The accruals concept is used by the standard to match the grant received with the related
costs.

The relationship between the grant and the related expenditure is the key to establishing
the accounting treatment. Grants should not be recognised until there is reasonable
assurance that the company can comply with the conditions relating to their receipt and
the grant will be received.

Provision should be made if it appears that the grant may have to be repaid.

There may be dif culties of matching costs and revenues when the terms of the grant do
not specify precisely the expense towards which the grant contributes. In this case the
grant appears to relate to both the building of hotels and the creation of
employment.

However, if the grant was related to revenue expenditure, then the terms would have been
related to payroll or a xed amount per job created. Hence it would appear that the grant is
capital based and should be matched against the depreciation of the hotels by using a
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deferred income approach or deducting the grant from the carrying value of the asset
(IAS20).

Additionally the grant is only to be repaid if the cost of the hotel is less than $500 million
which itself would seem to indicate that the grant is capital based.

If the company feels that the cost will not reach $500 million, a provision should
be made for the estimated liability if the grant has been recognised.

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 Syllabus C2e) Discuss and apply the accounting treatment for borrowing costs.

Borrowing Costs

Let’s say you need to get a loan to construct the asset of your dreams - well
the interest on the loan then is a directly attributable cost.

So instead of taking interest to the I/S as an expense you add it to the cost of the
asset. (in other words - you capitalise it)

There are 2 scenarios here to worry about:

1. You use current borrowings to pay for the asset

2. You get a speci c loan for the asset

1) Use current borrowings

This is looking at the scenario where we use funds we have already borrowed from
different sources.

So, if the funds are borrowed generally – we need to calculate the weighted average
cost of all the loans we have generally.

(I know you're thinking - how the cowing'eck do I work out the weighted average of
borrowings... aaarrgghh!).

Well relax my little monkey armpit - here's how you do it:

Step 1: Calculate the total amount of borrowings

Step 2: Calculate the interest payable on these in total

Step 3: Weighted average of borrowing costs = Divide the interest by the borrowing -
et voila!

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Step 4: We then take this weighted average of borrowing costs and multiply it by any
expenditure on the asset.

The amount capitalised should not exceed total borrowing costs incurred in the period.

Illustration

5% Overdraft 1,000
8% Loan 3,000
10% Loan 2,000

We buy an asset with a cost of 5,000 and it takes one year to build - how much interest
goes to the cost of the asset?

Solution

Calculate the WA cost of the borrowings:

Step 1: Total Borrowing = (1,000+3,000+2,000) = 6,000

Step 2: Interest payable = (50+240+200) = 490

Step 3: 490/6,000 = 8.17%

Step 4: So the total interest to be added to the asset is 8.17% x 5,000 = 408

2) Get a speci c loan

Ok well you would think this is easy - just the interest paid, surely?! But it’s not quite
that easy…

It is the actual borrowing costs less investment income on any temporary

investment of the funds

So what does this mean exactly?

Well imagine you need 10,000 to build something over 3 years. You borrow 10,000 at
the start but don’t need it all straight away.

So the bit you don’t need you leave in the bank to gain interest

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So, the amount you could capitalise would be the interest paid on the 10,000 less the
interest received on the amount not used and left in the bank (or reinvested elsewhere)

Steps:

1. Calculate the interest paid on the speci c loan

2. Calculate any interest received on loans proceeds not used

3. Add the net of these 2 to 'cost of the asset’

Illustration

Buy asset for 2,000 - takes 2 years to build.

Get a 2,000 10% loan.

We reinvest any money not used in an 8% deposit account.

In year 1 we spend 1,200.

How much interest is added to the cost of the asset?

1. Interest Paid = 2,000 x 10% = 200

2. Interest received = ((2,000-1,200) x 8%) = 64

3. Dr PPE Cost (200-64) = 136

Cr Interest Accrual

Basic Idea

Borrowing costs that are directly attributable to the acquisition, construction or

production of a qualifying asset form part of the cost of that asset.

Other borrowing costs are recognised as an expense.

So what is a “Qualifying asset?”

It is one which needs a substantial amount of time to get ready for use or sale.

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This means it can’t be anything that is available for use when you buy it.

It has to take quite a while to build (PPE, Investment Properties, Inventories and
Intangibles).

You don’t have to add the interest to the cost of the following assets:

1. Assets measured at fair value,

2. Inventories that are manufactured or produced in large quantities on a repetitive

basis even if they take a substantial period of time to get ready for use or sale.

When should we start adding the interest to the cost of the asset?

Capitalisation starts when all three of the following conditions are met:

1. Expenditure begins for the asset

2. Borrowing costs begin on the loan

3. Activities begin on building the asset e.g. Plans drawn up, getting planning etc.

So just having an asset for development without anything happening is not enough
to qualify for capitalisation

Are borrowing costs just interest?

It’s actually any costs that an entity incurs in connection with the borrowing of funds.

So it includes:

Interest expense calculated using the effective interest method.

Finance charges in respect of nance leases

What about if the activities stop temporarily?

Well you should stop capitalising when activities stop for an extended period

During this time borrowing costs go to the pro t or loss.

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 Be careful though - If the temporary delay is a necessary part of the construction
process then you can still capitalise, e.g. Bank holidays etc.

When will capitalisation stop?

Well, when virtually all the activities work is complete. This means up to the point when
just the nalising touches are left.

NB

• Stop capitalising when AVAILABLE for use. This tends to be when the construction is
nished

• If the asset is completed in parts then the interest capitalisation is stopped on the
completion of each part

• If the part can only be sold when all the other parts have been completed, then stop
capitalising when the last part is completed

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 Syllabus C3. Financial Instruments
Syllabus C3a) Evaluate and apply the initial recognition and measurement of nancial instruments
including the business model test.

Financial Instruments - Introduction

Ok, ok, relax at the back - this is not as bad as it seems… trust me

De nition

• First of all it must be a contract

• Then it must create a nancial asset in one entity and a nancial liability or
equity instrument in another.

Examples:
An obvious example is a trade receivable. There is a contract, one company has the
debt as a nancial asset and the other as a liability

Other examples:
Cash, investments, trade payables and loans….

And the trickier stuff…..

It also applies to derivatives nancial such as call and put options, forwards, futures,
and swaps.

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And the just plain weird….

It also applies to some contracts that do not meet the de nition of a nancial
instrument, but have characteristics similar to derivative nancial instruments.

Such as precious metals at a future date when the following applies:

1. The contract is subject to possible settlement in cash NET rather than by delivering
the precious metal

2. The purchase of the precious metal was not normal for the entity

The trick in the exam is to look for contracts which state “will NOT be delivered” or
“can be settled net” - these are almost always nancial instruments

The following are NOT nancial instruments:

• Anything without a contract

e.g. Prepayments

• Anything not involving the transfer of a nancial asset

e.g. Deferred income and Warranties

Recognition
The important thing to understand here is that you bring a FI into the accounts when
you enter into the contract NOT when the contract is settled.

Therefore derivatives are recognised initially even if nothing is paid for it initially.

• Substance over form

Form (legally) means a preference share is a share and so part of equity.

HOWEVER, a substance over form model is applied to debt/equity classi cation.
Any item with an obligation, such as redeemable preference shares, will be
shown as liabilities.

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De-recognition
This basically means when to get rid of it / take it out of the accounts

• So you should do this when:

The contractual rights you used to have have expired/gone

For Example

You sell an asset and its bene ts now go to someone else (no conditions attached)

• You DON’T de-recognise when..

You sell an asset but agree to buy it back later (this means you still have an interest
in the risk and rewards later)

The difference between equity and liabilities

IAS 32 Financial Instruments: Presentation

establishes principles for presenting nancial instruments as liabilities or equity.

• IAS 32 does not classify a nancial instrument as equity or nancial liability on the
basis of its legal form but the substance of the transaction.

The key feature of a nancial liability

1. is that the issuer is obliged to deliver either cash or another nancial asset to the
holder.

2. An obligation may arise from a requirement to repay principal or interest or

dividends.

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The key feature of an Equity

has a residual interest in the entity’s assets after deducting all of its liabilities.

• An equity instrument includes no obligation to deliver cash or another nancial asset

to another entity.

• A contract which will be settled by the entity receiving or delivering a xed number of
its own equity instruments in exchange for a xed amount of cash or another nancial
asset is an equity instrument.

• However, if there is any variability in the amount of cash or own equity instruments
which will be delivered or received, then such a contract is a nancial asset or liability
as applicable.

An accounting treatment of the contingent payments on acquisition of the NCI in

a subsidiary

• IAS 32 states that a contingent obligation to pay cash which is outside the control of
both parties to a contract meets the de nition of a nancial liability which shall be
initially measured at fair value.

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 Syllabus C3b) Explain and apply the subsequent measurement of nancial assets and nancial
liabilities including the fair value option and nancial liability modi cations

Financial liabilities - Categories

There's only 2 categories, FVTPL and Amortised cost.. Yay!

Right-y-o, we’ve looked at recognising (bring into the accounts for those of you who are
a sandwich short of a picnic*) - now we want to look at HOW MUCH to bring the
liabilities in at.

*A quaint old English saying - meaning you're an idiot :p

Basically there are 2 categories of Financial Liability…

1. Fair Value Through Pro t and Loss (FVTPL)

This includes nancial liabilities incurred for trading purposes and also
derivatives.

2. Amortised Cost

If nancial liabilities are not measured at FVTPL, they are measured at amortised
cost.

The good news is that whatever the category the nancial liability falls into - we always
recognise it at Fair Value INITIALLY.

It is how we treat them afterwards where the category matters (and remember here we
are just dealing with the initial measurement).

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Accounting Treatment of Financial Liabilities (Overview)

Initially At Year-End Any gain/loss

FVTPL Fair Value Fair Value Income Statement

Amortised Cost Fair Value Amortised Cost

So - the question is - how do you measure the FV of a loan??

All you do is those 2 steps:

STEP 1: Take all your actual future cash payments

STEP 2: Discount them down at the market rate

If the market rate is the same as the rate you actually pay (effective rate) then this is
no problem and you don’t really have to follow those 2 steps as you will just come back
to the capital amount…let me explain

10% 1,000 Payable Loan 3 years

Capital 1,000 x 0.751 = 751

Interest 100 x 2.486 = 249

Total 1,000

So the conclusion is - WHERE THE EFFECTIVE RATE YOU PAY (10%) IS THE SAME
AS THE MARKET RATE (10%) THEN THE FV IS THE PRINCIPAL - so no need to do
the 2 steps.

Always presume the market rate is the same as the effective rate you’re paying unless
told otherwise by El Examinero.

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Possible Naughty Bits

Premium on redemption

This is just another way of paying interest. Except you pay it at the end (on redemption)

e.g. 4% 1,000 payable loan - with a 10% premium on redemption.

This means that the EFFECTIVE interest rate (the rate we actually pay) is more than
4% - because we haven’t yet taken into account the extra 100 (10% x 1,000) payable at
the end.

So the examiner will tell you what the effective rate actually is - let’s say 8%.

The crucial point here is that you presume the effective rate (e.g. 8%) is the same as
the market rate (8%) so the initial FV is still 1,000.

Discount on Issue

Exactly the same as above - it is just another way of paying interest - except this time
you pay it at the start

e.g. 4% 1,000 payable loan with a 5% discount on issue.

So again the interest rate is not 4%, because it ignores the extra interest you pay at the
beginning of 50 (5% x 1,000). So the effective rate (the rate you actually pay) is let’s
say 7% (will be given in the exam).

The crucial point here is that the discount is paid immediately. So, although you
presume that the effective rate (7%) is the same as the market rate (7% say), the
INITIAL FV of the loan was 1,000 but is immediately reduced by the 50 discount - so is
actually 950

NB You still pay interest of 4% x 1,000 not 4% x 950

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 Financial Liabilities - Amortised Cost

So, we’ve just looked at initial measurement (at FV), now let’s look at how we
measure it from then onwards.

This is where the categories of nancial liabilities are important - so let’s remind
ourselves what they are:

Initially At Year-End Any gain/loss

FVTPL Fair Value Fair Value Income Statement
Amortised Cost Fair Value Amortised Cost

So you only have 2 rules to remember - cool…

1. FVTPL

- simple just keep the item at its FV (remember this is those 2 steps) and put the
difference to the income statement

2. Amortised Cost

- Amortised Cost is the measurement once the initial measurement at FV is done

Amortised Cost

This is simply spreading ALL interest over the length of the loan by charging
the effective interest rate to the income statement each year.

If there’s nothing strange (premiums etc) then this is simple.

For example: 10% 1,000 Payable Loan

Opening Interest to I/S Interest actually Paid Closing Loan on SFP

1,000 1,000 x 10% = 100 (100) 1,000

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 Now let’s make it trickier

10% 1,000 Loan with a 10% premium on redemption . Effective rate is 12%

Opening Interest to I/S Interest actually Paid Closing Loan on SFP

1,000 1,000 x 12% = 120 (100) 1,020

So in year 1 the income statement would show an interest charge of 120 and the loan
would be under liabilities on the SFP at 1,020.

This SFP gure will keep on increasing until the end of the loan where it will equal the
Loan + premium on redemption.

And trickier still…

10% 1,000 loan with a 10% discount on issue. Effective rate is 12%

Opening Interest to I/S Interest Closing Loan on SFP

actually
Paid
1,000 - (10% x 1,000) = 900 900 x 12%= 108 (100) 908

IFRS 9 requires FVTPL gains and losses on nancial liabilities to be split into:

1. The gain/loss attributable to changes in the credit risk of the liability (to be placed in
OCI)

2. The remaining amount of change in the fair value of the liability which shall be
presented in pro t or loss.

The new guidance allows the recognition of the full amount of change in the FVTPL
only if the recognition of changes in the liability's credit risk in OCI would create or
enlarge an accounting mismatch in P&L.

Amounts presented in OCI shall not be subsequently transferred to P&L, the entity may
only transfer the cumulative gain or loss within equity.

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 Financial Liabilities - convertible loans

When we recognise a nancial instruments we look at substance rather than

form

Anything with an obligation is a liability (debt).

However we now have a problem when we consider convertible payable loans.

The ‘convertible’ bit means that the company may not have to pay the bank back with
cash, but perhaps shares.

So is this an obligation to pay cash (debt) or an equity instrument?

In fact it is both! It is therefore called a Compound Instrument

Convertible Payable Loans

These contain both a liability and an equity component so each has to be shown
separately.

• This is best shown by example:

2% Convertible Payable Loan €1,000

• This basically means the company has offered the bank the option to convert the loan
at the end into shares instead of simply taking €1,000

• The important thing to notice is that that the bank has the option to do this.

• Should the share price not prove favourable then it will simply take the €1,000 as
normal.

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Features of a convertible payable loan

1. Better Interest rate

The bank likes to have the option. Therefore, in return, it will offer the company a
favourable interest rate compared to normal loans

2. Higher Fair Value of loan

This lower interest rate has effectively increased the fair value of the loan to the
company (we all like to pay less interest ;-))

We need to show all payable loans at their fair value at the beginning.

3. Lower loan gure in SFP

Important: If the fair value of a liability has increased the amount payable (liability)
shown in the accounts will be lower.

After all, fair value increases are good news and we all prefer lower liabilities!

How to Calculate the Fair Value of a Loan

So how is this new fair value, that we need at the start of the loan, calculated?

Well it is basically the present value of its future cash ows…

• Step 1: Take what is actually paid (The actual cash ows):

Capital €1,000
Interest (2%) €20 pa.

Now let’s suppose this is a 4 year loan and that normal (non-convertible) loans carry
an interest rate of 5%.

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• Step 2: Discount the payments in step 1 at the market rate for normal loans
(Get the cash ows PV)

Take what the company pays and discount them using the gures above as follows:

Capital €1,000 discounted @ 5% (4 years SINGLE discount gure) = 1,000 x 0.823

= 823

Interest €20 discounted @ 5% (4 years CUMULATIVE)= 20 x 3.465 = 69

Total = 892

This €892 represents the fair value of the loan and this is the gure we use in the
balance sheet initially.

The remaining €108 (1,000-892) goes to equity.

Dr Cash 1,000
Cr Loan 892
Cr Equity 108

• Next we need to perform amortised cost on the loan (the equity is left untouched
throughout the rest of the loan period).

The interest gure in the amortised cost table will be the normal non-convertible rate
and the paid will the amounts actually paid.

The closing gure is the SFP gure each year

Opening Interest Payment Closing

892 892 x 5% = 45 (1,000 x 2% = 20) 892 + 45 - 20 = 917
917 917 x 5% = 46 (1,000 x 2% = 20) 917 + 46 - 20 = 943
943 48 (1,000 x 2% = 20) 971
971 49 (1,000 x 2% = 20) 1,000

Now at the end of the loan, the bank decide whether they should take the shares
or receive 1,000 cash…

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1. Option 1: Take Shares (lets say 400 ($1) shares with a MV of $3)

Dr Loan 1,000
Dr Equity 108
Cr Share Capital 400
Cr Share premium 708 (balancing gure)

2. Option 2: Take the Cash

Dr Loan 1,000
Cr Cash 1,000

Dr Equity 108
Cr Income Statement 108

Conclusion

1. When you see a convertible loan all you need to do is take the capital and interest
PAYABLE.

2. Then discount these gures down at the rate used for other non convertible loans.

3. The resulting gure is the fair value of the convertible loan and the remainder sits in
equity.

4. You then perform amortised cost on the opening gure of the loan. Nothing
happens to the gure in equity

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Convertible Payable Loan with transaction costs - eek!

Ok well remember our 2 step process for dealing with a normal convertible loan?

Step 1) Write down the capital and interest to be PAID

Step 2) Discount these down at the interest rate for a normal non-convertible loan

Then the total will be the FV of the loan and the remainder just goes to equity.
Remember we do this at the start of the loan ONLY.

Right then let’s now deal with transaction or issue costs.

These are paid at the start.

Normally you simply just reduce the Loan amount with the full transaction costs.

However, here we will have a loan and equity - so we split the transaction costs pro-
rata

I know, I know - you want an example…. boy, you’re slow - lucky you’re gorgeous

e.g. 4% 1,000 3 yr Convertible Loan.

Transaction costs of £100 also to be paid.
Non convertible loan rate 10%

Step 1 and 2

Capital 1,000 x 0.751 = 751

Interest 40 x 2.486 = 99 (ish)
Total = 850

So FV of loan = 850, Equity = 150 (1,000-850)

Now the transaction costs (100) need to be deducted from these amounts pro-rata

So Loan = (850-85) = 765

Equity (150-15) = 135

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 Financial Assets - Initial Measurement

There are 3 categories to remember:

Category Initial Year-end Difference goes

Measurement Measurement where?
FVTPL FV FV Pro t and Loss
FVTOCI FV FV OCI
Amortised Cost FV Amortised Cost -

Financial assets that are Equity Instruments

e.g. Shares in another company

These are easy - Just 2 categories

• FVTPL = Fair Value through Pro t & Loss

These are Equity instruments (shares) Held for trading

Normally, equity investments (shares in another company) are measured at FV in the

SFP, with value changes recognised in P&L

Except for those equity investments for which the entity has elected to report value
changes in OCI.

• FVTOCI = Fair Value through Other Comprehensive Income

These are Equity instruments (shares) Held for longer term

• NB. The choice of these 2 is made at the beginning and cannot be changed
afterwards

There is NO reclassi cation on de-recognition

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 Financial Assets (FA) that are Receivable Loans

There are basically 3 types:

1. Fair Value Through Pro t & Loss (FVTPL)

A receivable loan where capital and interest aren’t the only cash ows (see CF test
below)

2. FVTOCI

Receivable loans where the cash ows are capital and interest only BUT the business
model is also to sell these loans (see Business model test below)

3. Amortised Cost

A FA that meets the following 2 conditions can be measured at amortised cost:

1. Business model test:

Do we normally keep our receivable loans until the end rather than sell them on?

2. Cash ows test

Are the ONLY cash ows coming in capital and interest?

So what sort of things go into the FVTPL category?

If one of the tests above are not passed then they are deemed to fall into the
FVTPL category

This will include anything held for trading and derivatives.

INITIAL measurement

Good news! Initially both are measured at FV.

Easy peasy to remember.

The FV is calculated, as usual, as all cash in ows discounted down at the market
rate.
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 FVTPL can be:

1. Equity items held for trading purposes

2. Equity items not held for trading (but OCI option not chosen)

3. A receivable loan where capital and interest aren’t the only cash ows

Derivative assets are always treated as held for trading

Initial recognition of trade receivables

1. Trade receivables without a signi cant nancing component

Use the transaction price from IFRS 15

2. Trade receivables with a signi cant nancing component

IFRS 9 does not exempt a trade receivable with a signi cant nancing component from
being measured at fair value on initial recognition.

Therefore, differences may arise between the initial amount of revenue recognised in
accordance with IFRS 15 – and the fair value needed here in IFRS 9

Any difference is presented as an expense.

FVTOCI - Receivable loans held for cash and selling

Interest revenue, credit impairment and foreign exchange gain or loss recognised in
P&L (in the same manner as for amortised cost assets)

Other gains and losses recognised in OCI

On de-recognition, the cumulative gain or loss previously recognised in OCI is

reclassi ed from equity to pro t or loss

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 Financial assets - Accounting Treatment

So we have these 3 categories..

Category Initial Year-end Difference goes

Measurement Measurement where?
FVTPL FV FV Pro t and Loss
FVTOCI FV FV OCI
Amortised Cost FV Amortised Cost -

Initially both are measured at FV.

Now let's look at what happens at the year-end..

FVTPL accounting treatment

1. Revalue to FV

2. Difference to I/S

FVTOCI accounting treatment

1. Revalue to FV

2. Difference to OCI

Amortised cost accounting treatment

1. Re-calculate using the amortised cost table

An Example:

8% 100 receivable loan (effective rate 10% due to a premium on redemption)

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Amortised Cost Table

Opening Balance Interest (effective (Cash Received) Closing balance

rate)
100 10 (8) 102

The interest (10) is always the effective rate and this is the gure that goes to the
income statement.

The receipt (8) is always the cash received and this is not shown in the income
statement - it just decreases the carrying amount

Any expected credit losses and forex gains/losses all go to I/S

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 Financial Assets - Convertible loan

Compound instruments (Convertible loans)

Be careful here as these are treated differently according to whether they are
receivable loans (assets) or payable loans (liabilities)

This is because, if you remember, the amortised cost category for nancial assets has
2 tests, whereas the amortised cost category for liabilities does not have any

The 2 tests for placing a nancial asset into the amortised cost category are:

1. Business model test - do we intend to keep (not sell) the loan

... presumably we do hold until the end and not sell it - so yes that test is passed

2. Cash ow test - Are the cash receipts capital and interest only?

No - There is the potential issue of shares that we may ask for instead of the capital
back.

For a receivable convertible loan - it fails the cash ow test - as one receipt may be
shares and not just capital and interest

Therefore a receivable convertible loan cannot be amortised cost and so is a FVTPL

item

Type Category
Receivable Convertible Loan FVTPL

Accounting Treatment

Initial Year End

FVTPL FV FV

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An Example:

2% Convertible Loan €1,000, a 4 year loan

You are also told the non-convertible interest rates are as follows:

Start: 5%
End of year 1: 6%
End of year 2: 7%
End of year 3: 8%

• As in the payable we need to calculate FV initially.

We did this and it came to 892.

• Then we perform amortised cost BUT also adjust to FV each year end as this a
FVTPL item.

Here’s a reminder of what we had before (but with a new FV adj column added....

Opening Interest Payment FV adj Closing

892 45 -20 917
917 46 -20 943
943 48 -20 971
971 49 -20 1,000

So we need to change the closing gures (and hence opening next year) to the
new FV at each year end.

Calculating the FV of a loan is the same as before..

• Step 1: Take all the CASH payments (capital and interest)

• Step 2: Discount them down at the MARKET rate

• FV at end of year 1
Capital discounted = 1,000 / 1.06^3 (3 years away only now) = 840
Interest = 20pa for 3 years @ 6% = 20 x 2.673 = 53
Total = 893

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• FV at end of year 2
Capital discounted = 1,000 / 1.07^2 (2 years away only now) = 873
Interest = 20pa for 2 years @ 7% = 20 x 1.808 = 36
Total = 909

• FV at end of year 3
Capital discounted = 1,000 / 1.08 (1 year away only now) = 926
Interest = 20pa for 1 year @ 8% = 20 x 0.926 = 19
Total = 945

So the table now becomes...

Opening Interest Payment FV adj Closing

892 45 -20 -24 917
893 46 -20 -10 943
909 48 -20 +8 971
945 49 -20 +26 1,000

Remember interest goes to the income statement as does the FV adjustment also

The closing gure is the SFP receivable loan amount

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 Financial Instruments - Transactions costs

Transaction Costs

There will usually be brokers’ fees etc to pay and how you deal with these depends on
the category of the nancial instrument...

For FVTPL - these go to the income statement.

For everything else they get added/deducted to the opening balance.

So if it is an asset - it will increase the opening balance

If it is a liability - it will decrease the opening balance

Nb. If a company issues its own shares, the transaction costs are debited to share
premium

Illustration 1

A debt security that is held for trading is purchased for 10,000. Transaction costs are
500.

The initial value is 10,000 and the transaction costs of 500 are expensed.

Illustration 2

A receivable bond is purchased for £10,000 and transaction costs are £500.

The initial carrying amount is £10,500.

Illustration 3

A payable bond is issued for £10,000 and transaction costs are £500.

The initial carrying amount is £9,500.

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 Note: With the amortised cost categories, the transaction costs are effectively being
spread over the length of the loan by using an effective interest rate which INCLUDES
these transaction costs

Illustration: Transaction costs

An entity acquires a nancial asset for its offer price of £100 (bid price £98)

IFRS 9 treats the bid-offer spread as a transaction cost:

1. If the asset is FVTPL

The transaction cost of £2 is recognised as an expense in pro t or loss and the

nancial asset initially recognised at the bid price of £98.

