ACCA - SBR

Strategic Business Reporting

(INT)

Study Notes
 Contents
Sr# Topics Page #
01 The Conceptual and Regulatory Framework for Financial 01
Reporting
02 Preparation of Financial Statements For Companies IAS 1 11
Presentation of Financial Statements
03 IAS 16 – Property, Plant and Equipment 14
04 IAS 38 - Intangible Assets 21
05 Subsequent Measurement of Intangible Assets 26
06 IAS 36 – Impairment of Assets 28

07 IAS 40-Investment Property 33

08 IAS 2 – Inventories 38
09 IAS 41 – Agriculture 41
10 IAS 23-Borrowing Cost 43
11 IAS-20 Accounting for Government Grants and Disclosure of 45
Government Assistance
12 IAS-8 Accounting Policies, Change in Accounting Estimates 48
and Errors
13 IAS 10 - Events after Reporting Date 52
14 IAS 37 – Provisons, Contingent Liabilities and Contingent 54
Assets
15 IFRS 16 – Leases 59

16 IFRS 15 – Revenue from Contracts with Customers 67

17 IFRS 13 – Fair Value Measurements 74

18 IAS 19 Employee Benefits 79
19 IFRS 2 - Share Based Payments 93
20 IAS 12 – Income Taxes 102
21 IFRS 8 – Operating Segments 118
22 IAS 33 – Earnings per Share 124
23 IFRS 5 – Non-Current Assets Held for Sale and Discontinued 129
Operations
24 Financial Instruments 133
25 IFRS 9 Financial Instruments (Replacement of IAS 39) 136
26 IFRS 7 Financial Instrument Disclosures 147
27 IFRS 10 – Consolidated Financial Statements 148
28 Consolidated Statement of Financial Position 151
29 Consolidated Statement Profit or Loss and Other 156
Comprehensive Income
30 IAS 28 – Investments in Associates 158
31 IFRS 11 – Joint Arrangements 161
32 IFRS 12 Disclosure of Interests in other Entities 165
33 Changes in Group Structures 167
34 IAS 21 – The Effects of Changes in Foreign Exchange Rates 174
35 IAS 7-Statement of Cash Flows 182
36 IAS 24 – Related Party Transactions 190
37 IAS 34-Interim Financial Reporting 194
38 Interpretation of Financial Statements and Ratio Analysis 198
39 Additional/Alternative Performance Measures 211
40 Small and Medium Sized Entities (SMES) 216
41 Specialised, Not-For-Profit and Public Sector Entities 224
42 Exposure Drafts 230
43 Measurement 233
44 Giving Investors What They Need 235
45 The Definition and Disclosure of Capital 238
46 Concepts Of Profit or Loss and Other Comprehensive Income 241
47 What Differentiates Profit or Loss from Other Comprehensive 246
Income?
48 When Does Debt Seem to be Equity? 249
49 Integrated Reporting <IR> 252
50 Current Developments 257
51 Technical Articles 275
52 Code of Ethics 297
The Conceptual & Regulatory Framework SBR Revision Notes

THE CONCEPTUAL AND REGULATORY FRAMEWORK FOR FINANCIAL

REPORTING
CONCEPTUAL FRAMEWORK
The IFRS Framework describes the basic concepts that underlie the preparation and presentation of financial
statements for external users. A conceptual framework can be seen as a statement of generally accepted accounting
principles (GAAP) that form a frame of reference for the evaluation of existing practices and the development of
new ones.

Purpose of framework
It is true to say that the Framework:
 Seeks to ensure that accounting standards have a consistent approach to problem solving and do not represent
a series of ad hoc responses that address accounting problems on a piece meal basis
 Assists the IASB in the development of coherent and consistent accounting standards
 Is not a standard, but rather acts as a guide to the preparers of financial statements to enable them to resolve
accounting issues that are not addressed directly in a standard
 Is an incredibly important and influential document that helps users understand the purpose of, and limitations
of, financial reporting
 Used to be called the Framework for the Preparation and Presentation of Financial Statements
 Is a current issue as it is being revised as a joint project with the IASB's American counterparts the Financial
Accounting Standards Board.

Advantages of a conceptual framework

 Financial statements are more consistent with each other
 Avoids firefighting approach and a has a proactive approach in determining best policy
 Less open to criticism of political/external pressure
 Has a principles based approach
 Some standards may concentrate on effect on statement of financial position; others on statement of profit or
loss

Disadvantages of a conceptual framework

 A single conceptual framework cannot be devised which will suit all users
 Need for a variety of standards for different purposes
 Preparing and implementing standards may still be difficult with a framework

The purpose of financial reporting is to provide useful information as a basis for economic decision making.

CONCEPTUAL FRAMEWORK FOR FINANCIAL REPOTING (Revised - March 2018)

In March 2018, the International Accounting Standards Board (the Board) finished its revision of The Conceptual
Framework for Financial Reporting (the Conceptual Framework) a comprehensive set of concepts for financial
reporting. The Board needed to consider that too many changes to the Conceptual Framework may have knock-on
effects to existing International Financial Reporting Standards (IFRS®). Despite that, the Board has now published a
new version of the Conceptual Framework.
It sets out:

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The Conceptual & Regulatory Framework SBR Revision Notes

 the objective of financial reporting

 the qualitative characteristics of useful financial information
 a description of the reporting entity and its boundary
 definitions of an asset, a liability, equity, income and expenses
 criteria for including assets and liabilities in financial statements (recognition) and guidance on when to
remove them (derecognition)
 measurement bases and guidance on when to use them
 concepts and guidance on presentation and disclosure

Chapter 1 – The objective of general purpose financial reporting

The objective of financial reporting is to provide financial information that is useful to users in making decisions
relating to providing resources to the entity. Users’ decisions involve decisions about buying, selling or holding equity
or debt instruments, providing or settling loans and other forms of credit and voting, or otherwise influencing
management’s actions. To make these decisions, users assess prospects for future net cash inflows to the entity and
management’s stewardship of the entity’s economic resources. To make both these assessments, users need
information about both the entity’s economic resources, claims against the entity and changes in those resources
and claims and how efficiently and effectively management has discharged its responsibilities to use the entity’s
economic resources.

As with any major renovation, all issues, both significant and minor, need to be considered. When considering the
objective of general purpose financial reporting, the Board reintroduced the concept of ‘stewardship’. This is a
relatively minor change and, as many of the respondents to the Discussion Paper highlighted, stewardship is not a
new concept. The importance of stewardship by management is inherent within the existing Conceptual Framework
and within financial reporting, so this statement largely reinforces what already exists.

Chapter 2 – The reporting entity

Qualitative characteristics identify the types of information likely to be most useful to users in making decisions
about the reporting entity on the basis of information in its financial report.

Fundamental qualitative characteristics

 Relevance
Relevant financial information is capable of making a difference in the decisions made by users if it has predictive
value, confirmatory value, or both.
Materiality is an entity-specific aspect of relevance based on the nature or magnitude (or both) of the items to
which the information relates in the context of an individual entity's financial report
 Faithful representation
Information must be complete, neutral and free from material error

Enhancing qualitative characteristics

 Comparability
Comparison with similar information about other entities and with similar information about the same entity
for another period or another date.

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The Conceptual & Regulatory Framework SBR Revision Notes

 Verifiability
It helps to assure users that information represents faithfully the economic phenomena it purports to represent.
Verifiability means that different knowledgeable and independent observers could reach consensus, although
not necessarily complete agreement

 Timeliness
It means that information is available to decision-makers in time to be capable of influencing their decisions.

 Understandability
Classifying, characterising and presenting information clearly and concisely. Information should not be excluded
on the grounds that it may be too complex/difficult for some users to understand

The IFRS framework states that going concern assumption is the basic underlying assumption

Changes in revised framework

Originally, the Board had not planned to make any changes to this chapter, however following many comments
made in responses to the Discussion Paper, there have been some.

Leaving the foundations in place

Primarily, the qualitative characteristics remain unchanged. Relevance and faithful representation remain as the two
fundamental qualitative characteristics. The four enhancing qualitative characteristics continue to be timeliness,
understandability, verifiability and comparability.

Restoring the original features

Whilst the qualitative characteristics remain unchanged, the Board decided to reinstate explicit references to
prudence and substance over form.

Although these two concepts were removed from the 2010 Conceptual Framework, the Board concluded that
substance over form was not a separate component of faithful representation. The Board also decided that, if
financial statements represented a legal form that differed from the economic substance, then they could not result
in a faithful representation.

Whilst that statement is true, the Board felt that the importance of the concept needed to be reinforced and so a
statement has now been included in Chapter 2 that states that faithful representation provides information about
the substance of an economic phenomenon rather than its legal form.

In the 2010 Conceptual Framework, faithful representation was defined as information that was complete, neutral
and free from error. Prudence was not included in the 2010 version of the Conceptual Framework because it was
considered to be inconsistent with neutrality. However, the removal of the term led to confusion and many
respondents to the Board’s Discussion Paper urged for prudence to be reinstated.

Therefore, an explicit reference to prudence has now been included in Chapter 2, stating that ‘prudence is the
exercise of caution when making judgements under conditions of uncertainty’.

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The Conceptual & Regulatory Framework SBR Revision Notes

Issue of asymmetry
As is often the case with projects, making one minor change may lead to others. The problem was that by adding in
the reference to prudence, the Board encountered the further issue of asymmetry.

Many standards, such as International Accounting Standard (IAS®) 37, Provisions, Contingent Liabilities and
Contingent Assets, apply a system of asymmetric prudence. In IAS 37, a probable outflow of economic benefits would
be recognised as a provision, whereas a probable inflow would only be shown as a contingent asset and merely
disclosed in the financial statements. Therefore, two sides in the same court case could have differing accounting
treatments despite the likelihood of the pay-out being identical for either party. Many respondents highlighted this
asymmetric prudence as necessary under some accounting standards and felt that a discussion of the term was
required. Whilst this is true, the Board believes that the Conceptual Framework should not identify asymmetric
prudence as a necessary characteristic of useful financial reporting.

The 2018 Conceptual Framework states that the concept of prudence does not imply a need for asymmetry, such as
the need for more persuasive evidence to support the recognition of assets than liabilities. It has included a
statement that, in financial reporting standards, such asymmetry may sometimes arise as a consequence of requiring
the most useful information.

Chapter 3 – Financial statements and the reporting entity

This chapter describes the objective and scope of financial statements and provides a description of the reporting
entity.

A reporting entity is an entity that is required, or chooses, to prepare financial statements. It can be a single entity
or a portion of an entity or can comprise more than one entity. A reporting entity is not necessarily a legal entity.

Determining the appropriate boundary of a reporting entity is driven by the information needs of the primary users
of the reporting entity’s financial statements.

Since the inception of the Conceptual Framework, the chapter on the reporting entity has been classified as ‘to be
added’. Finally, this addition has been made.

This addition relates to the description and boundary of a reporting entity. The Board has proposed the description
of a reporting entity as: an entity that chooses or is required to prepare general purpose financial statements.

This is a minor terminology change and not one that many examiners could have much enthusiasm for. Therefore,
it is unlikely to feature in many professional accounting exams.

Chapter 4 – The elements of financial statements

As part of this project, the Board has changed the definitions of assets and liabilities. To casual observers, it may
seem like some of these changes are the decorative equivalent of ‘repainting cream walls as magnolia’, but to some
accountants it can feel like a seismic change.

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The Conceptual & Regulatory Framework SBR Revision Notes

The changes to the definitions of assets and liabilities can be seen below.
2010 definition 2018 definition Supporting concept
Asset (of an entity) A resource controlled by A present economic
the entity as a result of resource controlled by the
past events and from entity as a result of past
which future economic events.
benefits are expected to
flow to the entity.
Economic resource A right that has the
potential to produce
economic benefits
Liability (of an entity) A present obligation of A present obligation of An entity’s obligation to
the entity arising from the entity to transfer an transfer and economic
past events, the economic resource as a resource must have the
settlement of which is result of past events. potential to require the
expected to result in an entity to transfer an
outflow from the entity of economic resource to
resources embodying another party.
economic benefits.
Obligation A duty of responsibility
that an entity has no
practical ability to avoid

The Board has therefore changed the definitions of assets and liabilities. Whilst the concept of ‘control’ remains for
assets and ‘present obligation’ for liabilities, the key change is that the term ‘expected’ has been replaced. For assets,
‘expected economic benefits’ has been replaced with ‘the potential to produce economic benefits’. For liabilities,
the ‘expected outflow of economic benefits’ has been replaced with the ‘potential to require the entity to transfer
economic resources’.

The reason for this change is that some people interpret the term ‘expected’ to mean that an item can only be an
asset or liability if some minimum threshold were exceeded. As no such interpretation has been applied by the Board
in setting recent IFRS Standards, this definition has been altered in an attempt to bring clarity.

The Board has acknowledged that some IFRS Standards do include a probability criterion for recognising assets and
liabilities. For example, IAS 37 Provisions, Contingent Liabilities and Contingent Assets states that a provision can
only be recorded if there is a probable outflow of economic benefits, while IAS 38 Intangible Assets highlights that
for development costs to be recognised there must be a probability that economic benefits will arise from the
development.

The proposed change to the definition of assets and liabilities will leave these unaffected. The Board has explained
that these standards don’t rely on an argument that items fail to meet the definition of an asset or liability. Instead,
these standards include probable inflows or outflows as a criterion for recognition. The Board believes that this
uncertainty is best dealt with in the recognition or measurement of items, rather than in the definition of assets or
liabilities.

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The Conceptual & Regulatory Framework SBR Revision Notes

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

Definitions of the elements relating to performance

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

Expense
Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of
assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to
equity participants.

Chapter 5 – Recognition and derecognition

In terms of recognition, the current framework specifies three recognition criteria that apply to all assets and
liabilities:
 The item meets the definition of an asset or liability;
 It is probable that any future economic benefit associated with the asset or liability will flow to or from the
entity; and
 The asset or liability has a cost or value that can be measured reliably.

The IASB has confirmed the new approach to recognition, which requires decisions to be made by reference to the
qualitative characteristics of financial information. The IASB has tentatively confirmed that an entity recognises an
asset or a liability (and any related income, expense or changes in equity) if such recognition provides users of
financial statements with:
 Relevant information about the asset or the liability and about any income, expenses or changes in equity;
 A faithful representation of the asset or liability and of any income, expenses or changes in equity; and
 Information that results in benefits exceeding the cost of providing that information.

A key change to this is the removal of a ‘probability criterion’. This has been removed as different financial reporting
standards apply different criterion; for example, some apply probable, some virtually certain and some reasonably
possible. This also means that it will not specifically prohibit the recognition of assets or liabilities with a low
probability of an inflow or outflow of economic resources.

This is potentially controversial, and the 2018 Conceptual Framework addresses this specifically in chapter 5;
paragraph 15 states that ‘an asset or liability can exist even if the probability of an inflow or outflow of economic
benefits is low’.

The key point here relates to relevance. If the probability of the event is low, this may not be the most relevant
information. The most relevant information may be about the potential magnitude of the item, the possible timing
and the factors affecting the probability.

Even stating all of this, the Conceptual Framework acknowledges that the most likely location for items such as this
is to be included within the notes to the financial statements.

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The Conceptual & Regulatory Framework SBR Revision Notes

Finally, a major change in chapter 5 relates to derecognition. This is an area not previously addressed by the
Conceptual Framework but the 2018 Conceptual Framework states that derecognition should aim to represent
faithfully both:
a) the assets and liabilities retained after the transaction or other event that led to the derecognition (including
any asset or liability acquired, incurred or created as part of the transaction or other event); and
b) the change in the entity’s assets and liabilities as a result of that transaction or other event.

Chapter 6 – Measurement
The 2010 version of the Conceptual Framework did not contain a separate section on measurement bases as it was
previously felt that this was unnecessary. However, when presented with the opportunity of re-drafting the
Conceptual Framework, some additions which are helpful and practical may be considered, even if we have
previously managed without them.

In the 2010 Framework, there were a brief few paragraphs that outlined possible measurement bases, but this was
limited in detail. In the 2018 version, there is an entire section devoted to the measurement of elements in the
financial statements.

The first of the measurement bases discussed is historical cost. The accounting treatment of this is unchanged, but
the Conceptual Framework now explains that the carrying amount of non-financial items held at historical cost
should be adjusted over time to reflect the usage (in the form of depreciation or amortisation). Alternatively, the
carrying amount can be adjusted to reflect that the historical cost is no longer recoverable (impairment). Financial
items held at historical cost should reflect subsequent changes such as interest and payments, following the principle
often referred to as amortised cost.

The 2018 Conceptual Framework also describes three measurements of current value: fair value, value in use (or
fulfilment value for liabilities) and current cost.

Fair value continues to be defined as the price in an orderly transaction between market participants.

Value in use (or fulfilment value) is defined as an entity-specific value, and remains as the present value of the cash
flows that an entity expects to derive from the continuing use of an asset and its ultimate disposal.

Current cost is different from fair value and value in use, as current cost is an entry value. This looks at the value in
which the entity would acquire the asset (or incur the liability) at current market prices, whereas fair value and value
in use are exit values, focusing on the values which will be gained from the item.

In addition to outlining these measurement bases, the Conceptual Framework discusses these in the light of the
qualitative characteristics of financial information. However, it stops short of recommending the bases under which
items should be carried, but gives some guidance in the form of examples to show where certain bases may be more
relevant.

The factors to be considered when selecting a measurement basis are relevance and faithful representation,
because the aim is to provide information that is useful to investors, lenders and other creditors.

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The Conceptual & Regulatory Framework SBR Revision Notes

Relevance is a key issue here. The 2018 Conceptual Framework discusses that historical cost may not provide
relevant information about assets held for a long period of time, and are certainly unlikely to provide relevant
information about derivatives. In both cases, it is likely that some variation of current value will be used to provide
more predictive information to users.

Conversely, the Conceptual Framework suggests that fair value may not be relevant if items are held solely for use
or to collect contractual cash flows. Alongside this, the Conceptual Framework specifically mentions items used in a
combination to generate cash flows by producing goods or services to customers. As these items are unlikely to be
able to be sold separately without penalising the activities, a cost-based measure is likely to provide more relevant
information, as the cost is compared to the margin made on sales.

Chapter 7 – Presentation and disclosure

This is a new section, containing the principles relating to how items should be presented and disclosed.

The first of these principles is that income and expenses should be included in the statement of profit or loss unless
relevance or faithful representation would be enhanced by including a change in the current value of an asset or a
liability in OCI.

The second of these relates to the recycling of items in OCI into profit or loss. IAS 1 Presentation of Financial
Statements suggests that these should be disclosed as items to be reclassified into profit or loss, or not reclassified.
The recycling of OCI is contentious and some commenters argue that all OCI items should be recycled. Others argue
that OCI items should never be recycled, whilst some argue that only some items should be recycled. Sometimes the
best way forward on a project isn’t necessarily to seek the wisdom of crowds.

Luckily, the Board has managed to find a middle ground on recycling. The 2018 Conceptual Framework now contains
a statement that income and expenses included in OCI are recycled when doing so would enhance the relevance or
faithful representation of the information. OCI may not be recycled if there is no clear basis for identifying the period
in which recycling should occur.

FINACIAL AND PHYSICAL CAPITAL MAINTENANCE

The IASB Conceptual Framework identifies two concepts of capital:
1. A financial concept of capital
2. A physical concept of capital

Financial capital maintenance

A financial concept of capital is whereby the capital of the entity is linked to the net assets, which is the equity of
the entity.

When a financial concept of capital is used, a profit is earned only if the financial amount of the net assets at the end
of the period is greater than the net assets at the beginning of the period, adjusted for any distributions paid to the
owners during the period, or any equity capital raised.

The main concern of the users of the financial statements is with the maintenance of the financial capital of the
entity.

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The Conceptual & Regulatory Framework SBR Revision Notes

Assets – Liabilities = Equity

Opening equity (net assets) + Profit – Distributions = Closing equity (net assets)

Physical capital maintenance

A physical concept of capital is one where the capital of an entity is regarded as its production capacity, which could
be based on its units of output.

When a physical concept of capital is used, a profit is earned only if the physical production capacity (or operating
capability) of the entity at the end of the period is greater than the production capacity at the beginning of the
period, adjusted for any distributions paid to the owners during the period, or any equity capital raised.

HISTORICAL COST ACCOUNTING

The application of historical cost accounting means that assets are recorded at the amount they originally cost, and
liabilities are recorded at the proceeds received in exchange for the obligation.

Advantages
 Simple to understand
 Figures are objective, reliable and verifiable
 Results in comparable financial statements
 There is less possibility for manipulation by using 'creative accounting' in asset valuation.

Disadvantages
 The carrying value of assets is often substantially different to market value
 No account is taken of inflation meaning that profits are overstated and assets understated
 Financial capital is maintained but not physical capital
 Ratios like Return on capital employed are distorted
 It does not measure any gain/loss of inflation on monetary items arising from the impact
 Comparability of figures is not accurate as past figures are not restated for the effects of inflation

STANDARD SETTING PROCESS

The due process for developing an IFRS comprises of six stages:
1. Setting the agenda
2. Planning the project
3. Development and publication of Discussion Paper
4. Development and publication of Exposure Draft
5. Development and publication of an IFRS Standard
6. Procedures after a Standard is issued

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The Conceptual & Regulatory Framework SBR Revision Notes

REGULATORY FRAMEWORK

International Financial Reporting Standards Foundation (IFRS Foundation)

Responsible for governance of standard setting process. It oversees, funds, appoints and monitors the operational
effectiveness of:

IFRS Advisory Council International Accounting International Financial Reporting

(IFRS AC) Standards Board (IASB) Standards Interpretations
Provide advice to IASB  Develop new Committee (IFRS IC)
on: accounting standards  Assist the IASB to establish and
 their agenda and work  Liaise with national improve
prioritization standard-setting bodies standards
 the impact of to promote  Issues Interpretations
proposed standards convergence of (known as IFRICs) which provide
 Provides strategic international and timely guidance on emerging
advice national accounting accounting issues not addressed
standards in full standards
 Assist in the
international/national
convergence process

PRINCIPLES VS RULES-BASED APPROACH

Rules-based accounting system
 Likely to be very descriptive
 Relies on a series of detailed rules or accounting requirements that prescribe how financial statements should
be prepared
 Considered less flexible, but often more comparable and consistent, than a principles-based system
 Can lead to looking for ‘loopholes’

Principles-based accounting system

 It relies on generally accepted accounting principles that are conceptually based and are normally underpinned
by a set of key objectives
 More flexible than a rules-based system
 Require judgment and interpretation which could lead to inconsistencies between reporting entities and can
sometimes lead to the manipulation of financial statements

Because IFRSs are based on The Conceptual Framework for Financial Reporting, they are often regarded as being a
principles-based system.

pg. 10
IAS 1 SBR Revision Notes

PREPARATION OF FINANCIAL STATEMENTS FOR COMPANIES

IAS 1 PRESENTATION OF FINANCIAL STATEMENTS

A complete set of financial statements comprises:

 A statement of financial position
 A statement of profit or loss and other comprehensive income
 A statement of changes in equity
 A statement of cash flows
 Accounting policies and explanatory notes

The statement of financial position

A recommended format is as follows:
XYZ Co. Statement of Financial Position as at 31 December 20X9
Assets $ $
Non-current assets:
Property, plant and equipment X
Intangible assets X
X
Current assets:
Inventories X
Trade receivables X
Cash and cash equivalents X
X
Total assets X
Equity and liabilities
Capital and reserves:
Share capital X
Share premium X
Revaluation reserve X
Retained earnings X
Other components of equity X
X
Total equity X
Non-current liabilities:
Long-term borrowings X
Deferred tax X
X
Current liabilities:
Trade and other payables X
Short-term borrowings X
Current tax payable X
Short-term provisions X
X
Total equity and liabilities X

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IAS 1 SBR Revision Notes

Current assets include all items which:

 Will be settled within 12 months of the reporting date, or
 Are part of the entity's normal operating cycle.

Within the capital and reserves section of the statement of financial position, other components of equity include:
 Revaluation reserve
 General reserve

STATEMENT OF CHANGES IN EQUITY

The statement of changes in equity provides a summary of all changes in equity arising from transactions with
owners in their capacity as owners.

This includes the effect of share issues and dividends.

XYZ Group
Statement of changes in equity for the year ended 31 December 20X9

Share Share Revaluation Retained Total

capital premium surplus earnings equity
$ $ $ $ $
Balance at 31 December 20X8 X X X X X
Change in accounting policy (X) (X)
__ __ __ __
Restated balance X X X X X
Dividends (X) (X)
Issue of share capital X X X
Total Comprehensive income for X X X
the year
Transfer to retained earnings (X) X -
__ __ __ __
Balance at 31 December 20X9 X X X X X

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IAS 1 SBR Revision Notes

STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME

A recommended format for the statement of profit or loss and other comprehensive income is as follows:

XYZ Group
Statement of profit or loss and other comprehensive income
For the year ended 31 December 20X9
$
Revenue X
Cost of sales (X)
Gross profit X
Distribution costs (X)
Administrative expenses (X)
Profit from operations X
Finance costs (X)
Profit before tax X
Income tax expense (X)
Net Profit for the period X

$
Profit for the year X
Other comprehensive income
Gain on property revaluation X
Income tax relating to components of other comprehensive income (X)

Other comprehensive income for the year, net of tax X

Total comprehensive income for the year X

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 IAS 16 SBR Revision Notes

IAS 16 – PROPERTY, PLANT AND EQUIPMENT

OBJECTIVE:
The objective of IAS 16 is to prescribe the accounting treatment for property, plant, and equipment.

DEFINITIONS:
Property plant and equipment are intangible assets that:
 Are held for use in the production or supply of goods or services ,for rental to others, or for administrative
purposes; and
 Are expected to be used during more than one year.

Carrying amount is the amount at which an asset is recognized after deducting any accumulated depreciation and
accumulated impairment losses

Depreciation is systematic allocation of the depreciable amount of assets over its useful life.

Depreciable amount is the cost of an asset less its residual value.

Residual Value is the estimated amount that an entity can obtain when disposing of an asset after its useful life has
ended. When doing this the estimated costs of disposing of the asset should be deducted.

There are essentially four key areas when accounting for property, plant and equipment:
 Initial recognition and measurement
 Depreciation
 Revaluation
 Derecognition (disposals).

RECOGNITION CRITERIA
PPE are recognized if
 It is probable that future economic benefits associated with the item will flow to the entity; and
 The cost of the item can be measured reliably.

Note: This criteria is applicable for both initial and subsequent recognition.

Aggregation and segmenting This IAS does not provide what constitute an item of property, plant and equipment
and judgment is required in applying the recognition criteria to specific circumstances or types of enterprise. That
is: -
i. It may be appropriate to aggregate individually insignificant items, such as moulds, tools dies, etc.
ii. It may be appropriate to allocate total expenditure on an asset to its component parts and
iii. account for each component separately e.g. an aircraft and its engines, parts of a furnace.

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IAS 16 SBR Revision Notes

MEASUREMENT CRITERIA
Initial measurement:
PPE are initially recognized at the cost.

Elements of costs comprise:

 Its purchase price
 Any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable
of operating,
 The initial estimate of the costs of dismantling and removing the item and restoring the site on which it is
located. The present value of dismantling cost will be added to the cost of asset and provision will be created
and the company will have to unwind this provision at every year end. The amount will be recognized in
statement of profit or loss as finance cost and provision will be increased in statement of financial position. This
treatment is as the accounting for provision as per IAS 37, Provisions, Contingent Assets and Liabilities
 Directly attributable cost of bringing the assets to the location and condition necessary for the intended
performance, e.g.
 Costs of employees benefits arising directly from the construction or acquisition of property, plant and
equipment
 The cost of site preparation
 Initial delivery and handling costs
 Installation costs
 Cost of testing whether the asset is functioning properly after the net proceeds from the sale of any trial
production (samples produced while testing equipment)
 Professional fees (architects, engineers)
 Borrowing costs in accordance with IAS 23, Borrowing Costs.

Where these costs are incurred over a period of time (such as employee benefits), the period for which the costs
can be included in the cost of PPE ends when the asset is ready for use, even if the asset is not brought into use until
a later date. As soon as an asset is capable of operating it is ready for use. The fact that it may not operate at normal
levels immediately, because demand has not yet built up, does not justify further capitalisation of costs in this period.
Any abnormal costs (for example, wasted material) cannot be included in the cost of PPE.

IAS 16 does not specifically address the issue of whether borrowing costs associated with the financing of a
constructed asset can be regarded as a directly attributable cost of construction. This issue is addressed in IAS 23,
Borrowing Costs. IAS 23 requires the inclusion of borrowing costs as part of the cost of constructing the asset. In
order to be consistent with the treatment of ‘other costs’, only those finance costs that would have been avoided if
the asset had not been constructed are eligible for inclusion. If the entity has borrowed funds specifically to finance
the construction of an asset, then the amount to be capitalised is the actual finance costs incurred. Where the
borrowings form part of the general borrowing of the entity, then a capitalisation rate that represents the weighted
average borrowing rate of the entity should be used. (IAS 23 discussed in detail later)

pg. 15
IAS 16 SBR Revision Notes

The cost of the asset will include the best available estimate of the costs of dismantling and removing the item and
restoring the site on which it is located, where the entity has incurred an obligation to incur such costs by the date
on which the cost is initially established. This is a component of cost to the extent that it is recognised as a provision
under IAS 37, Provisions, Contingent Liabilities and Contingent Assets. In accordance with the principles of IAS 37,
the amount to be capitalised in such circumstances would be the amount of foreseeable expenditure appropriately
discounted where the effect is material.

Measurement of self-constructed and exchanged assets

 Cost of self-constructed assets will be the cost of its production
 If an asset is exchanged, the cost will be measured at the fair value unless
(a) The exchange transaction lacks commercial substance or
(b) The fair value of neither the asset received nor the asset given up is reliably measurable. If the acquired
item is not measured at fair value, its cost is measured at the carrying amount of the asset given up.

SUBSEQUENT COSTS (SUBSEQUENT RECOGNITION)

Once an item of PPE has been recognised and capitalised in the financial statements, a company may incur further
costs on that asset in the future. IAS 16 requires that subsequent costs should be capitalised if:
 it is probable that future economic benefits associated with the extra costs will flow to the entity
 The cost of the item can be reliably measured.

All other subsequent costs should be recognised as an expense in the statement of profit or loss in the period that
they are incurred.

MEASUREMENT SUBSEQUENT TO INITIAL RECOGNITION:

IAS 16 permits two accounting models:
 Cost Model
 Revaluation Model
Under both models, the assets are reflected in statement of financial position at carrying value.

Carrying value:
Amount at which the asset is recognised after deducting any accumulated depreciation and accumulated
impairment losses.

DEPRECIATION OF PPE
IAS 16 defines depreciation as ‘the systematic allocation of the depreciable amount of an asset over its useful life’.
‘Depreciable amount’ is the cost of an asset, cost less residual value, or other amount.

Depreciation is not providing for loss of value of an asset, but is an accrual technique that allocates the depreciable
amount to the periods expected to benefit from the asset. Therefore assets that are increasing in value still need to
be depreciated.

The depreciation method used should reflect the pattern in which the asset's economic benefits are consumed by
the entity; a depreciation method that is based on revenue that is generated by an activity that includes the use of
an asset is not appropriate.

pg. 16
IAS 16 SBR Revision Notes

IAS 16 requires that depreciation should be recognised as an expense in the statement of profit or loss, unless it is
permitted to be included in the carrying amount of another asset.

Depreciation begins when the asset is available for use and continues until the asset is derecognised, even if it is
idle.

Depreciation methods
A number of methods can be used to allocate depreciation to specific accounting periods. Two of the more common
methods, specifically mentioned in IAS 16, are the straight line method, and the reducing (or diminishing) balance
method.
 Straight line
% on cost, or
Cost – residual value
Useful economic life

 Reducing balance
% on carrying value

Useful economic lives and residual value

The assessments of the useful life (UL) and residual value (RV) of an asset are extremely subjective. They will only be
known for certain after the asset is sold or scrapped, and this is too late for the purpose of computing annual
depreciation. Therefore, IAS 16 requires that the estimates should be reviewed at the end of each reporting period.
If either changes significantly, then that change should be accounted for over the remaining estimated useful
economic life.

Component depreciation
If an asset comprises two or more major components with different economic lives, then each component should
be accounted for separately for depreciation purposes and depreciated over its own useful economic life.

Impairment:
An item of PPE shall not be carried at more than recoverable amount. Recoverable amount is the higher of an asset's
fair value less costs to sell and its value in use (Discussed in detail later).

MODELS FOR SUBSEQUENT MEASUREMENT

Cost Model
The asset is carried at cost less accumulated depreciation and impairment.

Revaluation Model
The asset is carried at a revalued amount, being its fair value at the date of revaluation less subsequent depreciation
and impairment, provided that fair value can be measured reliably.

The change from cost model to revaluation model is a change in accounting policy but is dealt with prospectively.

pg. 17
IAS 16 SBR Revision Notes

REVALUATION MODEL
If the revaluation policy is adopted this should be applied to all assets in the entire category, i.e. if you revalue a
building, you must revalue all land and buildings in that class of asset. Revaluations must also be carried out with
sufficient regularity so that the carrying amount does not differ materially from that which would be determined
using fair value.

 Revalued assets are depreciated in the same way as under the cost model.

Accounting for a revaluation

There are a series of accounting adjustments that must be undertaken when revaluing a non-current asset. These
adjustments are indicated below.

The initial revaluation

You may find it useful in the exam to first determine if there is a gain or loss on the revaluation with a simple
calculation to compare:
Carrying value of non-current asset at revaluation date X
Valuation of non-current asset X
Difference = gain or loss revaluation X

Gain on revaluation should be credited to other comprehensive income and accumulated in equity under the
heading "revaluation surplus" unless it represents the reversal of a revaluation decrease of the same asset previously
recognized as an expense, in which case it should be recognized as income.

Double entry:
 Dr Non-current asset cost (difference between valuation and original cost/valuation)
 Dr Accumulated depreciation (with any historical cost accumulated depreciation)
 Cr Revaluation reserve (gain on revaluation)

A loss on revaluation should be recognized as an expense to the extent that it exceeds any amount previously
credited to the revaluation surplus relating to the same asset.

A revaluation loss should be charged against any related revaluation surplus to the extent that the decrease does
not exceed the amount held in the revaluation reserve in respect of the same asset. Any additional loss must be
charged as an expense in the income statement.
Double entry:
 Dr Revaluation reserve (to maximum of original gain)
 Dr Statement of profit or loss (any residual loss)
 Cr Non-current asset (loss on revaluation)

Depreciation
The asset must continue to be depreciated following the revaluation. However, now that the asset has been revalued
the depreciable amount has changed. In simple terms the revalued amount should be depreciated over the assets
remaining useful economic life.

pg. 18
IAS 16 SBR Revision Notes

Reserves transfer
The depreciation charge on the revalued asset will be different to the depreciation that would have been charged
based on the historical cost of the asset. As a result of this, IAS 16 permits a transfer to be made of an amount equal
to the excess depreciation from the revaluation reserve to retained earnings.

Double entry: Dr Revaluation reserve Cr Retained earnings

This movement in reserves should also be disclosed in the statement of changes in equity.

Exam focus
In the exam make sure you pay attention to the date that the revaluation takes place. If the revaluation takes place
at the start of the year then the revaluation should be accounted for immediately and depreciation should be
charged in accordance with the rule above.

If however the revaluation takes place at the year-end then the asset would be depreciated for a full 12 months first
based on the original depreciation of that asset. This will enable the carrying amount of the asset to be known at the
revaluation date, at which point the revaluation can be accounted for.

A further situation may arise if the examiner states that the revaluation takes place mid-way through the year. If this
were to happen the carrying amount would need to be found at the date of revaluation, and therefore the asset
would be depreciated based on the original depreciation for the period up until revaluation, then the revaluation
will take place and be accounted for. Once the asset has been revalued you will need to consider the last period of
depreciation. This will be found based upon the revaluation rules (depreciate the revalued amount over remaining
useful economic life). This will be the most complicated situation and you must ensure that your working is clearly
structured for this; i.e. depreciate for first period based on old depreciation, revalue, then depreciate last period
based on new depreciation rule for revalued assets.

DERECOGNITION
Property, plant and equipment should be derecognised when it is no longer expected to generate future economic
benefit or when it is disposed of.

When property, plant and equipment is to be derecognised, a gain or loss on disposal is to be calculated. This can
be found by comparing the difference between:

Carrying value X
Disposal proceeds X
Profit or loss on disposal X

When the disposal proceeds are greater than the carrying value there is a profit on disposal and when the disposal
proceeds are less than the carrying value there is a loss on disposal.

Remove the asset from statement of financial position when disposed of or abandoned. Recognize any resulting gain
or loss in the statement of profit or loss.

pg. 19
IAS 16 SBR Revision Notes

Disposal of previously revalued assets

When an asset is disposed of that has previously been revalued, a profit or loss on disposal is to be calculated (as
above). Any remaining surplus on the revaluation reserve is now considered to be a ‘realised’ gain and therefore
should be transferred to retained earnings as:
 Dr Revaluation reserve
 Cr Retained earnings

pg. 20
IAS 38 SBR Revision Notes

IAS 38 - INTANGIBLE ASSETS

OBJECTIVE
The objective of this IAS is to prescribe accounting treatment for intangible assets that are not dealt with specifically
in another IFRS.

INTANGIBLE ASSET - DEFINITION

An intangible asset is an identifiable non-monetary asset without physical substance held for use in the production
or supply of goods or services, for rental to others, or for administrative purposes. An asset is a resource that is
controlled by the entity as a result of past events (for example, purchase or self-creation) and from which future
economic benefits (inflows of cash or other assets) are expected.

Thus, the three critical attributes of an intangible asset are:

 Identifiability
 control (power to obtain benefits from the asset)
 future economic benefits (such as revenues or reduced future costs)

Intangible assets are business assets that have no physical form. Unlike a tangible asset, such as a computer, you
can’t see or touch an intangible asset.

Identifiability:
An intangible asset can be termed identifiable if it:
 is separable or
 arises from contractual or other legal rights

An intangible asset needs to be identifiable to be recorded in financial statements. To be separable, the asset should
be capable of being separated and sold, transferred, licensed, rented, or exchanged, either individually or together
with a related contract. So, it should be capable of being disposed of on its own, with the remainder of the business
being retained.

Goodwill can only be disposed of as part of the sale of a business, so is not separable. The lack of identifiability
prevents internally generated goodwill from being recognized.

Examples of intangible assets include:

o Computer software
o Patents
o Copyrights
o Motion picture films
o Mortgage servicing rights
o Licenses
o Important quotes
o Franchises
o Marketing rights

pg. 21
IAS 38 SBR Revision Notes

Level of control
Another aspect of the definition of an intangible asset is that it must be under the control of the entity as a
consequence of a past event. The entity must be able to enjoy the future benefits from the asset and deter external
parties from access to those benefits. A legally enforceable right is an example of such control but isn’t a necessary
prerequisite for determining control.

Some notable points to consider are:

a) Control over technical knowledge only exists if it is protected by a legal right
b) The skill of employees, arising out of the benefits of training costs, are unlikely to be considered as intangible
assets because of the relative uncertainty over the future actions of staff. The problem from a control point of
view is that the staff can leave at any point in time, taking their new skills with them.
c) Market share and customer loyalty are also fickle by nature and cannot be considered as intangible assets.

RECOGNITION AND MEASUREMENT

RECOGNITION CRITERIA
The recognition of an intangible asset requires an entity to demonstrate that the item meets:-
a) The definition of an intangible asset
b) The recognition criterion that:-
 It is probable that the expected economic benefits that are attributable to the asset will flow to the
entity; and
 The cost of the asset can be measured reliably

MEASUREMENT CRITERIA
An intangible asset shall be measured initially at cost.

There are two types of intangible assets: those that are purchased and those that are internally generated. The
accounting treatment of purchased intangibles is relatively straightforward in that the purchase price is capitalised
in the same way as for a tangible asset. Accounting for internally-generated assets, however, requires more thought.
R&D costs fall into the category of internally-generated intangible assets, and are therefore subject to
specific recognition (Discussed later).

Separate rules for recognition and initial measurement exist for intangible assets depending on whether they were:
 Acquired separately: At cost
 Acquired as part of a business combination: At fair value
 Acquired by way of a government grant: As per IAS 20
 Obtained in an exchange of assets: At fair value
 Generated internally (Discussed later)

Separate acquisition
The cost of a separately acquired intangible asset can be measured reliably when purchase consideration is in the
form of cash or other monetary assets. The cost comprises:-
a) Its purchase price, including import duties and non-refundable purchase taxes after deducting trade discounts
and rebates; and
b) Professional fees arising directly from bringing the asset to its working condition; and
c) Costs of testing whether the asset is functioning properly

pg. 22
IAS 38 SBR Revision Notes

Examples of expenditures that are NOT part of cost of an intangible asset are:-
a) Costs of introducing a new product or service (advertising cost)
b) Costs of conducting business in a new location or with a new class of customers (training cost of staff)
c) Pre-operating losses, Administration and other general overheads

The capitalization of expenses ceases when the asset is ready for its intended use therefore; the expenditures
incurred afterwards are not capitalized.

Deferred payments
If the payment for an intangible asset is deferred beyond normal credit terms, its cost will be the cash price
equivalent. The difference between this amount and the total payments will be recognized as interest expense or
will be capitalized if meets the requirements of IAS-23.

Acquisition as part of business combination

An acquirer recognizes an intangible asset, distinct from goodwill, on the acquisition date if the asset’s fair value can
be measured reliably, irrespective of whether the asset had been recognized by the acquiree before the business
combination (Research and development).

The circumstances when an entity cannot measure the fair value are when the intangible asset arises from legal or
other contractual rights and either:-
a) Is not separable; or
b) Is separable, but there is no history or evidence of exchange transactions for the same or similar assets, and
otherwise estimating fair value would be depended on immeasurable variables.

So, there is a presumption that the fair value (and therefore the cost) of an intangible asset acquired in a business
combination can be measured reliably. An expenditure (included in the cost of acquisition) on an intangible item
that does not meet both the definition of and recognition criteria for an intangible asset should form part of the
amount attributed to the goodwill recognised at the acquisition date

Acquisition by way of Government Grant

If an intangible asset is acquired through a government grant then the related asset and government grant will be
recognized as per the requirements of IAS-20.

Exchanges of asset
An asset may be acquired in exchange or part exchange for a non-monetary asset or assets, or a combination of
monetary and non-monetary assets.

The cost of such an item is the fair value unless the exchange transaction lacks commercial substance or the fair
value of the asset given up/ acquired is not reliably measureable, in which case the cost of the asset acquired will be
the carrying value of the asset given up.

The entity determines whether the exchange transaction has the commercial substance by considering the extent
to which its cash flows differ as a result of the transaction.

pg. 23
IAS 38 SBR Revision Notes

A transaction has commercial substance if:-

 The risk, timing and amount of cash flows of the asset acquired differ from the asset transferred.
 The entity specific value of the portion of the entity‘s operations affected by the transaction changes as a result
of the exchange (post tax cash flows).
 The difference in above two is significant relative to the fair value of the assets exchanged.

If the entity is able to measure the fair value of any of the asset given up/acquired then the cost of the new asset is
the fair value of the asset given up unless the fair value of the asset acquired is more reliable.

INTERNALLY GENERATED INTANGIBLE ASSETS

To assess whether an internally generated intangible assets meets the criteria for recognition, an enterprise classifies
the generation of the asset into RESEARCH and DEVELOPMENT.

Reason for spending money on R&D

Many businesses in the commercial world spend vast amounts of money, on an annual basis, on the research and
development of products and services. These entities do this with the intention of developing a product or service
that will, in future periods, provide significant amounts of income for years to come.

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

An example of research could be a company in the pharmaceuticals industry undertaking activities or tests aimed at
obtaining new knowledge to develop a new vaccine. The company is researching the unknown, and therefore, at
this early stage, no future economic benefit can be expected to flow to the entity.

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

An example of development is a car manufacturer undertaking the design, construction, and testing of a pre-
production model.

ACCOUNTING TREATMENT
RESEARCH PHASE
It is impossible to demonstrate whether or not a product or service at the research stage will generate any probable
future economic benefit. As a result, IAS 38 states that all expenditure incurred at the research stage should be
written off to the statement of profit or loss as an expense when incurred, and will never be capitalised as an
intangible asset.

DEVELOPMENT PHASE
An intangible asset arising from development (or from the development phase of an internal project) should be
recognized as asset (capitalized) if, and only if, an enterprise can demonstrate all of the following:
(a) The technical feasibility of completing the intangible asset so that it will be available for use or sale;
(b) Its intention to complete the intangible asset and use or sell it;
(c) Its ability to use or sell the intangible asset;

pg. 24
IAS 38 SBR Revision Notes

(d) How the intangible asset will generate probable future economic benefits. Among other things, the enterprise
should demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself
or, if it is to be used internally, the usefulness of the intangible asset;
(e) The availability of adequate technical, financial and other resources to complete the development and to use
or sell the intangible asset; and
(f) Its ability to measure the expenditure attributable to the intangible asset during its development reliably.

If any of the recognition criteria are not met then the expenditure must be charged to the statement of profit or loss
as incurred. Note that if the recognition criteria have been met, capitalisation must take place.

Internally generated brands, mastheads, publishing titles, customer lists and similar items should not be recognised
as intangible assets.

Treatment of capitalised development costs

Once development costs have been capitalised, the asset should be amortised in accordance with the accruals
concept over its finite life. Amortisation must only begin when commercial production has commenced (hence
matching the income and expenditure to the period in which it relates).

Each development project must be reviewed at the end of each accounting period to ensure that the recognition
criteria are still met. If the criteria are no longer met, then the previously capitalised costs must be written off to the
statement of profit or loss immediately.

Past expense not be recognized as an asset

Expenditure on an intangible asset that was initially recognized as an expense shall not be recognized as part of the
cost of an intangible asset.

Cost of an internally generated intangible asset

The cost comprises all directly attributable costs necessary to create, produce and prepare the asset to be capable
of operating in the manner intended by the management.
a) Costs, of materials and services used or consumed in generating the intangible asset;
b) Costs of employee benefits arising from the generation of intangible assets
c) Fees to register a legal right; and
d) Amortization of patents and licenses that are used to generate the intangible asset

The following are NOT components of the cost of an internally generated intangible asset:
(a) Selling, administrative and other general overhead expenditure unless this expenditure can be directly
attributed to preparing the asset for use;
(b) Clearly identified inefficiencies and initial operating losses incurred before an asset achieves planned
performance; and
(c) Expenditure on training staff to operate the asset.

Reinstatement
The Standard also prohibits an entity from subsequently reinstating as an intangible asset, at a later date, an
expenditure that was originally charged to expense.

pg. 25
Subsequent Measurement of Intangible Assets SBR Revision Notes

SUBSEQUENT MEASUREMENT OF INTANGIBLE ASSETS

COST MODEL
After initial recognition, an intangible asset shall be carried at its cost less any accumulated amortization and any
accumulated impairment loss.

REVALUATION MODEL
After initial recognition an intangible asset whose fair value can be determined with reference to the active market
shall be carried at revalued amount, less subsequent accumulated amortization and subsequent accumulated
impairment losses.

ACCOUNTING TREATMENT

Classification of intangible assets based on useful life

Intangible assets are classified as having:
 Indefinite life: no foreseeable limit to the period over which the asset is expected to generate net cash inflows
for the entity.
 Finite life: a limited period of benefit to the entity.

An entity shall assess whether the useful life of an intangible asset is finite or indefinite and if finite, the length of,
or number of production or similar units constituting, that useful life.

An intangible asset shall be regarded by the entity as having an indefinite useful life when, based on an analysis of
all of the relevant factors, there is no foreseeable limit to the period over which the asset is expected to generate
net cash inflows for the entity

The useful life of an intangible asset that is not being amortized shall be reviewed in each period to determine
whether events and circumstances continue to support an indefinite useful life assessment for that asset. If they do
not, the change in the useful life assessment from indefinite to finite shall be accounted for as change in an
accounting estimate in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.

Amortisation and Impairment

 The depreciable amount of an intangible asset with a finite useful life shall be allocated on a systematic basis
over its useful life.
 The amortization method should reflect the pattern of benefits
 Amortise when commercial production begins
 The amortization period and the amortization method for an intangible asset with a finite useful life shall be
reviewed at least at each financial year end.
 An intangible asset with an indefinite useful life shall not be amortized but will be tested for impairment at
every reporting date.
 The recoverable amount of the asset should be determined at least at each financial year end and any
impairment loss should be accounted for in accordance with IAS 36.

pg. 26
Subsequent Measurement of Intangible Assets SBR Revision Notes

DISPOSAL
Remove from statement of financial position when disposed of or abandoned. Recognize any gain or loss in the
statement of profit or loss.

GOODWILL
Goodwill is not normally recognised in the accounts of a business at all. The reason for this is that goodwill is
considered inherent in a business and it does not have any objective value.

Purchased goodwill
There is one exception to the principle that goodwill has no objective value, this is when a business is sold.

Purchased goodwill is shown in the statement of financial position because it has been paid for. It has no tangible
substance, and so it is an intangible non-current asset. It is dealt with under IFRS 3 Business Combinations

SUBSEQUENT EXPENDITURE
Due to the nature of intangible assets, subsequent expenditure will only rarely meet the criteria for being recognised
in the carrying amount of an asset. Subsequent expenditure on brands, mastheads, publishing titles, customer lists
and similar items must always be recognised in profit or loss as incurred.

pg. 27
IAS 36 SBR Revision Notes

IAS 36 – IMPAIRMENT OF ASSETS

OBJECTIVE
The objective of this IAS is to set rules to ensure that the assets of an enterprise are carried at no more than their
recoverable amount.

DEFINITIONS
 Recoverable amount is the higher of an asset’s net selling price and its value in use.
 Value in use is the present value of estimated future cash flows expected to arise from the continuing use of an
asset and from its disposal at the end of its useful life.
 Net selling price the amount obtainable from the sale of an asset in an arm’s length transaction between
knowledgeable, willing parties, less the costs of disposal.
 An impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount.
 A cash-generating unit is the smallest identifiable group of assets that generates cash inflows from continuing
use that are largely independent of the cash inflows from other assets or groups of assets.
 Corporate assets are assets other than goodwill that contribute to the future cash flows of both the cash-
generating unit under review and other cash-generating units.

IMPAIRMENT ASSESSMENT
An enterprise should assess at each reporting date: -
a) Whether there is any indication that an asset may be impaired;
b) Irrespective of any indication of impairment, an entity shall also: -
 Test in case of intangible assets having indefinite life or under development; and
 Test goodwill acquired in business combination for impairment annually

External sources of information include:

 Decline in asset’s market value significantly more than expected
 Significant changes with an adverse effect in the technological, market, economic or legal environment in
which the enterprise operates;
 Market interest rates or other market rates of return on investments have increased during the period, and
those increases are likely to affect the discount rate used in calculating an asset’s value in use and decrease
the asset’s recoverable amount materially

Internal sources of information include:

 Obsolescence or physical damage
 Significant changes with an adverse effect in the extent to which, or manner in which, an asset is used or is
expected to be used. These changes include plans to discontinue or restructure the operation to which an
asset belongs.
 Economic performance of an asset is worse than expected.
Other evidence from internal reporting may be: -
 Cash flows for acquiring and maintaining the asset are significantly higher than the originally budgeted;
 Actual cash flows are worst that the budgeted; and
 Operating losses or net cash outflows when current period amounts are aggregated with the budgeted
amounts for the future

pg. 28
IAS 36 SBR Revision Notes

MEASURING RECOVERABLE AMOUNT

Recoverable
Amount

Higher of

Value in Use Value in Sale

Entities have to bear in mind the following steps and considerations when evaluating an asset’s recoverable amount:
1. Recoverable amount is the higher of an asset’s net selling price and its value in use
2. It is not always necessary to determine both an asset’s net selling price and its value in use. For example, if
either of these amounts exceeds the asset’s carrying amount, the asset is not impaired and it is not necessary
to estimate the other amount.
3. If asset is held for disposal then present value of cash flow from the use of asset until its disposal are likely to be
negligible, in this case recoverable amount shall be equal to the selling price.
4. If it is not possible to determine the fair value less costs to sell because there is no active market for the asset,
the company can use the asset's value in use as its recoverable amount.
5. Similarly, if there is no reason for the asset's value in use to exceed its fair value less costs to sell, then the latter
amount may be used as its recoverable amount.
For example, where an asset is being held for disposal, the value of this asset is likely to be the net disposal
proceeds. The future cashflows from this asset from its continuing use are likely to be negligible
6. Recoverable amount is determined for an individual asset. If the asset does not generate cash flows independent
from other assets. This asset is clubbed to cash generating unit and impairment loss is calculated of this cash-
generating unit.

Measurement of net selling price (Value in sale)

 Price in Binding Sale Agreement less Disposal Cost.
 Cost of disposal includes legal costs, stamp duty and similar transaction taxes, costs of removing the asset, and
direct incremental costs to bring an asset into condition for its sale.

Measurement of Value in Use

Estimating the value in use of an asset involves the following steps:
 Estimating the future cash inflows and outflows to be derived from continuing use of the asset and from its
ultimate disposal; and
 Expectations about possible variations in the amount or timing of those future cash flows
 The time value of money, represented by the current market risk-free rate of interest
 The price for bearing the uncertainty inherent in the asset

pg. 29
IAS 36 SBR Revision Notes

 Other factors, such as illiquidity, that market participants would reflect in pricing the future cash flows the
entity expects to derive from the asset
 Applying the appropriate discount rate to these future cash flows.

Therefore, the appropriate discount rate needs to be applied to future cash flows. It is important that any cashflows
projections are based upon reasonable and supportable assumptions over a maximum period of five years unless it
can be proven that longer estimates are reliable. They should be based upon most recent financial budgets and
forecasts.

Discount Rate
 The discount rate should be a pre-tax rate.
 It should reflect the current market assessments of the time value of money and the risks that relate to the asset
for which the future cashflows have not yet been adjusted.

RECOGNITION AND MEASUREMENT OF IMPAIRMENT LOSS

If, and only if, the recoverable amount of an asset is less than its carrying amount, the carrying amount of the asset
should be reduced to its recoverable amount. That reduction is an impairment loss.

Recoverable Carrying Impairment

value value expense

An impairment loss should be recognized as an expense in the statement of profit or loss immediately, unless the
asset is carried at revalued amount. An impairment loss on a revalued asset is recognized directly against any
revaluation surplus for the asset to the extent that the impairment loss does not exceed the amount held in the
revaluation surplus for that same asset.

After the recognition of an impairment loss, the depreciation (amortization) charge for the asset should be adjusted
in future periods to allocate the asset’s revised carrying amount, less its residual value (if any), on a systematic basis
over its remaining useful life.

CASH GENERATING UNIT

A cash generating unit (CGU) is the smallest identifiable group of assets for which independent cash flows can be
identified and measured. For example, for a restaurant chain a CGU might be each individual restaurant.

Identification of Cash-Generating Unit to which an asset belongs

 If there is any indication that an asset may be impaired, recoverable amount should be estimated for the
individual asset. If it is not possible to estimate the recoverable amount of the individual asset, an enterprise
should determine the recoverable amount of the cash-generating unit to which the asset belongs (the asset’s
cash-generating unit).
 The recoverable amount of an individual asset cannot be determined if:
o The asset’s value in use cannot be estimated to be close to its net selling price (for example, when the future
cash flows from continuing use of the assets cannot be estimated to be negligible); and

pg. 30
IAS 36 SBR Revision Notes

o The asset does not generate cash inflows from use that are independent of those from other asset. In such
cases, value in use and, therefore recoverable amount, can be determined only for the asset’s cash-
generating unit.
o An asset’s cash generating unit is the smallest group of assets that includes the asset and that generates
cash inflows from continuing use that are largely independent of the cash inflows from other assets or
groups of assets.

Recoverable amount and carrying amount of cash generating unit

The recoverable amount of a cash-generating unit is the higher of the cash-generating unit’s net selling price and
value in use.

The carrying amount of a cash-generating unit includes the carrying amount of only those assets that can be
attributed directly, or allocated on a reasonable and consistent basis, to the cash-generating unit and that will
generate the future cash inflows estimated in determining the cash-generating unit’s value in use.

Goodwill
 As goodwill acquired in a business combination does not generate cash flows independently of other assets, it
must be allocated to each of the acquirer’s cash generating units
 A CGU to which goodwill has been allocated is tested for impairment annually. The carrying amount of the CGU
including the goodwill is compared with its recoverable amount.

RECOGNITION OF IMPAIRMENT LOSS OF CASH-GENERATING UNIT

An impairment loss should be recognized for a cash-generating unit if, and only if, its recoverable amount is less than
its carrying amount. The impairment loss should be allocated to reduce the carrying amount of the assets of the unit
in the following order:
 First to any asset that is impaired (e.g. if an asset was specifically damaged)
 Second, to goodwill in the cash generating unit
 Third, to all other assets in the CGU on a pro rata basis based on carrying value

These reductions in carrying amounts should be treated as impairment losses on individual assets.
In allocating in impairment loss, the carrying amount of an asset should not be reduced below the highest of:

Its net selling price (if determinable)

Its value in use (if determinable)

Zero

If this rule is applied then the impairment loss not allocated to the individual asset will be allocated on a pro-rata
basis to the other assets of the group.

pg. 31
IAS 36 SBR Revision Notes

REVERSAL OF IMPAIRMENT LOSS

An enterprise should assess at each reporting date whether there is any indication that an impairment loss
recognized for an asset in prior years may no longer exist or may have decreased. If any such indication exists, the
enterprise should estimate the recoverable amount of that asset.

Considerations on reversal of an impairment loss for an individual asset:

 The increase in carrying value of the asset due to a reversal on impairment loss can only be up to should not
exceed the carrying amount that would have been determined (net of amortization or depreciation) had no
impairment loss been recognized for the asset in prior years.
 A reversal of an impairment loss been recognized as income immediately in the statement of profit or loss,
unless the asset is carried at revalued amount (for example, under the allowed alternative treatment in IAS 16,
Property, Plant and Equipment). Any reversal of an impairment loss on a revalued asset should be treated as a
revaluation increase as per the respective standard.
 A reversal of an impairment loss on a revalued asset is credited directly to equity under the heading revaluation
surplus. However, to the extent that an impairment loss on the same revalued asset was previously recognized
as an expense in the statement of profit or loss, a reversal of that impairment loss is recognized, as income in
the statement of profit or loss.

After a reversal of an impairment loss is recognized, the depreciation (amortization) charge for the asset should be
adjusted in future periods to allocate the asset’s revised carrying amount, less its residual value (if any), on a
systematic basis over its remaining useful life.

Considerations on reversal of an impairment loss for a cash generating unit:

A reversal of an impairment loss for a cash-generating unit should be allocated to increase the carrying amount of
the asset of the unit in the following order:
 First, reverse on assets other than goodwill on a pro-rata basis based on the carrying amount of each asset in
the unit; and
 An impairment loss recognized for goodwill shall not be reversed in a subsequent period.
 There is no reversal for unwinding of discount

pg. 32
IAS 40 SBR Revision Notes

IAS 40-INVESTMENT PROPERTY

OBJECTIVE
The objective of this Standard is to prescribe the accounting treatment for investment property and related
disclosure requirements.

DEFINITIONS:
Investment property is property held to earn rentals or for capital appreciation or both, rather than for:
a) Use in the production or supply of goods or services or for administrative purposes; or
b) Sale in the ordinary course of business.

Owner-occupied property is property held (by the owner or by the lessee under a finance lease) for use in the
production or supply of goods or services or for administrative purposes.

Carrying amount is the amount at which an asset is recognised in the statement of financial position.

Cost is the amount of cash or cash equivalents paid or the fair value of other consideration given to acquire an asset
at the time of its acquisition or construction or, where applicable, the amount attributed to that asset when initially
recognised in accordance with the specific requirements of other IFRS.

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date. (See IFRS 13 Fair Value Measurement).

CLASSIFICATION
The following are examples of investment property:
a) Land held for long-term capital appreciation
b) Land held for a currently undetermined future use
c) Building leased out under operating lease
d) A building that is vacant but is held to be leased out under one or more operating leases.
e) Property that is being constructed or developed for future use as investment property

The following are examples of items that are not investment property:
a) Property held for use in the production or supply of goods or services or for administrative purposes
b) Property held for sale in the ordinary course of business or in the process of construction of development
for such sale (IAS 2 Inventories)
c) Property being constructed or developed on behalf of third parties
d) Owner-occupied property (IAS 16 Property, Plant and Equipment), including property held for future use as
owner-occupied property, property held for future development and subsequent use as owner-occupied
property, property occupied by employees and owner-occupied property awaiting disposal
e) Property leased to another entity under a finance lease

Property held under an operating lease.

A property interest that is held by a lessee under an operating lease may be classified and accounted for as
investment property provided that:

pg. 33
IAS 40 SBR Revision Notes

 The rest of the definition of investment property is met

 The operating lease is accounted for as if it were a finance lease in accordance with IFRS 16 Leases
 The lessee uses the fair value model set out in this Standard for the asset recognised

An entity may make the foregoing classification on a property-by-property basis.

Partial own use

If the owner uses part of the property for its own use, and part to earn rentals or for capital appreciation, and the
portions can be sold or leased out separately, they are accounted for separately. Therefore the part that is rented
out is investment property. If the portions cannot be sold or leased out separately, the property is investment
property only if the owner-occupied portion is insignificant.

Ancillary services
If the entity provides ancillary services to the occupants of a property held by the entity, the appropriateness of
classification as investment property is determined by the significance of the services provided. If those services are
a relatively insignificant component of the arrangement as a whole (for instance, the building owner supplies security
and maintenance services to the lessees), then the entity may treat the property as investment property. Where the
services provided are more significant (such as in the case of an owner-managed hotel), the property should be
classified as owner-occupied.

Intra-company rentals
Property rented to a parent, subsidiary, or fellow subsidiary is not investment property in consolidated financial
statements that include both the lessor and the lessee, because the property is owner-occupied from the perspective
of the group. However, such property could qualify as investment property in the separate financial statements of
the lessor, if the definition of investment property is otherwise met.

RECOGNITION:
Investment property shall be recognized as an asset when
(a) It is probable that the future economic benefits that are associated with the investment property will flow to
the entity; and
(b) The cost of the investment property can be measured reliably.

MEASUREMENT
Initial measurement
 An investment property shall be measured initially at its Cost + Transaction costs.
 The cost of a purchased investment property = Purchase price + any directly attributable expenditure.

The cost should not include start-up costs, abnormal waste, or initial operating losses incurred before the investment
property achieves the planned level of occupancy.

Subsequent expenditure
This should be added to the carrying amount of the investment property when it is probable that future economic
benefits in excess of the originally assessed standard of performance of the existing investment property will flow
to the enterprise. All other subsequent expenditure should be recognized as an expense in the period in which it is
incurred.

pg. 34
IAS 40 SBR Revision Notes

Exchanges of assets
An investment property may be acquired in exchange or part exchange for a non-monetary asset or assets or a
combination of monetary and non-monetary assets.

The cost of such an item is the fair value unless the exchange transaction lacks commercial substance or the fair
value of the asset given up / acquired is not reliably measurable. Then the cost of the asset acquired will be the
carrying value of the asset given up

SUBSEQUENT MEASUREMENT
IAS 40 permits entities to choose between
 A fair value model, and
 A cost model.

COST MODEL:
Under cost model, investment property should be measured at depreciated cost, less any accumulated impairment
losses.

FAIR VALUE MODEL

Under the fair value model the entity should:
 Revalue all its investment property to 'fair value' (open market value) at the end of each financial year, and
 Take the resulting gain or loss to profit or loss for the period in which it arises.

Fair value is the price that would be received to sell an asset or paid to transfer a liability, in an orderly transaction
between market participants at the measurement date.

Investment property is remeasured at fair value, which is the amount for which the property could be exchanged
between knowledgeable, willing parties in an arm's length transaction.

Fair value should reflect the actual market state and circumstances as of the reporting date. The best evidence of
fair value is normally given by current prices on an active market for similar property in the same location and
condition and subject to similar lease and other contracts. In the absence of such information, the entity may
consider current prices for properties of a different nature or subject to different conditions, recent prices on less
active markets with adjustments to reflect changes in economic conditions, and discounted cash flow projections
based on reliable estimates of future cash flows.

There is a rebuttable presumption that the entity will be able to determine the fair value of an investment property
reliably on a continuing basis. However:
 If an entity determines that the fair value of an investment property under construction is not reliably
determinable but expects the fair value of the property to be reliably determinable when construction is
complete, it measures that investment property under construction at cost until either its fair value becomes
reliably determinable or construction is completed.
 If an entity determines that the fair value of an investment property (other than an investment property under
construction) is not reliably determinable on a continuing basis, the entity shall measure that investment
property using the cost model in IAS 16. The residual value of the investment property shall be assumed to be
zero. The entity shall apply IAS 16 until disposal of the investment property.

pg. 35
IAS 40 SBR Revision Notes

Where a property has previously been measured at fair value, it should continue to be measured at fair value until
disposal, even if comparable market transactions become less frequent or market prices become less readily
available.

COST MODEL
The cost model is the same treatment in IAS 16. Investment property should be measured at cost less accumulated
depreciation less any accumulated impairment losses. An enterprise that chooses the cost model should disclose
the fair value of its investment property.

Adoption and change of models

One method must be adopted for all of an entity's investment property. Change is permitted only if this results in a
more appropriate presentation. IAS 40 notes that this is highly unlikely for a change from a fair value model to a cost
model.

TRANSFERS:
Transfers to, or from, investment property should only be made when there is a change in use, evidenced by one or
more of the following:
 Commencement of owner-occupation (transfer from investment property to owner-occupied property)
 Commencement of development with a view to sale (transfer from investment property to inventories)
 End of owner-occupation (transfer from owner-occupied property to investment property)
 Commencement of an operating lease to another party (transfer from inventories to investment property)
 End of construction or development (transfer from property in the course of construction/development to
investment property

When an entity decides to sell an investment property without development, the property is not reclassified as
inventory but is dealt with as investment property until it is derecognised.

RULES FOR TRANSFER:

 For a transfer from investment property carried at fair value to owner-occupied property or inventories, the fair
value at the change of use is the 'cost' of the property under its new classification
 For a transfer from owner-occupied property to investment property carried at fair value, IAS 16 should be
applied up to the date of reclassification. Any difference arising between the carrying amount under IAS 16 at
that date and the fair value is dealt with as a revaluation under IAS 16
 For a transfer from inventories to investment property at fair value, any difference between the fair value at
the date of transfer and it previous carrying amount should be recognized in profit or loss
 When an entity completes construction/development of an investment property that will be carried at fair
value, any difference between the fair value at the date of transfer and the previous carrying amount should be
recognized in profit or loss.

When an entity uses the cost model for investment property, transfers between categories do not change the
carrying amount of the property transferred, and they do not change the cost of the property for measurement or
disclosure purposes.

pg. 36
IAS 40 SBR Revision Notes

DISPOSAL
An investment property should be derecognized on disposal or when the investment property is permanently
withdrawn from use and no future economic benefits are expected from its disposal.
 The gain or loss on disposal should be calculated as the difference between the net disposal proceeds and the
carrying amount of the asset and should be recognized as income or expense
 Compensation from third parties is recognized when it becomes receivable.

ACCOUNTING TREATMENT DIFFERENCE – Fair value model & Revaluation model

Superficially, the revaluation model and fair value sound very similar; both require properties to be valued at their
fair value which is usually a market-based assessment (often by an independent valuer).

However, any gain (or loss) over a previous valuation is taken to profit or loss if it relates to an investment property,
whereas for an owner-occupied property, any gain is taken to a revaluation reserve (via other comprehensive income
and the statement of changes in equity).

A loss on the revaluation of an owner-occupied property is charged to profit or loss unless it has a previous surplus
in the revaluation reserve which can be used to offset the loss until it is exhausted. A further difference is that owner-
occupied property continues to be depreciated after revaluation, whereas investment properties are not
depreciated.

pg. 37
IAS 2 SBR Revision Notes

IAS 2 – INVENTORIES

OBJECTIVE
The objective of this IAS is to prescribe the accounting treatment of inventories.

DEFINITIONS
Inventories are assets; -
a) Held for sale in the ordinary course of business
b) In the process of production for such sale; or (work in progress, finished goods awaiting to be sold)
c) In the form of materials or supplies to be consumed in the production process or in the rendering of services

Net Realizable Value is the estimated selling price in the ordinary course of business less the estimated costs of
completion and the estimated cost necessary to make a sale.

MEASUREMENT OF INVENTORIES
Inventory shall be measured at the lower of cost and net realizable value.

COST OF INVENTORIES
The cost of inventories will comprise all costs of purchase, costs of conversion and other costs incurred in bringing
the inventories to their present location and condition.
(a) Purchase cost comprise the;
i) Purchase price plus;
ii) Import duties and other non –refundable taxes;
iii) Transport, handling and any other cost directly attributable to the acquisition of finished goods,
services and materials; less
iv) Trade discounts, rebates and other similar amounts
(b) Cost of conversion
i) Costs directly related to the units of production (direct labor); and
ii) Systematic allocation of fixed and variable production overheads that are incurred in converting
materials into finished goods. (Factory rent, depreciation of machinery, supervisor salary, power
consumption)
The allocation of fixed overheads to the costs of conversion is based on the normal capacity of the production
facilities.
(c) Other cost incurred in bringing the inventories to their present location and condition (i.e. non production
overheads or costs of designing products for specific customers).

The Standard excludes the following from the cost of inventories

a) The abnormal amount of wasted material, labor or other production cost;
b) Storage costs unless necessary for production before the further production process/stage;
c) Administrative overheads that do not contribute to bringing inventories to their present location and condition;
d) Selling cost
e) Foreign exchange differences arising directly on the recent acquisition of inventories invoiced in a foreign
currency
f) Interest cost when inventories are purchased with deferred settlement terms

pg. 38
IAS 2 SBR Revision Notes

Costs of Inventories of a service provider

The cost of inventories of service providers includes primarily the labour and other cost of the personnel directly
engaged in providing the service including supervisory personnel and directly attributable overheads.

