Notes PDF

Financial Accounting 2 – Lecture notes
©Prof Niamh Brennan

A Typical Accountant!
The 19th century philosopher, Elbert Hubbard, described the typical accountant as:
“A man past middle age, spare, wrinkled, intelligent, cold, passive, non-committal, with eyes
like a cod-fish, polite in contact, but at the same time, unresponsive, cold, calm and
damnably composed as a concrete post or plaster-of-paris cast; a human petrfication with
a heart of feldspar and without charm of the friendly germ, minus bowels, passion, or a
sense of humour.
Happily, they never reproduce and all of them finally go to hell”

(Source: Horngren, C.T. (1982) Cost Accounting: A Managerial Emphasis, 5th Ed, Prentice
Hall, p. 350)
A Typical Accountant!

What are the big questions in Accounting?
How should profit be calculated?
How should assets be valued?
Example 0.1: Illustrating the big questions in accounting
Required:
(a) (i) What do you understand by the term “profit”?
(a) (ii) Describe three ways to measure profit
(a) (iii) Calculate three measures of profit for the company
(b) (i) What do you understand by the term “value”?

(b) (ii) Describe three ways to measure value
(b) (iii) Calculate three balance sheets for the company

1. Principles of double entry bookkeeping and year-end adjusting entries
Section 1: Principles of double entry bookkeeping and year-end adjusting entries
Notes Problem questions

1.1 Types of business organisations
1.1.1 Sole trader
1.1.2 Partnership
1.1.3 A company
1.1.4 Charities, Societies, State Bodies
1.2 Double entry bookkeeping
1.2.1 Books of prime entry
1.2.2 Nominal ledger Question 1: Basic Recall Unlimited
1.2.3 Debits (Dr) and credits (Cr) Question 2: Clueless Limited
1.2.4 Nominal ledger accounts MCQ 1a.1 – 1a.3
1.2.5 Balancing off accounts MCQ 1a.4 – 1a.8
1.3 Preliminary and final trial balance
1.4 Year-end adjusting entries
1.5 Final financial statements
1.6 The balance sheet / statement of financial position
1.6.1 Assets
1.6.2 Liabilities
1.6.3 Capital (Equity)
1.6.4 The balance sheet equation
1.6.5 Example balance sheet/ statement of financial position
1.7 The profit and loss account (income statement) MCQ 1f.1 – 1f.5
1.7.1 Revenues
1.7.2 Expenses
1.7.3 Example profit and loss account/ income statement
1.8 Opening/Closing stock (inventory) MCQ 1b.1 – 1b.5
1.9 Accruals/Prepayments MCQ 1c.1 – 1c.9
1.9.1 Accruals of expense items
1.9.2 Prepayments of expense items
1.9.3 Accruals of revenue items
1.9.4 Prepayments of revenue items
1.10 Fixed (non-current) assets and depreciation MCQ 1d.1 – 1d.15
1.10.1 Example depreciation
1.10.2 Calculation of depreciation
1.10.3 Accounting entries for depreciation
1.11 Fixed (non-current) assets
1.11.1 Additions to fixed (non-current) assets
1.11.2 Disposal of fixed (non-current) assets
1.11.3 Accounting entries to record disposal of fixed (non-current) assets
1.11.4 Example of disposal of fixed (non-current) assets
1.12 Bad debts and bad debt provisions MCQ 1e.1 – 1e.16
1.12.1 Bad debts Question 3: J Green
1.12.2 Provisions for bad debts Question 4: Nigel Good

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Fra Luca Bartolomeo de Pacioli, the father of Accounting 1:

Summa de Arithmetica, Geometria, Proportioni et Proportionalità
First published description of double-entry bookkeeping (Venice 1494)
The terminology in these notes is a mixture of international accounting standards (IAS) Generally
Accepted Accounting Principles (GAAP) and UK GAAP, e.g., Inventories/stock, receivables/debtors,
payables/creditors, non-current assets/fixed assets, statement of financial position/balance sheet,
income statement/profit and loss account.
Section 1 of these notes provide a revision to Level 1 basic financial accounting. The notes deal
with four topics:
1. Types of business organisation
2. Double entry bookkeeping
3. Final financial statements
4. The balance sheet (statement of financial position)
5. The profit and loss account (income statement)
1.1 Types of business organisations
1.1.1 Sole trader
A single owner runs the business e.g., doctor. We can recognise sole traders because there is no
Ltd or plc in the name of the business (Ltd or plc is indicative of a registered company). Also,
there are items in the financial statements of sole traders which would not appear in the financial
statements of a company, for example, ‘Capital’ (called ‘share capital’ in a company) and
Drawings (called ‘dividends’ in a company).
The financial statements of sole traders are not subject to any regulations that influence the
format and presentation of the financial statements. There are two reasons why a sole trader
might prepare financial statements. The main reasons sole traders prepare financial
statements is for tax purposes. The sole trader has to provide sufficient information to satisfy the
requirements of the taxman. Financial statements may also be useful if a sole trader wants to
borrow money from a bank.
1.1.2 Partnership
A partnership involves a number of individuals owning and running the business together e.g., an
accountancy practice, firm of solicitors, architects. The financial statements of partnerships are not
subject to any regulations that influence the format and presentation of the financial statements.
There are three reasons why a partnership might prepare financial statements.  To calculate the
profit for the partnership and the share of profit for each partner.  Individual profit shares form
the basis of taxation of that person.  Financial statements may also be useful if a sole trader wants
to borrow money from a bank.
1.1.3 A company
A company is a business that is registered with the Registrar of Companies (Parnell House, Parnell
Square) under the Companies Act 2014. This procedure is called incorporation. There are many
different types of registered company, some of which are illustrated in Table 1.1. The name of the
1 Prof Alan Sangster dropped a “double entry bombshell” in the February 2015 edition of
Accountancy Ireland by tracking down an earlier treatise on double entry in the National Library,
Valetta, Malta. It turns out that Marino de Raphaeli, a teacher of double entry bookkeeping from
what is now Dubrovnic, Croatia, wrote a treatise on double entry bookkeeping in 1475, almost 20
years before Pacioli. de Raphaeli’s treatise is the starting point for Luca Pacioli’s work. Chartered
Accountants Ireland funded Prof Sangster’s research.
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company often indicates its type, distinguishing between private companies (Limited,
SARL/EURL/Inc) and public companies (Public Limited Company (plc)/SA/Inc).
Table 1.1: Types of registered company
Included in name of company

① Limited UK/Ireland France Germany US
• Private (i.e., non-listed, closely held companies) Limited (Ltd) SARL Inc
 Cannot offer shares to public /EURL
 Restricted right of transfer of shares
 Maximum 149 members/shareholders
• Public (i.e., does not meet  above; may be listed on a Public limited SA GmBH Inc
recognised stock exchange) company (plc)
② Unlimited (Facilitates avoiding accounts filing requirements)
③ Limited by guarantee (common in charities)
Almost all registered companies are limited liability companies i.e., the liability of the owners or
shareholders of the company is limited to the amount of capital they put into the company. 2 Thus,
when a company is put into liquidation or is wound up the creditors of the company may not get
fully paid. Because of limited liability, the liquidator of the company is not able to get more money
from the shareholders to fully pay off the creditors.
Section 347(1) of the Companies Act 2014 requires limited companies to file financial statements
with their annual returns. To get around these requirements, companies restructured into
unlimited companies, but had limited liability holding companies, thus retaining the “best of both
worlds”. In 1994, the financial statement filing requirements were extended to unlimited
companies “governed by the laws of a member state” (of the EU). The Isle of Man is not in the EU.
The loophole permitting Isle of Man unlimited companies avoid filing financial statements will be
closed for financial statements beginning on or after 1 January 2017 as a result of EU Directive
2013/34?EU. The Companies (Accounting) Act 2017 transposes the EU Accounting directive
2013/34/EU into Irish law, which abolishes “non-filing structures” for Irish unlimited companies.
The term '& company' is used to refer to the rest of the company of individuals in a partnership.
This term has nothing to do with registered companies. A registered company is usually indicated
by the letters plc/ltd.
The Irish Companies Act 2014 introduces a number of new types of company:
• Private limited company – company limited by shares (CLS)
• Private limited company – designated activity company (DAC) (Companies who list debt
securities / debentures must become a DAC; this form may also be suitable for special purpose
vehicles and charities)
• Public limited company – company limited by guarantee not having a share capital (CLG)
• Public limited company – Public limited company (PLC)
• Unlimited company – private unlimited company (ULC)
• Unlimited company – public unlimited company (PUC)
• Unlimited company – public unlimited company not having a share capital (PULC)
2
Ireland was the first country in the world to introduce the concept of limited liability. The
Anonymous Partnership Act of 1781 provided that partnerships could be formed in which
dormant partners enjoyed a modified form of limited liability. It was the development of the
company which ultimately provided the widespread privilege of limited liability (Brennan,
O’Brien and Pierce, 1992).
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1.1.4 Charities, Societies, State Bodies
These are businesses, usually of a specialist nature, which are legally incorporated under
legislation specifically drawn up for the business/type of business.
1.2 Double entry bookkeeping
The accounting system in a business is made up of a great many different types of accounting
documents. Bookkeeping involves the methodical recording of the repetitive day-to-day financial
transactions of a business. These transactions are entered (‘posted’) first in books of prime entry
and then in the nominal ledger.
1.2.1 Books of prime entry
Books (sometimes called journals or day books) of prime entry are the first point of entry of
transactions in the accounting system. Although transactions may be documented in the form of
source documents (e.g., cash receipts docket, cash register till rolls, petty cash vouchers, cheques
sales invoice, credit note, purchase invoice, credit note, wages pay slip, etc.), until they are recorded
in a book of prime entry, they are not part of accounting records. The books of prime entry are not
part of the double entry accounting system. Their purpose is to aggregate transactions into totals
(for example, monthly totals) which totals are then entered/posted to the nominal ledger on a
regular basis (e.g., monthly). This aggregation process reduces the number of double-entry
postings to be made. When the totals are posted from the journals to the nominal ledger, the entries
become part of the double entry accounting system.
Thus, books of prime entry have three purposes:

① Efficient posting of the nominal ledger
② Summarise similar transactions
③ Permits the analysis of transactions (e.g., analysis of different types of sales, i.e., sales of Product
X, Product Y, Product X).
There are usually seven (or more) books of prime entry in most businesses, as follows:
1. Cash receipts book/journal;

2. Cheque payments book/journal;
3. Petty cash book/journal;
4. Sales book/journal (sales returns book/journal);
5. Purchases book/journal (purchases returns book/journal);
6. Wages (salaries) book/journal;
7. General journal.
Example 1.1 shows a book of prime entry – the cheque payments book – for the month of January
20X2. The cheque payments book has a total column. The amounts in the total column are analysed
into four analytical categories. During that period, four cheques were written. At the end of the
month, the monthly totals are totalled. Then the monthly totals are posed to the nominal ledger.
The total of the debits posted must equal to total credits posted to the nominal ledger.

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Example 1.1: A book of prime entry – Cheque payments book
Analysis of total
Date Cheque no. Payee Total Creditors Rent Light & Heat Wages
01/01/20X2 1 Millers 2,000 2,000
09/01/20X2 2 Landlord 1,000 1,000
13/01/20X2 3 ESB 1,500 1,500
31/01/20X2 4 A.N.Employee 1,000 _______ ______ _______ 1,000
5,500 2,000 1,000 1,500 1,000
Post Post to Post Post to Post
to Creditors to Light & to
Bank (Dr) Rent Heat (Dr) Wages
(Cr) (Dr) (Dr)
Monthly postings to the nominal ledger
Entries in the General Journal (7th in the list earlier) (or ‘the journal’) are called journal entries.
Journal entries have three components:  the debit entry,  the credit entry and  the
accompanying narrative describing the transaction. This narrative often begins with the word
“being” as illustrated in Example 1.2.
Example 1.2: Recording journal entries
Dr Depreciation Expense (profit and loss account) X

Cr Accumulated Depreciation (balance sheet) X
Being depreciation charge for the year
(year-end adjusting entry – see Section 1.10)
Dr Purchases X
Cr Sales X
Being correction of purchases incorrectly posted to the Sales
account in the nominal ledger
(Correction of error)
Entries in the general journal are those that do not fit into any other book of prime entry. They
usually involve ① year-end adjusting entries (closing stock, accruals, prepayments, depreciation,
profit/loss on disposal of fixed assets, bad debt write offs, bad debt provisions, impairments, etc.)
or ② correction of errors.
1.2.2 Nominal ledger
The nominal/general ledger is the central part (heart) of the accounting system. All transactions
of the business are entered in the nominal/general ledger by means of double entry, from the

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books of prime entry. The nominal ledger is a collective term to refer to all the accounts of the
business.
1.2.3 Debits (Dr) and credits (Cr)
There are three rules of double entry;.
Rule ① The duality rule
All transactions are accounted for using double entry. Thus, all transactions are recorded twice (in
different accounts each time) in the nominal ledger. One entry is the debit entry and the other is
the credit entry. By convention, Assets and Expenses are recorded as debits. Paragraph 1.5.2
explains that assets when used up become expenses. Thus, it is not surprising that both assets and
expenses are debits. Liabilities (including liabilities to owners i.e., Capital) and Revenue are
represented by credits. Revenue gives rise to profit which is a liability to the owners of the business
and is therefore a credit.
Every transaction has a dual effect. It is therefore wrong to think 'x transaction is a debit' or 'y
transaction is a credit'. Every transaction has both a debit effect and a credit effect. It is because of
this dual effect and because of double entry that the balance sheet balances (provided no errors
are made!).
Rule ② The “when to debit, when to credit” rule
Table 1.2 summarised Rule ② of double entry.
Table 1.2: Summary of the rules of double entry
• Asset Debit balance (Dr)

• Expense Debit balance (Dr)
• Liability/capital Credit balance (Cr)
• Revenue Credit balance (Cr)
Balance sheet items

Assets and liabilities (capital)
Increase an asset (a debit balance) Dr
Decrease an asset (a debit balance) Cr
Increase a liability/capital (a credit balance) Cr
Decrease a liability/capital (a credit balance) Dr
Profit and loss account items
Revenues and expenses
Increase a revenue (a credit balance) Cr
Decrease a revenue (a credit balance) Dr
Increase an expense (a debit balance) Dr
Decrease an expense (a debit balance) Cr
Rule ③
The debit entry is on the left hand side, the credit entry is on the right hand side.

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Five steps to apply in recording a double entry
 Identify the two accounts affected by the transaction

 Classify the two accounts (Assets, liabilities, capital, revenue, expense)
 Is the account a debit or a credit balance?
 Did the balance go up or go down?
 Record the double entry
Assets, liabilities, capital, revenues, expenses
• Asset: An asset is something owned by a business which will provide future benefit to the
business (see Section 1.6.1)
• Liability: Liabilities are amounts owing/obligations to 'outsiders' (as opposed to the owners)
of a business (see Section 1.6.2)
• Capital/equity: 'Capital' or ‘equity’ are amounts owing/obligations to owners of a business by
the business (see Section 1.6.3)
• Revenue: Revenue is income earned during the accounting period (accruals concept) which is
usually received/receivable in cash (see Section 1.7.1)
• Expenses: Expenses are items used up in generating that revenue (matching principle) (see
Section 1.7.2)
Occasionally an account could be both an asset and a liability. An example of this is the bank
account, which is an asset if there is money in the bank, and a liability if there is a bank overdraft.
Occasionally an account could be both an expense and a revenue. An example of this is the disposal
account (opened to record the disposal of a fixed asset). If there is a profit on disposal, the account
will be a revenue; if there is a loss on disposal the account will be an expense.
Recording double entries
Double entries can be recorded in two ways: as journal entries or in nominal ledger accounts
(sometimes called ‘T’ accounts for their shape’). By tradition, the debit entry is shown first,
followed by the credit entry. Example 1.3 shows five transactions recorded as journal entries
(except the narrative for the journal entry is not shown, just the debit and credit entries).

