A L A N M E L V I L L E A L A N International Financial Reporting A Practical Guide Sixth Edition Reviews of the previous edition With more than 120 countries in the world now using international financial reporting standards (IFRS® Standards), knowledge of the standards issued by the International Accounting Standards Board (IASB®) is vital to students’ success in financial accounting Melville’s International Financial Reporting employs a practical, applied approach in exploring and explaining the key international standards With a focus on how to implement the standards, this text delivers a focused, user-friendly introduction to international financial reporting Key features • Unique practical approach • Class-tested by professional and degree students • Worked examples with solutions in every chapter • Chapter-end exercises featuring questions from past exam papers of key professional accountancy bodies Visit www.pearsoned.co.uk/melville for our suite of resources to accompany this textbook, including a complete solutions guide, PowerPoint slides for each chapter and opportunities for extra practice M E L V I L L E Renowned for clear and concise language, this sixth edition brings the book completely up-to-date with international standards issued as of January 2017 International Financial Reporting “A practical, no-nonsense guide to IFRS, backed up by plenty of worked examples to illustrate the requirements.” Katherine Martin, Nottingham University Business School A Practical Guide “Like Beethoven’s sixth, perfectly pitched for the intermediate accounting student!” Raymond Holly, Galway-Mayo Institute of Technology (Ireland) M E L V I L L E International Financial Reporting A Practical Guide Sixth Edition Alan Melville FCA BSc Cert Ed is a best-selling author Previously a Senior Lecturer at Nottingham Trent University, he has many years’ experience of teaching accounting and financial reporting Front cover image: © Butch Martin/Getty Images CVR_MELVILLE_06_AW2.indd www.pearson-books.com Sixth Edition 05/06/2017 10:27 International Financial Reporting Companion Website For open-access student resources specifically written to complement this textbook and support your learning, please visit www.pearsoned.co.uk/melville ON THE WEBSITE Lecturer Resources For password-protected online resources tailored to support the use of this textbook in teaching, please visit www.pearsoned.co.uk/melville Melville_INT_FINANCv6.indd 31/05/2017 16:32 At Pearson, we have a simple mission: to help people make more of their lives through learning We combine innovative learning technology with trusted content and educational expertise to provide engaging and effective learning experiences that serve people wherever and whenever they are learning From classroom to boardroom, our curriculum materials, digital learning tools and testing programmes help to educate millions of people worldwide – more than any other private enterprise Every day our work helps learning flourish, and wherever learning flourishes, so people To learn more, please visit us at www.pearson.com/uk Melville_INT_FINANCv6.indd 31/05/2017 16:32 International Financial Reporting A Practical Guide Sixth edition Alan Melville FCA, BSc, Cert Ed Harlow, England • London • New York • Boston • San Francisco • Toronto • Sydney • Dubai • Singapore • Hong Kong Tokyo • Seoul • Taipei • New Delhi • Cape Town • São Paulo • Mexico City • Madrid • Amsterdam • Munich • Paris • Milan Melville_INT_FINANCv6.indd 31/05/2017 16:32 PEARSON EDUCATION LIMITED Edinburgh Gate Harlow CM20 2JE United Kingdom Tel: +44 (0)1279 623623 Web: www.pearson.com/uk First published 2008 (print) Second edition published 2009 (print) Third edition published 2011(print) Fourth edition published 2014 (print and electronic) Fifth edition published 2015 (print and electronic) Sixth edition published 2017 (print and electronic) © Pearson Professional Limited 2008, 2011 (print) © Pearson Education Limited 2014, 2017 (print and electronic) The right of Alan Melville to be identified as author of this work has been asserted by him in accordance with the Copyright, Designs and Patents Act 1988 The print publication is protected by copyright Prior to any prohibited reproduction, storage in a retrieval system, distribution or transmission in any form or by any means, electronic, mechanical, recording or otherwise, permission should be obtained from the publisher or, where applicable, a licence permitting restricted copying in the United Kingdom should be obtained from the Copyright Licensing Agency Ltd, Barnard’s Inn, 86 Fetter Lane, London EC4A 1EN The ePublication is protected by copyright and must not be copied, reproduced, transferred, distributed, leased, licensed or publicly performed or used in any way except as specifically permitted in writing by the publishers, as allowed under the terms and conditions under which it was purchased, or as strictly permitted by applicable copyright law Any unauthorised distribution or use of this text may be a direct infringement of the author's and the publisher's rights and those responsible may be liable in law accordingly All trademarks used herein are the property of their respective owners The use of any trademark in this text does not vest in the author or publisher any trademark ownership rights in such trademarks, nor does the use of such trademarks imply any affiliation with or endorsement of this book by such owners Pearson Education is not responsible for the content of third-party internet sites ISBN: 978-1-292-20074-3 (print) 978-1-292-20076-7 (PDF) 978-1-292-20077-4 (ePub) British Library Cataloguing-in-Publication Data A catalogue record for the print edition is available from the British Library Library of Congress Cataloging-in-Publication Data A catalog record for the print edition is available from the Library of Congress 10 21 20 19 18 17 Front cover image: © Butch Martin/Getty Images Print edition printed and bound by Ashford Colour Press Ltd, Gosport NOTE THAT ANY PAGE CROSS REFERENCES REFER TO THE PRINT EDITION Melville_INT_FINANCv6.indd 31/05/2017 16:32 Contents Preface Acknowledgements List of international standards General features Structure and content of financial statements The statement of financial position The statement of comprehensive income The statement of changes in equity The notes to the financial statements Interim financial reporting Management commentary ix x xi Part Introduction to Financial Reporting The regulatory framework The need for regulation Sources of regulation Generally accepted accounting practice The International Accounting Standards Board (IASB) The standard-setting process The purpose of accounting standards 10 Worldwide use of international standards 11 First-time adoption of international standards 11 The IASB conceptual framework Purpose and scope of the IASB Conceptual Framework Objective of general purpose financial reporting Qualitative characteristics of financial information Underlying assumption Elements of financial statements Recognition of the elements of financial statements Measurement of the elements of financial statements Concepts of capital and capital maintenance Discounting and present value Completed version of the Conceptual Framework 17 Presentation of financial statements Purpose of financial statements Components of financial statements 36 37 37 19 21 24 25 27 28 33 40 41 45 49 51 52 53 61 61 66 66 Part Financial Reporting in Practice 18 28 32 Accounting policies, accounting estimates and errors Accounting policies Accounting estimates Prior period errors 38 Property, plant and equipment Definition of property, plant and equipment Recognition of property, plant and equipment Initial measurement of property, plant and equipment Subsequent measurement of property, plant and equipment Depreciation Disclosure requirements Borrowing costs Government grants Investment property IFRS13 Fair Value Measurement Intangible assets Definition of an intangible asset Initial recognition and measurement of intangible assets Subsequent measurement of intangible assets 75 76 77 79 80 82 86 87 89 92 95 100 101 102 106 v Contents Amortisation of intangible assets Derecognition Disclosure requirements Goodwill IFRS3 Business Combinations 108 110 110 111 112 Impairment of assets Indications of impairment Recoverable amount Recognition and measurement of an impairment loss Cash-generating units Reversal of impairment losses Disclosure requirements 118 119 120 Non-current assets held for sale and discontinued operations Classification of non-current assets as held for sale Measurement of non-current assets held for sale Presentation of non-current assets held for sale Discontinued operations Leases Classification of leases (IAS17) Accounting for operating leases Accounting for finance leases Disclosure requirements New leases standard (IFRS16) Lease accounting by lessees Lease accounting by lessors 123 124 128 129 134 135 137 141 142 148 149 150 150 154 155 155 159 10 Inventories Inventories Cost of inventories Cost formulas Net realisable value Disclosures relating to inventories 164 165 165 167 170 171 11 Financial instruments Definitions Classification of financial instruments Recognition and measurement Initial measurement of financial assets and liabilities Subsequent measurement of financial assets The effective interest method 175 176 177 180 vi 180 181 182 Subsequent measurement of financial liabilities Disclosure requirements 12 Provisions and events after the reporting period Recognition of a provision Measurement of a provision Application of the recognition and measurement rules Contingent liabilities and contingent assets Disclosure requirements Events after the reporting period 13 Revenue from contracts with customers Purpose and scope of IFRS15 The five-step model Identifying the contract Identifying performance obligations Determining the transaction price Allocating the transaction price Satisfaction of performance obligations Contract costs Presentation and disclosure Guidance to the application of IFRS15 184 185 190 191 193 194 196 197 198 204 205 205 206 208 209 211 212 213 214 216 14 Employee benefits Short-term employee benefits Post-employment benefits Accounting for defined contribution plans Accounting for defined benefit plans Other long-term employee benefits Termination benefits Share-based payments 220 221 223 15 Taxation in financial statements Current tax Deferred tax The tax base concept IAS12 requirements with regard to deferred tax Disclosure requirements 236 237 239 241 16 Statement of cash flows Cash and cash equivalents Classification of cash flows by activity Interest, dividends and taxes 251 252 253 254 223 224 229 229 230 246 246 Contents Reporting cash flows from operating activities Disclosures 17 Financial reporting in hyperinflationary economies Historical cost accounting and its weaknesses Strengths of historical cost accounting Alternatives to historical cost accounting Hyperinflationary economies The restatement of financial statements Disclosures required by IAS29 255 262 