Part 1 book “ Issues in financial accounting” has contents: institutional arrangements for setting accounting standards in australia, the choice of accounting methods, accounting for financial instruments, accounting for employee benefits, accounting for current assets, accounting for company income tax,… and other contents.
The book covers the significant recent developments to the accounting standards in Australia and is based on the AASB standards and interpretations that have been issued up to the end of 2012 ISSUES IN FINANCIAL ACCOUNTING This text presents students with real-world examples, current debates and the underlying rationale for the accounting concepts demonstrated Throughout the text academic studies and professional accounting research are referenced to give students a critical understanding of historical debates in financial accounting Henderson ◆ Peirson ◆ Herbohn ◆ Artiach ◆ Howieson The 15th edition of Issues in Financial Accounting addresses the controversial issues in financial accounting that have been debated by the preparers, users, auditors and regulators of financial statements Henderson ◆ Peirson ◆ Herbohn ◆ Artiach ◆ Howieson Issues in Financial Accounting 15th edition 15th EDITION Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2013 – 9781442561175 - Henderson/Issues in Financial Accounting 15e Henderson15e_Full Cover.indd spine: 33mm 12/07/13 9:44 AM Issues in Financial Accounting Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2013 – 9781442561175 - Henderson/Issues in Financial Accounting 15e A01_HEND1175_15_LT_FM.indd 10/07/13 1:54 PM To Margaret, Chris, John, John and Christopher Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2013 – 9781442561175 - Henderson/Issues in Financial Accounting 15e A01_HEND1175_15_LT_FM.indd 10/07/13 1:54 PM Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2013 – 9781442561175 - Henderson/Issues in Financial Accounting 15e A01_HEND1175_15_LT_FM.indd 10/07/13 1:54 PM Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2014 Pearson Australia Unit 4, Level 14 Aquatic Drive Frenchs Forest NSW 2086 www.pearson.com.au The Copyright Act 1968 of Australia allows a maximum of one chapter or 10% of this book, whichever is the greater, to be copied by any educational institution for its educational purposes provided that that educational institution (or the body that administers it) has given a remuneration notice to Copyright Agency Limited (CAL) under the Act For details of the CAL licence for educational institutions contact: Copyright Agency Limited, telephone: (02) 9394 7600, email: info@copyright.com.au All rights reserved Except under the conditions described in the Copyright Act 1968 of Australia and subsequent amendments, no part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the copyright owner Acquisitions Editor: Judith Bamber Senior Project Editor: Bernadette Chang Editorial Coordinator: Sophie Attwood Production Controller: Julie McArthur Copy Editor: Fiona Crawford Proofreader: Robyn Flemming Senior Copyright and Pictures Editor: Emma Gaulton Indexer: Mary Coe Cover and internal design by Simon Rattray, Squirt Creative Cover illustration © Sylverarts / Shutterstock.com Typeset by Midland Typesetters, Australia Printed in China 18 17 16 15 14 National Library of Australia Cataloguing-in-Publication Data Author: Henderson, Scott, author Title: Issues in financial accounting / Scott Henderson, Graham Peirson, Kathleen Herbohn, Tracy Artiach, Bryan Howieson Edition: 15th edition ISBN: 9781442561175 (Paperback) ISBN: 9781486017980 (Vital Source) Notes: Includes index Subjects: Accounting—Australia—Textbooks Financial statements—Australia—Textbooks Other Authors/Contributors: Peirson, Graham, author Herbohn, Kathy, author Artiach, Tracy, author Howieson, Bryan, author Dewey Number: 657 Every effort has been made to trace and acknowledge copyright However, should any infringement have occurred, the publishers tender their apologies and invite copyright owners to contact them Due to copyright restrictions, we may have been unable to include material from the print edition of the book in this digital edition, although every effort has been made to minimise instances of missing content Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2013 – 9781442561175 - Henderson/Issues in Financial Accounting 15e BRIEF CONTENTS Preface to the fifteenth edition About the authors Acknowledgements Part Chapter Chapter Chapter Chapter Institutional setting and the conceptual framework Institutional arrangements for setting accounting standards in Australia A conceptual framework: Scope, reporting entity and the objective of financial reporting A conceptual framework: The fundamentals of general purpose financial reporting A conceptual framework: Recognition and measurement of the elements of financial statements Chapter The choice of accounting methods Part The statement of financial position Chapter The statement of financial position: An overview Chapter Accounting for current assets Chapter Accounting for property, plant and equipment Chapter xi xii xiv The statement of comprehensive income and further financial reporting issues 501 Chapter 16 The statement of comprehensive income 502 Chapter 17 The statement of cash flows 530 Chapter 18 Financial reporting: Segment reporting, statements of value added, highlights statements and future-oriented financial information 549 25 Chapter 19 Further financial reporting issues Part 46 70 109 133 174 Chapter 10 Accounting for investments 279 Chapter 11 Accounting for intangible assets 304 Chapter 12 Accounting for leases 353 Chapter 13 Accounting for employee benefits 390 Chapter 14 Accounting for financial instruments 428 475 589 651 652 Chapter 21 Accounting for real estate development and construction contracts 699 Chapter 22 Accounting for agricultural activity 728 Chapter 23 Accounting for superannuation plans 752 Chapter 24 Accounting for financial institutions 782 Chapter 25 Financial reporting in the public sector 822 Part 149 Industry accounting standards Chapter 20 Accounting for the extractive industries International accounting 847 Chapter 26 International accounting standards, harmonisation and convergence 848 Chapter 27 Foreign currency translation 865 134 Accounting for company income tax 232 Chapter 15 Equity Part Part Accounting and the community 911 Chapter 28 Accounting for corporate social responsibilities 912 Chapter 29 Ethics in accounting 949 Appendix Glossary Author index Subject index 972 976 987 991 Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2013 – 9781442561175 - Henderson/Issues in Financial Accounting 15e A01_HEND1175_15_LT_FM.indd 10/07/13 1:54 PM DETAILED CONTENTS Preface to the fifteenth edition About the authors Acknowledgements Part Institutional setting and the conceptual framework Chapter Institutional arrangements for setting accounting standards in Australia 1.1 1.2 1.3 xi xii xiv 10 Selected references 17 Questions 17 Notes 19 Appendix 1.1: The development of institutional arrangements for standard setting in Australia 19 Chapter A conceptual framework: Scope, reporting entity and the objective of financial reporting 2.1 2.2 2.3 2.4 2.5 2.6 Introduction The development of a conceptual framework for financial reporting The structure of the Australian conceptual framework The border of the discipline The subject of financial reporting The objective of financial reporting Chapter A conceptual framework: The fundamentals of general purpose financial reporting 3.1 3.2 Introduction Accounting standard setting in Australia The preparation and enforcement of AASB Accounting Standards and AASB Interpretations Notes to Appendix 1.1 Appendix 2.1: Documents published by the AARF/AASB in the development of a conceptual 45 framework as at 31 December 2012 24 25 26 26 3.3 3.4 Chapter A conceptual framework: Recognition and measurement of the elements of financial statements 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 4.10 28 33 36 38 Selected references 41 Questions 41 Case study 43 Notes 43 Introduction The qualitative characteristics of useful financial information The elements of financial statements Profit Selected references Questions Problems Notes Introduction Recognition Measurement Measurement in accounting Assets Liabilities Equity Income Expenses Summary Selected references Questions Notes Appendix 4.1: Fair value measurement 46 47 47 52 64 65 66 67 69 70 71 73 73 75 76 87 97 97 99 100 101 101 103 105 Chapter The choice of accounting methods 109 5.1 5.2 110 110 