Advanced Financial Accounting and Corporate Reporting (Study Text)
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photocopying, recording or otherwise without prior written
permission or the ICMA’s Head Office.
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First Edition Published in 2014
Contents developed by a consortium led by KAPLAN.
Second Edition Published in 2020
Contents updated by the ICMA International
Third Edition Published in 2024
Contents updated by the ICMA International
Disclaimer
This document has been developed to serve as a comprehensive study
and reference guide to the faculty members, examiners and students.
It is neither intended to be exhaustive nor does it purport to be a legal
document. In case of any variance between what has been stated and
that contained in the relevant act, rules, regulations, policy statements
etc., the latter shall prevail. While utmost care has been taken in the
Advanced Financial Accounting and Corporate Reporting (Study Text)
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preparation of this publication, it should not be relied upon as a
substitute of legal advice.
Any deficiency found in the contents of study text can be reported to
the Education Department at
Advanced Financial Accounting and Corporate Reporting (Study Text)
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HOW TO USE THE MATERIAL
The main body of the text is divided into a number of chapters, each of which is
organized on the following pattern:
1) Detailed learning outcomes. You should assimilate theses before beginning
detailed work on the chapter, so that you can appreciate where your studies are
leading.
2) Step-by-step topic coverage. This is the heart of each chapter, containing detailed
explanatory text supported where appropriate by worked examples and exercises.
You should work carefully through this section, ensuring that you understand the
material being explained and can tackle the examples and exercises successfully.
Remember that in many cases knowledge is cumulative; if you fail to digest earlier
material thoroughly; you may struggle to understand later chapters.
3) Examples. Most chapters are illustrated by more practical elements, such as
relevant practical examples together with comments and questions designed to
stimulate discussion.
4) Self Test question. The test of how well you have learned the material is your ability
to tackle standard questions. Make a serious attempt at producing your own
answers, but at this stage don’t be too concerned about attempting the questions in
exam conditions. In particular, it is more important to absorb the material thoroughly
by completing a full solution than to observe the time limits that would apply in the
actual exam.
5) Solutions. Avoid the temptation merely to ‘audit’ the solutions provided. It is an
illusion to think that this provides the same benefits as you would gain from a
serious attempt of your own. However, if you are struggling to get started on a
question you should read the introductory guidance provided at the beginning of the
solution, and then make your own attempt before referring back to the full solution.
Advanced Financial Accounting and Corporate Reporting (Study Text)
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STUDY SKILLS AND REVISION GUIDANCE
Planning
To begin with, formal planning is essential to get the best return from the time you spend
studying. Estimate how much time in total you are going to need for each subject you are
studying for the Managerial Level. Remember that you need to allow time for revision as well
as for initial study of the material. This book will provide you with proven study techniques.
Chapter by chapter it covers the building blocks of successful learning and examination
techniques. This is the ultimate guide to passing your ICMAP written by a team of
developers and shows you how to earn all the marks you deserve, and explains how to
avoid the most common pitfalls.
With your study material before you, decide which chapters you are going to study in each
week, and which weeks you will devote revision and final question practice.
Prepare a written schedule summarizing the above and stick to it.
It is essential to know your syllabus. As your studies progress you will become more familiar
with how long it takes to cover topics in sufficient depth. Your timetable may need to be
adapted to allocate enough time for the whole syllabus.
Tips for effective studying
1)
Aim to find a quiet and undisturbed location for your study, and plan as far
as possible to use the same period of time each day. Getting into a routine
helps to avoid wasting time. Make sure that you have all the materials you
need before you begin so as to minimize interruptions.
2)
Store all your materials in one place, so that you do not waste time
searching for items around your accommodation. If you have to pack
everything away after each study period, keep them in a box or even a
suitcase, which will not be disturbed until the next time.
3)
Limit distractions. To make the most effective use of your study periods you
should be able to apply total concentration, so turn off all entertainment
equipment, set your phones to message mode and put up your ‘do not
disturb’ sign.
4)
Your timetable will tell you which topic to study. However, before dividing in
and becoming engrossed in the finer points, make sure you have an overall
picture of all the areas that need to be covered by the end of that session.
After an hour, allow yourself a short break and move away from your study
text. With experience. You will learn to assess the pace you need to work at
Advanced Financial Accounting and Corporate Reporting (Study Text)
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5)
Work carefully through a chapter, note imported points as you go. When you
have covered a suitable amount of material, very the pattern by attempting a
practice question. When you have finished your attempt, make notes of any
mistakes you make, or any areas that you failed to cover or covered more
briefly.
Advanced Financial Accounting and Corporate Reporting (Study Text)
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CONTENT
S No. Chapters
Page No
1
Substance over form
08
2
Financial instruments
22
3
Employee benefits
67
4
Share-based payments
97
5
Fair Value Measurement
120
6
Other Financial Reporting Standards
131
7
Introduction to group accounting
154
8
Consolidated statement of financial position
164
9
Consolidated statement of comprehensive income
228
10
Investment in associates and joint ventures
264
11
Changes in group structure
306
12
Complex group Structures
365
13
Group accounting - Foreign currency
414
14
Group statement of cash flows
470
15
Earnings Per share
535
16
Non-Financial Reporting
568
17
International Public Sector Accounting standards
(IPSASs)
605
18
Preparation and presentation of Financial Statements
of Specialized Companies
620
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Advanced Financial Accounting and Corporate Reporting (Study Text)
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SUBSTANCE OVER FORM
Chapter learning objectives
Upon completion of this chapter you, will be able to:
•
Explain and demonstrate the importance of recording the commercial substance
rather than the legal form of transactions
•
Describe the features which may indicate that the substance of transactions differs
from their legal form
•
Apply the principle of substance over form to recognition and derecognition of assets
and liabilities
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1
Reporting the Substance of Transactions
1.1
Introduction
IAS 1 requires that financial statements:
•
•
1.2
must represent faithfully the transactions that have been carried out
must reflect the economic substance of events and transactions and not
merely their legal form.
The Historical Problem
Historically, many companies tried to keep items off the statement of financial
position by ignoring their real substance.
Examples include:
•
leasing of assets – prior to the issue of IAS 17, leases were not capitalised,
i.e. the asset and its related financial commitment were not shown on the
lessee’s statement of financial position
•
controlled non-subsidiaries – under the definitions of a subsidiary prior to IAS
27, companies could control other companies by legal arrangements under
which technically they were not subsidiaries, so they were not consolidated in
the group accounts.
Example 1
Off Balance Sheet Finance
Note down two or three reasons why companies might wish to keep financing
liabilities off their statements of financial position.
Solution
There are a number of reasons why companies might wish to avoid showing
financing liabilities on their statements of financial position:
•
to maintain a level of gearing similar to their counterparts in other countries
(having regard to comparable permissible borrowing levels)
•
to maintain the share price on the basis that the market would place a lower
value on a company whose borrowings are considered by the analysts to be
high
•
to maintain ROCE by keeping the asset and the related liability out of the
statement of financial position until the asset starts to produce income
•
in groups of companies to keep activities which have different characteristics
(e.g. high gearing ratios) separate (by keeping them off the statement of
financial position) in order not to distort the financial ratios of the remainder of
the group.
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1.3
Determining the substance of a transaction
Common features of transactions whose substance is not readily apparent are:
•
•
•
the legal title to an asset may be separated from the principal benefits and
risks associated with the asset (such as is the case with finance leases)
a transaction may be linked with other transactions which means that the
commercial effect of the individual transaction cannot be understood without
an understanding of all of the transactions
options may be included in a transaction where the terms of the option make
it highly likely that the option will be exercised.
Identifying assets and liabilities
Key to determining the substance of a transaction is to identify whether assets and
liabilities arise subsequent to that transaction by considering:
•
•
who enjoys the benefits of any asset
who is exposed to the principal risks of any asset.
Assets are defined in the Framework as resources controlled by the entity as a result
of past events and from which future economic benefits are expected to flow to the
entity.
Liabilities are defined in the Framework as present obligations of the entity arising
from past events, the settlement of which is expected to result in an outflow of
resources from the entity.
2
Examples Where Substance and Form may Differ
2.1
Introduction
Examples of areas where substance and form may differ include:
•
consignment inventory and goods on sale or return
•
sale and repurchase agreements
•
sale and leaseback agreements
•
factoring of receivables.
2.2
Consignment inventory
Consignment inventory is inventory which:
•
•
is legally owned by one party
is held by another party, on terms which give the holder the right to sell the
inventory in the normal course of business or, at the holder’s option, to return
it to the legal owner.
This type of arrangement is common in the motor trade.
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Accounting for consignment inventory
Key question:
In which company’s statement of financial position should the car appear as
inventory between 1 May 20X9 and 30 June 20X9?
Factors to consider are:
•
•
Who bears the risks of the inventory?
Who has the benefits or rewards of the inventory?
Whoever bears the risks of the inventory should recognise it in the statement of
financial position.
Consignment inventory further detail
Legal title may pass when one of a number of events has occurred, e.g. when the
holder has held the inventory for a specified period such as six months, or when the
holder has sold the goods.
The sales price (to the holder of the inventory) may be determined at the date of
supply, or it may vary with the length of the period between supply and purchase, or
it may be the legal owner’s factory price at sale.
Other terms of such arrangements can include a requirement for the holder to pay a
deposit, and responsibility for insurance.
The arrangement should be analysed to determine whether the holder has in
substance acquired the inventory before the date of transfer of legal title.
The key factor will be who bears the risk of slow moving inventory. The risk involved
is the cost of financing the inventory for the period it is held.
In a simple arrangement where inventory is supplied for a fixed price that will be
charged whenever the title is transferred and there is no deposit, the legal owner
bears the slow movement risk. If, however, the price to be paid increases by a factor
that varies with interest rates and the time the inventory is held, then the holder bears
the risk.
If the price charged to the dealer is the legal owner’s list price at the date of sale,
then again, the risks associated with the inventory fall on the legal owner. Whoever
bears the slow movement risk should recognise the inventory in their accounts.
Example 2
Consignment Inventory
Hafeez Carmart, a car dealer, obtains stock from ABC Ltd, its manufacturer, on a
consignment basis. The purchase price is set at delivery and is calculated to include
an element of finance. Usually, Hafeez Carmart pays ABC Ltd for the car the day
after Carmart sells to a customer. However, if the car remains unsold after six
months then Carmart is obliged to purchase the car. There is no right of return.
Further, Carmart is responsible for insurance and maintenance from delivery.
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Describe how Hafeez Carmart should account for the above transactions.
Solution
•
•
•
•
Dealer faces the risk of slow movement as it is obliged to purchase the car
and has no right of return.
Dealer insures and maintains the cars.
Dealer faces risk of theft.
Dealer can sell the cars to the public.
Recognise the cars on dealer’s statement of financial position at delivery.
2.3
Sale and repurchase agreements
Introduction
Sale and repurchase agreements are situations where an asset is sold by one party
to another. The terms of the sale provide for the seller to repurchase the asset in
certain circumstances at some point in the future.
Sale and repurchase agreements are common in property developments
Accounting for sale and repurchase agreements
Arif Habib Bank
Hamid Ltd
Sells some machines to
The Bank for Rs 600,000
On 1 Jan 2000 and promises
to repurchase them 10 years
later for Rs 750,000
Key question:
Is the commercial effect of the transaction that of a sale or of a secured loan?
Factors to consider, whether
•
•
•
right to use asset
obligation / likely to repurchase
sales price below market price
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Example 3
Sale and Repurchase
X sold a building to Z an investment company, for Rs1 million when the current
market value was Rs2 million.
X can repurchase the property at any time within the next three years for the original
selling price (Rs1 million) plus a sum, added quarterly, based on the bank base
lending rate plus 2%.
How should X account for this transaction?
Solution
The substance of this deal is a secured loan from Z to X, with the expectation being
that X will exercise its option to repurchase the building.
No sale should therefore be recognised; the Rs1 million is a loan received from Z.
2.4
Sale and leaseback
Introduction
A sale and repurchase agreement can be in the form of a sale and leaseback.
•
Under a sale and leaseback transaction, an entity sells one of its own assets
and immediately leases the asset back’s is a common way of raising finance
whilst retaining the use of the related assets. The buyer / lessor is normally a
bank.
The leaseback is classified as finance or operating in accordance with the
usual IAS 17 criteria.
Accounting for sale and leaseback
Sale and finance leaseback:
•

•
asset derecognised, with any profit or loss deferred over the lease term.
asset then reinstated in accordance with IAS 17 finance lease rules (i.e.
recognise finance leased asset and liability at the lower of fair value or
present value of minimum lease payments).
asset value depreciated over lease term and lease interest charged to
statement of comprehensive income in accordance with actuarial method.
Sale and operating leaseback:
•
a sale is recorded and asset derecognised.
Operating lease rentals are recorded in the statement of comprehensive
income.
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2.5
Factoring of receivables
Introduction
Factoring of receivables is where a company transfers its receivables balances to
another organisation (a factor) for management and collection and receives an
advance on the value of those receivables in return.
Accounting for the factoring of receivables
Key question:
Is the seller in substance receiving a loan on the security of his receivables, or are
the receipts an actual sale of those receivable balances?
Factors to consider:
•
who bears the risk (of slow payment and irrecoverable debts).
Factoring of receivables further detail
In most forms of factoring, receivables balances are sold to the factor, but the latter’s
degree of control over, and responsibility for, those debts will vary from one
arrangement to another.
A significant accounting question is only likely to arise where the factoring
arrangement leads to the receipt of cash earlier than would have been the case had
the receivables been unfactored. If this is so, the question to be answered is whether
the seller has in substance received either a loan on the security of his receivables,
or has actually sold the receivable.
If the seller is in essence a borrower, and the factor a lender, then the arrangements
will be such as to provide that the seller pays the equivalent of interest to the factor
on the timing difference between amounts received by him from the factor and those
collected by the factor from the receivable. Such payment would be in addition to any
other charges.
The key factor in the analysis will be who bears the risk (of slow payment) and the
benefit (of early payment) by the receivable. If the finance cost reflects events
subsequent to transfer, then the transfer is likely to be equivalent to obtaining finance
because the seller is bearing the risks and rewards of the receivable. If the cost is
determined when the transfer is made, with no other variable costs, then it is likely to
be a straightforward sale.
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Chapter Summary
Advanced Financial Accounting and Corporate Reporting (Study Text)
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Self-Test Questions
1.
On 1 January 20X6 Carmaker Ltd, a manufacturer, entered into an agreement to
provide Sunrise Ltd, a retailer, with machines for resale. The terms of the
agreement were as follows.
•
•
•
•
•
•
•
Sunrise Ltd pays a fixed rental per month for each machine that it holds.
Sunrise Ltd pays the cost of insuring and maintaining the machines.
Sunrise Ltd can display the machines in its showrooms and use them as
demonstration models.
When a machine is sold to a customer, Sunrise Ltd pays Carmaker Ltd the
factory price at the time the machine was originally delivered.
All machines remaining unsold six months after their original delivery must be
purchased by Sunrise Ltd at the factory price at the time of delivery.
Carmaker Ltd can require Sunrise Ltd to return the machines at any time
within the six months period. In practice, this right has never been exercised.
Sunrise Ltd can return unsold machines to Carmaker Ltd at any time during
the six months period, without penalty. In practice, this has never happened.
At 31 December 20X6 the agreement is still in force and Sunrise Ltd holds several
machines which were delivered less than six months earlier.
How should these machines be treated in the accounts of Sunrise Ltd for the
year ended 31 December 20X6?
2.
Zaviar sells its head office, which cost Rs 10 million, to Pearl Ltd, a bank, for Rs 10
million on 1 January. Zaviar has the option to repurchase the property on 31
December, four years later at Rs 12 million. Zaviar will continue to use the property
as normal throughout the period and so is responsible for the maintenance and
insurance. The head office was valued at transfer on 1 January at Rs 18 million and
is expected to rise in value throughout the four-year period.
Giving reasons, show how Zaviar should record the above during the first year
following transfer
3.
Bright Ltd sold an item of machinery and leased it back over a five year finance lease.
The sale took place on 1 January 20X4 and the company has a 31 December year
end. The details of the scheme are as follows:
Proceeds of sale
Fair value of machine at date of sale
Carrying value of asset at date of sale
Annual lease payments (in arrears)
Remaining useful life of machine at date of sale
Implicit rate of interest
Rs
1,000,000
1,000,000
750,000
277,409
5 years
12%
Prepare the statement of comprehensive income and statement of financial
position extracts for Bright at 31 December 20X4
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4.
An entity has an outstanding receivables balance with a major customer
amounting to Rs 12 million and this was factored to Finance Co on 1
September 20X7. The terms of the factoring were:
Finance Co will pay 80% of the gross receivable outstanding account to the entity
immediately.
•
•
•
The balance will be paid (less the charges below) when the debt is collected
in full. Any amount of the debt outstanding after four months will be
transferred back to the entity at its full book value.
Finance Co will charge 1.0% per month of the net amount owing from the
entity at the beginning of each month. Finance Co had not collected any of
the factored receivable amount by the yearend.
the entity debited the cash from Finance Co to its bank account and removed
the receivable from its accounts. It has prudently charged the difference as an
administration cost.
How should this arrangement be accounted for in the financial statements for
the year ended 30 September 20X7?
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Answers
1.
The key issue is whether Sunrise Ltd has purchased the machines from Carmaker
Ltd or whether they are merely on loan.
It is necessary to determine whether Sunrise Ltd has the benefits of holding the
machines and is exposed to the risks inherent in those benefits.
Carmaker Ltd can demand the return of the machines and Sunrise Ltd is able to
return them without paying a penalty. This suggests that Sunrise Ltd does not have
the automatic right to retain or to use them.
Sunrise Ltd pays a rental charge for the machines, despite the fact that it may
eventually purchase them outright. This suggests a financing arrangement as the
rental could be seen as loan interest on the purchase price. Sunrise Ltd also incurs
the costs normally associated with holding inventories.
The purchase price is the price at the date the machines were first delivered. This
suggests that the sale actually takes place at the delivery date. Sunrise Ltd has to
purchase any inventory still held six months after delivery. Therefore the company is
exposed to slow payment and obsolescence risks. Because Sunrise Ltd can return
the inventory before that time, this exposure is limited.
It appears that both parties experience the risks and benefits. However, although the
agreement provides for the return of the machines, in practice this has never
happened.
Conclusion: the machines are assets of Sunrise Ltd and should be included in its
statement of financial position.
Note: The profit on disposal cannot be taken to the statement of comprehensive
income completely in year 1 as must be deferred over the lease term i.e. Dr bank Rs
1,000,000 Cr carrying value of asset Rs 750,000 Cr deferred income Rs 250,000).
Deferred income
Release to income
Statement
Bal c/d
50,000
200,000
–––––––
250,000
–––––––
Profit on disposal
deferred
Advanced Financial Accounting and Corporate Reporting (Study Text)
250,000
–––––––
250,000
–––––––
Page 19
2.
Pearl faces the risk of falling property prices.
•
Zaviar continues to insure and maintain the property.
•
Zaviar will benefit from a rising property price.
•
Zaviar has the benefit of use of the property.
Zaviar should continue to recognise the head office as an asset in the statement of
financial position. This is a secured loan with effective interest of Rs 2 million (Rs 12
million – Rs 10 million) over the four-year period.
3.
Statement of comprehensive income extract
Rs
200,000
120,000
50,000
Depreciation (W1)
Finance lease interest (W2)
Profit on disposal (W3)
Statement of financial position Noncurrent assets
Finance leased asset:
(1,000,000 - 200,000(W1))
800,000
Noncurrent liabilities
Finance lease obligation (W2)
Deferred income (W3)
666,293
150,000
Current liabilities
Finance lease obligation
Deferred income (W3)
176,298
50,000
Workings:
(W1)
Depreciation
(Rs1,000,000 × 1/5
(W2) Finance lease obligation
Year
Bal
Int
b/fwd
12%
20X4
1,000,000
120,000
20X5
842,591
101,111
200,000
Rental
(277,409)
(277,409)
Bal
c/fwd
842,591
666,293
(W3) Profit on disposal of asset (deferred over lease term)
Carrying value of asset
Proceeds
Profit on disposal
Advanced Financial Accounting and Corporate Reporting (Study Text)
750,000
1,000,000
–––––––
250,000
Page 20
Note: The profit on disposal cannot be taken to the statement of comprehensive
income completely in year 1 as must be deferred over the lease term i.e. Dr
bank Rs 1,000,000 Cr carrying value of asset Rs 750,000 Cr deferred income
Rs 250,000).
Deferred income
Release to income
Statement
Bal c/d
4.
50,000
200,000
–––––––
250,000
–––––––
Profit on disposal
deferred
250,000
–––––––
250,000
–––––––
As the entity still bears the risk of slow payment and irrecoverable debts, the
substance of the factoring is that of a loan on which finance charges will be made.
The receivable should not have been derecognised nor should all of the difference
between the gross receivable and the amount received from the factor have been
treated as an administration cost.
The required adjustments can be summarised as follows:
Receivables
Loan from factor
Administration Rs(12,000 – 9,600)
Finance costs: accrued interest (Rs 9.6 million 1.0%)
Accruals
Advanced Financial Accounting and Corporate Reporting (Study Text)
Dr
Rs 000
12,000
9,600
96
––––––
12,096
––––––
Cr
Rs 000
2,400
96
––––––
12,096
––––––
Page 21
Advanced Financial Accounting and Corporate Reporting (Study Text)
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FINANCIAL INSTRUMENTS
Chapter learning objectives
Upon completion of this chapter you will be able to:
•
apply and discuss the recognition and de-recognition of a financial asset or financial
liability
•
apply and discuss the classification of a financial asset or financial liability and their
measurement
•
apply and discuss the treatment of gains and losses arising on financial assets and
financial liabilities
•
apply and discuss the treatment of impairment of financial assets
•
record the accounting for derivative financial instruments, and simple embedded
derivatives
•
outline the principle of hedge accounting, and account for fair value hedges and cash
flow hedges including hedge effectiveness.
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1.
Introduction
1.1
Definitions
A financial instrument is any contract that gives rise to a financial asset of one
entity and a financial liability or equity instrument of another entity.
A financial asset is any asset that is:
1) cash
2) an equity instrument of another entity
3) a contractual right to receive cash or another financial asset from another
entity
4) a contractual right to exchange financial instruments with another entity under
conditions that are potentially favourable
5) a contract that will or may be settled in the entity’s own equity instruments,
and is a non-derivative for which the entity is or may be obliged to receive a
variable number of the entity’s own equity instruments
6) a contract that will or may be settled in the entity’s own equity instruments,
and is a derivative that will or may be settled other than by the exchange of a
fixed amount of cash or another financial asset for a fixed number of the
entity’s own equity instruments.
A financial liability is any liability that is a contractual obligation:
•
to deliver cash or another financial asset to another entity
•
to exchange financial instruments with another entity under conditions that
are potentially un-favourable
•
a contract that will or may be settled in the entity’s own equity instruments,
and is a non-derivative for which the entity is or may be obliged to deliver a
variable number of the entity’s own equity instruments
•
a contract that will or may be settled in the entity’s own equity instruments,
and is a derivative that will or may be settled other than by exchange of a
fixed amount of cash or another financial asset for a fixed number of the
entity’s own equity instruments.
An equity instrument is any contract that evidences a residual interest in the assets
of an entity after deducting all of its liabilities.
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1.2
Accounting standards
There are four reporting standards that deal with financial instruments:
•
IAS 32 Financial instruments: presentation
•
IFRS 7 Financial instruments: disclosures
•
IFRS 9 Financial instruments
IAS 32 deals with the classification of financial instruments and their presentation in
financial statements.
IFRS 9 deals with how financial instruments are measured and when they should be
recognised in financial statements.
IFRS 7 deals with the disclosure of financial instruments in financial statements.
2
Classification of Financial Instruments
2.1
IAS 32 Financial instruments: presentation provides the rules on classifying
financial instruments as liabilities or equity. These are detailed below.
Presentation of Liabilities and Equity
The issuer of a financial instrument must classify it as a financial liability, financial
asset or equity instrument on initial recognition according to its substance.
Financial liabilities
The instrument will be classified as a liability if the issuer has a contractual obligation:
•
to deliver cash (or another financial asset) to the holder
•
to exchange financial instruments on potentially unfavourable terms.
A redeemable preference share will be classified as a liability, because the issuer
has the contractual obligation to deliver cash to the holders on the redemption date.
Equity instruments
A financial instrument is only an equity instrument if both of the following conditions
are met:
(a)
The instrument includes no contractual obligation to deliver cash or another
financial asset to another entity; or to exchange financial assets or liabilities
with another under conditions that are potentially unfavourable to the issuer.
(b)
If the instrument will or may be settled in the issuer’s own equity instruments,
it is a non-derivative that includes no contractual obligation for the issuer to
deliver a variable number of its own equity instruments; or it is a derivative
Advanced Financial Accounting and Corporate Reporting (Study Text)
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that will be settled only by the issuer exchanging a fixed amount of cash or
another financial asset for a fixed number of its own equity shares.
2.2
2.3
Interest, dividends, losses and gains
•
The accounting treatment of interest, dividends, losses and gains relating to a
financial instrument follows the treatment of the instrument itself.
•
For example, dividends paid in respect of preference shares classified as a
liability will be charged as a finance expense through profit or loss.
•
Dividends paid on shares classified as equity will be reported in the statement
of changes in equity.
Offsetting a financial asset and a financial liability
IAS 32 states that a financial asset and a financial liability may only be offset in very
limited circumstances. The net amount may only be reported when the entity:
•
has a legally enforceable right to set off the amounts
•
intends either to settle on a net basis, or to realise the asset and settle the
liability simultaneously.
3.
Recognition and Measurement of Financial Assets
3.1
Initial recognition of financial assets
IFRS 9 deals with recognition and measurement of financial assets. An entity should
recognise a financial asset on its statement of financial position when, and only when,
the entity becomes party to the contractual provisions of the instrument.
Examples of this principle are as follows:
•
Unconditional receivables are recognised when the entity becomes a party to
the contract. At that point the entity has a legal right to receive cash.
•
Commitments to sell goods etc are not recognised until one party has fulfilled
its part of the contract. For example, a sales order will not be recognised as
revenue and a receivable until the goods have been delivered.
•
Forward contracts are recognised as assets on the commitment date, not on
the date when the item under contract is transferred from seller to buyer. (A
forward contract is a commitment to buy or sell a financial instrument or a
commodity.)
The four classifications of financial assets previously recognised under IAS 39 no
longer apply.
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Initial measurement of financial assets
At initial recognition, an entity shall measure a financial asset at its fair value plus, in
the case of a financial asset not at fair value through profit or loss, transaction costs
that are directly attributable to the acquisition of the financial asset.
Transaction costs are incremental costs that are directly attributable to the acquisition,
issue or disposal of a financial instrument. Examples of transaction costs are:

fees and commissions paid to agents, advisers, brokers and dealers;

levies by regulatory agencies and securities exchanges;

transfer taxes and duties;

credit assessment fees;

registration charges and similar costs.
Cost that do not qualify as transaction costs are debt premiums or discounts,
financing costs, internal administration costs and holding costs.
For all financial instruments that are not measured at FVTPL the treatment of
transaction costs is made on an instrument-by-instrument basis and increase
(financial asset) the amount initially recognised in the financial statements. For
financial instruments carried at FVTPL or all other transaction related costs that do
not qualify as transaction costs are expensed as they are incurred.
Subsequent measurement of financial assets
Subsequent measurement then depends upon whether the financial asset is a debt
instrument or an equity instrument as follows:
3.2
Debt instruments
Debt instruments would normally be measured at fair value through profit or loss
(FVTPL), but could be measured at amortised cost if the entity chooses to do so,
provided the following two tests are passed:
•
the business model test, and
•
the contractual cash flow characteristics test.
The business model test establishes whether the entity holds the financial asset to
collect the contractual cash flows or whether the objective is to sell the financial asset
prior to maturity to realise changes in fair value. If it is the former, it implies that there
will be no or few sales of such financial assets from a portfolio prior to their maturity
date. If this is the case, the test is passed.
Where this is not the case, it would suggest that the assets are not being held with
the objective to collect contractual cash flows, but perhaps may be disposed of to
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respond to changes in fair value. In this situation, the test is failed and the financial
asset cannot be measured at amortised cost.
Where an entity changes its business model, it may be required to reclassify its
financial assets as a consequence, but this is expected to be infrequent occurrence.
If reclassification does occur, it is accounted for from the first day of the accounting
period in which reclassification takes place.
The contractual cash flow characteristics test determines whether the contractual
terms of the financial asset give rise to cash flows on specified dates that are solely
payments of principal and interest based upon the principal amount outstanding. If
this is not the case, the test is failed and the financial asset cannot be measured at
amortised cost. For example, convertible bonds contain rights in addition to the
repayment of interest and principal (the right to convert the bond to equity) and
therefore would fail the test and must be accounted for as fair value through profit or
loss.
In summary, for a debt instrument to be measured at amortised cost, it will therefore
require that:
•
the asset is held within a business model whose objective is to hold the
assets to collect the contractual cash flows, and
•
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
outstanding.
Even if a financial instrument passes both tests, it is still possible to designate a debt
instrument as FVTPL if doing so eliminates or significantly reduces a measurement
or recognition inconsistency (i.e. accounting mismatch) that would otherwise arise
from measuring assets or liabilities or from recognising the gains or losses on them
on different bases. Therefore, it is now possible to have financial assets that meet the
criteria above and which will now be measured at amortised cost, even if they are
quoted in an active market.
3.3
Equity instruments
Equity instruments are measured at either:
•
fair value either through profit or loss, or
•
fair value through other comprehensive income.
The normal expectation is that equity instruments will have the designation of fair
value through profit or loss, with the price paid to acquire the financial asset
initially regarded as fair value. This could include unquoted equity investments, which
may present problems in arriving at a reliable fair value at each reporting date.
However, IFRS 9 does not include a general exception for unquoted equity
investments to be measured at cost; rather it provides guidance on when cost may,
or may not, be regarded as a reliable indicator of fair value.
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It is possible to designate an equity instrument as fair value through other
comprehensive income, provided specified conditions have been complied with as
follows:
•
the equity instrument cannot be held for trading, and
•
there must be an irrevocable choice for this designation upon initial
recognition.
In this situation, initial recognition will also include directly attributable transactions
costs. This may apply, for example, to strategic investments to be held on a
continuing basis which are not held to take advantage of changes in fair value. Equity
derivatives are excluded from adopting this designation.
Dividends on financial assets through other comprehensive income must be taken to
profit or loss, unless they represent a recovery of part of the investment. Changes in
fair value will be recognised in other comprehensive income.
If an equity instrument has been designated as fair value through other
comprehensive income, the requirements in IAS 39 to undertake an assessment of
impairment no longer apply as all fair value movements now remain in equity. Note
that there is no recycling or reclassification to profit or loss in subsequent periods of
any gains and losses taken to other comprehensive income, although upon derecognition there may be a transfer within equity. Consequently, in accordance with
IAS 1, amended in 2011, any amounts in other comprehensive income relating to
remeasurement of financial assets should be clearly identified as items which will not
be subject to recycling or reclassification in future periods.
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Overview of recognition and measurement of financial assets
4.
Recognition and Measurement of Financial Liabilities
4.1
IFRS 9 was updated in October 2010 to include accounting for financial liabilities. In
principle, the recognition and measurement criteria contained in IAS 39 have been
retained within IFRS 9.
IFRS 9 has two classes of financial liability as follows:
(1)
Financial liabilities at fair value through profit or loss, and
(2)
Other financial liabilities. This is the default class for financial liabilities if they
are not at fair value through profit or loss; these financial liabilities are
measured at amortised cost. Borrowings would normally be classed under this
heading.
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Financial
Measurement
Subsequent
Recognition in statement
Instrument
at recognition
measurement
of Comprehensive income
Financial
Fair value
Measured at fair
Fair value gains and
liabilities at
value with changes
losses recognized in
fair value
in value taken
profit or loss
through profit
through profit or Loss
or loss
Other
Amortised Cost
Measured at
The interest calculated
Financial
through effective
amortised cost
using the effective rate
Liabilities
interest rate state-
is charged to profit or
ment as a finance
loss within the income.
cost
Two forms of financial instrument which need to be considered are deep discounted
bonds and compound instruments.
4.2
Deep discounted bonds measured at amortised cost
•
One common form of financial instrument for many entities will be loans
payable. These will be measured at amortised cost. The amortised cost of a
liability equals: initial cost plus interest less repayments. (We will also use this
method with compound instruments.)
•
The interest will be charged at the effective rate or level yield. This is the
internal rate of return of the instrument.
An example of a loan that uses an effective rate of interest is a deep discount bond.
It has the following features:
•
This instrument is issued at a significant discount to its par value.
•
Typically, it has a coupon rate much lower than market rates of interest, e.g. a
2% bond when market interest is 10% pa.
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•
The initial carrying amount of the bond will be the net proceeds of issue.
•
The full finance cost will be charged over the life of the instrument so as to
give a constant periodic rate of interest.
•
The full cost will include:
–
issue costs
–
deep discount on issue
–
annual interest payments
–
premium on redemption.
The constant periodic rate of interest (sometimes called the effective rate) can be
calculated in the same way that the internal rate of return is calculated. In questions,
the effective rate of interest will normally be given.
Example 1
On 1 January 20X1 Jamil issued a deep discount bond with a Rs 50,000 nominal
value.
The discount was 16% of nominal value, and the costs of issue were Rs 2,000.
Interest of 5% of nominal value is payable annually in arrears.
The bond must be redeemed on 1 January 20X6 (after 5 years) at a premium of Rs
4,611.
The effective rate of interest is 12% p.a.
Required
How will this be reported in the financial statements of Jamil over the period to
redemption?
Solution
Firstly, we must establish at what amount the bond will be initially recognised in the
statement of financial position. The calculation set out below also works out the total
finance cost to be charged to profits.
Rs
Net proceeds
Face value
50,000
Less: 16% discount
(8,000)
Less: Issue costs
(2,000)
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––––––
40,000
Initial recognition of liability:
Repayments
Capital
50,000
Premium on redemption
4,611
––––––
Principal to be redeemed
54,611
Interest paid: Rs 50,000 × 5% × 5 years
12,500
––––––
67,111
––––––
Total finance cost
27,111
Secondly, we set up a table (similar to that used for compound instruments) to work
out the balance of the loan at the end of each period.
Year
Opening
Effective
Balance
interest
Payments
Closing
5%
balance
rate 12%
Rs
Rs
Rs
Rs__
1
40,000
4,800
(2,500)
42,300
2
42,300
5,076
(2,500)
44,876
3
44,876
5,385
(2,500)
47,761
4
47,761
5,731
(2,500)
50,992
5
50,992
6,119
(2,500)
54,611
––––––
––––––
27,111
(12,500)
To: Income
To: Statement of To: Statement of
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Statement
Cash flows
financial
Position
The finance charge taken to the income statement is greater than the actual interest
paid, and so the balance shown as a liability increases over the life of the instrument
until it equals the redemption value at the end of its term.
In Years 1 to 4 the balance shown as a liability is less than the amount that will be
payable on redemption. Therefore, the full amount payable must be disclosed in the
notes to the accounts.
4.3
Presentation of compound instruments
The issuer of a financial instrument must classify it as a financial liability or equity
instrument on initial recognition according to its substance.
• A compound instrument is a financial instrument that has characteristics of both
equity and liabilities, for example debt that can be converted into shares.
• The bondholder has the prospect of acquiring cheap shares in an entity, because
the terms of conversion are normally quite generous. Even if the bond-holder wants
cash rather than shares, the deal may still be good. On maturity the cash-hungry
bondholder will accept the conversion, and then sell the shares on the market for a
tidy profit.
• In exchange though, the bondholders normally have to accept a below market rate
of interest, and will have to wait some time before they get the shares that form a
large part of their return. There is also the risk that the entity’s shares will underperform, making the conversion unattractive.
• IAS 32 requires compound financial instruments be split into their component parts:
–
a financial liability (the debt)
–
an equity instrument (the option to convert into shares).
• These must be shown separately in the financial statements.
Example 2
On 1 January 20X1 DD issued a Rs 50m three-year convertible bond at par.
•
There were no issue costs.
•
The coupon rate is 10%, payable annually in arrears on 31 December.
•
The bond is redeemable at par on 1 January 20X4.
•
Bondholders may opt for conversion. The terms of conversion are 1 Rs 10
equity shares for every Rs 10 owed to each bondholder on 1 January 20X4.
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•
Bonds issued by similar entities without any conversion rights currently bear
interest at 15%.
•
Assume that all bondholders opt for conversion in full.
How will this be accounted for by DD?
Solution
On initial recognition, the method of splitting the bond between equity and liabilities is
as follows.
•
Calculate the present value of the debt component by discounting the cash
flows at the market rate of interest for an instrument similar in all respects,
except that it does not have conversion rights.
•
Deduct the present value of the debt from the proceeds of the issue.
(1)
Splitting the proceeds
The cash payments on the bond should be discounted to their present value
using the interest rate for a bond without the conversion rights, i.e. 15%.
Date
Cash flow
Discount
Present
factor @ 15%
value
Rs. ‘000’
Rs. ‘000’
31DecX1
Interest
5,000
1/1.15
4,347.8
31DecX2
Interest
5,000
1/1.152
3,780.7
31DecX3
Interest
5,000
1/1.153
3,287.6
1JanX4
Principal
50,000
1/1.153
32,875.8
–––––––
Present value (the liability component)
A
44,291.9
As the net proceeds of issue were
B
50,000.0
B–A
5,708.1
So, the equity component is
(2)
The annual finance costs and year end carrying amounts
Opening
Effective
Payments
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Balance
interest
Balance
rate 15%
(3)
Rs. ‘000’
Rs. ‘000’
Rs. ‘000’
Rs. ‘000’
20X1
44,291.9
6,643.8
(5,000)
45,935.7
20X2
45,935.7
6,890.4
(5,000)
47,826.1
20X3
47,826.1
7,173.9
(5,000)
50,000.0
The conversion of the bond
Rs. ‘000’
Equity
5,708.1
Liability – bond
50,000.0
–––––––
55,708.1
The conversion terms are one Rs 10 equity shares for every Rs 10, so Rs 50m × 0.1
= 5m shares, which have a nominal value of Rs 50m. The remaining Rs 5,708,100
should be classified as the share premium, also within equity. There is no remaining
liability, because conversion has extinguished it.
4.4
Fair value option for financial liabilities
Own credit risk definition
Own credit risk can be considered to be similar to the risk of default on a liability – it
is the risk that an entity will be unable to discharge a particular liability. It will not
necessarily be the same for all liabilities incurred by an entity. For example, if an
entity issues both secured and unsecured debt, the risk of default on the secured
debt is likely to be low and relatively stable, particularly if the loan agreement
includes performance and other criteria which protect the position of the lender.
However, the risk of default attaching to the unsecured debt will certainly be higher
and will almost certainly vary over time, due to trading performance and other factors,
until the liability is settled.
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Accounting treatment
IFRS 9 permits entities to opt to designate liabilities which would normally fall to be
measured at amortised cost, to be designated at fair value through profit or loss (Fair
value Option (FVO)). This designation, if made, must be made upon initial recognition
and is irrevocable. Where an entity opts for this treatment, any change in fair value of
the liability must be separated into two elements as follows:
•
Changes in fair value due to own credit risk, which are taken to other
comprehensive income, and
•
Other changes in fair value, which are taken to profit or loss.
One possible approach to identifying the two elements is to separate the interest rate
charged on the financial liability into a benchmark rate (e.g. such as KIBOR) and an
instrument-specific rate. Any change in the fair value of the liability which is not
wholly due to the change in the benchmark rate must therefore be due to a change
on own credit risk. The movement in fair value can then be split into the two separate
elements.
Note that IFRS 9 does not define what a “benchmark” interest rate is, nor does it
specify a required basis for separating the two elements of the change in fair value;
entities are therefore able to use an alternative basis from that which is included in
the guidance to IFRS 9 which they believe provides a better representation of the
change in fair value due to changes in own credit risk. If there is no standard basis
for accounting for own credit risk, this may lead to problems of inconsistency and lack
of comparability in reported information.
It is possible that the FVO may be appropriate to financial institutions, rather than
other entities generally. Accordingly, most entities will continue to account for
financial liabilities in accordance with IFRS 9 with no practical change from the
requirements of IAS 39. The FVO is not available if it will create or enlarge an
accounting mis-match or for financial liabilities that are held for trading; any change in
the fair value of such liabilities will be taken to profit or loss as before.
Example 3
On 1 January 20X8 an entity issues a 7-year bond at par value of Rs 300,000 and
annual fixed coupon rate of 9%, which is also the market rate, when KIBOR is 6%.
Therefore, the instrument-specific element of IRR = (9% - 6%) is 3%.
At 31 December 20X8, KIBOR has moved to 5.5%, thus making the benchmark
interest rate (5.5% + 3%) 8.5% (i.e. KIBOR plus the instrument-specific element of
IRR). If the fair value of the liability is consistent with a market interest rate of, say,
8.3%, then any change in the fair value of the liability from the benchmark rate to fair
value must be due to something other than the change in the benchmark rate – i.e. it
must be due to the change in the liability’s credit risk.
Required
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Calculate the amounts to be included within the financial statements for the
year ended 31 December 20X8.
Solution
It can be quantified by calculating the present value (PV) of the liability using the
benchmark rate and comparing it with the PV of the liability using the market rate as
follows:
PV at benchmark rate 8.5%
Cash flow
Factor
PV
Year
Rs
Rs
1–6
27,000
4.5533
122,939
6
300,000
0.6129
183,870
–––––––
306,809
Year
1–6
27,000
4.5808
123,684
6
300,000
0.6197
183,870
–––––––
306,809
Therefore, the change in the fair value of the liability which is not due to the change in
the benchmark rate must be due to the change in the liability’s credit risk.
Rs
PV of liability at market rate of 8.3% (on SOFP at
reporting date)
309,594
PV of liability at benchmark rate of 8.5%
306,809
––––––
Other comprehensive income
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IFRS 9 requires that this change in fair value relating to the change in the liability’s
credit risk is taken to Other Comprehensive Income. In the above situation, it will be
reflected by a reduction in equity as the carrying value of the liability is increased.
There are likely to be different models or bases of determination adopted by different
entities as they prepare annual financial statements to implement fully the
requirements relating to both financial assets and financial liabilities. From a
corporate reporting perspective, perhaps the best way to consider the total
movement in the fair value of financial liabilities from one reporting date to the next, is
to split it into two elements:
•
to the extent that the change in fair value relates to a change in own credit
risk, this is taken to OCI, and
•
to the extent that the change in fair value is related to anything else, this is
recognised in profit or loss for the year.
The only exception to this accounting treatment arises where the outcome would
create or enlarge an accounting mismatch in profit or loss. If this is the case, then an
entity will present all changes in fair value on that liability in profit or loss.
5.
Derecognition of Financial Instruments
Derecognition is the removal of a previously recognised financial asset or financial liability
from an entity’s statement of financial position.
Most transactions involving derecognition of a financial asset are straightforward. However,
financial assets may be subject to complicated transactions where some of the risks and
rewards that attach to an asset are retained but some are passed on.
It means is that a financial asset is derecognised if one of three combinations of
circumstances occurs:

the contractual rights to the cash flows from the financial asset expire; or

the financial asset is transferred and substantially all of the risks and rewards of
ownership pass to the transferee; or

the financial asset is transferred, substantially all of the risks and rewards of
ownership are neither transferred nor retained but control of the asset has been lost.
A financial asset should be derecognised if one of the following criteria occur:
•
the contractual rights to the cash flows of the financial asset have expired, e.g.
when an option held by the entity has expired worthless
•
the financial asset has been sold and the transfer qualifies for de-recognition
because substantially all the risks and rewards of ownership have been
transferred from the seller to the buyer.
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The analysis of where the risks and rewards of ownership lie after the transaction is
critical. For example, if an entity sells an investment in shares and enters into a total
return swap with the buyer, the buyer will return any increases in value to the entity
or the entity will pay the buyer for any decrease in value. In this case the entity has
retained substantially all of the risks and rewards of the investment, which therefore
should not be derecognised.
A financial liability should be derecognised when, and only when, the obligation
specified in the contract is discharged, cancelled or expires.
On de-recognition, the difference between the carrying amount of the asset or liability
and the amount received or paid for it should be recognised in the profit or loss for
the period.
IFRIC 19: Extinguishing financial liabilities with equity instruments
The terms of a liability might be renegotiated such that the lender (creditor) accepts
equity instruments as payment instead of cash. (The lender accepts a debt to equity
swap).
IFRIC 19 sets out how an entity that issues equity instruments to extinguish all or part
of a financial liability should account for the transaction.
Scope
IFRIC 19 does not address accounting by the creditor.
The following transactions are scoped out of IFRIC 19:

Transactions involving the creditor in its capacity as an existing shareholder (e.g.
a rights issue);

Transactions between businesses under common control both before and after
the transaction. This allows companies within a group to account for exchange of
debt for equity instruments in a corporate reconstruction without regard to the
rules in this interpretation.

Extinguishing a financial liability by issuing equity instruments in accordance with
the original terms of the liability (e.g. convertible instruments).
Issues addressed
How should an entity initially measure the equity instruments issued?
How should the entity account for any difference between the carrying amount of the
liability extinguished and the initially measured equity instruments?
Consensus: Are the equity instruments “consideration paid”
The issue of equity instruments is “consideration paid” to extinguish all or part of a
financial liability. This leads to the derecognition of the liability.
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Consensus: Initial measurement of equity instruments issued
Equity instruments issued must be initially measured at the fair value of those
instruments. If the fair value cannot be reliably measured, then the fair value of the
liability extinguished is used instead.
Consensus: Accounting for the difference
The difference between the carrying amount of the liability extinguished and the
consideration paid (fair value of equity instruments issued) must be recognised in
profit or loss. A separate line item or disclosure in the notes is required.
If only a part of the financial liability is extinguished the part of the consideration
allocated to the remaining liability must form part of the assessment as to whether
the remaining liability has been substantially modified.
6.
Impairment of Financial Assets
6.1
Impairment of most non-current assets is covered by IAS 36. IAS 36 operates an
incurred loss model. This means that impairment is recognised only when an event
has occurred which has caused a fall in the recoverable amount as compared to
carrying amount of an asset.
Impairment of financial instruments is dealt with by IFRS 9. IFRS 9 contains an
expected loss model. The expected loss model applies to all debt instruments (loans,
receivables etc.) recorded at amortised cost or at fair value through OCI. It also
applies to contract assets (IFRS 15).
The aim of the expected loss model is that financial statements should reflect the
deterioration or improvement in the credit quality of financial instruments held by an
entity. This is achieved by recognising amounts for the expected credit loss
associated with financial assets.
The rules look complex because they have been drafted to provide guidance to
banks and similar financial institutions on the recognition of credit losses on loans
made. However, there is a simplified regime that applies to other financial assets as
specified in the standard (such as trade receivables and lease receivables).
Key definitions
Credit loss
The difference between all contractual cash flows that are due to an entity in
accordance with the contract and all the cash flows that the entity expects to receive
(i.e. all cash shortfalls), discounted at the original effective interest rate)
Lifetime expected credit losses
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The expected credit losses that result from all possible default events over the
expected life of a financial instrument.
12-month expected credit losses
The portion of lifetime expected credit losses that represent the expected credit
losses that result from default events on a financial instrument that are possible
within the 12 months after the reporting date.
Simplified approach
This applies to trade receivables, contract assets and lease receivables. The
approach involves the recognition of lifetime expected losses for the relevant assets.
General approach
This approach must be applied to financial assets measured at amortised cost and
financial assets measured at fair value through OCI. The approach also applies to
lease receivables and contract assets unless the entity adopts the simplified
approach described above. (Any impairment losses on financial assets measured at
fair value through profit and loss are automatically recognised in profit or loss).
The objective of the requirements is to recognise lifetime expected credit losses for
all financial instruments for which there have been significant increases in credit risk
since initial recognition (whether assessed on an individual or collective basis)
considering all reasonable and supportable information.
Overview
For those financial assets to which the general approach applies, a loss allowance
measured as the 12-month expected credit losses is recognised at initial recognition.
The expected credit loss associated with the financial asset is then reviewed at each
subsequent reporting date. The amount of expected credit loss recognised as a loss
allowance depends on the extent of credit deterioration since initial recognition.

If there is no significant increase in credit risk the loss allowance for that asset
is remeasured to the 12 month expected credit loss as at that date.

If there is a significant increase in credit risk the loss allowance for that asset
is remeasured to the lifetime expected credit losses as at that date. This does
not mean that the financial asset is impaired. The entity still hopes to collect
amounts due but the possibility of a loss event has increased.

If there is credit impairment, the financial asset is written down to its
estimated recoverable amount. The entity accepts that not all contractual
cash flows will be collected and the asset is impaired.
Credit impairment
A financial asset is credit-impaired when one or more events that have a detrimental
impact on the estimated future cash flows of that financial asset have occurred.
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Evidence that a financial asset is credit-impaired include (but is not limited to)
observable data about the following events:

significant financial difficulty of the issuer or the borrower;

a breach of contract, such as a default or past due event;

the lender has granted to the borrower a concession for economic or
contractual reasons relating to the borrower’s financial difficulty that the
lender would not otherwise have considered:

it is becoming probable that the borrower will enter bankruptcy or other
financial reorganisation;

the disappearance of an active market for that financial asset because of
financial difficulties; or

the purchase or origination of a financial asset at a deep discount that reflects
the incurred credit losses.
If an entity revises its estimates of receipts it must adjust the gross carrying amount
of the financial asset to reflect actual and revised estimated contractual cash flows.
The financial asset must be remeasured to the present value of estimated future
cash flows from the asset discounted at the original effective rate.
6.2
Impairment review of financial assets measured at amortised cost
Examples of objective evidence of impairment at the reporting date include:
significant financial difficulty of the borrower, and the failure of the borrower to make
interest payments on the due date.
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An impairment loss on financial assets measured at amortised cost is determined as
follows:
Rs
Carrying value of the asset per the financial statements
X
Less:
PV of the estimated future cash flows discounted
at the original effective interest rate
(X)
–––
Impairment loss
X
Any impairment loss is recognised as an expense in profit or loss.
If recoverable amount exceeds carrying value, the asset is not impaired.
Example 4
On 1 February 20X6, E Ltd makes a four-year loan of Rs 10,000 to F Ltd. The
coupon rate on the loan is 6%, the same as the effective rate of interest. Interest is
received at the end of each year.
During February 20X9, it becomes clear that F is in financial difficulties. This is the
necessary objective evidence of impairment. At this time the current market interest
rate is 8%.
It is estimated that the future remaining cash flows from the loan will be only Rs
6,000, instead of Rs 10,600 (the Rs 10,000 principal plus interest for the fourth year
of Rs 600).
Solution
Because the coupon and the effective interest rate are the same, the carrying
amount of the principal will remain constant at Rs 10,000.
On 1 February 20X9, the carrying amount of the loan should be restated to the
present value of the estimated cash flows of Rs 6,000, discounted at the original
effective interest rate of 6% for one year.
6,000 × 1/1.06 = Rs 5,660
The result is an impairment loss of Rs 4,340 (Rs 10,000 – Rs 5,660).
The impairment loss is recognised as an expense in profit or loss.
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The asset will continue to be accounted for using amortised cost, based on the
revised carrying amount of the loan. In the last year of the loan, the interest income
of Rs 340 (5,660 × 6%) will be recognised in profit or loss.
6.3
Reversals of impairment losses
Reversal of an impairment loss is only permitted as a result of an event occurring
after the impairment loss has been recognised. An example would be the credit
rating of a customer being revised upwards by a credit rating agency.
Reversal of impairment losses in respect of financial assets measured at amortised
cost are recognised in profit or loss.
7
Derivatives
7.1
Definitions
A derivative is a financial instrument with the following characteristics:
7.2
(a)
Its value changes in response to the change in a specified interest rate,
security price, commodity price, foreign exchange rate, index of prices or
rates, a credit rating or credit index or similar variable (called the ‘underlying’).
(b)
It requires little or no initial net investment relative to other types of contract
that have a similar response to changes in market conditions.
(c)
It is settled at a future date.
Typical derivatives
Derivatives include the following types of contracts:
Forward contracts
•
The holder of a forward contract is obliged to buy or sell a defined amount of
a specific underlying asset, at a specified price at a specified future date.
•
For example, a forward contract for foreign currency might require £10,000 to
be exchanged for Rs 1,050,000 in three months time. Both parties to the
contract have both a financial asset and a financial liability. For example, one
party has the right to receive Rs 1,050,000 and the obligation to pay £10,000.
•
Forward currency contracts may be used to minimize the risk on amounts
receivable or payable in foreign currencies.
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Forward rate agreements
•
Forward rate agreements can be used to fix the interest charge on a floating
rate loan.
•
For example, an entity has a Rs 1m floating rate loan, and the current rate of
interest is 7%. The rates are reset to the market rate every six months, and
the entity cannot afford to pay more than 9% interest. The entity enters into a
six-month forward rate agreement (with, say, a bank) at 9% on Rs 1m. If the
market rates go up to 10%, then the bank will pay them Rs 5,000 (1% of Rs
1m for 6 months) which in effect reduces their finance cost to 9%. If the rates
only go up to 8% then the entity pays the bank Rs 5,000. The forward rate
agreement effectively fixes the interest rate payable at 9% for the period.
Future Contracts
•
Futures contracts oblige the holder to buy or sell a standard quantity of a
specific underlying item at a specified future date.
•
Futures contracts are very similar to forward contracts. The difference is that
futures contracts have standard terms and are traded on a financial exchange,
whereas forward contracts are tailor-made and are not traded on a financial
exchange. Also, whereas forward contracts will always be settled, a futures
contract will rarely be held to maturity.
Swaps
•
Two parties agree to exchange periodic payments at specified intervals over
a specified time period.
•
For example, in an interest rate swap, the parties may agree to exchange
fixed and floating rate interest payments calculated by reference to a notional
principal amount.
•
This enables companies to keep a balance between their fixed and floating
rate interest payments without having to change the underlying loans.
Options
•
7.3
These give the holder the right, but not the obligation, to buy or sell a specific
underlying asset on or before a specified future date.
Measurement of derivatives
•
On recognition, derivatives should initially be measured at fair value.
Transaction costs may not be included.
•
Subsequent measurement depends on how the derivative is categorised. In
many cases, this will involve the derivative being measured at fair value with
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changes in the fair value recognised in profit or loss. However, if the
derivative is used as a hedge (see later in this chapter), then the changes in
fair value should be recognised in equity.
Example 5
Entity A enters into a call option on 1 June 20X5, to purchase 10,000 shares in
another entity on 1 November 20X5 at a price of Rs 10 per share. The cost of each
option is Rs 1. A has a year end of 30 September.
By 30 September the fair value of each option has increased to Rs 1.30 and by 1
November to Rs 1.50, with the share price on the same date being Rs 11. A
exercises the option on 1 November and the shares are classified as at fair value
through profit or loss.
Solution
On 1 June 20X5 the cost of the option is recognised:
Debit Call option (10,000 × Rs 1)
Rs 10,000
Credit Cash
Rs 10,000
On 30 September the increase in fair value is recorded:
Debit Call option (10,000 × (Rs 1.30 – 1))
Rs 3,000
Credit Profit or loss
Rs 3,000
On 1 November the option is exercised, the shares recognised and the call option
derecognised. As the shares are financial assets at fair value through profit or loss,
they are recognised at Rs 110,000 (10,000 × the current market price of Rs 11)
Debit Investment in shares at fair value
Rs 110,000
Debit Expense – loss on call option
((10,000 + 3,000 + 100,000) – 110, 000)
Rs 3,000
Credit Cash (10,000 × Rs 10)
Rs 100,000
Credit Call option (10,000 + 3,000 carrying amount)
Rs 13,000
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7.4
Embedded derivatives
The treatment of embedded derivatives depends on whether the hybrid contract
contains a host that is an asset within the scope of IFRS 9.
Hybrid contains a host contract within the scope of IFRS 9
If the host contract is an asset within the scope of IFRS 9 the normal rules of
classification and accounting apply.
The contractual cash flows of the financial asset are assessed in their entirety, and
the asset as a whole is measured at FVTPL if any of its cash flows do not represent
payments of principal and interest.
For example:
An entity has an investment in a convertible bond, which can be converted into a
fixed number of equity shares at a specified future date.
IFRS 9 requires that embedded derivatives, such as the convertible bond, are
evaluated for correct classification in their entirety due to the presence of the
conversion option. In practical terms it would mean that the bond would fail the
contractual cash flow characteristics test and would therefore be measured at fair
value through profit or loss.
7.5
The need for a financial reporting standard
Derivatives can be easily acquired, often for little or no cost, but their values can
change very rapidly, exposing holders to the risk of large profits or losses. Because
many derivatives have no cost, they may not appear in a traditional historical cost
statement of financial position, even if they represent substantial assets or liabilities
of the entity. Gains and losses have traditionally not been recorded until cash is
exchanged.
Gains and losses can be easily realised, often simply by making a telephone call. If
gains and losses are recognised on a cash basis, then management can choose
when to report these gains and losses.
Derivatives can rapidly transform the position, performance and risk profile of an
entity. Consequently, there is great debate regarding the accounting for derivatives,
together with ensuring that there are adequate disclosures for users to fully
understand and appreciate their impact upon the reported financial performance and
position of an entity.
8.
Hedge Accounting
8.1
Definitions
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Hedging is a method of managing risk by designating one or more hedging
instruments so that their change in fair value is offset, in whole or in part, to the
change in fair value or cash flows of a hedged item.A hedged item is an asset or
liability that exposes the entity to risks of changes in fair value or future cash flows
(and is designated as being hedged).
A hedging instrument is a designated derivative whose fair value or cash flows are
expected to offset changes in fair value or future cash flows of the hedged item.
So the item generates the risk and the instrument modifies it.
8.2
The principles of hedge accounting
Hedge accounting provides special rules that allow the matching of the gain or loss
on the derivatives position with the loss or gain on the hedged item. This reduces
volatility in the statement of financial position and the statement of profit or loss, and
so is very attractive to the preparers of accounts.
The special rules for accounting for hedging can only be used where very stringent
conditions are met:


Hedge effectiveness requirements (prospective):

Economic relationship exists

Credit risk does not dominate value changes

Designated hedge ratio is consistent with risk management strategy.
Formal documentation must be prepared to describe

risk management objective and strategy;

hedging instrument;

hedged item;

nature of risk being hedged;

hedge effectiveness;
Hedge accounting models
Where the conditions for using hedge accounting are met, the method of hedge
accounting to be used depends on the type of hedge.
IFRS 9 identifies three types of hedging relationship:
 fair value hedges
 cash flow hedges; and
 hedges of a net investment in a foreign entity (accounted for as a cash flow
hedge).
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8.3
Fair Value Hedge
A fair value hedge is a hedge against the risk of a change in the fair value of an asset
or liability. For example, oil held in inventory could be hedged with an oil forward
contract to hedge the exposure to a risk of a fall in oil sales prices. Or the risk of a
change in the fair value of a fixed rate debt owed by a company could be hedged
using an interest rate swap.
Accounting treatment of fair value hedges
Accounting for a fair value hedge is as follows:

The gain or loss on the hedging instrument (the derivative) is taken to profit or
loss, as normal.

The carrying amount of the hedged item is adjusted by the loss or gain on the
hedged item attributable to the hedged risk with the other side of the entry
recognised in profit or loss.
Example 6
On 1 January 20X8 an entity purchased an equity instrument at a fair value of Rs
900,000. As it was not acquired with the intention of taking advantage of short-term
changes in fair value, it would normally be designated upon initial recognition to be
classified as fair value through other comprehensive income.
Due to the exposure to risk of changes in fair value of the equity instrument, the
entity entered into an interest rate swap, identifying the swap contract as a hedging
instrument as part of a fair value hedging arrangement. The fair value hedge has
been correctly documented and designated upon initial recognition and is expected
to be an effective hedging arrangement. Consequently, changes in fair value to both
the equity instrument (hedged item) and the swap contract (hedge instrument) will be
matched in profit or loss, rather than accounted for separately.
At the reporting date 31 December 20X8, the fair value of the equity instrument has
fallen to Rs 800,000, and there has been an increase in the fair value of the interest
rate swap contract of Rs 90,000.
Required
Illustrate and explain the accounting treatment for the fair value hedge arrangement
based upon the available information.
Solution
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The fall in fair value of the equity interest of Rs 100,000 is taken to profit or loss. This
is matched with the increase in fair value of the interest rate swap contact of Rs
90,000, resulting in a small net loss of Rs 10,000.
The effectiveness in the hedge arrangement (see later within section in Complete
Text) can be evaluated by comparing the change in the hedged item and the hedged
instrument as follows:
Change in hedged item Rs 100,000
Change in hedging instrument Rs 90,000
Either: 100,000/90,000 = 111%
Or: 90,000/100,000 = 90%
As long as either one of the two measures above fall within the range 80% – 125%,
the hedge is regarded as effective.
The above fair value hedge arrangement would therefore be regarded as effective.
8.4
Cash Flow Hedge
A cash flow hedge is a hedge against the risk of changes in cash flows relating to a
recognised asset or liability or an anticipated purchase or sale. For example, floating
rate debt issued by a company might be hedged using an interest rate swap to
manage increases in interest rates. Or future US dollar sales of airline seats by a
Pakistani company might be hedged by a US$/Rs. forward contracts to manage
changes in exchange rates. These are hedges relating to future cash flows from
interest payments or foreign exchange receipts.
Accounting treatment of cash flow hedges
Accounting for a cash flow hedge is as follows:

The change in the fair value of the hedging instrument is analysed into
‘effective’ and ‘ineffective’ elements.

The ‘effective’ portion is recognised in other comprehensive income (directly
in equity).

The ‘ineffective’ portion is recognised in profit or loss.

The amount recognised in other comprehensive income is subsequently
released to the profit or loss as a reclassification adjustment in the same
period as the hedged forecast cash flows affect profit or loss.
Hedges of a net investment in a foreign operation
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A later chapter explains the accounting treatment, for consolidation purposes, of an
investment in a foreign subsidiary or other foreign operation.
The net assets of the foreign subsidiary are translated at the end of each financial
year, and any foreign exchange differences are recognised in other comprehensive
income (until the foreign subsidiary is disposed of, when the cumulative profit or loss
is then reclassified from ‘equity’ to profit or loss).
This is accounted for as a cash flow hedge.
IFRIC 16: HEDGES OF A NET INVESTMENT IN A FOREIGN
OPERATION
IFRIC 16 applies to hedges of foreign currency risk in a net investment in a foreign
operation where an entity wishes to qualify for hedge accounting under IFRS 9.
IFRS 9 allows hedge accounting of hedges of a net investment in a foreign operation
(subject to satisfying the hedge accounting criteria).
Therefore, hedge accounting of the foreign exchange risk of the net investment in a
foreign operation only applies in financial statements where the interest in the foreign
operation is included as the investing company’s share of its net assets. This means
for example that hedge accounting in respect of the exchange risk associated with an
investment in a foreign subsidiary is only allowed in the consolidated financial
statements.
Where there is such a designated hedging relationship the effective part of the gain
or loss on the hedging instrument is recognised in other comprehensive income and
accumulated with the foreign exchange differences arising on translation of the
results and financial position of the foreign operation.
Investments in a foreign operation may be held directly or indirectly.
IFRIC 16 addresses the following three issues:

Where the hedging instrument should be held within a group.

The nature of the hedged risk and the amount of a hedged item for which a
hedging relationship may be designated?

The amounts that should be reclassified from equity to profit or loss as on
disposal of the foreign operation?
Consensus – Location of hedging instrument
The hedging instrument may be held by any entity within the group.
Consensus – Nature of hedged risk
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Hedge accounting may be applied only to foreign exchange differences arising
between the functional currency of the foreign operation and that of any parent entity
but not to hedges of forex differences between functional currency of a subsidiary to
presentation currency of a parent.
The hedged item may be an amount of net assets equal to or less than the carrying
amount of the net assets of the foreign operation.
A forex exposure arising from a net investment in a foreign operation may qualify for
hedge accounting only once in consolidated financial statements.
8.5
Hedge effectiveness
One of the requirements of IAS 39 is that to use hedge accounting, the hedge must
be effective. IAS 39 describes this as the degree to which the changes in fair value or
cash flows of the hedged item are offset by changes in the fair value or cash flows of
the hedging instrument.
A hedge is viewed as being highly effective if actual results are within a range of 80%
to 125%.
Illustration
JJ uses hedging transaction to minimise the risk of exposure to foreign exchange
fluctuations. He buys goods from overseas and takes out forward contracts to fix the
price of his inputs.
The gain on his forward contract for November was Rs 570. The loss on a foreign
currency creditor was Rs 600.
The effectiveness of the hedge is determined by dividing 570 by 600 or 600 by 570.
This gives an effectiveness percentage of 95% and 105% respectively.
The hedge meets the criteria of 80–125% and is effective.
9.
Disclosure of Financial Instruments
9.1
IFRS 7 Financial instruments: disclosures provide the disclosure requirements
for financial instruments. A summary of the requirements is detailed below.
The two main categories of disclosures required are:
(1)
Information about the significance of financial instruments.
(2)
Information about the nature and extent of risks arising from financial
instruments.
The disclosures made should be made by each class of financial instrument.
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9.2
9.3
Significance of financial instruments
•
An entity must disclose the significance of financial instruments for their
financial position and performance. The disclosures must be made for each
class of financial instruments.
•
An entity must disclose items of income, expense, gains, and losses, with
separate disclosure of gains and losses from each class of financial
instrument.
Nature and extent of risks arising from financial instruments need to be
disclosed
Qualitative disclosures
The qualitative disclosures describe:
•
risk exposures for each type of financial instrument
•
management’s objectives, policies, and processes for managing those risks
•
changes from the prior period.
Quantitative disclosures
The quantitative disclosures provide information about the extent to which the entity
is exposed to risk, based on information provided internally to the entity’s key
management personnel. These disclosures include:
•
summary quantitative data about exposure to each risk at the reporting date
•
disclosures about credit risk, liquidity risk, and market risk as further
described below
•
concentrations of risk.
10
IFRS 7 Disclosures
10.1
Introduction
In principle, there should be sufficient information to enable users of financial
statements to fully understand:
•
how financial assets and liabilities have been designated
•
the date, reason and effect of any reclassification of financial assets
The main categories of disclosures required are:
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10.2
(1)
Accounting policies applied in respect of accounting for financial instruments
(2)
Information about the significance of financial instruments upon the financial
performance and position of the entity.
(3)
Information about the nature and extent of risks arising from financial
instruments.
(4)
Detailed disclosures relating to the nature and extent of accounting for fair
value and cash flow hedging arrangements.
Types of risk
There are four types of financial risk:
(1)
Market risk – This refers to the possibility that the value of an asset (or
burden of a liability) might go up or down. Market risk includes three types of
risk: currency risk, interest rate risk and price risk.
(a)
Currency risk is the risk that the value of a financial instrument will
fluctuate because of changes in foreign exchange rates.
(b)
Fair value interest rate risk is the risk that the value of a financial
instrument will fluctuate due to changes in market interest rates. This
is a common problem with fixed interest rate bonds. The price of these
bonds goes up and down as interest rates go down and up.
(c)
Price risk refers to other factors affecting price changes. These can
be specific to the enterprise (bad financial results will cause a share
price to fall), relate to the sector as a whole or relate to the type of
security (bonds do well when shares are doing badly, and vice versa).
Market risk embodies not only the potential for a loss to be made but also a
gain to be made:
(2)
Credit risk – The risk that one party to a financial instrument fails to
discharge its obligations, causing a financial loss to the other party. For
example, a bank is exposed to credit risk on its loans, because a borrower
might default on its loan.
(3)
Liquidity risk – This is also referred to as funding risk. This is the risk that an
enterprise will be unable to meet its commitments on its financial instruments.
For example, a business may be unable to repay its loans when they fall due.
(4)
Cash flow interest rate risk – This is the risk that future cash flows
associated with a monetary financial instrument will fluctuate in amount due to
changes in market interest rates. For example, the cash paid (or received) on
floating rate loans will fluctuate in line with market interest rates.
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Chapter Summary
Self Test Questions
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1.
AB has the following financial assets:
(1)
Investments held for trading purposes.
(2)
Interest-bearing debt instruments that will be redeemed in five years;
AB intends to collect the contractual cash flows which consist solely of
repayments of interest and capital.
(3)
A trade receivable.
(4)
Derivatives held for speculation purposes.
(5)
Equity shares that AB has no intention of selling.
(6)
A convertible bond which is due to be converted into equity shares in
three years time.
Required
How should AB classify its financial assets?
2.
GG issues three debt instruments, each with a nominal value of Rs 10,000
and redeemable in two years. The effective interest rate for all three is 10%.
D1 has a coupon rate of 0%, is issued at par and is redeemed at a premium
of Rs 2,100.
D2 has a coupon rate of 0%, is issued at a discount of Rs 1,736 and is
redeemed at par.
D3 has a coupon rate of 2%, is issued at a discount of Rs 500 and is
redeemed at a premium of Rs 1,075.
Required
How should these debt instruments be accounted for?
3.
CG issues a Rs 100,000 4% three-year convertible loan on 1 January 20X6.
The market rate of interest for a similar loan without conversion rights is 8%.
The conversion terms are one equity share (Rs 10 nominal value) for every
Rs 20 of debt. Conversion or redemption at par takes place on 31 December
20X8
Required
How should this be accounted for:
(a)
if all holders elect for the conversion
(b)
no holders elect for the conversion?
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4.
MN has two receivables that it has factored to a bank in return for immediate
cash proceeds of less than the face value of the invoices. Both receivables
are due from long standing customers who are expected to pay in full and on
time. MN has agreed a three-month credit period with both customers.
The first receivable is for Rs 200,000 and in return for assigning the
receivable MN has just received from the factor Rs 180,000. Under the terms
of the factoring arrangement this the only money that MN will receive
regardless of when or even if the customer settles the debt, i.e. the factoring
arrangement is said to be "without recourse ".
The second receivable is for Rs 100,000 and in return for assigning the
receivable MN has just received Rs 70,000. Under the terms of this factoring
arrangement if the customer settles the account on time then a further Rs
5,000 will be paid by the factoring bank to MN, but if the customer does not
settle the account in accordance with the agreed terms then the receivable
will be reassigned back to MN who will then be obliged to refund the factor
the original Rs 70,000 plus a further Rs 10,000. This factoring arrangement is
said to be "with recourse".
Required
Discuss MN's accounting treatment of the monies received under the
terms of the two factoring arrangements.
5.
KL bought an investment for Rs 40 million plus associated transaction costs
of Rs 1 million. The asset was designated upon initial recognition as fair value
through other comprehensive income. At the reporting date the fair value of
the financial asset had risen to Rs 60 million. Shortly after the reporting date
the financial asset was sold for Rs 70 million.
Required
6.
(1)
How should this be accounted for?
(2)
How would the answer have been different if the investment had been
classified as at fair value through profit and loss?
On 1 January 20X2, HL makes a five-year loan of Rs 10,000 with an interest
rate of 10% (the same as the effective rate of interest), with the principal
being repaid at the end of five years.
During January 20X6, the borrower is in financial difficulty and it is estimated
that the future cash flows will be Rs 4,000 rather than Rs 11,000 (Rs 10,000
principal plus Rs 1,000 interest). At this date the current market interest rate
is 9%.
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Required
How should this be accounted for?
7.
HH buys a call option on 1 January 20X6 for Rs 5 per option that gives the
right to buy 100 shares in RM on 31 December at a price of Rs 10 per share.
Required
How should this be accounted for, given the following outcomes?
8.
(a)
The options are sold on 1 July 20X6 for Rs 15 each.
(b)
On 31 December 20X6, RM’s share price is Rs 8 and HH lets the
option lapse unexercised.
(c)
The option is exercised on 31 December when RM’s share price is Rs
25. The shares are classified as held for trading.
On 1 January 20X9 ST purchased an equity instrument at a fair value of Rs
5,000,000. As it was not acquired with the intention of taking advantage of
short-term changes in fair value, it would normally be designated upon initial
recognition to be classified as fair value through other comprehensive income.
Due to the exposure to risk of changes in fair value of the equity instrument,
the entity entered into an interest rate swap, identifying the swap contract as
a hedging instrument as part of a fair value hedging arrangement. The fair
value hedge has been correctly documented and designated upon initial
recognition and is expected to be an effective hedging arrangement.
At the reporting date 31 December 20X9, the fair value of the equity
instrument has fallen to Rs 4,200,000, and there has been an increase in the
fair value of the interest rate swap contract of Rs 750,000.
Required
Illustrate and explain the accounting treatment for the fair value hedge
arrangement based upon the available information.
Answers
1 – AB
Financial asset
(1)
Classification
Investments held for trading purposes Financial assets at fair value through profit or
loss
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(2) Interest bearing debt instruments that will
be redeemed in five years; AB intends to
collect the contractual cash flows which
consist solely of repayments of interest and
capital.
Debt instrument which passes both the
business model test and the contractual cash
flow characteristics test. It can be measured
at amortised cost.
(3) A trade receivable should model test and
flow can be measured at amortised cost
Debt instrument presumably held to collect
cash flows due. This pass both the business
the contractual cash characteristics test; it
(4)
Derivatives held for speculation
purposes through
Financial assets at fair value profit or loss
(5)
Equity shares that AB has no
intention through can to recognition other
income
Financial assets at fair value of selling profit
or loss, although it designated upon initial be
fair value through comprehensive.
(6)
A convertible bond which is due to be
converted addition into equity shares in three
years time cash flow it cannot The must be
through profit or loss.
As the bond contains rights in to the
repayment of interest and principal, the
contractual characteristics test is failed be
measured at amortised cost financial asset
as a whole measured at fair value
2 – GG
These are financial liabilities to be measured at amortised cost. Each financial liability
is initially recorded at the fair value of the consideration received, i.e. the cash
received. This amount is then increased each year to redemption by interest added
at the effective rate and reduced by the interest actually paid, with the result that the
carrying amount at the end of the first year is at amortised cost.
These are financial liabilities to be measured at amortised cost. Each financial liability
is initially recorded at the fair value of the consideration received, i.e. the cash
received. This amount is then increased each year to redemption by interest added
at the effective rate and reduced by the interest actually paid, with the result that the
carrying amount at the end of the first year is at amortised cost.
Closing
Opening
Effective
Payments
Balance
interest
rate 10%
balance
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Rs
Rs
Rs
D1 Year 1
10,000
1,000
Nil
Year 2
11,000
1,100
(12,100) (including
D2 Year 1
8,264
Rs
11,000
Rs 2,100 premium)
Nil
826
Nil
9,090
Nil
(10,000 –
1,736)
Year 2
9,090
910
(10,000) (no premium)
D3 Year 1
9,500
950
(200)
10,250
(10,000 –
500)
Year 2
10,250
1,025
(11,275) (including
Nil
Rs 200 interest and
Rs 1,075premium)
3 – CG
Up to 31 December 20X8, the accounting entries are the same under both scenarios.
The cash payments on the bond should be discounted to their present value using
the interest rate for a bond without the conversion rights, i.e. 8%.
Splitting the proceeds:
Date
Cash
Discount
Present
Flow
factor @ 8%
value
_____
_______
Rs
___________
Rs
31DecX6
Interest
4,000
1/1.08
3,704
31DecX7
Interest
4,000
1/1.082
3,429
31DecX8
Interest
and
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principal
104,000
1/1.083
82,559
––––––
Present value (the liability component)
A
89,692
As the net proceeds of issue were
B
100,000
B–A
10,308
So the equity component is
(2)
The annual finance costs and year end carrying amounts
Opening
Effective
Payments
Closing
Balance
interest
4%
balance
rate 8%
Rs
Rs
Rs
Rs
20X6
89,692
7,175
(4,000)
92,867
20X7
92,867
7,429
(4,000)
96,296
20X8
96,296
7,704
(4,000)
100,000
(3) (a) Conversion:
The carrying amounts at 31 December 20X8 are:
Rs
Equity
10,308
Liability – bond
100,000
–––––––
110,308
If the conversion rights are exercised, then 5,000 (Rs 100,000 ÷ 20) equity
shares of Rs 10 are issued and Rs 60,308 is classified as share premium.
(b)
Redemption:
The carrying amounts at 31 December 20X8 are the same as under 3a. On
redemption, the Rs 100,000 liability is extinguished by cash payments. The
Advanced Financial Accounting and Corporate Reporting (Study Text)
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equity component remains within equity, probably as a non-distributable
reserve.
4 – MN
The principle at stake with derecognition or otherwise of receivables is whether,
under the factoring arrangement, the risks and rewards of ownership pass from the
trading company i.e. MN. The principal risk with regard to receivables is the risk of
bad debt.
In the first arrangement the Rs 180,000 has been received as a one-off, non
refundable sum. This is factoring without recourse for bad debts. The risk of bad debt
has clearly passed from MN to the factoring bank. Accordingly MN should
derecognise the receivable and there will be an expense of Rs 20,000 recognised.
No liability will be recognised.
In the second arrangement the Rs 70,000 is simply a payment on account. More may
be received by MN implying that MN retains an element of reward. The monies
received are refundable in the event of default and as such represent an obligation.
This means that the risk of slow payment and bad debt remains with MN who is liable
to repay the monies so far received. As such despite the passage of legal title the
asset (i.e. receivable) should remain recognised in the accounts of MN. In substance
MN has borrowed Rs 70,000 and this loan should be recognised immediately. This
will increase the gearing of MN.
5 – KL
(1)
On purchase the investment is recorded at the consideration paid including,
as the asset is classified as fair value through other comprehensive income,
the associated transaction costs:
Rs. in Million
Dr
Asset
41
Cr
Cash
41
At the reporting date the asset is remeasured and the gain is recognised in
other comprehensive income and taken to equity:
Dr
Asset
19
Cr
Other components of equity
19
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On disposal, the asset is derecognised, the gain or loss on disposal is
determined by comparing disposal proceeds and carrying value, with the
result taken to profit or loss.
Dr
Cash
70
Cr
Asset
60
Cr
Profit
10
Note that the any gains or losses previously taken to equity are not recycled
upon derecognition, although they may be reclassified within equity.
(2)
If KL had designated the investment as fair value through profit and loss, the
transaction costs would have been recognised as an expense in profit or loss.
So, on purchase:
Dr
Asset
40m
Cr
Cash
40m
Dr
Expense
1m
Cr
Cash
1m
Subsequent measurement – at fair value through profit or loss:
Dr
Asset
20m
Cr
Profit
20m
On disposal the asset is derecognised with the gain taken to income
Dr
Cash
70
Cr
Asset
60
Cr
Profit
10
Note that the reported profit on derecognition of Rs 10 million is the same, whether
designated as fair value through profit or loss or fair value through other
comprehensive income. This is one change brought about by IFRS 9 as recycling of
gains and losses previously recognised in other comprehensive income is no longer
done.
6 – HL
Because the coupon and the effective interest rate are the same, the carrying
amount of the principal will remain constant at Rs 10,000.
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On 1 January 20X6 the impairment loss is calculated as:
Rs
Carrying amount
10,000
Recoverable amount (being the present value of the future cash
flows discounted at the original effective interest rate:
i.e. 4,000× 1/1.1)
(3,636)
–––––
Impairment loss
6,364
The impairment loss is recognised as an expense in profit or loss.
The asset will continue to be accounted for using amortised cost, based on the
revised carrying amount of the loan. In the last year of the loan, the interest income
of Rs 364 (3,636 × 10%) will be recognised in profit or loss.
7 – HH
In all scenarios the cost of the derivative on 1 January 20X6 is Rs 500 (Rs 5 × 100)
and an asset is recognised in the statement of financial position
Dr
Asset – option
Rs 500
Cr
Cash
Rs 500
Outcome A
If the option is sold for Rs 1,500 (100 × Rs 15) before the exercise date, it is
derecognised at a profit of Rs 1,000.
Dr
Cash
Cr
Asset – option
Cr
Profit
Rs 1,500
Rs 500
Rs 1,000
Outcome B
If the option lapses unexercised, then it is derecognised and there is a loss to be
taken to profit or loss:
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Dr
Expense
Rs 500
Cr
Asset – option
Rs 500
Outcome C
If the option is exercised, the option is derecognised, cash paid upon exercise and
the investment in shares is recognised at fair value. An immediate profit is
recognised:
Dr
Asset – investment (100 × Rs 25)
Rs 2,500
Cr
Cash 100 × Rs 10)
Rs 1,000
Cr
Asset – option
Cr
Profit
Rs 500
Rs 1,000
8 – ST
The fall in fair value of the equity interest of Rs 800,000 is taken to profit or loss. This
is matched with the increase in fair value of the interest rate swap contact of Rs
750,000, resulting in a small net loss of Rs 50,000.
The effectiveness in the hedge arrangement can be evaluated by comparing the
change in the hedged item and the hedged instrument as follows:
Change in hedged item Rs 800,000
Change in hedging instrument Rs 750,000
Either: 800,000/750,000 = 107%
Or: 750,000/800,000 = 94%
As long as either one of the two measures above falls within the range 80% – 125%,
the hedge is regarded as effective.
The above fair value hedge arrangement would therefore be regarded as effective.
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Advanced Financial Accounting and Corporate Reporting (Study Text)
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EMPLOYEE BENEFITS
Chapter learning objectives
Upon completion of this chapter you will be able to:
•
apply and discuss the accounting treatment of defined contribution plans
•
apply and discuss the accounting treatment of defined benefit plans
•
account for gains and losses on settlements and curtailments
•
apply and discuss the reporting of re-measurement gains and losses and the ‘Asset
Ceiling’ test
•
apply and discuss the accounting for short-term employee benefits
•
apply and discuss the accounting for termination benefits
•
apply and discuss the accounting for long-term Employee benefits.
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1
Introduction
1.1
IAS 19 Employee Benefits was issued in 1983 with the objective of specifying the
accounting treatment and associated disclosure requirements when accounting for
employee benefits. The original standard permitted a degree of choice when
accounting for employee benefits, which consequently resulted in a lack of
comparability between the financial statements of different entities.
IAS 19 has been subject to periodic amendment, with the most recent significant
amendments dated June 2011. The objectives of these amendments are to improve
users' understanding of how defined benefit obligations and assets are reported,
together with improving comparability of reported information by eliminating some
accounting treatment choices and standardizing supporting disclosures. The revised
version of IAS 19 is effective for accounting periods commencing on or after 1
January 2013, with early adoption permitted.
1.2
Types of employee benefit
IAS 19 identifies four types of employee benefit as follows:
•
Post-employment benefits This normally relates to retirement benefits,
which will typically take the form of either a defined contribution plan or a
defined benefit plan (sometimes referred to as a defined benefit scheme).
•
Short-term employee benefits This includes wages and salaries, bonuses
and other benefits.
•
Termination benefits Termination benefits arise when benefits become
payable upon employment being terminated, either by the employer or by the
employee accepting terms to have employment terminated.
•
Other long-term employee benefits This comprises other items not within
the above classifications and will include long-service leave or awards, longterm disability benefits and other long-service benefits.
Each will be considered within this chapter, with particular emphasis upon Postemployment defined benefit schemes.
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2
Post-Employment Benefit Plans
2.1
Introduction
A pension plan (sometimes called a postemployment benefit plan or scheme)
consists of a pool of assets, together with a liability for pensions owed to employees.
Pension plan assets normally consist of investments, cash and (sometimes)
properties. The return earned on the assets is used to pay pensions.
There are two main types of pension plan:
2.2
•
defined contribution plans
•
defined benefit plans.
Defined contribution plans
The pension payable on retirement depends on the contributions paid into the plan
by the employee and the employer:
•
The employer’s contribution is usually a fixed percentage of the employee’s
salary. The employer has no further obligation after this amount is paid.
Therefore, the annual cost to the employer is reasonably predictable.
•
Defined contribution plans present few accounting problems, other than
ensuring that an accrual is made, where required, for contributions due, but
not yet paid, at the reporting date.
In this situation, the employee bears the uncertainty regarding the value of the
pension that will be paid upon retirement.
2.3
Defined benefit plans
The pension payable on retirement normally depends on either the final salary or the
average salary of the employee during their career.
•
The employer undertakes to finance a pension income of a certain amount,
–
e.g. 2/3 × final salary × (years of service / 40 years)
•
The employer has an ongoing obligation to make sufficient contributions to
the plan to fund the pensions.
•
An actuary calculates the amount that must be paid into the plan each year in
order to provide the promised pension. The calculation is based on various
estimates and assumptions including:
–
life expectancy
–
investment returns
–
wage inflation.
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7) Therefore, the cost of providing defined benefit pensions will vary year by
year over the working life of employees due to changes in circumstances,
estimates and assumptions.
The actual contribution paid by the employer into a plan during an accounting
period does not usually represent the true cost to the employer of providing
pensions in that period. The financial statements must reflect the true cost of
providing pensions, rather than accounting only for the cash contributions
made into the pension plan.
2.4
Multi-employer plans
Often a small entity does not have the resources to run a pension plan in-house, so it
pays pension contributions over to an insurance company which runs a multiemployer plan. Such a plan can be either of a defined contribution nature or a
defined benefit nature. Alternatively, a group may operate a plan for the employees
of all subsidiaries within the group.
3
Accounting for Post-Employment Benefit Plans
3.1
Defined contribution plans
The expense of providing pensions in the period is normally the same as the amount
of contributions paid.
3.2
1.
The entity should charge the agreed pension contribution to profit or loss as
an employment expense in each period.
2.
An asset or liability for pensions only arises if the cash paid does not equal
the value of contributions due for the period.
3.
IAS 19 requires disclosure of the amount recognised as an expense in the
period.
Defined benefit plans: the basic principles
The entity recognises both the liability for future pension payments, together with the
plan assets.
1.
If the liability exceeds the assets, there is a plan deficit (the usual situation)
and a liability is reported in the statement of financial position.
2.
If the plan assets exceed the liability, there is a surplus and an asset is
reported in the statement of financial position.
3.
In simple terms, the movement in the net liability (or asset) from one reporting
date to the next is reflected in the statement of comprehensive income for the
year.
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Within the statement of total comprehensive income for the year, the movement is
separated into three components as follows:
Service cost component, which includes current and past service costs,
together with any gains or losses on curtailments and settlements. This is
charged to profit or loss for the year.
Net interest component, which is computed by applying the discount rate to
measure the plan obligation to the net defined benefit liability or asset. This is
charged (or credited) to profit or loss for the year.
Remeasurement component comprises actuarial gains and losses during
the reporting period, including the returns on plan assets less any amount
taken to profit or loss as part of the net interest component. This is taken to
other comprehensive income for the year and identified as an item which will
not be reclassified to profit or loss in future periods.
3.3
Measuring the liability and the assets
In practice, the actuary measures the plan assets and liabilities by applying carefully
developed estimates and assumptions relevant to the defined benefit pension plan.
The plan liability is measured at the present value of the defined benefit obligation,
using the Projected Unit Credit Method. This is an actuarial valuation method.
3.4
1.
Discounting is necessary because the liability will be settled many years in
the future and, therefore, the effect of the time value of money is material.
The discount rate used should be determined by market yields on high quality
corporate bonds at the end of the reporting period, and applied to the net
liability or asset as at the start of the reporting period.
2.
Plan assets are measured at fair value. This is normally market value. Where
no market value is available, fair value is estimated (for example, by
calculating the present value of expected future cash flows). Note that IFRS
13 Fair Value measurement (issued in May 2011) now provides a framework
for determining how fair value should be established.
3.
Valuations should be carried out with sufficient regularity to ensure that the
amounts recognised in the financial statements do not differ materially from
actual fair values at the reporting date. In other words, IAS 19 does not
prescribe a maximum time interval between valuations.
4.
Where there are unpaid contributions at the reporting date, these are not
included in the plan assets. Unpaid contributions are treated as a liability; they
are owed by the entity/employer to the plan.
Recognising the amounts in the financial statements
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Explanation of the terms used.

