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ACCA F7 Course Note by Mezbah Uddin PDF
ACCA F7 Course Note by Mezbah Uddin PDF
REPORTING (INT)
Primary objective of this document is to help students with
regular revision. Students are strongly advised to study full
text book chapters, regularly attend class lectures and
participate in discussion sessions for better understanding.
Course Note
Prepared by:
Mezbah Uddin Ahmed,
ACCA
Contents
Exam structure...................................................................................................................................... 2
Examiner................................................................................................................................................ 2
Past question analysis ......................................................................................................................... 3
Course plan ........................................................................................................................................... 5
IAS 1 Presentation of Financial Statements .................................................................................... 7
IAS 16 Property, plant and equipment ............................................................................................ 13
IAS 23 Borrowing costs ..................................................................................................................... 17
IAS 40 Investment property .............................................................................................................. 20
IAS 20 Government grants ............................................................................................................... 23
IAS 38 Intangible assets ................................................................................................................... 26
IAS 36 Impairment of assets ............................................................................................................ 29
IAS 8 Accounting policies, changes in accounting estimates and errors .................................. 32
IAS 17 Leases..................................................................................................................................... 35
IAS 18 Revenue ................................................................................................................................. 40
IAS 2 Inventories ................................................................................................................................ 42
IAS 37 Provisions, contingent liabilities and contingent assets .................................................. 44
IFRS 5 Non-current assets held for sale and discontinued operations ..................................... 48
IAS 11 Construction contracts .......................................................................................................... 51
IAS 12 Income taxes .......................................................................................................................... 53
Financial instruments ......................................................................................................................... 61
Consolidated statement of financial position.................................................................................. 65
Consolidated statement of comprehensive income ...................................................................... 69
IAS 7 Statement of cash flows ......................................................................................................... 71
Ratio analysis ...................................................................................................................................... 77
IAS 33 Earnings per share ................................................................................................................ 87
Receivables factoring ........................................................................................................................ 94
IAS 10 Events after reporting period ............................................................................................... 99
Important definitions......................................................................................................................... 101
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Topic
Consolidated financial statements
Single company financial statements
Cash flow statement &/ Ratios & interpretation of financial
statements
IFRS individual topic (one or two)
IFRS individual topic (one or two)
Marks
25 Marks
25 Marks
25 Marks
15 Marks
10 Marks
Examiner
The examiner is Steve Scott. Steve has many years experience in accounting lecturing at a leading
UK university. He qualified as an accountant with Stott and Golland and his background is in Audit
and Financial Reporting. He has been an ACCA examiner since 1998.
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FRMRK
Dec '07
4 (a), 5 (a)
Jun '08
4 (a)
IAS 2
4 (b)
IAS 7
Ratios
IAS 8
5 (b)
2 (ii)
2 (iv)
2 (v, vi)
Dec '08
3
Dec '09
4 (a)
3 (a-ii)
3 (b)
Jun '10
4 (a)
Dec '10
3
4 (a)
Dec '07
3
5
IAS 16
IAS 17
2 (i)
4 (b)
IAS 18
2 (vi)
4 (a), 4
(b-ii)
2 (a-iii)
IAS 23
2 (a-iv)
IAS 32
2 (ii)
Jun '09
2 (i)
2 (i)
Dec '09
2 (vi), 3 (i)
Jun '10
2 (ii), 3 (i)
Dec '10
2 (iii), 4 (b-i)
2 (ii)
Jun '11
2 (iii)
2 (ii), (vi)
2 (i)
2 (iii), 3 (ii), 5
2 (ii),
2 (iii)
2 (iv)
3 (i)
2 (i)
2 (iii), (iv), 3
(iii)
5
2 (vi),
3(ii), 4
(b-iii)
3 (i)
4 (b)
2 (ii)
Jun '12
2 (a-ii)
2 (a-ii)
IAS 37
IAS 38
2 (i)
2 (i)
4
2 (b)
IAS 40
IFRS 5
PASS
RATE
40%
33%
3 (i)
42%
Jun '09
30%
1 (i), 3
(ii), 4
(b)
Dec '09
Jun '10
Dec '10
2 (v)
5 (b)
2 (iii), 4
IAS 36
2 (iv)
Dec '11
Dec '08
IAS 33
2 (iii)
2 (i), 5
3 (iv)
2 (iv),
2 (vi)
Jun '08
Jun '08
2 (v)
2 (v)
2 (iii)
IAS 20
2 (v)
2 (v)
Dec '08
Dec '07
2 (ii)
IAS 12
2 (v)
Dec '11
Jun '12
IAS 11
Jun '09
Jun '11
IAS 10
39%
2 (ii)
2 (iii), 5
28%
47%
Jun '11
38%
Dec '11
56%
Jun '12
48%
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Class
No.
2
3
4
5
Date
Syllabus Area
Introduction to F7
IAS 1 Presentation of financial
statements
IAS 16 Property, plant and
equipment
IAS 16 Property, plant and
equipment
IAS 16 Property, plant and
equipment
BPP Text
Book Ref.
Chapter 3
Chapter 4
Chapter 4
18-Elite Leisure
Chapter 4
Chapter 4
21-Apex
Chapter 4
Chapter 4
Chapter 5
Chapter 6
Chapter 6
9
10
11
12
Questions to Practice
Chapter 7
Chapter 16
60-Branch, 61-Evans,
IAS 17 Leases
Chapter 16
62-Bowtock, 63-Fino
IAS 18 Revenue
Chapter 15
IAS 2 Inventories
Chapter 12
Chapter 13
Chapter 13
30-Partway (a)
Chapter 7
101-Manco
13
Chapter 12
14
Chapter 17
66-Bowtock II;
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15
Chapter 17
Chapter 14
16
17
18
19
20
21
22
23
24
25
26
Consolidated Statement of
Financial Position; Consolidated
Statement of Comprehensive
Income, IFRS 3 Business
combinations, IAS 27
Consolidated and separate
financial statements, IAS 28
Investment in associates
Chapter 5,
8, 9, 10, 11
Chapter 21
Ratios
Chapter 19
Chapter 18
Receivables factoring
Chapter 15
Chapter 20
FINAL MOCK - I
FINAL MOCK - II
* Financial reporting is a core area of ACCA study. Experience shows that students with poor F7
performance struggle in P2 & P7, and also working as professional accountant.
* Cherry picking of the syllabus areas shall never be a study strategy for ACCA.
* In most cases overlapping IAS/IFRS knowledge required to solve a problem. So, frequent revision of
previously learned IASs/IFRSs is mandatory.
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Page 7
$000
X
(X)
X
X
(X)
(X)
(X)
X/(X)
(X)
X
(X)
X/(X)
X/(X)
X/(X)
(single amount)
$X
$X
$000
$000
X/(X)
X/(X)
X/(X)
X/(X)
X/(X)
X/(X)
IFRS do not specify whether revenue can be presented only as a single line item in the statement
of comprehensive income, or whether an entity also may include the individual components of
revenue (for example: various sub-totals for banks).
Finance income cannot be netted against finance costs; it is included in Other income or show
separately in the income statement.
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XYZ plc Statement of Changes in Equity for the year ended 31 December 20X9
Ordinary
share
capital
Irredeemable
preference
share capital
Share
premium
Retained
earnings
Revaluati
on
reserve
Opening balance
Right issue or market
price issue of ordinary
share capital
(X)
(X)
(X)
Dividend
Profit/ (loss) after tax for
the year
Revaluation gain/ (loss)
(IAS 16)
Transfer of excess
depreciation from RR to
RE (IAS 16)
Gain/(loss) from Y/end
re-measurement of
financial assets through
other comprehensive
income
Closing balance (in
SFP)
Surplus from
financial
assets
through OCI
X
X/(X)
X/(X)
(X)
X/(X)
X/(X)
X/(X)
IAS 16 (PPE) permits and it is best practice to make a transfer between reserves of the excess
depreciation arising as a result of revaluation. [IAS 1: 41]
When an asset carrying using revaluation model is disposed, any remaining revaluation reserve
relating to that asset is transferred directly to retained earnings. [IAS 1: 41]
An entity can present components of changes in equity either in the Statement of Changes in
Equity or in the notes to the financial statements. [IAS 1: 106]
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X
X
X
X
X
X
X
X
X
X
X
X
X
X
Total assets
EQUITY AND LIABILITIES
Equity attributable to owners of the parent
Ordinary share capital
Preference share capital (irredeemable)
Share premium account
Revaluation surplus
Retained earnings
Non-current liabilities
Preference share capital (redeemable)
Finance lease liabilities (non-current portion)
Deferred tax liability
Long-term borrowings
$000
X
X
X
X
X
X
X
X
X
X
X
Current liabilities
Trade and other payables
Dividends payable
Current tax liability
Provisions
Short-term borrowings
Finance lease liabilities (current portion)
Total equity and liabilities
X
X
X
X
X
X
X
X
Reserves other than share capital and retained earnings may be grouped as other components
of equity.
Entities must present a set of previous years statements for comparison purposes.
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An
(a)
(b)
(c)
(d)
An
(a)
(b)
(c)
(d)
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An asset is a resource controlled by the entity as a result of past events and from which future
economic benefits are expected flow to the entity.
Initial recognition:
PPE should initially be recognised in an entity's statement of financial position at cost.
Cost is the amount of cash and cash equivalents paid to acquire the asset at the time of its
acquisition or construction PLUS the fair value of any other consideration given.
The initial estimate of dismantling and removing the item and restoring the site where it
is located if the entity is obliged to do so (to the extent it is recognised as a provision per
IAS 37). Gains from the expected disposal of assets should not be taken into account in
measuring a provision.
In case of a land, if initial estimation of restoration cost is capitalised then this capitalised
restoration cost shall be depreciated.
Any abnormal costs incurred by the entity, for example those arising from design errors,
wastage or industrial disputes, should be expensed as they are incurred and do not form part
of the capitalised cost of the PPE asset.
Estimated economic life and residual value of asset should be reviewed at the end of each
reporting period. If either changes significantly, the change should be accounted for over the
useful economic life remaining.
The residual value of an asset is the estimated amount that an entity would currently obtain
from disposal of the asset, after deducting the estimated costs of disposal, if the asset were
already of the age and in the condition expected at the end of its useful life. [IAS 16: 6]
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Subsequent expenditure only to be capitalised if enhances the life of the asset, or improves
quality or quantity of output, or reduces the cost. If not capitalised then recognise as expense
in I/S.
Examples of subsequent expenditure to be capitalised can include:
Modification of an item of plant to extend its useful life
Upgrade of machine parts to improve the quality of output
Adoption of a new production process, leading to large reductions in operating costs
Where an asset is made up of many distinct (i.e. significant) parts (examples: aircraft, ship),
these should be separately identified and depreciated.
Revaluation model:
Carrying asset at revalued amount less
subsequent accumulated depreciation and
impairment losses
ASSET IS REVALUED
Upwards
Has the asset previously
suffered a downward valuation?
Yes
Downwards
No
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No
Yes
Page 14
Revaluation model:
An entity can, if it chooses, revalue assets to their fair value (only if the fair value of the item
can be measured reliably)
For land and buildings this is normally determined based on their market values as
determined by an appraisal undertaken by professionally qualified valuers.