Introduction Choice by accounting standard setters Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2013 – 9781442561175 - Henderson/Issues in Financial Accounting 15e A01_HEND1175_15_LT_FM.indd 10/07/13 1:54 PM D ETA I LED C O NT EN T S 5.3 Choice by preparers of financial statements Selected references Questions Problems Notes 114 127 127 128 129 Part The statement of financial position 133 Chapter The statement of financial position: An overview 134 6.1 6.2 6.3 6.4 Introduction Format of the statement of financial position Presentation of elements of the statement of financial position Accounting standards Selected references Questions Problems Notes Chapter Accounting for current assets 7.1 7.2 7.3 Introduction Accounts receivable Inventories Selected references Questions Problems Notes Chapter Accounting for property, plant and equipment 8.1 8.2 8.3 8.4 Introduction Initial recognition of property, plant and equipment Subsequent measurement of property, plant and equipment Depreciation of property, plant and equipment Selected references Questions Problems Notes Chapter Accounting for company income tax 9.1 9.2 9.3 9.4 Introduction Alternative methods of accounting for company income tax: The fundamentals Accounting standards Empirical research on tax-effect accounting Selected references Questions Problems Notes 135 Chapter 10 Accounting for investments 135 10.1 10.2 10.3 136 138 145 145 146 147 149 150 151 153 170 170 171 173 Chapter 11 Accounting for intangible assets 11.1 11.2 11.3 11.4 11.5 11.6 11.7 174 175 176 188 215 224 224 226 231 Introduction Investments in the shares of other companies Accounting for investment properties Selected references Questions Problems Notes Introduction Nature of intangible assets Distinguishing intangible assets from goodwill Intangible assets: Purchased or developed internally Accounting for intangible assets Accounting standards on intangible assets Goodwill Selected references Questions Problems Notes Chapter 12 Accounting for leases 12.1 12.2 12.3 12.4 Leases Accounting standards on leases A new approach to lease accounting Instalment sales and hire purchase Selected references Questions Problems Notes vii 232 233 234 244 266 268 268 270 278 279 280 280 295 300 300 301 303 304 305 305 306 307 307 309 327 336 336 339 351 353 354 361 378 380 381 381 382 388 Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2013 – 9781442561175 - Henderson/Issues in Financial Accounting 15e A01_HEND1175_15_LT_FM.indd 10/07/13 1:54 PM viii DE TAIL E D C ON T E N T S Chapter 13 Accounting for employee benefits 13.1 13.2 13.3 13.4 13.5 13.6 Introduction Wages and salaries Compensated absences Profit-sharing and bonus plans Termination benefits Post-employment benefits Selected references Questions Problems Notes Chapter 14 Accounting for financial instruments 14.1 14.2 14.3 14.4 14.5 14.6 14.7 Introduction The definition of financial instruments Recognition and measurement of financial instruments Futures contracts Option contracts Swaps Disclosure Selected references Questions Problems Notes Appendix 14.1: Disclosures of derivative financial instruments: Brambles Limited – Annual Report 2011 Chapter 15 Equity 15.1 15.2 15.3 Introduction Components of equity Accounting standards Selected references Questions Problems Notes 16.3 391 395 396 406 408 410 422 423 424 427 428 507 521 521 522 529 Chapter 17 The statement of cash flows 530 17.1 17.2 17.3 17.4 17.5 429 430 434 442 448 452 459 461 462 462 463 464 18.1 18.2 18.3 18.4 18.5 476 476 495 498 498 498 500 Chapter 16 The statement of comprehensive income 502 16.1 16.2 503 503 Introduction Development of the statement of cash flows Meaning of funds The advantages of reporting cash flow information Accounting standards Selected references Questions Problems Notes 531 531 532 534 536 543 543 544 547 Chapter 18 Financial reporting: Segment reporting, statements of value added, highlights statements and future-oriented financial information 549 475 Part The statement of comprehensive income and further financial 501 reporting issues Introduction Measurement of profit Accounting standards Selected references Questions Problems Notes 390 Introduction Financial reporting by segments Statements of value added Highlights statements and performance indicators Future-oriented financial information Selected references Questions Problems Notes Appendix 18.1: Segment reports: Boral Ltd – Annual Report 2011 Appendix 18.2: Highlights statements: BHP Billiton Ltd – Annual Report 2011 Chapter 19 Further financial reporting issues 19.1 19.2 19.3 19.4 19.5 19.6 Introduction Differential reporting Materiality Events after the reporting period Accounting policies, changes in accounting estimates and errors Related-party transactions 550 550 558 562 576 580 580 581 584 586 588 589 590 590 594 601 606 617 Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2013 – 9781442561175 - Henderson/Issues in Financial Accounting 15e A01_HEND1175_15_LT_FM.indd 10/07/13 1:54 PM D ETA I LED C O NT EN T S 19.7 19.8 19.9 Continuous and interim reporting Concise financial reports Australian additional disclosures Selected references Questions Notes 625 638 640 641 642 648 Part Industry accounting standards 651 Chapter 20 Accounting for the extractive industries 20.1 20.2 20.3 20.4 Introduction Nature of the accounting problem in the extractive industries Accounting standards Alternative methods of accounting for pre-production costs Selected references Questions Problems Notes Appendix 20.1: Illustrations of the alternative methods of accounting for pre-production costs 652 653 654 657 677 683 684 685 692 694 Chapter 21 Accounting for real estate development and construction contracts 699 21.1 21.2 21.3 Real estate development Construction contracts Possible future changes in accounting standards Selected references Questions Problems Notes Chapter 22 Accounting for agricultural activity 22.1 22.2 22.3 22.4 22.5 Introduction Accounting classification of biological assets Measuring biological assets Accounting for changes in the carrying amount of biological assets Accounting standards for biological assets Selected references Questions Problems Notes 700 711 722 723 723 724 727 728 729 730 731 735 736 747 747 748 750 Chapter 23 Accounting for superannuation plans 23.1 23.2 23.3 23.4 Introduction Nature of superannuation plans Accounting and reporting by superannuation plans Accounting standards Selected references Questions Problems Notes Chapter 24 Accounting for financial institutions 24.1 24.2 24.3 24.4 24.5 24.6 Introduction Insurance Fixed-fee service contracts General insurance contracts Life insurance contracts Accounting for banks Selected references Questions Problems Notes Chapter 25 Financial reporting in the public sector 25.1 25.2 25.3 25.4 25.5 25.6 The nature of the public sector Accounting in the public sector Reporting entities Some issues in public sector accounting Accounting standards Government Finance Statistics reporting framework Selected references Questions Notes ix 752 753 754 754 757 777 778 779 781 782 783 783 784 785 800 803 818 818 820 820 822 823 827 828 831 836 841 844 844 845 Part International accounting 847 Chapter 26 International accounting standards, harmonisation and convergence 848 26.1 26.2 26.3 Introduction The International Accounting Standards Board International convergence and harmonisation policy in Australia 849 849 853 Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2013 – 9781442561175 - Henderson/Issues in Financial Accounting 15e A01_HEND1175_15_LT_FM.indd 10/07/13 1:54 PM 486 PA R T T HE S TAT E M E N T O F F I N A NC I A L P O S I T I O N In short, AASB stipulates that the remuneration is to be initially measured based on the number of options expected to vest As conditions change, adjustments to the remuneration expense are to be calculated Paragraph 21 details the required treatment of market-based vesting conditions Market conditions upon which vesting is conditional are to be taken into account when the fair value of the equity instrument granted is estimated No further adjustments are to be made This means that, irrespective of whether the market condition is met, a company recognises the fair value of the options if an employee satisfies all other vesting conditions The accounting method outlined in paragraphs 19 to 21 is known as the modified grant date method (Implementation Guidance, AASB 2, para IG9) This is because the number of equity instruments included in the determination of the remuneration expense is adjusted to