M/J 23 QUESTION 3

Question 3
Fernanda Co is the parent company of a group which constructs industrial properties. Fernanda Co is
currently preparing the consolidated financial statements for the year ended 31 December 20X7.
The following exhibits, available on the left-hand side of the screen, provide information relevant to
the question:
1. Roof collapse - describes the potential liability for a section of a roof collapsing which was
constructed by Fernanda Co.
2. Financial instruments - describes the accounting treatment by Fernanda Co of a put option and non-
redeemable preference shares.
3. Cash flow issues - describes the treatment of cash flows on the sale and purchase of subsidiaries.
This information should be used to answer the question requirements within the response option
provided.

Requirements (25 marks)

(a) Discuss the acceptability (Compliance or not) of Fernanda Co’s decision not to record any
liability for the roof collapse (WWD) in the consolidated financial statements for the year
ending 31 December 20X7.
(7 marks)
1. Roof collapse
Fernanda Co is a group which constructs industrial properties. In September 20X7, a section of the
roof of one of the buildings which it had constructed partially collapsed, injuring 10 people.
Production, which was taking place inside the building, had to be stopped. However, no legal
action had been brought against Fernanda Co as at 31 December 20X7, as accident investigators were
still trying to find out the reason for the collapse.
The investigators were assessing the responsibilities of the various parties involved, with the
report expected in February 20X8. (After the DOR)
The extent of the damage and the details of any compensation payments to be made had not as yet
been determined.
Fernanda Co felt that given the current stage of the investigation into the accident, there was no
requirement to record any liability in the consolidated financial statements as at 31 December 20X7,
especially as Fernanda Co felt that any compensation payable would be covered by insurance.
IAS 37 / Meet 3P+1R/ Past event yes / No present obligation ( 31 Dec x7/ Not been sued/No
reliable estimate/ WWD = Compliance with IAS 37, no need to recog prov
Past event = 10 injured/ production has stopped= perhaps possible obligation = disclose at CT
contingent liability.
IAS 37 = reimbursement can only be recognised = virtually certain/ In this case, not even paid/
No Question of reimbursement. No disclosure, nothing is recorded.

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(b) Discuss the acceptability of Fernanda Co’s decisions, in the consolidated financial
statements:
(i) to disclose a contingent liability for the estimated cost of redeeming the put options; and
(4 marks)
Put options
On 1 January 20X7, as a result of a business combination, Fernanda Co has written put options
( right to sell) to purchase the non-controlling interest shareholding in a newly acquired
subsidiary, Runda Co. This means that Fernanda Co would be obliged to purchase the non-
controlling interest shareholdings in the subsidiary if the put options were exercised by the non-
controlling interest shareholders. ( NCI Hold the put option / means right to sell/ Fernanado has
no choice but to purchase NCI share) / IAS 32/ IFRS 9/ Put option = create an financial
obligation to Fernando/ contractual obligation/ result in outflow of cash/ cannot avoid
At 31 December 20X7, Fernanda Co disclosed a contingent liability in the consolidated
financial statements for the estimated cost of redeeming the put options / Not the scope of IAS 37/
Scope of IAS 32= Financial liability= meet the definition of financial liability= recognised in
SOFP

(ii) to record the non-redeemable preference shares as equity (WWD = Wrong = Why?) rather
than a compound financial instrument (Why? Correct treatment).
(6 marks)

Preference shares
In addition, in order to partly fund the purchase of the subsidiary, on 1 January 20X7, Fernanda Co
issued non-redeemable preference shares ( Legal = no obligation , but we need to apply SOF,
IAS 32 = whenever there is Preference share, look at the various right that is attached / conduct
assessment – in order to decide whether it is equity or financial liabiltiy ) and recognised them as
equity instruments in the consolidated financial statements at 31 December 20X7.
IAS 32 = SOF = Clue = CCCOSO (conduct assessment- QI)
The preference shareholders receive an annual fixed cash dividend of 5% ( Critical feature =
cannot avoid this obligation/ mandatory ) and a participating dividend which was 7% of the
ordinary dividend ( If there is profit can participate = equity element). Fernanda Co stated that the
instrument had characteristics of equity capital as it provided for participation in the future
income of the company. ( Compound financial instrument/ IAS 32 = split accounting / IM =