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Example 1.3: Recording transactions as double entries
A company has five transactions as follows:

Transaction 1: Receive €100,000 cash from debtors/receivables
Transaction 2: Pay €200,000 cash to creditors/payables
Transaction 3: Buy plant and machinery on credit for €300,000
Transaction 4: Make cash sales of €400,000
Transaction 5: Make purchases of €500,000 on credit
Required:
Record the five transactions in the form of double entries.
Solution:
Five steps to apply in recording a double entry
 Identify the two accounts affected by the transaction
 Categorise the two accounts (Assets, liabilities, capital, revenue, expense)
 Is the account a debit or a credit balance?
 Did the balance go up or go down?
 Record the double entry

 Receive €100,000 cash from debtors/receivables
 Receive €100,000 cash [Asset] from debtors/receivables [Asset]
 Assets are debit balances
 Cash went up, Debtors/Receivables went down
 Dr Cash (Asset [current]) €100,000
Cr Debtors/receivables (Asset [current]) €100,000

 Pay €200,000 cash to creditors/payables
 Pay €200,000 cash [Asset] to creditors/payables [Liability]
 Assets are debit balances; Liabilities are credit balances
 Cash went down, creditors/payables went down
 Dr Creditors/payables (Liability[current]) €200,000
Cr Cash (Asset [current]) €200,000

 Buy plant and machinery on credit for €300,000
 Buy plant and machinery [Asset] on credit [Liability] for €300,000
 Assets are debit balances; Liabilities are credit balances
 Plant and machinery went up, creditors/payables went up
 Dr Plant and machinery (Asset [non-current]) €300,000
Cr Creditors/payables (Liability [current]) €300,000

 Make cash sales of €400,000
 Make cash [Asset] sales [Revenue] of €400,000
 Assets are debit balances; Revenues are credit balances
 Cash went up, Sales revenue went up
 Dr Cash (Asset [current]) €400,000
Cr Sales (Revenue) €400,000

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Example 1.3: Recording transactions as double entries (continued)

 Make purchases of €500,000 on credit
 Make purchases [Expense] of €500,000 on credit [Liability]
 Expenses are debit balances; Liabilities are credit balances
 Purchases went up, Creditors/payables went up
 Dr Purchases (Expense) €500,000
Cr Creditors/payables (Liability[current]) €500,000
Question-in-the-exam 1
Luca Pacioli (or his predecessor Marino de Raphaeli – see Footnote 1 earlier) decided that assets
and expenses would be debits and liabilities/capital and revenue would be credits. The CEO has
asked you to explain why profit is a credit balance.
1.2.4 Nominal ledger accounts
Nominal ledger accounts are also referred to as T–accounts (reflecting the manner in which such
accounts are depicted). The word ledger refers to the nominal/general ledger which as was stated
earlier is the central part of the accounting system. All transactions of the business are entered in
the nominal/general ledger by means of double entry in ledger or ‘T’ accounts.
There is no limit on the number of ‘T’ accounts that can be opened, nor is there any restrictions on
what each account is called. Accounts are normally opened for each type/class of asset, liability,
capital, revenue and expense.
Each account has two sides. The left hand side is referred to as the debit side and the right hand
side as the credit side. Each entry in a ‘T’ account has three elements: date, narrative
description, amount. This is illustrated in Example 1.4.
Example 1.4: ‘T’ account
Title of Account
Debit side Credit side
Date Narrative € Date Narrative €
Date Stating the other Amount Date Stating the other Amount
transaction account affected by transaction account affected by
is recorded the double entry is recorded the double entry
Example 1.5 shows a ‘T’ account where the balance on the account is a debit balance. Assets and
expenses are debits.

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Example 1.5: ‘T’ account that are debit balances (Asset or expense accounts)
Asset (or Expense) (these are debits) account

Increases go on this side Decreases go on this side
Increases (+) of Assets/Expenses are Debits Decreases (-) of Assets/Expenses are Credits
Example 1.6 shows a ‘T’ account where the balance on the account is a credit balance.
Liabilities/Capital and revenues are credits.
Example 1.6: ‘T’ account that are credit balances (Liabilities/Capital or revenue accounts)
Liability (or Capital) (or Revenue) (these are credits) account

Decreases go on this side Increases go on this side
Decreases (-) of Liabilities/Revenues are Debits Increases (+) of Liabilities/Revenues are Credits
Example 1.7 shows five transactions recorded in ‘T’ accounts.

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Example 1.7: Recording double entries in nominal ledger ‘T’ accounts

Required:
Record the five transactions in the form of entries in nominal ledger ‘T’ accounts.
Solution:
DEBIT CREDIT
Cash Debtors/Receivables Control Account
Date Debtors 100 100 Cash Date

Creditors/Payables Control Account Cash
Date Cash 200 200 Creditors Date

Plant and machinery Creditors/Payables Control Account
Date Creditors300 300 P&M Date

Cash Sales
Date Sales 400 400 Cash Date

Purchases Creditors/Payables Control Account
Date Creditors 500 500 Purchases Date
1.2.5 Balancing off accounts
In order to calculate the balance on a ‘T’ account, the larger side is added up, and a ‘plug’ figure is
added to the other side to make it add up to the larger total. This ‘plug’ figure is the balance on the
account. If the item is an asset, liability or capital (balance sheet item), the closing balance is
‘carried down’ (c/d) / ‘carried forward’ (c/f) to the opposite side of the ‘T’ account as the opening
balance of the following accounting period. At that point, the opening balance is referred to as or
‘brought down’ (b/d)/’brought forward’ (b/f)). If the item is a revenue or expense (income
statement item), the ‘plug’ figure is transferred to the profit and loss account. This is summarised
in five steps as follows:
 Add up the larger side

 Insert ‘plug’ figure to make other side add up to the amount in  above
 The ‘plug’ figure is ‘carried down’ (c/d) / ‘carried forward’ (c/f) to the opposite side of the ‘T’
account
 If the item is an asset, liability or capital (balance sheet item), the ‘plug’ figure is ‘brought down’
(b/d) / ‘brought forward’ (b/f) as the opening balance for the next accounting period
 If the item is a revenue or expense (income statement item), the ‘plug’ figure is transferred to
the profit and loss account. If there is an accrual or prepayment on a revenue/expense account,
the accrual/prepayment is ‘carried down’ (c/d) / ‘carried forward’ (c/f) to the next accounting

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period and is ‘brought down’ (b/d) / ‘brought forward’ (b/f) via the balance sheet as the
opening balance to the next accounting period.
 If the item is an asset, liability or capital (balance sheet item), the ‘plug’ figure is transferred to
the balance sheet. The closing balance will become the opening balance next year.
Example 1.8 illustrates this by reference to the five transactions recorded in Example 1.3 and
Example 1.7. There are no arrows in the sales and purchases account, as the balances on these
accounts are not brought/carried forward. Rather they are moved to the profit and loss account.
Example 1.8: Balancing off nominal ledger ‘T’ accounts
Assume a company has opening debtors of €300,000 and opening share capital of
€300,000. The company has five transactions as follows:
Required:
Record the five transactions in the form of entries in nominal ledger ‘T’ accounts.
Solution:
Five steps to balance off a ‘T’ account
① Add up the larger side
② Insert ‘plug’ figure to make other side add up to the amount in  above
③ The ‘plug’ figure is ‘carried down’ (c/d) / ‘carried forward’ (c/f) to the opposite side
of the ‘T’ account
④ If the item is an asset, liability or capital (balance sheet item), the ‘plug’ figure is
‘brought down’ (b/d) / ‘brought forward’ (b/f) as the opening balance for the next
accounting period
⑤ If the item is a revenue or expense (income statement item), the ‘plug’ figure is
transferred to the profit and loss account.
⑥ If the item is an asset, liability or capital (balance sheet item), the ‘plug’ figure is
transferred to the balance sheet. The closing balance this year (20X1 in the example)
will be the opening balance next year (20X2).

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Example 1.8: Balancing off nominal ledger ‘T’ accounts (continued)
Solution (continued):
Bank/Cash
Date Debtors 100 200 Creditors Date
Date Cash sales 400 300 Bal. c/d 31/12/20X1
500 500
Bal. b/d 1/1/20X2 300
Debtors/Receivables Control Account

1/1/20X1 Bal. b/d (per Question) 300 100 Cash Date
____ 200 Bal. c/d 31/12/20X1
300 300
1/1/20X2 Bal. b/d 200
Creditors/Payables Control Account

Date Cash 200 300 P&M Date
31/12/20X1 Bal. c/d 600 500 Purchases Date
800 800
600 Bal. b/d 1/1/20X2
Plant and machinery

Date Creditors 300 300 Bal. c/d 31/12/20X1
1/1/20X2 Bal. b/d 300
Sales
31/12/20X1 Bal. To P/L 400 400 Cash Date
Purchases
Date Creditors 500 500 Bal. To P/L 31/12/20X1
Share capital
31/12/20X1 Bal. c/d 300 300 Bal. b/d (per Question) 1/1/20X1
300 Bal. b/d 1/1/20X2
Symbols  to  cross-reference to/identify the double entries for the five transactions
in the example
1.3 Preliminary and final trial balances
The first step a business must take in preparing final financial statements is to close off the nominal
ledger accounts and extract a trial balance. The preliminary trial balance is used to ensure that
the accounts balance (i.e., that the debits = the credits) and to summarise the information held
in the nominal ledger. Examples of preliminary trial balances can be found in Q3 J Green and Q4
Nigel Good in the problem questions section of these materials.
Initially, if the preliminary trial balance does not balance, the difference is recorded in what is
called a “suspense account”. As the errors are corrected, the balance of the suspense account goes
to zero (i.e., when the accounts are balanced, i.e., when the debits = the credits.
Based on examples 1.3, 1.7 and 1.8, Example 1.9 shows the preliminary trial balance after the five
transactions of a company.

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Example 1.9: Preliminary trial balance and final accounts
Assume a company has opening debtors of €300,000 and opening share capital of
€300,000.

Required:
Based on the five transactions recorded in the form of entries in nominal ledger ‘T’
accounts in Example 1.8, prepare a preliminary trial balance, profit and loss account and
balance sheet.
Solution:
Preliminary Profit and Balance sheet
trial balance loss account
Dr Cr Dr Cr Dr Cr
€ € € € € €
Bank/Cash 300 300
Debtors/Receivables Control Account 200 200
Creditors/Payables Control Account 600 600
Plant and machinery 300 300
Sales 400 400
Purchases 500 500
Share capital 300 300
Profit and loss account (Loss) _______ _______ ____ 100 100 ____
1,300 1,300 500 500 900 900
Table 1.3 summarises the stages from recording transactions to preparing financial statements.

14
Table 1.3: From recording transactions to preparing financial statements
Transactions/Source documents Subsidiary ledgers

 (debtors ledger;
Books of prime entry creditors ledger)

Post double entries to accounts in the nominal ledger

Balance off accounts in the nominal ledger

Transfer nominal ledger account balances to preliminary trial balance

Record year-end adjusting entries

Extract a final trial balance

Revenue and expense account balances transferred to profit and loss account

Asset, liability and capital account balances transferred to balance sheet

Balance off profit and loss account

[11] Transfer profit and loss account balance to balance sheet

[11] Complete balance sheet
Action point 1.1: What are the ten steps, cradle to grave, from recording transactions to final
financial statements?
1.4 Year-end adjustments
Measuring corporate financial performance necessarily demands that we measure

performance over time. The default period is one year, but that is for reasons having
more to do with the accidents of celestial geometry than any underlying economic
reality. Unless you’re harvesting crops, the periodicity of the Earth’s orbit has only a
coincidental relationship with economic cycles (Raynor, 2013: 64).
Almost all transactions (except for debtors (receivables)/creditors in a credit sales/credit

purchases system) are recorded when cash is received or paid. Except for very small businesses,
few businesses use a cash only basis for recording transactions. Instead an 'accruals' system of
accounting is used. This means that transactions are recognised (this term has a particular
meaning in accounting - i.e., there is a double entry in the nominal ledger, a debit and credit entry)
in the accounts when they occur and not just when money is received/paid.
In practice, except for debtors (receivables)/creditors, during the accounting period transactions
are recorded on a cash received/paid basis. At the end of the accounting period the accounts are
adjusted to the accruals basis of accounting before final financial statements are prepared. These
adjustments are called year-end adjustments.
The year-end adjustments are prepared after the preliminary trial balance is extracted. The [Step
] preliminary trial balance is [Step ] adjusted for the year-end adjustments to give the [Step ]
final trial balance from which [Step ] the final financial statements are prepared.
Year-end adjusting entries are also characterised as transactions which overlap two or more
accounting periods. As a consequence, one side of a year-end adjusting double entry will affect the

15
balance sheet / statement of financial position and the other side the profit and loss account /
income statement).
Year-end adjusting entries arise in respect of expenses and revenues which overlap and relate to
more than one accounting period. The objective in making year-end adjusting entries is to:
1. Match against revenue the expenses incurred in generating that revenue, whether paid for or
not (matching concept)
2. Recognise revenue in the accounting period it is earned, and not just when the money is received
(realisation concept)
Examples of year-end adjusting entries are:

• Opening/Closing stock (inventory) (see Section 1.8 further on)
• Accruals (see Section 1.9 further on)
• Prepayments (see Section 1.9 further on)
• Depreciation (see Section 1.10 further on)
• Bad debts (see Section 1.12 further on)
All these year-end adjusting entries are dealt with later in this section.
1.5 Final financial statements
All registered companies must submit annual returns to the Registrar of companies on an annual
basis. The annual return includes the final financial statements. Five financial statements almost
always comprise the final financial statements:
• A balance sheet (statement of financial position) of the company at the year-end date;
• A profit and loss (income statement) for the previous year's trading; and
• [A statement of comprehensive income (see Section 8 of these notes)]
• [A statement of changes in equity (see Section 9 of these notes)]
• (A cash flow statement (not a legal requirement) (Not covered in Financial Accounting 2
module)).
These five financial statements appear in the annual report in the following order:
1. A profit and loss (income statement) for the previous year's trading; and
2. [A statement of comprehensive income (see Section 8 of these notes)]
3. [A statement of changes in equity (see Section 9 of these notes)]
4. A balance sheet (statement of financial position) of the company at the year-end date;
5. (A cash flow statement (not a legal requirement) (Not covered in Financial Accounting 2
module)).
1.6 The balance sheet / statement of financial position
The balance sheet / statement of financial position is a snapshot picture of a company's financial
position at a certain date. The choice of date will affect the picture portrayed by the balance sheet.
Thus the phrase “managing the snapshot” came up during the Anglo Irish Bank trial in April 2016.
The practice of entering into transactions over the year end to artificially misrepresent the
financial position of a company, known as “window dressing”, can also be described
euphemistically as “balance sheet management”, “managing the snapshot”, “the calendar effect”,
and “putting on your best suit for the photograph” (Brennan, 2016). I call I call Anglo Irish Bank’s
2007 year-end accounting practices “fraud”/“fraudulent financial reporting”!
Q01: Tesco plc’s balance sheet date is 28 February. In what way does the choice of this date affect
the snapshot picture given by the balance sheet?
The balance sheet is always headed up with (i) the name of the company to which it relates, (ii) the
title of the account (i.e., the balance sheet/ statement of financial position) and (iii) the balance
sheet date. (iv) The currency used is also shown at the top of the balance sheet and comparative
amounts are shown for the previous year.

16
The layout is almost always vertical (i.e., the assets are shown first with the liabilities and capital
underneath) although the more old fashioned horizontal layout (i.e., assets shown on the right/left
hand side of the page with the liabilities/capital opposite) is occasionally seen (see Arnotts
Illustration 3.5 for an example of a horizontal-layout balance sheet).
The balance sheet, as its title indicates, must balance. Thus, two amounts/totals will appear on the
balance sheet which will agree. These totals are distinguished by being double underlined. The
balance sheet is a statement of the company's financial position. This is represented by a list of the
company's assets, liabilities and capital.
Balance sheets that balance create the impression that published financial statements are accurate.
They are not! See also Footnote 2 in Section 2.3.1. Users of financial statements need to exercise
scepticism/remove their rose tinted glasses when reading financial statements, even if they are
audited. Example 1.10 provides some evidence of why constant vigilance is necessary when
reading financial statements (Typographical error 1) or listening to corporate executives
discussing accounting numbers (Typographical error 2).
Example 1.10: Typographical errors in financial statements
Typographical error 1
In October, the company was forced to restate details from its accounts due to “typographical
error”. Naibu said that the figure of Rmb2.6m (£269,000) given in its 2013 annual report for
the cost of office decoration and machinery for the Quangang factory during the year should
have been Rmb26m (£2.69m).
(Source: Johnson, Miles and Agnew, Harriet (2015) Sports shoe maker loses track of bosses,
Financial Times, 18 February 2015)
Typographical error 2
While investors were still digesting the guidance—which was lowered in large part because
of a tax accounting change that the company said had been recommended by the Securities
and Exchange Commission—an analyst also pointed out that Valeant had made a major error
in its press release, forecasting profits for the following four quarters of up to $6.6 billion,
when it said in its presentation that it actually expects only $6 billion through the first quarter
of 2017. Valeant promised to correct the $600 million typo, but one analyst mused aloud on
the conference call that, “it definitely looks like it was switched intentionally.”
(Source: Wieczner, Jen (2016) Valeant's Shares Are Having An Epically Bad Day, Fortune, 15
March 2016)
Action Point 1.2: Find more examples of typographical errors in financial statements and send
them to Niamh please!
1.6.1 Assets
An asset is something owned by a business which will provide future benefit to the business.
If the future benefit will be obtained within the next year the asset is a 'current asset' e.g., stock
(inventory) (which will usually be sold to generate profit in the next year), debtors (receivables)
(who will usually pay their debts within one year) and cash at bank/on hand (which can be used
within the next year.) If the future benefit will be obtained after more than one year the asset is a
'fixed (non-current) asset' e.g., Land and buildings, plant and machinery, fixtures and fittings,
motor vehicles all of which have a useful life of more than one year. Companies may hold shares in
other companies. Investments by companies in shares of other companies are also usually
classified as fixed (non-current) assets since the investments are usually held for more than one
year. These fixed (non-current) assets are termed “Financial assets”.