reflect the outcome of the vesting conditions, while no adjustment is made to the fair value of those equity instruments The fair value is estimated at grant date and is not subsequently revised The modified grant date method required by AASB is illustrated in Example 15.4 example 15.4 On July 2012, Gipp Ltd granted 4000 share options to its top 15 senior executives The conditions of the option plan were as follows: • vesting conditions: options can be exercised when Gipp’s share price increases to $4.20, but only if the executive in question has been in continuous service until this market condition is met; • the options have a nine-year life; and • the exercise price of the options is $3.70 The fair value of the options is not readily determinable because there are no options with similar terms and conditions that are traded Instead, Gipp Ltd has to apply a binomial option-pricing model to estimate the fair value of the share options at grant date This model takes into account the possibility that the share price target will be met over the nine-year life of the options, and also the possibility that the target will not be met The estimated fair value of the options at grant date was calculated to be $1.20 per option The model was also used to estimate the vesting period of the options at four years Gipp Ltd expected that two of the senior executives would leave before 30 June 2016 (four years from grant date of the options) However, three executives left – two during the year ended 30 June 2014 and one during the year ended 30 June 2015 The share price of Gipp Ltd reached the target price of $4.20 on October 2016 Outlined below are the steps required to measure the remuneration initially and to adjust this value in subsequent periods to take account of unexpected events and market-based vesting conditions The calculations conform with the requirements of AASB Initial measurement On July 2012 the best available estimate of the number of equity instruments expected to vest is 52 000 options (4000 options ϫ 13 senior executives) (para 20) The options were granted to 15 executives, but only 13 are expected to remain in continuous employment until 30 June 2016 At July 2012, Gipp Ltd would expect to recognise total remuneration of $62 400 (52 000 options ϫ $1.20) by the end of the vesting period Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2013 – 9781442561175 - Henderson/Issues in Financial Accounting 15e M15_HEND1175_15_LT_C15.indd 486 10/07/13 1:53 PM C HAP T E R 15 EQ U I T Y 487 Subsequent measurement The departure of a third executive during the estimated four-year vesting period ending on 30 June 2014 was not expected Consequently, Gipp Ltd should revise downwards the number of options expected to vest from 52 000 options to 48 000 options (4000 options ϫ 12 senior executives) (para 20) This adjustment affects the total remuneration to be recognised by the end of the vesting period, which is now equal to $57 600 (48 000 options ϫ $1.20) Treatment of market-based vesting conditions The share price target of $4.20 is not reached until October 2016, which lies outside the expected fouryear vesting period However, the total remuneration is not adjusted because the possibility of not meeting this market condition is already reflected in the fair value of the options estimated using the binomial option-pricing model at grant date (para 21) – that is, on July 2012 To which reporting periods should the remuneration expense be assigned? The total amount of the remuneration expense should be allocated to the periods during which the employees’ services leading to the expense are provided For many plans the periods during which the services are provided are not obvious In Example 15.3, for Renown’s plan the remuneration may be, at least partly, for services provided before the grant date Other possible periods are the period between the grant date and the earliest date on which the options could be exercised, the period between the grant date and the exercise date, the period between the grant date and the date on which the exercise period ceases, and the period during which exercise is possible The answer to this question can only be determined with knowledge of Renown’s intentions If it is a reward for services already provided by employees, the remuneration expense should be recognised as a prior-period adjustment in the period in which the options are issued It is much more likely, however, that the plan is intended to cover services to be provided in future periods It is desirable, therefore, that the plan should indicate the period of the remuneration For example, Renown’s plan could contain the information that the plan was granting options as part of the remuneration for services to be performed for the period January 2013 to 31 December 2015 For Renown’s plan, therefore, the remuneration expense would be allocated to the three years from the beginning of 2013 to the end of 2015 In the absence of any indication of the remuneration period intended by the plan, an arbitrary allocation is necessary AASB addresses these issues as follows If the equity instruments granted vest immediately, then in the absence of evidence to the contrary it is assumed that the employee has performed the services for which the equity instruments were granted (para 14) In this case, on grant date the entity must recognise the services received in full, with a corresponding increase in equity Alternatively, if the equity instruments granted not vest until employees complete a specified period of service, it is assumed that employees perform services during the vesting period for which the equity instruments will be received in the future (para 15) The entity must account for services received from employees during the vesting period with a corresponding increase in equity Employees may also be granted options conditional on achieving performance conditions If the performance condition is a market condition, the length of the vesting period must not be revised Paragraph 15(b) states that: the estimate of the length of the expected vesting period shall be consistent with the assumptions used in estimating the fair value of the options granted, and shall not be subsequently revised Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2013 – 9781442561175 - Henderson/Issues in Financial Accounting 15e M15_HEND1175_15_LT_C15.indd 487 10/07/13 1:53 PM 488 PA R T T HE S TAT E M E N T O F F I N A NC I A L P O S I T I O N However, if the performance condition is not a market condition, an entity must revise ‘its estimate of the length of the vesting period, if necessary, if subsequent information indicates that the length of the vesting period differs from previous estimates’ (para 15(b)) We revisit Example 15.4 to illustrate how AASB requires the total remuneration to be assigned to each reporting period example 15.4 (continued) Paragraph 15 requires the remuneration expense to be recognised over the vesting period from July 2012 to 30 June 2016 In the absence of evidence to the contrary, it is assumed that the executives provide services evenly over the vesting period In each of the first three years a remuneration expense of $15 600 ($62 400 ÷ years) would be recognised by Gipp Ltd During the last year of the four-year vesting period, another senior executive resigns Paragraph 19 requires an adjustment to the total remuneration to reflect the smaller number of options expected to vest, so the total remuneration is revised downwards from $62 400 to $57 600 (para 9) This is shown in the following table Year ended Remuneration expense recognised each year 30 June 2013 30 June 2014 30 June 2015 30 June 2016 Aggregate remuneration expense $15 600 15 600 15 600 10 800 $57 600 At the beginning of the year ended 30 June 2016, Gipp Ltd has recognised an aggregate remuneration expense of $46 800 ($15 600 ϫ years) The difference between the aggregate remuneration expense recognised to 30 June 2016 of $46 800 and the revised total remuneration of $57 600 would be recognised as the remuneration expense for the period ended 30 June 2016 The difference is $10 800 Note that the market condition of a share price target of $4.20 has not been met by the end of the estimated four-year vesting period (1 July 2012 to 30 June 2016) Paragraph 15 states that the length of the vesting period must not be revised if a market condition for vesting is not met What accounting entries should be made? AASB outlines accounting procedures for equity instruments issued to employees To