ACC 203 CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS
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Module for
ACC203
Conceptual Framework and
Presentation of Financial Statements
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Module 1
Conceptual Framework and Presentation of Financial Statements
Week 2 - 3
Introduction
This module tackles the new Conceptual Framework for Financial Reporting and PAS 1
for the Financial Statements Presentation. This discusses the concepts that underlies the
preparation and presentation of financial statements. The Conceptual Framework sets
the concepts and objectives of the general purpose financial reporting. PAS 1 Presentation of Financial Statements discusses the specific accounting standards that
are provided by the IASB in presenting the financial statements.
Learning Objectives
After studying this module, students should be able to:
1. Understand the purpose and content of the Conceptual Framework for Financial
Reporting.
2. Acquire the knowledge and concepts about the Philippine Accounting Standards
(PAS) 1 - Presentation of Financial Statements.
Discussion:
The Conceptual Framework for Financial Reporting
The Conceptual Framework for Financial Reporting is a basic document that sets
objectives and the concepts for general purpose financial reporting. Its predecessor,
Framework for the preparation and presentation of the financial statements was issued
back in 1989. Then in 2010, IASB published the new document, Conceptual Framework
for Financial Reporting.
Content of Conceptual Framework for Financial Reporting
1. The Objective of General Purpose Financial Reporting.
2. Qualitative Characteristics of Useful Financial Information.
3. Financial Statements and the Reporting Entity.
4. The Elements of Financial Statements.
5. Recognition and Derecognition.
6. Measurement
7. Presentation and Disclosure
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8. Concepts of capital and capital maintenance.
Is the Framework equivalent to the Standard?
Let me please make one point clear: Framework is NOT a Standard itself. Thus if you
wish to decide on the financial reporting of certain transaction, you need to look into the
appropriate standard – IFRS or IAS. Sometimes, it may even happen that the rules in that
IFRS or IAS standard will be contrary to what the Framework says. In this case, you need
to apply the standard, not the Framework.
When should you apply the Framework? In most cases, when there are no specific rules
for your transaction and you need to develop your accounting policy, then you would look
to the Framework as you cannot depart from its basic principles and definitions.
The objective of general purpose financial reporting
The main objective of general purpose financial reports is to provide the financial
information about the reporting entity that is useful to existing and potential:
● Investors,
● Lenders, and
● Other creditors
to help them make various decisions (e.g. about trading with debt or equity instruments
of a reporting entity).
The objective is NOT about the financial statements itself, instead, this describes more
general purpose reports that should contain the following information about the reporting
entity:
● Economic resources and claims (this refers to the financial position);
● The changes in economic resources and claims resulting from the entity's financial
performance and from other events.
This puts an emphasis on accrual accounting to reflect the financial performance of an
entity. It means that the events should be reflected in the reports in the periods when the
effects of transactions occur, regardless of the related cash flows.
However, the information about past cash flows is very important to assess
management’s ability to generate future cash flows.
Qualitative characteristics of useful financial information
The Framework describes 2 types of characteristics for financial information to be useful:
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1. Fundamental, and
2. Enhancing.
Fundamental qualitative characteristics
● Relevance: capable of making a difference in the users’ decisions. The financial
information is relevant when it has predictive value, confirmatory value, or both.
Materiality is closely related to relevance.
● Faithful representation: The information is faithfully represented when it is
complete, neutral and free from error.
Enhancing qualitative characteristics
● Comparability: Information should be comparable between different entities or time
periods;
● Verifiability: Independent and knowledgeable observers are able to verify the
information;
● Timeliness: Information is available in time to influence the decisions of users;
● Understandability: Information shall be classified, presented clearly and concisely.
Financial Statements and the Reporting Entity
Financial Statements
The financial statements should provide the useful information about the reporting entity:
1. In the statement of financial position, by recognizing
○ Assets,
○ Liabilities,
○ Equity
2. In the statements of financial performance, by recognizing
○ Income, and
○ Expenses
3. In other statements, by presenting and disclosing information about
○ recognized and unrecognized assets, liabilities, equity, income and
expenses, their nature and associated risks;
○ Cash flows;
○ Contributions from and distributions to equity holders, and
○ Methods, assumptions, judgements used, and their changes.
Financial statements are always prepared for a specified period of time, or the reporting
period. Normally, the financial statements are prepared on the going concern assumption.
It means that an entity will continue to operate for the foreseeable future (usually 12
months after the reporting date).
Reporting Entity
Although the term “reporting entity” has been used throughout IFRS for some time, the
Framework introduced it and “made it official” only in 2018. Reporting entity is an entity
who must or chooses to prepare the financial statements. It can be:
● A single entity – for example, one company;
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● A portion of an entity – for example, a division of one company;
● More than one entity – for example, a parent and its subsidiaries reporting as a
group.
As a result, we have a few types of financial statements:
● Consolidated: a parent and subsidiaries report as a single reporting entity;
● Unconsolidated: e.g. a parent alone provides reports, or
● Combined: e.g. reporting entity comprises two or more entities not linked by
parent-subsidiary relationship.
Elements of the financial statements
This extensively deals with the definitions of individual elements of the financial
statements. There are five basic elements:
1. Asset = a present economic resource controlled by the entity as a result of past
events;
2. Liability = a present obligation of the entity to transfer an economic resource as a
result of past events;
3. Equity = the residual interest in the assets of the entity after deducting all its
liabilities;
4. Income = increases in assets or decreases in liabilities resulting in increases in
equity, other than contributions from equity holders;
5. Expenses = decreases in assets or increases in liabilities resulting in decreases in
equity, other than distributions to equity holders;
The Framework then discusses each aspect of these definitions and provides wide
guidance on how to decide what element you are dealing with.
Recognition and derecognition
Recognition Simply speaking, recognition means including an element of financial
statements in the financial statements. In other words, if you decide on recognition, you
decide on whether to show this item in the financial statements. Recognition process links
the elements in the financial statements according to the following formula: Please let me
stress here that not all items that meet the definition of one of the elements listed above
are recognized in the financial statements.
The Framework requires recognizing the elements only when the recognition provides
useful information – relevant with faithful representation. Then, the Framework discusses
the relevance, faithful representation, cost constraints and other aspects in a detail.
Derecognition. it means removal of an asset or liability from the statement of financial
position and normally it happens when the item no longer meets the definition of an asset
or a liability. Again, the Framework discusses the derecognition in a greater detail.
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Measurement
Measurement means in what amount to recognize asset, liability, piece of equity, income
or expense in your financial statements. Thus, you need to select the measurement basis,
or the method of quantifying monetary amounts for elements in the financial statements.
The Framework discusses two basic measurement basis:
1. Historical cost – this measurement is based on the transaction price at the time of
recognition of the element;
2. Current value – it measures the element updated to reflect the conditions at the
measurement date. Here, several methods are included:
○ Fair value;
○ Value in use;
○ Current cost.
Each of these measurement bases is discussed in a greater detail. The Framework then
gives guidance on how to select the appropriate measurement basis and what factors to
consid (especially relevance and faithful representation). What I personally find really
useful is the guidance on measurement of equity. The issue here is that the equity is
defined as “residual after deducting liabilities from assets” and therefore total carrying
amount of equity is not measured directly. Instead, it is measured exactly by the formula:
● Total carrying amount of all assets, less
● Total carrying amount of all liabilities.
The Framework points out that it can be appropriate to measure some components of
equity directly (e.g. share capital), but it is not possible to measure total equity directly.
Presentation and disclosure
The main aim of presentation and disclosures is to provide an effective communication
tool in the financial statements.
Effective communication of information in the financial statements requires:
● Focus on objectives and principles of presentation and disclosure, not on the
rules;
● Group similar items and separate dissimilar items;
● Aggregate information, but do not provide unnecessary detail or the opposite –
excessive aggregation to obscure the information.
The Framework discusses classification of assets, liabilities, equity, income and
expenses in greater detail with describing offsetting, aggregation, distinguishing between
profit or loss and other comprehensive income and other related areas.
Concepts of capital and capital maintenance
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The Framework explains two concepts of capital:
1. Financial capital – this is synonymous with the net assets or equity of the entity.
Under the financial maintenance concept, the profit is earned only when the
amount of net assets at the end of the period is greater than the amount of net
assets in the beginning, after excluding contributions from and distributions to
equity holders.
The financial capital maintenance can be measured either in
a. Nominal monetary units, or
b. Units of constant purchasing power.
2. Physical capital – this is the productive capacity of the entity based on, for
example, units of output per day.
Here the profit is earned if physical productive capacity increases during the
period, after excluding the movements with equity holders.
The main difference between these concepts is how the entity treats the effects of
changes in prices in assets and liabilities.
PAS 1: Presentation of Financial Statements
Statement of Financial Position
1. Statement of Profit or Loss and Other Comprehensive Income
2. Statement of Changes in Equity
3. Statement of Cash Flow
4. Notes to the Financial Statement
Terms to Remember:
1. Financial Statements are written records that convey the business activities and
the financial performance of a company.
2. General Purpose Financial Statements are those intended to meet the needs of
users who are not in a position to require an entity to prepare reports tailored to
their particular information needs.
3. Objective of Financial Statements is to provide information about the financial
position, financial performance and cash flows of an entity that is useful to a wide
range of users in making economic decisions.
4. Frequency of Reporting states that financial statements shall be presented at least
annually.
5. Judgement is used to determine the best method of presenting information.
6. Statement of Financial Position is a formal statement showing the three elements
comprising financial position, namely assets, liabilities and equity. It is used to
evaluate such factors as liquidity, solvency and the need of the entity for additional
financing.
Asset
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-
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
benefits.
Classification of assets
Current Assets
1. Cash and cash equivalents
2. Financial assets at fair value such as trading securities and other investment in
quoted equity instruments
3. Trade and other receivables
4. Inventories
5. Prepaid expense
Non-Current Assets
1. Property, plant and equipment
2. Long-term investments
3. Intangible assets
4. Deferred tax assets
5. Other non-current assets
Liabilities
- are present obligations of the entity to transfer an economic resource as a result
of past events. An obligation is a duty of responsibility that the entity has no
practical ability to avoid.
Classification of liabilities
Current Liabilities
1. Trade and other payables
2. Current provisions
3. Short-term borrowing
4. Current portion of long-term debt
5. Current tax liability
Non-current Liabilities
1. Non-current portion of long-term debt
2. Finance lease liability
3. Deferred tax liability
4. Long-term obligations to company officers
5. Long-term deferred revenue
Currently maturing long-term debt
The original term was for a period longer than twelve months.
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An agreement to refinance or to reschedule payment on a long-term basis is completed
after the reporting period and before the financial statement are authorized for issue.
Discretion to refinance
- Or roll over an obligation for at least twelve months after the reporting period under
an existing loan facility, the obligation is classified as noncurrent.
Covenants
- is often attached to borrowing agreements which represent undertakings by the
borrower.
- Actual restriction on the borrower.
Effect of breach of covenant
IAS 1, paragraph 74: The liability is classified as current even if the lender has agreed,
after the reporting period and before the statements are authorized for issue, not to
demand payment as a consequence of the breach.
Equity
is the residual interest in the assets of the enterprise after deducting all its liabilities.
IAS 1, paragraph 7: The holders of instruments classified as equity are simply known as
owner. Shareholders’ equity is the residual interest of owners in the assets of a
corporation measured by the excess of assets over liabilities.
The Statement of Profit or Loss and Other Comprehensive Income
Profit or Loss
1. Revenue
2. Finance cost
3. Share of profits and losses of associates and joint ventures accounted for using
the equity method
4. A single amount for the total of discontinued operation
5. Tax expense
Other Comprehensive Income
1. Unrealized gain/loss on equity investment measured at fair value through OCI
2. Unrealized gain/loss on debt investment measure at fair value through OCI
3. Gain/Loss from translation of the financial statements of a foreign operation
4. Revaluation surplus during the year
5. Unrealized gain/loss from derivative contracts designated as cash flow hedge
6. “Remeasurements” of defined benefit plan, including actuarial gain/loss
7. Change in fair value attributable to credit risk of a financial liability designated at
fair value through profit/loss
Statement of Changes in Equity
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Comprehensive income for the period
1. The effects of changes in accounting policies and corrections of error
2. A reconciliation between carrying amount at the beginning and end of the period
Notes to the Financial Statement
Present information about the basis on which the financial statements were prepared and
which specific accounting policies were chosen and applied to significant transaction
1. Disclose any information which is required by IFRSs
2. Show any additional information that is relevant to understanding which is not
shown elsewhere in the financial statement
Assessments
Answer the following requirements:
1. Describe the Conceptual Framework for Financial Reporting
2. Enumerate the Objectives of a general purpose financial reporting?
3. Identify the Qualitative characteristics of a useful financial statement,
4. Find the relationship between financial statements and reporting entity
5. Enumerate the elements of financial statements.
6. Explain the concept of recognition, derecognition and measurement
7. Explain the presentation of financial
8. Explain the concept of capital and capital maintenance.
9. Enumerate the complete set of financial statements.
10. Define the elements of financial statements.
11. Explain the classification of assets and liabilities/
12. Identify the content of statement of comprehensive income
13. Explain the importance of notes to financial statements.
References
APA style
Source:
Peralta, Jose F., Valix, Christian Aris M., Valix, Conrado T. (2017), Financial
Accounting Volume Two. Manila, Philippines. GIC Enterprises & Co.,Inc.
Asuncion, Darrell Joe O. CPA,MBA, Escala, Raymund Francis A. CPA, MBA, Ngina,
Mark Alyson B. CPA, MBA (2018), Applied Auditing Book 2 of 2. Aurora Hill,
Baguio City. Real Excellence Publishing and Nation’s Foremost CPA Review Inc.
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Silvia.M.,2019.https://www.ifrsbox.com/ifrs-conceptual-framework2018/#:~:text=The%20Conceptual%20Framework%20for%20the,was%20issued%20ba
ck%20in%201989.
IFRS Community (2018). Retrieved From:
https://ifrscommunity.com/knowledge-base/ifrs-16-recognition-and-measurement-of-l
eases/#link-subsequent-measurement-of-the-lease-liability
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Module 2
Reporting Financial Performance and Statement of Cash Flows
Week 4 - 5
Introduction
This module discusses the events that affect the reporting of financial performance and
the presentation of Statement of cash flows. In reporting the financial performance, the
accountant must consider the following events: change in accounting policies; change in
accounting estimates, and prior period error, and analyse the effects of the
aforementioned events on the financial statements. The presentation of the Statement of
Cash flow, on the other hand, includes the identification and analysis of the operating
activities, investing activities and financing activities.
Learning Objectives
After studying this module, students should be able to:
1. Understand the events that affects the reporting of financial performance and its
required adjustments
2. Apply the concept on presenting the Statement of Cash Flows.
Concept to Review
1. Accounting Policies - The specific principles, bases, conventions, rules, and
practices adopted by an entity in preparing and presenting financial statements.
2. Change in Accounting Estimate. An adjustment of the carrying amount of an
asset or a liability or the amount of the periodic consumption of an asset.
3. Material . Omissions or misstatements of items are material if they could
influence the economic decision that users make on the basis of the financial
statements.
4. Prior Period Errors. Are omissions from, and misstatements in, the entity’s
financial statement for one or more prior periods arising from a failure to use, or
misuse of, reliable information
5. Retrospective Application . Applying a new accounting policy to transactions,
other events and conditions as if that policy had always been applie d.
6. Retrospective Restatement . Correcting the recognition, measurement, and
disclosure of amounts of elements of financial statements as if a prior period
error had never occurred.
7. Prospective Application . Application of a change in accounting policy and
recognizing the effect of a change in an accounting estimate. Impracticable . It is
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impracticable when an entity cannot apply a requirement after making every
reasonable effort to do so.
Accounting policies are determined by applying the relevant IFRS and considering any
relevant implementation Guidance issued by the IASB for that IFRS. When there is no
applicable IFRS or interpretation, management should use its judgment in developing
and applying an accounting policy that results in information that is relevant and reliable.
An entity must select and apply its accounting policies for a period consistently for
similar transactions, other events and conditions. The same accounting policies are
usually adopted from period to period, to allow users to analyze trends over time in
profit, cash flows, and financial position.
When can changes be applied?
The change is required by an IFRS; the change will result in a more appropriate
presentation of events or transactions in the financial statements of the entity.
The standard highlights two types of event w/c do not constitute changes:
1. Adopting an accounting policy for a new type of transaction or event not dealt
with previously by the entity,
2. Adopting a new accounting policy for a transaction or event which has not
occurred in the past or which was not material.
In the case of tangible noncurrent assets, a policy of a revaluation adopted for the first
time is not treated as a change in policy under IAS 8, but as a revaluation under IAS 16
Property. Plant, and Equipment.
Where a new IFRS is adopted, resulting in a change of accounting policy, IAS 8 requires
any transitional provisions in the new IFRS itself to be followed. If none are given,
provisions of IAS 8 shall be followed.
1. Reasons for the change/nature of change
2. Reasons why new policy provides more relevant/reliable information
3. Amount of the adjustment for the current period and for each period presented
4. Amount of the adjustment relating to periods prior to those included in the
comparative information
5. The fact that comparative information has been restated or that it is impracticable
to do so.
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6. Estimates arise in relation to business activities because of the uncertainties
inherent within them. Examples are: debt allowance, useful lives of depreciable
assets, and obsolescence of inventory.
The rule here is that the effect of a change in an accounting estimate should be included
in the determination of net proper or loss in one of:
1. The period of the change, if the change affects that period only
2. The period of the change and the future periods, if the
change affects both
Prior Period Errors
Nature of the prior period error:
For each prior period, to the extent practicable, the amount of the correction. The amount
of the correction at the beginning of the earliest prior period presente. If retrospective
restatement is impracticable for a particular prior period, the circumstances that led to the
existence of that condition and a description of how and from when the error has been
corrected. Subsequent periods need not repeat these disclosures.
IFRS 5: Non-current Asset held for Sale
IFRS 5 requires assets "held for sale" to be recognized separately in the statement of
financial position. It sets out the criteria for recognizing a discontinued operation.
Noncurrent Asset is an asset that does not meet the definition of a current asset.
Noncurrent Asset Held for Sale - IFRS 5, paragraph 6, provides that a noncurrent asset
or disposal group is classified as held for sale if the carrying amount will be recovered
principally through a sale transaction rather than through continuing use.
Conditions for classification as held for sale.
1. The asset or disposal group is available for immediate sale in the present con
ditio/n.
2. The sale must be highly probable.
PAS 7: Statement of Cash Flows
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Is a component of financial statements summarizing the operating, investing and
financing activities of an entity? The primary purpose of a statement of cash flows is to
provide relevant information about cash receipts and cash payment of an entity during a
period. An entity shall prepare a statement of cash flows and present it as an integral part
of the financial statements for each period for which financial statements are presented.
Benefits of Cash Flow Information
Users can gain further appreciation of the change in net assets, of the entity’s financial
position (liquidity and solvency) and the entity’s ability to adapt to changing circumstances
by affecting the amount and timing of cash flows. Statements of cash flows enhance
comparability as they are not affected by differing accounting policies used for the same
type of transaction.
The statement of cash flows is designed to provide information about the change in an
entity's cash and cash equivalents. Cash compromises cash on hand and demand
deposit
Cash Equivalents are short-term highly liquid investments that are readily convertible to
known amounts of cash and which are subject to an insignificant risk of change in value.
According to IAS 7, paragraph 7: An investment normally qualifies as a cash equivalent
only when it has a short maturity of three months or less from date of acquisition. In other
words, the investment must be acquired three months or less before the date of maturity.
Examples of Cash Equivalents
1. Three-month BSP treasury bill
2. Three-year BSP treasury bill purchased three months before date of maturity
3. Three-month money market instrument or commercial paper
4. Three-month time deposit
Indirect Method versus Direct Method
The direct method is encouraged where the necessary information is not too costly to
obtain, but IAS 7 does not require it. In practice the indirect method is more commonly
used, since it is quicker and easier
There are different ways in which the information about gross cash receipts and payments
can be obtained:
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1. Using the Direct Method. This is the most obvious way because it is obtained by
simply extracting information from the accounting records, which may be a
laborious task.
2. Using the Indirect Method. This method is undoubtedly easier from the point of
view of the preparer of the statement of cash flows. The net profit or loss for the
period is adjusted for:
Changes during the period in inventories, operating receivables and payables Non-cash
items, e.g. depreciation, provisions, profits/losses on the sales of assets Other items, the
cash flows from which should be classified under investing or financing activities
Cash flow from Investing Activities
Cash flow from investing activities is one of the sections on the cash flow statement that
reports how much cash has been generated or spent from various investment related
activities in a specific period. Investing activities include purchases of physical assets,
investments in securities, or the sale of securities or assets. Negative cash flow is often
indicative of a company's poor performance. However, negative cash flow from investing
activities might be due to significant amounts of cash being invested in the long term
health of the company, such as research and development. Cash flows from investing
activities provide an account of cash used in the purchase of non current assets or long
term assets that will deliver value in the future. Investing activity is an important aspect of
growth and capital.
