Module 3
Liabilities
Learning Objectives
On completion of this Module, you should:
•• Be able to explain the essential characteristics of lease agreements and be
able to distinguish between an operating and a finance lease
•• Be able to design the appropriate accounting policies for both lessees and
lessors in accounting for both operating and finance leases
•• Be able to outline the disclosures to apply in relation to finance and
operating leases in accordance with IAS 17 Leases
•• Understand the likely impact of the ED Leases ED/2013/16 on current practice
•• Be able to explain the background to IAS 37 Provisions Contingent Liabilities
and Contingent Assets
•• Be able to define provisions, obligations both legal and constructive, and
contingent liabilities and contingent assets
•• Be able to explain the accounting treatment for provisions and how to
calculate them
•• Be able to apply the principles in IAS 37 to specific issues (e.g. restructuring,
onerous contracts and foreseeable losses)
•• Be able to outline the impact of the changes from current practice that will
arise from the implementation of the ED Measurement of Liabilities in IAS
37 ED/2010/1 in the near future
•• Understand how to account for current tax liabilities and assets
•• Understand taxable temporary differences and deductable temporary
differences and how these affect the calculation of deferred tax
•• Be able to apply the measurement rules of IAS 12 Income Taxes in creating
deferred tax assets and liabilities and explain the disclosure requirements
•• Understand the definitions of functional and presentation currency as
defined by IAS 21 The Effects of Changes in Foreign exchange rates
•• Be able to apply the rules in IAS 21 in accounting for single entity transactions
•• Understand how to account for exchange differences
•• Be able to explain how to translate from functional to presentation currency
•• Be able to describe the characteristics that may indicate that an economy
is hyperinflationary as set out in IAS 29 Financial Reporting in
Hyperinflationary Economies
•• Be able to explain the procedures required to adjust the historical financial
statements for inflation prior to the process of translation under IAS 29
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Module 3
Introduction
Introduction and Overview of Module
This module will explain the characteristics of liabilities and the reporting
requirements under IFRS for different types of liability. The definition of a liability
is covered in Module 1 and is set out in Conceptual Framework for Financial
Reporting 2011 as ‘a present obligation to transfer economic benefits as a result
of a past event’. Under IFRS a liability is recognised in the statement of financial
position, when it is probable that the settlement of a present obligation arising from
past events will result in an outflow from the enterprise of resources embodying
economic benefits and the liability can be reliably measured.
Liabilities are classified as either non-current or current liabilities. Students will
be equipped with the knowledge to classify liabilities appropriately. Students will
be introduced to the principle IFRSs concerning both current and non-current
liabilities; IAS 17 Leases, IAS 37 Provisions, Contingent Liabilities and Contingent
Assets IAS 12 Income Taxes. Students are also introduced to other standards which
impact on this area including, IAS 21 The Effects of Changes in Foreign Exchange
Rates and IAS 29 Financial Reporting in Hyperinflationary Economies.
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Section 1
Section 1
3.1
IAS 17 Leases
This section of the module provides students with a brief overview of the
principles underlying IAS 17 Leases. Prior to the introduction of IAS 17 leases
had grown in popularity and represented a significant source of funding. There
was a lack of consistency in the accounting treatment of leases and little or no
disclosure of leases. This led to leases as a source of ‘off balance sheet finance’.
This meant that an entity had the use of resources which were not recognised
as liabilities in its financial statements. Despite the introduction of IAS 17
Leases, accounting for leases is a very significant area as many entities avail
of leasing to finance the purchase of assets, especially when other sources of
finance are in scarce supply. In this section the student is introduced to practical
guidance on how to implement IAS 17. The debate about the treatment of leases
in financial statements is also discussed, as is the current Exposure Draft on
leases.
3.1.1
Definition
A lease is an agreement where one party (the lessor) gives to another (the lessee)
the right to use an asset for an agreed period of time in return for payment, title
may or may not be transferred. Not all leases are alike; some are for short periods
of time, for example short-term car hire, while in other cases the lease can extend
for many years. IAS 17 Leases classifies leases into two types; finance leases and
operating leases.
IAS 17 sets out the following:
••
••
••
••
the classification of leases;
the treatment of leases in the financial statements of the lessor;
the treatment of leases in the financial statements of the lessee;
the treatment of sale and leaseback transactions.
3.1.2
Classification of Leases
IAS 17 states that leases must be classified as either finance leases or operating
leases. The classification depends on the economic substance of the transaction
rather than its legal form. The accounting treatment of the individual lease agreement
depends on its classification.
3.1.3
Finance Lease
A finance lease is a lease that transfers substantially all the risks and rewards
incidental to ownership of the asset to the lessee. In deciding whether substantially
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Section 1
all of the risks and rewards of ownership have been transferred, the standard
gives examples of situations that would indicate the existence of a finance lease,
as follows:
••
the lease transfers ownership of the asset to the lessee by the end of the lease
term;
••
the lessee has the option to purchase the asset at a price that is expected to be
sufficiently lower than fair value at the date the option is exercisable;
••
the lease term is for the majority 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 asset is of such a specialised nature that only the lessee can use it
without major modifications.
This list is just indicative and if there are other features that make it clear that the
lease does not transfer substantially all the risks and rewards of ownership, the
lease is treated as an operating lease.
Key Summary Point
A finance lease is a lease that transfers substantially all the
risks and rewards incidental to ownership of the asset to the
lease.
Title may or may not be transferred.
3.1.4
Operating Lease
An operating lease is a lease other than a finance lease.
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Module 3
Section 1
Flowchart to Classify Leases
Start
Is ownership
transferred at end of
lease term?
Yes
No
Does the lease contain
a bargain purchase
option?
Yes
No
Is the lease term for a
major part of the
asset’s economic life?
Yes
No
Is the Present Value of
minimum lease
payments > or
substantially all the
asset’s fair value?
Operating lease
Yes
Finance lease
Example
Bobby wants to acquire a new photocopier. The options available to him are
to buy it outright at a cost of 5,000 or to lease it using one of the schemes the
dealer operates. The estimated useful life of the photocopier is five years.
(Continued)
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Details of the schemes are as follows:
1. To hire the photocopier at a cost 500 per quarter to include paper and
toner for up to 5,000 copies per quarter. This contract is for 12 months
but can be extended.
2. To hire the photocopier at a cost of 400 per quarter for four years, but
Bobby would buy his own paper and toner. Bobby would have the
option of purchasing the asset for 10 at the end of the lease term.
Option 1 is an operating lease as the lease term is only for 20% of the life
of the asset and the rental payments made are not substantially all of the
fair value of the asset.
Option 2 is a finance lease as it is for substantially all the useful life of the
asset (80%). There is a purchase option at the end of the lease term at a
bargain price. While details of the rate of interest implicit in the lease are
not given, the total lease payments are 6,400 on an asset valued at 5,000.
Therefore, the substance of the transaction is that Bobby is borrowing
5,000 and repaying 5,000 plus charges of 1,400.
3.1.5
Accounting for Finance Leases
A finance lease is a lease where the risks and rewards incidental to ownership
are transferred to the lessee. The substance of this type of lease is that the lessee
borrows a sum of money and uses it to acquire the use of an asset for substantially
all of its useful economic life. This loan, with associated charges, is repaid over the
lease term. It is the substance of the transaction that is recognised in the financial
statements. The legal form of the lease may be that legal title does not pass to the
lessee, but the lessee has acquired an asset as defined by the Conceptual Framework
for Financial Reporting as the lessee has control over the asset and it is probable
that economic benefits will flow to the entity from the asset.
Initial measurement
At the commencement of the finance lease the lessee must recognise as an asset
and as a liability an amount equal to the fair value of the leased asset or, if lower,
the present value of the minimum lease payments at the inception of the lease.
Where there are initial direct costs associated with securing the lease, these costs
are added to the amount recognised as an asset. At the date of initial recognition
the leased asset and the leasing liability will be equal except for any direct costs
incurred that have been added to the asset value.
Subsequent measurement
Subsequent to initial recognition the lessee will pay the lessor regular payments
in accordance with the lease agreement. These payments must be apportioned
between finance charge and the reduction in the outstanding liability. The finance
charge must be allocated to each period to ensure that a constant periodic rate of
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Section 1
interest is charged. In practice an approximation method is used to allocate the
finance charge. The method most commonly used is the actuarial method.
3.1.6
Depreciation
A leased asset must be depreciated and the depreciation policy adopted must be
consistent with that adopted for depreciable assets that are owned. Depreciation on
leased assets is treated in accordance with IAS 16 Property Plant and Equipment
and IAS 38 Intangible Assets. If there is no reasonable certainty that the lessee
will obtain ownership of the asset by the end of the lease term, the asset must be
written off over the shorter of the lease term or its useful life.
Example
Anne entered into a four-year lease for a photocopier, with a useful life of five
years. The fair value of the photocopier at the inception of the lease was 9,500.
The terms of the lease were that Anne would pay four equal annual payments
of 3,000, paid in advance. Anne has the option to buy the photocopier at the
end of the lease term for 100.
This is a finance lease because:
••
••
the lease term is substantially all of the useful life of the asset;
••
there is the option to purchase the asset at the end of the lease term for
a bargain price.
the minimum lease payments are substantially the fair value of the asset
(4  3,000); and
3.1.7
Disclosure of Finance Leases
The entity must disclose the following for finance leases:
••
••
for each class of asset, the net carrying amount at the end of the reporting period;
••
the total future minimum lease payments at the period end and their present
value classified into payments
a reconciliation between the total of the future minimum lease payments at
the end of the reporting period and their present value;
cc
due in less than one year
cc
due between one and five years and
cc
due later than five years; and
••
••
contingent rents recognised as an expense in the period.
••
a general description of the leases material leasing arrangements
the total of future minimum sublease payments expected to be received under
non-cancellable subleases at the end of the reporting period.
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Example
ABC plc had the following finance lease liability at 31 December 2010
Finance lease liability
Due within 1 year
Due between 2–5 years
Due after 5 years
Less finance charges
allocated to future periods
Present value of minimum
lease payments
Minimum Lease
Payments
20,000
80,000
20,000
120,000
(20,492)
Present Value of
Minimum Lease Payments
13,512
65,996
20,000
99,508
99,508
Key Summary Point
A lessee of an asset leased under a finance lease must
recognise as an asset and as a liability an amount equal to the
fair value of the leased asset, or if lower, the present value
of the minimum lease payments at the inception of the lease.
Depreciation on a leased asset is usually written off over the
shorter of the lease term and the asset’s useful life.
Regular payments are apportioned between the finance charge
and reduction of the outstanding liability.
There are specific disclosure requirements.
3.1.8
Accounting for Operating Leases
Lease payments under an operating lease are recognised as an expense on a straightline basis over the term of the lease. No liability is recognised in the Statement of
Financial Position.
Disclosure of operating leases
Lessees must also disclose in the notes to the financial statements the total future
minimum lease payments at the period-end under non-cancellable operating leases
for each of the following periods:
••
••
••
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due in less than one year
due between one and five years and
due later than five years.
Module 3
Section 1
Key Summary Point
Assets leased under operating leases must be recognised by
lessees as an expense on a straight-line basis. Future lease
payments must be disclosed according to period.
3.1.9
Financial Statements of the Lessor
The principle of accounting for leases in the financial statements of the lessor is
the same as that for leases: it is the substance of the transaction that is considered,
not its legal form.
3.1.10 Finance Lease
The substance of a finance lease is that the risks and rewards of ownership have
passed to the lessee. This substance must be reflected in the financial statements
of the lessor. As the lessor no longer controls the asset under a finance lease, the
asset subject to the finance lease must not be recognised as a non-current asset in
the lessor’s financial statements. Lessors must recognise assets held under a finance
lease in their Statement of Financial Position as receivables at an amount equal to
the net investment in the lease.
Initial recognition
At the date of inception of a finance lease, the lessor must recognise as a
receivable an amount equal to the entity’s net investment in the lease. This is
defined by the standard as gross investment in the lease discounted at the rate of
interest implicit in the lease, with gross investment being equal to the minimum
lease payments receivable by the lessor and any unguaranteed residual value
accruing to the lessor.
Normally the value recognised as a receivable by the lessor should equal the fair
value of the asset at the inception of the lease plus any direct costs incurred by the
lessor in setting up the lease.
Subsequent measurement
After initial recognition of the finance lease, the lessor will receive lease payments
from the lease. These payments will be made up of capital repayments, which
reduce the receivable outstanding, and interest payments. The method used to
identify the capital/interest split should be the same as that used by the lessee, and
should be based on a pattern reflecting a constant periodic rate of return. In other
words it should reflect the rate of interest implicit in the lease. The interest elevent
is recognised as income.
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Example
A company agrees to provide a leasing arrangement on 1 January 2010 as
follows:
The fair value of the asset is 11,500.
The lessee will pay 5 annual instalments of 3,000 paid in arrears.
The lease is non cancellable.
The rate of interest implicit in the lease is 10%.
The lessor must recognise the amount outstanding as a receivable and the
interest received as income.
Finance lease
asset
31.12.2010
31.12.2011
Opening
asset
Interest
(income)
Payment
received
11,500
9,650
1,150
965
3,000
3,000
Balance
outstanding
31.12.
9,650
7,615
Key Summary Point
Net investment in finance leases must be recognised by the
lessor as a receivable. Regular payments received should be
recognised as capital repayments reducing the receivable and
interest receipts as income.
3.1.11 Operating Lease
Under an operating lease, substantially all the risks and rewards of ownership remain
with the lessor. Operating-lease receipts are treated as income in the Statement of
Profit or Loss and other Comprehensive Income on a straight-line basis unless
another systematic basis is more representative of the time pattern from which the
entity receives a benefit from the asset.
In the Statement of Financial Position, the asset subject to the operating lease
agreement is recognised in accordance with IAS 16 Property Plant and Equipment
and depreciation must be applied in a manner consistent with the entity’s normal
depreciation policy for similar assets.
Key Summary Point
Lessors of assets under operating leases must recognise
lease receipts as income and recognise the asset in accordance
with IAS 16.
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3.1.12 Manufacturer as Lessor
In many cases the lessor will be a specialist finance provider which arranges the
lease but is not a dealer or manufacturer of assets. In these circumstances, the
procedures detailed above apply. However, where the lessor is also a dealer or a
manufacturer of the asset, the lessor may offer the choice of outright purchase of
the asset or a lease arrangement.
If the lease arrangement is an operating lease, the amount of cost to be recognised
as an asset in the financial statements will be determined in accordance with IAS
16 Property Plant and Equipment and will not include any profit.
If the lease arrangement is a finance lease, then there are two sources of income:
••
••
the profit/loss on the asset to be leased; and
finance income over the term of the lease.
IAS 17 requires the entity to separate these transactions. All costs relating to the
manufacture of the asset and the entity’s usual profit margin are included in determining
the value of the asset at the date of the inception of the lease. Any profit on sale is
included in the entity’s Statement of Profit or Loss and other Comprehensive Income
in the usual way. The profit/loss on sale must be reduced by any direct costs relating
to setting up the lease arrangement. It must be noted that the profit recognised on the
‘sale’ of an asset subject to a finance lease is restricted to the excess of normal sales
value over cost.
Example
Chow Limited manufactures equipment for sale and to lease.
On 1 January 2010 Chow Limited leased a piece of equipment. The company
incurred costs of 500 to negotiate the lease document. The equipment cost
125,000 to manufacture and the company would normally sell this asset at
165,000. The present value of the minimum lease payments was 180,000 at the
date of inception of the lease
The profit on sale is 40,000 (165,000 2 125,000), as this is the normal selling
price.
Key Summary Point
In a finance lease where the lessor is the manufacturer of the
asset, any direct costs associated with setting up the lease
are expensed in the period in which the sale of the asset is
recognised. This treatment is different from that where the
lessor is not the manufacturer when costs incurred in setting
up the lease are added to the lease receivable amount.