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Liability will be present value of future cash flow/ EQ – residual / SM = Financial liability =
remeasure using ACM / EQ = measure once)
Fernanda Co concluded that compliance with IAS 32 Financial Instruments: Presentation would be so
misleading that it would conflict with the objective of financial statements set out in the Conceptual
Framework. (IAS 1 states that extremely rare cases when compliance of standard conflict with
the objective of preparing the FS – refer screenshot below)/ Not a valid argument as he is
looking at legal form whereas in SOF, it has the feature of liability and equity / must split
Fernanda Co considers the classification of the preference shares to be equity rather than a compound
instrument. (WWD is not in compliance with IAS 32)

(c) In accordance with IAS 7 Statement of Cash Flows:

 explain the importance of and the distinction between classification of cash flows from
investing activities (Company report from investor perspective/ investment in NCA/
information about how company can sustain or earn return in future/ Detail from
investment) and cash flows from financing activities ( Company report from issuer
perspective. How company raise or repay finance through equity capital and borrowed
capital /gauge gearing of the company/ these two activities are not the same / information
can only be relevant if it is separately presented;
 outline the circumstances where cash flows may be reported on a net basis (acquisition of
subsidiary net of cash acquired/ disposal of subsidiary net of cash received/ cash and cash
equivalent / related to and from the same party); and
 discuss the issues with Fernanda Co’s treatment of the cash flows for the year ended 31
December 20X7.
(8 marks)
Cash flow issues
On 31 December 20X7 (year end), Fernanda Co sold its entire holding in a subsidiary company,
Interactive Co (Full disposal / LOC/ Change in SSM/ show the disposal net of cash received =
investing activity). Fernanda Co had loaned $3 million to Interactive Co on 1 April 20X6 and
this remained outstanding after its sale.
As a result, the loan to the former subsidiary was recorded in the consolidated financial
statements at 31 December 20X7 ( not an intercompany loan anymore). Therefore, Fernanda Co

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presented the full amount of the loan as a cash outflow in investing activities in its consolidated
statement of cash flows at that date, despite the fact that there had been no cash movement on the
loan during the period. (In current year, no cash outflow, not an investing activity/ affected cash
flows in prior years/ dispose a subsidiary / dispose the liability/ derecognise the subsidiary. NA/
GW not impaired / NCI
Investing activities showed a cash inflow of $2 million. This was made up of the $10 million cash
received as consideration for the sale of the subsidiary,
less $8 million paid to acquire the shares in a newly acquired subsidiary, Runda Co. ( Cannot net of
cash received from disposal of Interactive with cash paid to acquire another subsidiary call
Runda)
Both appear as separate line items
Disposal of sub net of cash acquired 10-3 = 7m Cash inflow
Acquisition of sub net of cash received = 8m = Cash outflow
Cash and cash equivalents held by Interactive Co at the date of disposal were $3 million.

Exhibits
1. Roof collapse
Fernanda Co is a group which constructs industrial properties. In September 20X7, a section of the
roof of one of the buildings which it had constructed partially collapsed, injuring 10 people.
Production, which was taking place inside the building, had to be stopped. However, no legal
action had been brought against Fernanda Co as at 31 December 20X7, as accident investigators were
still trying to find out the reason for the collapse.
The investigators were assessing the responsibilities of the various parties involved, with the
report expected in February 20X8. The extent of the damage and the details of any compensation
payments to be made had not as yet been determined.
Fernanda Co felt that given the current stage of the investigation into the accident, there was no
requirement to record any liability in the consolidated financial statements as at 31 December 20X7,
especially as Fernanda Co felt that any compensation payable would be covered by insurance.