2. If the asset is classi ed as amortised cost

The transaction cost should be added to the fair value and the nancial asset
initially recognised at the offer price (the price actually paid) of £100.

Treasury shares

It is becoming increasingly popular for companies to buy back shares as another way of
giving a dividend. Such shares are then called treasury shares

Accounting Treatment

1. Deduct from equity

2. No gain or loss shown, even on subsequent sale

3. Consideration paid or received goes to equity

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Illustration

Company buys back 10,000 (£1) shares for £2 per share. They were originally issued
for £1.20

Dr RE 20,000 Cr Cash 20,000

The original share capital and share premium stays the same, just as it would
have done if they had been bought by a different third party

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 Syllabus C3c) Discuss and apply the derecognition of nancial assets and nancial liabilities.

De-recognition of Financial Instruments

De-recognition of Financial Assets

De-recognition of a nancial asset occurs where:

1. The contractual rights to the cash ows of the nancial asset have expired (debtor
pays), or

2. The nancial asset has been transferred (e.g., sold) including the risks and
rewards.

Illustration 1

A company sells an investment in shares, but retains the right to repurchase the shares
at any time at a price equal to their current fair value.

The company should de-recognise the asset

Illustration 2

A company sells an investment in shares and enters into an agreement whereby the
buyer will return any increases in value to the company and the company will pay the
buyer interest plus compensation for any decrease in the value of the investment.

The company should not de-recognise the investment as it has retained

substantially all the risks and rewards

Financial Liability De-recognition

The risks and rewards transfer does not apply for nancial liabilities. Rather, the focus
is on whether the nancial liability has been extinguished.

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 Syllabus C3d) Discuss and apply the reclassi cation of nancial assets.

The Reclassi cation Of Financial Assets

Re-classifying between FVTPL, FVTOCI and Amortised cost

1. ONLY if Financial assets business objective changes

2. Do not restate any previously recognised gains / losses

How to Re-classify
• Prospectively from the reclassi cation date

NEVER RECLASSIFY
• FVTOCI equity Investments

Accounting for the Re-Classi cation

On derecognition of a nancial asset in its entirety, the difference between:

(a) The carrying amount (measured at the date of derecognition); and

(b) The consideration received
is recognised in pro t or loss (IFRS 9: para. 3.2.12).

For investments in debt held at fair value through other comprehensive income, on
derecognition, the cumulative revaluation gain or loss previously recognised in other
comprehensive income is reclassi ed to pro t or loss (IFRS 9: para. 5.7.10).

Equity FVTOCI de-recognised

There should be no gain / loss as FV will be up to date (and therefore the same as the
amount sold for) and the gains \ losses will already be in OCI
These are NOT reclassi ed to I/S

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 Debt FVTOCI de-recognised
The same applies except....
...The cumulative revaluation gain or loss previously recognised in OCI is reclassi ed to
pro t or loss

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 Syllabus C3e) Account for derivative nancial instruments.
Syllabus C3f) Outline and apply the qualifying criteria for hedge accounting and account for fair value
hedges and cash ow hedges including hedge effectiveness

Hedging

Hedging is all about matching.

Objective
To manage risk companies often enter into derivative contracts
• e.g. Company buys wheat - so it is worried about the price of wheat rising (risk).
• To manage this risk it buys a wheat derivative that gains in value as the price of
wheat goes up.
• Therefore any price increase (hedged item) will be offset by the derivative gains
(hedging item)
So, the basic idea of hedge accounting is to represent the effect of an entity’s risk
management activities

IFRS 9 changes
• IFRS 9 has made hedge accounting more principles based to allow for effective risk
management to be better shown in the accounts
• It has also allowed more things to be hedged, including non- nancial items
• It has allowed more things to be hedging items also - options and forwards
• There also used to be a concept of hedge effectiveness which needed to be tested
annually to see if hedge accounting could continue - this has now been stopped.
Now if its a hedge at the start it remains so and if it ends up a bad hedge well the FS
will show this

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 Accounting Concept
The idea behind hedge accounting is that gains and losses on the hedging instrument and
the hedged item are recognised in the same period in the income statement
It is a choice - it doesn’t have to be applied

There are 3 types of hedge:

1. Fair value hedges

Here we are worried about an item losing fair value (not cash).
For example you have to pay a xed rate loan of 6%. If the variable rate drops to 4%
your loan has lost value. If the variable rate rises to 8%, then you have gained in fair
vale
Notice you still pay 6% in both scenarios - so the risk isn’t cash ow - it is fair value
2. Cash ow hedges
Here we are worried about losing cash on the item at some stage in the future
For example, you agree to buy an item in a foreign currency at a later date. If the rate
moves against you, you will lose cash
3. Hedges of a net investment in a foreign operation
This applies to an entity that hedges the foreign currency risk arising from its net
investments in foreign operations

Hedged items
The hedged item is the item you’re worried about - the one which has risk (which needs
managing)

A hedged item can be:

• A recognised asset or liability ( nancial or not)
• An unrecognised commitment
• A highly probable forecast transaction
• A net investment in a foreign operation

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 They must all be separately identi able, reliably measurable and the forecast transaction
must be highly probable.

When can we use hedge accounting?

The hedge must meet all of the following criteria: (replacing the old 80-125% criteria)

• An economic relationship exists between the hedged item and the hedging instrument –
meaning as one goes up in FV the other will go down
For example, a UK company selling to US customers - enters into a $100 to £ futures
contract which ends when the UK company is expected to receive $100
Here - the future $ receipt will be the hedged item and the futures contract the hedging
item
In the above example it is an obvious economic relationship as it’s the same amount and
same timing
However, sometimes the amounts and timings won’t be the same so you may use
judgement as to whether this is actually a proper hedge or not - here numbers could be
used

• Credit risk doesn’t dominate the fair value changes

So, after having established an economic relationship (above) - IFRS 9 just wants to
make sure that any credit risk to the hedged or hedging item wont affect it so much as to
destroy the relationship

Accounting treatment

• Fair Value Hedges

Gains and losses of both the Hedged and Hedging item are recognised in the current
period in the income statement

• Cash ow hedges
Here the hedged item has not yet made its gain or loss (it will be made in the future e.g.
Forex)

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 So, in order to match against the hedged item when it eventually makes its gain or loss,
the “effective” changes in fair value of the hedging instrument are deferred in reserves
(any ineffective changes go straight to the income statement)
These deferred gains/losses are then taken from reserves/OCI and to the income
statement when the hedged item eventually makes its gain or loss

• Hedges of a net investment in a foreign entity

Same as cash- ow, changes in fair value of the hedging instrument are deferred in
reserves/OCI
Normally individual company forex gains/losses are taken to the income statement and
foreign subsidiary retranslation gains/losses taken to the OCI/Reserves.
So, lets say a UK holding company has a UK subsid and a Maltese subsid. The Malta
sub also has loaned the UK sub some cash in Euros.
Normally the UK sub would retranslate this loan and put the difference to the income
statement. Also the Maltese sub is retranslated and the difference taken to OCI. Here, it
is allowed for the UK sub to hold the translation losses also is reserves (like a cash ow
hedge) as long as the loan is not larger than the net investment in the Maltese sub

Special cases of hedging items which reduce P&L Volatility

1. Options - time value element when intrinsic value of option is the designated
hedging item
If the hedging item is an option - then the time value changes in that option will be
taken to the OCI (and equity)
When the hedged item is realised, these then get reclassi ed to P&L
2. Forward points - when the spot element of a forward contract is the designated
hedging item
If the hedging item is a forward contract then the forward points FV changes MAY be
taken to OCI, and again gets reclassi ed when the hedged item hits the I/S
3. Currency basis risk
The spread from this can be eliminated from the hedge - and instead either be valued
as FVTPL or FVTOCI(with reclassi cation)

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 Illustration of a FV Hedge
5% 100,000 xed rate 5 year Receivable loan. (Current variable rates 5%).

Here we are worried that variable rates may rise above this - if they did then the FV of this
receivable would worsen.

So we would have a FV loss.

If the variable rates go lower, then we are happy (as we are receiving a xed rate) and so
the FV would improve.

This company hedges against the variable rates going down - by entering into a variable
rate swap (This is the hedging item).

With this derivative, if variable rates rise we will bene t from receiving more but the FV of
our xed rate receivable loan will have lowered.

These 2 should cancel themselves out.

Market interest rates then increase to 6%, so that the fair value of the xed rate bond has
decreased to $96,535.

As the bond is classi ed as a hedged item in a fair value hedge, the change in fair value of
the bond is instead recognised in pro t or loss:

At the same time, the company determines that the fair value of the swap has increased
by $3,465 to $3,465.

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Since the swap is a derivative, it is measured at fair value with changes in fair value
recognised in pro t or loss. Therefore, Entity A makes this journal entry:

Since the changes in fair value of the hedged item and the hedging instrument exactly
offset, the hedge is 100% effective, and the net effect on pro t or loss is zero.

Illustration Cash ow Hedge

Company has the euro as its functional currency. It will buy an asset for $20,000 next year.
It enters into a forward contract to purchase $20,000 a year´s time for a xed amount
(10,000).
Half way through the year (the company’s Year-end) the dollar has appreciated, so that
$20,000 for delivery next year now costs 12,000 on the market.
Therefore, the forward contract has increased in fair value to 2,000

Solution

When the company comes to pay for the asset, the dollar rate has further increased, such
that $20,000 costs 14,000 in the spot market.
Therefore, the fair value of the forward contract has increased to 4,000

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The forward contract is settled:

The asset is purchased for $10,000 (14,000):

The deferred gain left in equity of 4,000 should either

Remain in equity and be released from equity as the asset is depreciated or
Be deducted from the initial carrying amount of the machine.

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 Syllabus C3g) Discuss and apply the general approach to impairment of nancial instruments
including the basis for estimating expected credit losses.

Syllabus C3h) Discuss the implications of a signi cant increase in credit risk.

Impairment of Financial Instruments

Expected Credit Loss model

This applies to:

I. Amortised cost items

II. FVTOCI items

How it works
Initially you show 12m expected losses

Dr Expense
Cr Loss Allowance (This gets shown next to the nancial asset - it reduces it)
• Then you look to see if there's been a signi cant increase in credit risk? If so switch
from 12m to lifetime expected credit losses
• No signi cant increase in credit risk? Show 12-month expected losses only

How do you calculate the Expected Credit Loss?

Use:
1. a probability-weighted outcome
2. the time value of money
3. the best available forward-looking information.

Notice the use of forward-looking info - this means judgement is needed - so it will be
dif cult to compare companies

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Stage 1 - Assets with no signi cant increase in credit risk

For these assets:

1) 12-month expected credit losses (‘ECL’) are recognised and

2) Interest revenue is calculated on the gross carrying amount of the asset (that is,
without deduction for credit allowance)

12-month ECL are based on the asset’s entire credit loss but weighted by the probability
that the loss will occur within 12 months of the Y/E

Stage 2 - Assets with a signi cant increase in credit risk (but no evidence of
impairment)

For these assets:

1) Lifetime ECL are recognised

2) Interest revenue is still calculated on the gross carrying amount of the asset.

Lifetime ECL come from all possible default events over its expected life
Expected credit losses are the weighted average credit losses with the probability of
default (‘PD’) as the weight.

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 Stage 3 - Assets with evidence of impairment

For these assets:

1) Lifetime ECL are recognised and

2) Interest revenue is calculated on the net carrying amount (that is, net of credit
allowance

In subsequent reporting periods, if the credit quality improves so there’s no longer a

signi cant increase in credit risk since initial recognition, then the entity reverts to
recognising a 12-month ECL allowance

Where does the impairment go?

The changes in the loss allowance balance are recognised in pro t or loss as an
impairment gain or loss

Collective Basis

If the asset is small it’s just not practical to see if there’s been a signi cant increase in
credit risk

So, you can assess ECLs on a collective basis, to approximate the result of using
comprehensive credit risk information that incorporates forward-looking information at an
individual instrument level

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 Simpli ed Approach

This means no tracking changes in credit risk!

Instead just recognise a loss allowance based on lifetime ECLs at each reporting date,
right from origination.

The simpli ed approach is for trade receivables, contract assets with no signi cant
nancing component, or for contracts with a maturity of one year or less

12-month expected credit losses

These are a portion of the lifetime ECLs that are possible within 12 months

The portion is weighted by the probability of a default occurring

It is not the predicted (probable) defaults in the next 12 months. For instance, the
probability of default might be only 25%, in which case, this should be used to calculate
12-month ECLs, even though it is not probable that the asset will default.

Also, the 12-month expected losses are not the cash shortfalls that are predicted over only
the next 12 months. For a defaulting asset, the lifetime ECLs will normally be signi cantly
greater than just the cash ows that were contractually due in the next 12 months.

Lifetime expected credit losses

These are from all possible default events over the expected life

Estimate them based on the present value of all cash shortfalls

So, basically, it’s the difference between:

• The contractual cash ows And
• The cash ows now expected to receive

As PV is used, even late (but the same) cash ows create an ECL

For a nancial guarantee contract, the ECLs would be the PV of what it expects to pay as
guarantor less any amounts from the holder

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ILLUSTRATION 1:

A company has a 5yr 6% receivable loan of $1,000,000

They expect credit losses of $10,000 pa.
The present value (discounted at 6%) of these lifetime expected credit losses is $42,124.
The present value of the 12-month expected credit losses is $9,434

Solution - how to deal with this nancial asset

• On day 1
Dr Loan receivable $1,000,000
Cr Cash $1,000,000

• End of yr 1 - no signi cant increase in credit risk - show 12m ECL

Dr I/S Impairment loss $9,434
Cr Loss allowance in nancial position $9,434

• End of yr 1 - signi cant increase in credit risk - show re-estimate of lifetime ECL
Let’s say the present value of the lifetime expected credit losses is $34,651.
Dr I/S Impairment loss $25,217 (34,651 – 9,434)
Cr Loss allowance in nancial position $25,217

ILLUSTRATION 2:

A company has a receivable loan of $1,000,000.

They estimates that the loan has a 1% probability of a default occurring in the next 12
months.
It further estimates that 25% of the gross carrying amount will be lost if the loan defaults.
How much should the 12m ECL be?

Solution:
= 1% x 25% x $1,000,000 = $2,500

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ILLUSTRATION 3:

An entity has a 10 yr 6% loan receivable of $1,000,000.

On initial recognition the probability of default is 1%. Expected lifetime losses $250,000
End of year 1 - probability of default increases to 1.5%
End of year 2 - probability of default increases to 30% (but still no evidence of impairment)
- expected lifetime losses now $100,000
End of year 3 - probability of default increases further - expected lifetime losses now
150,000 (but still no evidence of impairment)
End of year 4 - probability of default increases further - expected lifetime losses now
200,000 (but still no evidence of impairment)
The loan eventually defaults at the end of Year 5 and the actual loss amounts to $250,000.
At the beginning of Year 6, the loan is sold to a third party for $740,000
How would this be dealt with under IFRS 9?

Solution

• Initial recognition
Dr Loan receivable – amortised cost asset $1,000,000
Cr Cash $1,000,000
Dr I/S Impairment loss (1% x 250,000) $2,500
Cr Loss allowance in nancial position $2,500

• At the end of Year 1

Dr Impairment loss in pro t or loss (3,750 – 2,500) $1,250
Cr Loss allowance in nancial position $1,250
The new 12m ECL would be 1.5% x 250,000 = $3,750.
Interest income 6% x 1,000,000 = $60,000.

• At the end of Year 2

Dr I/S Impairment loss (100,000 - 3,750) $96,250
Cr Loss allowance in nancial position $96,250
Interest income 6% x 1,000,000 = $60,000
Notice that interest is still calculated on gross amount

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• At the end of year 3
Dr I/S Impairment loss (150,000 - 100,000) $50,000
Cr Loss allowance in nancial position $50,000
Interest income 6% x 1,000,000 = $60,000

• At the end of year 4

Dr I/S Impairment loss (200,000 - 150,000) $50,000
Cr Loss allowance in nancial position $50,000
Interest income 6% x 1,000,000 = $60,000

• At the end of year 5

Dr I/S Impairment loss (250,000 - 200,000) $50,000
Cr Loss allowance in nancial position $50,000
Interest income 6% x 1,000,000 = $60,000

From Year 6 onward, interest income would be calculated at 6% on the net carrying
amount of the loan $750,000.

• Start of year 6
Dr Cash $740,000
Dr Loss allowance in nancial position – de-recognised $250,000
Dr Loss on disposal in pro t or loss $10,000
Cr Gross loan receivable – de-recognised $1,000,000

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 Syllabus C3i) Discuss and apply the treatment of purchased or originated credit impaired nancial
assets.

Purchased Or Originated Credit-Impaired Financial

Assets

So here the asset is credit-impaired immediately

Eg.

1. Signi cant nancial dif culty of the borrower;

2. A default
3. Probable that the borrower will enter bankruptcy
4. The disappearance of an active market for the nancial asset

Show lifetime expected losses immediately

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 Syllabus C4. Leases
Syllabus C4a) Discuss and apply the lessee accounting requirements for leases including the
identi cation of a lease and the measurement of the right of use asset and liability.

Leases - De nition

IFRS 16 gets rid of the Operating lease (which showed no liability on the
SFP).

So, every lease now shows a liability!

Therefore the de nition of what is a lease is super important (as it affects the amount of
debt shown on the SFP)

Here is that de nition:

A contract that gives the right to use an asset for a period of time in exchange for
consideration

So let's dig deeper

There's 3 tests to see if the contract is a lease..

1. The asset must be identi able

This can be explicitly - it's in the contract
Or implicitly - the contract only makes sense by using this asset
(There is no identi able asset if the supplier can substitute the asset (and would
bene t from doing so))

2. The customer must be able to get substantially all the bene ts while it uses it

3. The customer must be able to direct how and for what the asset is used

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Example

A contract gives you exclusive use of a speci c car

You can decide when to use it and for what

The car supplier cannot substitute / change the car

So does the contract contain a lease?

Does it pass the 3 tests?

1. Is there an Identi able asset?

Yes the car is explicitly referred to and the supplier cannot substitute the car

2. Does the customer have substantially all bene ts during the period?
Yes

3. Does the customer direct the use?

Yes he/she can use it for whatever and whenever they choose

So, yes this contract contains a lease because it's...

A contract that gives the right to use an asset for a period of time in exchange for
consideration

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Example

A contract gives you exclusive use of a speci c airplane

You can decide when it ies and what you y (passengers, cargo etc)

The airplane supplier though operates it using its own staff

The airplane supplier can substitute the airplane for another but it must meet speci c
conditions and would, in practice, cost a lot to do so

So does the contract contain a lease?

Does it pass the 3 tests?

1. Is there an Identi able asset?

Yes the airplane is explicitly referred to and the substitution right is not substantive
as they would incur signi cant costs

2. Does the customer have substantially all bene ts during the period?
Yes it has exclusive use

3. Does the customer direct the use?

Yes the customer decides where and when the airplane will y

So, yes this contract contains a lease because it's...

A contract that gives the right to use an asset for a period of time in exchange for
consideration

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 Basic Rule

Lessees recognise a right to use asset and associated liability on its SFP for
most leases

How to Value the Liability

Present value of the lease payments, where the lease payments are:

1 Fixed Payments

2 Variable Payments (if they depend on an index / rate)

3 Residual Value Guarantees

4 Probable purchase Options

5 Termination Penalties

How to Value the Right of Use asset?

Includes the following:

1 The Lease Liability (PV of payments)

2 Any lease payments made before the lease started

3 Any Restoration costs (Dr Asset Cr Provision)

4 All initial direct costs

After the initial Measurement - Asset

• Cost - depreciation (normally straight line) less any impairments

• Any subsequent re-measurements of the liability

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After the initial Measurement - Liability

• Effective interest rate method (amortised cost)

• Any re-measurements (e.g. residual value guarantee changes)

Example

3 year lease term

Annual lease payments in arrears 5,000

Rate implicit in lease: 12.04%

PV of lease payments: 12,000

Answer

The lease liability is initially the PV of future lease payments - given here to be 12,000

Double entry: Dr Asset 12,000 Cr Lease Liability 12,000

The Asset is then depreciated by 4,000pa (12,000 / 3)

The lease liability uses amortised cost:

Opening Interest (I/S) 12.04% (Payment) Closing

12,000 1,445 (5,000) 8,445

8,445 1,017 (5,000) 4,463
4,463 537 (5,000) 0

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Example - Variable lease payments (included in Lease Liability)

(Remember only include those linked to a rate or index)

So the lease contract says you have to pay more lease payments of 5% of the sales in
the shop you're leasing - should you include this potential variable lease payment in
your lease liability?

Answer

No - because it is not based on a rate or index

(They are just put to the Income statement when they occur)

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 Variable Lease payments example

10 year Lease contract:

500 payable at the start of every year

Increased payments every 2 years to re ect the change in the consumer price index

The consumer price index was 125 at the start of year 1

The consumer price index was 130 at the start of year 2

The consumer price index was 135 at the start of year 3

(so these are variable payments based upon an index / rate)

ANSWER (IGNORING DISCOUNTING)

Start of year 1:

Dr Asset 500 Cr Cash 500

Dr Asset 4500 Cr Lease Liability 4500 (9 x 500)

End of year 2:

Asset will be 5,000 - 1,000 (straight line depreciation) = 4,000

Lease liability will be 8 x 500 = 4,000

End of year 3:

Lease payments are now different - 500 x 135/125 = 540

So the lease liability will be 7 x 540 = 3,780

Asset will be 4,000 - 500 (depreciation) + 280 (re-measurement of Liability) = 3,780

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(Please note that this example ignored discounting - which would normally happen as
the liability is measured as the PV of future payments)

Variable payments that are really xed payments

These are included into the liability as they're pretty much xed and not variable

e.g. Payments made if the asset actually operates

(well it will operate of course and so this is effectively a xed payment and not a
variable one)

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 The Lease Term

This is important because..

The lease liability = PV of payments in the lease term!

How is the Lease Term calculated?

• Period which can't be cancelled

• + any option to extend period (if reasonably certain to take up)

• + period covered by option to terminate (if reasonably certain not to take up)

So what does "Reasonably Certain" mean?

1 Market conditions mean its favourable to do it

2 Signi cant leasehold improvements made

3 High costs to terminate the lease

4 The asset is very important to the lessee (or specialised/customised to

the lessee)

Problem

How do we 'weight' these factors that tell us whether the lessee is reasonably certain to
extend the term or not?

Eg A agship store in a prime and much sought-after location.

Signi cant judgement would be needed to determine whether the prime geographical
location of the store or other factors (for example termination penalties, lease hold
improvements, etc.) indicate that it is reasonably certain whether or not the lessee will
renew the store lease.

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When is the lease term re-assessed?

It's very rare but

1 When the lessee exercises (or not) an option in a different way than
previously was reasonably certain;

2 When something happens that contractually obliges the lessee to

exercise an option not previously included in the determination of the lease term or

3 When something signi cant happens that affects whether it is reasonably

certain to exercise an option. This trigger is only relevant for the lessee (and not the
lessor).

Example

A 10 year lease with an option to extend for 5 years.

Initially, the lessee is not reasonably certain that it will exercise the extension option. So
the lease term is set for 10 years.

After 5 years, they decides to sublease the building for 10 years

Answer

Entering into a sublease is a signi cant event and it affects the entity’s assessment of
whether it is reasonably certain to exercise the extension option.

So, the lessee must change the lease term of the head lease

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 Syllabus C4e)
Discuss the recognition exemptions under the current leasing standard

Exemptions to Leases treatment

So now we know that all lease contracts mean we have to show

1 A right to use Asset

2 A Liability

So remember we said there was no longer a concept of operating leases - all lease
contracts mean we need to show a right to use asset and its associated liability

Well.. there are some exemptions..

Exemption 1 - Short Term Leases

These are less than 12 months contracts (unless there's an option to extend that you'll
probably take or an option to purchase)

1 Treat them like operating leases

Just expense to the Income Statement (on a straight line / systematic basis)

2 Each class of asset must have the same treatment

3 This exemption ONLY applies to Lessees

Exemption 2: Low Value Assets

e.g. IT equipment, of ce furniture with a value of less than $5,000

1 Treat them like operating leases

Just expense to the Income Statement (on a straight line basis)

2 Choice is made on a lease by lease basis

3 This exemption ONLY applies to Lessees

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 Syllabus C4e) Discuss the recognition exemptions under the current leasing standard.

Measurement Exemptions

Exemption 1: Investment Property

(if it uses the FV model in IAS 40)

• Measure the property each year at Fair Value

Exemption 2 - PPE

(if revaluation model is used)

• Use revalued amount for asset

Exemption 3: Portfolio Approach

(Portfolio of leases with SIMILAR characteristics)

• Use same treatment for all leases in the portfolio

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 Syllabus C4d) Discuss and apply the reasons behind the separation of the components of a lease
contract into lease and non-lease elements.

Components of a Lease

Sometimes a contract is for more than 1 thing

So the supplier (lessor) has more than 1 obligation

These obligations might be lease components or a combination of lease and non-lease

components.

For example, a contract for a car lease might be combined with maintenance (non
lease component)

IFRS 16 says lease and non-lease components should be accounted for separately...

What is a separate component?

1 something the lessee can bene t from alone and

2 not dependent on other assets in the contract

What do you do with separate lease components?

Deal with them separately

1. The non-lease components should be assessed under IFRS 15 for separate

performance obligations.

2. The lease components are treated as nancial liabilities as normal under IFRS 16

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So if you treat 2 components in a contract differently..

How do you separate them in terms of allocating an amount of the lease payment to
them?

• Use their stand-alone prices (or an estimate if not available)

Practical expedient

Lessees are allowed not to separate lease and non-lease components and, instead,
account for them as a single lease component.

This accounting policy choice has to be made by class of underlying asset.