17
There are three categories of fixed assets: Tangible assets (physical assets), Intangible assets (non-
physical assets e.g., goodwill, brand values, legal rights such as patents, trademarks etc), and
financial assets (e.g., investments in other companies in the form of shares, loan stock, bonds, etc.).
An asset such as a motor vehicle could be classified as either a current asset or a fixed (non-current)
asset depending on how the asset is used. If the motor vehicle is purchased for use in the business
over the useful life of the vehicle then it will be recorded as a fixed (non-current) asset. If, on the
other hand, it is purchased for resale (as in a motor dealer's business) the vehicle will be treated
as a current asset called stock (inventory).
1.6.2 Liabilities
Liabilities are amounts owing/obligations to 'outsiders' (as opposed to the owners) of a

business. The person/business to whom the money is owed is often referred to as a creditor
(payables/suppliers). Moneys owing to creditors within one year are 'current liabilities' e.g., trade
creditors for goods/services supplied to the business, taxation due, bank overdraft). Moneys owing
after one year are long-term (non-current) liabilities e.g., Bank term loan, debentures.
1.6.3 Capital (Equity)
The owners (sole trader, partner, shareholder) of a business are treated from an accounting point
of view as completely separate from the business. All transactions between the owners and the
business are accounted for as if they, the owners and the business, were separate entities. When
an owner puts money into a business, the business is treated a owing that money back to the owner.
This 'liability' of the business to the owner is called 'capital' or ‘equity’. 'Capital' or ‘equity’
are amounts owing/obligations to owners) of a business. The business uses the owners' money
to earn profits. Any profit earned is also considered to be owing back to the owner by the business
and is treated as capital.
1.6.4 The balance sheet equation
The balance sheet is composed of assets, liabilities and capital/equity. The balance sheet must
always balance. This is because the following balance sheet equation must always hold true:
Assets = Capital/Equity + Liabilities
This equation can be rearranged in a number of different ways as shown in Table 1.4.
Table 1.4: Versions of the balance sheet equation
(1) Assets = Capital + Liabilities

(2) Assets - Liabilities = Capital
(3) Assets - Current Liabilities = Capital + Long-term (non-current) Liabilities
(4) Fixed Assets + Current Assets - Current Liabilities = Capital + Long-Term Liabilities
1.6.5 Example balance sheet / statement of financial position

(following International Accounting Standard (IAS) 1 layout)
Accountants sometimes use indentation to present numbers in a more digestible manner. The
20X1 numbers in Example 1.11 are indented to the left, with the subtotal in the column to the
right. By way of contrast, the comparative amounts for 20X0 are not indented. Rather, they are
presented in a single column. This is how CRH plc presents its balance sheet in Illustration 1.1.
The use of indentation is a matter of personal choice, personal preference.
By convention, current assets are shown in order of liquidity, i.e., how quickly can the asset be
converted into cash, from least liquid to most liquid. This is not a hard and fast rule.
18
Q02: Based on the four alternatives in Table 1.4, what form does the Example 1.11 Example Limited
balance sheet equation follow?
Example 1.11: Balance sheet
Example Limited
Balance sheet at 31 December 20X1
20X1 20X0
€000 €000 €000
ASSETS
Non-current assets
Property, Plant and Equipment
Land and buildings 1,000 750
Computer equipment 2,500 2,250
Motor vehicles 875 950
4,375 3,950
Current Assets
Inventories 1,000 500
Trade receivables 1,230 1,200
Other current assets - -
Bank and cash 340 890
2,570 2,590
Total assets 6,945 6,540
EQUITY AND LIABILITIES
Equity attributable to equity holders of the parent
Equity / ordinary share capital 3,000 3,000
Retained earnings 3 995 1,090
Total equity 3,995 4,090
Non-current liabilities
Bank term loan 1,000 1,000
Total non-current liabilities 1,000 1,000
Current liabilities
Trade and other payables 850 780
Current income tax liabilities 500 670
Bank overdraft 600 -
Total current liabilities 1,950 1,450
Total equity and liabilities 6,945 6,540
3
The company is accounted for separately from its owners (shareholders). The capital contributed by
shareholders to the company is shown as owing back to the shareholders, as is any profit earned by the
company using the owners’ capital not yet paid back to shareholders in dividends. The profit not yet
paid back to the owners is retained by the company and is called “retained earnings”.
19
CRH plc 2015 Q01: What type of assets does CRH show in its 2015 balance sheet?
CRH plc 2015 Q02: What type of capital/equity does CRH show in its 2015 balance sheet?
CRH plc 2015 Q03: What type of liabilities does CRH show in its 2015 balance sheet?
CRH plc 2015 Q04: Based on the four alternatives in Table 1.4, what form does the CRH balance
sheet equation follow?
Illustration 1.1: CRH plc’s Balance sheet
(Source: CRH plc Annual Report 2015, p. 134)

20
The equity section of the balance sheet of CRH plc contains preference shares and a share premium
account.
Preference shares carry a fixed rate (%) of dividend. The dividend and capital on preference shares
are repayable before (i.e., in preference to) the ordinary or equity shareholders. Thus, if a company
is in financial difficulties, holding preference shares may be advantageous.
CRH plc 2015 Q05: Which would you prefer to be: an equity/ordinary shareholder or a preference
shareholder in CRH plc?
Share premium represents the amount a company receives over and above the nominal value (i.e.,
par value, face value) of the shares. Shares are always recorded at their nominal value. A separate
account, the share premium account, is opened to record the extra premium received by the
company on issuing new shares. Example 1.12 is a simple illustration of how share premium is
recorded.
The double entry is:

Dr Bank and cash X
Cr Equity / ordinary share capital X
Cr Share premium X
Example 1.12: Share premium
Ash plc company issued 500,000 €1 shares at a premium of €1 per share during the year.
Question
• What is the nominal value of each share?
• What is the total nominal value of the shares?
• How much cash did Ash plc receive per share?
• How much cash did Ash plc receive in total?
• How would you record the new share issue?
Solution
• Nominal value of each share = €1/share
• Nominal value of the shares = €1/share x 500,000 shares = €500,000 total nominal value
• Cash received per share = €1Nominal value + €1Premium = €2 per share
• Cash received in total = €2 per share x 500,000 shares = €1,000,000 total cash
• How would you record the new share issue
Dr Bank and cash 1,000,000
Cr Share capital 500,000
Cr Share premium 500,000
Source: Note 7, Question 25 Ash plc
1.7 The profit and loss account (income statement)
The profit and loss account (income statement) is a statement of the revenues generated by a
business during a given period of time less the expenses incurred in generating that revenue
(matching concept).
The profit and loss account is headed up similarly to the balance sheet with the name of the
company, the title of the account (i.e., Profit and loss account/income statement), the period to
which the account relates. The currency used and comparative figures are also shown. If the
revenues exceed the expenses then the balance on the profit and loss account will represent profit.
If expenses exceed revenues then the business will have made a loss.

21
The profit and loss account in a manufacturing/retailing business has three distinct sections which
are shown one after the other in a vertical format: the trading account, the profit and loss account,
the profit and loss association account. The trading account could be seen as the “front office” part
of the business, the core business, with the profit and loss account being “back office”. Many firms
try and keep the “back office” costs as low as possible (e.g., Ryanair, Tesco, Lidl, Aldi).
The trading account (“front office”/core business)
This records the revenue from selling stock (inventory)/goods less the direct costs of those goods,
i.e., the purchase price of the goods. The balance on the trading account is the gross profit of the
business for the period.
The profit and loss account (“back office”)
This account adds sundry other revenue such as bank interest, discount received etc. to gross profit
transferred in from the trading account and subtracts expenses other than those incurred in
purchasing the goods for resale (which are recorded in the trading account). The expenses in the
profit and loss account are often grouped into selling and distribution costs, administrative
expenses and financial expenses. The balance remaining on this account is the net profit of the
business for the period.
The profit and loss appropriation account
This account records the amount of the net profit of the business paid back to/ appropriated (i.e.,
taken out as dividends or in some other form) by the owners of the business. The balance
remaining on this account is the profit retained by the business.
1.7.1 Revenues
Revenue is income earned during the accounting period (accruals concept) which is usually
received/receivable in cash. Examples are sales revenue, interest earned, rents receivable,
dividend/investment income, discount received.
1.7.2 Expenses
Expenses are items used up in generating that revenue (matching principle). Examples are
purchase costs, wages, administrative expenses etc. The list is endless. Assets and expenses are
very similar. An asset is something which has future benefit. When the benefit is used up the asset
becomes an expense. When the item is an asset it is recorded in the balance sheet. When the future
benefit is used up, the asset is taken out of the balance sheet and is put into the profit and loss
account as an expense instead, until the asset is fully depreciated (then it is left in the accounts in
the nominal ledger until it is disposed of).

22
1.7.3 Example profit and loss account / income statement
Example 1.13 illustrates the profit and loss statement. This statement is very detailed and would
not be suitable for publication. Companies do not want their competitors to see the detail.
Therefore, the profit and loss account in a form suitable for publication is much more summarised
– see Section 5 of these notes). The example is the pre-publication, draft profit and loss account.
While much more detailed than the published income statement, Example 1.13 reflects
International Accounting Standard (IAS) 1 layout – see Section 5 of these notes).
The unshaded version (1) of Example 1.13 assumes that the fall in retained earnings of €95,000 is
due to distributing €95,000 more in dividends than earned during the year. The shaded version
(2) of Example 1.13 assumes that the fall in retained earnings is due to losses of €95,000.
Example 1.13: Profit and loss account/Income statement
Example Limited
Trading, profit and loss account for the year ended 31 December 20X1
(1) €95 more
dividends paid than (2) Loss of (€95)
profit earned made
20X1 20X1
€000 €000 €000 €000
Sales 5,000 5,000
Cost of sales
Opening stock 500 500 Trading account
Purchases 4,500 4,500 “front office”/core busines
Closing stock (1,000) (4,000) (1,000) (4,000) Balance = gross profit
Gross profit 1,000 1,000
Other operating income - Rents received 200 200
Total profit 1,200 1,200
Selling and distribution expenses
Salesmen’s salaries (175) (175)
Depreciation of motor vehicles (25) (25)
Advertising (50) (250) (50) (250)
Administrative expenses
Office salaries (200) (200)
Depreciation of office buildings (25) (25)
Depreciation of computers (75) (75) Profit and loss account
Stationery (50) (50) “back office”
Bank charges (20) (370) (20) (370) Balance = profit after tax
Operating profit 580 580
Financial expenses
Interest received 50 50
Interest paid (100) (50) (725) (675)
Profit [(Loss)] before tax 530 (95)
Taxation Nil Nil
Profit / [(Loss)] after tax 530 (95)
Dividends paid Note 1 (625) Nil
Net (loss) retained for year (95) (95) Profit and loss
Retained profit brought/carried forward 1,090 1,090 appropriation account
Retained profit brought/carried down 995 995 Balance = retained profit
Note 1: Directors decide on the amount of dividends they consider appropriate to propose to each
annual general meeting, for adoption by the shareholders. In this instance, it is clear that the
directors decided to pay out all of the profits for 20X1 (i.e., €530) and a further €95 from the
retained profits brought forward from prior years of €1,090.
23
CRH plc 2015 Q06: Where is the trading account shown in CRH plc’s 2015 financial statements?
CRH plc 2015 Q07: What captions/headings are used in CRH plc’s 2015 income statement?
CRH plc 2015 Q08a: Where are appropriations shown in CRH plc’s 2015 financial statements?
CRH plc 2015 Q08b: Why are appropriations shown there in CRH plc’s 2015 financial statements?
CRH plc 2015 Q09: What revenues can you identify in CRH plc’s 2015 income statement?
CRH plc 2015 Q10: What expenses can you identify in CRH plc’s 2015 income statement?
Illustration 1.2 includes CRH plc’s income statement.
Illustration 1.2: CRH plc’s income statement

24
1.8 Opening/Closing stock (inventory)
If stock (inventory) were sold at the same price as purchased all movements of stock (inventory)
could be recorded in a stock (inventory) account and the balance on the account would represent
the unsold stock (inventory) on hand at cost. Stock (inventory), however, is usually sold at a profit
and if purchases and sales of stock (inventory) were recorded in the one account the balance on
the account would represent the unsold stock (inventory) on hand together with the profit earned
on the stock (inventory) sold during the period. For this reason, movements of stock (inventory)
(i.e., purchases and sales) are recorded in separate accounts, the purchases and sales accounts. The
only time the stock (inventory) account is used is to record the opening/closing balance of stock
(inventory) at the beginning/end of an accounting period. The movements in stock/inventory are
recorded in sales (stock sold out), purchases (stock purchased in) accounts. [Sales returns and
purchase returns may also be recorded in separate Sales Returns and Purchase returns accounts].
Example 1.14 shows the three accounts detailing with stock (inventory) – the sales and
purchases accounts which contain movements of stock (inventory) outwards (sales) and inwards
(purchases) while the stock account is the opening / closing balance at the start / end of the
financial year.
Example 1.14: Inventory and movements on inventory accounts
(Sales and purchase amounts from Example 1.7)

In addition, assume closing stock is 20.
Sales
31/12/20X1 Bal. To P/L 400 400 Cash Date
Purchases
Date Creditors 500 500 Bal. To P/L 31/12/20X1
Stock
31/12/20X1 Bal. To P/L (Cost of sales) 20 20 Bal. c/d (Will be given 31/12/20X1
1/1/20X2 Bal. b/d 20 in Question)
Sales, purchases and stock (inventory) accounts are shown in the trading account section of the
profit and loss account. Example 1.15 illustrates the trading account

25
Example 1.15: Accounting for stock/inventory
Example Limited commenced trading by purchasing 100,000 units

of stock @ €1 per unit. 80,000 units were sold @ €1.10 per unit.
Required:
• Calculate the gross profit for Year 1
• Prepare the balance sheet at the end of Year 1
• Calculate the gross profit for Year 2
• Prepare the balance sheet at the end of Year 2
Solution A (incorrect – mismatch between number of units

sold and purchased)
Profit and loss account Year 1 €000 €000
Sales (80 units x €1.10) 88
Purchases (100)
Gross profit (12)
Solution B (correct)
Cost of sales
Opening stock Nil
Purchases 100
Closing stock (20) (80)
Gross profit 8
Balance sheet end Year 1
Current assets
Stock 20
Equity
Retained Profit 8
Current liabilities
Bank overdraft ((100) Purchases + 88 Sales Year 1) 12
20

Cost of sales
Opening stock 20
Purchases Nil
Closing stock (Nil) (20)
Gross profit 2
Balance sheet end Year 2
Current assets
Bank ((100)Purchases + 88Sales Year 1 + 22 Sales Year 2) 10
Equity
Retained Profit (8Year 1 + 2Year 2) 10
The adjustment for opening/closing stock (inventory) was partly shown above in paragraph 1.5.4
dealing with the trading account. When the opening stock (inventory) is sold during an accounting
26
period, it is taken out of the balance sheet and is charged as part of Cost of Goods Sold in the trading
account. At the end of an accounting period when the stock-take indicates that some goods
purchased during the year remain unsold, the cost of this closing stock (inventory) is taken out of
purchases in the trading account and is transferred to the balance sheet to be charged as an
expense in the next accounting period. The double entries are as follows:
Dr Cr
Opening stock (inventory): Dr Trading account (income statement) X
Cr Stock (inventory) (balance sheet) X
Closing stock (inventory): Dr Stock (inventory) (balance sheet) X

Cr Trading account (income statement) X
CRH plc 2015 Q11a: Can you find the amounts for opening and closing stock (inventory) in CRH
plc’s 2015 financial statements?
CRH plc 2015 Q11b: Where is the other side of the double entry for opening and closing stock
(inventory) in CRH plc’s 2015 financial statements? Is the other side of the double entry disclosed
separately in CRH plc’s 2015 financial statements?
CRH plc 2015 Q11c: What is the breakdown/make-up of CRH plc’s inventory?
Illustration 1.3 shows CRH plc’s consolidated balance sheet inter alia containing amounts for
inventory.

