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(Association of Chartered Certified Accountants)
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ACCA
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Strategic
Business
Reporting
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(International)
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Class Notes
September 2018-June 2019
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© Interactive World Wide Ltd, May 2018
All rights reserved. No part of this publication may be reproduced, stored in a
retrieval system, or transmitted, in any form or by any means, electronic,
mechanical, photocopying, recording or otherwise, without the prior written
permission of Interactive World Wide Ltd.
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Contents
PAGE
INTRODUCTION TO THE PAPER
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CHAPTER 1: BASIC GROUPS
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17
CHAPTER 3: FOREIGN CURRENCY TRANSLATION
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CHAPTER 4: GROUP CASH FLOW STATEMENTS
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CHAPTER 5: PERFORMANCE REPORTING
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CHAPTER 6: PROVISIONS AND OTHER STANDARDS
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CHAPTER 7: NON-CURRENT ASSETS
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CHAPTER 8: LEASES
CHAPTER 9: EMPLOYEE BENEFITS
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CHAPTER 2: CHANGES IN GROUP OWNERSHIP
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CHAPTER 11: FINANCIAL INSTRUMENTS
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CHAPTER 12: TAX
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CHAPTER 10: SHARE-BASED PAYMENTS
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CHAPTER 13: CURRENT ISSUES AND OTHER CORPORATE REPORTING
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CLASS NOTES QUESTIONS
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APPENDIX: SUGGESTED SOLUTIONS TO QUESTIONS AND EXAMPLES
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IN T R O D U C T I O N T O T H E P A P ER
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Introduction to the
Paper
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IN T R O D U C T I O N T O T H E P A P E R
AIM OF THE PAPER
To apply knowledge, skills and exercise professional judgement in the application and
evaluation of financial reporting principles and practices in a range of business
contexts and situations.
FORMAT OF THE EXAM PAPER
The syllabus is assessed by a three-hour 15 minutes examination.
It examines professional competences within the corporate reporting environment.
Marks
1. Group case study
30
2. Ethical case study
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3. Accounting issues
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4. Accounting issues
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Question
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The ACCA have issued guidance outlining the way that the SBR exam will be
structured, briefly outlined in the format of the exam paper above. The ACCA have
made it clear that all the following proposed components, including the way in which
the marks are allocated between the questions, may vary from exam to exam. The
only promises that the ACCA make is that the ACCA exam will have only compulsory
questions in sections A and B, as outlined above, and a mixture of narrative and
computational requirements that address reporting issues, with a leaning towards
investor relations. However, the following structure based upon the ACCA SBR
specimen paper is a useful guide to understanding the SBR exam philosophy:
Explanation of numbers
Analysis of accounting and ethics
Accounting issues
Accounting issues
A
INTERNATIONAL EXAMINABLE DOCUMENTS
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For the official list of examinable documents check out the SBR web page under
“examinable documents”. You will find detail there. All the examinable standards
are covered herein. But frankly, SBR is not a list of documents to learn and
regurgitate. SBR is about understanding and applying. The examiner perceives
financial reporting as being largely problem solving and so rarely expects
regurgitation of standards.
UK STREAM
Some students may wish to consider the UK stream. Do not do so without reading
the ACCA guidance online on the UK stream. This stream does require extra work
and this extra work is unlikely to be of use to you in your career unless you have a
specific need for the UK stream syllabus.
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Chapter 1
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Basic Groups
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C H A P T E R 1 - B A S IC G R O U P S
RELATIONSHIPS
The process is determined by the relationships between the entities. There are three
relationships between entities:
●
control
●
influence
●
neither.
Subsidiary
Control is the power to direct activities.
When a parent has control of another entity, then that entity is known as a subsidiary
and is consolidated using acquisition accounting.
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Associate (& Joint Ventures)
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This means the subsidiary’s assets and liabilities are added to those of the parent.
Influence is the power to participate in management policy.
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When a parent has influence over another entity, then that entity is known as an
associate and is brought into the group fs using equity accounting.
Investment
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This means the group fs include a share of the profit on the profit or loss and cost
plus a share of the growth on the statement of financial position.
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When a parent has no relationship with another entity, then that entity is known as
an investment and brought into the fs using investment accounting. This means that
the shares are carried at fair value. Investment accounting is covered in much more
detail later, in the chapter on financial instruments.
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C H A P T ER 1 - BA S IC G R O U P S
Question: Peddle
The following are the summarised accounts of Peddle (P) and Saddle (S) for the year.
Profit or loss (Income Statements)
P
$’m
500
(200)
___________
300
(50)
___________
Profit before tax
Tax
250
(80)
Profit for the financial year
Retained profit brought forward
Retained profit carried forward
190
(20)
__________
170
(60)
___________
__________
170
500
110
200
___________
__________
670
___________
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Operating profit
Interest Expense
__________
310
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Revenue
Operating Costs
S
$’m
400
(210)
__________
P
$’m
260
120
390
S
$’m
360
___________
___________
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Investment in Saddle (80%)
Investment in Andlebar (30%)
Net assets
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Statements of financial position (Balance Sheets)
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Share Capital (nominal $1 each)
Retained Earnings
770
360
___________
__________
100
670
50
310
___________
___________
770
360
___________
__________
The shares in Saddle and the shares in Andlebar were acquired on the first day of the
year. Goodwill has suffered no impairment. The net assets of Andlebar were $330m
at the year start and $470m at the year end following growth of $140m reported
through profit or loss.
It is the group’s policy to value the non-controlling interest at fair value. The fair
value of the non-controlling interest in S at acquisition was $60m.
Required:
Prepare the consolidated statement of profit or loss (income statement) and
consolidated statement of financial position (balance sheet).
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C H A P T E R 1 - B A S IC G R O U P S
GOODWILL POLICIES
There are two permitted policies for goodwill:Full goodwill
Non-controlling interest is measured at fair value.
Partial goodwill
Non-controlling interest is measured at proportion of net assets.
GOODWILL IMPAIRMENT
Some groups questions require students to conduct an impairment review on the
subsidiaries at the year end. This results in a goodwill impairment.
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Impairment
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An impairment occurs if the recoverable value of an asset falls below the carrying
value.
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Recoverable value
This is the higher of VIU and FVLCTS (NRV).
VIV = Value in use
●
FVLCTS = fair value les costs to sell [this is almost identical to the more familiar
NRV = Net realisable value but more strictly this is actually phrased as “fair
value less cost to sell” which is essentially the same idea as NRV].
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Impairment of subsidiary
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Goodwill impairment is identified by looking at the impairment of the whole
subsidiary.
Question: Fakenstock
A parent, Fakenstock, bought 100% of the equity of a sub at the year start for $900m.
Share capital was $100m, retained earnings were $400m and retained profits for the
year were $200m.
Goodwill has in infinite life and an impairment review of the sub at the first year end
revealed a value in use (VIU) of $780m and a fair value less costs to sell (FVLCTS)
or net realisable value (NRV) of $350m.
Required:
Goodwill.
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C H A P T ER 1 - BA S IC G R O U P S
OTHER GROUPS TECHNIQUES
There are two more basic techniques frequently examined.
Fair Value Adjustments
FVA address the gap that opens up between subsidiary book value at acquisition and
fair value at acquisition. FVA are most useful for property where carrying value and
market value can be wildly different.
Provision for Unrealised Profit
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It is common for a subsidiary to trade with its parent and record a profit. Indeed it
is common for a parent to sell to a sub and record a profit. This profit is real from
the perspective of the selling entity but unreal from the perspective of the group.
PUP pulls this problem profit out of the seller profits.
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Question: Terra
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A parent, Terra, buys 70% of a sub for $800m at the year start, when the share
capital is $50m, retained earnings are $350m and a fair value adjustment (FVA) of
$100m is required on machines with a life of five years. The fair value of the noncontrolling interest is $317m
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During the year the sub made profits retained of $50m and the sub sold goods valued
at $12m to the parent with a margin of 25%; one third of which is still in inventory
in the parent.
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Goodwill has an infinite life and a year end review reveals a value in use (VIU) of
$360m and a fair value less costs to sell (FVLCTS) or net realisable value (NRV) of
$666m.
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It is the group’s policy to value the non-controlling interest at fair value (full goodwill).
Required:
Goodwill and NCI.
Note that the question is based upon full goodwill. The answer is therefore based
upon full goodwill. However, for completeness the answer also shows how the
impairment calculation changes very slightly if partial goodwill is assumed.
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C H A P T E R 1 - B A S IC G R O U P S
Joint Arrangements
IFRS 11 Joint Arrangements looks at entities under joint control. Joint control exists
only when decisions about the relevant activities require the unanimous consent of
the parties sharing control. Joint control occurs when you and I together have control
of another entity but individually have only influence. There are two arrangements:-
Joint Operations (JO)
A JO is essentially an unincorporated JA.
A JO is usually consolidated using proportional consolidation.
In a JO, you and I share control of the operation, but my assets are mine and your
assets are yours. The accounting follows the substance. My assets go on my balance
sheet and yours on yours.
Joint Venture (JV)
A JV is measured using equity accounting.
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A JV is an incorporated JA.
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In a JV, you and I share control and everything else as well. Joint control is seen as
very significant influence. So a JV is simply accounted for as an associate. The detail
of associate accounting remains in old IAS 28.
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Incorporation
It is not always true, but usually incorporation gives away the underlying nature. JVs
are incorporated and JOs are not.
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Question: You and I
Japan
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You and I are working together selling petrol.
We go into Japan and we both put $100m each into a newly incorporated company
that will build a refinery and buy oil to refine and sell to the Japanese. You will have
half the shares and I will have the other half. We agree to all strategic decisions will
be made by unanimous consent.
Russia
We also go into Russia. We agree to all strategic decisions will be made by unanimous
consent. We agree to share the revenue half and half. But you put your Russian
refinery into the deal and I put my trans-Siberian pipeline in. We agree that your
refinery remains yours and my pipeline remains mine, although to repeat, the
revenue is to be shared half and half.
Required
Discuss.
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C H A P T ER 1 - BA S IC G R O U P S
Disclosure
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IFRS 12 Disclosure of Interests in Other Entities is a very cute piece of standard
setting. IFRS 12 requires that a parent lists all the entities with which it has a
relationship and explain the basis of the parent conclusion. So the parent must list
all its subs and say why it believes it has control and list all its associates and say
why it believes it has influence and not control. This makes it even harder to pretend
a sub is an associate.
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C H A P T E R 1 - B A S IC G R O U P S
Classic question: Hebrides (parent sub associate)
Exactly half way through the year, Hebrides acquired 80% of the share capital of
Skye and 30% of the share capital of Aran. Hebrides acquired Skye by way of share
for share exchange. Hebrides issued five of its own shares for two Skye shares. The
market value of Hebrides’ shares was $5 on that day. The share issue has not yet
been recorded. Aran shares were acquired for $500,000 cash consideration.
It is the group’s policy to value the non-controlling interest at fair value which at
acquisition was $410,000.
The summarised draft financial statements are as follows:
Income Statement or Profit and loss account for the year ended 31 March
Hebrides
$’000
11,000
(6,000)
_____
Aran
$’000
3,600
1,820
(2,600) (1,400)
_____
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Revenue
Cost of sales
Skye
$’000
5,000
(2,500)
_____
1,000
(420)
_____
420
(220)
___
2,500
(700)
32
_____
580
(280)
200
(70)
___
___
1,832
(832)
_____
300
(100)
___
130
(30)
___
1,000
(400)
_____
200
(40)
___
100
(0)
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Profit retained
Retained profit brought forward
600
9,000
_____
160
600
___
100
400
___
Retained profit carried forward
9,600
_____
760
___
500
___
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Profit after tax
Dividends paid
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Profit before tax
Tax
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Operating profit
Interest
Dividends received from Skye
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Gross profit
Operating expenses
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C H A P T ER 1 - BA S IC G R O U P S
Statement of financial position as at 31 March
Hebrides
$’000
$’000
Non current assets
Land & building
Plant & machinery
Investment in Aran
Investment in other shares
Skye
$’000
$’000
Aran
$’000 $’000
9,000
4,000
500
600
______
2,000
1,500
800
700
300
_____
50
14,100
3,800
1,550
_____
70
170
40
___
2,900
_____
520
___
280
___
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300
150
70
___
900
700
_____
140
100
___
60
30
__
240
___
90
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Current Liabilities
Trade
Corporation tax
1,100
1,500
300
_____
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Current assets
Inventory
Receivables
Bank
1,600
_____
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1,300
Non Current Liabilities
Loan
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_____
280
190
(2,800)
______
(3,020)
_____
(940)
12,600
______
1,060
_____
700
1,000
2,000
9,600
______
200
100
760
_____
160
40
500
___
12,600
______
1,060
_____
700
___
_____
Share capital ($1 nominal each)
Share premium
Retained earnings
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C H A P T E R 1 - B A S IC G R O U P S
The following information is relevant:
At acquisition the fair value of all Aran’s assets was reasonably represented by
the book value. The same was true of Skye with the exception of some land
and plant. These had fair values of $400,000 and $300,000 above book values.
The plant had a remaining life of five years. Depreciation is charged to cost of
sales.
(2)
In the post-acquisition period Skye sold goods to Hebrides at $120,000.
Transfer transactions were calculated to give a margin of 20% (mark up of
25%). Skye held five sixths of these goods in inventory at the year end.
(3)
Goodwill related to the Skye acquisition was subject to a brief impairment
review and this was sufficient to confirm that there was no impairment.
However, a similar review of the goodwill related to Aran revealed that there
may be an impairment. So a more detailed review was conducted which
revealed a value in use of $790,000 for the whole of Aran and an equivalent
fair value less cost to sell of $560,000. Large impairment is separately
discloseable on the face of the income statement.
(4)
The current account between Hebrides and Skye did not agree due to cash in
transit from subsidiary to parent of $4,000. Hebrides recorded a receivable of
$25,000 at the year end. Dividends were paid in the last month before the year
end.
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(1)
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Required:
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Income statement (Profit or loss report) and statement of financial position (balance
sheet) for the group for the year ended 31 March.
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Chapter 2
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Changes in Group
ownership
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C H A P T E R 2 – C H A N G E S I N G R O U P O W N E R S H IP
CHANGES IN OWNERSHIP
A parent may simply buy or sell shares. However, the group viewpoint is quite
different. A group only acquires a sub when it gets control and only sells a sub when
it loses control. Other share exchanges are simply changes in ownership and result
in transfers of ownership between the two owners; the non-controlling interest and
the controlling interest.
Question: Lady Gaga
At the year start, Lady acquired a 13% speculative equity investment interest in Gaga
at a cost of $25m. At the year end Lady acquired a further 47% equity interest in
Gaga at a cost of $120m and obtained control. The fair value of the initial 13%
interest at this time was $27m and the fair value of the NCI was $110m. The fair
value of the identifiable net assets was $150m.
Goodwill.
Question: Adam Ant (UK) limited
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At the year start, Adam acquired 70% of Ant for $460m. Ant had identifiable net
assets with a fair value of $300m at acquisition and the fair value of the NCI was
$200m.
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At the year end, Adam sells 25% of Ant for $250m and loses control, but retains
influence through its remaining 45% ownership. The fair value of the associate
retained is measured at $410m.
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Required:
A
At the year end Ant had identifiable net assets of $330m. The growth of $30m had
been reported through the income statement.
Profit on disposal to be recognised in the income statement.
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C H A P T ER 2 – C H A N G E S I N G R O U P O W N E R S H IP
Question: Iggy Pop
At the year start, Iggy acquired 70% of Pop for $350m. The fair value of the
identifiable net assets of Pop at the point of acquisition was $110m. The fair value
of the NCI was $138m.
Required:
(a)
Goodwill.
At the year end, Iggy acquires a further 10% of Pop for $55m. Pop has made profits
and grown by $20m over the year and therefore the carrying value of identifiable net
assets of Pop is $130m at the year end.
Required:
Transfer from NCI and effect on controlling interest.
Question: Iggy Pop (parallel universe)
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(b)
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At the year start, Iggy acquired 80% of Pop for $200m. The fair value of the
identifiable net assets of Pop at the point of acquisition was $90m. The fair value of
the NCI was $39m.
(a)
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Required:
Goodwill.
Transfer from NCI and effect on controlling interest.
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(b)
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Required:
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At the year end, Iggy acquires a further 10% of Pop for $29m. Pop has made profits
and grown by $10m over the year and therefore the carrying value of identifiable net
assets of Pop is $100m at the year end.
Question: Busta Rhymes
At the year start, Busta acquired 90% of Rhymes for $440m. The fair value of the
identifiable net assets of Rhymes at the point of acquisition was $180m. The fair
value of the NCI was $40m.
Required:
(a)
Goodwill.
At the year end, Busta disposes of 15% of the equity of Rhymes for $90m and so
reduces its ownership to 75%. Rhymes has made profits and grown by $40m over
the year and therefore the carrying value of identifiable net assets of Rhymes is
$220m at the year end.
Required:
(b)
Transfer to NCI and effect on controlling interest.
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C H A P T ER 3 – F O R EI G N C U R R EN C Y T R A N S L A T I O N
Chapter 3
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Foreign Currency
Translation
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CHAPTER 3 – FOREIGN CURRENCY TRANSLATION
INTRODUCTION TO FOREIGN CURRENCY TRANSLATION
This chapter addresses the process of translating foreign currency information into
the home currency (IAS 21).
This chapter answers two questions:
(1)
Foreign transactions
‘How do I account for my foreign transactions?’
(2)
Foreign subsidiaries
‘How do I account for my foreign subsidiaries?’
FOREIGN TRANSACTIONS
x
The process of translating individual foreign transactions is referred to by the
expression “the individual company stage” within the IFRSs.
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Foreign transactions are translated into the home currency and foreign monetary
items on the statement of financial position are re-translated at the year end.
x
x
x
x
(x)
(x)
___
Non-monetary
items
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Non-current assets
Current assets
Inventory
Receivables
Bank
Current Liabilities
Non-current Liabilities
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This can be shown particularly well using the equity style of statement of financial
position presentation:
Monetary
items
Translate
and leave
Translate and
retranslate
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C H A P T ER 3 – F O R EI G N C U R R EN C Y T R A N S L A T I O N
Question: Furtive
A company buys a machine on three months credit from France for €50m just before
the year end of 31.12. It takes delivery on 15.12. The rates are as follows:
Date
Rate
Delivery (15.12)
Y/e (31.12)
$1: €1.00
$1: €1.25
Required:
Foreign exchange movement.
Question: Feature
Date
Rate
$1: 5 Roubles
$1: 4 Roubles
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Delivery
Y/e
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A company buys a fixed asset on three months credit two weeks before the year end
for 90,000 Roubles. Rates are as follows:
Foreign exchange movement.
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Required:
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Question: Feature (continued)
The company pays the creditor on schedule in the new year.
$1: 4 Roubles
$1: 4.5 Roubles
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Year start
Payment
Rate
A
Date
Required:
Foreign exchange movement.
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CHAPTER 3 – FOREIGN CURRENCY TRANSLATION
FOREIGN SUBSIDIARIES
Group stage
A foreign subsidiary needs translation before consolidation:
Statement
Rate
Statement of financial position
Profit and loss
Closing rate
Average rate
Goodwill
Goodwill is a subsidiary asset so from the parent point of view it’s a foreign asset.
Currencies
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Foreign subsidiaries communicate in two currencies. First there is the functional
currency. This is the currency that dominates the primary economic activities and is
therefore the currency the entity uses to produce its initial fs. Then there is the
presentational currency. The parent demands fs in the parent currency to help the
parent with consolidation. So the foreign sub must translate the initial fs from the
functional currency to the presentational currency.
Functional currency
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This is defined as the currency of the primary economic environment (IAS 21). This
means the currency that dominates the functions.
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Usually this is obvious. But some entities have similar reliance on two or more
currencies. When this occurs one practical way to interpret the IAS and solve the
problem is to add up all the transactions and the currency with most value is the
functional currency.
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However, if the decision is still marginal then the IAS guides that extra weight should
be given to the currency of the competitive forces.
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Presentational currency
This is defined by demand. So if the parent wants a Euro sub to report in Dollars
then the Euro sub must report in Dollars.
Question: Scuba
Scuba operates in two currencies: the currency of the country in which Scuba
operates (the Gooble “G”) and the currency of the parent (the dollar “$”).
The sales are all transacted in Gooble and the local environment dominates the
competitive behaviour. The goods are purchased half in Gooble and half in dollars.
The parent supplies the finance also in dollars. But rent and staff costs are both paid
to locals in Gooble.
Required
Identify the functional currency of Scuba.
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C H A P T ER 3 – F O R EI G N C U R R EN C Y T R A N S L A T I O N
Question: Kenya
Kenya purchased 90% of the ordinary shares of a foreign subsidiary, Malawi, which
has the functional currency of the kwacha (K). The subsidiary was acquired at the
start of the current accounting period when its reserves were 128 million kwachas
(Km).
It is the group’s policy to value the non-controlling interest at fair value. The fair
value of non-controlling interest at acquisition was 80 million kwachas. There was
no impairment in goodwill.
Statement of financial position
Investment in Malawi
Net Assets
Malawi
Km
70
450
80
600
40
260
300
Kenya
$m
280
(220)
60
(19)
41
Kenya
$m
10
Malawi
Km
936
(705)
231
(99)
132
Malawi
Km
-
Bo
x
Share capital
Retained earnings
Other components of equity
Kenya
$m
180
420
600
Profit or loss statement
G
lo
ba
l
Revenue
Costs
Profit before tax
Tax
Profit after tax
Other comprehensive income statement
AC
C
A
Revaluation
Kenya opening balances on reserves at the year start were:
Reserve
$m
Retained earnings
409
Other components of equity
70
300
300
Relevant exchange rates are:
Date
Year start
Year end
Weighted average for year
Exchange rate
(Kwachas to $1)
4
2
3
Required:
Prepare the following:A consolidated statement of financial position (balance sheet).
A consolidated statement of profit or loss and other comprehensive income (SPLOCI).
A consolidated statement of changes in equity (SOCIE).
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CHAPTER 3 – FOREIGN CURRENCY TRANSLATION
Supplementary question: Xtreme
Xtreme (X) acquired 70% of Golf (G) at the beginning of the year, on 1 January. G
is situated in a foreign country. The currency of this country is the Kram (Kr).
It is the group’s policy to value the non-controlling interest at fair value. The fair
value of non-controlling interest at acquisition was Kr1,888m.
Statement of profit or loss for current year ended 31 December
X
$m
G
Krm
500
(200)
_____
800
(400)
_____
Gross profits
Operating expenses
300
(100)
_____
400
(170)
_____
Operating profit
Interest expense
200
(10)
_____
230
(30)
_____
190
(90)
_____
200
(100)
_____
100
_____
100
_____
3,000
100
_____
2,000
100
_____
3,100
_____
2,100
_____
Bo
x
Revenue
Cost of sales
ba
l
Profit before tax
Tax
Reserve Movement
G
lo
Profit after tax
A
Accumulated profits brought forward
Profit after tax
AC
C
Accumulated profits carried forward
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C H A P T ER 3 – F O R EI G N C U R R EN C Y T R A N S L A T I O N
Statement of financial position as at 31 December
X
$m
Non current assets
Investment in G
Property plant & equipment
Current assets
Current liabilities
Non-current liabilities
G
Krm
1,100
3,000
1,700
2,300
2,200
(1,100) (1,050)
(1,200) (650)
_____
_____
4,100
_____
2,200
_____
X
$m
1,000
3,100
_____
Bo
x
Share capital
Reserves
4,100
_____
G
Krm
100
2,100
_____
2,200
_____
The fair value of the net assets of G at acquisition was Kr2,500 million. Goodwill
is unimpaired. The increase in the fair value of G over carrying value is
attributable to a fair value adjustment on machines of Kr400 million. Machines
are depreciated over ten years on the straight line basis.
(ii)
During the year, X sold $20 million in goods to G at a margin of 20%. All of
the goods had been utilised in production by the year end, but only one half of
the relevant finished goods have been sold. G received the goods on 16 June
and paid on the same day.
(iii)
X purchased a non current asset machine from a foreign supplier. The purchase
price was Dinar 396 million and X took delivery on 17 July and accurately
recorded the translation. However, the supplier offered long term credit for six
months and so the liability remains unpaid at the current year end. The
retranslation has not been recorded.
(iv)
The following exchange rates are relevant:
AC
C
A
G
lo
ba
l
(i)
Kram to $1
1 January
16 June
17 July
31 December
Weighted average for year
4
3
3.5
6
5
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Dinar to $1
9
10
11
12
10.1
27
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CHAPTER 3 – FOREIGN CURRENCY TRANSLATION
Required:
(a)
Calculate the foreign exchange movement on the retranslation of the foreign
subsidiary and explain the reporting of this loss in the current financial
statements.
(7 marks)
(b)
Calculate the foreign exchange movement of the retranslation of the foreign
payable and explain the reporting of this loss in the current financial
statements.
(3 marks)
AC
C
A
G
lo
ba
l
Bo
x
(10 marks)
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Chapter 4
AC
C
A
G
lo
ba
l
Bo
x
Group Cash Flow
Statements
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C H A P T E R 4 – G R O U P C A S H F L O W S T A T EM E N T S
INTRODUCTION TO CFS
The statement of cash flows is literal. This chapter addresses its preparation.
Here are a few introductory questions to remind you how to calculate the cash flow
from incomplete records:
Example 1 Non current assets (PPE)
The following information was extracted from the financial statements of an entity:
Current
900
70
30
60
40
10
Comparative
700
x
Property plant & equipment
Revaluation gain
Impairment
Depreciation
Disposal at net book value
Finance lease additions
Bo
Required:
Calculate the cash flow additions.
ba
l
Example 2 Tax
G
lo
The following information was extracted from the financial statements of an entity:
Current
400
110
380
30
20
Comparative
350
120
AC
C
Required:
A
Corporation tax
Deferred tax
Profit or loss statement charge
Other comprehensive income charge
Tax liability in sub disposal
Calculate the cash flow payment to the tax authorities.
Example 3 Associate
The following information was extracted from the financial statements of an entity:
Investment in associate
Share of associate profits in P/L
Forex gain on foreign associate
Current
900
430
40
Comparative
670
Required:
Calculate the cash flow dividends received from the associate.
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C H A P T ER 4 – G R O U P C A S H F L O W S T A T EM E N T S
Question: Ducky Group
The following draft financial statements relate to the Ducky Group:
Draft group statement of financial position at 31 May
ASSETS
Non-current assets
Goodwill
Tangible
Investment in associate
Comparative
$m
$m
78
2,473
545
____
92
1,248
550
____
3,096
____
1,890
____
734
689
57
____
622
601
205
____
Bo
x
Current assets
Inventories
Trade receivables
Cash and cash equivalents
Current
G
lo
EQUITY AND LIABILITIES
Equity
Ordinary shares of $1
Share premium account
Revaluation reserve
Retained earnings
AC
C
A
Non-controlling interest
Non-current liabilities
Deferred Tax
Pension deficit
Loans
1,428
____
4,576
____
3,318
____
ba
l
Total assets
1,480
____
100
185
90
1,218
____
60
75
10
725
____
1,593
157
____
870
107
____
1,750
977
390
200
1,005
____
417
230
570
____
Current liabilities
1,595
1,231
____
1,217
1,124
____
Total equity and liabilities
4,576
____
3,318
____
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C H A P T E R 4 – G R O U P C A S H F L O W S T A T EM E N T S
Draft group income statement for the year ended 31 May
$m
9,425
(7,878)
____
Revenue
Cost of sales
Gross profit
Distribution and administrative expenses
1,547
(757)
____
Profit from operations
Income from associates
Interest income
Interest expense
790
98
23
(45)
___
Profit before taxation
Tax
866
(213)
___
Profit for the period
653
___
Profit attributable to:
Controlling interest
Non-controlling interests
Bo
x
584
69
___
653
___
ba
l
Profit for the period
G
lo
Draft statement of changes in controlling interest equity for the year ended
31 May
Share
capital
Revaluation
reserves
$m
75
$m
10
80
AC
C
Balance closing
Retained
earnings
$m
725
584
(78)
A
Balance opening
Surplus on revaluation
Net profit for members
Dividends paid
Exchange difference
on foreign associate
Issue of share capital
$m
60
Share
premium
(13)
Total
$m
870
80
584
(78)
40
___
110
__
__
___
(13)
150
___
100
___
185
__
90
__
1,218
___
1,593
___
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C H A P T ER 4 – G R O U P C A S H F L O W S T A T EM E N T S
The following information is relevant to the Ducky Group:
(i)
Ducky acquired a 90% per cent holding in Prince during the year.
values of the assets of Prince on that day were as follows:
The fair
$m
172
33
27
3
(22)
(13)
___
Non-current assets (tangible)
Inventories
Trade receivables
Cash and cash equivalents
Trade payables
Taxation
200
___
Bo
x
The purchase consideration was $204 million and comprised 20 million ordinary
shares of $1 in Ducky (valued at $4 each) and the remainder in cash. An
impairment loss has been recognised on the goodwill arising on another
previously acquired wholly owned subsidiary acquisition and is included in cost
of sales. It is the group’s policy to value the non-controlling interest at the fair
value which at acquisition was $22m.
The remainder of the shares issued during the year were issued for cash during
a rights issue. Ducky had allotted 20 million ordinary shares for $3.50 each
during this issue.
(iii)
The tangible non-current asset movement for the period included the following
amounts at net book value.
G
lo
ba
l
(ii)
Disposals
Depreciation
$m
40
51
Current liabilities comprised the following items:
AC
C
(iv)
A
The disposal resulted in a profit on disposal of $7million, included in cost of
sales.
Trade payables
Interest accrual
Taxation
(v)
Current
$m
1,003
6
222
____
comparative
$m
913
9
202
____
1,231
____
1,124
____
The pension deficit represented a pension fund liability is excess of the
corresponding pension asset. Pension costs of $17m were charged to
administration.
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C H A P T E R 4 – G R O U P C A S H F L O W S T A T EM E N T S
Required:
Prepare a group cash flow statement using the indirect method for the Ducky Group
for the year ended 31 May.
The notes to the cash flow statement are not required.
Question: Squire
The following draft financial statements relate to Squire, a public limited company:
Draft group statement of financial position at 31 May
Current
$m
80
2,630
535
22
_____
Non-current assets
Intangible
Tangible
Investment in associate
Retirement benefit asset
Bo
x
3,267
_____
Current assets
Inventories
Trade receivables
Cash at bank and in hand
Comparative
$m
65
2,010
550
16
_____
2,641
_____
1,160
1,060
280
_____
2,610
_____
2,500
_____
5,877
_____
5,141
_____
200
60
92
508
_____
170
30
286
505
_____
Non-controlling interest
Non-current liabilities
Provisions for deferred tax
Current liabilities
860
522
1,675
200
2,620
_____
991
345
1,320
175
2,310
_____
Total equity and liabilities
5,877
_____
5,141
_____
ba
l
1,300
1,220
90
_____
G
lo
Total assets
AC
C
A
Capital and reserves
Nominal share capital
Share premium
Revaluation reserve
Retained earnings
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C H A P T ER 4 – G R O U P C A S H F L O W S T A T EM E N T S
Draft group income statement for the year ended 31 May
Revenue
Cost of sales
$m
8,774
(7,310)
_____
Distribution and administrative expenses
1,464
(1,030)
_____
Profit from operations
Share of operating profit in associate
Interest expense
434
65
(84)
_____
Profit before tax
Income tax expense (including tax on associate $20million)
415
(225)
_____
Profit for the period
190
_____
Bo
x
Profit attributable to:
Equity members of the parent
Non-controlling interest
Profit for the period
98
92
_____
190
_____
ba
l
Draft statement of changes in controlling interest equity for the year ended
31 May
$m
991
98
(85)
(10)
(194)
60
____
Closing Shareholders’ Funds
860
____
AC
C
A
G
lo
Opening Shareholders’ Funds
Profit for period attributable to equity members of the parent
Dividends paid
Foreign exchange difference of associate
Reversal of revaluation surplus
New shares issued
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C H A P T E R 4 – G R O U P C A S H F L O W S T A T EM E N T S
The following information relates to Squire:
(i)
Squire acquired a seventy per cent holding in Hunsten, a limited company,
during the year. The fair values of the net assets acquired were as follows:
$m
250
70
100
(90)
(30)
____
Tangible non-current assets
Inventories and work in progress
Receivables
Payables
Provisions for onerous contracts
300
____
ba
l
Bo
x
The purchase consideration was $200 million in cash and $50 million deferred
consideration which is payable next year. The deferred consideration attracts
market rate interest which has been paid and included in interest expenses.