If this model is applied to one asset, it must also be applied to all other assets in the same
class.
Note that when the revaluation model is used PPE must still be depreciated. The revalued
amount is depreciated over the asset's remaining useful life.
For a revalued asset, IAS 16 allows (and encourage) a reserve transfer in the statement
of changes in equity (from revaluation reserve to retained earnings) of the 'excess'
depreciation because of an upward revaluation.
Methods of depreciation:
Straight line method
Reducing balance method
Machine hour method
Sum-of-the-digits method
Sum of the years of assets expected life = N X (N+1)/2 where N is the assets expected life
Cost of a lorry was $15,000 and expected to last for five years. No scrap value.
Sum of the years of assets expected life = N X (N+1)/2 = 5 X (5+1)/2 = 15
Depreciation in Year
1
$15,000 X 5 /15
= $5,000
2
$15,000 X 4 /15
=$4,000
3
$15,000 X 3 /15
= $3,000
4
$15,000 X 2 /15
= $2,000
5
$15,000 X 1 /15
= $1,000
Derecognition: Property, plant and equipment shall be derecognised (i.e. removed from the
statement of financial position) either:
On disposal; or
When no future economic benefits are expected from its use or disposal.
If on disposal of a revalued asset there remains a balance on the revaluation surplus relating
to the asset, this balance should be transferred to retained earnings.
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Page 15
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An entity shall capitalise (i.e. as part of the asset) borrowing costs that are directly attributable to
the acquisition, construction or production of a qualifying asset as part of the costs of that asset.
[IAS 23: 8]
Borrowing costs are interest and other
costs that an entity incurs in connection
with the borrowing of funds. [IAS 23: 5]
Borrowing costs eligible for capitalisation are those that would have been
avoided otherwise. [IAS 23: 10]
An entity shall cease capitalisation borrowing costs when substantially all the activities necessary
to prepare the qualifying asset for its intended use or sale are complete. [IAS 23: 22]
01.01.12
- $1m loan
@10% for 2
years
28.02.12
- Purchase order
made to buy the
asset
31.03.12
- Payment made
to buy the asset
31.12.12
- Asset is
delivered &
ready to use
31.12.13
- Loan is
matured and
repaid
All three
conditions are
met at this point.
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Page 17
Amount of borrowing costs available for capitalisation is actual borrowing costs incurred less any
investment income from temporary investment of those borrowings. [IAS 23: 13]
On 1 January 20X6 Stremans Co borrowed $1.5m to finance the production of two assets, both of which
were expected to take a year to build. Work started during 20X6. The loan facility was drawn down and
incurred on 1 January 20X6, and was utilised as follows, with the remaining funds invested temporarily.
Asset A
Asset B
$'000
$'000
1 January 20X6
250
500
1 July 20X6
250
500
The loan rate was 9% and Stremans Co can invest surplus funds at 7%.
Required: Ignoring compound interest, calculate the borrowing costs which may be capitalised for each of
the assets and consequently the cost of each asset as at 31 December 20X6.
Asset A
$
45,000
(8,750)
36,250
Asset B
$
90,000
(17,500)
72,500
500,000
36,250
536,250
1,000,000
72,500
1,072,500
For borrowings obtained generally, apply the capitalisation rate to the expenditure on the asset
(weighted average borrowing cost). [IAS 23: 14]
Acruni Co had the following loans in place at the beginning and end of 20X6.
1 January
31 December
20X6
20X6
$m
$m
10% Bank loan repayable 20X8
120
120
9.5% Bank loan repayable 20X9
80
80
8.9% debenture repayable 20X7
150
The 8.9% debenture was issued to fund the construction of a qualifying asset (a piece of mining
equipment), construction of which began on 1 July 20X6.
On 1 January 20X6, Acruni Co began construction of a qualifying asset, a piece of machinery for a
hydroelectric plant, using existing borrowings. Expenditure drawn down for the construction was: $30m on
1 January 20X6, $20m on 1 October 20X6.
Required: Calculate the borrowing costs that can be capitalised for the hydro-electric plant machine.
Capitalisation rate = weighted average rate = (10% (120/ (80 + 120))) + (9.5% (80 / (120 + 80))) = 9.8%
Borrowing costs = ($30m 9.8%) + ($20m 9.8% 3/12) = $3.43m
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Page 18
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Page 19
Investment property is a property (land or a building or part of a building or both) held (by
the owner or by the lessee under a finance lease) to earn rentals or for capital appreciation or
both, rather than for:
Use in the production or supply of goods or services or for administrative purposes; or
Sale in the ordinary course of business. [IAS 40: 5]
Points to note:
If a portion of an asset meets investment property criteria and other portion is not, then an
entity accounts for the portions separately (e.g. one portion under IAS 40 and another
under IAS 16) if those portions could be sold separately or leased out separately under
finance lease. [IAS 40: 10]
Where an entity owns property that is leased to, and occupied by, its parent or another
subsidiary, the property is treated as an investment property in the entity's own accounts.
However, the property does not qualify as investment property in the consolidated financial
statements as it is owner-occupied from the group perspective. [IAS 40: 15]
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Page 20
Measurement after recognition: After initial measurement at cost, an entity can choose between
two models: [IAS 40: 30]
The IAS 16 cost model
The fair value model
If the fair value model is adopted, the accounting treatment of investment properties will be as
follows:
All investment properties should be measured at fair value at the end of each reporting
period provided fair value can be measured reliably.
Changes in fair value, whether gains or losses, should be recognised in profit or loss
for the period in which they arise. [IAS 40: 35]
When determining fair value, do not deduct costs to sale from the fair value. [IAS 40: 37]
The policy chosen should be applied consistently to all of the entity's investment property
IAS 40 encourages the assessment of fair value by independent, appropriately qualified and
experienced professionals but does not require it.
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Page 22
An entity should not recognise government grants until it has reasonable assurance that: [IAS 20:
7]
- The entity will comply with any conditions attached to the grant
- The entity will actually receive the grant
Receiving the grant not necessarily prove that the conditions attached to it have been or will
be fulfilled.
The treatment will be same whether the grant is received in cash or given as a reduction in a
liability to government. [IAS 20: 10]
Option 2:
Example: A company receives a grant from the EU for CU100,000 towards the cost of a new factory.
The overall cost of the factory is CU1,000,000. It has a 50 year useful life and NIL residual value. The
company's policy is to apply the straight-line method of depreciation.
Option 1
Option 2
At recognition:
Statement of financial position
Assets:
Factory
1,000,000
Liabilities:
Deferred income
100,000
At recognition:
Statement of financial position
Assets:
Factory (1,000,000 100,000)
At Year 1 end:
Statement of financial position
Assets: NCA
Factory
1,000,000
Accumulated depreciation
(20,000)
980,000
Liabilities:
Deferred income
100,000
Income released in the year
(2,000)
98,000
(Current liabilities 2,000; Non-current liabilities
96,000)
At Year 1 end:
Statement of financial position
Assets: NCA
Factory
900,000
Accumulated depreciation
(18,000)
882,000
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900,000
Page 23
Grants relating to income: Such grants should be recognised in profit or loss as other income or
deducted from the related expense. [IAS 20: 29]
- As with grants related to assets, the benefit of the grant should be recognised in profit or loss
over the periods in which the entity recognises as expenses the related costs for which the
grants are intended to compensate.
Government grants that cannot reasonably have a value placed on them (for example the
provision of free services by a government department) are excluded from the definition of
government grants.
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Page 24
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Page 25
An intangible asset is an identifiable non-monetary asset without physical substance. [IAS 38: 8]
An asset is identifiable if it either: [IAS 38: 12]
(a) is separable, i.e. is capable of being separated or divided from
the entity and sold, transferred, licensed, rented or exchanged,
either individually or together with a related contract, identifiable
asset or liability, regardless of whether the entity intends to do
so; or
(b) arises from contractual or other legal rights, regardless of
whether those rights are transferable or separable form the
entity or from other rights and obligations.
An asset is a resource
controlled by the entity as
a result of past event(s)
and from which future
economic benefits are
expected to flow to the
entity. [IAS 38: 8]
IAS 38 states that an intangible asset is to be recognised if, and only if, the following criteria are met:
[IAS 38: 21]
it is probable that future economic benefits from the asset will flow to the entity
the cost of the asset can be reliably measured.
Purchased
After initial recognition an entity can choose between: [IAS 38: 72]
the cost model, and
the revaluation model: if an active market exists for that type of asset [IAS 38: 75]
An active market cannot exist for brands, newspaper mastheads, music and film
publishing rights, patents or trademarks, because each such asset is unique and
transactions are relatively infrequent. The price paid for one asset may not provide
sufficient evidence of the fair value of another. Moreover, prices are often not available
to the public. [IAS 38: 78]
An intangible asset (other than goodwill) acquired as part of business combination should be
recognised at fair value. [IAS 38: 33]
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Page 26
Development phase
Internally generated
Research phase
Research is original and planned investigation, undertaken with the prospect of gaining new
scientific or technical knowledge and understanding. [IAS 38: 8]
The result of research is unknown and, so, no probable future economic benefit can be
expected
IAS 38 states that all expenditure incurred at the research stage should be written off
to the income statement as an expense when incurred [IAS 38: 54], and will never be
capitalised as an intangible asset. [IAS 38: 71]
If an entity cannot distinguish the research phase from the development phase, treat that as
in the research phase. [IAs 38: 53]
Each development project must be reviewed at the end of each accounting period to ensure
that the recognition criteria are still met.
Internally generated goodwill should not be recognised as an asset. [IAS 38: 48]
Internally generated brands, mastheads, publishing titles, customer lists and items similar in substance
shall not be recognised as intangible assets. [IAS 38: 63]
An intangible asset with a finite useful life should be amortised over its expected useful life [IAS 38: 89]
An intangible asset with an indefinite life should not be amortised [IAS 38: 89], but should be reviewed
for impairment on an annual basis [IAS 38: 108]
There must be an annual review of whether the indefinite life assessment is still appropriate. [IAS 38:
109]
Residual values should be assumed to be nil, except if an active market exists or there is a commitment
by a third party to purchase the asset at the end of its useful life [IAS 38: 100]
An active market is a market in which all the following conditions exist:
(a) The items traded in the market are homogeneous (i.e. similar)
(b) Willing buyers and sellers can normally be found at any time; and
(c) Prices are available to the public.
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Page 27
Throughout life people will make you mad, disrespect you and
treat you bad. Let God deal with the things they do, cause
hate in your heart will consume you too.