illustrate the entries, we use the Gipp Ltd plan outlined in Example 15.4 example 15.4 (continued) On 30 June of each of the three years 2013 to 2015, the following general journal entry would be passed to reflect the amount of remuneration expense applicable to that period ‘Employee options’ is an equity account representing the options granted to employees Remuneration expense Employee options Dr Cr $15 600 $15 600 Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2013 – 9781442561175 - Henderson/Issues in Financial Accounting 15e M15_HEND1175_15_LT_C15.indd 488 10/07/13 1:53 PM C HAP T E R 15 EQ U I T Y 489 For the fourth year, ended 30 June 2016, the following general journal entry would be passed: Remuneration expense Employee options Dr Cr $10 800 $10 800 If, on 20 November 2016, when the market price of Gipp Ltd’s shares is $4.90 per share, one senior executive exercises her option to purchase 4000 shares at $3.70 per share, the general journal entry would be as follows: Employee options Cash at bank Share capital a b c Dr Dr Cr $4 800a 14 800b $19 600c 4000 options ϫ $1.20 per option 4000 options ϫ $3.70 per share 4000 options ϫ $4.90 per share It is possible that some of the options will not be exercised by the end of the nine-year exercise period This could be because one of the executives granted options has chosen not to acquire the shares Suppose, for example, that options to purchase 4000 shares were not exercised by 30 June 2021 In this case, it may be expected that there would be a general journal entry on 30 June 2021 to reduce equity as follows: Employee options Remuneration expense Dr Cr $4 800 $4 800 However, AASB prohibits adjustments to total equity after the vesting date (para 23) Thus, Gipp Ltd is not permitted to reverse the amount recognised in equity for the options, although paragraph 23 does allow the company to make a transfer from one component of equity to another For example, the following general journal might be recorded by Gipp Ltd on 30 June 2021 in relation to 4000 options that were not exercised: Employee options General reserve Dr Cr $4 800 $4 800 Disclosures AASB specifies the disclosure of certain information about share options Paragraphs 44 to 52 specify the disclosure requirements for share-based payment transactions These disclosures have three objectives First, information is to be disclosed that enables users to understand the nature and extent of share-based arrangements for the period (para 44) This includes a description of the arrangement detailing vesting requirements, the maximum number of options granted, the method of settlement, the number of share options and weighted-average exercise prices for share options, and details of share options exercised and outstanding at the end of the period (para 45) Second, information is to be disclosed that allows users of the financial statements to understand how the fair value of any equity instruments granted during the period has been determined (para 46) For share options this includes the option-pricing model used and the inputs to that model, how expected volatility was determined, and whether and how any features of the option grant, such as a market condition, were incorporated into the measurement of fair value (para 47) Alternatively, if it is possible to measure directly the fair value of goods or services received, it should be disclosed how that fair value was determined (para 48) Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2013 – 9781442561175 - Henderson/Issues in Financial Accounting 15e M15_HEND1175_15_LT_C15.indd 489 10/07/13 1:53 PM PA R T T HE S TAT E M E N T O F F I N A NC I A L P O S I T I O N 490 Third, information is to be disclosed to highlight the effect of share-based payment transactions on a company’s profit or loss for the period and on its financial position (para 50) For share options these disclosures would include the total expense recognised for the period 15.2.4 Preference LEARNING OBJECTIVE Distinguish between ordinary shares and preference shares preference shares Shares that give the holders of those shares preference over ordinary shareholders with respect to the payment of dividends and usually the repayment of capital in the event that the company is dissolved LEARNING OBJECTIVE Understand the requirements of AASB 132 ‘Financial Instruments: Presentation’ as they relate to the classification of preference shares shares Preference shares are issued with conditions that give them priority (or preference) over ordinary shares under specified conditions These conditions are specified when the shares are issued Conditions attached to preference shares may give the preference shareholders priority in the repayment of capital on the winding-up of the company In this case, there are no accounting implications until the company is wound up Preference share dividends are usually subject to special conditions They may be set at a fixed minimum level, they may accumulate if they are not paid or they may participate in profits above the fixed minimum level For example, a company may issue 6.5% cumulative non-participating preference shares of $1 each This means that each preference shareholder will receive a fixed dividend of 6.5 cents per share As these dividends are cumulative, if the dividend is not paid in a particular year because the company has insufficient funds, it will accumulate as a liability until funds are available Ordinary shareholders will not receive a dividend until the entitlements of the preference shareholders have been met As the preference shares are non-participating, preference shareholders will receive the 6.5 cents per share dividend regardless of the profitability of the company Preference shares may also be redeemable, which requires the company to repay the preference shareholders’ capital contributions Some preference shares are redeemable when demanded by the holder of the share, and in other cases the preference share can only be redeemed at the discretion of the issuing company If redemption is probable, the shares may meet the definition of liabilities in Framework 2010 Liabilities are defined as ‘a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits’ (para 4.4(b)) If the redemption conditions are such that there is a present obligation to the preference shareholders, the definition of liabilities is satisfied The issue of how to classify preference shares is covered by AASB 132 AASB 132 requires that the issuer of a financial instrument classifies the instrument, or its component parts, in accordance with the substance of the arrangement – that is, as a financial asset, a financial liability or an equity instrument – at the time the instrument is initially recognised (para 15) An equity instrument is defined in paragraph 11 as ‘any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities’, and a financial liability includes a ‘contractual obligation to deliver cash or another financial asset to another entity’ The classification of preference shares as an equity instrument or a financial liability depends on the rights attached to the shares Preference shares that are redeemable on a specific date or at the option of the holder give rise to a financial liability, since the issuer has an obligation to transfer financial assets to the holder of the shares (Appendix, para AG25) In this case, the issuer should classify the redeemable preference shares as liabilities rather than equity On the other hand, preference shares that are redeemable at the option of the issuer not satisfy the definition of a liability (Appendix, para AG25) The issuer has no obligation to transfer financial assets to shareholders Consequently, these shares should be classified as equity For non-redeemable preference shares, classification is based on an assessment of the substance of the arrangement using the definitions of financial assets, financial liabilities and equity instruments Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2013 – 9781442561175 - Henderson/Issues in Financial Accounting 15e M15_HEND1175_15_LT_C15.indd 490 10/07/13 1:53 PM C HAP T E R 15 EQ U I T Y 491 (Appendix, para AG25) AASB 132 (Appendix, para AG26) requires an assessment of the other rights that attach to the shares in determining the substance of the arrangements The recognition of dividend payments on the preference shares must be consistent with their classification in the statement of financial position For example, if the preference shares are recognised as financial liabilities, the dividend