SBR Course notes
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Syllabus A: Fundamental Ethical And Professional Principles
3
Syllabus A1. Professional Behaviour & Compliance With Accounting Standards
3
Syllabus A2. Ethical requirements of corporate reporting
7
Syllabus B: THE FINANCIAL REPORTING FRAMEWORK
12
Syllabus B1. The Applications Of An Accounting Framework
12
Syllabus C: REPORTING THE FINANCIAL PERFORMANCE OF ENTITIES
45
Syllabus C1. Performance reporting
45
Syllabus C2. Non-current Assets
63
Syllabus C3. Financial Instruments
126
Syllabus C4. Leases
171
Syllabus C5. Employee Benefits
194
Syllabus C6. Income taxes
206
Syllabus C7. Provisions, contingencies and events after the reporting date
218
Syllabus C8. Share based payment
227
Syllabus C9. Fair Value Measurement
250
Syllabus C10. Reporting requirements of small and medium-sized entities (SMEs)
254
Syllabus C11. Other Reporting Issues
264
Syllabus D: FINANCIAL STATEMENTS OF GROUPS OF ENTITIES
275
Syllabus D1. Group accounting including statements of cash flows
275
Syllabus D2. Associates And Joint Arrangements
345
Syllabus D3: Changes in group structures
355
Syllabus D4: Foreign transactions and entities
360
Syllabus E: Interpret Financial Statements For Different Stakeholders
371
Syllabus E1: Analysis and interpretation of financial information and measurement of performance
371
Syllabus F: THE IMPACT OF CHANGES AND POTENTIAL CHANGES IN ACCOUNTING
REGULATION
405
Syllabus F1. Discussion of solutions to current issues in financial reporting
405
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Syllabus A: FUNDAMENTAL ETHICAL AND
PROFESSIONAL PRINCIPLES
Syllabus A1. Professional Behaviour & Compliance With
Accounting Standards
Syllabus A1a) Appraise and discuss the ethical and professional issues in advising on
corporate reporting.
Giving Advic
When giving advice be aware of:
1) Your own professional competence and that company directors must keep up to
date with IFRS development
The issues that may threaten this are
• Insuf cient tim
• Incomplete, restricted or inadequate informatio
• Insuf cient experience, training or educatio
• Inadequate resource
2) Your own objectivit
The issues that may threaten this are
• Financial interests (pro t-related bonuses /share options
• Inducements to encourage unethical behaviou
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In fact ACCA’s Code of Ethics and Conduct identi es that accountants must not be
associated with reports, returns, communications where they believe that the
information
• Contains a materially misleading statemen
• Contains statements or information furnished recklessl
• Has been prepared with bias, o
• Omits or obscures information required to be included where such omission or obscurit
would be misleadin
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Syllabus A1b) Assess the relevance and importance of ethical and professional issues in
complying with accounting standards.
Ethical and professional issue
Accounting professionals are expected to be
1. highly competen
2. reliabl
3. objectiv
4. high degree of professional integrity
A professional’s good reputation is one of their most important assets
Accountancy as a profession has accepted its overriding need to act in the best interest
of the public
This can create an ethical/professional dilemma
As accountants also have professional duties to their employer and clients
Where these duties are in contrast to the public interest, then the ethical conduct of the
accountant should be in favour of the public interest
This can create problems particularly on an audit, whereby you provide a service for the
client, yet may have to make public information which is detrimental to the company but in
the public interest
There is a very ne line between acceptable accounting practice and management’s
deliberate misrepresentation in the nancial statements
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The nancial statements must meet the following criteria
• Technical compliance
Generally accepted accounting principles (GAAP) used
• Economic substance:
The economic substance of the event that has occurred must be represented
(over and above GAAP
• Full disclosure and transparency:
Suf cient disclosures mad
Management often seeks loopholes in nancial reporting standards that allow them to
adjust the nancial statements as far as is practicable to achieve their desired aim
These adjustments amount to unethical practices when they fall outside the bounds of
acceptable accounting practice
In most cases conformance to acceptable accounting practices is a matter of personal
integrity
Reasons for such behaviour often includ
1. market expectation
2. personal realisation of a bonu
3. maintenance of position within a market secto
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Syllabus A2. Ethical requirements of corporate reporting
Syllabus A2a) Appraise the potential ethical implications of professional and managerial
decisions in the preparation of corporate reports.
ACCA has a Framework for Ethical Decision Makin
1) Understand the Real Issue
2) Any Ethical threats
These would be:
Self-Interest
Self-Review
Advocacy
Familiarity
Intimidatio
3) Are the Ethical threats signi cant?
Think about materiality, seniority of people involved and the amount of judgement neede
4) Can safeguards reduce these threats to an acceptable level
5) Can you look yourself in the mirror afterwards
Accountants need to act professionally and in the current conditions have even more of a
duty to present fair, accurate and faithfully represented information
It can be argued that accountants should have the presentation of truth, in a fair and
accurate manner, as a goal.
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Syllabus A2b) Assess the consequences of not upholding ethical principles in the
preparation of corporate reports.
Consequences Of Not Upholding Ethical Principle
One of the more obvious consequences is professional disciplinary
proceedings against unethical member
The results can be serious
• Fines / Priso
• No longer being able to be a Directo
• Expelled from your professional bod
Social Responsibilit
Looking after society and the environment costs .... no question... but in today's world,
thankfully, it also brings in sale
Companies are now often called 'corporate citizens'. With that comes social responsibility
Not taking CSR seriously will damage your chances of investment and risk losing sales
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Syllabus A2c) Identify related parties and assess the implications of related party
relationships in the preparation of corporate reports.
IAS 24 Related Partie
A party is said to be related to an entity if any of the following three situations
occur
The 3 situations are
1. Controls / is controlled by entit
2. is under common control with entit
3. has signi cant in uence over the entit
Types of related part
These therefore include
1. Subsidiarie
2. Associat
3. Joint ventur
4. Key managemen
5. Close family member of above (like my beautiful daughter pictured in her new
school uniform aaahhh
6. A post-employment bene t plan for the bene t of employee
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Not necessarily related partie
Two entities with a director in commo
Two joint venturer
Providers of nanc
A big customer, supplier et
Stakeholders need to know that all transactions are at arm´s length and if not then be
fully aware
Similarly they need to be aware of the volume of business with a related party, which
though may be at arm´s length, should the related party connection break then the
volume of business disappear also
Disclosure
• Genera
The name of the entity’s parent and, if different, the ultimate controlling part
The nature of the related party relationshi
Information about the transactions and outstanding balances necessary for an
understanding of the relationship on the nancial statement
• As a minimum, this includes
Amount of outstanding balances
Bad and doubtful debt informatio
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• Key management personnel compensation should be broken down by
• short-term employee bene t
• post-employment bene t
• other long-term bene t
• termination bene t
• share-based paymen
Group and Individual account
1. Individual account
Disclose related party transactions / outstanding balances of parent, venturer or
investor
2. Group account
The intra-group transactions and balances would have been eliminated
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Syllabus B: THE FINANCIAL REPORTING
FRAMEWORK
Syllabus B1. The Applications Of An Accounting
Framework
Syllabus B1a) Discuss the importance of a conceptual framework in underpinning the
production of accounting standards.
Framework - Basics and Argument
The IASB framework is not a standard nor does it override any standards
De nitio
It sets out the concepts which underlie the accounts. It means that basic principles do not
have to re-debated for every new standard
It is..
‘a constitution, a coherent system of interrelated objectives and fundamentals which
can lead to consistent standards and which prescribe the nature, function and limits
of nancial accounting and nancial statements
What’s its purpose
The IASB’s Framework for the Preparation and Presentation of Financial Statements
describes the basic concepts by which nancial statements are prepared
• Serves as a guide in developing accounting standards
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• Serves as a guide to resolving accounting issues that are not addressed directly in a
standard.
(In fact IAS 8 requires management to consider the de nitions, recognition criteria, and
measurement concepts for assets, liabilities, income, and expenses in the Framework.
What does it ‘look’ like
It includes the following
1. The objective of nancial statement
2. Underlying assumption
3. Qualitative characteristics of good informatio
4. Elements of F
5. Recognition of Element
6. Measurement of Element
7. Concepts of Capita
More on these in other section
Arguments for a conceptual framewor
• It may seem a very theoretical document but it has highly practical aims
• Without a framework then standards would be developed without consistency and also
the same basic principles would be continually examined. Perhaps even sometimes with
differing conclusions
• The IASB therefore becomes the architect of nancial reporting with a framework as
solid foundations upon which everything else relies
• Also without such a framework then a rules based system tends to come in instead. The
rules get added to as situations arise and nally become cumbersome and unadaptable
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• It also prevents political lobbyists from changing pressurising changes in standards as
the principles have already been agreed upon
So a conceptual framework basically provides a framework for
1. what should be brought into the account
2. when it should be brought into the accounts an
3. at how much it should be measure
Arguments against a conceptual framewor
• Financial Statements are prepared for many different users - can one set of principles be
agreed by all
• Perhaps different users need different information and hence different measurement
bases and principle
• Even with framework principles - standards go through a huge analysis process, for
example the revenue recognition exposure draft has now been re-exposed
GAAP & the framewor
In some ways the framework tries to codify the current GAAP into new standards - or
at least current thinkin
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Syllabus B1b) Discuss the objectives of financial reporting including disclosure of
information that can be used to help assess management’s stewardship of the entity’s
resources and the limitations of financial reporting.
Chapter 1: The Objective of Financial Reportin
This chapter sets out
The objective of general purpose nancial reportin
Information neede
Who the primary users of nancial reports are.
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Stewardship
Users need information to help them assess management’s stewardship.
This chapter states that users need information to help them assess management’s
stewardship so that they can hold management to account for resources entrusted to their
care.
This assessment in turn helps users make decisions about providing resources to the
entity, which is the objective of general purpose nancial reporting
Users of nancial reports
Users are investors, lenders and other creditors.
Those users must rely on nancial reports for much of the nancial information they need
Limitations of Financial Reporting
Users cannot require reporting entities to provide information directly to them, so must rely
on general purpose nancial reports
However, these cannot provide all of the information needed.
Information from other sources is needed, for example, general economic conditions and
expectations, political events and industry/company outlooks
• Financial accounts are not designed to show the value of an entity; but they help users
estimate i
• Different users have different needs
Standards try to meet the needs of the maximum number of primary users.
(However, an entity can include additional information for a particular subset of primary
users
• Management need not rely on general purpose nancial reports because it is able to
obtain the nancial information it needs internally
• Regulators and the public may also nd general purpose nancial reports useful.
However, those reports are not primarily directed to these other groups
• Financial reports are based on estimates and judgements
The Conceptual Framework establishes the concepts that underlie those estimates
The Conceptual Framework’s vision of ideal nancial reporting is unlikely to be achieved
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in full, because it takes time to understand, accept and implement new ways of analysing
transactions and other events.
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Syllabus B1c) Discuss the nature of the qualitative characteristics of useful financial
information.
Chapter 3: Qualitative Characteristics of Useful
Financial Informatio
Main Principl
Financial information is useful when it is relevant and represents faithfully what it purports
to represent.
The usefulness of nancial information is enhanced if it is comparable, veri able, timely
and understandable
Fundamental characteristics
1. Relevance
Relevant information makes a difference in the decisions made by users.
Therefore it must have a predictive value, con rmatory value, or both. The predictive
value and con rmatory value of nancial information are interrelated.
Materiality is an entity-speci c aspect of relevance. It is based on the nature and/or
size of the item relative to the nancial report
2. Faithful representation
General purpose nancial reports represent economic phenomena in words and
numbers.
To be useful, nancial information must not only be relevant, it must also represent
faithfully the phenomena it purports to represent.
This maximises the underlying characteristics of completeness, neutrality and freedom
from error
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Enhancing characteristics
1. Comparability (including consistency
2. Timeliness
3. Reliable informatio
4. Veri ability
Helps to assure users that information represents faithfully the economic phenomena
that it purports to represent.
It implies that knowledgeable observers could reach a general consensus (although
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not necessarily absolute agreement) that the information does represent faithfully the
economic phenomena
5. Understandability
Enables users with a reasonable knowledge to comprehend the information
Understandability is enhanced when the information is
• Classi e
• Characterise
• Presented clearly and concisel
However, relevant information should not be excluded solely because it may be too
complex
Two constraints that limit the information provided in useful nancial reports
1. Materiality
Information is material if its omission or misstatement could in uence the decisions
that users make on the basis of an entity’s nancial information.
Materiality is not a matter to be considered by standard-setters but by preparers and
their auditors
2. Cost-bene t
The bene ts of providing nancial reporting information should justify the costs of
providing that information
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Faithful Representatio
Accounts must represent faithfully the phenomena it purports to represent
Faithful representations mean
1. Substance over form
Faithful representation means capturing the real substance of the matter
2. Represents the economic phenomena
Faithful means an agreement between the accounting treatment and the economic
phenomena they represent.
The accounts are veri able and neutral
3. Completeness, Neutrality & Veri abilit
Example
Sell and buy back = Loa
An entity may sell some inventory to a nance house and later buy it back at a price based
on the original selling price plus a pre-determined percentage. Such a transaction is really
a secured loan plus interest. To show it as a sale would not be a faithful representation of
the transaction
Convertible Loan
Another example is that an entity may issue convertible loan notes.
Management may argue that, as they expect the loan note to be converted into equity, the
loan should be treated as equity.
They would try to argue this as their gearing ratio would then improve. However, it is
recorded as a loan as primarily this is what it is
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As noted previously, simply following rules in accounting standards can provide for
treatment which is essentially form over substance.
Whereas, users of accounts want the substance over form
The concept behind faithful representation should enable creators of nancial statements
to faithfully represent everything through measures and descriptions above and beyond
that in the accounting standard if necessary
Limitations to Faithful Representation
1. Inherent uncertaintie
2. Estimate
3. Assumption
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Syllabus B1d) Explain the roles of prudence and substance over form in financial
reporting.
Prudenc
Watch the video HERE
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Syllabus B1e) Discuss the high level of measurement uncertainty that can make financial
information less relevant.
Measurement Uncertainty And Relevanc
Too many measurement techniques
What makes a good measurement method
• Its cost should be justi ed by the bene ts of reporting that information to user
• It should be the minimum necessary to provide relevant informatio
• It should mean infrequent changes (any necessary changes clearly explained
• The same method for initial and subsequent measurement (for comparability and
consistency purposes
The existing Conceptual Framework worryingly provides very little guidance on
measuremen
Why not use one measurement basis for everything
It may not provide the most relevant information to users - (although many call for the use
of current values to provide the most relevant information
What methods do IFRSs therefore use
Fair value, historical cost, present value and net realisable value
Why
Different information from different measurement bases may be relevant in different
circumstances
So what's wrong with this
Different measurement bases may mean the totals in nancial statements have little
meaning
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Using 'Current Value
Pro t orientated businesses turn has market input values (inventory for example) into
market output values (sales of nished products
Therefore current market values should play a key role in measurement.
This would be the most relevant measure of assets and liabilities for nancial reporting
purposes. (in these circumstances
Mixed Measurement Approac
The IASB favour a mixed measurement approach - the most relevant method is selected.
Investors feel that this approach is consistent with how they analyse nancial statements
Maybe its problems of mixed measurement are outweighed by the greater relevance
achieved
• IFRS 9 requires the use of cost in some cases and fair value in other case
• IFRS 15 essentially applies cost allocatio
Measurement Uncertaint
Measurement uncertainty of an item should be considered when assessing whether a
particular measurement basis provides relevant information.
However, most measurement is uncertain and requires estimation.
For example, recoverable value for impairment, depreciation estimates and fair value
measures at level 2 and 3 under IFRS 13
The IASB thinks that the level of measurement uncertainty that makes information lack
relevance depends on the circumstances and can only be decided when developing
particular standards
Cash- ow-based measurement can be used to customise measurement bases, which can
result in more relevant information but it may also be more dif cult for users to understand.
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As a result the Exposure Draft does not identify those techniques as a separate category
Areas of debate about measurement include
1. Entry and exit value
2. Entity speci c value
3. Deprival value
4. Entity's business mode
For example, property can be measured at historical cost or fair value depending upon the
business model
The IASB believes that when selecting a measurement basis, the amount is more relevant
if the way in which an asset or a liability contributes to future cash ows is considered. The
IASB considers that the way in which an asset or a liability contributes to future cash ows
depends, in part, on the nature of the business activities
Historic Cos
Seems to be the easiest but what about..
• Deferred payment
• Impairment
• Depreciation estimate
• Exchanges of asset
Current Value
Current values have a variety of alternative valuation methods.
These include
• Market value (least ambiguous
• Value in Us
• Ful lment Valu
In the main, the details of how these different measurement methods are applied, are set
out in each accounting standard.
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Chapter 3—Financial Statements And The Reporting
Entit
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Chapter 4—The Elements Of Financial Statements Assets & Liabilitie
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An asset is a present economic resource controlled by the entity as a result of past events.
An economic resource is a right that has the potential to produce economic bene ts
This section discusses three aspects of those de nitions
Rights
These come from obligation of others (eg they owe you cash/goods/services)
These also come when there's no obligation of others (eg Use of Property)
These come from contract (eg Leasing an object)
Conceptually, the economic resource is the set of rights, not the physical object.
There may be a dispute over a right. Until that uncertainty is resolved—for example, by a
court ruling—it is uncertain whether an asset exist
Potential to produce economic bene ts
No need to be certain, or even likely, just that in one circumstance, it would produce
economic bene ts
However, low probability might affect decisions about whether the asset is recognised and
how it is measured.
The economic resource is the present right that contains that potential, not the future
economic bene ts
Paying for an object isn't conclusive proof it's an asset and vice-versa. Eg Government
granted right
Control
Control links an economic resource to an entity.
It helps to identify the economic resource. Eg You control a share of a property so the
asset is that share not the entire property
Control means the present ability to direct the use of the economic resource including
preventing others from doing so.
It usually comes from legal rights but not always. Eg A right to use (not patented) knowhow if it can keep it secret
Control is also indicated by exposure to signi cant variations in bene ts, but it is only one
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A liability is a present obligation of the entity to transfer an economic resource as a
result of past events
For a liability to exist, three criteria must all be satis ed
Obligation
Something you have no practical ability to avoid.
You can owe it even to society - you don't need to know their identity
Just because you have a liability of 100 doesn't mean the other party has an asset of 100
Eg. some IFRS contain different recognition criteria for liabilities and assets
They're normally from contracts but can just be from customary practices, published
policies or speci c statements. This is called a ‘constructive obligation’.
The obligation may be conditional (eg options in a contract) - here a liability exists only if
there's no practical ability to avoid it
You can't argue that liquidation is a practical way to avoid something - as you are deemed
to be a going concern
No practical ability to avoid means when avoiding it you'd be signi cantly worse off than
not avoiding i
Transfer of an economic resource
This, again, does not have to be probable, only that, in at least one circumstance, it would
require the entity to transfer an economic resource.
Instead of paying sometimes the following happen:
(a) settle the obligation by negotiating a release from the obligation;
(b) transfer the obligation to a third party; or
(c) replace that obligation to transfer an economic resource with another obligation by
entering into a new transaction.
Here, an entity has the obligation to transfer an economic resource until it has settled,
transferred or replaced that obligation
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Present obligation as a result of past events
This means:
(a) the entity has already obtained economic bene ts or taken an action; and
(b) as a consequence, the entity will or may have to transfer an economic resource that it
would not otherwise have had to
The enactment of legislation is not in itself suf cient to give an entity a present obligation.
Similarly, an entity’s customary practice becomes an obligation only when it has obtainined
economic bene ts (or took an action) and so now has to transfer an economic resource
that it would not otherwise have had to
A present obligation can exist even if a transfer is only enforceable in the future. Eg. a
contractual liability to pay cash may exist now even if the contract does not require a
payment until a future date.
If an entity has entered into a contract with an employee, there's no present obligation to
pay the salary until it has received the employee’s services. (Before then the contract is
executory
De nition of Equit
Equity is the residual interest in the assets of the entity after deducting all its liabilities
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Chapter 4—The Elements Of Financial Statements Units of Accoun
Watch the video HERE
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Syllabus B1f) Evaluate the decisions made by management on recognition,
derecognition and measurement.
Chapter 5: Recognitio
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So we recognise Assets / Liabilities / Income / Expense when it is RELEVANT to do so and
in doing so the item is FAITHFULLY REPRESENTE
An item may not be RELEVANT if it has a very low probability of bringing in bene t
An item may not be RELEVANT if it has a very high existence uncertaint
An item may not be FAITHFULLY REPRESENTED if it's measurement is highly uncertai
Everything is principle based. Different circumstances will need different levels of
probability et
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Chapter 5: De-Recognitio
Transferred Componen
The assets / Liabilities that have been transferred to another party - these are normally
derecognised - and Income / expenses show
Retained Componen
Any assets / liabilities left over - these are not derecognised and no Income / expenses
show
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Strange Situation
... where we don't derecognis
1. Asset transferred but retains exposure to signi cant variations in bene t
2. Asset transferred to an agent of yours (holding it for you
3. Asset transferred and, at the same time, entered into another transaction that results in
rights or obligations to reacquire the asset.
Eg a forward contract, a written put option, or a purchased call optio
Modi ed Contract
1. Only eliminates existing rights or obligations, normal derecognition rules appl
2. Only adds new rights or obligations, either show as new Assets and Liabilities or...
as part of the same unit of account as the existing rights and obligations
(whichever gives best Faithful Representation
3. Both eliminates existing rights/obligations and adds new ones
Potentially so big a modi cation that in substance, the modi cation replaces the old
asset or liability with a new asset or liability.
So, derecognise the original asset or liability, and recognise the new asset or liability.
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Chapter 6: Measuremen
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We all like a bit of Simpli cation, right?
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Chapter 6: Measurement - Factors to Conside
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statements and the reporting of items in the statement of profit or loss and other [3]
comprehensive income.
Reporting Of Items In The Soci And Oc
The performance of a company is reported in the statement of pro t or loss
and other comprehensive incom
The statement of pro t or loss is the primary source of information about an entity’s
nancial performanc
Therefore, all income and expenses are, in principle, included in that statement
However, in developing Standards, the Board may decide in exceptional circumstances
that income or expenses are to be included in OC
(when doing so would result in the statement of pro t or loss providing more relevant
information, or providing a more faithful representation of nancial performance
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Syllabus B1g) Critically discuss and apply the definitions of the elements of financial
What gets recycled
In principle, OCI items are reclassi ed into the statement of pro t or loss in a future period
(Again when doing so results in the statement of pro t or loss providing more relevant
information, or providing a more faithful representation of nancial performance)
However, if there is no clear basis for identifying the period (or amount) in which
reclassi cation would have that result the Board may, in developing Standards, decide that
no reclassi cation is allowe
Recycled means - gains or losses are rst recognised in the OCI and then in a later
accounting period also recognised in the P/L.
What gets recycled
• The re-translation of a Sub’s goodwill and net assets. (IAS 21)
First - exchange differences are recognised in OCI (and OCE reserve)
Then - when the sub is disposed of - The OCE reserve is emptied and reclassi ed to
P&L - to form part of the pro t on disposal
• The effective portion of gains and losses on hedging instruments in a cash ow
hedge under IFRS
What doesn't get re-cycled
• Revaluations' gains and losses (IAS 16) - these go the OCI (and OCE reserve)
On disposal - they are not re-cycled to the P/L - instead there's a transfer in the SO`CIE,
from the OCE into RE
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• FVTOCI items (IFRS 9) - Gains/losses on these go to OCI (and OCE reserve) but
again on disposal no re-cycling to P/L just a reserves transfer
Note: With no reclassi cation the earnings per share will never fully include the gains on
the sale of PPE and FVTOCI investments
• Remeasurements of a net de ned bene t liability or asset recognised in
accordance with IAS 1
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Syllabus C: REPORTING THE FINANCIAL
PERFORMANCE OF ENTITIES
Syllabus C1. Performance reporting
Syllabus C1a) Discuss and apply the criteria that must be met before an entity can apply the revenue
recognition model.
Criteria for IFRS 1
The following must be ok (at inception) before IFRS 15 can be use
1. Both parties have enforceable rights / obligation
2. Contract approved - (as long as both parties cannot unilaterally terminate
3. Payment terms agreed (not necessarily xed payments
4. Commercial substance to the contrac
5. Customer can (probably) and intends to pa
These are re-assesses later if not met at inceptio
IFRS15 applies to all contracts except for
• Lease Contract
• Insurance Contract
• Financial instruments and other contractual rights/obligations within the scope of lAS
39/lFRS 9, lFRS 10, lFRS 11, lAS 27 and lAS 2
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• Non-monetary exchanges between entities within the same business to facilitate
sale
Lets say a bank gives you a mortgage (Financial liability) and some other services to do
with the propert
The mortgage would be IFRS
And the other services probably IFRS 1
Basically if another standard deals with the issue - use that standard!
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Syllabus C1b) Discuss and apply the ve step model relating to revenue earned from a contract with
a customer.
Revenue Recognition - IFRS 15 - introductio
When & how much to Recognise Revenue
Here you need to go through the 5 step process
1. Identify the contract(s) with a custome
2. Identify the performance obligations in the contrac
3. Determine the transaction pric
4. Allocate the transaction price to the performance obligations in the contrac
5. Recognise revenue when (or as) the entity satis es a performance obligatio
Before we do that though, let’s get some key de nitions out of the way.
Key de nition
• Contract
An agreement between two or more parties that creates enforceable rights and
obligations
• Income
Increases in economic bene ts during the accounting period in the form of
increasing assets or decreasing liabilitie
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• Performance obligatio
A promise in a contract to transfer to the customer either
- a good or service that is distinct; o
- a series of distinct goods or services that are substantially the same and that have
the same pattern of transfer to the customer
• Revenue
Income arising in the course of an entity’s ordinary activities
• Transaction pric
The amount of consideration to which an entity expects to be entitled in exchange for
transferring promised goods or services to a customer.
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Revenue Recognition - IFRS 15 - 5 step
Ok let’s now get into a bit more detail
Step 1: Identify the contract(s) with a custome
• The contract must be approved by all involve
• Everyone’s rights can be identi e
• It must have commercial substanc
• The consideration will probably be pai
Step 2: Identify the separate performance obligations in the contrac
This will be goods or services promised to the custome
These goods / services need to be distinct and create a separately identi able
obligatio
• Distinct means
The customer can bene t from the goods/service on its own AN
The promise to give the goods/services is separately identi able (from other promises
• Separately identi able means
No signi cant integrating of the goods/service with others promised in the contrac
The goods/service doesn’t signi cantly modify another good or service promised in the
contract
The goods/service is not highly related/dependent on other goods or services promised
in the contract.
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Step 3: Determine the transaction pric
How much the entity expects, considering past customary business practice
• Variable Consideration
If the price may vary (eg. possible refunds, rebates, discounts, bonuses, contingent
consideration etc) - then estimate the amount expecte
• However variable consideration is only included if it’s highly probable there won’t
need to be a signi cant revenue reversal in the future (when the uncertainty has been
subsequently resolved
• However, for royalties from licensing intellectual property - recognise only when the
usage occur
Step 4: Allocate the transaction price to the separate performance obligation
If there’s multiple performance obligations, split the transaction price by using
their standalone selling prices. (Estimate if not readily available
• How to estimate a selling Pric
- Adjusted market assessment approach
- Expected cost plus a margin approach
- Residual approach (only permissible in limited circumstances)
• If paid in advance, discount down if it’s signi cant (>12m
Step 5: Recognise revenue when (or as) the entity satis es a performance
obligatio
Revenue is recognised as control is passed, over time or at a point in time
• What is Control
It’s the ability to direct the use of and get almost all of the bene ts from the asset
This includes the ability to prevent others from directing the use of and obtaining the
bene ts from the asset
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• Bene ts could be
- Direct or indirect cash ows that may be obtained directly or indirectl
- Using the asset to enhance the value of other assets
- Pledging the asset to secure a loa
- Holding the asset
• So remember we recognise revenue as asset control is passed (obligations satis ed)
to the customer
This could be over time or at a speci c point in time
Examples (of factors to consider) of a speci c point in time
1. The entity now has a present right to receive payment for the asset
2. The customer has legal title to the asset
3. The entity has transferred physical possession of the asset
4. The customer has the signi cant risks and rewards related to the ownership of the
asset; an
5. The customer has accepted the asset
Contract costs - that the entity can get back from the custome
These must be recognised as an asset (unless the subsequent amortisation would be
less 12m), but must be directly related to the contract (e.g. ‘success fees’ paid to
agents)
Examples would be direct labour, materials, and the allocation of overheads - this
asset is then amortised
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Revenues - Presentation in nancial statement
Show in the SFP as a contract liability, asset, or a receivable, depending on
when paid and performe
i.e.. Paid upfront but not yet performed would be a contract liability
Dr Cash
Cr Contract Liabilit
i.e.. Paid later but already performed
Dr Receivable
Cr Revenue (see below
Performed but not paid would be a contract receivable or asse
1. A contract asset if the payment is conditional (on something other than time
2. A receivable if the payment is unconditiona
Contract assets and receivables shall be accounted for in accordance with IFRS 9
Disclosure
All qualitative and quantitative information about
• its contracts with customers
• the signi cant judgments in applying the guidance to those contracts; an
• any assets recognised from the costs to ful l a contract with a customer
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Syllabus C1c) Apply the criteria for recognition of contract costs as an asset.
Incremental Costs Of Obtaining A Contrac
These are recognised as an asset (if they are expected to be recovered from
the customer
•
Incremental means these costs ONLY occurred due to the contract eg Sales
commissio
•
If amortisation of these costs would b
Exampl
1. Due diligence on a potential customer = Expense
(Incurred whether even if we don't take on the customer
2. Commissions to sales employees = Asset and amortised
(Incurred only for the customer contract & recovery expected through future sales
Costs To Ful l A Contrac
First, be careful these aren't just normal costs dealt under their own standard (eg IAS 2
Inventories, IAS 16 PPE & IAS 38 Intangibles)
Otherwise we again recognise these as an asset if they:
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1. Relate directly to the contrac
2. Generate resources we are going to use when we sel
3. Are expected to be recovere
Examples to show as assets include
Direct labour and Material
Allocations of depreciation or insuranc
Anything explicitly chargeable to the customer
Subcontractor cost
Examples to expense include
General and administrative costs (not explicitly chargeable to the customer)
Wasted materials, labour and other resources
Costs relating to satis ed or partially satis ed performance obligations (past performance)
must be expensed also
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Syllabus C1d) Discuss and apply the recognition and measurement of revenue including
performance obligations satis ed over time, sale with a right of return, warranties, variable
consideration, principal versus agent considerations and non-refundable up-front fees.
Speci c IFRS 15 Scenario
Sale With A Right Of Retur
Here we mean the Customer has the right to receive
1. A refund
2. Credit
3. A different product in exchang
(Please note the right to get for example a different colour or size isn't a return here
Accounting treatment for Right to Return item
1. Reduce Revenue by the expected value of return
2. Instead Dr Revenue Cr Refund liabilit
(Inventory of expected return items excluded from cost of sales
In subsequent periods, the vendor updates its expected levels of returns, adjusting the
measurement of the refund liability and the associated inventory asset.
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Warrantie
Assurance Warranties
These (normally free) warranties simply provide assurance the product complies with
agreed-upon speci cation
These are just bundled into the revenue for the product and a provision for the warranty
costs is made using IAS 37 as norma
Service Warranties
These (normally paid for) warranties provides a service in addition to the assurance
These are normally
1. Not required by la
2. For longer period
These warranties are therefore separate performance obligation
Example
A customer buys an item for $100,000, with a one-year standard warranty that speci es
the equipment will comply with the agreed-upon speci cations and will operate as
promised for a one-year period from the date of purchase
She also buys an extra $2,000 two-year warranty commencing after the expiry of the
standard one- year warranty.
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There are two warranties in this contract
1. assurance-type warranty — for rst year after purchas
2. service-type warranty — for two years after expiry of the initial standard warranty
The service-type warranty and is accounted for as a separate performance obligation.
Deferred revenue of $2,000 is recognised until the performance obligation is satis ed
The assurance-type warranty is accounted for using IAS 37 Provision
Non-Refundable Upfront Fee
When the upfront fee received is just an advance payment for future services, recognised
as revenue when those future services are provided
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Principal vs. Agen
The Principal controls the good before transfer to the custome
The Agent does not control the good before transfer to the customer. So the following
normally are indicators you're an agen
• Another party is primarily responsible for ful lling the contract
• You don't take inventory risk before or after a customer orde
• You don't set prices
• You receive commission only
• You take no credit risk for the amount receivabl
Accounting treatment for Principa
Show gross revenue and cost of sale
Accounting treatment for Agen
Show commission only as revenue
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Exam Standard Illustration
Illustration 1 - Agent or not?
An entity negotiates with major airlines to purchase tickets at reduced rate
It agrees to buy a speci c number of tickets and must pay even if unable to resell them
The entity then sets the price for these ticket for its own customers and receives cash
immediately on purchas
The entity also assists the customers in resolving complaints with the service provided
by airlines. However, each airline is responsible for ful lling obligations associated with
the ticket, including remedies to a customer for dissatisfaction with the service
How would this be dealt with under IFRS 15
Step 1: Identify the contract(s) with a custome
This is clear here when the ticket is purchase
Step 2: Identify the performance obligations in the contrac
This is tricky - is it to arrange for another party provide a ight ticket - or is it - to provide
the ight ticket themselves
Well - look at the risks involved. If the ight is cancelled the airline pays to reimburse
If the ticket doesn't get sold - the entity loses ou
Look at the rewards - the entity can set its own price and thus reward
On balance therefore the entity takes most of the risks and rewards here and thus
controls the ticket - thus they have the obligation to provide the right to y ticke
Step 3: Determine the transaction pric
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This is set by the entit
Step 4: Allocate the transaction price to the performance obligations in the
contrac
The price here is the GROSS amount of the ticket price (they sell it for
Step 5: Recognise revenue when (or as) the entity satis es a performance
obligatio
Recognise the revenue once the ight has occurre
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Illustration 2 - Loyalty discounts
An entity has a customer loyalty programme that rewards a customer with one
customer loyalty point for every $10 of purchases
Each point is redeemable for a $1 discount on any future purchase
Customers purchase products for $100,000 and earn 10,000 point
The entity expects 9,500 points to be redeemed, so they have a stand-alone selling
price $9,50
How would this be dealt with under IFRS 15
Step 1: Identify the contract(s) with a custome
This is when goods are purchase
Step 2: Identify the performance obligations in the contrac
The promise to provide points to the customer is a performance obligation along with,
of course, the obligation to provide the goods initially purchase
Step 3: Determine the transaction pric
$100,00
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Step 4: Allocate the transaction price to the performance obligations in the
contrac
The entity allocates the $100,000 to the product and the points on a relative standalone selling price basis as follows
So the standalone selling price total is 100,000 + 9,500 = 109,50
Now we split this according to their own standalone prices pro-rat
Product $91,324 [100,000 x (100,000 / 109,500]
Points $8,676 [100,000 x 9,500 /109,500
Step 5: Recognise revenue when (or as) the entity satis es a performance
obligatio
Of course the products get recognised immediately on purchase but now lets look at
the points.
Let’s say at the end of the rst reporting period, 4,500 points (out of the 9,500) have
been redeeme
The entity recognises revenue of $4,110 [(4,500 points ÷ 9,500 points) × $8,676] and
recognises a contract liability of $4,566 (8,676 – 4,110) for the unredeemed point
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Syllabus C2. Non-current Assets
Syllabus C2a) Discuss and apply the recognition, derecognition and measurement of non-current
assets including impairments and revaluations.
Initial Recognition of PP
When should we bring PPE into the accounts?
When the following 3 tests are passed
1. When we control the asse
2. When it’s probable that we will get future economic bene t
3. When the asset’s cost can be measured reliabl
What gets included in ‘Cost
1. Directly attributable costs to get it to work and where it needs to b
eg. site preparation, delivery and handling, installation, related professional fees for
architects and engineer
2. Estimated cost of dismantling and removing the asset and restoring the site.
This is:
Dr PPE
Cr Liabilit
All at present valu
This will need discounting and the discount unwound:
Dr interest (with unwinding of discount)
Cr liabilit
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3. Borrowing costs
If it is an asset that takes a while to construct
Interest at a market rate must be recognised or imputed
Let's look at the Future obligated costs in detail.
Future obligated cost
Dr PPE
Cr Liabilit
at present valu
• The present value is calculated by discounting down at the rate given in the exa
eg. 100 in 2 years time at 10% = 100/1.10/1.10 = 82.
• So the double entry would be
Dr PPE 82.6
Cr Liability 82.
However the LIABILITY needs unwinding.
• Unwinding of discoun
Dr Interest
Cr Liabilit
Use the original discount rate (so here 10%
10% x 82.6 = 8.2
Dr Interest 8.26
Cr Liability 8.2
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IAS 16 Depreciatio
The depreciable amount (cost less prior depreciation, impairment, and
residual value) should be allocated on a systematic basis over the asset’s
useful lif
Residual Value & UE
• Should be reviewed at least at each nancial year-en
• if expectations differ from previous estimates, any change is accounted
for prospectively as a change in estimate
Which Method of Depreciation should be used
It should re ect the pattern in which the asset’s economic bene ts are consumed
by the enterpris
How often should depreciation methods be reviewed
• At least annuall
• If the pattern of consumption changes, the depreciation method should be changed
prospectively as a change in estimate
Accounting treatmen
Depreciation should be charged to the income statemen
Depreciation begins when the asset is available for use and continues until the asset
is de-recognised
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Signi cant parts are depreciated separatel
• If the cost model is used each part of an item of PPE with a signi cant cost (in
relation to the total cost) must be depreciated separatel
• Parts which are regularly replaced - depreciate separately
The replacement cost is then added to the asset cost when recognition criteria are met.