- Will Smith
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Page 28
An asset is impaired when its carrying amount is higher than its recoverable amount. [IAS 36: 6]
Impairment loss = Carrying value Recoverable amount [IAS 36: 59]
higher of
Value in use:
-
Where it is not possible to estimate the recoverable amount of an individual asset, the entity estimates
the recoverable amount of the cash-generating unit to which it belongs. [IAS 36: 66]
A cash-generating unit is the smallest identifiable group of assets that generates cash inflows that
are largely independent of the cash inflows from other assets or groups of assets. [IAS 36: 68]
If an active market exists for the output produced by an asset or a group of assets, this group of
assets should be identified as a CGU even if some or all of the output is used internally. [IAS 36: 70]
If the cash inflows are affected by internal transfer pricing, managements best estimate of future
price that could be achieved in arms length transactions are used in estimating the CGUs value in
use. [IAS 36: 70]
Impairment loss is allocated among the asset/CGU in the following order: [IAS 36: 104]
1. any individual asset that is specifically impaired
2. goodwill allocated to the CGU
3. other assets pro rata to their carrying amount in the CGU (subject of the carrying amount of an asset
not being reduced below its individual recoverable amount. [IAS 36: 105]
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Page 29
Once recognised, impairment losses on goodwill are not reversed [IAS 36: 124]
In case of a reversal, the carrying amount of an asset must not increase above the lower of:
- Its recoverable amount; and
- Its depreciated carrying amount had no impairment loss originally been recognised. [IAS 36: 123]
Impairment indicators:
The entity should look for evidence at the end of each period and conduct an impairment review on any
asset where there is evidence of impairment. [IAS 36: 9]
External indicators: [IAS 36: 12]
Intangible assets with an indefinite useful life or not yet available for use, and goodwill acquired in
business combination are subject to annual impairment test irrespective of whether there are
indications of impairment. [IAS 36: 10]
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Page 30
Being busy does not always mean real work. The object of all
work is production or accomplishment and to either of these
ends there must be forethought, system, planning,
intelligence, and honest purpose, as well as perspiration.
Seeming to do is not doing.
- Thomas A. Edison
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Page 31
The same accounting policies are usually adopted from period to period, to allow users to analyse
trends over time in profit, cash flows and financial position.
Fair value model of cost model for investment properties (IAS 40: 31)
Retrospective application means that the new accounting policy is applied to transactions
and events as if it had always been in use. In other words, at the earliest date such
transactions or events occurred, the policy is applied from that date.
This involves restating opening balances of current year and comparative previous year.
On future transactions
Adopting an accounting policy for a new type of transaction or event not dealt with
previously by the entity.
(ii)
Adopting a new accounting policy for a transaction or event which has not occurred in
the past or which was not material.
Changes in accounting policy will be very rare and should be made only if:
-
The change will result in a more appropriate presentation of events or transactions in the
financial statements of the entity, providing more reliable and relevant information.
Revaluation of non-current assets should not be treated as changes in accounting policy (i.e. no
retrospective effect for revaluation).
mezbah.ahmed@hotmail.co.uk
Page 32
Errors:
o Errors discovered during a current period which relate to a prior period may arise through:
Mathematical mistakes
Mistakes in the application of accounting policies
Misinterpretation of facts
Omissions
Fraud
o Prior period errors correct retrospectively.
Either restating the comparative amounts for the prior period(s) in which the error occurred, or
when the error occurred before the earliest prior period presented, restating the opening balances
of assets, liabilities and equity for that period
mezbah.ahmed@hotmail.co.uk
Page 33
mezbah.ahmed@hotmail.co.uk
Page 34
Finance lease: A lease that transfers substantially all the risks and rewards incidental to ownership of
an asset to the lessee (who took the lease). Title may or may not eventually be transferred.
IAS 17 identifies five situations which would normally lead to a lease being classified as a finance
lease:
i.
Transfer of ownership of the asset to the lessee at the end of the lease term
ii.
The lessee has the option to purchase the asset at a price sufficiently below fair value at the
option exercise date, that it is reasonably certain the option will be exercised
iii.
The lease term is for a major part of the assets economic life even if title is not transferred at
end of lease term
iv.
Present value of minimum lease payment amounts to substantially all of the assets fair value at
inception
Present value of minimum lease payments is the payments over the lease term that the
lessee is required to make discounted applying implicit interest rate.
v.
The leased asset is so specialised that it could only be used by the lessee without major
modifications being made
At commencement of a finance lease, leasee (i.e. user of the asset) recognises a Non-current asset and
a Liability in Statement of financial position.
The amount of non-current asset to be capitalized is
Liability component comprises a current
lower of: [IAS 17: 20]
portion and a non-current portion; and
- Present value of minimum lease payment, and
amortised over the lease term.
- Fair value of the leased asset
use useful life if reasonable certainty exists that the lessee will obtain ownership (IAS 17: 27)
mezbah.ahmed@hotmail.co.uk
Page 35
(6,157)
Finance cost
(1,171)
61,570
(6,157)
55,413
51,033
8,708
31 Dec 20X4
2
$
59,741
3
$
57,876
4
$
55,974
5
$
54,033
(3,000)
(3,000)
(3,000)
(3,000)
56,741
54,876
52,974
51,033
1,135
1,098
1,059
1,020
57,876
55,974
54,033
52,053
mezbah.ahmed@hotmail.co.uk
Page 36
(5,000)
Finance cost
(2,074)
31 Dec 20X1
$
20,000
(1,150)
18,850
2,074
(4,000)
16,924
20,000
(5,000)
15,000
14,786
2,138
31 Dec 20X2
$
16,924
1,862
(4,000)
14,786
mezbah.ahmed@hotmail.co.uk
Page 37
(10,400)
(2,672)
21,696
1,376
mezbah.ahmed@hotmail.co.uk
Page 38
mezbah.ahmed@hotmail.co.uk
Page 39
Income
Revenue
Income is increases in economic benefits during the accounting period in the form of
inflows or enhancements of assets or decreases of liabilities that result in increases in
equity, other than those relating to contributions from equity participants. [Framework:
4.25(a)]
Revenue is income that arises in the course of ordinary activities of an entity. [IAS 18:
Objectives]
Amounts collected on behalf of third parties such as sales taxes, goods and services taxes and value
added taxes are not part of revenue. [IAS 18: 8]
In an agency relationship, for an agent, revenue is only the amount of his commission. [IAS 18: 8]
In some cases two or more transactions are considered together. For example, an entity may sell goods
and, at the same time, enter into a separate agreement to repurchase the goods at a later date. This
sale and repurchase agreement may constitute a secured loan and recognised as loan liability instead of
sales revenue. [IAS 18: 13]
mezbah.ahmed@hotmail.co.uk
Page 40
It is no use saying, 'We are doing our best.' You have got to
succeed in doing what is necessary.
- Winston Churchill
mezbah.ahmed@hotmail.co.uk
Page 41
Cost of purchase
Suppliers gross
price for raw
materials
+
Import duties, etc
+
Costs of transporting
materials to
business premises
Trade discounts
Net Realisable
Value (NRV)
Cost of conversion
Costs directly
related to the units
of production (e.g.
direct materials,
direct labours)
+
Fixed and variable
production
overheads incurred
in converting
materials to finished
goods, allocated on
a systematic basis
+
Borrowing costs (if
met IAS 23 criteria)
Estimated selling
price in the ordinary
course of business,
when completed
Estimated costs to
completion and the
estimated costs
necessary to make
the sale.
Write-down to NRV:
If inventories are write-down to their NRV, this will result closing inventory with lower carrying value,
which will have automatic effect on cost of sales (i.e. cost of sales will be increased).
IAS 2 does not apply to inventories covered by other standards, such as:
Work in progress under construction contracts (IAS 11 Construction contracts)
mezbah.ahmed@hotmail.co.uk
Page 42
mezbah.ahmed@hotmail.co.uk
Page 43
Provision: is a liability where there is uncertainty over its timing or the amount at which it will be settled.
A provision should be recognised where:
i.e. established past practice
A provision should not be recognised in respect of future operating losses since there is no present
obligation arising from a past event. [IAS 37: 63]
An entity can be required to recognise a provision and capitalise (DR Non-current asset: Property, plant
& equipment; CR Liability: Provision) initial estimation of future dismantling and restoration cost if above
provision recognition criteria and IAS 16 capitalisation criteria are met. [IAS 16: 16, 18]
Gains from the expected disposal of assets shall not be taken into account in measuring a
provision. [IAS 37: 51]
If an entity sells goods with a warranty, a provision recognition (DR I/S: Expense; CR Liability: Provision)
can be required based on the best estimate of the expenditure required to settle the present obligation at
the end of the reporting period. [IAS 37: 36]
When the selling price includes an identifiable (i.e. distinguishable) amount for subsequent
servicing, that amount is deferred (DR Asset: Cash/ Receivable; CR Liability: Deferred income)
and recognised as revenue over the period during which the service is performed (DR Liability:
Deferred income; CR I/S: Revenue). [IAS 18: 13]
Where the provision being measured involves a large population of items, the obligation is estimated
by expected value calculation. [IAS 37: 39]
A restructuring provision does not include costs of retraining or relocating continuing staff,
marketing, or investment in new systems [IAS 37: 81]
mezbah.ahmed@hotmail.co.uk
Page 44
Discounting to present value: When there is a significant period of time between the end of
reporting period and settlement of the obligation, the amount of provision should be discounted to
present value. [IAS 37: 45]
-n
Discount factor: (1+r)
The discount rate shall be a pre-tax rate that reflects current market assessment of the time
value of money and the risks specific to the liability.
Example: If a provision of $1,000 is required to settle a liability after 2 years; at 10% discount
rate the provision will be recognised at Year-0 is $827 ($1,000 X 0.827).
Reimbursement: An entity may be entitled to reimbursement from a third party for all or part of the
expenditure required to settle a provision. Such a reimbursement:
Should only be recognised (DR Assets: Receivable; CR I/S: Other income) where receipt is
virtually certain, and
Should be treated as a separate asset in the statement of financial position (i.e. not netted off
against the provision) at an amount no greater than that provision.
The provision and the amount recognised for reimbursement may be netted off in the I/S. [IAS
37: 53]
Contingent liability: is a possible obligation that arises from past events and whose existence will be
confirmed only by occurrence or non-occurrence of one or more uncertain future events not wholly within
the control of the entity.
Contingent liability is not recognised in the financial statements because either it is not probable,
or the amount cannot be measured with sufficient reliability.
Contingent liability is only disclosed in the notes of financial statements. [IAS 37: 10, 13]
mezbah.ahmed@hotmail.co.uk
Page 45
Contingent asset: is a possible asset that arises from past events and whose existence will be
confirmed only by occurrence or non-occurrence of one or more uncertain future events not wholly within
the control of the entity.
A contingent asset should not be recognised in the financial statements
Contingent assets should only be disclosed in the notes of financial statements when the
expected inflow of economic benefits is probable. [IAS 37: 31, 34]
When the realisation of income is virtually certain, then the related receivable is recognised in the
financial statements (DR Asset: Receivable; CR I/S: Other income) [IAS 37: 33]
Asset or income receivable because of past event
Probable
Yes
Reliable estimate
Yes
Disclosure as
contingent asset
Virtually certain
No
No
Do nothing
(i.e. do not
recognise or
disclose in the
FSs.