•
Current service cost is the increase in the present value of the defined benefit
obligation resulting from employee service in the current period. This is part of the
service cost component.
Past service cost is the change in the present value of the defined benefit obligation
for employee service in prior periods, resulting from a plan amendment or a
curtailment. In this context, a plan amendment is defined as the introduction of, or
withdrawal of, or changes to a postemployment benefit plan. It may either increase or
decrease present value of the defined benefit obligation. Past service costs could
arise, for example, when there has been an improvement in the benefits to be
provided under the plan. This will apply whether or not the benefits have vested (i.e.
whether or not employees are immediately entitled to those enhanced benefits), or
whether they are obliged to provide additional work and service to become eligible for
those enhanced benefits. They are part of the service cost component for the year
and are recognized at the earlier of:
1. when the related restructuring costs are recognised, where it is part of a
restructuring, or
2. when the related termination benefits are recognised, where it is linked
to termination benefits, or
3. when the curtailment occurs; this is a matter of judgement – it could be,
for example, when the change is announced, or when it is implemented.
A curtailment occurs when there is a significant reduction in the number of
employees covered by the plan. This may be a consequence of an individual
event such as plant closure or discontinuance of an operation, which will
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typically result in employees being made redundant. Any gain or loss on
curtailment is part of the service cost component.
8) A settlement occurs when an entity enters into a transaction to eliminate the
obligation for part or all of the benefits under a plan. For example, an
employee may leave the entity for a new job elsewhere, and a payment is
made from that pension plan to the pension plan operated by the new
employer. Any gain or loss on settlement is part of the service cost
component.
9) Net interest component relates to the change in measurement in both the
plan obligation and plan assets arising from the passage of time. It is
computed by applying the discount rate used to measure the plan obligation
to the net liability (or asset) at the start of the reporting period, irrespective of
whether this results in net interest expense (or interest income) for the year.
Net interest is charged (or credited) as a separate component to profit or loss
for the year. In practical terms, the discount rate will be used when reconciling
the movements in the plan obligation and plan assets for the year, whether
this is done separately, or on a combined net basis. This is because the
principal issue when accounting for defined benefit schemes is how to
account for what is effectively a long-term liability and how it is funded.
10)Remeasurement component comprises actuarial gains and losses arising
during the reporting period, including the actual returns on plan assets less
any amount taken to profit or loss as part of the net interest component.
Actuarial gains and losses are increases and decreases in the net pension
asset or net liability that occur either because the actuarial assumptions have
changed or because of differences between the previous actuarial
assumptions and what has actually happened (experience adjustments). This
component is recognised in other comprehensive income for the year and will
not be recycled or reclassified to profit or loss in future periods.
Note that this treatment of actuarial gains and losses is one of the key points of the
revisions made to IAS 19 in 2011. The revised standard eliminates the choice of
three possible accounting treatments for actuarial gains and losses which was
available under the original standard. This will help to improve consistency and
comparability of reported results.
Example 1
Defined Benefit Plan
The following information is provided in relation to a defined benefit plan operated by
Hamza Ltd. All transactions are assumed to occur at the reporting date of the
relevant year. At 1 January 20X4, the present value of the obligation was Rs 140
million and the fair value of the plan assets amounted to Rs 80 million.
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20X4
20X5
Discount rate at start of year
4%
3%
Current and past service cost (Rs m)
30
32
Benefits paid (Rs m)
20
22
Contributions into plan (Rs m)
25
30
Present value of obligation at 31 December (Rs m)
200
230
Fair value of plan assets at 31 December (Rs m)
120
140
Required:
Reconcile the movement for the year in the plan asset and obligation; determine the
amounts to be taken to profit or loss and other comprehensive income for the year,
together with the net plan obligation or asset at 31 December 20X4 and 20X5.
Solution
Step 1: Determine the amount of the remeasurement component on the assets
and liabilities for the period.
This is done by analysing the change in the plan obligation and plan assets for the
period; the remeasurement components are balancing figures. The current and past
service cost increases the plan obligation. The benefits paid during the year reduce
both the plan obligation and plan assets. The contributions into the scheme increase
the plan assets. The net interest returns or charge reflects the growth in the plan
assets and obligation due to the passage of time.
Assets – stated at fair value
20X4
20X5
Rs m
Rs m
Balance b/fwd at 1 Jan
80.0
120.0
Interest return (4% 20X4; 3% 20X5)
3.2
3.6
Benefits paid
(20.0)
(22.0)
Contributions into plan
25.0
30.0
Remeasurement component on assets (bal fig)
31.8
8.4
–––––
–––––
120.0
140.0
Balance c/fwd at 31 December
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–––––
–––––
20X4
20X5
Rs m
Rs m
140.0
200.0
Interest charge (4% 20X4; 3% 20X5)
5.6
6.0
Current and past service cost
30.0
32.0
Benefits paid
(20.0)
(22.0)
44.4
14.0
–––––
–––––
200.0
230.0
–––––
–––––
Obligation – stated at present value
Balance b/fwd at 1 January
Remeasurement (gain) loss on plan
obligation (balancing figure)
Balance c/fwd at 31 December
Note that the interest return on the plan assets uses the same rate as used for the
plan obligation. This means that any difference between interest return and actual
return is included within the remeasurement component
Step 2: Determine the net obligation or asset to be included in the statement of
financial position at the reporting date
20X4
20X5
Rs m
Rs m
PV of plan obligation
200.0
230.0
FV of plan assets
(120.0)
(140.0)
–––––
–––––
80.0
90.0
–––––
–––––
Closing net liability
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Step 3: Calculate the charge to profit or loss, together with other
comprehensive income for the year
Both the current service cost and the net interest cost are charged to profit or loss for
the year. The remeasurement component, which comprises actuarial gains and
losses, together with returns on plan assets to the extent that they are not included
within the net interest
component, is taken to other comprehensive income.
Profit or loss:
20X4
20X5
Rs m
Rs m
30.0
32.0
Service cost component:
Current and past service cost
Net interest component:
4% × Rs 60m
2.4
3% × Rs 80m
2.4
–––––
–––––
32.4
34.4
12.6
5.6
–––––
–––––
45.0
40.0
–––––
–––––
Other comprehensive income
Net remeasurement component (W1)
Total comprehensive income charge for year
Step 4: Reconcile the movement in the net obligation or asset for the year:
Obligation bal b/fwd 1 January
Advanced Financial Accounting and Corporate Reporting (Study Text)
20X4
20X5
Rs m
Rs m
140.0
200.0
Page 77
Asset bal b/fwd at 1 January
(80.0)
(120.0)
–––––
–––––
Net obligation b/fwd at 1 January
60.0
80.0
Current and past service cost
30.0
32.0
Net interest charge
4% × Rs 60m
2.4
3% × Rs 80m
0.4
Contributions into plan
(25.0)
(30.0)
12.6
5.6
–––––
–––––
80.0
90.0
–––––
–––––
Net remeasurement component on obligation
(W1)
Net obligation c/fwd at 31 December
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(W1) Summary of remeasurement components for the year
This statement reconciles the figures in the statement of financial position using the
charges to profit or loss.
20X4
20X5
Rs m
Rs m
Remeasurement component on obligation – loss
44.4
14.0
Remeasurement component on assets – gain
(31.8)
(8.4)
–––––
–––––
12.6
5.6
–––––
–––––
Net remeasurement component
3.5
The impact of revisions to IAS 19
The revisions made to IAS 19 in 2011 have gone some way to overcoming
weaknesses of the previous version of IAS 19 as follows:
•
The classification of amounts to be included in profit or loss for the year have
been standardised into two components; the service cost component and the
net interest component.
•
The net interest charge is recognition of the time value of money for what is
essentially a longterm net obligation. Any returns on plan assets earned due
to factors other than the time value of money are accounted for as part of
other comprehensive income.
•
The choice of three possible accounting treatments of actuarial gains and
losses has now been removed. Actuarial gains and losses on the plan
obligation and plan assets are now referred to as remeasurement
components, and are accounted for as part of other comprehensive income.
•
Accounting for past service costs has been simplified, in that any such costs
incurred during an accounting period, which result in amendments to the
defined benefit plan which increase or decrease the future obligation, are now
immediately recognised either when the related restructuring costs or
termination benefits are recognised, or when the plan amendment occurs.
Previously, any such costs would have been spread and recognised over the
vesting period which employees had to provide additional work and service to
become entitled to the enhanced benefits.
•
Accounting for a curtailment gives rise to a gain or loss which is included as
part of past service cost.
•
There should be improved consistency and comparability of information as a
consequence of the increased standardisation and simplification of
accounting treatments introduced by IAS 19 (revised)
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3.6
Multi-employer plans
Multi-employer plans are classified as either defined contribution plans or defined
benefit plans. Defined contribution multi-employer plans do not pose a problem
because the employer’s cost is limited to the contributions payable.
Defined benefit multi-employer plans expose participating employers to the actuarial
risks associated with the current and former employees of other entities. There are
also potential problems because an employer may be unable to identify its share of
the underlying assets and liabilities.
IAS 19 states that where a multi-employer plan is a defined benefit plan, the entity
accounts for its proportionate share of the obligations, benefits and costs associated
with the plan in the same way as usual. However, where sufficient information is not
available to do this, the entity accounts for the plan as if it were a defined contribution
plan and discloses:
•
the fact that the plan is a defined benefit plan
•
the reason why sufficient information is not available to account for the plan
as a defined benefit plan.
In this situation, the revised standard requires additional disclosures to be made
regarding the defined benefit plan, some of which may be quite onerous for preparers
of financial statements.
3.7
Past Service Costs
Past service costs arise either where a new retirement benefit plan is introduced, or
where the benefits under an existing plan are improved.
Where a new plan is introduced, employees are often given benefit rights for any
years of service before commencement of the plan.
•
If employees have the right to receive benefits under the plan immediately,
the benefits are said to be ‘vested’ and the cost must be recognised
immediately.
•
If employees become entitled to benefits only at some later date, the benefits
become vested at that later date, with the costs still recognized immediately
following revision of IAS 19 in June 2011.
Example 2
Accounting for Pension Plans
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An entity operates a pension plan that provides a pension of 2% of final salary for
each year of service. The benefits become vested after five years of service. On 1
January 20X5, the entity improves the pension to 2.5% of final salary, for each year
of service starting from 1 January 20X1. At the date of the improvement, the present
value of the additional benefits for service from 1 January 20X1 to 1 January 20X5, is
as follows:
Rs 000
Employees with more than five years’ service at 1.1.X5
150
Employees with less than five years’ service at 1.1.X5
(average period until vesting: three years)
120
–––––
270
–––––
Required:
Explain how the additional benefits are accounted for in the financial
statements of the entity.
Solution
The entity recognises all Rs 270,000 immediately as an increase in the defined
benefit obligation following the amendment to the plan on 1 January 20X5. Whether
or not the benefits have vested at that date is not relevant to their recognition as an
expense in the financial statements.
3.8
Curtailments and settlements
A curtailment occurs when there is a significant reduction in the number of
employees covered by a defined benefit plan. This may occur when there is closure
of a plant or discontinuance of an operation. A curtailment gives rise to a past service
cost which is recognised at the earlier of three possible dates:
•
when the related restructuring costs are recognised, if it is part of a
restructuring, or
•
when the related termination benefits are recognised, if it is linked to
termination, or
•
when the curtailment occurs.
A settlement is a transaction that eliminates all further legal or constructive
obligations for part or all of the benefits provided under a defined benefit plan.
For example, an employee leaves the entity for a new job elsewhere, and a payment
is made on behalf of the employee into the defined benefit plan of the new employer.
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The gain or loss arising on a curtailment or settlement should be recognized when
the curtailment or settlement occurs.
The gain or loss comprises the difference between the fair value of the plan assets
paid out and the reduction in the present value of the defined benefit obligation.
Curtailments and settlements do not affect profit or loss if they have already been
allowed for in the actuarial assumptions; any impact would be considered part of the
remeasurement component.
Example 3
Curtailment and Settlement AB
AB decides to close a business segment. The segment’s employees will be made
redundant and will earn no further pension benefits after being made redundant.
Their plan assets will remain in the scheme so that the employees will be paid a
pension when they reach retirement age (i.e. this is a curtailment without settlement).
Before the curtailment, the scheme assets had a fair value of Rs 500,000, and the
defined benefit obligation had a present value of Rs 600,000. It is estimated that the
curtailment will reduce the present value of the future obligation by 10%, which
reflects the fact that employees will have fewer years of work and service with AB
before retirement, and therefore be entitled to a smaller pension than previously
estimated or accounted for.
Required:
What is net gain or loss on curtailment and how will this be treated in the
financial statements?
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Solution
The obligation is to be reduced by 10% x Rs 600,000 = Rs 60,000, with no change in
the fair value of the assets as they remain in the plan. The reduction in the obligation
represents a gain on curtailment which should be included as part of the service cost
component and taken to profit or loss for the year. The net position of the plan
following curtailment will be:
Before
On
After
curtailment
Rs 000
Rs 000
Rs 000
Present value of obligation
600
(60)
540
Fair value of plan assets
(500)
–
(500)
–––––
–––––
–––––
100
(60)
40
–––––
–––––
–––––
Net obligation in SOFP
The gain on curtailment is Rs 60,000 and this will be included as part of the service
cost component in profit or loss for the year.
4
The Asset Ceiling
4.1
Sometimes the deduction of plan assets from the pension obligation results in a
negative amount: i.e. an asset. IAS 19 states that pension plan assets (surpluses)
are measured at the lower of:
•
the amount calculated as normal per earlier examples and illustrations. or
•
the total of the present value of any economic benefits available in the form of
refunds from the plan or reductions in future contributions to the plan.
Applying the ‘asset ceiling’ means that a surplus can only be recognised to the extent
that it will be recoverable in the form of refunds or reduced contributions in future.
This would make it compatible with the definition of an asset as included within the
2010 Conceptual Framework for Financial Reporting.
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Example 4
The Asset Ceiling
The following information relates to a defined benefit plan:
Rs 000
Fair value of plan assets
950
Present value of pension liability
800
Present value of future refunds and reductions in future
Contributions
70
Required:
What is the value of the asset that recognised in the financial statements?
Solution
The amount that can be recognised is the lower of:
Rs 000
Present value of plan obligation
800
Fair value of plan assets
(950)
–––––
(150)
–––––
Rs 000
PV of future refunds and/or reductions in future contributions
(70)
––––
Therefore, the amount of the asset recognised is restricted to Rs 70,000.
4.2
IFRIC 14 – The limit on a defined benefit asset, minimum funding requirements
and their interaction
The subject matter of IFRIC 14 was not incorporated into the 2011 revisions of IAS
19, and therefore is still relevant where there may be a net asset for the defined
benefit plan at the reporting date. Although IFRICs are not examinable documents for
the syllabus, the principles applied by IFRIC 14 are consistent with the Framework
for Financial Reporting 2010 and are therefore considered relevant to your studies in
that context.
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IFRIC 14 addresses areas of IAS 19 where detailed guidance is lacking, namely:
•
How to determine the asset ceiling
•
The effect of a minimum funding requirement (MFR) on that calculation
•
When an MFR creates an onerous obligation that should be recognised as a
liability.
It therefore only applies to those entities which have a plan surplus or are subject to
minimum funding requirements.
IAS 19 states that pension plan surpluses are limited to the total of the present value
of any economic benefits available in the form of refunds from the plan or reductions
in future contributions to the plan. IFRIC 14, clarifies this by defining ‘available’ as
having an unconditional right to realise the benefit at some point during the life of the
plan or when the plan is settled, even if the benefit is not realisable immediately at
the reporting date. If such a right is conditional, then no asset in respect of refunds or
reductions in contributions can be recognised.
5
Disclosure Requirements
IAS 19 has extensive disclosure requirements, which were added to when it was
revised in 2011. In summary, an entity should disclose the following information
about defined benefit plans:
•
explanation of the regulatory framework within which the plan operates,
together with explanation of the nature of benefits provided by the plan
•
explanation of the nature of the risks the entity is exposed to as a
consequence of operating the plan, together with explanation of any plan
amendments, settlements or curtailments in the year
•
the entity’s accounting policy for recognising actuarial gains and losses,
together with disclosure of the significant actuarial assumptions used to
determine the net defined benefit obligation or assets. Although there is no
longer a choice of accounting policy for actuarial gains and losses, it may still
be helpful to users to explain how they have been accounted for within the
financial statements.
•
a general description of the type of plan operated
•
a reconciliation of the assets and liabilities recognised in the statement of
financial position
•
a reconciliation showing the movements during the period in the net liability
(or asset) recognised in the statement of financial position
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•
the charge to total comprehensive income for the year, separated into the
appropriate components
•
analysis of the remeasurement component to identify returns on plan assets,
together with actuarial gains and losses arising on the net plan obligation
•
sensitivity analysis and narrative description of how the defined benefit plan
may affect the nature, timing and uncertainty of the entity’s future cash flows.
6
Other Employee Benefits
6.1
IAS 19 covers a number of other issues in addition to post-employment benefits as
follows:
Short-term employee benefits – This includes a number of issues including:
•
Wages and salaries and bonuses and other benefits. The general
principle is that wages and salaries costs are expenses as they are incurred
on a normal accruals basis, unless capitalisation is permitted in accordance
with another reporting standard, such as IAS 16 or IAS 38. Bonuses and
other short-term payments are recognised using normal criteria of
establishing an obligation based upon past events which can be reliably
measured.
•
Compensated absences. This covers issues such as holiday pay, sick leave,
maternity leave, jury service, study leave and military service. The key issue
is whether the absences are regarded as being accumulating or nonaccumulating:
–
accumulating benefits are earned over time and are capable of being
carried forward. In this situation, the expense for future compensated
absences is recognised over the period services are provided by the
employee. This will typically result in the recognition of a liability at the
reporting date for the expected cost of the accumulated benefit earned
but not yet claimed by an employee. An example of this would be a
holiday pay accrual at the reporting date where unused holiday
entitlement can be carried forward and claimed in a future period.
–
for non-accumulating benefits, an expense should only be recognised
when the absence occurs. This may arise, for example, where an
employee continues to receive their normal remuneration whilst being
absent due to illness or other permitted reason. A charge to profit or
loss would be made only when the authorised absence occurs; if there
is no such absence, there will be no charge to profit or loss.
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11) Benefits in kind. Recognition of cost should be based on the same principles
as benefits payable in cash; it should be measured based upon the cost to the
employer of providing the benefit and recognised as it is earned.
6.2
Termination benefits
The definition of what constitutes termination benefits, and how they should be
accounted for, was included in the revised edition of IAS 19 issued in June 2011.
Termination benefits may be defined as benefits payable as a result of employment
being terminated, either by the employer, or by the employee accepting voluntary
redundancy. Such payments are normally in the form of a lump sum; entitlement to
such payments is not accrued over time, and only become available in a relatively
short period prior to any such payment being agreed and paid to the employee. The
obligation to pay such benefits is recognised either when the employer can no longer
withdraw the offer of such benefits (i.e. they are committed to paying them), or when
it recognises related restructuring costs (normally in accordance with IAS 37).
Payments which are due to be paid more than twelve months after the reporting date
should be discounted to their present value.
6.3
Other long-term employee benefits
This comprises other items not within the above classifications and will include longservice leave, long-term disability benefits and other long-service benefits. These
employee benefits are accounted for in a similar manner to accounting for postemployment benefits, typically using the projected unit credit method, as benefits are
payable more than twelve months after the period in which services are provided by
an employee.
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Chapter Summary
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Self-Test Questions
1.
An entity makes contributions to the pension fund of employees at a rate of 5% of
gross salary. The contributions made are Rs 10,000 per month for convenience with
the balance being contributed in the first month of the following accounting year. The
wages and salaries for 20X6 are Rs 2.7m.
Required:
Calculate the pension expense for 20X6, and the accrual/prepayment at the end
of the year.
2.
The following information is provided relating to a defined benefit plan operated by JS
Ltd. All transactions are assumed to occur at the reporting date. At 1 January 20X1,
the present value of the obligation was Rs 1,000,000 and the fair value of the plan
assets amounted to Rs 900,000.
20X3
20X1
20X2
Discount rate at start of year
10%
9%
8%
Current and past service cost (Rs 000)
125
130
138
Benefits paid (Rs 000)
150
155
165
Contributions paid into plan (Rs 000)
90
95
105
PV of obligation at 31 December (Rs 000)
1,350
1,340
1,450
FV of plan assets at 31 December (Rs 000)
1,200
1,150
1,300
Required:
Show how the defined benefit plan would be shown in the financial statements
for each of the years ended 31 December 20X1, 20X2 and 20X3 respectively
3.
TC has a defined benefit pension plan and prepares financial statements to 31 March
each year. The following information is relevant for the year ended 31 March 20X3:
12)
The net pension obligation at 31 March 20X3 was Rs 55 million. At 31 March
20X2, the net obligation was Rs 48 million, comprising the present value of
the plan obligation stated at Rs 100 million, together with plan assets stated
at fair value of Rs 52 million.
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13) The discount rate relevant to the net obligation was 6.25% and the actual
return on plan assets for the year was Rs 4 million.
14) The current service cost was Rs 12 million.
15)
1)
At 31 March 20X3, TC granted additional benefits to those currently receiving
benefits that are due to vest over the next four years and which have a
present value of Rs 4 million at that date. They were not allowed for in the
original actuarial assumptions.
During the year, TC made pension contributions of Rs 8 million into the
scheme and the scheme paid pension benefits in the year amounting to Rs 3
million.
Required:
Prepare a summary of the movement in the net obligation for the year to 31
March 20X3, together with supporting explanation.
4. The following information relates to the defined benefit plan operated by M.J Ltd
for the year ended 30 June 20X4:
Rs m
FV of plan assets b/fwd at 30 June 20X3
2,600
PV of obligation b/fwd at 30 June 20X3
2,000
Current service cost for the year
100
Benefits paid in the year
80
Contributions into plan
90
FV of plan assets at 30 June 20X4
3,100
PV of plan obligation at 30 June 20X4
2,400
Discount rate for the defined benefit obligation – 10%
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4
M.J Ltd has identified that the asset ceiling at 30 June 20X3 and 30 June 20X4,
based upon the present value of future refunds from the plan and/or reductions in
future contributions amounts to Rs 200m at 30 June 20X3 and 30 June 20X4.
Required:
a) Reconcile the movement in the plan assets and obligation, to determine what is
charged in the statement of comprehensive income for the year ended 30 June 20X4,
together with identification of the balance reported on the statement of financial
position at 30 June 20X4.
b) Explain the purpose of the asset ceiling, together with its impact upon accounting for
the defined benefit plan operated by M.J Ltd.
Answers
1.
This appears to be a defined contribution scheme.
The charge to income should be:
Rs 2.7m × 5% = Rs 135,000
The statement of financial position will therefore show an accrual of Rs 15,000, being
the difference between the Rs 135,000 and the Rs 120,000 paid in the year
2.
Step 1 – Calculate remeasurement gains and losses
On obligations
20X1
20X2
20X3
Rs 000
Rs 000
Rs 000
1,000
1,350
1,340
Interest charge (10% X1/ 9% X2/ 8% X3)
100
122
107
Current and past service cost
125
130
138
Benefits paid
(150)
(155)
(165)
Remeasurement component (gain) loss – bal.fig
275
(107)
30
–––––
–––––
–––––
1,350
1,340
1,450
–––––
–––––
–––––
20X1
20X2
20X3
Rs 000
Rs 000
Rs 000
Obligation at start of the year
Obligation at end of the year
On assets
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Fair value at start of the year
900
1,200
1,150
Interest return: (10% X1/ 9% X2/ 8% X3)
90
108
92
Contributions into plan
90
95
105
Benefits paid
(150)
(155)
(165)
Remeasurement component gain (loss) – bal. fig
270
(98)
118
–––––
–––––
–––––
1,200
1,150
1,300
–––––
–––––
–––––
20X1
20X2
20X3
Rs 000
Rs 000
Rs 000
PV of obligation at 31 December
1,350
1,340
1,450
FV of assets at 31 December
(1,200)
(1,150)
(1,300)
150
190
150
Market value at end of the year
Step 2 – The statement of financial position
Net pension (asset) liability
Step 3 – Profit or loss and other comprehensive income for the year
20X1
20X2
20X3
Rs 000
Rs 000
Rs 000
Current and past service cost
125
130
138
Net interest component
10
14
15
–––––
–––––
–––––
135
144
153
5
(9)
(88)
–––––
–––––
–––––
140
135
65
–––––
–––––
–––––
Service cost component
Charge to profit or loss
Other comprehensive income:
Net remeasurement component (W1)
Total charge to comprehensive income
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Step 4 – Reconcile the movement in the net obligation or asset for the year
20X1
20X2
20X3
Rs 000
Rs 000
Rs 000
Obligation bal b/fwd at 1 January
1,000
1350
1,340
Asset bal b/fwd at 1 January
(900)
(1,200)
(1,150)
–––––
–––––
–––––
100
150
190
Net obligation at 1 January
Net interest:
10% × 100
10
9% × 150
14
8% × 190
15
Current and past service cost
125
130
138
Contributions into plan
(90)
(95)
(105)
5
(9)
(88)
–––––
–––––
–––––
150
190
150
–––––
–––––
–––––
20X1
20X2
20X3
Rs 000
Rs 000
Rs 000
275
(107)
30
(270)
98
(118)
–––––
–––––
–––––
5
(9)
(88)
–––––
–––––
–––––
Net remeasurement component
Net obligation at reporting date
(W1)
Net remeasurement component:
Remeasurement component in
obligation (gain)/loss
Remeasurement component in
assets (gain)/loss
Net remeasurement (gain)/loss
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3.
Rs m
Net obligation brought forward
48
Net interest component @ 6.25%
3
Service cost component:
Current service cost
12
Past service cost
4
16
––––
Contributions into the plan
(8)
Remeasurement component (bal fig)
(4)
––––
Net obligation carried forward
55
––––
Explanation:
•
The discount rate is applied to the net obligation brought forward and will be
charged to profit or loss for the year as the net interest component.
•
The current year service cost, together with the past service cost forms the
service cost component which is charged to profit or loss for the year. Past
service cost is charged in full, usually when the scheme is amended, rather
than when the additional benefits vest.
•
To the extent that there has been a return on assets in excess of the amount
identified by application of the discount rate to the fair value of plan assets,
this is part of the remeasurement component (i.e. Rs 4m – Rs 3.25m (Rs 52m
x 6.25%) = Rs 0.75m).
•
Contributions paid into the scheme during the year will reduce the net
obligation.
•
Benefits paid of Rs 3 million will reduce both the scheme assets and the
scheme obligation, so will have no impact on the net obligation.
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(a)
PV
Obligation
FV
Ceiling
Net
Note
Assets
Adjust
Defined
Benefit
asset
Rs m
Rs m
Rs m
Rs m
Balance b/fwd
2,000
(2,600)
400
(200)
1
Interest @10%
200
(260
40
(20)
2
Service cost
100
100
3
Benefits paid
(80)
80
4
Contributions in
(90)
(90)
5
–––––
–––––
–––––
–––––
2,220
(2,870)
440
(210)
180
(180)
Subtotal:
Remeasurement
component:
Obligation – loss
Asset – gain
Balance c/fwd
(230)
230
10
10
6
–––––
–––––
–––––
–––––
2,400
(3,100)
500
(200)
–––––
–––––
–––––
–––––
* note that this is effectively a balancing figure.
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Explanation
(1)
The asset ceiling adjustment at the previous reporting date of 30 June 20X3
measures the net defined benefit asset at the amount recoverable by refunds
and/or reduced future contributions, stated at Rs 200m. In effect, the value of
the asset was reduced for reporting purposes at 30 June 20X3.
(2)
Interest charged on the obligation or earned on the plan assets is based upon
the discount rate for the obligation, stated at 10%. This will then require
adjustment to agree with the net return on the net plan asset at the beginning
of the year. Net interest earned is taken to profit or loss for the year.
(3)
The current year service cost increases the plan obligation, which therefore
reduces the net plan asset. The current year service cost is taken to profit or
loss for the year.
(4)
Benefits paid in the year reduce both the plan obligation and the plan assets
by the same amount.
(5)
Contributions into the plan increase the fair value of plan assets, and also the
net plan asset during the year.
(6)
The remeasurement component, including actuarial gains and losses for the
year, is identified to arrive at the present value of the plan obligation and the
fair value of the plan assets at 30 June 20X4. As there is a net asset of Rs
700m (Rs 3,100m – Rs 2,400m) for the defined benefit pension plan, the
asset ceiling test is applied to restrict the reported asset to the expected
future benefits in the form of refunds and/or reduced future contributions,
which is stated in the question to be Rs 200m. To the extent that an
adjustment is required to the net asset at the reporting date, this is part of the
net remeasurement component.
(b)
The asset ceiling test is designed to ensure that any net pension asset is not
overstated on the statement of financial position. If it can be reliably
measured based upon the present value of future economic benefits to be
received, either in the form of reduced future contributions or refunds of
contributions already paid, this will comply with the definition of an asset from
the 2010 Conceptual Framework for Financial Reporting.
If the asset ceiling test was not applied, at 30 June 20X4, there would be a
net asset for the defined benefit plan amounting to Rs 700 m (Rs 3,100 – Rs
2,400). However, this amount would not be fully represented by the right to
receive future economic benefits in the form of refunds of amounts already
paid or reductions in future contributions into the plan. Consequently, the
asset would be overstated as, even though the plan assets are stated at fair
value, they are held to meet future payments in respect of a long-term
obligation.
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SHARE BASED PAYMENTS
Chapter learning objectives
Upon completion of this chapter you will be able to:
•
Apply and discuss the recognition and measurement criteria for Share based
payment transactions
•
Account for modifications, cancellations and settlements of Share based payment
transactions.
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1
Share-Based Payment
1.1
Introduction
Share-based payment has become increasingly common. Share-based payment
occurs when an entity buys goods or services from other parties (such as employees
or suppliers), and settles the amounts payable by issuing shares or share options to
them.
1) Part of the remuneration of directors is often in the form of shares or options.
Employees may also be granted share options.
2) Many new ‘ebusinesses’ do not expect to be profitable in their early years, so
try to attract quality staff by offering to employees share schemes rather than
high cash salaries.
1.2
The problem
If a company pays for goods or services in cash, an expense is recognized in profit or
loss. If a company ‘pays’ for goods or services in share options, there is no cash
outflow and under traditional accounting, no expense would be recognised.
3) But when a company issues shares to acquire an investment in another entity,
it is accepted that the acquirer has incurred a cost that should be recognised
in the financial statements at fair value. Issuing shares to acquire goods or
services is arguably no different.
4) When a company issues shares to employees, a transaction has occurred;
the employees have provided a valuable service to the entity, in exchange for
the shares/options. It is illogical not to recognise this transaction in the
financial statements.
5) IFRS 2 Share-based payment was issued to deal with this accounting
anomaly. IFRS 2 requires that all Share-based payment transactions must be
recognised in the financial statements.
2
Types of Transaction
2.1
IFRS 2 applies to all types of Share-based payment transaction. There are two main
types:
The most common type of Share-based payment transaction is where share options
are granted to employees or directors as part of their remuneration.
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•
in an equity settled share based payment transaction, the entity receives
goods or services in exchange for equity instruments of the entity (e.g. shares
or share options)
6) in a cash settled Share-based payment transaction, the entity acquires
goods or services in exchange for amounts of cash measured by reference to
the entity’s share price.
Illustration : How options work
2.2
The basic principles
When an entity receives goods or services as a result of a share based payment
transaction, it recognises either an expense or an asset.
7) If the goods or services are received in exchange for equity (e.g., for
share options), the entity recognises an increase in equity.
1) The double entry is: Dr Expense/Asset; Cr Equity (normally a special
reserve).
2) If the goods or services are received or acquired in a cash settled
share based payment transaction, the entity recognises a liability.
3) The double entry is: Dr Expense/Asset; Cr Liability.
All share based payment transactions are measured at fair value.
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3
Equity-Settled Share-Based Payment Transactions
3.1
Measurement
The basic principle is that all transactions are measured at fair value.
Fair value is the amount for which an asset could be exchanged, a liability settled, or
an equity instrument granted could be exchanged, between knowledgeable, willing
parties in an arm’s length transaction.
How fair value is determined:
The grant date is the date at which the entity and another party agree to the
arrangement.
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3.2
Determining Fair Value
Where a share-based payment transaction is with parties other than employees, it is
assumed that the fair value of the goods and services received can be measured
reliably, at their cash price for example.
Where shares or share options are granted to employees as part of their
remuneration, it is not usually possible to arrive at a reliable value for the services
received in return. For this reason, the entity measures the transaction by reference
to the fair value of the equity instruments granted.
The fair value of equity instruments is market value, if this is available. Where no
market price is available (for example, if the instruments are unquoted), a valuation
technique is used.
The fair value of share options is harder to determine. In rare cases there may be
publicly quoted traded options with similar terms, whose market value can be used
as the fair value of the options we are considering. Otherwise, the fair value of
options must be estimated
using a recognised option pricing model. IFRS 2 does not require any specific model
to be used. The most commonly used is the Black Scholes model.
3.3
Allocating the expense to reporting periods
Some equity instruments granted vest immediately, meaning that the holder is
unconditionally entitled to the instruments. In this case, the transaction should be
accounted for in full on the grant date.
The vesting date is the date on which the counterparty (e.g., the employee)
becomes entitled to receive the cash or equity instruments under the arrangement.
4) Note the difference in meaning between the grant date of options and the
vesting date.
However, when share options are granted to employees as part of their remuneration
package, the employees usually have to meet specified conditions before actually
becoming entitled to the shares. For example, they may have to complete a specified
period of service or to achieve particular performance targets.
5) For this reason, the transaction normally has to be recognised over more than
one accounting period.
IFRS 2 states that an entity should account for services as they are rendered during
the vesting period.
6) The vesting period is the period during which all the specified vesting
conditions are satisfied.
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Equity-settled Share-based payment transactions
On 1 January 20X1, A awards 1,000 share options to an employee, on condition that
he is still working for the company in two years’ time. The grant date is 1 January
20X1. The vesting period is from 1 January 20X1 to 31 December 20X2. The vesting
date is 31 December 20X2.
The entity should recognise an amount for the goods or services received during the
vesting period based on the best available estimate of the number of equity
instruments expected to vest.
7) Each year it should revise that estimate of the number of equity instruments
expected to vest if subsequent information indicates that this number differs
from previous estimates.
8) On vesting date, the entity should revise the estimate to equal the number of
equity instruments that actually vest.
9) Sometimes one of the vesting conditions is a ‘market condition’, for example,
where the share price must be above a certain amount on the vesting date.
Market conditions are taken into account when estimating the fair value of the
option at the grant date. Failure to satisfy a market condition is not taken into
account when subsequently calculating the amounts recognised in profit and
loss and equity over the vesting period.
Before the shares vest, the amount recognised in equity is normally credited to a
special reserve called (for example) ‘shares to be issued’.
10) After the share options vest and the shares are issued, the relevant amount is
usually transferred to share capital.
Example 1
On 1 January 20X1 an entity grants 100 share options to each of its 500 employees.
Each grant is conditional upon the employee working for the entity until 31 December
20X3. At the grant date the fair value of each share option is Rs15.
During 20X1, 20 employees leave and the entity estimates that a total of 20% of the
500 employees will leave during the three year period.
During 20X2, a further 20 employees leave and the entity now estimates that only a
total of 15% of its 500 employees will leave during the three year period.
During 20X3, a further 10 employees leave.
Calculate the remuneration expense that will be recognised in respect of the Sharebased
payment transaction for each of the three years ended 31 December 20X3.
Solution
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The entity recognises the remuneration expense as the employees’ services are
received during the three year vesting period. The amount recognised is based on
the fair value of the share options granted at the grant date (1 January 20X1).
Assuming that no employees left, the total expense would be Rs750,000 (100 × 500
× 15) and the expense charged to profit or loss for each of the three years would be
Rs250,000 (750,000/3).
In practice, the entity estimates the number of options expected to vest by estimating
the number of employees likely to leave. This estimate is revised at each year end.
The expense recognised for the year is based on this re-estimate. On the vesting
date (31 December 20X3), it recognises an amount based on the number of options
that actually vest.
A total of 50 employees left during the three year period and therefore 45,000 options
(500 – 50 × 100) vested.
The amount recognised as an expense for each of the three years is calculated as
follows:
Expense for year
Comulative Expense
(change in Cumulative)
Rs
at year end
____
_______________________
20X1
100 × (500 × 80%) × 15 × 1/3
200,000
200,000
20X2
100 × (500 × 85%) × 15 × 2/3
225,000
425,000
20X3
45,000 × 15
250,000
675,000
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Rs
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The financial statements will include the following amounts:
Income statement
Staff costs
20X1
20X2
20X3
Rs
Rs
Rs
200,000
225,000
250,000
–––––––
–––––––
–––––––
Year 1
Year 2
Year 3
200,000
425,000
675,000
–––––––
–––––––
–––––––
Statement of financial position
Included with equity
Example 2
Equity-settled Share-based payment transactions:
JJ grants 100 share options to each of its 20 employees providing they meet
performance targets for each of the next two years. At the end of the first year, it was
estimated that 80% of the employees would meet the targets over both years.
Improved performance meant that at the end of the second year it turned out that
85% of employees had done so.
The fair value of the option at the grant date was Rs10.
Calculate the charge to profits for each year.
Solution
At the end of year 1, 16 employees are eligible for the shares (20 × 80%).
The fair value of the options is: 100 × 16 × Rs10 = Rs16,000
This is spread over the two year vesting period, so the charge to profits Rs 8,000
(Rs16,000/2).
Dr Staff costs (income statement)
Rs 8,000
Cr Equity
Rs 8,000
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At the end of the second year, 17 employees are eligible for shares (20 × 85%). This
is the vesting date, so these 17 employees will receive share options.
The fair value of the options is: 100 × 17 × Rs10 = Rs 17,000
Rs 8,000 has already been charged to profits in the previous year, so to increase the
charge and the corresponding equity balance, the charge for the second year is Rs
9,000.
Dr Staff costs
Rs 9,000
Cr Equity
Rs 9,000
Accounting after vesting date
IFRS 2 states that no further adjustments to total equity should be made after vesting
date. This applies even if some of the equity instruments do not vest (for example,
because some of the employees do not exercise their right to buy shares).
11)But for those who do not vest, a transfer may be made from shares to be
issued to retained earnings.
4
Cash-Settled Share-based Payment Transactions
4.1
Examples of cash-settled share-based payment transactions include
12)share appreciation rights (SARs), where employees become entitled to a
future cash payment based on the increase in the entity’s share price from a
specified level over a specified period of time
13) those where employees are granted a right to shares that are redeemable.
This gives them a right to receive a future payment of cash.
The basic principle is that the entity measures the goods or services acquired and
the liability incurred at the fair value of the liability.
•
Until the liability is settled, the entity remeasures the fair value of the liability
at each reporting date until the liability is settled and at the date of settlement.
(Notice that this is different from accounting for equity Share-based payments,
where the fair value is fixed at the grant date.)
14)Changes in fair value are recognised in profit or loss for the period.
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Example 3
On 1 January 20X1 an entity grants 100 cash share appreciation rights (SAR) to
each of its 300 employees, on condition that they continue to work for the entity until
31 December 20X3.
During 20X1, 20 employees leave. The entity estimates that a further 40 will leave
during 20X2 and 20X3.
During 20X2, 10 employees leave. The entity estimates that a further 20 will leave
during 20X3.
During 20X3, 10 employees leave.
The fair values of one SAR for each year are shown below.
Fair value
Rs
20X1
10.00
20X2
12.00
20X3
15.00
Calculate the amount to be recognised as an expense for each of the three years
ended 31 December 20X3 and the liability to be recognized in the statement of
financial position at 31 December for each of the three years.
Solution
Year
Liability at
Expense
Year-end
for year
Rs. ‘000’
Rs. ‘000’
20X1 ((300 – 20 – 40) × 100 × 10 × 1/3)
80
80
20X2 ((300 – 20 – 10 – 20) × 100 × 12 × 2/3)
200
120
20X3 ((300 – 20 – 10 – 10) × 100 × 15)
390
190
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4.2
Hybrid Transactions
Some Share-based payment transactions give either the reporting entity or the other
party the choice of settling in cash or in equity instruments.
IFRS 2 states that if the entity has incurred a liability to settle in cash or other assets,
the transaction should be accounted for as a Cash-settled Share-based payment
transaction. Otherwise, it should be accounted for as an equity-settled share-based
payment transaction.
5
Disclosures
Entities should disclose information that enables users of the financial statements to
understand the nature and extent of Share-based payment arrangements that
existed during the period. The main disclosures are as follows:
•
a description of each type of Share-based payment arrangement that existed
at any time during the period
•
the number and weighted average exercise prices of share options:
1) outstanding at the beginning of the period
2) granted during the period
3) forfeited during the period

exercised during the period
4) expired during the period
5) outstanding at the end of the period
6) exercisable at the end of the period.
•
for share options exercised during the period, the weighted average share
price at the date of exercise
•
for share options outstanding at the end of the period, the range of exercise
prices and weighted average remaining contractual life.
IFRS 2 also requires disclosure of information that enables users of the financial
statements to understand how the fair value of the goods or services received, or the
fair value of the equity instruments granted, during the period was determined.
Entities should also disclose information that enables users of the financial
statements to understand the effect of Share-based payment transactions on the
entity’s profit or loss for the period and on its financial position, that is:
•
the total expense recognised for the period arising from Share-based
payment transactions
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•
for liabilities arising from Share-based payment transactions:
–
the total carrying amount at the end of the period
–
the total intrinsic value at the end of the period of liabilities for which
the counterparty’s right to cash or other assets had vested by the end
of the period.
6
Modifications, Cancellations and Settlements
6.1
Modifications to the terms on which equity instruments are granted
An entity may alter the terms and conditions of share option schemes during the
vesting period.
7) For example, it might increase or reduce the exercise price of the options,
which makes the scheme less favourable or more favourable to employees.
8) It might also change the vesting conditions, to make it more likely or less likely
that the options will vest.
The general rule is that, apart from dealing with reductions due to failure to satisfy
vesting conditions, the entity must always recognise at least the amount that would
have been recognised if the terms and conditions had not been modified (that is, if
the original terms had remained in force).
9) If the change reduces the amount that the employee will receive, there is no
reduction in the expense recognised in profit or loss.
10)If the change increases the amount that the employee will receive, the
difference between the fair value of the new arrangement and the fair value of
the original arrangement (the incremental fair value) must be recognised as a
charge to profit. The extra cost is spread over the period from the date of the
change to the vesting date.
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Example 4
An entity grants 100 share options to each of its 500 employees, provided that they
remain in service over the next three years. The fair value of each option is Rs20.
During year one, 50 employees leave. The entity estimates that a further 60
employees will leave during years two and three.
At the end of year one the entity reprices its share options because the share price
has fallen. The other vesting conditions remain unchanged. At the date of repricing,
the fair value of each of the original share options granted (before taking the repricing
into account) was Rs10. The fair value of each repriced share option is Rs15.
During year two, a further 30 employees leave. The entity estimates that a further 30
employees will leave during year three.
During year three, a further 30 employees leave.
Calculate the amounts to be recognised in the financial statements for each of the
three years of the scheme.
Solution
The repricing means that the total fair value of the arrangement has increased and
this will benefit the employees. This in turn means that the entity must account for an
increased remuneration expense. The increased cost is based upon the difference in
the fair value of the option, immediately before and after the repricing. Under the
original arrangement, the fair value of the option at the date of repricing was Rs10,
which increased to Rs15 following the repricing of the options, for each share
estimated to vest. The additional cost is recognised over the remainder of the vesting
period (years two and three).
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The amounts recognised in the financial statements for each of the three years are
as follows:
Amount
Expense
included
in equity
Rs
Rs
260,000
260,000
Year one Original (500 – 50 – 60)
× 100 × 20 × 1/3
–––––––
––––––
Year two Original (500 – 50 – 30 – 30) × 100 × 20 × 2/3
520,000
260,000
Incremental (500 – 50 – 30 – 30) × 100 × 5 × ½
97,500
97,500
–––––––
–––––––
617,500
357,500
–––––––
–––––––
780,000
260,000
195,000
97,500
–––––––
–––––––
975,000
357,500
–––––––
–––––––
Year three (500 – 50 – 30 – 30)
Original
× 100 × 20
Incremental (500 – 50 – 30 – 30)
× 100 × 5
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Example 5
An entity grants 100 share options to each of the 15 employees in its sales team, on
condition that they remain in service over the next three years. There is also a
performance condition: the team must sell more than 40,000 units of a particular
product over the three year period. At the grant date the fair value of each option is
Rs20.
During Year 2, the entity increases the sales target to 70,000 units. By the end of
Year 3, only 60,000 units have been sold and the share options do not vest.
All 15 employees remain with the entity for the full three years.
Calculate the amounts to be recognised in the financial statements for each of
the three years of the scheme.
Solution
IFRS 2 states that when a share option scheme is modified, the entity must
recognise, as a minimum, the services received, measured at the fair value at the
grant date. The employees have not met the modified sales target, but did meet the
original target set on grant date.
This means that the entity must recognise the expense that it would have incurred
had the original scheme continued in force.
The total amount recognised in equity is Rs30,000 (15 × 100 × 20). The entity
recognises an expense of Rs10,000 for each of the three years.
6.2
Cancellations and settlements
An entity may also cancel or settle a share option scheme before vesting date. In a
settlement, the employees receive compensation because the scheme is cancelled.
11)If the cancellation or settlement occurs during the vesting period, the entity
immediately recognises the amount that would otherwise have been
recognised for services received over the vesting period (an acceleration of
vesting).
12)Any payment made to employees up to the fair value of the equity instruments
granted at cancellation or settlement date is accounted for as a deduction
from equity (repurchase of an equity interest).
13)Any payment made to employees in excess of the fair value of the equity
instruments granted at cancellation or settlement date is accounted for as an
expense.
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7
Recent Developments
The amendments to IFRS 2 clarify the definition of vesting conditions and provide
guidance on the accounting treatment of cancellations by parties other than the entity.
7.1
Vesting conditions
Vesting conditions are defined in IFRS 2 as:
‘The conditions that must be satisfied for the counterparty to become entitled to
receive cash, other assets or equity instruments of the entity under a share-based
payment arrangement. Vesting conditions include service conditions, which require
the other party to complete a specified period of service, and performance conditions,
which require specific performance conditions to be met.’
Previously, IFRS 2 was silent on whether features of a share-based payment
transaction other than service conditions and performance conditions were vesting
conditions. In the 2008 amendment to the standard, the IASB has clarified that only
service and performance conditions are vesting conditions. Other features of a sharebased payment are not, but should be included in the grant date fair value of the
share-based payment.
7.2
Cancellations
IFRS 2 specified the accounting treatment when an entity cancels a grant of equity
instruments. However, it did not state how cancellations by a party other than the
entity should be accounted for.
The amended standard clarifies that all cancellations, whether by the entity or by
other parties, should receive the same accounting treatment. The amendments
above are effective for annual periods beginning on or after 1 January 2009, with
earlier adoption permitted.
Chapter Summary
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Self-Test Questions
1.
Alpha Ltd offered directors an option scheme based on a three year period of
service. The number of options granted to directors at the inception of the scheme
was 10 million. The options were exercisable shortly after the end of the third year.
The fair value of the options and the estimates of the number of options expected to
vest were:
Year
Rights expected
Fair Value
to vest
of option
Start of Year One
8m
30paisas
End of Year One
7m
33paisas
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End of Year Two
8m
37paisas
End of Year Three
9m
74paisas
Show how the option scheme will affect the financial statements for each of the
three years.
2.
Asif has set up an employee option scheme to motivate its sales team of ten key
sales people. Each sales person was offered 1 million options exercisable at
10paisas, conditional upon the employee remaining with the company during the
vesting period of 5 years. The options are then exercisable three weeks after the end
of the vesting period.
3.
This is year two of the scheme. At the end of year one, two sales people suggested
that they would be leaving the company during the second year. However, although
one did leave, the other recommitted to the company and the scheme. The other
employees have always been committed to the scheme and stated their intention to
stay with the company during the 5 years. Relevant market values are as follows:
Date
Share price
Option price
Grant date
10p
20paisas
End of Year One
24p
38paisas
End of Year Two
21p
33paisas
The option price is the market price of an equivalent marketable option on the
relevant date.
Show the effect of the scheme on the financial statements of Asif for Year Two.
4.
Bahzad has singled out the inventory control director for an employee option scheme.
He has been offered 3 million options exercisable at 20paisas, conditional upon him
remaining with the company for three years and improving inventory control by the
end of that period. The proportion of the options that vest is dependent upon the
inventory days on the last day of the three years. The schedule is as follows:
Inventory days
Proportion vesting
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5
100%
6
90%
7
70%
8
40%
9
10%
The options also have a vesting criteria related to market value. They only vest if the
share price is above 25paisas on the vesting day, i.e. at the end of the third year.
This is the second of the three years. At the end of year one it was estimated that the
inventory days at the end of the third year would be 7. However, during year two
inventory control improved and at the end of the year the estimate of inventory days
at the end of the third year was 6. The relevant market data is as follows:
Date
Share price
Option price
Grant date
20paisas
10paisas
End of Year One
19paisas
6paisas
End of Year Two
37paisas
19paisas
The option price is the market price of an equivalent marketable option on the
relevant date.
Show the effect of the scheme on the financial statements of Bahzad for Year
Two.
4.
On 1 January 20X4 Growler granted 200 cash share appreciation rights (SARs) to
each of its 500 employees, on condition that they continue to work for the entity for four
years. At 1 January 20X4, the entity expects that, based upon past experience, 5% of that
number is expected to leave each year.
During 20X4, 20 employees leave, and the entity expects that this number will leave
in each future year of the scheme.
During 20X5, 24 employees leave, and the entity expects that a total of 44
employees will leave over the remaining two-year period of the scheme.
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During 20X6, eighteen employees leave, with a further 20 expected to leave in the
final year. During 20X7, only 10 employees leave
The fair value of each SAR was as follows:
31 December 20X4 – Rs 5
31 December 20X5 – Rs 7
31 December 20X6 – Rs 8
31 December 20X7 – Rs 9
Required
Calculate the amount to be recognised as a remuneration expense in the
statement of comprehensive income, together with the liability to be
recognised in the statement of financial position for each of the four years of
the scheme, commencing with the reporting date 31 December 20X4.
Answers
1.
Year
Expense Amount included in equity
Rs. ‘000’
Rs. ‘000’
One (7m × 30paisas × 1/3)
700
700
Two (8m × 30paisas × 2/3)
900
1,600
1,100
2,700
Three (9m × 30paisas)
Note: the expense is measured using the fair value of the option at the grant date, i.e.
the start of year one.
2.
The expense is measured using the fair value of the option at the grant date, i.e. 20
paisas.
At the end of year two the amount recognised in equity should be Rs 720,000 (1m ×
(10 – 1) × 20 paisas × 2/5).
At the beginning of year two the amount recognised in equity would have been Rs
320,000 (1m × 8 × 20 paisas × 1/5).
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The charge to profit for Year Two is the difference between the two: Rs 400,000 (720
– 320).
3.
One of the conditions of vesting is a ‘market condition’ (the share price must be
above 25 paisas on the vesting day). This should already have been taken into
account when the option price was fixed and it does not affect the calculations below.
At the end of year two the amount recognised in equity is Rs 180,000 (3m × 10
paisas × 90% × 2/3).
At the beginning of year two the amount recognised in equity should have been Rs
70,000 (3m × 10 paisas × 70% × 1/3).
Therefore the charge to profit for year two is Rs 110,000 (180,000 – 70,000).
4.
The liability is remeasured at each reporting date, based upon the current
information available relating to known and expected leavers, together with the fair
value of the SAR at each date. The remuneration expense recognised is the
movement in the liability from one reporting date to the next as summarised below:
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Reporting
Workings
SOFP – liability
Change in
Date
Expense
SOCI
Liability
Rs
31/12/20X4
105,000
(500 –
20
Rs
– 20
–
20
Rs____
105,000
– 20) = 420 × 200 ×
Rs 5 × ¼
31/12/20X5
183,400
(500 – 20 – 24 –44)
288,400
288,400 –105,000
501,600
501,600 –288,400
770,400
770,400 –501,600
= 412 × 200 × Rs7 ×
2/4
31/12/20X6
213,200
(500 – 20 – 24 – 18
– 20) = 418 × 200 ×
Rs 8 × 3/4
31/12/20X7
268,800
(500 – 20 – 24 – 18
– 10) = 428 × 200 ×
Rs 9 × 4/4
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FAIR VALUE MEASUREMENT
Chapter learning objectives
Upon completion of this chapter you will be able to:
1) Explain the reasons for the introduction of IFRS 13 Fair value measurement
together with application of the key principles to determine fair value
measurement in specific situations.
2) Understand disclosure requirements of IFRS 13
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1
Fair Value Measurement – IFRS 13
1.1
Introduction
The objective of IFRS 13 is to provide a single source of guidance for fair value
measurement where it is required by a reporting standard, rather than it being spread
throughout several reporting standards. There is now a uniform framework for
measurement of fair value for entities around the world who apply either US GAAP or
IFRS GAAP. IFRS 13 does not extend the use of fair value – it provides guidance on
how it should be determined when an initial or subsequent fair value measurement is
required by a reporting standard.
Note that IFRS 13 does not apply to share-based payment transactions accounted
for by IFRS 2 Share-based Payment and IAS 17 Leases. IFRS 13 also does not
apply to situations where different measurements are required, such as net realisable
value or value in use which may be required by other reporting standards, such as
IAS 2 Inventories and IAS 36 Impairment respectively.
IFRS 13 is effective for accounting periods commencing on or after 1 January 2013,
with early adoption permitted
Reasons for the issue of IFRS 13
• To standardise the definition of fair value.
• To help users by providing additional disclosures relating to how fair value has been
determined.
• To improve consistency of reported information; this will also help to reduce
complexity in application of measurement of fair value.
• To increase the extent of convergence between IFRS and US GAAP
1.2
Definitions relevant to fair value.
Fair value is defined as the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants at the
measurement date; i.e. it is an exit price, whether observable in an active market
(level one inputs – see later), or estimated using a valuation technique (with the use
of level 2 and/or level three inputs – see later).
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Market participants comprise independent buyers and sellers who are informed and
willing and able to enter into a transaction in the principal or the most advantageous
market as appropriate. Fair value is the price that would apply between market
participants, whether observable in an active market (use of level 1 inputs – see
later), or estimated using a valuation technique (with the use of level 2 and 3 inputs –
see later).
Fair value of an asset or a liability may be required to be measured in a variety of
circumstances as follows:
(a) Fair value on a recurring basis arises when a reporting standard requires fair
value to be measured on an ongoing basis. Examples of this include IAS 40
Investment Property, or IFRS 9 Financial Instruments which require some financial
assets and liabilities to be measured at fair value.
(b) Fair value on a nonrecurring basis arises when a reporting standard requires fair
value to be measured at fair value only in certain specified circumstances. For
example, IFRS 5 requires that assets classified as held for sale are measured at fair
value.
(c) Fair value upon initial recognition arises when a reporting standard requires fair
value to be measured upon initial recognition. For example, IFRS 3 Business
Combinations (Revised) requires that the separable net assets of the acquired entity
are measured at fair value to determine goodwill at acquisition.
The price paid to acquire an asset or received to assume a liability (i.e. an entry price)
may (or may not) be fair value. If it is not, there should be an adjustment to fair value,
with a gain or loss recognised immediately, or when specified by the relevant
standard. In the case of a financial instrument, this may only be done when fair value
is evidenced by a data from observable inputs (see later).
To determine whether fair value at initial recognition equals transaction price, an
entity must consider factors specific to the transaction and factors specific to the
asset or liability to be measured; – is there any evidence to suggest that the
transaction may not be at fair value? One situation where the price paid to acquire an
asset may not be a reliable indicator of fair
value arises when the asset is purchased from a related party
1.3
The basis of a fair value measurement
The following factors should be taken into consideration when measuring fair value:
(a) The asset or liability to be measured may be an individual asset (e.g. plot of land)
or liability, or a group of assets and liabilities (e.g. a cash generating unit or
business), depending upon exactly what is required to be measured.
(b) The measurement should reflect the price at which an orderly transaction
between willing market participants would take place under current market conditions
– i.e. not a distress transaction.
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(c) The entity must determine the market in which an orderly transaction would take
place. This will be the principal market or, failing that, the most advantageous
market that an entity has access to at the measurement date. They will often, but not
always, be the same.
(d) Unless there is evidence otherwise, the market that an entity would normally enter
into is presumed to be the principal or most advantageous market.
(e) It is quite possible that different entities within a group or different businesses
within an entity may have different principal or most advantageous markets, for
example, due to their location.
(f) The valuation or measurement should reflect the characteristics of the
asset or liability (age, condition, location, restrictions on use or sale etc) if they are
relevant to market participants.
(g) It is not adjusted for transaction costs – they are not a feature of the asset or
liability, but may be relevant when determining the most advantageous market. If
location, for example, is a characteristic of the asset, then price may need to be
adjusted for any costs that may be incurred to transport an asset to or from a market.
Numerical Illustration
An asset is sold in two different active markets at different prices. An entity enters
into transactions in both markets and can access the price in those markets for the
asset at the measurement date as follows:
Market 1
Market 2
Rs
Rs
Price
26
25
Transactions cost
(3)
(1)
Transport cost
(2)
(2)
–––––
–––––
21
22
–––––
–––––
Net price received
If Market 1 is the principal market for the asset (i.e. the market with the greatest
volume and level of activity for the asset), the fair value of the asset would be
measured using the price that would be received in that market, after taking into
account transport costs is (Rs 26 – Rs 2) Rs 24. Transactions costs are ignored as
they are not a characteristic of the asset.
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If neither market is the principal market for the asset, the fair value of the asset would
be measured using the price in the most advantageous market. The most
advantageous market is the market that maximises the amount that would be
received to sell the asset, after taking into account transaction costs and transport
costs (i.e. the net amount that would be received in the respective markets).
Because the maximum net amount that the entity would receive is Rs 22 in Market 2
(Rs 25 – Rs 3), the fair value of the asset would be measured using the price in that
market (Rs 25), less transport costs of Rs 2, resulting in a fair value measurement of
Rs 23. Although transaction costs are taken into account when determining which
market is the most advantageous market, the price used to measure the fair value of
the asset is not adjusted for those costs (although it is adjusted for transport costs).
1.4
Valuation techniques
Valuation techniques should be used which are appropriate to the asset or liability at
the measurement date and for which sufficient data is available, applying the fair
value hierarchy to maximise the use of observable inputs as far as possible. IFRS 13
identifies three valuation approaches:
(1) Income approach – e.g. where estimated future cash flows may be converted into
a single, current amount stated at present value.
(2) Market approach – e.g. where prices and other market-related data is used for
similar or identical assets, liabilities or groups of assets and liabilities.
(3) Cost approach – e.g. to arrive at what may be regarded as current replacement
cost to determine the cost that would be incurred to replace the service or operational
capacity of an asset.
More than one valuation technique may be used in helping to determine fair value in
a particular situation. Note that a change in valuation technique is regarded as a
change of accounting estimate in accordance with IAS 8 which needs to be properly
disclosed in the
financial statements.
2
Fair Value Hierarchy
2.1
IFRS 13 establishes a hierarchy that categorises the inputs to valuation techniques
used to measure fair value. As follows:
(a) Level 1 inputs comprise quoted prices (‘observable’) in active markets for
identical assets and liabilities at the measurement date This is regarded as providing
the most reliable evidence of fair value and is likely to be used without adjustment.
(b) Level 2 inputs are observable inputs, other than those included within Level 1
above, which are observable directly or indirectly. This may include quoted prices for
similar (not identical) asset or liabilities in active markets, or prices for identical or
similar assets and liabilities in inactive markets. Typically, they are likely to require
some degree of adjustment to arrive at a fair value measurement.
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(c) Level 3 inputs are unobservable inputs for an asset or liability, based upon the
best information available, including information that may be reasonably available
relating to market participants. An asset or liability is regarded as having been
measured using the lowest level of inputs that is significant to its valuation.
2.2
Selection and use of inputs into valuation techniques
• Inputs into a valuation technique should be consistent with those which would be
used by market participants, including control premiums or discounts for lack of
control. Prices based upon bid-ask spreads should be the most representative of fair
value from within that spread.
• Prices may be provided by third parties, such as brokers, but the prices must be
determined in accordance with the requirements of IFRS 13; e.g. they may be
regarded as either observable or unobservable data.
• If markets are not active, then further analysis of transactions actually taking place,
and/or the prices, may be required. This may result in an adjustment of such prices to
establish fair value.
2.3
Inputs to determine fair value
Examples of inputs used to determine fair value include:
Level 1
Asset or liability
Example
Equity shares in a listed
Unadjusted quoted prices in
an active market
entity
Level 2
Finished goods inventory at
Price paid by retail customers
a retail outlet
Licence acquired as part of
The royalty rate contained
a business combination
within the contract
which as recently
negotiated with an
unrelated party
Cash generating unit
Valuation multiple from
observed
transactions
involving similar businesses
Building held and used
Price per square metre for the
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building from observable
market
data,
such
as
observed transactions for
similar buildings in similar
locations
Level 3
Interest rate swap
Adjustment
made
to
midmarket nonbinding
a
price using data that cannot
be directly observed or
corroborated
Decommissioning liability
Use of own data to make
assumed upon a business
estimates of expected future
combination
cash outflows to fulfil the
obligation used to estimate the
present value of that future
obligation.
Cash-generating
Profit or cash flow forecast
Unit
using own data.
3
Specific Application Principles
3.1
Non-financial assets
Fair value of a nonfinancial asset is based upon highest and best use of that asset
that would maximise its value, based upon uses which are physically possible, legally
permissible and financially feasible. This is considered from the perspective of
market participants, even if they may use the asset differently. Current use of a
nonfinancial
asset is presumed to be its highest and best use, unless there are factors that would
suggest otherwise.
• Used in combination with other assets – fair value of an asset will be based upon
what would be received if the asset was sold to another market participant, and that
the complementary assets and liabilities they needed for highest and best use would
be available to them.
• Used on a standalone basis – the price that would be received to sell the asset to a
market participant who would use it on a stand-alone basis.
In either situation, it is assumed that the asset is sold individually, rather than as part
of a collection of assets and liabilities.
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Illustration — Land
An entity acquires land in a business combination. In accordance with IFRS 3
(revised), this must be stated at fair value at the date of acquisition to help determine
the value of goodwill at that date. The land is currently developed for industrial use as
a site for a factory. Alternatively, the site could be developed into a block of
residential flats which, based upon evidence relating to adjoining plots of a similar
size, appears to be a practical use of the site.
The current use of land is presumed to be its highest and best use unless market or
other factors suggest a different use. In this situation, there is a possible alternative
use which should be considered as follows:
The highest and best use of the land would be determined by taking the higher
measurement from the two possible outcomes:
(a) the value of the land as currently developed for industrial use (i.e. the land would
be used in combination with other assets, such as the factory, or with other assets
and liabilities).
(b) the value of the land as a vacant site for residential use, taking into account the
costs of demolishing the factory and other costs (including the uncertainty about
whether the entity would be able to convert the asset to the alternative use, such as
legal and planning issues) necessary to convert the land to a vacant site (i.e. the land
is to be used by market participants on a stand-alone basis).
Illustration – Research and development project
An entity acquires a research and development (R&D) project in a business
combination. The entity does not intend to complete the project as, if completed, the
project would compete with one of its own projects (to provide the next generation of
the entity’s commercialised technology). Instead, the entity intends to hold (i.e. lock
up) the project to prevent its competitors from obtaining access to the technology. In
doing this the project is expected to provide defensive value, principally by improving
the prospects for the entity’s own competing technology and preventing access by
competitors to the technology.
To measure the fair value of the project at initial recognition, the highest and best use
of the project would be determined on the basis of its use by market participants. For
example, the highest and best use of the R&D project could be:
(a) to continue development if market participants would continue to develop the
project and that use would maximise the value of the group of assets or of assets
and liabilities in which the project would be used (i.e. the asset would be used in
combination with other
assets or with other assets and liabilities). The fair value of the project would be
measured on the basis of the price that would be received in a current transaction to
sell the project, assuming that the R&D would be used with its complementary assets
and the associated liabilities and that those assets and liabilities would be available
to market participants.
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(b) to cease development for competitive reasons if market participants would
lock up the project and that use would maximise the value of the group of assets or
of assets and liabilities in which the project would be used. The fair value of the
project would be measured on the basis of the price that would be received in a
current transaction to sell the project, assuming that the R&D would be used (i.e.
locked up) with its complementary assets and the associated liabilities and that those
assets and liabilities would be available to market participants.
(c) to cease development if market participants would discontinue its
development. The fair value of the project would be measured on the basis of the
price that would be received in a current transaction to sell the project on its own
(which might be zero).
3.2
Financial assets and financial liabilities – offsetting positions
If an entity manages a group of financial assets and liabilities within the scope of
IFRS 9 Financial Instruments, which are measured at fair value based upon their net
exposure to particular risks, then it is permitted to value the net exposure at fair value,
provided this is in accordance with documented strategy and information is reported
on this basis to key management.
3.3
Liabilities and equity instruments
Ideally, fair value is measured using quoted prices for identical instruments – i.e.
level one observable inputs. If this is not possible, it may be possible to use prices in
an inactive market – level two observable inputs. If this is not possible, a valuation
model should be
used e.g. present value measurement.
Note that any fair value measurement of a liability should include nonperformance or
default risk. This may be different for different types of liability held by an entity; for
example, default risk for a secured loan is less than default risk of an unsecured loan
at any point in time. Also, be aware that this risk may change over time as an entity
may or may not encounter financial and other commercial difficulties.
Fair value measurement of a liability or equity instrument assumes that it is
transferred at the measurement date, and that both a liability and/or equity instrument
would remain outstanding, rather than being settled or redeemed.
When a quoted price is not available for such an item, an entity shall measure fair
value from the perspective of a market participant who holds the identical item as an
asset at the measurement date. If there are no such observable prices, then an
alternative valuation technique must be used.
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3.4
Measurement of liabilities
Consider two entities, A and B, who each have a legal obligation to pay Rs 1000
cash to another entity, C, in ten years.
Entity A has an excellent credit rating and can borrow at 5 per cent, whereas Entity B
has a lower credit rating and is able to borrow at 8 per cent. Entity A will receive
approximately Rs 614 in exchange for its promise (the present value of Rs 1,000 in
ten years using a discount factor of 5%). Entity B will receive approximately Rs 463 in
exchange for its promise (the present value of Rs 1,000 in ten years using a discount
factor of 8%).
The fair value of the liability to each entity (i.e. the proceeds) therefore incorporates
that entity’s credit standing
4
Disclosures
Disclosures should provide information that enables users of financial statements to
evaluate the inputs and methods used to determine how fair value measurements
have been arrived at.
The level in the three-tier valuation hierarchy should be disclosed, together with
supporting details of valuation methods and inputs used where appropriate. As would
be expected, more detailed information is required where there is significant use of
levelthree inputs to arrive at a fair value measurement to enable users of financial
statements to understand how such fair values have been arrived at.
Disclosure should also be made when there is a change of valuation technique to
measure an asset or liability. This will include any change in the level of inputs used
to determine fair value of particular assets and/or liabilities.
Chapter Summary
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INTRODUCTION TO GROUP ACCOUNTING
Chapter learning objectives
Upon completion of this chapter you will be able to
IFRS 6: Exploration for and Evaluation of Mineral Resources
IFRS 14: Regulatory deferral accounts
IAS 26: Retirement benefit plans
IAS 29: Financial reporting in hyperinflationary economies
IFRIC 7: Applying the restatement approach under ias 29
IAS 34: Interim financial reporting
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IFRS 6: EXPLORATION FOR AND EVALUATION OF MINERAL RESOURCES
Objective and Scope
IFRS 6 specifies the financial reporting for the exploration for and evaluation of
mineral resources. In particular, the IFRS requires:
a) limited improvements to existing accounting practices for exploration and
evaluation expenditures.
b) entities that recognise exploration and evaluation assets to assess such
assets for impairment in accordance with IAS 36.
c) disclosures that identify and explain the amounts in the entity’s financial
statements arising from the exploration for and evaluation of mineral
resources and help users of those financial statements understand the
amount, timing and certainty of future cash flows from any exploration and
evaluation assets recognised.
IFRS 6 applies to expenditure incurred on exploration for and evaluation of mineral
resources but not to those expenditures incurred:


before the exploration for and evaluation of mineral resources (e.g.
expenditures incurred before the entity has obtained the legal rights to explore
a specific area); or
after the technical feasibility and commercial viability of extraction are
demonstrable
Exploration and Evaluation Assets
Exploration and evaluation assets are exploration and evaluation expenditures
recognised as assets in accordance with the entity’s accounting policy.
Exploration and Evaluation Expenditures
Exploration and evaluation expenditures are expenditures incurred by an entity in
connection with the expenditures for and evaluation of mineral resources before the
technical feasibility and commercial viability of extracting a mineral resource are
demonstrable.
Selection of accounting policies
IAS 8 sets out criteria which must be applied by a company when needs to develop
an accounting policy for a transaction not covered by a specific IFRS.
IFRS 6 exempts companies from applying these criteria in developing an accounting
policy for the recognition and measurement of exploration and evaluation assets.
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In other words, companies are free to develop an accounting policy (within the
broader guidance of IFRS 6) without reference to other parts of IFRS. This is
particularly useful when a company involved in this industry adopts IFRS because
they may be able to carry on using their pre IFRS accounting policy.
Changes in accounting policies
An entity is allowed to change accounting policies for exploration and evaluation
expenditures when the change makes information used as a basis of decision
making:


more relevant and no less reliable; or
more reliable and no less relevant
To justify a change, the company must demonstrate that the change brings the
financial statements closer to meeting the IAS 8 criteria but the change need not
achieve full compliance with those criteria.
Initial recognition and measurement
Exploration and evaluation assets are measured at cost.
Elements of cost
A company must determine a policy of specifying which expenditures are recognised
as exploration and evaluation assets and apply this policy consistently in doing this.
Following are examples of expenditures which might be included in the initial
measurement (the list is not exhaustive):






acquisition of exploration rights;
topographical, geological, geochemical and geophysical studies;
exploratory drilling;
trenching;
sampling; and
activities in relation to evaluating the technical feasibility and commercial
viability of extracting a mineral resource
Expenditures related to the development of mineral resources must not be
recognised as exploration and evaluation assets. The Conceptual Framework and
IAS 38 Intangible Assets provide guidance on the recognition of assets arising from
development.
IAS 37 applies to the recognition of any obligations for removal and restoration that
are incurred as a consequence of exploration for and evaluation of mineral resources.
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Subsequent measurement
A company must apply one of the following to exploration and evaluation assets:


cost model; or
revaluation model
If the revaluation model is applied (IAS 16 or IAS 38 model), it must be consistent
with the classification of the expenditure as tangible or intangible
This means that a revaluation model for expenditure classified as an intangible is
only possible if there is a fair value that can be measured with reference to an active
market
Presentation
Exploration and evaluation assets must be classified according to the nature of the
assets acquired as:


tangible (e.g. vehicles and drilling rigs); or
intangible (e.g. drilling rights).
The classification must be applied consistently.
An exploration and evaluation asset is reclassified from this category when the
technical feasibility and commercial viability of extracting a mineral resource are
demonstrable. In such cases they must be assessed for impairment before
reclassification.
Impairment
Exploration and evaluation assets must be:


allocated to cash-generating units (CGUs) or groups of CGUs for the purpose
of assessing such assets for impairment (the CGU; and
assessed for impairment when there are indications that the carrying amount
may exceed recoverable amount.
Exploration and evaluation assets are unlikely to generate cash flows independently
from other assets so as such they are similar to goodwill. Therefore, IFRS 6 requires
them to be allocated to CGUs groups for the purpose of impairment testing. They are
not tested individually for impairment.
Indicators of impairment include (the list is not exhaustive):

expiry of the period of the exploration right without expectation of renewal;
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



expenditure on further exploration/evaluation in the specific area previously
not budgeted/planned;
non discovery of commercially viable quantities of mineral resources;
a decision to discontinue activities in the specific area;
indication that the carrying amount of the exploration and evaluation asset is
unlikely to be recovered in full from successful development or by sale
Disclosure
Entities must disclose information that identifies and explains the amounts
recognised arising from the exploration and evaluation of mineral resources. To fulfill
this requirement, an entity shall disclose:


accounting policies for exploration and evaluation expenditures, and
recognition as assets;
amounts of assets, liabilities, income and expense and operating and
investing cash flows arising from the exploration for and evaluation of mineral
resources.
Exploration and evaluation assets must be treated as a separate class of assets (IAS
16 or IAS 38 disclosures apply depending on classification).
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IFRS 14: REGULATORY DEFERRAL ACCOUNTS
Introduction
Some countries regulate prices that can be charged for certain goods and services.
Such goods and services are said to be “rate regulated”. For example, National
Refinery petroleum products selling prices to be charged to Oil Marketing Companies
(e.g. PSO) are regulated by OGRA (Oil and Gas Regulatory Authority of Pakistan).
Definitions
Rate-regulated activities: An entity’s activities that are subject to rate regulation.
Rate regulation: A framework for establishing the prices that can be charged to
customers for goods or services and that framework is subject to oversight and/or
approval by a rate regulator.
Regulatory deferral account balance: The balance of any expense (or income)
account that would not be recognised as an asset or a liability in accordance with
other Standards, but that qualifies for deferral because it is included, or is expected to
be included, by the rate regulator in establishing the rate(s) that can be charged to
customers.
Key features
Below are some of the key features of this interim standard:
a) It allows (but does not require) an entity whose activities are subject to rate regulation
to continue applying most of its existing accounting policies for regulatory deferral
account balances upon first-time adoption of IFRS.
b) Existing IFRS preparers are prohibited from applying this standard.
c) Entities that adopt this standard must present the regulatory deferral accounts as
separate line items in the statement of financial position and present movements in
these account balances as separate line items in the statement of profit or loss and
other comprehensive income (OCI).
d) The standard requires disclosures on the nature of, and risks associated with, the
entity’s rate regulation and the effects of that rate regulation on its financial statements.
e) If the standard is applied, full retrospective application is required.
IFRS 14 is an optional standard that is intended to encourage rate-regulated entities
to adopt IFRS while bridging the gap with similar entities that already apply IFRS, but
which do not recognise regulatory deferral accounts. This would be achieved by
requiring separate presentation of the regulatory deferral account balances (and
movements in these balances) in the statement of financial position and statements of
profit or loss and other comprehensive income.
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IAS 26: RETIREMENT BENEFIT PLANS
Scope
IAS 26 complements IAS 19, Employee Benefits which is concerned with the
determination of the cost of retirement benefits in the financial statements of
employers.
IAS 26 applies to the reports of retirement benefit plans whether they are:



defined contribution plans; or
defined benefit plans; and
regardless of:
 whether a fund has a separate legal identity; or
 whether there are trustees.
All other IFRS apply to the reports of retirement benefit plans to the extent that they
are not superseded by IAS 26.
Insured benefits
Retirement benefit plans with assets invested with insurance companies are within
the scope of IAS 26 unless the contract with the insurance company is in the name
of a specified participant or a group of participants and the retirement benefit
obligation is solely the responsibility of the insurance company.
Outside scope
IAS 26 does not deal with other forms of employment benefits such as employment
termination indemnities, deferred compensation arrangements, long-service leave
benefits, special early retirement or redundancy plans, health and welfare plans or
bonus plans.
Government social security type arrangements are also excluded from the scope of
IAS 26.
Definitions
Retirement benefit plans are arrangements whereby an entity provides benefits for
its employees on or after termination of service (either in the form of an annual
income or as a lump sum) when such benefits, or the employer's contributions
towards them, can be determined or estimated in advance of retirement from the
provisions of a document or from the entity's practices.
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A retirement benefit plan is a reporting entity separate from the employers of the
participants in the plan.
Retirement benefit plans are known by a variety of names, for example, pension
schemes, superannuation schemes; or retirement benefit schemes'.
Defined contribution plans are retirement benefit plans under which amounts to be
paid as retirement benefits are determined by contributions to a fund together with
investment earnings thereon.
Defined benefit plans are retirement benefit plans under which amounts to be paid
as retirement benefits are determined by reference to a formula usually based on
employees' earnings and/or years of service.
Funding is the transfer of assets to an entity (the fund) separate from the employer's
entity to meet future obligations for the payment of retirement benefits.
Participants are the members of a retirement benefit plan and others who are
entitled to benefits under the plan.
Net assets available for benefits are the assets of a plan less liabilities other than
the actuarial present value of promised retirement benefits.
Actuarial present value of promised retirement benefits is the present value of
the expected payments by a retirement benefit plan to existing and past employees,
attributable to the service already rendered.
Vested benefits are benefits, the rights to which, under the conditions of a
retirement benefit plan, are not conditional on continued employment.
Valuation of plan assets
Retirement benefit plan investments are carried at fair value.
The fair value of marketable securities is market value.
Where an estimate of fair value is not possible for plan asset the reason why this is
the case must be disclosed.
Securities that have a fixed redemption value and that have been acquired to match
the obligations of the plan may be carried at amounts based on their ultimate
redemption value assuming a constant rate of return to maturity (amortised cost).
Defined Contribution Plans
Objective of report
The reporting objective is to provide information about the plan and the performance
of its investments.
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The participants are interested in


the activities of the plan because they directly affect the level of future benefits;
and
knowing whether contributions have been received and proper control has
been exercised to protect the rights of beneficiaries.
An employer is interested in the efficient and fair operation of the plan.
The reporting objective is usually achieved by providing a report including:



a description of significant activities for the period and the effect of any
changes relating to the plan, and its membership and terms and conditions;
statements reporting on the transactions and investment performance for the
period and the financial position of the plan at the end of the period; and
a description of the investment policies.
Requirement
The report of a defined contribution plan must contain:


a statement of net assets available for benefits; and
a description of the funding policy.
Defined Benefit Plans
Objective of report
The reporting objective is to provide information about the financial resources and
activities of the plan that is useful in assessing the relationships between the
accumulation of resources and plan benefits over time.
This is usually achieved by providing a report including the following:




a description of significant activities for the period and the effect of any
changes relating to the plan, and its membership and terms and conditions;
statements reporting on the transactions and investment performance for the
period and the financial position of the plan at the end of the period;
actuarial information either as part of the statements or by way of a separate
report; and
a description of the investment policies.
Requirement
The report must contain either:
A statement that shows:

the net assets available for benefits;
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

the actuarial present value of promised retirement benefits, distinguishing
between vested benefits and non-vested benefits; and
the resulting excess or deficit; or
A statement of net assets available for benefits including either:


a note disclosing the actuarial present value of promised retirement benefits,
distinguishing between vested benefits and non-vested benefits; or
a reference to this information in an accompanying actuarial report.
The report should explain:


the relationship between the actuarial present value of promised retirement
benefits; and the net assets available for benefits; and
the policy for the funding of promised benefits.
If an actuarial valuation has not been prepared at the date of the report, the most
recent valuation is used as a base and the date of the valuation disclosed.
Actuarial Present Value of Promised Retirement Benefits
The actuarial present value of promised retirement benefits is based on the benefits
promised under the terms of the plan on service rendered to date using either:


current salary levels; or
projected salary levels.
Disclosure
Specific requirement
The report of a retirement benefit plan (defined benefit or defined contribution) must
contain the following information:



a statement of changes in net assets available for benefits;
a summary of significant accounting policies; and
a description of the plan and the effect of any changes in the plan during the
period.
Guidance
Reports provided by retirement benefit plans include the following, if applicable:
A statement of net assets available for benefits disclosing:



assets at the end of the period suitably classified;
the basis of valuation of assets;
details of any single investment exceeding either 5% of the net assets
available for benefits or 5% of any class or type of security;
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

details of any investment in the employer; and
liabilities other than the actuarial present value of promised retirement
benefits;
A statement of changes in net assets available for benefits showing the following:











employer contributions;
employee contributions;
investment income such as interest and dividends;
other income;
benefits paid or payable (for example, as retirement, death and disability
benefits, and lump sum payments);
administrative expenses;
other expenses;
taxes on income;
profits and losses on disposal of investments and changes in value of
investments; and
transfers from and to other plans;
a description of the funding policy;
For defined benefit plans:


the actuarial present value of promised retirement benefits (which may
distinguish between vested benefits and non-vested benefits) based on the
benefits promised under the terms of the plan on service rendered to date
using either:
 current salary levels; or
 projected salary levels;
a description of the significant actuarial assumptions made and the method
used to calculate the actuarial present value of promised retirement benefits.
Report of retirement benefit plans
A description of the plan must be provided either as part of the financial information
or in a separate report.
It may contain the following:






the names of the employers and the employee groups covered;
the number of participants receiving benefits and the number of other
participants, classified as appropriate;
the type of plan - defined contribution or defined benefit;
a note as to whether participants contribute to the plan;
a description of the retirement benefits promised to participants;
a description of any plan termination terms; and
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
changes in any of the above during the period covered by the report.
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IAS 29: FINANCIAL REPORTING IN HYPERINFLATIONARY
ECONOMIES
Introduction
Primary financial statements are normally prepared on the historical cost basis
without taking into account:


changes in the general level of prices or
changes in specific prices of assets held (except to the extent that property,
plant and equipment and investments may be revalued).
Some entities may present primary financial statements prepared on a current cost
basis. Current cost accounts reflect the effects of specific price changes on the
financial statements of the entity. They do not reflect the general rate of inflation.
The accounting problem
In a hyperinflationary economy, money loses purchasing power at such a rate that
comparison of amounts from transactions occurring at different times (even within
the same accounting period) is misleading.
Reporting operating results and financial position in a hyperinflationary economy is
not useful without restatement.
What is hyperinflation?
IAS 29 does not establish an absolute rate at which hyperinflation is deemed to arise.
Features of a hyperinflationary economy include (but are not limited to) the following:





the general population prefers to keep its wealth in non-monetary assets or in
a relatively stable foreign currency. Amounts of local currency held are
immediately invested to maintain purchasing power;
the general population regards monetary amounts not in terms of the local
currency but in terms of a relatively stable foreign currency. Prices may be
quoted in that currency;
sales and purchases on credit take place at prices that compensate for the
expected loss of purchasing power during the credit period, even if the period
is short;
interest rates, wages and prices are linked to a price index; and
the cumulative inflation rate over three years is approaching, or exceeds,
100%.
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It is a matter of judgement when restatement of financial statements in accordance
with this standard becomes necessary.
Scope
IAS 29 must be applied to the primary financial statements (including the
consolidated financial statements) of any entity whose functional currency is the
currency of a hyperinflationary economy.
IAS 29 applies from the beginning of the reporting period in which an entity identifies
the existence of hyperinflation in the country in whose currency it reports.
Requirements
The financial statements of an entity that reports in the currency of a hyperinflationary economy must be stated in terms of the measuring unit current at the end
of reporting period date.
This applies to both:


historical cost accounts; and,
current cost accounts.
Comparatives should be restated in terms of the measuring unit current at the end of
reporting period date.
The gain or loss on the net monetary position should be included in net income and
separately disclosed.
It is not permitted to present the required information as a supplement to financial
statements that have not been restated. Also, separate presentation of the financial
statements before restatement is discouraged.
RESTATEMENT OF HISTORICAL COST FINANCIAL STATEMENTS
Statement of financial position
All balances must be stated in terms of the measuring unit current by applying
general price index at the end of reporting period date.
Not restated
Monetary items – No restatement is necessary as monetary items are already
expressed in terms of the monetary unit current at the end of reporting period date.
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Index linked assets and liabilities – The carrying value of these items will already
have been adjusted for inflation. Such items are carried at the adjusted amount in
the restated statement of financial position.
All other assets and liabilities are non-monetary.
Non-monetary items
Some non-monetary items will already be carried at the amount current at the end of
reporting period date (e.g. net realisable value or market value). These are not
restated.
All other non-monetary assets and liabilities are restated. There is a different
treatment for items carried at cost and those not carried at cost.
Non-monetary items carried at cost (or cost less depreciation)
The restated cost (or cost less depreciation) is determined by applying the change in
a general price index from the date of acquisition to the end of reporting period date.
Both the cost and the accumulated depreciation will be restated. Thus the following
are restated from the date of purchase:





property, plant and equipment;
investments;
inventories of raw materials and merchandise;
goodwill; and
patents, trademarks and similar assets.
Inventories of partly-finished and finished goods are restated from the dates on
which the costs of purchase and of conversion were incurred.
Non-monetary items carried at amounts other than cost
Revalued items will be indexed from the date of revaluation. No asset must be
valued in excess of its recoverable amount.
Equity accounted investments
Sometimes an entity may hold an investment in another entity that is accounted for
under the equity method and whose functional currency is that of a hyperinflationary
economy.
In these cases, the statement of financial position and statement of profit or loss of
the investee must be restated in accordance with this standard before applying the
equity method.
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Where the restated financial statements of the investee are expressed in a foreign
currency they are translated at closing rates.
Equity balances
At the beginning of the first period of application of this standard:



The components of owners' equity (except retained earnings and any
revaluation surplus) are restated by applying a general price index from the
dates the components were contributed/arose.
Any revaluation surplus that arose in previous periods is eliminated.
Restated retained earnings are derived from all the other amounts in the
restated statement of financial position.
At the end of the first period and in subsequent periods, all components of owners'
equity are restated by applying a general price index from the beginning of the period
(or the date of contribution, if later).
Practical problems
If detailed records of the date and cost of acquisition of property, plant and
equipment are not available, then an independent professional assessment can be
made of the items value in the first period of restatement.
If a general price index is not available for the whole period (or periods) required,
then an estimated index can be used. This could be based on, say, movements in
the exchange rate between the local currency and a relatively stable foreign currency.
Statement of profit or loss
The statement of profit or loss must be expressed in terms of the measuring unit
current at the reporting date.
All items in the statement of profit or loss will be restated by applying the change in
the general price index from the dates when the items of income and expenses
occurred and the reporting date.
Gain or loss on net monetary position
During a period of inflation an entity will:
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

suffer a loss if it holds net monetary assets during a period of inflation
because the purchasing power of those assets will be eroded.
make a gain if it holds net monetary liabilities because the burden of the
liabilities is reduced by inflation.
This gain or loss on the net monetary position may be derived as the difference
resulting from the restatement of non-monetary assets, owners' equity and statement
of profit or loss items and the adjustment of index linked assets and liabilities.
The gain or loss may be estimated by applying the change in a general price index to
the weighted average for the period of the difference between monetary assets and
monetary liabilities.
RESTATEMENT OF CURRENT COST FINANCIAL STATEMENTS
Statement of financial position
Items stated at current cost are not restated because they are already expressed in
terms of the measuring unit current at the end of reporting date.
Other items in the statement of financial position are restated.
Statement of profit or loss
The current cost statement of profit or loss, before restatement, generally reports
costs current at the time at which the underlying transactions or events occurred.
Cost of sales and depreciation are recorded at current costs at the time of
consumption;
Sales and other expenses are recorded at their money amounts when they occurred.
All amounts need to be restated into the measuring unit current at the end of
reporting period date by applying a general price index.
Gain or loss on net monetary position
The gain or loss on the net monetary position is credited or charged to the statement
of profit or loss.
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IFRIC 7: APPLYING THE RESTATEMENT APPROACH UNDER IAS
29
Applying the restatement approach under IAS 29
In the period in which an entity first identifies the existence of hyperinflation in the
economy of its functional currency, it must apply the requirements of IAS 29 as if the
economy had always been hyperinflationary.
This means that non-monetary items in the opening statement of financial position at
the beginning of the earliest period presented must be restated to reflect the effect of
inflation.