The provision for the onerous trade supplier contracts was no longer required
at the year end as Squire had paid compensation of $30 million in order to
settle with the counter party during the year. The intangible asset in the
group statement of financial position comprises goodwill only. An impairment
loss has been recognised during the year in respect of goodwill on another
different previously acquired and wholly owned subsidiary and this impairment
was charged to the income statement within cost of sales. It is the group’s
policy to value the non-controlling interest at its proportionate share of the
fair value of the subsidiary’s net assets.
There had been no disposals of tangible non-current assets during the year.
Depreciation for the period charged in cost of sales was $129 million.
(iii)
Current liabilities comprised the following items:
A
G
lo
(ii)
AC
C
Trade payables
Interest payable
Taxation
36
Current
$m
2,355
65
200
_____
2,620
_____
Comparative
$m
2,105
45
160
_____
2,310
_____
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C H A P T ER 4 – G R O U P C A S H F L O W S T A T EM E N T S
(iv)
Non-current liabilities comprised the following:
Current
$m
50
Deferred consideration for purchase of
sub
Liability for the purchase of tangible
non-current assets
Loans
(v)
355
Comparative
$m
-
1,270
_____
1,320
_____
1,675
_____
1,320
_____
The retirement benefit asset increased due to a substantial cash investment
during the year. The only other retirement benefit issue was a charge of $20m
to the income statement within cost of sales.
Required:
(10 marks)
AC
C
A
G
lo
ba
l
Bo
x
Prepare an extract of the group cash flow statement showing the reconciliation of the
profit before tax with the operating cash flow using the indirect method for Squire
group for the year ended 31 May.
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x
Bo
ba
l
G
lo
A
AC
C
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C H A P T ER 5 – P ER F O R M A N C E R E P O R T IN G
Chapter 5
AC
C
A
G
lo
ba
l
Bo
x
Performance Reporting
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C H A P T E R 5 – P E R F O R M A N C E R E P O R T IN G
PERFORMANCE REPORTS (IAS 1)
There are two performance reports, the profit or loss and the OCI.
Profit or loss report
The Statement of Profit or Loss records realised transactions and divides into four
sections:Operating
Superexceptionals
Financing
Tax
x
x
x
x
Superexceptionals are large unusual transactions, that are so significant they are
worthy of disclosure to the shareholders on the face of the income statement (IAS1).
The classic superexceptional is the profit on the disposal of a subsidiary.
Bo
x
Other Comprehensive Income
ba
l
The Other Comprehensive Income Statement (OCI) is also a primary statement and
dangles just below the Profit or Loss on the performance page of the financial
statements. It records unrealised transactions. The classic gain that appears here
is the revaluation gain.
G
lo
The P/L and OCI are best presented on one page because they present the two sides
of performance. When combined together on one page they are often called the
Comprehensive Income Statement but are also properly called the Statement of Profit
or Loss & Other Comprehensive Income (SPLOCI).
AC
C
A
Supposedly, realised gains go to P/L and unrealised gains go to OCI. However, the
distinction between realised and unrealised is nowhere defined and entirely arbitrary
anyway. So it is proposed that there be one performance statement going forward.
However, this proposal has been under development for many years and a format
for this single performance statement has never been finalised.
The result is five OCI items that go through OCI because that is the rules:H
hedging
chapter 12
foreign exchange movements on foreign subs
chapter 3
A
actuarial remeasurements
chapter 10
P
ppe revaluations
chapter 8
S
strategic equity (FVOCI FA)
chapter 12
E
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C H A P T ER 5 – P ER F O R M A N C E R E P O R T IN G
PRIOR PERIOD ADJUSTMENTS (IAS 8)
These result from
• a fundamental change in accounting policy or
• an error in last year’s fs.
The classic example of a change in accounting policy is a change in the way we do
things resultant from a new IFRS. A prior period adjustment requires that the
comparatives are adjusted to make them comparable. But restatement also requires
an adjustment to the opening statement of financial position. This last adjustment
is the PPA and is disclosed in the Statement Of Changes In Equity (SOCIE).
REVENUE (IFRS 15)
Revenue recognition
Bo
x
Revenue on contracts with customers is recognised as the performance obligation is
performed and control is transferred from the supplier to the customer. This is either
over time or at a point in time:-
ba
l
‘At’ revenue (formerly “sale of goods” model)
Revenue is recognised at the point that control is transferred.
G
lo
‘Over’ revenue (formerly “sale of services” model)
Revenue is recognised over the period the performance obligation is performed and
in accordance with completion in each reporting period.
An entity recognises revenue over time if one of the following criteria is met:
AC
C
A
• No Alternative Use: the entity’s performance does not create an asset with
an alternative use to the entity and the entity has an enforceable right to
payment for performance completed to date
(eg constructor builds a road for the government)
• Customer controlled asset: the entity’s performance creates or enhances an
asset that the customer controls
(eg an engineering company restore an old castle for a trust)
• Simultaneous: the customer consumes the benefits as the entity performs
(eg a mobile phone company provide a line for you)
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C H A P T E R 5 – P E R F O R M A N C E R E P O R T IN G
Question: Baby
Baby received $3m in advance for railway maintenance work in advance on the first
day of the current year and the first day of the contract. The work is expected to
take four years to complete. However, the customer’s surveyor certified the work as
one third complete at the current year end. Baby recognised the revenue in full at
the point that the cash was received.
Required:
Discuss the implications of the above on the current financial statements.
(4 marks)
Five step model
x
The standard provides a single, principles based five step model to be applied to all
contracts with customers:-
Bo
• Contract Criteria: Identify the contract with a customer
• Obligations: Identify the performance obligations (unbundling)
ba
l
• Price: Determine the transaction price (unbundling)
G
lo
• Allocate: Allocate the transaction price to the obligations (unbundling)
• Revenue: Recognise revenue when performance obligation satisfied (at/over)
Contract criteria
AC
C
The criteria are:-
A
The first step in the five step model starts with threshold criteria that must be fulfilled
before we even start to think about how we are going to recognise our sale.
• Probable collectability (confirm the receivable appears collectible at delivery)
• Identify the rights & obligations (of both customer and supplier)
• Substance (confirm the sale is real and not a hidden loan)
• Approval (confirm both parties are committed to the deal)
Unbundling
Some contracts have more than one performance obligation. Indeed some contracts
have both ‘at’ and ‘over’ components. These contracts are described as “bundled”
and the process of separating the components is called “unbundling”.
This
unbundling occurs at steps 2 and 4 above.
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C H A P T ER 5 – P ER F O R M A N C E R E P O R T IN G
Question: Dig (UK) limited
A regular customer phones to order a digger. This is specialist machinery and will be
built to order. The customer describes the requirements over the phone and the
price is discussed and then Dig confirm the details in an email to the customer. The
customer has always paid on time for previous orders. The basic price is $900,000
but there is a bonus/penalty clause of $10,000 per week for each week before/after
the agreed delivery date. At the time of order and at the current year end it is
expected the digger will be delivered 6 weeks early. The price including the clause
includes the delivery of fuel. The digger will use specialist fuel and Dig have delivered
this fuel to the customer just before the current year end. The ratio of the fair value
of the digger to the fuel is 9 to 1. At the current year end the digger is certified as
80% complete by customer engineers.
Required:
(7 marks)
AC
C
A
G
lo
ba
l
Bo
x
Discuss the implications of the above on the current financial statements.
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C H A P T E R 5 – P E R F O R M A N C E R E P O R T IN G
HELD FOR
(IFRS 5)
SALE
AND
DISCONTINUED
OPERATIONS
This IFRS has two distinct sections connected by a consistent criteria applied to both.
Held for sale
A non current asset is moved to current assets and classified as held for sale if it
fulfils certain criteria.
Held for sale criteria
An asset is hfs if criteria are fulfilled:• Sell = there must be a clear intent to sell
• Available = the asset must be available for immediate sale
x
• Locate = the entity must be seeking to locate a buyer
Bo
• Expected = the sale must be expected to be completed with 12 months
ba
l
Discontinued operations
Question: Rockby
G
lo
An operation is discontinued if it is closed or sold during the year or held for sale at
the year end.
AC
C
A
Rockby has committed itself before its year end to a plan to sell a subsidiary, Bye.
The sale is expected to be completed four months after the year end. The subsidiary
Bye has net assets of $5million and goodwill of $1million. Bye is expected to make
losses of $100,000 per month up to disposal giving $400,000 total for the four
months up to disposal. Rockby had entered negotiations to sell Bye at the year end
and prepared the subsidiary for disposal at that time. Rockby expected to receive
$4.5million for the company after selling costs. The value in use of Bye was estimated
at $3.9million.
Required:
Discuss the effect of the planned sale of Bye upon the current financial statements.
(7 marks)
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C H A P T ER 5 – P ER F O R M A N C E R E P O R T IN G
SEGMENTS (IFRS 8)
Segments are business divisions within a group that are sufficiently big and
sufficiently different from the core business to worthy of disclosure within a segmental
note. The standards do not define sufficiently big, but do suggest a 10% threshold.
As for sufficiently different to the core, that is entirely up to directors.
A multinational conglomerate (MNC) discloses both business and geographical
results.
Question: Kiplin
Kiplin is an education provider, in the UK and the US. The figures split out as follows:$m
x
700
200
500
Higher
Education
50%
30%
30%
50%
70%
70%
US
80%
50%
70%
AC
C
Required:
20%
50%
30%
A
Rev
OP
NA
UK
G
lo
Rev
OP
NA
ba
l
Professional
Education
Bo
Revenue
Operating profit
Net assets
Show the Segmental note for the current year.
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C H A P T E R 5 – P E R F O R M A N C E R E P O R T IN G
IFRS 8 disclosure
IFRS8 requires directors to communicate to the shareholders using the same
segmental divisions that they use when communicating amongst themselves. The
IFRS requires that the same segmental divisions are used in the fs as are used in the
board meetings. However, to avoid being Anglo centric, the IFRS refers to the board
of directors as the Chief Operating Decision Maker (COD maker!). But IFRS8 also
encourages directors to be succinct in their disclosure and avoid overwhelming
shareholders with information. So IFRS8 also addresses the idea of aggregation.
Aggregation
Aggregation is the idea that smaller segments can be aggregated into one for the
purpose of segmental disclosure. The overriding requirement of IFRS8 is that
directors use their common sense so as to produce a meaningful segmental report
that helps shareholders understand the business issues without unnecessary detail.
This simple idea is more than enough for the SBR exam.
x
Example
ba
l
Bo
So a group with four operating segments would report all four. But a group with 25
operating segments would be required to aggregate the smaller ones in order to
reduce the detail whilst still telling the important stories. The process of aggregation
would be down to judgement and depend on the issues the board felt required
communication.
G
lo
Guidance
To help with this process, IFR8 gives some guidance. This is enormously complex,
but boils down to two main ideas.
10% Guideline
AC
C
A
Any segment that has a figure (sales or profit or assets) that is greater than 10% of
the total should usually be reported separately.
75% Guideline
Also at least 75% of the whole group must be reported. This means “other segments”
should be kept to a minimum and certainly less than a maximum of 25% of the whole
group, so that a minimum of 75% of the group is clearly labelled.
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Chapter 6
AC
C
A
G
lo
ba
l
Bo
x
Provisions and Other
Standards
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CHAPTER 6 – PROVISIONS AND OT HER STANDARDS
PROVISIONS (IAS 37)
Three criteria:
(R) Reliable estimate
There must be a reasonably reliable estimate available for the future outflows.
(O) Obligation
There must be a present legal or constructive obligation at the year end.
(T) Probable ouTflow
There must be a probable future outflow.
Question: Russian Chemical Spill
Bo
x
A company spills chemicals onto Russian land, causing damage that will cost $7m to
clean. There is no environmental legislation but the company has clear green policies
on its websites.
Required:
ba
l
Discuss Financial Statement effects for the current year.
G
lo
Question: Oil Rig
A company starts using an oil rig at a cost as follows:
$m
Installation
200
A
Construction
100
AC
C
The oil starts pumping at the year start. At this point the company sign a licence
with the government agreeing to dismantle the rig when the oil runs out which is
estimated to be 20 years. The cost of dismantling the rig is estimated at $120m and
the discount rate is 10%.
Required:
Discuss Financial Statement effects for the current year.
(7 marks)
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C H A P T ER 6 – P R O V I S I O N S A N D O T H E R S T A N D A R D S
CONTINGENCIES (IAS 37)
Contingencies are cash flows that may or may not occur. They are accounted for
essentially as follows:
Liability (outflow)
Asset (inflow)
Probable (>50%)
Provide
Disclose
Possible
Disclose
Ignore
Remote
Ignore
Ignore
Question: Outrageous
Bo
x
A newspaper accuses a public figure of being mafia, even though they know this is
not true. The public figure sues and both sets of lawyers agree that it is likely that
the public figure will win the case and receive damages in the order of $1million.
There is no possibility of the case being resolved before the financial statements must
be finalised.
ba
l
Required:
AC
C
A
G
lo
Discuss how the above litigation will be represented in the financial statements of
both entities; the newspaper and the public figure.
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CHAPTER 6 – PROVISIONS AND OT HER STANDARDS
EVENTS AFTER THE REPORTING PERIOD (IAS 10)
These are usually referred to as Earp (events after the reporting period) and are
accounted for as follows:
Relationship of event to year end
Earp
Event gives evidence
existing at the year end
Adjusting
of
condition
Event does not give evidence
condition existing at the year end
of
Non-adjusting
Practical application
Bo
x
In practice, you look for the timing of the underlying event and recognise the
adjustment at that time. So look at the timing of the fraud, not the timing of the
discovery of the fraud. So look at the timing of the customer’s insolvency, not the
timing of the discovery of the customer’s insolvency.
Going concern
Question: Fraud
G
lo
ba
l
In the unlikely event that something happens after the year end that undermines the
going concern basis then provided the entity still is a going concern then the entity
will issue fs on a going concern basis but with a note about then event and how that
has created doubts over the going concern. Obviously, if an event after the year end
destroys an entity then it will enter formal insolvency and fs on a break up basis
would be necessary.
AC
C
A
Three weeks after the year end, internal auditors discover a fraud. The finance
director has stolen $30million from a bank account, $10million before the year end
and $20million after. The theft is, of course, unreflected in the draft fs.
Required:
Discuss the effect of the fraud upon the current financial statements.
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C H A P T ER 6 – P R O V I S I O N S A N D O T H E R S T A N D A R D S
RELATED PARTY DISCLOSURE (IAS 24)
Transactions between parties related by control or influence are disclosed.
Disclosure
●
Transaction
●
Parties
●
Relationship
Question: Cheated
x
Cheated private limited company is 70% owned by its chief executive officer, Mr
Cute. Mr Cute is married to Mrs Cute who owns 100% of Cheeky, a private limited
company. Cheated is a garage business and services Cheeky company cars for $100
each.
Bo
Required:
AC
C
A
G
lo
ba
l
Discuss the effect of the above transaction on the individual financial statements of
Cheated.
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CHAPTER 6 – PROVISIONS AND OT HER STANDARDS
AGRICULTURE (IAS 41)
Biological assets are carried FVPL (at fair value with gains and losses being reported
in the profit or loss).
In this context FV means FVLCTS (fair value less costs to sell) because a cow that is
further from the physical market place really is of less value than a cow close to the
market place.
Question: Cow
A cow is born to a farm early in the farm year. At the year end the young cow is
valued at $50 based on the price it would achieve in the distant market. But the
costs to the market are $15.
Required:
AC
C
A
G
lo
ba
l
Bo
x
Discuss the effect of the above transaction on the individual financial statements of
the farm.
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Chapter 7
AC
C
A
G
lo
ba
l
Bo
x
Non-current Assets
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CHAPTER 7 – NON-CURRENT ASSETS
COST (IAS 16)
The initial cost of a tangible non current asset is all the expenditure in bringing the
asset to its present location and condition.
FINANCE COSTS (IAS 23)
Finance related to the period of building a non current asset is capitalised.
Question: Supermarket
A supermarket chain build their own supermarket. Also a 10% loan of $40million
was taken out for the full year, but the building took only nine of those twelve months
to complete. Costs are as follows:
x
$M
30
20
2
3
5
Bo
Materials going into the supermarket
Labour building the supermarket
Legal costs related to planning permission
General legal costs related to the whole business
Apportioned management time
ba
l
Required:
AC
C
A
G
lo
Calculate Initial cost.
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C H A P T ER 7 – N O N - C U R R EN T A S S E T S
DEPRECIATION (IAS 16)
This simply involves taking the remaining carrying value and dividing by the
remaining life.
Question: Oops
Oops purchase a machine at the year start for $100,000 believing its life to be ten
years. At the first year end the expected life is unchanged. However, during the
second year it is recognised that the original estimate of life was overstated and that
there are only six further years of use including the current year. So with hindsight
it appears the likely total life is seven years.
Required:
AC
C
A
G
lo
ba
l
Bo
x
Financial statement effects for both the first and second years.
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CHAPTER 7 – NON-CURRENT ASSETS
REVALUATION (IAS 16)
The increase in the carrying value of property plant or equipment is called a
revaluation.
IMPAIRMENT (IAS 36)
This occurs when the recoverable value falls below the carrying value.
Recoverable value
This is the higher of value in use (VIU) and Fair Value Less Costs To Sell (FVLCTS).
Question: Blob
$’000
Smasher
Carrying value
300
400
Value in use (VIU)
Net realisable value (NRV)
ba
l
170
230
500
540
20
G
lo
Required:
$’000
Crasher
Bo
$’000
Basher
290
110
The figures are as
x
Blob have three machines that are suspected of impairment.
follows:
Calculate financial statement effects at the point of the impairment test.
A
Cash generating unit
AC
C
This is a unit that could independently generate an income.
Allocation
IAS allocation (IAS 36)
Losses are allocated in a CGU as follows:
(1)
Specific obvious impairment
(2)
Goodwill
(3)
Remainder (weighted average)
But never impair below FV.
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C H A P T ER 7 – N O N - C U R R EN T A S S E T S
Exam question: AB
AB acquired the entire share capital of a car taxi business on many years ago. The
values of the assets of the business at the current year end were as follows:
$000
40
20
10
90
30
10
50
(20)
230
Goodwill
Garage
Computers
Vehicles (9 vehicles)
Intangible assets (taxi licence)
Trade receivables (recoverable value)
Cash
Trade payables
ba
l
Bo
x
Just before the current year end, the taxi company had three of its vehicles
vandalised. The vehicles were a total write off. The net selling value and net book
value of each vehicle was $10,000. Because of non-disclosure of certain risks to the
insurance company, the vehicles were uninsured. Also just before the current year
end, a rival taxi company commenced business in the same area. It is anticipated
that the business revenue of AB will be reduced leading to a decline in the present
value in use of the business, which is calculated at $140,000. It is unlikely the
business could be sold as a going concern. The net selling value of the taxi licence
has fallen to $25,000 as a result of the rival taxi operator.
Required:
G
lo
Show how AB should treat the above in its financial statements.
Reversal
AC
C
A
A reversal is recognised in the same performance statement as the original
movement.
Question: Revert
A company purchased some land on the first day of last year. It has the policy of
revaluation of land.
Cost
Opening value
Closing value
$m
400
410
397
Required:
Discuss the effect of the above in the current financial statements.
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CHAPTER 7 – NON-CURRENT ASSETS
Question: Rethink
A company purchased a warehouse on the first day of last year. The warehouse had
a life of 10 years from purchase and this estimate is unchanged throughout. The
company has the policy of revaluation of property.
$m
Cost
Opening value
Closing value
8
10
4
Required:
Discuss the effect of the above in the current financial statements.
Note
Bo
x
Note that the above question is based upon the warehouse going up in value last
year and down in value this year. But the principles used for the above work equally
for down then up. So the answer in the back works the question both ways so that
you can see that the two movement sequences use the same ideas.
ba
l
Goodwill
Goodwill can never be pushed up in value so one can never record a revaluation or
reversal for goodwill.
G
lo
GOVERNMENT GRANTS (IAS 20)
AC
C
A
Non-current assets are grossed for government grants. Government grants are held
in deferred income and released to the p/l in line with the related asset (alternatives
are given in IAS and available in theory).
Question: Grant Mitchell
A building costs a net $100m at the year start and the government pay the supplier
an extra $20m. The estimated life of the building is 20 years.
Required:
Discuss financial statement effects for the first year.
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C H A P T ER 7 – N O N - C U R R EN T A S S E T S
INVESTMENT PROPERTIES (IAS 40)
Properties are only recognised as investment properties if three criteria are fulfilled:
●
The property is held for investment purposes
●
The property is substantially complete (so it’s not work in progress).
●
The property is entity unoccupied (unoccupied by the group).
Once a property fulfils the investment property criteria, then a simple rule is applied
(alternatives are given in IAS and available in theory):
FVPL (fair value through profit or loss)
Question: Decided
ba
l
Bo
x
Decided have a factory carried at an opening net book value of $40million. At the
year start they decided to sell the property, but continue to use the factory for
manufacture during the year. As they have made no positive moves towards
disposal, they are well aware that the property is not held for sale. But they do wish
to classify the building as an investment property and recognise a gain of $32million
in the income statement based on a closing market value of $72million. It is
estimated the factory has a remaining life of 20 years. Decided apply the cost model
to their other factories.
Required:
AC
C
A
G
lo
Discuss the financial statement effects of the above in the current year.
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CHAPTER 7 – NON-CURRENT ASSETS
INTANGIBLES (IAS 38)
Intangibles (excluding development) are recognised if they are purchased, either
directly or as part of a sub acquisition.
Development costs are deferred if they fulfil criteria designed to test the probability
of project success. The examiner rarely examines development and has never
examined the criteria. His focus is on the other intangibles above.
Question: Game
Game is a diversified business. Game purchases an incorporated football club
towards the end of their accounting year. In the football club is a squad of twenty
football players all trained by the club from school boys. Therefore, the subsidiary
attaches no carrying value to the squad. However, the twenty players in the squad
are worth a combined $23million at acquisition.
Bo
x
Immediately after the subsidiary acquisition the football club purchases a star striker
for $17million and starts to use the slogan “We are the Future”. Game argues that
because of the belief in their new venture, the slogan has a genuine value of $7million
at the year end.
ba
l
Required:
Exam question: Tyre
G
lo
Calculate and explain Group Intangibles at purchase.
AC
C
A
The property of the former administrative centre of Tyre is owned by the company.
Tyre had decided in the year that the property was surplus to requirements and
demolished the building on 10 June 2006. After demolition, the company will have
to carry out remedial environmental work, which is a legal requirement resulting from
the demolition. It was intended that the land would be sold after the remedial work
had been carried out. However, land prices are currently increasing in value and,
therefore, the company has decided that it will not sell the land immediately. Tyre
uses the ‘cost model’ in IAS16 ‘Property, plant and equipment’ and has owned the
property for many years.
Required:
Advise the directors how to treat the above in the financial statements for the year
ended 31 May 2006.
(7 marks)
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Chapter 8
AC
C
A
G
lo
ba
l
Bo
x
Leases
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CHAPTER 8 - LEASES
LEASE ACCOUNTING (IFRS 16)
The standard (IFRS 16) has inconsistent accounting between the two parties:
Lessee (the asset user)
Lessor (the asset owner)
Lessee accounting
All lease contract liabilities are recognised at discounted present value and a right
of use asset is recognised at the same amount.
Question: Ed
Ed leases a guitar for three years at $1,000 per annum in arrears at 10%.
x
Required:
Calculate FS effects for year one.
(b)
Describe the effect if the guitar life is 3 years or 20 years.
ba
l
Question: ABMN
Bo
(a)
Part 0ne (in advance)
G
lo
ABMN has the following lease contracts where instalments are paid in advance:
B
$800k
4 years
$220k
10%
$700k
7 years
$112K
10%
AC
C
A
Machine Cost (Obligation PV)
Life of contract
Instalments in advance
Interest
A
Required:
Calculate FS effects for year one.
Part Two (in arrears)
Also ABMN have two contracts in which the payments are made at the end of each
year:
Machine cost (Obligation PV)
Life of contract
Instalments in arrears
Interest
M
N
$500k
5 years
$130k
10%
$650k
13 years
$70k
10%
Required:
Calculate FS effects for year one.
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C H A P T ER 8 - L EA S ES
Materiality
The above is time consuming. So there is a materiality threshold below which you
can simply throw an operating cost into the p/l. This time saving short cut is available
if the lease is:•
Short lease = 12 months or less (even if it straddles a year end) or
•
Low value lease = underlying asset original cost low (similar to a “tablet”).
Question: Ed (continued)
Ed leases a guitar for three years at $1,000 per annum in arrears at 10%. The guitar
referred to is a “Little Martin” and retails for the price of an iPad. Ed proposes to
ignore the right of use asset and the corresponding liability and charge the $1,000 to
the p/l each year.
Required:
Bo
x
Comment on the acceptability of the proposal.
Lessor accounting
ba
l
The lessor sometimes does the same as above (and calls this “finance lease
accounting”) and sometimes puts a simple operating income straight into p/l (and
calls this “operating lease accounting”).
G
lo
The test distinguishing between these two is as follows:
Lessor lease
accounting
User (lessee)
Finance
Owner (lessor)
Operating
AC
C
A
Risks and rewards
of ownership with
Question: ABMN (revisited)
Part Three (in arrears)
ABMN have two contracts in which the payments are made at the end of each year
as above. Here is the first one again:
M
Machine cost (Obligation PV)
Life of contract
Instalments in arrears
Interest
$500k
5 years
$130k
10%
Required:
Calculate FS effects for year one from lessor perspective assuming asset life 5 years
then assuming asset life 50 years.
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CHAPTER 8 - LEASES
SALE AND LEASEBACK
The leases standard (IFRS 16) distinguishes between the two forms of sale and
leaseback by reference to the revenue standard (IFRS 15). The revenue standard
has a test for “commercial substance”. The two standards working together then
show that a sale followed by a leaseback that covers most of the asset life is not a
sale at all. The revenue standard is arguing that you have not sold something if you
keep the majority of its risks and rewards. This form of transaction is then identified
as a secured loan (IFRS 9). This gives two forms of sale and leaseback:
(A)
Real sale and real leaseback
The risks and rewards transfer out during the sale and stay out during the
leaseback. So the sale is recorded as a sale and the lease is recorded as a
lease.
(B)
Fake sale and fake leaseback
Bo
x
The risks and rewards transfer out during the sale and then come straight back
in again during the finance leaseback. So the sale is not a sale and the sale
proceeds are not sale proceeds. They are loan proceeds.
Question: Tabular
Sale proceeds
A
Description
G
lo
ba
l
The above company has had two sale and lease back transactions during the year.
They both relate to property. The first involves a leaseback contract for 20 years on
a warehouse believed to have a life of roughly the same duration. The second
involves a short contract of only 5 years on a property known to have a life of much
longer. The discounted present value of the lease obligation is $5m.
Sale and lease back
Lease life and asset life
both 20 years.
(ii)
Sale and leaseback
Lease life 5 years & asset
life much longer.
AC
C
(i)
Fair value
Book value
$m
30
$m
30
$m
23
50
50
42
Required:
Discuss how the above transactions might be accounted for in the current financial
statements.
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Chapter 9
AC
C
A
G
lo
ba
l
Bo
x
Employee Benefits
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CHAPTER 9 – EMPLOYEE BENEFITS
EMPLOYEE BENEFITS (IAS 19)
Essentially, this means pension accounting.
Pension accounting
There are two types of pensions:
1.
Defined contribution pension scheme
These are very simple. The company simply agrees to pay an amount into the
pension of an employee each year and then does it.
Risk
The risk lies with the employee.
Accounting
Defined benefit pension scheme
Bo
2.
x
The cash simply goes into operating costs.
G
lo
Risk
ba
l
This much more complicated deal is much less common. It involves making an
employee a promise to give the employee a certain amount of money when
they retire. This then generates an obligation and hence a liability. A portfolio
of investments that is built up over the years to pay them and hence the scheme
also generates an asset.
The risk lies with the employer.
Accounting
AC
C
A
The defined benefit creates an obligation and separate savings. So we account
for an asset and a liability.
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C H A P T ER 9 – E M P L O Y E E B EN EF I T S
Question: Glossary
The following information is given about a funded defined benefit plan. To keep the
computations simple, all transactions are assumed to occur at the year-end.
Present value of obligations at year start
$400m
Market value of plan assets at year start
$390m
Discount rate at start of year
10%
Current service cost
$14m
Benefits paid
$26m
Contributions paid
$34m
Bo
Market value of plan assets at year end
$530m
x
Present value of obligations at year end
$370m
ba
l
There was a variation in the benefit terms during the year, which resulted in a past
service cost of $100m.
Required:
Financial statement effects for the year.
G
lo
(a)
(b)
AC
C
Required:
A
Following the above, the pension is wound up at the year end. The market value of
the plan assets is unchanged by the curtailment. But the liability is affected. The
employees departing the scheme agree to receive the plan assets in full plus a further
payment of $167m. The cash was paid just before the year end.
Explain the effect of the above curtailment on the current financial statements.
A few years later, Glossary has a new defined benefit pension scheme with new
employees. This scheme is in surplus with an asset value of $100m and a liability
value of $82m. Of course, because the asset exceeds the liability, it is expected that
in the future it will be possible to reduce contributions into the scheme. However,
the asset ceiling (present value of the reductions in future contributions) is only
$16m.
Required:
(c)
Explain the effect of the above asset ceiling on the current financial
statements.
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CHAPTER 9 – EMPLOYEE BENEFITS
Pension exercises
Question: Contact Details PLC (formerly “Appendix”)
The following information is given about a funded defined benefit plan given to
employees by the above company who operate in the dating agency industry. To
keep the computations simple, all transactions are assumed to occur at the year-end.
The present value of the obligation was $990 million and the market value of the plan
assets was $1,000 million at 1 January year one. Actuarial gains and losses are to
be recognised as they occur outside the profit or loss in other comprehensive income.
Two
Three
$m
$m
$m
Current service cost
130
140
150
Benefits paid
150
180
190
100
110
1,100
1,380
1,408
1,372
1,188
1,190
G
lo
Market value of plan assets at 31
December
90
ba
l
Contributions paid
Present value of obligations at 31
December
x
One
Bo
Year
10%
9%
8%
Expected rate of return on plan assets at
start of year (ignore this!!)
12%
11%
10%
AC
C
A
Discount rate at start of year
Required:
Financial statement effects for all three years.
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C H A P T ER 9 – E M P L O Y E E B EN EF I T S
Short-term benefits
There are three tiny minor subjects under employee benefits. The first is short term
benefits and is covered here. The other two are curtailment and asset ceiling and
these are covered below.
Short term benefits to employees are recognised on a straight line basis to match the
benefit the employee provides. Normally this means that the cost of the benefit is
recognised by the entity as the cash flows. But if the entity pays up front there may
be an accrual. For example, if an entity pays health insurance for an employee now
for a year that straddles the accounting year end, then an accrual would be needed.
Curtailment
x
This occurs if a pension is wound up. Essentially, the asset and liability is measured
at the point of curtailment. The asset is unlikely to be changed by the curtailment.
But the curtailment is likely to change the liability. This will give a profit or more
usually a loss. The mechanics are illustrated in the question Glossary.
Bo
Asset ceiling
G
lo
ba
l
If the pension asset exceeds the pension liability then a net pension asset is recorded.
However, an asset must be a right to a source of economic benefit. So for this net
pension asset to be recorded in full, the net pension asset must be a genuine asset.
That is the asset must represent reduced future contributions to the pension scheme.
This reduction to the future contributions is called the “asset ceiling” and sets a limit
on the net pension asset.
AC
C
A
In real in almost all circumstances, the net pension asset will be recoverable in full
and the asset ceiling test will be irrelevant. The pension asset is a real asset
represented by stocks and shares and other investments. So of course if the asset
grows bigger than expected, outgrowing the liability, then the entity will benefit by
having to make smaller contributions in the future. In theory, it is possible if a
number of freak variables line up in an unusual way, then the amount the entity
expects to get back (the asset ceiling) might be less than the market value of the
excess (the net pension asset). This is just possible in real life, but very unlikely.
However, it may happen in the exam and the mechanics are illustrated in the question
Glossary.