272 273 278 279 280 280 285 Part Consolidated Financial Statements 18 Groups of companies (1) Requirement to prepare consolidated financial statements Group statement of financial position at date of acquisition Group statement of financial position in subsequent years Partly-owned subsidiaries Preference shares Elimination of intra-group balances Unrealised profits Reporting period and accounting policies Disclosure requirements 291 292 293 297 300 303 305 306 307 307 19 Groups of companies (2) Group statement of comprehensive income Group statement of changes in equity Subsidiary acquired part way through an accounting period 316 317 317 20 Associates and joint arrangements Associates and significant influence The equity method Application of the equity method Joint arrangements Disclosure requirements 331 332 333 333 340 341 21 Related parties and changes in foreign exchange rates Related parties 347 348 323 Definition of related party and related party transaction Disclosures required by IAS24 Foreign exchange accounting Reporting foreign currency transactions Translation to a presentation currency 348 350 351 352 354 Part Analysis of Financial Statements 22 Ratio analysis Accounting ratios Profitability ratios Liquidity ratios Efficiency ratios Investment ratios Limitations of ratio analysis Multivariate ratio analysis 361 362 363 367 369 372 379 380 23 Earnings per share Significance of EPS Calculation of basic EPS Shares issued during the accounting period Bonus issues Rights issues Calculation of diluted EPS Presentation and disclosure requirements 388 388 389 24 Segmental analysis Operating segments Reportable segments Disclosures required by IFRS8 404 405 405 407 391 393 394 397 399 Part Small and Medium-sized Entities 25 The IFRS for SMEs Standard Small and medium-sized entities Concepts and pervasive principles Financial statement presentation Statement of financial position Statement of comprehensive income and income statement Statement of changes in equity and Statement of income and retained earnings Statement of cash flows 417 418 419 420 421 421 422 422 vii Contents 25 The IFRS for SMEs Standard (cont.) Notes to the financial statements Consolidated and separate financial statements Accounting policies, estimates and errors Financial instruments Inventories Investments in associates and joint ventures Investment property Property, plant and equipment Intangible assets other than goodwill Business combinations and goodwill Leases Provisions and contingencies Liabilities and equity Revenue Government grants viii 422 423 423 424 424 424 425 425 426 426 426 426 427 427 428 Borrowing costs Share-based payment Impairment of assets Employee benefits Income tax Foreign currency translation and Hyperinflation Events after the end of the reporting period Related party disclosures Specialised activities Transition to the IFRS for SMEs Standard 428 428 428 429 429 429 429 430 430 430 Part Answers Answers to exercises Index 433 497 Preface The purpose of this book is to explain International Financial Reporting Standards (IFRS® Standards) and International Accounting Standards (IAS® Standards) at a level which is appropriate for students who are undertaking an intermediate course of study in financial reporting It is assumed that the reader has already completed an introductory accounting course and is familiar with the basics of financial accounting The book has not been written with any particular syllabus in mind but should be useful to second-year undergraduates studying for a degree in accounting and finance and to those who are preparing for the examinations of the professional accounting bodies IFRS Standards and IAS Standards (referred to in this book as "international standards") have gained widespread acceptance around the world and most accounting students are now required to become familiar with them The problem is that the standards and their accompanying documents occupy over 4,000 pages of fine print and much of this content is highly technical and difficult to understand What is needed is a textbook which explains each standard as clearly and concisely as possible and provides students with plenty of worked examples and exercises This book tries to satisfy that need The standards are of international application but, for the sake of convenience, most of the monetary amounts referred to in the worked examples and exercises in this book are denominated in £s Other than this, the book contains very few UK-specific references and should be relevant in any country which has adopted international standards Each chapter of the book concludes with a set of exercises which test the reader's grasp of the topics introduced in that chapter Some of these exercises are drawn from the past examination papers of professional accounting bodies Solutions to most of the exercises are located at the back of the book but solutions to those exercises which are marked with an asterisk (*) are intended for lecturers' use and are provided on a supporting website This sixth edition is in accordance with all international standards or amendments to standards issued as at January 2017 Alan Melville April 2017 ix www.downloadslide.com PART 6: Answers Workings: W1 Goodwill £000 Price paid by parent Subsidiary's share capital at 31 July 2015 Subsidiary's retained earnings at 31 July 2015 Fair value adjustment 100 220 80 ––– 90% × 400 ––– Goodwill at 31 July 2015 (and 31 July 2018) £000 410 360 –––– 50 –––– W2 Group retained earnings £000 Parent's retained earnings at 31 