Yes
Recognise in
financial statements
(DR Asset:
Receivable; CR I/S:
Other income
Disclosure let out: IAS 37 permits reporting entities to avoid disclosure requirements relating to
provisions, contingent liabilities and contingent assets if they would be expected to be seriously prejudicial
(i.e. will cause serious disadvantage) to the position of the entity in dispute with other parties.
mezbah.ahmed@hotmail.co.uk
Page 46
mezbah.ahmed@hotmail.co.uk
Page 47
The sale should be expected to take place within one year from the date of classification [IFRS
5: 8].
Once an asset or group of assets and related liabilities is classified as held for sale, the following rules
should be followed:
Fair value less cost to sell is equivalent to net realisable value
-
Carry at lower of its carrying amount and fair value less cost to sell, which may give rise to an
impairment loss [IFRS 5: 15].
. . . can include transport costs and
costs to advertise that the asset is
This is an exception to the normal IAS 36 rule. IAS 36
available for sale
impairment of assets requires an entity to recognise
an impairment loss only when an assets recoverable
amount is lower than its carrying amount.
Do not depreciate even if still being used by the entity. [IFRS 5: 1]
Present separately in the statement of financial position. [IFRS 5: 1]
Non-current asset held for sale recognise under current asset. [IFRS 5: 3]
Presentation of a non-current asset or a disposal group classified as held for sale: [IFRS 5: 38]
Non-current assets and disposal groups classified as held for sale should be presented separately from
other assets in the statements of financial position. The liabilities of a disposal group should be
presented separately from other liabilities in the statement of financial position.
Assets and liabilities held for sale should not be offset.
The major classes of assets and liabilities held for sale should be separately disclosed either on
the face of the statement of financial position or in the notes.
On ultimate disposal of an asset classified as held for sale, any difference between its carrying amount
and the disposal proceeds is treated as a loss or gain recognised in income statement.
A non-current asset or disposal group that is no longer classified as held for sale (for example,
because the sale has not taken place within one year) is measured at the lower of: [IFRS 5: 27]
Its carrying amount before it was classified as held for sale, adjusted for any depreciation that
would have been charged had the asset not been held for sale.
Its recoverable amount at the date of the decision not to sell.
mezbah.ahmed@hotmail.co.uk
Page 48
An asset that is to be abandoned should not be classified as held for sale. [IFRS 5: 13]
Discounted operation:
Discontinued operation is a component of an entity that has either been disposed of, or is classified as
held for sale, and:
represents a separate major line of business or geographical area of operations
is part of a single co-ordinated plan to dispose of a separate major line of business or geographical
area of operations, or
is a subsidiary acquired exclusively with a view to resale. [IFRS 5: 32]
For discontinued operations, an entity should disclose a single amount in the statement of
comprehensive income comprising the total of: [IFRS 5: 33]
The post-tax profit or loss from discontinued operations; and
The post-tax gain or loss on the re-measurement to fair value less costs to sell or on the disposal of
the discontinued operation.
An entity should also disclose an analysis of the above single amount either on the face of the
statement of comprehensive income or in the notes.
An entity shall disclose the amount of income from continuing operations and from discontinuing
operations attributable to owners of the parent.
An entity should also disclose the net cash flows attributable to the operating, investing and financing
activities of discontinued operations. These disclosures may be presented either on the face of the
statement of cash flows or in the notes.
Gains and losses on the re-measurement of a non-current asset or disposal group that is not a
discontinued operation but is held for sale should be included in profit or loss from continuing operations.
[IFRS 5: 37]
XYZ plc - Consolidated statement of comprehensive income for the year ended 31 December 20X9
$000
Revenue
X
Cost of sales
(X)
Gross profit
X
Other income
X
Distribution costs
(X)
Administrative expenses
(X)
Other expenses
(X)
Profit/ (loss) from operations
X/(X)
Finance costs
(X)
Share of profit/(loss) of associates
X/(X)
Profit/ (loss) before tax
X
Income tax expense
(X)
PROFIT/ (LOSS) FOR THE YEAR FROM CONTINUING OPERATIONS
X/(X)
PROFIT/ (LOSS) FOR THE YEAR FORM DISCONTINUED OPERATIONS (SINGLE AMOUNT) X/(X)
Profit/ (loss) for the year
X/(X)
mezbah.ahmed@hotmail.co.uk
Page 49
I don't pity any man who does hard work worth doing. I
admire him. I pity the creature who does not work, at
whichever end of the social scale he may regard himself as
being.
- Theodore Roosevelt
mezbah.ahmed@hotmail.co.uk
Page 50
Revenue and cost: should be recognised according to the stage of completion of the contract at the end
of the reporting period, but only when the outcome of the activity can be estimated reliably.
-
Contract costs which cannot be recovered should be recognised as an expense straight away.
If a loss is predicted (i.e. the contract value < total contract cost) on a contract then it should be
recognised immediately in I/S.
Costs incurred to date + costs will be incurred
Penalty charged by client (may be for delay) will reduce the revenue; will not increase the cost.
Finance costs should be included in contract costs under IAS 23 Borrowing Costs.
Accounting treatments:
Income Statement:
Revenue
((Total contract value X % completed) Revenue recognised in previous periods )
Cost of sales
((Total contract costs X % completed) Costs and losses charged in previous periods)
(X)
Foreseeable loss not previously recognised (ALWAYS test for foreseeable loss)
(((Total contract value Total contract cost) X % yet to complete)
Any of this loss previously recognised)
(X)
X/(X)
(X)
Net profit/(loss)
X/(X)
(Any rectification cost which will be reimbursed by client will increase both total contract value and
total contract costs)
Statement of financial position:
Contract costs incurred to date
Profits/(losses) recognised to date (before deducting non-reimbursable abnormal cost)
Progress billing to date
Receivables / (payables) (current asset/liability)
mezbah.ahmed@hotmail.co.uk
X
X/(X)
X
(X)
X/(X)
Page 51
mezbah.ahmed@hotmail.co.uk
Page 52
Tax
Sales tax
Income tax
DR SFP: Cash
115
CR I/S: Revenue
100
CR SFP: Current liability: Sales tax payable 15
(Because as per IAS 18, revenue cannot be
recognised for the amount ($15) collected on behalf
of others (i.e. sales tax collected on behalf of
government).
mezbah.ahmed@hotmail.co.uk
92
92
30
30
30
DR Purchase
CR SFP: Cash
Deferred tax
Page 53
Deferred tax: This is an accounting measure rather than a tax levied by government; it represents tax
payable or recoverable in future accounting periods in relation to transactions which have already taken
place.
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 taxable or
deductible.
Taxable temporary differences will result in taxable amounts in determining taxable profit (loss) of
future periods when the carrying amount of the asset or liability is recovered or settled.
Deferred tax liabilities: are the amounts of income taxes payable in future periods in respect
of taxable temporary differences.
DR Tax charge
CR SFP: Non-current liabilities: Deferred tax liability
-
Deductible temporary differences will result in amounts that are deductible in determining taxable
profit (tax loss) of future periods when the carrying amount of the asset is recovered or settled.
Deferred tax assets: are the amounts of income taxes recoverable in future periods in respect
of deductible temporary differences (and in respect of the carry forward of unused tax losses or
tax credits).
DR SFP: Non-current assets: Deferred tax asset
CR Tax charge
Recognise deferred tax (that is the difference between the opening and closing deferred tax
balances in the SFP) normally in profit or loss. But, exceptions are:
- Deferred tax relating to items dealt with as other comprehensive income (such as revaluation)
should be recognised as tax relating to other comprehensive income within the statement of
comprehensive income
- Deferred tax relating to items dealt with directly in equity (such as the correction of an error or
retrospective application of a change in accounting policy) should also be recognised directly in
equity
Step 2: Calculate the temporary difference (i.e. difference between carrying value and tax base
value) at year beginning and at year end.
- Temporary difference will be either taxable temporary difference or deductible temporary
difference. Check the decision tree below.
- In the question sometime the temporary differences are given. In that case you dont need to
apply Step 1.
Step 3: Apply tax rate on temporary differences to identify deferred tax asset or liability at year
beginning and at year end.
- The deferred tax asset or liability identified from year end balances is the amount to be
shown in Statement of Financial Position.
- The movement from year beginning deferred tax asset or liability to year end deferred tax
asset or liability to be shown in I/S (in other comprehensive income if the portion related to
revaluation).
Expense:
Asset
Liability
mezbah.ahmed@hotmail.co.uk
Income:
Asset
Liability
Page 54
The tax rate to be used in the calculation for determining a deferred tax asset or liability is
the rate that is expected to apply when the asset is realised, or the liability is settled.
Temporary differences
For asset:
Tax base value < Carrying amount
Tax base =
Carrying
amount
For liability:
Tax base > Carrying amount
Taxable temporary differences
Deferred tax liability
For asset:
Tax base value > Carrying amount
For liability:
Tax base value < Carrying amount
No deferred
tax
implications
The most important temporary difference is that between depreciation charged in the financial statements
and capital allowances in the tax computation. In practice capital allowances tend to be higher than
depreciation charges, resulting in accounting profits being higher than taxable profits. This means that the
actual tax charge (current tax) is too low in comparison with accounting profits. However, these differences
even out over the life of an asset, and so at some point in the future the accounting profits will be lower
than the taxable profits, resulting in a relatively high current tax charge.
These differences are misleading for investors who value companies on the basis of their post-tax profits
(by using EPS for example). Deferred tax adjusts the reported tax expense for these differences. As a
result the reported tax expense (the current tax plus the deferred tax) will be comparable to the reported
profits, and in the statement of financial position a provision is built up for the expected increase in the tax
charge in the future.
There are different ways that deferred tax could be calculated. IAS 12 states that the balance sheet liability
method should be used. [IAS 12: IN2]
mezbah.ahmed@hotmail.co.uk
Page 55
1
$
5,000
10,000
2
$
5,000
10,000
3
$
5,000
10,000
4
$
5,000
10,000
5
$
5,000
10,000
(12,500)
(12,500)
(12,500)
(12,500)
2,500
2,500
2,500
2,500
15,000
(1,000)
(1,000)
(1,000)
(1,000)
(6,000)
Opening liability
Closing liability (in SFP under Non-current
liabilities)
(Apply tax rate of 40% on temporary difference)
Liability (increase)/decrease
Income:
Asset
Liability
1
$
40,000
2
$
30,000
3
$
20,000
4
$
10,000
5
$
0
37,500
25,000
12,500
2,500
5,000
7,500
10,000
1
$
2
$
3
$
4
$
5
$
1,000
2,000
3,000
4,000
1,000
2,000
3,000
4,000
(1,000)
(1,000)
(1,000)
(1,000)
4,000
Expense:
Asset
Liability
1
$
5,000
2
$
5,000
3
$
5,000
4
$
5,000
5
$
5,000
Current tax
(1,000)
(1,000)
(1,000)
(1,000)
(6,000)
Deferred tax
Profit after tax
(1,000)
3,000
(1,000)
3,000
(1,000)
3,000
(1,000)
3,000
4,000
3,000
mezbah.ahmed@hotmail.co.uk
Page 56
Future
deductible
amounts
$
3,500
Tax
base
$
5,400
Future
taxable
amounts
$
(5,400)
Note
$
3,500
1,000
(1,000)
Nil
Nil
1,000
Nil
Nil
1,000
1,000
Nil
Nil
1,000
1,000
Nil
Nil
1,000
Note:
1.
