DEBIT Profit or loss – directors' remuneration $125,000
CREDIT Liability $120,000
CREDIT Equity $5,000
In effect, the director surrenders the right to $120,000 cash in order to obtain equity worth $125,000.
(c) Investment in Hardy
The investment in Hardy should be treated as an associate under IAS 28 Investments in associates and joint ventures. Between 20% and 50% of the share capital has been acquired, and significant influence may be exercised through the right to appoint directors. Associates are accounted for as cost plus post acquisition change in net assets, generally cost plus share of post-acquisition retained earnings. The cost is the fair value of the shares in Leigh exchanged for the shares of Handy. However, negative goodwill arises because the fair value of the net assets of Hardy exceeds this. The negative goodwill must be added back to determine the cost to be used for the carrying value, and, following a reassessment, credited to profit or loss. (Dr Cost 0.2, Cr P/L 0.2)
$m
Cost: 1m × $2.50 2.5
Add back negative goodwill: (2.5 + (9 × 70% 'NCI') – 9) 0.2
2.7
Post acquisition profits: (5 – 4) × 30% 0.3
Carrying value at 31 May 20X7 3.0
Note. The 0.2 is not part of post acquisition retained earnings. It is adjustment to the original cost to remove the negative goodwill.
Because negative goodwill has arisen, the investment must be impairment tested. A comparison must be made with the estimated recoverable amount of Hardy's net assets. The investment must not be carried above the recoverable amount:
Recoverable amount at 31 May 20X7: $11m 30% = $3.3m
The recoverable amount is above the carrying value, so the investment at 31 May 20X7 will be shown at
$3m.
176 Answers
30 Margie
Text reference. Share-based payment is covered in Chapter 8. Derivatives are covered in Chapter 7.
Top tips. This is a multi-part question, set in the context of share-related transactions. However, you should not assume that all transactions should be accounted for under IFRS 2. Part (a), a contract for the purchase of wheat, could be settled in the entity's own shares, but is intended to be settled net in cash, and is therefore a derivative rather than a share-based payment. Part (b) deals with the situation where share-based payment award is
exchanged for awards held by the acquiree's employees as part of the business combination, so IFRS 3 is relevant.
Part (c) deals with two share issues, one of which is outside the scope of IFRS 2. Part (d) is an equity-settled share- based payment with a variable vesting period based on a market condition.
Easy marks. There aren't any obvious easy marks here, but if you attempt all parts of the question you can gain the first few marks of each part.
Examiner's comment. In Part (a), Many candidates did not recognise the fact that the transaction should be dealt with under IFRS 9.This type of transaction has been examined recently but candidates did not seem to recognise the nature of the transaction. In Part (b), candidates had to understand the interaction of IFRS 2 and IFRS 3 in order to answer the question. The question was not well answered although candidates did seem to realise that there was a post combination expense to be taken into account. In Part (c), candidates often felt that the first transaction was within the scope of IFRS 2 and the second was not. Unfortunately this assumption was incorrect with the correct answer being that the first transaction was outside the scope and the second was within the scope. Part (d) was well answered. Candidates generally seemed to understand the effect of a market condition.
Marking scheme
Marks
(a) Discussion IFRS 9 5
Conclusion 2
(b) Discussion of IFRS 3/IFRS 2 4
Calculation 2
(c) Discussion 4
(d) Discussion 4
Calculation 2
Professional 2
25
(a) Contract for the purchase of wheat
Although the amount paid to settle the contract will be equal to the value of 2,500 of Margie's shares, this is not a share-based payment within the scope of IFRS 2. There are two main reasons for this:
(i) The contract may be settled net in cash.
(ii) The contract has not been entered into be entered into in order to satisfy Margie's normal sales and purchases requirements. Margie has no intention of taking delivery of the wheat; this is a financial contract to pay or receive a cash amount.
Contracts for purchase or sale of non-financial items that meet certain conditions are accounted for under under IFRS 9 Financial instruments. Specifically, contracts to buy or sell non-financial items are within the scope of IFRS 9 if they can be settled net in cash or another financial asset, and are not entered into and held for the purpose of the receipt or delivery of a non-financial item in accordance with the entity's expected purchase, sale, or usage requirements. Contracts to buy or sell non-financial items are inside the scope if net settlement occurs.
Any one of the following situations constitutes net settlement
(i) The terms of the contract permit either counterparty to settle net.
(ii) There is a past practice of settling similar contracts net.
(iii) There is a past practice, for similar contracts, of taking delivery of the underlying and selling it within a short period after delivery to generate a profit from short-term fluctuations in price, or from a dealer's margin.
(iv) The non-financial item is readily convertible to cash.
Contracts that allow net settlement in cash can be entered into for satisfying the normal sales and purchases requirements of the two parties but this is not such a contract.
The contract to purchase the wheat will be accounted for as a derivative and valued at fair value (an asset or liability at fair value according to IFRS 9). On inception the fair value of the contract will be nil because the value of 350 tonnes of wheat will be equivalent to 2,500 of Margie's shares. This will not be the case at subsequent period ends because factors affecting the market price of wheat will not be the same as those affecting the market price of Margie's shares. Accordingly, differences will arise and there will be a gain or loss, which must be taken to profit or loss for the year.