A change to property, plant, and equipment (PPE), a large line item on the balance sheet,
is considered an investing activity. When investors and analysts want to know how much
a company spends on PPE, they can look for the sources and uses of funds in the
investing section of the cash flow statement. Capital expenditures (CapEx), also found in
this section, is a popular measure of capital investment used in the valuation of stocks.
An increase in capital expenditures means the company is investing in future operations.
However, capital expenditures are a reduction in cash flow. Typically, companies with a
significant amount of capital expenditures are in a state of growth.
Below are a few examples of cash flows from investing activities along with whether the
items generate negative or positive cash flow.
1. Purchase of fixed assets–cash flow negative
2. Purchase of investments such as stocks or securities–cash flow negative
3. Lending money–cash flow negative
4. Sale of fixed assets–cash flow positive
5. Sale of investment securities–cash flow positive
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6. Collection of loans and insurance proceeds–cash flow positive
Cash flow from Financing Activities
Financing Activities are the activities that result in change in size and composition of the
equity capital and borrowings of the entity. Include from the transaction involving nontrade liabilities and equity of the entity.
Financing Activities are the cash flow that result from the transactions:
1. Between the entity and the owners equity financing
2. Between the entity and the creditors debt financing
Cash flow from financing activities in IAS 7, paragraph 43, provides that investing and
financing transactions that do not require use of cash or cash equivalents shall be
excluded from the statement of cash flows. Such transactions shall be disclosed
elsewhere in the financial statement either in the notes to the financial statement or in a
separate schedule or in a way that provides information about the transactions.
The following noncash transactions are disclosed separately:
1. Acquisition of asset by assuming directly related liability
2. Acquisition of asset by issuing share capital
3. Acquisition of asset by issuing bonds payable
4. Conversion of bonds payable into share capital
5. Conversion of preference share into ordinary shares
Interest
In IAS 7, paragraph 33, provides that Interest paid and interest received shall be classified
as operating cash flows because they enter into the determination of net income or loss.
Alternatively, interest paid may be classified as financing cash flow because it is a cost of
obtaining financial resources. Alternatively, interest received may be classified as
investing cash flow because it is return on investment. For a financial institution, interest
paid and interest received are usually classified as operating cash flows.
Dividends
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IAS 7, paragraph 33, provides that dividends received shall be classified as operating
cash flow because it enters into the determination of net income. Alternatively, dividend
received may be classified as investing cash flow because it is a return on investment.
IAS 7, paragraph 34 , provides that dividends paid shall be classified as financing cash
flow because it is the cost of obtaining financial resources. Alternatively, dividend paid
may be classified as operating cash flow in order to assist users to determine the ability
of the entity to pay dividends out of operating cash flows
Income Taxes
IAS 7, paragraph 35, provides that cash flow arising from income taxes shall be separately
disclosed as a cash flows from operating activities unless they can be specifically
identified with investing and financing activities.
Example of Cash Flows from Financing Activities
Inflow:
1. Cash receipt from issuance of ordinary and preference shares
2. Cash receipt from issuing debentures, loans notes, bonds, mortgages, and other
short or long-term borrowings
Outflow:
1. Cash payments for amounts borrowed
2. Cash payment by a lease for the reduction of the outstanding principal lease
liability.
3. Cash payment for dividends to shareholders
4. Cash payments to acquire treasury shares
Assessments
Exercises:
1. Explain change in accounting policies, change in accounting estimates and prior
periods. Cite examples for each.
2. Discuss the required adjustments and disclosures for change in accounting
policies, change in accounting estimates and prior period error, respectively.
3. Expound on how to account for a non-current asset held for sale.
4. Explain the presentation of the statement of cash flows.
5. Expound the difference between cash and cash equivalents.
6. Give examples of the operating activities, investing activities and financing
activities presented in the statement of cash flows.
7. Differentiate between indirect and direct of presentation the net cash flows from
operating activities.
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8. Discuss the presentation of interest, dividends and income taxes on the
statement of cash flows.
References
Peralta, Jose F., Valix, Christian Aris M., Valix, Conrado T. (2017), Financial
Accounting Volume Two. Manila, Philippines. GIC Enterprises & Co.,Inc.
Asuncion, Darrell Joe O. CPA,MBA, Escala, Raymund Francis A. CPA, MBA, Ngina,
Mark Alyson B. CPA, MBA (2018), Applied Auditing Book 2 of 2. Aurora Hill,
Baguio City. Real Excellence Publishing and Nation’s Foremost CPA Review Inc.
Silvia.M.,2019.https://www.ifrsbox.com/ifrs-conceptual-framework2018/#:~:text=The%20Conceptual%20Framework%20for%20the,was%20issued%20ba
ck%20in%201989.
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Module 3
Revenues from Contracts with Customers and Government Grants
Week 6
Introduction
This module discusses the accounting for Revenues from Contract with Customers and
for Government Grants. It sets out rules for the recognition of revenue based on the
transfer of control to the customers from the entity. This also tackles the step by step
process on accounting for revenues from contracts with customers and the identification
of the point of time in which revenues must be recognized. Additionally, this discusses
the recognition of government grants and disclosure for government assistance.
Learning Objectives
After studying this module, students should be able to:
1. Understand the recognition of revenues based on the transfer of control to the
customer from the entity.
2. Demonstrate the process on how to account for the revenues from contracts with
customers.
3. Identify the different points of time in the recognition of revenues.
4. Explain the recognition of government grants and disclosure for government
assistance.
Revenues from Contracts with Customers
Core Principle
1. Entity should recognize revenue in a manner that depicts the pattern of transfer of
goods or services to a customer.
2. Amount recognized as revenue should reflect the consideration to which the entity
expects to be entitled in exchange for good or service.
Things to remember:
1. Income - increases in economic benefits during the accounting period in the form
of inflows or enhancements of assets or decreases of liabilities that result in an
increase in equity, other than those relating to contributions from equity
instruments.
2. Revenue - income arising from course of entity's ordinary activities
3. Contract - agreement between two or more parties that creates enforceable rights
and obligations
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3. Contract Asset - entity's right to payment for goods and services that entity has
transferred to a customer if that right is conditioned on something other than the
passage of time.
4. Receivable - entity's right to consideration that is unconditional
5. Contract Liability - entity's obligation t o transfer goods and services to a customer
for which the entity has received consideration
6. Customer - party that has contracted with an entity to obtain goods or services that
are an output of the entity's ordinary activities in exchange for consideration
7. Performance obligation promise in a contract with a customer to deliver either:
a. good or service that is distinct; or
b. series of distinct goods or services that are substantially the same and that
have the same pattern of transfer to the customer
8. Stand alone Selling Price price at which an entity would sell a promised good or
service separately to a customer
9. Transaction Price amount of consideration to which entity expects to be entitled in
exchange for transferring promised goods or services to a customer
Five-Step Model
Step 1. Identify the contract with the customer.
Contract Criteria:
1. Approval of contract in writing, orally or in accordance with customary business
practice
2. Identification of rights and obligations of the parties and payment terms.
3. Contract has commercial substance and the collection of consideration is probable
Contract Criteria (Exception to Separate Contracts):
1. If the contracts are treated as a single package.
2. Consideration in one contract depends upon the good or service of another
contract.
3. Goods or services in the contract relate to a single performance obligation.
Step 2. Identify the performance obligation in the contract.
Distinct Good or Service Criteria:
1. The customer can benefit from the good or service.
2. The entity 's promise to transfer the good or service to the customer is separately
identifiable from other promises in the contract.
Distinct Good or Service:
1. Sale of finished goods produced by a manufacturer
2. Sale of merchandise inventory by a retailer
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3. Constructing, manufacturing or developing assets on behalf of customers, as in
long term construction contracts.
4. Granting license or franchise.
5. Performing a contractually agreed upon task for a customer, as in bookkeeping
service or payroll processing service.
Step 3. Determine the transaction price
Factors that Affect Transaction Price:
1. Variable consideration
2. Time value of money
3. Non-cash Consideration
4. Consideration payable to a customer
Step 4. Allocate the transaction price to the performance obligations in the
contract.
If not directly observable, it must be estimated using these Methods:
1. Adjusted Market Assessment Approach
2. Expected Cost Plus Margin Approach
3. Residual Approach
Step 5. Recognize revenue when or as the entity satisfies a performance obligation.
1. Revenue shall be recognized when an entity transfers control of the good or
service to a customer.
2. Control of an Asset is the ability to direct the use of the asset and obtain
substantially all of the benefits from the asset.
3. Revenue can be recognized either at point in time or over time.
Revenue Recognition at point of time
1. The entity has the right to receive payment for the asset and for which the customer
is obliged to pay.
2. The customer has legal title to the asset.
3. The entity ha s transferred physical possession of the asset to customers.
4. The customer has significant risks and rewards of ownership of the asset.
5. The customer has accepted the asset.
Revenue Recognition over time
1. Customer simultaneously receives and consumes the benefits provided by the
entity's performance as the entity performs.
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2. Entity's performance creates or enhances an asset that customer controls as the
asset is created or enhanced.
3. Entity's performance does not create an asset with alternative use to the entity and
the entity has the enforceable right to receive the payment for performance
completed to date.
Performance Obligation Satisfied Over Time
This meets the criteria in Step 5 and, if it entered into more than one accounting period,
would previously have been described as a long term contract; depending when a
performance obligation is fulfilled in a contract. Revenue is recognized "over time" when
an any of the following is satisfied:
1. The customer "simultaneously" receives and consumes the benefits provided by
the entity’s performance as the entity performs.
This criteria, according to the Financial Accounting Standards Board (FASB), is
mainly for services that are consumed by customers continuously over a period of
time. However, many service providers may have difficulty in determining whether
or not their customers consume benefits as they perform each obligation; this is
due to the subjectivity in determining what the “benefits” are. To address this issue,
the new standard requires the service provider to assess, in a hypothetical
situation, if another provider would need to substantially re perform the work
completed to date. If another provider does not need to substantially re perform
the work done, then the original service provider should establish that control is
transferred over time; consequently, the customer is assumed to receive and
consume the benefit as the service provider performs an obligation.
2. The entity’s performance "creates or enhances an asset" (for example, work in
process) that the customer controls as the asset is created or enhanced.
3. The entity’s performance does not create an asset with an alternative use to the
entity, and the "entity has an enforceable right to payment for performance
completed to date."
Alternative Use. To assess if an asset has an alternative use, the entity should consider
practical limitations as well as contractual restrictions. This assessment should be made
at the inception of the contract; nevertheless, should a modification in the contract arise
at a future date and that modification substantially changes the performance obligation in
the contract, then the entity should make a subsequent assessment.
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Practical Limitations . In considering practical limitations of directing an as set to another
use, the entity should consider whether the asset is designed and produced to fit unique
specifications of the customer. This could be determined by evaluating whether or not (a)
the entity would incur a significant cost to rework the asset for a different purpose or (b)
the entity would only be able to sell the asset at a significant loss. Moreover, an entity
should complete this evaluation based on the asset’s expected final form, not the asset’s
form while in production.
Contractual Restrictions . Practical limitations may not always be a viable method to
prove that an asset has no alternative use; hence, contractual restrictions may be more
relevant than practical limitations (e.g. some real estate contracts). Criterion 3 requires
the contractual restrictions be substantive. It means that an asset must not be
fundamentally interchangeable with other assets that the vendor owns; additionally, the
vendor should not be able to transfer that asset to another customer without incurring
significant loss or breaching the contract with the customer.
Right to Payment. ASC 606 10 25 29 states that the seller should assess whether it is
entitled to payment from the customer for its performance to date if the contract is
terminated. Since the seller is creating an asset that has no alternative use to the seller,
the seller is creating the asset on behalf of the customer. Therefore, the seller’s right to
payment indicates that the customer is receiving benefit
from the seller’s performance, hence control is transferred to
the customer.
Performance Obligations Satisfied at a Point in Time. This will be the point in time at
which the customer obtains control of the promised asset and the entity satisfies a
performance obligation.
The following factors would indicate revenue recognition of a point in time:
1. The entity has the "right to receive payment" for the asset and for which the
customer is obliged to pay. This exist only if goods or services have been delivered
to the point that the entity has the right to ask for the payment.
2. The customer has a "legal title" to the asset. If the asset is already under the name
of the customer, if not, for example is the long term rent called, lease.
3. The entity has "transferred physical possession" of the asset to the customer. It
inferred to other arrangements or contractual stipulations (e.g., consignment
4. The customer has the "significant risks and rewards" of ownership of the asset.
This requires judgment, for example, an entity sold goods to a customer and it
(entity) has the responsibility to deliver it, thus, it still has control of the goods.
However, the entity still need to determine the risks to the ownership of the asset
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that can separate performance obligation (e.g., maintenance services for
products), and the risks should not have an impact on the transfer of control.
5. The customer "has accepted the asset”
Common Types of Transaction
1. Warranties. If a customer has the option to purchase a warranty separately from
the product to which it relates, it constitutes a distinct service and is accounted for
as a separate performance obligation. This would apply to a warranty which
provides the customer with a service in addition to the assurance that the product
complies within agreed upon specifications. If the customer does not have the
option to purchase the warranty separately, for instance if the warranty is required
by law, that does not give rise to a performance obligation and the warranty is
accounted for in accordance with IAS 3 7.
2. Principal Versus Agent. An entity must establish in any transaction whether it is
acting as a principal or agent.
a. Principal. It is a principal if it controls the promised good or service before it
is transferred to the customer.
b. Agent. It is acting as agent if its performance obligation is to arrange for the
provision of goods and services by another party.
3. Repurchase Agreements. An entity sells an asset and promises, or has the
option to repurchase it. Repurchase agreements generally come in three forms:
a. An entity has an obligation to repurchase the asset (a forward contract).
b. An entity has the right to repurchase the asset (a call option)
c. An entity must repurchase the asset if requested to do so by the customer
(a put option).
4. Consignment Arrangement: Consignment . It is a method of marketing goods
in which the entity called "consignor" transfers physical possession of certain
goods to a dealer or distributor called the "consignee" that sells the goods on behalf
of the consignor. The consignor shall not recognize revenue upon delivery of the
goods to the consignee until the goods are sold by the consignee
REASON: The product is controlled by the consignor and the consignee does not have
an unconditional obligation to pay for the product. When consigned goods are sold by the
consignee, a report called "account sales" is given to the consignor together with a cash
remittance for the amount of sales minus commission and other expenses chargeable
against the consignor.
5. Bill and Hold Arrangement. A contract under which an entity bills a customer for
a product but the entity retains the possession of the product. For example, a
customer may request an entity to enter such a contract because of space for the
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product or because of delays in the customer's production schedule. Depending
on the terms of the contract, revenue shall be recognized "when the customer
obtains control or takes title of the product" even though the product remains in an
entity's physical possession.
All of the following criteria must be met for the recognition of revenue in a bill and
hold arrangement:
a. The customer requested for the arrangement.
b. The product must be "identified separately as belonging to the customer."
c. The product "must be ready for physical transfer to the customer anytime."
d. The entity cannot have the ability to use the product or to direct it to another
customer.
IAS 20 - GOVERNMENT GRANTS AND DISCLOSURE OF GOVERNMENT
ASSISTANCE
The treatment of government grants is covered by IAS 20 Accounting for Government
Grants and Disclosure of Government Assistance. IAS 20 does not cover:
1. Accounting on government grants in financial statements reflecting the effects of
changing prices
2. Government assistance given in the form of ‘tax breaks’
3. Government acting as part-owner of the entity
4. Grants covered by IAS 41 Agriculture
Terms to Remember:
Government. Government, government agencies
and similar bodies whether local, national or
international.
Government Assistance. Action by government designed to provide economic benefit
specific to an entity or range of entities qualifying under certain criteria.
Government Grants. Assistance in government in form of transfers of resources to an
entity in return for past or future compliance with certain conditions relating to the
operating activities of the entity. An entity should not recognize government grants until it
has reasonable assurance that:
1. The entity will comply with any conditions attached to the grant.
2. The entity will actually receive the grant.
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Non monetary Government Grants. A non monetary asset may be transferred by
government to an entity as grant, for example, piece of land, or other resources.
Grants Related to Assets . Government grants whose primary condition is that an entity
qualifying for them should purchase, construct or otherwise acquire non-current assets.
Presentation of Grants Related to Assets
There are two choices for how government grants related to assets should be shown in
the statement of financial position:
1. Set up grants as deferred income.
2. Deduct the grant in arriving at the carrying amount of an asset.
Presentation of Grants Related to Income
Choice in method of disclosure:
1. Present as a separate credit or under a general heading.
2. Deduct from the related expense.
Repayment of Government Grants
1. Repayment of Grant related to income: Apply first against any unamortized
deferred income set up in respect of the grant. Repayment of Grant related to
asset: Increase the carrying amount of the asset or reduce the deferred income
balance by the amount repayable.
Government Assistance
1. Some forms of government assistance cannot reasonably have a value placed on
them.
2. There are transactions with the government which cannot be distinguished from
the entity’s normal trading transactions.
Disclosure required of the following:
1. Accounting policy adopted, including method of presentation.
2. Nature and extent of government grants recognized and other forms of assistance
received.
3. Unfulfilled conditions and other contingencies attached to recognize government
assistance.
SIC 10 - GOVERNMENT ASSISTANCE
No Specific Relation to Operating Activities.
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-
Examples of such assistance are transfers of resources by governments to entities
which:
1. Operate in a particular industry
2. Continue operating in recently privatized Industries
3. Start or continue to run their business in underdeveloped areas.
Government assistance to entities meets the definition of government grants in IAS 20,
even if there are no conditions specifically relating to the operating activities of the entity
other than the requirement to operate.
Assessments
Tasks:
1. Differentiate between Income and Revenue.
2. Discuss on how to identify contracts with customers and the performance
obligation in a contract.
3. Illustrate the transaction price in the contract with customers
4. Explain the recognition of revenue from contracts with customers.
5. Expound the difference between the revenue recognition at point of time and
revenue recognition over time.
6. Identify the examples of common transactions with contracts with customers.
7. Discuss the accounting for government grants and disclosures for government
assistance.
References
Peralta, Jose F., Valix, Christian Aris M., Valix, Conrado T. (2017), Financial
Accounting Volume Two. Manila, Philippines. GIC Enterprises & Co.,Inc.
Asuncion, Darrell Joe O. CPA,MBA, Escala, Raymund Francis A. CPA, MBA, Ngina,
Mark Alyson B. CPA, MBA (2018), Applied Auditing Book 2 of 2. Aurora Hill,
Baguio City. Real Excellence Publishing and Nation’s Foremost CPA Review Inc.
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Module 4
Inventories and Agriculture
Week 7
Introduction
This module discusses the concept of recognition and measurement of inventories and
those items related to agriculture, e.g. biological assets and agricultural produce. This
tackles the different costs associated with inventories, the techniques in measuring the
cost of inventories, the accounting for inventory write down, and recognition and
measurement of biological assets and agricultural produce.
Learning Objectives
After studying this module, students should be able to:
1. Understand the concept of recognition and measurement of inventories and
accounting for the cost of inventories.
2. Explain the standards that govern with the accounting for biological assets and
agricultural produce.
Inventories
Inventories (PAS 2) are assets:
1. held for sale in the ordinary course of business'
2. in the process of production for such sale
3. in the form of materials or supplies to be consumed in the production process or in
the rendering of services
Net Realizable Value
is the estimated selling price in the ordinary course of business less the estimated
costs of completion and the estimated costs necessary to make the sale.
Fair Value
is the price that would be received to sell an asset or pa id to transfer a liability in
an orderly transaction between market participants at the measurement date.
Inventories can include any of the following:
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1. Goods purchased and held for resale, (e.g. goods held for sale by a retailer, or
land) and buildings held for resale
2. Finished goods produced
3. Work in progress being produced
4. Materials and supplies awaiting use in the production process (raw materials)
Measurement of Inventories
The standard states that “Inventories should be measured at the lower of cost and net
realizable value”.
Cost of Inventories:
1. Cost of Purchase
2. Costs of conversion
3. Other costs incurred in bringing the inventories to their present location and
condition
Cost of Purchase
The standard lists the following as comprising the costs of purchase of inventories:
1. Purchase price plus
2. Import duties and other taxes plus transport, handling and any other cost directly
attributable to the acquisition of finished goods, services and materials less trade
discounts, rebates, and other similar amounts
Costs of Conversion
Costs of conversion of inventories consist of two main parts:
1. Costs directly related to the units of production
2. Fixed and variable production overheads that are incurred in converting materials
into finished goods, allocated on a systematic basis.