- Future taxable amount considered as equivalent to the Carrying amount since the economic
benefit (e.g. operations of the business which will generate income) from using the P&E yet to be
taxable.
- Future deductible amount is $3,500 since $6,500 already claimed as tax depreciation in taxable
profit calculation. $3,500 will be deductible in the future periods taxable profit calculation.
2.
- The amount will be taxable on cash basis; i.e. when the cash will be received in the future. So, the
whole $1,000 amount is Future taxable amount.
- The amount will never be deductible in taxable profit calculation. So, Nil Future deductible
amount.
3.
- The amount already been taxed; so will not be taxed further. That is why Future taxable amount is
Nil.
- The amount will never be deductible in taxable profit calculation. So, Nil Future deductible
amount.
4. The amount not taxable and not deductible in the future. So, Future taxable amount and Future
deductible amount both are Nil.
5. The amount will not be taxed or deductible in the future. So, both of the values are Nil.
mezbah.ahmed@hotmail.co.uk
Page 57
Future
deductible
amounts
$
(1,000)
Tax
base
$
1,000
Future
taxable
amounts
$
Nil
Note
$
Nil
10,000
(10,000)
Nil
Nil
100
Nil
Nil
100
1,000
Nil
Nil
1,000
Note:
1.
- The related expense will be deducted for tax purposes on a cash basis. Since the amount yet to
be paid, the $1,000 will be Future deductible amount.
- The amount is an expense, so will not the taxable in the future.
2.
- The amount is charged for tax on cash basis. Since the cash is already received, the amount is
already taxed and will not be taxed again. That is why Future taxable amount is taken as a
negative figure, instead of positive (as given in the formula). This is exception to the general
formula, but in compliance with IAS 12 requirements.
- Alternative way of calculating Tax base of Unearned revenue is: Carrying amount Amount that
will not be taxable in the future. Thus the calculation will be: 10,000 - 10,000 = Nil
3. The amount will not be deductible, or chargeable for tax purposes.
4. The amount will not be deductible, or chargeable for tax purposes.
mezbah.ahmed@hotmail.co.uk
Page 58
mezbah.ahmed@hotmail.co.uk
Page 59
You never achieve success unless you like what you are
doing.
- Dale Carnegie
mezbah.ahmed@hotmail.co.uk
Page 60
An equity instrument is
any
contract
that
evidences a residual
interest in the assets of
an entity after deducting
all of its liabilities.
....
....
Examples:
- Cash and timed deposits
- Trade and loan receivables
- Investments in shares issued
by other entities (typically below
20%)
Examples:
Trade payables
Loans
and
redeemable
preference shares
Bank overdraft
Examples:
Companys
equity share
own
Cash flow
(200) (10,000X2%)
(200)
If there was a issue cost of $500, instead of initial $500 discount, the result would have been same.
mezbah.ahmed@hotmail.co.uk
Page 61
The fair value of the equity component should be measured as the remainder of the net
proceeds.
On 1 January 20X7 an entity issued 10,000 6% convertible bonds at a par value of 100. Each bond is
redeemable at par or convertible into four shares on 31 December 20X8. Interest is payable annually in
arrears. The market rate of interest for similar debt without the conversion option is 8%.
Year
20X7
20X8
Total liability component
Total proceeds (10,000 100)
Equity element
Cash flow
60,000
1,060,000
Discount factor
0.9259
0.8573
Will be given in Q
Present value
55,554
908,738
964,292
1,000,000
35,708
Opening balance
964,292
981,435
Will be charged in
I/S as Finance cost
77,143
78,515
Interest paid
(60,000)
(60,000)
Closing balance
981,435 Amount
999,950 will be in
SFP:
The amount should have been
Liabilities
1,000,000. The mismatch is
due to decimal places of the
Discount factor used. (not
incorrect in exam!)
If on 31 December 20X8 all the bond holders elect to convert into equity, then the 1 million
liability should be reclassified to equity, making 1,035,708 in total. The double entry should be:
DR Financial liability 1 million
CR Equity
1 million
If
none
of the
are of
converted
to equity,
the liability
million
willthe
be rate
extinguished
Note
thatbonds
the rate
interest on
the convertible
will ofbe1lower
than
of interestbyonthe
the
cash repayment.
However,
the
amount
already
included
in
equity
of
35,708
should
remain
comparable instrument without the convertibility option, because of the value of the option
to there.
acquire
The double
equity.entry should be:
DR Financial liability
1 million
CR Cash
1 million
Note that the rate of interest on the convertible will be lower than the rate of interest on the
comparable instrument without the convertibility option, because of the value of the option to acquire
equity.
mezbah.ahmed@hotmail.co.uk
Page 62
Preference share
Redeemable preference
share
- Treat this preference
share as liability in
SFP.
- Recognise dividend
paid to Redeemable
preference
shareholders
as
Finance cost in I/S
(i.e. do not recognise
in
Statement
of
changes in equity).
Non-cumulative
- Dividend will be due only when it is declared.
But, ordinary shareholders typically cannot
get dividend before preference shareholders.
- Ordinary shares and, generally, Irredeemable
preference shares are non-cumulative.
mezbah.ahmed@hotmail.co.uk
Reserves
Convertible
preference share
- This
is
also
known
as
compound
or
hybrid
financial
instrument.
- It has liability
component and
equity
component.
(see compound
instrument note)
Cumulative
- Dividend will be due
irrespective
of
declaration
during
the year.
- Typically redeemable
and
convertible
preference
shares
are cumulative.
Share premium
- This
represents
the additional
amount than
the
face
value
collected on
issue
of
ordinary
share.
- If face value
is $1 of per
ordinary
share
and
$1.2
collected on
issue of per
1,000 share:
Retained
earnings
- Generally,
this is amount
accumulated
from year-onyear
undistributed
(i.e. retained)
profit
after
tax.
- Profit
after
tax can be
distributed to
ordinary
shareholders
and
irredeemable
preference
shareholders.
Revaluation
reserves
- This is the
amount
derived from
IAS
16
Property,
plant
and
equipment
revaluation.
DR
Cash
1,200
CR
Share
capital 1,000
CR
Share
premium 200
Page 63
mezbah.ahmed@hotmail.co.uk
Page 64
INVESTMENT
CRITERIA
Subsidiary
Associate
Contractual agreement
Investments which is
none of the above
Investments held for
sale (IFRS 5: NonCurrent Asset Held for
Sale and Discontinued
Operations)
Investments in Subsidiary:
Control achieved by owning more than 50% voting power. But, control can still exist with less than
50% voting power.
When parent has:
-
Power over more than 50% of the voting rights by virtue of agreement with other investors.
The power to govern the financial and operating policies of the entity by statue or under an
agreement.
- The power to appoint or remove a majority of members of the board of directors.
- The power to cast a majority of votes at meetings of the board of directors.
Parent should cease to consolidate an entity which was a subsidiary when control is lost.
Control may be lost even without changing the ownership levels; when subsidiary becomes subject
to control of a government, court administration or regulator.
Exemptions from preparing group accounts: A parent need not present consolidated financial
statements if ALL of the following conditions are satisfied:
It is a wholly-owned subsidiary or a partially-owned subsidiary of another entity and its other owners
have not objected to the parent not presenting consolidated financial statements
Its securities are not publicly traded
It is not in the process of issuing securities in public securities markets
The ultimate or intermediate parent publishes consolidated financial statements that comply with
IFRS
Different reporting dates: If a subsidiarys reporting date is different then parent and bulk of other
subsidiaries in the group:
the subsidiary may prepare another set of financial statements
OR, if it is not possible, the subsidiarys accounts may still be used provided that the gap is not more
than three months and adjustments are made to reflect significant transactions or other events.
Differing accounting policies: Uniform accounting policies should be used. Adjustments should be
made where accounting policies of subsidiary differ from parent.
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Page 65
Subsidiary
Associate
Share capital
Reserves:
Retained earnings: credit/(debit) balance
Share premium
Other reserves (e.g. revaluation)
Unrealised profit when subsidiary sales to parent
Fair value adjustments
FV adj. Post-acquisition depreciation (cumulative effect from
acq. to y/e)
Total
Post-acquisition reserve (difference between Acq. & Y/end)
Subsidiary
Acq.
Y/end
$
$
X
X
Associate
Acq.
Y/end
$
$
X
X
X / (X)
X
X
X / (X)
-
X / (X)
X
X
(X)
X / (X)
(X) / X
X / (X)
X
X
X / (X)
-
X / (X)
X
X
X / (X)
(X) / X
Subsidiary
$
X
X
Associate
$
X
X
3) COST OF INVESTMENT:
Cash consideration
Acquisition date fair value of other consideration (e.g. acquisition
date market value of shares given by parent to subsidiary)
Contingent and deferred consideration (converted into PV
n
applying (1+r) )
Do not include costs like professional fees, legal fees in the cost of investment; these must be
recognised in the Profit or Loss account as expense as incurred. Also, in cost of investment do not
include loan issued to subsidiary.
Any contingent consideration payable must be included even at the date of acquisition if it is not
deemed probable that it will be paid
It is possible that the FV of the contingent consideration may change after the acquisition date. If it is
due to additional information obtained that affects the position at acquisition date, goodwill should be
remeasured (one year qualifying period applies). If the change is due to events after the acquisition
date (such as earnings target met) then the goodwill will not be remeasured (gain/loss from
remeasurement will be recognised in I/S)
4) GOODWILL:
i) New method: When examiner will require to use the new method, he will mention full, gross, new, or
calculate NCI at fair value. In this case FV of NCI (value of shares not acquired) at acquisition date will be
given.
ii) Old method: Where an exam question requires use of the old method, it will state that it is group policy to
value the non-controlling interest at its proportionate share of the fair value of the subsidiarys identifiable net
assets.
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Page 66
Subsidiary
$
$
X
X
(X)
X
(X)
X
Subsidiary
$
$
X
X
(X)
X
(X)
X
Old method
Non-controlling share of net asset at aqc. (NCI% X NA @ FV @ Acq.) (W-2)
NC% X Post-acquisition reserve (W-2)
NCI at Y/end in SFP
-
Subsidiary
$
X
X
(X)
X
Subsidiary
$
X
X
X
6) CONSOLIDATED RESERVE:
Parents reserves (Share premium, Retained earnings, Revaluation reserve) at
reporting date (100%)
Group share of post-acquisition reserve of:
Subsidiary: Acquisition % X Post-acquisition reserve (W2)
Associate: Acquisition % X Post-acquisition reserve (W2)
Unrealised profit - when parent sales to subsidiary
Unrealised profit when there is a transaction with associate (Group % X Unrealised
profit)
Unwinding of discounting of deferred/ contingent consideration (W-3)
Goodwill impairment to date (Acq. to Y/end):
Subsidiary: take only the G% of impairment if goodwill is calculated applying new method
Associate
Reserve in SFP
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$
X / (X)
X / (X)
X / (X)
(X)
(X)
(X)
(X)
(X)
X
Page 67
$
X
X / (X)
(X)
(X)
X
P Group
Consolidated statement of financial position as at 31.XX.XXXX
$
ASSETS
Non-current assets
Property, plant and equipments (Parent + Sub +/- FV adj. (W2))
Intangible assets (Parent + Sub +/-FV adj. (W-2)
X
X
Goodwill (W-4)
X
X
Current assets
Cash & bank (Parent + Sub)
X
X
Total assets
Reserves (W-6)
X
X
Current liabilities
Bank overdraft (Parent + Sub)
X
X
X
Total equity and liabilities
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Page 68
Adj.