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AC
C
A
G
lo
ba
l
Bo
x
CHAPTER 9 – EMPLOYEE BENEFITS
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Chapter 10
AC
C
A
G
lo
ba
l
Bo
x
Share-based Payments
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C H A P T E R 1 0 – S H A R E - B A S E D P A Y M EN T S
SHARE-BASED PAYMENT ACCOUNTING (IFRS 2)
This subject covers directors’ options.
Share-based payment obligation
This is based on an equation:
Obligation =
number of
rights
expected to
vest
x
fair value
x
timing ratio
Timing Ratio
This is simply the position of the year end within the contract.
Year end
Vesting period
x
Timing ratio =
Bo
Fair Value
This is the fair value of the rights given to the employees. It’s not the intrinsic value
of the options, nor is it the fair value of the shares.
Name
Options
Share Appreciation
Rights (SAR)
Fair Value
Grant Fair Value
Current Fair Value
A
Settlement
Settled in Equity
Settled in Cash
G
lo
ba
l
However, the recognition depends on the type of share based payment. There are
two types, options and share appreciation rights. They are almost identical. The fair
value is recognised as follows:
AC
C
Number of rights expected to vest
This is simply a guess at the current year end of the number of rights expected to
vest on the vesting date.
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C H A P T ER 1 0 – S H A R E - B A S ED P A Y M EN T S
Share-based payment exercises
Question: Benign
Benign offered directors an option scheme based on a three year period of service.
The number of rights taken up by directors at the inception of the scheme was 100
million. The options were exercisable shortly after the end of the third year. The fair
value of the options and the number of rights expected to vest were at each relevant
point:Rights expected to vest
Fair value of the option
0
97m
40c
1
90m
45c
2
93m
37c
3
94m
56c
Bo
x
Year
Required:
ba
l
Financial statement effects.
G
lo
Question: Bilberry
Bilberry offered a three year share based payment scheme to its directors.
volume granted was 20m.
Rights expected to vest
A
Year
1
2
3
17m
AC
C
0
The
Fair value of the option
20c
18m
27c
15m
33c
16m
29c
Required:
FS effects over 3 years, assuming that the share based payment used:
(i)
Options.
(ii)
Share appreciation rights.
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C H A P T E R 1 0 – S H A R E - B A S E D P A Y M EN T S
Exam question: Beth
Beth granted 200 share options to each of its 10,000 employees on 1 December
2006. The shares vest if the employees work for the Group for the next two years.
On 1 December 2006, Beth estimated that there would be 1,000 eligible employees
leaving in each year up to the vesting date. At 30 November 2007, 600 eligible
employees had left the company. The estimate of the number of employees leaving
in the year to 30 November 2008 was 500 at 30 November 2007. The fair value of
each share option at the grant date (1 December 2006) was $10. The share options
have not been accounted for in the financial statements.
Required:
Financial statements effects for the year ended 30 November 2007.
(4 marks)
x
Examiner’s article question: Jay
ba
l
Bo
Jay, a public limited company, has granted 300 share appreciation rights to each of
its 500 employees on 1 August 20X5. The management feels that as at 31 July 20X6,
the year end of Jay, 80% of the awards will vest on 31 July 20X7. The fair value of
each share appreciation right on 31 July 20X6 is $15.
Required:
G
lo
Show how this transaction will be dealt with in the financial statements for the year
ended 31 July 20X6.
Examiner’s article question: Crow
AC
C
A
Crow, a public limited company has granted 700 share appreciation rights (SARs) to
each of its 400 employees on 1 January 20X6. The rights are due to vest on 31
December 20X8 with payment being made on 31 December 20X9. During 20X6, 50
employees leave, and it is anticipated that a further 50 employees will leave during
the vesting period. Fair values of the SARs are as follows:
$
1 January 20X6
15
31 December 20X6 18
31 December 20X7 20
Required:
Show how this transaction will be dealt with in the financial statements for the year
ended 31 December 20X7.
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Chapter 11
AC
C
A
G
lo
ba
l
Bo
x
Financial Instruments
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C H A P T E R 1 1 – F IN A N C I A L I N S T R U M EN T S
FINANCIAL INSTRUMENTS (IFRS 9)
Financial instruments (FI) are essentially contracts that create an asset in one entity
and a liability or equity in another.
FI are pieces of paper with faces behind and FI come in three main blocks:- Debt
- Equity
- Derivatives (meaning “bets”)
FA classification summary
FA are carried at fair value (FV), unless FA fulfil two tests, in which case they are
carried at amortised cost. The two tests are the cash flow characteristics test and
the business model test.
Bo
x
Gains on FA carried at FV default to the profit or loss (FVPL) unless the entity can
show that there is a strategic intent to keep an equity investment, in which case the
gains go to the other comprehensive income (FVOCI).
ba
l
Also to add to the complexity it is possible to elect to carry FA at amortised cost at
fair value instead, if an accounting mismatch can be shown (the FVO).
These ideas are best understood by working steadily through the examples that
follow.
G
lo
Financial asset classification in more detail
A
This is based upon asking two questions:
AC
C
Cash flow characteristics test
(Simple debt?)
No
Yes
Business model test
(Collection basis?)
No
Yes
Amortised cost
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C H A P T ER 1 1 – F IN A N C I A L I N S T R U M EN T S
Cash flow characteristics test
This test is asking ‘Does the debt asset have interest and principal repayment and no
other features?’
In other words the IFRS is asking ‘Do you have a simple loan?’
Business model test
This test is asking ‘Is the debt asset managed for collection purposes?’
In other words the IFRS is asking ‘Do you intend to keep the asset until maturity?’
Two other FA issues
(1)
FVOCI
(2)
FVO
See below for further explanation of the FVO and FVOCI.
x
FL classification summary
Bo
FL classification is reasonably simple.
AC
C
A
G
lo
ba
l
All FL are carried at amortised cost unless an intent to trade the liability can be shown
in which case fair value applies.
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C H A P T E R 1 1 – F IN A N C I A L I N S T R U M EN T S
FA carried at amortised cost
The following two examples both look at the story from the point of view of the lender.
So both address the FA. But the numbers and the accounting would be identical in
the books of the borrower. So both also address the FL.
Financial asset classification
This is based upon asking two questions:
No
Cash flow characteristics test
(Simple debt?)
Yes
x
Yes
No
Bo
Business model test
(Collection basis?)
Fair value
ba
l
Amortised cost
G
lo
Question: John
AC
C
Required:
A
The above buy a debenture off the market with a nominal value of $8,000 million.
The coupon rate is 1%, but the market demands a return of 8%. The loan has four
years to run. The intent is to hold the investment to maturity.
Assess the financial asset classification. Calculate the amount that the company
would be prepared to pay for the asset and show how it would be accounted for over
the four years.
Question: Travolta
The above buy a debenture off the market with a nominal value of $1,000 million.
The coupon rate is 2%, but the market demands a return of 7%. The loan has three
years to run. The intent is to hold the investment to maturity.
Required:
Assess the financial asset classification. Calculate the amount that Travolta would be
prepared to pay for the asset and show how it would be accounted for over the three
years.
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C H A P T ER 1 1 – F IN A N C I A L I N S T R U M EN T S
FA carried at fair value
The following examples look at the easy accounting for FVTPL (financial assets carried
at fair value through the profit or loss). But then the examples move to FVTOCI
(financial assets at fair value through the other comprehensive income) and on to
the FVO (fair value option).
Question: Blip
Blip bought shares on the stock exchange for the purpose of speculating for $400
million shortly before the year end. The value at the year end is $330 million and
the value rises to $370 million a few weeks later when the shares are sold.
Required:
Financial statement effects.
x
Question: Bliny
ba
l
Bo
Bliny bought some debenture loans on the stock exchange for a short term
investment shortly before the year end. The cost was $900 million and the year end
value was $800 million. Shortly after the new year start the debentures were sold
for $850 million.
Financial statement effects.
Question: Bling
G
lo
Required:
AC
C
Required:
A
Bling bought derivatives for $100 million just before the year end. The value at the
year end was $110 million.
Financial statement effects.
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C H A P T E R 1 1 – F IN A N C I A L I N S T R U M EN T S
FA carried at FV through OCI (FVOCI)
Fair value accounting
The default position for the gains (and losses) on financial assets at fair value is the
profit or loss.
FVPL
These assets are often referred to as financial assets at fair value through profit or
loss (FVPL).
Strategic equity
However, if you have an equity investment and can show a strategic intent to keep
the asset, then gains (and losses) can be pushed through other comprehensive
income.
FVOCI
Bo
x
This strategic equity is more commonly known as a financial asset at fair value
through other comprehensive income (FVOCI).
Question: Footy
Required:
Financial statement effects.
A
Question: Special
G
lo
ba
l
Footy buy a small percentage of the share capital of a football club for $780 million.
The company intends to keep the investment indefinitely. At the year end the
investment is valued at $710 million.
AC
C
Special purchase equity representing a company that owns music rights that they
wish to keep forever. The cost was $500 million shortly before the year end and by
the year end the value had risen to $540 million. Then shortly after the year end the
plans as regards the music changed completely and the company sold the equity for
the year end value of $540 million.
Required:
Financial statement effects.
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C H A P T ER 1 1 – F IN A N C I A L I N S T R U M EN T S
Fair Value Option (FVO)
This is a solution to a problem.
The problem – The accounting mismatch
A related financial asset and financial liability pair are carried under different
recognition systems (one is using fair value sand the other is using amortised cost).
The solution – The fair value option
The entity can elect to carry both at fair value.
Question: FVO
Bo
x
FVO is a bank. FVO has a financial asset carried at amortised cost on the draft
financial statements for the current year ended 31 March. The asset is correctly
carried at amortised cost because it fulfils both the cash flow characteristics test and
the business model test. However, it has been noticed that a very similar liability is
being carried at fair value. This means that on the draft fs there is an asset on the
top of the position statement that is being carried at amortised cost that is very
similar to a liability on the bottom of the position statement being carried at fair
value.
ba
l
Required:
AC
C
A
G
lo
Discuss if there is a solution to this problem in IFRS9 Financial Instruments.
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C H A P T E R 1 1 – F IN A N C I A L I N S T R U M EN T S
FAIR VALUE MEASUREMENT (IFRS 13)
Definition
Fair value is the transaction price between market participants at the measurement
point.
Analysis
The measurement of fair value in the context of financial instruments and other areas
can involve some educated guess work. So the IFRS on fair value measurement
gives some guidance on how to measure fair value.
The IFRS first defines fair value quite simply as 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. Then the IFRS goes on to dictate a market
psychology when measuring fair value. You must use the best information available
to give a market price.
x
The IFRS uses a hierarchy to help with measuring the market price.
Bo
Hierarchy
ba
l
The rule when applying the above is that if level one works you must use it, if not
then level two; only if both fail can level three be used:
Level one inputs: Exact equivalent active market prices
G
lo
If there is an active market then the market price from that market on the
measurement date must be used.
Level two inputs: Approximately equivalent transaction prices
A
If level one fails to give a figure then level two requires that similar market data must
be used to approximate the market price. This similar market data can then be
adjusted for differences.
AC
C
Level three inputs: Unobservable inputs into financial models
If both level one and level two fail to give a number then you are required to use
financial models to estimate the unavailable market price.
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C H A P T ER 1 1 – F IN A N C I A L I N S T R U M EN T S
Question: Gambit
The above company is trying to obtain fair value measurements for the following four
assets:
Pawn
Gambit holds a number of shares in Pawn incorporated which is listed on an active
world share exchange.
Knight
Gambit holds a number of shares in Knight. Knight is a private company and the
shares are rarely traded. But Knight is a direct competitor of Pawn and the two
entities are very similar.
Bishop
Bishop is a building. There has been no trading in other buildings in the area for the
last year, but Gambit purchased Bishop only six months ago.
x
Queen
ba
l
Bo
Gambit also holds shares in a development company called Queen limited. The
development company is developing a new drug. There is nothing like this new drug
in the market and no competitors are developing anything similar. However,
technical development has been very positive and market research has plenty of data
on projected cash flows.
G
lo
Required:
AC
C
A
Discuss the methods most appropriate for the measurement of fair value in reference
to each of the above assets.
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C H A P T E R 1 1 – F IN A N C I A L I N S T R U M EN T S
EQUITY
Equity is poorly defined within IFRS:Framework
In the framework for financial reporting equity is defined as the residual in this
equation:Equity = Assets – Liabilities
Problem
But this defines equity in liquidation and so is of questionable value in a going
concern.
IAS 32 Equity Presentation
So the IASB developed a test for equity to be applied in practice. This test defines
equity as follows:-
Bo
x
“A financial instrument is an equity instrument only if the financial instrument
includes no contractual obligation to deliver cash or another financial asset to another
entity.”
Problem
G
lo
Question: Bee
ba
l
But this is a negative definition. Equity is tested as “not a liability”. This can lead to
classification errors and thereby mismeasurement of gearing.
Bee plc issued three classes of financial instrument to its investors at incorporation.
Each class raised $100m:-
A
The A shareholders have one vote each and the right to the residual
in liquidation. There is an expectation of dividends eventually but
there are no guarantees.
AC
C
A shares
B shares
The B shareholders have no voting powers. However, the B
shareholders have the right to a 5% dividend in perpetuity. The
market interest rate was 5% at issue.
Convertibles
The convertible bondholders have the right to 4% interest for 6
years and then the choice between repayment or A shares at
maturity. The discounted present value of the interest plus
principal was measured at $91m.
Required
Discuss the recognition of the above financial instruments by Bee at issue.
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C H A P T ER 1 1 – F IN A N C I A L I N S T R U M EN T S
IMPAIRMENT IN FINANCIAL ASSETS
All that the IFRS does in this area is formalize the process calculating the allowance
for bad debts. But the process is horribly complicated.
Expected credit loss (ECL)
This is the key new term. It is simply the new phrase for “bad debts allowance” or
“financial asset impairment” and it is defined mathematically:ECL = Gross receivable – Net receivable
Where:Gross receivable = contractual cash flows
Net receivable = expected cash flows
Expectations
Bo
x
The expectations are measured by reference to probability and supportable
information. This means that a receivables population with a recent history of 2%
default would require an ECL of 2% of gross receivables and the net receivables of
98% would appear on the face of the balance sheet.
Bad analysed receivables as follows:-.
$800m
Overdue
$100m
Required
Past history indicates 1% default rate.
G
lo
Within due date
ba
l
Question: Bad
Past history indicates 5% default rate
AC
C
A
Measure the appropriate expected credit loss.
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C H A P T E R 1 1 – F IN A N C I A L I N S T R U M EN T S
The three approaches
Further detail
However, the above barely scratches the surface of the issue. The following gives a
little more detail:Financial asset impairment
Financial asset impairment applies to any financial asset not carried at fair value
through p/l. So essentially we are talking about fa at amortised cost (trade
receivables and lending receivables).
Scope
However, the scope extends to more exotic financial assets like:Lease receivables
Financial guarantee receivables
x
Approaches
Bo
There are three approaches available to financial asset impairment measurements:General approach
Simplified approach
ba
l
Credit adjusted effective interest rate approach
General approach
G
lo
The general approach has three stages. These have picked up the memorable
nickname of ‘buckets’ and the image is intended to get you to imagine throwing each
receivable into one of the buckets as you go down the list of your receivables. The
stages are:credit risk unchanged (financially healthy customers)
Stage 2
credit risk increased (financially unhealthy customers)
Stage 3
credit impaired (financially sickly customers)
AC
C
A
Stage 1
Expected credit loss
As the customers problems increase and the credit risk increases then so does the
allowance for bad debts. This is called the “expected credit loss” or just ECL for short.
Stage 1
If the credit risk of the fa has not increased significantly since first recognition then
a 12 month ECL is required and interest is calculated on the gross.
Stage 2
If the credit risk of the fa has increased significantly since first recognition then a
lifetime ECL is required – meaning a big jump up in the size of the allowance. Interest
is still calculated on the gross.
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C H A P T ER 1 1 – F IN A N C I A L I N S T R U M EN T S
Stage 3
If the customer has suffered a credit impairment event then a larger lifetime ECL is
required but now interest is calculated on the net. A credit impairment event is any
event that indicates the customer is in real trouble – obviously the appointment of a
receiver would qualify but so would something softer like the demise of the
customer’s main supplier or adverse legislation.
Write off
There is in fact a fourth stage although this is not referred to as such. If the receivable
becomes irrecoverable then it is written off altogether.
Lifetime ECL
Now we turn to ECLs. The easiest to understand is the lifetime ECL as it is simply
the difference between the contractual cash and the expected cash.
ECL factors
Probability weighted outcome
•
Time value of money
•
Supportable information.
ba
l
Calculation
Bo
•
x
When measuring ECLs the IFRS requires consideration of three factors:-
12 month ECLs
G
lo
But there is no guidance as to how to actually calculate the ECL. There are a couple
of examples that use numbers. But they also use unexplained assumptions and so
there is likely to be great variation in the way different companies calculate ECLs.
AC
C
A
This is the lifetime losses expected to be incurred due to default events in the next
12 months. This difficult concept is not the simple difference between contractual
cash flows for the next twelve months and expectations for the next 12 months. So
there is likely to be much confusion there too.
Simplified approach
Then there is the simplified approach. The simplification is that this approach has
lifetime ECLs only and is available for adoption for trade receivables.
Credit adjusted effective interest rate approach
Then there is the CAEIR. This is required for purchased or originated credit impaired
financial assets. This means junk bonds. The approach is technical. Keeping in mind
that CAEIR is thrown on top of the other two approaches with little explanation this
surely gives rise to the risk of further confusion.
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C H A P T E R 1 1 – F IN A N C I A L I N S T R U M EN T S
HEDGING
This is the process of betting against yourself; whatever you fear, that is what you
bet on.
Hedging styles
There are two:
(1)
Cash flow hedging
(2)
Fair value hedging.
Cash flow hedging
This addresses the fear that the asset may rise in value before you can buy it. So
the company bets on a price rise.
Bo
x
Fair value hedging
This addresses the fear that the fair value of an asset might fall whilst you’re holding
it. So you bet on a price fall.
ba
l
Question: Spot
Spot the hedging style.
Weather reports make a coffee company fearful of coffee prices rising
before the coffee ripens. So they bet on a price rise.
Gold
The company hold gold for input into electronic inventory. They fear a
price fall so bet on gold prices dropping.
A
G
lo
Coffee
AC
C
Cash flow hedge accounting
The derivative bet is carried at fair value with gains and losses going through Other
Comprehensive Income to hedge reserve in Other Components of Equity.
Derivative carried FVOCI.
Fair value hedge accounting
The derivative and the primary risk asset are both carried at fair value with gains and
losses through Profit or Loss.
Both carried FVPL.
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C H A P T ER 1 1 – F IN A N C I A L I N S T R U M EN T S
Perfect hedging
When hedging, companies always try to make their hedges perfect. This means that
they try to set up the deal such that if they lose a $1 on the primary risk then they
win $1 back on the derivative. In practice, a hedge rarely works out as perfect but
in exam questions hedges are often perfect.
Zero cost
In real life, companies almost always have to pay for the derivative bet. There is
usually an initial outlay to enter the bet. However, the initial outlay is often so small
that it is negligible. But in an exam, the derivative bet is often literally zero cost.
Question: Bescafe
Bo
x
The above company plans to buy a massive consignment of coffee shortly after the
current year end when the coffee ripens and comes to the market. The bulk purchase
has an expected cost of $500m based on current market prices. However, freak
weather conditions and reports of global warming have caused the management to
fear that coffee prices will rise and that the price of the bulk purchase will be higher
when the crop of coffee beans comes to the market.
G
lo
ba
l
So the company enters into a perfect hedge instrument derivative based on the price
of coffee. The instrument is a bet on the price of coffee rising and pays $1m for
every $1m that the cost of the consignment rises above $500m. The cost of the
derivative is zero because the other party to the bet believes that the price of the
coffee will fall. The other party is looking at the same information but believes that
global warming will increase the volume of coffee being produced at the next harvest.
AC
C
A
By the year end, the market value of the consignment of coffee has risen to $530m
and this is the price at which the coffee is purchased shortly after the new year start.
So the derivative is closed out by the other party by paying $30m to clear their
liability. Clearly, Bescafe were right about coffee prices and so won the bet.
Required:
Explain the financial statement effects of the above using journals to show the
changes for both the years.
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Question: Kent
The above company plan to buy a specialist piece of machinery from a French
specialist manufacturer. The order will take six months to make and so Kent will take
delivery and make payment in full shortly after the current year end. The French
supplier demands that the invoice be agreed in their local currency and a contract is
signed to the effect that Kent becomes liable for 200m Euros upon delivery of the
machine to the Kent factory in the new year and will make payment the following
day.
The result is that Kent finds itself being exposed to changes in the value of currencies.
So being risk averse, Kent enters a future contract to buy 200m Euros at the current
market price of $150m. The derivative is a perfect hedge and is purchased at zero
cost.
x
By the year end the value of the 200m Euros has fallen to $140m and it at this price
that Kent buy the machine upon delivery in the new year. They make payment by
sending $140m to their bank, asking the bank to turn it into 200m Euros and
forwarding that to the French supplier.
Bo
Of course, at that time they also close out the derivative bet by paying the other
party the difference of $10m.
ba
l
Required:
Question: Jewellery
G
lo
Financial statement effects for both years.
AC
C
A
The above manufacture jewellery and have purchased $100m in gold for input into
their production of inventory. They made the bulk purchase because they believed
the price to be low. However, immediately after the purchase they fear that the price
may fall further and so obtain a zero cost perfect hedge by contracting into a gold
derivative.
The value of the gold actually rises and at the year end is valued at $109m.
The value of the gold continues to rise after the new year start. The value of the
gold is $112m when Jewellery transfer the gold into their work in progress, at which
point the hedge is deemed no longer necessary and the derivative contract is closed
out with the derivative trader.
Required:
Explain the effect of the above on the financial statements.
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Chapter 12
AC
C
A
G
lo
ba
l
Bo
x
Tax
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CHAPTER 12 – TAX
DEFERRED TAX FORMULA
Tax for our purposes means deferred tax (IAS 12).
Deferred tax is given by formula:
DT
=
TD
x
Rate
Deferred
Tax
=
Temporary
difference
x
Current tax
rate
Temporary difference
This is the difference between two assets, one in the statement of financial position
(carrying value) and one in the tax books (tax base).
Temporary difference is given by formula:
=
CV
x
TB
Temporary
Difference
=
Carrying
Value
x
Tax
Base
Bo
ba
l
Question: Formula Two
AC
C
Tax losses
1,000
600
30%
A
DT
G
lo
Closing PPE NBV (net book value)
Closing PPE TWDV (tax written down value)
CT rate
Required:
x
TD
A commonly examined deferred tax is the DT on losses.
A tax accountant carries losses forwards as if they were assets. However, we are
only permitted to recognise the DT asset if the asset appears likely to be recoverable.
In the context of a DT asset for losses carried forward, recoverability refers to the
prospect of the entity returning to profitability. If the entity is not going to return to
profits then we are not going to get the benefit from losses carried forward.
Question: Lost
The tax accountant is carrying forward losses of $100million. CT rate is 30%.
Required:
DT
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C H A P T ER 1 2 – T A X
Accelerated capital allowances (ACA)
Another common deferred tax is issue is the DT generated by tax depreciation
accelerating ahead of accounting depreciation. This temporary difference is often
referred to as an “accelerated capital allowance” or “ACA” for short. ACA occur when
capital allowances accelerate ahead of depreciation.
Question: Newly Incorporated
A newly incorporated business buys a machine for $8,000 that attracts capital
allowances at 25% but has life of 10 years. Assume a tax rate of 30%.
Required:
Show DT movement.
x
CONCEPTUAL BASIS OF DEFERRED TAX
G
lo
Conceptual question: Hold
ba
l
Bo
Deferred tax was developed in the 1970s when the focus of financial reporting was
on the income statement and the concept of matching. This form of accounting can
be referred to as “performance focus”. Even back then deferred tax had its critics.
Now financial reporting has moved to focus on the position statement and the concept
of the asset/liability. This form of accounting can be referred to as “position focus”.
This seriously undermines the conceptual basis of deferred tax.
AC
C
A
Hold purchased a small percentage of the share capital of a listed company. Hold
made this equity investment with the intent to speculate and therefore classified the
asset as fair value with gains being reported in the income statement. The purchase
occurred three weeks before the year end at a cost of $70,000. At the year end three
weeks later, the market value had risen to $110,000. So Hold recognised a gain of
$40,000 in the income statement and recognised a current asset investment at
$110,000 in the position statement.
Subsequent to this the auditors pointed out that the financial accounting asset value
of the investment differed from the tax accounting asset value of the investment.
They therefore requested that Hold recognise an appropriate deferred tax liability.
The finance director of Hold agreed to this, but pointed out that in truth there was no
liability to the tax authorities in respect of this asset at the year end and therefore
challenged the validity of deferred tax. The current year corporation tax rate is 30%.
Required:
Briefly discuss the conceptual basis of deferred tax, using the information above to
illustrate your answer.
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CHAPTER 12 – TAX
SPECIFIC TEMPORARY DIFFERENCES
Temporary differences occur when there are differences between the tax accounting
and the financial accounting. So a timing difference can occur anywhere. However,
there are certain specific temporary differences the examiner likes to examine.
ACA
As we know from the above, accelerated capital allowances are a common form of
temporary difference.
Question: Accentuate
x
A company purchased a building at the year start for $200k. The life of the building
is 20 years and there is no residual value. Capital allowances are allowed at 40% for
the year. CT rate is 30%.
Bo
Required:
DT effects.
ba
l
Revaluations
Question: Relative
G
lo
Of course, the tax man completely ignores revaluations, inevitably resulting in a
difference between what the tax man carries on his statement of financial position
and what we accountants carry on ours.
AC
C
A
A company purchased a building at the year start for $900k. The life of the building
is 10 years and there is no residual value. Capital allowances are allowed at 40% for
the year. At the year end the building is revalued to $950k. CT rate is 30%.
Required:
DT effects.
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C H A P T ER 1 2 – T A X
Development
In most countries the tax man allows development in full as the cash is spent.
Question: Deviation
A company spends $15million on a development project that will lead to five years
of sales including the current year. The tax man allows this cost in full as incurred.
CT rate is 30%.
Required:
DT.
Provisions
Bo
ba
l
Question: Proviso
Environmental provision
$60million
CT rate
30%
x
Most provisions are ignored by the tax man.
Required:
AC
C
A
DT.
G
lo
Tax man recognises environmental costs as the cash flow.
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CHAPTER 12 – TAX
GROUP TEMPORARY DIFFERENCES
Corporation tax applies to corporations. Each individual entity has its own CT.
Taxmen worldwide are blind to groups and so do not see group financial statements.
So if a figure is different in our group fs to the equivalent figure in the entity fs then
a temporary difference will arise.
Fair value adjustments
Of course, the tax man does not recognise FVA either.
Question: Inventory
x
A parent buys a sub just before year end. The sub has inventory as at cost of $50k
but fair value of $55k. All the inventory is still in inventory a few days later at the
year end. CT rate is 30%.
DT effects.
ba
l
Unremitted foreign dividends
Bo
Required:
Question: Thailand
G
lo
This one is much more difficult to understand, but fortunately is rarely examined.
AC
C
Required:
A
A parent bought a foreign sub for $300k, measured in the parental home currency.
The sub has grown to $370k because of net profits of $70k that the sub has retained.
The withholding tax rate is 60%.
DT effect.
Goodwill
The tax man always ignores goodwill. We accountants always calculate goodwill
during any acquisition. Inevitably this does lead to a difference. However, this
difference is always ignored.
Question: Acky
A parent acquires a sub incurring $1million in goodwill.
Required:
DT effects.
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C H A P T ER 1 2 – T A X
SBP TEMPORARY DIFFERENCES
The IFRS for share based payment was developed by the IASB. They took a lot of
care in the measurement of the obligation itself. However, little care was taken in
the related dt. The effect is an utterly bizarre accounting outcome.
Share-based payment
The deferred tax accounting for share-based payment is completely illogical. Instead
of recognising the carrying value at the actual carrying value, we use a made up
carrying value based on intrinsic value. Don’t try and look for some underlying logic
because there isn’t any and it will only make your head hurt.
Question: SBP
Bo
x
SBP are at the end of year one of a four year motivational option scheme. There are
20million options in the scheme and they are all expected to vest at the end. The
fair value of the options at the grant date was $10 and the current intrinsic value of
each is $8. CT rate is 30%.
Required:
AC
C
A
G
lo
ba
l
Calculate the actual carrying value, the carrying value for DT purposes and the DT
for the above.
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CHAPTER 12 – TAX
REAL DEFERRED TAX
Here is a shock. The deferred tax that derives from the following is real. The taxman
will acknowledge that there is a present right to a future economic inflow in the
context of the following.
Tax losses
A tax accountant carries losses forwards as if they were assets. However, we are
only permitted to recognise the dt asset if the asset appears likely to be recoverable.
In the context of a dt asset for losses carried forward, recoverability refers to the
prospect of the entity returning to profitability. If the entity is not going to return to
profits then we are not going to get the benefit from losses carried forward.
Question: Lost Again
x
The tax accountant is carrying forward losses of $200million. CT rate is 30%.
Bo
Required:
AC
C
A
G
lo
ba
l
DT effect.
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Chapter 13
AC
C
A
G
lo
ba
l
Bo
x
Current Issues and
Other Corporate
Reporting
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CURRENT ISSUES
Current Issues (CI) is a phrase used to address the broad subjects of corporate
governance, the reporting of information to users within that framework of corporate
governance and the development of standards to ensure that communication is clear
and understandable.
THE FRAMEWORK FOR FINANCIAL REPORTING
The framework for financial reporting requires that financial statements communicate
performance, position and cash flow for an entity to user. So of course, the
framework requires a performance statement, statement of financial position and
cash flow statement. However, the framework leans heavily towards the statement
of financial position and so the key concept in financial reporting is the definition of
an asset/liability.
x
Asset/Liability
Bo
To paraphrase the framework “an asset/liability is the present controlled
right/obligation to a future economic inflow/outflow of resources embodying
economic benefits”.
ba
l
More properly:Asset
Liability
G
lo
An asset is a resource controlled by the entity as a result of past events and from
which future economic benefits are expected to flow to the entity.
AC
C
A
A liability is a present obligation of the entity arising from past events, the settlement
of which is expected to result in an outflow from the entity of resources embodying
economic benefits.
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CURRENT REPORTING ISSUES
So the framework leads us to current developments. Having settled on a framework
for financial reporting, with its focus on assets, liabilities and fair value, the
International Accounting Standards Board (IASB) must drive us towards these goals.
Disclosure
The IASB is working upon communication in FR.
problems:•
Too little relevant information
•
Too much irrelevant information
•
Ineffective communication
The IASB noted three main
Two particular problems in ineffective communication are:Clutter: often entities over disclose.
•
Boiler plate: often entities use deliberately dull disclosure.
Bo
x
•
To address this the IASB has made this broad recommendation:•
Effective communication
ba
l
FS should be entity-specific + clear and simple + comparable.
To address this the IASB has made this specific recommendations:Alternative Performance Measures
G
lo
•
Performance measures like EBITDA should be clearly explained.
Materiality
Materiality definition
AC
C
•
A
There is new proposed guidance on materiality:-
Information is material if omitting, misstating or obscuring it could reasonably
be expected to influence decisions that the primary users.
•
Primary users
These are existing and potential investors and lenders and other creditors.
•
Four steps
Identify + assess + organize + review.
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Integrated Reporting
IR is a philosophy and a report:Philosophy
IR is the idea that the annual report (management commentary + financial
statements) should deliver a cohesive message.
Report
The IR is essentially an abbreviated annual report on strategy + sustainability +
performance.
Framework
OCI and recycling
Bo
x
An IASB research project was unable to find any consistent logic for the separation
of certain performance items in the OCI. The same project was unable to find any
consistency of views regarding the rerecognition of hedging and sub fx in the p/l after
previous recognition in the OCI.
Investors’ needs
ba
l
Investors need ROCE and gearing. At least that is what they think. But there are
problems.
Debt is undefined.
•
Equity is poorly defined.
•
Disclosure notes are difficult to use.
IFRS 3 Goodwill
G
lo
•
A
The IFRS on groups is due a review. Commentator feedback has been critical:Partial goodwill is daft. Recognising all the subs ppe and part of the subs
customers is inconsistent.
•
The choice between full and partial is damaging.
inconsistency and incomparability.
•
The recognition of goodwill impairment can be delayed.