Fixed production overheads are those indirect costs of production that remain relatively
constant regardless of the volume of production, (e.g. the cost of factory management
and administration)
Variable production overheads are those indirect costs of production that vary directly, or
nearly directly, with the volume of production. (e.g. indirect materials and labor)
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The standard emphasizes that fixed production overheads must be allocated to items of
inventory on the basis of the normal capacity of the production facilities.
Important Points:
1. Normal capacity is the expected achievable production based on the average over
several periods/seasons, under normal circumstances.
2. The above figure should take account of the capacity lost through planned
maintenance.
3. If it approximates to the normal level of activity, then the actual level of production
can be used.
4. Low production or idle plants will not result in a higher fixed overhead allocation to
each unit.
5. Unallocated overheads must be recognized as an expense in the period in which
they were incurred.
6. When production is abnormally high, the fixed production overhead allocated to
each unit will be reduced, so avoiding inventories being stated at more than cost.
7. The allocation of variable production overheads to each unit is based on the actual
use of production facilities.
Other Costs
The standard lists types of cost which would not be included in cost of inventories.
Instead, they should be recognized as an expense in the period they are incurred.
1. Abnormal amounts of wasted materials, labor or other production costs.
2. Storage costs (except costs which are necessary in the production process before
a further production stage.)
3. Administrative overheads not incurred to bring inventories to their location and
condition
4. Selling Costs
Techniques for the Measurement of Costs
Standard costs - are set up to take account of normal production values: Amount of raw
materials used, labor time etc. They are reviewed and revised on a regular basis.
Retail method: this is often used in the retail industry where there is a large turnover of
inventory items, which nevertheless have similar profit margins. The only practical method
of inventory valuation may be to take the total selling price of inventories and deduct an
overall average profit margin, thus reducing the value to an approximation of cost. The
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percentage will take account of reduced price lines. Sometimes different percentages are
applied on a department basis.
Cost Formula
There are different methods in determining the cost of inventories, these are the following:
1. First-In – First-Out Method
2. Last-In – First-Out Method
3. Weighted Average Method
4. Specific Identification
First-In-First-Out Method
Assumes that “the goods first purchased are first sold”. The inventory is thus expressed
in terms of recent or new prices while the cost of goods sold is representative of earlier
or old prices.
Last-In – First-Out Method
The standard does not permit anymore the use of LIFO method. Assumes that “the goods
last purchased are first sold.” The inventory is thus expressed in terms of earlier or old
prices and the cost of goods sold is representative of earlier or old prices.
Weighted Average Method
Cost of the beginning inventory plus the total cost of purchases during the period is
divided by the total units produced plus those in the beginning inventory to get the
weighted average unit cost.
Specific Identification
Cost of inventories should be assigned by specific identification of their individual cost for
items that are not ordinarily interchangeable and goods or services produced and
segregated for a specific project
Net Realizable Value (NRV)
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The estimated selling price in the ordinary course of business less the estimated cost of
completion and the estimated cost of disposal - as a general rule, assets should not be
carried at amounts greater than those expected to be realized from their sale or use.
Situations in which NRV is likely to be less than cost, i.e. when there has been:
1. an increase in cost or fall in selling price
2. physical deterioration in the condition of inventory
3. obsolescence of products
4. a decision as part of the company’s marketing strategy to manufacture and sell
products at a loss
5. errors in production or purchasing
Inventories are usually written down to net realizable value on an item by item or individual
basis.
ACCOUNTING FOR INVENTORY WRITE-DOWN
1. The cost is lower than net realizable value
2. The net realizable value is lower than cost.
The following treatment is required when inventories are sold:
1. The carrying amount is recognized as an expense in the period in which the related
revenue is recognized.
2. The amount of any write-down of inventories to NRV and all losses of inventories
are recognized as an expense in the period the write-down or loss occurs.
3. The amount of any reversal of any write-down of inventories arising from an
increase in NRV, is recognized as a reduction in the number of inventories
recognized as an expense in the period in which the reversal occurs.
Different Cost Formulas for Inventories
Two cost formulas allowed by IAS 2
1. First In- First Out (FIFO)
2. Weighted Average
IAS 2 provides that an entity should use the same cost formula for all inventories having
similar nature and use to the entity.
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IAS 41: AGRICULTURE
IAS 41 applies the requirements of IFRS to the treatment of Biological Assets. It was
issued in February 2001, it seeks to harmonize practice in accounting for agriculture,
which demonstrates fundamental differences in its nature and characteristics to other
business activities.
Terms to remember:
1. Agricultural activity is the management by an entity of the biological transformation
of biological assets for sale, into agricultural products or into additional biological
assets.
2. Agricultural produce is the harvested product of an entity’s biological assets
3. Biological assets are living animals or plants.
4. Biological transformation compromises the processes of growth, degeneration,
production and procreation that cause qualitative changes in a biological asset.
5. A group of biological assets is an aggregation of similar living animals or plants.
6. Harvest is the detachment produced from a biological asset or the cessation of a
biological asset’s life processes.
7. Fair value is 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 (IFRS
8. Carrying Amount is the amount at which an asset is recognized in the statement
of financial position.
Important points:
1. Biological: relates to life phenomena‟, living animals and plants with an innate
capacity of biological transformation which are dependent upon a combination of
natural resources.
2. Transformation: involves physical transformation, whereby animals and plants
undergo a change in biological quantity overtime
3. Management: biological transformation is managed.
4. Conditions are stabilized or enhanced. The transparency of the relationship
between input and outputs is determined by the degree of control (intensive vs.
extensive).
a. It is different from exploitation through extraction, where no attempt is made
to facilitate the transformation.
b. Biological assets are managed in groups of plant or animal classes, using
individual assets to ensure the sustainability of the group. D. Produce:
diverse and may require further processing before ultimate consumption
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Biological Assets
-
Agricultural produce at the point of harvest
Government grants
The standard does not apply to agricultural land or intangible assets related to agricultural activity.
After harvest, IAS 2 is applied. The core income-producing assets of agricultural activities,
held for their transformative capabilities that leads to various outcomes:
Asset changes:
- Growth: Increase in quantity and or quality
- Degeneration: Decrease in quantity and or quality Creation of new assets:
- Production: producing separable non-living product -Procreation: producing
separable living animals.
Two broad categories of agricultural production system:
1. Consumable: animals/plants themselves are harvested
2. Bearer: animals/plants bear produce for harvest
Biological assets are usually managed in groups of animals or plant classes, with
characteristics which allow sustainability in perpetuity.
Land often forms an integral part of the activity itself in pastoral and other land-based
agricultural activities.
Bearer Biological Assets
Amendment to IAS 41 regarding plant-based bearer biological assets including
trees grown in plantations, such as grape vines, rubber trees, and oil palms are used
solely to produce crops over several periods and are not in themselves consumed. The
fair value was not an appropriate measurement for these assets as, once they reach
maturity, the only economic benefit they produce comes from the agricultural produce
they create.
Biological Assets. These assets have been removed from the scope of IAS 41
and should be accounted for under IAS 16 Property, Plant and Equipment. They are
measured at accumulated costs until maturity and are then subject to depreciation and
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impairment charges. Agricultural produce from these plants continues to be recognized
under IAS 41/IAS 2.
1. The entity controls the assets as a result of IAS events.The entity controls the
assets as a result of IAS events.
2. It is probable that the future economic benefits associated It is probable that the
future economic benefits associated with the asset will flow to with the asset will
flow to the entity.the entity.
3. The fair value or cost of the asset to the entity can be The fair value or cost of the
asset to the entity can be measured reliably.measured reliably.
Presentation and disclosure
In the statement of financial position, biological assets should be classified as a separate
class of assets falling under neither current nor noncurrent classifications. This reflects
the view of such assets as having an unlimited life on a collective basis; it is the total
exposure of the entity to this type of asset that is important.
Biological asset should also be sub-classified either in statement of financial position or
as a note to the accounts:
1. Class of animal or plant
2. Nature of activities (consumable or bearer)
3. Maturity or immaturity for intended use
Agricultural Produce
It is recognized at the point of harvest. Agricultural produce is either incapable of biological
process or such processes remain dormant. Recognition ends once the produce enters
trading activities or production processes within integrated agribusinesses, although
processing activities that are incidental to agricultural activities and that do not materially
alter the form produce are not counted as processing.
Measurement and Presentation
The IAS states that agricultural produce should be measured at each year end at fair
value less estimated point of sale cost, the extent that is sourced from an entity’s urced
from an entity’s biological assets. This is logical that when you consider that, until harvest,
the agricultural produce was valued at fair value, anyway as part of the biological asset.
The change in carrying amount of the agricultural produce held at year end should be
recognized as income or expense in profit or loss. This will be rare as such produce is
usually sold or processed within a short time. within a short time
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Presentation in the Statement of Financial Position
Agricultural produce should be classified as inventory in the statement of financial position
and disclosed separately either in the statement of financial position or in the notes.
Assessments
Answer the following requirements:
1. Define inventories.
2. Give examples of inventories.
3. Explain the measurement for inventories.
4. Illustrate the costs attributable to inventories.
5. Discuss the different costing methods for inventories.
6. Expound the proper valuation of inventories.
7. Discuss the accounting treatment for agriculture
8. Differentiate the two categories of biological assets.
9. Explain the recognition principle for biological assets.
10. Define the proper valuation for biological assets and agricultural produce
References
Peralta, Jose F., Valix, Christian Aris M., Valix, Conrado T. (2017), Financial
Accounting Volume Two. Manila, Philippines. GIC Enterprises & Co.,Inc.
Asuncion, Darrell Joe O. CPA,MBA, Escala, Raymund Francis A. CPA, MBA, Ngina,
Mark Alyson B. CPA, MBA (2018), Applied Auditing Book 2 of 2. Aurora Hill,
Baguio City. Real Excellence Publishing and Nation’s Foremost CPA Review Inc.
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Module 5
FINANCIAL INSTRUMENTS
Week 5
Introduction
The modern globalized financial market, along with the new technologies
accessible to every person, became an integral part of everyday life and activities of both
physical persons and businesses. Financial instruments are a part of this financial market
and the relevant legal knowledge about them ensures greater financial security and
additional financial capabilities. Taking into account the importance of these instruments
in the modern economy and their complexity, the information analysed during the course
is particularly valuable. This module covers the related standards PAS 32 Financial
Instruments: Presentation; PFRS 7 Financial Instruments: Disclosure; PFRS 9 Financial
Instruments; and IFRIC 2 Members’ shares in Cooperative Entities and Similar
Instruments.
Learning Objectives
After studying this module, students should be able to:
1. Define financial instruments.
2. Give examples of financial assets and financial liabilities.
3. Differentiate between a financial liability and an equity instrument.
4. State the requirements for offsetting financial assets and financial liabilities.
5. State the classifications of financial assets and their initial and subsequent
measurements .
6. State the classifications of financial liabilities and their initial and subsequent
measurements.
Financial Instruments
PAS 32 prescribes the principles for presenting financial instruments as liabilities
or equity and for offsetting financial assets and financial liabilities.
PAS 32 complements PFRS 9 Financial Instruments, which prescribed the
recognition and measurement of financial assets and financial liabilities, and financial
liabilities, and PFRS 7 Financial Instruments: Disclosures, which prescribes the
disclosures for financial instruments.
PAS 32 applies to all types of financial instruments except the following for which
other Standards apply:
a. investments in subsidiaries, associates and joint ventures
b. employer’s rights and obligations under employee benefit plans
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c. Insurance contracts
PAS 32 applies to instruments designated to be measured at fair value through
profit or loss and contracts for the future purchase of delivery of a commodity or other
nonfinancial items that can be settled.
PAS 32 defines a financial instrument as a contract that gives rise to a financial
asset of one entity and a financial liability or equity instrument of another entity.
Financial asset is any asset that is:
cash;
an equity instrument of another entity;
a contractual right to receive cash or another financial asset from another entity;
a contractual right to exchange financial instruments with another entity under
conditions that are potentially favorable to the entity; or
e. a contract that will or may be settled in the entity's own equity instruments and is
not classified as the entity’s own equity instrument.
a.
b.
c.
d.
Examples of financial assets
a.
(e.g. cash on hand, in banks, shor-term money
placements, and cash funds)
b.
such as accounts, notes, loans, and finance lease receivables
c.
of other entities such as held for
trading securities, investments in subsidiaries, associates, joint ventures,
investments in bonds, and derivative assets
d.
and other long-term funds composed of cash and other
financial assets.
The following are NOT financial assets:
- Physical assets, such as inventories, biological assets, PPE and
investment property
- Intangible assets
- Prepaid expenses and advances to suppliers
- The entity’s own equity instrument (e.g., treasury shares)
Financial liability is any liability that is:
a. a contractual obligation to deliver cash or another financial asset to another entity;
b. a contractual obligation to exchange financial assets or financial liabilities with
another entity under conditions that are potentially unfavorable to the entity; or
c. a contract that will or may be settled in the entity's own equity instruments and is
not classified as the entity’s own equity instrument.
Examples of financial liabilities
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a.
such as accounts, notes, loans and bonds payable
b.
c. Held for
and
d.
e.
and
The following are NOT financial liabilities:
- Unearned revenues and warranty obligations that are to be settled by
future delivery of goods or provision of services
- Taxes, SSS, Philhealth and Pag-IBIG (HDMF) payables
- Constructive obligations
PAS 32 defines an equity instrument as any contract that evidences a residual
interest in the assets of an entity after deducting all of its liabilities.
Presentation
The issuer classifies a financial instrument, or its component parts, as a financial
asset, a financial liability or an equity instrument in accordance with the substance of the
contract (rather than its legal form) and the definitions of a financial asset , a financial
liability and an equity instrument.
When determining whether a financial instrument is a financial liability or an equity
instrument, the overriding consideration is whether the instrument meets the definition of
a financial liability.
Financial Liability
Equity Instrument
The entity has a contractual obligation to
pay cash or another financial asset or to
exchange financial instruments under
potentially unfavorable conditions.
The entity has no obligation to pay cash
or another financial asset or to exchange
financial instruments under potentially
unfavorable conditions.
A contract is not an equity instrument merely because it is to be setted in the
entity’s own equity instruments. The following guidance applies when a contract requires
settlement in the entity’s own equity instruments:
Financial Liability
Equity Instrument
The contract requires the delivery* of a
(a) variable number of the entity’s own
equity instruments in exchange for a fixed
amount of cash or another financial asset
or (b) a fixed number of the entity’s own
equity instruments in exchange for a
variable amount of cash or another
financial asset.
The contract requires delivery (receipt) of
a fixed number of the entity’s own equity
instruments in exchange for a fixed aount
of cash or another financial asset.
Example: a share option that gives the
holder a right to buy a fixed number of the
issuer’s shares for a fixed price.
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Examples:
- Variable number for a fixed
amount: a contract to deliver as
many shares as are quail to the
value of a fixed amount of cash or
a fixed number of units of a
commodity
- Fixed number for a variable
amount: a contract to deliver own
equity instruments in exchange for
an amount of cash
* a contract to receive (rather than to deliver) is a
financial asset
Notes:
For a financial asset/financial liability
- Variable number for a fixed amount
- Fixed number for a variable amount
For equity instruments
- Fixed number for a fixed amount
An essential feature of an equity instrument is the absence of a contractual
obligation to pay cash or another financial asset. This sistrue even if the holder of the
instrument is entitled to pro rata share in dividends or of the net assets of the entity in
case of liquidation.
Legal form is also irrelevant when determining if a financial instrument is a financial
liability or an equity instrument. Some instruments are in the form of shares of stocks but
the issuer classified them as financial liabilities if they meet the definition of a financial
liability.
Redeemable preference shares
● Are preferred stocks which the
holder has the right to redeem at a
set date
● Are classified as financial liability
because when the holder
exercises its right to redeem, the
issuer is mandatorily obligated to
pay for the redemption price
Callable preference shares
● Are preferred stocks in which the
issuer has the right to call at a set
date
● Are classified as equity instrument
because the right to call is at the
discretion of the issuer and
therefore has no obligation to pay
unless it chooses to call on the
shares
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IFRIC 2 Members’ shares in Cooperative Entities and Similar Instruments
addresses the classification of members’ shares in cooperatives. IFRIC 2 uses the
same principles as those of PAS 32.
Members’ shares in cooperative entities and similar instruments are equity if:
a. The entity has an unconditional right to refuse redemption of the members’
shares or
b. Redemption is unconditionally prohibited by law or relevant regulation.
Puttable instrument
A puttable instrument is one that gives the holder the right to return (put back) the
instrument to the issuer in exchange for cash or another financial asset or is automatically
put back to the issuer upon the occurrence of a specified future event, e.g. death of the
holder.
It includes a contractual obligation for the issuer to redeem or repurchase the
instrument. Accordingly, it is classified as a financial liability except when the instrument
also represents a residual interest in the net assets of the issuing entity.
As an exception to the definition of a of a financial liability , a puttable instrument
is classified as an equity instrument if it has the features of an equity instrument such as
entitlement to pro rata share in case of liquidation, non-priority over other instruments, no
other contractual obligations similar to those of a financial liability, and total cash flows
based substantially on profit or loss and changes in net assets.
In addition to these features, the issuer must have no other instrument that has
total cash flows based substantially on profit or loss and changes in net assets and the
effect of substantially restricting or fixing the residual return to the puttable instrument
holders.
Compound Financial Instruments
A compound financial instrument is a financial instrument that , from the issuer’s
perspective, contains both a liability and an equity component. These components are
classified and accounted for separately.
An example of a compound instrument is convertible bonds. Convertible bonds are
bonds that can be converted into shares of stocks of the issuer. When a n entity issues
convertible bonds, in effect, it is issuing tow instruments - (1) a debt instrument for the
bonds payable and (2) an equity instrument for the equity conversion feature. These two
components are presented separately in the statement of financial position.
Equity is defined as a residual amount. Therefore, to separate the debt and equity
component of a compound instrument, the entity simply deducts from the fair value of
the whole instrument the fair value of the debt component without the equity feature; the
remaining amount represents the equity component. This procedure follows the basic
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accounting equation “Assets = Liabilities + Equity” transposed to “Equity = Assets Liabilities”.
Equity component
=
Equity component equals
Assets
-
Cash proceeds from
issuance of compound
instrument less
Liabilities
Fair value of debt
component without the
equity feature
Fair value is the amount for which an asset could be exchanged, or a liability
settled, between knowledgeable, willing parties in an arm's length transaction.
The sum of the carrying amounts allocated to the liability and equity components
is always equal to the fair value of the whole instrument. No gain on the initial recognition
of the components.
The separate classifications of the components are not revised for subsequent
changes in the likelihood that the conversion option will be exercised.
Treasury Shares
Treasury shares (treasury stocks) are an entity’s own shares that were previously
issued but were subsequently reacquired but not retired.
Treasury shares are presented separately either in the statement of financial
position or in the notes as deduction from equity.
No gain or loss arises from the purchase, sale, issue or cancellation of the entity’s
own equity instruments. The consideration paid or received from such transactions is
recognized directly in equity.
Interest Dividends, Losses and Gains
The classification of a financial instrument as a financial liability or an equity
instrument determines the accounting for the related interest, dividends, losses and gains.
Those that relate to financial liability are recognized as income or expenses in profit
or loss. While those that relate to equity instruments are recognized directly in equity.
For example, dividends on redeemable preference shares (financial liability) are
recognized as expense (e.g., interest expense) in profit or loss while dividends on callable
preferences and other equity instruments are recognized directly in equity as a deduction
from retained earnings.
Premium or discount on financial liabilities is included in the carrying amount of the
financial liability and subsequently amortized to profit or loss while premium or discount
on equity instruments are recognized directly in equity.
Gains and losses on redemptions or refinancings of financial liabilities are
recognized in profit or loss while redemptions or refinancings of equity instruments are
recognized as changes in equity.
Changes in the fair value of a financial liability are generally not recognized unless
the financial liability is measured at fair value through profit or loss. Changes in fair value
of an equity instrument are not recognized.
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Transaction costs
Transaction costs on issuing equity instruments (e.g., stock issuance costs, such
as legal fees, registration costs and stock certificate printing costs), to the extent taht tey
are avoidable costs, are accounted for as a deduction from equity while transaction costs
on issuing financial liabilities (except liabilities measured at fair value through profit or
loss) are included in the carrying amount of the financial liability and subsequently
amortized to profit or loss.
Because of the varying treatments, transaction costs on issuing compound
financial instruments are allocated to the debt and equity components based on their
assigned values. Likewise, transactions that relate jointly to more than one transaction
are allocated to those transactions using a rational basis of allocation. The costs of an
abandoned equity transaction are recognized as expenses.