COST FORMULAS
For items that are interchangeable, IAS 2 allows the FIFO or weighted average cost formulas.

The LIFO formula, which had been allowed prior to the 2003 revision of IAS 2, is no longer allowed.

NET REALIZABLE VALUE

As a general rule assets should not be carried at amounts greater than those expected to be realized from their sale
or use. In case of inventories this amount could fall below cost when items are damaged or become wholly or
partially obsolete, or where the costs to completion have increased in order to make the sale or the prices have
declined. (Prudence Concept).

The principal situations in which NRV is likely to be less than cost, i.e. where there has been:
 An increase in costs or a fall in selling price
 A physical deterioration in conditions of inventory
 Obsolescence of products
 A decision as part of the company’s marketing strategy to manufacture and sell products at a loss
 Errors in production or purchasing

RULES:
 The write down of inventories would normally take place on an item-by-item basis but similar or related items
may be grouped together (in case of service provider each service will be treated as item).
 The NRV should be based on the most reliable evidence available at the time of estimates are made.
 Fluctuations after reporting date should also be taken into account to the extent they confirm the conditions
existing at the reporting date.
 The estimate of NRV should also take into account the purpose for which the inventory is held (firm sale /
purchase contracts).
 Materials or supplies held for use in the production process should not be written down below cost if the
finished products in which they will be incorporated are expected to be sold at or above cost. Otherwise, when
the decline in the value of materials indicates that the cost of finished goods exceeds NRV, the materials should
be written down to NRV.
 NRV should be reassessed at each reporting date and necessary adjustments such as further reduction or
increase in NRV should be made however, reversal of write down is limited to the original write down of
inventories.
 Material reductions should be disclosed separately

RECOGNITION AS EXPENSE
The following treatment is required, when inventories are sold.
a) The carrying amount is recognized as an expense in the period in which the related revenue is recognized
(matching concept)
b) The amount of any write down of inventories to NRV and all losses of inventories are recognized as an
expense in the period in which the related write down or loss occurred

pg. 39
IAS 2 SBR Revision Notes

c) The amount of any reversal of any write down of inventories, arising from the increase in NRV is recognized
as a reduction in the amount of inventories recognized as an expense in the period in which the reversal
occurs.

The inventories allocated to other assets i.e. when the inventory becomes the part of cost of self-constructed assets,
the inventories are recognized as an expense over the useful life of those assets.

pg. 40
IAS 41 SBR Revision Notes

IAS 41 – AGRICULTURE

OBJECTIVE
The objective of IAS 41 is to establish standards of accounting for agricultural activity

SCOPE
Within scope are Biological assets, Agricultural produce at the point of harvest and Government grants related to
biological assets.

Excluded from scope are Land and Intangible assets related to agricultural activity

DEFINITIONS
ACTIVE MARKET:
Exists when; the items traded are homogenous, willing buyers and sellers can normally be found at any time and
prices are available to the public.

AGRICULTURAL ACTIVITY:
The management of the transformation of a biological asset for sale into agricultural produce or another biological
asset.

Biological asset: A living animal or plant.

Agricultural produce: The harvested produce of the entity’s biological assets.

Biological transformation: The process of growth, degeneration, production, and procreation that cause an increase
in the value or quantity of the biological asset.

Harvest: The process of detaching produce from a biological asset or cessation of its life.

Bearer plant: A living plant that:

a. Is used in the production or supply of agricultural produce
b. Is expected to bear produce for more than one period, and
c. Has a remote likelihood of being sold as agricultural produce, except for incidental scrap sales.

Costs to sell: The incremental costs directly attributable to the disposal of an asset, excluding finance costs and
income taxes

RECOGNITION
Biological assets or agricultural produce are recognised when:
 Entity controls the asset as a result of a past event
 Probable that future economic benefit will flow to the entity; and
 Fair value or cost of the asset can be measurement reliably.

pg. 41
IAS 41 SBR Revision Notes

MEASUREMENT
Biological assets
Biological assets within the scope of IAS 41 are measured on initial recognition and at subsequent reporting dates at
fair value less estimated costs to sell, unless fair value cannot be reliably measured.

If no reliable measurement of fair value (no quoted market price in an active market and alternative fair value
measurements unreliable), biological assets are stated at cost less accumulated depreciation and accumulated
impairment losses.

If circumstances change and fair value becomes reliably measurable, a switch to fair value less costs is required.

Agricultural produce
Agricultural produce is measured at fair value less estimated costs to sell at the point of harvest.

Unlike a biological asset, there is no exception in cases in which fair value cannot be measured reliably. According to
IAS 41, agricultural produce can always be measured reliably because harvested produce is a marketable commodity.
Point of-sale costs include brokers’ and dealers’ commissions, any levies by regulatory authorities and commodity
exchanges, and any transfer taxes and duties. They exclude transport and other costs necessary to get the assets to
a market.

Treatment of gain/loss
 The gain on initial recognition of biological assets at fair value less costs to sell, and changes in fair value less
costs to sell of biological assets during a period, are included in profit or loss.
 A gain on initial recognition (e.g. as a result of harvesting) of agricultural produce at fair value less costs to sell
are included in profit or loss for the period in which it arises.
 All costs related to biological assets that are measured at fair value are recognised as expenses when incurred,
other than costs to purchase biological assets.

Government grants
An unconditional government grant related to a biological asset measured at fair value less estimated point-of-sale
costs is recognised as income when, and only when, the government grant becomes available
A conditional government grant, including where a government grant requires an entity not to engage in specified
agricultural activity, is recognised as income in profit or loss when and only when, the conditions of the grant are
met.

OTHER ISSUES
 The change in fair value of biological assets is part physical change (growth, etc) and part unit price change.
Separate disclosure of the two components is encouraged, not required.
 Agricultural produce is measured at fair value less costs to sell at harvest, and this measurement is considered
the cost of the produce at that time (for the purposes of IAS 2 Inventories or any other applicable standard).
 Agricultural land is accounted for under IAS 16 Property, Plant and Equipment. However, biological assets
(other than bearer plants) that are physically attached to land are measured as biological assets separate from
the land. In some cases, the determination of the fair value less costs to sell of the biological asset can be based
on the fair value of the combined asset (land, improvements and biological assets).
 Intangible assets relating to agricultural activity (for example, milk quotas) are accounted for under IAS 38
Intangible Assets.

pg. 42
IAS 23 SBR Revision Notes

IAS 23-BORROWING COST

OBJECTIVE:
To prescribe the accounting treatment for borrowing cost.

DEFINITIONS:
Borrowing costs are interest and other costs, incurred by an entity in connection with the borrowing of funds in
order to construct an asset.

Borrowing cost includes

 Interest on bank overdraft and short term borrowing;
 Finance lease charges in respect of finance lease; and
 Exchange differences arising from foreign currency borrowings to the extent that they are regarded as an
adjustment of interest cost
 Issuance costs
 Discount on issuance and premium on redemption

Qualifying asset: A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its
intended use or sale (e.g. inventories, manufacturing plants, power generation facilities, intangible assets,
investment properties etc.). However, financial assets, inventories produced over short period of time and assets
ready for intended sale are not qualifying assets.

ACCOUNTING TREATMENT:
Recognition
An entity should capitalize the borrowing costs that are directly attributable to the acquisition, construction or
production of a qualifying asset as part of the cost of that asset and, therefore, should be capitalized.

Other borrowing costs are expensed in statement of profit or loss when occurred.

Return on any surplus funds invested is first deducted from the amount of interest and then the remaining amount
is capitalized.

Specific Funds
The borrowing cost of funds, borrowed specifically for the qualifying asset, is the actual cost incurred on the funds
during the period less any investment income on the temporary investment of funds.

General funds
The borrowing cost of funds, borrowed generally, will be determined by applying a capitalization rate to the
expenditures incurred on those assets. The capitalization rate is the weighted average rate of the borrowings cost
applicable to the borrowings of the entity outstanding during that period other than specific borrowings. The amount
of borrowing cost capitalized during a period should not exceed the borrowing costs incurred during the period.
(Group borrowings)

pg. 43
IAS 23 SBR Revision Notes

Excess of carrying amount of the qualifying asset over recoverable amount

When the carrying amount exceeds the recoverable amount of that asset, the asset should be written down to its
recoverable value. (IAS 36)

PERIOD OF CAPITALIZATION
Commencement of capitalization
The capitalization commences: -
 Expenditures for the assets are being incurred;
 Borrowing costs are being incurred; and
 Activities necessary to prepare the asset for its intended use/sale are in progress

Expenditures on a qualifying asset include only those expenditures, which have resulted in transfer of cash/other
asset or assumption of interest bearing liabilities and will be reduced by any Government Grant (IAS –20).

The activities necessary to complete the qualifying asset include beside physical construction the
technical/administrative work such as obtaining permits prior to physical construction. However, such activities
exclude the holding of an asset when no production or development that changes the asset’s condition is taking
place (e.g. borrowing cost incurred while land is under development are capitalized during the period when activities
related to the development are in progress).

Suspension of capitalization
Capitalization should cease when during the extended period the active development is interrupted. Examples are:-
 Borrowing costs incurred during extended periods when activities to prepare an asset for its intended
use/sale are interrupted (costs of holding partially completed assets)
 On temporary delays the capitalization is not suspended (Geographical region involved - delays due to high
water levels, inventories to mature for sale, due to bad weather, strikes etc)

Cessation of capitalization
The capitalization should cease, when substantially all the activities necessary to complete the qualifying asset for
its intended use/sale are complete (physical construction is complete, administrative or decorative work may
continue).

When the construction of a qualifying asset is in parts the capitalization of borrowing cost should cease, when the
relevant part is complete for its intended use/sale (building park).

DISCLOSURE
 The accounting policy adopted.
 Amount of borrowing cost capitalized during the period.
 Capitalization rate used.

pg. 44
IAS 20 SBR Revision Notes

IAS-20 ACCOUNTING FOR GOVERNMENT GRANTS AND DISCLOSURE OF

GOVERNMENT ASSISTANCE

OBJECTIVE
To prescribe the accounting for, and disclosure of, government grants and other forms of government assistance.

SCOPE
IAS 20 applies to all government grants and other forms of government assistance. However, it does not cover
government assistance that is provided in the form of benefits in determining taxable income. It does not cover
government grants covered by IAS 41 Agriculture, either. The benefit of a government loan at a below-market rate
of interest is treated as a government grant.

DEFINITIONS
Government refers to government, government agencies and similar bodies whether local, national or international.
Government assistance is provision of economic benefits by government to a specific entity or range of entities
which meet specific criteria. Government assistance for the purpose of this Standard does not include benefits
provided only indirectly through action affecting general trading conditions, such as the provision of infrastructure
in development areas or the imposition of trading constraints on competitors.

Government grants are transfer of resources to an entity, from government, in return for compliance with certain
conditions.

It is the assistance by government in the form of transfers of resources to an entity in return for past or future
compliance with certain conditions relating to the operating activities of the entity. They exclude those forms of
government assistance which cannot reasonably have a value placed upon them and transactions with government
which cannot be distinguished from the normal trading transactions of the entity (subsidies, subvention, or
premiums).

ACCOUNTING TREATMENT
RECOGNITION
A government grant is recognized only when there is reasonable assurance that
 The entity will comply with any conditions attached to the grant
 The grant will be received.

The grant is recognised as income over the period necessary to match them with the related costs, for which they
are intended to compensate, on a systematic basis.

Non-monetary grants
Non-monetary grants such as land or other resources, are usually accounted for at fair value, although recording
both the asset and the grant at a nominal amount is also permitted.

Assistance without conditions

Even if there are no conditions attached to the assistance specifically relating to the operating activities of the entity
(other than the requirement to operate in certain regions or industry sectors), such grants should not be credited to
equity.

pg. 45
IAS 20 SBR Revision Notes

Compensation of already incurred costs

A grant receivable as compensation for costs already incurred or for immediate financial support, with no future
related costs, should be recognised as income in the period in which it is receivable.

GRANT RELATED TO ASSET

Grant related to depreciable assets are recognized over the useful life of the assets in the proportion of depreciation
charge.

Grant related to non-depreciable assets are also recognized over the period in which related expenses are made.

If grants are received as a package of financial or fiscal aids to which a number of conditions are attached then
reasons giving rise to costs and expenses should be identified and it may be appropriate to allocate part of grant on
one basis and part on another basis.

Presentation of grant related to asset

A grant relating to assets may be presented in one of two ways:
 As deferred income, or
 By deducting the grant from the asset's carrying amount.

GRANT RELATED TO INCOME

Such grants are recognized over the period and matched with the related expenses.

Presentation of grant related to income

A grant relating to income may be reported separately as 'other income' or deducted from the related expense.

Repayment:
 If the conditions of a grant are breached, it may need to be repaid.
 A government grant that becomes repayable shall be accounted for as a revision to an accounting estimate (IAS
–8).
 Repayment of a grant related to income shall be applied first against any un-amortized deferred credit and if
repayment exceeds the deferred credit the rest will be recognized immediately as expense.
 Repayment of grants related to assets shall be recorded by increasing the carrying amount of the asset or
reducing the deferred income balance by the amount payable. The cumulative additional depreciation that
would have been recognized to date as an expense in the absence of the grant shall be recognized immediately
as an expense.

Disclosure:
The following must be disclosed:
 Accounting policy adopted for grants, including method of statement of financial position presentation
 Nature and extent of grants recognized in the financial statements
 Unfulfilled conditions and contingencies attaching to recognized grant

GOVERNMENT ASSISTANCE
Government grants do not include government assistance whose value cannot be reasonably measured, such as
technical or marketing advice.

pg. 46
IAS 20 SBR Revision Notes

The government grants are not recognized because no value can be assigned to them or they are not distinguishable
from the other transactions of the entity if material shall be disclosed.

pg. 47
IAS 8 SBR Revision Notes

IAS-8 ACCOUNTING POLICIES, CHANGE IN ACCOUNTING ESTIMATES AND

ERRORS

OBJECTIVE
The objective of this Standard is to prescribe the criteria for selecting and changing accounting policies, the
accounting treatment and disclosure of changes in accounting policies, accounting estimates and corrections of
errors.

ACCOUNTING POLICIES
Definitions:
Accounting Policies are the specific principles, bases, conventions, rules and practices applied by an entity in
preparing and presenting financial statements.

Material Omissions or misstatements of items are material if they could, influence the economic decisions that users
make on the basis of the financial statements.

SELECTION OF ACCOUNTING POLICIES

Management selects accounting policies by applying accounting standards or using judgment:

Compulsory - Where a specific standard relates to a transaction or event, the accounting policy applied to that item
shall be determined by applying that standard.

Voluntary - Where there is no specific standard to deal with a particular transaction, event or condition,
management shall develop and apply accounting policies resulting in reliable .and more relevant information.

In developing accounting policy management should consider:

a) The requirements and guidance of accounting standards dealing with similar and related issues; and
b) The contents of the Accounting Framework for the Preparation and Presentation of Financial statements
(The Framework).

CHANGE IN ACCOUNTING POLICIES

The management can change accounting policy under the following circumstances:
Compulsory - Where a change is required by a specific standard or interpretation (external).

Voluntary - Management determines that a change in policy will result in the financial statements providing reliable
and more relevant information (internal).

Consistency in accounting policies

Although accounting policies can and sometimes must be changed in order to achieve comparability there is an
underlying requirement to be consistent in the selection and application of accounting policies.

To improve comparability, consistency requires that the same accounting policies should be applied to similar items
within each period, and from one period to the next.

pg. 48
IAS 8 SBR Revision Notes

Meaning of Relevant and Reliable

Relevant information helps the user to make economic decisions.

Reliable financial statements:

 Present faithfully the effects of transaction on financial position, financial performance and cash flows;
 Reflect the economic substance or transactions, other events and conditions
 Be neutral (no bias or error)
 Be prudent
 Be complete in all material respects.

Application of Changes in Accounting Policy

The change in accounting policy is applied retrospectively

Compulsory/Specific - Where a new standard/Interpretation forces a change in accounting policy and that standard
has specific transitional provisions then the entity must apply those provisions in accounting for the change.

Compulsory/Non-Specific - Where the change in accounting policy is compulsory but with no specific transitional
provisions, the change shall be applied retrospectively.

Voluntary - Where the change is voluntary, the change shall be applied retrospectively.

Retrospective application
It is applying a new accounting policy to transactions and other events as if that policy had always been applied, i.e.
make prior period adjustments.

This means restating the opening balance of equity for the earliest prior period presented and the other comparative
amounts disclosed for each prior period presented as if the new accounting policy had always been applied.

Items NOT changes in accounting policy

IAS 8 states that the introduction of an accounting policy to account for transactions where circumstances have
changed are not a change in accounting policy.

Similarly, a policy for transactions that did not occur previously or that were immaterial is not a change in policy and
therefore would be applied prospectively.

Limitations of Retrospective Application

IAS 8 does not permit the use of hindsight when applying a new accounting policy, either in making assumptions
about what management's intentions would have been in a prior period or in estimating amounts to be recognised,
measured or disclosed in a prior period.

When it is impracticable to determine the effect of a change in accounting policy on comparative information, the
entity is required to apply the new policy to the carrying amounts of the assets and liabilities as at the beginning of
the earliest period for which retrospective application is practicable. This could actually be the current period but
the entity should attempt to apply the policy from the earliest date possible.

pg. 49
IAS 8 SBR Revision Notes

The application of the requirement of a standard or interpretation is "impracticable" if the entity cannot apply it
after making every effort to do so.

Disclosures for Changes in Accounting Policies

When initial application of the standard or interpretation has an effect on current or prior periods, would have an
effect but it is impracticable to determine, or might have an effect, then entities shall disclose:
 The title of the Standard or Interpretation;
 If applicable, that the changes were made in accordance with the transitional provisions;
 The nature of the change;

In addition, for voluntary changes in accounting policies, a description must be provided of the reason for the new
policy providing reliable and more relevant information.

CHANGES IN ACCOUNTING ESTIMATES

Definition
A change in accounting estimate is an adjustment of the carrying amount of an asset or liability, or related expense,
resulting from reassessing the expected future benefits and obligations associated with that asset or liability.

Where the basis of measurement for the amount to be recognised is uncertain, an entity will use an estimation
technique, which is a normal part of the preparation of the financial statements without undermining their reliability.
Estimates involve judgments based on the latest available, reliable information and are applied in determining the
useful lives of property, plant and equipment, provisions, fair values of financial assets and liabilities and actuarial
assumptions relating to defined benefit pension schemes.

Many items in financial statements cannot be measured with precision but will be estimated. Estimation involves
judgement based on the latest available reliable information. Examples include:
 Estimating the recoverability of receivables at the year end, i.e. bad debts
 Inventory obsolescence
 Fair values of assets/liabilities
 Determining the remaining useful lives of; or the expected patterns of consumption of depreciable assets
 Estimating Income tax expenses

Comparison between change in accounting policy and estimate

Accounting estimates need to be distinguished from accounting policies as the effect of a change in an estimate is
reflected in the Statement of profit or loss and other comprehensive income, whereas a change in accounting policy
will generally require a prior period adjustment. If there is a change in the circumstances on which the estimate was
based or new information has arisen or more experience relating to the estimation process has occurred, then the
estimate may need to be changed. A change in the measurement basis is not a change in an accounting estimate,
but is a change in accounting policy. For example, if there is a move from historical cost to fair value, this is a change
in accounting policy but a change in the method of depreciation is a change in accounting estimate.

Accounting for changes in estimates

The effect of a change in an accounting estimate shall be recognized prospectively by including it in profit or loss in:
 The period of the change, if the change affects that period only e.g. change is estimated irrecoverable and
doubtful debts; or

pg. 50
IAS 8 SBR Revision Notes

 The period of the change and future periods, if the change affects both e.g. change in useful life of a depreciable
asset.

To the extent that a change in an accounting estimate gives rise to changes in assets and liabilities, or relates to an
item of equity, it shall be recognized by adjusting the carrying amount of the related asset, liability or equity item in
the period of the change.

ERRORS
Prior period errors are omissions from, and misstatements in, the entity’s financial statements for one or more prior
periods arising from a failure to use, or misuse of, reliable information that:
 Was available when financial statements for those periods were authorized for issue; and
 Could reasonably be expected to have been obtained and taken into account in the preparation and
presentation of those financial statements.
Accounting for errors
An entity shall correct material prior period errors retrospectively in the first set of financial statements authorized
for issue after their discovery by:
 restating the comparative amounts for the prior period(s) presented in which the error occurred; or
 if the error occurred before the earliest prior period presented, restating the opening balances of assets,
liabilities and equity for the earliest prior period presented

pg. 51
IAS 10 SBR Revision Notes

IAS 10 - EVENTS AFTER REPORTING DATE

OBJECTIVE
To prescribe:
 When an entity should adjust its financial statements for events after the reporting period; and
 The disclosures that an entity should give about the date when the financial statements were authorized for
issue and about events after the reporting period.

The Standard also requires that an entity should not prepare its financial statements on a going concern basis if
events after the reporting period indicate that the going concern assumption is not appropriate.

DEFINITIONS
Event after the reporting period occurs between the end of the reporting period and the date that the financial
statements are authorized for issue. These include:
 Adjusting events provide evidence of conditions that existed at the end of the reporting period.
 Non-adjusting events are those that are indicative of conditions that arose after the reporting period.

ACCOUNTING TREATMENT:
 Adjust financial statements for adjusting events
 Do not adjust for non-adjusting events
 If an entity declares dividends after the reporting period, the entity shall not recognize those dividends as a
liability at the end of the reporting period. That is a non-adjusting event.
 An entity shall not prepare its financial statements on a going concern basis if management determines after
the reporting period either that it intends to liquidate the entity or to cease trading.

ADJUSTING EVENTS – EXAMPLES

Adjusting events, as is evident by the name, require adjustments in the financial statements. Following are some
examples:
 Invoices received in respect of goods or services received before the year end
 The resolution after the reporting date of a court case giving rise to a liability
 Evidence of impairment of assets, such as news that a major customer is going into liquidation or the sale of
inventories below cost
 Discovery of fraud or errors showing that financial statements were incorrect
 Determination of employee bonuses/profit shares
 The tax rates applicable to the financial year are announced
 The auditors submit their fee
 The sale of a non-current asset at a loss indicates that it was impaired at the reporting date
 The bankruptcy of a customer indicates that their debt was irrecoverable at the reporting date
 The sale of inventory at less than cost indicates that it should have been valued at NRV in the accounts
 The determination of cost or proceeds of assets bought/sold during the accounting period indicates at what
amount they should be recorded in the accounts

pg. 52
IAS 10 SBR Revision Notes

NON-ADJUSTING EVENTS – EXAMPLES

Usually non-adjusting events do not require adjustments. However, if the event is of such importance that its non-
disclosure will affect the economic decision making of users it should be disclosed in the notes to the accounts. Some
examples of non-adjusting events are as follows:
 Business combinations
 Discontinuance of an operation
 Major sale/purchase of assets
 Destruction of major assets in natural disasters
 Major restructuring
 Major share transactions
 Unusual changes in asset prices/foreign exchange rates
 Commencing major litigation
 A purchase or sale of a non-current asset
 The destruction of assets due to fire or flood
 The announcement of plans to discontinue an operation
 An issue of shares

Dividends
If an entity declares dividends to holders of equity instruments after the reporting period but before the financial
statements, the entity shall not recognise those dividends as a liability at the end of the reporting period. This is
because no obligation exists at that time. Such dividends are disclosed in the notes.

Going concern
An entity shall not prepare its financial statements on a going concern basis if management determines after the
reporting period either that it intends to liquidate the entity or to cease trading, or that it has no realistic alternative
but to do so.

DISCLOSURE
Non-adjusting events should disclose the nature and financial effect of the event if its non-disclosure would affect
the judgment of users in making decisions.

Companies must disclose the following

 When the financial statements were authorized for issue
 Who gave that authorization
 Who has the power to amend the financial statements after issuance

pg. 53
IAS 37 SBR Revision Notes

IAS 37 – PROVISONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS

OBJECTIVE
The objective of this IAS is to ensure that appropriate recognition criteria and measurement bases are applied to
provisions, contingent liabilities and contingent assets.

PROVISIONS
DEFINITIONS
 A provision is a liability of uncertain timing or amount.
 An obligating event is an event that creates a legal or constructive obligation that results in an enterprise having
no realistic alternative to settling that obligation.
 A legal obligation is an obligation that derives from:
(a) A contract (through its explicit or implicit terms);
(b) Legislation; or
(c) Other operation of law.
 A constructive obligation is an obligation that derives from an enterprise’s action where:
(a) By an established pattern of past practice, published policies or a sufficiently specific current statement,
the enterprise has indicated to other parties that it will accept certain responsibilities; and
(b) As a result, the enterprise has created a valid expectation on the part of those other parties that it will
discharge those responsibilities.
 An onerous contract is a contract in which the unavoidable costs of meeting the obligations under the contract
exceed the economic benefits expected to be received under it.
 A restructuring is a program that is planned and controlled by management, and materially changes either:
(a) The scope of a business undertaken by an enterprise; or
(b) The manner in which that business is conducted.

RECOGNITION
A provision shall be recognized when:
a) An entity has a present obligation (legal or constructive) as a result of a past event;
b) It is possible than an outflow of resources embodying economic benefits will be required to settle the
obligation; and
c) A reliable estimate can be made of amount of the obligation.

If these conditions are not met, no provision shall be recognized.

Present obligation
In rare cases it is not clear whether there is a present obligation. In the cases, a past event is deemed to give rise to
a present obligation if, taking account of all available evidence, it is more likely than not that a present obligation
exists at the reporting date.

pg. 54
IAS 37 SBR Revision Notes

Past event
A past event that leads to a present obligation is called an obligating event. For an event to be an obligating event,
it is necessary that the entity has no realistic alternative to settling the obligation created by the event. This is the
case only:
a) Where the settlement of the obligation can be enforced by law; or
b) In the case of a constructive obligation, where the event (which may be an action of the entity) creates valid
expectations in other parties that the entity will discharge the obligation.

MEASUREMENT
The amount recognized as a provision shall be the best estimate of the expenditure required to settle the present
obligation at the reporting date. This means that:
 Provisions for one-off events (restructuring, environmental clean-up, settlement of a lawsuit) are measured at
the most likely amount.
 Provisions for large populations of events (warranties, customer refunds) are measured at a probability-
weighted expected value.
 Both measurements are at discounted present value using a pre-tax discount rate that reflects the current
market assessments of the time value of money and the risks specific to the liability.

In reaching its best estimate, the enterprise should take into account the risks and uncertainties that surround the
underlying events. Expected cash outflows should be discounted to their present values, where the effect of the
time value of money is material.

Reimbursement
If some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, the
reimbursement should be recognized as a reduction of the required provision when, and only when, it is virtually
certain that reimbursement will be received if the enterprise settles the obligation. The amount recognized should
not exceed the amount of the provision.

In SOFP, reimbursement should be shown as an asset and provision should be shown at gross amount however, in
statement of profit or loss they can be netted off.

Re-measurement of provisions
 Review and adjust provisions at each reporting date
 If outflow is no longer probable, reverse the provision to income statement.

Application of recognition and measurement rules

Some specific requirements on applying recognition and measurement rules are as follows:
 Future operating losses
Provisions shall not be recognized for future operating losses.
 Onerous contracts
If an entity has a contract that is onerous, the present obligation under the contract shall be recognized and
measured as a provision.

pg. 55
IAS 37 SBR Revision Notes

RESTRUCTURING
The following are examples of events that may fall under the definition of restructuring:
 Sale or termination of a line of business
 Closure of business locations
 Changes in management structure
 Fundamental re-organization of company

Restructuring provisions should be accrued as follows:

Sale of operation: Accrue provision only after a binding sale agreement. If the binding sale agreement is after
reporting date, disclose but do not accrue

Closure or re-organization: Accrue only after a detailed formal plan is adopted and announced publicly. A board
decision is not enough.

Restructuring provision on acquisition (merger): Accrue provision for terminating employees, closing facilities, and
eliminating product lines only if announced at acquisition and, then only if a detailed formal plan is adopted 3 months
after acquisition.

A management or board decision to restructure taken before the reporting date does not give rise to a constructive
obligation at the reporting date unless the entity has, before the reporting date:
a) Stated to implement the restructuring plan; or
b) Announced the main features the restructuring plan to those affected by it in a sufficiently specific manner
to raise a valid expectation in them that the entity will carry out the restructuring.

If an entity starts to implement a restructuring plan, or announces its main features to those affected, only after the
reporting date, disclosure is required under IAS 10 Events after the Reporting Date, if the restructuring is material
and non-disclosure could influence the economic decisions of users taken on the basis of the financial statements.

Restructuring provisions should include only direct expenditures caused by the restructuring, not costs that
associated with the ongoing activities of the enterprise such as: -
a) Retraining or relocating continuing staff;
b) Marketing; or
c) Investment in new systems and distribution networks

CONTINGENT LIABILITIES
Definition
A contingent liability is:
(a) A possible obligation that arises from past events and whose existence will be confirmed only by the occurrence
or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise; or
(b) A present obligation that arises from past events but is not recognized because:
(i) It is not probably that an outflow of resources embodying economic benefits will be required to settle
the obligation; or
(ii) The amount of the obligation cannot be measured with sufficient reliability.

pg. 56
IAS 37 SBR Revision Notes

Accounting treatment
 An enterprise should not recognize a contingent liability.
 A contingent liability is disclosed in financial statements, unless the possibility of an outflow of resources
embodying economic benefits is remote.

Where an enterprise is jointly and severally liable for an obligation, the part of the obligation that is expected to be
met by other parties is treated as a contingent liability.

The enterprise recognizes a provision for the part of the obligation for which an outflow of resources embodying
economic benefits is probable, except in the extremely rare circumstances where no reliable estimate can be made.
Contingent liabilities may develop in a way not initially expected. Therefore, they are assessed continually to
determine whether an outflow of resources embodying economic benefits has become probable. If it becomes
probable that an outflow of future economic benefits will be required for an item previously dealt with as a
contingent liability, a provision is recognized in the financial statements of the period in which the change in
probability occurs (except in the extremely rare circumstances where no reliable estimate can be made.)

CONTINGENT ASSETS
Definition
A contingent asset is a possible asset that arises from past events and whose existence will be confirmed only by
the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the
enterprise.

Accounting treatment
 An enterprise should not recognize a contingent asset.
 A contingent asset is disclosed in financial statements, where an inflow of economic benefits is probable.

Contingent assets usually arise from unplanned or other unexpected events that give rise to the possibility of an
inflow of economic benefits to the enterprise. An example is a claim that an enterprise is pursuing through legal
processes, where the outcome is uncertain.

Contingent assets are not recognized in financial statements since may result in the recognition of income that may
never be realized. However, when the realization of income is virtually certain, then the related asset is not a
contingent asset and its recognition is appropriate.

Contingent assets are assessed continually to ensure that developments are appropriately reflected in the financial
statements. If it has become virtually certain that an inflow of economic benefits will arise, the asset and the related
income are recognized in the financial statements of the period in which the change occurs. If an inflow of economic
benefits has become probable, an enterprise discloses the contingent asset.

pg. 57
IAS 37 SBR Revision Notes

Examples of Provisions

Situation Accrue a Provision?

Restructuring by sale of an operation Accrue a provision only after a binding sale agreement

Restructuring by closure or re-organization Accrue a provision only after a detailed formal plan is adopted and
announced publicly. A Board decision is not enough

Warranty Accrue a provision (past event was the sale of defective goods)

Land contamination Accrue a provision if the company's policy is to clean up even if

there is no legal requirement to do so (past event is the obligation
and public expectation created by the company's policy)

Offshore oil rig must be removed and sea Accrue a provision when installed, and add to the cost of the asset
bed restored

Abandoned leasehold, four years to run Accrue a provision

ACCA firm staff training for recent changes in No provision (there is no obligation to provide the training)
tax law

A chain of retail stores is self-insured for fire No provision until a an actual fire (no past event)
loss

Self-insured restaurant, people were Accrue a provision (the past event is the injury to customers)
poisoned, lawsuits are expected but none
have been filed yet

Major overhaul or repairs No provision (no obligation)

Onerous (loss-making) contract Accrue a provision

pg. 58
 IFRS 16 SBR Revision Notes

IFRS 16 – LEASES

OBJECTIVE
IFRS 16 establishes principles for the recognition, measurement, presentation and disclosure of leases, with the
objective of ensuring that lessees and lessors provide relevant information that faithfully represents those
transactions.

SCOPE
IFRS 16 Leases applies to all leases, including subleases, except for:
 Leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources;
 Leases of biological assets held by a lessee (see IAS 41 Agriculture);
 Licences of intellectual property granted by a lessor (see IFRS 15 Revenue from Contracts with Customers); and
 Rights held by a lessee under licensing agreements for items such as films, videos, plays, manuscripts, patents
and copyrights within the scope of IAS 38 Intangible Assets

KEY DEFINITIONS
Interest rate implicit in the lease
The interest rate that yields a present value of (a) the lease payments and (b) the unguaranteed residual value equal
to the sum of (i) the fair value of the underlying asset and (ii) any initial direct costs of the lessor.

Lease term
The non-cancellable period for which a lessee has the right to use an underlying asset, plus:
i. Periods covered by an extension option if exercise of that option by the lessee is reasonably certain; and
ii. Periods covered by a termination option if the lessee is reasonably certain not to exercise that option

Lessee’s incremental borrowing rate

The rate of interest that a lessee would have to pay to borrow over a similar term, and with a similar security, the
funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar economic environment.

LEASE – IMPORTANCE OF IFRS 16

A lease is an agreement whereby the lessor (the legal owner of an asset) conveys to the lessee (the user of the asset)
the right to use an asset for an agreed period of time in exchange for consideration (return for a payment or series
of payments).

The approach of IAS 17 was to distinguish between two types of lease. Leases that transfer substantially all the risks
and rewards of ownership of an asset were classified as finance leases. All other leases were classified as operating
leases. The lease classification set out in IAS 17 was subjective and there was a clear incentive for the preparers of
lessee’s financial statements to ‘argue’ that leases should be classified as operating rather than finance leases in
order to enable leased assets and liabilities to be left out of the financial statements.

It was for this reason that IFRS 16 was introduced.

pg. 59
IFRS 16 SBR Revision Notes

IFRS 16 - ASSETS
IFRS 16 defines a lease as 'A contract, or part of a contract, that conveys the right to use an asset for a period of time
in exchange for consideration'. In order for such a contract to exist the user of the asset needs to have the right to:
 Obtain substantially all of the economic benefits from the use of the asset.
 The right to direct the use of the asset.

An ‘identified asset’
One essential feature of a lease is that there is an ‘identified asset’. This normally takes place through the asset being
specified in a contract, or part of a contract.

A contract is, or contains, a lease if it conveys the right to control the use of an identified asset for a period of time
in exchange for consideration.

Control is conveyed where the customer has both the right to direct the identified asset’s use and to obtain
substantially all the economic benefits from that use.

An asset is typically identified by being explicitly specified in a contract, but an asset can also be identified by being
implicitly specified at the time it is made available for use by the customer.

For the asset to be ‘identified’ the supplier of the asset must not have the right to substitute the asset for an
alternative asset throughout its period of use. The fact that the supplier of the asset has the right or the obligation
to substitute the asset when a repair is necessary does not preclude the asset from being an ‘identified asset’.

A capacity portion of an asset is still an identified asset if it is physically distinct (e.g. a floor of a building). A capacity
or other portion of an asset that is not physically distinct (e.g. a capacity portion of a fiber optic cable) is not an
identified asset, unless it represents substantially all the capacity such that the customer obtains substantially all the
economic benefits from using the asset.

Example – identified assets

Under a contract between a local government authority (L) and a private sector provider (P), P provides L with 20
trucks to be used for refuse collection on behalf of L for a six-year period. The trucks, which are owned by P, are
specified in the contract. L determines how they are used in the refuse collection process. When the trucks are not
in use, they are kept at L’s premises. L can use the trucks for another purposes if it so chooses. If a particular truck
needs to be serviced or repaired, P is required to substitute a truck of the same type. Otherwise, and other than on
default by L, P cannot retrieve the trucks during the six-year period.

Conclusion: The contract is a lease. L has the right to use the 20 trucks for six years which are identified and explicitly
specified in the contract. Once delivered to L, the trucks can be substituted only when they need to be serviced or
repaired.

The right to direct the use of the asset

IFRS 16 states that a customer has the right to direct the use of an identified asset if either:
 The customer has the right to direct how and for what purpose the asset is used throughout its period of use,
or
 The relevant decisions about use are pre-determined and the customer has the right to operate the asset
throughout the period of use without the supplier having the right to change these operating instructions.

pg. 60
IFRS 16 SBR Revision Notes

Example – the right to direct the use of an asset

A customer (C) enters into a contract with a road haulier (H) for the transportation of goods from London to
Edinburgh on a specified truck. The truck is explicitly specified in the contract and H does not have substitution rights.
The goods will occupy substantially all of the capacity of the truck. The contract specifies the goods to be transported
on the truck and the dates of pickup and delivery.

H operates and maintains the truck and is responsible for the safe delivery of the goods. C is prohibited from hiring
another haulier to transport the goods or operating the truck itself.

Conclusion: This contract does not contain a lease.

There is an identified asset. The truck is explicitly specified in the contract and H does not have the right to substitute
that specified truck.

C does have the right to obtain substantially all of the economic benefits from use of the truck over the contract
period. Its goods will occupy substantially all of the capacity of the truck, thereby preventing other parties from
obtaining economic benefits from use of the truck.

However, C does not have the right to control the use of the truck because C does not have the right to direct its
use. C does not have the right to direct how and for what purpose the truck is used. How and for what purpose the
truck will be used (i.e. the transportation of specified goods from London to Edinburgh within a specified timeframe)
is predetermined in the contract. C has the same rights regarding the use of the truck as if it were one of many
customers transporting goods using the truck.

Separating components of a contract

For a contract that contains a lease component and additional lease and non-lease components, such as the lease
of an asset and the provision of a maintenance service, lessees shall allocate the consideration payable on the basis
of the relative stand-alone prices, which shall be estimated if observable prices are not readily available.

As a practical expedient, a lessee may elect, by class of underlying asset, not to separate non-lease components from
lease components and instead account for all components as a lease.

Lessors shall allocate consideration in accordance with IFRS 15 Revenue from Contracts with Customers.

ACCOUNTING FOR LEASES

With a very few exceptions (discussed later) IFRS 16 basically abolishes the distinction between an operating lease
and a finance lease in the financial statements of lessees. Lessees will recognise a right of use asset and an associated

Liability at the inception of the lease.

IFRS 16 basically requires that the ‘right of use asset’ and the lease liability should initially be measured at the
present value of the minimum lease payments. The discount rate used to determine present value should be the
rate of interest implicit in the lease.

pg. 61
IFRS 16 SBR Revision Notes

RECORDING THE ASSET

The ‘right of use asset’ would include the following amounts, where relevant:
 Any payments made to the lessor at, or before, the commencement date of the lease, less any lease incentives
received.
 Any initial direct costs incurred by the lessee.
 An estimate of any costs to be incurred by the lessee in dismantling and removing the underlying asset, or
restoring the site on which it is located (unless the costs are incurred to produce inventories, in which case they
would be accounted for in accordance with IAS 2 – Inventories). Costs of this nature are recognised only when
an entity incurs an obligation for them. IAS 37 – Provisions, Contingent Liabilities and Contingent Assets would
be applied to ascertain if an obligation existed.

Depreciation
The right of use asset is subsequently depreciated. Depreciation is over the shorter of the useful life of the asset and
the lease term, unless the title to the asset transfers at the end of the lease term, in which case depreciation is over
the useful life.

LEASE LIABILITY
The lease liability is effectively treated as a financial liability which is measured at amortised cost, using the rate of
interest implicit in the lease as the effective interest rate.

Example – accounting for leases

A lessee enters into a 20-year lease of one floor of a building, with an option to extend for a further five years. Lease
payments are $80,000 per year during the initial term and $100,000 per year during the optional period, all payable
at the end of each year. To obtain the lease, the lessee incurred initial direct costs of $25,000.

At the commencement date, the lessee concluded that it is not reasonably certain to exercise the option to extend
the lease and, therefore, determined that the lease term is 20 years. The interest rate implicit in the lease is 6% per
annum. The present value of the lease payments is $917,600.

At the commencement date, the lessee incurs the initial direct costs and measures the lease liability $917,600.

The carrying amount of the right of use asset after these entries is $942,600 ($917,600 + $25,000) and consequently
the annual depreciation charge will be $47,130 ($942,600 x 1/20).

The lease liability will be measured using amortised cost principles. In order to help us with the example in the
following section, we will measure the lease liability up to and including the end of year two. This is done in the
following table:

Balance Finance Balance

b/fwd cost (6%) Rental c/fwd
Year $ $ $ $

1 917,600 55,056 (80,000) 892,656

2 892,656 53,559 (80,000) 866,215

pg. 62
IFRS 16 SBR Revision Notes

At the end of year one, the carrying amount of the right of use asset will be $895,470 ($942,600 less $47,130
depreciation).

The interest cost of $55,056 will be taken to the statement of profit or loss as a finance cost.

The total lease liability at the end of year one will be $892,656. As the lease is being paid off over 20 years, some of
this liability will be paid off within a year and should therefore be classed as a current liability.

To find this figure, we look at the remaining balance following the payment in year two. Here, we can see that the
remaining balance is $866,215. This will represent the non-current liability, being the amount of the $892,656 which
will still be outstanding in over a year. The current liability element is therefore $26,441. This represents the $80,000
paid in year two less year two’s finance costs of $53,559 (or $892,656-$866,215).

Points to remember
Upon lease commencement a lessee recognises a right-of-use asset and a lease liability.

The right-of-use asset is initially measured at the amount of the lease liability plus any initial direct costs incurred
by the lessee. Adjustments may also be required for lease incentives, payments at or prior to commencement and
restoration obligations or similar.
After lease commencement, a lessee shall measure the right-of-use asset using a cost model, unless:
a) The right-of-use asset is an investment property and the lessee fair values its investment property under IAS 40;
or
b) The right-of-use asset relates to a class of PPE to which the lessee applies IAS 16’s revaluation model, in which
case all right-of-use assets relating to that class of PPE can be revalued.

Under the cost model a right-of-use asset is measured at cost less accumulated depreciation and accumulated
impairment.

The lease liability is initially measured at the present value of the lease payments payable over the lease term,
discounted at the rate implicit in the lease if that can be readily determined. If that rate cannot be readily
determined, the lessee shall use their incremental borrowing rate.

Variable lease payments

Variable lease payments are the payments that depend on an index or a rate are included in the initial measurement
of the lease liability and are initially measured using the index or rate as at the commencement date. Amounts
expected to be payable by the lessee under residual value guarantees are also included.

Variable lease payments that are not included in the measurement of the lease liability are recognised in profit or
loss in the period in which the event or condition that triggers payment occurs, unless the costs are included in the
carrying amount of another asset under another Standard.

The lease liability is subsequently remeasured to reflect changes in:

 The lease term (using a revised discount rate);
 The assessment of a purchase option (using a revised discount rate);
 The amounts expected to be payable under residual value guarantees (using an unchanged discount rate); or

pg. 63
IFRS 16 SBR Revision Notes

 Future lease payments resulting from a change in an index or a rate used to determine those payments (using
an unchanged discount rate).

The re-measurements are treated as adjustments to the right-of-use asset.

Lease modifications may also prompt re-measurement of the lease liability unless they are to be treated as separate
leases.

RECOGNITION EXEMPTIONS
A simplified approach for short-term or low-value leases – Exception
Instead of applying the recognition requirements of IFRS 16 described above, a lessee may elect to account for lease
payments as an expense on a straight-line basis over the lease term or another systematic basis for the following
two types of leases:
i) Leases with a lease term of 12 months or less and containing no purchase options – this election is made
by class of underlying asset; and
ii) Leases where the underlying asset has a low value when new (such as personal computers or small items
of office furniture) – this election can be made on a lease-by-lease basis.

A lease of an underlying asset does not qualify as a lease of a low-value asset if the nature of the asset is such that,
when new, the asset is typically not of low value. For example, leases of cars would not qualify as leases of low-value
assets because a new car would typically not be of low value.

Examples of low-value underlying assets can include tablet and personal computers, small items of office furniture
and telephones.

SALE AND LEASEBACK TRANSACTIONS

Introduction
The treatment of sale and leaseback transactions depends on whether or not the ‘sale’ constitutes the satisfaction
of a relevant performance obligation under IFRS 15 – Revenue from Contracts with Customers. The relevant
performance obligation would be the effective ‘transfer’ of the asset to the lessor by the previous owner (now the
lessee).

Transaction constituting a sale

If the transaction does constitute a ‘sale’ under IFRS 15 then the treatment is as follows:
 The seller-lessee shall recognise only the amount of any gain or loss that relates to the rights transferred to the
buyer-lessor.
 The buyer-lessor shall account for the purchase of the asset applying applicable Standards, and for the lease
applying the lessor accounting requirements in IFRS 16 (these being essentially unchanged from the predecessor
standard).

If the fair value of the consideration for the sale of an asset does not equal the fair value of the asset, or if the
payments for the lease are not at market rates, an entity shall make the following adjustments to measure the sale
proceeds at fair value:
 Any below-market terms shall be accounted for as a prepayment of lease payments; and
 Any above-market terms shall be accounted for as additional financing provided by the buyer-lessor to the
seller-lessee.

pg. 64
IFRS 16 SBR Revision Notes

Example – sale and leaseback

Entity X sells a building to entity Y for cash of $5 million. Immediately before the transaction, the carrying amount of
the building in the financial statements of entity X was $3.5 million. At the same time, X enters into a contract with
Y for the right to use the building for 20 years, with annual payments of $200,000 payable at the end of each year.
The terms and conditions of the transaction are such that the transfer of the building by X satisfies the requirements
for determining when a performance obligation is satisfied in IFRS 15, Revenue from Contracts with Customers.
Accordingly, X and Y account for the transaction as a sale and leaseback.

The fair value of the building at the date of sale is $4.5 million. Because the consideration for the sale of the building
is not at fair value, X and Y make adjustments to measure the sale proceeds at fair value. The amount of the excess
sale price of $500,000 ($5 million – $4.5 million) is recognised as additional financing provided by Y to X.

The annual interest rate implicit in the lease is 5%. The present value of the annual payments (20 payments of
$200,000, discounted at 5%) amounts to $2,492,400, of which $500,000 relates to the additional financing and
$1,992,400 ($2,492,200 – $500,000) relates to the lease (as adjusted for the fair value difference already identified).
The annual payment that would be required to be made 20 times in arrears to repay additional financing of $500,000
when the rate of interest is 5% per annum would be $40,122 ($500,000/12.462 (the cumulative discount factor for
5% for 20 years)). Therefore the residual would be regarded as a ‘lease rental’ at an amount of $159,878 ($200,000
– $40,122).

Given the IFRS 15 treatment as a ‘sale’ Y would almost certainly regard the lease of the building as an operating
lease. This means that Y would recognise the ‘lease rentals’ of $159,878 as income.

Transaction not constituting a ‘sale’

In these circumstances the seller does not ‘transfer’ the asset and continues to recognise it, without adjustment.
The ‘sales proceeds’ are recognised as a financial liability and accounted for by applying IFRS 9, Financial Instruments.
In the same circumstances, the buyer recognizes a financial asset equal to the ‘sales proceeds’.

IMPACT OF IFRS 16 ON ACCOUNTING RATIOS

The requirements of IFRS 16 will have significant impacts on key accounting ratios of lessees. The greater recognition
of leased assets and lease liabilities on the statement of financial position will reduce return on capital employed
and increase gearing. Initial measures of profit are likely to be reduced, as in the early years of a lease the
combination of depreciation of the right of use asset and the finance charge associated with the lease liability will
exceed the lease rentals (normally charged on a straight-line basis).

ACCOUNTING BY LESSORS
Lessors shall classify each lease as an operating lease or a finance lease.
A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership of
an underlying asset. Otherwise a lease is classified as an operating lease.

Examples of situations that individually or in combination would normally lead to a lease being classified as a finance
lease are:
 The lease transfers ownership of the asset to the lessee by the end of the lease term
 The lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than fair
value at the date the option becomes exercisable that, at the inception of the lease, it is reasonably certain
that the option will be exercised

pg. 65
IFRS 16 SBR Revision Notes

 The lease term is for the major part of the economic life of the asset, even if title is not transferred
 At the inception of the lease, the present value of the minimum lease payments amounts to at least
substantially all of the fair value of the leased asset
 The leased assets are of a specialised nature such that only the lessee can use them without major
modifications being made

Upon lease commencement, a lessor shall recognise assets held under a finance lease as a receivable at an amount
equal to the net investment in the lease.

A lessor recognises finance income over the lease term of a finance lease, based on a pattern reflecting a constant
periodic rate of return on the net investment.

At the commencement date, a manufacturer or dealer lessor recognises selling profit or loss in accordance with its
policy for outright sales to which IFRS 15 applies.

A lessor recognises operating lease payments as income on a straight-line basis or, if more representative of the
pattern in which benefit from use of the underlying asset is diminished, another systematic basis.

DISCLOSURE
The objective of IFRS 16’s disclosures is for information to be provided in the notes that, together with information
provided in the statement of financial position, statement of profit or loss and statement of cash flows, gives a basis
for users to assess the effect that leases have.

pg. 66
IFRS 15 SBR Revision Notes

IFRS 15 – REVENUE FROM CONTRACTS WITH CUSTOMERS

IFRS 15 specifies how and when an IFRS reporter will recognise revenue.

THE FIVE-STEP MODEL FRAMEWORK

The core principle of IFRS 15 is that an entity shall recognise revenue from the transfer of promised good or services
to customers at an amount that reflects the consideration to which the entity expects to be entitled in exchange for
those goods and services. The standard introduces a five-step model for the recognition of revenue.

The five-step model applies to revenue earned from a contract with a customer with limited exceptions, regardless
of the type of revenue transaction or the industry.

STEP 1: IDENTIFY THE CONTRACT WITH THE CUSTOMER

Step one in the five-step model requires the identification of the contract with the customer. A contract with a
customer will be within the scope of IFRS 15 if all the following conditions are met:
 The contract has been approved by the parties to the contract;
 Each party’s rights in relation to the goods or services to be transferred can be identified;
 The payment terms for the goods or services to be transferred can be identified;
 The contract has commercial substance; and
 It is probable that the consideration to which the entity is entitled to in exchange for the goods or services will
be collected.

Contracts may be in different forms (written, verbal or implied). If a contract with a customer does not meet these
criteria, the entity can continually reassess the contract to determine whether it subsequently meets the criteria.
Two or more contracts that are entered into around the same time with the same customer may be combined and
accounted for as a single contract, if they meet the specified criteria. The standard provides detailed requirements
for contract modifications. A modification may be accounted for as a separate contract or as a modification of the
original contract, depending upon the circumstances of the case.

STEP 2: IDENTIFY THE PERFORMANCE OBLIGATIONS IN THE CONTRACT

Step two requires the identification of the separate performance obligations in the contract. This is often referred
to as ‘unbundling’, and is done at the beginning of a contract. The key factor in identifying a separate performance
obligation is the distinctiveness of the good or service, or a bundle of goods or services.

At the inception of the contract, the entity should assess the goods or services that have been promised to the
customer, and identify as a performance obligation:
 a good or service (or bundle of goods or services) 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.

A series of distinct goods or services is transferred to the customer in the same pattern if both of the following
criteria are met:
 Each distinct good or service in the series that the entity promises to transfer consecutively to the customer
would be a performance obligation that is satisfied over time; and

pg. 67
IFRS 15 SBR Revision Notes

 A single method of measuring progress would be used to measure the entity’s progress towards complete
satisfaction of the performance obligation to transfer each distinct good or service in the series to the customer.

A good or service is distinct if both of the following criteria are met:

 The customer can benefit from the good or services on its own or in conjunction with other readily available
resources; and
 The entity’s promise to transfer the good or service to the customer is separately identifiable from other
promises/elements in the contract.

IFRS 15 requires that a series of distinct goods or services that are substantially the same with the same pattern of
transfer, to be regarded as a single performance obligation. A good or service which has been delivered may not be
distinct if it cannot be used without another good or service that has not yet been delivered. Similarly, goods or
services that are not distinct should be combined with other goods or services until the entity identifies a bundle of
goods or services that is distinct.

IFRS 15 provides indicators rather than criteria to determine when a good or service is distinct within the context
of the contract. This allows management to apply judgment to determine the separate performance obligations
that best reflect the economic substance of a transaction.

Factors for consideration as to whether a promise to transfer the good or service to the customer is separately
identifiable include, but are not limited to:
 The entity does not provide a significant service of integrating the good or service with other goods or services
promised in the contract.
 The good or service does not significantly modify or customise another good or service promised in the contract.
 The good or service is not highly interrelated with or highly dependent on other goods or services promised in
the contract.

STEP 3: DETERMINE THE TRANSACTION PRICE

Step three requires the entity to determine the transaction price, which is the amount of consideration that an
entity expects to be entitled to in exchange for the promised goods or services. When making this determination,
an entity will consider past customary business practices. This amount excludes amounts collected on behalf of a
third party – for example, government taxes. An entity must determine the amount of consideration to which it
expects to be entitled in order to recognise revenue.

Additionally, an entity should estimate the transaction price, taking into account non-cash consideration,
consideration payable to the customer and the time value of money if a significant financing component is present.
The latter is not required if the time period between the transfer of goods or services and payment is less than one
year. In some cases, it will be clear that a significant financing component exists due to the terms of the arrangement.
In other cases, it could be difficult to determine whether a significant financing component exists. This is likely to be
the case where there are long-term arrangements with multiple performance obligations such that goods or services
are delivered and cash payments received throughout the arrangement. For example, if an advance payment is
required for business purposes to obtain a longer-term contract, then the entity may conclude that a significant
financing obligation does not exist.

If an entity anticipates that it may ultimately accept an amount lower than that initially promised in the contract due
to, for example, past experience of discounts given, then revenue would be estimated at the lower amount with the

pg. 68
IFRS 15 SBR Revision Notes

collectability of that lower amount being assessed. Subsequently, if revenue already recognised is not collectable,
impairment losses should be taken to profit or loss.

Where a contract contains elements of variable consideration, the entity will estimate the amount of variable
consideration to which it will be entitled under the contract.

However, a different, more restrictive approach is applied in respect of sales or usage-based royalty revenue arising
from licences of intellectual property. Such revenue is recognised only when the underlying sales or usage occur.

STEP 4: ALLOCATE THE TRANSACTION PRICE TO THE PERFORMANCE OBLIGATIONS IN THE CONTRACTS
Step four requires the allocation of the transaction price to the separate performance obligations. Where a
contract has multiple performance obligations, an entity will allocate the transaction price to the performance
obligations in the contract by reference to the relative standalone selling prices of the goods or services promised.
This allocation is made at the inception of the contract. It is not adjusted to reflect subsequent changes in the
standalone selling prices of those goods or services.

The best evidence of standalone selling price is the observable price of a good or service when the entity sells that
good or service separately. If that is not available, an estimate is made by using an approach that maximises the use
of observable inputs – for example, expected cost plus an appropriate margin or the assessment of market prices
for similar goods or services adjusted for entity-specific costs and margins or in limited circumstances a residual
approach. The residual approach is different from the residual method that is used currently by some entities, such
as software companies.

When a contract contains more than one distinct performance obligation, an entity should allocate the transaction
price to each distinct performance obligation on the basis of the standalone selling price.

This will be a major practical issue as it may require a separate calculation and allocation exercise to be performed
for each contract. For example, a mobile telephone contract typically bundles together the handset and network
connection and IFRS 15 will require their separation.

STEP 5: RECOGNISE REVENUE WHEN (OR AS) THE ENTITY SATISFIES A PERFORMANCE OBLIGATION
Step five requires revenue to be recognised as each performance obligation is satisfied. This differs from IAS 18
where, for example, revenue in respect of goods is recognised when the significant risks and rewards of ownership
of the goods are transferred to the customer.

Revenue is recognised as control is passed. An entity satisfies a performance obligation by transferring control of a
promised good or service to the customer, which could occur over time or at a point in time.

Control of an asset is defined as the ability to direct the use of and obtain substantially all of the remaining benefits
from the asset. The benefits related to the asset are the potential cash flows that may be obtained directly or
indirectly. These include, but are not limited to:
 Using the asset to produce goods or provide services;
 Using the asset to enhance the value of other assets;
 Using the asset to settle liabilities or to reduce expenses;
 Selling or exchanging the asset;
 Pledging the asset to secure a loan; and

pg. 69
IFRS 15 SBR Revision Notes

 Holding the asset.

A performance obligation is satisfied at a point in time unless it meets one of the following criteria, in which case, it
is deemed to be satisfied over time. So, an entity recognises revenue over time if one of the following criteria is met:
 The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the
entity performs.
 The entity’s performance creates or enhances an asset that the customer controls as the asset is created or
enhanced.
 The entity’s performance does not create an asset with an alternative use to the entity and the entity has an
enforceable right to payment for performance completed to date.

Revenue is recognised in line with the pattern of transfer. Whether an entity recognises revenue over the period
during which it manufactures a product or on delivery to the customer will depend on the specific terms of the
contract.

If an entity does not satisfy its performance obligation over time, it satisfies it at a point in time. Revenue will
therefore be recognised when control is passed at a certain point in time. Factors that may indicate the point in time
at which control passes include, but are not limited to:
 The entity has a present right to payment for the asset;
 The customer has legal title to the asset;
 The entity has transferred physical possession of the asset;
 The customer has the significant risks and rewards related to the ownership of the asset; and
 The customer has accepted the asset.

As a consequence of the above, the timing of revenue recognition may change for some point-in-time transactions
when the new standard is adopted.

CONTRACT COSTS
The incremental costs of obtaining a contract must be recognised as an asset if the entity expects to recover those
costs.

Costs incurred to fulfill a contract are recognised as an asset if and only if all of the following criteria are met:
 The costs relate directly to a contract (or a specific anticipated contract);
 The costs generate or enhance resources of the entity that will be used in satisfying performance obligations
in the future; and
 The costs are expected to be recovered.

The asset recognised in respect of the costs to obtain or fulfill a contract is amortised on a systematic basis that is
consistent with the pattern of transfer of the goods or services to which the asset relates.

PRINCIPLES OF REVENUE RECOGNITION

Sale on return basis
 In case of sale on return basis, an estimate should be made of the amount of goods expected to be returned.
 The most likely amount of return can be determined by past experience or by assigning probability to
estimated figures

pg. 70
IFRS 15 SBR Revision Notes

 For the goods expected to be returned, sale is not recognized. A refund liability is recorded with the amount.
 The right to receive inventory with a corresponding adjustment to cost of sales
 If the item is ultimately not returned, then it will be recognized as sale at the point of confirmation of no
return.

Warranty
 In case of option to purchase warranty separately (extended), warranty is distinct and should be recognized
as a separate performance obligation
 If a customer does not have the option to purchase a warranty separately, an entity shall account for the
warranty in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Asset

Principal versus agent considerations

 When another party is involved in providing goods or services to a customer, the entity shall determine
whether the nature of its promise is a performance obligation to provide the specified goods or services itself
(ie the entity is a principal) or to arrange for the other party to provide those goods or services (ie the entity
is an agent).
 An entity is a principal if the entity controls a promised good or service before the entity transfers the good
or service to a customer. However, an entity is not necessarily acting as a principal if the entity obtains legal
title of a product only momentarily before legal title is transferred to a customer.
 When an entity that is a principal satisfies a performance obligation, the entity recognises revenue in the
gross amount of consideration to which it expects to be entitled in exchange for those goods or services
transferred.
 An entity is an agent if the entity’s performance obligation is to arrange for the provision of goods or services
by another party. When an entity that is an agent satisfies a performance obligation, the entity recognises
revenue in the amount of any fee or commission to which it expects to be entitled in exchange for arranging
for the other party to provide its goods or services.

Indicators that an entity is an agent are as follows:

a. Another party is primarily responsible for fulfilling the contract;
b. The entity does not have inventory risk before or after the goods have been ordered by a customer,
during shipping or on return;
c. The entity does not have discretion in establishing prices for the other party’s goods or services and,
therefore, the benefit that the entity can receive from those goods or services is limited;
d. The entity’s consideration is in the form of a commission; and
e. The entity is not exposed to credit risk for the amount receivable from a customer in exchange for the
other party’s goods or services.

Repurchase agreements
A repurchase agreement is a contract in which an entity sells an asset and also promises or has the option (either in
the same contract or in another contract) to repurchase the asset. The repurchased asset may be the asset that was
originally sold to the customer, an asset that is substantially the same as that asset, or another asset of which the
asset that was originally sold is a component.

pg. 71
IFRS 15 SBR Revision Notes

Repurchase agreements generally come in three forms:

a. An entity’s obligation to repurchase the asset (a forward);
b. An entity’s right to repurchase the asset (a call option); and
c. An entity’s obligation to repurchase the asset at the customer’s request (a put option).

Forward & Call option

 In case of forward and call option, the customer does not obtain control
 If entity can or must repurchase at an amount less than original selling price of asset, then it will be accounted
for as lease
 If entity can or must repurchase at an amount equal to or more than original selling price of asset, then
accounting done as financing arrangement —recognize the asset and a financial liability

Put option
 If repurchase price lower than original selling price then see does customer have significant economic incentive
to exercise right
 If yes then account for as lease. If no, then recognize as sale of product with right of return
 If repurchase price is equal or greater than original selling price following two options arise
 If repurchase price is more than expected market value then accounting done as financing arrangement —
recognize the asset and a financial liability
 If Repurchase price is less than expected market value and no significant economic incentive to exercise right
then record as sale of product with right of return

Bill and hold arrangement

 Bill-and-hold arrangements are those whereby an entity bills a customer for the sale of a particular product, but
the entity retains physical possession until it is transferred to the customer at a later date.
 In assessing whether revenue can be recognized in a bill-and-hold transaction, entities must first determine
whether control has transferred to the customer (as with any other sale under IFRS 15) through review of the
indicators for the transfer of control. One indicator is physical possession of the asset; however, physical
possession may not coincide with control in all cases (e.g., in bill-and-hold arrangements).
 In determining whether control has transferred in such arrangements, the specific criteria included in IFRS 15
for bill-and-hold transactions must all be met in order for revenue to be recognized.
o The reason for the bill-and-hold arrangement must be substantive (e.g., the customer has requested the
arrangement).
o The product must be identified separately as belonging to the customer.
o The product currently must be ready for physical transfer to the customer.
o The entity cannot have the ability to use the product or to direct it to another customer.
 An entity that has transferred control of the goods and met the bill-and-hold criteria to recognize revenue will
also need to consider whether it is providing other services (e.g., custodial services). If so, a portion of the
transaction price should be allocated to each of the separate performance obligations (i.e., the goods and the
custodial service).

Non-refundable up-front fees

Although the accounting conclusion may not change with respect to non-refundable upfront fees for retailers, the
assessment process for such fees differs under IFRS 15.

pg. 72
IFRS 15 SBR Revision Notes

Set up activities (e.g. retailers’ ‘club’ fees, health-club joining fees, set-up fees, etc.) are not generally considered to
be distinct performance obligations because the customer’s ability to benefit from them is highly dependent upon
other goods or services in the contract. In such circumstances, the related upfront fees are considered to be advance
payments for future goods and services and therefore comprise part of the overall transaction price. The entity
allocates the overall transaction price among the identified performance obligations (as discussed above) and
recognises revenue as those performance obligations are satisfied (Step 5).

Consignment arrangements
When an entity delivers a product to another party (such as a dealer or a distributor) for sale to end customers, the
entity shall evaluate whether that other party has obtained control of the product at that point in time. A product
that has been delivered to another party may be held in a consignment arrangement if that other party has not
obtained control of the product.

Accordingly, an entity shall not recognise revenue upon delivery of a product to another party if the delivered
product is held on consignment.

Indicators that an arrangement is a consignment arrangement include, but are not limited to, the following:
a. The product is controlled by the entity until a specified event occurs, such as the sale of the product to a
customer of the dealer or until a specified period expires;
b. The entity is able to require the return of the product or transfer the product to a third party (such as
another dealer); and
c. The dealer does not have an unconditional obligation to pay for the product (although it might be required
to pay a deposit).

pg. 73
IFRS 13 SBR Revision Notes

IFRS 13 – FAIR VALUE MEASUREMENTS

NEED FOR FAIR VALUE GUIDANCE & IFRS 13:

IFRS 13 provides a single source of guidance for all fair value measurements, clarifying the definition of fair value
and enhancing disclosures requirements about reported fair value estimates.

OBJECTIVE
IFRS 13, Fair Value Measurement was issued in May 2011 and defines fair value, establishes a framework for
measuring fair value and requires significant disclosures relating to fair value measurement. The International
Accounting Standards Board (IASB) wanted to enhance disclosures for fair value in order that users could better
assess the valuation techniques and inputs that are used to measure fair value. There are no new requirements as
to when fair value accounting is required but rather it relies on guidance regarding fair value measurements in
existing standards.

The guidance in IFRS 13 does not apply to transactions dealt with by certain standards. For example share based
payment transactions in IFRS 2, Share-based Payment, leasing transactions in IFRS 16, Leases, or to measurements
that are similar to fair value but are not fair value – for example, net realisable value calculations in IAS 2, Inventories
or value in use calculations in IAS 36, Impairment of Assets. Therefore, IFRS 13 applies to fair value measurements
that are required or permitted by those standards not scoped out by IFRS 13. It replaces the inconsistent guidance
found in various IFRSs with a single source of guidance on measurement of fair value

FAIR VALUE DEFINITION

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date.

From the above definition, it can be inferred that fair value is an exit price. Consequently, fair value is focused on
the assumptions of the market place, is not entity specific and so takes into account any assumptions about risk. This
means that fair value is measured using the same assumptions used by market participants and takes into account
the same characteristics of the asset or liability. Such conditions would include the condition and location of the
asset and any restrictions on its sale or use.

An entity cannot argue that prices are too low relative to its own valuation of the asset and that it would be unwilling
to sell at low prices. The prices to be used are those in ‘an orderly transaction’. An orderly transaction is one that
assumes exposure to the market for a period before the date of measurement to allow for normal marketing
activities to take place and to ensure that it is not a forced transaction. If the transaction is not ‘orderly’ then there
will not have been enough time to create competition and potential buyers may reduce the price that they are willing
to pay. Similarly if a seller is forced to accept a price in a short period of time, the price may not be representative.
Therefore, it does not follow that a market in which there are few transactions is not orderly. If there has been
competitive tension, sufficient time and information about the asset, then this may result in an acceptable fair value.

Unit of account
IFRS 13 does not specify the unit of account that should be used to measure fair value. This means that it is left to
the individual standard to determine the unit of account for fair value measurement. A unit of account is the single
asset or liability or group of assets or liabilities. The characteristic of an asset or liability must be distinguished from
a characteristic arising from the holding of an asset or liability by an entity. An example of this is where an entity

pg. 74
IFRS 13 SBR Revision Notes

sells a large block of shares, and it has to sell them at a discount price to the market price. This is a characteristic of
holding the asset rather than a characteristic of the asset itself and should not be taken into account when fair
valuing the asset.

MARKETS – ACTIVE MARKET

A market in which transactions for the asset or liability take place with sufficient frequency and volume to provide
pricing information on an ongoing basis

MARKETS – PRINCIPAL MARKET

Fair value measurement assumes that the transaction to sell the asset or transfer the liability takes place in the
principal market for the asset or liability or, in the absence of a principal market, in the most advantageous market
for the asset or liability. The principal market is the one with the greatest volume and level of activity for the asset
or liability that can be accessed by the entity.

IFRS 13 provides a new framework to estimate fair value in a consistent manner across standards. For a fair value
measurement, an entity has to determine:
 The particular asset or liability that is the subject of the measurement
 For an asset, the valuation premise that is appropriate for the measurement
 The most advantageous market for the asset or liability and
 The valuation technique appropriate for measurement

MARKETS – THE MOST ADVANTAGEOUS MARKET

It is assumed that transactions take place in the most advantageous market to which the entity has access. This
means that the entity is in a position to receive the maximum amount on sale of the asset or pay the minimum
amount to transfer a liability after considering transaction and transport costs.

While transaction and transport costs are relevant to identify the market, they are not considered in determining
the fair value.

MEASUREMENT ASSUMPTIONS
Fair value measurement of an asset or liability should use the assumptions that market participants would use in
pricing the asset or liability. These assumptions include:
 Buyers and sellers are independent of each other
 They have knowledge about the asset or liability
 They are capable of entering into a transaction
 They are willing to enter into a transaction, rather than being forced or otherwise compelled.

VALUATION TECHNIQUES
An entity uses valuation techniques appropriate in the circumstances and for which sufficient data are available to
measure fair value, maximising the use of relevant observable inputs and minimising the use of unobservable inputs.
Where fair value is determined using a valuation technique, IFRS 13 prescribes that the technique should be one of
the following.
i. Market approach: uses price and other relevant market information for identical or comparable assets or
liabilities
ii. Income approach: converts future amounts to a single discounted present value amount or

pg. 75
IFRS 13 SBR Revision Notes

iii. Cost approach: amount that would currently be required to replace the service capacity of the asset

When measuring fair value, the entity is required to maximise the use of observable inputs and minimise the use of
unobservable inputs. To this end, the standard introduces a fair value hierarchy, which prioritises the inputs into the
fair value measurement process.

FAIR VALUE HIERARCHY

IFRS 13 seeks to increase consistency and comparability in fair value measurements and related disclosures through
a 'Fair Value Hierarchy'. The hierarchy categorises the inputs used in valuation techniques into three levels.

Level 1 Inputs
Level 1 inputs are unadjusted quoted prices in active markets for items identical to the asset or liability being
measured. As with current IFRS, if there is a quoted price in an active market, an entity uses that price without
adjustment when measuring fair value. An example of this would be prices quoted on a stock exchange. The entity
needs to be able to access the market at the measurement date. Active markets are ones where transactions take
place with sufficient frequency and volume for pricing information to be provided. An alternative method may be
used where it is expedient. The standard sets out certain criteria where this may be applicable. For example where
the price quoted in an active market does not represent fair value at the measurement date. An example of this may
be where a significant event takes place after the close of the market such as a business reorganisation or
combination.