27
Illustration 1.3: CRH plc’s inventory
(CRH plc Annual Report 2015, p. 134, 170)
1.9 Accruals/Prepayments
These adjusting entries arise in respect of expenses and revenues which overlap and relate to more
than one accounting period. The objective is to:
1. Match against revenue the expenses incurred in generating that revenue, whether paid for or not;
2. Recognise revenue in the accounting period it is earned and not just when the money is received
Action Point 1.3: Following 2 above, when is revenue earned?
Example 1.16 illustrates the range of choices in deciding when to recognise revenue for a very
simple transaction. The difficulty is exacerbated when it comes to more complex transactions
spanning a number of years, such as the construction and supply of a large building.

28
Example 1.16: When is revenue earned? When should revenue be recognised?
Scenario
01.01.20X1 Niamh sees a lovely car in the showrooms of a reputable motor dealer
02.01.20X1 Niamh goes into the showrooms and makes enquiries about the car
03.01.20X1 Niamh takes the car out for a spin
04.01.20X1 Niamh telephones the motor dealer and says she is going to buy the car
05.01.20X1 Niamh is sent an invoice for the cost of the car
06.01.20X1 Niamh collects the car from the showroom and brings it home
07.01.20X1 Niamh pays the invoice for the car
Required
In relation to the seven events above, at which point do you think should the sale of the car to
Niamh be recognised by the motor dealer and the revenue on the sale recorded in the financial
statements?
Solution
There is no solution to this question. Recognition of revenue, deciding when to record revenue as
earned, is a matter of judgement. An appropriate time to recognise the revenue might be when the
invoice is raised (05.01.20X1).
1.9.1 Accruals of expense items
Expense items are normally only recorded in the nominal ledger when they are paid. Thus, an
expense incurred but not paid for will not appear in the accounts. In order to produce accurate
accounts, expenses incurred but not paid for should be recorded or accrued.
An accrual of an expense item is:

 increases the expense (to which it relates) in the profit and loss account.
 a liability to pay an expense in the future and is accordingly shown in the current liabilities
section of the balance sheet and
The year-end adjusting double entry is:

Dr Cr
Dr Expense account (Income statement) X
Cr Accruals (Balance sheet Current liabilities X
Trade and other payables)
At the end of the financial year, balances on revenue and expense accounts are transferred to
(swept into) the profit and loss account. Conversely, at the end of an accounting period, balances
on asset, liability and capital accounts are brought forward/carried forward via the balance sheet
as the opening balances brought down /carried down at the beginning of the next accounting
period.
Expense (and revenue) accounts with accruals (and prepayments) “double job” as (i) expense
accounts from which balances are swept into the profit and loss accounts and (ii) on which there
are closing balances (accrual or prepayment) which are brought forward/carried forward via the
balance sheet as the opening balances brought down/carried down at the beginning of the next
accounting period.
Example 1.17 provides a simple example of an accrual. In Example 1.17, €10,000 is swept from the
Rent account into the profit and loss account. At the same time, the closing balance of €2,500
accrual is transferred into the balance sheet. Thus, the ‘T’ account in Example 1.17 is “double
jobbing” – it acts as both an account whose balance goes into the profit and loss account and as an
account whose balance goes into the balance sheet.
29
Accruals in current liabilities in the balance sheet are the total accruals for all expense items added
together into one amount.
Example 1.17: Accrual (Expense incurred before it is paid for)
Rent €10,000 per annum (p.a.) is payable at the end of each quarter. The company’s
year end is 31 December 20X7. The following were the actual payments made by the
company during 20X7.
Date paid In respect of Amount
31 March 20X7 1st quarter €2,500
2 July 20X7 2nd quarter €2,500
4 October 20X7 3rd quarter €2,500
Required:
1. How much should be charged for rent in the profit and loss account for the year
ended 31 December 20X7?
2. How much must be accrued for the year ended 31 December 20X7?
3. What is the double entry to record the accrual?
4. How should the accrual be shown in the Rent Expense/Payable account?
5. How should the accrual be shown in the financial statements for the year ended
31 December 20X7?
Solution:
1. How much should be charged for rent expense in the profit and loss account?
Answer = €10,000
2. How much must be accrued for rent payable? Answer = €2,500
3. What is the double entry to record the rent accrual?
Dr Rent Expense/Payable €2,500
(Add €2,500 to rent expenses of €7,500 Rent
€10,000 in the profit and loss account)
Cr. Accruals (in current liabilities in balance sheet) €2,500
4. How should the accrual be shown in the Rent Expense/Payable account?
Rent Expense/Payable
31/03/20X7 Bank 2,500 10,000  P/L 31/12/20X7
02/07/20X7 Bank 2,500
04/10/20X7 Bank 2,500
31/12/20X7 Accrual c/d B/S 2,500 ________
10,000 10,000
2,500 Accrual b/d 01/01/20X8
5. How should the accrual be shown in the financial statements?

The adjustment to the rent expense account will not appear separately in the
financial statements. The accrual will appear as part of Trade and Other
Payables in Current Liabilities in the balance sheet, and will be separately
disclosed in the note to the financial statements.

30
Illustration 1.4 includes extracts from CRH plc’s balance sheet and notes thereto showing how
accruals are reported in the financial statements.
CRH plc 2015 Q12: Can you find any amounts for accruals in CRH plc’s 2015 financial statements?
Illustration 1.4: CRH plc’s accruals
(Source: CRH plc Annula Report, 2015, p. 134, p. 172)
1.9.2 Prepayments of expense items
Expense items paid for and thus appearing in the accounts but not incurred should also be adjusted
for. This type of adjustment is called a prepayment. An example of a prepayment is rent paid in
advance/insurance paid in advance.
Prepayments of expense items represent:

 items paid for which will provide future benefit and are therefore shown as current assets in the
balance sheet and
 reduces the expense (to which it relates) in the profit and loss account.

Dr Cr
Dr Prepayment (balance sheet) X
Cr Expense account (income statement) X

31
Example 1.18 provides a simple example of a prepayment. In Example 1.18, €60,000 is swept from
the Stationery account into the profit and loss account. At the same time, the closing balance of
€20,550 prepayment (it is not stock/inventory which is reserved for “front office” trading
stock/inventory) is transferred into the balance sheet. Thus, the ‘T’ account in Example 1.18 is
“double jobbing” – it acts as both an account whose balance goes into the profit and loss account
and as an account whose balance goes into the balance sheet.
Example 1.18: Prepayment (Expense paid before it is incurred)
A widget manufacturing company paid for stationery during year of €80,550. The
stock of stationery at the year end was €20,550.
Required:
1. How much should be charged for stationery in the profit and loss account?
2. How much must be prepaid?
3. What is the double entry to record the repayment?
4. How should the prepayment be shown in the Stationery account?
5. How should the stock of stationery be shown in the financial statements?
Solution:
1. How much should be charged for stationery in the profit and loss account? €60,000
2. How much must be prepaid? €20,550
3. What is the double entry to record the repayment?
Dr Prepayments €20,550
(in current assets in balance sheet)
Cr. Stationery €20,550
(Subtract €20,550 from stationery
expenses of €80,550 Stationery
€60,000 in the profit and loss account)
4. How should the prepayment be shown in the Stationery account?
Stationery
XX/XX/20XX Bank 80,550 60,000  P/L 31/12/20XX
________ 20,550 Prepayment c/d 31/12/20XX
80,550 80,550 B/S
01/01/20XX Prepayment b/d 20,550
5. How should the stock of stationery be shown in the financial statements? As a

prepayment. Inventory is reserved for manufacturing account items. Stationery is an
administration overhead. Stock of stationary should be included in prepayments.

32
Illustration 1.5 includes extracts from CRH plc’s balance sheet and notes thereto showing how
prepayments are reported in the financial statements.
CRH plc 2015 Q13: Can you find any amounts for prepayments in CRH plc’s 2015 financial
statements?
Illustration 1.5: CRH plc’s prepayments
1.9.3 Accruals of revenue items
Revenue items are normally only recorded in the nominal ledger when they are received. Thus, a
revenue earned but not received will not appear in the accounts. In order to produce accurate
accounts, revenues earned but not paid for should be recorded or accrued.
An accrual of a revenue items is:

 an asset representing the receivable in respect of the revenue earned
 increases the revenue (to which it relates) in the profit and loss account.

33

Dr Cr
Dr Accrual (Balance sheet Current assets  X
Other current assets)
Cr Revenue account (Income statement) X
1.9.4 Prepayments of revenue items
Revenue items are normally only recorded in the nominal ledger when they are received. Thus, a
revenue received but not yet earned will appear in the accounts. In order to produce accurate
accounts, revenues received but not yet earned should be recorded as a prepayment.
A prepayment of a revenue item is:

 Decreases in the revenue (to which it relates) in the profit and loss account.
 A liability representing that the receipt is repayable until the revenue is earned

Dr Cr
Dr Revenue account (Income statement) X
Cr Prepayment of revenue item (Balance sheet X
Current liabilities  Trade and other
payables)
Table 1.5 summarises the double entries for accruals and prepayments of expense and revenue
items.
Table 1.5: Summarising accruals and prepayments of expenses and revenues
Accrual expense item Accrual revenue item

Expense incurred not yet paid for Revenue earned not yet received
Dr Expense account Dr Current asset
Cr Current liability Cr Revenue account
Prepayment expense item Prepayment revenue item

Expense paid for not yet incurred Revenue received not yet earned
Dr Current asset Dr Revenue account
Cr Expense account Cr Current Liability
1.10 Tangible fixed (non-current) assets and depreciation
Fixed (non-current) assets of the business (which are used on a continuing basis) do not last
forever. To write-off the cost in one year would not be in accordance with the matching principle.
According to the matching / accruals principle, the amount to be written-off is the portion of the
cost of the fixed (non-current) asset that has been incurred in the period in generating the revenue
of the period.

34
Illustration 1.6 shows how CRH plc discloses its fixed assets and depreciation.
CRH plc 2015 Q14a: Where are the fixed (non-current) assets disclosed in CRH plc’s 2015 financial
statements?
CRH plc 2015 Q14b: How many categories of fixed (non-current) assets are disclosed in CRH plc’s
2015 financial statements?
CRH plc 2015 Q14c: Where are the categories of tangible fixed (non-current) assets (i.e., Property,
plant and equipment) disclosed in CRH plc’s 2015 financial statements?

35
Illustration 1.6: CRH plc’s fixed assets

36
1.10.1 Example: Depreciation
Example 1.19 is a simple example showing the wrong (Solution A) and right (Solution B) way to
depreciate an asset.
Example 1.19: Depreciation
Asset cost €5 million

Income from the asset is €5 million earned evenly over the asset’s five-year life
Required:
Show how the asset should be accounted for in the income statement and balance
sheet
Solution A (Incorrect - mismatch between charging cost of asset and

recognising revenue arising from use of the asset):
Year 1 Year 2 Year 3 Year 4 Year 5 Total
€m €m €m €m €m €m
Income statement
Income 1 1 1 1 1 5
Expense (5) __ __ __ __ (5)
Profit and loss (4) 1 1 1 1 Nil
account
Balance sheet
Asset - - - - - -
Solution B (Correct):
€m €m €m €m €m €m
Income statement
Income 1 1 1 1 1 5
Depreciation (1) (1) (1) (1) (1) (5)
Profit and loss Nil Nil Nil Nil Nil Nil
account
Balance sheet
Asset - - - - - -
Cost 5 5 5 5 5 5
Aggregate depreciation (1) (2) (3) (4) (5) (5)
Net Book Value 4 3 2 1 Nil Nil
A fixed (non-current) asset has a useful life of more than one year. As the usefulness of the asset is
used up it is no longer appropriate to record the item as an asset in the books. When the asset is
used up what was an asset becomes an expense. This expense is called “depreciation”.
Depreciation is a measure of the cost of a fixed (non-current) asset used up during an accounting
period. Depreciation is a measure of the wearing out, consumption or reduction in the useful
economic life of a fixed (non-current) asset whether arising from use, passage of time or
obsolescence through technological or market changes.
Deprecation decreases profits and assets each year in an effort to reflect the fact that assets are
being used up in the revenue generation process. Depreciation has nothing to do with replacement
of the fixed (non-current) assets.

37
Mechanics of entries for depreciation
① Record asset at cost in fixed (non-current) asset account

② Open depreciation expense account
③ Open aggregate depreciation account (= accumulated depreciation account = provision for
depreciation account)
④ Each year calculate and record annual depreciation in (i) the depreciation expense account
and (ii) the aggregate (accumulated) depreciation account (i.e., record the double entry for
depreciation: Dr Depreciation, Cr Aggregate Depreciation)
⑤ Charge depreciation expense in the profit and loss account each year
⑥ Keep the aggregate (accumulated) depreciation account separately from the fixed (non-
current) asset account.
⑦ Subtract the aggregate (accumulated) depreciation from the fixed (non-current) asset
account and show the net book value (NBV) in the balance sheet
⑧ When asset is fully depreciated (aggregate depreciation = cost of asset) continue to carry
forward fixed (non-current) asset balance and aggregate (accumulated) depreciation balance
until asset is disposed.
Implementing the above eight steps is illustrated in Example 1.20.
Example 1.20: Application of 8 steps to recording depreciation

Required:
Show the 8 steps above for recording the asset / depreciation in the income
statement and balance sheet
Solution:
€m €m €m €m €m €m
Income statement
Income 1 1 1 1 1 5
Depreciation  (1) (1) (1) (1) (1) (5)
Profit and loss account Nil Nil Nil Nil Nil Nil
Balance sheet
Asset - - - - - -
Cost 5 5 5 5 5 5
Aggregate depreciation  (1) (2) (3) (4) (5) (5)
Net Book Value  4 3 2 1 Nil Nil

38
Illustration 1.7 shows how CRH plc discloses depreciation in its financial statements.
1. CRH plc includes in Note 2 an analysis of costs

2. Note 2 starts by analysing costs in cost of sales
3. One of the costs is Depreciation, Amortisation and Impairment
4. Depreciation, Amortisation and Impairment is further analysed (in 3. above) into the three
separate elements
5. The first line, Depreciation, is analysed between cost of sales and operating costs
6. The total for Depreciation matches the total in Note 13 Property, plant and equipment
7. The above six points are identified on Illustration 1.7 using ❶❷❸❹❺❻
CRH plc 2015 Q15a: What was the charge for depreciation in CRH plc’s 2015 financial statements?
CRH plc 2015 Q15b: On how many categories of tangible fixed (non-current) assets was
depreciation charged in CRH plc’s 2015 financial statements?
CRH plc 2015 Q15c: On how many categories of tangible fixed (non-current) assets was
depreciation NOT charged in CRH plc’s 2015 financial statements?

39
Illustration 1.7: CRH plc’s depreciation
(CRH plc Annual Report 2015, p. 152, p. 164)

40
1.10.2 Calculation of depreciation
• Based on the original purchase price / cost (straight-line method) / net book value (reducing
balance method;
• Estimate of residual value may also be necessary;
• Estimate of economic life has to be made.
Methods of depreciation
There are a number of ways or methods of calculating depreciation, of which the following two are
the most common. The choice of method should reflect the revenue generation pattern of the asset.
For example, in Example 1.19 and Example 1.20 the revenue is “earned evenly over the asset’s five-
year life”. In Example 1.21, “more is expected to be earned in the earlier years of the use of the asset
over its five-year life”. This would suggest that the straight-line method is suitable for examples
1.14 and 1.15, while the reducing-balance method is more suitable in Example 1.21.
(A) Straight-line method
The most common method is the straight-line method. Straight-line depreciation charges the same
amount of the cost to each year of the useful life of the asset. Write-off the cost of the asset equally
over the useful life of the asset.
Cost – residual/scrap value = Depreciation charge per annum (p.a.)