Total
Revenue
(X)
Cost of sales
(X)
(X)
(X)
(X)
X
(X)
(X)
Gross profit
Operating expenses
(X)
(X)
(X)
(X)/X
(X)
Investment income
(X)
Old
(X)
(X)/X
New
(X)
(X)
(X)
X
(X)
(X)
(X)
X
(X)
(X)
(X)
X
(X)
(X)
X
Group share
X
X
Net profit
* If subsidiary is acquired part way through the year then all income and expenses of subsidiary shall
be time apportioned
1
X : Transaction value of inter-company trading (i.e. the total selling price in inter-company trading)
2
X : Who is the seller? (only deduct the unrealised profit)
3
X : Interest on inter-company loan
mezbah.ahmed@hotmail.co.uk
Page 69
Our greatest weakness lies in giving up. The most certain way
to succeed is always to try just one more time. - Thomas A.
Edison (Inventor)
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Page 70
Adjustments for:
Finance cost (Interest expense) for the year (amount charged in I/S )
Depreciation and amortisation for the year (amount charged in I/S) (W-4/5)
(X)/X
(X)/X
(X)
(X)
(X)/X
(X)/X
X/(X)
(X)
(X)
(X)
X/(X)
Direct method
Cash receipts from customers (W-13)
(X)
(X)
(X)
X/(X)
(X)
(X)
Income from investment properties (excluding revaluation gain & non-cash income)
Interest received
Divided received
X/(X)
(X)
(X)
mezbah.ahmed@hotmail.co.uk
X
(X)
Page 71
X/(X)
X/(X)
**Cash and cash equivalents at beginning of the period (from last year's SFP)
X/(X)
X/(X)
Workings-2
Tax payable
B/f - Asset (from last year's SFP):
Current
Deferred
X
X
Current
Deferred
X
X
Current
Deferred
Received during the year
(balancing figure)
X
X
X
X
X
X
X
X
X
X
Workings-3
Property, plant and equipment: Cost
B/f (from last year's SFP or other
information)
Disposal
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Page 72
Workings-5
Property, plant and equipment: Net book value
B/f (from last year's SFP)
X
X
Workings-7
Profit/ (loss) on disposal of PPE = Disposal proceed Carrying value at disposal date
Carrying value at disposal date = Cost Accumulated depreciation at disposal date
Workings-8
Development expenditure: NBV
B/f (from last year's SFP)
Workings-9
Finance lease: Liability
B/f - Liability (from last year's
SFP):
Payment during the year (balancing figure)
X
Current
Non-current
Non-current
X
X
mezbah.ahmed@hotmail.co.uk
Page 73
Government grant
B/f - Liability (from last year's
SFP):
X
Current
Non-current
X
X
X
X
Workings-11
Retained earnings
Bonus share issue from retained earnings
Dividend paid
X
X
X
X
X
X
X
(X)
(X)
(X)
Workings-12
Share capital and share premium account
B/f (from last year's SFP):
Bonus share issue from share
premium
C/f (from current year's SFP):
Share capital
Share premium
X
X
X
mezbah.ahmed@hotmail.co.uk
Share capital
Share premium
Bonus issue
X
X
Page 74
X
X
X
X
Workings-14
Payables
Cash payment during the year
Workings-15
Inventory
B/f (from last year's SFP)
X
X
X
X
****The formats are not comprehensive. All information in the formats may not be required in every
situation. It is very important to understand the underlying concept than mere memorising the
format.
mezbah.ahmed@hotmail.co.uk
Page 75
have been gazillions of people that have lived before all of us.
There's no new problem you could have . . . There's no new
problem that someone hasn't already had and written about it
in a book.
Will Smith
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Page 76
Shareholders capital:
Ordinary share capital
Reserves
Preference share capital*
Long-term liabilities
Current liabilities
X
X
X
X
X
X
X
*Redeemable preference share capital will be treated as a long-term liability. In that case its dividend will be treated
as interest (Finance cost in Income Statement).
LIQUIDITY RATIOS: Liquidity ratio measures a company's ability to pay short-term obligations
1. Current ratio =
o
o
o
o
o
o
Current Asset
Current Lia ilities
X:1
Current ratio is mainly used to give an idea of the company's ability to pay back its short-term
liabilities (debt and payables) with its short-term assets (cash, inventory, receivables).
The higher the current ratio, the more capable the company is of paying its obligations.
A current ratio of 1.5:1 to 2:1 can mean sufficient current asset to cover its current liabilities.
A current ratio of above 2:1 may mean over investment in working capital (i.e. in current assets).
Surplus assets can be used to
- to expand the business operation or to increase capacity which will earn additional profit,
- to repay debt which will save interest expenses,
- distribute to shareholders as dividend.
A current ratio below 1 suggests that the company would be unable to pay off all of its current
liabilities if they came due at that point.
Current ratio can be improved by
- selling of unused non-current assets,
- taking long-term loan,
- speeding up the receivables collection,
- slowing payables payment
A weak current ratio shows that the company is not in good financial health, but it does not
necessarily mean that it will go bankrupt as there are many ways to access financing; but it is
definitely not a good sign.
Companies that have trouble getting paid by its receivables or have long inventory turnover can run
into liquidity problems
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Page 77
=X:1
The quick ratio measures a company's ability to meet its short-term obligations with its most liquid
assets (as it excludes inventory).
Inventory is excluded because some companies (specially manufacturing companies with high
inventory holding period) have difficulty turning their inventory into cash.
The higher the quick ratio, the better the position of the company.
A quick ratio of 1:1 is normally most appropriate. For companies with a high inventory turnover ratio
(i.e. short inventory holding period) can have a less than 1 quick ratio without suggesting that the
company could be cash flow trouble.
If quick ratio is too low than the current ratio; this could mean that high amount of working capital is
tied up in inventory. High amount of inventory means high inventory holding costs.
PROFITIBALITY RATIOS:
1. Return on capital employed (ROCE) =
o
o
o
o
o
o
o
o
o
o
o
X 100% = X%
ROCE is the prime measure of operating performance. This ratio indicates how efficiently a business
(i.e. managers) is using the funds invested (equity and long-term debt).
It is the ratio over which operations management has most control.
ROCE increase from previous year or above industry average means a good sign and reflects the
fact that the company (by managers) has managed to increase the sales without a proportionate
increase in costs.
ROCE decrease from previous year or below industry average shows problem with controlling of
costs. Level of dividend may also fall as a consequence.
The value of capital employed is lower where company mainly uses rented assets (i.e. thorough
operating lease) rather owning or finance lease. This is also possible where assets carrying value is
lot less than the cost (remember in that case assets will need replacement). These may result a
higher ROCE.
Asset revaluation (especially land) will result a higher amount of Capital employed, which will give a
lower ROCE without indicating company performance became poorer.
ROCE should always be higher than the rate at which the company borrows; otherwise any increase
in borrowing will reduce shareholders' earnings.
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Page 78
o
o
o
o
o
o
o
o
Profit after tax and preference dividend is the Profit attributable to ordinary shareholders
It is common to use book values rather market value of shares (if market value used then
remember to exclude Reserves)
Better to use average of Shareholders Capital
(Opening + Closing Ordinary Share Capital and Reserves
2 where possible; specially,
when closing balance significantly differs from opening balance.
- If you are required to compare ratios between two different years and cannot calculate
average for both of the years, then take only the SFP value of the year (i.e. do not
average). This is for comparability purpose.
Return on equity (ROE) indicates to ordinary shareholders how well their investments have
performed measuring how much profit the company has generated for them with their money.
A good figure results in a high share price and makes it easy to attract new funds.
With a similar level of ROCE, a fall in ROE may mean increased finance cost because of new loans.
An improved ROE with a similar ROCE may mean some of the loans are repaid which resulted a
lower finance cost and, so, improved profit attributable to ordinary shareholders.
If new share issued sometime at period end, this may result a declined ROE without indicating poor
performance of the company because company really did not get time to utilise the new capital.
Gross Profit
Sales
o
o
X 100% = X%
High gross profit margin may indicate effective purchasing strategy which results a lower material &/
production cost (i.e. lower cost of sales). A high gross profit margin may also indicate concentration
on low volume-high margin sales.
Low gross profit margin may be an indication of selling products cheaply (i.e. at discount) in order to
generate high volume of sales. This may also indicate increased production cost (including material
and labour cost) without a proportionate increase in selling price.
X 100% = X%
X 100% = X%
Operating profit margin gives analysts an idea of how much profit (before interest and tax) the
company is making from each dollar of sales.
Typically operational management has full control over operating costs (the amount of loan capital
and, so, interest expense normally depends on more higher level of management and the amount of
tax payable depends on government policy). So, operating profit margin effectively measures
performance of operational management.
A poor or declining Operating profit margin may indicate business is struggling in controlling the
costs. This may also happen because of decrease in selling price.
A healthy operating profit margin is required for a company to be able to pay interest on loans.
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Page 79
o
o
o
o
o
X 100% = X%
Net profit margin sometimes calculated based on Profit before tax (after interest). Check
question for indication.
A higher percentage than last year or industry average indicates costs are being controlled better.
This may also indicate products are sold at higher price.
A weaken Net profit margin may indicate management is struggling in controlling the costs.
Company can sell at a discount to retain market share during economic downturn (and/or because of
intense competition). If costs remain at similar level this will result a lower Net Profit Margin.
Companies trading cheaper products can gain during economic downturn when customers generally
stop buying luxury products and turn to cheaper ones.
In large companies, where higher level of economies of scale can be achieved (i.e. lower level of per
unit cost) the net profit margin can be higher as a result.
Multinational companies can gain or loss from favourable or adverse exchange rate movements.
o
o
Sales
Capital Employed
= X:1
Use of Non-current assets instead of Capital employed is also correct. Check question for
indication. If question says nothing, then use Capital employed.
This shows the sales that is generated from each $1 worth of Capital (or asset) employed. The
higher the sales per $1 invested the more efficient use of the capital was.
If business is selling luxury products or products with higher profit margin that may result a lower
Asset turnover ratio without a weaken ROCE or Net profit margin ratio.
EFFICIENCY RATIOS:
1. Average receivables collection period =
o
o
o
o
o
o
o
o
X 365 = X days
Use only CREDIT SALES. If question gives us only a Sales figure (i.e. does not split
between credit and cash sales) then use the given Sales figure.
We need only TRADE RECEIVABLES (i.e. receivables derived from credit sales). Nontrade receivables (e.g. advance, damage claim, receivables of government grant) shall not
be included. If question gives us only a Receivables figure, and does not give any other
indication about its components then assume that is the Trade receivables figure.