The determination of whether a fair value measurement is based on level 2 or level 3 inputs depends on (i) whether
the inputs are observable inputs or unobservable and (ii) their significance.

Level 2 Inputs
Level 2 inputs are inputs other than the quoted prices in determined in level 1 that are directly or indirectly
observable for that asset or liability. They are likely to be quoted assets or liabilities for similar items in active markets
or supported by market data. For example interest rates, credit spreads or yields curves. Adjustments may be needed
to level 2 inputs and, if this adjustment is significant, then it may require the fair value to be classified as level 3.

Level 3 Inputs
Finally, level 3 inputs are unobservable inputs. These inputs should be used only when it is not possible to use Level
1 or 2 inputs. The entity should maximise the use of relevant observable inputs and minimise the use of unobservable
inputs.

However, situations may occur where relevant inputs are not observable and therefore these inputs must be
developed to reflect the assumptions that market participants would use when determining an appropriate price for
the asset or liability.

The general principle of using an exit price remains and IFRS 13 does not preclude an entity from using its own data.
For example cash flow forecasts may be used to value an entity that is not listed. Each fair value measurement is
categorised based on the lowest level input that is significant to it.

ASSET -SPECIFIC VALUATIONS

For a fair value measurement of an asset, it is assumed that the asset will be sold to a market participant who will
use it at its highest and best use.

pg. 76
IFRS 13 SBR Revision Notes

LIABILITY or EQUITY – SPECIFIC VALUATION

Fair value measurement of a liability, or owner’s own equity assumes that the liability is transferred to a market
participant at the measurement date. In many cases there is no observable market to provide pricing information
and the highest and best use is not applicable. In this case, the fair value is based on the perspective of a market
participant who holds the identical instrument as an asset.

Where there is no observable market price for the transfer of a liability, an entity would be required to measure the
fair value of the liability using the same methodology that the counterparty would use to measure the fair value of
the corresponding asset.

If there is no corresponding asset, then a corresponding valuation technique may be used. This would be the case
with a decommissioning activity.

The fair value of a liability reflects the nonperformance risk based on the entity’s own credit standing plus any
compensation for risk and profit margin that a market participant might require to undertake the activity.
Transaction price is not always the best indicator of fair value at recognition because entry and exit prices are
conceptually different.

Valuation concepts
IFRS 13 also sets out certain valuation concepts to assist in the determination of fair value. For non-financial assets
only, fair value is determined based on the highest and best use of the asset as determined by a market participant.
Highest and best use is a valuation concept that considers how market participants would use a non-financial asset
to maximise its benefit or value. The maximum value of a non-financial asset to market participants may come from
its use in combination with other assets and liabilities or on a standalone basis.

In determining the highest and best use of a non-financial asset, IFRS 13 indicates that all uses that are physically
possible, legally permissible and financially feasible should be considered. As such, when assessing alternative uses,
entities should consider the physical characteristics of the asset, any legal restrictions on its use and whether the
value generated provides an adequate investment return for market participants.

RULES IN BUSINESS COMBINATION:

IFRS 3 sets out general principles for arriving at the fair values of a subsidiary's assets and liabilities only if they
satisfy the following criteria:
 In the case of an asset other than an intangible asset, it is probable that any associated future economic benefits
will flow to the acquirer, and its fair value can be measured reliably. Vice versa for liabilities
 In the case of an intangible asset or a contingent liability, its fair value can be measured reliably.
 The acquiree's identifiable assets and liabilities might include assets and liabilities not previously recognised in
the acquiree's financial statements
 An acquirer should not recognise liabilities for future losses or other costs expected to be incurred as a result of
the business combination.
 The acquiree may have intangible assets which can only be recognised separately from goodwill if they are
identifiable. They must be able to be capable of being separated from the entity.
 The acquirer should measure the cost of a business combination as the total of the fair values at the date of
acquisition
 If part of the consideration is payable at a later date, this deferred consideration is discounted to present value
at the date of exchange.

pg. 77
IFRS 13 SBR Revision Notes

 In case of equity instruments as cost of investment, the published price at the date of exchange normally
provides the best evidence of the instrument's fair value.
 Costs attributable to the combination, for example professional fees and administrative costs, should not be
included: they are recognised as an expense when incurred.
 If an asset or liability has been recognised at fair value at acquisition, it must be recorded in the subsidiary’s
statement of financial position at fair value consequently also
 Some fair value adjustments are made on depreciable assets such as buildings, the assets with fair value
adjustment must be depreciated at its fair value so there will be an adjustment, which flows through to profit
or loss for this additional depreciation.

Disclosures
The guidance includes enhanced disclosure requirements that include:
 Information about the hierarchy level into which fair value measurements fall
 Transfers between levels 1 and 2
 Methods and inputs to the fair value measurements and changes in valuation techniques, and
 Additional disclosures for level 3 measurements that include a reconciliation of opening and closing balances,
and quantitative information about unobservable inputs and assumptions used.

pg. 78
 IAS 19 SBR Revision Notes

IAS 19 EMPLOYEE BENEFITS

OBJECTIVE
The objective of this Standard is to prescribe the accounting and disclosure for employee benefits.

SCOPE
Employee benefits include:
(a) Short-term employee benefits
(b) Post-employment benefits
(c) Other long-term employee benefits
(d) Termination benefits.

IAS 19 should be applied by all entities in accounting for the provision of all employee benefits, except those benefits
which are equity-based (awarding shares, share appreciation rights etc) and to which IFRS 2 applies. The Standard
applies regardless of whether the benefits have been provided as part of a formal contract or an informal
arrangement (constructive obligation).

Considerations given to an employee by an entity in exchange for the employee's services is in following forms.
i. Cash bonuses
ii. Retirement benefits
iii. Private health care

A number of accounting issues arise due to actuarial complexities and the impact of deferred taxes:
 The valuation problems linked to some forms of employee benefits; and
 The timing of benefits, which may not always be provided in the same period as the one in which the employee's
services are provided.

DEFINITIONS
Employee benefits are all forms of consideration given by an entity in exchange for service rendered by employees
or for the termination of employment.

Short-term employee benefits are employee benefits (other than termination benefits) that are expected to be
settled wholly before twelve months after the end of the annual reporting period in which the employees render
the related service.

Post-employment benefits are employee benefits (other than termination benefits and short-term employee
benefits) that are payable after the completion of employment.

Other long-term employee benefits are all employee benefits other than short-term employee benefits, post-
employment benefits and termination benefits.

Termination benefits are employee benefits provided in exchange for the termination of an employee’s employment
as a result of either:
(a) An entity’s decision to terminate an employee’s employment before the normal retirement date; or
(b) An employee’s decision to accept an offer of benefits in exchange for the termination of employment.

pg. 79
IAS 19 SBR Revision Notes

Investment risk: This is defined as the risk that there will be insufficient funds in the plan to meet the expected
benefits.

Actuarial risk: This is the risk that the actuarial assumptions such as those on employee turnover, life expectancy or
future salaries vary significantly from that actually happens.

SHORT TERM EMPLOYEE BENEFITS

Short-term employee benefits are employee benefits (other than termination benefits) that are expected to be
settled wholly before twelve months after the end of the annual reporting period in which the employees render
the related service and expense is recognized on accrual basis..

Short-term employee benefits include items such as:

(a) Wages, salaries and social security contributions;
(b) Short-term compensated absences (such as paid annual vacation, paid sick leave and paid maternity/paternity
leave. To fall within the definition, the absences should be expected to occur within 12 months of the end of
the period in which the employee services were provided;
(c) Profit-sharing and bonuses payable within 12 months of the end of the period
(d) Non-monetary benefits (such as medical care, housing, cars and free or subsidized goods or services) for current
employees.

Recognition and Measurement: All Short Term Employee Benefits

The undiscounted amount of short-term employee benefits expected to be paid in exchange for the service during
the period is recognized as:
(a) as a liability (accrued expense), after deducting any amount already paid (As an asset if prepaid expense)
(b) As an expense, unless another IFRS requires or permits the inclusion of the benefits in the cost of an asset.

Short Term Compensated Absences

Definition
Short-term compensated absences: Compensated absences are periods of absence from work for which the
employee receives some form of payment and which are expected to occur within 12 months of the end of the
period in which the employee renders the services.

Examples of short-term compensated absences are paid annual vacation and paid sick leave.
Short-term compensated absences fall into two categories:
 Accumulating absences. These are benefits, such as paid annual vacation, that accrue over an employee’s
period of service and can be potentially carried forward and used in future periods if not taken: and
 Non-accumulating absences. These are benefits that an employee is entitled to, but they elapse if not taken in
the current period. Where an employee has an unused entitlement at the end of the reporting period and the
entity expects to provide the benefit, a liability should be created.

Profit-sharing and bonus plans

An entity should recognise an expense and a corresponding liability for the cost of providing profit-sharing
arrangements and bonus payments when:
(i) The entity has a present legal or constructive obligation. The legal obligation arises when payment is part of an
employee's employment contract. The constructive obligation arises where past performance has led to the
expectation that benefits will be payable in the current period.

pg. 80
IAS 19 SBR Revision Notes

(ii) A reliable estimate of the obligation can be made.

Conditions may be attached to such bonus payments; commonly, the employee must still be in the entity's
employment when the bonus becomes payable. An estimate should be made based on the expectation of the level
of bonuses that will ultimately be paid. IAS 19 sets out that a reliable estimate for bonus or profit-sharing
arrangements can be made only when:
 There are formal terms setting out determination of the amount of the benefit:
 The amount payable is determined by the entity before the financial statements are authorised for issue; or
 Past practice provides clear evidence of the amount of a constructive obligation.

POST-EMPLOYMENT BENEFITS
Post-employment benefits are employee benefits other than termination benefits, which are payable after the
completion of employment.
Post-employment benefits include, for example:
(a) Retirement benefits, such as pensions; and
(b) Other post-employment benefits, such as post-employment life insurance and post-employment medical care.

Post-employment benefit plans are formal or informal arrangements under which an entity provides post-
employment benefits for one or more employees.

There are two main types of post-employment benefit schemes:

o Defined contribution schemes where the future pension depends on the value of the fund
o Defined benefit schemes where the future pension depends on the final salary and years worked

These two alternative schemes are discussed in more detail below.

A pension scheme will normally be held in the form of a trust (pension fund) separate from the sponsoring employer.
Although the directors of the sponsoring company may also be trustees of the pension scheme, the sponsoring
company and the pension scheme are separate legal entities that are accounted for separately. IAS 19 covers
accounting for the pension scheme in the sponsoring company's accounts.

Defined contribution plans are post-employment benefit plans under which an entity pays fixed contributions into
a separate entity (a fund) and will have no legal or constructive obligation to pay further contributions if the fund
does not hold sufficient assets to pay all employee benefits relating to employee service in the current and prior
periods.

Defined benefit plans are post-employment benefit plans other than defined contribution plans.

Multi-employer plans are defined contribution plans (other than state plans) or defined benefit plans (other than
state plans) that:
(a) Pool the assets contributed by various entities that are not under common control; and
(b) Use those assets to provide benefits to employees of more than one entity, on the basis that contribution and
benefit levels are determined without regard to the identity of the entity that employs the employees.

pg. 81
IAS 19 SBR Revision Notes

DEFINED CONTRIBUTION PLANS

Characteristics of a defined contribution plan are:
 Contributions into the plan are fixed, normally at a percentage of an employee’s salary
 The amount of pension paid to retirees is not guaranteed and will depend upon the size of the plan, which in
turn depends upon the performance of the pension fund investments.

Risk Associated with Defined Contribution Schemes

Contributions are usually paid into the plan by both the employer and the employee. The expectation is that the
investments made will grow through capital appreciation and the reinvestment of returns and that on a member’s
retirement, the plan should have grown to be sufficient to provide the anticipated benefits. If the investments have
not performed as anticipated (Investment risk), the size of the plan will be smaller than initially anticipated and
therefore there will be insufficient assets to meet the expected benefits. The insufficiency of assets is described as
the investment risk and is carried by the employee.

The other main risk with retirement plans is that a given amount of annual benefit will cost more than expected if,
for example, life expectancy has increased markedly by the time benefits come to be drawn. So, the actuarial
assumptions regarding pension may deviate from actual results (Actuarial risk) e.g. employee turnover, average age
of employees etc. This is described as the actuarial and, in the case of defined contribution plans, this is also carried
by the employee.

Variables-returns on investments
Time

Defined (therefore)
Contributions Variable Benefits

Accounting for defined contribution plans is straightforward as the obligation is determined by the amount paid into
the plan in each period.

Recognition and measurement

Contributions into a defined contribution plan by an employer are made in return for services provided by an
employee during the period. The employer has no further obligation for the value of the assets of the plan or the
benefits payable.
 The entity should recognise contributions payable as an expense in the period in which the employee provides
services (except to the extent that labour costs may be included within the cost of assets).
 A liability should be recognised where contributions arise in relation to an employee's service, but remain unpaid
at the period end.
In the unusual situation where contributions are not payable during the period (or within 12 months of the end of
the period) in which the employee provides his or her services on which they accrue, the amount recognised should
be discounted, to reflect the time value of money.

Any excess contributions paid should be recognised as an asset (prepaid expenses) but only to the extent that the
prepayment will lead to a reduction in future payments or cash refund.

pg. 82
IAS 19 SBR Revision Notes

Disclosure requirements
Where an entity operates a defined contribution plan during the period, it should disclose:
 The amount that has been recognised as an expense during the period in relation in relation to the plan
 A description of the plan

DEFINED BENEFIT PLANS

These are defined by IAS 19 as all post-employment plans other than defined contribution plans.

These are defined by IAS 19 as all plans other than defined contribution plans.
Characteristics of defined benefit plan are:
 The amount of pension paid to retirees is defined by reference to factors such as length of service and salary
levels (i.e. it is guaranteed)
 Contributions into the plan are therefore variable depending upon how the plan is performing in relation to the
expected future obligation (i.e. if there is a shortfall, contribution will increase and vice versa)

Contribution Levels
The actuary advises the company on contributions necessary to produce the defined benefits (‘the funding plan’).
Contributions may be varied as a result.

Risk associated with defined benefit schemes

As the employer is obliged to make up any shortfall in the plan, it is effectively underwriting the investment and
actuarial risk associated with the plan. Thus in a defined benefit plan, the employer carries both the investment and
the actuarial risk.

Types of Defined Benefit Plans

There are two types of defined benefit plan:
 Funded plans: These plans are set up as separate legal entities and are managed independently, often by
trustees. Contributions paid by the employer and employee are paid into the separate legal entity. The assets
held within the separate legal entities are effectively ring-fenced for the payments of benefits. Illustration:

The
Company

Pays
contributions

The
Pension
Separate legal
scheme
entity under
trustees

Pays Receives pension

contributions The and other benefits
Employee on retirement

pg. 83
IAS 19 SBR Revision Notes

Unfunded plans: These plans are held within employer legal entities and are managed by the employers’
management teams. Assets may be allocated towards the satisfaction of retirement benefit obligations, although
these assets are not ring-fenced for the payment of benefits and remain the assets of the employer entity.

DEFINITIONS RELATING TO THE NET DEFINED BENEFIT LIABILITY (ASSET)

The net defined benefit liability (asset) is the deficit or surplus, adjusted for any effect of limiting a net defined
benefit asset to the asset ceiling.

The deficit or surplus is:

(a) The present value of the defined benefit obligation less
(b) The fair value of plan assets (if any).

The asset ceiling is the present value of any economic benefits available in the form of refunds from the plan or
reductions in future contributions to the plan.

The present value of a defined benefit obligation is the present value, without deducting any plan assets, of
expected future payments required to settle the obligation resulting from employee service in the current and
prior periods.

Plan assets comprise:

(a) Assets held by a long-term employee benefit fund; and
(b) Qualifying insurance policies.
Assets held by a long-term employee benefit fund are assets (other than non-transferable financial instruments
issued by the reporting entity) that:
(a) Are held by an entity (a fund) that is legally separate from the reporting entity and exists solely to pay or fund
employee benefits; and
(b) Are available to be used only to pay or fund employee benefits, are not available to the reporting entity’s
own creditors (even in bankruptcy), and cannot be returned to the reporting entity, unless either:
(i) the remaining assets of the fund are sufficient to meet all the related employee benefit obligations of
the plan or the reporting entity; or
(ii) the assets are returned to the reporting entity to reimburse it for employee benefits already paid.

A qualifying insurance policy is an insurance policy11issued by an insurer that is not a related party (as defined
in IAS 24 Related Party Disclosures) of the reporting entity, if the proceeds of the policy:
(a) can be used only to pay or fund employee benefits under a defined benefit plan; and
(b) are not available to the reporting entity’s own creditors (even in bankruptcy) and cannot be paid to the
reporting entity, unless either:
(i) the proceeds represent surplus assets that are not needed for the policy to meet all the related employee
benefit obligations; or
(ii) The proceeds are returned to the reporting entity to reimburse it for employee benefits already paid.

DEFINITIONS RELATING TO DEFINED BENEFIT COST

Service cost comprises:
(a) Current service cost, which is the increase in the present value of the defined benefit obligation resulting
from employee service in the current period;

pg. 84
IAS 19 SBR Revision Notes

(b) Past service cost, which is the change in the present value of the defined benefit obligation for employee
service in prior periods, resulting from a plan amendment (the introduction or withdrawal of, or changes to,
a defined benefit plan) or a curtailment (a significant reduction by the entity in the number of employees
covered by a plan); and
(c) Any gain or loss on settlement.

Net interest on the net defined benefit liability (asset) is the change during the period in the net defined benefit
liability (asset) that arises from the passage of time.

Remeasurement of the net defined benefit liability (asset) comprise:

(a) Actuarial gains and losses;
(b) The return on plan assets, excluding amounts included in net interest on the net defined benefit liability
(asset); and 1 A qualifying insurance policy is not necessarily an insurance contract, as defined in IFRS 4
Insurance Contracts.
(c) Any change in the effect of the asset ceiling, excluding amounts included in net interest on the net defined
benefit liability (asset).

Actuarial gains and losses are changes in the present value of the defined benefit obligation resulting from:
(a) experience adjustments (the effects of differences between the previous actuarial assumptions and what has
actually occurred); and
(b) The effects of changes in actuarial assumptions.

The return on plan assets is interest, dividends and other income derived from the plan assets, together with
realised and unrealised gains or losses on the plan assets, less:
(a) any costs of managing plan assets; and
(b) Any tax payable by the plan itself, other than tax included in the actuarial assumptions used to measure the
present value of the defined benefit obligation.

A settlement is a transaction that eliminates all further legal or constructive obligations for part or all of the
benefits provided under a defined benefit plan, other than a payment of benefits to, or on behalf of, employees
that is set out in the terms of the plan and included in the actuarial assumptions.

RECOGNITION AND MEASUREMENT – A SUMMARY

IAS 19 requires the following.
(a) Contributions to a defined contribution plan should be recognised as an expense in the period they are payable
(except to the extent that labour costs may be included within the cost of assets).
(b) Any liability for unpaid contributions that are due as at the end of the period should be recognized as a liability
(accrued expense).
(c) Any excess contributions paid should be recognised as an asset (prepaid expense), but only to the extent that
the prepayment will lead to, e.g. a reduction in future payments or a cash refund.

In the (unusual) situation where contributions to a defined contribution plan do not fall due entirely within 12
months after the end of the period in which the employees performed the related service, then these should be
discounted.

pg. 85
IAS 19 SBR Revision Notes

RECOGNITION AND MEASUREMENT - DETAILS

Accounting by an entity for defined benefit plans involves the following steps:
(a) Determining the deficit or surplus. This involves:
(i) Using an actuarial technique, the projected unit credit method is used to make a reliable estimate of the
ultimate cost to the entity of the benefit using estimates (actuarial assumptions) about demographic
variables (such as employee turnover and mortality) and financial variables (such as future increases in
salaries and medical costs).
(ii) Calculating the present value of the defined benefit obligation and the current service cost
(iii) Deducting the fair value of any plan assets from the present value of the defined benefit obligation.
(b) Determining the amount of the net defined benefit liability (asset) as the amount of the deficit or surplus
determined in (a), adjusted for any effect of limiting a net defined benefit asset to the asset ceiling.
(c) Determining amounts to be recognised in profit or loss:
(i) Current service cost.
(ii) Any past service cost and gain or loss on settlement.
(iii) Net interest on the net defined benefit liability (asset).
(d) Determining the remeasurements of the net defined benefit liability (asset), to be recognised in other
comprehensive income, comprising:
(i) Actuarial gains and losses;
(ii) Return on plan assets, excluding amounts included in net interest on the net defined benefit liability (asset);
and
(iii) Any change in the effect of the asset ceiling , excluding amounts included in net interest on the net defined
benefit liability (asset).

Accounting For the Constructive Obligation

An entity shall account for any constructive obligation also that arises from the entity’s informal practices.

The Statement of Financial Position

In the statement of financial position, the amount recognised as a defined benefit liability (which may be a negative
amount, i.e. an asset) should be the following.
(a) The present value of the defined obligation at the year end, minus
(b) The fair value of the assets of the plan as at the yearend (if there are any) out of which the future obligations
to current and past employees will be directly settled.

Recognition and Measurement: Present Value of Defined Benefit Obligation and Current Service Cost
The ultimate cost of a defined benefit plan may be influenced by many variables, such as final salaries, employee
turnover and mortality, employee contributions and medical cost trends. The ultimate cost of the plan is uncertain
and this uncertainty is likely to persist over a long period of time. In order to measure the present value of the post-
employment benefit obligations and the related current service cost, it is necessary:
(a) To apply an actuarial valuation method;
(b) To attribute benefit to periods of service; and
(c) To make actuarial assumptions.

Attributing benefits to periods of service

 Where a plan provides for a lump sum benefit payment at a specified time in the future, IAS 19 requires that
the benefits are attributed to periods of service on a straight line basis over the period in which the benefit
accrues.

pg. 86
IAS 19 SBR Revision Notes

 Benefits accruing in later periods may be greater than those accruing in earlier periods. Where this is the case,
IAS 19 again requires benefits to be attributed to periods of service on a straight line basis over the period in
which the benefit accrues.
 If the benefit is to be based on a constant proportion of final salary for each year of service, the amount of
benefit attributable to each period of service is a constant proportion of the estimated final salary.

The Statement of Profit or Loss and Other Comprehensive Income

All of the gains and losses that affect the plan obligation and plan asset must be recognised. The components of
defined benefit cost must be recognised as follows in the statement of profit or loss and other comprehensive
income:
Component Recognised in
(a) Service cost Profit or loss
(b) Net interest on the net defined benefit liability Profit or loss
(c) Remeasurements of the net defined benefit liability Other comprehensive income (not
reclassified to P/L
Unwinding of Interest
IAS 19 requires that the interest should be calculated on the net defined benefit liability (asset). This means that the
amount recognised in profit or loss is the net of the interest charge on the obligation and the interest income
recognised on the assets.

The calculation is as follows:

Net defined benefit liability/(asset) x Discount Rate

The net defined benefit liability/(asset) should be determined as at the start of the accounting period, taking
account of changes during the period as a result of contributions paid into the scheme and benefits paid out.

Discount Rate
The discount rate adopted should be determined by reference to market yields on high quality fixed-rate corporate
bonds.
Dr. Interest cost
Cr. PV of defined benefit obligation

Service Costs
These comprise:
(a) Current service cost, this is the increase in the present value of the defined benefit obligation resulting from
employee services during the period.
(b) Past service cost, is the change in the obligation relating to service in prior periods. This results from
amendments or curtailments to the pension plan, and
(c) Any gain or loss on settlement.

Current Service Cost

The amount of pension paid out by defined benefit schemes is often calculated based on the number of years of
service of an employee. Therefore, with each year that an employee remains in employment, the pension liability
will increase.

pg. 87
IAS 19 SBR Revision Notes

The current service cost is accounted for by

Dr. Current service cost expense
Cr. PV of Defined Benefit Obligation

Past Service Costs

Past service cost is the change in the present value of the defined benefit obligation resulting from a plan
amendment or curtailment.

An entity shall recognise past service cost as an expense at the earlier of the following dates:
(a) When the plan amendment or curtailment occurs; and
(b) When the entity recognises related restructuring costs (see IAS 37) or termination benefits.

A plan amendment occurs when an entity introduces, or withdraws, a defined benefit plan or changes the benefits
payable under an existing defined benefit plan.

A curtailment occurs when an entity significantly reduces the number of employees covered by a plan. A curtailment
may arise from an isolated event, such as the closing of a plant, discontinuance of an operation or termination or
suspension of a plan.

Where an entity reduces benefits payable under an existing defined benefit plan and, at the same time, increases
other benefits payable under the plan for the same employees, the entity treats the change as a single net change.

Gains and Losses on Settlement

The gain or loss on a settlement is the difference between:
(a) The present value of the defined benefit obligation being settled, as determined on the date of settlement; and
(b) The settlement price, including any plan assets transferred and any payments made directly by the entity in
connection with the settlement.

An entity shall recognise a gain or loss on the settlement of a defined benefit plan when the settlement occurs.

RECOGNITION AND MEASUREMENT: PLAN ASSETS

Fair Value of Plan Assets

Plan assets are:

(a) Assets such as stocks and shares, held by a fund that is legally separate from the reporting entity, which exists
solely to pay employee benefits.
(b) Insurance policies, issued by an insurer that is not a related party, the proceeds of which can only be used to
pay employee benefits.

Points to Remember
1. The fair value of any plan assets is deducted from the present value of the defined benefit obligation in
determining the deficit or surplus.
2. When no market price is available, the fair value of plan assets is estimated, for example, by discounting
expected future cash flows using a discount rate that reflects both the risk associated with the plan assets and
the maturity or expected disposal date of those assets (or, if they have no maturity, the expected period until
the settlement of the related obligation).

pg. 88
IAS 19 SBR Revision Notes

3. Plan assets exclude unpaid contributions due from the reporting entity to the fund, as well as any non-
transferable financial instruments issued by the entity and held by the fund.
4. Plan assets are reduced by any liabilities of the fund that do not relate to employee benefits, for example, trade
and other payables and liabilities resulting from derivative financial instruments.

Retirement Benefits Paid Out

During an accounting year, some of the plan assets will be paid out to retirees, thus discharging part of the benefit
obligation. This is accounted for by:
Dr PV of defined benefit obligation X
CR FV of plan assets X

There is no cash entry as the pension plan itself rather than the sponsoring employer pays money out.

Contributions Paid Into Plan

Contributions will be made into the plan as advised by the actuary. This is accounted for by:
DR Fv of plan assets X
CR Cash X

Remeasurements of the net defined benefit liability (asset)

Remeasurements of the net defined benefit liability (asset) comprise:
(a) Actuarial gains and losses;
(b) The return on plan assets, excluding amounts included in net interest on the net defined benefit liability (asset);
and
(c) Any change in the effect of the asset ceiling, excluding amounts included in net interest on the net defined
benefit liability (asset).

Return on Plan Assets

In determining the return on plan assets, an entity deducts the costs of managing the plan assets (except other
administration costs) and any tax payable by the plan itself

Exam Focus
The opening and closing obligation and plan assets can be reconciled as follows:
PV of defined benefit FV of plan assets
obligation $
$
B/f at start of year (advised by actuary) (X) X
Retirement benefits paid out X (X)
Contributions paid into plan X
Expected return on plan assets X
Unwinding of interest (X)
Current service cost (X) ____
(X) X
Remeasurement gains / losses (Balancing figure) X(X) X(X)
C/f at end of year (advised by actuary) (X) X

pg. 89
IAS 19 SBR Revision Notes

Asset Ceiling Test

When we looked at the recognition of the net defined benefit liability/(asset) in the statement of financial position
stated above, the term ‘asset ceiling’ was mentioned.

This term relates to a threshold established by IAS 19 to ensure that any defined benefit asset (i.e. a pension surplus)
is carried at no more than its recoverable amount. In simple terms, this means that any net asset is restricted to the
amount of cash savings that will be available to the entity in future.

Net Defined Benefit Assets

A net defined benefit asset may arise if the plan has been overfunded or if actuarial gains have arisen. This meets
the definition of an asset ( as stated in the Framework) because all of the following apply.
(a) The entity controls a resource (the ability to use the surplus to generate future benefits).
(b) That control is the result of past events (contributions paid by the entity and service rendered by the employee).
(c) Future benefits are available to the entity in the form of a reduction in future contributions or a cash refund,
either directly or indirectly to another plan in deficit.

The asset ceiling is the present value of those future benefits. The discount rate used is the same as that used to
calculate the net interest on the net defined benefit liability/(asset). The net defined benefit asset would be reduced
to the asset ceiling threshold.

Any related write down would be treated as a remeasurement and recognised in other comprehensive income.

If the asset ceiling adjustment was needed in a subsequent year, the changes in its value would be treated as follows:
(a) Interest (as it is a discounted amount) recognised in profit or loss as prat of the net interst amount
(b) Other changes recognised in profit or loss.

Suggested approach and question

The suggested approach to defined benefit schemes is to deal with the change in the obligation and asset in the
following order.
Step Item Recognition
1 Record opening figures:
 Asset
 Obligation
2 Interest cost on obligation DEBIT Interest cost (P/L)
 Based on discount rate and PV obligation at (x% x b/d obligation)
start of period. CREDIT PV defined benefit obligation (SOFP)
 Should also reflect any changes in obligation
during period.
3 Interest on plan assets DEBIT Plan assets (SOFP)
 Based on discount rate and asset value at CREDIT Interest cost (P/L)
start of period. (x% x b/d assets)
 Technically, this interest is also time
apportioned on contributions less benefits
paid in the period.

pg. 90
IAS 19 SBR Revision Notes

4 Current service cost DEBIT Current service cost (P/L)

 Increase in the present value of the CREDIT PV defined benefit obligation (SOFP)
obligation resulting from employee service
in the current period.

5 Contributions DEBIT Plan assets (SOFP)

 As advised by actuary CREDIT Company cash

6 Benefits DEBIT PV defined benefit obligation (SOFP)

 Actual pension payments made CREDIT Plan assets (SOFP)

7 Past service cost Positive (increase ii obligation):

 Increase/decrease in PV obligation as a DEBIT Past service cost (P/L)
result of introduction or improvement of CREDIT PV defined benefit obligation (SOFP)
benefits. Negative (decrease in obligation:
DEBIT PV defined benefit obligation (SOFP)
CREDIT Past service cost (P/L)

8 Gains and losses on settlement Gain

 Difference between the value of the DEBIT PV defined benefit obligation (SOFP)
obligation being settled and the settlement CREDIT Service cost (P/L)
price Loss
DEBIT Service cost (P/L)
CREDIT PV defined benefit obligation (SOFP)
9 Remeasurements: actuarial gains and losses Gain
 Arising from annual valuations of DEBIT
PV defined benefit obligation (SOFP) CREDIT
obligation. Other comprehensive income (P/L)
 On obligation, differences between Loss
actuarial assumptions and actual DEBIT Other comprehensive income (P/L)
experience during the period, or changes in CREDIT PV defined benefit obligation (SOFP)
actuarial assumptions.

10 Remeasurements: return on assets Gain

 Arising from annual valuations of plan DEBIT FV plan assets (SOFP)
assets CREDIT Other comprehensive income (P/L)
Loss
DEBIT Other comprehensive income (P/L)
CREDIT FV plan assets (SOFP)
Other Long Term Benefits
Other long-term employee benefits include, for example:
(a) Long-term compensated absences such as long-service or sabbatical leave;
(b) Jubilee or other long-service benefits;
(c) Long-term disability benefits;
(d) Profit-sharing and bonuses payable twelve months or more after the end of the period in which the employees
render the related service; and
(e) Deferred compensation paid twelve months or more after the end of the period in which it is earned.

pg. 91
IAS 19 SBR Revision Notes

Recognition and Measurement: Other Long Term Benefits

There are many similarities between these types of benefits and defined benefit pensions. For example, in a long-
term bonus scheme, the employees may provide service over a number of periods to earn their entitlement to a
payment at a later date. In some case, the entity may put cash aside, or invest it in some way (perhaps by taking out
an insurance policy) to meet the liabilities when they arise.

As there is normally far less uncertainty relating to the measurement of these benefits, IAS 19 requires a simpler
method of accounting for them. Unlike the accounting method for post-employment benefits, this method does not
recognise remeasurements in other comprehensive income.

The entity should recognise all of the following in profit or loss.

(a) Service cost
(b) Net interest on the defined benefit liability (asset)
(c) Remeasurement of the defined benefit liability (asset)

pg. 92
IFRS 2 SBR Revision Notes

IFRS 2 - SHARE BASED PAYMENTS

INTRODUCTION
Share-based payment occurs when any entity purchases goods or services from another party such as a supplier or
employee and rather than paying directly in cash, settles the amount owing in shares, share options or future cash
amounts linked to the value of shares.

Prior to the publication of IFRS 2 there appeared to be an anomaly to the extent that if a company paid its employees
in cash, an expense was recognised in profit or loss, but if the payment was in share options, no expense was
recognised.

IFRS 2 requirements
IFRS 2 requires an expense to be recoginsed in profit or loss in relation to share-based payments.
 The argument against expensing share-based payments was that there is no true expense although expense is
being recognised.
 The main argument for was the share-based payments are simply another form of compensation that should
go into the calculation of earnings for the sake of transparency for investors and the business community.

OBJECTIVE
The objective of this IFRS is to specify the financial reporting by an entity when it undertakes a share-based payment
transaction.

SCOPE
A share-based payment transaction is one in which the entity transfers equity instruments, such as shares or share
options, in exchange for goods and services supplied by employees or third parties.

IFRS 2 applies to all share-based payment transactions. The Standard recognises and addresses three types of
transactions according to the method of settlement.
 Equity-settled share-based payment transactions
The entity receives goods or services in exchange for equity instruments of the entity (including shares or share
options).
 Cash-settled share-based payment transactions
The entity receives goods or services in exchange for amounts of cash that are based on the price (or value) of
the entity's shares or other equity Instruments of the entity.
 Transactions with a choice of settlement
The entity receives goods or services and either the entity or the supplier has a choice as to whether the entity
settles the transaction in cash (or other assets) or by issuing equity instruments.

Transactions outside the scope of IFRS 2

The following are outside the scope of IFRS 2:
 Transactions with employees and others in their capacity as a holder of equity instruments of the entity
 The issue of equity instruments in exchange for control of another entity In a business combination
 Contracts that may or will be settled, net in company shares (IFRS 9)

pg. 93
IFRS 2 SBR Revision Notes

DEFINITIONS
Before considering the accounting treatment of share-based payment transactions, it is important to understand
the terminology used within the topic.

Share-based payment transaction A share-based payment transaction in which the entity acquires goods or
services by incurring a liability to transfer cash or other assets to the supplier of those goods or services for amounts
that are based on the price (or value) of equity instruments (including shares or share options) of the entity or
another group entity.

Share-based payment arrangement An agreement between the entity and another party (including an employee)
to enter into a share-based payment transaction, which thereby entitles the other party to receive cash or other
assets of the entity for amounts that are based on the price of the entity's shares or other equity instruments of the
entity, or to receive equity instruments of the entity, provided the specified vesting conditions, if any, are met.

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

Equity instrument granted The right (conditional or unconditional) to an equity instrument of the entity conferred
by the entity on another party, under a share-based payment arrangement.

Share option A contract that gives the holder the right, but not the obligation, to subscribe to the entity's shares at
a fixed or determinable price for a specified period of time.

Grant date The date at which the entity and another party (including an employee) agree to a share-based payment
arrangement, being when the entity and the other party have a shared understanding of the terms and conditions
of the arrangement. At grant date the entity confers on the other party (the counterparty) the right to cash, other
assets, or equity instruments of the entity, provided the specified vesting conditions, if any, are met. If that
agreement is subject to an approval process (for example, by shareholders), grant date is the date when that
approval is obtained.

Intrinsic value The difference between the fair value of the shares to which the counterparty has the (conditional or
unconditional) right to subscribe or which it has the right to receive, and the price (if any) the other party is (or will
be) required to pay for those shares. For example, a share option with an exercise price of $15 on a share with a fair
value of $20, has an intrinsic value of $5.

Measurement date The date at which the fair value of the equity instruments granted is measured. For transactions
with employees and others providing similar services, the measurement date is grant date.

pg. 94
IFRS 2 SBR Revision Notes

For transactions with parties other than employees (and those providing similar services), the measurement date is
the date the entity obtains the goods or the counterparty renders service.

Vest To become an entitlement. Under a share-based payment arrangement, a counterparty’s right to receive cash,
other assets or equity instruments of the entity vests when the counterparty’s entitlement is no longer conditional
on the satisfaction of any vesting conditions.

Vesting conditions The conditions that must be satisfied for the counterparty to become entitled to receive cash,
other assets or equity instruments of the entity, under a share-based payment arrangement. Vesting conditions
include service conditions, which require the other party to complete a specified period of service, and performance
conditions, which require specified performance targets to be met (such as a specified increase in the entity's profit
over a specified period of time).

Vesting period The period during which all the specified vesting conditions of a share-based payment arrangement
are to be satisfied.

General rules – A summary

RECOGNITION
 An entity shall recognize the goods or services received or acquired in a share-based payment transaction when
it obtains the goods or as the services are received.
 When the goods or services received or acquired in a share-based payment transaction do not qualify for
recognition as assets, they shall be recognized as expenses.
 Goods might be consumed over a period of time or, in the case of inventories, sold at a later date, in which case
an expense is recognized when the goods are consumed or sold.
 The entity shall recognize a corresponding increase in equity if the goods or services were received in an equity-
settled share-based payment transaction or a liability if the goods or services were acquired in a cash-settled
share-based payment transaction.

MEASUREMENT
 For equity-settled share-based payment transactions, the entity shall measure the goods or services received,
and the corresponding increase in equity, directly, at the fair value of the goods or services received, unless
that fair value cannot be estimated reliably.
 If the entity cannot estimate reliably the fair value of the goods or services received, the entity shall measure
their value, and the corresponding increase in equity, indirectly, by reference to the fair value of the equity
instruments granted.

EQUITY-SETTLED SHARE-BASED PAYMENT TRANSACTIONS

Where payment for goods or services is in the form of shares or share options, the fair value of the transaction-is
recognised in profit or loss, spread over the vesting period.

Introduction
If goods or services are received in exchange for shares or share options the transaction is accounted for by:
Dr. Expense/Asset
Cr. Equity

pg. 95
IFRS 2 SBR Revision Notes

IFRS 2 does not stipulate which equity account the credit entry is made to. It is normal practice to credit a separate
component of equity, mostly retained earnings are credited.

We must next consider:

1 Measurement of the total expense taken to profit or loss
2 When this expense should be recorded.

Measurement
When considering the total expense to profit or loss, the basic principle is that equity-settled share-based
transactions are measured at fair value.

Fair value will depend upon who the transaction is with:

 There is a rebuttable presumption that the fair value of goods / services received from a third party can be
measured reliably.
 It is not normally possible to measure services received when the shares or share options form part of the
remuneration package of employees.

Transaction with third parties Transaction with employees

Can the fair value of goods /

services be measured reliably?

Yes No

Measure at fair value of the goods / Measure at fair value of the equity
services on the date they were instruments granted at grant date
received = Direct method = Indirect method

Transactions in Which Services are Received

Allocation of expense to financial years

Immediate vesting
Where the instruments granted vest immediately, i.e. the recipient party becomes entitled to them immediately,
and then the transaction is accounted for in full on the grant date.

Vesting period exists

Where entitlement to the instruments granted is conditional on vesting conditions, and these are to be met over a
specified vesting period, the expense is spread over the vesting period.

Transactions with third parties (non-employees)

Applying the rules seen in the sections above, transactions with third parties are normally
 Measured at the fair value of goods / services received
 Recorded when the goods / services are received

pg. 96
IFRS 2 SBR Revision Notes

Transactions with employees

Applying the rules seen in the sections above, transactions with employees are normally
 Measured at the fair value of equity instruments granted at grant date
 Spread over the vesting period (often a specified period of employment)

Immediate vesting
If the equity instruments granted vest immediately, the counterparty is not required to complete a specified period
of service before becoming unconditionally entitled to those equity instruments. The entity shall presume that
services rendered by the counterparty as consideration for the equity instruments have been received. In this case,
on grant date the entity shall recognize the services received in full, with a corresponding increase in equity.

Vesting Period
If the equity instruments granted do not vest until the counterparty completes a specified period of service, the
entity should account for those services as they are rendered by the counterparty during the vesting period.

Transactions Measured by Reference to the Fair Value of the Equity Instruments Granted Determining the fair
value of equity instruments granted
For transactions measured by reference to the fair value of the equity instruments granted, an entity shall measure
the fair value of equity instruments granted at the measurement date, based on market prices if available.

If market prices are not available, the entity shall estimate the fair value of the equity instruments granted using a
valuation technique to estimate what the price of those equity instruments would have been on the measurement
date in an arm’s length transaction between knowledgeable, willing parties.

Treatment of Vesting Conditions

The Impact of Different Types of Vesting Conditions

Vesting conditions may be:
 Non-market based i.e. not relating to the market value of the entity's shares
 Market based i.e. linked to the market price of the entity's shares in some way

Non-market based vesting conditions

 These conditions are taken into account when determining the expense which must be taken to profit or loss in
each year of the vesting period.
 Only the number of shares or share options expected to vest will be account for.
 At each period end (including interim periods), the number expected to vest should be revised as necessary
 On the vesting date, the entity should revise the estimate to equal the number of shares or share options that
do actually vest.

Market Based 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 financial statements will remain.

pg. 97
IFRS 2 SBR Revision Notes

Market and non market based vesting conditions

Where equity instruments are granted with both, market and non-market vesting conditions, an entity should
recognise an expense irrespective of whether market conditions are satisfied provided all other vesting conditions
are satisfied.

In summary, 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. Therefore, the amounts recognised as an
expense in each year will be the same regardless of what share price has been achieved.

Other issues
Transactions during the year
Where the grant date arises mid-year, the calculation of the amount charged to profit or loss must be prorated to
reflect that feet

Vested options not exercised

If, after the vesting date, options are not exercised or the equity instrument is forfeited, there will be no impact on
the financial statements. This is because the holder of the equity instrument has effectively made that decision as
an investor.

The services for which the equity instrument remunerated were received by the entity and the financial statements
reflect the substance of this transaction. IFRS 2 does, however, permit a transfer to be made between reserves in
such circumstances to avoid an amount remaining in a separate equity reserve where no equity instrument will be
issued.

Variable vesting date

Where the vesting date is variable depending upon non-market based vesting conditions, the calculation of the
amount expensed in profit or loss must be based upon the best estimate of when vesting will occur.

MODIFICATIONS AND RE-PRICING

Equity instruments may be modified before they vest.

E.g. A downturn in the equity market may mean that the original option exercise price set is no longer attractive.
Therefore the exercise price is reduced (the option is 're-priced') to make it valuable again.

Such modifications will often affect the fair value of the instrument and therefore the amount recognised in profit
or loss.

The accounting treatment of modifications and re-pricing is:

 Continue to recognise the original fair value of the instrument in the normal way (even where the modification
has reduced the fair value).
 Recognise any increase in fair value at the modification date (or any increase in the number of instruments
granted as a result of modification) spread over the period between the modification date and vesting date.
 If modification 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.

pg. 98
IFRS 2 SBR Revision Notes

CANCELLATIONS AND SETTLEMENTS

An entity may settle or cancel an equity instrument during the vesting period. Where this is the case, the correct
accounting treatment is:
 To immediately charge any remaining fair value of the instrument that has not been recognised in profit 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 profit or loss.

Cancellation and reissuance

Where an entity has been through a capital restructuring or there has been a significant 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.

Repurchase after vesting

Where equity instruments are repurchased by an employing entity following vesting, this is similar to the entity
providing the employee with cash remuneration in the first instance. The reporting therefore reflects this with the
payment being recognised as a deduction from equity. The charge recognised in profit or loss will remain, as this
reflects the services for which the employee has been remunerated. If the payment made is in excess of the fair
value of the instruments granted, then this is recognised immediately in profit or loss reflecting that this is payment
for additional services beyond what was originally agreed.

Determining the fair value of equity instruments granted

Where a transaction is measured by reference to the fair value of the equity instruments granted, fair value is based
on market prices where available.

If marker price are not available the entity should estimate the fair value of the equity instruments granted

CASH SETTLED BASED TRANSACTIONS

 For cash-settled share-based payment transactions, the entity shall measure the goods or services acquired and
the liability incurred at the fair value of the liability.
 Until the liability is settled, the entity shall remeasure the fair value of the liability at the end of each reporting
period and at the date of settlement, with any changes in fair value recognised in profit or loss for the period.

If goods or services are received in exchange for cash amounts linked to the value of shares, the transactions is
accounted for by:
Dr Expense/Asset
Cr Liability

TRANSACTION WITH A CHOICE OF SETTLEMENT

Counter party has the choice
For transactions with parties other than employees, the entity shall measure the equity component of the compound
financial instrument as the difference between the fair value of the goods or services received and the fair value of
the debt component, at the date when the goods or services are received.

pg. 99
IFRS 2 SBR Revision Notes

Fair value of goods/services $x

Less Liability (PV) ($x)
(R.V) Equity Option $x

Double Entry:
Dr. Asset/ Expense $xxx
Cr. Liability $xxx
Cr. Equity Option $xxx

Liability will be remeasured

For transactions with employees, the entity shall measure the fair value of the compound financial instrument at the
measurement date, taking into account the terms and conditions on which the rights to cash or equity instruments
were granted.
Fair value of equity route/ alternative $xxx
Less liability (PV) ($xxx)
(R.V) Equity Option $xxx

IFRS 2 requires that the value of the debt component is established first. The equity component is then measured as
the residual between that amount and the value of the instrument as a whole. In this respect IFRS 2 applies similar
principles to IFRS 9 Financial Instruments, where the value of the debt components is established first. However, the
method used to value the constituent parts of the compound instrument in IFRS 2 differs from that of IFRS 9.

Fair value of goods or Fair value of debt Equity component

= +
service component (residual)

For transactions in which the fair value of goods or services is measured directly (that is normally where the recipient
is not an employee of the company), the fair value of the equity component is measured as the difference between
the fair value of the goods or services required and the fair value of the debt component.

For other transactions including those with employees where the fair value of the goods or services is measured
indirectly by reference to the fair value of the equity instruments granted, the fair value of the compound instrument
is estimated as a whole.

The debt and equity components must then be valued separately. Normally transactions are structured in such a
way that the fair value of each alternative settlement is the same.

Entity has the choice

When entity has the choice of settlement, the entity shall determine whether it has present obligation to deliver
cash or not. Such circumstances arise where, for example, the entity is prohibited from issuing shares or where it
has a stated policy, or past practice, of issuing cash rather than shares.

If the entity has a present obligation to settle in cash, the entity should record the transaction as if it is cash settled
share based payment transaction.

pg. 100
IFRS 2 SBR Revision Notes

If no present obligation exists, the entity should treat the transaction as if it was equity settled transaction.

On settlement, if the transaction was treated as an equity-settled transaction and cash was paid, the cash should be
treated as if it was a repurchase of the equity instrument by a deduction against equity.

DEFERRED TAX IMPLICATIONS

Share based payments
Share-based transactions may be tax deductible in some jurisdictions. However, the amount deductible for tax
purpose does not always correspond to the amount that is charged to profit or loss under IFRS 2.

In most cases it is not just the amount but also the timing of the expense allowable for tax purposes that will differ
from that required by IFRS 2.

For example an entity recognises an expense for share options granted under IFRS 2, but does not receive a tax
deduction until die options are exercised. The tax deduction will be based on the share price on the exercise date
and will be measured on the basis of the options' intrinsic value i.e. the difference between market price and exercise
price at the exercise date. In the case of share-based employee benefits under IFRS 2 the cost of the services as
reflected in the financial statements is expensed and therefore the carrying amount is nil.

The difference between the carrying amount of nil and the tax base of share-based payment expense received to
date is a deferred tax asset, provided the entity has sufficient future taxable profits to utilise this deferred tax asset.
The deferred tax asset temporary difference is measured as:
$
Carrying amount of share-based payment expense 0
Less: tax base of share-based payment expense (X)
(estimated amount tax authorities will permit as a deduction In future
periods, based on year end information)
Temporary difference (X)
Deferred tax asset at X% X

If the amount of the tax deduction (or estimated future tax deduction) exceeds the amount of the related cumulative
remuneration expense, this indicates that the tax deduction relates also to an equity item.

The excess is therefore recognised directly in equity. The examples below show the accounting for equity-settled
and cash-settled transactions.

DISCLOSURES
IFRS 2 requires extensive disclosures under three main headings:
 Information that enables users of financial statements to understand the nature and extent of the share-based
payment transactions that existed during the period.
 Information that allows users of financial statements to understand how the fair value of the goods or services
received, or the fair value of the equity instruments which have been granted during the period, was
determined.
 Information that allows users of financial statements to understand the effect of expenses, which have arisen
from share-based payment transactions, on the entity’s profit or loss in the period.

pg. 101
IAS 12 SBR Revision Notes

IAS 12 – INCOME TAXES

IAS 12, Income Taxes, deals with taxes on income, both current tax and deferred tax. Income tax accounting is
complex, and preparers and users find some aspects difficult to understand and apply. These difficulties arise from
exceptions to the principles in the current standard, and from areas where the accounting does not reflect the
economics of the transactions.

Objective
The objective of IAS 12 is to prescribe the accounting treatment for income taxes.

Definitions
Accounting profit
This is the net profit (or loss) for the reporting period before deducting tax expense.

Taxable Profit
This is the profit (or loss) for a period, determined in accordance with the local tax authority's rules, upon which
income taxes are payable.

Tax Expense
Tax in the statement of profit or loss may consist of three elements:
 Current tax expense
 Adjustments to tax charges of prior periods (over/under provisions)
 Transfers to/from deferred tax.

CURRENT TAX
This is the amount of income tax payable (or recoverable) to tax authorities in relation to the current trading activities
and the taxable profit (or loss) for the current period.

Measurement of Current Tax

The current tax expense for a period is based on the taxable and deductible amounts that will be shown on the tax
return for the current year.

IAS 12 requires any unpaid tax in respect of the current or prior periods to be recognised as a liability. Conversely,
any excess tax paid in respect of current or prior periods over what is due should be recognised as an asset to the
extent it is probable that it will be recoverable.

The tax rate to be used in the calculation for determining a current tax asset or liability is the rate that is expected
to apply when the asset is expected to be recovered, or the liability to be paid. These rates should be based upon
tax laws that have already been enacted (are already part of law) or substantively enacted (have already passed
through sufficient parts of the legal process that they are virtually certain to be enacted) by the reporting date.

Accounting for Current Tax

In most jurisdictions, tax is paid several months after the end of the accounting period. At the period end, an
estimated amount is accrued based on the year’s profits:
Dr Income tax e xpense (P&L) estimated tax charge

pg. 102
IAS 12 SBR Revision Notes

Cr Tax payable (liability in SOFP) estimated tax charge

When the tax is actually paid some months later, it is recorded by:
Dr Tax payable (SFP) amount paid
Cr Cash amount paid.

Since the amount paid is likely to differ from the estimated tax charge originally accrued, a balance is left on the tax
payable account:

Tax payable
Cash (tax paid) X Income tax (estimated tax charge) X
Overprovision c/f X Under provision c/f X

An overprovision arises where the actual tax paid is less than the estimated tax charge. This reduces the following
year’s tax charge in the statement of profit or loss.

An underprovision arises where the actual tax paid is more than the estimated charge. This increases the following
year’s tax charge in the statement of profit or loss.

Recognition of current tax

Normally, current tax is recognised as income or expense and included in the net profit or loss for the period.
However, where tax arises from a transaction or event which is recognised as other comprehensive income
recognised directly in equity (in the same or a different period) rather than in profit or loss, then the related tax
should also be reported as other comprehensive income or reported directly in equity. An example of such a situation
is where, under IAS 8, an adjustment is made to the opening balance of retained earnings due to either a change in
accounting policy that is applied retrospectively, or to the correction of a material error. Any related tax is therefore
also recognised directly in equity.

Presentation
Statement of financial position, tax assets and liabilities should be shown separately. Current tax assets and liabilities
may be offset, only under the following conditions.
 The entity has a legally enforceable right to set off the recognised amounts.
 The entity intends to settle the amounts on a net basis, or to realise the asset and settle the liability at the same
time.

The tax expense (income) related to the profit or loss from ordinary activities should be shown on the face of the
statement of profit or loss and other comprehensive income as part of profit or loss for the period.

Summary: Accounting for Current Tax

 Current taxes include tax payable for current period and adjustment of under/over provision of prior periods
 Current taxes are to be treated as an expense
 If the tax expense and the provision at the end of the year are greater than the payment, the shortfall in the
payment will be disclosed as a current tax liability and vice versa.

pg. 103
IAS 12 SBR Revision Notes

DEFERRED TAX
A mismatch can occur because International Financial Reporting Standards (IFRS) recognition criteria for items of
income and expense are different from the treatment of items under tax law. Deferred taxation accounting attempts
to deal with this mismatch. The IAS 12 standard is based on the temporary differences between the tax base of an
asset or liability and its carrying amount in the financial statements.

Tax Base
This is the amount attributed to an asset or liability for tax purposes, based on the expected manner of recovery.
IAS 12 focuses on the future tax consequences of recovering an asset only to the extent of its carrying amount at the
date of the financial statements. Future taxable amounts arising from recovery of the asset will be capped at the
asset's carrying amount.

For example, a property may be revalued upwards but not sold, creating a temporary difference because the carrying
amount of the asset in the financial statements is greater than the tax base of the asset. The tax consequence is a
deferred tax liability.

Tax base-Asset
The tax base of an asset is the value of the asset in the current period for tax purposes. This is either;
 The amount that will be tax deductible in the future against taxable economic benefits when the carrying
amount of the asset is recovered, or
 If those economic benefits are not taxable, the tax base is equal to the carrying amount of the asset.

Tax base-Liability
 The tax base of a liability is its carrying amount less any amount that will be tax deductible in the future.
 For revenue received in advance, the tax base of the resulting liability is its carrying amount less any amount of
the revenue that will not be taxable in future periods.

Revenue received in advance.

The tax base of the recognised liability is its carrying amount, less revenue that will not be taxable in future periods
Unrecognised items.

If items have a tax base but are not recognised in the statement of financial position, the carrying amount is nil

Tax bases not immediately apparent.

If the tax base of an item is not immediately apparent, the tax base should effectively be determined in such as
manner to ensure the future tax consequences of recovery or settlement of the item is recognised as a deferred tax
amount

Consolidated financial statements.

In consolidated financial statements, the carrying amounts in the consolidated financial statements are used, and
the tax bases determined by reference to any consolidated tax return (or otherwise from the tax returns of each
entity in the group).

pg. 104
IAS 12 SBR Revision Notes

CASES OF NO DEFERRED TAX

IAS 12 states that in the following circumstances, the tax base of an asset or liability will be equal to its carrying
amount:
 Accrued expenses that have already been deducted in determining an entity's tax liability for the current or
earlier periods.
 A loan payable that is measured at the amount originally received and this amount is the same as the amount
repayable on final maturity of the loan.
 Accrued income that will never be taxable.

ACCOUNTING FOR DEFERRED TAX

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

In simple terms, deferred tax is tax that is payable in the future. However, to understand this definition more fully,
it is necessary to explain the term ‘taxable temporary differences’.

Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of:
 Deductible temporary differences
 The carry forward of unused tax losses
 The carry forward of unused tax credits

A deferred tax asset is recognised to the extent that it is probable that taxable profit will be available against which
the deductible temporary difference can be used. This also applies to deferred tax assets for unused tax losses
carried forward.

This is an application of prudence concept.

Reassessment of unrecognised deferred tax assets

For all unrecognised deferred tax assets, at each reporting date an entity should reassess the availability of future
taxable profits and whether part or all of any unrecognised deferred tax assets should now be recognised. This may
be due to an improvement in trading conditions which is expected to continue.

TEMPORARY DIFFERENCES
Temporary differences are differences between the carrying amount of an asset or liability in the SOFP and its tax
base.

Temporary differences may be of two types:

i. Taxable temporary differences are temporary differences that will result in taxable amounts in
determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is
recovered or settled.

IAS 12 requires that a deferred tax liability is recorded in respect of all taxable temporary differences that
exist at the year-end – this is sometimes known as the full provision method.

Within financial statements, non-current assets with a limited economic life are subject to depreciation.
However, within tax computations, non-current assets are subject to capital allowances (also known as tax

pg. 105
IAS 12 SBR Revision Notes

depreciation) at rates set within the relevant tax legislation. Where at the year-end the cumulative
depreciation charged and the cumulative capital allowances claimed are different, the carrying value of the
asset (cost less accumulated depreciation) will then be different to its tax base (cost less accumulated
capital allowances) and hence a taxable temporary difference arises.

Examples
A taxable temporary difference occurs when:
 Depreciation or amortisation is accelerated for tax purposes
 Development costs capitalised in the statement of financial position deducted against taxable profit
when the expenditure was incurred
 Interest income is included in the statement of financial position when earned, but included in taxable
profit when the cash is actually received
 Prepayments in the statement of financial position deducted against taxable profits when the cash
expense was incurred
 Revaluation/Fair value adjustment of assets with no adjustment of the tax base.
 Deferred tax on impairment where these adjustments are ignored for tax purposes until the asset is
sold.

ii. Deductible temporary differences are temporary differences that will result in amounts that are
deductible in determining taxable profit (tax loss) of future periods when the carrying amount of the asset
or liability is recovered or settled.

A deferred tax asset (DTA) shall be recognised for all deductible temporary differences to the extent it is
probable that taxable profit will be available against which the deductible temporary difference can be
utilised.
 Provisions, accrued product warranty costs for which the taxation laws do not permit the deduction
until the company actually pays the claims. This is a deductible difference as its taxable profits for the
current period will be higher than those in future, when they will be lower.

Calculation of Deferred taxes

Deferred tax assets and deferred tax liabilities can be calculated using the following formulae:
Temporary difference = Carrying amount - Tax base
Deferred tax asset or liability = Temporary difference x Tax rate

The following formula can be used in the calculation of deferred taxes arising from unused tax losses or unused tax
credits:
Deferred tax asset = Unused tax loss or unused tax credits x Tax rate

Measurement of deferred tax assets and liabilities

Deferred tax is provided in full for all temporary differences arising between the tax bases of assets and liabilities
and their carrying amounts in the financial statements.

Tax rates
 Measurement shall be at the tax rates expected to apply to the period when the asset is realised or liability is
settled.

pg. 106
IAS 12 SBR Revision Notes

 The rates used shall be those enacted or substantially enacted by the end of the reporting period.
 Measurement depends upon the expectations about the manner in which the recovery of tax asset or
settlement of tax liability will take place.
 Deferred tax expense is recognized as an expense in statement of profit or loss. If the tax relates to items that
are credited or charged directly to equity, then this current tax and deferred tax shall also be charged or credited
directly to equity.
 A change in tax rates or tax laws, a reassessment of the recoverability of deferred tax assets or a change in the
expected manner of recovery of an asset have tax consequences that are recognised in profit or loss, except to
the extent that they relate to items previously charged or credited outside profit or loss.
 The measurement of deferred tax liabilities and deferred tax assets reflects the tax consequences of the manner
in which the entity expects to recover or settle the carrying amount of its assets and liabilities. The expected
manner of recovery for land with an unlimited life is always through sale, but for other assets the manner in
which management expects to recover the asset, either through use or sale or both, should be considered at
each date of the financial statements.
 Where the tax rate or tax base is impacted by the manner in which the entity recovers its assets or settles its
liabilities (e.g. whether an asset is sold or used), the measurement of deferred taxes is consistent with the way
in which an asset is recovered or liability settled
 Where deferred taxes arise from revalued non-depreciable assets (e.g. revalued land), deferred taxes reflect the
tax consequences of selling the asset
 Deferred taxes arising from investment property measured at fair value under IAS 40 Investment Property
reflect the rebuttable presumption that the investment property will be recovered through sale
 If dividends are paid to shareholders, and this causes income taxes to be payable at a higher or lower rate, or
the entity pays additional taxes or receives a refund, deferred taxes are measured using the tax rate applicable
to undistributed profits

Discounting
 In the case of deferred tax assets and liabilities, the values are not to be discounted. Deferred tax assets and
liabilities should not be discounted because the complexities and difficulties involved will affect reliability and
comparability would be affected.

However that where carrying amounts of assets or liabilities are discounted (e.g. a pension obligation), the
temporary difference is determined based on a discounted value.

RECOGNITION OF DEFERRED TAX IN THE FINANCIAL STATEMENTS

The deferred tax amount calculated is recorded as a deferred tax balance in the statement of financial position with
a corresponding entry to the tax charge, other comprehensive income or goodwill.

Principles of recognition
As with current tax, deferred tax should normally be recognised as income or an expense amount within the tax
charge, and included in the net profit or loss for the period. Only the movement in the deferred tax asset / liability
on the statement of financial position is recorded:
Dr Tax charge X
Cr Deferred tax liability X
Or

pg. 107
IAS 12 SBR Revision Notes

Dr Deferred tax asset X

Cr Tax charge X
Note that the recognition of a deferred tax asset may be restricted

Therefore, the movement in the deferred tax liability in the year is recorded in the statement of profit or loss
where:
 an increase in the liability, increases the tax expense
 a decrease in the liability, decreases the tax expense.

The closing figures are reported in the Statement of Financial Position as the deferred tax liability.

Exceptions to recognition in profit or loss

 Deferred tax relating to items dealt with as other comprehensive income (such as a revaluation) should be
recognised as tax relating to other comprehensive income within the statement of comprehensive income.
 Deferred tax relating to items dealt with directly in equity (such as the correction of an error or retrospective
application of a change in accounting policy) should also be recognised directly in equity.
 Deferred tax resulting from a business combination is included in the initial cost of goodwill (This is covered in
more detail later in the chapter).
 Initial recognition of an asset or liability in a transaction that is not a business combination and that affects
neither accounting profit nor taxable profit.
 Investments in subsidiaries, branches, associates and joint ventures where certain criteria apply.

Where it is not possible to determine the amount of current/deferred tax that relates to other comprehensive
income and items credited/charged to equity, such tax amounts should be based on a reasonable pro rata allocation
of the entity's current/deferred tax.

COMPONENTS OF DEFERRED TAX

Deferred tax charges will consist of two components:
(a) Deferred tax relating to temporary differences.
(b) Adjustments relating to changes in the carrying amount of deferred tax assets/ liabilities (where there is no
change in temporary differences), eg changes in tax rates/ laws, reassessment of the recoverability of
deferred tax assets, or a change in the expected recovery of an asset

Common scenarios
There are a number of common examples which result in a taxable or deductible temporary difference. This list is
not, however exhaustive.

TAXABLE TEMPORARY DIFFERENCES

Accelerated capital allowances
 These arise when capital allowances for tax purposes are received before deductions for accounting
depreciation are recognised in the statement of financial position (accelerated capital allowances).
 The temporary difference is the difference between the carrying amount of the asset at the reporting date and
its tax written down value (tax base).
 The resulting deferred tax is recognised in profit or loss.

pg. 108
IAS 12 SBR Revision Notes

Interest revenue
 In some jurisdictions interest revenue may be included in profit or loss on an accruals basis, but taxed when
received.
 The temporary difference is equivalent to the income accrual at the reporting date as the tax base of the interest
receivable is nil.
 The resulting deferred tax is recognised in profit or loss.

Development costs
 Development costs may be capitalised for accounting purposes in accordance with IAS 38 while being deducted
from taxable profit in the period incurred (i.e. they receive immediate tax relief).
 The temporary difference is equivalent to the amount capitalised at the reporting date as the tax base of the
costs is nil since they have already been deducted from taxable profits.
 The resulting deferred tax is recognised in profit or loss.

Revaluations to fair value-property, plant and equipment

IFRS permits or requires some assets to be revalued to fair value, e.g. property, plant and equipment under IAS 16.

Temporary difference
In some jurisdictions a revaluation will affect taxable profit in the current period. In this case, no temporary
difference arises as both carrying value and the tax base are adjusted.

In other jurisdictions, including the UK, the revaluation does not affect taxable profits in the period of revaluation
and consequently, the tax base of the asset is not adjusted. Hence a temporary difference arises.

This should be provided for in full based on the difference between carrying amount and tax base.
An upward revaluation will therefore give rise to a deferred tax liability, even if:
 The entity does not intend to dispose of the asset
 Tax due on any future gain can be deferred through rollover relief

This is because the revalued amount will be recovered through use which will generate taxable income in excess of
the depreciation allowable for tax purposes in future periods.

Manner of recovery
The carrying amount of a revalued asset may be recovered
 Through sale, or
 Through continued use.
The manner of recovery may affect the tax rate applicable to the temporary difference, and / or the tax base of the
asset.

Recording deferred tax

As the underlying revaluation is recognised as other comprehensive income, so the deferred tax thereon is also
recognised as part of tax relating to other comprehensive income. The accounting entry is therefore:
Dr Tax on other comprehensive income X
Cr Deferred tax liability X

pg. 109
IAS 12 SBR Revision Notes

Non-depreciated revalued assets

Recovery of Revalued Non-Depreciable Assets requires that deferred tax should be recognised even where non-
current assets are not depreciated (e.g. land). This is because the carrying value will ultimately be recovered on
disposal.

Revaluations to fair value - other assets

IFRS permit or require certain other assets to be revalued to fair value, for example:
 Certain financial instruments under IFRS 9
 Investment properties under IAS 40

Where the revaluation is recognised in profit or loss (e.g. fair value through profit or loss instruments, investment
properties) and the amount is taxable / allowable for tax, and then no deferred tax arises as both the carrying value
and the tax base are adjusted.

Where the revaluation is recognised as other comprehensive income (e.g. financial assets at fair value through other
comprehensive income) and does not therefore impact taxable profits, then the tax base of the asset is not adjusted
and deferred tax arises. This deferred tax is also recognised as other comprehensive income.

Retirement benefit costs

In the financial statements, retirement benefit costs are deducted from accounting profit as the service is provided
by the employee. They are not deducted in determining taxable profit until the entity pays either retirement benefits
or contributions to a fund. Thus a temporary difference may arise.
 A deductible temporary difference arises between the carrying amount of the net defined benefit liability and
its tax base. The tax base is usually nil.
 The deductible temporary difference will normally reverse.
 A deferred tax asset is recognised for this temporary difference to the extent that it is recoverable, that is
sufficient profit will be available against which the deductible temporary difference can be utilised.
 If there is a net defined benefit asset for example when there is a surplus in the pension plan, a taxable
temporary difference arises and a deferred tax liability is recognised.

Under IAS 12, both current and deferred tax must be recognised outside profit or loss if the tax relates to items that
are recognised outside profit or loss. This could make things complicated as it interacts with IAS 19 Employee
benefits.

IAS 19 allows a choice of accounting policy regarding recognition of actuarial gains and losses:
 In profit or loss either in the period in which they occur or deferred on a systematic basis
 In other comprehensive income in the period in which they occur.

It may be difficult to determine the amount of current and deferred tax that relates to items recognised in profit or
loss or in other comprehensive income. As an approximation, current and deferred taxes are allocated on an
appropriate basis, often pro rata.

pg. 110
IAS 12 SBR Revision Notes

Deferred tax movement relating to the actuarial losses

IAS 12 Income Taxes requires deferred tax relating to items charged or credited to other comprehensive income to
be recognised in other comprehensive income hence the amount of the deferred tax movement relating to the
actuarial losses charged directly to OCI must be split out and credited directly to OCI.

Dividends receivable from overseas companies

 Dividends received from UK companies are not taxable on other UK companies. Dividends received from
overseas companies, however, are.
 Overseas dividends receivable may be included in profit or loss on an accruals basis, but taxed when received.
 The temporary difference is equal to the dividend receivable (asset) at the reporting date, as the tax base of the
dividend receivable is nil.
 The calculation of deferred tax should take into account any double taxation relief which may be available.
 The deferred tax arising is recognised in profit or loss.

DEDUCTIBLE TEMPORARY DIFFERENCES

Tax losses
Where tax losses arise, the manner of recognition of these in the financial statements depends upon how they are
expected to be utilised.
 If losses are carried back to crystallise a refund, then a receivable is recorded in the statement of financial
position and the corresponding credit is to the current tax charge.
 If losses are carried forward to be used against future profits or gains, then they should be recognised as
deferred tax assets to the extent that it is probable that future taxable profit will be available against which the
losses can be used.

Unused tax credits carried forward against taxable profits will also give rise to a deferred tax asset to the extent that
profits will exist against which they can be utilised.

Recognition of deferred tax asset

The existence of unused tax losses is strong evidence that future taxable profit may not be available. The following
should be considered before recognising any deferred tax asset:
 Whether an entity has sufficient taxable temporary differences against which the unused tax losses can be offset
 Whether it is probable that the entity will have taxable profits before the unused tax losses expire
 Whether the tax losses result from identifiable causes which are unlikely to recur
 Whether tax planning opportunities are available to create taxable profit

Group tax relief

Where the acquisition of a subsidiary means that tax losses which previously could not be utilised, can now be
utilised against the profits of the subsidiary, a deferred tax asset may be recognised in the financial statements of
the parent company. This amount is not taken into account in calculating goodwill arising on acquisition.

Provisions
 A provision is recognised for accounting purposes when there is a present obligation, but it is not deductible for
tax purposes until the expenditure is incurred
 In this case, the temporary difference is equal to the amount of the provision, since the tax base is nil
 Deferred tax is recognised in profit or loss

pg. 111
IAS 12 SBR Revision Notes

Share based payments

Share-based transactions may be tax deductible in some jurisdictions. However, the amount deductible for tax
purposes does not always correspond to the amount that is charged to profit or loss under IFRS 2.

In most cases it is not just the amount but also the timing of the expense allowable for tax purposes that will differ
from that required by IFRS 2.

For example an entity recognises an expense for share options granted under IFRS 2, but does not receive a tax
deduction until the options are exercised. The tax deduction will be based on the share price on the exercise date
and will be measured on the basis of the options' intrinsic value ie the difference between market price and exercise
price at the exercise date. In the case of share-based employee benefits under IFRS 2 the cost of the services as
reflected in the financial statements is expensed and therefore the carrying amount is nil.