Useful life of the asset
The scrap value of the asset at the end of its useful life is usually so small that it is assumed to be
€nil.
Advantages
• Easy to understand and apply.
Disadvantages
• Some assets do not depreciate evenly.
(B) Reducing-balance method
Write-off the cost – residual/scrap value of the asset using a constant percentage of the written-
down value/net book value.
Calculations
Year 1 depreciation: Cost of asset x Rate (%) of depreciation
Subtract Year 1 depreciation from cost of asset
Year 2 depreciation: (Cost of asset – Depreciation Year 1) x Rate (%) of depreciation
Cost – aggregate depreciation – residual/scrap value @ Rate = Depreciation charge p.a.
Advantages
• Maintenance may be low in early years and high in late years. Therefore maintenance +
depreciation will be constant over all years.
• Higher depreciation in early years may reflect obsolescence.
Disadvantages
• More complicated to calculate.

41
Example 1.21: Reducing-balance depreciation
• Asset cost €5 million

• Of the €5 million income generated by use of the asset, more is expected to be earned in the
earlier years of the use of the asset over its useful life.
Required:
You are required to apply the reducing-balance method of depreciation at a rate of 20% and to show
how this would be reflected in the profit and loss account and balance sheet for years 1 to 5
Solution:
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 etc
€m €m €m €m €m €m €m €m
Income statement
Income (*assumed) 1.00 0.80 0.64 0.51 0.41 0.328 0.2624 Etc
Depreciation 1(1.00) 2(0.80) 3(0.64) (0.51) (0.41) (0.328) (0.2624) (etc)
Profit and loss account Nil Nil Nil Nil Nil Nil Nil Nil
Balance sheet
Asset
Cost 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00
Aggregate depreciation (1.00) (1.80) (2.44) (2.95) (3.36) (3.688) (3.9504) (etc)
Net Book Value 4.00 3.20 2.56 2.05 1.64 1.312 1.0496 etc
4.00@20% 3.20@20% 2.56@20% 2.05@20%
Notes
*Assumed: Niamh made the income numbers exactly the same as the depreciation, so that the income
statement would be nil each year
1 €5 @ 20% = €1million
2 [€5 – €1Yr 1 depreciation] 4.00 @ 20% = €0.80 million
3 [€5 – €1Yr 1 depreciation – €0.80Yr 2 depreciation] 3.20 @ 20% = €0.64 million etc

42
Example 1.22 and Example 1.23 show the treatment of the residual amount (scrap value): using
straight-line versus reducing-balance methods of depreciation.
Example 1.22: Straight-line depreciation including scrap value
A company bought a fixed (non-current) asset for €5 million. The estimated scrap
value is €500,000.
Required:
If the company uses the straight-line method of depreciation and applies a
depreciation rate of 20%, what will the depreciation expense per annum be?
Solution:
€000 €000 €000 €000 €000 €000
Workings
Asset at cost 5,000 5,000 5,000 5,000 5,000 5,000
Scrap value (500) (500) (500) (500) (500) (500)
Depreciable amount 4,500 4,500 4,500 4,500 4,500 4,500
Depreciation @ 20% 900 900 900 900 900 4,500
Asset
Cost 5,000 5,000 5,000 5,000 5,000 5,000
Aggregate depreciation (900) (1,800) (2,700) (3,600) (4,500) 4,500
Net Book Value 4,100 3,200 2,300 1,400 500 500
Example 1.23: Reducing-balance depreciation including scrap value
A company bought a fixed (non-current) asset for €5 million. The estimated scrap
value is €500,000.
Required:
If the company uses the reducing-balance method of depreciation and applies a
depreciation rate of 20%, what will the depreciation expense in the second year be?
Solution:
€000 €000 €000 €000 €000 €000
Workings
Asset at cost/NBV 5,000 5,000-9004,100 5,000-900-7203,380
Scrap value (500) (500) Etc.
Depreciable amount 4,500 3,600
Depreciation @ 20% 900 720
Asset
Cost 5,000 5,000
Agg Depreciation 900 900+7201,620
Net Book Value 4,100 3,380

43
Illustration 1.8, which is extracted from CRH plc’s accounting policies, shows the method used by
CRH to depreciate property, plant and equipment.
CRH plc 2015 Q16a: Where does CRH disclose the method of depreciation followed in CRH plc’s
CRH plc 2015 Q16b: What methods and rates of depreciation does CRH apply in its 2015 financial
statements?
Illustration 1.8: CRH plc’s accounting policy for depreciation
Property, plant and equipment – Note 13
The Group’s accounting policy for property, plant and equipment is considered critical because
the carrying value of €13,062 million at 31 December 2015 represents a significant portion
(41%) of total assets at that date. Property, plant and equipment are stated at cost less any
accumulated depreciation and any accumulated impairments except for certain items that had
been revalued to fair value prior to the date of transition to IFRS (1 January 2004).
Repair and maintenance expenditure is included in an asset’s carrying amount or recognised as

a separate asset, as appropriate, only when it is probable that future economic benefits
associated with the item will flow to the Group and the cost of the item can be measured reliably.
All other repair and maintenance expenditure is charged to the Consolidated Income Statement
during the financial period in which it is incurred.
Borrowing costs incurred in the construction of major assets which take a substantial period
of time to complete are capitalised in the financial period in which they are incurred.
In the application of the Group’s accounting policy, judgement is exercised by management in

the determination of residual values and useful lives. Depreciation and depletion is calculated
to write off the book value of each item of property, plant and equipment over its useful
economic life on a straight-line basis at the following rates:
Land and buildings: The book value of mineral-bearing land, less an estimate of its residual
value, is depleted over the period of the mineral extraction in the proportion which production
for the year bears to the latest estimates of proven and probable mineral reserves. Land other
than mineral-bearing land is not depreciated. In general, buildings are depreciated at 2.5% per
annum (“p.a.”).
Plant and machinery: These are depreciated at rates ranging from 3.3% p.a. to 20% p.a.
depending on the type of asset. Plant and machinery includes transport which is, on average,
depreciated at 20% p.a.
Depreciation methods, useful lives and residual values are reviewed at each financial year-end.
Changes in the expected useful life or the expected pattern of consumption of future economic
benefits embodied in the asset are accounted for by changing the depreciation period or
method as appropriate on a prospective basis. For the Group’s accounting policy on
impairment of property, plant and equipment please see impairment of long-lived assets and
goodwill.
(Source: CRH plc Annual Report 2015, p. 140-141)

44
1.10.3 Accounting entries for depreciation
The element of the cost of the fixed (non-current) asset used up is taken out of the balance sheet
and charged as depreciation each year in the profit and loss account. Rather than altering the cost
of the asset in the balance sheet a separate account is opened to remove the depreciation. This
account can be called  “Accumulated depreciation” /  “Aggregate depreciation” /  “Provision
for depreciation” account. As more and more of the cost of the fixed (non-current) asset is used up
the accumulated depreciation account gets bigger and bigger. The ledger entries are as follows:
Dr Depreciation Expense (profit and loss account) X

Cr Accumulated Depreciation (balance sheet) X
Being depreciation charge
In the balance sheet the accumulated depreciation balance is subtracted from the fixed (non-
current) asset account to leave the asset at what is called net book value (NBV).
Elaborating on these entries a bit more, the nature of the asset being depreciated influences
where in the income statement the depreciation expense is charged. For example, factory
buildings, factory plant and machinery will be included in the manufacturing account / part of
cost of sales (see Section 2 of these notes), depreciation of the warehouse, of delivery vans will be
part of distribution costs and depreciation of office buildings, computers will be part of
administrative expenses.
Example 1.24 and Example 1.25 illustrate the double entries and nominal ledger ‘T’ account
entries to record deprecation.
Example 1.24: Double entries to record depreciation
 Asset cost €5 million

 Income from the asset is €5 million earned evenly, €1 million per annum
 over the asset’s five-year life
Required:
Show the double entries the above transactions
Solution: €m €m
Double entries
 Dr Fixed asset account (balance sheet) Year 1 5
 Cr Bank (balance sheet) Year 1 5
 Dr Bank (balance sheet) Year 1, 2, 3, 4, 5 1

 Cr Sales (income statement) Year 1, 2, 3, 4, 5 1
 Dr Depreciation (income statement) Year 1, 2, 3, 4, 5 1

 Cr Aggregate depreciation (balance sheet) Year 1, 2, 3, 4, 5 1

45
Example 1.25: Nominal ledger ‘T’ accounts to record depreciation

Required:
Show the nominal ledger ‘T’ accounts to record the asset / depreciation
Solution: €m €m
Nominal ledger ‘T’ accounts
Fixed asset account (Balance sheet)
Year 1 Bank 5 5 Bal. c/d B/S Year 1
Year 2 Bal. b/d 5 5 Bal. c/d B/S Year 2
Aggregate depreciation (Balance sheet)
Year 1 Bal. c/d B/S 1 1 Depreciation Year 1
Year 2 Bal. c/d B/S 2 1 Bal. b/d Year 2
_ 1 Depreciation Year 2
2 2
3 3
4 4
5 5
Depreciation (Income statement)
Year 1 Aggregate depreciation 1 1 P/L Year 1
Sales (Income statement)
Year 1 P/L 1 1 Bank Year 1
Bank (Balance sheet)

Year 1 Sales 1 5 Fixed asset Year 1
Year 2 Bal. c/d B/S 4 __
5 5
Year 2 Sales 1 4 Bal. b/d Year 2
4 4
3 3
2 2
1 1

46
1.11 Fixed (non-current) assets
There are two distinct transactions involving fixed (non-current) assets: Additions to fixed (non-
current) assets and disposals of fixed (non-current) assets. The terms “purchases” and “sales” are
reserved to purchases and sales of trading stock (inventory) items. For this reason, the terms
“additions” and “disposals” are used in relation to fixed (non-current) assets.
1.11.1 Additions to fixed (non-current) assets
Fixed (non-current) assets bought (or additions to) are recorded as follows:
Dr Fixed Assets X
Cr Bank or Creditors X
Being purchase of fixed (non-current) asset
If the asset is bought during the year then it may be depreciated for a whole year or part of a
year or not at all depending on the depreciation policy of the business, e.g.:
1. Assets in use at end of year are to be depreciated on a straight-line basis at 20% per annum
2. Assets are to be depreciated on a straight-line basis at 20% per annum, proportionately in the
case of additions and disposals
3. Assets in use at the start of the year are to be depreciated on a straight-line basis at 20% per
annum
4. Assets are to be depreciated on a straight-line basis at 20% per annum. No depreciation is to
be provided in the year of addition or disposal
CRH plc’s Note 13 illustrates how additions to property, plant and equipment are handled in the
financial statements (see Illustration 1.9).

47
CRH plc 2015 Q17a: Where would you find the additions to fixed assets in CRH plc’s 2015 financial
statements?
CRH plc 2015 Q17b: How much were the additions to CRH plc’s fixed (non-current) assets in 2015?
Illustration 1.9: CRH plc’s additions to fixed assets
1.11.2 Disposal of fixed (non-current) assets
• Assets can be disposed of during their economic lives or at the end of their economic lives.
• When an asset is disposed of for cash (or a trade-in allowance) may be received in payment
for it.
• On disposal, the asset must be removed from the balance sheet as it is no longer an asset of the
business.
• Any accumulated depreciation associated with it should also be removed.
• Profit or loss on disposal must be calculated. This is done using a disposal account.
CRH plc’s Note 13 illustrates how disposals of property, plant and equipment are handled in the
financial statements (see Illustration 1.10).
48
CRH plc 2015 Q18a: Where would you find the disposals of fixed (non-current) assets in CRH plc’s
CRH plc 2015 Q18b: How much were the disposals of CRH plc’s fixed (non-current) assets in 2015?
Illustration 1.10: CRH plc’s Disposal of fixed assets

49
1.11.3 Accounting entries to record disposal of fixed (non-current) assets
Step 
Dr Disposal account (with the original asset cost) X

Cr Asset account (Original asset cost) X
Being the removal of the asset at cost from the balance sheet
Step 
Dr Accumulated depreciation X
Cr Disposal account (with the Accum.Depreciation) X
Being the removal of accumulated depreciation on asset to date
of disposal from the balance sheet
Step 
Dr Bank (Proceeds of sale of asset) X

Cr Disposal account (Proceeds) X
Being receipt of proceeds for sale of fixed (non-current) asset
OR
Dr Fixed assets (where proceeds are in the form of a X

trade in against a new asset)
Cr Disposal account (Proceeds) X
Being disposal of fixed (non-current) asset by means of trade in
Step 
OR
Dr Profit and loss account X Dr Disposal account X
Cr Disposal account X Cr Profit and loss account X
Being loss on disposal Being profit on disposal

50
1.11.4 Example disposal of fixed (non-current) assets
The double entries to record the disposal of a fixed asset are summarised in Example 1.26.
Example 1.26: Double entries recording the disposal of a fixed asset for cash
• Asset originally cost €50m

• Accumulated depreciation on that asset to the date of disposal was €30m
• The asset was disposed of for €5m
Required:
• Show the double entries to record the disposal of the fixed asset
Solution:
Step 
Dr Disposal account (Original asset cost) 50
Cr Asset account (Original cost) 50
Being the removal of the asset from the balance sheet
Step 
Dr Accumulated depreciation 30
Cr Disposal account (Agg. Depreciation) 30
Being the removal of accumulated depreciation on asset to date of disposal from the balance sheet
Step 
Dr Bank (Proceeds of sale of asset) 5
Cr Disposal Account (Proceeds) 5
Being receipt of proceeds for sale of fixed asset
Step  (Calculate balance on disposal account)
Dr Profit and loss account 15
Cr Disposal account 15
Being loss on disposal (This last entry is reversed in the case of a profit)
Expressing these double entries in layman’s language:

  Add the fixed asset disposed of to the disposal account
  Take the fixed asset disposed of out of the fixed asset account
 Take the accumulated depreciation on the fixed asset disposed of out of the accumulated
depreciation account
 Add the accumulated depreciation on the fixed asset disposed of to the disposal account
  Add the cash received on disposal of the asset to the bank account
 Add the cash received on disposal of the asset to the disposal account
  Calculate the profit or loss on disposal in the Disposal account (total the bigger side in the
‘T’ account [see below], make the opposite side the same total using a ‘plug’ figure, which
represents the profit or loss on disposal)
 Transfer the profit or loss on disposal in the disposal account to the profit and loss
account
The double entries to record the disposal of a fixed asset in a ‘T’ account are summarised in
Example 1.27.

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Example 1.27: Recording cash disposal of fixed asset in the disposal account

• The asset was disposed of for €5m cash
Required:
• Show the disposal account to record the double entries for disposal of the
asset
Solution:
The disposal account is shown in “t account” format (the shape accountants use to
depict accounts):
Disposal account
1/12/20X1  Fixed asset (@ cost) 50 30 Agg. Depreciation 1/12/20X1  Transfer aggregate depreciation on fixed asset from
aggregate depreciation account to disposal account
5 Bank Disposal proceeds 1/12/20X1  Record cash received on disposal
__ 15 P/L account (loss) 1/12/20X1  Calculate profit or loss on disposal
50 50
The double entries to record the disposal of a fixed asset by way of trade-in allowance rather
than cash (this is the most common way in which cars/motor vehicles are disposed of) are
summarised in Example 1.28.