July 2018 Subsidiary's retained earnings at 31 July 2018 Subsidiary's retained earnings at 31 July 2015 380 220 ––– 90% × 160 ––– Associate's retained earnings (25% × 40) £000 2,420 144 10 –––– 2,574 –––– Group retained earnings at 31 July 2018 W3 Non-controlling interest Subsidiary's share capital at 31 July 2018 Subsidiary's retained earnings at 31 July 2018 Fair value adjustment Non-controlling interest at 31 July 2018 £000 100 380 80 ––– 10% × 560 ––– £000 56 –––– 56 –––– 20.4 Notes: On 30 September 2014, the total equity of L Ltd was £300,000 (£200,000 + £100,000) Therefore the price paid for goodwill was £20,000 (£140,000 – 40% of £300,000) This is not negative and so is not recognised separately The retained earnings of L Ltd have increased by £220,000 since K Ltd acquired its holding A 40% share of this increase is £88,000, so the investment in L Ltd should be carried at £228,000 (£140,000 + £88,000) However, unrealised profit of £1,000 (40% of one-quarter of £10,000) reduces the carrying amount of the investment to £227,000 The profit after tax of L Ltd for the year to 30 September 2018 is £110,000, of which a 40% share is £44,000 The unrealised profit reduces this to £43,000 On 30 September 2017, the retained earnings of L Ltd had increased by £160,000 since K Ltd acquired its holding So the carrying amount of the investment on that date would have been £204,000 (£140,000 + (40% × £160,000)) The carrying amount at 30 September 2018 is therefore (£204,000 + £43,000 – dividend £20,000) = £227,000, as stated above 486 www.downloadslide.com Answers to Exercises Statement of comprehensive income for the year to 30 September 2018 Operating profit Share of profit of associate ((40% × 110) – 1) Profit before tax Taxation Profit for the year £000 650 43 –––– 693 170 –––– 523 –––– Statement of financial position as at 30 September 2018 £000 Assets Non-current assets Property, plant and equipment Investment in associate (204 + 43 – 20) Current assets Equity Ordinary share capital Retained earnings (W2) Liabilities Current liabilities 1,600 227 ––––– 1,827 780 ––––– 2,607 ––––– 1,000 1,297 ––––– 2,297 310 ––––– 2,607 ––––– Statement of changes in equity (retained earnings only) for the year to 30 September 2018 Balance at 30 September 2017 (W1) Profit for the year Balance at 30 September 2018 (W2) £000 774 523 –––––– 1,297 –––––– Workings: W1 Retained earnings at 30 September 2017 £000 K Ltd retained earnings at 30 September 2017 L Ltd retained earnings at 30 September 2017 L Ltd retained earnings at 30 September 2014 Retained earnings at 30 September 2017 260 100 ––– 40% × 160 ––– £000 710 64 –––– 774 –––– 487 www.downloadslide.com PART 6: Answers W2 Retained earnings at 30 September 2018 £000 K Ltd retained earnings at 30 September 2018 L Ltd retained earnings at 30 September 2018 L Ltd retained earnings at 30 September 2014 Less: Unrealised profit Retained earnings at 30 September 2018 320 100 ––– 40% × 220 ––– £000 1,210 88 –––– 1,298 –––– 1,297 –––– Chapter 21 21.1 (a) Alan is a related party unless it can be demonstrated that his shareholding does not give him significant influence over the company If he is a related party, Elaine is also a related party (b) Y plc is controlled by Z plc, so Y plc is a related party (c) Z plc does not control X plc and (presumably) does not exert significant influence over the company or jointly control it Therefore X plc is not a related party (d) Barbara is a member of the key management personnel of Z plc and is a related party David is a close family member of Barbara and so is also a related party Barbara controls W Ltd, so W Ltd is a related party of Z plc David does not control V Ltd and there is no indication of joint control Therefore V Ltd is not a related party of Z plc (e) Colin may or may not be a related party It depends upon whether he is a member of the key management personnel of Z plc If he is a related party, then so is Fiona (f) The pension scheme is a related party 488 www.downloadslide.com Answers to Exercises 21.2 (a) January 2018 £115,000 (€143,750 ÷ 1.25) is debited to equipment and credited to X February 2018 £40,000 (€48,000 ÷ 1.20) is debited to purchases and credited to Y 28 February 2018 £115,000 is debited to X and £125,000 (€143,750 ÷ 1.15) is credited to bank The difference of £10,000 is debited to exchange differences 15 March 2018 £11,000 (€13,200 ÷ 1.20) is debited to Y and £12,000 (€13,200 ÷ 1.10) is credited to bank The difference of £1,000 is debited to exchange differences 15 March 2018 £70,000 (€77,000 ÷ 1.10) is debited to Z and credited to sales (b) On 31 March 2018, there is no adjustment to equipment or inventory, since both of these are carried at historical cost The amount owed to Y (€34,800) is translated to £34,800 (using an exchange rate of £1 = €1.00) This debt was previously carried at £29,000 (€34,800 ÷ 1.20) so there is an adverse exchange difference of £5,800 The amount owed by Z (€77,000) is translated to £77,000, giving rise to a favourable exchange difference of £7,000 The total exchange difference for the period is £9,800 (£10,000 + £1,000 + £5,800 – £7,000) This is an adverse difference and is recognised as an expense in the statement of comprehensive income 21.3 Statement of comprehensive income for the year to 30 June 2018 Fn 67,200 40,320 ––––– Profit for the year 26,880 Other comprehensive income ––––– 26,880 ––––– Statement of financial position as at 30 June 2018 Rate 5 £ 13,440 8,064 ––––– 5,376 6,344 ––––– 11,720 ––––– Fn 112,400 ––––– 60,000 26,880 ––––– 86,880 