(Opening + Closing
Better to use average trade receivables
2 where possible; specially,
when closing balance significantly differs from opening balance.
An alternative of using Average Receivables is using year-end receivables figure where
amount of receivables did not change significantly from year-beginning to year-end.
- If you are required to compare ratios between two different years and cannot
calculate average for both of the years, then take only the SFP value of the year
(i.e. do not average). This is for comparability purpose.
Irrecoverable debts and provision for doubtful debts normally not deducted from Trade
Receivables collection period is an approximate measure of the length of time customers take to pay
what they owe.
A Receivables Collection Period similar to Payables Payment Period may be an indication of good
credit control policy.
Collection Period of less than 30 days may seem normal. Significantly in excess of 30 days
might be representative of poor management of funds of the business. However, some
businesses such as export oriented businesses normally needs to allow generous credit terms
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Page 80
o
o
o
o
If Credit purchase or purchase amount cannot be identified from the question, use Cost of
sales as it serves as an approximation.
Use only Trade payables; i.e. payables generated from credit purchase.
Increasing or long payment period may indicate liquidity problem; and also may indicate loosing
opportunity of prompt payment discounts.
A longer payment period may also mean company has succeeded in obtaining very favourable credit
terms from its suppliers; contradictorily, this may also mean unethical business practice.
Long credit term from suppliers is a source of interest free financing. But, some suppliers may
charge interest if payment period exceeds a certain duration.
Declining or short payment period may indicate business has sufficient cash to meet payables. A
short payment period may put companys credit ratings in higher position.
If receivables collection period is longer than the payables payment period then it can cause cash
flow difficulties.
o
o
o
o
or,
o
o
o
X 365 = X days
Average Inventory
Cost of Sales
Cost of Sales
Average Inventory
= X Times
Better to use Average Inventory figure to take into account the variation between Opening
inventory and Closing inventory. But, instead of Average Inventory the closing inventory
figure can be used where opening inventory level cannot be determined; in that case
comparable figure has to derive from same approach.
This ratio is an estimate of the average time that inventory is held before it is used or sold. If average
inventory holding period is 30 days, this means that the inventory is turned over (i.e. sold) on
average 12.16 times (= 365/30) in a year
A low turnover (i.e. high holding period) implies slow sales and, therefore, excess inventory and/ or
high level of inventory holding costs.
High inventory levels are unhealthy because they represent an investment with a zero rate of return.
It may also put company at a great loss if prices start to decline (think about technological products).
mezbah.ahmed@hotmail.co.uk
Page 81
In F9:
Average FG Inventory
X 365 days = X days
Cost of Sales
Average R Inventory
Raw materials inventory turnover period =
X 365 days = X days
Annul Purchases
Average IP
Average production (WIP) period =
X 365 days = X days
Cost of Sales
This cycle is the length of time between cash payment to suppliers and cash received form
customers. This measured how long a firm will be deprived of cash.
A company could even achieve a negative cycle by collecting from customers before paying
suppliers. This policy of strict collections and delay payments is not always sustainable or
appreciable by customers (because they have to pay early) and suppliers (because they are being
paid late).
INVESTMENT RATIOS:
1. Earnings per share (EPS) =
or,
o
o
o
o
o
o
= $X
= $X
EPS is generally considered to be the single most important variable in determining a shares price.
This is a key measure of company performance from ordinary shareholders point of view.
EPS shows the amount of profit attributable to each ordinary share. But, it does not represent actual
income of the ordinary shareholders.
Increase in EPS generally indicates success; whereas a decrease is not welcomed by shareholders.
A constant growth in EPS may result in favourable movements (i.e. increase) in share price.
Both right issue and bonus issue of shares result in a fall of EPS. So, care must be taken while
interpreting.
EPS often ignores the amount of capital employed to generate the earnings. Two companies could
generate the same EPS, but one could do so with less investment; this could mean that this
company was more efficient at using its capital.
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Page 82
= X$
o DPS is the actual portion of income received by the ordinary shareholders from EPS.
o DPS is important for shareholders who are seeking income from shares rather capital gain.
o Growth in dividend per share used in share price valuation. So, companies may have a policy of
achieving steady growth in dividend pay-out per share. A steady growth normally creates
positive market reaction (i.e. increase in share price).
or,
o
o
or,
o
o
o
o
X 100% = X%
X 100% = X%
Dividend pay-out ratio is the percentage of earnings paid to shareholders as dividends. This shows
how well earnings support the dividend payments.
High dividend pay-out ratio may mean company confidence on future earnings. But, where majority
of shares are held by a small number of shareholders, it may also mean that shareholders are taking
out as much profit as they can; and this does not necessarily serve companys long-term interest.
Low dividend pay-out ratio may mean company is expecting difficulties in the future; so now
interested in retaining earnings. But, it can also mean expansion (by reinvesting the retained
earnings) of business in the future.
Mature companies tend to have a higher pay-out ratio.
4. Dividend cover =
= X Times
= X Times
Dividend cover represents how many times dividend could have paid from the profit attributable to
ordinary shareholders.
Dividend cover is a measure of the ability of a company to maintain the level of dividend paid out.
The higher the cover, the better the ability to maintain dividend pay-out if profits drop.
Typically, a ratio of 2 or higher is considered safe in the sense that the company can well afford the
dividend; but dividend cover below 1.5 may seem risky.
If the dividend cover is below 1 then the company is using its retained earnings from previous years
to pay current years dividend
A low level of dividend cover might be acceptable in a company with very stable profits, but the same
level of cover for a company with volatile profits would indicate that company may not able to
maintain the current level of dividend pay-out.
mezbah.ahmed@hotmail.co.uk
Page 83
or,
o
o
o
o
o
o
o
o
o
= X Times
Company s ar et Capitalisation
Earnings (i e Profit) Attri uta le to Ordinary Shareholders
= X Times
Market capitalisation is the total market value of all the issued ordinary shares of the
company.
P/E ratio also knows as Price Multiple or Earnings Multiple ratio
P/E ratio is a measure of company performance from the markets point of view.
P/E ratio shows how much money investors are currently willing to pay for each dollar of earnings. It
gives an indication of the confidence that the investors have in the future success (i.e. earnings) of
the business.
In a very basic term, a P/E ratio of 20 means investors are paying equivalent of 20 years earnings
(at current EPS level) to own a share in the company.
A P/E ratio of 1 means market is currently willing to pay $1 for each dollar of earnings currently made
by the company; this shows very little confidence on the companys future prosperity. Whereas, a
P/E ratio of 20 expresses a great deal of optimism about the future of the company since investors
are currently willing to pay $20 for each dollar of companys earnings. Investors paying 20 times of
current earnings believe that company will do significantly better in coming years, and this will not
take long to get the $20 earnings.
Market can over-value or under-value company shares depending of information available.
6. Dividend yield =
o
X 100% = X%
Dividend Yield is a financial ratio that shows how much a company pays out in dividends relative to
its share price.
In the absence of any capital gains, the Dividend Yield is the return on investment for a share.
Investors can secure a minimum stream of cash flow from their investment portfolio by investing in
shares which is paying relatively high and stable dividend yields.
Mature and well-established companies tend to have higher dividend yields; while young and growth
oriented companies tend to have lower yield. Many fast growing companies do not have a dividend
yield at all because they do not pay-out any dividend.
Debt ratio =
Total De t
Total Assets
X 100% = X%
o
o
o
o
This ratio represents how much money company owes compared to its Total assets.
If Debt ratio is greater than 50%, the business can be considered as a risky company. But, a high
Debt ratio may also mean companys ability to raise debt finance which shows confidence of debt
holders on the company.
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3. Leverage ratio =
o
o
o
o
o
o
o
o
o
o
o
o
Equity Capital
Equity Capital De t Capital
X 100% = X%
X100%
Take current liability portion as well of long-term liabilities in Debt capital calculation.
Normally do not include Deferred tax liability within Debt capital.
In F9 Preference share considered as Debt capital not Equity capital.
Also in F9, values for Gearing ratio can be either book values or market values. If using
market values remember market value of ordinary shares take account of reserves (i.e. do
not add reserve amount with total market value of ordinary shares)
A gearing level of more than 50% (where Debt Capital to Total Capital used) or more than 100%
(where Debt Capital to Equity Capital used) or Leverage ratio of less than 50% means company is
highly geared (i.e. risky).
Risk is high for investors in a high geared company because of obligation to pay the interest and
repaying capital on time.
The standard level of gearing depends on industry sector.
A relatively higher gearing may mean company adopted an aggressive strategy to expand its
operation. This has to be justified with sales and profit growth. A higher gearing may also mean
company is having financial difficulties; so may be a going concern issue.
A low or declining gearing may mean company is getting stronger financially and confident on future
earnings.
Where gearing is high, shareholders required rate of return will increase because of high level of risk
involve in the investment.
To lend money in a highly geared company, lenders may impose some covenants on the company
(example: a maximum limit of gearing, a minimum level of interest cover, pledge on some assets)
4. Interest cover =
o
De t Capital
De t Capital
= X Times
Interest cover is a measure of the adequacy of a company's profit relative to interest payment on its
debt.
A high interest cover ratio means that the business is easily able to meet its interest obligations from
profits. Similarly, a low level of interest cover ratio means that the business is potentially in danger of
not being able to meet its interest obligations.
Interest cover of more than 2 is normally considered reasonably safe. But, companies with very
volatile earnings may require an even higher level of Interest cover.
Interest cover of less than 1 means the company did not earn sufficient earning (i.e. profit) to meet
its interest charge. This means company will have to pay some of its interest from retained profit
from previous years. This may also raise question about companys going concern.
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that I loved what I did. You've got to find what you love. And
that is as true for your work as it is for your lovers. Your work is
going to fill a large part of your life, and the only way to be truly
satisfied is to do what you believe is great work. And the only
way to do great work is to love what you do. If you haven't
found it yet, keep looking. Don't settle. As with all matters of the
heart, you'll know when you find it. And, like any great
relationship, it just gets better and better as the years roll on. So
keep looking until you find it. Don't settle. . .
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An entity is required to calculate and present a basic EPS and a diluted EPS amount based on the profit/
(loss) attributable to the ordinary shareholders (of the parent entity).
Basic and diluted EPS figures should be presented on the face of the statement of comprehensive
income with equal prominence.
Shares are usually included
in the weighted average
number of shares from the
date
consideration
is
receivable.
Basic EPS =
Example:
Number of shares at year beginning (at 01.01.11)
New issue of shares at full market price (at 31.05.11)
Number of share at year end
170,000
80,000
250,000
Basic EPS with bonus issue (scrip issue, capitalisation issue) and share split: increases number of
shares without any consideration. As a result, this distorts the comparison of EPS in the current year with
the EPS in the previous year. So, to ensure that the distortion does not occur:
The EPS of the current year is calculated as if the bonus issue was in existence of the beginning
took place at the start of the year; and,
The corresponding previous years EPS also restated as that bonus issue was in existence
throughout that previous year.