2. Financial instruments
Put options
On 1 January 20X7, as a result of a business combination, Fernanda Co has written put options to
purchase the non-controlling interest shareholding in a newly acquired subsidiary, Runda Co.
This means that Fernanda Co would be obliged to purchase the non-controlling interest
shareholdings in the subsidiary if the put options were exercised by the non-controlling interest
shareholders. At 31 December 20X7, Fernanda Co disclosed a contingent liability in the
consolidated financial statements for the estimated cost of redeeming the put options.
Preference shares

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In addition, in order to partly fund the purchase of the subsidiary, on 1 January 20X7, Fernanda Co
issued non-redeemable preference shares and recognised them as equity instruments in the
consolidated financial statements at 31 December 20X7.
The preference shareholders receive an annual fixed cash dividend of 5% and a participating dividend
which was 7% of the ordinary dividend. Fernanda Co stated that the instrument had characteristics of
equity capital as it provided for participation in the future income of the company.
Fernanda Co concluded that compliance with IAS 32 Financial Instruments: Presentation would be so
misleading that it would conflict with the objective of financial statements set out in the Conceptual
Framework. Fernanda Co considers the classification of the preference shares to be equity rather than
a compound instrument.
3. Cash flow issues
On 31 December 20X7, Fernanda Co sold its entire holding in a subsidiary company, Interactive Co.
Fernanda Co had loaned $3 million to Interactive Co on 1 April 20X6 and this remained
outstanding after its sale.
As a result, the loan to the former subsidiary was recorded in the consolidated financial
statements at 31 December 20X7. Therefore, Fernanda Co presented the full amount of the loan as a
cash outflow in investing activities in its consolidated statement of cash flows at that date, despite the
fact that there had been no cash movement on the loan during the period.
Investing activities showed a cash inflow of $2 million. This was made up of the $10 million cash
received as consideration for the sale of the subsidiary, less $8 million paid to acquire the shares in a
newly acquired subsidiary, Runda Co.
Cash and cash equivalents held by Interactive Co at the date of disposal were $3 million.

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M/J 23 QUESTION 3
Question 3
Fernanda Co is the parent company of a group which constructs industrial properties. Fernanda Co is
currently preparing the consolidated financial statements for the year ended 31 December 20X7.
The following exhibits, available on the left-hand side of the screen, provide information relevant to
the question:
1. Roof collapse - describes the potential liability for a section of a roof collapsing which was
constructed by Fernanda Co.
2. Financial instruments - describes the accounting treatment by Fernanda Co of a put option and non-
redeemable preference shares.
3. Cash flow issues - describes the treatment of cash flows on the sale and purchase of subsidiaries.
This information should be used to answer the question requirements within the response option
provided.

Requirements (25 marks)

(a) Discuss the acceptability of Fernanda Co’s decision not to record any liability for the roof
collapse in the consolidated financial statements for the year ending 31 December 20X7.
(7 marks)
(b) Discuss the acceptability of Fernanda Co’s decisions, in the consolidated financial
statements:
(i) to disclose a contingent liability for the estimated cost of redeeming the put options; and
(4 marks)
(ii) to record the non-redeemable preference shares as equity rather than a compound financial
instrument.
(6 marks)
(c) In accordance with IAS 7 Statement of Cash Flows:
 explain the importance of and the distinction between classification of cash flows from
investing activities and cash flows from financing activities;
 outline the circumstances where cash flows may be reported on a net basis; and
 discuss the issues with Fernanda Co’s treatment of the cash flows for the year ended 31
December 20X7.
(8 marks)

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Exhibits
1. Roof collapse
Fernanda Co is a group which constructs industrial properties. In September 20X7, a section of the
roof of one of the buildings which it had constructed partially collapsed, injuring 10 people.
Production, which was taking place inside the building, had to be stopped. However, no legal
action had been brought against Fernanda Co as at 31 December 20X7, as accident investigators were
still trying to find out the reason for the collapse.
The investigators were assessing the responsibilities of the various parties involved, with the
report expected in February 20X8. The extent of the damage and the details of any compensation
payments to be made had not as yet been determined.
Fernanda Co felt that given the current stage of the investigation into the accident, there was no
requirement to record any liability in the consolidated financial statements as at 31 December 20X7,
especially as Fernanda Co felt that any compensation payable would be covered by insurance.
(a) Discuss the acceptability of Fernanda Co’s decision not to record any liability for the roof
collapse in the consolidated financial statements for the year ending 31 December 20X7.
(7 marks)

