ACCA SBR course notes

SBR Course notes
 aCOWtancy.com Syllabus A: Fundamental Ethical And Professional Principles Syllabus A1 Professional Behaviour & Compliance With Accounting Standards Syllabus A2 Ethical requirements of corporate reporting Syllabus B: THE FINANCIAL REPORTING FRAMEWORK 12 Syllabus B1 The Applications Of An Accounting Framework 12 Syllabus C: REPORTING THE FINANCIAL PERFORMANCE OF ENTITIES 33 Syllabus C1 Performance reporting 33 Syllabus C2 Non-current Assets 51 Syllabus C3 Financial Instruments 114 Syllabus C4 Leases 159 Syllabus C5 Employee Benefits 182 Syllabus C6 Income taxes 194 Syllabus C7 Provisions, contingencies and events after the reporting date 206 Syllabus C8 Share based payment 215 Syllabus C9 Fair Value Measurement 238 Syllabus C10 Reporting requirements of small and medium-sized entities (SMEs) 242 Syllabus C11 Other Reporting Issues 252 Syllabus D: FINANCIAL STATEMENTS OF GROUPS OF ENTITIES 263 Syllabus D1 Group accounting including statements of cash flows 263 Syllabus D2 Associates And Joint Arrangements 333 Syllabus D3: Changes in group structures 343 Syllabus D4: Foreign transactions and entities 348 Syllabus E: Interpret Financial Statements For Different Stakeholders 359 Syllabus E1: Analysis and interpretation of financial information and measurement of performance 359 Syllabus F: THE IMPACT OF CHANGES AND POTENTIAL CHANGES IN ACCOUNTING REGULATION Syllabus F1 Discussion of solutions to current issues in financial reporting 393 393 aCOWtancy.com Syllabus A: FUNDAMENTAL ETHICAL AND PROFESSIONAL PRINCIPLES Syllabus A1 Professional Behaviour & Compliance With Accounting Standards Syllabus A1a) Appraise and discuss the ethical and professional issues in advising on corporate reporting Giving Advice When giving advice be aware of: 1) Your own professional competence and that company directors must keep up to date with IFRS developments The issues that may threaten this are: • Insufficient time • Incomplete, restricted or inadequate information • Insufficient experience, training or education • Inadequate resources 2) Your own objectivity The issues that may threaten this are: • Financial interests (profit-related bonuses /share options) • Inducements to encourage unethical behaviour aCOWtancy.com In fact ACCA’s Code of Ethics and Conduct identifies that accountants must not be associated with reports, returns, communications where they believe that the information: • Contains a materially misleading statement • Contains statements or information furnished recklessly • Has been prepared with bias, or • Omits or obscures information required to be included where such omission or obscurity would be misleading aCOWtancy.com Syllabus A1b) Assess the relevance and importance of ethical and professional issues in complying with accounting standards Ethical and professional issues Accounting professionals are expected to be: highly competent reliable objective high degree of professional integrity A professional’s good reputation is one of their most important assets Accountancy as a profession has accepted its overriding need to act in the best interest of the public This can create an ethical/professional dilemma As accountants also have professional duties to their employer and clients Where these duties are in contrast to the public interest, then the ethical conduct of the accountant should be in favour of the public interest This can create problems particularly on an audit, whereby you provide a service for the client, yet may have to make public information which is detrimental to the company but in the public interest There is a very fine line between acceptable accounting practice and management’s deliberate misrepresentation in the financial statements aCOWtancy.com The financial statements must meet the following criteria: • Technical compliance: Generally accepted accounting principles (GAAP) used • Economic substance:
 The economic substance of the event that has occurred must be represented (over and above GAAP) • Full disclosure and transparency:
 Sufficient disclosures made Management often seeks loopholes in financial reporting standards that allow them to adjust the financial statements as far as is practicable to achieve their desired aim These adjustments amount to unethical practices when they fall outside the bounds of acceptable accounting practice In most cases conformance to acceptable accounting practices is a matter of personal integrity Reasons for such behaviour often include market expectations personal realisation of a bonus maintenance of position within a market sector aCOWtancy.com Syllabus A2 Ethical requirements of corporate reporting Syllabus A2a) Appraise the potential ethical implications of professional and managerial decisions in the preparation of corporate reports ACCA has a Framework for Ethical Decision Making 1) Understand the Real Issue 2) Any Ethical threats? These would be:
 Self-Interest
 Self-Review
 Advocacy
 Familiarity
 Intimidation 3) Are the Ethical threats significant?
 Think about materiality, seniority of people involved and the amount of judgement needed 4) Can safeguards reduce these threats to an acceptable level? 5) Can you look yourself in the mirror afterwards? Accountants need to act professionally and in the current conditions have even more of a duty to present fair, accurate and faithfully represented information It can be argued that accountants should have the presentation of truth, in a fair and accurate manner, as a goal.
 aCOWtancy.com Syllabus A2b) Assess the consequences of not upholding ethical principles in the preparation of corporate reports Consequences Of Not Upholding Ethical Principles One of the more obvious consequences is professional disciplinary proceedings against unethical members The results can be serious… • Fines / Prison • No longer being able to be a Director • Expelled from your professional body Social Responsibility Looking after society and the environment costs no question but in today's world, thankfully, it also brings in sales Companies are now often called 'corporate citizens' With that comes social responsibility Not taking CSR seriously will damage your chances of investment and risk losing sales
 aCOWtancy.com Syllabus A2c) Identify related parties and assess the implications of related party relationships in the preparation of corporate reports IAS 24 Related Parties A party is said to be related to an entity if any of the following three situations occur: The situations are: Controls / is controlled by entity is under common control with entity has significant influence over the entity Types of related party These therefore include: Subsidiaries Associate Joint venture Key management Close family member of above (like my beautiful daughter pictured in her new school uniform aaahhh) A post-employment benefit plan for the benefit of employees aCOWtancy.com Not necessarily related parties Two entities with a director in common Two joint venturers Providers of finance A big customer, supplier etc Stakeholders need to know that all transactions are at arm´s length and if not then be fully aware Similarly they need to be aware of the volume of business with a related party, which though may be at arm´s length, should the related party connection break then the volume of business disappear also Disclosures • General The name of the entity’s parent and, if different, the ultimate controlling party The nature of the related party relationship Information about the transactions and outstanding balances necessary for an understanding of the relationship on the financial statements • As a minimum, this includes: Amount of outstanding balances
 Bad and doubtful debt information 10 aCOWtancy.com • Key management personnel compensation should be broken down by: • short-term employee benefits • post-employment benefits • other long-term benefits • termination benefits • share-based payment Group and Individual accounts Individual accounts Disclose related party transactions / outstanding balances of parent, venturer or investor Group accounts The intra-group transactions and balances would have been eliminated 11 aCOWtancy.com Syllabus B: THE FINANCIAL REPORTING FRAMEWORK Syllabus B1 The Applications Of An Accounting Framework Syllabus B1a) Discuss the importance of a conceptual framework in underpinning the production of accounting standards Framework - Basics and Arguments The IASB framework is not a standard nor does it override any standards Definition It sets out the concepts which underlie the accounts It means that basic principles not have to re-debated for every new standard It is 
 ‘a constitution, a coherent system of interrelated objectives and fundamentals which can lead to consistent standards and which prescribe the nature, function and limits of financial accounting and financial statements’ What’s its purpose? The IASB’s Framework for the Preparation and Presentation of Financial Statements describes the basic concepts by which financial statements are prepared: • Serves as a guide in developing accounting standards 12 aCOWtancy.com • Serves as a guide to resolving accounting issues that are not addressed directly in a standard 
 (In fact IAS requires management to consider the definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the Framework.) What does it ‘look’ like? It includes the following: The objective of financial statements Underlying assumptions Qualitative characteristics of good information Elements of FS Recognition of Elements Measurement of Elements Concepts of Capital More on these in other sections Arguments for a conceptual framework • It may seem a very theoretical document but it has highly practical aims • Without a framework then standards would be developed without consistency and also the same basic principles would be continually examined Perhaps even sometimes with differing conclusions • The IASB therefore becomes the architect of financial reporting with a framework as solid foundations upon which everything else relies • Also without such a framework then a rules based system tends to come in instead The rules get added to as situations arise and finally become cumbersome and unadaptable 13 aCOWtancy.com • It also prevents political lobbyists from changing pressurising changes in standards as the principles have already been agreed upon So a conceptual framework basically provides a framework for: what should be brought into the accounts when it should be brought into the accounts and at how much it should be measured Arguments against a conceptual framework • Financial Statements are prepared for many different users - can one set of principles be agreed by all? • Perhaps different users need different information and hence different measurement bases and principles • Even with framework principles - standards go through a huge analysis process, for example the revenue recognition exposure draft has now been re-exposed! GAAP & the framework In some ways the framework tries to codify the current GAAP into new standards - or at least current thinking 14 aCOWtancy.com Syllabus B1b) Discuss the objectives of financial reporting including disclosure of information that can be used to help assess management’s stewardship of the entity’s resources and the limitations of financial reporting Chapter 1: The Objective of Financial Reporting The objective is to provide financial information that is useful to present and potential equity investors, lenders and other creditors in making decisions The degree to which that financial information is useful will depend on its qualitative characteristics A few observations about the objective: • Wide Scope
 Its scope is wider than financial statements It is the objective of financial reporting in general • Users
 Financial reporting is aimed primarily at capital providers That does not mean that others will not find financial reports useful It is just that, in deciding on the principles for recognition, measurement, presentation, and disclosure, the information needs of capital providers are paramount • Decision usefulness & stewardship
 Decision usefulness to capital providers is the overriding purpose of financial reporting, as well as assessing the stewardship of resources already committed to the entity.
 The ability of management to discharge their stewardship responsibilities effectively has an effect on the entity’s ability to generate net cash inflows in the future, implying that potential investors are also assessing management performance as they make their investment decision 15 aCOWtancy.com • Capital providers - main users 
 The Framework identifies equity investors, lenders and other creditors as ‘capital providers’ Governments, their agencies, regulatory bodies, and members of the public are identified as groups that may find the information in general purpose financial reports useful However, these groups have not been identified as primary users Limitations of FS The Boards note that users of financial reports should be aware of the limitations of the information included in such reports – specifically, estimates and the use of judgement Additionally, financial reports are but one source of information needed by those who make investment decisions Information about general economic conditions, political events and industry outlooks should also be considered Financial reporting should also include management’s explanations, since management knows more about the entity than external users What to Report and Where • Economic Resources and Claims in the SOFP • Changes in ER & C (caused by financial performance) in SOCI • Changes in ER & C (NOT caused by financial performance) in SOCIE • Changes in cashflows in SOCF 16 aCOWtancy.com Syllabus B1c) Discuss the nature of the qualitative characteristics of useful financial information Chapter 3: Qualitative Characteristics of Useful Financial Information Main Principle Financial information is useful when it is relevant and represents faithfully what it purports to represent The usefulness of financial information is enhanced if it is comparable, verifiable, timely and understandable Fundamental characteristics: Relevance
 Relevant information makes a difference in the decisions made by users.
 Therefore it must have a predictive value, confirmatory value, or both The predictive value and confirmatory value of financial information are interrelated 
 Materiality is an entity-specific aspect of relevance It is based on the nature and/or size of the item relative to the financial report Faithful representation
 General purpose financial reports represent economic phenomena in words and numbers.  
 To be useful, financial information must not only be relevant, it must also represent faithfully the phenomena it purports to represent.
 This maximises the underlying characteristics of completeness, neutrality and freedom from error 17 aCOWtancy.com Enhancing characteristics: Comparability (including consistency) Timeliness Reliable information Verifiability
 Helps to assure users that information represents faithfully the economic phenomena that it purports to represent.
 It implies that knowledgeable observers could reach a general consensus (although not necessarily absolute agreement) that the information does represent faithfully the economic phenomena Understandability
 Enables users with a reasonable knowledge to comprehend the information Understandability is enhanced when the information is: • Classified • Characterised • Presented  clearly and concisely However, relevant information should not be excluded solely because it may be too complex Two constraints that limit the information provided in useful financial reports: Materiality
 Information is material if its omission or misstatement could influence the decisions that users make on the basis of an entity’s financial information 
 Materiality is not a matter to be considered by standard-setters but by preparers and their auditors Cost-benefit
 The benefits of providing financial reporting information should justify the costs of providing that information 18 aCOWtancy.com Potential Problems Decision usefulness seen  as more important than the giving information about how well the company is being looked after (Stewardship) Although it may be said that stewardship is taken into account when talking about decision usefulness - perhaps there should be a more specific mention of it Faithful representation has replaced reliability This is even more vague and could lead to problems regarding treatment of some items where substance over form exists Should it encompass not for profits also? Why the split between fundamental and enhancing characteristics? 19 aCOWtancy.com Faithful Representation Accounts must represent faithfully the phenomena it purports to represent Faithful representations means Substance over form
 Faithful representation means capturing the real substance of the matter Represents the economic phenomena
 Faithful means an agreement between the accounting treatment and the economic phenomena they represent.
 The accounts are verifiable and neutral Completeness, Neutrality & Verifiability Examples Sell and buy back = Loan An entity may sell some inventory to a finance house and later buy it back at a price based on the original selling price plus a pre-determined percentage Such a transaction is really a secured loan plus interest To show it as a sale would not be a faithful representation of the transaction Convertible Loans Another example is that an entity may issue convertible loan notes Management may argue that, as they expect the loan note to be converted into equity, the loan should be treated as equity They would try to argue this as their gearing ratio would then improve However, it is recorded as a loan as primarily this is what it is 20 aCOWtancy.com As noted previously, simply following rules in accounting standards can provide for treatment which is essentially form over substance Whereas, users of accounts want the substance over form The concept behind faithful representation should enable creators of financial statements to faithfully represent everything through measures and descriptions above and beyond that in the accounting standard if necessary Limitations to Faithful Representation Inherent uncertainties Estimates Assumptions 21 aCOWtancy.com Syllabus B1d) Explain the roles of prudence and substance over form in financial reporting Prudence In 2010, the IASB decided to remove the word ‘prudence’ from its conceptual framework The previous version of the conceptual framework defined prudence as ‘the inclusion of a degree of caution in the exercise of the judgements needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated’ In other words, err on the side of caution But not too much The framework stated ‘prudence does not allow, for example, the creation of hidden reserves or excessive provisions’ So why remove it from the framework?  Because it's inconsistent with the principle of neutrality Faithful representation of transactions and balances needs neutrality, or free from bias And prudence is, ultimately, bias! So is Prudence dead?! No!: • The standard on accounting policies (IAS 8) states that management should use its judgement, that results in prudent • The standard on accounting policies (IAS 8) states that management should use its judgement, that results in prudent • The standard on provisions (IAS 37) requires potential liabilities to be only ‘probable’ but potential assets have to be ‘reasonably certain’ • The standard on Fair Values (IFRS 13) says that level assets and liabilities might need a risk adjustment when there is significant measurement uncertainty 22 aCOWtancy.com Bringing Prudence back? IASB has proposed to reinstate prudence into its framework Calling it the exercise of caution when making judgments under conditions of uncertainty Maybe it will be re-introduced but highlighting that we must keep neutral too wherever possible
 23 aCOWtancy.com Syllabus B1e) Discuss the high level of measurement uncertainty that can make financial information less relevant Measurement Uncertainty And Relevance Too many measurement techniques? What makes a good measurement method? • Its cost should be justified by the benefits of reporting that information to users • It should be the minimum necessary to provide relevant information • It should mean infrequent changes (any necessary changes clearly explained) • The same method for initial and subsequent measurement (for comparability and consistency purposes) The existing Conceptual Framework worryingly provides very little guidance on measurement Why not use one measurement basis for everything? It may not provide the most relevant information to users - (although many call for the use of current values to provide the most relevant information) What methods IFRSs therefore use? Fair value, historical cost, present value and net realisable value Why? Different information from different measurement bases may be relevant in different circumstances So what's wrong with this? Different measurement bases may mean the totals in financial statements have little meaning 24 aCOWtancy.com Using 'Current Value' Profit orientated businesses turn has market input values (inventory for example) into market output values (sales of finished products) Therefore current market values should play a key role in measurement.  This would be the most relevant measure of assets and liabilities for financial reporting purposes (in these circumstances) Mixed Measurement Approach The IASB favour a mixed measurement approach - the most relevant method is selected.  Investors feel that this approach is consistent with how they analyse financial statements  Maybe its problems of mixed measurement are outweighed by the greater relevance achieved • IFRS requires the use of cost in some cases and fair value in other cases • IFRS 15 essentially applies cost allocation Measurement Uncertainty Measurement uncertainty of an item should be considered when assessing whether a particular measurement basis provides relevant information.  However, most measurement is uncertain and requires estimation.  For example, recoverable value for impairment, depreciation estimates and fair value measures at level and under IFRS 13 The IASB thinks that the level of measurement uncertainty that makes information lack relevance depends on the circumstances and can only be decided when developing particular standards Cash-flow-based measurement can be used to customise measurement bases, which can result in more relevant information but it may also be more difficult for users to understand 25 aCOWtancy.com As a result the Exposure Draft does not identify those techniques as a separate category Areas of debate about measurement include: Entry and exit values Entity specific values Deprival values Entity's business model For example, property can be measured at historical cost or fair value depending upon the business model The IASB believes that when selecting a measurement basis, the amount is more relevant if the way in which an asset or a liability contributes to future cash flows is considered The IASB considers that the way in which an asset or a liability contributes to future cash flows depends, in part, on the nature of the business activities Historic Cost Seems to be the easiest but what about • Deferred payments • Impairments • Depreciation estimates • Exchanges of assets Current Values Current values have a variety of alternative valuation methods These include: • Market value (least ambiguous) • Value in Use • Fulfilment Value In the main, the details of how these different measurement methods are applied, are set out in each accounting standard.
 26 aCOWtancy.com Syllabus B1f) Evaluate the decisions made by management on recognition, derecognition and measurement Recognition and measurement Recognition Please remember this!!! For an item to be recognised in the accounts it must pass three tests: Meet the definition of an asset/liability or income/expense or equity Be probable Be reliably measurable Definitions Asset
 An asset is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise Liability
 A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits Equity
 Equity is the residual interest in the assets of the enterprise after deducting all its liabilities 27 aCOWtancy.com Income
 Income is increases in assets (or decreases of liabilities) that result in increases in equity, other than contributions from equity participants Expense
 Expenses are decreases in assets or (incurrences of liabilities) that result in decreases in equity, other than distributions to equity participants How this is applied in specific cases? • Factoring of receivables
 
 Where debts are factored, the firm sells its debts to the factor This may be a true sale or just a means of getting cash in and so in effect a loan.
 It all depends on whether the debtors sold are still an asset to the company.
 The definition of an asset refers to economic benefits so whoever receives those benefits should hold the debtors as an asset.
 Example
 RCA (that fine academy) sells some of its debtors to a factor The terms of the arrangement are as follows: 
 Factor charges 5% Interest on all outstanding debts every month 
 Any bad debts are transferred back to RCA for a refund Solution
 The best way to view this is by looking at who takes the risks The risk of a debtor is that they pay slowly and/or go bad 
 The 5% interest charge means that if the debtor is a slow payer, RCA pays 5% so takes the risk Equally if the debt goes bad RCA takes the risk So they remain RCA debtors The money from the so called sale is treated as a loan As the debtors pay the factor that is the loan being paid off 28 aCOWtancy.com • Consignment Stock
 
 This is where inventories are held by one party but are owned by another (for example a manufacturer and car dealer arrangement) 
 Often used in a ‘sale or return’ basis.
 Issue 
 The issue is - to whom does the stock belong? Not the legal form but the substance Again look at who is taking most of the risks and it is they who should have the stock on their SFP Risks
 Who takes the risk of obsolescence?
 Who takes the risk of the sell on price falling?
 Who takes the risk of the stock taking a long time to sell? Example Here’s an agreement between a car manufacturer (m) and a car dealer (d) The price of vehicles is fixed at the date of transfer (Price fall risk taken by d) D has no right to return unsold cars (obsolescence risk taken by d) D pays m 2% a month on all unsold cars (slow moving stock risk taken by d) Therefore the cars should be on D’s statement of financial position 29 aCOWtancy.com Syllabus B1g) Critically discuss and apply the definitions of the elements of financial statements and the reporting of items in the statement of profit or loss and other [3] comprehensive income Reporting Of Items In The Soci And Oci The performance of a company is reported in the statement of profit or loss and other comprehensive income Nothing yet explains, conceptually, where gains/losses should go - OCI or P/L? So no principles based approach here - instead we currently have is a rules based approach Each individual standard tells us where to put the gains and losses This is confusing for users Conceptual Framework Discussion Paper Suggestions • P/L should recognise the results of transactions, consumption and impairments of assets and fulfilment of liabilities in the period in which they occur • P/L should also recognise changes in the cost of assets and liabilities as well as any gains or losses resulting from their initial recognition • OCI then supports the P/L - Gains and losses would only be recognised in OCI if it made the P&L more relevant 30 aCOWtancy.com What gets recycled? Recycled means - gains or losses are first recognised in the OCI and then in a later accounting period also recognised in the P/L.  Individual standards again state when to this - no principle just rules again What gets recycled: • The re-translation of a Sub’s goodwill and net assets (IAS 21)
 First - exchange differences are recognised in OCI (and OCE reserve)
 Then - when the sub is disposed of - The OCE reserve is emptied and reclassified to P&L - to form part of the profit on disposal • The effective portion of gains and losses on hedging instruments in a cash flow hedge under IFRS What doesn't get re-cycled? • Revaluations' gains and losses (IAS 16) - these go the OCI (and OCE reserve)
 On disposal - they are not re-cycled to the P/L - instead there's a transfer in the SO`CIE, from the OCE into RE • FVTOCI items (IFRS 9) - Gains/losses on these go to OCI (and OCE reserve) but again on disposal no re-cycling to P/L just a reserves transfer 
 Note: With no reclassification the earnings per share will never fully include the gains on the sale of PPE and FVTOCI investments • Remeasurements of a net defined benefit liability or asset recognised in accordance with  IAS 19 31 aCOWtancy.com Future Options? Option 1: NO OCI This would reduce certainly reduce complexity!  Also all gains and losses just recognised once.  Although then the EPS would contain many non-operational, unrealised gains and losses  that were non-operational, unrealised and not relating to the accounting period Option 2: NARROW APPROACH TO THE OCI A restricted OCI - where only bridging and mismatch gains and losses are included in OCI (and be recycled) Eg A FVTOCI is revalued on the SFP but no effect on P/L - so the OCI acts as a bridge between the SFP and P/L  The re-cycling on disposal means the same amount would be shown in the P/L as if it had been measured at cost The effective gain or loss on a cash flow hedge of a future transaction is an example of a mismatch gain or loss as it relates to a transaction in a future accounting period so needs to be carried forward so that it can be matched in the P/L of a future accounting period Only by recognising the effective gain or loss in OCI and allowing it to be reclassified from equity to P/L can users to see the results of the hedging relationship Option 3: BROAD APPROACH TO THE OCI Like the narrow approach but also includes transitory gains / losses.  The IASB would decide in each IFRS whether a transitory remeasurement should be recycled Eg The remeasurement of defined benefit pensions and revaluations of PPE.
 32 aCOWtancy.com Syllabus C: REPORTING THE FINANCIAL PERFORMANCE OF ENTITIES Syllabus C1 Performance reporting Syllabus C1a) Discuss and apply the criteria that must be met before an entity can apply the revenue recognition model Criteria for IFRS 15 The following must be ok (at inception) before IFRS 15 can be used Both parties have enforceable rights / obligations Contract approved - (as long as both parties cannot unilaterally terminate) Payment terms agreed (not necessarily fixed payments) Commercial substance to the contract Customer can (probably) and intends to pay These are re-assesses later if not met at inception IFRS15 applies to all contracts except for: • Lease Contracts • Insurance Contracts • Financial instruments and other contractual rights/obligations within the scope of lAS 39/lFRS 9, lFRS 10, lFRS 11, lAS 27 and lAS 28 33 aCOWtancy.com • Non-monetary exchanges between entities within the same business to facilitate sales Lets say a bank gives you a mortgage (Financial liability) and some other services to with the property The mortgage would be IFRS And the other services probably IFRS 15 Basically if another standard deals with the issue - use that standard!
 34 aCOWtancy.com Syllabus C1b) Discuss and apply the five step model relating to revenue earned from a contract with a customer Revenue Recognition - IFRS 15 - introduction When & how much to Recognise Revenue? Here you need to go through the step process… Identify the contract(s) with a customer Identify the performance obligations in the contract Determine the transaction price Allocate the transaction price to the performance obligations in the contract Recognise revenue when (or as) the entity satisfies a performance obligation Before we that though, let’s get some key definitions out of the way Key definitions • Contract An agreement between two or more parties that creates enforceable rights and obligations • Income Increases in economic benefits during the accounting period in the form of increasing assets or decreasing liabilities 35 aCOWtancy.com • Performance obligation A promise in a contract to transfer to the customer either: - a good or service that is distinct; or - a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer • Revenue Income arising in the course of an entity’s ordinary activities • Transaction price The amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer.
 36 aCOWtancy.com Revenue Recognition - IFRS 15 - steps Ok let’s now get into a bit more detail… Step 1: Identify the contract(s) with a customer • The contract must be approved by all involved • Everyone’s rights can be identified • It must have commercial substance • The consideration will probably be paid Step 2: Identify the separate performance obligations in the contract This will be goods or services promised to the customer These goods / services need to be distinct and create a separately identifiable obligation • Distinct means: The customer can benefit from the goods/service on its own AND The promise to give the goods/services is separately identifiable (from other promises) • Separately identifiable means: No significant integrating of the goods/service with others promised in the contract The goods/service doesn’t significantly modify another good or service promised in the contract The goods/service is not highly related/dependent on other goods or services promised in the contract.
 37 aCOWtancy.com Step 3: Determine the transaction price How much the entity expects, considering past customary business practices • Variable Consideration
 If the price may vary (eg possible refunds, rebates, discounts, bonuses, contingent consideration etc) - then estimate the amount expected • However variable consideration is only included if it’s highly probable there won’t need to be a significant revenue reversal in the future (when the uncertainty has been subsequently resolved) • However, for royalties from licensing intellectual property - recognise only when the usage occurs Step 4: Allocate the transaction price to the separate performance obligations If there’s multiple performance obligations, split the transaction price by using their  standalone selling prices (Estimate if not readily available) • How to estimate a selling Price - Adjusted market assessment approach 
 - Expected cost plus a margin approach 
 - Residual approach (only permissible in limited circumstances) • If paid in advance, discount down if it’s significant (>12m) Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation Revenue is recognised as control is passed, over time or at a point in time • What is Control
 It’s the ability to direct the use of and get almost all of the benefits from the asset This includes the ability to prevent others from directing the use of and obtaining the benefits from the asset 38 aCOWtancy.com • Benefits could be: - Direct or indirect cash flows that may be obtained directly or indirectly - Using the asset to enhance the value of other assets; - Pledging the asset to secure a loan - Holding the asset • So remember we recognise revenue as asset control is passed (obligations satisfied) to the customer
 