The carrying amount of the replaced parts is de-recognise
Major Inspections for faults (e.g. Aircraft
The inspection cost is added to the asset cost when recognition criteria are me
If necessary, the estimated cost of a future similar inspection may be used as an
indication of what the cost of the existing inspection component was when the item was
acquired or constructe
An asset with a component included with a different UEL
This could be something like Land and buildings - basically you should take the land
value away from the total cost and then depreciate the remainder over the UEL of the
building
• Illustratio
Buy House for 100,000.
The land has a value of 40,000.
UEL of building is 10 year
• Solution
The value of the building itself is: 100,000 - 40,000 = 60,00
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Depreciation would be:
Land 40,000 - zero depreciation
Building 60,000 / 10 years = 6,000
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PPE - After Initial recognitio
After the initial recognition there are 2 choices:
Cost mode
• Cost less accumulated depreciation and impairmen
• Depreciation should begin when ready for use not wait until actually use
Revaluation mode
Fair value at the date of revaluation less depreciatio
• If we follow the revaluation model - how often should we revalue
Revaluations should be carried out regularl
For volatile items this will be annually, for others between 3-5 years or less if deemed
necessary
• Ok and which assets get revalued
If an item is revalued, its entire class of assets should be revalue
• And to what value
Market value normally is fair value
Specialised properties will be revalued to their depreciated replacement cost
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Accounting treatment of a Revaluation
An increase in the revalued amount (above depreciated historic cost
Any increase above depreciated historic cost is credited to equity under the heading
"revaluation surplus" (and shown in the OCI
DR Asset
CR equity - “revaluation surplus
An increase in the revalued amount (up to depreciated historic cost
is taken to the income statement
DR Assets
CR I/
A decrease down to Historic cos
Any decrease down to depreciated historic cost is taken to the revaluation reserve (and
OCI) as a debit
DR equity - “revaluation surplus”
CR Asset
A decrease below historic cos
Any decrease below depreciated historic cost is debited to the income statemen
DR Income statement
CR Asset
Disposal of a Revalued Asse
The revaluation surplus in equity - IS NOT transferred to the income statement - it just
drops into RE
It will, therefore, only show up in the statement of changes in equity
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Let´s make no mistake about this - the revaluation adjustments can be very
tricky
when you revalue upwards
1. the asset will increase .... therefor
2. the depreciation will increase ... and henc
3. the expenses will increase ..
4. This means smaller pro ts and smaller retained earnings just because of the
revaluation
Shareholders will not be impressed by this as retained earnings are where they are
legally allowed to get their dividends from
Because of this, a transfer is made out of the revaluation reserve and into retained
earnings every year with the extra depreciation caused by the previous revaluation
This, though, then causes more problems if the asset is subsequently impaired etc. but worry not - the COW has the answer
This is what you do in a tricky looking revaluation question
1. Calculate the Depreciated Historic Cos
This is basically what the asset would have been worth had nothing (revaluations/
impairments) occurred in the past
We do this because anything above this gure is a genuine revaluation and so goes to
the RR
Similarly anything below this is a genuine impairment and goes to the income
statement
2. Calculate the NBV just before the Revaluation or Impairment in questio
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3. Now calculate the difference between step 2 and the new NBV (the amount to
be revalued or impaired to)
This will be the debit or credit to the asset
The other side of the entry will depend on the depreciated historic cost calculated in
step 1
I know all that sounds tricky - so let’s look at an illustration
Illustratio
An asset is bought for 1,000 (10yr UEL).
2 years later it is revalued to 1,000.
One year after that it is impaired to 400
What is the double entry for this impairment
1. Calculate the Depreciated Historic Cos
DHC would be 1,000 less 3 years of depreciation = 70
2. Calculate the NBV just before the Impairmen
NBV at date of impairment = 1000 NBV one year earlier.
So 1,000 less depreciation of (1,000 / 8) = 125 = 87
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3. Now calculate the difference between step 2 and the amount to be impaired t
Impair to 400
So from 875 to 400 - credit Asset 47
4. Accounting treatmen
Dr RR with any amount above the DHC of 700. So 875-700 = 175
Dr I/S with any amount below DHC of 700. So 700-400 = 30
Dr I/S 300
Dr RR 175
Cr PPE 47
Illustratio
1/1/20x2 an asset has a carrying amount of 140 and a remaining UEL of 7 years. No
residual value. The asset is revalued to 60 on 1/1/20x3
On 1/120x5 the asset is revalued to 11
1. Calculate the Depreciated Historic Cos
DHC would be 140 - depreciation (140 / 7 years x 3 years) = 8
2. Calculate the NBV just before the Revaluatio
The asset is revalued to 60 on 1/1/20x3
So 60 less depreciation of (60 / 6 x 2) = 4
3. Now calculate the difference between step 2 and the amount to be revalued t
On 1/120x5 the asset is revalued to 11
So from 40 to 110 - DR Asset 7
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4. Accounting treatmen
Cr RR with any amount above the DHC of 80. So 110-80 = 30
Cr I/S with any amount below DHC of 80. So 80-40 = 4
Dr PPE 70
Cr I/S 40
Cr RR 3
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Review Pag
1. PPE costs $1,000, has installation costs of $100, dismantling fee with a present value of
$50 and some losses expected at rst while operators get used to the system of $50. At
what Value should the PPE be in the accounts initially?
2. The PPE above has a 10 yr. UEL but is not used for the rst year. How much is
depreciation and from when?
3. A piece of PPE has a dismantling fee in 2 years of $1,000 and the discount rate is 10%.
What entries would be put in the accounts for this in year 1?
4. What is the best method for depreciation? Reducing balance or straight line?
5. An item of PPE is bought for 1,000 and has a 10 yr. UEL. What is the NBV in 3 years
time?
6. The PPE above is then revalued 1,050. How is this increase accounted for
7. What would the depreciation charge be for the following year
8. At the end of that year what is the NBV
9. What is the Depreciated Historic Cost
10. It is now revalued down to 400. How is this fall accounted for
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Exam Standard Questio
A piece of property, plant and equipment (PPE) cost $12 million on 1 May 2008. It is being
depreciated over 10 years on the straight-line basis with zero residual value.
On 30 April 2009, it was revalued to $13 million and on 30 April 2010, the PPE was
revalued to $8 million.
The whole of the revaluation loss had been posted to the statement of comprehensive
income and depreciation has been charged for the year.
Make any adjustments necessary for the year ended 30 April 201
Answe
At 30 April 2009, a revaluation gain of ($13m – $12m – depreciation $1·2m) $2·2 million
would be recorded in equity for the PPE. At 30 April 2010, the carrying value of the PPE
would be $13m – depreciation of $1·44m i.e. $11·56m.
Thus there will be a revaluation loss of $11·56m – $8m i.e. $3·56m. Of this amount $1·96m
will be charged against revaluation surplus in reserves and $1·6 million will be charged to
profit or loss
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Componentisatio
Various components of an asset to be identi ed and depreciated separately if
they have differing patterns of bene ts.
If a signi cant component is expected to wear out quicker than the overall asset, it is
depreciated over a shorter period
Then any restoring or replacing is capitalised
This approach means different depreciation periods for different components
Examples are land, roof, walls, boilers and lifts
So the depreciation re ects the effect of a future restoration or replacement
A challenging process due to.
• Dif culties valuing component
because it is unusual for the various component parts to be valued, so.
1. Involve company personnel in the analysi
2. Applying component accounting to all asset
3. How far the asset should be broken down into component
4. Any measure used to determine components is subjectiv
5. Asset registers may need to be rewritte
6. Breaking down assets needs ‘materiality', setting a de minimis limi
• When a component is replaced or restore
The old component is de-recognised to avoid double-counting and the new component
recognised
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• Where it is not possible to determine the carrying amount of the replaced part
of an item of PP
Best estimates are required
A possibility is
Use the replacement cost of the component, adjusted for any subsequent
depreciation and impairmen
• A revaluatio
Apportion over the signi cant components
• When a component is replace
1. The carrying value of the component replaced should be charged to the income
statemen
2. The cost of the new component recognised in the statement of nancial positio
Transition to IFR
Use the ‘fair value as deemed cost’ for the asset
The fair value is then allocated to the different signi cant parts of the asse
Componentisation adds to subjectivity
The additional depreciation charge can be signi cant
Accountants and other professionals must use their professional judgment when
establishing signi cance levels, assessing the useful lives of components and
apportioning asset values over recognised components
Discussions with external auditors will be key one during this proces
IAS 36 Impairment
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A company cannot show anything in its accounts higher than what they’re
actually worth
“What they’re actually worth” is called the “Recoverable Amount”
So no asset can be in the accounts at MORE than the recoverable amount
Less is ne, just not more
So, assets need to be checked that their NBV is not greater than the RA
If it is then it must be impaired down to the R
So how do you calculate a Recoverable Amount
There are 2 things an entity can do with an asse
1. Sell it o
2. Use i
It will obviously choose the one which is most bene cia
So, you'll choose the higher of the followin
• FV-CT
(Fair value less costs to sell
• VI
(Value in use
So the higher of the FV - CTS and VIU is called the Recoverable amoun
Illustratio
In the accounts an item of PPE is carried at 100.
It’s FV-CTS is 90 and its VIU is 80
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• This means the recoverable amount is 90 (higher of FV-CTS and VIU
• And that the PPE (100) is being carried at higher than the RA, which is not allowed,
and so an impairment of 10 down to the RA is required in the accounts (100 - 90
Recognition of an Impairment Loss
An impairment loss should be recognised whenever RA is below carrying amount
The impairment loss is an expense in the income statemen
Adjust depreciation for future periods
Here's some boring de nitions for you
• Fair value
The amount obtainable from the sale of an asset in a bargained transaction between
knowledgeable, willing parties
• Value in use
The discounted present value of estimated future cash ows expected to arise from
- the continuing use of an asset, and fro
- its disposal at the end of its useful lif
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Recoverable Amount in more detail
Fair Value Less Costs to Sel
• If there is a binding sale agreement, use the price under that agreement less costs of
disposa
• If there is an active market for that type of asset, use market price less costs of
disposal
Market price means current bid price if available, otherwise the price in the most recent
transactio
• If there is no active market, use the best estimate of the asset's selling price less
costs of disposal (direct added costs only (not existing costs or overhead)
Let's look at VIU in more detail.
The future cash ows
• Must be based on reasonable and supportable assumption
(the most recent budgets and forecasts
• Budgets and forecasts should not go beyond ve year
• The cash ows should relate to the asset in its current conditio
– future restructuring to which the entity is not committed and expenditures to improve
the asset's performance should not be anticipate
• The cash ows should not include cash from nancing activities, or income ta
• The discount rate used should be the pre-tax rate that re ects current market
assessments of the time value of money and the risks speci c to the asse
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Identifying an Asset That May Be Impaired
At each balance sheet date, review all assets to look for any indication that an asset
may be impaired.
If there is an indication that an asset may be impaired, then you must calculate the
asset’s recoverable amount... to see if it is below carrying valu
if it is - then you must impair i
Illustratio
Asset has carrying value of 10
It has a FV-CTS of 9
It has a VIU of 9
It's recoverable amount is therefore the higher of the 2 = 95 and this is below the
carrying value in the books (100) and so needs impairment of 5
What are the indicators of impairment
1. Losses / worse economic performanc
2. Market value decline
3. Obsolescence or physical damag
4. Changes in technology, markets, economy, or law
5. Increases in market interest rate
6. Loss of key employee
7. Restructuring / re-organisatio
Just to confuse you a little bit more, we do not JUST check for impairment when there
has been an indicator (listed above)
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We also check the following ANNUALLY regardless of whether there has been an
impairment indicator or not
1. an intangible asset with an inde nite useful lif
2. an intangible asset not yet available for us
3. goodwill acquired in a business combinatio
Reversal of an Impairment Los
First of all you need to think about WHY the impairment has been reversed.
1. Discount Rate Change
Here, no reversal is allowed. So if the discount rate lowers and thus improves the VIU,
this is not considered to be a reversal of an impairment
2. Other
The increased carrying amount due to reversal should not be more than what the
depreciated historical cost would have been if the impairment had not been recognise
3. Accounting treatmen
Reversal of an impairment loss is consistent with the original treatment of the
impairment in terms of whether recognised as income in the income statement or OCI
Reversal of an impairment loss for goodwill is prohibited
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Cash Generating Unit
Sometimes individual assets do not generate cash in ows so the calculation
of VIU is impossible
In such a case then the asset will belong to a larger group that does generate cash
This is called a cash generating unit (CGU) and it is the carrying value of this which is
then tested for impairmen
Recoverable amount should then be determined for the asset's cash-generating unit
(CGU
CGU - A restauran
For example, the tables in a restaurant do not generate cash
They do belong to a larger CGU though (the restaurant itself)
It is the restaurant that is then tested for impairmen
The carrying amount of the CGU is made up of the carrying amounts of all the assets
directly attributed to it
Added to this will be assets that are not directly attributed such as head of ce and a
portion of goodwill
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Illustratio
A subsidiary was acquired, which included 3 cash generating units and the goodwill for
the whole subsidiary was 40
Each CGU would be allocated part of the 40 according to the carrying amount of the
assets in each CGU as follows
CGU
1
2
3
NBV
200
200
400
10
10
20
Goodwill
A CGU to which goodwill has been allocated (like the 3 above) shall then be tested for
impairment at least annually by comparing the carrying amount of the unit, including the
goodwill, with the recoverable amount of the CG
If the carrying amount of the unit exceeds the recoverable amount of the unit, the entity
must recognise an impairment loss (down to the unit’s RA
Order of Impairmen
But the problem is what do you impair rst - the assets or the goodwill in the unit
The impairment loss is allocated in the following order
1. Reduce any goodwill allocated to the CG
2. Reduce the assets of the unit pro rat
Note: The carrying amount of an asset should not be reduced below its own
recoverable amoun
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Illustration
The following carrying amounts were recorded in the books of a restaurant immediately
prior to the impairment
Goodwill
100
Property, plant and equipment
100
Furniture and xtures
100
The fair value less costs to sell of these assets is $260m whereas the value in use is
$270
Required: Show the impact of the impairmen
Solutio
Recoverable amount is 270 - so the CV of the CGU needs to be reduced from 300 to
270 = 3
This 30 reduces goodwill down to 7
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Review Pag
1. When do you check for impairment
2. What is recoverable amount
3. If RA is higher than the carrying amount what do you do
4. If RA is lower than the carrying amount what do you do
5. What if the asset that is being checked for impairment is not a cash generating unit what
must you do
6. What are steps for calculating the correct impairment to goodwill when the proportionate
method is used
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Exam Standard Questio
A subsidiary company had purchased computerised equipment for $4 million on 31
October 2006 to improve the manufacturing process.
Whilst re-organising the group, Ghorse had discovered that the manufacturer of th
computerised equipment was now selling the same system for $2·5 million. The projected
cash ows from the equipment are
Year ended 31 Octobe
2008 $1·
2009 $2·
2010 $2·
The residual value of the equipment is assumed to be zero.
The company uses a discount rate of 10%. The directors think that the fair value less costs
to sell of the equipment is $2 million. The directors of Ghorse propose to write down the
non-current asset to the new selling price of $2·5 million.
The company’s policy is to depreciate its computer equipment by 25% per annum on the
straight line basis. (5 marks
Solutio
At each balance sheet date, Ghorse should review all assets to look for any indication that
an asset may be impaired, i.e. where the asset’s carrying amount ($3 million) is in excess
of the greater of its net selling price and its value in use.
IAS36 has a list of external and internal indicators of impairment. If there is an indication
that an asset may be impaired, then the asset’s recoverable amount must be calculated
(IAS36 paragraph 9).
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The recoverable amount is the higher of an asset’s fair value less costs to sell (sometimes
called net selling price) and its value in use which is the discounted present value of
estimated future cash ows expected to arise from
(i) the continuing use of an asset, and fro
(ii) its disposal at the end of its useful lif
If the manufacturer has reduced the selling price, it does not mean necessarily that the
asset is impaired. One indicator of impairment is where the asset’s market value has
declined signi cantly more than expected in the period as a result of the
passage of time or normal usage. The value-in-use of the equipment will be $4·7 million
Cash Discounted at 10
$m
2008 1·
2009 1·
2010 1·
–––
Value in use – 4·
–––
The fair value less costs to sell of the asset is estimated at $2 million. Therefore, the
recoverable amount is $4·7 million which is higher than the carrying value of $3 million
and, therefore, the equipment is not impaired
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Syllabus C2b) Discuss and apply the accounting requirements for the classi cation and
measurement of non-current assets held for sale.
Assets Held for Sal
How do we deal with items in our accounts which we are no longer going to
use, instead we are going to sell them
So, think about this for a moment.. Why does this matter to users
Well, the accounts show the business performance and position, and you expect to see
assets in there that they actually are looking to continue using
Therefore their values do not have to be shown at their market value necessarily (as
your intention is not to sell them
Here, though, everything changes… we are going to sell them
So maybe market value is a better value to use, but they haven’t been sold yet, so
showing them at MV might still not be appropriate as this value has not yet been
achieve
So these are the issues that IFRS 5 tried, in part, to deal with and came up with the
following solution.
Accounting Treatmen
1. Step 1 - Calculate the Carrying Amount..
Bring everything up to date when we decide to sel
This means
- charge the depreciation as we would normally up to that date or
- revalue it at that date (if following the revaluation policy
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2. Step 2 - Calculate FV - CT
Now we can get on with putting the new value on the asset to be sold.
Measure it at Fair Value less costs to sell (FV-cts)
This is because, if you think about it, this is the what the company will receive
HOWEVER, the company hasn’t actually made this sale yet and so to revalue it now to
this amount would be showing a pro t that has not yet happene
3. Step 3 - Value the Assets held for sal
IFRS 5 says the new value should actually be
...The lower of carrying amount (step 1) and FV-CTS (step 2
4. Step 4 - Check for an Impairmen
Revaluing to this amount might mean an impairment (revaluation downwards) is
needed
This must be recognised in pro t or loss, even for assets previously carried at revalued
amounts
Also, any assets under the revaluation policy will have been revalued to FV under step
1
Then in step 2, it will be revalued downwards to FV-cts
Therefore, revalued assets will need to deduct costs to sell from their fair value and this
will result in an immediate charge to pro t or loss
Subsequent increase in Fair Value
• This basically happens at the year-end if the asset still has not been sol
A gain is recognised in the p&l up to the amount of all previous impairment losses
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Non-depreciatio
Non-current assets or disposal groups that are classi ed as held for sale shall not be
depreciated
When is an asset recognised as held for sale
• Management is committed to a plan to sel
• The asset is available for immediate sal
• An active programme to locate a buyer is initiate
• The sale is highly probable, within 12 months of classi cation as held for sal
• The asset is being actively marketed for sale at a sales price reasonable in relation
to its fair valu
Abandoned Asset
The assets need to be disposed of through sale. Therefore, operations that are
expected to be wound down or abandoned would not meet the de nition. Therefore
assets to be abandoned would still be depreciated
Balance sheet presentatio
Presented separately on the face of the balance sheet in current asset
• Subsidiaries Held for Disposa
IFRS 5 applies to accounting for an investment in a subsidiary held only with a view to
its subsequent disposal in the near future
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• Subsidiaries already consolidated now held for sal
The parent must continue to consolidate such a subsidiary until it is actually disposed
of. It is not excluded from consolidation and is reported as an asset held for sale under
IFRS 5
So subsidiaries held for sale are accounted for initially and subsequently at FV-CTS of
all the net assets not just the amount to be disposed of.
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Held for sale disposal grou
This is where we sell more than a single asset, in fact it may be a whole
company
A 'disposal group' is a group of assets, possibly with some associated liabilities, which
an entity intends to dispose of in a single transaction
Any impairment losses reduce the carrying amount of the disposal group in the order of
allocation required by IAS 3
A disposal group with reversal of impairment losse
Normally the rule here is that an impairment under IFRS 5 can only be reversed up to
as much as a previous impairment
A disposal group may take up the advantage of some assets within the group using up
the unused Impairment losses on other assets
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Illustratio
Disposal
group assets
Asset 1
Asset 2
Asset 3
Previous
impairment
(100)
(20)
(30)
NBV
80
90
100
Here the total nbv is 270
If by the year end the FV-CTS is now
Asset 1: 150,
Asset 2: 100
Asset 3: 15
Asset 1 it can be revalued to 150, increase of 70 as previous impairment was 10
Asset 2 can be revalued to 100, an increase of 10 as previous impairment was 2
Asset 3 could normally not be revalued to 150, an increase of 50 but only to 130 as it’s
previous impairment was only 3
However, it can also use any unused impairments of the other assets in it's disposal
group such as 10 from asset 2 and a further 10 from asset 1, and so can be revalued
up to 150
What if the asset or disposal group is not sold within 12 months
1. Normally, returns to PPE at the amount it would have been at had it not gone to
held for sale
2. Check for impairment
3. Or, keep in HFS if delay is caused by circumstances outside the control of the entity
e.g
Buyer unexpectedly imposes transfer conditions which extend beyond a yea
Or the market demand has collapsed.
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1. When a company decides to sell one of its assets what must it do to that asset rst
2. At what value is a HFS asset held initially in the SFP
3. Where is this value shown on the SFP
4. What happens if this asset is still not sold at the year end and has decreased in value
5. What happens if this asset is still not sold at the year end and has Increased in value
6. What is the rule for reversal of impairment losses for HFS assets
7. What is special about disposal groups when looking at reversal of impairment losses
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Exam Question Pag
Ghorse identi ed two manufacturing units, Cee and Gee, which it had decided to dispose
of in a single transaction. These units comprised non-current assets only.
One of the units, Cee, had been impaired prior to the nancial year end on 30 September
2007 and it had been written down to its recoverable amount of $35 million
The criteria in IFRS5, ‘Non-current Assets Held for Sale and Discontinued Operations’, for
classi cation as held for sale, had been met for Cee and Gee at 30 September 2007. The
following information related to the assets of the cash generating units at 30 September
2007
Depreciated
Historic Cost
FV-CTS
IFRS 5 Value
Cee
50
35
35
Gee
70
90
70
The fair value less costs to sell had risen at the year end to $40 million for Cee and $95
million for Gee.
The increase in the fair value less costs to sell had not been taken into account by Ghorse
Solutio
The two manufacturing units are deemed to be a disposal group under IFRS5 ‘Non-current
Assets Held for Sale and Discontinued Operations’ as the assets are to be disposed of in a
single transaction
Any impairment loss will reduce the carrying amount of the non-current assets in the
disposal group in the order of allocation required by IAS36 ‘Impairment of Assets’
.
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Immediately before the initial classi cation of the asset as held for sale, the carrying
amount of the asset will be measured in accordance with applicable IFRSs
On classi cation as held for sale, disposal groups are measured at the lower of carrying
amount and fair value less costs to sell. Impairment must be considered both at the time of
classi cation as held for sale and subsequently.
On classi cation as held for sale, any impairment loss will be based on th
difference between the adjusted carrying amounts of the disposal group and fair value less
costs to sell.
Any impairment loss that arises by using the measurement principles in IFRS5 must be
recognised in pro t or loss (IFRS5 paragraph 20)
Thus Ghorse should not increase the value of the disposal group above $105 million at 30
September 2007 as this is the carrying amount of the assets measured in accordance with
applicable IFRS immediately before being classi ed as held fo
sale (IAS36 and IAS16).
After classi cation as held for sale, the disposal group will remain at this value as this is
the lower of the carrying value and fair value less costs to sell, and there is no impairment
recorded as the recoverable amount of the disposal group is in excess of the carrying
value.
At a subsequent reporting date the disposal group should be measured at fair value less
costs to sell. However, IFRS5 (paragraphs 21–22) allows any subsequent increase in fair
value less costs to sell to be recognised in pro t or loss to the extent that it is not in excess
of any impairment loss recognised in accordance with IFRS5 or previously with IAS36.
Thus any increase in the fair value less costs to sell can be recognised as follows at 31
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October 2007
$
Fair value less costs to sell – Cee 4
Fair value less costs to sell – Gee 9
This gives a total of 135, compared to the carrying value (105) - meaning a potential
increase of 3
However an increase can only be as much as a previous impairment, which only occurred
in Cee (50 – 35) 1
Therefore, the carrying value of the disposal group can increase by $15 million and pro t
or loss can be increased by the same amount, where the fair value rises. Thus the value of
the disposal group will be $120 million.
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Syllabus C2c) Discuss and apply the accounting treatment of investment properties including
classi cation, recognition, measurement and change of use.
Investment propert
A building (or land) owned but not used - just an investment
The building is not used it just makes cash by
1. its FV going up (capital appreciation) o
2. from rental incom
It might not even belong to the entity it could even be just on an operating lease
This is still an IP (if the FV model is used
This allows leased land (which is normally an operating lease) to be classi ed as
investment property
Land held for indeterminate future use is an investment property where the entity has
not decided that it will use the land as owner occupied or for short-term sal
Accounting treatment for the Rental Incom
1
Add it to the income statemen
2
Easy! (Even for a gonk like you!) :
Accounting treatment for the FV increas
The difference in FV each year goes to the I/
Double easy - double gonk
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No depreciation is needed because it's not used :
Give me examples of what can be Investment Properties cowy
ok you asked for it
1. Land held for long-term capital appreciation rather than short-term sal
2. Land held for a currently undetermined future us
This basically means they haven't yet decided what to do with the lan
3. A building owned but leased to a third party under an operating leas
4. A building which is vacant but is held to be leased out under an operating leas
5. Property being constructed or developed for future use as an investment propert
Ok smarty pants - what ISN'T an Investment property
• Property intended for sale in the ordinary course of busines
(It's stock!
• Owner-occupied propert
• Property leased to another entity under a nance leas
• Property being constructed for third partie
Parts of propert
These can be investment properties if the different sections can be sold or leased
separately
Mais oui, monsier/madam
For example, company owns a building and uses 4 oors and rents out 1. The
latter can be an IP while the rest is treated as normal PP
Can it still be an IAS 40 Investment property if we are involved in the building still
by giving services to it
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and insigni cant
If it’s a signi cant part of the deal with the tenant then the property becomes an
IAS 16 property
What if my subsidiary uses it but I don’t
Right ok - now your questions are getting on my nerves… but still - it’s an IAS 40
Investment property in your own individual accounts - because you personally are not
using it
However, in the group accounts it´s an IAS 16 property because someone in the group
is using it
..now enough of the questions already.. get back to facebook .
When can we bring an Investment Property into the accounts?
As with everything else, an investment property should be recognised when
1. It is probable that the future economic bene ts will ow; an
2. The cost of the investment property can be measured reliably
Cool - and at how much do we show it at initially
Initially measured at cost
This includes
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Si Claro hombre/mujer - It´’s still an IAS 40 Investment property if the supply is small
1. Purchase pric
2. Directly attributable costs, for example transaction costs (professional fees,
property transfer taxe
This does not include
1. Start-up cost
2. Operating losses incurred before the investment property achieves the planned
level of occupanc
3. Abnormal amounts of wasted labour, material or other resources incurred in
constructing or developing the propert
N
If the property is held under a lease then you must show it initially at the lower of
• Fair value an
• The present value of the minimum lease payment
Ok so how do we value it after the initial cost
You choose between two models
1. The IAS 16 cost mode
2. The fair value mode
The policy chosen should be applied consistently to all of the entity’s investment
property
If the property is held under an operating lease the fair value model must be adopted.
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Basically as per IAS 16. The property is measured at cost less depreciation and
impairment losses (the fair value should still be disclosed though)
Fair value mode
All investment properties should be measured at fair value at the end of each reporting
period
Changes in fair value added to / subtracted from the asset and the other side
recognised in the income statement
No depreciation is therefore ever recognised
Change in use
This bit deals with when we decide say to use it as a normal property instead of renting
it out or vice-versa etc
Example
1. We occupy and start to use the investment propert
All owner-occupied property falls under IAS 16 - cost less depreciation and
impairment losses
If the FV model was being used then the FV at change of use date is the deemed
cost for future accounting
2. Start developing an investment property with the intention of selling it when
nishe
The property is to be sold in the normal course of business and should therefore
be reclassi ed as inventory and accounted for under IAS 2 Inventories
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Cost mode
3. Start developing an investment property with the intention of letting it out
when nishe
The property should continue to be held as an investment property under IAS 40
4. We were using the building but now we are going to let it out when nishe
Transfer to investment properties and account under IAS 40.
When we transfer it though (if FV model) we revalue it
Any revaluation here goes to the Revaluation reserve and OCI as normal (not the
income statement as under IAS 40)
5. A property that was originally held as inventory has now been let to a third
party
Transfer from inventory to investment properties
Here when the transfer is made, we revalue (if FV model) to FV and any
difference goes to the income statement
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Review Pag
1. How much interest can be capitalised on an asset which takes 3 weeks to build
2. How much interest can be added to the cost of an asset when using a speci c loa
3. How much interest can be added to the cost of an asset when using general funds
4. What is an Investment Property
5. How is an IP using the FV model accounted for
6. Can 1 oor of a building be an IP
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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.
Solutio
The land should be classified as an investment property. Although Grange has not decided
what to do with the land, it is being held for capital appreciation.
IAS 40 ‘Investment Property’ states that land held for indeterminate future use is an
investment property where the entity has not decided that it will use the land as owner
occupied or for short-term sale.
The fall in value of the investment property after the year-end will not affect its year-end
valuation as the uncertainty relating to the regeneration occurred after
the year-end
Dr Investment property $6 millio
Cr PPE $6 millio
Dr Investment property $2 millio
Cr Profi t or loss $2 millio
No depreciation will be charge
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Exam Question Pag
Syllabus C2d) Discuss and apply the accounting treatment of intangible assets including the criteria
for recognition and measurement subsequent to acquisition.
What is an intangible asse
What is an Intangible asset?
Well, according to IAS 38, it’s an identi able non-monetary asset without physical
substance, such as a licence, patent or trademark
The three critical attributes of an intangible asset are
1. Identi abilit
2. Control (power to obtain bene ts from the asset
3. Future economic bene t
Whooah there partner, what´s identi able mean?
Well it just means the asset is one of 2 things
1. It is SEPARABLE, meaning it can be sold or rented to another party on its own
(rather than as part of a business) o
2. It arises from contractual or other legal rights
It is the lack of identi ability which prevents internally generated goodwill being
recognised. It is not separable and does not arise from contractual or other legal rights
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Example
• Employees can never be recognised as an asset; they are not under the control of
the employer, are not separable and do not arise from legal right
• A taxi licence can be an intangible asset as they are controlled, can be sold/
exchanged/transferred and arise from a legal right
(The intangible doesn’t have to be separable AND arise from a legal right, just one or
the other is enough).
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When can you recognise an IA and for how much
Well it's the old reliably measurable and probable again!
In posher terms..
1. When it is probable that future economic bene ts attributable to the asset will ow
to the entit
2. The cost of the asset can be measured reliabl
So at how much should we show the asset at initially
Well thick pants - it’s obviously brought in at cost!! Aaarh but what is cost I hear you
whisper in my big oppy cow-like ears.. well it’
Purchase price plus directly attributable cost
Remember that directly attributable means costs which otherwise would not have
been paid, so often staff costs are excluded
Let’s now look at some speci c issues that come up often in the exam
• IA acquired as part of a business combinatio
Well this time, the intangible asset (other than goodwill ) should initially be recognised
at its fair value
If the FV cannot be ascertained then it is not reliably measurable and so cannot be
shown in the accounts
In this case by not showing it, this means that goodwill becomes higher
• Research and Development Cost
Research costs are always expensed in the income statemen
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Development costs are capitalised only after technical and commercial feasibility of the
asset for sale or use have been established
This means that the enterprise must intend and be able to complete the intangible
asset and either use it or sell it and be able to demonstrate how the asset will generate
future economic bene ts
If entity cannot distinguish between research and development - treat as research and
expens
• Research and Development Acquired in a Business Combinatio
Recognised as an asset at cost, even if a component is research
Subsequent expenditure on that project is accounted for as any other research and
development cos
• Internally Generated Brands, Mastheads, Titles, List
Should not be recognised as assets - expense them as there is no reliable measur
• Computer Softwar
If purchased: capitalise as an IA
Operating system for hardware: include in hardware cos
If internally developed: charge to expense until technological feasibility, probable
future bene ts, intent and ability to use or sell the software, resources to complete the
software, and ability to measure cost
Always expense the following
1. Internally generated goodwi
2. Start-up, pre-opening, and pre-operating cost
3. Training cos
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4. Advertising and promotional cost, including mail order catalogue
5. Relocation costs
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Intangible Assets - Future Measuremen
So we can use either historic cost or revaluation.
Historic Cost (and amortise
Generally intangible assets should be amortised over their useful economic life
1. If has a useful economic lif
Amortise over UE
Residual values should be assumed to be nil, except in the rare circumstances
when an active market exists or there is a commitment by a third party to
purchase the asset at the end of its useful life
2
If has an inde nite UE
Check for impairment every yea
There should also be an annual review to see if the inde nite life assessment is
still appropriate
Revaluation (and amortise
This model can only be adopted if an active market exists for that type of asset
Revaluing Intangibles is hard, because there is no physical substance, and so a
reliable measure is tricky
1. There MUST be an active marke
2. The item MUST be unique
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So what’s an ‘active market’
• Firstly I should mention that these are rare, but may exist for certain licences and
production quota
• These, though, are markets where the products are unique, always trading and prices
available to publi
Examples where they might exist
1
Milk quota
2
Stock exchange seat
3
Taxi medallion
These two tests make it very dif cult for any intangibles to be revalued so the historic
cost choice is by far the most common
If the revaluation model is adopted, revaluation surpluses and de cits are accounted for
in the same way as those for PPE
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Research and developmen
Research is expensed, Development is often an asset.
Researc
Research is investigation to get new knowledge and understandin
All goes to I/
Developmen
Under IAS 38, an intangible asset must demonstrate all of the following criteria
(use pirate as a memory jogger
1. Probable future economic bene t
2. Intention to complete and use or sell the asse
3. Resources (technical, nancial and other resources) are adequate and available
to complete and use the asse
4. Ability to use or sell the asse
5. Technical feasibility of completing the intangible asset (so that it will be available
for use or sale
6. Expenditure can be measured reliabl
Once capitalised they should be amortised
Amortisation begins when commercial production has commenced.
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Once capitalised they should be amortise
The cost of the development expenditure should be amortised over the useful life.
Therefore, the cost of the development expenditure is matched against the revenue it
produces
Amortisation must only begin when the asset is available for use (hence matching the
income and expenditure to the period in which it relates)
It is an expense in the income statement
Dr Amortisation expense (I/S)
Cr Accumulated amortisation (SFP
It must be reviewed at the year-end to check it still is an asset and not an expense
If the criteria are no longer met, then the previously capitalised costs must be written off
to the statement of pro t or loss immediately
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Review Pag
1. What does identi able mean
2. What happens if an IA is bought as part of a subsidiary, but its value cannot be
measured reliably
3. When acquiring a sub which has some research costs - how are these treated in the
group accounts initially
4. What options are available for the accounting treatment of Intangibles
5. Which option is rare and why
6. Should all intangibles be amortised
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Exam Question Pag
H is acquiring S.
S has several marketing-related intangible assets that are used primarily in marketing or
promotion of its products
These include trade names, internet domain names and non-competition agreements.
These are not currently recognised in S’s nancial statement
How should these be treated
Solutio
Intangible assets should be recognised on acquisition under IFRS3 (Revised).
These include trade names, domain names, and non-competition agreements. Thus these
assets will be recognised and goodwill effectively reduced.
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Review Pag
1. Where do you put income from a revenue grant
2. What are the choices for a capital grant
3. What if the grant is for land
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Exam Question Pag
Norman has obtained a signi cant amount of grant income for the development of hotels
in Europe.
The grants have been received from government bodies and relate to the size of the hotel
which has been built by the grant assistance.
The intention of the grant income was to create jobs in areas where there was signi cant
unemployment.
The grants received of $70 million will have to be repaid if the cost of building the hotels is
less than $500 million. (4 marks
Solutio
The accruals concept is used by the standard to match the grant received with the related
costs.
The relationship between the grant and the related expenditure is the key to establishing
the accounting treatment. Grants should not be recognised until there is reasonable
assurance that the company can comply with the conditions relating to their receipt and
the grant will be received.
Provision should be made if it appears that the grant may have to be repaid
There may be dif culties of matching costs and revenues when the terms of the grant do
not specify precisely the expense towards which the grant contributes. In this case the
grant appears to relate to both the building of hotels and the creation o
employment.
However, if the grant was related to revenue expenditure, then the terms would have been
related to payroll or a xed amount per job created. Hence it would appear that the grant is
capital based and should be matched against the depreciation of the hotels by using a
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deferred income approach or deducting the grant from the carrying value of the asset
(IAS20).