Offsetting a financial asset and a financial liability
A financial asset and a financial liability are offset and only the net amount is
presented in the statement of financial position. When the entity has both:
a. A legal right of set off and
b. An
he amounts on a net basis or simultaneously.
Both of the conditions above must be met before offsetting is permitted.
PAS 32 requires presenting financial assets and financial liabilities on a net basis
when doing so reflects an entity’s expected future cash flows from settling two or more
separate financial instruments. When the entity has both the legal right to net settlement
and intention to do so, it has, in effect, only a single financial asset or financial liability.
Neither a legal right alone nor an intention warrants offsetting.
➢ A mere intention to settle net without the right to do so is not sufficient to justify
offsetting because the rights and obligations associated with the individual financial
asset and financial liability remain unaltered.
➢ Conversely, a legal right to settle net without the intention to do so is also not
sufficient to justify offsetting because this does not reflect the entity’s expected
future cash flows from settling two or more separate financial instruments.
Offsetting is inappropriate for (a) financial asset or other assets that are pledged
as collateral for non-recourse financial liabilities and (b) sinking fund and the related
financial liability for which the fund was established.
Scope of PFRS 9 Financial Instruments
PFRS 9 establishes the financial reporting principles for financial assets and
financial liabilities, particularly their classification and measurement. It applies to all
financial instruments except those that are dealt with under other Standards, such as:
➢ interest in subsidiaries (PFRS 10 Consolidated Financial Statements);
➢ investment in associates and joint ventures (PAS 28);
➢ those arising from employee benefit plans (PAS 19);
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➢
➢
➢
➢
leases (PFRS 16 Leases)
share-based payment transactions (PFRS 2)
those that are required to be classified as equity instruments (PAS 32)
those arising from contracts with customers (PFRS 15 Revenue from Contracts
with Customers)
Initial Recognition
Financial assets and financial liabilities are recognized only when the entity becomes a
party to the contractual provisions of the instrument.
Classification of Financial Assets
Financial assets are classified as subsequently measured at:
a. amortized cost;
b. fair value through other comprehensive income (FVOCI); or
c. fair value through profit or loss (FVPL)
Basis for classification
Financial assets, except those that are designated, are classified on the basis of both:
a. The entity’s business model for managing the financial assets; and
b. The contractual cash flow characteristics of the financial asset.
Classification at Amortized cost
A financial asset is measured at amortized cost if both of the following conditions are met:
a. The asset is held within a business model whose objective is to hold financial
assets in order to collect contractual cash flows (“hold to collect” business model);
and
b. The contractual terms of the financial asset give rise on specified dates to cash
flows that are solely payment of principal and interest on the principal amount
outstanding
Classification at Fair Value through Other Comprehensive Income
A financial asset is measured at fair value through other comprehensive income (FVOCI)
if both of the following conditions are met:
a. The financial asset is held within a business model whose objective is achieved by
both collecting contractual cash flows and selling financial assets (“hold to collect
and sell” business model); and
b. The contractual terms of the financial asset give rise on specified dates to cash
flows that are solely payments of principal and interest on the principal amount
outstanding.
Classification at Fair Value through Profit or Loss
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A financial asset that does not meet the conditions for measurement at amortized cost
of FVOCI is measured at fair value through profit or loss (FVPL). This is normally the case
for “held for trading” securities.
Assessments
Answer the following questions:
1. What are financial instruments?
2. What are the differences between financial assets and financial liabilities?
Explain.
3. What are the classifications of financial assets? Explain each.
4. What are the classifications of financial liabilities? Explain each.
5. What are the proper measurement for financial assets, and for financial liabilities,
respectively?
References
Millan, Zeus Vernon B. ( 2019) Conceptual Framework and Accounting Standards .
Bandolin Enterprise.
https://www.ifrs.org/issued-standards/list-of-standards/ifrs-9-financial-instruments/
https://www.iasplus.com/en/standards/ias/ias32
https://www.iasplus.com/en/standards/ifrs/ifrs7
https://www.iasplus.com/en/standards/ifrs/ifrs9
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Module 6
Accounting for Tangible Non-current Assets
Week 11
Introduction
This module tackles the recognition and measurement of the tangible non-current assets.
This primarily discusses the accounting for property, plant and equipment under PAS 16
and investment property under PAS 40. This also illustrates the accounting for
depreciation and derecognition of property, plant and equipment and investment property.
Learning Objectives
After studying this module, students should be able to:
1. Understand the concept of recognition and measurement of property, plant and
equipment and investment property.
2. Explain the accounting for depreciation of property, plant and equipment and
investment property.
3. Discuss the requirements for disclosures for property, plant and equipment and
investment property.
Property, Plant and Equipment
IAS 16 Property, plant and equipment
Objective
The objective of this Standard is to prescribe the accounting treatment for property,
plant and equipment so that users of the financial statements can discern information
about an entity’s investment in its property, plant and equipment and the changes in
such investment.
The principal issues in accounting for property, plant and equipment are the
recognition of the assets, the determination of their carrying amounts and the
depreciation charges and impairment losses to be recognised in relation to them.
Scope
This Standard shall be applied in accounting for property, plant and equipment
except when another Standard requires or permits a different accounting treatment.
This Standard does not apply to:
(a)
property, plant and equipment classified as held for sale in accordance
with IFRS 5 Non-current Assets Held for Sale and Discontinued
Operations.
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(b)
(c)
(d)
biological assets related to agricultural activity other than bearer plants
(see IAS 41 Agriculture). This Standard applies to bearer plants but
it does not apply to the produce on bearer plants.
the recognition and measurement of exploration and evaluation assets
(see IFRS 6 Exploration for and Evaluation of Mineral Resources).
mineral rights and mineral reserves such as oil, natural gas and similar nonregenerative resources.
However, this Standard applies to property, plant and equipment used to develop or
maintain the assets described in (b)–(d).
An entity using the cost model for investment property in accordance with IAS 40
Investment Property shall use the cost model in this Standard for owned investment
property.
Effective date
An entity shall apply this Standard for annual periods beginning on or after 1 January
2005. Earlier application is encouraged. If an entity applies this Standard for a period
beginning before 1 January 2005, it shall disclose that fact.
Defined terms
A bearer plant is a living plant that:
(a)
is used in the production or supply of agricultural produce;
(b) is expected to bear produce for more than one period; and
(c)
has a remote likelihood of being sold as agricultural produce, except for incidental
scrap sales.
The carrying amount of an asset is the amount at which an asset is recognised
after deducting any accumulated depreciation and accumulated impairment losses.
Cost is the amount of cash or cash equivalents paid or the fair value of the other
consideration given to acquire an asset at the time of its acquisition or construction
or, where applicable, the amount attributed to that asset when initially recognised in
accordance with the specific requirements of other IFRSs.
The depreciable amount is the cost of an asset, or other amount substituted for cost, less
its residual value.
Depreciation is the systematic allocation of the depreciable amount of an asset over its
useful life.
The entity-specific value is the present value of the cash flows an entity expects to arise
from the continuing use of an asset and from its disposal at the end of its useful life or
expects to incur when settling a liability.
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Fair value is 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.
An impairment loss is the amount by which the carrying amount of an asset exceeds its
recoverable amount.
The recoverable amount is the higher of an asset’s fair value less costs to sell and its
value in use.
The residual value of an asset is the estimated amount that an entity would currently
obtain from disposal of the asset, after deducting the estimated costs of disposal, if
the asset were already of the age and in the condition expected at the end of its
useful life.
Useful life is defined as:
(a)
the period over which an asset is expected to be available for use by an entity; or
(b) the number of production or similar units expected to be obtained from the asset by
an entity.
Property, Plant and Equipment are held for use in production or supply of goods or
services, for rental to others , or for administrative purposes, and are expected to be used
during more than one period. Their major characteristics are:
1. Tangible Assets
2. Used in Business
3. Expected to be used over a period of more than
Examples of property, plant and equipment:
1. Land
2. Land Improvements
3. Building
4. Machinery
5. Ship
6. Aircraft
7. Furniture and Fixtures
8. Office Equipment
9. Patterns, Molds, and Dies
10. Tools
11. Bearer Plant
Recognition of Property, plant and equipment:
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An item of property, plant, and equipment shall be recognized as asset when:
1. It is probable that future economic benefits associated with the asset will flow to
the entity.
2. The cost of the asset can be measured reliably.
Measurement at Recognition
An item of property, plant and equipment that qualifies for recognition as an asset shall
be measured at cost.
Cost - amount of cash or cash equivalent paid and the fair value of the other consideration
given to acquire an asset at the time of acquisition
Element of Cost
1. Purchase Price
2. Cost directly attributable to bringing the asset to the location and condition
necessary for it to be capable of operating in the manner intended by management.
3. Initial estimate of the cost of dismantling and removing the item and restoring the
site on which it is located for which an entity has present obligation.
Directly Attributable Cost
1. Cost of Employee Benefit arising directly for the construction or acquisition of an
item of property, plant and equipment
2. Cost of site preparation
3. Initial delivery and handling cost
4. Installation and assembly cost
5. Professional Fee
6. Cost of testing whether the asset is functioning properly
Cost not Qualifying for Recognition
1. Cost of opening a new facility
2. Cost of introducing a new product or service
3. Cost of conducting business in a new location or with a new class of customer,
including cost of staff training
4. Administration and other general overhead cost
5. Cost incurred while an item capable of operating in the manner intended has yet
to be brought into use or is operated at less than full capacity
6. Initial operating loss
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7. Cost of relocating or reorganizing part or all of an entity’s operation
Initial recognition of indirect costs
Items of property, plant and equipment may be acquired for safety or environmental
reasons. The acquisition of such property, plant and equipment, although not directly
increasing the future economic benefits of any particular existing item of property, plant
and equipment, may be necessary for an entity to obtain the future economic benefits
from its other assets.
Such items of property, plant and equipment qualify for recognition as assets because
they enable an entity to derive future economic benefits from related assets in excess
of what could be derived had those items not been acquired
Subsequent recognition of indirect costs
Day to day servicing:
·
An entity does not recognise in the carrying amount of an item of property,
plant and equipment the costs of the day-to-day servicing of the item. The
purpose of these expenditures is often described as for the ‘repairs and
maintenance’ are primarily the costs of labour and consumables, and may
include the cost of small parts. These costs are expensed through profit and
loss.
Replacement parts:
·
Parts of some items of property, plant and equipment may require replacement
at regular intervals or acquired to make a less frequently recurring replacement, an
entity recognises in the carrying amount of an item of property, plant and equipment
the cost of replacing part of such an item when that cost is incurred provided that the
recognition criteria are met
Major inspections:
·
Costs incurred for major inspections for faults regardless of whether parts
of the item are replaced are recognised to the carrying amount of the item of
property, plant and equipment.
·
Any remaining carrying amount of the cost of the previous inspection (as
distinct from physical parts) is derecognised. This occurs regardless of whether the
cost of the previous inspection was identified in the transaction in which the item
was acquired or constructed.
Measurement at recognition
An item of property, plant and equipment that qualifies for recognition as an asset
shall be measured at its cost. The cost of a self-constructed asset is determined using
the same principles as for an acquired asset. Bearer plants are accounted for in the
same way as self-constructed items of property, plant and equipment before they are
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in the location and condition necessary to be capable of operating in the manner
intended by management
The cost of an item of property, plant and equipment comprises:
(a)
its purchase price, including import duties and non-refundable purchase
taxes, after deducting trade discounts and rebates.
(b)
any costs directly attributable to bringing the asset to the location and
condition necessary for it to be capable of operating in the manner intended by
management.
(c)
the initial estimate of the costs of dismantling and removing the item and
restoring the site on which it is located, the obligation for which an entity incurs either
when the item is acquired or as a consequence of having used the item during a
particular period for purposes other than to produce inventories during that period.
Cash price equivalent
The cost of an item of property, plant and equipment is the cash price equivalent at
the recognition date. If payment is deferred beyond normal credit terms, the difference
between the cash price equivalent and the total payment is recognised as interest over
the period of credit unless such interest is capitalised in accordance with IAS 23
Borrowing Costs.
Asset exchange
One or more items of property, plant and equipment may be acquired in exchange for
a non-monetary asset or assets, or a combination of monetary and non-monetary
assets. The following discussion refers simply to an exchange of one non-monetary
asset for another, but it also applies to all exchanges described in the preceding
sentence.
The cost of such an item of property, plant and equipment is measured at fair value
unless:
(a)
the exchange transaction lacks commercial substance or
(b)
the fair value of neither the asset received nor the asset given up is reliably
measurable.
The acquired item is measured in this way even if an entity cannot immediately
derecognise the asset given up. If the acquired item is not measured at fair value, its
cost is measured at the carrying amount of the asset given up.
An entity determines whether an exchange transaction has commercial substance by
considering the extent to which its future cash flows are expected to change as a result
of the transaction. An exchange transaction has commercial substance if:
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(a) the configuration (risk, timing and amount) of the cash flows of the asset
received differs from the configuration of the cash flows of the asset transferred;
or
(b) the entity-specific value of the portion of the entity’s operations affected by the
transaction changes as a result of the exchange; and
(c) the difference in (a) or (b) is significant relative to the fair value of the assets
exchanged.
For the purpose of determining whether an exchange transaction has commercial
substance, the entity-specific value of the portion of the entity’s operations affected by
the transaction shall reflect post-tax cash flows. The result of these analyses may be
clear without an entity having to perform detailed calculations.
The fair value of an asset is reliably measurable if:
(a) the variability in the range of reasonable fair value measurements is not significant
for that asset; or
(b) the probabilities of the various estimates within the range can be reasonably
assessed and used when measuring fair value.
If an entity is able to measure reliably the fair value of either the asset received or the
asset given up, then the fair value of the asset given up is used to measure the cost of
the asset received unless the fair value of the asset received is more clearly evident.
Government assistance
The carrying amount of an item of property, plant and equipment may be reduced by
government grants in accordance with IAS 20 Accounting for Government Grants and
Disclosure of Government Assistance.
Measurement after recognition
An entity shall choose either the cost model or the revaluation model as its
accounting policy and shall apply that policy to an entire class of property, plant and
equipment.
Cost model
After recognition as an asset, an item of property, plant and equipment shall be
carried at its cost less any accumulated depreciation and any accumulated
impairment losses.
Revaluation model
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After recognition as an asset, an item of property, plant and equipment whose fair
value can be measured reliably shall be carried at a revalued amount, being its fair
value at the date of the revaluation less any subsequent accumulated depreciation
and subsequent accumulated impairment losses.
Revaluations shall be made with sufficient regularity to ensure that the carrying
amount does not differ materially from that which would be determined using fair
value at the end of the reporting period.
When an item of property, plant and equipment is revalued, the carrying amount
of that asset is adjusted to the revalued amount. At the date of the revaluation,
the asset is treated in one of the following ways:
(a)
the gross carrying amount is adjusted in a manner that is consistent with the
revaluation of the carrying amount of the asset. The gross carrying amount may be
restated by reference to observable market data or it may be restated proportionately to
the change in the carrying amount. The accumulated depreciation at the date of the
revaluation is adjusted to equal the difference between the gross carrying amount and
the carrying amount of the asset after taking into account accumulated impairment
losses; or
(b)
the accumulated depreciation is eliminated against the gross carrying amount of
the asset.
Revaluation changes shall be accounted for as follows:
The effects of taxes on income, if any, resulting from the revaluation of property, plant
and equipment are recognised and disclosed in accordance with IAS 12 Income Taxes.
The revaluation surplus included in equity in respect of an item of property, plant and
equipment may be transferred directly to retained earnings when the asset is
derecognised. This may involve transferring the whole of the surplus when the asset is
retired or disposed of. However, some of the surplus may be transferred as the asset is
used by an entity. In such a case, the amount of the surplus transferred would be the
difference between depreciation based on the revalued carrying amount of the asset
and depreciation based on the asset’s original cost. Transfers from revaluation surplus
to retained earnings are not made through profit or loss.
Acquisition of PPE:
1. Cash Basis
2. On Account
3. On Installment Basis
DERECOGNITION
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The cost of the property, plant, and equipment together with the related accumulated
depreciation shall be removed from the balance sheet. IAS 16, Paragraph 67, provides
that the carrying amount of an item of property, plant and equipment shall be
derecognized on disposal or w hen no future economic benefits are expected from the
use or disposal.
Fully Depreciated Property
When the carrying amount is equal to zero, or the carrying amount is equal to residual
value. In such a case, the asset account and the related accumulated depreciation
accounts are closed and the residual value is set up in a separate account.
The cost of fully depreciated asset remaining in service and the related accumulated
depreciation ordinarily shall not be removed from the accounts.
Some ideas how long the non current assets useful life will be and how the entity might
decide what to do with it:
1. Keep on using the non current asset until it becomes completely
2. worn out, useless and worthless.
3. Sell off the non current asset at the end of its useful life, either by selling it as a
second hand item or as scrap.
DEPRECIATION ACCOUNTING
Depreciation
- It is defined as the systematic allocation of a depreciable amount of an asset over
the useful life.
- Its objective is to have each period benefitting from the use of the asset bear an
equitable share of the asset cost.
- Depreciation for the accounting period is charged to net profit or loss for the period
either directly or indirectly.
Depreciation in the Financial Statements
- It is an expense.
- It may be part of the cost of goods manufactured or an operating expense.
- The depreciation charge for each period shall be recognized as expense unless it
is included in the carrying amount of another asset.
Depreciation Period
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-
The depreciable amount of an asset shall be allocated on a systematic basis over
the useful life.
Depreciation of an as set only begins when it is available for use.
Depreciation ceases when the asset is derecognized.
Depreciable Assets
- Are expected to be used during more than one accounting period
- Have a limited useful life
- Are held by an entity for use in the production or supply of goods and services, for
rental to others, or for administrative purposes
Useful life
- The period over which a depreciable asset is expected to be used by the entity; or
- The number of production or similar units expected to be obtained from the asset
by the entity
Factors in Determining Useful Life
1. Expected usage of the asset Usage is assessed by reference to the asset’s
expected capacity or physical output
2. Expected physical wear and tear This depends on the operational factors such as
the number of shifts the asset is used, the repair and maintenance program and
the care and maintenance of the asset while idle.
3. Technical or commercial obsolescence This arises from changes or improvements
in production or change in the market demand for the product output of the asset.
4. Legal limits Legal limits for the use of the asset, such as the expiry date of the
related lease.
Residual Period
- It is the estimated net amount currently obtainable if the asset is at the end of the
useful life.
- If there’s any changes, it should account for as a change in an accounting estimate.
- It may increase to an amount equal to or greater than the carrying amount.
- Depreciation is recognized even if the fair value of the asset exceeds the carrying
amount as long as the residual value does not exceed the carrying amount
Depreciable Amount
- The depreciable amount of a depreciable asset is the historical cost or other
amount substituted for cost in the financial statements, less the estimated residual
value.
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-
Each part of an item of property, plant and equipment with a cost that is significant
in relation to the total cost of the item shall be depreciated separately.
The entity also depreciates separately that remainder of the item and the
remainder consists of the parts of the item that are individually not significant.
Depreciation Methods
1. Straight line Method
- The annual depreciation charge is calculated by allocating the depreciable
amount equally over the number of years of useful life.
- It is a constant charge over the useful life of the asset.
- It is adopted when the principal cause of depreciation
- It is a passage of time.
- The straight line approach considers depreciation a function of time rather
than as a function of usage.
2. Reducing Balance Method
- It provides higher depreciation in the earlier years and lower depreciation in
the later years of the useful life of the asset.
- This method results in a decreasing depreciation charge over the useful life.
3. Machine Hour Method
- It is also similar to production method
- It assumes that depreciation is more a function of use rather than passage
of time.
- The useful life of the asset is considered in terms of the output it produces
or the number of hours it works.
- The depreciation is related to the estimated production capability of the
asset and is expressed in a rate per unit of output or per hour of use.
- It is adopted if the principal cause of depreciation is usage
4. Sum of the digits Method
- Together with Double Declining Method , sum of the digits method is one of
the accelerated methods of depreciation
- It begins by adding up the years of expected life.
Each part of an item of property, plant and equipment with a cost that is significant in
relation to the total cost of the item shall be depreciated separately.
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The depreciation charge for each period shall be recognised in profit or loss unless
it is included in the carrying amount of another asset. The depreciable amount of an
asset shall be allocated on a systematic basis over its useful life and shall reflect the
pattern in which the asset’s future economic benefits are expected to be consumed
by the entity.
A variety of depreciation methods can be used to allocate the depreciable amount
of an asset on a systematic basis over its useful life. These methods include:
1. straight-line method, the diminishing balance method and the units of production
method. Straight-line
2. depreciation results in a constant charge over the useful life if the asset’s residual
value does not change.