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3.1.13 Leases Relating to Land and Buildings
Buildings can be subject to leases in the same way as other assets: some leases
may be operating leases for short periods of time and other leases may be finance
leases. However, where land and buildings are concerned there is a unique asset
in land, as it normally has an indefinite life, unless it is used in the extraction
industries.
A finance lease transfers substantially all the risks and rewards of ownership of the
asset to the lessee. A feature of a finance lease is that the lease term is usually for
substantially all of the economic life of the asset. As land has an indefinite life, a
finance lease of land is not possible. Therefore any lease of land must be treated as
an operating lease.
When land and buildings are leased together and legal title does not pass to the
lessee the lease must be treated as two leases:
••
••
an operating lease for the land; and
a separate lease for the building, which can be an operating lease or a finance
lease depending on the characteristics of the lease.
When a lease for land and buildings is classified as an operating lease for the
land element and a finance lease for the buildings element, the minimum lease
payments must be allocated to the two elements in proportion to their fair values
at the inception of the lease.
Example
A company enters into a lease arrangement for its office accommodation.
Details are as follows:
The lease term is 20 years.
The building has a remaining useful life of 20 years.
The fair value of the land and building is 600,000 (50% represents the value
of the land).
At the end of the lease the land is expected to have a value of 400,000
(PV 150,000).
Lease payments are 160,000 per annum.
The lease is a finance lease for the building as all of its remaining life is the
lease term and an operating lease for the land as it has an indefinite life.
The lease payments must be split between the two leases.
300,000 value of buildings lease
150,000 value of land lease (300,000 2 150,000 residual value).
Lease payments split; operating lease 160,000 3 150,000/(300,000 1 150,000) 5
53,333
Finance lease 160,000 3 300,000/(300,000  150,000) 5 106,667
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Key Summary Point
A lease of land will always be treated as an operating lease.
If the lease is for land and buildings the asset value and lease
payments must be apportioned between land and buildings.
3.1.14 Sale and Leaseback
A sale and leaseback transaction involves the sale of an asset and the leasing back
of the same asset. The sale price and the lease payment are usually interdependent
as they are negotiated as a package.
3.1.15 Accounting for Sale and Leaseback
The accounting treatment of a sale and leaseback transaction depends on the type
of lease involved.
Finance lease
If the sale and leaseback transaction results in a finance lease, any excess of sales
proceeds over the carrying amount of the asset are not treated as a normal disposal
in accordance with IAS 16. Instead, the excess is deferred and amortised over the
lease term.
Operating lease
If the sale-and-leaseback transaction results in an operating lease and it is clear
that the sale was at fair value, any profit or loss is recognised immediately in the
Statement of Profit or Loss and other Comprehensive Income. The exception to this
treatment is if the lease payments are below market price. In this case the loss/
profit is deferred and amortised over the period for which the asset is expected to
be used.
Example
Robinson Limited needed funds to finance expansion. The company owned a
building it could use to raise finance. On 1 July 2010 the company entered into
a sale-and-leaseback arrangement. Details are as follows:
The lease term is 20 years.
The building has a remaining useful life of 20 years.
Sale proceeds 500,000
Net book value of building at 1 July 2010 300,000
Annual lease payment 35,000
The profit on disposal is 200,000 (500,000 2 300,000). However, as the lease is
a finance lease, the profit must be deferred and amortised over the life of the
lease – 10,000 per annum over 20 years.
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Key Summary Point
A sale-and-leaseback arrangement occurs when an asset is
sold but there is a related lease arrangement, which may be
an operating or a finance lease. If the lease is a finance lease,
any profit on disposal is deferred and amortised over related
lease term.
3.1.16 Incentives to Customers
On occasion, lessors may offer incentives to customers to encourage them to take
out operating leases. The most common incentives are rent-free periods and cashback incentives. These matters are not addressed by IAS 17, but guidance is given in
SIC 15 Incentives in an Operating Lease. SIC 15 states that all incentives associated
with an operating lease should be considered as part of the net consideration
agreed for the leased asset, regardless of the form of the incentive or the timing of
the lease payments.
Lessors should account for incentives by reducing rental income over the term
of the lease. Lessees who benefit from lease incentives should reduce the rental
expense over the term of the lease.
Example
Simon enters into a five-year lease for a shop unit. As the unit has been vacant
for some time, he is receiving six months free rental. The annual payment is
12,000 for five years.
The benefit to Simon is 6,000. This must be taken with the total term of
the lease of 60 months. Therefore the annual lease payments are 10,800 
(60,000 2 6,000)/5.
Key Summary Point
Incentives, regardless of their form, must be considered as a
reduction in the lease rental and taken into account over the
lease term.
3.1.17 Proposed Changes in Accounting for Leases
The area of lease accounting has been the subject of debate for a number of years.
Some commentators argue that the treatment under IAS 17 is incompatible with the
Conceptual Framework for Financial Reporting.
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Many entities also have significant obligations arising from non-cancellable operating
leases. At present these obligations, which meet the definition of a liability, are
excluded from liabilities in the Statement of Financial Position. The proposed
changes affect how both lessees and lessors account for leases – Exposure Draft
Leases ED/2013/6.
The main proposals are as follows:
••
The core principle of the proposed requirements is that an entity should
recognise assets and liabilities arising from a lease. This represents an
improvement over existing leases requirements, which do not require lease
assets and lease liabilities to be recognised by many lessees.
••
In accordance with that principle, a lessee would recognise assets and liabilities
for leases
••
with a maximum possible term of more than 12 months. A lessee would
recognise a liability to make lease payments (the lease liability) and a right-ofuse asset representing its right to use the leased asset (the underlying asset)
for the lease term.
••
The recognition, measurement and presentation of expenses and cash flows
arising from a lease by a lessee would depend on whether the lessee is
expected to consume more than an insignificant portion of the economic
benefits embedded in the underlying asset. For practical purposes, this
assessment would often depend on the nature of the underlying asset.
For most leases of assets other than property (for example, equipment, aircraft,
cars, trucks), a lessee would classify the lease as a Type A lease and would do the
following:
(a) recognise a right-of-use asset and a lease liability, initially measured at the
present value of lease payments; and
(b) recognise the unwinding of the discount on the lease liability as interest
separately from the amortisation of the right-of-use asset.
For most leases of property (ie land and/or a building or part of a building), a
lessee would classify the lease as a Type B lease and would do the following:
(a) recognise a right-of-use asset and a lease liability, initially measured at the
present value of lease payments; and
(b) recognise a single lease cost, combining the unwinding of the discount on the
lease liability with the amortisation of the right-of-use asset, on a straight-line
basis.
Similarly, the accounting applied by a lessor would depend on whether the lessee
is expected to consume more than an insignificant portion of the economic benefits
embedded in the underlying asset. For practical purposes, this assessment would
often depend on the nature of the underlying asset.
For most leases of assets other than property, a lessor would classify the lease as a
Type A lease and would do the following:
(a) derecognise the underlying asset and recognise a right to receive lease
payments (the lease receivable) and a residual asset (representing the rights
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the lessor retains relating to the underlying asset);
(b) recognise the unwinding of the discount on both the lease receivable and the
residual asset as interest income over the lease term; and
(c) recognise any profit relating to the lease at the commencement date.
For most leases of property, a lessor would classify the lease as a Type B lease and
would apply an approach similar to existing operating lease accounting in which
the lessor would do the following:
(a) continue to recognise the underlying asset; and
(b) recognise lease income over the lease term, typically on a straight-line basis.
When measuring assets and liabilities arising from a lease, a lessee and a lessor
would exclude most variable lease payments. In addition, a lessee and a lessor
would include payments to be made in optional periods only if the lessee has a
significant economic incentive to exercise an option to extend the lease, or not to
exercise an option to terminate the lease.
For leases with a maximum possible term (including any options to extend) of 12
months or less, a lessee and a lessor would be permitted to make an accounting
policy election, by class of underlying asset, to apply simplified requirements that
would be similar to existing operating lease accounting.
An entity would provide disclosures to meet the objective of enabling users of
financial statements to understand the amount, timing and uncertainty of cash
flows arising from leases.
On transition, a lessee and a lessor would recognise and measure leases at the
beginning of the earliest period presented using either a modified retrospective
approach or a full retrospective approach.
Key Summary Point
Proposals have been made that all lease liabilities should be
recognised in the financial statements of lessees.
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Key Points
•• Under IAS 17 Leases, leases are divided into finance leases
and operating leases.
•• A finance lease is a lease that transfers substantially all the
risks and rewards incidental to ownership of the asset to
the lessee.
•• At the commencement of a finance lease the lessee must
recognise as an asset and as a liability an amount equal to
the fair value of the leased property or, if lower, the present
value of the minimum lease payments at the inception of
the lease.
•• Regular payments will be made by the lessee over the life of
the lease. These payments must be apportioned between
the finance charge and the reduction in the outstanding
liability.
•• Depreciation on a leased asset is usually written off over
the shorter of the lease term and the asset’s useful life.
•• A lessee must disclose its total finance lease liability
analysed between amounts;
a. Due within one year
b. Between one and five years
c. And over five years
•• An operating lease is a lease which is not a finance
lease
•• In the financial statements of the lessor the principle
of accounting for leases is the same as that for lessees
•• Special rules apply where the lessor is the manufacturer
•• Lease payments under an operating lease are
recognised as an expense on a straight line basis over
the term of the lease.
•• No liability is recognised under an operating lease
•• Proposals have been made that all lease liabilities should
be recognised in the financial statements of lessees
•• A lease for land will always be an operating lease.
If the lease is for land and buildings the asset value
and lease payments must be split between land and
buildings.
3.1.18 Self-Test Questions
Question 1
Alpha entered into an equipment lease on 1st January 2010. The lease is for five
years with the option to extend the lease for a further 10 years at a rent of 10 per
annum. Five equal annual rentals of 95,000 are to be paid in advance. The fair value
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Module 3
Section 1
of the equipment, which has a useful life of 5 years at 1.1.2010, was 400,000. The
rate of interest implicit in the lease is 9.4136%
What are the appropriate accounting entries?
Solution
Year ended Balance Repayment Balance Interest Closing
b/f
Int
9.4136% Balance
upon
Current
liability
Noncurrent
liability
31/12/2010
31/12/2011
31/12/2012
31/12/2013
31/12/2014
72,529
79,356
86,826
95,000
–
261,183
181,827
95,000
–
–
400,000
333,711
261,183
181,827
95,000
295,000
295,000
295,000
295,000
295,000
305,000
238,711
166,183
86,827
–
28,711
22,471
15,644
8,174
–
333,711
261,183
181,827
95,000
–
Question 2
Sheila Ltd entered into a lease for a large piece of machinery on 1 January 2011.
The terms of the lease are as follows:
Rate of interest implicit in the lease is 10.047%
Fair value of machine 500,000
Annual rental in advance 120,000
Lease term 5 years
Useful life of machine 5 years
What amount should appear in the Statement of Financial Position of Sheila Ltd as
at 31 December 2014 for the lease obligation?
Solution
Year ended Balance Repayment Balance Interest Closing Current
b/f
Int upon 10.047% Balance liability
Noncurrent
liability
31/12/2011
31/12/2012
31/12/2013
31/12/2014
31/12/2015
328,137
229,048
120,004
–
–
3/18
500,000
418,179
328,137
229,048
120,004
2120,000
2120,000
2120,000
2120,000
2120,000
380,000
298,179
208,137
109,048
–
38,179
29,958
20,911
10,956
–
418,179 90,042
328,137 99,089
229,048 109,044
120,004 120,000
–
–
Module 3
Section 1
Question 3
Freddie Limited enters into a lease agreement the details are as follows: 3 lease
payments of 40,000 are made annually in advance and a final lease payment of
30,000 is made at the end of the 3 year term. The implicit annual rate of interest
is 10%.
How much interest expense will be recognised in the first year?
Solution
We need to calculate the present value of the minimum lease payments
Year
Year
Year
Year
Payments
40,000
40,000
40,000
30,000
0
1
2
3
Discount Rate 10%
0
0.909
0.826
0.751
Opening liability
Payment
131,930
40,000
Year 1
Capital
outstanding
91,930
Present Value
40,000
36,360
33,040
22,530
131,930
Interest
10%
9,193
Closing
liability
101,123
Answer 9,193
3.1.19Examples from Published Financial Statements –
See Appendix M3
Ryanair year ended 31 March 2010 (Ireland)
Accounting Policy Note
CRH plc year ended 31 December 2009 (Ireland)
Accounting Policy Note
Note to the Financial Statements
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Module 3
Section 2
Section 2
3.2
IAS 37 Provisions, Contingent Liabilities and
Contingent Assets
This section provides guidance on a contentious area of accounting, namely
provisions, contingent liabilities and contingent assets. IAS 37 was introduced as
there was no consistency of treatment for provisions and there was evidence that
some entities were deliberately manipulating the lack of guidance in this area by
adopting ‘big bath’ provisions in periods when large profits were made and then
releasing these provisions in years when profits were not high. Provisions were also
made in some cases when no obligation but a mere intention existed. An Exposure
Draft proposing substantial changes to IAS 37 Provisions, Contingent Liabilities
and Contingent Assets was first published in 2005, but the changes proposed have
not yet taken effect.
3.2.1
Scope of the Standard
IAS 37 applies to all provisions, contingent liabilities and contingent assets except
those which arise from;
••
a non-onerous executory contract, which is a where neither party has
performed any of its obligations or both parties have performed obligations
of an equal amount;
••
items covered by other IASs, such as IAS 11 Construction Contracts; IAS 12
Income Taxes; IAS 17 Leases; IAS 19 Employee Benefits and IFRS 4 Insurance
Contracts; or
••
financial instruments within the scope of IFRS 9 Financial Instruments.
3.2.2
Definition of Provision
A provision is defined by the standard as a liability of uncertain timing or amount.
Therefore, to meet the definition of a provision, the definition of a liability must
first be met. A liability is defined as a present obligation of an entity, arising from
past events, which is expected to result in an outflow from the entity of resources
embodying economic benefits.
Key Summary Point
A provision is a liability of uncertain timing or amount.
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Module 3
3.2.3
Section 2
Obligation
A liability arises from a present obligation arising from past events, the settlement
of which is expected to result in an outflow from the entity of resources embodying
economic benefits. This obligation may arise from:
••
a legal obligation. This arises from a legal contract, legislation or other
operation of law; or
••
a constructive obligation. This is an obligation that arises from the entity’s
actions where it has established a pattern of past practice or published policies
or sufficiently specific current statements which indicate that it will accept
responsibility and as a result of this pattern of practice or policies the entity
has created a valid expectation that it will discharge these responsibilities.
An example of a constructive obligation would be where an entity makes a public
announcement that it will donate one million to earthquake victims in the aftermath
of an earthquake. The announcement is the obligating event.
3.2.4
Contingent Liabilities
A contingent liability is defined by the standard as
••
a possible obligation arising from past events whose existence will only be
confirmed by the occurrence or non-occurrence of one or more uncertain
future events not wholly within the control of the entity – for example an
ongoing court case where the outcome is uncertain; or
••
a present obligation arising from past events which has not been recognised as
a provision because it is not probable that an outflow of resources embodying
economic benefits will be required to settle the obligation or the amount of
the obligation cannot be measured with sufficient reliability – for example less
than 50% probability that transfer of resources will take place.
Contingent liabilities are not recognised as liabilities as they do not meet the
recognition criteria of a liability, are only possible obligations or cannot be reliably
measured. A contingent liability is disclosed unless the possibility of any outflow in
settlement is remote (see 3.2.16 for details)
3.2.5
Contingent Assets
A contingent asset is a possible asset arising from past events whose existence will
be confirmed only by the occurrence or non-occurrence of one or more uncertain
future events not wholly within the control of the entity.
An entity must not recognise a contingent asset. An example of a contingent asset
would be a claim by an entity going through the legal process, where the outcome
is uncertain. However a contingent asset cannot be recognised as the benefits may
not be realised. If it is probable that economic benefits will flow to the entity, the
contingent asset should be disclosed in the notes to the financial statements (see
3.2.16 for details).