Additionally the grant is only to be repaid if the cost of the hotel is less than $500 million
which itself would seem to indicate that the grant is capital based.
If the company feels that the cost will not reach $500 million, a provision shoul
be made for the estimated liability if the grant has been recognised
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Syllabus C2e) Discuss and apply the accounting treatment for borrowing costs.
Borrowing Cost
Let’s say you need to get a loan to construct the asset of your dreams - well
the interest on the loan then is a directly attributable cost
So instead of taking interest to the I/S as an expense you add it to the cost of the
asset. (in other words - you capitalise it
There are 2 scenarios here to worry about
1. You use current borrowings to pay for the asse
2. You get a speci c loan for the asse
1) Use current borrowing
This is looking at the scenario where we use funds we have already borrowed from
different sources
So, if the funds are borrowed generally – we need to calculate the weighted average
cost of all the loans we have generally
(I know you're thinking - how the cowing'eck do I work out the weighted average of
borrowings... aaarrgghh!)
Well relax my little monkey armpit - here's how you do it
Step 1: Calculate the total amount of borrowing
Step 2: Calculate the interest payable on these in tota
Step 3: Weighted average of borrowing costs = Divide the interest by the borrowing et voila
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Step 4: We then take this weighted average of borrowing costs and multiply it by any
expenditure on the asset
The amount capitalised should not exceed total borrowing costs incurred in the period
Illustratio
5% Overdraft 1,000
8% Loan 3,000
10% Loan 2,00
We buy an asset with a cost of 5,000 and it takes one year to build - how much interest
goes to the cost of the asset
Solutio
Calculate the WA cost of the borrowings
Step 1: Total Borrowing = (1,000+3,000+2,000) = 6,00
Step 2: Interest payable = (50+240+200) = 49
Step 3: 490/6,000 = 8.17
Step 4: So the total interest to be added to the asset is 8.17% x 5,000 = 40
2) Get a speci c loa
Ok well you would think this is easy - just the interest paid, surely?! But it’s not quite
that easy
It is the actual borrowing costs less investment income on any temporary
investment of the fund
So what does this mean exactly
Well imagine you need 10,000 to build something over 3 years. You borrow 10,000 at
the start but don’t need it all straight away
So the bit you don’t need you leave in the bank to gain interes
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So, the amount you could capitalise would be the interest paid on the 10,000 less the
interest received on the amount not used and left in the bank (or reinvested elsewhere
Steps
1. Calculate the interest paid on the speci c loa
2. Calculate any interest received on loans proceeds not use
3. Add the net of these 2 to 'cost of the asset
Illustratio
Buy asset for 2,000 - takes 2 years to build
Get a 2,000 10% loan
We reinvest any money not used in an 8% deposit account.
In year 1 we spend 1,200
How much interest is added to the cost of the asset
1. Interest Paid = 2,000 x 10% = 20
2. Interest received = ((2,000-1,200) x 8%) = 6
3. Dr PPE Cost (200-64) = 136
Cr Interest Accrua
Basic Ide
Borrowing costs that are directly attributable to the acquisition, construction or
production of a qualifying asset form part of the cost of that asset
Other borrowing costs are recognised as an expense
So what is a “Qualifying asset?
It is one which needs a substantial amount of time to get ready for use or sale
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This means it can’t be anything that is available for use when you buy it
It has to take quite a while to build (PPE, Investment Properties, Inventories and
Intangibles)
You don’t have to add the interest to the cost of the following assets
1. Assets measured at fair value
2. Inventories that are manufactured or produced in large quantities on a repetitive
basis even if they take a substantial period of time to get ready for use or sale
When should we start adding the interest to the cost of the asset
Capitalisation starts when all three of the following conditions are met
1. Expenditure begins for the asse
2. Borrowing costs begin on the loa
3. Activities begin on building the asset e.g. Plans drawn up, getting planning etc
So just having an asset for development without anything happening is not enough
to qualify for capitalisatio
Are borrowing costs just interest
It’s actually any costs that an entity incurs in connection with the borrowing of funds
So it includes
Interest expense calculated using the effective interest method
Finance charges in respect of nance lease
What about if the activities stop temporarily
Well you should stop capitalising when activities stop for an extended perio
During this time borrowing costs go to the pro t or loss
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process then you can still capitalise, e.g. Bank holidays etc
When will capitalisation stop
Well, when virtually all the activities work is complete. This means up to the point when
just the nalising touches are left
N
• Stop capitalising when AVAILABLE for use. This tends to be when the construction is
nishe
• If the asset is completed in parts then the interest capitalisation is stopped on the
completion of each par
• If the part can only be sold when all the other parts have been completed, then stop
capitalising when the last part is completed
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B
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Be careful though - If the temporary delay is a necessary part of the construction
Syllabus C3. Financial Instruments
Syllabus C3a) Discuss and apply the initial recognition and measurement of nancial instruments.
Financial Instruments - Introductio
Ok, ok, relax at the back - this is not as bad as it seems… trust me
De nitio
• First of all it must be a contract
• Then it must create a nancial asset in one entity and a nancial liability or
equity instrument in another
Examples:
An obvious example is a trade receivable. There is a contract, one company has the
debt as a nancial asset and the other as a liabilit
Other examples:
Cash, investments, trade payables and loans…
And the trickier stuff….
It also applies to derivatives nancial such as call and put options, forwards, futures,
and swaps
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And the just plain weird…
It also applies to some contracts that do not meet the de nition of a nancial
instrument, but have characteristics similar to derivative nancial instruments
Such as precious metals at a future date when the following applies
1. The contract is subject to possible settlement in cash NET rather than by delivering
the precious meta
2. The purchase of the precious metal was not normal for the entit
The trick in the exam is to look for contracts which state “will NOT be delivered” or
“can be settled net” - these are almost always nancial instruments
The following are NOT nancial instruments
• Anything without a contract
e.g. Prepayment
• Anything not involving the transfer of a nancial asset
e.g. Deferred income and Warrantie
Recognitio
The important thing to understand here is that you bring a FI into the accounts when
you enter into the contract NOT when the contract is settled.
Therefore derivatives are recognised initially even if nothing is paid for it initially
• Substance over for
Form (legally) means a preference share is a share and so part of equity.
HOWEVER, a substance over form model is applied to debt/equity classi cation.
Any item with an obligation, such as redeemable preference shares, will be
shown as liabilities.
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De-recognitio
This basically means when to get rid of it / take it out of the account
• So you should do this when
The contractual rights you used to have have expired/gon
For Exampl
You sell an asset and its bene ts now go to someone else (no conditions attached
• You DON’T de-recognise when.
You sell an asset but agree to buy it back later (this means you still have an interest
in the risk and rewards later
The difference between equity and liabilities
IAS 32 Financial Instruments: Presentatio
establishes principles for presenting nancial instruments as liabilities or equity
• IAS 32 does not classify a nancial instrument as equity or nancial liability on the
basis of its legal form but the substance of the transaction
The key feature of a nancial liabilit
1. is that the issuer is obliged to deliver either cash or another nancial asset to the
holder
2. An obligation may arise from a requirement to repay principal or interest or
dividends
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The key feature of an Equit
has a residual interest in the entity’s assets after deducting all of its liabilities
• An equity instrument includes no obligation to deliver cash or another nancial asset
to another entity
• A contract which will be settled by the entity receiving or delivering a xed number of
its own equity instruments in exchange for a xed amount of cash or another nancial
asset is an equity instrument
• However, if there is any variability in the amount of cash or own equity instruments
which will be delivered or received, then such a contract is a nancial asset or liability
as applicable
An accounting treatment of the contingent payments on acquisition of the NCI in
a subsidiar
• IAS 32 states that a contingent obligation to pay cash which is outside the control of
both parties to a contract meets the de nition of a nancial liability which shall be
initially measured at fair value
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Syllabus C3b) Discuss and apply the subsequent measurement of nancial assets and nancial
liabilities.
Financial liabilities - Categorie
There's only 2 categories, FVTPL and Amortised cost.. Yay
Right-y-o, we’ve looked at recognising (bring into the accounts for those of you who are
a sandwich short of a picnic*) - now we want to look at HOW MUCH to bring the
liabilities in at
*A quaint old English saying - meaning you're an idiot :
Basically there are 2 categories of Financial Liability
1. Fair Value Through Pro t and Loss (FVTPL
This includes nancial liabilities incurred for trading purposes and also
derivatives
2. Amortised Cos
If nancial liabilities are not measured at FVTPL, they are measured at amortised
cost
The good news is that whatever the category the nancial liability falls into - we always
recognise it at Fair Value INITIALLY
It is how we treat them afterwards where the category matters (and remember here we
are just dealing with the initial measurement).
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Accounting Treatment of Financial Liabilities (Overview
Initially
At Year-End
Any gain/loss
FVTPL
Fair Value
Fair Value
Income Statement
Amortised Cost
Fair Value
Amortised Cost
So - the question is - how do you measure the FV of a loan?
All you do is those 2 steps
STEP 1:
Take all your actual future cash payments
STEP 2:
Discount them down at the market rate
If the market rate is the same as the rate you actually pay (effective rate) then this is
no problem and you don’t really have to follow those 2 steps as you will just come back
to the capital amount…let me explai
10% 1,000 Payable Loan 3 years
Capital
1,000 x 0.751 =
751
Interest
100 x 2.486 =
249
Total
1,000
So the conclusion is - WHERE THE EFFECTIVE RATE YOU PAY (10%) IS THE SAME
AS THE MARKET RATE (10%) THEN THE FV IS THE PRINCIPAL - so no need to do
the 2 steps
Always presume the market rate is the same as the effective rate you’re paying unless
told otherwise by El Examinero.
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Possible Naughty Bit
Premium on redemptio
This is just another way of paying interest. Except you pay it at the end (on redemption
e.g. 4% 1,000 payable loan - with a 10% premium on redemption
This means that the EFFECTIVE interest rate (the rate we actually pay) is more than
4% - because we haven’t yet taken into account the extra 100 (10% x 1,000) payable at
the end.
So the examiner will tell you what the effective rate actually is - let’s say 8%
The crucial point here is that you presume the effective rate (e.g. 8%) is the same as
the market rate (8%) so the initial FV is still 1,000
Discount on Issu
Exactly the same as above - it is just another way of paying interest - except this time
you pay it at the star
e.g. 4% 1,000 payable loan with a 5% discount on issue
So again the interest rate is not 4%, because it ignores the extra interest you pay at the
beginning of 50 (5% x 1,000). So the effective rate (the rate you actually pay) is let’s
say 7% (will be given in the exam)
The crucial point here is that the discount is paid immediately. So, although you
presume that the effective rate (7%) is the same as the market rate (7% say), the
INITIAL FV of the loan was 1,000 but is immediately reduced by the 50 discount - so is
actually 95
NB You still pay interest of 4% x 1,000 not 4% x 950
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Financial Liabilities - Amortised Cos
So, we’ve just looked at initial measurement (at FV), now let’s look at how we
measure it from then onwards
This is where the categories of nancial liabilities are important - so let’s remind
ourselves what they are
Initially
At Year-End
Any gain/loss
FVTPL
Fair Value
Fair Value
Income Statement
Amortised Cost
Fair Value
Amortised Cost
So you only have 2 rules to remember - cool
1. FVTP
- simple just keep the item at its FV (remember this is those 2 steps) and put the
difference to the income statemen
2. Amortised Cos
- Amortised Cost is the measurement once the initial measurement at FV is don
Amortised Cos
This is simply spreading ALL interest over the length of the loan by charging
the effective interest rate to the income statement each year
If there’s nothing strange (premiums etc) then this is simple.
For example: 10% 1,000 Payable Loa
Opening
Interest to I/S
Interest actually Paid
1,000 1,000 x 10% = 100
Closing Loan on SFP
(100)
1,000
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Now let’s make it trickier
10% 1,000 Loan with a 10% premium on redemption . Effective rate is 12
Opening
Interest to I/S
Interest actually Paid
1,000 1,000 x 12% = 120
Closing Loan on SFP
(100)
1,020
So in year 1 the income statement would show an interest charge of 120 and the loan
would be under liabilities on the SFP at 1,020.
This SFP gure will keep on increasing until the end of the loan where it will equal the
Loan + premium on redemption
And trickier still…
10% 1,000 loan with a 10% discount on issue. Effective rate is 12
Opening
Interest to I/S
Interest
actually
Paid
1,000 - (10% x 1,000) = 900 900 x 12%= 108
Closing Loan on SFP
(100)
908
IFRS 9 requires FVTPL gains and losses on nancial liabilities to be split into
1. The gain/loss attributable to changes in the credit risk of the liability (to be placed in
OCI
2. The remaining amount of change in the fair value of the liability which shall be
presented in pro t or loss
The new guidance allows the recognition of the full amount of change in the FVTPL
only if the recognition of changes in the liability's credit risk in OCI would create or
enlarge an accounting mismatch in P&L
Amounts presented in OCI shall not be subsequently transferred to P&L, the entity may
only transfer the cumulative gain or loss within equity
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Financial Liabilities - convertible loan
When we recognise a nancial instruments we look at substance rather than
for
Anything with an obligation is a liability (debt)
However we now have a problem when we consider convertible payable loans.
The ‘convertible’ bit means that the company may not have to pay the bank back with
cash, but perhaps shares
So is this an obligation to pay cash (debt) or an equity instrument
In fact it is both! It is therefore called a Compound Instrument
Convertible Payable Loan
These contain both a liability and an equity component so each has to be shown
separately
• This is best shown by example:
2% Convertible Payable Loan €1,00
• This basically means the company has offered the bank the option to convert the loan
at the end into shares instead of simply taking €1,00
• The important thing to notice is that that the bank has the option to do this
• Should the share price not prove favourable then it will simply take the €1,000 as
normal
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Features of a convertible payable loa
1. Better Interest rat
The bank likes to have the option. Therefore, in return, it will offer the company a
favourable interest rate compared to normal loan
2. Higher Fair Value of loa
This lower interest rate has effectively increased the fair value of the loan to the
company (we all like to pay less interest ;-)
We need to show all payable loans at their fair value at the beginning
3. Lower loan gure in SF
Important: If the fair value of a liability has increased the amount payable (liability)
shown in the accounts will be lower
After all, fair value increases are good news and we all prefer lower liabilities
How to Calculate the Fair Value of a Loa
So how is this new fair value, that we need at the start of the loan, calculated
Well it is basically the present value of its future cash ows
• Step 1: Take what is actually paid (The actual cash ows)
Capital €1,000
Interest (2%) €20 pa
Now let’s suppose this is a 4 year loan and that normal (non-convertible) loans carry
an interest rate of 5%
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• Step 2: Discount the payments in step 1 at the market rate for normal loans
(Get the cash ows PV
Take what the company pays and discount them using the gures above as follows
Capital €1,000 discounted @ 5% (4 years SINGLE discount gure) = 1,000 x 0.823
= 82
Interest €20 discounted @ 5% (4 years CUMULATIVE)= 20 x 3.465 = 6
Total = 892
This €892 represents the fair value of the loan and this is the gure we use in the
balance sheet initially
The remaining €108 (1,000-892) goes to equity
Dr Cash 1,000
Cr Loan 892
Cr Equity 10
• Next we need to perform amortised cost on the loan (the equity is left untouched
throughout the rest of the loan period)
The interest gure in the amortised cost table will be the normal non-convertible rate
and the paid will the amounts actually paid
The closing gure is the SFP gure each yea
Opening
Interest
Payment
Closing
892
892 x 5% = 45
(1,000 x 2% = 20) 892 + 45 - 20 = 917
917
917 x 5% = 46
(1,000 x 2% = 20) 917 + 46 - 20 = 943
943
48
(1,000 x 2% = 20)
971
971
49
(1,000 x 2% = 20)
1,000
Now at the end of the loan, the bank decide whether they should take the shares
or receive 1,000 cash
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1. Option 1: Take Shares (lets say 400 ($1) shares with a MV of $3
Dr Loan 1,000
Dr Equity 108
Cr Share Capital 400
Cr Share premium 708 (balancing gure
2. Option 2: Take the Cas
Dr Loan 1,000
Cr Cash 1,00
Dr Equity 108
Cr Income Statement 10
Conclusio
1. When you see a convertible loan all you need to do is take the capital and interest
PAYABLE
2. Then discount these gures down at the rate used for other non convertible loans
3. The resulting gure is the fair value of the convertible loan and the remainder sits in
equity
4. You then perform amortised cost on the opening gure of the loan. Nothing
happens to the gure in equit
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Convertible Payable Loan with transaction costs - eek
Ok well remember our 2 step process for dealing with a normal convertible loan?
Step 1) Write down the capital and interest to be PAI
Step 2) Discount these down at the interest rate for a normal non-convertible loa
Then the total will be the FV of the loan and the remainder just goes to equity.
Remember we do this at the start of the loan ONLY
Right then let’s now deal with transaction or issue costs
These are paid at the start
Normally you simply just reduce the Loan amount with the full transaction costs
However, here we will have a loan and equity - so we split the transaction costs prorata
I know, I know - you want an example…. boy, you’re slow - lucky you’re gorgeou
e.g. 4% 1,000 3 yr Convertible Loan.
Transaction costs of £100 also to be paid.
Non convertible loan rate 10%
Step 1 and
Capital 1,000 x 0.751 = 751
Interest 40 x 2.486 = 99 (ish)
Total = 85
So FV of loan = 850, Equity = 150 (1,000-850
Now the transaction costs (100) need to be deducted from these amounts pro-rat
So Loan = (850-85) = 765
Equity (150-15) = 13
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Financial Assets - Initial Measuremen
There are 3 categories to remember
Category
Initial
Measurement
Year-end
Measurement
Difference goes
where?
FVTPL
FV
FV
Pro t and Loss
FVTOCI
FV
FV
OCI
Amortised Cost
FV
Amortised Cost
-
Financial assets that are Equity Instrument
e.g. Shares in another compan
These are easy - Just 2 categorie
• FVTPL = Fair Value through Pro t & Los
These are Equity instruments (shares) Held for trading
Normally, equity investments (shares in another company) are measured at FV in the
SFP, with value changes recognised in P&
Except for those equity investments for which the entity has elected to report value
changes in OCI
• FVTOCI = Fair Value through Other Comprehensive Incom
These are Equity instruments (shares) Held for longer term
• NB. The choice of these 2 is made at the beginning and cannot be changed
afterward
There is NO reclassi cation on de-recognition
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Financial Assets (FA) that are Receivable Loan
There are basically 3 types
1. Fair Value Through Pro t & Loss (FVTPL
A receivable loan where capital and interest aren’t the only cash ows (see CF test
below
2. FVTOC
Receivable loans where the cash ows are capital and interest only BUT the business
model is also to sell these loans (see Business model test below
3. Amortised Cos
A FA that meets the following 2 conditions can be measured at amortised cost
1. Business model test
Do we normally keep our receivable loans until the end rather than sell them on
2. Cash ows tes
Are the ONLY cash ows coming in capital and interest
So what sort of things go into the FVTPL category
If one of the tests above are not passed then they are deemed to fall into the
FVTPL categor
This will include anything held for trading and derivatives
INITIAL measuremen
Good news! Initially both are measured at FV
Easy peasy to remember
The FV is calculated, as usual, as all cash in ows discounted down at the market
rate.
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FVTPL can be
1. Equity items held for trading purpose
2. Equity items not held for trading (but OCI option not chosen
3. A receivable loan where capital and interest aren’t the only cash ow
Derivative assets are always treated as held for tradin
Initial recognition of trade receivable
1. Trade receivables without a signi cant nancing componen
Use the transaction price from IFRS 1
2. Trade receivables with a signi cant nancing componen
IFRS 9 does not exempt a trade receivable with a signi cant nancing component from
being measured at fair value on initial recognition
Therefore, differences may arise between the initial amount of revenue recognised in
accordance with IFRS 15 – and the fair value needed here in IFRS
Any difference is presented as an expense
FVTOCI - Receivable loans held for cash and sellin
Interest revenue, credit impairment and foreign exchange gain or loss recognised in
P&L (in the same manner as for amortised cost assets
Other gains and losses recognised in OC
On de-recognition, the cumulative gain or loss previously recognised in OCI is
reclassi ed from equity to pro t or loss
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Financial assets - Accounting Treatmen
So we have these 3 categories.
Category
Initial
Measurement
Year-end
Measurement
Difference goes
where?
FVTPL
FV
FV
Pro t and Loss
FVTOCI
FV
FV
OCI
Amortised Cost
FV
Amortised Cost
-
Initially both are measured at FV
Now let's look at what happens at the year-end.
FVTPL accounting treatmen
1. Revalue to F
2. Difference to I/
FVTOCI accounting treatmen
1. Revalue to F
2. Difference to OC
Amortised cost accounting treatmen
1. Re-calculate using the amortised cost tabl
An Example
8% 100 receivable loan (effective rate 10% due to a premium on redemption)
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Amortised Cost Table
Opening Balance
Interest (effective
rate)
(Cash Received)
Closing balance
100
10
(8)
102
The interest (10) is always the effective rate and this is the gure that goes to the
income statement
The receipt (8) is always the cash received and this is not shown in the income
statement - it just decreases the carrying amoun
Any expected credit losses and forex gains/losses all go to I/
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Financial Assets - Convertible loa
Compound instruments (Convertible loans
Be careful here as these are treated differently according to whether they are
receivable loans (assets) or payable loans (liabilities
This is because, if you remember, the amortised cost category for nancial assets has
2 tests, whereas the amortised cost category for liabilities does not have an
The 2 tests for placing a nancial asset into the amortised cost category are
1. Business model test - do we intend to keep (not sell) the loa
... presumably we do hold until the end and not sell it - so yes that test is passe
2. Cash ow test - Are the cash receipts capital and interest only
No - There is the potential issue of shares that we may ask for instead of the capital
back
For a receivable convertible loan - it fails the cash ow test - as one receipt may be
shares and not just capital and interes
Therefore a receivable convertible loan cannot be amortised cost and so is a FVTPL
ite
Type
Category
Receivable Convertible Loan
FVTPL
Accounting Treatmen
FVTPL
Initial
Year End
FV
FV
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An Example
2% Convertible Loan €1,000, a 4 year loa
You are also told the non-convertible interest rates are as follows
Start: 5%
End of year 1: 6%
End of year 2: 7%
End of year 3: 8
• As in the payable we need to calculate FV initially
We did this and it came to 892
• Then we perform amortised cost BUT also adjust to FV each year end as this a
FVTPL item
Here’s a reminder of what we had before (but with a new FV adj column added...
Opening
Interest
Payment
FV adj
Closing
892
45
-20
917
917
46
-20
943
943
48
-20
971
971
49
-20
1,000
So we need to change the closing gures (and hence opening next year) to the
new FV at each year end
Calculating the FV of a loan is the same as before.
• Step 1: Take all the CASH payments (capital and interest
• Step 2: Discount them down at the MARKET rat
• FV at end of year 1
Capital discounted = 1,000 / 1.06^3 (3 years away only now) = 840
Interest = 20pa for 3 years @ 6% = 20 x 2.673 = 53
Total = 893
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• FV at end of year 2
Capital discounted = 1,000 / 1.07^2 (2 years away only now) = 873
Interest = 20pa for 2 years @ 7% = 20 x 1.808 = 36
Total = 90
• FV at end of year 3
Capital discounted = 1,000 / 1.08 (1 year away only now) = 926
Interest = 20pa for 1 year @ 8% = 20 x 0.926 = 19
Total = 94
So the table now becomes..
Opening
Interest
Payment
FV adj
Closing
892
45
-20
-24
917
893
46
-20
-10
943
909
48
-20
+8
971
945
49
-20
+26
1,000
Remember interest goes to the income statement as does the FV adjustment als
The closing gure is the SFP receivable loan amount
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Financial Instruments - Transactions cost
Transaction Costs
There will usually be brokers’ fees etc to pay and how you deal with these depends on
the category of the nancial instrument..
For FVTPL - these go to the income statement
For everything else they get added/deducted to the opening balance
So if it is an asset - it will increase the opening balanc
If it is a liability - it will decrease the opening balanc
Nb. If a company issues its own shares, the transaction costs are debited to share
premiu
Illustration
A debt security that is held for trading is purchased for 10,000. Transaction costs are
500
The initial value is 10,000 and the transaction costs of 500 are expensed
Illustration
A receivable bond is purchased for £10,000 and transaction costs are £500
The initial carrying amount is £10,500
Illustration
A payable bond is issued for £10,000 and transaction costs are £500
The initial carrying amount is £9,500.
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spread over the length of the loan by using an effective interest rate which INCLUDES
these transaction cost
Illustration: Transaction cost
An entity acquires a nancial asset for its offer price of £100 (bid price £98
IFRS 9 treats the bid-offer spread as a transaction cost
1. If the asset is FVTP
The transaction cost of £2 is recognised as an expense in pro t or loss and the
nancial asset initially recognised at the bid price of £98
2. If the asset is classi ed as amortised cos
The transaction cost should be added to the fair value and the nancial asset
initially recognised at the offer price (the price actually paid) of £100
Treasury share
It is becoming increasingly popular for companies to buy back shares as another way of
giving a dividend. Such shares are then called treasury share
Accounting Treatmen
1. Deduct from equit
2. No gain or loss shown, even on subsequent sal
3. Consideration paid or received goes to equity
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Note: With the amortised cost categories, the transaction costs are effectively being
Illustratio
Company buys back 10,000 (£1) shares for £2 per share. They were originally issued
for £1.2
Dr RE 20,000 Cr Cash 20,00
The original share capital and share premium stays the same, just as it would
have done if they had been bought by a different third part
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Syllabus C3c) Discuss and apply the derecognition of nancial assets and nancial liabilities.
De-recognition of Financial Instrument
De-recognition of Financial Asset
De-recognition of a nancial asset occurs where
1. The contractual rights to the cash ows of the nancial asset have expired (debtor
pays), o
2. The nancial asset has been transferred (e.g., sold) including the risks and
rewards
Illustration
A company sells an investment in shares, but retains the right to repurchase the shares
at any time at a price equal to their current fair value
The company should de-recognise the asse
Illustration
A company sells an investment in shares and enters into an agreement whereby the
buyer will return any increases in value to the company and the company will pay the
buyer interest plus compensation for any decrease in the value of the investment
The company should not de-recognise the investment as it has retained
substantially all the risks and reward
Financial Liability De-recognition
The risks and rewards transfer does not apply for nancial liabilities. Rather, the focus
is on whether the nancial liability has been extinguished
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Syllabus C3d) Discuss and apply the reclassi cation of nancial assets.
The Reclassi cation Of Financial Asset
Re-classifying between FVTPL, FVTOCI and Amortised cos
1. ONLY if Financial assets business objective change
2. Do not restate any previously recognised gains / losse
How to Re-classif
•
Prospectively from the reclassi cation dat
NEVER RECLASSIF
•
FVTOCI equity Investment
Accounting for the Re-Classi catio
On derecognition of a nancial asset in its entirety, the difference between
(a) The carrying amount (measured at the date of derecognition); an
(b) The consideration receive
is recognised in pro t or loss (IFRS 9: para. 3.2.12)
For investments in debt held at fair value through other comprehensive income, o
derecognition, the cumulative revaluation gain or loss previously recognised in othe
comprehensive income is reclassi ed to pro t or loss (IFRS 9: para. 5.7.10)
Equity FVTOCI de-recognise
There should be no gain / loss as FV will be up to date (and therefore the same as the
amount sold for) and the gains \ losses will already be in OC
These are NOT reclassi ed to I/
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Debt FVTOCI de-recognise
The same applies except...
...The cumulative revaluation gain or loss previously recognised in OCI is reclassi ed to
pro t or loss
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Syllabus C3e) Account for derivative nancial instruments, and simple embedded derivatives.
Embedded derivative
Normal derivatives (not used for hedging) are simply treated as FVTP
Embedded Derivative
Sometimes a seemingly normal contract has terms which make the cash ows act like a
derivative..
...We call this an embedded derivativ
Such a contract then has 2 elements
1) A host contract and
2) An embedded derivativ
The accounting treatment generally is to take out the embedded derivative and treat it as a
FVTP
Illustratio
A company borrows some money and agrees to pay back interest that is linked to the price
of gol
•
Now there is clearly a derivative here (based on the price of gold) alongside a loa
•
Therefore we need to take out the embedded derivative (as the economic
characteristics of gold are not the same as interest) and treat it as FVTP
Sometimes we don't take out the embedded derivative
when..
•
The embedded derivative's risks are closely related to those of the host
contract
Eg. An oil contract between two companies reporting in €, but priced in $.
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The 'derivative' element is a normal feature of the contract (as oil is priced in $) so
not really a derivativ
•
The combined instrument is measured at FVTPL anyway (so no need to split
•
The host contract is a financial asset anyway (so no need to split
•
The embedded derivative significantly modi es the cash ows of the contract.
If the derivative element changes the cash ows so much, then the whole instrument
should be measured at FVTPL (due to the risk involved)
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Syllabus C3f) Outline and apply the qualifying criteria for hedge accounting and account for fair value
hedges and cash ow hedges including hedge effectiveness
Hedgin
Hedging is all about matching
Objectiv
To manage risk companies often enter into derivative contract
• e.g. Company buys wheat - so it is worried about the price of wheat rising (risk)
• To manage this risk it buys a wheat derivative that gains in value as the price of
wheat goes up
• Therefore any price increase (hedged item) will be offset by the derivative gains
(hedging item)
So, the basic idea of hedge accounting is to represent the effect of an entity’s risk
management activitie
IFRS 9 change
• IFRS 9 has made hedge accounting more principles based to allow for effective risk
management to be better shown in the account
• It has also allowed more things to be hedged, including non- nancial item
• It has allowed more things to be hedging items also - options and forward
• There also used to be a concept of hedge effectiveness which needed to be tested
annually to see if hedge accounting could continue - this has now been stopped.
Now if its a hedge at the start it remains so and if it ends up a bad hedge well the FS
will show thi
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Accounting Concep
The idea behind hedge accounting is that gains and losses on the hedging instrument and
the hedged item are recognised in the same period in the income statement
It is a choice - it doesn’t have to be applie
There are 3 types of hedge
1. Fair value hedges
Here we are worried about an item losing fair value (not cash).
For example you have to pay a xed rate loan of 6%. If the variable rate drops to 4%
your loan has lost value. If the variable rate rises to 8%, then you have gained in fair
vale
Notice you still pay 6% in both scenarios - so the risk isn’t cash ow - it is fair valu
2. Cash ow hedges
Here we are worried about losing cash on the item at some stage in the future
For example, you agree to buy an item in a foreign currency at a later date. If the rate
moves against you, you will lose cas
3. Hedges of a net investment in a foreign operation
This applies to an entity that hedges the foreign currency risk arising from its net
investments in foreign operation
Hedged item
The hedged item is the item you’re worried about - the one which has risk (which needs
managing
A hedged item can be
• A recognised asset or liability ( nancial or not
• An unrecognised commitmen
• A highly probable forecast transactio
• A net investment in a foreign operatio
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They must all be separately identi able, reliably measurable and the forecast transaction
must be highly probable
When can we use hedge accounting
The hedge must meet all of the following criteria: (replacing the old 80-125% criteria
• An economic relationship exists between the hedged item and the hedging instrument –
meaning as one goes up in FV the other will go down
For example, a UK company selling to US customers - enters into a $100 to £ futures
contract which ends when the UK company is expected to receive $100
Here - the future $ receipt will be the hedged item and the futures contract the hedging
item
In the above example it is an obvious economic relationship as it’s the same amount and
same timing
However, sometimes the amounts and timings won’t be the same so you may use
judgement as to whether this is actually a proper hedge or not - here numbers could be
use
• Credit risk doesn’t dominate the fair value changes
So, after having established an economic relationship (above) - IFRS 9 just wants to
make sure that any credit risk to the hedged or hedging item wont affect it so much as to
destroy the relationshi
Accounting treatmen
• Fair Value Hedges
Gains and losses of both the Hedged and Hedging item are recognised in the current
period in the income statemen
• Cash ow hedges
Here the hedged item has not yet made its gain or loss (it will be made in the future e.g.
Forex)
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So, in order to match against the hedged item when it eventually makes its gain or loss,
the “effective” changes in fair value of the hedging instrument are deferred in reserves
(any ineffective changes go straight to the income statement)
These deferred gains/losses are then taken from reserves/OCI and to the income
statement when the hedged item eventually makes its gain or los
• Hedges of a net investment in a foreign entity
Same as cash- ow, changes in fair value of the hedging instrument are deferred in
reserves/OCI
Normally individual company forex gains/losses are taken to the income statement and
foreign subsidiary retranslation gains/losses taken to the OCI/Reserves.
So, lets say a UK holding company has a UK subsid and a Maltese subsid. The Malta
sub also has loaned the UK sub some cash in Euros.
Normally the UK sub would retranslate this loan and put the difference to the income
statement. Also the Maltese sub is retranslated and the difference taken to OCI. Here, it
is allowed for the UK sub to hold the translation losses also is reserves (like a cash ow
hedge) as long as the loan is not larger than the net investment in the Maltese su
Special cases of hedging items which reduce P&L Volatilit
1. Options - time value element when intrinsic value of option is the designated
hedging item
If the hedging item is an option - then the time value changes in that option will be
taken to the OCI (and equity)
When the hedged item is realised, these then get reclassi ed to P&
2. Forward points - when the spot element of a forward contract is the designate
hedging item
If the hedging item is a forward contract then the forward points FV changes MAY be
taken to OCI, and again gets reclassi ed when the hedged item hits the I/
3. Currency basis risk
The spread from this can be eliminated from the hedge - and instead either be valued
as FVTPL or FVTOCI(with reclassi cation)
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Illustration of a FV Hedg
5% 100,000 xed rate 5 year Receivable loan. (Current variable rates 5%).
Here we are worried that variable rates may rise above this - if they did then the FV of this
receivable would worsen.
So we would have a FV loss.
If the variable rates go lower, then we are happy (as we are receiving a xed rate) and so
the FV would improve
This company hedges against the variable rates going down - by entering into a variable
rate swap (This is the hedging item)
With this derivative, if variable rates rise we will bene t from receiving more but the FV of
our xed rate receivable loan will have lowered.
These 2 should cancel themselves out
Market interest rates then increase to 6%, so that the fair value of the xed rate bond has
decreased to $96,535.
As the bond is classi ed as a hedged item in a fair value hedge, the change in fair value of
the bond is instead recognised in pro t or loss:
At the same time, the company determines that the fair value of the swap has increased
by $3,465 to $3,465.
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Since the swap is a derivative, it is measured at fair value with changes in fair value
recognised in pro t or loss. Therefore, Entity A makes this journal entry:
Since the changes in fair value of the hedged item and the hedging instrument exactly
offset, the hedge is 100% effective, and the net effect on pro t or loss is zero
Illustration Cash ow Hedg
Company has the euro as its functional currency. It will buy an asset for $20,000 next year
It enters into a forward contract to purchase $20,000 a year´s time for a xed amount
(10,000)
Half way through the year (the company’s Year-end) the dollar has appreciated, so that
$20,000 for delivery next year now costs 12,000 on the market
Therefore, the forward contract has increased in fair value to 2,00
Solution
When the company comes to pay for the asset, the dollar rate has further increased, such
that $20,000 costs 14,000 in the spot market
Therefore, the fair value of the forward contract has increased to 4,000
.
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The forward contract is settled:
The asset is purchased for $10,000 (14,000):
The deferred gain left in equity of 4,000 should eithe
Remain in equity and be released from equity as the asset is depreciated o
Be deducted from the initial carrying amount of the machine.
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Syllabus C3g) Discuss and apply the general approach to impairment of nancial instruments
including the basis for estimating expected credit losses.
Syllabus C3h) Discuss the implications of a signi cant increase in credit risk.
Impairment of Financial Instrument
Expected Credit Loss mode
This applies to
I.
II.
Amortised cost item
FVTOCI item
How it work
Initially you show 12m expected losse
Dr Expense
Cr Loss Allowance (This gets shown next to the nancial asset - it reduces it
•
Then you look to see if there's been a signi cant increase in credit risk? If so switch
from 12m to lifetime expected credit losse
•
No signi cant increase in credit risk? Show 12-month expected losses onl
How do you calculate the Expected Credit Loss
Use
1. a probability-weighted outcom
2. the time value of mone
3. the best available forward-looking information
Notice the use of forward-looking info - this means judgement is needed - so it will be
dif cult to compare companie
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Stage 1 - Assets with no signi cant increase in credit risk
For these assets
1) 12-month expected credit losses (‘ECL’) are recognised and
2) Interest revenue is calculated on the gross carrying amount of the asset (that is,
without deduction for credit allowance
12-month ECL are based on the asset’s entire credit loss but weighted by the probability
that the loss will occur within 12 months of the Y/
Stage 2 - Assets with a signi cant increase in credit risk (but no evidence of
impairment
For these assets
1) Lifetime ECL are recognise
2) Interest revenue is still calculated on the gross carrying amount of the asset.
Lifetime ECL come from all possible default events over its expected life
Expected credit losses are the weighted average credit losses with the probability of
default (‘PD’) as the weight.