AC
C
•
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The choice leads to
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IAS 37 Provisions
IAS 37 has worked well. But it is showing its age. So the IASB have asked for
feedback. Here is the main criticism:Probable outflow
The requirement for a full provision for a probable outflow means we provide $100m
for a 51% chance of $100m outflow and provide $0m for a 49% chance of a $100m
outflow.
IFRS for SMEs
This has not been widely adopted following issue despite being widely demanded
before issue.
Some of the main simplifications in the IFRS for SMEs are as follows:(1)
Goodwill recognition
Goodwill amortisation
Bo
(2)
x
Partial method recognition is required (see Basic Groups Chapter).
Amortisation is required (over 10 years) to avoid the annual impairment test.
(3)
Borrowing Costs
(4)
ba
l
The capitalisation of finance cost on PPE is not allowed.
Development
AC
C
A
G
lo
Development is written off like research.
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IVORY TOWER ARTICLES
Here are some more detailed articles that explore the above issues discussed in the
“Ivory Tower” of the IASB.
Provisions
The IFRS on provisions (IAS 37) is showing its age a little now. So the IASB are
considering putting the standard back into the masher to see if a new improved
standard can be attained. To this end the IASB has been compiling criticism of the
IFRS. But before we start slinging the mud, let us look at what IAS37 has achieved.
Bo
x
IAS37 was issued in 1998 with an equivalent UK standard that had the same logic.
Prior to the issue of the standard it was common place for entities to have big sloshy
provisions slapping about on their balance sheets ready to release in a bad year. It
was felt to be good accounting to hack down high profits in good years by deferring
credits on the balance sheet. There was no attempt to represent these buckets as
actual liabilities. They just sat there ready to be released to the p/l in the next bad
year. This was profit smoothing and it was thought to be a good thing. But it was
not. It lulled unsuspecting investors into thinking a volatile business was dull and
safe. And investors who could not afford to lose their money lost their money as a
result.
ba
l
The issue of IAS37 stopped all that. Well most of that! But it introduced its own
problems particularly in the area of the criteria. The recognition criteria that outlawed
the profit smoothing referred to above are as follows. I call it “spot the ROT”:Meaning
Reliable estimate
G
lo
Criteria
there must be a reasonable guess available
either because of law or what you have said
Transfer
probable outflow of benefit
A
Obligation (legal or constructive)
AC
C
The criteria are ok but there is substantial ambiguity.
Reliable estimate
This criteria is a little daft because although the standard says that there must be a
reliable estimate of the outflow before the provision can be allowed then the standard
goes on to clarify that essentially any guess is adequate. The standard says that only
in the most extreme circumstances should this criteria be applied. Then the standard
further clarifies that the circumstances for failing this criteria are so extreme that it
is not even possible to give an example! What nonsense! This is a criteria that is
not a criteria. The standard is trying to say that if there is an obligation then you
must provide; no matter the uncertainties. But you can imagine that some entities
might accidently on purpose misinterpret the requirement to avoid a provision.
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Obligation
A legal obligation is easy enough to match to the word “obligation”. You have to do
the thing because the law says so. But a constructive obligation is very tenuous.
The idea is that if I tell my wife that I will pick up my son after school then I have to
pick up my son after school. But the room for manoeuvre is enormous. Does a
company really have to clean up environmental damage in an area where there is no
environmental legislation just because it says it will? The standard says “yes” but
others say “no”. Does a company that promises a training course have to provide
for that training course? The standard says “no” but others say “yes”.
Transfer
But probably widest criticised is the probable outflow criteria. The standard advises
that a provision is required if “more likely than not”. This implies that a 100%
provision is required for a 51% chance outflow but a 0% provision is required for a
49% outflow. This on/off switch gives even more room for creative accounting.
Contingency accounting
Asset (inflow)
Disclose
Ignore
Ignore
ba
l
Probable (>50%)
Possible (<50%)
Remote
Liability (outflow)
Provide
Disclose
Ignore
Bo
x
The above also appears in IAS37 and is roundly criticised. The accounting is messy
but is essentially characterised as follows:-
G
lo
This results in the counter intuitive perversity that the two sides of one court case
may end up with differing accounting; the defendant providing and the plaintiff
disclosing.
Costs
Volume
AC
C
A
Which brings us to costs. The classic confusion is court costs. Some provide for
those on the grounds they are unavoidable even though they have not been incurred
and others do not provide even after they have been incurred.
And volume makes a difference to the size of a provision. In a large population it is
common to provide for the probability weighted average expected outflow. But this
appears contradictory if each individual outflow is in fact highly unlikely.
Conclusion
All this shows the IASB will have plenty to talk about when they finally decide to
reignite this development project.
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Contingent liability inconsistency
I have just won over £1 billion on the galactic lotto and foolishly I decide to sink some
of the cash into football. So I buy Liverpool Football Club from Fenway. Not
unreasonably, Fenway want to get some return if Liverpool get into the top four next
season and qualify for Europe. They argue that any outstanding performance next
season must be partly down to Fenway management. I accept, but I also want
equivalent protection from an awful first season. So Fenway and I agree the following
terms:
£250m now in cash.
£220m in one year if Liverpool finishes in the top half of the table next season (80%).
£121m in two years if Liverpool finishes in the top four next season (15%).
Consideration
Bank
Current liability (220x80%/1.1)
Non-current liability (121x15%/1.12)
425
250
160
15
Bo
Dr
Cr
Cr
Cr
x
The probabilities are given above and the net assets are valued at £230m at
acquisition. I buy all the shares and so there is no non-controlling interest. The cost
of capital is 10%. That is plenty enough information to calculate the goodwill which
requires both consideration and net assets to be valued at fair value. I am not a
massive fan of double entry but I think it will help me make my point. So here goes:
A
G
lo
ba
l
You probably know that the two liabilities represent contingent consideration
liabilities and as said previously that is measured at fair value. So the goodwill is
measured as follows:
£m
Fair value of consideration
425
Fair value of net assets
(230)
___
Goodwill
195
___
AC
C
So far so good. But what I have not told you is that litigious claimants are trying to
get their grubby hands on my winnings. There are two in particular. The first has
an 80% chance of getting £220m in one year’s time and the second has a 15%
chance of getting £121m in two years’ time. The timing and the probabilities are
identical to those above for the contingent consideration. But these two are simple
contingent liabilities and are not valued at fair value. Instead these liabilities use an
on off switch style of recognition where probable outflows (>50%) are recognised in
full and others are not recognised at all (being either disclosed or ignored altogether).
So I ignore the second liability and recognise the first in full as follows:
Dr
Cr
Cost
Current liabilities (220/1.1)
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200
200
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So when I draw up my balance sheet a few days after the acquisition I find that I
have inconsistency between my liabilities. Of course, identical liabilities should be
recognised the same but they are not. How did this ridiculous situation arise?
What we have hit upon is the clash between IFRS3 on business combinations and
IAS37 on provisions. The newer standard, IFRS3, was developed with getting a fair
value for goodwill in mind and as a result used fair value for contingent consideration.
The International Accounting Standards Board (IASB) thought nothing of this as it
was both logical and in tune with a wider aim of getting all contingencies at fair value.
But when the IASB actually came to roadshow their ideas on contingencies at fair
value then a riot broke out in the ivory towers of financial reporting. The IASB
thought maybe that it was the way that they had presented their ideas that was the
problem. So they withdrew the project and later reissued a simplified proposal. But
again it was roundly thrown back in their faces. So that was it. Game over. We now
find ourselves in the bizarre situation where two identical liabilities are recognised
differently depending on whether they are tied up in an acquisition or not.
Sploci
A
G
lo
ba
l
Bo
x
"Sploci". It is a beautiful Icelandic fishing village with chocolate box houses. I am
joking. It is both a wonderful acronym and an admission of defeat. The letters stand
for “Statement of Profit or Loss and Other Comprehensive Income”. It is the new
name for the former “Comprehensive Income Statement”. The former name worked
for me. It was punchy and it revealed intent. The IASB have long held a torch for a
philosophy usually referred to as "position focus". It has served them well and helped
solve problems like share based payment by suggesting that the way to measure the
cost of sbp is to measure the obligation at each year end and from there measure
the cost as the growth in the obligation. Position focus is canny stuff and I cannot
resist suggesting that position focus maybe hard wired into our brains. You see the
birth of writing is tangled up with the desire to express wealth at a point in time.
Those ancient clay tablets measuring 31 units of wheat and 212 head of sheep from
Euphrates cities with biblical names are nothing more than balance sheets. It seems
nobody fussed too much about profit back then. But we do now.
AC
C
The IASB had been endeavouring to wean us off our obsession with profit; an
obsession that drives our strategies and dominates our financial reporting. You see
the next step from a “Comprehensive Income Statement” envisaged by the IASB was
the “Performance Statement” communicating the performance as simply the
categorised growth in position from one position statement to another. This
statement would be unconcerned about measuring a single “profit” and would present
a holistic picture of performance across broad fronts. That was the intent. But no
longer. The idea of a “Performance Statement” appealed to the believers but appalled
the markets. "Move away from profit - not on your life" the markets told the IASB.
And the title SPLOCI is the admission of defeat, the white flag waving over the ivory
towers of the IASB. "Ok. You can keep profit” say the IASB “and what is more you
can call your profit statement ‘The Statement of Profit…. or loss’ to reinforce the profit
focus”.
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But what exactly is profit? Everybody knows what it is until they come to define it.
Indeed the chairman of the IASB Hans Hoogervorst asked the question “'Defining
Profit or Loss and OCI... can it be done?” in the title of a recent seminar. I missed it
– it was in Japan. But reading between the lines it is clear the answer from the
urbane Mr Hoogervorst was “probably not”. He noted that the big brains at the
Accounting Standards Advisory Forum had a bash at defining profit. He described
their attempt as a “courageous effort” but noted with a wry smile that there was
“very little consensus” on the meaning of profit. He is smooth, our chairman.
But one thing he did say was that most commentators agree that profit is the bottom
line of the Statement of Profit or Loss. So profit is no more than the sum of the stuff
pumped through the p/l for the year. And most stuff does go through the p/l. But
some stuff is not allowed through p/l because it is not “profit” and so has to be
pumped through a dumping zone called “Other Comprehensive Income”. I use a silly
little mnemonic to help me remember the five gains and losses that are banned from
p/l and languish in the oci. It is as follows:hedging –cash flow hedge gains
E
exchange on subs – forex gains on the retranslation of foreign subs
A
actuarial – remeasurement gains in pensions
P
ppe revaluations – gains on occupied properties
S
strategic equity – gains on financial assets classified FVOCI
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AC
C
A
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“Heaps” – get it? The “heaps” heaps at the bottom of the p/l in a heap. Very funny
Mr Jones. But why are these things driven from the p/l. What did they do wrong?
Just about any argument you put forward can be shot down by example. The classic
argument is that p/l items are near cash and oci items are far cash. But that
argument is shot down by pointing out that a ppe revaluation gain on a property that
you will sell next year goes through oci and an investment property gain on a property
you will keep for a hundred years goes through p/l. Another classic argument is that
the p/l items are “realised” and oci items are “unrealised”. But that fails because
there is no definition of realised or unrealised. The IASB make some progress by
using phrases like “bridging items”, “mismatched remeasurements” and “transitory
remeasurements” to describe the oci items. But in the end the IASB rather dolefully
admit that this is little more than fancy labelling for stuff we put through the oci
because we do.
The IASB seem to have concluded that the split between p/l and oci is necessarily
arbitrary and are currently suggesting that the following best describes the mangled
logic:
•
Profit or loss provides the primary source of information about the return
an entity has made on its economic resources in a period.
•
To support profit or loss, OCI should only be used if it makes profit or loss
more relevant.
But this is itself is an admission of defeat as, of course, it must be the IASB that
dictate what must go through the oci in order to make the “profit or loss more
relevant”. And then there is “recycling”… don’t get me talking about recycling.
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Recycling
‘And then there is “recycling”… don’t get me talking about recycling’. In the article
above I ended with that phrase. But maybe you should get me talking about
“recycling” as it is a current issue that everyone else is talking about. There is a
wonderful Peppa Pig episode called “recycling” and even a lovely little tune to go. It
is one of my son’s favourites and the tune is looping around my head as I write this.
Have a look on YouTube if you have a mo. But recycling in corporate reporting does
not involve keeping your plastic bottles in one bin and the glass in another. And
recycling in corporate reporting is most certainly not a good thing.
x
Recycling is the rerecognition of a previously recognised gain. There you go – that
is all there is to recycling – but what a technical phrase this is. Gains and losses are
reported through a performance statement called the Statement of Profit or Loss and
Other Comprehensive Income or SPLOCI for short. As the “and” tells us, the SPLOCI
is a compound report with two components: the P/L and the OCI. And as was
discussed in the SPLOCI article, most gains and losses go through p/l except five as
follows which go through the OCI:hedging –cash flow hedge gains
E
exchange on subs – forex gains on the retranslation of foreign subs
A
actuarial – remeasurement gains in pensions
P
ppe revaluations – gains on occupied properties
S
strategic equity – gains on financial assets classified FVOCI
ba
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G
lo
As discussed in that earlier article, there is no underlying logic to the gains that are
banished from the p/l and languish in the oci. It is just the way it is. And likewise
there is no logic with recycling. The top two (hedging gains and forex gains on foreign
subs) do recycle and the other three do not. But how does recycling work? As usual
the best way to get a feel for the process is with an example.
AC
C
A
In year one, our imaginary entity makes a forex gain of $60m on a new foreign sub
measured in the home currency and a ppe revaluation gain of $60m on the rise in
the value of the new home factory. Both these gains go through OCI (Other
Comprehensive Income) in the performance statement and both are accumulated in
OCE (Other Components of Equity) on the position statement. Then at the start of
year two the foreign sub and the home factory are both sold for $500m. Both the
sub and the factory have an exit carrying value of $400m. So there is a profit on
disposal of $100m to be reported in the p/l for each. But hang on; there is an
accumulated $120m of gain in OCE related to these two sold items. You may know
that there is a culture of interpreting the OCE as “unrealised” and “undistributable”
because the gains in OCE are not represented by cash. But this $120m is represented
by cash. Both the sub and the factory have been sold. So the $120m must move to
the retained earnings (RE) where it is “realised” and “distributable”.
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So the $60m gain on the factory is simply moved from the OCE to the RE. The gain
goes from one equity bucket to the other on the b/s with no fuss. No need to put
the gain through this year’s performance because the gain already went through last
year’s performance. And of course it made perfect sense to recognise the gain last
year as it was last year that the factory rose in value. This is in perfect tune with
sales. Sales are recognised in the year of the sale and not when the cash flows. If
a sale happens just before the year end and the cash is received just after the new
year start then we would not recognise the sale again in the year of cash receipt.
Rerecognition would just be plain silly. Exactly. Now comes the tricky bit.
We do rerecognise the $60m forex gain on the sale of the foreign sub. The $60m
sitting in OCE representing the accumulated forex gains on the foreign sub are
dragged out of the OCE and added to the actual profit on foreign sub disposal of
$100m to give a reported profit on disposal of $160m in the p/l. The profit ends up
in the RE, of course, which is fine. The problem is the recognition of the same gain
twice. Once in the year of the gain and again in the year of the cash flow. The same
$60m has appeared in both this year’s SPLOCI and last year’s SPLOCI.
G
lo
Investors’ needs
ba
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This rerecognition of gains and losses on foreign subs and cash flow hedges is called
“recycling” and has been widely criticised. There appears to be no logic to the
isolation of five gains that go through OCI and there appears to be less logic to the
isolation of the two of those that later go through p/l. But it appears this culture is
so entrenched that the IASB are powerless to reverse it. However, it has resulted in
the cumbersome division of items in the oci between those that “will not be
reclassified to profit” and those that “may be reclassified to profit”. You may have
seen these phrases in the OCI and wondered what that was all about. Now you know.
AC
C
A
There is a word loaded with meaning and ambiguity. And this ambiguity can have a
massive influence on how users view an entity. The phrase “capital” is usually taken
to mean “financial capital” as in debt plus equity and is the bottom of the key ratio
Return on Capital Employed or “ROCE” as everyone calls it. The problem is that this
ratio is very widely used but because the meaning of capital is ambiguous the
widespread use of ROCE introduces problems of inconsistency and incomparability.
Debt/equity
The problem is further compounded by the lack of clarity in the distinction between
the above two. This “debt/equity problem” has been kicking around forever and I
have written about it before. It can be very difficult for an entity to distinguish its
debt from its equity. Indeed some issued capital can have features of both. The
classic example is preference shares. These financial instruments were going out of
fashion when I started accounting in 1990. But preference share issue seems to be
raising its head again. National Grid recently issued prefs and won a prize for
innovation. You know the guys. Always digging up your roads and then disappearing
off for a cup of tea. Alright that is a little harsh but I bet you wish they were as
innovative with their roadworks as they are with their capital issues.
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Question
Anyhow, I thought you might like to see a question and answer on this subject so
here we go:Required
The definitions of “debt” and “equity” are problematical in financial reporting. Discuss
this problem and the resultant effects on ratio analysis by users.
Answer
Here is an answer using the standard heading + sentence + sentence structure:-
ROCE
The key ratio affected by the ambiguity of debt and equity is Return on Capital
Employed. ROCE is usually defined as Profit before interest and tax (PBIT) divided
by debt plus equity.
x
Users
Bo
Users widely use this ratio to analyse investment decisions. Essentially, the higher
the ROCE the more keen investors will be to put in their money either by buying
shares or lending loans.
ba
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Debt
G
lo
One problem is that the phrase “debt” is entirely undefined within financial reporting.
Some companies include lease liabilities and overdraft and short term borrowing and
others do not.
Published ROCE
A
This problem is particularly visible in published ROCE. This should be comparable
from Tesco’s to Sainsbury’s to Carrefour to Walmart. But ROCE is not comparable
because of the different interpretations of debt.
AC
C
Compulsory publication
This problem is exacerbated by the compulsory publication of performance analysis
required by law in many countries (UK and USA for example) and by culture in other
countries (France and South Africa for example).
Integrated report
This compulsory publication of ROCE is usually in the Management Commentary
component of the Annual Report. ROCE is then copied across to the Integrated
Reports of entities that embrace integrated reporting.
Equity
And that is just the start of the problems. Another massive problem is the poor
quality definition of equity. This is defined within the conceptual framework as the
residual in this classic equation: equity = assets – liabilities.
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Liquidation
That looks fine until you look a little harder. The equation says equity is what is left
over when all the assets are turned into cash and the suppliers have been paid off.
But this describes liquidation and has limited meaning in a going concern.
Solution
The solution to the problem of defining equity is part solved in a standard dedicated
to this issue (IAS 32). This IFRS defines equity as “not a liability” or in more detail
“possessing no contractual obligations to cash outflows”. But this definition is often
criticised as it says what equity is not rather than what it is.
Problem with the solution
Because the above solution (IAS 32) is so clumsy, the definition works poorly in
practice resulting in interpretation errors where debt is classed as equity and equity
is classed as debt.
x
Gearing
Bo
This makes no difference to ROCE but makes a huge difference to another widely
used ratio; gearing. Gearing is usually defined as debt over debt plus equity. Clearly
a misclassification of debt as equity would reduce the quoted gearing.
ba
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Disclosure
Disclosure standard
G
lo
In theory it should not matter if entities mess up their classification of financial capital
or use assumptions that are inconsistent with their rivals when quoting their ratios in
their reports. This is because in theory everything you need to know about the
financial structure of the entity should be disclosed.
AC
C
A
You see there is a standard that requires the disclosure of information on the finance
an entity uses (IFRS 7). So in theory a user does not need to use published gearing
and ROCE. In theory a user can calculate these ratios themselves and get consistency
from entity to entity.
Time consuming
However, getting into the finance of an entity and calculating ROCE from first
principals is a pain in the backside. And doing the calculations yourself completely
undermines the utility of the published ratios.
IASB
But more realistically, analysing an entity's finance from first principles is only
possible in theory. Disclosure in practice is often so poor that a user cannot fully
understand the finance of an entity and reliably calculate ROCE. This is one reason
why the IASB have recently announced a project to look at improving disclosure.
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Business combinations
I love YouTube. And if I am honest I always use Google for my searches. The reason
that I mention these two together is that they both belong to the same entity
“Alphabet” which is the newish name for the Google group ultimate parent. It is a
quirk of financial reporting that the brand “YouTube” is recognised on the group
balance sheet but the more valuable brand “Google” is not. This is because only
purchased intangibles are recognised. The brand “YouTube” was purchased as part
of the acquisition of YouTube Inc in 2006 and of course the brand “Google” was
internally developed.
This brings me to the news. The IASB are deliberating on feedback on current group
consolidation accounting. The last sizable shake up was in 2008 when full and partial
goodwill was introduced into IFRS 3.
Whilst it is recognised that the 2008
improvements to IFRS 3 Business Combinations were significant, the feedback from
the Post Implementation Review (PIR) reads like a shopping list of failings from a
“could do better” school report.
ba
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x
First up is a criticism of the separation of intangibles from goodwill. The brand
“YouTube” was separated from the goodwill during the 2006 acquisition. But the
feedback questions the meaningfulness of this distinction. Intangible recognition
recognises the customer loyalty to the brand and goodwill recognition recognises
customer loyalty to the entity. You can see why commentators argue that the
difference is so small as to make no difference.
G
lo
Next up is a criticism of definition of a “business” in IFRS 3. A business combination
requires the calculation of goodwill to recognise the fair value of the customer loyalty
and an asset purchase does not. IFRS 3 defines a business as an entity that has
inputs and processes and outputs. An asset is just an asset. But the feedback is
that it can be difficult to make this distinction work in real life transactions.
AC
C
A
Then the feedback criticised the accounting for contingent liabilities under a business
combination. This requires that a contingent liability must be measured at fair value
in an acquisition (IFRS 3). Other contingent liabilities are carried at full value or zero
value depending upon a probable/possible analysis (IAS 37). This inconsistency has
already been dealt with in this column under the heading “Contingent Liability
Inconsistency” and is clearly a thorn for other commentators.
Contingent consideration is also addressed. This like everything in an acquisition is
measured at fair value but the feedback was that it is really devilishly difficult to
derive a fair value for share consideration that may flow five years into the future if
uncertain criteria are fulfilled.
Criticism of fair value continued in commentary on organic growth. It is currently
difficult to compare a group that has grown through organic growth with one that has
grown through acquisitions as the acquisitive group will inevitably have a bigger
balance sheet from the fair value measurement of the incoming subs.
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Interestingly amortisation of goodwill raised its head. I thought this idea was long
dead but some commentators still believe that amortisation has logic founded in the
idea that purchased goodwill is steadily replaced by inherent goodwill through the
customer relations fostered by the sub under the guidance of the parent. You could
make a persuasive argument that the goodwill that we all feel for YouTube in 2016
is more to do with the parent management since acquisition in 2006 than the original
management from before acquisition.
Bo
x
And lastly commentators criticised the choice between full and partial goodwill. This
drives me nuts and I would put this way out ahead in first place as my number one
criticism of IFRS 3. Under current rules groups can value nci either at fair value (full
goodwill) or at nci proportion of net assets (partial goodwill). Groups are generally
plumping for full goodwill but clearly the choice gives the potential for inconsistency.
But even worse, IFRS 3 allows full or partial goodwill on a transaction by transaction
basis. This means two acquisitions in the same group on the same day could be
measured using different methods. I do not know of any group actually doing this
but this really highlights the craziness of the choice. However, commentators
generally placed criticisms of the choice lower down on their list of criticisms. I guess
the difference is that I am a teacher and in exam questions there is always nci but in
real life nci is actually quite rare.
Integrated Reporting
ba
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Everybody is talking about “integrated reporting”. There is even a funny little arrow
symbol invented to jazz up the abbreviation as follows: <IR>. I am not one to refuse
a bandwagon. So here goes my two pence worth.
A
G
lo
The International Integrated Reporting Council (IIRC) tells me that “<IR> is a process
that results in communication by an organization, most visibly a periodic integrated
report, about value creation over time. An integrated report is a concise
communication about how an organization’s strategy, governance, performance and
prospects, in the context of its external environment, lead to the creation of value
over the short, medium and long term.”
AC
C
That is a lot of fancy words, but what does it mean? Well essentially the IIRC are
talking about the published annual report. Currently there is a culture of publishing
the statutory financial statements in a pdf document with a management
commentary appended. As the name suggests, the management commentary is the
commentary of management on the fs plus their wider comments on strategy and
corporate social responsibility (CSR). All the IIRC are doing is trying to encourage
companies to publish annual reports that are “integrated”; in other words, annual
reports that tell a clear useful story in a document that hangs together. Some entities
like BP on the London Stock Exchange are brilliant at this already, perhaps because
of a defensive reaction to their “dirty business” image. Some are improving like
Telefonica the parent of O2 on the Madrid Stock Exchange. And some businesses are
awful like Omnicom quoted on the New York Stock Exchange. Omnicom in particular
have no excuse as they are the world’s biggest advertising agency and so should
know how to tell a story.
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So what is new? Well this is the thing. As far as I can see, nothing is new, except
maybe one element. This push for improved corporate reporting seems to have really
captured the imagination of a few hard core believers; then spread to the press who
have picked up on the story and now everybody is talking about it. I have not seen
so much interest in annual report presentation since the management commentary
first burst on the scene in the 1980s. In the 1980s companies like Sainsbury’s hit on
the idea of explaining their numbers in a commentary. Of course the city boys and
girls loved it and so there was a visible rise in the Sainsbury’s share price. So
everybody got interested and soon everybody was doing it. But the commentary
grew like a wild unmanaged garden and soon all consistency was lost and worse some
businesses lost sight of the purpose of the commentary. Many interested parties had
a bash at cleaning up; the IASB had a go, even the UK government took a bite, but
all to no avail because there was not the motivation to improve or the profile for the
story. But now there is and for the life of me I cannot figure out what is so special
about the IIRC and their words. But who cares? They do appear to have captured
imaginations and maybe the poorer annual reports will start to tell the story going
forward.
B Connectivity of information
C Stakeholder responsiveness
G
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D Materiality and conciseness
ba
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A Strategic focus and future orientation
Bo
x
So let us look at what exactly the IIRC are saying. The IIRC have a framework in
development which tells us that there are six guiding principles for the publication of
one of these integrated reports:-
E Reliability and completeness
F Consistency and comparability
AC
C
A
The IIRC also have core of a hundred trailblazers who have adopted the framework
even though it is still in progress. But here is where the progress goes wobbly. Some
of the trailblazers have published <IR> that really do lock in to the essence of holistic
reporting. Companies like Marks & Spencer and our own ACCA clearly get it. But
there is a huge swathe of trailblazers that seem to think that <IR> means CSR or
sustainability reporting. Coca cola have a lovely report on the quality of the water
going into their cans and Tata has some good stuff on their employment
responsibilities. But the reports are not really integrated. I think this is a minor
point, however. The big news is that the big businesses in the US and across the
world really do seem interested in making their annual reports useful and that has to
be good news for everybody.
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PROFESSIONAL ETHICS
Directors are required to take a professional attitude to their responsibility to
communicate. Deliberate deviation from fair reporting is often called “creative
accounting” and is in direct contradiction to corporate social responsibility.
Clearly, financial reporting requires that the directors present financial statements
that show a true and fair view. This in turn requires that the directors adopt a
professional and ethical behaviour. This area of corporate social responsibility is
widely referred to as “corporate governance”.
There are five widely accepted principals are professional ethics:the avoidance of disrepute
Integrity
honesty
Competence
knowledge and delivery of products
Confidentiality
keeping clients secrets
Objectivity
independence
AC
C
A
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Professionalism
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CURRENT ISSUES EXAM QUESTIONS
Question: Value
The ‘value relevance’ of published financial statements is increasingly being put into
question.
Investment analysts are developing their own global investment
performance standards which increasingly do not use historical cost as a basis for
evaluating a company. The traditional accounting ratio analysis is outdated with a
new range of performance measures now being used by analysts.
Required:
(a)
Discuss the importance of published financial statements as a source of
information for the investor, giving examples of the changing nature of the
performance and value measures being utilised by investors.
(7 marks)
ba
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Companies are under pressure to report information which is more transparent and
which includes many non-financial disclosures. At the same time the move towards
global accounting standards has become more important to companies wishing to
raise capital in foreign markets. Corporate reporting is changing in order to meet the
investors’ needs. However, earnings are still the critical ‘number’ in both the
company and the analyst’s eyes.
Required:
Discuss how financial reporting is changing to meet the information
requirements of investors and why the emphasis on the ‘earnings’ figure is
potentially problematical.
G
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(b)
(6 marks)
AC
C
A
In order to meet the increasing information needs of investors, standard setters are
requiring the use of prospective information and current values more and more with
the traditional historical cost accounts and related ratios seemingly becoming less
and less important.
Required:
(c)
Discuss whether the intended use of fair values will reduce the importance of
historical cost information.
(5 marks)
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An entity Questionable PLC recently purchased a subsidiary with a brand “Hard Rock
Fish and Chips”. The financial controller proposes to value the asset at zero because
the asset was abandoned shortly after the acquisition and the financial controller
understands that fair value represents the value in use of an asset. The finance
director agrees with this treatment because the finance director is keen to avoid the
implied impairment.
Required:
(d)
Discuss the accounting treatment proposed by Questionable with reference to
the ethical issues.
AC
C
A
G
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x
(4 marks)
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Appendix
AC
C
A
G
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ba
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Bo
x
Suggested Solutions to
Questions and
Examples
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A P P E N D I X – S U G G E S T E D S O L U T I O N S T O Q U ES T IO N S A N D EX A M P L ES
CHAPTER 1
Answer: Peddle
Net assets
S
Share capital
Reserves
Acq
SFP
50
200
__
50
310
___
250
__
360
___
260
60
(250)
___
Goodwill
70
___
Bo
Fair value of cost
Fair value of nci
Fair value of net assets
x
Goodwill
(260-80%(250))
(60-20%(250))
60
10
___
to nci below
G
lo
CI
NCI
ba
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The split of ownership of goodwill is not required unless specifically requested. But
here it is for completeness:-
Goodwill
70
___
A
Group statement of financial position (balance sheet)
AC
C
Non-current assets
Goodwill
Investment in associate [Roll forward: 120+30%(470-330)]
Net assets (390 + 360)
70
162
750
___
982
___
Share capital
100
Reserves
800
Non-controlling interest [Roll forward: 60+20%(360-250) or At: 20%(360)+10gw)] 82
___
982
___
Reserves
Parent
S (360 - 250) (80%)
A (470 – 330) (30%)
670
88
42
___
800
___
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Group income statement (profit and loss)
Parent
Revenue
Operating costs
500
(200)
Operating profit
Associate[140](30%)
Interest expense
42
(50)
Profit before tax
Tax
(80)
Sub
Adj
400
(210)
900
(410)
_____
490
42
(70)
_____
(20)
462
(140)
_____
(60)
___
Profit after tax
110
___
20%
Non-controlling interest
322
(22)
_____
ba
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Opening
Profit attributable to members
Bo
x
Profit attributable to members
Group Reserve movement (not required)
300
_____
500
300
_____
800
_____
AC
C
A
G
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Closing
Group
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Answer: Fakenstock
Net assets
SC
Reserves
At acq
At SFP
100
400
___
100
600
___
500
___
700
___
Goodwill
FV of consideration
NA
900
(500)
___
Goodwill at acquisition
Impairment
400
(320)*
___
Goodwill at statement of financial position
80
___
Impairment
Carry value (NA 700 + GW 400)
Impairment (balancing)
Bo
x
1,100
(320)*
___
Recoverable value (higher of VIU and NRV)
780
___
ba
l
*Impairment of sub is the impairment of goodwill.
___
At SFP
50
400
80
(1)
___
500
___
529
___
A
At acq
50
350
100
AC
C
Net assets
SC
Reserves
FVA (machines)
PUP (12 x 0.25 x 1/3)
G
lo
Answer: Terra
Full Goodwill
FV of consideration
FV of nci
FV of NA
800
317
(500)
___
Goodwill at acquisition
Impairment (from below)
617
(480)
___
Goodwill at statement of financial position
Impairment
Carry value (GW 617 +NA 529)
Impairment (balancing figure)
Recoverable value
137
___
β
1,146
(480)
___
666
___
122
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A P P E N D I X – S U G G E S T ED S O L U T I O N S T O Q U ES T I O N S A N D EX A M P L ES
Note that the full goodwill dominates the goodwill impairment. So we use full net
assets and full recoverable value.