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Module 3
Section 2
Key Summary Point
Contingent liabilities are not recognised in the financial
statements, but details are disclosed in the notes.
Contingent assets are only disclosed when it is probable that
economic benefits will flow to the entity.
Decision Tree
IAS 37 Provisions, Contingent Liabilities and Contingent Assets
Copyright. International Accounting Standards Foundation.
3.2.6
Recognition of a Provision
Provisions are recognised as liabilities where:
••
••
••
••
a present obligation exists (legal or constructive);
it is the result of past events;
it is probable (50% probability – more likely than not) that an outflow
of resources embodying economic benefits will be required to settle the
obligation; and
the amount of the provision can be reliably measured.
If these conditions are not met, no provision shall be recognised.
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3.2.7
Section 2
Measurement of Provision
In order to be recognised as a liability, the provision must be reliably measurable.
If it cannot be reliably measured, but an obligation exists at the period-end, it
is classified as a contingent liability and disclosed in the notes to the financial
statements. No liability is recognised.
This is an area where considerable judgement is required. The amount recognised
as a provision should be the best estimate of the expenditure required to settle the
obligation. The measurement of the provision depends on the nature of the obligation.
Provisions for one-off events are measured at the most likely amount to be required
to settle the obligation.
Example
An entity is involved in a court case. Lawyers have advised that the entity has
a 70% chance of losing and that damages to be awarded against the entity are
likely to be 100,000. A provision should be made as the event is more likely
than not to occur. The amount of the provision should be 100,000.
Provisions for large populations of events, such as warranties or customer refunds,
are measured at a probability-weighted value.
Example
An entity has given an undertaking to repair any faults that occur with its
products, within 12 months of purchase. Management expect that 80% of its
products will not develop faults. 10% will develop faults that will cost 50 each
to repair and the remaining 10% will develop faults that will cost 200 each
to repair. The entity sold one million units during the year. The entity should
make a provision for the expected value of 25 million calculated as follows:
Probability %
Cost of repair
80
10
10
0
50
200
Total provision
1 million units sold
000
0
5,000
20,000
25,000
Where the time value of money is significant, provisions must be discounted to
present value. The discount rate used must be the pre-tax rate that reflects current
market assessments of the time value of money and the risks specific to the liability.
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3.2.8
Section 2
Changes in Provisions
At each year-end an entity must review its provisions and adjustment must be made
to ensure that the provision is stated at current best estimate at that date. If it is no
longer probable that an outflow of resources embodying economic benefits will be
required to settle the obligation, the provision must be reversed. When discounting
is used, the provision will increase with time as the settlement date approaches.
Any unwinding of discount is to be treated as a borrowing cost in the Statement of
Profit or Loss and other Comprehensive Income.
A provision must only be used for expenditure for which it was originally provided.
It cannot be used for any expenditure other than its original purpose.
3.2.9
Reimbursements
In some cases expenditure to settle an obligation may be reimbursed – for
example, a legal claim against an entity may result in the entity counterclaiming
from a third party. When expenditure to settle an obligation is expected to be
reimbursed, the reimbursement can only be recognised when it is virtually certain
that the reimbursement will be received if the entity settles the obligation. The
reimbursement must be recognised as a separate asset, but it must not exceed the
amount of the related provision.
In the Statement of Profit or Loss and other Comprehensive Income, the expense
relating to the provision may be presented net of the amount recognised for the
reimbursement.
Key Summary Point
Provisions must be reviewed at each period-end to ensure
that they reflect the liability at that date. A provision set up
for a specific liability must be used for that specific purpose.
3.2.10 Application of the Recognition and Measurement Rules
The IAS sets out specific guidance on the application of the recognition and
measurement rules concerning future operating losses, onerous contracts and
restructuring.
3.2.11 Future Operating Losses
Future operating losses do not meet the definition of a liability as a present obligation
does not exist and therefore they must not be recognised as a provision. The entity
could cease trading and therefore incur no further losses. The expectation of future
losses may be an indication of impairment and an impairment review may be
required in accordance with IAS 36 Impairment of Assets.
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Module 3
Section 2
Key Summary Point
Provisions for future losses are specifically disallowed by
IAS 37.
3.2.12 Onerous Contracts
Many contracts which an entity enters into may be cancelled without paying
compensation to the other party. In other cases, the unavoidable costs of meeting
obligations under a contract may exceed the economic benefits received from this
contract. This is defined as an onerous contract. IAS 37 requires that any present
obligation under an onerous contract must be recognised and measured as a
provision.
The amount of the provision for an onerous contract will be the lower of:
••
••
the costs of fulfilling the contract; and
any compensation or penalties arising from failure to fulfil the contract.
Example
An entity entered into a lease arrangement for a property five years ago.
The lease term is 25 years and the annual rental is 100,000. The tenant who
occupied the premises under a sublease has been declared bankrupt and
there is no prospect of finding another tenant. A surveyor has informed the
entity that, if a tenant could be found, the current rental income for similar
properties has dropped to 20,000 per annum, due to a downturn in the
economy.
This is an onerous contract. The entity is committed to paying 100,000 for the
next 20 years and a provision must be made for the full amount.
Key Summary Point
Any present obligation under an onerous contract must be
recognised and measured as a provision.
3.2.13 Restructuring
Detailed guidance is given in the standard on accounting for restructuring as this
was an area where provisions were previously manipulated to smooth earnings
from one year to another.
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Module 3
Section 2
The IAS defines restructuring as;
••
••
the sale or termination of a line of business;
••
changes in management structure such as the removal of a layer of management;
and
••
fundamental reorganisations that have a material effect on the nature and
focus of the entity’s operations.
the closure of business locations in a country or region or the relocation of
business activities from one country or region to another;
A provision for restructuring can only be recognised when the general recognition
rules for provisions are met. However, the standard states that a constructive
obligation to restructure arises when and only when:
••
••
a detailed formal plan for restructuring has been drawn up detailing at least:
cc
the part of the business concerned,
cc
the principal locations affected,
cc
the location, function and approximate numbers of staff who will be
compensated for the termination of their services,
cc
the expenditure to be undertaken,
cc
when the plan will be implemented; and
the entity has raised a valid expectation in those affected that it will carry out
the restructuring by starting to implement that plan or announcing its main
features to those affected by it.
Where the restructuring involves the sale of an operation, no obligation
arises until a binding sale agreement has been entered into, as until that date
management can change their decision. However, where the sale is only part of
a restructuring plan, a constructive obligation may exist for the other parts of the
restructuring.
A restructuring provision must include only direct expenditure arising from the
restructuring, which is both:
••
••
necessarily entailed by the restructuring; and
not associated with the ongoing activities of the entity.
Costs which are specifically disallowed from inclusion in a restructuring provision
include:
••
••
••
3/26
retraining or relocating continuing staff;
marketing;
investment in new systems and distribution networks.
Module 3
Section 2
Key Summary Point
Restructuring is a planned programme and is controlled by
management and materially changes:
•• the scope of the business; or
•• the manner in which the business is conducted
A provision for restructuring can be recognised only when
the general recognition rules for provisions are met and
a constructive obligation to restructure arises. Only direct
expenditure necessarily entailed by the restructuring and not
associated with ongoing activities can be provided for.
3.2.14 Recent Proposals for Changes in Accounting for Liabilities
In 2005 the IASB published an exposure draft of an IFRS to replace IAS 37
Provisions, Contingent Liabilities and Contingent Assets. However no new standard
was published. In 2010 the IASB published an Exposure Draft Measurement of
Liabilities in IAS 37.
The 2005 ED main proposals were:
••
the elimination of ‘contingent asset’ and ‘contingent liability’. The Conceptual
Framework for Financial Reporting definition of a liability or an asset should
be what determines whether an asset or a liability exists;
••
the elimination of the probability recognition criterion because, if an item
satisfies the definition of a liability, it automatically meets this criterion;
••
it recommended that a non-financial liability should be measured at the
amount that the entity would rationally pay to settle the obligation. It further
specified that the expected-cash-flow approach was the appropriate basis for
measuring a non-financial liability for both a single obligation and a class of
similar obligations, and that measuring a single obligation at its most likely
outcome would not be consistent with this basis.
The 2010 Exposure Draft only deals with one aspect of the original ED addressing
the issue of the measurement requirements for liabilities within the scope of
IAS 37. The current standard IAS 37 requires that a liability be measured at “the best
estimate of the expenditure required to settle the obligation”. The best estimate is
defined as the amount the entity would rationally pay to settle the obligation. This
was criticised as being too vague. The ED proposes that the amount of the liability
should be determined as the lowest of:
••
••
the present value of the resources required to fulfil the obligation; or
••
the amount the entity would have to pay to cancel the obligation.
the amount the entity would have to pay to transfer the obligation to a third
party; and
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Section 2
The amount the entity would have to pay to cancel or transfer the obligation is
defined by the ED as the price that the other party or a third party would demand,
plus any costs associated with the cancellation or transfer.
The ED proposes that, if there is no evidence that the obligation could be transferred
or cancelled, the entity must measure the liability at the present value of the
resources required to fulfil the obligation.
3.2.15Measuring the Present Value of Resources Required
to Fulfil the Obligation
The ED proposes that, when the amount or timing of outflows is uncertain, the
entity should estimate the probability-weighted average of the range of possible
outcomes, but that the calculation need not be complex as a limited number of
probabilities and outcomes could provide a reasonable estimate.
However, the comment letters received in response to the 2010 ED demonstrated
opposition to the proposals and, in particular, it now looks likely that the probability
criterion in deciding whether a liability exists or not will be retained in line with
the current IAS 37. The matter is not yet resolved and is unlikely to be resolved for
some time.
Example
Old IAS 37
A legal case is taken against the company for one million. Legal advice is that
there is a 30% chance that the case will be successful. No provision is made as it
is not probable that a claim will be successful (there is a less than 50% chance)
Proposal
Given the scenario above, provision would be made on a “probability of
outcomes in the measurement” basis.
30% (1 million) 300,000
70% (0)
0
Total provision 300,000
Key Summary Point
Proposals have been made to amend IAS 37. These proposals
would result in the removal of the probability-of-outcomes
principle of IAS 37 – i.e. a provision is only made where there is
50% chance that an outflow of economic benefits will occur.
Instead, provisions would be calculated to reflect the probability
of outcomes, even if the likelihood of an outflow is low. This
would result in provisions where none are currently required.
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Module 3
Section 2
3.2.16 Disclosure
An entity must disclose:
••
••
••
for each class of provision:
cc
the carrying amount at the beginning and end of the period,
cc
additional provisions made in the period,
cc
amounts used in the period,
cc
amounts reversed in the period,
cc
changes in discounted amount arising from the passage of time or from
changes in discount rate,
cc
a brief description of the nature of the obligation and the expected timing
of any resulting outflows of economic benefits,
cc
an indication of the uncertainties about the amount or timing of outflows,
and
cc
the amount of any expected reimbursements;
for each contingent liability
cc
a brief description of the nature of the contingency.
cc
an estimate of the financial effects.
cc
an indication of the uncertainties about the amount or timing of
outflows.
cc
the amount of any expected reimbursements;
for each contingent asset, a brief description of the nature and financial
effect of the contingent asset, if probable. If only possible, no disclosure
is made.
IAS 37 permits a reporting entity to avoid disclosure requirements relating to
provisions, contingent liabilities and contingent assets if disclosure would be likely
to seriously prejudice the position of the entity in a dispute. In such cases an
entity need not disclose the information, but shall disclose the general nature of
the dispute, together with the fact that; and reason why, the information has not
been disclosed. However, it is expected that this would be very rare in practice.
Key Summary Point
There are specific disclosure requirements for each provision,
contingent liability and contingent asset.
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Module 3
Section 2
Key Points
•• A provision is a liability of uncertain timing or amount.
•• A liability arises from a present obligation arising from past
events to transfer economic benefits.
•• An obligation can be;
cclegal
– arising from a legal contract or
ccconstructive – arising from the entity’s actions or published
policies.
•• Contingent liabilities arise from:
cca
possible obligation arising from past events whose
existence will only be confirmed by the occurrence or nonoccurrence of uncertain events or
cca present obligation arising from past events where it is not
probable that an outflow of economic benefits will flow
from the entity or the obligation cannot be measured with
sufficient reliability.
•• Contingent
liabilities are not recognised in the financial
statements, but details are disclosed in the notes.
•• Contingent
assets are only disclosed when it is probable
that economic benefits will flow to the entity.
•• At each year-end an entity must review its provisions and
make adjustment as required.
•• A provision can be used only for expenditure for which it
was originally provided.
•• Provisions
for future losses are specifically disallowed by
IAS 37.
•• Provisions for restructuring are allowed if specific conditions
set out in IAS 37 are met.
3.2.17 Self-Test Questions
Question 1
1.
2.
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Marchmaine plc’s financial statements to 31 December 2010 include a provision
for staff training of 80,000. Due to the rapid technological change in the industry,
Marchmaine creates a provision for staff training each year. The provision of
80,000 shown in the financial statements has been built up during 2008 and
2009. The directors wish to provide an additional 40,000 for 2010.
During the year ended 31 December 2010, a claim was made against
Marchmaine by a customer alleging poor workmanship, irreparable damage
Module 3
Section 2
to their vehicle and substantial inconvenience. Marchmaine’s legal advisors
have indicated that the company will most likely have to pay damages of
100,000 but that it may be possible to counterclaim against the manufacturer
of the equipment for 10,000.
Solution
1. Provision for staff training
There is no legal (or constructive) obligation until the training is carried out.
Therefore the provision should be reversed.
‘000
‘000
Dr
Provisions
80
Cr Retained earnings – prior year adjustment
80
2. Customer claim
Amount payable is probable (more likely than not to be paid), and ‘000
‘000
therefore provision is required for the full amount
Dr
Operating expenses
100
Cr Current liabilities – provision for claim
100
The counterclaim/contingent gain should be shown in the notes only if it is
probable to result in an inflow of resources. It should not be offset as legal
opinion does not suggest that the two outcomes are connected and/or that it is
likely to succeed.
Question 2
On 10 December 2010, McFee made a public announcement of its intention to
reduce its carbon emissions. This will require investment in the company’s facilities.
The average remaining useful life of its facilities at 31 December 2010 was 10 years.
Depreciation is provided on a straight-line basis. The directors estimate that the
costs of the reductions will be 15 million per annum for a three-year period from
31 December 2010. Contracts were signed on 17 February 2011.
The appropriate discount rate is 10%.
What are the appropriate accounting entries?
Solution
By making a public announcement, the company has created a constructive
obligation as at the date of the announcement. The amounts can be reliably
estimated. Therefore a provision is required
31 December 2010
Provision 31 December 2010
2011
15,000,000 @ 0.909
13,635,000
2012
15,000,000 @ 0.826
12,390,000
2013
15,000,000 @ 0.751
11,265,000
37,290,000
An asset and a liability should be recognised at 31 December 2010, of 37,290,000
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Module 3
Section 2
31 December 2011
2012
2013
Provision 31 December 2011
15,000,000 @ 0.909
15,000,000 @ 0.826
13,635,000
12,390,000
26,025,000
Provision at 31 December 2011 of 26,025,000
Depreciation of asset written off on the same basis as facilities 37,290,000/10 
3,729,000
Unwinding of discount – finance cost 3,735,000
Finance cost
Opening provision
Costs incurred during 2011
Unwinding of discount
Closing provision
37,290,000
(15,000,000)
3,735,000
26,025,000
31 December 2012
2013
Finance cost
15,000,000 @ 0.909
Opening provision
Costs incurred during 2012
Unwinding of discount
Closing provision
13,635,000
26,025,000
(15,000,000)
2,610,000
13,635,000
Provision at 31 December 2012 of 13,635,000
Depreciation of asset written off on the same basis as facilities 37,290,000/10 
3,729,000
Unwinding of discount –finance cost 2,610,000
Question 3
Winlock Limited’s directors decided on 23 November 2009 to restructure the
company’s operations as follows:
••
••
a factory in Northland would be closed down and put on the market for sale;
••
the remaining 20 employees working in Northland would be transferred to
Westland, which would continue operating.