 This could be over time or at a specific point in time Examples (of factors to consider) of a specific point in time: The entity now has a present right to receive payment for the asset; The customer has legal title to the asset; The entity has transferred physical possession of the asset; The customer has the significant risks and rewards related to the ownership of the asset; and The customer has accepted the asset Contract costs - that the entity can get back from the customer These must be recognised as an asset (unless the subsequent amortisation would be less 12m), but must be directly related to the contract (e.g ‘success fees’ paid to agents) Examples would be direct labour, materials, and the allocation of overheads  - this asset is then amortised
 39 aCOWtancy.com Revenues - Presentation in financial statements Show in the SFP as a contract liability, asset, or a receivable, depending on when paid and performed i.e Paid upfront but not yet performed would be a contract liability Dr Cash Cr Contract Liability i.e Paid later but already performed Dr Receivable Cr Revenue (see below) Performed but not paid would be a contract receivable or asset A contract asset if the payment is conditional (on something other than time) A receivable if the payment is unconditional Contract assets and receivables shall be accounted for in accordance with IFRS Disclosures All qualitative and quantitative information about: • its contracts with customers; • the significant judgments in applying the guidance to those contracts; and • any assets recognised from the costs to fulfil a contract with a customer 40 aCOWtancy.com Syllabus C1c) Apply the criteria for recognition of contract costs as an asset Incremental Costs Of Obtaining A Contract These are recognised as an asset (if they are expected to be recovered from the customer) • Incremental means these costs ONLY occurred due to the contract eg Sales commission • If amortisation of these costs would be Example Due diligence on a potential customer = Expense 
 (Incurred whether even if we don't take on the customer) Commissions to sales employees = Asset and amortised
 (Incurred only for the customer contract & recovery expected through future sales) Costs To Fulfil A Contract First, be careful these aren't just normal costs dealt under their own standard (eg IAS Inventories, IAS 16 PPE & IAS 38 Intangibles)  Otherwise we again recognise these as an asset if they:
 41 aCOWtancy.com Relate directly to the contract Generate resources we are going to use when we sell Are expected to be recovered Examples to show as assets include: Direct labour and Materials Allocations of depreciation or insurance Anything explicitly chargeable to the customer  Subcontractor costs Examples to expense include: General and administrative costs (not explicitly chargeable to the customer)  Wasted materials, labour and other resources  Costs relating to satisfied or partially satisfied performance obligations (past performance) must be expensed also
 42 aCOWtancy.com Syllabus C1d) Discuss and apply the recognition and measurement of revenue including performance obligations satisfied over time, sale with a right of return, warranties, variable consideration, principal versus agent considerations and non-refundable up-front fees Specific IFRS 15 Scenarios Sale With A Right Of Return Here we mean the Customer has the right to receive: A refund  Credit  A different product in exchange (Please note the right to get for example a different colour or size isn't a return here) Accounting treatment for Right to Return items Reduce Revenue by the expected value of returns Instead Dr Revenue Cr Refund liability (Inventory of expected return items excluded from cost of sales) In subsequent periods, the vendor updates its expected levels of returns, adjusting the measurement of the refund liability and the associated inventory asset.
 43 aCOWtancy.com Warranties Assurance Warranties  These (normally free) warranties simply provide assurance the product complies with agreed-upon specifications These are just bundled into the revenue for the product and a provision for the warranty costs is made using IAS 37 as normal Service Warranties  These (normally paid for) warranties provides a service in addition to the assurance These are normally: Not required by law For longer periods These warranties are therefore separate performance obligations Example A customer buys an item for $100,000, with a one-year standard warranty that specifies the equipment will comply with the agreed-upon specifications and will operate as promised for a one-year period from the date of purchase She also buys an extra $2,000 two-year warranty commencing after the expiry of the standard one- year warranty.
 44 aCOWtancy.com There are two warranties in this contract: assurance-type warranty — for first year after purchase service-type warranty — for two years after expiry of the initial standard warranty The service-type warranty and is accounted for as a separate performance obligation Deferred revenue of $2,000 is recognised until the performance obligation is satisfied The assurance-type warranty is accounted for using IAS 37 Provisions Non-Refundable Upfront Fees When the upfront fee received is just an advance payment for future services, recognised as revenue when those future services are provided 45 aCOWtancy.com Principal vs Agent The Principal controls the good before transfer to the customer The Agent does not control the good before transfer to the customer So the following normally are indicators you're an agent • Another party is primarily responsible for fulfilling the contract  • You don't take inventory risk before or after a customer order • You don't set prices  • You receive commission only  • You take no credit risk for the amount receivable Accounting treatment for Principal Show gross revenue and cost of sales Accounting treatment for Agent Show commission only as revenue
 46 aCOWtancy.com Exam Standard Illustrations Illustration - Agent or not? An entity negotiates with major airlines to purchase tickets at reduced rates It agrees to buy a specific number of tickets and must pay even if unable to resell them The entity then sets the price for these ticket for its own customers and receives cash immediately on purchase The entity also assists the customers in resolving complaints with the service provided by airlines However, each airline is responsible for fulfilling obligations associated with the ticket, including remedies to a customer for dissatisfaction with the service How would this be dealt with under IFRS 15? Step 1: Identify the contract(s) with a customer This is clear here when the ticket is purchased Step 2: Identify the performance obligations in the contract This is tricky - is it to arrange for another party provide a flight ticket - or is it - to provide the flight ticket themselves? Well - look at the risks involved If the flight is cancelled the airline pays to reimburse, If the ticket doesn't get sold - the entity loses out Look at the rewards - the entity can set its own price and thus rewards On balance therefore the entity takes most of the risks and rewards here and thus controls the ticket - thus they have the obligation to provide the right to fly ticket Step 3: Determine the transaction price 47 aCOWtancy.com This is set by the entity Step 4: Allocate the transaction price to the performance obligations in the contract The price here is the GROSS amount of the ticket price (they sell it for) Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation Recognise the revenue once the flight has occurred 48 aCOWtancy.com Illustration - Loyalty discounts An entity has a customer loyalty programme that rewards a customer with one customer loyalty point for every $10 of purchases Each point is redeemable for a $1 discount on any future purchases Customers purchase products for $100,000 and earn 10,000 points The entity expects 9,500 points to be redeemed, so they have a stand-alone selling price $9,500 How would this be dealt with under IFRS 15? Step 1: Identify the contract(s) with a customer This is when goods are purchased Step 2: Identify the performance obligations in the contract The promise to provide points to the customer is a performance obligation along with, of course, the obligation to provide the goods initially purchased Step 3: Determine the transaction price $100,000 49 aCOWtancy.com Step 4: Allocate the transaction price to the performance obligations in the contract The entity allocates the $100,000 to the product and the points on a relative standalone selling price basis as follows: So the standalone selling price total is 100,000 + 9,500 = 109,500 Now we split this according to their own standalone prices pro-rata Product $91,324 [100,000 x (100,000 / 109,500] 
 Points $8,676 [100,000 x 9,500 /109,500] Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation Of course the products get recognised immediately on purchase but now lets look at the points Let’s say at the end of the first reporting period, 4,500 points (out of the 9,500) have been redeemed The entity recognises revenue of $4,110 [(4,500 points ÷ 9,500 points) × $8,676] and recognises a contract liability of $4,566 (8,676 – 4,110) for the unredeemed points 50 aCOWtancy.com Syllabus C2 Non-current Assets Syllabus C2a) Discuss and apply the recognition, derecognition and measurement of non-current assets including impairments and revaluations Initial Recognition of PPE When should we bring PPE into the accounts? When the following tests are passed: When we control the asset When it’s probable that we will get future economic benefits When the asset’s cost can be measured reliably What gets included in ‘Cost’ Directly attributable costs to get it to work and where it needs to be eg site preparation, delivery and handling, installation, related professional fees for architects and engineers Estimated cost of dismantling and removing the asset and restoring the site This is:
 Dr PPE
 Cr Liability All at present value This will need discounting and the discount unwound:
 Dr interest (with unwinding of discount) 
 Cr liability 51 aCOWtancy.com Borrowing costs If it is an asset that takes a while to construct Interest at a market rate must be recognised or imputed Let's look at the Future obligated costs in detail Future obligated costs Dr PPE
 Cr Liability at present value • The present value is calculated by discounting down at the rate given in the exam eg 100 in years time at 10% = 100/1.10/1.10 = 82.6 • So the double entry would be: Dr PPE 82.6
 Cr Liability 82.6 However the LIABILITY needs unwinding • Unwinding of discount Dr Interest
 Cr Liability Use the original discount rate (so here 10%) 10% x 82.6 = 8.26 Dr Interest 8.26
 Cr Liability 8.26 52 aCOWtancy.com IAS 16 Depreciation The depreciable amount (cost less prior depreciation, impairment, and residual value) should be allocated on a systematic basis over the asset’s useful life Residual Value & UEL • Should be reviewed at least at each financial year-end • if expectations differ from previous estimates, any change is accounted for  prospectively as a change in estimate Which Method of Depreciation should be used? It should reflect the pattern in which the asset’s economic benefits are consumed by the enterprise How often should depreciation methods be reviewed? • At least annually • If the pattern of consumption changes, the depreciation method should be changed prospectively as a change in estimate Accounting treatment Depreciation should be charged to the income statement Depreciation begins when the asset is available for use and continues until the asset is de-recognised
 53 aCOWtancy.com Significant parts are depreciated separately • If the cost model is used each part of an item of PPE with a significant cost (in relation to the total cost) must be depreciated separately • Parts which are regularly replaced - depreciate separately The replacement cost is then added to the asset cost when recognition criteria are met The carrying amount of the replaced parts is de-recognised Major Inspections for faults (e.g Aircraft) The inspection cost is added to the asset cost when recognition criteria are met If necessary, the estimated cost of a future similar inspection may be used as an indication of what the cost of the existing inspection component was when the item was acquired or constructed An asset with a component included with a different UEL: This could be something like Land and buildings - basically you should take the land value away from the total cost and then depreciate the remainder over the UEL of the building • Illustration Buy House for 100,000. 
 The land has a value of 40,000. 
 UEL of building is 10 years • Solution: The value of the building itself is: 100,000 - 40,000 = 60,000 54 aCOWtancy.com Depreciation would be:
 Land 40,000 - zero depreciation
 Building 60,000 / 10 years = 6,000
 55 aCOWtancy.com PPE - After Initial recognition After the initial recognition there are choices: Cost model • Cost less accumulated depreciation and impairment • Depreciation should begin when ready for use not wait until actually used Revaluation model Fair value at the date of revaluation less depreciation • If we follow the revaluation model - how often should we revalue? Revaluations should be carried out regularly For volatile items this will be annually, for others between 3-5 years or less if deemed necessary • Ok and which assets get revalued? If an item is revalued, its entire class of assets should be revalued • And to what value? Market value normally is fair value Specialised properties will be revalued to their depreciated replacement cost 56 aCOWtancy.com Accounting treatment of a Revaluation An increase in the revalued amount (above depreciated historic cost) Any increase above depreciated historic cost is credited to equity under the heading "revaluation surplus" (and shown in the OCI) DR Asset
 CR equity - “revaluation surplus” An increase in the revalued amount (up to depreciated historic cost) is taken to the income statement DR Assets
 CR I/S A decrease down to Historic cost Any decrease down to depreciated historic cost is taken to the revaluation reserve (and OCI) as a debit DR equity - “revaluation surplus”
 CR Assets A decrease below historic cost Any decrease below depreciated historic cost is debited to the income statement DR Income statement
 CR Assets Disposal of a Revalued Asset The revaluation surplus in equity - IS NOT transferred to the income statement - it just drops into RE It will, therefore, only show up in the statement of changes in equity 57 aCOWtancy.com Let´s make no mistake about this - the revaluation adjustments can be very tricky when you revalue upwards: the asset will increase therefore the depreciation will increase and hence the expenses will increase This means smaller profits and smaller retained earnings just because of the revaluation! Shareholders will not be impressed by this as retained earnings are where they are legally allowed to get their dividends from Because of this, a transfer is made out of the revaluation reserve and into retained earnings every year with the extra depreciation caused by the previous revaluation This, though, then causes more problems if the asset is subsequently impaired etc but worry not - the COW has the answer! This is what you in a tricky looking revaluation question: Calculate the Depreciated Historic Cost This is basically what the asset would have been worth had nothing (revaluations/ impairments) occurred in the past We this because anything above this figure is a genuine revaluation and so goes to the RR Similarly anything below this is a genuine impairment and goes to the income statement Calculate the NBV just before the Revaluation or Impairment in question 58 aCOWtancy.com Now calculate the difference between step and the new NBV (the amount to be revalued or impaired to) This will be the debit or credit to the asset The other side of the entry will depend on the depreciated historic cost calculated in step I know all that sounds tricky - so let’s look at an illustration: Illustration An asset is bought for 1,000 (10yr UEL).
 years later it is revalued to 1,000. 
 One year after that it is impaired to 400 What is the double entry for this impairment? Calculate the Depreciated Historic Cost DHC would be 1,000 less years of depreciation = 700 Calculate the NBV just before the Impairment NBV at date of impairment = 1000 NBV one year earlier. 
 So 1,000 less depreciation of (1,000 / 8) = 125 = 875 59 aCOWtancy.com Now calculate the difference between step and the amount to be impaired to Impair to 400 So from 875 to 400 - credit Asset 475 Accounting treatment Dr RR with any amount above the DHC of 700 So 875-700 = 175
 Dr I/S with any amount below DHC of 700 So 700-400 = 300 Dr I/S 300
 Dr RR 175
 Cr PPE 475 Illustration 1/1/20x2 an asset has a carrying amount of 140 and a remaining UEL of 7  years No residual value The asset is revalued to 60 on 1/1/20x3 On 1/120x5 the asset is revalued to 110 Calculate the Depreciated Historic Cost DHC would be 140 - depreciation (140 / years x years)  = 80 Calculate the NBV just before the Revaluation The asset is revalued to 60 on 1/1/20x3 So 60 less depreciation of (60 / x 2) = 40 Now calculate the difference between step and the amount to be revalued to On 1/120x5 the asset is revalued to 110 So from 40 to 110 - DR Asset 70 60 aCOWtancy.com Accounting treatment Cr RR with any amount above the DHC of 80 So 110-80 = 30
 Cr I/S with any amount below DHC of 80 So 80-40 = 40 Dr PPE 70
 Cr I/S 40
 Cr RR 30 61 aCOWtancy.com Review Page PPE costs $1,000, has installation costs of $100, dismantling fee with a present value of $50 and some losses expected at first while operators get used to the system of $50 At what Value should the PPE be in the accounts initially? The PPE above has a 10 yr UEL but is not used for the first year How much is depreciation and from when? A piece of PPE has a dismantling fee in years of $1,000 and the discount rate is 10% What entries would be put in the accounts for this in year 1? What is the best method for depreciation? Reducing balance or straight line? An item of PPE is bought for 1,000 and has a 10 yr UEL What is the NBV in years time? The PPE above is then revalued 1,050 How is this increase accounted for? What would the depreciation charge be for the following year? At the end of that year what is the NBV? What is the Depreciated Historic Cost? 10 It is now revalued down to 400 How is this fall accounted for? 62 aCOWtancy.com Exam Standard Question A piece of property, plant and equipment (PPE) cost $12 million on May 2008 It is being depreciated over 10 years on the straight-line basis with zero residual value On 30 April 2009, it was revalued to $13 million and on 30 April 2010, the PPE was revalued to $8 million The whole of the revaluation loss had been posted to the statement of comprehensive income and depreciation has been charged for the year Make any adjustments necessary for the year ended 30 April 2010 Answer At 30 April 2009, a revaluation gain of ($13m – $12m – depreciation $1·2m) $2·2 million would be recorded in equity for the PPE At 30 April 2010, the carrying value of the PPE would be $13m – depreciation of $1·44m i.e $11·56m Thus there will be a revaluation loss of $11·56m – $8m i.e $3·56m Of this amount $1·96m will be charged against revaluation surplus in reserves and $1·6 million will be charged to profit or loss 63 aCOWtancy.com Componentisation Various components of an asset to be identified and depreciated separately if they have differing patterns of benefits If a significant component is expected to wear out quicker than the overall asset, it is depreciated over a shorter period Then any restoring or replacing is capitalised This approach means different depreciation periods for different components Examples are land, roof, walls, boilers and lifts So the depreciation reflects the effect of a future restoration or replacement A challenging process due to • Difficulties valuing components because it is unusual for the various component parts to be valued, so Involve company personnel in the analysis Applying component accounting to all assets How far the asset should be broken down into components Any measure used to determine components is subjective Asset registers may need to be rewritten Breaking down assets needs ‘materiality', setting a de minimis limit • When a component is replaced or restored The old component is de-recognised to avoid double-counting and the new component recognised 64 aCOWtancy.com • Where it is not possible to determine the carrying amount of the replaced part of an item of PPE Best estimates are required A possibility is: Use the replacement cost of the component, adjusted for any subsequent depreciation and impairment • A revaluation Apportion over the significant components • When a component is replaced The carrying value of the component replaced should be charged to the income statement The cost of the new component recognised in the statement of financial position Transition to IFRS Use the ‘fair value as deemed cost’ for the asset: The fair value is then allocated to the different significant parts of the asset Componentisation adds to subjectivity The additional depreciation charge can be significant Accountants and other professionals must use their professional judgment when establishing significance levels, assessing the useful lives of components and apportioning asset values over recognised components Discussions with external auditors will be key one during this process IAS 36 Impairments 65 aCOWtancy.com A company cannot show anything in its accounts higher than what they’re actually worth “What they’re actually worth” is called the “Recoverable Amount” So no asset can be in the accounts at MORE than the recoverable amount Less is fine, just not more So, assets need to be checked that their NBV is not greater than the RA If it is then it must be impaired down to the RA So how you calculate a Recoverable Amount? There are things an entity can with an asset Sell it or Use it It will obviously choose the one which is most beneficial So, you'll choose the higher of the following • FV-CTS (Fair value less costs to sell) • VIU (Value in use) So the higher of the FV - CTS and VIU is called the Recoverable amount Illustration In the accounts an item of PPE is carried at 100. 
 It’s FV-CTS is 90 and its VIU is 80 66 aCOWtancy.com • This means the recoverable amount is 90 (higher of FV-CTS and VIU) • And that the PPE (100) is being carried at higher than the RA, which is not allowed, and so an impairment of 10 down to the RA is required in the accounts (100 - 90) Recognition of an Impairment Loss An impairment loss should be recognised whenever RA is below carrying amount The impairment loss is an expense in the income statement Adjust depreciation for future periods Here's some boring definitions for you: • Fair value
 The amount obtainable from the sale of an asset in a bargained transaction between knowledgeable, willing parties • Value in use
 The discounted present value of estimated future cash flows expected to arise from: - the continuing use of an asset, and from - its disposal at the end of its useful life 67 aCOWtancy.com Recoverable Amount in more detail Fair Value Less Costs to Sell • If there is a binding sale agreement, use the price under that agreement less costs of disposal • If there is an active market for that type of asset, use market price less costs of disposal Market price means current bid price if available, otherwise the price in the most recent transaction • If there is no active market, use the best estimate of the asset's selling price less costs of disposal (direct added costs only (not existing costs or overhead)) Let's look at VIU in more detail The future cash flows: • Must be based on reasonable  and supportable assumptions (the most recent budgets and forecasts) • Budgets and forecasts should not go beyond five years • The cashflows should relate to the asset in its current condition – future restructuring to which the entity is not committed and expenditures to improve the asset's performance should not be anticipated • The cashflows  should not include cash from financing activities, or income tax • The discount rate used should be the pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the asset 68 aCOWtancy.com Identifying an Asset That May Be Impaired At each balance sheet date, review all assets to look for any indication that an asset may be impaired.   If there is an indication that an asset may be impaired, then you must calculate the asset’s recoverable amount to see if it is below carrying value if it is - then you must impair it Illustration Asset has carrying value of 100 It has a FV-CTS of 90 It has a VIU of 95 It's recoverable amount is therefore the higher of the = 95 and this is below the carrying value in the books (100) and so needs impairment of What are the indicators of impairment? Losses / worse economic performance Market value declines Obsolescence or physical damage Changes in technology, markets, economy, or laws Increases in market interest rates Loss of key employees Restructuring / re-organisation Just to confuse you a little bit more, we not JUST check for impairment when there has been an indicator (listed above) 69 aCOWtancy.com We also check the following ANNUALLY regardless of whether there has been an impairment indicator or not: an intangible asset with an indefinite useful life an intangible asset not yet available for use goodwill acquired in a business combination Reversal of an Impairment Loss First of all you need to think about WHY the impairment has been reversed Discount Rate Changes Here, no reversal is allowed So if the discount rate lowers and thus improves the VIU, this is not considered to be a reversal of an impairment Other The increased carrying amount due to reversal should not be more than what the depreciated historical cost would have been if the impairment had not been recognised Accounting treatment Reversal of an impairment loss is consistent with the original treatment of the impairment in terms of whether recognised as income in the income statement or OCI Reversal of an impairment loss for goodwill is prohibited 70 aCOWtancy.com Cash Generating Units Sometimes individual assets not generate cash inflows so the calculation of VIU is impossible In such a case then the asset will belong to a larger group that does generate cash This is called a cash generating unit (CGU) and it is the carrying value of this which is then tested for impairment Recoverable amount should then be determined for the asset's cash-generating unit (CGU) CGU - A restaurant For example, the tables in a restaurant not generate cash They belong to a larger CGU though (the restaurant itself) It is the restaurant that is then tested for impairment The carrying amount of the CGU is made up of the carrying amounts of all the assets directly attributed to it Added to this will be assets that are not directly attributed such as head office and a portion of goodwill 71 aCOWtancy.com Illustration A subsidiary was acquired, which included cash generating units and the goodwill for the whole subsidiary was 40m 
 Each CGU would be allocated part of the 40 according to the carrying amount of the assets in each CGU as follows: CGU NBV 200 200 400 10 10 20 Goodwill A CGU to which goodwill has been allocated (like the above) shall then be tested for impairment at least annually by comparing the carrying amount of the unit, including the goodwill, with the recoverable amount of the CGU If the carrying amount of the unit exceeds the recoverable amount of the unit, the entity must recognise an impairment loss (down to the unit’s RA) Order of Impairment But the problem is what you impair first - the assets or the goodwill in the unit? The impairment loss is allocated in the following order: Reduce any goodwill allocated to the CGU Reduce the assets of the unit pro rata Note: The carrying amount of an asset should not be reduced below its own recoverable amount 72 aCOWtancy.com Illustration  The following carrying amounts were recorded in the books of a restaurant immediately prior to the impairment: Goodwill 100 Property, plant and equipment  100 Furniture and fixtures  100 The fair value less costs to sell of these assets is $260m whereas the value in use is $270m 
 Required: Show the impact of the impairment Solution Recoverable amount is 270 - so the CV of the CGU needs to be reduced from 300 to 270 = 30 This 30 reduces goodwill down to 70 73 aCOWtancy.com Review Page When you check for impairment? What is recoverable amount? If RA is higher than the carrying amount what you do? If RA is lower than the carrying amount what you do? What if the asset that is being checked for impairment is not a cash generating unit what must you do? What are steps for calculating the correct impairment to goodwill when the proportionate method is used? 74 aCOWtancy.com Exam Standard Question A subsidiary company had purchased computerised equipment for $4 million on 31 October 2006 to improve the manufacturing process Whilst re-organising the group, Ghorse had discovered that the manufacturer of the computerised equipment was now selling the same system for $2·5 million The projected cash flows from the equipment are: Year ended 31 October 2008 $1·3 2009 $2·2 2010 $2·3 The residual value of the equipment is assumed to be zero The company uses a discount rate of 10% The directors think that the fair value less costs to sell of the equipment is $2 million The directors of Ghorse propose to write down the non-current asset to the new selling price of $2·5 million The company’s policy is to depreciate its computer equipment by 25% per annum on the straight line basis (5 marks) Solution At each balance sheet date, Ghorse should review all assets to look for any indication that an asset may be impaired, i.e where the asset’s carrying amount ($3 million) is in excess of the greater of its net selling price and its value in use IAS36 has a list of external and internal indicators of impairment If there is an indication that an asset may be impaired, then the asset’s recoverable amount must be calculated (IAS36 paragraph 9).
 75 aCOWtancy.com The recoverable amount is the higher of an asset’s fair value less costs to sell (sometimes called net selling price) and its value in use which is the discounted present value of estimated future cash flows expected to arise from: (i) the continuing use of an asset, and from (ii) its disposal at the end of its useful life If the manufacturer has reduced the selling price, it does not mean necessarily that the asset is impaired One indicator of impairment is where the asset’s market value has declined significantly more than expected in the period as a result of the passage of time or normal usage The value-in-use of the equipment will be $4·7 million Cash Discounted at 10% $m 2008 1·2 2009 1·8 2010 1·7 –––– Value in use – 4·7 –––– The fair value less costs to sell of the asset is estimated at $2 million Therefore, the recoverable amount is $4·7 million which is higher than the carrying value of $3 million and, therefore, the equipment is not impaired
 76 aCOWtancy.com Syllabus C2b) Discuss and apply the accounting requirements for the classification and measurement of non-current assets held for sale Assets Held for Sale How we deal with items in our accounts which we are no longer going to use, instead we are going to sell them So, think about this for a moment Why does this matter to users? Well, the accounts show the business performance and position, and you expect to see assets in there that they actually are looking to continue using Therefore their values not have to be shown at their market value necessarily (as your intention is not to sell them) Here, though, everything changes… we are going to sell them So maybe market value is a better value to use, but they haven’t been sold yet, so showing them at MV might still not be appropriate as this value has not yet been achieved So these are the issues that IFRS tried, in part, to deal with and came up with the following solution Accounting Treatment Step - Calculate the Carrying Amount Bring everything up to date when we decide to sell This means: - charge the depreciation as we would normally up to that date or
 - revalue it at that date (if following the revaluation policy) 77 aCOWtancy.com Step - Calculate FV - CTS Now we can get on with putting the new value on the asset to be sold Measure it at Fair Value less costs to sell (FV-cts) This is because, if you think about it, this is the what the company will receive HOWEVER, the company hasn’t actually made this sale yet and so to revalue it now to this amount would be showing a profit that has not yet happened Step - Value the Assets held for sale IFRS says the new value should actually be… The lower of carrying amount (step 1) and FV-CTS (step 2) Step - Check for an Impairment Revaluing to this amount might mean an impairment (revaluation downwards) is needed This must be recognised in profit or loss, even for assets previously carried at revalued amounts Also, any assets under the revaluation policy will have been revalued to FV under step Then in step 2, it will be revalued downwards to FV-cts Therefore, revalued assets will need to deduct costs to sell from their fair value and this will result in an immediate charge to profit or loss Subsequent increase in Fair Value? • This basically happens at the year-end if the asset still has not been sold A gain is recognised in the p&l up to the amount of all previous impairment losses 78 aCOWtancy.com Non-depreciation Non-current assets or disposal groups that are classified as held for sale shall not be depreciated When is an asset recognised as held for sale? • Management is committed to a plan to sell • The asset is available for immediate sale • An active programme to locate a buyer is initiated • The sale is highly probable, within 12 months of classification as held for sale • The asset is being actively marketed for sale at a sales price reasonable in relation to its fair value Abandoned Assets The assets need to be disposed of through sale Therefore, operations that are expected to be wound down or abandoned would not meet the definition Therefore assets to be abandoned would still be depreciated Balance sheet presentation Presented separately on the face of the balance sheet in current assets • Subsidiaries Held for Disposal IFRS applies to accounting for an investment in a subsidiary held only with a view to its subsequent disposal in the near future 79 aCOWtancy.com • Subsidiaries already consolidated now held for sale The parent must continue to consolidate such a subsidiary until it is actually disposed of It is not excluded from consolidation and is reported as an asset held for sale under IFRS So subsidiaries held for sale are accounted for initially and subsequently at FV-CTS of all the net assets not just the amount to be disposed of.
 80 aCOWtancy.com Held for sale disposal group This is where we sell more than a single asset, in fact it may be a whole company A 'disposal group' is a group of assets, possibly with some associated liabilities, which an entity intends to dispose of in a single transaction Any impairment losses reduce the carrying amount of the disposal group in the order of allocation required by IAS 36 A disposal group with reversal of impairment losses Normally the rule here is that an impairment under IFRS can only be reversed up to as much as a previous impairment A disposal group may take up the advantage of some assets within the group using up the unused Impairment losses on other assets 81 aCOWtancy.com Illustration Disposal group assets Asset Asset Asset Previous impairment (100) (20) (30) NBV 80 90 100 Here the total nbv is 270 If by the year end the FV-CTS is now: Asset 1: 150, 
 Asset 2: 100
 Asset 3: 150 Asset it can be revalued to 150, increase of 70 as previous impairment was 100 Asset can be revalued to 100, an increase of 10 as previous impairment was 20 Asset could normally not be revalued to 150, an increase of 50 but only to 130 as it’s previous impairment was only 30 However, it can also use any unused impairments of the other assets in it's disposal group such as 10 from asset and a further 10 from asset 1, and so can be revalued up to 150 What if the asset or disposal group is not sold within 12 months? Normally, returns to PPE at the amount it would have been at had it not gone to held for sale Check for impairment Or, keep in HFS if delay is caused by circumstances outside the control of the entity e.g Buyer unexpectedly imposes transfer conditions which extend beyond a year Or the market demand has collapsed.
 82 aCOWtancy.com Review Page When a company decides to sell one of its assets what must it to that asset first? At what value is a HFS asset held initially in the SFP? Where is this value shown on the SFP? What happens if this asset is still not sold at the year end and has decreased in value? What happens if this asset is still not sold at the year end and has Increased in value? What is the rule for reversal of impairment losses for HFS assets? What is special about disposal groups when looking at reversal of impairment losses
 83 aCOWtancy.com Exam Question Page Ghorse identified two manufacturing units, Cee and Gee, which it had decided to dispose of in a single transaction These units comprised non-current assets only One of the units, Cee, had been impaired prior to the financial year end on 30 September 2007 and it had been written down to its recoverable amount of $35 million The criteria in IFRS5, ‘Non-current Assets Held for Sale and Discontinued Operations’, for classification as held for sale, had been met for Cee and Gee at 30 September 2007 The following information related to the assets of the cash generating units at 30 September 2007: Depreciated Historic Cost FV-CTS IFRS Value Cee 50 35 35 Gee 70 90 70 The fair value less costs to sell had risen at the year end to $40 million for Cee and $95 million for Gee The increase in the fair value less costs to sell had not been taken into account by Ghorse Solution The two manufacturing units are deemed to be a disposal group under IFRS5 ‘Non-current Assets Held for Sale and Discontinued Operations’ as the assets are to be disposed of in a single transaction Any impairment loss will reduce the carrying amount of the non-current assets in the disposal group in the order of allocation required by IAS36 ‘Impairment of Assets’ 
 84 aCOWtancy.com Immediately before the initial classification of the asset as held for sale, the carrying amount of the asset will be measured in accordance with applicable IFRSs On classification as held for sale, disposal groups are measured at the lower of carrying amount and fair value less costs to sell Impairment must be considered both at the time of classification as held for sale and subsequently On classification as held for sale, any impairment loss will be based on the difference between the adjusted carrying amounts of the disposal group and fair value less costs to sell Any impairment loss that arises by using the measurement principles in IFRS5 must be recognised in profit or loss (IFRS5 paragraph 20) Thus Ghorse should not increase the value of the disposal group above $105 million at 30 September 2007 as this is the carrying amount of the assets measured in accordance with applicable IFRS immediately before being classified as held for sale (IAS36 and IAS16) After classification as held for sale, the disposal group will remain at this value as this is the lower of the carrying value and fair value less costs to sell, and there is no impairment recorded as the recoverable amount of the disposal group is in excess of the carrying value At a subsequent reporting date the disposal group should be measured at fair value less costs to sell However, IFRS5 (paragraphs 21–22) allows any subsequent increase in fair value less costs to sell to be recognised in profit or loss to the extent that it is not in excess of any impairment loss recognised in accordance with IFRS5 or previously with IAS36 Thus any increase in the fair value less costs to sell can be recognised as follows at 31 
 85 aCOWtancy.com October 2007: $m Fair value less costs to sell – Cee 40 Fair value less costs to sell – Gee 95 This gives a total of 135, compared to the carrying value (105) - meaning a potential increase of 30 However an increase can only be as much as a previous impairment, which only occurred in Cee (50 – 35) 15 Therefore, the carrying value of the disposal group can increase by $15 million and profit or loss can be increased by the same amount, where the fair value rises Thus the value of the disposal group will be $120 million 
 86 aCOWtancy.com Syllabus C2c) Discuss and apply the accounting treatment of investment properties including classification, recognition, measurement and change of use Investment property A building (or land) owned but not used - just an investment The building is not used it just makes cash by: its FV going up (capital appreciation) or from rental income It might not even belong to the entity it could even be just on an operating lease This is still an IP (if the FV model is used) This allows leased land (which is normally an operating lease) to be classified as investment property Land held for indeterminate future use is an investment property where the entity has not decided that it will use the land as owner occupied or for short-term sale Accounting treatment for the Rental Income Add it to the income statement Easy! (Even for a gonk like you!) :p Accounting treatment for the FV increase The difference in FV each year goes to the I/S Double easy - double gonky 87 aCOWtancy.com No depreciation is needed because it's not used :) Give me examples of what can be Investment Properties cowy ok you asked for it: Land held for long-term capital appreciation rather than short-term sale Land held for a currently undetermined future use This basically means they haven't yet decided what to with the land A building owned but leased to a third party under an operating lease A building which is vacant but is held to be leased out under an operating lease Property being constructed or developed for future use as an investment property Ok smarty pants - what ISN'T an Investment property? • Property intended for sale in the ordinary course of business (It's stock!) • Owner-occupied property • Property leased to another entity under a finance lease • Property being constructed for third parties Parts of property These can be investment properties if the different sections can be sold or leased separately Mais oui, monsier/madame For example, company owns a building and uses floors and rents out The latter can be an IP while the rest is treated as normal PPE Can it still be an IAS 40 Investment property if we are involved in the building still by giving services to it? 88 aCOWtancy.com Si Claro hombre/mujer - It´’s still an IAS 40 Investment property if the supply is small and insignificant If it’s a significant part of the deal with the tenant then the property becomes an IAS 16 property What if my subsidiary uses it but I don’t? Right ok - now your questions are getting on my nerves… but still - it’s an IAS 40 Investment property in your own individual accounts - because you personally are not using it However, in the group accounts it´s an IAS 16 property because someone in the group is using it now enough of the questions already get back to facebook When can we bring an Investment Property into the accounts? As with everything else, an investment property should be recognised when: It is probable that the future economic benefits will flow; and The cost of the investment property can be measured reliably Cool - and at how much we show it at initially? Initially measured at cost This includes: 89 aCOWtancy.com Purchase price Directly attributable costs, for example transaction costs (professional fees, property transfer taxes This does not include: Start-up costs Operating losses incurred before the investment property achieves the planned level of occupancy Abnormal amounts of wasted labour, material or other resources incurred in constructing or developing the property NB If the property is held under a lease then you must show it initially at the lower of: • Fair value and • The present value of the minimum lease payments Ok so how we value it after the initial cost? You choose between two models: The IAS 16 cost model The fair value model The policy chosen should be applied consistently to all of the entity’s investment property If the property is held under an operating lease the fair value model must be adopted.
 90 aCOWtancy.com Cost model Basically as per IAS 16 The property is measured at cost less depreciation and impairment losses (the fair value should still be disclosed though) Fair value model All investment properties should be measured at fair value at the end of each reporting period Changes in fair value added to / subtracted from the asset and the other side recognised in the income statement No depreciation is therefore ever recognised Change in use This bit deals with when we decide say to use it as a normal property instead of renting it out or vice-versa etc Examples We occupy and start to use the investment property All owner-occupied property falls under IAS 16 - cost less depreciation and impairment losses If the FV model was being used then the FV at change of use date is the deemed cost for future accounting Start developing an investment property with the intention of selling it when finished The property is to be sold in the normal course of business and should therefore be reclassified as inventory and accounted for under IAS Inventories 91 aCOWtancy.com Start developing an investment property with the intention of letting it out when finished The property should continue to be held as an investment property under IAS 40 We were using the building but now we are going to let it out when finished Transfer to investment properties and account under IAS 40.
 When we transfer it though (if FV model) we revalue it Any revaluation here goes to the Revaluation reserve and OCI as normal (not the income statement as under IAS 40) A property that was originally held as inventory has now been let to a third party Transfer from inventory to investment properties Here when the transfer is made, we revalue (if FV model) to FV and any difference goes to the income statement 92 aCOWtancy.com Review Page How much interest can be capitalised on an asset which takes weeks to build? How much interest can be added to the cost of an asset when using a specific loan How much interest can be added to the cost of an asset when using general funds? What is an Investment Property? How is an IP using the FV model accounted for? Can floor of a building be an IP? 93 aCOWtancy.com Exam Question Page Grange acquired a plot of land on December 2008 in an area where the land is expected to rise significantly in value if plans for regeneration go ahead in the area The land is currently held at cost of $6 million in property, plant and equipment until Grange decides what should be done with the land The market value of the land at 30 November 2009 was $8 million but as at 15 December 2009, this had reduced to $7 million as there was some uncertainty surrounding the viability of the regeneration plan Solution The land should be classified as an investment property Although Grange has not decided what to with the land, it is being held for capital appreciation IAS 40 ‘Investment Property’ states that land held for indeterminate future use is an investment property where the entity has not decided that it will use the land as owner occupied or for short-term sale The fall in value of the investment property after the year-end will not affect its year-end valuation as the uncertainty relating to the regeneration occurred after the year-end Dr Investment property $6 million Cr PPE $6 million Dr Investment property $2 million Cr Profi t or loss $2 million No depreciation will be charged 94 aCOWtancy.com Syllabus C2d) Discuss and apply the accounting treatment of intangible assets including the criteria for recognition and measurement subsequent to acquisition What is an intangible asset What is an Intangible asset? Well, according to IAS 38, it’s an identifiable non-monetary asset without physical substance, such as a licence, patent or trademark The three critical attributes of an intangible asset are: Identifiability Control (power to obtain benefits from the asset) Future economic benefits Whooah there partner, what´s identifiable mean?? Well it just means the asset is one of things: It is SEPARABLE, meaning it can be sold or rented to another party on its own (rather than as part of a business) or It arises from contractual or other legal rights It is the lack of identifiability which prevents internally generated goodwill being recognised It is not separable and does not arise from contractual or other legal rights 95 aCOWtancy.com Examples • Employees can never be recognised as an asset; they are not under the control of the employer, are not separable and not arise from legal rights • A taxi licence can be an intangible asset as they are controlled, can be sold/ exchanged/transferred and arise from a legal right
 (The intangible doesn’t have to be separable AND arise from a legal right, just one or the other is enough).
 96 aCOWtancy.com When can you recognise an IA and for how much? Well it's the old reliably measurable and probable again! In posher terms When it is probable that future economic benefits attributable to the asset will flow to the entity The cost of the asset can be measured reliably So at how much should we show the asset at initially? Well thick pants - it’s obviously brought in at cost!!  Aaarh but what is cost I hear you whisper in my big floppy cow-like ears well it’s Purchase price plus directly attributable costs Remember that directly attributable means costs which otherwise would not have been paid, so often staff costs are excluded Let’s now look at some specific issues that come up often in the exam: • IA acquired as part of a business combination Well this time, the intangible asset (other than goodwill ) should initially be recognised at its fair value If the FV cannot be ascertained then it is not reliably measurable and so cannot be shown in the accounts In this case by not showing it, this means that goodwill becomes higher • Research and Development Costs Research costs are always expensed in the income statement 97 aCOWtancy.com Development costs are capitalised only after technical and commercial feasibility of the asset for sale or use have been established This means that the enterprise must intend and be able to complete the intangible asset and either use it or sell it and be able to demonstrate how the asset will generate future economic benefits If entity cannot distinguish between research and development - treat as research and expense • Research and Development Acquired in a Business Combination Recognised as an asset at cost, even if a component is research Subsequent expenditure on that project is accounted for as any other research and development cost • Internally Generated Brands, Mastheads, Titles, Lists Should not be recognised as assets - expense them as there is no reliable measure • Computer Software If purchased: capitalise as an IA
 Operating system for hardware: include in hardware cost If internally developed: charge to expense until technological feasibility, probable future benefits, intent and ability to use or sell the software, resources to complete the software, and ability to measure cost Always expense the following: Internally generated goodwil Start-up, pre-opening, and pre-operating costs Training cost 98 aCOWtancy.com Advertising and promotional cost, including mail order catalogues Relocation costs
 99 aCOWtancy.com Intangible Assets - Future Measurement So we can use either historic cost or revaluation Historic Cost (and amortise) Generally intangible assets should be amortised over their useful economic life If has a useful economic life Amortise over UEL Residual values should be assumed to be nil, except in the rare circumstances when an active market exists or there is a commitment by a third party to purchase the asset at the end of its useful life If has an indefinite UEL Check for impairment every year There should also be an annual review to see if the indefinite life assessment is still appropriate Revaluation (and amortise) This model can only be adopted if an active market exists for that type of asset Revaluing Intangibles is hard, because there is no physical substance, and so a reliable measure is tricky There MUST be an active market The item MUST be unique
 100 aCOWtancy.com So what’s an ‘active market’? • Firstly I should mention that these are rare, but may exist for certain licences and production quotas • These, though, are markets where the products are unique, always trading and prices available to public Examples where they might exist: Milk quotas Stock exchange seats Taxi medallions These two tests make it very difficult for any intangibles to be revalued so the historic cost choice is by far the most common If the revaluation model is adopted, revaluation surpluses and deficits are accounted for in the same way as those for PPE
 101 aCOWtancy.com Research and development Research is expensed, Development is often an asset Research Research is investigation to get new knowledge and understanding All goes to I/S Development Under IAS 38, an intangible asset must demonstrate all of the following criteria: (use pirate as a memory jogger) Probable future economic benefits Intention to complete and use or sell the asset Resources (technical, financial and other resources) are adequate and available
 to complete and use the asset Ability to use or sell the asset Technical feasibility of completing the intangible asset (so that it will be available
 for use or sale) Expenditure can be measured reliably Once capitalised they should be amortised Amortisation begins when commercial production has commenced.
 102 aCOWtancy.com Once capitalised they should be amortised The cost of the development expenditure should be amortised over the useful life.   Therefore, the cost of the development expenditure is matched against the revenue it produces Amortisation must only begin when the asset is available for use (hence matching the income and expenditure to the period in which it relates) It is an expense in the income statement: Dr Amortisation expense (I/S)
 Cr Accumulated amortisation (SFP) It must be reviewed at the year-end to check it still is an asset and not an expense If the criteria are no longer met, then the previously capitalised costs must be written off to the statement of profit or loss immediately 103 aCOWtancy.com Review Page What does identifiable mean? What happens if an IA is bought as part of a subsidiary, but its value cannot be measured reliably? When acquiring a sub which has some research costs - how are these treated in the group accounts initially? What options are available for the accounting treatment of Intangibles? Which option is rare and why? Should all intangibles be amortised? 104 aCOWtancy.com Exam Question Page H is acquiring S S has several marketing-related intangible assets that are used primarily in marketing or promotion of its products These include trade names, internet domain names and non-competition agreements These are not currently recognised in S’s financial statements How should these be treated? Solution Intangible assets should be recognised on acquisition under IFRS3 (Revised) These include trade names, domain names, and non-competition agreements Thus these assets will be recognised and goodwill effectively reduced 105 aCOWtancy.com Review Page Where you put income from a revenue grant? What are the choices for a capital grant? What if the grant is for land? 106 aCOWtancy.com Exam Question Page Norman has obtained a significant amount of grant income for the development of hotels in Europe The grants have been received from government bodies and relate to the size of the hotel which has been built by the grant assistance The intention of the grant income was to create jobs in areas where there was significant unemployment The grants received of $70 million will have to be repaid if the cost of building the hotels is less than $500 million (4 marks) Solution The accruals concept is used by the standard to match the grant received with the related costs The relationship between the grant and the related expenditure is the key to establishing the accounting treatment Grants should not be recognised until there is reasonable assurance that the company can comply with the conditions relating to their receipt and the grant will be received Provision should be made if it appears that the grant may have to be repaid There may be difficulties of matching costs and revenues when the terms of the grant not specify precisely the expense towards which the grant contributes In this case the grant appears to relate to both the building of hotels and the creation of employment However, if the grant was related to revenue expenditure, then the terms would have been related to payroll or a fixed amount per job created Hence it would appear that the grant is capital based and should be matched against the depreciation of the hotels by using a 
 107 aCOWtancy.com deferred income approach or deducting the grant from the carrying value of the asset (IAS20) Additionally the grant is only to be repaid if the cost of the hotel is less than $500 million which itself would seem to indicate that the grant is capital based If the company feels that the cost will not reach $500 million, a provision should be made for the estimated liability if the grant has been recognised 108 aCOWtancy.com Syllabus C2e) Discuss and apply the accounting treatment for borrowing costs Borrowing Costs Let’s say you need to get a loan to construct the asset of your dreams - well the interest on the loan then is a directly attributable cost So instead of taking interest to the I/S as an expense you add it to the cost of the asset. (in other words - you capitalise it) There are scenarios here to worry about: You use current borrowings to pay for the asset You get a specific loan for the asset 1) Use current borrowings This is looking at the scenario where we use funds we have already borrowed from different sources So, if the funds are borrowed generally – we need to calculate the weighted average cost of all the loans we have generally (I know you're thinking - how the cowing'eck I work out the weighted average of borrowings aaarrgghh!) Well relax my little monkey armpit - here's how you it: Step 1: Calculate the total amount of borrowings Step 2: Calculate the interest payable on these in total Step 3: Weighted average  of borrowing costs = Divide the interest by the borrowing et voila! 109 aCOWtancy.com Step 4: We then take this weighted average of borrowing costs and multiply it by any expenditure on the asset The amount capitalised should not exceed total borrowing costs incurred in the period Illustration 5% Overdraft 1,000
 8% Loan 3,000
 10% Loan 2,000 We buy an asset with a cost of 5,000 and it takes one year to build - how much interest goes to the cost of the asset? Solution Calculate the WA cost of the borrowings: Step 1: Total Borrowing = (1,000+3,000+2,000) = 6,000 Step 2: Interest payable = (50+240+200) = 490 Step 3: 490/6,000 = 8.17% Step 4: So the total interest to be added to the asset is 8.17% x 5,000 = 408 2) Get a specific loan Ok well you would think this is easy - just the interest paid, surely?! But it’s not quite that easy… It is the actual borrowing costs less investment income on any temporary investment of the funds So what does this mean exactly? Well imagine you need 10,000 to build something over years You borrow 10,000 at the start but don’t need it all straight away So the bit you don’t need you leave in the bank to gain interest 110 aCOWtancy.com So, the amount you could capitalise would be the interest paid on the 10,000 less the interest received on the amount not used and left in the bank (or reinvested elsewhere) Steps: Calculate the interest paid on the specific loan Calculate any interest received on loans proceeds not used Add the net of these to 'cost of the asset’ Illustration Buy asset for 2,000 - takes years to build Get a 2,000 10% loan We reinvest any money not used in an 8% deposit account. 
 In year we spend 1,200 How much interest is added to the cost of the asset? Interest Paid = 2,000 x 10% = 200 Interest received = ((2,000-1,200) x 8%) = 64 Dr  PPE Cost (200-64) = 136
 Cr  Interest Accrual Basic Idea Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset form part of the cost of that asset Other borrowing costs are recognised as an expense So what is a “Qualifying asset?” It is one which needs a substantial amount of time to get ready for use or sale 111 aCOWtancy.com This means it can’t be anything that is available for use when you buy it It has to take quite a while to build (PPE, Investment Properties, Inventories and Intangibles) You don’t have to add the interest to the cost of the following assets: Assets measured at fair value, Inventories that are manufactured or produced in large quantities on a repetitive basis even if they take a substantial period of time to get ready for use or sale When should we start adding the interest to the cost of the asset? Capitalisation starts when all three of the following conditions are met: Expenditure begins for the asset Borrowing costs begin on the loan Activities begin on building the asset e.g Plans drawn up, getting planning etc So just having an asset for development without anything happening is not enough to qualify for capitalisation Are borrowing costs just interest? It’s actually any costs that an entity incurs in connection with the borrowing of funds So it includes: Interest expense calculated using the effective interest method Finance charges in respect of finance leases What about if the activities stop temporarily? Well you should stop capitalising when activities stop for an extended period During this time borrowing costs go to the profit or loss 112 aCOWtancy.com Be careful though - If the temporary delay is a necessary part of the construction process then you can still capitalise, e.g Bank holidays etc When will capitalisation stop? Well, when virtually all the activities work is complete This means up to the point when just the finalising touches are left NB • Stop capitalising when AVAILABLE for use This tends to be when the construction is finished • If the asset is completed in parts then the interest capitalisation is stopped on the completion of each part • If the part can only be sold when all the other parts have been completed, then stop capitalising when the last part is completed
 113 aCOWtancy.com Syllabus C3 Financial Instruments Syllabus C3a) Discuss and apply the initial recognition and measurement of financial instruments Financial Instruments - Introduction Ok, ok, relax at the back - this is not as bad as it seems… trust me Definition • First of all it must be a contract • Then it must create a financial asset in one entity and a financial liability or equity instrument in another Examples:
 An obvious example is a trade receivable There is a contract, one company has the debt as a financial asset and the other as a liability Other examples:
 Cash, investments, trade payables and loans… And the trickier stuff… It also applies to derivatives financial such as call and put options, forwards, futures, and swaps 114 aCOWtancy.com And the just plain weird… It also applies to some contracts that not meet the definition of a financial instrument, but have characteristics similar to derivative financial instruments Such as precious metals at a future date when the following applies: The contract is subject to possible settlement in cash NET rather than by delivering the precious metal The purchase of the precious metal was not normal for the entity The trick in the exam is to look for contracts which state “will NOT be delivered” or “can be settled net” - these are almost always financial instruments The following are NOT financial instruments: • Anything without a contract
 e.g Prepayments • Anything not involving the transfer of a financial asset
 e.g Deferred income and Warranties Recognition The important thing to understand here is that you bring a FI into the accounts when you enter into the contract NOT when the contract is settled Therefore derivatives are recognised initially even if nothing is paid for it initially • Substance over form Form (legally) means a preference share is a share and so part of equity HOWEVER, a substance over form model is applied to debt/equity classification Any item with an obligation, such as redeemable preference shares, will be shown as liabilities.
 115 aCOWtancy.com De-recognition This basically means when to get rid of it / take it out of the accounts • So you should this when: The contractual rights you used to have have expired/gone For Example You sell an asset and its benefits now go to someone else (no conditions attached) • You DON’T de-recognise when You sell an asset but agree to buy it back later (this means you still have an interest in the risk and rewards later) The difference between equity and liabilities IAS 32 Financial Instruments: Presentation establishes principles for presenting financial instruments as liabilities or equity • IAS 32 does not classify a financial instrument as equity or financial liability on the basis of its legal form but the substance of the transaction The key feature of a financial liability is that the issuer is obliged to deliver either cash or another financial asset to the holder An obligation may arise from a requirement to repay principal or interest or dividends 116 aCOWtancy.com The key feature of an Equity has a residual interest in the entity’s assets after deducting all of its liabilities • An equity instrument includes no obligation to deliver cash or another financial asset to another entity • A contract which will be settled by the entity receiving or delivering a fixed number of its own equity instruments in exchange for a fixed amount of cash or another financial asset is an equity instrument • However, if there is any variability in the amount of cash or own equity instruments which will be delivered or received, then such a contract is a financial asset or liability as applicable An accounting treatment of the contingent payments on acquisition of the NCI in a subsidiary • IAS 32 states that a contingent obligation to pay cash which is outside the control of both parties to a contract meets the definition of a financial liability which shall be initially measured at fair value 117 aCOWtancy.com Syllabus C3b) Discuss and apply the subsequent measurement of financial assets and financial liabilities Financial liabilities - Categories There's only categories, FVTPL and Amortised cost Yay! Right-y-o, we’ve looked at recognising (bring into the accounts for those of you who are a sandwich short of a picnic*) - now we want to look at HOW MUCH to bring the liabilities in at *A quaint old English saying - meaning you're an idiot :p Basically there are categories of Financial Liability… Fair Value Through Profit and Loss (FVTPL) This includes financial liabilities incurred for trading purposes and also derivatives Amortised Cost If financial liabilities are not measured at FVTPL, they are measured at amortised cost The good news is that whatever the category the financial liability falls into - we always recognise it at Fair Value INITIALLY It is how we treat them afterwards where the category matters (and remember here we are just dealing with the initial measurement).
 118 aCOWtancy.com Accounting Treatment of Financial Liabilities (Overview) Initially At Year-End Any gain/loss FVTPL Fair Value Fair Value Income Statement Amortised Cost Fair Value Amortised Cost So - the question is - how you measure the FV of a loan?? All you is those steps: STEP 1: Take all your actual future cash payments STEP 2: Discount them down at the market rate 
 If the market rate is the same as the rate you actually pay (effective rate) then this is no problem and you don’t really have to follow those steps as you will just come back to the capital amount…let me explain 10% 1,000 Payable Loan years
   Capital  1,000 x 0.751 = 751 Interest 100 x 2.486 = 249 Total 1,000 
 So the conclusion is - WHERE THE EFFECTIVE RATE YOU PAY (10%) IS THE SAME AS THE MARKET RATE (10%) THEN THE FV IS THE PRINCIPAL - so no need to the steps Always presume the market rate is the same as the effective rate you’re paying unless told otherwise by El Examinero.
 119 aCOWtancy.com Possible Naughty Bits Premium on redemption This is just another way of paying interest Except you pay it at the end (on redemption) e.g 4% 1,000 payable loan - with a 10% premium on redemption This means that the EFFECTIVE interest rate (the rate we actually pay) is more than 4% - because we haven’t yet taken into account the extra 100 (10% x 1,000) payable at the end So the examiner will tell you what the effective rate actually is - let’s say 8% The crucial point here is that you presume the effective rate (e.g 8%) is the same as the market rate (8%) so the initial FV is still 1,000 Discount on Issue Exactly the same as above - it is just another way of paying interest - except this time you pay it at the start e.g 4% 1,000 payable loan with a 5% discount on issue So again the interest rate is not 4%, because it ignores the extra interest you pay at the beginning of 50 (5% x 1,000) So the effective rate (the rate you actually pay) is let’s say 7% (will be given in the exam) The crucial point here is that the discount is paid immediately So, although you presume that the effective rate (7%) is the same as the market rate (7% say), the INITIAL FV of the loan was 1,000 but is immediately reduced by the 50 discount - so is actually 950 NB You still pay interest of 4% x 1,000 not 4% x 950
 120 aCOWtancy.com Financial Liabilities - Amortised Cost So, we’ve just looked at initial measurement (at FV), now let’s look at how we measure it from then onwards This is where the categories of financial liabilities are important - so let’s remind ourselves what they are: Initially At Year-End Any gain/loss FVTPL Fair Value Fair Value Income Statement Amortised Cost Fair Value Amortised Cost So you only have rules to remember - cool… FVTPL - simple just keep the item at its FV (remember this is those steps) and put the difference to the income statement Amortised Cost - Amortised Cost is the measurement once the initial measurement at FV is done Amortised Cost This is simply spreading ALL interest over the length of the loan by charging the effective interest rate to the income statement each year If there’s nothing strange (premiums etc) then this is simple For example: 10% 1,000 Payable Loan Opening Interest to I/S 1,000 1,000 x 10% = 100 121 Interest actually Paid (100) Closing Loan on SFP 1,000 aCOWtancy.com Now let’s make it trickier
 