52
Example 1.28: Recording the disposal of a fixed asset by way of trade-in allowance

• The asset was traded-in for €5m against a new asset with a list price of €60m
Required:
• Show the double entries to record the disposal of the fixed asset
• Show the disposal account and fixed asset account
Solution:
Step 
Dr Disposal account (Original asset cost) 50
Cr Asset account (Original cost) 50
Being the removal of the asset from the balance sheet
Step 
Dr Accumulated depreciation 30
Cr Disposal account (Agg. Depreciation) 30
Being the removal of accumulated depreciation on asset to date of disposal from the balance sheet
Step 
Dr Fixed assets 5
Cr Disposal Account (Trade-in allowance) 5
Being receipt of proceeds for sale of fixed asset
Step  (Calculate balance on disposal account)
Dr Profit and loss account 15
Cr Disposal account 15
Being loss on disposal (This last entry is reversed in the case of a profit)
Step 
Dr Fixed assets 55
Cr Bank 55
Being balance of payment for purchase of fixed asset
Expressing these double entries in layman’s language:
Disposal account
1/12/20X1  Fixed asset (@ cost) 50 30 Aggregate depreciation 1/12/20X1
5 Fixed assetsTrade-in allowance 1/12/20X1
__ 15 P/L account (loss) 1/12/20X1
50 50
Fixed assets
1/1/20X1 Bal. b/d 50 50  Disposal account (@ cost) 1/12/20X1
1/12/20X1  Disposal account 5
 Bank 55 60 Bal. c/d 31/12/20X1
110 100
1/1/20X2 Bal. b/d 60

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1.12 Bad debts and bad debt provisions
1.12.1 Bad debts
Some debtors (receivables) of the company may not pay their debts due to bankruptcy, insolvency,
receivership or disputes. An asset of the company should not be recorded in the balance sheet if it
will not be collected or realised. Irrecoverable debtors (receivables) must be written-off against
profits.
When a bad debt is discovered the asset account must be reduced and the bad debt expense
account increased. The total balance in the bad debts account goes to the profit and loss account.
Accounting entries
Dr Bad Debts Expense (Income statement) X

Cr Debtors (Receivables) (Balance sheet) X
Being write-off of debtor
Example 1.29 provides a simple example of the double entries require to record bad debts, while
Example 1.30 shows the entries in a ‘T’ account.
Example 1.29: Bad debts – double entries
 Sales made during the year to A Ltd were €50

 Sales made during the year to B Ltd were €240
 Cash received from B Ltd on 30 November 20X1 amounted to €200.
 Bad debts are to be written-off for the year ended 31 December 20X1 as follows:
A Ltd. €50; B Ltd. €40.
Required:
Show the double entries to record the above transactions.
Solution:
Double entries
Nominal ledger Debtors ledger (individual accounts)
 Dr. Debtors Control account €50 Dr. Debtors Ledger – A Ltd €50
Cr. Credit sales €50
 Dr. Debtors Control account €240 Dr. Debtors Ledger – B Ltd €240
Cr. Credit sales €240
 Dr. Bank €200
Cr. Debtors Control account €200 Dr. Debtors Ledger – B Ltd €200
 Dr. Bad debts €90
Cr. Debtors Control account €90 Dr. Debtors Ledger – A Ltd €50
Dr. Debtors Ledger – B Ltd €40

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Example 1.30: Bad debts – ‘T’ accounts
 Sales made during the year to A Ltd were €50

 Sales made during the year to B Ltd were €240
 Cash received from B Ltd on 30 November 20X1 amounted to €200.
 Bad debts are to be written-off for the year ended 31 December 20X1 as follows:
A Ltd. €50; B Ltd. €40.
Required:
Show the entries in the relevant (a) nominal ledger and (b) debtors ledger accounts.
Solution:
(a) Nominal ledger accounts
Sales (nominal ledger account Revenue in income statement)
50 Debtors control 20X1
31/12/X1 Profit & loss 290 240 Debtors control 20X1
290 290
Debtors control (nominal ledger account current assets in balance sheet)

20X1 Sales 50 200 Cash 20X1
Sales 240 90 Bad debts 31/12/20X1
290 290
Bank (nominal ledger account current assets in balance sheet)

30/11/X1 Cash 200 200 Bal. c/d 31/12/X1
1/1/20X2 Bal. b/d 200
Bad debts (nominal ledger account Expense account in income statement)

31/12/X1 Debtors control 50
31/12/X1 Debtors control 40 90 Profit & loss 31/12/X1
90 90
Charge in profit and loss account: Bad debts €90
(b) Debtors ledger accounts

A Ltd (Debtors ledger account)
20X1 Credit sales 50 50 Bad debts 31/12/X1
B Ltd (Debtors ledger account)

20X1 Credit sales 240 200 Cash 20X1
___ 40 Bad debts 31/12/X1
240 240
Debtors/creditors control accounts

It is not enough to have a debtors (creditors) control account in the nominal ledger
recording the total balance owing from debtors/to creditors. In addition, a parallel
debtors/creditors subsidiary ledger is required which shows the individual balances for
individual debtors/creditors mirroring the total amount in the nominal ledger control
accounts.
Thus, in the example above, the entries in the Debtors control account in the nominal
ledger are duplicated in the debtors ledger, in individual accounts for A Ltd and for B Ltd.
The total on the Debtors control account in the nominal ledger at the end of the
accounting period (Nil in this example) equals the sum total of the individual accounts in
the debtors ledger (A Ltd Nil + B Ltd Nil = Total debtors ledger balances = Nil)

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1.12.2 Provisions for bad debts
Based on past experience, managers know that there is a chance that some of the debts of the
company may not be collected. A debtor which originates in year 1 may give rise to a specific bad
debt in year 2. Unless bad debts are estimated each year:
• Net profit will be overstated
• Assets will be overstated
Bad debts are usually not known until the year following the sale. This gives rise to problems in
applying the matching principle and in profit determination.
In accordance with the matching or accruals concept an estimate of bad debts expected to occur
should be charged against the related revenue (i.e., the sale) rather than waiting for the actual bad
debt to occur in the future. The charge will be an estimate. This estimate is called a Provision for
any bad debts that may arise.
At each year end, the estimated expense for bad debts is calculated. This is called the provision for
bad debts (or Provision for doubtful debts).
Thus, in the profit and loss account there are two charges for bad debts:
• Debts written-off as irrecoverable;
• Increase in provision for any debt whose recovery in the future is in doubt (Decrease in
provision would result in the opposite of a charge in the profit and loss account).
Entries to record a provision for bad debts are exemplified in Example 1.31.

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Example 1.31: Bad debt provision
• This is the first year of trading (i.e., balance on bad debt provision account is €Nil).
• At the end of the first year of business 20X1, debtors are €150
• You discover at the year-end date that Bloggs Ltd, which owes the company €20,
has gone into liquidation with no hope of any recovery for creditors
• The company’s accounting policy is to make a provision for bad debts of 10% of
debtors at the year end.
Required:
Show (i) the journal entries, (ii) ‘T’ accounts, (iii) charge for bad debts in the profit and
loss account and (iv) the debtors in the balance sheet.
Solution:
(i) Double entries
Dr Bad debts (P/L) 20
Cr Debtors 20
Being bad debt written off
Dr Bad debts (P/L) [150Debtors – 20Bloggs Ltd written off] @ 10%]) 13

Cr Bad debt provision 13
Being increase in bad debt provision account balance from opening balance of €nil
(first year trading) to closing balance of €13 charged to the profit and loss account
Thus, there are two charges for bad debts in the profit and loss account:
• Debts written-off as irrecoverable - €20
• Provision for any debt whose recovery is in doubt €13 ( [150Debtors – 20Bloggs Ltd
written off] @ 10%])
Thus, the total charge in the profit and loss account for bad debts is €33 (€20bad debt
written off + €13increase in provision for bad debt)
(ii) ‘T’ Accounts

Debtors (Balance sheet, Current asset)
Date Credit sales 150 20 Bad debts Date
____ 130 Bal. c/d 31/12/20X1
150 150
1/1/20X2 Bal. b/d 130
Bad debt provision (Balance sheet, Negative current asset)

31/12/20X1 Bal. c/d (B/S) 13 Nil Bal. b/d 1/1/20X1
___ 13 Bad debts 31/12/20X1
13 13
13 Bal. b/d 1/1/20X2
Bad debts (Profit and loss account, Expense)

31/12/20X1 Debtors 20 33 P/L 31/12/20X1
31/12/20X1 Bad debt provision 13 __
33 33
(iii) Profit and loss account (extract)

Selling and distribution costs
Bad debts €33
(vi) Balance sheet (extract)

Current assets
Debtors €117
(Workings: 150Debtors – 20Bloggs Ltd written off = 130Closing debtors – 13Provision for bad debts)

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There are two methods of estimating bad debt provisions:

• Set provision at constant % gross debtors (receivables) at the year end. The amount of the
provision is usually a fixed (say 5%) percentage of total debtors (receivables).
• Prepare a schedule ageing each debtor balance at the year end. The debtors (receivables)
figure might be broken down into subgroups depending on how long the debt is outstanding.
Each subgroup total is then multiplied by a percentage depending on the management’s
assessment of the likelihood of bad debts.
The two methods of estimating a bad debt provision are shown in Example 1.32.
Example 1.32: Methods of estimating bad debt provision
The aged analysis of debtors in 20X1 is as follows:

Days Outstanding Amount
€
0 – 30 5,000
31 – 60 10,500
61 – 90 3,500
19,000
Required:
Calculate the bad debt provision for 20X1 assuming:
(i) a fixed percentage of 5% of total debtors; and
(ii) 1%/5%/10% on debtors 1/2/3 months old
Solution:
(i) 5% of total debtors i.e., 5% x 19,000 = €950 bad debt provision
(ii)
Days Amount Percent Provision
0 - 30 5,000 1% 50
31- 60 10,500 5% 525
61- 90 3,500 10% 350
19,000 925 Bad debt provision
Companies in high risk businesses such as builders suppliers may make quite substantial
provisions.
As shown in Illustration 1.11, CRH plc discloses an aged analysis of its debtors/receivables as part
of Note 17 Trade Receivables. The amount aged-analysed is the gross debtors/trade receivables. It
would appear that CRH plc’s terms of trading are 30 days, as amounts less than 60 days are
designated “past due”.
CRH plc 2015 Q19a: What does CRH plc’s aged analysis of debtors look like?
CRH plc 2015 Q19b: Is CRH good at collecting amounts due?

58
Illustration 1.11: CRH plc’s Aged analysis of debtors

59
Example 1.33, which extends Example 1.32, shows how to record bad debt provisions.
Example 1.33: Recording bad debt provision - Year 1
This is the first year of trading (i.e., balance on bad debt provision account is €Nil).
Debtors at the end of 20X1 are €19,000. A bad debt provision of 5% of debtors is to be
provided for.
Required:
Show how the bad debt provision would be recorded in the financial statements.
Solution:
5% of total debtors i.e., 5% x €19,000 = €950 bad debt provision
Dr Bad debts expense (Increase: NilOpening provision – 950Provision at end year 1)(P/L) 950
Cr Bad Debts Provision (NilOpening balance + 950Increase = 950Closing balance) (B/S) 950
Being increase in bad debts provision
Expressing this double entry in the nominal ledger in layman’s language:

 Add increase in bad debt provision as expenses in the profit and loss account
 Add the increase in bad debt provisions to the Bad Debt Provision account (this account
is subtracted from debtors in arriving at the amount for debtors in the balance sheet)
Profit and loss account (extract) €

Bad debt expense 950
Debtors in the balance sheet should be shown net of the provision for bad debts.
Balance sheet (extract)
Current assets €
Stock 20,000
Debtors 18,050
(Workings: 19,000Debtors - 950Provision for bad debts)

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As shown in Illustration 1.12, CRH plc discloses the movements on it provision for impairment of
debtors/receivables as part of Note 17 Trade Receivables.
CRH plc 2015 Q20a: What does CRH disclose about bad debt provisions in its 2015 financial
statements?
CRH plc 2015 Q20b: Does CRH plc’s provisioning policy appear reasonable?
Illustration 1.12: CRH plc’s movement on bad debt provisions

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Example 1.34 develops and extends Example 1.33 on bad debt provisioning.
Example 1.34: Recording bad debt provision - Year 2
Taking the data as for Example 1.33, assume that in the following year 20X2, the bad debt
provision:
(i) Increased (i.e., expense, debit in profit and loss account) to €1,025 (Closing debtors 20X2
€20,500 @5%)
(ii) Decreased (i.e., negative expense, credit in profit and loss account) to €850 (Closing
debtors €17,000 @5%)
Required:
Show how the bad debt provision for 20X2 would be recorded in the financial statements.
Solution:
(i) Increase in bad debt provision
Dr Bad debts (Profit and loss account) 75
(Increase: 950Provision year 1 – 1,025Provision year 2)
Cr Provision for bad debts (950Opening balance + 75Increase = 1,025Closing balance) (B/S) 75
Being increase in bad debts provision

 Add increase in bad debt provision as expenses in the profit and loss account and
 Add the increase in bad debt provisions to the Bad Debt Provision account (this account
is subtracted from debtors in arriving at the amount for debtors in the balance sheet).
Income statement (extract) €

Bad debt provision – Increase Expense 75

Current assets
Stock 20,000
Debtors 19,475
(Workings: 20,500Debtors – 1,025Provision for bad debts)
(ii) Decrease in bad debt provision

Dr Provision for bad debts (950Opening balance - 100Decrease = 850Closing balance) (B/S) 100
Cr Profit and loss account (Decrease: 950Provision year 1 – 850Provision year 2) (P/L) 100
Being decrease in bad debts provision

 Deduct decrease in bad debt provision as negative expense in the profit and loss account
and
Subtract the decrease in bad debt provisions from the Bad Debt Provision account (this
account is subtracted from debtors in arriving at the amount for debtors in the balance
sheet).
Income statement (extract) €

Bad debt provision – Decrease Reduce expense (100)

Current assets
Stock 20,000
Debtors 16,150
(Workings: 17,000Debtors – 850Provision for bad debts)

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Another example of how to record bad debt provisions is included in Example 1.35 and Example
1.36.
Example 1.35: Recording bad debts and bad debt provisions (1)
The balance on the debtors control account is €3,000, the balance on the bad debt
account is €500 and the balance on the provision for bad debts account is €200.
Required:
What is the net amount for debtors in the balance sheet?
Solution:
Balance sheet (extract) €
Current assets (extract
Debtors 2,800
(Workings: 3,000Debtors - 200Provision for bad debts)
(Bad debts of €500, have already been deducted from Debtors and the other side of the
double entry (Bad debts) will be charged in the income statement)
Example 1.36: Recording bad debts and bad debt provisions (2)
The balance on the debtors control account is €5,000, the balance on the bad debts
account is €500 and the balance on the provision for bad debts account is €200. You are
to write off additional bad debts of €100 and make a final provision of 5% of debtors.
Required:
What is the charge for bad debts in the income statement and the net amount for debtors
in the balance sheet?
Solution:
Income statement (extract) € €
Bad debt expense (500+100) 600
Bad debt provision (5,000Debtors – 100Written off @ 45
5%=245Closing provision-200Opening provision=45Increase
645
Current assets (extract)
Debtors 4,655
(5,000Debtors – 100Written off – Provision for bad debts
(200Opening provision+45Increase)

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Example 1.37 shows the interrelationship between bad debts and bad debt provisions (for the
doubting Thomas’s!).
Example 1.37: Interrelationship between bad debts and bad debt provisions
Year 1 Year 2
Sales €10,000 Cash received €9,500
Debtors at year end €10,000 Actual bad debts €500
Estimate that 5% of debtors will turn out to be bad
Required:
Show the income statement and balance sheet for Year 1 and Year 2
Solution:
Profit and loss account (Extract) Year 1 Year 2
Sales 10,000
(Increase)/Decrease in bad debt provision (€NilOpening balance- (500) 500
€5005%€10,000 Closing balance)/ (€500Opening balance – NilClosing balance)
Bad debts for year - (500)
Profit for year 9,500 Nil
Balance sheet year 2(Extract)
Current assets
Debtors (10,000–500Bad debt provision)/ (9,500Opening balance-9,500Cash received) 9,500 Nil
Cash Nil 9,500
Equity 9,500 9,500
Share capital Nil Nil
P/L (year 1 retained profit, not distributed, carried forward to year 2) 9,500 9,500
9,500 9,500
Conclusion:
• By creating a provision for bad debts in Year 1, the bad debt expense was charged
against Year 1’s revenue (sales) which gave rise to that expense;
• In Year 2 the bad debt provision is available to be set against the actual bad debt
expense when it arises such that there is no charge for bad debts in Year 2’s profit
and loss account (the reduction in the provision and the actual bad debt expense
cancel each other)
• It is difficult to see this relationship when there are many debtor balances and in a
continuing business where there is roll-over of the provision from one year to the
next.