Margie wishes to use this contract as part of its hedging strategy. However, this would not be appropriate.
There is no firm commitment to purchase the wheat (in fact Margie has no intention of purchasing it), and it is not a highly probable forecast transaction.
(b) Replacement award
In a business combination, an acquirer may exchange its share-based payment awards for awards held by employees of the acquiree. This may be termed a replacement award, and must be measured using IFRS 2 Share-based payment. Part of the fair value of the replacement award may, depending on the
circumstances, be treated in accordance with IFRS 3 Business combinations.
IFRS 3 provides guidance on whether share-based payment awards in a business combination are part of the consideration transferred to obtain control (accounted for under IFRS 3) or as a post-combination expense (accounted for under IFRS 2). If the acquirer is obliged to replace the acquiree's award, then all or part of the acquirer's award is part of the consideration transferred. If not, then it is a post-
combination expense.
Margie obliged to replace Antalya's award
If the Margie is obliged to replace Antalya's award, all or a portion of the fair value of Margie's replacement award must be included in the measurement of the consideration transferred by Margie. The amount included in the consideration transferred is the fair value of Antalya's award at the acquisition date of
$20 million.
The difference between the fair value of Margie's replacement award and the fair value of the reward replaced, $22m – $20m = $2m is recognised as an expense in the post-combination profit or loss. This is the case even though no post-combination services are required.
Margie not obliged to replace Antalya's award
If Margie is not obliged to replace Antalya's award, then Margie should not adjust the consideration, whether or not it actually does replace Antalya's award. All of the fair value of Margie's award would be recognised immediately as a post-combination expense, despite the fact that no post-combination services are required.
(c) Issue of shares to employees
Margie's issue of shares to its employees who are already shareholders does not fall within the scope of IFRS 2 Share-based payment. The issue was made to the employees in their capacity as shareholders, not as employees. There are no service or performance requirements demanded in exchange for the shares.
178 Answers
The employees are therefore just shareholders like any other, and the issue of shares will be accounted for like any other, with a debit to cash and a credit to share capital and to share premium for any excess over the nominal value.
Issue of shares to Grief
The issue of the shares to Grief does come within the scope of IFRS 2 Share-based payment. Share-based payment occurs when an entity purchases goods or services from another party such as a supplier or employee and rather than paying directly in cash, settles the amount owing in shares, share options or future cash amounts linked to the value of shares.
In this case, Grief is acting as a supplier (of the building), the payment is in shares, and the purpose of issuing the shares was to buy the building. In accordance with IFRS 2, the building will be shown at fair value on the statement of financial position, with a corresponding credit to equity.
(d) Share-based payment with variable vesting period
The grant of the options to employees clearly falls within the scope of IFRS 2. In this case there is a market condition which must be met before the shares vest. The vesting period may change as a result of a vesting condition being met. IFRS 2 makes a distinction between the handling of market based performance features from non-market features. Market conditions are those related to the market price of any entity's equity, such as achieving a specified share price or a specified target based on a comparison of the entity's share price with an index of share prices of other entities. Market based performance features should be included in the grant-date fair value measurement. However, the fair value of the equity instruments should not be reduced to take into consideration non-market based performance features or other vesting features.
An entity needs to estimate, at grant date, the expected vesting period over which the charge should be spread, on the assumption that services will be rendered by employees over this vesting period in exchange for the equity instruments.
If the vesting period turns out to be shorter than estimated, the charge will be accelerated in the period in which the entity must fulfil its obligations by delivering shares or cash to the employee or supplier. If the actual vesting period is longer than estimated, the expense is recognised over the original vesting period.
At the grant date (1 December 20X1), Margie estimated the vesting period to be four years, the assumption being that the market condition would be met four years later in 20X5. Thus the charge over the four years was calculated as (100 × 4,000 × $10) ÷ 4 years = $1m per year.
The market condition was actually met a year early, on 30 November 20X4. The expense therefore needs to be accelerated and charged in the year ended 30 November 20X4. The charge for the year is calculated as:
$m
Total charge: 100 × 4,000 × $10 4
Less already charged in the two years to 30.11. 20X3: 2 × $1m (2)
Charge in the year ended 30.11.20X4 2
31 Greenie
Text reference. Specialised entities are covered in general terms in Chapter 20. The specific issues are covered as follows: share-based payment in Chapter 8, provisions and contingencies in Chapter 9, associates in Chapter 12 and preference shares in Chapter 7.
Top tips. This question is set in the airport industry. In keeping with the examiner's guidance, no specific knowledge of this industry is required. Part (a) covered provisions, contingent liabilities and contingent assets.
There is a lot of information, but this part is more straightforward than it looks. In Part (b) you need to consider whether IAS 28 should be applied, that is whether there is significant influence. The percentage holding is not the only determining factor. Part (c) covered purchase of a franchise by issuing shares. This is a form of share-based payment. This part asked for the treatment of irredeemable preference shares with a fixed cash dividend. This meets the definition of a financial liability (in this case a contractual obligation to deliver cash) but also has an equity component, so needs to be accounted for as a compound instrument.