25,520 ––––– 112,400 ––––– Rate £ 28,100 ––––– 10,000 5,376 6,344 ––––– 21,720 6,380 ––––– 28,100 ––––– Sales revenue Expenses Assets Share capital (issued July 2017) Retained earnings Foreign exchange reserve Liabilities bal fig 489 www.downloadslide.com PART 6: Answers Statement of comprehensive income for the year to 30 June 2019 Fn 71,820 41,580 ––––– Profit for the year 30,240 Other comprehensive income ––––– 30,240 ––––– Statement of financial position as at 30 June 2019 Rate 4.5 4.5 £ 15,960 9,240 ––––– 6,720 (4,040) ––––– 2,680 ––––– Fn 145,920 ––––– 60,000 57,120 ––––– 117,120 28,800 ––––– 145,920 ––––– Rate 4.8 £ 30,400 ––––– 10,000 12,096 2,304 ––––– 24,400 6,000 ––––– 30,400 ––––– Sales revenue Expenses Assets Share capital (issued July 2017) Retained earnings Foreign exchange reserve Liabilities bal fig 4.8 Notes: (i) Retained earnings (in £) at 30 June 2019 are (£5,376 + £6,720) = £12,096 (ii) The reduction of £4,040 in the foreign exchange reserve (from £6,344 at 30 June 2018 to £2,304 at 30 June 2019) is shown as negative other comprehensive income in the statement of comprehensive income for the year to 30 June 2019 490 www.downloadslide.com Answers to Exercises Chapter 22 22.1 The main assumptions made when calculating the ratios for R Ltd are: (i) The figures shown in the statement of financial position are representative of the year as a whole and so can be used instead of average figures (which are not available in this case) (ii) All sales and purchases are made on credit terms (iii) Cost of sales can be used as a reasonable approximation to purchases The ratios are as follows: (a) ROCE = 60/279 × 100% = 21.5% (b) ROE = (35 – 1)/119 × 100% = 28.6% (c) Gross profit margin = 175/410 × 100% = 42.7% (d) Net profit margin = 45/410 × 100% = 11.0% (e) Current ratio = 147/76 = 1.9 (f) Quick assets ratio = (147 – 82)/76 = 0.9 (g) Inventory holding period = 82/235 × 365 = 127 days (h) Trade receivables collection period = 58/410 × 365 = 52 days (i) Trade payables payment period = 45/235 × 365 = 70 days (j) Capital gearing ratio = (150 + 10)/279 × 100% = 57.3% (k) Interest cover = 60/15 = (l) Dividend cover = (35 – 1)/20 = 1.7 (m) Earnings per share = (35 – 1)/100 × 100p = 34p 22.2 Company X will have a high gross profit margin but much of the gross profit will be absorbed by overhead expenses so that the net profit margin might be disappointingly low The inventory holding period and the trade receivables collection period will both be comparatively long The company will often have to pay for supplies of clothing well before the clothing is sold to customers and this may cause some liquidity problems As a consequence, the company may have needed to obtain a source of long-term finance This would be reflected in the capital gearing ratio and might depress the return obtained on equity Company Y will have a low gross profit margin but the lack of overhead costs may result in a surprisingly high net profit margin The inventory holding period and trade receivables collection period will both be short The company will often be able to sell goods and receive payment for them before having to pay its own suppliers, so that liquidity should not be a major problem 491 www.downloadslide.com PART 6: Answers 22.3 (a) Earnings per share = (90,000 – 15,000)/1,000,000 × 100p = 7.5p (b) Dividend cover = (90,000 – 15,000)/55,000 = 1.4 (c) Dividend yield = 5.5/70 × 100% = 7.9% (d) Price earnings ratio = 70/7.5 = 9.3 22.4 Profitability ratios 2017 2016 (a) ROCE 820/6,508 × 100% = 12.6% 745/5,583 × 100% = 13.3% (b) ROE 475/5,508 × 100% = 8.6% 500/5,433 × 100% = 9.2% (c) Gross profit margin 907/5,327 × 100% = 17.0% 820/3,725 × 100% = 22.0% (d) Net profit margin 690/5,327 × 100% = 13.0% 725/3,725 × 100% = 19.5% These ratios all show a deterioration in the year 2017 The reduction in the gross profit margin was deliberate and was presumably responsible (in part) for the 43% increase in sales, but overall the company was substantially less profitable in the year 2017 than in 2016 In absolute terms, the company's profit actually fell in the year 2017 It appears that the company's attempts to stimulate sales have been successful but the objective of increasing profits has not been achieved Liquidity ratios (e) Current ratio (f) Quick assets ratio 2017 2016 2,623/1,235 = 2.12 1,726/843 = 2.05 (2,623 – 1,334)/1,235 = 1.04 (1,726 – 730)/843 = 1.18 The current ratio has improved slightly in 2017 but this is mainly due to the large (and deliberate) increase in the company's inventories The quick assets ratio fell in 2017 It is important to realise that the company had virtually no cash left at the end of 2017, despite raising an extra £850,000 during the year from long-term loans Given that the company is now offering longer credit to its customers, the liquidity position looks poor Efficiency ratios 2017 2016 (g) Inv holding period 1,334/4,420 × 365 = 110 days 730/2,905 × 365 = 92 days (h) Rec collection period 1,278/5,327 × 365 = 88 days 596/3,725 × 365 = 58 days The increases in these ratios are expected, given the company's policy of holding larger inventories and offering longer credit to customers Gearing ratio (i) Capital gearing ratio 2017 2016 1,000/6,508 × 100% = 15.4% 150/5,583 × 100% = 2.7% The company has moved from being a very low-geared company in 2016 to being a moderately low-geared company in 2017 The interest cover is still adequate but the ordinary dividend is barely covered by the profit after tax If the company is forced by its liquidity position to increase