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Stage 3 - Assets with evidence of impairment
For these assets
1) Lifetime ECL are recognised and
2) Interest revenue is calculated on the net carrying amount (that is, net of credit
allowanc
In subsequent reporting periods, if the credit quality improves so there’s no longer a
signi cant increase in credit risk since initial recognition, then the entity reverts to
recognising a 12-month ECL allowanc
Where does the impairment go
The changes in the loss allowance balance are recognised in pro t or loss as an
impairment gain or los
Collective Basi
If the asset is small it’s just not practical to see if there’s been a signi cant increase in
credit ris
So, you can assess ECLs on a collective basis, to approximate the result of using
comprehensive credit risk information that incorporates forward-looking information at an
individual instrument level
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This means no tracking changes in credit risk
Instead just recognise a loss allowance based on lifetime ECLs at each reporting date,
right from origination
The simpli ed approach is for trade receivables, contract assets with no signi cant
nancing component, or for contracts with a maturity of one year or les
12-month expected credit losse
These are a portion of the lifetime ECLs that are possible within 12 month
The portion is weighted by the probability of a default occurrin
It is not the predicted (probable) defaults in the next 12 months. For instance, the
probability of default might be only 25%, in which case, this should be used to calculate
12-month ECLs, even though it is not probable that the asset will default.
Also, the 12-month expected losses are not the cash shortfalls that are predicted over only
the next 12 months. For a defaulting asset, the lifetime ECLs will normally be signi cantly
greater than just the cash ows that were contractually due in the next 12 months
Lifetime expected credit losse
These are from all possible default events over the expected lif
Estimate them based on the present value of all cash shortfall
So, basically, it’s the difference between
• The contractual cash ows An
• The cash ows now expected to receiv
As PV is used, even late (but the same) cash ows create an EC
For a nancial guarantee contract, the ECLs would be the PV of what it expects to pay as
guarantor less any amounts from the holder
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Simpli ed Approac
ILLUSTRATION 1
A company has a 5yr 6% receivable loan of $1,000,000
They expect credit losses of $10,000 pa.
The present value (discounted at 6%) of these lifetime expected credit losses is $42,124.
The present value of the 12-month expected credit losses is $9,43
Solution - how to deal with this nancial asse
• On day
Dr Loan receivable $1,000,00
Cr Cash
$1,000,00
• End of yr 1 - no signi cant increase in credit risk - show 12m EC
Dr I/S Impairment loss
$9,43
Cr Loss allowance in nancial position
$9,43
• End of yr 1 - signi cant increase in credit risk - show re-estimate of lifetime EC
Let’s say the present value of the lifetime expected credit losses is $34,651.
Dr I/S Impairment loss
$25,217 (34,651 – 9,434
Cr Loss allowance in nancial position
$25,21
ILLUSTRATION 2
A company has a receivable loan of $1,000,000.
They estimates that the loan has a 1% probability of a default occurring in the next 12
months.
It further estimates that 25% of the gross carrying amount will be lost if the loan defaults.
How much should the 12m ECL be
Solution
= 1% x 25% x $1,000,000 = $2,500
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ILLUSTRATION 3
An entity has a 10 yr 6% loan receivable of $1,000,000.
On initial recognition the probability of default is 1%. Expected lifetime losses $250,00
End of year 1 - probability of default increases to 1.5
End of year 2 - probability of default increases to 30% (but still no evidence of impairment)
- expected lifetime losses now $100,00
End of year 3 - probability of default increases further - expected lifetime losses now
150,000 (but still no evidence of impairment
End of year 4 - probability of default increases further - expected lifetime losses now
200,000 (but still no evidence of impairment
The loan eventually defaults at the end of Year 5 and the actual loss amounts to $250,000
At the beginning of Year 6, the loan is sold to a third party for $740,00
How would this be dealt with under IFRS 9
Solutio
• Initial recognitio
Dr Loan receivable – amortised cost asset
$1,000,00
Cr Cas
$1,000,00
Dr I/S Impairment loss (1% x 250,000)
$2,50
Cr Loss allowance in nancial position
$2,50
• At the end of Year
Dr Impairment loss in pro t or loss (3,750 – 2,500)
$1,25
Cr Loss allowance in nancial position
$1,25
The new 12m ECL would be 1.5% x 250,000 = $3,750.
Interest income 6% x 1,000,000 = $60,000
• At the end of Year
Dr I/S Impairment loss (100,000 - 3,750)
$96,25
Cr Loss allowance in nancial position
$96,25
Interest income 6% x 1,000,000 = $60,00
Notice that interest is still calculated on gross amount
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• At the end of year
Dr I/S Impairment loss (150,000 - 100,000)
$50,00
Cr Loss allowance in nancial position
$50,00
Interest income 6% x 1,000,000 = $60,00
• At the end of year
Dr I/S Impairment loss (200,000 - 150,000)
$50,00
Cr Loss allowance in nancial position
$50,00
Interest income 6% x 1,000,000 = $60,00
• At the end of year
Dr I/S Impairment loss (250,000 - 200,000)
$50,00
Cr Loss allowance in nancial position
$50,00
Interest income 6% x 1,000,000 = $60,00
From Year 6 onward, interest income would be calculated at 6% on the net carrying
amount of the loan $750,000
• Start of year
Dr Cash
$740,00
Dr Loss allowance in nancial position – de-recognised
$250,00
Dr Loss on disposal in pro t or loss
$10,00
Cr Gross loan receivable – de-recognised
$1,000,000
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Syllabus C3i) Discuss and apply the treatment of purchased or originated credit impaired nancial
assets.
Purchased Or Originated Credit-Impaired Financial
Asset
So here the asset is credit-impaired immediatel
Eg
1. Signi cant nancial dif culty of the borrower;
2. A default
3. Probable that the borrower will enter bankruptcy
4. The disappearance of an active market for the nancial asse
Show lifetime expected losses immediately
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Syllabus C4. Leases
Syllabus C4a) Discuss and apply the lessee accounting requirements for leases including the
identi cation of a lease and the measurement of the right of use asset and liability.
Leases - De nitio
IFRS 16 gets rid of the Operating lease (which showed no liability on the
SFP)
So, every lease now shows a liability
Therefore the de nition of what is a lease is super important (as it affects the amount of
debt shown on the SFP
Here is that de nition
A contract that gives the right to use an asset for a period of time in exchange for
consideratio
So let's dig deepe
There's 3 tests to see if the contract is a lease.
1. The asset must be identi able
This can be explicitly - it's in the contract
Or implicitly - the contract only makes sense by using this asset
(There is no identi able asset if the supplier can substitute the asset (and would
bene t from doing so)
2. The customer must be able to get substantially all the bene ts while it uses i
3. The customer must be able to direct how and for what the asset is use
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Exampl
A contract gives you exclusive use of a speci c ca
You can decide when to use it and for wha
The car supplier cannot substitute / change the ca
So does the contract contain a lease
Does it pass the 3 tests
1. Is there an Identi able asset?
Yes the car is explicitly referred to and the supplier cannot substitute the ca
2. Does the customer have substantially all bene ts during the period?
Ye
3. Does the customer direct the use?
Yes he/she can use it for whatever and whenever they choos
So, yes this contract contains a lease because it's..
A contract that gives the right to use an asset for a period of time in exchange for
consideratio
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Exampl
A contract gives you exclusive use of a speci c airplan
You can decide when it ies and what you y (passengers, cargo etc
The airplane supplier though operates it using its own staf
The airplane supplier can substitute the airplane for another but it must meet speci c
conditions and would, in practice, cost a lot to do s
So does the contract contain a lease
Does it pass the 3 tests
1. Is there an Identi able asset?
Yes the airplane is explicitly referred to and the substitution right is not substantive
as they would incur signi cant cost
2. Does the customer have substantially all bene ts during the period?
Yes it has exclusive us
3. Does the customer direct the use?
Yes the customer decides where and when the airplane will
So, yes this contract contains a lease because it's..
A contract that gives the right to use an asset for a period of time in exchange for
consideration
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Basic Rul
Lessees recognise a right to use asset and associated liability on its SFP for
most lease
How to Value the Liabilit
Present value of the lease payments, where the lease payments are
Fixed Payment
Variable Payments (if they depend on an index / rate
Residual Value Guarantee
Probable purchase Option
Termination Penaltie
How to Value the Right of Use asset
Includes the following
The Lease Liability (PV of payments
Any lease payments made before the lease starte
Any Restoration costs (Dr Asset Cr Provision
All initial direct cost
After the initial Measurement - Asse
Cost - depreciation (normally straight line) less any impairment
Any subsequent re-measurements of the liabilit
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After the initial Measurement - Liabilit
Effective interest rate method (amortised cost
Any re-measurements (e.g. residual value guarantee changes
Exampl
3 year lease ter
Annual lease payments in arrears 5,00
Rate implicit in lease: 12.04
PV of lease payments: 12,00
Answe
The lease liability is initially the PV of future lease payments - given here to be 12,00
Double entry: Dr Asset 12,000 Cr Lease Liability 12,00
The Asset is then depreciated by 4,000pa (12,000 / 3
The lease liability uses amortised cost
Opening
Interest (I/S) 12.04
(Payment)
Closing
12,000
1,445
(5,000)
8,445
8,445
1,017
(5,000)
4,463
4,463
537
(5,000)
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Example - Variable lease payments (included in Lease Liability
(Remember only include those linked to a rate or index
So the lease contract says you have to pay more lease payments of 5% of the sales in
the shop you're leasing - should you include this potential variable lease payment in
your lease liability
Answe
No - because it is not based on a rate or inde
(They are just put to the Income statement when they occur
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Variable Lease payments exampl
10 year Lease contract
500 payable at the start of every yea
Increased payments every 2 years to re ect the change in the consumer price inde
The consumer price index was 125 at the start of year
The consumer price index was 130 at the start of year
The consumer price index was 135 at the start of year
(so these are variable payments based upon an index / rate
ANSWER (IGNORING DISCOUNTING
Start of year 1
Dr Asset 500 Cr Cash 50
Dr Asset 4500 Cr Lease Liability 4500 (9 x 500
End of year 2
Asset will be 5,000 - 1,000 (straight line depreciation) = 4,00
Lease liability will be 8 x 500 = 4,00
End of year 3
Lease payments are now different - 500 x 135/125 = 54
So the lease liability will be 7 x 540 = 3,780
Asset will be 4,000 - 500 (depreciation) + 280 (re-measurement of Liability) = 3,78
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(Please note that this example ignored discounting - which would normally happen as
the liability is measured as the PV of future payments
Variable payments that are really xed payment
These are included into the liability as they're pretty much xed and not variabl
e.g. Payments made if the asset actually operate
(well it will operate of course and so this is effectively a xed payment and not a
variable one
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The Lease Ter
This is important because.
The lease liability = PV of payments in the lease term
How is the Lease Term calculated
• Period which can't be cancelle
• + any option to extend period (if reasonably certain to take up
• + period covered by option to terminate (if reasonably certain not to take up
So what does "Reasonably Certain" mean
Market conditions mean its favourable to do i
Signi cant leasehold improvements mad
High costs to terminate the leas
The asset is very important to the lessee (or specialised/customised to
the lessee
Proble
How do we 'weight' these factors that tell us whether the lessee is reasonably certain to
extend the term or not
Eg A agship store in a prime and much sought-after location
Signi cant judgement would be needed to determine whether the prime geographical
location of the store or other factors (for example termination penalties, lease hold
improvements, etc.) indicate that it is reasonably certain whether or not the lessee will
renew the store lease
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It's very rare bu
When the lessee exercises (or not) an option in a different way than
previously was reasonably certain
When something happens that contractually obliges the lessee to
exercise an option not previously included in the determination of the lease term o
When something signi cant happens that affects whether it is reasonably
certain to exercise an option. This trigger is only relevant for the lessee (and not the
lessor)
Exampl
A 10 year lease with an option to extend for 5 years
Initially, the lessee is not reasonably certain that it will exercise the extension option. So
the lease term is set for 10 years
After 5 years, they decides to sublease the building for 10 year
Answe
Entering into a sublease is a signi cant event and it affects the entity’s assessment of
whether it is reasonably certain to exercise the extension option
So, the lessee must change the lease term of the head lease
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When is the lease term re-assessed
Exemptions to Leases treatmen
So now we know that all lease contracts mean we have to sho
A right to use Asse
A Liabilit
So remember we said there was no longer a concept of operating leases - all lease
contracts mean we need to show a right to use asset and its associated liabilit
Well.. there are some exemptions.
Exemption 1 - Short Term Lease
These are less than 12 months contracts (unless there's an option to extend that you'll
probably take or an option to purchase
Treat them like operating leases
Just expense to the Income Statement (on a straight line / systematic basis
Each class of asset must have the same treatmen
This exemption ONLY applies to Lessee
Exemption 2: Low Value Asset
e.g. IT equipment, of ce furniture with a value of less than $5,00
Treat them like operating leases
Just expense to the Income Statement (on a straight line basis
Choice is made on a lease by lease basi
This exemption ONLY applies to Lessees
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Syllabus C4e)
Discuss the recognition exemptions under the current leasing standard
Syllabus C4e) Discuss the recognition exemptions under the current leasing standard.
Measurement Exemption
Exemption 1: Investment Propert
(if it uses the FV model in IAS 40
Measure the property each year at Fair Valu
Exemption 2 - PP
(if revaluation model is used
Use revalued amount for asse
Exemption 3: Portfolio Approac
(Portfolio of leases with SIMILAR characteristics
Use same treatment for all leases in the portfolio
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Syllabus C4d) Discuss and apply the reasons behind the separation of the components of a lease
contract into lease and non-lease elements.
Components of a Leas
Sometimes a contract is for more than 1 thin
So the supplier (lessor) has more than 1 obligatio
These obligations might be lease components or a combination of lease and non-lease
components
For example, a contract for a car lease might be combined with maintenance (non
lease component
IFRS 16 says lease and non-lease components should be accounted for separately..
What is a separate component
something the lessee can bene t from alone an
not dependent on other assets in the contrac
What do you do with separate lease components
Deal with them separatel
1. The non-lease components should be assessed under IFRS 15 for separate
performance obligations
2. The lease components are treated as nancial liabilities as normal under IFRS 1
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How do you separate them in terms of allocating an amount of the lease payment to
them
Use their stand-alone prices (or an estimate if not available
Practical expedien
Lessees are allowed not to separate lease and non-lease components and, instead,
account for them as a single lease component
This accounting policy choice has to be made by class of underlying asset
Because not separating a non-lease component would increase the lessee’s lease
liability, the IASB expects that a lessee will use this exemption only if the non-lease
component is not signi cant.
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?
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So if you treat 2 components in a contract differently.
Lessor Accounting - Finance Leas
Is it a Finance Lease or an Operating Lease
If the majority of the risks and rewards are transferred to the lessee then it's a nance
leas
Other Indicators of a Finance Leas
Ownership transferred at the en
Option to buy at the end at less than Fair Valu
Lease term is for majority of the asset's UE
PV of future lease payments is close to the actual Fair Value of the asse
The asset is specialised and customised for the lesse
Finance Lease accountin
Dr Lease Receivable Cr Asse
What makes up the Lease Receivable
PV of lease payments
(Fixed receipts, Variable receipts (based on index / rate), Residual Value guaranteed to
receive, Exercise price to be received of any likely purchase option from the lessee,
Any penalties likely to be received from the lessee for early termination
Un-guaranteed Residual Valu
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Syllabus C4b) Discuss and apply the accounting for leases by lessors.
Opening Lease
Receivable
Effective Interest
Receive
Dr Lease Receivabl
Cr PPE
Dr Lease Receivabl
Cr Interest Receivable
Amounts Receive
Closing Lease
Receivabl
Dr Cas
Cr Lease Receivable
Balancing
gure
Lessor accounting if Operating Leas
Remember this is when the lessor keeps the risks and rewards of the asse
Accounting rule
Keep the Asset on the SFP as norma
Show lease receipts on the income statement (straight line basis
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Lessor - Finance Lease accountin
Syllabus C4b) Discuss and apply the accounting for leases by lessors.
Lessor Accounting - Operating Leas
Ok - let´s have a think about thi
Remember that when we say operating lease - we mean the risks and rewards are
NOT taken by the lessee. So have we sold the asset or not
Revenue recognition tells us that when the risks and rewards for goods are passed on
then we have made a sale and can recognise the revenue
So, no the lessor has NOT in substance sold the asset. Therefore the lessor keeps the
asset on its SFP
Income from an operating lease (not including services such as insurance and
maintenance), should be shown straight-line in the income statement over the length
of the lease (unless the item is used up on a different basis - if so use that basis)
SFP
Income statement
Keep the Asset there
Operating Lease rentals received
Negotiating costs et
Any initial direct costs incurred by lessors should be added to the carrying amount of
asset on the SFP and expensed over the lease term (NOT the assets life)
Operating Lease Incentive
The lessor should reduce the rental income over the lease term, on a straight-line basis
with the total of these.
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Syllabus C4f) Discuss and apply the principles behind accounting for sale and leaseback
transactions.
Sale and Leasebac
Let’s have a little ponder over this before we dive into the details
So - the seller makes a sale (easy) BUT remember also leases it back - so the seller
becomes the lessee always, and the buyer becomes the lessor alway
Seller = Lessee (after)
Buyer = Lessor (after
However, If we sell an item and lease it back - have we actually sold it? Have we got rid
of the risk and rewards
So the rst question is.
Have we sold it according to IFRS 15? (revenue from contracts with customers
Option 1: Yes - we have sold it under IFRS 1
This means the control has passed to the buyer (lessor now
But remember we (the seller / lessee) have a lease - and so need to show a right to use
asset and a lease liabilit
Step 1: Take the asset (PPE) ou
Dr Cas
Cr Asse
Cr Initial Gain on sale
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Dr Right to use asse
Cr Finance Lease / Liabilit
Dr/Cr Gain on sale (balancing gure
How much do we show the Right to Use asset at?
The proportion (how much right of use we keep) of our old carrying amount
The PV of lease payments / FV of the asset x Carrying amount before sal
How much do we show the nance liability at?
The PV of lease payment
Exampl
A seller-lessee sells a building for 2,000. Its carrying amount at that time was 1,000 and
FV 1,80
The seller-lessee then leases back the building for 18 years, for 120 p.a in arrears
The interest rate implicit in the lease is 4.5%, which results in a present value of the
annual payments of 1,45
The transfer of the asset to the buyer-lessor has been assessed as meeting the
de nition of a sale under IFRS 15
Answe
Notice rst that the seller received 200 more than its FV - this is treated as a nancing
transaction
Dr Cash 20
Cr Financial Liability 20
Now onto the sale and leaseback.
Step1: Recognise the right-of-use asset - at the proportion (how much right of use
we keep) of our old carrying amoun
Old carrying amount = 1,00
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Step 2: Bring the right to use asset i
How much right we keep = 1,259 / 1,800 (The 1,259 is the 1,459 we actually pay - 200
which was for the nancing
So, 1,259 / 1,800 x 1,000 = 69
Step 2: Calculate Finance Liability - PV of the lease payment
Given - 1,25
So the full double entry is
Dr Cash 2,00
Cr Asset 1,00
Cr Finance Liability 20
Cr Gain On Sale 80
Dr Right to use asset 69
Cr Finance lease / liability 1,25
Dr Gain on sale 560 (balance
Option 2: It's not a sale under IFRS 1
So the buyer-lessor does not get control of the asse
Therefore the seller-lessee leaves the asset in their accounts and accounts for the cash
received as a nancial liability
The buyer-lessor simply accounts for the cash paid as a nancial asset (receivable)
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Further Guidance on Lease accountin
Some further guidance on measuring Right to use Asset
Discount rate
The lessee uses the discount rate the interest rate implicit in the lease - if this rate
cannot be readily determined, the lessee should use its incremental borrowing rate (for
similar amount, term & security
Restoration costs
This should be included in the initial measurement of the right-of-use asset and as a
provision. This corresponds to the accounting for restoration costs in IAS 16 Property,
Plant and Equipment
If the expected restoration costs change - then the right-of-use asset and provision is
change
Initial direct costs
These are incremental costs that would not have been incurred if a lease had not been
obtained. e.g. commissions or some payments made to existing tenants to obtain the
lease.
All initial direct costs are included in the initial measurement of the right-of-use asset
Subsequent measurement
The lease liability is measured in subsequent periods using the effective interest rate
method.
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Syllabus C4c) Discuss and apply the circumstances where there may be re-measurement of the
lease liability.
The right-of-use asset is depreciated on a straight-line basis or another systematic
basis that is more representative of the pattern in which the entity expects to consume
the right-of-use asset.
The lessee must also apply the impairment requirements in IAS 36,‘Impairment of
assets’, to the right-of-use asset
Using straight-line depreciation (for the asset) and the effective interest rate (for the
lease liability) will mean higher charges at the start of the lease and less at the end
(‘frontloading’
But this might not properly re ect the economic characteristics of a lease contract
(especially for 'operating leases'.
It also means the carrying amount of the right-of-use asset and the lease liability won't
be equal in subsequent periods. The right-of-use asset will, in general, be lower than
the carrying amount of the lease liability
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When should the lease liability be reassessed
(only if the change in cash ows is based on contractual clauses that have been part of
the contract since inception) otherwise it's a modi cation not a reassessmen
Component of the lease liabilit
Reassessment
Lease Term
When? – If there is a change in the lease
term
How? – Re ect the revised payments using a
revised discount rate(the interest rate implicit
in the lease for the remainder of lease term)
Exercise price of a purchase option
When? – A signi cant event (within the control
of the lessee) affects whether the lessee is
reasonably certain to exercise an option
How? – Re ect the revised payments using a
revised discount rate(the interest rate implicit
in the lease for the remainder of lease term)
Residual value guarantee
When? – If there is a change in the amount
expected to be paid.
How? – Include the revised residual payment
using the unchanged discount rate.
Variable lease payment (dependent
on an index or a rate)
When? – If a change in the index/rate results
in a change in cash ows.
How? – Re ect the revised payments based
on the index/rate at the date when the new
cash ows take effect for the remainder of the
term using the unchanged discount rate
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Syllabus C5. Employee Benefits
Syllabus C5a) Discuss and apply the accounting treatment of short term and long term employee
bene ts and de ned contribution and de ned bene t plans.
Pensions Introductio
Objective of IAS 1
Companies give their employees bene ts - the most obvious being wages but there
are, of course, other things they may offer such as pensions
IAS 19 says that the bene t should be shown when earned rather than when paid
Employee bene ts include paid holiday, sick leave and free or subsidised goods given
to employees
Short-term Employee Bene t
As we mentioned above, any bene ts payable within a year after the work is done,
(such as wages, paid vacation and sick leave, bonuses etc.) should be recognised
when the work is done not when paid for
Pro t-sharing and Bonus Payment
Recognise when there is an obligation to make such payments and a reliable estimate
of the expected cost can be made
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Illustratio
Grazydays PLC give their employees 6 weeks of paid holiday each year, and because
they’re groovy employers, any holiday not taken can be carried forward to the next
year
Accounting Treatment
Any untaken holiday entitlement should be recognised as a liability in the current
year even though it wouldn’t be taken until the next year
Types of Post-employment Bene t Plan
There are two types
1. De ned Contribution pla
In this one the company just promises to pay xed contributions into a pension fund for
the employee and has no further obligations
The contribution payable is recognised in the income statement for that period
If contributions are not payable until after a year they must be discounted
2. De ned Bene t pla
This is a post-employment bene t that gives the company an obligation to pay a
de ned pension to its employees who have left
The SFP Figur
The present value of the obligation less FV of assets (in the pension fund)
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De ned Bene t Scheme - Term
De ned Bene t Scheme - Term
De ned bene t pla
As we said in the intro - this is “A post-employment bene t that creates a constructive
obligation to the enterprise’s employees”
• The SFP shows the pension fund as it stands at the year end in terms of the present
value of the obligation less FV of assets
Let’s dig a little deeper to make some sense out of this
• The idea is that the company puts money into the fund, the fund spends that money
on assets
The assets make an EXPECTED return. The company hopes this return will pay off the
employees future pensions when they leave the company
• Of course, the fund will not always exactly match the pension liability. Therefore there
will either be a surplus or de cit on the SFP
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Let’s look at some terms before we put it all together
1. Actuarial gains/losse
These occur due to differences between previous estimates and what actually
occurred
These are recognised in the OCI
2. Past service cos
Dr Income statement
Cr Pension Liabilit
This is a change in the pension plan resulting in a higher pension obligation for
employee service in prior periods
They should be recognised immediately if already vested or not
3. Plan curtailments or settlement
Curtailments are reductions in bene ts or the number of employees covered by the
pension
Any gain/loss is recognised when the curtailment occurs
4. Current service cos
Increase in pension liability due to bene ts earned by employee service in the period
Dr Income statement
Cr Pension Liabilit
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5. Interest cos
The unwinding on the discount of the pension liability
Dr Interest
Cr Pension Liabilit
6. Expected return on plan asset
This is the Interest, dividends and other revenue from the pension assets and is now to
be based on the return from AA-rated corporate bonds
This means companies cannot set expected returns according to the assets actually
held by the pla
It could encourage them to invest in more secure vehicles than is currently the case,
seeing as the potential higher return will no longer be re ected in the accounts
The reason behind this is to improve transparency and consistency
Dr Pension Asset
Cr Interest receive
The Interest cost and EROA are netted off against each other. They use the same
discount rate
So if a fund has more assets than liabilities (a surplus) - it will have net interest
received
If a fund has more liabilities than assets (a de cit) - it will have net interest paid
7. Contributions to Pension fun
This is simply the money that the company puts in to the fund - so the fund can buy
assets to generate an expected return
Dr Pension Asset
Cr Cash
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8. Bene ts pai
These are the actual pensions paid out to former employees
Paying the pensions means we reduce the liability, but we use the pension fund to do it,
so we reduce the pension asset also
Dr Pension Liability
Cr Pension Asse
Other Long-term Bene ts (e.g. Pro t shares, bonuses
A simpli ed application of the model described above for other long-term employee
bene ts
All past service cost is recognised immediately
Termination Bene ts (e.g. Redundancy
Amount payable only recognised when committed to either
1. Terminating the employment of employees before the normal retirement date; o
2. Providing bene ts in order to encourage voluntary redundancy
“Demonstrably committed” means a detailed formal plan without realistic
possibility of withdrawal
Discount down if payable in more than a year
Equity Compensation Bene t
No recognition for stock options issued to employees as compensation
Nor does it require disclosure of the fair values of stock options or other share-based
payment
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IAS 19 ‘Asset Ceiling
This stops gains being shown just because Past service costs (unvested) have been
deferred
It may be that there are net assets but not all can be recovered through refunds /
contributing less in the future
In such cases, deferral of past service cost may not result in a refund to the entity or a
reduction in future contributions to the pension fund, so a gain is prohibited in these
circumstances
So, any asset recognised in the balance sheet should be the lower of
• the net total calculated; an
• the net total of
(i) past service costs not recognised as an expense; an
(ii) the present value of any economic bene ts available in the form of refunds from the
plan or reductions in future contributions to the plan
An asset may arise where a de ned bene t plan has been overfunded or in certain
cases where actuarial gains are recognised
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De ned Bene t - Illustratio
This is best seen on the video - but here goes in the written word…
Illustratio
Pension Fund asset b/f 400
Pension Fund Liability b/f 600
Current service cost 100
Expected return on assets 10%
Discount rate 10%
Contributions paid (@ year-end) 80
Bene ts paid (@ year-end) 6
Actuarial c/f: Pension Fund Asset 500
Pension Fund Liability 65
Solutio
• Current Service cos
Dr I/S 100
Cr Pension Liability 10
• Expected return on Asset
Dr Pension asset 40 (10% x 400)
Cr Interest 4
• Unwinding of discoun
Dr Interest 60 (10% x 600)
Cr Pension Liability 6
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• Contributions Pai
Dr Pension asset 80
Cr Cash 8
• Bene ts pai
Dr Pension Liability 60
Cr Pension Asset 6
Having done those double entry we can see that assets have increased by 60 (400 to
460) and liabilities have increased by 100 (600 to 700) giving a net increase in the SFP
pension liability of 40.
We now compare the pension assets and liabilities gure (which is based upon
assumptions) to what has actually occurred
This is given in the actuarial gures c/f
So, the assets made an actuarial gain of 40 and the liabilities a gain of 50
This total gain of 90 is recognised in the OCI as a gain
The balance sheet is showing a liability of 240, less the re-measurement of 90, equals
150 Liability
This matches what is actually in the pension fund (650- 500) = 150
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De ned Contribution Schem
Short-term Employee Bene t
Bene ts payable within a year after work is done, such as wages, paid vacation and
sick leave, bonuses etc. should be recognised when work is done
Pro t-sharing and Bonus Payment
Recognise when there is an obligation to make such payments and a reliable estimate
of the expected cost can be made
De ned contribution pla
• The enterprise pays xed contributions into a fund and has no further obligations
• The contribution payable is recognised in the income statement for that period
• If contributions are not payable until after a year they must be discounted.
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Syllabus C5b) Account for gains and losses on settlements and curtailments.
Curtailments and Settlement
Curtailment
An amendment is made to the plan which improves bene ts for plan members
An increase to the obligation (and expense) is recognised when the amendment occurs
DEBIT Pro t or loss
CREDIT Present value of de ned bene t obligation
Settlement
A settlement eliminates all further obligation
Eg: A lump-sum cash payment made in exchange for rights to receive post-employment
bene ts
The gain or loss on a settlement is recognised in pro t or loss when the settlement occurs
DEBIT PV obligation (as advised by actuary)
CREDIT FV plan assets (any assets transferred)
CREDIT Cash (paid directly by the entity)
CREDIT/ DEBIT Pro t or loss (difference) X
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Syllabus C5c) Account for the “Asset Ceiling” test and the reporting of actuarial gains and losses.
Asset Ceiling Tes
The 'Asset Ceiling' tes
The net pension amount can't be in the shown at more than its recoverable amount
So basically any net pension asset gets measured at the lower of
1) Net reported asset (in the books) o
2) The PV of any refunds/ reduction of future contributions available from the pension pla
Any impairment loss is charged immediately to OC
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Syllabus C6. Income taxes
Syllabus C6a) Discuss and apply the recognition and measurement of deferred tax liabilities and
deferred tax assets.
Syllabus C6b) Discuss and apply the recognition of current and deferred tax as income or expense.
Current tax
The amount of income taxes payable or receivable in a perio
Any tax loss that can be carried back to recover current tax of a previous period is shown
as an asse
If the gain or loss went to the OCI, then the related tax goes there to
Deferred Ta
This is basically the matching concept
Let´s say we have credit sales of 100 (but not paid until next year)
There are no costs
The tax man taxes us on the cash basis (i.e. next year)
The Income statement would look like this
Income Statement
Sales
100
Tax (30%)
0
Pro t
100
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This is how it should look
The tax is brought in this year even though it´s not payable until next year, it´s just a
temporary timing difference.
Income Statement
SFP
Sales
100
Tax (30%)
0 Deferred tax payable
Pro t
30
100
Illustratio
Tax Bas
Let’s presume in one country’s tax law, royalties receivable are only taxed when they are
receive
IFR
IFRS, on the other hand, recognises them when they are receivable
Now let’s say in year 1, there are 1,000 royalties receivable but not received until year 2
The Income statement would show
Royalties Receivable
Ta
100
(0) (They are taxed when received in yr 2
This does not give a faithful representation as we have shown the income but not the
related tax expense
Therefore, IFRS actually states that matching should occur so the tax needs to be brought
into year 1
Dr Tax (I/S
Cr Deferred Tax (SFP provision
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Deferred tax on a revaluatio
Deferred tax is caused by a temporary difference between accounts rules and tax rules
One of those is a revaluation
Accounting rules bring it in now.
Tax rules ignore the gain until it is sold
So the accounting rules will be showing more assets and more gain so we need to
match with the temporarily missing tax
Illustratio
A company revalues its assets upwards making a 100 gain as follows
OCI
SFP
PPE
Revaluation Gain
100
1,000 + 100
Revaluation surplus 100
This is how it should look
The tax is brought in this year even though it´s not payable until sold, it´s just a
temporary timing difference.
Notice the tax matches where the gain has gone to
OCI
SFP
Revaluation Gain
100 - 30
PPE
1,000 + 100
Deferred tax payable (30%)
(30)
Revaluation surplus
100 - 30
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Deferred Tax Scenario
So as we saw in the introductory section, deferred tax is all about matching.
If the accounts show the income, then they must also show any related tax.
This is normally not a problem as both the accounts and taxman often charge amounts
in the same period
The problem occurs when they don’t.
We saw how the accounts may show income when the performance occurs, while the
taxman only taxes it (tax base) when the money is received.
In this case, as nancial reporters we must make sure we match the income and
related expense
So this was a case of the accounts showing ‘more income’ than the tax man in the
current year (he will tax it the following year when the money is received).
So we had to bring in ‘more tax’ ourselves by creating a deferred tax liability
So, basically deferred tax is caused simply by timing differences between IFRS rules and
tax rules
Therefore IFRS demands that matching should occur i.e
Difference
between IFRS
and Tax base
Tax adjustment
needed for
matching to
occur
Deferred Tax
Double entry
More Income in I/S
More tax needed
Liability
Dr Tax (I/S
Cr Def Tax Liability
(SFP)
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Hopefully you can see then that the opposite also applies
Difference
Tax effect
Deferred Tax
Double entry
More expense in I/S
less tax needed
Asset
Dr Def tax asse
Cr tax (I/S)
In fact, the following table all applies
Difference
Tax effect
Difference
1 More Income
More tax
Liability
2 Less income
Less tax
Asset
3 More expense
Less tax
Asset
4 Less expense
More tax
Liability
Remember this “more income etc.” is from the point of view of IFRS. I.e. The accounts
are showing more income, as the taxman does not tax it until next year
We will now look at each of these 4 cases in more detail
Case
Difference
1 More Income
Tax effect
Difference
More tax
Liability
Issu
IFRS shows more income than the taxman has taken into account
Example
Royalties receivable above
Double entry required:
Dr Tax (I/S)
Cr Deferred tax Liability (SFP
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Case
Difference
Tax effect
Difference
2
Issu
IFRS shows less income than the taxman has taken into account
Example
Taxman taxes some income which IFRS states should be deferred such as upfront
receipts on a long term contract
Double entry required:
Dr Deferred Tax Asset (SFP)
Cr Tax (I/S
This will have the effect of eliminating the tax charge for now, so matching the fact that
IFRS is not showing the income yet either.
Once the income is shown, then the tax will also be shown by
Dr Tax (I/S)
Cr Deferred tax asset (SFP
Case
Difference
3 More Expense
Tax effect
Difference
Less tax
Asset
Issu
IFRS shows more expense than the taxman has taken into account
Example
IFRS depreciation is more than Tax depreciation (WDA or CA)
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Double entry required:
Dr Deferred Tax Asset (SFP)
Cr Tax (I/S
Illustratio
IFRS
TAX
Asset Cost
1,000
1,000
Depreciation
(400)
(300)
600
700
NBV
Simply compare 700-600 =10
100 x tax rate = deferred tax asse
Case
Difference
4 Less Expense
Tax effect
Difference
More tax
Liability
Issu
IFRS shows less expense than the taxman has taken into account
Example
IFRS depreciation is less than Tax depreciation (WDA or CA)
Double entry required:
Dr Tax I/S
Cr Deferred Tax Liabilit
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Illustratio
IFRS
TAX
Asset Cost
1,000
1,000
Depreciation
(300)
(400)
700
600
NBV
Simply compare 700-600 =10
100 x tax rate = deferred tax liabilit
Then multiply this by the tax rate (e.g. 30%) = 100 x 30% = 3
NOT
In actual fact, the standard refers to assets and liabilities rather than more income and
more expense etc.
Simply use the above tables and substitute the word asset for income and expense for
liability
Difference
Tax effect
Tax effect
1 More Asset
More tax
Liability
2 Less Asset
Less tax
Asset
3 More Liability
Less tax
Asset
4 Less Liability
More tax
Liability
Possible Examination examples of Case 1&
Accelerated capital allowances (accelerated tax depreciation) - see above
Interest revenue - some interest revenue may be included in pro t or loss on an
accruals basis, but taxed when received
Development costs - capitalised for accounting purposes in accordance with IAS 38
while being deducted from taxable pro t in the period incurred
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Revaluations to fair value
In some countries the revaluation does not affect the tax base of the asset and hence a
temporary difference occurs which should be provided for in full based on the difference
between its carrying value and tax base
NOTE: Double entry here is:
Dr Revaluation Reserve with the tax (as this is where the “income” went)
Cr Deferred tax liabilit
Fair value adjustments on consolidation
IFRS 3/ IAS 28 require assets acquired on acquisition of a subsidiary or associate to be
brought in at their fair value rather than carrying amount
The deferred tax effect is a consolidation adjustment - this is more assets (normally) so
a deferred tax liability. The other side would be though to increase goodwill. And viceversa
Undistributed pro ts of subsidiaries, branches, associates and joint ventures
No deferred tax liability if Parent controls the timing of the dividend.
Possible Examination examples of Case 2 &
Provisions - may not be deductible for tax purposes until the expenditure is incurred.
Losses - current losses that can be carried forward to be offset against future taxable
pro ts result in a deferred tax asset
Fair value adjustments
liabilities recognised on business combinations result in a deferred tax asset where the
expenditure is not deductible for tax purposes until a later period
A deferred tax asset also arises on downward revaluations where the fair value is less
than its tax base.