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2. Financial instruments
Put options
On 1 January 20X7, as a result of a business combination, Fernanda Co has written put options to
purchase the non-controlling interest shareholding in a newly acquired subsidiary, Runda Co.
This means that Fernanda Co would be obliged to purchase the non-controlling interest
shareholdings in the subsidiary if the put options were exercised by the non-controlling interest
shareholders. At 31 December 20X7, Fernanda Co disclosed a contingent liability in the
consolidated financial statements for the estimated cost of redeeming the put options.
(b) Discuss the acceptability of Fernanda Co’s decisions, in the consolidated financial
statements:
(i) to disclose a contingent liability for the estimated cost of redeeming the put options; (4 marks)

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Preference shares
In addition, in order to partly fund the purchase of the subsidiary, on 1 January 20X7, Fernanda Co
issued non-redeemable preference shares and recognised them as equity instruments in the
consolidated financial statements at 31 December 20X7.
The preference shareholders receive an annual fixed cash dividend of 5% and a participating dividend
which was 7% of the ordinary dividend. Fernanda Co stated that the instrument had characteristics of
equity capital as it provided for participation in the future income of the company.
Fernanda Co concluded that compliance with IAS 32 Financial Instruments: Presentation would be so
misleading that it would conflict with the objective of financial statements set out in the Conceptual
Framework. Fernanda Co considers the classification of the preference shares to be equity rather than
a compound instrument.
(b) Discuss the acceptability of Fernanda Co’s decisions, in the consolidated financial
statements:
(ii) to record the non-redeemable preference shares as equity rather than a compound financial
instrument. (6 marks)

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3. Cash flow issues
On 31 December 20X7, Fernanda Co sold its entire holding in a subsidiary company, Interactive Co.
Fernanda Co had loaned $3 million to Interactive Co on 1 April 20X6 and this remained
outstanding after its sale.
As a result, the loan to the former subsidiary was recorded in the consolidated financial
statements at 31 December 20X7. Therefore, Fernanda Co presented the full amount of the loan as a
cash outflow in investing activities in its consolidated statement of cash flows at that date, despite the
fact that there had been no cash movement on the loan during the period.
Investing activities showed a cash inflow of $2 million. This was made up of the $10 million cash
received as consideration for the sale of the subsidiary, less $8 million paid to acquire the shares in a
newly acquired subsidiary, Runda Co.
Cash and cash equivalents held by Interactive Co at the date of disposal were $3 million.
(c) In accordance with IAS 7 Statement of Cash Flows:
 explain the importance of and the distinction between classification of cash flows from
investing activities and cash flows from financing activities;
 outline the circumstances where cash flows may be reported on a net basis; and
 discuss the issues with Fernanda Co’s treatment of the cash flows for the year ended 31
December 20X7. (8 MARKS)

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SD 22 – Ques 3
Question 3
Rubul Co is a group which manufactures furniture and is currently preparing its financial
statements for the year ended 31 December 20X7.
The following exhibits, available on the left-hand side of the screen, provide information
relevant to the question:

1. Consignment arrangement - describes the sale and despatch of garden furniture to garden
centres and its inclusion in the financial statements.

2. Provision for tax liability - describes the basis of the calculation of sales and income tax
liabilities for the current and previous years.

3. Historic exchange rate - describes the use of the historic exchange rate which is not
updated to disclose financial statement movements.
This information should be used to answer the question requirements within the response
option provided.
Requirements (25 marks)
a) Explain, in accordance with IFRS 15 Revenue from Contracts with Customers, how the
consignment arrangement should be dealt with in the financial statements of Rubul Co
and explain why the proposed treatment of revenue is not in accordance with IFRS 15.
(7 marks)
Done in the class – to check again

(b) Assess whether Rubul Co should create a provision in accordance with IAS
37 Provisions, Contingent Liabilities and Contingent Assets for its sales tax and income tax
liabilities in the financial statements for the year ended 31 December 20X7.