Non-monetary amounts carried at historical cost are restated to reflect
inflation form the date of recognition up to the date of the opening statement
of financial position.
Non-monetary amounts carried at revalued amounts are restated to reflect
inflation form the date of revaluation up to the date of the opening statement
of financial position.
Deferred taxation
Deferred tax is calculated by applying the requirements in IAS 12 to the restated
balances.
The comparative deferred tax balance is based on the figure that would have been in
last year’s restated financials adjusted for this year’s price movement.
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IAS 34: INTERIM FINANCIAL REPORTING
Scope
IAS 1 requires that financial statements should be produced at least annually. Many
companies are required by national regulations to produce accounts on a half-yearly
basis or sometimes on a quarterly basis. For example, the Listing Regulations of
Pakistan requires listed companies whose shares are traded on the Pakistan Stock
Exchange to present financial statements on quarterly, half yearly and annual basis.
IAS 34 Interim financial reporting does not specify the frequency of interim reporting.
However, governments, securities regulators, stock exchanges, and accountancy
bodies often require entities whose debt or equity securities are publicly traded to
publish interim financial reports. IAS 34 focuses on providing guidance on the form
and content of these interim accounts.
It encourages publicly-traded entities to prepare interim financial reports at least as
of the end of the first half of their financial year and to file them with the regularity
authority no later than 60 days after the end of the interim period.
Form and content of interim financial statements
IAS 34 requires that, as a minimum, an interim financial report should include:





a condensed statement of financial position
a condensed statement of profit or loss and other comprehensive income,
presented as either a condensed single statement or a condensed separate
statement of profit or loss followed by a condensed statement of other
comprehensive income
a condensed statement of changes in equity
a condensed statement of cash flows, and
selected explanatory notes.
In the statement that presents the components of profit or loss an entity should
present the basic and diluted EPS for the period.
If an entity publishes a set of condensed financial statements in its interim financial
report, those condensed statements shall include, at a minimum, each of the
headings and subtotals that were included in its most recent annual financial
statements and the selected explanatory notes as required by this Standard.
Additional line items or notes shall be included if their omission would make the
condensed interim financial statements misleading.
The interim statements are designed to provide an update on the performance and
position of the entity. It should focus on new activities, events, and circumstances
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that have occurred since the previous annual financial statements were issued. They
should not duplicate information that has already been reported in the past.
Periods for which interim financial statements must be presented
Interim reports must include the following financial statements (condensed or
complete):





a statement of financial position at the end of the current interim period and a
comparative balance sheet at the end of the previous financial year.
statements of profit or loss and other comprehensive income for the current
interim period and cumulatively for the current financial year to date.
comparative statements of profit or loss and other comprehensive income for
the comparable interim period last year, and the comparable cumulative
period last year.
a statement of changes in equity for the current financial year to date, with a
comparative statement for the comparable year-to-date period in the previous
year.
a statement of cash flows cumulatively for the current financial year to date,
with a comparative statement for the comparable year-to-date period in the
previous year.
Recognition and measurement
An entity should use the same accounting policies in the interim accounts that it uses
in the annual financial statements.
Measurement for interim purposes should be made on a year-to-date basis. For
example, suppose that a company uses quarterly reporting and in the first quarter of
the year, it writes down some inventory to zero. If it is then able to sell the inventory
in the next quarter, the results for the six-month period require no write-down of
inventory, and the write-down of inventory should be reversed for the purpose of
preparing the interim accounts for the first six months of the year.
An appendix to IAS 34 gives some guidance on applying the general recognition and
measurement rules from the IASB Conceptual Framework to the interim accounts.
Some examples are given below.
Intangible assets
The guidance in IAS 34 states that an entity should follow the normal recognition
criteria when accounting for intangible assets. Development costs that have been
incurred by the interim date but do not meet the recognition criteria should be
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expensed. It is not appropriate to capitalise them as an intangible asset in the belief
that the criteria will be met by the end of the annual reporting period.
Tax
Interim period income tax expense is accrued using the tax rate that would be
applicable to expected total annual earnings, that is, the estimated average annual
effective income tax rate applied to the pre-tax income of the interim period.
Use of estimates in interim financial statements
The interim financial statements should be reliable and relevant. However, IAS 34
recognises that the preparation of interim accounts will generally rely more heavily
on estimates than the annual financial statements. An appendix of IAS 34 provides
examples.
Pensions
A company is not expected to obtain an actuarial valuation of its pension liabilities at
the interim date. The guidance suggests that the most recent valuation should be
rolled forward and used in the interim accounts.
Provisions
The calculation of some provisions requires the assistance of an expert. IAS 34
recognises that this would be too costly and time-consuming for the interim accounts.
IAS 34 therefore states that the figure included in the annual financial statements for
the previous year should be updated without reference to an expert.
Inventories
A full count of inventory may not be necessary at the interim reporting date. It may
be sufficient to make estimates based on sales margins to establish a valuation for
the interim accounts.
Disclosures
The following is a list of events and transactions for which disclosures would be
required if they are significant: the list is not exhaustive.

the write-down of inventories to net realisable value and the reversal of such a
write-down;
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











recognition of a loss from the impairment of financial assets, property, plant
and equipment, intangible assets, assets arising from contracts with
customers, or other assets, and the reversal of such an impairment loss;
the reversal of any provisions for the costs of restructuring;
acquisitions and disposals of items of property, plant and equipment;
commitments for the purchase of property, plant and equipment;
litigation settlements;
corrections of prior period errors;
changes in the business or economic circumstances that affect the fair value
of the entity’s financial assets and financial liabilities, whether those assets or
liabilities are recognised at fair value or amortised cost;
any loan default or breach of a loan agreement that has not been remedied on
or before the end of the reporting period;
related party transactions;
transfers between levels of the fair value hierarchy used in measuring the fair
value of financial instruments;
changes in the classification of financial assets as a result of a change in the
purpose or use of those assets; and
changes in contingent liabilities or contingent assets
An entity shall include the following information, in the notes to its interim financial
statements or elsewhere in the interim financial report. The information shall
normally be reported on a financial year-to-date basis.







a statement that the same accounting policies and methods of computation
are followed in the interim financial statements as compared with the most
recent annual financial statements
explanatory comments about the seasonality or cyclicality (particularly
revenue) of interim operations.
the nature and amount of items affecting assets, liabilities, equity, net income
or cash flows that are unusual because of their nature, size or incidence.
the nature and amount of changes in estimates of amounts reported in prior
interim periods of the current financial year or changes in estimates of
amounts reported in prior financial years.
issues, repurchases and repayments of debt and equity securities.
dividends paid (aggregate or per share) separately for ordinary shares and
other shares.
the disclosure of segment information is required in an entity’s interim
financial report only if IFRS 8 Operating Segments requires that entity to
disclose segment information in its annual financial statements).
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INTRODUCTION TO GROUP ACCOUNTING
Chapter Learning Objectives
Upon completion of this chapter you will be able to:
1) describe the concept of a group as a single economic unit
2) explain and apply the definition of a subsidiary according to IFRS 10
3) identify circumstances in which a group is required to prepare consolidated
financial statements in accordance with IAS 27
4) describe the circumstances when a group may claim exemption from the
preparation of consolidated financial statements in accordance with IAS 27
5) list the circumstances where it is permitted not to consolidate a subsidiary
according to IAS 27
6) explain why it is necessary to eliminate intra-group transactions
7) the Concept of Group Accounts
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1.1
What is a group?
If one company owns more than 50% of the ordinary shares of another company:
1.2
•
this will usually give the first company ‘control’ of the second company
•
the first company (the parent company, P) has enough voting power to appoint
majority of directors of the second company (the subsidiary company, S)
•
P is, in effect, able to manage S as if it were merely a department of P, rather
than a separate entity
•
in strict legal terms P and S remain distinct, but in economic substance they
can be regarded as a single unit (a ‘group’).
Group Concept
Although from the legal point of view, every company is a separate entity, from the
economic point of view several companies may not be separate.
In particular, when one company owns enough shares in another company to have a
majority of votes at that company’s annual general meeting (AGM), the first company
may appoint majority of the directors of, and decide what dividends should be paid by,
the second company.
This degree of control enables the first company to manage the trading activities and
future plans of the second company as if it were merely a department of the first
company.
International accounting standards recognise that this state of affairs often arises, and
require a parent company to produce consolidated financial statements showing the
position and results of the whole group.
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1.3
Group Accounts
The key principle underlying group accounts is the need to reflect the economic
substance of the relationship.
P
Controls
Groups
1)
P is an individual legal entity.
2)
S is an individual legal entity.
P controls S and therefore they form a single economic entity – the Group.
1.4
The Single Economic Unit Concept
The purpose of consolidated accounts is to:
•
present financial information about a parent undertaking and its subsidiary
undertakings as a single economic unit
•
show the economic resources controlled by the group
•
show the obligations of the group, and
•
show the results the group achieves with its resources
Business combinations consolidate the results and net assets of group members so as
to display the group’s affairs as those of a single economic entity. As already
mentioned, this conflicts with the strict legal position that each company is a distinct
entity. Applying the single entity concept is a good example of the accounting principle
of showing economic substance over legal form.
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1.5
Consolidated financial statements under the entity concept
This is by far the most common form of group accounts. Consolidated financial
statements are prepared by replacing the cost of investments with the individual assets
and liabilities underlying that investment. If the subsidiary is only partly owned, all the
assets and liabilities of the subsidiary are consolidated, but the non-controlling
shareholders’ interest in those net assets is presented.
The single economic unit concept focuses on the existence of the group as an
economic unit rather than looking at it only through the eyes of the dominant
shareholder group. It concentrates on the resources controlled by the entity.
1.6
Group Financial Statements
Group financial statements could be prepared in various ways, but in normal
circumstances much the best way of showing the results of a group is to imagine that
all the transactions of the group had been carried out by a single equivalent company
and to prepare a statement of financial position, an income statement and a statement
showing other comprehensive income for that company.
Each company in a group prepares its own accounting records and annual financial
statements in the usual way. From the individual companies' financial statements, the
parent prepares consolidated financial statements.
2. Definitions
2.1
IFRS 10 Consolidated Financial Statements uses the following definitions:
•
parent – an entity that controls one or more entities
•
subsidiary – an entity that is controlled by another entity (known as the parent)
•
control of an investee – an investor controls an investee when the investor is
exposed, or has rights, to variable returns from its involvement with the
investee and has the ability to affect those returns through its power over the
investee.
Requirements for consolidated financial statements
IFRS 10 outlines the circumstances in which a group is required to prepare
consolidated financial statements.
Consolidated financial statements should be prepared when the parent company has
control over the subsidiary (for examination purposes control is usually established
based on ownership of more than 50% of voting power).
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Control is identified by IFRS 10 as the sole basis for consolidation and comprises the
following three elements:
2.2
•
power over the investee
•
exposure, or rights, to variable returns from its involvement with the investee
•
the ability to use its power over the investee to affect the amount of the
investor's returns
Control
IFRS 10 adopts a principles based approach to determining whether or not control is
exercised in a given situation, which may require the exercise of judgement. One
outcome is that it should lead to more consistent judgements being made, with the
consequence of greater comparability of financial reporting information.
IFRS 10 states that investors should periodically consider whether control over an
investee has been gained or lost and goes on to consider that a range of
circumstances may need to be considered when determining whether or not an
investor has power over an investee, such as:
1) Exercise of the majority of voting rights in an investee;
2) Contractual arrangements between the investor and other parties;
3)
Holding less than 50% of the voting shares, with all other equity interests held by a
numerically large, dispersed and unconnected group;
4)
Potential voting rights (such as share options or convertible loans) may result in an
investor gaining or losing control at some specific date.
5) Exemption from Preparation of Group Financial Statements
3.1
A parent need not present consolidated financial statements if and only if:
•
the parent itself is a wholly owned subsidiary or a partially-owned subsidiary
and its owners, (including those not otherwise entitled to vote) have been
informed about, and do not object to, the parent not preparing consolidated
financial statements;
•
the parent's debt or equity instruments are not traded in a public market;
•
the parent did not file its financial statements with a securities commission or
other regulatory organisation for the purpose of issuing any class of
instruments in a public market;
•
the ultimate parent company produces consolidated financial statements that
comply with IFRS and are available for public use.
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A parent that is an investment entity shall not present consolidated financial
statements if it is required, in accordance with paragraph 31 of IFRS 10, to measure all
of its subsidiaries at fair value through profit or loss.
If this is the case, IAS 27 Separate Financial Statements (revised) requires that the
following disclosures are made:
3.2
•
the fact that consolidated financial statements have not been presented;
•
a list of significant investments (subsidiaries, associates etc.) including
percentage shareholdings, principle place of business and country of
incorporation;
•
the bases on which those investments listed above have been accounted for in
its separate financial statements.
Reasons for Wanting to Exclude a Subsidiary
The directors of a parent company may not wish to consolidate some subsidiaries due to:
•
poor performance of the subsidiary
•
poor financial position of the subsidiary
•
differing activities of the subsidiary from the rest of the group.
These reasons are not permitted according to IFRSs.
a)
Excluded Subsidiaries IFRS 10 and IAS 27 (revised) do not specify any other
circumstances when subsidiaries must be excluded from consolidation. However, there
may be specific circumstances that merit particular consideration as follows:
Reason for
Accounting treatment
exclusion
Subsidiary held
for resale
Materiality
3.4
Held as current asset investment at the lower of carrying amount
and fair value less costs to sell.
Accounting standards do not apply to immaterial items; therefore
an immaterial item need not be consolidated.
Subsidiary held for resale
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If on acquisition a subsidiary meets the criteria to be classified as ‘held for sale’ in
accordance with IFRS 5, then it must still be included in the consolidation but
accounted for in accordance with that standard. The parent's interest will be presented
separately as a single figure on the face of the consolidated statement of financial
position, rather than being consolidated like any other subsidiary.
This might occur when a parent has acquired a group with one or more subsidiaries
that do not fit into its long-term strategic plans and are therefore likely to be sold. In
these circumstances the parent has clearly not acquired the investment with a view to
long-term control of the activities, hence the logic of the exclusion.
3.5
Materiality
If a subsidiary is excluded on the grounds of immateriality, the case must be reviewed
from year to year, and the parent would need to consider each subsidiary to be
excluded on this basis, both individually and collectively. Ideally, a parent should
consolidate all subsidiaries which it controls in all accounting periods, rather than
report changes in the corporate structure from one period to the next.
4
Non-Coterminous Year Ends
4.1
Some companies in the group may have differing accounting dates. In practice such
companies will often prepare financial statements up to the group accounting date for
consolidation purposes.
For the purpose of consolidation, IFRS 10 states that where the reporting date for a
parent is different from that of a subsidiary, the subsidiary should prepare additional
financial information as of the same date as the financial statements of the parent
unless it is impracticable to do so.
If it is impracticable to do so, IFRS 10 allows use of subsidiary financial statements
made up to a date of not more than three months earlier or later than the parent's
reporting date, with due adjustment for significant transactions or other events between
the dates.
4.2
Uniform Accounting Policies
If a member of a group uses accounting policies other than those adopted in the
consolidated financial statements for like transactions and events in similar
circumstances, appropriate adjustments are made to that group member's financial
statements in preparing the consolidated financial statements to ensure conformity
with the group's accounting policies
4.3
Related Parties
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Two parties are considered to be related if:
•
one party has the ability to control the other party, or
•
one party has the ability to exercise significant influence over the other party, or
•
the parties are under common control.
Therefore:
•
a company that is a subsidiary is a related party of its parent company
•
this means that the financial statements may have been affected by related
party transactions.
The types of transaction that may occur between parent and subsidiary (related parties)
and their impact on the financial statements of the individual company and the group
are:
Transaction
Potential impact
Sales and purchases
Favourable prices, affecting profits.
Advantageous settlement terms, affecting
receivables and payables days.
Finance
profits.
Favourable rates of interest, affecting
Non-current assets
Favourable terms for cost or financing.
Provision of services
At minimal or no cost, affecting profits.
Guarantees for loans
Without which they wouldn’t have been
and overdrafts
granted
Such transactions may or may not be at ‘arm’s length’, i.e. on normal commercial
terms. Even where related party transactions are at arm’s length, it is still important to
realise that they are related party transactions.
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Using ‘single economic unit’ concept while preparing consolidated financial statements
such related party transactions need to be adjusted, adjustment of such transactions is
given in detail in following chapters.
Chapter Summary
GROUP
DEFINATION
PARENT =
CONTROLLING
ENTITY
SUBSIDAIRY
CONTROLLED
ENTITY
Show position of
group as single
economic entity
by way of group
accounts.
Exclusion from consolidation acceptable where
1) materiality
2) subsidiary held for resale
Principles of consolidation
1) Non-coterminous year ends
2) Uniform accounting polices
3) Elimination of intra – group
transactions
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CONSOLIDATED STATEMENT OF FINANCIAL POSITION
Chapter learning objectives
Upon completion of this chapter you will be able to:
•
prepare a consolidated statement of financial position for a simple group (parent and one
subsidiary)
•
deal with non-controlling interests (at fair value or proportionate share of net assets)
•
describe the required accounting treatment of consolidated goodwill
•
explain the consolidation of other reserves (e.g. share premium and revaluation)
•
account for the effects of intra-group trading in the statement of financial position together
with their effects in non-controlling interest
•
explain why it is necessary to use fair values when preparing consolidated financial
statements
•
explain the treatment of reserves of subsidiary acquired during the accounting period
•
prepare consolidated statement of changes in Equity
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1
1.1
Principles Of The Consolidated Statement Of Financial Position
Basic principle
The basic principle of a consolidated statement of financial position is that it shows all
assets and liabilities of the parent and subsidiary. Intra-group items are excluded, e.g.
receivables and payables shown in the consolidated statement of financial position only
include amounts owed from/to third parties.
Method of preparing a consolidated statement of financial position
(1)
The investment in the subsidiary (S) shown in the parent’s (P’s) statement of
financial position is replaced by the net assets of S.
(2)
The cost of the investment in S is effectively cancelled with the ordinary share
capital and reserves of the subsidiary.
This leaves a consolidated statement of financial position showing:
•
the net assets of the whole group (P + S)
•
the share capital of the group which always equals the share capital of P only and
•
the retained profits, comprising profits made by the group (i.e. all of P’s historical
profits + profits made by S post-acquisition).
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Example 1
Statements of financial position at 31 December 20X4
P
S
Rs. ‘000’
Rs. ‘000’
Non-current assets
60
50
Investment in S at cost
50
Current assets
40
40
___
___
150
90
___
___
Ordinary share capital (Rs 10 shares)
100
40
Retained earnings
30
10
Current liabilities
20
40
___
___
150
90
___
___
Required
P acquired all the shares in S on 31 December 20X4 for a cost of Rs 50,000.
Prepare the consolidated statement of financial position at 31 December 20X4.
Solution
Approach
(1)
The balance on ‘investment in subsidiary account’ in P’s accounts will be replaced
by the underlying assets and liabilities which the investment represents, i.e. the
assets and liabilities of S.
(2)
The cost of the investment in the subsidiary is effectively cancelled with the
ordinary share capital and reserves of S. This is normally achieved in consolidation
workings (discussed in more detail below). However, in this simple case, it can be
seen that the relevant figures are equal and opposite (Rs 50,000), and therefore
cancel directly.
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This leaves a consolidated statement of financial position showing:
•
the net assets of the whole group (P + S)
•
the share capital of the group, which equals the share capital of P only – Rs
100,000
•
retained earnings comprising profits made by the group. Here this will only
include the Rs 30,000 retained earnings of the parent company. S is
purchased on the reporting date, therefore there are no post-acquisition
earnings to include in the group amount.
By cross-casting the net assets of each company, and cancelling the investment in S against the
share capital and reserves of S, we arrive at the consolidated statement of financial position given
below.
P consolidated statement of financial position at 31 December 20X4:
Rs. ‘000’
Non-current assets Rs (60,000 + 50,000)
110
Current assets Rs (40,000 + 40,000)
80
___
190
___
Share capital (Rs 10 ordinary shares)
100
Retained earnings
30
Current liabilities Rs (20,000 + 40,000)
60
___
190
___
Note: Under no circumstances will any share capital of any subsidiary company ever be
included in the figure of share capital in the consolidated statement of financial position
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1.2
The Mechanics of Consolidation
A standard group accounting question will provide the accounts of P and the accounts of S
and will require the preparation of consolidated accounts.
The best approach is to use a set of standard workings.
(W1)
Establish the group structure
P
Date of
This indicates that P owns 80% of the ordinary shares of S and when
they were acquired
Acquisition
S
(W2)
Net assets of subsidiary
At date of acquisition
At the reporting date
Rs
Rs
X
X
Share premium
X
X
Retained earnings
X
X
––
––
X
X
––
––
Share capital
Reserves:
(W3)
Goodwill
Rs
Parent holding (investment) at fair value
X
NCI value at acquisition (*)
X
—
X
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Less:
Fair value of net assets at acquisition (W2)
(X)
—
Goodwill on acquisition
X
Impairment
(X)
—
X
(*) If fair value method adopted, NCI value = fair value of NCI's holding at
acquisition (number of shares NCI own × subsidiary share price).
(*) If proportion of net assets method adopted, NCI value = NCI % × fair value of
net assets at acquisition (from W2).
(W4)
Non controlling interest
Rs
NCI value at acquisition (as in W3)
X
NCI share of post-acquisition reserves (W2)
X
NCI share of impairment (fair value method only)
(X)
—
X
—
(W5)
Group retained earnings
Rs
P's retained earnings (100%)
X
P's % of sub's post-acquisition
retained earnings
X
Less: Parent share of impairment (W3)
(X)
—
X
—
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2
Goodwill
2.1
Goodwill on acquisition
In example 1 the cost of the shares in S was Rs 50,000. Equally the net assets of S were
Rs 50,000. This is not always the case.
The value of a company will normally exceed the value of its net assets. The difference is
goodwill. This goodwill represents assets not shown in the statement of financial position
of the acquired company such as the reputation of the business.
Goodwill on acquisition is calculated by comparing the value of the subsidiary acquired to
its net assets.
Where 100% of the subsidiary is acquired, the calculation is therefore:
Rs
Cost of investment (= value of the subsidiary)
X
Net assets of subsidiary
(X)
___
Goodwill
X
Where less than 100% of the subsidiary is acquired, the value of the subsidiary comprises
two elements:
•
The value of the part acquired by the parent
•
The value of the part not acquired by the parent, known as the non-controlling
interest
There are 2 methods in which Goodwill may be calculated:
(i)
Proportion of net assets method (as seen in consolidation workings).
(ii)
Fair value method (as seen in consolidation workings).
(iii)
The proportion of net assets method calculates the portion of goodwill attributable to the
parent only, while the fair value method calculates the goodwill attributable to the group as
a whole. This is known as the gross goodwill i.e. goodwill is shown in full as this is the
asset that the group controls.
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Example 2
Hafeez acquired 80% of the ordinary share capital of Atlas on 31 December 20X6 for Rs
78,000. At this date the net assets of Atlas were Rs 85,000.
What goodwill arises on the acquisition
(i)
if the NCI is valued using the proportion of net assets method
(ii)
if the NCI is valued using the fair value method and the fair value of the NCI on the
acquisition date is Rs 19,000?
Solution
Rs
(i)
Parent holding (investment) at fair value
78,000
NCI value at acquisition (20% × Rs 85,000)
17,000
————
95,000
Less:
Fair value of net assets at acquisition
(85,000)
————
Goodwill on acquisition
10,000
————
(iv)
Parent holding (investment) at fair value
78,000
NCI value at acquisition
19,000
————
97,000
Less:
Fair value of net assets at acquisition
(85,000)
————
Goodwill on acquisition
12,000
————
2.2
IFRS 3 Business Combination
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IFRS 3 revised governs accounting for all business combinations other than joint ventures
and a number of other unusual arrangements not included in this syllabus. The definition
of goodwill is:
Goodwill is an asset representing the future economic benefits arising from other assets
acquired in a business combination that are not individually identified and separately
recognised.
Goodwill is calculated as the excess of the consideration transferred and amount of any
non-controlling interest over the net of the acquisition date identifiable assets acquired and
liabilities assumed.
2.3
Treatment of Goodwill
Positive goodwill
•
Capitalised as an intangible non-current asset.
•
Tested annually for possible impairments.
•
Amortisation of goodwill is not permitted by the standard.
Impairment of positive goodwill
If goodwill is considered to have been impaired during the post-acquisition period it must
be reflected in the group financial statements. Accounting for the impairment differs
according to the policy followed to value the non controlling interests.
Proportion of net assets method:
Dr Group reserves (W5)
Cr Goodwill (W3)
Fair value method:
Dr Group reserves (% of impairment attributable to the parent – W5)
Dr NCI (% of impairment attributable to NCI – W4)
Cr Goodwill (W3)
Negative goodwill
•
Capitalised as an intangible Non-current asset.
•
Tested annually for possible impairments.
•
Amortisation of goodwill is not permitted by the standard.
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•
Arises where the cost of the investment is less than the value of net assets
purchased.
•
IFRS 3 does not refer to this as negative goodwill (instead it is referred to as a
bargain purchase), however this is the commonly used term.
•
Most likely reason for this to arise is a misstatement of the fair values of assets and
liabilities and accordingly the standard requires that the calculation is reviewed.
•
After such a review, any negative goodwill remaining is credited directly to the
income statement.
3
Pre And Post-Acquisition Profits
3.1
Pre-acquisition profits are the reserves which exist in a subsidiary company at the date
when it is acquired.
They are capitalised at the date of acquisition by including them in the goodwill calculation.
Post-acquisition profits are profits made and included in the retained earnings of the
subsidiary company following acquisition. They are included in group retained earnings.
3.2
Group reserves
When looking at the reserves of S at the year end, e.g revaluation reserve, a distinction
must be made between:
•
those reserves of S which existed at the date of acquisition by P (pre-acquisition
reserves) and
•
the increase in the reserves of S which arose after acquisition by P (postacquisition reserves).
As with retained earnings, only the group share of post-acquisition reserves of S is
included in the group statement of financial position
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Example 3
The following statements of financial position were extracted from the books of two
companies at 31 December 20X9.
Hamza Ltd
Orient Ltd
Rs
Rs
75,000
11,000
Non-current assets
Property, plant & equipment
Investments
Shares in Orient Ltd
27,000
–––––––
102,000
Current assets
214,000
33,000
–––––––
–––––––
316,000
44,000
–––––––
Equity
Share capital
80,000
4,000
Share premium
20,000
6,000
Retained earnings
40,000
9,000
–––––––
–––––––
140,000
19,000
–––––––
–––––––
176,000
25,000
–––––––
–––––––
316,000
44,000
–––––––
–––––––
Current liabilities
Hamza Ltd acquired all of the share capital of Orient Ltd one year ago. The retained
earnings of Orient Ltd stood at Rs 2,000 on the day of acquisition. Goodwill is calculated
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using the proportion of net asset method. There has been no impairment of goodwill since
acquisition.
Required
Prepare the consolidated statement of financial position of Hamza Ltd as at 31 December
20X9.
Solution
Hamza Ltd consolidated statement of financial position at 31 December 20X9:
Non-current assets
Rs. ‘000’
Goodwill (W3)
15
PPE Rs (75,000 + 11,000)
86
Current assets Rs (214,000 + 33,000)
247
–––
348
–––
Share capital (Hamza Ltd only)
80
Share premium (Hamza Ltd only)
20
Group retained earnings (W5)
47
–––
147
Current liabilities Rs (176,000 + 25,000)
201
–––
348
–––
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(W1)
Establish the group structure
Hamza Ltd
100%
1 Jan 20X9
Orient Ltd
(W2)
Net assets of Orient Ltd
At date of acquisition
At the reporting date
Rs
Rs
4,000
4,000
Share premium
6,000
6,000
Retained earnings
2,000
9,000
––––––
––––––
12,000
19,000
––––––
––––––
Share capital
Reserves:
(W3)
Goodwill
Rs
Parent holding (investment) at fair value
27,000
Less:
Fair value of net assets at acquisition (W2)
(12,000)
————
Goodwill on acquisition
15,000
————
(W4)
NCI
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Not applicable to this example as Orient Ltd is 100% owned.
(W5)
Group retained earnings
Rs
Hamza Ltd retained earnings (100%)
40,000
Orient Ltd – group share of post-acquisition
retained earnings 100% × Rs (19,000 – 12,000 (W2))
7,000
–––––
47,000
–––––
4
Non-Controlling Interest
4.1
What is a non-controlling interest?
In some situations, a parent may not own all of the shares in the subsidiary, e.g. if P owns
only 80% of the ordinary shares of S, there is a non-controlling interest of 20%.
Note, however, that P still controls S.
4.2
Accounting treatment of a non-controlling interest
As P controls S:
•
in the consolidated statement of financial position, include all of the net assets of S
(to show control).
•
give back’ the net assets of S which belong to the non-controlling interest within the
equity section of the consolidated statement of financial position (calculated in W4).
5
Fair Values
5.1
Fair value of consideration and net assets
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To ensure that an accurate figure is calculated for goodwill:
•
the consideration paid for a subsidiary must be accounted for at fair value
•
the subsidiary’s identifiable assets and liabilities acquired must be accounted for at
their fair values.
Fair value of assets and liabilities is defined in IFRS 13 Fair value measurement as the
price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date (i.e. an exit price).
In order to account for an acquisition, the acquiring company must measure the cost of
what it is accounting for, which will normally represent:
•
the cost of the investment in its own statement of financial position
•
the amount to be allocated between the identifiable net assets of the subsidiary,
the non-controlling interest and goodwill in the consolidated financial statements.
The subsidiary’s identifiable assets and liabilities are included in the consolidated accounts
at their fair values for the following reasons.
•
Consolidated accounts are prepared from the perspective of the group, rather than
from the perspectives of the individual companies. The book values of the
subsidiary’s assets and liabilities are largely irrelevant, because the consolidated
accounts must reflect their cost to the group (i.e. to the parent), not their original
cost to the subsidiary. The cost to the group is their fair value at the date of
acquisition.
•
Purchased goodwill is the difference between the value of an acquired entity and
the aggregate of the fair values of that entity’s identifiable assets and liabilities. If
fair values are not used, the value of goodwill will be meaningless.
Identifiable assets and liabilities recognised in the accounts are those of the acquired
entity that existed at the date of acquisition.
Assets and liabilities are measured at fair values reflecting conditions at the date of
acquisition.
The following do not affect fair values at the date of acquisition and are therefore dealt with
as post-acquisition items.
•
Changes resulting from the acquirer’s intentions or future actions.
•
Changes resulting from post-acquisition events.
•
Provisions for future operating losses or re-organisation costs incurred as a result
of the acquisition.
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5.2
Calculation of cost of investment
The cost of acquisition includes the following elements:
•
cash paid
•
fair value of any other consideration i.e. deferred/contingent considerations and
share exchanges.
Incidental costs of acquisition such as legal, accounting, valuation and other professional fees
should be expensed as incurred. The issue costs of debt or equity associated with the
acquisition should be recognised in accordance with IFRS 9/IAS 32.
5.3
Deferred and contingent consideration
In some situations, not all of the purchase consideration is paid at the date of the
acquisition, instead a part of the payment is deferred until a later date – deferred
consideration.
•
Deferred consideration should be measured at fair value at the date of the
acquisition (i.e. a promise to pay an agreed sum on a pre-determined date in the
future taking into account the time value of money).
•
The fair value of any deferred consideration is calculated by discounting the
amounts payable to present value at acquisition.
•
Any contingent consideration should always be included as long as it can be
measured reliably. This will be indicated where relevant in an exam question. (A
contingent consideration is an agreement to settle in the future provided certain
conditions attached to the agreement are met. These conditions vary depending on
the terms of the settlement).
There are two ways to discount the deferred amount to fair value at the acquisition date:
(1)
The examiner may give you the present value of the payment based on a given
cost of capital.
(For example, Rs 1 receivable in three years time based on a cost of capital of
10% = Rs 0.75)
(2)
You may need to use the interest rate given and apply the discount fraction where r
is the interest rate and n the number of years to settlement
1
––––––
(1 + r ) n
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Each year the discount is then "unwound". This increases the deferred liability
each year (to increase to future cash liability) and the discount is treated as a
finance cost.
Contingent Consideration
Shares
Where contingent consideration involves the issue of shares, there is no liability (obligation
to transfer economic benefits). This should be recognised as part of shareholders' funds
under a separate caption representing shares to be issued.
Changes in fair value
The fair value of the contingent consideration at acquisition could be different to the actual
consideration transferred. Any differences are normally treated as a change in accounting
estimate and adjusted prospectively in accordance with IAS 8.
5.4
Share exchange
Often the parent company will issue shares in its own company in return for the shares
acquired in the subsidiary. The share price at acquisition should be used to record the cost
of the shares at fair value.
Example 4
Cost of Investment
J Ltd acquires 2.4 million Rs 10 shares (80%) of the ordinary shares of B Ltd by offering a
share-for-share exchange of two shares for every three shares acquired in B Ltd and a
cash payment of Rs 1 per share payable three years later. J Ltd's shares have a nominal
value of Rs 10 and a current market value of Rs 20. The cost of capital is 10% and Rs 1
receivable in 3 years can be taken as Rs 0.75
Required
1) Calculate the cost of investment and show the journals to record it in J Ltd's
accounts.
2) Show how the discount would be unwound.
Solution:
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1) Cost of investment
Rs
Deferred cash (at present value)
Rs 0.75 × (Rs 10 × 2.4m)
18m
Shares exchange
(2.4m × 2/3) × Rs 20
32m
___
50m
Rs 50m is the cost of investment for the purposes of the calculation of goodwill
Journals in J Ltd's individual accounts
Dr Cost of investment in subsidiary
Rs 50m
Cr Non-current liabilities deferred
Consideration
Rs 18m
Cr Share capital (1.6 million shares issued × Rs 10
nominal value)
Rs 16m
Cr Share premium (1.6 million shares issued × Rs 10
premium element)
Rs 16m
2) Unwinding the discount
Rs 18m × 10% = Rs 1.8m
Dr Finance cost
Rs 1.8m
Cr Non-current liabilities deferred
Consideration
Rs 1.8m
For the next three years the discount will be unwound, taking the interest to finance
cost until the full Rs 24 million payment is made in Year 3.
6
Fair Value of Net Assets Acquired
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6.1
IFRS 3 revised requires that the subsidiary’s assets and liabilities are recorded at their fair
value for the purposes of the calculation of goodwill and production of consolidated
accounts.
Adjustments will therefore be required where the subsidiary’s accounts themselves
do not reflect fair value.
How to include fair values in consolidation workings
(1)
Adjust both columns of W2 to bring the net assets to fair value at acquisition and
reporting date.
This will ensure that the fair value of net assets is carried through to the goodwill
and non-controlling interest calculations.
(2)
6.2
At acquisition
At reporting date
Rs. ‘000’
Rs. ‘000’
Ordinary share capital + reserves
X
X
Fair value adjustments
X
X
___
___
X
X
___
___
At the reporting date make the adjustment on the face of the SOFP when adding
across assets and liabilities.
Uniform Accounting Policies
All group companies should have the same accounting policies.
If a group member uses different accounting policies, its financial statements must be
adjusted to achieve consistency before they are consolidated.
This is achieved by:
7
(1)
adjusting the relevant asset or liability balance in the subsidiary’s individual
statement of financial position prior to adding across on a line by line basis, and
(2)
adjusting W2 to reflect the impact of the different policy on the subsidiary’s net
assets.
Intra-Group Trading
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7.1
Types of intra-group trading
P and S may well trade with each other leading to the following potential problem
areas:
a) current accounts between P and S
b) loans held by one company in the other
c) dividends and loan interest.
d) unrealised profits on sales of inventory
e) unrealised profits on sales of Non-current assets
7.2
Current accounts
If P and S trade with each other then this will probably be done on credit leading to:
•
a receivables (current) account in one company’s SOFP
•
a payables (current) account in the other company’s SOFP.
These are amounts owing within the group rather than outside the group and therefore
they must not appear in the consolidated statement of financial position.
They are therefore cancelled (contra’d) against each other on consolidation.
7.3
Cash/goods in transit
At the year end, current accounts may not agree, owing to the existence of in-transit
items such as goods or cash.
The usual rules are as follows:
•
f the goods or cash are in transit between P and S, make the adjusting entry to the
statement of financial position of the recipient:
– cash in transit adjusting entry is:
– Dr Cash in transit
– Cr Receivables current account
– goods in transit adjusting entry is:
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– Dr Inventory
–Cr Payables current account this adjustment is for the purpose of
consolidation only.
•
Once in agreement, the current accounts may be contra’d and cancelled as part of
the process of cross casting the assets and liabilities.
•
This means that reconciled current account balance amounts are removed from
both receivables and payables in the consolidated statement of financial position.
Example 5
Current accounts and cash in transit
Draft SOFPs of P Ltd and S Ltd on 31 March 20X7 are as follows.
P Ltd
S Ltd
Rs. ‘000’
Rs. ‘000’
Property, Plant & equipment
100
140
Investment in S at cost
180
Current assets
Inventory
30
35
Trade receivables
20
10
Cash
10
5
___
___
340
190
Share capital: Ordinary Rs 10 shares
200
100
Share premium
10
30
Retained earnings
40
20
___
___
250
150
Equity and liabilities
Non-current liabilities
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10% loan notes
65
-
Current liabilities
25
40
___
___
340
190
Notes
• P Ltd bought 8,000 shares in S Ltd in 20X1 when S Ltd ’s reserves included a share
premium of Rs 30,000 and retained profits of Rs 5,000.
• P Ltd 's accounts show Rs 6,000 owing to S Ltd ; S Ltd 's accounts show Rs 8,000 owed
by P Ltd . The difference is explained as cash in transit.
• No impairment of goodwill has occurred to date.
• P Ltd uses the proportion of net assets method to value the non-controlling interest.
Required
Prepare a consolidated statement of financial position as at 31 March 20X7.
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Solution
P Ltd Group Consolidated statement of financial position as at 31 March 20X7
Assets
Rs 000
Rs 000
Non-current assets
Intangible assets – goodwill (W3)
72
Property,Plant & equipment
(100 + 140)
240
312
–––
Current assets
Inventory Rs (30 + 35)
65
Trade receivables
(20 + 10 2(CIT) – 6 (inter-co))
22
Cash (10 + 5 + 2 (CIT))
17
–––
104
–––
416
Equity
Share capital
200
Share premium
10
Retained earnings (W5)
52
Non-controlling interest (W4)
30
–––
292
–––
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Non-current liabilities
10% loan notes
65
Current liabilities
Payables Rs (25 + 40 – 6 (inter-co))
59
–––
416
Workings
Note: Cash in transit
The Rs 2,000 cash in transit should be adjusted for in S Ltd 's accounts prior to
consolidation.
Assume that the cash has been received and therefore:
•
increase S Ltd 's cash balance by Rs 2,000 to Rs 7,000
•
decrease S Ltd 's receivables balance by Rs 2,000 to Rs 8,000
The outstanding intercompany balance requiring cancelling is therefore Rs 6,000.
(W1)
Group structure
P
20X1
80%
S
(W2)
Net assets of S Ltd
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(W3)
At date of acquisition
At reporting date
Rs. ‘000’
Rs. ‘000’
Share capital
100
100
Share premium
30
30
Retained earnings
5
20
––––
––––
135
150
––––
––––
Goodwill
Rs. ‘000’
Parent holding (investment) at fair value
180
NCI value at acquisition
(20% × Rs 135 (W2)
27
____
207
Less:
Fair value of net assets at acquisition
(135)
____
Goodwill on acquisition
72
____
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(W4)
Non-controlling interest
Rs. ‘000’
NCI value at acquisition (as in W3)
27
NCI share of post acquisition reserves
(20% × (20-5))
3
–––
30
___
(W5)
Group retained earnings
Rs. ‘000’
P Ltd retained earnings
40
80% of S Ltd 's post-acquisition
retained earnings
(80% × Rs (20,000 – 5,000) (W2))
12
–––
52
–––
8
Unrealised Profit
8.1
Profits made by members of a group on transactions with other group members are:
•
recognised in the accounts of the individual companies concerned, but
•
in terms of the group as a whole, such profits are unrealised and must be
eliminated from the consolidated accounts.
Unrealised profit may arise within a group scenario on:
8.2
•
inventory where companies trade with each other
1)
Non-current assets where one group company has transferred an asset to another.
Intra-group trading and unrealised profit in inventory
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When one group company sells goods to another a number of adjustments may be
needed.
•
Current accounts must be cancelled (see earlier in this chapter).
•
Where goods are still held by a group company, any unrealised profit must be
cancelled.
•
Inventory must be included at original cost to the group (i.e. cost to the company
which then sold it).
Where goods have been sold by one group company to another at a profit and some of
these goods are still in the purchaser’s inventory at the year end, then the profit loading on
these goods is unrealised from the viewpoint of the group as a whole.
This is because we are treating the group as if it is a single entity. No one can make a
profit by trading with himself. Until the goods are sold to an outside party there is no
realised profit from the group perspective.
For example, if Alpha purchased goods for Rs 400 and then sold these goods onto Beta
during the year for Rs 500, Alpha would record a profit of Rs 100 in their own individual
financial statements. The statement of financial position of Beta will include closing
inventory at the cost to Beta i.e. Rs 500.
This situation results in two problems within the group:
(1)
The profit made by Alpha is unrealised. The profit will only become realised when
sold on to a third party customer.
(2)
The value in Beta’s inventory (Rs 500) is not the cost of the inventory to the group
(cost to the group was the purchase price of the goods from the external third party
supplier i.e. Rs 400).
An adjustment will need to be made so that the single entity concept can be upheld
i.e. The group should report external profits, external assets and external liabilities
only.
Adjustments for unrealised profit in inventory
The process to adjust is:
(1)
Determine the value of closing inventory included in an individual company’s
accounts which has been purchased from another company in the group.
(2)
Use markup or margin to calculate how much of that value represents profit earned
by the selling company.
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(3)
Make the adjustments. These will depend on who the seller is.
If the seller is the parent company, the profit element is included in the holding
company’s accounts and relates entirely to the group.
Adjustment required
Dr Group retained earnings (deduct the profit in W5)
Cr Group inventory
If the seller is the subsidiary, the profit element is included in the subsidiary company’s
accounts and relates partly to the group, partly to non-controlling interests (if any).
Adjustment required
Dr Subsidiary retained earnings (deduct the profit in W2 at reporting date)
Cr Group inventory
8.3
Non Current Assets
If one group member sells Non-current assets to another group member, adjustments
must be made to recreate the situation that would have existed if the sale had not
occurred:
•
There would have been no profit on the sale.
•
Depreciation would have been based on the original cost of the asset to the group.
Any profit on sale that is made by the selling entity is unrealised and eliminated as with
inventory. Unlike inventory, which is usually sold shortly after the reporting date, goods
that become Non-current assets of the receiving entity are likely to be included in the
consolidated SOFP for a number of years.
Where there is unrealised profit on property, plant and equipment in Non-current assets
the necessary provision for unrealised profit will reduce as the Non-current asset is
depreciated. Therefore, it must be recomputed at the end of each period in which the
asset appears in the consolidated SOFP.
Adjustments for unrealised profit in Non-current assets
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 192
The easiest way to calculate the adjustment required is to compare the carrying value (CV)
of the asset now with the CV that it would have been held at had the transfer never
occurred:
CV at reporting date with transfer
X
CV at reporting date without transfer
(X)
–––
Adjustment required
X
The calculated amount should be:
(1) deducted when adding across P’s Non-current assets + S’s Non-current assets
(2) deducted in the retained earnings of the seller (W2 if the seller is the subsidiary; W5 if it
is the parent company)
Example 6
Unrealised profit in NCA
Parent company (P) transfers an item of Plant to its subsidiary (S) for Rs 6,000 at the start
of 20X1. The Plant originally cost P Rs 10,000 and had an original useful economic life of
5 years when purchased 3 years ago. The useful economic life of the asset has not
changed as a result of the transfer.
What is the unrealised profit on the transaction at the end of the year of transfer (20X1)?
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 193
Solution
NBV Before
Rs
Cost
10,000
Depreciation (3 yrs)
(6,000)
NBV After
Difference
Transfer
Transfer
Rs
Rs
–––––
Carrying value
4,000
6,000
2,000
Depreciation
(2,000)
(3,000)
(1,000)
Carrying value
2,000
3,000
1,000
The overall adjustment would be Rs 1,000 at the reporting date. To adjust the accounts:
Dr Consolidated retained earnings (W5)
Rs 1,000
Cr Property, Plant and equipment
Rs 1,000
9
Mid-Year Acquisitions
9.1
Calculation of reserves at date of acquisition
If a parent company acquires a subsidiary midyear, the net assets at the date of
acquisition must be calculated based on the net assets at the start of the subsidiary's
financial year plus the profits of up to the date of acquisition.
To calculate this, it is normally assumed that S’s profit after tax accrues evenly over time
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 194
10
Consolidated Statement Of Changes In Equity
Consolidated statement of changes in equity reflects the combined ‘Net Asset’ position of
Parent company and its Subsidiary companies. Proforma of Consolidated statement of
changes in equity is :
Share
Share
Retained
Total
Capital
Premium
Earnings
______
Opening
xxx
Share Issue during the year
xxx
xxx
xxx
xxx
Total comprehensive income for the year
xxx
xxx
Dividends*
(xxx)
(xxx)
* Dividends include only Parent Company’s dividends to its shareholders
.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 195
Chapter Summary
CSPF
Pre-acquisition
profit and group
reserves
Only include postacquisition
movement in
reserve of
subsidiary in group
account.
CONSOLIDATION
WORKINGS
(W1) Group structure
(W2) Net assets
(W3) Goodwill
(W4) Non-controlling interest
(W5) Group retained earnings
Goodwill (IFRS3)
Fair value
Of cost
Of assets
acquired.
Calculation
Treatment of
positive goodwill
Treatment of
negative goodwill.
Non-controlling
interest
= non-group
owners of
subsidiary
‘Return’ their share
of subs net assets
at reporting date in
non-controlling
interest line in
CSPF
Mid-year
acquisitions
Need reserves
of subsidiary at
date of
acquisition (W2).
Unrealized
profits
in inventory and
non-current
assets
Fair Value
Of cost
of assets
acquired.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 196
Self Test Questions
1.
Draft SOFPs of Paper Ltd and Swan Ltd on 31 December 20X1 are as follows:
Paper Ltd
Swan Ltd
Rs. ‘000’
Rs. ‘000’
Property, Plant & equipment
90
100
Investment in Swan Ltd at cost
110
Current assets
50
30
––––
––––
250
130
––––
––––
Ordinary share capital Rs 10
100
100
Retained earnings
120
20
–––
–––
220
120
–––
–––
30
10
–––
–––
250
130
–––
–––
Equity and liabilities
Equity
Current liabilities
Paper Ltd had bought 8,000 of the ordinary shares of Swan Ltd on 1 January 20X1 when
the retained profits of Swan Ltd were Rs 15,000. No impairment of goodwill has occurred
to date.
Prepare a consolidated statement of financial position as at 31 December 20X1, assuming
that the Paper Ltd group values the non-controlling interest using the proportion of net
assets method.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 197
2.
The following SOFPs have been prepared at 31 December 20X8:
H Ltd
Rs
J Ltd
Rs
Non-current assets:
Property, Plant & equipment
85,000
18,000
Investments:
Shares in J Ltd
60,000
––––––
145,000
Current assets
160,000
84,000
––––––
––––––
305,000
102,000
––––––
––––––
Ordinary Rs 10 shares
65,000
20,000
Share premium
35,000
10,000
Retained earnings
70,000
25,000
––––––
––––––
170,000
55,000
135,000
––––––
47,000
––––––
305,000
102,000
––––––
––––––
Equity
Current liabilities
H Ltd acquired 1,600 ordinary Rs 10 shares in J Ltd on 1 January 20X8, when J Ltd’
retained earnings stood at Rs 20,000. On this date, the fair value of the 20% noncontrolling
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 198
shareholding in J Ltd was Rs 12,500.
The H Ltd Group uses the fair value method to value the non-controlling interest.
Prepare the consolidated statement of financial position of H Ltd as at 31 December 20X8.
3.
Cost of investment
Statements of Financial Position of P and S as at 30 June 20X8 are given below:
P
S
Rs
Rs
Property, Plant & equipment
15,000
9,500
Investments
5,000
Current assets
7,500
5,000
––––––
––––––
27,500
14,500
––––––
––––––
Share capital Rs 10
6,000
5,000
Share premium
4,000
Retained earnings
12,500
7,200
––––––
––––––
22,500
12,200
Non-current liabilities
1,000
500
Current liabilities
4,000
1,800
––––––
––––––
27,500
14,500
––––––
––––––
P acquired 60% of S on 1 July 20X7 when the retained earnings of S were Rs 5,800. P
paid Rs 5,000 in cash. P also issued 2 Rs 10 shares for every 5 acquired in S and agreed
to pay a further Rs 2,000 in 3 years time. The market value of P’s shares at 1 July 20X7
was Rs 18. P has only recorded the cash paid in respect of the investment in S. Current
interest rates are 6%.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 199
The P group uses the fair value method to value the non-controlling interests. At the date
of acquisition the fair value of the non-controlling interest was Rs 5,750.
Required:
Prepare the consolidated Statement of Financial Position of P group as at 30 June
20X8.
4.
Hazelnut acquired 80% of the share capital of Peppermint two years ago, when the
reserves of Peppermint stood at Rs 125,000. Hazelnut paid initial cash consideration of Rs
1 million. Additionally Hazelnut issued 20,000 shares with a nominal value of Rs 10 and a
current market value of Rs 18. It was also agreed that Hazelnut would pay a further Rs
500,000 in three years’ time. Current interest rates are 10% pa. The appropriate discount
factor for Rs 1 receivable three years from now is 0.751. The shares and deferred
consideration have not yet been recorded.
Below are the statements of financial position of Hazelnut and Peppermint as at 31
December 20X4:
Hazelnut
Peppermint
Rs. ‘000’
Rs. ‘000’
Investment in Peppermint at cost
1,000
Property,Plant & equipment
5,500
1,500
Inventory
550
100
Receivables
400
200
Cash
200
50
–––––
–––––
7,650
1,850
–––––
–––––
Share capital
2,000
500
Retained earnings
1,400
300
–––––
–––––
3,400
800
3,000
400
Current assets
Non-current liabilities
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 200
Current liabilities
1,250
650
–––––
–––––
7,650
1,850
–––––
–––––
At acquisition the fair values of Peppermint’s Plant exceeded its book value by Rs 200,000.
The Plant had a remaining useful life of five years at this date.
For many years Peppermint has been selling some of its products under the brand name
of ‘Supermint’. At the date of acquisition the directors of Hazelnut valued this brand at Rs
250,000 with a remaining life of 10 years. The brand is not included in Peppermint’s
statement of financial position.
The consolidated goodwill has been impaired by Rs 258,000.
The Hazelnut Group values the non-controlling interest using the fair value method. At the
date of acquisition the fair value of the 20% non-controlling interest was Rs 380,000
Prepare the consolidated statement of financial position as at 31 December 20X4.
5.
Fair value adjustments/intercompany balances
Statements of Financial Position of P and S as at 30 June 20X8 are given below:
P
S
Rs
Rs
Land
4,500
2,500
Plant & equipment
2,400
1,750
Investments
8,000
Non-current assets
––––
––––––
14,900
4,250
Inventory
3,200
900
Receivables
1,400
650
600
150
––––––
––––––
5,200
1,700
––––––
––––––
Current assets
Bank
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 201
20,100
5,9500
––––––
––––––
Ordinary share capital Rs 10 each
5,000
1,000
Retained earnings
8,300
3,150
––––––
––––––
13,300
4,150
8% loan stock
4,000
500
Current liabilities
2,800
1,300
––––––
––––––
20,100
5,950
––––––
––––––
Non-current liabilities
P acquired 75% of S on 1 July 20X5 when the balance on S’s retained earnings was Rs
1,150. P paid Rs 3,500 for its investment in the share capital of S. At the same time, P
invested in 60% of S’s 8% loan stock.
At the reporting date P recorded a payable to S of Rs 400. This did not agree to the
corresponding amount in S's financial statements of Rs 500. The difference is explained
as cash in transit.
At the date of acquisition it was determined that S’s land, carried at cost of Rs 2,500 had a
fair value of Rs 3,750. S’s Plant was determined to have a fair value of Rs 500 in excess
of its carrying value and had a remaining life of 5 years at this time. These values had not
been recorded by S.
The P group uses the fair value method to value the non-controlling interest. For this
purpose the subsidiary share price at the date of acquisition should be used. The
subsidiary share price at acquisition was Rs 44 per share.
Goodwill has impaired by Rs 100.
Required
Prepare the consolidated statement of financial position of the P group as at 30 June 20X8.
Health (H) bought 90% of the equity share capital of Safety (S), two years ago on 1
January 20X2 when the retained earnings of Safety stood at Rs 5,000. Statements of
financial position at the year end of 31 December 20X3 are as follows:
Health
Rs. ‘000’
Rs. ‘000’
Advanced Financial Accounting and Corporate Reporting (Study Text)
Safety
Rs. ‘000’
Rs. ‘000’
Page 202
Non-current assets:
Property, Plant & equipment
100
Investment in Safety at cost
34
30
––––
––––
134
30
Current assets:
Inventory
90
20
Receivables
110
25
Bank
10
5
––––
––––
210
50
––––
––––
344
80
––––
––––
Equity
Share capital
15
5
Retained earnings
159
31
––––
174
36
Non-current liabilities
120
28
Current liabilities
50
16
––––
––––
344
80
––––
––––
Safety transferred goods to Health at a transfer price of Rs 18,000 at a markup of 50%.
Two-thirds remained in inventory at the year end. The current account in Health and
Safety stood at Rs 22,000 on that day. Goodwill has suffered an impairment of Rs 10,000.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 203
The Health group uses the fair value method to value the non-controlling interest. The fair
value of the non-controlling interest at acquisition was Rs 4,000
Prepare the consolidated statement of financial position at 31/12/X3.
7.
Consolidated Statement of Financial Position
On 1 May 2007 K Ltd bought 60% of S Ltd paying Rs 76,000 cash. The summarised
Statements of Financial Position for the two companies as at 30 November 2007 are:
Non-current assets
Property, Plant & equipment
138,000
115,000
Investments
98,000
-
Inventory
15,000
17,000
Receivables
19,000
20,000
Cash
2,000
-
––––––
––––––
272,000
152,000
Share capital
50,000
40,000
Retained earnings
189,000
69,000
––––––
––––––
239,000
109,000
-
20,000
33,000
23,000
––––––
––––––
272,000
––––––
152,000
––––––
Current assets
Non-current liabilities
8% Loan notes
Current liabilities
The following information is relevant
1)
The inventory of S Ltd includes Rs 8,000 of goods purchased from K Ltd at cost
plus 25%.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 204
(2)
On 1 June 2007 S Ltd transferred an item of Plant to K Ltd for Rs 15,000. Its
carrying amount at that date was Rs 10,000. The asset had a remaining useful
economic life of 5 years.
(3)
The K Ltd Group values the non-controlling interest using the fair value method. At
the date of acquisition, the fair value of the 40% non-controlling interest was Rs
50,000.
(4)
An impairment loss of Rs 1,000 is to be charged against goodwill at the yearend.
(5)
S Ltd earned a profit of Rs 9,000 in the year ended 30 November 2007.
(6)
The loan note in S Ltd’s books represents monies borrowed from K Ltd during the
year. All of the loan note interest has been accounted for.
(7)
Included in K Ltd’s receivables is Rs 4,000 relating to inventory sold to S Ltd during
the year. S Ltd raised a cheque for Rs 2,500 and sent it to K Ltd on 29 November
2007. K Ltd did not receive this cheque until 4 December 2007.
Answers
1.
Paper Ltd consolidated statement of financial position as at 31 December 20X1
Rs. ‘000’
Non-current assets
Goodwill (W3)
18
PPE Rs (90,000 + 100,000)
190
–––
208
Current assets Rs (50,000 + 30,000)
80
–––
Total assets
288
–––
Equity
Ordinary share capital Rs 10 (100% P only)
100
Retained earnings (W5)
124
Non-controlling interest (W4)
24
–––
248
Current liabilities Rs (30,000 + 10,000)
Advanced Financial Accounting and Corporate Reporting (Study Text)
40
Page 205
–––
Total equity and liabilities
288
___
Workings
(W1)
Establish the group structure
(percentage of shares purchased 8,000 / 10,000 = 80%)
P
1 Jan X1
80%
S
(W2)
Net assets of Swan Ltd
At date of
At the
Acquisition
reporting
date
Rs. ‘000’
Rs. ‘000’
Ordinary share capital
100
100
Retained earnings
15
20
___
___
115
120
___
___
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 206
(W3)
Goodwil
Parent holding (investment) at fair value
Rs. ‘000’
110
NCI value at acquisition
(20% × 115 (W2))
23
——
133
Less:
Fair value of net assets at acquisition (W2)
(115)
———
Goodwill on acquisition
18
———
(W4)
NCI
NCI value at acquisition (as in W3)
23
NCI share of post-acquisition reserves (W2)
1
(20% × (120 – 115) (W2))
––––
24
––––
(W5)
Group retained earnings
Paper Ltd (100%)
80% of Swan Ltd post-acquisition retained earnings
120
4
(80% × (120 – 115) (W2))
124
___
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 207
2.
H Ltd consolidated statement of financial position as at 31 December 20X8:
Rs
Non-current assets
Goodwill (W3)
22,500
PPE
(85,000 + 18,000)
103,000
Current assets
(160,000 + 84,000)
244,000
______
369,500
______
Equity:
Share capital
65,000
Share premium
35,000
Group retained earnings (W5)
74,000
Non-controlling interest (W4)
13,500
______
187,500
Current liabilities
(135,000 + 47,000)
182,000
______
369,500
______
(W1)
Group structure
(percentage of shares purchased 1,600 / 2,000 = 80%)
D
1 Jan X8
80%
J
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 208
(W2)
Net assets of J Ltd
At date of acquisition
At reporting date
Share capital
20,000
20,000
Share premium
10,000
10,000
Retained earnings
20,000
25,000
______
______
50,000
55,000
______
______
Net assets
(W3)
Goodwill
Parent holding (investment) at fair value
60,000
NCI value at acquisition
12,500
______
72,500
Less:
Fair value of net assets at acquisition
(50,000)
______
Goodwill on acquisition
22,500
______
(W4)
Non-controlling interests
NCI value at acquisition (as in W3)
NCI share of post-acquisition reserves (W2)
12,500
1,000
(20% × (25,000 - 20,000))
———
13,500
———
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 209
(W5)
Group retained earnings
H Ltd
70,000
80% J Ltd post acquisition profit
4,000
(80% × Rs (25,000 -20,000
(W2))
–––––
74,000
–––––
3.
Consolidated Statement of Financial Position as at 30 June 20X8:
Non-current assets
Rs
Goodwill (W3)
3,790
Property, Plant & equip (15,000 + 9,500)
24,500
Investments (5,000 – 5,000)
Current Assets (7,500 + 5,000)
12,500
––––––
40,790
––––––
Share capital (6,000 + 1,200)
7,200
Share premium (4,000 + 960)
4,960
Retained earnings (W5)
13,239
Non-controlling Interest (W4)
6,310
––––––
31,709
Non-current liabilities (1,000 + 500 + 1,680 +101)
3,281
Current liabilities (4,000 + 1,800)
5,800
––––––
40,790
––––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 210
Workings
(W1)
Group structure
P
60%
S
1 July 20x7 i.e. 1 yr
(W2)
(W3)
Net Assets
@ acq'n
@ rep date
Share capital
5,000
5,000
Retained earnings
5,800
7,200
––––––
––––––
10,800
12,200
––––––
_____
Goodwill
Parent holding (investment) at fair value:
Cash paid
5,000
Share exchange
2,160
(60% × 500 × 2/5 × Rs 18)
Deferred consideration
1,680
(2,000 × 1/1.063)
––––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 211
8,840
NCI value at acquisition
5,750
––––––
14,590
Less:
Fair value of net assets at acquisition (W2)
(10,800)
––––––
Goodwill on acquisition
3,790
––––––
Shares
P has issued 120 shares valued at Rs 18 each. These have not yet been recorded
and so an adjustment is required to:
Cr Share capital
1,200
Cr Share premium
960
Deferred consideration
P has a liability to pay Rs 2,000 in 3 yrs time which has not yet been recorded. The
liability is being measured at its present value of Rs 1,680 at the date of acquisition
and so the adjustment required is:
Cr Non-current liabilities Rs 1,680
The Statement of Financial Position date is 1 year after the date of acquisition and
so the present value of the liability will have increased by 6% (i.e. it is unwound by
6%) by the Statement of Financial Position date. An adjustment is therefore
required to reflect this increase:
Dr Finance cost i.e. Retained earnings of P (6% x 1,680)
Rs 101
Cr Deferred consideration i.e. Non-current liabilities
Rs 101
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 212
(W4)
Non-controlling interests
NCI value at acquisition (as in W3)
5,750
NCI share of post acquisition reserves (W2)
560
(40% × (7,200- 5,800))
––––––
6,310
––––––
(W5)
Retained earnings
P retained earnings
12,500
Deferred consideration finance cost
(101)
S (60% × (12,200 – 10,800 (W2)))
840
–––––
13,239
–––––
4.
Hazelnut consolidated statement of financial position at 31 December 20X4:
Rs. ‘000’
Goodwill (W3)
783
Brand name (W2)
200
Property, Plant & equipment (5,500 + 1,500 + 200 80)
7,120
Current assets:
Inventory (550 + 100)
650
Receivables (400 + 200)
600
Cash (200 + 50)
250
–––––
9,603
–––––
Share capital (2,000 + 200)
2,200
Share premium (0 + 160)
160
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 213
Retained earnings (W5)
1,151
–––––
3,511
Non-controlling interest (W4)
337
–––––
3,848
Non-current liabilities (3,000 + 400)
3,400
Current liabilities (1,250 + 650)
1,900
Deferred consideration (376 + 79)
455
–––––
9,603
–––––
Workings
(W1)
Group structure
Hazelnut
2 years ago
80%
Peppermint
(W2)
Net assets of Peppermint
At date of acquisition
At reporting date
Share capital
500
500
Retained earnings
125
300
Plant fair value adjustment
200
200
Depreciation adjustment
(80)
(200 / 5 years × 2 years)
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 214
Brand fair value adjustment
250
250
Amortisation adjustment
(250 / 10 years × 2 years)
(W3)
(50)
_____
_____
1,075
1,120
_____
_____
Goodwill
Parent holding (investment) at fair value:
Cash paid
1,000
Share exchange (20 × Rs 18)
360
Deferred consideration (500 × 0.751)
376
———
1,736
NCI value at acquisition
380
———
2,116
Less:
Fair value of net assets at acquisition (W2)
(1,075)
———
Goodwill on acquisition
1,041
Impairment
(258)
———
Carrying goodwill
783
———
Note: the cost of the investment in Hazelnut’s SOFP is Rs 1 million, i.e. the cash
consideration paid. Hazelnut has:
Dr
Investment
Rs 1 million
Cr
Bank
Rs 1 million
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 215
Hazelnut has not yet recorded the share consideration or the deferred
consideration. The journals required to record these are:
Dr Investment
Rs 360,000
Cr Share capital (nominal element)
Rs 200,000
Cr Share premium (premium element)
Rs 160,000
And
Dr Investment
Rs 376,000
Cr Deferred consideration
Rs 376,000
In the CSOFP, since the cost of the investment does not appear there is no need
to worry about the debit side of the entries. The credit entries do, however, need
recording.
(W4)
Non-controlling interest
NCI value at acquisition (as in W3)
380
NCI share of post acquisition reserves
9
(20% × (1,120 -1,075) (W2))
——
389
NCI share of impairment
(52)
(258 × 20%)
——
337
——
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 216
(W5)
Group retained earnings
Hazelnut retained earnings
1,400
Unwind discount (W6)
(79)
Peppermint (80% × (1,120 – 1,075))
36
Impairment of goodwill (W3)
(80% × 258)
(206)
_____
1,151
_____
(W6)
Unwinding of discount
Present value of deferred consideration at acquisition
376
Present value of deferred consideration at reporting date
455
___
79
At acquisition, Hazelnut should record a liability of 376, being the present value of
the future cash flow at that date.
The reporting date is two years’ liability and there is only one year to go until the
deferred consideration will be paid. Therefore the liability in Hazelnut’s SOFP at
this date is 376 × 1.102.
So, Hazelnut needs to:
Dr Income statement
Cr Deferred consideration liability
Advanced Financial Accounting and Corporate Reporting (Study Text)
79
79
Page 217
5.
Consolidated statement of financial position as at 30 June 20X8:
Non-current assets
Rs
Goodwill (W3)
600
Land (4,500 + 2,500 + 1,250)
8,250
Plant & equipment (2,400 + 1,750 + 500 – 300)
4,350
Investments (8,000 – 3,500 – (60% × 500))
4,200
––––––
17,400
Current Assets
Inventory
4,100
(3,200 + 900)
Receivables
(1,400 + 650- 100 (CIT) – 400 (interco))
Bank (600 + 150 + 100 (CIT))
1,550
850
––––––
6,500
––––––
23,900
––––––
Equity
Share capital
5,000
Retained earnings (W5)
9,500
Non-controlling
Interest (W4)
1,500
––––––
16,000
Non-current liabilities (4,000 + 500 – (60% × 500))
4,200
Current liabilities (2,800 + 1,300 400)
3,700
––––––
23,900
––––––
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Workings
(W1)
Group structure
P
75%
S
1 July 20x5 i.e. 3 yrs
(W2)
(W3)
Net assets
At Acquisition Date
At Reporting Date
Share capital
1,000
1,000
Retained earnings
1,150
3,150
FV Adj Land (3,750 – 2,500)
1,250
1,250
FV Adj Plant
500
500
Dep'n Adj (500 × 3/5)
(300)
–––––
–––––
3,900
5,600
–––––
–––––
Goodwill
Parent holding (investment) at fair value
3,500
NCI value at acquisition
1,100
((100 shares × 25%) × Rs 44)
–––––
4,600
Advanced Financial Accounting and Corporate Reporting (Study Text)
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Less:
Fair value of net assets at acquisition (W2)
(3,900)
–––––
Goodwill on acquisition
700
Impairment
(100)
–––––
Carrying goodwill
600
–––––
(W4)
Non-controlling interest
NCI value at acquisition (as in W3)
NCI share of post acquisition reserves (W2)
1,100
425
(25% × (5,600 - 3,900))
Less:
NCI share of impairment
(25)
(25% × 100)
–––––
1,500
–––––
(W5)
Group retained earnings
100% P
8,300
75% of S post acq retained earnings
(75% × (5,600 – 3,900))
75% Impairment
1,275
(75)
(75% × 100)
–––––
9,500
–––––
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6.
Consolidated SOFP for Health as at 31/12/X3:
Rs. ‘000’
Non-current assets
Goodwill (W3)
18
Property, Plant & equipment
(100 + 30)
130
——
148
Current Assets
Inventory
(90 + 20 4 (W6))
106
Receivables
113
(110 + 25 22 intra-co receivable)
Bank
15
(10 + 5)
——
234
——
382
——
Equity
Share capital
15.0
Group retained earnings (W5)
169.8
NCI (W4)
5.2
——
190.0
Non-current liabilities
(120 + 28)
148.0
Current liabilities
(50 + 16 22 intra-co payable)
44.0
———
382.0
———
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Working paper
(W1)
Group structure
H
90%
01/01/X2
2 years ago
S
(W2)
Net assets
At Acquisition Date At Reporting Date
Share capital
5
5
Retained earnings
5
31
Provision for unrealized profit (W6)
(W3)
(4)
—
—
10
32
—
—
Goodwill
Parent holding (investment) at fair value
34
NCI value at acquisition
4
––––
38
Less:
Fair value of net assets at acquisition (W2)
(10)
––––
Goodwill on acquisition
28
Impairment
(10)
––––
Carrying goodwill
18
––––
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(W4)
Non-controlling interest
NCI value at acquisition (as in W3)
4
NCI share of post acquisition reserves (W2)
2.2
(10% × (32 - 10))
Less:
NCI share of impairment
(1)
(10% × Rs 10)
–––––
5.2
–––––
(W5)
Group reserves
100% Health
159
90% safety PostAcq
(90% × (Rs 32 - Rs 10 (W2))
19.8
Impairment (W3)
(9)
(90% × Rs 10)
——
169.8
——
(W6)
Provision for unrealized profit
Sales
Rs 18
COS
Gross profit
Advanced Financial Accounting and Corporate Reporting (Study Text)
150%
100%
–––––
–––––
Rs 6
50%
–––––
–––––
Page 223
×2/3
Provision for unrealized profit = Rs 4
7.
Consolidated Statement of Financial Position as at 30 November 2007
Rs
Non-current assets
Goodwill (W3)
21,250
PPE
(138,000 + 115,000 – 4,500)
248,500
Investments
(98,000 – 76,000 – 20,000)
2,000
Current Assets
Inventory
(15,000 + 17,000 – 1,600)
30,400
Receivables
(19,000 + 20,000 2,500 - 1,500)
35,000
Cash
(2,000 + 2,500)
4,500
–––––––
341,650
–––––––
Share capital
50,000
Group retained earnings (W5)
187,250
Non-controlling
Interest (W4)
49,900
–––––––
287,150
Non-current liabilities
(20,000 – 20,000)
Current liabilities
54,500
(33,000 + 23,000 – 1,500)
–––––––
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341,650
–––––––
Workings
(W1)
Group structure
K
60%
S
1 May 2007 i.e. 7 months
(W2)
Net assets
@ acq
@ rep
Date
Share capital
40,000
40,000
Retained earnings
63,750
69,000
Provision for unrealized profits (W7)
(4,500)
–––––––
–––––––
103,750
104,500
–––––––
–––––––
RE @ acq'n (balance) (ß)
63,750
Post acq profit (7/12 × 9,000)
5,250
–––––––
RE @ reporting date
69,000
–––––––
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(W3)
Goodwill
Parent holding (investment) at fair value
76,000
NCI value at acquisition
50,000
126,000
Less:
Fair value of net assets at acquisition (W2)
(103,750)
––––––
Goodwill on acquisition
22,250
Impairment
(1,000)
––––––
Carrying goodwill
21,250
––––––
(W4)
Non-controlling interest
NCI value at acquisition (as in W3)
NCI share of post acquisition reserves (W2)
50,000
300
(40% × (104,500 - 103,750))
Less:
NCI share of impairment
(400)
(40% × Rs 1,000)
–––––
49,900
–––––
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(W5)
Group retained earnings
100% K Ltd
189,000
Provision for unrealized profits
(1,600)
60% S Ltd post-acq profit
(60% × (104,500 – 103,750 (W2)))
450
Impairment group share
(60% × 1,000 (W3))
(600)
–––––––
187,250
–––––––
(W6)
Provision for unrealized profit – Inventory
Profit in inventory (25/125 × 8,000) 1,600
(W7)
Provision for unrealized profit – Plant
NBV in books (15,000 – (15,000 × 1/5 × 6/12))
13,500
NBV should be (10,000 – (10,000 × 1/5 × 6/12))
(9,000)
–––––
Provision for unrealized profit
4,500
–––––
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Advanced Financial Accounting and Corporate Reporting (Study Text)
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CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
Chapter learning objectives
Upon completion of this chapter you will be able to:
•
Prepare a consolidated statement of comprehensive income for a simple group and a noncontrolling interest.
•
Account for the effects of intra-group trading in the statement of comprehensive income
•
Prepare a consolidated statement of comprehensive income for a simple group with an
acquisition in the period and non-controlling interest
•
Account for impairment of goodwill
•
Prepare a consolidated statement of comprehensive income
Advanced Financial Accounting and Corporate Reporting (Study Text)
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1
Principles of the Consolidated Statement of Comprehensive Income
1.1
Basic principle
The consolidated statement of comprehensive income shows the profit generated by all
resources disclosed in the related consolidated statement of financial position, i.e. the net
assets of the parent company (P) and its subsidiary (S).
The consolidated statement of comprehensive income follows these basic principles:
1.2
•
From revenue to profit for the year include all of P’s income and expenses plus all
of S’s income and expenses (reflecting control of S).
•
After profit for the year show split of profit between amounts attributable to the
parent's shareholders and the non-controlling interest (to reflect ownership).
The mechanics of consolidation
As with the statement of financial position, it is common to use standard workings when
producing a consolidated statement of comprehensive income:
1.3
•
group structure diagram
•
net assets of subsidiary at acquisition (required for goodwill calculation if asked to
calculate)
•
goodwill calculation (if asked to calculate goodwill or if you are required to calculate
an impairment that is to be charged to profits (see below))
•
non-controlling interest (NCI) share of profit (see below)
Non-controlling interest
This is calculated as:
NCI % × subsidiary’s profit after tax
X
Less:
NCI % × fair value depreciation
(X)
NCI % × Provision for unrealized profit (sub = seller only)
(X)
NCI % × impairment (fair value method)
(X)
–––––
X
–––––
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2
Intra-Company Trading
2.1
Sales and purchases
The effect of intra-group trading must be eliminated from the consolidated statement of
comprehensive income.
Such trading will be included in the sales revenue of one group company and the
purchases of another.
2.2
•
Consolidated sales revenue = P’s revenue + S’s revenue – intra-group sales.
•
Consolidated cost of sales = P’s COS + S’s COS – intra-group sales.
Interest
If there is a loan outstanding between group companies the effect of any loan interest
received and paid must be eliminated from the consolidated statement of comprehensive
income.
The relevant amount of interest should be deducted from group investment income and
group finance costs.
2.3
Dividend
A payment of a dividend by S to P will need to be cancelled. The effect of this on the
consolidated financial statements is:
• only dividends paid by P to its own shareholders appear in the consolidated financial
statements. These are shown within the consolidated statement of changes in equity
• any dividend income shown in the consolidated statement of comprehensive income
must arise from investments other than those in subsidiaries or associates
Advanced Financial Accounting and Corporate Reporting (Study Text)
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Example 1
The statement of comprehensive incomes for P Ltd and S Ltd for the year ended 31
August 20X4 are shown below. P Ltd acquired 75% of the ordinary share capital of S Ltd
several years ago.
P Ltd
S Ltd
Rs. ‘000’
Rs. ‘000’
Revenue
2,400
800
Cost of sales and expenses
(2,160)
(720)
––––––
–––––
240
80
Trading profit
Investment income:
Dividend received from S Ltd
1.5
––––––
–––––
Profit before tax
241.5
80
Tax
(115)
(38)
––––––
––––––
126.5
42
Profit for the year
Required
Prepare the consolidated statement of comprehensive income for the year.
Advanced Financial Accounting and Corporate Reporting (Study Text)
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Solution
P Ltd consolidated statement of comprehensive income for year ended 31 August
20X4
Rs. ‘000’
Revenue
(2,400 + 800
3,200
Cost of sales and expenses
(2,160 + 720)
(2,880)
––––––
Profit before tax
320
Tax
(115 + 38)
(153)
––––––
Profit for the year
167
Attributable to:
Group (167 – NCI)
156.5
Non-controlling interest ( W1)
10.5
(W1) Non-controlling interest
NCI share of subsidiary profit for the year
25% × Rs 42 = Rs 10.5
Advanced Financial Accounting and Corporate Reporting (Study Text)
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2.4
Provision for unrealised profit (PURP)
Inventory
If any goods sold intra-group are included in closing inventory, their value must be
adjusted to the lower of cost and net realisable value (NRV) to the group (as in the
CSOFP).
The adjustment for unrealised profit should be shown as an increase to cost of sales
(return inventory back to true cost to group and eliminate unrealized profit).
In the previous chapter, the treatment of unrealised trading profits in the consolidated
SOFP was dealt with. In producing the consolidated statement of comprehensive income,
a rather more involved adjustment is required.
If, in a certain year:
•
A buys an inventory item for Rs 60
•
A sells it to B for Rs 80, B being a member of the same group as A
•
B still holds the item at the reporting date, then the statement of comprehensive
incomes of the two companies will include, in respect of these events:
A
B
Rs
Rs
Sales revenue
80
–
Cost of sales
(60)
–
___
Profit
20
–
___
Note that B's cost of sales is nil since the goods are still held at the year end, hence they
do not qualify as 'cost of sales'. The Rs 20 is the unrealised profit whose cancellation in
the SOFP was discussed in the previous chapter. In the statement of comprehensive
income, we must
(1)
eliminate sales of Rs 80 in A's books and purchases of Rs 80 in B's books
(2)
cancel the unrealised profit of Rs 20 in A (the seller's) books.
Advanced Financial Accounting and Corporate Reporting (Study Text)
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If B had sold the item for Rs 95 by the reporting date, the statement of comprehensive
incomes of the two companies would have shown:
A
B
Rs
Rs
Sales revenue
80
95
Cost of sales
(60)
(80)
__
__
20
15
__
__
Gross profit (and other subtotals)
Both companies would have realised their profits and so these should not be adjusted. However, a
single equivalent company would show in its statement of comprehensive income:
Rs
Sales revenue
95
Cost of sales
(60)
__
Gross profit (and other subtotals)
35
__
In this case, we need to eliminate only the Rs 80 from sales revenue and the Rs 80 from
cost of sales in order to establish the correct revenue and cost of sales figures. No
adjustment would be required for unrealised profit since all profits are now realised.
Effect on non-controlling interests
If the unrealised profit originally arose in the subsidiary, the non-controlling interest must
be adjusted for its share in the unrealised profit. To achieve this, in the first instance all the
unrealised profit must be eliminated to determine the correct amount of gross profit earned
by the group trading as if it were a single entity. Then the NCI’s share is calculated by
reference to the reduced amount of the subsidiary's post-tax profits. Provision for
unrealized profit is added in to cost of sales and remove NCI share in the NCI working.
Example 2
On 1 January 20X9 Zee Ltd acquired 60% of the ordinary shares of Bee Ltd.
Advanced Financial Accounting and Corporate Reporting (Study Text)
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The following statement of comprehensive incomes have been produced by Zee Ltd and
Bee Ltd for the year ended 31 December 20X9.
Zee Ltd Bee Ltd
Rs. ‘000’
Rs. ‘000’
Revenue
1,260
520
Cost of sales
(420)
(210)
–––––
–––––
Gross profit
840
310
Distribution costs
(180)
(60)
Administration expenses
(120)
(90)
Profit from operations
540
160
Investment income from Bee Ltd
36
––––– –––––
–––––
–––––
Profit before taxation
576
160
Taxation
(130)
(26)
Profit for the year
446
134
–––––
–––––
During the year ended 31 December 20X9 Zee Ltd had sold Rs 84,000 worth of goods to
Bee Ltd. These goods had cost Zee Ltd Rs 56,000. On 31 December 20X9 Bee Ltd still
had Rs 36,000 worth of these goods in inventories (held at cost to Bee Ltd).
Prepare the consolidated statement of comprehensive income to incorporate Zee Ltd and
Bee Ltd for the year ended 31 December 20X9.
Note: Goodwill on consolidation has not been impaired.
Solution
Zee Ltd consolidated statement of comprehensive income for the year ended 31
December 20X9
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 236
Rs 000
Revenue
1,696
(1,260 + 520 - 84)
Cost of sales
(558)
(420 + 210 - 84 + 12)
–––––
Gross profit
1,138
Distribution costs
(180 + 60)
Administrative expenses
(240)
(210)
(120 + 90)
–––––
Profit from operations
688
Taxation
(156)
(130 + 26)
–––––
Profit for the year
532
Amount attributable to
Equity holders of the parent (532 – NCI)
478.4
Non-controlling interests (W3)
53.6
Workings
Advanced Financial Accounting and Corporate Reporting (Study Text)
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(W1)
Group structure
Zee Ltd
1 Jan x 9
60%
Bee Ltd
(W2)
Unrealised profit in inventory
Rs. ‘000’
Selling price
84
Cost
(56)
–––
Total profit
28
–––
The profit markup is therefore one third of the selling price
=
Since closing inventory at selling price is Rs 36,000 the unrealised profit is
x Rs 36,000 = Rs 12,000
(W-3) Non-controlling interest
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 238
Rs. ‘000’
NCI share of subsidiary’s profit after tax 40% x Rs 134,000
53.6
Transfers of non-current assets
If one group company sells a non-current asset to another group company the following
adjustments are needed in the statement of comprehensive income to account for the
unrealised profit and the additional depreciation.
•
Any profit or loss arising on the transfer must be removed from the consolidated
statement of comprehensive income.
•
The depreciation charge must be adjusted so that it is based on the cost of the
asset to the group.
Non-current assets may be sold between group companies. If the selling price of such an
asset is the same as the carrying value in the books of the seller at the time of the sale,
then no adjustments are necessary as the buyer will account for (and depreciate) the
asset by reference to its original cost to the group.
If, however the seller makes a profit on the sale, the buyer will account for the asset at a
value higher than the depreciated cost to the group. The profit made by the seller is
gradually realised over the asset’s remaining life by the buyer’s depreciation charges
being calculated on a value higher than original cost to the group. So at the time when the
buyer has fully depreciated the acquired asset, the whole of the seller’s profit has been
realised and no adjustments are necessary.
However, as long as the buyer is still depreciating the acquired asset, the amount of the
seller’s unrealised profit must be eliminated from both earnings and the carrying value of
the asset. Adjustments are needed in order to return to the situation if the sale had not
taken place:
3
•
any remaining unrealised profit or loss arising on the transfer is eliminated
•
the asset’s cost and accumulated depreciation are adjusted so that they are based
on the cost of the asset to the group.
Other Consolidated Income Statement Adjustments
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 239
3.1
Impairment of goodwill
Once any impairment has been identified during the year, the charge for the year will be
passed through the consolidated statement of comprehensive income. This will usually be
through operating expenses, however always follow instructions from the examiner.
If non-controlling interests have been valued at fair value, a portion of the impairment
expense must be removed from the non-controlling interest's share of profit.
3.2
Fair values
If a depreciating Non-current asset of the subsidiary has been revalued as part of a fair
value exercise when calculating goodwill, this will result in an adjustment to the
consolidated statement of comprehensive income.
The subsidiary's own statement of comprehensive income will include depreciation based
on the value the asset is held at in the subsidiary's own SOFP.
The consolidated statement of comprehensive income must include a depreciation charge
based on the fair value of the asset, included in the consolidated SOFP.
Extra depreciation must therefore be calculated and charged to an appropriate cost
category (usually in line with examiner requirements).
4
Midyear acquisitions
4.1
Midyear acquisition procedure
If a subsidiary is acquired part way through the year, then the subsidiary’s results should
only be consolidated from the date of acquisition, i.e. the date on which control is obtained.
In practice this will require:
•
Identification of the net assets of S at the date of acquisition in order to calculate
goodwill.
•
Time apportionment of the results of S in the year of acquisition. For this purpose,
unless indicated otherwise, assume that revenue and expenses accrue evenly.
•
After time-apportioning S’s results, deduction of post acquisition intra-group items
as normal.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 240
Example 3
The following statement of comprehensive incomes were prepared for the year ended 31
March 20X9.
E Ltd
F Ltd
Rs. ‘000’
Rs. ‘000’
Revenue
303,600
217,700
Cost of sales
(143,800)
(102,200)
_______
_______
Gross profit
159,800
115,500
Operating expenses
(71,200)
(51,300)
_______
_______
Profit from operations
88,600
64,200
Investment income
2,800
1,200
_______
_______
Profit before tax
91,400
65,400
Taxation
(46,200)
(32,600)
_______
_______
45,200
32,800
Profit for the year
On 30 November 20X8 E Ltd acquired 75% of the issued ordinary capital of F Ltd. No
dividends were paid by either company during the year. The investment income is from
quoted investments and has been correctly accounted for.
The profits of both companies are deemed to accrue evenly over the year.
5
The Consolidated Statement of Comprehensive Income
5.1
The consolidated statement of comprehensive income may be asked for in the exam
instead of a consolidated income statement. The consolidated statement of
comprehensive income is the starting point and the other comprehensive income items are
then recorded.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 241
The items that you may need to consider for items of other comprehensive income include
revaluations gains or losses and fair value through other comprehensive income gains or
losses. To demonstrate how these items should be dealt with we will take Self Test
Question No 3 and add items of comprehensive income to illustrate this.
Illustration
The answer to Self Test Question No 3 shows the consolidated statement of
comprehensive income of the Steel Ltd group.
In addition Steel Ltd recorded a revaluation gain on its land of Rs 500 at the year end and
a loss on fair value through other comprehensive income financial assets for the year of
Rs 100. All items are deemed to accrue evenly over time except where otherwise indicated.
Consolidated Statement of comprehensive income for the Steel Ltd group for the
year ended 31 March 20X7:
Rs
Revenue
34,600
Cost of Sales
(18,150)
––––––
Gross profit
16,450
Operating expenses
(10,980)
––––––
Profit from operations
5,470
Investment Income
1,650
––––––
Profit before tax
7,120
Tax
(2,475)
––––––
Profit for the year
4,645
––––––
Other comprehensive income
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 242
Gain on revaluation of land
500
Loss on financial assets (100 × 9/12)
(75)
––––––
425
––––––
Total comprehensive income
5,070
––––––
Profit attributable to:
NCI
58.5
Group
4,586.5
––––––
4,645
––––––
Total comprehensive income attributable to:
NCI (58.5 + (500 ( 100 x 9/12) x 30%))
Group (4586.5 + (500 ( 100 x 9/12) x 70%))
186
4,884
––––––
5,070
––––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 243
Chapter Summary
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 244
Self Test Questions
1) Set out below are the draft statement of comprehensive incomes of S Ltd and its
subsidiary company F Ltd for the year ended 31 December 20X7.
On 1 January 20X6 S Ltd purchased 75,000 ordinary shares in F Ltd from an issued share
capital of 100,000 Rs 1 ordinary shares.
Statement of comprehensive incomes for the year ended 31 December 20X7:
S Ltd
F Ltd
Rs. ‘000’
Rs. ‘000’
Revenue
600
300
Cost of sales
(360)
(140)
––––
––––
Gross profit
240
160
Operating expenses
(93)
(45)
––––
––––
Profit from operations
147
115
Finance costs
(3)
––––
––––
Profit before tax
147
112
Tax
(50)
(32)
––––
––––
97
80
Profit for the year
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 245
The following additional information is relevant:
1) During the year F Ltd sold goods to S Ltd for Rs 20,000, making a markup of one
third. Only 20% of these goods were sold before the end of the year, the rest were
still in inventory.
(2)
Goodwill has been subject to an impairment review at the end of each year since
acquisition and the review at the end of this year revealed another impairment of
Rs 5,000. The current impairment is to be recognised as an operating cost.
(3)
At the date of acquisition a fair value adjustment was made and this has resulted in
an additional depreciation charge for the current year of Rs 15,000. It is group
policy that all depreciation is charged to cost of sales.
(4)
S Ltd values the non-controlling interests using the fair value method.
Prepare the consolidated statement of comprehensive income for the year ended 31
December 20X7.
2.
Given below are the statement of comprehensive incomes for P Ltd and its subsidiary L
Ltd for the year ended 31 December 20X5.
P Ltd
L Ltd
Rs. ‘000’
Rs. ‘000’
Revenue
3,200
2,560
Cost of sales
(2,200)
(1,480)
–––––
–––––
Gross profit
1,000
1,080
Distribution costs
(160)
(120)
Administrative expenses
(400)
(80)
–––––
–––––
Profit from operations
440
880
Investment income
160
–
–––––
–––––
Profit before tax
600
880
Taxation
(400)
(480)
–––––
–––––
200
400
Profit for the year
Additional information
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 246
•
P Ltd paid Rs 1.5 million on 31 December 20X1 for 80% of L Ltd’s 800,000
ordinary shares.
•
Goodwill impairments at 1 January 20X5 amounted to Rs 152,000. A further
impairment of Rs 40,000 was found to be necessary at the year end. Impairments
are included within administrative expenses.
•
P Ltd made sales to L Ltd, at a selling price of Rs 600,000 during the year. Not all
of the goods had been sold externally by the year end. The profit element included
in L Ltd’s closing inventory was Rs 30,000.
•
Fair value depreciation for the current year amounted to Rs 10,000. All
depreciation should be charged to cost of sales.
•
L Ltd paid an interim dividend during the year of Rs 200,000.
•
P Ltd values the non-controlling interests using the fair value method.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 247
Required
Prepare Consolidated Income statement for the year ended 31 Dec 2005
3.
Steel Ltd bought 70% of Salt on 1 July 20X6. The following are the Statement of
comprehensive incomes of Steel Ltd and Salt for the year ended 31 March 20X7:
Steel Ltd
Salt
Rs
Rs
Revenue
31,200
10,400
Cost of sales
(17,800)
(5,600)
––––––
––––––
Gross profit
13,400
4,800
Operating expenses
(8,500)
(3,200)
––––––
––––––
Profit from operations
4,900
1,600
Investment Income
2,000
-
––––––
––––––
Profit before tax
6,900
1,600
Tax
(2,100)
(500)
––––––
––––––
4,800
1,100
––––––
––––––
Profit for the year
The following information is available:
1) On 1 July 20X6, an item of plant in the books of Salt had a fair value of Rs 5,000 in
excess of its carrying value. At this time, the plant had a remaining life of 10 years.
Depreciation is charged to cost of sales.
(2)
During the post-acquisition period Salt sold goods to Steel Ltd for Rs 4,400. Of this
amount, Rs 500 was included in the inventory of Steel Ltd at the yearend. Salt
earns a 35% margin on its sales.
(3)
Goodwill amounting to Rs 800 arose on the acquisition of Salt, which had been
measured using the fair value method. Goodwill is to be impaired by 10% at the
yearend. Impairment losses should be charged to operating expenses.
(4)
Salt paid a dividend of Rs 500 on 1 January 20X7.
Required
Advanced Financial Accounting and Corporate Reporting (Study Text)
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Prepare the consolidated statement of comprehensive income for the year ended 31
March 20X7.
4.
Paper Ltd acquired 70% of Wood Ltd three years ago, when Wood Ltd’s retained earnings
were Rs 430,000.
The Financial Statements of each company for the year ended 31 March 2007 are as
follows:
Statements of Financial Position as at 31 March 2007:
Paper Ltd
Wood Ltd
Rs. ‘000’
Rs. ‘000’
Property, plant and equipment
900
400
Investment in S at cost
700
-
Current assets
300
600
–––––
–––––
1,900
1,000
–––––
–––––
Share capital (Rs 10)
200
150
Share premium
50
-
Retained earnings
1,350
700
–––––
–––––
1,600
850
Non-current liabilities
100
90
Current liabilities
200
60
–––––
–––––
1,900
1,000
–––––
–––––
Non-current assets
Statement of comprehensive incomes for the year ended 31 March 2007:
Advanced Financial Accounting and Corporate Reporting (Study Text)
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Paper Ltd
Wood Ltd
Rs 000
Rs 000
Revenue
1,000
260
Cost of Sale
(750)
(80)
–––––
–––––
Gross profit
250
180
Operating expenses
(60)
(35)
–––––
–––––
Profit from operations
190
145
Finance costs
(25)
(15)
Investment Income
20
-
–––––
–––––
Profit before tax
185
130
Tax
(100)
(30)
–––––
–––––
85
100
–––––
–––––
Profit for the year
You are provided with the following additional information:
1) Wood Ltd had plant in its Statement of Financial Position at the date of acquisition
with a carrying value of Rs 100,000 but a fair value of Rs 120,000. The plant had a
remaining life of 10 years at acquisition. Depreciation is charged to cost of sales.
2) The Paper Ltd group values the non-controlling interests at fair value. The fair
value of the non-controlling interests at the date of acquisition was Rs 250,000.
Goodwill is to be impaired by 30% at the reporting date, of which one third related
to the current year.
(3)
At the start of the year Paper Ltd transferred a machine to Wood Ltd for Rs 15,000.
The asset had a remaining useful economic life of 3 years at the date of transfer. It
had a carrying value of Rs 12,000 in the books of Paper Ltd at the date of transfer.
(4)
During the year Wood Ltd sold some goods to Paper Ltd for Rs 60,000 at a markup
of 20%. 40% of the goods remained unsold at the yearend. At the yearend, Wood
Advanced Financial Accounting and Corporate Reporting (Study Text)
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Ltd’s books showed a receivables balance of Rs 6,000 as being due from Paper
Ltd. This
disagreed with the payables balance of Rs 1,000 in Paper Ltd’s books due to
Paper Ltd having sent a cheque to Wood Ltd shortly before the yearend which
Wood Ltd had not yet received.
(5)
Wood Ltd paid a dividend of Rs 20,000 on 1 March 2007.
Required
Prepare the consolidated Statement of Financial Position and consolidated Statement of
comprehensive income for the year ended 31 March 2007.
Advanced Financial Accounting and Corporate Reporting (Study Text)
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Answers
1.
S Ltd consolidated statement of comprehensive income for the year ended 31
December 20X7:
Rs. ‘000’
Revenue
880
(600 + 300 - 20)
Cost of sales
(499)
(360 + 140 20 + 4 (W2) + 15 (fv dep'n))
–––––
Gross profit
381
Operating expenses
(143)
(93 + 45 + 5 (impairment))
–––––
Profit from operations
238
Finance costs
(3)
–––––
Profit before tax
235
Tax
(82)
(50 + 32)
–––––
Profit for the year
153
–––––
Attributable to:
Non-controlling interest (W3)
14
Group (153 – 14)
139
–––––
153
–––––
Workings
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(W1)
Group structure
S
75%
F
(W2)
Unrealised profit
Rs. ‘000’
(80% × Rs 20) × 33% /133%
(W3)
4
Non-controlling interest
NCI share of subsidiary's profit for the year
20
(25 % × Rs 80)
Rs.
‘000’
Less:
NCI share of Provision for Unrealized profit
(1)
(25% × Rs 4 (W2))
NCI share of impairment
(1.25)
(25% × Rs 5)
NCI share of fair value dep'n
(3.75)
(25% × Rs 15)
–––––
14.00
–––––
2.
P Ltd consolidated statement of comprehensive income for the year ended
31December 20X5:
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Rs. ‘000’
Revenue
5,160
(3,200 + 2,560 600)
Cost of sales
(3,120)
(2,200 + 1,480 600 + 30 + 10 (fv dep'n)
_____
Gross profit
2,040
Investment income (external only)
Distribution costs
–
(280)
(160 + 120)
Administrative expenses
(520)
(400 + 80 + 40)
_____
Profit before tax
1,240
Taxation
(880)
(400 + 480)
_____
Profit for the year
360
_____
Attributable to:
Equity holders of the parent
290
Non-controlling interests (W2)
70
_____
360
_____
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Workings
(W1)
Group structure
P Ltd
31 Dec x 1
80%
L Ltd
(W2)
Non-controlling interest
NCI share of profit after tax
80
(20% × Rs 400)
Less:
NCI share of impairment
(8)
(20% × Rs 40)
NCI share of fair value dep'n
(2)
(20% × Rs 10)
–––––
70
–––––
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3
Consolidated Statement of comprehensive income for the Steel Ltd group for
the year ended 31 March 20X7
Revenue (31,200 + (9/12 × 10,400) – 4,400 (W4))
34,600
Cost of Sales (17,800 + (9/12 × 5,600) + 375 (W3) – 4,400
(18,150)
(W4)+ 175 (W4))
Gross profit
16,450
Operating expenses (8,500 + (9/12 × 3,200) + 80 (W5))
(10,980)
––––––
Profit from operations
5,470
Investment Income (2,000 – 350 (W6))
1,650
––––––
Profit before tax
7,120
Tax (2,100 + (9/12 × 500)
(2,475)
––––––
Profit for the year
4,645
––––––
Profit attributable to:
NCI (W2)
Group
58.5
4,586.5
––––––
4,645
––––––
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(W-1) Group structure
Steel
70%
Salt
1 July 20x6 i.e. 9 months
(W2)
Non-controlling Interests
Rs
NCI share of sub's profit for the year
(30% × (9/12 × Rs 1,100)
247.5
Less:
NCI share of fair value depreciation
(112.5)
(30% × Rs 375 (W3))
NCI share of Provision for Unrealized profit
(52.5)
(30% × Rs 175 (W4))
NCI share of impairment
(24)
(30% × Rs 80 (W5))
––––
58.5
––––
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(W3)
Fair value depreciation
FV Adj
Dep'n Adj
(W4)
=
Rs 5,000
Rs 5,000 × 1/10 × 9/12 = Rs 375
Intercompany sales / Provision for Unrealized profit
Inter-co-sales of Rs 4,400 need eliminating from revenue and cost of sales
Provision for Unrealized profit in inventory 35% × Rs 500 = Rs 175
The Provision for Unrealized profit will increase cost of sales and since the sub
sold the goods will reduce the NCI's share of profits.
(W5)
Impairment
Impairment Rs 800 × 10% = Rs 80
(W6)
Dividend
The sub paid a dividend of Rs 500 and so the parent will have recorded investment
income of 70% × 500 = 350. As an intra-group transaction this needs eliminating.
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4
Consolidated Statement of Financial Position as at 31 March 2007
Rs 000
Noncurrent assets
245
Goodwill (W3)
Property, plant and equipment
1,312
(900 + 400 + 20 – 6 – 2)
Current assets (300 + 600 – 4 – 6+ 5)
895
–––––
2,452
–––––
Share capital
200
Share premium
50
Retained earnings (W5)
1,456.5
––––––
1,706.5
Non-controlling Interests (W4)
296.5
–––––
2,003
Noncurrent liabilities (100 + 90)
190
Current liabilities (200 + 60 – 1)
259
–––––
2,452
–––––
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Consolidated Statement of comprehensive income for the year ended 31 March
2007:
Rs. ‘000’
Revenue (1,000 + 260 – 60)
1,200
Cost of Sales (750 + 80 – 60 + 2(Dep'n) + 4+ 2
(778)
––––
Gross profit
422
Operating expenses (60 + 35 + 35 (IMP))
(130)
––––
Profit from operations
292
Finance costs (25 + 15)
(40)
Investment Income (20 – (70% × 20))
6
––––
Profit before tax
258
Tax (100+30)
(130)
––––
Profit after tax
128
––––
Attributable to
Non-controlling interests (W4)
17.7
Parent shareholders
110.3
––––
128
––––
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Workings
P
70%
3 yrs
W
(W2)
Net Assets of sub
Acq'n
Reporting date
Rs
Rs
Share capital
150
150
RE
430
700
FV – machine (120 – 100)
20
20
Dep'n (20 × 3/10)
(6)
Provision for Unrealized profit (W7)
(4)
Advanced Financial Accounting and Corporate Reporting (Study Text)
–––
–––
600
860
–––
–––
Page 261
(W3)
Goodwill
Parent holding (investment) at fair value
700
NCI value at acquisition
250
–––––
950
Less: Fair value of net assets at acquisition (W2)
(600)
–––––
350
Impairment
(105)
–––––
245
–––––
Of the total impairment of Rs 105, a third i.e. Rs 35 is to be charged to this years
consolidated statement of comprehensive income.
(W4)
NCI's – CSOFP
NCI value at acquisition (as in W3)
250
NCI share of post-acquisition reserves (W2)
78
(30% × (860 – 600))
NCI share of impairment
(31.5)
(30% × 105)
–––––
296.5
–––––
NCI’s – CIS
Profit after tax
100
Dep'n (20 × 1/10)
(2)
Provision for Unrealized profit (W7)
(4)
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–––––
94
NCI share × 30%
28.2
Impairment (30% × 35)
(10.5)
–––––
17.7
–––––
(W5)
Group retained earnings
Parent retained earnings
1,350
Provision for Unrealized profit (W6)
(2)
Sub post acq profit
182
(70% × (860 – 600))
Impairment
(73.5)
(70% × 105)
––––––
1,456.5
––––––
(W6)
Provision for Unrealized profit – Fixed asset
CV in books (15 – (15 × 1/3yrs))
10
CV should be (12 × (12 × 1/3 yrs))
(8)
–––
Provision for Unrealized profit
(W7)
2
Provision for Unrealized profit – Inventory
Profit on sale (20/120 × 60)
10
Profit in Inventory (40% × 10)
4
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Advanced Financial Accounting and Corporate Reporting (Study Text)
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INVESTMENT IN ASSOCIATES AND JOINT VENTURES
Chapter learning objectives
Upon completion of this chapter you, will be able to:
•
define an associate according to IAS 28
•
explain the principles and reasoning for the use of equity accounting
•
define forms of joint venture
•
explain accounting treatment of jointly controlled entities
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1
IAS 28 Investments in Associates and Joint Ventures
1.1
Definitions
IAS 28 defines an associate as:
An entity over which the investor has significant influence and that is neither a
subsidiary nor an interest in joint venture.
Significant influence is the power to participate in the financial and operating policy
decisions of the investee but is not control or joint control over those policies.
Significant influence is assumed with a shareholding of 20% to 50%.
1.2
Principles of equity accounting and Reasoning Behind It
Equity accounting is a method of accounting whereby the investment is initially
recorded at cost and adjusted thereafter for the post-acquisition change in the
investor’s share of net assets of the associate.
The effect of this is that the consolidated statement of financial position includes:
•
100% of the assets and liabilities of the parent and subsidiary company on a
line by line basis
•
an ‘investments in associates’ line within noncurrent assets which includes
the group share of the assets and liabilities of any associate.
The consolidated statement of comprehensive income includes:
•
100% of the income and expenses of the parent and subsidiary company on
a line by line basis
•
one line ‘share of profit of associates’ which includes the group share of any
associate’s profit after tax.
Note: in order to equity account, the parent company must already be producing
consolidated financial statements (i.e. it must already have at least one subsidiary).
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1.3
Equity Method Exemption
Accounting for associates according to IAS 28
The equity method of accounting is normally used to account for associates in the
consolidated financial statements.
The equity method should not be used if:

the investment is classified as held for sale in accordance with IFRS 5 or

the parent is exempted from having to prepare consolidated accounts on the
grounds that it is itself a wholly, or partially, owned subsidiary of another
company (IFRS 10).
2
Associates in the consolidated Statement of Financial Position
2.1
Preparing the CSFP including an associate
The CSFP is prepared on a normal line-by-line basis following the acquisition method
for the parent and subsidiary.
The associate is included as a non-current asset investment calculated as:
Rs 000
Cost of investment
X
Add : Share of post acquisition profits
X
Less: impairment losses
(X)
___
X
___
The group share of the associate’s post acquisition profits or losses and the
impairment of goodwill will also be included in the group retained earnings calculation.
Standard workings
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The calculations for an associate (A) can be incorporated into standard CSFP
workings as follows.
(W1)
Group structure
P
30%
This indicates that
A
80%
P owns 80% of the ordinary shares of S
and P also owns 30% of the shares in A
S
(W2)
Net assets of subsidiary
At date of acquisition
At reporting date
Rs
Rs
Share capital
X
X
Retained earnings
X
X
___
___
X
X
___
___
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(W3)
Goodwill – subsidiary
Parent holding (investment) at fair value
X
NCI value at acquisition
X
—
X
Less:
Fair value of net assets at acquisition (W2)
(X)
—
Goodwill at acquisition
X
Impairment
(X)
—
Carrying goodwill
X
—
(W4)
Non controlling interest (NCI)
NCI value at acquisition (as in W3)
X
NCI share of subsidiary post-acquisiton reserves (W2)
X
NCI share of impairment (W3) (fair value method only)
(X)
—
X
—
(W5)
Group retained earnings
Rs
Parent retained earnings (100%)
X
Group % of sub's post-acquisition retained earnings
X
Group % of assoc post-acquisition retained earnings
X
Less: Impairment losses to date (S + A) (W3)
X
—
X
—
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(W6)
Investment in associate company
Rs
Cost of investment
X
Post-acquisition profits (W5)
X
Less: impairment
X
—
X
—
Example 1
Associates in CSFP
Below are the statements of financial position of three companies as at 31 December 20X9.
Dee
Lee
Po
Rs 000
Rs 000
Rs 000
1,120
980
840
672,000 shares in Lee
644
-
-
168,000 shares in Po
224
-
-
–––
–––––
1,988
980
840
Inventory
380
640
190
Receivables
190
310
100
Bank
35
58
46
–––––––
–––––––
–––––––
605
1,008
336
–––––––
–––––––
–––––––
2,593
1,988
1,176
–––––––
–––––––
–––––––
Noncurrent assets
Property, plant & equipment
Investments
–––
Current assets
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Equity
Rs 10 ordinary shares
1,120
840
560
Retained earnings
1,232
602
448
–––––––
–––––––
–––––––
2,352
1,442
1,008
Trade payables
150
480
136
Taxation
91
66
32
–––––––
–––––––
–––––––
241
546
168
–––––––
–––––––
–––––––
2,593
1,988
1,176
–––––––
–––––––
–––––––
Current liabilities
You are also given the following information:
(1)
Dee acquired its shares in Lee on 1 January 20X9 when Lee had retained losses of
Rs 56,000.
(2)
Dee acquired its shares in Po on 1 January 20X9 when Po had retained earnings of
Rs 140,000.
(3)
An impairment test at the year end shows that goodwill for Lee remains unimpaired
but the investment in Po has impaired by Rs 2,800.
(4)
The Dee Group values the non controlling interest using the fair value method. The
fair value on 1 January 20x9 was Rs 60,000.
Prepare the consolidated statement of financial position for the year ended 31
December 20X9.
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Solution
Dee consolidated statement of financial position as at 31 December 20X9
Rs 000
Rs 000
Noncurrent assets
Goodwill (W3)
Property, plant & equipment
20.0
2,100.0
(1,120 + 980)
Investment in associate (W6)
313.6
–––––––
2,433.6
Current assets
Inventory (380 + 640)
1,020.0
Receivables (190 + 310)
500.0
Cash (35 + 58)
93.0
–––––––
1,613.0
–––––––
4,046.6
–––––––
Equity
Rs 10 ordinary shares
1,120.0
Retained earnings (W5)
1,848.0
–––––––
2,968.0
Non-controlling interest (W4)
291.6
–––––––
3,259.6
Current liabilities
Trade payables (150 + 480)
630.0
Taxation (91 + 66)
157.0
––––
787.0
–––––––
4,046.6
–––––––
Workings
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(W1)
Group structure
Dee
80%
30%
PO
(W2)
Net assets – Lee
At date of acquisition
At reporting date
Rs 000
Rs 000
Share capital
840.0
840.0
Retained earnings
(56.0)
602.0
–––––
–––––
784.0
1,442.0
–––––
–––––
Note that Lee has retained losses at the date of acquisition rather than the more
usual retained earnings or profits.
2.2
Fair values and the associate
If the fair value of the associate’s net assets at acquisition are materially different
from their book value the net assets should be adjusted in the same way as for a
subsidiary.
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2.3
Balances with the associate
Generally the associate is considered to be outside the group. Therefore balances
between group companies and the associate will remain in the consolidated
statement of financial position.
If a group company trades with the associate, the resulting payables and receivables
will remain in the consolidated statement of financial position.
2.4
Unrealised profit in inventory
Unrealised profits on trading between group and associate must be eliminated to the
extent of the investor's interest (i.e. % owned by parent).
Adjustment must be made for unrealised profit in inventory as follows.
(1)
Determine the value of closing inventory which is the result of a sale to or
from the associate.
(2)
Use markup/ margin to calculate the profit earned by the selling company.
(3)
Make the required adjustments. These will depend upon who the seller is:
Parent company selling to associate — the profit element is included in the parent
company’s accounts and associate holds the inventory.
Dr Group retained earnings (W5)
Cr Investment in associate (W6)
Associate selling to parent company— the profit element is included in the
associate company’s accounts and the parent holds the inventory.
Dr Group retained earnings (W5)
Cr Group inventory
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3
Associates in the Consolidated Statement of Comprehensive
3.1
Equity accounting
Income
The equity method of accounting requires that the consolidated statement of
comprehensive income:
•
does not include dividends from the associate
•
instead includes group share of the associate’s profit after tax less any
impairment of the associate in the year (included below group profit from
operations).
Trading with the associate
Generally the associate is considered to be outside the group. Therefore any sales or
purchases between group companies and the associate are not normally eliminated
and will remain part of the consolidated figures in the statement of comprehensive
income.
It is normal practice to instead adjust for the unrealised profit in inventory.
Dividends from associates
Dividends from associates are excluded from the consolidated statement of
comprehensive income; the group share of the associate’s profit is included instead.
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Example 2
Below are the statement of comprehensive incomes for P, S and A for the year
ended 30 September 20X8
Statement of comprehensive incomes for the year ended 30 September 20X8
P
S
A
Rs 000
Rs 000
Rs 000
Revenue
8,000
4,500
3,000
Operating expenses
(4,750)
(2,700)
(2,050)
–––––
–––––
–––––
Profit from operations
3,250
1,800
950
Finance costs
(750)
(100)
(50)
–––––
–––––
–––––
Profit before tax
2,500
1,700
900
Tax
(700)
(500)
(300)
–––––
–––––
–––––
1,800
1,200
600
–––––
–––––
–––––
Profit for the year
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Further information:
o
P acquired 80% of S several years ago.

P acquired 30% of the equity share capital of A on 1 October 20X6.

During the year, P sold goods to A for Rs 1 million at a markup of 25%. At the
yearend, A still held one quarter of these goods in inventory.

At 30 September 20X8, it was determined that the investment in the associate was
impaired by Rs 35,000, of which Rs 20,000 related to the current year.
Required:
Prepare the consolidated statement of comprehensive income for the P group for the
year ended 30 September 20X8.
Solution:
Consolidated statement of comprehensive income for the year ended 30 September
20X8
Rs 000
Revenue
(8,000 + 4,500)
12,500
Operating expenses
(4,750 + 2,700 + 15 (W2))
(7,465)
–––––
Profit from operations
5,035
Share of associate:
((30% × 600) – 20 impairment)
160
Finance costs
(750 + 100)
(850)
–––––
4,345
Taxation
(700 + 500)
(1,200)
–––––
Profit for the year
3,145
–––––
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(W2)
Provision for Unrealized Profits
Intercompany balances between the parent and associate are not eliminated as the
associate is outside the group. Therefore, no adjustment in respect of the sale for Rs
1 million needs to be made.
Provision for unrealized profit = P's % × Profit in inventory
Profit on sale:
(25 / 125 × Rs 1,000 )
Rs 200
Profit in inventory
(1/4 × Rs 200)
Rs 50
Provision for unrealized profit
(30% × Rs 50)
Rs 15
In the CIS, Provision for unrealized profit will increase cost of sales since the parent
is selling company.
4
IFRS 11 – Joint Arrangements
4.1
IFRS 11 Joint Arrangements was issued in 2011 to replace IAS 31. IFRS 11 provides
new or updated definitions to determine whether there is a joint arrangement and, if
so, the nature of that arrangement together with associated accounting requirements.
It adopts the definition of control as included in IFRS 10 as a basis for determining
whether there is joint control
4.2
Definitions
Joint arrangements are defined as arrangements where two or more parties have
joint control, and that this will only apply if the relevant activities require unanimous
consent of those who collectively control the arrangement. They may take the form of
either joint operations or joint ventures. The key distinction between the two forms is
based upon the parties’ rights and obligations under the joint arrangement
Joint operations are defined as joint arrangements whereby the parties that have
joint control have rights to the assets and obligations for the liabilities. Normally, there
will not be a separate entity established to conduct joint operations. IFRS 11 requires
that joint operators each recognise their share of assets, liabilities, revenues and
expenses of the joint operation over which they have rights and obligations. This may
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consist of maintaining a joint operation account to record transactions undertaken on
behalf of the joint operation, together with balances due to or from other parties to the
joint operation.
Example of a joint operation
A and B decide to enter into a joint operation to produce a new product. A undertakes
one manufacturing process and B undertakes the other. A and B have agreed that
decisions regarding the joint operation will be made unanimously and that each will
bear their own expenses and take an agreed share of the sales revenue from the
product.
Joint ventures are defined as joint arrangements whereby the parties have joint
control of the arrangement and have rights to the net assets of the arrangement. This
will normally be established in the form of a separate entity to conduct the joint
venture activities. The equity method of accounting must be used in this situation.
The accounting policy choice of proportionate consolidation or equity accounting
previously allowed by IAS 31 is no longer available; all interests in joint ventures
must now be equity accounted.
IAS 28 deals with accounting for associates and joint ventures and is considered
elsewhere within this chapter.
Example of a joint venture
A and B decide to set up a separate entity, C, to enter into a joint venture. A will own
55% of the equity capital of C, with B owning the remaining 45%. A and B have
agreed that decision-making regarding the joint venture will be unanimous. Neither
party will have direct right to the assets, or direct obligation for the liabilities of the
joint venture; instead, they will have an interest in the net assets of entity C set up for
the joint venture.
Joint control is defined as contractually agreed sharing of control of an arrangement
which exists only when the decisions about the relevant activities require the
unanimous consent of the parties sharing control.
The key aspects of joint control are described as follows:
• Contractually agreed – contractual arrangements are usually, but not always,
written, and provide the terms of the arrangement.
• Control and relevant activities – IFRS 10 describes how to assess whether a party
has control, and how to identify the relevant activities.
• Unanimous consent – exists when the parties to an arrangement have collective
control over the arrangement and no single party has control.
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4.3
Accounting For Joint Arrangements
Joint operations
Arrangements defined as joint operations by IFRS 11 were previously classified as
either jointly controlled operations or jointly controlled assets by IAS 31. In principle,
there is no change for the accounting for such arrangements in accordance with
IFRS 11. The individual financial statements of each joint operator will recognise:
• the assets that it controls and the liabilities that it incurs, and
• the expenses that it incurs, and
• share of the revenue that it earns from the sale of goods or services by the joint
venture.
This may also include amounts due to and from the other joint operators.
As the income, expenses, assets and liabilities of the joint venture are included in the
individual financial statements they will automatically flow through to the consolidated
financial statements.
Joint ventures
Joint arrangements classified as joint ventures by IFRS 11 are accounted for in a
separate entity. The individual financial statements of each joint venture party will
recognise:
• the cost of the investment in the joint venture entity (e.g. the share capital
subscribed for), and
• any returns received in the form of dividends from the joint venture entity.
In the consolidated financial statements, the interest in the joint venture entity will be
equity accounted as required by IAS 28.
In situations where there are transactions between a joint venture party and the
separate joint venture entity, the joint venture party should recognise only that part of
any gain attributable to the interests of the other joint venture parties – it cannot
make a profit out of transactions with itself.
To the extent that a loss arises on transactions between a joint venture party and the
separate joint venture entity, the full amount of the loss should be recognised as this
is likely to reflect a fall in the net realisable value of a current asset and/or impairment
of a noncurrent asset (investment in the joint venture entity).
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Note that if an interest in a joint venture meets the definition of held for sale as
specified in IFRS 5, it should be accounted for accordingly
5
IFRS 12 Disclosure of Interests in Other Entities
IFRS 12 was issued in May 2011 and is now the single source of disclosure
requirements that were previously contained within IAS 27 (group accounts), IAS 28
(associates) and IAS 31 (joint ventures). This reporting standard has also extended
the disclosure requirements to include additional information which is regarded as
being helpful to users of financial statements, including:
• disclosure of significant assumptions and judgements made in determining whether
an investor has control, joint control or significant influence over an investee
• disclose the nature, extent and financial effects of its interests in joint arrangements
and associates
• additional disclosures relating to subsidiaries with Non-controlling interests, joint
arrangements and associates that are individually material,
• significant restrictions on the ability of the parent to access and use the assets or to
settle the liabilities of its subsidiaries, and
• extended disclosures relating to "structured entities", previously referred to as
special purpose
entities, to enable a full understanding of the nature of the arrangement and
associated risks, such as the terms on which an investor may be required to provide
financial support to such an entity.
IFRS 12 is effective for accounting periods commencing on or after 1 January 2013,
but early adoption of IFRS 12 is permitted, either as an individual standard, or in
conjunction with IFRS 10, IFRS 11, IFRS 12 and revised standards IAS 27 and IAS
28.
6
IAS 27 Separate Financial Statements
IAS 27 (revised) applies when an entity has interests in subsidiaries, joint ventures or
associates and either elects to, or is required to, prepare separate non-consolidated
financial statements.
Disclosures required when separate, nonconsolidated, Financial statements have
been prepared by the parent entity:
• the fact that exemption from consolidation has been used (usually as an
intermediate holding company), together with the name, place of business and
country of incorporation of the ultimate holding company who have prepared group
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financial statements in compliance with IFRS, and an address from which those
financial statements can be obtained
• in other cases than being an intermediate holding company, the fact that they are
separate financial statements, together with the reason why separate financial
statements have been prepared
• a list of names, interests in equity capital and principal place of business for each
significant subsidiary, associate and joint venture, including details of how they have
been accounted for in the separate financial statements
If the financial statements are not consolidated, they must therefore present interests
in other entities at cost or in accordance with IFRS 9 Financial Instruments.
In the previous version of IAS 27, disclosure requirements relating to group accounts
where included within this reporting standard. These requirements have been
transferred to IFRS 12 Disclosure of Interests in Other Entities which are considered
elsewhere within this chapter.
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Chapter Summary
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Self Test Questions
1) Below are the statements of financial position of three entities as at 30
September 20X8
P
S
A
Rs 000
Rs 000
Rs 000
Property, plant and equipment
14,000
7,500
3,000
Investments
10,000
-
-
–––––
–––––
–––––
24,000
7,500
3,000
6,000
3,000
1,500
–––––
–––––
–––––
30,000
10,500
4,500
–––––
–––––
–––––
Share capital (Rs 10 ordinary shares)
10,000
1,000
500
Retained earnings
7,500
5,500
2,500
–––––
–––––
–––––
17,500
6,500
3,000
Noncurrent liabilities
8,000
1,250
500
Current liabilities
4,500
2,750
1,000
–––––
–––––
–––––
30,000
10,500
4,500
–––––
–––––
–––––
Noncurrent assets
Current assets
Equity
Further information
•
P acquired 75% of the equity share capital of S several years ago, paying Rs
5 million in cash. At this time the balance on S's retained earnings was Rs 3
million.
•
P acquired 30% of the equity share capital of A on 1 October 20X6, paying Rs
750,000 in cash. At 1 October 20X6 the balance on A's retained earnings was
Rs 1.5 million.
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•
During the year, P sold goods to A for Rs 1 million at a mark up of 25%. At
the yearend, A still held one quarter of these goods in inventory.
•
As a result of this trading, P was owed Rs 250,000 by A at the reporting date.
This agrees with the amount included in A's trade payables.
•
At 30 September 20X8, it was determined that the investment in the associate
was impaired by Rs 35,000.
•
Non-controlling interests are valued using the fair value method. The fair
value of the Non-controlling interest at the date of acquisition was Rs 1.6
million.
Required:
Prepare the consolidated statement of financial position of the P group as at 30
September 20X8.
2.
P acquired 80% of S on 1 December 2004 paying Rs 4.25 in cash per share. At this
date the
balance on S’s retained earnings were Rs 870,000. On 1 March 2007 P
acquired 30% of A’s ordinary shares.
The consideration was settled by share exchange of 4 new shares in P for every 3
shares acquired in A. The share price of P at the date of acquisition was Rs 50. P
has not yet recorded the acquisition of A in its books.
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The Statements of Financial Position of the three companies as at 30 November
2007 are as follows:
P
S
A
Rs 000
Rs 000
Rs 000
1,300
850
900
450
210
150
1,825
-
-
Inventory
550
230
200
Receivables
300
340
400
Cash
120
50
140
–––––
–––––
–––––
4,545
1,680
1,790
–––––
–––––
–––––
1,800
500
250
Share premium
250
80
-
Retained earnings
1,145
400
1,200
–––––
–––––
–––––
3,195
980
1,450
500
300
-
Trade Payables
520
330
250
Income tax
330
70
90
–––––
–––––
–––––
4,545
1,680
1,790
–––––
–––––
–––––
Noncurrent assets
Property
Plant & Equipment
Investments
Current assets
Share capital Rs 10
Noncurrent liabilities
10% Loan notes
Current liabilities
The following information is relevant
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1) As at 1 December 2004, plant in the books of S was determined to have a fair
value of Rs 50,000 in excess of its carrying value. The plant had a remaining
life of 5 years at this time.
•
During the post acquisition period, S sold goods to P for Rs 400,000 at a
markup of 25%. P had a quarter of these goods still in inventory at the yearend.
2) In September A sold goods to P for Rs 150,000. These goods had cost A Rs
100,000. P had Rs 90,000 (at cost to P) in inventory at the year-end.
3) As a result of the above intercompany sales, P’s books showed Rs 50,000
and Rs 20,000 as owing to S and A respectively at the yearend. These
balances agreed with the amounts recorded in S’s and A’s books.
•
Non-controlling interests are measured using the fair value method. The fair
value of the Non-controlling interest at the date of acquisition was Rs 368,000.
Goodwill has impaired by Rs 150,000 at the reporting date. An impairment
review found the investment in the associate was to be impaired by Rs
15,000 at the yearend.
4) A’s profit after tax for the year is Rs 600,000.
Required:
Prepare the consolidated Statement of Financial Position as at 30 November 2007.
3.
The summarised statements of financial position of B, T and R as at 31 March 20X7
are as follows:
B
T
R
Rs 000
Rs 000
Rs 000
3,820
4,425
500
–
200
–
1,600
–
–
–––––
–––––
–––––
5,420
4,625
500
2,740
1,280
250
Non-current assets
Property, plant & equipment
Development expenditure
Investments
Current assets
Inventory
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Receivables
1,960
980
164
Cash at bank
1,260
–
86
–––––
–––––
–––––
5,960
2,260
500
–––––
–––––
–––––
11,380
6,885
1,000
4,000
500
200
800
125
Retained earnings at 31 March 20X6
2,300
380
450
Retained for year
1,760
400
150
–––––
–––––
–––––
8,860
1,405
800
–––––
–––––
–––––
Trade payables
2,120
3,070
142
Bank overdraft
–
2,260
–
400
150
58
–––––
–––––
–––––
2,520
5,480
200
–––––
–––––
–––––
11,380
6,885
1,000
–––––
–––––
–––––
Total assets
Equity
Ordinary shares of Rs 10 each
Reserves:
Share premium
Current liabilities
Taxation
Total equity and liabilities
The following information is relevant
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(i)
Investments
B acquired 40,000 shares in T on 1 April 20X6 paying Rs 30 per share. On 1
October 20X6 B acquired 40% of the share capital of R for Rs 400,000.
(ii)
Group accounting policies
Development expenditure
Development expenditure is to be written off as incurred as it does not meet
the criteria for capitalisation in IAS 38. The development expenditure in the
statement of financial position of T relates to a project that was commenced
on 1 April 20X5. At the date of acquisition the value of the capitalised
expenditure was Rs 80,000. No development expenditure of T has yet been
amortised.
(iii)
Intra-group trading
The inventory of B includes goods at a transfer price of Rs 200,000
purchased from T after the acquisition. The inventory of R includes goods at a
transfer price of Rs 125,000 purchased from B. All transfers were at cost plus
25%.
The receivables of B include an amount owing from T of Rs 250,000. This
does not agree with the corresponding amount in the books of T due to a
cash payment of Rs 50,000 made on 29 March 20X7, which had not been
received by B at the year end.
(iv)
It is group policy to value the Non-controlling interest using the fair value at
the date of acquisition. At the date of acquisition the fair value of the Noncontrolling interest was Rs 95,000.
Required:
Prepare a consolidated statement of financial position of the B group as at 31
March 20X7.
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4.
Below are the statement of comprehensive incomes of the B group and its
associated companies, as at 31 December 20X8.
B
K
S
Rs 000
Rs 000
Rs 000
Revenue
385
100
60
Cost of sales
(185)
(60)
(20)
––––
––––
––––
Gross profit
200
40
40
Operating expenses
(50)
(15)
(10)
––––
––––
––––
Profit before tax
150
25
30
Tax
(50)
(12)
(10)
––––
––––
––––
100
13
20
Profit for the year
You are also given the following information.
1) B acquired 4,500 ordinary shares in K a number of years ago. K has 5,000 Rs
10 ordinary shares.
2) B acquired 6,000 ordinary shares in S a number of years ago. S has 20,000
Rs 10 ordinary shares.
3) During the year S sold goods to B for Rs 28,000. B still holds some of these
goods in inventory at the year end. The profit element included in these
remaining goods is Rs 2,000.
(4)
Non-controlling interests are valued using the fair value method.
(5)
Goodwill and the investment in the associate were impaired for the first time
during the year as follows:
S Rs 2,000
K Rs 3,000
Impairment of the subsidiary’s goodwill should be charged to operating
expenses.
Prepare the consolidated statement of comprehensive income for B including
the results of its associated company.
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Answers
Consolidated statement of financial position for P group as at 30 September 20X8.
Rs 000
Non-current assets
Goodwill (W3)
2,600
Property, plant and equipment
21,500
(14,000 + 7,500)
Investments
4,250
(10,000 5,000
(cost of inv in S) 750 (cost of inv in A))
Investment in associate (W6)
1,000
–––––
29,350
Current assets
(6,000 + 3,000)
9,000
–––––
38,350
–––––
Equity
Share capital
10,000
Group retained earnings (W5)
9,625
Non-controlling interest (W4)
2,225
–––––
21,850
Non-current liabilities
(8,000 + 1,250)
9,250
Current liabilities
(4,500 + 2,750)
7,250
–––––
38,350
–––––
(W1)
Group structure
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P
30%
75%
A
S
Several years ago
(W2)
Two years ago
Net Assets
at acq
at rep date
Share capital
1,000
1,000
Retained earnings
3,000
5,500
–––––
–––––
4,000
6,500
–––––
–––––
(W3)
Goodwill
Rs 000
Parent holding (investment) at fair value:
Cash
5,000
Fair value of NCI
1,600
–––––
6,600
Less:
Fair value of net assets at acquisition (W2)
(4,000)
–––––
Total goodwill
(W4)
2,600
Non-controlling interest
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Fair value of NCI
25% post acquisition profit
1,600
625
(25% × (6,500 - 4,000))
–––––
2,225
–––––
(W5)
Group retained earnings
100% parent
7,500
Sub (75% × (6,500 – 4,000))
1,875
Assoc (30% × (2,500 – 1,500))
300
Provision for unrealized profits (W7)
(15)
Impairment
(35)
–––––
9,625
–––––
(W6)
Investment in associate
Cost of investment
750
Share of post-acquisition profit
300
(30% × (2,500 - 1,500))
Impairment
(35)
Provision for unrealized profits (W7)
(15)
–––––
1,000
–––––
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(W7)
2.
Provision for unrealized profits – A = seller
Profit on sale (25/125 × 1,000)
200
Profit in inventory (1/4 × 200)
50
Group share (30% × 50)
15
Consolidated Statement of Financial Position as at 31 March 2007
Rs 000
Non-current assets
Goodwill (W3)
Property (1,300 + 850)
418
2,150
Plant & Equipment (450 + 210 + 50 – 30)
680
Investments (1,825 – 1,700)
125
Investment in Associate (W6)
620
Current assets
Inventory (550 + 230 – 20 – 9)
751
Receivables (300 + 340 – 50)
590
Cash (120 + 50)
170
–––––
5,504
–––––
Share capital (1,800 + 100)
1,900
Share premium (250 + 400)
650
Retained earnings (W5)
720
–––––
3,270
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Non-controlling Interests (W4)
234
–––––
3,504
Non-current liabilities
10% Loan notes (500 + 300)
800
Current liabilities
Trade payables (520 + 330 – 50)
800
Income Tax (330 + 70)
400
–––––
5,504
–––––
Workings
(W1)
Group structure
P
80 %
3 yrs
30 % 9 months
S
A
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(W2)
Net assets
@ acq
@ rep
date
Share capital
500
500
Share premium
80
80
Retained earnings
870
400
FV – plant
50
50
FV Dep (50 × 3/5)
(30)
Provision for unrealized profits (W7)
(20)
–––––
––––
1,500
980
–––––
––––
(W3) Goodwill
Rs 000
Parent holding (investment) at fair value:
Cash
((80% × 500) × Rs 4.25)
Fair value of NCI
1,700
368
–––––
2,068
Less:
Fair value of net assets at acquisition
(1,500)
–––––
Goodwill at acquisition
568
Impairment
(150)
–––––
Carrying goodwill
418
–––––
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Share exchange:
10 shares issued at Rs 50
(W4)
Cr Share capital (nominal element)
100
Cr Share premium (premium element)
400
Non-controlling interest
Fair value of NCI
368
20% post-acquisition loss
(104)
(20% × (980 - 1,500))
Impairment
(30)
(20% × 150)
–––
234
–––
(W5)
Group retained earnings
100% parent
1,145
Provision for unrealized profits (W8)
(9)
Sub (80% × (980 – 1,500))
(416)
Assoc (30% × (1,450 – 1,000))
135
Impairment (150 × 80%)
(120)
Impairment (W3)
(15)
–––
720
–––
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(W6)
Investment in associate
Cost of investment (30% × 250) × 4/3 × Rs 5)
500
Share of post-acquisition profit (30% × (1,450 - 1,000)
135
Impairment
(15)
–––
620
–––
(W7)
Provision for unrealized profits – Sub
Profit on sale (25/125 × 400)
80
Profit in inventory (1/4 × 80)
20
(W8)
Provision for unrealized profits – Assoc
Profit on sale (150 – 100)
50
Profit in inventory (90/150 × 50)
30
Group share (30% × 30)
9
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3.
Consolidated statement of financial position as at 31 March 20X7
Rs 000
Rs 000
Non-current assets:
PPE (3,820 + 4,425)
8,245
Goodwill (W3)
370
Investment in associate (W6)
420
–––––
9,035
Current assets:
Inventory (2,740 + 1,280 – 40)
3,980
Receivables (1,960 + 980 – 250)
2,690
Bank (1,260 + 50 cash in transit)
1,310
–––––
7,980
–––––
Total assets
17,015
–––––
Ordinary shares of Rs 10 each
4,000
Reserves:
Share premium
Retained earnings (W5)
800
4,272
–––––
5,072
–––––
9,072
Non-controlling interest (W4)
143
–––––
9,215
Current liabilities:
Trade payables (2,120 + 3,070 — 200)
4,990
Bank overdraft
2,260
Taxation (400 + 150)
550
–––––
7,800
–––––
Total equity and liabilities
17,015
–––––
Workings
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(W1)
Group structure
B
40%
R
40
(6 months ago)
80%
50
(1 year ago)
(W2)
Net assets in subsidiary
At acquisition
At reporting date
Rs 000
Rs 000
Share capital
500
500
Share premium
125
125
Retained earnings
380
780
––––
––––
1,005
1,405
(80)
(200)
Development expenditure w/off
Provision for unrealized profits (W2a)
(40)
––––
––––
925
1,165
––––
––––
(W2a) Provision for unrealized profits
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Rs 200,000 × 25 /125 = Rs 40,000 Dr W2 at reporting date Cr Inventory
(W3)
Goodwill
Rs 000
Parent holding (investment) at fair value
1,200
(30*40)
NCI value at acquisition
95
–––––
1,295
Fair value of net assets at acquisition (W2)
(925)
____
Goodwill on acquisition
370
––––
(W4)
Non-controlling interest
Rs 000
NCI value at acquisition (as in W3)
95
NCI share of post-acquisition reserves (W2)
48
(20% × (1,165 - 925))
____
143
____
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(W5)
Retained earnings
Rs 000
B
4,060
Unrealised profit on inventory (below)
(10)
T (1,165 – 925) × 80%
192
R (150 profit for year × 6/12 ) × 40%
30
–––––
4,272
–––––
•
Provision for unrealized profits = Sold by B to R, group share only as it is an
associate, 40% of (Rs 125,000 × 25/125) = Rs 10,000
4) P = seller, therefore, Dr W5 Cr Investment in associate (W6)
(W6)
Investment in associate
Rs 000
Cost of investment
400
Share of post acquisition profits
30
(150 profit for year × 6/12 ) × 40%
Provision for unrealized profits
(10)
–––
420
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4.
Solution
B consolidated statement of comprehensive income for the year ended 31
December 20X8
Rs 000
Revenue
485.0
(385 + 100)
Cost of sales
(245.0)
(185 + 60)
–––––
Gross profit
240.0
Investment income (external only)
Operating expenses
(50 + 15 + 3 impairment)
(68.0)
–––––
Profit from operations
172.0
Share of profits of associate company (W3)
3.4
–––––
Profit before tax
175.4
Taxation
(62.0)
(50 + 12)
–––––
Profit for the year
113.4
Amount attributable to:
Equity holders of the parent
112.4
Non-controlling interests (W2)
1.0
–––––
113
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(W1)
Group structure
K
S
4,500/5,000 = 90%
6,000/20,000 = 30%
B
90
30%
S
(W2)
NCI in K
NCI share of subsidiary’s profit after tax:
1.3
(10% × Rs 13)
Rs 000
Less:
NCI share of impairment
(0.3)
(10% × Rs 3)
–––––
1.0
–––––
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(W3)
Share of associate
Rs 000
30% of associate profit for the year
6
(30% × Rs 20)
Less:
30% of Provision for unrealized profits
(0.6)
(30% × Rs 2)
Impairment
(2)
___
3.4
___
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CHANGES IN GROUP STRUCTURE
Chapter learning objectives
Upon completion of this chapter you will be able to:
•
prepare group financial statements where activities have been acquired, discontinued
or have been disposed of in the period
•
discuss and apply the treatment of a subsidiary that has been acquired exclusively
with a view to subsequent disposal
•
discuss the treatment of business combination achieved in stages
•
discuss and apply the treatment for transactions between equity holders where either
additional shares have been purchased, or shares have been disposed of, without
any change in control.
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1
Acquisition of a Subsidiary
1.1
Remember that a parent entity acquires control of a subsidiary from the date that it
obtains a majority shareholding. If this happens midyear, then it will be necessary to
pro-rata the results of the subsidiary for the year to identify the net assets at the date
of acquisition.
Example 1
Mid Year Acquisition of Subsidiary
On 1 July 2004 P Ltd purchased 1,600,000 of 2,000,000 equity shares of Rs 1 each
in S Ltd Ltd for Rs 10,280,000. On the same date it also acquired 1,000,000 of S
Ltd’s 10% loan notes. At the date of acquisition the retained earnings of S Ltd were
Rs 6,150,000. The summarised draft statement of comprehensive income for each
company for the year ended 31 March 2005 was as follows.
P Ltd
S Ltd
Rs 000
Rs 000
Revenue
60,000
24,000
Cost of sales
(42,000)
(20,000)
–––––––
–––––––
Gross profit
18,000
4,000
Distribution costs
(2,500)
(50)
Administration expenses
(3,500)
(150)
–––––––
–––––––
Profit from operations
12,000
3,800
Interest received/(paid)
75
(200)
–––––––
–––––––
Profit before tax
12,075
3,600
Tax
(3,000)
(600)
–––––––
–––––––
9,075
3,000
–––––––
–––––––
16,525
5,400
–––––––
–––––––
Profit for the year
Retained earnings b'fwd
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The following information is relevant:
(1)
The fair values of S Ltd’s assets at the date of acquisition were mostly equal
to their book values with the exception of plant, which was stated in the books
at Rs 2,000,000 but had a fair value of Rs 5,200,000. The remaining useful
life of the plant in question was four years at the date of acquisition.
Depreciation is charged to cost of sales and is time apportioned on a monthly
basis.
(2)
During the post-acquisition period P Ltd sold S Ltd some goods for Rs 12
million. The goods had originally cost Rs 9 million. During the remaining
months of the year S Ltd sold Rs 10 million (at cost to S Ltd) of these goods
to third parties for Rs 13 million.
(3)
Revenues and expenses should be deemed to accrue evenly throughout the
year.
(4)
P Ltd has a policy of valuing non-controlling interests using the full goodwill
method. The fair value of non-controlling interest at the date of acquisition
was Rs 2,520,000.
(5)
The fair value of goodwill was impaired by Rs 300,000 at the reporting date
Required:
Prepare a consolidated statement of comprehensive income for P Ltd group for the
year to 31 March 2005.
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Solution
P Ltd group statement of comprehensive income for the year ended 31 March 2005:
P Ltd
S Ltd
Adjusts
Group
(9/12)
SOCI
Rs 000
Rs 000
Rs 000
Revenue
60,000
18,000
(12,000)
Cost of sales
(42,000)
(15,000)
12,000
URPS (W4)
(500)
FVA adjust dep'n (W2)
66,000
(46,100)
(600)
––––––
Gross profit
19.900
Distribution costs
(2,500)
(38)
Administration expenses
(3,500)
(112)
Goodwill impairment (W3)
(2,538)
(300)
(3,912)
––––––
Profit from operations
13,450
Interest received
75
Interest paid
(150)
(75)
–
75
(75)
––––––
Profit before tax
Tax
13,375
(3,000)
Profit after tax for the year
NCI – take 20% of 1,650
(450)
(3,450)
–––––
––––––
1,650
9,925
–––––
––––––
330
Less: NCI goodwill
impairment (300 × 20%)
(60)
–––––
270
Group share of profit after tax – bal fig
9,655
––––––
9,925
––––––
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(W1)
(W2)
Group structure – P Ltd owns 80% of S Ltd Ltd
–
the acquisition took place three months into the year
–
nine months is post-acquisition
Net assets
date
Acq'n date
Rs 000
Rs 000
Equity capital
2,000
2,000
Retained earnings
6,150
8,400
––––––
––––––
8,150
10,400
3,200
3,200
FVA – PPE
FVA – dep'n adjust 3,200/48 × 9
(W3)
Rep
(600)
––––––
––––––
11,350
13,000
––––––
––––––
Goodwill
S Ltd Ltd
Rs 000
Cost of investment
10,280
FV of NCI at acquisition
2,520
–––––––
12,800
FV of net assets at acquisition (W2)
(11,350)
–––––––
Total goodwill at acquisition
1,450
Impaired during year
(300)
–––––––
Unimpaired goodwill
1,150
–––––––
(W4)
provision for unrealized profit of parent company
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Rs 2,000 × (33.33/133.33 = Rs 500)
2
Step Acquisitions
2.1
Step acquisitions
1) A step acquisition occurs when the parent entity acquires control over the
subsidiary in stages. This is achieved by buying blocks of shares at different
times.
2) Amendments to IFRS 3 and IAS 27 mean that acquisition accounting
(accounting for recognition of goodwill and non-controlling interests) is only
applied at the date when control is achieved.
•
•
Any preexisting equity interest in an entity is accounted for according to:
–
IFRS 9 in the case of simple investments
–
IAS 28 in the case of associates and joint ventures
–
IFRS 11 in the case of joint arrangement
At the date when equity interest is increased and control achieved:
(1)
remeasure the previously held equity interest to fair value
(2)
recognise any resulting gain or loss in profit or loss
(3)
calculate goodwill and non-controlling interest on either a partial (i.e.
proportionate) or full (i.e. fair value) basis in accordance with IFRS 3
Revised. The cost of acquiring control will be the fair value of the
previously held equity interest plus the cost of the most recent
purchase of shares at acquisition date.
•
If there has been remeasurement of any previously held equity interest that
was recognised in other comprehensive income, any changes in value
recognised in earlier years are now reclassified from equity to profit or loss.
•
The situation of a further purchase of shares in a subsidiary after control has
been acquired (for example taking the group interest from 60% to 75%) is
regarded as a transaction between equity holders; goodwill is not recalculated.
This situation is dealt with separately within this chapter.
Example 2
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A Ltd holds a 10% investment in B Ltd at Rs 24,000 in accordance with IAS 39. On 1
June 20X7, it acquires a further 50% of B Ltd’s equity shares at a cost of Rs 160,000.
On this date fair values are as follows:
•
B Ltd’s net assets – Rs 200,000
•
The non-controlling interest – Rs 100,000
•
The 10% investment – Rs 26,000
How do you calculate the goodwill arising in B Ltd
Note: the non-controlling interest is to be valued using the full method.
Solution
(W1) Group Structure
A Ltd
60%
B Ltd
Note – due to step acquisition – revalue the investment – take gain or loss to
statement of comprehensive income – i.e. an increase in carrying value from
Rs 24,000 to Rs 26,000.
Dr Investment
2,000
Cr Profit on remeasurement
2,000
(W2)
Net assets
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At date of acquisition
1 June 20X7
Net assets
(W3)
200,000
Goodwill – fair value (full goodwill) method
Rs
Purchase consideration (26,000 + 160,000)
186,000
FV of NCI at acquisition date
100,000
–––––––
286,000
–––––––
Total Goodwill
86,000
–––––––
3
Disposal Scenarios
3.1
During the year, one entity may sell some or all of its shares in another entity.
Possible situations include:
(1)
the disposal of all the shares held in the subsidiary
(2)
the disposal of part of the shareholding, leaving a controlling interest after the sale
(3)
the disposal of part of the shareholding, leaving a residual holding after the
sale, which is regarded as an associate
(4)
the disposal of part of the shareholding, leaving a residual holding after the
sale, which is regarded as a trade investment.
When a group disposes of all or part of its interest in a subsidiary undertaking, this
must be reflected both in the investing entity’s individual accounts and in the group
accounts.
4
Investing Entity’s Accounts
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4.1
Gain to investing entity
In all of the above scenarios, the gain on disposal in the investing entity’s accounts is
calculated as follows:
Rs
Sales proceeds
X
Carrying amount (usually cost) of shares sold
(X)
–––
X
Tax – amount or rate given in question
(X)
–––
Net gain to parent
X
–––
The gain would often be reported as an exceptional item; if so, it must be disclosed
separately on the face of the parent’s statement of comprehensive income/statement
of comprehensive income after operating profit.
4.2
Tax on gain on disposal
The tax arising as a result of the disposal is always calculated based on the gain in
the investing entity’s accounts, as identified above.
The tax calculated forms part of the investing (parent) entity’s total tax charge. As
such this additional tax forms part of the group tax charge.
5
Group Accounts
5.1
In the group accounts the accounting for the sale of shares in a subsidiary will
depend on whether or not the transaction causes control to be lost, or whether after
the sale control is still maintained.
Where control is lost, there will be a gain or loss to the group which must be included
in the group statement of comprehensive income for the year. Additionally, there will
be derecognition of the assets and liabilities of the subsidiary disposed of, together
with elimination of goodwill and non-controlling interest from the group accounts. The
statement of comprehensive income of the subsidiary will be consolidated up to the
date of disposal.
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Where control is of the subsidiary is retained, there is no gain or loss to be recorded
in the group accounts. Instead, the transaction is regarded as one between equity
holders, with the end result being an increase in non-controlling interest. The group
continues to recognise the goodwill, assets and liabilities of the subsidiary at the year
end, and consolidates the statement of comprehensive income of the subsidiary for
the year.
5.2
Accounting for a disposal where control is lost
•
Where control is lost (i.e. the subsidiary is completely disposed of or
becomes an associate or investment), the parent:
–
Recognises
–
the consideration received
–
any investment retained in the former subsidiary at fair value on the
date of disposal
–
Derecognises
–
the assets and liabilities of the subsidiary at the date of disposal
–
unimpaired goodwill in the subsidiary
–
the non-controlling interest at the date of disposal (including any
components of other comprehensive income attributable to them)
–
Any difference between these amounts is recognised as an
exceptional gain or loss on disposal in the group accounts.
1) In the group statement of comprehensive income, it will also be necessary to
pro-rata the results of the subsidiary for the year into pre-disposal for
consolidation, and post-disposal for accounting as an associate or simple
investment as appropriate.
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Proceeds
X
FV of retained interest
X
–––
X
Less interest in subsidiary disposed of:
Net assets of subsidiary at disposal date
X
Unimpaired goodwill at disposal date
X
Less: carrying value of NCI
(X)
–––
(X)
–––
Pretax gain/loss to the group
X
Presentation in the group statement of comprehensive income when control is lost:
Exceptional Gain
The gain to the group would often be reported as an exceptional item, i.e. presented
as an exceptional item on the face of the statement of comprehensive income after
operating profit.
There are two ways of presenting the results of the disposed subsidiary:
1) Time apportionment line-by-line
In the group statement of comprehensive income, where the sale of the
subsidiary has occurred during the year, basic consolidation principles will
only allow the income and expenses of the subsidiary to be consolidated up
to the date of disposal. The traditional way is to time apportion each line of
the disposed subsidiary’s results in the same way that a subsidiary’s results
that had been acquired part way through the year would be consolidated.
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2) Time-apportioned and a discontinued operation
If however the subsidiary that has been disposed qualifies as a discontinued
operation in accordance with “IFRS 5 Accounting for Non-current Assets held
for sale and discontinued operations”, then the predisposal results of the
subsidiary are aggregated and presented in a single line on the face of the
statement of comprehensive income immediately after profit after tax from
continuing operations.
A discontinued operation is a component of an entity that either has been
disposed of or is classified as held for sale, and:
•
represents a separate major line of business or geographical area of
operations,
•
is part of a single coordinated 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.
Associate time-apportioned
Further if the disposal means control is lost but it leaves a residual interest that gives
that the parent significant influence, this will mean that in the group statement of
comprehensive income there will be an associate to account for, for example if a
parent sells half of its 80% holding to leave it owning a 40% associate. Associates
are accounted for using equity accounting and as the associate relationship will only
be relevant from the date of disposal it will be time apportioned in the group
statement of comprehensive income
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6
Group Accounts – Entire Disposal
6.1
Entire disposal
Example 3
Rock has held a 70% investment in Cliff for two years. Rock is disposing of this
investment.Goodwill has been calculated using the full goodwill method. No goodwill
has been impaired Details are:
Rs
Cost of investment
2,000
Cliff – Fair value of net assets at acquisition
1,900
Cliff – Fair value of the non-controlling
interest at acquisition
800
Sales proceeds
3,000
Cliff – Net assets at disposal
2,400
Required:
Calculate the profit/loss on disposal.
(a)
In Rock's individual accounts
(b)
In the consolidated accounts
Rock is subject to tax at the rate of 25%
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Solution.
(a)
Gain to Rock
Rs
Sales proceeds
3,000
Cost of shares sold
(2,000)
––––––
Gain on disposal
1,000
Tax charge against Rock at 25%
(b)
250
Consolidated accounts
Rs
Sales proceeds
Net assets at disposal
Unimpaired goodwill (W1)
Rs
3000
2,400
900
Less: carrying value of NCI at disposal date:
FV of NCI at acquisition
800
NCI % of postacq'n retained earnings:
30% × (2,400 – 1,900)
150
(950)
–––
–––––
(2,350)
–––––
Gain to group before tax
650
–––––
Tax charge on gain made by Rock (as above)
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250
Page 320
(W1)
Goodwill
Rs
Cost of investment
FV of NCI at acquisition
2,000
800
______
2,800
FV of net assets at acquisition
(1,900)
______
Total Goodwill
900
______
7
Group Accounts Disposal – Subsidiary to Associate
This situation is where the disposal results in the subsidiary becoming an associate,
e.g. 90% holding is reduced to a 40% holding.
After the disposal the income, expenses, assets and liabilities of the ex-subsidiary
can no longer be consolidated on a line by line basis; instead they must be
accounted for under the equity method, with a single amount in the statement of
comprehensive income/statement of comprehensive income for the share of the post
tax profits for the period after disposal and a single amount in the statement of
financial position for the fair value of the investment retained
plus the share of post-acquisition retained profits.
Consolidated statement of comprehensive income
•
•
Pro-rate the subsidiary’s results up to the date of disposal and :
–
consolidate the results up to the date of disposal
–
equity account for the results after the date of disposal.
Include the group gain on part disposal
Consolidated statement of financial position
•
Equity account by reference to the yearend holding, based on the fair value of
the associate holding at disposal date.
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Example 4
Copper Ltd disposed of a 25% holding in Zinc Ltd on 30 June 20X6 for Rs 125,000. A
70% holding in Zinc Ltd had been acquired five years prior to this. Copper Ltd uses
the full goodwill method in accordance with IFRS 3 revised. Goodwill was impaired
and written off in full prior to the year of disposal.
Details of Zinc Ltd are as follows:
Rs
Net assets at disposal date
340,000
Fair value of a 45% holding at 30 June 20X6
245,000
If the carrying value of NCI is Rs 80,000 at the date of the share disposal, what gain
on disposal is reported in the Copper Ltd Group accounts for the year ended 31
December 20X6?
Ignore tax
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Solution
(W1)
Group Structure
Copper Ltd
70%
Copper Ltd
(25%)
75%
–––––
45%
45%
Zinc Ltd
Zinc Ltd
Subsidiary
Associate
x 6/12
x 6/12
Gain or loss to the group on disposal
Rs
Proceeds
125,000
FV of retained interest
245,000
–––––––
370,000
Net assets recognised at disposal
340,000
Less: NCI at disposal date
(80,000)
(260,000)
–––––––
–––––––
Group gain on disposal
110,000
–––––––
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8
Group Accounts – Disposal with Trade Investment Retained
This situation is where the subsidiary becomes a trade investment, e.g. 90% holding
is reduced to a 10% holding.
Consolidated statement of comprehensive income/statement of comprehensive
income
•
Pro rate the subsidiary’s results up to the date of disposal and then:
–
consolidate the results up to the date of disposal
–
only include dividend income after the date of disposal.
3) Include the group gain on part disposal.
Consolidated statement of financial position
•
Recognise the residual holding retained as an investment, measured at fair
value in accordance with IFRS 9.
9
Disposal where Control is not Lost (Increase in NCI)
9.1
From the perspective of the group accounts, where there is a sale of shares but the
parent still retains control then, in essence, this is an increase in the non-controlling
interest.
For example if the parent holds 80% of the shares in a subsidiary and sells 5%, the
relationship remains one of a parent and subsidiary and as such will remain
consolidated in the group accounts in the normal way, but the NCI has risen from
20% to 25%. Where there is such an increase in the non-controlling interest:
1) No gain or loss on disposal is calculated
2) No adjustment is made to the carrying value of goodwill
3) The difference between the proceeds received and change in the noncontrolling interest is accounted for in shareholders’ equity as follows:
Rs
Cash proceeds received
X
NCI % increase x (NAs at date of change + unimpaired goodwill of
sub)
(X)
––––
Difference to equity
X
––––
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Example 5
Until 30 September 20X7, Jupiter held 90% of Mars. On that date it sold a 10%
interest in the equity capital for Rs 15,000. At the date of share disposal, the carrying
value of net assets and goodwill of Jupiter were Rs 100,000 and Rs 20,000
respectively.
How should the disposal transaction be accounted for in the Jupiter Group accounts?
Solution
Rs
Cash proceeds
15,000
Increase in NCI: 10% × (100,000 + 20,000)
12,000
–––––
Increase in equity
3,000
–––––
There is no gain or loss to the group as there has been no loss of control. Note that,
depending upon the terms of the share disposal, there could be either an increase or
decrease in equity.
9.2
Disposal With No Loss of Control
In this situation, the subsidiary remains a subsidiary, albeit the shareholding is
reduced, e.g. 90% holding is reduced to a 60% holding.
Consolidated statement
comprehensive income
of
comprehensive
income
/
statement
of
•
Consolidate the subsidiary’s results for the whole year.
•
Calculate the non-controlling interest relating to the periods before and after
the disposal separately and then add together:
•
e.g. ( X / 12 × profit × 10%) + ( Y / 12 × profit × 40%)
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Consolidated statement of Financial Position
10
•
Consolidate as normal, with the non-controlling interest valued by reference
to the yearend holding
•
take the difference between proceeds and the change in the NCI to
shareholders' equity as previously discussed.
Subsidiaries Acquired Exclusively with a View to Subsequent Disposal
IFRS 5: non-current assets held for sale and discontinued operations
4) A subsidiary acquired exclusively with a view to resale is not exempt from
consolidation.
•
•
But if it meets the criteria in IFRS 5:
–
it is presented in the financial statements as a disposal group
classified as held for sale. This is achieved by amalgamating all its
assets into one line item and all its liabilities into another
–
it is measured, both on acquisition and at subsequent reporting dates,
at fair value less costs to sell. (IFRS 5 sets down a special rule for
such subsidiaries, requiring the deduction of costs to sell. Normally, it
requires acquired assets and liabilities to be measured at fair value).
The criteria include the requirements that:
–
the subsidiary is available for immediate sale
–
it is likely to be disposed of within one year of the date of its
acquisition.
–
•
the sale is highly probable.
A newly acquired subsidiary which meets these held for sale criteria
automatically meets the criteria for being presented as a discontinued
operation.
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Example 6
IFRS 5
P Ltd acquires R Ltd on 1 March 20X7. R Ltd is a holding entity with two whollyowned subsidiaries, M Ltd and J Ltd. J Ltd is acquired exclusively with a view to
resale and meets the criteria for classification as held for sale. P Ltd’s yearend is 30
September.
On 1 March 20X7 the following information is relevant:

the identifiable liabilities of J Ltd have a fair value of Rs 40m
•
the acquired assets of J Ltd have a fair value of Rs 180m
•
the expected costs of selling J Ltd are Rs 5m.
On 30 September 20X7, the assets of J Ltd have a fair value of Rs 170. The liabilities
have a fair value of Rs 35m and the selling costs remain at Rs 5m.
Discuss how J Ltd will be treated in the P Ltd Group financial statements on
acquisition and at 30 September 20X7.
Solution
On acquisition the assets and liabilities of J Ltd are measured at fair value less costs
to sell in accordance with IFRS 5’s special rule.
Rs m
Assets
180
Less selling costs
(5)
––––
175
Liabilities
(40)
––––
Fair value less costs to sell
135
––––
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At the reporting date, the assets and liabilities of J Ltd are remeasured to update the
fair value less costs to sell.
Rs m
Assets
170
Less selling costs
(5)
––––
165
Liabilities
(35)
––––
Fair value less costs to sell
130
––––
The fair value less costs to sell has decreased from Rs 135m on 1 March to Rs 130m
on 30 September. This Rs 5m reduction in fair value must be presented in the
consolidated statement of comprehensive income as part of the single line item
entitled ‘discontinued operations’. Also included in this line items is the post-tax profit
or loss earned/incurred by J Ltd in the March –September 20X7 period.
The assets and liabilities of J Ltd must be disclosed separately on the face of the
statement of financial position. Below the subtotal for the P Ltd group’s current assets
J Ltd’s assets will be presented as follows:
Rs m
Non-current assets classified as held for sale
165
Below the subtotal for the P Ltd group’s current liabilities J Ltd’s liabilities will be
presented as follows:
Rs m
Liabilities directly associated with non-current assets
classified as held for sale
35
No other disclosure is required.
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11
Further purchase by group after control obtained (decrease in NCI)
From the perspective of the group accounts where there is a purchase of more
shares in a subsidiary then, in essence, this is not an acquisition – it is a decrease in
the non-controlling interest.
For example if the parent holds 80% of the shares in a subsidiary and buys 5% more
the relationship remains one of a parent and subsidiary and as such will be remain
consolidated in the group accounts in the normal way, but the NCI has decreased
from 20% to 15%.
Where there is such a decrease in the NCI:
•
There is no change in the goodwill asset
•
No gain or loss arises as this is a transaction within equity i.e. with the NCI
•
A difference will arise that will be taken to equity and is determined in the
following proforma.
Rs
Cash paid
X
Decrease in NCI (prop'n decrease in NCI x NCI at date of decrease)
X
–––
Difference to equity
X
–––
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Chapter Summary
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Self Test Questions
1.
The statements of financial position of two entities, Major and Minor as at 31
December 20X6 are as follows:
Major
Minor
Rs 000
Rs 000
Investment
160
Sundry assets
350
250
–––––
–––––
510
250
Equity share capital
200
100
Retained earnings
250
122
Liabilities
60
28
–––––
–––––
510
250
Major acquired 40% of Minor on 31 December 20X1 for Rs 90,000. At this time the
retained earnings of Minor stood at Rs 76,000. A further 20% of shares in Minor was
acquired by Major three years later for Rs 70,000. On this date, the fair value of the
existing holding in Minor was Rs 105,000.
Minor’s retained earnings were Rs 100,000 on the second acquisition date, at which
date the fair value of the non-controlling interest was Rs 90,000. It is group policy to
value the non-controlling interest on a full fair value basis.
Required:
Prepare the consolidated statement of financial position for the Major group as
at 31 December 20X6.
2.
Hamid Ltd purchased 80% of the shares in Pepsico for Rs 100,000 when the net
assets of Pepsico had a fair value of Rs 50,000. Goodwill was calculated using the
proportion of net assets method amounting to Rs 60,000 and has not suffered any
impairment to date. Hamid has just disposed of its entire shareholding in Pepsico for
Rs 300,000, when the net assets were stated at Rs 110,000. Tax is payable by
Hamid at 30% on any gain on disposal of shares.
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Required:
3.
•
Calculate the gain or loss arising to the parent entity on disposal of
shares in Pepsico.
•
Calculate the gain or loss arising to the group on disposal of the
controlling interest in Pepsico.
The following information relates to the acquisition by Bridge of a 60% subsidiary,
Walkway, where goodwill and non-controlling interests are measured on a full fair
value basis. At disposal, no goodwill had been impaired and tax is payable at 30%
Net assets at
Acquisition
Investment
Net Assets at
Disposal Date
Proceeds
Fair Value of NCI
at acquisition
Cost of
Sale
Rs m
Rs m
Rs m
Rs m
Rs m
500
750
300
900
3,000
Required:
4.
•
Calculate the gain arising to the parent entity on disposal.
•
Calculate the gain arising to the group on disposal.
Paper purchased 80% of the shares in Wood four years ago for Rs 100,000. On 30
June it sold all of these shares for Rs 250,000. The net assets of Wood at acquisition
were Rs 69,000 and at disposal, Rs 88,000. Fifty per cent of the goodwill arising on
acquisition had been written off in an earlier year. The fair value of the non-controlling
Interest in Wood at the date of acquisition was Rs 15,000. It is group policy to value
the non-controlling interest using the full goodwill method.
Tax is charged at 30%.
Required:
What profits/losses on disposal are reported in Paper’s statement of
comprehensive income and in the consolidated statement of comprehensive
income?
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 332
5.
H Ltd has held a 60% investment in M Ltd for several years, using the full goodwill
method to value the non-controlling interest. Half of the goodwill has been impaired
prior to the date of disposal of shares by H Ltd. Details are as follows:
Rs 000
Cost of investment
6,000
M Ltd – Fair value of net assets at acquisition
2,000
M Ltd – Fair value of a 40% investment at acquisition date
1,000
M Ltd – Net assets at disposal
3,000
M Ltd – FV of a 30% investment at disposal date
3,500
Required:
(a)
Assuming a full disposal of the holding and proceeds of Rs 10 million,
calculate the profit/loss arising:
(i)
in H Ltd's individual accounts
(ii)
in the consolidated accounts
Tax is 25%
(b)
Assuming a disposal of half the holding and proceeds of Rs 5 million:
1) calculate the profit/loss arising in the consolidated accounts
(ii)
explain how the residual holding will be accounted for.
Ignore tax.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 333
6.
The statement of comprehensive incomes for the year ended 31 December
20X9 are as follows:
K
L
group
Rs
Rs
Revenue
553,000
450,000
Operating costs
(450,000)
(400,000)
–––––––
–––––––
103,000
50,000
8,000
–
–––––––
–––––––
Profit before tax
111,000
50,000
Tax
(40,000)
(14,000)
–––––––
–––––––
71,000
36,000
–––––––
–––––––
Retained earnings b/f
100,000
80,000
Profit after tax
71,000
36,000
Dividend paid
(25,000)
(10,000)
–––––––
–––––––
146,000
106,000
–––––––
–––––––
Operating profits
Dividends receivable
Profit after tax
Retained earnings c/f
•
The accounts of the K group do not include the results of L.
•
On 1 January 20X5 K acquired 70% of the shares of L for Rs 100,000 when
the fair value of L's net assets were Rs 110,000. L has equity capital of Rs
50,000. At that date, the fair value of the non-controlling interest was Rs
40,000.
•
L paid its 20X9 dividend in cash on 31 March 20X9.
•
Goodwill is to be accounted for based upon the fair value of non-controlling
interest. No goodwill has been impaired.
•
K has other subsidiaries participating in the same activities as L, and
therefore the disposal of L shares does not represent a discontinued
operation per IFRS 5.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 334
Required:
1)
(i)
Prepare the consolidated statement of comprehensive income for the year
ended 31 December 20X9 for the K group on the basis that K plc sold its
holding in L on 1 July 20X9 for Rs 200,000. This disposal is not yet recognised
in any way in K group’s statement of comprehensive income.
(ii)
2)
Compute the group retained earnings at 31 December 20X9.
Explain and illustrate how the results of L are presented in the group
statement of comprehensive income in the event that L represented a
discontinued activity per IFRS 5.
Ignore tax on the disposal.
(b)
(i)
Prepare the consolidated statement of comprehensive income for the
year ended 31 December 20X9 for the K group on the basis that K
sold half of its holding in L on 1 July 20X9 for Rs 100,000 This
disposal is not yet recognised in any way in K group’s statement of
comprehensive income. The residual holding of 35% has a fair value
of Rs 100,000 and leaves the K group with significant influence.
(ii)
Compute the group retained earnings at 31 December 20X9
Ignore tax on the disposal.
7.
P Ltd has owned 90% of G Ltd for many years and is considering selling part of
its holding, whilst retaining control of G Ltd.
At the date of considering disposal of part of the shareholding in G Ltd, the NCI has a
carrying value of Rs 7,200 and the net assets and goodwill have a carrying value of
Rs 70,000 and Rs 20,000 respectively.
(i)
P Ltd could sell 5% of the G Ltd shares for Rs 5,000 leaving it holding 85%
and increasing the NCI to 15%, or
(ii)
P Ltd could sell 25% of the G Ltd shares for Rs 20,000 leaving it holding 65%
and increasing the NCI to 35%.
Required:
Calculate the difference arising that will be taken to equity for each situation
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 335
8.
H, S and M are three entities preparing their financial statements under IFRSs.
Their statements of financial position as at 30 September 20X5 are given below:
Statements of Financial Position
H
S
M
Rs 000
Rs 000
Rs 000
Property, plant and equipment
160,000
60,000
64,000
Investments
80,000
–
–
–––––––
–––––––
–––––––
240,000
60,000
64,000
65,000
50,000
36,000
–––––––
–––––––
–––––––
305,000
110,000
100,000
–––––––
–––––––
–––––––
Equity capital (Rs 1 shares)
50,000
20,000
15,000
Retained earnings
185,000
43,000
42,000
–––––––
–––––––
–––––––
235,000
63,000
57,000
Non-current liabilities
25,000
18,000
20,000
Current liabilities
45,000
29,000
23,000
–––––––
–––––––
–––––––
305,000
110,000
100,000
–––––––
–––––––
–––––––
Non-current assets:
Current assets
Note 1- Investment by H in S
On 1 October 20X3, H acquired 70% of the equity share capital of S for Rs 45
million in cash, when the balance on S’s retained earnings was Rs 28 million.
It was determined that at this date, land with carrying value of Rs 40 million
had a fair value of Rs 45 million.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 336
On 30 September 20X5, H acquired a further 10% of the equity shares of S
paying Rs 10 million in cash.
Note 2 – Investment by H in M
On 1 January 20X2, H acquired 60% of the equity shares of M for Rs 21
million in cash, when the balance on M’s retained earnings was Rs 15 million.
It was determined that the book value of M’s net assets on 1 January 20X2
were equal to their fair values.
On 30 September 20X5, H disposed of one quarter of its shareholding in M
for Rs 15 million cash. H’s remaining 45% holding enabled H to exercise
significant influence over the operating and financial policies of M. The fair
value of the remaining 45% holding was Rs 35 million at 30 September 20X5.
H have recorded the proceeds of Rs 15 million by debiting cash and crediting
investments, but no other entries have been made.
Note 3 – Intra-group trading
During the year ended 30 September 20X5, H sold goods to S for Rs 8 million. These
goods were sold at a profit margin of 25%. Half of these goods remain in S’s
inventory at the reporting date.
Note 4 – NCIs and goodwill
H’s policy is to value NCIs at acquisition at fair value. The fair value of the noncontrolling interest in S was Rs 17.4 million and the fair value of the non-controlling
interest in M was Rs 13 million at the relevant dates of acquisition. No impairment
losses have arisen on goodwill.
Required:
Prepare the consolidated statement of financial position of the H group as at 30
September 20X5.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 337
9.
G Ltd has owned 80% of M Ltd for many years. G Ltd is considering acquiring more
shares in M Ltd, which will decrease the NCI. The NCI of M Ltd currently has a
carrying value of Rs 20,000, with the net assets and goodwill having a value of Rs
125,000 and Rs 25,000 respectively.
G Ltd is considering the following two scenarios:
(i)
G Ltd could buy 20% of the M Ltd shares leaving no NCI for Rs 25,000, or
(ii)
G Ltd could buy 5% of the M Ltd shares for Rs 4,000 leaving a 15% NCI.
Required:
Calculate the difference arising that will be taken to equity for each situation
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 338
Answers
1.
Consolidated statement of financial position for Major as at 31 December 20X6
Rs
Goodwill (W3)
65,000
Sundry assets (350,000 + 250,000)
600,000
–––––––
665,000
–––––––
Equity and liabilities
Rs
Equity share capital
200,000
Retained earnings (W5)
278,200
Non-controlling interest (W4)
98,800
Liabilities (60,000 + 28,000)
88,000
–––––––
665,000
–––––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 339
W-1
Group structure
Major
40% acquired 5 years ago
20% acquired 2 years ago
Minor
Therefore, Minor becomes a subsidiary of Major from December 20X4.
The investment will need to be revalued
Dr Investment 15,000
(105,000 – 90,000)
Cr Profit
W-2
15,000
Net assets
At Acquisition
At Reporting
20X4
date
Rs
Rs
Share capital
100,000
100,000
Retained earnings
100,000
122,000
–––––––
–––––––
200,000
222,000
–––––––
–––––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 340
W-3
Goodwill
Rs
Consideration paid by parent
175,000
(105,000 + 70,000)
FV of NCI (given)
90,000
–––––––
265,000
Less: FV of NA at acquisition (W2)
(200,000)
–––––––
65,000
–––––––
(W4)
Noncontrolling interest
Rs
FV at acquisition date
90,000
NCI % of postacquisition retained earnings
(40% x Rs 22,000)
8,800
–––––––
98,800
–––––––
(W5)
Group Retained earnings
Rs
Major
250,000
Gain on remeasurement
15,000
Minor 60% (222,000 – 200,000)
13,200
–––––––
278,200
–––––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 341
2.
(a)
Gain to Hamid
Rs 000
Sales proceeds
300
Cost of shares sold
(100)
––––
Gain on disposal
200
Tax at 30%
(60)
––––
Net gain on disposal
140
1) Consolidated accounts
Rs 000
Proceeds
300
FV of retained interest
NIL
––––
300
Less interest in subsidiary disposed of:
Net assets of subsidiary at disposal date
110
Unimpaired goodwill at disposal date
60
Less: NCI carrying value at disposal date (W1)
(22)
––––
(148)
––––
152
Tax on gain as per Hamid (part (a))
(60)
––––
Post-tax gain to group
Advanced Financial Accounting and Corporate Reporting (Study Text)
92
Page 342
(W1)
NCI at disposal date
Rs 000
NCI % of net assets at acquisition
(20% × 100)
10
NCI % of increase in net assets to disposal (20% × (110 –50))
Date
12
––––
22
––––
3.
(a)
Gain to parent entity
Rs 000
Sales proceeds
3,000
Cost of shares sold
(900)
––––––
Gain on disposal
2,100
Tax at 30%
(630)
––––––
Net gain on disposal
(b)
1,470
Consolidated accounts
Rs
Proceeds
3,000
FV of retained interest
NIL
–––––
3,000
Less interest in subsidiary disposed of:
Net assets of subsidiary at disposal date
750
Unimpaired goodwill at disposal date (W1)
700
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 343
Less: NCI at disposal date (W2)
(400)
(1,050)
–––––
1,950
Tax on gain as per parent entity
(630)
–––––
Posttax
gain to group
1,320
–––––
(W1)
Goodwill calculation
Rs m
Cost of investment
900
FV of NCI at acquisition (given)
300
––––
1,200
FV of net assets acquisition
(500)
Fair value of goodwill at acquisition
––––
700
––––
(W2)
NCI at disposal date
Rs m
FV of NCI at acquisition (given)
300
NCI share of postacquisition retained earnings
(40% x (750 – 500))
100
––––
400
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 344
4.
(a)
Gain to Paper
Rs 000
Sales proceeds
250
Cost of shares sold
(100)
–––––
Gain on disposal
150
Tax at 30%
(45)
–––––
Net gain on disposal
b.
105
Consolidated accounts
Rs 000
Sales proceeds
Rs 000
250.0
Carrying value of subsidiary at disposal date:
Net assets at disposal date – given
88.0
Unimpaired goodwill at disposal date (W1)
23.0
–––––
111.0
Less: CV of NCI at disposal (W2)
(14.2)
–––––
(96.8)
–––––
Pretax gain to group on disposal
153.2
Tax (per parent in part (a)
(45.0)
–––––
Net gain to group after tax
108.2
–––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 345
(W1)
Goodwill
Rs 000
Cost of investment
100.0
FV of NCI at acquisition
15.0
–––––
115.0
FV of net assets at acquisition
(69.0
–––––
Full goodwill at acquisition
46.0
Goodwill impaired to extent of
50%
Group share – 80%
(18.4)
NCI share – 20% (4.6)
(23.0)
–––––
Unimpaired goodwill at disposal date
–––––
23.0
–––––
(W2)
NCI at disposal date
Rs 000
FV at date of acquisition
15.0
NCI % of postacq'n retained earnings
(20% x (88.0 – 69.0))
3.8
NCI % of impairment (W1)
(4.6)
–––––
14.2
–––––
Normally the parent entity profit is greater than the group profit, by the share of the
post-acquisition retained earnings now disposed of. In this case the reverse is true,
because the Rs 23,000 impairment loss already recognised exceeds the Rs 15,200
((88,000 – 69,000) × 80%) share of post acquisition retained earnings.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 346
5.
(W1)
Goodwill
Rs 000
Cost of investment
6,000
FV of the NCI at date of acquisition
1,000
––––––
7,000
FV of net assets at the date of acquisition (given)
(2,000)
––––––
Total goodwill
5,000
Impaired (50%)
(2,500)
––––––
Unimpaired goodwill
2,500
––––––
(W2)
NCI at disposal date
Rs 000
FV at date of acquisition
NCI share of post-acquisition retained earnings
1,000
400
(40% x (3,000 – 2,000))
Less: NCI share of goodwill impairment (40% x 2500)
(1,000)
––––––
400
––––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 347
Full disposal of shares
Gain in H Ltd's individual accounts
Rs 000
(a)
(i)
Sale proceeds
10,000
Less Cost of shares sold
(6,000)
––––––
Gain to parent
4,000
Tax at 25% × 4,000
(1,000)
––––––
3,000
––––––
Full disposal of shares – gain in H Ltd Group accounts
Rs 000
Sale proceeds
10,000
FV of retained interest
nil
CV of subsidiary at disposal:
Net Assets
3,000
Unimpaired goodwill (W1)
2,500
–––––
5,500
Less: NCI at disposal date (W2)
(400)
–––––
(5,100)
–––––
Gain before tax
4,900
Tax per part (a)(i)
(1,000)
–––––
3,900
–––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 348
(b)
(i)
Disposal of half of the holding to leave a residual shareholding:
Rs 000
Rs 000
Disposal proceeds
5,000
FV of retained interest
3,500
–––––
8,500
CV of subsidiary at disposal date:
Net assets
3,000
Unimpaired goodwill (W1)
2,500
–––––
5,500
Less: FV of NCI at disposal date (W2)
(400)
–––––
(5,100
–––––
3,400
–––––
2)
After the date of disposal, the residual holding will be equity accounted, with a
single amount in the statement of comprehensive income for the share of the
post-tax retained earnings for the period after disposal and a single amount in
the statement of financial position for the fair value at disposal date of the
investment retained plus the group share of post-acquisition retained earnings.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 349
6.
(a)
(i)
Consolidated statement of comprehensive income – full disposal
K
L
Group
Group
Rs
Rs
Revenue
553,000
(6 / 12 x 450,000)
778,000
Operating costs
450,000
(6 / 12 x 400,000)
(650,000)
–––––––
Operating profit
Dividend
128,000
8,000 less
Inter-co (70%
× 10,000)
1,000
Profit on disposal (W4)
80,400
–––––––
Profit before tax
Tax
209,400
40,000
(6 / 12 × 14,000)
(47,000)
–––––––
Profit after tax
162,400
–––––––
Attributable to:
Equity holders of
K (β)
157,000
Noncontrolling
Interest
(30% × 36,000 ×
5,400
6/12)
–––––––
162,400
–––––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 350
(ii)
Group retained earnings at 31 December 20X9 – full disposal
Rs
Brought forward K
100,000
Group % of L's post acquisition retained
earnings b/f
(70% × (130,000 (W1) – 110,000) (per Q))
14,000
––––––––
114,000
Profit for year per consolidated statement of
comprehensive income
157,000
Less Dividend paid
(25,000)
––––––––
Retained earnings carried forward
246,000
––––––––
(iii)
Group statement of comprehensive income – discontinued operations presentation
K
Group
Group
Rs
Rs
Revenue
553,000
553,000
Operating costs
450,000
(450,000)
––––––––
Operating profit
Dividend
103,000
8,000 less
Interco (70%
× 10,000)
Profit on disposal (W4)
1,000
80,400
––––––––
Profit before tax
184,400
Tax
(40,000)
––––––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 351
Profit after tax – continuing
operations
144,400
Discontinued operations
(Rs 36,000 × 6/12)
18,000
––––––––
162,400
––––––––
Attributable to:
Equity holders of
157,000
K (β)
Noncontrolling
Interest
(30% × 36,000 × 6/12)
5,400
––––––––
162,400
––––––––
Notice that the posttax results of the subsidiary up to the date of disposal are
presented as a oneline entry in the group statement of comprehensive income. There
is no line-by-line consolidation of results when this method of presentation is adopted.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 352
b.
(i)
Consolidated statement of comprehensive income – part disposal
with residual interest
K
L
Group
Group
Rs
Rs
Revenue
553,000
(6 / 12 × 450,000)
778,000
Operating costs
450,000
(6 / 12 × 400,000)
(650,000)
–––––––
Operating profit
128,000
Dividend
8,000 less
Interco (70%
× 10,000)
Income from associate
1,000
(35% × 36,000)
6,300
× 6 / 12)
Profit on disposal (W4)
80,400
–––––––
Profit before tax 215,700
Tax 40,000 (6 / 12 × 14,000)
(47,000)
–––––––
Profit after tax
168,700
–––––––
Attributable to:
Equity holders of K (β)
Noncontrolling interest
163,300
(30% × 36,000 × 6 / 12)
5,400
–––––––
168,700
–––––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 353
(ii)
Group retained earnings at 31 December 20X9 – part disposal
Rs
K
100,000
Group % of L’s post acquisition retained earnings b/f
(70% × (130,000 (W1) – 110,000) (per Q))
14,000
–––––––
114,000
Group income per consolidated statement of comprehensive income
163,300
Less Dividend paid
(25,000)
–––––––
252,300
–––––––
Alternatively:
Rs
K c/fwd
146,000
Parent gain on disposal of shares
(Rs 100,000 – (50% × Rs 100,000)
50,000
Gain on remeasurement of residual holding
(Rs 100,000 – Rs 50,000)
50,000
Share of associate profit (6/12 × 35% × Rs 36,000)
6,300
–––––––
252,300
–––––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 354
Workings
(W1)
Net assets – L
Net assets
Net assets
at disposal
b/f
Rs
Rs
50,000
50,000
B/f
80,000
80,000
6 / 12 × 36,000
18,000
Less Dividend
(10,000)
–
–––––––
–––––––
138,000
130,000
–––––––
–––––––
Share capital
Retained earnings
(W2)
Goodwill
Rs
Cost to parent
100,000
FV of NCI at date of acquisition
40,000
–––––––
140,000
FV of net assets at date of acquisition (per question)
110,000
–––––––
Unimpaired goodwill
30,000
–––––––
(W3)
NCI at disposal date
FV of NCI at date of acquisition
40,000
NCI share of postacquisition retained earnings
(30% x (138,000 – 110,000)
8,400
–––––––
48,400
–––––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 355
(W4)
Profit on disposal
Full disposal (a)(i)
Rs
Proceeds
Rs
200,000
Net assets recorded prior to disposal
Net assets
138,000
Full goodwill – unimpaired
30,000
––––––
168,000
NCI at date of disposal (W3)
(48,400)
––––––
(119,600)
–––––––
Profit on disposal
80,400
–––––––
Part disposal (b)(i)
Proceeds
100,000
FV of retained interest (per question)
100,000
–––––––
200,000
Net assets recorded prior
to disposal
Net assets
138,000
Unimpaired goodwill at disposal date
30,000
–––––––
168,000
NCI at date of disposal (W3)
(48,400)
–––––––
(119,600)
–––––––
80,400
–––––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 356
7.
(i)
Sale of 5% of G Ltd shares
Rs
Cash proceeds
5,000
Increase in NCI (5% x (70,000 +20,000)
(4,500)
–––––
Increase in equity
500
–––––
(ii)
Sale of 25% of G Ltd shares
Rs
Cash proceeds
20,000
Increase in NCI (25% x (70,000 + 20,000)
(22,500)
––––––
Decrease in equity
(2,500)
––––––
Note that in both situations, G Ltd remains a subsidiary of P Ltd after the sale
of shares. There is no gain or loss to the group – the difference arising is
taken to equity. G Ltd would continue to be consolidated within the P Ltd
Group like any other subsidiary; there is no change to the carrying value of
goodwill. The only impact will be the calculation of NCI share of retained
earnings for the year – this would need to be time-apportioned based upon
the NCI percentage pre and post disposal during the year.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 357
8.
H – Consolidated Statement of Financial Position at 30 September 20X5
Assets:
Rs 000
Goodwill (W3)
9,400
Property, plant & equipment
(160,000 + 60,000 + 5,000(FVA))
225,000
Investments
(80,000 – 45,000(W3) – 10,000(W7) –
19,000
21,000(W3) + 15,000(W8))
Investment in associate
Current assets
35,000
(65,000 + 50,000 – 1,000(W6))
114,000
––––––
402,400
––––––
Equity and liabilities:
Rs 000
Equity Capital
50,000
Retained earnings
223,500
(W5)
Other components of equity (W7)
(2,700)
Noncontrolling interest (W4)
14,600
––––––
285,400
Noncurrent
liabilities
(25,000 + 18,000)
43,000
Current liabilities
(45,000 + 29,000)
74,000
––––––
402,400
––––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 358
Workings:
(W1)
Group structure
H
1 Oct X3
70%
1 Jan X2
60%
30 Sept X5
10%
30 Sept X5
(15%)
–––
Rep date
80%
S
–––
Rep date
45%
M
Note that H controls S from 1 October 20X3. The purchase of additional shares on 30
September 20X5 does not change this situation. An equity transfer is required
between the group and NCI to reflect the purchase of additional shares.
Note that H controls M from 1 January 20X2. The sale of shares on 30 September
20X5 results in a loss of control, on which a group gain or loss disposal should be
computed and included in the group statement of comprehensive income. The fair
value of the residual holding should be included in the calculation of the group gain or
loss on disposal and also as initial recognition of an associate as significant influence
is exercised following the loss of control.
(W2)
Net assets
Acquisition
Reporting
date
date
S
Rs 000
Rs 000
Share capital
20,000
20,000
Retained earnings
28,000
43,000
FVA – Land (45,000 – 40,000)
5,000
5,000
––––––
––––––
53,000
68,000
––––––
––––––
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(W3)
Acquisition
Disposal
date
date
M
Rs 000
Rs 000
Share capital
15,000
15,000
Retained earnings
15,000
42,000
––––––
––––––
30,000
57,000
––––––
––––––
Goodwill
S
Rs 000
FV of cost of gaining control
45,000
FV of NCI at acquisition
17,400
––––––
62,400
Less: FV of net assets at acquisition (W2)
(53,000)
––––––
Goodwill at acquisition – not impaired
9,400
––––––
M
Rs 000
FV of cost of gaining control
21,000
FV of NCI at acquisition
13,000
––––––
34,000
Less: FV of net assets at acquisition (W2)
(30,000)
––––––
Goodwill at acquisition – unimpaired at disposal date
4,000
––––––
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(W4)
Non – controlling interest
S
Rs 000
NCI at acquisition date (W3)
17,400
NCI share of postacq'n retained earnings
4,500
(30% × (Rs 68,000 – Rs 53,000) (W2))
–––––
NCI before equity transfer
21,900
Equity transfer due to purchase of additional shares by group (W7)
(7,300)
–––––
NCI at reporting date
14,600
–––––
M
Rs 000
NCI at acquisition date (W3)
13,000
NCI share of postacq'n retained earnings (40% × (Rs 57,000 –
10,800
Rs 30,000)(W2))
–––––
NCI at disposal date
23,800
–––––
(W5)
Retained earnings
Rs 000
H
185,000
Provision for unrealised profit (W6)
(1,000)
S (70% × Rs 15,000 (W2))
10,500
M (60% × Rs 27,000 (W2))
16,200
Gain on disposal of M (W8)
12,800
–––––––
223,500
–––––––
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(W6)
Provision for unrealised profits
Rs 000
Goods in inventory (1/2 × Rs 8,000)
4,000
–––––
Provision for unrealised profit
(25% × Rs 4,000) made by H
1,000
–––––
(W7)
Equity transfer between group and NCI
Rs 000
Cash paid by H to buy additional shares
10,000
Decrease in NCI (10/30 × Rs 21,900(W4))
7,300
–––––
Net decrease in equity of the group
2,700
–––––
Dr NCI (W4)
7,300
Dr Equity
2,700
Cr Investments (reversal of original
10,000
accounting for receipt of disposal proceeds)
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(W8)
Group gain/loss on disposal of M
Rs 000
Rs 000
Proceeds
15,000
Fair value of residual interest
35,000
––––––
Less: interest in M disposed of:
Net assets at disposal date (W2)
57,000
Unimpaired goodwill at disposal date (W3)
4,000
Gain on disposal of M (W8)
––––––
61,000
Less: NCI at disposal date (W5)
Group gain on disposal to retained earnings (W5)
(23,800)
(37,200)
––––––
––––––
12,800
––––––
At the reporting date, the residual investment is accounted for as an associate
at a deemed cost of Rs 35 million.
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9.
1)
Purchase of 20% of M Ltd shares
Rs
Cash paid
25,000
Decrease in NCI ((20% / 20%) x 20,000)
20,000
–––––
Decrease in equity
5.000
–––––
2)
Purchase of 5% of M Ltd shares
Rs
Cash paid
4,000
Decrease in NCI ((5% / 20%) x 20,000)
5,000
–––––
Increase in equity
1,000
–––––
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Advanced Financial Accounting and Corporate Reporting (Study Text)
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COMPLEX GROUP STRUCTURES
Chapter learning objectives
Upon completion of this chapter you will be able to:
Determine appropriate procedures to be used in preparing group financial statements:
•
apply the method of accounting for business combinations, including complex group
structures (vertical and D-shaped/ mixed groups)
•
apply the recognition and measurement criteria for identifiable acquired assets and
liabilities and goodwill in step acquisitions
•
determine the appropriate procedures to be used in preparing group financial
statements. Where parent has direct/indirect holding in sub-subsidiaries
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1
Complex Group Structures
1.1
Complex group structures exist where a subsidiary of a parent entity owns a majority
shareholding in another entity which makes that other entity also a subsidiary of the
parent entity.
Complex structures can be classified under two headings:
1.2
•
vertical groups
•
mixed groups.
Vertical groups
Definition
A vertical group arises where a subsidiary of the parent entity holds shares in a
further entity such that control is achieved. The parent entity therefore controls both
the subsidiary entity and, in turn, its subsidiary (often referred to as a sub-subsidiary
entity). Look at the two situations:
Situation 1:
Situation 2:
H
H
owns 90% of S
owns 70% of S
who, in turn, owns 80% of
who, in turn, owns 60% of
T
T
In both situations, H controls both S and also T there is a vertical group comprising
three entities. H has a controlling interest in entity S. S has a controlling interest in
entity T. H is therefore able to exert control over T by virtue of its ability to control S.
The normal consolidation principles and workings will be applied to consolidate a
vertical group. Goodwill must be calculated and non-controlling interests recognised
for each subsidiary in the group. Particular care will be needed to apply the holding
entity (H in the two situations above) effective interest in the sub-subsidiary (T in the
two situations above) in the workings.
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The narrative which follows explains and illustrates how the group effective interest
and non-controlling effective interest in a sub-subsidiary is determined, together with
workings to calculate goodwill, NCI and group retained earnings as required. There is
also explanation to determine when the sub-subsidiary becomes a member of the
group for consolidation.
Consolidation
Where a parent entity owns a controlling interest in a subsidiary, which in turn owns a
controlling interest in a sub-subsidiary, then the group accounts of the ultimate parent
entity must include the underlying net assets and earnings of both the subsidiary and
the sub-subsidiary companies.
Thus, both entities that are controlled by the parent are consolidated.
The basic techniques of consolidation are the same as seen previously, although
calculations of goodwill and the non-controlling interest become slightly more
complicated.
1.3
Effective shareholding and non-controlling interest
In the two situations identified opposite, H has a direct interest in S and an indirect
interest in T (exercised via S’s holding in T).
In situation 1, H has an effective interest of only 72% (90% × 80%) in T.
Nevertheless, T is a sub-subsidiary of H because H has a controlling interest in S
and S has a controlling interest in T. As H has an effective interest in T of 72%, it
follows that the non-controlling
interest in T is 28%. This can be analysed as follows:
%
Owned by outside shareholders in T
20
Owned by outside shareholders in H (100% – 90%) × 80%)
8
–––
Effective non-controlling interest in T
28
–––
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Similarly, in situation 2, H has an effective interest of just 42% (70% × 60%) in T.
Nevertheless, T is a sub-subsidiary of H because H has a controlling interest in S
and S has a controlling interest in T. As H has an effective interest in T of 42%, it
follows that the non-controlling interest in T is 58%. This can be analysed as follows:
%
Owned by outside shareholders in T
40
Owned by outside shareholders in H (100% – 90%) × 80%)
18
–––
Effective non-controlling interest in T
58
–––
The group effective interest in T will be used within the goodwill and group reserve
calculations for the sub-subsidiary. In situation 2, do not be put off by the fact that the
effective group interest in T is less than 50%, and that the effective non-controlling
interest in T is more than 50%. The effective interest calculations are the result of a
two-stage acquisition and are used to simplify the consolidation workings.
1.4
Group reserves
Only the group or effective percentage of each of the reserves of the sub-subsidiary
are included within group reserves. Often the only reserve will be retained earnings,
but there could be others, such as revaluation reserve.
1.5
Date of acquisition
The date of acquisition of each subsidiary is the date on which H gains control. If S
already held T when H acquired S, treat S and T as being acquired on the same day.
Consider the following situations to determine when the sub-subsidiary company, T,
becomes a member of the H group::
(1)
H acquired control of S on 1 January 2004; S subsequently acquired control
of another entity, T, on 1 July 2006.
(2)
H acquired control of S on 1 July 2006; S had already acquired control of
another entity, T, on 1 January 2004.
In the first situation, T does not come under the control of H until S acquires shares in
T – i.e. on 1 July 2006. In the second situation, H cannot gain control of T until S
acquires shares in T on 1 July 2006.
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To identify the date that the sub-subsidiary becomes a member of the group, include
the dates of share purchases within your group structure when answering questions:
the key date will be the later of the two possible dates of acquisition.
The following examples consider situations where:
(1)
the subsidiary is acquired by the parent first; the subsidiary later acquires the
sub-subsidiary, and
(2)
the parent acquires the subsidiary that already holds the sub-subsidiary
Example 1
Vertical Group
The draft statements of financial position of D, C and J, as at 31 December
20X4, are as follows:
D
C
J
D
Rs 000 Rs 000 Rs 000
Sundry assets
280
180
130
C
J
Rs 000 Rs 000 Rs 000
Equity capital 200
100
50
Retained
100
60
30
100
100
50
earnings
Cost of investment
120
80
Liabilities
––––
––––
––––
––––
––––
––––
400
260
130
400
260
130
––––
––––
––––
––––
––––
––––
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You ascertain the following:
1) D acquired 75,000 Rs 1 shares in C on 1 January 20X4 when the retained
earnings of C amounted to Rs 40,000. At that date, the fair value attributable
to the non-controlling interest in C was valued at Rs 38,000.
2) C acquired 40,000 Rs 1 shares in J on 30 June 20X4 when the retained
earnings of J amounted to Rs 25,000; they had been Rs 20,000 on the date of
D's acquisition of C. At that date, the fair value of the non-controlling interest in
J (both direct and indirect), based upon effective shareholdings, was valued at
Rs 31,000.
3) Goodwill has suffered no impairment
Required:
Produce the consolidated statement of financial position of the D group at 31
December 20X4. It is group policy to use the full goodwill method.
1.
Solution vertical group
Step 1 – Group structure
Draw a diagram of the group structure and set out the respective interests of the
parent entity and the non-controlling interests, distinguishing between direct (D) and
indirect (I) interests. You may find it useful to include on the diagram the dates of
acquisition of the subsidiary and the sub-subsidiary.
D
75% acquired 1 Jan X4
C
80% acquired 30 June X4
J
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Group and Non Controlling interests
C
J
Group interest
75%
60% (75% × 80%)
Non Controlling interest
25%
40% (25% × 80%)
–––––
–––––
100%
100%
–––––
–––––
Step 2
Start with the net assets consolidation working as normal.
Care must be taken in determining the date for the split between post-acquisition and
preacquisition retained earnings. The relevant date will be that on which D (the
parent company) acquired control of each entity:
•
C: 1 January 20X4
•
J: 30 June 20X4
Therefore, the information given regarding J’s retained earnings at 1 January 20X4 is
irrelevant in this context.
Net assets of subsidiaries
C
J
At acq'n
At rep date
At acq'n
At rep date
Rs
Rs
Rs
Rs
Equity capital
100,000
100,000
50,000
50,000
Reserves
40,000
60,000
25,000
30,000
–––––––
–––––––
––––––
––––––
140,000
160,000
75,000
80,000
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Step 3
Goodwill
•
A separate calculation is required to determine goodwill for each subsidiary.
•
For the sub-subsidiary, goodwill is calculated from the perspective of the
ultimate parent entity (D) rather than the immediate parent (C). Therefore, the
effective cost of J is only D's share of the amount that C paid for J, i.e. Rs
80,000 × 75% = Rs 60,000.
C
Rs 000
J
Rs 000
Cost of investment in subsidiary
120
60 (i.e. 75% × 80,000)
Fair value of NCI
38
31
FV of net assets (W2)
––––
––––
158
91
(140)
(75)
––––
––––
18
––––
16
––––
Step 4
Non-controlling interest
When taking the non-controlling share of C’s net assets, an adjustment must be
made to take out the cost of investment in J that is included in the net assets of C.
In the group statement of financial position, the cost of investment is replaced by
including all the net assets of J, so no investment must remain.
The non-controlling interest in C are entitled to their (indirect) share of the net assets
of J, but they receive these by virtue of the effective interest that will be used to
calculate the non-controlling interest in J.
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Rs 000
C: NCI FV at acquisition
38
C NCI share of postacq'n retained earnings (25% × 20,000)
5
Less: NCI share of cost of investment in J (25% × 80,000)
(20)
––––
23
J: NCI FV at acquisition
31
J NCI share of post acq'n retained earnings (40% × 5)
2
––––
56
––––
Step 5
Group retained earnings
Rs 000
D
100
C 75% × 20,000 (post-acquisition retained earnings)
15
J 60% × 5,000 (post-acquisition retained earnings)
3
––––
118
––––
Note that again, only the group or effective interest of 60% is taken of the postacquisition retained earnings of J.
Step 6
Summarised consolidated statement of financial position of D its subsidiary entities
as at 31 December 20X4
Rs
Goodwill (18,000 + 16,000)
34,000
Sundry assets (280,000 + 180,000 + 130,000)
590,000
–––––––
624,000
–––––––
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Equity and liabilities:
Equity capital
200,000
Retained earnings (Step 5)
118,000
–––––––
318,000
Non-controlling interest (Step 4)
56,000
–––––––
Total equity
374,000
Liabilities (100,000 + 100.000 + 50,000)
250,000
–––––––
624,000
–––––––
Example 2 – Vertical group 2
The draft statements of financial position of D, C and J as at 31 December 20X4 are as
follows:
D
C
J
D
Rs 000 Rs 000 Rs 000
Sundry
180
80
80
assets
Cost of Investment
120
80
C
J
Rs 000 Rs 000 Rs 000
Equity
capital
200
100
50
Retained
100
60
30
earnings
–––
–––
–––
–––
–––
–––
300
160
80
300
160
80
–––
–––
–––
–––
–––
–––
•
C acquired 4,000 Rs 10 shares in J on 1 January 20X4 when the retained
earnings of J amounted to Rs 25,000.
•
D acquired 7,500 Rs 10 shares in C on 30 June 20X4 when the retained
earnings of C amounted to Rs 40,000 and those of J amounted to Rs 30,000.
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It is group policy to value the non-controlling interest using the proportion of net
assets method.
Required:
Produce the consolidated statement of financial position of the D group at 31
December 20X4.
Solution vertical group 2
Solution
Assets:
Rs 000
Goodwill (W3) (15 + 12)
27
Assets (180 + 80 + 80)
340
–––––
367
–––––
Equity and liabilities:
Rs 000
Equity capital
200
Retained earnings (W5)
115
NCI (W4)
52
–––––
367
–––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
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(W1)
Group structure
Draw a diagram of the group structure and set out the respective interests of the
parent entity and the non-controlling interests, distinguishing between direct (D) and
indirect (I) interests. You may find it useful to include on the diagram the dates of
acquisition of the
subsidiary and the sub-subsidiary.
D
75% acquired 30 Jun X4
C
80% acquired 1 Jan X4
J
The relevant acquisition date for both entities is the date that they both joined the D
group, i.e. 30 June 20X4.
(W2)
Net assets for each subsidiary – remember correct date of acquisition
C
J
At
At
At
At
acquisition
reporting
acquisition
reporting
date
date
Rs
Rs
Rs
Rs
Share capital
100,000
100,000
50,000
50,000
Reserves
40,000
60,000
30,000
30,000
———
———
———
———
140,000
160,000
80,000
80,000
———
———
———
———
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(W3)
Goodwill – proportionate basis
Cost of investment
C
J
Rs 000
Rs 000
120
(75% × 80,000)
60
35
(40% × 80,000) (W2)
32
FV of NCI at acquisition:
(25% × 140,000) (W2)
FV of NA at acquisition (W2)
Goodwill
(W4)
———
———
155
92
(140)
(80)
———
———
15
12
———
———
NCI
Rs 000
FV of NCI at acquisition:(25% × 140,000) (W2)
35
Share of postacq'n RE ((25% × (160,000 – 140,000) (W2)
5
Rs 000
40
——
J:
FV of NA at acquisition: (40% × 80,000) (W2)
32
Share of postacq'n
RE ((40% × (80,000 – 80,000) (W2)
–
32
——
Less: NCI% of cost of investment by C in J (25% × 80,000)
(20)
——
52
——
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(W5)
Group retained earnings
Rs 000
D
100
C (75% × 20) (post-acquisition retained earnings)
15
J (no post-acquisition retained earnings)
–
––––
115
––––
2
Sub-associates
2.1
Sub-associates arise where in vertical group, parent has controlling interest in an
entity which in turns has a significant influence over another entity, such another
entity is sub-associate of parent group, Look at the situation below:
Situation 1:
H
owns 80% of S
who, in turn, owns 35% of
T
In the situation above, H has a direct interest in S and an indirect interest in T
(exercised via S’s holding in T).
In situation 1, H has an effective interest of only 28% (80% × 35%) in T.
Nevertheless, T is a sub-associate of H because H has a controlling interest in S and
S has significant influence in T.
Consolidation
In such situation, the consolidated statement of financial position of parent group
shall include:
•
100% of the assets and liabilities of the parent and subsidiary company on a
line by line basis and
Advanced Financial Accounting and Corporate Reporting (Study Text)
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•
an ‘investments in sub-associates’ line within non-current assets which
includes the Subsidiary’s interest in the assets and liabilities of any associate.
1) NCI of subsidiary shall include its share in sub-associate’s profit after tax.
The consolidated statement of comprehensive income shall include:
•
100% of the income and expenses of the parent and subsidiary company on
a line by line basis
•
one line ‘share of profit of sub-associates’ which includes the group share in
sub-associate’s profit after tax.
Example 3
Vertical Group 3- Sub-associate
The draft statements of financial position of D, C and J, as at 31 December 20X4, are
as follows:
D
C
J
D
Rs 000 Rs 000 Rs 000
Sundry assets
280
230
130
C
J
Rs 000 Rs 000 Rs 000
Equity capital 200
100
50
Retained
100
60
30
100
100
50
earnings
Investment
120
30
Liabilities
––––
––––
––––
––––
––––
––––
400
260
130
400
260
130
––––
––––
––––
––––
––––
––––
You ascertain the following:
2) D acquired 75,000 Rs 1 shares in C on 1 January 20X4 when the retained
earnings of C amounted to Rs 40,000. At that date, the fair value attributable
to the non-controlling interest in C was valued at Rs 38,000.
Advanced Financial Accounting and Corporate Reporting (Study Text)
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3) C acquired 15,000 Rs 1 shares in J on 30 June 20X4 when the retained
earnings of J amounted to Rs 25,000; they had been Rs 20,000 on the date of
D's acquisition of C.
4) Goodwill has suffered no impairment
Required:
Produce the consolidated statement of financial position of the D group at 31
December 20X4. It is group policy to use the full goodwill method.
1.
Solution vertical group
Step 1 – Group structure
Draw a diagram of the group structure and set out the respective interests of the
parent entity and the non-controlling interests, distinguishing between direct (D) and
indirect (I) interests. You may find it useful to include on the diagram the dates of
acquisition of the subsidiary and the sub-associate.
D
75% acquired 1 Jan X4
C
30% acquired 30 June X4
J
Group and Non Controlling interests
C
J
Group interest
75%
22.5%(75%x30%)
Non Controlling interest
25%
7.5%(25%x30%)
–––––
–––––
100%
30%
–––––
–––––
Step 2
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Page 381
Start with the net assets consolidation working.
Care must be taken in determining the date for the split between post-acquisition and
pre-acquisition retained earnings. The relevant date will be that on which D (the
parent company) acquired control or is capable to exert significant influence on each
entity:
•
C: 1 January 20X4
•
J: 30 June 20X4
Therefore, the information given regarding J’s retained earnings at 1 January 20X4 is
irrelevant in this context.
Net assets of subsidiary and sub-associate
C
J
At acq'n
At rep date
At acq'n
At rep date
Rs
Rs
Rs
Rs
Equity capital
100,000
100,000
50,000
50,000
Reserves
40,000
60,000
25,000
30,000
–––––––
–––––––
––––––
––––––
140,000
160,000
75,000
80,000
Step 3
Goodwill
•
A separate calculation is required to determine goodwill for subsidiary.
C
Rs 000
Cost of investment in subsidiary
120
Fair value of NCI
38
––––
158
FV of net assets
(140)
––––
18
––––
Step 4
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Non-controlling interest
The non-controlling interest in C are entitled to their (indirect) share of the post-acq
net assets of J, but they receive these using their own proportion which is
25%x30%=7.5%
Rs 000
C: NCI FV at acquisition
38
C NCI share of postacq'n retained earnings (25% × 20,000)
5
––––
43
J: NCI share of post-acq net assets (7.5%x5000)
0.375
––––
43.375
––––
Step 5
Group retained earnings
Rs 000
D
100
C 75% × 20,000 (post-acquisition retained earnings)
15
J 22.5% × 5,000 (post-acquisition retained earnings)
1.125
––––
116.125
––––
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Step 6
Investment in sub-associate
Rs 000
Cost of Investment
30
Share in post acq net assets(30%x5000)
1.5
––––
31.5
––––
Step 7
Summarised consolidated statement of financial position of D its subsidiary entities
as at 31 December 20X4
Rs
Goodwill
18,000
Sundry assets (280,000 + 230,000)
510,000
Investment in sub-associate
31500
–––––––
559,500
–––––––
Equity and liabilities:
Equity capital
200,000
Retained earnings (Step 5)
116,125
–––––––
316,125
Non-controlling interest (Step 4)
43,375
–––––––
Total equity
359,500
Liabilities (100,000 + 100.000)
200,000
–––––––
559,500
–––––––
3
Mixed (D-shaped) Groups
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3.1
Definition
In a mixed group situation the parent entity has a direct controlling interest in at least
one subsidiary. In addition, the parent entity and the subsidiary together hold a
controlling interest in a further entity.
e.g.
H
60%
30%
S
T
30%
•
H controls 60% of S; S is therefore a subsidiary of H.
•
H controls 30% of T directly and another 30% indirectly via its interest in S. T
is therefore a sub-subsidiary of the H group. H has control of 60%, either
directly or indirectly, of the shares in T and is therefore able to control it.
Date of Acquisition
As with the vertical group structure considered earlier in this chapter, identify the
dates of the respective share purchases to help determine the date when the entity at
the bottom of the group (often, but not always a sub-subsidiary) becomes a member
of the group. Using the example of H, S & T above, if dates of share purchases are
added as follows:
Suppose H acquired a 60% interest in S on 1 January 2004, and acquired its 30%
interest on the same date. S subsequently acquired its 30% interest in T on 1 July
2006.
Initially, from 1 January 2004, H exercises significant influence over T as an
associate entity. It is only from 1 July 2006 that H has access to more than 50% of
the voting power in T; T is therefore consolidated into the H group accounts as a
subsidiary from 1 July 2006.
Advanced Financial Accounting and Corporate Reporting (Study Text)
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Alternatively, suppose H acquired a 60% interest in S on 1 January 2006, and
acquired its 30% interest on the same date. S acquired its 30% interest in T on 1 July
2004.
Initially, from 1 January 2004, S exercises significant influence over T as an associate entity.
It is only from 1 July 2006 that H has access to more than 50% of the voting power in T; T is
therefore consolidated into the H group accounts from 1 July 2006.
Consolidation
All three entities in the above mixed group are consolidated. The approach is similar
to dealing with sub-subsidiaries, i.e. an effective interest is computed and used to
allocate share capital and retained earnings.
From the example above:
S
T
Group share
60%
NCI
40%
Group share
Direct
30%
Indirect
18%
–––––
Total
48%
NCI
52%
All consolidation workings are the same as those used in vertical group situations,
with the exception of goodwill.
The goodwill calculation for the sub-subsidiary differs in that two elements to cost
must be considered, namely:
•
the cost of the parent’s direct holding
1) the parent’s percentage of the cost of the subsidiary’s holding (the indirect
holding).
Example 4 – Mixed (D-shaped)
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 386
The statements of financial position of H, S and M as at 31 December 20X5 were as
follows:
H
S
M
Rs
Rs
Rs
4,500 shares in S
72,000
1,600 shares in M
25,000
1,200 shares in M
Sundry assets
20,000
125,000
120,000
78,000
–––––––
–––––––
–––––––
222,000
140,000
78,000
–––––––
–––––––
–––––––
Equity share capital (Rs 10 shares)
120,000
60,000
40,000
Retained earnings
95,000
75,000
35,000
Liabilities
7,000
5,000
3,000
–––––––
–––––––
–––––––
222,000
140,000
78,000
–––––––
–––––––
–––––––
All shares were acquired on 31 December 20X2 when the retained earnings of S
amounted to Rs 30,000 and those of M amounted to Rs 10,000.
It is group accounting policy to value non-controlling interest on a proportionate basis.
Required:
Prepare the statement of financial position for the H group at 31 December 20X5.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 387
Solution
Group statement of financial position – H group at 31 December 20X5
Rs
Intangible – goodwill (4,500 + 8.750) (W3)
13,250
Sundry assets (125,000 + 120,000 + 78,000)
323,000
––––––––
336,250
––––––––
Equity and liabilities:
Rs
Equity share capital
120,000
Retained earnings (W5)
144,375
Non-controlling interest (W4)
56,875
––––––––
Total equity
321,250
Liabilities (7,000 + 5,000 + 3,000)
15,000
––––––––
336,250
––––––––
(W1)
Determine group structure:
In S: 4,500 / 6,000 × 100% =
75%
–––––
In M
Direct
1,600 / 4,000 × 100% =
40.0%
Indirect
75% × 1,200 / 4,000 × 100% =
22.5%
–––––
62.5%
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 388
(W2)
Net assets
S
At acq'n
(W2)
Rs
Net assets of Rs & M
M
At rep date
At acq'n
At rep date
Rs
Rs
Rs
Equity capital
60,000
60,000
40,000
40,000
Retained earnings
30,000
75,000
10,000
35,000
––––––
––––––
––––––
––––––
90,000
135,000
50,000
75,000
––––––
––––––
––––––
––––––
(W3)
Goodwill S & M
Rs
Cost of investment
72,000
Rs
Direct
Indirect
FV of NCI at acquisition
(25% × 90)
25,000
(75% × 20)
15,000
(37.5% × 50)
18,750
22,500
––––––
––––––
94,500
58,750
(90,000)
(50,000)
––––––
______
4,500
8,750
––––––
––––––
Less: FV of NA at
acquisition (W2)
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 389
(W4)
Non-controlling interest
Rs
S – FV of NCI at acquisition
22,500
Share of post acqu'n retained
(25% × (135,000 –
Earnings
90,000)) (W2)
11,250
M – FV of NCI at acquisition
18,750
37.5% × Rs 75,000 (W2)
Share of post acqu'n retained
(37.5% × (75,000 –
Earnings
50,000)) (W2)
Less: NCI share of S cost of
(25% × Rs 20,000)
9,375
(5,000)
investment in M
–––––
56,875
–––––
(W5)
Retained earnings
Rs
H
95,000
S – (75% × (135,000 – 90,000)) (W2)
33,750
M – (62.5% × (75,000 – 50,000)) (W2)
15,625
––––––
144,375
––––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 390
Example 5 – Excellence
The Excellence Group carries on business as a distributor of warehouse equipment
and importer of fruit. Excellence is a listed entity and was incorporated over 20 years
ago to distribute warehouse equipment. Since then the group has diversified its
activities to include the import and distribution of fruit, and it expanded its operations
by the acquisition of shares in Melon in 20X1 and in Kiwi in 20X3, both listed entities.
Accounts for all entities are prepared up to 31 December.
The draft statements of comprehensive income for Excellence, Melon and Kiwi for
the year ended 31 December 20X6 are as follows:
Excellence
Melon
Kiwi
Rs 000
Rs 000
Rs 000
45,600
24,700
(18,050)
(5,463)
(5,320)
––––––
––––––
––––––
Gross profit
27,550
19,237
17,480
Distribution costs
(3,325)
(2,137)
(1,900)
Administrative expenses
(3,475)
(950)
(1,900)
––––––
––––––
––––––
20,750
16,150
13,680
(325)
−
−
––––––
––––––
––––––
Profit before tax
20,425
16,150
13,680
Tax
(8,300)
(5,390)
(4,241)
––––––
––––––
––––––
12,125
10,760
9,439
––––––
––––––
––––––
Excellence
Melon
Kiwi
13,315
10,459
Revenue
Cost of sales
Profit from operations
Finance costs
Profit for the period
800
22,
Notes
Dividends paid in the year
9,500
Retained earnings brought forward
20,013
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 391
The draft statements of financial position as at 31 December 20X6 are as follows:
Excellence
Melon
Kiwi
Rs 000
Rs 000
Rs 000
35,483
24,273
13,063
6,650
−
−
−
3,800
−
1,568
9,025
8,883
––––––
––––––
––––––
43,701
37,098
21,946
––––––
––––––
––––
Equity shares (Rs 10)
8,000
3,000
2,000
Retained earnings
22,638
24,075
19,898
––––––
––––––
––––––
Total equity
30,638
27,075
21,898
Sundry liabilities
13,063
10,023
48
––––––
––––––
––––––
43,701
37,098
21,946
––––––
––––––
––––––
Assets:
Non-current
assets (NBV)
Investments:
Shares in Melon
Shares in Kiwi
Current assets
Total assets
Equity and liabilities:
Total equity and liabilities
The following information is available relating to Excellence, Melon and Kiwi:
(1)
On 1 January 20X1 Excellence acquired 270,000 Rs 10 equity shares in
Melon for Rs 6,650,000 at which date there was a credit balance on the
retained earnings of Melon of Rs 1,425,000. No shares have been issued by
Melon since Excellence acquired its interest.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 392
(2)
On 1 January 20X3 Melon acquired 160,000 Rs 10 equity shares in Kiwi for
Rs 3,800,000 at which date there was a credit balance on the retained
earnings of Kiwi of Rs 950,000. No shares have been issued by Kiwi since
Melon acquired its interest.
(3)
During 20X6, Kiwi had made intercompany sales to Melon of Rs 480,000
making a profit of 25% on cost and Rs 75,000 of these goods were in
inventory at 31 December 20X6.
(4)
During 20X6, Melon had made intercompany sales to Excellence of Rs
260,000 making a profit of 33⅓% on cost and Rs 60,000 of these goods were
in inventory at 31 December 20X6.
(5)
On 1 November 20X6 Excellence sold warehouse equipment to Melon for Rs
240,000 from inventory. Melon has included this equipment in its Non-current
assets. The equipment had been purchased on credit by Excellence for Rs
200,000 in October 20X6 and this amount is included in its liabilities as at 31
December 20X6.
(6)
Melon charges depreciation on its warehouse equipment at 20% on cost. It is
company policy to charge a full year’s depreciation in the year of acquisition
to be included in the cost of sales.
(7)
It is group policy to account for non-controlling interest on a proportionate
basis. Since acquisition, the goodwill of Melon has been fully written off as a
result of an impairment review which took place two years ago. The goodwill
of Kiwi has been impaired 60% by 31 December 20X5 and a further 50% of
the remaining balance of goodwill was impaired in the year ended 31
December 20X6.
Required:
(a)
Prepare a consolidated statement of comprehensive income for the
Excellence Group for the year ended 31 December 20X6 including a
reconciliation of retained earnings for the year.
(b)
Prepare a consolidated statement of financial position as at that date
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 393
Solution Excellence
(a)
Consolidated statement of comprehensive income for the year ended 31
December 20X6
Excellence
Melon
Kiwi
Adjusts
SOCI
Rs 000
Rs 000
Rs 000
Rs 000
Rs 000
Revenue
45,600
24,700
22,800
(980) )
92,120
Cost of sales
(18,150)
(5,463)
(5,320)
(740) )
Cost re equipment sale
200
URPS made by Melon and Kiwi (W5)
(27.915)
(15)
Excess dep'n adj (W6)
(15)
8
––––––
Gross profit
64,205
Distribution costs
(3,325)
(2,137)
(1,900)
(7,362)
Administration expenses
(3,475)
(950)
(1,900)
(6,325)
Goodwill impaired (W3)
(259)
––––––
Profit from operations
50,259
Finance costs
(325)
(325)
––––––
Profit before tax
Tax
(8,300)
Profit for the period
49,9
(5,390)
(4,241)
(17,931)
––––––
–––––
––––––
10,753
9,424
32,003
––––––
–––––
––––––
Attributable to:
Equity holders of the parent (bal fig)
28,289
Non-controlling interests (W8)
3,714
––––––
32,003
––––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 394
Reconciliation of retained earnings:
Retained earnings brought forward (W9)
34,115
Profit for the period
28,289
Dividends paid
(9,500)
––––––
Retained earnings carried forward
52,904
––––––
(b)
Consolidated statement of financial position as at 31 December 20X6
Rs 000
Assets:
Non-current
assets (35,483 + 24,273 + 13,063 – 32 (W6))
Goodwill (W3)
Current assets (1,568 + 9,025 + 8,883 – 30)
72,787
259
19,446
––––––
Total assets
92,492
––––––
Equity and liabilities:
Rs 10 equity shares
8,000
Group retained earnings (W7)
52,904
––––––
60,904
Non-controlling interest (W4)
8,454
––––––
Total equity
69,358
Sundry liabilities:(13,063 + 10,023 + 48)
23,134
––––––
Total equity and liabilities
92,492
––––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 395
Workings
(W1)
Group structure
=
90%
Excellence
90%
Effective interest of Excellence in
Kiwi (90% x 80%) =72%
Melon
Effective NCI in Kiwi =28%
80%
=
(W2)
80%
Kiwi
Net assets
At date of acquisition
At reporting date
Rs 000
Rs 000
Rs 000
Rs 000
Melon
Equity capital
Retained earnings
3,000
1,425
3,000
24,075
Excess depreciation (W6)
8
Unrealised profit (W5)
(15)
––––––
––––––
1,425
24,068
––––––
––––––
4,425
27,068
––––––
–––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 396
At date of acquisition
At reporting date
Rs 000
Rs 000
Rs 000
Rs 000
Kiwi
Equity capital
Retained earnings
2,000
950
19,898
Unrealised profit (W5)
(W3)
2,000
(15)
––––––
––––––
950
19,883
––––––
––––––
2,950
21,883
––––––
––––––
Goodwill
Cost of investment to the group
In Melon
In Kiwi
Rs 000
Rs 000
6,650
90% × 3,800
Melon: NCI% of CV of NA at acq'n (10% × 4425)(W2)
3,420
4442
Kiwi: NCI% of CV of NA at acq'n (28% × 950)(W2)
826
––––––
–––––
7,092
4,246
Fair value of all net assets at acquisition:
Melon: (W2)
(4,425)
Kiwi: (W2)
Impairment – in previous years (100%) / 60%
Impairment current year (50% × 518) (I/S)
Advanced Financial Accounting and Corporate Reporting (Study Text)
(2,950)
––––––
–––––
2,667
1,296
(2,667)
(778)
––––––
–––––
−
518
−
(259)
Page 397
Statement of financial position
Charged against retained earnings
––––––
–––––
−
259
––––––
–––––
2,667
1,037
(W4) Non-controlling Interest – proportionate basis for both subsidiaries
Melon
CV of NCI at acquisition (10% × 4,425) (W2)
442.5
Share of postacq'n retained earnings
(10% × (27,068 – 4,425)) (W2)
2264.3
–––––
(rounded)
2,707
Kiwi (use effective interest %)
CV of NCI at acquisition (28% × 2,950) (W2)
826
Share of post-acq'n retained earnings
(28% × (21,883 – 2,950)) (W2)
5,301
Less: NCI share of cost of investment by melon in Kiwi
(10% × 3,800)
(380)
–––––
8,454
–––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 398
(W5)
Unrealised profit in inventory
Kiwi – Melon
75,000 × 25 ÷ 125
= 15,000
Melon – Excellence
60,000 × 33 1/3
= 15,000
1331/3
(W6)
Intercompany transfers of Non-current assets
Excellence – Melon
240,000
Therefore Excellence has made an unrealised profit.
Debit group statement of comprehensive income
40,000
Credit group Non-current assets
40,000
Total intra-group revenues (480 + 260 + 240) = Rs 980,000
Total intra-group adjustment to cost of sales (480 + 260)
= Rs 740,000
Total intra-group addition to NCA re equipt sold by Excellence to Melon = Rs 240,000
when original cost was Rs 200,000.
Depreciation is charged on Rs 240,000 at 20% on cost (i.e. Rs 48,000 each year).
This should be charged in the group accounts at 20% on Rs 200,000 (i.e. Rs 40,000).
Therefore Rs 8,000 extra depreciation has been charged each year and must be
added back.
Debit depreciation group
8,000
Credit statement of comprehensive income group
8,000
Therefore net impact Rs 40,000 – Rs 8,000 =
32,000
Net Non-current assets credit
32,000
Statement of comprehensive income debit
32,000
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 399
(W7)
Consolidated retained earnings carried forward
Rs 000
All of Excellence
Per the question
Unrealised profit (W6)
22,638
(40)
––––––
22,598
Share of Melon
90% (24,068 – 1,425) (W2)
20,378
Share of Kiwi
72% (19,883 – 950) (W2)
13,632
Goodwill impairment (2,667 + 1,037) (W3)
(3,704)
––––––
52,904
––––––
(W8)
Non-controlling interest in profit
Melon (10,753 × 10%)
1075
Kiwi’s profit (9,424 × 28%)
2,639
–––––
3,714
–––––
(W9) Consolidated retained earnings brought forward
Rs 000
All of Excellence
20,013
Share of Melon
90% (13,315 – 1,425) (W2)
10,701
Share of Kiwi
72% (10,459 – 950) (W2)
6,846
Goodwill impairment (2,667 + 778) (W3)
(3,445)
––––––
34,115
––––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 400
Chapter Summary
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 401
Self-Test Questions
1.
The following are the statements of financial position at 31 December 20X7 for H
group companies:
4,500 shares in S
H
S
T
Rs
Rs
Rs
65,000
3,000 shares in T
Sundry assets
55,000
280,000
133,000
100,000
–––––––
–––––––
–––––––
345,000
188,000
100,000
–––––––
––––––
–––––––
Equity share capital (Rs 10 shares)
100,000
60,000
50,000
Retained earnings
45,000
28,000
25,000
Liabilities
200,000
100,000
25,000
–––––––
–––––––
–––––––
345,000
188,000
100,000
–––––––
–––––––
–––––––
The intercompany shareholdings were acquired on 1 January 20X1 when the
retained earnings of S were Rs 10,000 and those of T were Rs 8,000. At that date,
the fair value of the non-controlling interest in S was Rs 20,000. The fair value of the
total non-controlling interest (direct and indirect) in T was Rs 50,000. It is group policy
to value the non-controlling interest using the full goodwill method. At the reporting
date, goodwill is fully impaired and had been written off in an earlier year.
Required:
Prepare the consolidated statement of financial position for the H group at 31
December 20X7.
2.
Grape purchased 4,000 of the 5,000 Rs 10 shares in Vine on 1 July 20X5, when the
retained earnings of that entity were Rs 80,000. At that time, Vine held 750 of the
1,000 Rs 10 shares in Wipe. These had been purchased on 1 January 20X5 when
Wipe’s retained earnings were Rs 65,000. On 1 July 20X5, Wipe’s retained earnings
were Rs 67,000.
At 1 July 20X5, the fair value of the non-controlling interest in Vine was Rs 27,000,
and that of Wipe (both direct and indirect) was Rs 31,500.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 402
Statements of financial position of the three entities at 30 June 20X6 were as follows:
Grape
Vine
Wipe
Rs 000
Rs 000
Rs 000
Investment
110
60
Sundry assets
350
200
120
––––
––––
––––
460
260
120
––––
––––
––––
Equity share capital
100
50
10
Retained earnings
210
110
70
Liabilities
150
100
40
––––
––––
––––
460
260
120
––––
––––
––––
Net assets
Required:
Prepare the consolidated statement of financial position for Grape group at 30 June
20X6. It is group policy to value the non-controlling interest using the full goodwill
method.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 403
3.
T, S & R
The following are the summarised statements of financial position of T, S and R as at
31 December 20X4.
T
S
R
Rs
Rs
Rs
Non-current assets
140,000
61,000
170,000
Investments
200,000
65,000
–
Current assets
20,000
20,000
15,000
–––––––
–––––––
–––––––
360,000
146,000
185,000
–––––––
–––––––
–––––––
Equity shares of Rs 10 each
200,000
80,000
100,000
Retained earnings
150,000
60,000
80,000
Liabilities
10,000
6,000
5,000
–––––––
–––––––
–––––––
360,000
146,000
185,000
–––––––
–––––––
–––––––
On 1 January 20X3 S acquired 3,500 ordinary shares in R at a cost of Rs 65,000
when the retained earnings of R amounted to Rs 40,000.
On 1 January 20X4 T acquired 6,400 shares in S at a cost of Rs 120,000 and 4,000
shares in R at a cost of Rs 80,000. The retained earnings of S and R amounted to Rs
50,000 and Rs 60,000 respectively on 1 January 20X4. The fair value of the NCI in S
at that date was Rs 27,000. The fair value of the whole (direct and indirect) NCI in R
was Rs 56,000. The non-controlling interest is measured using the full goodwill
method. At the reporting date, goodwill has not been impaired.
Required:
Prepare the consolidated statement of financial position of the T group as at 31
December 20X4.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 404
Answers
1
– H, S & T
Consolidated statement of financial position as at 31 December 20X7
Rs
Sundry net assets (280,000 + 133,000 + 100,000)
513,000
–––––––
Equity and liabilities
Equity share capital
100,000
Retained earnings (W5)
39,938
NCI (W4)
48,062
Liabilities (200,000 + 100,000 + 25,000)
325,000
–––––––
513,000
–––––––
(W1)
Group structure
H
4.5/6 = 75%
S
3/5 = 60%
T
Consolidation
%
S: Group share
75%
NCI
25%
T: Group share 75% of 60%
45%
NCI
60% =)
55%
Advanced Financial Accounting and Corporate Reporting (Study Text)
(40% directly plus (25% ×
15% indirectly)
Page 405
(W2)
Net assets
S
(W3)
T
At
At
At
At
acq'n
rep date
acq'n
rep date
Rs
Rs
Rs
Rs
Equity capital
60,000
60,000
50,000
50,000
Retained earnings
10,000
28,000
8,000
25,000
––––––
––––––
––––––
––––––
70,000
88,000
58,000
75,000
––––––
––––––
––––––
––––––
Goodwill
S
T
Rs
Rs
Consideration paid
65,000
55,000
FV of NCI
20,000
50,000
Indirect Holding Adjustment (25% × Rs 55,000)
(13,750)
––––––
––––––
85,000
91,250
(70,000)
(58,000)
––––––
––––––
15,000
33,250
––––––
––––––
Group share (75%:45%)
(11,250)
(14,962)
NCI share (25%:55%)
(3,750)
(18,288)
––––––
––––––
Nil
Nil
––––––
––––––
FV of NA at acquisition
Goodwill at acquisition
Less: allocation of impairment based upon
shareholdings
Goodwill at reporting date
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 406
(W4)
Non-controlling interest
Rs
S – FV at date of acquisition
20,000
S – NCI share of postacq'n retained earnings (25% × 18,000)
4,500
T – FV at date of acquisition
50,000
T – NCI share of postacq'n retained earnings (55% × 17,000)
9,350
Indirect Holding Adjustment (25% × 55,000)
(13,750)
––––––
70,100
Less NCI share of goodwill impairment re S & T (3,750 +
18,288) (W3)
(22,038)
––––––
Total for CSFP
48,062
––––––
(W5)
Consolidated retained earnings
Rs
Retained earnings of H
45,000
Group share of post-acquisition
retained earnings or change in net assets
S (75% × 18,000)
13,500
T (45% × 17,000)
7,650
Goodwill impaired (11,250 + 14,962) (W3)
(26,212)
––––––
39,938
––––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 407
2
Grape, Vine and Wipe
Consolidated statement of financial position as at 30 June 20X6
Rs
Goodwill (7,000 + 2,500 (W3))
9,500
Sundry assets (350,000 + 200,000 + 120,000)
670,000
–––––––
679,500
–––––––
Equity and liabilities
Rs
Equity share capital
100,000
Retained earnings (W5)
235,800
Non-controlling interest (W4)
53,700
Liabilities (150,000 + 100,000 + 40,000)
290,000
–––––––
679,500
–––––––
(W1)
Group structure
Consolidation
%
Vine Group share
80%
NCI
20%
Wipe Group share 80% of 75%
60%
NCI
75% =)
40%
Advanced Financial Accounting and Corporate Reporting (Study Text)
(25% directly plus (20% ×
15% indirectly)
Page 408
(W2)
Net assets
Vine
Wipe
At
At
At
At
acq'n
reporting
acq'n reporting
date
date
Rs
Rs
Rs
Rs
Equity capital
50,000
50,000
10,000
10,000
Retained earnings
80,000
110,000
67,000
70,000
–––––––
–––––––
––––––
––––––
130,000
160,000
77,000
80,000
–––––––
–––––––
––––––
––––––
The acquisition date for both entities is the date they joined the Grape group,
i.e. 1 July 20X5.
(W3)
Goodwill – full basis
Vine
Wipe
Rs
Rs
Consideration paid
110,000
60,000
FV of NCI
27,000
31,500
Indirect holding adjustment (20% × Rs 60,000)
FV of net assets at acquisition (W2)
Goodwill – full basis
Advanced Financial Accounting and Corporate Reporting (Study Text)
(12,000)
–––––––
––––––
137,000
79,500
(130,000)
(77,000)
–––––––
––––––
7,000
2,500
–––––––
––––––
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(W4)
Non-controlling interest
Rs
V – FV of NCI at date of acquisition
27,000
V – NCI share of post acq'n retained earnings (20% × 30,000)
6,000
W – FV of NCI at date of acquisition
31,500
W – NCI share of post acq'n retained earnings (40% × 3,000)
1,200
Indirect Holding Adjustment (20% × 60,000)
(12,000)
––––––
53,700
––––––
(W5)
Consolidated retained earnings
Rs
Retained earnings of Grape
210,000
Group share of post-acquisition retained earnings
V (80% × Rs 30,000)
24,000
W (60% × Rs 3,000)
1,800
–––––––
235,800
–––––––
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3
– T, S & R
T consolidated statement of financial position as at 31 December 20X4
Rs
Intangible fixed assets: goodwill (17,000 + 28,000(W3))
45,000
Non-current assets (140,000 + 61,000 + 170,000)
371,000
Current assets (20,000 + 20,000 + 15,000)
55,000
–––––––
471,000
–––––––
Rs
Equity share capital
200,000
Group retained earnings (W5)
171,600
–––––––
371,600
Non-controlling (W4)
78,400
Liabilities (10,000 + 6,000 + 5,000)
21,000
–––––––
471,000
–––––––
(W1)
Group structure
T has a controlling interest in both S and R as follows:
Interest in S
T
NCI
Interest in R
80%
20%
T – direct
40%
T – indirect (80% × 35%)
28%
NCI
68%
32%
_____
_____
100%
100%
_____
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_____
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(W2)
Net assets of S and R
S
R
At acq'n
At rep date
At acq'n At rep date
Rs
Rs
Rs
Rs
Equity share capital
80,000
80,000
100,000
100,000
Retained earnings
50,000
60,000
60,000
80,000
–––––––
–––––––
–––––––
–––––––
130,000
140,000
160,000
180,000
–––––––
–––––––
–––––––
–––––––
T's acquisition date for both entities is 1 January 20X4.
(W3
Goodwill – S Fair value (full goodwill) method
Rs
Consideration paid
120,000
FV of NCI
27,000
–––––––
147,000
FV of net assets at acquisition (W2)
(130,000)
–––––––
Total Goodwill
17,000
–––––––
Goodwill – R
Rs
Direct purchase consideration
80,000
Indirect purchase consideration (80% × 65,000)
52,000
Fair value of NCI at acquisition
56,000
–––––––
188,000
FV of net assets at acquisition (W2)
(160,000)
–––––––
Full goodwill
28,000
–––––––
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(W4)
Non-controlling interest
Rs
S – FV of NCI at acquisition
27,000
S – NCI share of post-acquisition retained earnings
(20% × 10,000)
2,000
Less NCI share of S cost of investment in R (20% × 65,000)
(13,000)
R – FV of NCI at acquisition
56,000
R – NCI share of post-acquisition retained earnings (32% × 20,000)
6,400
––––––
Total NCI to SOFP
78,400
––––––
(W5)
Group retained earnings
Rs
T
150,000
S (share of post-acquisition retained earnings)
80% × Rs 10,000
8,000
R (share of post-acquisition retained earnings)
68% × Rs 20,000
13,600
–––––––
171,600
–––––––
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GROUP ACCOUNTING – FOREIGN CURRENCY
Chapter learning objectives
Upon completion of this chapter you will be able to:
1) Outline and apply the principles for translating foreign currency amounts,
including translations into the functional currency and presentation currency
2) Account for the consolidation of foreign operations and their disposal.
3) Understand how to report operating results and financial position of companies
exisiting in hyperinflationary economy in accordance with IAS 29
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1
IAS 21 The Effects of Changes in Foreign Exchange Rates:
1.1
IAS 21 deals with:
•
the definition of functional and presentation currencies
•
accounting for individual transactions in a foreign currency
•
translating the financial statements of a foreign operation.
1.2
Functional and presentation currencies:
Functional Currency:
The functional currency is the currency an entity will use in its day-to-day transactions.
IAS 21 also identifies that that an entity should consider the following factors in
determining its functional currency:
•
The currency in which funding from issuing debt and equity is generated.
•
The currency in which receipts from operating activities are usually retained.
Let us consider an example to illustrate this point. Entity A operates in the USA. It sells
goods throughout the USA and Europe with all transactions denominated in dollar. Cash is
received from sales in dollar. It raises finance locally from US banks with all loans
denominated in dollar.
Looking at the factors listed above it is apparent that the functional currency for Entity A is
dollar. It trades in this currency and raises finance in this currency.
Therefore Entity A would record its accounting transactions in dollar as its functional
currency.
One complication in determining functional currency arises if an entity is a foreign operation.
For example, if Entity A (from above) has a subsidiary Entity B located in Europe, Entity B
will also have to determine its functional currency. The question arises as to whether this will
be the same as the parent or will be the local currency where Entity B is located.
The factors that must be considered are:
•
whether the activities of the foreign operation are carried out as an extension
of the parent, rather than with a significant degree of autonomy
•
whether transactions with the parent are a high or low proportion of the
foreign operation’s activities
•
whether cash flows from the foreign operation directly affect the cash flows of
the parent and are readily available for remittance to it
Advanced Financial Accounting and Corporate Reporting (Study Text)
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•
whether cash flows from the activities of the foreign operation are sufficient to
service existing debt obligations without funds being made available by the
parent.
So, continuing with the example above, if Entity B operates as an independent
operation, generating income and expenses in its local currency and raising finance
in its local currency, then its functional currency would be its local currency and not
that of Entity A. However, if Entity B was merely an extension of Entity A, only selling
goods imported from Entity A and remitting all profits back to Entity A, then the
functional currency should be the same as the parent. In this case Entity B would
record its transactions in dollar and not its local currency.
Once a functional currency is determined it is not changed unless there is a change
in the underlying circumstances that were relevant when determining the original
functional currency.
Presentation Currency:
The presentation currency is the currency in which the entity presents its financial
statements. This can be different from the functional currency, particularly if the entity
in question is a foreign-nowned subsidiary. It may have to present its financial
statements in the currency of its parent, even though that is different from its own
functional currency.
IAS 21 states that whereas an entity is constrained by the factors listed above in
determining its functional currency, it has a completely free choice as to the currency
in which it presents its financial statements. If the presentation currency is different
from the functional currency, then the financial statements must be translated into the
presentation
currency. For example, a group may have subsidiaries whose functional currencies
are different to that of the parent. These must be translated into the presentation
currency so that the consolidation procedure can take place.
1.3
Accounting for individual transactions in a foreign currency:
Where an entity enters into a transaction denominated in a currency other than its
functional currency, that transaction must be translated into the functional currency
before it is recorded
Examples of foreign currency transactions:
Whenever a business enters into a contract where the consideration is expressed in
a foreign currency, it will be necessary to translate that foreign currency amount at
some stage into the functional currency for inclusion into its own accounts. Examples
include:
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•
imports of raw materials
•
exports of finished goods
•
importation of foreign-manufactured non-current assets
•
investments in foreign securities
•
raising an overseas loan.
The exchange rate used should be:
•
the spot exchange rate on the date the transaction occurred
•
an average rate over a period of time, providing the exchange rate has not
fluctuated significantly.
Cash settlement:
When cash settlement occurs, for example payment by a receivable, the settled
amount should be translated using the spot exchange rate on the settlement date. If
this amount differs from that used when the transaction occurred, there will be an
exchange difference.
Exchange differences on settlement:
These must be recognised in profit or loss in the period in which they arise.
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Illustration:
Exchange differences on settlement
On 7 May 20X6 an entity sells goods to a foreign entity for FC 48,000 when the rate
of exchange was Rs 1 = FC 3.2
To record the sale:
Rs
Dr Customer FC 48,000 @ 3.2
15,000
Cr Sales
15,000
On 20 July 20X6 the customer remitted a draft for FC 48,000 when the rate of
exchange was Rs 1 = FC 3.17.
Rs
Dr Bank FC 48,000 @ 3.17
15,142
Cr Customer
15,000
Cr Statement of Comprehensive Income (exchange gain)
142
Rs 142 exchange gain forms part of the profit for the year.
2
Treatment of Year-End Balances:
2.1
The treatment of any ‘foreign’ items remaining in the statement of financial position at
the yearend will depend on whether they are classified as monetary or non-monetary:
2.2
Exchange differences on retranslation of monetary items:
These must be recognised in profit or loss in the period in which they arise.
Illustration:
Non-Monetary Items
An entity purchases plant, for its own use, from a foreign supplier on 30 June 20X7
for cash of FC 90,000 when the rate of exchange was Rs 1 = FC 1.80.
The asset is recorded at Rs 50,000 (FC 90,000 @ 1.80)
Dr Non-current asset
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Rs 50,000
Page 419
Cr Cash
Rs 50,000
No further translation will occur. All depreciation charged on this asset will be based
on
Rs 50,000
3
Translating the financial statements of a foreign operation:
3.1
Where a subsidiary entity’s functional currency is different from the presentation
currency of its parent, its financial statements must be translated into the parent’s
presentation currency prior to consolidation.
The following exchange rates should be used in the translation:
Statement of comprehensive income:
Income
( At the rate for each transaction or, as an approximation, the
Expenses
average rate for the year)
Statement of financial position:
Assets and liabilities
At the closing rate
Share capital
At the closing rate
Pre-acquisition reserves
rate on reporting date
Post-acquisition reserves
rate on reporting date
The balancing figure that makes up the post-acquisition reserves includes the
exchange difference for the year and prior post-acquisition years. This amount
should be disclosed as a component of other comprehensive income and, following
amendment of IAS 1 in June 2011, should be identified within other comprehensive
income as an item that may be reclassified to profit or loss in a subsequent year. It
should also be accumulated each year and disclosed as a separate component
within equity. The following section deals with its calculation
3.2
Exchange difference arising on translation of accounts:
Exchange differences arise because items are translated at different points in time at
different rates of exchange.
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The exchange difference arising on translation of foreign currency accounts arises as
follows:
Opening net assets
+ Profit
These were translated at
Revenue and expenses
last year's closing rate
are translated within the
(CR) for the purpose of
Statement of Comprehensive
Income at the
last year's accounts. For
the purpose of this year's
accounts they are included
within closing net assets at
this year's closing rate.
3.3
= Closing net assets
average rate. The profit
is, however, included
within this year's closing
net assets at the
closing rate
Consolidation of a foreign operation:
In principle, the same workings and adjustments required in any consolidation
question will be required. You should prepare a group structure, and workings for net
assets, goodwill, non-controlling interest and retained earnings will typically be
required. However, IAS 21 requires that goodwill is calculated using the functional
currency of the subsidiary and then subject to annual retranslation at the closing rate
at each reporting date. It follows that the cost of investment and NCI should be
calculated using the same closing exchange rate.
Where goodwill is calculated on a "full" or "fair value" basis, it should be calculated
using a two-stage approach. This will determine the respective group and NCI share
of goodwill. This ratio will then be used to allocate exchange gains or losses arising
on retranslation of goodwill each year between the group and NCI.
3.4
Goodwill on consolidation:
Goodwill is calculated as follows:
Rs
Cost to group of gaining control
X
Less: group share of net assets at acquisition
(X)
––
Proportionate goodwill
X
––
NCI at fair value
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X
Page 421
Less: NCI share of net assets at acquisition
(X)
NCI goodwill
––
X
––
Goodwill at fair value
X
––
IAS 21 states that the fair value of net assets acquired should be restated at each
year end using the closing exchange rate. This annual restatement will result in an
exchange difference, calculated as:
Goodwill (in foreign currency) at this year’s closing rate
X
Goodwill (in foreign currency) at last year’s closing rate
X
––
Exchange gain(loss) on retranslation
X
In the consolidated accounts this exchange difference will form part of the total
exchange difference disclosed as other comprehensive income and accumulated in
other components of equity.
The exchange difference arising on goodwill will be allocated as follows:
• to the group only if goodwill is accounted for on a proportionate basis.
• between group and NCI if goodwill is accounted for on a full (fair value) basis. Note
that the allocation is made based upon their respective share of total goodwill. This
will therefore require goodwill to be calculated in a two-stage process as identified
earlier within this section.
In order to calculate the foreign exchange differences arising on the net investment in
a foreign operation, calculate the following:
Illustration – Calculation of exchange differences:
The three elements of foreign exchange differences are as follows:
•
opening net assets of subsidiary
•
profit for the year of subsidiary
•
goodwill – whether calculated on a fair value or proportionate basis
Parent
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NCI
Page 422
Opening net assets of subsidiary
(= equity brought forward)
@ closing rate
X
@ opening rate
(X)
–––
Gain/(loss)
X/(X) x parent% X/(X)
x NCI%
Profit of subsidiary for year
@ closing rate
X
@ average rate
(X)
X/(X)
–––
Gain/(loss)
X/(X) x parent% X/(X)
x NCI%
Opening goodwill – P's share
X/(X)
@ closing rate
X
@ opening rate
(X)
–––
Gain/(loss)
X/(X) x 100%
X/(X)
Opening goodwill – NCI's share
Note: full goodwill method only
@ closing rate
X
@ opening rate
(X)
–––
Gain/(loss)
X/(X) x 100%
–
–––
Gain/(loss) for year
X/(X)
–––
X/(X)
X/(X)
–––
–––
Example 1:
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Translation of Goodwill:
S Ltd , whose currency is the Dracma (DR), acquired 75% of Flash on 1 June 20X5
for cash consideration of DEK(Kr) 250,000. The equity and liabilities of Flash at 31
May 20X6 are as follows:
Kr
Equity capital
100,000
Retained earnings – at 1 June 20X5
125,000
– profit for the year
75,000
–––––––
300,000
–––––––
The S Group values the non-controlling interest using the proportion of net assets
method
Required:
At what value should the goodwill be shown in the consolidated financial statements
of S for the year ended 31 May 20X6?
Exchange rates were as follows:
Kr to DR
1 June 20X5
2.5
31 May 20X6
2.0
Solution:
Step 1:
Advanced Financial Accounting and Corporate Reporting (Study Text)
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The net assets of Flash must be translated into DR at the closing rate on 31 May
20X6:
Kr
Rate
DR
Equity capital
100,000 2.0 50,000
Retained earnings – at 1 June 20X5
125,000 2.0 62,500
– profit for the year
75,000
2.0 37,500
–––––––
–––––––
300,000
150,000
–––––––
–––––––
This also gives us the net assets at acquisition translated at this year’s closing rate,
being the total of the equity capital and the pre-acquisition retained earnings, i.e. DR
50,000 + DR 62,500 = DR 112,500.
Step 2:
The cost of investment must be calculated. When S bought the shares in Flash, Kr
250,000 cash was paid and the exchange rate at that date was Kr 2.5 : DR 1. The
investment would have been recorded in the individual accounts of S as follows
Dr Cost of investment (Kr 250,000/2.5)
DR100,000
Cr Cash
DR100,000
If we are to calculate goodwill at the year end, the cost of investment needs to be
retranslated to the closing rate. As seen in Step 1, the net assets at acquisition have
been translated at the closing rate, so the cost of investment must be on the same
basis.
Therefore, the cost of investment will become:
Kr 250,000/2.0 = DR 125,000
S has a gain on the cost of investment of DR 25,000. This must be credited to group
reserves. The other side of the entry is in goodwill, as the cost of investment that has
been retranslated is the one used to calculate goodwill at the closing rate.
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Step 3:
Now we have both components of goodwill and can calculate the goodwill at 31 May
20X6.
DR
Cost of investment (step 2)
125,000
Non-controlling interest
(25% x (50,000 + 62,500))
28,125
–––––––
153,125
Net assets of Flash at acq'n
(112,500)
–––––––
40,625
–––––––
3.5
Cost of investment – parent's books:
Since IAS 21 requires the cost of investment within the goodwill calculation to be
based on the closing rate, an extra adjustment is required as part of the consolidation
process.
The cost of investment in the parent's accounts must be retranslated to the closing
rate. An exchange gain or loss is recorded as a component of other comprehensive
income in the group accounts, and so accumulated as a component of equity.
3.6
Goodwill retranslation journals:
•
As part of the consolidation process, the investment in the parent entity’s
accounts is replaced with the group share of the subsidiary’s net assets and
goodwill arising on acquisition.
•
Although the journal is embedded within the consolidation workings, this is in
part achieved by:
Dr Goodwill calculation
cost of investment
Cr Investment in Parent’s account
cost of investment
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•
In the parent’s own accounts, the cost of investment is treated as a nonmonetary asset and so held at the historic rate of exchange.
•
The IAS 21 rules on the calculation of goodwill, as seen above, require the
cost of investment to be retranslated prior to calculating goodwill, based on
the closing rate.
•
These rules mean that the above journal does not involve equal amounts.
•
Therefore, as part of the consolidation process, the investment held in the
parent’s accounts must be retranslated using the closing rate.
•
The resulting exchange gain or loss is disclosed as an element of other
comprehensive income and recorded within other components of equity
4
Non-Controlling Interests:
4.1
Statement of Comprehensive Income:
The non-controlling interest is the share of the subsidiary's profit after tax for the year
as translated for consolidation purposes.
4.2
Statement of financial position:
The non-controlling interest is computed by reference to either fair value at
acquisition plus share of post acquisition retained earnings or the net assets of the
subsidiary, in either case translated at the closing rate at the reporting date.
Example 2:
On 1 July 20X1 H acquired 80% of ABC Ltd , whose functional currency is FC. The
cost of gaining control was FC 7,500. Their financial statements at 30 June 20X2
were as follows.
Statement of financial position:
H
ABC
Assets
PKR
FC
Investment in ABC
5,000
–
Non-current assets
10,000
3,000
Current assets
5,000
2,000
––––––
––––––
20,000
5,000
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––––––
––––––
Rs
KR
Equity capital
6,000
1,500
Retained earnings
4,000
2,500
Liabilities
10,000
1,000
––––––
––––––
20,000
5,000
––––––
––––––
H
ABC
Rs
FC
Revenue
25,000
35,000
Operating costs
(15,000)
(26,250)
––––––
––––––
Profit before tax
10,000
8,750
Tax
(8,000)
(7,450)
––––––
––––––
2,000
1,300
––––––
––––––
Equity and liabilities
Statement of Comprehensive Income:
Profit for the year
Neither entity recognised any components of other comprehensive income in their
individual accounts in the period.
The following information is applicable
(i)
At the date of acquisition the fair value of the net assets of ABC were FC
6,000. The increase in the fair value is attributable to land that remains
carried by ABC at its historical cost.
(ii)
During the year H sold goods on cash terms for Rs 1,000 to ABC.
(iii)
On 1 June 20X2 H made a short-term loan to ABC of Rs 400. The liability is
recorded by ABC at the historic rate. The loan is recorded within current
assets and liabilities as appropriate
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(iv)
The non-controlling interest is valued using the proportion of net assets
method.
Exchange rates to Rs
FC
1 July 20X1
1.50
Average rate
1.75
1 June 20X2
1.90
30 June 20X2
2
Required:
Prepare the group statement of financial position, Statement of Comprehensive
Income and statement of other comprehensive income
Solution;
H & ABC Group statement of financial position
Assets
Rs
Non-current assets
Intangible – goodwill (W3)
1,350
Tangible (10,000 + (FC 3,000 + FC 3,300) /2.0
13,150
––––––
14,500
Current assets (5,000 + FC 2,000 /2.0 – inter-co 400)
5,600
––––––
20,100
––––––
Equity and liabilities
Rs
Share capital
6,000
Retained earnings (W5)
4,576
Group exchange differences (W8)
(1,322)
––––––
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9,254
Non-controlling interest (W4)
726
––––––
Equity
9,980
Liabilities (10,000 + (FC 1.000 + 40(W1)) /2.0 – inter-co 400)
10,120
––––––
20,100
––––––
H Group – Statement of comprehensive income for the year:
Rs
Revenue (25,000 + (35,000/1.75) – inter-co 1,000)
44,000
Operating costs (15,000 + (26,250 + 40(W1) /1.75) – inter-co 1,000)
(29,023)
–––––––
Profit before tax
14,977
Tax (8,000 + (7,450 / 1.75))
(12,257)
–––––––
Profit after tax
2,720
Other comprehensive income – amounts which may be reclassified to profit or loss in
subsequent years:
Exchange differences on translation of foreign
operations (W8)
(1,540)
––––––
Total comprehensive income
1,180
––––––
Profit for the year attributable to:
Owners of parent (β)
Non-controlling interest (20% × ((1,260 (W2)) /1.75))
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2,576
144
Page 430
––––––
Total comprehensive income for the year attributable to:
Owners of parent (β)
1,254
Non-controlling interest (144 (as above) – 218)(W8))
74
––––––
(W1)
Group structure:
H
NCI = 20% for full year
80%
ABC
Note (iii) error to correct before translation
H has made a loan to ABC. ABC therefore has a liability outstanding at the reporting
date of a monetary item denominated in foreign currency – this needs to be restated
at the closing rate prior to translation at the yearend. Any gain or loss on translation
is part of the operating results of ABC for the year.
1 June ABC received loan of Rs 400 @ 1.9 = FC 760
30 June restate loan at closing rate Rs 400 @ 2.0 = FC 800
i.e. increased liability and exchange loss of FC 40 for ABC
(W2)
Net assets of subsidiary in own functional currency:
FC
FC
Equity capital
1,500
1,500
Retained earnings
1,200
2,500
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FVA – land
3,300
Exchange loss (W1)
3,300 to SOFP
(40)
––––– –––––
Movement in post acq'n retained earnings
6,000
7,260 1,260
––––– ––––– –––––
(W3)
Goodwill in ABC functional currency – proportionate basis:
FC
Investment in ABC Rs 5,000 × 1.5
7,500
FV of NCI at acquisition (FC 6,000 × 20%)
1,200
–––––
8,700
Less: FV of NA at acquisition (W2)
(6,000)
–––––
Prop goodwill to SOFP
2,700
– no impairment to date – / CR 2.0 = Rs 1,350
–––––
Exchange loss by parent company on retranslation of cost of investment
Rs
At acq'n FC 7,500 @ 1.5
5,000
At cl rate FC 7,500 @ 2.0
3,750
–––––
Exchange loss on retranslation of cost of investment (W6) 1,250
–––––
(W4)
NCI – need to translate sub NA at closing rate:
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FC
NCI at date of acquisition (20%× 6,000) (W2)
Rs
1,200
NCI %age of postacq'n retained earnings
(20% × (7,260 – 6,000)) (W2)
252
–––– –––
Translate at closing rate @ 2.0
1,452 726
–––– –––
(W5)
Retained earnings:
These group reserves comprise both realised profit and unrealised group exchange
differences; strictly, they should be separated out.
Rs
Parent
4,000
80%(W1) x (W2) FC 1,260/1.75
576
i.e. post-acquisition retained earnings of sub @ average rate
–––––
4,576
–––––
(W6) Group retained earnings including other equity components:
Rs
Parent
4,000
Less exchange loss on cost of investment by parent (W3)
(1,250)
Less goodwill impaired Nil
Plus group % of post-acquisition (80% × (FC 1,260 (W2) / 2.0))
504
––––––
3,254
––––––
(W7) Proof of group retained earnings including other equity components:
Rs
Opening group retained earnings
(parent only (4,000 – 2,000))
2,000
Group income for the year – per SOCI
2,576
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 433
Group exchange difference (W8)
(1,322)
––––––
Closing group retained earnings
3,254
––––––
These group reserves comprise both realised profit and unrealised group exchange
differences; strictly, they should be separated out.
(W8) Exchange difference:
Rs
Rs Group
NCI
FC 6,000(W2) @ 2.0 cl rate
3,000
80%
20%
FC 6,000(W2) @ 1.5 acq'n rate
(4,000)
(1,090)
(872)
(218)
(450)
(450)
––––––
–––––
––––
(1,540)
(1,322)
(218)
––––––
–––––
––––
On opening net assets
––––– (1,000)
On income
FC 1,260 (W2) @ 2.0 cl rate
FC 1,260 (W2) @ 1.75 ave rate
630
(720)
–––––
(90)
–––––
On goodwill – prop basis
FC 2,700 @ 2.0 cl rate
1,350
FC 2,700 @ 1.5 acq'n rate
1,800
–––––
Summary of total exchange gains and
Losses
5
Disposal of a Foreign Entity:
On the disposal of a foreign subsidiary, the cumulative exchange difference
recognised as other comprehensive income and accumulated in a separate
component of equity (because it was unrealised) becomes realised. The standard
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 434
requires the exchange reserve to be reclassified on the disposal of the subsidiary as
part of the gain/loss on disposal.
6
Equity Accounting:
The principles to be used in translating a subsidiary’s financial statements also apply
to the translation of an associate’s.
Once the results are translated, the carrying amount of the associate (cost (at the
closing rate) plus the share of post-acquisition retained earnings) can be calculated
together with the group’s share of the profits for the period and included in the group
financial statements
7
Reporting in Hyperinflationary Economies IAS 29:
In a hyperinflationary economy, reporting of operating results and financial position in
the local currency without restatement is not useful. Money loses purchasing power
at such a rate that comparison of amounts from transactions and other events that
have occurred at different times, even within the same accounting period, is
misleading. The Standard does not establish an absolute rate at which hyperinflation
is deemed to arise. It is a matter of judgement when restatement of financial
statements in accordance with the Standard becomes necessary.
Prices change over time as the result of various specific or general political,
economic and social forces.. In addition, general forces may result in changes in the
general level of prices and therefore in the general purchasing power of money.
Entities that prepare financial statements on the historical cost basis of accounting do
so without regard either to changes in the general level of prices or to increases in
specific prices of recognised assets or liabilities. The exceptions to this are those
assets and liabilities that the entity is required, or chooses, to measure at fair value.
For example, property, plant and equipment may be revalued to fair value and
biological assets are generally required to be measured at fair value. Some entities,
however, present financial statements that are based on a current cost approach that
reflects the effects of changes in the specific prices of assets held.
In a hyperinflationary economy, financial statements, whether they are based on a
historical cost approach or a current cost approach, are useful only if they are
expressed in terms of the measuring unit current at the end of the reporting period.
As a result, the Standard applies to the financial statements of entities reporting in
the currency of a hyperinflationary economy. The financial statements of an entity
whose functional currency is the currency of a hyperinflationary economy, whether
they are based on a historical cost approach or a current cost approach, shall be
stated in terms of the measuring unit current at the end of the reporting period. The
corresponding figures for the previous period required by IAS 1 Presentation of
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 435
Financial Statements and any information in respect of earlier periods shall also be
stated in terms of the measuring unit current at the end of the reporting period.
The gain or loss on the net monetary position shall be included in profit or loss and
separately disclosed.
The restatement of financial statements in accordance with the Standard requires the
application of certain procedures as well as judgement. The consistent application of
these procedures and judgements from period to period is more important than the
precise accuracy of the resulting amounts included in the restated financial
statements.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 436
Chapter Summary:
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 437
Self Test Questions:
1
(a)
An entity, BB Ltd, has a reporting date of 31 December. On 27 November
20X6 BB Ltd buys goods from a foreign supplier for FC 324,000.
On 19 December 20X6 BB Ltd pays the foreign supplier in full. Exchange
rates were as follows:
27 November 20X6 Rs 1 = FC 11.15
19 December 20X6 Rs 1 = FC 10.93
Required:
Show how the expense and liability, together with the exchange
difference arising, should be accounted for in the financial statements.
(b)
An entity, Waiter, which has a reporting date of 31 December and the Rs as
its functional currency borrows in the foreign currency of the Kram (K). The
loan of K 120,000 was taken out on 1 January 20X7. A repayment of K40,000
was made on 1 March 20X7
The following rates of exchange are relevant
K1 to Rs
1 January 20X7
K1: Rs 2
1 March 20X7
K1: Rs 3
31 December 20X7
K1: Rs 3.5
Required:
Show how the liability and the exchange difference will be represented in the
year end financial statements.
(c)
An entity, Attendant, which has a reporting date of 31 December, has the Rs
as its functional currency purchased a plot of land overseas on 1 March 20X0.
The entity paid for the land in the currency of the Rylands (R). The purchase
cost of the land at was R 60,000. The value of the land at the reporting date
was R 80,000.
Advanced Financial Accounting and Corporate Reporting (Study Text)
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Rates of exchange were as follows:
1 March 20X0 R 8 : Rs 1
31 December 20X0 R 10 :Rs 1
Required:
Show how this transaction should be accounted for in the financial
statements for the year ended 31 December 20X0:
2.
(a)
•
if the land is carried at cost
•
if the land is carried at valuation
On 15 March an entity, Rays Ltd, purchased a non-current asset on one
month’s credit for KR 20,000, having its functional currency Ryland (R)
Exchange rates
15 March KR 5 : R 1
31 March KR 4 : R 1
Required:
Explain and illustrate how the transaction is recorded and dealt with if
the reporting date is 31 March
(b)
The following transactions were undertaken by Sunshine Ltd in the
accounting year ended 31 December 20X1, having functional currency (FC)
Date
Narrative
Amount
KR
1 January 20X1
Purchase of a non-current
100,000
asset on credit
31 March 20X1
30 June 20X1
Payment for the non-current asset 100,000
Purchases on credit
50,000
Sales on credit
95,000
30 September 20X1 Payment for purchases
Advanced Financial Accounting and Corporate Reporting (Study Text)
50,000
Page 439
30 November 20X1 Longterm loan taken out
200,000
Exchange rates
KR : FC
1 January 20X1
2.0 : 1
31 March 20X1
2.3 : 1
30 June 20X1
2.1 : 1
30 September 20X1
2.0 : 1
30 November 20X1
1.8 : 1
31 December 20X1
1.9 : 1
Required:
Prepare journal entries to record the above transactions.
3.
Parent & Overseas:
Parent is an entity that owns 80% of the ordinary shares of its foreign subsidiary that
has the Shilling as its the functional currency. The subsidiary was acquired at the
start of the current accounting period on 1 January 20X7 when its reported reserves
were 6,000 Shillings.
At that date the fair value of the net assets of the subsidiary was 20,000 Shillings.
This included a fair value adjustment in respect of land of 4,000 Shillings that the
subsidiary has not incorporated into its accounting records and still owns.
Parent wishes the presentation currency of the group accounts to be Rs. Goodwill is
to be accounted for on a fair value basis, which is unimpaired at the reporting date.
At the date of acquisition, the non-controlling interest in Overseas had a fair value of
5,000 Shillings.
Statements of financial position
Parent
Overseas
Rs Shillings
Investment (21,000 shillings)
3,818
Assets
9,500
40,000
–––––––
–––––––
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Page 440
Equity and liabilities
13,318
40,000
–––––––
–––––––
Rs Shillings
Equity capital
5,000
10,000
Retained earnings
6,000
8,200
Liabilities
2,318
21,800
–––––––
–––––––
13,318
40,000
–––––––
–––––––
Statement of comprehensive income
Parent
Overseas
Rs Shillings
Revenue
8,000
5,200
Costs
(2,500)
(2,600)
––––––
–––––––
Profit before tax
5,500
2,600
Tax
(2,000)
(400)
––––––
–––––––
3,500
2,200
––––––
–––––––
Profit for the year
Neither entity recognised any other comprehensive income in their individual
accounts in the period.
Relevant exchange rates (Shillings to Rs 1) are:
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 441
Date
Exchange rate (Shillings to Rs 1)
1 January 20X7
5.5
31 December 20X
75
Weighted average for year
5.2
Required:
Prepare the consolidated statement of financial position at 31 December 20X7,
together with a consolidated Statement of Comprehensive Income for the year ended
31 December 20X7, a statement showing other comprehensive income and a
schedule of the movement over the year on retained earnings and other components
of equity.
4
S Ltd & A Ltd:
On the 1 July 20X1 S Ltd acquired 60% of A Ltd Inc, whose functional currency is D’s.
The financial statements of both entities as at 30 June 20X2 were as follows.
S Ltd
Assets:
D
A Ltd
Rs
Investment in A Ltd
5,000
–
Loan to A
1,400
–
Tangible assets
10,000
15,400
Inventory
5,000
4,000
Receivables
4,000
500
Cash at bank
1,600560
Equity and liabilities:
Advanced Financial Accounting and Corporate Reporting (Study Text)
––––––
––––––
27,000
20,460
––––––
––––––
Rs
D
Page 442
Equity capital (Rs 10 D 1)
10,000
1,000
Share Premium
3,000
500
Reserves
4,000
12,500
Non Current Liabilities
5,000
5,460
Current Liabilities
5,000
1,000
–––––––
–––––––
27,000
20,460
–––––––
–––––––
S Ltd
A Ltd
Rs
Revenue
50,000
60,000
Cost of sales
(20,000)
(30,000)
–––––––
––––––
Gross profit
30,000
30,000
Distribution and Administration expenses
(20,000)
(12,000)
–––––––
–––––––
Profit before tax
10,000
18,000
Tax
(8,000)
(6,000)
–––––––
–––––––
2,000
12,000
–––––––
–––––––
Income for Year
The following information is applicable.
1) S Ltd purchased the shares in A Ltd for D 10,000 on the first day of the
accounting period. At the date of acquisition the retained earnings of A Ltd
were D 500 and there was an upward fair value adjustment of D 1,000. The
fair value adjustment is attributable to plant with a remaining five year life as at
the date of acquisition. This plant remains held by A Ltd and has not been
revalued. No shares have issued since the date of acquisition.
2) Just before the year-end S Ltd acquired some goods from a third party at a
cost of Rs 800, which it sold to A Ltd for cash at a mark up of 50%. At the
reporting date all the goods remain unsold.
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Page 443
3) On 1 June X2 S Ltd lent A Ltd Rs 1,400. The liability is recorded at the historic
rate within the non-current liabilities of A Ltd.
4) No dividends have been paid. Neither company has recognised any gain or
loss in reserves.
5) Goodwill is to be accounted for on a "full" fair value basis. No goodwill has
been impaired. The fair value of the non-controlling interest at the date of
acquisition was D 5,000. The presentational currency of the group is to be the
Rs.
Exchange rates to Rs 1
D
1 July 20X1
2.00
Average rate
3.00
1 June 20X2
3.90
30 June 20X2
4.00
Required:
5
(1)
Prepare the group statement of financial position at 30 June 20X2
(2)
Prepare the group Statement of Comprehensive Income for the year ended
30 June 20X2
(3)
Prepare the group statement of other comprehensive income for the period
showing the group exchange difference arising in the year.
The LUMS group has sold its entire 100% holding in an overseas subsidiary for
proceeds of Rs 50,000. The net assets at the date of disposal were Rs 20,000 and
the carrying value of goodwill at that date was Rs 10,000. The cumulative balance on
the group foreign currency reserve is a gain of Rs 5,000. Tax can be ignored.
Required:
Calculate the exceptional gain arising to the group on the disposal of the foreign
subsidiary.
6
Little was incorporated over 20 years ago, operating as an independent entity for 15
years until 1 April 20X0 when it was taken over by Large. Large’s directors decided
that the local expertise of Little’s management should be utilised as far as possible,
and since the takeover they have allowed the subsidiary to operate independently,
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 444
maintaining its existing supplier and customer bases. Large exercises ‘arms’ length’
strategic control, but takes no part in day-to-day operational decisions.
The statements of financial position of Large and Little at 31 March 20X4 are given below.
The statement of financial position of Little is prepared in francos (F), its functional currency.
Large
Rs. ‘000’
Rs. ‘000’
Little
F 000
F000
Non-current assets:
Property, plant and equipment
63,000
80,000
Investments
12,000
-
————
————
75,000
80,000
51,000
63,000
————
————
126,000
143,000
————
————
30,000
40,000
–
6,000
35,000
34,000
————
————
65,000
80,000
Equity:
Equity capital:
(Rs 10 /1 Franco shares)
Revaluation reserve
Retained earnings
Non-current liabilities:
Long-term borrowings
20,000
25,000
Deferred tax
6,000
10,000
————
————
26,000
35,000
Current liabilities:
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 445
Trade payables
25,000
20,000
Tax
7,000
8,000
Bank overdraft
3,000
-
————
————
35,000
28,000
————
————
126,000
143,000
————
————
Notes to the SFPs:
Note 1 – Investment by Large in Little:
On 1 April 20X0 Large purchased 36 million shares in Little for 72 million francos.
The retained earnings of Little at that date were 26 million francos. It is group
accounting policy to account for goodwill on a proportionate basis. At 1 April 20X3
goodwill had been fully written off as a result of impairment losses.
Answers
1
BB Ltd, Waiter and Attendant:
BB Ltd – Solution:
27 November 20X6
29,058
Translate transaction prior to 324,000 / = Rs
recording:
Dr Purchases
Rs 29,058
Cr Payables
Rs 29,058
19 December 20X6
FC 324,000 is paid.
11.15
At 19 December rate this is: 324,000 / = Rs 29,643
10.93
Dr Payables
November)
Rs 29,058 (being the payable created on 27
Dr Income
Rs 585 i.e. exchange loss
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 446
statement
Cr Cash
Rs 29,643
Rs 585 is an exchange loss arising because the functional currency (Rs ) has
weakened against the transaction currency (FC) since the transaction
occurred.
(b)
Waiter – Solution:
K
Rs
Exchange Rate
1 January 20X7 record liability
120,000
2.0
240,000
1 March 20X7 repay part of liability
(40,000)
3.0
(120,000)
Exchange loss – balancing figure – taken to
(160,000)
income
––––––
31 December 20X7
80,000
–––––––
3.5
––––––
280,000
–––––––
The Rs 160,000 is the loss that will be reported in income for the year. The
liability as a monetary item has been retranslated at the closing rate will be
reported on the statement of financial position as Rs 280,000.
(c)
Attendant:
As the asset is a nonmonetary item, it will not be subject to retranslation at
the reporting date. If the land is carried at cost, the asset remains stated at Rs
cost translated at the rate ruling at the date of purchase as follows:
R 60,000 divided by 8 = Rs 7,500
Assuming that the asset is revalued then the revalued amount will be
translated to create a gain or loss that is taken directly to equity / reserves.
1 March 20X0 purchase land
R
Rate
Rs
60,000
8.0
7,500
Gain to equity
Advanced Financial Accounting and Corporate Reporting (Study Text)
500
Page 447
––––––
31 December 20X0
2
80,000
––––––
10.0
8,000
Rays:
On 15 March the purchase is recorded using the exchange rate on that date.
Dr Non-current asset
(KR 20,000/5)
Cr Payable
R 4,000
R 4,000
•
At the year end the non-current asset, being a nonmonetary item, is not
retranslated but remains measured at R 4,000.
•
The payable remains outstanding at the yearend. This is a monetary item and
must be retranslated using the closing rate: KR 20,000 / 4 = R 5,000
•
The payable must be increased by R 1,000, giving rise to an unrealised
exchange loss:
Dr Statement of Comprehensive Income (exchange loss)
R1,000
Cr Payable
R1,000
Sunshine:
1 January
KR100,000 /
=
Dr Non-current
20X1
2.0
FC 50,000
assets
31 March
KR100,000 /
=
20X1
2.3
FC 43,478
FC 50,000
Cr Payable
FC 50,000
Dr Payable
FC 50,000
Cr Cash
FC 43,478
Cr Income
FC 6,522
Statement
KR 50,000 / 2.3
=
Dr Purchases
FC 21,739
Cr Payables
FC 21,739
FC 21,739
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Page 448
30 June 20X1 KR
95,000 / 2.1 =
Dr Receivables
FC 45,238
Cr Sales revenue
FC 45,238
Dr Payables
FC 21,739
FC 45,238
30 September 20X1
= FC 25,000
Income
FC 3,261
30 November 20X1
Dr Statement of Comprehensive
= FC 111,111
Cr Cash
FC 25,000
Dr Cash
FC 111,111
Cr Loan
FC 111,111
31 December 20X1*
= FC 50,000
Income
Dr Receivables
Cr Statement of Comprehensive
FC 4,762
= FC 105,263
Cr Statement of Comprehensive Income
FC 4,762
Dr Loan
FC 5,848
FC 5,848
*Note: at the reporting date of 31 December, any monetary items designated in
foreign currency which are still outstanding or unsettled are restated using the closing
rate of exchange at that date. This will provide the best estimate at the reporting date
of the FC of any future receipt or payment of cash when the monetary item is
subsequently settled. Consequently, the receivables recorded in June and the foreign
currency loan recorded in November must be restated.
3
Parent & Overseas:
Group statement of financial position:
Note: the assets and liabilities of Overseas have been translated at the closing rate
of 5 Shillings – Rs 1.
Rs
Goodwill
Assets 9,500 + ((40,000 + 4000) / 5.0)
Advanced Financial Accounting and Corporate Reporting (Study Text)
(W3)
1,200
18,300
Page 449
––––––
19,500
––––––
Equity and liabilities
Rs
Equity capital
5,000
Retained earnings and other components of equity (W5)
6,734
––––––
11,734
Non-controlling interest (W4)
1,088
––––––
Total equity of the group
12,822
Liabilities (2,318 + (21,800 / 5.0)
6,678
––––––
19,500
––––––
Group Statement of Comprehensive Income:
Note: the income and expenses for Overseas have been translated at the average
rate of 5.2 Shillings = Rs 1
Rs
Revenue (8,000 + (5,200 / 5.2)
9,000
Costs (2,500 + (2,600 / 5.2)
(3,000)
–––––
Profit before tax
6,000
Tax (2,000 + (400 / 5.2)
(2,077)
–––––
Profit for the year
3,923
Other comprehensive income which may be reclassified to profit
or loss in future years:
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 450
Exchange gains on net investment of foreign subsidiary (W7)
490
–––––
Total comprehensive income for the year
4,413
–––––
Profit for the year attributable to:
Owners of Parent ( β)
3,838
Non-controlling
interest (20% × (2,200 / 5.2))
85
–––––
3,923
–––––
Total comprehensive income attributable to:
Owners of Parent ( β)
4,234
Non-controlling
interest 85 (per IS) + 94 (W6)
179
–––––
Total comprehensive income
4,413
–––––
Workings
(W1)
Group structure:
P
80%
O
(W2)
NCI = 20% for complete year
Net assets of subsidiary in functional currency:
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 451
Acq'n date
Rep date
Shillings
Shillings
Share capital
10,000
10,000
Retained earnings
6,000
8,200
Fair value adjustment – land
4,000
4,000
–––––
–––––
20,000
22,200
2,200
–––––
–––––
–––––
Shillings
Post-acquisition
movement
(W3) Goodwill at fair value in subsidiary functional currency You need to identify the
respective share of goodwill between the parent and subsidiary entities as this is used to
allocate exchange gains and losses arising on the retranslation of goodwill at the closing rate
at each reporting date. This can either be done by calculation of both elements of goodwill
for parent and NCI separately, or by identifying the parent share of goodwill and deducting
this from full goodwill. Both approaches are shown below:
Either: Calculation of full goodwill in normal manner, then deduct parent share
of goodwill (i.e. proportionate goodwill), to arrive at NCI share of goodwill:
Full goodwill:
Shillings
Cost of investment Rs 3,818 @ 5.5
FV of NCI at acquisition
20,999
(20% × 20,000)
(W2)
5,000
25,999
FV of NA at acquisition
20,000
––––––
Full goodwill at acquisition
5,999
––––––
Translate at closing rate @ 5.0
Rs 1,200
––––––
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Page 452
Proportionate goodwill:
Shillings
Cost of investment Rs 3,818 @ 5.5
CV of NCI at acquisition
20,999
(20% × 20,000)
(W2)
4,000
24,999
FV of NA at acquisition
20,000
––––––
Proportionate goodwill
4,999
––––––
Therefore NCI share of goodwill = Sh5,999 – Sh4,999 = Sh1,000
Or: Calculation of the separate elements of goodwill:
Parent share of goodwill
Shillings
Cost of investment Rs 3,818 @ 5.5
20,999
80% x 20,000(W2)
(16,000)
––––––
Proportionate goodwill
4,999
NCI at fair value
5,000
20% x 20,000(W2)
4,000
1.000
–––––
––––––
5,999
––––––
Translate at closing rate @ 5.0
Rs 1,200
––––––
Gain or loss to Parent on retranslation of cost of investment:
Cost of investment in Overseas 20,999 Shillings @ 5.5 acquisition rate = Rs
3,818
Cost of investment in Overseas 20,000 Shillings @ 5.0 closing rate = Rs
4,200
Exchange gain Rs 382 to group reserves (W5)
(W4)
Non-controlling interest at fair value:
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 453
Shillings
Fair value at acquisition
Rs
5,000
NCI share of post acquisition profit
(20% x 2,200 (W2))
440
––––––
Translated at closing rate @ 5.0
(W5)
5,440
1,088
––––––
–––––
Shillings
Rs
Group reserves:
Parent
6,000
Group share of post acquisition profit
(80% x 2,200 (W2))
1,760
Translated at closing rate @ 5.0
352
Gain on retranslation of cost of investment (W3)
382
–––––
6,734
–––––
Comprising group retained earnings of Rs 6,338 and exchange gains on net
investment in foreign subsidiary Rs 396 – see below:
Group retained earnings
Parent
Rs
6,000
Group share of post acquisition profit
(80% x 2,200 (W2))
Translated at average rate @ 5.2
338
–––––
6,338
–––––
(W6)
Group exchange difference:
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 454
The group exchange difference is dealt with as other comprehensive income
and it arises on the retranslation of three elements: the opening net assets,
the subsidiary profit for the year and goodwill as follows.
Opening net assets
Rs
20,000 Shillings @ 5.5 opening (or acq'n) rate
3,636
20,000 Shillings @ 5.0 closing rate
4,000
Rs
Group
NCI
364
291
73
17
14
3
109
91
18
–––
–––
––
490
396
94
–––
–––
––
––––
Exchange gain split (80:20)
Profit for the year
2,200 Shillings @ 5.2 average rate
423
2,200 Shillings @ 5.0 closing rate
440
––––
Exchange gain split (80:20)
Goodwill at fair value
5,999 Shillings @ 5.5 opening (or acq'n) rate
1,091
5,999 Shillings @ 5.0 closing rate
1,200
––––
Exchange gain split in proportion per W3 (5:1)
Advanced Financial Accounting and Corporate Reporting (Study Text)
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4
S Ltd & A Ltd:
Note: Assets and liabilities of A Ltd translated at the closing rate of D 4 = Rs 1
Statement of financial position:
Rs
Goodwill (W3)
3,000
Loan to A
1,400
Interco
Nil
(1,400)
Tangible assets
10,000
+ 4,050
14,050
Inventory
5,000
+
purp (W5)
1,000
(400)
5,600
Receivables
4,000
+ 125
4,125
Cash at bank
1,600
+ 140
1,740
–––––
28,515
–––––
Rs
Equity capital
10,000
Share premium
3,000
Group reserves (W5)
2,849
(profit 5,932(W6) + foreign currency
loss (3,083)(W7))
Non-controlling interest (W4)
Non-current liabilities
Current liabilities
2,416
5,000
5,000
+
Inter-co
1,400
(1,400)
+ 250
5,000
5,250
–––––
28,515
–––––
Note: income and expenses of A Ltd translated at the average rate for the year of D3
= Rs 1.
Advanced Financial Accounting and Corporate Reporting (Study Text)
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Statement of comprehensive income:
Rs
Revenue
50,000 + 20,000
Less Interco (Rs 1,200)
68,800
Cost of sales
20,000 + 10,000
Less Interco (Rs1,200)
(29,314)
purp Rs 400
depr on FV D200 @ 3 = Rs 67
correction D140 @ 3 = Rs 47
––––––
Gross profit
Admin exps
39,486
20,000 + 4,000
(24,000)
––––––
Profit before tax
Tax
15,486
8,000 + 2,000
(10,000)
––––––
Profit for Year
5,486
Statement of other Comprehensive Income:
Profit for the Year
5,486
Item that may be classified to profit or loss in subsequent periods:
Total exchange differences arising on foreign operations
(W7)
(4,722)
–––––
Total Comprehensive income for the year
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764
Page 457
Profit for the year
Attributable to Group
Bal fig
Attributable to NCI (D11,660(W2) @ 3 x 40%)
3,931
1,555
–––––
5,486
Total comprehensive income
Attributable to Group
Attributable to NCI (1,555 – 1,639)(W7) (W8)
Bal fig
848
(84)
–––––
764
(W1)
Group Structure:
S Ltd
60 % acquired one year ago – NCI = 40%
A Ltd
Advanced Financial Accounting and Corporate Reporting (Study Text)
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(W2) Net assets of subsidiary in own functional currency:
At acquisition
Rep date
D
D
Equity capital
1,000
1,000
Share premium
500
500
Retained earnings
500
12,500
1,000
1,000
D
Fair value adjustment – plant
FVA – dep'n on plant (1/5)
(200)
Exchange loss on loan
(140)
Post acquisition movement
–––––
–––––
3,000
14,660
–––––
–––––
11,660
Exchange loss on loan received by A Ltd
Received 1 June X2 Rs 1,400 @ 3.9 = D5,460
Non-current liability 30 June X2 Rs 1,400 @ 4.0 = D5,600
Exchange loss A Ltd = D140 and increased non-current liability
Advanced Financial Accounting and Corporate Reporting (Study Text)
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(W3)
Goodwill at fair value in functional currency of subsidiary:
In order to correctly calculate exchange differences on the net investment in a
foreign subsidiary, goodwill needs to be calculated separately for the group
and non-controlling interests elements as follows:
Full goodwill:
D
Cost to parent Rs 5,000 @ 2
10,000
FV of NCI at acquisition
5,000
–––––
15,000
FV of NA at acquisition
(3,000)
NCI share of NA at acquisition
–––––
Fair value goodwill – not impaired
12,000
––––––
Translate at closing rate @ 4 for SOFP
Rs 3,000
––––––
Proportionate goodwill:
D
Cost to parent Rs 5,000 @
CV of NCI at acquisition (40% × 3,000)
2 10,000
1,200
–––––
11,200
FV of NA at acquisition
(3,000)
NCI share of NA at acquisition
–––––
Fair value goodwill – not impaired
8,200
–––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
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NCI share of full goodwill: (D12,000 – D8,200) = D3,800
There is also an exchange gain or loss to the parent entity due to the annual
retranslation of the cost of investment calculated as follows:
Cost of investment to parent D10,000 at acq'n rate @ 2 = Rs 5,000
Cost of investment to parent D10,000 at closing rate @ 4 = Rs 2,500
Exchange loss to parent on retranslation of cost of investment = Rs 2,500
(W4)
Non-controlling interest at fair value:
Rs
D
FV at acquisition per question
5,000
NCI share of post acquisition profit (40% x D11,660)
4,664
–––––
Translate at closing rate @ 4 to SOFP
9,664
–––––
(W5)
2,416
2,416
–––––
–––––
Group reserves:
Rs
Parent retained earnings
4,000
Exchange loss to parent on cost of investment (W3)
(2,500)
Group share of post-acq'n profit 60% x (D11,660 / 4) cl rate
1,749
URPS on inventory (800 x 1.5 = 1,200 800 = 400)
(400)
–––––
2,849
–––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 461
Alternatively:
Group b'fwd: (only S Ltd)
2,000
Group income after tax per IS
3,932
Group exchange gains and losses on net investment in foreign
subsidiary (W7)
(3,083)
–––––