Because not separating a non-lease component would increase the lessee’s lease
liability, the IASB expects that a lessee will use this exemption only if the non-lease
component is not signi cant.

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 Syllabus C4b) Discuss and apply the accounting for leases by lessors.

Lessor Accounting - Finance Lease

Is it a Finance Lease or an Operating Lease?

If the majority of the risks and rewards are transferred to the lessee then it's a nance
lease

Other Indicators of a Finance Lease

1 Ownership transferred at the end

2 Option to buy at the end at less than Fair Value

3 Lease term is for majority of the asset's UEL

4 PV of future lease payments is close to the actual Fair Value of the asset

5 The asset is specialised and customised for the lessee

Finance Lease accounting

Dr Lease Receivable Cr Asset

What makes up the Lease Receivable?

1 PV of lease payments
(Fixed receipts, Variable receipts (based on index / rate), Residual Value guaranteed to
receive, Exercise price to be received of any likely purchase option from the lessee,
Any penalties likely to be received from the lessee for early termination)

2 Un-guaranteed Residual Value

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 Lessor - Finance Lease accounting

Opening Lease Effective Interest Amounts Received Closing Lease

Receivable Received Receivable

Dr Lease Receivable Dr Lease Receivable Dr Cash Balancing

Cr PPE Cr Interest Receivable Cr Lease Receivable gure

Lessor accounting if Operating Lease

Remember this is when the lessor keeps the risks and rewards of the asset

Accounting rules
• Keep the Asset on the SFP as normal
• Show lease receipts on the income statement (straight line basis)

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 Syllabus C4b) Discuss and apply the accounting for leases by lessors.

Lessor Accounting - Operating Lease

Ok - let´s have a think about this

Remember that when we say operating lease - we mean the risks and rewards are
NOT taken by the lessee. So have we sold the asset or not?

Revenue recognition tells us that when the risks and rewards for goods are passed on
then we have made a sale and can recognise the revenue.

So, no the lessor has NOT in substance sold the asset. Therefore the lessor keeps the
asset on its SFP.

Income from an operating lease (not including services such as insurance and
maintenance), should be shown straight-line in the income statement over the length
of the lease (unless the item is used up on a different basis - if so use that basis).

SFP Income statement

Keep the Asset there Operating Lease rentals received

Negotiating costs etc

Any initial direct costs incurred by lessors should be added to the carrying amount of
asset on the SFP and expensed over the lease term (NOT the assets life).

Operating Lease Incentives

The lessor should reduce the rental income over the lease term, on a straight-line basis
with the total of these.

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 Syllabus C4f) Discuss and apply the principles behind accounting for sale and leaseback
transactions.

Sale and Leaseback

Let’s have a little ponder over this before we dive into the details…

So - the seller makes a sale (easy) BUT remember also leases it back - so the seller
becomes the lessee always, and the buyer becomes the lessor always

Seller = Lessee (after)

Buyer = Lessor (after)

However, If we sell an item and lease it back - have we actually sold it? Have we got rid
of the risk and rewards?

So the rst question is..

Have we sold it according to IFRS 15? (revenue from contracts with customers)

Option 1: Yes - we have sold it under IFRS 15

This means the control has passed to the buyer (lessor now)

But remember we (the seller / lessee) have a lease - and so need to show a right to use
asset and a lease liability

Step 1: Take the asset (PPE) out

Dr Cash

Cr Asset

Cr Initial Gain on sale

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 Step 2: Bring the right to use asset in

Dr Right to use asset

Cr Finance Lease / Liability

Dr/Cr Gain on sale (balancing gure)

• How much do we show the Right to Use asset at?

The proportion (how much right of use we keep) of our old carrying amount
The PV of lease payments / FV of the asset x Carrying amount before sale

• How much do we show the nance liability at?

The PV of lease payments

Example

A seller-lessee sells a building for 2,000. Its carrying amount at that time was 1,000 and
FV 1,800

The seller-lessee then leases back the building for 18 years, for 120 p.a in arrears.

The interest rate implicit in the lease is 4.5%, which results in a present value of the
annual payments of 1,459

The transfer of the asset to the buyer-lessor has been assessed as meeting the
de nition of a sale under IFRS 15.

Answer

Notice rst that the seller received 200 more than its FV - this is treated as a nancing
transaction:

Dr Cash 200

Cr Financial Liability 200

Now onto the sale and leaseback..

Step1: Recognise the right-of-use asset - at the proportion (how much right of use
we keep) of our old carrying amount

Old carrying amount = 1,000

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How much right we keep = 1,259 / 1,800 (The 1,259 is the 1,459 we actually pay - 200
which was for the nancing)

So, 1,259 / 1,800 x 1,000 = 699

Step 2: Calculate Finance Liability - PV of the lease payments

Given - 1,259

So the full double entry is:

Dr Cash 2,000

Cr Asset 1,000

Cr Finance Liability 200

Cr Gain On Sale 800

Dr Right to use asset 699

Cr Finance lease / liability 1,259

Dr Gain on sale 560 (balance)

Option 2: It's not a sale under IFRS 15

So the buyer-lessor does not get control of the asset

Therefore the seller-lessee leaves the asset in their accounts and accounts for the cash
received as a nancial liability.

The buyer-lessor simply accounts for the cash paid as a nancial asset (receivable).

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 Syllabus C4c) Discuss and apply the circumstances where there may be re-measurement of the
lease liability.

Further Guidance on Lease accounting

Some further guidance on measuring Right to use Assets

1 Discount rate
The lessee uses the discount rate the interest rate implicit in the lease - if this rate
cannot be readily determined, the lessee should use its incremental borrowing rate (for
similar amount, term & security)

2 Restoration costs
This should be included in the initial measurement of the right-of-use asset and as a
provision. This corresponds to the accounting for restoration costs in IAS 16 Property,
Plant and Equipment.

If the expected restoration costs change - then the right-of-use asset and provision is
changed

3 Initial direct costs

These are incremental costs that would not have been incurred if a lease had not been
obtained. e.g. commissions or some payments made to existing tenants to obtain the
lease.

All initial direct costs are included in the initial measurement of the right-of-use asset.

4 Subsequent measurement
The lease liability is measured in subsequent periods using the effective interest rate
method.

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The right-of-use asset is depreciated on a straight-line basis or another systematic
basis that is more representative of the pattern in which the entity expects to consume
the right-of-use asset.

The lessee must also apply the impairment requirements in IAS 36,‘Impairment of
assets’, to the right-of-use asset.

Using straight-line depreciation (for the asset) and the effective interest rate (for the
lease liability) will mean higher charges at the start of the lease and less at the end
(‘frontloading’)

But this might not properly re ect the economic characteristics of a lease contract
(especially for 'operating leases'.

It also means the carrying amount of the right-of-use asset and the lease liability won't
be equal in subsequent periods. The right-of-use asset will, in general, be lower than
the carrying amount of the lease liability.

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 When should the lease liability be reassessed?

(only if the change in cash ows is based on contractual clauses that have been part of
the contract since inception) otherwise it's a modi cation not a reassessment

Component of the lease liability Reassessment

Lease Term When? – If there is a change in the lease

term.

How? – Re ect the revised payments using a

revised discount rate(the interest rate implicit
in the lease for the remainder of lease term)
Exercise price of a purchase option When? – A signi cant event (within the control
of the lessee) affects whether the lessee is
reasonably certain to exercise an option.

How? – Re ect the revised payments using a

revised discount rate(the interest rate implicit
in the lease for the remainder of lease term)
Residual value guarantee When? – If there is a change in the amount
expected to be paid.

How? – Include the revised residual payment

using the unchanged discount rate.
Variable lease payment (dependent When? – If a change in the index/rate results
on an index or a rate) in a change in cash ows.

How? – Re ect the revised payments based

on the index/rate at the date when the new
cash ows take effect for the remainder of the
term using the unchanged discount rate

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 Syllabus C5. Employee Benefits
Syllabus C5a) Discuss and apply the accounting treatment of short term and long term employee
bene ts, termination bene ts and de ned contribution and de ned bene t plans.

Pensions Introduction

Objective of IAS 19

Companies give their employees bene ts - the most obvious being wages but there
are, of course, other things they may offer such as pensions.

IAS 19 says that the bene t should be shown when earned rather than when paid.

Employee bene ts include paid holiday, sick leave and free or subsidised goods given
to employees.

Short-term Employee Bene ts

As we mentioned above, any bene ts payable within a year after the work is done,
(such as wages, paid vacation and sick leave, bonuses etc.) should be recognised
when the work is done not when paid for.

Pro t-sharing and Bonus Payments

Recognise when there is an obligation to make such payments and a reliable estimate
of the expected cost can be made.

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 Illustration

Grazydays PLC give their employees 6 weeks of paid holiday each year, and because
they’re groovy employers, any holiday not taken can be carried forward to the next
year.

Accounting Treatment
Any untaken holiday entitlement should be recognised as a liability in the current
year even though it wouldn’t be taken until the next year.

Types of Post-employment Bene t Plans

There are two types:

1. De ned Contribution plan

In this one the company just promises to pay xed contributions into a pension fund for
the employee and has no further obligations.

The contribution payable is recognised in the income statement for that period.

If contributions are not payable until after a year they must be discounted.

2. De ned Bene t plan

This is a post-employment bene t that gives the company an obligation to pay a

de ned pension to its employees who have left.

The SFP Figure

The present value of the obligation less FV of assets (in the pension fund).

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 De ned Bene t Scheme - Terms

De ned Bene t Scheme - Terms

De ned bene t plan

As we said in the intro - this is “A post-employment bene t that creates a constructive

obligation to the enterprise’s employees”.

• The SFP shows the pension fund as it stands at the year end in terms of the present
value of the obligation less FV of assets.

Let’s dig a little deeper to make some sense out of this.

• The idea is that the company puts money into the fund, the fund spends that money
on assets.

The assets make an EXPECTED return. The company hopes this return will pay off the
employees future pensions when they leave the company.

• Of course, the fund will not always exactly match the pension liability. Therefore there
will either be a surplus or de cit on the SFP.

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Let’s look at some terms before we put it all together:

1. Actuarial gains/losses

These occur due to differences between previous estimates and what actually
occurred.

These are recognised in the OCI.

2. Past service cost

Dr Income statement
Cr Pension Liability

This is a change in the pension plan resulting in a higher pension obligation for
employee service in prior periods.

They should be recognised immediately if already vested or not.

3. Plan curtailments or settlements

Curtailments are reductions in bene ts or the number of employees covered by the

pension.

Any gain/loss is recognised when the curtailment occurs.

4. Current service cost

Increase in pension liability due to bene ts earned by employee service in the period.

Dr Income statement
Cr Pension Liability

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5. Interest cost

The unwinding on the discount of the pension liability.

Dr Interest
Cr Pension Liability

6. Expected return on plan assets

This is the Interest, dividends and other revenue from the pension assets and is now to
be based on the return from AA-rated corporate bonds.

This means companies cannot set expected returns according to the assets actually
held by the plan

It could encourage them to invest in more secure vehicles than is currently the case,
seeing as the potential higher return will no longer be re ected in the accounts.

The reason behind this is to improve transparency and consistency.

Dr Pension Asset
Cr Interest received

The Interest cost and EROA are netted off against each other. They use the same
discount rate.

So if a fund has more assets than liabilities (a surplus) - it will have net interest
received.

If a fund has more liabilities than assets (a de cit) - it will have net interest paid.

7. Contributions to Pension fund

This is simply the money that the company puts in to the fund - so the fund can buy
assets to generate an expected return.

Dr Pension Asset
Cr Cash

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 8. Bene ts paid

These are the actual pensions paid out to former employees.

Paying the pensions means we reduce the liability, but we use the pension fund to do it,
so we reduce the pension asset also.

Dr Pension Liability
Cr Pension Asset

Other Long-term Bene ts (e.g. Pro t shares, bonuses)

A simpli ed application of the model described above for other long-term employee
bene ts:

All past service cost is recognised immediately.

Termination Bene ts (e.g. Redundancy)

Amount payable only recognised when committed to either:

1. Terminating the employment of employees before the normal retirement date; or

2. Providing bene ts in order to encourage voluntary redundancy.

“Demonstrably committed” means a detailed formal plan without realistic

possibility of withdrawal.

Discount down if payable in more than a year.

Equity Compensation Bene ts

No recognition for stock options issued to employees as compensation.

Nor does it require disclosure of the fair values of stock options or other share-based
payment.

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IAS 19 ‘Asset Ceiling’

This stops gains being shown just because Past service costs (unvested) have been
deferred.

It may be that there are net assets but not all can be recovered through refunds /
contributing less in the future.

In such cases, deferral of past service cost may not result in a refund to the entity or a
reduction in future contributions to the pension fund, so a gain is prohibited in these
circumstances.

So, any asset recognised in the balance sheet should be the lower of:

• the net total calculated; and

• the net total of:

(i) past service costs not recognised as an expense; and

(ii) the present value of any economic bene ts available in the form of refunds from the
plan or reductions in future contributions to the plan.

An asset may arise where a de ned bene t plan has been overfunded or in certain
cases where actuarial gains are recognised.

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 De ned Bene t - Illustration

This is best seen on the video - but here goes in the written word….

Illustration

Pension Fund asset b/f 400

Pension Fund Liability b/f 600
Current service cost 100
Expected return on assets 10%
Discount rate 10%
Contributions paid (@ year-end) 80
Bene ts paid (@ year-end) 60

Actuarial c/f: Pension Fund Asset 500

Pension Fund Liability 650

Solution

• Current Service cost

Dr I/S 100
Cr Pension Liability 100

• Expected return on Assets

Dr Pension asset 40 (10% x 400)

Cr Interest 40

• Unwinding of discount

Dr Interest 60 (10% x 600)

Cr Pension Liability 60

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 • Contributions Paid

Dr Pension asset 80
Cr Cash 80

• Bene ts paid

Dr Pension Liability 60
Cr Pension Asset 60

Having done those double entry we can see that assets have increased by 60 (400 to
460) and liabilities have increased by 100 (600 to 700) giving a net increase in the SFP
pension liability of 40.
We now compare the pension assets and liabilities gure (which is based upon
assumptions) to what has actually occurred.

This is given in the actuarial gures c/f.

So, the assets made an actuarial gain of 40 and the liabilities a gain of 50.

This total gain of 90 is recognised in the OCI as a gain.

The balance sheet is showing a liability of 240, less the re-measurement of 90, equals
150 Liability.

This matches what is actually in the pension fund (650- 500) = 150.

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 De ned Contribution Scheme

Short-term Employee Bene ts

Bene ts payable within a year after work is done, such as wages, paid vacation and
sick leave, bonuses etc. should be recognised when work is done.

Pro t-sharing and Bonus Payments

Recognise when there is an obligation to make such payments and a reliable estimate
of the expected cost can be made.

De ned contribution plan

• The enterprise pays xed contributions into a fund and has no further obligations.

• The contribution payable is recognised in the income statement for that period.

• If contributions are not payable until after a year they must be discounted.

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 Syllabus C5b) Account for gains and losses on settlements and curtailments.

Curtailments and Settlements

Curtailments

An amendment is made to the plan which improves bene ts for plan members.
An increase to the obligation (and expense) is recognised when the amendment occurs:

DEBIT Pro t or loss X

CREDIT Present value of de ned bene t obligation X

Settlements

A settlement eliminates all further obligations

Eg: A lump-sum cash payment made in exchange for rights to receive post-employment
bene ts.

The gain or loss on a settlement is recognised in pro t or loss when the settlement occurs:

DEBIT PV obligation (as advised by actuary) X

CREDIT FV plan assets (any assets transferred) X
CREDIT Cash (paid directly by the entity) X
CREDIT/ DEBIT Pro t or loss (difference) X

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 Syllabus C5c) Account for the “Asset Ceiling” test and the reporting of actuarial gains and losses.

Asset Ceiling Test

The 'Asset Ceiling' test

The net pension amount can't be in the shown at more than its recoverable amount.

So basically any net pension asset gets measured at the lower of:

1) Net reported asset (in the books) or

2) The PV of any refunds/ reduction of future contributions available from the pension plan

Any impairment loss is charged immediately to OCI

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 Syllabus C6. Income taxes
Syllabus C6a) Evaluate and apply the recognition and measurement of current and deferred tax
liabilities and assets

Syllabus C6b) Discuss and apply the treatment of deferred taxation on a business combination.

Current tax

The amount of income taxes payable or receivable in a period

Any tax loss that can be carried back to recover current tax of a previous period is shown
as an asset

If the gain or loss went to the OCI, then the related tax goes there too

Deferred Tax

This is basically the matching concept.

Let´s say we have credit sales of 100 (but not paid until next year).
There are no costs.
The tax man taxes us on the cash basis (i.e. next year).
The Income statement would look like this:

Income Statement
Sales 100
Tax (30%) 0
Pro t 100

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 This is how it should look.

The tax is brought in this year even though it´s not payable until next year, it´s just a
temporary timing difference.

Income Statement SFP

Sales 100
Tax (30%) 0 Deferred tax payable 30
Pro t 100

Illustration
Tax Base
Let’s presume in one country’s tax law, royalties receivable are only taxed when they are
received

IFRS
IFRS, on the other hand, recognises them when they are receivable

Now let’s say in year 1, there are 1,000 royalties receivable but not received until year 2.

The Income statement would show:

Royalties Receivable 1000

Tax (0) (They are taxed when received in yr 2)

This does not give a faithful representation as we have shown the income but not the
related tax expense.

Therefore, IFRS actually states that matching should occur so the tax needs to be brought
into year 1.

Dr Tax (I/S)
Cr Deferred Tax (SFP provision)

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Deferred tax on a revaluation

Deferred tax is caused by a temporary difference between accounts rules and tax rules.

One of those is a revaluation:

Accounting rules bring it in now.

Tax rules ignore the gain until it is sold.

So the accounting rules will be showing more assets and more gain so we need to
match with the temporarily missing tax.

Illustration

A company revalues its assets upwards making a 100 gain as follows:

OCI SFP
PPE 1,000 + 100

Revaluation Gain 100 Revaluation surplus 100

This is how it should look.

The tax is brought in this year even though it´s not payable until sold, it´s just a
temporary timing difference.

Notice the tax matches where the gain has gone to.

OCI SFP
PPE 1,000 + 100
Deferred tax payable (30%) (30)
Revaluation Gain 100 - 30 Revaluation surplus 100 - 30

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 Deferred Tax Scenarios

So as we saw in the introductory section, deferred tax is all about matching.

If the accounts show the income, then they must also show any related tax.

This is normally not a problem as both the accounts and taxman often charge amounts
in the same period.

The problem occurs when they don’t.

We saw how the accounts may show income when the performance occurs, while the
taxman only taxes it (tax base) when the money is received.

In this case, as nancial reporters we must make sure we match the income and
related expense.

So this was a case of the accounts showing ‘more income’ than the tax man in the
current year (he will tax it the following year when the money is received).

So we had to bring in ‘more tax’ ourselves by creating a deferred tax liability.

So, basically deferred tax is caused simply by timing differences between IFRS rules and
tax rules.

Therefore IFRS demands that matching should occur i.e.

Difference Tax adjustment Deferred Tax Double entry
between IFRS needed for
and Tax base matching to
occur

Dr Tax (I/S)
More Income in I/S More tax needed Liability Cr Def Tax Liability
(SFP)

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Hopefully you can see then that the opposite also applies:
Difference Tax effect Deferred Tax Double entry

Dr Def tax asset

More expense in I/S less tax needed Asset
Cr tax (I/S)

In fact, the following table all applies:

Difference Tax effect Difference

1 More Income More tax Liability
2 Less income Less tax Asset
3 More expense Less tax Asset
4 Less expense More tax Liability

Remember this “more income etc.” is from the point of view of IFRS. I.e. The accounts
are showing more income, as the taxman does not tax it until next year.

We will now look at each of these 4 cases in more detail.

Case 1

Difference Tax effect Difference

1 More Income More tax Liability

Issue

IFRS shows more income than the taxman has taken into account.

Example
Royalties receivable above.

Double entry required:

Dr Tax (I/S)
Cr Deferred tax Liability (SFP)

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Case 2

Difference Tax effect Difference

2

Issue

IFRS shows less income than the taxman has taken into account.

Example
Taxman taxes some income which IFRS states should be deferred such as upfront
receipts on a long term contract.

Double entry required:

Dr Deferred Tax Asset (SFP)
Cr Tax (I/S)

This will have the effect of eliminating the tax charge for now, so matching the fact that
IFRS is not showing the income yet either.

Once the income is shown, then the tax will also be shown by:

Dr Tax (I/S)
Cr Deferred tax asset (SFP)

Case 3

Difference Tax effect Difference

3 More Expense Less tax Asset

Issue

IFRS shows more expense than the taxman has taken into account.

Example
IFRS depreciation is more than Tax depreciation (WDA or CA).

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Double entry required:
Dr Deferred Tax Asset (SFP)
Cr Tax (I/S)

Illustration

IFRS TAX
Asset Cost 1,000 1,000
Depreciation (400) (300)
NBV 600 700

Simply compare 700-600 =100

100 x tax rate = deferred tax asset

Case 4

Difference Tax effect Difference

4 Less Expense More tax Liability

Issue

IFRS shows less expense than the taxman has taken into account.

Example

IFRS depreciation is less than Tax depreciation (WDA or CA).

Double entry required:

Dr Tax I/S
Cr Deferred Tax Liability

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Illustration

IFRS TAX
Asset Cost 1,000 1,000
Depreciation (300) (400)
NBV 700 600

Simply compare 700-600 =100

100 x tax rate = deferred tax liability

Then multiply this by the tax rate (e.g. 30%) = 100 x 30% = 30

NOTE

In actual fact, the standard refers to assets and liabilities rather than more income and
more expense etc.

Simply use the above tables and substitute the word asset for income and expense for
liability.

Difference Tax effect Tax effect

1 More Asset More tax Liability
2 Less Asset Less tax Asset
3 More Liability Less tax Asset
4 Less Liability More tax Liability

Possible Examination examples of Case 1& 4

Accelerated capital allowances (accelerated tax depreciation) - see above.

Interest revenue - some interest revenue may be included in pro t or loss on an

accruals basis, but taxed when received.

Development costs - capitalised for accounting purposes in accordance with IAS 38

while being deducted from taxable pro t in the period incurred.

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 Revaluations to fair value
In some countries the revaluation does not affect the tax base of the asset and hence a
temporary difference occurs which should be provided for in full based on the difference
between its carrying value and tax base.

NOTE: Double entry here is:

Dr Revaluation Reserve with the tax (as this is where the “income” went)
Cr Deferred tax liability

Fair value adjustments on consolidation

IFRS 3/ IAS 28 require assets acquired on acquisition of a subsidiary or associate to be
brought in at their fair value rather than carrying amount.

The deferred tax effect is a consolidation adjustment - this is more assets (normally) so
a deferred tax liability. The other side would be though to increase goodwill. And vice-
versa.

Undistributed pro ts of subsidiaries, branches, associates and joint ventures

No deferred tax liability if Parent controls the timing of the dividend.

Possible Examination examples of Case 2 & 3

Provisions - may not be deductible for tax purposes until the expenditure is incurred.

Losses - current losses that can be carried forward to be offset against future taxable
pro ts result in a deferred tax asset.

Fair value adjustments

liabilities recognised on business combinations result in a deferred tax asset where the
expenditure is not deductible for tax purposes until a later period.

A deferred tax asset also arises on downward revaluations where the fair value is less
than its tax base.

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 NOTE: Here, the deferred tax asset here is another asset of S at acquisition and so
reduces goodwill.

Unrealised pro ts on intra-group trading

the tax base is based on the pro ts of the individual company who has made a realised
pro t.

THERE IS NO DEFERRED TAX EFFECT ON INITIAL GOODWILL.

How much deferred tax?

1. Deferred tax is measured at the tax rates expected to apply to the period when the
asset is realised or liability settled, based on tax rates (and tax laws) that have been
enacted by the end of the reporting period.

2. No Discounting

3. Deferred tax assets are only recognised to the extent that it is probable that taxable
pro t will be available against which the deductible temporary difference can be used

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 Syllabus C6c) Discuss and apply the treatment of deferred taxation on a business combination.

Miscellaneous Deferred Tax Items

On acquiring a Subsidiary

Here you need to check the Net Assets at acquisition (from your equity table) and compare
it to the tax base of the NA (this will be given in the exam)

Again you just look to see if the accounts are showing more or less assets and create a
deferred tax liability / asset at acquisition also. This will affect goodwill.

Illustration
H acquires 100% S for 1,000. At that date the FV of S’s NA was 800 and the tax base 700.
Tax is 30%.

How much is goodwill?

Goodwill

FV of Consideration 1,000

NCI -

FV of NA acquired -800

New Deferred tax liability 30

(800-700) x 30%

Goodwill 230

Un-remitted Earnings of Group Companies

H always has the right to receive pro ts (and dividends from them) from S or A. However
not all pro ts are immediately paid out as dividends.

This creates deferred tax as H will receive the full amount one day and when it does it will
be taxed. Therefore, a deferred tax liability should be created to match against the pro ts
shown from S and A

However, for Subsidiaries only, H might control its dividend policy and have no intention of
paying dividends out and no intention of selling S either in the foreseeable future.

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Therefore when this is the case NO deferred tax liability is created (this can not be the
case for Associates as H does not control A)

Unrealised Pro t Adjustments

Here, the group makes an adjustment and decreases pro ts, in the group accounts only.

However, tax is charged on the individual companies and not the group. So, the group
accounts will be showing less pro ts and so the tax needs adjusting by creating a deferred
tax asset

The issue though is what tax rate to use - that of the selling company or that of the buyer
who holds the stock?