borrowings still further and become more high-geared, it may be that the dividend paid to the ordinary shareholders will have to be reduced 492 www.downloadslide.com Answers to Exercises Chapter 23 23.1 (a) Basic EPS is (£390,000 – £80,000)/4,000,000 × 100p = 7.75p (b) If the company's profit after tax includes £50,000 from a discontinued operation, a second basic EPS figure must be presented, based on the profit from continuing operations This is (£390,000 – £50,000 – £80,000)/4,000,000 × 100p = 6.5p 23.2 (a) £188,000/100,000 = £1.88 (b) The weighted average number of ordinary shares outstanding during the year is (100,000 × 5/12) + (115,000 × 7/12) = 108,750 Therefore basic EPS is £217,500/108,750 = £2.00 23.3 (a) The bonus issue is treated as if it was made at the start of the year to 31 October 2016 Basic EPS for the year to 31 October 2017 is £341,000/550,000 × 100p = 62p (b) Restated basic EPS for the year to 31 October 2016 is £330,000/550,000 × 100p = 60p This would have been originally stated as £330,000/500,000 × 100p = 66p but is restated so as to be comparable with the figure for 2017 23.4 (a) Before the rights issue, the total market value of the company's shares (and so the worth of the company) was £120,000 (150,000 × 80p) The rights issue consisted of 30,000 shares and raised £15,000 (30,000 × 50p) Therefore the number of issued shares rose to 180,000 and the company's worth increased to £135,000 This gives a theoretical market price after the rights issue of 75p per share (£135,000/180,000) If the share price had fallen to 75p as the result of a bonus issue, the number of shares outstanding after this issue would have been 160,000 (since 160,000 × 75p = £120,000) So the size of bonus issue that would have caused a fall in market price to 75p per share is an issue of 10,000 shares (a for 15 bonus issue) Therefore the rights issue is treated as a bonus issue of 10,000 shares followed by an issue of 20,000 shares at full price The weighted average number of ordinary shares outstanding during the year to 30 September 2017 is (160,000 × 9/12) + (180,000 × 3/12) = 165,000 Therefore basic EPS for the year is £52,800/165,000 × 100p = 32p (b) Restated basic EPS for the year to 30 September 2016 is £50,000/160,000 × 100p = 31.25p 493 www.downloadslide.com PART 6: Answers 23.5 (a) Basic EPS is £640,000/800,000 × 100p = 80p (b) If the loan stock had been converted into ordinary shares, profit before tax would have risen by £100,000 and profit after tax would have risen by £80,000 to £720,000 The number of extra shares would be 200,000 so that the total number of shares outstanding would become one million Therefore diluted EPS is £720,000/1,000,000 × 100p = 72p (c) Basic EPS is still 80p The extra 200,000 shares that would arise if the loan stock is converted are treated as if issued on October 2017 The weighted average number of ordinary shares outstanding during the year to 31 March 2018 would become (800,000 × 6/12) + (1,000,000 × 6/12) = 900,000 Only half a year's interest would be saved so profit after tax would rise by £40,000 to £680,000 Therefore diluted EPS is £680,000/900,000 × 100p = 75.6p Chapter 24 24.1 (a) Many entities (especially large companies) engage in a wide range of business activities and operate in several economic environments Each business activity and each environment may be subject to differing risks and returns Therefore an analysis of an entity's results by business activity or by economic environment will help users to understand the entity's past performance, assess the entity's risks and returns and make more informed judgements Such an analysis is required by international standard IFRS8 (b) IFRS8 applies to entities whose shares or securities are publicly traded 24.2 (a) An operating segment (as defined by IFRS8) is a component of an entity that meets all of the following criteria: – it is engaged in business activities from which it may earn revenues and incur expenses – its operating results are regularly reviewed by the chief operating decision maker to assess its performance and to make resource allocation decisions – separate financial information is available for it (b) IFRS8 states that an operating segment is a reportable segment if it satisfies at least one of a number of quantitative thresholds In broad terms, the segment's sales must be at least 10% of total sales or its profit must be at least 10% of total profit or its assets must be at least 10% of total assets (See Chapter 24 for more details) If the external revenue of reportable segments is less than 75% of the entity's total external revenue, additional operating segments must be identified as reportable (even though they fail the 10% tests) until at least 75% of total external revenue is included in reportable segments 494 www.downloadslide.com Answers to Exercises 24.3 The four main classes of information are: (a) (b) (c) (d) general information information about each reportable segment reconciliations entity-wide information See Chapter 24 for a list of the disclosures required for each class 24.4 External revenue is £77.4m and internal revenue is £5.6m, so total revenue is £83m An operating segment will satisfy the 10% test with respect to revenue if it has total revenue of at least £8.3m Combined profits are £5.6m and combined losses are £780,000 An operating segment will satisfy the 10% test with respect to segment result if it has a profit or a loss of at least £560,000 Total assets are £38m An operating segment will satisfy the 10% test with