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2. Manufacturing accounts
Section 2: Manufacturing accounts
Notes Problem questions for completion

2.1 Differences between retailing and manufacturing businesses MCQ 2.1 – MCQ 2.16
2.1.1 Retail businesses Question 5: Product & Co.
2.1.2 Manufacturing businesses Question 6: John Brown
2.2 Manufacturing expense analysis in more detail
2.2.1 Examples
2.3 Manufacturing account layout
2.4 Example manufacturing account
These notes deal with four aspects of manufacturing accounts:

• Differences between retail and manufacturing businesses
• Manufacturing expense analysis in more detail
• Manufacturing account layout
• Examples
2.1 Differences between retail and manufacturing businesses
2.1.1 Retail businesses
• Keep records of purchases (this is straightforward – take from purchase invoices)

• Count stock at year end (X units)
• Value stock at cost (€X per unit)
• Compute cost of goods sold (X units x €X per unit)
Example 2.1 shows the trading account section of the income statement for a retail business.
Example 2.1: Computing cost of sales in a retail business
Cost of sales €
Opening stock 250
Purchases 10,000
Cost of goods available for sale 10,250
Less: Closing stock (180)
Cost of goods sold 10,070
2.1.2 Manufacturing business
• Buy raw materials

• Convert into products using labour and factory overheads
• Sell products
Manufacturer cannot calculate Cost of goods sold as easily because s/he has to compute cost
rather than taking it from invoices.
Need to calculate:
1. Cost of goods produced in a year
2. Value of inventory @ cost at year-end

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Manufacturing accounts are used by management internally. They are not made public and can,
therefore, be produced in any format. The primary function of manufacturing accounts is to
calculate the production cost of finished goods manufactured (i.e., equivalent to purchases in a
retail business), which amount is transferred to the trading account to calculate gross profit.
Note
Production cost of goods completed ≠ Total production cost.
Total production cost is adjusted for opening and closing work-in-progress to obtain the
production cost of goods completed.
The manufacturing account contains all the expenses pertaining to production (i.e., factory-
related) whereas the profit and loss account contains the non-factory expenses such as
administrative, selling and distribution and financial expenses. The manufacturing account is
mainly composed of expenses (Drs.), although a few production-related revenue items (Crs.) such
as bulk/quantity discounts may be included. Note that sales invoices and purchase invoices tend
to include bulk/quantity discounts. As a result, Sales and Purchases include any bulk/quantity
discounts allowed (on sales) or received (on purchases). Discount allowed and received appearing
in the trial balance, therefore, represent settlement (i.e., pay-on-time) discount. This settlement
(i.e., pay-on-time) discount is dealt with in the profit and loss account.
Apart from gross profit calculation, the manufacturing account aids management decision making
so it should be presented and laid out in a manner that makes it most useful for decision-making
purposes.
2.2 Manufacturing expense analysis in more detail
The manufacturing account calculates the production cost of goods completed during an account
period. There are three main categories of cost/expense making up production cost:
• Direct material (i.e., raw material): Direct material costs are obtained by adjusting purchases
of direct or raw materials for any opening and closing raw material stock.
• Direct labour (i.e., skilled craftsmen or conveyor belt employees working directly on units
produced); and
• Factory overheads: Factory overheads include all indirect manufacturing costs such as
indirect material, indirect labour, factory insurance, depreciation on factory plant and
machinery.
Including both direct costs and factory overheads in cost is referred to as “full absorption costing”..
In preparing manufacturing accounts expenses must be analysed between direct and indirect
expenses and often between fixed and variable expenses.
Direct expenses are identifiable and traceable to particular units of production. Indirect expenses,
although necessary for production, cannot be traced to or related to specific units produced.
Fixed expenses are fixed even if production varies. Variable expenses vary proportionately with
production.

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2.2.1 Examples of manufacturing expenses
The expenses in Example 2.2 are analysed as exemplars of how they would be classified.
Example 2.2: Analysis of manufacturing expenses (1)
Direct Materials • Purchase invoice

• Carriage in /transport in
• Duty on imported goods
Direct Labour: • Production operators
Direct Expense: • Levy per unit produced e.g., royalties
Factory Overhead: • Indirect labour
 Factory supervisor
 Factory fork-lift truck operator
• Factory light and heat
• Depreciation of factory machinery
• Hire of fork-lift trucks in factory etc.
Example 2.3 further teases out how manufacturing expenses are classified and analysed.
Example 2.3: Analysis of manufacturing expenses (2)
Assume a business manufactures patented hand-made chairs. The following are the expenses
in the business: Wood/timber, Glue & varnish, Wages of the craftsmen, Wages of the factory
foreman/supervisor, Cost of factory cleaning, Licence fees (€1/chair), Factory rent & rates,
Factory electricity, Salary of the CEO
Required:
Analyse the expenses between direct/indirect and variable/fixed
Expense Analysis
Wood/timber Direct, variable
Glue & varnish Indirect (?), variable
Wages, craftsmen Direct, variable
Salary, factory foreman/supervisor Indirect, fixed
Cost, factory cleaning Indirect, fixed
Licence fees (€1/chair) Direct, variable (assuming the fee is charged per unit
produced)
Factory rent & rates Indirect, fixed
Factory electricity Indirect, variable
Salary, CEO Non-manufacturing expense
Many expenses cannot be analysed perfectly between direct/indirect and especially between fixed
and variable. They are included for convenience in the most appropriate category.

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2.3 Manufacturing account layout
The manufacturing account starts with the direct expenses. The term prime cost is a collective
term for the total of all direct costs. Factory overheads are shown after prime cost and the
manufacturing account ends with adjustment for opening and closing work-in-progress stock.
The layout of the ①manufacturing account in outline is as follows:

+Direct materials
+Direct labour
+Direct expenses
=Prime Cost
+Factory overhead - variable
+ - fixed
=②Total Production Cost
The total production cost is adjusted by ③opening and closing work-in-progress to get
④production cost of goods completed.
① Manufacturing Account
Used to calculate Cost of goods produced. Cost of Goods Produced is made up of

• Raw material cost
• Direct labour cost
• Factory overhead cost
Raw material cost:

• Stock of raw materials at start
• plus: Purchases
• less: Stock of raw materials at end
• Equals: Raw materials cost (Direct material)
Direct labour cost:

Wages of those actually engaged in producing output
Prime cost:
Raw material cost +Direct labour cost +Direct expenses = Prime Cost
Factory overheads:
Factory overheads comprise all costs incurred in production other than raw materials and direct
labour. Examples of factory overheads include:
• Indirect wages (e.g., Supervisor)
• Factory power
• Factory salaries
• Depreciation of factory
• Depreciation of machinery
• Repairs to machinery
Factory overheads are often allocated or apportioned to units of production on different bases, the
basis being related to the overhead cost to be allocated. The simplest basis of allocation is on a per
unit basis, treading all units of product as if they were the same and dividing the factory overhead
over the number of units. This simple approach might not be suitable, for example, between
standard and deluxe units of product. A more accurate approach might be, for example, to allocate
(say) rent of property between cost of sales (i.e., production), distribution and administration
based on square footage; cost of the restaurant may be based on number of employees in the
factory (cost of sales), warehouse (distribution costs) or office (administrative expenses) etc.

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② Total production cost
③ Work-in-Progress (WIP)
• Cost incurred to date on production commenced but not completed.
• These items should be counted as stock at the year end.
• The stage of completion should be estimated (e.g., half completed, one-third completed, etc.)
• Value work-in-progress (number of incomplete units x stage of completion x cost / unit)
• Adjust for opening and closing balances
④ Total production cost of goods completed
2.4 Example manufacturing account
Example 2.4 illustrates the manufacturing account and how it relates to the subsequent income
statement and balance sheet.

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Example 2.4: Comprehensive example including manufacturing account

Example Manufacturing Ltd
Manufacturing Account for the Year Ended 31.12.20X1
€000 €000
Direct materials
Opening stock raw materials 250
Purchases of raw materials 10,000
Carriage/transport in 200
Closing stock raw materials (180) 10,270
Direct labour 5,400
Prime cost 15,670
Factory overhead
Indirect factory wages 1,000
Factory rent and rates 700
Factory light and heat 430
Depreciation – Factory premises 200
Depreciation – Plant & Machinery 560
2,890
Total manufacturing cost 18,560
Add: Opening work-in-progress 600
Less: Closing work-in-progress (800)
Cost of manufacture of goods completed (to trading account) 18,360
Production cost of goods completed
(Note: The manufacturing account will not be published)

Trading & Profit and Loss Account for the year ended 31.12.20X1
€000 €000
Sales 23,000
Cost of sales
Opening stock finished goods 1,700
Cost of goods completed (Manufacturing account) 18,360
Closing stock finished goods (1,400)
18,660
Gross profit 4,340
Expenses
Selling and Distribution costs
Motor expenses (850)
Motor repairs (20) (870)
Clerical wages (770)
Office light and heat (430)
Office rent and rates (260)
Insurance (130)
Postage (80)
Sundry expenses (25) (1,695)
Net Profit/(Loss) 1,775
(Note: This profit and loss account will not be published – it contains too much
detail)

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Income statement for the year ended 31.12.20X1
(in a form suitable for publication – See Section 5 of these notes)
Revenue 23,000
Cost of sales (18,660)
Gross profit 4,340
Distribution costs (870)
Administrative expenses (1,695)
Net Profit/(Loss) 1,775

Balance Sheet at 31.12.20X1
€000 €000 €000

NON-CURRENT ASSETS
Fixed assets Cost Acc. Dep NBV
Property 2,500 520 1,980
Plant and Machinery 4,320 1,390 2,930
4,910
Current assets
Stock (180Raw Materials+800WIP+1,400Finished Goods) 2,380
Debtors and Prepayments 3,250
Cash at bank and on hand 170 5,800
10,710
EQUITY
Capital and reserves
Share capital 3,000
Opening balance retained earnings 1,565
Retained earnings for the year (from profit and loss) 1,775 3,340
Closing balance retained earnings 6,340
Current liabilities
Creditors 4,080
Bank overdraft 290
4,370
Total equity and liabilities 10,710
  : These symbols identify the three double entries to record the year-end adjusting double
entries for raw material, work-in-progress and closing stock.

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Statement of financial position at 31.12.20X1
(in a form suitable for publication – See Section 7 of these notes)
€000
ASSETS
Non-current assets 4,910
Current assets
Inventory 2,380
Trade and other receivables 3,250
Cash at bank and on hand 170
5,800
Total assets 10,710

Equity
Share capital 3,000
Retained earnings 6,340
Equity 9,340
Current liabilities
Trade payables 4,080
Bank overdraft 290
4,370
Equity and liabilities 10,710

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3. Regulatory framework: Legislation and International Accounting Standards
Section 3: Regulatory framework: Legislation and International Accounting Standards

3.1 Regulatory sources governing listed companies MCQ 3.1-3.11
3.2 Legal regulations applying to financial statements Q7 Regulatory framework
3.3 Stock exchange financial reporting disclosure requirements
3.4 International regulation of financial reporting Q8 ET goes home
3.4.1 Accounting harmonisation Q8 IAS 1 arrives
3.4.2 International Accounting Standards
3.4.3 Introducing International Accounting Standards in the UK
3.4.4 Introducing UK Accounting Standards in the Republic of Ireland
3.4.5 Irish legislation and International Accounting Standards
3.4.6 Principles-based versus rules-based accounting
3.5 The standard setters
3.6 Local vs. international accounting standards: Dealing with two sets of rules
3.7 International accounting standards
3.7.1 International Accounting Standards (IASs) in force September 2018
3.7.2 International Financial Reporting Standards (IFRSs) in force September 2018
3.8 FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland
3.8.1 Application of financial reporting requirements
3.8.2 Reduced disclosures
3.8.3 FRS 102
3.9 Users of financial reports
3.9.1 Nine groups of users
3.10 Characteristics of useful information
3.11 Financial accounting conventions
3.12 Accounting terminology in different jurisdictions
3.1 Regulatory sources governing listed companies
Regulations for financial reporting (i.e., the regulatory framework) are contained in three sources:
• Legal/statutory (registered companies only)
• Stock exchanges (for listed companies only)
• Accounting standards

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3.2 Legal regulations applying to financial statements
Table 3.1 summarises Irish company legislation influencing financial reporting.
Table 3.1: Summary of the accounting provisions of the Companies Act 2014
Legal provision Issue

S281 CA2014 Keeping of adequate accounting records
S289 CA2014 Financial statements to give a true and fair view
S290 CA2014 Preparation of financial statements
S293 CA2014 Group financial statements
Chapter 6 CA2014 Disclosure of directors’ remuneration and transactions
Chapter 7 CA2014 Detailed accounting disclosures
Chapter 10 CA2014 Obligations to have financial statements audited
Chapter 14 CA2014 Disclosure exemptions for small- and medium-sized companies
Chapter 15 CA2014 Audit exemptions for small companies
Chapter 9 CA2014 Directors’ reports
It is critical that there be clarity between the roles of the directors and of the auditors. Every set of financial
statements includes a statement of their responsibilities (see Illustration 3.1 and Illustration 3.2).
CRH plc 2015 Q21a: Who are responsible for preparing the financial statements of a company?
CRH plc 2015 Q21b: What is the external auditors’ responsibility for the financial statements of a company?
Directors in Ireland are required by law to personally attest to the financial statements by two members of
the board signing their names on face of the income statement balance sheet, etc. In the case of CRH plc, the
chairman of the board, Nicky Hartery, and the CEO, Albert Manifold are the signatories (see Illustration
3.1). It is usual in Ireland and the UK for the chairman and CEO to be the signatories. Exceptions to that
include Paddy Power plc where the CEO, Patrick Kennedy, and CFO Cormac McCarthy, were the signatories
to the 2013 financial statements.

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Illustration 3.1: CRH plc’s directors’ responsibilities
Statement of Directors’ Responsibilities

The Directors as at the date of this report, whose names are listed on pages 52 to 55, are responsible for preparing
the Annual Report and Consolidated Financial Statements in accordance with applicable laws and regulations.
Irish Company law requires the Directors to prepare financial statements for each financial year which give a true
and fair view of the assets, liabilities, financial position of the Parent Company and of the Group and of the profit or
loss of the Group taken as a whole for that period (the “Consolidated Financial Statements”).
In preparing the Consolidated Financial Statements, the Directors are required to:
— select suitable accounting policies and then apply them consistently;
— make judgements and estimates that are reasonable and prudent;
— comply with applicable International Financial Reporting Standards as adopted by the European Union,
subject to any material departures disclosed and explained in the financial statements; and
— prepare the financial statements on the going concern basis unless it is inappropriate to presume that the
Group will continue in business.
The Directors are required by the Transparency (Directive 2004/109/EC) Regulations 2007 and the Transparency
Rules of the Central Bank of Ireland to include a management report containing a fair review of the development
and performance of the business and the position of the Parent Company and of the Group taken as a whole and a
description of the principal risks and uncertainties facing the Group.
The Directors confirm that to the best of their knowledge they have complied with the above requirements in
preparing the 2015 Annual Report and Consolidated Financial Statements. The considerations set out above for
the Group are also required to be addressed by the Directors in preparing the financial statements of the Parent
Company (which are set out on pages 210 to 216), in respect of which the applicable accounting standards are
those which are generally accepted in the Republic of Ireland.
The Directors have elected to prepare the Company Financial Statements in accordance with Irish law and
accounting standards issued by the Financial Reporting Council and promulgated by the Institute of Chartered
Accountants in Ireland (Generally Accepted Accounting Practice in Ireland), including FRS 102, the Financial
Reporting Standard applicable in the UK and Republic of Ireland.
The Directors are responsible for keeping adequate accounting records which disclose with reasonable accuracy at
any time the financial position of the Parent Company and which enable them to ensure that the Consolidated
Financial Statements are prepared in accordance with applicable International Financial Reporting Standards as
adopted by the European Union and comply with the provisions of the Companies Act 2014 and Article 4 of the IAS
Regulation.
The Directors have appointed appropriate accounting personnel, including a professionally qualified Finance
Director, in order to ensure that those requirements are met. The books and accounting records of the Company
are maintained at the principal executive offices located at Belgard Castle, Clondalkin, Dublin 22.
The Directors are also responsible for safeguarding the assets of the Group and hence for taking reasonable steps
for the prevention and detection of fraud and other irregularities.
Each of the Directors, whose names are listed on pages 52 to 55, confirms that they consider that the Annual
Report and Consolidated Financial Statements, taken as a whole, is fair, balanced and understandable and provides
the information necessary for shareholders to assess the Company’s position, performance, business model and
strategy.

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Illustration 3.2: CRH plc’s respective responsibilities of directors and auditors
Independent auditor’s report (extract)

Respective responsibilities of Directors and auditor
As explained more fully in the Directors’ Responsibilities Statement set out on page 112 the
Directors are responsible for the preparation of the financial statements and for being satisfied
that they give a true and fair view and otherwise comply with the Companies Act 2014. Our
responsibility is to audit and express an opinion on the financial statements in accordance with
Irish law and International Standards on Auditing (UK and Ireland). Those standards require us
to comply with the Auditing Practices Board’s Ethical Standards for Auditors.
The financial statements are required to show a “true and fair” view. The company's auditors must carry
out an annual audit and the auditor’s opinion on the true and fair view must be included with the financial
statements (note that just because financial statements show a true and fair view does not necessarily mean
that the financial statements are correct). In Ireland (other countries may have similar provisions) there is
an audit exemption for small companies (i.e., Turnover < €7.3 million; Balance sheet total <€3.650 million;
<50 employees; Not a parent or subsidiary; Up-to-date with filing obligations).