 10% 1,000 Loan with a 10% premium on redemption Effective rate is 12% Opening Interest to I/S Interest actually Paid 1,000 1,000 x 12% = 120 Closing Loan on SFP (100) 1,020 
 So in year the income statement would show an interest charge of 120 and the loan would be under liabilities on the SFP at 1,020 This SFP figure will keep on increasing until the end of the loan where it will equal the Loan + premium on redemption And trickier still…
 
 10% 1,000 loan with a 10% discount on issue Effective rate is 12% Opening Interest to I/S Interest actually Paid 1,000 - (10% x 1,000) = 900 900 x 12%= 108 Closing Loan on SFP (100) 908 IFRS requires FVTPL gains and losses on financial liabilities to be split into: The gain/loss attributable to changes in the credit risk of the liability (to be placed in OCI) The remaining amount of change in the fair value of the liability which shall be presented in profit or loss The new guidance allows the recognition of the full amount of change in the FVTPL only if the recognition of changes in the liability's credit risk in OCI would create or enlarge an accounting mismatch in P&L Amounts presented in OCI shall not be subsequently transferred to P&L, the entity may only transfer the cumulative gain or loss within equity 122 aCOWtancy.com Financial Liabilities - convertible loans When we recognise a financial instruments we look at substance rather than form Anything with an obligation is a liability (debt) However we now have a problem when we consider convertible payable loans The ‘convertible’ bit means that the company may not have to pay the bank back with cash, but perhaps shares So is this an obligation to pay cash (debt) or an equity instrument? In fact it is both! It is therefore called a Compound Instrument Convertible Payable Loans These contain both a liability and an equity component so each has to be shown separately • This is best shown by example: 2% Convertible Payable Loan €1,000 • This basically means the company has offered the bank the option to convert the loan at the end into shares instead of simply taking €1,000 • The important thing to notice is that that the bank has the option to this • Should the share price not prove favourable then it will simply take the €1,000 as normal 123 aCOWtancy.com Features of a convertible payable loan Better Interest rate The bank likes to have the option Therefore, in return, it will offer the company a favourable interest rate compared to normal loans Higher Fair Value of loan This lower interest rate has effectively increased the fair value of the loan to the company (we all like to pay less interest ;-)) We need to show all payable loans at their fair value at the beginning Lower loan figure in SFP Important: If the fair value of a liability has increased the amount payable (liability) shown in the accounts will be lower After all, fair value increases are good news and we all prefer lower liabilities! How to Calculate the Fair Value of a Loan So how is this new fair value, that we need at the start of the loan, calculated? Well it is basically the present value of its future cashflows… • Step 1: Take what is actually paid (The actual cashflows): Capital €1,000
 Interest (2%)  €20 pa Now let’s suppose this is a year loan and that normal (non-convertible) loans carry an interest rate of 5% 124 aCOWtancy.com • Step 2: Discount the payments in step at the market rate for normal loans (Get the cashflows PV) Take what the company pays and discount them using the figures above as follows: Capital €1,000 discounted @ 5% (4 years SINGLE discount figure) = 1,000 x 0.823 = 823 Interest €20   discounted @ 5% (4 years CUMULATIVE)= 20 x 3.465 = 69 Total = 892
  