3. diminishing balance method results in a decreasing charge over the useful life.
4. units of production method result in a charge based on the expected use or output.
The entity selects the method that most closely reflects the expected pattern of
consumption of the future economic benefits embodied in the asset. That method is
applied consistently from period to period unless there is a change in the expected
pattern of consumption of those future economic benefits.
The depreciable amount of an asset is determined after deducting its residual value.
In practice, the residual value of an asset is often insignificant and therefore
immaterial in the calculation of the depreciable amount.
Depreciation of an asset begins when it is available for use, i.e. when it is in the location
and condition necessary for it to be capable of operating in the manner intended by
management.
Depreciation of an asset ceases at the earlier of the date that the asset is classified
as held for sale (or included in a disposal group that is classified as held for sale)
and the date that the asset is derecognised.
Therefore, depreciation does not cease when the asset becomes idle or is retired
from active use unless the asset is fully depreciated. However, under usage methods
of depreciation the depreciation charge can be zero while there is no production.
The residual value and the useful life and depreciation method of an asset shall be
reviewed at least at each financial year-end and, if expectations differ from previous
estimates, the change(s) shall be accounted for as a change in an accounting
estimate in accordance with IAS 8 Accounting Policies, Changes in Accounting
Estimates and Errors.
A depreciation method that is based on revenue that is generated by an activity that
includes the use of an asset is not appropriate. The revenue generated by an activity
that includes the use of an asset generally reflects factors other than the consumption
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of the economic benefits of the asset. For example, revenue is affected by other inputs
and processes, selling activities and changes in sales volumes and prices. The price
component of revenue may be affected by inflation, which has no bearing upon the
way in which an asset is consumed.
Impairment
To determine whether an item of property, plant and equipment is impaired, an entity
applies IAS 36 Impairment of Assets. That Standard explains how an entity reviews
the carrying amount of its assets, how it determines the recoverable amount of an
asset, and when it recognises, or reverses the recognition of, an impairment loss.
Compensation for impairment
Compensation from third parties for items of property, plant and equipment that were
impaired, lost or given up shall be included in profit or loss when the compensation
becomes receivable.
Derecognition
The carrying amount of an item of property, plant and equipment shall be derecognised:
(a)
(b)
on disposal; or
when no future economic benefits are expected from its use or disposal.
The gain or loss arising from the derecognition of an item of property, plant and
equipment shall be determined as the difference between the net disposal proceeds, if
any, and the carrying amount of the item.
The gain or loss shall be included in profit or loss when the item is derecognised
(unless IFRS 16 Leases requires otherwise on a sale and leaseback). Gains shall
not be classified as revenue.
However, an entity that, in the course of its ordinary activities, routinely sells items of
property, plant and equipment that it has held for rental to others shall transfer such
assets to inventories at their carrying amount when they cease to be rented and
become held for sale. The proceeds from the sale of such assets shall be recognised
as revenue in accordance with IFRS 15 Revenue from Contracts with Customers.
IFRS 5 does not apply when assets that are held for sale in the ordinary course of
business are transferred to inventories.
Presentation and disclosure
An entity shall present and disclose information that enables users of the financial
statements about the entity’s
investment in its property, plant and equipment and the changes in such investment.
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In the Notes to the financial statement:
(a)
The financial statements shall disclose, for each class of property, plant and
equipment:
(i)
the measurement bases used for determining the gross carrying
amount;
(ii)
the depreciation methods used;
(iii)
the useful lives or the depreciation rates used;
(iv)
the gross carrying amount and the accumulated depreciation
(aggregated with accumulated impairment losses) at the beginning
and end of the period; and
(v)
a reconciliation of the carrying amount at the beginning and end of the
period showing:
➔ additions;
➔ assets classified as held for sale or included in a disposal
group classified as held for sale and other disposals;
➔ acquisitions through business combinations;
➔ increases or decreases resulting from revaluations and
from impairment losses recognised or reversed in other
comprehensive income;
➔ impairment losses recognised in profit or loss;
➔ impairment losses reversed in profit or loss;
➔ depreciation;
➔ the net exchange differences arising on the translation of the
financial statements from the functional currency into a
different presentation currency, including the translation of a
foreign operation into the presentation currency of the
reporting entity; and
➔ other changes.
(b)
The financial statements shall also disclose:
(i) the existence and amounts of restrictions on title, and property, plant
and equipment pledged as security for liabilities;
(ii) the amount of expenditures recognised in the carrying amount of an
item of property, plant and equipment in the course of its construction;
(iii) the amount of contractual commitments for the acquisition of property,
plant and equipment; and
(iv) if it is not disclosed separately in the statement of comprehensive
income, the amount of compensation from third parties for items of property,
plant and equipment that were impaired, lost or given up that is included in
profit or loss.
(c) If items of property, plant and equipment are stated at revalued amounts, the
following shall be disclosed in addition to the disclosures required by IFRS 13
Fair Value Measurement:
(i)
the effective date of the revaluation;
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(ii) whether an independent valuer was involved;
(iii) for each revalued class of property, plant and equipment, the carrying
amount that would have been recognized had the assets been carried under
the cost model; and
(iv) the revaluation surplus, indicating the change for the period and any
restrictions on the distribution of the balance to shareholders.
Users of financial statements may also find the following information relevant to
their needs:
(a) the carrying amount of temporarily idle property, plant and equipment;
(b) the gross carrying amount of any fully depreciated property, plant and
equipment that is still in use;
(c) the carrying amount of property, plant and equipment retired from
active use and not classified as held for sale; and
(d) when the cost model is used, the fair value of property, plant and
equipment when this is materially different from the carrying amount.
IAS 40: INVESTMENT PROPERTY
Investment property is a property (land or a building or part of a building or both) held
(by the owner or by the lessee as a right of use asset) to earn rentals or for capital
appreciation or both, rather than for: use in the production or supply of goods or services
or for administrative purposes, or sale in the ordinary course of business
Investment Property Examples:
1. Land held for long term capital
2. A building owned by the reporting entity and leased out under an operating lease
3. A building held by a parent and leased to a subsidiary
4. Property that is being constructed or developed for future use as an investment
property
Type of Non-Investment Property
1. Property intended for sale in the ordinary course of business
2. Property being constructed or developed on behalf of third parties
3. Owner-occupied property (property held by the owner (or by the lessee as a rightof-use asset) for use in the production or supply of goods and services or for
administrative purposes.)
Recognition Principle
1. When it is probable that future economic benefits that are associated with the
investment property will flow to the entity
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2. The cost of the investment property can be measured reliably
Measurement subsequent to initial recognition
1. Fair value model
- The price at which the property could be exchanged between
knowledgeable, willing parties in an arm’s length transaction without
deducting transaction cost.
2. Cost value model (PAS 16)
- Cost less accumulated depreciation and any accumulated impairment
losses
Terms to remember:
1. Changing Models. Once the entity has chosen the fair value or cost model, it
should apply it to all its investment property. It should not change from one model
to the other unless the change will result in a more appropriate presentation.
2. Transfers. Transfer to or from investment property should only be made when
there is a change in use.
3. Disposal . Derecognize (eliminate from the statement of financial position) an
investment property on disposal or when it is permanently withdrawn from use and
no future economic benefits are expected from its disposal.
PAS 23: Borrowing cost
1. Borrowing Costs - interests and other costs incurred by an entity in connection
with the borrowing of funds.
2. Qualifying Asset - an asset that necessarily takes a substantial period of time to
get ready for its intended use or sale.
The standard lists what may be included in borrowing costs:
1. Interest on bank overdrafts and short term and long term borrowings
2. Amortization of discounts or premiums relating to borrowings
3. Amortization of ancillary costs incurred in connection with the arrangement of
borrowings
4. Finance charges in respect of leases recognized in accordance with IFRS 16
5. Exchange differences arising from foreign currency borrowings to the extent that
they are regarded as an adjustment to interest costs
Qualifying Asset
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Depending on the circumstances, any of the following may be qualifying assets:
1. Inventories
2. Manufacturing plants
3. Power generation facilities
4. Intangible Assets
5. Investment properties
Capitalization
Only borrowing costs that are directly attributable to the acquisition, construction or
production of a qualifying asset can be capitalized as part of the cost of that asset
Asset Financed by Specific Borrowing
PAS 23, paragraph 12, provides that if the funds are borrowed specifically for the purpose
of acquiring a qualifying asset, the amount of capitalizable borrowing cost is the actual
borrowing cost incurred during the period less any investment income from the temporary
investment of those borrowings.
Asset Financed by General Borrowing
PAS 23, paragraph 11, provides that if the funds are borrowed generally and used for
acquiring a qualifying asset, the amount of capitalizable borrowing cost is equal to the
average carrying amount of the asset during the period multiplied by a capitalization rate
or average interest rate.
However, the capitalizable borrowing cost shall not
exceed the actual interest incurred.
Assessments
Answer the following questions:
1. What is property, plant and equipment?
2. What are the examples of assets classified as property, plant and equipment?
3. When should an asset be recognized as property, plant and equipment?
4. What is the initial measurement for property, plant and equipment?
5. How would property, plant and equipment be measured subsequently after its
initial recognition?
6. How would you account for depreciation of property, plant and equipment?
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7. What are the methods of depreciation? Explain each.
8. What is investment property?
9. How would you recognize an investment property?
10. What is borrowing costs as described in the PAS 23?
11. How would you account for borrowing cost as part of the tangible asset?
References
Peralta, Jose F., Valix, Christian Aris M., Valix, Conrado T. (2017), Financial
Accounting Volume Two. Manila, Philippines. GIC Enterprises & Co.,Inc.
Asuncion, Darrell Joe O. CPA,MBA, Escala, Raymund Francis A. CPA, MBA, Ngina,
Mark Alyson B. CPA, MBA (2018), Applied Auditing Book 2 of 2. Aurora Hill,
Baguio City. Real Excellence Publishing and Nation’s Foremost CPA Review Inc.
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Module 7
Accounting for Property, Plant and Equipment, Intangibles and Impairment of
Assets
Week 12-13
Introduction
This module discusses the standards which relate to tangible and intangible Assets and
Impairment of Assets. It also presents the standard related to non-current assets held
for sale and discontinued operations.
IAS 38 Intangible Assets
IAS 36 Impairment of Assets
IFRS 5 Non-Current Assets Held for Sale and Discontinued Operations
Learning Objectives
After studying this module, students should be able to:
1. Define an intangible asset.
2. State the initial measurement of intangible assets that are externally acquired
and internally generated.
3. State the subsequent measurement of intangible assets that have a finite useful
life and indefinite useful life.
4. State the core principle of IAS 36.
5. Describe the criteria for held for sale classification.
6. State the initial and subsequent measurement of held for sale assets.
7. State the presentation requirements of a discontinued operation.
IAS 38 Intangible Assets
Objective
The objective of this Standard is to prescribe the accounting treatment for
intangible assets that are not dealt with specifically in another Standard. This Standard
requires an entity to recognise an intangible asset if, and only if, specified criteria are met.
Scope
This Standard shall be applied in accounting for intangible assets, except:
(a) intangible assets that are within the scope of another Standard;
(b) financial assets, as defined in IAS 32 Financial Instruments: Presentation;
(c) the recognition and measurement of exploration and evaluation
assets (see IFRS 6 Exploration for and Evaluation of Mineral
Resources); and
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(d) expenditure on the development and extraction of minerals, oil,
natural gas and similar non-regenerative resources.
If another Standard prescribes the accounting for a specific type of intangible
asset, an entity applies that Standard instead of this Standard. For example,
this Standard does not apply to:
(a) intangible assets held by an entity for sale in the ordinary course of
business (see IAS 2 Inventories).
(b) deferred tax assets (see IAS 12 Income Taxes).
(c) leases that are within the scope of IAS 17 Leases.
(d) assets arising from employee benefits (see IAS 19 Employee Benefits).
(e) financial assets as defined in IAS 32 Financial Instruments:
Presentation. The recognition and measurement of some financial assets
are covered by IFRS 10 Consolidated Financial Statements, IAS 27
Separate Financial Statements and IAS 28 Investments in Associates and
Joint Ventures.
(f) goodwill acquired in a business combination (see IFRS 3 Business
Combinations).
(g) deferred acquisition costs, and intangible assets, arising from an
insurer’s contractual rights under insurance contracts within the scope of
IFRS 4 Insurance Contracts. IFRS 4 sets out specific disclosure
requirements for those deferred acquisition costs but not for those intangible
assets. Therefore, the disclosure requirements in this Standard apply to
those intangible assets.
(h) non-current intangible assets classified as held for sale (or included in
a disposal group that is classified as held for sale) in accordance with IFRS
5 Non-current Assets Held for Sale and Discontinued Operations.
Defined terms
An intangible asset is an identifiable, non-monetary item without physical substance,
which is within the control of the entity and is capable of generating future economic
benefits for the entity.
An active market is a market in which the items traded are homogenous, willing buyers
and sellers can be found at any time and prices are available to the public.
An asset is identifiable if it is either:
(a) separable, i.e. is capable of being separated or divided from
the entity and sold, transferred, licensed, rented or exchanged,
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either individually or together with a related contract, identifiable
asset or liability, regardless of whether the entity intends to do so;
or
(b) arises from contractual or other legal rights, regardless of
whether those rights are transferable or separable from the entity
or from other rights and obligations.
Residual value is the estimated amount that an entity would currently obtain from
disposal of the asset, after deducting the estimated costs of disposal, if the asset were
already of the age and in the condition expected at the end of its useful life.
Useful life is either:
(a) the period over which an asset is expected to be available for use by
an entity; or
(b) the number of production or similar units expected to be obtained from
the asset by an entity.
Research is the original planned investigation undertaken with the prospect of gaining
new scientific or technical knowledge and understanding.
Development is the application of research findings or other knowledge to a plan or design
for the production of new or substantially improved materials, devices, products,
processes or services before the start of commercial production.
Amortisation refers to the systematic allocation of the depreciable amount of an intangible
asset over its useful life. Recognition and initial measurement
An intangible asset shall be recognised if, and only if:
(a) it is probable that future economic benefits that are attributable to the asset will
flow to the entity; and
(b) the cost of the asset can be measured reliably.
An entity shall assess the probability of expected future economic benefits using
reasonable and supportable assumptions that represent management’s best estimate of
the set of economic conditions that will exist over the useful life of the asset.
An intangible asset shall be measured initially at cost.
Separate acquisition
The cost of a separately acquired intangible asset can usually be measured reliably. This
is when the purchase consideration is in the form of cash or other monetary assets.
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The cost of a separately acquired intangible asset comprises:
(a) its purchase price, including import duties and non-refundable
purchase taxes, after deducting trade
discounts and rebates; and
(b) any directly attributable cost of preparing the asset for its intended use.
Directly attributable costs are:
(a) costs of employee benefits (as defined in IAS 19 Employee
benefits) arising directly from bringing the
asset to its working condition;
(b) professional fees arising directly from bringing the asset to its working condition;
and
(c) costs of testing whether the asset is functioning properly.
Subsequent expenditure on an acquired in-process research and development
project
Research or development expenditure that:
(a) relates to an in-process research or development project acquired
separately or in a business combination
and recognised as an intangible asset; and
(b) is incurred after the acquisition of that project shall be accounted for in terms of this
Standard.
Exchange of assets
Intangible assets may be acquired in exchange for a non-monetary asset or
asset. The cost is measured at fair value. If
the acquired asset is not measured at fair value, its cost is measured at the
carrying amount of the asset given up.
Intangible asset acquired in a business combination
If an intangible asset acquired in a business combination is separable or
arises from contractual or other legal rights, sufficient information exists to
measure reliably the fair value of the asset.
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An intangible asset acquired in a business combination might be separable,
but only together with a related contract, identifiable asset or liability. In such
cases, the acquirer recognises the intangible asset separately from goodwill,
but together with the related item.
Government grant
Initially recognition at either fair value or normal value plus direct expenses to prepare
for use.
Internally generated goodwill
Internally generated goodwill shall not be recognised as an asset.
Internally generated intangible assets
To assess whether an internally generated intangible asset meets the criteria
for recognition, an entity classifies the generation of the asset into:
Internally generated brands, mastheads, publishing titles, customer lists and items
similar in substance shall not be recognised as intangible assets.
Measurement after recognition
An entity shall choose either the cost model or the revaluation model as its
accounting policy. If an intangible asset is accounted for using the revaluation
model, all the other assets in its class shall also be accounted for using the
same model, unless there is no active market for those assets.
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Cost model
After initial recognition, an intangible asset shall be carried at its cost less any
accumulated amortisation and any accumulated impairment losses.
Revaluation model
After initial recognition, an intangible asset shall be carried at a revalued amount, being
its fair value at the date of the revaluation less any subsequent accumulated amortisation
and any subsequent accumulated impairment losses. For the purpose of revaluations
under this Standard, fair value shall be measured by reference to an active market.
Revaluations shall be made with such regularity that at the end of the reporting period
the carrying amount of the asset does not differ materially from its fair value.
When an intangible asset is revalued, the carrying amount of that asset is adjusted to
the revalued amount. At the date of the revaluation, the asset is treated in one of the
following ways:
(a) the gross carrying amount is adjusted in a manner that is consistent with the
revaluation of the carrying
amount of the asset.
(b) the accumulated amortisation is eliminated against the gross carrying amount of the
asset and the amount
of the adjustment of accumulated amortisation forms part of the increase or
decrease in the carrying
amount.
If an intangible asset in a class of revalued intangible assets cannot be revalued because
there is no active market for this asset, the asset shall be carried at its cost less any
accumulated amortisation and impairment losses.
If the fair value of a revalued intangible asset can no longer be measured by reference
to an active market, the carrying amount of the asset shall be its revalued amount at the
date of the last revaluation by reference to the active market less any subsequent
accumulated amortisation and any subsequent accumulated impairment losses. The fact
that an active market no longer exists for a revalued intangible asset may indicate that
the asset may be impaired and that it needs to be tested in accordance with IAS 36
Impairment of Assets.
Revaluation changes shall be accounted for as follows:
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The effects of taxes on income, if any, resulting from the revaluation of
property, plant and equipment are recognised and disclosed in accordance
with IAS 12 Income Taxes.
Useful life
An entity shall assess whether the useful life of an intangible asset is finite or indefinite
and, if finite, the length of, or number of production or similar units constituting that useful
life. An intangible asset shall be regarded by the entity as having an indefinite useful life
when, based on an analysis of all of the relevant factors, there is no foreseeable limit to
the period over which the asset is expected to generate net cash inflows for the entity.
The useful life of an intangible asset that arises from contractual or other legal rights
shall not exceed the period of the contractual or other legal rights, but may be shorter
depending on the period over which the entity expects to use the asset. If the contractual
or other legal rights are conveyed for a limited term that can be renewed, the useful life
of the intangible asset shall include the renewal period(s) only if there is evidence to
support renewal by the entity without significant cost.
The useful life of a reacquired right recognised as an intangible asset in a business
combination is the remaining contractual period of the contract in which the right was
granted and shall not include renewal periods.
Factors to be considered when determining the useful life of an intangible asset:
(a) the expected usage of the asset by the entity and whether the asset could be
managed efficiently by another management team;
(b) typical product life cycles for the asset and public information on estimates of useful
lives of similar assets that are used in a similar way;
(c) technical, technological, commercial or other types of obsolescence;
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(d) the stability of the industry in which the asset operates and changes in the market
demand for the products or services output from the asset;
(e) expected actions by competitors or potential competitors;
(f)
the level of maintenance expenditure required to obtain the expected future
economic benefits from the asset and the entity’s ability and intention to reach such a
level;
(g) the period of control over the asset and legal or similar limits on the use of the asset,
such as the expiry dates of related leases; and
(h) whether the useful life of the asset is dependent on the useful life of other assets of
the entity.
Intangible assets with indefinite useful lives
An intangible asset with an indefinite useful life shall not be amortised.
In accordance with IAS 36 Impairment of Assets, an entity is required to test an intangible
asset with an indefinite useful life for impairment by comparing its recoverable amount
with its carrying amount:
(a) annually, and
(b) whenever there is an indication that the intangible asset may be impaired.
Review of useful life assessment:
The useful life of an intangible asset that is not being amortised shall be reviewed each
period to determine whether events and circumstances continue to support an indefinite
useful life assessment for that asset.
If they do not, the change in the useful life assessment from indefinite to finite shall be
accounted for as a change in an accounting estimate in accordance with IAS 8 Account
Policies, Changes in Estimates and Errors.
Intangible assets with finite useful lives
Amortisation period and amortisation method:
The depreciable amount of an intangible asset with a finite useful life shall
be allocated on a systematic basis over its useful life. Amortisation shall
begin when the asset is available for use, i.e. when it is in the location and
condition necessary for it to be capable of operating in the manner intended
by management.