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Done in the class- to check again
(10 marks)

(c) Discuss:

• the advantages for the users of the financial statements of applying a single
historic fixed exchange rate in the financial statements of Rubul Co; ( Easy to
understand/ misleading as totally eliminate reporting exchange gain or loss/ from
user perspective, they only get actual trading results not affected by exchange
rate movement)

• whether this is acceptable practice under IFRS standards; and (IAS 21, must
translate at spot rate / but if it is not practical, SOPL will be translated at AR or
closing rate/ use presentation currency method = calculate translation gain or
loss = 3 reason/ recognise to CSOCI/ cumulative in translation reserve in equity/
only on disposal = reclassification adjustment)

• whether it would enhance the usefulness of the financial statements if the foreign
exchange gains or losses on Rubul Co’s overseas deposits were recognised in
other comprehensive income. – Part of trading activity = SOPL, but if not
trading activity , then take it to SOCI, more relevant / users will get actual
trading profit not affected by exchange rates/ What is loss in current year =
could become gain in the future/ bypassing the SOPL, will ensure EPS and
ROCE not affected.
(8 marks)

1. Consignment arrangement

Rubul Co provides garden centres with furniture on a consignment basis. Rubul Co retains
legal title to the furniture until they are sold by the garden centre to a customer. The
products are immediately available for sale on delivery to the garden centres. The garden
centre does not have any obligation to pay Rubul Co until a sale to a customer occurs.
Physical possession remains with the garden centre unless the furniture is sold or returned to
Rubul Co. Rubul Co also retains the right to have any unsold furniture returned to them, or to
transfer unsold products to another retailer. Once the garden centre has sold the furniture,
Rubul Co has no further obligations. The garden centres then remit to Rubul Co the sales
proceeds net of their agent’s commission.Rubul Co has decided to include the sales value of
all furniture delivered to and held by garden centres in revenue.

2. Provision for tax liability

Sales tax
Rubul Co has shipped and sold goods in an overseas country for ten years. Rubul Co was
under the impression that the sales in the overseas country are subject to sales tax if

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the company had a physical and economic presence in the country. Rubul Co had
always understood that because it did not have a physical presence in the country, it was
exempt from sales tax. However, the tax law stated that companies were subject to sales tax if
they had a physical or economic presence. Therefore, at 31 December 20X7, Rubul Co has
realised that a liability for sales tax has existed for the previous ten years.

Rubul Co has never collected sales tax or filed sales tax returns in the overseas country.
Rubul Co has never been contacted regarding sales tax by the tax authorities in the overseas
country.
Rubul Co therefore considers that the risk of detection by the taxation authorities is
very low.
However, if the taxation authorities knew about Rubul Co’s activities, it is probable that
Rubul Co would be liable for uncollected sales taxes, interest and penalties.
Rubul Co considers that the tax authorities would settle for an amount less than the full
liability if full disclosure was made as it is ‘widely understood’ that the taxation authority
would look back no more than seven years to determine the amount of sales tax due.
The tax authorities can reclaim any sales tax liability from prior years.

Income tax
On 31 December 20X7, legal proceedings were started against Rubul Co by the tax
authorities in the same overseas country for unpaid income tax. Rubul Co disputes the
fact that it owes income tax as it has always paid this tax on time. Rubul Co considers that
it is just coincidence that these proceedings have commenced and does not relate to the sales
tax issue. Rubul Co considers that there is little chance of the income tax case succeeding. In
any event, Rubul Co considers that it cannot measure any potential income tax liability as in
its opinion none exists.

3. Historic exchange rate

Rubul Co has substantial deposits in currencies other than its functional currency.
It also has a number of overseas subsidiaries where the local currency is used to
prepare the financial statements which are then translated into the presentation currency
under IAS 21 The Effects of Changes in Foreign Exchange Rates.
These countries often suffer fluctuations in exchange rates, so Rubul Co decided to eliminate
the effect of exchange rate differences and presented financial information using a single
historic fixed exchange rate for the translation of the international subsidiaries, which
is not updated between periods.

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MJ 22 – Ques 3
Question 3
Bohai Co trades as a leisure travel group and provides travellers with unique vacations. The
financial year end of the company is 31 December 20X8.

The following exhibits, available on the left-hand side of the screen, provide information
relevant to the question:

1 Impairment test - describes why the directors did not conduct an impairment test at 31
. December 20X8.

2 Deferred tax asset - describes the accounting treatment of deferred tax assets at 1
. January 20X8 and 31 December 20X8.