2,849
–––––
Comprising:
Group retained earnings (W6)
5,932
Group exchange gains and losses on net
investment in foreign subsidiary (W7)
(3,083)
–––––
2,849
–––––
(W6)
Group retained earnings:
Rs
Parent retained earnings
4,000
Group share of post-acq'n profit 60% x (D11,660 / 3) avg rate
2,332
URPS on inventory (800 x 1.5 = 1,200 800 = 400)
(400)
–––––
5,932
–––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 462
(W7)
Exchange differences on net investment in foreign subsidiary:
On full goodwill
NCI
D
Rate
Rs
at acq'n rate
12,000
2.0
6,000
at rep date
12,000
4.0
3,000
Group
–––––
Exchange loss (split per respective
(3,000)
(2,050)
(950)
(450)
(300)
(972)
(583)
(389)
–––––
––––– –––––
Summary of total exchange
(4,722)
(3083)
(1,639)
gains and losses on net investment
–––––
–––––
–––––
share of total goodwill per W3
(8,200:3,800)
–––––
On opening net assets
at opening date
3,000
2.0
1,500
at rep date
3,000
4.0
750
–––––
Exchange loss split per respective
(750)
shareholdings (60:40)
–––––
On subsidiary profit for the year
ave rate of year
11,660
3.0
3,887
at rep date
11,660
4.0
2,915
–––––
Exchange loss split per respective
shareholdings (60:40)
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 463
5
LUMS Group:
Rs
Proceeds
50,000
Net assets recorded prior to disposal:
Net assets
20,000
Goodwill
10,000
_______
(30,000)
Realisation of the group exchange
difference, reclassified to profit as part of the gain
5,000
______
25,000
6
Large & Little:
Group accounting – foreign currency Large and Little
(a)
It is clear from the information contained in the question that, on a day to day basis,
Little operates as a relatively independent entity, with its own supplier and customer
bases. Therefore, the cash flows of Little do not have a day-to-day impact on the
cash flows of Large. The functional currency of Little is the Franco, rather than the
Rupees. For consolidation purposes, the financial statements of Little must be
translated into a presentation currency: the Rupees (the functional currency of Large,
in which the consolidated financial statements of Large are presented). In these
circumstances, IAS 21 The effects of changes in foreign exchange rates requires that
the financial statements be translated using the closing rate (or net investment)
method (the presentation currency method). This involves translating the net assets
in the statement of financial position at the spot rate of exchange at the reporting
date and income and expenses in the Statement of Comprehensive Income and
statement of other comprehensive income at the rate on the date of the transactions,
or as an approximation, a weighted average rate for the year.
Exchange differences are reported as other comprehensive income as they do not
impact on the cash flows of the group until the relevant investment is disposed of.
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(b)
Group statement of financial position – Large Group
Rs. ‘000’
Non-current assets
63,000 + ((80,000 – 6,000) / 5)
77,800
25,000 + ((30,000 – 1,250
30,750
Current assets
Inventories
(URP)) / 5)
Trade receivables
20,000 + (28,000 / 5) – 1,000 (CIT)
24,600
Cash
6,000 + (5,000 / 5) + 1,000 (CIT)
8,000
———
141,150
———
Equity share capital
30,000
Revaluation reserve
(6,000 – 6,000)
–
Retained earnings:
(W5)
36,095
Non-controlling interest
(W4)
1,455
———
Total equity
67,550
Non-current liabilities
20,000 + (25,000 / 5)
25,000
Deferred tax
6,000 + (10,000 / 5)
8,000
Payables
25,000 + (20,000 / 5)
29,000
Tax
7,000 + (8,000 / 5)
8,600
Overdraft
3,000 + 0
3,000
Current liabilities
———
141,150
———
Advanced Financial Accounting and Corporate Reporting (Study Text)
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Workings:
(W1)
Group structure:
P
80%
O
(W2)
NCI = 20% for complete year
Net assets of subsidiary in functional currency:
Acquisition Date
Reporting date
F000
F000
Equity capital
40,000
40,000
Retained earnings
26,000
34,000
Revaluation reserve
6,000
Accounting policy adjustment (**see below)
(6,000)
URPS (*see below)
(1,250)
––––––
––––––
66,000
72,750
––––––
––––––
*Calculation of unrealised profit on closing inventory sold by subsidiary:
URPS on inventory sold by subsidiary
%age
F000
Cost
100.0
3,750
Profit element
33.3
1,250
––––––
––––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 466
Selling price
133.3
5,000
––––––
––––––
**Accounting policy adjustment:
This arises due to the parent and subsidiary having different accounting
policies relating to property. At the reporting date, the property has been
owned by the subsidiary, and depreciated, for one year (F25m / 25 year =
F1m per annum), giving a carrying value of F24m before the revaluation is
accounted for at the reporting date. The revaluation reserve created is
therefore (F30m – F24m) F6m. This needs to be removed from both noncurrent assets and revaluation reserve of the subsidiary.
(W3)
Goodwill on proportionate basis in subsidiary functional currency:
F000
Cost
72,000
90% x 66,000(W2)
59,400
––––––
12,600
––––––
Translated at closing rate @ 5 – fully impaired (W5)
Rs 2,520
––––––
Gain or loss on retranslation of cost of investment:
Cost at acquisition F72,000 @ 6
Rs 12,000
Cost retranslated at closing rate F72,000 @ 5
Rs 14,400
––––––
Gain to parent (W5)
2,400
––––––
(W4)
Non-controlling interest on proportionate basis:
Rs. ‘000’
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 467
F72,750 (W2) @ 5 x 10%
1,455
–––––
(W5)
Group retained earnings:
Rs. ‘000’
Large
Little
35,000
F6,750 @ 5 x 90%
1,215
Goodwill impaired (W3)
(2,520)
Gain on retranslation of cost of investment (W3)
2,400
––––––
36,095
––––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
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Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 469
GROUP STATEMENT OF CASH FLOWS
Chapter learning objectives
Upon completion of this chapter you, will be able to:
•
prepare and discuss the group statement of cash flows according to IAS 7
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 470
1.
Objective of Statement of Cash Flows
1.1
•
IAS 7 Statement of cash flows provides guidance on the preparation of a
statement of cash flow.
•
The objective of a statement of cash flows is to provide information on an
entity’s changes in cash and cash equivalents during the period.
•
The statement of financial position and statement of comprehensive income
(SCI) are prepared on an accruals basis and do not show how the business
has generated and used cash in the accounting period.
•
The statement of comprehensive income (SCI) may show profits on an
accruals basis even if the company is suffering severe cash flow problems.
•
Statements of cash flows enable users of the financial statements to assess
the liquidity, solvency and financial adaptability of a business.
1.2
Definitions:
•
Cash consists of cash in hand and deposits repayable upon demand, less
overdrafts. This includes cash held in a foreign currency.
•
Cash equivalents are short-term, highly liquid investments that are readily
convertible to known amounts of cash and are subject to an insignificant risk
of changes in value.
•
Cash flows are inflows and outflows of cash and cash equivalents.
2.
Classification of Cash Flows
2.1
IAS 7 does not prescribe a specific format for the statement of cash flows, although it
requires that cash flows are classified under three headings:
•
cash flows from operating activities, defined as the entity’s principal revenue
earning activities and other activities that do not fall under the next two
headings
•
cash flows from investing activities, defined as the acquisition and disposal of
long-term assets and other investments (excluding cash equivalents)
•
cash flows from financing activities, defined as activities that change the size
and composition of the entity’s equity and borrowings
Advanced Financial Accounting and Corporate Reporting (Study Text)
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Proforma statement of cash flow per IAS 7
Rs
Rs
Operating activities
Profit before tax
X
Add: interest expense
X
Less: Income from associate
X
Adjust for non-cash items dealt with in arriving at operating profit:
Add: depreciation
X
Add: loss on impairment
X
Add: loss on disposal of non-current assets
X
Add: increase in provisions
X
––––
X
Changes in working capital:
Increase in inventory
(X)
Increase in receivables
(X)
Decrease in payables
(X)
––––
Cash generated
X
Interest paid
(X)
Taxation paid
(X)
––––
Investing activities
Payments to purchase NCA
(X)
Receipts from NCA disposals
X
Cash paid to acquire subsidiary (net of cash balances acquired)
(X)
Cash proceeds from subsidiary disposal
(net of cash balances disposed)
X
Dividend received from associate
X
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 472
Interest received
X
––––
X(X)
Financing activities
Proceeds from share issue
X
Proceeds from loan or debenture issue
X
Cash repayment of loans or debentures
(X)
Finance lease repayments
(X)
Equity dividend paid
(X)
Dividend paid to NCI
(X)
––––
X(X)
––––
Change in cash and equivalents
X(X)
Cash and equivalents brought forward
X(X)
––––
Cash and equivalents carried forward
2.2
X(X)
Cash flows from operating activities
There are two methods of calculating the cash from operations.
•
The direct method shows operating cash receipts and payments. This
includes cash receipts from customers, cash payments to suppliers and cash
payments to and on behalf of employees.
•
The indirect method starts with profit before tax and adjusts it for non-cash
charges and credits, to reconcile it to the net cash flow from operating
activities.
IAS 7 permits either method; note that the standard encourages, but does not require,
use of the direct method. The methods differ only in respect of derivation of the item
'net cash inflow from operating activities'. Subsequent inflows and outflows for
investing and financing activities are the same. A comparison between the direct and
indirect method to arrive at net cash inflow from operating activities is shown below.
Direct method:
Rs m
Indirect method:
Advanced Financial Accounting and Corporate Reporting (Study Text)
Rs m
Page 473
Cash receipts from Customers
15,424
Profit before tax
6,022
Cash payments to suppliers
(5,824)
Depreciation charges
899
behalf of employees
(2,200)
Increase in inventory
(194)
Other cash payments
(511)
Increase in receivables
(72)
Increase in payables
234
Cash payments to and on
––––
Net cash inflow from
operating activities
––––
Net cash inflow from
6,889
operating activities
6,889
The principal advantage of the direct method is that it discloses operating cash
receipts and payments. Knowledge of the specific sources of cash receipts and the
purposes for which cash payments have been made in past periods may be useful in
assessing and predicting future cash flows.
Under the indirect method, typically begin with profit before tax and then make adjustments
for a number of items, the most frequently occurring of which are:
2.3
•
depreciation or amortisation charges in the year
•
impairment charged to profit or loss in the year
•
profit or loss on disposal of non current assets
•
change in inventory
•
change in receivables
•
change in payables
Cash flows from investing activities
Cash flows to appear under this heading include:
•
cash paid for property, plant and equipment and other non-current assets
•
cash received on the sale of property, plant and equipment and other noncurrent Assets
1) cash paid for investments in or loans to other entities (excluding movements
on loans from financial institutions, which are shown under financing)
•
cash received for the sale of investments or the repayment of loans to other
entities (again excluding loans from financial institutions).
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 474
2.4
Cash flows from financing activities
Financing cash flows mainly comprise receipts or repayments of principal from or to
external providers of finance.
Financing cash inflows include:
2.5
•
receipts from issuing shares or other equity instruments
•
receipts from issuing debentures, loans, notes and bonds and from other
long-term and short-term borrowings (other than overdrafts, which are
normally included in cash and cash equivalents).
•
repayments of amounts borrowed (other than overdrafts)
•
the capital element of finance lease rental payments
•
payments to reacquire or redeem the entity’s shares.
Interest and dividends
There are divergent and strongly held views about how interest and dividends cash
flows should be classified. Some regard them as part of operating activities, because
they are as much part of the day to day activities as receipts from customers,
payments to suppliers and payments to staff. Others regard them as part of financing
activities, the heading under which the instruments giving rise to the payments and
receipts are classified. Still others believe they are part of investing activities,
because this is what the long-term finance raised in this way is used for.
IAS 7 allows interest and dividends, whether received or paid, to be classified under
any of the three headings, provided the classification is consistent from period to
period.
The practice adopted in this workbook is to classify:
3.
•
interest received as a cash flow from investing activities
•
interest paid as a cash flow from operating activities
•
dividends received as a cash flow from investing activities
•
dividends paid as a cash flow from financing activities.
Calculation of Net Cash Flow from Operating Activities
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 475
3.1
Profit before tax is computed on the accruals basis, whereas net cash flow from
operating
activities only records the cash inflows and outflows arising out of trading. The main
categories of items in the statement of comprehensive income /statement of
comprehensive income and on the statement of financial position that form part of the
reconciliation between profit before tax and net cash flow from operating activities
using the indirect method are:
•
Depreciation.
Depreciation is a non-cash cost, being a book write-off of capital expenditure.
Capital expenditure will be recorded under ‘investing activities’ at the time of
the cash outflow. Depreciation therefore represents an addition to reported
profit in deriving cash inflow.
•
Profit/loss on disposal of non-current assets
The cash inflow from such a disposal needs to be recorded under ‘investing
activities’. If the profit or loss on the sale has been included in profit before tax,
an adjustment is necessary in computing operating cash flow. A loss on
disposal is added to reported profit, while a profit on disposal is deducted
from reported profit.
•
Statement of financial position change in inventories
Inventory at the reporting date represents a purchase that has not actually been
charged against current profits. However, as cash was spent on its purchase or
a payable incurred, it does represent an actual or potential cash outflow. The
effect on the statement of cash flows of a change in inventories is:
•
–
an increase in inventory is a deduction from reported profit, because it
requires financing
–
a decrease in inventory is an addition to reported profit, because the
amount of financing required has fallen.
Statement of financial position change in receivables
A sale once made creates income irrespective of the date of cash receipt. If
the cash has not been received by the reporting date, there is no cash inflow
from operating activities for the current accounting period. Similarly, opening
receivables represent sales of a previous accounting period, most of which
will be cash receipts in the current period.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 476
The change between opening and closing receivables will thus represent the
adjustment required to move from profit to net cash inflow. The reasoning is
the same as for inventories.
•
–
An increase in receivables is a deduction from reported profit.
–
A decrease in receivables is an addition to reported profit.
Statement of financial position change in payables
A purchase represents the incurring of expenditure and a charge or potential
charge to the statement of comprehensive income (SCI). It does not represent
a cash outflow until paid. To the extent that a purchase results in a charge to
the statement of comprehensive income (SCI):
–
an increase in payables between two reporting dates is an addition to
reported profit
–
a decrease in payables is a deduction from reported profit.
If the purchase does not result in a charge to the statement of comprehensive
income in the current year, the corresponding payable is not included in the
reconciliation of profit to net cash inflow. For example, a payable in respect of
a non-current asset is not included.
3.2
Tax Expense
Cash flows arising from taxes on income should be separately disclosed as part of
operating activities unless they can be specifically identified with financing or
investing activities. It is reasonable to include income taxes as part of operating
activities unless a question gives a clear indication to the contrary.
If income tax payments are allocated over more than one class of activity, the total
should be disclosed by note.
The computation of income taxes paid may present a practical problem.
It is often convenient to arrive at the figure by means of a single tax working account
into which all tax balances, whether current or deferred, are entered.
Sales tax
The existence of sales tax raises the question of whether the relevant cash flows
should be reported gross or net of the tax element and how the balance of tax paid to,
or repaid by, the taxing authorities should be reported.
The cash flows of an entity include sales tax where appropriate and thus strictly the
various elements of the statement of cash flows should include sales tax. However,
this treatment does not take into account the fact that normally sales tax is a shortterm timing difference as far as the entity’s overall cash flows are concerned and the
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 477
inclusion of sales tax in the cash flows may distort the allocation of cash flows to
standard headings.
In order to avoid this distortion and to show cash flows attributable to the reporting
entity’s activities, it is usual for amounts to be shown net of sales taxes and the net
movement on the amount payable to, or receivable from, the taxing authority should
be allocated to cash flows from operating activities unless a different treatment is
more appropriate in the particular circumstances concerned.
3.3
Unusual items and non-cash Transactions
Unusual cash flows
Where cash flows are unusual because of their size or incidence, sufficient
disclosure should be given to explain their cause and nature.
For a cash flow to be unusual on the grounds of its size alone, it must be unusual in
relation to cash flows of a similar nature.
Discontinued activities
Cash flows relating to discontinued activities are required by IFRS 5 to be shown
separately, either on the face of the statement of cash flows or by note.
Major non-cash transactions
Material transactions not resulting in movements of cash should be disclosed in the
notes to the statement of cash flows if disclosure is necessary for an understanding
of the underlying transactions.
Consideration for transactions may be in a form other than cash. The purpose of a
statement of cash flows is to report cash flows, and non-cash transactions should
therefore not be reported in a statement of cash flows. However, to obtain a full
picture of the alterations in financial position caused by the transactions for the period,
separate disclosure of material non-cash transactions is also necessary.
Examples of non-cash transactions are:
•
the acquisition of assets by finance leases
Finance leases are accounted for by the lessee capitalising the present value
of the minimum lease payments. A liability and a corresponding asset are
produced, which do not reflect cash flows in the accounting period. The
statement of cash flows records the cash flow, i.e. the rentals paid, with the
reduction in liability shown under financing. The interest element of the
payment may be included in operating activities with only the portion of the
payment which reduces the lease liability shown under financing activities.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 478
•
the conversion of debt to equity
If debt is issued with conversion rights attached it will be cancelled using an
issue of shares and no cash flow will arise. The statement of cash flows is not
affected.
•
the acquisition of a subsidiary by issue of shares
If the purchase consideration on acquisition of a subsidiary is settled using a
share for share exchange no cash flow will arise and the statement of cash
flows is not affected.
4.
Preparation of Group Statement of Cash Flows
So far in this chapter, we have revised the basics on statements of cash flows. You
should be familiar with this from previous studies.
Group statements of cash flows add three extra elements:
4.1
•
cash paid to non-controlling interests
•
cash received from associates
•
acquisition and disposal of subsidiaries.
Cash paid to Non-controlling Interest
•
When a subsidiary that is not wholly owned pays a dividend, some of that
dividend is paid outside of the group to the non-controlling interest.
•
Such dividends paid to non-controlling interests should be disclosed
separately in the statement of cash flows.
•
To calculate the amount paid, reconcile the non-controlling interest in the
statement of financial position from the opening to the closing balance. You
can use a T-account to do this. This working remains the same whichever
method is used to value the non-controlling interest.
Example 1
The following information has been extracted from the consolidated financial
statements of WG for the years ended 31 December:
NCI in consolidated net assets
Advanced Financial Accounting and Corporate Reporting (Study Text)
20X7
20X6
Rs 000
Rs 000
780
690
Page 479
NCI in consolidated profit after tax
120
230
What is the dividend paid to non-controlling interests in the year 20X6?
Solution
Steps:
(1)
Set up a T account for the NCI interest balance.
(2)
Insert the opening and closing balances for net assets and the NCI share of
profit after tax.
(3)
Balance the account.
(4)
The balancing figure is the cash paid to the NCI.
Non-controlling interests
Rs 000
Rs 000
Dividends paid Balance b/d
(bal fig)
30
NCI
690
Balance c/d NCI
780
Share of profits in year
120
––––
––––
810
810
Watch out for an acquisition or disposal of a subsidiary in the year. This will affect the
NCI and will need to be taken account of in the T-account, showing the NCI that has
been acquired or disposed of in the period.
4.2
Cash Received from Associates
Associates generate cash flows into or out of the group to the extent that:
•
dividends are received out of the profits of the associate
•
trading occurs between the group and associate
•
further investment is made in the associate.
Advanced Financial Accounting and Corporate Reporting (Study Text)
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Associates are usually dealt with under the equity method of accounting and this
terminology is used below. (This also applies to jointly controlled entities as defined
in IAS 31 Interests in joint ventures).
Standard accounting practice
•
The cash flows of any equity accounted entity should be included in the group
statement of cash flows only to the extent of the actual cash flows between
the group and the entity concerned, for example dividends received in cash
and loans made or repaid.
Dividends
•
Only dividends received represent a cash inflow. Dividends declared but
unpaid represent an increase in group receivables.
•
When reconciling group net cash inflow to group reported profit, the
movement between opening and closing receivables must exclude dividends
receivable from the associate so that dividends received can be shown in the
statement of cash flows.
•
Dividends received from associates should be included as a separate item in
the group statement of cash flows.
Trading between group and associate
•
Trading between the group and an associate will give rise to inter-entity
balances in the group statement of financial position at the year end.
•
The balances will be treated in the same way as any other trading receivables
and payables, i.e. the movement between opening and closing balances
forms part of the reconciliation between group profit and group net cash inflow
from operating activities.
Change in investment in associate
A change in investment in the associate can arise when:
•
an additional shareholding is purchased or part of the shareholding is sold
•
loans are made to/from the associate or amounts previously loaned are
repaid.
Advanced Financial Accounting and Corporate Reporting (Study Text)
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Example 2
Associates
The following information has been extracted from the consolidated financial
statements of H for the year ended 31 December 20X1:
Group statement of comprehensive income
Rs 000
Operating profit
734
Income from associate
68
–––––
Profit before tax
802
Tax on profit (including 20 in respect of associate)
(324)
––––
Profit after tax
478
Group statement of financial position
20X1
20X0
Rs 000
Rs 000
Share of net assets
466
456
Loan to associate
380
300
260
190
40
70
Investments in associates
Current assets
Receivables
Included within group receivables is the following amount:
Current account with associate
Advanced Financial Accounting and Corporate Reporting (Study Text)
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Show the relevant figures to be included in the group statement of cash flows for the
year ended 31 December 20X1
Solution
When dealing with the dividend from the associate, the process is the same as we
have already seen with the non-controlling interest.
Set up a T account and bring in all the balances that relate to the associate. When
you balance the account, the balancing figure will be the cash received from the
associate.
(W1) Dividend received from associate
Associate
Rs 000
Balance b/d
Share of net assets
Share of profit after tax
(68–20)
Rs 000
Dividend received
456
(bal fig)
38
Share of net assets
466
48
––––
––––
504
504
––––
––––
Note that the current account with the associate remains within receivables.
Extracts from statement of cash flows
Rs 000
Cash flows from operating activities
Profit before tax
802
Share of profit of associate
(68)
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Investing activities
4.3
Dividend received from associate (W1)
38
Loan to associate (380 – 300)
(80)
Acquisition and Disposal of Subsidiaries
Standard accounting practice
•
If a subsidiary joins or leaves a group during a financial year, the cash flows
of the group should include the cash flows of that subsidiary for the same
period that the results of the subsidiary are included in the statement of
comprehensive income / SCI.
•
Cash payments to acquire subsidiaries and receipts from disposals of
subsidiaries must be reported separately in the statement of cash flows under
investing activities. The cash and cash equivalents acquired or disposed of
should be shown separately.
•
A note to the statement of cash flows should show a summary of the effects
of acquisitions and disposals of subsidiaries, indicating how much of the
consideration comprised cash and cash equivalents, and the assets and
liabilities acquired or disposed of.
Acquisitions
•
In the statement of cash flows we must record the actual cash flow for the
purchase, not the net assets acquired.
•
The assets and liabilities purchased will not be shown with the cash outflow in
the statement of cash flows.
•
All assets and liabilities acquired must be included in any workings to
calculate the cash movement for an item during the year. If they are not
included in deriving the balancing figure, the incorrect cash flow figure will be
calculated. This applies to all assets and liabilities acquired including the noncontrolling interest.
Advanced Financial Accounting and Corporate Reporting (Study Text)
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Disposals
•
The statement of cash flows will show the cash received from the sale of the
subsidiary, net of any cash balances that were transferred out with the sale.
•
The assets and liabilities disposed of are not shown in the cash flow. When
calculating the movement between the opening and closing balance of an
item, the assets and liabilities that have been disposed of must be taken into
account in order to calculate the correct cash figure. As with acquisitions, this
applies to all assets and liabilities and the non-controlling interest.
Example 3
Acquisition of Subsidiary
The extracts of a company’s statement of financial position is shown below:
Inventory
20X8
20X7
Rs
Rs
74,666
53,019
During the year, a subsidiary was acquired. At the date of acquisition, the subsidiary
had an inventory balance of Rs 9,384.
Calculate the movement on inventory for the statement of cash flows.
Solution
At the beginning of the year, the inventory balance of Rs 53,019 does not include
the inventory of the subsidiary.
At the end of the year, the inventory balance of Rs 74,666 does include the inventory
of the newly acquired subsidiary.
In order to calculate the correct cash movement, the acquired inventory must be
excluded as it is dealt with in the cash paid to acquire the subsidiary. The comparison
of the opening and closing inventory figures is then calculated on the same basis.
The movement on inventory is: (74,666 – 9,384) – 53,019 = Rs 12,263 increase. This
is shown as a negative cash flow.
Advanced Financial Accounting and Corporate Reporting (Study Text)
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Example 4
Disposal of Subsidiary
The same principle applies if there is a disposal in the period.
For example, the year end receivables balance was as follows:
Receivables
20X8
20X7
Rs
Rs
52,335
48,991
During the year, a subsidiary was disposed of. At the date of disposal the subsidiary
had a receivables balance of Rs 6,543.
Calculate the movement on receivables for the statement of cash flows.
Solution
At the beginning of the year, the receivables balance of Rs 48,911 does include the
receivables of the subsidiary.
At the end of the year, the receivables balance of Rs 52,335 does not include the
receivables of the disposed subsidiary.
In order to calculate the correct cash movement, the receivables of the disposed
subsidiary must be excluded.
The movement on receivables is:
52,335 – (48,911 – 6,543) = Rs 9,967 increase, which is shown as a negative cash
flow.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 486
5.
Foreign Currency Transactions
5.1
It is likely that any statement of cash flows question will require you to deal
with exchange gains and losses.
Individual entity stage
•
Exchange differences arising at the individual entity stage are in most
instances reported as part of operating profit. If the foreign currency
transaction has been settled in the year, the cash flows will reflect the
reporting currency cash receipt or payment and thus no problem arises.
•
An unsettled foreign currency transaction will, however, give rise to an
exchange difference for which there is no cash flow effect in the current year.
Such exchange differences therefore need to be eliminated in computing net
cash flows from operating activities.
•
Fortunately this will not require much work if the unsettled foreign currency
transaction is in working capital. Adjusting profit by movements in working
capital will automatically adjust correctly for the non-cash flow exchange
gains and losses.
Example 5
The financial statements of A are as follows:
Statements of financial position at 31 December 20X3 20X4
Rs
Rs
Inventory
300,000
300,000
Cash
335,000
595,000
–––––––
–––––––
635,000
895,000
–––––––
–––––––
Equity and liabilities
100,000
190,000
Foreign currency loan
235,000
245,000
Trade payables
300,000
460,000
–––––––
–––––––
Non-current assets – –
Current assets
Advanced Financial Accounting and Corporate Reporting (Study Text)
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635,000
895,000
–––––––
–––––––
Capital and reserves
100,000
190,000
Foreign currency loan
235,000
245,000
Trade payables
300,000
460,000
–––––––
–––––––
635,000
895,000
–––––––
–––––––
Statement of comprehensive income for the year ended 31 December 20X4
Revenue – all cash sales
1,003,000
Cost of sales
(910,000)
–-––––––
Operating profit before exchange differences
93,000
–-––––––
Exchange differences
Trading (2 + 5)
7,000
Loan (245 – 235)
(10,000)
––––––
(3,000)
–––––––
Profit before tax
90,000
Tax
–
–––––––
Profit for the period
90,000
Statement of comprehensive income for the year ended 31 December 20X4
Rs
Rs
Revenue – all cash sales
1,003,000
Cost of sales
(910,000)
–-––––––
Operating profit before exchange differences
93,000
–-––––––
Exchange differences
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Trading (2 + 5)
7,000
Loan (245 – 235)
(10,000)
–-–––––
(3,000)
–––––––
Profit before tax
90,000
Tax
–
–––––––
Profit for the period
90,000
During the year, A purchased raw materials for Z 200,000, recorded in its books as
Rs 100,000. By the year end A had settled half the debt for Rs 48,000 and the
remaining payable is retranslated at closing rate at Rs 45,000.
These transactions are included in the purchase ledger control account, which is as
follows:
Purchase ledger control
Rs
Cash
743,000
Exchange gains
Rs
Balance b/d
300,000
Purchases
910,000
On settled transaction
(50,000 – 48,000)
2,000
On unsettled transaction
(50,000 – 45,000)
5,000
Balance c/d
Foreign currency payable
45,000
Other
415,000
–-––––––
–-––––––
1,210,000
1,210,00
Show the gross cash flows (i.e. cash flows under the direct method) from operating
activities, together with a reconciliation of profit before tax to net cash flow from
operating activities.
Advanced Financial Accounting and Corporate Reporting (Study Text)
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Solution
Statement of cash flows for the year
Rs
Cash received from customers
1,003,000
Cash payments to suppliers
743,000
Rs
––––––––
Net cash inflow from operations
260,000
–-––––––
Increase in cash
260,000
–-––––––
Note that because there is no change in inventory, cost of sales is the same as
purchases
Reconciliation of profit before tax to net cash inflow from operating activities
Rs
Profit before tax
90,000
Exchange loss on foreign currency loan
10,000
Increase in payables
160,000
–––––––
Net cash inflow from operations
5.2
260,000
Consolidated statement of cash flows
The key to the preparation of a group statement of cash flows involving a
foreign subsidiary is an understanding of the makeup of the foreign exchange
differences themselves.
•
None of the differences reflects a cash inflow/outflow to the group. The main
concern, therefore, is to determine the real cash flows, particularly if they
have to be derived as balancing figures from the opening and closing
statements of financial position.
•
If cash balances are partly denominated in a foreign currency, the effect of
exchange rate movements on cash is reported in the statement of cash flows
in order to reconcile the cash balances at the beginning and end of the period.
This amount is presented separately from cash flows from operating,
investing and financing activities.
Advanced Financial Accounting and Corporate Reporting (Study Text)
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5.3
Closing rate/net investment method
•
Using the closing rate/net investment method, the exchange difference on
translating the statements of the foreign entity will relate to the opening net
assets of that entity (i.e. non-current assets, inventories, receivables, cash,
payables and loans) and also to the difference between the average and the
closing rates of exchange on translation of the result for the period.
•
Under the closing rate/net investment method, translation exchange
differences are disclosed as other comprehensive income and taken to other
components of equity in the statement of financial position.
Care needs to be taken in two areas:
•
Analysis of non-current assets
Non-current assets may require analysis in order to determine cash
expenditure. Part of the movement in non-current assets may reflect an
exchange gain/loss.
•
Analysis of non-controlling interests
If non-controlling interests require analysis to determine the dividend paid to
them, it must be remembered that they have a share in the exchange
gain/loss arising from the translation of the subsidiary’s accounts.
Example 6: Foreign currency transactions
B Group recognised a gain of Rs 160,000 on the translation of the financial
statements of a 75% owned foreign subsidiary for the year ended 31 December 20X7.
This gain is found to be made up as follows
Rs
Gain on opening net assets:
Non-current assets
90,000
Inventories
30,000
Receivables
50,000
Payables
(40,000)
Cash
30,000
–––––––
160,000
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Page 491
B Group recognised a loss of Rs 70,000 on retranslating the parent entity’s foreign
currency loan. This loss has been disclosed as other comprehensive income and
charged to reserves in the draft financial statements.
Consolidated statements of financial position as at 31 December 20X7 20X6
Rs 000
Rs 000
2,100
1,700
Inventories
650
480
Receivables
990
800
Cash
500
160
––––––
––––––
4,240
3,140
––––––
––––––
Share capital
1,000
1,000
Consolidated reserves
1,600
770
––––––
––––––
2,600
1,770
520
370
––––––
––––––
3,120
2,140
Long term loan
250
180
Payables
870
820
––––––
––––––
4,240
3,140
––––––
––––––
Non-current assets
Noncontrolling interest
Equity
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Page 492
There were no non-current asset disposals during the year.
Consolidated statement of comprehensive income for the year ended 31
December 20X7
Rs 000
Profit before tax (after depreciation of Rs 220,000)
2,170
Tax
(650)
––––––
Group profit for the year
1,520
––––––
Profit attributable to:
Owners of the parent
1,260
Non-controlling interest
260
––––––
Net profit for the period
1,520
––––––
Note: The dividend paid during the year was Rs 480,000.
Prepare a consolidated statement of cash flows for the year ended 31 December
20X7.
Advanced Financial Accounting and Corporate Reporting (Study Text)
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Solution
The first stage is to produce a statement of reserves so as to analyse the movements
during the year.
Statement of reserves
Rs 000
Reserves brought forward
770
Retained profit (1,260 – 480)
780
Exchange gain
(160,000 × 75%) – 70,000
50
–––––
Reserves carried forward
1,600
–––––
Statement of cash flows for the year ended 31 December 20X7
Cash flows from operating activities
Rs 000
Profit before tax
2,170
Depreciation charges
220
Increase in inventory (650 – 480 – 30)
(140)
Increase in receivables (990 – 800 – 50)
(140)
Increase in payables (870 – 820 – 40)
10
–––––
Cash generated from operations
2,120
Income taxes paid
(650)
–––––
Net cash from operating activities
1,470
Cash flows from investing activities
Purchase of non-current assets (W2)
(530)
–––––
–––––
(530)
Advanced Financial Accounting and Corporate Reporting (Study Text)
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Cash flows from financing activities
Dividends paid to non-controlling interests (W1)
(150)
Dividends paid
(480)
–––––
(630)
Exchange gain on cash
30
–––––
Increase in cash
340
Cash at 1 Jan 20X7
160
–––––
Cash at 31 Dec 20X7
500
Workings:
(W-1) Non-controlling interest
Rs 000
Rs 000
Dividend paid (bal fig)
150
Balance b/d
370
Balance c/d
520
Total comprehensive income (Note) 300
–––––
–––––
670
670
–––––
–––––
Note: i.e. NCI share of tax 260 + (25% x Rs 160,000 exchange gain) = 300
Advanced Financial Accounting and Corporate Reporting (Study Text)
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(W-2) Non-current assets
Rs 000
Rs 000
Balance b/d
1,700
Depreciation
220
Exchange gain
90
Balance c/d
2,100
Additions (bal fig)
530
Exchange gain
––––––
–––––
2,320
2,320
Example 7
Opening
Closing
Balance
Balance
Rs 000
Rs 000
Non-current assets
400
500
Loans
600
300
Tax
300
200
Group statement of financial position extracts
Statement of comprehensive income extracts
Depreciation
50
Loss on disposal of non-current asset
(sold for Rs 30,000)
10
Tax charge
200
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During the accounting period, one subsidiary was sold, and another acquired.
Extracts from the statements of financial position are as follows:
Sold
Acquired
Rs 000
Rs 000
Non-current assets
60
70
Loans
110
80
Tax
45
65
During the accounting period, the following net exchange gain arose in respect of
overseas net assets:
Rs 000
Non-current assets
40
Loans
(5)
Tax
(5)
Required:
Calculate the group cash flows for non-current assets, loans and tax.
Advanced Financial Accounting and Corporate Reporting (Study Text)
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SOLUTION
Non-current assets
Rs 000
Opening balance
400
Depreciation
(50)
Disposal (30 + 10)
(40)
Disposal of subsidiary
(60)
Acquisition of subsidiary
70
Exchange gain
40
––––
360
Cash acquisitions (bal figure)
140
––––
Closing balance
500
––––
Loans
Opening balance
600
Disposal of subsidiary
(110)
Acquisition of subsidiary
80
Exchange loss
5
––––
575
Therefore redemption
(275)
––––
Closing balance
300
––––
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Tax
Opening balance
300
Charge for the year
200
Disposal of subsidiary
(45)
Acquisition of subsidiary
65
Exchange loss
5
––––
525
Therefore, cash paid
(325)
––––
Closing balance
200
––––
6.
Evaluation of Statement of Cash Flows
6.1
Usefulness of statement of cash flows
A statement of cash flows can provide information that is not available from
statements of financial position and statements of comprehensive income.
(a)
It may assist users of financial statements in making judgements on the
amount, timing and degree of certainty of future cash flows.
(b)
It gives an indication of the relationship between profitability and cash
generating ability, and thus of the quality of the profit earned.
(c)
Analysts and other users of financial information often, formally or informally,
develop models to assess and compare the present value of the future cash
flow of entities. Historical cash flow information could be useful to check the
accuracy of past assessments.
(d)
A statement of cash flow in conjunction with a statement of financial position
provides information on liquidity, solvency and adaptability. The statement of
financial position is often used to obtain information on liquidity, but the
information is incomplete for this purpose as the statement of financial
position is drawn up at a particular point in time.
(e)
Cash flow cannot easily be manipulated and is not affected by judgement or
by accounting policies.
Advanced Financial Accounting and Corporate Reporting (Study Text)
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6.2
Limitations of statement of cash flows
Statements of cash flows should normally be used in conjunction with statement of
comprehensive incomes/statements of comprehensive income and statements of
financial position when making an assessment of future cash flows.
(a)
Statements of cash flows are based on historical information and therefore do
not provide complete information for assessing future cash flows.
(b)
There is some scope for manipulation of cash flows. For example, a business
may delay paying suppliers until after the yearend, or it may structure
transactions so that the cash balance is favourably affected. It can be argued
that cash management is an important aspect of stewardship and therefore
desirable. However, more deliberate manipulation is possible (e.g. assets
may be sold and then immediately repurchased). Application of the substance
over form principle should alert users of the financial statements to the true
nature of such arrangements
(c)
Cash flow is necessary for survival in the short term, but in order to survive in
the long term a business must be profitable. It is often necessary to sacrifice
cash flow in the short term in order to generate profits in the long term (e.g. by
investment in non-current assets). A substantial cash balance is not a sign of
good management if the cash could be invested elsewhere to generate profit.
Neither cash flow nor profit provides a complete picture of an entity’s performance
when looked at in isolation.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 500
Chapter Summary
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 501
Self-Test Questions
1.
Cash Flow Exercises
Calculate the cash flows given the following extracts from statements of financial
position drawn up at the year ended 31 December 20X0 and 20X1.
(1)
Non-current assets (CV)
20X0
20X1
Rs
Rs
100
250
During the year depreciation charged was Rs 20, a revaluation surplus of Rs 60 was
recorded, non-current assets with a CV of Rs 15 were disposed of and non-current
assets acquired subject to finance leases had a CV of Rs 30.
Required:
How much cash was spent on non-current assets in the period?
(2)
20X0
20X1
Rs
Rs
Deferred tax
50
100
Income tax liability
100
120
20X0
20X1
Rs
Rs
440
840
The income tax charge was Rs 180.
Required:
How much tax was paid in the period?
(3)
Non-controlling interest
The group statement of comprehensive income reported a non controlling interest of
Rs 500.
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Required:
How much was the cash dividend paid to the non-controlling interest?
(4)
20X0
20X1
Rs
Rs
500
850
Non-controlling interest
The group statement of comprehensive income reporting a non-controlling interest of
Rs 600.
Required:
How much was the cash dividend paid to the non-controlling interest?
(5)
20X0
20X1
Rs
Rs
200
500
Investment in associate undertaking
The group statement of comprehensive income reported ‘Income from Associate
Undertakings’ of Rs 750.
Required:
How much was the cash dividend received by the group?
(6)
Investment in associate undertaking
20X0
20X1
Rs
Rs
600
3200
The group statement of comprehensive income reported ‘Income from Associate
Undertakings’ of Rs 4,000
In addition, during the period the associate revalued its non-current assets, the group
share of which is Rs 500.
Advanced Financial Accounting and Corporate Reporting (Study Text)
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Required:
How much was the cash dividend received by the group?
(7)
Non-current asset (CV)
20X0
20X1
Rs
Rs
150
500
During the year depreciation charged was Rs 50, and the group acquired a
subsidiary with non-current assets of Rs 200.
Required:
How much cash was spent on non-current assets in the period?
(8)
Loan
20X0
20X1
Rs
Rs
2,500
1,000
The loan is denominated in an overseas currency, and a loss of Rs 200 has been
recorded on the retranslation.
Required:
How much cash was paid?
The group had the following working capital:
(9)
20X0
2.0X1
Rs
Rs
Inventory
200
100
Receivables
200
300
Trade payables
200
500
Advanced Financial Accounting and Corporate Reporting (Study Text)
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During the period the group acquired a subsidiary with the following working capital.
Inventory
50
Receivables
200
Trade Payables
40
During the period the group disposed of a subsidiary with the following working
capital.
Inventory
25
Receivables
45
Trade Payables
20
During the period the group experienced the following exchange rate differences.
Inventory
Gain
11
Receivables
Gain
21
Trade payables
Loss
31
Required:
Calculate the extract from the statement of cash flows for working capital.
2.
AH Group
Extracts from the consolidated financial statements of the AH Group for the year
ended 30 June 20X5 are given below:
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AH Group: Consolidated statement of comprehensive income for the year
ended 30 June 20X5
20X5
Rs 000
Revenue
85,000
Cost of sales
(60,750)
–––––––
Gross profit
24,250
Operating expenses
(5,650)
–––––––
Operating Profit
18,600
Finance cost
(1,400)
During the period the group acquired a subsidiary with the following working capital.
Inventory
50
Receivables
200
Trade Payables
40
During the period the group disposed of a subsidiary with the following working
capital.
Inventory
25
Receivables
45
Trade Payables
20
During the period the group experienced the following exchange rate differences.
Inventory
Gain
11
Receivables
Gain
21
Trade payables
Loss
31
Required:
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 506
Calculate the extract from the statement of cash flows for working capital.
AH Group: Consolidated statement of comprehensive income for the year ended
30 June 20X5
20X5
ASSETS
Rs 000
20X4
Rs 000
Rs 000
Rs 000
Non-current assets
Property, plant and equipment
50,600
44,050
Goodwill (note 3)
5,910
4,160
––––––
––––––
56,510
48,210
Current assets
Inventories
33,500
28,750
Trade receivables
27,130
26,300
Cash
1,870
3,900
––––––
––––––
62,500
58,950
–––––––
–––––––
119,010
107,160
–––––––
–––––––
Equity and liabilities
Equity shares @ Rs 10 each
20,000
18,000
Share premium
12,000
10,000
Retained earnings
24,135
18,340
––––––
––––––
56,135
46,340
3,875
1,920
–––––––
––––––
60,010
48,260
Non-controlling interest
Total equity
Non-current liabilities
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Interest bearing borrowings
18,200
19,200
Trade payables
33,340
32,810
Interest payables
1,360
1,440
Tax
6,100
5,450
––––––
––––––
40,800
39,700
–––––––
–––––––
119,010
107,160
Current liabilities
Notes:
(1)
Several years ago, AH acquired 80% of the issued equity shares of its
subsidiary, BI. On 1 January 20X5, AH acquired 75% of the issued equity
shares of CJ in exchange for a fresh issue of 0.2 million of its own Rs 10
equity shares (issued at a premium of Rs 10 each) and Rs 2 million in cash.
The net assets of CJ at the date of acquisition were assessed as having the
following fair values:
Rs 000
Property, plant and equipment
4,200
Inventories
1,650
Receivables
1,300
Cash
Trade payables
Tax
50
(1,950)
(250)
–––––
5,000
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 508
(2)
During the year, AH disposed of a non-current asset of property for proceeds
of Rs 2,250,000. The carrying value of the asset at the date of disposal was
Rs 1,000,000. There were no other disposals of non-current assets.
Depreciation of Rs 7,950,000 was charged against consolidated profits for the
year.
(3)
Goodwill on acquisition relates to the acquisition of two subsidiaries. Entity BI
was acquired many years ago, and goodwill relating to this acquisition was
calculated on a proportion of net assets basis. Goodwill relating to the
acquisition of entity CJ during the year was calculated on the full goodwill
basis. On 1 January 20X5 when CJ was acquired, the fair value of the noncontrolling interest was Rs 1,750,000. Any impairment of goodwill during the
year was accounted for within cost of sales.
Required:
Prepare the consolidated statement of cash flows of the AH Group for the financial
year ended 30 June 20X5 in the form required by IAS 7 Statements of Cash Flows,
and using the indirect method. Notes to the statement of cash flows are NOT
required, but full workings should be shown.
3.
Cash Ltd
Extract from the consolidated financial statements of Cash Ltd are given below:
20X5
Rs 000
20X4
Rs 000
Rs 000
Rs 000
Non-current assets
Property, plant and equipment
5,900
4,400
Goodwill
85
130
Investment in associate
170
140
––––––
––––––
6,155
4,670
Current assets
Inventories
1,000
930
Receivables
1,340
1,140
Short term deposits
35
20
Cash at bank
180
120
––––––
––––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 509
2,555
2,210
––––––
––––––
8,710
6,880
––––––
––––––
Equity and liabilities
Equity capital
2,000
1,500
Share premium
300
–
Other components of equity
50
–
3,400
3,320
––––––
––––––
5,750
4,820
75
175
––––––
––––––
5,825
4,995
1,400
1,000
Obligations under finance leases
210
45
Deferred tax
340
305
––––––
––––––
1,950
1,350
Trade payables
885
495
Accrued interest
7
9
Income tax
28
21
Obligations under finance leases
15
10
––––––
––––––
935
535
––––––
––––––
8,710
6,880
Retained earnings
Non-controlling interests
Total equity
Non-current liabilities
Interest bearing borrowings
Current liabilities
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 510
Consolidated statement of comprehensive income for the year ended 31 March
20X5
Rs 000
Revenue
875
Cost of sales
(440)
–––––
Gross profit
435
Other operating expenses
(210)
–––––
Profit from operations
225
Finance cost
(100)
Gain on sale of subsidiary
30
Share of associate’s profit
38
–––––
Profit before tax
193
Tax
(48)
–––––
Profit for the year
145
Other comprehensive income
Gains on land revaluation
50
–––––
Total comprehensive income for the year
195
Profit attributable to:
Equity holders of the parent
120
Non-controlling interests
25
–––––
145
–––––
Total comprehensive income attributable to:
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 511
Equity holders of the parent
170
Non-controlling interests
25
–––––
195
Notes:
Dividends
Cash Ltd paid a dividend of Rs 40,000 during the year.
Property, plant and equipment
The following transactions took place during the year:
2) Land was revalued upwards by Rs 50,000 on 1st April 20X4.
3) During the year, depreciation of Rs 80,000 was charged in the statement of
comprehensive income.
4) Additions include Rs 300,000 acquired under finance leases.
5) A property was disposed of during the year for Rs 250,000 cash. Its carrying
amount was Rs 295,000 at the date of disposal. The loss on disposal has
been included within cost of sales.
Gain on sale of subsidiary
On 1 January 20X5, Cash Ltd disposed of a 80% owned subsidiary for Rs 390,000 in
cash. The subsidiary had the following net assets at the date of disposal:
Rs 000
Property, plant and equipment
635
Inventory
20
Receivables
45
Cash
35
Payables
(130)
Income tax
(5)
Interest-bearing borrowings
(200)
––––
400
This subsidiary had been acquired on 1 January 20X1 for a cash payment of Rs
220,000 when its net assets had a fair value of Rs 225,000 and the non-controlling
interest had a fair value of Rs 50,000.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 512
Goodwill
The Cash Ltd Group uses the full goodwill method to calculate goodwill. No
impairments have arisen during the year.
Required:
Prepare the consolidated statement of cash flows of the Cash Ltd group for the year
ended 31 March 20X5 in the form required by IAS 7 Statement of cash flows. Show
your workings clearly.
4.
Border Ltd
Set out below is a summary of the accounts of Border Ltd, a public limited company,
for the year ended 31 December 20X7.
Consolidated statement of comprehensive income for the year ended 31
December 20X7
Rs 000
Revenue
44,754
Cost of sales and other expenses
(39,613)
Income from associates
Finance cost
30
(305)
––––––
Profit before tax
4,866
Tax:
(2,038)
––––––
Net profit for the period
2,828
––––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 513
Attributable to:
Owners of the parent
Non-controlling interests
2,805
23
––––––
2,828
––––––
Statement of other comprehensive income
Profit for the year
Exchange difference on translation of foreign operations (note 5)
2,828
302
––––––
Total comprehensive income
3,130
––––––
Summary of changes in equity for the year
Equity b/f
14,164
Profit for year
2,805
Dividends paid
(445)
Exchange differences
302
–––––
Equity c/f
Advanced Financial Accounting and Corporate Reporting (Study Text)
16,826
Page 514
Consolidated statements of financial position at 31 December
20X7
Note
Rs 000
20X6
Rs 000
Rs 000
Rs 000
Non-current assets
Intangible assets – goodwill
Tangible assets
(1)
Investment in associate
500
–
11,157
8,985
300
280
––––––
–––––
11,957
9,265
Current assets
Inventories
9,749
7,624
Receivables
5,354
4,420
Short term investments
1,543
741
Cash at bank and in hand
1,013
17,659
394
13,179
–––––
––––––
–––––
–––––
29,616
22,444
––––––
–––––
Rs 000
Rs 000
Equity share capital @ Rs 10
1,997
1,997
Share premium
5,808
5,808
Retained earnings
9,021
6,359
––––––
––––––
16,826
14,164
170
17
––––––
––––––
16,996
14,181
2,102
1,682
Equity and liabilities
Non-controlling interest
Total equity
Non-current liabilities:
Loans
Provisions
(3)
1,290
935
Current liabilities:
(2)
9,228
5,646
––––––
––––––
29,616
22,444
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 515
Notes to the accounts
(1)
Tangible assets
Non-current asset movements included the following:
(2)
(3)
Disposals at carrying amount
305
Proceeds from asset sales
854
Depreciation provided for the year
907
Current liabilities
20X7
20X6
Rs 000
‘000’
Bank overdrafts
1,228
91
Trade payables
4,278
2,989
Tax
3,722
2,566
––––––
––––––
9,228
5,646
Deferred
Total
Provisions
Pensions
taxation
Rs 000
Rs 000
Rs 000
At 31 December 20X6
246
689
935
Exchange rate adjustment
29
–
29
Increase in provision
460
–
460
Decrease in provision
–
(134)
(134)
–––––
–––––
–––––
735
555
1,290
At 31 December 20X7
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 516
(4)
LAS Ltd
During the year, the company acquired 82% of the issued equity capital of
LAS Ltd for a cash consideration of Rs 1,268,000. The fair values of the
assets of LAS Ltd were as follows:
Rs 000
Non-current assets
208
Inventories
612
Trade receivables
500
Cash in hand
232
Trade payables
(407)
Debenture loans
(312)
–––––
833
(5)
Exchange gains on translating the financial statements of a wholly-owned
subsidiary have been taken to equity and comprise differences on the
retranslation of the following:
Rs 000
Non-current assets
138
Pensions
(29)
Inventories
116
Trade receivables
286
Trade payables
(209)
_____
302
(6)
Non-controlling interest
The non-controlling interest is valued using the proportion of net assets
method.
Required:
Prepare a statement of cash flows for the year ended 31 December 20X7.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 517
Answers
1.
Non-current assets (CV)
(1)
Rs
Rs
Balance b/f
100
Depreciation
20
Revaluation
60
Disposals
15
Additions (bal fig)
125
Balance c/f
250
––––
––––
285
285
Cash additions = 125 – finance lease additions of 30 = 95
Tax
(2)
Rs
Tax paid (bal fig)
110
Balances c/fwd
DT
100
CT
120
(3)
Rs
Balances b/fwd
DT
50
CT
100
Statement of comprehensive income180
––––
––––
330
330
Non-controlling interest
Rs
Rs
Balance b/f
Cash dividend paid (bal. fig)
100
Balance c/f
840
440
Statement of comprehensive income500
––––
––––
940
940
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 518
(4)
Non-controlling interest
Rs
Rs
Balance b/f
Cash dividend paid (bal. fig)
income600
250
Balance c/f
850
(5)
500
Statement of comprehensive
–––––
–––––
1,100
1,100
Associate
Rs
Rs
Balance b/f
200
Cash received (bal fig)
450
Statement of comprehensive income
750
Balance c/f
500
(6)
––––
––––
950
950
Associate
Rs
Balance b/f
Statement of comprehensive income
Revaluation
(7)
Rs
600
4,000
500
Cash received (bal fig)
1,900
Balance c/f
3,200
–––––
–––––
5,100
5,100
Non-current assets (CV)
Rs
Balance b/f
150
New subsidiary
200
Cash additions (bal fig)
200
Rs
Depreciation
50
Balance c/f
500
––––
––––
550
550
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 519
(8)
Loan
Rs
Rs
Balance b/f
Cash paid (bal fig)
1,700
Balance c/f
1,000
Exchange loss
2,500
200
–––––
–––––
2,700
2,700
(9)
Rs
Movement in inventory (W1)
136
Movement in receivables (W2)
76
Movement in payables (W3)
249
(W1)
Movement in inventory
Rs
Rs
B/f balance
200
C/f balance
100
Disposal
(25)
Acquisition
(50)
Exchange gain
(11)
––––
Revised b/f
175
––––
Revised c/f
39
Movement therefore a decrease of 136
(W2)
Movement of receivables
Rs
Rs
B/f balance
200
C/f balance
300
Disposal
(45)
Acquisition
(200)
Exchange gain
(21)
––––
Revised b/f
155
––––
Revised c/f
79
Movement therefore a decrease of 76.
(W3)
Movement of payables
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 520
Rs
Rs
B/f balance
200
C/f balance
500
Disposal
(20)
Acquisition
(40)
Exchange loss
(31)
––––
Revised b/f
180
––––
Revised c/f
429
Movement therefore an increase of 249
2.
AH Group
Consolidated statement of cash flows for the year ended 30 June 20X5
Rs 000
Rs 000
Operating activities
Profit before tax
18,450
Adjustment
Less: gain on disposal of property
(1,250)
Add: finance cost
1,400
Adjustment for non-cash items dealt with in arriving at operating profit:
Depreciation
Decrease in trade and other receivables (27,130 – 26,300 – 1,300)
7,950
470
Increase in inventories (33,500 – 28,750 – 1,650)
(3,100)
Decrease in trade payables (33,340 – 32,810 – 1,950)
(1,420)
Goodwill impaired (W4)
1,000
––––––
-
Cash generated from operations
23,500
Interest paid (W1)
(1,480)
Income taxes paid (W2)
(5,850)
––––––
Net cash from operating activities
16,170
Investing activities
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 521
Acquisition of subsidiary net of cash acquired (2,000 – 50) (1,950)
Purchase of property, plant, and equipment (W3)
(11,300)
Proceeds from sale of property
2,250
––––––
Net cash used in investing activities
(11,000)
Financing activities
Repayment of long-term borrowings (18,200 – 19,200)
(1,000)
Dividend paid by parent (W7)
(6,000)
Dividends paid to NCI (W6)
(200)
–––––
Net cash used in financing activities
(7,200)
––––––
Net decrease in cash and cash equivalents
(2,030)
Cash and cash equivalents at 1 July 20X4
3,900
––––––
Cash and cash equivalents at 30 June 20X5
1,870
Workings:
(W1)
Interest paid
Rs 000
Rs 000
Cash paid (balancing figure)
1,480
Balance b/d
Balance c/d
1,360
Statement of
comprehensive income
1,440
1,400
–––––
–––––
2,840
2,840
(W2)
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 522
Income taxes paid
Rs 000
Cash paid (balancing figure)
5,850
Rs 000
Balance b/d
5,450
Statement of comprehensive
income6,250
Balance c/d
6,100
New subsidiary
250
–––––
–––––
11,950
11,950
(W3)
Property, plant and equipment
Rs 000
Rs 000
Balance b/d
44,050
Depreciation
7,950
New subsidiary
4,200
Disposals
1,000
Additions (balancing figure)
11,300
Balance c/d
50,600
–––––
–––––
59,550
59,550
(W4) Goodwill re acquisition during year
Rs 000
Fair value of shares issued
Equity capital – nominal value
2,000
Share premium
2,000
Cash paid
2,000
–––––
6,000
Fair value of NCI
per question
1,750
–––––
7,750
Fair value of net assets at acquisition
per question
5,000
–––––
Full goodwill at acquisition
2,750
(W5)
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 523
Goodwill
Rs 000
Rs 000
Balance b/d
4,160
Impaired in year (bal fig)
1,000
Full goodwill on subsidiary acquired (W4)
2,750
Balance c/d
5,910
–––––
–––––
6,910
6,910
(W6)
Non-controlling interest
Rs 000
Dividend paid (balancing figure)
200
Rs 000
Balance b/d
1,920
NCI at fair value re CJ acquired1,750
Balance c/d
income405
3,875
Statement of comprehensive
–––––
–––––
4,075
4,075
(W7)
Retained earnings
Rs 000
Rs 000
Dividend paid (balancing figure)
6,000
Balance b/d
Balance c/d
income11,795
24,135
Statement of comprehensive
3.
18,340
–––––
–––––
30,135
30,135
Cash Ltd
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 524
Consolidated statement of cash flows for the year ended 31 March 20X5
Rs 000
Rs 000
Cash flows from operating activities
Profit before tax
193
Gain on sale of subsidiary
(30)
Share of associate’s profit
(38)
Finance costs
100
Adjust for non-cash items dealt with in arriving at operating profit:
Depreciation
80
Loss on disposal of property (250 – 295)
45
–––––
Operating profit before working capital changes
350
Increase in inventory (1,000 – (930 – 20))
(90)
Increase in receivables (1,340 – (1,140 – 45))
(245)
Increase in payables (885 – (495 – 130))
520
–––––
535
Finance costs paid (W2)
Tax paid (W3)
(102)
(1)
–––––
432
Cash flows from investing activities
Sale of property
Purchases of property, plant and equipment (W4)
Dividends received from associate (W5)
Proceeds from sale of subsidiary, net of cash balances (390 – 35)
250
(2,160)
8
355
–––––
(1,547)
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 525
Cash flows from financing activities
Repayments of finance leases (W6)
(130)
Cash raised from interest bearing borrowings (W7)
600
Issue of shares (500 + 300)
800
Dividends paid to equity shareholders of parent
(40)
Dividends paid to non-controlling interests (W8)
(40)
–––––
1,190
–––––
Increase in cash and cash equivalents
75
Opening cash and cash equivalents (120 + 20)
140
–––––
Closing cash and cash equivalents (180 + 35)
215
–––––
(1) Goodwill
Goodwill on acquisition of subsidiary disposed of during the year
Rs 000
Fair value of consideration paid
220
Fair value of NCI
50
––––
270
Less: Fair value of net assets at acquisition
(225)
––––
Full goodwill at acquisition
45
––––
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 526
Goodwill
Rs 000
Bal b/d
130
Rs 000
Disposal of sub (as above)
45
Bal c/d
85
––––
––––
130
130
(2) Finance
Finance
Rs 000
Cash (bal fig)
102
Bal b/d
7
Rs 000
Bal b/d
SCI
9
100
––––
––––
109
109
(3) Tax paid
Tax
Disposal of sub
Bal b/d – IT
21
Bal b/d – DT
305
5
SCI – group
Tax paid (bal fig)
1
Bal c/d – IT
28
Bal c/d – DT
340
48
––––
––––
374
374
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 527
(4) Purchase of non-current assets
Property, plant and equipment
Rs
Bal b/d
Rs
4,400
Revaluation
50
Depreciation
80
Finance leases (W6)
300
Disposal –property
295
Disposal – sub
635
Cash (bal fig)
2,160
Bal c/d
5,900
–––––
–––––
6,910
6,910
(5) Dividend from associate
Associates
Rs
Bal b/d
140
Share of profit for the year
38
Rs
Dividend received (bal: fig)
Bal c/d
8
170
––––
––––
178
178
(6) Repayment of finance leases
Finance leases
Rs
Repayments (bal fig)
130
Bal c/d (15 + 210)
225
Rs
Bal b/d (10 + 45)
55
New leases (W4)
300
––––
––––
355
355
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 528
(7) Cash raised from borrowings
Interest bearing borrowings
Rs
Rs
Bal b/d
Disposal of sub
200
Bal b/d
Cash (bal fig)
1,000
600
1,400
–––––
–––––
1,600
1,600
(8) Dividend paid to non-controlling interests
Non-controlling interests
Rs
NCI in sub at disposal date (W9)
85
Dividends paid (bal fig)
40
Bal c/d
75
Rs
Bal b/d
175
Share of profits
25
––––
––––
200
200
(W9) NCI in sub at disposal date
FV of NCI at acquisition
50
NCI share of increase in post-acquisition retained earnings (20% x (400 –225))
35
–––
85
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 529
4.
Border Ltd
Statement of cash flows for the year ended 31 December 20X7
Rs 000
Rs 000
Operating activities
Profit before tax
4,866
Interest payable
305
Income from associate
(30)
–––––
Operating profit
5,141
Non-cash items
Depreciation
907
Goodwill (W7)
85
Gain on disposal of assets (W1)
(549)
Increase in pension provision
460
–––––
6,044
Change in working capital
Increase in inventory
(9,749 – 7,624 – 612 acq – 116 ex diff)
(1,397)
Increase in receivables
(5,354 – 4,420 – 500 acq – 286 ex diff)
(148)
Increase in payables
(4,278 – 2,989 – 407 acq – 209 ex diff)
673
–––––
5,172
Interest paid
(305)
Tax paid (W2)
(1,016)
–––––
–––––
3,851
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 530
Investing activities
Purchase of non-current assets (W3)
Proceeds on disposal
(3,038)
854
Cash consideration paid on acquisition of subsidiary,
net of cash acquired (1,268 – 232)
Dividend received from associate (W4)
(1,036)
10
–––––
–––––
(3,210)
Financing activities
Dividends paid
(445)
Dividends paid to NCI (W6)
(20)
Proceeds from debt issue (W5)
108
–––––
–––––
(357)
–––––
Change in cash and cash equivalents
Opening cash and cash equivalents (394 + 741 – 91)
284
1,044
–––––
Closing cash and cash equivalents (1,013 + 1,543 – 1,228)
1,328
Workings
W-1
Proceeds of disposal of NCA
Rs
Sales proceeds
854
CV
(305)
––––
Profit on disposal
Advanced Financial Accounting and Corporate Reporting (Study Text)
549
Page 531
(W2)
Tax
Rs
Rs
Cash
1,016
Balance b/f–CT
2,566
Balance c/f–CT
3,722
Balance b/f–DT
689
Balance c/f–DT
555
I/S
2,038
–––––
–––––
5,293
5,293
(W3)
Non-current assets
Rs
Balance b/f
8,985
Rs
Depreciation
907
Exchange gain
138
Disposal
305
Acquisition
208
Balance c/f
11,157
Cash
3,038
–––––
–––––
12,369
12,369
(W4)
Dividends from associates
Rs
Rs
Balance b/f
280
Cash
10
Profit
30
Balance c/f
300
––––
––––
310
310
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 532
(W5)
Debentures
Rs
Balance c/f
2,102
Rs
Balance b/f
1,682
Acquisition
312
Cash
108
–––––
–––––
2,102
2,102
(W6)
Non-controlling interest
Rs
Rs
Cash
20
Balance b/f
17
Balance c/f
170
I/S
23
Acquisition (18% × 833)
150
––––
––––
190
190
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 533
(W7)
Goodwill – proportionate basis
Rs
Cost of investment
CV of NCI at acquisition (18% × 833)
1,268
150
–––––
1,418
FV of net assets at acquisition
(833)
–––––
Goodwill at acquisition
585
Balance b/fwd
nil
–––––
585
Amount written off (Bal fig)
(85)
–––––
Bal c/fwd per closing group SOFP
Advanced Financial Accounting and Corporate Reporting (Study Text)
500
Page 534
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 535
EARNINGS PER SHARE
Chapter learning objectives
Upon completion of this chapter you will be able to:
•
define and calculate basic earnings per share (EPS)
•
explain the relevance of diluted EPS (DEPS)
•
calculate DEPS involving convertible debt
•
calculate DEPS involving share options (warrants)
•
explain the importance of EPS as a stock market indicator
•
explain why the trend in EPS may be a more accurate indicator of performance than
a company’s profit trend
•
explain the limitations of EPS as a performance measure.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 536
1
Introduction
1.1
Earnings per share (EPS) is widely regarded as the most important indicator of a
company’s performance. It is important that users of the financial statements:
•
are able to compare the EPS of different entities and
•
are able to compare the EPS of the same entity in different accounting
periods.
IAS 33 achieves comparability by:
1.2
•
defining earnings
•
prescribing methods for determining the number of shares to be included in
the calculation of EPS
•
requiring standard presentation and disclosures.
The Scope of IAS 33
IAS 33 applies to entities whose ordinary shares are publicly traded.
Publicly traded entities which present both parent and consolidated financial
statements are only required to present EPS based on the consolidated figures.
2
Basic EPS
2.1
The basic EPS calculation is simply
Earnings
–––––––––
Shares
•
Earnings: group profit after tax, less non-controlling interests and
irredeemable preference share dividends.
•
Shares: weighted average number of ordinary shares outstanding during the
period.
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2.2
Issue of shares at full market price
Earnings should be apportioned over the weighted average equity share capital (i.e.
taking account of the date any new shares are issued during the year).
Example 1
Full Market Share Issue
A company issued 200,000 shares at full market price (Rs 3.00) on 1 July 20X8.
Relevant information
20X8
20X7
the year ending 31 December
Rs 550,000
Rs 460,000
Number of ordinary shares in issue at 31 December
1,000,000
800,000
Profit attributable to the ordinary shareholders for
Requirement
Calculate the EPS for each of the years.
Solution
Calculation of EPS
Rs 460,000
20X7
EPS
= –––––––– = Rs 0.575
800,000
Issue at full market price:
Date
Actual number of shares Fraction of year
Total
1 Jan 20X8
800,000
6/12
400,000
1 July 20X8
1,000,000
6/12
500,000
–––––––
Number of shares in EPS calculation
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900,000
Page 538
–––––––
Rs 550,000
20X8
EPS
= –––––––– = Rs 0.611
900,000
Since the 200,000 shares have only generated additional resources towards the
earning of profits for half a year, the number of new shares is adjusted proportionately.
Note that the approach is to use the earnings figure for the period without adjustment,
but divide by the average number of shares weighted on a time basis.
2.3
Bonus issue
A bonus issue (or capitalization issue or scrip issue):
•
does not provide additional resources to the issuer
•
means that the shareholder owns the same proportion of the business before
and after the issue.
In the calculation of EPS:
•
the bonus shares are deemed to have been issued at the start of the year
•
comparative figures are restated to allow for the proportional increase in share
capital caused by the bonus issue.
Illustration
Consider:
•
Mr A owns 5,000 shares in Company B which has an issued capital of
100,000 shares. Mr A therefore owns 5% of Company B.
•
Company B makes a 1 for 1 bonus issue.
•
Mr A now owns 10,000 shares and Company B has 200,000 shares in issue.
Mr A still owns 5% of Company B.
The shares issued as a result of the bonus issue are deemed to have been issued at
the start of the year, regardless of the actual date when the bonus issue took place.
To ensure that the EPS for the year of the bonus issue remains comparable with the
EPS of previous years, comparative figures for earlier years are restated using the
same increased figure.
Example 2
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A company makes a bonus issue of one new share for every five existing shares held
on 1 July 20X8.
20X8
20X7
Rs 550,000
Rs 460,000
1,200,000
1,000,000
Profit attributable to the ordinary shareholders for
the year ending 31 December
Number of ordinary shares in issue at 31
December
Calculate the EPS in 20X8 accounts.
Solution
Calculation of EPS in 20X8 accounts.
Rs 460,000
20X7
–––––––– = Rs 0.383
1,200,000
Rs 550,000
20X8
–––––––– = Rs 0.458
1,200,000
In the 20X7 accounts, the EPS for the year would have appeared as Rs 0.46 (Rs
460,000 ÷ 1,000,000). In the example above, the computation has been reworked in
full. However, to make the changes required it would be simpler to adjust directly the
EPS figures themselves.
Since the old calculation was based on dividing by 1,000,000 while the new is
determined by using 1,200,000, it would be necessary to multiply the EPS by the first
and divide by the second. The fraction to apply is, therefore:
1,000,000
5
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–––––––– or ––
1,200,000
6
5
Consequently: 0.46 × –– = Rs 0.383
6
2.4
Rights issue
Rights issues present special problems:
Therefore they combine the characteristics of issues at full market price and bonus
issues.
•
they contribute additional resources
•
they are normally priced below full market price.
Determining the weighted average capital, therefore, involves two steps as follows:
(1)
adjust for bonus element in rights issue, by multiplying capital in issue before
the rights issue by the following fraction:
Actual cum rights price
––––––––––––––––––––
Theoretical ex rights price
(2)
calculate the weighted average capital in the issue as above.
Example 3
Right Issue
A company issued one new share for every two existing shares held by way of rights
at Rs 1.50 per share on 1 July 20X8. Pre-issue market price was Rs 3.00 per share.
Relevant information:
20X8
20X7
Profit attributable to the ordinary shareholders for
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the year ending 31 December
Rs 550,000
Rs 460,000
1,200,000
800,000
Number of ordinary shares in issue at 31
December
Solution
20X8:
Earnings
Rs 550,000
–––––––––––––––––––––––––––––
Weighted average number of shares (W1)
=
–––––––
= Rs 0.509
1,080,000
20X7:
The prior year EPS must be adjusted to reflect the bonus element in the rights issue.
Rs 2.50 (W2)
EPS = 57.5 paisas (W3) ×
––––––––– = Rs 0.479
Rs 3.00
NB: To restate the EPS for the previous year simply multiply EPS by the inverse of
the rights issue bonus fraction.
(W1) 20X8 Weighted average number of shares
The number of shares before the rights issue must be adjusted for the bonus element
in the rights issue using the theoretical ex rights price.
6/12 × 800,000 × 3.00/2.50 (W2)
480,000
6/12 × 1,200,000
600,000
––––––––
1,080,000
––––––––
(W2)
Theoretical ex rights price
2 shares @ Rs 3.00
Rs 6.00
1 share @ Rs 1.50
Rs 1.50
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–––––
3 shares
Rs 7.50
–––––
Theoretical ex rights price = Rs 7.50/3
Rs 2.50
(W3)
20X7 comparative EPS =
Rs 460,000
––––––––
800,000
=
3
Diluted Earnings per Share (DEPS)
3.1
Introduction
Rs 0.575
Equity share capital may change in the future owing to circumstances which exist
now – known as dilution. The provision of a diluted EPS figure attempts to alert
shareholders to the potential impact on EPS.
Examples of dilutive factors are:
3.2
•
the conversion terms for convertible bonds
•
the conversion terms for convertible preference shares
•
the exercise price for options and the subscription price for warrants.
Basic principles of calculation
To deal with potential ordinary shares, adjust basic earnings and number of shares
assuming convertibles, options, etc. had converted to equity shares on the first day of
the accounting period, or on the date of issue, if later.
DEPS is calculated as follows:
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Earnings + notional extra earnings
–––––––––––––––––––––––––––––––
Number of shares + notional extra shares
3.3
Why DEPS is calculated?
The basic EPS figure calculated as above could be misleading to users if at some
future time the number of shares in issue will increase without a proportionate
increase in resources. For example, if an entity has issued bonds convertible at a
later date into ordinary shares, on conversion the number of ordinary shares will rise,
no fresh capital will enter the entity and earnings will rise by the savings in no longer
having to pay the post-tax amount of the interest on the bonds. Often the earnings
increase is less, proportionately, than the increase in the shares in issue. This effect
is referred to as ‘dilution’ and the shares to be issued are called ‘dilutive potential
ordinary shares’.
IAS 33 therefore requires an entity to disclose the DEPS, as well as the basic EPS,
calculated using current earnings but assuming that the worst possible future dilution
has already happened. Existing shareholders can look at the DEPS to see the effect
on current
profitability of commitments already entered into to issue ordinary shares in the future.
For the purpose of calculating DEPS, the number of ordinary shares should be the
weighted average number of ordinary shares calculated as for basic EPS, plus the
weighted average number of ordinary shares which would be issued on the
conversion of all the dilutive potential ordinary shares into ordinary shares. Dilutive
potential ordinary shares are deemed to have been converted into ordinary shares at
the beginning of the period or, if later, the date of the issue of the potential ordinary
shares.
3.4
Convertibles
The principles of convertible bonds and convertible preference shares are similar and
will be dealt with together.
If the convertible bonds/preference shares had been converted:
•
the interest/dividend would be saved therefore earnings would be higher
•
the number of shares would increase.
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Example 4
On 1 April 20X1, a company issued Rs 1,250,000 8% convertible unsecured bonds
for cash at par. Each Rs 100 nominal of the loan stock will be convertible in
20X6/20X9 into the number of ordinary shares set out below:
•
On 31 December 20X6 124 shares.
•
On 31 December 20X7 120 shares.
•
On 31 December 20X8 115 shares.
•
On 31 December 20X9 110 shares.
Up to 20X5, the maximum number of shares issuable after the end of the financial
year will be at the rate of 124 shares per Rs 100 on Rs 1,250,000 debt, which is
1,550,000 shares. With 4,000,000 already in issue, the total becomes 5,550,000. It is
the maximum possible number of shares that can be converted into which is always
used.
Relevant information
Issued share capital:
•
Rs 500,000 in 10% cumulative irredeemable preference shares of Rs 1.
•
Rs 1,000,000 in ordinary shares of Rs 0.25 = 4,000,000 shares.
•
Income taxes are 30%.
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Trading results for the years ended 31 December were as follows:
20X2
Rs
Profit before interest and tax
20X1
Rs
1,100,000
991,818
100,000
75,000
––––––––
––––––––
Profit before tax
1,000,000
916,818
Income tax
(300,000)
(275,045)
––––––––
––––––––
700,000
641,773
––––––––
––––––––
20X2
20X1
Rs
Rs
Profit after tax
700,000
641,773
Less: Preference dividend
(50,000)
(50,000)
––––––––
––––––––
650,000
591,773
––––––––
––––––––
Rs 0.1625
Rs 0.148
––––––––
––––––––
650,000
591,773
–––––––
–––––––
Interest on 8% convertible unsecured bonds
Profit after tax
Solution
Calculation of EPS
Basic EPS
Earnings
EPS based on 4,000,000 shares
DEPS
Earnings as above
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Add: Interest on the convertible
Unsecured bonds
100,000
75,000
Less: Income tax
(30,000)
(22,500)
–––––––
–––––––
70,000
52,500
–––––––
–––––––
720,000
644,273
–––––––
–––––––
Rs 0.13
Rs 0.125
–––––––
–––––––
Adjusted earnings
EPS based on
5,550,000 shares (20X1 – 5,162,500)
The weighted average number of shares issued and issuable for 20X1 would have
been one-quarter of 4,000,000 plus three-quarters of 5,550,000, i.e. 5,162,500.
Convertible preference shares are dealt with on the same basis, except that often
they do not qualify for tax relief so there is no tax saving foregone to be adjusted for.
3.5
Options and warrants to subscribe for shares
An option or warrant gives the holder the right to buy shares at some time in the
future at a predetermined price.
Cash does enter the entity at the time the option is exercised, and the DEPS
calculation must allow for this.
The total number of shares issued on the exercise of the option or warrant is split into
two:
•
the number of shares that would have been issued if the cash received had
been used to buy shares at fair value (using the average price of the shares
during the period)
•
the remainder, which are treated like a bonus issue (i.e. as having been
issued for no consideration).
The number of shares issued for no consideration is added to the number of shares
when calculating the DEPS.
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Example 5
Options
On 1 January 20X7, a company has 4 million ordinary shares in issue and issues
options over another million shares. The net profit for the year is Rs 500,000.
During the year to 31 December 20X7 the average fair value of one ordinary share
was Rs 3 and the exercise price for the shares under option was Rs 2.
Calculate basic EPS and DEPS for the year ended 31 December 20X7.
Solution
Rs 500,000
Basic EPS = –––––––– = Rs 0.125
4,000,000
Options or warrants
Rs
Earnings
500,000
––––––––
Number of shares
Basic
4,000,000
Options (W1)
333,333
––––––––
4,333,333
––––––––
Rs 500,000
The DEPS is therefore
–––––––– = Rs 0.115
4,333,333
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(W1)
Number of shares at option price
Options
= 1,000,000 × Rs 2.00
= Rs 2,000,000
Rs 2,000,000
At fair value
––––––––
= 666,667
Rs 3.00
Number issued free = 1,000,000 – 666,667 = 333,333
3.6
Anti-dilutive Instruments
The objective of DEPS’ inclusion in financial statements is to present lowest possible
earning per share, in order to arrive at this minimum ratio we must exclude any antidilutive instruments. Anti dilutive instruments are those instruments whose effect on
numerator is greater than the denominator i.e an increased ratio of earning per share.
To do so, we calculate effect of each dilutive instrument on EPS separately and rank
those with lowest EPS ranked 1st and ignore the anti-dilutive instrument which is
bringing an increase in the lowest possible EPS, consider the following example.
Example 6
The profit after tax earned by AAZ Limited during the year ended December
31,2007 amounted to Rs. 127.83 million. The weighted average number of shares
outstanding during the year was 85.22 million.
Details of potential ordinary shares as at December 31, 2007 are as follows:
• The company had issued debentures which are convertible into 3 million
ordinary shares. The debenture holders can exercise the option on December 31,
2009. If the debentures are not converted into ordinary shares they shall be
redeemed on December 31, 2009. The interest on debentures for the year 2007
amounted to Rs. 7.5 million.
• Preference shares issued in 2004 are convertible into 4 million ordinary shares
at the option of the preference shareholders. The conversion option is exercisable
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on December 31, 2010. The dividend paid on preference shares during the year
2007 amounted to Rs. 2.45 million.
• The company has issued options carrying the right to acquire 1.5 million ordinary
shares of the company on or after December 31, 2007 at a strike price of Rs. 9.90
per share.
During the year 2007, the average market price of the shares was Rs. 11 per
share.
The company is subject to income tax at the rate of 30%.
Required
Compute diluted earnings per share.
Solution
Step 1: Ranking in order of dilution
Increase
Increase in
Earnings per
in
no. of
incremental
earnings
ordinary
shares
Rank
shares
Rs.
Convertible
Debentures
Rs.
5,250,000
3,000,000
1.75
3
2,450,000
4,000,000
0.61
2
Increase in
earnings (Rs.
7.5m x 70%)
Increase in
shares
Convertible
Preference
Shares
Increase in
earnings
Increase in
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shares
Options
-
150,000
-
1
Increase in
earnings
Increase in
shares (1.5m x
1.1 / 11)
Step 2: Testing for dilutive effect
Profit from
Ordinary
operations
Shares
EPS
Effect
attributable to
ordinary
shareholders
Rs.
Basic Earnings per
share
Options (Rank 1)
Convertible
preference shares
(Rank 2)
Convertible
debentures (Rank 3)
Rs.
*125,380,000
85,220,000
-
150,000
125,380,000
85,370,000
2,450,000
4,000,000
127,830,000
89,370,000
5,250,000
3,000,000
133,080,000
92,370,000
1.471
-
1.469
Dilutive
1.430
Dilutive
1.44
AntiDilutive
*Rs. 127,830,000 – Rs. 2,450,000 = Rs. 125,380,000
Example 7
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Following data related to AC Company and its subsidiary DC Company for the year ended
June 30, 2012:
AC Company: (in .000. )
Profit attributable to ordinary share holders of AC Company
Rs.
25,000
Ordinary shares outstanding
10,000
Instruments of DC Company owned by AC Company:
Ordinary shares outstanding
900
Warrants exercisable to purchase ordinary share of DC
Company
300
Convertible preference shares
375
DC Company
Profit for the year (after tax)
Rs. 8,000
Ordinary shares outstanding
1,200
Warrants exercisable to purchase ordinary shares of
DC Company
600
Convertible preference shares (convertible into
1 equity share)
500
Exercise price is Rs.10
Average market price is Rs. 20
Dividend on preference shares is Re.1 per share
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Required
Calculate basic earnings per share and diluted earnings per share for
1)
the subsidiary and
2) The group.
Ignore income tax and assume that no inter-company elimination or adjustment is
necessary except for dividends.
Solution
a)
Basic EPS of subsidiary
(Rs.L000)
Profit (W1)
Rs.7,500.00
No of shares
1,200.00
Basic EPS (7,500 /1,200)
Rs.6.25
Diluted Earning per share
Profit
Rs.8,000
No of shares (W2)
2,000
Diluted Earning per share (8,000 / 2,000)
Rs.4.00
Working 1
Profit
Rs.8,000
Less : Dividend paid to preference share holder
Rs. (500)
Rs.7,500
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Working 2
Ordinary shares
1,200
Incremental shares from warrants
[600 (600 x 10) + 20]
300
Convertible preference shares
500
2,000
b)
For Group
Basic EPS
Profit (W1)
Rs.31,000
No of shares
10,000
Basic EPS (31,000 = 10,000)
Rs.3.10
Diluted Earning per share
Profit (W2)
Rs.30,700
No of shares
10,000
Diluted Earning per share (30,700 + 10,000)
Rs.3.07
Working 1
Profit
Rs.25,000
Add Portion of DC profit (375x1)+(900x6.25)
Rs.6,000
Rs.31,000
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Working 2
Profit
Rs.25,000
Add DC's earning attributable to ordinary shareholder
(1200 x 4.00 x 75%)
Rs.3,600
Add DC's earning attributable to Warrant (300 x 4) x 50%
Rs.600
Add DC's earning attributable to Preference share
(500x4)x75%
Rs.1.500
30,700
4
The Importance of EPS
4.1
Price earnings ratio
The EPS figure is used to compute the major stock market indicator of performance,
the price earnings ratio (P/E ratio). The calculation is as follows:
Market value of share
P/E ratio =
–––––––––––––––
EPS
Trend in EPS
Although EPS is based on profit on ordinary activities after taxation, the trend in EPS
may be a more accurate performance indicator than the trend in profit,
EPS
•
measures performance from the perspective of investors and potential
investors
•
shows the amount of earnings available to each ordinary shareholder, so that
it indicates the potential return on individual investments.
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4.2
Importance of DEPS
DEPS is important for the following reasons:
4.3
•
it shows what the current year’s EPS would be if all the dilutive potential
ordinary shares in issue had been converted
•
it can be used to assess trends in past performance
•
in theory, it serves as a warning to equity shareholders that the return on their
investment may fall in future periods.
Limitations of EPS
Although EPS is believed to have a real influence on the market price of shares, it
has several important limitations as a performance measure:
•
real.
It does not take account of inflation. Apparent growth in earnings may not be
•
It is based on historic information and therefore it does not necessarily have
predictive value.
•
An entity’s earnings are affected by the choice of its accounting policies.
Therefore it may not always be appropriate to compare the EPS of different
companies.
•
DEPS is only an additional measure of past performance despite looking at
future potential shares.
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Chapter Summary
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Self Test Questions
1.
G Ltd 's earnings for the year ended 31 December 20X4 are Rs 2,208,000. On 1
January 20X4, the issued share capital of G Ltd was 8,280,000 ordinary shares of Rs
10 each. The company issued 331,200 shares at full market value on 30 June 20X4.
Calculate the EPS for G Ltd for 20X4.
2.
Bell Ltd had the following capital and reserves on 1 April 20X1:
Rs. ‘000’
Share capital (Rs 10 ordinary shares)
7,000
Share premium
900
Revaluation reserve
500
Retained earnings
9,000
––––––
Shareholders’ funds
17,400
Bell Ltd makes a bonus issue, of one share for every seven held, on 31 August 20X2.
Bell Ltd ’s results are as follows:
Profit after tax and NCI
Advanced Financial Accounting and Corporate Reporting (Study Text)
20X3
20X2
Rs 000
Rs 000
1,150
750
––––––
––––––
Page 558
Calculate EPS for the year ending 31 March 20X3, together with the
comparative EPS for 20X2 that would be presented in the 20X3 accounts.
3.
On 31 December 20X1, the issued share capital consisted of 100,000 ordinary
shares of Rs 10 each, and the shares were quoted at Rs 40. On 1 July 20X2 the
company made a rights issue in the proportion of 1 for 4 at Rs 20 per share. Its
trading results for the last two years were as follows:
Year ended 31 December
Profit after tax
20X1
20X2
Rs
Rs
320,000
425,000
Show the calculation of basic EPS to be presented in the financial statements
for the year ended 31 December 20X2 (including the comparative figure).
4.
A company had 8.28 million shares in issue at the start of the year and made no new
issue of shares during the year ended 31 December 20X4, but on that date it had in
issue Rs 2,300,000 10% convertible loan stock 20X6-20X9. Assume a corporation
tax rate of 30%.The earnings for the year were Rs 2,208,000.
This loan stock will be convertible into ordinary Rs 1 shares as follows.
20X6
90 Rs 1 shares for Rs 100 nominal value loan stock
20X7
85 Rs 1 shares for Rs 100 nominal value loan stock
20X8
80 Rs 1 shares for Rs 100 nominal value loan stock
20X9
75 Rs 1 shares for Rs 100 nominal value loan stock
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Calculate the fully DEPS for the year ended 31 December 20X4.
5.
A company had 0.828 million shares in issue at the start of the year and made no
issue of shares during the year ended 31 December 20X4, but on that date there
were outstanding options to purchase 92,000 ordinary Rs 10 shares at Rs 17 per
share. The average fair value of ordinary shares was Rs 18. Earnings for the year
ended 31 December 20X4 were Rs 2,208,000.
Calculate the fully DEPS for the year ended 31 December 20X4.
6.
On 1 January the issued share capital of Box Ltd was 12 million preference shares
of Rs 1 each and 10 million ordinary shares of Rs 1 each. Assume where appropriate
that the income tax rate is 30%. The earnings for the year ended 31 December were
Rs 5,950,000.
Calculate the EPS separately in respect of the year ended 31 December for each of
the following circumstances (a)(f), on the basis that:
(a)
there was no change in the issued share capital of the company during the
year ended 31 December
(b)
the company made a bonus issue on 1 October of one ordinary share for
every four shares in issue at 30 September
(c)
the company issued 1 share for every 10 on 1 August at full market value of
Rs 4
(d)
the company made a rights issue of Rs 1 ordinary shares on 1 October in the
proportion of 1 of every 3 shares held, at a price of Rs 3. The middle market
price for the shares on the last day of quotation cum rights was Rs 4 per
share
(e)
the company made no new issue of shares during the year ended 31
December, but on that date it had in issue Rs 2,600,000 10% convertible
bonds. These bonds will be convertible into ordinary Rs 1 shares as follows:
20X6 90 Rs 1 shares for Rs 100 nominal value bonds
20X7 85 Rs 1 shares for Rs 100 nominal value bonds
20X8 80 Rs 1 shares for Rs 100 nominal value bonds
20X9 75 Rs 1 shares for Rs 100 nominal value bonds
(f)
the company made no issue of shares during the year ended 31 December,
but on that date there were outstanding options to purchase 74,000 ordinary
Rs 1 shares at Rs 2.50 per share. Share price during the year was Rs 4.
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Answers
1.
Issue at full market price
Date
Actual number of shares
Fraction of year
Total
1 January 20X4
828,000
6/12
414,000
30 June 20X4
1,159,200 (W1)
6/12
579,600
–––––––
Number of shares in EPS
calculation
993,600
–––––––
(W1)
New number of shares
Original number
828,000
New issue
331,200
–––––––––
New number
1,159,200
The earnings per share for 20X4 would now be calculated as:
Rs 2,208,000
–––––––––– = Rs 2.22
993,600
2.
The number of shares to be used in the EPS calculation for both years is
700,000 + 100,000 = 800,000.
The EPS for 20X2 is 750,000 / 800,000 × 1 = Rs 0.94
The EPS for 20X3 is 1,150,000 / 800,000 × 1 = Rs 1.44
Alternatively adjust last year’s EPS
20X2 750,000/700,000 × 7/8 = Rs 0.94
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3.
EPS =
Rs 425,000
118,055
= Rs 3.6 per share
20x1 EPS
Applying correction factor to calculate adjusted comparative figure of EPS:
0.08 x
Theoreticalexrightsprice
36
= Rs 0.08 x
= Rs 2.88 per shares
Actual cum rights price
1
(W-1) Current year weighted average number of shares
Number of shares 1 January 20x2 to 30 June 20x 2 (as adjusted):
100,000 x
Actualcumrightprice
6 montsh
x
Theoretifcal cum rights price 12 months
100,000 x
100 6
x
= 55,555 shares
90 12
Number of shares 1 July 20X2 to 31 December 20X2 (actual):
6
x 125,000 = 62,500 shares
12
Total adjusted shares for year 118,055
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(W-2) Theoretical ex rights price
Because the rights issue contains a bonus element, the past EPS figures
should be adjusted by the factor:
Theoretical ex rights price
––––––––––––––––––––
Actual cum rights price
Rs
Prior to rights issue
4 shares
worth 4 × Rs 40 =
160
Taking up rights
1 share
cost Rs 20 =
20
––
––––
5
180
––
––––
i.e. theoretical ex rights price of each share is Rs 180 ÷ 5 = Rs 36
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(W3)
Prior year EPS
Last year, reported EPS were Rs 320,000 ÷ 100,000 = Rs 3.2
4.
If this loan stock was converted to shares the impact on earnings would be as follows.
Rs
Basic earnings
Rs
2,208,000
Add notional interest saved
(Rs 2,300,000 × 10%)
230,000
Less tax relief Rs 230,000 × 30%
(69,000)
––––––
161,000
–––––––––
Revised earnings
2,369,000
–––––––––
Number of shares if loan converted
Basic number of shares
8,280,000
Notional extra shares under the most dilution possible
2,300,000 ×
90
100
2,070,000
–––––––––
Revised number of shares
10,350,000
–––––––––
DEPS =
Rs2,369,000
=
10,350,000
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Rs 0.229
Page 564
5.
Rs
Earnings
2,208,000
–––––––––
Number of shares
Basic
828,000
Options (W1)
5,111
–––––––––
833,111
–––––––––
The DEPS is therefore
(W1)
Rs2,208,000
833,111
= Rs 2.65
= 92,000 ×
Rs 17
Number of shares at option price
Options
= Rs 1,564,000
Rs 1,564,000
At fair value:
Number issued free
6.
(a)
Rs1,564,000
Rs 18
= 86,889
= 920,000 – 868,889
= 5,111
EPS (basic) = Rs 0.595
Earnings
Rs 5,950
Shares
10,000
––––––
EPS
0.595
––––––
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(b)
EPS (basic) =
Earnings
Shares (10m × 5/4)
0.476
Rs 5,950
12,500
––––––
EPS
0.476
––––––
(c)
EPS (basic) = Rs 0.571
Earnings
Rs 5,950
Shares
10,416
––––––
EPS
0.571
––––––
(d)
Pre (7/12 ×10m)
Rs 5,833
Post (5/12 ×10m ×11/10)
Rs 4,583
EPS (basic) = Rs 0.525
Earnings
Rs 5,950
Shares
11,333
––––––
EPS
0.525
––––––
(e)
Pre (9/12 × 10m × 4.00/3.75)
8,000
Post (3/12 × 10m × 4/3)
3,333
Actual cum rights price
Rs 4.00
TERP (1@300 +3@400)/4
Rs 3.75
EPS (basic) = Rs 0.595
EPS (fully diluted) = Rs 0.497
Earnings (5.95m + (10% × 2.6m × 70%))
Shares (10m + (90/100 × 2.6m))
Rs 6,132
12,340
––––––
EPS
0.497
––––––
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(f)
EPS (basic) = Rs 0.595
EPS (fully diluted) = Rs 0.593
Earnings
Shares (10m + (150/400× 74)
Rs 5,950
10,028
––––––
EPS
0.593
––––––
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NON-FINANCIAL REPORTING
Chapter learning objectives
Upon completion of this chapter you will be able to:
1) discuss the increased demand for transparency in corporate reports, and the
emergence of non-financial reporting standards
2) understand the purpose, presentation and elements of Management
Commentary Reports
3) discuss the progress towards a framework for environmental and sustainability
reporting
4) appraise the impact of environmental, social and ethical factors on
performance measurement
5) discuss human resource reporting
6) discuss why entities might include disclosures relating to the environment and
society.
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1
Non-Financial Reporting
Non-financial information, in the form of additional information provided alongside the
financial information in the annual report, has become more important in recent years.
While financial information remains important, stakeholders are interested in other
aspects of an entity’s performance.
For example:
•
how the business is managed
•
its future prospects
•
the entity’s policy on the environment
•
its attitude towards social responsibility,and so on.
Many of these issues, whilst included within the financial statements to some extent,
have not always been fully reported to meet the needs of users of financial
statements. In recent years, there has been a growing demand for transparency of
reported information covering both financial and non-financial information. This could
include information relating to a
number of issues such as:
•
selection, application and appropriate disclosure of accounting policies
adopted by an entity, so that users of financial statements fully understand
the basis upon which financial statements have been prepared.
•
the impact of the entity's activities on the environment – this could include
waste management and recycling policies, use of renewable energy sources
and pollution management policies.
•
the interaction of the entity with society generally or particular communities
within which it operates – this could include labour recruitment and
development policies, charitable donations and activities and other
contributions to the local community. Many organisations now actively
participate within the communities within which they operate, perhaps by
supporting or donating to local charities, with the intention of 'putting
something back' into those communities. This may happen, for example, if an
entity permits staff to take time away from their employment to provide work
or service to a local charity or similar organisation for benevolent reasons.
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Although these activities do have an impact upon financial position and performance,
some users of financial statements may have a particular interest in these activities.
For example, potential shareholders may be attracted to invest in a particular entity
(or not), based upon their environmental or social policies, in addition to their
financial performance. Regulators or consumer pressure groups may also have a
particular interest in such policies and disclosures to manage their activities or
monitor the effectiveness of their activities.
All of this information is reported in a number of ways.
1) An operating and financial review (OFR) will assess the results of the period
and discuss the future prospects of the business. Many entities have
embraced the spirit of the regulation, rather than merely complied with the
legal requirements, as a means to improve
2) stakeholder understanding and awareness, which could lead to competitive
advantage.
3) A report on corporate governance will report on how the entity is managed and
directed. For example, entities which are listed on the Stock Exchange, are
required to comply with a code of best practice and to make disclosures
regarding the extent of compliance or noncompliance with the code as
appropriate.
4) An environmental and social report will report upon entity policies and
responsibilities towards the environment and society, or both of these issues
could be combined in a report on sustainability. This may include policy
statements, supported by narrative explanation
5) together with both qualitative and quantitative disclosures to enable its
evaluation by users of that information.
6) Information may be provided in the form of a management commentary. The
IASB has acknowledged that there is a growing demand for this form of
reporting, and a willingness on the part of entities to provide it, with the
publication of Practice Statement 1 (PS) Management Commentary in
December 2010 (see later within chapter).
The additional reports and disclosures go some way towards providing transparency for
evaluation of entity financial performance, position and strategy. Transparency fosters
confidence in the information which is made available to investors and other
stakeholders who may be interested in both financial and non-financial information
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2
Management Commentary
2.1
Purpose of the Management Commentary (MC)
The IFRS Practice Statement (PS) Management Commentary provides a broad,
nonbinding framework for the presentation of management commentary that relates
to financial statements that have been prepared in accordance with International
Financial Reporting Standards (IFRSs)
It is a narrative report that provides a context within which to interpret the financial
position, financial performance and cash flows of an entity. Management are able to
explain its objectives and its strategies for achieving those objectives. Users routinely
use the type of information provided in management commentary to help them
evaluate an entity’s prospects and its general risks, as well as the success of
management’s strategies for achieving its stated objectives. For many entities,
management commentary is already an important element of their communication
with the capital markets, supplementing as well as complementing the financial
statements.
This PS helps management to provide useful commentary to financial statements
prepared in accordance with IFRS information. The users are identified as existing
and potential members, together with lenders and creditors.
2.2
Frameworkfor presentation of management commentary
The following principles should be applied when a management commentary is
prepared:
1) to provide management’s view of the entity’s performance, position and
progress; and
2) to supplement and complement information presented in the financial
statements
Consequently, the MC should include information which is both forward-looking and
adheres to the qualitative characteristics of information as described in the 2010
Conceptual Framework for Financial Reporting
The management commentary should provide information to help users of the
financial reports to assess the performance of the entity and the actions of its
management relative to stated strategies and plans for progress. That type of
commentary will help users of the financial reports to understand, risk exposures and
strategies of the entity, relevant non-financial factors and other issues not otherwise
included within the financial statements.
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Management commentary should provide management’s perspective of the entity’s
performance, position and progress. Management commentary should derive from
the information that is important to management in managing the business.
2.3
Elements of management commentary
Although the particular focus of management commentary will depend on the facts
and circumstances of the entity, management commentary should include
information that is essential to an understanding of:
1) the nature of the business;
2) management’s objectives and its strategies for meeting those objectives;
3) the entity’s most significant resources, risks and relationships;
4) the results of operations and prospects; and
5) the critical performance measures and indicators that management uses to
evaluate the entity’s performance against stated objectives
3
Sustainability
3.1
Definition
Sustainability is the process of conducting business in such a way that it enables an
entity to meet its present needs without compromising the ability of future
generations to meet their needs.
Introduction
In a corporate context, sustainability means that a business entity must attempt to
reduce its environmental impact through more efficient use of natural resources and
improving environmental practices.
More and more business entities are reporting their approach to sustainability in
addition to the financial information reported in the annual report. There are
increased public expectations for business entities and industries to take
responsibility for the impact their activities have on the environment and society.
3.2
Reporting sustainability
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1) Currently, sustainability reporting is voluntary, although its use is increasing.
2) Reports include highlights of non-financial performance such as
environmental, social and economic reports during the accounting period.
3) The report may be included in the annual report or published as a stand alone
document, possibly on the entity’s website.
4) The increase in popularity of such reports highlights the growing trend that
business entities are taking sustainability seriously and are attempting to be
open about the impact of their activities.
5) Reporting sustainability is sometimes called reporting the ‘triple bottom line’
covering environment, social and economic reporting.
3.3
Framework for sustainability reporting
1) There is no framework for sustainability reporting in IFRS, so this reporting is
voluntary.
This lack of regulation leads to several potential problems:
2) Because disclosure is largely voluntary, not all businesses disclose
information. Those that do tend to do so either because they are under
particular pressure to prove their ‘green’ credentials (for example, large public
utility companies whose operations directly affect the environment) or
because they have deliberately built their reputation on environmental
3) friendliness or social responsibility.
4) The information disclosed may not be complete or reliable. Many businesses
see environmental reporting largely as a public relations exercise and
therefore only provide information that shows them in a positive light.
5) The information may not be disclosed consistently from year to year.
6) Some businesses, particularly small and medium sized entities, may believe
that the costs of preparing and circulating additional information outweigh the
benefits of doing so:
1) The most accepted framework for reporting sustainability is the Global
Reporting Initiative’s Sustainability Reporting Guidelines, the latest of which
'G3' – the third version of the guidelines – was issued in October 2006. As at
August 2010, this is still the most recent
version of the guidelines.
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2) The most accepted framework for reporting sustainability is the Global
Reporting Initiative’s Sustainability Reporting Guidelines, the latest of which
'G3' – the third version of the guidelines – was issued in October 2006. As at
August 2010, this is still the most recent
3) version of the guidelines.
4) The G3 Guidelines provide universal guidance for reporting on sustainability
performance. They are applicable to all entities including SMEs and not-forprofit entities worldwide. The G3 consist of principles and disclosure
items .The principles help to define report content, quality of the report, and
give guidance on how to set the report boundary. Disclosure items include
disclosures on management of issues, as well as performance indicators
themselves.
The best way to understand sustainability is to look at some examples of
sustainability reports in financial statements.
Global Reporting Initiative
5) You can also look at
(www.globalreporting.org)
the
Global
Reporting
Initiative
website
6) The financial statements of companies that have applied the GRI guidelines
are listed with a link to their reports
4
International Integrated Reporting Committee (IIRC)
4.1
What is the purpose of the IIRC?
The IIRC is being created to respond to this need for a concise, clear,
comprehensive and comparable integrated reporting framework structured around
the organization’s strategic objectives, its governance and business model and
integrating both material financial and non-financial information. The objectives for an
integrated reporting framework are to:
7) support the information needs of longterm investors, by showing the broader
and longerterm consequences of decisionmaking;
8) reflect the interconnections between environmental, social, governance and
financial factors in decisions that affect longterm performance and condition,
making clear the link between sustainability and economic value;
9) provide the necessary framework for environmental and social factors to be
taken into account systematically in reporting and decisionmaking;
10)rebalance performance metrics away from an undue emphasis on short-term
financial performance; and
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11)bring reporting closer to the information used by management to run the
business on a day-to-day basis.
4.2
What is the role of the IIRC?
At present a range of standard-setters and regulatory bodies are responsible for
individual elements of reporting. No single body has the oversight or authority to
bring together these different elements that are essential to the presentation of an
integrated picture of an organization and the impact of environmental and social
factors on its performance. In
addition, globalisation means that an accounting and reporting framework needs to
be developed on an international basis. At present, there is a risk that, as individual
regulators respond to the risks faced, multiple standards will emerge.
The role of the IIRC is to:
1) raise awareness of this issue and develop a consensus among governments,
listing authorities, business, investors, accounting bodies and standard
setters for the best way to address it;
2) develop an overarching integrated reporting framework setting out the scope
of integrated reporting and its key components;
3) identify priority areas where additional work is needed and provide a plan for
development;
4) consider whether standards in this area should be voluntary or mandatory and
facilitate collaboration between standard-setters and convergence in the
standards needed to underpin integrated reporting; and
5) promote the adoption of integrated reporting by relevant regulators and report
preparers
IFRS S1 — General Requirements for Disclosure of Sustainability-related
Financial Information
Overview
IFRS S1 sets out overall requirements with the objective to require an entity to
disclose information about its sustainability-related risks and opportunities that is
useful to the primary users of general purpose financial reports in making decisions
relating to providing resources to the entity.
IFRS S1 was issued in June 2023 and applies to annual reporting periods beginning
on or after 1 January 2024.
Objective
The objective of IFRS S1 is to require an entity to disclose information about its
sustainability-related risks and opportunities that is useful to the primary users of
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general purpose financial reports in making decisions relating to providing resources
to the entity.
Information about sustainability-related risks and opportunities is useful to primary
users because an entity’s ability to generate cash flows over the short, medium and
long term is inextricably linked to the interactions between the entity and its
stakeholders, society, the economy and the natural environment throughout the
entity’s value chain. Together, the entity and the resources and relationships
throughout its value chain form an interdependent system in which the entity
operates. The entity’s dependencies on those resources and relationships and its
impacts on those resources and relationships give rise to sustainability-related risks
and opportunities for the entity.
The value chain is defined in IFRS S1 as the full range of interactions, resources and
relationships related to a reporting entity’s business model and the external
environment in which it operates. A value chain encompasses the interactions,
resources and relationships an entity uses and depends on to create its products or
services from conception to delivery, consumption and end-of-life, including
interactions, resources and relationships in the entity’s operations, such as human
resources; those along its supply, marketing and distribution channels, such as
materials and service sourcing and product and service sale and delivery; and the
financing, geographical, geopolitical and regulatory environments in which the entity
operates.
IFRS S1 requires an entity to disclose information about all sustainability-related
risks and opportunities that could reasonably be expected to affect the entity’s cash
flows, its access to finance or cost of capital over the short, medium or long term.
IFRS S1 prescribes how an entity prepares and reports its sustainability-related
financial disclosures. It sets out general requirements for the content and
presentation of those disclosures so that the information disclosed is useful to
primary users in making decisions about providing resources to the entity.
Scope
An entity is required to apply IFRS S1 in preparing and reporting sustainabilityrelated financial disclosures in accordance with IFRS Sustainability Disclosure
Standards. An entity may apply IFRS Sustainability Disclosure Standards irrespective
of whether the entity’s related general purpose financial statements are prepared in
accordance with IFRS Accounting Standards or other generally accepted accounting
principles or practices (GAAP).
Conceptual foundations
For sustainability-related financial information to be useful, it must be relevant and
faithfully represent what it purports to represent. These are fundamental qualitative
characteristics of useful sustainability-related financial information. The usefulness of
sustainability-related financial information is enhanced if the information is
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comparable, verifiable, timely and understandable. These are enhancing qualitative
characteristics of useful sustainability-related financial information.
Fair presentation
A complete set of sustainability-related financial disclosures presents fairly all
sustainability-related risks and opportunities that could reasonably be expected to
affect an entity’s prospects.
Fair presentation requires disclosure of relevant information about sustainabilityrelated risks and opportunities that could reasonably be expected to affect the entity’s
prospects, and their faithful representation in accordance with the principles set out in
IFRS S1. To achieve faithful representation, an entity is required to provide a
complete, neutral and accurate depiction of those sustainability-related risks and
opportunities.
Fair presentation also requires that an entity:
a) to disclose information that is comparable, verifiable, timely and understandable;
and
b) to discloses additional information if compliance with the specifically applicable
requirements in IFRS Sustainability Disclosure Standards is insufficient to enable
users of general purpose financial reports to understand the effects of
sustainability-related risks and opportunities on the entity’s cash flows, its access
to finance and cost of capital over the short, medium and long term.
Applying IFRS Sustainability Disclosure Standards, with additional information
disclosed when necessary, is presumed to result in sustainability-related financial
disclosures that achieve fair presentation.
Materiality
An entity is required to disclose material information about the sustainability-related
risks and opportunities that could reasonably be expected to affect the entity’s
prospects.
In the context of sustainability-related financial disclosures, information is material if
omitting, misstating or obscuring that information could reasonably be expected to
influence decisions that primary users of general purpose financial reports make on
the basis of those reports, which include financial statements and sustainabilityrelated financial disclosures and which provide information about a specific reporting
entity.
When an entity applies IFRS Sustainability Disclosure Standards, it is required to
consider all facts and circumstances and decide how to aggregate and disaggregate
information in its sustainability-related financial disclosures. The entity is not
permitted to reduce the understandability of its sustainability-related financial
disclosures by obscuring material information with immaterial information or by
aggregating material items of information that are dissimilar to each other.
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Law or regulation might specify requirements for an entity to disclose sustainabilityrelated information in its general purpose financial reports. In such circumstances,
the entity is permitted to include in its sustainability-related financial disclosures
information to meet legal or regulatory requirements, even if that information is not
material. However, such information should not obscure material information.
If an entity determines that information about a sustainability-related opportunity is
commercially sensitive, the entity is permitted in limited circumstances to omit that
information from its sustainability-related financial disclosures. Such an omission is
permitted even if information is otherwise required by an IFRS Sustainability
Disclosure Standard and the information is material.
Reporting entity and connected information
An entity’s sustainability-related financial disclosures are required to be for the same
reporting entity as the related financial statements.
An entity is required to provide information in a manner that enables users of general
purpose financial reports to understand the following types of connections:
a) the connections between the items to which the information relates—such as
connections between various sustainability-related risks and opportunities that
could reasonably be expected to affect the entity’s prospects; and
b) the connections between disclosures provided by the entity:
I.
within its sustainability-related financial disclosures—such as connections
between disclosures on governance, strategy, risk management and
metrics and targets; and
II.
across its sustainability-related financial disclosures and other general
purpose financial reports published by the entity—such as its related
financial statements.
An entity is required to identify the financial statements to which the sustainabilityrelated financial disclosures relate.
Data and assumptions used in preparing the sustainability-related financial
disclosures are required to be consistent—to the extent possible considering the
requirements of IFRS Accounting Standards or other applicable GAAP—with the
corresponding data and assumptions used in preparing the related financial
statements.
When currency is specified as the unit of measure in the sustainability-related
financial disclosures, the entity is required to use the presentation currency of its
related financial statements.
Core content
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Unless another IFRS Sustainability Disclosure Standard permits or requires
otherwise in specified circumstances, an entity is required to provide disclosures
about:
a) governance—the governance processes, controls and procedures the entity uses
to monitor and manage sustainability-related risks and opportunities;
b) strategy—the approach the entity uses to manage sustainability-related risks and
opportunities;
c) risk management—the processes the entity uses to identify, assess, prioritise and
monitor sustainability-related risks and opportunities; and
d) metrics and targets—the entity’s performance in relation to sustainability-related
risks and opportunities, including progress towards any targets the entity has set,
or is required to meet by law or regulation.
IFRS S1 sets out objectives for each of these aspects, and disclosure requirements
to achieve those objectives.
General requirements
Sources of guidance
Identifying sustainability-related risks and opportunities
In identifying sustainability-related risks and opportunities that could reasonably be
expected to affect an entity’s prospects, an entity is required to apply IFRS
Sustainability Disclosure Standards.
In addition to IFRS Sustainability Disclosure Standards:
a) an entity is required to refer to and consider the applicability of the disclosure
topics in the SASB Standards; and
b) an entity may refer to and consider the applicability of:
I.
the CDSB Framework Application Guidance for Water- and Biodiversityrelated Disclosures;
II.
the most recent pronouncements of other standard- setting bodies whose
requirements are designed to meet the information needs of users of
general purpose financial reports; and
III.
the sustainability-related risks and opportunities identified by entities that
operate in the same industry(s) or geographical region(s).
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Identifying applicable disclosure requirements
In identifying applicable disclosure requirements about a sustainability-related risk or
opportunity that could reasonably be expected to affect an entity’s prospects, an
entity is required to apply the IFRS Sustainability Disclosure Standard that
specifically applies to that sustainability-related risk or opportunity.
In the absence of an IFRS Sustainability Disclosure Standard that specifically applies
to a sustainability-related risk or opportunity, an entity is required to apply
judgement to identify information that:
a) is relevant to the decision- making of users of general purpose financial reports;
and
b) faithfully represents that sustainability-related risk or opportunity.
In making that judgement, an entity:
a) is required to refer to and consider the applicability of the metrics associated with
the disclosure topics included in the SASB Standards
b) may—to the extent that these sources do not conflict with IFRS Sustainability
Disclosure Standards—refer to and consider the applicability of:

the CDSB Framework Application Guidance for Water- and Biodiversityrelated disclosures;

the most recent pronouncements of other standard- setting bodies whose
requirements are designed to meet the information needs of users of general
purpose financial reports; and

the information, including metrics, disclosed by entities that operate in the
same industry(s) or geographical region(s).
c) may—to the extent that these sources assist the entity in meeting the objective of
IFRS S1 and do not conflict with IFRS Sustainability Disclosure Standards—refer
to and consider the applicability of the Global Reporting Initiative (GRI) Standards
and the European Sustainability Reporting Standards (ESRS)
An entity is required to identify:
a) the specific standards, pronouncements, industry practice and other sources of
guidance that the entity has applied in preparing its sustainability-related financial
disclosures, including, if applicable, identifying the disclosure topics in the SASB
Standards; and
b) the industry(s) specified in the IFRS Sustainability Disclosure Standards, the
SASB Standards or other sources of guidance relating to a particular industry(s)
that the entity has applied in preparing its sustainability-related financial
disclosures, including in identifying applicable metrics.
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Location of disclosures and timing of reporting
An entity is required to provide disclosures required by IFRS Sustainability Disclosure
Standards as part of its general purpose financial reports.
Subject to any regulation or other requirements that apply to an entity, there are
various possible locations in its general purpose financial reports in which to disclose
sustainability-related financial information. Sustainability-related financial disclosures
could be included in an entity’s management commentary or a similar report when it
forms part of an entity’s general purpose financial reports. Management commentary
or a similar report is a required report in many jurisdictions. It might be known by or
included in reports with various names, such as ‘management report’,
‘management’s discussion and analysis’, ‘operating and financial review’, ‘integrated
report’ or ‘strategic report’.
An entity is required to report its sustainability-related financial disclosures at the
same time as its related financial statements. The entity’s sustainability-related
financial disclosures are required to cover the same reporting period as the related
financial statements.
Comparative information
Unless another IFRS Sustainability Disclosure Standard permits or requires
otherwise, an entity is required to disclose comparative information in respect of the
preceding period for all amounts disclosed in the reporting period. If such information
would be useful for an understanding of the sustainability-related financial
disclosures for the reporting period, the entity is also required to disclose
comparative information for narrative and descriptive sustainability-related financial
information.
Statement of compliance
An entity whose sustainability-related financial disclosures comply with all the
requirements of IFRS Sustainability Disclosure Standards is required to make an
explicit and unreserved statement of compliance. An entity is not permitted to
describe sustainability-related financial disclosures as complying with IFRS
Sustainability Disclosure Standards unless they comply with all the requirements of
IFRS Sustainability Disclosure Standards.
Judgements, uncertainties and errors
An entity is required to disclose information to enable users of general purpose
financial reports to understand the judgements, apart from those involving
estimations of amounts, that the entity has made in the process of preparing its
sustainability-related financial disclosures and that have the most significant effect on
the information included in those disclosures.
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In addition, an entity is required to disclose information to enable users of general
purpose financial reports to understand the most significant uncertainties affecting
the amounts reported in its sustainability-related financial disclosures.
An entity is required to:
a) identify the amounts that it has disclosed and that are subject to a high level of
measurement uncertainty; and
b) in relation to each amount identified, disclose information about:
I.
the sources of measurement uncertainty—for example, the dependence
of the amount on the outcome of a future event, on a measurement
technique or on the availability and quality of data from the entity’s value
chain; and
II.
the assumptions, approximations and judgements the entity has made in
measuring the amount.
Furthermore, an entity is required to correct material prior period errors by restating
the comparative amounts for the prior period(s) disclosed unless it is impracticable to
do so.
Effective date and transition
An entity is required to apply IFRS S1 for annual reporting periods beginning on or
after 1 January 2024. Earlier application is permitted. If an entity applies IFRS S1
earlier, it is required to disclose that fact and apply IFRS S2 at the same time.
An entity is not required to provide the disclosures specified in IFRS S1 for any
period before the beginning of the annual reporting period in which an entity first
applies IFRS S1. Accordingly, an entity is not required to disclose comparative
information in the first annual reporting period in which it applies IFRS S1.
5
Environmental Reporting
5.1
Definition
Environmental reporting is the disclosure of information in the published annual
report or elsewhere, of the effect that the operations of the business have on the
natural environment.
This section details the contents of an environment report together with any
accounting issues.
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Environmental reporting in practice
There are two main vehicles that companies use to publish information about the
ways in which they interact with the natural environment:
(a) The published annual report (which includes the financial statements)
(b) A separate environment report (either as a paper document or simply posted on
the company website).
The IASB encourages the presentation of environmental reports if management
believe that they will assist users in making economic decisions, but they are not
mandatory.
IAS 1 points out that any statement or report presented outside financial statements
is outside the scope of IFRSs, so there are no mandatory IFRS requirements on
separate environmental reports.
5.2
Separate Environment Reports
Many large public companies publish environmental reports that are completely
separate from the annual report and financial statements. The environmental report
is often combined in a sustainability report.
Most environmental reports take the form of a combined statement of policy and
review of activity. They cover issues such as:
1)
2)
3)
4)
5)
6)
waste management
pollution
intrusion into the landscape
the effect of an entity’s activities upon wildlife
use of energy
the benefits to the environment of the entity’s products and services.
Generally, the reports disclose the entity’s targets and/or achievements, with direct
comparison between the two in some cases. They may also disclose financial
information, such as the amount invested in preserving the environment.
Public and media interest has tended to focus on the environmental report rather
than on the disclosures in the published annual report and financial statements. This
separation reflects the fact that the two reports are aimed at different audiences.
Shareholders are the main users of the annual report, while the environmental report
is designed to be read by the general public. Many companies publish their
environmental and social reports on their websites, which encourages access to a
wide audience.
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5.3
The content of environment reports
The content of an environment report may cover the following areas.
1) Environmental issues pertinent to the entity and industry
The entity’s policy towards the environment and any improvements made since first adopting
the policy. Whether the entity has a formal system for managing environmental risks.
The identity of the director(s) responsible for environmental issues.
The entity’s perception of the risks to the environment from its operations.
The extent to which the entity would be capable of responding to a major environmental
disaster and an estimate of the full economic consequences of such a future major disaster.
The effects of, and the entity’s response to, any government legislation on environmental
matters.
Details of any significant infringement of environmental legislation or regulations.
Material environmental legal issues in which the entity is involved.
Details of any significant initiatives taken, if possible linked to amounts in financial
statements.
Details of key indicators (if any) used by the entity to measure environmental performance.
Actual performance should be compared with targets and with performance in prior periods.
2) Financial information
a)
The entity’s accounting policies relating to environmental costs, provisions and
contingencies.
b)
The amount charged to the income statement or statement of comprehensive
income during the accounting period in respect of expenditure to prevent or rectify
damage to the environment caused by the entity’s operations. This could be
analysed between expenditure that the entity was legally obliged to incur and
other expenditure.
c)
The amount charged to the income statement or statement of comprehensive
income during the accounting period in respect of expenditure to protect
employees and society in general from the consequences of damage to the
environment caused by the entity’s operations. Again, this could be analysed
between compulsory and voluntary expenditure.
d)
Details (including amounts) of any provisions or contingent liabilities relating to
environmental matters.
e)
The amount of environmental expenditure capitalised during the year.
f)
Details of fines, penalties and compensation paid during the accounting period in
respect of noncompliance with environmental regulations.
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IFRS S2 — Climate-related Disclosures
Overview
IFRS S2 sets out the requirements for identifying, measuring and disclosing
information about climate-related risks and opportunities that is useful to primary
users of general purpose financial reports in making decisions relating to providing
resources to the entity.
IFRS S2 was issued in June 2023 and applies to annual reporting periods beginning
on or after 1 January 2024.
Objective and scope
The objective of IFRS S2 is to require an entity to disclose information about its
climate-related risks and opportunities that is useful to primary users of general
purpose financial reports in making decisions relating to providing resources to the
entity. These are climate-related risks and opportunities that could reasonably be
expected to affect the entity’s cash flows, its access to finance or cost of capital over
the short, medium or long term.
IFRS S2 applies to:
a) climate-related risks to which the entity is exposed, which are:
I.
climate-related physical risks; and
II.
climate-related transition risks; and
b) climate-related opportunities available to the entity.
Climate-related risks and opportunities that could not reasonably be expected to
affect an entity’s prospects are outside the scope of IFRS S2.
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Governance
The objective of climate-related financial disclosures on governance is to enable
users of general purpose financial reports to understand the governance processes,
controls and procedures an entity uses to monitor, manage and oversee climaterelated risks and opportunities.
To achieve this objective, an entity is required to disclose information about the
governance body(s) (which can include a board, committee or equivalent body
charged with governance) or individual(s) responsible for oversight of climate-related
risks and opportunities. Specifically, the entity is required to identify the body(s) or
individual(s).
An entity is also required to disclose information about management’s role in the
governance processes, controls and procedures used to monitor, manage and
oversee climate-related risks and opportunities.
Strategy
The objective of climate-related financial disclosures on strategy is to enable users of
general purpose financial reports to understand an entity’s strategy for managing
climate-related risks and opportunities.
Specifically, an entity is required to disclose information to enable users of general
purpose financial reports to understand:
a) the climate-related risks and opportunities that could reasonably be expected to
affect the entity’s prospects;
b) the current and anticipated effects of those climate-related risks and opportunities
on the entity’s business model and value chain;
c) the effects of those climate-related risks and opportunities on the entity’s strategy
and decision-making, including information about its climate-related transition
plan;
d) the effects of those climate-related risks and opportunities on the entity’s financial
position, financial performance and cash flows for the reporting period, and their
anticipated effects on the entity’s financial position, financial performance and
cash flows over the short, medium and long term taking into consideration how
those climate-related risks and opportunities have been factored into the entity’s
financial planning; and
e) the climate resilience of the entity’s strategy and its business model to climaterelated changes, developments and uncertainties—taking into consideration the
entity’s identified climate-related risks and opportunities.
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Risk management
The objective of climate-related financial disclosures on risk management is to
enable users of general purpose financial reports to understand an entity’s processes
to identify, assess, prioritise and monitor climate-related risks and opportunities,
including whether and how those processes are integrated into and inform the
entity’s overall risk management process.
To achieve this objective, an entity is required to disclose information about:
a) the processes and related policies the entity uses to identify, assess, prioritise and
monitor climate-related risks, including information about:
I.
the inputs and parameters the entity uses (for example, information about
data sources and the scope of operations covered in the processes);
II.
whether and how the entity uses climate-related scenario analysis to inform its
identification of climate-related risks;
III.
how the entity assesses the nature, likelihood and magnitude of the effects of
those risks (for example, whether the entity considers qualitative factors,
quantitative thresholds or other criteria);
IV.
whether and how the entity prioritises climate-related risks relative to other
types of risk;
V.
how the entity monitors climate-related risks; and
VI.
whether and how the entity has changed the processes it uses compared with
the previous reporting period.
b) the processes the entity uses to identify, assess, prioritise and monitor climaterelated opportunities, including information about whether and how the entity uses
climate-related scenario analysis to inform its identification of climate-related
opportunities; and
c) the extent to which, and how, the processes for identifying, assessing, prioritising and
monitoring climate-related risks and opportunities are integrated into and inform the
entity’s overall risk management process.
Metrics and targets
The objective of climate-related financial disclosures on metrics and targets is to
enable users of general purpose financial reports to understand an entity’s
performance in relation to its climate-related risks and opportunities, including
progress towards any climate-related targets it has set, and any targets it is required
to meet by law or regulation.
To achieve this objective, an entity is required to disclose:
a) information relevant to the cross-industry metric categories;
b) industry-based metrics that are associated with particular business models, activities
or other common features that characterise participation in an industry; and
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c) targets set by the entity, and any targets it is required to meet by law or regulation, to
mitigate or adapt to climate-related risks or take advantage of climate-related
opportunities, including metrics used by the governance body or management to
measure progress towards these targets.
Climate-related metrics and targets
An entity is required to disclose information relevant to the cross-industry metric
categories of:
a) greenhouse gases—the entity is required to:
I.
disclose its absolute gross greenhouse gas emissions generated during the
reporting period, expressed as metric tonnes of CO2 equivalent, classified as
scope 1, 2 and 3 greenhouse gas emissions;
II.
measure its greenhouse gas emissions in accordance with the Greenhouse
Gas Protocol: A Corporate Accounting and Reporting Standard (2004) unless
required by a jurisdictional authority or an exchange on which the entity is
listed to use a different method for measuring its greenhouse gas emissions;
III.
disclose the approach it uses to measure its greenhouse gas emissions
including:
1. the measurement approach, inputs and assumptions the entity uses to
measure its greenhouse gas emissions;
2. the reason why the entity has chosen the measurement approach,
inputs and assumptions it uses to measure its greenhouse gas
emissions; and
3. any changes the entity made to the measurement approach, inputs
and assumptions during the reporting period and the reasons for those
changes.
IV.
for Scope 1 and Scope 2 greenhouse gas emissions, disaggregate emissions
between:
1. the consolidated accounting group (for example, for an entity applying
IFRS Accounting Standards, this group would comprise the parent
and its consolidated subsidiaries); and
2. other investees excluded from the consolidated accounting group (for
example, for an entity applying IFRS Accounting Standards, these
investees would include associates, joint ventures and unconsolidated
subsidiaries.
V.
for Scope 2 greenhouse gas emissions, disclose its location-based Scope 2
greenhouse gas emissions, and provide information about any contractual
instruments that is necessary to inform users’ understanding of the entity’s
Scope 2 greenhouse gas emissions; and
VI.
for Scope 3 greenhouse gas emissions, disclose:
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1.
the categories included within the entity’s measure of Scope 3
greenhouse gas emissions, in accordance with the Scope 3
categories described in the Greenhouse Gas Protocol Corporate
Value Chain (Scope 3) Accounting and Reporting Standard (2011);
and
2.
additional information about the entity’s Category 15 greenhouse gas
emissions or those associated with its investments (financed
emissions), if the entity’s activities include asset management,
commercial banking or insurance;
b) climate-related transition risks—the amount and percentage of assets or business
activities vulnerable to climate-related transition risks;
c) climate-related physical risks—the amount and percentage of assets or business
activities vulnerable to climate-related physical risks;
d) climate-related opportunities—the amount and percentage of assets or business
activities aligned with climate-related opportunities;
e) capital deployment—the amount of capital expenditure, financing or investment
deployed towards climate-related risks and opportunities;
f)
internal carbon prices—the entity is required to disclose:
I.
an explanation of whether and how the entity is applying a carbon price in
decision-making (for example, investment decisions, transfer pricing and
scenario analysis); and
II.
the price for each metric tonne of greenhouse gas emissions the entity uses
to assess the costs of its greenhouse gas emission; and
g) remuneration—the entity is required to disclose:
I.
a description of whether and how climate-related considerations are factored
into executive remuneration; and
II.
the percentage of executive management remuneration recognised in the
current period that is linked to climate-related considerations.
In addition, an entity is required to disclose the quantitative and qualitative climaterelated targets it has set to monitor progress towards achieving its strategic goals,
and any targets it is required to meet by law or regulation, including any greenhouse
gas emissions targets. For each target, the entity is required to disclose:
a) the metric used to set the target;
b) the objective of the target (for example, mitigation, adaptation or conformance
with science-based initiatives);
c) the part of the entity to which the target applies (for example, whether the target
applies to the entity in its entirety or only a part of the entity, such as a specific
business unit or specific geographical region);
d) the period over which the target applies;
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e) the base period from which progress is measured;
f)
any milestones and interim targets;
g) if the target is quantitative, whether it is an absolute target or an intensity target;
and
h) how the latest international agreement on climate change, including jurisdictional
commitments that arise from that agreement, has informed the target.
Industry-based guidance
Industry-based Guidance on Implementing IFRS S2 suggests possible ways to apply
some of the disclosure requirements in IFRS S2. The guidance does not create
additional requirements. Specifically, the guidance suggests ways to identify and
disclose information about climate-related risks and opportunities associated with
particular business models, activities or other common features that characterise
participation in an industry. In applying IFRS S2, an entity is required to refer to and
consider the applicability of the information set out in the guidance.
The industry-based guidance has been derived from Sustainability Accounting
Standards Board (SASB) Standards, which are maintained by the ISSB. Because the
guidance is industry-based, only a subset is likely to apply to any entity.
Effective date and transition
An entity is required to apply IFRS S2 for annual reporting periods beginning on or
after 1 January 2024. Earlier application is permitted. If an entity applies IFRS S2
earlier, it is required to disclose that fact and apply IFRS S1 at the same time.
An entity is not required to provide the disclosures specified in IFRS S2 for any
period before the beginning of the annual reporting period in which an entity first
applies IFRS S2 (the date of initial application). Accordingly, an entity is not required
to disclose comparative information in the first annual reporting period in which it
applies IFRS S2.
5.4
Accounting for environment costs
Definitions
Environmental costs:
include environmental measures and environmental losses.
Environmental measures
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are the costs of preventing, reducing or repairing damage to the environment and the
costs of conserving resources.
Environmental losses
are costs that bring no benefit to the business.
Environmental measures can include:
1) capital expenditure
2) closure or decommissioning costs
3) clean-up costs
4) development expenditure
5) costs of recycling or conserving energy.
6) Environmental losses can include:
7) fines, penalties and compensation
8) impairment or disposal losses relating to assets that have to be scrapped
or abandoned because they damage the environment.
Accounting Treatment
Environmental costs are treated in accordance with the requirements of current accounting
standards.
Most expenditure is charged in the income statement or statement of comprehensive income
in the period in which it is incurred. Material items may need to be disclosed separately in
the notes to the accounts or on the face of the income statement/statement of
comprehensive income as required by IAS 1.
Entities may have to undertake fundamental reorganisations or restructuring or to
discontinue particular activities in order to protect the environment. If a sale or termination
meets the definition of a discontinued operation, its results must be separately disclosed in
accordance with the requirements of IFRS 5. Material restructuring costs may need to be
separately disclosed on the face of the income statement/statement of comprehensive
income.
Fines and penalties for noncompliance with regulations are charged to the income statement
or statement of comprehensive income in the period in which they are incurred. This applies
even if the activities that resulted in the penalties took place in an earlier accounting period,
as they cannot be treated retrospectively as prior period adjustments.
Expenditure on noncurrent assets is capitalised and depreciated in the usual way as per IAS
16 Property, plant and equipment. Any government grants received for expenditure that
protects the environment are treated in accordance with IAS 20 Accounting for
government grants and disclosure of government assistance.
Noncurrent assets (including goodwill) may become impaired as a result of environmental
legislation or new regulations. IAS 36 Impairment of assets lists events that could trigger
an impairment review, one of which is a significant adverse change in the legal environment
in which the business operates.
Research and development expenditure in respect of environmentally friendly products,
processes or services is covered by IAS
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6
Social Reporting
6.1
Definition
Corporate social reporting is the process of communicating the social and environmental
effects of organisations’ economic actions to particular interest groups within society and to
society at large.
It involves extending the accountability of organisations (particularly companies) beyond the
traditional role of providing a financial account to the owners of capital. Social and ethical
reporting would seem to be at variance with the prevailing business. However, there are a
number of reasons why entities publish social reports.
1) They may have deliberately built their reputation on social responsibility in
order to attract a particular customer base.
2) They may perceive themselves as being under particular pressure to prove
that their activities do not exploit society as a whole or certain sections of it
(e.g. Shell International and large utility companies).
3) They may be genuinely convinced that it is in their long-term interests to
balance the needs of the various stakeholder groups.
4) They may fear that the government will eventually require them to publish
socially oriented information if they do not do so voluntarily
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6.2
Social responsibility
A business interacts with society in several different ways as follows.
It employs human resources in the form of management and other employees.
Its activities affect society as a whole, for example, it may:
a) be the reason for a particular community’s existence
b) produce goods that are helpful or harmful to particular members of
society
c) damage the environment in ways that harm society as a whole
d) undertake charitable works in the community or promote particular
values
If a business interacts with society in a responsible manner, the needs of other
stakeholders should be taken into account and performance may encompass:
a) providing fair remuneration and an acceptable working environment
b) paying suppliers promptly
c) minimising the damage to the environment caused by the entity’s activities
d) contributing to the community by providing employment or by other means.
6.3
Social reporting in practice
Social reporting in the financial statements
Disclosures of social reporting matters in financial statements tend to be
required by national legislation and by the stock exchange on which an entity
is quoted. There is little mention of social matters in international accounting
standards.
IAS 1 requires disclosure of the total cost of employee benefits for the period.
If the ‘nature of expense’ method is chosen for the income
statement/statement of comprehensive income, then the total charge for
employee costs will be shown on the face of the income statement/statement
of comprehensive income. If the ‘function of expense’ method is chosen, then
IAS 1 requires disclosure of the total employee costs in a note to the financial
statements.
1)
IAS 24 Related party disclosures requires the benefits paid to key
management personnel to be disclosed in total and analysed into the
categories of benefits.
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2)
6.4
Other possible disclosures (e.g. details of directors and corporate
governance matters, employee policies, supplier payment policies,
charitable contributions, etc.) are normally dealt with by local
legislation and would only be required by IFRSs when such disclosure
is necessary to present fairly the entity’s financial performance.
Special Social Reports
Stand alone social and ethical reports do not have to be audited and there are
no international regulations prescribing their content.
There are some sets of nonmandatory guidelines and codes of best practice,
for example, the standard AA1000, which has been issued by the Institute of
Social and Ethical Accountability (ISEA).
Some organisations have the data in their reports independently verified and
include the auditor’s report in their published document.
The social report may or may not be combined with the environmental report
It has been suggested that there should be three main types of information in the
social report.
1) Information about relationships with stakeholders, e.g. employee
numbers, wages and salaries, provision of facilities for customers and
information about involvement with local charities.
2) Information about the accountability of the entity, e.g. sickness leave,
accident rates, noise levels, numbers of disabled employees, compliance
with current legal, ethical and industry standards.
3) Information about dialogue with stakeholders, e.g. the way in which
the entity consults with all stakeholders and provides public feedback on
the stakeholders’ perceptions of the entity’s responsibilities to the
community and its performance in meeting stakeholder needs.
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7
Human Capital Management (HCM)
7.1
Definition:
Human capital management relates to the management of the recruitment,
retention, training and development of employees. It views employees as a
business asset, rather than just a cost.
HCM is a key resource of competitive advantage and, ultimately, profitability. Any
business needs to ensure that its workforce has the right mix of people, with
appropriate skills and experiences, allowing the business to compete effectively.
7.2
Accounting for People Task Force
the Accounting for People Task Force is set up by to look at ways in which
organisations can measure the quality and effectiveness of their human capital
management. Its brief was to:
1. look at the performance measures currently used to assess investment in HCM
2. consider best practice in human capital reporting, and the performance measures
that are most valuable to stakeholders
3. establish and champion the business case for producing such reports
4. produce a final advisory report
The Task Force believes that effective people policies and practices will benefit
organisations and their stakeholders. Managers, investors, workers, consumers and
clients all have an interest in knowing that an organisation is aiming for high
performance by investing in their people.
The Task Force recommends that reports on HCM should have a strategic focus.
They should communicate clearly, fairly and unambiguously the board’s current
understanding of the links between the HCM policies and practices, its business
strategy and its performance.
They should include information on:
a) the size and composition of the workforce
b) retention and motivation of employees
c) the skills and competences necessary for success, and training to achieve these
d) remuneration and fair employment practices
e) leadership and succession planning
f) being balanced and objective, following a process that is susceptible to review by
auditors
g) providing information in a form that enables comparisons over time.
In summary, this will become another area of corporate reporting alongside environmental
and social reports that companies will be expected to produce. Already there is some
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guidance from the findings of the Task Force as to what should be included in such a
report. It remains to be seen whether this requirement will become mandatory in the future.
There is no doubt that by requiring companies to consider this area, the link between
investment in employees and improved business performance will be made.
8
Impact on Performance Measures
The developments outlined above in the reporting of the environmental and social
consequences of an entity’s activities have identified a wide array of areas, over and
above financial performance, in which management performance should be
evaluated, such as:
a)
b)
c)
d)
e)
Environmental
Social
Management of customers
Management of employees
Ethics
(a)
environmental:
a)
b)
c)
d)
e)
f)
(b)
use of energy, including proportion from renewable sources
efficiency of energy creation (for power generators)
CO2 emissions
waste management
accidents affecting environment
transport.
social:
a)
b)
c)
d)
e)
f)
g)
investment in local community initiatives
time off for employees involved in charitable work
matching money raised by employees for charitable work
employment opportunities for the disadvantaged
ethnic balance in workforce
equality, e.g. women in senior management positions
accidents affecting the community.
To these can be added other headings, such as:
(c)
customers:
a)
b)
c)
d)
(d)
failures to supply on time and in good condition
customer complaints, e.g. about direct selling techniques
fair pricing
help for the disadvantaged through special pricing schemes.
employees:
a)
b)
c)
d)
absenteeism rates
sickness leave
diversity
equal opportunities
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e) investment in training
f) number of industrial relations tribunals in respect of the entity.
(e)
ethics:
a) number and cost of incidents leading to fines and/or penalties
b) number and cost of incidents leading to compensation:
 to customers
 to employees
 to others
c) nonpenalisation of whistle blowers.
But for performance measurement in these areas to be useful, the result must be
information which is helpful in the making of economic decisions, whether they relate
to the choice of investment, employment or suppliers. The IASB Framework’s
characteristics for useful financial information are that it should be relevant, reliable
and comparable. These characteristics can be applied to environmental, social and
ethical areas as follows.
Relevance: how much weight do/will investors, employees and consumers give
to these factors, compared with that given to financial factors (so return on
investment, employee benefits and price, respectively)?
Reliability: how much can the performance measured in these areas be relied
on? How sure can users of this information be that it is a faithful representation
of what has occurred, as opposed to a selective view, focusing on the successes?
Are there external assurance processes that can validate the information,
perhaps using the GRI guidelines?
Comparability: is the information produced by different entities pulled together
on a comparable basis, using similar measurement policies, so that the users
can make informed choices between entities? If not, all that can be measured is
an entity’s performance compared with its own performance in previous periods.
Even if the information is reliable and comparable, is it useful, i.e. will it change the
behaviour of investors, employees and consumers?
The answers to these questions will determine whether entities take such reporting
seriously or merely treat it as part of their promotional activities. And the answers in
ten years’ time will almost certainly be different from those of today
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Chapter Summary
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SELF TEST QUESTIONS
1.
You are the chief accountant of Crescent and you are currently finalising the financial
statements for the year ended 31 December 20X1. Your assistant (who has prepared
the draft accounts) is unsure about the treatment of two transactions that have taken
place during the year. She has written you a memorandum that explains the key
principles of each transaction and also the treatment adopted in the draft accounts.
Transaction one
One of the corporate objectives of the enterprise is to ensure that its activities are
conducted in such a way as to minimise any damage to the natural environment. It is
committed in principle to spending extra money in pursuit of this objective but has not
yet made any firm proposals. The directors believe that this objective will prove very
popular with customers and are anxious to emphasise their environmentally friendly
policies in the annual report.
Your assistant suggests that a sum should be set aside from profits each year to
create a provision in the financial statements against the possible future costs of
environmental protection. Accordingly, she has charged the income statement for the
year ended 31 December 20X1 with a sum of Rs 100,000 and proposes to disclose
this fact in a note to the accounts.
Transaction two
A new law has recently been enacted that will require Crescent to change one of its
production processes in order to reduce the amount of carbon dioxide that is emitted.
This will involve purchasing and installing some new plant that is more efficient than
the equipment currently in use. To comply with the law, the new plant must be
operational by 31 December 20X2. The new plant has not yet been purchased.
Required:
Draft a reply to your assistant that:
(a) reviews the treatment suggested by your assistant and recommends
changes where relevant. In each case your reply should refer to relevant
International Accounting Standards
(b) replies to her suggestion that the financial statements for the year ended 31
December 20X0 were wrong because they made no reference to environmental
matters.
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2.
(a)
Explain why companies may wish to make social and environmental
disclosures in their annual report. Discuss how this content should be
determined.
(b) Company B owns a chemical plant, producing paint. The plant uses a
great deal of energy and releases emissions into the environment. Its byproduct is harmful and is treated before being safely disposed of. The
company has been fined for damaging the environment following a
spillage of the toxic waste product. Due to stricter monitoring routines set
up by the company, the fines have reduced and in the current year they
have not been in breach of any local environment laws.
The company, is aware that emissions are high and has been steadily reducing them.
They purchase electricity from renewable sources and in the current year have
employed a temporary consultant to calculate their carbon footprint so they can take
steps to reduce it.
Discuss the information that could be included in Company B’s environmental
report.
Answers
1.
MEMORANDUM
To: Assistant Accountant
From: Chief Accountant
Subject: Accounting treatment of two transactions and disclosure of environmental
matters in the financial statements
Date: 25 March 20X2
(a) Accounting treatment of two transactions
Transaction one
IAS 37 Provisions, contingent liabilities and contingent assets states that
provisions should only be recognised in the financial statements if:
g) there is a present obligation as a result of a past event
h) it is probable that a transfer of economic benefits will be required to settle
the obligation
i)
a reliable estimate can be made of the amount of the obligation.
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In this case, there is no obligation to incur expenditure. There may be a constructive
obligation to do so in future, if the board creates a valid expectation that it will protect
the environment, but a board decision alone does not create an obligation.
There is also some doubt as to whether the expenditure can be reliably quantified.
The sum of Rs 100,000 could be appropriated from retained earnings and transferred
to an environmental protection reserve within other components of equity, subject to
formal approval by the board. A note to the financial statements should explain the
transfer.
Transaction two
Again, IAS 37 states that a provision cannot be recognised if there is no obligation to
incur expenditure. At first sight it appears that there is an obligation to purchase the
new equipment, because the new law has been enacted. However, the obligation
must arise as
the result of a past event. At 31 December 20X1, no such event had occurred as the
new plant had not yet been purchased and the new law had not yet come into effect.
In theory, the company does not have to purchase the new plant. It could completely
discontinue the activities that cause pollution or it could continue to operate the old
equipment and risk prosecution under the new law. Therefore no provision can be
recognised for the cost of new equipment.
It is likely that another effect of the new law is that the company will have to dispose
of the old plant before it would normally have expected to do so. IAS 36 Impairment
of assets requires that the old plant must be reviewed for impairment. If its carrying
value is greater than its recoverable amount, it must be written down and an
impairment loss must be
charged against profits. This should be disclosed separately in the notes to the
income statement/statement of comprehensive income if it is material
b)
Reference to environmental matters in the financial statements
At present, companies are not obliged to make any reference to environmental
matters within their financial statements. Current international financial reporting
practice is more designed to meet the needs of investors and potential investors,
rather than the general public. Some companies choose to disclose information
about the ways in which they attempt to safeguard the environment, something that
is often carried out as a public relations exercise. Disclosures are often framed in
very general terms and appear outside the financial statements proper. This means
that they do not have to be audited.
Several companies publish fairly detailed ‘environmental reports’. It could be argued
that as Crescent’s operations affect the wider community, it has a moral responsibility
to disclose details of its activities and its environmental policies. However, at present
it is not required to do so by IFRSs.
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If a company has, or may have, an obligation to make good any environmental
damage that it has caused, it is obliged to disclose information about this
commitment in its financial statements (unless the likelihood of this is remote).
If it is probable (more likely than not) that the company will have to incur expenditure
to meet its obligation, then it is also required to set up a provision in the financial
statements.
In practice, these requirements are unlikely to apply unless a company is actually
obliged by law to rectify environmental damage or unless it has made a firm
commitment to the public to do so (for example, by promoting itself as an
organisation that cares for the environment, as the directors propose that Redstart
should do in future).
2. (a) The way in which companies manage their social and environmental responsibilities
is a high level strategic issue for management. Companies that actively manage these
responsibilities can help create long-term sustainable performance in an increasingly
competitive business environment.
Reports that disclose transparent information will benefit organisations and their
stakeholders. These stakeholders will have an interest in knowing that the company
is attempting to adopt best practice in the area. Institutional investors will see value in
the ‘responsible ownership’ principle adopted by the company.
Although there is no universal ‘best practice’, there seems to be growing consensus
that high performance is linked with high quality practice in such areas as recruitment,
organisational culture, training and reduction of environmental risks and impact.
Companies that actively reduce environmental risks and promote social disclosures
could be considered to be potentially more sustainable, profitable, valuable and
competitive. Many companies build their reputation on the basis of social and
environmental responsibility and go to substantial lengths to prove that their activities
do not exploit their workforce or any other section of society
Governments are encouraging disclosure by passing legislation, for example in the
area of anti-discrimination and by their own example in terms of the depth and
breadth of reporting (also by requiring companies who provide services to the
government to disclose such information). External awards and endorsements, such
as environmental league tables and employer awards, encourage companies to
adopt a more strategic approach to these issues. Finally, local cultural and social
pressures are causing greater demands for transparency of reporting.
There is no IFRS that determines the content of an environmental and social report.
While companies are allowed to include the information they wish to disclose, there is
a lack of comparability and the potential that only the positive actions will be shown.
A common framework that provided guidelines on sustainability reporting would be
useful for both companies and stakeholders.
The Global Reporting Initiative (GRI) provides guidelines on the content of a
sustainability report, but these are not mandatory. However, a number of companies
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prepare their reports in accordance with the guidelines and the GRI is becoming the
unofficial best practice guide in this area.
(b)
Company B’s environmental report should include the following
information.
1) A statement of the environmental policy covering all aspects of business
activity. This can include their aim of using renewable electricity and reducing
their carbon footprint – the amount of carbon dioxide released into the
environment as a result of their activities.
2) The management systems that reduce and minimise environmental risks.
3) Details of environmental training and expertise.
4) A report on their environmental performance including verified emissions to
air/land and water, and how they are seeking to reduce these and other
environmental impacts. Operating site reports for local communities for
businesses with high environmental impacts. Company B’s activities have a
significant impact so it is important to show how this is dealt with. The
emissions data could be graphed to show it is reducing. If they have the data,
they could compare their carbon dioxide emissions or their electricity usage
over previous periods. Presenting this information graphically helps
stakeholders see how the business is performing in the areas it is targeting.
5) Details of any environmental offence that resulted in enforcement action, fine,
etc. and any serious pollution incident. They can disclose how fines have
been reducing and state that there have not been any pollution incidents in
the current period.
6) A report on historical trends for key indicators and a comparison with the
corporate targets.
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International Public Sector Accounting standards (IPSASs)
Chapter learning objectives
Upon completion of this chapter you will be able to
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IPSAS – 1 Presentation of Financial Statements
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Purpose of financial statements
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Components of financial statements
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Fair presentation and compliance with IPSAS
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Statement of financial position
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Statement of financial performance
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Statement of changes in net assets/equity
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Financial reporting under the cash basis of accounting
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IPSAS – 1 Presentation of Financial Statements
Objective
The objective of this Standard is to prescribe the manner in which general purpose financial
statements should be presented to ensure comparability both with the entity’s financial
statements of previous periods and with the financial statements of other entities. To achieve
this objective, this Standard sets out overall considerations for the presentation of financial
statements, guidance for their structure, and minimum requirements for the content of
financial statements prepared under the accrual basis of accounting. The recognition,
measurement, and disclosure of specific transactions and other events are dealt with in
other IPSASs.
Scope
This Standard shall be applied to all general purpose financial statements prepared and
presented under the accrual basis of accounting in accordance with IPSASs.
General purpose financial statements are those intended to meet the needs of users who
are not in a position to demand reports tailored to meet their particular information needs.
Users of general purpose financial statements include taxpayers and ratepayers, members
of the legislature, creditors, suppliers, the media, and employees. General purpose financial
statements include those that are presented separately or within another public document,
such as an annual report. This Standard does not apply to condensed interim financial
information. This Standard applies equally to all entities and whether or not they need to
prepare consolidated financial statements or separate financial statements, as defined in
IPSAS 6, “Consolidated and Separate Financial Statements.”
This Standard applies to all public sector entities other than Government Business
Enterprises. The “Preface to International Public Sector Accounting Standards” issued by the
IPSASB explains that Government Business Enterprises (GBEs) apply IFRSs issued by the
IASB.
Purpose of Financial Statements
Financial statements are a structured representation of the financial position and financial
performance of an entity. The objectives of general purpose financial statements are 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 and evaluating decisions about the
allocation of resources. Specifically, the objectives of general purpose financial reporting in
the public sector should be to provide information useful for decision making, and to
demonstrate the accountability of the entity for the resources entrusted to it, by:
a) Providing information about the sources, allocation, and uses of financial resources;
b) Providing information about how the entity financed its activities and met its cash
requirements;
c) Providing information that is useful in evaluating the entity’s ability to finance its
activities and to meet its liabilities and commitments;
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d) Providing information about the financial condition of the entity and changes in it; and
e) Providing aggregate information useful in evaluating the entity’s performance in
terms of service costs, efficiency, and accomplishments.
General purpose financial statements can also have a predictive or prospective role,
providing information useful in predicting the level of resources required for continued
operations, the resources that may be generated by continued operations, and the
associated risks and uncertainties. Financial reporting may also provide users with
information:
a) Indicating whether resources were obtained and used in accordance with the legally
adopted budget; and
b) Indicating whether resources were obtained and used in accordance with legal and
contractual requirements, including financial limits established by appropriate
legislative authorities.
To meet these objectives, the financial statements provide information about an entity’s:
a) Assets;
b) Liabilities;
c) Net assets/equity;
d) Revenue;
e) Expenses;
f)
Other changes in net assets/equity; and
g) Cash flows.
Components of Financial Statements
A complete set of financial statements comprises:
a) A statement of financial position;
b) A statement of financial performance;
c) A statement of changes in net assets/equity;
d) A cash flow statement;
e) When the entity makes publicly available its approved budget, a comparison of
budget and actual amounts either as a separate additional financial statement or as a
budget column in the financial statements; and
f)
Notes, comprising a summary of significant accounting policies and other explanatory
notes.
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Fair Presentation and Compliance with IPSASs
Financial statements shall present fairly the financial position, financial performance, and
cash flows of an entity. Fair presentation requires the faithful representation of the effects of
transactions, other events, and conditions in accordance with the definitions and recognition
criteria for assets, liabilities, revenue, and expenses set out in IPSASs.
The application of IPSASs, with additional disclosures when necessary, is presumed to
result in financial statements that achieve a fair presentation.
An entity whose financial statements comply with IPSASs shall make an explicit and
unreserved statement of such compliance in the notes. Financial statements shall not be
described as complying with IPSASs unless they comply with all the requirements of IPSASs.
Going Concern
When preparing financial statements, an assessment of an entity’s ability to continue as a
going concern shall be made. This assessment shall be made by those responsible for the
preparation of financial statements. Financial statements shall be prepared on a going
concern basis unless there is an intention to liquidate the entity or to cease operating, or if
there is no realistic alternative but to do so. When those responsible for the preparation of
the financial statements are aware, in making their assessment, of material uncertainties
related to events or conditions that may cast significant doubt upon the entity’s ability to
continue as a going concern, those uncertainties shall be disclosed. When financial
statements are not prepared on a going concern basis, that fact shall be disclosed, together
with the basis on which the financial statements are prepared and the reason why the entity
is not regarded as a going concern.
Consistency of Presentation
The presentation and classification of items in the financial statements shall be retained from
one period to the next unless:
a) It is apparent, following a significant change in the nature of the entity’s operations or
a review of its financial statements, that another presentation or classification would
be more appropriate having regard to the criteria for the selection and application of
accounting policies in IPSAS 3; or
b) An IPSAS requires a change in presentation.
Materiality and Aggregation
Each material class of similar items shall be presented separately in the financial statements.
Items of a dissimilar nature or function shall be presented separately, unless they are
immaterial.
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Offsetting
Assets and liabilities, and revenue and expenses, may not be offset unless offsetting is
permitted or required by another IPSAS.
Comparative Information
Except when an IPSAS permits or requires otherwise, comparative information shall be
disclosed in respect of the previous period for all amounts reported in the financial
statements. Comparative information shall be included for narrative and descriptive
information when it is relevant to an understanding of the current period’s financial
statements.
Identification of the Financial Statements
The financial statements shall be identified clearly, and distinguished from other information
in the same published document.
IPSASs apply only to financial statements, and not to other information presented in an
annual report or other document. Therefore, it is important that users can distinguish
information that is prepared using IPSASs from other information that may be useful to users
but is not the subject of those requirements. Each component of the financial statements
shall be identified clearly.
In addition, the following information shall be displayed prominently, and repeated when it is
necessary for a proper understanding of the information presented:
a) The name of the reporting entity or other means of identification, and any change in
that information from the preceding reporting date;
b) Whether the financial statements cover the individual entity or the economic entity;
c) The reporting date or the period covered by the financial statements, whichever is
appropriate to that component of the financial statements;
d) The presentation currency, as defined in IPSAS 4, “The Effects of Changes in Foreign
Exchange Rates;” and
e) The level of rounding used in presenting amounts in the financial statements.
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Reporting Period
Financial statements shall be presented at least annually. When an entity’s reporting date
changes and the annual financial statements are presented for a period longer or shorter
than one year, an entity shall disclose, in addition to the period covered by the financial
statements:
a) The reason for using a longer or shorter period; and
b) The fact that comparative amounts for certain statements such as the statement of
financial performance, statement of changes in net assets/equity, cash flow statement,
and related notes are not entirely comparable.
Timeliness
The usefulness of financial statements is impaired if they are not made available to users
within a reasonable period after the reporting date. An entity should be in a position to issue
its financial statements within six months of the reporting date. Ongoing factors such as the
complexity of an entity’s operations are not sufficient reason for failing to report on a timely
basis. More specific deadlines are dealt with by legislation and regulations in many
jurisdictions.
Statement of Financial Position
Current/Non-current Distinction
An entity shall present current and non-current assets, and current and non-current liabilities,
as separate classifications on the face of its statement of financial position, except when a
presentation based on liquidity provides information that is reliable and is more relevant.
When that exception applies, all assets and liabilities shall be presented broadly in order of
liquidity.
Information to be Presented on the Face of the Statement of Financial Position
As a minimum, the face of the statement of financial position shall include line items that
present the following amounts:
a) Property, plant and equipment;
b) Investment property;
c) Intangible assets;
d) Financial assets (excluding amounts shown under (e), (g), (h) and (i));
e) Investments accounted for using the equity method;
f)
Inventories;
g) Recoverables from non-exchange transactions (taxes and transfers);
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h) Receivables from exchange transactions;
i)
Cash and cash equivalents;
j)
Taxes and transfers payable;
k) Payables under exchange transactions;
l)
Provisions;
m) Financial liabilities (excluding amounts shown under (j), (k) and (l));
n) Minority interest, presented within net assets/equity; and
o) Net assets/equity attributable to owners of the controlling entity.
Additional line items, headings, and sub-totals shall be presented on the face of the
statement of financial position when such presentation is relevant to an understanding of the
entity’s financial position.
Information to be Presented either on the Face of the Statement of Financial Position
or in the Notes
An entity shall disclose, either on the face of the statement of financial position or in the
notes, further sub classifications of the line items presented, classified in a manner
appropriate to the entity’s operations. The detail provided in sub classifications depends on
the requirements of IPSASs and on the size, nature and function of the amounts involved.
The disclosures vary for each item, for example:
a) Items of property, plant and equipment are disaggregated into classes in accordance
with IPSAS 17;
b) Receivables are disaggregated into amounts receivable from user charges, taxes
and other non-exchange revenues, receivables from related parties, prepayments,
and other amounts;
c) Inventories are sub classified in accordance with IPSAS 12, “Inventories,” into
classifications such as merchandise, production supplies, materials, work in progress,
and finished goods;
d) Taxes and transfers payable are disaggregated into tax refunds payable, transfers
payable, and amounts payable to other members of the economic entity;
e) Provisions are disaggregated into provisions for employee benefits and other items;
and
f)
Components of net assets/equity are disaggregated into contributed capital,
accumulated surpluses and deficits, and any reserves.
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Statement of Financial Performance
Surplus or Deficit for the Period
All items of revenue and expense recognized in a period shall be included in surplus or
deficit, unless an IPSAS requires otherwise.
Information to be Presented on the Face of the Statement of Financial Performance
As a minimum, the face of the statement of financial performance shall include line items
that present the following amounts for the period:
a) Revenue;
b) Finance costs;
c) Share of the surplus or deficit of associates and joint ventures accounted for using
the equity method;
d) Pre-tax gain or loss recognized on the disposal of assets or settlement of liabilities
attributable to discontinuing operations; and
e) Surplus or deficit.
Information to be Presented either on the Face of the Statement of Financial
Performance or in the Notes
When items of revenue and expense are material, their nature and amount shall be
disclosed separately.
Circumstances that would give rise to the separate disclosure of items of revenue and
expense include:
a) Write-downs of inventories to net realizable value or of property, plant, and
equipment to recoverable amount or recoverable service amount as appropriate, as
well as reversals of such write-downs;
b) Restructurings of the activities of an entity and reversals of any provisions for the
costs of restructuring;
c) Disposals of items of property, plant, and equipment;
d) Privatizations or other disposals of investments;
e) Discontinuing operations;
f)
Litigation settlements; and
g) Other reversals of provisions.
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Statement of Changes in Net Assets/Equity
An entity shall present a statement of changes in net assets/equity showing on the face of
the statement:
a) Surplus or deficit for the period;
b) Each item of revenue and expense for the period that, as required by other
Standards, is recognized directly in net assets/equity, and the total of these items;
c) Total revenue and expense for the period (calculated as the sum of (a) and (b)),
showing separately the total amounts attributable to owners of the controlling entity
and to minority interest; and
d) For each component of net assets/equity separately disclosed, the effects of changes
in accounting policies and corrections of errors recognized in accordance with IPSAS
3.
An entity shall also present, either on the face of the statement of changes in net
assets/equity or in the notes:
a) The amounts of transactions with owners acting in their capacity as owners, showing
separately distributions to owners;
b) The balance of accumulated surpluses or deficits at the beginning of the period and
at the reporting date, and the changes during the period; and
c) To the extent that components of net assets/equity are separately disclosed, a
reconciliation between the carrying amount of each component of net assets/equity
at the beginning and the end of the period, separately disclosing each change.
Cash Flow Statement
Cash flow information provides users of financial statements with a basis to assess (a) the
ability of the entity to generate cash and cash equivalents, and (b) the needs of the entity to
utilize those cash flows. IPSAS 2 sets out requirements for the presentation of the cash flow
statement and related disclosures.
Notes
Structure
The notes shall:
a) Present information about the basis of preparation of the financial statements and the
specific accounting policies used;
b) Disclose the information required by IPSASs that is not presented on the face of the
statement of financial position, statement of financial performance, statement of
changes in net assets/equity, or cash flow statement; and
c) Provide additional information that is not presented on the face of the statement of
financial position, statement of financial performance, statement of changes in net
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assets/equity, or cash flow statement, but that is relevant to an understanding of any
of them.
Notes shall, as far as practicable, be presented in a systematic manner. Each item on the
face of the statement of financial position, statement of financial performance, statement of
changes in net assets/equity, and cash flow statement shall be cross-referenced to any
related information in the notes.
Notes are normally presented in the following order, which assists users in understanding
the financial statements and comparing them with financial statements of other entities:
a) A statement of compliance with IPSASs;
b) A summary of significant accounting policies applied;
c) Supporting information for items presented on the face of the statement of financial
position, statement of financial performance, statement of changes in net
assets/equity, or cash flow statement, in the order in which each statement and each
line item is presented; and
d) Other disclosures, including:
i.
Contingent liabilities, and unrecognized contractual commitments; and
ii.
Non-financial disclosures, e.g., the entity’s financial risk management objectives
and policies.
FINANCIAL REPORTING UNDER THE CASH BASIS OF ACCOUNTING
This Standard comprises two parts:
Part 1 is mandatory. It sets out the requirements which are applicable to all public sector
entities preparing general purpose financial statements under the cash basis of accounting.
It defines the cash basis of accounting, establishes requirements for the disclosure of
information in the financial statements and supporting notes, and deals with a number of
specific reporting issues. The requirements in this part of the Standard must be complied
with by public sector entities which claim to be reporting in accordance with the International
Public Sector Accounting Standard Financial Reporting under the Cash Basis of Accounting.
Part 2 is not mandatory. It identifies additional accounting policies and disclosures that a
public sector entity is encouraged to adopt to enhance the usefulness of its financial
statements for accountability and decision-making purposes and to support its transition to
the accrual basis of financial reporting and adoption of accrual IPSAS.
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PART 1: REQUIREMENTS
Objective
The purpose of this Standard is to prescribe the manner in which general purpose financial
statements are to be presented under the cash basis of accounting.
The objectives of financial reporting by public sector entities are to provide information about
the entity that is useful to users of general purpose financial statements and other general
purpose financial reports (GPFRs) for accountability and decision-making purposes.
Information about the cash receipts, cash payments and cash balances of an entity is
necessary for accountability purposes and provides input useful for assessments of the
ability of the entity to generate adequate cash in the future and the likely sources and uses
of cash. In making and evaluating decisions about the allocation of cash resources and the
sustainability of the entity’s activities, users require an understanding of the timing and
certainty of cash receipts and cash payments.
Scope of the Requirements
The IPSAS are designed to apply to public sector entities that meet all the following criteria:
a) Are responsible for the delivery of services2 to benefit the public and/or to
redistribute income and wealth;
b) Mainly finance their activities, directly or indirectly, by means of taxes and/or
transfers from other levels of government, social contributions, debt or fees; and
c) Do not have a primary objective to make profits.
A public sector entity which prepares and presents general purpose financial statements
(financial statements) under the cash basis of accounting, as defined in this Standard, shall
apply the requirements of Part 1 of this Standard in the presentation of its annual financial
statements.
Cash Basis of Accounting
The cash basis of accounting recognizes transactions and events only when cash (including
cash equivalents) is received or paid by the entity. Financial statements prepared under the
cash basis provide readers with information about the sources of cash raised during the
period, the purposes for which cash was used and the cash balances at the reporting date.
The measurement focus in the financial statements is balances of cash and changes therein.
Notes to the financial statements may provide additional information about liabilities, such as
payables and borrowings, and some non-cash assets, such as receivables, investments and
property, plant and equipment.
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Financial Statements
An entity shall prepare and present financial statements which include the following
components:
a) A statement of cash receipts and payments which recognizes all cash receipts, cash
payments and cash balances controlled by the entity;
b) Accounting policies and explanatory notes; and
c) When the entity makes publicly available it’s approved budget, a comparison of
budget and actual amounts either as a separate additional financial statement or as a
budget column in the statement of cash receipts and payments.
When an entity elects to disclose information prepared on a different basis from the cash
basis of accounting as defined in this Standard, such information shall be disclosed in the
notes to the financial statements.
Information to be Presented in the Statement of Cash Receipts and Payments
The statement of cash receipts and payments shall present the following amounts for the
reporting period:
a) Total cash receipts of the entity showing separately a sub-classification of total cash
receipts using a classification basis appropriate to the entity’s operations;
b) Total cash payments of the entity showing separately a sub-classification of total
cash payments using a classification basis appropriate to the entity’s operations; and
c) Beginning and closing cash balances of the entity.
Total cash receipts and total cash payments, and cash receipts and cash payments for each
sub-classification of cash receipt and payment, shall be reported on a gross basis, except
that cash receipts and payments may be reported on a net basis when:
a) They arise from transactions which the entity administers on behalf of other parties
and which are recognized in the statement of cash receipts and payments; or
b) They are for items in which the turnover is quick, the amounts are large, and the
maturities are short.
Line items, headings and sub-totals shall be presented in the statement of cash receipts and
payments when such presentation is necessary to present fairly the entity’s cash receipts,
cash payments and cash balances.
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Accounting Policies and Explanatory Notes
The notes to the financial statements of an entity shall:
a) Present information about the basis of preparation of the financial statements and the
specific accounting policies selected and applied for significant transactions and
other events; and
b) Provide additional information which is not presented on the face of the financial
statements but is necessary for a fair presentation of the entity’s cash receipts, cash
payments and cash balances.
Notes to the financial statements shall be presented in a systematic manner. Each item on
the face of the statement of cash receipts and payments and other financial statements shall
be cross referenced to any related information in the notes.
Presentation of Budget Information in Financial Statements
An entity that makes publicly available its approved budget(s) shall present a comparison of
the budget amounts for which it is held publicly accountable and actual amounts either as a
separate additional financial statement or as additional budget columns in the statement of
cash receipts and payments currently presented in accordance with this Standard. The
comparison of budget and actual amounts shall present separately for each level of
legislative oversight:
a) The original and final budget amounts;
b) The actual amounts on a comparable basis; and
c) By way of note disclosure, an explanation of material differences between the budget
for which the entity is held publicly accountable and actual amounts, unless such
explanation is included in other public documents issued in conjunction with the
financial statements, and a cross reference to those documents is made in the notes.
Presentation
An entity shall present a comparison of budget and actual amounts as additional budget
columns in the statement of cash receipts and payments only where the financial statements
and the budget are prepared on a comparable basis.
Comparisons of budget and actual amounts may be presented in a separate financial
statement (“statement of comparison of budget and actual amounts” or a similarly titled
statement). Alternatively, where the financial statements and the budget are prepared on a
comparable basis – that is, on the same basis of accounting for the same entity and
reporting period, and adopt the same classification structure – additional columns may be
added to the statement of cash receipts and payments presented in accordance with this
Standard. These additional columns will identify original and final budget amounts and, if the
entity so chooses, differences between the budget and actual amounts.
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When the budget and financial statements are not prepared on a comparable basis, a
separate statement of comparison of budget and actual amounts is presented. In these
cases, to ensure that readers do not misinterpret financial information which is prepared on
different bases, the financial statements could usefully clarify that the budget and the
accounting bases differ and the statement of comparison of budget and actual amounts is
prepared on the budget basis.
Changes from Original to Final Budget
An entity shall present an explanation of whether changes between the original and final
budget are a consequence of reallocations within the budget, or of other factors, either:
a) By way of note disclosure in the financial statements; or
b) In a report issued before, at the same time as, or in conjunction with the financial
statements, and shall include a cross reference to the report in the notes to the
financial statements.
Reconciliation of Actual Amounts on a Comparable Basis and Actual Amounts in the
Financial Statements
The actual amounts presented on a comparable basis to the budget shall, where the
financial statements and the budget are not prepared on a comparable basis, be reconciled
to total cash receipts and total cash payments, identifying separately any basis, timing and
entity differences. The reconciliation shall be disclosed on the face of the statement of
comparison of budget and actual amounts or in the notes to the financial statements.
Differences between the actual amounts identified consistent with the comparable basis and
the actual amounts recognized in the financial statements can usefully be classified into the
following:
a) Budgetary basis differences, which occur when the approved budget is prepared on
a basis other than the accounting basis. For example, where the budget is prepared
on the accrual basis or modified cash basis and the financial statements are
prepared on the cash basis;
b) Timing differences, which occur when the budget period differs from the reporting
period reflected in the financial statements; and
c) Entity differences, which occur when the budget omits programs or entities that are
part of the entity for which the financial statements are prepared.
There may also be differences in formats and classification schemes adopted for
presentation of financial statements and the budget.
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Preparation and presentation of Financial Statements of
Specialized Companies
Chapter learning objectives
Upon completion of this chapter you will be able to
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IFRS for Small and Medium Size Entities
Contents of the IFRS for SMEs
Fair Value Measurement
Hedge Accounting
Lessees – finance leases:
Mutual Funds
Banks
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IFRS for Small and Medium Size Entities
Announcement of issuance of the IFRS for SMEs
On 9 July 2009, the IASB issued the IFRS for SMEs. This is the first set of international
accounting requirements developed specifically for small and medium-sized entities (SMEs).
It has been prepared on IFRS foundations but is a stand-alone product that is separate from
the full set of International Financial Reporting Standards (IFRSs). The IFRS for SMEs has
simplifications that reflect the needs of users of SMEs' financial statements and cost-benefit
considerations. Compared with full IFRSs, it is less complex in a number of ways:

Topics not relevant to SMEs are omitted.