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Amortisation shall cease at the earlier of the date that the asset is classified as held for
sale (or included in a disposal group that is classified as held for sale and the date that
the asset is derecognised. The amortisation method used shall reflect the pattern in
which the asset’s future economic benefits are expected to be consumed by the entity.
If that pattern cannot be determined reliably, the straight-line method shall be used. The
amortisation charge for each period shall be recognised in profit or loss unless this or
another Standard permit or requires it to be included in the carrying amount of another
asset.
Residual value:
The residual value of an intangible asset with a finite useful life shall be assumed to be
zero unless:
(a) there is a commitment by a third party to purchase the asset at the end of its useful
life; or
(b) there is an active market for the asset and:
(i)
residual value can be determined by reference to that market; and
(ii) it is probable that such a market will exist at the end of the asset’s useful life.
Review of amortisation period and amortisation method:
The amortisation period and the amortisation method for an intangible asset with a finite
useful life shall be
reviewed at least at each financial year-end. If the expected useful life of the asset is
different from previous estimates, the amortisation period shall be changed accordingly.
If there has been a change in the expected pattern of consumption of the future economic
benefits embodied in the asset, the amortisation method shall be changed to reflect the
changed pattern. Such changes shall be accounted for as changes in accounting
estimates in accordance with IAS 8 Account Policies, Changes in Estimates and Errors.
Retirement and disposals
An intangible asset shall be de-recognised:
(a) on disposal; or
(b) when no future economic benefits are expected from its use or disposal.
The gain or loss arising from the de-recognition of an intangible asset shall be
determined as the difference between the net disposal proceeds, if any, and the
carrying amount of the asset. It shall be recognised in profit or loss when the
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asset is de-recognised (unless IAS 17 Leases requires otherwise on a sale and
leaseback). Gains shall not be classified as revenue.
Presentation and disclosure
An entity shall disclose the following for each class of intangible assets, distinguishing
between internally generated intangible assets and other intangible assets:
In the Notes to the financial statement:
(a) The financial statements shall disclose, for each intangible asset:
(i)
the whether the useful lives are indefinite or finite and, if finite,
the useful lives or the amortisation
rates used;
(ii)
the amortisation methods used for intangible assets with finite
useful lives;
(iii) the gross carrying amount and any accumulated
amortisation (aggregated with accumulated
impairment losses) at the beginning and end
of the period;
(iv) the line item(s) of the statement of comprehensive
income in which any amortisation of intangible
assets is included;
(v) a reconciliation of the carrying amount at the beginning and end
of the period showing:
•
additions, indicating separately those
from internal development, those acquired
separately, and those acquired
through business combinations;
• assets classified as held for sale or included in
a disposal group classified as held for sale in
and other disposals;
•
increases or decreases during the period
resulting from revaluations and from impairment
losses recognised or reversed in other
comprehensive income;
•
impairment losses recognised in profit or loss during the
period;
•
impairment losses reversed in profit or loss during the
period;
• any amortisation recognised during the period;
• net exchange differences arising on the translation of the
financial statements into the
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•
presentation currency, and on the translation of
a foreign operation into the presentation
currency of the entity; and
other changes in the carrying amount during the period.
(b)
The financial statements shall also disclose:
(i)
for an intangible asset assessed as having an indefinite useful
life, the carrying amount of that asset
and the reasons supporting the assessment of an
indefinite useful life. In giving these reasons, the entity
shall describe the factor(s) that played a significant
role in determining that the asset has an indefinite
useful life.
(ii)
a description, the carrying amount and remaining amortisation
period of any individual intangible
asset that is material to the entity’s financial statements.
(iii) for intangible assets acquired by way of a government grant and
initially recognised at fair value:
• the fair value initially recognised for these assets;
• their carrying amount; and
• whether they are measured after recognition
under the cost model or the revaluation
model.
(iv) the existence and carrying amounts of intangible
assets whose title is restricted and the carrying
amounts of intangible assets pledged as
security for liabilities.
(v) the amount of contractual commitments for the acquisition of
intangible assets.
(c) If intangible assets are accounted for at revalued amounts, an entity
shall disclose the following:
(i)
by class of intangible assets:
• the effective date of the revaluation;
• the carrying amount of revalued intangible assets; and
•
the carrying amount that would have been
recognised had the revalued class of intangible
assets been measured after recognition
using the cost model; and
(ii)
the amount of the revaluation surplus that relates to intangible
assets at the beginning and end of
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the period, indicating the changes during the period
and any restrictions on the distribution of the balance
to shareholders.
An entity is encouraged, but not required, to disclose the following
information:
(a) a description of any fully amortised intangible asset that is still in use;
and
(b)
a brief description of significant intangible assets
controlled by the entity but not recognised as assets
because they did not meet the recognition criteria in
this Standard or because they were acquired or
generated before the version of IAS 38 Intangible
Assets issued in 1998 was effective.
An entity shall disclose the aggregate amount of research and
development expenditure recognised as an expense during the
period.
IAS 36 Impairment of Assets
Objective
To prescribe the procedures that an entity applies to ensure that its assets are carried
at no more than its recoverable amount. An asset is carried at more than their
recoverable amount if its carrying amount exceeds the amount to be recovered
through use or sale of the asset. If this is the case, the asset is described as impaired
and the entity is required to recognize an impairment loss.
Scope
This Standard shall be applied in accounting for the impairment of all assets, other than:
(a)
Inventories;
(b)
Assets arising from construction contracts;
(c)
Deferred tax assets;
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(d)
Assets arising from employee benefits;
Financial assets within the scope of IAS 39 Financial Instruments: Recognition and
Measurement;
(e)
(f)
Investment property that is measured at fair value;
Biological assets related to agricultural activity within the scope of IAS 41
Agriculture that are measured at fair value less costs to sell;
(g)
Deferred acquisition costs, and intangible assets, arising from an insurer’s
contractual rights under
(h)
insurance contracts within the scope of IFRS 4 Insurance Contracts; and
Non-current assets (or disposal groups) classified as held for sale in
accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued
Operations.
(i)
Effective date
An entity shall apply this Standard:
to goodwill and intangible assets acquired in business combinations for which the
agreement date is on or after 31 March 2004; and
(a)
to all other assets prospectively from the beginning of the first annual period
beginning on or after 31 March 2004
(b)
Defined terms
An impairment loss is the amount by which the carrying amount of an asset or a cash
generating unit exceeds its recoverable amount.
A cash generating unit is the smallest identifiable group of assets that generates cash
inflows that are largely independent of the cash inflows from other assets or group of
assets.
The carrying amount is the amount at which an asset is recognised after deducting any
accumulated depreciation (amortisation) and accumulated impairment losses thereon.
The recoverable amount is the higher of an asset’s or cash generating unit fair value less
costs of disposal and its value in use.
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An assets value in use is the present value of the future cash flows expected to be
derived from an asset or cash generating unit.
Fair value is 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.
Useful life is:
(a)
the period of time over which an asset is expected to be used by an entity; or
the number of production or similar units expected to be obtained from the asset
by an entity.
(b)
Identifying when as asset may be impaired
An entity shall assess at the end of each reporting period whether there is any
indication that an asset may be impaired. If any such indication exists, the entity shall
estimate the recoverable amount of the asset.
Irrespective of whether there is any indication of impairment, an entity shall also:
test an intangible asset with an indefinite useful life or an intangible asset not
yet available for use for impairment annually by comparing its carrying amount
with its recoverable amount
(a)
(b)
test goodwill acquired in a business combination for impairment annually.
As a minimum, the following indicators shall be considered:
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Measuring recoverable amount
As stated, the recoverable amount is the higher of an asset’s or cash-generating
unit’s fair value less costs of disposals and its value in use.
It is not always necessary to determine both an asset’s fair value less costs of
disposal and its value in use. If either of these amounts exceeds the asset’s carrying
amount, the asset is not impaired and it is not necessary to estimate the other
amount.
The recoverable amount is determined for an individual asset, unless the asset does not
generate cash inflows that are largely independent of those from other assets or groups
of assets. If this is the case, recoverable amount is determined for the cash-generating
unit to which the asset belongs unless either:
(a)
the asset’s fair value less costs of disposal is higher than its carrying amount; or
(b)
the asset’s value in use can be estimated to be close to its fair value less
costs of disposal and fair value less costs of disposal can be measured.
Fair value less costs of disposal
- This is the amount obtainable from the sale of an asset or cash generating unit (CGU)
in an arm’s length transaction between knowledgeable, willing parties, less the cost of
disposal.
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- The best evidence of an assets fair value less cost to sell is a price in a binding sale
agreement in an arm’s length transaction, adjusted for incremental costs that are directly
attributable to the disposal of the asset. If there is no binding sale agreement, but an asset
is traded in an active market, the asset’s market price less costs of disposal would provide
the best evidence of fair value less cost to sell.
If there is no sale agreement or active market for an asset, fair value less costs to
sell is determined based on the best information available to reflect the amount that an
entity could obtain, at reporting date, from the disposal of the asset through an arm’s
length transaction between knowledgeable, willing parties, less the costs of disposal.
- Cost of disposals include legal costs, stamp duty and similar transaction taxes, costs
of removing the asset and direct incremental costs to bring an asset into condition for its
sale.
Value in use
Estimate the future cash inflows and outflows to be derived from continuing use of the
asset and from its ultimate disposal and apply the appropriate discount rate to those future
cash flows:
Composition of estimates of future cash flows
Estimates of future cash flows shall include:
(a) projections of cash inflows from the continuing use of the asset;
(b)
projections of cash outflows that are necessarily incurred to generate the
cash inflows from continuing use of the asset (including cash outflows to
prepare the asset for use) and can be directly attributed, or allocated on a
reasonable and consistent basis, to the asset; and
(c)
net cash flows, if any, to be received (or paid) for the disposal of the asset
at the end of its useful life.
Basis for estimates of future cash flows
In measuring value in use an entity shall:
(a)
base cash flow projections on reasonable and supportable assumptions
that represent management’s best estimate of the range of economic
conditions
(b)
base cash flow projections on the most recent financial budgets/forecasts
approved by management.
(c)
estimate cash flow projections beyond the period covered by the most
recent budgets/forecasts by extrapolating the projections based on the
budgets/forecasts using a steady or declining growth rate for subsequent
years.
The discount rate(s) shall be a pre-tax rate(s) that reflect(s) current market assessments
of:
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(a)
the time value of money; and
(b)
the risks specific to the asset for which the future cash flow estimates have not
been adjusted.
For foreign currency, denominated future cash flows an entity translates the
present value using the spot exchange rate at the date of the value in use
calculation.
Recognizing an impairment loss
If, and only if, the recoverable amount of an asset is less than its carrying amount, the
carrying amount of the asset shall be reduced to its recoverable amount. That
reduction is an impairment loss.
An impairment loss shall be recognised immediately in profit or loss, unless the asset is
carried at revalued amount in accordance with another Standard.
Any impairment loss of a revalued asset shall be treated as a revaluation decrease in
accordance with that other Standard.
When the amount estimated for an impairment loss is greater than the carrying amount
of the asset to which it relates, an entity shall recognise a liability if, and only if, that is
required by another Standard.
After the recognition of an impairment loss, the depreciation (amortisation) charge for the
asset shall be adjusted in future periods to allocate the asset’s revised carrying amount,
less its residual value (if any), on a systematic basis over its remaining useful life.
Measuring recoverable amount of an intangible asset with an indefinite useful life
The recoverable amount of an intangible asset with an indefinite useful life or an
intangible asset not yet available for use should be estimated annually irrespective
of whether there is any indication of impairment in order to test the affected intangible
asset for impairment.
Cash-generating units and Goodwill
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Identifying the cash-generating unit to which an asset belongs
If there is any indication that an asset may be impaired, the recoverable amount shall be
estimated for the individual asset. If it is not possible to estimate the recoverable amount
of the individual asset, an entity shall determine the recoverable amount of the cashgenerating unit to which the asset belongs (the asset’s cash- generating unit).
If an active market exists for the output produced by an asset or group of assets, that
asset or group of assets shall be identified as a cash-generating unit, even if some or all
of the output is used internally.
If the cash inflows generated by any asset or cash-generating unit are affected by
internal transfer pricing, an
entity shall use management’s best estimate of future price(s) that could be achieved in
arm’s length transactions
in estimating:
(a)
the future cash inflows used to determine the asset’s or cash-generating unit’s
value in use; and
(b) the future cash outflows used to determine the value in use of any other assets
or cash-generating units that are affected by the internal transfer pricing.
Corporate assets
In testing a cash-generating unit for impairment, an entity shall identify all the
corporate assets that relate to the cash-generating unit under review. If a portion of
the carrying amount of a corporate asset:
(a)
can be allocated on a reasonable and consistent basis to that unit, the entity
shall compare the carrying amount of the unit, including the portion of the carrying
amount of the corporate asset allocated to the unit, with its recoverable amount. Any
impairment loss shall be recognised.
(b)
shall:
cannot be allocated on a reasonable and consistent basis to that unit, the entity
(i)
compare the carrying amount of the unit, excluding the
corporate asset, with its recoverable amount and recognise
any impairment loss;
(ii)
identify the smallest group of cash-generating units that includes
the cash-generating unit under review and to which a portion of the
carrying amount of the corporate asset can be allocated on a
reasonable and consistent basis; and
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(iii)
compare the carrying amount of that group of cash-generating
units, including the portion of the carrying amount of the corporate
asset allocated to that group of units, with the recoverable amount
of the group of units.
Goodwill
For the purpose of impairment testing, goodwill acquired in a business combination
shall, from the acquisition date, be allocated to each of the acquirer’s cash-generating
units, or groups of cash-generating units, that is expected to benefit from the synergies
of the combination, irrespective of whether other assets or liabilities of the acquiree
are assigned to those units or groups of units.
Each unit or group of units to which the goodwill is so allocated shall:
(a) represent the lowest level within the entity at which the goodwill is monitored
for internal management purposes; and
(b)
not be larger than an operating segment as defined by IFRS 8 Operating Segments
before aggregation.
If goodwill has been allocated to a cash-generating unit and the entity disposes of an
operation within that unit, the goodwill associated with the operation disposed of shall
be:
(a)
included in the carrying amount of the operation when determining the gain or
loss on disposal; and
(b) measured on the basis of the relative values of the operation disposed of and
the portion of the cash- generating unit retained, unless the entity can demonstrate
that some other method better reflects the goodwill associated with the operation
disposed of.
A cash-generating unit to which goodwill has been allocated shall be tested for
impairment annually and whenever there is an indication that the unit may be
impaired.
Impairment loss for a cash-generating unit
An impairment loss shall be recognised for a cash-generating unit (the smallest group
of cash-generating units to which goodwill or a corporate asset has been allocated) if,
and only if, the recoverable amount of the unit (group of units) is less than the carrying
amount of the unit (group of units).
The impairment loss shall be allocated to reduce the carrying amount of the assets of the
unit (group of units) in the following order:
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(a) first, to reduce the carrying amount of any goodwill allocated to the cash-generating
unit (group of units); and
then, to the other assets of the unit (group of units) pro rata on the basis of the
carrying amount of each asset in the unit (group of units).
(b)
In allocating an impairment loss an entity shall not reduce the carrying amount of an
asset below the highest of:
(a)
its fair value less costs of disposal (if measurable);
(b)
its value in use (if determinable); and
(c)
zero.
The amount of the impairment loss that would otherwise have been allocated to the
asset shall be allocated pro rata to the other assets of the unit (group of units).
A liability shall be recognised for any remaining amount of an impairment loss for a
cash-generating unit if, and only if, that is required by another IFRS.
Reversing an impairment loss
An entity shall assess at the end of each reporting period whether there is any
indication that an impairment loss recognised in prior periods for an asset other than
goodwill may no longer exist or may have decreased. If any such indication exists, the
entity shall estimate the recoverable amount of that asset as follows:
(a)
Reversing an impairment loss for an individual asset
The increased carrying amount of an asset other than goodwill attributable to a
reversal of an impairment loss shall not exceed the carrying amount that would have
been determined (net of amortisation or depreciation) had no impairment loss been
recognised for the asset in prior years.
(b)
Reversing an impairment loss for a cash-generating unit
A reversal of an impairment loss for a cash-generating unit shall be allocated to the
assets of the unit, except for goodwill, pro rata with the carrying amounts of those assets.
These increases in carrying amounts shall be treated as reversals of impairment losses
for the individual assets within the cash-generating unit. In allocating the reversal of the
impairment, the carrying amount of an asset shall not be increased above the lower of:
(i)
its recoverable amount (if determinable); and
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the carrying amount that would have been determined (net of amortisation or
depreciation) had no impairment loss been recognised for the asset in prior
periods.
(ii)
Reversing an impairment loss for goodwill – An impairment loss recognised for
goodwill shall not be reversed in a subsequent period.
(c)
In the Statement of Comprehensive Income
(a) For an individual asset, for which an impairment loss has been recognised or
reversed during the period:
(i) the events and circumstances that led to the recognition or reversal of the
impairment loss;
(ii)
the amount of the impairment loss recognised or reversed;
(iii)
the nature of the asset; and
if the entity reports segment information in accordance with IFRS 8
Operating Segments the reportable segment to which the asset belongs.
(iv)
(b) For a cash-generating unit, for which an impairment loss has been recognised
or reversed during the period:
(i) the events and circumstances that led to the recognition or reversal of the
impairment loss;
(ii) the amount of the impairment loss recognised or reversed;
(iii) a description of the cash-generating unit (such as whether it is a product
line, a plant, a business operation, a geographical area, or a reportable
segment;
(iv) the amount of the impairment loss recognised or reversed by class of
assets and, if the entity reports segment information in accordance with
IFRS 8 Operating Segments, by reportable segment; and
(v) if the aggregation of assets for identifying the cash-generating unit has
changed since the previous estimate of the cash-generating unit’s
recoverable amount (if any), a description of the current and former way of
aggregating assets and the reasons for changing the way the cashgenerating unit is identified.
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(c) If the recoverable amount is:
(i) fair value less costs of disposal, the entity shall disclose the following
information:
-
the level of fair the fair value hierarchy (see IFRS 13 Fair Value
Measurement) within which the fair value measurement of the asset
(cash-generating unit) is categorised in its entirety (without taking into
account whether the ‘costs of disposal’ are observable);
-
for fair value measurements categorized within Level 2 and 3 of the fair
value hierarchy, description of the valuation technique(s) used to
measure fair value less costs of disposal; and each key assumption on
which management has based its determination of fair value less costs
of disposal; or
(ii) value in use , the discount rate(s) used in the current estimate and
previous estimate (if any) of value in use and key assumptions used to
which the asset’s (cash-generating unit’s) recoverable amount is most
sensitive.
(d) An entity shall disclose the information required for each cash-generating unit
(group of units) for which the carrying amount of goodwill or intangible assets with
indefinite useful lives allocated to that unit (group of units) is significant in
comparison with the entity’s total carrying amount of goodwill or intangible assets
with indefinite useful lives:
(i)
the carrying amount of goodwill allocated to the unit (group of units);
(ii)
the carrying amount of intangible assets with indefinite useful lives
allocated to the unit (group of units);
(iii)
the basis on which the unit’s (group of units’) recoverable amount has
been determined (i.e. value in use or fair value less costs of disposal).
(iv)
if the unit’s (group of units’) recoverable amount is based on value in use:
•
each key assumption on which management has based its cash
flow projections for the period covered by the most recent
budgets/forecasts. Key assumptions are those to which the unit’s (group
of units’) recoverable amount is most sensitive.
•
a description of management’s approach to determining the
value(s) assigned to each key assumption, whether those value(s) reflect
past experience or, if appropriate, are consistent with external sources of
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information, and, if not, how and why they differ from past experience or
external sources of information.
•
the period over which management has projected cash flows based
on financial budgets/forecasts approved by management and, when a
period greater than five years is used for a cash-generating unit (group of
units), an explanation of why that longer period is justified.
•
the growth rate used to extrapolate cash flow projections beyond
the period covered by the most recent budgets/forecasts, and the
justification for using any growth rate that exceeds the long-term average
growth rate for the products, industries, or country or countries in which
the entity operates, or for the market to which the unit (group of units) is
dedicated.
•
the discount rate(s) applied to the cash flow projections.
(v)
Or if the unit’s (group of units’) recoverable amount is based on fair value
less costs of disposal, the valuation technique(s) used to measure fair value less
costs of disposal. An entity is not required to provide the disclosures required by
IFRS 13 Fair value measurement. If fair value less costs of disposal is not
measured using a quoted price for an identical unit (group of units), an entity shall
disclose the following information:
•
each key assumption on which management has based its
determination of fair value less costs of disposal. Key assumptions
arethose to which the unit’s (group of units’) recoverable amount is most
sensitive.