 This €892 represents the fair value of the loan and this is the figure we use in the balance sheet initially The remaining €108 (1,000-892) goes to equity Dr Cash 1,000
 Cr Loan 892
 Cr Equity 108 • Next we need to perform amortised cost on the loan (the equity is left untouched throughout the rest of the loan period) The interest figure in the amortised cost table will be the normal non-convertible rate and the paid will the amounts actually paid The closing figure is the SFP figure each year Opening Interest Payment Closing 892 892 x 5% = 45 (1,000 x 2% = 20) 892 + 45 - 20 = 917 917 917 x 5% = 46 (1,000 x 2% = 20) 917 + 46 - 20 = 943 943 48 (1,000 x 2% = 20) 971 971 49 (1,000 x 2% = 20) 1,000 Now at the end of the loan, the bank decide whether they should take the shares or receive 1,000 cash… 125 aCOWtancy.com Option 1: Take Shares (lets say 400 ($1) shares with a MV of $3) Dr Loan 1,000
 Dr Equity 108
 Cr Share Capital 400
 Cr Share premium 708 (balancing figure) Option 2: Take the Cash Dr Loan 1,000
 Cr Cash 1,000 Dr Equity 108
 Cr Income Statement 108 Conclusion When you see a convertible loan all you need to is take the capital and interest PAYABLE Then discount these figures down at the rate used for other non convertible loans The resulting figure is the fair value of the convertible loan and the remainder sits in equity You then perform amortised cost on the opening figure of the loan Nothing happens to the figure in equity 126 aCOWtancy.com Convertible Payable Loan with transaction costs - eek! Ok well remember our step process for dealing with a normal convertible loan? Step 1) Write down the capital and interest to be PAID Step 2) Discount these down at the interest rate for a normal non-convertible loan Then the total will be the FV of the loan and the remainder just goes to equity Remember we this at the start of the loan ONLY Right then let’s now deal with transaction or issue costs These are paid at the start Normally you simply just reduce the Loan amount with the full transaction costs However, here we will have a loan and equity - so we split the transaction costs prorata I know, I know - you want an example… boy, you’re slow - lucky you’re gorgeous e.g. 4% 1,000 yr Convertible Loan. 
 Transaction costs of £100 also to be paid. 
 Non convertible loan rate 10% Step and Capital 1,000 x 0.751 = 751
 Interest 40 x 2.486 = 99 (ish)
 Total = 850 So FV of loan = 850, Equity = 150 (1,000-850) Now the transaction costs (100) need to be deducted from these amounts pro-rata So Loan = (850-85) = 765
 Equity (150-15) = 135 127 aCOWtancy.com Financial Assets - Initial Measurement There are categories to remember: Category Initial Measurement Year-end Measurement Difference goes where? FVTPL FV FV Profit and Loss FVTOCI FV FV OCI Amortised Cost FV Amortised Cost - Financial assets that are Equity Instruments e.g Shares in another company These are easy - Just categories • FVTPL = Fair Value through Profit & Loss These are Equity instruments (shares) Held for trading Normally, equity investments (shares in another company) are measured at FV in the SFP, with value changes recognised in P&L Except for those equity investments for which the entity has elected to report value changes in OCI • FVTOCI = Fair Value through Other Comprehensive Income These are Equity instruments (shares) Held for longer term • NB The choice of these is made at the beginning and cannot be changed afterwards There is NO reclassification on de-recognition
 128 aCOWtancy.com Financial Assets (FA) that are Receivable Loans There are basically types: Fair Value Through Profit & Loss (FVTPL) A receivable loan where capital and interest aren’t the only cashflows (see CF test below) FVTOCI Receivable loans where the cashflows are capital and interest only BUT the business model is also to sell these loans (see Business model test below) Amortised Cost A FA that meets the following conditions can be measured at amortised cost: Business model test: Do we normally keep our receivable loans until the end rather than sell them on? Cashflows test Are the ONLY cashflows coming in capital and interest? So what sort of things go into the FVTPL category? If one of the tests above are not passed then they are deemed to fall into the FVTPL category This will include anything held for trading and derivatives INITIAL measurement Good news! Initially both are measured at FV Easy peasy to remember The FV is calculated, as usual, as all cash inflows discounted down at the market rate.
 129 aCOWtancy.com FVTPL can be: Equity items held for trading purposes Equity items not held for trading (but OCI option not chosen) A receivable loan where capital and interest aren’t the only cashflows Derivative assets are always treated as held for trading Initial recognition of trade receivables Trade receivables without a significant financing component Use the transaction price from IFRS 15 Trade receivables with a significant financing component IFRS does not exempt a trade receivable with a significant financing component from being measured at fair value on initial recognition Therefore, differences may arise between the initial amount of revenue recognised in accordance with IFRS 15 – and the fair value needed here in IFRS Any difference is presented as an expense FVTOCI - Receivable loans held for cash and selling Interest revenue, credit impairment and foreign exchange gain or loss recognised in P&L (in the same manner as for amortised cost assets) Other gains and losses recognised in OCI On de-recognition, the cumulative gain or loss previously recognised in OCI is reclassified from equity to profit or loss
 130 aCOWtancy.com Financial assets - Accounting Treatment So we have these categories Category Initial Measurement Year-end Measurement Difference goes where? FVTPL FV FV Profit and Loss FVTOCI FV FV OCI Amortised Cost FV Amortised Cost - Initially both are measured at FV Now let's look at what happens at the year-end FVTPL accounting treatment Revalue to FV Difference to I/S FVTOCI accounting treatment Revalue to FV Difference to OCI Amortised cost accounting treatment Re-calculate using the amortised cost table An Example: 8% 100 receivable loan (effective rate 10% due to a premium on redemption)
 131 aCOWtancy.com Amortised Cost Table  Opening Balance Interest (effective rate) (Cash Received) Closing balance 100 10 (8) 102 The interest (10) is always the effective rate and this is the figure that goes to the income statement The receipt (8) is always the cash received and this is not shown in the income statement - it just decreases the carrying amount Any expected credit losses and forex gains/losses all go to I/S 132 aCOWtancy.com Financial Assets - Convertible loan Compound instruments (Convertible loans) Be careful here as these are treated differently according to whether they are receivable loans (assets) or payable loans (liabilities) This is because, if you remember, the amortised cost category for financial assets has tests, whereas the amortised cost category for liabilities does not have any The tests for placing a financial asset into the amortised cost category are: Business model test - we intend to keep (not sell) the loan presumably we hold until the end and not sell it - so yes that test is passed Cashflow test - Are the cash receipts capital and interest only? No - There is the potential issue of shares that we may ask for instead of the capital back For a receivable convertible loan - it fails the cashflow test - as one receipt may be shares and not just capital and interest Therefore a receivable convertible loan cannot be amortised cost and so is a FVTPL item Type Category Receivable Convertible Loan FVTPL Accounting Treatment FVTPL 133 Initial Year End FV FV aCOWtancy.com An Example: 2% Convertible Loan €1,000, a year loan You are also told the non-convertible interest rates are as follows: Start: 5%
 End of year 1: 6%
 End of year 2: 7%
 End of year 3: 8% • As in the payable we need to calculate FV initially We did this and it came to 892 • Then we perform amortised cost BUT also adjust to FV each year end as this a FVTPL item Here’s a reminder of what we had before (but with a new FV adj column added Opening Interest Payment FV adj Closing 892 45 -20 917 917 46 -20 943 943 48 -20 971 971 49 -20 1,000 So we need to change the closing figures (and hence opening next year) to the new FV at each year end Calculating the FV of a loan is the same as before • Step 1: Take all the CASH payments (capital and interest) • Step 2: Discount them down at the MARKET rate • FV at end of year 1
 Capital discounted = 1,000 / 1.06^3 (3 years away only now) = 840
 Interest = 20pa for years @ 6% = 20 x 2.673 = 53
 Total = 893
 134 aCOWtancy.com • FV at end of year 2
 Capital discounted = 1,000 / 1.07^2 (2 years away only now) = 873
 Interest = 20pa for years @ 7% = 20 x 1.808 = 36
 Total = 909 • FV at end of year 3
 Capital discounted = 1,000 / 1.08 (1 year away only now) = 926
 Interest = 20pa for year @ 8% = 20 x 0.926 = 19
 Total = 945 So the table now becomes Opening Interest Payment FV adj Closing 892 45 -20 -24 917 893 46 -20 -10 943 909 48 -20 +8 971 945 49 -20 +26 1,000 Remember interest goes to the income statement as does the FV adjustment also The closing figure is the SFP receivable loan amount
 135 aCOWtancy.com Financial Instruments - Transactions costs Transaction Costs There will usually be brokers’ fees etc to pay and how you deal with these depends on the category of the financial instrument For FVTPL - these go to the income statement For everything else they get added/deducted to the opening balance So if it is an asset - it will increase the opening balance If it is a liability - it will decrease the opening balance 
 Nb If a company issues its own shares, the transaction costs are debited to share premium Illustration A debt security that is held for trading is purchased for 10,000 Transaction costs are 500 The initial value is 10,000 and the transaction costs of 500 are expensed Illustration A receivable bond is purchased for £10,000 and transaction costs are £500 The initial carrying amount is £10,500 Illustration A payable bond is issued for £10,000 and transaction costs are £500 The initial carrying amount is £9,500.
 136 aCOWtancy.com Note: With the amortised cost categories, the transaction costs are effectively being spread over the length of the loan by using an effective interest rate which INCLUDES these transaction costs Illustration: Transaction costs An entity acquires a financial asset for its offer price of £100 (bid price £98) IFRS treats the bid-offer spread as a transaction cost: If the asset is FVTPL The transaction cost of £2 is recognised as an expense in profit or loss and the financial asset initially recognised at the bid price of £98 If the asset is classified as amortised cost The transaction cost should be added to the fair value and the financial asset initially recognised at the offer price (the price actually paid) of £100 Treasury shares It is becoming increasingly popular for companies to buy back shares as another way of giving a dividend Such shares are then called treasury shares Accounting Treatment Deduct from equity No gain or loss shown, even on subsequent sale Consideration paid or received goes to equity
 137 aCOWtancy.com Illustration Company buys back 10,000 (£1) shares for £2 per share They were originally issued for £1.20 Dr RE 20,000 Cr Cash 20,000 The original share capital and share premium stays the same, just as it would have done if they had been bought by a different third party 138 aCOWtancy.com Syllabus C3c) Discuss and apply the derecognition of financial assets and financial liabilities De-recognition of Financial Instruments De-recognition of Financial Assets De-recognition of a financial asset occurs where: The contractual rights to the cash flows of the financial asset have expired (debtor pays), or The financial asset has been transferred (e.g., sold) including the risks and rewards Illustration A company sells an investment in shares, but retains the right to repurchase the shares at any time at a price equal to their current fair value The company should de-recognise the asset Illustration A company sells an investment in shares and enters into an agreement whereby the buyer will return any increases in value to the company and the company will pay the buyer interest plus compensation for any decrease in the value of the investment The company should not de-recognise the investment as it has retained substantially all the risks and rewards Financial Liability De-recognition The risks and rewards transfer does not apply for financial liabilities Rather, the focus is on whether the financial liability has been extinguished 139 aCOWtancy.com Syllabus C3d) Discuss and apply the reclassification of financial assets The Reclassification Of Financial Assets Re-classifying between FVTPL, FVTOCI and Amortised cost ONLY if Financial assets business objective changes Do not restate any previously recognised gains / losses How to Re-classify • Prospectively from the reclassification date NEVER RECLASSIFY • FVTOCI equity Investments Accounting for the Re-Classification On derecognition of a financial asset in its entirety, the difference between: (a) The carrying amount (measured at the date of derecognition); and (b) The consideration received is recognised in profit or loss (IFRS 9: para 3.2.12) For investments in debt held at fair value through other comprehensive income, on derecognition, the cumulative revaluation gain or loss previously recognised in other comprehensive income is reclassified to profit or loss (IFRS 9: para 5.7.10) Equity FVTOCI de-recognised There should be no gain / loss as FV will be up to date (and therefore the same as the amount sold for) and the gains \ losses will already be in OCI These are NOT reclassified to I/S 140 aCOWtancy.com Debt FVTOCI de-recognised The same applies except .The cumulative revaluation gain or loss previously recognised in OCI is reclassified to profit or loss
 141 aCOWtancy.com Syllabus C3e) Account for derivative financial instruments, and simple embedded derivatives Embedded derivatives Normal derivatives (not used for hedging) are simply treated as FVTPL Embedded Derivatives Sometimes a seemingly normal contract has terms which make the cashflows act like a derivative We call this an embedded derivative Such a contract then has elements: 1) A host contract and  2) An embedded derivative The accounting treatment generally is to take out the embedded derivative and treat it as a FVTPL Illustration A company borrows some money and agrees to pay back interest that is linked to the price of gold • Now there is clearly a derivative here (based on the price of gold) alongside a loan • Therefore we need to take out the embedded derivative (as the economic characteristics of gold are not the same as interest) and treat it as FVTPL Sometimes we don't take out the embedded derivative: when • The embedded derivative's risks are closely related to those of the host contract
 Eg An oil contract between two companies reporting in €, but priced in $.
 142 aCOWtancy.com The 'derivative' element is a normal feature of the contract (as oil is priced in $) so not really a derivative • The combined instrument is measured at FVTPL anyway (so no need to split) • The host contract is a financial asset anyway (so no need to split) • The embedded derivative significantly modifies the cash flows of the contract.
 If the derivative element changes the cash flows so much, then the whole instrument should be measured at FVTPL (due to the risk involved)
 143 aCOWtancy.com Syllabus C3f) Outline and apply the qualifying criteria for hedge accounting and account for fair value hedges and cash flow hedges including hedge effectiveness Hedging Hedging is all about matching Objective To manage risk companies often enter into derivative contracts • e.g Company buys wheat - so it is worried about the price of wheat rising (risk) • To manage this risk it buys a wheat derivative that gains in value as the price of wheat goes up • Therefore any price increase (hedged item) will be offset by the derivative gains (hedging item)
 So, the basic idea of hedge accounting is to represent the effect of an entity’s risk management activities IFRS changes • IFRS has made hedge accounting more principles based to allow for effective risk management to be better shown in the accounts • It has also allowed more things to be hedged, including non-financial items • It has allowed more things to be hedging items also - options and forwards • There also used to be a concept of hedge effectiveness which needed to be tested annually to see if hedge accounting could continue - this has now been stopped. 
 Now if its a hedge at the start it remains so and if it ends up a bad hedge well the FS will show this 144 aCOWtancy.com Accounting Concept The idea behind hedge accounting is that gains and losses on the hedging instrument and the hedged item are recognised in the same period in the income statement  It is a choice - it doesn’t have to be applied There are types of hedge: Fair value hedges
 Here we are worried about an item losing fair value (not cash). 
 For example you have to pay a fixed rate loan of 6% If the variable rate drops to 4% your loan has lost value If the variable rate rises to 8%, then you have gained in fair vale
 Notice you still pay 6% in both scenarios - so the risk isn’t cashflow - it is fair value Cash flow hedges
 Here we are worried about losing cash on the item at some stage in the future
 For example, you agree to buy an item in a foreign currency at a later date If the rate moves against you, you will lose cash Hedges of a net investment in a foreign operation
 This applies to an entity that hedges the foreign currency risk arising from its net investments in foreign operations Hedged items The hedged item is the item you’re worried about - the one which has risk (which needs managing) A hedged item can be: • A recognised asset or liability (financial or not) • An unrecognised commitment • A highly probable forecast transaction • A net investment in a foreign operation 145 aCOWtancy.com They must all be separately identifiable, reliably measurable and the forecast transaction must be highly probable When can we use hedge accounting? The hedge must meet all of the following criteria: (replacing the old 80-125% criteria) • An economic relationship exists between the hedged item and the hedging instrument – meaning as one goes up in FV the other will go down
 For example, a UK company selling to US customers - enters into a $100 to £ futures contract which ends when the UK company is expected to receive $100
 Here - the future $ receipt will be the hedged item and the futures contract the hedging item 
 In the above example it is an obvious economic relationship as it’s the same amount and same timing
 However, sometimes the amounts and timings won’t be the same so you may use judgement as to whether this is actually a proper hedge or not - here numbers could be used • Credit risk doesn’t dominate the fair value changes 
 So, after having established an economic relationship (above) - IFRS just wants to make sure that any credit risk to the hedged or hedging item wont affect it so much as to destroy the relationship Accounting treatment • Fair Value Hedges
 Gains and losses of both the Hedged and Hedging item are recognised in the current period in the income statement • Cashflow hedges
 Here the hedged item has not yet made its gain or loss (it will be made in the future e.g Forex)
 146 aCOWtancy.com So, in order to match against the hedged item when it eventually makes its gain or loss, the “effective” changes in fair value of the hedging instrument are deferred in reserves (any ineffective changes go straight to the income statement)
 These deferred gains/losses are then taken from reserves/OCI and to the income statement when the hedged item eventually makes its gain or loss • Hedges of a net investment in a foreign entity
 Same as cash-flow, changes in fair value of the hedging instrument are deferred in reserves/OCI 
 Normally individual company forex gains/losses are taken to the income statement and foreign subsidiary retranslation gains/losses taken to the OCI/Reserves.
 So, lets say a UK holding company has a UK subsid and a Maltese subsid The Malta sub also has loaned the UK sub some cash in Euros.
 Normally the UK sub would retranslate this loan and put the difference to the income statement Also the Maltese sub is retranslated and the difference taken to OCI Here, it is allowed for the UK sub to hold the translation losses also is reserves (like a cashflow hedge) as long as the loan is not larger than the net investment in the Maltese sub Special cases of hedging items which reduce P&L Volatility Options - time value element when intrinsic value of option is the designated hedging item
 If the hedging item is an option - then the time value changes in that option will be taken to the OCI (and equity)
 When the hedged item is realised, these then get reclassified to P&L Forward points - when the spot element of a forward contract is the designated hedging item
 If the hedging item is a forward contract then the forward points FV changes MAY be taken to OCI, and again gets reclassified when the hedged item hits the I/S Currency basis risk 
 The spread from this can be eliminated from the hedge - and instead either be valued as FVTPL or FVTOCI(with reclassification)
 147 aCOWtancy.com Illustration of a FV Hedge 5% 100,000 fixed rate year Receivable loan (Current variable rates 5%).
 Here we are worried that variable rates may rise above this - if they did then the FV of this receivable would worsen.  So we would have a FV loss.  If the variable rates go lower, then we are happy (as we are receiving a fixed rate) and so the FV would improve This company hedges against the variable rates going down - by entering into a variable rate swap (This is the hedging item) With this derivative, if variable rates rise we will benefit from receiving more but the FV of our fixed rate receivable loan will have lowered.  These should cancel themselves out Market interest rates then increase to 6%, so that the fair value of the fixed rate bond has decreased to $96,535.  As the bond is classified as a hedged item in a fair value hedge, the change in fair value of the bond is instead recognised in profit or loss: At the same time, the company determines that the fair value of the swap has increased by $3,465 to $3,465.
 148 aCOWtancy.com Since the swap is a derivative, it is measured at fair value with changes in fair value recognised in profit or loss Therefore, Entity A makes this journal entry: Since the changes in fair value of the hedged item and the hedging instrument exactly offset, the hedge is 100% effective, and the net effect on profit or loss is zero Illustration Cashflow Hedge Company has the euro as its functional currency It will buy an asset for $20,000 next year It enters into a forward contract to purchase $20,000 a year´s time for a fixed amount (10,000) Half way through the year (the company’s Year-end)  the dollar has appreciated, so that $20,000 for delivery next year now costs 12,000 on the market Therefore, the forward contract has increased in fair value to 2,000 Solution When the company comes to pay for the asset, the dollar rate has further increased, such that $20,000 costs 14,000 in the spot market Therefore, the fair value of the forward contract has increased to 4,000 149 aCOWtancy.com The forward contract is settled: The asset is purchased for $10,000 (14,000): The deferred gain left in equity of 4,000 should either Remain in equity and be released from equity as the asset is depreciated or Be deducted from the initial carrying amount of the machine.
 150 aCOWtancy.com Syllabus C3g) Discuss and apply the general approach to impairment of financial instruments including the basis for estimating expected credit losses Syllabus C3h) Discuss the implications of a significant increase in credit risk Impairment of Financial Instruments Expected Credit Loss model This applies to: I II Amortised cost items FVTOCI items How it works Initially you show 12m expected losses Dr Expense  Cr Loss Allowance (This gets shown next to the financial asset - it reduces it) • Then you look to see if there's been a significant increase in credit risk? If so switch from 12m to lifetime expected credit losses • No significant increase in credit risk? Show 12-month expected losses only How you calculate the Expected Credit Loss? Use: a probability-weighted outcome the time value of money the best available forward-looking information Notice the use of forward-looking info - this means judgement is needed - so it will be difficult to compare companies 
 151 aCOWtancy.com Stage - Assets with no significant increase in credit risk For these assets: 1) 12-month expected credit losses (‘ECL’) are recognised and 2) Interest revenue is calculated on the gross carrying amount of the asset (that is, without deduction for credit allowance) 12-month ECL are based on the asset’s entire credit loss but weighted by the probability that the loss will occur within 12 months of the Y/E Stage - Assets with a significant increase in credit risk (but no evidence of impairment) For these assets: 1) Lifetime ECL are recognised 2) Interest revenue is still calculated on the gross carrying amount of the asset Lifetime ECL come from all possible default events over its expected life Expected credit losses are the weighted average credit losses with the probability of default (‘PD’) as the weight.
 152 aCOWtancy.com Stage - Assets with evidence of impairment For these assets: 1) Lifetime ECL are recognised and 2) Interest revenue is calculated on the net carrying amount (that is, net of credit allowance In subsequent reporting periods, if the credit quality improves so there’s no longer a significant increase in credit risk since initial recognition, then the entity reverts to recognising a 12-month ECL allowance Where does the impairment go? The changes in the loss allowance balance are recognised in profit or loss as an impairment gain or loss Collective Basis If the asset is small it’s just not practical to see if there’s been a significant increase in credit risk So, you can assess ECLs on a collective basis, to approximate the result of using comprehensive credit risk information that incorporates forward-looking information at an individual instrument level 
 153 aCOWtancy.com Simplified Approach This means no tracking changes in credit risk! Instead just recognise a loss allowance based on lifetime ECLs at each reporting date, right from origination The simplified approach is for trade receivables, contract assets with no significant financing component, or for contracts with a maturity of one year or less 12-month expected credit losses These are a portion of the lifetime ECLs that are possible within 12 months The portion is weighted by the probability of a default occurring It is not the predicted (probable) defaults in the next 12 months For instance, the probability of default might be only 25%, in which case, this should be used to calculate 12-month ECLs, even though it is not probable that the asset will default Also, the 12-month expected losses are not the cash shortfalls that are predicted over only the next 12 months For a defaulting asset, the lifetime ECLs will normally be significantly greater than just the cash flows that were contractually due in the next 12 months Lifetime expected credit losses These are from all possible default events over the expected life Estimate them based on the present value of all cash shortfalls So, basically, it’s the difference between: • The contractual cash flows And • The cash flows now expected to receive As PV is used, even late (but the same) cashflows create an ECL For a financial guarantee contract, the ECLs would be the PV of what it expects to pay as guarantor less any amounts from the holder
 154 aCOWtancy.com ILLUSTRATION 1: A company has a 5yr 6% receivable loan of $1,000,000 They expect credit losses of $10,000 pa The present value (discounted at 6%) of these lifetime expected credit losses is $42,124 The present value of the 12-month expected credit losses is $9,434 Solution - how to deal with this financial asset • On day Dr Loan receivable $1,000,000 Cr Cash $1,000,000 • End of yr - no significant increase in credit risk - show 12m ECL Dr I/S Impairment loss $9,434 Cr Loss allowance in financial position $9,434 • End of yr - significant increase in credit risk - show re-estimate of lifetime ECL Let’s say the present value of the lifetime expected credit losses is $34,651 Dr I/S Impairment loss $25,217 (34,651 – 9,434) Cr Loss allowance in financial position $25,217 ILLUSTRATION 2: A company has a receivable loan of $1,000,000 They estimates that the loan has a 1% probability of a default occurring in the next 12 months It further estimates that 25% of the gross carrying amount will be lost if the loan defaults How much should the 12m ECL be? Solution: = 1% x 25% x $1,000,000 = $2,500 
 155 aCOWtancy.com ILLUSTRATION 3: An entity has a 10 yr 6% loan receivable of $1,000,000 On initial recognition the probability of default is 1% Expected lifetime losses $250,000 End of year - probability of default increases to 1.5% End of year - probability of default increases to 30% (but still no evidence of impairment) - expected lifetime losses now $100,000 End of year - probability of default increases further - expected lifetime losses now 150,000 (but still no evidence of impairment) End of year - probability of default increases further - expected lifetime losses now 200,000 (but still no evidence of impairment) The loan eventually defaults at the end of Year and the actual loss amounts to $250,000 At the beginning of Year 6, the loan is sold to a third party for $740,000 How would this be dealt with under IFRS 9? Solution • Initial recognition Dr Loan receivable – amortised cost asset $1,000,000 Cr Cash $1,000,000 Dr I/S Impairment loss (1% x 250,000) $2,500 Cr Loss allowance in financial position $2,500 • At the end of Year Dr Impairment loss in profit or loss (3,750 – 2,500) $1,250 Cr Loss allowance in financial position $1,250 The new 12m ECL would be 1.5% x 250,000 = $3,750 Interest income 6% x 1,000,000 = $60,000 • At the end of Year Dr I/S Impairment loss (100,000 - 3,750) $96,250 Cr Loss allowance in financial position $96,250 Interest income 6% x 1,000,000 = $60,000 Notice that interest is still calculated on gross amount
 156 aCOWtancy.com • At the end of year Dr I/S Impairment loss (150,000 - 100,000) $50,000 Cr Loss allowance in financial position $50,000 Interest income 6% x 1,000,000 = $60,000 • At the end of year Dr I/S Impairment loss (200,000 - 150,000) $50,000 Cr Loss allowance in financial position $50,000 Interest income 6% x 1,000,000 = $60,000 • At the end of year Dr I/S Impairment loss (250,000 - 200,000) $50,000 Cr Loss allowance in financial position $50,000 Interest income 6% x 1,000,000 = $60,000 From Year onward, interest income would be calculated at 6% on the net carrying amount of the loan $750,000 • Start of year Dr Cash $740,000 Dr Loss allowance in financial position – de-recognised $250,000 Dr Loss on disposal in profit or loss $10,000 Cr Gross loan receivable – de-recognised $1,000,000
 157 aCOWtancy.com Syllabus C3i) Discuss and apply the treatment of purchased or originated credit impaired financial assets Purchased Or Originated Credit-Impaired Financial Assets So here the asset is credit-impaired immediately Eg Significant financial difficulty of the borrower;  A default  Probable that the borrower will enter bankruptcy  The disappearance of an active market for the financial asset Show lifetime expected losses immediately
 158 aCOWtancy.com Syllabus C4 Leases Syllabus C4a) Discuss and apply the lessee accounting requirements for leases including the identification of a lease and the measurement of the right of use asset and liability Leases - Definition IFRS 16 gets rid of the Operating lease (which showed no liability on the SFP) So, every lease now shows a liability! Therefore the definition of what is a lease is super important (as it affects the amount of debt shown on the SFP) Here is that definition: A contract that gives the right to use an asset for a period of time in exchange for consideration So let's dig deeper There's tests to see if the contract is a lease The asset must be identifiable
 This can be explicitly - it's in the contract
 Or implicitly - the contract only makes sense by using this asset
 (There is no identifiable asset if the supplier can substitute the asset (and would benefit from doing so)) The customer must be able to get substantially all the benefits while it uses it The customer must be able to direct how and for what the asset is used 159 aCOWtancy.com Example A contract gives you exclusive use of a specific car You can decide when to use it and for what The car supplier cannot substitute / change the car So does the contract contain a lease? Does it pass the tests? Is there an Identifiable asset?
 Yes the car is explicitly referred to and the supplier cannot substitute the car Does the customer have substantially all benefits during the period?
 Yes Does the customer direct the use?
 Yes he/she can use it for whatever and whenever they choose So, yes this contract contains a lease because it's A contract that gives the right to use an asset for a period of time in exchange for consideration 160 aCOWtancy.com Example A contract gives you exclusive use of a specific airplane You can decide when it flies and what you fly (passengers, cargo etc) The airplane supplier though operates it using its own staff The airplane supplier can substitute the airplane for another but it must meet specific conditions and would, in practice, cost a lot to so So does the contract contain a lease? Does it pass the tests? Is there an Identifiable asset?
 Yes the airplane is explicitly referred to and the substitution right is not substantive as they would incur significant costs Does the customer have substantially all benefits during the period?
 Yes it has exclusive use Does the customer direct the use?
 Yes the customer decides where and when the airplane will fly So, yes this contract contains a lease because it's A contract that gives the right to use an asset for a period of time in exchange for consideration
 161 aCOWtancy.com Basic Rule Lessees recognise a right to use asset and associated liability on its SFP for most leases How to Value the Liability Present value of the lease payments, where the lease payments are: Fixed Payments Variable Payments  (if they depend on an index / rate) Residual Value Guarantees Probable purchase Options Termination Penalties How to Value the Right of Use asset? Includes the following: The Lease Liability (PV of payments) Any lease payments made before the lease started Any Restoration costs (Dr Asset Cr Provision) All initial direct costs After the initial Measurement - Asset 162 • Cost - depreciation (normally straight line) less any impairments • Any subsequent re-measurements of the liability aCOWtancy.com After the initial Measurement - Liability • Effective interest rate method (amortised cost) • Any re-measurements (e.g residual value guarantee changes) Example year lease term Annual lease payments in arrears 5,000 Rate implicit in lease: 12.04% PV of lease payments: 12,000 Answer The lease liability is initially the PV of future lease payments - given here to be 12,000 Double entry: Dr Asset 12,000 Cr Lease Liability 12,000 The Asset is then depreciated by 4,000pa (12,000 / 3) The lease liability uses amortised cost: Opening 163 Interest (I/S) 12.04% (Payment) Closing 12,000 1,445 (5,000) 8,445 8,445 1,017 (5,000) 4,463 4,463 537 (5,000) aCOWtancy.com Example - Variable lease payments (included in Lease Liability) (Remember only include those linked to a rate or index) So the lease contract says you have to pay more lease payments of 5% of the sales in the shop you're leasing - should you include this potential variable lease payment in your lease liability? Answer No - because it is not based on a rate or index (They are just put to the Income statement when they occur) 164 aCOWtancy.com Variable Lease payments example 10 year Lease contract: 500 payable at the start of every year Increased payments every years to reflect the change in the consumer price index The consumer price index was 125 at the start of year The consumer price index was 130 at the start of year The consumer price index was 135 at the start of year (so these are variable payments based upon an index / rate) ANSWER (IGNORING DISCOUNTING) Start of year 1: Dr Asset 500 Cr Cash 500 Dr Asset 4500 Cr Lease Liability 4500 (9 x 500) End of year 2: Asset will be 5,000 - 1,000 (straight line depreciation) = 4,000 Lease liability will be x 500 = 4,000 End of year 3: Lease payments are now different - 500 x 135/125 = 540 So the lease liability will be x 540 = 3,780 Asset will be 4,000 - 500 (depreciation) + 280 (re-measurement of Liability) = 3,780 165 aCOWtancy.com (Please note that this example ignored discounting - which would normally happen as the liability is measured as the PV of future payments) Variable payments that are really fixed payments These are included into the liability as they're pretty much fixed and not variable e.g Payments made if the asset actually operates (well it will operate of course and so this is effectively a fixed payment and not a variable one) 166 aCOWtancy.com The Lease Term This is important because The lease liability = PV of payments in the lease term! How is the Lease Term calculated? • Period which can't be cancelled • + any option to extend period (if reasonably certain to take up) • + period covered by option to terminate (if reasonably certain not to take up) So what does "Reasonably Certain" mean? Market conditions mean its favourable to it Significant leasehold improvements made High costs to terminate the lease The asset is very important to the lessee (or specialised/customised to the lessee) Problem How we 'weight' these factors that tell us whether the lessee is reasonably certain to extend the term or not? Eg A flagship store in a prime and much sought-after location Significant judgement would be needed to determine whether the prime geographical location of the store or other factors (for example termination penalties, lease hold improvements, etc.) indicate that it is reasonably certain whether or not the lessee will renew the store lease 167 aCOWtancy.com When is the lease term re-assessed? It's very rare but When the lessee exercises (or not) an option in a different way than previously was reasonably certain; When something happens that contractually obliges the lessee to exercise an option not previously included in the determination of the lease term or When something significant happens that affects whether it is reasonably certain to exercise an option This trigger is only relevant for the lessee (and not the lessor) Example A 10 year lease with an option to extend for years Initially, the lessee is not reasonably certain that it will exercise the extension option So the lease term is set for 10 years After years, they decides to sublease the building for 10 years Answer Entering into a sublease is a significant event and it affects the entity’s assessment of whether it is reasonably certain to exercise the extension option So, the lessee must change the lease term of the head lease
 168 aCOWtancy.com Syllabus C4e) Discuss the recognition exemptions under the current leasing standard Exemptions to Leases treatment So now we know that all lease contracts mean we have to show A right to use Asset A Liability So remember we said there was no longer a concept of operating leases - all lease contracts mean we need to show a right to use asset and its associated liability Well there are some exemptions Exemption - Short Term Leases These are less than 12 months contracts (unless there's an option to extend that you'll probably take or an option to purchase) Treat them like operating leases 
 Just expense to the Income Statement (on a straight line / systematic basis) Each class of asset must have the same treatment This exemption ONLY applies to Lessees Exemption 2: Low Value Assets e.g IT equipment, office furniture with a value of less than $5,000 Treat them like operating leases 
 Just expense to the Income Statement (on a straight line basis) Choice is made on a lease by lease basis This exemption ONLY applies to Lessees
 169 aCOWtancy.com Syllabus C4e) Discuss the recognition exemptions under the current leasing standard Measurement Exemptions Exemption 1: Investment Property (if it uses the FV model in IAS 40) • Measure the property each year at Fair Value Exemption - PPE (if revaluation model is used) • Use revalued amount for asset Exemption 3: Portfolio Approach (Portfolio of leases with SIMILAR characteristics) • 170 Use same treatment for all leases in the portfolio
 aCOWtancy.com Syllabus C4d) Discuss and apply the reasons behind the separation of the components of a lease contract into lease and non-lease elements Components of a Lease Sometimes a contract is for more than thing So the supplier (lessor) has more than obligation These obligations might be lease components or a combination of lease and non-lease components For example, a contract for a car lease might be combined with maintenance (non lease component) IFRS 16 says lease and non-lease components should be accounted for separately What is a separate component? something the lessee can benefit from alone and not dependent on other assets in the contract What you with separate lease components? Deal with them separately The non-lease components should be assessed under IFRS 15 for separate performance obligations The lease components are treated as financial liabilities as normal under IFRS 16 171 aCOWtancy.com So if you treat components in a contract differently How you separate them in terms of allocating an amount of the lease payment to them? • Use their stand-alone prices (or an estimate if not available) Practical expedient Lessees are allowed not to separate lease and non-lease components and, instead, account for them as a single lease component This accounting policy choice has to be made by class of underlying asset Because not separating a non-lease component would increase the lessee’s lease liability, the IASB expects that a lessee will use this exemption only if the non-lease component is not significant.
 172 aCOWtancy.com Syllabus C4b) Discuss and apply the accounting for leases by lessors Lessor Accounting - Finance Lease Is it a Finance Lease or an Operating Lease? If the majority of the risks and rewards are transferred to the lessee then it's a finance lease Other Indicators of a Finance Lease Ownership transferred at the end Option to buy at the end at less than Fair Value Lease term is for majority of the asset's UEL PV of future lease payments is close to the actual Fair Value of the asset The asset is specialised and customised for the lessee Finance Lease accounting Dr Lease Receivable Cr Asset What makes up the Lease Receivable? PV of lease payments 
 (Fixed receipts, Variable receipts (based on index / rate), Residual Value guaranteed to receive, Exercise price to be received of any likely purchase option from the lessee, Any penalties likely to be received from the lessee for early termination) 173 Un-guaranteed Residual Value aCOWtancy.com Lessor - Finance Lease accounting Opening Lease Receivable Effective Interest Received Dr Lease Receivable Dr Lease Receivable Cr PPE Cr Interest Receivable Amounts Received Closing Lease Receivable Dr Cash Cr Lease Receivable Balancing figure Lessor accounting if Operating Lease Remember this is when the lessor keeps the risks and rewards of the asset Accounting rules • Keep the Asset on the SFP as normal • Show lease receipts on the income statement (straight line basis) 174 aCOWtancy.com Syllabus C4b) Discuss and apply the accounting for leases by lessors Lessor Accounting - Operating Lease Ok - let´s have a think about this Remember that when we say operating lease - we mean the risks and rewards are NOT taken by the lessee So have we sold the asset or not? Revenue recognition tells us that when the risks and rewards for goods are passed on then we have made a sale and can recognise the revenue So, no the lessor has NOT in substance sold the asset Therefore the lessor keeps the asset on its SFP Income from an operating lease (not including services such as insurance and maintenance),  should be shown straight-line in the income statement over the length of the lease (unless the item is used up on a different basis - if so use that basis) SFP Keep the Asset there Income statement Operating Lease rentals received Negotiating costs etc Any initial direct costs incurred by lessors should be added to the carrying amount of asset on the SFP and expensed over the lease term (NOT the assets life) Operating Lease Incentives The lessor should reduce the rental income over the lease term, on a straight-line basis with the total of these.
 175 aCOWtancy.com Syllabus C4f) Discuss and apply the principles behind accounting for sale and leaseback transactions Sale and Leaseback Let’s have a little ponder over this before we dive into the details… So - the seller makes a sale (easy) BUT remember also leases it back - so the seller becomes the lessee always, and the buyer becomes the lessor always Seller = Lessee (after)
 Buyer = Lessor (after) However, If we sell an item and lease it back - have we actually sold it? Have we got rid of the risk and rewards? So the first question is Have we sold it according to IFRS 15? (revenue from contracts with customers) Option 1: Yes - we have sold it under IFRS 15 This means the control has passed to the buyer (lessor now) But remember we (the seller / lessee) have a lease - and so need to show a right to use asset and a lease liability Step 1: Take the asset (PPE) out Dr Cash Cr Asset Cr Initial Gain on sale
 176 aCOWtancy.com Step 2: Bring the right to use asset in Dr Right to use asset Cr Finance Lease / Liability Dr/Cr Gain on sale (balancing figure) • How much we show the Right to Use asset at?
 The proportion (how much right of use we keep) of our old carrying amount 
 The PV of lease payments / FV of the asset x Carrying amount before sale • How much we show the finance liability at?
 The PV of lease payments Example A seller-lessee sells a building for 2,000 Its carrying amount at that time was 1,000 and FV 1,800 The seller-lessee then leases back the building for 18 years, for 120 p.a in arrears The interest rate implicit in the lease is 4.5%, which results in a present value of the annual payments of 1,459 The transfer of the asset to the buyer-lessor has been assessed as meeting the definition of a sale under IFRS 15 Answer Notice first that the seller received 200 more than its FV - this is treated as a financing transaction: Dr Cash 200 Cr Financial Liability 200 Now onto the sale and leaseback Step1: Recognise the right-of-use asset - at the proportion (how much right of use we keep) of our old carrying amount Old carrying amount = 1,000 177 aCOWtancy.com How much right we keep = 1,259 / 1,800 (The 1,259 is the 1,459 we actually pay - 200 which was for the financing) So, 1,259 / 1,800 x 1,000 = 699 Step 2: Calculate Finance Liability - PV of the lease payments Given - 1,259 So the full double entry is: Dr Cash 2,000 Cr Asset 1,000 Cr Finance Liability 200 Cr Gain On Sale 800 Dr Right to use asset 699 Cr Finance lease / liability 1,259 Dr Gain on sale 560 (balance) Option 2: It's not a sale under IFRS 15 So the buyer-lessor does not get control of the asset Therefore the seller-lessee leaves the asset in their accounts and accounts for the cash received as a financial liability The buyer-lessor simply accounts for the cash paid as a financial asset (receivable) 178 aCOWtancy.com Syllabus C4c) Discuss and apply the circumstances where there may be re-measurement of the lease liability Further Guidance on Lease accounting Some further guidance on measuring Right to use Assets Discount rate
 The lessee uses the discount rate the interest rate implicit in the lease - if this rate cannot be readily determined, the lessee should use its incremental borrowing rate (for similar amount, term & security) Restoration costs
 This should be included in the initial measurement of the right-of-use asset and as a provision This corresponds to the accounting for restoration costs in IAS 16 Property, Plant and Equipment If the expected restoration costs change - then the right-of-use asset and provision is changed Initial direct costs
 These are incremental costs that would not have been incurred if a lease had not been obtained e.g.  commissions or some payments made to existing tenants to obtain the lease All initial direct costs are included in the initial measurement of the right-of-use asset Subsequent measurement
 The lease liability is measured in subsequent periods using the effective interest rate method 179 aCOWtancy.com The right-of-use asset is depreciated on a straight-line basis or another systematic basis that is more representative of the pattern in which the entity expects to consume the right-of-use asset 
 The lessee must also apply the impairment requirements in IAS 36,‘Impairment of assets’, to the right-of-use asset 
 Using straight-line depreciation (for the asset) and the effective interest rate (for the lease liability) will mean higher charges at the start of the lease and less at the end (‘frontloading’) 
 But this might not properly reflect the economic characteristics of a lease contract (especially for 'operating leases' 
 It also means the carrying amount of the right-of-use asset and the lease liability won't be equal in subsequent periods The right-of-use asset will, in general, be lower than the carrying amount of the lease liability 180 aCOWtancy.com When should the lease liability be reassessed? (only if the change in cash flows is based on contractual clauses that have been part of the contract since inception) otherwise it's a modification not a reassessment Component of the lease liability Reassessment Lease Term When? – If there is a change in the lease term How? – Reflect the revised payments using a revised discount rate(the interest rate implicit in the lease for the remainder of lease term) Exercise price of a purchase option When? – A significant event (within the control of the lessee) affects whether the lessee is reasonably certain to exercise an option How? – Reflect the revised payments using a revised discount rate(the interest rate implicit in the lease for the remainder of lease term) Residual value guarantee When? – If there is a change in the amount expected to be paid How? – Include the revised residual payment using the unchanged discount rate Variable lease payment (dependent on an index or a rate) When? – If a change in the index/rate results in a change in cash flows How? – Reflect the revised payments based on the index/rate at the date when the new cash flows take effect for the remainder of the term using the unchanged discount rate 181 aCOWtancy.com Syllabus C5 Employee Benefits Syllabus C5a) Discuss and apply the accounting treatment of short term and long term employee benefits and defined contribution and defined benefit plans Pensions Introduction Objective of IAS 19 Companies give their employees benefits - the most obvious being wages but there are, of course, other things they may offer such as pensions IAS 19 says that the benefit should be shown when earned rather than when paid Employee benefits include paid holiday, sick leave and free or subsidised goods given to employees Short-term Employee Benefits As we mentioned above, any benefits payable within a year after the work is done, (such as wages, paid vacation and sick leave, bonuses etc.) should be recognised when the work is done not when paid for Profit-sharing and Bonus Payments Recognise when there is an obligation to make such payments and a reliable estimate of the expected cost can be made 182 aCOWtancy.com Illustration Grazydays PLC give their employees weeks of paid holiday each year, and because they’re groovy employers, any holiday not taken can be carried forward to the next year Accounting Treatment 
 Any untaken holiday entitlement should be recognised as a liability in the current year even though it wouldn’t be taken until the next year Types of Post-employment Benefit Plans There are two types: Defined Contribution plan In this one the company just promises to pay fixed contributions into a pension fund for the employee and has no further obligations The contribution payable is recognised in the income statement for that period If contributions are not payable until after a year they must be discounted Defined Benefit plan This is a post-employment benefit that gives the company an obligation to pay a defined pension to its employees who have left The SFP Figure The present value of the obligation less FV of assets (in the pension fund) 183 aCOWtancy.com Defined Benefit Scheme - Terms Defined Benefit Scheme - Terms Defined benefit plan As we said in the intro - this is “A post-employment benefit that creates a constructive obligation to the enterprise’s employees” • The SFP shows the pension fund as it stands at the year end in terms of the present value of the obligation less FV of assets Let’s dig a little deeper to make some sense out of this • The idea is that the company puts money into the fund, the fund spends that money on assets The assets make an EXPECTED return The company hopes this return will pay off the employees future pensions when they leave the company • Of course, the fund will not always exactly match the pension liability Therefore there will either be a surplus or deficit on the SFP 184 aCOWtancy.com Let’s look at some terms before we put it all together: Actuarial gains/losses These occur due to differences between previous estimates and what actually occurred These are recognised in the OCI Past service cost Dr Income statement
 Cr Pension Liability This is a change in the pension plan resulting in a higher pension obligation for employee service in prior periods They should be recognised immediately if already vested or not Plan curtailments or settlements Curtailments are reductions in benefits or the number of employees covered by the pension Any gain/loss is recognised when the curtailment occurs Current service cost Increase in pension liability due to benefits earned by employee service in the period Dr Income statement
 Cr Pension Liability 185 aCOWtancy.com Interest cost The unwinding on the discount of the pension liability Dr Interest
 Cr Pension Liability Expected return on plan assets This is the Interest, dividends and other revenue from the pension assets and is now to be based on the return from AA-rated corporate bonds This means companies cannot set expected returns according to the assets actually held by the plan It could encourage them to invest in more secure vehicles than is currently the case, seeing as the potential higher return will no longer be reflected in the accounts The reason behind this is to improve transparency and consistency Dr Pension Asset
 Cr Interest received The Interest cost and EROA are netted off against each other They use the same discount rate So if a fund has more assets than liabilities (a surplus) - it will have net interest received If a fund has more liabilities than assets (a deficit) - it will have net interest paid Contributions to Pension fund This is simply the money that the company puts in to the fund - so the fund can buy assets to generate an expected return Dr Pension Asset
 Cr Cash
 186 aCOWtancy.com Benefits paid These are the actual pensions paid out to former employees Paying the pensions means we reduce the liability, but we use the pension fund to it, so we reduce the pension asset also Dr Pension Liability
 Cr Pension Asset Other Long-term Benefits (e.g Profit shares, bonuses) A simplified application of the model described above for other long-term employee benefits: All past service cost is recognised immediately Termination Benefits (e.g Redundancy) Amount payable only recognised when committed to either: Terminating the employment of employees before the normal retirement date; or Providing benefits in order to encourage voluntary redundancy “Demonstrably committed” means a detailed formal plan without realistic possibility of withdrawal Discount down if payable in more than a year Equity Compensation Benefits No recognition for stock options issued to employees as compensation Nor does it require disclosure of the fair values of stock options or other share-based payment 187 aCOWtancy.com IAS 19 ‘Asset Ceiling’ This stops gains being shown just because Past service costs (unvested) have been deferred It may be that there are net assets but not all can be recovered through refunds / contributing less in the future In such cases, deferral of past service cost may not result in a refund to the entity or a reduction in future contributions to the pension fund, so a gain is prohibited in these circumstances So, any asset recognised in the balance sheet should be the lower of: • the net total calculated; and • the net total of: (i) past service costs not recognised as an expense; and (ii) the present value of any economic benefits available in the form of refunds from the plan or reductions in future contributions to the plan An asset may arise where a defined benefit plan has been overfunded or in certain cases where actuarial gains are recognised 188 aCOWtancy.com Defined Benefit - Illustration This is best seen on the video - but here goes in the written word… Illustration Pension Fund asset b/f 400
 Pension Fund Liability b/f 600
 Current service cost 100
 Expected return on assets 10%
 Discount rate 10%
 Contributions paid (@ year-end) 80
 Benefits paid (@ year-end) 60 Actuarial c/f:  Pension Fund Asset 500
 Pension Fund Liability 650 Solution • Current Service cost Dr I/S 100
 Cr Pension Liability 100 • Expected return on Assets Dr Pension asset 40 (10% x 400)
 Cr Interest 40 • Unwinding of discount Dr Interest 60 (10% x 600)
 Cr Pension Liability 60 189 aCOWtancy.com • Contributions Paid Dr Pension asset 80
 Cr Cash 80 • Benefits paid Dr Pension Liability 60
 Cr Pension Asset 60 Having done those double entry we can see that assets have increased by 60 (400 to 460) and liabilities have increased by 100 (600 to 700) giving a net increase in the SFP pension liability of 40.
 We now compare the pension assets and liabilities figure (which is based upon assumptions) to what has actually occurred This is given in the actuarial figures c/f So, the assets made an actuarial gain of 40 and the liabilities a gain of 50 This total gain of 90 is recognised in the OCI as a gain The balance sheet is showing a liability of 240, less the re-measurement of 90, equals 150 Liability This matches what is actually in the pension fund (650- 500) = 150 190 aCOWtancy.com Defined Contribution Scheme Short-term Employee Benefits Benefits payable within a year after work is done, such as wages, paid vacation and sick leave, bonuses etc should be recognised when work is done Profit-sharing and Bonus Payments Recognise when there is an obligation to make such payments and a reliable estimate of the expected cost can be made Defined contribution plan • The enterprise pays fixed contributions into a fund and has no further obligations • The contribution payable is recognised in the income statement for that period • If contributions are not payable until after a year they must be discounted.
 191 aCOWtancy.com Syllabus C5b) Account for gains and losses on settlements and curtailments Curtailments and Settlements Curtailments An amendment is made to the plan which improves benefits for plan members An increase to the obligation (and expense) is recognised when the amendment occurs: DEBIT Profit or loss X CREDIT Present value of defined benefit obligation X Settlements A settlement eliminates all further obligations Eg: A lump-sum cash payment made in exchange for rights to receive post-employment benefits The gain or loss on a settlement is recognised in profit or loss when the settlement occurs: DEBIT PV obligation (as advised by actuary) X CREDIT FV plan assets (any assets transferred) X CREDIT Cash (paid directly by the entity) X CREDIT/ DEBIT Profit or loss (difference) X
 192 aCOWtancy.com Syllabus C5c) Account for the “Asset Ceiling” test and the reporting of actuarial gains and losses Asset Ceiling Test The 'Asset Ceiling' test The net pension amount can't be in the shown at more than its recoverable amount So basically any net pension asset gets measured at the lower of: 1) Net reported asset (in the books) or 2) The PV of any refunds/ reduction of future contributions available from the pension plan Any impairment loss is charged immediately to OCI 193 aCOWtancy.com Syllabus C6 Income taxes Syllabus C6a) Discuss and apply the recognition and measurement of deferred tax liabilities and deferred tax assets Syllabus C6b) Discuss and apply the recognition of current and deferred tax as income or expense Current tax The amount of income taxes payable or receivable in a period Any tax loss that can be carried back to recover current tax of a previous period is shown as an asset If the gain or loss went to the OCI, then the related tax goes there too Deferred Tax This is basically the matching concept Let´s say we have credit sales of 100 (but not paid until next year) There are no costs The tax man taxes us on the cash basis (i.e next year) The Income statement would look like this: Income Statement Sales Tax (30%) Profit 194 100 100 aCOWtancy.com This is how it should look The tax is brought in this year even though it´s not payable until next year, it´s just a temporary timing difference.  Income Statement SFP Sales 100 Deferred tax payable Tax (30%) 30 100 Profit Illustration Tax Base Let’s presume in one country’s tax law, royalties receivable are only taxed when they are received IFRS IFRS, on the other hand, recognises them when they are receivable Now let’s say in year 1, there are 1,000 royalties receivable but not received until year The Income statement would show: Royalties Receivable Tax 1000 (0) (They are taxed when received in yr 2) This does not give a faithful representation as we have shown the income but not the related tax expense Therefore, IFRS actually states that matching should occur so the tax needs to be brought into year Dr Tax (I/S) Cr Deferred Tax (SFP provision) 195 aCOWtancy.com Deferred tax on a revaluation Deferred tax is caused by a temporary difference between accounts rules and tax rules One of those is a revaluation: Accounting rules bring it in now.
 Tax rules ignore the gain until it is sold So the accounting rules will be showing more assets and more gain so we need to match with the temporarily missing tax Illustration A company revalues its assets upwards making a 100 gain as follows: OCI SFP PPE Revaluation Gain 100 1,000 + 100 Revaluation surplus 100 This is how it should look The tax is brought in this year even though it´s not payable until sold, it´s just a temporary timing difference.  Notice the tax matches where the gain has gone to OCI Revaluation Gain 196 SFP 100 - 30 PPE 1,000 + 100 Deferred tax payable (30%) (30) Revaluation surplus 100 - 30 aCOWtancy.com Deferred Tax Scenarios 
 So as we saw in the introductory section, deferred tax is all about matching If the accounts show the income, then they must also show any related tax This is normally not a problem as both the accounts and taxman often charge amounts in the same period The problem occurs when they don’t We saw how the accounts may show income when the performance occurs, while the taxman only taxes it (tax base) when the money is received In this case, as financial reporters we must make sure we match the income and related expense So this was a case of the accounts showing ‘more income’ than the tax man in the current year (he will tax it the following year when the money is received) So we had to bring in ‘more tax’ ourselves by creating a deferred tax liability So, basically deferred tax is caused simply by timing differences between IFRS rules and tax rules Therefore IFRS demands that matching should occur i.e Difference between IFRS and Tax base Tax adjustment needed for matching to occur Deferred Tax Double entry More Income in I/S More tax needed Liability Dr Tax (I/S) Cr Def Tax Liability (SFP) 197 aCOWtancy.com Hopefully you can see then that the opposite also applies: Difference Tax effect Deferred Tax Double entry More expense in I/S less tax needed Asset Dr Def tax asset Cr tax (I/S) In fact, the following table all applies: Difference Tax effect Difference More Income More tax Liability Less income Less tax Asset More expense Less tax Asset Less expense More tax Liability 
 Remember this “more income etc.” is from the point of view of IFRS I.e The accounts are showing more income, as the taxman does not tax it until next year We will now look at each of these cases in more detail Case Difference More Income Tax effect Difference More tax Liability Issue IFRS shows more income than the taxman has taken into account Example
 Royalties receivable above Double entry required:
 Dr Tax (I/S)
 Cr Deferred tax Liability (SFP) 198 aCOWtancy.com Case Difference Tax effect Difference Issue IFRS shows less income than the taxman has taken into account Example
 Taxman taxes some income which IFRS states should be deferred such as upfront receipts on a long term contract Double entry required:
 Dr Deferred Tax Asset (SFP)
 Cr Tax (I/S) This will have the effect of eliminating the tax charge for now, so matching the fact that IFRS is not showing the income yet either.
 Once the income is shown, then the tax will also be shown by: Dr Tax (I/S)
 Cr Deferred tax asset (SFP) Case Difference More Expense Tax effect Difference Less tax Asset Issue IFRS shows more expense than the taxman has taken into account Example
 IFRS depreciation is more than Tax depreciation (WDA or CA) 199 aCOWtancy.com Double entry required:
 Dr Deferred Tax Asset (SFP)
 Cr Tax (I/S) Illustration IFRS TAX Asset Cost 1,000 1,000 Depreciation (400) (300) 600 700 NBV Simply compare 700-600 =100 100 x tax rate = deferred tax asset Case Difference Less Expense Tax effect Difference More tax Liability Issue IFRS shows less expense than the taxman has taken into account Example
 
 IFRS depreciation is less than Tax depreciation (WDA or CA) Double entry required:
 Dr Tax I/S
 Cr Deferred Tax Liability 200 aCOWtancy.com Illustration IFRS TAX Asset Cost 1,000 1,000 Depreciation (300) (400) 700 600 NBV Simply compare 700-600 =100 100 x tax rate = deferred tax liability Then multiply this by the tax rate (e.g 30%) = 100 x 30% = 30 NOTE In actual fact, the standard refers to assets and liabilities rather than more income and more expense etc Simply use the above tables and substitute the word asset for income and expense for liability Difference Tax effect Tax effect More Asset More tax Liability Less Asset Less tax Asset More Liability Less tax Asset Less Liability More tax Liability Possible Examination examples of Case 1& Accelerated capital allowances (accelerated tax depreciation) - see above Interest revenue - some interest revenue may be included in profit or loss on an accruals basis, but taxed when received Development costs - capitalised for accounting purposes in accordance with IAS 38 while being deducted from taxable profit in the period incurred 201 aCOWtancy.com Revaluations to fair value 
 In some countries the revaluation does not affect the tax base of the asset and hence a temporary difference occurs which should be provided for in full based on the difference between its carrying value and tax base NOTE: Double entry here is:
 Dr Revaluation Reserve with the tax (as this is where the “income” went)
 Cr Deferred tax liability Fair value adjustments on consolidation 
 IFRS 3/ IAS 28 require assets acquired on acquisition of a subsidiary or associate to be brought in at their fair value rather than carrying amount The deferred tax effect is a consolidation adjustment - this is more assets (normally) so a deferred tax liability The other side would be though to increase goodwill And viceversa Undistributed profits of subsidiaries, branches, associates and joint ventures 
 No deferred tax liability if Parent controls the timing of the dividend.  Possible Examination examples of Case & Provisions - may not be deductible for tax purposes until the expenditure is incurred. 
 