100 employees working in Northland would be made redundant effective on
31 December 2009 and would be paid their accumulated entitlements plus 3
months’ wages; and
As at 31 December 2009 the following transactions and events had occurred:
••
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the factory in Northland was shut down on 30 November 2009. An offer had
been received for the site, but there was no binding sales agreement;
Module 3
Section 2
••
the 100 employees had been made redundant and their accumulated
entitlements had been paid, with the exception of a portion of their 3-months’
wages of 60,000; and
••
costs of 20,000 were expected to be incurred in transferring the 20 employees
to their new work in Westland. The transfer will occur on 10 February 2010.
Requirement
Calculate the amount of the restructuring provision to be recognised in Winlock’s
financial statements for the year to 31 December 2009, in accordance with IAS 37.
Solution
The factory was shut down on 30 November. The fact that no binding sales
agreement is in place is of no significance. The factory has already been shut down
and thus the implementation of the restructuring has virtually been completed.
••
The amount of 60,000, representing a portion of the 3-months’ wages for
the redundant employees, is included in the provision as the implementation
of the restructuring has commenced and the amount represents a present
obligation.
••
Costs of 20,000 were expected to be incurred in transferring the 20 employees
to their new work. The transfer will occur on 10 February. No provision is
made for these costs as they relate to ongoing operations.
••
The total provision to be made is 60,000.
3.2.18Examples from Published Financial Statements –
See Appendix M3
Imperial Tobacco year ended 30 September 2010 (England)
Royal Dutch Shell year ended 31 December 2009 (England)
Note to the financial statements
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Section 3
Section 3
3.3
IAS 12 Income Taxes
Objective of IAS 12
This section deals with the area of income tax. Income tax in the context of
IAS 12 Income Taxes is all taxes payable by the entity. Issues concerning income tax
in financial statements can be split into current tax and the future consequences of
income tax (deferred tax).
3.3.1
Current Income Tax
The principle underlying IAS 12 is that an entity should account for the tax
consequences of a transaction in the same way that it accounts for the transaction
itself. Therefore, if a transaction is recognised in the Statement of Profit or Loss
and other Comprehensive Income, any related tax should also be recognised in the
same statement.
The tax expense on profits from ordinary activities for a reporting period must be
presented on the face of the Statement of Profit or Loss and other Comprehensive
Income.
The tax expense for a period in the Statement of Profit or Loss and other
Comprehensive Income will be made up as follows:
••
••
the current tax expense for the reporting period;
••
the amount of any previously unrecognised tax loss or other adjustment that
is used to reduce the current tax expense; and
••
the amount of tax relating to changes in accounting policy and fundamental
errors as allowed by IAS 8 Accounting Policies, Changes in Accounting
Estimate and Errors.
any adjustment made in the current period for prior periods (an adjustment
for underpaid or overpaid tax in a prior period);
Example
Income tax on profits for the period to 31.12.2011
Underpaid tax 2010
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30,000
500
30,500
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Key Summary Point
Current tax is the amount actually payable (recoverable) to
the tax authorities in relation to the trading activities of the
entity during the reporting period
3.3.2
Statement of Financial Position
The standard requires that current tax and tax of prior periods, to the extent
unpaid, must be recognised as a current liability. If the amount of tax paid in
respect of current and prior periods exceeds the amount due for those periods, the
excess must be recognised as an asset. The tax asset and tax liability at the periodend must be measured at the amount expected to be paid to (or recovered from)
taxation authorities, using the rates/laws that are in force or substantively enacted
by the period end.
3.3.3
Tax Losses
In some circumstances tax losses can be carried back to recover current tax of a
previous period. If this arises the standard requires that this benefit be recognised
as an asset.
Key Summary Point
Current tax payable is always shown on the face of the
Statement of Financial Position as a current liability. Excess tax
paid and benefits of tax losses carried back are recognised as
an asset.
3.3.4
Presentation of Current Tax
An entity may have, at a reporting date, tax assets and tax liabilities. The standard
requires that these be reported separately. However current tax assets and current
tax liabilities should be offset if, and only if,
••
the entity has a legally enforceable right to set off the recognised amounts,
and
••
the entity intends either to settle on a net basis or it intends to realise the asset
and settle the liability simultaneously.
3.3.5
Deferred tax
Deferred tax liabilities are the amounts of income taxes payable in future periods
in respect of taxable temporary differences.
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Deferred tax assets are the amounts of income taxes recoverable in future periods
in respect of:
(a) deductible temporary differences;
(b) the carryforward of unused tax losses; and
(c) the carryforward of unused tax credits.
3.3.6
Permanent Differences
Profit as presented in the Statement of Profit or Loss and other Comprehensive
Income in accordance with IFRS may not be the profit for tax purposes in
accordance with relevant tax legislation. Some expenses which are disallowed for
tax purposes include costs associated with entertaining customers and companyformation expenses. These expenses are permanently disallowed for tax purposes.
There is no reversal of the disallowance in future reporting periods. Therefore, no
adjustment is made in the financial statements for permanent differences.
3.3.7
Temporary differences
Temporary differences are differences between the carrying amount of an asset or
liability in the statement of financial position and its tax base. Temporary differences
may be either:
(a) taxable temporary differences, which are temporary differences that will result
in taxable amounts in determining taxable profit (tax loss) of future periods
when the carrying amount of the asset or liability is recovered or settled; or
(b) deductible temporary differences, which are temporary differences that will result
in amounts that are deductible in determining taxable profit (tax loss) of future
periods when the carrying amount of the asset or liability is recovered or settled.
The tax base of an asset or liability is the amount attributed to that asset or liability
for tax purposes.
3.3.8
Taxable temporary differences
A deferred tax liability shall be recognised for all taxable temporary differences,
except to the extent that the deferred tax liability arises from
(a) the initial recognition of goodwill; or
(b) the initial recognition of an asset or liability in a transaction which:
(i) is not a business combination; and
(ii) at the time of the transaction, affects neither accounting profit nor taxable
profit (tax loss).
However, for taxable temporary differences associated with investments in
subsidiaries, branches and associates, and interests in joint arrangements, a deferred
tax liability shall be recognised except to the extent that both of the following
conditions are satisfied:
(a) the parent, investor, joint venturer or joint operator is able to control the
timing of the reversal of the temporary difference; and
(b) it is probable that the temporary difference will not reverse in the foreseeable
future.
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Carrying amount of assets vs. Tax base
It is inherent in the recognition of an asset that its carrying amount will be
recovered in the form of economic benefits that flow to the entity in future periods.
When the carrying amount of the asset exceeds its tax base, the amount of taxable
economic benefits will exceed the amount that will be allowed as a deduction for
tax purposes. This difference is a taxable temporary difference and the obligation
to pay the resulting income taxes in future periods is a deferred tax liability. As the
entity recovers the carrying amount of the asset, the taxable temporary difference
will reverse and the entity will have taxable profit. This makes it probable that
economic benefits will flow from the entity in the form of tax payments.
Example
An asset which cost 150 has a carrying amount of 100. Cumulative depreciation
for tax purposes is 90 and the tax rate is 25%.
The tax base of the asset is 60 (cost of 150 less cumulative tax depreciation
of 90). To recover the carrying amount of 100, the entity must earn taxable
income of 100, but will only be able to deduct tax depreciation of 60.
Consequently, the entity will pay income taxes of 10 (40 at 25%) when
it recovers the carrying amount of the asset. The difference between the
carrying amount of 100 and the tax base of 60 is a taxable temporary
difference of 40. Therefore, the entity recognises a deferred tax liability
of 10 (40 at 25%) representing the income taxes that it will pay when it
recovers the carrying amount of the asset.
Timing differences of income and expenses
Some temporary differences arise when income or expense is included in accounting
profit in one period but is included in taxable profit in a different period. Such
temporary differences are often described as timing differences. The following
are examples of temporary differences of this kind which are taxable temporary
differences and which therefore result in deferred tax liabilities:
(a) interest revenue is included in accounting profit on a time proportion basis
but may, in some jurisdictions, be included in taxable profit when cash is
collected. The tax base of any receivable recognised in the statement of
financial position with respect to such revenues is nil because the revenues
do not affect taxable profit until cash is collected;
(b) depreciation used in determining taxable profit (tax loss) may differ from
that used in determining accounting profit. The temporary difference is the
difference between the carrying amount of the asset and its tax base which is
the original cost of the asset less all deductions in respect of that asset permitted
by the taxation authorities in determining taxable profit of the current and
prior periods. A taxable temporary difference arises, and results in a deferred
tax liability, when tax depreciation is accelerated (if tax depreciation is less
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rapid than accounting depreciation, a deductible temporary difference arises,
and results in a deferred tax asset); and
(c) development costs may be capitalised and amortised over future periods in
determining accounting profit but deducted in determining taxable profit in
the period in which they are incurred. Such development costs have a tax base
of nil as they have already been deducted from taxable profit. The temporary
difference is the difference between the carrying amount of the development
costs and their tax base of nil.
Other taxable temporary difference
Taxable temporary differences also arise when
(a) the identifiable assets acquired and liabilities assumed in a business
combination are recognised at their fair values in accordance with IFRS 3
Business Combinations, but no equivalent adjustment is made for tax purposes
(b) assets are revalued and no equivalent adjustment is made for tax purposes
(whether you intend to sell the asset or not)
(c) goodwill arises in a business combinatio
(d) the tax base of an asset or liability on initial recognition differs from its initial
carrying amount, for example when an entity benefits from non-taxable
government grants related to assets
(e) the carrying amount of investments in subsidiaries, branches and associates
or interests in joint arrangements becomes different from the tax base of the
investment or interest
3.3.9
Deductible temporary differences
A deferred tax asset shall be recognised for all 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, unless the deferred tax asset arises
from the initial recognition of an asset or liability in a transaction that:
(a) is not a business combination; and
(b) at the time of the transaction, affects neither accounting profit nor taxable
profit (tax loss).
However, for deductible temporary differences associated with investments in
subsidiaries, branches and associates, and interests in joint arrangements, a
deferred tax asset shall be recognised in accordance to the extent that, and only
to the extent that, it is probable that;]
(a) the temporary difference will reverse in the foreseeable future; and
(b) taxable profit will be available against which the temporary difference can be
utilised.
Carrying amount of liabilities vs. tax base
It is inherent in the recognition of a liability that the carrying amount will be settled
in future periods through an outflow from the entity of resources embodying
economic benefits. When resources flow from the entity, part or all of their amounts
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may be deductible in determining taxable profit of a period later than the period
in which the liability is recognised. In such cases, a temporary difference exists
between the carrying amount of the liability and its tax base. Accordingly, a deferred
tax asset arises in respect of the income taxes that will be recoverable in the future
periods when that part of the liability is allowed as a deduction in determining
taxable profit. Similarly, if the carrying amount of an asset is less than its tax base,
the difference gives rise to a deferred tax asset in respect of the income taxes that
will be recoverable in future periods.
Example
An entity recognises a liability of 100 for accrued product warranty costs. For
tax purposes, the product warranty costs will not be deductible until the entity
pays claims. The tax rate is 25%.
The tax base of the liability is nil (carrying amount of 100, less the amount that will
be deductible for tax purposes in respect of that liability in future periods). In settling
the liability for its carrying amount, the entity will reduce its future taxable profit by
an amount of 100 and, consequently, reduce its future tax payments by 25 (100 at
25%). The difference between the carrying amount of 100 and the tax base of nil is a
deductible temporary difference of 100. Therefore, the entity recognises a deferred tax
asset of 25 (100 at 25%), provided that it is probable that the entity will earn sufficient
taxable profit in future periods to benefit from a reduction in tax payments.
The following are examples of deductible temporary differences that result in
deferred tax assets:
(a) retirement benefit costs may be deducted in determining accounting profit
as service is provided by the employee, but deducted in determining taxable
profit either when contributions are paid to a fund by the entity or when
retirement benefits are paid by the entity. A temporary difference exists
between the carrying amount of the liability and its tax base; the tax base of
the liability is usually nil. Such a deductible temporary difference results in a
deferred tax asset as economic benefits will flow to the entity in the form of a
deduction from taxable profits when contributions or retirement benefits are
paid;
(b) research costs are recognised as an expense in determining accounting profit
in the period in which they are incurred but may not be permitted as a
deduction in determining taxable profit (tax loss) until a later period. The
difference between the tax base of the research costs, being the amount the
taxation authorities will permit as a deduction in future periods, and the
carrying amount of nil is a deductible temporary difference that results in a
deferred tax asset;
(c) with limited exceptions, an entity recognises the identifiable assets acquired
and liabilities assumed in a business combination at their fair values at the
acquisition date. When a liability assumed is recognised at the acquisition
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date but the related costs are not deducted in determining taxable profits
until a later period, a deductible temporary difference arises which results in
a deferred tax asset. A deferred tax asset also arises when the fair value of an
identifiable asset acquired is less than its tax base. In both cases, the resulting
deferred tax asset affects goodwill;
(d) certain assets may be carried at fair value, or may be revalued, without an
equivalent adjustment being made for tax purposes. A deductible temporary
difference arises if the tax base of the asset exceeds its carrying amount.
The reversal of deductible temporary differences results in deductions in
determining taxable profits of future periods. However, economic benefits in the
form of reductions in tax payments will flow to the entity only if it earns sufficient
taxable profits against which the deductions can be offset. Therefore, an entity
recognises deferred tax assets only when it is probable that taxable profits will be
available against which the deductible temporary differences can be utilised.
It is probable that taxable profit will be available against which a deductible
temporary difference can be utilised when there are sufficient taxable temporary
differences relating to the same taxation authority and the same taxable entity
which are expected to reverse:
(a) in the same period as the expected reversal of the deductible temporary
difference; or
(b) in periods into which a tax loss arising from the deferred tax asset can be
carried back or forward.
In such circumstances, the deferred tax asset is recognised in the period in which
the deductible temporary differences arise.
When there are insufficient taxable temporary differences relating to the same
taxation authority and the same taxable entity, the deferred tax asset is recognised
to the extent that:
(a) it is probable that the entity will have sufficient taxable profit relating to the
same taxation authority and the same taxable entity in the same period as the
reversal of the deductible temporary difference (or in the periods into which
a tax loss arising from the deferred tax asset can be carried back or forward).
In evaluating whether it will have sufficient taxable profit in future periods, an
entity ignores taxable amounts arising from deductible temporary differences
that are expected to originate in future periods, because the deferred tax asset
arising from these deductible temporary differences will itself require future
taxable profit in order to be utilised; or
(b) tax planning opportunities are available to the entity that will create taxable
profit in appropriate periods.
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Example
Barry Limited bought a machine for 100,000 in this reporting period. Tax
incentives are available which amount to 100% of the cost of machinery
being allowable as a taxable deduction in the year of purchase. Barry Limited
depreciates machinery at 20% on cost.
Barry Limited estimated that its profits before tax for the next five years will
be 100,000 per annum. Income tax on profits is charged at 25%.
Tax calculation
Profits
Add back
Depreciation
Taxable
allowance
Taxable
profits
Current
Tax @ 25%
Year 1
100,000
20,000
Year 2
100,000
20,000
Year 3
100,000
20,000
Year 4
100,000
20,000
Year 5
100,000
20,000
(100,000)
Total
500,000
100,000
(100,000)
20,000
120,000
120,000
120,000
120,000
500,000
5,000
30,000
30,000
30,000
30,000
125,000
40,000
0
20,000
0
0
0
40,000
20,000
0
10,000
5,000
0
(5,000)
(5,000)
Deferred tax calculation
Asset carrying
value
80,000
60,000
Tax base
0
0
Temporary
differences
80,000
60,000
Deferred tax
liability
20,000
15,000
Deferred
Tax @ 25%
Change in
deferred tax
to statement
of profit or
loss
20,000
(5,000)
Profit for year 100,000
Income tax
5,000
Deferred tax
20,000
Total tax
25,000
Profit after
tax
75,000
(5,000)
0
0
100,000 100,000 100,000 100,000 500,000
30,000
30,000
30,000
30,000
(5,000)
(5,000)
(5,000)
(5,000)
25,000
25,000
25,000
25,000 125,000
75,000
75,000
75,000
75,000
375,000
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Key Summary Point
Deferred tax is an accounting measure made to match the tax
effects of transactions with their accounting impact
Example
I s a deferred tax asset/liability to be recognised or not in the following
scenarios?