Easy marks. This was a challenging question and required a lot of thought. However, there are some easy marks for textbook learning in explaining what a provision is and what a contingent liability is, and also for listing the ways in which significant influence can be shown.
Examiner's comment. This question dealt with real world scenarios taken from corporate financial statements.
Parts (a) of the question was well answered although many candidates came to the incorrect conclusion. Part (b) was also well answered, but many candidates did not use the scenario and in this question it was critical to discuss the facts in the question. Part (c) was not well answered , particularly regarding the irredeemable preference shares.
Marking scheme
Marks
(a) Provision discussion 3
Contingent liability discussion 3
(b) Significant influence discussion and application 10
(c) Intangible assets 3
Preference shares 4
Professional 2
25
(a) Provision or contingent liability?
A provision is defined by IAS 37 Provisions, contingent liabilities and contingent assets as a liability of uncertain timing or amount. IAS 37 states that a provision should only be recognised if:
There is a present obligation as the result of a past event
An outflow of resources embodying economic benefits is probable, and
A reliable estimate of the amount can be made If these conditions apply, a provision must be recognised.
The past event that gives rise, under IAS 37, to a present obligation, is known as the obligating event. The obligation may be legal, or it may be constructive (as when past practice creates a valid expectation on the part of a third party). The entity must have no realistic alternative but to settle the obligation.
As at 30 November 20X0, Greenie has no legal obligation to pay compensation to third parties. No legal action has been brought in respect of the accident. Nor can Greenie be said to have a constructive obligation at the year end, because the investigation has not been concluded, and the expert report will not be
presented to the civil courts until 20X1.Therefore under IAS 37 Provisions, contingent liabilities and contingent assets no provision would be recognised for this amount.
However, the possible payment does fall within the IAS 37 definition of a contingent liability, which is:
A possible obligation depending on whether some uncertain future event occurs, or
A present obligation but payment is not probable or the amount cannot be measured reliably There is uncertainty as to the outcome of the investigation and findings of the report, and the extent of the damages and any compensation arising remain to be confirmed. However, the uncertainty over these details is not so great that the possibility of an outflow of economic benefits is remote.
Therefore as a contingent liability the details and, if possible an estimate of the amount payable, would be disclosed in the notes to the financial statements.
The question arises as to whether the possible recovery of the compensation costs from the insurance company constitutes a contingent asset under IAS 37. A contingent asset is a possible asset that arises from past events, and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity.
180 Answers
Because any insurance claim will only be made after the courts have determined compensation, and will then need to be assessed on its merits, any payout is one step removed from the potential payment of
compensation. In other words it is merely possible rather than probable, and disclosure of a contingent asset would not be appropriate.
(b) Significant influence
In accounting for Manair, Greenie needs to have regard to IAS 28 Investments in associates and joint ventures. IAS 28 defines an associate as 'an entity in which an investor has significant influence but not control or joint control'.
Significant influence is the power to participate in the financial and operating policy decisions of an economic activity but is not control or joint control over those policies.
Significant influence can be determined by the holding of voting rights (usually attached to shares) in the entity. IAS 28 states that if an investor holds 20% or more of the voting power of the investee, it can be presumed that the investor has significant influence over the investee, unless it can be clearly shown that this is not the case.
Significant influence can be presumed not to exist if the investor holds less than 20% of the voting power of the investee, unless it can be demonstrated otherwise.
The existence of significant influence is evidenced in one or more of the following ways.
(i) Representation on the board of directors (or equivalent) of the investee (ii) Participation in the policy making process
(iii) Material transactions between investor and investee (iv) Interchange of management personnel
(v) Provision of essential technical information
The fact that Greenie holds 19. 9% of the voting shares of Manair suggests that it wishes to keep just below the threshold at which significant influence would be presumed in order to avoid accounting for Manair as an associate. The percentage of shares held is only one factor to consider, and the other factors above need to be considered in turn.
(i) Greenie does have representation on the board of directors.
(ii) Greenie can participate in some decisions. It is not clear whether these are financial and operating decisions, but the fact that the shareholders' agreement requires a unanimous or majority decision suggests that Greenie is more than just an ordinary investor.
(ii) During the year, Greenie has sold Mainair a software licence for $5m, which is at least one material transaction.
(iv) There is no evidence of interchange of management personnel.
(v) Greenie has provided Manair with maintenance and technical services, another indication of significant influence.
The fact that so many indications of significant influence appear to be present, together with the holding of just under the threshold, suggests that Greenie does have significant influence over Manair. Accordingly, IAS 28 applies: Manair must be treated as an associate and equity accounted in the financial statements.
Related party
As an associate, Manair is a related party of Greenie under IAS 24 Related party disclosures. IAS 24 requires disclosure in the financial statements of Greenie of the related party relationship between Greenie and Manair and also of transactions between the two companies, the total value of those transactions and outstanding balances and, if applicable, debts deemed irrecoverable.