The difference between the carrying amount of nil and the tax base of share-based payment expense received to
date is a deferred tax asset, provided the entity has sufficient future taxable profits to utilise this deferred tax asset
The deferred tax asset temporary difference is measured as:
$
Carrying amount of share-based payment expense 0
Less: tax base of share-based payment expense (X)
(estimated amount tax authorities will permit as a deduction in future
periods, based on year end information)
Temporary difference (X)
Deferred tax asset at X% X
If the amount of the tax deduction (or estimated future tax deduction) exceeds the amount of the related cumulative
remuneration expense, this indicates that the tax deduction relates also to an equity item.

pg. 112
IAS 12 SBR Revision Notes

The excess is therefore recognised directly in equity. The diagrams below show the accounting for equity-settled
and cash-settled transactions.

Equity-settled transactions

Estimated Future
Tax Deduction
Greater than Smaller than

Cumulative Cumulative
remuneration remuneration
expense expense

The tax The tax

benefit is benefit is
recorded in recorded in
profit on loss profit or loss
up to the
amount of the
cumulative
expense

Cash-settled transactions
Estimated Recorded in
All
future tax profit or loss
deduction

DEFERRED TAX ARISING FROM A BUSINESS COMBINATION

Fair value adjustments on consolidation
IFRS 3 requires assets acquired on acquisition of a subsidiary or associate to be recognized at their fair value rather
than their carrying amount in the individual financial statements of the subsidiary. The fair value adjustment does
not, however, have any impact on taxable profits or the tax base of the asset. This is much like a revaluation in an
individual company's accounts.

pg. 113
IAS 12 SBR Revision Notes

Therefore, an upwards fair value adjustment made to an asset will result in the carrying value of the asset exceeding
the tax base and so a taxable temporary difference will arise.

The resulting deferred tax liability is recorded in the consolidated accounts by:
Dr Goodwill (group share)
Cr Deferred tax liability

Undistributed profited of subsidiaries, branches, associated and joint ventures

 The carrying amount of, for example, a subsidiary in consolidated financial statement is equal to the group share
of the net assets of the subsidiary plus purchased goodwill.
 The tax base is usually equal to the cost of the investment.
 The difference between these two amounts is a temporary difference. It can be calculated as the parent’s share
of the subsidiary’s post acquisition profits which have not been distributed.

Recognition of deferred tax

A deferred tax liability should be recognized on the temporary difference unless:
 The parent / investor / venture is able to control the timing of the reversal of the temporary difference, and
 It is probable that the temporary difference will not reverse (i.e. the profits will not be paid out) in the
foreseeable future.

This can be applied to different levels of investment as follows:

 Subsidiary
As a parent company can control the dividend policy of a subsidiary, deferred tax will not arise in relation
to undistributed profits.
 Associate
An investor in an associate does not control that entity and so cannot determine its dividend policy. Without
an agreement requiring that the profits of the associate should not be distributed in the foreseeable future,
therefore, an investor should recognize a deferred tax liability arising from taxable temporary differences
associated with its investment in the associate. Where an investor cannot determine the exact amount of
tax, but only a minimum amount, then the deferred tax liability should be that amount.
 Joint venture
In a joint venture, the agreement between the parties usually deals with profit sharing. When a venture can
control the sharing of profits and it is probable that the profits will not be distribute in the foreseeable
future, a deferred liability is not recognized.

Changes in foreign exchange rates

Where a foreign operation’s taxable profit or tax loss (and therefore the tax base of its non-monetary assets and
liabilities) is determined in a foreign currency, changes in the exchange rate give rise to taxable or deductible
temporary differences.

These relate to the foreign entity’s own assets and liabilities, rather than to the reporting entity’s investment in that
foreign operation, and so the reporting entity should recognize the resulting deferred tax liability or asset, both these
are probable:
a) That the temporary difference will reverse in the foreseeable future, and
b) That taxable profit will be available against which the temporary difference can be utilized.

pg. 114
IAS 12 SBR Revision Notes

DEDUCTIBLE TEMPORARY DIFFERENCES

Unrealised profits on intra-group trading
 From a tax perspective, one group company selling goods to another group company is taxed on the resulting
profit in the period that the sale is made.
 From an accounting perspective no profit is realized until the recipient group company sells the goods to a third
party outside the group. This may occur in a different accounting period from that in which the initial group sale
is made.
 A temporary difference therefore arises equal to the amount of unrealized intra-group profit. This is the
difference between:
- Tax base, being cost to the recipient company (i.e. cost to selling company plus unrealized intra-group profit
on sale to the recipient company)
- Carrying value to the group, being the original cost to the selling company, since the intra-group profit is
eliminated on consolidation
 Deferred tax is provided on consolidation

Fair value adjustments

IFRS 3 requires assets and liabilities acquired on acquisition of a subsidiary or associate to be brought in at their fair
value rather than the carrying amount. The fair value adjustment does not, however, have any impact on taxable
profits or the tax base of the asset.

Therefore a fair value adjustment which increases a recognized liability or creates a new liability will result in the tax
base of the liability exceeding the carrying value and so deductible temporary difference will arise.

A deductible temporary difference also arises where an asset’s carrying amount is reduced to a fair value less than
its tax base.

The resulting deferred tax asset is recorded in the consolidated accounts by:
Dr Deferred tax asset X
Cr Goodwill X

Deferred tax assets of an acquired subsidiary

Deferred tax assets of a subsidiary may not satisfy the criteria for recognition when a business combination is initially
accounted for but may be realized subsequently.

These should be recognized as follows:

 If recognized within 12 months of the acquisition date and resulting from new information about circumstances
existing at the acquisition date, the credit entry should be made to goodwill. If the carrying amount of goodwill
reduced to zero, any further amounts should be recognized in profit or loss.
 If recognized outside the 12 months ‘measurement period’ or not resulting from new information about
circumstances existing at the acquisition date, the credit entry should be made to profit or loss.

PRESENTATION AND DISCLOSURE

Presentation
Current tax assets and current tax liabilities can only be offset in the statement of financial position if the entity has
the legal right and the intention to settle on a net basis.

pg. 115
IAS 12 SBR Revision Notes

Deferred tax assets and deferred tax liabilities can only be offset in the statement of financial position if the entity
has the legal right to settle current tax amounts on a net basis and the deferred tax amounts are levied by the same
taxing authority on the same entity or different entities that intend to realise the asset and settle the liability at the
same time.

The amount of tax expense (or income) related to profit or loss is required to be presented in the statement(s) of
profit or loss and other comprehensive income.

The tax effects of items included in other comprehensive income can either be shown net for each item, or the items
can be shown before tax effects with an aggregate amount of income tax for groups of items (allocated between
items that will and will not be reclassified to profit or loss in subsequent periods).

Disclosure
IAS 12 requires the following disclosures:
 Major components of tax expense (tax income). Examples include:
o Current tax expense (income)
o Any adjustments of taxes of prior periods
o Amount of deferred tax expense (income) relating to the origination and reversal of temporary differences
o Amount of deferred tax expense (income) relating to changes in tax rates or the imposition of new taxes
o Amount of the benefit arising from a previously unrecognised tax loss, tax credit or temporary difference
of a prior period
o Write down, or reversal of a previous write down, of a deferred tax asset
o Amount of tax expense (income) relating to changes in accounting policies and corrections of errors.

IAS 12 further requires the following disclosures:

 Aggregate current and deferred tax relating to items recognised directly in equity
 Tax relating to each component of other comprehensive income
 Explanation of the relationship between tax expense (income) and the tax that would be expected by applying
the current tax rate to accounting profit or loss (this can be presented as a reconciliation of amounts of tax or a
reconciliation of the rate of tax)
 Changes in tax rates
 Amounts and other details of deductible temporary differences, unused tax losses, and unused tax credits
 Temporary differences associated with investments in subsidiaries, branches and associates, and interests in
joint arrangements
 For each type of temporary difference and unused tax loss and credit, the amount of deferred tax assets or
liabilities recognised in the statement of financial position and the amount of deferred tax income or expense
recognised in profit or loss
 Tax relating to discontinued operations
 Tax consequences of dividends declared after the end of the reporting period
 Information about the impacts of business combinations on an acquirer's deferred tax assets
 Recognition of deferred tax assets of an acquiree after the acquisition date.

Other required disclosures:

 Details of deferred tax assets
 Tax consequences of future dividend payments.

pg. 116
IAS 12 SBR Revision Notes

In addition to the disclosures required by IAS 12, some disclosures relating to income taxes are required by IAS 1
Presentation of Financial Statements, as follows:
 Disclosure on the face of the statement of financial position about current tax assets, current tax liabilities,
deferred tax assets, and deferred tax liabilities
 Disclosure of tax expense (tax income) in the profit or loss section of the statement of profit or loss and other
comprehensive income (or separate statement if presented).

Deferred tax and the framework

As we have seen, IAS 12 considers deferred tax by taking a balance sheet approach to the accounting problem by
considering temporary differences in terms of the difference between the carrying values and the tax values of assets
and liabilities – also known as the valuation approach. This can be said to be consistent with the IASB Framework’s
approach to recognition within financial statements. However, the valuation approach is applied regardless of
whether the resulting deferred tax will meet the definition of an asset or liability in its own right.

Thus, IAS 12 considers the overriding accounting issue behind deferred tax to be the application of matching –
ensuring that the tax consequences of an item reported within the financial statements are reported in the same
accounting period as the item itself.

For example, in the case of a revaluation surplus, since the gain has been recognised in the financial statements, the
tax consequences of this gain should also be recognised – that is to say, a tax charge. In order to recognise a tax
charge, it is necessary to complete the double entry by also recording a corresponding deferred tax liability.

However, part of the Framework’s definition of a liability is that there is a ‘present obligation’. Therefore, the
deferred tax liability arising on the revaluation gain should represent the current obligation to pay tax in the future
when the asset is sold. However, since there is no present obligation to sell the asset, there is no present obligation
to pay the tax.

Therefore, it is also acknowledged that IAS 12 is inconsistent with the Framework to the extent that a deferred tax
asset or liability does not necessarily meet the definition of an asset or liability.

pg. 117
IFRS 8 SBR Revision Notes

IFRS 8 – OPERATING SEGMENTS

Large entities produce a wide range of products and services, often in several different countries. Further
information on how the overall results of entities are made up from each of these product or geographical areas will
help the users of the financial statements. Following are the reasons for segment reporting (By product, region or
operation).
 The entity's past performance will be better understood
 The entity's risks and returns may be better assessed
 More informed judgments may be made about the entity as a whole

OBJECTIVE
An entity shall disclose information to enable users of its financial statements to evaluate the nature and financial
effects of the business activities in which it engages and the economic environments in which it operates.

SCOPE
This IFRS shall apply to the separate and consolidated financial statements of an entity:
(i) whose debt or equity instruments are traded in a public market (a domestic or foreign stock exchange or
an over-the-counter market, including local and regional markets), or
(ii) that files, or is in the process of filing, its financial statements with a securities commission or other
regulatory organisation

OPERATING SEGMENTS
An operating segment is a component of an entity:
(a) that engages in business activities from which it may earn revenues and incur expenses (including revenues and
expenses relating to transactions with other components of the same entity),
(b) whose operating results are regularly reviewed by the entity’s chief operating decision maker to make decisions
about resources to be allocated to the segment and assess its performance, and
(c) For which discrete financial information is available.

An operating segment may engage in business activities for which it has yet to earn revenues, for example, start-up
operations may be operating segments before earning revenues.

The term ‘chief operating decision maker’ identifies a function, not necessarily a manager with a specific title. That
function is to allocate resources to and assess the performance of the operating segments of an entity.

This definition means that not every part of an entity is necessarily an operating segment. IFRS 8 quotes the example
of a corporate headquarters that may earn no or incidental revenues and so would not be an operating segment.

Aggregation criteria
Two or more operating segments may be aggregated into a single operating segment if aggregation is consistent
with the core principle of this IFRS, the segments have similar economic characteristics, and the segments are similar
in each of the following respects:
(a) The nature of the products and services;
(b) The nature of the production processes;
(c) The type or class of customer for their products and services;

pg. 118
IFRS 8 SBR Revision Notes

(d) The methods used to distribute their products or provide their services; and
(e) If applicable, the nature of the regulatory environment, for example, banking, insurance or public utilities.

DETERMINING REPORTABLE SEGMENTS

An entity shall report separately information about an operating segment that meets
I) the definition of an operating segment, and
II) any of the following quantitative thresholds:

(a) Its reported revenue, including both sales to external customers and intersegment sales or transfers, is 10 per
cent or more of the combined revenue, internal and external, of all operating segments.
(b) The absolute amount of its reported profit or loss is 10 per cent or more of the greater, in absolute amount, of
(i) the combined reported profit of all operating segments that did not report a loss and (ii) the combined
reported loss of all operating segments that reported a loss.
(c) Its assets are 10 per cent or more of the combined assets of all operating segments.

If the total external revenue reported by operating segments constitutes less than 75 per cent of the entity’s
revenue, additional operating segments shall be identified as reportable segments until at least 75 per cent of the
entity’s revenue is included in reportable segments.

Operating segments that do not meet any of the quantitative thresholds may be considered reportable, and
separately disclosed, if management believes that information about the segment would be useful to users of the
financial statements.

Aggregating segments
Two or more operating segments below the thresholds may be aggregated to produce a reportable segment if the
segments have similar economic characteristics, and the segments are similar in a majority of the aggregation criteria
above

Non reportable segments

An entity may combine information about operating segments that do not meet the quantitative thresholds to
produce a reportable segment only if the operating segments have similar economic characteristics and share a
majority of the aggregation criteria.

pg. 119
IFRS 8 SBR Revision Notes

DECISION TREE TO ASSIST IN IDENTIFYING REPORTABLE SEGMENTS

Identify operating segments based on
management reporting system

Yes
Aggregate
Do some operating No
segments meet all segment if
Yes aggregation criteria? desired

No
Do some operating segments meet the
quantitative thresholds?
No

Aggregate
Do some remaining operating
segment if
segments meet aNo
majority of the
desired aggregation criteria?

Do identified reportable segments

account for 75 per cent of the entity’s
revenue?

Report additional segment if external

revenue of all segments is less than 75
per cent of the entity’s revenue

These are reportable

segments to be disclosed Aggregate remaining segments into ‘all other
segments’ category

Measurement
The amount of each segment item reported shall be the measure reported to the chief operating decision maker for
the purposes of making decisions about allocating resources to the segment and assessing its performance.

pg. 120
IFRS 8 SBR Revision Notes

pg. 121
IFRS 8 SBR Revision Notes

DISCLOSURES BY REPORTABLE OPERATING SEGMENTS

IFRS 8 provides a framework on which to base the reported disclosures.
1. Entities are required to provide general information on such matters as how the reportable segments are
identified and the types of products or services from which each reportable segment derives its revenue.
2. Entities are required to report a measure of profit or loss and total assets for each reportable segment. Both
should be based on the information provided to the chief operating decision maker. If the chief operating
decision maker is regularly provided with information on liabilities for its operating segments then these
liabilities should also be reported on a segment basis.

IFRS 8 specifies disclosures that are needed regarding profit or loss and assets where the amounts are included in
the measure of profit or loss and total assets:
 Revenues - internal and external.
 Interest revenues and interest expense. These must not be netted off unless the majority of a segment's
revenues are from interest and the chief operating decision maker assesses the performance of the segment
based on net interest revenue.
 Depreciation and amortization.
 Material items of income and expense disclosed separately.
 Share of profit after tax of, and carrying value of investment in, entities accounted for under the equity
method.
 Material non-cash items other than depreciation and amortization.
 The amount of additions to non-current assets other than financial instruments, deferred tax assets, post-
employment benefit assets and rights arising under insurance contracts.

The measurement basis for each item separately reported should be the one used in the information provided to
the chief operating decision maker. The internal reporting system may use more than one measure of an operating
segment's profit or loss, or assets or liabilities. In such circumstances the measure used in the segment report should
be the one that management believes is most consistent with those used to measure the corresponding amounts in
the entity's financial statements.

Entities are required to provide a number of reconciliations:

 The total of the reportable segments' revenues to the entity's revenue
 The total of the reportable segments' profit or loss to the entity's profit or loss
 The total of the reportable segments' assets to the entity's assets
 Where separately identified, the total of the reportable segments' liabilities to the entity's liabilities and
 The total of the reportable segments' amounts for every other material item disclosed to the corresponding
amount for the entity.

Entity-wide disclosures
Unless otherwise provided in the segment report IFRS 8 requires entities to provide information about its revenue
on a geographical and 'class of business' basis. Entities also need to provide information on non-current assets on a
geographical basis, but not on a 'class of business' basis.

If revenues from single external customer amount to 10% or more of the total revenue of the entity then the entity
needs to disclose that fact plus:
 The total revenue from each customer (although the name is not needed) and

pg. 122
IFRS 8 SBR Revision Notes

 The segment or segment reporting the revenues.

The 'entity-wide disclosures' are needed even where the entity has only a single operating segment, and therefore
does not effectively segment report

Criticisms of IFRS 8
(a) Some commentators have criticized the 'management approach' as leaving segment identification too much to
the discretion of the entity.
(b) The management approach may mean that financial statements of different entities are not comparable.
(c) Segment determination is the responsibility of directors and is subjective.
(d) Management may report segments which are not consistent for internal reporting and control purposes,
making its usefulness questionable.
(e) For accounting periods beginning on or after 1 January 2005 listed entities within the EU are required to use
adopted international standards in their consolidated financial statements. The EU has not yet adopted IFRS 8
and until it does IAS 14 will continue to apply here. Some stakeholders believe the standard to be flawed due to
the amount of discretion it gives to management.
(f) Geographical information has been downgraded. It could be argued that this breaks the link between a
company and its stakeholders.
(g) There is no defined measure of segment profit or loss.

pg. 123
IAS 33 SBR Revision Notes

IAS 33 – EARNINGS PER SHARE

INTRODUCTION
Earnings Per Share (EPS) is an unusual accounting ratio in that it has a whole standard devoted to its calculation and
presentation. The importance attached to this ratio derives from the fact that it is used as a basis for a number of
significant statistics used by investors.

USES OF EPS
The uses of EPS as a financial indicator include:
 The assessment of management performance over time.
 Trend analysis of EPS to give an indication of earnings performance.
 An indicator of dividend payouts. The higher the EPS the greater the expectation of an increased dividend
compared to previous periods.
 An important component in determining the entity's price/earnings (P/E) ratio.

Scope and Objective

The objective of the standard is to prescribe principles for the determination and presentation of earning per share
in order to improve performance comparisons between different entities in the same period and over time for the
same entity.

IAS 33 only applies to entities whose securities are publicly traded or that are in the process of issuing securities to
the public. This is because entities, whose securities are not traded, do not have a readily observable market price
which would make it difficult to calculate a P/E ratio.

DEFINITIONS
Ordinary shares: an equity instrument that is subordinate to all other classes of equity shares.

Potential ordinary shares: a financial instrument or other contract that may entitle its holder to ordinary shares.

Examples of potential ordinary shares include:

 Convertible debt
 Convertible preference shares
 Share warrants
 Share options

Warrants or options: financial instruments that give the holder the right to purchase ordinary shares.

Dilution: a reduction in EPS or an increase in loss per share resulting from the assumption that convertible
instruments are converted, the options or warranties are exercised, or that ordinary shares are issued upon the
satisfaction of specified conditions.

Antidilution: an increase in EPS or a reduction in loss per share resulting from the assumption that convertible
instruments are converted, the options or warranties are exercised, or that ordinary shares are issued upon the
satisfaction of specified conditions.

pg. 124
IAS 33 SBR Revision Notes

BASIC EPS
The basic EPS should be calculated by dividing the net profit or loss attributable to ordinary equity shareholders by
the weighted average number of ordinary shares outstanding during the period.

The net profit is profit after tax and preference dividends.

CHANGES IN THE CAPITAL STRUCTURE

Most of the complications in the computation of EPS arise from changes in the share capital. The underlying principle
is that EPS should be comparable from period to period.

Thus in arriving at the denominator in the EPS calculation, the shares in issue at the beginning of the period may
need to be adjusted for shares bought back or issued during the period multiplied by a time weighting factor.

It is necessary to time apportion and come up with a weighted average number of shares outstanding; because
where capital has been invested through the issue of shares part-way through the year, additional earnings will only
have been generated from the date at which the investment took place. If earnings for the year were apportioned
over shares in issue at the year end the resultant EPS would not fairly reflect performance for the current period in
comparison to a previous period when there may have been no such change in equity. Similar logic applies where
shares have been bought back in the year.

The four most common reasons for adjusting shares in issue at the beginning of the period are:
 Issue of new shares during the period (fully or partly paid)
 Bonus issues
 Rights issues;
 Potential ordinary shares (resulting in calculation of diluted EPS)

Issue of new shares during the period (Fully paid)

Shares should be included in the weighted average calculation from the date consideration is receivable

Issue of new shares during the period (Partly paid)

The general principle under IAS 33 that shares should be included in the weighted average calculation from the date
consideration is receivable does not apply to shares that are issued in partly paid form. Partly paid shares are treated
as fractions of shares; based on payments received to date as a proportion of the total subscription price. These
shares are included in the averaging calculation only to the extent that they participate in dividends for the period.
Dividend entitlement of such shareholders is usually restricted to an amount based on this fraction.

The weighted average number of shares should be restricted based on this fraction. If the actual receipts to date
were only applied to the issue of fully paid shares, then the number of fully paid shares would be smaller than was
actually the case for partly paid shares being issued.

Bonus issue, share split and share consolidation

Where a company issues new shares by way of a capitalisation of reserves (a bonus issue) during the period, the
effect is to increase only the number of shares outstanding after the issue. There is no effect on earnings as there is
no inflow of funds as a result of the issue.

pg. 125
IAS 33 SBR Revision Notes

As shareholders rights are not affected; each individual will hold the same proportion of outstanding shares as before
the issue. IAS 33 requires that the bonus shares are treated as if they had occurred at the beginning of the period.
The EPS from the previous period should also be recalculated using the new number of shares in issue to allow
comparison with the current year's EPS, as if the issue had taken place at the beginning of that period as well.
When calculating the prior period EPS comparator then multiply last year's EPS by the factor:

Number of Shares before bonus issue

Number of Shares after bonus issue

When calculating the weighted average number of shares then the bonus factor to apply is the inverse of the above,
i.e.
Number of Shares after bonus issue
Number of Shares before bonus issue

Similar considerations apply where ordinary shares are split into shares of smaller nominal value (a share of $1 is
split into four share of 25c each) or consolidated into shares of higher nominal value (four shares of 25c each are
consolidated into one share of $1). In both these situations, the number of shares outstanding before the event is
adjusted for the proportionate change in the number of shares outstanding after the event.

RIGHTS ISSUE
With a rights issue additional capital is raised by the issue of the shares. Existing shareholders are offered the right
to purchase new shares from the company, usually at a discount to the current market price.

Then when dealing with a rights issue at a discount, calculation of EPS should mark adjustment for the two elements:
 A bonus issue (reflecting the fact that the cash received would not pay for all the/shares issued if based on fair
values, rather than being discounted).
 An assumed issue at full price (reflecting the fact that new shares are issued in return for cash);

Consequently the number of shares outstanding at the beginning of the year should be adjusted for the bonus factor
to give a deemed number of shares in issue before the rights issue. This should be weighted for the period up to the
date of the rights issue.

The bonus factor is equal to: Fair Value before rights issue
Theoretical ex - rights Price after rights issue

Additionally the number of shares actually in issue after the rights issue is weighted for the period after the rights
issue.

As in the section on bonus issues, the prior period EPS should be adjusted for the bonus factor. This is achieved by
taking the reciprocal of the bonus factor (turn fraction Upside down) and multiplying by last year's EPS.

DILUTED EARNINGS PER SHARE

An entity may have in issue at the reporting date a number of financial instruments that give rights to ordinary shares
at a future date. IAS 33 refers to these as potential ordinary shares. Examples of potential ordinary shares include:
 Convertible debt;
 Convertible preference shares;

pg. 126
IAS 33 SBR Revision Notes

 Share warrants
 Share options

Where these rights are exercised they will increase the number of shares. Earnings may also be affected. The overall
effect will tend towards lowering (or diluting) the EPS.

This will tend to be the case because holders of these rights will only take them if it is to their benefit which tends
to be prejudicial to existing shareholders

So that existing shareholders can see the potential dilution of their present earnings, IAS 33 requires that a diluted
EPS is calculated.

The calculation is performed as if the potential ordinary shares had been in issue throughout the period. If the rights
were granted during the reporting the period, then time apportion.

The diluted EPS is:

Earnings as per basic eps + Adjustment for dilutive potential ordinary shares
Weighted Average number of shares per basic EPS + Adjustment for dilutive potential ordinal

CONVERTIBLE FINANCIAL INSTRUMENTS

CALCULATION OF EARNINGS
The basic earnings figure should be adjusted to reflect any changes in profit that would arise when the potential
ordinary shares outstanding are actually issued. Adjust:
1. Profits
There will be a saving of interest. Interest is a tax-deductible expense and so the post- tax effects will be
brought into the adjusted profits.

There will be a saving of preference dividend. There is no associated tax effect.

Therefore, the numerator should be adjusted for the after-tax effects of dividends and interest charged in
relation to dilutive potential ordinary shares and for any other changes in income that would result from
the conversion of the potential ordinary shares.

2. The number of shares

The denominator should include shares that would be issued on the conversion.

The potential ordinary shares are deemed to be converted to ordinary shares at the start of the period
unless they were issued during the reporting period.

SHARE WARRANTS AND OPTIONS

A share option or warrant gives the holder the right to purchase or subscribe for ordinary shares. IAS 33 requires
that the assumed proceeds from these shares should be considered to have been received from the issue of shares
at fair value. These would have no effect on EPS.

pg. 127
IAS 33 SBR Revision Notes

The difference between the number of shares that would have been issued at fair value and the number of shares
actually issued is treated as an issue of ordinary shares for no consideration. This bonus element has a dilutive effect
with regard to existing shareholders.

pg. 128
IFRS 5 SBR Revision Notes

IFRS 5 – NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED

OPERATIONS
OBJECTIVE
The objective of this standard is to specify the accounting for Non-current assets held for sale, and presentation and
disclosure of discontinued operations.

NON-CURRENT ASSETS HELD FOR SALE

HELD FOR SALE
This term refers to a non-current asset whose carrying amount will be recovered principally through a sale
transaction rather than through continuing use.

DISCONTINUED OPERATION
A discontinued operation includes the following criteria (Discussed in detail after measurement):
 Is a separately identifiable component
 Must represent a major line of the entity’s business
 Is part of a plan to dispose of a major line of business or a geographical area
 Is a subsidiary acquired with a view to resell

DISPOSAL GROUP
This is a group of assets and possibly some liabilities that an entity intends to dispose of in a single transaction.

CLASSIFICATION OF NON-CURRENT ASSETS AS HELD FOR SALE

For an asset to be classified as held for sale:
a) It must be available for immediate sale in its present condition allowing for terms that are usual or
customary;
b) Its sale must be highly probable {expected within 1 year of reclassification);
c) It must be genuinely sold, not abandoned.

Immediate sale
The application of the phrase does make allowance for conditions considered 'usual and customary' in selling the
asset, e.g. allowance would be made for searches and surveys when selling property.

No allowance is made for conditions imposed by the seller of the asset or disposal group.

Highly probable
For a sale to be highly probable it must be significantly more likely than probable. In addition the standard sets out
the following criteria to be satisfied:
 Management, at a level that has the authority to sell the assets or disposal group, is committed to a plan to sell;

 An active program to locate a buyer and complete the sale must have begun. This will include making it known
to those that might be interested that the asset or disposal group is available for sale;

 The asset or disposal group must be actively marketed at a price that is reasonable compared to its current fair
value.

pg. 129
IFRS 5 SBR Revision Notes

This should take account of local conditions in the market. Thus if it is customary to price above fair value in the
expectation of low bids, or vice versa, this is acceptable. The term actively marketed requires that the entity is
making positive efforts to sell, not just to locate a buyer, e.g. by engaging a selling agent.

 The sale of the asset is expected to be recorded as completed within time, ear from the date of classification.

(If the sale is not completed within one year and this is due to events beyond entity's control, it is still possible
for the asset to be continued to be classified as held for sale provided the entity is still committed to selling the
asset).

 The actions required to complete the plan should indicate that it is not likely that there will be significant
changes made to the plan or that the plan will be withdrawn.

MEASUREMENT
Non-current assets or disposal groups that meet the criteria to be classified as held for sale are measured at the
lower of:
 Fair value less costs to sell; and
 Carrying amount (in accordance with the relevant Standard).

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date.

Costs to sell are "the incremental costs directly attributable to the disposal of an asset (or disposal group)". Examples
would include lawyer's or estate agent's fees.

The costs must be incremental; internal costs cannot be included in costs to sell.

Measurement on initial classification as held for sale

IFRS 5 requires that immediately before the initial classification of an asset (or disposal group) as held for sale, the
carrying amount of the asset (or all the assets and liabilities in a disposal group) should be measured in accordance
with the relevant IFRS.

Initial classification as held for sale may lead to a write down to fair value less costs to sell.
Note:
 Any impairment loss on initial or subsequent write-down of the asset or disposal group to fair value less cost to
sell is to be recognised in the statement of profit or loss.
 Any subsequent increase in fair value less cost to sell can be recognised in the statement of profit or loss to the
extent that it is not in excess of the cumulative impairment loss that has been recognised in accordance with
the IFRS 5 or previously in accordance with IAS 36.
 Any impairment loss recognised for disposal group should be applied in the order set out in IAS 36. The standard
sets out how to allocate the impairment loss among the constituent parts of the disposal group (or cash
generating unit). The loss itself is still charged to the statement of profit or loss.

pg. 130
IFRS 5 SBR Revision Notes

SUBSEQUENT REMEASUREMENT
 Whilst a non-current asset/disposal group is classified as held for sale it should not be depreciated or amortised.
 At each reporting date where a non-current asset or disposal group continues to be classified as held for sale it
should be re-measured at fair value less costs to sell at that date.
 This may give rise to further impairments or a reversal of previous impairment losses. In either case recognise
in the statement of profit or loss.

DISCONTINUED OPERATIONS – Detailed explanation

As mentioned earlier, discontinued operation is a component of an entity that:
i.) Either has been disposed of, or
ii.) Is classified as held for sale, and that component

a) Represents a separate major line of business or geographical area of operations, or

b) Is part of a single co-ordinated plan to dispose of a separate major line of business or geographical area
of operations, or
c) It is a subsidiary acquired exclusively with a view to resale.

Component:
The standard defines this term as "operations and cash flows that can be clearly distinguished, operationally and for
financial reporting purposes, from the rest of the entity”.

A component will have been a single Cash Generating Unit (CGU) or a collection of CGUs while held for use in the
business.
A component can be distinguished operationally and for financial reporting purposes if:
 Its operating assets and liabilities can be directly attributed to it;
 Its income (gross revenue) can be directly attributed to it;
 At least a majority of its operating expenses can be directly attributed to it.

Classification as discontinued operation

A component of the reporting entity is classified as discontinued at:
 The date of its disposal (sale/termination); or
 Or when the operation meets the IFRS criteria to be classified as held for sale.

In order to have been classified as a discontinued operation by the reporting date the disposal or reclassification as
'held for sale' must have taken place by that reporting period end.

If an operation is to be terminated, but it is not actually closed by the reporting date then it will not be classified as
discontinued at the year end.

Major line of business or geographical segment

A separate business segment or geographical segment as defined in IFRS 8 – Operating Segments, would normally
meet this condition.

pg. 131
IFRS 5 SBR Revision Notes

Single plan
If a component is not itself a separate major line of business or geographical area of operations then it must be "part
of a single co-ordinated plan" to dispose of such a line of business or geographical area of operations. The single plan
might relate to a disposal in one transaction or piecemeal.

PRESENTATION
 Non-current assets that meet the criteria are presented separately on the Statement of Financial Position within
current assets.
 If the held for sale item is a disposal group then related liabilities are also reported separately within current
liabilities.
 Discontinued operations and operations held for sale must be disclosed separately in the statement of financial
position at the lower of their carrying value less costs to sell.

pg. 132
Financial Instruments SBR Revision Notes

FINANCIAL INSTRUMENTS

Introduction to Financial Instruments

1. IAS 32 Financial Instruments: Presentation
2. IFRS 7 Financial Instruments: Disclosures
3. IFRS 9 Financial Instruments

IAS 32 FINANCIAL INSTRUMENTS: PRESENTATION

OBJECTIVE
The stated objective of IAS 32 is to establish principles for presenting financial instruments as liabilities or equity and
for offsetting financial assets and liabilities.

IAS 32 addresses this in a number of ways:

 clarifying the classification of a financial instrument issued by an entity as a liability or as equity
 prescribing the accounting for treasury shares (an entity's own repurchased shares)
 prescribing strict conditions under which assets and liabilities may be offset in the balance sheet

SCOPE
 IAS 32 applies in presenting and disclosing information about all types of financial instruments with the
exceptions of items under IAS 27, IAS 28, IFRS 11, IAS 19 and IFRS 2 and non-financial items which will be settled
through physical delivery.

However, IAS 32 applies to:

 The contracts to buy or sell a non-financial item that can be settled net in cash or another financial instrument

DEFINITIONS
The following terms are used in this Standard with the meanings specified:
A Financial Instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity
instrument of another entity.

A Financial Asset is any asset that is:

(a) Cash;
(b) An equity instrument of another entity;
(c) A contractual right:
(i) To receive cash or another financial asset from another entity; or
(ii) To exchange financial assets or financial liabilities with another entity under conditions that are
potentially favourable to the entity; or
(d) A contract that will or may be settled in the entity’s own equity instruments and is:
(i) A non-derivative for which the entity is or may be obliged to receive a variable number of the entity’s
own equity instruments; or
(ii) A derivative that will or may be settled other than by the exchange of a fixed amount of cash or another
financial asset for a fixed number of the entity’s own equity instruments.

pg. 133
Financial Instruments SBR Revision Notes

A Financial Liability is any liability that is:

(a) A contractual obligation:
(i) To deliver cash or another financial asset to another entity; or
(ii) To exchange financial assets or financial liabilities with another entity under conditions that are
potentially unfavourable to the entity; or
(b) a contract that will or may be settled in the entity’s own equity instruments and is:
(i) a non-derivative for which the entity is or may be obliged to deliver a variable number of the entity’s
own equity instruments; or
(ii) a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another
financial asset for a fixed number of the entity’s own equity instruments.

An Equity Instrument is any contract that evidences a residual interest in the assets of an entity after deducting all
of its liabilities.

A Puttable Instrument is a financial instrument that gives the holder the right to put the instrument back to the
issuer for cash or another financial asset or is automatically put back to the issuer on the occurrence of an uncertain
future event or the death or retirement of the instrument holder.

Examples of financial assets include Trade receivables, Options, Shares (when used as an investment).

Examples of financial liabilities include Trade payables, Debenture loans payable, Redeemable preference (non-
equity) shares and Forward contracts standing at a loss.

Financial instruments include both of the following.

(a) Primary instruments: e.g. receivables, payables and equity securities
(b) Derivative instruments: e.g. financial options, futures and forwards, interest rate swaps and currency swaps,
whether recognized or unrecognized

IAS 32 makes it clear that the following items are not financial instruments.
 Physical assets, e.g. inventories, property, plant and equipment, leased assets and intangible assets (patents,
trademarks etc).
 Prepaid Expenses, deferred revenue and most warranty obligations.
 Liabilities or assets that is not contractual in nature
 Contractual rights/obligations that do not involve transfer of a financial asset, e.g. commodity futures
contracts, operating leases

Compound Financial Instruments

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

An entity recognises separately the components of a financial instrument that:

(a) creates a financial liability of the entity and
(b) Grants an option to the holder of the instrument to convert it into an equity instrument of the entity.

pg. 134
Financial Instruments SBR Revision Notes

Treasury Shares
If an entity reacquires its own equity instruments, those instruments (‘treasury shares’) shall be deducted from
equity. No gain or loss shall be recognized in profit or loss on the purchase, sale, issue or cancellation of an entity’s
own equity instruments. Consideration paid or received shall be recognized directly in equity.

Interest, Dividends, Losses and Gains

Interest, dividends, gains, and losses relating to an instrument classified as a liability should be reported in profit or
loss. This means that dividend payments on preferred shares classified as liabilities are treated as expenses. On the
other hand, distributions (such as dividends) to holders of a financial instrument classified as equity should be
charged directly against equity, not against earnings.

Transaction costs of an equity transaction are deducted from equity. Transaction costs related to an issue of a
compound financial instrument are allocated to the liability and equity components in proportion to the allocation
of proceeds.

OFFSETTING FINANCIAL ASSETS AND LIABILITIES

IAS 32 also prescribes rules for the offsetting of financial assets and financial liabilities. It specifies that a financial
asset and a financial liability should be offset and the net amount reported when, and only when, an entity:
 Has a legally enforceable right to set off the amounts; and
 Intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously.

Disclosures
Financial instruments disclosures are in IFRS 7 Financial Instruments: Disclosures, and no longer in IAS 32.

pg. 135
IFRS 9 SBR Revision Notes

IFRS 9 FINANCIAL INSTRUMENTS (REPLACEMENT OF IAS 39)

OBJECTIVE
The objective of this IFRS is to establish principles for the financial reporting of financial assets and financial liabilities
that will present relevant and useful information to users of financial statements for their assessment of the
amounts, timing and uncertainty of an entity’s future cash flows.

RECOGNITION AND DERECOGNITION

Initial Recognition
Financial asset or financial liability should be recognized by an entity in its statement of financial position when the
entity becomes party to the contractual provisions of the financial asset or financial liability, even at nil cost.

Effective interest rate method

Total finance cost: $
Interest paid xx
Issuance cost xx
Discount xx
Premium xx
Total finance cost (Allocate over loan term xx
using effective interest rate)

Years Opening Finance cost charged Interest paid Rollover Closing

balance balance
Y1 xx Issue cost, discount & Nominal value x Discount, issue cost Xx
premium Par value & premium

Calculation of fair value of financial instrument

 Fair value = Present value of future cash flows at current market interest for similar financial instruments
 Use market rate of relevant year or date
 Future cash flows will be used.

CLASSIFICATION OF FINANCIAL ASSETS

An entity shall classify financial assets as subsequently measured at:
 Amortised cost or
 Fair value through profit or loss (FVTPL)
 Fair value through other comprehensive income (FVTOCI)

A financial asset (debt instrument only) shall be measured at amortised cost if both of the following conditions are
met:
(a) The asset is held within a business model whose objective is to hold assets in order to collect contractual cash
flows (Solely principal amount and interest).
(b) The contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments
of principal and interest on the principal amount outstanding. Interest is compensation for time value of money
and credit risk.

pg. 136
IFRS 9 SBR Revision Notes

Important points
 Assess business management model on portfolio level not on individual investment
 Irregular sales of investments do not impact business management model
 Businesses may have different business management models for different investments

Fair Value Designation of Financial Assets

Even if an instrument meets the two amortised cost tests, IFRS 9 contains an option to designate a financial asset as
measured at Fair Value Through Profit and Loss if doing so eliminates or significantly reduces a measurement or
recognition inconsistency.

Fair value through other comprehensive income

The criteria are as follows:
For investments in equity For investment in debt
Investment in equity not held for trading Business management model is to hold
investment for collection of contractual cash
flows and to sell
Entity has made an irrevocable election to recognize Investment can generate contractual cash flow at
gain/ (loss) in other comprehensive income specified time, Principal and Interest, where
interest is compensation of time value of money
& credit risk

Fair value through profit or loss

The criteria are as follows:
 It is the default category (After not meeting any other category’s criteria)
 Investments not categorized at amortized cost and FVTOCI will be classified here

Examples
Investment in perpetuity bond At FVTPL
Investment in convertible bond At FVTPL
Investment in fixed rate bond Could be at amortised cost
Investment in variable interest rate bond Could be at amortised cost, market
interest rates are reset periodically
therefore it accounts for time value of
money and credit risk of the company
Investment in bond of $10,000 at 6% variable with:
Gold price At FVTPL
Stock market At FVTPL
Inflation (Credit risk & Time value of money) Could be at amortised cost

MEASUREMENT OF FINANCIAL ASSETS

1) At Amortised cost:
Initial measurement: Fair value (Cash paid) + Transaction cost
Subsequent measurement: At amortised cost using effective interest rate method
2) At FVTOCI:
Initial measurement: Fair value (Cash paid) + Transaction cost

pg. 137
IFRS 9 SBR Revision Notes

Subsequent measurement: At fair value and gain/loss will be charged to OCI

3) At FVTPL:
Initial measurement: Fair value (Cash paid)
Transaction cost is charged to P&L
Subsequent measurement: At fair value and gain/loss will be charged to P&L

DERECOGNITION OF FINANCIAL ASSETS

Derecognition is the removal of a previously recognised financial instrument from an entity’s statement of financial
position.

An entity should derecognize a financial asset when:

(a) The contractual rights to the cash flows from the financial asset expire e.g., cash received from receivable,
Option exercised, option expired etc. , OR
(b) The entity transfers substantially all the risks and rewards of ownership of the financial asset to another party.

Accounting Treatment
On derecognition the difference between the carrying amount and consideration received should be recognised in
P&L. Reclassify in P&L any accumulated gains or losses already recognised in OCI

pg. 138
IFRS 9 SBR Revision Notes

Consolidate all subsidiaries (including any SPE)

Determine whether the derecognition principles

below are applied to a part or all of an asset
(or group of similar assets)

Have the rights to the cash

flows from the asset expired? Yes Derecognize the asset

No

Has the entity transferred its

rights to receive the cash
flows from the asset?

No

Has the entity assumed an

Yes obligation to pay the cash
flows from the asset that No Continue to recognise the asset
meets the conditions
recognisition

Yes

Has the entity transferred

substantially all risks and Derecognise the asset
Yes
rewards?

No

Has the entity retained

substantially all risks and Continue to recognise the asset
rewards? Yes

No

Has the entity retained No Derecognise the asset

control of the asset?

Yes

Continue to recognise the asset to the extent of the

entity’s continuing involvement

pg. 139
IFRS 9 SBR Revision Notes

Assess risk and rewards of financial asset immediately before and after transfer
a) Substantial risk and rewards transferred
Derecognize:
Dr. Cash/Asset xx
Dr/Cr. (loss)/Profit xx
Cr. Financial asset xx

Examples:
 Unconditional sale of financial asset
 Factoring of receivables (without recourse)
 Sales of asset on repurchase terms where repurchase will be at market price
 Sale of asset with call or put option and option is deep out of money

b) Substantial risks and rewards retained

Continue to recognize the asset
Any cash received would be secured loan
Dr. Cash xx
Cr. Loan xx
Examples:
 Factoring of receivables with recourse
 Sales of asset on repurchase term where repurchase price is already decided
 Sale of asset with call or put option and option is deep in the money
 Sale of asset with return swap contract

Remember always to apply the principle of substance over form.

CLASSIFICATION OF FINANCIAL LIABILITIES

Financial liabilities are either classified as:
 Financial liabilities at amortised cost; or
 Financial liabilities as at fair value through profit or loss (FVTPL).

Financial liabilities are measured at amortised cost unless either:

 The financial liability is held for trading and is therefore required to be measured at FVTPL (e.g. derivatives not
designated in a hedging relationship), or
 The entity elects to measure the financial liability at FVTPL (using the fair value option).

MEASUREMENT OF FINANCIAL LIABILITIES

1) At Amortised cost:
Initial measurement: Fair value (Cash received) - Issue cost
Subsequent measurement: At amortised cost using effective interest rate method
Examples of items at amortised cost are Trade payables, Loan payables, Bank borrowings

2) At Fair value option:

Fair value Gain/Loss will be split
 Gain/Loss due to own credit risk will be charged to OCI

pg. 140
IFRS 9 SBR Revision Notes

 Gain/Loss due to other credit risk will be charged to P&L

3) At FVTPL:
Initial measurement: Fair value (Cash received)

Transaction cost is charged to P&L

Subsequent measurement:
 Fair value will be calculated by PV(FCF) by using current market interest rate
 Any Gain or loss will be charged to P&L
Examples of items at FVTPL are Held for trading liability, Derivatives standing at loss, Contingent liability arising
at business combination

RECLASSIFICATION OF FINANCIAL INSTRUMENTS

For financial assets, reclassification is required between FVTPL and amortised cost, or vice versa, if and only if the
entity's business model objective for its financial assets changes so its previous model assessment would no longer
apply.

If reclassification is appropriate, it must be done prospectively from the reclassification date. An entity does not
restate any previously recognised gains, losses, or interest.

IFRS 9 does not allow reclassification where:

 Financial assets have been classified as equity instruments, or
 The fair value option has been exercised in any circumstance for a financial assets or financial liability.

DERECOGNITION OF FINANCIAL LIABILITIES

An entity shall remove a financial liability (or a part of a financial liability) from its statement of financial position
when, and only when, it is extinguished - i.e. when the obligation specified in the contract is discharged or cancelled
or expires.

The difference between the carrying amount of a financial liability (or part of a financial liability) extinguished or
transferred to another party and the consideration paid, including any non-cash assets transferred or liabilities
assumed, shall be recognised in profit or loss.

IMPAIRMENT OF FINANCIAL INSTRUMENTS

Scope
The impairment requirements are applied to:
 Financial assets measured at amortised cost (incl. trade receivables)
 Financial assets measured at fair value through OCI
 Loan commitments and financial guarantees contracts where losses are currently accounted for under IAS 37
Provisions, Contingent Liabilities and Contingent Assets
 Lease receivables.

pg. 141
IFRS 9 SBR Revision Notes

The impairment model follows a three-stage approach based on changes in expected credit losses of a financial
instrument that determine
 The recognition of impairment, and
 The recognition of interest revenue.

Initial recognition
At initial recognition of the financial asset an entity recognises a loss allowance equal to 12 months expected credit
losses which consist of expected credit losses from default events possible within 12 months from the entity’s
reporting date. An exception is purchased or originated credit impaired financial assets.

Subsequent measurement
Stage 1 2 3
Impairment 12 month expected credit loss Lifetime expected credit loss
Interest Effective interest on the gross carrying amount (before deducting fective interest on the net
expected losses) (carrying) amount

THREE STAGE APPROACH

Stage 1
12 month expected credit losses (gross interest)
 Applicable when no significant increase in credit risk
 Entities continue to recognise 12 month expected losses that are updated at each reporting date
 Presentation of interest on gross basis

Stage 2
Lifetime expected credit losses (gross interest)
 Applicable in case of significant increase in credit risk
 Recognition of lifetime expected losses
 Presentation of interest on gross basis

Stage 3
Lifetime expected credit losses (net interest)
 Applicable in case of credit impairment
 Recognition of lifetime expected losses
 Presentation of interest on a net basis

PRACTICAL EXPEDIENTS
30 days past due rebuttable presumption
 Rebuttable presumption that credit risk has increased significantly when contractual payments are more than
30 days past due
 When payments are 30 days past due, a financial asset is considered to be in stage 2 and lifetime expected credit
losses would be recognised
 An entity can rebut this presumption when it has reasonable and supportable information available that
demonstrates that even if payments are 30 days or more past due, it does not represent a significant increase
in the credit risk of a financial instrument.

pg. 142
IFRS 9 SBR Revision Notes

Low credit risk instruments

 Instruments that have a low risk of default and the counterparties have a strong capacity to repay (e.g. financial
instruments that are of investment grade)
 Instruments would remain in stage 1, and only 12 month expected credit losses would be provided.

SIMPLIFIED APPROACH
Short term trade receivables
 Recognition of only ‘lifetime expected credit losses’ (i.e. stage 2)
 Expected credit losses on trade receivables can be calculated using provision matrix (e.g. geographical region,
product type, customer rating, collateral or trade credit insurance, or type of customer)
 Entities will need to adjust the historical provision rates to reflect relevant information about current conditions
and reasonable and supportable forecasts about future expectations.

Long term trade receivables and lease receivables

Entities have a choice to either apply:
 the three-stage expected credit loss model; or
 The ‘simplified approach’ where only lifetime expected credit losses are recognised.

LOAN COMMITMENTS AND FINANCIAL GUARANTEES

 The three-stage expected credit loss model also applies to these off balance sheet financial commitments
 An entity considers the expected portion of a loan commitment that will be drawn down within the next 12
months when estimating 12 month expected credit losses (stage 1), and the expected portion of the loan
commitment that will be drawn down over the remaining life the loan commitment (stage 2)
 For loan commitments that are managed on a collective basis an entity estimates expected credit losses over
the period until the entity has the practical ability to withdraw the loan commitment.

Purchased or originated credit-impaired financial assets

Purchased or originated credit-impaired financial assets are treated differently because the asset is credit-impaired
at initial recognition. For these assets, an entity would recognise changes in lifetime expected losses since initial
recognition as a loss allowance with any changes recognised in profit or loss. Under the requirements, any favourable
changes for such assets are an impairment gain even if the resulting expected cash flows of a financial asset exceed
the estimated cash flows on initial recognition.

HEDGING
Hedging, for accounting purposes, means designating one or more hedging instruments so that their change in fair
value is an offset, in whole or in part, to the change in fair value or cash flows of a hedged item.

Hedging instruments: A hedging instrument is a designated derivative or (in limited circumstances) another financial
asset or liability whose fair value or cash flows are expected to offset changes in the fair value or cash flows of a
designated hedged item.

Hedged item
A hedged item is an asset, liability, firm commitment, or forecasted future transaction that:
(a) exposes the entity to risk of changes in fair value or changes in future cash flows, and that
(b) is designated as being hedged

pg. 143
IFRS 9 SBR Revision Notes

Hedge accounting
Hedge accounting recognises the offsetting effects on profit or loss of changes in the fair values of the hedging
instrument and the hedged item.

Hedging relationships are of three types:

(a) Fair value hedge: a hedge of the exposure to changes in fair value of a recognised asset or liability or an
unrecognised firm commitment, or an identified portion of such an asset, liability or firm commitment, that is
attributable to a particular risk and could affect profit or loss.
(b) Cash flow hedge: a hedge of the exposure to variability in cash flows that (i) is attributable to a particular risk
associated with a recognised asset or liability (such as all or some future interest payments on variable rate
debt) or a highly probable forecast transaction and (ii) could affect profit or loss.
(c) Hedge of a net investment in a foreign operation as defined in IAS 21.

Designation and Documentation

Must be formalised at the inception of the hedging relationship:
 The hedging relationship
 Risk management strategy and objective for undertaking the hedge
 The hedged item and hedging instrument
 How hedge effectiveness will be assessed.

All three hedge effectiveness requirements met

(a) An economic relationship exists between the hedged item and hedging instrument
(b) Credit risk does not dominate changes in value
(c) The hedge ratio is the is the same for both the:
 Hedging relationship
 Quantity of the hedged item actually hedged, and the quantity of the hedging instrument used to hedge
it.

Types of Hedging
1. Fair value hedge
It is the exposure to changes in fair value of recognized asset or liabilities
Accounting treatment
 Hedge Instrument:
Hedge instrument gain/loss will be charged to P&L (unless hedge item is equity instrument measured at
FVTOCI).
 Hedge Item:
Hedge item gain/loss will be charged to P&L (unless hedge item is equity instrument at FVTOCI, then
recognize in OCI)

2. Cash flow hedge

It is a hedge of the exposure to variability in cash flows that:
• Attributable to particular risk associated with recognized asset or liability or a high probable forecast
transaction
• Could affect profit or loss

pg. 144
IFRS 9 SBR Revision Notes

Accounting treatment
Hedge Instrument:
• Gain or loss on hedge instrument that’s determined to be an effective hedge must be recognized in OCI
(will become spate reserve in SOCIE) and ineffective portion will be charged to P&L , and effective portion
(separate reserve) will be reclassified to P&L when cash flows expected to effect P&L
• If non-financial asset recognized due to hedge item then reserve can be adjusted in initial cost of non-
financial asset

DERIVATIVES
Definition:
Any contract, that have three features:
1. Its initial cost is zero or nominal as compared to other contracts that has similar response to changes in market
value
2. It will be settled in future
3. Its value is dependent on certain underlying item

Derivative contracts
Types of derivative contract are as follows:
 Future contract
 Forward contract
 Options
 Swap contract

Accounting treatment:
 Fair value through profit and loss
 Initial measurement: Fair Value
 Subsequent measurement: Fair value and gain/(loss) will be charged to P&L
 Derivative Standing at gain; Financial Asset
 Derivative Standing at loss; Financial Liability

Embedded Derivatives
An embedded derivative is a component of a hybrid contract that also includes a non-derivative host—with the
effect that some of the cash flows of the combined instrument vary in a way similar to a stand-alone derivative.
Host contracts are the contracts in which derivative contracts are embedded.

Examples include:
(a) A lease
(b) A debt or equity instrument
(c) An insurance contract
(d) A sale or purchase contract
(e) A construction contract

A derivative that is attached to a financial instrument but is contractually transferable independently of that
instrument, or has a different counterparty, is not an embedded derivative, but a separate financial instrument.

pg. 145
IFRS 9 SBR Revision Notes

Measurement
Hybrid contracts with financial asset hosts
If a hybrid contract contains a host that is an asset within the scope of this IFRS, an entity shall apply the
measurement rules to the entire hybrid contract (recognized at FVTPL). E.g. Investment in convertible loan,
Investment in bond where interest rate vary with gold prices

Other hybrid contracts

If host contact is a financial liability or non-financial contracts E.g. Issue of convertible loan, lease/construction
contract in foreign currency

Criteria: (if met separation required)

• Economic characteristic should be different (host contract and derivative)
• Host contract should not be measured at FVTPL
• Embedded derivatives should meet the definition of “stand alone derivative”

pg. 146
IFRS 7 SBR Revision Notes

IFRS 7 FINANCIAL INSTRUMENT DISCLOSURES

Objective
IFRS 7 requires entities to provide disclosures in their financial statements that enable users to evaluate:
 The significance of financial instruments for the entity’s financial position and performance; and
 The nature and extent of risks arising from financial instruments to which the entity is exposed during the period
and at the reporting date, and how the entity manages those risks.

Classes of financial instruments and level of disclosures

IFRS 7 requires that certain disclosures should be given by class of financial instruments. The classes of financial
instruments that will be disclosed should be appropriate to the nature of the information disclosed and should take
into account the characteristics of those financial instruments. An entity should provide sufficient information to
permit reconciliation to the line items presented in the statement of financial position.

Statement of financial position:

 Financial assets measured at fair value through profit and loss, showing separately those held for trading and
those designated at initial recognition
 Special disclosures about financial assets and financial liabilities designated to be Measured at fair value through
profit and loss, including disclosures about credit risk and market risk, changes in fair values attributable to these
risks and the methods of measurement.
 Reclassifications of financial instruments from one category to another (e.g. from fair value to amortised cost
or vice versa)
 information about financial assets pledged as collateral and about financial or non- financial assets held as
collateral
 Reconciliation of the allowance account for credit losses (bad debts) by class of financial Assets.
 Information about compound financial instruments with multiple embedded derivatives
 Breaches of terms of loan agreements

Statement of profit or loss and other comprehensive income

 Items of income, expense, gains, and losses, with separate disclosure of gains and losses from financial assets
measured at fair value through profit and loss, showing separately those held for trading and those designated
at initial recognition
 total interest income and total interest expense for those financial instruments that are not measured at fair
value through profit and loss
 fee income and expense
 amount of impairment losses by class of financial assets
 interest income on impaired financial assets

pg. 147
IFRS 10 SBR Revision Notes

IFRS 10 – CONSOLIDATED FINANCIAL STATEMENTS

A group is formed when one company, known as the parent, acquires control over another company, known as its
subsidiary.

The subsidiary and the holding company are considered separate legal entities. Group accounts are presented as if
the parent company and its subsidiary were one single entity – an application of the substance over form concept.

DEFINITIONS
Group of Companies arises when one company (Parent) takes control of another company (subsidiary).

Subsidiary is a company controlled by another company.

Parent is a company that controls one or more subsidiaries.

Non-Controlling Interest is a collective representation of the shareholders that normally own 49% or less of equity.

Consolidated Financial Statements means F/S of whole Group presented as a single set of accounts.

CONTROL
According to IFRS 10 Consolidated
Financial Statements an investor controls investee when it is exposed, or has rights, to variable returns from its
involvement with the investee and has the ability to affect those returns through its power over the investee.

Existence of parent subsidiary relationship

Parent subsidiary relationship exists when:
 The parent holds more than one half of the voting power of the entity
 The parent has power over more than one half of the voting rights by virtue of an agreement with other investors
(common control)
 The parent has the power to govern the financial and operating policies of the entity under the articles of
association of the entity
 The parent has the power to appoint or remove a majority of the board of directors
 The parent has the power to cast the majority of votes at meetings of the board

EXEMPTION FROM PREPARING GROUP ACCOUNTS

A parent need not present consolidated financial statements if the following stipulations hold:
 The parent itself is a wholly-owned subsidiary or it is a partially owned subsidiary of another entity Its securities
are not publicly traded
 The parent’s debt or equity instruments are not traded in a public market
 The parent did not file its financial statements with a securities commission or other regulatory organisation
 The ultimate parent publishes consolidated financial statements that comply with International Financial
Reporting Standards.

pg. 148
IFRS 10 SBR Revision Notes

CONDITIONS - DIRECTORS MAY NOT WISH TO CONSOLIDATE A SUBSIDIARY

The directors of a parent company may not wish to consolidate some subsidiaries due to:
 Control is temporary as the subsidiary was purchased for re-sale
 Unsatisfactory performance and weak financial position of the subsidiary
 Differing activities (nature) of the subsidiary from the rest of the group
 Reduction of apparent gearing by avoiding consolidation of subsidiary’s loan
 Legal conditions restricting the parent’s ability to run the subsidiary.

Apart from legal restriction, these reasons are not permitted according to IFRSs and consolidated financial
statements should be prepared including all these subsidiaries.

IFRS 3 requires exclusion from consolidation only if the parent has lost control over its investment. This could occur
in cases where control over a subsidiary is lost because of a restriction from government, a regulator, a court of law,
or as a result of a contractual agreement.

GENERAL RULES
 Same accounting policies should be used for both the holding company and the subsidiaries. Adjustments must
be made where there is a difference
 The reporting dates of parent and subsidiary will be the same in most cases. In case of difference, the subsidiary
will be allowed to prepare another set of accounts for consolidation purposes (if the difference is of more than
three months).

Accounting for subsidiaries in separate financial statements of the holding company

The holding company will usually produce its own separate financial statements. Investments in subsidiaries and
associates have to be accounted for at cost or in accordance with IFRS 9. Where subsidiaries are classified as held
for sale then the provisions of IFRS 5 have to be complied with.

Acquisition costs
In accordance with IFRS 3, because acquisition-related costs are not part of the exchange transaction between the
acquirer and the acquiree (or its former owners), they are not considered part of the business combination.
Costs of issuing debt or equity instruments are accounted for under IAS 32 Financial Instruments: Presentation and
IFRS 9 Financial Instruments. All other costs associated with an acquisition must be expensed, including
reimbursements to the acquiree for bearing some of the acquisition costs. Therefore, transaction costs no longer
form a part of the acquisition price; they are expensed as incurred. Transaction costs are not deemed to be part of
what is paid to the seller of a business. They are also not deemed to be assets of the purchased business that should
be recognised on acquisition. The standard requires entities to disclose the amount of transaction costs that have
been incurred.

Examples of costs to be expensed include finder's fees; advisory, legal, accounting, valuation and other professional
or consulting fees; and general administrative costs, including the costs of maintaining an internal acquisitions
department.

pg. 149
IFRS 10 SBR Revision Notes

ACQUIRED ASSETS AND LIABILITIES

IFRS 3 establishes the following principles in relation to the recognition and measurement of items arising in a
business combination:
 Recognition principle. Identifiable assets acquired, liabilities assumed, and non-controlling interests in the
acquiree, are recognised separately from goodwill
 Measurement principle. All assets acquired and liabilities assumed in a business combination are measured at
acquisition-date fair value.

IFRS 3 (Revised) has introduced some changes to the assets and liabilities recognised in the acquisition statement of
financial position. The existing requirement to recognise all of the identifiable assets and liabilities of the acquiree is
retained. Most assets are recognised at fair value, with exceptions for certain items such as deferred tax and pension
obligations.

Intangible assets
Acquired intangible assets must be recognised and measured at fair value in accordance with the principles if it is
separable or arises from other contractual rights, irrespective of whether the acquiree had recognised the asset prior
to the business combination occurring. This is because there is always sufficient information to reliably measure the
fair value of these assets.

Acquirers are required to recognise brands, licences and customer relationships, and other intangible assets.

Contingent amounts
Contingent assets are not recognised, and contingent liabilities are measured at fair value.

Until a contingent liability is settled, cancelled or expired, a contingent liability that was recognised in the initial
accounting for a business combination is measured at the higher of the amount the liability would be recognised
under IAS 37 Provisions, Contingent Liabilities and Contingent Assets, and the amount less accumulated amortization
(amount under the relevant standard).

The acquirer can seldom recognise a reorganisation provision at the date of the business combination. There is no
change from the previous guidance in the new standard: the ability of an acquirer to recognise a liability for
terminating or reducing the activities of the acquiree is severely restricted. A restructuring provision can be
recognised in a business combination only when the acquiree has, at the acquisition date, an existing liability for
which there are detailed conditions in IAS 37, but these conditions are unlikely to exist at the acquisition date in
most business combinations.

Timeline for acquisition accounting

An acquirer has a maximum period of 12 months from the date of acquisition to finalise the acquisition accounting.
The adjustment period ends when the acquirer has gathered all the necessary information, subject to the 12-month
maximum. There is no exemption from the 12-month rule for deferred tax assets or changes in the amount of
contingent consideration. The revised standard will only allow adjustments against goodwill within this one-year
period.

pg. 150
Consolidated Statement of Financial Position SBR Revision Notes

CONSOLIDATED STATEMENT OF FINANCIAL POSITION

At the date of acquisition, the investment by the parent company in the subsidiary company is cancelled of against
the equity (share capital, state premium, and retained earnings of subsidiary company. Any excess remaining is
known as goodwill.

All assets and liabilities of subsidiary company are than added on a line by line basis with the assets and liabilities of
the parent company.

In the consolidated statement of financial position, the share capital and share premium will ALWAYS be of Parent
Co. only.

If the parent contacts less than 100% of a subsidiary, the remaining investment is known as non-controlling interest
and a portion of equity shall now be attributable to NCI.

Types of consideration
There are five different ways in which consideration may be paid at the acquisition of subsidiary co. A sum of all of
these is called the COST OF INVESTMENT.

Consideration might be paid in the following ways:

 By cash
 By share for share exchange
 By deferred consideration
 By contingent consideration
 By loan notes

 By Cash

The consideration is calculated by multiplying the number of shares acquired with per share cash paid i.e.
Total no. of shares of subsidiary co. x % holding x cash paid per share.

 By Share for share exchange

The consideration is calculated by multiplying the number of shares issued by Parent Co. with per share price
of Parent Co. at the date of acquisition. i.e. No. of shares issued by Parent co. x Parent co. per share price
 By Deferred consideration: Deferred consideration is recorded at present value at the date of acquisition.
Initial recognition:
Dr. Cost of investment
Cr. Provision for deferred consideration

Subsequent recognition Unwinding of discount

Dr. Consolidates retained earnings
Cr. Provision for deferred consideration

pg. 151
Consolidated Statement of Financial Position SBR Revision Notes

 Contingent consideration: At times, the parent Co. agrees to pay the consideration only if some specified
conditions are met such conditions are contingent events and IFRS 3 requires to measure such consideration at
fair value.

Initial recognition:
Dr. Cost of investment
Cr. Provision for contingent consideration

Subsequent recognition
Fair value of contingent considered is re-assessed at every subsequent reporting date. Increase/ Decrease in fair
value is charged to consolidated retained earnings.

In case of increase in fair value, following double entry will be passed.

Dr. Consolidates retained earnings
Cr. Provision for contingent consideration

 By transferring asset
In case of transfer of asset to subsidiary company in exchange for shares acquired, the consideration is recorded
at the fair value of asset transferred

 By loan notes
The consideration is calculated by recording the loan notes issued to shareholders of subsidiary co. at the date
of acquisition.

The loan notes are issued to shareholders of subsidiary co. so these are NOT subsequently adjusted as
intercompany loan.

Fair Value Adjustment

All items in subsidiary co. financial statements are brought at their fair value at the date of acquisition for a valid
calculation of goodwill. Gain or loss on fair value adjustment is included in the calculation of goodwill.

Additional depreciation due to fair value adjustment is deducted from retained earnings.

Goodwill in consolidated Statement of Financial Position:

Acquisition-date fair value of consideration transferred by parent X
Plus: Fair (or full) value of the N-CI at date of acquisition X
Less: Fair value of subsidiary's identifiable net assets at date of acquisition (X)
Equals: Total Goodwill X

pg. 152
Consolidated Statement of Financial Position SBR Revision Notes

Format for detailed working of Full Goodwill calculation

Cost of investment by Parent Co. X
Fair value of NCI at the date of acquisition X XX

Fair value of net assets of subsidiary co.

Share capital X
Share premium X
Pre-acquisition retained earnings X
Pre-acquisition revaluation reserve X
Fair value adjustment X/(X) (XX)
GOODWILL XX/(XX)

Negative goodwill is called Bargain Purchase Gain. It is charged to current year statement of profit or loss as income.

Impairment Of Goodwill
Under this approach the goodwill appearing in the consolidated Statement of Financial Position is the total goodwill.
The accounting treatment will be:
Dr Group retained Earnings X
Dr Non-controlling interest X
Cr Goodwill X

INTRA-GROUP BALANCES:
Intra-group balances shall be removed from consolidated statement of financial position (CSOFP) only if the balances
reconcile.
Dr. Payables
Cr. Receivables

If balances do not reconcile then there can be two possible reasons for it. It is either due to cash in transit or goods
in transit.

Make the adjustments for in transit items to bring their values at the same level in parent and subsidiary co.
 Cash in transit
DR Cash
CR Receivables

 Goods in transit
DR Inventories
CR Payables

Intra-Group unrealized profits

These are the profits on inventory arising as a result of intercompany/intra group sale and the goods are still unsold
at the year end.

pg. 153
Consolidated Statement of Financial Position SBR Revision Notes

Downstream transactions: If P Co has sold goods to S Co and these goods remain the in inventory at the year end,
the profit recognized by the parent Co. Shall be eliminated (No impact on NCI)
Dr. Consolidated Reserves
Cr. Inventory

Upstream transaction: If the S Co. has sold goods to the P.Co. the profits have been earned by the S.Co. and shall be
eliminated not only from group reserve but also from NCI
Dr. Consolidated Reserves
Dr. NCI
Cr. Inventories

Intra-group loans:
The portion of loan given by the P.Co to its subsidiary is an intra-group receivable, payable and shall be eliminated
as such.
Dr. Loan liability
Cr. Loan Asset

Any interest receivable payable on such loans shall also be eliminated but only to the extent related to the parent
Dr. Interest payable
Cr. Interest receivable

If the P.Co has not recorded interest receivable on loans given to the sub Co. the first treatment is to record the
interest receivable.
Dr. Interest receivable
Cr. Consolidated reserves

After this an intra-group interest receivable payables exists which shall be eliminated
Dr. Interest payable
Cr. Interest receivable

If P.Co. has recorded the receivable but subsidiary company has not included a payable in its own financial
statements, first treatment is to record the interest payable.

After this an intra-group interest receivable, payable asset which shall be eliminated.

Intra-group dividends: If the parent Co has not recorded the dividend recoverable the first treatment is to record
the receivables.
Dr. Dividend receivable
Cr. Consolidated reserve

After this an intra-group, dividends receivable/payable exists which shall be eliminated:

Dr. Consolidated reserves
Dr. NCI
Cr. Dividend payable

pg. 154
Consolidated Statement of Financial Position SBR Revision Notes

Redeemable Preference Shares: Treat like any other long-term loans i.e. eliminate as an inter-company loan and
adjust for any interest accrual.

Full or fair value of NCI: IFRS-3, allows/requires goodwill to be stated at full value i.e. a part of goodwill shall now
be attributable to NCI.

Now goodwill impairment shall be charged not only to be parent company but also to NCI
Dr. NCI
Dr. Consolidated Reserves
Cr. Goodwill

FORMAT FOR CALCULATION OF NCI

Fair value of NCI at the date of acquisition* X
Subsidiary Co. share of post acquisition retained earnings X
Share of post acquisition revaluation reserve X
Unrealised profit (Upstream transaction) (X)
Impairment of Goodwill (Share) (X)
Additional depreciation on fair value adjustment (X)
Non- controlling Interest XX

*If fair value of NCI is not available in question, it can be calculated by multiplying NCI no. of shares with Subsidiary
Co. per share price at the date of acquisition

CONSOLIDATD RETAINED EARNINGS

Format for calculation of consolidated retained earnings
Parent Co. total retained earnings X
Subsidiary Co. share of post acquisition retained earnings X
Unrealised profit (X)
Impairment of Goodwill (Share) (X)
Additional depreciation on fair value adjustment (X)
Unwinding of present value of deferred consideration (X)
Increase/ Decrease in fair value of contingent consideration (X)/X
Any other adjustment as per question (X)/X
Consolidated Retained Earnings XX

pg. 155
Consolidated Statement Profit or Loss SBR Revision Notes

CONSOLIDATED STATEMENT PROFIT OR LOSS AND OTHER COMPREHENSIVE

INCOME

The basic idea of preparing consolidated statement of profit or loss is to show the results of the group as if it were a
single entity.

The majority of figures are simple aggregations of the results of the parent and all the subsidiaries (line by line) down
to profit after tax.

In aggregating the results of the parent and subsidiaries, intra-group transactions such as dividend income, interest
income and unrealised profits are eliminated.

Any non-controlling interest is ignored until profit after tax. Their interest in profits after tax is then subtracted as a
one-liner to leave profits attributable to members of the parent.