••
A company has tax losses it cannot utilise in the current period, but the
local tax laws allow these losses to be carried forward indefinitely and
set against future profits.
Yes, a deferred tax asset should be recognised
••
Receivables of 240,000 are stated net of allowances for doubtful debts of
20,000. No tax relief is available for allowances for doubtful debts.
Yes, a deferred tax asset will be recognised
••
Accrued income at the period end is 30,000, but the tax base is zero as it
is taxed when received.
Yes, a deferred tax liability must be recognised.
Key Summary Point
A deferred tax asset must be recorded for all temporary
differences to the extent it is probable that taxable profits will
be realised in future but there are specific rules for deferred
tax arising from initial recognition of an asset/liability.
3.3.10 Disclosure
IAS 12 requires detailed disclosure concerning tax as follows:
The major components of the tax expense must be disclosed separately including:
••
••
••
current tax expense;
••
••
the amount of deferred tax expense or income arising due to changes in tax rates;
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any adjustment recognised in the period for current tax of prior periods;
the amount of deferred tax expense or income relating to the origination and
reversal of temporary differences;
the amount of the benefit arising from previously unrecognised tax loss, tax
credit or temporary difference;
Module 3
Section 3
••
the amount of tax expense relating to changes in accounting policy and
correction of errors;
••
the tax component relating to each component of other comprehensive
income;
••
an explanation of the relationship between tax expense and accounting profit.
The following should also be disclosed;
••
the amount of deductible temporary differences, unused tax losses and unused
tax credits for which no deferred-tax asset is recognised in the Statement of
Financial Position;
••
the aggregate value of temporary differences associated with investments in
subsidiaries, associates, branches and joint ventures for which no deferred tax
liabilities have been recognised;
••
for each type of temporary difference, unused tax loss and unused tax credit:
••
••
cc
the amount of the deferred tax asset and liability recognised in the Statement
of Financial Position, and
cc
the amount of the deferred tax income or expense recognised in the
statement of profit or loss;
details of tax on discontinued activities; and
details of changes in tax rates.
Key Points
•• Current tax is the amount of tax actually payable to the tax
authorities in relation to the trading activities of the entity.
•• Current tax is always shown on the face of the Statement
of Financial Position as a current liability.
•• Deferred tax is the accounting measure made to match the
tax effects of transactions with their accounting impact.
•• IAS 12 introduces the concept of a tax base for individual
assets and liabilities which may differ from the asset or
liability’s value for accounting purposes.
•• A deferred tax liability must be recognised for all temporary
differences, except goodwill.
•• Accounting
for deferred tax must be consistent with the
transaction or event itself.
•• Deferred tax liabilities must not be discounted to present
value, even if the time value of money is significant.
•• A deferred tax asset must be recognised for all temporary
differences to the extent that it is probable that a taxable
profit will be realised in the future.
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3.3.11 Self-Test Questions
Question 1
Robbie Limited is a company involved in the music industry, preparing its financial
statements to 31st December each year.
Statement of Financial Position as at 31st December 2010
Non-current assets
Property, plant and equipment
Capitalised development costs
Current assets
Bank
Equity and liabilities
Share capital
Retained earnings
Non-current liabilities
Government grants
Deferred tax (liability at 1.1.2010)
Current liabilities
Trade payables
Book value
‘000
Tax base
‘000
1,440
4,920
6,360
960
0
960
96
6,456
96
1,056
120
3,096
3,216
120
96
216
2,400
816
3,216
0
816
816
24
24
6,456
1,056
Additional information
a)
b)
c)
d)
The directors decided to record the property at revalued amount with effect
from 31st December 2010. The fair value of the property at 31st December
2009 was 600,000 more than net book value above.
The development costs of 4,920,000 shown above have been capitalised in
accordance with IAS 38. These costs are an allowable tax expense in the
period in which they are incurred.
Government grants are not taxable.
The rate of tax is 25%.
Requirement
Calculate the deferred tax expense and the deferred tax asset or liability at
31st December 2010.
Solution
Property, plant and equipment
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Book
value
‘000
2,040
Tax
base
‘000
960
Taxable
Temporary
difference
1,080
(Continued)
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Section 3
Capitalised development costs
Bank
Government grants
Deferred tax (liability at 1.1.2010)
Trade payables
4,920
96
2,400
(816)
(24)
0
96
0
(816)
(24)
4,920
0
0
0
6,000
1,500
(816)
684
Deferred tax liability @ 25%
Opening balance
Movement
Split-other comprehensive income
(deferred tax on revaluation gain)
600 @ 25%
Statement of Profit or Loss and other
Comprehensive Income
(150)
534
Question 2
The following details have been extracted from the records of Andrews Limited at
31 December 2010.
Asset/(liability)
Machinery
Accounts receivable
Provisions (warranty on products)
Value in Statement of
Financial Position
195,000
270,000
20,000
Tax base
140,000
300,000
0
Andrews Limited charges depreciation at 20% while the tax allowance of machinery
is 25%. Tax relief is only allowed on provisions when the amount is paid. The
receivables balance of 270,000 is calculated after allowance for doubtful debts of
30,000.
Tax is payable at 30%
Requirement
Calculate the temporary differences for Andrews Limited as at 31 December 2010,
giving reasons for your answer.
Solution
Andrews Ltd
Deferred Tax Worksheet as at 31 December 2010
Carrying Future
Future
Tax
Taxable
amount taxable deductible
base
temporary
amount
amount
differences
Assets
Receivables (1)
Machinery (2)
Liabilities
270,000
(0)
195,000 (195,000)
30,000
140,000
300,000
140,000
Deductible
temporary
differences
30,000
55,000
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Provision for
warranty (3)
Total
Deferred tax
liability 30%
Deferred tax
asset 30%
Beginning
balances
Movement
during year
Adjustment
Section 3
20,000
0
(20,000)
0
20,000
55,000
50,000
16,500
15,000
(0)
(0)
-
-
16500 Cr
15000 Dr
Explanations
1.
2.
3.
Receivables. The carrying amount is 30,000 less than the tax base due to
the allowance for doubtful debts. This reduction will only occur for taxation
purposes when the debts actually go bad and are written off in the books.
Thus, a deductible temporary difference exists for which a deferred tax asset
will be raised.
Machinery. The tax base for machinery is less than the carrying amount
because the asset is being depreciated faster for taxation purposes than for
accounting purposes. Thus, the company will be paying less tax in the early
years of the asset’s useful life due to the extra deduction for depreciation.
When the asset is written off for tax purposes, the accounting expense will
not be deductible and more tax will be payable. Thus, a deferred tax liability
is created.
Provision for warranty. The carrying amount of the liability is 20,000 greater
than the tax base of zero. Expenditure on warranty claims will only be
deductible when they are paid. Hence the carrying amount represents future
deductions for which a deferred tax asset should be raised.
3.3.12Examples from Published Financial Statements –
see Appendix M3
Rio Tinto plc year ended 31 December 2009 (UK)
Note to the Financial Statements
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3.4
IAS 21 The Effects of Changes in Foreign Exchange
Rates
This section provides guidance on the practical implementation of IAS 21 The
Effects of Changes in Foreign Exchange Rates. Many businesses now operate in
a global environment and even the smallest of entities is likely to have at least
occasional transactions denominated in a foreign currency. There are other entities
which may have operations or branches located in a foreign country. The results of
these operations will need to be translated into the currency in which the financial
statements are presented before the results can be consolidated. All these matters
are addressed in IAS 21.
Objective of IAS 21
The objective of IAS 21 The Effects of Changes in Foreign Exchange Rates is to
prescribe the accounting treatment for transactions in a foreign currency. At the
centre of the standard is the concept of the entity’s functional currency.
3.4.1
Functional Currency
The functional currency of an entity is defined as the currency of the primary
economic environment in which it operates. An entity cannot choose its own
functional currency. It is the currency in which the entity primarily generates and
spends its cash. The standard sets out the factors to be taken into consideration
when determining an entity’s functional currency as follows:
••
it is the currency which mainly influences the selling prices for the entity’s
goods and services;
••
it is the currency of the country whose competitive forces and regulations
determine selling prices of its goods and services;
••
it is the currency which mainly influences the cost of labour and materials of
the entity;
••
it is the currency in which finance for the entity is generated.
Key Summary Point
An entity cannot choose its functional currency. It is the
currency of the primary economic environment in which the
entity operates.
3.4.2
Accounting for Foreign Currency Transactions
Where an entity has transactions in a foreign currency, these transactions must be
translated or converted into the functional currency before they can be recorded.
These transactions include:
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••
••
••
Section 4
buying or selling goods or services;
borrowing or lending funds in a foreign currency;
otherwise acquiring or disposing of assets in a foreign currency.
The foreign currency transaction is initially recognised at the date of the transaction
at the ‘spot exchange-rate’. The spot rate is the exchange rate for immediate delivery.
When payment is received, or the amount settled, the spot rate may be different
from that at the date of the initial transaction. This will give rise to a gain or loss
on foreign exchange.
Example
Abbey purchased office equipment from America on 1 June at a cost of $5,000.
She paid for the equipment on 1 August. Abbey’s functional currency is €.
Relevant exchange rates are as follows;
Date
1 June
1 August
€
1
1
$
1.5
1.3
The accounting entries for this transaction are as follows:
Debit
The initial transaction is translated at the spot rate
at that date 5,000/1.5  3,333
Debit Property, plant and equipment
Credit Trade payables
At the date of payment the actual amount paid
is 5,000/1.3  3846
Debit Trade payables
Credit Bank
There is an exchange difference of 3,333  3,846
DebitExchange loss expense (Statement of Profit
or Loss and other Comprehensive Income)
Credit Trade payable
Credit
3,333
3,333
3,846
3,846
513
513
3.4.3Treatment of Gains and Losses Arising on
Foreign Currency Transactions
Any gain or loss arising on a foreign exchange transaction is recognised in profit or
loss in the period in which it arises.
If at the reporting date there is an amount (receivable or payable) outstanding
(a monetary asset or liability) denominated in a foreign currency, this must be
converted into the functional currency of the entity. The spot rate at the reporting
date is used (closing rate). Any profit or loss on exchange is recognised in profit or
loss for the period.
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Example
Abbey purchased office equipment as detailed above. She prepares her
financial statements to 30 June each year.
Relevant exchange rates are as follows;
Date
1 June
30 June
1 August
€
1
1
1
$
1.5
1.4
1.3
The accounting entries for this transaction are as follows:
Debit
The initial transaction is translated at the spot rate at that
date 5,000/1.5  3,333
Debit Property, plant and equipment
Credit Trade payable
Credit
3,333
3,333
At the year end the monetary liability must be converted to 5,000/1.4  3,571.
There is a difference of 238 to be taken to the Statement of Profit or Loss and
other Comprehensive Income
Debit
Exchange loss (Statement of Profit or Loss)
(only)
Credit
Trade payable
At the date of payment the actual amount paid is used
5,000/1.3  3846
Debit Trade payable
Credit Bank
There is an exchange difference of 3,571  3,846
Debit Exchange loss (Statement of Profit or Loss)
(only)
Credit Trade payable
238
238
3,846
3,846
275
275
The total amount recognised as a foreign exchange loss is the same in both
scenarios but, when there is a monetary liability at the period-end, the loss is
split between accounting periods.
At the end of the reporting period
(a)
foreign currency monetary item e.g. recoverables/payables shall be
translated using the closing rate
(b) non-monetary items that are measured in terms of historical cost in a
foreign currency shall be translated using the exchange rate at the date
of the transaction, and
(c) non-monetary items that are measured at fair value in a foreign currency
should be translated using the exchange rates at the date when the fair
value was measured
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Key Summary Point
Subject to certain exceptions, foreign currency transactions are
normally initially recognised at the spot exchange-rate at the
date of the transaction, resulting in a gain or loss arising when
the transaction is settled. Gains and losses are recognised on
outstanding foreign currency assets and liabilities at reporting
date using the spot rate on that date.
3.4.4
Foreign Operations
Some entities may have operations in a foreign country. The results of these
operations must be translated before they can be included in the consolidated
financial statements. The important factor where foreign operations are concerned
is determining the functional currency of the operations in the foreign location.
This will determine the accounting treatment.
This area is dealt with in Module 4
Key Summary Point
The functional currency of foreign operations determines the
accounting treatment.
3.4.5
Presentation Currency
Unlike the functional currency, which is determined by reference to a number of
factors and cannot be chosen by the entity, an entity can choose its presentation
currency. The presentation currency is the currency in which the financial statements
are reported.
Key Summary Point
The presentation currency is the currency in which the financial
statements are reported
3.4.6
Determining the Functional Currency of Foreign Operations
When determining the functional currency of foreign operations, all the factors
described above are taken into consideration, but there are additional considerations.
The entity needs to decide if the functional currency of the foreign operations is the
same as the functional currency of the reporting entity.
The additional factors are as follows:
••
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whether the activities of the foreign operation are carried out as an extension
of the reporting entity or do they have a significant degree of autonomy.
Module 3
Section 4
Autonomy can be demonstrated by local management of the foreign operations
determining selling prices, organising their own finance and only remitting a
dividend to the reporting entity;
••
whether transactions with the reporting entity are a high or a low proportion
of the foreign operation’s activities;
••
whether cash flows from the foreign operations directly affect the cash flows
of the reporting entity and are readily available for remittance to it – for
example, whether bank balances of the foreign operation are remitted to head
office on a daily basis;
••
whether the cash flows from the foreign operation are sufficient to service
existing or normally expected debt obligations without the need for funds
from the reporting entity.
3.4.7
Foreign Operations as an Extension of the Reporting Entity
Where the foreign operations are an extension of the reporting entity, the functional
currency of those operations will be the reporting entity’s functional currency as
that is the currency of the primary economic environment in which the foreign
activities operate. The foreign activities are translated into the functional currency
in the same way as individual transactions – i.e. the rate of exchange at the date
of the transaction is used and any resulting profit or loss on foreign exchange is
recognised in profit or loss for the period as it is part of the normal activities of the
business.
Key Summary Point
When foreign operations are an extension of the reporting
entity, both operations will have the same functional currency.
3.4.8
Autonomous Foreign Operations
Where the foreign operations are autonomous, the reporting entity’s interest is in
the net investment in the operations, not in the individual assets and liabilities. It
is therefore not appropriate to translate the individual assets at the date of these
transactions. The accounting treatment of the net investment is to translate the
operations at the closing rate. Any exchange gain or loss is not recognised in profit
or loss for the period but is shown in other comprehensive income and also in the
Statement of Changes in Equity, as it is taken to a foreign exchange reserve.
Key Summary Point
Where foreign operations are autonomous, the reporting
entity’s interest is in the net investment, which is translated at
the closing rate, not in individual assets and liabilities.
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Module 3
Section 4
Example
Case 1
AB Limited, a business based in France whose functional currency is the euro,
sets up a subsidiary in Australia, as it sees great opportunities in that country.
The Australian subsidiary only sells products manufactured in France by AB
Limited. The Australian subsidiary does not set its own selling prices. Staff
from the French head office are seconded to work in Australia and all finance
to set up the business was raised by head office.
The functional currency of the Australian subsidiary is euro as this is the
currency of the primary economic environment in which the business operates.