payments are recognised as expenses in the same way as interest on a bond (para 35) 15.2.5 Compound financial instruments In the previous section we note that, under certain conditions, preference shares may satisfy the definition of liabilities Similarly, there are other securities that are legally classified as debt but which contain elements of equity They are generally referred to as compound financial instruments because there are difficulties in classifying them as either equity or debt since they have components of both The most common example of compound financial instruments is convertible securities Convertible notes are debt instruments that include an option to convert them to equity under specified conditions For example, Meridien Resources Limited issued convertible notes in December 2010 at a price of $0.20 per note and an interest rate of 10% per annum The notes were convertible on any day until January 2012 with note holders being issued a bonus share with a face value of $0.20 at the rate of one bonus share for every three convertible notes converted or repaid (adjusted for bonus shares, rights issues and capital reconstructions) Notes not converted were repaid at the issue price of $0.20 on January 2012.17 If Meridien’s share price had been higher than $0.20 on January 2012, it is likely that noteholders would have converted their notes into shares They could sell the shares for the market price and make a profit If the share price had been less than $0.20 on January 2012, noteholders are likely to have retained their notes and accepted the redemption price of $0.20 The following Accounting in Focus box contains extracts from the website of Westpac Ltd in relation to the issue in March 2012 of $1.19 billion of convertible preference shares LEARNING OBJECTIVE Explain the nature of compound financial instruments and how to account for them convertible notes Debt instruments that include an option to convert them to equity under specified conditions accounting in focus Westpac convertible preference shares On 23 March 2012, Westpac issued 11,893,605 Westpac Convertible Preference Shares (Westpac CPS), at an issue price of A$100 each, raising approximately A$1.19 billion Westpac CPS commenced trading on the ASX on a deferred settlement basis on 26 March 2012 and on a normal settlement basis on April 2012 under the ASX code ‘WBCPC’ Holding statements confirming the number of Westpac CPS allocated to successful applicants were despatched on April 2012 Any refunds were also despatched on April 2012 Investors who sell their Westpac CPS before receiving their holding statement so at their own risk What are Westpac CPS? Westpac CPS are fully paid, perpetual, convertible, unguaranteed and unsecured preference shares issued by Westpac, which rank in priority to Ordinary Shares and which qualify as Non-Innovative Residual Tier Capital of Westpac for APRA purposes Westpac CPS are listed on the Australian Securities Exchange (ASX) under the code WBCPC and can be traded like any other securities listed on the ASX Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2013 – 9781442561175 - Henderson/Issues in Financial Accounting 15e M15_HEND1175_15_LT_C15.indd 491 10/07/13 1:53 PM 492 PA R T T HE S TAT E M E N T O F F I N A NC I A L P O S I T I O N Dividends on Westpac CPS Westpac CPS offer holders preferred, non-cumulative, floating rate, semi-annual dividends, which are scheduled to be paid on 31 March and 30 September (subject to the Dividend Payment Test) Westpac CPS dividends are expected to be fully franked and accordingly holders are expected to receive cash dividends and franking credits However, your ability to use franking credits will depend on your individual tax position Dividends are calculated as follows: (Dividend Rate ؋ Face Value ؋ N) divided by 365 The Dividend Rate is a floating rate and will be set on the first Business Day of each Dividend Period using the following formula: (180 day Bank Bill Rate + Margin) ؋ (1 – Tax Rate) • 180 day Bank Bill Rate is the 180 day Bank Bill Rate on the first business day of each Dividend Period (except for the first Dividend Period, where the 180 day Bank Bill Rate was determined on the Issue Date (23 March 2012)) • The Margin is 3.25% per annum • The Tax Rate is the Australian corporate tax rate applicable to the franking account of Westpac as at the Dividend Payment Date As at the date of the Prospectus, the relevant tax rate is 30% or, expressed as a decimal in the formula, 0.30 • The Face Value is $100.00 per Westpac CPS • N = the number of days in the Dividend Period The potential value of the franking credits does not accrue to you at the same time as you receive the cash dividend and a holder’s ability to use franking credits will depend on their individual tax position Conversion, Transfer and Redemption On the Scheduled Conversion Date Westpac CPS will either be: • converted into Westpac Ordinary Shares; or • transferred to a Nominated Party (at Westpac’s election) for $100 cash for each Westpac CPS The Scheduled Conversion Date will be the earlier of: • 31 March 2020; and • The first Dividend Payment Date after 31 March 2020; on which both Conversion Conditions are satisfied Westpac CPS will be Converted earlier upon: • a Capital Trigger Event; or • an Acquisition Event provided the Conversion Conditions are satisfied and Westpac has not otherwise elected to Convert or Redeem Westpac CPS can also be Converted, Transferred or Redeemed by Westpac under certain circumstances: • A Tax Event or Regulatory Event • An Acquisition Event on or after the fifth anniversary of the Issue Date • An Optional Conversion/Redemption Date (31 March 2018 or any Dividend Payment Date thereafter) Conversions or Redemptions are subject to APRA’s prior written approval and in respect of Conversions, to the Conversion Conditions being satisfied Holders should not expect that APRA’s prior written approval will be given Further details on Westpac CPS are included in the Prospectus dated 24 February 2012 Source: Copyright Westpac Banking Corporation Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2013 – 9781442561175 - Henderson/Issues in Financial Accounting 15e M15_HEND1175_15_LT_C15.indd 492 10/07/13 1:53 PM C HAP T E R 15 EQ U I T Y There are three ways in which convertible notes could be treated First, they could be recognised as a liability consistent with their legal form Second, the definitions and recognition criteria of liabilities and equity in Framework 2010 could be applied If conversion to equity is the probable outcome, the notes would be recognised as equity, whereas if redemption at maturity is the probable outcome the notes would be recognised as a liability This approach treats the notes as a single financial instrument and classifies them according to whether they meet the definition of liabilities or the definition of equity Third, the notes could be separated into equity and debt components This is the approach adopted in AASB 132 Paragraph 28 requires an issuer of a financial instrument with a financial liability and an equity element to classify the instrument’s components separately in its statement of financial position The rationale is that the ‘economic effect of issuing such an instrument is substantially the same as issuing simultaneously a debt instrument with an early settlement provision and warrants to purchase ordinary shares’ (para 29) The separate classification of the liability and equity components of compound instruments requires measurement of the different components Measurement of financial assets and liabilities is dealt with by AASB ‘Financial Instruments’, which is discussed in Chapter 14 A residual valuation approach for the equity component is required by paragraph 31 of AASB 132 That is, the equity component of a compound financial instrument ‘is assigned the residual amount after deducting from the fair value of the instrument as a whole the amount separately determined for the liability component’ (para 31) The issuer of a convertible note would first determine the value of the liability component by measuring the fair value of a similar liability without the equity component (para 32) This amount is then deducted from the fair value of the compound financial instrument as a whole to determine the carrying amount of the associated equity component (para 32) The treatment of convertible notes in accordance with AASB 132 is illustrated in Example 15.5 493 LEARNING OBJECTIVE 10 Understand the requirements of AASB 132 ‘Financial Instruments: Presentation’ as they relate to accounting for convertible notes example 15.5 On July 2013, Pilly Ltd issued 10 million $4 notes with a coupon rate of 8% per annum and a term of 10 years at a time when the market interest rate for similar debt without the conversion option was 10% per annum In this case, the liability component is measured as the present value of two cash flows; namely, the annual coupon payments ($3 200 000 = 8% ϫ $40 000 000) and principal repayment ($40 000 000) in 10 years’ time discounted at 10% per annum Therefore, using the present value tables in the appendix to this book, the amount of the liability component is: $3 200 000 ϫ 6.1445 = $19 662 400 $40 000 000 ϫ 0.38554 = 15 421 600 $35 084 000 The noteholders have paid $40 million for these notes, so the conversion option has a value of $40 000 000 – 35 084 000 = $4 916 000, calculated in accordance with paragraph 31 At the time the notes are issued, paragraph 28 requires the compound financial instrument to be treated as comprising two financial instruments – a debt instrument and an equity instrument To reflect this classification, the following general journal entry would be passed to recognise the convertible notes liability and convertible note option (equity) Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2013 – 9781442561175 - Henderson/Issues in Financial Accounting 15e M15_HEND1175_15_LT_C15.indd 493 10/07/13 1:53 PM 494 PA R T T HE S TAT E M E N T O F F I N A NC I A L P O S I T I O N Cash at bank Convertible notes liability Convertible notes option (equity) Dr Cr Cr $40 000 000 $35 084 000 916 000 Subsequent to initial recognition, interest expense is recognised at fair value using the ‘effective interest method’ throughout the term of the notes, until such time as the convertible note option is exercised The preparation of an effective interest schedule is shown in the following table Date 1/07/2013 30/06/2014 30/06/2015 30/06/2016 30/06/2017 30/06/2018 30/06/2019 30/06/2020 30/06/2021 30/06/2022 30/06/2023 Interest payment ($40M ؋ 8% coupon rate) $ 200 000 200 000 200 000 200 000 200 000 200 000 200 000 200 000 200 000 200 000 Interest expense (convertible notes liability ؋ 10% market rate) $ 508 400 539 240 573 164 610 480 651 528 696 681 746 349 800 984 861 083 928 091* Fair value (FV) adjustment (interest expense – interest payment) $ Convertible notes liability (FV adjustment + notes liability at beginning) $ 308 400 339 240 373 164 410 480 451 528 496 681 546 349 600 984 661 083 728 091 35 084 000 35 392 400 35 731 640 36 104 804 36 515 284 36 966 812 37 463 493 38 009 842 38 610 826 39 271 909 40 000 000 * Subject to rounding error The schedule shows that interest expense – that is, the effective interest – is measured at fair value The effective interest schedule also shows the fair value of the convertible notes liability outstanding at the end of each reporting period during the term of the convertible notes issue At maturity on 30 June 2023, the convertible notes issue must be settled by a cash payment of $40 million, unless the convertible notes option is exercised to convert the notes liability to equity The following general journal entry is made at the end of each reporting period to recognise interest expense and the convertible notes liability at fair value The general journal entry made on 30 June 2014 is: Interest expense Cash at bank Convertible notes liability Dr Cr Cr $3 508 435 $3 200 000 308 435 If, at maturity on 30 June 2023 note holders exercise the convertible notes option to convert the notes to equity, the following general journal entry is made: Convertible notes liability Convertible notes option (equity) Share capital Dr Dr Cr $40 000 000 915 654 $44 915 654 If, however, the exercise of the convertible notes option occurs, say, earlier on 30 June 2017, the following general journal entry is made: Convertible notes liability Convertible notes option (equity) Share capital Dr Dr Cr $36 515 791 915 654 $41 431 445 Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2013 – 9781442561175 - Henderson/Issues in Financial Accounting 15e M15_HEND1175_15_LT_C15.indd 494 10/07/13 1:53 PM C HAP T E R 15 EQ U I T Y 495 However, if note holders not exercise the convertible notes option at maturity, the following general journal entries are made to recognise settlement of the convertible notes liability and the derecognition of the convertible notes option through retained earnings: Convertible notes liability Cash at bank Convertible notes option (equity) Retained earnings 15.2.6 Reserves Dr Cr Dr Cr $40 000 000 $40 000 000 915 654 915 654 and retained earnings Reserves arise from two sources Some come directly from the application of the Corporations Act and accounting standards, while others arise from transfers from retained earnings Two reserves arise from the application of the Corporations Act and accounting standards The first is the revaluation surplus, arising from the application of AASB 116 ‘Property, Plant and Equipment’, which is discussed in Chapter The second is the translation reserve, arising from the application of AASB 121 ‘The Effect of Changes in Foreign Exchange Rates’ to the translation of financial statements of foreign operations, which is discussed in Chapter 27 AASB 116 places no restrictions on the uses that can be made of the revaluation surplus It may be used for the issue of shares, but it is usually retained as a reserve in the statement of financial position Although not required by AASB 121, the translation reserve usually remains untouched in the statement of financial position as a cushion for future unfavourable fluctuations in foreign currency exchange rates However, the balance in the translation reserve relating to a foreign operation should be recognised in the statement of comprehensive income on disposal of the foreign operation Other reserves are created by transfers from retained earnings The transfers from retained earnings to reserves are often designed to indicate to shareholders that some part of retained earnings is not available for the payment of dividends Instead, reserves have been set aside for other purposes There are no restrictions on transfers to and from reserves as long as the company is reporting retained earnings rather than accumulated losses Retained earnings or accumulated losses represent the balance of the profits (or losses) that a company has made since incorporation that has not been paid as dividends, used to fund share issues to shareholders, transferred to reserves or used to buy back shares 15.3 Accounting standards Two standards deal with accounting for components of equity – AASB and AASB 132 (with AASB 139 ‘Financial Instruments: Recognition and Measurement’ providing guidance on measurement).18 The accounting and disclosure requirements of these standards are discussed earlier in this chapter An additional standard, AASB 101, is also relevant to equity At the time of writing, the most recent version is compiled to September 2011 and is applicable to annual reporting periods beginning on or after January 2013 with early adoption permitted for annual reporting periods beginning on or after July 2012 LEARNING OBJECTIVE 11 Distinguish between reserves and retained earnings reserves Part of equity disclosed in the balance sheet that generally arises from two sources – the application of the Corporations Act and accounting standards, or transfers from retained earnings retained earnings The balance of profits (or losses) that a company has made since incorporation that has not been paid as dividends, used to fund share issues to shareholders, transferred to reserves or used to buy back shares Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2013 – 9781442561175 - Henderson/Issues in Financial Accounting 15e M15_HEND1175_15_LT_C15.indd 495 10/07/13 1:53 PM 496 PA R T T HE S TAT E M E N T O F F I N A NC I A L P O S I T I O N 15.3.1 Classification LEARNING OBJECTIVE 12 Understand the requirements of AASB 101 ‘Presentation of Financial Statements’ as they relate to the classification and disclosure of equity and disclosure of equity AASB 101 classifies equity into two broad categories: owner changes in equity – for example, equity contributions, dividends and the buyback of an entity’s own equity instruments (para 9(e)); non-owner changes in equity – that is, those items recognised as ‘other comprehensive income’ in the determination of ‘total comprehensive income’; for example, translation differences relating to foreign operations and changes