P group plc - Pro-forma Consolidated statement of profit or loss

For year ended 30 November 20X6
$'m
Sales revenue (P+S less intra-group sales) X
Cost of Sales (P+S less intra-group purchases plus unrealised profit in inventory) (X)
Gross Profit X
Distribution Costs (P+S) (X)
Administrative Expenses (P+S) (X)
Group operating Profit X
Interest and similar income receivable (P+S less intra group interest income) X
Interest expenses (P+S less intra-group interest expense) (X)
X
Share of Profits of Associate (PAT) X
Profit before tax X
Income tax expense (P+S) (X)
Profit for the period X
Profit attributable to :
Owners of the parent X
Non-controlling interest X
X
OTHER ADJUSTMENTS
 If the subsidiary is acquired during the current accounting period it is necessary to apportion the profit for the
period between its pre-acquisition and post-acquisition elements. This is dealt with by determining on a line-
by-line basis the post-acquisition figures of the subsidiary.

 After profit after tax in consolidated statement of profit or loss, total profits are divided between profits
attributable to group and profit attributable to NCI

 Any dividends receivable by the parent must be cancelled against dividends paid from the subsidiary
undertaking.

pg. 156
Consolidated Statement Profit or Loss SBR Revision Notes

 Where group companies trade with each other one will record a sale and the other an equal amount as a
purchase. These items must be removed from the consolidated statement of profit or loss by cancelling from
both sales and cost of sales.

 The unrealized profit adjustment is to increase cost of sales. In case of upstream transaction, the unrealized
profit is deducted from profit attributable to NCI also.

 Investment in loans means an intra-group finance cost for one company and interest income for the other. The
intra-group interest should be eliminated from both finance cost and interest income.

 Dividend declared by subsidiary company would be reflected as investment income in parent company’s
statement of profit or loss, as per the relevant shareholding. This dividend income needs to be removed. The
dividend paid figure is adjusted in statement of changes in equity. All inter-company dividends should be
eliminated.
 Impairment of goodwill is treated as an administration expense unless otherwise stated.

 In case of full goodwill method, an additional adjustment is made in profit attributable to NCI. The share of
impairment for the year related to NCI is deducted from the profit attributable to NCI.

 There is no impact of fair value adjustment on acquisition at the statement of profit or loss. However, any
additional depreciation related to such fair value adjustment must be charged by adding to cost of sales and
deducting from profit after tax of subsidiary while calculating profit attributable to NCI

pg. 157
IAS 28 SBR Revision Notes

IAS 28 – INVESTMENTS IN ASSOCIATES

SCOPE
This Standard shall be applied in accounting for investments in associates.

DEFINITIONS
The following terms are used in this Standard with the meanings specified:-
 An associate is an entity, including an unincorporated entity such as a partnership, over which the investor has
significant influence and that is neither a subsidiary nor an interest in a joint venture.
 The equity method is a method of accounting whereby the investment is initially recognized at cost and adjusted
thereafter for the post-acquisition change in the investor’s share of net assets of the investee. The profit or loss
of the investor includes the investor’s share of the profit or loss of the investee.
 Significant influence is the power to participate in the financial and operating policy decisions of the investee
but is not control or joint control over those policies. Investments of 20% to 50% in voting power of companies
lead to existence of significant influence. Significant influence by an investor is usually evidenced in one or more
of the following ways:-
a. Representation on the board of directors or equivalent governing body of the investee.
b. Participating in policy making process, including participation in decisions about dividends or other
distributions.
c. Material transactions between the investor and the investee
d. Interchange of managerial personnel; or
e. Provision of essential technical information.

ACCOUNTING OF ASSOCIATE
Associate should be accounted for in consolidated financial statement using equity method; i.e. investment is
 Initially recorded at cost;
 Adjusted for post-acquisition change in net assets (investor share); Or post acquisition profits/losses (investor
share);
 The profit or loss of the investor includes the investor’s share of the profit or loss of the investee.
 Dividend paid or distributions made will reduce the investment.
 On acquisition any difference between the cost of investment and investor’s share of net fair value of associate’s
identifiable assets, liabilities and contingent liabilities is accounted for in accordance with IFRS-3.
 Goodwill relating to an associate is included in the carrying value of investment
 Any excess of the investor’s share of net fair value of the associate’s assets, liabilities and contingent
liabilities over the cost of investment is excluded from the carrying value of investment and is included in
the income statement of the year of acquisition.
 Adjustments in investor’s share of profit and loss after acquisition are made in respect of depreciation based on
Fair Value.
 If different reporting dates, adjust the effect of significant events between reporting dates;
 The investor’s financial statements shall be prepared using uniform accounting policies for like transactions and
events in similar circumstances.
 If the investor’s share of losses exceeds or equals its interest in associate, the investor will discontinue the
recognition of further losses. Additional losses can only be recognized if there exist any legal or constructive
obligation

pg. 158
IAS 28 SBR Revision Notes

 In case of trading between group and associate, the profits or losses resulting from these transactions are
recognized in the investor’s financial statements only to the extent of un-related investor’s interest in associate.
 Downstream transactions are sales of assets from the investor to an associate. Upstream transactions are sales
of assets from an associate to the investor. Profits and losses resulting from 'upstream' and 'downstream'
transactions between an investor and an associate are eliminated to the extent of the investor's interest in the
associate. In this case, only the group's share is eliminated.
 Impairment test will be applied on the entire amount of investment under IAS -36 and the impairment loss will
be recognized.
 No netting-off is done between receivables and payables

EXCEPTIONS TO THE EQUITY METHOD

An investment in an associate shall be accounted for using the equity method except when:
1) There is an evidence that the investment is acquired and held exclusively with a view to its disposal within twelve
months from acquisition date (Then apply IFRS -5).
2) All of the following apply:
a. The investor is a wholly-owned subsidiary its other owners do not object if the investor does not apply the
equity method;
b. The investor’s debt or equity instruments are not traded in a public market
c. The investor did not file its financial statements with securities commission, and
d. The ultimate parent of the investor produces consolidated financial statements.

Some noteworthy points include:

 Investment described in 1 above shall be classified as held for trading and accounted for in accordance with
IFRS-5.

EQUITY METHOD
STATEMENT OF PROFIT OR LOSS
 Dividend income from associates (reported in the investor's books) is replaced by the profit after tax of the
associate.

STATEMENT OF FINANCIAL POSITION

Initially the Investments in Associates is shown at cost (same as in the individual accounts), identifying any goodwill
included in the cost.
In subsequent years the Investor's accounts will show:
 The investment at cost
 Plus group share of associate's post acquisition reserves.
 Less any impairment of investment to date.

pg. 159
IAS 28 SBR Revision Notes

On the bottom of the balance sheet consolidated reserves will reflect the other side of these adjustments.
Method $
Cost of Investment X
Plus group share of post-acquisition reserves X
Less impairment of investment (X)
INVESTMENT IN ASSOCIATES X

Transactions between a Group and Associate

Profits and losses resulting from ‘upstream’ and ‘downstream’ transactions between an investor (including its
consolidated subsidiaries) and an associate are recognised in the investor’s financial statements only to the extent
of unrelated investors’ interests in the associate.

Upstream’ transactions are, for example, sales of assets from an associate to the investor.

‘Downstream’ transactions are, for example, sales of assets from the investor to an associate.

The investor’s share in the associate’s profits and losses resulting from these transactions is eliminated.

The double entry is as follows, where a% is the parent's holding in the associate, and PUP is the provision for
unrealised profit.

DEBIT Retained earnings of parent PUP × A%

CREDIT Group inventories PUP × A%

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

OR

DEBIT Retained earnings of parent /subsidiary PUP × A%

CREDIT Investment in associate PUP × A%

For downstream transactions, (parent/subsidiary sells to associate) where the associate holds the inventory.

DISCLOSURES
There are no disclosures specified in IAS 28. Instead, IFRS 12 Disclosure of Interests in Other Entities outlines the
disclosures required for entities with joint control of, or significant influence over, an investee.

pg. 160
IFRS 11 SBR Revision Notes

IFRS 11 – JOINT ARRANGEMENTS

OBJECTIVE
The objective of this IFRS is to establish principles for financial reporting by entities that have an interest in
arrangements that are controlled jointly (i.e. joint arrangements).

SCOPE
This IFRS shall be applied by all entities that are a party to a joint arrangement.

DEFINITIONS
Joint arrangement: An arrangement of which two or more parties have joint control.

Joint control: The contractually agreed sharing of control of an arrangement, which exists only when decisions about
the relevant activities require the unanimous consent of the parties sharing control.

Joint operation A joint arrangement whereby the parties that have joint control of the arrangement have rights to
the assets, and obligations for the liabilities, relating to the arrangement.

Separate vehicle A separately identifiable financial structure, including separate legal entities or entities recognised
by statute, regardless of whether those entities have a legal personality.

JOINT ARRANGEMENTS
A joint arrangement has the following characteristics:
(a) The parties are bound by a contractual arrangement.
(b) The contractual arrangement gives two or more of those parties joint control of the arrangement.

Contractual Arrangements
The contractual arrangement sets out the terms upon which the parties participate in the activity that is the subject
of the arrangement.

The contractual arrangement generally deals with such matters as:

(a) The purpose, activity and duration of the joint arrangement.
(b) How the members of the board of directors, or equivalent governing body, of the joint arrangement, are
appointed.
(c) The decision-making process: the matters requiring decisions from the parties, the voting rights of the parties
and the required level of support for those matters. The decision-making process reflected in the contractual
arrangement establishes joint control of the arrangement.
(d) The capital or other contributions required of the parties.
(e) How the parties share assets, liabilities, revenues, expenses or profit or loss relating to the joint arrangement.

Classification of a Joint Arrangement

The classification of joint arrangements requires the parties to assess their rights and obligations arising from the
arrangement. When making that assessment, an entity shall consider the following:
(a) The structure of the joint arrangement.
(b) When the joint arrangement is structured through a separate vehicle:

pg. 161
IFRS 11 SBR Revision Notes

(i) The legal form of the separate vehicle ;

(ii) The terms of the contractual arrangement and
(iii) When relevant, other facts and circumstances.

A joint arrangement is either a joint operation or a joint venture.

The following table compares common terms in contractual arrangements of parties to a joint operation and
common terms in contractual arrangements of parties to a joint venture. The examples of the contractual terms
provided in the following table are not exhaustive.

Joint operation Joint venture

The terms of the The parties to the joint arrangement have rights The parties to the joint arrangement have
contractual to the assets, and obligations for the liabilities, rights to the assets, and obligations for the
Arrangement relating to the arrangement. liabilities, relating to the arrangement.

Rights to assets The parties to the joint arrangement share all The assets brought into the arrangement
interests (eg rights, title or ownership) in the or subsequently acquired by the joint
assets relating to the arrangement in a specified arrangement are the arrangement’s
proportion (eg in proportion to the parties’ assets. The parties have no interests (ie no
ownership interest in the arrangement or in rights, title or ownership) in the assets of
proportion to the activity carried out through the arrangement.

pg. 162
IFRS 11 SBR Revision Notes

the arrangement that is directly attributed to

them).

Obligations for The parties share all liabilities, obligations, costs The joint arrangement is liable for the
liabilities and expenses in a specified proportion (e.g. in debts and obligations of the arrangement.
proportion to their ownership interest in the
arrangement or in proportion to the activity
carried out through the arrangement that is
directly attributed to them).

The parties are liable to the arrangement

only to the extent of Their respective:
 Investments in the arrangement, or
 Obligations to contribute any unpaid
or additional capital to the
arrangement, or
 Both

The parties to the joint arrangement are liable Creditors of the joint arrangement do not
for claims by third parties. have rights of recourse against any party.

Revenues, The contractual arrangement establishes the The contractual arrangement establishes
expenses, profit allocation of revenues and expenses on the each party’s share in the profit or loss
or loss basis of the relative performance of each party relating to the activities of the
to the joint arrangement. For example, the arrangement.
contractual arrangement might establish that
revenues and expenses are allocated on the
basis of the capacity that each party uses in a
plant operated jointly.

Guarantees The provision of guarantees to third parties, or the commitment by the parties to provide
them, does not, by itself, determine that the joint arrangement is a joint operation.

FINANCIAL STATEMENTS OF PARTIES TO JOINT ARRANGEMENTS

Joint Operations
A joint operator shall recognise in relation to its interest in a joint operation:
(a) its assets, including its share of any assets held jointly;
(b) its liabilities, including its share of any liabilities incurred jointly;
(c) its revenue from the sale of its share of the output arising from the joint operation;
(d) its share of the revenue from the sale of the output by the joint operation; and
(e) Its expenses, including its share of any expenses incurred jointly.

pg. 163
IFRS 11 SBR Revision Notes

Joint Ventures
A joint venture shall recognise its interest in a joint venture as an investment and shall account for that investment
using the equity method in accordance with IAS 28 Investments in Associates and Joint Ventures unless the entity is
exempted from applying the equity method as specified in that standard.

Application of IAS 28 (2011) To Joint Ventures

The consolidated statement of financial position is prepared by:
 Including the interest in the joint venture at cost plus share of post-acquisition total comprehensive income
 Including the group share of the post-acquisition total comprehensive income in group reserves

The consolidated statement of profit or loss and other comprehensive income will include:
 The group share of the joint venture’s profit or loss
 The group share of the joint venture’s other comprehensive income.

The use of the equity method should be discontinued from the date on which the joint venture ceases to have joint
control over, or have significant influence on, a joint venture.

Transactions between a Joint Venture and a Joint Venture

Upstream transactions: A joint venture may sell or contribute assets to a joint venture so making a profit or loss. Any
such gain or loss should, however, only be recognised to the extent that it reflects the substance of the transaction.

Therefore:
 Only the gain attributable to the interest of the other joint ventures should be recognised in the financial
statements.

The full amount of any loss should be recognised when the transaction shows evidence that the net realisable value
of current assets is less than cost, or that there is an impairment loss.

Downstream transactions: When a joint venture purchases assets from a joint venture, the joint venture should not
recognise its share of the profit made by the joint venture on the transaction in question until it resells the assets to
an independent third party, i.e. until the profit is realised.

Losses should be treated in the same way, except losses should be recognised immediately if they represent a
reduction in the net realisable value of current assets, or a permanent decline in the carrying amount of non-current
assets. The major line of business or geographical area of operations then it must be "part of a single co-ordinated
plan" to dispose of such a line of business or geographical area of operations. The single plan might relate to a
disposal in one transaction or piecemeal.

PRESENTATION
 Non-current assets that meet the criteria are presented separately on the Statement of Financial Position within
current assets.
 If the held for sale item is a disposal group then related liabilities are also reported separately within current
liabilities.
 Discontinued operations and operations held for sale must be disclosed separately in the statement of financial
position at the lower of their carrying value less costs to sell.

pg. 164
IFRS 12 SBR Revision Notes

IFRS 12 DISCLOSURE OF INTERESTS IN OTHER ENTITIES

OBJECTIVE
The objective of IFRS 12 is to require the disclosure of information that enables users of financial statements to
evaluate:
 The nature of, and risks associated with, its interests in other entities
 The effects of those interests on its financial position, financial performance and cash flows

DEFINITIONS
Structured entity an entity that has been designed so that voting or similar rights are not the dominant factor in
deciding who controls the entity, such as when any voting rights relate to administrative tasks only and the relevant
activities are directed by means of contractual arrangements.

The standard requires disclosure of:

(a) Significant judgements and assumptions.
(b) Information about interests in subsidiaries, associates, joint arrangements and structured entitiesthat are not
controlled by an investor.

Significant judgements and assumptions

An entity discloses information about significant judgements and assumptions it has made (and changes in those
judgements and assumptions) in determining:
 That it controls another entity
 That it has joint control of an arrangement or significant influence over another entity
 The type of joint arrangement (i.e. joint operation or joint venture) when the arrangement has been structured
through a separate vehicle

Interests in subsidiaries
An entity shall disclose information that enables users of its consolidated financial statements to:
 Understand the composition of the group
 Understand the interest that non-controlling interests have in the group’s activities and cash flows
 Evaluate the nature and extent of significant restrictions on its ability to access or use assets, and settle liabilities,
of the group
 Evaluate the nature of, and changes in, the risks associated with its interests in consolidated structured entities
 Evaluate the consequences of changes in its ownership interest in a subsidiary that do not result in a loss of
control
 Evaluate the consequences of losing control of a subsidiary during the reporting period.

Interests in joint arrangements and associates

An entity shall disclose information that enables users of its financial statements to evaluate:
 The nature, extent and financial effects of its interests in joint arrangements and associates, including the nature
and effects of its contractual relationship with the other investors with joint control of, or significant influence
over, joint arrangements and associates
 The nature of, and changes in, the risks associated with its interests in joint ventures and associates.

pg. 165
IFRS 12 SBR Revision Notes

Interests in unconsolidated structured entities (not controlled by an investor)

An entity shall disclose information that enables users of its financial statements to:
 Understand the nature and extent of its interests in unconsolidated structured entities
 Evaluate the nature of, and changes in, the risks associated with its interests in unconsolidated structured
entities.

pg. 166
Changes in Group Structures SBR Revision Notes

CHANGES IN GROUP STRUCTURES

STEP ACQUISITIONS AND DISPOSALS

STEP ACQUISITIONS
What is a step acquisition?
A ‘step acquisitions’ is a business combination achieved in stages, where the acquirer (parent company) gains control
of an acquiree (subsidiary) in stages over a period of time.

When control is achieved

 Any previously held equity shareholding should be treated as if it had been disposal of and then reacquired at
fair value at the acquisition date.
 Any gain or loss on remeasurement to fair value should be recognised in profit or loss in the period.

Goodwill is calculated as:

$
Fair value of consideration paid to acquire control X
Non-controlling interest (valued using either fair value or the proportion of net assets method) X
Fair value of previously held equity interest at acquisition date X
X
Fair value of net assets of acquiree (X)
Goodwill X

Increasing or reducing a shareholding whilst retaining control

After a parent company has acquired a subsidiary, it might increase or reduce its shareholding, whilst still retaining
control.

IAS 27 (revised) states that when an entity changes the percentage size of its ownership in a subsidiary without losing
control, the transaction should be accounted for as an equity transaction.
 A group of companies is viewed as a single economic entity, and the equity ownership of this entity consists of
equity shareholders in the parent and non-controlling interests in subsidiaries.
 The sale of shares between the parent company and non-controlling interests is therefore a transaction
between equity owners of the group.
 Since the sale of the shares is a transaction between equity owners in their capacity as owners of the group, no
profit or loss arises on the transaction, and there is no gain or loss to report either as 'other comprehensive
income'.
 The transaction should simply result in an adjustment to equity. The carrying amounts of the parent's interests
and the non-controlling interests in the equity of the group are adjusted to record the change in their ownership
interests.

The rules summarised

When shares in a subsidiary are bought from or sold to non-controlling interests, but the parent entity retains control
over the subsidiary, the transaction should be recorded directly in equity for the purpose of preparing consolidated
accounts.

pg. 167
Changes in Group Structures SBR Revision Notes

When shares are purchased from NCI, the difference between the price paid for the shares and the carrying value
of the NCI shares purchased should be recorded as a debit or credit to the parent entity's equity interest in the group.
If the price paid for the shares exceeds their carrying value, there will be a reduction in the parent entity's equity
interest in the group, and so the excess price paid should be debited to the parent entity's interest. Similarly when
shares in a subsidiary are sold to NCI but the parent retains control over the subsidiary the difference between the
prices paid for the shares and the carrying value of the NCI shares purchased should be recorded as a debit or credit
to the parent entity's equity interest in the group.

A 'gain' on the sale will be recorded as a credit to the parent entity's equity interest in the group.

It follows that no additional goodwill or reduction in goodwill occurs as a result of these transactions.

There is also no recognition of any gain or loss on the transaction in the consolidated statement of comprehensive
income (either profit or loss, or other comprehensive, income).
The calculation is as follows:
$
Fair value of consideration paid (X)
Decrease in NCI in net assets at date of transaction X
Decrease in NCI in goodwill at date of transaction X
Adjustment to parent's equity (X)

Full and partial disposals of shares in a subsidiary

Four possible situations following a disposal
 Disposals of shares in subsidiaries without loss of control
 Disposals of shares in subsidiaries and loss of control: the general accounting rules
 Full disposal of shares in a subsidiary
 Partial disposal of shares: subsidiary becomes an associate after the disposal
 Partial disposal of shares: the remaining shares become an ordinary investment

Full and partial disposals of shares in a subsidiary

Whenever you cross the 50% boundary, you revalue, and a gain or loss is reported in profit or loss for the year. If
you do not cross the 50% boundary, no gain or loss is reported: instead there is an adjustment to the parent’s equity.

Disposal of Shares in Subsidiaries without Loss of Control

The previous section explained the accounting rules for an increase or reduction in the shareholding of a parent
entity in a subsidiary, without any change in control. The transaction is accounted for within equity, as a transaction
between owners of equity in the group.

The same rules apply to the disposal of some shares without losing control as to the purchase of additional shares
when control already exists.

Disposals where control is lost: accounting treatment

For a full disposal, apply the following treatment.
(a) Statement of profit or loss and other comprehensive income
(i) Consolidate results and non-controlling interest to the date of disposal.
(ii) Show the group profit or loss on disposal.

pg. 168
Changes in Group Structures SBR Revision Notes

(b) Statement of financial position

There will be no non-controlling interest and no consolidation as there is no subsidiary at the date the statement of
financial position is being prepared.

Disposal of a whole subsidiary or associate - revision

Parent company's accounts
In the parent's Individual financial statements the profit or loss on disposal of a subsidiary or associate holding will
be calculated as:
$
Sales proceeds X
Less: Carrying amount (cost in P's own statement of financial position) (X)
Profit (loss) on disposal X/(X)
Group accounts — disposal of subsidiary
Gain or loss on disposal
In the group financial statements the profit or loss on disposal will be calculated as:
$ $
Proceeds X
Less: Amounts recognised prior to disposal:
Net assets of subsidiary X
Goodwill X
Non-controlling interest (X) (X)
Profit / loss X/(X)

Remember:
 If the disposal is midyear:
 A working will be required to calculate both net assets and the non-controlling interest at the disposal date.
 Any dividends declared or paid in the year of disposal and prior to the disposal date must be deducted from
the net assets of the subsidiary if they have not already been accounted for.
 Goodwill recognised prior to disposal is original goodwill arising less any impairments to date.

For partial disposals, use the following treatments.

(a) Subsidiary to associate
(i) Statement of profit or loss and other comprehensive income
(1) Treat the undertaking as a subsidiary up to the date of disposal, i.e. consolidate for the correct number
of months and show the non-controlling interest in that amount.
(2) Show the profit or loss on disposal.
(3) Treat as an associate thereafter.
(ii) Statement of financial position
(1) The investment remaining is at its fair value at the date of disposal (to calculate the gain)
(2) Equity account (as an associate) thereafter, using the fair value as the new 'cost'. (Post 'acquisition'
retained earnings are added to this cost in future years to arrive at the carrying value of the investment
in the associate in the statement of financial position.)

pg. 169
Changes in Group Structures SBR Revision Notes

GAIN OR LOSS ON DISPOSAL

In this case there is a loss of control, and so a gain or loss on disposal is calculated as:
$ $
Proceeds X
Fair value of interest retained X
X
Less: net assets of subsidiary recognised prior to disposal:
Net assets X
Goodwill X
Non-controlling interest X
X
Profit / loss X/(X)
(b) Subsidiary to trade investment/IEI
(i) Statement of profit or loss and other comprehensive income
(1) Treat the undertaking as a subsidiary up to the date of disposal, i.e. consolidate.
(2) Show profit or loss on disposal.
(3) Show dividend income only thereafter.

(ii) Statement of financial position

(1) The investment remaining is at its fair value at the date of disposal (to calculate the gain).
(2) Thereafter, treat as an investment in equity instruments under IFRS 9.

GROUP REORGANISATIONS AND RESTRUCTURING

Changes in direct ownership (i.e. internal group reorganisations) can take many forms. Apart from divisionalisation,
all other internal reorganisations will not affect the consolidated financial statements, but they will affect the
accounts of individual companies within the group.

Groups will reorganise on occasions for a variety of reasons.

(a) A group may want to float a business to reduce the gearing of the group. The holding company will initially
transfer the business into a separate company.
(b) Companies may be transferred to another business during a divisionalisation process.
(c) The group may 'reverse' into another company to obtain a stock exchange quotation.
(d) Internal reorganisations may create efficiencies of group structure for tax purposes.

GROUP REORGANISATIONS AND RESTRUCTURING

Methods of reorganising/restructuring
Groups may sometimes be restructured or reorganised. There are various reasons why a restructuring might be
considered necessary or desirable. These are explained later. Examples of reorganisations or restructuring include
the following:
 Creating a new holding company for the group
 A change in ownership between companies in the group
 Divisionalisation
 A demerger

pg. 170
Changes in Group Structures SBR Revision Notes

Creating a new holding company

A new holding company may be created for the group. The reason for this may be to improve the structure of the
group, possibly with a view to making more changes later, such as adding new subsidiaries.

The effect of creating a new holding company is typically as follows:

Before: After:
Shareholders Shareholders

Company X Holding company H

Company X

To create the new holding company, the former shareholders of Company X may exchange their shares in Company
X for shares in the new holding company H. They become the owners of H, and H is the 100% owner of Company X.
In these arrangements, there is usually just a share-for-share exchange, with shares in X exchanged for shares in H,
and no cash transactions are involved.

A change in ownership of companies within a group

When companies in a group are 100%-owned, it may be decided to reorganise the group and transfer ownership of
subsidiaries from one Group Company to another.

For example, a holding company H may own two subsidiaries, Entity A and Entity B. It may be proposed that Entity
A should buy the shares in Entity B from H, for cash. As a result of this reorganisation, Entity B would become a
subsidiary of Entity A and a sub-subsidiary of H. There would also be a transfer of cash from Entity A to H, in exchange
for the shares in Entity B.
Current structure Proposed structure

Shareholders Shareholders

H
H

100% 100% A

A B B

Company A buys the equity capital of B from H for cash.

All companies continue to operate.

pg. 171
Changes in Group Structures SBR Revision Notes

In the proposed structure, there is a change in the ownership of Entity B, as it has been transferred so that it is
directly owned by Entity A, not H.

The accounting implications are as follows:

 The reorganisation has not changed the assets of the group and so will not affect the group financial statements.

 In the individual accounts of H, there is a gain or loss in disposal of the shares in Entity B. In H's own financial
statements, the cost of the investment in Entity B is removed and replaced with the cash received, together
with the resulting gain or loss (in H's reserves).

ALTERNATIVE CHANGE IN OWNERSHIP

An alternative situation is where a subsidiary becomes directly owned by the parent, as can be seen in the diagram
below.

Before After:

Company A Company A

Company B
Company B Company C

Company C

This type of group reorganisation is often done when the parent company wishes to sell Company B, but to retain
company C. This reorganisation will have no effect on the consolidated accounts because the group remains the
same. It is the individual companies whose accounts will change.

This transaction cannot normally be effected by a share-for-share exchange, because the law in some countries does
not allow a subsidiary to hold shares in a parent company. Instead, Company B pays a special dividend called a
'dividend in specie' to the parent, which is effectively the cost of investment in Company C. Company B must have
sufficient distributable profits to do this.

Alternatively, Company A can pay cash to Company B in return for the investment in Company C.
 There is no effect on the group financial statements as the assets of the group are unchanged.
 There has not been a disposal of shares in Entity B by H, so the investment must remain in the accounts of H.
 The investment in Entity B in the individual H's accounts will certainly have suffered impairment, given that the
trade of Entity B has been transferred to Entity A.
 If any goodwill arose when H acquired B, this will also be impaired, because the business to which the goodwill
relates has now been transferred.
 Entity A has not bought the shares of Entity B. It has bought the net assets of B in exchange for cash. Entity A
will therefore include all of B's net assets into its own statement of financial position, as B's business operations
have now been merged with A's own.

pg. 172
Changes in Group Structures SBR Revision Notes

DIVISIONALISATION WITHIN A GROUP

Within a group, there may be operating divisions, and each division may be established as a subsidiary company
within the group. Each division may own several sub-subsidiaries, each responsible for a different aspect of the
division's overall operations.

When there is divisionalisation of operations within the group, it may be decided from time to time to switch assets
from one division to another. For example, it may be decided to close down one division and transfer its operations
to another division.

Accounting for a Divisional Reorganisation

This is a divisionalisation restructuring or reorganisation. It does not affect the ownership of Entity B. Entity B is still
owned by H and the investment remains in the statement of financial position of H. Entity B has simply transferred
its assets, liabilities and all business operations to Entity A, in exchange for cash. As a result, Entity B is now a 'shell'
company, containing just share capital and the cash from the sale.

SUBSIDIARY ACQUIRED EXCLUSIVELY WITH A VIEW TO SUBSEQUENT DISPOSAL

Subsidiaries acquired exclusively with a view to resell are classified as Discontinued Operations under IFRS 5.

Entity that is committed to a sale involving loss of control of a subsidiary that qualifies for held-for-sale classification
under IFRS 5 classifies all of the assets and liabilities of that subsidiary as held for sale, even if the entity will retain a
non-controlling interest in its former subsidiary after the sale.

pg. 173
IAS 21 SBR Revision Notes

IAS 21 – THE EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES

OBJECTIVE
The objective of this Standard is to prescribe how to include foreign currency transactions and foreign operations in
the financial statements of an entity and how to translate financial statements into a presentation currency.

SCOPE
This Standard shall be applied:
(a) In accounting for transactions and balances in foreign currencies, except for those derivative transactions and
balances that are within the scope of IFRS 9 Financial Instruments;
(b) In translating the results and financial position of foreign operations that are included in the financial statements
of the entity by consolidation, proportionate consolidation or the equity method; and
(c) In translating an entity’s results and financial position into a presentation currency.

DEFINITIONS
The following terms are used in this Standard with the meanings specified:

Closing rate is the spot exchange rate at the end of the reporting period.

Exchange difference is the difference resulting from translating a given number of units of one currency into another
currency at different exchange rates.

Exchange rate is the ratio of exchange for two currencies.

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date.

Foreign currency is a currency other than the functional currency of the entity.

Foreign operation is an entity that is a subsidiary, associate, joint venture or branch of a reporting entity, the
activities of which are based or conducted in a country or currency other than those of the reporting entity.

Functional currency is the currency of the primary economic environment in which the entity operates.

A group is a parent and all its subsidiaries.

Monetary items are units of currency held and assets and liabilities to be received or paid in a fixed or determinable
number of units of currency.

Net investment in a foreign operation is the amount of the reporting entity’s interest in the net assets of that
operation.

Presentation currency is the currency in which the financial statements are presented.

Spot exchange rate is the exchange rate for immediate delivery.

pg. 174
IAS 21 SBR Revision Notes

INDICATORS OF FUNCTIONAL CURRENCY

Primary economic indicators
The primary economic environment in which an entity operates is normally the one in which it primarily generates
and expends cash. An entity considers the following factors in determining its functional currency:
(a) The currency:
(i) That mainly influences sales prices for goods and services and
(ii) Of the country whose competitive forces and regulations mainly determine the sales prices of its goods
and services.
(b) The currency that mainly influences labour, material and other costs of providing goods or services

Secondary Indicators
The following factors may also provide evidence of an entity’s functional currency (judgements from management
if functional currency is not immediately):
(a) The currency in which funds from financing activities (i.e. issuing debt and equity instruments) are generated.
(b) The currency in which receipts from operating activities are usually retained.

Functional Currency of Foreign Operations

The following additional factors are considered in determining the functional currency of a foreign operation:
(a) Whether the activities of the foreign operation are carried out as an extension of the reporting entity, rather
than being carried out with a significant degree of autonomy.
(b) Whether transactions with the reporting entity are a high or a low proportion of the foreign operation’s
activities.
(c) Whether cash flows from the activities of the foreign operation directly affect the cash flows of the reporting
entity and are readily available for remittance to it.
(d) whether cash flows from the activities of the foreign operation are sufficient to service existing and normally
expected debt obligations without funds being made available by the reporting entity

Change in Functional Currency

Once determined, the functional currency is not changed unless there is a change in those underlying transactions,
events and conditions.

Currency of Hyperinflationary Economies

If the functional currency is the currency of a hyperinflationary economy, the entity’s financial statements are
restated in accordance with IAS 29 Financial Reporting in Hyperinflationary Economies.

REPORTING FOREIGN CURRENCY TRANSACTIONS IN THE FUNCTIONAL CURRENCY

INITIAL RECOGNITION
A foreign currency transaction is a transaction that is denominated or requires settlement in a foreign currency,
including transactions arising when an entity:
(a) Buys or sells goods or services whose price is denominated in a foreign currency;
(b) Borrows or lends funds when the amounts payable or receivable are denominated in a foreign currency; or
(c) Otherwise acquires or disposes of assets, or incurs or settles liabilities, denominated in a foreign currency.

A foreign currency transaction shall be recorded, on initial recognition in the functional currency, by applying to the
foreign currency amount the spot exchange rate between the functional currency and the foreign currency at the
date of the transaction.

pg. 175
IAS 21 SBR Revision Notes

SUBSEQUENT Measurement
A foreign currency transaction may give rise to assets or liabilities that are denominated in a foreign currency. These
assets and liabilities will need to be translated into the entity's functional currency at each reporting date. How they
will be translated depends on whether the assets or liabilities are monetary or non-monetary items.

Monetary items
The essential feature of a monetary item, as the definition implies, is the right to receive (or an obligation to deliver)
a fixed or determinable number of units of currency. Examples of monetary assets include:
 Cash and bank balances
 Trade receivables and payables
 Loan receivables and payables
 Foreign currency bonds held as available for sale
 Foreign currency bonds held to maturity
 Pensions and other employee benefits to be paid in cash
 Provisions that are to be settled in cash
 Cash dividends that are recognised as a liability
 A contract to receive (or deliver) a variable number of the entity's own equity instruments or a variable amount
of assets in which the fair value to be received (or delivered) equals a fixed or determinable number of units of
currency

Foreign currency monetary items outstanding at the end of the reporting date shall be translated using the closing
rate. The difference between this amount and the previous carrying amount in functional currency is an exchange
gain or loss.

Non-monetary items
A non-monetary item does not give the right to receive or create the obligation to deliver a fixed or determinable
number of units of currency. Examples of non-monetary items include:
 Amounts prepaid for goods and services (e.g. prepaid rent)
 Goodwill
 Intangible assets
 Inventories
 Property, plant and equipment
 Provisions to be settled by the delivery of a non-monetary asset
 Equity instruments that are held as available for sale financial assets
 Equity investments in subsidiaries, associates or joint ventures

Non-monetary items carried at historic cost are translated using the exchange rate at the date of the transaction
when the asset arose (historical rate). They are not subsequently retranslated in the individual financial statements
of the entity.

Issues in the measurement of non-monetary assets

 Subsequent depreciation should be translated on the same basis as the asset to which it relates, so the rate at
the date of acquisition for assets carried at cost and at the rate at the last valuation date for assets carried at
revalued amounts. Application of the depreciation method to the translated amount will achieve this.

pg. 176
IAS 21 SBR Revision Notes

 The carrying amount of inventories is the lower of cost and net realisable value in accordance with IAS 2
Inventories. The carrying amount in the functional currency is determined by comparing:
 The cost, translated at the exchange rate at the date when that amount was determined.
 The net realisable value, translated at the exchange rate at the date when that value was determined (e.g.
the closing date at the reporting date).

Impairment testing of foreign currency non-monetary assets

Similarly in accordance with IAS 36 Impairment 0/ Assets, the carrying amount of an asset for which there is an
indication of impairment, is the lower of:
 The carrying amount, translated at the exchange rate at the date when that amount was determined.
 The recoverable amount, translated at the exchange rate at the date when that value was determined (e.g. the
closing rate at the reporting date).

The effect of this comparison may be that an impairment loss is recognised in the functional currency but would not
be recognised in the foreign currency or vice versa.

The Rules
The rules in IAS 21 for reporting assets and liabilities at the end of a subsequent reporting period make a distinction
between:
 Monetary items, such as trade payables and trade receivables, and
 Non-monetary items, such as non-current assets and inventory.

The rules are as follows, for entities preparing their individual financial statements:
Asset or liability Accounting treatment for the statement of financial
position:
Monetary items Re-translate at the closing rate.
Non-monetary items carried at No re-translation. The transaction is left at the
cost original spot rate.
Non-monetary items carried at Re-translate at the exchange rate ruling at the
fair value date of the fair value adjustment.

Recognition of Exchange Differences

Exchange differences arising on the settlement of monetary items or on translating monetary items at rates different
from those at which they were translated on initial recognition during the period or in previous financial statements
shall be recognised in profit or loss in the period in which they arise, except as described below
There are two situations to consider.
(a) The transaction is settled in the same period as that in which it occurred: all the exchange difference is
recognised in that period.
(b) The transaction is settled in a subsequent accounting period: the exchange difference recognised in each
intervening period up to the period of settlement is determined by the change in exchange rates during that
period.

pg. 177
IAS 21 SBR Revision Notes

When a gain or loss on a non-monetary item is recognised in other comprehensive income, any exchange component
of that gain or loss shall be recognised in other comprehensive income. Conversely, when a gain or loss on a non-
monetary item is recognised in profit or loss, any exchange component of that gain or loss shall be recognised in
profit or loss.

Exchange differences arising on a monetary item that forms part of a reporting entity’s net investment in a foreign
operation shall be recognised in profit or loss in the separate financial statements of the reporting entity or the
individual financial statements of the foreign operation, as appropriate.

In the financial statements that include the foreign operation and the reporting entity (e.g. consolidated financial
statements when the foreign operation is a subsidiary), such exchange differences shall be recognised initially in
other comprehensive income and reclassified from equity to profit or loss on disposal of the net investment.

Change in functional currency

When there is a change in an entity’s functional currency, the entity shall apply the translation procedures applicable
to the new functional currency prospectively from the date of the change.

The foreign operation: accounting rules

Three stages in the consolidation process:
 The translation stage
 The consolidation stage

The Foreign Operation: Accounting Rules

Three stages in the consolidation process
If a company has a foreign operation (such as a foreign subsidiary) that prepares its accounts in a functional currency
that is different from the group's presentation currency, there are three stages in the accounting process, for the
purpose of preparing consolidated financial statements (or including the foreign associate or joint venture in the
financial statements of the reporting entity).
Stage Description
Adjust and update  Ensure that the individual financial statements of the foreign entity is correct and
up-to-date.
 If any adjustments are required to correct the financial statements of the foreign
entity, these should be made in the statements of the foreign entity and in its own
functional currency.
Translate  The assets and liabilities of the foreign entity should be translated into the
presentation currency of the parent company. (As explained earlier, the
presentation currency of the parent company might be the same or might be
different from its functional currency.)
 The rules for translation are explained below.
Consolidate  After translation, all the financial statements are now in the same currency.
 Normal group accounting principles are now used to prepare the consolidated
accounts of the group.
The translation stage
The rules set out below apply where the functional currency of the foreign entity is not a currency suffering from
hyperinflation.

pg. 178
IAS 21 SBR Revision Notes

The normal rules for translation, contained in IAS 21, are as follows:
(1) The statement of financial position
 The assets and liabilities of the foreign operation, for inclusion in the consolidated statement of financial
position, are translated at the closing rate. (Comparative figures for the previous year are translated at
the same rate.)
 For foreign subsidiaries, this rule also applies to purchased goodwill arising on the acquisition of the
subsidiary.
(2) The statement of profit or loss and other comprehensive income
 Income and expenses for inclusion in the consolidated statement of profit or loss and other
comprehensive income are translated at the spot rates at the dates of each of the transactions.
 For practical reasons, average rates for a period may be used, if they provide a reasonable approximation
of the spot rates when the transactions took place.
(3) Exchange differences
 All resulting exchange differences are recognised in other comprehensive income for the period and are
credited (gain) or debited (loss) to a separate reserve within the equity section of the consolidated
statement of financial position, and this reserve is maintained within equity until the foreign operation is
eventually disposed of.
 Gains or losses are therefore reported as gains or losses in other comprehensive income and movements
in the separate reserve, and not as a gain or loss in profit or loss and an increase or reduction in retained
earnings.

The gain or loss on translation

The exchange differences on translation result in a gain or loss. These gains or losses arise from a combination of
two factors:
 Income and expense items are translated at the exchange rates ruling during the period, but assets and liabilities
are translated at closing rates. The profit is therefore calculated at the actual exchange rates, but the
accumulated profit in the consolidated statement of financial position is re-translated at the closing rate.
 The net assets of the subsidiary were translated at last year's closing rate at the end of the previous financial
year. These net assets have now been retranslated and included in this year's statement of financial position at
this year's closing rate.

IAS 21 states that these differences on translation are not recognised in profit or loss because changes in the
exchange rates for these items have little or no effect on cash flows from operations. It would therefore be
misleading to include them in profit or loss. However the actual treatment is that the exchange loss should be
recognised in other comprehensive income for the year and taken to a separate reserve within equity in the
consolidated statement of financial position.

The consolidation stage

After the translation stage, the financial statements of the overseas entity are in the presentation currency of the
parent company.

The basic rule is that normal consolidation techniques can now be used. However, foreign exchange reserve must
be included in the consolidated statement of financial position for the cumulative exchange differences.

It is also necessary to comply with the requirements of IAS 21 for purchased goodwill and foreign subsidiaries.

pg. 179
IAS 21 SBR Revision Notes

Purchased goodwill and foreign subsidiaries

IAS 21 requires that goodwill and any fair value adjustments arising on the acquisition of a foreign subsidiary are to
be treated as part of the assets and liabilities of the foreign subsidiary. The rules already described apply to these
items.

This means that:

 Goodwill arising on the purchase of the foreign subsidiary (and also any fair value adjustments to the value of
assets of the subsidiary) should be stated in the functional currency of the foreign subsidiary.
 The goodwill and fair value adjustments will therefore be translated each year at the closing exchange rate.

A gain or loss on translation will therefore arise (as described above for other assets and liabilities).

The effect of this rule is that goodwill and the acquisition of a foreign operation is re-stated over time because it is
re-translated every year at the new closing exchange rate.

Exchange differences in other comprehensive income

Using the method of creating the consolidated statement of financial position shown in the previous example, you
do not need to worry about exchange differences. By translating every balance in the subsidiary's statement of
financial position at the closing rate, the exchange differences are automatically included in reserves.

However, you may be asked to calculate exchange differences arising for reporting in other comprehensive income
and a separate equity reserve.

The easiest way to work out the exchange differences (excluding the gain or loss on re-translation of goodwill) is to
create the accounting equation for the foreign subsidiary in its own currency. Once this is translated into the parent's
currency it will not balance, and the exchange differences are the balancing figure. These are the exchange
differences arising from:
 Re-translating the opening net assets of the subsidiary at the closing rate, and
 Re-translating the subsidiary's post-acquisition profit at the closing rate.

DISPOSAL OF A FOREIGN SUBSIDIARY

Most of the accounting rules for the disposal of a foreign subsidiary, or for the partial disposal of a foreign subsidiary,
are set out in IAS 27 (revised). Disposals are explained in another chapter.

However IAS 27 does not deal with the accounting treatment of the balance on the separate equity reserve account
when a foreign subsidiary is disposed of. This matter is dealt with by IAS 21.
 When the entire investment in a foreign subsidiary is disposed of, the cumulative balance in the separate equity
reserve (which represents amounts previously recognised in other comprehensive income) should now be
reclassified from equity to profit and loss.
 If there was a non-controlling interest in the subsidiary, the NCI is derecognised in the consolidated statement
of financial position. Amounts previously recognised in other comprehensive income and attributed to NCI must
not be reclassified and recognised in profit or loss of the reporting entity.
 When a proportion of an investment in a foreign subsidiary is disposed of, a proportionate share of the amounts
previously recognised in other comprehensive income (the cumulative balance in the separate equity reserve)
should now be reclassified from equity to profit or loss.

pg. 180
IAS 21 SBR Revision Notes

When income previously recognised as other comprehensive income is reclassified as a gain or loss to profit or loss
as a re-classification adjustment, there must be an offsetting loss or gain in other comprehensive income, to avoid
double-counting of the gain (or loss).

In other comprehensive income, negative income of $2 million should be recognised, to avoid double counting of
the income previously recognised as other comprehensive income but now reclassified in profit or loss.

Disclosure
 The amount of exchange differences recognised in profit or loss (excluding differences arising on financial
instruments measured at fair value through profit or loss in accordance with IAS 39).
 Net exchange differences recognised in other comprehensive income and accumulated in a separate
component of equity, and a reconciliation of the amount of such exchange differences at the beginning and end
of the period.
 When the presentation currency is different from the functional currency, disclose that fact together with the
functional currency and the reason for using a different presentation currency.
 A change in the functional currency of either the reporting entity or a significant foreign operation and the
reason therefore.

When an entity presents its financial statements in a currency that is different from its functional currency, it may
describe those financial statements as complying with IFRS only if they comply with all the requirements of each
applicable Standard (including IAS 21) and each applicable interpretation.

pg. 181
IAS 7 SBR Revision Notes

IAS 7-STATEMENT OF CASH FLOWS

Group: Statement of Cash Flows

OBJECTIVE
The objective of this Standard is to require the provision of information about the historical changes in cash and cash
equivalents of an entity by means of a statement of cash flows which classifies cash flows during the period from
operating, investing and financing activities.

Benefits of Cash Flow Information

 Cash flow information is useful in assessing the ability of the entity to generate cash and cash equivalents and
enables users to develop models to assess and compare the present value of the future cash flows of different
entities
 It also enhances the comparability of the reporting of operating performance by different entities
 It is also useful in checking the accuracy of past assessments of future cash flows and in examining the
relationship between profitability and net cash flow and the impact of changing prices.

DEFINITIONS
The following terms are used in this Standard with the meanings specified:
Cash comprises cash on hand and demand deposits.

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

Cash flows are inflows and outflows of cash and cash equivalents.

Operating activities are the principal revenue-producing activities of the entity and other activities that are not
investing or financing activities.

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

Financing activities are activities that result in changes in the size and composition of the contributed equity and
borrowings of the entity.

Cash and Cash Equivalents

Cash equivalents are held for the purpose of meeting short-term cash commitments rather than for investment or
other purposes. For an investment to qualify as a cash equivalent it must be readily convertible to a known amount
of cash and be subject to an insignificant risk of changes in value.

PRESENTATION OF A STATEMENT OF CASH FLOWS

The statement of cash flows shall report cash flows during the period classified by
 Operating,
 Investing and
 Financing activities.

pg. 182
IAS 7 SBR Revision Notes

Operating Activities
Cash flows from operating activities are primarily derived from the principal revenue-producing activities of the
entity. Examples of cash flows from operating activities are:
(a) Cash receipts from the sale of goods and the rendering of services;
(b) Cash receipts from royalties, fees, commissions and other revenue;
(c) Cash payments to suppliers for goods and services;
(d) Cash payments to and on behalf of employees;
(e) Cash receipts and cash payments of an insurance entity for premiums and claims, annuities and other policy
benefits;
(f) Cash payments or refunds of income taxes unless they can be specifically identified with financing and investing
activities; and
(g) Cash receipts and payments from contracts held for dealing or trading purposes.

Investing Activities
Examples of cash flows arising from investing activities are:
(a) Cash payments to acquire property, plant and equipment, intangibles and other long-term assets.
(b) cash receipts from sales of property, plant and equipment, intangibles and other long-term assets;
(c) Cash payments to acquire equity or debt instruments of other entities and interests in joint ventures.
(d) Cash receipts from sales of equity or debt instruments of other entities and interests in joint ventures.

Financing Activities
Examples of cash flows arising from financing activities are:
(a) cash proceeds from issuing shares or other equity instruments;
(b) cash payments to owners to acquire or redeem the entity’s shares;
(c) cash proceeds from issuing debentures, loans, notes, bonds, mortgages and other short-term or long-term
borrowings;
(d) cash repayments of amounts borrowed; and
(e) Cash payments by a lessee for the reduction of the outstanding liability relating to a finance lease.

REPORTING CASH FLOWS FROM OPERATING ACTIVITIES

An entity shall report cash flows from operating activities using either:
(a) the direct method, whereby major classes of gross cash receipts and gross cash payments are disclosed; or
(b) the indirect method, whereby profit or loss is adjusted for the effects of transactions of a non-cash nature, any
deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense
associated with investing or financing cash flows.

Under the indirect method, the net cash flow from operating activities is determined by adjusting profit or loss for
the effects of:
(a) changes during the period in inventories and operating receivables and payables;
(b) Non-cash items such as depreciation, provisions, deferred taxes, unrealized foreign currency gains and losses,
and undistributed profits of associates; and
all other items for which the cash effects are investing or financing cash flows.

pg. 183
IAS 7 SBR Revision Notes

A proforma of such a calculation is as follows and this method may be more common in the exam.
$
Profit before taxation (statement of profit or loss and other comprehensive income) X
Add depreciation X
Loss (profit) on sale of non-current assets X
(Increase)/decrease in inventories (X)/X
(Increase)/decrease in receivables (X)/X
Increase/(decrease) in payables X/(X)
Cash generated from operations X
Interest (paid)/received (X)
Income taxes paid (X)
Net cash flows from operating activities X

It is important to understand why certain items are added and others subtracted. Note the following points.
(a) Depreciation is not a cash expense, but is deducted in arriving at the profit figure in the statement of
comprehensive income. It makes sense, therefore, to eliminate it by adding it back.
(b) By the same logic, a loss on a disposal of a non-current asset (arising through under provision of depreciation)
needs to be added back and a profit deducted.
(c) An increase in inventories means less cash – you have spent cash on buying inventory.
(d) An increase in receivables means the company's credit customers have not paid as much, and therefore there
is less cash.
(e) If we pay off payables, causing the figure to decrease, again we have less cash.

Indirect versus direct

The direct method is encouraged where the necessary information is not too costly to obtain, but IAS 7 does not
require it, and favours the indirect method. In practice, therefore, the direct method is rarely used. It is not obvious
that IAS 7 is right in favouring the indirect method. It could be argued that companies ought to monitor their cash
flows carefully enough on an ongoing basis to be able to use the direct method at minimal extra cost.

Reporting cash flows from investing and financing activities

An entity shall report separately major classes of gross cash receipts and gross cash payments arising from investing
and financing activities, except to the extent that cash flows described below are reported on a net basis.

Cash flows arising from the following operating, investing or financing activities may be reported on a net basis:
(a) cash receipts and payments on behalf of customers when the cash flows reflect the activities of the customer
rather than those of the entity; and
(b) Cash receipts and payments for items in which the turnover is quick, the amounts are large, and the maturities
are short.

Foreign currency cash flows

Cash flows arising from transactions in a foreign currency shall be recorded in an entity’s functional currency by
applying to the foreign currency amount the exchange rate between the functional currency and the foreign
currency at the date of the cash flow. The cash flows of a foreign subsidiary shall be translated at the exchange rates
between the functional currency and the foreign currency at the dates of the cash flows.

pg. 184
IAS 7 SBR Revision Notes

Interest and dividends

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

Interest paid and interest and dividends received may be classified as operating cash flows because they enter into
the determination of profit or loss. Alternatively, interest paid and interest and dividends received may be classified
as financing cash flows and investing cash flows respectively, because they are costs of obtaining financial resources
or returns on investments.

Dividends paid may be classified as a financing cash flow because they are a cost of obtaining financial resources.
Alternatively, dividends paid may be classified as a component of cash flows from operating activities in order to
assist users to determine the ability of an entity to pay dividends out of operating cash flows.

Taxes on income
Cash flows arising from taxes on income shall be separately disclosed and shall be classified as cash flows from
operating activities unless they can be specifically identified with financing and investing activities.

Other disclosures
All entities should disclose, together with a commentary by management, any other information likely to be of
importance.
(a) Restrictions on the use of or access to any part of cash equivalents.
(b) The amount of undrawn borrowing facilities which are available.
(c) Cash flows which increased operating capacity compared to cash flows which merely maintained operating
capacity.

CONSOLIDATED STATEMENT OF CASH FLOWS

The special features of a consolidated statement of cash flows
A consolidated statement of cash flows is prepared largely from the consolidated statement of financial position,
statement of comprehensive income (or income statement) and statement of changes in equity.

The rules for preparing a group statement of cash flows are similar to the rules for a statement of cash flows for an
individual entity.

However, there are additional items in a consolidated statement of cash flows that are not found in the statement
of cash flows of an individual company. The most significant of these are cash flows (or adjustments to profit before
tax) relating to:
 Non-controlling interests
 Associates
 And acquiring or disposing of subsidiaries during the year.

Illustrative format
It might be useful to look at the format of a consolidated statement of cash flows, to see where these items appear.
The indirect method is used here to present the cash flows from operating activities.

pg. 185
IAS 7 SBR Revision Notes

Entity XYZ
Statement of cash flows for the year ended 31 December 20X7
$000 $000
Cash flows from operating activities
Profit before tax 440
Adjustments for:
Depreciation and amortisation charges 450
Loss on disposal of plant and machinery 50
Share of profit of associates and joint ventures (100)
Foreign exchange loss 40
Investment income (25)
Interest expense 25
880
Increase in trade and other receivables (80)
Increase in inventories (60)
Increase in trade payables 40
Cash generated from operations 780
Interest paid (30)
Income taxes paid (200)
Net cash from operating activities 550
Cash flows from investing activities
Acquisition of subsidiary, net of cash acquired (note 1) (450)
Purchase of property, plant and equipment (note 2) (220)
Proceeds from the sale of equipment 30
Interest received 25
Dividends received from associates 45

Net cash used in investing activities (570)

Cash flows from financing activities
Proceeds from the issue of share capital 500
Proceeds from long-term loan 100
Redemption of debt securities (150)
Payment of finance lease liabilities (80)
Dividends paid to non-controlling interests (NCI) (70)
Dividends paid to parent company shareholders (200)
Net cash inflow from financing activities 100
Net increase in cash and cash equivalents 80
Cash and cash equivalents at the beginning of the period (note 3) 150
Cash and cash equivalents at the end of the period (note 3) 230

Exchange rate differences

A gain or loss arising from exchange rate differences is not a cash flow item. When the indirect method is used to
present cash flows from operating activities, it is therefore necessary to make an adjustment to get from 'profit' to
'cash flow'.

pg. 186
IAS 7 SBR Revision Notes

 A loss arising from exchange rate differences (shown in the example above as a 'foreign exchange loss') must be
added back.
 A gain arising from exchange rate differences must be subtracted.

Cash flows to the non-controlling interest

The non-controlling interest represents a third party so dividends paid to the non-controlling interest are reflected
as a cash outflow. This payment should be presented separately and classified as ‘Cash flows from financing
activities’
$
Non-controlling interest in group net assets at the beginning of the year X
Non-controlling interest in profits after tax for the year X
X
Non-controlling interest in group net assets at the end of the year (X)
Dividends paid to non-controlling interests (balancing figure) X

The dividend paid of $120,000 will be disclosed as a cash flow from financing activities.

Associates and the group statement of cash flows

When a group has an interest in an associate entity, the consolidated statement of cash flows must show the cash
flows that occur between the associate and the group. The consolidated statement of cash flows shows the effect
on the group's cash position of transactions between the group and its associate.

Share of profit (or loss) of an associate

In the consolidated statement of comprehensive income or the income statement, the group profit includes the
group's share of the profits of associates.

These profits are not a cash flow item. When the indirect method is used to present the cash flows from operating
activities, an adjustment is therefore needed to get from 'profit' to 'cash flow'.
 The group's share of the profit of an associate must be deducted from profit.
 The group's share of the loss of an associate must be added to profit.

Cash flows involving associates

The cash flows that might occur between a group and an associate, for inclusion in the consolidated statement of
cash flows are as follows:
 Investing activities
- Cash paid to acquire shares in an associate during the year
- Cash received from the disposal of shares in an associate during the year
- Dividends received from an associate during the year.
 Financing activities
- Cash paid as a new loan to or from an associate during the year
- Cash received as a repayment of a loan to or from an associate during the year.

Note that dividends received from an associate are shown as cash flows from investing activities; whereas dividends
paid to non-controlling interests in subsidiaries are (usually) shown as cash flows from financing activities.

pg. 187
IAS 7 SBR Revision Notes

Dividends received from the associate must be disclosed as a separate cash flow classified as ‘Cash flows from
investing activities’.

The cash receipt can be calculated as follows:

$
Group investment in net assets of associate at the beginning of the X
Year
Group share of associate's profits before tax X
Group's share of associate's tax on profits (X)
X
Group investment in net assets of associate at the end of the year (X)
Dividends received from associate in the year X

Acquisitions and disposals of subsidiaries in the statement of cash flows

Acquisition of a subsidiary in the statement of cash flows
When a subsidiary is acquired:
 The group gains control of the assets and liabilities of the subsidiary, which might include some cash and cash
equivalents, and
 The group pays for its share of the subsidiary, and the purchase consideration might consist partly or entirely of
cash.

If the subsidiary is acquired or disposed of during the accounting period the net cash effect of the purchase or sale
transaction should be shown separately under ‘Cash flows from investing activities’. The net cash effect will be the
cash purchase price/cash disposal proceeds net of any cash or cash equivalents acquired or disposed of.

Inventory, trade receivables, trade payables

When a subsidiary has been acquired, the working capital brought into the group (receivables plus inventory minus
trade payables of the acquired subsidiary) is paid for in the purchase price to acquire the subsidiary. As we have
seen, this is treated as a separate item in the investing activities section of the statement of cash flows.

To avoid double counting of the effects of the working capital in the subsidiary at the acquisition date, we need to
deduct from the value in the closing statement of financial position, or add to the value in the opening statement of
financial position:
 The receivables in the net assets of the subsidiary acquired, as at the acquisition date
 The inventory in the net assets of the subsidiary acquired, as at the acquisition date, and
 The trade payables in the net assets of the subsidiary acquired, as at the acquisition date

pg. 188
IAS 7 SBR Revision Notes

Purchases of Non-Current Assets

When non-current assets are at carrying amount (net book value)
When non-current assets are shown at their carrying amount (net book value) and a subsidiary has been acquired
during the year, purchases of non-current assets (assumed to be cash payments) are calculated as follows. (Figures
have been included in the table for illustrative purposes.)
$
Non-current assets at carrying amount, at the end of the year 290,000
Minus: Non-current assets acquired on acquisition of the subsidiary (65,000)
225,000
Net book value of disposals of non-current assets during the year 30,000
Depreciation charge for the year 40,000
295,000
Non-current assets at carrying amount, at the beginning of the year 240,000
Cash paid to acquire non-current assets during the year 55,000

When non-current assets are at cost

When non-current assets are shown at cost and a subsidiary has been acquired during the year, purchases of non-
current assets (assumed to be cash payments) are calculated as follows. (Again, figures have been included in the
table for illustrative purposes.)
$
Non-current assets at cost, at the end of the year 485,000
Non-current assets acquired on acquisition of the subsidiary (90,000)
395,000
Cost of disposals of non-current assets during the year 60,000
455,000
Non-current assets at cost, at the beginning of the year (400,000)
Cash paid to acquire non-current assets during the year 55,000

Disposal of a Subsidiary in the Statement of Cash Flows

The procedures for reporting the cash effect of disposals of subsidiaries in a group statement of cash flows are similar
to those used for acquisitions, except that the process applies in reverse.

In the group statement of cash flows, the cash received from the disposal is the cash actually received from the
disposal, minus any cash in the subsidiary at the disposal date.

A note to the statement of cash flows should show the details of the disposal, including the cash received from the
sale minus the cash in the subsidiary at the disposal date.

Note:
You should remember the assets and liabilities disposed of, and the non-controlling interest that leaves the group
on the disposal, to avoid double counting the other cash flow items in the statement of cash flows.

pg. 189
IAS 24 SBR Revision Notes

IAS 24 – RELATED PARTY TRANSACTIONS

OBJECTIVE
The objective of this Standard is to ensure that an entity’s financial statements contain the disclosures necessary to
draw attention to the possibility that its financial position and profit or loss may have been affected by the existence
of related parties and by transactions and outstanding balances, including commitments, with such parties.

SCOPE
This Standard shall be applied in:
(a) Identifying related party relationships and transactions;
(b) Identifying outstanding balances, including commitments, between an entity and its related parties;
(c) Identifying the circumstances in which disclosure of the items in (a) and (b) is required; and
(d) Determining the disclosures to be made about those items.

DEFINITIONS
The following terms are used in this Standard with the meanings specified:

A related party is a person or entity that is related to the entity that is preparing its financial statements (in this
Standard referred to as the ‘reporting entity’).
(a) A person or a close member of that person’s family is related to a reporting entity if that person:
(i) has control or joint control over the reporting entity;
(ii) has significant influence over the reporting entity; or
(iii) is a member of the key management personnel of the reporting entity or of a parent of the reporting
entity.
(b) An entity is related to a reporting entity if any of the following conditions applies:
(i) The entity and the reporting entity are members of the same group (which means that each parent,
subsidiary and fellow subsidiary is related to the others).
(ii) One entity is an associate or joint venture of the other entity (or an associate or joint venture of a
member of a group of which the other entity is a member).
(iii) Both entities are joint ventures of the same third party.
(iv) One entity is a joint venture of a third entity and the other entity is an associate of the third entity.
(v) The entity is a post-employment benefit plan for the benefit of employees of either the reporting entity
or an entity related to the reporting entity. If the reporting entity is itself such a plan, the sponsoring
employers are also related to the reporting entity.
(vi) The entity is controlled or jointly controlled by a person identified in (a).
(vii) A person identified in (a)(i) has significant influence over the entity or is a member of the key
management personnel of the entity (or of a parent of the entity).

A related party transaction is a transfer of resources, services or obligations between a reporting entity and a related
party, regardless of whether a price is charged.

Close members of the family of a person are those family members who may be expected to influence, or be
influenced by, that person in their dealings with the entity and include:
(a) That person’s children and spouse or domestic partner;
(b) Children of that person’s spouse or domestic partner; and

pg. 190
IAS 24 SBR Revision Notes

(c) Dependants of that person or that person’s spouse or domestic partner.

Compensation includes all employee benefits (as defined in IAS 19 Employee Benefits) including employee benefits
to which IFRS 2 Share-based Payment applies.

Employee benefits are all forms of consideration paid, payable or provided by the entity, or on behalf of the entity,
in exchange for services rendered to the entity.

It also includes such consideration paid on behalf of a parent of the entity in respect of the entity.

Compensation includes:
(a) Short-term employee benefits, such as wages, salaries and social security contributions, paid annual leave and
paid sick leave, profit-sharing and bonuses (if payable within twelve months of the end of the period) and non-
monetary benefits (such as medical care, housing, cars and free or subsidised goods or services) for current
employees;
(b) Post-employment benefits such as pensions, other retirement benefits, post-employment life insurance and
post-employment medical care;
(c) Other long-term employee benefits, including long-service leave or sabbatical leave, jubilee or other long-
service benefits, long-term disability benefits and, if they are not payable wholly within twelve months after the
end of the period, profit-sharing, bonuses and deferred compensation;
(d) Termination benefits; and
(e) Share-based payment.

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

Joint control is the contractually agreed sharing of control over an economic activity.

Key management personnel are those persons having authority and responsibility for planning, directing and
controlling the activities of the entity, directly or indirectly, including any director (whether executive or otherwise)
of that entity.

Significant influence is the power to participate in the financial and operating policy decisions of an entity, but is not
control over those policies. Significant influence may be gained by share ownership, statute or agreement.

Government refers to government, government agencies and similar bodies whether local, national or international.
A government-related entity is an entity that is controlled, jointly controlled or significantly influenced by a
government.

DISCLOSURE
Relationships between parents and subsidiaries. Regardless of whether there have been transactions between a
parent and a subsidiary, an entity must disclose the name of its parent and, if different, the ultimate controlling
party.

pg. 191
IAS 24 SBR Revision Notes

Management compensation. Disclose key management personnel compensation in total and for each of the
following categories:
 Short-term employee benefits
 Post-employment benefits
 Other long-term benefits
 Termination benefits
 Share-based payment benefits

Key management personnel are those persons having authority and responsibility for planning, directing, and
controlling the activities of the entity, directly or indirectly, including any directors (whether executive or otherwise)
of the entity.

Related party transactions. If there have been transactions between related parties, disclose the nature of the
related party relationship as well as information about the transactions and outstanding balances necessary for an
understanding of the potential effect of the relationship on the financial statements. These disclosures would be
made separately for each category of related parties and would include:
 The amount of the transactions
 The amount of outstanding balances, including terms and conditions and guarantees
 Provisions for doubtful debts related to the amount of outstanding balances
 Expense recognised during the period in respect of bad or doubtful debts due from related parties

The disclosures shall be made separately for each of the following categories:
(a) The parent;
(b) Entities with joint control or significant influence over the entity;
(c) Subsidiaries;
(d) Associates;
(e) Joint ventures in which the entity is a venturer;
(f) Key management personnel of the entity or its parent; and
(g) Other related parties.

Items of a similar nature may be disclosed in aggregate except when separate disclosure is necessary for an
understanding of the effects of related party transactions on the financial statements of the entity.

A reporting entity is exempt from the disclosure requirements in relation to related party transactions and
outstanding balances, including commitments, with:
(a) a government that has control, joint control or significant influence over the reporting entity; and
(b) Another entity that is a related party because the same government has control, joint control or significant
influence over both the reporting entity and the other entity.

If a reporting entity applies the exemption, it shall disclose the following about the transactions and related
outstanding balances:
(a) the name of the government and the nature of its relationship with the reporting entity (i.e. control, joint control
or significant influence);
(b) the following information in sufficient detail to enable users of the entity’s financial statements to understand
the effect of related party transactions on its financial statements:

pg. 192
IAS 24 SBR Revision Notes

(i) The nature and amount of each individually significant transaction; and
(ii) For other transactions that are collectively, but not individually, significant, a qualitative or quantitative
indication of their extent.

NOTE: This topic is very important for Ethics based questions.

pg. 193
IAS 34 SBR Revision Notes

IAS 34-INTERIM FINANCIAL REPORTING

OBJECTIVE
The objective of this Standard is to prescribe the minimum content of an interim financial report and to prescribe
the principles for recognition and measurement in complete or condensed financial statements for an interim
period.

SCOPE
This Standard does not mandate which entities should be required to publish interim financial reports, how
frequently, or how soon after the end of an interim period.

Publicly traded entities are encouraged:

(a) To provide interim financial reports at least as of the end of the first half of their financial year; and
(b) To make their interim financial reports available not later than 60 days after the end of the interim period.

DEFINITIONS
Interim period is a financial reporting period shorter than a full financial year.

Interim financial report means a financial report containing either a complete set of financial statements (as
described in IAS 1 Presentation of Financial Statements (as revised in 2007)) or a set of condensed financial
statements (as described in this Standard) for an interim period.

Minimum components of an interim financial report

An interim financial report shall include, at a minimum, the following components:
(a) a condensed statement of financial position;
(b) a condensed statement of profit or loss and other comprehensive income, presented as either;
(c) a condensed statement of changes in equity;
(d) a condensed statement of cash flows; and
(e) Selected explanatory notes.

FORM AND CONTENT OF INTERIM FINANCIAL STATEMENTS

The condensed statement of financial position should include, as a minimum, each of the major components of
assets, liabilities and equity as were in the statement of financial position at the end of the previous financial year,
thus providing a summary of the economic resources of the entity and its financial structure.

The condensed statement of profit or loss and other comprehensive income should include, as a minimum, each
of the component items of income and expense as are shown in profit or loss for the previous financial year, together
with the earnings per share and diluted earnings per share.

The condensed statement of cash flows should show, as a minimum, the three major sub-totals of cash flow as
required in statements of cash flows by IAS 7, namely: cash flows from operating activities, cash flows from investing
activities and cash flow from financing activities.

The condensed statement of changes in equity should include, as a minimum, each of the major components of
equity as were contained in the statement of changes in equity for the previous financial year of the entity.

pg. 194
IAS 34 SBR Revision Notes

Significant events and transactions

An entity shall include in its interim financial report an explanation of events and transactions that are significant to
an understanding of the changes in financial position and performance of the entity since the end of the last annual
reporting period. Information disclosed in relation to those events and transactions shall update the relevant
information presented in the most recent annual financial report.

The following is a list of events and transactions for which disclosures would be required if they are significant: the
list is not exhaustive.
 Accounting policy changes
 Seasonality or cyclicality of operations
 Unusual and significant items
 Changes in estimates
 Issuances, repurchases, and repayments of debt and equity securities
 Dividends paid
 A few items of segment information (for those entities required by IFRS 8 to report segment information
annually)
 Significant events after the end of the interim period
 Business combinations
 Long-term investments
 Restructurings and reversals of restructuring provisions
 Discontinued operations
 Changes in contingent liabilities and contingent assets
 Corrections of prior period errors
 Write-down of inventory to net realisable value
 Impairment loss on property, plant, and equipment; intangibles; or other assets, and reversal of such
impairment loss
 Litigation settlements
 Any debt default or any breach of a debt covenant that has not been corrected subsequently
 Related party transactions
 Acquisitions and disposals of property, plant, and equipment
 Commitments to purchase property, plant, and equipment

Periods for which interim financial statements are required to be presented

Interim reports shall include interim financial statements (condensed or complete) for periods as follows:
(a) Statement of financial position as of the end of the current interim period and a comparative statement of
financial position as of the end of the immediately preceding financial year.
(b) Statement of profit or loss and comprehensive income for the current interim period and cumulatively for the
current financial year to date, with comparative statements of comprehensive income for the comparable
interim periods (current and year-to-date) of the immediately preceding financial year.
(c) Statement of changes in equity cumulatively for the current financial year to date, with a comparative
statement for the comparable year-to-date period of the immediately preceding financial year.
(d) Statement of cash flows cumulatively for the current financial year to date, with a comparative statement for
the comparable year-to-date period of the immediately preceding financial year.

pg. 195
IAS 34 SBR Revision Notes

If the company's business is highly seasonal, IAS 34 encourages disclosure of financial information for the latest
12 months, and comparative information for the prior 12-month period, in addition to the interim period
financial statements.

Materiality
In deciding how to recognise, measure, classify, or disclose an item for interim financial reporting purposes,
materiality shall be assessed in relation to the interim period financial data.