respect to assets if it has total assets of at least £3.8m The results of the three 10% tests for each segment are as follows: Total revenue at least £8.3m Segment P Segment Q Segment R Segment S Y Y N N Profit or loss at least £560,000 Y Y N N Assets at least £3.8m Y Y N Y Reportable segment Y Y N Y Segment R fails all of the 10% tests and is not a reportable segment The remaining three segments have external revenue totalling £71.2m This exceeds 75% of £77.4m so the 75% test is satisfied The reportable segments are segments P, Q and S 495 www.downloadslide.com PART 6: Answers 24.5 All four segments satisfy the 10% test with regard to revenue and therefore all four segments are reportable segments The required information might be presented as follows: Total £m Segment revenue External sales revenue Inter-segment sales Total revenue Segment profit Unallocated expenses Profit before tax Tax expense Profit after tax Segment assets Unallocated assets Total assets Segment liabilities Unallocated liabilities Total liabilities Other segment information Interest income Interest expense Depreciation Other non-cash expenses Capital expenditure 496 Segment A £m Segment B £m Segment C £m Segment D £m 3,025 781 ––––– 3,806 ––––– 620 120 ––––– 500 150 ––––– 350 ––––– 652 127 –––– 779 –––– 159 –––– 764 234 –––– 998 –––– 165 –––– 389 87 –––– 476 –––– 63 –––– 1,220 333 –––– 1,553 –––– 233 –––– 2,475 457 ––––– 2,932 ––––– 530 –––– 653 –––– 310 –––– 982 –––– 1,038 658 ––––– 1,696 ––––– 245 –––– 276 –––– 119 –––– 398 –––– 85 192 551 65 289 17 34 101 17 99 12 51 132 12 68 20 65 - 56 87 253 29 122 www.downloadslide.com Index Accounting estimates, 66 Accounting policies, 38, 51, 61-65, 423 Accounting ratios, 361-380 Accounting standards, Accrual basis, 21, 39, 419 Actuarial gains and losses, 225 Actuarial method, 151 Adjusting event, 198 Aggregation, 39, 420 Amortisation, 108 Amortised cost, 181, 182 Asset, 25 Asset turnover, 369 Associates, 332-339, 424 Balance sheet, 37, 41 Basic earnings per share, 389 Bonus issues, 393 Borrowing costs, 87-88, 428 Business combinations, 103, 112-113, 426 Consolidated financial statements, 292, 423 Constructive obligation, 25, 192, 222 Contingent asset, 196, 426 Contingent liability, 196, 426 Contracts with customers, 204-217 Control, 292 Conversion costs, 165 Corporate assets, 126 Cost formulas, 167 Cost model, 80, 93, 106 Credit risk, 186 Currency risk, 186 Current assets, 42 Current cost, 28 Current cost accounting, 279 Current liabilities, 42 Current purchasing power accounting, 279 Current ratio, 367 Current service cost, 224 Current tax, 237-238, 429 Capital, 28 Capital gearing ratio, 373 Capital maintenance, 28, 273 Carrying amount, 76 Cash, 252 Cash equivalent, 42, 252 Cash-generating unit, 124, 135, 142 Comparability, 10, 23, 38, 40, 419 Comparative information, 40, 420 Completeness, 22 Compliance with standards, 38, 51, 420 Components of financial statements, 37 Compound financial instruments, 178 Comprehensive income, 45, 419 Conceptual framework, 17 Condensed financial statements, 52 Consignment arrangements, 217 Consistency, 23, 40 Date of transition, 12 Deferred tax, 239-247, 429 Defined benefit obligation, 224 Defined benefit plan, 224 Defined contribution plan, 223 Depreciable amount, 82 Depreciation, 82 Development expenditure, 104 Diluted earnings per share, 397 Diminishing balance method, 84 Direct method, 255 Discontinued operations, 142-144, 389 Discounting, 28, 32-33 Disposal group, 135 Dividend cover, 372 Dividend yield, 373 Dividends, 49, 184, 198, 205, 254, 317 Downstream transaction, 338 497 www.downloadslide.com Index Earnings per share, 372, 388-400 Effective interest method, 182 Efficiency ratios, 369 Elements of financial statements, 25 Employee benefits, 220-232, 429 Enhancing characteristics, 23 Entity, Equity, 26 Equity instrument, 176 Equity method, 333, 341 Errors, 66-68, 423 Estimates, 66, 423 Estimation uncertainty, 51 Events after the reporting period, 198, 429 Exchange differences, 352, 354 Expected value, 193, 210 Expenses, 26, 47 Exposure draft, Extraordinary items, 46, 421 Fair presentation, 38, 420 Fair value, 80, 95, 181, 184, 419 Fair value less costs of disposal, 120,122 Fair value less costs to sell, 137 Fair value model, 93 Fair value through OCI, 181 Fair value through profit or loss, 181, 184 Faithful representation, 10, 22 FASB, 5, 17 Finance lease, 149, 150-154 Financial asset, 176 Financial capital maintenance, 29, 273 Financial instruments, 175-187, 424 Financial liability, 176 Financial reporting, 3, 19 Financial statements, 21, 36 Financing activities, 254 First-in, first-out (FIFO), 167 First-time adoption, 11, 430 Fixed production overheads, 165 Foreign currency transactions, 352, 429 Foreign operations, 351, 354, 429 Functional currency, 280, 351 Fundamental characteristics, 21 GAAP, Gearing ratio, 373 498 Generally accepted accounting practice, Going concern, 24, 39, 420 Goodwill, 103, 111-113, 126, 295, 426 Government grants, 89-91, 428 Gross profit margin, 366 Group, 292 Group changes in equity, 317 Group comprehensive income, 316-325 Group financial position, 293-307 Group financial statements, 292 Historical cost, 28 Historical cost accounting, 273-279 Holding gains, 277 Hyperinflationary economies, 280-285, 429 IAS1, 36-51 IAS2, 164-171 IAS7, 251-262 IAS8, 61-68, 83 IAS10, 198, 237 IAS11, 164, 204 IAS12, 236-247 IAS16, 76-86 IAS17, 148-154 IAS18, 204 IAS19, 220-230 IAS20, 89-91 IAS21, 351-356 IAS23, 87-88 IAS24, 348-350 IAS27, 292 IAS28, 332-339 IAS29, 280-285 IAS32, 176-179 IAS33, 