NCI (317 + 30%(529-500) – (30%)(480))
182
Partial Goodwill
This is not required by the question. The examiner said at the conference in February
2009 that the focus of SBR would be on full goodwill. However, he did not say that
partial goodwill would cease to be examined. So the following is given for
completeness.
Partial Goodwill
800
150
(500)
___
Goodwill at acquisition
Impairment (from below)
450
(354)
___
96
___
Bo
Goodwill at statement of financial position
G
lo
Recoverable value (666(70%))
ba
l
Impairment
Carry value (GW 450 +NA 529(70%))
Impairment (balancing figure)
x
FV of consideration
FV of nci (30%)(500)
FV of NA
β
820
(354)
___
466
___
AC
C
NCI (30%)(529)
A
Note that the partial goodwill dominates the goodwill impairment. So we use partial
(70%) net assets and partial (70%) recoverable value.
159
___
Note that the above nci has no interest in the goodwill. So it is completely unaffected
by the goodwill impairment.
Answer: You and I
Japan
The Japanese joint arrangement is a JV. Everything is shared 50/50. Nothing is
yours absolutely and nothing is mine absolutely. Everything belongs to the JV and
the JV belongs to us half and half. Backing this conclusion up is the incorporation of
the JV.
So the Japanese arrangement will be recorded as a 50% associate in my books and
the same in yours.
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A P P E N D I X – S U G G E S T E D S O L U T I O N S T O Q U ES T IO N S A N D EX A M P L ES
Russia
But the Russian deal is quite different. It is a JO. The pipeline is mine and not yours.
The refinery is yours and not mine. We share the revenue and so operate jointly but
we do not share everything.
So the pipeline will stay on my SFP and the refinery will stay on yours.
Answer: Hebrides
Net assets
1,700
_____
SFP
SFP
200
100
760
400
270
(20)
_____
160
40
450
160
40
500
___
___
1,710
_____
650
___
700
___
Bo
Share capital
200
Share Premium
100
Reserves(Opening 600 + 6/12(200 PAT) = 700) 700
FVA (land)
400
FVA (plant) (half year depreciation to y/e)
300
PUP (120) (20%) (5/6)
_____
A
Acq
x
S
Acq
ba
l
Note that the acquisition reserves are required for the mid point of the year, whereas
the dividend is after that and so is ignored when rolling forward from the year start
to the year middle.
G
lo
Associate
AC
C
Acquisition {given}
Growth (700-650)30%
A
Note also that under the ‘roll forward’ method applied to the associate, you do not
need to calculate the associate goodwill. So you can now calculate the associate
carrying value as follows:
Closing before impairment
Impairment (balancing figure)
Closing after impairment for SFP (790)(30%){given}
124
Associate
500
15
___
515
(278)
___
237
___
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A P P E N D I X – S U G G E S T ED S O L U T I O N S T O Q U ES T I O N S A N D EX A M P L ES
Goodwill
Fair value of consideration
(200)(80%)(5/2)$5 {see below}
Fair value of nci
Fair value of net assets
2,000 (split nominal 400 & premium 1600)
410
(1,700)
_____
Goodwill at statement of financial position
710
___
Note the parent targeted all 200,000 shares in the sub. But only bought 80% which is 160,000
sub shares. But the parent had to issue 5 parent shares for each 2 sub shares. And each of
those parent shares was worth $5 each; split $1 nominal and $4 premium. But this share
issue was not recorded. So when we get to the SFP we will see the share issue appear again,
split $400k and $1,600k, as discussed below.
Note the associate suffers the impairment and not the sub.
Gross profit
Operating expenses
11,000
(6,000)
1,800
(1,300)
PUP(20)
FVA(30)
15
(278)
A
Operating profit
Associate (6/12)(100)(30%)
Associate impairment
(210)
G
lo
(2,500)
(700)
(140)
Profit before tax
Tax
(832)
(50)
_____
AC
C
Profit before interest and tax
Interest
Profit after tax
Non-controlling interest
Adj
Bo
Sub
ba
l
Revenue
Cost of sales
Parent
x
Group income statement (profit and loss)
50
20%
Profit attributable to parent members PAM)
(120)
120
Group
12,680
(7,230)
______
5,450
(2,710)
_____
2,740
15
(278)
_____
2,477
(840)
_____
1,637
(882)
_____
755
(10)
___
745
___
Group reserve movement (not required)
Opening reserves
PAM
Dividends
9,000
745
(400)
_____
Closing reserves
9,345
_____
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Group statement of financial position
Non-current assets
Goodwill
Associate [790(30%) see above]
Land and buildings (9,000 + 2,000 + 400 FVA)
Plant and machinery (4,000 + 1,500 + 270 FVA)
Investment in other shares (600 + 300)
710
237
11,400
5,770
900
Current assets
Inventory (1,100 + 300 – 20(pup))
Receivables (1,500 + 150 – 25(inter-company))
Bank (300 + 70 + 4(cash in transit))
1,380
1,625
374
______
22,396
______
Equity
Bo
x
Share capital (1,000 + 400(parent share issue nominal) see below)
Share premium (2,000 + 1,600(parent share issue premium) see below)
Retained earnings
Non-controlling interest [410+(1710-1700)(20%)]
Loan (2,800 + 3,020)
Current liabilities
G
lo
Trade (900 + 140 – 21(inter-company))
Tax (700 + 100)
ba
l
Non-current liabilities
1,400
3,600
9,345
412
5,820
1,019
800
______
22,396
______
AC
C
A
Note: Parent share issue was consideration for the sub acquisition described in the
opening paragraph. This issue was 400,000 shares with a nominal value of $1 and
a premium value of $4. The sum of $400k nominal and $1,600k premium gives the
fv of consideration at the top of the goodwill schedule. Hence the SFP balances.
Note: We strip $21k out of trade payables because that’s the balance in there. The
sub records a liability of $21k because after sending a cheque of $4k on a liability of
$25k it still owes $21k.
Reserves
Parent
Sub (1,710 – 1,700) (80%)
Ass (700 – 650) (30%)
Impairment
9,600
8
15
(278)
_____
9,345
_____
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A P P E N D I X – S U G G E S T ED S O L U T I O N S T O Q U ES T I O N S A N D EX A M P L ES
CHAPTER 2
Answer: Lady Gaga
Full Goodwill
FV
FV
FV
FV
of
of
of
of
consideration
previous
nci
NA
120
27
110
(150)
___
Goodwill at acquisition
107
___
By the way, there is also a gain on the previous equity of $2m (27-25). That would
be recorded in the P/L.
Bo
x
Answer: Adam Ant
Full Goodwill
460
200
(300)
___
ba
l
FV of consideration
FV of nci
FV of NA
Profit
AC
C
Actual sale proceeds
Deemed sale proceeds
Nci (200+30%(30))
Net assets
Goodwill
A
Disposal
360
___
G
lo
Goodwill at acquisition
250
410
209
(330)
(360)
___
179
___
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A P P E N D I X – S U G G E S T E D S O L U T I O N S T O Q U ES T IO N S A N D EX A M P L ES
Answer: Iggy Pop
Full Goodwill
FV of consideration
FV of nci
FV of NA
350
138
(110)
___
Goodwill at acquisition
378
___
Transfer (use proportion of one third)
Nci before
(138+30%(20))
{Usual roll forward: acq plus growth}
Transfer
(10%/30%)(144)
{one third of nci}
144
___
96
___
Nci after
Bo
Reduction in ci
x
(48)
48
(55)
___
(7)
___
ba
l
Transfer in
Consideration out
AC
C
FV of consideration
FV of nci
FV of NA
A
Full Goodwill
G
lo
Answer: Iggy Pop (parallel universe)
Goodwill at acquisition
200
39
(90)
___
149
___
Transfer (use proportion of one half)
Nci before
(39+20%(10))
{Usual roll forward: acq plus growth}
Transfer
(10%/20%)(41)
{one half of nci}
Nci after
41
(20.5)
___
20.5
___
Reduction in ci
Transfer in
Consideration out
20.5
(29)
___
(8.5)
___
128
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A P P E N D I X – S U G G E S T ED S O L U T I O N S T O Q U ES T I O N S A N D EX A M P L ES
Answer: Busta Rhymes
As you remember from the two examples above (Q Toy and Q Love), there is
inconsistency between the methods used by the examiner in this area. For no
obvious reason, the examiner uses a proportion when the nci transfers to the ci (see
Q Iggy Pop). But the examiner uses a percentage when the ci transfer to nci (see
this Q Busta Rhymes).
If you are uncertain about this conundrum, then you need to go back to the primary
examples above (Q Toy and Q Love).
Full Goodwill
FV of consideration
FV of nci
FV of NA
440
40
(180)
___
Goodwill at acquisition
300
___
Sub (220na+300gw)
{Whole sub carrying value}
Percentage
{Forget about proportion when ci transfers to nci}
Bo
x
Transfer (use percentage of 15%)
520
15%
ba
l
___
78
___
Increase in ci
(78)
90
___
12
___
AC
C
A
Transfer out
Consideration in
G
lo
Transfer
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A P P E N D I X – S U G G E S T E D S O L U T I O N S T O Q U ES T IO N S A N D EX A M P L ES
CHAPTER 3
Answer: Furtive
Delivery
Y/e
€
Rate
$
50
50
1.00
1.25
50
40
______
Forex gain
10
______
Delivery journal
Dr
Fixed asset (cost)
Cr
Creditors
50
50
Creditor
Cr
(P&L) Forex gain (financing)
Bo
Dr
x
Year end journal
Roubles
Rate
90,000
90,000
5
4
Journals
Dr
18,000
22,500
______
4,500
______
AC
C
At delivery
$
A
Forex loss
G
lo
Delivery
Y/e
10
ba
l
Answer: Feature
10
Fixed asset (cost)
Cr
Creditors
18,000
18,000
At year end
Dr
Financing (Forex loss) (P&L)
Cr
Creditor
130
4,500
4,500
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A P P E N D I X – S U G G E S T ED S O L U T I O N S T O Q U ES T I O N S A N D EX A M P L ES
Answer: Feature (continued)
Year start
Payment
Roubles
Rate
$
90,000
90,000
4
4.5
22,500
20,000
______
Forex gain
2,500
______
Journals (closure)
Dr
Creditor
Cr
Financing (Forex gain) (P&L)
2,500
2,500
Creditor
Cr
Bank
20,000
20,000
x
Dr
Bo
Answer: Scuba
ba
l
The functional currency is the Gooble. The majority of functions are in Goobles and
importantly the sales and competitive behaviour is dominated by the Gooble.
Answer: Kenya
G
lo
Net assets
Growth
AC
C
A
Share capital
Reserves
At acq
40
128
______
At B/S
40
260
______
168
______
300
______
132
______
Goodwill
FV of consideration ($180m)(4)
FV of nci (given)
FV of NA (above)
720
80
(168)
______
Goodwill at acquisition
632
______
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A P P E N D I X – S U G G E S T E D S O L U T I O N S T O Q U ES T IO N S A N D EX A M P L ES
Group profit and loss
Parent
Sales
Costs
PBT
Tax
Sub
Rate
Sub
280
(220)
936
(705)
3
3
312
(235)
(19)
_____
(99)
_____
3
(33)
_____
PAT
41
132
3
Adj
Group
592
(455)
_____
137
(52)
_____
44
@10%
85
Non-controlling interest
(4.4)
_____
Profit attributable to members (PAM)
80.6
_____
Parent
Rate
10
Adj
Group
10
222
_____
232
222
_____
222
@10%
_____
10
OCI
Sub
Bo
Revaluation
Sub FX (see below)
Sub
x
Group other comprehensive income
ba
l
Non-controlling interest
G
lo
OCI attributable to members (OCIAM)
(22.2)
_____
209.8
_____
Group statement of changes in equity (SOCIE)
SC
Closing
A
70
AC
C
Opening
Acquisition (80/4)
PAT
OCI
_____
70
_____
RE
OCE
409
70
80.6
_____
489.6
_____
209.8
_____
279.8
_____
132
NCI
Group
0
20
4.4
22.2
_____
46.6
_____
549
20
85
232
_____
886
_____
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A P P E N D I X – S U G G E S T ED S O L U T I O N S T O Q U ES T I O N S A N D EX A M P L ES
Subsidiary foreign currency retranslation
Retranslation of the sub PAT to closing rate from average rate
132/2 =
132/3 =
66
44
___
Forex gain
22
___
22
Retranslation of opening NA to closing rate from opening rate
168/2 =
168/4 =
84
42
_____
Forex gain
42
_____
42
316
158
_____
Forex gain
158
_____
Bo
632/2 =
632/4 =
x
Retranslation of goodwill to closing rate from opening rate
158
_____
ba
l
Sub FX
222 To OCI
_____
G
lo
Group statement of financial position
A
Goodwill (632/2)
Other Net Assets (420 + 300/2)
AC
C
Share capital
Retained earnings
Other components of equity
Non-controlling interest
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316
570
______
886
______
70
489.6
279.8
46.6
______
866
______
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A P P E N D I X – S U G G E S T E D S O L U T I O N S T O Q U ES T IO N S A N D EX A M P L ES
Subsidiary foreign currency retranslation as a balance
Retranslation of the sub opening net assets plus profit:Opening net assets (168/4)
Profit (132/3)
Forex gain (balance)
42
44
64
___
Closing net assets (300/2)
150
___
64
Retranslation of goodwill:Opening goodwill (632/4)
Forex gain (balance)
158
158
___
Closing goodwill (632/2)
316
___
158
_____
222
_____
x
Sub FX
Bo
Answer: Xtreme
ba
l
(a)
Net assets
A
G
lo
SC
RE
FVA (ii) (40 depreciation for the current year)
AC
C
Growth
Acq
SFP
100
2,000
400
_____
100
2,100
360
_____
(given)2,500
_____
2,560
_____
60
Goodwill
FV of cost (1,100)(4)
FV of nci (given)
FV of NA (given)
4,400
1,888
(2,500)
_____
3,788
_____
(2 marks for goodwill)
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Subsidiary foreign currency retranslation as a balance
Retranslation of the sub opening net assets plus profit:Opening net assets (2500/4)
Profit (60/5) {profit is the growth above}
Forex gain (balance)
625
12
(210)
___
Closing net assets (2560/6)
(210)
427
___
Retranslation of goodwill:Opening goodwill (3788/4)
Forex gain (balance)
947
(316)
___
Closing goodwill (3788/6)
631
___
(316)
_____
(526)
_____
Bo
x
Sub FX
Subsidiary foreign currency retranslation derived from PAT & goodwill & NA
A
G
lo
(2)
___
Forex on opening na at acquisition
Forex
2,500/6 =
417
2,500/4 =
(625)
___
ba
l
Forex on PAT
Sub PAT is $60m after accommodation of the FVA depreciation of $40m (100-{400/10yrs}).
Forex
60/6
=
10
60/5
=
(12)
___
(208)
AC
C
(208)
___
Forex on goodwill
Forex
3,788/6 =
3,788/4 =
(2)
631
(947)
___
(316)
___
(316)
_____
Sub FX
(526)
_____
(3 marks for fx calculated either way but not both)
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A P P E N D I X – S U G G E S T E D S O L U T I O N S T O Q U ES T IO N S A N D EX A M P L ES
Reporting
There is a split performance recognition required by IAS21.
There are two types of fx
movement and two parts to the SPLOCI. One loss goes in one report and the other in the
other:
Forex
performance reporting
Forex on transaction translation
to profit or loss (p/l)
(on retranslation of receivables on payables)
Forex on sub translation
to other comprehensive income (oci)
(on retranslation of profit & na & gw in sub)
Sub FX
So this means the above $526m loss will appear in the group oci.
Ownership split
The above fx loss of $526m is attributable to the sub and therefore split between the sub
owners; the controlling interest and the non-controlling interest.
The split is therefore
x
70%/30% in the OCI and through the SOCIE and onto the balance sheet in OCE and NCI.
Bo
(2 marks for narrative)
(b)
Payable FX
Forex gain
396
396
11
12
36
33
______
ba
l
$
3
______
(2 marks for calculation)
A
Reporting
Rate
G
lo
Delivery
Y/e
Dinar
The transaction FX gain above would be reported in the group p/l. the FX gain is attributable
Note
AC
C
to the parent and therefore there are no NCI implications.
(1 mark for comment)
For completeness here is the full p/l and socie and b/s so that you can see how the above all
fits together:-
Net assets
SC
RE
FVA (ii) (40 depreciation for the current year)
136
Acq
SFP
100
2,000
400
_____
100
2,100
360
_____
(given)2,500
_____
2,560
_____
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Goodwill
FV of cost (1,100)(4)
FV of nci (given)
FV of NA
4,400
1,888
(2,500)
_____
3,788
_____
Group P/L
Parent
Rate
Sub
800
(400)
FVA (40)
5
5
5
160
(80)
(8)
(100)
(170)
5
(34)
Operating profit
Interest expense
Forex gain on payable
(10)
3
(30)
5
(6)
Profit before tax
Tax
(90)
(100)
_____
5
60
_____
5
Profit after tax
add down for both PAT
(20)
20
640
(270)
_____
370
(134)
_____
236
(16)
3
_____
223
(110)
_____
(20)
_____
12
_____
30%
113
(4)
___
G
lo
NCI
Group
Bo
Gross profit
Operating expenses
Adj
x
500
(200)
Pup (2)
ba
l
Revenue
Cost of sales
Sub
PAM (Profit Attributable to Members)
109
___
AC
C
A
Group other comprehensive income
Parent
Sub
Rate
Foreign exchange loss on sub
_____
Other comprehensive income
NCI
_____
Sub
Group
(526)
_____
(367)
_____
(526)
_____
30%
(526)
Other comprehensive income attributable to parent members (OCIAM)
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Adj
(158)
___
(368)
___
137
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A P P E N D I X – S U G G E S T E D S O L U T I O N S T O Q U ES T IO N S A N D EX A M P L ES
Group statement of changes in equity (SOCIE)
Opening
Acquisition (1888/4)
PAT
OCI
SC
RE
1000
3000
0
109
_____
1000
_____
Closing
OCE
_____
3109
_____
(368)
_____
(368)
_____
NCI
Group
0
472
4
(158)
_____
318
_____
4000
472
113
(526)
_____
4059
_____
Group SFP
NCA
Goodwill (3,788/6)
Tangible (3,000 + [1,700 + FVA 360]/6)
CA (2,300 + 2,200/6 -2(iii)pup)
CL (1,100-3(vi) + (1,050)/6)
NCL (1,200 + (650)/6)
Bo
x
631
3,343
2,665
(1,272)
(1,308)
_____
1,000
3,109
(368)
318
_____
4,059
_____
AC
C
A
G
lo
ba
l
Share Capital
Retained earnings
Other components of equity
NCI
4,059
_____
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A P P E N D I X – S U G G E S T ED S O L U T I O N S T O Q U ES T I O N S A N D EX A M P L ES
CHAPTER 3
Answer: Example 1
Cash flow additions (700-900+70-30-60-40+10) = 250.
Answer: Example 2
Tax paid (350-400+120-110+380+30-20) = 350.
Answer: Example 3
Associate dividend received (670-900+430+40) = 240.
x
Answer: Ducky
Bo
Cash flow statement (IAS7)
G
lo
AC
C
Cash generated from operations
Interest paid (9 – 6 + 45)
Tax paid
Operating cash flow
Investing
Interest received
Sub acquisition (204 – 80)
Sub acquisition Cash in hand
Sale of tangibles (40 + 7)
Associate dividend received
Purchase of tangibles
Pension contributions
866
45
(23)
(98)
___
790
(79)
(61)
68
51
(7)
40
17
___
A
Operating profit
Inventory (622 – 734 + 33)
Receivables (601 – 689 + 27)
Payables (913 – 1,003 + 22)
Depreciation
Disposal
Impairment of goodwill
Pension costs
ba
l
Profit before tax
Interest payable
Interest receivable
Associate
819
(48)
(233)
___
538
23
(124)
3
47
90
(1,064)
(47)
___
(1,072)
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A P P E N D I X – S U G G E S T E D S O L U T I O N S T O Q U ES T IO N S A N D EX A M P L ES
Financing
Share issue (100 – 60 + 185 - 75 - 80)
Borrowings issue (570 – 1,005)
Dividend paid
NCI dividend paid
70
435
(78)
(41)
___
386
___
Cash flow
Opening
(148)
205
___
Closing
57
___
Workings
Goodwill
Bo
x
Opening
Closing
GW [204 + 22 -200]
Impairment
ba
l
Tangible
A
AC
C
Cash flow purchases
G
lo
Opening
Closing
Revaluation
Acquisition
Disposal
Depreciation
92
(78)
26
__
40
__
1,248
(2,473)
80
172
(40)
(51)
_____
(1,064)
_____
Associate
Opening
Closing
P/L
Forex
Cash dividend
550
(545)
98
(13)
___
90
___
NCI
Opening
Closing
P/L
Acquisition (given para (i))
107
(157)
69
22
___
Dividend paid
41
___
140
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A P P E N D I X – S U G G E S T ED S O L U T I O N S T O Q U ES T I O N S A N D EX A M P L ES
Tax
Opening CT
Closing CT
Opening DT
Closing DT
P/L
Acquisition
202
(222)
417
(390)
213
13
___
Tax paid
233
Answer: Squire
415
84
(65)
___
Operating profit
Inventory (1,160 – 1,300 + 70)
Receivables (1,060 – 1,220 + 100)
Payables (2,105 – 2,355 + 90)
Depreciation
Disposal
Compensation payment
Goodwill impairment
Pension charge
434
(70)
(60)
160
129
(30)
25
20
___
Bo
ba
l
608
(64)
(140)
___
404
___
(10 Marks)
AC
C
A
Operating cash flow
G
lo
Cash generated from operations
Interest paid (45 – 65 + 84)
Tax paid
x
Profit before tax
Interest
Associate
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A P P E N D I X – S U G G E S T E D S O L U T I O N S T O Q U ES T IO N S A N D EX A M P L ES
Cash flow statement (IAS7)
For completeness here is the rest of the cfs:Operating cash flow
Investing
Sub acquisition
Pension payment
Tangible non current assets
Associate
404
(200)
(26)
(338)
50
_____
(514)
Financing
Share issue (30 + 30)
Dividend paid
Loan repayment
NCI dividend paid
60
(85)
(50)
(5)
___
(80)
_____
Bo
x
Cash flow
Opening
Closing
ba
l
Workings
Opening
Acq (250+30%(300)-300)
Closing
90
___
65
40
(80)
__
25
__
AC
C
A
Impairment
G
lo
Intangible
(190)
280
___
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A P P E N D I X – S U G G E S T ED S O L U T I O N S T O Q U ES T I O N S A N D EX A M P L ES
Tangible
Opening
Closing
Reversal
Acquisition
Finance addition
Depreciation
2,010
(2,630)
(194)
250
355
(129)
_____
Purchase payment
(338)
_____
Associate
Opening
Closing
P/L
P/L
Forex
550
(535)
65
(20)
(10)
___
Bo
x
Dividend received
Retirement
ba
l
Opening
Closing
Pension charge
Dividend
Tax
AC
C
Opening
Closing
P/L
Acquisition (30%)(300)
A
NCI
G
lo
Cash flow
Opening CT
Closing CT
Opening DT
Closing DT
P/L
50
___
16
(22)
(20)
___
(26)
___
345
(522)
92
90
___
5
___
160
(200)
175
(200)
205
___
Tax paid
140
___
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A P P E N D I X – S U G G E S T E D S O L U T I O N S T O Q U ES T IO N S A N D EX A M P L ES
CHAPTER 5
Answer: Baby
Revenue
Revenue is recognised either at the point that control transfers or over the period
that the performance obligation is fulfilled depending upon the source of revenue.
Sources
There are three sources of revenue for which the “over” revenue model applies:• No Alternative Use revenue
• Customer controlled asset revenue
• Simultaneous consumption revenue.
Maintenance
Bo
x
The customer controls the road whilst the supplier supplies the maintenance. So the
revenue should be recognised over the four years.
Journal
Dr
Bank
Cr
Revenue
Cr
Deferred Income
$3m
$1m
G
lo
$2m
A
Answer: Dig
Revenue
ba
l
So Baby should have recognised the following using the surveyor’s certification:-
AC
C
There is a five step model
C
contract
identify the contract
O
obligations
identify the individual obligations
P
price
identify the price
A
allocation
allocate the price to the obligations
R
revenue
recognise the revenue at or over
Contract
There is a contract. The phone call is enough to create obligations for both Dig and
the customer and the email backs this up.
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A P P E N D I X – S U G G E S T ED S O L U T I O N S T O Q U ES T I O N S A N D EX A M P L ES
Obligations
There are two separate obligations. The digger is specialist equipment and
probably cannot be sold to other customers easily. But the fuel is likely to saleable
to others.
Price
The basic price is $900k but it seems the variable consideration can be reasonably
estimated at $10k per week for 6 weeks and is unlikely to be reversed. The price is
$960k.
Allocation
The price can be allocated 9 to 1 as fuel ($96k) and digger ($864k).
Revenue
The fuel revenue is simple ‘at’ revenue and the control passed to the customer at
delivery. The digger performance obligation appears to generate an asset with no
alternative use and so the ‘over’ revenue model appears appropriate.
Bo
x
Conclusion
Revenue is recognised in the current period as follows:$k
Fuel
96
Digger (80% of $864k)
ba
l
Performance obligation
691
Revenue
G
lo
___
787
Answer: Rockby
AC
C
Discontinued
A
___
An operation is discontinued if it is closed or sold during the year or held for sale at
the year end. Bye is clearly not closed or sold during the year. So now Bye should
be tested for hfs.
Held for sale
And asset is hfs if criteria are fulfilled:• Sell = there must be a clear intent to sell
• Available = the asset must be available for immediate sale
• Locate = the entity must be seeking to locate a buyer
• Expected = the sale must be expected to be completed with 12 months
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A P P E N D I X – S U G G E S T E D S O L U T I O N S T O Q U ES T IO N S A N D EX A M P L ES
Bye HFS
The criteria are all fulfilled as follows based on quotes from the scenario:• Sell = “committed”
• Available = “prepared the sub for disposal”
• Locate = “negotiations”
• Expected = “four months after year end”
Effect
So bye is discontinued and would be bundled into one line on the p/l and one line
on the SFP. Both single lines would be labelled “discontinued”.
Impairment
There also appears to be an impairment. An impairment occurs when the carrying
value of a sub is above the recoverable value (higher of viu and fvlcts).
x
Bye Impairment
Bo
So the Bye impairment would be like this:Before
After
{first} (1.0)
0.0
5
{second} (0.5)
4.5
6
{balance} (1.5)
{higher} 4.5
1
ba
l
Goodwill
Impairment
CGU
Provisions
A
There are three criteria:-
G
lo
Net assets
• Reliable estimate = reasonable guess
AC
C
• Obligation = legal or constructive requirement
• Transfer = probable future outflow
Bye Provision
The can be no obligation to make losses. So the $400k cannot be provided. So the
$400k is recognised next year.
Answer: Kiplin
T/O
OP
NA
T/O
OP
NA
Total
Professional
Higher
700
200
500
350
60
150
350
140
350
Total
US
UK
700
200
500
560
100
350
140
100
150
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A P P E N D I X – S U G G E S T ED S O L U T I O N S T O Q U ES T I O N S A N D EX A M P L ES
CHAPTER 6
Answer: Russian Chemical Spill
(R) Reasonably reliable estimate
There is already an estimate available in the sum of $7m.
(O) Obligation
There is a constructive obligation resultant from the public green policy.
Decision
Obligation
Public
Secret
Constructive
None
Obviously money will flow out when the land is cleaned.
Bo
Conclusion
Double entry
The following journal is appropriate:
ba
l
The costs must be provided.
Cleaning costs (super exceptional) (P&L)
Cr
Provisions (SFP)
Answer: Oil Rig
$7m
G
lo
Dr
x
(T) Transfer
$7m
A
(R) Reasonably reliable estimate
AC
C
The company already have a guess of $120m for dismantling the rig.
(O) Obligation
There is a legal obligation derived from the licence.
(T) Transfer
Of course cash will transfer out.
Conclusion
The oil company should provide.
Measurement
The liability should be measured at the discounted present value of the future cash
flow.
Provision = $120m/1.120 = $18m
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A P P E N D I X – S U G G E S T E D S O L U T I O N S T O Q U ES T IO N S A N D EX A M P L ES
Double entry
The following journal is required:
Dr
Fixed asset cost (SFP)
Cr
Provisions (SFP)
$18m
$18m
Fixed asset
The above cost is slapped on top of the other two costs:
$m
Construction
Installation
Dismantling
200
100
18
___
Initial cost
318
___
x
Depreciation
Depreciation - operating costs (P/L)
Cr
Fixed asset (SFP)
Unwinding
ba
l
Dr
Bo
Then the above is depreciated over 20 years:
15.9 (318/20 yrs)
15.9
Also, quite separately, the provision is unwinding over 20 years. First year journal:
Financing (P/L)
Cr
Provision (SFP)
G
lo
Dr
Table
A
Opening
18.00
19.80
21.80
23.96
AC
C
Year
1
2
3
4
Finance
1.80
1.98
2.18
2.40
20
$1.8m
$1.8m
(18)(0.1)
Closing
19.80
21.78
23.96
26.40
120.0
Answer: Outrageous
Newspaper provides, public figure discloses.
Answer: Fraud
Adjust for 10million theft. Disclose the rest.
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A P P E N D I X – S U G G E S T ED S O L U T I O N S T O Q U ES T I O N S A N D EX A M P L ES
Answer: Cheated
The entities Cheated and Cheeky are related via Mr and Mrs Cute. So any transaction
between them is a related party transaction and must be disclosed.
Answer: Cow
Carry the cow FVPL as follows:$
Cow born
0
Gain to pl
35
___
Closing (50-15)
35
AC
C
A
G
lo
ba
l
Bo
x
___
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A P P E N D I X – S U G G E S T E D S O L U T I O N S T O Q U ES T IO N S A N D EX A M P L ES
CHAPTER 7
Answer: Supermarket
Materials
Labour
Legal
Interest (10%)(40)(/12)
30
20
2
3
__
Initial cost
55
__
Answer: Oops
100
(10)
___
Opening
Depreciation (90/6years)
90
(15)
__
Bo
x
Cost
Depreciation
ba
l
Closing
Before
Impairment
S
C
300
(10)
___
400
(170)
___
500
(0)
___
290
___
230
___
500
___
Before
Impairment
After
AC
C
A
After
B
G
lo
Answer: Blob
75
__
Answer: AB
Goodwill
Garage
Computers
Vehicles
Intangibles
Receivables
Cash
Payables
150
40
20
10
90
30
10
50
(20)
___
(40)
(10)
(5)
(30)
(5)
__
10
5
60
25
10
50
(20)
___
230
___
(90)
__
140
___
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A P P E N D I X – S U G G E S T ED S O L U T I O N S T O Q U ES T I O N S A N D EX A M P L ES
Answer: Revert
Cost
Revaluation (to OCI)
400
10
___
Opening
Reversal (to OCI)
410
(10)
__
400
(3)
___
Historical net book value (400cost – zero depn)
Impairment (to P/L)
Closing
397
___
Note that the reversal is limited by the hnbv. Historical net book value is the figure
that the entity would have been carrying had there been neither an increase nor
decrease in value, only depreciation, which for land is zero.
x
Answer: Rethink
G
lo
Current year opening
Depreciation (10/9years)
ba
l
Before
Revaluation gain (to OCI){balance}
Before
Reversal of revaluation gain(to OCI){balance}
AC
C
A
Historical net book value (8cost – 1.6depn)
Impairment (to P/L){balance}
Closing
8.00
(0.80)
__
7.20
2.80
___
Bo
Cost
Depreciation (8/10years)
10.00
(1.11)
__
8.89
(2.49)
__
6.40
(2.40)
___
4.00
___
Note that the reversal is limited by the hnbv. Note also (if you are particularly hot
with numbers) that the reversal is 8/9 of the original gain. Here is the answer again
but this time based on down to $4m at the current year start and then up to $10m
at the current year end. Note how the application of hnbv is unchanged.