 Losses - current losses that can be carried forward to be offset against future taxable profits result in a deferred tax asset Fair value adjustments 
 liabilities recognised on business combinations result in a deferred tax asset where the expenditure is not deductible for tax purposes until a later period A deferred tax asset also arises on downward revaluations where the fair value is less than its tax base. 
 202 aCOWtancy.com NOTE: Here, the deferred tax asset here is another asset of S at acquisition and so reduces goodwill Unrealised profits on intra-group trading 
 the tax base is based on the profits of the individual company who has made a realised profit THERE IS NO DEFERRED TAX EFFECT ON INITIAL GOODWILL How much deferred tax? Deferred tax is measured at the tax rates expected to apply to the period when the asset is realised or liability settled, based on tax rates (and tax laws) that have been enacted by the end of the reporting period No Discounting Deferred tax assets are only recognised to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be used 203 aCOWtancy.com Syllabus C6c) Discuss and apply the treatment of deferred taxation on a business combination Miscellaneous Deferred Tax Items On acquiring a Subsidiary Here you need to check the Net Assets at acquisition (from your equity table) and compare it to the tax base of the NA (this will be given in the exam) Again you just look to see if the accounts are showing more or less assets and create a deferred tax liability / asset at acquisition also This will affect goodwill Illustration H acquires 100% S for 1,000 At that date the FV of S’s NA was 800 and the tax base 700 Tax is 30% How much is goodwill? Goodwill FV of Consideration 1,000 NCI - FV of NA acquired -800 New Deferred tax liability (800-700) x 30% 30 Goodwill 230 Un-remitted Earnings of Group Companies H always has the right to receive profits (and dividends from them) from S or A However not all profits are immediately paid out as dividends This creates deferred tax as H will receive the full amount one day and when it does it will be taxed Therefore, a deferred tax liability should be created to match against the profits shown from S and A However, for Subsidiaries only, H might control its dividend policy and have no intention of paying dividends out and no intention of selling S either in the foreseeable future 204 aCOWtancy.com Therefore when this is the case NO deferred tax liability is created (this can not be the case for Associates as H does not control A) Unrealised Profit Adjustments Here, the group makes an adjustment and decreases profits, in the group accounts only However, tax is charged on the individual companies and not the group So, the group accounts will be showing less profits and so the tax needs adjusting by creating a deferred tax asset The issue though is what tax rate to use - that of the selling company or that of the buyer who holds the stock? IAS 12 says you should use the tax rate of the buyer Setting Off A deferred tax asset can normally be set off against a deferred tax liability (to the same tax jurisdiction) as the liability gives strong evidence that profits are being made and so the asset will come to fruition Deferred Tax Liability 1,000 Deferred Tax Asset -800 200 If, however, the deferred tax asset is more than the liability then the deferred tax asset can only be recognised if is probable that it will be recovered in the near future Deferred Tax Liability 1,000 Deferred Tax Asset -1,100 NO SET OFF 205 aCOWtancy.com Syllabus C7 Provisions, contingencies and events after the reporting date Syllabus C7a) Discuss and apply the recognition, de-recognition and measurement of provisions, contingent liabilities and contingent assets including environmental provisions and restructuring provisions Provisions A provision is a liability of uncertain timing or amount Double entry Dr Expense Cr Provision (Liability SFP) If it is part of a cost of an asset (e.g Decommissioning costs) Dr Asset Cr Provision (Liability SFP) Recognise when There is an obligation (constructive or legal) There is a probable outflow It is reliably measurable 206 aCOWtancy.com At how much? The best estimate of the expenditure Large Population of Items use expected values Single Item the individual most likely outcome may be the best estimate Discounting of provisions Provisions should be discounted Eg A future liability of 1,000 in years time (discount rate 10%) 1,000 x 1/1.10 x 1/1.10 = 826 Dr Expense 826 Cr Provision 826 Then the discount unwound Year 826 x 10% = 83 Dr Interest 83 Cr Provision 83 Year (826+83) x 10% = 91 Dr Interest 91 Cr Provision 91 207 aCOWtancy.com Measurement of a Provision • The amount recognised as a provision should be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period • Provisions for one-off events E.g restructuring, environmental clean-up, settlement of a lawsuit Measured at the most likely amount • Large populations of events E.g warranties, customer refunds Measured at a probability-weighted expected value Illustration A company sells goods with a warranty for the cost of repairs required in the first months after purchase Past experience suggests: 88% of the goods sold will have no defects 7% will have minor defects 5% will have major defects If minor defects were detected in all products sold, the cost of repairs will be $24,000; If major defects were detected in all products sold, the cost would be $200,000 What amount of provision should be made? (88% x 0) + (7% x 24,000) + (5% x 200,000) = $11,680 208 aCOWtancy.com Contingent Liabilities These are simply a disclosure in the accounts They occur when a potential liability is not probable but only possible (Also occurs when not reliably measurable) Contingent Assets Here, it is not a potential liability, but a potential asset The principle of PRUDENCE is important here, it must be harder to show a potential asset in your accounts than it is a potential liability This is achieved by changing the probability test For a potential (contingent) asset - it needs to be virtually certain (rather than just probable) Probability test for Contingent Liabilities Remote chance of paying out - Do nothing Possible chance of paying out - Disclosure Probable chance of paying out - Create a provision Probability test for Contingent Assets Remote chance of receiving - Do nothing Possible chance of receiving - Do nothing Probable chance of receiving - Disclosure Virtually certain of receiving - create an asset in the accounts
 209 aCOWtancy.com Some typical examples Specific types of provision Future operating losses Provisions are not recognised for future operating losses (no obligation) Onerous contracts Recognised and measured as a provision (as there is a contract and so a legal obligation) Restructuring Create a provision when: There is a detailed formal plan for the restructuring; and There is a valid expectation in those affected that it will carry out the restructuring by starting to implement that plan or announcing its main features to those affected by it (this creates a constructive obligation) Provide only for costs that are: (a) necessarily entailed by the restructuring; and (b) not associated with the ongoing activities of the entity Possible Exam Scenarios Warranties Yes there is a legal obligation so provide The amount is based on the class as a whole rather than individual claims Use expected values Major Repairs These are not provided for Instead they are treated as replacement non current assets See that chapter Self Insurance This is trying to provide for potential future fires etc Clearly no provision as no obligation to pay until fire actually occurs Environmental Contamination Clearance Yes provide if legally required to so or other parties would expect the company to so as it is its known policy
 210 aCOWtancy.com Decommissioning Costs All costs are provided for The debit would be to the asset itself rather than the income statement Restructuring Provide if there is a detailed formal plan and all parties affected expect it to happen Only include costs necessary caused by it and nothing to with the normal ongoing activities of the company (e.g don’t provide for training, marketing etc) Reimbursements This is when some or all of the costs will be paid for by a different party This asset can only be recognised if the reimbursement is virtually certain, and the expense can still be shown separately in the income statement Circumstance Provide? Warranties/guarantees  Accrue a provision (past event was the sale of defective goods)  Customer refunds Accrue if the established policy is to give refunds  Land contamination  Accrue a provision if the company's policy is to clean up even if there is no legal requirement to so Firm offers staff training No provision (there is no obligation to provide the training) Restructuring by sale of an operation/ Accrue a provision only after a binding line of business sale agreement  Restructuring by closure of business Accrue a provision only after a detailed locations or reorganisation  formal plan is adopted and announced publicly A Board decision is not enough  211 aCOWtancy.com Syllabus C7b) Discuss and apply the accounting for events after the reporting period IAS 10 Events After The Reporting Period Events can be adjusting or non-adjusting We are looking at transactions that happen in this period, and whether we should go back and adjust our accounts for the year end or not adjust and just put into next year’s accounts If the event gives us more information about the condition at the year-end then we adjust If not then we don’t When is the "After the Reporting date" period? It is anytime between period end and the date the accounts are authorised for issue After the SFP date = Between period end and date authorised for issue Ok and why is it important? Well it may well be that many of the figures in the accounts are estimates at the period end However, what if we get more information about these estimates etc afterwards, but before the accounts are authorised and published should we change the accounts or not? The most important thing to remember is that the accounts are prepared to the SFP date Not afterwards 212 aCOWtancy.com So we are trying to show what the situation at the SFP date was However, it may be that more information ABOUT the conditions at the SFP date have come about afterwards and so we should adjust the accounts Sometimes we not adjust though… Adjusting Events Here we adjust the accounts if: The event provides evidence of conditions that existed at the period end Examples are Debtor goes bad days after SFP date (This is evidence that debtor was bad at SFP date also) Stock is sold at a loss weeks after SFP date IAS2 ‘Inventories’ states that estimates of net realisable value should take into account fluctuations in price occurring after the end of the period to the extent that it confirms conditions at the year end (This is evidence that the stock was worth less at the SFP date also) Property gets impaired weeks after SFP date (This implies that the property was impaired at the SFP date also) The result of a court case confirming the company did have a present obligation at the year end The settling of a purchase price for an asset that was bought before the year end but the price was not finalised 213 aCOWtancy.com The discovery of fraud or error in the year Non-Adjusting Events - these are disclosed only These are events (after the SFP date) that occurred which not give evidence of conditions at the year end, rather they are indicative of conditions AFTER the SFP date Stock is sold at a loss because they were damaged post year-end (This is evidence that they were fine at the year-end - so no adjustment) Property impaired due to a fall in market values generally post year end (This is evidence that the property value was fine at the year end - so no adjustment required) The acquisition or disposal of a subsidiary post year end A formal plan issued post year end to discontinue a major operation The destruction of an asset by fire or similar post year end Dividends declared after the year end Non-adjusting event which affects Going Concern Adjust the accounts to a break up basis regardless if the event was a non-adjusting event 214 aCOWtancy.com Syllabus C8 Share based payment Syllabus C8a) Discuss and apply the recognition and measurement of share-based payment transactions Share Based Payments - Introduction What is a SBP transaction? Well first of all it needs to be for receiving good or services1 and in return the company gives: 1) Its own shares 2) Cash based upon the price of its own shares Contracts to buy or sell non-financial items that may be settled net in shares or rights to shares are outside the scope of IFRS and are addressed by IAS 32 There are types of Share based payment: Equity-settled share-based payment This is where the company pays shares in return for goods and/or services received Dr Expense
 Cr Equity Cash-settled share-based payment This is where cash is paid in return for goods and services received, HOWEVER the actual cash amount though is based on the share price Goods and services not identified are still under IFRS e.g Payments to Trade Unions etc 215 aCOWtancy.com These are also called SARs (Share Appreciation Rights) Dr Expense
 Cr Liability Transactions with a choice of settlement A choice of cash or shares paid in return for goods and services received Vesting period 
 Often share based payments are not immediate but payable in say years The expense is spread over these years and this is called the vesting period How much to recognise? So we have decided that share based payments (either shares or cash based on share price) should go into the accounts (Dr expense Cr Equity or Liability) We now have to look at the value to put on these: • Option 1: Direct method Use the FV of the goods or services received • Option 2: Indirect method Use the FV of the shares issued by the company Equity settled - Use FV of shares @ grant date
 Cash settled - Update FV of shares each year IFRS suggests you choose option - the FV of the goods/services However, if the FV of these cannot be reliably measured then you should go for option - FV of shares issued 216 aCOWtancy.com Strangely enough, option is the most common This is because share based payments are often associated with paying employees You cannot put a value on the work done by employees - except for the value of what you pay them i.e Option 217 aCOWtancy.com SBP - Equity Settled This is where payments are made with an equity instrument such as a share or a share option Measurement The FV of the product / service acquired (if possible) FV of equity instrument issued FV of Equity Instrument This is basically MARKET VALUE, taking into account the terms and market related conditions of the offer If there is no MV available, then the “Intrinsic Value” option is available This is basically the share price less the exercise price However, if this is chosen then the accounting treatment below is slightly different It will need to be remeasured to the new intrinsic value each year - this will be very rare Accounting Treatment Dr Expense (or asset)
 Cr Equity The problem is we only the above double entry once the item has ‘vested’ (i.e satisfied all conditions to be met to make the share payable) For example, if shares are issued for the purchase of a building, and the building is available to use immediately, then it has vested immediately and you would Dr PPE Cr Equity with the FV of the asset acquired If, however, share options are issued, but only once employees have stayed in the job for say years, then this means they not fully vest for years What you here, is recognise the expense as it vests - over what we call the ‘vesting period’ So, in this 218 aCOWtancy.com example, you would calculate the full cost of the options at grant date and in the first year Dr Expense Cr Equity with 1/3 of that total Precise Measurement You take the best available estimate at the time of the number of equity instruments expected to vest at the end The value used for the share options throughout the vesting period remains at the GRANT DATE value (with the exception of “intrinsic value” method above) Illustrations Equity Settled An entity grants 100 share options on its $1 shares to each of its 500 employees on January Year Each grant is conditional upon the employee working for the entity over the next three years The fair value of each share option as at January Year is $10.
 On the basis of a weighted average probability, the entity estimates on January that 100 employees will leave during the three-year period and therefore forfeit their rights to share options The following actually occurs:
 – 20 employees leave during Year and the estimate of total employee departures over the three-year period is revised to 70 employees
 – 25 employees leave during Year and the estimate of total employee departures over the three-year period is revised to 60 employees
 – 10 employees leave during Year 3
 219 aCOWtancy.com Solution Step 1: Decide if this is a cash or equity settled SBP - share options are equity settled (so Dr Expense Cr Equity) Step 2: Decide whether to value directly or indirectly - these are for employees so indirectly Step 3: Calculate how many employees (and their share options each) are expected to be issued at the end of the vesting period Year 1:  430 Employees expected to be left at end (500-70) x 100 (share options each) x $10 (FV @ GRANT date) x 1/3 (time through vesting period) = 143,300 Year 2: 440 x 100 x $10 x 2/3 - 143,300 = 150,000 Year 3: 445 x 100 x $10 x 3/3 - 293,300 = 151,700 So you can see that the “costs” and so the entries into the accounts would be: Year 1: Dr Expense 143,300 Cr Equity 143,300
 Year 2: Dr Expense 150,000 Cr Equity 150,000
 Year 3: Dr Expense 151,700 Cr Equity 151,700 Notice that if you add these up it comes to 445,000 This is exactly our final liability (445 x 100 x $10 x 3/3) - it’s just we’ve spread it over the years vesting period 220 aCOWtancy.com SBP - Cash Settled These are when a company promises to pay for goods or services for cash, however the cash price is linked to the share price They are often called “Share Appreciation Rights (SARs)” The double entry is: Dr Expense
 Cr Cash or Liability If the payment is for a service stretching over a number of years (vesting period) then the expense is recognised over the number of years and the liability is calculated by taking into account the change in the share price Illustration 1 Jan Year - 100 share appreciation rights (SARs) given to each of the company’s 1000 employees FV of these at grant date was £5 The employees had to be in service for years to take the SAR End of year - 100 employees had left and 140 more expected to leave by the end of year FV of SAR now £6 End of year -  40 employees left in the year and another 50 expected to leave in year FV of SAR now £8 End of year -  60 employees left and the FV of SAR is now £7 Solution Year - 760 (1,000 - 100 -140) x 100 x £6 x 1/3 = 152,000 (Dr Expense Cr Liability) 221 aCOWtancy.com Year - 810 (1,000 - 100 - 40 - 50) x 100 x £8 x 2/3 = 432,000 - 152,000 = 280,000 (Dr Expense Cr Liability) Year - 800 (1,000 - 100 - 40 - 60) x 100 x £7 x 3/3 = 560,000 - 432,000 = 128,000 (Dr Expense Cr Liability) Finally the 560,000 is paid Dr Liability 560,000 Cr Cash 560,000 Illustration An entity grants 100 share options on its $1 shares to each of its 500 employees on January Year Each grant is conditional upon the employee working for the entity over the next three years The fair value of each share option as at January Year is $10.
 On the basis of a weighted average probability, the entity estimates on January that 100 employees will leave during the three-year period and therefore forfeit their rights to share options The following actually occurs:
 – 20 employees leave during Year and the estimate of total employee departures over the three-year period is revised to 70 employees
 – 25 employees leave during Year and the estimate of total employee departures over the three-year period is revised to 60 employees
 – 10 employees leave during Year Information of share price at the end of each year:
 Year 10
 Year 12
 Year 14 222 aCOWtancy.com Solution 
 
 As this is cash settled then the double entry becomes Dr Expense Cr Liability and we not keep the value of the option @ grant date but change it as we pass through the vesting period Y1: 430 x 100 x 10 x 1/3 = 143,300
 Y2: 440 x 100 x 12 x 2/3 - 143,300 = 208,700
 Y3: 445 x 100 x 14 x 3/3 - 623,000 x 3/3 - 352,000 = 271,000 So you can see that the “costs” and so the entries into the accounts would be: Year 1: Dr Expense 143,300 Cr Liability 143,300
 Year 2: Dr Expense 208,700 Cr Liability 208,700
 Year 3: Dr Expense 271,000 Cr Liability 271,000 Notice that if you add these up it comes to 623,000 This is exactly our final liability (445 x 100 x $14 x 3/3) - it’s just we’ve spread it over the years vesting period.
 223 aCOWtancy.com SBP with a Choice of Settlement Share-based payment with a choice of settlement Entity has the choice Is there a present obligation to settle in cash? Yes Treat as cash-settled No Treat as equity-settled
 Counter-party has the choice The transaction is a compound financial instrument which needs splitting into debt and equity Debt Portion This must be calculated first the FV of the cash option at grant date Then it is treated just like a normal cash-settled SBP Equity Portion This is the FV of the option less the debt portion calculated above at grant date 224 aCOWtancy.com Illustration An entity grants an employee a right to receive either 8,000 shares or cash to the value, on that date, of 7,000 shares She has to remain in employment for years The market price of the entity's shares is $21 at grant date, $27 at the end of year 1, $33 at the end of year and $42 at the end of the vesting period, at which time the employee elects to receive the shares The entity estimates the fair value of the share route to be $19 Show the accounting treatment Solution The fair value of the cash route at grant date is: 7,000 × $21 = $147,000
 The fair value of the share route is: 8,000 × $19 = $152,000 - 147,000 = $5,000 We then treat them as cash and equity settled SBPs as appropriate: Year Cash 7,000 x $27 x 1/3 63,000 7,000 x $33 x 2/3 154,000 7,000 x $42 x 3/3 294,000 Equity 5,000 x 1/3 1,667 5,000 x 1/3 1,667 5,000 x 1/3 1,667 I/S 64,667 92,667 141,667 Entity has the choice of issuing shares or cash Option - Obligated to pay cash The entity is prohibited from issuing shares or where it has a stated policy, or past practice, of issuing cash rather than shares Treat as a cash-settled SBP Option - Not obligated to pay cash Treat as if it was purely an equity-settled transaction If on settlement, cash was actually paid, the cash should be treated as if it was a repurchase of the equity instrument by a deduction against equity.
 225 aCOWtancy.com Vesting Period This is normally a set amount of time but sometimes it may be dependent upon a condition to be satisfied Vesting Conditions These are conditions that have to be met before the holder gets the right to the shares or share options There are types of Vesting Condition: Non-market based2 Those not relating to the market value of the entity’s shares Market based3 Those linked to the market price of the entity’s shares in some way Non-Market Vesting Conditions Here only the number of shares or share options expected to vest will be accounted for At each period end (including interim periods), the number expected to vest should be revised as necessary Employee completing minimum service; Achieving sales target; EPS target; On flotation; Increase in SP; Increase in shareholder return; Target SP 226 aCOWtancy.com Illustration An entity granted 10,000 share options to one director The director had to work there for years, and indeed he did Also to get the options, the director had to reduce costs by 10% over the vesting period At the end of the first year, costs had reduced by 12% By the end of the 2nd year, costs had only reduced in total by 7% By the end of yr though the costs had been reduced by 11% The FV of the option at grant date was $21 How should the transaction be recognised? Solution The cost reduction target is a non-market performance condition which is taken into account in estimating whether the options will vest The expense recognised in profit or loss in each of the three years is: Year Year (performance target not expected to be met) Year 227 Yearly Charge Cumulative (10,000 × £21)/3 years = 70,000 70,000 -70,000 (10,000 x $21) 210,000 210,000 aCOWtancy.com Market Vesting Conditions These conditions are taken into account when calculating the fair value of the equity instruments at the grant date They are not taken into account when estimating the number of shares or share options likely to vest at each period end If the shares or share options not vest, any amount recognised in the financial statements will remain Make an estimate of the vesting period at the acquisition date If vesting period is shorter than original estimate Expense all the remainder in the year the vesting condition is complied with If vesting period is longer than the original estimate Expense still using the original estimate of vesting period Market and non-market based vesting conditions together Where both market and non-market vesting conditions exist, then as long as the non market conditions are met the company must expense (irrespective of whether market conditions are satisfied) So, where market and non-market conditions co-exist, it makes no difference whether the market conditions are achieved The possibility that the target share price may not be achieved has already been taken into account when estimating the fair value of the options at grant date 228 aCOWtancy.com Therefore, the amounts recognised as an expense in each year will be the same regardless of what share price has been achieved Illustration A company granted 10,000 share options to a director He must work there for years He did this Also the share price should increase by at 25% over the three-year period During the 1st year the share price rose by 30% and by 26% compound over the first two years and 24% per annum compound over the whole period At the date of grant the fair value of each share option was estimated at £184 How should the transaction be recognised? Solution The director satisfied the service requirement but the share price growth condition was not met The share price growth is a market condition and is taken into account in estimating the fair value of the options at grant date Therefore, no adjustment should be made if there are changes from that estimated in relation to the market condition There is no write-back of expenses previously charged, even though the shares not vest The expense recognised in profit or loss in each of the three years is one third of 10,000 x £18 = £60,000 Remember this would already include the probability of meeting the 25% increase over the years 229 aCOWtancy.com IFRS Share based payments deferred tax Deferred tax implications Issue An entity recognises an expense for share options but the taxman offers the tax deduction on the later exercise date This is therefore an example of accounts showing more expenses (than the taxman has allowed so far) and so a deferred tax asset occurs The taxman may calculate his expense on the intrinsic value basis This may offer a greater deduction (at the end) than our expense This extra deferred tax asset is set off against equity (and OCI) not the income statement Illustration An entity granted 1,000 share options to an employee vesting years later The fair value of at the grant date was $3.
 Tax law allows a tax deduction of the intrinsic value of$1.20 at the end of year and $3.40 at the end of year 2.
 Assume a tax rate of 30% Solution Year Accounts 
 1,000 x 1/3 x = 1,000 Tax 
 Has allowed 0
 However, at the end he will allow 1,000 x 1/3 x 1.2 = 400 230 aCOWtancy.com Therefore the deferred tax asset is capped at 400 So, the double entry is:
 Dr Deferred Tax Asset (400x30%) 120
 Cr Tax (I/S) 120 Year 2 
 
 Accounts 
 1,000 x 2/3 x - 1,000 = 1,000 Tax 
 1,000 x 2/3 x 3.4 - 400 = 1.867 Therefore we have expensed 2,000 (1,000 + 1,000)
 The tax man will allow at the end 2,267 (400 + 1,867)
 So, the deferred tax asset should now be 2267 x 30% = 680 Of this only 2,000 x 30% = 600 should have gone to the income statement (to match with the 2,000 expense).
 The remaining 80 should have gone to equity 
 Year 2
 Income statement 
 Expense 1,000
 Tax (600 - 120) -480 Equity 
 Share Options 2,000
 Tax asset 80 Double entry 
 Dr Deferred tax asset (680-120) 560
 Cr Income statement 480
 Cr Equity 80 231 aCOWtancy.com IFRS Modifications and Cancellations The entity might:
 Reprice (modify) share options, or Cancel or settle the options Equity instruments may be modified before they vest 
 For example, a fall in the actual share price may mean that the original option exercise price is no longer attractive Therefore the exercise price is reduced (the option is ‘re-priced’) to make it valuable again 
 Such modifications will often affect the fair value of the instrument and therefore the amount recognised in profit or loss 
 Accounting treatment Continue to recognise the original fair value of the instrument in the normal way (even where the modification has reduced the fair value) Recognise any increase in fair value at the modification date (or any increase in the number of instruments granted as a result of modification) spread over the period between the modification date and vesting date If modification occurs after the vesting date, then the additional fair value must be recognised immediately unless there is, for example, an additional service period, in which case the difference is spread over this period Illustration At the beginning of year 1, an entity grants 100 share options to each of its 500 employees over a vesting period of years at a fair value of $15 Year 1 
 40 leave, further 70 expected to leave; share options repriced (as mv of shares has fallen) as the FV had fallen to $5 After the repricing they are now worth $8.
 232 aCOWtancy.com Year 2 
 35 leave, further 30 expected to leave Year 3 
 28 leave 
 Solution 
 The repricing has increased FV by (8-5) = This amount is recognised over the remaining two years of the vesting period, along with remuneration expense based on the original option value of $15 Year   
 Income statement & Equity
 (500-110) x 100 x 1/3 x $15 = 195,000 Year 2 
 Income statement & Equity
 [(500 – 105) × 100 × (($15 × 2/3) + ($3 × ½))]  454,250 - 195,000
  
 Dr Expenses $259,250 Cr Equity $259,250
  
 Year 3 
 Income statement & Equity
 [(500 – 103) × 100 × ($15 + $3 )  714,600 - 454,250 Dr Expenses $260,350
 Cr Equity $260,350
 233 aCOWtancy.com Illustration An entity granted 1,000 share options at an exercise price of £50 to each of its 30 key management personnel They had to stay with the entity for years At grant date, the fair value of the share options was estimated at £20 and the entity estimated that the options would vest with 20 managers This estimate didn’t change in year The share price fell early in the 2nd year So half way through that year they modified the scheme by reducing the exercise price to £15 (The fair value of an option was £2 immediately before the price reduction and £11 immediately after.) It retained its estimate that options would vest with 20 managers How should the modification be recognised? Solution The total cost to the entity of the original option scheme was: 1,000 shares × 20 managers × £20 = £400,000
 This was being recognised at the rate of £100,000 each year The cost of the modification is:
 1,000 x 20 managers × (£11 – £2) = £180,000 This additional cost should be recognised over 30 months, being the remaining period up to vesting, so £6,000 a month The total cost to the entity in the second year and from then on is: £100,000 + (£6,000 × 6) = £136,000 234 aCOWtancy.com Cancellations and settlements 
 An entity may settle or cancel an equity instrument during the vesting period Basically treat this as the vesting period being shortened Accounting treatment Charge any remaining fair value of the instrument that has not been recognised immediately in profit or loss (the cancellation or settlement accelerates the charge and does not avoid it) Any amount paid to the employees by the entity on settlement should be treated as a buyback of shares and should be recognised as a deduction from equity If the amount of any such payment is in excess of the fair value of the equity instrument granted, the excess should be recognised immediately in profit or loss A cash settlement made to an employee on cancellation Dr Equity
 Dr Income statement (excess over amount in equity)
 Cr Cash An equity settlement made to an employee on cancellation This is basically a replacement of the option and so is treated as a modification (see earlier) at this value: Fair value of replacement instruments*  X
 Less: Net fair value of cancelled instruments (X) Illustration 2,000 share options granted at an exercise price of $18 to each of its 25 key management personnel The management must stay for years The fair value of the options was estimated at $33 and the entity estimated that the options would vest with 23 managers This estimate stayed the same in year 1
 235 aCOWtancy.com In year the entity decided to abolish the existing scheme half way through the year when the fair value of the options was $60 and the market price of the entity's shares was $70 Compensation was paid to the 24 managers in employment at that date, at the rate of $63 per option 
 