In making assessments of materiality, it shall be recognised that interim measurements may rely on estimates to a
greater extent than measurements of annual financial data.

RECOGNITION AND MEASUREMENT

Accounting Policies
The same accounting policies should be applied for interim reporting as are applied in the entity's annual financial
statements, except for accounting policy changes made after the date of the most recent annual financial statements
that are to be reflected in the next annual financial statements.

Measurement
Measurements for interim reporting purposes should be made on a year-to-date basis, so that the frequency of the
entity's reporting does not affect the measurement of its annual results.
 Revenues received seasonally, cyclically, or occasionally within a financial year shall not be anticipated or
deferred as of an interim date if anticipation or deferral would not be appropriate at the end of the entity’s
financial year.
Some entities consistently earn more revenues in certain interim periods of a financial year than in other interim
periods, for example, seasonal revenues of retailers. Such revenues are recognised when they occur.
 Costs incurred unevenly during the financial year shall be anticipated or deferred for interim reporting purposes
if, and only if, it is also appropriate to anticipate or defer that type of cost at the end of the financial year.
 Employer payroll taxes and insurance contributions on an annual basis
 Major planned periodic maintenance or overhaul expected to occur late in the year is not anticipated
 Year-end bonuses are anticipated for interim reporting purposes if, and only if:
o The bonus is a legal obligation, or past practice would make the bonus a constructive obligation and the
o Entity has no realistic alternative but to make the payments; and
o A reliable estimate of the obligation can be made.
 Holiday pay: If an enforceable obligation on the employer, then any unpaid accumulated holiday pay may be
accrued in the interim financial report.
 Intangible assets: Entities are required to apply the definition and recognition criteria for an intangible asset in
the same way in an interim period as in an annual period.
 Other planned but irregularly occurring costs are generally are discretionary, even though they are planned and
tend to recur from year to year.
 Depreciation and amortization are based only on assets owned during that interim period. They should not take
into account asset acquisitions or disposals planned for later in the financial year.
 Use of estimates: All material relevant financial information being appropriately disclosed.

pg. 196
IAS 34 SBR Revision Notes

DISCLOSURE IN ANNUAL FINANCIAL STATEMENTS

If an estimate of an amount reported in an interim period is changed significantly during the financial interim period
in the financial year but a separate financial report is not published for that period, the nature and amount of that
change must be disclosed in the notes to the annual financial statements.

pg. 197
Interpretation of Financial Statements SBR Revision Notes

INTERPRETATION OF FINANCIAL STATEMENTS AND RATIO ANALYSIS

Ratio analysis is a technique whereby complicated information is summarised to a common denominator so that a
meaningful comparison of the company's performance and financial position can be made.

Financial statements provide important financial information for people who do not have access to the internal
accounts. For example, current and potential shareholders can see how much profit a company has made, the value
of its assets, and the level of its cash reserves. Although these figures are useful they do not mean a great deal by
themselves. If the user is to make any real sense of the figures in the financial statements, they need to be properly
analysed using accounting ratios and then compared with either the previous year’s ratios, or measured against
averages for the industry.

ANALYSIS AND INTERPRETATION

Calculation of key ratios from Explanation of ratios to

financial statements establish strengths and
weaknesses

PURPOSE
Depends on USER

Management Lender / analyst Investors / analyst

Cost control Lending Buy/Hold/Sell shares
Profitability analysis Security Quality of management
Investment decisions Credit worthiness

Comparison required with:

Previous years
Predetermined forecasts
Industry averages

LIMITATIONS

Availability of information Consistency Historic cost accounting

Cost/difficulty of obtaining Changes in accounting policies Inherent limitations of HCA in
Information between years periods of price level
changes
Different policies used by different
companies
The scenario of a performance appraisal question can take many forms.

pg. 198
Interpretation of Financial Statements SBR Revision Notes

Vertical or trend analysis

A company's performance may be compared to its previous period's performance. Past results may be adjusted for
the effects of price changes. This is referred to as trend or vertical analysis. A weakness of this type of comparison is
that there are no independent benchmarks to determine whether the chosen company's current year results are
good or bad. Just because a company's results are better than its results in the previous financial period - it does not
mean the results are good. It may be that its results in the prior year were particularly poor.

Horizontal analysis
To try to overcome the problem of vertical analysis, it is common to compare a company's performance for a
particular period with the performance of an equivalent company for the same period. This introduces an
independent yardstick to the comparison. However, it is important to pick a similar sized company that operates in
the same industry. Again, this type of analysis is not without criticism - it may be that the company selected as a
comparator may have performed particularly well or particularly poorly.

Industry average comparison

This type of analysis compares a company's results (ratios) to a compilation of the average of many other similar
types of company. Such schemes are often operated on a subscription basis whereby subscribing companies
calculate specified ratios and submit them to the scheme. In return they receive the average of the same ratios from
all equivalent companies in the scheme. This has the advantage of anonymity and avoids the bias of selecting a single
company.

The context of the analysis needs to be kept in mind. A student may be asked to compare two companies as a basis
for selecting one (presumably the better performing one) for an acquisition. Alternatively, a shareholder may be
asking for advice on how their investment in a company has performed. A bank may be considering offering a loan
to a company and requires advice. It may be that the chief executive asks for the chief accountant’s opinion on your
company's results

WHAT IS THE OBJECTIVE OF FINANCIAL STATEMENTS?

To provide information about the financial position, performance and financial adaptability of an enterprise that is
useful to a wide range of users for assessing the stewardship of management and for making economic decisions

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Interpretation of Financial Statements SBR Revision Notes

PROVIDE USEFUL INFORMATION ON

Financial Performance Financial

Position adaptability

Statement of  Statement of profit or Statement of Resources, solvency &

Financial Position loss Financial Position financial structure

 Statement of Statement of Performance &

Changes in equity profit or loss Distributions

 Statement of Cash flows Statement of Realised gains/losses

changes in equity & unrealized gains
losses (reserve
movements)
Cash flows Amounts of cash flow
statement Timings of cash flow
Quality of profits
Who are these users and what information do they want?

Shareholders (investment decisions) Profit and dividend prospects

Loan creditors (lending decisions) Creditworthiness and liquidity
Employees (safety of employment) Wage bargaining and future prospects
Suppliers (credit decisions) Ability to pay on time and short term liquidity

Note that most users will be interested in what has happened in the past, and what may happen in the future!

pg. 200
Interpretation of Financial Statements SBR Revision Notes

OVERVIEW

DIVISION OF RATIOS

PERFORMANCE LIQUIDITY EFFICIENCY STOCK MARKET

ROCE%  SHORT Inventory t/o in days ROE%

TERM
Profit margin% Current ratio Debtors t/o in days EPS
Creditors t/o in days Dividend yield%
Gross profit% Acid-test ratio

Net profit%  LONG TERM Asset turnover

Gearing Dividend cover

Interest cover

Calculating a ratio is easy, and usually is little more than dividing one number by another. Indeed, the calculations
are so basic that they can be programmed into a spreadsheet. The real skill comes in interpreting the results and
using that information. Saying

That a ratio has increased because the top line in the calculation has increased (or the bottom line decreased) is
rather pointless: this is simply translating the calculation into words. Use the mnemonic RATIO to remind yourself
to keep asking the following questions:

¤ Reason – why has this change occurred?

¤ Accident – is the change real or simply an accident of timing?
¤ Test – what can be done to test our conclusions? What other work should we do?
¤ Implications – what does this change mean? Liquidity crisis? Poor management etc?
¤ Other information – is this consistent with other information?

EXAM TECHNIQUE:
• RATIO ANALYSIS-----------use appendices to show calculations / always show formula used
• COMMENTS (cause) & CONSEQUENCES (effect)
3 steps

- The gearing ratio has moved from......}

- The gearing ratio measures.................} What is the overall picture?

- The move may be due to................}

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Interpretation of Financial Statements SBR Revision Notes

STYLE OF REPORT

FORMAT STRUCTURE BE CONCISE

Formal: External Use sub-headings: Keep it simply and short

Introduction Avoid
Informal: Internal Separate paragraphs
Conclusion

INTERPRETATION OF RATIOS
Ratios can generally be broken down into several key areas: profitability, liquidity, gearing and investment.

PROFITABILITY
Profitability ratios, as their name suggests, measure the organisation’s ability to deliver profits. Profit is necessary to
give investors the return they require, and to provide funds for reinvestment in the business. Three ratios are
commonly used.

Return on capital employed (ROCE)

Profit before interest and tax
Shareholders' equity + debt
This ratio is generally considered to be the primary profitability ratio as it shows how well a business has generated
profit from its long term financing. An increase in ROCE is generally considered to be an improvement.

So, Return on capital employed (sometimes known as return on investment or ROI) measures the return that is being
earned on the capital invested in the business. It measures how efficiently and effectively management has
deployed the resources available to it, irrespective of how those resources have been financed.

Candidates are sometimes confused about which profit and capital figures to use. What is important is to compare
like with like. Operating profit (profit before interest) represents the profit available to pay interest to debt investors
and dividends to shareholders. It is therefore compared with the long-term debt and equity capital invested in the
business (non current liabilities + total equity). By similar logic, if we wished to calculate return on ordinary
shareholders funds (the return to equity holders), we would use profit after interest and tax divided by total equity).
A return on capital is necessary to reward investors for the risks they are taking by investing in the company. As
mentioned earlier, generally, the higher the ROCE figure, the better it is for investors. It should be compared with
returns on offer to investors on alternative investments of a similar risk.

Movements in return on capital employed are best interpreted by examining profit margins and asset turnover in
more detail (often referred to as the secondary ratios) as ROCE is made up of these component parts. For example,
an improvement in ROCE could be due to an improvement in margins or more efficient use of assets.

Asset turnover
Revenue
Total assets - current liabilities

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Interpretation of Financial Statements SBR Revision Notes

Asset turnover shows how efficiently management have utilised assets to generate revenue. When looking at the
components of the ratio a change will be linked to either a movement in revenue, a movement in net assets, or both.
There are many factors that could both improve and deteriorate asset turnover. For example, a significant increase
in sales revenue would contribute to an increase in asset turnover or, if the business enters into a sale and lease
back agreement, then the asset base would become smaller, thus improving the result.

In other words, this ratio measures the ability of the organisation to generate sales from its capital employed. A
possible variant is non-current asset turnover (revenue ÷ non-current assets). Generally the higher the better, but
in later studies you will consider the problems caused by overtrading (operating a business at a level not sustainable
by its capital employed). Commonly a high asset turnover is accompanied with a low return on sales and vice versa.
Retailers generally have high asset turnovers accompanied by low margins: Jack Cohen, the founder of Tesco,
famously used the motto ’Pile it high and sell it cheap’!

Profit margins
Gross profit
Revenue

The gross profit margin looks at the performance of the business at the direct trading level. Typically variations in
this ratio are as a result of changes in the selling price/sales volume or changes in cost of sales. For example, cost of
sales may include inventory write downs that may have occurred during the period due to damage or obsolescence,
exchange rate fluctuations or import duties.

Gross margin on the other hand focuses on the organisation’s trading activities. Once again, in simple terms, the
higher the better, with poor performance often being explained by prices being too low or costs being too high.

Changes in the gross profit percentage ratio can be caused by a number of factors. For example, a decrease may
indicate greater competition in the market and therefore lower selling prices and a lower gross profit or,
alternatively, an increase in the cost of purchases. An increase in the gross profit percentage may indicate that the
company is in a position to exploit the market and charge higher prices for its products or that it is able to source its
purchases at a lower cost.

Operating profit
Revenue

The operating profit margin (or net profit margin) is generally calculated by comparing the profit before interest and
tax of a business to revenue, but, beware in the exam as sometimes the examiner specifically requests the calculation
to include profit before tax.

Analysing the operating profit margin enables you to determine how well the business has managed to control its
indirect costs during the period. In the exam when interpreting operating profit margin it is advisable to link the
result back to the gross profit margin. For example, if gross profit margin deteriorated in the year then it would be
expected that operating margin would also fall.

However, if this is not the case, or the fall is not so severe, it may be due to good indirect cost control or perhaps
there could be a one-off profit on disposal distorting the operating profit figure.

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Interpretation of Financial Statements SBR Revision Notes

The relationship between the gross and the net profit percentage gives an indication of how well a company is
managing its business expenses. If the net profit percentage has decreased over time while the gross profit
percentage has remained the same, this might indicate a lack of internal control over expenses.

LIQUIDITY
This measures the ability of the organisation to meet its short-term financial obligations. Liquidity refers to the
amount of cash a company can generate quickly to settle its debts. A reasonable level of liquidity is essential to the
survival of a company, as poor cash control is one of the main reasons for business failure.

The two commonly used ratios are Current ratio and Quick ratio.

Current ratio
Current assets
Current liabilities

The current ratio compares liabilities that fall due within the year with cash balances, and assets that should turn
into cash within the year. It assesses the company’s ability to meet its short-term liabilities. The current ratio
considers how well a business can cover the current liabilities with its current assets.

Therefore, this ratio compares a company’s liquid assets (ie cash and those assets held which will soon be turned
into cash) with short-term liabilities (payables/creditors due within one year). The higher the ratio the more liquid
the company. As liquidity is vital, a higher current ratio is normally preferred to a lower one.

Traditionally textbooks tell us that this ratio should exceed 2.0:1 for a company to be able to safely meet its current
liabilities should they fall due. However this ideal will vary from industry to industry. For example, a business in the
service industry would have little or no inventory and therefore could have a current ratio of less than 1. This does
not necessarily mean that it has liquidity problems so it is better to compare the result to previous years or industry
averages. Many companies operate safely at below the 2:1 level.

A current ratio of less than one is often considered alarming as there might be going concern worries, but you have
to look at the type of business before drawing conclusions. In a supermarket business, inventory will probably turn
into cash in a stable and predictable manner, so there will always be a supply of cash available to pay the liabilities.
A very high current ratio is not necessarily good. It could indicate that a company is too liquid. Cash is often described
as an ’idle asset‘ because it earns no return, and carrying too much cash is considered wasteful. A high ratio could
also indicate that the company is not making sufficient use of cheap short-term finance and it ratio may suggest that
funds are being tied up in cash or other liquid assets, and may not be earning the highest returns possible.

Quick ratio (sometimes referred to as acid test ratio)

Current assets - inventory
Current liabilities

A stricter test of liquidity is the acid test ratio (also known as the quick ratio) which excludes inventory/stock as a
current asset. This approach can be justified because for many companies inventory/stock cannot be readily
converted into cash. In a period of severe cash shortage, a company may be forced to sell its inventory/stock at a
discount to ensure sales.

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Interpretation of Financial Statements SBR Revision Notes

The quick ratio excludes inventory as it takes longer to turn into cash and therefore places emphasis on the business's
'quick assets' and whether or not these are sufficient to cover the current liabilities. Here the ideal ratio is thought
to be 1:1 but as with the current ratio, this will vary depending on the industry in which the business operates.

When assessing both the current and the quick ratios, look at the information provided within the question to
consider whether or not the company is overdrawn at the year-end. The overdraft is an additional factor indicating
potential liquidity problems and this form of finance is both expensive (higher rates of interest) and risky (repayable
on demand).

In practice a company’s current ratio and acid test should be considered alongside the company’s operating
cashflow. A healthy cashflow will often compensate for weak liquidity ratios.

Caution should always be exercised when trying to draw definite conclusions on the liquidity of a company, as both
the current ratio and the acid test ratio use figures from the Statement of financial position. The Statement of
financial position is only a ‘snapshot’ of the financial position at the end of a specific period. It is possible that the
Statement of financial position figures are not representative of the liquidity position during the year. This may be
due to exceptional factors, or simply because the business is seasonal in nature and the Statement of financial
position figures represent the cash position at just one particular point in the cycle.

Receivables collection period (in days)

Receivables x 365
Credit sales

The receivables/debtors collection period (in days or months) provides an indication of how successful (or efficient)
the debt collection process has been. For liquidity purposes the faster money is collected the better. Therefore, it is
preferable to have a short credit period for receivables as this will aid a business's cash flow. However, some
businesses base their strategy on long credit periods. When too high, it may be that some irrecoverable (bad) debts
have not been provided for, or an indication of worsening credit control. It may also be deliberate, e.g. the company
has decided to offer three-months' credit in the current year, instead of two as in previous years. It may do this to
try to stimulate higher sales and be more competitive than similar entities offering shorter credit periods.

If the receivables days are shorter compared to the prior period it could indicate better credit control or potential
settlement discounts being offered to collect cash more quickly whereas an increase in credit periods could indicate
a deterioration in credit control or potential bad debts. However, too much pressure on customers to pay quickly
may damage a company’s ability to generate sales.

Payables collection period (in days)

Payables x 365
Credit purchases*

*(or use cost of sales if purchases figure is not available)

Payable days measures the average amount of time taken to pay suppliers. Because the purchases figure is often
not available to analysts external to the business, the cost of sales figure is often used to approximate purchases.

pg. 205
Interpretation of Financial Statements SBR Revision Notes

An increase in payables days could indicate that a business is having cash flow difficulties and is therefore delaying
payments using suppliers as a free source of finance. If the payables’ period is too long, it may be an indication of
poor liquidity (perhaps at the overdraft limit), and there may be a danger of further or renewed credit being refused
by suppliers. It is important that a business pays within the agreed credit period to avoid conflict with suppliers. If
the payables days are reducing this indicates suppliers are being paid more quickly. This could be due to credit terms
being tightened or taking advantage of early settlement discounts being offered.

Inventory days
Closing (or average) inventory x 365
Cost of sales

It measures how long a company carries inventory before it is sold. Therefore, the inventory/stock turnover period
indicates the average number of days that inventory/stock is held for. A company needs to carefully plan and manage
its inventory/stock levels. Ideally, it must avoid tying up too much capital in inventory/stock, yet the inventory/stock
levels must always be sufficient to meet customer demand.

Generally the lower the number of days that inventory is held the better as holding inventory for long periods of
time constrains cash flow and increases the risk associated with holding the inventory. The longer inventory is held
the greater the risk that it could be subject to theft, damage or obsolescence. However, a business should always
ensure that there is sufficient inventory to meet the demand of its customers. Too little inventory can result in
production stoppages and dissatisfied customers.

If the holding period is long, it may be an indication of obsolete stock or poor sales achievement. Sales may have
fallen (perhaps due to an economic recession), but the company has been slow to cut back on production, or an
unnecessary build up of inventory levels.

A change in the inventory/stock turnover period can be a useful indicator of how well a company is doing. Inventory
turnover can also be calculated using the following formula. It shows the above inventory days in terms of inventory
turnover times.

Inventory turnover:
Cost of sales____________
(Average or closing) inventory

Liquidity problems may also be caused by 'overtrading'. In some ways this is a symptom of the success of the
business. It is usually a lack of adequate financing and may be solved by an injection of capital.

GEARING/ CAPITAL GEARING

Company directors often spend a great deal of time and money to make this ratio appear in line with acceptable
levels.

Current and potential investors will be interested in a company’s financing arrangements. The extent to which a
company is financed by outside parties is referred to as gearing. The level of gearing in a company is an important
factor in assessing risk. A company that has borrowed money obviously has a commitment to pay future interest
charges and make capital repayments. This can be a financial burden and possibly increase the risk of insolvency.
Most companies will be geared to some extent.

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Interpretation of Financial Statements SBR Revision Notes

The gearing ratio measures the company’s commitments to its long-term lenders against the long-term capital in
the company. The level of gearing will be influenced by a number of factors, for example the attitude of the owners
and managers to risk, the availability of equity funds, and the type of industry in which the company operates.

Its main importance is that as borrowings rise, risk increases (in many ways) and as such, further borrowing is difficult
and expensive. Many companies have limits to the amount of borrowings they are permitted to have. These may be
in the form of debt covenants imposed by lenders or they may be contained in a company's Articles, such as a
multiple of shareholders funds.

Measures of gearing
Gearing is basically a comparison of debt to equity. Preference shares are usually treated as debt for this purpose.

There are two alternatives:

Debt or Debt
Equity Debt + equity

Also known as leverage. Capital gearing looks at the proportions of owner’s capital and borrowed capital used to
finance the business. Many different definitions exist; the two most commonly used ones are given above. When
necessary in the exam, you will be told which definition to use.

A large proportion of borrowed capital is risky as interest and capital repayments are legal obligations and must be
met if the company is to avoid insolvency. The payment of an annual equity dividend on the other hand is not a legal
obligation. Despite its risks, borrowed capital is attractive to companies as lenders accept a lower rate of return
than equity investors due to their secured positions. Also interest payments, unlike equity dividends, are corporation
tax deductible.

Levels of capital gearing vary enormously between industries. Companies requiring high investment in tangible
assets are commonly highly geared. Consequently, it is difficult to generalise about when capital gearing is too high.
However, most accountants would agree that gearing is too high when the proportion of debt exceeds the
proportion of equity.

The gearing ratio is of particular importance to a business as it indicates how risky a business is perceived to be based
on its level of borrowing. As borrowing increases so does the risk as the business is now liable to not only repay the
debt but meet any interest commitments under it. In addition, to raise further debt finance could potentially be
more difficult and more expensive.

If a company has a high level of gearing it does not necessarily mean that it will face difficulties as a result of this.
For example, if the business has a high level of security in the form of tangible non-current assets and can
comfortably cover its interest payments () a high level of gearing should not give an investor cause for concern.

Interest cover
Interest cover = Profit before interest and tax
Interest

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Interpretation of Financial Statements SBR Revision Notes

This is sometimes known as income gearing. It looks at how many times a company’s operating profits exceed its
interest payable. The higher the figure, the more likely a company is to be able to meet its interest payments.
Anything in excess of four is usually considered to be safe.

As mentioned above, the interest cover ratio measures the amount of profit available to cover the interest payable
by the company. The lower the level of interest cover the greater the risk to lenders that interest payments will not
be met. If interest payments and capital repayments are not paid when they fall due there can be serious
consequences for a company. In the event of a default, a lender may have the right to seize the assets on which the
loan is secured and sell them to repay the amount outstanding. Where lenders do not have security on their loan,
they could still apply to the courts for the winding up of a company so that assets can be liquidated and debts repaid.

INVESTMENT RATIOS
Earnings per share
Profit after tax and preference dividends
Number of equity shares in issue

The earnings per share ratio of a company represents the relationship between the earnings made during an
accounting period (and available to shareholders) and the number of shares issued. For ordinary shareholders, the
amount available will be represented by the net profit after tax (less any preference dividend where applicable).

Many investment analysts regard the earnings per share ratio as a fundamental measure of a company’s
performance. The trend in earnings per share over time is used to help assess the investment potential of a
company’s shares. However, an attempt should be made to take into account the effect of a company increasing its
retained earnings. Most companies retain a significant proportion of the funds they generate, and hence their
earnings per share will increase even if there is no increase in profitability.

In isolation, this ratio is meaningless for inter-company comparisons. Its major usefulness is as part of the P/E ratio,
and as a measure of profit trends.

Price/earnings ratio
Market price of equity share
EPS

This is calculated by dividing a company's market price by its EPS. Say the price of a company's shares is $2.40, and
its last reported EPS was 20c. It would have a P/E ratio of 12. The mechanics of the movement of a company's P/E
ratio are complex, but if this company's EPS improved to 24c in the following year, it would not mean that its P/E
ratio would be calculated as 10 ($2.40/24c). It is more likely that its share price would increase such that it
maintained or even improved its P/E ratio. If the share price increased to say $2.88, the P/E ratio would remain at
12 ($2.88/24c). This demonstrates the real importance of EPS in the way it has a major influence on a company's
share price.

The price earnings ratio compares the benefits derived from owning a share with the cost of purchasing such a share.
It provides a clear indication of the value placed by the capital market on those earnings and what it is prepared to
pay for participation. It reflects the capital market assessment of both the amount and the risk of these earnings,
albeit subject to overall market and economic considerations.

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Interpretation of Financial Statements SBR Revision Notes

Earning yield
________EPS____________
Market price per equity share

This is a relatively 'old' ratio which has been superseded by the P/E ratio. It is in fact its reciprocal. Earnings yield is
the EPS/share price x 100. In the above example, a P/E ratio of 12 would be equivalent to an earnings yield of 8.3%.

Dividend yield
Ordinary dividends appropriated in period
Market price of equity shares

This is similar to the above except that the dividend per share is substituted for the EPS. It is a crude measure of the
return to shareholders, but it does ignore capital growth which is often much higher than the return for dividends.
The dividend yield compares the amount of dividend per share with the market price of a share, and provides a
direct measure of the return on investment in the shares of a company. Investors are able to use this ratio to assess
the relative merits of different investment opportunities.

Dividend cover
Profit after tax and preference dividends
Ordinary dividends appropriated in period

This is the number of times the current year's dividend could have paid out of the current year's profit available to
ordinary shareholders. It is a measure of security. A high figure indicates high levels of security. In other words,
profits in future years could fall substantially and the company would still be able to pay the current level of
dividends. An alternative view of a high dividend cover is that it indicates that the company operates a low dividend
distribution policy.

The dividend cover ratio focuses on the security of the current rates of dividends, and therefore provides a measure
of the likelihood that those dividends will be maintained in the future. It does this by measuring the proportion
represented by current rates of dividends of the profits from which such dividends can be declared without drawing
on retained earnings. The higher the ratio, the more profits can decline without dividends being affected.

LIMITATIONS OF RATIO ANALYSIS

1. It is an oversimplification of a harsh business world
2. Ratios are based on highly subjective accounting figures
3. Historical cost accounts do not take into account the impact of inflation
4. Ratios do not make allowances for external factors: economic or political
5. Users are more interested in future prospects rather than past events

Specific problems in SBR Exam

When marking this style of question there are some common weaknesses that are identified by examiner, some of
which are highlighted below:
 Limited knowledge of ratio calculations
 Appraisal not linked to scenario
 Poor understanding of the topic
 Limited understanding of what accounting information represents

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Interpretation of Financial Statements SBR Revision Notes

 Lack of commercial awareness

 Discursive elements often not attempted
 Inability to come to a conclusion
 Poor English.

The majority of questions that feature performance appraisal have an accompanying scenario to the question
requirement. A weak answer will make no attempt to refer to this information in the appraisal and, therefore, will
often score few marks. It is important that you carefully consider this information and incorporate it into your
appraisal because it has been provided for a reason. Do not simply list all the possibilities of why a ratio may have
changed; link the reason to the scenario that you have been provided with.

Exam approach
In an exam there is a (time) limit to the amount of ratios that may be calculated. A structured approach is useful
where the question does not specify which ratios to calculate:
 Limit calculations to important areas and avoid duplication (eg inventory turnover and inventory holding
periods)
 It is important to come to conclusions, as previously noted, candidates often get carried away with the ratio
calculations and fail to comment on them
 Often there are some 'obvious' conclusions that must be made (eg liquidity has deteriorated dramatically, or a
large amount of additional non-current assets have been purchased without a proportionate increase in sales).

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Additional/Alternative Performance Measures SBR Revision Notes

ADDITIONAL/ALTERNATIVE PERFORMANCE MEASURES

Introduction
Many jurisdictions have enforced a standard format for performance reporting, with no additional analysis
permitted on the face of the Statement of Profit or Loss. Others have allowed entities to adopt various methods of
conveying the nature of ‘underlying’ or ‘sustainable’ earnings.

Although financial statements are prepared in accordance with applicable financial reporting standards, users are
demanding more information and issuers seem willing to give users their understanding of the financial information.
This information varies from the disclosure of additional key performance indicators of the business to providing
more information on individual items within the financial statements. These additional performance measures
(APMs) can assist users in making investment decisions, but they do have limitations.

What is an APM?
APMs are also known as non-GAAP financial measures and non-financial KPIs. They cover a broad range of areas that
can be relevant to the performance of a company.

Common practice
It is common practice for entities to present APMs, such as normalised profit, earnings before interest and tax (EBIT)
and earnings before interest, tax, depreciation and amortisation (EBITDA). These alternative profit figures can
appear in various communications, including company media releases and analyst briefings. Alternative profit
calculations normally exclude particular income and expense items from the profit figure reported in the financial
statements. Also, there could be the exclusion of income or expenses that are considered irrelevant from the
viewpoint of the impact on this year’s performance or when considering the expected impact on future performance.
An example of the latter has been gains or losses from changes in the fair value of financial instruments. The
exclusion of interest and tax helps to distinguish between the results of the entity’s operations and the impact of
financing and taxation.

These APMs can help enhance users’ understanding of the company’s results and can be important in assisting users
in making investment decisions, as they allow them to gain a better understanding of an entity’s financial statements
and evaluate the entity through the eyes of the management. They can also be an important instrument for easier
comparison of entities in the same sector, market or economic area.

However, they can be misleading due to bias in calculation, inconsistency in the basis of calculation from year to
year, inaccurate classification of items and, as a result, a lack of transparency. Often there is little information
provided on how the alternative profit figure has been calculated or how it reconciles with the profit reported in the
financial statements.

The APMs are also often described in terms which are neither defined by issuers nor included in professional
literature and thus cannot be easily recognised by users.
APMs include:
 All measures of financial performance not specifically defined by the applicable financial reporting framework
 All measures designed to illustrate the physical performance of the activity of an issuer’s business
 All measures disclosed to fulfil other disclosure requirements included in public documents containing regulated
information.

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Additional/Alternative Performance Measures SBR Revision Notes

An example demonstrating the use of APMs is the financial statements of Telecom Italia Group for the year ended
31 December 2011. These contained a variety of APMs as well as the conventional financial performance measures
laid down by IFRS® Standards. The non-IFRS APMs used in the Telecom Italia statements were:

EBITDA.
Used by Telecom Italia as the financial target in its internal presentations (business plans) and in its external
presentations (to analysts and investors). The entity regarded EBITDA as a useful unit of measurement for evaluating
the operating performance of the group and the parent.

Organic change in revenues,

EBITDA and EBIT. These measures express changes in revenues, EBITDA and EBIT, excluding the effects of the change
in the scope of consolidation, exchange differences and non-organic components constituted by non-recurring items
and other non-organic income and expenses. The organic change in revenues, EBITDA and EBIT is also used in
presentations to analysts and investors.

Net financial debt.

Telecom Italia saw net financial debt as an accurate indicator of its ability to meet its financial obligations. It is
represented by gross financial debt less cash and cash equivalents and other financial assets. The report on
operations includes two tables showing the amounts taken from the statement of financial position and used to
calculate the net financial debt of the group and parent.

Adjusted net financial debt.

A new measure introduced by Telecom Italia to exclude effects that are purely accounting in nature resulting from
the fair value measurement of derivatives and related financial assets and liabilities.

Examples of financial APMs that are commonly used in company reporting include:
 Earnings before interest, taxes, depreciation and amortization (EBITDA)
 Earnings before interest and tax (EBIT)
 Adjusted earnings
 Free cash flow
 Debt ratio
 Return on capital employed (ROCE)
 Order intake and backlog

Examples of non-financial APMs that are commonly used in company reporting include:
 Production metrics
 Sales metrics
 Reserves
 Injury frequency tables
 Total water or energy consumed
 Workforce
 Cost savings
 Greenhouse gas emissions

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Additional/Alternative Performance Measures SBR Revision Notes

Advantages and disadvantages of reporting on APMs

Audit committees should be aware that, while there are many advantages to reporting on APMs, there are also some
significant disadvantages. Understanding both is the key to ascertaining the quality of their companies’ reporting.

Advantages of reporting on APMs:

 Offer valuable insight to analysts and investors — together with GAAP measures, APMs can provide a holistic
view of the company and lessen the likelihood of share price volatility.
 Highlight key value drivers — APMs are a way for management to highlight the key value drivers within the
business that may not be obvious in the financial statements. For example, organic company growth or
heightened product demand.
 Provide a useful comparison — analysts and investors can find APMs a useful means to compare and contrast
the prospects of different companies within the same sector.
 Set benchmark for corporate reporting — APMs can provide a useful link between financial results and non-
financial performance, setting the scene for broader and more relevant integrated reporting.

Disadvantages of reporting on APMs:

 Lack of comparability between peers — if the company does not report on similar APMs to its peers, the work
of analysts and investors becomes more difficult, possibly to the detriment of the company’s share price.
 Risk of management bias — management may report on measures that lead to favorable results. APM reporting
is then being used as a marketing tool, rather than as a means of improving transparency.
 Risk of disqualifying the financial statements — if APM reporting is not reconciled to the GAAP reporting, they
might contradict each other, rendering the financial statements meaningless.
 Risk of share price volatility — market participants sometimes pay more attention to APMs than to GAAP
measures. This increases the risk of share price volatility if management predictions are not met.
 Lack of external verification — since the data is not subject to the statutory audit process, it could be inaccurate
and give a misleading impression of the company.

Evaluating the aims

The International Accounting Standards Board (IASB) is undertaking an initiative to explore how disclosures in IFRS
financial reporting can be improved. The project has started to look at possible ways to address the issues arising
from the use of APMs. This initiative is made up of a number of projects. It will consider such things as adding an
explanation in IAS® 1 that too much detail can obscure useful information and adding more explanations, with
examples, of how IAS 1 requirements are designed to shape financial statements instead of specifying precise terms
that must be used. This includes whether subtotals of IFRS numbers such as EBIT and EBITDA should be
acknowledged in IAS 1.

In the UK, the Financial Reporting Council supports the inclusion of APMs when users are provided with additional
useful, relevant information. In contrast, the Australian Financial Reporting Council feels that such measures are
outside the scope of the financial statements. In 2012, the Financial Markets Authority (FMA) in the UK issued a
guidance note on disclosing APMs and other types of non-GAAP financial information, such as underlying profits,
EBIT and EBITDA.

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Additional/Alternative Performance Measures SBR Revision Notes

APMs appear to be used by some issuers to present a confusing or optimistic picture of their performance by
removing negative aspects. There seems to be a strong demand for guidance in this area, but there needs to be a
balance between providing enough flexibility, while ensuring users have the necessary information to judge the
usefulness of the APMs.

To this end, the European Securities and Markets Authority (ESMA) has launched a consultation on APMs. The aim
is to improve the transparency and comparability of financial information while reducing information asymmetry
among the users of financial statements. ESMA also wishes to improve coherency in APM use and presentation and
restore confidence in the accuracy and usefulness of financial information.

ESMA has therefore developed draft guidelines that address the concept and description of APMs, guidance for the
presentation of APMs and consistency in using APMs. The main requirements are:
 Issuers should define the APM used, the basis of calculation and give it a meaningful label and context.
 APMs should be reconciled to the financial statements.
 APMs that are presented outside financial statements should be displayed with less prominence.
 An issuer should provide comparatives for APMs and the definition and calculation of the APM should be
consistent over time.
 If an APM ceases to be used, the issuer should explain its removal and the reasons for the newly defined APM.

However, these guidelines may not be practicable when the cost of providing this information outweighs the benefit
obtained or the information provided may not be useful to users. Issuers will most likely incur both implementation
costs and ongoing costs. Most of the information required by the guidelines is already collected for internal
management purposes, but may not be in the format needed to satisfy the disclosure principles.

ESMA believes that the costs will not be significant because APMs should generally not change over periods.
Therefore, ongoing costs will relate almost exclusively to updating information for every reporting period. ESMA
believes that the application of these guidelines will improve the understandability, relevance and comparability of
APMs.

Application of the guidelines will enable users to understand the adjustments made by management to figures
presented in the financial statements. ESMA believes that this information will help users to make better-grounded
projections and estimates of future cashflows and assist in equity analysis and valuations. The information provided
by issuers in complying with these guidelines will increase the level of disclosures, but should lead issuers to provide
more qualitative information. The national competent authorities will have to implement these guidelines as part of
their supervisory activities and provide a framework against which they can require issuers to provide information
about APMs.

SBR Exam
 Section B will mostly have and Analysis and Interpretation question
 Students have to analyse financial statements and APMs
 There can be specific and generic questions. Specific questions will provide APMs used by companies and ask to
analyse them. General questions will ask advantages, disadvantages, impacts etc. of overall APMs
 Students have to appraise the APMs – identify whether they are good or bad.
 In the next step, students have to discuss the rationale – arguments for and against every APM under
consideration

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Additional/Alternative Performance Measures SBR Revision Notes

 Discuss what are the APMs telling about the organisation

 Discuss what is included in each APM and which items have been excluded.
 Discuss the stakeholder impact – what information provided by APM.
 Students have to see the requirement and link the answer to the scenario

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Small & Medium Sized Entities SBR Revision Notes

SMALL AND MEDIUM SIZED ENTITIES (SMES)

REPORTING REQUIREMENTS OF SMES

International accounting standards are written to meet the needs of investors in international capital markets. Most
companies adopting IFRS are large listed entities. The IASB has not stated that IFRSs only aimed at quoted companies,
but certainly the majority of adopters are large entities. In many countries IFRSs are used as national GAAP which
means that unquoted small and medium-sized entities (SMEs) have to apply them.

A SME is often owned and managed by a small number of entrepreneurs, and may be a family-owned and family-
run business. Large companies, in contrast, are run by professional boards of directors, who must be held
accountable to their shareholders.

Some commentators suggest that SMEs and public entities should be allowed to use simplified or differing standards
as the nature of their business is different from large quoted entities.

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.

Approaches/Options for IASB in Developing IFRS for SMEs

There were several approaches, which could have been taken in developing standards for SMEs.
 One course of action would have been for GAAP for SMEs to be developed on a national basis, with IFRS focusing
on accounting for listed company activities. The main issue would have been that the practices developed for
SMEs may not have been consistent and may have lacked comparability across national boundaries.
Additionally, if a SME had wished to list its shares on a capital market, the transition to IFRS would have been
more difficult.
 Another approach would have been to detail the exemptions given to smaller entities in the mainstream IFRS.
In this case, an appendix would have been included within the standard detailing the exemptions given to
smaller enterprises.
 A third approach would have been to introduce a separate set of standards comprising all the issues addressed
in IFRS, which are relevant to SMEs.

Issuance of IFRS for SMEs

In July 2009, the International Accounting Standards Board (IASB) issued the IFRS for Small and Medium-sized Entities
(IFRS for SMEs). This standard provides an alternative framework that can be applied by eligible entities in place of
the full set of International Financial Reporting Standards (IFRSs).

The IFRS for SMEs is a self-contained standard, incorporating accounting principles based on existing IFRSs which
have been simplified to suit the entities that fall within its scope.

The Standard is organised by topic with the intention that the standard would be helpful to preparers and users of
SME financial statements. The IFRS for SMEs and full IFRSs are separate and distinct frameworks. Entities that are
eligible to apply the IFRS for SMEs, and that choose to do so, must apply that Standard in full and cannot choose the
most suitable accounting policy from full IFRS or IFRS for SMEs.

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Small & Medium Sized Entities SBR Revision Notes

Due to big differences between SMEs and large quoted companies, it is not clear whether there is any reason why
SMEs should comply with IFRSs. There are arguments in favour of using SMEs, and arguments against.

Arguments against the use of IFRSs by SMEs

There are several reasons why SMEs should not adopt IFRSs for the preparation of their financial statements.
 Some IFRSs deal with subjects that are of little or no relevance to SMEs, such as accounting standards on
consolidation, associates, joint ventures, deferred tax, construction contracts and standards that deal with
complex issues of fair value measurement.
 The costs of complying with IFRSs can be high. For SMEs, the cost is proportionately much higher, and it is
doubtful whether the benefits of complying with IFRSs would justify the costs.
 There are not many users of financial statements of SMEs, and they use the financial statements for a smaller
range of decisions, compared to investors in international capital markets. So would it be a waste of time (as
well as cost) to comply with IFRSs?

Arguments in Favour of the use of IFRSs by SMEs

There are also reasons why SMEs should adopt IFRSs for the preparation of their financial statements.
 If SMEs use different accounting rules and requirements to prepare their financial statements, there will be a
‘two-tier’ system of accounting. This could make it difficult to compare results of larger and smaller companies,
should the need arise. Confidence in the quality of financial reporting might be affected adversely.
 If SMEs prepared financial statements in accordance with their national GAAP, it will be impossible to compare
financial statements of companies in different countries. If SMEs grow in size and eventually obtain a stock
market quotation, they will have some difficulty in the transition from national GAAP to IFRSs.
 It has also been argued that full statutory accounts for SMEs would be in the public interest, and might help to
protect other stakeholders in the company (such as suppliers, customers, lenders and employees).

IFRS for SMEs

The IFRS for SMEs is designed to facilitate financial reporting by small and medium-sized entities in a number of
ways:
(a) It provides significantly less guidance than full IFRS.
(b) Many of the principles for recognising and measuring assets, liabilities, income and expenses in full IFRSs are
simplified.
(c) Where full IFRSs allow accounting policy choices, the IFRS for SMEs allows only the easier option.
(d) Topics not relevant to SMEs are omitted.
(e) Significantly fewer disclosures are required.
(f) The standard has been written in clear language that can easily be translated

Scope
The IFRS is suitable for all entities except those whose securities are publicly traded and financial institutions such
as banks and insurance companies. Although it has been prepared on a similar basis to IFRS, it is a stand-alone
product and will be updated on its own timescale.

There are no quantitative thresholds for qualification as a SME; instead, the scope of the IFRS is determined by a
test of public accountability.

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Small & Medium Sized Entities SBR Revision Notes

Effective date
In May 2015, the IASB completed its first comprehensive review of IFRS for SMEs and issued limited amendments;
these are effective on 1 January 2017 with early application permitted.

The IFRS will be revised only once every three years. It is hoped that this will further reduce the reporting burden
for SMEs.

DEFINITIONS
Small and medium-sized entities are entities that:
 Do not have public accountability, and
 Publish general purpose financial statements for external users. Examples of internal users include owners who
are not involved in managing the business, existing and potential creditors, and credit rating agencies. General
purpose financial statements are those that present fairly financial position, operating results, and cash flows
for external capital providers and others.

An entity has public accountability if:

 Its debt or equity instruments are traded in a public market or it is in the process of issuing such instruments; or
 It holds assets in a fiduciary capacity for a broad group of outsiders as one of its primary businesses (e.g. banks,
mutual fund, securities brokers/dealers and insurance companies).

The standard does not contain a limit on the size of an entity that may use the IFRS for SMEs provided that it does
not have public accountability. Nor is there a restriction on its use by a public utility, not-for-profit entity, or public
sector entity. A subsidiary whose parent or group uses full IFRSs may use the IFRS for SMEs if the subsidiary itself
does not have public accountability. The standard does not require any special approval by the owners of an SME
for it to be eligible to use the IFRS for SME. Listed companies, no matter how small, may not use the IFRS for SMEs.

Key Features of the IFRS for SMEs

A complete set of financial statements of an entity reporting under the IFRS for SMEs is similar to that required by
full IFRS and comprises:
 A statement of financial position
 Either a single statement of comprehensive income, or a separate income statement and a separate statement
of comprehensive income
 A statement of changes in equity
 A statement of cash flows
 Notes including a summary of significant accounting policies
 Comparative information

The IFRS for SMEs imposes a lesser burden on SMEs due to:
 Some topics in IFRSs being omitted because they are not relevant to typical SMEs
 The simplification of many of the recognition and measurement requirements available in full IFRSs
 Substantially fewer disclosures

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Small & Medium Sized Entities SBR Revision Notes

Accounting Policies
For situations where the IFRS for SMEs does not provide specific guidance, it provides a hierarchy for determining a
suitable accounting policy. An SME must consider, in descending order:
 The guidance in the IFRS for SMEs on similar and related issues.
 The definitions, recognition criteria and measurement concepts in Section 2 Concepts and Pervasive Principles
of the standard.

Omitted Topics
There are a number of accounting standards and disclosures that may not be relevant for the users of SME financial
statements. As a result the standard does not address the following topics:
 Earnings per share
 Interim accounting
 Segment reporting
 Insurance (because entities that issue insurance contracts are not eligible to use the standard) and
 Assets held for sale

Examples of options in full IFRS not included in the IFRS for SMEs
 Revaluation model for intangible assets
 Choice between cost and fair value models for investment property (measurement depends on the
circumstances)
 Proportionate consolidation for investments in jointly controlled entities
 Options for government grants

SIMPLIFICATIONS
Following are the differences in IFRSs for SMEs from regular Standards. Remaining treatments are significantly same
in both.

Investments in associates and joint ventures

 Can be measured at cost unless there is a published price quotation (Then fair value must be used).
 Jointly controlled entities can be accounted for using the cost model, the equity method or the fair value model
(proportionate consolidation is not allowed)

Investment properties
 Must be measured at fair value (cost model not allowed, unless fair value cannot be measured reliably without
undue cost or effort)
 If fair value cannot be calculated then must be treated as property, plant and equipment

Property, plant and equipment

 Historical cost-depreciation-impairment model or revaluation model
 Residual value, useful life and depreciation need to be reviewed only if there is an indication they may have
changed since the most recent annual reporting date (full IFRSs require an annual review).
 Impairment testing and reversal

Borrowing costs
 All borrowing costs must be recognised as expense when incurred (cannot be capitalised)

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Small & Medium Sized Entities SBR Revision Notes

Intangible assets
 Revaluation not allowed
 Research and development costs must be recognised as expenses (cannot be capitalised)
 Indefinite-life intangibles are amortised over their useful lives, but if useful life cannot be reliably estimated
then use the management’s best estimate but not more than 10 years

Business combinations and Goodwill

 Acquisition (purchase) method used.
 Acquisition costs are capitalized in the cost of investment
 Goodwill is amortised over its useful life (10 years if this can’t be estimated reliably )
 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.

Leases
 Lease classified either as finance lease or operating lease and treated accordingly
 If a sale and leaseback results in a finance lease, the seller should not recognise any excess as a profit, but
recognise the excess over the lease term. If a sale and leaseback results in an operating lease, and the
transaction was at fair value, the seller shall recognise any profits immediately.

Financial instruments
The Government grants
 All grants are measured at the fair value of the asset received or receivable standard eliminates the 'available-
for-sale' and 'held-to maturity' classifications of IAS 39, Financial instruments: recognition and measurement. All
financial instruments are measured at amortised cost using the effective interest method except that
investments in non-convertible and non-puttable ordinary and preference shares that are publicly traded or
whose fair value can otherwise be measured reliably without undue cost or effort are measured at fair value
through profit or loss. All amortised cost instruments must be tested for impairment. At the same time the
standard simplifies the hedge accounting and derecognition requirements. However, SMEs can choose to apply
IAS 39 in full if they so wish.

Defined benefits plans

 The projected unit credit method is only used when it could be applied without undue cost or effort.
 Otherwise, en entity can simplify its calculation:
 Ignore estimated future salary increases
 Ignore future service of current employees (assume closure of plan)
 Ignore possible future in-service mortality
 Plan introductions, changes, curtailments, settlements: Immediate recognition (no deferrals)
 For group plans, consolidated amount may be allocated to parent and subsidiaries on a reasonable basis
 Actuarial gains and losses may be recognised in profit or loss or as an item of other comprehensive
income – but No deferral of actuarial gains or losses, including no corridor approach and all past service
cost is recognised immediately in profit or loss

Financial statements Presentation

In full IFRSs, a statement of changes in equity is required, presenting a reconciliation of equity items between the
beginning and end of the period. Same is the requirement for SMEs. However, if the only changes to the equity

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Small & Medium Sized Entities SBR Revision Notes

during the period are a result of profit 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.

Assets held for sale

 Assets held for sale are not covered in IFRSs for SMEs, the decision to sell an asset is considered an
impairment indicator.

Transition
The standard also contains a section on transition, which allows all of the exemptions in IFRS 1, First-time Adoption
of International Financial Reporting Standards. It also contains 'impracticability' exemptions for comparative
information and the restatement of the opening statement of financial position.

As a result of the above, the IFRS requires SMEs to comply with less than 10% of the volume of accounting
requirements applicable to listed companies complying with the full set of IFRSs.

Application criteria
There is no universally agreed definition of an SME. No single definition can capture all the dimensions of a small or
medium-sized business, or cannot be expected to reflect the differences between firms, sectors, or countries at
different levels of development.

Most definitions based on size use measures such as number of employees, net assets total, or annual turnover.
However, none of these measures apply well across national borders. The IFRS for SMEs is intended for use by
entities that have no public accountability (ie its debt or equity instruments are not publicly traded).

Ultimately, the decision regarding which entities should use the 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 the IFRS for SMEs, it must follow the standard in its entirety - it cannot cherry pick between the requirements of
the IFRS for SMEs and those of full IFRSs.

The International Accounting Standards Board (IASB) makes it clear that the prime users of IFRSs are the capital
markets. This means that IFRSs are primarily designed for quoted companies and not SMEs. The vast majority of the
world's companies are small and privately owned, and it could be argued that IFRSs 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 benefit.

Advantages of the IFRS for SMEs

(a) It is virtually a 'one stop shop'.
(b) It is structured according to topics, which should make it practical to use.
(c) It is written in an accessible style.
(d) There is considerable reduction in disclosure requirements.
(e) Guidance not relevant to private entities is excluded.

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Small & Medium Sized Entities SBR Revision Notes

Disadvantages of the IFRS for SMEs

(a) It does not focus on the smallest companies.
(b) The scope extends to 'non-publicly accountable' entities. Potentially, the scope is too wide.
(c) The standard will be onerous for small companies.

Explanation
The main argument for separate SME accounting standards is the undue cost burden of reporting, which is
proportionately heavier for smaller firms. The cost burden of applying the full set of IFRSs may not be justified on
the basis of user needs. Further, much of the current reporting framework is based on the needs of large business,
so SMEs perceive that the full statutory financial statements are less relevant to the users of SME accounts. SMEs
also use financial statements for a narrower range of decisions, as they have less complex transactions and therefore
less need for a sophisticated analysis of financial statements. Thus, the disclosure requirements in the IFRS for SMEs
are also substantially reduced when compared with those in full IFRSs partly because they are not considered
appropriate for users' needs and for cost-benefit considerations. Many disclosures in full IFRSs are more relevant to
investment decisions in capital markets than to the transactions undertaken by SMEs.

There are arguments against different reporting requirements for SMEs in that it may lead to a two-tier system of
reporting. Entities should not be subject to different rules, which could give rise to different 'true and fair views'.

The IFRS for SMEs is a self-contained set of accounting principles that are based on full IFRSs, but that have been
simplified so that they are suitable for SMEs. The standard has been organised by topic with the intention that the
standard would be user-friendly for preparers and users of SME financial statements.

The IFRS for SMEs and full IFRSs are separate and distinct frameworks. Entities that are eligible to apply the IFRS for
SMEs, and that choose to do so, must apply that standard in full and cannot chose the most suitable accounting
policy from full IFRS or IFRS for SMEs.

However, the standard for SMEs is naturally a modified version of the full standard, and not an independently
developed set of standards. They are based on recognised concepts and pervasive principles and they will allow
easier transition to full IFRS if the SME decides to become a public listed entity. In deciding on the modifications 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. 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. Some disclosure requirements are intended to meet the
needs of listed entities, or to assist users in making forecasts of the future. Users of financial statements of SMEs
often do not make such kinds of forecasts. Small companies pursue different strategies, and their goals are more
likely to be survival and stability rather than growth and profit maximisation.

The stewardship function is often absent in small companies, with the accounts playing an agency role between the
owner-manager and the bank.

Where financial statements are prepared using the standard, the basis of presentation note and the auditor's report
will refer to compliance with the IFRS for SMEs. This reference may improve access to capital. The standard also
contains simplified language and explanations of the standards.

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Small & Medium Sized Entities SBR Revision Notes

In the absence of specific guidance on a particular subject. An SME may, but is not required to, consider the
requirements and guidance in full IFRSs dealing with similar issues. The IASB has produced full implementation
guidance for SMEs.

The 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 businesses that is much simpler than full
IFRSs. The IFRS for SMEs should provide improved comparability for users of accounts while enhancing the overall
confidence in the accounts of SMEs, and reducing the significant costs involved of maintaining standards on a
national basis.

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Specialised not for Profit & Public Sector Entities SBR Revision Notes

SPECIALISED, NOT-FOR-PROFIT AND PUBLIC SECTOR ENTITIES

TYPES OF ENTITY
Most of this study text is about the financial statements of profit-making entities, such as limited liability companies.
Other types of entity also prepare and publish financial statements. These entities include:
 Not-for-profit entities: such as charities, clubs and societies. Each of these organisations is set up for a specific
purpose. For example, a charity might be set up to campaign for the protection of the natural environment or
to help the poor.
 Public sector entities: these include central government bodies; local government bodies; and other
organisations that operate for the benefit of the general public, such as state schools and hospitals. A public
sector entity is owned by the state or by the general public.

Many different types of entity could be described under these headings. These entities are different from limited
liability companies, partnerships and sole traders in one vital respect. They do not primarily exist to make a profit.
In practice, the terms 'specialised entity', 'not-for-profit entity' and 'public benefit entity' are often used
interchangeably.

OBJECTIVES OF SPECIALISED ENTITIES

The main objective of large listed entities is to maximise their profits in order to provide a return to their owners
(investors) in the form of a dividend. This may not be their only objective (for example, they may provide
employment to the local community, or aim to operate in a socially responsible way), but it is their main objective.
The objective of owner managed businesses (small privately owned entities) is also to make a profit.

In contrast, the main objective of a specialised entity is to carry out the activities for which it has been created. Again,
this may not be the only objective, because all entities need some form of income. Many large charities, for example,
carry out trading activities. However, making a profit is not the main aim. In fact, most not-for-profit entities will aim
to break even, rather than to generate a surplus of income over expenditure.

In some public sector entities, performance is measured in terms of whether the entity provides value for money
from the resources it has available. Assessment of performance will look at how well the resources have been used
and it is often done using the 3 E's - economy, effectiveness and efficiency.

Economy means buying goods and services at a cheap price, so that the entity is not paying too much for its input
costs, which could include accommodation, staff and other items.

Efficiency means operating so that inputs are used in the best possible way to provide a maximum output. In the
case of a hospital, it may be making sure that the required service is provided at the lowest cost and wastage is kept
to a minimum.

Effectiveness means that an organisation has met its goals by using the right resources at the right time.

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Specialised not for Profit & Public Sector Entities SBR Revision Notes

Accounting standards and specialised entities

International accounting standards are designed for profit-making entities.

Whether they are relevant to not-for-profit entities will depend on the way in which they have to report and the
information that they have to provide. There is a great deal of variation from organisation to organisation and from
country to country.

In some countries, charities and public sector bodies are required to follow accounting standards specifically
designed for the purpose (in the UK these are called Statements of Recommended Practice.) Alternatively, the form
and content of financial statements and the accounting treatments to be followed may be prescribed by law. IASs
and IFRSs are probably largely irrelevant for these entities.

Some not-for-profit entities may be able to draw up accounts in any form that its members or officers wish. Many
not-for-profit entities prepare accounts on a cash basis, rather than on an accruals basis. Public sector bodies may
also use cash accounting. (This was the case in the UK until fairly recently.) IASs and IFRSs require accruals accounting.
In some countries, public sector bodies and many charities are increasingly expected to apply commercial-style
accounting practices. Even for those entities that are not formally required to adopt them, IASs and IFRSs are a useful
source of information on current best practice.

THE NOT-FOR-PROFIT SECTOR: REGULATORY FRAMEWORK

The IASB and the FASB are working on a framework for reporting, which includes not-for-profit entities.

The International Public Sector Accounting Standards Board (IPSAB) is developing a set of International Public Sector
Accounting Standard based on IFRS.

Regulation of public not-for-profit entities, principally local and national governments and governmental agencies,
is by the International Public Sector Accounting Standards Board (IPSAB), which comes under the International
Federation of Accountants (IFAC).

Statement of Financial Activities

In addition to a statement of financial position, charities also produce a Statement of Financial Activities (SOFA), an
Annual Report to the Charity Commission and sometimes an income and expenditure account. The Statement of
Financial Activities is the primary statement showing the results of the charity's activities for the period.

The SOFA shows Incoming resources, Resources expended, and the resultant Net movement in funds. Under
incoming resources, income from all sources of funds are listed. These can include:

Subscription or membership fees

 Public donations
 Donations from patrons
 Government grants
 Income from sale of goods
 Investment income
 Publication sales
 Royalties

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Specialised not for Profit & Public Sector Entities SBR Revision Notes

The resources expended will show the amount spent directly in furtherance of the Charity's objects. It will also show
items which form part of any statement of profit or loss and other comprehensive income, such as salaries,
depreciation, travelling and entertaining, audit and other professional fees. These items can be very substantial.
Charities, especially the larger charities, now operate very much in the way that profit-making entities do.

They run high-profile campaigns which cost money and they employ professional people who have to be paid. At
the same time, their stakeholders will want to see that most of their donation is not going on running the business,
rather than achieving the aims for which funds were donated.

One of the problems charities experience is that, even although the accruals basis is being applied, they will still have
income and expenditure recognised in different periods, due to the difficulty of correlating them. The extreme
example is a campaign to persuade people to leave money to the charity in their will. The costs will have to be
recognised, but there is no way to predict when the income will arise.

Exam Approach
In the exam, you may be given a scenario involving a not-for-profit entity or public sector entity and asked to advise
on a particular transaction. In many ways your advice should be no different for a not-for-profit entity as for a
commercial profit-making entity, but you will need to be aware of the context of the question and the fact that the
objectives of a not for profit entity differ from a standard trading entity.

Users of the financial statements of a not-for-profit entity are almost always interested in the way that the entity
manages and uses its resources.

For example:
 A charity may be managed by trustees on behalf of its supporters and those who benefit from its activities.
 A public sector organisation is managed by elected officials on behalf of the general public.

Performance measurement of non- profit organisation

Additionally, if you have to interpret any information relating to not-for-profit and public sector entities then make
sure you are aware who the users of that information are and what they will be interested in.

Typically, users will want to know whether:

 The entity has enough finance to achieve its objectives
 The money raised is being spent on the activities for which it was intended
 The public are receiving value for money (in the case of a public sector entity)
 Services are being provided economically, efficiently and effectively (in the case of a public sector entity)
 The level of spending is reasonable in relation to the services provided.

Additionally, standard ratios may not be suitable for these entities so you may have to look at other measures, such
as non-financial rations including:
 The average time that hospital patients wait for treatment
 The number of schools built in an area
 Serious crimes per 1,000 of the population
 Number of complaints by members of the public in a given period
 Number of visits made to museums and art galleries in an area.

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Specialised not for Profit & Public Sector Entities SBR Revision Notes

Entity Reconstructions
 You need to identify when an entity may no longer be viewed as a going concern and why a reconstruction
might be an appropriate alternative to liquidation.
 You will not need to suggest a scheme of reconstruction, but you will need an outline of the accounting
treatment.

Background
Most of a study text on financial accounting is inevitably concerned with profitable, even expanding businesses. It
must of course be recognised that some companies fail. From a theoretical discounted cash flow viewpoint, a
company should be wound up if the expected return on its value in liquidation is less than that required. In practice
(and in law), a company is regarded as insolvent if it is unable to pay its debts. This term needs some qualification.
It is not uncommon, for example, to find a company that continues to trade and pays its creditors on time despite
the fact that its liabilities exceed its assets. On the other hand, a company may be unable to meet its current liabilities
although it has substantial sums locked up in assets which cannot be liquidated sufficiently quickly.

The procedures and options open to a failing company will depend on the degree of financial difficulties it faces. If
the outlook is hopeless, liquidation may be the only feasible solution. However, many firms in serious financial
positions can be revived to the benefit of creditors, members and society. When considering any scheme of
arrangement it is important to remember that the protection of creditors is usually of paramount importance. The
position of the shareholders and in particular, the protection of class rights, must be considered but the creditors
come first. This section considers some possibilities, but local legislation will govern these situations.

Going concern. The entity is normally viewed as a going concern, that is, as continuing in operation for the
foreseeable future. It is assumed that the entity has neither the intention nor the necessity of liquidation or of
curtailing materially the scale of its operations. (Framework) It is generally assumed that the entity has no intention
to liquidate or curtail major operations. If it did, then the financial statements would be prepared on a different
(disclosed) basis. Indications that an entity may no longer be a going concern include the following (from
International Standard on Auditing, ISA 570 Going concern):
(a) Financial indicators, e.g. recurring operating losses, net liability or net current liability position, negative cash
flow from operating activities, adverse key financial ratios, inability to obtain financing for essential new product
development or other essential investments, default on loan or similar agreements, arrear as in dividends,
denial of usual trade credit from suppliers, restructuring of debt, non-compliance with statutory capital
requirements, need to seek new sources or methods of financing or to dispose of substantial assets.
(b) Operating matters, e.g. loss of key management without replacement, loss of a major market, key customers,
licence, or principal suppliers, labour difficulties, shortages of important supplies or the emergence of a highly
successful competitor.
(c) Other matters, e.g. pending legal or regulatory proceedings against the entity, changes in law or regulations
that may adversely affect the entity; or uninsured or underinsured catastrophe such as a drought, earthquake
or flood.

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Specialised not for Profit & Public Sector Entities SBR Revision Notes

Internal reconstructions
A company may be able to enter into any type of scheme regarding either its creditors or its shareholders as long as
the scheme does not conflict with general law or any particular statutory provision.

For a reconstruction of this type to be considered worthwhile in the first place, the business must have some future
otherwise it might be better for the creditors if the company went into liquidation. In any scaling down of claims
from creditors and loan stock holders, two conditions should be met.
(a) A reasonable chance of successful operations
(b) Fairness to parties

Transfer of Assets to a New Company

Another form of reconstruction is by means of voluntary liquidation whereby the liquidator transfers the assets of
the company to a new company in exchange for shares or other securities in the new company. The old company
may be able to retain certain of its assets, usually cash, and make a distribution to the shareholders of the old
company who still have an interest in the undertaking through their shareholding in the new company. There may
be various rules governing the protection of non-controlling shareholders.

Such a procedure would be applied to the company which is proposed to be or is in course of being wound up
voluntarily. A company in liquidation must dispose of its assets (other than cash) by sale in order to pay its debts and
distribute any surplus to its members. The special feature of this kind of reconstruction is that the business or
property of Company P is transferred to Company Q in exchange for shares of the latter company which are allotted
direct or distributed by the liquidator to members of Company P. Obviously the creditors of Company P will have to
be paid cash.

Finding the cash to pay creditors and to buy out shareholders who object to the scheme is often the major drawback
to a scheme of this kind. It is unlikely to be used much because the same result can be more satisfactorily achieved
by a takeover: Company Q simply acquires the share capital of Company P, which becomes its subsidiary, and the
assets and liabilities are transferred from the subsidiary to the new holding company. In this situation usually no
cash has to be found (although obviously there is no guarantee of success).

The advantage of transferring a business from one company to another (with the same shareholders in the end) is
that by this means the business may be moved away from a company with a tangled history to a new company which
makes a fresh start. As explained above this procedure can also be used to effect a merger of two companies each
with an existing business.

Accounting procedures for a transfer to a new company

The basic procedure when transferring the undertaking to a new company is as follows.
(a) To close off the ledger accounts in the books of the old company.
(b) To open up the ledger accounts in the books of the new company.

The basic procedure is as follows.

Step 1 Open a realisation account and transfer in all the assets and liabilities to be taken over by the new company
at book value.

Step 2 Open a sundry members account with columns for ordinary and preference shareholders.
Transfer in the share capital, reserve balances, assets written off and gains and losses on realisation.

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Specialised not for Profit & Public Sector Entities SBR Revision Notes

Step 3 With the purchase consideration for the members:

DEBIT Sundry members a/c
CREDIT Realisation a/c

Take any profit or loss on realisation to the sundry members account (ordinary).

Step 4 In the new company, open a purchase of business account:

CREDIT it with assets taken over
(DEBIT asset accounts)

DEBIT it with liabilities taken over

(CREDIT liabilities a/cs)

DEBIT it with the purchase consideration

(CREDIT shares, loan stock etc)

Any balance is goodwill or a gain on a bargain purchase.

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Exposure Drafts SBR Revision Notes

EXPOSURE DRAFTS
ED/2019/7: General Presentation and Disclosures

The International Accounting Standards Board (Board) has proposed improvements to the way information is
communicated in the financial statements, with a focus on financial performance. Responding to investor demand,
the proposals would require more comparable information in the statement of profit or loss and a more disciplined
and transparent approach to the reporting of management-defined performance measures (‘non-GAAP’).

The Board developed these proposals as part of its Primary Financial Statements project and wider work on ‘Better
Communication in Financial Reporting’. The proposals cover three main topics.

The Board’s objective

To improve how information is communicated in the financial statements, with a focus on information about
performance in the statement of profit or loss.

Proposals: The Board proposes to require companies to:

1. present new defined subtotals in the statement of profit or loss;
2. disaggregate information in a better way; and
3. disclose information about some performance measures defined by management (‘non-GAAP’ measures)

New subtotals in the statement of profit or loss

Companies would be required to provide three new profit subtotals, including ‘operating profit’. Operating profit is
commonly reported by companies but is currently not defined by IFRS Standards, making meaningful comparisons
between companies difficult. The new subtotals would give better structure to the information and enable investors
to compare companies. Sample structure as per snapshot by IFRS is as follows:

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Exposure Drafts SBR Revision Notes

‘Non-GAAP’ transparency
Companies would be required to disclose management performance measures—subtotals of income and expenses
that are not specified in IFRS Standards—in a single note to the financial statements. In this note, companies would
be required to explain why the measures provide useful information, how they are calculated and to provide a
reconciliation to the most comparable profit subtotal specified by IFRS Standards. These requirements would add
much-needed transparency and discipline to the use of non-GAAP measures and make it easier for investors to find
the information they need to make their own analyses.

Improved disaggregation of information

Investors sometimes find it difficult to unpick a company’s reported information because items may be lumped
together with insufficient labelling or explanations. Therefore, the Board has proposed new guidance to help
companies disaggregate information in the most useful way for investors. Companies would also be required to
provide better analysis of their operating expenses and to identify and explain in the notes any unusual income or
expenses, using the Board’s definition of ‘unusual’. These requirements would help investors analyse companies’
earnings and forecast future cash flows.

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Exposure Drafts SBR Revision Notes

The proposals would result in a new IFRS Standard that sets out general presentation and disclosure requirements
relevant for all companies, replacing IAS 1 Presentation of Financial Statements. The Board is also proposing to
amend some other IFRS Standards.

TECHNICAL ARTICLES
Following are some important technical articles provided by the examining team of SBR. These are very important
from exam point of view.
1. MEASUREMENT
2. GIVING INVESTORS WHAT THEY NEED
3. THE DEFINITION AND DISCLOSURE OF CAPITAL
4. CONCEPTS OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME
5. WHAT DIFFERENTIATES PROFIT OR LOSS FROM OTHER COMPREHENSIVE INCOME?
6. WHEN DOES DEBT SEEM TO BE EQUITY?

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Measurement SBR Revision Notes

MEASUREMENT

The relevance of information provided by a particular measurement method depends on how it affects the financial
statements. The cost should be justified by the benefits of reporting that information to existing and potential
users. The different measures used should be the minimum necessary to provide relevant information and there
should be infrequent changes with any necessary changes clearly explained. Further it makes sense for comparability
and consistency purposes, to use the same method for initial and subsequent measurement unless there is a good
reason from not doing so.

The existing Conceptual Framework provides very little guidance on measurement, which constitutes a serious gap
in the Framework. A single measurement basis may not provide the most relevant information to users and therefore
IFRSs adopt a mixed measurement basis, which includes fair value, historical cost, and net realisable value. Different
information from different measurement bases may be relevant in different circumstances. A particular
measurement bases may be easier to understand, more verifiable and less costly to implement. However, if different
measurement bases are used, it can be argued that the totals in financial statements have little meaning. Those that
prefer a single measurement method favour the use of current values to provide the most relevant information.

A business that is profit orientated has processes to transform market input values (inventory for example) into
market output values.(sales of finished products).Thus it makes sense that current values should play a key role in
measurement. Current market value would appear to be the most relevant measure of assets and liabilities for
financial reporting purposes.

The IASB favour a mixed measurement approach whereby the most relevant measurement method is selected. It
appears that investors feel that this approach is consistent with how they analyse financial statements and that the
problems of mixed measurement are outweighed by the greater relevance achieved. In recent standards, it seems
that the IASB felt that fair value would not provide the most relevant information in all circumstances. For example,
IFRS 9 requires the use of cost in some cases and fair value in other cases, while IFRS 15 essentially applies cost
allocation.

A factor to be considered when selecting a measurement basis is the degree of measurement uncertainty. The
Exposure Draft on the Conceptual Framework states that for some estimates, a high level of measurement
uncertainty may outweigh other factors to such an extent that the resulting information may have little relevance.
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.Consequently, the IASB believes that
the level of uncertainty associated with the measurement of an item should be considered when assessing whether
a particular measurement basis provides relevant information.

Measurement uncertainty could be considered too great with the result that the entity may not recognise the asset
or liability. An example of this would be research activities. However, sometimes a measure with a high degree of
uncertainty provides the most relevant information about an item. For example, financial instruments for which
prices are not observable. 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.

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Measurement SBR Revision Notes

It would be easier if measurement bases were categorised as either historical cost or current value. The Exposure
Draft on the Conceptual Framework describes these two categories but also states that cash-flow-based
measurement techniques are generally used to estimate the measure of an asset or a liability as part of a prescribed
measurement basis. Cash-flow-based measurement can be used to customise measurement bases, which can result
in more relevant information but it may also be more difficult for users to understand. As a result the Exposure Draft
does not identify those techniques as a separate category.

There are several areas of debate about measurement. For example, should any discussion of measurement bases
include the use of entry and exit values, entity-specific values and the role of deprival value. Again should an entity’s
business model affect the measurement of its assets and liabilities. Many would advocate that different
measurement methods should be applied that are dependent both on the nature of assets and liabilities and also,
importantly, on how these are used in the business. For example, property can be measured at historical cost or fair
value depending upon the business model.

In order to meet the objective of financial reporting, information provided by a particular measurement basis must
be useful to users of financial statements. A measurement basis achieves this if the information is relevant and
faithfully represents what it essentially is supposed to represent. In addition, the measurement basis needs to
provide information that is comparable, verifiable, timely and understandable. 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 flows is considered. The IASB considers that the way in which an asset or a liability contributes to future cash
flows depends, in part, on the nature of the business activities.