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A P P E N D I X – S U G G E S T E D S O L U T I O N S T O Q U ES T IO N S A N D EX A M P L ES
Cost
Depreciation (8/10years)
8.00
(0.80)
__
7.20
(3.20)
___
Before
Impairment (to P/L){balance}
Current year opening
Depreciation (4/9years)
4.00
(0.44)
__
3.56
2.84
__
6.40
3.60
___
Before
Reversal of impairment loss (to P/L){balance}
Historical net book value (8cost – 1.6depn)
Revaluation gain (to OCI){balance}
Closing
10.00
___
x
Answer: Grant Mitchell
Bo
NCA
Cost (100 + 20)
Depreciation (120/20)
ba
l
Closing
Deferred income
Closing
AC
C
Answer: Decided
120
(6)
___
114
___
Grant
20
(1)
__
19
__
A
G
lo
Grant
Income
Building
The factory is a simple occupied property.
Opening carrying value
Depreciation
Closing
$m
40
(2)
__
38
__
Answer: Game
$m
23
17
0
__
40
__
Squad (Twenty Players)
Star
Slogan
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A P P E N D I X – S U G G E S T ED S O L U T I O N S T O Q U ES T I O N S A N D EX A M P L ES
Answer: Tyre
Depreciation
Depreciation recognises the cost of use. The admin centre was abandoned mid year.
But up to that point it was in use and so requires depreciation up the point the admin
team moved out.
Impairment test
The admin team moved out mid year. That is clear evidence of impairment. So an
impairment test is required at this point. We should not wait until the building is
knocked down.
Impairment
Of course the building needs to be written off altogether.
= zero (not in use)
Fvlcts
= zero (not going to be sold)
x
Viu
Bo
Land (HFS)
That leaves the land. Maybe the land is held for sale from the point that admin
moved out. These are the criteria:sell
clear intent to sell
A
available
asset ready to go
L
locate
E
expected
ba
l
S
G
lo
looking for a buyer
sale expected within 12 months
Application
A
The scenario tells us that “the company decided not to sell the land immediately”.
That results in a fail of all three of the top three criteria. So the land is not hfs.
AC
C
Land (IP)
But maybe the land is an investment property. Here are the criteria:I
C
E
investment
held for eventual sale (or rent)
complete
finished
entity unoccupied
not occupied by the group
Application
I think this is a fit. The land is held for eventual sale and the land is land and so is
finished and the building above has been abandoned and so the land is not occupied.
I think the land is an investment property for the last few months of the year.
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A P P E N D I X – S U G G E S T E D S O L U T I O N S T O Q U ES T IO N S A N D EX A M P L ES
FVPL
So the land will be held fvpl for the last few months. And this means a surveyor’s
value for the land to the SFP and a gain to the p/l.
Provision
The remedial work has the feel of a provision. Here are the criteria:R
reasonably reliable estimate
O
obligation (legal or constructive)
T
transfer (probable outflow)
Application
AC
C
A
G
lo
ba
l
Bo
x
But there is a trick here. The scenario clearly tells us that there is no obligation at
the year end. The work is required following the demolition and the building was not
demolished before the year end. So no provision.
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A P P E N D I X – S U G G E S T ED S O L U T I O N S T O Q U ES T I O N S A N D EX A M P L ES
CHAPTER 8
Answer: Ed
(a) Lessee accounting
The discounted present value of $1000 for three years at 10% is $2487. To get the asset
below you lop off $829 in depreciation each year. To get the year end liabilities you add
10% interest to the opening figure and lop off $1000 for each year end payment.
Year end two
Year end three
Cost
$
$
$
$
Asset
1658
829
0
0
Liability
1735
909
0
0
829
829
829
2487
248
174
Operating cost
Financing cost
91
Bo
(depreciation)
x
Year end one
(interest)
Total cost
513
3000
ba
l
The above shows the position at all three year ends to give the full picture. But actually only
year end one is required.
G
lo
(b) No difference.
Answer: Ed (continued)
AC
C
A
Acceptable (low value asset lease).
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A P P E N D I X – S U G G E S T E D S O L U T I O N S T O Q U ES T IO N S A N D EX A M P L ES
Answer: ABMN
B
800
(200)
___
700
(100)
___
NBV
600
___
600
___
< 1 year
> 1 year
220
418
___
112
535
___
Total
638
___
647
___
(200)
___
(100)
___
58
___
59
___
Fixed asset: Cost
Depreciation
Creditors:
Profit and loss
Depreciation
10% interest
Closing
58
___
638
___
ba
l
Interest
Advance
Opening
Instalment
A
800
___
(220)
___
B
700
___
x
A
Bo
Part one: Statement of financial position
647
___
59
___
AC
C
A
G
lo
(112)
___
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A P P E N D I X – S U G G E S T ED S O L U T I O N S T O Q U ES T I O N S A N D EX A M P L ES
Part two: Statement of financial position
M
N
500
(100)
___
650
(50)
___
NBV
400
___
600
___
< 1 year
> 1 year
88
332
___
5
640
___
Total
420
___
645
___
(100)
___
(50)
___
(50)
___
(65)
___
Fixed asset: Cost
Depreciation
Creditors:
Interest
Arrears
Opening
Interest
M
1
2
500
420
___
50
42
___
N
1
2
650
645
___
65
64.5
___
G
lo
Part three: FS effect
Instalment
Closing
(130)
(130)
___
420
332
___
(70)
(70)
___
645
640
___
ba
l
Year
Bo
Depreciation
x
Profit and loss
AC
C
A
Assuming 5 year asset life (Finance lease accounting for lessor)
Lessor records a sale and a receivable equal to the lessees payable.
Assuming 50 year asset life (Operating lease accounting for lessor)
Lessor records only an operating income equal to the instalment.
Profit or loss
Operating Income: Rental
130
___
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Answer: Tabular
(ii)
Simple secured loan of $30m.
Dr
Bank
30
Cr
Loan
30
Sale and lease with combined proceeds of $50m. The combined cash received
is $50m and the lease liability is $5m; so the rest $45m must be sale proceeds;
meaning that 90% of the asset must have been sold (45/50). So we record the
derecognition of 90% {(50-5)/50} of PPE. And the balance is profit on sale of
90% of the property; which itself is 90% of the profit that would have been
recorded had the whole property been sold {(50-42)90%}.
Dr
Bank {given}
50
Cr
Lease liability {given}
Cr
PPE (90%)(42)
Cr
Profit {balance}
5
37.8
7.2
x
(i)
AC
C
A
G
lo
ba
l
Bo
{Alternative interpretations of IFRS 16 are permitted}.
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CHAPTER 9
Answer: Glossary
(a) Gross Presentation
Movement on assets
$m
Market value at start of the year
390
Expected return on the assets
39
Contributions
34
Benefits paid
(26)
Actuarial gain (loss) – balancing fig
(67)
Market value at end of the year
370
Movement on obligations
400
x
Obligation at start of the year
40
Bo
Interest
Service cost (14 + 100)
114
(26)
Actuarial (gain) loss – balancing fig
Obligation at end of the year
ba
l
Benefits paid
2
530
Pension assets
Pension obligations
370
(530)
(160)
A
Net pension asset (liability)
G
lo
The statement of financial position
AC
C
The income statement
Operating
Service cost
Finance
Finance cost (39-40) also (390-400)10%
(114)
(1)
Other Comprehensive Income
Actuarial (loss) on assets
(67)
Actuarial (loss) on obligations
Net Actuarial (loss)
(2)
(69)
Note: net presentation as given in question contact following is also acceptable.
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(b)
Curtailment
The technical name for the winding up of the policy and paying off the employees is
called “curtailment”. It is a nasty business where the entity tries to pay the
employees less than they are owed and the employees try to fight for every penny
but in fear of their jobs. There is lots of it out there at the moment and you may
have read about BA staff caught up in this mess.
Fs
The fs effect is dead easy. The asset, the liability and the settlement cash are swept
into the p/l to give a profit or loss on settlement:$m
Asset
370
Liability
(530)
____
(160)
167
Bo
Settlement cash
x
Net pension liability
____
Settlement loss
7
ba
l
____
This is a loss because Glossary has paid more than they thought they owed.
Asset ceiling
G
lo
(c)
AC
C
Fs
A
The present value of the reductions in the future contributions is called the “asset
ceiling”. It is so called because it sets an upper limit on any net pension asset. On
rare occasions the asset ceiling may fall below the value of the net pension asset. In
this case this has occurred and the top of the net pension asset is shaved off and
dumped in the p/l.
The fs effect for this is also dead easy:$m
Asset
100
Liability
(82)
____
Apparent net pension asset
18
Derecognition loss
(2)
to P/L as operating cost
____
Recorded net pension asset
Limited by Asset ceiling
16
to SFP as nca
____
Note that although the net pension asset at first appears to be $18m because $2m
has been written off, only $16m is recorded on SFP.
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Comment
Asset ceilings are rarely applicable in real life and were included in the IAS to account
for problems created by unusual pensions legislation.
Answer: Contact Details PLC
Net presentation
Opening (1000-990)
Finance (10%)(10)
Contributions
Service cost
One
Two
Three
10
90
(8)
1
8
(1)
90
100
110
(140)
(150)
119
———
(66)
———
(171)
———
90
(8)
(220)
(130)
Actuarial gain (loss) – balancing fig
AC
C
A
G
lo
ba
l
Bo
x
Closing (1190-1100)
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Gross Presentation (see above for net presentation)
On assets
One
Two
Market value at start of the year
Expected return on the assets
(Using the discount rate!!)
Contributions
Benefits paid
Three
1,000
1,190
1,372
100
107
109
Round
down
90
100
110
(180)
(190)
(150)
Actuarial gain (loss) – balancing fig
150
———
155
———
(213)
———
Market value at end of the year
1,190
1,372
1,188
990
1,100
1,380
99
99
110
130
140
Interest
(also using discount rate)
Current service cost
Benefits paid
(150)
31
———
Obligation at end of the year
1,100
Pension assets
Pension obligations
A
Net Pension asset (liability)-disclosed
(190)
221
———
(42)
———
1,380
1,408
1,190
1,372
1,188
(1,100)
———
(1,380)
———
(1,408)
———
G
lo
The statement of financial
position
(180)
ba
l
Actuarial (gain) loss – balancing fig
150
Bo
Obligation at start of the year
x
On obligations
90
(8)
(220)
(130)
(140)
(150)
100
107
110
AC
C
The income statement
Operating
Current service cost - disclosed
Finance
Expected return on assets
Interest cost
Finance income (expense) - disclosed
(99)
———
(99)
———
1
8
Actuarial gain (loss) on assets
150
155
Actuarial gain (loss) on obligations
(31)
Net actuarial gain (loss) - disclosed
119
(110)
———
0
Other Comprehensive Income
(221)
(66)
162
(213)
42
(171)
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CHAPTER 10
Benign
Opening
Increase
0.0
12.0
____
Closing year one (90)(0.40)(1/3)
Increase
12.0
12.8
____
Closing year two (93)(0.40)(2/3)
Increase
24.8
12.8
____
Closing year three (94)(0.40)(3/3)
37.6
____
x
Bilberry
G
lo
Closing year two (15)(0.20)(2/3)
Increase
ba
l
Closing year one (18)(0.20)(1/3)
Increase
Bo
Opening
Increase
Closing year three (16)(0.20)(1/2)
AC
C
Opening
Increase
A
Beth
Closing (200)(10,000 – 1,100)(10)(1/2)
0.0
1.2
___
1.2
0.8
___
2.0
1.2
___
3.2
___
0.0
8.9
___
8.9
___
Jay
Opening
Increase
0
900
___
Closing (300)(500)(80%)(15)(1/2)
900
___
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Crow
Opening (400 – 100)(700)(18)(1/3)
Increase
1,260
1,540
_____
Closing (400 - 100)(700)(20)(2/3)
2,800
_____
CHAPTER 11
Answer: John
This must be a loan asset carried at amortised cost. The asset is an uncomplicated
loan and the intent is to keep the asset to maturity.
DF
80
80
80
8,080
PV
0.926
0.857
0.794
0.735
74
69
63
5,939
______
ba
l
1
2
3
4
CF
Bo
DCF
6,145
______
G
lo
FV on market
Opening
Finance
Received
6,145
6,557
7,001
7,482
492
525
560
598
(80)
(80)
(80)
(80)
AC
C
A
Accounting
1
2
3
4
x
The amount the company would be prepared to pay:
Closing
6,557
7,001
7,481
8,000
Answer: Travolta
This must be a loan asset carried at amortised cost. The asset is an uncomplicated
loan and the intent is to keep the asset to maturity.
Travolta would be prepared to pay the discounted present value of the future cash
inflow.
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Discounted cash flow
DCF
1
2
3
Discount factor
DF
CF
20
20
1,020
0.930
0.873
0.816
PV
18.69
17.46
832.32
______
Present value
869.00 (Also known as FV)
______
Accounting
Opening
Finance
Received
869
910
954
62
64
66
(20)
(20)
(20)
1
2
3
Closing
910
954
1,000
Bo
x
Strictly the asset starts at zero and closes out at zero when the nominal is repaid.
But this is usually left off the table.
Answer: Blip
Purchase journal
Dr
Investment
Cr
Cash (bank)
Financing (P&L)
Cr
Investment (SFP) (400 – 330)
AC
C
Dr
A
Year end journal
G
lo
ba
l
This financial asset is for speculating which is for trading. So it is a financial asset at
fair value with gains and losses to profit and loss.
400
400
70
70
Closure journals
Dr
Dr
Investment (SFP)
Cr
Finance (P&L)
Bank (SFP)
Cr
Investment
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40
370
370
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Answer: Bliny
This is a short-term investment and so asset held for trading. This is a financial asset
at fair value with gains and losses to profit and loss.
Purchase journal
Dr
Investment (debenture)
Cr
Bank
900
900
Year end journal
Dr
Financing (P&L)
Cr
Investment (SFP)
100
100
Closure journals
50
50
850
x
Dr
Investment
Cr
Financing
Bank
Cr
Investment
850
Bo
Dr
Answer: Bling
ba
l
This is a derivative therefore it is a financial asset at fair value with gains and losses
to profit and loss.
Dr
G
lo
Purchase journal
Derivative
Cr
Bank
Year end journal
A
Derivative
Cr
Finance (P&L)
100
10
10
AC
C
Dr
100
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Answer: Footy
The equity is held with the intention of holding forever. So this is a strategic equity
investment. Often these are called financial assets carried at fair value through other
comprehensive income or FVTOCI for short.
Purchase journal
Dr
Equity investment
Cr
Bank
780
780
Year end journal
Dr
Available for sale (SFP)
Cr
Equity investment (SFP)
70
70
x
It is unspoken in the IFRS, but it is clearly implied that if we plan to keep the asset
forever, then the loss is unrealized. So the loss goes into a separate equity bucket.
Bo
Answer: Special
ba
l
The asset is bought with the intention to keep forever hence this is a strategic equity
investment with gains and losses to reserves (even though later they change their
mind). So again this is classified strategic equity investment (FVTOCI), at least until
the directors’ intent regarding the equity changes, which we have assumed is just
before the actual sale.
Investment
Cr
Bank
Year end journal
Investment
Cr
Reserves (strategic equity reserve)
AC
C
Dr
A
Dr
G
lo
Purchase journal
500
500
40
40
Closure journals
Dr
Dr
Bank
Cr
Investment
Reserves (strategic equity reserve)
Cr
retained earnings (accumulated profits reserve)
540
540
40
40
Compare and contrast
Revaluation gain
Gain on strategic equity
Year of gain
Year of cash flow
Recognised (in OCI)
Recognised (in OCI)
transferred to RE
transferred to RE
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Answer: Gambit
(1)
Pawn
Gambit must use the last transaction price on the market at the year end just before
the year ends (level one input).
(2)
Knight
Gambit must use Pawn share price to estimate the Knight share price. The pawn
share price will almost certainly need adjusting to accommodate differences like the
sizes of the two entities and the number of shares (level two input).
(3)
Bishop
The purchase of bishop was a market transaction. So it is good data. The only
problem is that the data is six months old and so the purchase price must be adjusted
to reflect market movements since the transaction (level two input).
(4)
Queen
Answer: Bee
Bee plc would record the following:-
DR
Bank
CR
Equity
G
lo
A shares
100
100
CR
Liabilities
100
AC
C
Bank
A
B shares
DR
ba
l
Bo
x
There is nothing like Queen out there for Gambit to use as a guide. So Gambit is
forced to use financial modelling. Almost certainly a discounted cash flow using the
market research data would give the best available fair value (level three input).
100
Convertibles
DR
Bank
CR
Liabilities
CR
Equity (balance)
100
91
9
Answer: Bad
Bad ECL is measured as follows:-.
Within due date
$800m*1%
Overdue
$100m*5%
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Answer: Spot
Coffee
Cash Flow Hedging
Gold
Fair Value Hedging
Answer: Bescafe
Opening journal
Dr
Derivative
Cr
Bank
0
0
Year end journal
Dr
Derivative
Cr
Hedge reserve
30
30
Dr
Bo
Dr
Inventory
Cr
Bank
Bank
Cr
Derivative
Hedge reserve
Cr
Inventory
G
lo
Answer: Kent
Opening journal
Derivative
Cr
Bank
Year end journal
Hedge reserve
Cr
Derivative
AC
C
Dr
A
Dr
530
530
30
30
30
30
ba
l
Dr
x
Closure journals
0
0
10
10
Closure journals
Dr
Dr
Dr
Machine
Cr
Bank
Derivative
Cr
Bank
Machine
Cr
Hedge reserve
140
140
10
10
10
10
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Answer: Jewellery
Opening journal
Dr
Dr
Inventory
Cr
Bank
Derivative
Cr
Bank
100
100
0
0
Year end journal
Dr
Dr
Inventory
Cr
P/L
P/L
Cr
Derivative
9
9
9
9
Closing journal
Dr
x
WIP
Cr
Inventory
Derivative
Cr
Bank
3
3
3
3
112
112
12
12
AC
C
A
G
lo
Dr
Bo
Dr
Inventory
Cr
P/L
P/L
Cr
Derivative
ba
l
Dr
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CHAPTER 12
Formula Two
DT (1000-600)(30%)
120
___
Lost
CV
TB
0
100
Losses
DT
(100)
X 30%
___
(30)
___
x
Newly Incorporated
Bo
Opening
Increase
AC
C
Timing difference
Capital allowance
Depreciation
G
lo
TD
A
Temporary difference
Carrying value
Tax base
ba
l
Closing (1,200)(30%)
TD
TD
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360
___
360
___
7,200
(6,000)
_____
1,200
_____
2,000
(800)
_____
1,200
_____
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Hold
Deferred tax
Deferred tax is defined by an equation as follows:Deferred tax = temporary difference x corporation tax rate
Temporary difference
This is also defined by equation:Temporary difference = carrying value – tax base
Meaning
x
The carrying value is the asset value carried on the balance sheet by the financial
accountant and the tax base is the asset value carried in the tax pool by the tax
accountant. So the td represents the difference of opinion between two people
looking at the same asset from a different perspective.
Bo
Problem
ba
l
The problem is that the mathematical basis of dt does not stand up to conceptual
scrutiny by reference to the conceptual framework.
Conceptual framework
Future obligation
G
lo
The conceptual framework demands that for an asset/liability to be recognised it
must be a present right/obligation to a future economic inflow/outflow.
AC
C
Illustration
A
However, dt is a future obligation to a future economic outflow. As such it fails the
definition of a liability and should not be recognised at all.
The equity investment by Hold conveniently illustrates this. As the fd points out,
there is no obligation to the tax authorities at the year end. It is true that if Hold had
sold the asset at the year end then Hold would have a tax liability. But that is the
point; Hold has not sold the asset at the year end, so owes nothing.
Numbers
But regardless of this logical argument, Hold is required by IAS12 to recognise a dt
liability as follows:Dt = (110-70) x 30%
Dt = 12k
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Accentuate
Building
CV
TB
190
120
DT (IAS12)
TD
70
X 30%
___
21
___
Relative
Building
950
540
Bo
Proviso
410
X 30%
___
123
TB
TD
(60)
0
(60)
X 30%
___
(18)
___
CV
TB
TD
12
0
12
X 30%
___
AC
C
Development
A
Deviation
G
lo
DT
TD
CV
ba
l
Provision
DT
TB
x
DT (IAS12)
CV
3.6
___
Inventory
Inventory
DT (IAS12)
CV
TB
TD
55
50
5
X 30%
___
1.5
___
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Thailand
Sub
CV
TB
370
300
DT (IAS12)
TD
70
X 60%
___
42
___
Actually, IAS12 says that the above DT should not be provided unless there is intent
to distribute. This is entirely inconsistent with other DT where intent is ignored. This
is the kind of nonsense the IASB plans to sort out in their current development project
on DT.
Acky
SBP
=
(20)(10)(1/4) =
Carrying value for DT
=
(20)(8)(1/4) =
G
lo
SBP
CV
TB
TD
(40)
0
(40)
X 30%
___
(12)
___
AC
C
A
DT
50
__
40
__
ba
l
Actual carrying value
Bo
x
DT on goodwill is ignored because IAS12 says so.
Lost Again
Losses
DT
CV
TB
0
200
TD
(200)
X 30%
___
(60)
___
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CHAPTER 13
Answer: Value Relevance
(a)
IMPORTANT
FS are still important and I can prove it:
Proof 1 – Share price
The share price moves when FS results are announced. If nobody was listening
the share price wouldn’t move.
Proof 2 - Enron
A lot of people got very upset when Enron lied in its FS. If FS were not important
no-one would have got upset.
x
REDUCED
Bo
But on the other hand, it is true that FS importance has reduced over the years
due to the new alternatives.
Alternative 1 - Internet
ba
l
Probably the principle alternative to annual FS is the company website.
Alternative 2 – Analyst reports
G
lo
Also analysts issue reports on their assessment of strategy and performance.
Alternative 3 - Newspapers
Even newspapers have articles on businesses and finance and this forms an
alternative to the FS.
A
PERFORMANCE MEASURES
AC
C
The modern investments analysts tend to use models based on DCF (discounted
cash flow).
Example 1 – DVM (dividend valuation model)
The DVM discounts future dividend stream down to present value.
Example 2 – OVM (operating cash flow valuation models)
The OVM use discounting of estimated future operating cash flows.
Example 3 – EBITDA (Earnings
Depreciation and Amortisation)
before
Interest
and
Tax
and
But because operating cash flow can be volatile, some analysts like to substitute
EBITDA into their DCF models in place of operating cash flow.
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HISTORICAL INFORMATION
But of course, all the above does use past information from fs to estimate future
cash flows. For example, EBITDA is usually published on the p/l in the fs.
TRADITIONAL RATIOS
And of course, analysts still use gearing and ROCE, just as they did in the 20th
century.
(b)
EARNINGS 1
Manipulation
Any analysts who over-focus on profit will be easily fooled by creative
accounting.
EARNINGS 2
Single figure
Bo
x
Even if the earnings are faithful, it is still a single figure and cannot sum up the
company.
CHANGING 1
ba
l
Convergence
CHANGING 2
Transparent
G
lo
The world is increasingly adopting IFRS. This makes comparative analysis by
cross border investors much easier.
AC
C
A
Financial reporting is becoming increasingly transparent with clear presentation
and notes. This makes it easier for investors to make appropriate decisions
about where to put their money.
CHANGING 3
Fair values
Financial reporting is making increasing use of fair values, to make the position
statement more meaningful. FV is widely accepted as relevant information for
users making investment decisions.
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A P P E N D I X – S U G G E S T ED S O L U T I O N S T O Q U ES T I O N S A N D EX A M P L ES
CHANGING 4
Revenue
There is a new standard on revenue making the manipulation of sales more
difficult. So investors can trust fs and make better investment decisions.
CHANGING 5
Leases
The new standard on leases recognizes a liability for all leases. So investors
can rely upon the stated liabilities without the need for adjustment.
(c)
OBVIOUSLY
FVA (fair value accounting) and HCA (historical cost accounting) are mutually
exclusive. So obviously the more you use one, the less you use the other.
FAIR VALUE
Bo
x
This has come to mean market value. The standard on fair value measurement
(IFRS 13) defines fair value is the transaction price between market participants
at the measurement date.
ba
l
HISTORICAL COST
RELEVANCE
G
lo
This is the past cost paid at purchase. Various standards (IAS 2 and IAS 16)
define cost as the expenditure getting an asset into place in the business.
RELIABILITY
Investors are always
A
FVA is preferred because of its greater relevance.
interested in current market value.
AC
C
It is true that HCA has greater reliability, but reliability is probably less
important than relevance.
FAIR VALUE MEASUREMENT
And to address concerns regarding the reliability of FV the IASB has issued a
standard on FVM that has improved the reliability of FVM by standardising the
process of FVM into a hierarchy of three levels.
CONCLUSION
So financial reporting is moving towards FVA to improve the usefulness of FS.
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A P P E N D I X – S U G G E S T E D S O L U T I O N S T O Q U ES T IO N S A N D EX A M P L ES
(d)
Fair value
As discussed above, fair value is market value. It’s the price that market
players are using to transact at the measurement point. This idea is often
expressed in the phrase “exit price” and is entirely independent of the owners
intentions.
Brand
So the brand should be measured at fair value using the market price at
acquisition and the brand should be written down to zero when abandoned. So
both accountants are wrong to recommend a zero entry price for the brand.
FC
It is often difficult to know why someone does something. However, the
reference to value in use by the FC appears to indicate that the FC has made a
genuine mistake. The raises questions about his competence.
x
FD
AC
C
A
G
lo
ba
l
Bo
But it does appear that the FD understands the issue clearly and recognises
that the asset should enter at market price and then suffer an impairment. It
appears the FD is deliberately ignoring this error to avoid the reporting of the
loss. This raises questions about his integrity.
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AC
C
A
G
lo
ba
l
Bo
x
Class Notes
Questions
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CLASS NOTES QUESTIONS
1. Whitebirk
The principal aim when developing accounting standards for small to mediumsized entities (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. There is no universally agreed
definition of an SME and it is difficult for a single definition to capture all the
dimensions of a small or medium-sized business. The main argument for a
separate SME accounting standard is the undue cost burden of reporting, which
is proportionately heavier for smaller firms.
Required:
Bo
x
Comment on the different approaches which could have been taken
by the International Accounting Standards Board (IASB) in
developing the IFRS for Small and Medium-sized Entities (IFRS for
SMEs), explaining the approach finally taken by the IASB.
(5 marks)
ba
l
Discuss the main differences and modifications to IFRS which the
IASB made to reduce the burden of reporting for SMEs, giving
specific examples where possible and include in your discussion
how the Board has dealt with the problem of defining an SME.
(7 marks)
(2 marks)
A
G
lo
Discuss the main differences and modifications to IFRS which the
IASB made to reduce the burden of reporting for SMEs, giving
specific examples where possible and include in your discussion
how the Board has dealt with the problem of defining an SME.
AC
C
Professional marks will be awarded in part (a) for clarity and quality
of discussion.
180
(2 marks)
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CLASS NOTES QUESTIONS
Whitebirk has met the definition of a SME in its jurisdiction and wishes to comply
with the IFRS for Small and Medium-sized Entities. The entity wishes to seek
advice on how it will deal with the following accounting issues in its financial
statements for the year ended 30 November 2010 assuming that Whitebirk adopts
the IFRS for SMEs. The entity currently prepares its financial statements under full
IFRS.
(i) Whitebirk had capitalised borrowing costs of $100,000 onto the initial cost of a
building valued at $600,000 including those borrowing costs on 1 December
2008. The life of the building was estimated at 10 years.
x
(ii) Whitebirk purchased 90% of Close, an SME, on 1 December 2009. The purchase
consideration was $5·7 million and the value of Close’s identifiable assets was
$6 million. The value of the non-controlling interest at 1 December 2009 was
estimated at $0·7 million. Whitebirk has used the full goodwill method to
account for business combinations and the estimated life of goodwill cannot be
estimated with any accuracy. Whitebirk wishes to know how to account for
goodwill under the IFRS for SMEs.
Bo
(iii) Whitebirk has incurred $1 million of research expenditure to develop a new
product in the year to 30 November 2010. Additionally, it incurred $500,000 of
development expenditure to bring another product to a stage where it is ready
to be marketed and sold.
ba
l
Required:
G
lo
Discuss how the above transactions should be dealt with in the
financial statements of Whitebirk, under the IFRS for Small and
Medium-sized Entities.
(9 marks)
AC
C
A
Note: the marks are allocated equally between the three parts in
requirement (b) above.
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CLASS NOTES QUESTIONS
2. Warrburt
The following draft group financial statement relates to Warrburt, a listed public
limited company:
Warrburt Group: Statement of cash flows for the year ended at 30
November 2008
Loss before tax
(21)
Associate
(8)
Finance
9
Operating Loss
(20)
Inventory
63
Receivables
71
Payables
(86)
36
Disposal
(7)
x
Depreciation
Bo
GW Impairment & intangible impairment
Pension expense
Insurance gain
Forex loss
Interest paid
Tax paid
Investing
A
Operating cashflow
G
lo
Cash generated from operations
ba
l
Strategic equity profit on disposal
AC
C
Pension Investment
Associate Dividend
Associate Acquisition
Strategic Equity Disposal
32
10
(7)
(2)
2
92
(8)
(39)
45
(10)
2
(96)
45
PPE Additions
(57)
PPE Disposals
63
Financing
Share Issue
55
Loan Repaid
(44)
Dividends
(9)
NCI Dividends
(5)
Cashflow
(11)
Opening
323
Closing
312
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CLASS NOTES QUESTIONS
Directors’ concerns
Warrburt’s directors are concerned about the results for the year in the statement
of comprehensive income and the subsequent effect on the cash flow statement.
They have suggested that the proceeds of the sale of property, plant and
equipment (“PPE disposal” above) and the sale of financial assets (“Strategic
equity disposal” above) should be included in ‘cash generated from operations’.
The directors are afraid of an adverse market reaction to their results and of the
importance of meeting targets in order to ensure job security, and feel that the
adjustments for the proceeds would enhance the ‘cash health’ of the business. The
company accountant is responsible for the preparation of group financial
statements and is newly appointed to his role.
Required:
Discuss the key issues which the statement of cash flows
highlights regarding the cash flow of the company.
(10 marks)
Bo
x
Discuss the ethical responsibility of the company accountant in
ensuring that manipulation of the statement of cash flows, such
as that suggested by the directors, does not occur.
(7 marks)
(25 marks)
AC
C
A
G
lo
ba
l
Discuss the current issues with IAS 7 Statement of Cash Flows
identifying problems in current presentation and classification
guidance and briefly describe the proposed amendments to IAS 7 set
out in the recent Exposure Draft.
(8 marks)
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CLASS NOTES QUESTIONS
3. Bravado
Bravado, a public limited company, has acquired two subsidiaries and an associate.
The draft statements of financial position are as follows at 31 May 2009:
Assets:
Bravado
Message
Mixted
$m
$m
$m
265
230
161
Non-current assets
Property, plant and equipment
Investments in subsidiaries
Message
300
Mixted
128
20
Financial assets
51
6
5
764
236
166
Current assets:
135
55
73
91
45
32
102
100
8
328
200
113
1,092
436
279
520
220
100
240
150
80
12
4
7
772
374
187
120
15
5
25
9
3
145
24
8
115
30
60
60
8
24
Total current liabilities
175
38
84
Total liabilities
320
62
92
1,092
436
279
Bo
Inventories
x
Investment in associate – Clarity
Trade receivables
ba
l
Cash and cash equivalents
G
lo
Total assets
Equity and liabilities:
Share capital
Retained earnings
AC
C
Total equity
A
Other components of equity
Non-current liabilities:
Long-term borrowings
Deferred tax
Total non-current liabilities
Current liabilities
Trade and other payables
Current tax payable
Total equity and liabilities
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CLASS NOTES QUESTIONS
The following information is relevant to the preparation of the group financial
statements:
1. On 1 June 2008 at the current year start, Bravado acquired 80% of the equity
interests of Message, a private entity. The purchase consideration comprised
cash of $300 million. The fair value of the identifiable net assets of Message
was $400 million. The owners of Message had to dispose of their 80% stake
in Message for tax purposes by a specified date and, therefore, sold the entity
to the first company to bid for it, which was Bravado. An independent valuer
has stated that the fair value of the non-controlling interest in Message was
$86 million on 1 June 2008 at the current year start. Bravado measures noncontrolling interest at fair value (full goodwill).