IAS 12 says you should use the tax rate of the buyer

Setting Off

A deferred tax asset can normally be set off against a deferred tax liability (to the same tax
jurisdiction) as the liability gives strong evidence that pro ts are being made and so the
asset will come to fruition

Deferred Tax Liability 1,000

Deferred Tax Asset -800

200

If, however, the deferred tax asset is more than the liability then the deferred tax asset can
only be recognised if is probable that it will be recovered in the near future

Deferred Tax Liability 1,000

Deferred Tax Asset -1,100

NO SET OFF

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Syllabus C7. Provisions, contingencies and events after
the reporting date
Syllabus C7a) Discuss and apply the recognition, de-recognition and measurement of provisions,
contingent liabilities and contingent assets including environmental provisions and restructuring
provisions.

Provisions

A provision is a liability of uncertain timing or amount

Double entry

Dr Expense
Cr Provision (Liability SFP)

If it is part of a cost of an asset (e.g. Decommissioning costs)

Dr Asset
Cr Provision (Liability SFP)

Recognise when

1. There is an obligation (constructive or legal)

2. There is a probable out ow
3. It is reliably measurable

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At how much?

The best estimate of the expenditure

Large Population of Items..

use expected values.

Single Item...
the individual most likely outcome may be the best estimate.

Discounting of provisions
Provisions should be discounted

Eg. A future liability of 1,000 in 2 years time (discount rate 10%)

1,000 x 1/1.10 x 1/1.10 = 826

Dr Expense 826
Cr Provision 826

Then the discount unwound

Year 1
826 x 10% = 83

Dr Interest 83
Cr Provision 83

Year 2
(826+83) x 10% = 91

Dr Interest 91
Cr Provision 91

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Measurement of a Provision

• The amount recognised as a provision should be the best estimate of the

expenditure required to settle the present obligation at the end of the reporting period.

• Provisions for one-off events

E.g. restructuring, environmental clean-up, settlement of a lawsuit

Measured at the most likely amount

• Large populations of events

E.g. warranties, customer refunds

Measured at a probability-weighted expected value

Illustration

A company sells goods with a warranty for the cost of repairs required in the rst 2
months after purchase.

Past experience suggests:

88% of the goods sold will have no defects

7% will have minor defects

5% will have major defects

If minor defects were detected in all products sold, the cost of repairs will be $24,000;

If major defects were detected in all products sold, the cost would be $200,000.

What amount of provision should be made?

(88% x 0) + (7% x 24,000) + (5% x 200,000) = $11,680

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Contingent Liabilities

These are simply a disclosure in the accounts

They occur when a potential liability is not probable but only possible
(Also occurs when not reliably measurable)

Contingent Assets

Here, it is not a potential liability, but a potential asset.

The principle of PRUDENCE is important here, it must be harder to show a potential

asset in your accounts than it is a potential liability.

This is achieved by changing the probability test.

For a potential (contingent) asset - it needs to be virtually certain (rather than just
probable).

Probability test for Contingent Liabilities

Remote chance of paying out - Do nothing

Possible chance of paying out - Disclosure

Probable chance of paying out - Create a provision

Probability test for Contingent Assets

Remote chance of receiving - Do nothing

Possible chance of receiving - Do nothing

Probable chance of receiving - Disclosure

Virtually certain of receiving - create an asset in the accounts

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 Some typical examples

Speci c types of provision

Future operating losses
Provisions are not recognised for future operating losses (no obligation)

Onerous contracts
Recognised and measured as a provision (as there is a contract and so a legal obligation)

Restructuring
Create a provision when:

1. There is a detailed formal plan for the restructuring; and

2. There is a valid expectation in those affected that it will carry out the restructuring by
starting to implement that plan or announcing its main features to those affected by it
(this creates a constructive obligation)

Provide only for costs that are:

(a) necessarily entailed by the restructuring; and
(b) not associated with the ongoing activities of the entity

Possible Exam Scenarios

Warranties
Yes there is a legal obligation so provide. The amount is based on the class as a whole
rather than individual claims. Use expected values

Major Repairs
These are not provided for. Instead they are treated as replacement non current assets.
See that chapter

Self Insurance
This is trying to provide for potential future res etc. Clearly no provision as no obligation to
pay until re actually occurs

Environmental Contamination Clearance

Yes provide if legally required to do so or other parties would expect the company to do so
as it is its known policy

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Decommissioning Costs
All costs are provided for. The debit would be to the asset itself rather than the income
statement

Restructuring
Provide if there is a detailed formal plan and all parties affected expect it to happen. Only
include costs necessary caused by it and nothing to do with the normal ongoing activities
of the company (e.g. don’t provide for training, marketing etc)

Reimbursements
This is when some or all of the costs will be paid for by a different party.

This asset can only be recognised if the reimbursement is virtually certain, and the
expense can still be shown separately in the income statement

Circumstance Provide?
Warranties/guarantees Accrue a provision (past event was the
sale of defective goods)
Customer refunds Accrue if the established policy is to give
refunds

Land contamination Accrue a provision if the company's

policy is to clean up even if there is no
legal requirement to do so
Firm offers staff training No provision (there is no obligation to
provide the training)
Restructuring by sale of an operation/ Accrue a provision only after a binding
line of business sale agreement
Restructuring by closure of business Accrue a provision only after a detailed
locations or reorganisation formal plan is adopted and announced
publicly. A Board decision is not enough

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 Syllabus C7b) Discuss and apply the accounting for events after the reporting period.

IAS 10 Events After The Reporting Period

Events can be adjusting or non-adjusting.

We are looking at transactions that happen in this period, and whether we should go back
and adjust our accounts for the year end or not adjust and just put into next year’s
accounts

If the event gives us more information about the condition at the year-end then we
adjust.

If not then we don’t.

When is the "After the Reporting date" period?

It is anytime between period end and the date the accounts are authorised for issue.

After the SFP date = Between period end and date authorised for issue

Ok and why is it important?

Well it may well be that many of the gures in the accounts are estimates at the period
end.

However, what if we get more information about these estimates etc afterwards, but
before the accounts are authorised and published.. should we change the accounts or
not?

The most important thing to remember is that the accounts are prepared to the SFP
date. Not afterwards.

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 So we are trying to show what the situation at the SFP date was. However, it may be
that more information ABOUT the conditions at the SFP date have come about
afterwards and so we should adjust the accounts.

Sometimes we do not adjust though…

Adjusting Events
Here we adjust the accounts if:

The event provides evidence of conditions that existed at the period end

Examples are..

1. Debtor goes bad 5 days after SFP date

(This is evidence that debtor was bad at SFP date also)

2. Stock is sold at a loss 2 weeks after SFP date

IAS2 ‘Inventories’ states that estimates of net realisable value should take into account
uctuations in price occurring after the end of the period to the extent that it con rms
conditions at the year end

(This is evidence that the stock was worth less at the SFP date also)

3. Property gets impaired 3 weeks after SFP date

(This implies that the property was impaired at the SFP date also)

4. The result of a court case con rming the company did have a present
obligation at the year end

5. The settling of a purchase price for an asset that was bought before the year
end but the price was not nalised

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6. The discovery of fraud or error in the year

Non-Adjusting Events - these are disclosed only

These are events (after the SFP date) that occurred which do not give evidence of
conditions at the year end, rather they are indicative of conditions AFTER the SFP date

1. Stock is sold at a loss because they were damaged post year-end

(This is evidence that they were ne at the year-end - so no adjustment)

2. Property impaired due to a fall in market values generally post year end

(This is evidence that the property value was ne at the year end - so no adjustment
required).

3. The acquisition or disposal of a subsidiary post year end

4. A formal plan issued post year end to discontinue a major operation

5. The destruction of an asset by re or similar post year end

6. Dividends declared after the year end

Non-adjusting event which affects Going Concern

Adjust the accounts to a break up basis regardless if the event was a non-adjusting
event.

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 Syllabus C8. Share based payment
Syllabus C8a) Evaluate and apply the recognition and measurement of share-based payment
transactions.

Share Based Payments - Introduction

What is a SBP transaction?

Well rst of all it needs to be for receiving good or services1 and in return the company
gives:

1) Its own shares

2) Cash based upon the price of its own shares

Contracts to buy or sell non- nancial items that may be settled net in shares or rights to
shares are outside the scope of IFRS 2 and are addressed by IAS 32

There are 3 types of Share based payment:

1. Equity-settled share-based payment

This is where the company pays shares in return for goods and/or services received.

Dr Expense
Cr Equity

2. Cash-settled share-based payment

This is where cash is paid in return for goods and services received, HOWEVER..the
actual cash amount though is based on the share price.

1 Goods and services not identi ed are still under IFRS 2 e.g.. Payments to Trade Unions etc

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These are also called SARs (Share Appreciation Rights).

Dr Expense
Cr Liability

3. Transactions with a choice of settlement

A choice of cash or shares paid in return for goods and services received.

Vesting period

Often share based payments are not immediate but payable in say 3 years. The
expense is spread over these 3 years and this is called the vesting period.

How much to recognise?

So we have decided that share based payments (either shares or cash based on share
price) should go into the accounts .

(Dr expense Cr Equity or Liability)

We now have to look at the value to put on these:

• Option 1: Direct method

Use the FV of the goods or services received

• Option 2: Indirect method

Use the FV of the shares issued by the company

Equity settled - Use FV of shares @ grant date

Cash settled - Update FV of shares each year

IFRS 2 suggests you choose option 1 - the FV of the goods/services.

However, if the FV of these cannot be reliably measured then you should go for
option 2 - FV of shares issued.

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 Strangely enough, option 2 is the most common. This is because share based
payments are often associated with paying employees.

You cannot put a value on the work done by employees - except for the value of
what you pay them i.e. Option 2.

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 SBP - Equity Settled

This is where payments are made with an equity instrument such as a share
or a share option.

Measurement

The FV of the product / service acquired (if possible)

FV of equity instrument issued

FV of Equity Instrument

This is basically MARKET VALUE, taking into account the terms and market related
conditions of the offer.

If there is no MV available, then the “Intrinsic Value” option is available. This is basically
the share price less the exercise price.

However, if this is chosen then the accounting treatment below is slightly different. It will
need to be remeasured to the new intrinsic value each year - this will be very rare.

Accounting Treatment

Dr Expense (or asset)

Cr Equity

The problem is we only do the above double entry once the item has ‘vested’ (i.e.
satis ed all conditions to be met to make the share payable)

For example, if shares are issued for the purchase of a building, and the building is
available to use immediately, then it has vested immediately and you would Dr PPE Cr
Equity with the FV of the asset acquired.

If, however, share options are issued, but only once employees have stayed in the job
for say 3 years, then this means they do not fully vest for 3 years. What you do here, is
recognise the expense as it vests - over what we call the ‘vesting period’. So, in this

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example, you would calculate the full cost of the options at grant date and in the rst
year Dr Expense Cr Equity with 1/3 of that total.

Precise Measurement

You take the best available estimate at the time of the number of equity instruments
expected to vest at the end.

The value used for the share options throughout the vesting period remains at the
GRANT DATE value (with the exception of “intrinsic value” method above).

Illustrations

Equity Settled

An entity grants 100 share options on its $1 shares to each of its 500 employees on 1
January Year 1.

Each grant is conditional upon the employee working for the entity over the next three
years.

The fair value of each share option as at 1 January Year 1 is $10.

On the basis of a weighted average probability, the entity estimates on 1 January that
100 employees will leave during the three-year period and therefore forfeit their rights
to share options.

The following actually occurs:

– 20 employees leave during Year 1 and the estimate of total employee departures
over the three-year period is revised to 70 employees
– 25 employees leave during Year 2 and the estimate of total employee departures
over the three-year period is revised to 60 employees
– 10 employees leave during Year 3

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Solution

Step 1: Decide if this is a cash or equity settled SBP - share options are equity settled
(so Dr Expense Cr Equity).

Step 2: Decide whether to value directly or indirectly - these are for employees so
indirectly.

Step 3: Calculate how many employees (and their share options each) are expected to
be issued at the end of the vesting period.

Year 1: 430 Employees expected to be left at end (500-70) x 100 (share options each)
x $10 (FV @ GRANT date) x 1/3 (time through vesting period) = 143,300

Year 2: 440 x 100 x $10 x 2/3 - 143,300 = 150,000

Year 3: 445 x 100 x $10 x 3/3 - 293,300 = 151,700

So you can see that the “costs” and so the entries into the accounts would be:

Year 1: Dr Expense 143,300 Cr Equity 143,300

Year 2: Dr Expense 150,000 Cr Equity 150,000
Year 3: Dr Expense 151,700 Cr Equity 151,700

Notice that if you add these up it comes to 445,000. This is exactly our nal liability (445
x 100 x $10 x 3/3) - it’s just we’ve spread it over the 3 years vesting period.

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 SBP - Cash Settled
These are when a company promises to pay for goods or services for cash, however
the cash price is linked to the share price

They are often called “Share Appreciation Rights (SARs)”

The double entry is:

Dr Expense
Cr Cash or Liability

If the payment is for a service stretching over a number of years (vesting period) then
the expense is recognised over the number of years and the liability is calculated by
taking into account the change in the share price

Illustration 1

1 Jan Year 1 - 100 share appreciation rights (SARs) given to each of the company’s
1000 employees. FV of these at grant date was £5. The employees had to be in service
for 3 years to take the SAR

End of year 1 - 100 employees had left and 140 more expected to leave by the end of
year 3. FV of SAR now £6

End of year 2 - 40 employees left in the year and another 50 expected to leave in year
3. FV of SAR now £8

End of year 3 - 60 employees left and the FV of SAR is now £7

Solution

Year 1 - 760 (1,000 - 100 -140) x 100 x £6 x 1/3 = 152,000 (Dr Expense Cr Liability)

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Year 2 - 810 (1,000 - 100 - 40 - 50) x 100 x £8 x 2/3 = 432,000 - 152,000 = 280,000 (Dr
Expense Cr Liability)

Year 3 - 800 (1,000 - 100 - 40 - 60) x 100 x £7 x 3/3 = 560,000 - 432,000 = 128,000 (Dr
Expense Cr Liability)

Finally the 560,000 is paid

Dr Liability 560,000

Cr Cash 560,000

Illustration 2

An entity grants 100 SARs to each of its 500 employees on 1 January Year 1.

Each grant is conditional upon the employee working for the entity over the next three
years.

The fair value of each share option as at 1 January Year 1 is $10.

On the basis of a weighted average probability, the entity estimates on 1 January that
100 employees will leave during the three-year period and therefore forfeit their rights
to share options.

The following actually occurs:

– 20 employees leave during Year 1 and the estimate of total employee departures
over the three-year period is revised to 70 employees
– 25 employees leave during Year 2 and the estimate of total employee departures
over the three-year period is revised to 60 employees
– 10 employees leave during Year 3

Information of share price at the end of each year:

Year 1 10
Year 2 12
Year 3 14

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Solution

As this is cash settled then the double entry becomes Dr Expense Cr Liability and we
do not keep the value of the option @ grant date but change it as we pass through the
vesting period.

Y1: 430 x 100 x 10 x 1/3 = 143,300

Y2: 440 x 100 x 12 x 2/3 - 143,300 = 208,700
Y3: 445 x 100 x 14 x 3/3 - 623,000 x 3/3 - 352,000 = 271,000

So you can see that the “costs” and so the entries into the accounts would be:

Year 1: Dr Expense 143,300 Cr Liability 143,300

Year 2: Dr Expense 208,700 Cr Liability 208,700
Year 3: Dr Expense 271,000 Cr Liability 271,000

Notice that if you add these up it comes to 623,000.

This is exactly our nal liability (445 x 100 x $14 x 3/3) - it’s just we’ve spread it over the
3 years vesting period.

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 SBP with a Choice of Settlement

Share-based payment with a choice of settlement

Entity has the choice

Is there a present obligation to settle in cash?

Yes

Treat as cash-settled

No

Treat as equity-settled

Counter-party has the choice

The transaction is a compound nancial instrument which needs splitting into debt and
equity

Debt Portion
This must be calculated rst..the FV of the cash option at grant date

Then it is treated just like a normal cash-settled SBP

Equity Portion
This is the FV of the option less the debt portion calculated above at grant date

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Illustration
An entity grants an employee a right to receive either 8,000 shares or cash to the value,
on that date, of 7,000 shares. She has to remain in employment for 3 years.

The market price of the entity's shares is $21 at grant date, $27 at the end of year 1, $33
at the end of year 2 and $42 at the end of the vesting period, at which time the employee
elects to receive the shares.

The entity estimates the fair value of the share route to be $19.

Show the accounting treatment.

Solution

The fair value of the cash route at grant date is: 7,000 × $21 = $147,000

The fair value of the share route is: 8,000 × $19 = $152,000 - 147,000 = $5,000

We then treat them as cash and equity settled SBPs as appropriate:

Year Cash Equity I/S

7,000 x $27 x 1/3 5,000 x 1/3

1
63,000 1,667 64,667
7,000 x $33 x 2/3 5,000 x 1/3
2
154,000 1,667 92,667
7,000 x $42 x 3/3 5,000 x 1/3
3
294,000 1,667 141,667

Entity has the choice of issuing shares or cash

Option 1 - Obligated to pay cash

The entity is prohibited from issuing shares or where it has a stated policy, or past practice,
of issuing cash rather than shares.

Treat as a cash-settled SBP

Option 2 - Not obligated to pay cash

Treat as if it was purely an equity-settled transaction.

If on settlement, cash was actually paid, the cash should be treated as if it was a
repurchase of the equity instrument by a deduction against equity.

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 Vesting Period

This is normally a set amount of time but sometimes it may be dependent upon a condition
to be satis ed..

Vesting Conditions

These are conditions that have to be met before the holder gets the right to the shares or
share options

There are 2 types of Vesting Condition:

Non-market based2
Those not relating to the market value of the entity’s shares

Market based3
Those linked to the market price of the entity’s shares in some way

Non-Market Vesting Conditions

Here only the number of shares or share options expected to vest will be accounted for.

At each period end (including interim periods), the number expected to vest should be
revised as necessary.

2 Employee completing minimum service; Achieving sales target; EPS target; On otation;
3 Increase in SP; Increase in shareholder return; Target SP

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Illustration
An entity granted 10,000 share options to one director. The director had to work there for 3
years, and indeed he did

Also to get the options, the director had to reduce costs by 10% over the vesting period. At
the end of the rst year, costs had reduced by 12%. By the end of the 2nd year, costs had
only reduced in total by 7%. By the end of yr. 3 though the costs had been reduced by 11%

The FV of the option at grant date was $21

How should the transaction be recognised?

Solution
The cost reduction target is a non-market performance condition which is taken into
account in estimating whether the options will vest. The expense recognised in pro t or
loss in each of the three years is:

Yearly Charge Cumulative

(10,000 × £21)/3 years =

Year 1 70,000
70,000
Year 2 (performance
target not expected to be -70,000 0
met)

(10,000 x $21)
Year 3
210,000 210,000

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Market Vesting Conditions

These conditions are taken into account when calculating the fair value of the equity
instruments at the grant date.

They are not taken into account when estimating the number of shares or share options
likely to vest at each period end.

If the shares or share options do not vest, any amount recognised in the nancial
statements will remain.

Make an estimate of the vesting period at the acquisition date

If vesting period is shorter than original estimate

Expense all the remainder in the year the vesting condition is complied with

If vesting period is longer than the original estimate

Expense still using the original estimate of vesting period

Market and non-market based vesting conditions together

Where both market and non-market vesting conditions exist, then as long as the non
market conditions are met the company must expense (irrespective of whether market
conditions are satis ed)

So, where market and non-market conditions co-exist, it makes no difference whether the
market conditions are achieved.

The possibility that the target share price may not be achieved has already been taken into
account when estimating the fair value of the options at grant date.

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Therefore, the amounts recognised as an expense in each year will be the same
regardless of what share price has been achieved.

Illustration
A company granted 10,000 share options to a director. He must work there for 3 years. He
did this.

Also the share price should increase by at 25% over the three-year period.

During the 1st year the share price rose by 30% and by 26% compound over the rst two
years and 24% per annum compound over the whole period

At the date of grant the fair value of each share option was estimated at £184

How should the transaction be recognised?

Solution
The director satis ed the service requirement but the share price growth condition was not
met.

The share price growth is a market condition and is taken into account in estimating the
fair value of the options at grant date.

Therefore, no adjustment should be made if there are changes from that estimated in
relation to the market condition. There is no write-back of expenses previously charged,
even though the shares do not vest.

The expense recognised in pro t or loss in each of the three years is one third of 10,000 x
£18 = £60,000.

4 Remember this would already include the probability of meeting the 25% increase over the 3 years

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 IFRS 2 Share based payments deferred tax

Deferred tax implications

Issue

An entity recognises an expense for share options but the taxman offers the tax
deduction on the later exercise date.

This is therefore an example of accounts showing more expenses (than the taxman
has allowed so far) and so a deferred tax asset occurs.

The taxman may calculate his expense on the intrinsic value basis. This may offer a
greater deduction (at the end) than our expense. This extra deferred tax asset is set off
against equity (and OCI) not the income statement.

Illustration

An entity granted 1,000 share options to an employee vesting 3 years later. The fair
value of at the grant date was $3.
Tax law allows a tax deduction of the intrinsic value of$1.20 at the end of year 1 and
$3.40 at the end of year 2.
Assume a tax rate of 30%.

Solution

Year 1

Accounts
1,000 x 1/3 x 3 = 1,000

Tax
Has allowed 0
However, at the end he will allow 1,000 x 1/3 x 1.2 = 400
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Therefore the deferred tax asset is capped at 400. So, the double entry is:
Dr Deferred Tax Asset (400x30%) 120
Cr Tax (I/S) 120

Year 2

Accounts
1,000 x 2/3 x 3 - 1,000 = 1,000

Tax
1,000 x 2/3 x 3.4 - 400 = 1.867

Therefore we have expensed 2,000 (1,000 + 1,000)

The tax man will allow at the end 2,267 (400 + 1,867)
So, the deferred tax asset should now be 2267 x 30% = 680

Of this only 2,000 x 30% = 600 should have gone to the income statement (to match
with the 2,000 expense).
The remaining 80 should have gone to equity.

Year 2
Income statement
Expense 1,000
Tax (600 - 120) -480

Equity
Share Options 2,000
Tax asset 80

Double entry
Dr Deferred tax asset (680-120) 560
Cr Income statement 480
Cr Equity 80

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 IFRS 2 Modi cations and Cancellations

The entity might:

Reprice (modify) share options, or

Cancel or settle the options.

Equity instruments may be modi ed before they vest.

For example, a fall in the actual share price may mean that the original option exercise
price is no longer attractive.

Therefore the exercise price is reduced (the option is ‘re-priced’) to make it valuable again.

Such modi cations will often affect the fair value of the instrument and therefore the
amount recognised in pro t or loss.

Accounting treatment
1. Continue to recognise the original fair value of the instrument in the normal way
(even where the modi cation has reduced the fair value)

2. Recognise any increase in fair value at the modi cation date (or any increase in the
number of instruments granted as a result of modi cation) spread over the period
between the modi cation date and vesting date.

3. If modi cation occurs after the vesting date, then the additional fair value must be
recognised immediately unless there is, for example, an additional service period, in
which case the difference is spread over this period.

Illustration

At the beginning of year 1, an entity grants 100 share options to each of its 500
employees over a vesting period of 3 years at a fair value of $15.

Year 1
40 leave, further 70 expected to leave; share options repriced (as mv of shares has
fallen) as the FV had fallen to $5. After the repricing they are now worth $8.

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Year 2
35 leave, further 30 expected to leave

Year 3
28 leave

Solution
The repricing has increased FV by (8-5) = 3

This amount is recognised over the remaining two years of the vesting period, along
with remuneration expense based on the original option value of $15.

Year 1
Income statement & Equity
(500-110) x 100 x 1/3 x $15 = 195,000

Year 2
Income statement & Equity
[(500 – 105) × 100 × (($15 × 2/3) + ($3 × ½))] 454,250 - 195,000

Dr Expenses $259,250 Cr Equity $259,250

Year 3
Income statement & Equity
[(500 – 103) × 100 × ($15 + $3 ) 714,600 - 454,250

Dr Expenses $260,350
Cr Equity $260,350

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Illustration

An entity granted 1,000 share options at an exercise price of £50 to each of its 30 key
management personnel.

They had to stay with the entity for 4 years

At grant date, the fair value of the share options was estimated at £20 and the entity
estimated that the options would vest with 20 managers.

This estimate didn’t change in year 1

The share price fell early in the 2nd year. So half way through that year they modi ed the
scheme by reducing the exercise price to £15. (The fair value of an option was £2
immediately before the price reduction and £11 immediately after.)

It retained its estimate that options would vest with 20 managers.

How should the modi cation be recognised?

Solution

The total cost to the entity of the original option scheme was: 1,000 shares × 20 managers
× £20 = £400,000

This was being recognised at the rate of £100,000 each year.

The cost of the modi cation is:

1,000 x 20 managers × (£11 – £2) = £180,000

This additional cost should be recognised over 30 months, being the remaining period up
to vesting, so £6,000 a month.

The total cost to the entity in the second year and from then on is: £100,000 + (£6,000 × 6)
= £136,000.

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Cancellations and settlements

An entity may settle or cancel an equity instrument during the vesting period.

Basically treat this as the vesting period being shortened.

Accounting treatment

Charge any remaining fair value of the instrument that has not been recognised
immediately in pro t or loss (the cancellation or settlement accelerates the charge and
does not avoid it).

Any amount paid to the employees by the entity on settlement should be treated as a
buyback of shares and should be recognised as a deduction from equity.

If the amount of any such payment is in excess of the fair value of the equity instrument
granted, the excess should be recognised immediately in pro t or loss.