This means that all the transactions of the subsidiary will be translated as if
they were transactions of the parent – i.e. at the rate of exchange at the date
of the transaction. Any monetary assets and liabilities at the year-end will be
translated at the closing rate. Any gain/loss on translation will be recognised
in profit/loss for the year.
Case 2
AB Limited sets up a subsidiary in Australia. The new business is financed
partly by head office and partly by loans raised in Australian dollars. While the
Australian subsidiary sells AB Limited’s goods, it also sources complementary
products locally. While a member of staff was sent to oversee the opening
of the business, most of the employees are Australian. The local staff have
considerable autonomy in how the business is operated and are have
performance-related pay.
This is a mixed scenario as there is exposure to both euro and Australian
dollar. However, the balance would suggest that the functional currency of the
Australian subsidiary is Australian dollar as this is the currency of the primary
economic environment in which the business operates.
The interest of the parent is in the net investment and not in individual assets/
liabilities. Therefore, all assets and liabilities will be translated at the closing
rate. Any gain/loss on translation is not recognised in profit but in other
comprehensive income and taken to a reserve as the gain/loss is unrealised
until AB Limited disposes of the subsidiary.
3.4.9
Presentation Currency Compared with Functional Currency
An entity can present its financial statements in whatever currency it chooses. If
the presentation currency is different from its functional currency, its results and
financial position are translated as follows:
••
••
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assets and liabilities are translated at the closing rate;
income and expenses are translated at the rate of exchange at the date of
the transaction. For practical reasons average rates may be used where the
average approximates the relevant rates;
Module 3
••
Section 4
all exchange differences are shown as a separate component of equity, and
reported in other comprehensive income and the Statement of Changes of Equity.
Extract from Statement of Profit or Loss and other Comprehensive Income
Year ended 31 December 2010
Profit after tax
Other comprehensive income
Loss on exchange translation
Total comprehensive income
4,780
(238)
4,542
Note: Assuming 100% subsidiary, non-controlling interest would also need to be
accounted for if not a wholly-owned subsidiary-see Module 4.
Extract from Statement of Changes in Equity
Year ended December 2010
Opening balance
Comprehensive income
Dividends
Balance 31 December 2010
Share
capital
Retained
earnings
24,960
5,660
4,780
(200)
10,240
24,960
Exchange
translation
reserve
(10,402)
(238)
(10,640)
Total
20,218
4,542
(200)
24,560
Extract from Statement of Financial Position 31 December 2010
Capital and reserves
Share capital
Retained earnings
Exchange-translation reserve
24,960
10,240
(10,640)
24,560
3.4.10 Disclosure Requirements
The notes to the financial statements must disclose:
••
••
••
••
••
the functional currency of the entity;
the amount of exchange profit or loss recognised in profit or loss for the period;
the net exchange difference classified as a component of equity;
where the presentation currency is different from the functional currency, the
reason for using a different presentation currency should be disclosed; and
where there is a change in the functional currency of the entity or a significant
foreign operation, this fact must be disclosed together with reasons for the change.
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Module 3
Section 4
Key Summary Point
There are specific disclosure requirements in respect of
functional and presentation currency and resulting foreign
exchange profits and losses.
Key Points
•• An entity’s functional currency is the currency of its primary
economic environment.
•• An entity cannot choose its functional currency.
•• The presentational currency is the currency in which
the
financial statements are reported.
•• Where
an entity has a foreign currency transaction, this
is recognised at the date of the transaction at the “spot
exchange rate”.
•• Any movement between the “spot rate” at the date of the
transaction and the rate when payment is received or the
amount settled is an exchange gain or loss and is recognised
in profit/loss for the year. At the year end monetary assets
or liabilities in a foreign currency are translated at the closing
rate of exchange, with any difference taken to profit or loss.
•• Foreign
operations must be converted before they are
included in the entity’s financial statements.
•• The
accounting treatment of foreign operations depends
on the functional currency of those operations.
•• When foreign operations are an extension of the reporting
entity, both operations will have the same functional
currency and the foreign operations are treated in the same
way as foreign transactions, with any profit/loss on foreign
exchange taken to profit or loss in the periods incurred.
•• Where foreign operations are autonomous, the reporting
entity’s interest is in the net investment, not in individual
assets and liabilities.
•• Where
the foreign operations are autonomous, the
following apply:
ccassets and liabilities are translated at closing rate;
ccincome and expenditure are translated at the date of
the transaction or the average rate;
ccall exchange differences are shown as a separate
component of equity and reported in other
comprehensive income.
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Module 3
Section 4
3.4.11 Self-Test Questions
Question 1
On 1st January 2010 Wilbert Limited received an 18-month variable rate loan
denominated in US dollars of 150,000. The loan translated to €75,000 at the date
of receipt. Wilbert Limited repaid the loan on 30th June 2011 at a cost of €65,000.
Exchange rates:
31st December 2009 €1  2 Dollars
31st December 2010 €1  2.5 Dollars
Show how this loan should be accounted for in the financial statements to 31st
December 2010 and 31st December 2011.
Solution
Year ended 31st December 2010
Loan outstanding at year-end must be translated at closing rate
150,000/2.5  60,000
Exchange difference 75,000  60,000  15,000
Journal
US dollar Loan
15,000
Exchange gain to Statement of Profit or Loss (only)
15,000
At 30th June 2011
During the y/e 31 December 2011 the loan was repaid. The cost to the company
was more than the amount of the liability in the company accounts. Any difference
arising is taken to the Statement of Profit or Loss and other Comprehensive
Income
Journal
US dollar Loan
Exchange loss to Statement of Profit or Loss (only)
Bank
60,000
5,000
65,000
Question 2
Boat Ltd is an international shipping company which is currently targeting further
acquisition of foreign subsidiaries and branches in order to increase its operational
base. It prepares its accounts to 31 January each year. It has invested in an American
subsidiary, Anchor Inc; this investment is wholly financed by USD borrowings.
At 31 January 2009, an exchange loss of £2 million had arisen on the investment
while an exchange gain of £3 million had arisen on the borrowings.
Which of the following is the appropriate accounting entry in the consolidated
accounts of Boat Ltd at 31 January 2009?
a)
b)
c)
credit to the statement of profit or loss £1 million
credit to other comprehensive income £1 million
credit to the reserves £3 million
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Module 3
Section 4
Solution Answer (b)
The investment in the American subsidiary had US dollars as a functional currency.
Boat’s interest is its net investment in the subsidiary. Foreign currency movements
are therefore recognised in other comprehensive income under IAS 21.
3.4.12Examples from Published Financial Statements – See
Appendix M3
Ryanair year ended 31 March 2010 (Ireland)
Accounting Policy Note
Imperial Tobacco year ended 30 September 2010 (England)
Accounting Policy Note
CRH plc year ended 31 December 2009 (Ireland)
Accounting policy Note
Note to the financial statements
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Module 3
Section 5
Section 5
3.5
IAS 29 Financial Reporting in Hyperinflationary
Economies
In this section the principles underlying IAS 29 Financial Reporting in
Hyperinflationary Economies are introduced. Students are given practical guidance
to equip them to make judgments on when it is appropriate to apply this standard.
3.5.1
Definition of Hyperinflation
Hyperinflationary economies are those where money loses purchasing power at
such a rate that comparison of transactions which have taken place at different
times is misleading. IAS 29 does not set out an absolute rule as to what constitutes
hyperinflation. This is a matter of judgement for management. However, it does
provide guidance on indicators which may indicate that the economic environment
of a country may be experiencing hyperinflation. These indicators are as follows:
••
the general population prefers to keep its wealth in non-monetary assets or in
a relatively stable currency;
••
the general population regards monetary amounts, not in terms of the local
currency, but in terms of a stable currency. Prices may be quoted in that stable
currency;
••
sales and purchases on credit take place at prices that compensate for the
expected loss of purchasing power during the credit period;
••
••
interest rates, wages and prices are linked to a price index; and
the cumulative inflation rate over three years is approaching or exceeds 100%.
3.5.2
Commencement Date of Application of IAS 29
The standard states that it is preferable if all entities that report in the currency
of an economy that has been identified as hyperinflationary should apply the IAS
from the same date. However, the IAS further states that the requirements apply
to any entity from the beginning of the reporting period in which it identifies the
existence of hyperinflation in the country in whose currency it reports, regardless
of decisions made by other entities.
3.5.3
The Restatement of Financial Statements
Most entities prepare their financial statements on the historical-cost basis. No
adjustment is usually made for changes in the general level of prices, with the
notable exception of property, plant and equipment and investments, which are
often stated at revalued amount.
IAS 29 requires that the financial statements of an entity whose functional currency
is the currency of a hyperinflationary economy, whether prepared on a historicalcost basis or on a current-cost basis, must be stated in terms of the measuring unit
current at the reporting date. Adjustment is also required to the corresponding
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Module 3
Section 5
figures for the previous period, which are restated in terms of the measuring unit
at the reporting date.
The net gain or loss on the net monetary position must be included in profit or loss
for the period and disclosed separately.
Key Summary Point
IAS 29 requires that financial statements of entities operating
in hyperinflationary economies be stated in terms of the
measuring unit current at the reporting date. These economies
are those where money loses purchasing power at such a
rate that comparison of transactions that have taken place at
different times is misleading.
Presentation of information required by IAS 29 as a supplement
to unrestated financial statements is not permitted and the
presentation of financial statements before restatement is
discouraged.
3.5.4
Restatement of Individual Balances
At the year-end, non-monetary items in the Statement of Financial Position are
restated by applying a general price index. The index used will apply from the date
of original acquisition to the period-end date.
No adjustment is required to monetary items as they are already stated in terms of
the monetary unit at the period-end. An exception to this rule arises where there is
an agreement on changes in prices, such as an index-linked loan. In this case the
adjustment required will be in line with the agreement.
If inventory has been written down to net realisable value, no additional adjustment
will be required as it is already stated at an amount current at the reporting date.
Other assets stated at market value, such as investments, do not require adjustment
for the same reason.
The standard requires that all items in the Statement of Profit or Loss and other
Comprehensive Income are expressed in terms of the measuring unit current at the
period end. This is achieved by applying a general price index from the dates when
transactions occurred to the period end.
3.5.5
Index
The standard requires that a general price index be used to reflect the changes
in general purchasing power. It also states that it is preferable that all entities
reporting in the currency of the same economy use the same index.
Key Summary Point
At year-end, non-monetary items that are not revalued to
current valuation must be restated by applying a general price
index.
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Module 3
3.5.6
Section 5
Cessation of Application
When the economy ceases to be hyperinflationary, the entity must cease to restate
its financial statements. The amounts reported in the last set of restated financial
statements form the basis for the preparation of subsequent financial statements.
3.5.7
Disclosure
An entity must disclose the following:
••
the fact that the financial statements and the corresponding figures for previous
periods have been restated for changes in general purchasing power of the
functional currency at the period-end;
••
whether the financial statements are based on historical cost or current cost;
and
••
the identity and level of the price index at the period end and the movement
in the index during the current and previous period.
Example
On 1 January 2006 a UK-based company set up in a country suffering from
hyperinflation. It acquired land in that hyperinflationary country on 1st
January 2006 for T400, 000.
Exchange rates
1 January 2006
T5  £1
31 December 2010
T25  £1
Relevant price index
1 January 2006
100
31 December 2010
550
If no general price index adjustment is made the position would be as follows
At 1 January 2006
400,000/5
80,000
At 31 December 2010
400,000/25
16,000
Exchange loss
64,000
Under IAS 29 adjustment
400,000 3 550/100  2,200,000
At 1 January 2006
At 31 December 2010
Exchange gain
400,000/5
2,200,000/25
80,000
88,000
8,000
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Module 3
Section 5
Key Points
•• Accounting in hyperinflationary economies is dealt with in
IAS 29.
•• Hyperinflationary
economies are those where money
loses purchasing power at such a rate that comparison of
transactions which have taken place at different times is
misleading.
•• IAS
29 sets out the factors which may indicate that an
economy is experiencing hyperinflation.
•• One
indication is where cumulative inflation over three
years is approaching or exceeds 100%.
•• An
entity whose functional currency is that of a
hyperinflationary economy must be restated in terms of
the measuring unit current at the reporting date.
•• Presentation of information required by IAS 29 as a supplement
to unrestated financial statements is not permitted.
•• Presentation of financial statements before restatement is
discouraged.
•• It is preferable if all entities that report in the currency that
has been identified as hyperinflationary should apply the
IAS from the same date.
3.5.8Extracts from Published Financial Statements – See
Appendix M3
Smurfit Kappa Plc year ended 31 December 2009 (Ireland)
Accounting Policy Note
British American Tobacco year ended 31 December 2009 (England)
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Module 3
Section 5
Learning Objectives
On completion of this Module, you should:
•• Be able to explain the essential characteristics of lease agreements and be
able to distinguish between an operating and a finance lease
•• Be able to design the appropriate accounting policies for both lessees and
lessors in accounting for both operating and finance leases
•• Be able to outline the disclosures to apply in relation to finance and
operating leases in accordance with IAS 17 Leases
•• Understand the likely impact of the ED Leases ED/2013/16 on current practice
•• Be able to explain the background to IAS 37 Provisions Contingent Liabilities
and Contingent Assets
•• Be able to define provisions, obligations both legal and constructive, and
contingent liabilities and contingent assets
•• Be able to explain the accounting treatment for provisions and how to
calculate them
•• Be able to apply the principles in IAS 37 to specific issues (e.g. restructuring,
onerous contracts and foreseeable losses)
•• Be able to outline the impact of the changes from current practice that will
arise from the implementation of the ED Measurement of Liabilities in IAS
37 ED/2010/1 in the near future
•• Understand how to account for current tax liabilities and assets
•• Understand taxable temporary differences and deductable temporary
differences and how these affect the calculation of deferred tax
•• Be able to apply the measurement rules of IAS 12 Income Taxes in creating
deferred tax assets and liabilities and explain the disclosure requirements
•• Understand the definitions of functional and presentation currency as
defined by IAS 21 The Effects of Changes in Foreign exchange rates
•• Be able to apply the rules in IAS 21 in accounting for single entity transactions
•• Understand how to account for exchange differences
•• Be able to explain how to translate from functional to presentation currency
•• Be able to describe the characteristics that may indicate that an economy
is hyperinflationary as set out in IAS 29 Financial Reporting in
Hyperinflationary Economies
•• Be able to explain the procedures required to adjust the historical financial
statements for inflation prior to the process of translation under IAS 29
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Module 3
Section 5
Module 3 Classroom Case Studies
Case Study 1
Clifford Limited has prepared its draft financial statements as follows:
Statement of Profit or Loss and other Comprehensive Income for the year ended 31st
December 2010
Revenue
‘000
720
Cost of sales
Gross profit
Administrative expenses
Finance costs
Profit before tax
Income tax expense
Profit for the period
(420)
300
(180)
(15)
105
25
80
Statement of Financial Position as at 31st December 2010
Non-current assets
Property, plant and equipment
Current assets
Inventories
Receivables
Bank
Equity and liabilities
Share capital
Retained earnings
Non-current liabilities
Loan
Provision
Current liabilities
Trade and other payables
Current tax payable
Loan
a)
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2010
‘000
216
38
36
50
340
60
130
190
28
36
40
24
22
340
During 2010 Clifford entered into a lease for shop equipment. The lease is
initially for 5 years and rentals are 60,000, due annually in advance. Both parties
have the option to extend the lease for a further 5-year period at an annual
Module 3
b)
c)
d)
Section 5
rental of 50. The fair value of the equipment at the date of inception of the
lease was 255,000, and the expected useful life is 5 years. One 60,000 payment
was made during the year and included in property, plant and equipment.
Depreciation has been calculated at 20% straight-line. The effective interest
rate is 8.855%.
Due to a change in the law at 31st December 2010, the company is legally
obliged to restore the environment at one of its horticultural sites, where it
extracts peat, when extraction is complete. This is expected to occur in 2020.