 How should the entity recognise the cancellation? Solution 
 The original cost to the entity for the share option scheme was: 2,000 shares × 23 managers × $33 = $1,518,000 
 This was being recognised at the rate of $506,000 in each of the three years 
 At half way through year when the scheme was abolished, the entity should recognise a cost based on the amount of options it had vested on that date The total cost is: 
 2,000 × 24 managers × £33 = $1,584,000
 After deducting the amount recognised in year 1, the year charge to profit or loss is $1,078,000 The compensation paid is: 2,000 × 24 × $63 = $3,024,000
 Of this, the amount attributable to the fair value of the options cancelled is: 
 2,000 × 24 × $60 (the fair value of the option, not of the underlying share) = $2,880,000
 This is deducted from equity as a share buyback The remaining $144,000 ($3,024,000 less $2,880,000) is charged to profit or loss Cancellation and resistance 
 Where an entity has been through a capital restructuring or there has been a significant downturn in the equity market through external factors, an alternative to repricing the share options is to cancel them and issue new options based on revised terms The end result is essentially the same as an entity modifying the original options and therefore should be recognised in the same way 
 236 aCOWtancy.com IFRS Scope Share-based payments can be more than just employee share options, and the trick in the exam is to know which scenarios you apply IFRS to, and which you don’t… It Applies to All Entities 
 There is no exemption for private or smaller entities In fact, subsidiaries using their parent’s or fellow subsidiary’s equity as consideration for goods or services are within the scope of the Standard Goods and Services Only 
 IFRS is used when shares are issued (or rights to shares given) in return for goods and services ONLY What does fall under IFRS • Share appreciation rights • Employee share purchase plans • Employee share ownership plans • Share option plans and • Plans where share issues (or rights to shares) depend on certain conditions What doesn’t fall under IFRS • When shares are issued to buy a subsidiary (rather than for employing the subs directors primarily).
 So, in a question, care should be taken to distinguish share-based payments related to the acquisition from those related to employee services • When the item is being paid for with shares is a commodity-based derivative (such as those dealing with the price of gold, oil etc.) These are IFRS financial instruments instead.
 237 aCOWtancy.com Syllabus C9 Fair Value Measurement Syllabus C9a) Discuss and apply the definitions of ‘fair value’ measurement and ‘active market’ Fair Value Measurement IFRS 13 defines Fair Value using an 'exit price' notion and a 'fair value hierarchy' So it's a market-based, rather than entity-specific, measurement Fair Value Definition The price that would be received  / paid   in an orderly transaction between market participants Active Market Definition A market with sufficient frequency and volume to provide pricing information on an ongoing basis Exit Price Definition The price that would be received (to sell an asset) or paid (to transfer a liability) Overview of Approach A fair value measurement requires an entity to determine all of the following: • The particular asset (liability) and its unit of account • For a non-financial asset: An appropriate valuation premise (it's highest and best use) • Its principal (or most advantageous) market • Its appropriate valuation technique using market data and the fair value hierarchy 238 aCOWtancy.com Syllabus C9b) Discuss and apply the ‘fair value hierarchy’ The ‘Fair Value Hierarchy’ This hierarchy aims to increase consistency and comparability in fair value measurements  So it categorises the inputs used in valuation techniques into three levels.  Highest priority given to quoted prices in active markets for identical assets  Lowest priority to unobservable inputs Level inputs are Quoted prices in accessible active markets for identical assets
 These give the most reliable evidence of fair value and are used without adjustment
 (This is used even if the market's cannot absorb the quantity held by the entity) Level inputs are observable inputs (other than quoted market prices) 
 Level inputs include:
 Quoted prices for similar assets in active markets 
 Inputs that are corroborated by observable market data by correlation for example ('market-corroborated inputs') Level inputs are unobservable inputs for the asset 
 Use the best information available in the circumstances, eg Your own data, taking into account all information about market participant assumptions that is reasonably available 239 aCOWtancy.com Syllabus C9c) Discuss and apply the principles of highest and best use, most advantageous and principal market C9d) Explain the circumstances where an entity may use a valuation technique Highest and Best Use The use of a non-financial asset by market participants that would maximise the value of the business using it Most Advantageous Market The market that maximises the amount received (after transaction costs and transport costs) Principal Market The market with the greatest volume and level of activity Guidance On Measurement Take into account the condition, location & any restrictions placed on the asset Fair value assumes a transaction taking place in the principal market for the asset 
 (In the absence of a principal market, the most advantageous market is used) Fair value of a non-financial asset uses its highest and best use The fair value of a liability reflects non-performance risk and own credit risk Valuation Techniques 240 aCOWtancy.com Valuation techniques should maximise the use of observable and minimise unobservable inputs Three widely used valuation techniques are shown below Sometimes, just one technique is appropriate, other times multiple techniques: • Market approach
 Uses prices generated by market transactions involving identical or comparable (similar) assets • Income approach
 Converts future cash flows to a single current (discounted) amount (reflecting current market expectations about those future amounts) • Cost approach
 The amount needed to replace the service capacity of an asset (current replacement cost) 241 aCOWtancy.com Syllabus C10 Reporting requirements of small and medium-sized entities (SMEs) Syllabus C10a) Discuss the key differences in accounting treatment between full IFRS and the IFRS for SMEs Syllabus C10b) Discuss and apply the simplifications introduced by IFRS for SMEs IFRS for SME - Introduction The principal aim when developing accounting standards for small-to medium-sized enterprises (SMEs) is to provide a framework that generates relevant, reliable and useful information, which should provide a high-quality and understandable set of accounting standards suitable for SMEs.  The only real users of accounts for SMEs are: 1) Shareholders 2) Management 3) Possibly government   IFRS for SMEs is a self-contained standard, incorporating accounting principles based on existing IFRS, which have been simplified to suit SMEs If a topic is not covered in the standard there is no mandatory default to full IFRS Topics not really required for SMEs are excluded and so the standard does not address the following topics: • Earnings per share  • Interim financial reporting  • Segment reporting  • Insurance (because entities that issue insurance contracts are not eligible to use the standard)  242 aCOWtancy.com • Assets held for sale Good news! The standards are relatively short and get the preparers to think IFRS for SMEs therefore contains concepts and pervasive principles, any further disclosures may be needed to give a true and fair view It will be updated once every or years only   What is an SME? There is no universally agreed definition of an SME As there are differences between firms, sectors, or countries at different levels of development Most definitions based on size use measures such as number of employees, balance sheet total, or annual turnover However, none of these measures apply well across national borders.  Ultimately, the decision regarding who uses IFRS for SMEs stays with national regulatory authorities and standard-setters These bodies will often specify more detailed eligibility criteria If an entity opts to use IFRS for SMEs, it must follow the standard in its entirety – it cannot cherry pick between the requirements of IFRS for SMEs and the full set   Different users entirely  IFRS users are the capital markets So, quoted companies and not SMEs.  The vast majority of the world's companies are small and privately owned, and it could be argued that full International Financial Reporting Standards are not relevant to their needs or to their users It is often thought that small business managers perceive the cost of compliance with accounting standards to be greater than their benefit Because of this, the IFRS for SMEs makes numerous simplifications to the recognition, measurement and disclosure requirements in full IFRS 
 243 aCOWtancy.com Examples of these simplifications are: Goodwill and other indefinite-life intangibles are amortised over their useful lives, but if useful life cannot be reliably estimated, then 10 years.  A simplified calculation is allowed if measurement of defined benefit pension plan obligations (under the projected unit credit method) involve undue cost or effort.  The cost model is permitted for investments in associates and joint ventures.
 244 aCOWtancy.com Differing approaches Some argue having sets of rules may mean true and fair views  Local GAAP for SME? An alternative could have been for GAAP for SMEs to have been developed on a national basis, with IFRS focusing on accounting for listed company activities Then though, SMEs may not have been consistent and may have lacked comparability across national boundaries Also, if an SME wished to later list its shares on a capital market, the transition to IFRS could be harder.    List SME exemptions in the full IFRS? Under another approach, the exemptions given to smaller entities would have been prescribed in the mainstream accounting standard For example, an appendix could have been included within the standard, detailing those exemptions given to smaller enterprises.  Separate SME standard for each IFRS? Yet another approach would have been to introduce a separate standard comprising all the issues addressed in IFRS that were relevant to SMEs.    245 aCOWtancy.com As it stands now User friendly The standard has been organised by topic with the intention of being user-friendlier for preparers and users of SME financial statements The standard also contains simplified language and explanations of the standards Easier transition to full IFRS It is based on recognised concepts and pervasive principles and it allows easier transition to full IFRS if the SME later becomes a public listed entity In deciding on the modifications to make to IFRS, the needs of the users have been taken into account, as well as the costs and other burdens imposed upon SMEs by the IFRS.    Cost Benefit Relaxation of some of the measurement and recognition criteria in IFRS had to be made in order to achieve the reduction in these costs and burdens.  Stewardship not so important Small companies pursue different strategies, and their goals are more likely to be survival and stability rather than growth and profit maximisation The stewardship function is often absent in small companies, with the accounts playing an agency role between the owner-manager and the bank Access to capital Where financial statements are prepared using the standard, the basis of presentation note and the auditor's report will refer to compliance with IFRS for SMEs This reference may improve SME's access to capital 246 aCOWtancy.com In the absence of specific guidance on a particular subject, an SME may, but is not required to, consider the requirements and guidance in full IFRS dealing with similar issues The IASB has produced full implementation guidance for SMEs IFRS for SMEs is a response to international demand from developed and emerging economies for a rigorous and common set of accounting standards for smaller and medium-sized enterprises that is much easier to use than the full set of IFRS.   It should provide improved comparability for users of accounts while enhancing the overall confidence in the accounts of SMEs, and reduce the significant costs involved in maintaining standards on a national basis 247 aCOWtancy.com Main Changes Financial statements Full IFRS: A statement of changes in equity is required, presenting a reconciliation of equity items between the beginning and end of the period IFRS for SMEs: Same requirement However, if the only changes to the equity during the period are a result of profit or loss, payment of dividends, correction of prior-period errors or changes in accounting policy, a combined statement of income and retained earnings can be presented instead of both a statement of comprehensive income and a statement of changes in equity Business combinations Full IFRS: Transaction costs are excluded under IFRS (revised) Contingent consideration is recognised regardless of the probability of payment IFRS for SMEs: Transaction costs are included in the cost of investment Contingent considerations are included as part of the cost of investment if it is probable that the amount will be paid and its fair value can be measured reliably Expense recognition Full IFRS: Research costs are expensed as incurred; development costs are capitalised and amortised, but only when specific criteria are met Borrowing costs are capitalised if certain criteria are met IFRS for SMEs: All research and development costs and all borrowing costs are recognised as an expense 
 248 aCOWtancy.com Non-current assets and goodwill Full IFRS: For tangible and intangible assets, there is an accounting policy choice between the cost model and the revaluation model Goodwill and other intangibles with indefinite lives are reviewed for impairment and not amortised IFRS for SMEs: The cost model is the only permitted model All intangible assets, including goodwill, are assumed to have finite lives and are amortised Intangible Assets Full IFRS: Under IAS 38, ‘Intangible assets’, the useful life of an intangible asset is either finite or indefinite The latter are not amortised and an annual impairment test is required IFRS for SMEs: There is no distinction between assets with finite or infinite lives The amortisation approach therefore applies to all intangible assets These intangibles are tested for impairment only when there is an indication Investment Property Full IFRS: IAS 40, ‘Investment property’, offers a choice of fair value and the cost method IFRS for SMEs: Investment property is carried at fair value if this fair value can be measured without undue cost or effort Held for Sale Full IFRS: IFRS 5, ‘Non-current assets held for sale and discontinued operations’, requires non-current assets to be classified as held for sale where the carrying amount is recovered principally through a sale transaction rather than though continuing use 
 249 aCOWtancy.com IFRS for SMEs: Assets held for sale are not covered, the decision to sell an asset is considered an impairment indicator Employee benefits – defined benefit plans Full IFRS: The use of an accrued benefit valuation method (the projected unit credit method) is required for calculating defined benefit obligations IFRS for SMEs: The circumstance-driven approach is applicable, which means that the use of an accrued benefit valuation method (the projected unit credit method) is required if the information that is needed to make such a calculation is already available, or if it can be obtained without undue cost or effort If not, simplifications are permitted in which future salary progression, future service or possible mortality during an employee’s period of service are not considered Income taxes Full IFRS: A deferred tax asset is only recognised to the extent that it is probable that there will be sufficient future taxable profit to enable recovery of the deferred tax asset IFRS for SMEs: A valuation allowance is recognised so that the net carrying amount of the deferred tax asset equals the highest amount that is more likely than not to be recovered The net carrying amount of deferred tax asset is likely to be the same between full IFRS and IFRS for SMEs Full IFRS: No deferred tax is recognised upon the initial recognition of an asset and liability in a transaction that is not a business combination and affects neither accounting profit nor taxable profit at the time of the transaction IFRS for SMEs: No such exemption Full IFRS: There is no specific guidance on uncertain tax positions In practice, management will record the liability measured as either a single best estimate or a 250 aCOWtancy.com weighted average probability of the possible outcomes, if the likelihood is greater than 50% IFRS for SMEs: Management recognises the effect of the possible outcomes of a review by the tax authorities It should be measured using the probability-weighted average amount of all the possible outcomes There is no probable recognition threshold 251 aCOWtancy.com Syllabus C11 Other Reporting Issues Syllabus C11a) Discuss and apply the accounting for, and disclosure of, government grants and other forms of government assistance Government Grants Government grants are a form of government assistance When can you recognise a government grant? When there is reasonable assurance that: • The entity will comply with any conditions attached to the grant and • the grant will be received However, IAS 20 does not apply to the following situations: Tax breaks from the government Government acting as part-owner
  of the entity Free technical or marketing advice Accounting treatment of government grants Dr Cash The debit is always cash so we only have to know where we put the credit There are approaches - depending on what the grant is given for: • Capital Grant approach:
  (Given for Assets - For NCA such as machines and buildings)
 Recognise the grant outside profit or loss initially:
 Dr Cash
 252 aCOWtancy.com Cr Cost of asset
 or
 Cr Deferred Income • Income Grant approach:
 (Given for expenses - For I/S items such as wages etc)
 Recognise the grant in profit or loss
 Dr Cash 
 Cr Other income (or expense) Capital Grant approach - accounting for as "Cr Cost of asset" • Dr Cash Cr Cost of  asset
 This will have the effect of reducing depreciation on the income statement and the asset on the SFP • An Example
 Asset $100 with 10yrs estimated useful life
 Received grant of $50
 Accounting for a grant received:
 DR Cash $50
 CR Asset $50
 At the Y/E
 Depreciation charge:
 DR Depreciation expense (I/S) (100-50)/10yrs = $5
 CR Accumulate depreciation $5 Capital Grant approach - accounting for as "Cr Deferred Income" • Dr Cash 
 Cr Deferred Income
 This will have the effect of keeping full depreciation on the income statement and the full asset and liability on the SFP
 Then 
 Dr Deferred Income 
 Cr Income statement (over life of asset)
 This will have the effect of reducing the liability and the expense on the income statement 253 aCOWtancy.com • An Example
 Asset $100 with 10yrs estimated useful life
 Received grant of $50
 Accounting for a grant received:
 DR Cash $50
 CR Deferred income $50
 At the Y/E
 Depreciation charge:
 DR Depreciation expense (I/S) 100/10yrs = $10
 CR Accumulate depreciation $10
 Release of deferred income:
 DR Deferred income 50/10yrs =$5
 CR I/S $5 Conditions These may help the company decide the periods over which the grant will be earned.  It may be that the grant needs to be split up and taken to the income statement on different bases Compensation The grant may be for compensation on expenses already spent.  Or it might be just for financial support with no actual related future costs Whatever the situation, the grant should be recognised in profit or loss when it becomes receivable NB If a condition might not be met then a contingent liability should be disclosed in the notes Similarly if it has already not been met then a provision is required 254 aCOWtancy.com Non-monetary government grants Think here, for example, of the government giving you some land (ie not cash).  To put a value on it - we use the Fair Value   Alternatively, both may be valued at a nominal amount Repayment of government grants This means when we are not allowed the grant anymore and so have to repay it back.  This would be a change in accounting estimate (IAS 8) and so you not change past periods just the current one Accounting treatment (capital grant repayment): 
 • Dr Any deferred Income Balance or Dr Cost of asset
 • Dr Income statement with any balance
 and CR cash with the amount repaid 
 The extra depreciation to date that would have been recognised had the grant not been netted off against cost should be recognised immediately as an expense Accounting treatment - Income Grant Repayment
 Dr Income statement
 Cr Cash 255 aCOWtancy.com Syllabus C11b) Discuss and apply the principles behind the initial recognition and subsequent measurement of a biological asset or agricultural produce Accounting for Biological Assets Learn by Doing! Try our revolutionary new technique - where you literally learn by doing HERE :) No teaching, nada.
 256 aCOWtancy.com Syllabus C11c) Outline the principles behind the application of accounting policies and measurement in interim reports IAS 34 Interim Financial Reporting Entities whose shares are publicly traded should produce interim financial reports Definitions Interim period
 is a financial reporting period shorter than a full financial year Interim financial report
 means a financial report containing either a complete set of FS or set of condensed FS for an interim period Scope The standard does not make the preparation of interim financial reports mandatory The IASB strongly recommend to governments that interim reporting should be a requirement for companies whose equity or debt securities are publicly traded • An interim financial report should  be produced for at least the first months of their financial year • The report should be available no later than 60 days after the end of the interim period • E.g A company with a year end (Y/E) ending 31 December will prepare an interim report for the half year to  30 June.
 This report will be available before the end of August 257 aCOWtancy.com Minimum Content of an Interim Financial Report • a condensed balance sheet, • a condensed income statement, • a condensed statement of changes in equity, • a condensed cash flow statement and • selected explanatory notes If the entity provides a complete set of FS then it should comply with IAS If condensed, they should include each of the headings and sub-totals included in the most recent annual financial statements and the explanatory notes required by IAS 34 Additional line-items should be included if their omission would make the interim financial information misleading The interim accounts are designed to provide an update so should focus on new events and not duplicate info already reported on Measurement Items are measured on a year to date basis Lets say a company produces quarterly interim accounts and in the first quarter it writes off some inventory, but then in the next quarter it actually sells it In the second quarter interim accounts therefore the write down is reversed Estimates These will be used more heavily in interim accounts Pensions
 No need for an actuarial valuation Just use the most recent and roll it forward Provisions
 No need for expert guidance at the interim stage 258 aCOWtancy.com Inventories
 No need for a full stock count Make an estimate based in sales margins to get a valuation Recognition Intangible Assets
 If development costs not meet the capitalisation criteria at the interim date they should not be capitalised, even if they are expected to be reached by the financial year end Tax
 This should be accrued using the tax rate that would be applicable to total expected earnings The periods to be covered by the interim financial statements are as follows: Balance sheet  
 as of the end of the current interim period and a comparative balance sheet as of the end of the immediately preceding financial year; Income statements  
 for the current interim period and cumulatively for the current financial year to date, with comparative income statements for the comparable interim periods of the immediately preceding financial year; Changes in equity  
 cumulatively for the current financial year to date, with a comparative statement for the comparable year-to-date period of the immediately preceding financial year; and Cash flow statement 
 cumulatively for the current financial year to date, with a comparative statement for the comparable year-to-date period of the immediately preceding financial year If the company's business is highly seasonal, IAS 34 encourages disclosure of financial information for the latest 12 months, and comparative information for the prior 12-month period, in addition to the interim period financial statements
 259 aCOWtancy.com Syllabus C11d) Discuss and apply the judgments required in selecting and applying accounting policies, accounting for changes in estimates and reflecting corrections of prior period errors IAS Accounting policies and estimates Comparatives are changed for accounting POLICY changes only Changes in accounting estimates have no effect on the comparative Changes in accounting policy means we must change the comparative too to ensure we keep the accounts comparable for trend analysis Accounting Policy Definition “the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting the financial statements” An entity should follow accounting standards when deciding its accounting policies If there is no guidance in the standards, management should use the most relevant and reliable policy 260 aCOWtancy.com Changes to Accounting Policy These are only made if: - It is required by a Standard or Interpretation; or - It would give more relevant and reliable information • Adjust the comparative amounts for the affected item
 (as if the policy had always been applied) • Adjust Opening retained earnings
 (Show this in statement of changes in Equity too) Accounting Estimates Definition “an adjustment of the carrying amount of an asset or liability, or related expense, resulting from reassessing the expected future benefits and obligations associated with that asset or liability” Examples Allowances for doubtful debts; Inventory obsolescence; A change in the estimate of the useful economic life of property, plant and equipment Changes in Accounting Estimate Simply change the current year No change to comparatives 261 aCOWtancy.com Prior Period Errors These are accounted for in the same way as changes in accounting policy Accounting treatment • Adjust the comparative amounts for the affected item • Adjust Opening retained earnings
 (Show this in statement of changes in Equity too)
 262 aCOWtancy.com Syllabus D: FINANCIAL STATEMENTS OF GROUPS OF ENTITIES Syllabus D1 Group accounting including statements of cash flows Syllabus D1a) Discuss and apply the principles behind determining whether a business combination has occurred Has a Business Combination Occurred? Is a transaction a business combination? IFRS provides this guidance: Can be by: 
 Giving Cash
 Taking on Liabilities
 Issuing Shares, or 
 by not issuing consideration at all (i.e by contract alone) Structures can be: 
 eg.
 An entity becoming a subsidiary of another
 An entity transfers its Net assets to another or to a new entity There must be an acquisition of a business
 263 aCOWtancy.com A business generally has elements
 Inputs 
 An economic resource (e.g PPE) that creates outputs when one or more processes are applied to it 
 Process
 A system when applied to inputs, creates outputs
 Output 
 The result of inputs and processes
 264 aCOWtancy.com Syllabus D1b) Discuss and apply the method of accounting for a business combination including identifying an acquirer and the principles in determining the cost of a business combination Method Of Accounting For Business Combinations Acquisition Method The Acquisition Method is used for all business combinations Steps in applying it are: Identifying the 'Acquirer' Determining the 'Acquisition Date' Recognising (and measuring) the identifiable assets acquired, the liabilities assumed and any NCI (non-controlling Interest) Recognising (and measuring) Goodwill (or a gain from a Bargain Purchase) Identifying an Acquirer This is the entity that obtains 'control' of the Acquire IFRS provides additional guidance: • The Acquirer usually transfers cash (or other assets) • The Acquirer usually issues shares (where the transaction is effected in this manner)
 You must also consider though:
 Relative voting rights in the combined entity after the business combination
 A large minority interest when no other owner has a significant voting interest 
 The composition of the board and senior management of the combined entity 
 The terms on which equity interests are exchanged
 265 aCOWtancy.com • The acquirer usually has the largest relative size (assets, revenues or profit) • For business combinations involving multiple entities, look for who initiated the combination, and the relative sizes of the combining entities 
 266 aCOWtancy.com Syllabus D1b) Discuss and apply the method of accounting for a business combination including identifying an acquirer and the principles in determining the cost of a business combination Syllabus D1f) Discuss and apply the application of the control principle Group Accounting Presentation According to IAS accounts must distinguish between: Profit or Loss for the period Other gains or losses not reported in profits above (Other Comprehensive Income) Equity transactions (share issues and dividends) Terminology Consolidated financial statements: The financial statements of a group presented as those of a single economic entity Parent An entity that has one or more subsidiaries Control The power to govern the financial and operating policies of an entity so as to obtain benefits from its activities Two or more investors can control when they act together to direct the activities of the subsidiary However, if one party cannot individually control then it is not a subsidiary Instead it is accounted for as a Joint Venture
 267 aCOWtancy.com Subsidiary This is a company controlled by the parent Identification of subsidiaries Control is presumed when the parent has 50% + voting rights of the entity It could also come from the parent controlling one subsidiary, which in turn controls another The parent then controls both subsidiaries Even when less than 50%, control may be evidenced by power • Getting the 50%+ by an arrangement with other investors • Governing the financial and operating policies • Appointing the majority of the board of directors • Casting the majority of votes Power So a parent needs the power to affect the subsidiary and as we said before this is normally given by owning more than 50% of the voting rights It might also come from complex contractual arrangements 268 aCOWtancy.com Syllabus D1c) Apply the recognition and measurement criteria for identifiable acquired assets and liabilities including contingent amounts and intangible assets Recognition and Measurement of Net Assets Acquired Acquired Assets And Liabilities Recognition Principle 
 Identifiable Assets (& Liabs) and NCI are recognised separately from goodwill Measurement Principle 
 All assets and liabilities are measured at acquisition-date FAIR VALUE The acquirer looks at the contractual terms, economic conditions, operating and accounting policies at the acquisition date For example, this might mean separating embedded derivatives from host contracts (See later in the course!) However, Leases & Insurance contracts are classified on the basis of conditions in place at the inception of the contract Intangible Assets Acquired These must be recognised and measured at fair value even if the acquiree didn't recognise them before 
 This is because there is always sufficient information to reliably measure the fair value of these assets on acquisition Contingent Liabilities Until settled, these are measured at the higher of:
 1)  The amount that would be recognised under IAS 37 Provisions
 2)  The amount less accumulated amortisation under IFRS 15 Revenue.
 269 aCOWtancy.com Syllabus D1d) Discuss and apply the accounting for goodwill and non-controlling interest Business combinations - the basics The purpose of consolidated accounts is to show the group as a single economic entity So first of all - what is a business combination? Well my little calf, it’s an event where the acquirer obtains control of another business 
 Let me explain, let’s say we are the Parent acquiring the subsidiary 
 We must prepare our own accounts AND those of us and the sub put together (called “consolidated accounts”)
 This is to show our shareholders what we CONTROL Basic principles The accounts show all that is controlled by the parent, this means: • All assets and liabilities of a subsidiary are included • All income and expenses of the subsidiary are included Non controlling Interest (NCI) However the parent does not always own all of the above So the % that is not owned by the parent is called the “non-controlling interest”.
 270 aCOWtancy.com • A line is included in equity called non-controlling interests This accounts for their share of the assets and liabilities on the SFP • A line is also included on the income statement which accounts for the NCI’s share of the income and expenses One Thing you must understand before we go on Forgive me if this is basic, but hey, sometimes it’s good to be sure Notice if you add the assets together and take away the liabilities for H - it comes to 400 (500+200+100-100-300) There are things to understand about this figure: It is NOT the true/fair value of the company It is equal to the equity section of the SFP Equity • This shows you how the net assets figure has come about The share capital is the capital introduced from the owners (as is share premium) 271 aCOWtancy.com • The reserves are all the accumulated profits/losses/gains less dividends since the business started Here the figure is 400 for H.
 Notice it is equal to the net assets Acquisition costs • Where there’s an acquisition there’s probably some of the costs eg legal fees etc
 Costs directly attributable to the acquisition are expensed to the income statement • Be careful though, any costs which are just for the parent (acquirer)  issuing its own debt or shares are deducted from the debt or equity itself (often share premium).
 272 aCOWtancy.com Syllabus D1d) Discuss and apply the accounting for goodwill and non-controlling interest Goodwill Simple Goodwill When a company buys another - it is not often that it does so at the fair value of the net assets only This is because most businesses are more than just the sum total of their ‘net assets’ on the SFP Customer base, reputation, workforce etc are all part of the value of the company that is not reflected in the accounts This is called “goodwill” Goodwill only occurs on a business combination Individual companies cannot show their individual goodwill on their SFPs This is because they cannot get a reliable measure, This is because nobody has purchased the company to value the goodwill appropriately.
  