388-400 IAS34, 52-53 IAS36, 118-130 IAS37, 190-197 IAS38, 101-111 IAS39, 175 IAS40, 92-93 IASB, 5, IASB Conceptual Framework, 17-30 IASB website, 33 Identifiable asset, 102 Identification of financial statements, 41 www.downloadslide.com Index IFRS1, 11-13 IFRS2, 230-232 IFRS3, 103, 112-113, 295, 302 IFRS5, 134-144 IFRS7, 185-187 IFRS8, 404-410 IFRS9, 180-185 IFRS10, 291-307, 316-325 IFRS11, 340-341 IFRS12, 307, 341 IFRS13, 95 IFRS15, 204-217 IFRS16, 155-159 IFRS Advisory Council, IFRS for SMEs Standard, 6, 417-430 IFRS Foundation, IFRS Interpretations Committee, Impairment of assets, 118-130, 183, 428 Income, 26 Indirect method, 255 Intangible assets, 100-113, 426 Interest, 182, 205, 254 Interest cost, 224 Interest cover, 375 Interest income, 225 Interest rate risk, 186 Interim financial reporting, 52 Internally generated intangible asset, 103 International Accounting Standards, International Accounting Standards Board, International Financial Reporting Standards, Interpretations, Intra-group items, 305, 317 Inventories, 164-171, 424 Inventory holding period, 370 Investing activities, 253 Investment property, 92-93, 425 Investment ratios, 372 Level spread method, 151 Liability, 25 Liquidity ratios, 367 Liquidity risk, 186 Long-term employee benefits, 229 Low-value asset, 155 Joint arrangements, 340 Joint control, 340 Joint operations, 340-341 Joint ventures, 340-341, 424 Parent, 292 Payables payment period, 371 Performance obligation, 208 Permanent difference, 239 Physical capital maintenance, 29, 274 Post-employment benefits, 223 Preference shares, 178, 303 Last-in, first-out (LIFO), 168 Leases, 148-159, 426 Management commentary, 53 Market risk, 186 Materiality, 22, 39, 420 Measurement of an element, 28 Minimum lease payments, 151 Monetary asset, 102 Monetary items, 276, 352 Multivariate ratio analysis, 380 Negative goodwill, 112, 295 Net profit margin, 366 Net realisable value, 170 Neutrality, 22 Non-adjusting event, 198 Non-controlling interest, 300, 317 Non-current assets, 42 Non-current assets held for sale, 134-142 Non-current liabilities, 42 Non-monetary asset, 102 Notes to the financial statements, 51, 422 Objective of financial reporting, 19 Objective of financial statements, 37, 419 Obligating event, 192 Obligation, 25, 191 Offsetting, 39, 419 Onerous contract, 194 Operating activities, 253 Operating lease, 149, 150 Operating segments, 404-410 Options, 398 Other comprehensive income, 45, 81, 106, 420 499 www.downloadslide.com Index Present obligation, 25, 191, 222 Present value, 28, 32-33, 150, 183, 193 Presentation currency, 280, 351, 354 Presentation of financial statements, 36 Price earnings ratio, 372 Prior period errors, 66-68, 423 Profitability ratios, 363 Prompt payment discounts, 209 Property, plant and equipment, 75-86, 425 Provisions, 26, 190-197, 426 Prudence, 23, 419 Purchasing power, 29, 273 Qualitative characteristics, 21, 419 Quick assets ratio, 368 Ratio analysis, 361-380 Realisable value, 28 Receivables collection period, 370 Reclassification to profit or loss, 46, 81, 107, 181, 226, 354 Recognition of an element, 27 Recoverable amount, 120, 141 Redeemable preference shares, 178 Reducing balance method, 84 Regulatory framework, Related parties, 348-350, 430 Relevance, 22, 38, 419 Reliability, 38, 419 Reportable segment, 405 Repurchase agreement, 217 Research expenditure, 103 Residual value, 83, 109 Restructuring costs, 195 Retail method, 166 Retrospective application, 63 Retrospective correction, 67 Return on capital employed, 364 Return on equity, 365 Return on plan assets, 225 Returns, 216 Revaluation gains, 81, 106 Revaluation losses, 81, 107 Revaluation model, 80, 106 Revenue, 204-217, 427 Right-of-use asset, 155 Rights issues, 394 500 Segmental analysis, 404-410 Separable asset, 102 Separately acquired intangible asset 102 Share-based payment, 230-232, 428 Short-term employee benefits, 221 Short-term lease, 155 Significant influence, 332 Small and medium-sized entities, 6, 417-430 Standard costs, 166 Statement of cash flows, 251-262, 422 Statement of changes in equity, 49, 422 Statement of comprehensive income, 45, 421 Statement of financial position, 41, 421 Statement of income and retained earnings, 422 Statement of profit or loss, 46 Statement of profit or loss and other comprehensive income, 45 Stewardship, 21 Straight-line method, 84 Subsidiary, 292 Substance over form, 23, 148, 177, 419 Sum of digits method, 151 Tax base, 241 Taxation, 236-247, 254, 429 Temporary difference, 239, 242 Termination benefits, 229, 429 Timeliness, 23 Trade payables, 184 Trade receivables, 181 Transaction price, 209 Underlying asset, 155 Underlying assumption, 24 Understandability, 24, 38, 419 Units of production method, 84 Unrealised profits, 306, 317, 338 Upstream transaction, 338 Useful life, 83, 108 Users of financial statements, 19, 20 Value in use, 120, 122, 141 Venturer, 340 Verifiability, 23 Warranties, 191, 217 Weighted average cost (AVCO), 168 ... IASB are known as International Financial Reporting Standards (IFRS® Standards) Standards published by the IASC are known as International Accounting Standards (IAS® Standards) Many of the IAS... explain International Financial Reporting Standards (IFRS® Standards) and International Accounting Standards (IAS® Standards) at a level which is appropriate for students who are undertaking an intermediate... USA has a Financial Accounting Standards Board (FASB) and there are standardsetters in other countries such as Germany, Japan, Australia etc However, the increasing globalisation of business has