2010
$60,000
400,000
100,000
500,000
400,000
100,000
500,000
EPS
Earnings
As shares were in
existence
at
the
beginning of both
years!
$0.12 is the restated EPS of 2010 in 2011 financial statements for comparison.
Originally, in 2010, the EPS was reported as ($60,000/400,000) = $0.15
Calculating corresponding previous years restated EPS using a formula =
Original EPS X
= $0.15 X
400,000
500,000
= $0.12
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Original EPS X
= $0.15 X
4
4+1
= $0.12
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Description
Opening balance
Full market price issue
Total N. of shares
Bonus issue:
400,000/4
=
100,000/4
=
Total N. of shares
N. of shares
400,000 X
100,000 X
500,000
Month weight
12/12
10/12
=
=
100,000 X
25,000 X
625,000
12/12
10/12
=
=
100,000
20,833
604,166
Alternative way:
Date
Description
01.01.11
01.03.11
Opening balance
Full market price
issue
Total N. of shares
after full market
price issue
Bonus issue (1 for
4 held)
(500,000/4)
Total N. of shares
after bonus issue
01.04.11
Number
shares
400,000
100,000
of
Bonus
effect
5/4
-
issue
Month weight
2/12
-
Weighted
avg.
number of shares
83,333
-
500,000
5/4
1/12
52,083
125,000
625,000
9/12
468,750
604,166
$60,000
4
4
4+1
In a right issue, shares are sold at a reduced price; so, we need to divide the total number of shares
issued into bonus shares and fully paid shares and treat as such.
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Deduct original number of shares from the result of the above formula to get the bonus
shares
PROBLEM!!
when there will be multiple issues
check the example below
Step 4: Calculate corresponding previous years EPS taking the bonus share effect. We can use
following formula:
Re-stated EPS of the previous year =
Original EPS of the previous year X
Holding ratio to have the onus share(s) Theoretical ex right price
X
Share ratio with onus shares
Cum right price
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Narrative
Shares
1.1.X1 b/d
31.1.X1 Rights issue
Time weight
5,000,000 X
1,250,000
6,250,000 X
30.6.X1 Full-market price125,000
6,375,000 X
30.11.X1 Bonus issue 637,500
7,012,500 X
EPS for y/e 31.12.X1 =
$2,900,000
6,840,918
5
12
5
12
1
12
1.95
11
Weighted avg.
470,085
2,864,583
2,921,875
- =
584,375
6,840,918
10
11
10
11
10
12
10
11
1.95
2
= 41.1c
Diluted EPS:
Diluted EPS warns existing shareholders that the EPS may fall in future years because of potential
new ordinary shares that have been issued.
Potential ordinary shares may be issued in the following forms:
- Convertible bonds (bonds and debentures that can be converted into ordinary shares)
- Convertible preference shares (Preference shares that can be converted into ordinary
shares)
- Options and warrants (Option holders has right, but not obligation, to buy ordinary shares
in a future date at a predetermined price)
- Contingently issuable shares (these are ordinary shares will be issued if certain conditions
are met)
-
The diluted EPS is calculated by revising the original earnings (e.g. cancelling interest and its tax
effect in case of convertible bond) and weighted average number of shares as though the potential
ordinary shares had already been issued.
When calculating the revised weighted average number of shares, the convertible instrument (e.g.
convertible bond) is deemed to have been converted into ordinary shares at the beginning of the period
or, if later, the date of the convertible instrument issued.
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$
200,000
(50,000)
6,000
156,000
(46,800)
109,200
o
-
Dilutive or antidilutive:
Only diluted shares should be included in the diluted EPS calculation.
Potential new ordinary shares are not dilutive if EPS would have been higher if the potential shares
had been actual shares in the period.
Example: Ardent Co has 5,000,000 ordinary shares of 25 cents each in issue. The total earnings in
2010 were $1,750,000. The rate of income tax is 35%. Decide which one of the following will dilute the
EPS and will be included in diluted EPS calculation:
(a) $1,000,000 of 14% convertible loan stock, convertible in three years time at the rate of 2 shares
per $10of stock
(b) $2,000,000 of 10% convertible loan stock, convertible in one years time at the rate of 3 shares
per $5 of stock
Solution:
Basic EPS = $1,750,000/5,000,000 = 35 cents
(a) Earnings increased (i.e. interest expense saves): i X(1 t) = $1,000,000 X 0.14 (1 0.35) =
$91,000
Potential ordinary shares: ($1,000,000 X 2)/ $10 = 200,000 shares
So, incremental EPS = $91,000/200,000 = 45.5c
Incremental EPS is higher than basic EPS; so NOT diluted and do not include in the diluted EPS
calculation.
(b) Earnings increased (i.e. interest expense saves): i X(1 t) = $2,000,000 X 0.10 (1 0.35) =
$130,000
Potential ordinary shares: ($2,000,000 X 3)/ $5 = 1,200,000 shares
So, incremental EPS = $130,000/1,200,000 = 10.8c
Incremental EPS is lower than basic EPS; so diluted (i.e. weakened) and need to include in the
diluted EPS calculation.
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o
-
Example: Brand Co had net profit of $1,200,000 for the year ending 31 December 2010. Weighted
average number of ordinary shares outstanding during the year was 500,000. Average fair value of
one ordinary share during the year was $20. Brand Co issued share option of 100,000 shares with
exercise price applicable of $15. Calculate both basic and diluted EPS.
Solution:
If the options are exercised, the company will raise cash of (100,000 shares X $15) = $1,500,000. That
is ($1,500,000 / $20) = 75,000 shares if issued full price. So, the company is giving away (100,000
75,000) = 25,000 shares for free. These 25,000 shares will dilute the basic EPS.
Number of shares
Profit after tax
Basic
500,000
$1,200,000
Dilutive effect
25,000
No effect
525,000
$1,200,000
Basic EPS in 2010 = $1,200,000 / 500,000 = $2.40
Diluted EPS in 2010 = $1,200,000 / 525,000 = $2.29
o
Performance related
Grant date
If shares are partly paid (i.e. less than shares market value is paid):
The equivalent number of fully paid shares must be established to the extent that partly paid shares
are entitled to participate in dividends during the period; and the equivalent full number is included in
the basic EPS calculation.
To the extent that partly paid shares are not entitled to participate in dividends during the period they
are treated as the equivalent of warrants or options in the calculation of diluted EPS.
Diluted losses: when loss per share would be higher if potential shares were in issue.
Bonus issue, share splits and share consolidations after the year end but before the financial
statements are authorised for issue, the number of shares in the EPS calculation is adjusted for the
period just ended and prior periods presented.
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Receivables factoring: Companies sometimes need cash before customers pay their account
balances. In such situations, the company may choose to sell accounts receivable to another company
that specializes in collections. This process is called factoring, and the company that purchases
accounts receivable is often called a factor.
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Group A
Group B
Group C
Required: For the accounts of Jedders, calculate the finance costs and receivables allowance for each
group of trade receivables for the period 1 October 31 December 20X0 and show the financial position
values for those trade receivables as at 31 December 20X0.
Solution:
Group A: No factoring
By 31 December 20X0, 80% (30%+30%+20%) of the receivables collected by Jedders. So, Receivables
allowance of 20% to be recognised on remaining 20% receivables balance.
@ 31 October 20X0:
DR SFP: Bank
($1,250,000 X 30%)
CR SFP: Receivables
(30% of receivables collected by Jedders. So, decrease in receivables)
$375,000
$375,000
@ 30 November 20X0:
DR SFP: Bank
($1,250,000 X 30%)
$375,000
CR SFP: Receivables
$375,000
(Further 30% of receivables collected by Jedders. So, decrease in receivables)
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$1,900,000
$100,000
$2,000,000
There is no need for recognising any allowance for receivables on 31 December 20X0, since all the
receivables balance derecognised on 1 October 20X0. Jedders transferred the risk of any under-collection to
Fab Factors; that is, Jedders has no more right on receivables balance.
(Shortcut answer is in the book! Check Q-55-Jedders of BPP question bank.)
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The cut-off date for the consideration of events after the reporting period is the date on which the
financial statements are authorised for issue.
Normally the financial statements are authorised by the directors before being issued to the
shareholders for approval.
Where a supervisory board is made up wholly of non-executive directors, the financial statements
will first be authorised by the executive directors for issue to that supervisory board for its approval.
The relevant cut-off date is the date on which the financial statements are authorised for issue to the
supervisory board.
The date on which the financial statements were authorised for issue should be disclosed.
If a significant event occurs after the authorisation of the financial statements but before the annual
report is published, then the entity is not required to apply the requirements of IAS 10.
However, if the event was so material that it affects the entitys business and operations in the future,
the entity may wish to discuss the event in the narrative section at the front of the Annual Review but
outside of the financial statements themselves.
Equity dividend (i.e. dividend to ordinary and irredeemable non-cumulative preference shares) should
only be recognised as a liability where they have been declared before the reporting date, as this is the
date on which the entity has an obligation.
Where equity dividends are declared after the reporting date, this fact should be disclosed but no
liability recognised at the reporting date.
Where the going-concern basis is clearly not appropriate, break-up basis should be adopted.
The break-up measures the assets at their recoverable amount in a non trading environment, and a
provision is recognised for future costs that will be incurred to break-up the business.
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Asset: A resource controlled by an entity as a result of past events and from which future economic
benefits are expected to flow to the entity. [Conceptual Framework: 4.4a]
Liability: A present obligation of the entity arising from past events, the settlement of which is expected
to result in an outflow from the entity of resources embodying economic benefits. [Conceptual
Framework: 4.4b]
Equity: The residual interest in the assets of the entity after deducting all its liabilities. [Conceptual
Framework: 4.4c]
Income: Increases in economic benefits during the accounting period in the form of inflows or
enhancements of assets or decrease of liabilities that result in increases in equity, other than those
relating to contributions from equity participants. [Conceptual Framework: 4.25a]
Expenses: Decrease in economic benefits during the accounting period in the form of outflow or
depletions of assets or incurrences of liabilities that result in decrease in equity, other than those relating
to distributions to equity participants. [Conceptual Framework: 4.25b]
Liquidity: The availability of sufficient funds to meet deposit withdrawals and other short-term financial
commitments as they fall due.
Solvency: The availability of cash over the longer term to meet financial commitments as they fall due.
Going concern: The entity is normally viewed as a going concern, that is, as continuing in operation
for the foreseeable future. It is assumed that the entity has neither the intention nor the necessity of
liquidation or of curtailing materially the scale of its operations. [Conceptual Framework: 4.1]
Materiality: Information is material if its omissions or misstatements could influence the economic
decisions of users taken on the basis of the financial statements. [Conceptual Framework: QC11]
Substance over form: The principle that transactions and other events are accounted for and presented
in accordance with their substance and economic reality and not merely their legal form.
Qualitative characteristics: The attributes which make the information provided in financial statements
useful to the users. [Conceptual Framework: QC19]
Comparability
Verifiability (Reliability)
Timeliness (Relevance)
Understandability
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'As is a tale, so is life: not how long it is, but how good it is, is
what matters.' - J. K. Rowling Speaks at Harvard
Commencement 08
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* * * End * * *
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