Where full IFRSs allow accounting policy choices, the IFRS for SMEs allows only the
easier option.

Many of the principles for recognising and measuring assets, liabilities, income and
expenses in full IFRSs are simplified.

Significantly fewer disclosures are required.

And the standard has been written in clear, easily translatable language.
To further reduce the reporting burden for SMEs, revisions to the IFRS will be limited to once
every three years. It is suitable for all entities except those whose securities are publicly
traded and financial institutions such as banks and insurance companies. The IFRS for
SMEs is available for any jurisdiction to adopt whether or not it has adopted the full IFRSs. It
is up to each jurisdiction to determine which entities should use the standard. It is effective
immediately on issue.
Contents of the IFRS for SMEs
IFRS for SME’s include a preface and 35 sections to cover different areas.
Here are the brief details of the sections.
Preface
The IFRS for Small and Medium-sized Entities is organised by topic, with each topic
presented in a separate section. All of the paragraphs in the standard have equal authority.
The standard is appropriate for general purpose financial statements and other financial
reporting of all profit-oriented entities. General purpose financial statements are directed
towards the common information needs of a wide range of users, for example, shareholders,
creditors, employees and the public at large.
The IASB intends to issue a comprehensively reviewed standard after two year's
implementation, to address issues identified and also, if appropriate, recent changes to full
IFRSs. Thereafter, an omnibus proposal of amendments will be issued, if necessary, once
every three years.
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Section 1 Small and Medium-sized Entities
Definition of SME as used by IASB:
Small and medium-sized entities are entities that:
a) do not have public accountability, and
b) publish general purpose financial statements for external users. Examples of external
users include owners who are not involved in managing the business, existing and
potential creditors, and credit rating agencies. General purpose financial statements
are those that present fairly financial position, operating results, and cash flows for
external capital providers and others.
An entity has public accountability if:
a) its debt or equity instruments are traded in a public market or it is in the process of
issuing such instruments for trading in a public market (a domestic or foreign stock
exchange or an over-the-counter market, including local and regional markets), or
b) it holds assets in a fiduciary capacity for a broad group of outsiders as one of its
primary businesses. This is typically the case for banks, credit unions, insurance
companies, securities brokers/dealers, mutual funds and investment banks. If an
entity holds assets in a fiduciary capacity as an incidental part of its business, that
does not make it publicly accountable. Entities that fall into this category may
include public utilities, travel and real estate agents, schools, and charities.
The standard does not contain a limit on the size of an entity that may use the IFRS for
SMEs provided that it does not have public accountability nor is there a restriction on its use
by a public utility, not-for-profit entity, or public sector entity. A subsidiary whose parent or
group uses full IFRSs may use the IFRS for SMEs if the subsidiary itself does not have
public accountability. The standard does not require any special approval by the owners of
an SME for it to be eligible to use the IFRS for SME. Listed companies, no matter how small,
may not use the IFRS for SMEs
Section 2 Concepts and Pervasive Principles
Objective of SMEs' financial statements: To provide information about financial position,
performance, cash flows and also shows results of stewardship of management over
resources.
Qualitative characteristics mentioned in section 2 are same as in “conceptual framework”,
(understandability, relevance, materiality, reliability, substance over form, prudence,
completeness, comparability, timeliness, balance between benefit and cost, undue cost or
effort).
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Definitions:
Asset: Resource with future economic benefits.
Liability: Present obligation arising from past events, result in outflow of resources.
Income: Inflows of resources that increase equity, other than owner investments.
Expenses: Outflows of resources that decrease equity, other than owner withdrawals.
Financial position: the relationship of assets and liabilities at a specific date.
Performance: the relationship of income and expenses during a reporting period.
Total comprehensive income: arithmetic difference between income and expenses.
Profit or loss: arithmetic difference between income and expenses other than those items
of income or expense that are classified as 'other comprehensive income'.
There are only 3 items of other comprehensive income (OCI) in the IFRS for SMEs:
Some foreign exchange gains and losses relating to a net investment in a foreign operation
Some changes in fair values of hedging instruments – in a hedge of variable interest rate risk
of a recognised financial instrument, foreign exchange risk or commodity price risk in a firm
commitment or highly probable forecast transaction, or a net investment in a foreign
operation (Section 12) (Note that hedge accounting is optional)
Some actuarial gains and losses (Section 28) (Note that reporting actuarial gains and losses
in OCI is optional)
Basic recognition concept – An item that meets the definition of an asset, liability, income, or
expense is recognised in the financial statements if:

it is probable that future benefits associated with the item will flow to or from the
entity, and

the item has a cost or value that can be measured reliably
Basic measurement concepts:
 Historical cost and
 Fair value
Basic financial assets and liabilities are generally measured at amortised cost. Other
financial assets and liabilities are generally measured at fair value through profit or loss.
Non-financial assets are generally measured using a cost-based measure and non-financial
liabilities are generally measured at settlement amount.
Offsetting of assets and liabilities or of income and expenses is prohibited unless expressly
required or permitted.
Section 3 Financial Statement Presentation
Fair presentation: presumed to result if the IFRS for SMEs is followed (may be a need for
supplemental disclosures).
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An entity will give a statement of compliance with IFRS for SMEs only if the financial
statements are in full compliance with IFRS for SMEs. Financial statements do include 'true
and fair override' but this should be 'extremely rare'.
IFRS for SMEs presumes the reporting entity is a going concern and shall present a
complete set of financial statements at least annually with one year comparative prior period
financial statements and notes to the accounts.
Presentation and classification of items should be consistent from one period to the next in
case of any change in presentation or classification of items in financial statements entity
must justify and disclose.
Materiality: an omission or misstatement is material if it could influence economic decision of
the user of the financial statements.
Components of the Financial Statements
Complete set of financial statements will include:
 Statement of financial position
 Either a single statement of comprehensive income, or two statements: an income
statement and a statement of comprehensive income
 Statement of changes in equity
 Statement of cash flows
 Notes
If the only changes to equity arise from profit or loss, payment of dividends, corrections of
errors, and changes in accounting policy, an entity may present a single (combined)
statement of income and retained earnings instead of the separate statements of
comprehensive income and of changes in equity.
An entity may present only an income statement (no statement of comprehensive income) if
it has no items of other comprehensive income (OCI).
The only OCI items under the IFRS for SMEs are:
 Some foreign exchange gains and losses relating to a net investment in a foreign
operation
 Some changes in fair values of hedging instruments – in a hedge of variable interest
rate risk of a recognised financial instrument, foreign exchange risk or commodity
price risk in a firm commitment or highly probable forecast transaction, or a net
investment in a foreign operation
 Some actuarial gains and losses
Section 4 Statement of Financial Position
May still be called 'balance sheet'. Current/non-current split is not required if the entity
concludes that a liquidity approach produces more relevant information.
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Minimum line items required on face of statement of financial position are:
 Cash and equivalents
 Receivables
 Financial assets
 Inventories
 Property, plant, and equipment
 Investment property at cost
 Investment property at fair value
 Intangible assets
 Biological assets at cost
 Biological assets at fair value
 Investment in associates
 Investment in joint ventures
 Payables
 Financial liabilities
 Current tax assets and liabilities
 Deferred tax assets and liabilities
 Provisions
 Non-controlling interest
 Equity of owners of parent
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Following items may be presented either on face of the statement of financial position or in
the notes to the accounts:
 Categories of property, plant, and equipment
 Information about assets with binding sale agreements
 Categories of receivables
 Categories of inventories
 Categories of payables
 Employee benefit obligations
 Classes of equity, including OCI and reserves
 Details about share capital
Section 5 Statement of Comprehensive Income and Income Statement
Section 5 contains two approaches to present statement of comprehensive income:

One-statement approach – a single statement of comprehensive income

Two-statement approach – an income statement and a statement of comprehensive
income
Discontinued operations must be segregated from continuing operations. Section 5 prohibits
to label an item as “extraordinary” but unusual items can be presented separately. Expenses
may be presented by nature or by function either on face of the statement or in the notes.
Single statement of comprehensive income:
Revenue
Expenses, showing separately:
finance costs
profit or loss from associates and jointly controlled entities
tax expense
discontinued operations
Profit or loss (may omit if no OCI)
Items of other comprehensive income
Total comprehensive income (may label Profit or Loss if no OCI)
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Separate statements of income and comprehensive income:
Income Statement:
Bottom line is profit or loss (as above)
Statement of Comprehensive Income:
Begins with profit or loss
Shows each item of other comprehensive income
Bottom line is Total Comprehensive Income
Section 6 Statement of Changes in Equity and Statement of Comprehensive Income
and Retained Earnings
Shows all changes to equity including:
 total comprehensive income
 owners' investments
 dividends
 owners' withdrawals of capital
 treasury share transactions
Can omit the statement of changes in equity if the entity has no owner investments or
withdrawals other than dividends and elects to present a combined statement of
comprehensive income and retained earnings.
Section 7 Statement of Cash Flows
Presents information about an entity's changes in cash and cash equivalents for a period.
Cash equivalents are short-term, highly liquid investments (expected to be converted to
cash in three months) held to meet short-term cash needs rather than for investment or other
purposes.
Cash flows are classified as operating, investing, and financing cash flows and entity has the
option to use the indirect method or the direct method to present operating cash flows.
Interest paid and interest and dividends received may be operating, investing, or financing
Dividends paid may be operating or financing
Income tax cash flows are operating unless specifically identified with investing or financing
activities
Separate disclosure is required of some non-cash investing and financing transactions (for
example, acquisition of assets by issue of debt)
Reconciliation of components of cash
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Section 8 Notes to the Financial Statements
Notes are normally in this sequence:

Basis of preparation (ie IFRS for SMEs)

Summary of significant accounting policies, including

Information about judgements

Information about key sources of estimation uncertainty

Supporting information for items in financial statements

Other disclosures
Comparative prior period amounts are required by Section 3 (unless another section allows
omission of prior period amounts)
Section 9 Consolidated and Separate Financial Statements
Consolidated financial statements are required when a parent company controls another
entity (a subsidiary).
Control: Power to govern financial and operating policies to obtain benefits. More than 50%
of voting power will be presumed as control. Control exists when entity owns less than 50%
but has power to govern by agreement or statute, or power to appoint majority of the board,
or power to cast majority of votes at board meetings. Control can be achieved by currently
exercisable options that, if exercised, would result in control.
A subsidiary is not excluded from consolidation because:

Investor is a venture capital organisation

Subsidiary's business activities are dissimilar to those of parent or other subs

Subsidiary operates in a jurisdiction that imposes restrictions on transferring cash or
other assets out of the jurisdiction
However, consolidated financial statements are not required, even if a parent-subsidiary
relationship exists:

Subsidiary was acquired with intent to dispose within one year

Parent itself is a subsidiary and its parent or ultimate parent uses IFRSs or IFRS for
SMEs
Parent must consolidate all controlled special-purpose entities (SPEs).
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Consolidation procedures

Eliminate intracompany transactions and balances

Uniform reporting date unless impracticable

Uniform accounting policies

Non-controlling interest is presented as part of equity

Losses are allocated to a subsidiary even if non-controlling interest goes negative
Separate financial statements (but they are not required)
In a parent's separate financial statements, it may account for subsidiaries, associates, and
joint ventures that are not held for sale at cost or fair value through profit and loss or using
the equity method.
Section 10 Accounting Policies, Estimates and Errors
Choice of Accounting Policies

If the IFRS for SMEs addresses an issue, the entity must follow the IFRS for SMEs

If the IFRS for SMEs does not address an issue:

Choose policy that results in the most relevant and reliable information

Try to analogise from standards in the IFRS for SMEs

Or use the concepts and pervasive principles in Section 2

Entity may look to guidance in full IFRSs (but not required)
Change in accounting policy

If mandated, follow the transition guidance as mandated

If voluntary, retrospective
Change in accounting estimate
All changes in accounting estimates must be accounted for prospectively.
Correction of prior period error
Restate prior periods if practicable.
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Section 11 Basic Financial Instruments
IFRS for SMEs has two sections on financial instruments:
 Section 11 on Basic Financial Instruments
 Section 12 on Other FI Transactions
SME has an 0ption to follow IFRS 9 instead of sections 11 and 12. Even if IFRS 9 is followed,
make Section 11 and 12 disclosures (not IFRS 7 disclosures).
Essentially, Section 11 is an amortised historical cost model except for equity investments
with quoted price or readily determinable fair value. These are measured at fair value
through profit or loss.
Scope of Section 11 includes:

Cash

Demand and fixed deposits

Commercial paper and bills

Accounts and notes receivable and payable

Debt instruments where returns to the holder are fixed or referenced to an
observable rate

Investments in nonconvertible and non-puttable ordinary and preference shares

Most commitments to receive a loan
Initial measurement
Basic financial assets and financial liabilities are initially measured at the transaction price
(including transaction costs except in the initial measurement of financial assets and
liabilities that are measured at fair value through profit or loss) unless the arrangement
constitutes, in effect, a financing transaction. A financing transaction may be indicated in
relation to the sale of goods or services, for example, if payment is deferred beyond normal
business terms or is financed at a rate of interest that is not a market rate. If the
arrangement constitutes a financing transaction, measure the financial asset or financial
liability at the present value of the future payments discounted at a market rate of interest for
a similar debt instrument.
Measurement subsequent to initial recognition
Debt instruments at amortised cost using the effective interest method. Debt instruments that
are classified as current assets or current liabilities are measured at the undiscounted
amount of the cash or other consideration expected to be paid or received (ie net of
impairment) unless the arrangement constitutes, in effect, a financing transaction. If the
arrangement constitutes a financing transaction, the entity shall measure the debt instrument
at the present value of the future payments discounted at a market rate of interest for a
similar debt instrument.
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Investments in non-convertible preference shares and non-puttable ordinary or preference
shares:

if the shares are publicly traded or their fair value can otherwise be measured reliably
without undue cost or effort, measure at fair value with changes in fair value
recognised in profit or loss

measure all other such investments at cost less impairment
Impairment
Must test all amortised cost instruments for impairment or uncollectibility.
Previously recognised impairment is reversed if an event occurring after the impairment was
first recognised causes the original impairment loss to decrease.
Fair Value Measurement
Guidance is provided on determining fair values of financial instruments.

The most reliable is a quoted price in an active market

When a quoted price is not available the most recent transaction price provides
evidence of fair value

If there is no active market or recent market transactions, a valuation technique may
be used
Derecognition
Derecognise a financial asset when:

the contractual rights to the cash flows from the financial asset expire or are settled;

the entity transfers to another party all of the significant risks and rewards relating to
the financial asset; or

the entity, despite having retained some significant risks and rewards relating to the
financial asset, has transferred the ability to sell the asset in its entirety to an
unrelated third party who is able to exercise that ability unilaterally and without
needing to impose additional restrictions on the transfer.
Derecognise a financial liability when the obligation is discharged, cancelled, or expires
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Disclosures

Categories of financial instruments

Details of debt and other instruments

Details of derecognition

Collateral

Defaults and breaches on loans payable

Items of income and expense
Section 12 Additional Financial Instruments Issues
Financial instruments not covered by Section 11 (and, therefore, are within Section 12) are
measured at fair value through profit or loss. This includes:

Investments in convertible and puttable ordinary and preference shares

Options, forwards, swaps, and other derivatives

Financial assets that would otherwise be in Section 11 but that have 'exotic'
provisions that could cause gain/loss to the holder or issuer
Hedge Accounting
Hedge accounting involves matching the gains and losses on a hedging instrument and
hedged item.
It is allowed only for the following kinds of risks:

interest rate risk of a debt instrument measured at amortised cost

foreign exchange or interest rate risk in a firm commitment or a highly probable
forecast transaction

price risk of a commodity that it holds or in a firm commitment or highly probable
forecast transaction to purchase or sell a commodity

foreign exchange risk in a net investment in a foreign operation.
Hedges must be documented up front to qualify for hedge accounting
Section 13 Inventories
Inventories include assets for sale in the ordinary course of business, being produced for
sale, or to be consumed in production.
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Measurement
Inventories are measured at the lower of cost and estimated selling price less costs to
complete and sell.
Cost is determined using:
 specific identification is required for large items
 option to choose FIFO or weighted average for others
 LIFO is not permitted
Inventory cost includes costs to purchase, costs of conversion, and costs to bring the asset
to present location and condition.
Inventory cost excludes abnormal waste and storage, administrative, and selling costs.
If a production process creates joint products and/or by-products, the costs are allocated on
a consistent and rational basis.
A manufacturer allocates fixed production overheads to inventories based on normal
capacity.
Standard costing, retail method, and most recent purchase price may be used only if the
result approximates actual cost.
Section 14 Investments in Associates
Associates are investments where significant influence exists. Significant influence is defined
as the power to participate in the financial and operating policy decisions of the associate but
where there is neither control nor joint control over those policies. Presumption that
significant influence exists if investor owns 20% or more of the voting shares.
Following options are available to account for the investment in associates:

Cost-impairment model (except if there is a published quotation – then must use fair
value through profit or loss)

Equity method (investor recognises its share of profit or loss of the associate – detailed
guidance is provided)

Fair value through profit or loss
Investments in associates are always classified as non-current assets.
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Section 15 Investments in Joint Ventures
For investments in jointly controlled entities, there is an option for the venturer to use:

Cost model (except if there is a published quotation – then must use fair value through
profit or loss)

Equity method (using the guidance in Section 14)

Fair value through profit or loss
Proportionate consolidation is prohibited for jointly controlled entities.
For jointly controlled operations, the venturer should recognise assets that it controls and
liabilities it incurs as well as its share of income earned and expenses that are incurred.
For jointly controlled assets, the venturer should recognise its share of the assets and
liabilities it incurs as well as income it earns and expenses that are incurred.
Section 16 Investment Property
Investment property is investments in land, buildings (or part of a building), and some
property interests in finance leases held to earn rentals or for capital appreciation or both.
Property interests that are held under an operating lease may be classified as an investment
property provided the property would otherwise have met the definition of an investment
property
Mixed use property must be separated between investment and operating property.
If fair value can be measured reliably without undue cost or effort, use the fair value through
profit or loss model. Otherwise, an entity must treat investment property as property, plant
and equipment using Section 17 (Property, Plant and Equipment).
Section 17 Property, Plant and Equipment
Section 17 Property, Plant and Equipment prescribes two measurement models:

Historical cost-depreciation-impairment model or

Revaluation model
Section 17 applies to most investment property as well (but if fair value of investment
property can be measured reliably without undue cost or effort then the fair value model in
Section 16 applies).
Section 17 applies to property held for sale – there is no special section on assets held for
sale. Holding for sale is an indicator of possible impairment.
Cost model: Measurement is initially at cost, including costs to get the property ready for its
intended use; subsequent to acquisition, the entity uses the cost-depreciation-impairment
model, which recognises depreciation and impairment of the carrying amount.
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Revaluation model: Measurement is at fair value at the date of the revaluation less any
subsequent accumulated depreciation and subsequent accumulated impairment losses;
revaluations must be made with sufficient regularity.
The carrying amount of an asset, less estimated residual value, is depreciated over the
asset's anticipated useful life. The method of depreciation shall be the method that best
reflects the consumption of the asset's benefits over its life. Separate significant components
should be depreciated separately.
Review useful life, residual value, depreciation rate only if there is a significant change in the
asset or how it is used. Any adjustment is a change in estimate and to be accounted for
prospectively.
Section 18 Intangible Assets other than Goodwill
Section 18 states that internally generated intangible assets can’t be recognized as
intangible asset. Therefore:

Charge all research and development costs to expense

Charge the following items to expense when incurred: Costs of internally generated
brands, logos, and masthead, start-up costs, training costs, advertising, and relocating
of a division or entity
All intangible assets that are purchased separately, acquired in a business combination,
acquired by grant, and acquired by exchange of other assets must be measured by using
cost model.
Intangible assets must be amortised over useful life. If the entity is unable to estimate useful
life, then use the management’s best estimate but not more than 10 years.
Review useful life, residual value, depreciation rate only if there is a significant change in the
asset or how it is used. Any adjustment is a change in estimate and to be accounted for
prospectively.
Any revaluation of intangible assets is prohibited.
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Section 19 Business Combinations and Goodwill
Section does not apply to combinations of entities under common control.
All other business combinations are required to be accounted for using Acquisition
(purchase) method. Under this method:

An acquirer must always be identified

The cost of the business combination is measured. Cost is the fair value of assets
given, liabilities incurred or assumed, and equity instruments issued, plus costs directly
attributable to the combination

At the acquisition date, the cost is allocated to the assets acquired and liabilities and
provisions for contingent liabilities assumed. The identifiable assets acquired and
liabilities and provisions for contingent liabilities assumed are measured at their fair
values. Any difference between cost and amounts allocated to identifiable assets and
liabilities (including provisions) is recognised as goodwill or so-called 'negative goodwill'.
All goodwill must be amortised. If the entity is unable to estimate useful life, then use 10
years.
'Negative goodwill' – first reassess original accounting. If that is ok, then immediate credit to
profit or loss.
Section 20 Leases
Scope includes arrangements that contain a lease.
Leases are classified as either finance leases or operating leases.
Finance leases result in substantially all the risks and rewards incidental to ownership being
transferred between the parties, while operating leases do not.
Substantially all risks and rewards of ownership are presumed transferred if:

the lease transfers ownership of the asset to the lessee by the end of the lease term

the lessee has a 'bargain purchase option'

the lease term is for the major part of the economic life of the asset even if title is not
transferred

at the inception of the lease the present value of the minimum lease payments
amounts to at least substantially all of the fair value of the leased asset

the leased assets are of such a specialised nature that only the lessee can use them
without major modifications

the lessee bears the lessor losses if cancelled

a secondary rental period at below market rates

the residual value risk is borne by the lessee.
Lessees – finance leases:
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The rights and obligations are to be recognised as assets and liabilities at fair value, or, if
lower, the present value of the minimum lease payments. Any direct costs of the lessee are
added to the asset amount recognised. Subsequently, payments are to be split between a
finance charge and reduction of the liability. The asset should be depreciated either over the
useful life or the lease term.
Lessees – operating leases:
Payments are to be recognised as an expense on the straight line basis, unless payments
are structured to increase in line with expected general inflation or another systematic basis
is better representative of the time pattern of the user's benefit.
Lessors – finance leases:
The rights are to be recognised as assets held, i.e. as a receivable at an amount equal to the
net investment in the lease. The net investment in a lease is the lessor's gross investment in
the lease (including unguaranteed residual value) discounted at the interest rate implicit in
the lease.
For finance leases other than those involving manufacturer or dealer lessors, initial direct
costs are included in the initial measurement of the finance lease receivable and reduce the
amount of income recognised over the lease term.
If there is an indication that the estimated unguaranteed residual value used in computing
the lessor's gross investment in the lease has changed significantly, the income allocation
over the lease term is revised, and any reduction in respect of amounts accrued is
recognised immediately in profit or loss.
Lessors – finance leases by a manufacturer or dealer:
A finance lease of an asset by a manufacturer or dealer lessor gives rise to two types of
income:

profit or loss equivalent to the profit or loss resulting from an outright sale of the asset
being leased, at normal selling prices, reflecting any applicable volume or trade
discounts; and

finance income over the lease term.
The sales revenue recognised at the commencement of the lease term by a manufacturer or
dealer lessor is the fair value of the asset or, if lower, the present value of the minimum
lease payments accruing to the lessor, computed at a market rate of interest.
The cost of sale recognised at the commencement of the lease term is the cost, or carrying
amount if different, of the leased property less the present value of the unguaranteed
residual value. The difference between the sales revenue and the cost of sale is the selling
profit, which is recognised in accordance with the entity's policy for outright sales.
If artificially low rates of interest are quoted, selling profit shall be restricted to that which
would apply if a market rate of interest were charged. Costs incurred by manufacturer or
dealer lessors in connection with negotiating and arranging a lease shall be recognised as
an expense when the selling profit is recognised.
Lessors – operating leases:
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Lessors retain the assets on their balance sheet and payments are to be recognised as
income on the straight-line basis, unless payments are structured to increase in line with
expected general inflation or another systematic basis is better representative of the time
pattern of the user's benefit.
Sale and leaseback:

If a sale and leaseback results in a finance lease, the seller should not recognise any
excess as a profit, but recognise the excess over the lease term.

If a sale and leaseback results in an operating lease, and the transaction was at fair
value, the seller shall recognise any profits immediately.
Section 21 Provisions and Contingencies
Provisions:
Provisions are recognised only when:
a) there is a present obligation as a result of a past event,
b) it is probable that the entity will be required to transfer economic benefits, and
c) the amount can be estimated reliably
The obligation may arise due to contract or law or when there is a constructive obligation
due to valid expectations having been created from past events. However, these do not
include any future actions that may create an expectation. Nor can expected future losses be
recognised as provisions.
Initially recognised at the best possible estimate at the reporting date. This value should take
into any time value of money if this is considered material. When all or part of a provision
may be reimbursed by a third party, the reimbursement is to be recognised separately only
when it is virtually certain payment will be received.
Subsequently, provisions are to be reviewed at each reporting date and adjusted to meet the
best current estimate. Any adjustments are recognised in profit and loss while any unwinding
of discounts is to be treated as a finance cost.
Section 21 Provisions and Contingencies requires to recognize provisions for (examples):

Onerous contracts

Warranties

Restructuring if legal or constructive obligation to restructure

Sales refunds
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Section 21 Provisions and Contingencies prohibits to recognize provisions for
(examples):

Future operating losses, no matter how probable

Possible future restructuring (plan but not yet a legal or constructive obligation)
Contingent liabilities:

These are not recognised as liabilities

Unless remote, disclose an estimate of the financial effect, indications of the
uncertainties relating to timing or amount, and the possibility of reimbursement
Contingent assets:

These are not recognised as assets.

Disclose a description of the nature and the financial effect.
Section 22 Liabilities and Equity
Section 22 requires classification of an instrument as liability or equity. An instrument is a
liability if the issuer could be required to pay cash.
Puttable financial instruments are only recognised as equity if it has all of the following
features:

The holder is entitled to a pro rata share of the entity's net assets in the event of
liquidation.

The instrument is the most subordinate class.

All financial instruments in the most subordinate class have identical features.

Apart from the puttable features the instrument includes no other financial instrument
features.

The total expected cash flows attributable to the instrument over the life of the instrument
are based substantially on the change in the value of the entity.
Members' shares in co-operative entities and similar instruments are only classified as equity
if the entity has an unconditional right to refuse redemption of the members' shares or the
redemption is unconditionally prohibited by local law, regulation or the entity's governing
charter. If the entity could not refuse redemption, the members' shares are classified as
liabilities.
Section 22 covers some material not covered by full IFRSs, including:
Original issuance of shares and other equity instruments. Shares are only recognised as
equity when another party is obliged to provide cash or other resources in exchange for the
instruments. The instruments are measured at the fair value of cash or resources received,
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net of transaction cost, unless the time value of money is significant in which case initial
measurement is at the present value amount. When shares are issued before the cash or
other resources are received, the amount receivable is presented as an offset to equity in
the statement of financial position and not as an asset. Any shares subscribed for which no
cash is received are not recognised as equity before the shares are issued.
stock dividends and stock splits – these do not result in changes to total equity but, rather,
reclassification of amounts within equity.
'Split accounting' is required to account for issuance of convertible instruments. Proceeds on
issue of convertible and other compound financial instruments are split between liability
component and equity component. The liability is measured at its fair value, and the residual
amount is the equity component. The liability is subsequently measured using the effective
interest rate, with the original issue discount amortised as added interest expense.
If a liability is fully or partially extinguished by issuing equity instruments to the creditor, the
equity instruments issued are measured at their fair value. If the fair value of the equity
instruments issued cannot be measured reliably without undue cost or effort, the equity
instruments is measured at the fair value of the financial liability extinguished.
Treasury shares (an entity's own shares that are reacquired) are measured at the fair value
of the consideration paid and are deducted from the equity. No gain or loss is recognised on
subsequent resale of treasury shares.
Minority interest changes that do not affect control do not result in a gain or loss being
recognised in profit and loss. They are equity transactions between the entity and its owners.
Dividends paid in the form of distribution of assets other than cash are recognised when the
entity has an obligation to distribute the non-cash assets:
 The dividend liability is measured at the fair value of the assets to be distributed.
 If the fair value of the assets to be distributed cannot be measured reliably without
undue cost or effort, the liability shall be measured at the carrying amount of the
assets to be distributed.
Section 23 Revenue
Revenue results from the sale of goods, services being rendered, construction contracts
income by the contractor and the use by others of your assets.
Some types of revenue are excluded from this section and dealt with elsewhere:

leases (section 20)

dividends from equity accounted entities (section 14 and 15)

changes in fair value of financial instruments (section 11 and 12)

initial recognition and subsequent re-measurement of biological assets (section 34) and
initial recognition of agricultural produce (section 34)
Measurement
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Principle for measurement of revenue is the fair value of the consideration received or
receivable, taking into account any possible trade discounts or rebates, including volume
rebates and prompt settlement discounts. If payment is deferred beyond normal payment
terms, there is a financing component to the transaction. In that case, revenue is measured
at the present value of all future receipts. The difference is recognised as interest revenue.
Recognition
Sale of goods: An entity shall recognise revenue from the sale of goods when all the
following conditions are satisfied:
a) the entity has transferred to the buyer the significant risks and rewards of ownership
of the goods.
b) the entity retains neither continuing managerial involvement to the degree usually
associated with ownership nor effective control over the goods sold.
c) the amount of revenue can be measured reliably.
d) it is probable that the economic benefits associated with the transaction will flow to
the entity.
e) the costs incurred or to be incurred in respect of the transaction can be measured
reliably.
Revenue against rendering of services: Use the percentage of completion method if the
outcome of the transaction can be estimated reliably. Otherwise use the cost-recovery
method.
Revenue against construction contracts: Use the percentage of completion method if the
outcome of the contract can be estimated reliably. Otherwise use the cost-recovery method.
Interest: Interest shall be recognised using the effective interest method.
Royalties: Royalties shall be recognised on an accrual basis in accordance with the
substance of the relevant agreement.
Dividends: Dividends shall be recognised when the shareholder's right to receive payment is
established.
Award credits or other customer loyalty plan awards need to be accounted for separately.
The fair value of such awards reduces the amount of revenue initially recognised and,
instead, is recognised when awards are redeemed.
Section 24 Government Grants
This section does not apply to any 'grants' in the form of income tax benefits. All grants are
measured at the fair value of the asset received or receivable
Recognition as income:
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Grants without future performance conditions are recognised in profit or loss when proceeds
are receivable. If there are performance conditions, the grant is recognised in profit or loss
only when the conditions are met.
Section 25 Borrowing Costs
Borrowing costs are interest and other costs arising on an entity's financial liabilities and
finance lease obligations.
All borrowing costs are charged to expense when incurred – none are capitalised
Section 26 Share-based Payment
Basic principle: all share-based payment must be recognised
Equity-settled:
Transactions with other than employees are recorded at the fair value of the goods and
services received, if these can be estimated reliably. Transactions with employees or where
the fair value of goods and services received cannot be reliably measured are measured
with reference to the fair value of the equity instruments granted
Cash-settled:
Liability is measured at fair value on grant date and at each reporting date and settlement
date, with each adjustment through profit or loss. For employees where shares only vest
after a specific period of service has been completed, recognise the expense as the service
is rendered.
Share-based payment with cash alternatives:
Account for all such transactions as cash settled, unless the entity has a past practice of
settling by issuing equity instruments or the option has no commercial substance because
the cash settlement amount bears no relationship to, and is likely to be lower in value than,
the fair value of the equity instrument.
Certain government-mandated plans provide for equity investors (such as employees) to
acquire equity without providing goods or services that can be specifically identified (or by
providing goods or services that are clearly less than the fair value of the equity instruments
granted). These are equity-settled share-based payment transactions within the scope of this
section.
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Section 27 Impairment of Assets
Inventories – write down, in profit or loss, to lower of cost and selling price less costs to
complete and sell, if below carrying amount. When the circumstances that led to the
impairment no longer exist, the impairment is reversed through profit or loss.
Other assets – write down, in profit or loss, to recoverable amount, if below carrying amount.
When the circumstances that led to the impairment no longer exist, the impairment is
reversed through profit or loss.
Recoverable amount is the greater of fair value less costs to sell and value in use.
If recoverable amount of an individual asset cannot be determined, measure recoverable
amount of that asset's cash generating unit
If an impairment indicator exists, the entity should review the useful life and the depreciation
methods even though an impairment may not be recognised
Section 28 Employee Benefits
Short-term benefits:
Measured at an undiscounted rate and recognised as the services are rendered. Other costs
such as annual leave are recognised as a liability as services are rendered and expensed
when the leave is taken or used. Bonus payments are only recognised when an obligation
exists and the amount can be reliably estimated.
Post-Employment Benefits – Defined Contribution Plans:
Contributions are recognised as a liability or an expense when the contributions are made or
due.
Post-Employment Benefits – Defined benefit plans
Recognise a liability based on the net of present value of defined benefit obligations less the
fair value of any plan assets at balance sheet date. The projected unit credit method is only
used when it could be applied without undue cost or effort. Otherwise, an entity can simplify
its calculation by ignore estimated future salary increases, future service of current
employees (assume closure of plan) and possible future in-service mortality.
Plan introductions, changes, curtailments, settlements require immediate recognition (no
deferrals).
For group plans, consolidated amount may be allocated to parent and subsidiaries on a
reasonable basis
Actuarial gains and losses may be recognised in profit or loss or as an item of other
comprehensive income. All past service cost is recognised immediately in profit or loss
Other Long-Term benefits:
The entity shall recognise a liability at the present value of the benefit obligation less any fair
value of plan assets.
Termination benefits:
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These are recognised in profit and loss immediately as there are no future economic benefits
to the entity.
Section 29 Income Tax (Revised)
Requires a temporary difference approach, similar to IAS 12
Current tax:
Recognise a current tax liability for tax payable on taxable profit for the current and past
period. Recognise a current tax asset for the benefit of a tax loss that can be carried back to
recover tax paid in a previous period. Measure the current tax liability (asset) at the amount
expected to pay (recover) using the tax rates and laws that have been enacted or
substantively enacted by the reporting date. Current tax assets and liabilities are not
discounted.
Deferred tax:
Recognise a deferred tax asset or liability for tax recoverable or payable in future periods as
a result of past transactions or events.
The tax base of an asset is the amount that will be deductible for tax purposes against
taxable economic benefits. The tax base of a liability is its carrying amount less any amount
that will be deductible for tax purposes in respect of that liability in future.
Temporary difference arises if the tax basis of such assets or liabilities is different from
carrying amount. Recognise a deferred tax liability for most taxable temporary differences
and recognise a deferred tax asset for most deductible temporary differences to the extent
that it is probable that taxable profit will be available against which the deductible temporary
difference can be utilised.
Measure deferred tax liabilities and assets using the tax rates and tax laws that have been
enacted or substantively enacted by the reporting date. Deferred tax assets and liabilities are
not discounted. At the end of each reporting period, reassess any unrecognised deferred tax
assets and recognise previously unrecognised deferred tax assets to the extent that it has
become probable that future taxable profit will allow the deferred tax asset to be recovered.
Deferred taxes are all presented as non-current.
Recognition of changes in current or deferred tax must be allocated to the related
components of profit or loss, other comprehensive income and equity.
Offsetting current tax assets and current tax liabilities or offsetting deferred tax assets and
deferred tax liabilities is only permissible if an entity has a legally enforceable right to set off
the amounts and the entity plans either to settle on a net basis or to realise the asset and
settle the liability simultaneously.
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Section 30 Foreign Currency Translation
Functional currency approach similar to that in IAS 21. An entity's functional currency, is the
currency of the primary economic environment in which it operates and is a matter of fact,
not an accounting policy choice. A change in functional currency is applied prospectively
from the date of the change.
To record a foreign currency transaction in an entity's functional currency:
 On initial recognition, record the transaction by applying the spot rate at the date of
the transaction. An average rate may be used, unless there are significant
fluctuations in the rate.
 At reporting date, translate foreign currency monetary items using the closing rate.
For non-monetary items measured at historical cost, use the exchange at the date
of the transaction. For non-monetary items measured at fair value, use the
exchange at the date when the fair value was determined.
For monetary and non-monetary item translations, gains or losses are recognised where
they were initially recognised – either in profit or loss, comprehensive income, or equity.
Exchange differences arising from a monetary item that forms part of the net investment in a
foreign operation are recognised in equity and are not 'recycled' through profit or loss on
disposal of the investment. Goodwill arising on acquisition of a foreign operation is deemed
to be an asset of the subsidiary, and translated at the closing rate at year end.
An entity may present its financial statements in a currency different from its functional
currency (a 'presentation currency'). If the entity's functional currency is not hyperinflationary,
translation of assets, liabilities, income, and expense from functional currency into
presentation currency is done as follows:
 Assets and liabilities for each statement of financial position presented are translated
at the closing rate at the date of that statement of financial position;
 Income and expenses are translated at exchange rates at the dates of the
transactions;
 All resulting exchange differences are recognised in other comprehensive income.
Section 31 Hyperinflation
An entity must prepare general price-level adjusted financial statements when its functional
currency is hyperinflationary. IFRS for SMEs provides indicators of hyperinflation but not an
absolute rate. One indicator is where cumulative inflation approaches or exceeds 100% over
a 3-year period.
In price-level adjusted financial statements, all amounts are stated in terms of the
(hyperinflationary) presentation currency at the end of the reporting period. Comparative
information and any information presented in respect of earlier periods must also be restated
in the presentation currency.
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All assets and liabilities not recorded at the presentation currency at the end of the reporting
period must be restated by applying the general price index (generally an index published by
the government). All amounts in the statement of comprehensive income and statement of
cash flows must also be recorded at the presentation currency at the end of the reporting
period. These amounts are restated by applying the general price index from the dates when
they were recorded. The gain or loss on translating the net monetary position is included in
profit or loss. However, that gain or loss is adjusted for those assets and liabilities linked by
agreement to changes in prices.
Section 32 Events after the End of the Reporting Period
Adjust financial statements to reflect adjusting events – events after the balance sheet date
that provide further evidence of conditions that existed at the end of the reporting period.
Do not adjust for non-adjusting events – events or conditions that arose after the end of the
reporting period. For these, the entity must disclose the nature of event and an estimate of
its financial effect.
If an entity declares dividends after the reporting period, the entity shall not recognise those
dividends as a liability at the end of the reporting period. That is a non-adjusting event.
Section 33 Related Party Disclosures
Disclose parent-subsidiary relationships, including the name of the parent and (if any) the
ultimate controlling party.
Disclose key management personnel compensation in total for all key management.
Compensation includes salaries, short-term benefits, post-employment benefits, other longterm benefits, termination benefits and share-based payments. “Key management
personnel are persons responsible for planning, directing and controlling the activities of an
entity, and include executive and non-executive directors”.
Disclose the following for transactions between related parties:

Nature of the relationship

Information about the transactions and outstanding balances necessary to understand
the potential impact on the financial statements

Amount of the transaction

Provisions for uncollectible receivables

Any expense recognised during the period in respect of an amount owed by a related
party
Government departments and agencies are not related parties simply by virtue of their
normal dealings with an entity
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Section 34 Specialised Activities
Agriculture:
If the fair value of a class of biological asset is readily determinable without undue cost or
effort, use the fair value through profit or loss model. If the fair value is not readily
determinable, or is determinable only with undue cost or effort, measure the biological
assets at cost less and accumulated depreciation and impairment. At harvest, agricultural
produce is be measured at fair value less estimated costs to sell. Thereafter it is accounted
for as inventory.
Exploration for and evaluation of mineral resources:
Determine an accounting policy that specifies which expenditures are recognised as
exploration and evaluation assets and apply the policy consistently. Exploration and
evaluation assets shall be measured on initial recognition at cost. (Subsequently) Tangible
or intangible assets used in extractive activities are accounted for under Section 17 Property,
Plant and Equipment and Section 18 Intangible Assets other than Goodwill.
Assess exploration and evaluation assets for impairment when facts and circumstances
suggest that the carrying amount of an exploration and evaluation asset may exceed its
recoverable amount. Measure, present and disclose any resulting impairment loss in
accordance with Section 27 Impairment of Assets.
An obligation to dismantle or remove items or restore sites is accounted for using Section 17
and Section 21 Provisions and Contingencies.
Service concession arrangements:
Guidance is provided on how the operator accounts for a service concession arrangement.
The operator either recognises a financial asset or an intangible asset depending on whether
the grantor (government) has provided an unconditional guarantee of payment or not.
A financial asset is recognised to the extent that the operator has an unconditional
contractual right to receive cash or another financial asset from or at the direction of the
grantor for the construction services.
An intangible asset is recognised to the extent that the operator receives a right or license to
charge users for the public service.
Section 35 Transition to the IFRS for SMEs
First-time adoption is the first set of financial statements in which the entity makes an explicit
and unreserved statement of compliance with the IFRS for SMEs: '...​ in conformity with the
International Financial Reporting Standard for Small and Medium-sized Entities'.
An entity can switch from National GAAP, Full IFRSs or never published General Purpose
Financial Statements in the past.
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Date of transition is beginning of earliest period presented. Entity will select accounting
policies based on IFRS for SMEs at end of reporting period of first-time adoption. Many
accounting policy decisions depend on circumstances – not 'free choice' but some are pure
'free choice'.
Current year and one prior year's financial statements using the IFRS for SMEs are required
but there are many exceptions from restating specific items, these exceptions include some
optional and other are mandatory. All of the special exemptions in IFRS 1 are included in the
IFRS for SMEs and a general exemption for impracticability.
Mutual Funds
The mutual funds industry is regulated by The Securities and Exchange Commission of
Pakistan (SECP).
A mutual fund is a collective investment scheme, which specialises in investing a pool of
money collected from investors for the purpose of investing in shares, bonds and other
securities. This gives small investors access to professionally managed, diversified portfolios
of equities, debt instruments etc. that they would otherwise not be able to achieve.
Mutual funds are operated by asset management companies (AMCs). An AMC is a public
limited company registered under Companies Act, 2017.
Investors purchase units (shares) and receive a share of income based on the number of
units (shares) which they own. The value of the units (shares) changes on an ongoing basis
so the holders are exposed to capital gain or loss.
The value of a unit (share) is based on the net asset value at the date of the valuation and
the number of units available.
Types of mutual funds
There are basically two types of mutual funds:
Open-ended mutual funds:

Open-ended mutual funds (also called unit trusts) are funds which continually issue or
redeem new units on demand.

Units may be purchased or redeemed at the prevailing net asset value.

Trading is through a management company which announces offer and redemption
prices daily.
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Closed-ended mutual funds

Closed-ended mutual funds have a fixed number of units which are quoted on an
exchange.

Units are traded on the exchange based on price determined by market forces which
is closely related with the Net Asset Value per unit.
Accounting for interests in funds by the AMCs
A mutual fund is an entity controlled by the AMC that manages it. In the absence of rules to
the contrary, an AMC which managed a fund would classify it as a subsidiary and therefore
have consolidate it.
IFRS 10 contains an exemption from the general requirement to consolidated controlled
entities in this circumstance.
An investment entity must not consolidate the entities that it controls but it must measure
them at fair value through profit or loss in accordance with IFRS 9: Financial Instruments.
Nature of the units
Units in open ended mutual funds are redeemable on demand. This means that in the
absence of further guidance they would be classified as liabilities in accordance with the
definition of liabilities found in IAS 32: Financial instruments: Presentation. In that case, the
statement of financial position of such a fund would have no equity.
IAS 32 contains rules under which instruments of this kind are classified as equity. It
describes such instruments as puttable instruments and rules that they should be classified
as equity as long as they meet certain criteria. These criteria are designed to include units of
mutual funds but prevent other liabilities from being classified as equity when it would not be
appropriate to do so.
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Financial statements of mutual funds
Mutual funds: Statement of Comprehensive Income
Statement of comprehensive income for the year ended --------------------.
Income
Rs. “000”
Mark-up/ interest income
XXX
Dividend income
XXX
Gain/(loss) on sale of investments
XXX
Other income
XXX
XXX
Expenses
Remuneration to management
XXX
Brokerage commissions and fees
XXX
Administrative and general expenses
XXX
Other expenses
XXX
(XXX)
Net income for the period
XXX
Element of income paid on redemption of units
(XXX)
Net income available for distribution
XXX
Net income available for distribution:
Pertaining to capital gain
XXX
Pertaining to other than capital gain
XXX
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Statement of financial position as at XX/XX/XXXX
Rs. “000”
ASSETS
Cash and bank balances
XXX
Investments
XXX
Others
XXX
Total Assets
XXX
LIABILITIES
Payable to investment advisor
XXX
Others
XXX
XXX
Net Assets
XXX
Outstanding Units
XXX
Net Assets Value Per Unit
XXX
Other statements and disclosures
Mutual funds must provide information on distributions made in the period and explain the
movement on unit holders’ funds in the period.
Movement in unit holders’ funds
Statement of Movement in unit holders’ funds for the year ended XX/XX/XXXX
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Capital value
Undistributed
Income
Total
XXX
XXX
XXX
Capital value
XXX
-
XXX
Element of income
XXX
-
XXX
Total proceeds on issuance of units
XXX
-
XXX
Capital value
(XXX)
-
(XXX)
Element of loss
(XXX)
-
(XXX)
Total payment of redemption of
units
(XXX)
-
(XXX)
Total comprehensive income for
the year
-
XXX
XXX
Distribution during the year
-
(XXX)
(XXX)
Net assets at end of the year
XXX
XXX
XXX
Capital value
Undistributed
Income
Total
Realized Income
XXX
XXX
Unrealized Income
XXX
XXX
XXX
XXX
Related to capital gains
XXX
XXX
Excluding capital gains
XXX
XXX
XXX
XXX
(XXX)
(XXX)
XXX
XXX
XXX
XXX
Rs. “000”
Net assets at beginning of the year
Issue of xxxx units:
Redemption of xxxx units:
Rs. “000”
Undistributed Income brought
forward
Accounting income available for
distribution
Distribution during the year
Undistributed income c/f
-
Undistributed income c/f:
Realized Income
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Unrealized Income
XXX
XXX
XXX
XXX
Banks
Banking Companies Ordinance 1962 requires that every bank incorporated in Pakistan must
prepare financial statements in accordance with the second schedule of the act.
The second schedule requirements are now published as in BPRD (Banking Policy and
Regulation Department) circular No. 2 of 2023 issued by the State Bank of Pakistan.
This also applies to banks incorporated overseas in respect of all business transacted
through branches in Pakistan.
Banks must also pay regard to the requirements of the Companies Act, 2017 in so far as
they are not inconsistent with the Banking Companies Ordinance 1962. Therefore, banks
must prepare financial statements in accordance with IFRS just like any other type of
company.
All banks operating in Pakistan must prepare their accounts in accordance with the following:

directives issued by the State Bank of Pakistan;

the Banking Companies Ordinance 1962;

IFRS as notified in the official Gazette by the Securities and Exchange Commission of
Pakistan for listed companies under section 234(3)(i) of the Companies Act, 2017.
BPRD circular No. 2 of 2023 contains formats that must be used when preparing financial
statements. The formats for the statement of financial performance (profit and loss account)
and statement of financial position (balance sheet) are shown in the following sections.
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STATEMENT OF FINANCIAL POSITION AS AT ____________
Note
(Current
Year)
(Prior
Year)
Rupees in '000
ASSETS
Cash and balances with treasury banks
5
xxxxxxxx
xxxxxxxx
Balances with other banks
6
xxxxxxxx
xxxxxxxx
Lending to financial institutions
7
xxxxxxxx
xxxxxxxx
Investments
8
xxxxxxxx
xxxxxxxx
Advances
9
xxxxxxxx
xxxxxxxx
Property and equipment
10
xxxxxxxx
xxxxxxxx
Right-of-use assets
11
xxxxxxxx
xxxxxxxx
Intangible assets
12
xxxxxxxx
xxxxxxxx
Deferred tax assets
13
xxxxxxxx
xxxxxxxx
Other assets
14
xxxxxxxx
xxxxxxxx
xxxxxxxx
xxxxxxxx
Total Assets
LIABILITIES
Bills payable
16
xxxxxxxx
xxxxxxxx
Borrowings
17
xxxxxxxx
xxxxxxxx
Deposits and other accounts
18
xxxxxxxx
xxxxxxxx
Lease liabilities
19
xxxxxxxx
xxxxxxxx
Subordinated debt
20
xxxxxxxx
xxxxxxxx
Deferred tax liabilities
21
xxxxxxxx
xxxxxxxx
Other liabilities
22
xxxxxxxx
xxxxxxxx
xxxxxxxx
xxxxxxxx
Total Liabilities
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NET ASSETS
xxxxxxxx
xxxxxxxx
xxxxxxxx
xxxxxxxx
xxxxxxxx
xxxxxxxx
xxxxxxxx
xxxxxxxx
xxxxxxxx
xxxxxxxx
xxxxxxxx
xxxxxxxx
REPRESENTED BY
Share capital / Head office capital account - net
23
Reserves
Surplus / (Deficit) on revaluation of assets
24
Unappropriated / Unremitted profit / (loss)
CONTINGENCIES AND COMMITMENTS
25
STATEMENT OF PROFIT AND LOSS ACCOUNT FOR THE YEAR
ENDED _________
Note
(Prior
(Current Year) Year)
Rupees in ‘000
Mark-up / Return / Interest earned
27
xxxxxxxx
xxxxxxxx
Mark-up / Return / Interest expensed
28
xxxxxxxx
xxxxxxxx
xxxxxxxx
xxxxxxxx
xxxxxxxx
xxxxxxxx
Dividend income
xxxxxxxx
xxxxxxxx
Foreign exchange income or (loss)
xxxxxxxx
xxxxxxxx
Income / (Loss) from derivatives
xxxxxxxx
xxxxxxxx
30
xxxxxxxx
xxxxxxxx
31
xxxxxxxx
xxxxxxxx
Net mark-up / interest income
NON MARK-UP / INTEREST INCOME
Fee and commission income
Gain / (Loss) on securities
Net gains / (losses) on derecognition of financial assets measured at
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amortised cost
Other income / (loss)
32
xxxxxxxx
xxxxxxxx
Total non-markup / interest income / (loss)
xxxxxxxx
xxxxxxxx
Total income / (loss)
xxxxxxxx
xxxxxxxx
xxxxxxxx
xxxxxxxx
xxxxxxxx
xxxxxxxx
xxxxxxxx
xxxxxxxx
Total non-markup / interest expenses
xxxxxxxx
xxxxxxxx
Profit / (Loss) before credit loss allowance
xxxxxxxx
xxxxxxxx
xxxxxxxx
xxxxxxxx
Other income / expense items (to be specified)
xxxxxxxx
xxxxxxxx
PROFIT/(LOSS) BEFORE TAXATION
xxxxxxxx
xxxxxxxx
xxxxxxxx
xxxxxxxx
xxxxxxxx
xxxxxxxx
NON MARK-UP/INTEREST EXPENSES
Operating expenses
33
Workers welfare fund
Other charges
Credit loss allowance and write offs - net
Taxation
34
35
36
PROFIT/(LOSS) AFTER TAXATION
Basic earning / (loss) per share
37
xxxxxxxx
xxxxxxxx
Diluted earning / (loss) per share
38
xxxxxxxx
xxxxxxxx
Current Year
Prior Year
STATEMENT OF COMPREHENSIVE INCOME
FOR THE YEAR ENDED _________
-------------(Rupees in
‘000)-------------
Profit after taxation for the year
xxxxxx
Other comprehensive income
Items that may be reclassified to profit and loss account in
subsequent periods:
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 657
xxxxx
Effect of translation of net investment in foreign branches
xxxxxx
xxxxx
Movement in surplus / (deficit) on revaluation of debt investments through
FVOCI - net of tax
xxxxxx
xxxxxx
Others (to be specified)
xxxxxx
xxxxx
xxxxxx
xxxxxx
Remeasurement gain / (loss) on defined benefit obligations - net of
tax
xxxxxx
xxxxx
Movement in surplus / (deficit) on revaluation of investments in equity
investments - net of tax
xxxxxx
xxxxxx
Movement in surplus on revaluation of property and equipment - net
of tax
xxxxxx
xxxxxx
Movement in surplus on revaluation of non-banking assets - net of
tax
xxxxxx
xxxxxx
Others (to be specified)
xxxxxx
xxxxx
xxxxxx
xxxxxx
xxxxx
xxxxx
Items that will not be reclassified to profit and loss account in
subsequent periods:
Total comprehensive income
Other statements and disclosures
Banks are subject to disclosure requirements that require them to provide information on
accounting issues specific to banks.

Cash and Balance with Treasury banks

Lending to financial institutions

Investments

Advances

Borrowings

Deposits and other accounts
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 658
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 659
(Prior
(Current
Year)
Year)
Rupees in '000
CASH AND BALANCES WITH TREASURY BANKS
In hand
Local currency
xxxx
xxxx
Foreign currency
xxxx
xxxx
xxxx
xxxx
Local currency current account
xxxx
xxxx
Foreign currency current account
xxxx
xxxx
Local currency deposit account (to be specified)
xxxx
xxxx
Foreign currency deposit account (to be specified)
xxxx
xxxx
xxxx
xxxx
Foreign currency current account
xxxx
xxxx
Foreign currency deposit account
xxxx
xxxx
xxxx
xxxx
Local currency current account
xxxx
xxxx
Local currency deposit account (to be specified)
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
With State Bank of Pakistan in
With other central banks in
With National Bank of Pakistan in
Prize
bonds
Less: Credit loss allowance held against cash and balances with
treasury banks
Cash and balances with treasury banks - net of credit loss
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 660
allowance
(Prior
(Current
Year)
Year)
Rupees in '000
LENDINGS TO FINANCIAL INSTITUTIONS
Call / clean money lendings
xxxx
xxxx
Reverse repo agreements
xxxx
xxxx
- with State Bank of Pakistan
xxxx
xxxx
- with other financial institutions
xxxx
xxxx
Others (to be specified)
xxxx
xxxx
xxxx
xxxx
Less: Credit loss allowance held against lending to financial
institutions
xxxx
xxxx
Lending to financial institutions - net of credit loss allowance
xxxx
xxxx
Bai Muajjal receivable
Disclose information about the extent and nature, including significant terms and conditions
that may affect the amount, timing and certainty of future cash flows.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 661
(Prior
(Current
Year)
Year)
Particulars of lending
Rupees in '000
In local currency
xxxx
xxxx
In foreign currencies
xxxx
xxxx
xxxx
xxxx
Securities held as collateral
against Lending to financial
institutions
Current Year
Prior Year
Held
by
bank
Held by
bank
Further
given as
collateral
Total
Further
given as Total
collateral
Rupees in '000
Market Treasury Bills
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Pakistan Investment Bonds
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Bai Muajjal
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Others (to be specified)
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Total
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Lending to Fis - Particulars of credit
loss allowance
Current Year
Lending
Domestic
Credit loss
allowance
held
Prior Year
Lending
Credit
loss
allowance
held
Rupees in '000
Performing
Stage 1
xxxx
xxxx
xxxx
xxxx
Under performing
Stage 2
xxxx
xxxx
xxxx
xxxx
Non-performing
Stage 3
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 662
Substandard
xxxx
xxxx
xxxx
xxxx
Doubtful
xxxx
xxxx
xxxx
xxxx
Loss
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Total
Overseas
Performing
Stage
1
xxxx
xxxx
xxxx
xxxx
Under performing
Stage
2
xxxx
xxxx
xxxx
xxxx
Non-performing
Stage
3
Substandard
xxxx
xxxx
xxxx
xxxx
Doubtful
xxxx
xxxx
xxxx
xxxx
Loss
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Total
Current Year
Stage 1
Stage 2
Stage 3
Total
'Rupees
in ‘000’
Balance at the start of the
year
xxxx
xxxx
xxxx
xxxx
Transfer to stage 1
xxxx
xxxx
xxxx
xxxx
Transfer to stage 2
xxxx
xxxx
xxxx
xxxx
Transfer to stage 3
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Net remeasurement of credit loss
allowance
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 663
New financial assets originated or
purchased
xxxx
xxxx
xxxx
xxxx
Financial assets that have been
derecognised
xxxx
xxxx
xxxx
xxxx
Write offs
xxxx
xxxx
xxxx
xxxx
Unwind of discount
xxxx
xxxx
xxxx
xxxx
Changes in risk parameters
(PDs/LGDs/EADs)
xxxx
xxxx
xxxx
xxxx
Balance at the end of the
year
xxxx
xxxx
xxxx
xxxx
Stage 3
Total
Prior Year
Stage 1
Stage 2
Rupees
in ‘000’
Balance at the start of the
year
xxxx
xxxx
xxxx
xxxx
Transfer to stage 1
xxxx
xxxx
xxxx
xxxx
Transfer to stage 2
xxxx
xxxx
xxxx
xxxx
Transfer to stage 3
xxxx
xxxx
xxxx
xxxx
Net remeasurement of loss allowance
xxxx
xxxx
xxxx
xxxx
New financial assets originated or
purchased
xxxx
xxxx
xxxx
xxxx
Financial assets that have been
derecognised
xxxx
xxxx
xxxx
xxxx
Write offs
xxxx
xxxx
xxxx
xxxx
Unwind of discount
xxxx
xxxx
xxxx
xxxx
Foreign exchange and other
movements
xxxx
xxxx
xxxx
xxxx
Balance at 31 December
xxxx
xxxx
xxxx
xxxx
Investments
Disclosures must show investments by type (meaning how they are classified in the financial
statements) and by segment (meaning the market segment that has been invested in.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 664
INVESTMENTS
(Current
Year)
(Prior
Year)
Investments by Type
Fair value /
Amortised
cost
Credit
loss
allowance
Surplus
/ (Deficit)
Carrying
value
Fair value
/
Amortised
cost
Credit
loss
allowance
Surplus
/
(Deficit)
Carrying
value
Rupees in '000
Debt Instruments
Classified / Measured at amortised
cost
Federal Government
securities
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Provincial Government
securities
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Non Government debt
securities
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Foreign securities
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Others (to be specified)
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Provincial Government
The balances on both should agree
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Classified / Measured
at FVOCI
Federal Government
securities
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 665
securities
Non Government debt
securities
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Foreign securities
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Others (to be specified)
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Federal Government
securities
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Provincial Government
securities
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Non Government debt
securities
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Foreign securities
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Others (to be specified)
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Listed compaies
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Unlisted companies
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Classified / Measured
at FVPL
Instruments mandatorily classified /
measured at FVPL
To be specified
Equity instruments
Classified / Measured
at FVPL
Shares
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 666
xxxx
xxxx
xxxx
xxxx
xxxx
Advanced Financial Accounting and Corporate Reporting (Study Text)
xxxx
xxxx
Page 667
xxxx
Classified / Measured at FVOCI (NonReclassifiable)
Shares
Listed compaies
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Unlisted companies
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Subsdiaries
Disclose individually
by name
Associates
Disclose individually
by name
Total investments
(Curre
nt
Year)
Cost/
Amorti
sed
cost
Investments by segments:
(Prior
Year)
Credit
loss
allowa
nce for
diminut
ion
Surpl
us /
(Defi
cit)
Carryi
ng
value
Cost
/Amorti
sed
cost
Credit
loss
allowa
nce
for
diminu
tion
Surplus
/ (Deficit)
Carryi
ng
value
'Rupees in '000
Federal Government
securities:
Market Treasury Bills
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Pakistan Investment Bonds
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Ijarah Sukuks
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Others (all investments to
be specified)
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 668
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Listed companies
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Unlisted companies
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Listed
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Unlisted
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Government securities
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Non Government debt
securities
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Provincial Government
securities
Shares:
Non Government debt
securities
Foreign securities
Equity securities
Associates
(disclose individually by
name)
Subsidiaries
(disclose individually by
name)
Total Investments
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 669
Investments given as
collateral
Current
Year
Prior
Year
Rupees in '000
To be specified
Advanced Financial Accounting and Corporate Reporting (Study Text)
xxxx
Page 670
xxxx
Particlurs of credit loss
allowance
Current Year
Prior Year
Stage 1 Stage 2 Stage 3
Stage 1
Rupees in ‘000’
Rupees in ‘000’
Opening balance
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
New investments
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Investments derecognised or
repaid
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Transfer to stage 1
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Transfer to stage 2
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Transfer to stage 3
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Amounts written off / charged
Off
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Other changes (to be specific)
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Closing balance
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Stage 2
Stage 3
Investments - exposure
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 671
Investments - Credit loss
allowance
Current Year
Prior Year
Stage 1
Stage 1
Stage 2 Stage 3
Stage 2
Stage 3
Rupees
in ‘000’
Rupees
in ‘000’
Gross carrying amount Current year
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
New investments
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Investments derecognised or
repaid
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Transfer to stage 1
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Transfer to stage 2
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Transfer to stage 3
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Amounts written off / charged
off
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Changes in risk parameters
(PDs/LGDs/EADs)
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Changes (to be specific)
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Closing balance - Current
year
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 672
Particulars of credit loss allowance against debt
securities
Domestic
Rupees in ‘000’
Current Year
Prior Year
Outsta
nding
amoun
t
Credit
loss
allow
ance
held
Outstan
ding
amount
Credit
loss
allowa
nce
held
xxxx
xxxx
xxxx
xxxx
Substandard
xxxx
xxxx
xxxx
xxxx
Doubtful
xxxx
xxxx
xxxx
xxxx
Loss
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Performing
Stage 1
Underperforming
Stage 2
Non-Performing
Stage 3
Total
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 673
Overseas
Current Year
Outsta
nding
amoun
t
Credit
loss
allow
ance
held
Prior Year
Outstan
ding
amount
Credit
loss
allowa
nce
held
Rupees in '000
Performing
Stage 1
xxxx
xxxx
xxxx
xxxx
Underperforming
Stage 2
Non-Performing
Stage 3
Substandard
xxxx
xxxx
xxxx
xxxx
Doubtful
xxxx
xxxx
xxxx
xxxx
Loss
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Total
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 674
Advances
Performing
Non
Performing
Current
Year
Curre
nt
Year
Prior
Year
Total
Prio
r
Yea
r
Current
Year
Prior
Year
Rupees
in '000
Loans, cash credits, running
finances, etc.
xxxx
xxxx
xxxx
xxx
x
xxxx
xxxx
Islamic financing and
related assets
xxxx
xxxx
xxxx
xxx
x
xxxx
xxxx
Bills discounted and
purchased
xxxx
xxxx
xxxx
xxx
x
xxxx
xxxx
Advances - gross
xxxx
xxxx
xxxx
xxx
x
xxxx
xxxx
xxxx
xxxx
xxxx
xxx
x
xxxx
xxxx
xxxx
xxxx
xxxx
xxx
x
xxxx
xxxx
xxxx
xxx
x
xxxx
xxxx
xxxx
xxx
x
xxxx
xxxx
xxxx
xxx
x
xxxx
xxxx
Credit loss allowance against
advances
-Stage 1
-Stage 2
-Stage 3
xxxx
xxxx
Advances - net of credit loss
allowance
xxxx
xxxx
xxxx
xxxx
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 675
Includes net investment in right-of-use assets / finance lease as
disclosed below:
(Current
Year)
Not later
than one
year
(Prior
Year)
Later
than
one
and
less
than
five
years
Over
five
years
Total
Not
later
than
one
year
Late
r
than
one
Over
and
five
less
years
than
five
year
s
Total
Rupees in '000
Lease rentals receivable
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
Residual value
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
Minimum lease payments
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
Financial charges for
future periods
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
Present value of minimum
lease payments
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 676
(Curren
t Year)
(Prior
Year)
Particulars of advances
(Gross)
Rupees in ‘000’
In local currency
xxx
xxx
In foreign currency
xxx
xxx
xxx
xxx
Particulars of credit loss
allowance
Advances - Exposure
Current
Year
Prior
Year
Stage 1 Stage 2 Stage 3
Stage 1 Stage 2 Stage 3
Rupees
in ‘000’
Rupees
in ‘000’
Gross carrying amount Current year
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
New advances
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Advances derecognised or
repaid
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Transfer to stage 1
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Transfer to stage 2
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Transfer to stage 3
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Amounts written off /
charged off
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Changes (to be specific)
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Closing balance - Current
year
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 677
Disclose the purchase originated and credit impairment assets, if any as per the
disclosure requirements of IFRS.
Current
Year
Advances - Credit loss
allowance
Stage 1 Stage 2
Prior
Year
Stage 3
Stage 1 Stage 2 Stage 3
Rupees
in ‘000’
Rupees
in ‘000’
Opening balance
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
New Advances
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Advances derecognised or
repaid
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Transfer to stage 1
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Transfer to stage 2
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Transfer to stage 3
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Amounts written off /
charged off
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Changes in risk parameters
(PDs/LGDs/EADs)
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Other changes (to be
specific)
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Closing balance
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 678
Advances - Credit loss
allowance details
Stage 1 Stage 2 Stage 3
Stage 1 Stage 2 Stage 3
Rupees
in '000
Rupees
in '000
Internal / Extrernal rating /
stage clasification
Outstanding gross
exposure
Performing - Stage 1
(to be specified)
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Substandard
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Doubtful
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Loss
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
(to be specified as shown
above)
xxxx
xxxx
-
xxxx
xxxx
-
Stage 3
-
-
xxxx
-
-
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Under Performing Stage 2
(to be specified)
Non-perfroming - Stage 3
Total
Corresponding ECL
Stage 1 and stage 2
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 679
BORROWINGS
(Current
Year)
(Prior
Year)
Rupees in ‘000’
Secured
Borrowings from State Bank of Pakistan
Under export refinance scheme
xxx
xxx
Under Locally Manufactured Machinery (LMM)
scheme
xxx
xxx
Others (to be specified)
xxx
xxx
xxx
xxx
xxx
xxx
and associated undertakings
xxx
xxx
Borrowings from directors (including chief executive) of
the bank
xxx
xxx
Others (to be specified)
xxx
xxx
Total secured
xxx
xxx
Call borrowings
xxx
xxx
Overdrawn nostro accounts
xxx
xxx
Others (to be specified)
xxx
xxx
Repurchase agreement borrowings
Borrowings from subsidiary companies, managed
modarabas
Unsecured
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 680
Total unsecured
xxx
xxx
xxx
xxx
Disclose information about the extent and nature, including significant terms and conditions that
may affect the amount, timing and certainty of future cash flows. Further, disclose the nature and
carrying amount of the assets pledged as security.
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 681
(Current
Year)
(Prior
Year)
Particulars of borrowings with respect to
currencies
Rupees in ‘000’
In local currency
xxx
xxx
In foreign currencies
xxx
xxx
xxx
xxx
DEPOSITS AND OTHER ACCOUNTS
Current Year
Prior Year
In Local In Foreign
Total
currency currencies
In Local In Foreign
Total
currency currencies
Rupees in '000
Customers
Current deposits
xxx
xxx
xxx
xxx
xxx
xxx
Savings deposits
xxx
xxx
xxx
xxx
xxx
xxx
Term deposits
xxx
xxx
xxx
xxx
xxx
xxx
Others
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
Current deposits
xxx
xxx
xxx
xxx
xxx
xxx
Savings deposits
xxx
xxx
xxx
xxx
xxx
xxx
Term deposits
xxx
xxx
xxx
xxx
xxx
xxx
Others
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
xxx
Financial institutions
Current accounts - deposits repayable on demand,
non-remunerative
Advanced Financial Accounting and Corporate Reporting (Study Text)
Page 682
Saving accounts - deposits repayable on demand,
remunerative
Others: Disclose those accounts in this category that are neither current or saving accounts and those
do not fall under the aforesaid definition of current and saving accounts e.g. margin, call deposits etc.
Vostro accounts should be classified
here.
(Current
Year)
(Prior
Year)
Rupees in ‘000’
Composition of deposits
- Individuals
xxx
xxx
- Government (Federal
and Provincial)
xxx
xxx
- Public sector entities
xxx
xxx
- Banking companies
xxx
xxx
- Non-banking financial
institutions
xxx
xxx
- Private sector
xxx
xxx
xxx
xxx
This includes deposits eligible to be covered under insurance arrangements
amounting to Rs xxxx.
Insurance Companies
Introduction to accounting by insurance companies
Insurance companies, in Pakistan, are subject to the Insurance Ordinance, 2000 and
Insurance Rules, 2017 which requires all insurance companies to prepare the Financial
Statements as follows:
in the case of a life insurer:

Statement of Financial Position

Statement of Comprehensive Income

Statement of Cash Flows

Statement of Changes in equity
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in the case of a non-life insurer:

Statement of Financial Position

Statement of Comprehensive Income

Statement of Cash Flows

Statement of Changes in equity
Insurance companies must also pay regard to the requirements of the Companies Act, 2017
in so far as they are not inconsistent with the Insurance Ordinance, 2000. Therefore,
insurance companies must prepare financial statements in accordance with IFRS just like
any other type of company.
All insurance companies operating in Pakistan must prepare their accounts in accordance
with the following:

the Companies Act, 2017;

the Insurance Ordinance, 2000;

Insurance Rules, 2017; and

IFRS as notified in the official Gazette by the Securities and Exchange Commission of
Pakistan for listed companies.
Financial Statements of Life Insurance Companies
STATEMENT OF FINANCIAL POSITION AS AT ………….
Note
Current
Year
Prior
Year
Rupees in ‘000’
Assets
Property and equipment
XXX
XXX
Intangible assets
XXX
XXX
Investment property
XXX
XXX
Investments in subsidiaries and associates (only equity
method)
XXX
XXX
Investments
XXX
XXX
Equity securities
XXX
XXX
Government securities
XXX
XXX
Debt securities
XXX
XXX
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Term deposits
XXX
XXX
Mutual funds
XXX
XXX
Others (please specify)
XXX
XXX
Loans secured against life insurance policies
XXX
XXX
Insurance / reinsurance receivables
XXX
XXX
Other loans and receivables
XXX
XXX
Deferred tax asset
XXX
XXX
Taxation - payments less provision
XXX
XXX
Prepayments
XXX
XXX
Cash & Bank
XXX
XXX
Total Assets
XXX
XXX
Capital and reserves attributable to Company's equity holders
XXX
XXX
Ordinary share capital
XXX
XXX
Share premium
XXX
XXX
Ledger account
XXX
XXX
Reserves
XXX
XXX
Unappropriated profit/(Accumulated loss)
XXX
XXX
Total Equity
XXX
XXX
Surplus on Revaluation of Fixed Assets
XXX
XXX
Insurance Liabilities
XXX
XXX
Liabilities under Investment Contracts
XXX
XXX
Retirement benefit obligations
XXX
XXX
Deferred taxation
XXX
XXX
Borrowings
XXX
XXX
Premium received in advance
XXX
XXX
Insurance / reinsurance payables
XXX
XXX
Other creditors and accruals
XXX
XXX
Taxation - provision less payments
XXX
XXX
Total Liabilities
XXX
XXX
Total Equity and Liabilities
XXX
XXX
Equity and Liabilities
Liabilities
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Contingencies and commitments
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR
ENDED.......
Current
Note Year
Prior Year
Rupees in ‘000’
Premium Revenue
XXX
XXX
Premium ceded to reinsurers
XXX
XXX
Net premium revenue
XXX
XXX
Fee income
XXX
XXX
Investment income
XXX
XXX
Net realised fair value gains on financial assets
XXX
XXX
Net fair value gains on financial assets at fair value through profit or
loss
XXX
XXX
Net rental Income
XXX
XXX
Net realised gains / losses on investment property
XXX
XXX
Net unrealised gains / losses on investment property
XXX
XXX
Other income / loss
XXX
XXX
XXX
XXX
Net income
XXX
XXX
Insurance benefits
XXX
XXX
Recoveries from reinsurers
XXX
XXX
Claims related expenses
XXX
XXX
Net Insurance Benefits
XXX
XXX
Net Change in Insurance Liabilities (other than outstanding claims)
XXX
XXX
Acquisition expenses
XXX
XXX
Marketing and administration expenses
XXX
XXX
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Other expenses
XXX
XXX
Total Expenses
XXX
XXX
Finance costs
XXX
XXX
Results of operating activities
XXX
XXX
Share of (loss)/profit of associates
XXX
XXX
Profit before tax
XXX
XXX
Income tax expense
XXX
XXX
Profit for the year
XXX
XXX
Change in unrealised gains/(losses) on financial assets
XXX
XXX
Currency translation differences
XXX
XXX
Actuarial gains/(losses) on retirement benefit schemes
XXX
XXX
Other comprehensive income for the year, net of tax
XXX
XXX
Total comprehensive income for the year
XXX
XXX
Earnings (after tax) per share – Rupees
XXX
XXX
Other comprehensive income:
NET INSURANCE PREMIUM REVENUE
Current Year Prior Year
Rupees in ‘000’
Gross Premiums
Regular Premium Individual Policies
XXX
XXX
First year
XXX
XXX
Second year renewal
XXX
XXX
Subsequent year renewal
XXX
XXX
Single Premium Individual Policies
XXX
XXX
Group Policies with Cash Values
XXX
XXX
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Group Policies without Cash Values
XXX
XXX
Less: Experience refund (if any)
XXX
XXX
Annuities
XXX
XXX
Total Gross Premiums
XXX
XXX
Less: Reinsurance Premiums Ceded
XXX
XXX
On individual life First year business
XXX
XXX
On individual life Second year business
XXX
XXX
On individual life Renewal business
XXX
XXX
On group policies
XXX
XXX
Less: Experience refund (if any)
XXX
XXX
Less: Reinsurance commission on risk premiums
XXX
XXX
On annuities
XXX
XXX
On others (please specify)
XXX
XXX
Net Premiums
XXX
XXX
NET INSURANCE BENEFITS
Current Year Prior Year
Rupees in ‘000’
Gross Claims
Claims under individual policies:
by death
XXX
XXX
by insured event other than death
XXX
XXX
by maturity
XXX
XXX
by surrender
XXX
XXX
annuity payments
XXX
XXX
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bonus in cash
XXX
XXX
Total gross individual policy claims
XXX
XXX
by death
XXX
XXX
by insured event other than death
XXX
XXX
by maturity
XXX
XXX
by surrender
XXX
XXX
annuity payments
XXX
XXX
bonus in cash
XXX
XXX
Total gross group policy claims
XXX
XXX
Total Gross Claims
XXX
XXX
On Individual life claims
XXX
XXX
On Group Life claims
XXX
XXX
On annuities
XXX
XXX
On others
XXX
XXX
XXX
XXX
XXX
XXX
Claims under group policies:
Less: Reinsurance Recoveries
Net Insurance benefit expense
Financial Statements of Non-Life Insurance Companies
STATEMENT OF FINANCIAL POSITION AS
AT ………….
Note
Current
Year
Prior Year
Rupees in ‘000’
Assets
Property and equipment
XXX
XXX
Intangible assets
XXX
XXX
Investment property
XXX
XXX
Investments in subsidiary and associate
XXX
XXX
Investments:
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Equity securities
XXX
XXX
Debt securities
XXX
XXX
Term deposits
XXX
XXX
Loans and other receivables
XXX
XXX
Insurance / Reinsurance receivables
XXX
XXX
Reinsurance recoveries against outstanding claims
XXX
XXX
Salvage recoveries accrued
XXX
XXX
Deferred Commission Expense / Acquisition cost
XXX
XXX
Deferred taxation
XXX
XXX
Taxation - payment less provisions
XXX
XXX
Prepayments
XXX
XXX
Cash & Bank
XXX
XXX
Total Assets
XXX
XXX
Capital and reserves attributable to Company's equity holders
XXX
XXX
Ordinary share capital
XXX
XXX
Share premium
XXX
XXX
Reserves
XXX
XXX
Unappropriated profit/(Accumulated loss)
XXX
XXX
Total Equity
XXX
XXX
Surplus on revaluation of fixed assets
XXX
XXX
Underwriting Provisions
XXX
XXX
Outstanding claims including IBNR
XXX
XXX
Unearned premium reserves
XXX
XXX
Premium deficiency reserves
XXX
XXX
Unearned Reinsurance Commission
XXX
XXX
Retirement benefit obligations
XXX
XXX
Deferred taxation
XXX
XXX
Borrowings
XXX
XXX
Premium received in advance
XXX
XXX
Insurance / Reinsurance Payables
XXX
XXX
Equity and Liabilities
Liabilities
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Other Creditors and Accruals
XXX
XXX
Taxation - provision less payment
XXX
XXX
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Total Liabilities
XXX
XXX
Total Equity and Liabilities
XXX
XXX
Contingencies and commitments
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED ………….
Note Current Year
Prior Year
Rupees in 000
Net insurance premium
XXX
XXX
Net Insurance claims
XXX
XXX
Premium deficiency
XXX
XXX
Net Commission and other acquisition costs
XXX
XXX
Insurance claims and acquisition expenses
XXX
XXX
Management Expenses
XXX
XXX
Underwriting results
XXX
XXX
Investment income
XXX
XXX
Rental income
XXX
XXX
Other income
XXX
XXX
Other expenses
XXX
XXX
Results of operating activities
XXX
XXX
Finance costs
XXX
XXX
Share of (loss)/profit of associates
XXX
XXX
Profit before tax
XXX
XXX
Income tax expense
XXX
XXX
Profit after tax
XXX
XXX
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Other comprehensive income:
Unrealised gains / (losses) on Financial Assets
XXX
XXX
Others (please specify)
XXX
XXX
Other comprehensive income for the year
XXX
XXX
Total comprehensive income for the year
XXX
XXX
Earnings (after tax) per share - Rupees
XXX
XXX
Current
Year
Prior Year
NET INSURANCE PREMIUM
Rupees in 000
Written Gross Premium
XXX
XXX
Add: Unearned premium reserve opening
XXX
XXX
Less: Unearned premium reserve closing
XXX
XXX
Premium earned
XXX
XXX
Less :Reinsurance premium ceded
XXX
XXX
Add: Prepaid reinsurance premium opening
XXX
XXX
Less: Prepaid reinsurance premium closing
XXX
XXX
Reinsurance expense
XXX
XXX
XXX
XXX
Current
Year
Prior Year
NET INSURANCE CLAIMS EXPENSE
Rupees in ‘000’
Claim Paid
XXX
XXX
Add : Outstanding claims including IBNR closing
XXX
XXX
Less: Outstanding claims including IBNR Opening
XXX
XXX
Claims expense
XXX
XXX
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Less: Reinsurance and other recoveries received
XXX
XXX
Add: Reinsurance and other recoveries in respect of
outstanding claims net of impairment (if any) Opening
XXX
XXX
Less: Reinsurance and other recoveries in respect of
outstanding claims net of impairment (if any) Closing
XXX
XXX
Reinsurance and other recoveries revenue
XXX
XXX
XXX
XXX
Current
Year
Prior Year
NET COMMISSION EXPENSE / ACQUISITION COST
Rupees in ‘000’
Commission paid or payable
XXX
XXX
Add: Deferred commission expense opening
XXX
XXX
Less: Deferred commission expense closing
XXX
XXX
Net Commission
XXX
XXX
Less: Commission received or recoverable
XXX
XXX
Add: Unearned Reinsurance Commission
XXX
XXX
Less: Unearned Reinsurance Commission
XXX
XXX
Commission from reinsurers
XXX
XXX
XXX
XXX
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