Holding
Bo
x
2. On 1 June 2007 at the start of the previous accounting period, Bravado
acquired 6% of the ordinary shares of Mixted. Bravado had treated this
investment as fair value through other comprehensive income (FVTOCI) in the
financial statements to 31 May 2008 but had restated the investment at cost
on Mixted becoming a subsidiary. On 1 June 2008, Bravado acquired a further
64% of the ordinary shares of Mixted and gained control of the company. The
consideration for the acquisitions was as follows:
Consideration
1 June 2007
6%
10
64%
118
G
lo
1 June 2008
ba
l
$m
70%
128
AC
C
A
Under the purchase agreement of 1 June 2008 at the current year start,
Bravado is required to pay the former shareholders 30% of the profits of
Mixted for each of the financial years to 31 May 2009 and 31 May 2010. The
fair value of this arrangement was estimated at $12 million at 1 June 2008
and at 31 May 2009 this value had not changed. This amount has not been
included in the financial statements.
At 1 June 2008, the fair value of the equity interest in Mixted held by Bravado
before the business combination was $15 million and the fair value of the
non-controlling interest in Mixted was $53 million. The fair value of the
identifiable net assets at 1 June 2008 of Mixted was $173 million. There is
no impairment of goodwill arising on the acquisitions.
3. Bravado acquired a 10% interest in Clarity, a public limited company, on 1
June 2007 at the previous year start for $8 million. The investment was
accounted for as fair value through other comprehensive incomem (FVTOCI)
and at 31 May 2008, its value was $9 million. Last year’s gain was reported
through other comprehensive income (OCI) and remains in other components
of equity (OCE). On 1 June 2008 at the current year start, Bravado acquired
an additional 15% interest in Clarity for $11 million and achieved significant
influence. Clarity made profits after dividends of $6 million and $10 million for
the years to 31 May 2008 and 31 May 2009.
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CLASS NOTES QUESTIONS
4. Bravado manufactures equipment for the retail industry. The inventory is
currently valued at cost. There is a market for the part completed product at
each stage of production. The cost structure of the equipment is as follows:
Cost per unit $
Selling price per unit $
1,000
1,050
Production process – 1st stage
Conversion costs – 2nd stage
500
Finished product
1,500
1,700
x
The selling costs are $10 per unit and Bravado has 100,000 units at the first
stage of production and 200,000 units of the finished product at the current
year end of 31 May 2009. Shortly before the year end, a competitor released
a new model onto the market which caused the equipment manufactured by
Bravado to become less attractive to customers. The result was a reduction
in the selling price to $1,450 of the finished product and $950 for 1st stage
product.
Bo
On 1 June 2007 at the previous year start, Bravado purchased an equity
instrument of 11 million dinars which was its fair value. The instrument was
classified as fair value through other comprehensive income (FVTOCI). The
relevant exchange rates and fair values were as follows:
Fair value of instrument dinars
5.1
10
4.8
7
ba
l
$ to dinars
31 May 2008
G
lo
31 May 2009
AC
C
Required:
A
Bravado has not recorded any change in the value of the instrument since
31 May 2008 at the previous year end.
(i)
Calculate the goodwill for the acquisitions of Message and
Mixted and explain the accounting treatment of the goodwill.
(10 marks)
(ii)
Calculate and explain the carrying value of the associate
Clarity at the current year end.
(5 marks)
(iii) Discuss with suitable workings how the inventory and equity
instrument should be valued at the current year end.(7 marks)
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CLASS NOTES QUESTIONS
The acquisition of the two subsidiaries Message and Mixted at the current year
start were the first two subsidiary acquisitions by the parent Bravado. The
parent Bravado has adopted a policy of measurement of non-controlling
interest at fair value (full goodwill) as discussed above. But the parent is
interested in the alternative policy to value non-controlling interest at the
proportionate share of net assets (partial goodwill).
Required:
Calculate and explain the impact on the calculation of goodwill if the
non-controlling interest was calculated on a proportionate basis for
Message and Mixted.
(8 marks)
AC
C
A
G
lo
ba
l
Bo
x
(30 marks)
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CLASS NOTES QUESTIONS
4.
Aron
The directors of Aron, a public limited company, are worried about the challenging
market conditions which the company is facing. The majority of markets are
volatile and some markets are illiquid. The central government is injecting
liquidity into the economy. The directors are concerned about the significant shift
towards the use of fair values in financial statements. IFRS9 ‘Financial
Instruments’ refers to fair value and requires the initial measurement of financial
instruments to be at fair value. The directors are uncertain of the relevance of fair
value measurements in these current market conditions.
Required:
(a)
Briefly discuss how the fair value of financial instruments is
determined, commenting on the relevance of fair value
measurements for financial instruments where markets are volatile
and illiquid.
x
(4 marks)
Bo
Further they would like advice on accounting for the following transactions
within the financial statements for the year ended 31 May 2009:
(i) Aron issued one million convertible bonds on 1 June 2006. The bonds had
AC
C
A
G
lo
ba
l
a term of three years and were issued with a total fair value of $100
million which is also the par value. Interest is paid annually in arrears at
a rate of 6% per annum and bonds, without the conversion option,
attracted an interest rate of 9% per annum on 1 June 2006. The company
incurred issue costs of $1 million. The impact of the issue costs is to
increase the effective interest rate to 9·38%. If the investor did not
convert to shares they would have been redeemed at par. At maturity all
of the bonds were converted into 25 million ordinary shares of $1 of Aron.
No bonds could be converted before that date. The directors are uncertain
how the bonds should have been accounted for up to the date of the
conversion on 31 May 2009.
(6 marks)
(ii) Aron held 3% holding of the shares in Smart, a public limited company.
The investment was held with an intent to keep and so classified as fair
value through other comprehensive income (FVTOCI) and at 31 May 2009
was fair valued at $5 million. The cumulative gain recognised in equity
relating to the investment was $400,000. On the same day, the whole of
the share capital of Smart was acquired by Given, a public limited
company, and as a result, Aron received shares in Given with a fair value
of $5·5 million in exchange for its holding in Smart. The company wishes
to know how the exchange of shares in Smart for the shares in Given
should be accounted for in its financial records.
(4 marks)
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CLASS NOTES QUESTIONS
(iii) The functional and presentation currency of Aron is the dollar ($). Aron has
a wholly owned foreign subsidiary, Gao, whose functional currency is the
zloti. Gao owns a debt instrument which is held for trading. In Gao’s financial
statements for the year ended 31 May 2008, the debt instrument was carried
at its fair value of 10 million zloti. At 31 May 2009, the fair value of the debt
instrument had increased to 12 million zloti. The exchange rates were:
Zloti to $1
31 May 2008
3
31 May 2009
2
Average rate for year to 31 May 2009
2.5
(5 marks)
Required:
ba
l
Bo
Aron granted interest free loans to its employees on 1 June 2008 of $10
million. The loans will be paid back on 31 May 2010 as a single payment by
the employees. The market rate of interest for a two-year loan on both of
the above dates is 6% per annum. The company is unsure how to account
for the loan but wishes to classify the loans as amortised cost.
(4 marks)
G
lo
(iv)
x
The company wishes to know how to account for this instrument in Gao’s
entity financial statements and the consolidated financial statements of
the group.
Discuss, with relevant computations, how the above financial
instruments should be accounted for in the financial statements for
the year ended 31 May 2009.
AC
C
A
Note. The mark allocation is shown against each of the transactions
above.
Professional marks will be awarded for clarity and quality of
discussion.
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(2 marks)
(25 marks)
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CLASS NOTES QUESTIONS
5. Grange
Grange, a public listed limited company, operates in the manufacturing sector.
The draft statements of financial position of the group companies are as follows
at 30 November 2009:
Grange
Park
Fence
$m
$m
$m
257
311
238
Assets:
Non-current assets
Property, plant and equipment
Park
340
Fence
134
16
Bo
Investment in Sitin
x
Investments in subsidiaries
747
311
238
475
304
141
1,222
615
379
430
230
150
410
170
65
22
14
17
862
414
232
172
124
38
178
71
105
10
6
4
Total current liabilities
188
77
109
Total liabilities
360
201
147
1,222
615
379
Total assets
G
lo
Equity and liabilities:
Share capital
Retained earnings
AC
C
A
Other components of equity
Total equity
ba
l
Current assets
Non-current liabilities
Current liabilities
Trade and other payables
Provisions for liabilities
Total equity and liabilities
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CLASS NOTES QUESTIONS
The following information is relevant to the preparation of the group financial
statements:
1. On 1 June 2008 half way through the previous year, Grange acquired 60% of
the equity interests of Park, a public limited company. The purchase
consideration comprised cash of $250 million. Excluding the franchise referred
to below, the fair value of the identifiable net assets was $360 million. The
excess of the fair value of the net assets is due to an increase in the value of
non-depreciable land.
Park held a franchise right, which at 1 June 2008 had a fair value of $10
million. This had not been recognised in the financial statements of Park. The
franchise agreement had a remaining term of five years to run at that date
and is not renewable. Park still holds this franchise at the year-end.
x
Grange wishes to use the ‘full goodwill’ method for all acquisitions. The fair
value of the non-controlling interest in Park was $150 million on 1 June 2008.
The retained earnings of Park were $115 million and other components of
equity were $10 million at the date of acquisition.
Bo
Grange acquired a further 20% interest from the non-controlling interests in
Park on 30 November 2009 for a cash consideration of $90 million.
G
lo
ba
l
2. On 1 December 2008 at the current year start, Grange acquired a 100% of
the equity interests of Fence for a cash consideration of $214 million. The
identifiable net assets of Fence had a provisional fair value of $202 million,
including any contingent liabilities but excluding the plant described below. At
the time of the business combination, Fence had a contingent liability with a
fair value of $30 million. At 30 November 2009, the contingent liability met
the recognition criteria of IAS 37 Provisions, Contingent Liabilities and
Contingent Assets and the revised estimate of this liability was $25 million.
The accounting of Fence is yet to account for this liability.
AC
C
A
An item of plant included in property plant and equipment was excluded from
the provisional value of net assets above until a detailed assessment was
possible. Following the detailed assessment it was estimated that the excess
of the fair value over book value at the date of acquisition was $4 million. The
plant had a remaining life of 4 years from acquisition.
The retained earnings of Fence were $73 million and other components of
equity were $9 million at 1 December 2008 before any adjustment for the
contingent liability.
On 30 November 2009, Grange disposed of 25% of its equity interest in Fence
to the non-controlling interest for a consideration of $80 million. The disposal
proceeds had been credited to the cost of the investment in the statement of
financial position.
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CLASS NOTES QUESTIONS
3. On 30 June 2008, Grange had acquired a 100% interest in Sitin, a public
limited company, for a cash consideration of $39 million. Sitin’s identifiable
net assets were fair valued at $32 million.
On 30 November 2009, Grange disposed of 60% of the equity of Sitin when
its identifiable net assets were $36 million. The sale proceeds were $23 million
and the remaining equity interest was fair valued at $13 million. Grange could
still exert significant influence after the disposal of the interest. The only
accounting entry made in Grange’s financial statements was to increase cash
and reduce the cost of the investment in Sitin.
Required:
Calculate the goodwill on the acquisitions of Park and Fence.
(4 marks)
Bo
x
Show the effect of the purchase of the further 20% of Park and
the sale of the 25% of Fence upon the group equity. (12 marks)
Calculate the gain or loss arising on the disposal of the equity
interest in Sitin.
(4 marks)
G
lo
ba
l
Grange acquired a plot of land on 1 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.
AC
C
A
Grange has a property located in a foreign country, which was acquired at a
cost of 8 million dinars on 30 November 2008 when the exchange rate was
$1 = 2 dinars. At 30 November 2009, the property was revalued to 12 million
dinars. The exchange rate at 30 November 2009 was $1 = 1.5 dinars. The
property was being carried at its value as at 30 November 2008. The
company policy is to revalue property, plant and equipment whenever
material differences exist between book and fair value. Depreciation on the
property can be assumed to be immaterial.
Grange anticipates that it will be fined $1 million by the local regulator for
environmental pollution. It also anticipates that it will have to pay
compensation to local residents of $6 million although this is only the best
estimate of that liability. In addition, the regulator has requested that certain
changes be made to the manufacturing process in order to make the process
more environmentally friendly. This is anticipated to cost the company $4
million. Requests of this nature are routinely ignored by manufacturers.
Grange has no policy regarding environmental responsibility.
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CLASS NOTES QUESTIONS
Required:
Explain with suitable computations how the land and foreign
property should have been recorded in the group financial
statements.
(8 marks)
Briefly explain how the fine should have been recorded in the
group financial statements.
(2 marks)
AC
C
A
G
lo
ba
l
Bo
x
(30 marks)
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CLASS NOTES QUESTIONS
6. Cate
Cate is an entity in the software industry. The year-end is 31 May 2010.
x
Cate had incurred substantial losses in the five previous financial years from
31 May 2004 to 31 May 2009. In the current financial year to 31 May 2010
Cate made a small profit before tax. This included significant non-operating
gains. In 2009, Cate recognised a material deferred tax asset in respect of
carried forward losses, which will expire during 2012. Cate again recognised
the deferred tax asset in 2010 on the basis of anticipated performance in the
years from 2010 to 2012, based on budgets prepared in 2010. The budgets
included high growth rates in profitability. Cate argued that the budgets were
realistic as there were positive indications from customers about future
orders. Cate also had plans to expand sales to new markets and to sell new
products whose development would be completed soon. Cate was taking
measures to increase sales, implementing new programs to improve both
productivity and profitability. Deferred tax assets represent 25% of
shareholders’ equity at 31 May 2010.
G
lo
ba
l
Bo
At the current year end of 31 May 2010 Cate held an investment in and had
a significant influence over Bates, a public limited company. Cate had carried
out an impairment test in respect of its investment in accordance with the
procedures prescribed in IAS 36, Impairment of assets. Cate argued that fair
value was the only measure applicable in this case as value-in-use was not
determinable as cash flow forecasts had not been produced. Cate also stated
that the quoted share price was not an appropriate measure when considering
the fair value of Cate’s significant influence on Bates. Therefore, Cate
estimated the fair value of its interest in Bates through application of two
measurement techniques; one based on earnings multiples and the other
based on an option–pricing model. Neither of these methods supported the
existence of an impairment loss as of 31 May 2010.
AC
C
A
In the current financial year to 31 May 2010, Cate disclosed the existence of
a voluntary fund established in order to provide a post-retirement benefit plan
to employees. Cate considers its contributions to the Plan to be voluntary, and
has not recorded any related liability in its consolidated financial statements.
Cate has a history of paying benefits to its former employees, even increasing
them to keep pace with inflation since the commencement of the Plan. The
main characteristics of the Plan are as follows:
The Plan is totally funded by Cate;
The contributions for the Plan are made periodically;
The post retirement benefit is calculated based on a percentage of the
final salaries of Plan participants dependent on the years of service;
The annual contributions to the Plan are determined as a function of the
fair value of the assets less the liability arising from past services.
Cate argues that it should not have to recognise the Plan because, according
to the underlying contract, it can terminate its contributions to the Plan, if
and when it wishes. The termination clauses of the contract establish that
Cate must immediately purchase lifetime annuities from an insurance
company for all the affected employees.
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CLASS NOTES QUESTIONS
Required:
Discuss the ethical and accounting implications of the above under
International Financial Reporting Standards.
(18 marks)
Note: The marks are allocated equally between (a) and (b) and (c).
Professional marks will be awarded in this question for clarity and
quality of discussion.
(2 marks)
AC
C
A
G
lo
ba
l
Bo
x
(20 marks)
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CLASS NOTES QUESTIONS
7. Jocatt
The following draft group financial statements relate to Jocatt, a public limited
company:
Jocatt Group: Statement of financial position as at 30 November
2010
2009
$m
$m
327
254
8
6
Goodwill
48
68
Intangible assets
85
72
Investment in associate
54
–
Financial assets
94
90
616
490
105
128
62
113
232
143
399
384
1,015
874
290
275
351
324
15
20
656
619
55
36
711
655
Long-term borrowings
67
71
Deferred tax
35
41
Pension liability
25
22
144
55
33
30
1,015
874
Assets
Non-current assets
Property, plant and equipment
Bo
x
Investment property
Current assets
ba
l
Inventories
Trade receivables
G
lo
Cash and cash equivalents
Total assets
Equity and Liabilities
AC
C
Share capital
A
Equity attributable to the owners of the
parent
Retained earnings
Other components of equity
Non-controlling interest
Total equity
Non-current liabilities
Current liabilities:
Trade payables
Current tax payable
Total equity and liabilities
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CLASS NOTES QUESTIONS
Jocatt Group: Statement of profit or loss and other comprehensive
income for the year ended 30 November 2010
Profit or loss
$m
Revenue
432
Cost of sales
(317)
Gross profit
115
Other income
36
Distribution costs
(56)
Administrative expenses
(36)
Finance costs paid
(6)
Share of profit of associate
6
Bo
x
Profit before tax
Income tax expense
Profit for the year
59
(11)
48
Gain on financial assets
G
lo
Losses on property revaluation
ba
l
Other comprehensive income after tax:
Actuarial losses on defined benefit plan
A
Other comprehensive income for the year, net of tax
AC
C
Total comprehensive income for the year
3
(7)
(6)
(10)
38
Profit attributable to:
Owners of the parent
38
Non-controlling interest
10
48
Total comprehensive income attributable to
Owners of the parent
28
Non-controlling interest
10
38
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CLASS NOTES QUESTIONS
The following information relates to the financial statements of Jocatt:
1. On 1 December 2008, Jocatt acquired 8% of the ordinary shares of Tigret.
Jocatt had carried this investment at cost in the financial statements to 30
November 2009 and therefore included the cost in financial assets. On 1
December 2009, Jocatt acquired a further 52% of the ordinary shares of Tigret
and gained control of the company. At this point Jocatt derecognised the cost
of the 8% of Tigret from financial assets at cost in order to recognise a profit
on deemed disposal of the previous 8% which has been included in
administration expenses. The consideration for the acquisitions was as
follows:
Holding Consideration
$m
8%
4
1 December 2009
52%
30
x
1 December 2008
34
Bo
60%
G
lo
ba
l
At 1 December 2009, the fair value of the 8% holding in Tigret held by Jocatt
at the time of the business combination was $5 million and the fair value of
the non-controlling interest in Tigret was $20 million. The gain on the 8%
holding in Tigret has been reported in the administration expenses at 1
December 2009. The purchase consideration at 1 December 2009 comprised
cash of $15 million and shares of $15 million.
The fair value of the identifiable net assets of Tigret, excluding deferred tax
assets and liabilities, at the date of acquisition comprised the following:
$m
15
Intangible assets
18
AC
C
A
Property, plant and equipment
Inventory
8
Trade receivables
5
Cash
7
Trade payables
8
The tax base of the identifiable net assets of Tigret was $40 million at 1
December 2009. The tax rate of Tigret is 30%.
2. Jocatt purchased a project from a third party including certain patents on 1
December 2009 for $8 million and recognised it as an intangible asset. During
the year, Jocatt incurred further costs, which included $2 million on
completing the research phase, $4 million in developing the product for sale
and $1 million for the initial marketing costs. There were no other additions
to intangible assets in the period other than those on the acquisition of Tigret.
Jocatt had correctly accounted for the above expenses, capitalising and writing
off as appropriate. There was an impairment on intangibles.
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CLASS NOTES QUESTIONS
3. Jocatt operates a defined benefit scheme. The current service costs for the
year ended 30 November 2010 are $10 million. Jocatt enhanced the benefits
on 1 December 2009. The total cost of the enhancement is a past service cost
of $2 million. The finance cost on the net opening liability was $2 million for
the year. Both the service costs and the finance cost have been included in
cost of sales. Jocatt has the policy of presenting pension contributions in
operating cash flow.
4. Jocatt had exchanged surplus land with a carrying value of $10 million for
cash of $15 million and plant valued at $4 million. The transaction has
commercial substance. The gain on the disposal has been included in other
income on the face of the profit or loss. Depreciation for the period for
property, plant and equipment was $27 million. Jocatt owns an investment
property. There was a gain on investment property value during the year and
this has been included in other income on the face of the profit or loss.
x
5. Goodwill relating to all subsidiaries had been impairment tested in the year to
30 November 2010 and any impairment accounted for. The goodwill
impairment related to those subsidiaries which were 100% owned.
ba
l
Bo
6. The financial assets are equity investments classified as fair value through
other comprehensive income. Deferred tax of $1 million arose on the gains on
these financial asset investments in the year. The gain on financial assets in
other comprehensive income is shown net of this deferred tax charge.
Required:
AC
C
A
G
lo
Prepare a reconciliation of profit before tax with cash generated
from operations for presentation within a consolidated statement of
cash flows for the Jocatt Group using the indirect method under IAS
7 ‘Statement of Cash Flows’.
(15 marks)
Calculate the tax paid by Jocatt during the year ended 30
November 2010.
(4 marks)
Calculate the cash flow purchases of property plant and
equipment by Jocatt during the year ended 30 November 2010.
(4 marks)
The directors of Jocatt feel that the indirect method is more useful and
informative to users of financial statements than the direct method.
Required:
Comment on the directors’ view that the indirect method of
preparing statements of cash flow is more useful and informative to
users than the direct method.
(7 marks)
(30 marks)
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CLASS NOTES QUESTIONS
8. Alexandra
Alexandra, a public listed limited company, designs and manages business
solutions and IT infrastructures. The current financial year end was 30 April 2011.
In November 2010, Alexandra defaulted on an interest payment on an issued
bond loan of $100 million repayable in fifteen years. The loan agreement
stipulates that such default leads to an obligation to repay the whole of the
loan immediately, including accrued interest and expenses. In January 2011
the bondholders issued a waiver postponing the interest payment until 31
May 2011. The waiver also postponed the obligation to pay the capital until
31 May 2011. In May 2011, Alexandra paid the interest due and the
bondholders reinstated the Alexandra rights to repay the capital in fifteen
years. Alexandra classified the loan as long-term debt in its statement of
financial position at 30 April 2011 on the basis that the loan was not in default
at the end of the reporting period as the bondholders had issued waivers and
had not sought redemption.
Bo
x
Alexandra has a two-tier board structure consisting of a management and a
supervisory board. Alexandra remunerates its board members as follows:
− Annual base salary
− Variable annual compensation (bonus)
ba
l
− Share options
G
lo
In the group financial statements, within the related parties note under IAS
24 Related Party Disclosures, Alexandra disclosed the total remuneration
paid to directors and non-executive directors and a total for each of these
boards. No further breakdown of the remuneration was provided.
AC
C
A
The management board comprises both the executive and non-executive
directors. The remuneration of the non-executive directors, however, was
not included in the key management disclosures. Some members of the
supervisory and management boards are of a particular nationality.
Alexandra was of the opinion that in that jurisdiction, it is not acceptable to
provide information about remuneration that could be traced back to
individuals. Consequently, Alexandra explained that it had provided the
related party information in the annual accounts in an ambiguous way to
prevent users of the financial statements from tracing remuneration
information back to specific individuals.
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CLASS NOTES QUESTIONS
Alexandra’s pension plan was accounted for as a defined benefit plan in 2010.
In the year ended 30 April 2011, Alexandra changed the accounting method
used for the scheme and accounted for it as a defined contribution plan,
restating the comparative 2010 financial information. The effect of the
restatement was significant. In the 2011 financial statements, Alexandra
explained that, during the year, the arrangements underlying the retirement
benefit plan had been subject to detailed review. Since the pension liabilities
are fully insured and indexation of future liabilities can be limited up to and
including the funds available in a special trust account set up for the plan,
which is not at the disposal of Alexandra, the plan qualifies as a defined
contribution plan under IAS 19 Employee Benefits rather than a defined
benefit plan. If an employee leaves Alexandra and transfers the pension to
another fund, Alexandra is liable for, or is refunded the difference between
the benefits the employee is entitled to and the insurance premiums paid.
Required:
Bo
x
Discuss how the above transactions should be dealt with in the
financial statements of Alexandra for the year ended 30 April 2011
and discuss the ethical implications of the above situations.
(18 marks)
ba
l
Note: The marks are allocated equally between (a) and (b) and (c)
(2 marks)
(20 marks)
AC
C
A
G
lo
Professional marks will be awarded for clarity and quality of
discussion.
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CLASS NOTES QUESTIONS
9. Jayach
The International Accounting Standards Board has completed a joint project
with the Financial Accounting Standards Board (FASB) on fair value
measurement by issuing IFRS 13 Fair Value Measurement. IFRS 13 defines
fair value, establishes a framework for measuring fair value and requires
significant disclosures relating to fair value measurement.
The IASB wanted to enhance the guidance available for assessing fair value
in order that users could better gauge the valuation techniques and inputs
used to measure fair value. There are no new requirements as to when fair
value accounting is required, but the IFRS gives guidance regarding fair value
measurements in existing standards. Fair value measurements are
categorised into a three-level hierarchy, based on the type of inputs to the
valuation techniques used. However, the guidance in IFRS 13 does not apply
to transactions dealt with by certain specific standards.
Required:
Bo
x
Discuss the main principles of fair value measurement as set out in
IFRS 13.
(7 marks)
ba
l
Describe the three-level hierarchy for fair value measurements
used in IFRS 13.
(6 marks)
Jayach, a public limited company, is reviewing the fair valuation of certain
assets and liabilities in light of IFRS 13.
AC
C
Market data
A
G
lo
It carries an asset that is traded in different markets and is uncertain as to
which valuation to use. The asset has to be valued at fair value under
International Financial Reporting Standards. Jayach currently only buys and
sells the asset in the Australasian market. The data relating to the asset are
set out below:
Year to 30 November 2012
Asian
European
Australasian
Market
Market
Market
4 million
2 million
1 million
$19
$16
$22
Costs of entering the market
$2
$2
$3
Transaction costs
$1
$2
$2
Volume of market – units
Price
Additionally, Jayach had acquired an entity on 30 November 2012 and is
required to fair value a decommissioning liability. The entity has to
decommission a mine at the end of its useful life, which is in three years’ time.
Jayach has determined that it will use a valuation technique to measure the
fair value of the liability.
If Jayach were allowed to transfer the liability to another market participant,
then the following data would be used.
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CLASS NOTES QUESTIONS
Input amount
Labour and material cost
$2 million
Overhead
30% of labour and material
cost
Third party mark-up – industry average
20%
Annual inflation rate
5%
Risk adjusted discount rate appropriate to
Jayach
6%
Jayach needs advice on how to fair value the asset and liability.
Required:
(10 marks)
Bo
x
Discuss, with relevant computations, how Jayach should fair value the
above asset and liability under IFRS 13.
Note: the mark allocation is equal between the asset and the liability.
(2 marks)
(25 marks)
AC
C
A
G
lo
ba
l
Professional marks will be awarded for the clarity and quality of the
presentation and discussion.
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CLASS NOTES QUESTIONS
10. Rose
Rose, a public listed company, operates in the mining sector. Rose group has a
year end of 30 April 2011. Rose acquired 52% of the ordinary shares of Stem on
1 May 2010. Stem is located in a foreign country and operates a mine. The income
of Stem is denominated and settled in dinars. The output of the mine is routinely
traded in dinars and its price is determined initially by local supply and demand.
Stem pays 40% of its costs and expenses in dollars with the remainder being
incurred locally and settled in dinars. Stem’s management has a considerable
degree of authority and autonomy in carrying out the operations of Stem and is
not dependent upon group companies for finance. Rose wishes to use the ‘full
goodwill’ method to consolidate the financial statements of Stem. There have
been no issues of ordinary shares and no impairment of goodwill since acquisition.
Required:
Bo
x
Discuss and apply the principles set out in IAS 21 The Effects of
Changes in Foreign Exchange Rates in order to determine the
functional currency of Stem.
(5 marks)
The draft statements of financial position are as follows, at 30 April 2011:
Petal
Stem
$m
$m
Dinars m
370
110
380
15
7
50
544
117
430
Current assets
118
100
330
Total assets
662
217
760
Share capital
158
38
200
Retained earnings
256
56
300
7
4
–
421
98
500
56
42
160
Current liabilities
185
77
100
Total liabilities
241
119
260
Total equity and liabilities
662
217
760
ba
l
Rose
Non-current assets
G
lo
Assets:
Property, plant and equipment
Petal
AC
C
Stem
A
Investments in subsidiaries
Financial assets
113
46
Equity and liabilities
Other components of equity
Total equity
Non-current liabilities
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CLASS NOTES QUESTIONS
The following information is relevant to the preparation of the group financial
statements:
On 1 May 2010, Rose acquired 70% of the equity interests of Petal, a public
limited company. The purchase consideration comprised cash of $94 million.
The fair value of the identifiable net assets recognised by Petal was $120
million excluding the patent below. The identifiable net assets of Petal at 1
May 2010 included a patent which had a fair value of $4 million. This had not
been recognised in the financial statements of Petal. The patent had a
remaining term of four years to run at that date and is not renewable. The
retained earnings of Petal were $49 million and other components of equity
were $3 million at the date of acquisition. The remaining excess of the fair
value of the net assets is due to an increase in the value of land.
x
Rose wishes to use the ‘full goodwill’ method. The fair value of the noncontrolling interest in Petal was $46 million on 1 May 2010. There have been
no issues of ordinary shares since acquisition and goodwill on acquisition is
not impaired. Rose acquired a further 10% interest from the non-controlling
interest in Petal on 30 April 2011 for a cash consideration of $19 million.
1 May 2010
A
30 April 2011
G
lo
ba
l
Bo
Rose acquired 52% of the ordinary shares of Stem on 1 May 2010 when
Stem’s retained earnings were 220 million dinars. The fair value of the
identifiable net assets of Stem on 1 May 2010 was 495 million dinars. The
excess of the fair value over the net assets of Stem is due to an increase in
the value of land. The fair value of the non-controlling interest in Stem at 1
May 2010 was 250 million dinars. The following exchange rates are relevant
to the preparation of the group financial statements:
6
5
5·8
AC
C
Average for year to 30 April 2011
Dinars to $
Required:
Calculate the Petal goodwill and explain the effect of the purchase
of the further 10% interest in Petal.
(6 marks)
Calculate the Stem goodwill and show how this would be
presented to parent shareholders in the Rose group statement of
financial position at the year end of 30 April 2011.
(4 marks)
Calculate the group foreign subsidiary exchange gain or loss for
the year and show how this would be split between the parent and
non-controlling interest on the group statement of financial
position at the year end of 30 April 2011.
(7 marks)
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CLASS NOTES QUESTIONS
Rose has a property located in the same country as Stem. The property was
acquired on 1 May 2010 and is carried at a cost of 30 million dinars. The
property is depreciated over 20 years on the straight-line method. At 30 April
2011, the property was revalued to 35 million dinars. Depreciation has been
charged for the year but the revaluation has not been taken into account in
the preparation of the financial statements as at 30 April 2011. Rose has the
policy of revaluation of property.
Rose purchased plant for $20 million on 1 May 2007 with an estimated useful
life of six years. Its estimated residual value at that date was $1.4 million. At
1 May 2010, the estimated residual value changed to $2.6 million. The change
in the residual value has not been taken into account when preparing the
financial statements as at 30 April 2011.
x
Show how the above issues with Rose property plant and equipment
should have been recorded in the financial statements of Rose group
for the year ended 30 April 2011.
(8 marks)
(30 marks)
AC
C
A
G
lo
ba
l
Bo
Note: The marks are allocated equally between the property and the
plant.
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CLASS NOTES QUESTIONS
11.Ethan
Ethan, a public listed company, develops, operates and sells investment
properties. The current year end is 31 May 2012.
Ethan focuses mainly on acquiring properties where it foresees growth potential,
through rental income as well as value appreciation. The properties are
unoccupied by the group and complete at purchase. The acquisition of an
investment property is usually realised through the acquisition of the entity, which
holds the property.
In Ethan’s consolidated financial statements, investment properties acquired
through business combinations are recognised at fair value, using a discounted
cash flow model as approximation to fair value. There is currently an active
market for this type of property.
ba
l
Bo
x
Goodwill arising on business combinations is determined using the measurement
principles for the investment properties as outlined above. Goodwill is only
considered impaired if and when the related deferred tax liability is reduced below
the amount at which it was first recognised. This reduction can be caused both
by a reduction in the value of the real estate or a change in local tax regulations.
As long as the deferred tax liability is equal to, or larger than, the prior year, no
impairment is charged to goodwill. Ethan explained its accounting treatment by
it is normal in the industry to account for goodwill in this way.
AC
C
A
G
lo
Since 2008, Ethan has incurred substantial annual losses except for the year
ended 31 May 2011, when it made a small profit before tax. In year ended 31
May 2011, most of the profit consisted of income recognised on revaluation of
investment properties. Ethan had announced early in its financial year ended 31
May 2012 that it anticipated substantial growth and profit. Later in the year,
however, Ethan announced that the expected profit would not be achieved and
that, instead, a substantial loss would be incurred. Ethan had a history of
reporting considerable negative variances from its budgeted results. Ethan’s
recognised deferred tax assets have been increasing year-on-year despite the
deferred tax liabilities recognised on business combinations. Ethan’s deferred tax
assets consist primarily of unused tax losses that can be carried forward which
are unlikely to be offset against anticipated future taxable profits.