A cash settlement made to an employee on cancellation

Dr Equity
Dr Income statement (excess over amount in equity)
Cr Cash

An equity settlement made to an employee on cancellation

This is basically a replacement of the option and so is treated as a modi cation (see
earlier) at this value:

Fair value of replacement instruments* X

Less: Net fair value of cancelled instruments (X)

Illustration

2,000 share options granted at an exercise price of $18 to each of its 25 key management
personnel. The management must stay for 3 years. The fair value of the options was
estimated at $33 and the entity estimated that the options would vest with 23 managers.
This estimate stayed the same in year 1

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In year 2 the entity decided to abolish the existing scheme half way through the year when
the fair value of the options was $60 and the market price of the entity's shares was $70.

Compensation was paid to the 24 managers in employment at that date, at the rate of $63
per option.

How should the entity recognise the cancellation?

Solution
The original cost to the entity for the share option scheme was: 2,000 shares × 23
managers × $33 = $1,518,000

This was being recognised at the rate of $506,000 in each of the three years.

At half way through year 2 when the scheme was abolished, the entity should recognise a
cost based on the amount of options it had vested on that date. The total cost is:
2,000 × 24 managers × £33 = $1,584,000

After deducting the amount recognised in year 1, the year 2 charge to pro t or loss is
$1,078,000.

The compensation paid is: 2,000 × 24 × $63 = $3,024,000

Of this, the amount attributable to the fair value of the options cancelled is:
2,000 × 24 × $60 (the fair value of the option, not of the underlying share) = $2,880,000

This is deducted from equity as a share buyback.

The remaining $144,000 ($3,024,000 less $2,880,000) is charged to pro t or loss.

Cancellation and resistance

Where an entity has been through a capital restructuring or there has been a signi cant
downturn in the equity market through external factors, an alternative to repricing the share
options is to cancel them and issue new options based on revised terms.

The end result is essentially the same as an entity modifying the original options and
therefore should be recognised in the same way.

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 IFRS 2 Scope
Share-based payments can be more than just employee share options, and the trick in
the exam is to know which scenarios you apply IFRS 2 to, and which you don’t…

It Applies to All Entities

There is no exemption for private or smaller entities.

In fact, subsidiaries using their parent’s or fellow subsidiary’s equity as consideration for
goods or services are within the scope of the Standard.

Goods and Services Only

IFRS 2 is used when shares are issued (or rights to shares given) in return for goods
and services ONLY.

What does fall under IFRS 2

• Share appreciation rights

• Employee share purchase plans
• Employee share ownership plans
• Share option plans and
• Plans where share issues (or rights to shares) depend on certain conditions

What doesn’t fall under IFRS 2

• When shares are issued to buy a subsidiary (rather than for employing the subs
directors primarily).
So, in a question, care should be taken to distinguish share-based payments related
to the acquisition from those related to employee services.

• When the item is being paid for with shares is a commodity-based derivative (such as
those dealing with the price of gold, oil etc.). These are IFRS 9 nancial instruments
instead.

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 Syllabus C9. Fair Value Measurement
Syllabus C9a) Discuss and apply the de nitions of ‘fair value’ measurement and ‘active market’.

Fair Value Measurement

IFRS 13 de nes Fair Value using an 'exit price' notion and a 'fair value hierarchy'
So it's a market-based, rather than entity-speci c, measurement

Fair Value De nition

The price that would be received / paid ....
...in an orderly transaction between market participants

Active Market De nition

A market with suf cient frequency and volume to provide pricing information on an ongoing
basis

Exit Price De nition

The price that would be received (to sell an asset) or paid (to transfer a liability)

Overview of Approach
A fair value measurement requires an entity to determine all of the following:

• The particular asset (liability) and its unit of account

• For a non- nancial asset: An appropriate valuation premise (it's highest and best use)
• Its principal (or most advantageous) market
• Its appropriate valuation technique using market data and the fair value hierarchy

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 Syllabus C9b) Evaluate and apply the ‘fair value hierarchy’ including valuation techniques

The ‘Fair Value Hierarchy’

This hierarchy aims to increase consistency and comparability in fair value measurements

So it categorises the inputs used in valuation techniques into three levels.

Highest priority given to quoted prices in active markets for identical assets
Lowest priority to unobservable inputs

Level 1 inputs
are Quoted prices in accessible active markets for identical assets

These give the most reliable evidence of fair value and are used without adjustment
(This is used even if the market's cannot absorb the quantity held by the entity)

Level 2 inputs
are observable inputs (other than quoted market prices)

Level 2 inputs include:

Quoted prices for similar assets in active markets
Inputs that are corroborated by observable market data by correlation for example
('market-corroborated inputs').

Level 3 inputs
are unobservable inputs for the asset

Use the best information available in the circumstances, eg. Your own data, taking into
account all information about market participant assumptions that is reasonably available

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 Syllabus C9c) Justify and apply the principles of highest and best use, most advantageous and
principal market

Highest and Best Use

The use of a non- nancial asset by market participants that would maximise the value of
the business using it

Most Advantageous Market

The market that maximises the amount received (after transaction costs and transport
costs)

Principal Market
The market with the greatest volume and level of activity

Guidance On Measurement

1. Take into account the condition, location & any restrictions placed on the asset

2. Fair value assumes a transaction taking place in the principal market for the asset
(In the absence of a principal market, the most advantageous market is used)

3. Fair value of a non- nancial asset uses its highest and best use

4. The fair value of a liability re ects non-performance risk and own credit risk

Valuation Techniques
Valuation techniques should maximise the use of observable and minimise unobservable
inputs

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Three widely used valuation techniques are shown below. Sometimes, just one technique
is appropriate, other times multiple techniques:

• Market approach
Uses prices generated by market transactions involving identical or comparable (similar)
assets

• Income approach
Converts future cash ows to a single current (discounted) amount (re ecting current
market expectations about those future amounts)

• Cost approach
The amount needed to replace the service capacity of an asset (current replacement
cost)

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 Syllabus C10. Reporting requirements of small and
medium-sized entities (SMEs)
Syllabus C10a) Discuss the key differences in accounting treatment between full IFRS Standards and
the IFRS for SMEs Standard

Syllabus C10b) Discuss and apply the simpli cations introduced by the IFRS for SMEs Standard.

IFRS for SME - Introduction

The principal aim when developing accounting standards for small-to medium-sized
enterprises (SMEs) is to provide a framework that generates relevant, reliable and useful
information, which should provide a high-quality and understandable set of accounting
standards suitable for SMEs.

The only real users of accounts for SMEs are:

1) Shareholders
2) Management
3) Possibly government

IFRS for SMEs is a self-contained standard, incorporating accounting principles based on

existing IFRS, which have been simpli ed to suit SMEs.

If a topic is not covered in the standard there is no mandatory default to full IFRS.

Topics not really required for SMEs are excluded and so the standard does not address
the following topics:

• Earnings per share

• Interim nancial reporting
• Segment reporting
• Insurance (because entities that issue insurance contracts are not eligible to use the
standard)

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 • Assets held for sale
Good news! The standards are relatively short and get the preparers to think. IFRS for
SMEs therefore contains concepts and pervasive principles, any further disclosures may
be needed to give a true and fair view. It will be updated once every 2 or 3 years only.

What is an SME?
There is no universally agreed de nition of an SME. As there are differences between
rms, sectors, or countries at different levels of development.

Most de nitions based on size use measures such as number of employees, balance
sheet total, or annual turnover. However, none of these measures apply well across
national borders.

Ultimately, the decision regarding who uses IFRS for SMEs stays with national regulatory
authorities and standard-setters. These bodies will often specify more detailed eligibility
criteria. If an entity opts to use IFRS for SMEs, it must follow the standard in its entirety – it
cannot cherry pick between the requirements of IFRS for SMEs and the full set.

Different users entirely

IFRS users are the capital markets. So, quoted companies and not SMEs.

The vast majority of the world's companies are small and privately owned, and it could be
argued that full International Financial Reporting Standards are not relevant to their needs
or to their users.

It is often thought that small business managers perceive the cost of compliance with
accounting standards to be greater than their bene t.

Because of this, the IFRS for SMEs makes numerous simpli cations to the recognition,
measurement and disclosure requirements in full IFRS.

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 Examples of these simpli cations are:
Goodwill and other inde nite-life intangibles are amortised over their useful lives, but if
useful life cannot be reliably estimated, then 10 years.
A simpli ed calculation is allowed if measurement of de ned bene t pension plan
obligations (under the projected unit credit method) involve undue cost or effort.

The cost model is permitted for investments in associates and joint ventures.

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 Differing approaches

Some argue having 2 sets of rules may mean 2 true and fair views

Local GAAP for SME?

An alternative could have been for GAAP for SMEs to have been developed on a national
basis, with IFRS focusing on accounting for listed company activities.

Then though, SMEs may not have been consistent and may have lacked comparability
across national boundaries.

Also, if an SME wished to later list its shares on a capital market, the transition to IFRS
could be harder.

List SME exemptions in the full IFRS?

Under another approach, the exemptions given to smaller entities would have been
prescribed in the mainstream accounting standard.

For example, an appendix could have been included within the standard, detailing those
exemptions given to smaller enterprises.

Separate SME standard for each IFRS?

Yet another approach would have been to introduce a separate standard comprising all the
issues addressed in IFRS that were relevant to SMEs.

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 As it stands now

User friendly
The standard has been organised by topic with the intention of being user-friendlier for
preparers and users of SME nancial statements

The standard also contains simpli ed language and explanations of the standards.

Easier transition to full IFRS

It is based on recognised concepts and pervasive principles and it allows easier transition
to full IFRS if the SME later becomes a public listed entity.

In deciding on the modi cations to make to IFRS, the needs of the users have been taken
into account, as well as the costs and other burdens imposed upon SMEs by the IFRS.

Cost Bene t
Relaxation of some of the measurement and recognition criteria in IFRS had to be made in
order to achieve the reduction in these costs and burdens.

Stewardship not so important

Small companies pursue different strategies, and their goals are more likely to be survival
and stability rather than growth and pro t maximisation.

The stewardship function is often absent in small companies, with the accounts playing an
agency role between the owner-manager and the bank.

Access to capital
Where nancial statements are prepared using the standard, the basis of presentation
note and the auditor's report will refer to compliance with IFRS for SMEs.

This reference may improve SME's access to capital.

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 In the absence of speci c guidance on a particular subject, an SME may, but is not
required to, consider the requirements and guidance in full IFRS dealing with similar
issues.

The IASB has produced full implementation guidance for SMEs.

IFRS for SMEs is a response to international demand from developed and emerging
economies for a rigorous and common set of accounting standards for smaller and
medium-sized enterprises that is much easier to use than the full set of IFRS.

It should provide improved comparability for users of accounts while enhancing the overall
con dence in the accounts of SMEs, and reduce the signi cant costs involved in
maintaining standards on a national basis.

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 Main Changes

Financial statements
Full IFRS: A statement of changes in equity is required, presenting a reconciliation of
equity items between the beginning and end of the period.

IFRS for SMEs: Same requirement. However, if the only changes to the equity during the
period are a result of pro t or loss, payment of dividends, correction of prior-period errors
or changes in accounting policy, a combined statement of income and retained earnings
can be presented instead of both a statement of comprehensive income and a statement
of changes in equity.

Business combinations
Full IFRS: Transaction costs are excluded under IFRS 3 (revised). Contingent
consideration is recognised regardless of the probability of payment.

IFRS for SMEs: Transaction costs are included in the cost of investment.

Contingent considerations are included as part of the cost of investment if it is probable

that the amount will be paid and its fair value can be measured reliably.

Expense recognition
Full IFRS: Research costs are expensed as incurred; development costs are capitalised
and amortised, but only when speci c criteria are met. Borrowing costs are capitalised if
certain criteria are met.

IFRS for SMEs: All research and development costs and all borrowing costs are
recognised as an expense.

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 Non-current assets and goodwill
Full IFRS: For tangible and intangible assets, there is an accounting policy choice
between the cost model and the revaluation model.

Goodwill and other intangibles with inde nite lives are reviewed for impairment and not
amortised.

IFRS for SMEs: The cost model is the only permitted model. All intangible assets,
including goodwill, are assumed to have nite lives and are amortised.

Intangible Assets
Full IFRS: Under IAS 38, ‘Intangible assets’, the useful life of an intangible asset is either
nite or inde nite. The latter are not amortised and an annual impairment test is required.

IFRS for SMEs: There is no distinction between assets with nite or in nite lives. The
amortisation approach therefore applies to all intangible assets. These intangibles are
tested for impairment only when there is an indication.

Investment Property
Full IFRS: IAS 40, ‘Investment property’, offers a choice of fair value and the cost method.

IFRS for SMEs: Investment property is carried at fair value if this fair value can be
measured without undue cost or effort.

Held for Sale

Full IFRS: IFRS 5, ‘Non-current assets held for sale and discontinued operations’, requires
non-current assets to be classi ed as held for sale where the carrying amount is recovered
principally through a sale transaction rather than though continuing use.

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 IFRS for SMEs: Assets held for sale are not covered, the decision to sell an asset is
considered an impairment indicator.

Employee bene ts – de ned bene t plans

Full IFRS: The use of an accrued bene t valuation method (the projected unit credit
method) is required for calculating de ned bene t obligations.

IFRS for SMEs: The circumstance-driven approach is applicable, which means that the
use of an accrued bene t valuation method (the projected unit credit method) is required if
the information that is needed to make such a calculation is already available, or if it can
be obtained without undue cost or effort.

If not, simpli cations are permitted in which future salary progression, future service or
possible mortality during an employee’s period of service are not considered.

Income taxes
Full IFRS: A deferred tax asset is only recognised to the extent that it is probable that
there will be suf cient future taxable pro t to enable recovery of the deferred tax asset.

IFRS for SMEs: A valuation allowance is recognised so that the net carrying amount of the
deferred tax asset equals the highest amount that is more likely than not to be recovered.
The net carrying amount of deferred tax asset is likely to be the same between full IFRS
and IFRS for SMEs.

Full IFRS: No deferred tax is recognised upon the initial recognition of an asset and
liability in a transaction that is not a business combination and affects neither accounting
pro t nor taxable pro t at the time of the transaction.

IFRS for SMEs: No such exemption.

Full IFRS: There is no speci c guidance on uncertain tax positions. In practice,

management will record the liability measured as either a single best estimate or a

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weighted average probability of the possible outcomes, if the likelihood is greater than
50%.

IFRS for SMEs: Management recognises the effect of the possible outcomes of a review
by the tax authorities. It should be measured using the probability-weighted average
amount of all the possible outcomes. There is no probable recognition threshold.

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 Syllabus C11. Other Reporting Issues
Syllabus C11a) Evaluate and apply the accounting for, and disclosure of, government grants and
other forms of government assistance.

Government Grants

Government grants are a form of government assistance.

When can you recognise a government grant?

When there is reasonable assurance that:
• The entity will comply with any conditions attached to the grant and
• the grant will be received

However, IAS 20 does not apply to the following situations:

1. Tax breaks from the government
2. Government acting as part-owner
of the entity
3. Free technical or marketing advice

Accounting treatment of government grants

Dr Cash
The debit is always cash so we only have to know where we put the credit..

There are 2 approaches - depending on what the grant is given for:

• Capital Grant approach:

(Given for Assets - For NCA such as machines and buildings)
Recognise the grant outside pro t or loss initially:
Dr Cash

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 Cr Cost of asset
or
Cr Deferred Income
• Income Grant approach:
(Given for expenses - For I/S items such as wages etc)
Recognise the grant in pro t or loss
Dr Cash
Cr Other income (or expense)

Capital Grant approach - accounting for as "Cr Cost of asset"

• Dr Cash Cr Cost of asset
This will have the effect of reducing depreciation on the income statement and the
asset on the SFP
• An Example
Asset $100 with 10yrs estimated useful life
Received grant of $50
Accounting for a grant received:
DR Cash $50
CR Asset $50
At the Y/E
Depreciation charge:
DR Depreciation expense (I/S) (100-50)/10yrs = $5
CR Accumulate depreciation $5

Capital Grant approach - accounting for as "Cr Deferred Income"

• Dr Cash
Cr Deferred Income
This will have the effect of keeping full depreciation on the income statement and the
full asset and liability on the SFP
Then...
Dr Deferred Income
Cr Income statement (over life of asset)
This will have the effect of reducing the liability and the expense on the income
statement

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 • An Example
Asset $100 with 10yrs estimated useful life
Received grant of $50
Accounting for a grant received:
DR Cash $50
CR Deferred income $50
At the Y/E
Depreciation charge:
DR Depreciation expense (I/S) 100/10yrs = $10
CR Accumulate depreciation $10
Release of deferred income:
DR Deferred income 50/10yrs =$5
CR I/S $5

Conditions
These may help the company decide the periods over which the grant will be earned.

It may be that the grant needs to be split up and taken to the income statement on different
bases.

Compensation
The grant may be for compensation on expenses already spent.

Or it might be just for nancial support with no actual related future costs.

Whatever the situation, the grant should be recognised in pro t or loss when it becomes
receivable.

NB
If a condition might not be met then a contingent liability should be disclosed in the notes.
Similarly if it has already not been met then a provision is required.

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Non-monetary government grants
Think here, for example, of the government giving you some land (ie not cash).

To put a value on it - we use the Fair Value.

Alternatively, both may be valued at a nominal amount.

Repayment of government grants

This means when we are not allowed the grant anymore and so have to repay it back.
This would be a change in accounting estimate (IAS 8) and so you do not change past
periods just the current one.

Accounting treatment (capital grant repayment):

• Dr Any deferred Income Balance or Dr Cost of asset
• Dr Income statement with any balance
and CR cash with the amount repaid

The extra depreciation to date that would have been recognised had the grant not been
netted off against cost should be recognised immediately as an expense.

Accounting treatment - Income Grant Repayment

Dr Income statement
Cr Cash

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 Syllabus C11b) Appraise and apply the judgements made in selecting and applying accounting
policies, accounting for changes in estimates and re ecting corrections of prior period errors.

IAS 8 Accounting policies and estimates

Comparatives are changed for accounting POLICY changes only

Changes in accounting estimates have no effect on the comparative

Changes in accounting policy means we must change the comparative too to ensure we
keep the accounts comparable for trend analysis

Accounting Policy

De nition
“the speci c principles, bases, conventions, rules and practices applied by an entity in
preparing and presenting the nancial statements”

An entity should follow accounting standards when deciding its accounting policies

If there is no guidance in the standards, management should use the most relevant and
reliable policy

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 Changes to Accounting Policy

These are only made if:

- It is required by a Standard or Interpretation; or
- It would give more relevant and reliable information

• Adjust the comparative amounts for the affected item

(as if the policy had always been applied)

• Adjust Opening retained earnings

(Show this in statement of changes in Equity too)

Accounting Estimates
De nition
“an adjustment of the carrying amount of an asset or liability, or related expense, resulting
from reassessing the expected future bene ts and obligations associated with that asset or
liability”

Examples
Allowances for doubtful debts;
Inventory obsolescence;
A change in the estimate of the useful economic life of property, plant and equipment

Changes in Accounting Estimate

Simply change the current year

No change to comparatives

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Prior Period Errors

These are accounted for in the same way as changes in accounting policy

Accounting treatment

• Adjust the comparative amounts for the affected item

• Adjust Opening retained earnings

(Show this in statement of changes in Equity too)

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 Syllabus C11c) Identify related parties and assess the implications of related party
relationships in the preparation of corporate reports.

IAS 24 Related Parties

A party is said to be related to an entity if any of the following three situations

occur:

The 3 situations are:

1. Controls / is controlled by entity

2. is under common control with entity

3. has signi cant in uence over the entity

Types of related party

These therefore include:

1. Subsidiaries

2. Associate

3. Joint venture

4. Key management

5. Close family member of above (like my beautiful daughter pictured in her new
school uniform aaahhh)

6. A post-employment bene t plan for the bene t of employees

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Not necessarily related parties

Two entities with a director in common

Two joint venturers

Providers of nance

A big customer, supplier etc

Stakeholders need to know that all transactions are at arm´s length and if not then be
fully aware.

Similarly they need to be aware of the volume of business with a related party, which
though may be at arm´s length, should the related party connection break then the
volume of business disappear also.

Disclosures

• General

The name of the entity’s parent and, if different, the ultimate controlling party

The nature of the related party relationship

Information about the transactions and outstanding balances necessary for an

understanding of the relationship on the nancial statements

• As a minimum, this includes:

Amount of outstanding balances

Bad and doubtful debt information

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• Key management personnel compensation should be broken down by:

• short-term employee bene ts

• post-employment bene ts

• other long-term bene ts

• termination bene ts

• share-based payment

Group and Individual accounts

1. Individual accounts

Disclose related party transactions / outstanding balances of parent, venturer or

investor.

2. Group accounts

The intra-group transactions and balances would have been eliminated.

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Syllabus D: FINANCIAL STATEMENTS OF
GROUPS OF ENTITIES
Syllabus D1. Group accounting including statements of
cash flows
Syllabus D1a) Evaluate and apply the principles behind determining whether a business combination
has occurred including the control principle.

Has a Business Combination Occurred?

Is a transaction a business combination?

IFRS 3 provides this guidance:

1. Can be by:
Giving Cash
Taking on Liabilities
Issuing Shares, or
by not issuing consideration at all (i.e. by contract alone)

2. Structures can be:

eg.
An entity becoming a subsidiary of another
An entity transfers its Net assets to another or to a new entity

3. There must be an acquisition of a business

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 A business generally has 3 elements

1. Inputs
An economic resource (e.g. PPE) that creates outputs when one or more processes
are applied to it

2. Process
A system when applied to inputs, creates outputs

3. Output
The result of inputs and processes

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 Syllabus D1b) Evaluate and apply the method of accounting for a business combination including
identifying an acquirer and the principles in determining the cost of a business combination

Method Of Accounting For Business Combinations

Acquisition Method

The Acquisition Method is used for all business combinations

Steps in applying it are:

Identifying the 'Acquirer'
Determining the 'Acquisition Date'
Recognising (and measuring) the identi able assets acquired, the liabilities assumed
and any NCI (non-controlling Interest)
Recognising (and measuring) Goodwill (or a gain from a Bargain Purchase)

Identifying an Acquirer

This is the entity that obtains 'control' of the Acquire

IFRS 3 provides additional guidance:

• The Acquirer usually transfers cash (or other assets)

• The Acquirer usually issues shares (where the transaction is effected in this manner)
You must also consider though:
1. Relative voting rights in the combined entity after the business combination
2. A large minority interest when no other owner has a signi cant voting interest
3. The composition of the board and senior management of the combined entity
4. The terms on which equity interests are exchanged

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• The acquirer usually has the largest relative size (assets, revenues or pro t)

• For business combinations involving multiple entities, look for who initiated the
combination, and the relative sizes of the combining entities

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 Group Accounting

Presentation

According to IAS 1 accounts must distinguish between:

1. Pro t or Loss for the period

2. Other gains or losses not reported in pro ts above (Other Comprehensive Income)
3. Equity transactions (share issues and dividends)

Terminology

Consolidated nancial statements:

The nancial statements of a group presented as those of a single economic entity.

Parent
An entity that has one or more subsidiaries

Control
The power to govern the nancial and operating policies of an entity so as to obtain
bene ts from its activities

Two or more investors can control when they act together to direct the activities of the
subsidiary.
However, if one party cannot individually control then it is not a subsidiary. Instead it is
accounted for as a Joint Venture

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 Subsidiary
This is a company controlled by the parent

Identi cation of subsidiaries

Control is presumed when the parent has 50% + voting rights of the entity.

It could also come from the parent controlling one subsidiary, which in turn controls
another. The parent then controls both subsidiaries

Even when less than 50%, control may be evidenced by power..

• Getting the 50%+ by an arrangement with other investors

• Governing the nancial and operating policies
• Appointing the majority of the board of directors
• Casting the majority of votes

Power
So a parent needs the power to affect the subsidiary and as we said before this is normally
given by owning more than 50% of the voting rights

It might also come from complex contractual arrangements

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 Syllabus D1c) Justify the recognition and measurement criteria used for identifying acquired assets
and liabilities including contingent amounts and intangible assets.

Recognition and Measurement of Net Assets Acquired

Acquired Assets And Liabilities

1. Recognition Principle
Identi able Assets (& Liabs) and NCI are recognised separately from goodwill
2. Measurement Principle
All assets and liabilities are measured at acquisition-date FAIR VALUE

The acquirer looks at the contractual terms, economic conditions, operating and
accounting policies at the acquisition date
For example, this might mean separating embedded derivatives from host contracts (See
later in the course!)
However, Leases & Insurance contracts are classi ed on the basis of conditions in place at
the inception of the contract.

Intangible Assets Acquired

These must be recognised and measured at fair value even if the acquiree didn't
recognise them before
This is because there is always suf cient information to reliably measure the fair value of
these assets on acquisition

Contingent Liabilities
Until settled, these are measured at the higher of:
1) The amount that would be recognised under IAS 37 Provisions
2) The amount less accumulated amortisation under IFRS 15 Revenue.

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 Syllabus D1d) Evaluate and apply the accounting for goodwill and non-controlling interests.

Business combinations - the basics

The purpose of consolidated accounts is to show the group as a single

economic entity.

So rst of all - what is a business combination?

Well my little calf, it’s an event where the acquirer obtains control of another business.

Let me explain, let’s say we are the Parent acquiring the subsidiary.

We must prepare our own accounts AND those of us and the sub put together (called
“consolidated accounts”)

This is to show our shareholders what we CONTROL.

Basic principles
The accounts show all that is controlled by the parent, this means:
• All assets and liabilities of a subsidiary are included
• All income and expenses of the subsidiary are included

Non controlling Interest (NCI)

However the parent does not always own all of the above.
So the % that is not owned by the parent is called the “non-controlling interest”.

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• A line is included in equity called non-controlling interests.
This accounts for their share of the assets and liabilities on the SFP.

• A line is also included on the income statement which accounts for the NCI’s share of the
income and expenses.

One Thing you must understand before we go on

Forgive me if this is basic, but hey, sometimes it’s good to be sure.