3 Operating leases - describes the lease and non-lease components of agreements with
. third parties.

Exhibit 1: Impairment test

Bohai Co has a portfolio of global cruise brands and a fleet of over 100 ships. At 31
December 20X8 as a result of a global recession, the directors of Bohai Co assessed whether
there was any indication that its cruise ships may be impaired. The directors concluded that
the ships should be measured at their carrying amount without conducting an impairment test.
The directors had highlighted several factors which were pertinent to this conclusion.

‐ The price-to-book ratio, calculated by dividing the market price per share by the carrying
amount of the net assets per share, was 0·3. The directors were happy with this ratio as it
was similar to other companies in the industry.

‐ There had been no losses from the disposal of surplus ships in 20X8 which were material
in respect of the 20X8 year end financial statements.

‐ There had only been an estimated 2% drop in the market value of the fleet in December
20X8. The directors had not engaged a qualified valuer to estimate the market value of
the fleet and this value was not based upon market transactions.

‐ The cost of fuel for the ships had fallen and there was an increase in demand for cruising
after a significant reduction due to a recession.

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‐ Bohai Co has started negotiations with its creditors to defer payments of its debt into
20X9.

Bohai Co had ignored the fact that several companies in the industry had written
down the carrying amount of their ships during 20X8. This was as a result of many ships,
including Bohai Co’s ships, lying idle as a result of overcapacity due to the recession. Even
though the losses from the total sale of ships in Bohai Co were not material in the financial
statements for the year ended 31 December 20X8, there were several cases where the loss
relating to the disposal of a ship was 40% of the carrying amount of the ship.

The price of a cruise had not increased in two years and therefore conservative income
estimates had been applied in future budgets because of an anticipated delay in the recovery
of the cruise market.

Exhibit 2: Deferred tax asset

Bohai Co applied the expected credit loss (ECL) model in accordance with IFRS 9
Financial Instruments for the first time at 1 January 20X8. As a result, the ECL
model had a negative impact on the opening retained earnings as Bohai Co correctly
applied the impairment model retrospectively. Therefore, a deferred tax asset (DTA) was
recognised of $25 million because of increased tax losses. The recoverability of the DTA
was based upon future budgets.

As at 31 December 20X8, there was a change in the ECL allowance. As a result,

Bohai Co increased the amount of DTAs assessed as recoverable from $25 million to
$30 million and recognised the increase in DTAs of $5 million in profit or loss.

Bohai Co has a subsidiary, Yuyan Co, which has a deferred tax liability of $10
million. Bohai Co has a legally enforceable right to offset its own tax assets and
liabilities but not that of its subsidiary. The directors of Bohai Co have decided that, as
Yuyan Co is located within the same taxation jurisdiction as Bohai Co, they can offset the
deferred tax asset of $30 million against Yuyan Co’s deferred tax liability of $10 million.

Exhibit 3: Operating leases

The business model of Bohai Co also includes the management and refurbishment of
cruise ships. Income is generated by:
(I) leasing cruise ships on operating leases to third parties, normally for a period of five
years; and
(II) managing the cruise ships operations (non-lease element).

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Gross revenue therefore comprises rental income and recharges of operating fees.
Bohai Co bears all costs which occur when the lessee operates the cruise ships and
recharges them to the lessee.
For some operational items such as fuel and food supplies, the lessee can enter into
direct purchase agreements with third parties at each port but the third parties bill Bohai Co
directly as Bohai Co arranges the port facility. In this specific case, Bohai Co then recharges
the costs to the lessee based on the lessee’s consumption of goods plus a management fee.
For other operating costs of the cruise ship such as engine maintenance and cleaning of the
cruise ship, these are billed at a price agreed on the date when the lease is signed.
Bohai Co concluded that it acts as a principal in all of its dealings with the lessee and
recorded all revenue gross.