Required:
Discuss how the above transactions and events should be recorded in the
consolidated financial statements of Ethan and discuss the ethical
implications of the above situations.
(18 marks)
Professional marks will be awarded for the quality of the discussion.
(2 marks)
(20 marks)
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CLASS NOTES QUESTIONS
12.Havana
Havana owns a chain of health clubs and has prepared draft financial
statements for the year ended 30 November 2013.
Havana has entered into binding contracts with sports organisations, which
earn income over given periods. The services rendered in return for such
income include access to their database of members, and admission to health
clubs, including the provision of coaching and other benefits. These contracts
are for periods of between 9 and 18 months. Havana feels that because it only
assumes limited obligations under the contract mainly relating to the provision
of coaching, this could not be seen as the rendering of services for accounting
purposes. As a result, Havana’s accounting policy for revenue recognition is
to recognise the contract income in full at the date when the contract was
signed.
(8 marks)
AC
C
A
G
lo
ba
l
Bo
x
In May 2013, Havana decided to sell one of its regional business divisions
through a mixed asset and share deal and immediately began searching for a
buyer. The decision to sell the division at a price of $40 million was made
public in November 2013 and gained shareholder approval in December 2013.
The target was to dispose of the business within 6 months although it was
decided that the payment of any agreed sale price could be deferred until 30
November 2015. The business division was presented as a disposal group in
the statement of financial position as at 30 November 2013. At the initial
classification of the division as held for sale, its net carrying amount was $90
million. In writing down the disposal group’s carrying amount, Havana
accounted for an impairment loss of $30 million which represented the
difference between the carrying amount and value of the assets measured in
accordance with applicable International Financial Reporting Standards
(IFRS). In the financial statements at 30 November 2013, Havana has ignored
the following issues raised by the accountant. These costs were related to the
business division being sold and were as follows:
(i)
A loss relating to a potential write-off of a trade receivable which had
gone into liquidation.
(ii)
An expense relating to the discounting of the long-term receivable on
the fixed amount of the sale price of the disposal group.
(iii)
A provision was rejected which related to the expected transaction costs
of the sale including legal advice and lawyer fees.
(10 marks)
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CLASS NOTES QUESTIONS
Required:
Advise Havana on how the above transactions should be dealt with in
its financial statements with reference to International Financial
Reporting Standards and ethical issues where appropriate.
Note: The mark allocation is shown against each of the issues above.
Professional marks will be awarded for clarity and quality of
presentation.
(2 marks)
AC
C
A
G
lo
ba
l
Bo
x
(20 marks)
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CLASS NOTES QUESTIONS
13.Verge
In its annual financial statements for the year ended 31 March 2013, Verge, a
public limited company, had identified the following operating segments:
(i)
Segment 1
local train operations
(ii)
Segment 2
inter-city train operations
(iii)
Segment 3
railway constructions
Bo
x
The company disclosed two reportable segments. Segments 1 and 2 were
aggregated into a single reportable operating segment. Operating segments 1
and 2 have been aggregated on the basis of their similar business
characteristics, and the nature of their products and services. In the local train
market, it is the local transport authority which awards the contract and pays
Verge for its services. In the local train market, contracts are awarded following
a competitive tender process, and the ticket prices paid by passengers are set
by and paid to the transport authority. In the inter-city train market, ticket
prices are set by Verge and the passengers pay Verge for the service provided.
(5 marks)
G
lo
ba
l
Verge entered into a contract with a government body on 1 April 2011 to
undertake maintenance services on a new railway line. The total revenue from
the contract is $5 million over a three-year period. The contract states that $1
million will be paid at the commencement of the contract but although invoices
will be subsequently sent at the end of each year, the government authority
will only settle the subsequent amounts owing when the contract is completed.
The invoices sent by Verge to date (including $1 million above) were as follows:
Year ended 31 March 2012 $2·8 million
A
Year ended 31 March 2013 $1·2 million
AC
C
The balance will be invoiced on 31 March 2014. Verge has only accounted for
the initial payment in the financial statements to 31 March 2012 as no
subsequent amounts are to be paid until 31 March 2014. The amounts of the
invoices reflect the work undertaken in the period. Verge wishes to know how
to account for the revenue on the contract in the financial statements to date.
Market interest rates are currently at 6%.
(6 marks)
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CLASS NOTES QUESTIONS
In February 2012 shortly before the current year start, an inter-city train did
what appeared to be superficial damage to a storage facility of a local company.
The directors of the company expressed an intention to sue Verge but in the
absence of legal proceedings, Verge had not recognised a provision in last year’s
financial statements to 31 March 2012. In July 2012, Verge received notification
for damages of $1·2m, which was based upon the estimated cost to repair the
building. The local company claimed the building was much more than a storage
facility as it was a valuable piece of architecture which had been damaged to a
greater extent than was originally thought. The head of legal services advised
Verge that the company was clearly negligent and the view obtained from an
expert surveyor was that the value of the building was $800,000 and that the
rectification would cost $350,000. Verge had an insurance policy that would cover
the first $200,000 of such claims.
(6 marks)
(6 marks)
A
Required:
G
lo
ba
l
Bo
x
Verge was given a building by a private individual in February 2012, shortly
before the current year start. The benefactor included a condition that it must be
brought into use as a train museum in the interests of the local community or
the asset must be returned. The fair value of the asset was $1·5 million in
February 2012. Verge took possession of the building in May 2012. However, it
could not utilise the building in accordance with the condition until February 2013
as the building needed some refurbishment and adaptation and in order to fulfil
the condition. Verge spent $1 million on adaptation. On 1 July 2012, Verge
obtained a cash grant of $250,000 from the government. Part of the grant related
to the creation of 20 jobs at the train museum by providing a subsidy of $5,000
per job created. The remainder of the grant related to capital expenditure on the
project. At 31 March 2013, all of the new jobs had been created.
AC
C
Advise Verge on how the above accounting issues should be dealt with in its
financial statements for the year ending 31 March 2013 (including the
comparatives where applicable) including a discussion of how the
accounting addresses the needs of investors.
Note: The mark allocation is shown against each of the four issues above.
Professional marks will be awarded for clarity and quality of presentation.
(2 marks)
(25 marks)
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CLASS NOTES QUESTIONS
14.Minny
Minny is a company which operates in the service sector. Minny has business
relationships with Bower and Heeny. All three entities are public limited
companies. The draft statements of financial position of these entities are as
follows at 30 November 2012:
Minny
Bower
Heeny
$m
$m
$m
696
620
310
Assets:
Non-current assets
Property, plant and equipment
730
Heeny
224
Bo
Bower
x
Investments in subsidiaries
Investment in Puttin
48
198
30
35
1,896
650
345
895
480
250
2,791
1,130
595
920
400
200
73
37
25
895
442
139
1,888
879
364
Non-current liabilities
495
123
93
Current liabilities
408
128
138
Total liabilities
903
251
231
2,791
1,130
595
ba
l
Intangible assets
G
lo
Current assets
Total assets
Share capital
A
Equity and liabilities:
AC
C
Other components of equity
Retained earnings
Total equity
Total equity and liabilities
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CLASS NOTES QUESTIONS
The following information is relevant to the preparation of the group financial
statements:
On 1 December 2010 at the previous year start, Minny acquired 70% of the equity
interests of Bower. The purchase consideration comprised cash of $730 million.
At acquisition, the fair value of the non-controlling interest in Bower was $295
million. On 1 December 2010, the fair value of the identifiable net assets acquired
was $835 million and retained earnings of Bower were $319 million and other
components of equity were $27 million. The excess in fair value is due to nondepreciable land.
x
On 1 December 2011 at the current year start, Bower acquired 80% of the equity
interests of Heeny for a cash consideration of $320 million. The fair value of a
20% holding of the non-controlling interest was $72 million; a 30% holding was
$108 million and a 44% holding was $161 million. At the date of acquisition, the
identifiable net assets of Heeny had a fair value of $362 million, retained earnings
were $106 million and other components of equity were $20 million. The excess
in fair value is due to non-depreciable land. It is the group’s policy to measure
the non-controlling interest at fair value at the date of acquisition.
Explain with suitable workings how the goodwill should be
calculated for the acquisition of Bower and Heeny showing how
the impairment tests in each affected the carrying value of
goodwill at the current year end.
AC
C
A
(i)
G
lo
Required:
ba
l
Bo
Both Bower and Heeny were impairment tested at the current year end of 30
November 2012. The recoverable amounts of both cash generating units as stated
in the individual financial statements at 30 November 2012 were Bower, $1,425
million, and Heeny, $644 million, respectively. The recoverable amount has been
determined without consideration of liabilities which all relate to the financing of
operations.
(12 marks)
Minny acquired a 14% interest in Puttin, a public limited company, on 1 December
2010 for a cash consideration of $18 million. The investment was accounted for
under IFRS 9 Financial Instruments and was designated as at fair value through
other comprehensive income. On 1 June 2012, Minny acquired an additional 16%
interest in Puttin for a cash consideration of $27 million and achieved significant
influence. The value of the original 14% investment on 1 June 2012 was $21
million. Puttin made profits after tax of $20 million and $30 million for the years
to 30 November 2011 and 30 November 2012 respectively. On 30 November
2012, Minny received a dividend from Puttin of $2 million, which has been credited
to other components of equity.
(ii) Explain with suitable workings how the carrying value of the
associate should be measured at the current year end.
(6 marks)
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CLASS NOTES QUESTIONS
Minny intends to dispose of a major line of the parent’s business operations.
At the date the held for sale criteria were met, the carrying amount of the
assets and liabilities comprising the line of business were:
$m
Property, plant and equipment
(PPE)
49
Inventory
18
Current liabilities
3
It is anticipated that Minny will realise $30 million for the business. No
adjustments have been made in the financial statements in relation to the
above decision.
Required:
Bo
x
Discuss the effect of the classification of the major line of business as
a disposal group.
(4 marks)
ba
l
Note: Marks will only be awarded above for the discussion of the effect of the
classification as a disposal group. There are no marks for the discussion of the
criteria which are discussed below.
AC
C
Required:
A
G
lo
Minny intends to dispose of a major line of business in the above scenario and
the entity has stated that the held for sale criteria were met under IFRS 5
Non-current Assets Held for Sale and Discontinued Operations. Regulators
have been known to question entities on the application of the standard. The
two criteria which must be met before an asset or disposal group will be
defined as recovered principally through sale are: that it must be available for
immediate sale in its present condition and the sale must be highly probable.
Discuss what is meant in IFRS 5 by ‘available for immediate sale in its
present condition’ and ‘the sale must be highly probable’, setting out
briefly why regulators may question entities on the application of the
standard.
(8 marks)
(30 marks)
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CLASS NOTES QUESTIONS
15. Clive
Clive is an entity in the publications industry. The year-end is 31 May 2010.
Bo
x
On 1 April 2009 two months before the current year start Clive bought a direct
holding of shares giving 70% of the equity voting rights in Date, a limited
company operating a farm. In May 2010, shortly before the current year end,
Date issued new shares, which were wholly subscribed for by a new investor.
After the increase in capital, Clive retained an interest of 35% of the voting
rights in its former subsidiary Date. At the same time, the shareholders of Date
signed an agreement providing new governance rules for Date. Based on this
new agreement, Clive was no longer to be represented on Date’s board or
participate in its management. As a consequence Clive considered that its
decision not to subscribe to the issue of new shares was equivalent to a decision
to disinvest in Date. Clive argued that the decision not to invest clearly showed
its new intention not to recover the investment in Date principally through
continuing use of the asset and was considering selling the investment. Due to
the fact that Date is a separate line of business (with separate cash flows,
management and customers), Clive considered that the results of Date for the
period to 31 May 2010 should be presented based on principles provided by
IFRS 5 Non-current Assets Held for Sale and Discontinued Operations.
ba
l
Required:
G
lo
Discuss whether the accounting treatments proposed by the company
are acceptable under International Financial Reporting Standards for
the year end 31 May 2010.
(8 marks)
AC
C
A
Leasing is important to Clive, a public limited company as a method of financing
the business. The Directors feel that it is important that they provide users of
financial statements with a complete and understandable picture of the entity’s
leasing activities. Clive has adopted IFRS 16 Leases. However, Clive has failed
to recognise one lease in accordance with IFRS 16 Leases. Clive has rented
plant for a fixed term of six years and the useful life of the plant is 12 years.
The contract is non-cancellable, and there are no rights to extend the lease
term or purchase the machine at the end of the term. There are no guarantees
of its value at that point. The legal owner does not have the right of access to
the plant until the end of the contract or unless permission is granted by Clive.
Fixed payments are due annually over the term after delivery of the plant, which
is maintained by Clive. Clive accounts for the payments as rental costs directly
to profit or loss.
Required:
Discuss the reasons why IFRS 16 requires the recognition of an asset
and a liability by lessees for leases except for leases for which there is
a recognition exemption. Discuss whether the plant and the
corresponding obligation in the rental agreement meet the definition
of an asset and liability as set out in the ‘Framework for the Preparation
and Presentation of Financial Statements.’
(10 marks)
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CLASS NOTES QUESTIONS
Clive acquired a property for $4 million and annual depreciation of $300,000 is
charged on the straight line basis. At the end of the previous financial year, when
accumulated depreciation was $1 million, a further amount relating to an
impairment loss of $350,000 was recognised, which resulted in the property being
valued at its estimated value in use. On 1 October 2010, as a consequence of a
proposed move to new premises, the property was classified as held for sale. At
the time of classification as held for sale, the fair value less costs to sell was $2·4
million. At the date of the published interim financial statements, 1 December
2010, the property market had improved and the fair value less costs to sell was
reassessed at $2·52 million and at the year end on 31 May 2014 it had improved
even further, so that the fair value less costs to sell was $2·95 million. The
property was sold on 5 June 2014 for $3 million.
Required:
(7 marks)
(25 marks)
AC
C
A
G
lo
ba
l
Bo
x
Explain the movement in the property carrying value under International
Financial Reporting Standards for the year end 31 May 2010.
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CLASS NOTES QUESTIONS
16.Pod
The introduction of a new accounting standard can have significant impact on an
entity by changing the way in which financial statements show particular
transactions or events. In many ways, the impact of a new accounting standard
requires the same detailed considerations as is required when an entity first
moves from local Generally Accepted Accounting Practice to International
Financial Reporting Standards (IFRS).
A new or significantly changed accounting standard often provides the key focus
for examination of the financial statements of listed companies by national
enforcers who issue common enforcement priorities. These priorities are often
highlighted because of significant changes to accounting practices as a result of
new or changed standards or because of the challenges faced by entities as a
result of the current economic environment. Recent priorities have included
recognition and measurement of deferred tax assets and impairment of financial
and non-financial assets.
Bo
x
Required:
ba
l
(i) Discuss the key practical considerations, and financial statement
implications which an entity should consider when implementing
a move to a new IFRS.
(8 marks)
A
G
lo
(ii) Discuss briefly the reasons why regulators might focus on the
impairment of non-financial assets and deferred tax assets in a
period of slow economic growth, setting out the key areas which
entities should focus on when accounting for these elements.
(7 marks)
AC
C
Professional marks will be awarded for clarity and quality of
presentation.
(2 marks)
(i) Pod is a listed company specialising in the distribution and sale of
photographic products and services. Pod's statement of financial position
included an intangible asset which was a portfolio of customers acquired
from a similar business which had gone into liquidation. Pod changed its
assessment of the useful life of this intangible asset from 'finite' to
'indefinite'. Pod felt that it could not predict the length of life of the
intangible asset, stating that it was impossible to foresee the length of life
of this intangible due to a number of factors such as technological evolution,
and changing consumer behaviour.
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CLASS NOTES QUESTIONS
(ii) Pod has a significant network of retail branches. In its financial statements,
Pod changed the determination of a cash generating unit (CGU) for
impairment testing purposes at the level of each major product line, rather
than at each individual branch. The determination of CGUs was based on the
fact that each of its individual branches did not operate on a standalone basis
as some income, such as volume rebates, and costs were dependent on the
nature of the product line rather than on individual branches. Pod considered
that cash inflows and outflows for individual branches did not provide an
accurate assessment of the actual cash generated by those branches. Pod,
however, has daily sales information and monthly statements of profit or loss
produced for each individual branch and this information is used to make
decisions about continuing to operate individual branches.
Required:
x
Discuss whether the changes to accounting practice suggested by Pod
are acceptable under International Financial Reporting Standards.
(8 marks)
(25 marks)
AC
C
A
G
lo
ba
l
Bo
Note: The marks are allocated equally between (b)(i) and (b)(ii).
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CLASS NOTES QUESTIONS
17.Marchant
The following draft financial statements relate to Marchant, a public listed limited
company.
Marchant Group: Draft statements of profit or loss and other comprehensive
income for the year ended 30 April 2014.
Marchant
Nathan
Option
$m
$m
$m
400
115
70
(312)
(65)
(36)
Gross profit
88
50
34
Other income
21
7
2
Administrative costs
(15)
(9)
(12)
Other expenses
(35)
(19)
(8)
Operating profit
59
29
16
(5)
(6)
(4)
Revenue
Finance income
Bo
x
Cost of sales
6
5
8
Profit before tax
60
28
20
(19)
(9)
(5)
41
19
15
19
15
ba
l
Finance costs
Income tax expense
G
lo
Profit for the year
Other comprehensive income – revaluation
surplus
Total comprehensive income for year
10
51
A
The following information is relevant to the preparation of the group statement of
profit or loss and other comprehensive income:
AC
C
1. On 1 May 2012, Marchant acquired 60% of the equity interests of Nathan, a
public limited company. The purchase consideration comprised cash of $80
million and the fair value of the identifiable net assets acquired was $110
million at that date. The fair value of the non-controlling interest (NCI) in
Nathan was $45 million on 1 May 2012. Marchant wishes to use the ‘full
goodwill’ method for all acquisitions. The share capital and retained earnings
of Nathan were $25 million and $65 million respectively and other components
of equity were $6 million at the date of acquisition. The excess of the fair value
of the identifiable net assets at acquisition is due to non-depreciable land.
Goodwill has been impairment tested annually and as at 30 April 2013 had
reduced in value by 20%. However at 30 April 2014, the impairment of
goodwill had reversed and goodwill was valued at $2 million above its original
value.
2. Marchant disposed of an 8% equity interest in Nathan on 30 April 2014 for a
cash consideration of $18 million and had accounted for the gain or loss in
other income. The retained earnings were $85 million and the other
components of equity were $10 million at 30 April 2014.
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CLASS NOTES QUESTIONS
3. Marchant acquired 60% of the equity interests of Option, a public limited
company, on 30 April 2012. The purchase consideration was cash of $70
million. Option’s identifiable net assets were fair valued at $86 million and the
NCI had a fair value of $28 million at that date. On 1 November 2013,
Marchant disposed of a 40% equity interest in Option for a consideration of
$50 million. Option’s identifiable net assets were $90 million and the value of
the NCI was $34 million at the date of disposal. The remaining equity interest
was fair valued at $40 million. After the disposal, Marchant exerts significant
influence. Any increase in net assets since acquisition has been reported in
profit or loss and the carrying value of the investment in Option had not
changed since acquisition. Goodwill had been impairment tested and no
impairment was required. No entries had been made in the financial
statements of Marchant for this transaction other than for cash received.
Required:
Bo
x
(i) Explain with suitable workings how the goodwill of Nathan should
have been measured at the current year end of 30 April 2014.
(6 marks)
(6 marks)
G
lo
ba
l
(ii) Explain, with suitable calculations, how the sale of the 8% interest
in Nathan should be dealt with in the group statement of financial
position at 30 April 2014.
A
(iii)Explain, with suitable calculations, how the sale of the 40%
interest in Option should be dealt with in the group statement of
profit or loss for the year ended 30 April 2014.
(7 marks)
AC
C
Marchant sold inventory to Nathan for $12 million at fair value. Marchant
made a profit on the transaction of $2 million and Nathan still holds $8 million
in inventory at the year end.
Required:
Explain with suitable workings how the revenue of the Marchant
group would be measured for the current year end of 30 April 2014.
(4 marks)
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CLASS NOTES QUESTIONS
On 1 May 2012, Marchant purchased an item of property, plant and equipment
for $12 million and this is being depreciated using the straight line basis over
10 years with a zero residual value. At 30 April 2013, the asset was revalued
to $13 million but at 30 April 2014, the value of the asset had fallen to $7
million. Marchant uses the revaluation model to value its non-current assets.
The effect of the revaluation at 30 April 2014 had not been taken into account
in total comprehensive income but depreciation for the year had been
charged. Marchant has the policy of transferring a proportion of the
revaluation reserve to retained earnings in line with the related asset life.
Required:
Explain with suitable workings how the fall in value of the property
would be measured for the current year end of 30 April 2014.
(4 marks)
Required:
G
lo
ba
l
Bo
x
On 1 May 2012, Marchant made an award of 8,000 share options to each of
its seven directors. The condition attached to the award is that the directors
must remain employed by Marchant for three years. The fair value of each
option at the grant date was $100 and the fair value of each option at 30 April
2014 was $110. At 30 April 2013, it was estimated that three directors would
leave before the end of three years. Due to an economic downturn, the
estimate of directors who were going to leave was revised to one director at
30 April 2014. The expense for the year as regards the share options had not
been included in profit or loss for the current year and no directors had left by
30 April 2014.
AC
C
A
Explain with suitable workings how the option scheme would be
measured for the current year end of 30 April 2014.
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CLASS NOTES QUESTIONS
18. Kayte
Kayte operates in the shipping industry and owns vessels for transportation.
Kate directors receive a bonus based upon group profit.
During the current year, Kayte acquired Ceemone whose assets were entirely
investments in small companies. The small companies each owned and
operated one or two shipping vessels. There were no employees in Ceemone
or the small companies. At the acquisition date, there were only limited
activities related to managing the small companies as most activities were
outsourced. All the personnel in Ceemone were employed by a separate
management company. The companies owning the vessels had an
agreement with the management company concerning assistance with
chartering, purchase and sale of vessels and any technical management. The
management company used a shipbroker to assist with some of these tasks.
The agreement with the management company can be terminated with a
months’ notice.
ba
l
Bo
x
Kayte accounted for the investment in Ceemone as an asset purchase. The
consideration paid and related transaction costs were recognised as the
purchase price of the vessels. Kayte argued that the vessels were only
passive investments and that Ceemone did not own a business consisting of
processes, since all activities regarding commercial and technical
management were outsourced to the management company. As a result, the
acquisition was accounted for as if the vessels were bought on a stand-alone
basis.
G
lo
There is evidence that the customer base of Ceemone has deteriorated
following adverse publicity.
(10 marks)
AC
C
A
Kayte’s vessels constitute a material part of its total assets. The economic
life of the vessels is estimated to be 30 years and so depreciation is spread
over 30 years. But the useful life of most of the Kayte vessels is only 10
years because Kayte’s policy is to sell these vessels when they are 10 years
old. Kayte estimated the residual value of these vessels at sale to be half of
acquisition cost and this value was assumed to be constant during their
useful life. Kayte argued that the estimates of residual value used were
conservative in view of an immature market with a high degree of
uncertainty and presented documentation which indicated some vessels
were being sold for a price considerably above carrying value. Broker
valuations of the residual value were considerably higher than those used by
Kayte. Kayte argued against broker valuations on the grounds that it would
result in greater volatility in reporting.
(8 marks)
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CLASS NOTES QUESTIONS
Required:
Discuss the accounting treatment of the above transactions in the
financial statements of Kayte and how the proposed accounting reflects
upon the ethics of the directors.
Note: The mark allocation is shown against each of the elements above.
Professional marks
presentation.
will
be
awarded
for
clarity
and
quality
of
(2 marks)
AC
C
A
G
lo
ba
l
Bo
x
(20 marks)
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CLASS NOTES QUESTIONS
19.Bubble
The following draft financial statements relate to Bubble, a public limited company
and two other companies in which it owns investments.
Draft statements of financial position as at 31 October 2015
Bubble
Salt
Tyslar
$m
$m
Dinars m
Property, plant and equipment
280
105
390
Investment in Salt
110
Assets
Non-current assets
46
Financial assets
12
9
98
448
114
x
Investment in Tyslar
488
20
12
16
30
25
36
14
11
90
64
48
142
512
162
630
80
50
210
230
74
292
40
12
350
136
502
Non-current liabilities
95
7
110
Current liabilities
67
19
18
162
26
128
512
162
630
Bo
Current assets
Inventories
Total assets
Equity and liabilities
Equity shares
A
Retained earnings
G
lo
Cash and cash equivalents
Other components of equity
AC
C
Total equity
ba
l
Trade and other receivables
Total equity and liabilities
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CLASS NOTES QUESTIONS
The following information is relevant to the preparation of the group statement of
financial position:
Bubble acquired 80% of the equity shares of Salt on 1 November 2013 when
Salt's retained earnings were $56 million and other components of equity were
$8 million. The fair value of the net assets of Salt was $120 million at the date of
acquisition. This does not include a contingent liability which was disclosed in
Salt's financial statements as a possible obligation of $5 million. The fair value of
the obligation was assessed as $1 million at the date of acquisition and remained
unsettled as at 31 October 2015. $5 million is still disclosed as a possible
obligation with no change in its fair value. Any remaining difference in the fair
value of the net assets at acquisition relates to non-depreciable land. The fair
value of the non-controlling interest at acquisition was estimated as $25 million.
Bubble always adopts the full goodwill method under IFRS 3 Business
Combinations.
ba
l
Bo
x
Bubble also owns 60% of the equity shares of Tyslar, a company located overseas
which uses the dinar as its functional currency. The shares in Tyslar were acquired
on 1 November 2014 at a cost of 368 million dinars. At the date of acquisition,
retained earnings were 258 million dinars and Tyslar had no other components of
equity. No fair value adjustments were deemed necessary in relation to the
acquisition of Tyslar. The fair value of the non-controlling interest was estimated
as 220 million dinars at acquisition. An impairment review of goodwill was
undertaken as at 31 October 2015. No impairment was necessary in relation to
Salt, but the goodwill of Tyslar is to be impaired by 20%. Neither Bubble, Salt nor
Tyslar has issued any equity shares since acquisition.
A
1 November 2014
G
lo
The following exchange rates are relevant for the preparation of the group
financial statements:
AC
C
1 February 2015
1 May 2015
Dinars to $
8
9
9
31 October 2015
9·5
Average for the year to 31 October 2015
8·5
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CLASS NOTES QUESTIONS
Required:
(i)
Calculate the goodwill for presentation on the consolidated
statement of financial position of the Bubble Group at 31 October
2015 in accordance with International Financial Reporting
Standards.
(6 marks)
(ii) Calculate the gain or loss on the retranslation of the foreign
subsidiary showing the split between controlling interest and
non-controlling interest and the closing balance on the foreign
currency reserve to be presented on the consolidated statement
of financial position of the Bubble Group at 31 October 2015 in
accordance with International Financial Reporting Standards.
x
(6 marks)
ba
l
Bo
Bubble wished to expand its overseas operations and on 1 May 2015 acquired an
overseas property with a fair value of 58·5 million dinars. In exchange for the
building, Bubble paid the supplier with land which Bubble had held but had yet to
determine its use. The carrying amount of the land was $5 million but it had an
open market value of $7 million. Bubble was unsure as to how to deal with this
transaction and so has transferred $5 million from investment properties to
property, plant and equipment. The transaction has commercial substance.
A
G
lo
In addition, Bubble spent $0·5 million to help relocate staff to the new property
and added this amount to the cost of the asset. Bubble has made no other entries
in its financial statements in relation to the property. Bubble has a policy of
depreciating properties over 35 years and follows the revaluation model under
IAS 16 Property, Plant & Equipment. Due to a surge in the market, it is estimated
that the fair value of the property is 75 million dinars as at 31 October 2015.
AC
C
Bubble operates a defined benefit scheme for its employees but has yet to record
anything for the current year except to expense the cash contributions which were
$6 million. The opening position was a net liability of $15 million which is included
in the non-current liabilities of Bubble in its draft financial statements. Current
service costs for the year were $5 million and interest rates on good quality
corporate bonds fell from 8% at the start of the year to 6% by 31 October 2015.
In addition, a payment of $3 million was made out of the cash of the pension
scheme in relation to employees who left the scheme. The reduction in the
pension scheme liability as a result of the curtailment was $4 million. The actuary
has assessed that the scheme is in deficit by $17 million as at 31 October 2015.
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CLASS NOTES QUESTIONS
Required:
(iii)
Explain with suitable calculations how the purchase of the foreign
property would be recorded in the consolidated statement of
financial position of the Bubble Group at 31 October 2015 in
accordance with International Financial Reporting Standards.
(5 marks)
(iv)
Show how the defined benefit pension scheme would be recorded in
the consolidated financial statements of the Bubble Group at 31
October 2015 in accordance with International Financial Reporting
Standards.
(4 marks)
ba
l
Bo
x
The directors of Bubble are not fully aware of the requirements of IAS 21 The
Effects of Changes in Foreign Exchange Rates in relation to exchange rate
differences. They would like advice on how exchange differences should be
recorded on both monetary and non-monetary assets in the financial statements
of individual entities trading with foreign suppliers and how these differ from the
requirements for the translation of an overseas entity. The directors also wish
advice on what would happen to the exchange differences if Bubble were to sell
all of its equity shares in Tyslar.
Required:
(9 marks)
(30 marks)
AC
C
A
G
lo
Explain to the directors of Bubble the correct accounting treatment
for the various issues raised.
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CLASS NOTES QUESTIONS
20.Cloud
Bo
x
IAS 1 Presentation of Financial Statements defines profit or loss and other
comprehensive income. The purpose of the statement of profit or loss and other
comprehensive income is to show an entity’s financial performance in a way which
is useful to a wide range of users so that they may attempt to assess the future
net cash inflows of an entity. The statement should be classified and aggregated
in a manner which makes it understandable and comparable. However, the
International Integrated Reporting Council (IIRC) is calling for a shift in thinking
more to the long term, to think beyond what can be measured in quantitative
terms and to think about how the entity creates value for its owners. Historical
financial statements are essential in corporate reporting, particularly for
compliance purposes, but it can be argued that they do not provide meaningful
information. Preparers of financial statements seem to be unclear about the
interaction between profit or loss and other comprehensive income (OCI)
especially regarding the notion of reclassification, but are equally uncertain about
whether the IIRC’s Framework constitutes suitable criteria for report preparation.
A Discussion Paper on the Conceptual Framework published by the International
Accounting Standards Board (IASB) has tried to clarify what distinguishes
recognised items of income and expense which are presented in profit or loss
from items of income and expense presented in OCI.
Describe the current presentation requirements relating to the
statement of profit or loss and other comprehensive income.
G
lo
(i)
ba
l
Required:
(4 marks)
AC
C
A
(ii) Discuss, with examples, the nature of a reclassification
adjustment and the arguments for and against allowing
reclassification of items to profit or loss.
(5 marks)
(iii) Discuss the principles and key components of the IIRC’s
Framework, and any concerns which could question the
Framework’s suitability for assessing the prospects of an entity.
228
(8 marks)
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CLASS NOTES QUESTIONS
(b)
Cloud, a public limited company, regularly purchases steel from a foreign
supplier and designates a future purchase of steel as a hedged item in a cash
flow hedge. The steel was purchased on 1 May 2014 and at that date, a
cumulative gain on the hedging instrument of $3 million had been credited
to other comprehensive income. At the year end of 30 April 2015, the
carrying amount of the steel was $8 million and its net realisable value was
$6 million. The steel was finally sold on 3 June 2015 for $6·2 million.
On a separate issue, Cloud purchased an item of property, plant and
equipment for $10 million on 1 May 2013. The asset is depreciated over five
years on the straight line basis with no residual value. At 30 April 2014, the
asset was revalued to $12 million. At 30 April 2015, the asset’s value has
fallen to $4 million. The entity makes a transfer from revaluation surplus to
retained earnings for excess depreciation, as the asset is used.
Required:
Bo
x
Show how the above transactions would be dealt with in the financial
statements of Cloud from the date of the purchase of the assets.
(8 marks)
(25 marks)
AC
C
A
G
lo
ba
l
Note: The marks are allocated equally between the two issues.
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