Notice if you add the assets together and take away the liabilities for H - it comes to 400
(500+200+100-100-300)

There are 2 things to understand about this gure:

It is NOT the true/fair value of the company
It is equal to the equity section of the SFP

Equity
• This shows you how the net assets gure has come about. The share capital is the
capital introduced from the owners (as is share premium).

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• The reserves are all the accumulated pro ts/losses/gains less dividends since the
business started. Here the gure is 400 for H.
Notice it is equal to the net assets

Acquisition costs
• Where there’s an acquisition there’s probably some of the costs eg legal fees etc
Costs directly attributable to the acquisition are expensed to the income statement.
• Be careful though, any costs which are just for the parent (acquirer) issuing its own debt
or shares are deducted from the debt or equity itself (often share premium).

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 Goodwill
Simple Goodwill

When a company buys another - it is not often that it does so at the fair value of the net
assets only.
This is because most businesses are more than just the sum total of their ‘net assets’ on
the SFP.
Customer base, reputation, workforce etc. are all part of the value of the company that is
not re ected in the accounts.
This is called “goodwill”

Goodwill only occurs on a business combination. Individual companies cannot show their
individual goodwill on their SFPs.
This is because they cannot get a reliable measure, This is because nobody has
purchased the company to value the goodwill appropriately.

On a business combination the acquirer (Parent) purchases the subsidiary - normally at an

amount higher than the FV of the net assets on the SFP, they buy it at a gure that
effectively includes goodwill.
Therefore the goodwill can now be measured and so does show in the group accounts.

How is goodwill calculated?

On a basic level - I hope you can see - that it is the amount paid by the parent less the FV
of the subs assets on their SFP.

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Let me explain..

In this example S’s Net assets are 900 (same as their equity remember).
This is just the ‘book value’ of the net assets.
The Fair Value of the net assets may be, say, 1,000.
However a company may buy the company for 1.200. So, Goodwill would be 200.
The goodwill represents the reputation etc. of a company and can only be reliably
measured when the company is bought out.
Here it was bought for 1,200. Therefore, as the FV of the net assets of S was only 1,000 -
the extra 200 is deemed to be for goodwill.
The increase from book value 900 to FV 1,000 is what we call a Fair Value adjustment.

Bargain Purchase
This is where the parent and NCI paid less at acquisition than the FV of S’s net assets.
This is obviously very rare and means a bargain was acquired
So rare in fact that the standard suggests you look closely again at your calculation of S’s
net assets value because it is strange that you got such a bargain and perhaps your
original calculations of their FV were wrong
However, if the calculations are all correct and you have indeed got a bargain then
this is NOT shown on the SFP rather it is shown as:
Income on the income statement in the year of acquisition

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 NCI in the Goodwill calculation

So far we have presumed that the company has been 100% purchased when calculating
goodwill.

Our calculation has been this:

Non-controlling Interests
Let’s now take into account what happens when we do not buy all of S. (eg. 80%)
This means we now have some non-controlling interests (NCI) at 20%
The formula changes to this:

This NCI can be calculated in 2 ways:

1) Proportion of FV of S’s Net Assets
2) FV of NCI itself

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 Proportion of FV of S’s Net Assets method
This is very straight forward. All we do is give the NCI their share of FV of S’s Net
Assets..Consider this:
P buys 80% S for 1,000. The FV of S’s Net assets were 1,100.
How much is goodwill?

The NCI is calculated as 20% of FV of S’s NA of 1,100 = 220

“Fair Value Method” of Calculating NCI in Goodwill

• So in the previous example NCI was just given their share of S’s Net assets.
They were not given any of their reputation etc.
In other words, NCI were not given any goodwill.

• I repeat, under the proportionate method, NCI is NOT given any goodwill.
Under the FV method, they are given some goodwill.

• This is because NCI is not just given their share of S’s NA but actually the FV of their
20% as a whole (ie NA + Goodwill).
This FV gure is either given in the exam or can be calculated by looking at the share
price (see quiz 2).

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P buys 80% S for 1,000. The FV of S’s Net assets were 1,100. The FV of NCI at this date
was 250.

How much is goodwill?

Notice how goodwill is now 30 more than in the proportionate example. This is the goodwill
attributable to NCI.
NCI goodwill = FV of NCI - their share of FV of S’s NA

Remember
Under the proportionate method NCI does not get any of S’s Goodwill (only their share of
S’s NA).
Under the FV method, NCI gets given their share of S’s NA AND their share of S’s goodwill

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 Equity Table
S’s Equity Table

As you will see when we get on to doing bigger questions, this is always our rst working.
This is because it helps all the other workings.
Remember that Equity = Net assets

Equity is made up of:

1. Share Capital
2. Share Premium
3. Retained Earnings
4. Revaluation Reserve
5. Any other ‘reserve’!

If any of the above is mentioned in the question for S, then they must go into this equity
table working.

What does the table look like?

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Remember that any other reserve would also go in here.

So how do we ll in this table?

1. Enter the "Year end" gures straight from the SFP
2. Enter the "At acquisition" gures from looking at the information given normally in
note 1 of the question.
Please note you can presume the share capital and share premium is the same as
the year-end gures, so you're only looking for the at acquisition reserves gures
3. Enter "Post Acquisition" gures simply by taking away the "At acquisition" gures
away from the "Year end" gures
(ie. Y/E - Acquisition = Post acquisition)

So let's try a simple example.. (although this is given in a different format to the actual
exam let's do it this way to start with).

A company has share capital of 200, share premium of 100 and total reserves at
acquisition of 100 at acquisition and have made pro ts since of 400. There have been no
issues of shares since acquisition and no dividends paid out.

Show the Equity table to calculate the net assets now at the year end, at acquisition
and post-acquisition

Solution

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 Fair Value Adjustments
Ok the next step is to also place into the Equity table any Fair Value adjustments
When a subsidiary is purchased - it is purchased at FAIR VALUE at acquisition.
Using the gures above, if I were to tell you that the FV of the sub at acquisition was 480.
Hopefully you can see we would need to make an adjustment of 80 (let’s say that this was
because Land had a FV 80 higher than in the books):

Now as land doesn’t depreciate - it would still now be at 80 - so the table changes to this:

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If instead the FV adjustment was due to PPE with a 10 year useful economic life left - and
lets say acquisition was 2 years ago, the table would look like this:

The -16 in the post acquisition column is the depreciation on the FV adjustment. (80 / 10
years x 2 years).
This makes the now column 64 (80 at acquisition - 16 depreciation post acquisition).

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 NCI on the SFP
Non-Controlling Interests

So far we have looked at goodwill and the effect of NCI on this.. Now let’s look at NCI in a
bit more detail (don’t worry we will pull all this together into a bigger question later).

If you remember there are 2 methods of measuring NCI at acquisition:

1. Proportionate method
This is the NCI % of FV of S’s Net assets at acquisitio
2. FV Method
This is the FV of the NCI shares at acquisition (given mostly in the question).

This choice is made at the beginning.

Obviously, S will make pro ts/losses after acquisition and the NCI deserve their share of
these.

Therefore the formula to calculate NCI on the SFP is as follows:

* This gure depends on the option chosen at acquisition (Proportionate or FV method).

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 Impairment
S may become impaired over time. If it does, it is S’s goodwill which will be reduced in
value rst. If this happens it only affects NCI if you are using the FV method.
This is because the proportionate method only gives NCI their share of S’s Net assets and
none of the goodwill.
Whereas, when using the FV method, NCI at acquisition is given a share of S’s NA and a
share of the goodwill.

NCI on the SFP Formula revised

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 Reserves Calculation
SFP Group Reserves

So far we have looked at how to calculate goodwill and then NCI for the SFP, now we are
looking at how to calculate any group reserves on the SFP
There could be many reserves (eg Retained Earnings, Revaluation Reserve etc), however
they are all calculated the same way

Basic Idea
The basic idea is that group accounts are written from the Parent companies point of view.
Therefore we include all of Parent (P’s) reserves plus parent share of Subs post
acquisition gains or losses in that reserve.
Let’s look at an example of this using Retained Earnings.

Illustration 1
P acquired 80% S when P’s Retained earnings were 1,000 and S’s were 600
Now, P’s RE are 1,400 and S’s RE are 700.
What is the RE on the SFP now?

It is worth pointing out here that all these workings only really to start to make sense once
you start to do lots of examples - see my videos for this.

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Impairment
If Goodwill has been impaired then goodwill will reduce and retained earnings will reduce
too.

However, the amount of the impairment depends on the NCI method chosen:
1. Proportionate NCI method
This means that NCI has zero goodwill, so any goodwill impaired all belongs to the
parent and so 100% is taken to RE
2. FV method
Here NCI is given a share of NCI, so also takes a share of the impairment.
Therefore the group only gets its share of the impairment in RE (eg 80%)

Illustration 2
P acquired 80% S when P’s Retained earnings were 1,000 and S’s were 600.
Now, P’s RE are 1,400 and S’s RE are 700.
P uses the FV method of accounting for NCI and impairment of 40 has occurred since.
What is the RE on the SFP now?

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 Basic groups - Simple Question 1

Have a look at this question and solution below and see if you can work out where all the
gures in the solution have come from.
Make sure to check out the videos too as these explain numbers questions such as these
far better than words can..

P acquired 80% S when S’s reserves were 80.

Prepare the Consolidated SFP, assuming P uses the proportionate method for
measuring NCI at acquisition.

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Goodwill

NCI

Reserves

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Group SFP

Notice
1) Share Capital (and share premium) is always just the holding company
2) All P + S assets are just added together
3) “Investment in S”..becomes “Goodwill” in the consolidated SFP
4) NCI is an extra line in the equity section of consolidated SFP

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 Basic groups - Simple Question 2

P acquired 80% S when S’s Reserves were 40.

At that date the FV of S’s NA was 150.
Difference is due to Land.
There have been no issues of shares since acquisition.
P uses the FV of NCI method at acquisition, and at acquisition the FV of NCI was 35. No
impairment of goodwill.
Prepare the consolidated set of accounts.

Step 1: Prepare S’s Equity Table

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Now the extra 10 FV adjustment now must be added to the PPE when we come to do the
SFP at the end.

Step 2: Goodwill

Step 3: Do any adjustments in the question

: NONE

Step 4: NCI

Step 5: Reserves

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Step 6: Prepare the nal SFP (with all adjustments included)

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 Syllabus D1f) Determine and apply appropriate procedures to be used in preparing consolidated
nancial statements.

Group Income Statement

Rule 1 - Add Across 100%

Like with the SFP, P and S are both added together. All the items from revenue down to

Pro t after tax; except for:

1) Dividends from Subsidiaries
2) Dividends from Associates

Rule 2 - NCI
This is an extra line added into the consolidated income statement at the end. It is
calculated as NCI% x S’s PAT.
The reason for this is because we add across all of S (see rule 1) even if we only own 80%
of S.
We therefore owe NCI 20% of this which we show at the bottom of the income statement.

Rule 3 - Associates
Simply show one line (so never add across an associate).
The line is called “Share in Associates’ Pro t after tax”.

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 Rule 4 - Depreciation from the Equity table working
Remember this working from when we looked at group SFP’s?

The -10 from the FV adjustment is a group adjustment. So needs to be altered on the
group income statement. It represents depreciation, so simply put it to admin expenses (or
wherever the examiner tells you), be careful though to only out in THE CURRENT YEAR
depreciation charge.

Rule 5 - Time Apportioning

This isn’t dif cult but can be awkward/tricky. Basically all you need to remember is the
group only shows POST -ACQUISITION pro ts. i.e. Pro ts made SINCE we bought the
sub or associate.

If the sub or associate was bought many years ago this is not a problem in this year’s
income statement as it has been a sub or assoc. all year.

The problem arises when we acquire the sub or the associate mid year. Just remember to
only add across pro ts made after acquisition. The same applies to NCI (as after all this
just a share of S’s PAT).

For example if our year end is 31/12 and we buy the sub or assoc. on 31/3. We only add
across 9/12 of the subs gures and NCI is % x S’s PAT x 9/12.
One nal point to remember here is adjustments such as unrealised pro ts / depreciation
on FV adjustments are entirely post - acquisition and so are NEVER time apportioned.

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Rule 6 - Unrealised Pro t
You will remember this table I hope

Well the idea stays the same - it’s just how we alter the accounts that changes, because
this is an income statement after all and not an SFP. So the table you need to remember
becomes:

Notice how we do not need to make an adjustment to reduce the value of inventory. This is
because we have increased cost of sales (to reduce pro ts), but we do this by actually
reducing the value of the closing stock.

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 Unrealised Pro t

The key to understanding this - is the fact that when we make group accounts - we are
pretending P & S are the same entity.
Therefore you cannot make a pro t by selling to yourself!
So any pro ts made between two group companies (and still in group inventory) need
removing - this is what we call ‘unrealised pro t’.

Unrealised pro t - more detail

Pro t is only ‘unrealised’ if it remains within the group. If the stock leaves the group it has
become realised.
So ‘Unrealised pro t” is pro t made between group companies and REMAINS IN STOCK.

Example
P buys goods for 100 and sells them to S for 150. S has sold 2/5 of this stock.
The Unrealised Pro t is: Pro t between group companies 50 x 3/5 (what remains in stock)
= 30.

How do we then deal with Unrealised Pro t

If P buys goods for 100 and sells them to S for 150.
Thereby making a pro t of 50 by selling to another group company.
S sells 4/5 of them to 3rd parties.
Unrealised pro t is 50 x 1/5 = 10

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So why do we reduce inventory as well as pro t?
Well let’s say that S buys goods for 100 and sells them to P for 150 and P still has them in
stock.
How much did the stock actually cost the group?
The answer is 100, as they are still in the group.
However P will now have them in their stock at 150.
So we need to reduce stock/inventory also with any unrealised pro t.

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 Intra-Group Balances & In-transit Items

Inter-group company balances

As with Unrealised Pro t - this occurs because group companies are considered to be the
same entity in the group accounts.
Therefore you cannot owe or be owed by yourself.
So if P owes S - it means P has a payable with S, and S has a receivable from P in their
INDIVIDUAL accounts.
In the group accounts, you cannot owe/be owed by yourself - so simply cancel these out:
Dr Payable (in P)
Cr Receivable (in S)

The only time this wouldn’t work is if the amounts didn’t balance, and the only way this
could happen is because something was still in transit at the year end. This could be stock
or cash.

You always alter the receiving company. What I mean is - if the item is in transit, then the
receiving company has not received it yet - so simply make the RECEIVING company
receive it as follows:

Stock in transit
In the RECEIVING company’s books:
Dr Inventory
Cr Payable

Cash in transit
In the RECEIVING company’s books:
Dr Cash
Cr Receivable

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Having dealt with the amounts in transit - the inter group balances (receivables/payables)
will balance so again you simply:
Dr Payable
Cr Receivable

Intra-group dividends
eliminate all dividends paid/payable to other entities within the group, and all intragroup
dividends received/receivable from other entities within the group.

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 Impairment of Goodwill

Goodwill is reviewed for impairment not amortised.

An impairment occurs when the subs recoverable amount is less than the subs carrying
value + goodwill.
How this works in practice depends on how NCI is measured - Proportionate or Fair Value
method.

Proportionate NCI
Here, NCI only receives % of S's net assets.
NCI DOES NOT have any share of the goodwill.

1. Compare the recoverable amount of S (100%) to..

2. NET ASSETS of S (100%) +
Goodwill (100%)
3. The problem is that goodwill on the SFP is for the parent only - so this needs
grossing up rst
4. Then nd the difference - this is the impairment - but only show the parent % of the
impairment

Example
H owns 80% of S. Proportionate NCI
Goodwill is 80 and NA are 200
Recoverable amount is 240
How much is the impairment?

Solution
RA = 240
NA = 200 + G/W (80 x 100/80) = 100 = 300
Impairment is therefore 60.
The impairment shown in the accounts though is 80% x 60 = 48.

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 This is because the goodwill in the proportionate method is parent goodwill only. Therefore
only parent impairment is shown.

Fair Value NCI

Here, NCI receives % of S's net assets AND goodwill.
NCI DOES now own some goodwill.

1. Compare the recoverable amount of S (100%) to..

2. NET ASSETS of S (100%) +
Goodwill (100%)
3. As, here, goodwill on the SFP is 100% (parent & NCI) - so NO grossing up needed
4. Then nd the difference - this is the impairment - this is split between the parent and
NCI share

Example
H owns 80% of S. Fair Value NCI
Goodwill is 80 and NA are 200
Recoverable amount is 240
How much is the impairment?

Solution
RA = 240
NA = 200 + G/W 80 = 280
Impairment is therefore 40.
The impairment shown in P's RE as 80% x 40 = 32.
The impairment shown in NCI is 20% x 40 = 8.

Impairment adjustment on the Income Statement

1. Proportionate NCI
Add it to P's expenses.
2. Fair Value NCI
Add it to S's expenses
(this reduces S's PAT so reduces NCI when it takes its share of S's PAT).

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 Make sure you use FV of Consideration

Consideration is simply what the Parent pays for the sub.

It is the rst line in the goodwill working as follows:

Normal Consideration
This is straightforward. It is simply:
Dr Investment in S
Cr Cash

Future Consideration
This is a little more tricky but not much. Here, the payment is not made immediately but in
the future. So the credit is not to cash but is a liability.
Dr Investment in S
Cr Liability

The only dif culty is with the amount.

As the payment is in the future we need to discount it down to the present value at the
date of acquisition.

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Illustration
P agrees to pay S 1,000 in 3 years time (discount rate 10%).
Dr Investment in S 751
Cr Liability 751 (1,000 / 1.10^3)
As this is a discounted liability, we must unwind this discount over the 3 years to get it back
to 1,000. We do this as follows:

Contingent Consideration

This is when P MAY OR MAY NOT have to pay an amount in the future (depending on,
say, S’s subsequent pro ts etc.). We deal with this as follows:
Dr Investment in S
Cr Liability
All at fair value

You will notice that this is exactly the same double entry as the future consideration (not
surprising as this is a possible future payment!).
The only difference is with the amount.
Instead of only discounting, we also take into account the probability of the payment
actually being made.
Doing this is easy in the exam - all you do is value it at the FV
(this will be given in the exam you’ll be pleased to know).

Illustration

1/1/x7 H acquired 100% S when it’s NA had a FV of £25m. H paid 4m of its own shares
(mv at acquisition £6) and cash of £6m on 1/1/x9 if pro ts hit a certain target.

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At 1/1/x7 the probability of the target being hit was such that the FV of the consideration
was now only £2m. Discount rate of 8% was used.
At 31/12/x7 the probability was the same as at acquisition.
At 31/12/x8 it was clear that S would beat the target.
Show the double entry
Contingent consideration should always be brought in at FV. Any subsequent changes to
this FV post acquisition should go through the income statement.
Any discounting should always require an winding of the discount through interest on the
income statement

Double entry - Parent Company

1/1/x7
Dr Investment in S (4m x £6) + £2 = 26
Cr Share Capital 4
Cr Share premium 20
Cr Liability 2

31/12/x7

Dr interest 0.16
Cr Liability 0.16

31/12/x8

Dr Income statement 4 (6-2)

Dr Liability 2
Cr Cash 6

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 Goodwill - FV of NA (more detail)

Goodwill

So let’s remind ourselves of the goodwill working:

We have just looked in more detail at the sort of surprises the examiner can spring on us
in the rst line “consideration” - now let´s look at the bottom line in more detail:

Fair values of Net Assets at Acquisition

Operating leases. If terms are favourable to the market - recognise as an asset
Internally generated intangibles would now have a reliable measure and would be brought
in the consolidated accounts
Remember both of these items would need to be depreciated in our equity table working
contingent liabilities (see bottom of this page)

Illustration
1/7/x5 H acquired 80% S for 16m, nci measured at share of net assets. FV of NA was
10m.
S had a production backlog with a FV of 2m (uel 2 years) and unrecognised trademarks
with a FV of 1m. These are renewable at any time at a negligible cost.
S made a pro t of 5m in the year to 31/12/x5.
What would goodwill be in the consolidated SFP?

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 FV of NA working
Per Accounts 10 + FV adj (2+1) 3

Provisional Goodwill
We get “provisional goodwill’ when we cannot say for certain yet what the FV of Net Assets
are at the date of acquisition.
This is ne, we just state in the accounts that the goodwill gure is provisional.
This means we then have 12 months (from the date of acquisition) to change the goodwill
gure IF AND ONLY IF the information you nd (within those 12 months) gives you more
information about the conditions EXISTING at the year-end.
Any information after the 12 month period (even if about conditions at acquisition) does not
change goodwill.
Any differences are simply written off to the income statement.
So, in summary, the FV of NA can be altered retrospectively if within 12 months of
acquisition.
This means goodwill would change. Any alteration after 12 months is through the income
statement.

Illustration
A acquired 70% B on 1/7/x7, NCI measured at share of net assets acquired.
A provisional fair value only was used for plant and machinery of £8m (UEL 10yrs).
Goodwill was £4m.
The year-end of 31/12/x7 accounts were then approved on 25/2/x8.
On 1/4/x8 the FV of the plant was nalised at 7.2m.
How would this affect the consolidated accounts?
Provisional goodwill is acceptable if disclosed as such in the accounts.

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 The parent then has one year after acquisition to nalise the FV and alter goodwill. Should
the nalisation occur after one year - no adjustment is required to goodwill.
Provisional Goodwill 4m
Adjusted Goodwill
Original 4m + (0.8 x 70%) = 4.56m

Contingent liabilities
Normally these are just disclosures in the accounts.
However, remember that when a sub is acquired, it is brought into the accounts at FV.
A contingent liability does have a fair value.
Therefore they must be actually recognised in the consolidated accounts until the amount
is actually paid.

So the rules are:

1. Bring in at the FV
2. Measure afterwards at this amount unless it then becomes probable. As usual, a
probable liability is then measured at the full liability

Note. If it remains just possible then keep it at the initial FV until it is either written off or
paid

Illustration
1/7/x6 P acquired all of S when it’s NA had a CV of £2m. However, they had disclosed a
contingent liability. This has a FV of £150,000.
1/12/x7 this potential liability was paid at an amount of £200,000.
How are the accounts affected?
Well we would bring it into the equity table (at acquisition column) in the workings at its FV
of 150. This would affect goodwill working accordingly.
Keep it at this amount until it either becomes probable (show at full amount) or paid
Here it is paid so the year end would show no liability - and the post-acquisition column
+150. This would then affect the NCI and reserves working accordingly.
The extra 50 paid will have already been taken into account when the full amount was paid

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 Syllabus D1e) Evaluate and apply the accounting principles relating to a business combination
achieved in stages.

Step Acquisitions

When Control is achieved is the key date..

Consolidation only occurs when control is eventually achieved.

When Control is achieved this occurs:

Remeasure all previous holdings to FV
Any gain or loss to income statement

Illustration
P acquired 10% of S in year 1 for 100.
P acquired a further 60% of S in year 2 for 800. At this date, the original 10% now has a
FV of 140.

How would this be accounted for?

The key date of when controlled is achieved is year 2. At this date we must:
• Revalue the original 10% from 100 to 140
• The 40 gain goes to the income statement (and retained earnings)
• Also we would now start consolidating S (as we now control it). The Consideration gure
in the goodwill working would now be 940 (140 + 800).

Further acquisition after control is achieved

If there are further acquisitions after control - this is deemed to be a purchase from the
other owners (NCI) - so no pro t is calculated. Simply.
Here you will need to do the following calculation:

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Illustration
H acquired 60% S for 100 in year 4 when the FV of its NA was 90. Proportionate NCI
method is used.
2 years later its NA are 150 and H acquires another 20% for 80.
Calculate decrease in NCI and movement in parents equity for the latest acquisition.

NCI

SO NCI was 60 (representing 40%). Now, by acquiring a further 20% from the NCI, this
means NCI will go from 40% to 20%. It has halved.

So NCI has gone down by 30.

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 Comprehensive Examples - Step AcquisitionJoint

Arrangements (IFRS 11)

Comprehensive Question

SFP for YEAR 6

P acquired 30% S in year 1 for 60. It acquired another 30% in year 4 for 140
S’s reserves were 10 in year 1 and 60 in year 4.
FV of S’s NA in year 1 was 120 and in year 4 190. Difference is due to Land.
FV of NCI in year 4 was 90.
FV of 30% holding in Year 4 is 120.
P acquired a further 10% of S on the last day of year 6 for 50.
Show the Consolidated SFP at the end of year 6.

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Solution
Step 1: Equity Table

Step 2: Goodwill

Step 3: NCI

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Step 4: Further Acquisition from NCI

Step 5: Reserves

Final Answer

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 Syllabus D1g) Evaluate and apply the implications of changes in ownership interest and loss of
control or signi cant in uence.

Partial Disposals

A partial disposal means selling but keeping control - so we must keep above 50%
ownership afterwards e.g. Selling from 80% to 60%.
As we keep control, then the sale must be to those who do not have control - the NCI.
NCI will therefore increase after a partial disposal.
Therefore, this is just an exchange between the owners of the business (controllers and
non-controllers) and so any gain or loss must go to EQUITY (other reserves) not Income
statement.

How is the gain or loss calculated?

How do you calculate the ‘Increase in NCI’ line?

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What is the double entry for the disposal?

What is the Income Statement Effect?

The subsidiary is still consolidated in full.
NCI % is time apportioned (eg 20% to date of disposal, 40% thereafter).

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 Syllabus D1i) Discuss and apply the treatment of a subsidiary which has been acquired exclusively
with a view to subsequent disposal.

Discontinued Operation

An analysis between continuing and discontinuing operations improves the

usefulness of nancial statements.

When forecasting ONLY the results of continuing operations should be used.

Because discontinued operations pro ts or losses will not be repeated.

What is a discontinued operation?

1. A separate major line of business or geographical area
2. is part of a single co-ordinated plan to dispose of a separate major line of
business or geographical area
3. is a subsidiary acquired exclusively with a view to resale

How is it shown on the Income Statement?