in revaluation surplus (para 7) AASB 101 states that the separate presentation of owner changes in equity from non-owner changes in equity provides better information to users This is because owner changes in equity provide information to users about items that not change the entity’s net assets, whereas non-owner changes in equity provide users with information about items that can increase or decrease the entity’s net assets In this chapter we consider only the paragraphs of AASB 101 relevant to the presentation and disclosure of equity In particular, paragraph 54 requires, as a minimum, the following items of equity to be shown on the face of the statement of financial position: ◆ non-controlling interest,19 presented within equity; and ◆ issued capital and reserves attributable to owners of the parent The rationale for these requirements is that the items are sufficiently different in nature or function to warrant separate disclosure on the face of the statement of financial position (para 57) However, AASB 101 does not prescribe the order or format in which they are to be presented (para 57) Further sub-classification of these items is required either on the face of the statement of financial position or in the notes (para 77) Paragraph 78(e) requires that equity and reserves are disaggregated into various classes, such as paid-in capital and reserves AASB 101 also requires detailed disclosure about the various classes of equity, either in the statement of financial position or in the statement of changes in equity, or in the notes (para 79) The following disclosures are made for each class of share capital: ◆ the number of shares authorised; ◆ the number of shares issued and the extent to which they are fully paid; ◆ the par value of the shares or that the shares have no par value; ◆ a reconciliation of the number of shares outstanding at the beginning and end of the period; ◆ the rights, preferences and restrictions on each share class in respect to dividends and repayment of capital; ◆ shares in the entity held by the entity or by its subsidiaries or associates; ◆ shares reserved for issue under options and contracts for the sale of shares, including terms and amounts; and ◆ a description of the nature and purpose of each reserve within equity 15.3.2 Statement of changes in equity Apart from the disclosures relating to equity discussed above, AASB 101 also requires the preparation of a statement of changes in equity The statement of changes in equity includes on its face (para 106): (a) total comprehensive income for the period, showing separately total amounts attributable to owners of the parent and to non-controlling interest; Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2013 – 9781442561175 - Henderson/Issues in Financial Accounting 15e M15_HEND1175_15_LT_C15.indd 496 10/07/13 1:53 PM C HAP T E R 15 EQ U I T Y 497 (b) for each component of equity, the effects of retrospective changes in accounting policies and corrections of errors recognised in accordance with AASB 108; (c) the amounts of transactions with owners in their capacity as owners, showing separately contributions by and distributions to owners; and (d) for each component of equity, a reconciliation between the carrying amount at the beginning and end of the period, separately disclosing each change Each component of equity includes, for example, each class of contributed equity, the accumulated balance of each class of other comprehensive income and retained earnings (para 108) AASB101 also requires dividends and related per-share amounts to be disclosed on the face of the statement of changes in equity or in the notes (para 107) Examples of items required by other Australian standards to be recognised directly in equity include changes in accounting policies, changes in accounting estimates and corrections of errors AASB 108 requires retrospective adjustments to the balance of retained earnings to give effect to changes in accounting policies and restatements to correct errors (item (b) above) AASB 101 points out that retrospective adjustments and retrospective restatements, as a result of the application of AASB 108, represent adjustments to the opening balance of retained earnings and not represent changes in equity per se (para 110) To illustrate, a statement of changes in equity has been prepared for Gerr Ltd using the format prescribed by paragraph 106 of AASB 101 Gerr Ltd Statement of Changes in Equity for the year ended 30 June 2013 Consolidated 2013 2012 $000 $000 TOTAL COMPREHENSIVE INCOME Attributable to: Members of the parent Non-controlling interest SHARE CAPITAL Ordinary shares Balance at beginning of period Issue of share capital Share issue costs Total share capital RESERVES Foreign currency translation reserve Balance at beginning of period Gain (loss) on translation Balance at end of period Total reserves RETAINED EARNINGS Balance at beginning of period Total comprehensive income Changes in accounting policy Total for the period Dividends Balance at end of period $3 780 $9 320 472 308 $3 780 095 225 $9 320 32 680 – – $32 680 30 000 000 (320) $32 680 15 000 (3000) 12 000 $12 000 10 000 000 15 000 $15 000 $27 613 $3 780 – 31 393 (407) $30 986 $20 016 $9 320 (1 200) 28 136 (523) $27 613 Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2013 – 9781442561175 - Henderson/Issues in Financial Accounting 15e M15_HEND1175_15_LT_C15.indd 497 10/07/13 1:53 PM PA R T T HE S TAT E M E N T O F F I N A NC I A L P O S I T I O N 498 Selected references Brown, P., ‘Notes of the University of Sydney Pacioli Society’, Abacus, February 2004, pp 132–7 Brown, P and B Howieson, ‘Accounting for Employee Share Options’, Australian Accounting Review, November 1994, pp 22–34 Coulton, J and S Taylor, ‘Accounting for Executive Stock Options: A Case Study in Avoiding Tough Decisions’, Australian Accounting Review, March 2002a, pp 3–10 Coulton, J and S Taylor, ‘Option Awards for Australian CEOs: The Who, What and Why’, Australian Accounting Review, March 2002b, pp 25–35 Kerr, J St G., ‘The Concept of Equity in Financial Accounting’, Accounting Theory Monograph No 9, Australian Accounting Research Foundation, Melbourne, 1989 Taylor, S., ‘Executive Share Options: An Economic Framework’, Australian Accounting Review, November 1994, pp 13–21 Questions What are the implications arising from the definition of equity in Framework 2010? How does equity differ from assets and liabilities? How reserves differ from retained earnings? Outline the way in which you would account for a share buyback ‘The legal form of a preference share or a convertible note is paramount.’ Critically discuss this statement in light of: (a) Framework 2010’s definitions of liabilities and equity; and (b) the requirements of AASB 132 What is the general approach to accounting for equity-settled share-based payments, such as granting share options to employees, that is adopted in AASB 2? ‘Share-based payments to employees are not expenses and should not be recognised as such in the profit or loss statement.’ Evaluate this comment As part of your answer consider what reasons might be given for arguing that share-based payments are not an expense and why accounting standard setters might have rejected these reasons Explain the requirements of AASB for the measurement of share options How does AASB require vesting conditions to be treated when measuring the value of share options? 10 Describe the main features of the ‘modified grant date method’ of accounting for share options that is required in AASB 11 Strahan Ltd issued redeemable, cumulative preference shares What factors would be relevant in deciding whether these shares should be classified as liabilities or equity in accordance with AASB 132? 