Requirements
(a) Discuss whether the directors of Bohai Co were correct in not conducting an
impairment test at 31 December 20X8. ( WWD = No Impairment / IAS 36 / Evidence =
Internal and external / impairment test / CV to RA / RA higher of VIU and FV – CTS_
(9 marks)

Exhibit 1: Impairment test

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Bohai Co has a portfolio of global cruise brands and a fleet of over 100 ships. At 31
December 20X8 as a result of a global recession ( there will be market changes =
external evidence), the directors of Bohai Co assessed whether there was any indication that
its cruise ships may be impaired. The directors concluded that the ships should be measured
at their carrying amount without conducting an impairment test. The directors had
highlighted several factors (assess the factors and decide if impairment test or not) which
were pertinent to this conclusion.
‐ The price-to-book ratio, calculated by dividing the market price per share $3 by the
carrying amount of the net assets per share 10, was 0·3. The directors were happy with
this ratio as it was similar to other companies in the industry. ( Follow the standard/
Not industrial norm / NA ( SOFP) = $10/ market only has confidence $3/ evidence
for impairment / external evidence / IAS 36 market capitalisation show lower than
net asset= evidence for impairment)

‐ There had been no losses from the disposal of surplus ships in 20X8 which were material
in respect of the 20X8 year end financial statements. = Seem that RA >CV then no
impair/ but this is because Bohai has ignored 40% drop in sales value/ not a valid
argument

‐ There had only been an estimated 2% drop in the market value (Incorrect as Bohai has
ignored the write down of fleets by other companies) of the fleet in December 20X8.
The directors had not engaged a qualified valuer to estimate the market value of the fleet
and this value was not based upon market transactions. ( FV not in accordance with
IFRS 13 / Not reliable evidence) Even if no qualified valuer , must still base on level
2 , because fleet is non financial asset and it will be based on HABU MP/ but here
used entity specific assumption

‐ The cost of fuel for the ships had fallen and there was an increase in demand for cruising
after a significant reduction due to a recession. ( Market show business is picking and
therefore no evidence)

‐ Bohai Co has started negotiations with its creditors to defer payments of its debt into
20X9. (Bohai has cash flow problem = evidence for impairment/ as it may not meet
its obligation)

Bohai Co had ignored the fact that several companies in the industry had written
down the carrying amount of their ships during 20X8. This was as a result of many ships,
including Bohai Co’s ships, lying idle as a result of overcapacity due to the recession. Even
though the losses from the total sale of ships in Bohai Co were not material in the financial
statements for the year ended 31 December 20X8, there were several cases where the loss
relating to the disposal of a ship was 40% of the carrying amount of the ship.

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The price of a cruise had not increased in two years and therefore conservative income
estimates had been applied in future budgets because of an anticipated delay in the recovery
of the cruise market.( Evidence for impairment / caused by market changes/ external
evidence)

(b) In accordance with IAS 12 Income Taxes, discuss:

• whether it is acceptable for Bohai Co to recognise the additional deferred tax asset
of $5 million in profit or loss rather than equity at 31 December 20X8; and
• whether the deferred tax liability of Yuyan Co of $10 million can be offset against
the deferred tax asset of $30 million of Bohai Co at the same date.
(7 marks)

(c) Explain how Bohai Co should account for the lease and non-lease components of the
cruise ship agreements in accordance with IFRS 15 Revenue from Contracts with
Customers and IFRS 16 Leases.
(9 marks)

Exhibit 3: Operating leases

The business model of Bohai Co also includes the management and refurbishment of
cruise ships. Income is generated by:
(III) leasing cruise ships on operating leases to third parties, normally for a period of five
years; and (Lessor, the rental income must taken to SOPL)
(IV) managing the cruise ships operations (non-lease element).

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Gross revenue therefore comprises rental income and recharges of operating fees.
Bohai Co bears all costs which occur when the lessee operates the cruise ships and
recharges them to the lessee.
For some operational items such as fuel and food supplies, the lessee can enter into
direct purchase agreements with third parties at each port but the third parties bill Bohai Co
directly as Bohai Co arranges the port facility. In this specific case, Bohai Co then recharges
the costs to the lessee based on the lessee’s consumption of goods plus a management fee.(
Bohai is an agent/ commission =revenue)
For other operating costs of the cruise ship such as engine maintenance and cleaning of the
cruise ship, these are billed at a price agreed on the date when the lease is signed ( Bohai is
principal/ revenue = gross amount).
Bohai Co concluded that it acts as a principal in all of its dealings with the lessee and
recorded all revenue gross. ( not comply)

(25 marks)

19
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