The PAT and any gain/loss on disposal
A single line in I/S

How is it shown on the SFP?

If not already disposed of yet?
Held for sale disposal group

How is it shown on the cash- ow statement?

Separately presented
in all 3 areas - operating; investing and nancing

No Retroactive Classi cation

IFRS 5 prohibits the retroactive classi cation as a discontinued operation, when the
discontinued criteria are met after the end of the reporting period

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 Full Disposal

This is when we lose control, so we go from owning a % above 50 to one below 50 (eg
80% to 30%).
In this case we have effectively disposed of the subsidiary (and possibly created a new
associate).
As the sub has been disposed of - then any gain or loss goes to the INCOME
STATEMENT (and hence retained earnings).
Also, the old Subs assets and liabilities no longer get added across, there will be no
goodwill or NCI for it either.

How do you calculate this gain or loss?

What’s the effect on the Income Statement?

Consolidated until sale; Then treat as Associate (if we have signi cant in uence) otherwise
a FVTPL investment.
Show pro t on disposal (see above).

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 Subsidiary acquired with a view to disposal

A subsidiary that is acquired exclusively with a view to its subsequent disposal is

classi ed on the acquisition date of the subsidiary as a non-current disposal group 'held
for sale' (if it is expected that the subsidiary will be disposed of within one year and the
other IFRS 5 criteria are met with within three months of the acquisition date)

Classi cation as a discontinued operation

A subsidiary classi ed as 'held for sale', is included in the de nition of a discontinued
operation, with treatment as follows:

• Income statement
Single Line “Discontinued operations” - PAT of the Sub + gain/loss on re-measurement to
held for sale
The income and expenses of the subsidiary are therefore not consolidated on a line-by-
line basis with the income and expenses of the holding company.
• Statement of nancial position
The assets and liabilities classi ed as 'held for sale' presented separately (the assets
and liabilities of the same disposal group may not be offset against each other).
The assets and liabilities of the subsidiary are therefore not consolidated on a line-by-line
basis with the assets and liabilities of the holding company.
• Statement of Cash ows
No need to disclose the net cash ows attributable to the operating, investing and
nancing activities of the discontinued operation (which is normally required) but is not
required for newly acquired subsidiaries which meet the criteria to be classi ed as 'held
for sale' on the acquisition date

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 Syllabus D1j) Discuss and apply accounting for group companies in the separate nancial
statements of the parent company.

Accounting For Group Companies In The Parent

In the parent's own nancial statements…

Investments in subsidiaries are held at cost or at fair value under IFRS 9

Consequently the pro t or loss on disposal of a sub is different from the group pro t or loss
on disposal:

Fair value of consideration received X

Less carrying amount of investment disposed of (X)
Pro t/ (loss) X

This would be in P's Income statement and is ignored in group accounts - the group loss
on disposal is shown instead

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 IAS 27

With reorganisations where a new parent is inserted above an existing parent, the ‘cost’ of
investment in the sub can now be its carrying amount rather than its FV

This relief is limited to where

1. The new parent obtains control of the original parent (or entity) by issuing shares
2. The assets and liabilities of the new group and the original group are the same
immediately before and after the reorganisation; and
3. The owners of the original parent before the reorganisation have the same absolute
and relative interests after the reorganisation.

If any of the above is not met then the reorganisation must be accounted for as normal at
FV (rather than CV)

IAS 27 will require all dividends received to be shown in the income statement

However, if the dividend exceeds the total comprehensive income of the subsidiary in the
period the dividend is declared; or the carrying amount of the investment exceeds the
amount of net assets (including associated goodwill) recognised - then impairment should
be checked for

The distinction between pre- and post-acquisition pro ts is no longer required.

Recognising dividends received from subsidiaries as income will give rise to greater
income being recognised. Care will need to be taken as to what constitutes a dividend
(de ned as a distribution of pro ts).
.

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Syllabus D1k) Identify and explain the circumstances when a group may claim an exemption from the
preparation of consolidated nancial statements.

Group Accounting Exemptions

Who needs to prepare consolidated accounts?

Basically a parent company, one with a subsidiary

However there are exceptions to this rule:
• The parent is itself a wholly owned subsidiary
• The parent is a partially (e.g. 80%) owned sub and the other 20% owners allow it to not
prepare consolidated accounts
• The parents shares are not publicly traded
• The parents own parent produces consolidated accounts

Sometimes a sub is purchased with a view to it being sold.

In this case it is an IFRS 5 discontinued operation
The group share of its pro ts are shown on the income statement and all of its assets and
liabilities shown separately on the SFP

Not Valid reasons for exemption

1. A subsidiary whose business is of a different nature from the parent’s.
2. A subsidiary that operates under severe long-term restrictions impairing the
subsidiary’s ability to transfer funds to the parent.
3. A subsidiary that had previously been consolidated and that is now being held for
sale.

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 Syllabus D1l) Evaluate and apply the principles relating to the preparation of group statements of
cash ows.

Cash ow statements - Step 1

Indirect method

The idea here is simply to get to the pro t from operating activities as a starting point -
nothing more!
So IAS tells us that although we need to get to the operating pro t gure we must start
with Pro t before tax (PBT) and reconcile this to the operating pro t gure.

Operating Pro t
Before we do this let’s remind ourselves what “Operating pro t” is.
Operating Pro t is:

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 Illustration

Start with the pro t before tax gure and then reconcile to the operating pro t gure.
Operating pro t would be:

So, let’s start reconciling…

Then ll in the reconciling gures between them (income is a negative and expense a
positive here). This is because we are going upwards on the income statement, rather
than the normal downwards.

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So this is the nal answer to step 1:

You place this in the “Cash ow from Operating Activities” part of the cash- ow statement.

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 Cash ow statements - Step 2

Now we have the operating pro t gure we need to get to the cash.
We do this by taking the pro t gure (calculated and reconciled to in step 1) and adding
back all the non-cash items (we get to the cash therefore indirectly).

Key point to remember here

The non-cash items we add back are ONLY those in operating pro t (Sales, COS, admin
and distr. costs).

For example:
Depreciation, amortisation, impairments, pro t on sale, receivables, payables and
inventory
There could be more - it depends on the question - but dealing with these will ensure you
pass

So the operating activities part of the cash ow will now look like this:

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Ensure you get the signs the right way around!
For example an increase in stock means less cash so (x).
Notice we added back receivables / payables & Inventory.
This is because credit sales, stock and credit payables are not cash and are in the
operating pro t gure.
You just need to be careful that you get the signs the right way around as with these we
just account for the movement in them.

Think of it like this:

• Increase in Inventory - means less cash - so show as a negative
• Increase in receivables - means less cash now - so show as a negative
• Increase in payables - means don’t have to pay people just yet so an increase in cash -
so show as a positive

We have now dealt with the rst part of the income statement - Sales, COS, administration
expenses and distribution costs. We have indirectly got the cash from these gures by
adding back all the non-cash items that may have been in there (as above).

All of this happens in the “Cash ow from Operating Activities” part of the cash- ow
statement.

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 Cash ow statements - Step 3

So far we have got the cash (indirectly) from operating pro t. This means we have the
cash from Sales, COS, admin and distribution costs. What we now do is look at what’s left
in the income statement and try to nd the cash.
(In our example in step 1, we would have to deal with IP income, nance costs and tax).
So we are looking at the other parts of the income statement (after operating pro t) and
nding the cash and putting this directly into the cash- ow statement.

Direct method
We do this by using a different method to the one in step 2 as we are now looking to put
the cash in directly to the cash- ow statement (rather than taking a pro t gure and adding
back the non-cash items to indirectly arrive at cash).

So how do we do this?

General Method Explanation

Let’s say you owed somebody 100, then bought 20 more in the year - you should therefore
owe them 120 right?
However you look at your books at the year end and you see you only owe them 70
Therefore, you must have paid cash to them of 50 - this is the gure we then put in our
cash- ow statement.
To show this differently (and how the examiner often shows it):

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We use this format for the rest of the cash ow question - though it may need adjusting
slightly (PPE is calculated differently).

We will now go on to look at the different items that you may nd in the income statement
and how we deal with them in the cash- ow statement using this method.

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 Cash ow statement - nance costs

Finance Costs - Illustration of Step 3

Solution

Finance costs of 120 paid go to the operating activities section of the cash ow
statement.

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 Cash ow statement - taxation

Taxation - Illustration of Step 3

Solution

Taxation costs of 150 paid go to the operating activities section of the cash ow
statement.

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 Cash ow statement - Investment property

Investment Property Income - Illustration of Step 3

There were no purchases of IP in the year.

Solution

Investment property income of 20 (rent received probably) goes to the investing

activities section of the cash ow statement.

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 Cash ow statements - Step 4

So in the rst 3 steps, we have turned the Income statement into cash and placed it into
the cash- ow statement. We now need to do the same with the S - remember much of it
we have already dealt with (e.g. receivables, inventory, payables, investment

Property, interest and tax payable

So let’s begin with…

PPE
We deal with this slightly differently to the income statement items in step 3:
Process to follow
Here’s the process to follow:
Write down the PPE gures per the accounts
Work out the cash element of each item (if any)

Illustration

Notes:
Depreciation in year = 50
Revaluation = 100
Disposal = Asset sold for 100 making 20 pro t

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Solution
The key here is to try and nd the balancing gure (per the accounts) which will be
additions in the year.
Note: we are dealing with NBVs.
Write down the PPE gures per the accounts.

The balancing gure is 90 and this is additions.

Work out the cash element of each item (if any):

All PPE items go the investing activities section of the cash ow statement.

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 Cash ow statements - Step 5 - Shares

So in steps 1-3 we looked at how we got the cash from the income statement and into the
statement of cash ows.
In step 4 we looked at getting the cash ows from PPE.
So now in our nal step we look at getting cash from what’s left in the SFP… starting with
shares.

Share issues
Again let’s look at this by illustration and we are using virtually the same technique as step
3 as you will see..

Solution

Share Proceeds goes to the nancing activities section of the cash ow statement.

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Effect of Bonus Issue
If there’s been a bonus issue, you need to be careful.
You need to look at where the debit went - share premium or retained earnings:
If share premium - ignore the bonus issue and the answer calculated above is still correct
If Retained earnings - reduce the cash by the amount of the bonus issue
See the quizzes for examples of this.

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 Cash ow statements - Step 5 - Loans

Let’s now look at another one of the items that would still be left on the SFP, that we need
to nd the cash and take to the cash- ow statement - Loans

Illustration
Follow same techniques as before..

Solution

Loan repayments of 40 go to the nancing activities section of the cash ow

statement.

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 Syllabus D2. Associates And Joint Arrangements

Important Examinable Narrative & Miscellaneous

points
These are:
• Transactions related to acquiring a subsidiary are to be written off to the Income
statement

• Any future contingent consideration towards the cost of investment is included in cost of
investment at its FAIR VALUE regardless of whether it is probable or not

• If the FAIR VALUE of the above changes after acquisition goodwill is NOT adjusted
unless it is simply providing more information about what the fair value would have been
at acquisition date

• A company is a sub when it is controlled only. This means more than 50% of the voting
rights; or control of the nancial and operating activities or power to appoint a majority of
the board

• It may be that H owns 40% + 20% potential shares (eg share options). To see whether
this means H controls S all terms must be examined, disregarding management
intentions

• Subsidiaries held for sale must be consolidated (see above)

• JV’s and A’s are not consolidated if they are held for sale

• Subsidiaries with very different activities to H must also be consolidated as IFRS 8

segmental reporting will deal with these problems

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 • Subs with severe long term restrictions must still be consolidated until actual control is
lost

• Associates with severe long term restrictions must still be equity accounted until actual
signi cant in uence is lost

• A company is an associate when there is no control but there is signi cant in uence.
This means 20% or more of the voting rights (unless someone else holds more than 50%
solely in which case they control it and we have no signi cant in uence at all).
Participation in policy making is deemed to be signi cant in uence

• H does NOT need to consolidate if it is itself a 100% sub or if the shares aren’t traded
publicly and the ultimate parent prepares consolidated accounts

• Subs may have a different reporting date to H but they must prepare further accounts to
make consolidation possible. Unless the difference in date is 3 months or less in which
case S’s accounts can be used and adjustments made for signi cant events

• Consolidated accounts must be made with uniform accounting policies. So if S has

different policies to H, group level adjustments need to be made

• NCI can be negative - they are simply owners of the group like the parent and so losses
are possible

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 Syllabus D2a) Justify the use of, and apply the equity method
of, accounting for associates.

Associates

An associate is an entity over which the group has signi cant in uence, but not control.

Signi cant in uence

Signi cant in uence is normally said to occur when you own between 20-50% of the
shares in a company but is usually evidenced in one or more of the following ways:

• representation on the board of directors

• participation in the policy-making process
• material transactions between the investor and the investee
• interchange of managerial personnel; or
• provision of essential technical information

Accounting treatment
An associate is not a group company and so is not consolidated. Instead it is accounted
for using the equity method. Inter-company balances are not cancelled.

Statement of Financial Position

There is just one line only “investment in Associate” that goes into the consolidated SFP
(under the Non-current Assets section).

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 It is calculated as follows:

Consolidated income statement

Again just one line in the consolidated income statement:

Include share of PAT less any impairment for that year in associate.

Do not include dividend received from A.

What’s important to notice is that you do NOT add across the associate’s Assets and
Liabilities or Income and expenses into the group totals of the consolidated accounts. Just
simply place one line in the SFP and one line in the Income Statement.

Unrealised pro ts for an associate

1. Only account for the parent’s share (eg 40%).
This is because we only ever place in the consolidated accounts P’s share of A’s
pro ts so any adjustment also has to be only P’s share.
2. Adjust earnings of the seller

Adjustments required on Income Statement

• If A is the seller - reduce the line “share of A’s PAT”
• If P is the seller - increase P’s COS

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 Adjustments required on SFP
• If A is the seller - reduce A’s Retained earnings and P’s Inventory
• If P is the seller - reduce P’s Retained Earnings and the “Investment in Associate” line

Illustration
P sells goods to A (a 30% associate) for 1,000; making a 400 pro t. 3/4 of the goods have
been sold to 3rd parties by A.
What entries are required in the group accounts?
Pro t = 400; Unrealised (still in stock) 1/4 - so unrealised pro t = 400 x 1/4 = 100. As this is
an associate we take the parents share of this (30%). So an adjustment of 100 x 30% = 30
is needed.
Adjustment required on the Income statement
P is the seller - so increase their COS by 30.
Adjustment required on the group SFP
P is the seller - so reduce their retained earnings and the line “Investment in Associate” by
30.

The retained earnings of S and A were £70,000 and £30,000 respectively when they were
acquired 8 years ago.
There have been no issues of shares since then, and no FV adjustments required.
The group use the proportionate method for valuing NCI at acquisition.

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Prepare the consolidated SFP

Solution

Step 1: Equity Table

Step 2: Goodwill

H owns 18,000 of S’s share capital of 30,000 so 60%.

Step 3: NCI

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Step 4: Retained Earnings

Step 5: Investment in Associate

Final answer - Goodwill

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 Syllabus D2b) Discuss and apply the application of the joint control principle and apply to the
classi cation of joint arrangements.

Joint Ventures

A joint arrangement is an arrangement of which two or more parties have joint

control.

A joint arrangement has the following characteristics:

• The parties are bound by a contract, and
• The contract gives two or more parties joint control

What is Joint Control?

The sharing of control where decisions about the relevant activities need unanimous
consent.
The rst step is to see if the parties control the arrangement per IFRS 10.
After that, the entity needs to see if it has joint control as per paragraph above
Unanimous consent means any party can prevent other parties from making unilateral
decisions (about the relevant activities).

Types of joint arrangements

Joint arrangements are either joint operations or joint ventures:
• A joint operation
Here the parties have rights to the assets, and obligations for the liabilities, relating to the
arrangement.
They are called joint operators.
• A joint venture
Here the parties have rights to the net assets of the arrangement.
Those parties are called joint venturers.

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 • Classifying joint arrangements
This depends upon the rights and obligations of the parties to the arrangement.
Regardless of the purpose, structure or form of the arrangement.
A joint arrangement in which the assets and liabilities relating to the arrangement are
held in a separate vehicle can be either a joint venture or a joint operation.
A joint arrangement that is not structured through a separate vehicle is a joint operation.

Financial statements of parties to a joint arrangement

Joint Operations
A joint operator recognises:
• its assets, including its share of any assets held jointly
• its liabilities, including its share of any liabilities incurred jointly
• its revenue from the sale of its share of the output of the joint operation
• its share of the revenue from the sale of the output by the joint operation; and
• its expenses, including its share of any expenses incurred jointly

A joint operator accounts for the assets, liabilities, revenues and expenses relating to its
involvement in a joint operation in accordance with the relevant IFRSs

Illustration
An of ce building is being constructed by A and B, each entitled to half the pro ts
A has invoiced 300 and had costs of 280
B has invoiced 500 and had costs of 420
This shows that total sales are 800, total costs are 700 - so a pro t of 100 needs splitting
50 each.
A is currently showing a pro t of 20, and B of 80. Therefore A now needs to show a
receivable of 30 from B (and B a payable to A).
Revenue should be 400 each, so A needs an extra 100 and costs should be 350 each so
an 70 is required.

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Double entry for A
Dr Receivables 30
Cr Revenue 100
Dr COS 70

If an does not have joint control of a joint operation - it accounts for its interest in the
arrangement in accordance with the above if that party has rights to the assets, and
obligations for the liabilities, relating to the joint operation.

Joint Ventures
The group accounts for this using the equity method (see associates).
(A party that does not have joint control of a joint venture accounts for its interest in the
arrangement in accordance with IFRS 9).

Unrealised pro t on sales with JV - always just the share (e.g. 50%)
• P to JV
- Income Statement
- Increase P’s COS
- SFP
- Decrease P’s RE
- Decrease Investment in JV

• JV to P
- Income Statement
- Decrease “Share of JV PAT”
- Decrease JV’s RE
- Decrease P’s stock

• No Elimination of Receivables and Payables to each other

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 Syllabus D3: Foreign transactions and entities
Syllabus D3a) Evaluate and apply the translation of foreign currency amounts and transactions into
the functional currency and the presentational currency.

Foreign Exchange Single company

Transactions in a single company

This is where a company simples deals with companies abroad (who have a different
currency).

The key thing to remember is that…

ALL EXCHANGE DIFFERENCES TO INCOME STATEMENT

So - a company will buy on credit (or sell) and then pay or receive later. The problem is
that the exchange rate will have moved and caused an exchange difference.

Step 1: Translate at spot rate

Step 2: If there is a creditor/debtor @ y/e - retranslate it (exch gain/loss to I/S)
Step 3: Pay off creditor - exchange gain/loss to I/S

Illustration 1
On 1 July an entity purchased goods from a foreign country for Y$10,000.
On 1 September the goods were paid in full.

The exchange rates were:

1 July $1 = Y$10
1 September $1 = Y$9

Calculate the exchange difference to be included in pro t or loss according to IAS

21 The Effects of Changes in Foreign Exchange Rates.

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Solution
Account for Payables on 1 July: Y$10,000/10 = 1,000
Payment performed on 1 September: Y$10,000 / 9 = 1,111
The Exchange difference: 1,000 - 1,111 = 111 loss

Illustration 2
Maltese Co. buys £100 goods on 1st June (£1:€1.2)
Year End (31/12) payable still outstanding (£1:€1.1)
5th January £100 paid (£1:€1.05)

Solution
Initial Transaction
Dr Purchases 120
Cr Payables 120

Year End
Dr Payables 10
Cr I/S Ex gain 10

On payment
Dr Payables 110
Cr I/S Ex gain 5
Cr Cash 105

Also items revalued to Fair Value will be retranslated at the date of revaluation and the
exchange gain/loss to Income statement.
All foreign monetary balances are also translated at the year end and the differences taken
to the income statement.
This would include receivables, payables, loans etc.

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 Syllabus D3b) Evaluate and apply the principles relating to the consolidation of foreign operations,
including subsidiaries, associates and joint arrangements, and their disposal.

Foreign exchange - subsidiaries

Ok so in the previous section we looked at foreign exchange differences which occur when
an individual company buys/sells at one rate and pays/receives at another. Either that or a
retranslation of a foreign monetary balance.

Now we look at what happens to our CONSOLIDATED accounts when we have a foreign
subsidiary.

Clearly we cannot just add their foreign currency gures to our home currency gures - we
need to translate S rst. We do this using the following rates:

Exchange rates to be used:

Income Statement Average rate
SFP (Assets and Liabs) Closing rate
ALL EXCHANGE DIFFERENCES TO RESERVES
How we actually go about doing this in the exam means a slight adjustment to our group
workings as stated here:

Net Assets Table

At acquisition column Acquisition rate
Year end column Closing rate
The post-acquisition column and hence retained earnings effectively includes the
exchange gains/losses. This should be disclosed separately in the OCI and in Equity.

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 Foreign Exchange Translation Reserve
Remember that actually, by using the rates we have in the equity table, any foreign
exchange differences will end up in the post-acquisition column which we then use for our
retained earnings working. If requested we could calculate the exact amount and take it
out of retained earnings and put it into its own reserve.
This can be calculated as follows:

Translation Reserve

Goodwill
This should be retranslated every year end (closing rate). Any exchange gain/loss to
Equity.

Illustration
Notice rst of all you should calculate goodwill in the FOREIGN CURRENCY. This allows
us to retranslate it whenever we want.

Goodwill (in foreign currency)

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Take this 17,000 and translate it at the acquisition rate at rst.
e.g. 17,000 x 0.5 = $8,500
Now take the 17,000 and translate it at the year-end rate.
e.g. 17,000 x 0.6 = $10,200
The $10,200 is shown in the group SFP and the gain of $1,700 is taken to retained
earnings.

Illustration
Steps
1. Do S only adjustments (in foreign currency)
2. Translate S (using rates above) and do Net Asset Table
3. Do adjustments and workings as normal - but calculate goodwill exchange gain or loss
and add to retained earnings

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P acquired 80% S @ start of year. At Acquisition S’s Land had a FV 4,000 pintos higher
than book value
Proportionate NCI method
Exchange rates (Pinto:$)
Last year end 5.5
This year end 5
Average for year 5.2

Solution
1. Step 1: S only adjustments - none
2. Step 2: Net Asset Table (Acq. @ acq. rate; Year-end @closing rate)

Translate S - all assets and liabilities at closing rate. Income statement at average
rate.

SFP - so far

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Income statement

Step 3 Workings and adjustments as normal

Goodwill

Retranslate at year end:

909 x 5.5/5 1,000
Gain of 91 to retained earnings

NCI

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Retained Earnings

Translation Reserve
NOT NORMALLY REQUIRED IN EXAM

80% of this 381 is taken from RE as this belongs to P.

100% of the goodwill revaluation gain also is an exchange difference 91 and this would
also be taken from the retained earnings.
Giving the retranslation reserve a balance of 396 (80% x 381 + 91).

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Final Answer
Don’t forget to translate all of S’s NA @ closing rate.

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 Foreign currency - extras

Foreign Currency - Examinable Narrative & Miscellaneous points

Functional Currency
Every entity has its own functional currency and measures its results in that currency

Functional currency is the one that:

- in uences sales price
- the one used in the country where most competitors are and where regulations are made
- the one that in uences labour and material costs

If functional currency changes then all items are translated at the exchange rate at the
date of change

Presentation Currency
An entity can present in any currency it chooses.

The foreign sub (with a foreign functional currency) will present normally in the parents
presentation currency and hence the need for foreign sub translation rules!

Foreign currency dealings between H and S

There is often a loan between H and a foreign sub. If the loan is in a foreign currency don’t
forget that this will need retranslating in H’s or S’s (depending on who has the ‘foreign’
loan) own accounts with the difference going to its income statement.

If H sells foreign S, any exchange differences (from translating that sub) in equity are
taken to the income statement (and out of the OCI).

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Deferred tax
There are deferred tax consequences of foreign exchange gains (see tax chapter). This is
because the gains and losses are recognised by H now but will not be dealt with by the
taxman until S is eventually sold.

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 Syllabus E: INTERPRET FINANCIAL
STATEMENTS FOR DIFFERENT
STAKEHOLDERS
Syllabus E1: Analysis and interpretation of financial
information and measurement of performance

Syllabus E1a) Discuss and apply relevant indicators of financial and non- financial
performance including earnings per share and additional performance measures.

Indicators Of (Non) Financial Performance

Analysis is not just calculations!

So remember this is not a baby paper now so…

1. Explaining the ratio is just not enough

2. You need to compare (eg to prior periods or industry averages)
3. Then say what the movement/difference is telling you - by using the scenario - and
what this may mean for the company and its stakeholders
4. Now also consider any non- nancial consequences? (quality, ethics etc)
5. Any transactions/events in the year that had a signi cant impact on ratios
6. Any impact of different accounting policies on ratios? (particularly if comparing to
other entities)

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A Ratio Analysis Technique

1. Always see if the ratio has improved or deteriorated (Not 'increased' or 'decreased')
2. The say why the ratio has improved or deteriorated - here is where you use the
scenario not a textbook!
3. Finally explain the longer term impact on the company and make a
recommendation for action where appropriate.

EPS

PAT / NO. OF SHARES

EPS means nothing on its own
It always needs to be compared over time
Remuneration packages might be linked to EPS growth, so increasing the pressure on
management to improve EPS, and be an inherent ethical risk

Illustration
A company changes its depreciation policy (longer UEL) - in order to reduce depreciation -
and thus increase EPS

Answer
Step 1: State the IFRS knowledge:
An entity should review UEL every year - and any change is a change in accounting
estimate
Changes in accounting estimates only allowed if a result of new information

Step 2: Apply the rule or principle to the scenario

So in the scenario you'd look for things like:
1) Large pro ts on disposals - a result of too short a useful life previously
2) Other evidence of longer UELs on similar assets
3) Buying periods matching the new UEL

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 Step 3: Explain the ethical issues (if you think this is solely to manipulate the
earnings gure)
Threat to objectivity
Also non-compliance with IAS 16 and therefore, contravene the fundamental principle of
professional competence.