•
a description of management’s approach to determining the value
(or values) assigned to each key assumption, whether those values reflect
past experience or, if appropriate, are consistent with external sources of
information, and, if not, how and why they differ from past experience or
external sources of information.
•
the level of the fair value hierarchy within which the fair value
measurement is categorised in its entirety (without giving regard to the
observability of ‘costs of disposal’).
•
if there has been a change in valuation technique, the change and
the reason(s) for making it.
(vi)
And if fair value less costs of disposal is measured using discounted cash
flow projections, an entity shall disclose the following information:
•
the period over which management has projected cash flows.
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•
the growth rate used to extrapolate cash flow projections
•
the discount rate(s) applied to the cash flow projections.
IFRS 5 Non-current Assets Held for Sale and Discontinued Operations
This outlines how to account for non-current assets held for sale (or for distribution to
owners). In general terms, assets (or disposal groups) held for sale are not depreciated,
are measured at the lower of carrying amount and fair value less costs to sell, and are
presented separately in the statement of financial position. Specific disclosures are also
required for discontinued operations and disposals of non-current assets.
Held-for-sale classification
In general, the following conditions must be met for an asset (or 'disposal group') to be
classified as held for sale: [IFRS 5.6-8]
management is committed to a plan to sell the asset is available for immediate sale an
active programme to locate a buyer is initiated the sale is highly probable, within 12
months of classification as held for sale (subject to limited exceptions) the asset is being
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actively marketed for sale at a sales price reasonable in relation to its fair value actions
required to complete the plan indicate that it is unlikely that plan will be significantly
changed or withdrawn
The assets need to be disposed of through sale. Therefore, operations that are expected
to be wound down or abandoned would not meet the definition (but may be classified as
discontinued once abandoned). [IFRS 5.13]
An entity that is committed to a sale involving loss of control of a subsidiary that qualifies
for held-for-sale classification under IFRS 5 classifies all of the assets and liabilities of
that subsidiary as held for sale, even if the entity will retain a non-controlling interest in its
former subsidiary after the sale. [IFRS 5.8A]
Held for distribution to owners classification
The classification, presentation and measurement requirements of IFRS 5 also apply to
a non-current asset (or disposal group) that is classified as held for distribution to owners.
[IFRS 5.5A and IFRIC 17] The entity must be committed to the distribution, the assets
must be available for immediate distribution and the distribution must be highly probable.
[IFRS 5.12A]
Disposal group concept
A 'disposal group' is a group of assets, possibly with some associated liabilities, which an
entity intends to dispose of in a single transaction. The measurement basis required for
non-current assets classified as held for sale is applied to the group as a whole, and any
resulting impairment loss reduces the carrying amount of the non-current assets in the
disposal group in the order of allocation required by IAS 36. [IFRS 5.4]
Measurement
The following principles apply:
At the time of classification as held for sale. Immediately before the initial classification of
the asset as held for sale, the carrying amount of the asset will be measured in
accordance with applicable IFRSs. Resulting adjustments are also recognised in
accordance with applicable IFRSs. [IFRS 5.18] After classification as held for sale. Noncurrent assets or disposal groups that are classified as held for sale are measured at the
lower of carrying amount and fair value less costs to sell (fair value less costs to distribute
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in the case of assets classified as held for distribution to owners). [IFRS 5.15-15A]
Impairment.Impairment must be considered both at the time of classification as held for
sale and subsequently:
At the time of classification as held for sale. Immediately prior to classifying an asset or
disposal group as held for sale, impairment is measured and recognised in accordance
with the applicable IFRSs (generally IAS 16 Property, Plant and Equipment, IAS 36
Impairment of Assets, IAS 38 Intangible Assets, and IAS 39 Financial Instruments:
Recognition and Measurement/IFRS 9 Financial Instruments). Any impairment loss is
recognised in profit or loss unless the asset had been measured at revalued amount
under IAS 16 or IAS 38, in which case the impairment is treated as a revaluation
decrease. After classification as held for sale. Calculate any impairment loss based on
the difference between the adjusted carrying amounts of the asset/disposal group and
fair value less costs to sell. Any impairment loss that arises by using the measurement
principles in IFRS 5 must be recognised in profit or loss [IFRS 5.20], even for assets
previously carried at revalued amounts. This is supported by IFRS 5 BC.47 and BC.48,
which indicate the inconsistency with IAS 36.
Assets carried at fair value prior to initial classification. For such assets, the requirement
to deduct costs to sell from fair value may result in an immediate charge to profit or loss.
Subsequent increases in fair value. A gain for any subsequent increase in fair value less
costs to sell of an asset can be recognised in the profit or loss to the extent that it is not
in excess of the cumulative impairment loss that has been recognised in accordance with
IFRS 5 or previously in accordance with IAS 36. [IFRS 5.21-22] No depreciation. Noncurrent assets or disposal groups that are classified as held for sale are not depreciated.
[IFRS 5.25]
The measurement provisions of IFRS 5 do not apply to deferred tax assets, assets arising
from employee benefits, financial assets within the scope of IFRS 9 Financial Instruments,
non-current assets measured at fair value in accordance with IAS 41 Agriculture, and
contractual rights under insurance contracts. [IFRS 5.5]
Presentation
Assets classified as held for sale, and the assets and liabilities included within a disposal
group classified as held for sale, must be presented separately on the face of the
statement of financial position. [IFRS 5.38]
Disclosures
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IFRS 5 requires the following disclosures about assets (or disposal groups) that are held
for sale: [IFRS 5.41]
description of the non-current asset or disposal group description of facts and
circumstances of the sale (disposal) and the expected timing impairment losses and
reversals, if any, and where in the statement of comprehensive income they are
recognised if applicable, the reportable segment in which the non-current asset (or
disposal group) is presented in accordance with IFRS 8 Operating Segments
Disclosures in other IFRSs do not apply to assets held for sale (or discontinued
operations, discussed below) unless those other IFRSs require specific disclosures in
respect of such assets, or in respect of certain measurement disclosures where assets
and liabilities are outside the scope of the measurement requirements of IFRS 5. [IFRS
5.5B]
Key provisions of IFRS 5 relating to discontinued operations
Classification as discontinuing
A discontinued operation is a component of an entity that either has been disposed of or
is classified as held for sale, and: [IFRS 5.32]
represents either a separate major line of business or a geographical area of operations
is part of a single co-ordinated plan to dispose of a separate major line of business or
geographical area of operations, or is a subsidiary acquired exclusively with a view to
resale and the disposal involves loss of control.
IFRS 5 prohibits the retroactive classification as a discontinued operation, when the
discontinued criteria are met after the end of the reporting period. [IFRS 5.12]
Disclosure in the statement of comprehensive income
The sum of the post-tax profit or loss of the discontinued operation and the post-tax gain
or loss recognised on the measurement to fair value less cost to sell or fair value
adjustments on the disposal of the assets (or disposal group) is presented as a single
amount on the face of the statement of comprehensive income. If the entity presents profit
or loss in a separate statement, a section identified as relating to discontinued operations
is presented in that separate statement. [IFRS 5.33-33A].
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Detailed disclosure of revenue, expenses, pre-tax profit or loss and related income taxes
is required either in the notes or in the statement of comprehensive income in a section
distinct from continuing operations. [IFRS 5.33] Such detailed disclosures must cover
both the current and all prior periods presented in the financial statements. [IFRS 5.34]
Cash flow information
The net cash flows attributable to the operating, investing, and financing activities of a
discontinued operation is separately presented on the face of the cash flow statement or
disclosed in the notes. [IFRS 5.33]
Disclosures
The following additional disclosures are required:
adjustments made in the current period to amounts disclosed as a discontinued operation
in prior periods must be separately disclosed [IFRS 5.35] if an entity ceases to classify a
component as held for sale, the results of that component previously presented in
discontinued operations must be reclassified and included in income from continuing
operations for all periods presented [IFRS 5.36]
Assessments
References
https://www.pkf.com/media/10033170/ias-16-property-plant-and-equipment-summary.pdf
https://www.pkf.com/media/10033172/ias-36-impairment-of-assets-summary.pdf
https://www.pkf.com/media/10031776/ias-38-intangible-assets-summary.pdf
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Module 8
Accounting for Provisions; Revenue Contracts; Employee Benefits and Sharebased Payment
Week 14
Introduction
This module discusses the accounting for provisions, revenue contracts, employee
benefits and share based payment. It includes the recognition, measurement,
presentation and disclosure in the financial statements. The standards and procedures
to account and record these topics are also covered under this module.
Learning Objectives
After studying this module, students should be able to:
1. Define the provision, revenue contracts, employee benefits and share based
payments
2. Understand the recognition, measurement, presentation and disclosure in the
financial statements
3. Explain the application of accounting principles for provision and revenue contracts
4. Differentiate between employees benefits and share based payments
Provision
A provision is an existing liability of uncertain timing or uncertain amount. Provisions are
actually estimated liability because it is both probable and measurable.
Recognition of Provision
A provision is recognized when:
A. An entity has a present obligation (legal or constructive) as a result of past
event;
B. It is probable that an outflow of resources embodying economic benefits will
be required to settle obligation.
C. A reliable estimate can be made of the amount of the obligation.
If these conditions are not met, no provision shall be recognized.
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Legal obligation is an obligation arising from a contract, legislation or other operation of
law.
Constructive obligation is an obligation that derives from an entity’s actions where:
• The entity has indicated to other parties (by a pattern of past practice, published policies
or a current statement) that it will accept certain responsibilities; and
• As a result, the entity has created in the other parties a valid expectation it will discharge
those responsibilities.
Obligating event gives rise to a present obligation and an event that creates a legal or
constructive obligation because the entity has no realistic alternative but to settle the
obligation created by the event.
Pro-forma journal entry:
To record the recognition of a provision:
Expense
xx
Estimated liability
xx
Definition of Contingent Liability
A contingent liability either a:
A. possible obligation arising from past events whose existence will be confirmed
only by the occurrence or non-occurrence of some uncertain future event not
wholly within the entity’s control, or
B. present obligation that arises from a past event but is not recognized because
either:
(i) it is not probable that an outflow of resources embodying economic
benefits will be required to settle the obligation, or
(ii) the amount of the obligation cannot be measured with sufficient reliability.
Relationship between provision and contingent liability
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In general sense, all provisions are contingent because they are uncertain in timing
or amount. The term “contingent” is used for items that are not recognized because their
existence will be confirmed by occurrence or non-occurrence of one or more uncertain
future events not within the control of the entity.
The “contingent liability” is used for liabilities that do not meet the recognition criteria.
Specific Applications
l No provision should be made for future operating losses, including those relating to
a restructuring, as they do not meet the definition of a liability at the end of the
financial reporting period.
l Provisions should be made for onerous contracts, being contracts where the
unavoidable future costs under the contract exceed the expected future economic
benefits (e.g. a leased property sub-let at a lower rent).
l A restructuring is a sale or termination of a line of business, closure of business
locations, changes in management structure or a fundamental re-organization of
the company. No obligation arises for the sale of an operation until there is a
binding sale agreement.
l A provision for restructuring costs is recognized only when the general recognition
criteria are met. More specifically, a constructive obligation only arises when a
detailed formal plan is in place and it has begun or been announced to those
affected by it. A board decision is not enough. Restructuring provisions should
include only direct expenditures caused by the restructuring, not costs that
associated with the ongoing activities of the entity.
Measurement of Provisions
The amount recognized as a provision should be the best estimate of the
expenditure required to settle the present obligation at the financial reporting date.
Consideration in determining best estimate:
1. Risks and uncertainties that surround the underlying events.
2. Future events
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A. Forecast reasonable changes in applying existing technology
B. Ignore possible gains on sale of assets
C. Consider changes in legislation only if virtually certain to be enacted
3. Discounted present value using a pre-tax discount rate that reflects the current
market assessments of the the value of money and the risks specific to the
liability.
4. Reimbursement by another party. The reimbursement should be recognized as a
separate asset provided it is virtually certain that reimbursement will be received
if the entity settles the obligation. The amount recognized as an asset should not
exceed the amount of the provision and it should not be treated as a reduction
of the required provision.
5. Gains on expected disposal of assets.
An entity recognizes gains on expected disposals of assets at the tome of disposition
of assets.
6. Presence of onerous contact
If an entity has an onerous contract, the present obligation under the contract shall
be recognized and measured as a provision.
7. Re-measurement of provisions
The following shall be performed when measuring provisions subsequent to initial
recognition.
A. Review and adjust provisions at each reporting date.
B. If an outflow no longer probable, provision is reversed.
8. Use of provisions
If it is no longer probable that an outflow of resources will be required to settle the
obligation, the provision should be reversed.
Revenue Contracts
IFRS 15 Revenue from Contracts with Customers applies to all contracts with
customers except for: leases within the scope of IAS 17 Leases; financial instruments
and other contractual rights or obligations within the scope of IFRS 9 Financial
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Instruments, IFRS 10 Consolidated Financial Statements, IFRS 11 Joint Arrangements,
IAS 27 Separate Financial Statements and IAS 28 Investments in Associates and Joint
Ventures; insurance contracts within the scope of IFRS 4 Insurance Contracts; and nonmonetary exchanges between entities in the same line of business to facilitate sales to
customers or potential customers.
A contract with a customer may be partially within the scope of IFRS 15 and partially
within the scope of another standard. In that scenario:
A. If other standards specify how to separate and/or initially measure one or more
parts of the contract, then those separation and measurement requirements are applied
first. The transaction price is then reduced by the amounts that are initially measured
under other standards;
B. If no other standard provides guidance on how to separate and/or initially measure
one or more parts of the contract, then IFRS 15 will be applied.
Contract an agreement between two or more parties that creates enforceable rights and
obligations.
Customer a party that has contracted with an entity to obtain goods or services that are
an output of the entity’s ordinary activities in exchange for consideration.
Income increases in economic benefits during the accounting period in the form of inflows
or enhancements of assets or decreases of liabilities that result in an increase in equity,
other than those relating to contributions from equity participants.
Performance obligation a promise in a contract with a customer to transfer to the
customer either a good or service (or a bundle of goods or services) that is distinct; or a
series of distinct goods or services that are substantially the same and that have the same
pattern of transfer to the customer.
Revenue income arising in the course of an entity’s ordinary activities.
Transaction price the amount of consideration to which an entity expects to be entitled
in exchange for transferring promised goods or services to a customer, excluding
amounts collected on behalf of third parties.
Recognition and Measurement of Revenue
Generally, revenue is recognized when entity has transferred promised goods or services
to the customer. IFRS 15 sets out five steps for the recognition process:
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1.
2.
3.
4.
5.
Identify the contract with the customer
Identify the separate performance obligations
Determine the transaction price
Allocate the transaction price to the performance obligations
Recognize revenue when (or as) performance is satisfied
Employee Benefits
These are all forms of consideration given by an entity in exchange for services rendered
or for the termination of employment.
Classification of Employee Benefits
1. Short-term employee benefits are employee benefits (other than termination
benefits) that are expected to be settled wholly before twelve months after the end of the
annual reporting period in which the employees render the related services.
Examples of short-term employee benefits:
A. Wages, salaries and social security contributions
B. Compensated absences(paid vacation and sick leave)
C. Profit sharing and bonuses
D. Non-monetary benefits
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2. Post-employment benefits employee benefits payable after the completion of
employment (excluding termination and short term benefits), such as:
A. Retirement benefits (e.g. pensions, lump sum payments)
B. Other post-employment benefits (e.g. post-employment life insurance, medical
care).
Two types of post-employment benefit plans
A. Defined contribution plan - are post-employment benefit plans under which an
entity pays fixed contributions into a separate entity (a fund) and will have no legal or
constructive obligation to pay further contributions if the fund does not hold sufficient
assets to pay all employee benefits relating to employee service in the current and prior
periods.
B. Defined benefit plan - these are post-employment plans other than defined
contribution plans. These would include both formal plans and those informal practices
that create a constructive obligation to the entity’s employees.
3. Other long-term employee benefits include items such as the following, if not
expected to be settled wholly before twelve months after the end of the annual reporting
period in which the employees render the related service:
A. Long term paid absences such as long service or sabbatical leave
B. Jubilee or other long service benefits
C. Long term disability benefits
D. Profit sharing and bonuses
E. Deferred remuneration
4. Termination benefits an employee benefits provided in exchange for the termination
of an employee’s employment, as a result of either:
A. An entity’s decision to terminate an employee or group employee before the normal
retirement date; or
B. An employee’s decision to accept an offer of benefits in exchange for the
termination of employment.
Recognition and Measurement
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1. Short-term employee benefits
When an employee has rendered service to an entity during an accounting period,
the entity shall recognize the undiscounted amount of short term employee benefits
expected to be paid in exchange for that service:
A. As a liability (accrued expenses), after deducting any amount paid.
B. As an asset (prepaid expense) to the extent that the prepayments will lead to, for
example, a reduction in future payments or a cash refund.
C. As an expense, unless the benefit paid forms part of cost of an asset
(I.e.,PPE,inventories).
If the entity’s expectations of the timing of settlement change temporarily, it need not
reclassify a short term employee benefit.
2. Post-employment benefits
A. Defined Contribution Plans
When an employee has rendered service to an entity during a period, the entity shall
recognize the contribution payable to a defined contribution plan in exchange for that
service:
A. As a liability (accrued expenses), after deducting any contribution already paid. If
the contribution already paid exceeds the contribution due for service before the end of
the reporting period.
B. As an asset (prepaid expense) to the extent that prepayment will lead to, for
example, a reduction in future payments or a cash refund.
C. As an expense, unless another PFRS requires or permits the inclusion of the
contribution in the cost of an asset.
B. Defined Benefit Plans
May be unfunded, or they may be wholly or partly funded by contributions by an entity,
and sometimes its employees, into an entity, or fund, that is legally separate from the
reporting entity and from which the employees benefits are paid. The payment of funded
benefits when they fall due depends not only on the financial position and the investment
performance of the fund but also on an entity’s ability, and willingness, to make good any
shortfall in the fund’s assets. Therefore, the entity is, in substance, underwriting the
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actuarial and investment risks associated with the plan. Consequently, the expense
recognized for a defined benefit plans not necessarily the amount of the contribution due
for the period.
3. Other long-term employee benefits
Accounting for long term benefits is same with accounting for post employment
benefits in that:
A. Actuarial gains and losses are recognized immediately and no ‘corridor’ (as
discussed above for post employment benefits) is applied; and
B. All past service costs are recognized immediately.
4. Termination benefits
Recognize liability and expense at the earlier of:
A. The date the entity can no longer withdraw the benefit or offer
B. The date the entity recognizes restructuring costs under PAS 37.
An entity shall measure termination benefits on initial recognition, and shall measure
and recognize subsequent changes, in accordance with the nature of the employee
benefit, provided that if the termination benefits are an enhancement to post employee
benefits, the entity shall apply the requirements for post employment benefits. Otherwise:
A. If termination benefits settled wholly before 12 months from reporting date,
liabilities should not be discounted.
B. If termination benefits are not settled wholly before 12 months from reporting date,
they should be discounted.
Share-based Payments
A share-based payment is a transaction in which the entity receives goods or
services as consideration for equity instruments of the entity (including shares or share
options), or acquires goods or services for amounts that are based on the price of the
entity’s shares or other equity instruments of the entity.
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Types of Share-based Payments Transactions
1. Equity settled
The entity issues equity instruments in consideration for services received, e.g., stock
options.
2. Cash settled
The entity incurs a liability for services received and liability is based on the entity’s
equity instruments, e.g., stock appreciation rights.
3. Share-based payments with cash alternatives
a. Originally equity-settled and cash settled was subsequently added, or
b. Granted simultaneously
Share option or stock option is a contract that gives the holder the right, but not the
obligation, to subscribe to the entity’s shares at a fixed or determinable price for specified
period of time. It is granted to officers and key employees, as an additional compensation,
to enable them to acquire shares of stock of the entity during a specified period upon
fulfillment of certain conditions at a specified price.
Recognition
In accordance with paragraph 7 of PFRS 2,”an entity shall recognize the goods or
services received or acquired in a share-based payment transaction when it obtains the
goods or as the services are received.” For
1. Equity-settled share based payment transaction - recognize a corresponding
increase in equity if the goods or services were received.
2. Cash-settled share based payment transaction - recognize a liability if the goods
or services were acquired.
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When the goods or services received or acquired in a share based payment transaction
do not qualify from recognition as assets, they shall be recognized as expenses.
Cash-settled share based payment transaction
The entity shall measure the goods or services acquired and the liability incurred at
the fair value of the liability. Until the liability is settled, the entity shall remeasure the fair
value of the liability at the end of each reporting period and at the date of settlement, with
any changes in fair value recognized in profit or loss for the period.