 On a business combination the acquirer (Parent) purchases the subsidiary - normally at an amount higher than the FV of the net assets on the SFP, they buy it at a figure that effectively includes goodwill.  Therefore the goodwill can now be measured and so does show in the group accounts How is goodwill calculated? On a basic level - I hope you can see - that it is the amount paid by the parent less the FV of the subs assets on their SFP.
 273 aCOWtancy.com Let me explain In this example S’s Net assets are 900 (same as their equity remember) This is just the ‘book value’ of the net assets The Fair Value of the net assets may be, say, 1,000 However a company may buy the company for 1.200 So, Goodwill would be 200 The goodwill represents the reputation etc of a company and can only be reliably measured when the company is bought out Here it was bought for 1,200 Therefore, as the FV of the net assets of S was only 1,000 the extra 200 is deemed to be for goodwill The increase from book value 900 to FV 1,000 is what we call a Fair Value adjustment Bargain Purchase This is where the parent and NCI paid less at acquisition than the FV of S’s net assets This is obviously very rare and means a bargain was acquired So rare in fact that the standard suggests you look closely again at your calculation of S’s net assets value because it is strange that you got such a bargain and perhaps your original calculations of their FV were wrong However, if the calculations are all correct and you have indeed got a bargain then this is NOT shown on the SFP rather it is shown as: Income on the income statement in the year of acquisition
 274 aCOWtancy.com Syllabus D1d) Discuss and apply the accounting for goodwill and non-controlling interest NCI in the Goodwill calculation So far we have presumed that the company has been 100% purchased when calculating goodwill Our calculation has been this: Non-controlling Interests Let’s now take into account what happens when we not buy all of S (eg 80%) This means we now have some non-controlling interests (NCI) at 20% The formula changes to this: This NCI can be calculated in ways: 1) Proportion of FV of S’s Net Assets 2) FV of NCI itself
 275 aCOWtancy.com Proportion of FV of S’s Net Assets method This is very straight forward All we is give the NCI their share of FV of S’s Net Assets Consider this: P buys 80% S for 1,000 The FV of S’s Net assets were 1,100 How much is goodwill? The NCI is calculated as 20% of FV of S’s NA of 1,100 = 220 “Fair Value Method” of Calculating NCI in Goodwill • So in the previous example NCI was just given their share of S’s Net assets. 
 They were not given any of their reputation etc. 
 In other words, NCI were not given any goodwill • I repeat, under the proportionate method, NCI is NOT given any goodwill.
 Under the FV method, they are given some goodwill • This is because NCI is not just given their share of S’s NA but actually the FV of their 20% as a whole (ie NA + Goodwill).
 This FV figure is either given in the exam or can be calculated by looking at the share price (see quiz 2).
 276 aCOWtancy.com P buys 80% S for 1,000 The FV of S’s Net assets were 1,100  The FV of NCI at this date was 250 How much is goodwill? Notice how goodwill is now 30 more than in the proportionate example This is the goodwill attributable to NCI NCI goodwill = FV of NCI - their share of FV of S’s NA Remember Under the proportionate method NCI does not get any of S’s Goodwill (only their share of S’s NA) Under the FV method, NCI gets given their share of S’s NA AND their share of S’s goodwill
 277 aCOWtancy.com Syllabus D1d) Discuss and apply the accounting for goodwill and non-controlling interest Equity Table S’s Equity Table As you will see when we get on to doing bigger questions, this is always our first working.  This is because it helps all the other workings Remember that Equity = Net assets Equity is made up of: Share Capital Share Premium Retained Earnings Revaluation Reserve Any other ‘reserve’! If any of the above is mentioned in the question for S, then they must go into this equity table working What does the table look like? 278 aCOWtancy.com Remember that any other reserve would also go in here So how we fill in this table? Enter the "Year end" figures straight from the SFP Enter the "At acquisition" figures from looking at the information given normally in note of the question.  Please note you can presume the share capital and share premium is the same as the year-end figures, so you're only looking for the at acquisition reserves figures Enter "Post Acquisition" figures simply by taking away the "At acquisition" figures away from the "Year end" figures 
 (ie Y/E - Acquisition = Post acquisition) So let's try a simple example (although this is given in a different format to the actual exam let's it this way to start with) A company has share capital of 200, share premium of 100 and total reserves at acquisition of 100 at acquisition and have made profits since of 400 There have been no issues of shares since acquisition and no dividends paid out Show the Equity table to calculate the net assets now at the year end, at acquisition and post-acquisition Solution 279 aCOWtancy.com Fair Value Adjustments Ok the next step is to also place into the Equity table any Fair Value adjustments When a subsidiary is purchased - it is purchased at FAIR VALUE at acquisition Using the figures above, if I were to tell you that the FV of the sub at acquisition was 480.  Hopefully you can see we would need to make an adjustment of 80 (let’s say that this was because Land had a FV 80 higher than in the books): Now as land doesn’t depreciate - it would still now be at 80 - so the table changes to this: 280 aCOWtancy.com If instead the FV adjustment was due to PPE with a 10 year useful economic life left - and lets say acquisition was years ago, the table would look like this: The -16 in the post acquisition column is the depreciation on the FV adjustment (80 / 10 years x years) This makes the now column 64 (80 at acquisition - 16 depreciation post acquisition).
 281 aCOWtancy.com Syllabus D1d) Discuss and apply the accounting for goodwill and non-controlling interest NCI on the SFP Non-Controlling Interests So far we have looked at goodwill and the effect of NCI on this Now let’s look at NCI in a bit more detail (don’t worry we will pull all this together into a bigger question later) If you remember there are methods of measuring NCI at acquisition: Proportionate method
 This is the NCI % of FV of S’s Net assets at acquisitio FV Method
 This is the FV of the NCI shares at acquisition (given mostly in the question) This choice is made at the beginning Obviously, S will make profits/losses after acquisition and the NCI deserve their share of these Therefore the formula to calculate NCI on the SFP is as follows: * This figure depends on the option chosen at acquisition (Proportionate or FV method) 282 aCOWtancy.com Impairment S may become impaired over time If it does, it is S’s goodwill which will be reduced in value first If this happens it only affects NCI if you are using the FV method This is because the proportionate method only gives NCI their share of S’s Net assets and none of the goodwill Whereas, when using the FV method, NCI at acquisition is given a share of S’s NA and a share of the goodwill NCI on the SFP Formula revised 283 aCOWtancy.com Syllabus D1d) Discuss and apply the accounting for goodwill and non-controlling interest Reserves Calculation SFP Group Reserves So far we have looked at how to calculate goodwill and then NCI for the SFP, now we are looking at how to calculate any group reserves on the SFP There could be many reserves (eg Retained Earnings, Revaluation Reserve etc), however they are all calculated the same way Basic Idea The basic idea is that group accounts are written from the Parent companies point of view Therefore we include all of Parent (P’s) reserves plus parent share of Subs post acquisition gains or losses in that reserve Let’s look at an example of this using Retained Earnings Illustration P acquired 80% S when P’s Retained earnings were 1,000 and S’s were 600 Now, P’s RE are 1,400 and S’s RE are 700 What is the RE on the SFP now? It is worth pointing out here that all these workings only really to start to make sense once you start to lots of examples - see my videos for this.
 284 aCOWtancy.com Impairment If Goodwill has been impaired then goodwill will reduce and retained earnings will reduce too However, the amount of the impairment depends on the NCI method chosen: Proportionate NCI method 
 This means that NCI has zero goodwill, so any goodwill impaired all belongs to the parent and so 100% is taken to RE FV method 
 Here NCI is given a share of NCI, so also takes a share of the impairment. 
 Therefore the group only gets its share of the impairment in RE (eg 80%) Illustration P acquired 80% S when P’s Retained earnings were 1,000 and S’s were 600 Now, P’s RE are 1,400 and S’s RE are 700.  P uses the FV method of accounting for NCI and impairment of 40 has occurred since What is the RE on the SFP now? 285 aCOWtancy.com Syllabus D1d) Discuss and apply the accounting for goodwill and non-controlling interest Basic groups - Simple Question Have a look at this question and solution below and see if you can work out where all the figures in the solution have come from Make sure to check out the videos too as these explain numbers questions such as these far better than words can P acquired 80% S when S’s reserves were 80 Prepare the Consolidated SFP, assuming P uses the proportionate method for measuring NCI at acquisition 286 aCOWtancy.com Goodwill NCI Reserves 287 aCOWtancy.com Group SFP Notice 1) Share Capital (and share premium) is always just the holding company 2) All P + S assets are just added together 3) “Investment in S” becomes “Goodwill” in the consolidated SFP 4) NCI is an extra line in the equity section of consolidated SFP
 288 aCOWtancy.com Basic groups - Simple Question P acquired 80% S when S’s Reserves were 40 At that date the FV of S’s NA was 150 Difference is due to Land There have been no issues of shares since acquisition P uses the FV of NCI method at acquisition, and at acquisition the FV of NCI was 35 No impairment of goodwill Prepare the consolidated set of accounts Step 1: Prepare S’s Equity Table
 289 aCOWtancy.com Now the extra 10 FV adjustment now must be added to the PPE when we come to the SFP at the end Step 2: Goodwill Step 3: Do any adjustments in the question : NONE Step 4: NCI Step 5: Reserves 290 aCOWtancy.com Step 6: Prepare the final SFP (with all adjustments included) 291 aCOWtancy.com Syllabus D1g) Determine and apply appropriate procedures to be used in preparing consolidated financial statements Group Income Statement Rule - Add Across 100% Like with the SFP, P and S are both added together All the items from revenue down to Profit after tax; except for: 1) Dividends from Subsidiaries 2) Dividends from Associates Rule - NCI This is an extra line added into the consolidated income statement at the end It is calculated as NCI% x S’s PAT The reason for this is because we add across all of S (see rule 1) even if we only own 80% of S.  We therefore owe NCI 20% of this which we show at the bottom of the income statement Rule - Associates Simply show one line (so never add across an associate).  The line is called “Share in Associates’ Profit after tax” 292 aCOWtancy.com Rule - Depreciation from the Equity table working Remember this working from when we looked at group SFP’s? The -10 from the FV adjustment is a group adjustment So needs to be altered on the group income statement It represents depreciation, so simply put it to admin expenses (or wherever the examiner tells you), be careful though to only out in THE CURRENT YEAR depreciation charge Rule - Time Apportioning This isn’t difficult but can be awkward/tricky Basically all you need to remember is the group only shows POST -ACQUISITION profits i.e Profits made SINCE we bought the sub or associate If the sub or associate was bought many years ago this is not a problem in this year’s income statement as it has been a sub or assoc all year The problem arises when we acquire the sub or the associate mid year Just remember to only add across profits made after acquisition The same applies to NCI (as after all this just a share of S’s PAT).  For example if our year end is 31/12 and we buy the sub or assoc on 31/3 We only add across 9/12 of the subs figures and NCI is % x S’s PAT x 9/12 One final point to remember here is adjustments such as unrealised profits / depreciation on FV adjustments are entirely post - acquisition and so are NEVER time apportioned.
 293 aCOWtancy.com Rule - Unrealised Profit You will remember this table I hope Well the idea stays the same - it’s just how we alter the accounts that changes, because this is an income statement after all and not an SFP So the table you need to remember becomes: Notice how we not need to make an adjustment to reduce the value of inventory This is because we have increased cost of sales (to reduce profits), but we this by actually reducing the value of the closing stock 294 aCOWtancy.com Unrealised Profit The key to understanding this - is the fact that when we make group accounts - we are pretending P & S are the same entity Therefore you cannot make a profit by selling to yourself! So any profits made between two group companies (and still in group inventory) need removing - this is what we call ‘unrealised profit’ Unrealised profit - more detail Profit is only ‘unrealised’ if it remains within the group If the stock leaves the group it has become realised So ‘Unrealised profit” is profit made between group companies and REMAINS IN STOCK Example P buys goods for 100 and sells them to S for 150 S has sold 2/5 of this stock The Unrealised Profit is: Profit between group companies 50 x 3/5 (what remains in stock) = 30 How we then deal with Unrealised Profit If P buys goods for 100 and sells them to S for 150.  Thereby making a profit of 50 by selling to another group company.  S sells 4/5 of them to 3rd parties Unrealised profit is 50 x 1/5 = 10 295 aCOWtancy.com So why we reduce inventory as well as profit? Well let’s say that S buys goods for 100 and sells them to P for 150 and P still has them in stock How much did the stock actually cost the group?  The answer is 100, as they are still in the group.  However P will now have them in their stock at 150.  So we need to reduce stock/inventory also with any unrealised profit.
 296 aCOWtancy.com Intra-Group Balances & In-transit Items Inter-group company balances As with Unrealised Profit - this occurs because group companies are considered to be the same entity in the group accounts Therefore you cannot owe or be owed by yourself So if P owes S - it means P has a payable with S, and S has a receivable from P in their INDIVIDUAL accounts In the group accounts, you cannot owe/be owed by yourself - so simply cancel these out: Dr Payable (in P)
 Cr Receivable (in S) The only time this wouldn’t work is if the amounts didn’t balance, and the only way this could happen is because something was still in transit at the year end This could be stock or cash You always alter the receiving company What I mean is - if the item is in transit, then the receiving company has not received it yet - so simply make the RECEIVING company receive it as follows: Stock in transit In the RECEIVING company’s books: Dr Inventory
 Cr Payable Cash in transit In the RECEIVING company’s books: Dr Cash
 Cr Receivable
 297 aCOWtancy.com Having dealt with the amounts in transit - the inter group balances (receivables/payables) will balance so again you simply: Dr Payable
 Cr Receivable Intra-group dividends eliminate all dividends paid/payable to other entities within the group, and all intragroup dividends received/receivable from other entities within the group.
 298 aCOWtancy.com Impairment of Goodwill Goodwill is reviewed for impairment not amortised An impairment occurs when the subs recoverable amount is less than the subs carrying value + goodwill How this works in practice depends on how NCI is measured - Proportionate or Fair Value method Proportionate NCI Here, NCI only receives % of S's net assets NCI DOES NOT have any share of the goodwill Compare the recoverable amount of S (100%) to NET ASSETS of S (100%) +
 Goodwill (100%) The problem is that goodwill on the SFP is for the parent only - so this needs grossing up first Then find the difference - this is the impairment - but only show the parent % of the impairment Example H owns 80% of S Proportionate NCI Goodwill is 80 and NA are 200 Recoverable amount is 240 How much is the impairment? Solution RA = 240 NA = 200 + G/W (80 x 100/80) = 100 = 300 Impairment is therefore 60 The impairment shown in the accounts though is 80% x 60 = 48.
 299 aCOWtancy.com This is because the goodwill in the proportionate method is parent goodwill only Therefore only parent impairment is shown Fair Value NCI Here, NCI receives % of S's net assets AND goodwill NCI DOES now own some goodwill Compare the recoverable amount of S (100%) to NET ASSETS of S (100%) +
 Goodwill (100%) As, here, goodwill on the SFP is 100% (parent & NCI) - so NO grossing up needed Then find the difference - this is the impairment - this is split between the parent and NCI share Example H owns 80% of S Fair Value NCI Goodwill is 80 and NA are 200 Recoverable amount is 240 How much is the impairment? Solution RA = 240 NA = 200 + G/W 80 = 280 Impairment is therefore 40 The impairment shown in P's RE as 80% x 40 = 32 The impairment shown in NCI is 20% x 40 = Impairment adjustment on the Income Statement Proportionate NCI
 Add it to P's expenses Fair Value NCI
 Add it to S's expenses
 (this reduces S's PAT so reduces NCI when it takes its share of S's PAT) 300 aCOWtancy.com Make sure you use FV of Consideration Consideration is simply what the Parent pays for the sub It is the first line in the goodwill working as follows: Normal Consideration This is straightforward It is simply: Dr Investment in S
 Cr Cash Future Consideration This is a little more tricky but not much Here, the payment is not made immediately but in the future So the credit is not to cash but is a liability Dr Investment in S
 Cr Liability The only difficulty is with the amount As the payment is in the future we need to discount it down to the present value at the date of acquisition 301 aCOWtancy.com Illustration P agrees to pay S 1,000 in years time (discount rate 10%) Dr Investment in S 751 Cr Liability 751 (1,000 / 1.10^3) As this is a discounted liability, we must unwind this discount over the years to get it back to 1,000 We this as follows: Contingent Consideration This is when P MAY OR MAY NOT have to pay an amount in the future (depending on, say, S’s subsequent profits etc.) We deal with this as follows: Dr Investment in S
 Cr Liability All at fair value You will notice that this is exactly the same double entry as the future consideration (not surprising as this is a possible future payment!) The only difference is with the amount Instead of only discounting, we also take into account the probability of the payment actually being made Doing this is easy in the exam - all you is value it at the FV (this will be given in the exam you’ll be pleased to know) Illustration 1/1/x7 H acquired 100% S when it’s NA had a FV of £25m H paid 4m of its own shares (mv at acquisition £6) and cash of £6m on 1/1/x9 if profits hit a certain target.
 302 aCOWtancy.com At 1/1/x7 the probability of the target being hit was such that the FV of the consideration was now only £2m Discount rate of 8% was used At 31/12/x7 the probability was the same as at acquisition At 31/12/x8 it was clear that S would beat the target Show the double entry Contingent consideration should always be brought in at FV Any subsequent changes to this FV post acquisition should go through the income statement Any discounting should always require an winding of the discount through interest on the income statement Double entry - Parent Company 1/1/x7 Dr Investment in S (4m x £6) + £2 = 26 Cr Share Capital Cr Share premium 20 Cr Liability 31/12/x7 Dr interest 0.16 Cr Liability 0.16 31/12/x8 Dr Income statement (6-2) Dr Liability Cr Cash 303 aCOWtancy.com Goodwill - FV of NA (more detail) Goodwill So let’s remind ourselves of the goodwill working: We have just looked in more detail at the sort of surprises the examiner can spring on us in the first line “consideration” - now let´s look at the bottom line in more detail: Fair values of Net Assets at Acquisition Operating leases If terms are favourable to the market - recognise as an asset Internally generated intangibles would now have a reliable measure and would be brought in the consolidated accounts Remember both of these items would need to be depreciated in our equity table working contingent liabilities (see bottom of this page) Illustration 1/7/x5 H acquired 80% S for 16m, nci measured at share of net assets FV of NA was 10m S had a production backlog with a FV of 2m (uel years) and unrecognised trademarks with a FV of 1m These are renewable at any time at a negligible cost S made a profit of 5m in the year to 31/12/x5 What would goodwill be in the consolidated SFP?
 304 aCOWtancy.com FV of NA working Per Accounts 10 + FV adj (2+1)  3 Provisional Goodwill We get “provisional goodwill’ when we cannot say for certain yet what the FV of Net Assets are at the date of acquisition This is fine, we just state in the accounts that the goodwill figure is provisional.  This means we then have 12 months (from the date of acquisition) to change the goodwill figure IF AND ONLY IF the information you find (within those 12 months) gives you more information about the conditions EXISTING at the year-end Any information after the 12 month period (even if about conditions at acquisition) does not change goodwill.  Any differences are simply written off to the income statement So, in summary, the FV of NA can be altered retrospectively if within 12 months of acquisition.  This means goodwill would change Any alteration after 12 months is through the income statement Illustration A acquired 70% B on 1/7/x7, NCI measured at share of net assets acquired.  A provisional fair value only was used for plant and machinery of £8m (UEL 10yrs).  Goodwill was £4m.  The year-end of 31/12/x7 accounts were then approved on 25/2/x8 On 1/4/x8 the FV of the plant was finalised at 7.2m How would this affect the consolidated accounts? Provisional goodwill is acceptable if disclosed as such in the accounts.
 305 aCOWtancy.com The parent then has one year after acquisition to finalise the FV and alter goodwill Should the finalisation occur after one year - no adjustment is required to goodwill Provisional Goodwill 4m Adjusted Goodwill Original 4m + (0.8 x 70%) = 4.56m Contingent liabilities Normally these are just disclosures in the accounts.  However, remember that when a sub is acquired, it is brought into the accounts at FV.  A contingent liability does have a fair value.  Therefore they must be actually recognised in the consolidated accounts until the amount is actually paid So the rules are: Bring in at the FV Measure afterwards at this amount unless it then becomes probable As usual, a probable liability is then measured at the full liability Note If it remains just possible then keep it at the initial FV until it is either written off or paid Illustration 1/7/x6 P acquired all of S when it’s NA had a CV of £2m However, they had disclosed a contingent liability This has a FV of £150,000 1/12/x7 this potential liability was paid at an amount of £200,000 How are the accounts affected? Well we would bring it into the equity table (at acquisition column) in the workings at its FV of 150 This would affect goodwill working accordingly Keep it at this amount until it either becomes probable (show at full amount) or paid Here it is paid so the year end would show no liability - and the post-acquisition column +150 This would then affect the NCI and reserves working accordingly The extra 50 paid will have already been taken into account when the full amount was paid
 306 aCOWtancy.com Syllabus D1e) Apply the accounting principles relating to a business combination achieved in stages Step Acquisitions When Control is achieved is the key date Consolidation only occurs when control is eventually achieved When Control is achieved this occurs: Remeasure all previous holdings to FV Any gain or loss to income statement Illustration P acquired 10% of S in year for 100 P acquired a further 60% of S in year for 800 At this date, the original 10% now has a FV of 140 How would this be accounted for? The key date of when controlled is achieved is year At this date we must: • Revalue the original 10% from 100 to 140 • The 40 gain goes to the income statement (and retained earnings) • Also we would now start consolidating S (as we now control it) The Consideration figure in the goodwill working would now be 940 (140 + 800) Further acquisition after control is achieved If there are further acquisitions after control - this is deemed to be a purchase from the other owners (NCI) - so no profit is calculated Simply Here you will need to the following calculation: 307 aCOWtancy.com Illustration H acquired 60% S for 100 in year when the FV of its NA was 90 Proportionate NCI method is used years later its NA are 150 and H acquires another 20% for 80 Calculate decrease in NCI and movement in parents equity for the latest acquisition NCI SO NCI was 60 (representing 40%) Now, by acquiring a further 20% from the NCI, this means NCI will go from 40% to 20% It has halved So NCI has gone down by 30.
 308 aCOWtancy.com Comprehensive Examples - Step AcquisitionJoint Arrangements (IFRS 11) Comprehensive Question SFP for YEAR P acquired 30% S in year for 60 It acquired another 30% in year for 140 S’s reserves were 10 in year and 60 in year FV of S’s NA in year was 120 and in year 190 Difference is due to Land FV of NCI in year was 90 FV of 30% holding in Year is 120 P acquired a further 10% of S on the last day of year for 50 Show the Consolidated SFP at the end of year 309 aCOWtancy.com Solution Step 1: Equity Table Step 2: Goodwill Step 3: NCI 310 aCOWtancy.com Step 4: Further Acquisition from NCI Step 5: Reserves Final Answer
 311 aCOWtancy.com Syllabus D1h) Discuss and apply the implications of changes in ownership interest and loss of control Partial Disposals A partial disposal means selling but keeping control - so we must keep above 50% ownership afterwards e.g Selling from 80% to 60% As we keep control, then the sale must be to those who not have control - the NCI NCI will therefore increase after a partial disposal Therefore, this is just an exchange between the owners of the business (controllers and non-controllers) and so any gain or loss must go to EQUITY (other reserves) not Income statement How is the gain or loss calculated? How you calculate the ‘Increase in NCI’ line? 312 aCOWtancy.com What is the double entry for the disposal? What is the Income Statement Effect? The subsidiary is still consolidated in full NCI % is time apportioned (eg 20% to date of disposal, 40% thereafter).
 313 aCOWtancy.com Syllabus D1i) Prepare group financial statements where activities have been discontinued, or have been acquired or disposed of in the period Discontinued Operation An analysis between continuing and discontinuing operations improves the usefulness of financial statements When forecasting ONLY the results of continuing operations should be used Because discontinued operations profits or losses will not be repeated What is a discontinued operation? A separate major line of business or geographical area is part of a single co-ordinated plan to dispose of a separate major line of business or geographical area is a subsidiary acquired exclusively with a view to resale How is it shown on the Income Statement? The PAT and any gain/loss on disposal A single line in I/S How is it shown on the SFP? If not already disposed of yet? Held for sale disposal group How is it shown on the cash-flow statement? Separately presented in all areas - operating; investing and financing No Retroactive Classification IFRS prohibits the retroactive classification as a discontinued operation, when the discontinued criteria are met after the end of the reporting period
 314 aCOWtancy.com Syllabus D1h) Discuss and apply the implications of changes in ownership interest and loss of control Full Disposal This is when we lose control, so we go from owning a % above 50 to one below 50 (eg 80% to 30%) In this case we have effectively disposed of the subsidiary (and possibly created a new associate) As the sub has been disposed of - then any gain or loss goes to the INCOME STATEMENT (and hence retained earnings) Also, the old Subs assets and liabilities no longer get added across, there will be no goodwill or NCI for it either How you calculate this gain or loss? What’s the effect on the Income Statement? Consolidated until sale; Then treat as Associate (if we have significant influence) otherwise a FVTPL investment Show profit on disposal (see above).
 315 aCOWtancy.com Syllabus D1j) Discuss and apply the treatment of a subsidiary which has been acquired exclusively with a view to subsequent disposal Subsidiary acquired with a view to disposal A subsidiary that is acquired exclusively with a view to its subsequent disposal is  classified on the acquisition date of the subsidiary as a non-current disposal group 'held for sale' (if it is expected that the subsidiary will be disposed of within one year and the other IFRS criteria are met with within three months of the acquisition date) Classification as a discontinued operation A subsidiary classified as 'held for sale', is included in the definition of a discontinued operation, with treatment as follows: • Income statement 
 Single Line “Discontinued operations” - PAT of the Sub + gain/loss on re-measurement to held for sale
 The income and expenses of the subsidiary are therefore not consolidated on a line-byline basis with the income and expenses of the holding company • Statement of financial position
 The assets and liabilities classified as 'held for sale' presented separately (the assets and liabilities of the same disposal group may not be offset against each other). 
 The assets and liabilities of the subsidiary are therefore not consolidated on a line-by-line basis with the assets and liabilities of the holding company • Statement of Cashflows
 No need to disclose the net cash flows attributable to the operating, investing and financing activities of the discontinued operation (which is normally required) but is not required for newly acquired subsidiaries which meet the criteria to be classified as 'held for sale' on the acquisition date
 316 aCOWtancy.com Syllabus D1k) Identify and outline: - the circumstances in which a group is required to prepare consolidated financial statements - the circumstances when a group may claim and exemption from the preparation of consolidated financial statements - why directors may not wish to consolidate a subsidiary and where this is permitted Group Accounting Exemptions Who needs to prepare consolidated accounts? Basically a parent company, one with a subsidiary However there are exceptions to this rule: • The parent is itself a wholly owned subsidiary • The parent is a partially (e.g 80%) owned sub and the other 20% owners allow it to not prepare consolidated accounts • The parents shares are not publicly traded • The parents own parent produces consolidated accounts Sometimes a sub is purchased with a view to it being sold.  In this case it is an IFRS discontinued operation The group share of its profits are shown on the income statement and all of its assets and liabilities shown separately on the SFP Not Valid reasons for exemption A subsidiary whose business is of a different nature from the parent’s A subsidiary that operates under severe long-term restrictions impairing the subsidiary’s ability to transfer funds to the parent A subsidiary that had previously been consolidated and that is now being held for sale 317 aCOWtancy.com Syllabus D1i) Prepare group financial statements where activities have been discontinued, or have been acquired or disposed of in the period Cash flow statements - Step Indirect method The idea here is simply to get to the profit from operating activities as a starting point nothing more! So IAS tells us that although we need to get to the operating profit figure we must start with Profit before tax (PBT) and reconcile this to the operating profit figure Operating Profit Before we this let’s remind ourselves what “Operating profit” is Operating Profit is: 318 aCOWtancy.com Illustration Start with the profit before tax figure and then reconcile to the operating profit figure Operating profit would be: So, let’s start reconciling… Then fill in the reconciling figures between them (income is a negative and expense a positive here) This is because we are going upwards on the income statement, rather than the normal downwards.
 319 aCOWtancy.com So this is the final answer to step 1: You place this in the “Cashflow from Operating Activities” part of the cash-flow statement.
 320 aCOWtancy.com Cash flow statements - Step Now we have the operating profit figure we need to get to the cash We this by taking the profit figure (calculated and reconciled to in step 1) and adding back all the non-cash items (we get to the cash therefore indirectly) Key point to remember here The non-cash items we add back are ONLY those in operating profit (Sales, COS, admin and distr costs) For example: Depreciation, amortisation, impairments, profit on sale, receivables, payables and inventory There could be more - it depends on the question - but dealing with these will ensure you pass So the operating activities part of the cash flow will now look like this: 321 aCOWtancy.com Ensure you get the signs the right way around! For example an increase in stock means less cash so (x) Notice we added back receivables / payables & Inventory This is because credit sales, stock and credit payables are not cash and are in the operating profit figure You just need to be careful that you get the signs the right way around as with these we just account for the movement in them Think of it like this: • Increase in Inventory - means less cash - so show as a negative • Increase in receivables - means less cash now - so show as a negative • Increase in payables - means don’t have to pay people just yet so an increase in cash so show as a positive We have now dealt with the first part of the income statement - Sales, COS, administration expenses and distribution costs We have indirectly got the cash from these figures by adding back all the non-cash items that may have been in there (as above) All of this happens in the “Cashflow from Operating Activities” part of the cash-flow statement.
 322 aCOWtancy.com Cash flow statements - Step So far we have got the cash (indirectly) from operating profit This means we have the cash from Sales, COS, admin and distribution costs What we now is look at what’s left in the income statement and try to find the cash (In our example in step 1, we would have to deal with IP income, finance costs and tax) So we are looking at the other parts of the income statement (after operating profit) and finding the cash and putting this directly into the cash-flow statement Direct method We this by using a different method to the one in step as we are now looking to put the cash in directly to the cash-flow statement (rather than taking a profit figure and adding back the non-cash items to indirectly arrive at cash) So how we this? General Method Explanation Let’s say you owed somebody 100, then bought 20 more in the year - you should therefore owe them 120 right? However you look at your books at the year end and you see you only owe them 70 Therefore, you must have paid cash to them of 50 - this is the figure we then put in our cash-flow statement To show this differently (and how the examiner often shows it): 323 aCOWtancy.com We use this format for the rest of the cashflow question - though it may need adjusting slightly (PPE is calculated differently) We will now go on to look at the different items that you may find in the income statement and how we deal with them in the cash-flow statement using this method.
 324 aCOWtancy.com Cashflow statement - finance costs Finance Costs - Illustration of Step Solution Finance costs of 120 paid go to the operating activities section of the cashflow statement.
 325 aCOWtancy.com Cashflow statement - taxation Taxation - Illustration of Step Solution Taxation costs of 150 paid go to the operating activities section of the cashflow statement 326 aCOWtancy.com Cashflow statement - Investment property Investment Property Income - Illustration of Step There were no purchases of IP in the year Solution Investment property income of 20 (rent received probably) goes to the investing activities section of the cashflow statement.
 327 aCOWtancy.com Cashflow statements - Step So in the first steps, we have turned the Income statement into cash and placed it into the cash-flow statement We now need to the same with the S - remember much of it we have already dealt with (e.g receivables, inventory, payables, investment Property, interest and tax payable So let’s begin with… PPE We deal with this slightly differently to the income statement items in step 3: Process to follow Here’s the process to follow: Write down the PPE figures per the accounts Work out the cash element of each item (if any) Illustration Notes: Depreciation in year = 50 Revaluation = 100 Disposal = Asset sold for 100 making 20 profit
 328 aCOWtancy.com Solution The key here is to try and find the balancing figure (per the accounts) which will be additions in the year Note: we are dealing with NBVs Write down the PPE figures per the accounts The balancing figure is 90 and this is additions Work out the cash element of each item (if any): All PPE items go the investing activities section of the cashflow statement.
 329 aCOWtancy.com Cashflow statements - Step - Shares So in steps 1-3 we looked at how we got the cash from the income statement and into the statement of cash flows In step we looked at getting the cash flows from PPE So now in our final step we look at getting cash from what’s left in the SFP… starting with shares Share issues Again let’s look at this by illustration and we are using virtually the same technique as step as you will see Solution Share Proceeds goes to the financing activities section of the cashflow statement.
 330 aCOWtancy.com Effect of Bonus Issue If there’s been a bonus issue, you need to be careful You need to look at where the debit went - share premium or retained earnings: If share premium - ignore the bonus issue and the answer calculated above is still correct If Retained earnings - reduce the cash by the amount of the bonus issue See the quizzes for examples of this.
 331 aCOWtancy.com Cashflow statements - Step - Loans Let’s now look at another one of the items that would still be left on the SFP, that we need to find the cash and take to the cash-flow statement - Loans Illustration Follow same techniques as before Solution Loan repayments of 40 go to the financing activities section of the cashflow statement 332 aCOWtancy.com Syllabus D2 Associates And Joint Arrangements Important Examinable Narrative & Miscellaneous points These are: • Transactions related to acquiring a subsidiary are to be written off to the Income statement • Any future contingent consideration towards the cost of investment is included in cost of investment at its FAIR VALUE regardless of whether it is probable or not • If the FAIR VALUE of the above changes after acquisition goodwill is NOT adjusted unless it is simply providing more information about what the fair value would have been at acquisition date • A company is a sub when it is controlled only This means more than 50% of the voting rights; or control of the financial and operating activities or power to appoint a majority of the board • It may be that H owns 40% + 20% potential shares (eg share options) To see whether this means H controls S all terms must be examined, disregarding management intentions • Subsidiaries held for sale must be consolidated (see above) • JV’s and A’s are not consolidated if they are held for sale • Subsidiaries with very different activities to H must also be consolidated as IFRS segmental reporting will deal with these problems 333 aCOWtancy.com • Subs with severe long term restrictions must still be consolidated until actual control is lost • Associates with severe long term restrictions must still be equity accounted until actual significant influence is lost • A company is an associate when there is no control but there is significant influence This means 20% or more of the voting rights (unless someone else holds more than 50% solely in which case they control it and we have no significant influence at all) Participation in policy making is deemed to be significant influence • H does NOT need to consolidate if it is itself a 100% sub or if the shares aren’t traded publicly and the ultimate parent prepares consolidated accounts • Subs may have a different reporting date to H but they must prepare further accounts to make consolidation possible Unless the difference in date is months or less in which case S’s accounts can be used and adjustments made for significant events • Consolidated accounts must be made with uniform accounting policies So if S has different policies to H, group level adjustments need to be made • NCI can be negative - they are simply owners of the group like the parent and so losses are possible
 334 aCOWtancy.com Syllabus D2a) Identify associate entities Syllabus D2b) Discuss and apply the equity method of accounting for associates Associates An associate is an entity over which the group has significant influence, but not control Significant influence Significant influence is normally said to occur when you own between 20-50% of the shares in a company but is usually evidenced in one or more of the following ways: • representation on the board of directors • participation in the policy-making process • material transactions between the investor and the investee • interchange of managerial personnel; or • provision of essential technical information Accounting treatment An associate is not a group company and so is not consolidated Instead it is accounted for using the equity method Inter-company balances are not cancelled Statement of Financial Position There is just one line only “investment in Associate” that goes into the consolidated SFP (under the Non-current Assets section).
 335 aCOWtancy.com It is calculated as follows: Consolidated income statement Again just one line in the consolidated income statement: Include share of PAT less any impairment for that year in associate Do not include dividend received from A What’s important to notice is that you NOT add across the associate’s Assets and Liabilities or Income and expenses into the group totals of the consolidated accounts Just simply place one line in the SFP and one line in the Income Statement Unrealised profits for an associate Only account for the parent’s share (eg 40%). 
 This is because we only ever place in the consolidated accounts P’s share of A’s profits so any adjustment also has to be only P’s share Adjust earnings of the seller Adjustments required on Income Statement • If A is the seller - reduce the line “share of A’s PAT” • If P is the seller - increase P’s COS 336 aCOWtancy.com Adjustments required on SFP • If A is the seller - reduce A’s Retained earnings and P’s Inventory • If P is the seller - reduce P’s Retained Earnings and the “Investment in Associate” line Illustration P sells goods to A (a 30% associate) for 1,000; making a 400 profit 3/4 of the goods have been sold to 3rd parties by A What entries are required in the group accounts? Profit = 400; Unrealised (still in stock) 1/4 - so unrealised profit = 400 x 1/4 = 100 As this is an associate we take the parents share of this (30%) So an adjustment of 100 x 30% = 30 is needed Adjustment required on the Income statement P is the seller - so increase their COS by 30 Adjustment required on the group SFP P is the seller - so reduce their retained earnings and the line “Investment in Associate” by 30 The retained earnings of S and A were £70,000 and £30,000 respectively when they were acquired years ago There have been no issues of shares since then, and no FV adjustments required The group use the proportionate method for valuing NCI at acquisition.
 337 aCOWtancy.com Prepare the consolidated SFP Solution Step 1: Equity Table Step 2: Goodwill H owns 18,000 of S’s share capital of 30,000 so 60% Step 3: NCI
 338 aCOWtancy.com Step 4: Retained Earnings Step 5: Investment in Associate Final answer - Goodwill
 339 aCOWtancy.com Syllabus D2c) Discuss and apply the application of the joint control principle Syllabus D2d) Discuss and apply the classification of joint arrangements Joint Ventures A joint arrangement is an arrangement of which two or more parties have joint control A joint arrangement has the following characteristics: • The parties are bound by a contract, and • The contract gives two or more parties joint control What is Joint Control? The sharing of control where decisions about the relevant activities need unanimous consent The first step is to see if the parties control the arrangement per IFRS 10 After that, the entity needs to see if it has joint control as per paragraph above Unanimous consent means any party can prevent other parties from making unilateral decisions (about the relevant activities) Types of joint arrangements Joint arrangements are either joint operations or joint ventures: • A joint operation
 Here the parties have rights to the assets, and obligations for the liabilities, relating to the arrangement. 
 They are called joint operators • A joint venture
 Here the parties have rights to the net assets of the arrangement. 
 Those parties are called joint venturers 340 aCOWtancy.com • Classifying joint arrangements
 This depends upon the rights and obligations of the parties to the arrangement Regardless of the purpose, structure or form of the arrangement.
 A joint arrangement in which the assets and liabilities relating to the arrangement are held in a separate vehicle can be either a joint venture or a joint operation.
 A joint arrangement that is not structured through a separate vehicle is a joint operation Financial statements of parties to a joint arrangement Joint Operations
 A joint operator recognises: • its assets, including its share of any assets held jointly • its liabilities, including its share of any liabilities incurred jointly • its revenue from the sale of its share of the output of the joint operation • its share of the revenue from the sale of the output by the joint operation; and • its expenses, including its share of any expenses incurred jointly A joint operator accounts for the assets, liabilities, revenues and expenses relating to its involvement in a joint operation in accordance with the relevant IFRSs
 
 Illustration An office building is being constructed by A and B, each entitled to half the profits
 A has invoiced 300 and had costs of 280 B has invoiced 500 and had costs of 420
 This shows that total sales are 800, total costs are 700 - so a profit of 100 needs splitting 50 each.
 A is currently showing a profit of 20, and B of 80 Therefore A now needs to show a receivable of 30 from B (and B a payable to A).
 Revenue should be 400 each, so A needs an extra 100 and costs should be 350 each so an 70 is required.
 341 aCOWtancy.com Double entry for A
 Dr Receivables  30
 Cr Revenue  100
 Dr COS  70 
 If an does not have joint control of a joint operation - it accounts for its interest in the arrangement in accordance with the above if that party has rights to the assets, and obligations for the liabilities, relating to the joint operation.
 
 Joint Ventures The group accounts for this using the equity method (see associates) (A party that does not have joint control of a joint venture accounts for its interest in the arrangement in accordance with IFRS 9) Unrealised profit on sales with JV - always just the share (e.g 50%) • P to JV - Income Statement
 - Increase P’s COS - SFP
 - Decrease P’s RE
 - Decrease Investment in JV • JV to P - Income Statement
 - Decrease “Share of JV PAT” - Decrease JV’s RE
 - Decrease P’s stock • No Elimination of Receivables and Payables to each other 342 aCOWtancy.com Syllabus D3: Changes in group structures Syllabus D3a) Discuss and apply accounting for group companies in the separate financial statements of the parent company Accounting For Group Companies In The Parent In the parent's own financial statements… Investments in subsidiaries are held at cost or at fair value under IFRS Consequently the profit or loss on disposal of a sub is different from the group profit or loss on disposal:
 Fair value of consideration received X
 Less carrying amount of investment disposed of (X)
 Profit/ (loss) X
 This would be in P's Income statement and is ignored in group accounts - the group loss on disposal is shown instead
 343 aCOWtancy.com IAS 27 With reorganisations where a new parent is inserted above an existing parent, the ‘cost’ of investment in the sub can now be its carrying amount rather than its FV This relief is limited to where The new parent obtains control of the original parent (or entity) by issuing shares The assets and liabilities of the new group and the original group are the same immediately before and after the reorganisation; and The owners of the original parent before the reorganisation have the same absolute and relative interests after the reorganisation If any of the above is not met then the reorganisation must be accounted for as normal at FV (rather than CV) IAS 27 will require all dividends received to be shown in the income statement However, if the dividend exceeds the total comprehensive income of the subsidiary in the period the dividend is declared; or the carrying amount of the investment exceeds the amount of net assets (including associated goodwill) recognised - then impairment should be checked for The distinction between pre- and post-acquisition profits is no longer required Recognising dividends received from subsidiaries as income will give rise to greater income being recognised Care will need to be taken as to what constitutes a dividend (defined as a distribution of profits) 344 aCOWtancy.com Syllabus D3b) Apply the accounting principles where the parent reorganises the structure of the group by establishing a new entity or changing the parent De-mergers As a company or group grows they sometimes diversify into other areas This can cause problems For example: If each division has a different risk profile it could be commercially desirable to reduce the overall risk profile If different shareholders/managers are involved in different areas of the business they may wish to split the business (sometimes known as a partition) so that they each own only the business area they are involved in Shareholders cannot just divide up a company or group and set up separate enterprises without incurring significant tax liabilities unless the separation falls within the conditions for either: A statutory demerger, or A company reconstruction using a members’ voluntary liquidation A statutory demerger is the simpler of the two alternatives but the circumstances in which they can be used are limited and the conditions which need to be met are more stringent It can only be used to split two or more trades It cannot be used to split out a trade from, say, a property investment business How it works The mechanics of a statutory demerger are relatively straightforward, either: the shares in a subsidiary are distributed out to the members or the trade is transferred to a new company and shares in the new company are issued to the members of the old company 345 aCOWtancy.com Parent Reorganises The Structure Of The Group Internal Group Re-Organisations Typically: 1) The ultimate shareholders remain the same 2) No cash leaves the group 3) There is no change in NCI Therefore, ultimately, the group remains the same - so no effect on group accounts.  However, individual accounts within the group will be affected Questions on group reorganisations are more likely to focus on the principles behind the numbers rather than the numbers themselves Eg Sub-subsidiary becomes a subsidiary 
 How?
 P buys S2 for cash (or other assets) or
 S1 could pay a dividend to P in the form of the shares in S2
 Effect 
 Just means that S2 now reports directly to P rather then through S1
 This means S2 can be sold off without selling off S1. 
 Also means S1 and S2 report independently to P (Divisionalisation) The opposite to pont 1. 
 This time we make a direct sub a sub-subsidiary
 How?
 S1 could buy S2 for cash (or olher assets) (DR INV IN S2 CR CASH) or
 S1 could issue additional shares to P to pay for S2 (Dr INV IN S2 CR SHARES)
 Effect 
 So S2 reports to S1
 A gain or loss may be made in the separate financial statements of S1 This needs to be eliminated in the group accounts
 346 aCOWtancy.com Group reorganisations lend themselves well to ethics questions For example, pressure from the CEO to overstate profits on disposal (on loss of control) or putting a partial disposal profit to P/L instead of reserves
 347 aCOWtancy.com Syllabus D4: Foreign transactions and entities Syllabus D4a) Outline and apply the translation of foreign currency amounts and transactions into the functional currency and the presentational currency Foreign Exchange Single company Transactions in a single company This is where a company simples deals with companies abroad (who have a different currency) The key thing to remember is that… ALL EXCHANGE DIFFERENCES TO INCOME STATEMENT So - a company will buy on credit (or sell) and then pay or receive later The problem is that the exchange rate will have moved and caused an exchange difference Step 1: Translate at spot rate Step 2: If there is a creditor/debtor @ y/e - retranslate it (exch gain/loss to I/S) Step 3: Pay off creditor - exchange gain/loss to I/S Illustration On July an entity purchased goods from a foreign country for Y$10,000.  On September the goods were paid in full The exchange rates were:  July $1 = Y$10  September $1 = Y$9 Calculate the exchange difference to be included in profit or loss according to IAS 21 The Effects of Changes in Foreign Exchange Rates.
 348 aCOWtancy.com Solution
 Account for Payables on July: Y$10,000/10 = 1,000
 Payment performed on September: Y$10,000 / = 1,111
 The Exchange difference: 1,000 - 1,111 = 111 loss Illustration Maltese Co buys £100 goods on 1st June (£1:€1.2) Year End (31/12) payable still outstanding (£1:€1.1) 5th January £100 paid (£1:€1.05) Solution Initial Transaction Dr Purchases 120 Cr Payables 120 Year End Dr Payables 10 Cr I/S Ex gain 10 On payment Dr Payables 110 Cr I/S Ex gain   Cr Cash 105 Also items revalued to Fair Value will be retranslated at the date of revaluation and the exchange gain/loss to Income statement All foreign monetary balances are also translated at the year end and the differences taken to the income statement This would include receivables, payables, loans etc.
 349 aCOWtancy.com Syllabus D4b) Account for the consolidation of foreign operations and their disposal Foreign exchange - subsidiaries Ok so in the previous section we looked at foreign exchange differences which occur when an individual company buys/sells at one rate and pays/receives at another Either that or a retranslation of a foreign monetary balance Now we look at what happens to our CONSOLIDATED accounts when we have a foreign subsidiary Clearly we cannot just add their foreign currency figures to our home currency figures - we need to translate S first We this using the following rates: Exchange rates to be used: Income Statement Average rate
 SFP (Assets and Liabs) Closing rate ALL EXCHANGE DIFFERENCES TO RESERVES How we actually go about doing this in the exam means a slight adjustment to our group workings as stated here: Net Assets Table At acquisition column Acquisition rate
 Year end column Closing rate The post-acquisition column and hence retained earnings effectively includes the exchange gains/losses This should be disclosed separately in the OCI and in Equity.
 350 aCOWtancy.com Foreign Exchange Translation Reserve Remember that actually, by using the rates we have in the equity table, any foreign exchange differences will end up in the post-acquisition column which we then use for our retained earnings working If requested we could calculate the exact amount and take it out of retained earnings and put it into its own reserve This can be calculated as follows: Translation Reserve Goodwill This should be retranslated every year end (closing rate) Any exchange gain/loss to Equity Illustration Notice first of all you should calculate goodwill in the FOREIGN CURRENCY This allows us to retranslate it whenever we want Goodwill (in foreign currency) 351 aCOWtancy.com Take this 17,000 and translate it at the acquisition rate at first e.g 17,000 x 0.5 = $8,500 Now take the 17,000 and translate it at the year-end rate e.g 17,000 x 0.6 = $10,200 The $10,200 is shown in the group SFP and the gain of $1,700 is taken to retained earnings Illustration Steps Do S only adjustments (in foreign currency) Translate S (using rates above) and Net Asset Table Do adjustments and workings as normal - but calculate goodwill exchange gain or loss and add to retained earnings 352 aCOWtancy.com P acquired 80% S @ start of year At Acquisition S’s Land had a FV 4,000 pintos higher than book value Proportionate NCI method Exchange rates (Pinto:$) Last year end 5.5 This year end Average for year 5.2 Solution Step 1: S only adjustments - none Step 2: Net Asset Table (Acq @ acq rate; Year-end @closing rate) Translate S - all assets and liabilities at closing rate Income statement at average rate SFP - so far 353 aCOWtancy.com Income statement Step Workings and adjustments as normal Goodwill Retranslate at year end: 909 x 5.5/5 1,000 Gain of 91 to retained earnings NCI 354 aCOWtancy.com Retained Earnings Translation Reserve NOT NORMALLY REQUIRED IN EXAM 80% of this 381 is taken from RE as this belongs to P 100% of the goodwill revaluation gain also is an exchange difference 91 and this would also be taken from the retained earnings Giving the retranslation reserve a balance of 396 (80% x 381 + 91).
 355 aCOWtancy.com Final Answer Don’t forget to translate all of S’s NA @ closing rate 356 aCOWtancy.com Foreign currency - extras Foreign Currency - Examinable Narrative & Miscellaneous points Functional Currency Every entity has its own functional currency and measures its results in that currency Functional currency is the one that: - influences sales price - the one used in the country where most competitors are and where regulations are made - the one that influences labour and material costs If functional currency changes then all items are translated at the exchange rate at the date of change Presentation Currency An entity can present in any currency it chooses The foreign sub (with a foreign functional currency) will present normally in the parents presentation currency and hence the need for foreign sub translation rules! Foreign currency dealings between H and S There is often a loan between H and a foreign sub If the loan is in a foreign currency don’t forget that this will need retranslating in H’s or S’s (depending on who has the ‘foreign’ loan) own accounts with the difference going to its income statement If H sells foreign S, any exchange differences (from translating that sub) in equity are taken to the income statement (and out of the OCI).
 357 aCOWtancy.com Deferred tax There are deferred tax consequences of foreign exchange gains (see tax chapter) This is because the gains and losses are recognised by H now but will not be dealt with by the taxman until S is eventually sold.
 358 aCOWtancy.com Syllabus E: INTERPRET FINANCIAL STATEMENTS FOR DIFFERENT STAKEHOLDERS Syllabus E1: Analysis and interpretation of financial information and measurement of performance Syllabus E1a) Discuss and apply relevant indicators of financial and non- financial performance including earnings per share and additional performance measures Indicators Of (Non) Financial Performance Analysis is not just calculations! So remember this is not a baby paper now so… Explaining the ratio is just not enough You need to compare (eg to prior periods or industry averages) Then say what the movement/difference is telling you - by using the scenario - and what this may mean for the company and its stakeholders Now also consider any non-financial consequences? (quality, ethics etc) Any transactions/events in the year that had a significant impact on ratios Any impact of different accounting policies on ratios? (particularly if comparing to other entities)
 359 aCOWtancy.com A Ratio Analysis Technique Always see if the ratio has improved or deteriorated (Not 'increased' or 'decreased') The say why the ratio has improved or deteriorated - here is where you use the scenario not a textbook! Finally explain the longer term impact on the company and make a recommendation for action where appropriate EPS PAT / NO OF SHARES EPS means nothing on its own It always needs to be compared over time Remuneration packages might be linked to EPS growth, so increasing the pressure on management to improve EPS, and be an inherent ethical risk Illustration A company changes its depreciation policy (longer UEL) - in order to reduce depreciation and thus increase EPS Answer Step 1: State the IFRS knowledge:
 An entity should review UEL every year - and any change is a change in accounting estimate
 Changes in accounting estimates only allowed if a result of new information Step 2: Apply the rule or principle to the scenario
 So in the scenario you'd look for things like:
 1) Large profits on disposals - a result of too short a useful life previously 
 2) Other evidence of longer UELs on similar assets
 3) Buying periods matching the new UEL 360 aCOWtancy.com Step 3: Explain the ethical issues (if you think this is solely to manipulate the earnings figure)
 Threat to objectivity
 Also non-compliance with IAS 16 and therefore, contravene the fundamental principle of professional competence Ethics note So far we only looked at the manipulation of earnings Other examples could include: Significant sales to related parties and the directors not wanting to disclose details of the transactions Directors trying to window dress revenue by offering large incentives to make sales to uncreditworthy customers or Manipulating estimates to achieve required results.
 361 aCOWtancy.com Interpret NFPIs The use of non-financial performance indicators are an additional tool to monitor performance in not-for-profit organisations For example, if the case of a secondary school, some non-financial performance indicators about the performance of the school would be: • The number of pupils taught • The number of subjects taught per pupil • How many examination papers are taken • The pass rate • The proportion of students which go on to further education Let’s take a bus service which is non-profit seeking In fact, its mission is to provide reliable and affordable public transport to the citizens   It often involves operating services that would be considered uneconomic by the private sector bus companies.  Let’s have a look at some non-financial performance indicators for the public bus service: Non-financial performance indicator % of buses on time % of buses cancelled Customer rating of cleanliness of facilities % of new customers Employee morale Importance Punctuality is important to passengers Reliability is important to passengers Passengers require good quality service New customers are vital for sustained growth Happy employees are vital for success in a service business In not-for-profit organisations, decisions may be taken to improve short-term performance but may have a negative impact on long-term performance.
 362 aCOWtancy.com This will have limited benefit to the organisation as it will not convey the full picture regarding the factors that will drive the achievement of objectives e.g customer satisfaction, quality of service Results may be manipulated to show a better picture but the effect on stakeholders will be negative Let’s take an example The hospital tends to manipulate its results with respect to waiting times for operations Obviously, citizens will be disappointed and start losing trust in the organisation Example Cowsville is a town with a population of 100,000 people.  The town council of Cowsville operates a bus service which links all parts of the town with the town centre.  The service is non-profit seeking and its mission statement is ‘to provide efficient, reliable and affordable public transport to all the citizens of Cowsville.’  Attempting to achieve this mission often involves operating services that would be considered uneconomic by private sector bus companies, due either to the small number of passengers travelling on some routes or the low fares charged.  The majority of the town council members are happy with this situation as they wish to reduce traffic congestion and air pollution on Cowsville’s roads by encouraging people to travel by bus rather than by car However, one member of the council has recently criticised the performance of the Cowsville bus service as compared to those operated by private sector bus companies in other towns. 
 363 aCOWtancy.com She has produced the following information: 364 aCOWtancy.com Operating Statistics for the year ended 31 March 2016 Total passengers carried = 2,400,000 passengers Total passenger miles travelled = 4,320,000 passenger miles Private sector bus companies Industry average ratios Year ended 31 March 2016 Return on capital employed = 10% Return on sales (net margin) = 30% Asset turnover =0·33 times Average cost per passenger mile = 37·4p Required: (a) Calculate the following ratios for the Cowsville bus service (i) Return on capital employed (based upon opening investment); (ii) Return on sales (net margin); (iii) Asset turnover; (iv) Average cost per passenger mile.  (b) Explain the meaning of each ratio you have calculated Discuss the performance of the Cowsville bus service using the four ratios Solution: (a) Ratios 
 Return on Capital employed
 Operating Profit / Capital employed   x  100  =  20 /  2,210  x  100  = 0,9%     
 Return on sales (net margin)
 Operating profit / Sales   x  100 =  20 / 1,200  x  100  =  1.7% 
 365 aCOWtancy.com Asset Turnover 
 Sales / Capital employed   =  1,200 / 2,210  =  0.54 times
 Average cost per passenger mile 
 Operating cost  / Passenger miles =  1,180,000 / 4,320,000   =    27.3p 
        