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NOTE: Here, the deferred tax asset here is another asset of S at acquisition and so
reduces goodwill
Unrealised pro ts on intra-group trading
the tax base is based on the pro ts of the individual company who has made a realised
pro t
THERE IS NO DEFERRED TAX EFFECT ON INITIAL GOODWILL
How much deferred tax
1. Deferred tax is measured at the tax rates expected to apply to the period when the
asset is realised or liability settled, based on tax rates (and tax laws) that have been
enacted by the end of the reporting period.
2. No Discountin
3. Deferred tax assets are only recognised to the extent that it is probable that taxable
pro t will be available against which the deductible temporary difference can be use
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Syllabus C6c) Discuss and apply the treatment of deferred taxation on a business combination.
Miscellaneous Deferred Tax Item
On acquiring a Subsidiar
Here you need to check the Net Assets at acquisition (from your equity table) and compare
it to the tax base of the NA (this will be given in the exam
Again you just look to see if the accounts are showing more or less assets and create a
deferred tax liability / asset at acquisition also. This will affect goodwill
Illustratio
H acquires 100% S for 1,000. At that date the FV of S’s NA was 800 and the tax base 700.
Tax is 30%.
How much is goodwill
Goodwill
FV of Consideration
1,000
NCI
-
FV of NA acquired
-800
New Deferred tax liabilit
(800-700) x 30%
30
Goodwill
230
Un-remitted Earnings of Group Companie
H always has the right to receive pro ts (and dividends from them) from S or A. However
not all pro ts are immediately paid out as dividends
This creates deferred tax as H will receive the full amount one day and when it does it will
be taxed. Therefore, a deferred tax liability should be created to match against the pro ts
shown from S and
However, for Subsidiaries only, H might control its dividend policy and have no intention of
paying dividends out and no intention of selling S either in the foreseeable future
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Therefore when this is the case NO deferred tax liability is created (this can not be the
case for Associates as H does not control A
Unrealised Pro t Adjustment
Here, the group makes an adjustment and decreases pro ts, in the group accounts only
However, tax is charged on the individual companies and not the group. So, the group
accounts will be showing less pro ts and so the tax needs adjusting by creating a deferred
tax asse
The issue though is what tax rate to use - that of the selling company or that of the buyer
who holds the stock?
IAS 12 says you should use the tax rate of the buye
Setting Of
A deferred tax asset can normally be set off against a deferred tax liability (to the same tax
jurisdiction) as the liability gives strong evidence that pro ts are being made and so the
asset will come to fruitio
Deferred Tax Liability
1,000
Deferred Tax Asset
-800
200
If, however, the deferred tax asset is more than the liability then the deferred tax asset can
only be recognised if is probable that it will be recovered in the near futur
Deferred Tax Liability
1,000
Deferred Tax Asset
-1,100
NO SET OFF
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Syllabus C7. Provisions, contingencies and events after
the reporting date
Syllabus C7a) Discuss and apply the recognition, de-recognition and measurement of provisions,
contingent liabilities and contingent assets including environmental provisions and restructuring
provisions.
Provision
A provision is a liability of uncertain timing or amount
Double entr
Dr Expens
Cr Provision (Liability SFP
If it is part of a cost of an asset (e.g. Decommissioning costs
Dr Asse
Cr Provision (Liability SFP
Recognise whe
1. There is an obligation (constructive or legal
2. There is a probable out o
3. It is reliably measurabl
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At how much
The best estimate of the expenditur
Large Population of Items.
use expected values.
Single Item..
the individual most likely outcome may be the best estimate.
Discounting of provisions
Provisions should be discounted
Eg. A future liability of 1,000 in 2 years time (discount rate 10%
1,000 x 1/1.10 x 1/1.10 = 826
Dr Expense 82
Cr Provision 82
Then the discount unwound
Year
826 x 10% = 8
Dr Interest 8
Cr Provision 8
Year
(826+83) x 10% = 9
Dr Interest 9
Cr Provision 9
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Measurement of a Provisio
• The amount recognised as a provision should be the best estimate of the
expenditure required to settle the present obligation at the end of the reporting period
• Provisions for one-off event
E.g. restructuring, environmental clean-up, settlement of a lawsui
Measured at the most likely amoun
• Large populations of event
E.g. warranties, customer refund
Measured at a probability-weighted expected valu
Illustratio
A company sells goods with a warranty for the cost of repairs required in the rst 2
months after purchase
Past experience suggests
88% of the goods sold will have no defect
7% will have minor defect
5% will have major defect
If minor defects were detected in all products sold, the cost of repairs will be $24,000
If major defects were detected in all products sold, the cost would be $200,000
What amount of provision should be made
(88% x 0) + (7% x 24,000) + (5% x 200,000) = $11,68
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Contingent Liabilitie
These are simply a disclosure in the account
They occur when a potential liability is not probable but only possible
(Also occurs when not reliably measurable
Contingent Asset
Here, it is not a potential liability, but a potential asset
The principle of PRUDENCE is important here, it must be harder to show a potential
asset in your accounts than it is a potential liability
This is achieved by changing the probability test
For a potential (contingent) asset - it needs to be virtually certain (rather than just
probable)
Probability test for Contingent Liabilitie
Remote chance of paying out - Do nothin
Possible chance of paying out - Disclosur
Probable chance of paying out - Create a provisio
Probability test for Contingent Asset
Remote chance of receiving - Do nothin
Possible chance of receiving - Do nothin
Probable chance of receiving - Disclosur
Virtually certain of receiving - create an asset in the accounts
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Some typical example
Speci c types of provision
Future operating losses
Provisions are not recognised for future operating losses (no obligation)
Onerous contracts
Recognised and measured as a provision (as there is a contract and so a legal obligation
Restructuring
Create a provision when
1. There is a detailed formal plan for the restructuring; and
2. There is a valid expectation in those affected that it will carry out the restructuring by
starting to implement that plan or announcing its main features to those affected by it
(this creates a constructive obligation
Provide only for costs that are
(a) necessarily entailed by the restructuring; and
(b) not associated with the ongoing activities of the entit
Possible Exam Scenario
Warrantie
Yes there is a legal obligation so provide. The amount is based on the class as a whole
rather than individual claims. Use expected value
Major Repair
These are not provided for. Instead they are treated as replacement non current assets.
See that chapte
Self Insuranc
This is trying to provide for potential future res etc. Clearly no provision as no obligation to
pay until re actually occur
Environmental Contamination Clearanc
Yes provide if legally required to do so or other parties would expect the company to do so
as it is its known policy
)
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Decommissioning Cost
All costs are provided for. The debit would be to the asset itself rather than the income
statemen
Restructurin
Provide if there is a detailed formal plan and all parties affected expect it to happen. Only
include costs necessary caused by it and nothing to do with the normal ongoing activities
of the company (e.g. don’t provide for training, marketing etc
Reimbursement
This is when some or all of the costs will be paid for by a different party
This asset can only be recognised if the reimbursement is virtually certain, and the
expense can still be shown separately in the income statemen
Circumstance
Provide?
Warranties/guarantees
Accrue a provision (past event was the
sale of defective goods)
Customer refunds
Accrue if the established policy is to give
refunds
Land contamination
Accrue a provision if the company's
policy is to clean up even if there is no
legal requirement to do so
Firm offers staff training
No provision (there is no obligation to
provide the training)
Restructuring by sale of an operation/
Accrue a provision only after a binding
line of business
sale agreement
Restructuring by closure of business
Accrue a provision only after a detailed
locations or reorganisation
formal plan is adopted and announced
publicly. A Board decision is not enough
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Syllabus C7b) Discuss and apply the accounting for events after the reporting period.
IAS 10 Events After The Reporting Perio
Events can be adjusting or non-adjusting
We are looking at transactions that happen in this period, and whether we should go back
and adjust our accounts for the year end or not adjust and just put into next year’s
account
If the event gives us more information about the condition at the year-end then we
adjust
If not then we don’t
When is the "After the Reporting date" period
It is anytime between period end and the date the accounts are authorised for issue
After the SFP date = Between period end and date authorised for issu
Ok and why is it important
Well it may well be that many of the gures in the accounts are estimates at the period
end
However, what if we get more information about these estimates etc afterwards, but
before the accounts are authorised and published.. should we change the accounts or
not
The most important thing to remember is that the accounts are prepared to the SFP
date. Not afterwards
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that more information ABOUT the conditions at the SFP date have come about
afterwards and so we should adjust the accounts
Sometimes we do not adjust though
Adjusting Event
Here we adjust the accounts if
The event provides evidence of conditions that existed at the period en
Examples are.
1. Debtor goes bad 5 days after SFP dat
(This is evidence that debtor was bad at SFP date also
2. Stock is sold at a loss 2 weeks after SFP dat
IAS2 ‘Inventories’ states that estimates of net realisable value should take into account
uctuations in price occurring after the end of the period to the extent that it con rms
conditions at the year en
(This is evidence that the stock was worth less at the SFP date also
3. Property gets impaired 3 weeks after SFP dat
(This implies that the property was impaired at the SFP date also
4. The result of a court case con rming the company did have a present
obligation at the year en
5. The settling of a purchase price for an asset that was bought before the year
end but the price was not nalise
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So we are trying to show what the situation at the SFP date was. However, it may be
6. The discovery of fraud or error in the year
Non-Adjusting Events - these are disclosed onl
These are events (after the SFP date) that occurred which do not give evidence of
conditions at the year end, rather they are indicative of conditions AFTER the SFP dat
1. Stock is sold at a loss because they were damaged post year-en
(This is evidence that they were ne at the year-end - so no adjustment
2. Property impaired due to a fall in market values generally post year en
(This is evidence that the property value was ne at the year end - so no adjustment
required)
3. The acquisition or disposal of a subsidiary post year en
4. A formal plan issued post year end to discontinue a major operatio
5. The destruction of an asset by re or similar post year en
6. Dividends declared after the year en
Non-adjusting event which affects Going Concer
Adjust the accounts to a break up basis regardless if the event was a non-adjusting
event
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Syllabus C8. Share based payment
Syllabus C8a) Discuss and apply the recognition and measurement of share-based payment
transactions.
Share Based Payments - Introductio
What is a SBP transaction
Well rst of all it needs to be for receiving good or services1 and in return the company
gives
1) Its own share
2) Cash based upon the price of its own share
Contracts to buy or sell non- nancial items that may be settled net in shares or rights to
shares are outside the scope of IFRS 2 and are addressed by IAS 3
There are 3 types of Share based payment
1. Equity-settled share-based paymen
This is where the company pays shares in return for goods and/or services received
Dr Expense
Cr Equit
2. Cash-settled share-based paymen
This is where cash is paid in return for goods and services received, HOWEVER..the
actual cash amount though is based on the share price
Goods and services not identi ed are still under IFRS 2 e.g.. Payments to Trade Unions etc
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These are also called SARs (Share Appreciation Rights)
Dr Expense
Cr Liabilit
3. Transactions with a choice of settlemen
A choice of cash or shares paid in return for goods and services received
Vesting perio
Often share based payments are not immediate but payable in say 3 years. The
expense is spread over these 3 years and this is called the vesting period
How much to recognise
So we have decided that share based payments (either shares or cash based on share
price) should go into the accounts
(Dr expense Cr Equity or Liability
We now have to look at the value to put on these
• Option 1: Direct metho
Use the FV of the goods or services receive
• Option 2: Indirect metho
Use the FV of the shares issued by the compan
Equity settled - Use FV of shares @ grant date
Cash settled - Update FV of shares each yea
IFRS 2 suggests you choose option 1 - the FV of the goods/services
However, if the FV of these cannot be reliably measured then you should go for
option 2 - FV of shares issued
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Strangely enough, option 2 is the most common. This is because share based
payments are often associated with paying employees
You cannot put a value on the work done by employees - except for the value of
what you pay them i.e. Option 2
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SBP - Equity Settle
This is where payments are made with an equity instrument such as a share
or a share option
Measuremen
The FV of the product / service acquired (if possible
FV of equity instrument issue
FV of Equity Instrumen
This is basically MARKET VALUE, taking into account the terms and market related
conditions of the offer
If there is no MV available, then the “Intrinsic Value” option is available. This is basically
the share price less the exercise price
However, if this is chosen then the accounting treatment below is slightly different. It will
need to be remeasured to the new intrinsic value each year - this will be very rare
Accounting Treatmen
Dr Expense (or asset)
Cr Equit
The problem is we only do the above double entry once the item has ‘vested’ (i.e.
satis ed all conditions to be met to make the share payable
For example, if shares are issued for the purchase of a building, and the building is
available to use immediately, then it has vested immediately and you would Dr PPE Cr
Equity with the FV of the asset acquired
If, however, share options are issued, but only once employees have stayed in the job
for say 3 years, then this means they do not fully vest for 3 years. What you do here, is
recognise the expense as it vests - over what we call the ‘vesting period’. So, in this
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example, you would calculate the full cost of the options at grant date and in the rst
year Dr Expense Cr Equity with 1/3 of that total
Precise Measuremen
You take the best available estimate at the time of the number of equity instruments
expected to vest at the end
The value used for the share options throughout the vesting period remains at the
GRANT DATE value (with the exception of “intrinsic value” method above)
Illustration
Equity Settle
An entity grants 100 share options on its $1 shares to each of its 500 employees on 1
January Year 1.
Each grant is conditional upon the employee working for the entity over the next three
years.
The fair value of each share option as at 1 January Year 1 is $10.
On the basis of a weighted average probability, the entity estimates on 1 January that
100 employees will leave during the three-year period and therefore forfeit their rights
to share options
The following actually occurs:
– 20 employees leave during Year 1 and the estimate of total employee departures
over the three-year period is revised to 70 employees
– 25 employees leave during Year 2 and the estimate of total employee departures
over the three-year period is revised to 60 employees
– 10 employees leave during Year 3
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Solutio
Step 1: Decide if this is a cash or equity settled SBP - share options are equity settled
(so Dr Expense Cr Equity)
Step 2: Decide whether to value directly or indirectly - these are for employees so
indirectly
Step 3: Calculate how many employees (and their share options each) are expected to
be issued at the end of the vesting period
Year 1: 430 Employees expected to be left at end (500-70) x 100 (share options each)
x $10 (FV @ GRANT date) x 1/3 (time through vesting period) = 143,30
Year 2: 440 x 100 x $10 x 2/3 - 143,300 = 150,00
Year 3: 445 x 100 x $10 x 3/3 - 293,300 = 151,70
So you can see that the “costs” and so the entries into the accounts would be
Year 1: Dr Expense 143,300 Cr Equity 143,300
Year 2: Dr Expense 150,000 Cr Equity 150,000
Year 3: Dr Expense 151,700 Cr Equity 151,70
Notice that if you add these up it comes to 445,000. This is exactly our nal liability (445
x 100 x $10 x 3/3) - it’s just we’ve spread it over the 3 years vesting period
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SBP - Cash Settle
These are when a company promises to pay for goods or services for cash, however
the cash price is linked to the share pric
They are often called “Share Appreciation Rights (SARs)
The double entry is
Dr Expense
Cr Cash or Liabilit
If the payment is for a service stretching over a number of years (vesting period) then
the expense is recognised over the number of years and the liability is calculated by
taking into account the change in the share pric
Illustration
1 Jan Year 1 - 100 share appreciation rights (SARs) given to each of the company’s
1000 employees. FV of these at grant date was £5. The employees had to be in service
for 3 years to take the SA
End of year 1 - 100 employees had left and 140 more expected to leave by the end of
year 3. FV of SAR now £
End of year 2 - 40 employees left in the year and another 50 expected to leave in year
3. FV of SAR now £
End of year 3 - 60 employees left and the FV of SAR is now £
Solutio
Year 1 - 760 (1,000 - 100 -140) x 100 x £6 x 1/3 = 152,000 (Dr Expense Cr Liability
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Year 2 - 810 (1,000 - 100 - 40 - 50) x 100 x £8 x 2/3 = 432,000 - 152,000 = 280,000 (Dr
Expense Cr Liability
Year 3 - 800 (1,000 - 100 - 40 - 60) x 100 x £7 x 3/3 = 560,000 - 432,000 = 128,000 (Dr
Expense Cr Liability
Finally the 560,000 is pai
Dr Liability 560,00
Cr Cash 560,00
Illustration
An entity grants 100 SARs to each of its 500 employees on 1 January Year 1.
Each grant is conditional upon the employee working for the entity over the next three
years.
The fair value of each share option as at 1 January Year 1 is $10.
On the basis of a weighted average probability, the entity estimates on 1 January that
100 employees will leave during the three-year period and therefore forfeit their rights
to share options
The following actually occurs:
– 20 employees leave during Year 1 and the estimate of total employee departures
over the three-year period is revised to 70 employees
– 25 employees leave during Year 2 and the estimate of total employee departures
over the three-year period is revised to 60 employees
– 10 employees leave during Year
Information of share price at the end of each year:
Year 1 10
Year 2 12
Year 3 1
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Solution
As this is cash settled then the double entry becomes Dr Expense Cr Liability and we
do not keep the value of the option @ grant date but change it as we pass through the
vesting period
Y1: 430 x 100 x 10 x 1/3 = 143,300
Y2: 440 x 100 x 12 x 2/3 - 143,300 = 208,700
Y3: 445 x 100 x 14 x 3/3 - 623,000 x 3/3 - 352,000 = 271,00
So you can see that the “costs” and so the entries into the accounts would be
Year 1: Dr Expense 143,300 Cr Liability 143,300
Year 2: Dr Expense 208,700 Cr Liability 208,700
Year 3: Dr Expense 271,000 Cr Liability 271,00
Notice that if you add these up it comes to 623,000.
This is exactly our nal liability (445 x 100 x $14 x 3/3) - it’s just we’ve spread it over the
3 years vesting period.
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SBP with a Choice of Settlemen
Share-based payment with a choice of settlemen
Entity has the choic
Is there a present obligation to settle in cash
Ye
Treat as cash-settle
N
Treat as equity-settled
Counter-party has the choic
The transaction is a compound nancial instrument which needs splitting into debt and
equit
Debt Portio
This must be calculated rst..the FV of the cash option at grant dat
Then it is treated just like a normal cash-settled SB
Equity Portio
This is the FV of the option less the debt portion calculated above at grant dat
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Illustratio
An entity grants an employee a right to receive either 8,000 shares or cash to the value,
on that date, of 7,000 shares. She has to remain in employment for 3 years
The market price of the entity's shares is $21 at grant date, $27 at the end of year 1, $33
at the end of year 2 and $42 at the end of the vesting period, at which time the employee
elects to receive the shares.
The entity estimates the fair value of the share route to be $19
Show the accounting treatment
Solutio
The fair value of the cash route at grant date is: 7,000 × $21 = $147,000
The fair value of the share route is: 8,000 × $19 = $152,000 - 147,000 = $5,00
We then treat them as cash and equity settled SBPs as appropriate
Year
Cash
Equity
7,000 x $27 x 1/3
1
5,000 x 1/
63,000
5,000 x 1/
154,000
92,667
1,667
7,000 x $42 x 3/3
3
64,667
1,667
7,000 x $33 x 2/3
2
I/S
5,000 x 1/
294,000
141,667
1,667
Entity has the choice of issuing shares or cas
Option 1 - Obligated to pay cas
The entity is prohibited from issuing shares or where it has a stated policy, or past practice,
of issuing cash rather than shares.
Treat as a cash-settled SB
Option 2 - Not obligated to pay cas
Treat as if it was purely an equity-settled transaction.
If on settlement, cash was actually paid, the cash should be treated as if it was a
repurchase of the equity instrument by a deduction against equity.
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Vesting Perio
This is normally a set amount of time but sometimes it may be dependent upon a condition
to be satis ed.
Vesting Condition
These are conditions that have to be met before the holder gets the right to the shares or
share option
There are 2 types of Vesting Condition
Non-market based2
Those not relating to the market value of the entity’s shares
Market based3
Those linked to the market price of the entity’s shares in some way
Non-Market Vesting Condition
Here only the number of shares or share options expected to vest will be accounted for.
At each period end (including interim periods), the number expected to vest should be
revised as necessary.
2
Employee completing minimum service; Achieving sales target; EPS target; On otation;
3
Increase in SP; Increase in shareholder return; Target SP
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Illustratio
An entity granted 10,000 share options to one director. The director had to work there for 3
years, and indeed he di
Also to get the options, the director had to reduce costs by 10% over the vesting period. At
the end of the rst year, costs had reduced by 12%. By the end of the 2nd year, costs had
only reduced in total by 7%. By the end of yr. 3 though the costs had been reduced by 11
The FV of the option at grant date was $2
How should the transaction be recognised
Solutio
The cost reduction target is a non-market performance condition which is taken into
account in estimating whether the options will vest. The expense recognised in pro t or
loss in each of the three years is
Yearly Charge
Cumulative
(10,000 × £21)/3 years
Year 1
70,000
70,000
Year 2 (performance
target not expected to be
met)
-70,000
(10,000 x $21)
Year 3
210,000
0
210,000
%
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Market Vesting Condition
These conditions are taken into account when calculating the fair value of the equity
instruments at the grant date.
They are not taken into account when estimating the number of shares or share options
likely to vest at each period end.
If the shares or share options do not vest, any amount recognised in the nancial
statements will remain.
Make an estimate of the vesting period at the acquisition dat
If vesting period is shorter than original estimat
Expense all the remainder in the year the vesting condition is complied wit
If vesting period is longer than the original estimat
Expense still using the original estimate of vesting perio
Market and non-market based vesting conditions togethe
Where both market and non-market vesting conditions exist, then as long as the non
market conditions are met the company must expense (irrespective of whether market
conditions are satis ed
So, where market and non-market conditions co-exist, it makes no difference whether the
market conditions are achieved.
The possibility that the target share price may not be achieved has already been taken into
account when estimating the fair value of the options at grant date.
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Therefore, the amounts recognised as an expense in each year will be the same
regardless of what share price has been achieved
Illustratio
A company granted 10,000 share options to a director. He must work there for 3 years. He
did this
Also the share price should increase by at 25% over the three-year period.
During the 1st year the share price rose by 30% and by 26% compound over the rst two
years and 24% per annum compound over the whole perio
At the date of grant the fair value of each share option was estimated at £184
How should the transaction be recognised
Solutio
The director satis ed the service requirement but the share price growth condition was not
met.
The share price growth is a market condition and is taken into account in estimating the
fair value of the options at grant date.
Therefore, no adjustment should be made if there are changes from that estimated in
relation to the market condition. There is no write-back of expenses previously charged,
even though the shares do not vest
The expense recognised in pro t or loss in each of the three years is one third of 10,000 x
£18 = £60,000
Remember this would already include the probability of meeting the 25% increase over the 3 years
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IFRS 2 Share based payments deferred ta
Deferred tax implication
Issu
An entity recognises an expense for share options but the taxman offers the tax
deduction on the later exercise date
This is therefore an example of accounts showing more expenses (than the taxman
has allowed so far) and so a deferred tax asset occurs
The taxman may calculate his expense on the intrinsic value basis. This may offer a
greater deduction (at the end) than our expense. This extra deferred tax asset is set off
against equity (and OCI) not the income statement
Illustratio
An entity granted 1,000 share options to an employee vesting 3 years later. The fair
value of at the grant date was $3.
Tax law allows a tax deduction of the intrinsic value of$1.20 at the end of year 1 and
$3.40 at the end of year 2.
Assume a tax rate of 30%
Solutio
Year
Accounts
1,000 x 1/3 x 3 = 1,00
Tax
Has allowed 0
However, at the end he will allow 1,000 x 1/3 x 1.2 = 40
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Therefore the deferred tax asset is capped at 400. So, the double entry is:
Dr Deferred Tax Asset (400x30%) 120
Cr Tax (I/S) 12
Year 2
Accounts
1,000 x 2/3 x 3 - 1,000 = 1,00
Tax
1,000 x 2/3 x 3.4 - 400 = 1.86
Therefore we have expensed 2,000 (1,000 + 1,000)
The tax man will allow at the end 2,267 (400 + 1,867)
So, the deferred tax asset should now be 2267 x 30% = 68
Of this only 2,000 x 30% = 600 should have gone to the income statement (to match
with the 2,000 expense).
The remaining 80 should have gone to equity
Year 2
Income statement
Expense 1,000
Tax (600 - 120) -48
Equity
Share Options 2,000
Tax asset 8
Double entry
Dr Deferred tax asset (680-120) 560
Cr Income statement 480
Cr Equity 8
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IFRS 2 Modi cations and Cancellation
The entity might:
Reprice (modify) share options, o
Cancel or settle the options
Equity instruments may be modi ed before they vest.
For example, a fall in the actual share price may mean that the original option exercise
price is no longer attractive.
Therefore the exercise price is reduced (the option is ‘re-priced’) to make it valuable again.
Such modi cations will often affect the fair value of the instrument and therefore the
amount recognised in pro t or loss.
Accounting treatmen
1. Continue to recognise the original fair value of the instrument in the normal way
(even where the modi cation has reduced the fair value
2. Recognise any increase in fair value at the modi cation date (or any increase in the
number of instruments granted as a result of modi cation) spread over the period
between the modi cation date and vesting date.
3. If modi cation occurs after the vesting date, then the additional fair value must be
recognised immediately unless there is, for example, an additional service period, in
which case the difference is spread over this period.
Illustratio
At the beginning of year 1, an entity grants 100 share options to each of its 500
employees over a vesting period of 3 years at a fair value of $15
Year 1
40 leave, further 70 expected to leave; share options repriced (as mv of shares has
fallen) as the FV had fallen to $5. After the repricing they are now worth $8.
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Year 2
35 leave, further 30 expected to leav
Year 3
28 leav
Solution
The repricing has increased FV by (8-5) = 3
This amount is recognised over the remaining two years of the vesting period, along
with remuneration expense based on the original option value of $15
Year 1
Income statement & Equity
(500-110) x 100 x 1/3 x $15 = 195,00
Year 2
Income statement & Equity
[(500 – 105) × 100 × (($15 × 2/3) + ($3 × ½))] 454,250 - 195,000
Dr Expenses $259,250 Cr Equity $259,250
Year 3
Income statement & Equity
[(500 – 103) × 100 × ($15 + $3 ) 714,600 - 454,25
Dr Expenses $260,350
Cr Equity $260,350
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Illustratio
An entity granted 1,000 share options at an exercise price of £50 to each of its 30 key
management personnel.
They had to stay with the entity for 4 years
At grant date, the fair value of the share options was estimated at £20 and the entity
estimated that the options would vest with 20 managers.
This estimate didn’t change in year
The share price fell early in the 2nd year. So half way through that year they modi ed the
scheme by reducing the exercise price to £15. (The fair value of an option was £2
immediately before the price reduction and £11 immediately after.
It retained its estimate that options would vest with 20 managers
How should the modi cation be recognised
Solutio
The total cost to the entity of the original option scheme was: 1,000 shares × 20 managers
× £20 = £400,000
This was being recognised at the rate of £100,000 each year
The cost of the modi cation is:
1,000 x 20 managers × (£11 – £2) = £180,00
This additional cost should be recognised over 30 months, being the remaining period up
to vesting, so £6,000 a month
The total cost to the entity in the second year and from then on is: £100,000 + (£6,000 × 6)
= £136,000
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Cancellations and settlements
An entity may settle or cancel an equity instrument during the vesting period.
Basically treat this as the vesting period being shortened
Accounting treatmen
Charge any remaining fair value of the instrument that has not been recognised
immediately in pro t or loss (the cancellation or settlement accelerates the charge and
does not avoid it).
Any amount paid to the employees by the entity on settlement should be treated as a
buyback of shares and should be recognised as a deduction from equity.
If the amount of any such payment is in excess of the fair value of the equity instrument
granted, the excess should be recognised immediately in pro t or loss.
A cash settlement made to an employee on cancellatio
Dr Equity
Dr Income statement (excess over amount in equity)
Cr Cas
An equity settlement made to an employee on cancellatio
This is basically a replacement of the option and so is treated as a modi cation (see
earlier) at this value
Fair value of replacement instruments* X
Less: Net fair value of cancelled instruments (X
Illustratio
2,000 share options granted at an exercise price of $18 to each of its 25 key management
personnel. The management must stay for 3 years. The fair value of the options was
estimated at $33 and the entity estimated that the options would vest with 23 managers.
This estimate stayed the same in year 1
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In year 2 the entity decided to abolish the existing scheme half way through the year when
the fair value of the options was $60 and the market price of the entity's shares was $70.
Compensation was paid to the 24 managers in employment at that date, at the rate of $63
per option.
How should the entity recognise the cancellation?
Solution
The original cost to the entity for the share option scheme was: 2,000 shares × 23
managers × $33 = $1,518,000
This was being recognised at the rate of $506,000 in each of the three years.
At half way through year 2 when the scheme was abolished, the entity should recognise a
cost based on the amount of options it had vested on that date. The total cost is:
2,000 × 24 managers × £33 = $1,584,000
After deducting the amount recognised in year 1, the year 2 charge to pro t or loss is
$1,078,000.
The compensation paid is: 2,000 × 24 × $63 = $3,024,000
Of this, the amount attributable to the fair value of the options cancelled is:
2,000 × 24 × $60 (the fair value of the option, not of the underlying share) = $2,880,000
This is deducted from equity as a share buyback.
The remaining $144,000 ($3,024,000 less $2,880,000) is charged to pro t or loss.
Cancellation and resistanc
Where an entity has been through a capital restructuring or there has been a signi cant
downturn in the equity market through external factors, an alternative to repricing the share
options is to cancel them and issue new options based on revised terms.
The end result is essentially the same as an entity modifying the original options and
therefore should be recognised in the same way.
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IFRS 2 Scop
Share-based payments can be more than just employee share options, and the trick in
the exam is to know which scenarios you apply IFRS 2 to, and which you don’t
It Applies to All Entities
There is no exemption for private or smaller entities.
In fact, subsidiaries using their parent’s or fellow subsidiary’s equity as consideration for
goods or services are within the scope of the Standard
Goods and Services Only
IFRS 2 is used when shares are issued (or rights to shares given) in return for goods
and services ONLY
What does fall under IFRS
• Share appreciation right
• Employee share purchase plan
• Employee share ownership plan
• Share option plans an
• Plans where share issues (or rights to shares) depend on certain condition
What doesn’t fall under IFRS 2
• When shares are issued to buy a subsidiary (rather than for employing the subs
directors primarily).
So, in a question, care should be taken to distinguish share-based payments related
to the acquisition from those related to employee services
• When the item is being paid for with shares is a commodity-based derivative (such as
those dealing with the price of gold, oil etc.). These are IFRS 9 nancial instruments
instead.
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Syllabus C9. Fair Value Measurement
Syllabus C9a) Discuss and apply the de nitions of ‘fair value’ measurement and ‘active market’.
Fair Value Measuremen
IFRS 13 de nes Fair Value using an 'exit price' notion and a 'fair value hierarchy
So it's a market-based, rather than entity-speci c, measuremen
Fair Value De nitio
The price that would be received / paid ....
...in an orderly transaction between market participant
Active Market De nitio
A market with suf cient frequency and volume to provide pricing information on an ongoing
basi
Exit Price De nitio
The price that would be received (to sell an asset) or paid (to transfer a liability
Overview of Approac
A fair value measurement requires an entity to determine all of the following
• The particular asset (liability) and its unit of accoun
• For a non- nancial asset: An appropriate valuation premise (it's highest and best use
• Its principal (or most advantageous) marke
• Its appropriate valuation technique using market data and the fair value hierarch
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Syllabus C9b) Discuss and apply the ‘fair value hierarchy’.
The ‘Fair Value Hierarchy
This hierarchy aims to increase consistency and comparability in fair value measurements
So it categorises the inputs used in valuation techniques into three levels.
Highest priority given to quoted prices in active markets for identical assets
Lowest priority to unobservable input
Level 1 inputs
are Quoted prices in accessible active markets for identical assets
These give the most reliable evidence of fair value and are used without adjustment
(This is used even if the market's cannot absorb the quantity held by the entity
Level 2 inputs
are observable inputs (other than quoted market prices)
Level 2 inputs include:
Quoted prices for similar assets in active markets
Inputs that are corroborated by observable market data by correlation for example
('market-corroborated inputs')
Level 3 inputs
are unobservable inputs for the asset
Use the best information available in the circumstances, eg. Your own data, taking into
account all information about market participant assumptions that is reasonably availabl
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Syllabus C9c) Discuss and apply the principles of highest and best use, most advantageous and
principal market.
C9d) Explain the circumstances where an entity may use a valuation technique.
Highest and Best Us
The use of a non- nancial asset by market participants that would maximise the value of
the business using i
Most Advantageous Marke
The market that maximises the amount received (after transaction costs and transport
costs
Principal Marke
The market with the greatest volume and level of activit
Guidance On Measuremen
1.
Take into account the condition, location & any restrictions placed on the asse
2.
Fair value assumes a transaction taking place in the principal market for the asset
(In the absence of a principal market, the most advantageous market is used
3.
Fair value of a non- nancial asset uses its highest and best us
4.
The fair value of a liability re ects non-performance risk and own credit ris
Valuation Technique
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Valuation techniques should maximise the use of observable and minimise unobservable
input
Three widely used valuation techniques are shown below. Sometimes, just one technique
is appropriate, other times multiple techniques
• Market approach
Uses prices generated by market transactions involving identical or comparable (similar)
asset
• Income approach
Converts future cash ows to a single current (discounted) amount (re ecting current
market expectations about those future amounts
• Cost approach
The amount needed to replace the service capacity of an asset (current replacement
cost
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medium-sized entities (SMEs)
Syllabus C10a) Discuss the key differences in accounting treatment between full IFRS and the IFRS
for SMEs.
Syllabus C10b) Discuss and apply the simpli cations introduced by IFRS for SMEs.
IFRS for SME - Introductio
The principal aim when developing accounting standards for small-to medium-sized
enterprises (SMEs) is to provide a framework that generates relevant, reliable and useful
information, which should provide a high-quality and understandable set of accounting
standards suitable for SMEs.
The only real users of accounts for SMEs are
1) Shareholder
2) Managemen
3) Possibly governmen
IFRS for SMEs is a self-contained standard, incorporating accounting principles based on
existing IFRS, which have been simpli ed to suit SMEs.
If a topic is not covered in the standard there is no mandatory default to full IFRS
Topics not really required for SMEs are excluded and so the standard does not address
the following topics
• Earnings per share
• Interim nancial reporting
• Segment reporting
• Insurance (because entities that issue insurance contracts are not eligible to use the
standard)
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Syllabus C10. Reporting requirements of small and
Good news! The standards are relatively short and get the preparers to think. IFRS for
SMEs therefore contains concepts and pervasive principles, any further disclosures may
be needed to give a true and fair view. It will be updated once every 2 or 3 years only
What is an SME
There is no universally agreed de nition of an SME. As there are differences between
rms, sectors, or countries at different levels of development
Most de nitions based on size use measures such as number of employees, balance
sheet total, or annual turnover. However, none of these measures apply well across
national borders.
Ultimately, the decision regarding who uses IFRS for SMEs stays with national regulatory
authorities and standard-setters. These bodies will often specify more detailed eligibility
criteria. If an entity opts to use IFRS for SMEs, it must follow the standard in its entirety – it
cannot cherry pick between the requirements of IFRS for SMEs and the full set
Different users entirely
IFRS users are the capital markets. So, quoted companies and not SMEs.
The vast majority of the world's companies are small and privately owned, and it could be
argued that full International Financial Reporting Standards are not relevant to their needs
or to their users.
It is often thought that small business managers perceive the cost of compliance with
accounting standards to be greater than their bene t.
Because of this, the IFRS for SMEs makes numerous simpli cations to the recognition,
measurement and disclosure requirements in full IFRS.
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• Assets held for sal
Examples of these simpli cations are
Goodwill and other inde nite-life intangibles are amortised over their useful lives, but if
useful life cannot be reliably estimated, then 10 years.
A simpli ed calculation is allowed if measurement of de ned bene t pension plan
obligations (under the projected unit credit method) involve undue cost or effort.
The cost model is permitted for investments in associates and joint ventures.
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Some argue having 2 sets of rules may mean 2 true and fair views
Local GAAP for SME
An alternative could have been for GAAP for SMEs to have been developed on a national
basis, with IFRS focusing on accounting for listed company activities.
Then though, SMEs may not have been consistent and may have lacked comparability
across national boundaries.
Also, if an SME wished to later list its shares on a capital market, the transition to IFRS
could be harder.
List SME exemptions in the full IFRS
Under another approach, the exemptions given to smaller entities would have been
prescribed in the mainstream accounting standard.
For example, an appendix could have been included within the standard, detailing those
exemptions given to smaller enterprises.
Separate SME standard for each IFRS
Yet another approach would have been to introduce a separate standard comprising all the
issues addressed in IFRS that were relevant to SMEs.
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Differing approache
User friendl
The standard has been organised by topic with the intention of being user-friendlier for
preparers and users of SME nancial statement
The standard also contains simpli ed language and explanations of the standards.
Easier transition to full IFR
It is based on recognised concepts and pervasive principles and it allows easier transition
to full IFRS if the SME later becomes a public listed entity.
In deciding on the modi cations to make to IFRS, the needs of the users have been taken
into account, as well as the costs and other burdens imposed upon SMEs by the IFRS.
Cost Bene t
Relaxation of some of the measurement and recognition criteria in IFRS had to be made in
order to achieve the reduction in these costs and burdens.
Stewardship not so importan
Small companies pursue different strategies, and their goals are more likely to be survival
and stability rather than growth and pro t maximisation.