There are many different ways in which an asset or liability can be measured. Historical cost seems to be the easiest
of these measures but even here, complexity can arise where there is a deferred payment or a payment, which
involves an asset exchange. Subsequent accounting after initial recognition is not necessarily straightforward with
historical cost as such matters as impairment of assets have to be taken into account and the latter is dependent
upon rules, which can be sometimes subjective.

Current values have a variety of alternative valuation methods. These include market value, value-in-use and
fulfilment value. Of these various methods, there is less ambiguity around current market prices as with any other
measure of current value, there is likely to be specific rules in place to avoid inconsistency. In the main, the details
of how these different measurement methods are applied, are set out in each accounting standard.

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Giving Investors What They Need SBR Revision Notes

GIVING INVESTORS WHAT THEY NEED

ADDTHIS SHARING BUTTONS

Often the advice to investors is to focus upon cash and cash flow when analysing corporate reports. However
insufficient financial capital can cause liquidity problems and sufficiency of financial capital is essential for growth.
Discussion of the management of financial capital is normally linked with entities that are subject to external capital
requirements but it is equally important to those entities which do not have regulatory obligations.

WHAT IS IT?
Financial capital is defined in various ways. The term has no accepted definition having been interpreted as equity
held by shareholders or equity plus debt capital including finance leases. This can obviously affect the way in which
‘capital’ is measured which has an impact on return on capital employed (ROCE).

An understanding of what an entity views as capital and its strategy for capital management is important to all
companies and not just banks and insurance companies. Users have diverse views of what is important in their
analysis of capital. Some focus on historical invested capital, others on accounting capital and others on market
capitalisation.

INVESTOR NEEDS
Investors have specific but different needs for information about capital depending upon their approach to the
valuation of a business. If the valuation approach is based upon a dividend model, then shortage of capital may have
an impact upon future dividends. If ROCE is used for comparing the performance of entities, then investors need to
know the nature and quantity of the historical capital employed in the business. There is diversity in practice as to
what different companies see as capital and how it is managed.

There are various requirements for entities to disclose information about ‘capital’. In drafting IFRS 7, Financial
Instruments: Disclosures, the IASB considered whether it should require disclosures about capital. In assessing the
risk profile of an entity, the management and level of an entity’s capital is an important consideration.

The IASB believes that disclosures about capital are useful for all entities, but they are not intended to replace
disclosures required by regulators as their reasons for disclosure may differ from those of the IASB. As an entity’s
capital does not relate solely to financial instruments, the IASB has included these disclosures in IAS V1, Presentation
of Financial Statements rather than IFRS 7. IFRS 7 requires some specific disclosures about financial liabilities, it does
not have similar requirements for equity instruments.

The IASB considered whether the definition of ‘capital’ is different from the definition of equity in IAS 32, Financial
Instruments; Presentation. In most cases disclosure capital would be the same as equity but it might also include or
exclude some elements. The disclosure of capital is intended to give entities the ability to describe their view of the
elements of capital if this is different from equity.

IAS 1 DISCLOSURES
As a result, IAS 1 requires an entity to disclose information that enables users to evaluate the entity’s objectives,
policies and processes for managing capital. This objective is obtained by disclosing qualitative and quantitative data.
The former should include narrative information such as what the company manages as capital, whether there are
any external capital requirements and how those requirements are incorporated into the management of capital.

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Giving Investors What They Need SBR Revision Notes

Some entities regard some financial liabilities as part of capital whilst other entities regard capital as excluding some
components of equity for example those arising from cash flow hedges. The IASB decided not to require quantitative
disclosure of externally imposed capital requirements but rather decided that there should be disclosure of whether
the entity has complied with any external capital requirements and, if not, the consequences of non-compliance.
Further there is no requirement to disclose the capital targets set by management and whether the entity has
complied with those targets, or the consequences of any non-compliance.

EXAMPLES
Examples of some of the disclosures made by entities include information as to how gearing is managed, how capital
is managed to sustain future product development and how ratios are used to evaluate the appropriateness of its
capital structure. An entity bases these disclosures on the information provided internally to key management
personnel.

If the entity operates in several jurisdictions with different external capital requirements such that an aggregate
disclosure of capital would not provide useful information, the entity may disclose separate information for each
separate capital requirement.

Besides the requirements of IAS 1, the IFRS Practice Statement Management Commentary suggests that
management should include forward-looking information in the commentary when it is aware of trends,
uncertainties or other factors that could affect the entity’s capital resources.

COMPANIES ACT
Additionally, some jurisdictions refer to capital disclosures as part of their legal requirements. In the UK, Section 414
of the Companies Act 2006 deals with the contents of the Strategic Report and requires a ‘balanced and
comprehensive analysis’ of the development and performance of the business during the period and the position of
the company at the end of the period.

The section further requires that to the extent necessary for an understanding of the development, performance or
position of the business, the strategic report should include an analysis using key performance indicators. It makes
sense that any analysis of a company’s financial position should include consideration of how much capital it has and
its sufficiency for the company’s needs.

The Financial Reporting Council Guidance on the Strategic Report suggests that comments should appear in the
report on the entity’s financing arrangements such as changes in net debt or the financing of long-term liabilities.

CAPITALISATION TABLE
In addition to the annual report, an investor may find details of the entity’s capital structure where the entity is
involved in a transaction, such as a sale of bonds or equities.

It is normal for an entity to produce a capitalisation table in a prospectus showing the effects of the transactions
on the capital structure. The table shows the ownership and debt interests in the entity but may show potential
funding sources, and the effect of any public offerings.

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The capitalisation table may present the pro forma impact of events that will occur as a result of an offering such as
the automatic conversion of preferred stock, the issuance of common stock, or the use of the offering proceeds for
the repayment of debt or other purposes. The IASB does not require such a table to be disclosed but it is often
required by securities regulators.

For example, in the US, the table is used to calculate key operational metrics. Amedica Corporation announced in
February 2016 that it had ‘made significant advancements in its ongoing initiative toward improving its capitalisation
table, capitalisation, and operational structure’.

It can be seen that information regarding an entity’s capital structure is spread across several documents including
the management commentary, the notes to financial statements, interim accounts and any document required by
securities regulators.

DEBT AND EQUITY

Essentially there are two classes of capital reported in financial statements, namely debt and equity. However, debt
and equity instruments can have different levels of right, benefit and risks.

When an entity issues a financial instrument, it has to determine its classification either as debt or as equity. The
result of the classification can have a significant effect on the entity’s reported results and financial position. Liability
classification impacts upon an entity’s gearing ratios and results in any payments being treated as interest and
charged to earnings. Equity classification may be seen as diluting existing equity interests.

IAS 32 sets out the nature of the classification process but the standard is principle based and sometimes the
outcomes are surprising to users. IAS 32 does not look to the legal form of an instrument but focuses on the
contractual obligations of the instrument.

IAS 32 considers the substance of the financial instrument, applying the definitions to the instrument’s contractual
rights and obligations. The variety of instruments issued by entities makes this classification difficult with the
application of the principles occasionally resulting in instruments that seem like equity being accounted for as
liabilities. Recent developments in the types of financial instruments issued have added more complexity to capital
structures with the resultant difficulties in interpretation and understanding.

The IASB has undertaken a research project with the aim of improving accounting for financial instruments that have
characteristics of both liabilities and equity. The IASB has a major challenge in determining the best way to report
the effects of recent innovations in capital structure.

DIVERSITY AND DIFFICULTY

There is a diversity of thinking about capital, which is not surprising given the issues with defining equity, the
difficulty in locating sources of information about capital and the diversity of business models in an economy.

Capital needs are very specific to the business and are influenced by many factors such as debt covenants, and
preservation of debt ratings. The variety and inconsistency of capital disclosures does not help the decision making
process of investors. Therefore the details underlying a company’s capital structure are essential to the assessment
of any potential change in an entity’s financial flexibility and value.

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The Definition & Disclosure of Capital SBR Revision Notes

THE DEFINITION AND DISCLOSURE OF CAPITAL

ADDTHIS SHARING BUTTONS

Why does it matter anyway?

This article is useful to those candidates studying for SBR, Strategic Business Reporting. It is structured in two parts:
first, it considers what might be included as the capital of a company and, second, why this distinction is important
for the analysis of financial information.

Essentially, there are two classes of capital reported in financial statements: debt and equity. However, debt and
equity instruments can have different levels of right, benefit and risks. When an entity issues a financial instrument,
it has to determine its classification either as debt or as equity. The result of the classification can have a significant
effect on the entity’s reported results and financial position. Liability classification impacts upon an entity’s gearing
ratios and results in any payments being treated as interest and charged to earnings. Equity classification may be
seen as diluting existing equity interests.

IAS 32, Financial Instruments: Presentation sets out the nature of the classification process but the standard is
principle-based and sometimes the outcomes that result from its application are surprising to users. IAS 32 does not
look to the legal form of an instrument but focuses on the contractual obligations of the instrument. IAS 32 considers
the substance of the financial instrument, applying the definitions to the instrument’s contractual rights and
obligations.

MORE COMPLEXITY
The variety of instruments issued by entities makes this classification difficult with the application of the principles
occasionally resulting in instruments that seem like equity being accounted for as liabilities. Recent developments
in the types of financial instruments issued have added more complexity to capital structures with the resultant
difficulties in interpretation and understanding. Consequently, the classification of capital is subjective which has
implications for the analysis of financial statements.

To avoid this subjectivity, investors are often advised to focus upon cash and cash flow when analysing corporate
reports. However, insufficient financial capital can cause liquidity problems and sufficiency of financial capital is
essential for growth. Discussion of the management of financial capital is normally linked with entities that are
subject to external capital requirements, but it is equally important to those entities that do not have regulatory
obligations.

Financial capital is defined in various ways but has no widely accepted definition having been interpreted as equity
held by shareholders or equity plus debt capital including finance leases. This can obviously affect the way in which
capital is measured, which has an impact on return on capital employed (ROCE). An understanding of what an entity
views as capital and its strategy for capital management is important to all companies and not just banks and
insurance companies. Users have diverse views of what is important in their analysis of capital. Some focus on
historical invested capital, others on accounting capital and others on market capitalisation.

Investors have specific but different needs for information about capital depending upon their approach to the
valuation of a business. If the valuation approach is based upon a dividend model, then shortage of capital may have
an impact upon future dividends. If ROCE is used for comparing the performance of entities, then investors need to

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The Definition & Disclosure of Capital SBR Revision Notes

know the nature and quantity of the historical capital employed in the business. There is diversity in practice as to
what different companies see as capital and how it is managed.

There are various requirements for entities to disclose information about ‘capital’. In drafting IFRS 7, Financial
Instruments: Disclosures, the IASB considered whether it should require disclosures about capital. In assessing the
risk profile of an entity, the management and level of an entity’s capital is an important consideration. The IASB
believes that disclosures about capital are useful for all entities, but they are not intended to replace disclosures
required by regulators as their reasons for disclosure may differ from those of the IASB. As an entity’s capital does
not relate solely to financial instruments, the IASB has included these disclosures in IAS 1, Presentation of Financial
Statements rather than IFRS 7. IFRS 7 requires some specific disclosures about financial liabilities; it does not have
similar requirements for equity instruments.

The IASB considered whether the definition of capital is different from the definition of equity in IAS 32. In most
cases, capital would be the same as equity but it might also include or exclude some other elements. The disclosure
of capital is intended to give entities the ability to describe their view of the elements of capital if this is different
from equity.

As a result, IAS 1 requires an entity to disclose information that enables users to evaluate the entity’s objectives,
policies and processes for managing capital. This objective is obtained by disclosing qualitative and quantitative data.
The former should include narrative information such as what the company manages as capital, whether there are
any external capital requirements and how those requirements are incorporated into the management of capital.
Some entities regard some financial liabilities as part of capital, while other entities regard capital as excluding some
components of equity – for example, those arising from cash flow hedges.

The IASB decided not to require quantitative disclosure of externally imposed capital requirements but rather
decided that there should be disclosure of whether the entity has complied with any external capital requirements
and, if not, the consequences of non-compliance. Further, there is no requirement to disclose the capital targets set
by management and whether the entity has complied with those targets, or the consequences of any non-
compliance.

Examples of some of the disclosures made by entities include information as to how gearing is managed, how capital
is managed to sustain future product development and how ratios are used to evaluate the appropriateness of its
capital structure. An entity bases these disclosures on the information provided internally to key management
personnel. If the entity operates in several jurisdictions with different external capital requirements, such that an
aggregate disclosure of capital would not provide useful information, the entity may disclose separate information
for each separate capital requirement.

TRENDS
Besides the requirements of IAS 1, the IFRS Practice Statement Management Commentary suggests that
management should include forward-looking information in the commentary when it is aware of trends,
uncertainties or other factors that could affect the entity’s capital resources. Additionally, some jurisdictions refer
to capital disclosures as part of their legal requirements.

In the UK, Section 414 of the Companies Act 2006 deals with the contents of the Strategic Report and requires a
‘balanced and comprehensive analysis’ of the development and performance of the business during the period and
the position of the company at the end of the period. The section further requires that to the extent necessary for

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The Definition & Disclosure of Capital SBR Revision Notes

an understanding of the development, performance or position of the business, the strategic report should include
an analysis using key performance indicators. It makes sense that any analysis of a company’s financial position
should include consideration of how much capital it has and its sufficiency for the company’s needs. The Financial
Reporting Council Guidance on the Strategic Report suggests that comments should appear in the report on the
entity’s financing arrangements such as changes in net debt or the financing of long-term liabilities.

In addition to the annual report, an investor may find details of the entity’s capital structure where the entity is
involved in a transaction, such as a sale of bonds or equities. It is normal for an entity to produce a capitalisation
table in a prospectus showing the effects of the transactions on the capital structure. The table shows the ownership
and debt interests in the entity but may show potential funding sources and the effect of any public offerings. The
capitalisation table may present the pro forma impact of events that will occur as a result of an offering such as the
automatic conversion of preferred stock, the issuance of common stock, or the use of the offering proceeds for the
repayment of debt or other purposes.

The IASB does not require such a table to be disclosed but it is often required by securities regulators. For example,
in the USA, the table is used to calculate key operational metrics. Amedica Corporation announced in February 2016
that it had ‘made significant advancements in its ongoing initiative toward improving its capitalization table,
capitalization, and operational structure’.

It can be seen that information regarding an entity’s capital structure is spread across several documents including
the management commentary, the notes to financial statements, interim accounts and any document required by
securities regulators.

The IASB has undertaken a research project with the aim of improving the accounting for financial instruments that
have characteristics of both liabilities and equity. This is likely to be a major challenge in determining the best way
to report the effects of recent innovations in capital structure.

There is a diversity of thinking about capital that is not surprising given the issues with defining equity, the difficulty
in locating sources of information about capital and the diversity of business models in an economy. Capital needs
are very specific to the business and are influenced by many factors, such as debt covenants and preservation of
debt ratings. The variety and inconsistency of capital disclosures does not help the decision making process of
investors.

Therefore, the details underlying a company’s capital structure are essential to the assessment of any potential
change in an entity’s financial flexibility and value. An appreciation of these issues and their significance is important
to candidates studying for SBR.

pg. 240
Concepts of Profits or Loss SBR Revision Notes

CONCEPTS OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME

This article explains the current rules and the conceptual debate as to where in the statement of comprehensive
income, profits and losses should be recognised – i.e. when should they be recognised in profit or loss and when in
the other comprehensive income. Further, it explores the debate as to whether it is appropriate to recognise profits
or losses twice!

The performance of a company is reported in the statement of profit or loss and other comprehensive income. IAS
1, Presentation of Financial Statements, defines profit or loss as ‘the total of income less expenses, excluding the
components of other comprehensive income’. Other comprehensive income (OCI) is defined as comprising ‘items of
income and expense (including reclassification adjustments) that are not recognised in profit or loss as required or
permitted by other IFRSs’. Total comprehensive income is defined as ‘the change in equity during a period resulting
from transactions and other events, other than those changes resulting from transactions with owners in their
capacity as owners’.

It is a myth, and simply incorrect, to state that only realised gains are included in profit or loss (P/L) and that only
unrealised gains and losses are included in the OCI. For example, gains on the revaluation of land and buildings
accounted for in accordance with IAS 16, Property Plant and Equipment (IAS 16 PPE), are recognised in OCI and
accumulate in equity in Other Components of Equity (OCE). On the other hand, gains on the revaluation of land and
buildings accounted for in accordance with IAS 40, Investment Properties, are recognised in P/L and are part of the
Retained Earnings (RE). Both such gains are unrealised. The same point could be made with regard to the gains and
losses on the financial asset of equity investments. If such financial assets are designated in accordance with IFRS 9,
Financial Instruments (IFRS 9), at inception as Fair Value Through Other Comprehensive Income (FVTOCI) then the
gains and losses are recognised in OCI and accumulated in equity in OCE. Whereas if management decides not to
make this election, then the investment will by default be designated and accounted for as Fair Value Through Profit
or Loss (FVTP&L) and the gains and losses are recognised in P/L and become part of RE.

There is at present no overarching accounting theory that justifies or explains in which part of the statement gains
and losses should be reported. The IASB’s Conceptual Framework for Financial Reporting is silent on the matter. So
rather than have a clear principles based approach what we currently have is a rules based approach to this issue. It
is down to individual accounting standards to direct when gains and losses are to be reported in OCI. This is clearly
an unsatisfactory approach. It is confusing for users.

In July 2013 the International Accounting Standards Board (IASB) published a discussion paper on its Conceptual
Framework for Financial Reporting. This addressed the issue of where to recognise gains and losses. It suggests that
the P/L should provide the primary source of information about the return an entity has made on its economic
resources in a period. Accordingly the P/L should recognise the results of transactions, consumption and
impairments of assets and fulfilment of liabilities in the period in which they occur. In addition the P/L would also
recognise changes in the cost of assets and liabilities as well as any gains or losses resulting from their initial
recognition. The role of the OCI would then be to support the P/L. Gains and losses would only be recognised in OCI
if it made the P&L more relevant. In my view whilst this may be an improvement on the current absence of any
guidance it does not provide the clarity and certainty users crave.

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Concepts of Profits or Loss SBR Revision Notes

Recycling (the reclassification from equity to P&L)

Now let us consider the issue of recycling. This is where gains or losses are reclassified from equity to P/L as a
reclassification adjustment. In other words gains or losses are first recognised in the OCI and then in a later
accounting period also recognised in the P/L. In this way the gain or loss is reported in the total comprehensive
income of two accounting periods and in colloquial terms is said to be recycled as it is recognised twice. At present
it is down to individual accounting standards to direct when gains and losses are to be reclassified from equity to P/L
as a reclassification adjustment. So rather than have a clear principles based approach on recycling what we currently
have is a rules based approach to this issue. This is clearly, again, an unsatisfactory approach but also as we shall see
one addressed by the July 2013 IASB discussion paper on its Conceptual Framework for Financial Reporting IAS 21,
The Effects of Changes in Foreign Exchange Rates (IAS 21), is one example of a standard that requires gains and
losses to be reclassified from equity to P/L as a reclassification adjustment. When a group has an overseas subsidiary
a group exchange difference will arise on the re-translation of the subsidiary’s goodwill and net assets. In accordance
with IAS 21 such exchange differences are recognised in OCI and so accumulate in OCE. On the disposal of the
subsidiary, IAS 21 requires that the net cumulative balance of group exchange differences be reclassified from equity
to P&L as a reclassification adjustment – ie the balance of the group exchange differences in OCE is transferred to
P/L to form part of the profit on disposal.

IAS 16 PPE is one example of a standard that prohibits gains and losses to be reclassified from equity to P/L as a
reclassification adjustment. If we consider land that cost $10m which is treated in accordance with IAS 16 PPE. If the
land is subsequently revalued to $12m, then the gain of $2m is recognised in OCI and will be taken to OCE. When in
a later period the asset is sold for $13m, IAS 16 PPE specifically requires that the profit on disposal recognised in the
P/L is $1m – ie the difference between the sale proceeds of $13m and the carrying value of $12m. The previously
recognised gain of $2m is not recycled/reclassified back to P/L as part of the gain on disposal. However the $2m
balance in the OCE reserve is now redundant as the asset has been sold and the profit is realised. Accordingly, there
will be a transfer in the Statement of Changes in Equity, from the OCE of $2m into RE.

Double entry
For those who love the double entry let me show you the purchase, the revaluation, the disposal and the transfer to
RE in this way.
On purchase $m $m
Dr Land PPE 10
Cr Cash 10

On revaluation
Dr Land PPE 2
Cr OCE and recognised in OCI 2

On disposal
Dr Cash 13
Cr Land PPE 12
Cr P/L 1

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Concepts of Profits or Loss SBR Revision Notes

On transfer
Dr OCE 2
Cr Retained Earnings 2

If IAS 16 PPE allowed the reclassification from equity to P&L as a reclassification adjustment, the profit on disposal
recognised in P&L would be $3m including the $2m reclassified from equity to P&L and the last two double entries
above replaced with the following.

On reclassification from equity to P/L $m $m

Dr Cash 13
Cr Land PPE 12
Cr P/L 3
Dr OCE 2

IFRS 9 also prohibits the recycling of the gains and losses on FVTOCI investments to P/L on disposal. The no
reclassification rule in both IAS 16 PPE and IFRS 9 means that such gains on those assets are only ever reported once
in the statement of profit or loss and other comprehensive income – ie are only included once in total comprehensive
income. However many users, it appears, rather ignore the total comprehensive income and the OCI and just base
their evaluation of a company’s performance on the P/L. These users then find it strange that gains that have become
realised from transactions in the accounting period are not fully reported in the P/L of the accounting period. As
such we can see the argument in favour of reclassification. With no reclassification the earnings per share will never
fully include the gains on the sale of PPE and FVTOCI investments.

The following extract from the statement of comprehensive income summarises the current accounting treatment
for which gains and losses are required to be included in OCI and, as required, discloses which gains and losses can
and cannot be reclassified back to profit and loss.

Extract from the statement of profit or loss and other comprehensive income

$m

Profit for the year XX

Other comprehensive income

Gains and losses that cannot be reclassified back to

profit or loss

Changes in revaluation surplus where the revaluation

method is used in accordance with IAS 16 XX / (XX)
Remeasurements of a net defined benefit liability or
asset recognised in accordance with IAS 19 XX / (XX)
Gains and losses on remeasuring FVTOCI financial
assets in accordance with IFRS 9 XX / (XX)

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Concepts of Profits or Loss SBR Revision Notes

$m

Gains and losses that can be reclassified back to profit or loss

Group exchange differences from translating functional currencies into presentation

currency in accordance with IAS 21 XX / (XX)

The effective portion of gains and losses on hedging instruments in a cash flow hedge under
IFRS 9 XX / (XX)

Total comprehensive income XX / (XX)

The future of reclassification

In the July 2013 discussion paper on the Conceptual Framework for Financial Reporting the role of the OCI and the
reclassification from equity to P/L is debated.

No OCI and no reclassification

It can be argued that reclassification should simply be prohibited. This would free the statement of profit or loss and
other comprehensive income from the need to formally to classify gains and losses between P/L and OCI. This would
reduce complexity and gains and losses could only ever be recognised once. There would still remain the issue of
how to define the earnings in earnings per share, a ratio loved by investors, as clearly total comprehensive income
would contain too many gains and losses that were non-operational, unrealised, outside the control of management
and not relating to the accounting period.

Narrow approach to the OCI

Another suggestion is that the OCI should be restricted, should adopt a narrow approach. On this basis only bridging
and mismatch gains and losses should be included in OCI and be reclassified from equity to P/L.

A revaluation surplus on a financial asset classified as FVTOCI is a good example of a bridging gain. The asset is
accounted for at fair value on the statement of financial position but effectively at cost in P/L. As such, by recognising
the revaluation surplus in OCI, the OCI is acting as a bridge between the statement of financial position and the P/L.
On disposal reclassification ensures that the amount recognised in P/L will be consistent with the amounts that
would be recognised in P/L if the financial asset had been measured at amortised cost.

The effective gain or loss on a cash flow hedge of a future transaction is an example of a mismatch gain or loss as it
relates to a transaction in a future accounting period so needs to be carried forward so that it can be matched in the
P/L of a future accounting period. Only by recognising the effective gain or loss in OCI and allowing it to be reclassified
from equity to P/L can users to see the results of the hedging relationship.

Broad approach to the OCI

A third proposition is for the OCI to adopt a broad approach, by also including transitory gains and losses. The IASB
would decide in each IFRS whether a transitory remeasurement should be subsequently recycled.

Examples of transitory gains and losses are those that arise on the remeasurement of defined benefit pension funds
and revaluation surpluses on PPE.

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Concepts of Profits or Loss SBR Revision Notes

Conclusion
Whilst the IASB has not yet determined which approach will be adopted, its chairman Hans Hoogervorst has gone
on the record as saying ‘It is absolutely vital that the P/L contains all information that can be relevant to investors
and that nothing of importance gets left out… and… the IASB should be very disciplined in its use of OCI as resorting
to OCI too easily would undermine the credibility of net income so the OCI should only be used as an instrument of
last resort’.

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What Differentiates Profit or Loss SBR Revision Notes

WHAT DIFFERENTIATES PROFIT OR LOSS FROM OTHER COMPREHENSIVE

INCOME?

The purpose of the statement of profit or loss and other comprehensive income (OCI) is to show an entity’s financial
performance in a way that is useful to a wide range of users so that they may attempt to assess the future net cash
inflows of an entity. The statement should be classified and aggregated in a manner that makes it understandable
and comparable. IFRS currently requires that the statement be presented as either one statement, being a combined
statement of profit or loss and other comprehensive income or two statements, being the statement of profit or loss
and the statement of profit or loss and other comprehensive income. An entity has to show separately in OCI, those
items which would be reclassified (recycled) to profit or loss and those items which would never be reclassified
(recycled) to profit or loss. The related tax effects have to be allocated to these sections.

Profit or loss includes all items of income or expense (including reclassification adjustments) except those items of
income or expense that are recognised in OCI as required or permitted by IFRS. Reclassification adjustments are
amounts recycled to profit or loss in the current period that were recognised in OCI in the current or previous
periods. An example of items recognised in OCI that may be reclassified to profit or loss are foreign currency gains
on the disposal of a foreign operation and realised gains or losses on cash flow hedges. Those items that may not be
reclassified are changes in a revaluation surplus under IAS 16, Property, Plant and Equipment, and actuarial gains
and losses on a defined benefit plan under IAS 19, Employee Benefits.

However, there is a general lack of agreement about which items should be presented in profit or loss and in OCI.
The interaction between profit or loss and OCI is unclear, especially the notion of reclassification and when or which
OCI items should be reclassified. A common misunderstanding is that the distinction is based upon realised versus
unrealised gains. This lack of a consistent basis for determining how items should be presented has led to an
inconsistent use of OCI in IFRS. It may be difficult to deal with OCI on a conceptual level since the IASB are finding it
difficult to find a sound conceptual basis. However, there is urgent need for some guidance around this issue.

Opinions vary but there is a feeling that OCI has become a ‘dumping ground’ for anything controversial because of
a lack of clear definition of what should be included in the statement. Many users are thought to ignore OCI as the
changes reported are not caused by the operating flows used for predictive purposes. Financial performance is not
defined in the Conceptual Framework but could be viewed as reflecting the value the entity has generated in the
period and this can be assessed from other elements of the financial statements and not just the statement of profit
or loss and other comprehensive income. Examples would be the statement of cash flows and disclosures relating
to operating segments. The presentation in profit or loss and OCI should allow a user to depict financial performance
including the amount, timing and uncertainty of the entity’s future net cash inflows and how efficiently and
effectively the entity’s management have discharged their duties regarding the resources of the entity.

Reclassification: for and against

There are several arguments for and against reclassification. If reclassification ceased, then there would be no need
to define profit or loss, or any other total or subtotal in profit or loss, and any presentation decisions can be left to
specific IFRSs. It is argued that reclassification protects the integrity of profit or loss and provides users with relevant
information about a transaction that occurred in the period. Additionally, it can improve comparability where IFRS
permits similar items to be recognised in either profit or loss or OCI.

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What Differentiates Profit or Loss SBR Revision Notes

Those against reclassification argue that the recycled amounts add to the complexity of financial reporting, may lead
to earnings management and the reclassification adjustments may not meet the definitions of income or expense in
the period as the change in the asset or liability may have occurred in a previous period.

The original logic for OCI was that it kept income-relevant items that possessed low reliability from contaminating
the earnings number. Markets rely on profit or loss and it is widely used. The OCI figure is crucial because it can
distort common valuation techniques used by investors, such as the price/earnings ratio. Thus, profit or loss needs
to contain all information relevant to investors. Misuse of OCI would undermine the credibility of net income. The
use of OCI as a temporary holding for cash flow hedging instruments and foreign currency translation is non-
controversial.

However, other treatments such the policy of IFRS 9 to allow value changes in equity investments to go through OCI,
are not accepted universally.

US GAAP will require value changes in all equity investments to go through profit or loss. Accounting for actuarial
gains and losses on defined benefit schemes are presented through OCI and certain large US corporations have been
hit hard with the losses incurred on these schemes. The presentation of these items in OCI would have made no
difference to the ultimate settled liability but if they had been presented in profit or loss, the problem may have
been dealt with earlier. An assumption that an unrealised loss has little effect on the business is an incorrect one.

The Discussion Paper on the Conceptual Framework considers three approaches to profit or loss and reclassification.
The first approach prohibits reclassification. The other approaches, the narrow and broad approaches, require or
permit reclassification. The narrow approach allows recognition in OCI for bridging items or mismatched
remeasurements. While the broad approach has an additional category of ‘transitory measurements’ (for example,
remeasurement of a defined benefit obligation) which would allow the IASB greater flexibility. The narrow approach
significantly restricts the types of items that would be eligible to be presented in OCI and gives the IASB little
discretion when developing or amending IFRSs.

A bridging item arises where the IASB determines that the statement of comprehensive income would communicate
more relevant information about financial performance if profit or loss reflected a different measurement basis from
that reflected in the statement of financial position For example, if a debt instrument is measured at fair value in the
statement of financial position, but is recognised in profit or loss using amortised cost, then amounts previously
reported in OCI should be reclassified into profit or loss on impairment or disposal of the debt instrument. The IASB
argues that this is consistent with the amounts that would be recognised in profit or loss if the debt instrument were
to be measured at amortised cost.

A mismatched remeasurement arises where an item of income or expense represents an economic phenomenon so
incompletely that, in the opinion of the IASB, presenting that item in profit or loss would provide information that
has little relevance in assessing the entity’s financial performance. An example of this is when a derivative is used to
hedge a forecast transaction; changes in the fair value of the derivative may arise before the income or expense
resulting from the forecast transaction. The argument is that before the results of the derivative and the hedged
item can be matched together, any gains or losses resulting from the remeasurement of the derivative, to the extent
that the hedge is effective and qualifies for hedge accounting, should be reported in OCI. Subsequently, those gains
or losses are reclassified into profit or loss when the forecast transaction affects profit or loss. This allows users to
see the results of the hedging relationship.

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What Differentiates Profit or Loss SBR Revision Notes

The IASB’s preliminary view is that any requirement to present a profit or loss total or subtotal could also result in
some items being reclassified. The commonly suggested attributes for differentiation between profit or loss and OCI
(realised/unrealised, frequency of occurrence, operating/non-operating, measurement certainty/uncertainty,
realisation in the short/long-term or outside management control) are difficult to distil into a set of principles.

Therefore, the IASB is suggesting two broad principles, namely:

(a) Profit or loss provides the primary source of information about the return an entity has made on its economic
resources in a period.
(b) To support profit or loss, OCI should only be used if it makes profit or loss more relevant.

The IASB feels that changes in cost-based measures and gains or losses resulting from initial recognition should not
be presented in OCI and that the results of transactions, consumption and impairments of assets and fulfilment of
liabilities should be recognised in profit or loss in the period in which they occur. As a performance measure, profit
or loss is more used although there are a number of other performance measures derived from the statement of
profit or loss and OCI.

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When Does Debt Seem to be Equity? SBR Revision Notes

WHEN DOES DEBT SEEM TO BE EQUITY?

The difference between debt and equity in an entity’s statement of financial position is not easy to distinguish for
preparers of financial statements. Many financial instruments have both features with the result that this can lead
to inconsistency of reporting.

The International Accounting Standards Board (IASB) agreed with respondents from its public consultation on its
agenda (December 2012 report) that it needs greater clarity in its definitions of assets and liabilities for debt
instruments. This should therefore help eliminate some uncertainty when accounting for assets and financial
liabilities or non-financial liabilities. The respondents felt that defining the nature of liabilities would advance the
IASB’s thinking on distinguishing between financial instruments that should be classified as equity and those
instruments that should be classified as liabilities.

The objective of IAS 32, Presentation is to establish principles for presenting financial instruments as liabilities or
equity and for offsetting financial assets and liabilities. The classification of a financial instrument by the issuer as
either debt or equity can have a significant impact on the entity’s gearing ratio, reported earnings, and debt
covenants. Equity classification can avoid such impact but may be perceived negatively if it is seen as diluting existing
equity interests. The distinction between debt and equity is also relevant where an entity issues financial instruments
to raise funds to settle a business combination using cash or as part consideration in a business combination.

Understanding the nature of the classification rules and potential effects is critical for management and must be
borne in mind when evaluating alternative financing options. Liability classification normally results in any payments
being treated as interest and charged to earnings, which may affect the entity's ability to pay dividends on its equity
shares.

The key feature of debt is that the issuer is obliged to deliver either cash or another financial asset to the holder.
The contractual obligation may arise from a requirement to repay principal or interest or dividends. Such a
contractual obligation may be established explicitly or indirectly but through the terms of the agreement. For
example, a bond that requires the issuer to make interest payments and redeem the bond for cash is classified as
debt. In contrast, equity is any contract that evidences a residual interest in the entity’s assets after deducting all of
its liabilities. A financial instrument is an equity instrument only if the instrument includes no contractual obligation
to deliver cash or another financial asset to another entity, and if the instrument will or may be settled in the issuer's
own equity instruments.

For instance, ordinary shares, where all the payments are at the discretion of the issuer, are classified as equity of
the issuer. The classification is not quite as simple as it seems. For example, preference shares required to be
converted into a fixed number of ordinary shares on a fixed date, or on the occurrence of an event that is certain to
occur, should be classified as equity.

A contract is not an equity instrument solely because it may result in the receipt or delivery of the entity’s own equity
instruments. The classification of this type of contract is dependent on whether there is variability in either the
number of equity shares delivered or variability in the amount of cash or financial assets received. A contract that
will be settled by the entity receiving or delivering a fixed number of its own equity instruments in exchange for a
fixed amount of cash, or another financial asset, is an equity instrument. This has been called the ‘fixed for fixed’

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When Does Debt Seem to be Equity? SBR Revision Notes

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

For example, where a contract requires the entity to deliver as many of the entity’s own equity instruments as are
equal in value to a certain amount, the holder of the contract would be indifferent whether it received cash or shares
to the value of that amount. Thus, this contract would be treated as debt.

Other factors that may result in an instrument being classified as debt are:
 Is redemption at the option of the instrument holder?
 Is there a limited life to the instrument?
 Is redemption triggered by a future uncertain event that is beyond the control of both the holder and issuer of
the instrument?
 Are dividends non-discretionary?

Similarly, other factors that may result in the instrument being classified as equity are whether the shares are non-
redeemable, whether there is no liquidation date or where the dividends are discretionary.

The classification of the financial instrument as either a liability or as equity is based on the principle of substance
over form. Two exceptions from this principle are certain puttable instruments meeting specific criteria and certain
obligations arising on liquidation. Some instruments have been structured with the intention of achieving particular
tax, accounting or regulatory outcomes, with the effect that their substance can be difficult to evaluate.

The entity must make the decision as to the classification of the instrument at the time that the instrument is initially
recognised. The classification is not subsequently changed based on changed circumstances. For example, this
means that a redeemable preference share, where the holder can request redemption, is accounted for as debt even
though legally it may be a share of the issuer.

In determining whether a mandatorily redeemable preference share is a financial liability or an equity instrument, it
is necessary to examine the particular contractual rights attached to the instrument's principal and return elements.
The critical feature that distinguishes a liability from an equity instrument is the fact that the issuer does not have
an unconditional right to avoid delivering cash or another financial asset to settle a contractual obligation. Such a
contractual obligation could be established explicitly or indirectly. However, the obligation must be established
through the terms and conditions of the financial instrument. Economic necessity does not result in a financial
liability being classified as a liability. Similarly, a restriction on the ability of an entity to satisfy a contractual
obligation, such as the company not having sufficient distributable profits or reserves, does not negate the entity's
contractual obligation.

Some instruments are structured to contain elements of both a liability and equity in a single instrument. Such
instruments – for example, bonds that are convertible into a fixed number of equity shares and carry interest – are
accounted for as separate liability and equity components. 'Split accounting' is used to measure the liability and the
equity components upon initial recognition of the instrument. This method allocates the fair value of the
consideration for the compound instrument into its liability and equity components. The fair value of the
consideration in respect of the liability component is measured at the fair value of a similar liability that does not
have any associated equity conversion option. The equity component is assigned the residual amount.

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IAS 32 requires an entity to offset a financial asset and financial liability in the statement of financial position only
when the entity currently has a legally enforceable right of set-off and intends either to settle the asset and liability
on a net basis or to realise the asset and settle the liability simultaneously. An amendment to IAS 32 has clarified
that the right of set-off must not be contingent on a future event and must be immediately available. It also must
be legally enforceable for all the parties in the normal course of business, as well as in the event of default, insolvency
or bankruptcy. Netting agreements, where the legal right of offset is only enforceable on the occurrence of some
future event – such as default of a party – do not meet the offsetting requirements.

Rights issues can still be classified as equity when the price is denominated in a currency other than the entity’s
functional currency. The price of the right is denominated in currencies other than the issuer’s functional currency,
when the entity is listed in more than one jurisdiction or is required to do so by law or regulation. A fixed price in a
non-functional currency would normally fail the fixed number of shares for a fixed amount of cash requirement in
IAS 32 to be treated as an equity instrument. As a result, it is treated as an exception in IAS 32 and therefore treated
as equity.

Two measurement categories exist for financial liabilities: fair value through profit or loss (FVTPL) and amortised
cost. Financial liabilities held for trading are measured at FVTPL, and all other financial liabilities are measured at
amortised cost unless the fair value option is applied.

The IASB and FASB have been working on a project to replace IAS 32 and converge IFRS and US GAAP for a number
of years. The ‘Financial instruments with characteristics of equity’ project (‘FICE’) resulted in a discussion paper in
2008, but has been put on hold.

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Integrated Reporting SBR Revision Notes

INTEGRATED REPORTING <IR>

Introduction
In 2013, the International Integrated Reporting Council (IIRC) released a framework for integrated reporting. This
followed a three-month global consultation and trials in 25 countries.

The framework establishes principles and concepts that govern the overall content of an integrated report. An
integrated report sets out how the organisation’s strategy, governance, performance and prospects, which lead to
the creation of value. There is no benchmarking for the above matters and the report is aimed primarily at the private
sector but it could be adapted for public sector and not-for-profit organisations.

The aim is to give investors and shareholders a broader picture of how companies make their money and their
prospects in the short, medium and long term.

Designed to be an approach to reporting which accurately conveys an organisation’s business model and its sources
of value creation over time, the IR model recognises six types of capital, with these being consumed by a business
and also created as part of its business processes. It is the way that capitals are consumed, transformed and created
which is at the heart of the IR model.

Purpose of integrated report

The primary purpose of an integrated report is to explain to providers of financial capital how an organisation creates
value over time. An integrated report benefits all stakeholders interested in a company’s ability to create value,
including employees, customers, suppliers, business partners, local communities, legislators, regulators and
policymakers, although it is not directly aimed at all stakeholders. Providers of financial capital can have a significant
effect on the capital allocation and attempting to aim the report at all stakeholders would be an impossible task and
would reduce the focus and increase the length of the report. This would be contrary to the objectives of the report,
which is value creation.

Historical financial statements are essential in corporate reporting, particularly for compliance purposes, but do not
provide meaningful information regarding business value. Users need a more forward-looking focus without the
necessity of companies providing their own forecasts and projections. Companies have recognised the benefits of
showing a fuller picture of company value and a more holistic view of the organisation.

The International Integrated Reporting Framework will encourage the preparation of a report that shows their
performance against strategy, explains the various capitals used and affected, and gives a longer-term view of the
organisation. The integrated report is creating the next generation of the annual report as it enables stakeholders
to make a more informed assessment of the organisation and its prospects.

EXPLANATION
Definition: <IR> demonstrates how organisations really create value:
 It is a concise communication of an organisation’s strategy, governance and performance
 It demonstrates the links between its financial performance and its wider social, environmental and economic
context
 It shows how organisations create value over the short, medium and long term

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Integrated reporting is about integrating material financial and non-financial information to enable investors and
other stakeholders to understand how an organisation is really performing. An integrated report looks beyond the
traditional time frame and scope of the current financial report by addressing the wider as well as longer-term
consequences of decisions and action and by making clear the link between financial and non-financial value. It is
important that an integrated report demonstrates the link between an organisation's strategy, governance and
business model

An Integrated Report should be a single report which is the organization’s primary report – in most jurisdictions the
Annual Report or equivalent.

PRINCIPLE-BASED FRAMEWORK
The IIRC has set out a principle-based framework rather than specifying a detailed disclosure and measurement
standard. This enables each company to set out its own report rather than adopting a checklist approach. The culture
change should enable companies to communicate their value creation better than the often boilerplate disclosures
under IFRS. The report acts as a platform to explain what creates the underlying value in the business and how
management protects this value. This gives the report more business relevance rather than the compliance led
approach currently used.

Integrated reporting will not replace other forms of reporting but the vision is that preparers will pull together
relevant information already produced to explain the key drivers of their business’s value. Information will only be
included in the report where it is material to the stakeholder’s assessment of the business. There were concerns that
the term ‘materiality’ had a certain legal connotation, with the result that some entities may feel that they should
include regulatory information in the integrated report. However, the IIRC concluded that the term should continue
to be used in this context as it is well understood.

The integrated report aims to provide an insight into the company’s resources and relationships that are known as
the capitals and how the company interacts with the external environment and the capitals to create value. These
capitals can be financial, manufactured, intellectual, human, social and relationship, and natural capital, but
companies need not adopt these classifications.

Following are the capitals (resources and relationships) on which the organisation depends, how the organisation
uses them and its impact upon them!

Financial capital: This comprises the pool of funds available to the business, which includes both debt and equity
finance. This description of financial capital focuses on the source of funds.

Manufactured capital. This is the human-created, production-oriented equipment and tools used in production or
service provision, such as buildings, equipment and infrastructure. Manufactured capital draws a distinction is
between inventory (as a short-term asset) and plant and equipment (tangible capital).

Human capital: Is understood to consist of the knowledge, skills and experience of the company’s employees and
managers, as they are relevant to improving operational performance.

Intellectual capital. This is a key element in an organisation’s future earning potential, with a close link between
investment in R&D, innovation, human resources and external relationships, as these can determine the
organisation’s competitive advantage.

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Natural capital. This is any stock of natural resources or environmental assets which provide a flow of useful goods
or services, now and in the future.

Social and relationships capital. Comprises the relationships within an organisation, as well as those between an
organisation and its external stakeholders, depending on where social boundaries are drawn. These relationships
should enhance both social and collective well-being.

The purpose of this framework is to establish principles and content that governs the report, and to explain
the fundamental concepts that underpin them. The report should be concise, reliable and complete, including all
material matters, both positive and negative in a balanced way and without material error.

Key components
Integrated reporting is built around the following key components:
1. Organisational overview and the external environment under which it operates
2. Governance structure and how this supports its ability to create value
3. Business model
4. Risks and opportunities and how they are dealing with them and how they affect the company’s ability to create
value
5. Strategy and resource allocation
6. Performance and achievement of strategic objectives for the period and outcomes
7. Outlook and challenges facing the company and their implications
8. The basis of presentation needs to be determined, including what matters are to be included in the integrated
report and how the elements are quantified or evaluated.

The framework does not require discrete sections to be compiled in the report but there should be a high level
review to ensure that all relevant aspects are included. The linkage across the above content can create a key
storyline and can determine the major elements of the report such that the information relevant to each company
would be different.

RELATIONSHIP WITH STAKEHOLDERS

An integrated report should provide insight into the nature and quality of the organisation’s relationships with its
key stakeholders, including how and to what extent the organisation understands, takes into account and responds
to their needs and interests. Further, the report should be consistent over time to enable comparison with other
entities.

South African organisations have been acknowledged as among the leaders in this area of corporate reporting with
many listed companies and large state-owned companies having issued integrated reports. An integrated report may
be prepared in response to existing compliance requirements – for example, a management commentary. Where
that report is also prepared according to the framework, or even beyond the framework, it can be considered an
integrated report. An integrated report may be either a standalone report or be included as a distinguishable part
of another report or communication. For example, it can be included in the company’s financial statements.

The IIRC considered the nature of value and value creation. These terms can include the total of all the capitals, the
benefit captured by the company, the market value or cash flows of the organisation and the successful achievement
of the company’s objectives. However, the conclusion reached was that the framework should not define value from
any one particular perspective because value depends upon the individual company’s own perspective. It can be

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shown through movement of capital and can be defined as value created for the company or for others. An
integrated report should not attempt to quantify value as assessments of value are left to those using the report.
Many respondents felt that there should be a requirement for a statement from those ‘charged with governance’
acknowledging their responsibility for the integrated report in order to ensure the reliability and credibility of the
integrated report. Additionally, it would increase the accountability for the content of the report.

The IIRC feels the inclusion of such a statement may result in additional liability concerns, such as inconsistency with
regulatory requirements in certain jurisdictions, and could lead to a higher level of legal liability. The IIRC also felt
that the above issues might result in a slower take-up of the report and decided that those ‘charged with governance’
should, in time, be required to acknowledge their responsibility for the integrated report while, at the same time,
recognising that reports in which they were not involved would lack credibility.

There has been discussion about whether the framework constitutes suitable criteria for report preparation and for
assurance. The questions asked concerned measurement standards to be used for the information reported and
how a preparer can ascertain the completeness of the report.

There were concerns over the ability to assess future disclosures, and recommendations were made that specific
criteria should be used for measurement, the range of outcomes and the need for any confidence intervals be
disclosed. The preparation of an integrated report requires judgment but there is a requirement for the report to
describe its basis of preparation and presentation, including the significant frameworks and methods used to
quantify or evaluate material matters. Also included is the disclosure of a summary of how the company determined
the materiality limits and a description of the reporting boundaries.

The IIRC has stated that the prescription of specific KPIs and measurement methods is beyond the scope of a
principles-based framework. The framework contains information on the principle-based approach and indicates
that there is a need to include quantitative indicators whenever practicable and possible. Additionally, consistency
of measurement methods across different reports is of paramount importance. There is outline guidance on the
selection of suitable quantitative indicators.

A company should consider how to describe the disclosures without causing a significant loss of competitive
advantage. The entity will consider what advantage a competitor could actually gain from information in the
integrated report, and will balance this against the need for disclosure.

Companies struggle to communicate value through traditional reporting. The framework can prove an effective tool
for businesses looking to shift their reporting focus from annual financial performance to long-term shareholder
value creation. The framework will be attractive to companies who wish to develop their narrative reporting around
the business model to explain how the business has been developed.

SUMMARY – BENEFITS AND CHALLENGES

Benefits of <IR>
Integrated reporting gives a ‘dashboard’ view of an organisation’s activities and performance in this broader context.
 Systems and Accountability. The need to report on each type of capital would create and enhance a system of
internal measurement which would record and monitor each type for the purposes of reporting.
 Decision-making. The connections made through <IR> enable investors to better evaluate the combined impact
of the diverse factors, or ‘capitals’, affecting the business.

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 Reputation. The greater transparency and disclosure of <IR> should result in a decrease in reputation risk, which
in turn should result in a lower cost of, and easier access to, sources of finance.
 Harmonisation. <IR> provides a platform for standard-setters and decision-makers to develop and harmonise
business reporting. This in turn should reduce the need for costly bureaucracy imposed by central authorities.
 Communications. The information disclosed, once audited and published, would create a fuller and more
detailed account of the sources of added value, and threats to value (i.e. risks), for shareholders and others.
 Relationships. The information will lead to a higher level of trust from, and engagement with, a wide range of
stakeholders.

Challenges in IR
 Progress towards IR will happen at different speeds in different countries as regulations and directors duties
vary across the globe
 Directors liability will increase as they will be reporting on the future and on evolving issues
 A balance will need to be created between benefits of reporting and the desire to avoid disclosing competitive
information
 It will take time to convince management to overcome focus on short term rewards.

Use of concepts of materiality in applying the IR Framework

Integrated reporting (IR) takes a broader view of business reporting, emphasising the need for entities to provide
Information to help investors assess the sustainability of their business model. IR is a process which results in
Communication, through the integrated report, about value creation over time. An integrated report is a concise
Communication about how an organisation’s strategy, governance, performance and prospects lead to the creation
of Value over the short, medium and long term. The materiality definition for IR purposes would consider that
material.

Matters are those which are of such relevance and importance that they could substantively influence the
assessments of the intended report users. In the case of IR, relevant matters are those which affect or have the
potential to affect the organisation’s ability to create value over time. For financial reporting purposes, the nature
or extent of an omission or misstatement in the organisation’s financial statements determines relevance. Matters
which are considered material for financial reporting purposes, or for other forms of reporting, may also be material
for IR purposes if they are of such relevance and importance that they could change the assessments of providers of
financial capital with regard to the organisation’s ability to create value. Another feature of materiality for IR
purposes is that the definition emphasises the involvement of senior management and those charged with
governance in the materiality determination process in order for the organisation to determine how best to disclose
its value creation development in a meaningful and transparent way.

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CURRENT DEVELOPMENTS

This Chapter includes topics currently under debate and all recent changes and standards issued by the IASB. The
following have been incorporated in the chapter:

1. IFRS Practice Statement: Management Commentary

2. IFRS Practice Statement: Making Materiality Judgements
3. IFRS 1 First Time Adoption of International Financial Reporting Standards
4. Convergence with US GAAP
5. IAS 21 – Does it need amending
6. The IASB’s Principles of Disclosure Initiative
7. Future trends in sustainability reporting

IFRS PRACTICE STATEMENT: MANAGEMENT COMMENTARY

What is management commentary?
Management commentary is a narrative report that provides a context within which to interpret the financial
position, financial performance and cash flows of an entity. It also provides management with an opportunity to
explain its objectives and its strategies for achieving those objectives. Users routinely use the type of information
provided in management commentary to help them evaluate an entity’s prospects and its general risks, as well as
the success of management’s strategies for achieving its stated objectives. For many entities, management
commentary is already an important element of their communication with the capital markets, supplementing as
well as complementing the financial statements.

Objective
The objective of the Practice Statement is to assist management in presenting useful management commentary that
relates to financial statements that have been prepared in accordance with International Financial Reporting
Standards (IFRSs).

Scope
The Practice Statement applies only to management commentary and not to other information presented in either
the financial statements or the broader financial reports.

Framework for the presentation of management commentary

Purpose
 Management commentary should provide users of financial statements with integrated information that
provides a context for the related financial statements. Such information explains management’s view not only
about what has happened, including both positive and negative circumstances, but also why it has happened
and what the implications are for the entity’s future.
 Management commentary complements and supplements the financial statements by communicating
integrated information about the entity’s resources and the claims against the entity and its resources, and the
transactions and other events that change them.
 Management commentary should also explain the main trends and factors that are likely to affect the entity’s
future performance, position and progress. Consequently, management commentary looks not only at the
present, but also at the past and the future.

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Principles
In aligning with those principles, management commentary should include:
(a) Forward-looking information; and
(b) Information that possesses the qualitative characteristics described in the Conceptual Framework for Financial
Reporting.

Management commentary should provide information to help users of the financial reports to assess the
performance of the entity and the actions of its management relative to stated strategies and plans for progress.
That type of commentary will help users of the financial reports to understand, for example:
(a) The entity’s risk exposures, its strategies for managing risks and the effectiveness of those strategies;
(b) How resources that are not presented in the financial statements could affect the entity’s operations; and
(c) How non-financial factors have influenced the information presented in the financial statements.

Presentation
Management commentary should be clear and straightforward. The form and content of management commentary
will vary between entities, reflecting the nature of their business, the strategies adopted by management and the
regulatory environment in which they operate.

Elements of management commentary

Although the particular focus of management commentary will depend on the facts and circumstances of the entity,
management commentary should include information that is essential to an understanding of:
(a) The nature of the business;
(b) Management’s objectives and its strategies for meeting those objectives;
(c) The entity’s most significant resources, risks and relationships;
(d) The results of operations and prospects; and
(e) The critical performance measures and indicators that management uses to evaluate the entity’s performance
against stated objectives.

Application date
An entity may apply this Practice Statement to management commentary presented prospectively from 8 December
2010.

IFRS PRACTICE STATEMENT: MAKING MATERIALITY JUDGEMENTS

Objective
The objective of IFRS Practice Statement Making Materiality Judgements is to assist management in presenting
financial information about the entity that is useful to existing and potential investors, lenders and other creditors
in making decisions about providing resources to the entity.

The Practice Statement is not an IFRS. Consequently, entities applying IFRSs are not required to comply with the
Practice Statement. However, it should be noted that materiality is a pervasive principle in IFRSs.

Scope
The Practice Statement applies to the preparation of financial statements in accordance with full IFRS. It is not
intended for entities applying the IFRS for SMEs.

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General characteristics of materiality

Definition of material
The Practice Statement works with the definition of materiality in the current Conceptual Framework.

Information is material if omitting it or misstating it could influence decisions that users make on the basis of financial
information about a specific reporting entity. In other words, materiality is an entity-specific aspect of relevance
based on the nature or magnitude, or both, of the items to which the information relates in the context of an
individual entity’s financial report.

Similar definitions are contained in IAS 1 Presentation of Financial Statements and IAS 8 Accounting Policies, Changes
in Accounting Estimates and Errors.

Pervasiveness of materiality judgements

The Practice Statement notes that the need for materiality judgements is pervasive in the preparation of financial
statements and affects recognition, measurement, presentation, and disclosure. Thus an entity is only required to
apply recognition and measurement requirements when the effect of applying them is material and need not
provide a disclosure specified by an IFRS if the information resulting from that disclosure is not material.

Judgement
When assessing whether information is material, an entity considers its own specific circumstances and the
information needs of the primary users of its financial statements. Materiality judgements are reassessed at each
reporting date.

Primary users and their information needs

Primary users of an entity's financial statements are existing and potential investors, lenders and other creditors.
They can be expected to have a reasonable knowledge of business and economic activities and to review and analyse
the information included in the financial statements diligently. The objective of financial statements is to provide
these primary users with financial information that is useful to them in making decisions about providing resources
to the entity. Therefore, an entity also needs to consider what type of decisions these users have to make. However,
general purpose financial statements are not intended to address specialised information needs, they focus on
common information needs.

Impact of publicly available information

Financial statements are required to be comprehensive documents and an entity assesses whether information is
material to its financial statements, regardless of whether some of the information may be also available from other
sources.

Four-step process
The Practice Statement notes that an entity may find it helpful to follow a systematic process in making materiality
judgements and offers an example of such a process.

Step 1
The entity identifies information that has the potential to be material. In doing so it considers the IFRS requirements
applicable to its transactions, other events and conditions and its primary users’ common information needs.

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Step 2
The entity then assesses whether the information identified in Step 1 is material. In making this assessment, the
entity needs to consider quantitative (size) and qualitative (nature) factors. The Practice Statement notes that the
presence of a qualitative factor lowers the thresholds for the quantitative assessment, i.e. the more significant the
qualitative factors, the lower those quantitative thresholds will be. This could, in fact, result in a quantitative
threshold of zero if an item of information could reasonably be expected to influence primary users’ decisions
regardless of its size.

Step 3
In a next step, the entity organises the information within the draft financial statements in a manner that supports
clear and concise communication. The Practice Statement notes the following helpful points:
 Emphasise material matters;
 Tailor information to the entity’s own circumstances;
 Describe the entity’s transactions, other events and conditions as simply and directly as possible;
 Highlight relationships between different pieces of information;
 Provide information in a format that is appropriate for its type;
 Provide information in a way that maximises, to the extent possible, comparability;
 Avoid or minimise duplication of information; and
 Ensure material information is not obscured by immaterial information.

Step 4
In the most important step, the entity then steps back and assesses the information provided in the draft financial
statements as a whole. It needs to consider whether the information is material both individually and in combination
with other information. This final assessment may lead to adding additional information or removing information
that is now considered immaterial, aggregating, disaggregating or reorganising information or even to begin the
process again from Step 2.

Guidance on materiality judgements in specific circumstances

The Practice Statement also offers some guidance on materiality judgements in specific circumstances. These are
prior-period information (including prior-period information not previously provided and summarising prior-period
information), errors (including cumulative errors), information about covenants, and materiality judgements for
interim reporting (including interim reporting estimates)

Application date: None. It can be applied with immediate effect.

IFRS 1: FIRST-TIME ADOPTION OF INTERNATIONAL REPORTING STANDARDS

A first-time adopter of IFRSs is an entity that presents IFRS financial statements for the first time, and fully complies
with the requirements of IFRSs.

The special requirements for a first-time adopter are set out in IFRS 1.
 A first-time adopter must adjust its statement of financial position produced under 'local GAAP' to a statement
of financial position produced using IFRSs.
 This adjustment should be made by 'retrospective application' of the IFRSs.
 In order to make adjustments to move from a statement of financial position prepared under local GAAP to a
statement of financial position prepared with IFRSs, a number of prior year adjustments must be made for all

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the accounting policy changes. These adjustments are made in the financial statements by adjusting the opening
reserves in the first-time adopter's opening IFRS statement of financial position. These adjustments are usually
made to the accumulated profits reserve (retained profits reserve).

Opening statement of financial position of a first-time adopter

The retrospective application of IFRSs means that adjustments are made to the first-time adopter's opening
statement of financial position. This is the entity's statement of financial position at the date of transition to IFRSs.
IFRS 1 defines the date of transition to IFRSs as 'the beginning of the earliest period for which an entity presents full
comparative information under IFRS in its first IFRS financial statements.'

IFRS 1 also states that an entity must use the same accounting policies in its opening IFRS statement of financial
position and throughout all the financial periods presented in its first IFRS financial statements. These should be the
IFRSs that apply as at the reporting date for the first IFRS financial statements (and any previous versions of IFRSs
that may have applied at earlier dates should not be used).

Example 1
A company was a first-time adopter of IFRS and prepared its first IFRS financial statements for the year to 31
December 2003. In its financial statements, it prepared comparative financial information for the previous financial
year.

The previous financial year is the year to 31 December 2004.

The date of transition to IFRS is the beginning of this period, which is 1 January 2004.
The opening IFRS statement of financial position of this first-time adopter is therefore 1st January 2004. The
adjustments made by retrospective application of IFRSs must therefore be made to a statement of financial
position as at this date.

Opening IFRS statement of financial position: exemptions from IFRSs

The general rule in IFRS 1 is that in the opening IFRS statement of financial position, a first-time adopter must:
 recognise all assets and liabilities whose recognition is required by IFRSs
 Not recognise assets or liabilities if IFRSs do not permit such recognition
 Re-classify items recognised under the previous GAAP as one type of asset, liability or component of equity if
IFRSs require that they should be classified differently
 Apply IFRSs in measuring all assets and liabilities.

Main exemptions from applying IFRS in the opening IFRS statement of financial position
(a) Property, plant and equipment, investment properties and intangible assets
 Fair value/previous GAAP revaluation may be used as a substitute for cost at date of transition to IFRSs.
(b) Business combinations
For business combinations prior to the date of transition to IFRSs:
 The same classification (acquisition or uniting of interests) is retained as under previous GAAP.
 For items requiring a cost measure for IFRSs, the carrying value at the date of the business combination is
treated as deemed cost and IFRS rules are applied from thereon.
 Items requiring a fair value measure for IFRSs are revalued at the date of transition to IFRS.
 The carrying value of goodwill at the date of transition to IFRSs is the amount as reported under previous
GAAP.

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(c) Employee benefits

 Unrecognised actuarial gains and losses can be deemed zero at the date of transition to IFRSs. IAS 19 is
applied from then on.
(d) Cumulative translation differences on foreign operations
 Translation differences (which must be disclosed in a separate translation reserve under IFRS) may be
deemed zero at the date of transition to IFRS. IAS 21 is applied from then on.
(e) Adoption of IFRS by subsidiaries, associates and joint ventures
If a subsidiary, associate or joint venture adopts IFRS later than its parent, it measures its assets and liabilities:
 Either: At the amount that would be included in the parent’s financial statements, based on the parent’s
date of transition
 Or: At the amount based on the subsidiary (associate or joint venture)’s date of transition.

Presentation and disclosure by a first-time adopter

IFRS 1 requires that a first-time adopter must include at least one year of comparative information in its first IFRS
financial statements. (This is why the date of transition to IFRS cannot be later than the beginning of the previous
financial year).

IFRS 1 also requires a first-time adopter to disclose the following reconciliations:

 A reconciliation of equity that was reported under the previous GAAP with the equity reported under IFRSs, for
both of the following dates: (1) the date of transition to IFRS and (2) the end of the last financial period in which
the entity presented its financial statements under the previous GAAP.
 For example, suppose that a first-time adopter presents just one year of comparative information, and prepared
its first IFRS financial statements for the year to 31 December 2005. The reconciliation of equity between 'old
GAAP' and IFRSs should be made for both 1 January 2004 and 31 December 2004.
 A reconciliation of the profit or loss reported under the previous GAAP and the profit or loss using IFRSs, for the
entity's most recent financial period before adopting IFRSs.
 If the entity recognises impairment losses for the first time in its opening IFRS statement of financial position, it
should provide the information that would have been required by IAS 36 Impairment of assets if the impairment
losses had been recognised in the financial period beginning with the date of transition to IFRS.

CONVERGENCE WITH IFRS AND IMPROVEMENTS TO IFRSS

International Harmonisation
Comparable, transparent, and reliable financial information is fundamental for the smooth functioning of capital
markets. In the global arena, the need for comparable standards of financial reporting has become paramount
because of the dramatic growth in the number, reach, and size of multinational corporations, foreign direct
investments, cross-border purchases and sales of securities, as well as the number of foreign securities listings on
the stock exchanges. However, because of the social, economic, legal, and cultural differences among countries, the
accounting standards and practices in different countries vary widely. The credibility of financial reports becomes
questionable if similar transactions are accounted for differently in different countries.

To improve the comparability of financial statements, harmonization of accounting standards is advocated.

Harmonization strives to increase comparability between accounting principles by setting limits on the alternatives
allowed for similar transactions. Harmonization differs from standardization in that the latter allows no room for
alternatives even in cases where economic realities differ.

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Advantages and disadvantages of harmonisation

There are some strong arguments in favour of the harmonisation of accounting standards in all countries of the
world, and in particular for the convergence of US GAAP and IFRSs.

However, there are also some arguments against harmonisation -even though these are probably not as strong as
the arguments in favour.

Advantages of harmonisation
1. Investors and analysts of financial statements can make better comparisons between the financial position,
financial performance and financial prospects of entities in different countries. This is very important, in view of
the rapid growth in international investment by institutional investors.
2. For international groups, harmonisation will simplify the preparation of group accounts. If all entities in the
group share the same accounting framework, there should be no need to make adjustments for consolidation
purposes.
3. If all entities are using the same framework for financial reporting, management should find it easier to monitor
performance within their group.
4. Global harmonisation of accounting framework may encourage growth in cross-border trading, because entities
will find it easier to assess the financial position of customers and suppliers in other countries.
5. Access to international finance should be easier, because banks and investors in the international financial
markets will find it easier to understand the financial information presented to them by entities wishing to raise
finance.

Disadvantages of harmonisation
1. National legal requirements may conflict with the requirements of IFRSs. Some countries may have strict legal
rules about preparing financial statements, as the statements are prepared mainly for tax purposes.
Consequently, laws may need re-writing to permit the accounting policies required by IFRSs.
2. Some countries may believe that their framework is satisfactory or even superior to IFRSs. This has been a
problem with the US, although currently is not as much of an issue as in the past.
3. Cultural differences across the world may mean that one set of accounting standards will not be flexible enough
to meet the needs of all users.

Convergence with US GAAP

The IASB and the US Financial Accounting Standards Board (FASB) have been working together since 2002 to achieve
convergence of IFRSs and US generally accepted accounting principles (GAAP).

A common set of high quality global standards remains a priority of both the IASB and the FASB.
In September 2002 the IASB and the FASB agreed to work together, in consultation with other national and regional
bodies, to remove the differences between international standards and US GAAP. This decision was embodied in a
Memorandum of Understanding (MoU) between the boards known as the Norwalk Agreement.

The boards’ commitment was further strengthened in 2006 when the IASB and FASB set specific milestones to be
reached by 2008 (A roadmap for convergence 2006 – 2008).

Norwalk Agreement (MoU)

At their joint meeting in Norwalk, Connecticut, USA on September 18, 2002, the Financial Accounting Standards
Board (FASB) and the International Accounting Standards Board (IASB) each acknowledged their commitment to the

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development of high-quality, compatible accounting standards that could be used for both domestic and cross-
border financial reporting.

To achieve compatibility, the FASB and IASB (together, the “Boards”) agree, as a matter of high priority, to undertake
a short-term project aimed at removing a variety of individual differences between U.S.
GAAP and International Financial Reporting Standards (IFRSs, which include International Accounting Standards,
IASs);

In 2008 the two boards issued an update to the MoU, which identified a series of priorities and milestones to
complete the remaining major joint projects by 2011, emphasising the goal of joint projects to produce common,
principle-based standards instead of 'rule based approach' followed by FASB.

Common conceptual framework

In October 2004 the IASB and FASB agreed to develop a common conceptual framework which would be a significant
step towards harmonisation of future standards. The project has been divided into two phases:
(a) The initial focus is on particular aspects of the frameworks dealing with objectives, qualitative characteristics,
elements, recognition, and measurement, giving priority to issues affecting projects for new/ revised Standards.
(b) Later, they will consider the applicability of those concepts to other sectors, beginning with not for profit entities
in the private sector.

Memorandum of understanding
In February 2006, the two Boards signed a 'Memorandum of Understanding'. This laid down a 'roadmap of
convergence' between IFRSs and US GAAP in the period 2006-2008.

The aim was to remove by 2009 the requirement for foreign companies reporting under IFRSs listed on a US stock
exchange to have to prepare a reconciliation to US GAAP.

Events moved faster than expected, and in November 2007 the US Securities and Exchange Commission (SEC)
decided to allow non-US filers to report under IFRSs for years ended after 15 November 2007 with no reconciliation
to US GAAP.

Consultation is also underway on the possibility of the use of IFRSs by US filers. In November 2008, the SEC published
a proposal, titled Roadmap for the Potential Use of Financial Statements Prepared in accordance with International
Financial Reporting Standards by U.S. Issuers. The proposed roadmap sets out milestones that, if achieved, could
lead to the adoption of IFRSs in the US in 2014.

It also proposes to permit the early adoption of IFRSs from 2010 for some US entities.

FASB/IASB projects
Some of the main results of the convergence project between FASB and the IASB have been:
(a) The issue of IFRS 5 Non-current assets held for sale and discontinued operations
(b) The issue of IFRS 8 Operating segments
(c) Revision of IAS 23 Borrowing costs, to align with US GAAP
(d) Revision of IAS 1 Presentation of financial statements and an agreement on common wording to be used in
accounting standards
(e) Revision of IFRS 3 Business combinations and IAS 27 Consolidated and separate financial statements

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(f) The issue of IFRS 9 Financial instruments, exposure drafts on impairment and hedging
(g) There are also Discussion Papers, Exposure drafts or completed/revised IFRSs on the following topics:
i. Conceptual Framework
ii. Financial statements presentation
iii. Leases
iv. Revenue Recognition
v. Fair value measurement
vi. Income taxes
vii. Pension accounting

IAS 21 – DOES IT NEED AMENDING

The International Accounting Standards Board (IASB) recently initiated a research project, which examined a
previous research. This research considered whether any work on IAS 21, The Effects of Changes in Foreign Exchange
Rates, was appropriate. The following text looks at some of the issues raised by the project in the context of IAS 21.
The foreign exchange market is affected by many factors, and in countries with a floating exchange rate, their foreign
exchange rates are inevitably exposed to volatility due to the effects of the different factors influencing the market.
For example, the ongoing problem of Greece repaying its enormous debts has significantly affected the value of the
euro.

As the barriers to international flows of capital are further relaxed, the volatility of the foreign exchange market is
likely to continue. This volatility affects entities that engage in foreign currency transactions and there has been a
resultant call in some quarters to amend IAS 21.

IFRS 7, Financial Instruments: Disclosure requires disclosure of market risk, which is the risk that the fair value or
cashflows of a financial instrument will fluctuate due to changes in market prices. Market risk reflects, in part,
currency risk. In IFRS 7, the definition of foreign currency risk relates only to financial instruments. IFRS 7 and IAS 21
have a different conceptual basis. IFRS 7 is based upon the distinction between financial/non-financial elements,
whereas IAS 21 utilises the monetary/non-monetary distinction.

The financial/non-financial distinction determines whether an item is subject to foreign currency risk under IFRS 7,
whereas translation in IAS 21 uses monetary/non-monetary distinction, thereby possibly causing potential
conceptual confusion. Foreign currency risk is little mentioned in IAS 21 and on applying the definition in IFRS 7 to
IAS 21, non-financial instruments could be interpreted as carrying no foreign currency risk. Under IAS 21, certain
monetary items include executory contracts, which do not meet the definition of a financial instrument. These items
would be translated at the closing rate, but as such items are not financial instruments, they could be deemed not
to carry foreign currency risk under IFRS 7.

Foreign currency translation should be conceptually consistent with the conceptual framework. IAS 21 was issued in
1983 with the objective of prescribing how to include foreign currency transactions and foreign operations in the
financial statements of an entity and how to translate financial statements into a presentation currency.

There is little conceptual clarification of the translation requirements in IAS 21. The requirements of IAS 21 can be
divided into two main areas: the reporting of foreign currency transactions in the functional currency; and the
translation to the presentation currency. Exchange differences arising from monetary items are reported in profit or
loss in the period, with one exception which is that exchange differences arising on monetary items that form part

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of the reporting entity’s net investment in a foreign operation are recognised initially in other comprehensive
income, and in profit or loss on disposal of the net investment.