12 If convertible securities are recognised following the components approach required in AASB 132, how should the equity component be measured? Give reasons 13 Give two examples of reserves that are required by accounting standards Problems Hammond Ltd was incorporated on October 2013 and 65 000 ordinary shares are issued Prepare the general journal entries to record the issue of the shares, assuming: (a) the shares are issued at $0.80 per share; and (b) the shares are issued at $1.25 per share Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2013 – 9781442561175 - Henderson/Issues in Financial Accounting 15e M15_HEND1175_15_LT_C15.indd 498 10/07/13 1:53 PM C HAP T E R 15 EQ U I T Y 499 Twain Ltd is incorporated on July 2014 At that time, 1.2 million ordinary shares are issued for $1.65 each By 30 June 2018, Twain Ltd has retained earnings of $3.6 million and decides to buy back 275 000 ordinary shares at the market price of $2.60 Required Prepare the general journal entries to record the share issue and the buyback On July 2013, Hardy Ltd granted 3500 share options to 18 executives The conditions of the option plan are: • options may only be exercised when profit after tax exceeds $20 million and the executive has been in continuous service until this time; • options have a 10-year life; and • the exercise price is $3.50 A binomial option-pricing model shows that the estimated fair value of the options at grant date is $1.90 per option and the vesting period of the options is five years Three executives are expected to leave before 30 June 2018 (five years from the grant date of the options) However, four executives leave – two during the year ended 30 June 2017 and two during the year ended 30 June 2018 Hardy Ltd’s profit after tax exceeds $20 million for the first time in December 2018 Required Calculate the value of the executive remuneration in accordance with the requirements of AASB On July 2013, Raynor Ltd granted 300 share options to every one of its 400 employees The options vest only if Raynor continuously employs an individual employee for a period of four years from grant date After examining the fair values of similar options issued by other companies within the same industry, Raynor estimates the fair value of each option at $1.55 A consideration of its employee profiles indicates that, on the balance of probabilities, 21 employees will leave during the four-year vesting period Fourteen employees left during the year ended 30 June 2014, another seven left during the year ended 30 June 2015, and three left during the year ended 30 June 2017 Required (a) Prepare general journal entries to account for the share options granted by Raynor Ltd for each of the four years in accordance with the requirements of AASB (b) How would your answer to (a) change if one more employee left on 31 December 2017? Glenelg Ltd issued million 7% six-year $2.20 convertible notes at a time when the market interest rate for similar securities without the conversion option was 9% per annum Required How would you record the issue of these notes, following: (a) the requirements of Framework 2010? (b) the requirements of AASB 132? In order to expand its business, Zest Ltd issued 30 000 convertible notes with a face value of $27 million for a term of four years on 30 June 2012 Each of the 30 000 notes was issued at its face value of $900 The coupon interest rate is 6.7% per annum Except for the interest rate and the conversion feature, all the terms of the convertible note are the same as the terms of outstanding issues of otherwise comparable non-convertible debt The market interest rate for otherwise comparable non-convertible debt is 10% per annum Required (a) Prepare the general journal entry to record the issue of convertible notes in accordance with the requirements of AASB 132 (b) Assume that the notes are converted into ordinary shares at the end of the first year ending 30 June 2013 (after receiving interest payments) Prepare any necessary general journal entries in accordance with AASB 132 Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2013 – 9781442561175 - Henderson/Issues in Financial Accounting 15e M15_HEND1175_15_LT_C15.indd 499 10/07/13 1:53 PM PA R T T HE S TAT E M E N T O F F I N A NC I A L P O S I T I O N 500 On 30 June 2013, Green Ltd issued 55 000 convertible notes with a face value of $55 million for a term of five years The coupon interest rate is 8% per annum, while the market interest rate for comparable non-convertible debt is 12% per annum Due to its falling share price, Green Ltd expects that note holders will not exercise the note options and convert the debt outstanding under the convertible note issue to equity instruments (a) Prepare an effective interest schedule and distinguish between the allocation of interest payments and interest expense for each reporting period during the term of the note issue (b) Prepare the general journal entry to record the non-exercise of the conversion options in accordance with AASB 132 Notes 10 11 12 13 14 15 16 17 18 19 SAC4 ‘Definition and Recognition of the Elements of Financial Statements’, para 80 op cit., para 84 In many charities and other not-for-profit entities, the equity is not distributable to the members of the charity Rather, the constitutions of these charities often require that any remaining assets on winding up must be distributed to another charity with a similar purpose For a detailed discussion of the issue process, see G Peirson, R Brown, S Easton , P Howard and S Pinder, Business Finance, 11th edn, McGraw-Hill, Sydney, 2012, Ch For more details, see L Walsh and S Kelly, ‘AMP puts buyback on hold’, Herald Sun, 15 February 2008, p 39 More information on the different types of permissible share buyback can be found on the Australian Securities and Investments Commission’s website at: J Coulton and S Taylor, ‘Option Awards for Australian CEOs: The Who, What and Why’, Australian Accounting Review, March 2002b, pp 25–35 Z Matolscy and A Wright, ‘Australian CEO Compensation: The Descriptive Evidence’, Australian Accounting Review, November 2007, pp 47–59 PricewaterhouseCoopers, 2011 Global Equity Incentives Survey: The Rise of Performance-based Equity Executive Summary, Delaware, 2011 While share options were not recognised, information on the options granted to directors and related parties was disclosed in accordance with AASB 1017 ‘Related Party Disclosures’ Chapter 19 discusses director and executive disclosures For example, Brown (2004, p 136) notes that, of the almost 250 ED2 ‘Share-based Payment’ comment letters posted on the IASB website, ‘about one third are from the UK, 20 per cent are from other European countries and another 20 per cent from the USA, about per cent from Australia and New Zealand, and the remainder from a range of countries around the globe’ For a more detailed discussion of constituents’ lobbying activities, see Brown and Howieson (1994), Taylor (1994), and Coulton and Taylor (2002a) See Coulton and Taylor (2002a) for a more detailed discussion of these arguments E Stoddart, ‘Employee Benefits: Survey of Equity-based Compensation Arrangements’, Transparency, June 2001, pp 2–5 It could be argued that non-compensatory plans are outside the scope of AASB To qualify as an equity-settled sharebased payment transaction, AASB requires that employees provide goods and services to the entity as consideration for the share options It could be argued that the mere fact of being an employee does not mean that services have been provided to an entity for which the share options are considered compensation An alternative view is that noncompensatory plans reward employees for their services in general to the employing entity We adopt the latter view in this book ibid For discussions of these models, see sections 18.3 and 18.4 of G Peirson, R Brown, S Easton, P Howard and S Pinder, Business Finance, 11th edn, McGraw-Hill, Sydney, 2012 See Meridien Resources Ltd, Media Release: Convertible Notes, 24 December 2010: At the time of writing, guidance on the measurement of equity was still contained in AASB 139 but the AASB is expected to eventually revise this guidance and place it in AASB ‘Financial Instruments’ These changes are dependent upon developments at the IASB In groups of controlled companies the equity of the subsidiaries that does not belong to the parent company is called ‘noncontrolling interest’ Chapter 10 of this book contains more information about the accounting treatment of subsidiaries Copyright © Pearson Australia (a division of Pearson Australia Group Pty Ltd) 2013 – 9781442561175 - Henderson/Issues in Financial Accounting 15e M15_HEND1175_15_LT_C15.indd 500 10/07/13 1:53 PM ... tax-effect accounting Selected references Questions Problems Notes 13 5 Chapter 10 Accounting for investments 13 5 10 .1 10.2 10 .3 13 6 13 8 14 5 14 5 14 6 14 7 14 9 15 0 15 1 15 3 17 0 17 0 17 1 17 3 Chapter 11 Accounting. .. 11 Accounting for intangible assets 11 .1 11. 2 11 .3 11 .4 11 .5 11 .6 11 .7 17 4 17 5 17 6 18 8 215 224 224 226 2 31 Introduction Investments in the shares of other companies Accounting for investment... Ltd) 2 013 – 97 814 425 611 75 - Henderson /Issues in Financial Accounting 15 e M 01_ HEND 117 5 _15 _LT_CO1.indd 10 /07 /13 1: 54 PM Chapter Institutional arrangements for setting accounting standards in Australia