The stewardship function is often absent in small companies, with the accounts playing an
agency role between the owner-manager and the bank
Access to capita
Where nancial statements are prepared using the standard, the basis of presentation
note and the auditor's report will refer to compliance with IFRS for SMEs.
This reference may improve SME's access to capital.
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As it stands no
In the absence of speci c guidance on a particular subject, an SME may, but is not
required to, consider the requirements and guidance in full IFRS dealing with similar
issues.
The IASB has produced full implementation guidance for SMEs
IFRS for SMEs is a response to international demand from developed and emerging
economies for a rigorous and common set of accounting standards for smaller and
medium-sized enterprises that is much easier to use than the full set of IFRS.
It should provide improved comparability for users of accounts while enhancing the overall
con dence in the accounts of SMEs, and reduce the signi cant costs involved in
maintaining standards on a national basis
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Main Change
Financial statements
Full IFRS: A statement of changes in equity is required, presenting a reconciliation of
equity items between the beginning and end of the period.
IFRS for SMEs: Same requirement. However, if the only changes to the equity during the
period are a result of pro t or loss, payment of dividends, correction of prior-period errors
or changes in accounting policy, a combined statement of income and retained earnings
can be presented instead of both a statement of comprehensive income and a statement
of changes in equity.
Business combinations
Full IFRS: Transaction costs are excluded under IFRS 3 (revised). Contingent
consideration is recognised regardless of the probability of payment.
IFRS for SMEs: Transaction costs are included in the cost of investment.
Contingent considerations are included as part of the cost of investment if it is probable
that the amount will be paid and its fair value can be measured reliably.
Expense recognition
Full IFRS: Research costs are expensed as incurred; development costs are capitalised
and amortised, but only when speci c criteria are met. Borrowing costs are capitalised if
certain criteria are met.
IFRS for SMEs: All research and development costs and all borrowing costs are
recognised as an expense.
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Full IFRS: For tangible and intangible assets, there is an accounting policy choice
between the cost model and the revaluation model.
Goodwill and other intangibles with inde nite lives are reviewed for impairment and not
amortised.
IFRS for SMEs: The cost model is the only permitted model. All intangible assets,
including goodwill, are assumed to have nite lives and are amortised.
Intangible Asset
Full IFRS: Under IAS 38, ‘Intangible assets’, the useful life of an intangible asset is either
nite or inde nite. The latter are not amortised and an annual impairment test is required.
IFRS for SMEs: There is no distinction between assets with nite or in nite lives. The
amortisation approach therefore applies to all intangible assets. These intangibles are
tested for impairment only when there is an indication.
Investment Propert
Full IFRS: IAS 40, ‘Investment property’, offers a choice of fair value and the cost method.
IFRS for SMEs: Investment property is carried at fair value if this fair value can be
measured without undue cost or effort.
Held for Sal
Full IFRS: IFRS 5, ‘Non-current assets held for sale and discontinued operations’, requires
non-current assets to be classi ed as held for sale where the carrying amount is recovered
principally through a sale transaction rather than though continuing use.
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Non-current assets and goodwill
IFRS for SMEs: Assets held for sale are not covered, the decision to sell an asset is
considered an impairment indicator.
Employee bene ts – de ned bene t plans
Full IFRS: The use of an accrued bene t valuation method (the projected unit credit
method) is required for calculating de ned bene t obligations.
IFRS for SMEs: The circumstance-driven approach is applicable, which means that the
use of an accrued bene t valuation method (the projected unit credit method) is required if
the information that is needed to make such a calculation is already available, or if it can
be obtained without undue cost or effort.
If not, simpli cations are permitted in which future salary progression, future service or
possible mortality during an employee’s period of service are not considered.
Income taxes
Full IFRS: A deferred tax asset is only recognised to the extent that it is probable that
there will be suf cient future taxable pro t to enable recovery of the deferred tax asset.
IFRS for SMEs: A valuation allowance is recognised so that the net carrying amount of the
deferred tax asset equals the highest amount that is more likely than not to be recovered.
The net carrying amount of deferred tax asset is likely to be the same between full IFRS
and IFRS for SMEs.
Full IFRS: No deferred tax is recognised upon the initial recognition of an asset and
liability in a transaction that is not a business combination and affects neither accounting
pro t nor taxable pro t at the time of the transaction.
IFRS for SMEs: No such exemption.
Full IFRS: There is no speci c guidance on uncertain tax positions. In practice,
management will record the liability measured as either a single best estimate or a
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weighted average probability of the possible outcomes, if the likelihood is greater than
50%.
IFRS for SMEs: Management recognises the effect of the possible outcomes of a review
by the tax authorities. It should be measured using the probability-weighted average
amount of all the possible outcomes. There is no probable recognition threshold.
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Syllabus C11. Other Reporting Issues
Syllabus C11a) Discuss and apply the accounting for, and disclosure of, government grants and
other forms of government assistance.
Government Grant
Government grants are a form of government assistance
When can you recognise a government grant
When there is reasonable assurance that
•
The entity will comply with any conditions attached to the grant an
•
the grant will be receive
However, IAS 20 does not apply to the following situations
1. Tax breaks from the governmen
2. Government acting as part-owner
of the entit
3. Free technical or marketing advic
Accounting treatment of government grant
Dr Cash
The debit is always cash so we only have to know where we put the credit.
There are 2 approaches - depending on what the grant is given for
•
Capital Grant approach:
(Given for Assets - For NCA such as machines and buildings)
Recognise the grant outside pro t or loss initially:
Dr Cash
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Cr Cost of asset
or
Cr Deferred Incom
•
Income Grant approach:
(Given for expenses - For I/S items such as wages etc)
Recognise the grant in pro t or loss
Dr Cash
Cr Other income (or expense
Capital Grant approach - accounting for as "Cr Cost of asset
•
Dr Cash Cr Cost of asset
This will have the effect of reducing depreciation on the income statement and the
asset on the SF
•
An Example
Asset $100 with 10yrs estimated useful life
Received grant of $50
Accounting for a grant received:
DR Cash $50
CR Asset $50
At the Y/E
Depreciation charge:
DR Depreciation expense (I/S) (100-50)/10yrs = $5
CR Accumulate depreciation $
Capital Grant approach - accounting for as "Cr Deferred Income
•
Dr Cash
Cr Deferred Income
This will have the effect of keeping full depreciation on the income statement and the
full asset and liability on the SFP
Then...
Dr Deferred Income
Cr Income statement (over life of asset)
This will have the effect of reducing the liability and the expense on the income
statemen
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•
An Example
Asset $100 with 10yrs estimated useful life
Received grant of $50
Accounting for a grant received:
DR Cash $50
CR Deferred income $50
At the Y/E
Depreciation charge:
DR Depreciation expense (I/S) 100/10yrs = $10
CR Accumulate depreciation $10
Release of deferred income:
DR Deferred income 50/10yrs =$5
CR I/S $
Condition
These may help the company decide the periods over which the grant will be earned.
It may be that the grant needs to be split up and taken to the income statement on different
bases
Compensatio
The grant may be for compensation on expenses already spent.
Or it might be just for nancial support with no actual related future costs
Whatever the situation, the grant should be recognised in pro t or loss when it becomes
receivable
N
If a condition might not be met then a contingent liability should be disclosed in the notes.
Similarly if it has already not been met then a provision is required
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Non-monetary government grant
Think here, for example, of the government giving you some land (ie not cash).
To put a value on it - we use the Fair Value.
Alternatively, both may be valued at a nominal amount
Repayment of government grant
This means when we are not allowed the grant anymore and so have to repay it back.
This would be a change in accounting estimate (IAS 8) and so you do not change past
periods just the current one
Accounting treatment (capital grant repayment):
• Dr Any deferred Income Balance or Dr Cost of asset
• Dr Income statement with any balance
and CR cash with the amount repai
The extra depreciation to date that would have been recognised had the grant not been
netted off against cost should be recognised immediately as an expense
Accounting treatment - Income Grant Repayment
Dr Income statement
Cr Cas
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Syllabus C11b) Discuss and apply the principles behind the initial recognition and subsequent
measurement of a biological asset or agricultural produce.
Accounting for Biological Asset
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IAS 34 Interim Financial Reportin
Entities whose shares are publicly traded should produce interim nancial
report
De nition
Interim period
is a nancial reporting period shorter than a full nancial yea
Interim nancial report
means a nancial report containing either a complete set of FS or set of condensed FS for
an interim perio
Scop
The standard does not make the preparation of interim nancial reports mandatory
The IASB strongly recommend to governments that interim reporting should be a
requirement for companies whose equity or debt securities are publicly trade
• An interim nancial report should be produced for at least the rst 6 months of their
nancial yea
• The report should be available no later than 60 days after the end of the interim perio
• E.g. A company with a year end (Y/E) ending 31 December will prepare an interim report
for the half year to 30 June.
This report will be available before the end of Augus
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Syllabus C11c) Outline the principles behind the application of accounting policies and measurement
in interim reports.
Minimum Content of an Interim Financial Repor
• a condensed balance sheet
• a condensed income statement
• a condensed statement of changes in equity
• a condensed cash ow statement an
• selected explanatory notes
If the entity provides a complete set of FS then it should comply with IAS
If condensed, they should include each of the headings and sub-totals included in the
most recent annual nancial statements and the explanatory notes required by IAS 34
Additional line-items should be included if their omission would make the interim nancial
information misleadin
The interim accounts are designed to provide an update so should focus on new events
and not duplicate info already reported o
Measuremen
Items are measured on a year to date basi
Lets say a company produces quarterly interim accounts and in the rst quarter it writes off
some inventory, but then in the next quarter it actually sells i
In the second quarter interim accounts therefore the write down is reverse
Estimate
These will be used more heavily in interim account
Pensions
No need for an actuarial valuation. Just use the most recent and roll it forwar
Provisions
No need for expert guidance at the interim stag
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Inventories
No need for a full stock count. Make an estimate based in sales margins to get a valuatio
Recognitio
Intangible Assets
If development costs do not meet the capitalisation criteria at the interim date they should
not be capitalised, even if they are expected to be reached by the nancial year en
Tax
This should be accrued using the tax rate that would be applicable to total expected
earning
The periods to be covered by the interim nancial statements are as follows
Balance sheet
as of the end of the current interim period and a comparative balance sheet as of the end
of the immediately preceding nancial year
Income statements
for the current interim period and cumulatively for the current nancial year to date, with
comparative income statements for the comparable interim periods of the immediately
preceding nancial year
Changes in equity
cumulatively for the current nancial year to date, with a comparative statement for the
comparable year-to-date period of the immediately preceding nancial year; an
Cash ow statement
cumulatively for the current nancial year to date, with a comparative statement for the
comparable year-to-date period of the immediately preceding nancial year
If the company's business is highly seasonal, IAS 34 encourages disclosure of nancial
information for the latest 12 months, and comparative information for the prior 12-month
period, in addition to the interim period nancial statements
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Syllabus C11d) Discuss and apply the judgments required in selecting and applying accounting
policies, accounting for changes in estimates and re ecting corrections of prior period errors.
IAS 8 Accounting policies and estimate
Comparatives are changed for accounting POLICY changes onl
Changes in accounting estimates have no effect on the comparativ
Changes in accounting policy means we must change the comparative too to ensure we
keep the accounts comparable for trend analysi
Accounting Polic
De nitio
“the speci c principles, bases, conventions, rules and practices applied by an entity in
preparing and presenting the nancial statements
An entity should follow accounting standards when deciding its accounting policie
If there is no guidance in the standards, management should use the most relevant and
reliable polic
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Changes to Accounting Polic
These are only made if
- It is required by a Standard or Interpretation; o
- It would give more relevant and reliable informatio
• Adjust the comparative amounts for the affected item
(as if the policy had always been applied
• Adjust Opening retained earnings
(Show this in statement of changes in Equity too
Accounting Estimate
De nitio
“an adjustment of the carrying amount of an asset or liability, or related expense, resulting
from reassessing the expected future bene ts and obligations associated with that asset or
liability
Example
Allowances for doubtful debts
Inventory obsolescence
A change in the estimate of the useful economic life of property, plant and equipmen
Changes in Accounting Estimat
Simply change the current yea
No change to comparative
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Prior Period Error
These are accounted for in the same way as changes in accounting polic
Accounting treatmen
• Adjust the comparative amounts for the affected ite
• Adjust Opening retained earnings
(Show this in statement of changes in Equity too)
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Syllabus D: FINANCIAL STATEMENTS OF
GROUPS OF ENTITIES
Syllabus D1. Group accounting including statements of
cash flows
Syllabus D1a) Discuss and apply the principles behind determining whether a business combination
has occurred.
Has a Business Combination Occurred
Is a transaction a business combination
IFRS 3 provides this guidance
1. Can be by:
Giving Cash
Taking on Liabilities
Issuing Shares, or
by not issuing consideration at all (i.e. by contract alone
2. Structures can be:
eg.
An entity becoming a subsidiary of another
An entity transfers its Net assets to another or to a new entit
3. There must be an acquisition of a business
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A business generally has 3 elements
1. Inputs
An economic resource (e.g. PPE) that creates outputs when one or more processes
are applied to it
2. Process
A system when applied to inputs, creates outputs
3. Output
The result of inputs and processes
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Syllabus D1b) Discuss and apply the method of accounting for a business combination including
identifying an acquirer and the principles in determining the cost of a business combination.
Method Of Accounting For Business Combination
Acquisition Metho
The Acquisition Method is used for all business combination
Steps in applying it are
Identifying the 'Acquirer
Determining the 'Acquisition Date'
Recognising (and measuring) the identi able assets acquired, the liabilities assumed
and any NCI (non-controlling Interest
Recognising (and measuring) Goodwill (or a gain from a Bargain Purchase
Identifying an Acquire
This is the entity that obtains 'control' of the Acquir
IFRS 3 provides additional guidance
• The Acquirer usually transfers cash (or other assets
• The Acquirer usually issues shares (where the transaction is effected in this manner)
You must also consider though:
1. Relative voting rights in the combined entity after the business combination
2. A large minority interest when no other owner has a signi cant voting interest
3. The composition of the board and senior management of the combined entity
4. The terms on which equity interests are exchanged
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• The acquirer usually has the largest relative size (assets, revenues or pro t
• For business combinations involving multiple entities, look for who initiated the
combination, and the relative sizes of the combining entities
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Syllabus D1b) Discuss and apply the method of accounting for a business combination including
identifying an acquirer and the principles in determining the cost of a business combination.
Syllabus D1f) Discuss and apply the application of the control principle.
Group Accountin
Presentatio
According to IAS 1 accounts must distinguish between
1. Pro t or Loss for the perio
2. Other gains or losses not reported in pro ts above (Other Comprehensive Income
3. Equity transactions (share issues and dividends
Terminolog
Consolidated nancial statements
The nancial statements of a group presented as those of a single economic entity
Paren
An entity that has one or more subsidiarie
Contro
The power to govern the nancial and operating policies of an entity so as to obtain
bene ts from its activitie
Two or more investors can control when they act together to direct the activities of the
subsidiary
However, if one party cannot individually control then it is not a subsidiary. Instead it is
accounted for as a Joint Venture
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Subsidiar
This is a company controlled by the paren
Identi cation of subsidiarie
Control is presumed when the parent has 50% + voting rights of the entity
It could also come from the parent controlling one subsidiary, which in turn controls
another. The parent then controls both subsidiarie
Even when less than 50%, control may be evidenced by power.
• Getting the 50%+ by an arrangement with other investor
• Governing the nancial and operating policie
• Appointing the majority of the board of director
• Casting the majority of vote
Powe
So a parent needs the power to affect the subsidiary and as we said before this is normally
given by owning more than 50% of the voting right
It might also come from complex contractual arrangement
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Syllabus D1c) Apply the recognition and measurement criteria for identi able acquired assets and
liabilities including contingent amounts and intangible assets.
Recognition and Measurement of Net Assets Acquire
Acquired Assets And Liabilitie
1. Recognition Principle
Identi able Assets (& Liabs) and NCI are recognised separately from goodwil
2. Measurement Principle
All assets and liabilities are measured at acquisition-date FAIR VALU
The acquirer looks at the contractual terms, economic conditions, operating and
accounting policies at the acquisition date
For example, this might mean separating embedded derivatives from host contracts (See
later in the course!
However, Leases & Insurance contracts are classi ed on the basis of conditions in place at
the inception of the contract
Intangible Assets Acquire
These must be recognised and measured at fair value even if the acquiree didn't
recognise them before
This is because there is always suf cient information to reliably measure the fair value of
these assets on acquisitio
Contingent Liabilitie
Until settled, these are measured at the higher of:
1) The amount that would be recognised under IAS 37 Provisions
2) The amount less accumulated amortisation under IFRS 15 Revenue.
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Syllabus D1d) Discuss and apply the accounting for goodwill and non-controlling interest.
Business combinations - the basic
The purpose of consolidated accounts is to show the group as a single
economic entity.
So rst of all - what is a business combination
Well my little calf, it’s an event where the acquirer obtains control of another business.
Let me explain, let’s say we are the Parent acquiring the subsidiary.
We must prepare our own accounts AND those of us and the sub put together (called
“consolidated accounts”)
This is to show our shareholders what we CONTROL
Basic principle
The accounts show all that is controlled by the parent, this means
• All assets and liabilities of a subsidiary are include
• All income and expenses of the subsidiary are include
Non controlling Interest (NCI
However the parent does not always own all of the above.
So the % that is not owned by the parent is called the “non-controlling interest”.
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• A line is included in equity called non-controlling interests.
This accounts for their share of the assets and liabilities on the SFP
• A line is also included on the income statement which accounts for the NCI’s share of the
income and expenses
One Thing you must understand before we go o
Forgive me if this is basic, but hey, sometimes it’s good to be sure.
Notice if you add the assets together and take away the liabilities for H - it comes to 400
(500+200+100-100-300
There are 2 things to understand about this gure
It is NOT the true/fair value of the compan
It is equal to the equity section of the SF
Equit
• This shows you how the net assets gure has come about. The share capital is the
capital introduced from the owners (as is share premium)
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• The reserves are all the accumulated pro ts/losses/gains less dividends since the
business started. Here the gure is 400 for H.
Notice it is equal to the net asset
Acquisition cost
• Where there’s an acquisition there’s probably some of the costs eg legal fees etc
Costs directly attributable to the acquisition are expensed to the income statement
• Be careful though, any costs which are just for the parent (acquirer) issuing its own debt
or shares are deducted from the debt or equity itself (often share premium).
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Syllabus D1d) Discuss and apply the accounting for goodwill and non-controlling interest.
Goodwil
Simple Goodwil
When a company buys another - it is not often that it does so at the fair value of the net
assets only
This is because most businesses are more than just the sum total of their ‘net assets’ on
the SFP.
Customer base, reputation, workforce etc. are all part of the value of the company that is
not re ected in the accounts.
This is called “goodwill
Goodwill only occurs on a business combination. Individual companies cannot show their
individual goodwill on their SFPs
This is because they cannot get a reliable measure, This is because nobody has
purchased the company to value the goodwill appropriately.
On a business combination the acquirer (Parent) purchases the subsidiary - normally at an
amount higher than the FV of the net assets on the SFP, they buy it at a gure that
effectively includes goodwill.
Therefore the goodwill can now be measured and so does show in the group accounts
How is goodwill calculated
On a basic level - I hope you can see - that it is the amount paid by the parent less the FV
of the subs assets on their SFP.
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Let me explain..
In this example S’s Net assets are 900 (same as their equity remember)
This is just the ‘book value’ of the net assets
The Fair Value of the net assets may be, say, 1,000
However a company may buy the company for 1.200. So, Goodwill would be 200
The goodwill represents the reputation etc. of a company and can only be reliably
measured when the company is bought out
Here it was bought for 1,200. Therefore, as the FV of the net assets of S was only 1,000 the extra 200 is deemed to be for goodwill
The increase from book value 900 to FV 1,000 is what we call a Fair Value adjustment
Bargain Purchas
This is where the parent and NCI paid less at acquisition than the FV of S’s net assets.
This is obviously very rare and means a bargain was acquire
So rare in fact that the standard suggests you look closely again at your calculation of S’s
net assets value because it is strange that you got such a bargain and perhaps your
original calculations of their FV were wron
However, if the calculations are all correct and you have indeed got a bargain then
this is NOT shown on the SFP rather it is shown as
Income on the income statement in the year of acquisition
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Syllabus D1d) Discuss and apply the accounting for goodwill and non-controlling interest.
NCI in the Goodwill calculatio
So far we have presumed that the company has been 100% purchased when calculating
goodwill
Our calculation has been this:
Non-controlling Interest
Let’s now take into account what happens when we do not buy all of S. (eg. 80%
This means we now have some non-controlling interests (NCI) at 20
The formula changes to this:
This NCI can be calculated in 2 ways
1) Proportion of FV of S’s Net Asset
2) FV of NCI itself
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Proportion of FV of S’s Net Assets metho
This is very straight forward. All we do is give the NCI their share of FV of S’s Net
Assets..Consider this
P buys 80% S for 1,000. The FV of S’s Net assets were 1,100
How much is goodwill?
The NCI is calculated as 20% of FV of S’s NA of 1,100 = 22
“Fair Value Method” of Calculating NCI in Goodwil
• So in the previous example NCI was just given their share of S’s Net assets.
They were not given any of their reputation etc.
In other words, NCI were not given any goodwill
• I repeat, under the proportionate method, NCI is NOT given any goodwill.
Under the FV method, they are given some goodwill
• This is because NCI is not just given their share of S’s NA but actually the FV of their
20% as a whole (ie NA + Goodwill).
This FV gure is either given in the exam or can be calculated by looking at the share
price (see quiz 2).
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P buys 80% S for 1,000. The FV of S’s Net assets were 1,100. The FV of NCI at this date
was 250
How much is goodwill?
Notice how goodwill is now 30 more than in the proportionate example. This is the goodwill
attributable to NCI
NCI goodwill = FV of NCI - their share of FV of S’s N
Remembe
Under the proportionate method NCI does not get any of S’s Goodwill (only their share of
S’s NA)
Under the FV method, NCI gets given their share of S’s NA AND their share of S’s goodwill
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Syllabus D1d) Discuss and apply the accounting for goodwill and non-controlling interest.
Equity Tabl
S’s Equity Tabl
As you will see when we get on to doing bigger questions, this is always our rst working.
This is because it helps all the other workings
Remember that Equity = Net asset
Equity is made up of
1. Share Capita
2. Share Premiu
3. Retained Earning
4. Revaluation Reserv
5. Any other ‘reserve’
If any of the above is mentioned in the question for S, then they must go into this equity
table working
What does the table look like?
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Remember that any other reserve would also go in here
So how do we ll in this table
1. Enter the "Year end" gures straight from the SF
2. Enter the "At acquisition" gures from looking at the information given normally in
note 1 of the question.
Please note you can presume the share capital and share premium is the same as
the year-end gures, so you're only looking for the at acquisition reserves gure
3. Enter "Post Acquisition" gures simply by taking away the "At acquisition" gures
away from the "Year end" gures
(ie. Y/E - Acquisition = Post acquisition
So let's try a simple example.. (although this is given in a different format to the actual
exam let's do it this way to start with)
A company has share capital of 200, share premium of 100 and total reserves at
acquisition of 100 at acquisition and have made pro ts since of 400. There have been no
issues of shares since acquisition and no dividends paid out
Show the Equity table to calculate the net assets now at the year end, at acquisition
and post-acquisitio
Solution
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Fair Value Adjustment
Ok the next step is to also place into the Equity table any Fair Value adjustment
When a subsidiary is purchased - it is purchased at FAIR VALUE at acquisition
Using the gures above, if I were to tell you that the FV of the sub at acquisition was 480.
Hopefully you can see we would need to make an adjustment of 80 (let’s say that this was
because Land had a FV 80 higher than in the books):
Now as land doesn’t depreciate - it would still now be at 80 - so the table changes to this:
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If instead the FV adjustment was due to PPE with a 10 year useful economic life left - and
lets say acquisition was 2 years ago, the table would look like this:
The -16 in the post acquisition column is the depreciation on the FV adjustment. (80 / 10
years x 2 years)
This makes the now column 64 (80 at acquisition - 16 depreciation post acquisition).
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Syllabus D1d) Discuss and apply the accounting for goodwill and non-controlling interest.
NCI on the SF
Non-Controlling Interest
So far we have looked at goodwill and the effect of NCI on this.. Now let’s look at NCI in a
bit more detail (don’t worry we will pull all this together into a bigger question later)
If you remember there are 2 methods of measuring NCI at acquisition
1. Proportionate method
This is the NCI % of FV of S’s Net assets at acquisiti
2. FV Method
This is the FV of the NCI shares at acquisition (given mostly in the question)
This choice is made at the beginning
Obviously, S will make pro ts/losses after acquisition and the NCI deserve their share of
these
Therefore the formula to calculate NCI on the SFP is as follows:
* This gure depends on the option chosen at acquisition (Proportionate or FV method)
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Impairmen
S may become impaired over time. If it does, it is S’s goodwill which will be reduced in
value rst. If this happens it only affects NCI if you are using the FV method
This is because the proportionate method only gives NCI their share of S’s Net assets and
none of the goodwill
Whereas, when using the FV method, NCI at acquisition is given a share of S’s NA and a
share of the goodwill
NCI on the SFP Formula revised
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Syllabus D1d) Discuss and apply the accounting for goodwill and non-controlling interest.
Reserves Calculatio
SFP Group Reserve
So far we have looked at how to calculate goodwill and then NCI for the SFP, now we are
looking at how to calculate any group reserves on the SF
There could be many reserves (eg Retained Earnings, Revaluation Reserve etc), however
they are all calculated the same wa
Basic Ide
The basic idea is that group accounts are written from the Parent companies point of view
Therefore we include all of Parent (P’s) reserves plus parent share of Subs post
acquisition gains or losses in that reserve
Let’s look at an example of this using Retained Earnings
Illustration
P acquired 80% S when P’s Retained earnings were 1,000 and S’s were 60
Now, P’s RE are 1,400 and S’s RE are 700
What is the RE on the SFP now?
It is worth pointing out here that all these workings only really to start to make sense once
you start to do lots of examples - see my videos for this.
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Impairmen
If Goodwill has been impaired then goodwill will reduce and retained earnings will reduce
too
However, the amount of the impairment depends on the NCI method chosen
1. Proportionate NCI method
This means that NCI has zero goodwill, so any goodwill impaired all belongs to the
parent and so 100% is taken to R
2. FV method
Here NCI is given a share of NCI, so also takes a share of the impairment.
Therefore the group only gets its share of the impairment in RE (eg 80%
Illustration
P acquired 80% S when P’s Retained earnings were 1,000 and S’s were 600
Now, P’s RE are 1,400 and S’s RE are 700.
P uses the FV method of accounting for NCI and impairment of 40 has occurred since
What is the RE on the SFP now?
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Basic groups - Simple Question
Have a look at this question and solution below and see if you can work out where all the
gures in the solution have come from
Make sure to check out the videos too as these explain numbers questions such as these
far better than words can..
P acquired 80% S when S’s reserves were 80
Prepare the Consolidated SFP, assuming P uses the proportionate method for
measuring NCI at acquisition
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Syllabus D1d) Discuss and apply the accounting for goodwill and non-controlling interest.
Goodwill
NCI
Reserves
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Group SFP
Notic
1) Share Capital (and share premium) is always just the holding compan
2) All P + S assets are just added togethe
3) “Investment in S”..becomes “Goodwill” in the consolidated SF
4) NCI is an extra line in the equity section of consolidated SFP
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Basic groups - Simple Question
P acquired 80% S when S’s Reserves were 40
At that date the FV of S’s NA was 150
Difference is due to Land
There have been no issues of shares since acquisition
P uses the FV of NCI method at acquisition, and at acquisition the FV of NCI was 35. No
impairment of goodwill
Prepare the consolidated set of accounts
Step 1: Prepare S’s Equity Table
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Now the extra 10 FV adjustment now must be added to the PPE when we come to do the
SFP at the end
Step 2: Goodwill
Step 3: Do any adjustments in the questio
: NON
Step 4: NCI
Step 5: Reserves
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Step 6: Prepare the nal SFP (with all adjustments included)
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Group Income Statemen
Rule 1 - Add Across 100
Like with the SFP, P and S are both added together. All the items from revenue down to
Pro t after tax; except for
1) Dividends from Subsidiarie
2) Dividends from Associate
Rule 2 - NC
This is an extra line added into the consolidated income statement at the end. It is
calculated as NCI% x S’s PAT
The reason for this is because we add across all of S (see rule 1) even if we only own 80%
of S.
We therefore owe NCI 20% of this which we show at the bottom of the income statement
Rule 3 - Associate
Simply show one line (so never add across an associate).
The line is called “Share in Associates’ Pro t after tax”
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fi
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Syllabus D1g) Determine and apply appropriate procedures to be used in preparing consolidated
nancial statements.
Rule 4 - Depreciation from the Equity table workin
Remember this working from when we looked at group SFP’s?
The -10 from the FV adjustment is a group adjustment. So needs to be altered on the
group income statement. It represents depreciation, so simply put it to admin expenses (or
wherever the examiner tells you), be careful though to only out in THE CURRENT YEAR
depreciation charge
Rule 5 - Time Apportionin
This isn’t dif cult but can be awkward/tricky. Basically all you need to remember is the
group only shows POST -ACQUISITION pro ts. i.e. Pro ts made SINCE we bought the
sub or associate
If the sub or associate was bought many years ago this is not a problem in this year’s
income statement as it has been a sub or assoc. all year
The problem arises when we acquire the sub or the associate mid year. Just remember to
only add across pro ts made after acquisition. The same applies to NCI (as after all this
just a share of S’s PAT).
For example if our year end is 31/12 and we buy the sub or assoc. on 31/3. We only add
across 9/12 of the subs gures and NCI is % x S’s PAT x 9/12
One nal point to remember here is adjustments such as unrealised pro ts / depreciation
on FV adjustments are entirely post - acquisition and so are NEVER time apportioned.
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Rule 6 - Unrealised Pro
You will remember this table I hope
Well the idea stays the same - it’s just how we alter the accounts that changes, because
this is an income statement after all and not an SFP. So the table you need to remember
becomes:
Notice how we do not need to make an adjustment to reduce the value of inventory. This is
because we have increased cost of sales (to reduce pro ts), but we do this by actually
reducing the value of the closing stock
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Unrealised Pro
The key to understanding this - is the fact that when we make group accounts - we are
pretending P & S are the same entity
Therefore you cannot make a pro t by selling to yourself
So any pro ts made between two group companies (and still in group inventory) need
removing - this is what we call ‘unrealised pro t’
Unrealised pro t - more detai
Pro t is only ‘unrealised’ if it remains within the group. If the stock leaves the group it has
become realised
So ‘Unrealised pro t” is pro t made between group companies and REMAINS IN STOCK
Exampl
P buys goods for 100 and sells them to S for 150. S has sold 2/5 of this stock
The Unrealised Pro t is: Pro t between group companies 50 x 3/5 (what remains in stock)
= 30
How do we then deal with Unrealised Pro
If P buys goods for 100 and sells them to S for 150.
Thereby making a pro t of 50 by selling to another group company.
S sells 4/5 of them to 3rd parties
Unrealised pro t is 50 x 1/5 = 10
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So why do we reduce inventory as well as pro t
Well let’s say that S buys goods for 100 and sells them to P for 150 and P still has them in
stock
How much did the stock actually cost the group?
The answer is 100, as they are still in the group.
However P will now have them in their stock at 150.
So we need to reduce stock/inventory also with any unrealised pro t.
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Intra-Group Balances & In-transit Item
Inter-group company balance
As with Unrealised Pro t - this occurs because group companies are considered to be the
same entity in the group accounts
Therefore you cannot owe or be owed by yourself
So if P owes S - it means P has a payable with S, and S has a receivable from P in their
INDIVIDUAL accounts
In the group accounts, you cannot owe/be owed by yourself - so simply cancel these out
Dr Payable (in P)
Cr Receivable (in S
The only time this wouldn’t work is if the amounts didn’t balance, and the only way this
could happen is because something was still in transit at the year end. This could be stock
or cash
You always alter the receiving company. What I mean is - if the item is in transit, then the
receiving company has not received it yet - so simply make the RECEIVING company
receive it as follows
Stock in transi
In the RECEIVING company’s books
Dr Inventory
Cr Payabl
Cash in transi
In the RECEIVING company’s books
Dr Cash
Cr Receivable
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Having dealt with the amounts in transit - the inter group balances (receivables/payables)
will balance so again you simply
Dr Payable
Cr Receivabl
Intra-group dividend
eliminate all dividends paid/payable to other entities within the group, and all intragroup
dividends received/receivable from other entities within the group.
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Impairment of Goodwil
Goodwill is reviewed for impairment not amortised
An impairment occurs when the subs recoverable amount is less than the subs carrying
value + goodwill
How this works in practice depends on how NCI is measured - Proportionate or Fair Value
method
Proportionate NC
Here, NCI only receives % of S's net assets
NCI DOES NOT have any share of the goodwill
1. Compare the recoverable amount of S (100%) to.
2. NET ASSETS of S (100%) +
Goodwill (100%
3. The problem is that goodwill on the SFP is for the parent only - so this needs
grossing up rs
4. Then nd the difference - this is the impairment - but only show the parent % of the
impairmen
Exampl
H owns 80% of S. Proportionate NC
Goodwill is 80 and NA are 20
Recoverable amount is 24
How much is the impairment
Solutio
RA = 24
NA = 200 + G/W (80 x 100/80) = 100 = 30
Impairment is therefore 60
The impairment shown in the accounts though is 80% x 60 = 48.
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This is because the goodwill in the proportionate method is parent goodwill only. Therefore
only parent impairment is shown
Fair Value NC
Here, NCI receives % of S's net assets AND goodwill
NCI DOES now own some goodwill
1. Compare the recoverable amount of S (100%) to.
2. NET ASSETS of S (100%) +
Goodwill (100%
3. As, here, goodwill on the SFP is 100% (parent & NCI) - so NO grossing up neede
4. Then nd the difference - this is the impairment - this is split between the parent and
NCI shar
Exampl
H owns 80% of S. Fair Value NC
Goodwill is 80 and NA are 20
Recoverable amount is 24
How much is the impairment
Solutio
RA = 24
NA = 200 + G/W 80 = 28
Impairment is therefore 40
The impairment shown in P's RE as 80% x 40 = 32
The impairment shown in NCI is 20% x 40 = 8
Impairment adjustment on the Income Statemen
1. Proportionate NCI
Add it to P's expenses
2. Fair Value NCI
Add it to S's expenses
(this reduces S's PAT so reduces NCI when it takes its share of S's PAT)
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Make sure you use FV of Consideratio
Consideration is simply what the Parent pays for the sub
It is the rst line in the goodwill working as follows:
Normal Consideratio
This is straightforward. It is simply
Dr Investment in S
Cr Cas
Future Consideratio
This is a little more tricky but not much. Here, the payment is not made immediately but in
the future. So the credit is not to cash but is a liability
Dr Investment in S
Cr Liabilit
The only dif culty is with the amount
As the payment is in the future we need to discount it down to the present value at the
date of acquisition
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Illustratio
P agrees to pay S 1,000 in 3 years time (discount rate 10%)
Dr Investment in S 75
Cr Liability 751 (1,000 / 1.10^3
As this is a discounted liability, we must unwind this discount over the 3 years to get it back
to 1,000. We do this as follows:
Contingent Consideratio
This is when P MAY OR MAY NOT have to pay an amount in the future (depending on,
say, S’s subsequent pro ts etc.). We deal with this as follows
Dr Investment in S
Cr Liabilit
All at fair valu
You will notice that this is exactly the same double entry as the future consideration (not
surprising as this is a possible future payment!)
The only difference is with the amount
Instead of only discounting, we also take into account the probability of the payment
actually being made
Doing this is easy in the exam - all you do is value it at the FV
(this will be given in the exam you’ll be pleased to know)
Illustratio
1/1/x7 H acquired 100% S when it’s NA had a FV of £25m. H paid 4m of its own shares
(mv at acquisition £6) and cash of £6m on 1/1/x9 if pro ts hit a certain target.
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At 1/1/x7 the probability of the target being hit was such that the FV of the consideration
was now only £2m. Discount rate of 8% was used
At 31/12/x7 the probability was the same as at acquisition
At 31/12/x8 it was clear that S would beat the target
Show the double entr
Contingent consideration should always be brought in at FV. Any subsequent changes to
this FV post acquisition should go through the income statement
Any discounting should always require an winding of the discount through interest on the
income statemen
Double entry - Parent Compan
1/1/x7
Dr Investment in S (4m x £6) + £2 = 2
Cr Share Capital
Cr Share premium 2
Cr Liability
31/12/x7
Dr interest 0.1
Cr Liability 0.1
31/12/x8
Dr Income statement 4 (6-2
Dr Liability
Cr Cash
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Goodwill - FV of NA (more detail
Goodwil
So let’s remind ourselves of the goodwill working:
We have just looked in more detail at the sort of surprises the examiner can spring on us
in the rst line “consideration” - now let´s look at the bottom line in more detail
Fair values of Net Assets at Acquisitio
Operating leases. If terms are favourable to the market - recognise as an asse
Internally generated intangibles would now have a reliable measure and would be brought
in the consolidated account
Remember both of these items would need to be depreciated in our equity table workin
contingent liabilities (see bottom of this page
Illustratio
1/7/x5 H acquired 80% S for 16m, nci measured at share of net assets. FV of NA was
10m
S had a production backlog with a FV of 2m (uel 2 years) and unrecognised trademarks
with a FV of 1m. These are renewable at any time at a negligible cost
S made a pro t of 5m in the year to 31/12/x5
What would goodwill be in the consolidated SFP?