It is estimated that the costs of rectification will be one million in 2020. The
appropriate discount rate is 10%. No adjustment has been made in the draft
financial statements.
The provision in the draft financial statements relates to the refurbishment of
the company’s premises. The refurbishment takes place every 4 years and the
provision has been built over 3 years.
During the year to 31st December 2010 the company introduced a new product
with a 3-year warranty at no extra cost to the customer. The selling price of the
product was 400. During 2010, 300 units were sold and have been included
in the draft financial statements. One of Clifford’s competitors sells a similar
produce for 350 excluding a warranty, while an independent insurer offers a
3-year warranty for 70. The experience of similar products is that there is an
equal probability of the product breaking down in each of the 3 years covered
by the warranty. Only 10% of the machines are likely to develop faults during
the warranty period, costing 20 to repair. No claims were made during 2010.
Requirement
Advise the company of the treatment of the above items and adjust the financial
statements appropriately.
Case Study 2
You are the newly-appointed financial accountant of Martin plc, a company that
prepares its financial statements to 31st December each year. A trial balance has
been extracted from the books and you have been asked to prepare the financial
statements for the year ended 31st December 2010.
Martin plc trial balance as at 31st December 2010
Note
Property, plant and equipment – carrying amount at
31st December 2009
Inventory at 31st December 2009
Trade receivables
Allowance for trade receivables as at 31st December
2009
Trade payables
Dr
‘000
18,570
Cr
‘000
620
430
9
10
1,260
(Continued)
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Module 3
Section 5
Bank
10% debentures
Ordinary shares
Share premium account
Deferred tax
General reserve
Retained earnings as at 31st December 2009
Provision for warranties
Revenue
Purchases
Administrative expenses
Debenture interest
Under-provision for tax 2009
80
720
4,000
620
200
5,800
4,690
100
8,200
3
10
4,500
1,500
50
10
25,680
25,680
Additional information
1. Inventory at 31st December 2010 was valued at 740,000.
2. Property plant in the company’s trial balance comprises:
Cost
Accumulated depreciation
Carrying amount
31 December 2010
Freehold
property
‘000
17,500
Equipment
Ships
Total
‘000
960
‘000
1,720
‘000
20,180
(930)
16,570
(380)
580
(120)
1,600
1,430
18,750
Freehold property is to be revalued at 31st December 2010 at 19,000,000
3. Deferred tax is to be provided in full.
The tax bases for the assets are as follows:
Tax base
‘000
Property
17,500
Equipment
700
Ships
1,000
4. Profits are taxed at 30%.
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Module 3
Section 5
5. During the year Martin plc entered into the following lease arrangements:
Lease 1
Electronic equipment
Yearly rental payable in advance
Term of lease
Date of lease
Fair value of equipment
Possible secondary term at 100 p.a.
Anticipated life of asset
Effective interest rate
9,000
5 years
1 January 2010
40,000
10 years
8 years
6.26%
Lease 2
Plant
Yearly rental payable in advance
Term of lease
Date of lease
Fair value of equipment
Anticipated life of asset
2,000
3 years
1 January 2010
30,000
20 years
One year’s rental has been paid for both leases and is included in operating
expenses in the trial balance. No other entries were made in the accounts.
6. Martin plc had the following foreign exchange transactions during 2010:
$
1
2
Rate of exchange at
date of transaction
$.60
Purchase of goods
2,000
for resale 1.3.10
Date of settlement
1.4.2010
$.50
The only accounting entry made was the transfer of funds on
1.4.2010
Purchase of goods
5,000
$.65
for resale 1.12.10
Date of settlement
10.1.2011
$.60
Rate of exchange at 31 December 2010
$.55
No entries were made in the books of account in the year to 31
December 2010
7. During
the year ended 31st December 2010, a claim was made against
Martin plc by a customer alleging poor workmanship, irreparable damage to
their vehicle and substantial inconvenience. Martin plc’s legal advisors have
indicated that the company will most likely have to pay damages of 50,000
but that it may be possible to counterclaim against the manufacturer of the
equipment for 10,000.
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Module 3
Section 5
8. The
directors estimate that the tax charge on profits for the year to 31st
December 2010 will be 180,000.
9. It
is company policy to maintain an allowance for doubtful debts equal to
5% of gross trade receivables.
10. Martin plc offers a 12-month warranty on one of its products. The provision
in the trial balance is for this purpose and is made up as follows:
Balance 31.12.2009
Repair costs during 2010
‘000
190
90
100
Provisions are only allowed for tax when amounts are paid.
During 2010 Martin plc sold 100,000 units of this product. The company
estimates that 90% of these products will be fault free. 50% of those products
with faults will need to be replaced at a cost of 40 each and 50% will cost
10 to repair.
11. Martin has a division which is involved in shipping. The directors have told
you that a major overhaul is required to its vessel every five years. They
estimate that the cost of the overhaul will be one million and have told you
to include 20% of the cost in the financial statements to 31st December 2010.
12. Some years ago the company entered into a 10-year lease for office premises.
These premises are now vacant as they are superfluous to the needs of the
business. The company is unable to sublet the premises due to a clause in
the lease agreement prohibiting subletting. Rent is 50,000 per annum. The
annual rent for the year to 31st December is included in operating expenses
in the trial balance. The lease has four years left to run. The landlord has said
he is prepared to cancel the lease if compensation of 180,000 is paid within
90 days.
13. Martin plc has given an unlimited guarantee to the bank concerning the
overdraft of Oreo Ltd, a related company. The overdraft is currently 100,000,
but the company is solvent and trading normally.
14. Martin plc prides itself in its environmental policies and is considered a
‘green company’ by its customers. During late 2010 the company caused
damage to the landscape near its factory. The cost of making good the
damage is estimated to be 30,000. There is no legal requirement to make
good the damage.
15. The cost of capital of Martin plc is assumed to be 10%.
16. The present value for 10% is as follows;
Year
1
2
3
4
5
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Factor
.90
.82
.75
.68
.62
Module 3
Section 5
Requirement
(a) advise the directors on the amounts that can be included in the financial
statements to 31st December 2010 for provisions;
(b) prepare the deferred tax computation;
(c) prepare the entries for leases;
(d) prepare the entries for foreign transactions;
(e) prepare the financial statements for Martin plc for the year ended 31 December
2010.
Case Study 3
Titchmarch plc is a company involved in gardening supplies. The assistant accountant
has produced the draft financial statements for the year ended 31st December 2010,
as follows:
Titchmarch plc
Draft Statement of Profit or Loss and other Comprehensive Income for year ended
31 December 2010
Revenue
‘000
14,500
Cost of sales
Gross profit
Administrative expenses
Finance costs
Profit before tax
Income tax expense
Profit for the period
(9,100)
5,400
(2,000)
(400)
3,000
600
2,400
Draft Statement of Financial Position as at 31st December 2010
Non-current assets
Property, plant and equipment
Current assets
Inventories
Receivables
Bank
Equity and liabilities
Share capital
Share premium
Retained earnings
2010
‘000
14,070
2009
‘000
7,840
2,020
2,160
80
18,330
1,370
1,720
130
11,060
3,000
3,000
7,920
13,920
1,500
6,490
7,990
(Continued)
3/67
Module 3
Non-current liabilities
Loan
Current liabilities
Trade and other payables
Current tax payable
Section 5
670
420
3,170
570
18,330
2,150
500
11,060
Additional information
1.
2.
3.
4.
On 10th November 2010, when the exchange rate was €1  $2 Titchmarch
plc sold goods to an American company for $250,000. The sale has not
been recorded in the draft financial statements. The customer paid for the
goods on 17th January 2011, when the exchange rate was €1  $2.20. The
rate of exchange at 31st December 2010 was €1  $1.60.
In February 2011, one of the company’s customers lodged a legal claim
against the company, alleging that the company had been negligent in
carrying out work in November 2006. Titchmarch’s legal team have advised
that the claimant has a 60% chance of winning his case. The customer
is claiming 500,000 in damages. Legal fees are estimated to be 50,000,
regardless of the outcome of the case. No adjustment has been made in the
draft accounts for this case.
During the year, the company entered into a lease agreement for a machine
with a fair value of 75,000, and an economic life of five years and no
residual value. The terms of the lease are that the company will pay five
payments of 18,000 annually in advance. The first payment was paid on 3rd
December 2010 and was included in operating expenses. No other entry
has been made for this lease. Effective interest for the lease was 10.047%
On 12th December the directors decided to close down one of the company’s
operations. This would involve redundancy payments of 250,000. At 31st
December 2010 the directors’ decision had not been announced and no
action had been taken to implement it.
Requirement
Advise the company of the treatment of the above items and adjust the financial
statements appropriately.
Case Study 4
Marcus Limited, whose functional currency is £ Sterling, is preparing its financial
statements to 31st March 2010 and has asked for advice on the following points:
1.
3/68
The company had a number of transactions in € during the last months of the
financial year. No entries have been made except that the bank transactions
have been double entered in a “foreign currency suspense account”
Details are as follows:
a) On 1st January 2010, equipment costing €287,500 was purchased on
credit.
Module 3
Section 5
b)
On 14th February, inventory costing €72,000 was purchased on credit
from Zen.
c) On 27th February, the equipment supplier was paid in full.
d) On 18th March, the company paid Zen €20,000 on account.
e) On 21st March, sold inventory to Pat for €80,000.
The exchange rates are as follows:
1st January
14th February
27th February
18th March
21st March
31st March
£
1
1
1
1
1
1
€
 1.25
 1.22
 1.18
 1.12
 1.10
 1.05
2. Marcus provides a free three-year warranty with a new product introduced
this year. During the year ended 31st March 2010, 20,000 units were sold.
It is estimated that 15% of the units will develop faults, split evenly over
the three-year warranty period.
Expected cost of repair
Per unit
Year 1
20
Year 2
40
Year 3
60
25,000 was paid for repairs under warranty during the year ended 31st
March 2010.
3.
Marcus bought the premises of a competitor from the liquidator, as the
site was better than that previously occupied by Marcus. Production has
been moved to the new premises. Unfortunately the company has a lease
on its old premises with 5 years remaining. The annual rent is 30,000, and
Marcus has not been able to find a tenant. Professional advice has been
received that the premises are unlikely to be let in the current climate.
Negotiation with the landlord had not been successful.
Requirement
You are required to prepare the relevant journal entries (together with
explanations) for the transactions listed above
Case Study 5
Loughridge plc (a UK company) acquired all the share capital of Tiger Limited,
a Croatian company, on 1st January 2008, when Tiger Limited’s reserves were
Kuna65 million. Loughridge’s presentation currency is the £ sterling. Tiger operates
independently of Loughridge and its functional currency is the Kuna (K).
3/69
Module 3
Section 5
Statement of Profit or Loss and other Comprehensive Income for year ended 31
December 2010
Loughridge plc
£’000
730,000
(470,000)
260,000
(80,000)
180,000
(70,000)
110,000
Revenue
Cost of sales
Gross profit
Administrative expenses
Profit before tax
Income-tax expense
Profit for the period
Tiger Ltd
K’000
500,000
(320,000)
180,000
(60,000)
120,000
(50,000)
70,000
Statement of Financial Position as at 31st December 2010
Non-current assets
Property, plant and equipment
Investment in Tiger Ltd
Current assets
Inventories
Receivables
Bank
Equity and liabilities
Share capital
Retained earnings
Non-current liabilities
Loans
Current liabilities
Trade and other payables
Loughridge plc
£’000
420,000
50,000
470,000
60,000
80,000
40,000
180,000
650,000
30,000
70,000
20,000
120,000
400,000
20,000
430,000
450,000
30,000
220,000
250,000
90,000
50,000
110,000
650,000
100,000
400,000
The relevant exchange rates are as follows:
1st January 2008
Average 2009
31st December 2009
31st December 2010
Average 2010
3/70
€1  K
2
2.5
3
5
4
Tiger Ltd
K’000
280,000
0
280,000
Module 3
Section 5
Requirement
Prepare the consolidated Statement of Profit or Loss and other Comprehensive
Income for the year ended 31st December 2010 and a Statement of financial Position
as at that date.
Case Study 1 Solution
a)
This finance lease must be recognised in the financial statements. The
lease term is for the useful life of the asset and the lease payments are
substantially all of the fair value of the asset.
Lease payments 5  60,000
300
Fair value of asset
255
Year ended Balance Repayment Balance Interest Closing Current Non-current
b/f
Int upon
Balance liability liability
31/12/2010
31/12/2011
31/12/2012
31/12/2013
31/12/2014
b)
255,000
212,267
165,751
115,115
59,995
260,000
260,000
260,000
260,000
260,000
195,000 17,267 212,267 46,517
152,267 13,483 165,751 50,636
105,751 9,364 115,115 55,120
55,115 4,880 59,995 60,000
–
–
2
2
165,751
115,115
59,995
2
2
The creating of the environmental damage was the event giving rise to
the liability to restore the environment. Therefore a provision is required.
However, as the payment will not be required until 10 years in the future the
liability may be discounted to present value. At the date of the recognition of
the provision, an asset of the same amount should be recognised. This will
be depreciated over the life of the asset (10 years). Over the next 10 years
the discount on the provision will unwind giving rise to a finance cost. There
is no need to recognise a finance cost or depreciation in the current year as
the provision is only being created at the reporting date
Discount 10%  1/(1.1)10  .3855
Therefore provision  1,000  3,855  385.5
Dr Property, plant and equipment
385.5
Cr Non-current provision
385.5
Being provision re environmental damage
(c)
This is not a qualifying provision under IAS 37. There
is no obligation to refurbish the premises. Therefore
provision must be reversed
Dr Provision
Cr Administrative expenses
36
36
Being reversal of provision for refurbishment
3/71
Module 3
(d)
Section 5
There are two separate sales (machine  warranty). It is
necessary to split the proceeds.
Machine only
350
Warranty
70
420
Machine 350/420  400  333
Warranty 70/420  400  67
Revenue recognised 300  400  120,000
Should be machine 300  333  99,900
Warranty 300  67/3  6,700
Total 106,600: difference 13,400
A provision is required for the repair of the machines as
the sale in the event giving rise to an obligation
300  10%  20 per unit  600
Income received in advance is deferred income
Dr Revenue
13.4
Cr Deferred income (current)
6.7
Cr Deferred income (non-current)
6.7
Being correction of revenue
Dr Administrative expenses
.6
Cr Provision: warranty
.6
Being expected cost of repairs
Statement of Profit or Loss and other Comprehensive Income for the year ended
31st December 2010
Revenue
‘000
720
Cost of sales
Gross profit
Administrative expenses
420
300
180
Finance costs
Profit before tax
Income-tax expense
Profit for the period
3/72
15
105
25
80
Adjustment
(d) 13.4
706.6
420
286.6
(a) 26
(c) 36
(d) .6
(a) 17
21
170.6
32
84
28
59
Module 3
Section 5
Statement of Financial Position as at 31st December 2010
2010
Adjustment
Non-current assets
‘000
‘000
Property, plant and equipment
216
(a) 255  60  26
(b) 385.5
Current assets
Inventories
38
Receivables
36
50
Bank
340
Equity and liabilities
Share capital
60
Retained earnings
130
21
190
Non-current liabilities
Loan
28
Provision
36
(b) 385.5
(c) 36
(d) .6
Finance lease
(a) 165
Deferred income
(d) 6.7
Current liabilities
Trade and other payables
Current tax payable
Loan
Finance lease
Deferred income
40
24
22
(a) 47
(d) 6.7
340
‘000
770.5
38
36
50
894.50
60
109
169
28
386.1
165
6.7
585.8
40
24
22
47
6.7
894.50
Case Study 2 Solution
(a) Provisions
There are a number of possible provisions to consider in accordance with
IAS 37.