Ethics note
So far we only looked at the manipulation of earnings

Other examples could include:

Signi cant sales to related parties and the directors not wanting to disclose details of the
transactions
Directors trying to window dress revenue by offering large incentives to make sales to un-
creditworthy customers or Manipulating estimates to achieve required results.

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 Interpret NFPIs

The use of non- nancial performance indicators are an additional tool to

monitor performance in not-for-pro t organisations.

For example, if the case of a secondary school, some non- nancial performance
indicators about the performance of the school would be:

• The number of pupils taught

• The number of subjects taught per pupil
• How many examination papers are taken
• The pass rate
• The proportion of students which go on to further education

Let’s take a bus service which is non-pro t seeking

In fact, its mission is to provide reliable and affordable public transport to the citizens.
It often involves operating services that would be considered uneconomic by the private
sector bus companies.
Let’s have a look at some non- nancial performance indicators for the public bus service:

Non- nancial performance

Importance
indicator
% of buses on time Punctuality is important to passengers
% of buses cancelled Reliability is important to passengers
Customer rating of cleanliness of
Passengers require good quality service
facilities
% of new customers New customers are vital for sustained growth
Happy employees are vital for success in a service
Employee morale
business

In not-for-pro t organisations, decisions may be taken to improve short-term performance

but may have a negative impact on long-term performance.

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This will have limited bene t to the organisation as it will not convey the full picture
regarding the factors that will drive the achievement of objectives e.g. customer
satisfaction, quality of service.

Results may be manipulated to show a better picture but the effect on stakeholders will be
negative.

Let’s take an example.

The hospital tends to manipulate its results with respect to waiting times for operations.
Obviously, citizens will be disappointed and start losing trust in the organisation.

Example 1

Cowsville is a town with a population of 100,000 people.

The town council of Cowsville operates a bus service which links all parts of the town with
the town centre.

The service is non-pro t seeking and its mission statement is ‘to provide ef cient, reliable
and affordable public transport to all the citizens of Cowsville.’

Attempting to achieve this mission often involves operating services that would be
considered uneconomic by private sector bus companies, due either to the small number
of passengers travelling on some routes or the low fares charged.

The majority of the town council members are happy with this situation as they wish to
reduce traf c congestion and air pollution on Cowsville’s roads by encouraging people to
travel by bus rather than by car.

However, one member of the council has recently criticised the performance of the
Cowsville bus service as compared to those operated by private sector bus companies in
other towns.

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She has produced the following information:

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Operating Statistics for the year ended 31 March 2016

Total passengers carried = 2,400,000 passengers

Total passenger miles travelled = 4,320,000 passenger miles

Private sector bus companies Industry average ratios Year ended 31 March 2016.

Return on capital employed = 10%

Return on sales (net margin) = 30%
Asset turnover =0·33 times
Average cost per passenger mile = 37·4p

Required:

(a) Calculate the following ratios for the Cowsville bus service
(i) Return on capital employed (based upon opening investment);
(ii) Return on sales (net margin);
(iii) Asset turnover;
(iv) Average cost per passenger mile.
(b) Explain the meaning of each ratio you have calculated. Discuss the performance of the
Cowsville bus service using the four ratios.

Solution:
(a) Ratios
Return on Capital employed
Operating Pro t / Capital employed x 100 = 20 / 2,210 x 100 = 0,9%

Return on sales (net margin)

Operating pro t / Sales x 100 = 20 / 1,200 x 100 = 1.7%

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 Asset Turnover
Sales / Capital employed = 1,200 / 2,210 = 0.54 times

Average cost per passenger mile

Operating cost / Passenger miles = 1,180,000 / 4,320,000 = 27.3p

Tutorial Note: the term pro t is used throughout this answer; in the public
sector it would normally be referred to as surplus.

(b) Meaning of each ratio

Return on Capital employed.
This ratio measures the pro ts earned on the long-term nance invested in
the business. The Cowsville bus service is only generating an annual pro t of
0.9p for every £1 invested. The equivalent gure for private bus companies is
10p.

Return on sales.
This ratio measures the pro tability of sales. For the Cowsville bus services
1.7p of every £1 of sales is pro t. The equivalent gure for private bus
companies is 30p.

Asset turnover.
This ratio measures a rm’s ability to generate sales from its capital
employed. The Cowsville bus service generates sale of 54p for every £1 of
capital employed. The equivalent gure for private bus companies is only
33p.

Average cost per passenger mile.

This measures the cost of transporting passengers per mile travelled. The
Cowsville bus service incurs a cost of 27.3p per passenger mile as compared
to 37.4p for private bus companies.

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 Performance of the bus service

On rst sight the Cowsville bus service appears to have performed poorly as compared to
private sector bus companies.

It has a low return on capital employed, largely due to a poor return on sales.

This could be explained by the low fares charged.

On the positive side its ability to generate sales is good and its buses to be more
intensively used than private sector equivalents.

However, if we take into account the objectives of the council and the mission statement of
the bus service it is possible to draw a different conclusion.

Private sector companies usually seek to maximise investor wealth.

The council appears to be trying to encourage usage of public transport in an attempt to

reduce traf c congestion.

To do this it charges low fares, resulting in a poor return on sales and a low return on
capital employed.

However, the low fares, and willingness to operate uneconomic routes has led to a high
asset turnover, implying above industry average usage of the bus service.

In turn this greater usage of the service leads to a lower cost per passenger mile as xed
costs are spread more thinly over a larger number of passenger miles.

Before drawing any rm conclusions it would be sensible to compare the performance of

the Cowsville bus service with that of bus operators pursuing similar objectives.

(Tutorial Note: If we compare average fare per passenger mile we can see that the
Cowsville bus service charges lower fares than the private sector.

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Cowsville fare per passenger mile = passenger fares ÷ passenger miles
= £1,200,000 ÷ 4,320,000 = 27.8p

Private sector = Average cost ÷ (1 - net margin)

= 37.4p ÷ (1 – 0.3) = 53.4p

Cowsville charges lower fares per passenger mile. Which may explain its higher load
factor and therefore its lower cost per passenger mile)

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 Non- nancial reporting

This is concerned with business ethics and accountability to stakeholders

Companies should look after ALL shareholders and be transparent in its dealings with
them when compiling corporate reports.

CSR requires directors to look at the aims and purposes of the company and not assume
pro t to be the only motive for shareholders.

Arrangements should be put in place to ensure that the business is conducted in a

responsible manner.

This includes environmental and social targets, monitoring of these and continuous
improvement.

There is pressure now for companies to show more awareness and concern, not only for
the environment but for the rights and interests of the people they do business with.

Governments have made it clear that directors must consider the short-term and long-term
consequences of their actions, and take into account their relationships with employees
and the impact of the business on the community and the environment.

CSR requires the directors to address strategic issues about the aims, purposes, and
operational methods of the organisation, and some rede nition of the business model that
assumes that pro t motive and shareholder interests de ne the core purpose of the
company.

The reporting of the company's effects on society at large

It expands the traditional role that company´s only provide for the shareholders.

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Why prepare a social report?
1. Build their reputation on it (e.g. body shop)
2. Society expects it (Shell)
3. Long term it will increase pro ts
4. Fear that governments may force it otherwise

How companies interact responsibly with society

• Provide fair pay to employees

• Safe working environment
• Improvements to physical infrastructure in which it operates

Is it against the maximising shareholder wealth principle?

Organisations are rarely controlled by shareholders as most are passive investors.

This means large companies can manipulate markets - so social responsibility is a way of
recognising this, and doing something to prevent it happening from within.

Also, of course, business get help from outside and so owe something back. They bene t
from health, roads, education etc. of the workforce and suppliers and customers.

This social contract means that the companies then take on their own social responsibility

Human Capital Reporting

Sees employees as an asset not an expense and competitive advantage is gained by
employees.

The training, recruitment, retention and development of employees is all part of what would
therefore be reported

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Implications
• People are a resource like any other and so needs to be effectively and ef ciently
managed
• Safeguarding of the asset as normal
• Impairment could mean a simple drop in motivation

HCM reports should:

• Show size of workforce
• Retention rates
• Skills needed for success
• Training
• Remuneration levels
• Succession planning

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 Syllabus E1b) Appraise the impact of environmental, social, and ethical factors on
disclosure.
Syllabus E1d) Discuss the importance of sustainability reporting, integrated reporting and
segmental information to stakeholders.

Environmental, Social, And Ethical Factors On

Performance Measurement

IFRS

No required disclosure requirements for environmental and social matters.

However:

1. Provisions for environmental damage are recognised under IAS 37

2. IAS 1 requires disclosure to a proper understanding of nancial statements.

Voluntary Disclosure

Voluntary disclosure and the publication of environmental reports has now become the
norm for quoted companies in certain countries as a result of pressure from stakeholder
groups to give information about their environmental and social 'footprint'.

The creation of ethical indices has added to this pressure - for example the FTSEA Good
index in the UK, and the Dow Jones Sustainability Group Index in the US.

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Sustainability Reporting

This integrates environmental, social and economic performance data

The most well-known is the Global Reporting Initiative.

The GRI is a long-term, multi-stakeholder, international not-lor-pro t organisation

whose mission is to develop and disseminate globally applicable GRI Standards on
sustainability reporting for voluntary use by organisations

Environmental Reporting

This is the disclosure of environmental responsibilities and activities

Increasing awareness of environmental issues and pressure from non governmental
organisations (NGOs) make this vital to an entity

Social Reporting

This discloses the social impact of a business's activities:

Eg.

Charity donations
Giving employees time to support charities
Employee satisfaction levels and remuneration issues;
Community support; and
Stakeholder consultation information

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 Framework for environmental and sustainability
reporting

The idea here is that everything must be able to continue in the future

We must not use up resources, social or environmental, without replacing them

Any that is not replaced is often termed the social or environmental footprint

Reporting Sustainability

• Voluntary
• Increasingly popular (often put on website too)
• Sometimes called ‘the triple bottom line’ (Pro ts, people and planet)

Environmental Reporting

1. Can be in the published annual report

2. Can be a separate report
3. No mandatory standards to follow
4. Covers inputs (Using up of resources)
5. Covers outputs (Pollution etc.)

Its voluntary basis causes problems:

• Users can disclose the good but not the bad

• No external in uence means less con dence in the report

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 Bene ts of an Environmental Report

• Can highlight inef ciencies

• Identi es opportunities to reduce waste
• Can create a positive image as a good corporate citizen
• Increased consumer con dence in it
• Employees like it
• Investors look for environmental concerns nowadays
• Reduces risk of litigation against it
• Can give competitive edge

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 Demand For Transparency

Transparency in Corporate Reports

Stakeholders are demanding more from entities.

Investors in particular need to know what they are investing in ethically, hence the demand
for transparency in corporate reports. Stakeholders need to understand how an entity does
business.

For example

EU law requires large companies to disclose certain information on the way they operate
and manage social and environmental challenges.

This helps investors, consumers, policy makers and other stakeholders to evaluate the
non- nancial performance of large companies and encourages these companies to
develop a responsible approach to business.

Companies are required to include non- nancial statements in their annual reports from
2018 onwards.

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 Transparency & Non-Financial Standards

This has become more important recently as stakeholders are interested in:

1. Management of business
2. Future prospects
3. Environmental concerns
4. Social responsibility of company

How is this reported…?

• Operating and Financial Review (OFR)
Looks at results and talks about future prospects

• Corporate Governance Report

Looks at how the company is directed and controlled

• Environmental and social report

Looks at the environment and social concerns and the sustainability of these

• Management Commentary
Looks at the trends behind the gures and what is likely to affect future performance
and position

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 Purpose and content of an integrated report

To explain to providers of nancial capital how an organisation creates value

over time.

It bene ts all stakeholders interested in an organisation’s ability to create value over time,
including:

• employees
• customers
• suppliers
• business partners
• local communities
• legislators
• regulators and policy-makers

The ‘building blocks’ of an integrated report are:

• Guiding principles
These underpin the integrated report
They guide the content of the report and how it is presented

• Content elements
These are the key categories of information
They are a series of questions rather than a prescriptive list

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Guiding Principles
• Are you showing an insight into the future strategy..?

• Are you showing a holistic picture of the organisation's ability to create value over
time?
Look at the combination, inter-relatedness and dependencies between the factors
that affect this.

• Are you showing the quality of your stakeholder relationships?

• Are you disclosing information about matters that materially affect your ability to
create value over the short, medium and long term?

• Are you being concise?

Not being burdened by less relevant information.

• Are you showing Reliability, completeness, consistency and comparability when

showing your own ability to create value?

Content Elements
• Organisational overview and external environment
What does the organisation do and what are the circumstances under which it
operates?

• Governance
How does an organisation’s governance structure support its ability to create
value in the short, medium and long term?

• Business model
What is the organisation’s business model?

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• Risks and opportunities
What are the speci c risk and opportunities that affect the organisation’s ability to
create value over the short, medium and long term? And how is the organisation
dealing with them?

• Strategy and resource allocation

Where does the organisation want to go and how does it intend to get there?

• Performance
To what extent has the organisation achieved its strategic objectives for the period
and what are its outcomes in terms of effects on the capitals?

• Outlook
What challenges and uncertainties is the organisation likely to encounter in
pursuing its strategy, and what are the potential implications for its business
model and future performance?

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 Syllabus E1c) Evaluate and explain the principles of reportable segments.

Segmental Reporting (IFRS 8) - Introduction

Objective of IFRS 8

The objective of IFRS 8 is to present information by line of business and by

geographical area.

It applies to plcs and any entity voluntarily providing segment information should
comply with the requirements of the Standard.

So why is it a good thing to have information by line of business and geographical

area?

Well, imagine you are an Apple shareholder.

You will naturally be interested in how well the company is doing.

That information would only make real sense though if it was broken down by business
area.

For example, if most of the pro ts were from i-Pods, then this would be worrying as this
market is in decline.

You would want to know how they are doing in the desktop computer market, how they
are doing in the smartphone and tablet market as well as any new areas they may be
diversifying into.

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 Key De nitions

Business segment (e.g. i-Phone segment):

A component of an entity that

(a) provides a single product or service and

(b) is subject to risks and returns that are different from those of other business
segments.

Geographical segment (e.g. European market):

A component of an entity that

(a) provides products and services and

(b) is subject to risks and returns that are different from those of components
operating in other economic environments.

May be based either on where the entity’s assets are located or on where its customers
are located.

Operating Segment

Engages in business (even if all internal), whose results are regularly reviewed by the
chief operating decision maker and for which separate nancial information is available.

• Earns revenue and incurs expenses from a business activity

• Is regularly reviewed by the chief decision maker when handing out resources

• Has separate nancial info available

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 Therefore the head of ce is not an operating segment as it is not a business activity.
The idea behind the regular review part is that the entity reports on those segments that
are actually used by management to monitor the business

Aggregating Segments

Operating Segments can be aggregated together only if

they have similar economic characteristics such as:

1. Similar product / service

2. Similar production process

3. Similar sort of customer

4. Similar distribution methods

5. Similar regulations

Quantitative Thresholds

Any segment which meets these thresholds must be reported on:

1. Pro t is 10% or more of all pro table segments

2. Assets are 10% or more of the total assets of all operating segments

Reportable Segments

If the total EXTERNAL revenue of the operating segments reported on (meeting the
quantitative thresholds) is less than 75% of total revenue of the company then additional
operating segments results (those not meeting the quantitative thresholds) are reported
upon (until the 75% is met)

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 Illustration

A B C D E Total

External 220 300 75 55 60 710

Revenue

Internal 60 15 5 10 90
Revenue

Pro t 60 50 20 -11 14 133

Assets 5000 4000 300 300 400 10,000

Which of the segments A-E should be reported upon?

A B C D E

280 / 800 = 315 / 800 = 75 / 800 = 60 / 800 = 70 / 800 =

Revenue
35% 39% 9% 7.5% 9%
Test
PASS PASS FAIL FAIL FAIL

60 / 144* = 50 / 144 = 20 / 144 = 14 / 144 =

Pro t Test 42% 35% 14% 9%
PASS PASS PASS FAIL

5,000 / 4,000 / 300 / 300 / 400 /

10,000 = 10,000 = 10,000 = 10,000 = 10,000
Assets Test
50% 40% 3% 3% = 4%
PASS PASS FAIL FAIL FAIL

*Pro table segments only

A, B and C all pass one of the tests and so would be reported on

External Revenue Test

A + B + C = 595 / 710 = 84% PASS (No more segments needed)

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 Disclosures for each segment

Pro t
Total Assets and Liabilities
External Revenues
Internal Revenues
Interest income and expense
Depreciation
Pro t from Associates and JVs
Tax
Other material non-cash items

Measurement

This shall be the same as the one used when reporting to the chief decision maker.
So it is the internal measure rather than an IFRS one

A reconciliation is then provided between this measure and the entity’s actual gures for:
1) Pro t (e.g. Allocation of centrally incurred costs)
2) Assets & Liabilities

Also any asymmetrical allocations.

For example, one segment may be charged depreciation for an asset not allocated to it

IFRS 8 requires the information presented to be the same basis as it is reported internally,
even if the segment information does not comply with IFRS or the accounting policies used
in the consolidated nancial statements.

Examples of such situations include segment information reported on a cash basis (as
opposed to an accruals basis), and reporting on a local GAAP basis for segments that are
comprised of foreign subsidiaries.

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Although the basis of measurement is exible, IFRS 8 requires entities to provide an
explanation of:

1. the basis of accounting for transactions between reportable segments;

2. the nature of any differences between the segments’ reported amounts and the
consolidated totals.

For example, those resulting from differences in accounting policies and policies for the
allocation of centrally incurred costs that are necessary for an understanding of the
reported segment information.

In addition, IFRS 8 requires reconciliations between the segments’ reported amounts and
the consolidated nancial statements.

Entity Wide Disclosures

A. External revenue for each product/service

B. Totals for revenue made at home and abroad
C. NCA totals for those held at home and abroad
D. If 1 customer accounts for 10%+ of revenue this total must be disclosed alongside
which segment it is reported in

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 IFRS 8 Determining Reporting segments

Identifying Business and Geographical Segments

• An entity must look to its organisational structure and internal reporting system to
identify reportable segments.

In fact, the segmentation used for internal reports for the board should be the same
for external reports

• Only if internal segments are not along either product/service or geographical lines is
further disaggregation appropriate.

Primary and Secondary Segments

• For most entities one basis of segmentation is primary and the other is secondary
(with considerably less disclosure required for secondary segments)

• To decide which is primary, the entity should see whether business or geographical
factors most affect the risk and returns.

This should be helped by looking at entity’s internal organisational and management

structure and its system of internal nancial reporting to senior management.

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 Illustration

Product External Internal Pro t Assets Liabilities

Revenue Revenue
The Nose picker 2,000 30 (100) 3,000 2,000
The Earwax extractor 3,000 20 600 8,000 3,000
Other Products 5,000 50 1,050 20,000 14,000

Which segments should be reported upon?

Let’s look at the 3 reportable segment tests:

10% of combined revenue = 1,010
10% of pro ts = 165
10% of losses = 10
10% of assets = 3,100
So,

1. The Nose picker only passes the revenue test, it fails the pro ts test as a loss of
100 is less than 165 (165 is higher than 10), it fails the assets test. It is still a
reportable segment though as only 1 test needs to be passed

2. The Earwax extractor passes all 3 tests

3. Other Products These are not separate segments and can only be added together if
the nature of the products are similar, as are their customer type and distribution
method. So ordinarily these would not be disclosed. However we need to check
whether the 2 reported segments meet the 75% external revenue test:

4. Currently only 5,000 out of 10,000 (50%). Therefore additional operating segments
(other products) may be added until the 75% threshold is reached

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 IFRS 8 Pros and Cons

IFRS 8 follows what we call the “managerial approach” as opposed to the old “risks and
rewards” approach to determining what segments are.

• This has the following advantages:

Cost effective as data can be reported in the same way as it is in the managerial
accounts (though it does need reconciling)

• The segment data re ects the operational strategy of the business

However there are problems also:

• It gives a lot of subjective responsibility to the directors as to what they disclose

• Also the internal nature of how it is reported may actually make it less useful to some
users and lead to problems of comparability

• There is also no de ned measure of pro t/loss in IFRS 8

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 Syllabus E1e) Evaluate the usefulness of management commentary to investors.

IFRS Practice Statement Management Commentary

Objective
To help management present a useful commentary to nancial statements
(The Practice Statement is not an IFRS, so following it is not compulsory)

Scope
Management commentary..
"...provides users with historical explanations of the amounts presented in the nancial
statements.
...an entity's prospects and other information not presented in the nancial statements.
..a basis for understanding management's objectives and its strategies"

Elements of the Commentary

• The nature of the business - including its external environment
• Management's objectives and strategies
• The entity's most signi cant resources, risks and relationships
• The results of operations and prospects
• The critical performance measures and indicators that management uses to evaluate the
entity's performance against stated objectives

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 IFRS Practice Statement Management Commentary

• On 8 December 2010 the IASB issued the IFRS Practice Statement Management
Commentary.

The Practice Statement provides a broad, non-binding framework for the

presentation of management commentary that relates to nancial statements
prepared in accordance with IFRS.
The Practice Statement is not an IFRS. Consequently, entities are not required to
comply with the Practice Statement, unless speci cally required by their jurisdiction.

• Management commentary is a narrative report that provides a context within which

to interpret the nancial position, nancial performance and cash ows of an
entity.

It also provides management with an opportunity to explain its objectives and its
strategies for achieving those objectives.

Management commentary encompasses reporting that jurisdictions may describe

as management’s discussion and analysis (MD&A), operating and nancial review
(OFR), or management’s report.

• Management commentary ful ls an important role by providing users of nancial

statements with a historical and prospective commentary on the entity’s nancial
position, nancial performance and cash ows.

• The Practice Statement permits entities to adapt the information provided to

particular circumstances of their business, including the legal and economic
circumstances of individual jurisdictions.
This exible approach will generate more meaningful disclosure about the most
important resources, risks and relationships that can affect an entity’s value, and
how they are managed.

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Syllabus F: THE IMPACT OF CHANGES
AND POTENTIAL CHANGES IN
ACCOUNTING REGULATION

Syllabus F1. Discussion of issues in financial reporting

Syllabus F1a) Appraise the accounting implications of the adoption of new accounting
standards.

Accounting Implications

Implications of new accounting standards include:

• New accounting policies or changes in existing policies that affect the recognition,
measurement and/or disclosure of items in the nancial statements.

For example, before the issue of IFRS 2 Share-based Payment, share options granted as
remuneration were not expensed or recognised in nancial statements.

• Disclosures on initial application (IAS 8):

- the title of the IFRS Accounting Standard;
- the nature of the change in accounting policy;
- the amount of adjustments, to the extent practicable;
• if retrospective application is impracticable, why that is the case and how and from
when the change in accounting policy has been applied.

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The introduction of a new accounting standard might have signi cant impact on a
company by changing the way in which nancial statements show particular transactions
or events.

Here we look at 1st time adoption of IFRS

An entity’s rst IFRS nancial statements must:

• be transparent for users and comparable over all periods presented

• provide a suitable starting point for IFRS accounting
• be generated at a cost that does not exceed the bene ts

An opening IFRS based SFP (using the same accounting policies as the future IFRS
based FS) is needed at the date of moving to IFRSs.

This is the suitable starting point.

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 The opening IFRS based SFP shall…

1. recognise all assets and liabilities (where IFRSs say they should be recognised)
2. not recognise assets or liabilities (where IFRSs say they should not be recognised)
3. reclassify items (that IFRS say needs reclassi cation)
4. apply IFRSs in measuring all recognised assets and liabilities

Limited exemptions
Where the cost of complying is likely to exceed the bene ts to users of nancial
statements.

Retrospective Application
This is applying IFRS to previous periods - this is restricted if it means management
judgements (about past conditions) are needed when the actual outcome is now in fact
known.

Disclosures
Needed to explain how the transition from previous GAAP to IFRSs affected the entity’s
reported nancial position, nancial performance and cash ows

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 Syllabus F1c) Evaluate and apply one or more existing accounting standards to
contemporary issues such as:
• digital assets
• natural disasters
• climate change
• global events
• going concern.

Digital Assets

Kindly watch the videos on Digital Assets HERE

Effects of a Natural Disaster

Kindly watch the videos on Effects of a Natural Disaster HERE

Effects of a Effects of a Global Event

Kindly watch the videos on Effects of a Natural Disaster HERE

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 Initial Coin Offerings

ICOs are a type of crowdfunding or crowd investing tool conducted entirely on the
blockchain.

Originally, new projects were funded by pre-selling coins to investors.

Entrepreneurs present a whitepaper of the business model and the technical speci cations
of a project before the ICO.

They lay out a timeline for the project and set a target budget where they describe the
future funds spending (marketing, R&D, etc.) as well as coin distribution (how many coins
are they going to keep for themselves, token supply, etc.).

During the crowdfunding campaign, investors purchase coins/tokens with already

established cryptocurrencies like Bitcoin and Ethereum.

As opposed to traditional crowdfunding where the investment is considered to be a

donation or a pre-buy of a product, ICOs give the supporters the possibility of a return of
investment when selling their coin later at a possibly higher price.

ICOs are similar to IPOs only if the token represents a stake in the project.

ICOs could be seen as a mix between a donation, investment or risk capital.

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 Climate change

Refers to long-term shifts in temperatures and weather patterns.

Recently human activities have been the main drivers of climate change, especially due to
the burning of fossil fuels.

Climate change is creating signi cant risks for businesses, both as a result of more regular
and severe weather events, which disrupt operations.

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