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Per Accounts 10 + FV adj (2+1)
Provisional Goodwil
We get “provisional goodwill’ when we cannot say for certain yet what the FV of Net Assets
are at the date of acquisition
This is ne, we just state in the accounts that the goodwill gure is provisional.
This means we then have 12 months (from the date of acquisition) to change the goodwill
gure IF AND ONLY IF the information you nd (within those 12 months) gives you more
information about the conditions EXISTING at the year-end
Any information after the 12 month period (even if about conditions at acquisition) does not
change goodwill.
Any differences are simply written off to the income statement
So, in summary, the FV of NA can be altered retrospectively if within 12 months of
acquisition.
This means goodwill would change. Any alteration after 12 months is through the income
statement
Illustratio
A acquired 70% B on 1/7/x7, NCI measured at share of net assets acquired.
A provisional fair value only was used for plant and machinery of £8m (UEL 10yrs).
Goodwill was £4m.
The year-end of 31/12/x7 accounts were then approved on 25/2/x8
On 1/4/x8 the FV of the plant was nalised at 7.2m
How would this affect the consolidated accounts
Provisional goodwill is acceptable if disclosed as such in the accounts.
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FV of NA workin
The parent then has one year after acquisition to nalise the FV and alter goodwill. Should
the nalisation occur after one year - no adjustment is required to goodwill
Provisional Goodwill 4
Adjusted Goodwil
Original 4m + (0.8 x 70%) = 4.56
Contingent liabilitie
Normally these are just disclosures in the accounts.
However, remember that when a sub is acquired, it is brought into the accounts at FV.
A contingent liability does have a fair value.
Therefore they must be actually recognised in the consolidated accounts until the amount
is actually paid
So the rules are
1. Bring in at the F
2. Measure afterwards at this amount unless it then becomes probable. As usual, a
probable liability is then measured at the full liabilit
Note. If it remains just possible then keep it at the initial FV until it is either written off or
pai
Illustratio
1/7/x6 P acquired all of S when it’s NA had a CV of £2m. However, they had disclosed a
contingent liability. This has a FV of £150,000
1/12/x7 this potential liability was paid at an amount of £200,000
How are the accounts affected
Well we would bring it into the equity table (at acquisition column) in the workings at its FV
of 150. This would affect goodwill working accordingly
Keep it at this amount until it either becomes probable (show at full amount) or pai
Here it is paid so the year end would show no liability - and the post-acquisition column
+150. This would then affect the NCI and reserves working accordingly
The extra 50 paid will have already been taken into account when the full amount was paid
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Syllabus D1e) Apply the accounting principles relating to a business combination achieved in stages
Step Acquisition
When Control is achieved is the key date.
Consolidation only occurs when control is eventually achieved
When Control is achieved this occurs
Remeasure all previous holdings to F
Any gain or loss to income statemen
Illustratio
P acquired 10% of S in year 1 for 100
P acquired a further 60% of S in year 2 for 800. At this date, the original 10% now has a
FV of 140
How would this be accounted for
The key date of when controlled is achieved is year 2. At this date we must
• Revalue the original 10% from 100 to 14
• The 40 gain goes to the income statement (and retained earnings
• Also we would now start consolidating S (as we now control it). The Consideration gure
in the goodwill working would now be 940 (140 + 800)
Further acquisition after control is achieve
If there are further acquisitions after control - this is deemed to be a purchase from the
other owners (NCI) - so no pro t is calculated. Simply
Here you will need to do the following calculation
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Illustratio
H acquired 60% S for 100 in year 4 when the FV of its NA was 90. Proportionate NCI
method is used
2 years later its NA are 150 and H acquires another 20% for 80
Calculate decrease in NCI and movement in parents equity for the latest acquisition.
NCI
SO NCI was 60 (representing 40%). Now, by acquiring a further 20% from the NCI, this
means NCI will go from 40% to 20%. It has halved
So NCI has gone down by 30.
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Comprehensive Examples - Step AcquisitionJoint
Arrangements
(IFRS 11
Comprehensive Questio
SFP for YEAR 6
P acquired 30% S in year 1 for 60. It acquired another 30% in year 4 for 14
S’s reserves were 10 in year 1 and 60 in year 4
FV of S’s NA in year 1 was 120 and in year 4 190. Difference is due to Land
FV of NCI in year 4 was 90
FV of 30% holding in Year 4 is 120
P acquired a further 10% of S on the last day of year 6 for 50
Show the Consolidated SFP at the end of year 6
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Solutio
Step 1: Equity Table
Step 2: Goodwill
Step 3: NCI
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Step 4: Further Acquisition from NCI
Step 5: Reserves
Final Answer
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Syllabus D1h) Discuss and apply the implications of changes in ownership interest and loss of
control.
Partial Disposal
A partial disposal means selling but keeping control - so we must keep above 50%
ownership afterwards e.g. Selling from 80% to 60%
As we keep control, then the sale must be to those who do not have control - the NCI
NCI will therefore increase after a partial disposal
Therefore, this is just an exchange between the owners of the business (controllers and
non-controllers) and so any gain or loss must go to EQUITY (other reserves) not Income
statement
How is the gain or loss calculated?
How do you calculate the ‘Increase in NCI’ line?
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What is the double entry for the disposal?
What is the Income Statement Effect
The subsidiary is still consolidated in full
NCI % is time apportioned (eg 20% to date of disposal, 40% thereafter).
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Syllabus D1i) Prepare group nancial statements where activities have been discontinued, or have
been acquired or disposed of in the period.
Discontinued Operatio
An analysis between continuing and discontinuing operations improves the
usefulness of nancial statements
When forecasting ONLY the results of continuing operations should be used
Because discontinued operations pro ts or losses will not be repeated
What is a discontinued operation
1. A separate major line of business or geographical are
2. is part of a single co-ordinated plan to dispose of a separate major line of
business or geographical are
3. is a subsidiary acquired exclusively with a view to resale
How is it shown on the Income Statement
The PAT and any gain/loss on disposa
A single line in I/
How is it shown on the SFP
If not already disposed of yet
Held for sale disposal grou
How is it shown on the cash- ow statement
Separately presente
in all 3 areas - operating; investing and nancin
No Retroactive Classi catio
IFRS 5 prohibits the retroactive classi cation as a discontinued operation, when the
discontinued criteria are met after the end of the reporting period
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Syllabus D1h) Discuss and apply the implications of changes in ownership interest and loss of
control.
Full Disposa
This is when we lose control, so we go from owning a % above 50 to one below 50 (eg
80% to 30%)
In this case we have effectively disposed of the subsidiary (and possibly created a new
associate)
As the sub has been disposed of - then any gain or loss goes to the INCOME
STATEMENT (and hence retained earnings)
Also, the old Subs assets and liabilities no longer get added across, there will be no
goodwill or NCI for it either
How do you calculate this gain or loss?
What’s the effect on the Income Statement
Consolidated until sale; Then treat as Associate (if we have signi cant in uence) otherwise
a FVTPL investment
Show pro t on disposal (see above).
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Subsidiary acquired with a view to disposa
A subsidiary that is acquired exclusively with a view to its subsequent disposal is
classi ed on the acquisition date of the subsidiary as a non-current disposal group 'held
for sale' (if it is expected that the subsidiary will be disposed of within one year and the
other IFRS 5 criteria are met with within three months of the acquisition date
Classi cation as a discontinued operatio
A subsidiary classi ed as 'held for sale', is included in the de nition of a discontinued
operation, with treatment as follows
• Income statement
Single Line “Discontinued operations” - PAT of the Sub + gain/loss on re-measurement to
held for sale
The income and expenses of the subsidiary are therefore not consolidated on a line-byline basis with the income and expenses of the holding company
• Statement of nancial position
The assets and liabilities classi ed as 'held for sale' presented separately (the assets
and liabilities of the same disposal group may not be offset against each other).
The assets and liabilities of the subsidiary are therefore not consolidated on a line-by-line
basis with the assets and liabilities of the holding company
• Statement of Cash ows
No need to disclose the net cash ows attributable to the operating, investing and
nancing activities of the discontinued operation (which is normally required) but is not
required for newly acquired subsidiaries which meet the criteria to be classi ed as 'held
for sale' on the acquisition date
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Syllabus D1j) Discuss and apply the treatment of a subsidiary which has been acquired exclusively
with a view to subsequent disposal.
Group Accounting Exemption
Who needs to prepare consolidated accounts
Basically a parent company, one with a subsidiar
However there are exceptions to this rule
• The parent is itself a wholly owned subsidiar
• The parent is a partially (e.g. 80%) owned sub and the other 20% owners allow it to not
prepare consolidated account
• The parents shares are not publicly trade
• The parents own parent produces consolidated account
Sometimes a sub is purchased with a view to it being sold.
In this case it is an IFRS 5 discontinued operatio
The group share of its pro ts are shown on the income statement and all of its assets and
liabilities shown separately on the SF
Not Valid reasons for exemptio
1. A subsidiary whose business is of a different nature from the parent’s
2. A subsidiary that operates under severe long-term restrictions impairing the
subsidiary’s ability to transfer funds to the parent
3. A subsidiary that had previously been consolidated and that is now being held for
sale
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Syllabus D1k) Identify and outline:
- the circumstances in which a
group is required to prepare consolidated nancial statements.
- the circumstances when a group may claim and exemption from the preparation of consolidated
nancial statements.
- why directors may not wish to consolidate a subsidiary and where this is permitted.
Syllabus D1i) Prepare group nancial statements where activities have been discontinued, or have
been acquired or disposed of in the period.
Cash ow statements - Step
Indirect metho
The idea here is simply to get to the pro t from operating activities as a starting point nothing more
So IAS tells us that although we need to get to the operating pro t gure we must start
with Pro t before tax (PBT) and reconcile this to the operating pro t gure
Operating Pro
Before we do this let’s remind ourselves what “Operating pro t” is
Operating Pro t is:
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Illustration
Start with the pro t before tax gure and then reconcile to the operating pro t gure
Operating pro t would be:
So, let’s start reconciling…
Then ll in the reconciling gures between them (income is a negative and expense a
positive here). This is because we are going upwards on the income statement, rather
than the normal downwards.
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So this is the nal answer to step 1:
You place this in the “Cash ow from Operating Activities” part of the cash- ow statement.
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Cash ow statements - Step
Now we have the operating pro t gure we need to get to the cash
We do this by taking the pro t gure (calculated and reconciled to in step 1) and adding
back all the non-cash items (we get to the cash therefore indirectly)
Key point to remember her
The non-cash items we add back are ONLY those in operating pro t (Sales, COS, admin
and distr. costs)
For example
Depreciation, amortisation, impairments, pro t on sale, receivables, payables and
inventor
There could be more - it depends on the question - but dealing with these will ensure you
pas
So the operating activities part of the cash ow will now look like this:
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Ensure you get the signs the right way around
For example an increase in stock means less cash so (x)
Notice we added back receivables / payables & Inventory
This is because credit sales, stock and credit payables are not cash and are in the
operating pro t gure
You just need to be careful that you get the signs the right way around as with these we
just account for the movement in them
Think of it like this
• Increase in Inventory - means less cash - so show as a negativ
• Increase in receivables - means less cash now - so show as a negativ
• Increase in payables - means don’t have to pay people just yet so an increase in cash so show as a positiv
We have now dealt with the rst part of the income statement - Sales, COS, administration
expenses and distribution costs. We have indirectly got the cash from these gures by
adding back all the non-cash items that may have been in there (as above)
All of this happens in the “Cash ow from Operating Activities” part of the cash- ow
statement.
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So far we have got the cash (indirectly) from operating pro t. This means we have the
cash from Sales, COS, admin and distribution costs. What we now do is look at what’s left
in the income statement and try to nd the cash
(In our example in step 1, we would have to deal with IP income, nance costs and tax)
So we are looking at the other parts of the income statement (after operating pro t) and
nding the cash and putting this directly into the cash- ow statement
Direct metho
We do this by using a different method to the one in step 2 as we are now looking to put
the cash in directly to the cash- ow statement (rather than taking a pro t gure and adding
back the non-cash items to indirectly arrive at cash)
So how do we do this
General Method Explanatio
Let’s say you owed somebody 100, then bought 20 more in the year - you should therefore
owe them 120 right
However you look at your books at the year end and you see you only owe them 7
Therefore, you must have paid cash to them of 50 - this is the gure we then put in our
cash- ow statement
To show this differently (and how the examiner often shows it):
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Cash ow statements - Step
We use this format for the rest of the cash ow question - though it may need adjusting
slightly (PPE is calculated differently)
We will now go on to look at the different items that you may nd in the income statement
and how we deal with them in the cash- ow statement using this method.
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Cash ow statement - nance cost
Finance Costs - Illustration of Step
Solutio
Finance costs of 120 paid go to the operating activities section of the cash ow
statement.
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Cash ow statement - taxatio
Taxation - Illustration of Step
Solutio
Taxation costs of 150 paid go to the operating activities section of the cash ow
statement
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Cash ow statement - Investment property
Investment Property Income - Illustration of Step
There were no purchases of IP in the year
Solution
Investment property income of 20 (rent received probably) goes to the investing
activities section of the cash ow statement.
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Cash ow statements - Step
So in the rst 3 steps, we have turned the Income statement into cash and placed it into
the cash- ow statement. We now need to do the same with the S - remember much of it
we have already dealt with (e.g. receivables, inventory, payables, investmen
Property, interest and tax payabl
So let’s begin with
PP
We deal with this slightly differently to the income statement items in step 3
Process to follo
Here’s the process to follow
Write down the PPE gures per the account
Work out the cash element of each item (if any
Illustration
Notes
Depreciation in year = 5
Revaluation = 10
Disposal = Asset sold for 100 making 20 pro t
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Solutio
The key here is to try and nd the balancing gure (per the accounts) which will be
additions in the year
Note: we are dealing with NBVs
Write down the PPE gures per the accounts
The balancing gure is 90 and this is additions
Work out the cash element of each item (if any):
All PPE items go the investing activities section of the cash ow statement.
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Cash ow statements - Step 5 - Shares
So in steps 1-3 we looked at how we got the cash from the income statement and into the
statement of cash ows
In step 4 we looked at getting the cash ows from PPE
So now in our nal step we look at getting cash from what’s left in the SFP… starting with
shares
Share issue
Again let’s look at this by illustration and we are using virtually the same technique as step
3 as you will see..
Solution
Share Proceeds goes to the nancing activities section of the cash ow statement.
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Effect of Bonus Issu
If there’s been a bonus issue, you need to be careful
You need to look at where the debit went - share premium or retained earnings
If share premium - ignore the bonus issue and the answer calculated above is still correc
If Retained earnings - reduce the cash by the amount of the bonus issu
See the quizzes for examples of this.
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Cash ow statements - Step 5 - Loan
Let’s now look at another one of the items that would still be left on the SFP, that we need
to nd the cash and take to the cash- ow statement - Loan
Illustratio
Follow same techniques as before..
Solution
Loan repayments of 40 go to the nancing activities section of the cash ow
statement
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Syllabus D2. Associates And Joint Arrangements
Important Examinable Narrative & Miscellaneous
points
These are
• Transactions related to acquiring a subsidiary are to be written off to the Income
statemen
• Any future contingent consideration towards the cost of investment is included in cost of
investment at its FAIR VALUE regardless of whether it is probable or no
• If the FAIR VALUE of the above changes after acquisition goodwill is NOT adjusted
unless it is simply providing more information about what the fair value would have been
at acquisition dat
• A company is a sub when it is controlled only. This means more than 50% of the voting
rights; or control of the nancial and operating activities or power to appoint a majority of
the boar
• It may be that H owns 40% + 20% potential shares (eg share options). To see whether
this means H controls S all terms must be examined, disregarding management
intention
• Subsidiaries held for sale must be consolidated (see above
• JV’s and A’s are not consolidated if they are held for sal
• Subsidiaries with very different activities to H must also be consolidated as IFRS 8
segmental reporting will deal with these problem
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• Subs with severe long term restrictions must still be consolidated until actual control is
los
• Associates with severe long term restrictions must still be equity accounted until actual
signi cant in uence is los
• A company is an associate when there is no control but there is signi cant in uence.
This means 20% or more of the voting rights (unless someone else holds more than 50%
solely in which case they control it and we have no signi cant in uence at all).
Participation in policy making is deemed to be signi cant in uenc
• H does NOT need to consolidate if it is itself a 100% sub or if the shares aren’t traded
publicly and the ultimate parent prepares consolidated account
• Subs may have a different reporting date to H but they must prepare further accounts to
make consolidation possible. Unless the difference in date is 3 months or less in which
case S’s accounts can be used and adjustments made for signi cant event
• Consolidated accounts must be made with uniform accounting policies. So if S has
different policies to H, group level adjustments need to be mad
• NCI can be negative - they are simply owners of the group like the parent and so losses
are possible
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Syllabus D2a) Identify associate entities.
Syllabus D2b) Discuss and apply the equity method of accounting for associates.
Associate
An associate is an entity over which the group has signi cant in uence, but not control
Signi cant in uenc
Signi cant in uence is normally said to occur when you own between 20-50% of the
shares in a company but is usually evidenced in one or more of the following ways
• representation on the board of director
• participation in the policy-making proces
• material transactions between the investor and the investee
• interchange of managerial personnel; o
• provision of essential technical informatio
Accounting treatmen
An associate is not a group company and so is not consolidated. Instead it is accounted
for using the equity method. Inter-company balances are not cancelled
Statement of Financial Positio
There is just one line only “investment in Associate” that goes into the consolidated SFP
(under the Non-current Assets section).
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It is calculated as follows:
Consolidated income statemen
Again just one line in the consolidated income statement:
Include share of PAT less any impairment for that year in associate
Do not include dividend received from A
What’s important to notice is that you do NOT add across the associate’s Assets and
Liabilities or Income and expenses into the group totals of the consolidated accounts. Just
simply place one line in the SFP and one line in the Income Statement
Unrealised pro ts for an associat
1. Only account for the parent’s share (eg 40%).
This is because we only ever place in the consolidated accounts P’s share of A’s
pro ts so any adjustment also has to be only P’s share
2. Adjust earnings of the selle
Adjustments required on Income Statemen
• If A is the seller - reduce the line “share of A’s PAT
• If P is the seller - increase P’s CO
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Adjustments required on SF
• If A is the seller - reduce A’s Retained earnings and P’s Inventor
• If P is the seller - reduce P’s Retained Earnings and the “Investment in Associate” lin
Illustratio
P sells goods to A (a 30% associate) for 1,000; making a 400 pro t. 3/4 of the goods have
been sold to 3rd parties by A
What entries are required in the group accounts
Pro t = 400; Unrealised (still in stock) 1/4 - so unrealised pro t = 400 x 1/4 = 100. As this is
an associate we take the parents share of this (30%). So an adjustment of 100 x 30% = 30
is needed
Adjustment required on the Income statemen
P is the seller - so increase their COS by 30
Adjustment required on the group SF
P is the seller - so reduce their retained earnings and the line “Investment in Associate” by
30.
The retained earnings of S and A were £70,000 and £30,000 respectively when they were
acquired 8 years ago
There have been no issues of shares since then, and no FV adjustments required
The group use the proportionate method for valuing NCI at acquisition.
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Prepare the consolidated SF
Solutio
Step 1: Equity Table
Step 2: Goodwill
H owns 18,000 of S’s share capital of 30,000 so 60%
Step 3: NCI
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Step 4: Retained Earnings
Step 5: Investment in Associate
Final answer - Goodwill
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Syllabus D2c) Discuss and apply the application of the joint control principle.
Syllabus D2d) Discuss and apply the classi cation of joint arrangements.
Joint Venture
A joint arrangement is an arrangement of which two or more parties have joint
control
A joint arrangement has the following characteristics
• The parties are bound by a contract, an
• The contract gives two or more parties joint control
What is Joint Control
The sharing of control where decisions about the relevant activities need unanimous
consent
The rst step is to see if the parties control the arrangement per IFRS 10
After that, the entity needs to see if it has joint control as per paragraph abov
Unanimous consent means any party can prevent other parties from making unilateral
decisions (about the relevant activities)
Types of joint arrangement
Joint arrangements are either joint operations or joint ventures
• A joint operation
Here the parties have rights to the assets, and obligations for the liabilities, relating to the
arrangement.
They are called joint operators
• A joint venture
Here the parties have rights to the net assets of the arrangement.
Those parties are called joint venturers
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• Classifying joint arrangements
This depends upon the rights and obligations of the parties to the arrangement.
Regardless of the purpose, structure or form of the arrangement.
A joint arrangement in which the assets and liabilities relating to the arrangement are
held in a separate vehicle can be either a joint venture or a joint operation.
A joint arrangement that is not structured through a separate vehicle is a joint operation
Financial statements of parties to a joint arrangemen
Joint Operations
A joint operator recognises
• its assets, including its share of any assets held jointl
• its liabilities, including its share of any liabilities incurred jointl
• its revenue from the sale of its share of the output of the joint operatio
• its share of the revenue from the sale of the output by the joint operation; an
• its expenses, including its share of any expenses incurred jointl
A joint operator accounts for the assets, liabilities, revenues and expenses relating to its
involvement in a joint operation in accordance with the relevant IFRSs
Illustration
An of ce building is being constructed by A and B, each entitled to half the pro ts
A has invoiced 300 and had costs of 28
B has invoiced 500 and had costs of 420
This shows that total sales are 800, total costs are 700 - so a pro t of 100 needs splitting
50 each.
A is currently showing a pro t of 20, and B of 80. Therefore A now needs to show a
receivable of 30 from B (and B a payable to A).
Revenue should be 400 each, so A needs an extra 100 and costs should be 350 each so
an 70 is required.
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Double entry for A
Dr Receivables 30
Cr Revenue 100
Dr COS 7
If an does not have joint control of a joint operation - it accounts for its interest in the
arrangement in accordance with the above if that party has rights to the assets, and
obligations for the liabilities, relating to the joint operation.
Joint Venture
The group accounts for this using the equity method (see associates)
(A party that does not have joint control of a joint venture accounts for its interest in the
arrangement in accordance with IFRS 9)
Unrealised pro t on sales with JV - always just the share (e.g. 50%
• P to J
- Income Statement
- Increase P’s CO
- SFP
- Decrease P’s RE
- Decrease Investment in J
• JV to
- Income Statement
- Decrease “Share of JV PAT
- Decrease JV’s RE
- Decrease P’s stoc
• No Elimination of Receivables and Payables to each othe
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Syllabus D3: Changes in group structures
Syllabus D3a) Discuss and apply accounting for group companies in the separate nancial
statements of the parent company.
Accounting For Group Companies In The Paren
In the parent's own nancial statements
Investments in subsidiaries are held at cost or at fair value under IFRS
Consequently the pro t or loss on disposal of a sub is different from the group pro t or loss
on disposal:
Fair value of consideration received X
Less carrying amount of investment disposed of (X)
Pro t/ (loss) X
This would be in P's Income statement and is ignored in group accounts - the group loss
on disposal is shown instead
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With reorganisations where a new parent is inserted above an existing parent, the ‘cost’ of
investment in the sub can now be its carrying amount rather than its F
This relief is limited to wher
1. The new parent obtains control of the original parent (or entity) by issuing share
2. The assets and liabilities of the new group and the original group are the same
immediately before and after the reorganisation; an
3. The owners of the original parent before the reorganisation have the same absolute
and relative interests after the reorganisation.
If any of the above is not met then the reorganisation must be accounted for as normal at
FV (rather than CV
IAS 27 will require all dividends received to be shown in the income statemen
However, if the dividend exceeds the total comprehensive income of the subsidiary in the
period the dividend is declared; or the carrying amount of the investment exceeds the
amount of net assets (including associated goodwill) recognised - then impairment should
be checked for
The distinction between pre- and post-acquisition pro ts is no longer required.
Recognising dividends received from subsidiaries as income will give rise to greater
income being recognised. Care will need to be taken as to what constitutes a dividend
(de ned as a distribution of pro ts).
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IAS 27
Syllabus D3b) Apply the accounting principles where the parent reorganises the structure of the
group by establishing a new entity or changing the parent.
De-merger
As a company or group grows they sometimes diversify into other areas. This can cause
problems
For example
1. If each division has a different risk pro le it could be commercially desirable to
reduce the overall risk pro le
2. If different shareholders/managers are involved in different areas of the business
they may wish to split the business (sometimes known as a partition) so that they
each own only the business area they are involved in
Shareholders cannot just divide up a company or group and set up separate
enterprises without incurring signi cant tax liabilities unless the separation falls
within the conditions for either
A statutory demerger, o
A company reconstruction using a members’ voluntary liquidation
A statutory demerger
is the simpler of the two alternatives but the circumstances in which they can be used are
limited and the conditions which need to be met are more stringent
It can only be used to split two or more trades. It cannot be used to split out a trade from,
say, a property investment business.
How it work
The mechanics of a statutory demerger are relatively straightforward, either
1. the shares in a subsidiary are distributed out to the members o
2. the trade is transferred to a new company and shares in the new company are issued
to the members of the old company.
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Parent Reorganises The Structure Of The Grou
Internal Group Re-Organisation
Typically
1) The ultimate shareholders remain the sam
2) No cash leaves the grou
3) There is no change in NC
Therefore, ultimately, the group remains the same - so no effect on group accounts.
However, individual accounts within the group will be affected
Questions on group reorganisations are more likely to focus on the principles behind the
number
rather than the numbers themselves
Eg. Sub-subsidiary becomes a subsidiary
How?
P buys S2 for cash (or other assets) or
S1 could pay a dividend to P in the form of the shares in S2
Effect
Just means that S2 now reports directly to P rather then through S1
This means S2 can be sold off without selling off S1.
Also means S1 and S2 report independently to P (Divisionalisation
The opposite to pont 1.
This time we make a direct sub a sub-subsidiary
How?
S1 could buy S2 for cash (or olher assets) (DR INV IN S2 CR CASH) or
S1 could issue additional shares to P to pay for S2. (Dr INV IN S2 CR SHARES)
Effect
So S2 reports to S1
A gain or loss may be made in the separate nancial statements of S1. This needs to be
eliminated in the group accounts
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Group reorganisations lend themselves well to ethics question
For example, pressure from the CEO to overstate pro ts on disposal (on loss of control) or
putting a partial disposal pro t to P/L instead of reserves
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Syllabus D4: Foreign transactions and entities
Syllabus D4a) Outline and apply the translation of foreign currency amounts and transactions into the
functional currency and the presentational currency.
Foreign Exchange Single compan
Transactions in a single compan
This is where a company simples deals with companies abroad (who have a different
currency)
The key thing to remember is that
ALL EXCHANGE DIFFERENCES TO INCOME STATEMEN
So - a company will buy on credit (or sell) and then pay or receive later. The problem is
that the exchange rate will have moved and caused an exchange difference
Step 1: Translate at spot rat
Step 2: If there is a creditor/debtor @ y/e - retranslate it (exch gain/loss to I/S
Step 3: Pay off creditor - exchange gain/loss to I/
Illustration
On 1 July an entity purchased goods from a foreign country for Y$10,000.
On 1 September the goods were paid in full
The exchange rates were:
1 July $1 = Y$10
1 September $1 = Y$
Calculate the exchange difference to be included in pro t or loss according to IAS
21 The Effects of Changes in Foreign Exchange Rates.
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Solution
Account for Payables on 1 July: Y$10,000/10 = 1,000
Payment performed on 1 September: Y$10,000 / 9 = 1,111
The Exchange difference: 1,000 - 1,111 = 111 los
Illustration
Maltese Co. buys £100 goods on 1st June (£1:€1.2
Year End (31/12) payable still outstanding (£1:€1.1
5th January £100 paid (£1:€1.05
Solutio
Initial Transactio
Dr Purchases 12
Cr Payables 12
Year En
Dr Payables 1
Cr I/S Ex gain 1
On paymen
Dr Payables 11
Cr I/S Ex gain
Cr Cash 10
Also items revalued to Fair Value will be retranslated at the date of revaluation and the
exchange gain/loss to Income statement
All foreign monetary balances are also translated at the year end and the differences taken
to the income statement
This would include receivables, payables, loans etc.
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Syllabus D4b) Account for the consolidation of foreign operations and their disposal.
Foreign exchange - subsidiarie
Ok so in the previous section we looked at foreign exchange differences which occur when
an individual company buys/sells at one rate and pays/receives at another. Either that or a
retranslation of a foreign monetary balance
Now we look at what happens to our CONSOLIDATED accounts when we have a foreign
subsidiary
Clearly we cannot just add their foreign currency gures to our home currency gures - we
need to translate S rst. We do this using the following rates
Exchange rates to be used
Income Statement Average rate
SFP (Assets and Liabs) Closing rat
ALL EXCHANGE DIFFERENCES TO RESERVE
How we actually go about doing this in the exam means a slight adjustment to our group
workings as stated here
Net Assets Tabl
At acquisition column Acquisition rate
Year end column Closing rat
The post-acquisition column and hence retained earnings effectively includes the
exchange gains/losses. This should be disclosed separately in the OCI and in Equity.
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Foreign Exchange Translation Reserv
Remember that actually, by using the rates we have in the equity table, any foreign
exchange differences will end up in the post-acquisition column which we then use for our
retained earnings working. If requested we could calculate the exact amount and take it
out of retained earnings and put it into its own reserve
This can be calculated as follows
Translation Reserve
Goodwil
This should be retranslated every year end (closing rate). Any exchange gain/loss to
Equity
Illustratio
Notice rst of all you should calculate goodwill in the FOREIGN CURRENCY. This allows
us to retranslate it whenever we want
Goodwill (in foreign currency)
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Take this 17,000 and translate it at the acquisition rate at rst
e.g. 17,000 x 0.5 = $8,50
Now take the 17,000 and translate it at the year-end rate
e.g. 17,000 x 0.6 = $10,20
The $10,200 is shown in the group SFP and the gain of $1,700 is taken to retained
earnings
Illustratio
Step
1. Do S only adjustments (in foreign currency
2. Translate S (using rates above) and do Net Asset Tabl
3. Do adjustments and workings as normal - but calculate goodwill exchange gain or loss
and add to retained earnings
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P acquired 80% S @ start of year. At Acquisition S’s Land had a FV 4,000 pintos higher
than book valu
Proportionate NCI metho
Exchange rates (Pinto:$
Last year end 5.
This year end
Average for year 5.
Solutio
1. Step 1: S only adjustments - non
2. Step 2: Net Asset Table (Acq. @ acq. rate; Year-end @closing rate)
Translate S - all assets and liabilities at closing rate. Income statement at average
rate
SFP - so far
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Income statement
Step 3 Workings and adjustments as norma
Goodwill
Retranslate at year end
909 x 5.5/5 1,00
Gain of 91 to retained earning
NCI
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Retained Earnings
Translation Reserv
NOT NORMALLY REQUIRED IN EXAM
80% of this 381 is taken from RE as this belongs to P
100% of the goodwill revaluation gain also is an exchange difference 91 and this would
also be taken from the retained earnings
Giving the retranslation reserve a balance of 396 (80% x 381 + 91).
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Final Answe
Don’t forget to translate all of S’s NA @ closing rate.
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Foreign currency - extra
Foreign Currency - Examinable Narrative & Miscellaneous point
Functional Currenc
Every entity has its own functional currency and measures its results in that currenc
Functional currency is the one that
- in uences sales pric
- the one used in the country where most competitors are and where regulations are made
- the one that in uences labour and material cost
If functional currency changes then all items are translated at the exchange rate at the
date of chang
Presentation Currenc
An entity can present in any currency it chooses
The foreign sub (with a foreign functional currency) will present normally in the parents
presentation currency and hence the need for foreign sub translation rules
Foreign currency dealings between H and
There is often a loan between H and a foreign sub. If the loan is in a foreign currency don’t
forget that this will need retranslating in H’s or S’s (depending on who has the ‘foreign’
loan) own accounts with the difference going to its income statement
If H sells foreign S, any exchange differences (from translating that sub) in equity are
taken to the income statement (and out of the OCI).
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Deferred ta
There are deferred tax consequences of foreign exchange gains (see tax chapter). This is
because the gains and losses are recognised by H now but will not be dealt with by the
taxman until S is eventually sold.
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Syllabus E: INTERPRET FINANCIAL
STATEMENTS FOR DIFFERENT
STAKEHOLDERS
Syllabus E1: Analysis and interpretation of financial
information and measurement of performance
Syllabus E1a) Discuss and apply relevant indicators of financial and non- financial
performance including earnings per share and additional performance measures.
Indicators Of (Non) Financial Performance
Analysis is not just calculations
So remember this is not a baby paper now so
1
Explaining the ratio is just not enoug
2
You need to compare (eg to prior periods or industry averages
3.
Then say what the movement/difference is telling you - by using the scenario - and
what this may mean for the company and its stakeholder
4.
Now also consider any non- nancial consequences? (quality, ethics etc
5.
Any transactions/events in the year that had a signi cant impact on ratio
6.
Any impact of different accounting policies on ratios? (particularly if comparing to
other entities)
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A Ratio Analysis Techniqu
1.
Always see if the ratio has improved or deteriorated (Not 'increased' or 'decreased'
2
The say why the ratio has improved or deteriorated - here is where you use the
scenario not a textbook
3.
Finally explain the longer term impact on the company and make a
recommendation for action where appropriate
EP
PAT / NO. OF SHARE
EPS means nothing on its ow
It always needs to be compared over tim
Remuneration packages might be linked to EPS growth, so increasing the pressure on
management to improve EPS, and be an inherent ethical ris
Illustratio
A company changes its depreciation policy (longer UEL) - in order to reduce depreciation and thus increase EP
Answe
Step 1: State the IFRS knowledge:
An entity should review UEL every year - and any change is a change in accounting
estimate
Changes in accounting estimates only allowed if a result of new informatio
Step 2: Apply the rule or principle to the scenario
So in the scenario you'd look for things like:
1) Large pro ts on disposals - a result of too short a useful life previously
2) Other evidence of longer UELs on similar assets
3) Buying periods matching the new UE
)
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Step 3: Explain the ethical issues (if you think this is solely to manipulate the
earnings gure)
Threat to objectivity
Also non-compliance with IAS 16 and therefore, contravene the fundamental principle of
professional competence
Ethics not
So far we only looked at the manipulation of earning
Other examples could include
Signi cant sales to related parties and the directors not wanting to disclose details of the
transaction
Directors trying to window dress revenue by offering large incentives to make sales to uncreditworthy customers or Manipulating estimates to achieve required results.
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Interpret NFPI
The use of non- nancial performance indicators are an additional tool to
monitor performance in not-for-pro t organisations
For example, if the case of a secondary school, some non- nancial performance
indicators about the performance of the school would be
•
The number of pupils taugh
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The number of subjects taught per pupi
•
How many examination papers are take
•
The pass rat
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The proportion of students which go on to further educatio
Let’s take a bus service which is non-pro t seekin
In fact, its mission is to provide reliable and affordable public transport to the citizens.
It often involves operating services that would be considered uneconomic by the private
sector bus companies.
Let’s have a look at some non- nancial performance indicators for the public bus service
Non- nancial performance
indicator
% of buses on time
Importance
Punctuality is important to passengers
% of buses cancelled
Customer rating of cleanliness of
facilities
% of new customers
Employee morale
Reliability is important to passengers
Passengers require good quality service
New customers are vital for sustained growth
Happy employees are vital for success in a service
business
In not-for-pro t organisations, decisions may be taken to improve short-term performance
but may have a negative impact on long-term performance.
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This will have limited bene t to the organisation as it will not convey the full picture
regarding the factors that will drive the achievement of objectives e.g. customer
satisfaction, quality of service
Results may be manipulated to show a better picture but the effect on stakeholders will be
negative
Let’s take an example
The hospital tends to manipulate its results with respect to waiting times for operations
Obviously, citizens will be disappointed and start losing trust in the organisation
Example
Cowsville is a town with a population of 100,000 people.
The town council of Cowsville operates a bus service which links all parts of the town with
the town centre.
The service is non-pro t seeking and its mission statement is ‘to provide ef cient, reliable
and affordable public transport to all the citizens of Cowsville.’
Attempting to achieve this mission often involves operating services that would be
considered uneconomic by private sector bus companies, due either to the small number
of passengers travelling on some routes or the low fares charged.
The majority of the town council members are happy with this situation as they wish to
reduce traf c congestion and air pollution on Cowsville’s roads by encouraging people to
travel by bus rather than by car
However, one member of the council has recently criticised the performance of the
Cowsville bus service as compared to those operated by private sector bus companies in
other towns.
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She has produced the following information:
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Operating Statistics for the year ended 31 March 201
Total passengers carried = 2,400,000 passenger
Total passenger miles travelled = 4,320,000 passenger mile
Private sector bus companies Industry average ratios Year ended 31 March 2016
Return on capital employed = 10
Return on sales (net margin) = 30
Asset turnover =0·33 time
Average cost per passenger mile = 37·4
Required
(a) Calculate the following ratios for the Cowsville bus servic
(i) Return on capital employed (based upon opening investment)
(ii) Return on sales (net margin)
(iii) Asset turnover
(iv) Average cost per passenger mile.