However, it would be useful to re-examine whether it is more appropriate to recognise a gain or loss on a monetary
item in other comprehensive income instead of profit or loss in the period and to define the objective of translation.
Due to the apparent lack of principles in IAS 21, difficulty could arise in determining the nature of the information to
be provided on translation.

There is an argument that the current accounting standards might not reflect the true economic substance of long-
term monetary assets and liabilities denominated in foreign currency because foreign exchange rates at the end of
the reporting period are used to translate amounts that are to be repaid in the future. IAS 21 states that foreign
currency monetary amounts should be reported using the closing rate with gains or losses recognised in profit or
loss in the period in which they arise, even when the rate is abnormally high or low.

There are cases where an exchange rate change is likely to be reversed, and thus it may not be appropriate to
recognise foreign exchange gains or losses of all monetary items as realised gains or losses. Thus there is an argument
that consideration should be given as to whether foreign exchange gains or losses should be recognised in profit or
loss or in other comprehensive income (OCI) based on the distinction between current items and non-current items.
Any potential fluctuation in profit or loss account would be reduced by recognising in OCI those foreign exchange
gains or losses of non-current items with a high possibility of reversal. Furthermore, the question would arise as to
whether these items recognised in OCI could be reclassified.

However, the IASB is currently determining via its conceptual framework project the purpose and nature of OCI, as
there is no obvious principle that drives gains and losses out of profit or loss and into OCI, and there is no shared
view among the IASB’s constituents about what should be in profit or loss and what should be in OCI.

IAS 21 does provide some guidance on non-monetary items by stating that when a gain or loss on a non-monetary
item is recognised in OCI, any exchange component of that gain or loss shall be recognised in OCI.

Conversely, when a gain or loss on a non-monetary item is recognised in profit or loss, any exchange component of
that gain or loss shall be recognised in profit or loss.

Long-term liabilities
In the case of long-term liabilities, although any translation gains must be recognised in profit or loss, and treated as
part of reported profit, in some jurisdictions, these gains are treated as unrealised for the purpose of computing
distributable profit.

The reasoning is that there is a greater likelihood in the case of long-term liabilities that the favourable fluctuation
in the exchange rate will reverse before repayment of the liability falls due.

As stated already, IAS 21 requires all foreign currency monetary amounts to be reported using the closing rate; non-
monetary items carried at historical cost are reported using the exchange rate at the date of the transaction and
non-monetary items carried at fair value are reported at the rate that existed when the fair values were determined.
As monetary items are translated at the closing rate, although the items are not stated at fair value, the use of the
closing rate does provide some fair value information. However, this principle is not applied to non-monetary items

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as, unless an item is measured at fair value, the recognition of a change in the exchange rate appears not to provide
useful information.

A foreign operation is defined in IAS 21 as a subsidiary, associate, joint venture, or branch whose activities are based
in a country or currency other than that of the reporting entity. Thus the definition of a foreign operation is quite
restrictive. It is possible to conduct operations in other ways; for example, using a foreign broker. Therefore, the
definition of a foreign operation needs to be based upon the substance of the relationship and not the legal form.

Although the exchange rate at the transaction date is required to be used for foreign currency transactions at initial
recognition, an average exchange rate may also be used. The date of a transaction is the date on which the
transaction first qualifies for recognition in accordance with International Financial Reporting Standards. For
practical reasons, a rate that approximates to the actual rate at the date of the transaction is often used. For
example, an average rate for a week or a month might be used for all transactions in each foreign currency occurring
during that period. However, if exchange rates fluctuate significantly, the use of the average rate for a period is
inappropriate.

Average exchange rate

A question arises as to which exchange rate to use and therefore it would be useful to have more specific guidance
on the use of the average exchange rate. IAS 21 allows a certain amount of flexibility in calculating the average rate.
The determination of the average rate depends upon factors such as the frequency and value of transactions, the
period over which the rate will apply and the nature of the entity’s systems. There are a large number of methods
that can be used to calculate the average rate, but no guidance is given in IAS 21 as to how such a rate is determined.
The IASB has completed its initial assessments on this project and decided that narrow scope amendments were
unnecessary. In May 2015, it had no plans to undertake any additional work and is to remove this project from the
research programme, subject to feedback in the next agenda consultation.

THE IASB’S PRINCIPLES OF DISCLOSURE INITIATIVE

The International Accounting Standards Board (IASB) has published a comprehensive discussion paper (DP) setting
out the Board's preliminary views on disclosure principles that should be included in a general disclosure standard
or in or in non-mandatory guidance on the topic.

Background
For the years 2017-2021 the IASB has chosen "Better communication" as its central theme, and in addition to the
primary financial statements project and the IFRS Taxonomy this also includes the disclosure initiative. A related
project is also the Conceptual Framework project. In fact, some concepts and financial reporting issues have been
moved back and forth between different projects of this group.

The disclosure initiative itself is made up of a number of projects:

 Amendments to IAS 1 to remove barriers to the exercise of judgement and amendments to IAS 7 to improve
disclosure of liabilities from financing activities have already been completed.
 Guidance on the application of materiality has been split into two projects and will see a final practice
statement and an exposure draft of proposed amendments to IAS 1 and IAS 8 published in June.

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The IASB's project on the principles of disclosure

The objective of the principles of disclosure project is to help preparers to communicate information more
effectively, to improve disclosures for users of financial statements, and to help the Board to develop disclosure
requirements in standards. Since IAS 1 Presentation of Financial Statements contains general requirements for
disclosures in the financial statements, the project uses the IAS 1 requirements as a starting point to see whether
parts of IAS 1 can be amended to reach the project's objective or whether a new disclosure standard should be
developed to replace parts of IAS 1 (both options a subsumed under the expression "general disclosure standard"
throughout the DP).

Summary of main proposals

Contents. The DP contains 110 pages and is divided into eight sections accompanied by an appendix. The paper is
preceded by an executive summary describing the reasons behind publishing the DP, its reach, the main content of
the document, the preliminary views of the Board, the terminology used, and the next steps. The paper itself is
structured as follows:
Section Topic
1 Overview of the ‘disclosure problem’ and the objective of this project
2 Principles of effective communication
3 Roles of the primary financial statements and the notes
4 Location of information
5 Use of performance measures in the financial statements
6 Disclosure of accounting policies
7 Centralised disclosure objectives
New Zealand Accounting Standards Board staff’s approach to drafting disclosure requirements in IFRS
8
Standards
Appendix Illustration of applying Method B in Section 7

The key issues dealt with in each section are summarised below.
Section 1 (Overview of the ‘disclosure problem’ and the objective of this project). The first section offers
background information on the disclosure initiative and discusses the "disclosure problem" that demonstrates the
need for principles of disclosure. The section also outlines the objective of the project and the DP and describes the
interactions with the other IASB projects.

Section 2 (Principles of effective communication). The core of this section are the principles the Board believes
entities should apply when preparing financial statements. Seven principles are identified ranging from the principle
that the information provided should be entity-specific to avoid generic, ‘boilerplate’ language or information to the
principle that the information should be provided in a format that is appropriate for that type of information. Except
for one, these principles were originally included in the 2013 Conceptual Framework DP. The Board has come to the
conclusion that these principles should be provided either in a general disclosure standard or in non-mandatory
guidance on the topic, not in the Conceptual Framework. New is the principle on formatting as the Board has
received feedback that more effective use of formatting would improve how entities communicate information.

Section 3 (Roles of the primary financial statements and the notes). This section contains a discussion of the roles
of the different financial statements as the Board has received feedback that information in the primary financial
statements is used more frequently and is subject to more scrutiny from users, auditors, and regulators. Entities also
state that they find it difficult to decide what information should be presented in the primary financial statements

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instead of being disclosed in the notes, not least because of the inconsistent use of the terms ‘present’ and ‘disclose’
in IFRSs. Therefore, this section identifies and describes the role of the primary financial statements based on the
objective of financial statements in the 2015 Conceptual Framework ED and sets out the implications of that role. It
also describe the role and content of the notes based on the proposals in the Conceptual Framework ED. The Board
has also concluded that going forward it will also specify the intended location as being either ‘in the primary
financial statements’ or ‘in the notes’ when it uses the terms 'present' or 'disclose' to indicate a location.

Section 4 (Location of information). This section discusses providing information that is necessary to comply with
IFRSs outside the financial statements and providing non-IFRS information within the financial statements. The
Board’s preliminary view is that a general disclosure standard should include a principle that an entity can provide
information that is necessary to comply with IFRSs outside of the financial statements if the information it is provided
within the entity’s annual report and this location makes the annual report as a whole more understandable and if
is clearly cross-referenced. Similarly, the Board has concluded that a general disclosure standard should not prohibit
an entity from including non-IFRS information in its financial statements as long as such information is clearly
identified as not being prepared in accordance with IFRSs and the entity explains why the information is useful and
has been included.

Section 5 (Use of performance measures in the financial statements). The fifth section is dedicated to the fair
presentation of performance measures in the financial statements. The Board’s preliminary views are that the
presentation of an EBITDA subtotal using the nature of expense method and the presentation of an EBIT subtotal
under both a nature of expense method and a function of expense method comply with IFRSs if such subtotals are
relevant to an understanding of the financial statements. The Board also believes that it should develop guidance in
relation to the presentation of unusual or infrequently occurring items. However, the Board notes that both issues
(EBITDA/EBIT and unusual items) will be dealt with within the Board’s project on primary financial statements. On
fair presentation of performance measures, the Board notes that this information must be displayed with equal or
less prominence than the line items in the primary financial statements, reconciled to the most directly comparable
IFRS measure, accompanied by an explanation of its relevance and reason, be neutral, free from error and clearly
labelled, include comparative information, be classified, measured and presented consistently, and indicate whether
it has been audited. This is entirely in line with guidelines already published by various securities regulators but now
finds its way into IFRS literature.

Section 6 (Disclosure of accounting policies). In this section, the IASB takes a closer look at how entities should
disclose their accounting policies. The Board’s preliminary views are that a general disclosure standard should
include requirements to explain the objective of providing accounting policy disclosures. It should describe the
categories of accounting policies, which are accounting policies that are always necessary for understanding
information in the financial statements, accounting policies that also relate to items, transactions or events that are
material to the financial statements, and any other accounting policies. The Board has also come to the conclusion
that there are alternatives for locating accounting policy disclosures, but that it can be presumed that entities
disclose information about significant judgements and assumptions adjacent to disclosures about related accounting
policies.

Section 7 (Centralised disclosure objectives). This section discusses the development of a central set of disclosure
objectives that consider the objective of financial statements and the role of the notes. Such centralised objectives
could be used by the Board as a basis for developing disclosure objectives and requirements in standards that are
more unified and better linked to the overall objective of financial statements. The DP identifies two methods that
could be used for developing centralised disclosure objectives: Method A would entail focusing on the different

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types of information disclosed about an entity’s assets, liabilities, equity, income and expenses; Method B focusing
on information about an entity’s activities. The appendix to the DP provides two examples that illustrate the
application of Method B to develop disclosure objectives and requirements. The DP notes that Board has not yet
formed any preliminary views about the two methods. Finally, the DP asks whether respondents think that the Board
should consider locating all disclosure objectives and requirements in IFRSs within a single standard (or set of
standards) for disclosures.

Section 8 (New Zealand Accounting Standards Board staff’s approach to drafting disclosure requirements in IFRS
Standards). The eighth section describes an approach that has been developed by the staff of the NZASB for drafting
disclosure objectives and requirements in IFRSs. The main features of the approach are: an overall disclosure
objective for each standard with subobjectives for each type of information required, a two-tier approach that would
see the amount of information provided depend on the relative importance of an item or transaction to the reporting
entity, greater emphasis on the need to exercise judgement, and less prescriptive wording in disclosure
requirements. The DP notes that Board has not yet formed any views about the approach but would nevertheless
welcome feedback as it could be used in the project on standards-level review of disclosures.

DISCLOSURE INITIATIVE (AMENDMENTS TO IAS 1)

Background
As a result of the IASB’s Agenda Consultation 2011, the IASB received a request to review the disclosure
requirements within the existing standards and to develop a disclosure framework.

The IASB has considered elements of presentation and disclosure as part of its revision of the Conceptual Framework
for Financial Reporting. In addition, and to complement the work being done in relation to the Conceptual
Framework project, the IASB started its Disclosure Initiative project during 2013. The Disclosure Initiative is a
portfolio of projects affecting existing IFRSs, as well as other implementation and research projects.

The amendments to IAS 1 have resulted predominately from decisions made during the Disclosure Initiative project,
with one additional proposal, regarding the presentation of an entity’s share of other comprehensive income (OCI)
from equity accounted interest in associates and joint ventures, arising from a submission received by the IFRS
Interpretations Committee.

Summary of the proposals

The amendments made to IAS 1 are designed to address concerns expressed by constituents about existing
presentation and disclosure requirements and to encourage entities to use judgement in the application of IAS 1
when considering the layout and content of their financial statements.

In addition, an amendment is made to IAS 1 to clarify the presentation of an entity’s share of other comprehensive
income (OCI) from its equity accounted interests in associates and joint ventures. The amendment requires an
entity’s share of other comprehensive income to be split between those items that will and will not be reclassified
to profit or loss, and presented in aggregate as single line items within those two groups.

This would result in amendments to various paragraphs of IAS 1:

 Materiality and aggregation (paragraphs 29 to 31)

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 Statement of financial position (paragraphs 54 to 55A), and statement of profit or loss and other comprehensive
income (paragraphs 82 and 85 to 85B)
 Notes to the financial statements (paragraphs 112 to 116)
 Accounting policies (paragraphs 117 to 121)
 Equity accounted investments (paragraph 82A).

Materiality and aggregation

Information is not to be aggregated or disaggregated in a manner that obscures material information and reduces
the understandability of financial statements (e.g. aggregating items that have different natures or functions or
overwhelming useful information with immaterial information)

Materiality applies to all four primary financial statements and the notes to the financial statements.

Even when a standard contains a list of specific minimum disclosure requirements, preparers need to assess whether
each required disclosure is material, and consequently whether presentation or disclosure of that information is
warranted. This combines with the existing definition of materiality in IAS 1.7, which requires consideration of items
both individually and collectively, because a group of immaterial items may, when combined, be material. Preparers
also need to consider whether particularly significant items mean that disclosures, in addition to minimum
requirements specified in IFRSs, are required to provide an appropriate amount of information.

Statement of financial position, and statement of profit or loss and other comprehensive income
It is clarified that the requirements to present specific line items in the ‘statement of profit or loss and other
comprehensive income’ and ‘statement of financial position’ can be met by disaggregating these line items if this is
relevant to an understanding of the entity’s financial position and performance.

New requirements are introduced when an entity presents subtotals in primary statements in accordance with IAS
1.55 and 85. The amendments clarify that additional subtotals must be made up of items recognised in accordance
with IFRSs, need to be presented and labelled in a manner that makes the subtotals understandable and consistent
from period to period, and are not permitted to be displayed with more prominence than the subtotals and totals
required by IFRSs.

Notes
It is emphasised that understandability and comparability of financial statements should be considered by an entity
when deciding the order in which the notes are presented.

It is clarified that entities have flexibility for the order of the notes, which do not necessarily need to be presented
in the order listed in IAS 1.114 (e.g. it may be decided to give more prominence to areas that the entity considers to
be most relevant to its financial performance and position, such as grouping together

Disclosure of accounting policies

The examples in IAS 1.120 of accounting policies for income taxes and foreign exchange gains and losses have been
removed, because the examples were unclear about why a user of financial statements would always expect these
specific policies to be disclosed.

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Equity accounted investments

This amendment clarifies the presentation of an entity’s share of other comprehensive income (OCI) from equity
accounted associates and joint ventures.

The amendment would require entities to include two separate line items in OCI for those items, being amounts that
will and will not be reclassified to profit or loss.

What the amendments mean

Respondents to the IASB’s Agenda Consultation 2011 asked the IASB to review the disclosure requirements of
existing IFRSs and to develop a disclosure framework. A number of these requests arose from the increasing length
of many financial statements prepared in accordance with IFRS, and disclosure overload in those financial
statements.

In 2013, to complement work being carried out to revise the Conceptual Framework, the IASB started its Disclosure
Initiative. This is made up of a number of short and medium term projects, and on-going activities, which are looking
at how to improve presentation and disclosure principles in existing IFRSs.

The materiality requirements of IAS 1 have been amended to emphasise that information should not be aggregated
or disaggregated in a way that obscures material information. The changes also highlight that materiality applies to
all aspects of financial statements, including the primary financial statements, the notes and specific disclosures
required by individual IFRSs. The purpose is to encourage entities (and others involved in the preparation and review
of financial statements) to give careful consideration to presentation requirements, and to the items that need to
be included in financial statements.

The content of primary statement line items has been clarified, including that as well as aggregating immaterial
items, individual lines that contain significant items may need to be disaggregated. Additional guidance has also
been added for the use of subtotals, requiring that these are derived using amounts that are reported in accordance
with IFRS.

The amendment related to the submission to the IFRS Interpretations Committee and addresses uncertainty about,
and diversity in, the presentation of an entity’s share of other comprehensive income (OCI) from equity accounted
associates and joint ventures. The effect is to include two separate line items in OCI for items that will, and for items
that will not, be reclassified to profit or loss.

What should entities do in response to the amendments?

Disclosure overload and the increased complexity of financial reporting have been key drivers in the IASB’s decision
to start its Disclosure Initiative. The amendments are designed to encourage entities to improve the
understandability, comparability and clarity of their financial statements.

Although the amendments do not introduce many new requirements to IAS 1 (and are not inconsistent with its
existing guidance), they would encourage additional thought to be given to the content and layout of financial
statements. Entities may wish to revisit:
 Their application of materiality
 The level of aggregation and disaggregation of line items in the financial statements
 The use of subtotals
 Presenting information in an orderly and logical manner

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 The order of the notes to the financial statements

 The content and presentation of accounting policies
 The amount of information to disclose for material transactions so that the economic substance of the
transaction can be adequately explained
 Which accounting policies are significant to users of financial statements in understanding specific transactions?

The focus on disclosing material and relevant information are likely to require ongoing application of judgement.
Entities may also consider engagement with their auditors and shareholders as part of their process of determining
which disclosures are material and relevant for the current reporting period.

Entities with interests in associates and/or joint ventures should note that the amendments may result in a different
presentation of items within OCI.

FUTURE TRENDS IN SUSTAINABILITY REPORTING

Global Reporting Initiative (GRI) and international think tank and strategic advisory firm SustainAbility have
published the latest insights from the GRI Corporate Leadership Group on Reporting 2025 which explored four key
trends fundamental to the UN Sustainable Development Goals: climate change, human rights, wealth inequality,
and data and technology.

ContentThe insights, captured in the report Future Trends in Sustainability Reporting provide practical guidance to
reporting organizations working to respond to the risks and opportunities that we face on our path to a sustainable
future.

The publication presents key information on each sustainability trend. Highlights from the report include:
Climate change: There was clear consensus in the group that it is not a matter of if business should or can act on
climate change but how, and how fast they deliver change. Companies are solution providers: they are expected to
be part of the solutions, from new energy models to efficiencies in the production and distribution of goods.
Furthermore, clear and ambitious science-based targets are needed, and greater company and country engagement
is expected.

Human rights: Expectations of corporate reporting on the many facets of human rights are growing: human rights
due diligence is now the expected minimum. Investors, rating agencies and regulators are increasingly seeking this
information. Key human rights issues set to receive greater focus include labor rights and issues linked to natural
resources. The group highlighted that modern slavery is a new form of severe labor abuse and is leading to a broader
movement from a focus on audit and compliance to due diligence and collaboration. Conflict over natural resource
wealth is also becoming a more recognized issue with land rights increasingly disputed.

Wealth inequality: Various challenges for business related to wealth inequality were discussed, including radically
increasing the share of value captured by workers and small-scale producers - for instance, achieving living wages
for laborers and living incomes for small-scale producers. Eliminating economic gender inequality and gender
discrimination is also becoming a key issue, as is tackling the race-to-the-bottom on public governance to attract
investment. Calls to end the era of tax havens are increasingly expected, and breaking market concentration and
addressing the unequal distribution of power will become imperative.

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Data and Technology: When it comes to corporate reporting, data and technology are often seen as an opportunity
and a challenge in equal measure. Challenges include securing sufficient internal buy-in; promoting the culture and
creating awareness for good use of the internal systems that deliver high-quality, comparable data; lack of
availability of sensitive and confidential data; and a need for more analytical tools to better understand data.
Opportunities include online reporting; embedding sustainability data into targets and performance management
systems; monitoring and providing feedback loops to data providers; and better understanding the dynamics and
other demands on the data to improve the information channels and lower the burden for colleagues.

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CROWDFUNDING AND IMPAIRMENT OF FINANCIAL INSTRUMENTS

This article addresses the application of accounting principles in contemporary contexts (an exam technique issue)
and the impairment of financial instruments (a technical knowledge issue).

Applying accounting principles to different contexts

Many candidates perceive accounting to be a technical practice and believe that SBR tests ‘how you do accounting’.
While some of this is true, SBR also tests the application of accounting principles in different contexts because
accounting is fundamentally a social practice, which guides and influences the behaviour of people in organisations
and society. As such, accounting needs to be studied and understood in the contexts within which it operates. The
SBR syllabus therefore focuses on the concepts, principles and practices that underpin the preparation and
interpretation of corporate reports in different contexts (including ethical contexts). This is because the application
of knowledge is a skill that employers’ value and therefore seek… after all, an employer will not present you with a
problem that has already been solved or one that you have seen before. Understandably, candidates struggle with
this because they are expected to be able to use knowledge in new situations, make connections, explore outcomes
and generate ideas.

Crowdfunding
SBR candidates should be prepared for exam questions to test accounting concepts within different accounting
contexts that they may not necessarily have encountered before. This section considers crowdfunding as one such
context and describes the process that candidates should go through to apply their knowledge to this particular
context.

Crowdfunding is the funding of a new start-up or project by collecting cash from a variety of individuals/entities
often via the Internet. There are 4 common ways of raising funds:
 Equity-based crowdfunding: The equity-based approach is targeted at investors who receive shares in the new
company.
 Debt-based crowdfunding: With debt-based crowdfunding, a contributor makes a loan to a business that’s
looking to crowdfund, with the intention of subsequently being repaid with interest.
 Reward-based crowdfunding: This involves promising specific items (rewards) to contributors before the launch
of a new project, product, or business. A reward-based campaign isn’t generally targeted at contributors who
are looking to profit from their investment but at those who want to own a new product.
 Donation-based crowdfunding: Contributors make 'donations' to a project or company and may receive existing
‘rewards’ in return. Some forms of donation-based crowdfunding don’t involve any sort of reward as donors
wish to contribute to further a particular cause.

Considerations
Using the question scenario, candidates would be expected to breakdown a scenario and understand the
information provided – ie candidates may not have considered the crowdfunding context before, however, they
should be able to understand the accounting implications of the four options above. They should be able to apply
their knowledge to the context provided; for example, if the crowdfund is considered to be a debt instrument it will
fall within the scope of IFRS 9, Financial Instruments, whereas if it gives rise to an issue of capital, it will fall within
the scope of IAS 32, Financial Instruments Presentation.

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If the crowdfunding campaign involves the issuing of ‘rewards’, then IFRS 15, Revenue from Contracts with
Customers, should be used to determine when to recognise revenue. For each performance obligation, the company
will need to determine whether the performance obligation is satisfied over time (ie control of the good or service
transfers to the customer over time). If one or more of the criteria in IFRS 15 are met, then the company recognises
revenue over time. If none of the criteria is met, then control transfers to the customer at a point in time and the
company recognises revenue at that point in time. However, if the company cannot reasonably measure the
outcome but expects to recover the costs incurred in satisfying the performance obligation, then it recognises
revenue to the extent of the costs incurred.

EXAMPLE
On 1 September 20X9, Burnett Co decided to undertake a crowdfunding campaign to finance the production of a
new racing bike, the Cracken. They made a short film with famous cyclists which set out the qualities of the Cracken
bike and posted it on the PeddleStarter crowdfunding platform. The campaign raised $4 million on which
PeddleStarter charged 7% commission. The contributors to the crowdfunding campaign were promised a reward of
1 Cracken bike for every $4,000 dollars contributed. At the financial year end of 31 December 20X9, Burnett Co had
manufactured only 50 Cracken bikes at a total cost of $240,000 but none had been delivered to contributors. There
was some doubt as to the capability of the company to develop, manufacture, and deliver the bikes promised but
Burnett Co is sure that the funding will cover any costs incurred.

Suggested answer:
IFRS 15, Revenue from Contracts with Customers, should be used to determine when to recognise revenue. At 31
December 20X9, it is difficult to know what the outcome will be as only 50 bikes have been manufactured out of a
promised 1000 bikes ($4 million/$4000) and there is a doubt as to whether the company has the capability to
develop, manufacture, and deliver the bikes promised. However, Burnett Co expects to recover the costs incurred
in satisfying the performance obligation, thus it will recognise revenue to the extent of the costs incurred to date
$520,000 ($240,000 + commission $280,000) as at 31 December 20X9. The balance remaining from the crowd funded
amount will be shown as accrued revenue in the financial statements ($3,480,000). The commission ($280,000)
would be charged against profit or loss for the period.

Guidance
Many SBR candidates may now have some extra time to reflect and rethink values, concerns and routines, one of
which may be their approach to study. It may be a time to not focus on accounting techniques but on accounting
principles, to maybe read around the subject and gain an understanding of what lies behind it. Remember the
following:
 The importance of a robust conceptual framework
 An understanding that rules will not be able to cover all situations
 Use of reasonable judgement is always needed in the decision-making process

To further help understand what is expected of you, SBR candidates should read all of the examiner’s reports that
are available at each exam diet; for example, the examiner’s report for March 2020 observed that there was a lack
of knowledge of some basic accounting concepts and many candidates did not have an understanding of ‘equity
accounting’. A significant number of candidates did not know that ‘the investment is initially recognised at cost and
adjusted thereafter for the post-acquisition change in the investor's share of the investee's net assets.’ If candidates
do not understand the basics, it will be almost impossible to apply that knowledge to different accounting contexts.

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Therefore, it is important that the basic principles of Financial Reporting (FR) are understood by
candidates before attempting the SBR exam. See ‘Stepping up from Financial Reporting’ for more information.

The impairment of financial instruments

One technical area of the SBR syllabus that candidates often struggle with is the impairment rules of IFRS 9, Financial
Instruments. IFRS 9 uses an Expected Credit Loss (ECL) model which requires a calculation of the expected value
decrease in a financial asset. Essentially, a provision is required for expected credit losses on the financial asset over
a period of time. Expected losses should be discounted to the reporting date using the effective interest rate of the
financial asset that was determined at initial recognition.

The impairment model of IFRS 9 introduces a three-stage approach:

 Stage 1 deals with financial instruments that have not had a significant increase in credit risk since they were
first recognised or that have low credit risk at the financial year end. For these assets, 12-month ECL are
recognised which means that the entity has to calculate the expected losses in the next 12 months taking into
account the risk of default. Any interest revenue is calculated on the gross carrying amount of the asset without
the deduction of the credit loss.
 Stage 2 deals with financial instruments that have had a significant increase in credit risk since they were first
recognised unless the credit risk is still low at the financial year end. These instruments are not credit-impaired.
The expected losses over the life of the financial instrument are recognised (lifetime ECL) taking into account
the risk of default. Interest revenue is still calculated on the gross carrying amount of the asset.
 Stage 3 deals with financial assets that are credit-impaired, which is where events have occurred that have a
detrimental impact on the estimated future cash flows from the financial asset. For these assets, lifetime ECL
are also recognised. However, interest revenue is calculated on the carrying amount less the ECL allowance.

EXAMPLE
On 1 January 20X6, Lunar Co granted Skyzer Co a $5 million secured loan repayable on 31 December 20X9 with an
interest rate of 3% payable annually at the reporting date.

Stage 1 Stage 2 Stage 3

On 31 December 20X6, there On 31 December 20X7, the On 31 December 20X8, the loan
has been no increase in credit credit risk of the loan has is credit impaired. The
risk and the probability of increased significantly. estimated present value that is
default in the next 12 months is expected to be recovered (less
5%. The present value of the The probability of default costs) is $4 million.
cash shortfalls expected over occurring over the remaining
the life of the instrument if the life of the loan is 45%. The The gross carrying amount of
default occurs in the next 12 present value of ECLs from the loan is $5,150,000 which is
months is $200,000. default events over the life of the loan plus unpaid interest
the loan are expected to be for the year.
$400,000.

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12-month ECLs = $10,000 Lifetime ECLs = $180,000 Lifetime ECLs = $1.15 million
($200,000 × 5%). ($400,000 × 45%) ($5.15 – $4) million

Interest revenue = $150,000 The change of $170,000 in the The change of $970,000
(3% × $5m – ie no adjustment cumulative impairment ($1.15–$0.18)m in the
for any loss allowance). allowance is recognised in cumulative impairment
profit or loss. allowance is recognised in
profit or loss.
Interest revenue = $150,000
(3% × $5m – ie no adjustment 20X9 interest revenue =
for any loss allowance). $120,000 (3% × $4 million)
which is based on gross
carrying amount minus loss
allowance.

For trade receivables or contract assets that do not contain a significant financing component, the loss allowance
should be measured, at initial recognition and throughout the life of the receivable, at an amount equal to lifetime
ECL. As an exception to the general model, if the credit risk of a financial instrument is low at the reporting date,
management can measure impairment using 12-month ECL, and so it does not have to assess whether a significant
increase in credit risk has occurred.

Guidance
If you are struggling with a technical issue in the SBR syllabus, try to pair it back to basic principles that you can use
in any context. For example, the suggested solution above relies on an understanding of the accounting principles
that apply at each stage of credit impairment. Understanding and applying these principles in an exam context will
demonstrate a deep understanding of the issue and an ability to apply it to the question scenario. It is these skills
that employers are looking for and examiners will award marks for.

Conclusion
This article addresses two issues that SBR candidates have struggled with in recent exam diets; one relates to exam
technique and the other a more technical issue.

Finally, a plea for SBR candidates to answer all parts of all questions. Please help the examining team to pass you!

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BUSINESS COMBINATIONS, SHARE-BASED PAYMENTS AND ACCOUNTING

CONSIDERATIONS OF A PANDEMIC OR NATURAL DISASTER

This article identifies the kinds of 'control' issues that candidates should be considering when constructing their
response to such exam questions. It also reflects upon how share-based payments should be accounted for when
they are made as part of the purchase consideration for a subsidiary in a business combination.

Finally, it uses the Covid-19 pandemic as a context within which to consider what IFRS standards might be applicable
to reporting entities and why.

Recent examiner reports have stated that SBR candidates often do not provide an effective consideration of whether
or not control has been obtained by the acquirer in a business combination.

This article therefore identifies the kinds of 'control' issues that candidates should be considering when constructing
their response to such exam questions. It also reflects upon how share-based payments should be accounted for
when they are made as part of the purchase consideration for a subsidiary in a business combination.
Finally, it uses the Covid-19 pandemic as a context within which to consider what IFRS standards might be applicable
to reporting entities and why.

Business combinations

Revision of the basic principles of consolidation

When answering SBR exam questions that test control, candidates don’t often focus on the inter-related principles
of control despite the fact that the requirement asks them to do so. Control is not simply a matter of owning more
than 50% of the voting share capital of an entity and consideration of the individual elements of control in isolation
can give rise to the conclusion, incorrectly, that almost any ‘involvement’ with another entity creates a controlling
relationship. However, it is important to note that the three criteria that define control (considered below) are inter-
related and that all three must be present to conclude that the acquirer (investor) has control of the subsidiary.

IFRS 10 Consolidated Financial Statements (para 7) states that an investor controls an investee when the investor
has all of the following:
i. Power over the investee
ii. Exposure, or rights, to variable returns from its involvement with the investee, and
iii. The ability to use its power over the investee to affect the amount of the investors returns

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The following table considers each of the control criteria and identifies issues that candidates need to apply to the
SBR exam question scenario to identify whether (or not) control has been transferred to the acquirer:

Control criteria (IFRS 10) Considerations to apply to the SBR exam question scenario:

Power over the investee  Owning a majority of the voting rights is not always necessary to have
control. Instead, control requires that the investor’s power/rights are
sufficient for it to unilaterally direct the relevant activities that most
affect the investee’s returns. For example, SBR candidates should
consider who makes the operating, financing and capital decisions, and
who appoints key management personnel.

 More analysis and judgement is required to determine whether an

investor with a significant minority of voting or other rights has control.
For example, power over an investee can still exist even when another
entity has significant influence and SBR candidates must be prepared to
consider this.

Exposure or rights to variable  Returns should be interpreted broadly, for example, to include synergy
returns benefits as well as financial returns

 Returns can be negative or positive

 A right to returns that is fixed is not normally consistent with control

The ability to use its power to  In more complex control assessments, IFRS 10 requires identification of
affect returns the activities that most affect the investee’s returns and how they are
directed

 In simple assessments, it is sufficient to consider activities at the

financial and policy level.

If, after applying these considerations to the SBR exam question scenario, the outcome of the assessment of control
is still unclear, other evidence must be considered, including:
 ability to direct investee to act on investor’s behalf
 key management personnel or the majority of governing body are related parties of investor
 special relationships between investee and investor

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EXAMPLE
Joo Co and Cat Co hold 40% each of the voting rights of Door Co. The remaining 20% are held by Hag Co. A
shareholders’ agreement states that the purpose of Door Co is to generate capital gains from buying and selling
properties. All decisions concerning buying and selling properties, and their financing require the unanimous
agreement of both Joo Co and Cat Co.

Joo Co is responsible for all management activities for which it receives payment and additionally has the final
decision on appointments to the board of directors.

Suggested answer
The major finance and management activities will both affect Door Co’s returns. Therefore, Joo Co and Cat Co should
evaluate which set of activities has the greatest effect on returns.

Given the purpose of Door Co is to achieve capital gains, this may indicate capital investment activities have the most
significant impact. If so, the conclusion would be that Joo Co and Cat Co have joint control because these activities
are directed by joint decision-making. The deemed significant influence of Hag Co would not change this assessment
of which entity has power over Door Co. If however management activities and key management personnel
appointments are considered more significant, the conclusion would be that Joo Co has control of Door Co because
it solely directs these relevant activities.

Guidance
Different exam question scenarios will provide different amounts of information and sometimes it won’t be possible
to consider all of the control criteria that has been identified in the table above. However, SBR candidates should
ensure that their response considers more than just the 50% ownership criteria. In doing so, they can demonstrate
that they are aware that other criteria exist and that they know how to apply them. Such an approach is likely to
produce an answer that has both breadth and depth.

Share-based payment – replacement awards on acquisition

Another issue that SBR candidates appear to struggle with is the accounting treatment required when an entity
includes a share-based payment as part of the consideration paid for a subsidiary in a business combination; for
example, when the acquirer agrees to take over any existing share-based payment awards that have already been
issued to the employees of the acquiree. Alternatively, the acquirer may change the terms of the share-based
payment awards to provide an incentive for key employees to remain an employee of the acquired entity. Such
transactions are included within the scope of IFRS 2, Share-based Payment.

Such an arrangement needs to be analysed to determine whether it represents compensation for services in the pre-
combination/acquisition period, the post-combination/acquisition period, or both. Amounts attributable to the pre-
acquisition period should be accounted for as part of the purchase consideration. Amounts attributable to the post-
acquisition period should be recognised as a cost of that period. Amounts attributable to both the pre- and post-
acquisition periods should be allocated to the purchase consideration and post-acquisition costs accordingly.

Transactions that benefit the acquiree before the acquisition are included as part of the purchase consideration. If
the transaction was arranged for the economic benefit of the acquirer, the transaction is not deemed to be part of
the purchase consideration.

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EXAMPLE
On 1 April 20X3, Natural Co granted equity share-based payment awards to its employees. These shares awards had
a fair value of $20 million and were subject to the employees remaining in employment for the next 3 years.

On 1 April 20X5, Digital Co purchased all of the share capital of Natural Co for cash of $80 million. A condition of the
acquisition is that Digital Co is required to issue replacement equity share awards to the employees of Natural Co
that will vest on 31 March 20X6.

On 1 April 20X5, the fair value of Natural Co’s net assets was $90 million, the fair value of the original share award
was $24 million and that of the replacement share awards was $28 million.

The financial year end is 31 March each year.

Required: calculate the impact of the share-based payment awards when accounting for the acquisition, including
goodwill.

Suggested answer
The amount of the replacement share award that is attributable to pre- acquisition services is determined by
multiplying the fair value of the original award by the ratio of the vesting period completed at the date of the
business combination to the greater of:
 The total vesting period, as determined at the date of the business combination, and
 The original vesting period

The period before the date of acquisition is (a) 2 years [1 April 20X3 to 31 March 20X5].

The vesting period of the replacement awards is (b) 1 year (b) [1 April 20X5 to 31 March 20X6].

The original vesting period is (c) 3 years [1 April 20X3 to 31 March 20X6].

Therefore, the total vesting period at 1 April 20X5 is 3 years (a+b) which is the same as the original vesting period.

The pre-acquisition service amount is $24 million x 2 years/3 years = $16 million – this is accounted for as part of the
purchase consideration (see below).

The post-acquisition service amount therefore is ($28-$16) million – $12 million – this is accounted for as a cost for
the year ended 31 March 20X6.

Goodwill at 1 April 20X5 $m

Cash consideration 80

Equity-share based awards 16

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96

Net assets of Natural Co (fair value) 90

Goodwill 6

At 31 March 20X6 (vesting date) $m

Remuneration cost (PL) 12

Equity-share based awards (SFP- Equity) 12

The above approach is a sensible one which is also logical and clear to mark. Therefore, it is an approach that the
SBR examining team recommends that you follow when answering similar such questions.

The accounting considerations of a pandemic or other natural disaster

Learning outcome F1(c) of the SBR syllabus states that candidates should be able to:
Discuss the impact of current issues in corporate reporting. This learning outcome may be tested by requiring the
application of one or several existing standards to an accounting issue. It is also likely to require and explanation of
the resulting accounting implications (for example, accounting for cryptocurrency in the Digital Age or accounting
for the effects of a natural disaster and the resulting environmental liabilities).

The Covid-19 pandemic is an example of a natural disaster which has undoubtedly had an impact on the financial
reporting practices of many entities in different business contexts. Indeed, many entities are experiencing conditions
that are often associated with a significant economic downturn. However, there is no one particular IFRS standard
that is more relevant than any other.

The SBR examining team has often commented that candidates incorrectly think that only one IFRS standard can be
used to provide an answer to an exam question scenario. Such an approach is likely to produce a response that is
very narrow in its consideration of the issues applicable to the exam question scenario. By using the context of the
Covid-19, the following table demonstrates the wide number of IFRS standards that are impacted by this pandemic
which would also apply to other situations like economic downturns.

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The following tables consider some of the existing accounting requirements that should be considered when
addressing the financial effects of the Covid-19 outbreak:

IFRS Standards Issues for discussion

IAS 1, Presentation of Assessment of an entity’s ability to continue as a going concern at the dates
Financial Statements the financial statements are approved.

Disclose uncertainties – significant judgements and sources of

estimation/uncertainty need to be appropriately disclosed. This will also
have impacts on the going concern assessments if judged material.

If going concern is at issue consider preparation of financial statement on

net realizable basis/net settlement value.

IAS 2, Inventories Inventory must be stated at the lower of cost or net realisable value (NRV)
however NRV calculation may be challenging (no market prices or no
demand for products).

Entities may need to reassess their practices for fixed overhead cost
allocation as production levels fall materially.

Obsolete inventory considerations, especially perishable inventory.

IAS 10, Events after the The evaluation of Covid-19 information that becomes available after the
reporting period end of the reporting period but before the date of authorisation of the
financial statements.

Entities will need to judge how much of the impact of Covid-19 should be
considered to arise from adjusting or non-adjusting events given the dates
when knowledge of the pandemic became known and events like travel
bans, lockdowns and similar took effect.

IAS 12, Income Taxes Recovery of deferred tax (DT) assets arising from accumulated tax losses
and therefore assess probable future taxable profits or tax planning
opportunities or whether sufficient DT liabilities which are expected to
reverse.

Will entities have to restrict the Dt Asset recognised?

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Consequences of adjustments to the carrying amounts of assets and

liabilities will have DT impact. Some examples will include the Impact of
impairment losses or decreases in the value of a pension surplus.

IAS 19, Employee Benefits Adjustments/provisions for severance.

Falls in interest rates and plan asset portfolios may require significant
adjustments requiring the services of actuaries to reflect changes in any
defined benefit schemes.

IAS 20, Accounting for Government assistance to help entities that are experiencing financial
Government Grants and difficulty.
Disclosure of Government
Assistance Reimbursement of employment costs is recognised in profit or loss.
Disclosure of aid such as short-term debt facilities.

IAS 23, Borrowing Costs Suspension of capitalisation of borrowing costs if Covid-19 has interrupted
the acquisition, construction or production of a qualifying asset. Any
borrowing costs incurred during such periods should be expensed through
P/L.

IAS 36, Impairment of Assets Assess whether the impact of Covid-19 has potentially led to an asset
impairment (tangible, intangibles and financial assets) – effectively Covid-
19 is a trigger event that indicates an impairment review is required.

Management may face significant challenges in preparing the budgets and

forecasts necessary to estimate the recoverable amount of an asset (or
CGU) because of decreased demand, business interruptions, cancelled
orders and similar issues.

Difficulty assessing fair values when no active market or market

participants

IAS 37, Provisions, Contingent Potential restructuring provisions and onerous contract provisions may
Liabilities and Contingent need measured and recognised and insurance recoveries disclosed (need
Assets to assess certainty of these recoveries).

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If material expenses or income for example restructuring and onerous

contract provisions and impairment losses) should they be disclosed
separately?

IFRS 2, Share-based Payment Vesting conditions for share-based payments with performance conditions
may not be met.

IFRS 5, Non-current Assets An asset (or a disposal group) no longer meets the conditions for ‘held for
Held for Sale and sale’ for example an entity may now face difficulties in identifying a buyer
Discontinued Operations or in completing the sale within the 12-month period from classification.

Ceased operations that meet the definition of discontinued operations will

require separate presentation and disclosure.

IFRS 9, Financial Instruments Allowance for expected credit losses (ECL) - reductions in forecasts in
economic growth increase the probability of default and entities will need
to revisit the provision matrix approach for trade receivables.

Classification of financial assets – consider whether there has been a

change in the entity’s business model. An entity may decide or need to sell
receivables classified as ‘held to collect’ which will therefore change
classification.

Hedge accounting – entities may need to consider whether the transaction

is still a 'highly probable forecasted transaction'.

There will be many more considerations with IFRS 9 regarding interest rate
changes/debt covenants/modifications to payment terms.

IFRS 13, Fair Value Companies need to look at the decisions, assumptions and inputs to fair
Measurement value measurement as market-based measures are likely to change
significantly and perhaps in unpredictable ways. If using level 2 or 3 inputs
will require more extensive disclosure.

IFRS 15, Revenue from Contract enforceability - may not be able to approve a contract under an
contracts with customers entity’s normal business practices

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Collectability – may be a significant deterioration of a customer’s ability to

pay.

Contract modifications – entity may grant a price concession to a customer.

Variable considerations – an entity may need to consider updating its

estimated transaction price

Significant financing component -an entity may provide extended payment

terms.

Revenue recognition - an entity may need to reconsider the timing of

revenue recognition if it is unable to satisfy its performance obligations on
a timely basis.

IFRS 16, Leases Impairments to right-of use assets.

Economic stimulus measures have led to lower interest rates and changes
to lease terms – lease liabilities may need remeasured.

Impairments of lease receivables for lessors.

Other non-IFRS
considerations

Discount rates Many central banks have cut their base rates – this will affect the measurement of
many assets and liabilities

Alternative Entities may consider providing new alternative performance measures (APMs) or
performance adjust existing APMs – adequate/extensive disclosures will be required to ensure
measures they do not mislead

While the SBR examining team is not stating that consideration of all of these IFRS standards would be required, or
could be expected, to answer an SBR exam question, the table does demonstrate that the accounting context of
Covid-19 requires the consideration of a range of accounting standards and has wide and varied implications.
Likewise, an SBR exam question is unlikely to require the consideration of only one IFRS standard in isolation.

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SBR candidates should use the signposts and clues contained in the question scenario to identify which IFRS
standards that they should consider.

Conclusion
This article should be used to stimulate thoughts about how these issues might impact on responses when practicing
SBR exam questions. However, this article should not be interpreted as a signpost to the content of future SBR exam
questions.

ACCA candidates should focus on wider reading including making use of the learning resources that ACCA have
available such as technical articles and the examiner reports. By using these resources now, exam technique can be
refined and improved.

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ASSET CEILING TEST (IAS 19), INITIAL COIN OFFERINGS, NON-GAAP, AND NON-
FINANCIAL PERFORMANCE MEASURES

This article discusses the asset ceiling test in IAS 19, Employee Benefits, and explains how many IFRS standards
and principles might be relevant to an accounting issue for which there is no existing IFRS standard (in this case
Initial Coin Offering (ICO)).

Finally, it examines some non-financial performance measures that have been reported in practice in a global digital
entity.

This article explains a complex area of the SBR syllabus, the asset ceiling test in IAS 19, Employee Benefits, and
explains how many IFRS standards and principles might be relevant to an accounting issue for which there is no
existing IFRS standard (in this case Initial Coin Offering (ICO)). Finally, it examines some non-financial performance
measures that have been reported in practice in a global digital entity.

However, first it is worth reiterating that candidates will not be able to successfully answer SBR questions by rote
learning and reproducing textbook answers. Candidates should always explain the relevant principles which
underpin their answers because in SBR, marks are awarded first for an explanation of the principles and then for
their application to the scenario. An understanding of the principles will allow candidates to deal with the many
accounting issues that arise in practice and to cope with the changes and developments in the business environment,
such as ICO’s. In addition, candidates will not be awarded professional marks if there is no reference to the scenario.

Asset ceiling test IAS 19

Defined benefit pension accounting is generally acknowledged to be a complex area of accounting and asset ceiling
test is possibly one of the more complex aspects of IAS 19, Employee Benefits that might be examined. A pension
asset exists when a defined benefit pension plan has a surplus of plan assets over its liabilities. IAS 19 requires the
employer to consider the recoverability of any such surplus and there must be economic benefit (for example
reduced contributions or a cash refund) available to the company to enable this recovery. An entity should recognise
a net pension asset in such cases because the entity controls a resource, and that control is a result of past events.
This is in the form of contributions paid by the entity and service rendered by the employee. Future economic
benefits are available to the entity in the form of a reduction in future contributions or a cash refund, either directly
to the entity or indirectly to another plan in deficit. The asset ceiling is the present value of those future benefits.

IAS 19 states that, when an entity has a surplus in a defined benefit plan, it should measure the net defined benefit
of the asset at the lower of:
i. the surplus in the defined benefit plan, and
ii. the asset ceiling.

Note: the asset ceiling will be provided as part of the question scenario in the SBR exam but in practice is determined
using the discount rate based upon market yields at the end of the reporting period on high quality corporate bonds
A further issue can arise when a plan amendment, curtailment or settlement occurs. An entity should recognise any
past service cost, or a gain or loss on settlement in profit or loss. In doing so, the entity should not consider the effect
of the asset ceiling. After the plan amendment, curtailment or settlement has been accounted for, the entity should
then determine the effect of the asset ceiling.

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A plan amendment, curtailment or settlement might reduce or eliminate a surplus, which could impact on how the
asset ceiling is measured. Any changes in the value of the asset ceiling is recognised in other comprehensive income,
as opposed to being recognised in the statement of profit or loss.

Illustrative example
Apolline Co manages a defined benefit scheme for its employees. At 1 January 20X8, the fair value of the pension
scheme assets were estimated to be $137 million and the present value of the pension scheme liabilities were $122
million. The asset ceiling has been calculated at $4 million. The discount rate on high quality corporate bonds is 4%.
The following are the details of the scheme for the year to 31 December 20X8.

$m

Cash contributions 7

Benefits paid 6

Current service cost 5

At 31 December 20X8, the asset ceiling has been calculated at $11 million. During the year, there was a scheme
curtailment which resulted in a gain on settlement of $3 million. Immediately after the scheme curtailment the
actuary valued the scheme’s assets as $148 million and the scheme’s liabilities as $136 million.

Suggested answer
At 1 January 20X8, the surplus of the scheme/net plan asset is $15 million ($137 million – $122 million). However,
the asset ceiling is $4 million so the net defined benefit pension asset is restricted to this figure. Interest on the
opening asset will be based upon this figure at $160,000 (4% X $4 million) and will be recorded in profit or loss. The
cash contributions of $7 million will be added to the scheme assets, and the current service cost of $5 million charged
to profit or loss. The benefits paid of $6 million are deducted from both the schemes assets and the schemes
liabilities and therefore have a nil effect.

As any past service cost does not consider the effect on the asset ceiling, a gain on settlement of $3 million should
therefore be recognised in profit and loss.

The pension scheme surplus at 31 December 20X8 is summarised here.

At 31 December 20X8, the scheme is now valued at the lower of the:

 Surplus of the scheme, $12 million ($148 million – $136 million), and
 The present value of the economic benefits in the form of refunds from the plan or reductions in the future
combinations (the asset ceiling) – ie $11 million.

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This means that there is a net gain of $1.84 million being the difference between the net plan asset in the scheme
($9.16 million) and the asset ceiling ($11 million). This gain is credited to other comprehensive income.

If the effect of the asset ceiling had not been taken into account, there would have been a remeasurement loss of
$8.6 million ($20.6 million – $12 million) at 31 December 20X8 which would have been recognised in other
comprehensive income.

Understanding the context of Initial Coin Offering (ICO) tokens

SBR will often provide candidates with a scenario that they have not encountered before. These scenarios allow
candidates to demonstrate their ability to apply accounting principles and show how more than one IFRS standard
might be relevant. The next few paragraphs use an ICO to demonstrate how candidates should use accounting
principles (such as control) and existing IFRS standards to suggest potential accounting treatments.

In an ICO (also called a ‘token sale’), instead of receiving shares, participants (also known as supporters) receive
‘tokens’ and, instead of paying cash, participants often pay in cryptocurrency. They are similar in many ways to
crowdfunding but for their ‘support’ they receive a reward – ie the tokens. The tokens are a digital asset based on
the same logic as cryptocurrencies, like Bitcoin. Although the tokens have no inherent value, if the ICO is successful,
these new tokens will become valuable and a market to trade them will subsequently develop. If unsuccessful, then
the tokens would have no value. ICOs raise money by issuing a ‘white paper’ that provides details of the proposed
venture. This may be the development of a new app or product or service; for example, the development of an app
to subsequently support the trade of the tokens.

The tokens are usually issued in exchange for either conventional currency or cryptocurrency. As the ICO issues a
token, rather than shares, they are not considered to be a securities offering, so the associated regulation and
controls have not been applied.

There are ethical issues for accountants because the white paper may not properly represent the nature of the offer.
For example, unrealistic forecasts or factual inaccuracies.

During the preparation for the ICO, the costs should be recognised as expenses if they don’t satisfy the requirements
for recognition of intangible assets in accordance with IAS 38, Intangible Assets. Following the circulation of the
tokens, the issuing company generally loses control of the market of these tokens. However, if the issuer is able to
get further economic benefits from token holders by providing them with intermediary or similar services that are
not related to the subsequent sale of uncirculated tokens, then the costs may satisfy the requirements of IAS 38.
Examples may be the management of the platform supporting the market of circulated tokens by annulling
purchased tokens or changing the content of smart contracts (a computer program that executes, controls and
documents legal events).

If all inflows received for tokens are in excess of the expenses of the initial ICO and are not related to further
commitments to holders of tokens, such further inflows are considered as revenue by the issuer.

Sometimes the rights given to the token holders may be similar to the rights of the holders of debt, equity
instruments or other financial instruments. For example, the issuer may contract to pay a fixed amount of annual
profits to the token holder but not to redeem the tokens. At the initial recognition, such a right is recorded as a
contingent liability, the value of which depends on a future uncertain event – ie the annual profit margin. During the
reporting period, the liability should be increased as the issuer earns profits.

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Alternatively, the issuer may commit to the holders of tokens to pay annual interest based upon the fair value of a
cryptocurrency. Such a liability should be recognised as a financial derivative.

Revenue recognition in accordance with IFRS 15, Revenue from Contracts with Customers is based on the transfer of
control. Control is defined as the ability to direct the use of and obtain substantial control over the remaining benefits
associated with the asset. The issuer therefore needs to determine if the transfer of control happens over time.
If control happens over time, revenue cannot be recognised in full at the time of the initial ICO sale. Instead, it must
be recognised as the performance obligation is satisfied. This will most likely occur if the token is presented to the
issuer for redemption into goods or services, such as granting access to software.

A useful background article can be found within the SBL technical articles here. Please note that this article is not
examinable but is purely for additional reading.

Non-GAAP/non-financial performance measures and quarterly press releases

Finally, SBR candidates need to be able to understand additional performance measures (APMs) that are produced
by companies in the context of their different business models. This final part of the article uses a social media
company to demonstrate the range of APMs reported in practice.

Some companies issue quarterly press releases which contain forward-looking statements regarding the future
expectations of the business. Often, they will supplement the consolidated financial statements with some non-
GAAP financial measures. For example, some social media companies will report advertising revenue excluding
foreign exchange effect and free cash flow. Investors are often cautioned that there are material limitations
associated with the use of non-GAAP financial measures as an analytical tool. In addition, they state that these
measures may be different from non-GAAP financial measures used by other companies, limiting their usefulness
for comparison purposes. These non-GAAP measures are reported because they provide investors with useful
supplemental information and allow for greater transparency with respect to key metrics used by management in
operating their business.

SBR candidates need to be aware how these additional performance measures might be useful to users when
provided in conjunction with financial statements that are compliant with IFRS standards. These measures are
usually derived from the business model of the company; for example, a social media company will often publish
‘Operational and Other Financial Highlights’ which include a range of metrics that the directors feel are important
to investors. They may include conventional profitability ratio’s such as earnings per share but also such things as:
 Social media monthly active users
 Family daily and monthly active people
 Family average revenue per person
 Revenue by user geography
 Advertising revenue by user geography
 Effective tax rate
 Free cash flow reconciliation

Well known social media companies are quick to point out the limitations of some of the above ratios. For example,
Facebook states that the numbers for their key metrics are calculated using internal company data based on the
activity of user accounts. They try and eliminate the number of 'duplicate' and 'false' accounts among their users as
many people use more than one of their products, and some have multiple user accounts within an individual
product. The data regarding the geographic location of their users is estimated based on a number of factors, such

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as the user's IP address and self-disclosed location. These factors do not always accurately reflect the user's actual
location.

It seems that for some digital companies, conventional financial accounting ratios cannot account for the importance
of other effects such as the network or the increase in the value of a resource with its use. Hence, some companies
will use ratios which are particular to their type of digital business model.

SBR candidates must be able to discuss the issues raised by the increasing demand by various stakeholders for non-
financial additional performance measures including transparency, consistency and comparability. There is a
technical article that discusses additional performance measures which can be found here.

SBR candidates must be able to discuss the ethical issues associated with regards non-GAAP/non-financial
performance measures being used, for instance conflicts of interests between managements interests and the
investor perspective. The examples provided above raise many of these issues on the tensions between demand for
more information from stakeholders and how it should be calculated and presented alongside IFRS standard
disclosures.

Onerous lease contracts and impairments, and investor issues

This article addresses the technical matter of onerous lease contracts and their impairment and then considers two
types of approach to SBR exam questions:
(i) Investors issues in SBR questions and
(ii) The application of knowledge to SBR question scenarios.

This article addresses the technical matter of onerous lease contracts and their impairment and then considers two
types of approach to SBR exam questions:
(i) Investors issues in SBR questions and
(ii) The application of knowledge to SBR question scenarios

Specifically, question 3 from the March 2020 exam is used to illustrate this point.

Onerous lease contracts and impairments

IFRS 16, Leases has brought significant change to the accounting treatment of leases, the most important of these
changes being that lessees now have to recognise operating leases as a right-of-use (ROU) asset and a lease liability.
As with other assets, this ROU asset may have to be tested for impairment. Since the ROU asset is a non-financial
asset, the requirements of IAS 36 apply. However, there are two exemptions to the IAS 36 impairment model.

Firstly, when a lessee applies the fair value model in accordance with IAS 40 for its investment properties, it also
applies the fair value model to the ROU asset. Secondly, if a ROU asset relates to a class of PPE to which the lessee
applies the revaluation model, then the lessee can elect to apply the revaluation model to all of the ROU assets that
relate to that class of PPE.

In accordance with IAS 36, the ROU asset is tested for impairment on a standalone basis unless it forms part of a
cash-generating unit (CGU). If the ROU asset is tested for impairment as a part of the CGU then it should be included
in the CGU’s carrying amount. IAS 36 requires entities to consider whether a buyer would be required to assume any
liabilities, which could include the lessee’s lease liability. In such a case, the lease liability needs to be included in the
recoverable amount of the CGU and in the carrying amount of CGU as well.

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When considering onerous contracts, these are governed by IAS 37, Provisions, Contingent Liabilities and Contingent
Assets and this IFRS standard is applied to any contract for which unavoidable costs of meeting the contract
obligations exceed the economic benefits expected to be received under that contract. However, it is interesting to
consider whether IAS 37 and IFRS 16 can co-exist.

The International Accounting Standards Board (the Board) decided not to specify any particular requirements in IFRS
16 for onerous contracts. The Board made this decision because:
(a) For leases that have already commenced, no requirements are necessary. After the commencement date, an
entity can appropriately reflect an onerous lease contract by applying the requirements of ifrs 16. A lessee will
determine and recognise any impairment of right-of-use assets applying ias 36, impairment of assets.
(b) For leases that have not already commenced, the requirements for onerous contracts in IAS 37, Provisions,
Contingent Liabilities and Contingent Assets are sufficient. The requirements in IAS 37 apply to any contract (and
hence any lease contract) that meets the definition of an onerous contract in that standard.

The question also arises as to how to deal with onerous contracts when initially applying IFRS 16. A company can
either:
 Apply IAS 36 to its right-of-use assets, or
 Not apply IAS 36 on the date of initial application, but instead rely on its assessment of whether any of its leases
are onerous under IAS 37. Any onerous lease provision is derecognised and an equal amount is deducted from
the carrying amount of the relevant right-of-use asset.

This choice can also be applied on a lease-by-lease basis.

Thus, candidates should carefully read the question before answering to determine whether IAS 36 or IAS 37 should
be applied to the onerous leasing contract. If the examining team wants candidates to consider the matter under a
specific IFRS standard (ie IAS 37 or IFRS 16), then that standard will be specifically referred to in the requirement.
However, candidates should also appreciate that marks will be awarded for any discussion that is rational and logical,
even though it doesn’t appear in the suggested solution.

Investors issues in SBR

Every SBR exam will include a question that tests an investor’s perspective. Although the nature of the question will
vary, it will normally include 2 professional marks. The question may require candidates to comment upon the
usefulness of certain types of information to investors and their needs. When answering a question on a specific
IFRS standard, candidates should use their knowledge of that accounting standard to discuss how this could impact
on the investment decisions of investors. For example, there may be a need for a clear explanation of deferred tax
balances in financial statements and an analysis of the expected timing of reversals so that investors can see the
time period over which deferred tax assets arising from losses might reverse.

As a general rule, the principles of good disclosure would be useful to investors. Thus, candidates can use these
principles as a framework for answering generic questions which involve an investor perspective. The Board has
received feedback from investors along the following lines:
 Investors are concerned about ineffective communication. In particular, they highlight the importance of proper
application of materiality by entities when deciding what to disclose and how best to communicate that
information.
 Investors consider comparability and entity-specific information to be particularly important but note that there
is potential for conflict between these two principles.

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 Many investors think that the inclusion of IFRS information outside the financial statements could be useful in
some circumstances but have some concerns about understandability, assurance and the on-going availability
of information.
 Many investors agree that the Board should not prohibit the inclusion of non-IFRS standard information in
financial statements. However, investors have concerns about the risk of entities providing misleading
information, or clouding IFRS standard information.
 Investors think that the Board should require an entity to clearly identify, label, explain and reconcile any non-
IFRS standard information presented in the financial statements.
 Many investors feel that the Board should define performance measures. Many investors have encouraged the
Board to define one or more of the following: EBIT, EBITDA and other performance measures such as operating
profit.
 Most investors support the suggestion to develop definitions of, and requirements for the presentation of,
unusual or infrequently occurring items. Investors think that this would help to avoid misleading or inconsistent
use of those terms.
 Investors think that useful accounting policy disclosures are those that relate to material items, transactions or
events or provide insight into how an entity has exercised judgement in selecting and applying accounting
policies.
The above principles could be used when SBR candidates answer several types of investor related questions but
would only gain marks if applied to the scenario.

The application of SBR knowledge to question scenarios

It is important to explore this latter point further. The SBR exam requires candidates to answer questions using the
application of knowledge to a question scenario. However, in SBR, candidates often fail to gain valuable marks
through not using the scenario in their answer.

The verb used in the question requirement and the number of marks allocated to it gives the candidate an idea
about the nature and degree of detail required. A purely discursive answer will lose marks if computations are
required and no marks will be awarded to calculations that have not been asked for. Simply repeating facts from the
scenario or an accounting standard without any further explanation or application of that knowledge is insufficient.
This is because markers are looking for evidence of analysis and professional judgment.

There is some evidence that some candidates practice poor time management. Often, these candidates do not
attempt all of the questions with the result that relatively easy marks, particularly in the final parts of question 4 are
lost. Some candidates spend a disproportionate amount of time addressing the issues in question 1 with the result
that there is little time left to answer question 4. There needs to be a balance between the time spent on all of
questions and an understanding that spending too much time on any one question will affect performance.

If candidates forget the principles in a particular accounting standard, a good strategy is to refer to the Conceptual
Framework. If candidates feel that they cannot answer part of a question, then the principles in the Conceptual
Framework, applied correctly, will always gain some marks. This is the case even if the Conceptual Framework is not
mentioned in the suggested solution. Candidates are advised to structure and present their answer in a way that
assists the marking process and so it is not advisable to merge many parts of an answer into one.

SBR consciously includes challenging and contemporary question scenarios. Candidates will be awarded marks for
discussion of issues which do not appear in the suggested solution but are relevant to the scenario. Additionally,
extra marks may be gained if a candidate discusses a point particularly well.

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A good example of this approach can be seen in question 3 March 2020, which you can find here.

The question required candidates to discuss how to account for contingent performance conditions where individual
football players are paid bonuses which represent additional contract costs. Candidates needed to be able to discuss
when the bonuses would be recognised. There is no existing IFRS standard to refer to in this question, therefore
candidates were required to use accounting principles. There is diversity in practice where accounting for contingent
performance conditions is concerned.

So, how should SBR candidates have answered this question?

There are several ways in which this question could have been answered and candidates could either refer to the
Conceptual Framework or other existing accounting standards. For example, candidates could use the definition of
a liability in the Conceptual Framework to help: 'a liability is a present obligation of the entity to transfer an economic
resource as a result of past event'. So, the entity should have an obligation. When a player’s contract is signed,
management should make an assessment of the likely outcome of performance conditions in order to determine if
there is an obligation.

Secondly, there needs to be an obligation to transfer an economic resource. The economic resource being
transferred will be a cash amount.

Thirdly, the obligation needs to be a present obligation that exists as a result of past event. Hence, any contingent
amounts will only be recognised from the date management believes that the performance conditions will be met.
Before this date, an obligation will not exist and the past event can be argued as the signing of the contract.

Alternatively, the definition of a provision in IAS 37 could be used to answer the question. A provision is a present
obligation that has arisen as a result of a past event, payment is probable, and the amount can be estimated reliably.
Leicester City Football Club states in its financial statements that ‘Contractual obligations are recognised when they
become payable with prepayments/accruals recognised at each period end. However, Manchester United Football
Club states the following re bonus payments to players – 'Any performance bonuses are recognised when the
Company considers that it is probable that the condition related to the payment will be achieved.' The suggested
solution to Q3 March 2020 is written in accordance with this accounting policy.

However, there is an argument that there is a possible financial liability which should be recognised at the acquisition
of the player. The examining team do not necessarily agree with this view as players can leave the football club or
become injured and not trigger the payments. However, if candidates argued this point coherently, then marks
would have been awarded accordingly.

It is worth remembering that the examining team give credit for answers that are not included in the suggested
solution at every exam. This is because corporate reporting is not an exact science! It requires judgement and is
subjective… it is your judgement and opinions that employers want to see and so these are the skills that the SBR
examining team is attempting to develop. Therefore, SBR candidates should be prepared to apply their corporate
reporting knowledge to many different business contexts and contemporary SBR questions.

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Code of Ethics SBR Revision Notes

THE PROFESSIONAL AND ETHICAL DUTIES OF THE ACCOUNTANT

Code of Ethics
(a) Integrity – to be A professional accountant shall not knowingly be associated with reports,
straightforward and honest returns, communications or other information where the professional
in all professional and accountant believes that the information:
business relationships. (a) Contains a materially false or misleading statement;
(b) Contains statements or information furnished recklessly; or
(c) Omits or obscures information required to be included where such
omission or obscurity would be misleading.
(b) Objectivity – to not allow A professional accountant may be exposed to situations that may impair
bias, conflict of interest or objectivity. It is impracticable to define and prescribe all such situations. A
undue influence of others to professional accountant shall not perform a professional service if a
override professional or circumstance or relationship biases or unduly influences the accountant’s
business judgments professional judgment with respect to that service.
(c) Professional Competence The principle of professional competence and due care imposes the
and Due Care – to maintain following obligations on all professional accountants:
professional knowledge and (a) To maintain professional knowledge and skill at the level required to
skill at the level required to ensure that clients or employers receive competent professional
ensure that a client or service;
employer receives and
competent professional (b) To act diligently in accordance with applicable technical and
services based on current professional standards when providing professional services.
developments in practice, Competent professional service requires the exercise of sound
legislation and techniques judgment in applying professional knowledge and skill in the
and act diligently and in performance of such service. Professional competence may be divided
accordance with applicable into two separate phases:
technical and professional (a) Attainment of professional competence; and
standards. (b) Maintenance of professional competence.
(d) Confidentiality – to respect The principle of confidentiality imposes an obligation on all professional
the confidentiality of accountants to refrain from:
information acquired as a (a) Disclosing outside the firm or employing organization confidential
result of professional and information acquired as a result of professional and business
business relationships and, relationships without proper and specific authority or unless there is a
therefore, not disclose any legal or professional right or duty to disclose; and
such information to third (b) Using confidential information acquired as a result of professional and
parties without proper and business relationships
specific authority, unless
there is a legal or The following are circumstances where professional accountants are or may
professional right or duty to be required to disclose confidential information or when such disclosure
disclose, nor use the may be appropriate:
information for the personal (a) Disclosure is permitted by law and is authorized by the client or the
advantage of the employer;
professional accountant or (b) Disclosure is required by law, for example:
third parties.

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Code of Ethics SBR Revision Notes

(i) Production of documents or other provision of evidence in the

course of legal proceedings; or
(ii) Disclosure to the appropriate public authorities of
infringements of the law that come to light; and by law:
(i) To comply with the quality review of a member body or
professional body;
(ii) To respond to an inquiry or investigation by a member body or
regulatory body;
(iii) To protect the professional interests of a professional
accountant in legal proceedings; or
(iv) To comply with technical standards and ethics requirements.

In deciding whether to disclose confidential information, relevant factors to

consider include:
 Whether the interests of all parties, including third parties whose
interests may be affected, could be harmed if the client or employer
consents to the disclosure of information by the professional
accountant.
 Whether all the relevant information is known and substantiated, to the
extent it is practicable; when the situation involves unsubstantiated
facts, incomplete information or unsubstantiated conclusions,
professional judgment shall be used in determining the type of
disclosure to be made, if any.
 The type of communication that is expected and to whom it is
addressed.
 Whether the parties to whom the communication is addressed are
appropriate recipients.
(e) Professional Behavior – to The principle of professional behavior imposes an obligation on all
comply with relevant laws professional accountants to comply with relevant laws and regulations and
and regulations and avoid avoid any action that the professional accountant knows or should know
any action that discredits the may discredit the profession. This includes actions that a reasonable and
profession. informed third party, weighing all the specific facts and circumstances
available to the professional accountant at that time, would be likely to
conclude adversely affects the good reputation of the profession.

In marketing and promoting themselves and their work, professional

accountants shall not bring the profession into disrepute. Professional
accountants shall be honest and truthful and not:
(a) Make exaggerated claims for the services they are able to offer, the
qualifications they possess, or experience they have gained; or
(b) Make disparaging references or unsubstantiated comparisons to the
work of others.

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Code of Ethics SBR Revision Notes

THREATS TO FUNDAMENTAL PRINCIPLES

a) Self-interest threat – the threat that a financial or other interest will inappropriately influence the professional
accountant’s judgment or behavior;
b) Self-review threat – the threat that a professional accountant will not appropriately evaluate the results of a
previous judgment made or service performed by the professional accountant, or by another individual within
the professional accountant’s firm or employing organization, on which the accountant will rely when forming
a judgment as part of providing a current service;
c) Advocacy threat – the threat that a professional accountant will promote a client’s or employer’s position to
the point that the professional accountant’s objectivity is compromised;
d) Familiarity threat - the threat that due to a long or close relationship with a client or employer, a professional
accountant will be too sympathetic to their interests or too accepting of their work; and
e) Intimidation threat – the threat that a professional accountant will be deterred from acting objectively because
of actual or perceived pressures, including attempts to exercise undue influence over the professional
accountant.

SBR EXAM QUESTION

Second question likely to ask to “discuss the ethical and accounting implications” of a certain set of facts

Solution presentation
 What are the ethical issues – these will be related to the accounting implications.
 Are any ethical principles breached or threatened?
 What actions should be taken? Who are you in the scenario and what actions are available to you?
 What is the impact on stakeholders?

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