Share-based payments with cash alternatives
1. Continue to recognized the original fair value of the instrument in the normal way.
2. Recognized the liability to settle in cash at the modification date based on the fair value
of the shares at modification date and extent to which the specified services have been
received.
3. Remeasure the fair value of the liability at each reporting date and at the date of
settlement, which any changes in fair value recognized in profit or loss for the period.
4. Balance of the equity components should be the excess of the original fair value of the
equity instruments, date of grant minus fair value of cash alternative, date of
modification)x number of share options x the extent to which the specified services have
been received.
Assessments
Tasks:
1. Discuss on how to identify provisions and revenue contracts
2. Explain the recognition and measurement of provisions and revenue contracts
3. Differentiate between the employee benefits and share based payments
4. Discuss the presentation and disclosure of provision, revenue contracts in the
financial statements
5. Differentiate between employee benefits and share based payments
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References
Ballada, Win (2020), Conceptual Framework and Accounting Standards. Manila,
Philippines. Domdane Publishers Co.
Peralta, Jose F., Valix, Christian Aris M., Valix, Conrado T. (2017), Financial
Accounting Volume Two. Manila, Philippines. GIC Enterprises & Co.,Inc.
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Module 9
Accounting for Leases
Week 15
Introduction
This module discusses the accounting for Leases, its features, recognition,
measurement, presentation and disclosure in the financial statements. It also includes
Lessee Accounting, sale and leaseback.
Learning Objectives
After studying this module, students should be able to:
1. Define and recognize Lease Accounting
2. Discuss the principles for the recognition, measurement, presentation and
disclosure of leases
3. Differentiate between operating lease and financial lease
4. Explain Sale and Leaseback concept
ACCOUNTING FOR LEASES
Lease
Under Appendix A of IFRS 16, a lease is defined as a contract that conveys the right
to use the underlying asset for a period of time in exchange for consideration.
Appendix B9 provides that to be a lease, a contract must convey the right to control
the use of an identified asset.
Types of Lease
1. Finance lease - is a lease that transfers substantially all the risks and rewards
incidental to ownership of an asset. Title may or may not eventually be transferred.
2. Operating lease - is a lease other than a finance lease.
Criteria for Classification of Lease as Finance Lease
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Major Criteria
Under PAS 17, among others, ANY of the following situations would normally lead to
a lease being classified as finance lease:
1. Transfer of ownership
The lease transfers ownership of the leased asset to the lessee at the end of the
lease term.
2. Bargain purchase option
The lease provides that the lessee has the option to purchase the leased asset
at a price sufficiently lower than the fair value of the asset at the date of option
becomes exercisable. And that at the inception of the lease, it is reasonably certain
that the option will be exercised.
3. Major part of the economic life
The lease term is for the major part of the economic life of the asset even if the
title is not transferred. Under the US GAAP,”major part” means atleast 75% of the
economic life of the asset.
4. Substantially all of the fair value of leased asset
The present value of the minimum lease payment amounts to substantially all the
fair value of the leased asset at the inception of the lease.
Other Criteria
Other situations that individually or in combination could also lead to a lease being
classified as finance lease are:
1. Specialized nature
The leased asset is of such specialized nature that only the lessee can use it
without major modification.
2. Losses are borne by the lessee
If the lessee can cancel the lease, the lessor’s losses associated with the
cancellation are borne by the lessee.
3. Gain or losses from changes in fair value accrue to the lessee
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Gains or losses from the fluctuation in the fair value of the residual accrue to the
lessee.
4. Extension of lease term at the option of the lessee
The lessee has the ability to continue the lease for secondary period at a rent that
is substantially lower than market rent.
Accounting for the Finance Lease: Book of the Lessee
IFRS 16, paragraph 22, provides that at the commencement date, a lessee shall
recognize a right of use asset and a lease liability. This simply means that a lessee is
required to initially recognize a right of use asset for the right to use the underlying asset
over the lease term and a lease liability for the obligation to make payments.
Initial measurement right of use asset
A right of use asset is defined as an asset that represents the right of lessee to use
an underlying asset over the lease term finance lease.
IFRS 16, paragraph 23, provides that the lessee shall measure the right of use asset
at cost at commencement date.
Paragraph 24 provides that the cost of right of use asset comprises:
A. The amount of initial measurement of the lease liability or the present value of
lease payments.
B. Lease payments made to lessor at or before commencement date, such as lease
bonus, less any lease incentives received.
C. Initial direct costs incurred by the lessee.
D. Estimate of cost of dismantling, removing and restoring the underlying asset for
which the lessee has a present obligation.
Subsequent measurement right of use asset
IFRS 16, paragraph 29, provides that a lessee shall measure the right of use asset
applying the cost model.
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To apply the cost model, the lessee shall measure the right use of an asset at cost
less any accumulated depreciation and impairment loss.
Moreover, the carrying amount of the right of use asset is adjusted for any
remeasurement of the lease liability.
Initial measurement of the lease liability
The lease liability should be initially recognized and measured at the present value of
the lease payments. Lease payments comprise:
1. Fixed payments, less any lease incentives receivable
2. Variable lease payments that depend on an index or a rate
3. Amounts expected to be payable by the lessee under residual value guarantees,
4. The exercise price of a purchase option if the lessee is reasonably certain to exercise
that option; and
5. Payments of penalties for terminating the lease, if the lease term reflects the lessee
exercising an option to terminate the lease.
Subsequent measurement of the lease liability
After the initial recognition, the measurement of a lease liability is affected by:
1. Accruing interest on the lease liability
Lease liabilities are measured on an amortized cost basis using an effective interest
method, similarly to other financial liabilities
Interest is recognized in P/L unless it can be capitalized under IAS 23.
2. Lease payments made
Lease payments reduce the carrying amount of the lease liability.
Variable lease payments not included in the measurement of the lease liability are
recognized in P/L in the period in which the event or condition that triggers those
payments occurs.
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3. Remeasurements reflecting any reassessment or lease modifications.
Remeasurements of the lease liability are treated as adjustments to the right-of-use
asset. If the carrying amount is reduced to zero, any further reduction is recognized
immediately in P/L.
The lease liability is remeasured when:
A. there is a change in the assessment of a lease term, or
B. there is a change in the assessment of an option to purchase the underlying asset,
or
C. there is a change in the amounts expected to be payable under a residual value
guarantee, or
D. there is a change in future lease payments resulting from a change in an index or
a rate used to determine those payments
The remeasurements made under (a) and (b) should be made using a revised
discount rate, and under (c) and (d) using an unchanged discount rate. However,
remeasurements made under (d) should be made using a revised discount rate if they
are caused by a change in floating interest rates.
Accounting for the Finance Lease: Book of the Lessor
Finance Lease-Lessor
A. Direct Financing Lease
Does not involve a manufacturer’s or dealer’s profit. Initial direct cost is included in
the initial measurement of the net lease receivable or net investment. If there is initial
direct cost a new implicit rate will be computed using interpolation.
Gross investment in the lease is the total of the minimum lease payments receivable by
the lessor under a finance lease plus any unguaranteed residual value accruing to the
lessor. This figure is actually the amount debited to the lease receivable.
Net investment in the lease is equal to the gross investment less unearned finance
income or the gross investment in the lease discounted at the interest rate implicit in the
lease.
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ACC 203 CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS
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Manufacturer’s or dealer’s profit is the difference between the present value of the
minimum lease payments and the cost of the leased asset.
B. Sales type lease
Involves the recognition of a manufacturer’s or dealer’s profit or loss on the transfer
of the asset to the lessee. Initial direct cost is expensed immediately (or added to the cost
of sales account.)
Gross investment this is equal to the gross rentals for the entire lease term plus the
absolute amount of the residual value, whether guaranteed or unguaranteed.
Net investment in the lease this is equal to the present value of the gross rentals plus
the present value of the residual value, whether guaranteed or unguaranteed.
Unearned interest income is the difference between the difference between the gross
investment and net investment in the lease.
Sales is the amount to the net investment in the lease or fair value of the asset, whichever
is lower.
Cost of goods sold this is equal to the cost of the asset sold plus the initial direct cost
paid by the lessor.
Gross profit this is usual formula of sales minus cost of good sold.
Accounting for the Operating Lease: Book of the Lessee
IFRS 16, paragraph 5, provides that a lessee is permitted to make an accounting
policy election to apply the operating lease accounting and not recognize an asset and
lease liability in two optional exemptions.
A. Short term lease
Appendix A defines a short term lease as a lease that has as term of 12 months or
less at the commencement date of the lease.
B. Low value lease
Appendix B3 states that a lessee shall assess the value of un underlying asset based
on the value of the asset when it is new regardless of the age of the asset being leased.
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ACC 203 CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS
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Paragraph 6 provides that if the lease elects to apply the operating lease accounting
under the two exemptions, the lessee shall recognize lease payments as an expense in
either a straight line basis over the lease term or another systematic basis.
Accounting for the Operating Lease: Book of the Lessor
IFRS 16, paragraph 81, provides that a lessor shall recognize lease payments from
operating lease as income either on a straight line basis or another systematic basis.
The lessor shall apply another systematic basis if this is more representative of the
pattern in which benefit from the use of the underlying asset is diminished.
Otherwise stated, the periodic rental received by the lessor in an operating lease is
simply recognized as rent income.
A lessor shall present an underlying asset subject to operating lease in the statement
of financial position according to the nature of asset.
The underlying asset remains as an asset of the lessor. Consequently, the lessor
bears all ownership or executory costs such as depreciation of leased property, real
property taxes, insurance and maintenance.
However, the lessor may pass on to the lessee the payment for taxes, insurance and
maintenance cost.
The depreciation policy for depreciable leased asset shall be consistent with the
lessor’s normal depreciation for similar asset.
Accounting for Sales and Leaseback
A sale and leaseback is an arrangement whereby one party sells a property to
another party and then immediately leases the property back from its new owner. Thus,
the seller becomes a seller-lessee and the purchaser.
Pro-forma journal entries
Books of the seller-lessee
1. To record the sale
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ACC 203 CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS
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Cash (consideration received)
xx
Accumulated Depreciation
xx
Loss on sale of asset (if any)
xx
Equipment (consideration given)
xx
Deferred gain on sale and leaseback(if any)
xx
2. To record the leaseback
Equipment
xx
Lease liability
xx
3. To record the first rental payment
Lease liability
xx
Interest expense
xx
Cash
xx
4. To record depreciation of leased asset
Depreciation expense
xx
Accumulated Depreciation
xx
5. To record amortization of deferred gain
Deferred gain on sale and leaseback
xx
Gain on sale and leaseback
xx
Books of the purchaser-lessor
1. To record the purchase
Equipment
xx
Cash
xx
2. To record the lease as finance lease
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ACC 203 CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS
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Lease receivable
xx
Equipment
xx
Unearned interest income
xx
3. To record the first rental payment
Cash
xx
Lease receivable
xx
4. To record earned interest
Unearned interest income
xx
Interest Income
xx
Leaseback as a Operating Lease
For leaseback as an operating lease, the following rules should be observed:
Pro-forma journal entries
Books of the seller-lessee
1. To record the sale
Cash (consideration received)
xx
Accumulated Depreciation
xx
Loss on sale of asset (if any)
xx
Deferred loss on sale and leaseback(if any)
xx
Equipment (consideration given)
xx
Gain on sale and leaseback(if any)
xx
Deferred gain on sale and leaseback(if any)
xx
2. To record annual rental
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ACC 203 CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS
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Rent Expense
xx
Cash
xx
3. To record amortization of deferred gain
Deferred gain on sale and leaseback
xx
Gain on sale and leaseback
xx
4. To record amortization of deferred loss
Loss on sale and leaseback/Rent Expense
Deferred loss on sale and leaseback
xx
xx
Books of the purchaser-lessor
1. To record the purchase
Equipment
xx
Cash
xx
2. To record the first rental payment
Cash
xx
Rent Income
xx
3. To record depreciation of leased asset
Depreciation Expense xx
Accumulated Depreciation
xx
Sale and Leaseback
A transaction which involves the sale of an asset and the leasing back of the same asset.
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IFRS 16 requires an initial assessment to be made regarding whether or not the transer
constitute a sale.
Assessments
Tasks:
1. Define the Accounting for Leases
2. Explain the Major and other criteria in recognition of Lease
3. Differentiate between Operating Lease and Finance lease
4. Discuss the proforma entries for Lease
References
Ballada, Win (2020), Conceptual Framework and Accounting Standards. Manila,
Philippines. Domdane Publishers Co.
Peralta, Jose F., Valix, Christian Aris M., Valix, Conrado T. (2017), Financial
Accounting Volume Two. Manila, Philippines. GIC Enterprises & Co.,Inc.
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Module 10
Accounting for Insurance Contracts; Deferred Tax; and Earnings per Share
Week 16-17
Introduction
This module comprises Accounting for Insurance Contracts, Deferred Tax, and
Earnings per share topics. It tackles the definition, measurement and recognition of
these items. The related standards are incorporated in the discussion as well as the
presentation and disclosure in the financial statements.
Learning Objectives
After studying this module, students should be able to:
1. Understand and explain the concepts under Insurance Contracts, Deferred Tax
and Earnings per share
2. State the recognition and measurement under the accounting standards
3. Demonstrate the presentation and disclosure of the
Accounting for Insurance Contracts
Definition of Insurance Contracts
The Insurance Contracts is a “contract under which one party (the insurer) accepts
significant insurance risk from another party (the policyholder) by agreeing to compensate
the policyholder if a specified uncertain future event (the insured event) adversely affects
the policyholder.”
Scope of Insurance Contracts
Insurance contracts, including reinsurance contracts, it issues; Reinsurance contracts
it holds; and investment contracts with discretionary participation features it issues,
provided the entity also issues insurance contracts.
Some contracts meet the definition of an insurance contract but have as their primary
purpose the provision of services for a fixed fee. Such issued contracts are in a scope of
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ACC 203 CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS
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the standard, unless an entity chooses to apply to them IFRS 15 Revenue from Contracts
with Customers and provided the following conditions are met:
A. The entity does not reflect an assessment of the risk associated with an individual
customer in setting the price of the contract with that customer;
B. The contract compensates the customer by providing a service, rather than making
cash payments to the customer;
C. The insurance risk transferred by the contract arises primarily from the customer’s
use of services rather than from uncertainty over the cost of those services.
Recognition of Insurance Contracts
An entity shall recognize a group of insurance contracts issued from the earliest of the
following:
a. The beginning of the coverage period of the group of contracts
b. The date when the first payment from a policyholder in the group becomes due
c. For a group of onerous contracts, when the group becomes onerous.
Measurement of Insurance Contracts
On initial recognition, an entity shall measure a group of insurance contracts at the total
of the fulfillment of cash flows and contractual margin. Subsequently, the carrying amount
of a group insurance contract at the end of each reporting period shall be the sum of: the
liability for remaining coverage and the liability for incurred claims.
Deferred Tax
Definition of Deferred tax liability and Deferred tax asset
1. Deferred tax liability is the amount of income tax payable in future periods with respect
to a taxable temporary difference. It also the deferred tax consequences attributable to
taxable temporary difference or future taxable amount.
Actually, a deferred tax liability arises from the following:
A. When the accounting income is higher than taxable income because of timing
differences.
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ACC 203 CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS
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B. When carrying amount of an asset is higher than tax base.
C. When carrying amount of a liability is lower than the tax base.
2. Deferred tax asset is the amount of income tax recoverable in the future periods with
respect to deductible temporary difference and operating loss carry forward. In other
words, a deferred tax asset is the deferred tax consequence attributable to a future
deductible amount and operating loss carry forward.
A deferred tax asset arises from the following:
A. When the accounting income is higher than taxable income because of timing
differences.
B. When tax base of an asset is higher than carrying amount.
C. When tax base of a liability is lower than the carrying amount.
Recognition of Deferred tax liability
PAS 12, paragraph 15, provides that deferred tax liability shall be recognized for all
taxable temporary differences.
However, a deferred tax liability is not recognized when the taxable temporary
difference arises from:
A. Goodwill resulting from a business combination and whivh is nondeductible for tax
purposes.
B. Initial recognition of an asset or liability in a transaction that is not a business
combination and affects neither accounting income nor taxable income.
C. Undistributed profit of subsidiary, associate or joint venture when the parent,
investor or venturer is able to control the timing of the reversal of the temporary difference.
Recognition of Deferred tax asset
PAS 12, paragraph 24, provides that a deferred tax asset shall be recognized for all
deductible temporary differences and operating loss carry forward when it is probable that
taxable income will be available against which the deferred tax asset can be used.
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ACC 203 CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS
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Operating loss carry forward is an excess of tax deductions over gross income in a
year that may be carried forward to reduce taxable income in a future year.
Certain entities registered with the Board of Investments are permitted to carry over
net operating loss for tax purposes subject to limitations of the relevant law and
implementing regulations of the Board of Investments.
Earnings per Share
Earning per share is the amount attributable to every share of ordinary share
outstanding during the period. Thus, the earnings per share information pertain only to
ordinary share. Earnings per share is not computed for preference share because there
is a fixed rate return for such share.
Types of Earning per Share
1. Basic Earnings per share
Determination of basic earnings (or loss) per share
The net income is equal to the amount after deducting dividends on preference share.
If the preference share is cumulative, the preference dividend for the current year only
is deducted from the net income, whether such dividend is declared or not. If the
preference share is noncumulative, the preference dividend for the current year is
deducted from the net income only if there is declaration. If there is a significant change
in the ordinary share capital during the year, the weighted average number of ordinary
shares outstanding during the period should be used as denominator.
In a bonus issue, ordinary shares are issued to existing shareholders for no
consideration. Therefore, the number of ordinary shares is increased without increase
in resources. A bonus issue is actually a share dividend.
Application Guidance 2 of PAS 33, provides that “the number of ordinary shares to
be used in calculating basic earnings per share for all periods prior to the rights issue
is the number of ordinary shares outstanding prior to the rights issue multiplied by an
adjustment factor”.
2. Diluted earnings per share
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ACC 203 CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS
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It is the amount attributable to every share of ordinary share outstanding during the
period while giving effect to all dilutive potential ordinary shares outstanding during the
period.
The reduction in earnings per share or an increase in loss per share resulting from
the assumption that convertible instruments are converted, that options or warrants are
exercised, or that ordinary shares are issued upon the satisfaction of specified conditions
is termed as dilution.
Potential ordinary share is a financial instrument or other contract that may entitle
the holder to ordinary shares or represents future issuance of ordinary shares.
Three major types of potential ordinary shares:
1. Convertible bond payable are dilutive whenever interest per ordinary share obtainable
on conversion is lesser that the basic earnings per share. The computation of diluted
earnings per share assumes that the bonds payable is converted into ordinary share.
Accordingly, adjustments shall be made both to net income and to the number of
ordinary shares outstanding. The net income is adjusted by adding back the interest
expense on the bond payable, net of tax.
The number of ordinary shares outstanding is increased by the number of ordinary
shares that would have been issued upon conversion of the bond payable.
2. Convertible preference share are dilutive whenever the amount of dividend on such
shares declared in or accumulated for the current period per ordinary share obtainable
on conversion is lesser than the basic earnings per share. The computation of diluted
earnings per share also assumes that the bonds payable is converted into ordinary share.
Accordingly, the net income is not reduced anymore by the amount of preference
dividend. The number of ordinary shares outstanding is increased by the number of
ordinary shares that would have been issued upon conversion of the preference share.
3. Share option and warrant have a dilutive effect only when the average market price of
ordinary shares during the period exceeds the exercise price of the options or warrants.
For the purpose of calculating diluted earnings per share, an entity shall assume the
exercise of dilutive options and warrants of the entity.
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ACC 203 CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS
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The assumed proceeds from these instruments shall be regarded as having been
received from the issue of ordinary shares at the average market price of ordinary shares
during the period. This is also known as treasury shares method.
The difference between the number of ordinary shares issued and the number of
ordinary shares that would have been issued at the average market price of ordinary
shares during the period shall be treated as an issue of ordinary shares for no
considerations.
Entities required to present earnings per share
Public enterprises are required to present earnings per share to achieve comparability
in financial reporting. On the other hand, nonpublic enterprises are only encouraged but
not required to present earnings per share.
Assessments
Tasks:
1. Define the Accounting for Insurance Contracts and Deferred Tax
2. Explain the concept of Earnings per Share
3. Discuss the measurement and recognition for Insurance Contracts and Deferred
Tax
References
Ballada, Win (2020), Conceptual Framework and Accounting Standards. Manila,
Philippines. Domdane Publishers Co.
Peralta, Jose F., Valix, Christian Aris M., Valix, Conrado T. (2017), Financial
Accounting Volume Two. Manila, Philippines. GIC Enterprises & Co.,Inc.
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