 Tutorial Note: the term profit is used throughout this answer; in the public sector it would normally be referred to as surplus (b) Meaning of each ratio Return on Capital employed. 
 This ratio measures the profits earned on the long-term finance invested in the business The Cowsville bus service is only generating an annual profit of 0.9p for every £1 invested The equivalent figure for private bus companies is 10p.
 Return on sales. 
 This ratio measures the profitability of sales For the Cowsville bus services 1.7p of every £1 of sales is profit The equivalent figure for private bus companies is 30p.
 Asset turnover. 
 This ratio measures a firm’s ability to generate sales from its capital employed The Cowsville bus service generates sale of 54p for every £1 of capital employed The equivalent figure for private bus companies is only 33p.
 Average cost per passenger mile. 
 This measures the cost of transporting passengers per mile travelled The Cowsville bus service incurs a cost of 27.3p per passenger mile as compared to 37.4p for private bus companies.
 366 aCOWtancy.com Performance of the bus service 
 On first sight the Cowsville bus service appears to have performed poorly as compared to private sector bus companies. 
 It has a low return on capital employed, largely due to a poor return on sales. 
 This could be explained by the low fares charged. 
 On the positive side its ability to generate sales is good and its buses to be more intensively used than private sector equivalents. 
 However, if we take into account the objectives of the council and the mission statement of the bus service it is possible to draw a different conclusion. 
 Private sector companies usually seek to maximise investor wealth. 
 The council appears to be trying to encourage usage of public transport in an attempt to reduce traffic congestion. 
 To this it charges low fares, resulting in a poor return on sales and a low return on capital employed. 
 However, the low fares, and willingness to operate uneconomic routes has led to a high asset turnover, implying above industry average usage of the bus service. 
 In turn this greater usage of the service leads to a lower cost per passenger mile as fixed costs are spread more thinly over a larger number of passenger miles.
 Before drawing any firm conclusions it would be sensible to compare the performance of the Cowsville bus service with that of bus operators pursuing similar objectives.
 (Tutorial Note: If we compare average fare per passenger mile we can see that the Cowsville bus service charges lower fares than the private sector.
 367 aCOWtancy.com Cowsville fare per passenger mile = passenger fares ÷ passenger miles
              = £1,200,000 ÷ 4,320,000 = 27.8p
 Private sector    = Average cost ÷ (1 - net margin)
              = 37.4p ÷ (1 – 0.3) = 53.4p
 Cowsville charges lower fares per passenger mile Which may explain its higher load factor and therefore its lower cost per passenger mile) 368 aCOWtancy.com Non-financial reporting This is concerned with business ethics and accountability to stakeholders Companies should look after ALL shareholders and be transparent in its dealings with them when compiling corporate reports CSR requires directors to look at the aims and purposes of the company and not assume profit to be the only motive for shareholders Arrangements should be put in place to ensure that the business is conducted in a responsible manner This includes environmental and social targets, monitoring of these and continuous improvement There is pressure now for companies to show more awareness and concern, not only for the environment but for the rights and interests of the people they business with Governments have made it clear that directors must consider the short-term and long-term consequences of their actions, and take into account their relationships with employees and the impact of the business on the community and the environment CSR requires the directors to address strategic issues about the aims, purposes, and operational methods of the organisation, and some redefinition of the business model that assumes that profit motive and shareholder interests define the core purpose of the company The reporting of the company's effects on society at large It expands the traditional role that company´s only provide for the shareholders.
 369 aCOWtancy.com Why prepare a social report? Build their reputation on it (e.g body shop) Society expects it (Shell) Long term it will increase profits Fear that governments may force it otherwise How companies interact responsibly with society • Provide fair pay to employees • Safe working environment • Improvements to physical infrastructure in which it operates Is it against the maximising shareholder wealth principle? Organisations are rarely controlled by shareholders as most are passive investors This means large companies can manipulate markets - so social responsibility is a way of recognising this, and doing something to prevent it happening from within Also, of course, business get help from outside and so owe something back They benefit from health, roads, education etc of the workforce and suppliers and customers This social contract means that the companies then take on their own social responsibility Human Capital Reporting Sees employees as an asset not an expense and competitive advantage is gained by employees The training, recruitment, retention and development of employees is all part of what would therefore be reported 370 aCOWtancy.com Implications • People are a resource like any other and so needs to be effectively and efficiently managed • Safeguarding of the asset as normal • Impairment could mean a simple drop in motivation HCM reports should: • Show size of workforce • Retention rates • Skills needed for success • Training • Remuneration levels • Succession planning
 371 aCOWtancy.com Syllabus E1b) Discuss the increased demand for transparency in corporate reports, and the emergence of non-financial reporting standards Demand For Transparency Transparency in Corporate Reports Stakeholders are demanding more from entities Investors in particular need to know what they are investing in ethically, hence the demand for transparency in corporate reports Stakeholders need to understand how an entity does business For example EU law requires large companies to disclose certain information on the way they operate and manage social and environmental challenges This helps investors, consumers, policy makers and other stakeholders to evaluate the non-financial performance of large companies and encourages these companies to develop a responsible approach to business Companies are required to include non-financial statements in their annual reports from 2018 onwards.
 372 aCOWtancy.com Transparency & Non-Financial Standards This has become more important recently as stakeholders are interested in: Management of business Future prospects Environmental concerns Social responsibility of company How is this reported…? • Operating and Financial Review (OFR) Looks at results and talks about future prospects • Corporate Governance Report Looks at how the company is directed and controlled • Environmental and social report Looks at the environment and social concerns and the sustainability of these • Management Commentary Looks at the trends behind the figures and what is likely to affect future performance and position IFRS Practice Statement Management Commentary • On December 2010 the IASB issued the IFRS Practice Statement Management Commentary 
 The Practice Statement provides a broad, non-binding framework for the presentation of management commentary that relates to financial statements prepared in accordance with IFRS 
 373 aCOWtancy.com The Practice Statement is not an IFRS Consequently, entities are not required to comply with the Practice Statement, unless specifically required by their jurisdiction • Management commentary is a narrative report that provides a context within which to interpret the financial position, financial performance and cash flows of an entity 
 It also provides management with an opportunity to explain its objectives and its strategies for achieving those objectives 
 Management commentary encompasses reporting that jurisdictions may describe as management’s discussion and analysis (MD&A), operating and financial review (OFR), or management’s report • Management commentary fulfils an important role by providing users of financial statements with a historical and prospective commentary on the entity’s financial position, financial performance and cash flows • The Practice Statement permits entities to adapt the information provided to particular circumstances of their business, including the legal and economic circumstances of individual jurisdictions 
 This flexible approach will generate more meaningful disclosure about the most important resources, risks and relationships that can affect an entity’s value, and how they are managed • The purpose of an OFR is to assist users, principally investors, in making a forwardlooking assessment of the performance of the business by setting out management’s analysis and discussion of the principal factors underlying the entity’s performance and financial position.
 374 aCOWtancy.com Typically, an OFR would comprise some or all of the following: Description of the business and its objectives; Management’s strategy for achieving the objectives; Review of operations; Commentary on the strengths and resources of the business; Commentary about such issues as human capital, research and development activities, development of new products and services; Financial review with discussion of treasury management, cash inflows and outflows and current liquidity levels The publication of such a statement would have the following advantages: It could be helpful in promoting the entity as progressive and as eager to communicate as fully as possible with investors; It could be a genuinely helpful medium of communicating the entity’s plans and management’s outlook on the future; However, there could be some drawbacks: If an OFR is to be genuinely helpful to investors, it will require a considerable input of senior management time This could be costly, and it may be that the benefits of publishing an OFR would not outweigh the costs; There is a risk in publishing this type of statement that investors will read it in preference to the financial statements, and that they may therefore fail to read important information 375 aCOWtancy.com Sir David Tweedie, ex-Chairman of the IASB , said: “Management commentary is one of the most interesting parts of the annual report.  It provides management with an opportunity to add context to the published financial information, and to explain their future strategy and objectives.  It is also becoming increasingly important in the reporting of non-financial metrics such as sustainability and environmental reporting   The publication of this Practice Statement will benefit both users and preparers by enhancing the international consistency of this important source of information.” 376 aCOWtancy.com Syllabus E1c) Appraise the impact of environmental, social, and ethical factors on performance measurement Environmental, Social, And Ethical Factors On Performance Measurement IFRS No required disclosure requirements for environmental and social matters However: Provisions for environmental damage are recognised under IAS 37 IAS requires disclosure to a proper understanding of financial statements Voluntary Disclosure Voluntary disclosure and the publication of environmental reports has now become the norm for quoted companies in certain countries as a result of pressure from stakeholder groups to give information about their environmental and social 'footprint' The creation of ethical indices has added to this pressure - for example the FTSEA Good index in the UK, and the Dow Jones Sustainability Group Index in the US Sustainability Reporting This integrates environmental, social and economic performance data  The most well-known is the Global Reporting Initiative The GRI is a long-term, multi-stakeholder, international not-lor-profit organisation whose mission is to develop and disseminate globally applicable GRI Standards on sustainability reporting for voluntary use by organisations.
 377 aCOWtancy.com Environmental Reporting This is the disclosure of environmental responsibilities and activities  Increasing awareness of environmental issues and pressure from non governmental organisations (NGOs) make this vital to an entity Social Reporting This discloses the social impact of a business's activities: Eg Charity donations Giving employees time to support charities Employee satisfaction levels and remuneration issues; Community support; and Stakeholder consultation information 378 aCOWtancy.com Framework for environmental and sustainability reporting The idea here is that everything must be able to continue in the future We must not use up resources, social or environmental, without replacing them Any that is not replaced is often termed the social or environmental footprint Reporting Sustainability • Voluntary • Increasingly popular (often put on website too) • Sometimes called ‘the triple bottom line’ (Profits, people and planet) Environmental Reporting Can be in the published annual report Can be a separate report No mandatory standards to follow Covers inputs (Using up of resources) Covers outputs (Pollution etc.) Its voluntary basis causes problems: • Users can disclose the good but not the bad • No external influence means less confidence in the report
 379 aCOWtancy.com Benefits of an Environmental Report • Can highlight inefficiencies • Identifies opportunities to reduce waste • Can create a positive image as a good corporate citizen • Increased consumer confidence in it • Employees like it • Investors look for environmental concerns nowadays • Reduces risk of litigation against it • Can give competitive edge 380 aCOWtancy.com Syllabus E1d) Discuss the current framework for integrated reporting (IR) including the objectives, concepts, guiding principles and content of an Integrated Report Purpose and content of an integrated report To explain to providers of financial capital how an organisation creates value over time It benefits all stakeholders interested in an organisation’s ability to create value over time, including: • employees • customers • suppliers • business partners • local communities • legislators • regulators and policy-makers The ‘building blocks’ of an integrated report are: • Guiding principles
 These underpin the integrated report
 They guide the content of the report and how it is presented • Content elements
 These are the key categories of information 
 They are a series of questions rather than a prescriptive list
 381 aCOWtancy.com Guiding Principles • Are you showing an insight into the future strategy ? • Are you showing a holistic picture of the organisation's ability to create value over time?
 Look at the combination, inter-relatedness and dependencies between the factors that affect this • Are you showing the quality of your stakeholder relationships? • Are you disclosing information about matters that materially affect your ability to create value over the short, medium and long term? • Are you being concise? 
 Not being burdened by less relevant information • Are you showing Reliability, completeness, consistency and comparability when showing your own ability to create value? Content Elements • Organisational overview and external environment
 What does the organisation and what are the circumstances under which it operates? • Governance
 How does an organisation’s governance structure support its ability to create value in the short, medium and long term? • Business model 
 What is the organisation’s business model?
 382 aCOWtancy.com • Risks and opportunities 
 What are the specific risk and opportunities that affect the organisation’s ability to create value over the short, medium and long term? And how is the organisation dealing with them? • Strategy and resource allocation
 Where does the organisation want to go and how does it intend to get there? • Performance
 To what extent has the organisation achieved its strategic objectives for the period and what are its outcomes in terms of effects on the capitals? • Outlook
 What challenges and uncertainties is the organisation likely to encounter in pursuing its strategy, and what are the potential implications for its business model and future performance? 383 aCOWtancy.com Syllabus E1e) Determine the nature and extent of reportable segments Syllabus E1f) Discuss the nature of segment information to be disclosed and how segmental information enhances the quality and sustainability of performance Segmental Reporting (IFRS 8) - Introduction Objective of IFRS The objective of IFRS is to present information by line of business and by geographical area It applies to plcs and any entity voluntarily providing segment information should comply with the requirements of the Standard So why is it a good thing to have information by line of business and geographical area? Well, imagine you are an Apple shareholder You will naturally be interested in how well the company is doing That information would only make real sense though if it was broken down by business area For example, if most of the profits were from i-Pods, then this would be worrying as this market is in decline You would want to know how they are doing in the desktop computer market, how they are doing in the smartphone and tablet market as well as any new areas they may be diversifying into 384 aCOWtancy.com Key Definitions Business segment (e.g i-Phone segment): A component of an entity that (a) provides a single product or service and (b) is subject to risks and returns that are different from those of other business segments Geographical segment (e.g European market):
 A component of an entity that (a) provides products and services and (b) is subject to risks and returns that are different from those of components operating in other economic environments May be based either on where the entity’s assets are located or on where its customers are located Operating Segment 
 Engages in business (even if all internal), whose results are regularly reviewed by the chief operating decision maker and for which separate financial information is available • Earns revenue and incurs expenses from a business activity • Is regularly reviewed by the chief decision maker when handing out resources • Has separate financial info available
 385 aCOWtancy.com Therefore the head office is not an operating segment as it is not a business activity The idea behind the regular review part is that the entity reports on those segments that are actually used by management to monitor the business Aggregating Segments Operating Segments can be aggregated together only if they have similar economic characteristics such as: Similar product / service Similar production process Similar sort of customer Similar distribution methods Similar regulations Quantitative Thresholds Any segment which meets these thresholds must be reported on: Profit is 10% or more of all profitable segments Assets are 10% or more of the total assets of all operating segments Reportable Segments If the total EXTERNAL revenue of the operating segments reported on (meeting the quantitative thresholds) is less than 75% of total revenue of the company then additional operating segments results (those not meeting the quantitative thresholds) are reported upon (until the 75% is met) 386 aCOWtancy.com Illustration A B External Revenue 220 300 Internal Revenue 60 15 Profit 60 50 Assets 5000 4000 C 75 D E Total 55 60 710 10 90 20 -11 14 133 300 300 400 10,000 Which of the segments A-E should be reported upon? A B C D E Revenue Test 280 / 800 = 35% PASS 315 / 800 = 39% PASS 75 / 800 = 9% FAIL 60 / 800 = 7.5% FAIL 70 / 800 = 9% FAIL Profit Test 60 / 144* = 42% PASS 50 / 144 = 35% PASS 20 / 144 = 14% PASS Assets Test 5,000 / 10,000 = 50% PASS 4,000 / 10,000 = 40% PASS 300 / 10,000 = 3% FAIL 14 / 144 = 9% FAIL 300 / 10,000 = 3% FAIL 400 / 10,000 = 4% FAIL *Profitable segments only A, B and C all pass one of the tests and so would be reported on External Revenue Test A + B + C = 595 / 710 = 84% PASS (No more segments needed)
 387 aCOWtancy.com Disclosures for each segment Profit Total Assets and Liabilities External Revenues Internal Revenues Interest income and expense Depreciation Profit from Associates and JVs Tax Other material non-cash items Measurement This shall be the same as the one used when reporting to the chief decision maker So it is the internal measure rather than an IFRS one A reconciliation is then provided between this measure and the entity’s actual figures for: 1) Profit (e.g Allocation of centrally incurred costs) 2) Assets & Liabilities Also any asymmetrical allocations For example, one segment may be charged depreciation for an asset not allocated to it IFRS requires the information presented to be the same basis as it is reported internally, even if the segment information does not comply with IFRS or the accounting policies used in the consolidated financial statements Examples of such situations include segment information reported on a cash basis (as opposed to an accruals basis), and reporting on a local GAAP basis for segments that are comprised of foreign subsidiaries 388 aCOWtancy.com Although the basis of measurement is flexible, IFRS requires entities to provide an explanation of: the basis of accounting for transactions between reportable segments; the nature of any differences between the segments’ reported amounts and the consolidated totals For example, those resulting from differences in accounting policies and policies for the allocation of centrally incurred costs that are necessary for an understanding of the reported segment information In addition, IFRS requires reconciliations between the segments’ reported amounts and the consolidated financial statements Entity Wide Disclosures A External revenue for each product/service B Totals for revenue made at home and abroad C NCA totals for those held at home and abroad D If customer accounts for 10%+ of revenue this total must be disclosed alongside which segment it is reported in
 389 aCOWtancy.com IFRS Determining Reporting segments Identifying Business and Geographical Segments • An entity must look to its organisational structure and internal reporting system to identify reportable segments In fact, the segmentation used for internal reports for the board should be the same for external reports • Only if internal segments are not along either product/service or geographical lines is further disaggregation appropriate Primary and Secondary Segments • For most entities one basis of segmentation is primary and the other is secondary (with considerably less disclosure required for secondary segments) • To decide which is primary, the entity should see whether business or geographical factors most affect the risk and returns This should be helped by looking at entity’s internal organisational and management structure and its system of internal financial reporting to senior management 390 aCOWtancy.com Illustration Product External Revenue Internal Revenue Profit Assets Liabilities The Nose picker 2,000 30 (100) 3,000 2,000 The Earwax extractor 3,000 20 600 8,000 3,000 Other Products 5,000 50 1,050 20,000 14,000 Which segments should be reported upon? Let’s look at the reportable segment tests:
 10% of combined revenue = 1,010
 10% of profits = 165
 10% of losses = 10
 10% of assets = 3,100
 So, The Nose picker only passes the revenue test, it fails the profits test as a loss of 100 is less than 165 (165 is higher than 10), it fails the assets test It is still a reportable segment though as only test needs to be passed The Earwax extractor passes all tests Other Products These are not separate segments and can only be added together if the nature of the products are similar, as are their customer type and distribution method So ordinarily these would not be disclosed However we need to check whether the reported segments meet the 75% external revenue test: Currently only 5,000 out of 10,000 (50%) Therefore additional operating segments (other products) may be added until the 75% threshold is reached 391 aCOWtancy.com IFRS Pros and Cons IFRS follows what we call the “managerial approach” as opposed to the old “risks and rewards” approach to determining what segments are • This has the following advantages:
 Cost effective as data can be reported in the same way as it is in the managerial accounts (though it does need reconciling) • The segment data reflects the operational strategy of the business However there are problems also: • It gives a lot of subjective responsibility to the directors as to what they disclose • Also the internal nature of how it is reported may actually make it less useful to some users and lead to problems of comparability • There is also no defined measure of profit/loss in IFRS 392 aCOWtancy.com Syllabus F: THE IMPACT OF CHANGES AND POTENTIAL CHANGES IN ACCOUNTING REGULATION Syllabus F1 Discussion of solutions to current issues in financial reporting Syllabus F1a) Discuss and apply the accounting implications of the first time adoption of new accounting standards Here we look at 1st time adoption of IFRS An entity’s first IFRS financial statements must: • be transparent for users and comparable over all periods presented • provide a suitable starting point for IFRS accounting • be generated at a cost that does not exceed the benefits An opening IFRS based SFP (using the same accounting policies as the future IFRS based FS) is needed at the date of moving to IFRSs This is the suitable starting point 393 aCOWtancy.com The opening IFRS based SFP shall… recognise all assets and liabilities (where IFRSs say they should be recognised) not recognise assets or liabilities (where IFRSs say they should not be recognised) reclassify items (that IFRS say needs reclassification) apply IFRSs in measuring all recognised assets and liabilities Limited exemptions Where the cost of complying is likely to exceed the benefits to users of financial statements Retrospective Application This is applying IFRS to previous periods - this is restricted if it means management judgements (about past conditions) are needed when the actual outcome is now in fact known Disclosures Needed to explain how the transition from previous GAAP to IFRSs affected the entity’s reported financial position, financial performance and cash flows
 394 aCOWtancy.com Syllabus F1c) Discuss the impact of current issues in corporate reporting The following examples are relevant to the current syllabus: The revision of the Conceptual Framework The IASB’s Principles of Disclosure Initiative Materiality in the context of financial reporting Primary Financial Statements Management commentary Developments in sustainability reporting Current Issue - The Revision Of The Conceptual Framework Status and purpose of the Conceptual Framework The Conceptual Framework's purpose is: 1) To help develop and revise IFRSs that are based on consistent concepts 2) To help preparers develop consistent accounting policies for areas that are not covered by a standard or where there is choice of accounting policy, and  3) To help everyone understand and interpret IFRS The framework does not override any specific IFRS Chapter - The Objective Of General Purpose Financial Reporting The objective is to provide financial information that's useful to investors, lenders and other creditors in making decisions about providing resources to the entity.
 395 aCOWtancy.com This information is about the entity’s economic resources / claims against and the effects of transactions that change the resources / claims This information can also help users assess management’s stewardship of the resources Chapter - Qualitative Characteristics Of Useful Financial Information Financial information is useful when it is relevant and represents faithfully what it purports to represent The usefulness of financial information is enhanced if it is comparable, verifiable, timely and understandable Fundamental qualitative characteristics Relevance and faithful representation are the fundamental qualitative characteristics of useful financial information Relevance Relevant financial information is capable of making a difference in the decisions made by users Meaning it has predictive value, confirmatory value, or both Materiality is an entity-specific aspect of relevance Faithful representation General purpose financial reports represent economic phenomena in words and numbers To be useful, financial information must not only be relevant, it must also represent faithfully the phenomena it purports to represent Faithful representation means representation of the substance of an economic phenomenon instead of representation of its legal form only A faithful representation seeks to maximise the underlying characteristics of completeness, neutrality and freedom from error A neutral depiction is supported by the exercise of prudence Prudence is the exercise of caution when making judgements under conditions of uncertainty.
 396 aCOWtancy.com Applying the fundamental qualitative characteristics Information must be both relevant and faithfully represented if it is to be useful Enhancing qualitative characteristics Comparability, verifiability, timeliness and understandability are qualitative characteristics that enhance the usefulness of information that is relevant and faithfully represented Comparability Information about a reporting entity is more useful if it can be compared with a similar information about other entities and with similar information about the same entity for another period or another date Comparability enables users to identify and understand similarities in, and differences among, items Verifiability Verifiability helps to assure users that information represents faithfully the economic phenomena it purports to represent Verifiability means that different knowledgeable and independent observers could reach consensus, although not necessarily complete agreement, that a particular depiction is a faithful representation Timeliness Timeliness means that information is available to decision-makers in time to be capable of influencing their decisions Understandability Classifying, characterising and presenting information clearly and concisely makes it understandable While some phenomena are inherently complex and cannot be made easy to understand, to exclude such information would make financial reports incomplete and potentially misleading Financial reports are prepared for users who have a reasonable knowledge of business and economic activities and who review and analyse the information with diligence.
 397 aCOWtancy.com Applying the enhancing qualitative characteristics Enhancing qualitative characteristics should be maximised to the extent necessary However, enhancing qualitative characteristics (either individually or collectively) cannot render information useful if that information is irrelevant or not represented faithfully The cost constraint on useful financial reporting Cost is a pervasive constraint on the information that can be provided by general purpose financial reporting Reporting such information imposes costs and those costs should be justified by the benefits of reporting that information.  The IASB assesses costs and benefits in relation to financial reporting generally, and not solely in relation to individual reporting entities The IASB will consider whether different sizes of entities and other factors justify different reporting requirements in certain situations Chapter - Financial Statements And The Reporting Entity The objective of financial statements (to provide information about an entity's assets, liabilities, equity, income and expenses that helps users assess the prospects for future net cash inflows and management's stewardship of resources Going concern is assumed The reporting entity is an entity that is required, or chooses, to prepare financial statements It can be a single entity or a portion of an entity or can comprise more than one entity A reporting entity is not necessarily a legal entity Determining the appropriate boundary of a reporting entity is driven by the information needs of the primary users of the reporting entity’s financial statements
 398 aCOWtancy.com Only two statements are mentioned explicitly: 1) The Statement of Financial Position  2) The Statement(s) of Financial Performance The rest are "other statements and notes” Financial statements are prepared for a specified period of time and provide comparative information and under certain circumstances forward-looking information Generally, consolidated financial statements are more likely to provide useful information to users of financial statements than unconsolidated financial statements Chapter - The Elements Of Financial Statements The main focus of this chapter is on the definitions of assets, liabilities, and equity as well as income and expenses The definitions are quoted below: Asset A present economic resource controlled by the entity as a result of past events An economic resource is a right that has the potential to produce economic benefits Liability A present obligation of the entity to transfer an economic resource as a result of past events Equity The residual interest in the assets of the entity after deducting all its liabilities Income Increases in assets or decreases in liabilities that result in increases in equity, other than those relating to contributions from holders of equity claims Expenses  Decreases in assets or increases in liabilities that result in decreases in equity, other than those relating to distributions to holders of equity claims.
 399 aCOWtancy.com The expression "economic resource" instead of simply "resource" stresses that the IASB no longer thinks of assets as physical objects but as sets of rights The definitions of asets and liabilities also no longer refer to "expected" inflows or outflows Instead, the definition of an economic resource refers to the potential of an asset/liability to produce/to require a transfer of economic benefits Chapter - Recognition And Derecognition Only items that meet the definition of an asset, a liability or equity are recognised in the statement of financial position and Only items that meet the definition of income or expenses are to be recognised in the statement(s) of financial performance However, their recognition depends on providing users with:  (1) relevant information about the asset / liability / income / expenses / equity and  (2) a faithful representation of the asset / liability / income / expenses / equity The framework also notes a cost constraint Derecognition The new Framework states that derecognition should aim to represent faithfully both: • any assets and liabilities retained after the transaction that led to the derecognition; and • the change in the entity’s assets and liabilities as a result of that transaction In situations when derecognition supported by disclosure is not sufficient to meet both aims, it might be necessary for an entity to continue to recognise the transferred component.
 400 aCOWtancy.com Chapter - Measurement Historic Cost (uses an entry value) Asset Historical cost, including transaction costs, to the extent unconsumed (or uncollected) and recoverable It includes interest accrued on any financing component Liability Historical consideration as yet owing in respect of goods and services received (net of transaction costs), increased by any onerous provision It includes interest accrued on any financing component Value in use/ Fulfilment value (uses an exit value) Asset Present value of future cash flows from the continuing use of the asset and from its disposal, net of transaction costs on disposal Liability Present value of future cash flows that will arise in fulfilling the liability, including future transaction costs Current Cost (uses an entry value) Asset Consideration that would be given to acquire an equivalent asset at measurement date plus transaction costs It reflects the current age and condition of the asset Liability Consideration that would be received to incur an equivalent liability at measurement date minus transaction costs.
 401 aCOWtancy.com Fair Value (uses an exit value) The price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date It excludes any potential transaction costs on sale or transfer Factors to consider when selecting a measurement basis Choosing a measurement basis is the same as that of financial statements: i.e to provide relevant information that faithfully represents the underlying substance of a transaction So it is important to consider the nature of the information & the relative importance of the information presented in these statements will depend on facts and circumstances Relevance Look at how the characteristics of the asset or liability and how it contributes to future cash flows are two of the factors to see which basis provides most relevant information For example, if an asset is sensitive to market factors, fair value might provide more relevant information than historical cost But FV wouldn't be relevant if the asset is held solely for use or to collect contractual cash flows rather than for sale Faithful representation Uncertainty does not make a measurement basis irrelevant However, a balance must be achieved between relevance and faithful representation Other considerations In most cases, using the same measurement basis in both SFP and Income statement would provide the most useful information Normally select the same measurement basis for the initial measurement of an asset or a liability and its subsequent measurement.
 402 aCOWtancy.com No single factor is determinative when selecting an appropriate measurement basis The relative importance of each factor will depend on facts and circumstances Chapter - Presentation and Disclosure The statement of statement of comprehensive income is newly described as "Statement of Financial Performance", however, the framework does not specify whether this statement should consist of a single statement or two statements, it only requires that a total or subtotal for profit or loss must be provided It also notes that the statement of profit or loss is the primary source of information about an entity’s financial performance for the reporting period and that only in "exceptional circumstances" the Board may decide that income or expenses are to be included in other comprehensive income Notably, the framework does not define profit or loss, thus the question of what goes into profit or loss or into other comprehensive income is still unanswered Chapter - Concepts of Capital And Capital Maintenance The content in this chapter was taken over from the existing Conceptual Frameworkand and discusses concepts of capital (financial and physical), concepts of capital maintenance (again financial and physical) and the determination of profit as well as capital maintenance adjustments The IASB decided that updating the discussion of capital and capital maintenance could have delayed the completion of the framework significantly The Board might consider revising the description and discussion of capital maintenance in the future if it considers such a revision necessary
 403 aCOWtancy.com Current Issue - The IASB’s Principles of Disclosure Initiative Principles of Disclosure Preparers & auditors say that disclosure requirements in IFRS are difficult to work with Investors say that they aren’t getting the right information… In a nutshell, the disclosure problem is the perception that financial statements: • not provide enough relevant information • include too much irrelevant information, and  • communicate the information ineffectively At the heart of this is JUDGEMENT – deciding what to disclose and how to disclose it Behavioural Problem: The IASB says that Managers treat disclosure requirements as a checklist (because it saves time and reduces risks) Preparers are discouraged from using their judgement also because:  • Standards lack clear disclosure objectives • Long lists of prescriptive disclosure requirements promote the use of a ‘checklist’ approach Principles not checklists So the Board thinks that developing a set of disclosure principles would help improve the effectiveness of disclosures Nevertheless, the Board thinks it will only work if Management and others start to use judgement in disclosing information.
 404 aCOWtancy.com The disclosure PRINCIPLES the Board considered: Principles of effective communication
 a) Entity‐specific and tailored 
 b) Simple and direct language;
 c) Organised to highlight important matters; 
 d) Properly cross‐referenced to highlight relationships
 e) No duplication
 f) In a way that optimises comparability Principles on where to disclose information
 a The role of the primary financial statements and of the notes
 b Location of information 
 1) Specify that the ‘primary financial statements’ comprise the four statements 
 This term would then be used consistently throughout all Standards when referring to the underlying four statements with the understanding that ‘primary’ is not intended to imply that the notes provide secondary or less important information than the PFS. 
 Instead, they provide DIFFERENT information from the PFS and have a DIFFERENT role.
 2) Define the roles of the PFS and the notes. 
 This would help in deciding what information is required in the PFS or in the notes
 Would also help judgements about the appropriate level of disaggregation in the PFS and in the notes.
 Disclosing IFRS information outside the financial statements
 Information necessary to comply with the Standards can be disclosed outside the financial statements if: 
 a it is disclosed within the entity’s annual report; 
 b its disclosure outside the financial statements makes the annual report as a whole more understandable,  and
 c it is clearly identified and incorporated in the financial statements by means of a cross‐ reference that is made in the financial statements.
 405 aCOWtancy.com Disclosing non‐IFRS information within the financial statements
 An entity can include non‐IFRS information in the financial statements but :
 a Clearly identify as not being prepared in accordance with the Standards and, if applicable, as unaudited;
 b Disclose in the financial statements a list of the information labelled as non‐IFRS information; and
 c Explain why the information is relevant and represents faithfully the economic events that it purports to represent Principles to address specific disclosure concerns expressed by users of financial statements
 a Use of performance measures
 b Disclosure of accounting policies 
 Presentation of APMs is ok but they should meet the following criteria: 
 a Displayed with equal or less prominence than the totals/subtotals required by the Standards;
 b reconciled to the most directly comparable measures specified in the Standards;
 c neutral, free from error and clearly labelled so they are not misleading;
 d classified, measured and presented consistently over time;
 e identified as to whether they form part of the financial statements and whether they have beenaudited; and
 f accompanied by certain explanations and comparative information Improving disclosure objectives and requirements – centralised disclosure objectives
 categories of accounting policies are suggested and only accounting policies in Categories and must be disclosed,
  (those in Category may be disclosed) 
 Category - always necessary to understand the financial statements This is the case when the accounting policy:
 a) Relates to material items, transactions or events;
 406 aCOWtancy.com b) Is selected from alternatives in IFRSs;
 c) Reflects a change from a previous period;
 d) Is developed by the entity in the absence of specific requirements; and/or
 e) Requires use of significant judgements or assumptions.
 Category — not in Category but necessary to understand the financial statements. 
 Category - not in Categories and but is used in preparing the financial statements. 
 Centralised disclosure objectives
 Method A would focus on the different types of information disclosed about an entity's assets, liabilities, equity, income and expenses
 Method B would focus on information about an entity's activities
 407 aCOWtancy.com Current Issue - Materiality Draft IFRS Practice Statement: Application of Materiality to Financial Statements There were concerns with the application of the concept of materiality Leading to too much immaterial information - meaning the important information could get lost So, this provides non-mandatory guidance to assist with the application of the concept of materiality Characteristics of Materiality Definition of Materiality  "Information is material if omitting it or misstating it could influence decisions that the primary users of general purpose financial reports make on the basis of financial information about a specific reporting entity.” The IASB concedes that judgement is needed to see if info could reasonably be expected to influence decisions that its primary users make To see if something is material involves assessing qualitative and quantitative factors Presentation And Disclosure In The Financial Statements Management should provide information that helps assess future cash & stewardship of resources.  So different materiality assessments in different parts of the financial statements is possible  Financial statements should not obscure material information with immaterial information although "IFRS does not prohibit entities from disclosing immaterial information".
 408 aCOWtancy.com The IASB proposes three steps: Assess what information should be presented in the primary financial statements Assess what information should be disclosed within the notes Review the financial statements as a whole
 (to ensure that the financial statements are a comprehensive document with an appropriate overall mix and balance of information)
 409 aCOWtancy.com Current Issue - Primary Financial Statements Disclosure initiative — Primary Financial Statements [Research] The Primary Financial Statements project is early stage research examining possible changes to the structure and content of the primary financial statements Initial research will focus on: The structure and content of the statement(s) of Financial Performance 
 with: 
 A defined sub-total for operating profit and 
 Alternative performance measures Changes to the statement of cash flows and the SFP
 This research will include feedback on a proposed discussion paper on the statement of cash flows being prepared by the staff of the UK Financial Reporting Council; and The implications of digital reporting for the structure and content of the primary financial statements In the September 2017 IASB Staff Paper, the IASB included an illustrative example of the Statement of financial performance Below is an example of how management performance measure (MPM) fits into the statement(s) of financial performance (provided as MPM subtotal).
 410 aCOWtancy.com 411 aCOWtancy.com Current Issue - Management Commentary IFRS Practice Statement Management Commentary Objective To help management present a useful commentary to financial statements (The Practice Statement is not an IFRS, so following it is not compulsory) Scope Management commentary " provides users with historical explanations of the amounts presented in the financial statements .an entity's prospects and other information not presented in the financial statements a basis for understanding management's objectives and its strategies" Elements of the Commentary • The nature of the business - including its external environment • Management's objectives and strategies • The entity's most significant resources, risks and relationships • The results of operations and prospects • The critical performance measures and indicators that management uses to evaluate the entity's performance against stated objectives 412 aCOWtancy.com ... (profit-related bonuses /share options) • Inducements to encourage unethical behaviour aCOWtancy.com In fact ACCA? ??s Code of Ethics and Conduct identifies that accountants must not be associated with reports,... ethical implications of professional and managerial decisions in the preparation of corporate reports ACCA has a Framework for Ethical Decision Making 1) Understand the Real Issue 2) Any Ethical threats?... the transaction Convertible Loans Another example is that an entity may issue convertible loan notes Management may argue that, as they expect the loan note to be converted into equity, the loan