(b) Explain the meaning of each ratio you have calculated. Discuss the performance of the
Cowsville bus service using the four ratios
Solution
(a) Ratios
Return on Capital employed
Operating Pro t / Capital employed x 100 = 20 / 2,210 x 100 = 0,9%
Return on sales (net margin)
Operating pro t / Sales x 100 = 20 / 1,200 x 100 = 1.7%
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Asset Turnover
Sales / Capital employed = 1,200 / 2,210 = 0.54 times
Average cost per passenger mile
Operating cost / Passenger miles = 1,180,000 / 4,320,000 =
27.3p
Tutorial Note: the term pro t is used throughout this answer; in the public
sector it would normally be referred to as surplus
(b) Meaning of each rati
Return on Capital employed.
This ratio measures the pro ts earned on the long-term nance invested in
the business. The Cowsville bus service is only generating an annual pro t of
0.9p for every £1 invested. The equivalent gure for private bus companies is
10p.
Return on sales.
This ratio measures the pro tability of sales. For the Cowsville bus services
1.7p of every £1 of sales is pro t. The equivalent gure for private bus
companies is 30p.
Asset turnover.
This ratio measures a rm’s ability to generate sales from its capital
employed. The Cowsville bus service generates sale of 54p for every £1 of
capital employed. The equivalent gure for private bus companies is only
33p.
Average cost per passenger mile.
This measures the cost of transporting passengers per mile travelled. The
Cowsville bus service incurs a cost of 27.3p per passenger mile as compared
to 37.4p for private bus companies.
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Performance of the bus servic
On rst sight the Cowsville bus service appears to have performed poorly as compared to
private sector bus companies.
It has a low return on capital employed, largely due to a poor return on sales.
This could be explained by the low fares charged.
On the positive side its ability to generate sales is good and its buses to be more
intensively used than private sector equivalents.
However, if we take into account the objectives of the council and the mission statement of
the bus service it is possible to draw a different conclusion.
Private sector companies usually seek to maximise investor wealth.
The council appears to be trying to encourage usage of public transport in an attempt to
reduce traf c congestion.
To do this it charges low fares, resulting in a poor return on sales and a low return on
capital employed.
However, the low fares, and willingness to operate uneconomic routes has led to a high
asset turnover, implying above industry average usage of the bus service.
In turn this greater usage of the service leads to a lower cost per passenger mile as xed
costs are spread more thinly over a larger number of passenger miles.
Before drawing any rm conclusions it would be sensible to compare the performance of
the Cowsville bus service with that of bus operators pursuing similar objectives.
(Tutorial Note: If we compare average fare per passenger mile we can see that the
Cowsville bus service charges lower fares than the private sector.
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Cowsville fare per passenger mile = passenger fares ÷ passenger miles
= £1,200,000 ÷ 4,320,000 = 27.8p
Private sector
= Average cost ÷ (1 - net margin)
= 37.4p ÷ (1 – 0.3) = 53.4p
Cowsville charges lower fares per passenger mile. Which may explain its higher load
factor and therefore its lower cost per passenger mile
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Non- nancial reportin
This is concerned with business ethics and accountability to stakeholder
Companies should look after ALL shareholders and be transparent in its dealings with
them when compiling corporate reports
CSR requires directors to look at the aims and purposes of the company and not assume
pro t to be the only motive for shareholders
Arrangements should be put in place to ensure that the business is conducted in a
responsible manner.
This includes environmental and social targets, monitoring of these and continuous
improvement
There is pressure now for companies to show more awareness and concern, not only for
the environment but for the rights and interests of the people they do business with
Governments have made it clear that directors must consider the short-term and long-term
consequences of their actions, and take into account their relationships with employees
and the impact of the business on the community and the environment
CSR requires the directors to address strategic issues about the aims, purposes, and
operational methods of the organisation, and some rede nition of the business model that
assumes that pro t motive and shareholder interests de ne the core purpose of the
company
The reporting of the company's effects on society at larg
It expands the traditional role that company´s only provide for the shareholders.
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Why prepare a social report
1. Build their reputation on it (e.g. body shop
2.
Society expects it (Shell
3.
Long term it will increase pro t
4.
Fear that governments may force it otherwis
How companies interact responsibly with societ
•
Provide fair pay to employee
•
Safe working environmen
•
Improvements to physical infrastructure in which it operate
Is it against the maximising shareholder wealth principle
Organisations are rarely controlled by shareholders as most are passive investors
This means large companies can manipulate markets - so social responsibility is a way of
recognising this, and doing something to prevent it happening from within
Also, of course, business get help from outside and so owe something back. They bene t
from health, roads, education etc. of the workforce and suppliers and customers
This social contract means that the companies then take on their own social responsibilit
Human Capital Reportin
Sees employees as an asset not an expense and competitive advantage is gained by
employees
The training, recruitment, retention and development of employees is all part of what would
therefore be reporte
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Implication
• People are a resource like any other and so needs to be effectively and ef ciently
manage
• Safeguarding of the asset as norma
• Impairment could mean a simple drop in motivatio
HCM reports should
•
Show size of workforc
•
Retention rate
•
Skills needed for succes
•
Trainin
•
Remuneration level
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Succession planning
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Syllabus E1b) Discuss the increased demand for transparency in corporate reports, and
the emergence of non-financial reporting standards.
Demand For Transparenc
Transparency in Corporate Report
Stakeholders are demanding more from entities
Investors in particular need to know what they are investing in ethically, hence the demand
for transparency in corporate reports. Stakeholders need to understand how an entity does
business
For exampl
EU law requires large companies to disclose certain information on the way they operate
and manage social and environmental challenges
This helps investors, consumers, policy makers and other stakeholders to evaluate the
non- nancial performance of large companies and encourages these companies to
develop a responsible approach to business
Companies are required to include non- nancial statements in their annual reports from
2018 onwards.
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Transparency & Non-Financial Standard
This has become more important recently as stakeholders are interested in
1. Management of busines
2. Future prospect
3. Environmental concern
4. Social responsibility of compan
How is this reported…
Operating and Financial Review (OFR)
•
Looks at results and talks about future prospect
Corporate Governance Repor
•
Looks at how the company is directed and controlle
Environmental and social report
•
Looks at the environment and social concerns and the sustainability of thes
Management Commentar
•
Looks at the trends behind the gures and what is likely to affect future performance
and positio
IFRS Practice Statement Management Commentar
On 8 December 2010 the IASB issued the IFRS Practice Statement Management
•
Commentary
The Practice Statement provides a broad, non-binding framework for the
presentation of management commentary that relates to nancial statements
prepared in accordance with IFRS.
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The Practice Statement is not an IFRS. Consequently, entities are not required to
comply with the Practice Statement, unless speci cally required by their jurisdiction
Management commentary is a narrative report that provides a context within which
•
to interpret the nancial position, nancial performance and cash ows of an
entity
It also provides management with an opportunity to explain its objectives and its
strategies for achieving those objectives.
Management commentary encompasses reporting that jurisdictions may describe
as management’s discussion and analysis (MD&A), operating and nancial review
(OFR), or management’s report
Management commentary ful ls an important role by providing users of nancial
•
statements with a historical and prospective commentary on the entity’s nancial
position, nancial performance and cash ows.
The Practice Statement permits entities to adapt the information provided to
•
particular circumstances of their business, including the legal and economic
circumstances of individual jurisdictions.
This exible approach will generate more meaningful disclosure about the most
important resources, risks and relationships that can affect an entity’s value, and
how they are managed
The purpose of an OFR is to assist users, principally investors, in making a forward-
•
looking assessment of the performance of the business by setting out
management’s analysis and discussion of the principal factors underlying the
entity’s performance and nancial position.
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Typically, an OFR would comprise some or all of the following
1.
Description of the business and its objectives
2.
Management’s strategy for achieving the objectives
3.
Review of operations
4.
Commentary on the strengths and resources of the business
5.
Commentary about such issues as human capital, research and developmen
activities, development of new products and services
6.
Financial review with discussion of treasury management, cash in ows an
out ows and current liquidity levels
The publication of such a statement would have the following advantages
1.
It could be helpful in promoting the entity as progressive and as eager to
communicate as fully as possible with investors
2.
It could be a genuinely helpful medium of communicating the entity’s plans and
management’s outlook on the future
However, there could be some drawbacks
1.
If an OFR is to be genuinely helpful to investors, it will require a considerable inpu
of senior management time.
This could be costly, and it may be that the bene ts of publishing an OFR would not
outweigh the costs
2.
There is a risk in publishing this type of statement that investors will read it i
preference to the nancial statements, and that they may therefore fail to read
important information
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, said
“Management commentary is one of the most interesting parts of the annual report.
It provides management with an opportunity to add context to the published nancial
information, and to explain their future strategy and objectives.
It is also becoming increasingly important in the reporting of non- nancial metrics such as
sustainability and environmental reporting
The publication of this Practice Statement will bene t both users and preparers by
enhancing the international consistency of this important source of information.
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Sir David Tweedie, ex-Chairman of the IAS
Syllabus E1c) Appraise the impact of environmental, social, and ethical factors on
performance measurement.
Environmental, Social, And Ethical Factors On
Performance Measuremen
IFR
No required disclosure requirements for environmental and social matters
However
1
Provisions for environmental damage are recognised under IAS 3
2
IAS 1 requires disclosure to a proper understanding of nancial statements
Voluntary Disclosur
Voluntary disclosure and the publication of environmental reports has now become the
norm for quoted companies in certain countries as a result of pressure from stakeholder
groups to give information about their environmental and social 'footprint'
The creation of ethical indices has added to this pressure - for example the FTSEA Good
index in the UK, and the Dow Jones Sustainability Group Index in the US
Sustainability Reportin
This integrates environmental, social and economic performance data
The most well-known is the Global Reporting Initiative
The GRI is a long-term, multi-stakeholder, international not-lor-pro t organisation
whose mission is to develop and disseminate globally applicable GRI Standards on
sustainability reporting for voluntary use by organisations.
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Environmental Reportin
This is the disclosure of environmental responsibilities and activities
Increasing awareness of environmental issues and pressure from non governmental
organisations (NGOs) make this vital to an entit
Social Reportin
This discloses the social impact of a business's activities
Eg
Charity donation
Giving employees time to support charitie
Employee satisfaction levels and remuneration issues
Community support; an
Stakeholder consultation informatio
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Framework for environmental and sustainability
reportin
The idea here is that everything must be able to continue in the futur
We must not use up resources, social or environmental, without replacing the
Any that is not replaced is often termed the social or environmental footprin
Reporting Sustainabilit
•
Voluntar
•
Increasingly popular (often put on website too
•
Sometimes called ‘the triple bottom line’ (Pro ts, people and planet
Environmental Reportin
1. Can be in the published annual repor
2. Can be a separate repor
3. No mandatory standards to follo
4. Covers inputs (Using up of resources
5. Covers outputs (Pollution etc.
Its voluntary basis causes problems
• Users can disclose the good but not the ba
• No external in uence means less con dence in the report
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Bene ts of an Environmental Repor
•
Can highlight inef ciencie
•
Identi es opportunities to reduce wast
•
Can create a positive image as a good corporate citize
•
Increased consumer con dence in i
•
Employees like i
•
Investors look for environmental concerns nowaday
•
Reduces risk of litigation against i
•
Can give competitive edg
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Syllabus E1d) Discuss the current framework for integrated reporting (IR) including the
objectives, concepts, guiding principles and content of an Integrated Report.
Purpose and content of an integrated repor
To explain to providers of nancial capital how an organisation creates value
over time.
It bene ts all stakeholders interested in an organisation’s ability to create value over time
including
• employee
• customer
• supplier
• business partner
• local communitie
• legislator
• regulators and policy-maker
The ‘building blocks’ of an integrated report are
• Guiding principles
These underpin the integrated report
They guide the content of the report and how it is presente
• Content elements
These are the key categories of information
They are a series of questions rather than a prescriptive list
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Guiding Principle
•
Are you showing an insight into the future strategy..
•
Are you showing a holistic picture of the organisation's ability to create value over
time?
Look at the combination, inter-relatedness and dependencies between the factors
that affect this
•
Are you showing the quality of your stakeholder relationships
•
Are you disclosing information about matters that materially affect your ability to
create value over the short, medium and long term
Are you being concise?
•
Not being burdened by less relevant information
Are you showing Reliability, completeness, consistency and comparability when
•
showing your own ability to create value
Content Element
Organisational overview and external environment
•
What does the organisation do and what are the circumstances under which it
operates
Governance
•
How does an organisation’s governance structure support its ability to create
value in the short, medium and long term
Business model
•
What is the organisation’s business model?
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Risks and opportunities
What are the speci c risk and opportunities that affect the organisation’s ability to
create value over the short, medium and long term? And how is the organisation
dealing with them
•
Strategy and resource allocation
Where does the organisation want to go and how does it intend to get there
•
Performance
To what extent has the organisation achieved its strategic objectives for the period
and what are its outcomes in terms of effects on the capitals
•
Outlook
What challenges and uncertainties is the organisation likely to encounter in
pursuing its strategy, and what are the potential implications for its business
model and future performance
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Syllabus E1e) Determine the nature and extent of reportable segments.
Syllabus E1f) Discuss the nature of segment information to be disclosed and how
segmental information enhances the quality and sustainability of performance.
Segmental Reporting (IFRS 8) - Introductio
Objective of IFRS
The objective of IFRS 8 is to present information by line of business and by
geographical area
It applies to plcs and any entity voluntarily providing segment information should
comply with the requirements of the Standard
So why is it a good thing to have information by line of business and geographical
area?
Well, imagine you are an Apple shareholder.
You will naturally be interested in how well the company is doing.
That information would only make real sense though if it was broken down by business
area.
For example, if most of the pro ts were from i-Pods, then this would be worrying as this
market is in decline
You would want to know how they are doing in the desktop computer market, how they
are doing in the smartphone and tablet market as well as any new areas they may be
diversifying into
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Key De nition
Business segment (e.g. i-Phone segment)
A component of an entity that
(a) provides a single product or service and
(b) is subject to risks and returns that are different from those of other business
segments
Geographical segment (e.g. European market):
A component of an entity that
(a) provides products and services and
(b) is subject to risks and returns that are different from those of components
operating in other economic environments
May be based either on where the entity’s assets are located or on where its customers
are located
Operating Segment
Engages in business (even if all internal), whose results are regularly reviewed by the
chief operating decision maker and for which separate nancial information is available
• Earns revenue and incurs expenses from a business activit
• Is regularly reviewed by the chief decision maker when handing out resource
• Has separate nancial info available
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Therefore the head of ce is not an operating segment as it is not a business activity.
The idea behind the regular review part is that the entity reports on those segments that
are actually used by management to monitor the busines
Aggregating Segment
Operating Segments can be aggregated together only i
they have similar economic characteristics such as
1. Similar product / servic
2. Similar production proces
3. Similar sort of custome
4. Similar distribution method
5. Similar regulation
Quantitative Thresholds
Any segment which meets these thresholds must be reported on
1. Pro t is 10% or more of all pro table segment
2. Assets are 10% or more of the total assets of all operating segment
Reportable Segments
If the total EXTERNAL revenue of the operating segments reported on (meeting the
quantitative thresholds) is less than 75% of total revenue of the company then additional
operating segments results (those not meeting the quantitative thresholds) are reported
upon (until the 75% is met
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Illustratio
A
B
External
Revenue
220
300
Internal
Revenue
60
15
Pro t
60
50
Assets
5000
4000
C
D
75
E
Total
55
60
710
5
10
90
20
-11
14
133
300
300
400
10,000
Which of the segments A-E should be reported upon
A
B
C
D
E
Revenue
Test
280 / 800 =
35
PASS
315 / 800 =
39
PASS
75 / 800 =
9
FAIL
60 / 800 =
7.5
FAIL
70 / 800 =
9
FAIL
Pro t Test
60 / 144* =
42
PASS
50 / 144 =
35
PASS
20 / 144 =
14
PASS
Assets Test
5,000 /
10,000 =
50
PASS
4,000 /
10,000 =
40
PASS
300 /
10,000
3
FAIL
14 / 144 =
9
FAIL
300 /
10,000
3
FAIL
400 /
10,00
=4
FAIL
*Pro table segments onl
A, B and C all pass one of the tests and so would be reported o
External Revenue Tes
A + B + C = 595 / 710 = 84% PASS (No more segments needed)
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Disclosures for each segmen
Pro
Total Assets and Liabilitie
External Revenue
Internal Revenue
Interest income and expens
Depreciatio
Pro t from Associates and JV
Ta
Other material non-cash item
Measuremen
This shall be the same as the one used when reporting to the chief decision maker.
So it is the internal measure rather than an IFRS on
A reconciliation is then provided between this measure and the entity’s actual gures for
1) Pro t (e.g. Allocation of centrally incurred costs)
2) Assets & Liabilitie
Also any asymmetrical allocations.
For example, one segment may be charged depreciation for an asset not allocated to i
IFRS 8 requires the information presented to be the same basis as it is reported internally,
even if the segment information does not comply with IFRS or the accounting policies used
in the consolidated nancial statements.
Examples of such situations include segment information reported on a cash basis (as
opposed to an accruals basis), and reporting on a local GAAP basis for segments that are
comprised of foreign subsidiaries.
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Although the basis of measurement is exible, IFRS 8 requires entities to provide an
explanation of
1. the basis of accounting for transactions between reportable segments
2. the nature of any differences between the segments’ reported amounts and the
consolidated totals.
For example, those resulting from differences in accounting policies and policies for the
allocation of centrally incurred costs that are necessary for an understanding of the
reported segment information.
In addition, IFRS 8 requires reconciliations between the segments’ reported amounts and
the consolidated nancial statements
Entity Wide Disclosure
A. External revenue for each product/servic
B. Totals for revenue made at home and abroa
C. NCA totals for those held at home and abroa
D. If 1 customer accounts for 10%+ of revenue this total must be disclosed alongside
which segment it is reported in
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IFRS 8 Determining Reporting segments
Identifying Business and Geographical Segment
• An entity must look to its organisational structure and internal reporting system to
identify reportable segments
In fact, the segmentation used for internal reports for the board should be the same
for external report
• Only if internal segments are not along either product/service or geographical lines is
further disaggregation appropriate
Primary and Secondary Segment
• For most entities one basis of segmentation is primary and the other is secondary
(with considerably less disclosure required for secondary segments
• To decide which is primary, the entity should see whether business or geographical
factors most affect the risk and returns
This should be helped by looking at entity’s internal organisational and management
structure and its system of internal nancial reporting to senior management
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Illustratio
Product
External
Revenue
Internal
Revenue
Pro t
Assets
Liabilities
The Nose picker
2,000
30
(100)
3,000
2,000
The Earwax extractor
3,000
20
600
8,000
3,000
Other Products
5,000
50
1,050
20,000
14,000
Which segments should be reported upon
Let’s look at the 3 reportable segment tests:
10% of combined revenue = 1,010
10% of pro ts = 165
10% of losses = 10
10% of assets = 3,100
So
1. The Nose picker only passes the revenue test, it fails the pro ts test as a loss of
100 is less than 165 (165 is higher than 10), it fails the assets test. It is still a
reportable segment though as only 1 test needs to be passe
2. The Earwax extractor passes all 3 test
3. Other Products These are not separate segments and can only be added together if
the nature of the products are similar, as are their customer type and distribution
method. So ordinarily these would not be disclosed. However we need to check
whether the 2 reported segments meet the 75% external revenue test
4. Currently only 5,000 out of 10,000 (50%). Therefore additional operating segments
(other products) may be added until the 75% threshold is reache
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IFRS 8 Pros and Con
IFRS 8 follows what we call the “managerial approach” as opposed to the old “risks and
rewards” approach to determining what segments are
• This has the following advantages:
Cost effective as data can be reported in the same way as it is in the managerial
accounts (though it does need reconciling
• The segment data re ects the operational strategy of the busines
However there are problems also
• It gives a lot of subjective responsibility to the directors as to what they disclos
• Also the internal nature of how it is reported may actually make it less useful to some
users and lead to problems of comparabilit
• There is also no de ned measure of pro t/loss in IFRS
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Syllabus F: THE IMPACT OF CHANGES
AND POTENTIAL CHANGES IN
ACCOUNTING REGULATION
Syllabus F1. Discussion of solutions to current issues in
financial reporting
Syllabus F1a) Discuss and apply the accounting implications of the first time adoption of
new accounting standards.
Here we look at 1st time adoption of IFR
An entity’s rst IFRS nancial statements must
•
be transparent for users and comparable over all periods presente
•
provide a suitable starting point for IFRS accountin
•
be generated at a cost that does not exceed the bene t
An opening IFRS based SFP (using the same accounting policies as the future IFRS
based FS) is needed at the date of moving to IFRSs.
This is the suitable starting point
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The opening IFRS based SFP shall
1.
2.
3.
4.
recognise all assets and liabilities (where IFRSs say they should be recognised
not recognise assets or liabilities (where IFRSs say they should not be recognised
reclassify items (that IFRS say needs reclassi cation
apply IFRSs in measuring all recognised assets and liabilitie
Limited exemption
Where the cost of complying is likely to exceed the bene ts to users of nancial
statements
Retrospective Applicatio
This is applying IFRS to previous periods - this is restricted if it means management
judgements (about past conditions) are needed when the actual outcome is now in fact
known
Disclosure
Needed to explain how the transition from previous GAAP to IFRSs affected the entity’s
reported nancial position, nancial performance and cash ows
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Syllabus F1c) Discuss the impact of current issues in corporate reporting.
The following examples are relevant to the current syllabus:
1. The revision of the Conceptual Framework
2. The IASB’s Principles of Disclosure Initiative
3. Materiality in the context of financial reporting
4. Primary Financial Statements
5. Management commentary
6. Developments in sustainability reporting
Current Issue - The Revision Of The Conceptual
Framewor
Status and purpose of the Conceptual Framewor
The Conceptual Framework's purpose is
1) To help develop and revise IFRSs that are based on consistent concept
2) To help preparers develop consistent accounting policies for areas that are not covered
by a standard or where there is choice of accounting policy, and
3) To help everyone understand and interpret IFRS
The framework does not override any speci c IFRS
Chapter 1 - The Objective Of General Purpose Financial Reportin
The objective is to provide nancial information that's useful to investors, lenders and other
creditors in making decisions about providing resources to the entity.
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This information is about the entity’s economic resources / claims against and the effects
of transactions that change the resources / claims
This information can also help users assess management’s stewardship of the resources
Chapter 2 - Qualitative Characteristics Of Useful Financial Informatio
Financial information is useful when it is relevant and represents faithfully what it purports
to represent
The usefulness of nancial information is enhanced if it is comparable, veri able, timely
and understandabl
Fundamental qualitative characteristic
Relevance and faithful representation are the fundamental qualitative characteristics of
useful nancial informatio
Relevanc
Relevant nancial information is capable of making a difference in the decisions made by
users. Meaning it has predictive value, con rmatory value, or both
Materiality is an entity-speci c aspect of relevanc
Faithful representatio
General purpose nancial reports represent economic phenomena in words and numbers.
To be useful, nancial information must not only be relevant, it must also represent
faithfully the phenomena it purports to represent. Faithful representation means
representation of the substance of an economic phenomenon instead of representation of
its legal form only
A faithful representation seeks to maximise the underlying characteristics of completeness,
neutrality and freedom from error
A neutral depiction is supported by the exercise of prudence. Prudence is the exercise of
caution when making judgements under conditions of uncertainty.
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Applying the fundamental qualitative characteristic
Information must be both relevant and faithfully represented if it is to be useful
Enhancing qualitative characteristic
Comparability, veri ability, timeliness and understandability are qualitative characteristics
that enhance the usefulness of information that is relevant and faithfully represented
Comparabilit
Information about a reporting entity is more useful if it can be compared with a similar
information about other entities and with similar information about the same entity for
another period or another date. Comparability enables users to identify and understand
similarities in, and differences among, items
Veri abilit
Veri ability helps to assure users that information represents faithfully the economic
phenomena it purports to represent. Veri ability means that different knowledgeable and
independent observers could reach consensus, although not necessarily complete
agreement, that a particular depiction is a faithful representation
Timelines
Timeliness means that information is available to decision-makers in time to be capable of
in uencing their decisions
Understandabilit
Classifying, characterising and presenting information clearly and concisely makes it
understandable
While some phenomena are inherently complex and cannot be made easy to understand,
to exclude such information would make nancial reports incomplete and potentially
misleading
Financial reports are prepared for users who have a reasonable knowledge of business
and economic activities and who review and analyse the information with diligence.
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Enhancing qualitative characteristics should be maximised to the extent necessary.
However, enhancing qualitative characteristics (either individually or collectively) cannot
render information useful if that information is irrelevant or not represented faithfully
The cost constraint on useful nancial reportin
Cost is a pervasive constraint on the information that can be provided by general purpose
nancial reporting
Reporting such information imposes costs and those costs should be justi ed by the
bene ts of reporting that information.
The IASB assesses costs and bene ts in relation to nancial reporting generally, and not
solely in relation to individual reporting entities
The IASB will consider whether different sizes of entities and other factors justify different
reporting requirements in certain situations
Chapter 3 - Financial Statements And The Reporting Entit
The objective of nancial statements (to provide information about an entity's assets,
liabilities, equity, income and expenses that helps users assess the prospects for future
net cash in ows and management's stewardship of resource
Going concern is assumed
The reporting entity is an entity that is required, or chooses, to prepare nancial
statements. It can be a single entity or a portion of an entity or can comprise more than
one entity. A reporting entity is not necessarily a legal entity
Determining the appropriate boundary of a reporting entity is driven by the information
needs of the primary users of the reporting entity’s nancial statements
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Applying the enhancing qualitative characteristic
Only two statements are mentioned explicitly
1) The Statement of Financial Position
2) The Statement(s) of Financial Performanc
The rest are "other statements and notes
Financial statements are prepared for a speci ed period of time and provide comparative
information and under certain circumstances forward-looking information
Generally, consolidated nancial statements are more likely to provide useful information
to users of nancial statements than unconsolidated nancial statements
Chapter 4 - The Elements Of Financial Statement
The main focus of this chapter is on the de nitions of assets, liabilities, and equity as well
as income and expenses
The de nitions are quoted below
Asse
A present economic resource controlled by the entity as a result of past events. An
economic resource is a right that has the potential to produce economic bene ts
Liabilit
A present obligation of the entity to transfer an economic resource as a result of past
events
Equit
The residual interest in the assets of the entity after deducting all its liabilities
Incom
Increases in assets or decreases in liabilities that result in increases in equity, other than
those relating to contributions from holders of equity claims
Expenses
Decreases in assets or increases in liabilities that result in decreases in equity, other than
those relating to distributions to holders of equity claims.
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The expression "economic resource" instead of simply "resource" stresses that the IASB
no longer thinks of assets as physical objects but as sets of rights
The de nitions of asets and liabilities also no longer refer to "expected" in ows or out ows.
Instead, the de nition of an economic resource refers to the potential of an asset/liability to
produce/to require a transfer of economic bene ts
Chapter 5 - Recognition And Derecognitio
Only items that meet the de nition of an asset, a liability or equity are recognised in the
statement of nancial position an
Only items that meet the de nition of income or expenses are to be recognised in the
statement(s) of nancial performance
However, their recognition depends on providing users with:
(1) relevant information about the asset / liability / income / expenses / equity and
(2) a faithful representation of the asset / liability / income / expenses / equity
The framework also notes a cost constraint
Derecognitio
The new Framework states that derecognition should aim to represent faithfully both
• any assets and liabilities retained after the transaction that led to the derecognition; an
• the change in the entity’s assets and liabilities as a result of that transaction
In situations when derecognition supported by disclosure is not suf cient to meet both
aims, it might be necessary for an entity to continue to recognise the transferred
component.
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Historic Cost (uses an entry value
Asse
Historical cost, including transaction costs, to the extent unconsumed (or uncollected) and
recoverable. It includes interest accrued on any nancing component
Liabilit
Historical consideration as yet owing in respect of goods and services received (net of
transaction costs), increased by any onerous provision. It includes interest accrued on any
nancing component
Value in use/ Ful lment value (uses an exit value
Asse
Present value of future cash ows from the continuing use of the asset and from its
disposal, net of transaction costs on disposal
Liabilit
Present value of future cash ows that will arise in ful lling the liability, including future
transaction costs
Current Cost (uses an entry value
Asse
Consideration that would be given to acquire an equivalent asset at measurement date
plus transaction costs. It re ects the current age and condition of the asset
Liabilit
Consideration that would be received to incur an equivalent liability at measurement date
minus transaction costs.
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Chapter 6 - Measuremen
The price that would be received to sell an asset, or paid to transfer a liability, in an orderly
transaction between market participants at the measurement date. It excludes any
potential transaction costs on sale or transfer
Factors to consider when selecting a measurement basi
Choosing a measurement basis is the same as that of nancial statements: i.e. to provide
relevant information that faithfully represents the underlying substance of a transaction
So it is important to consider the nature of the information & the relative importance of the
information presented in these statements will depend on facts and circumstances
Relevanc
Look at how the characteristics of the asset or liability and how it contributes to future cash
ows are two of the factors to see which basis provides most relevant informatio
For example, if an asset is sensitive to market factors, fair value might provide more
relevant information than historical cost
But FV wouldn't be relevant if the asset is held solely for use or to collect contractual cash
ows rather than for sale
Faithful representatio
Uncertainty does not make a measurement basis irrelevant. However, a balance must be
achieved between relevance and faithful representation
Other consideration
In most cases, using the same measurement basis in both SFP and Income statement
would provide the most useful information
Normally select the same measurement basis for the initial measurement of an asset or a
liability and its subsequent measurement.
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Fair Value (uses an exit value
No single factor is determinative when selecting an appropriate measurement basis. The
relative importance of each factor will depend on facts and circumstances
Chapter 7 - Presentation and Disclosur
The statement of statement of comprehensive income is newly described as "Statement of
Financial Performance", however, the framework does not specify whether this statement
should consist of a single statement or two statements, it only requires that a total or
subtotal for pro t or loss must be provided
It also notes that the statement of pro t or loss is the primary source of information about
an entity’s nancial performance for the reporting period and that only in "exceptional
circumstances" the Board may decide that income or expenses are to be included in other
comprehensive income
Notably, the framework does not de ne pro t or loss, thus the question of what goes into
pro t or loss or into other comprehensive income is still unanswered
Chapter 8 - Concepts of Capital And Capital Maintenanc
The content in this chapter was taken over from the existing Conceptual Frameworkand
and discusses concepts of capital ( nancial and physical), concepts of capital
maintenance (again nancial and physical) and the determination of pro t as well as
capital maintenance adjustments
The IASB decided that updating the discussion of capital and capital maintenance could
have delayed the completion of the framework signi cantly
The Board might consider revising the description and discussion of capital maintenance
in the future if it considers such a revision necessary
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Current Issue - The IASB’s Principles of Disclosure
Initiativ
Principles of Disclosur
Preparers & auditors say that disclosure requirements in IFRS are dif cult to work wit
Investors say that they aren’t getting the right information
In a nutshell, the disclosure problem is the perception that nancial statements
• do not provide enough relevant informatio
• include too much irrelevant information, and
• communicate the information ineffectively
At the heart of this is JUDGEMENT – deciding what to disclose and how to disclose it
Behavioural Problem
The IASB says that Managers treat disclosure requirements as a checklist (because it
saves time and reduces risks
Preparers are discouraged from using their judgement also because:
• Standards lack clear disclosure objective
• Long lists of prescriptive disclosure requirements promote the use of a ‘checklist’
approac
Principles not checklist
So... the Board thinks that developing a set of disclosure principles would help improve the
effectiveness of disclosures
Nevertheless, the Board thinks it will only work if Management and others start to use
judgement in disclosing information.
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The disclosure PRINCIPLES the Board considered
Principles of effective communication
a) Entity‐speci c and tailored
b) Simple and direct language;
c) Organised to highlight important matters;
d) Properly cross‐referenced to highlight relationships
e) No duplication
f) In a way that optimises comparabilit
Principles on where to disclose information
a. The role of the primary nancial statements and of the notes
b. Location of informatio
1) Specify that the ‘primary nancial statements’ comprise the four statements
This term would then be used consistently throughout all Standards when referring to
the underlying four statements with the understanding that ‘primary’ is not intended to
imply that the notes provide secondary or less important information than the PFS.
Instead, they provide DIFFERENT information from the PFS and have a DIFFERENT role.
2) De ne the roles of the PFS and the notes.
This would help in deciding what information is required in the PFS or in the notes
Would also help judgements about the appropriate level of disaggregation in the PFS and
in the notes.
Disclosing IFRS information outside the nancial statements
Information necessary to comply with the Standards can be disclosed outside the nancial
statements if:
a. it is disclosed within the entity’s annual report;
b. its disclosure outside the nancial statements makes the annual report as a whole more
understandable, and
c. it is clearly identi ed and incorporated in the nancial statements by means of a cross‐
reference that is made in the nancial statements.
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Disclosing non‐IFRS information within the nancial statements
An entity can include non‐IFRS information in the nancial statements but...:
a. Clearly identify as not being prepared in accordance with the Standards and, if
applicable, as unaudited;
b. Disclose in the nancial statements a list of the information labelled as non‐IFRS
information; and
c. Explain why the information is relevant and represents faithfully the economic events
that it purports to represen
Principles to address speci c disclosure concerns expressed by users of nancial
statements
a. Use of performance measures
b. Disclosure of accounting policie
Presentation of APMs is ok but they should meet the following criteria:
a. Displayed with equal or less prominence than the totals/subtotals required by the
Standards;
b. reconciled to the most directly comparable measures speci ed in the Standards;
c. neutral, free from error and clearly labelled so they are not misleading;
d. classi ed, measured and presented consistently over time;
e. identi ed as to whether they form part of the nancial statements and whether they have
beenaudited; and
f. accompanied by certain explanations and comparative information
Improving disclosure objectives and requirements – centralised disclosure
objectives
3 categories of accounting policies are suggested and only accounting policies in
Categories 1 and 2 must be disclosed,
(those in Category 3 may be disclosed
Category 1 - always necessary to understand the nancial statement
This is the case when the accounting policy:
a) Relates to material items, transactions or events;
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b) Is selected from alternatives in IFRSs;
c) Re ects a change from a previous period;
d) Is developed by the entity in the absence of speci c requirements; and/or
e) Requires use of signi cant judgements or assumptions.
Category 2 — not in Category 1 but necessary to understand the financial statements.
Category 3 - not in Categories 1 and 2 but is used in preparing the nancial statements.
Centralised disclosure objectives
Method A would focus on the different types of information disclosed about an entity's
assets, liabilities, equity, income and expenses
Method B would focus on information about an entity's activities
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Current Issue - Materialit
Draft IFRS Practice Statement: Application of Materiality to Financial
Statement
There were concerns with the application of the concept of materialit
Leading to too much immaterial information - meaning the important information could get
los
So, this provides non-mandatory guidance to assist with the application of the concept of
materialit
Characteristics of Materialit
De nition of Materiality
"Information is material if omitting it or misstating it could in uence decisions that the
primary users of general purpose nancial reports make on the basis of nancial
information about a speci c reporting entity.
1. The IASB concedes that judgement is needed to see if info could reasonably be
expected to in uence decisions that its primary users mak
2. To see if something is material involves assessing qualitative and quantitative factor
Presentation And Disclosure In The Financial Statement
Management should provide information that helps assess future cash & stewardship of
resources.
So different materiality assessments in different parts of the nancial statements is
possible
Financial statements should not obscure material information with immaterial information
although "IFRS does not prohibit entities from disclosing immaterial information".
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The IASB proposes three steps
1. Assess what information should be presented in the primary nancial statement
2. Assess what information should be disclosed within the note
3. Review the nancial statements as a whole
(to ensure that the nancial statements are a comprehensive document with an
appropriate overall mix and balance of information)
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Disclosure initiative — Primary Financial Statements [Research
The Primary Financial Statements project is early stage research examining possible
changes to the structure and content of the primary nancial statements
Initial research will focus on
1. The structure and content of the statement(s) of Financial Performance
with:
A de ned sub-total for operating pro t and
Alternative performance measure
2. Changes to the statement of cash ows and the SFP
This research will include feedback on a proposed discussion paper on the statement
of cash ows being prepared by the staff of the UK Financial Reporting Council; an
3. The implications of digital reporting for the structure and content of the primary
nancial statements
In the September 2017 IASB Staff Paper, the IASB included an illustrative example of the
Statement of nancial performance. Below is an example of how management
performance measure (MPM) ts into the statement(s) of nancial performance (provided
as MPM subtotal).
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Current Issue - Management Commentar
IFRS Practice Statement Management Commentar
Objectiv
To help management present a useful commentary to nancial statement
(The Practice Statement is not an IFRS, so following it is not compulsory
Scop
Management commentary.
"...provides users with historical explanations of the amounts presented in the nancial
statements
...an entity's prospects and other information not presented in the nancial statements
..a basis for understanding management's objectives and its strategies
Elements of the Commentar
• The nature of the business - including its external environmen
• Management's objectives and strategie
• The entity's most signi cant resources, risks and relationship
• The results of operations and prospect
• The critical performance measures and indicators that management uses to evaluate the
entity's performance against stated objective
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