Poor workmanship claim (note 7)
The legal advice received is that the company is likely to lose this case and is
likely to be required to pay damages of 50,000. As it is more likely than not
that damages will be paid, a provision for the full amount must be made at
31st December 2010. It is only possible that the counterclaim of 10,000 will
be successful. If it were probable that the money would be received it should
be disclosed as a contingent asset
3/73
Module 3
Section 5
Provide 50,000
Warranties (note 10)
The company has a legal obligation to fulfil conditions of the warranty and
there is sufficient evidence from past experience that they will be paid. The
amount of the repairs can be reliably measured using the expected-value
technique.
No repairs
Repairs 10 per unit
Replacement 40 per unit
Total provision
Provision in TB
Increase in provision
90% 100,000
5% 100,000
5% 100,000
0
50,000
200,000
250,000
100,000
150,000
Provide additional 150,000
Major overhaul (note 11)
A major overhaul may be required by law, but it does not meet the requirements
of IAS 37 as the company could dispose of the ship and therefore avoid the
overhaul cost. No liability exists
No provision is made
Onerous contract (note 12)
This is an onerous contract within the remit of IAS 37. This is a contract from
which the company will not receive a benefit. It should be provided for in
full at the lower of the cost of rentals or the compensation needed to secure
release from the contract.
The present value of future rent is as follows;
Year
1
2
3
4
Rent
50,000
50,000
50,000
50,000
PV factor
.90
.82
.75
.68
PV
45,000
41,000
37,500
34,000
157,500
As the PV of future rents is lower than the compensation required of 180,000,
the rents will be the amount of the provision
Provide
157,500
Bank guarantee (note 13)
This guarantee is a contingent liability and must be disclosed in the notes. No
provision is required as it is not probable that economic benefits will leave
the company
3/74
Module 3
Section 5
Environmental damage (note 14)
Martin plc has a constructive obligation to make good the environmental
damage as it has created a valid expectation that it will carry out the work.
Provide 30,000
Summary of provisions
Legal damages
Warranties
Onerous contract
Environmental damage
31.12.10
000
50
250
157.5
30
487.5
Change in
year
000
50
150
157.5
30
387.5
Note: Could split between current & Non-current Liabilities
(b) Deferred tax
Property (revalued)
Equipment
Ships
Receivables
(less doubtful debts)
Provisions
Carrying
amount
Tax base
‘000
19,000
580
1,600
408.5
‘000
17,500
700
1,000
430
487.5
90
Deferred tax liability
Deferred tax asset
Opening balance
Movement in year
Other comprehensive
income (revaluation)
Statement of profit or loss
30%
30%
Deductible
Taxable
Temporary Temporary
differences differences
‘000
‘000
1500
120
600
21.5
2,100
630
397.5
539
161.7
200
430
450
(20)
(c) Leases
Lease 1 is a finance lease as it is for substantially all of the life of the asset
and the lease payments are substantially the fair value of the asset and the
secondary period is at a bargain price
3/75
Module 3
Section 5
Year ended Balance Repayment Balance Interest Closing Current
b/f
Int upon
Balance liability
31/12/2010 40,000
31,000
1,941
32,941
29,000
31/12/2011 32,941
23,941
1,499
25,439
29,000
31/12/2012 25,439
16,439
1,029
17,468
29,000
31/12/2013 17,468
8,468
530
8,999
29,000
31/12/2014 8,999
–
29,000
2
2
Lease 2 is an operating lease and rentals are treated as
the non-cancellable operating lease in the notes.
Noncurrent
liability
7,501
25,439
7,971
17,468
8,470
8,999
9,000
2
–
2
expenses. Disclose
(d) Foreign currency
The transactions must be translated at the rate of exchange at the date
of the transaction. Any loss or gain on exchange translation is treated as
an expense in the Statement of Profit or Loss and other Comprehensive
Income. At the year-end any outstanding monetary asset/liability is
translated at the closing rate.
Debit
1
2
Accounting entries
Debit
Purchases
1,200
Credit
Payable
Being purchases 2000 @.60
Debit
Payable
1,000
Credit
Bank
Debit
Payable
200
Credit
Exchange gain
Being payment of 2,000 @.50 and gain
Debit
Purchases
3,250
Credit
Payables
Being purchases 5000 @.65
Debit
Payables
500
Credit
Exchange gain
Being gain on translation at 31.12.10 5000 @ (.65–.55)
(e) Accounts preparation
Revaluation
Carrying amount 31.12.10
Revaluation
Other comprehensive income
Deferred tax
Net revaluation
3/76
‘000
16,570
19,000
2,430
450
1,980
Credit
1,200
1,000
200
3,250
500
Module 3
Cost of sales
Opening inventory
Purchases
Closing inventory
Foreign transaction 1
Foreign transaction 2
Section 5
‘000
620
4,500
(740)
.2
3.25
4,383.45
Expenses
Operating expenses
Foreign transaction gain 1
Foreign transaction gain 2
Finance lease payment
Doubtful-debt provision (430 @ 5%  10)
Depreciation on lease
Provisions
Taxation
Current tax 2010
Under provision 2009
Decrease in deferred tax liability
Increase in deferred tax asset
‘000
1,500
(.2)
(.5)
(9)
11.5
5
387.5
1,894.3
180
10
(20)
(161.7)
8.3
Statement of Profit or Loss and other Comprehensive Income
for the year ended 31st December 2010
‘000
‘000
Revenue
8,200
Cost of sales
(4,383.45)
Gross profit
3,816.55
Administrative expenses
(1,894.3)
Finance costs (72  2)
(74)
Profit before tax
1,848.25
Income tax expense
(8.3)
Profit after tax
1,839.95
Other comprehensive income
Revaluation surplus
2,430
Deferred tax
(450)
1,980
Total comprehensive income
3,819.95
3/77
Module 3
Section 5
Statement of Changes in Equity
Ordinary Share General Revaluation Retained
surplus
earnings
share premium reserve
capital
‘000
‘000
‘000
‘000
‘000
Balance 1st
January 2010
Comprehensive
income
Balance 31st
December 2010
4,000
4,000
620
620
5,800
5,800
0
4,690
Total
‘000
15,110
1,980
1,839.95 3,819.95
1,980
6,529.95 18,929.95
Statement of Financial Position as at 31 December 2010
Non-current assets
Property, plant and equipment (18,570  2,430  40  5)
Deferred tax asset
Current assets
Inventories
Receivables (430-10-11.5)
‘000
740
408.5
Equity and liabilities
Share capital
Share premium
General reserve
Revaluation surplus
Retained Earnings
Non-current liabilities
Deferred tax
Provisions
Leases
10% debentures
Current liabilities
Trade payables (1260  2.75  22)
Bank overdraft
Leases
Current tax payable
3/78
‘000
21,035
161.7
21,196.7
1,148.5
22,345.2
4,000
620
5,800
1,980
6,529.95
18,929.95
630
487.5
25.5
720
1,863
1,284.75
80
7.5
180
1,552.25
Module 3
Section 5
Workings 1
Debentures 720 * 10% 5
Cost already incurred
Annual required
72
(50)
22
22,345.2
Case study 3 Solution
(a)
Dr
Cr
Dr
Cr
(b)
Dr
Cr
Record sale at date of transaction
$250,000/2  125,000
Receivables
Revenue
At year-end, monetary asset must be translated at
rate of exchange at reporting date
$250,000/1.6  156,250
Less already recognised 125,000, gives an exchange
gain of 31,250. This is taken to profit for the period
Receivables
Foreign exchange gain
At the date of settlement of the account, the
difference between the receivable as stated at the
reporting date and the actual amount received will
be recognised as an exchange loss in profit for the
period.
There is >50% chance of an outflow, but the claim
depends on the outcome of a court case and
therefore this is a contingent liability. No provision
made for damages, but contingent liability disclosed
in the notes.
The legal costs are a liability and must be recognised
at the period end.
Legal expenses
Trade and other payables
125,000
125,000
31,250
31,250
50,000
50,000
Year ended Balance Repayment Balance Interest Closing Current
b/f
Int upon
Balance liability
Noncurrent
liability
31/12/2010
31/12/2011
31/12/2012
31/12/2013
31/12/2014
49,220
34,357
18,001
–
–
75,000
62,727
49,220
34,357
18,001
218,000
218,000
218,000
218,000
218,000
57,000
44,727
31,220
16,357
–
5,727
4,494
3,137
1,643
–
62,727
49,220
34,357
18,001
–
13,506
14,863
16,357
18,000
–
3/79
Module 3
Section 5
Statement of Profit or Loss and other Comprehensive Income for the year ended 31st
December 2010
Revenue
‘000
14,500
Cost of sales
Gross profit
Administrative expenses
9,100
5,400
2,000
Finance costs
Profit before tax
Income tax expense
Profit for the period
400
3,000
600
2,400
Adjustment
(a) 125
(a) 31.25
(b) 50
(c) 18 15
(c) 6
103.75
‘000
14,625
9,100
5,525
2015.75
406
3103.25
600
2503.25
Statement of Financial Position as at 31st December 2010
Non-current assets
Property, plant and equipment
Current assets
Inventories
Receivables
Bank
Equity and liabilities
Share capital
Share premium
Retained earnings
Non-current liabilities
Loan
Finance lease
Current liabilities
Trade and other payables
Finance lease
Current tax payable
3/80
2010
‘000
14,070
2,020
2,160
80
18,330
Adjustment
(c) 75  15
(a) 125 31.25
3,000
3,000
7,920
‘000
14,130
2,020
2,316.25
80
18,546.25
3,000
3,000
103.25
(changes in
income)
8,023.25
13,920
14,023.25
670
670
49.5
3,170
570
18,330
(b) 50
(c) 13.50
3,220
13.5
570
18,546.25
Module 3
Section 5
Case Study 4 Solution
1.
As Marcus Limited’s functional currency is £ sterling, the transactions in euro
must be recognised at the rate of exchange at the date of the transactions.
Any movement in the exchange rate between the date of the transaction and
the date of settlement is taken as a loss/gain in the period in which it occurs
as part of operating profit. Any balances outstanding at the year-end must be
translated at the closing rate of exchange.
(a) Purchase of equipment
287,500/1.25  230,000
Dr Property, plant and equipment
230,000
Cr Supplier payables
230,000
Being purchase of equipment
(b) The purchase of inventory must be recorded at the date of
the transaction 72,000/1.22  59,016
Dr Purchases
59,016
Cr Payables
59,016
Being purchase of inventory
(c) The equipment supplier was paid in full, giving rise to an
exchange loss
Settlement 287,500/1.18  243,644
Initial recognition
Loss
230,000
13,644
The amount in PPE is not adjusted. The loss is taken in
profit for the year
Dr Exchange loss
13,644
Dr Payables
230,000
Cr Foreign exchange suspense a/c
243,644
Being loss on settlement of foreign currency transaction
(d) Settlement €20,000/1.12  17857
Initial recognition €20,000/1.22  16393
Loss  1,464
Dr Zen payables
Dr Exchange loss
Cr Foreign exchange suspense
Being payment on account to Zen
(e) Sale must be recorded at date of transaction
€80,000/1.10  72,727
Dr Receivables
Cr Revenue
Being euro sales
16,393
1,464
17,857
72,727
72,727
3/81
Module 3
Section 5
At the year-end all foreign currency assets and liabilities
must be translated at the closing rate which was £  €1.05
The outstanding balances are a payable of €52,000 and a
receivable of €80,000
Payable 52,000/1.05  49,523
Amount outstanding per books of account
59,016  16,393  42,623
Exchange loss 6,900  49,523  42,623
Dr Exchange loss
Cr Payables
Being exchange loss on translation of payables at year end
Receivable at year end €80,000/1.05  76,190
Amount per records 72,727
Gain on foreign exchange translation
76,190  72,727  3,463
Dr
Receivables
Cr
Exchange gain
6,900
6,900
3,463
3,463
Being gain on € receivable translation at year-end.
2.
The sale of these goods gives rise to an obligation, within the meaning of IAS
37. Therefore a provision must be set up when the sale is made.
20,000 units were sold during the year and 15% will require repairs. The best
estimate of the actual costs must be used to make up the provision.
Year 1
Year 2
Year 3
Units
20,000
20,000
20,000
%
5%
5%
5%
15%
Actual cost
Cost
20
40
60
to date
Provision
20,000
40,000
60,000
120,000
(25,000)
95,000
A provision for 95,000 must be set up, and charged to operating expenses.
Dr Administrative expenses
95,000
Cr Provision
95,000
3.
There is specific guidance given in IAS 37 concerning onerous contracts. These
are contracts in which the unavoidable costs of meeting the contract exceed the
economic benefits expected to be received from the contract. This lease would be
classified as an onerous contract. Therefore a provision must be set up for the full
amount of the rent for the next five years 5  30,000  150,000. This amount
can be discounted to present value, if the time value of money is material.
Dr Administrative expenses
Cr Provisions
3/82
150,000
150,00
Module 3
Section 5
Case Study 5 Solution
Goodwill calculation
K’000
Consideration
Share capital
Pre-acquisition retained earnings
£’000
50,000
30,000
65,000
95,000
@2
Goodwill at date of acquisition
Restated at year-end
Exchange loss
(47,500)
2,500
1,000
(1,500)
2/5
Consolidated Statement of Profit or Loss and other Comprehensive Income for
the year ended
31st December 2010
Revenue
Loughridge
plc
£’000
730,000
Tiger Ltd
K’000
500,000
Cost of sales
Gross profit
Administrative expenses
Profit before tax
Income tax expense
Profit for the period
470,000
260,000
80,000
180,000
70,000
110,000
320,000
180,000
60,000
120,000
50,000
70,000
4
4
4
4
Tiger
translated
£’000
125,000
£’000
855,000
80,000
45,000
15,000
30,000
12,500
17,500
550,000
305,000
95,000
210,000
82,500
127,500
Translation of Statement of Financial Position
Non-current assets
Property, plant and equipment
Investment in Tiger Ltd
Tiger Ltd
K’000
280,000
0
5
280,000
£’000
56,000
56,000
Current assets
Inventories
Receivables
Bank
Equity and liabilities
Share capital
30,000
70,000
20,000
120,000
400,000
5
5
5
6,000
14,000
4,000
24,000
80,000
30,000
2
15,000
3/83
Module 3
Retained earnings
Section 5
220,000
Profit for the year
Exchange loss
Balancing
figure
From SOCI
Per working
250,000
Non-current liabilities
Loans
Current liabilities
Trade and other payables
45,000
17,500
(27,500)
50,000
50,000
5
10,000
100,000
400,000
5
20,000
80,000
Exchange difference
K’000
Opening net assets
Share capital
Retained profits (220,000  70,000)
£’000
30,000
150,000
180,000
@ opening rate 3
@ closing rate 5
60,000
(36,000)
(24,000)
Difference between average rate and
closing rate in SOFP
Profit
@ average rate 4
@ closing rate 5
70,000
17,500
(14,000)
(3,500)
(27,500)
Consolidated reserves
Loughridge
Tiger
Balancing figure from SOFP
Profit for the year
Foreign exchange loss
Less pre-acquisition profits (65,000/2)
Re-translation of goodwill
£’000
430,000
45,000
17,500
(27,500)
(32,500)
2,500
(1,500)
431,000
3/84
Module 3
Section 5
Consolidated Statement of Financial Position as at 31st December 2010
Non-current assets
Property, plant and equipment
Goodwill
Investment in Tiger Ltd
Loughridge plc
£’000
420,000
Tiger Ltd
£’000
56,000
476,000
1,000
50,000
470,000
56,000
477,000
60,000
80,000
40,000
180,000
650,000
6,000
14,000
4,000
24,000
80,000
66,000
94,000
44,000
204,000
681,000
20,000
430,000
20,000
431,000
450,000
15,000
45,000
17,500
(27,500)
50,000
90,000
10,000
100,000
110,000
650,000
20,000
80,000
130,000
681,000
Current assets
Inventories
Receivables
Bank
Equity and liabilities
Share capital
Retained Earnings
Profit for the year
Translation reserve
Non-current liabilities
Loans
Current liabilities
Trade and other payables
451,000
3/85
Module 3 Appendices
Extracts from Financial Statements