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What does true and fair view mean? The true and fair view requirement applies across the European Union.
Example 3.1 illustrates just how difficult it is to get a grasp on this vague concept, showing the variety of
wording used in the national legislation in some EU countries.
Example 3.1: What does “true and fair view” mean?
(Source: Aisbitt and Nobes, 2001, p. 84)
3.3 Stock exchange financial reporting disclosure requirements
Stock Exchange rules apply to listed companies only. The listing agreement requires quoted companies to
observe certain rules (“listing rules”). There are some accounting disclosure requirements additional to
company law and IAS/IFRS requirements, such as extensive disclosure of directors’ remuneration and
disclosure of price-sensitive information.
Companies listed on a stock exchange must adopt the additional disclosure requirements of the stock
exchange which largely relate to governance principles and practice. Irish and UK listed companies must
apply the main and supporting principles of the 2014 UK Corporate Governance Code (the Code). In
addition, Irish listed companies must also takes into account the disclosure requirements set out in the
corporate governance annex to the listing rules of the Irish Stock Exchange.
3.4 International regulation of financial reporting
In order to have some structure around financial reporting laws and regulations (the rules) have been put
in place to guide the preparer and the user.
Over time different countries and bodies have implemented their own rules. Not surprisingly they were not
always consistent with each other.

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3.4.1 Accounting harmonisation
In an attempt to harmonise accounting practice among EU countries, the European Commission published
a number of documents, notably the Fourth and Seventh Company Law Directives on annual and
consolidated financial statements which have been adopted by EU countries in their national legislation.
These have been successful in improving the comparability of financial statements, thus facilitating cross-
border business.
However, these Directives are not accepted as a basis for adequate financial reporting in major securities
markets outside Europe. Consequently, in 1996, the European Commission put forward a new strategy to
improve the financial reporting framework for European companies. The objectives of the new strategy are
to promote:
• Easier access for European companies in international capital markets;
• Improved comparability of consolidated financial statements within the single European market.
The Commission’s strategy is to associate the EU with the efforts of the International Accounting Standards
Committee (IASC), now the International Accounting Standards Board (IASB) and IOSCO (International
Organisation of Securities Commissions) with a view to EU companies preparing consolidated financial
statements in conformity with International Accounting Standards of the IASB.
3.4.2 International Accounting Standards
Accounting Standards
Accounting standards are authoritative statements of how particular types of transactions should be
reflected in financial statements. Compliance with standards is necessary for financial statements to give a
'True and Fair View'. Accounting standards are statements on various accounting issues setting out:
• How transactions should be accounted for – recognition and measurement
• Presentation formats for financial statements
• Disclosure in financial statements
IASs/IFRSs influence financial statements in two ways. Firstly, domestic standard-setters are increasingly
attempting to produce standards that comply as much as possible with IASs/IFRSs. Over recent years, there
has been considerable cooperation between standard-setters across the world. Consequently, with some
exceptions, UK/Irish Generally Accepted Accounting Principles (GAAP) are consistent with IASs/IFRSs.
The UK Accounting Standards Board (ASB) has indicated its commitment to a strategy of gradual
introduction of international standards into the UK. ASB’s aim is to provide as smooth a path as possible
for the transition from current UK standards to future IAS compliance. Consistent with this strategy, the
ASB has issued some standards (e.g., FRS 20 Share-based payment (IFRS 2); FRS 21 Events after the balance
sheet date (IAS 10)) entirely based on International Accounting Standards).
In some cases, UK accounting standards are word-for-word the same as their IFRS counterpart.
Consequently, with some exceptions, UK Generally Accepted Accounting Principles (GAAP) are consistent
with IASs/ IFRSs.
Secondly, companies that are quoted on stock exchanges outside their own country may adopt
international accounting standards to improve their acceptability in other jurisdictions. For example, the

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London Stock Exchange accepts from its registrants financial statements prepared under IAS Generally
Accepted Accounting Principles (GAAP). However, the New York Stock Exchange does not yet do so.
In June 2000, the European Commission issued a policy document proposing that all European companies
listed on regulated markets (including banks and other financial institutions) should be required to prepare
consolidated financial statements in accordance with IASs/IFRSs by 2005 at the latest.
The requirement to use IASs/IFRSs applies to the consolidated financial statements of listed companies.
Member States are permitted either to require or to allow unlisted companies to publish financial
statements in accordance with the same set of standards as those for listed companies.
In June 2002, the EU formally adopted the International Accounting Standards (IAS) Regulation. This
Regulation requires all EU companies listed on a regulated market to present their consolidated financial
statements in accordance with IASs/IFRSs from 2005. Unlike directives, EU Regulations have the force of
law without requiring transposition into national legislation. Member States have the option of extending
the requirements of this Regulation to unlisted companies and to parent company individual financial
statements.
3.4.3 Introducing International Accounting Standards in the UK
The UK Department of Trade and Industry allows unlisted companies and unlisted groups to choose to
comply with either IASs/IFRSs or UK standards. IFRSs are mandatory for the group financial statements of
listed companies. Holding companies and subsidiaries of listed groups may choose to adopt IFRSs or UK
FRSs in their individual company financial statements. However, once a company has chosen to adopt IFRSs
it will not subsequently be allowed to revert to UK standards.
3.4.4 Introducing UK Accounting Standards in the Republic of Ireland
Accounting standards developed in UK by the Accounting Standards Board (ASB) are promulgated in
Ireland through the Institute of Chartered Accountants in Ireland. Thus, UK generally accepted accounting
principles (GAAP) are similar in almost all respects to Irish GAAP.
3.4.5 Irish legislation and International Accounting Standards
Listed companies must use IASs/IFRSs from 1/1/2005. International Accounting Standards were
introduced into Irish law in 2005. Section 272 of the Companies Act 2014 allows companies to prepare
either Companies Act financial statements or international accounting standards financial statements.
Other (i.e., unlisted) companies have a one-way choice (i.e., can’t change their minds) between adopting
international accounting standards or Irish legislation, unless their circumstances change (e.g., taken over
by another company using the other (Companies Act accounting or international accounting standards)
accounting approach).
Consistency of treatment is required within groups of companies.
3.4.6 Principles-based versus rules-based accounting
UK GAAP and IAS GAAP adopt a principles-based approach to accounting. By contrast US GAAP adopts a
rules-based approach. There has been considerable debate as to which approach is most appropriate.
Following the financial crisis, in March 2009 Hector Sants, the chief executive of the Financial Services
Authority, observed “A principles-based approach does not work with individuals who have no principles”.
(Source: Hector Sants says bankers should be 'very frightened' by the FSA, Telegraph, 12 March 2009).
3.5 The standard setters
From 1970-1990 the regulatory body publishing accounting standards was the Accounting Standards
Committee (ASC). The ASC published exposure drafts (EDs) of standards for comment and thereafter
Statements of Standard Accounting Practice (SSAPs).

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From 1990 a new regulatory body was established - the Accounting Standards Board (ASB). The ASB issues
Financial Reporting Exposure Drafts (FREDs) and Financial Reporting Standards (FRSs).
SSAPs/FRSs aim to narrow the range of accounting practices and to make financial statements more
comparable. There are 25 SSAPs to date (not all of which continue to apply) and 30 FRSs.
In 1973 the International Accounting Standards Committee (IASC) was established. It issued exposure
drafts (EDs) and international accounting standards (IASs). Taking over from IASC, the IASB was formed in
2001. The IASB issues International Financial Reporting Exposure Drafts (IFREDs) and International
Financial Reporting Standards (IFRSs). From 2005, all EU listed companies are required to follow
international accounting standards issued by the International Accounting Standards Board (IASB).
The objectives of accounting standards are to narrow the range of accounting practices permitted and to
make financial statements of different companies more comparable by standardising to a limited extent the
way in which certain transactions are accounted for (e.g., all companies must depreciate buildings).
Scots man, former KPMG partner, UK Accounting Standard Board (ASB) chairman 1990-2000 and
International Accounting Standards Board (IASB) chairman 2001-2011, Sir David Tweedie, makes some
interesting observations on the application of accounting standards in practice in Example 3.2.
Example 3.2: A perspective on the application of accounting standards
"David Tweedie himself in his more candid moments confesses that his job is a bit like
painting the Forth Bridge. Once it is finished you start all over again. He realised that
whatever rules you put in place, smart people will find a way to express a distorted or
flattering picture of their performance".
(Source: Smith, Terry (1996) Accounting for Growth, Second Edition, Century Business, p.
10)

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International Accounting Standards Board The International Accounting Standards Board is an

independent, privately-funded accounting standard
setter based in London, UK. Board Members come
from nine countries and have a variety of functional
backgrounds. The Board is committed to
developing, in the public interest, a single set of high
quality, understandable and enforceable global
accounting standards that require transparent and
comparable information in general purpose
financial statements. In addition, the Board
cooperates with national accounting standard
setters to achieve convergence in accounting
standards around the world.
Accounting Standards Board (UK/Ireland) The role of the Accounting Standards Board (ASB) is
to issue accounting standards. It took over the task
of setting accounting standards from the Accounting
Standards Committee (ASC) in 1990. The ASB also
collaborates with accounting standard-setters from
other countries and the International Accounting
Standards Board (IASB) both in order to influence
the development of international standards and in
order to ensure that its standards are developed
with due regard to international developments.
Financial Accounting Standards Board (US) The mission of the Financial Accounting Standards
Board (FASB) is to establish and improve standards
of financial accounting and reporting for the
guidance and education of the public, including
issuers, auditors, and users of financial information
Accounting standard setting is a political process, often influenced by lobbying from big business. Example
3.3 illustrates the political process at play, including the manipulation of words, which I have already
referred to in these notes in connection with impression management and the use of weasel words (see
Example 3.6). The article refers to the careful choice of words (“could” to “would”, just one word!) that can
have such an impact in practice. As well as careful choice of words, deception by omission is another
powerful impression management practice. In Example 3.3, I also like the reference to accounting
standards being “wishy-washy”. The article also highlights the importance of materiality, which critical-to-
financial-reporting theme is picked up further on in this section of the notes. The article (second last
paragraph) also highlights the conflicts of interest between the accounting and finance industry (note the
mixed use of the word “profession” and “industry”) where client-driven motives may outweigh the duty to
protect investors.

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Example 3.3: Accounting standard setting is a political process
Even as the nation is gripped by the populist politics of the presidential primaries, special
interests continue to shape the rules of the economy in the shadows. Last year, a market
regulator called the Financial Accounting Standards Board released a proposal that could
make it easier for corporations to withhold important financial information from
shareholders. This could put the economy at greater risk of another huge accounting
fraud, like Enron or Lehman Brothers. But the board’s proposal, which could become a
final rule any day now, has gotten nowhere near the strong dose of sunlight it deserves.
Let’s back up. Current accounting standards require corporations to make financial
disclosures of information that “could” influence investors. If this sounds wishy-washy, it
is. The accounting board’s proposal would rewrite this already subjective standard to
require corporate disclosure only when there is a “substantial likelihood” that information
“would” significantly alter investor decisions.
The language change is troublesome because it lowers the bar for excluding important or
“material” information. Even just changing “could” to “would” is a big deal. “Could”
connotes possibility and invites broader disclosure; “would” connotes more certainty and
can be used by firms to exclude disclosure.
Imagine a pharmaceutical company that discovers that a promising new drug in the
pipeline is performing poorly in patient trials. Such information “could” sway investing
decisions, and, under current rules, there’s a strong case for disclosure. But it’s much
harder to establish that there is “substantial likelihood” that disclosing this information
“would” significantly alter investor choices. If the new proposal is enacted, the drug
company gets a free pass to avoid disclosure.
The accounting board justifies its proposal by arguing that investors and businesses alike
are suffering from disclosure overload — a point echoed by several special interests
pushing for the changes, including the United States Chamber of Commerce and several
powerful Fortune 500 companies. There is some merit to this concern: Corporate financial
disclosures are often foggy and impenetrable. But this calls for improved quality of
disclosure — more plain English, less legalese — not weakening disclosure standards.
This is particularly true with the advent of technology that enables rapid text searches.
Given the technological advances, we support re-examining the current rules that govern
“material” corporate disclosure. After all, these rules haven’t exactly served investors well.
Consider the examples of Enron and Lehman Brothers.

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Example 3.3: Accounting standard setting is a political process (continued)
When Enron collapsed at the turn of this century, the fallout was devastating: thousands of
jobless and countless investors left with worthless shares. As the company unraveled, we
learned that years of financial statements were little more than an illusion sustained by
misleading and inadequate disclosures. Enron’s conduct was fraudulent, of course; but the
deceit was partly enabled by rules allowing the company to overstate assets by over $1.5
billion because offsetting adjustments were “determined to be immaterial.” With a still-
lower threshold for disclosure, as the accounting board is now proposing, Enron could
have cooked the books even further, and the resulting devastation could have been
greater.
Many remember Lehman as the firm whose crash ignited a global financial crisis; few
recall how it exemplified the poor disclosure practices that were common in the years
leading up to it. Not only did this fuzzy disclosure mislead markets on the health of the
housing market, in Lehman’s case it helped mask the firm’s manipulation of financial
statements. In one email from early 2008, Lehman’s president called its accounting
gimmicks “another drug we r on.” Amazingly, in the aftermath of Lehman’s failure, the
Securities and Exchange Commission concluded that the company’s non-disclosures did
not violate current materiality standards.
There is reason to believe that such shoddy, deceptive practices remain common. A 2015
survey by researchers from Columbia, Duke, Emory and the National Bureau of Economic
Research reveals that the nearly 400 financial executives surveyed believe 20 percent of
firms intentionally distort their earnings figures by an average of 10 percent.
Disclosure is the cornerstone of fair and efficient markets. Investors can make educated
decisions only if they have access to relevant information about public companies.
Weakening disclosure standards imperils the integrity of markets.
In principle, the S.E.C. has final authority to set disclosure rules for public companies. But
the S.E.C. decades ago turned over much of this work to the private-sector accounting
standards board. This body draws its members largely from the accounting and finance
professions, citing the need for expertise from industry. It’s this state of affairs that has
partly gotten us to where we are today.
The board’s changes contradict the S.E.C.’s own strategic plan, which notes that “an
educated and informed investor ultimately provides the best defense against fraud and
costly mistakes.” The accounting board should abandon its efforts to undermine
disclosure rules. Even better, the S.E.C. should use this opportunity to step in and
strengthen them.
(Source: Ramanna, Karthik and Dreschel, Allen (2016) The Quiet War on Corporate
Accountability, New York Times, 23 April 2016)
3.6 Local vs. international accounting standards: Dealing with two sets of rules
Irish companies are permitted to prepare their financial statements (annual accounts) using UK/Irish
Generally Accepted Accounting Principles (GAAP).
For the purposes of Level 2 Financial Accounting we will prepare financial statements using International
Financial Reporting Standards (IFRSs).

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3.7 International accounting standards
International accounting standards issued under the International Accounting Standards Committee (IASC)
were known as International Accounting Standards (IASs), and under the International Accounting
Standards Board (IASB) were known as International Financial Reporting Standards (IFRSs). The
International Accounting Standards Committee (IASC) was restructured into the International Accounting
Standards Board (IASB) in 2001.
3.7.1 International Accounting Standards (IASs) in force September 2018
Standards issued by the International Accounting Standards Committee (IASC) are called International
Accounting Standards (IASs) (Those in bold are covered in Financial Accounting 2).
IAS 1* Presentation of Financial Statements

IAS 2* Inventories
IAS 7 Cash Flow Statements
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors
IAS 10* Events After the Reporting Period
IAS 11 Construction Contracts
IAS 12 Income Taxes
IAS 16* Property, Plant and Equipment
IAS 17 Leases
IAS 18 Revenue
IAS 19 Employee Benefits
IAS 20* Accounting for Government Grants and Disclosure of Government Assistance
IAS 21 The Effects of Changes in Foreign Exchange Rates
IAS 23 Borrowing Costs
IAS 24 Related Party Disclosures
IAS 26 Accounting and Reporting by Retirement Benefit Plans
IAS 27 Separate Financial Statements
IAS 28 Investments in Associates and Joint Ventures
IAS 29 Financial Reporting in Hyperinflationary Economies
IAS 32 Financial Instruments: Presentation
IAS 33* Earnings per share
IAS 34 Interim Financial Reporting
IAS 36 Impairment of Assets
IAS 37* Provisions, Contingent Liabilities and Contingent Assets
IAS 38 Intangible Assets
IAS 39 Financial Instruments: Recognition and Measurement
IAS 40 Investment Property
IAS 41 Agriculture
* These standards are covered in the Financial Accounting 2 module

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3.7.2 International Financial Reporting Standards (IFRSs) in force September 2018
Standards issued by the International Accounting Standards Board (IASB) are called International Financial
Reporting Standards (IFRSs).
IFRS 1 First-time Adoption of International Financial Reporting Standards

IFRS 2 Share-based Payment
IFRS 3 Business Combinations
IFRS 4 Insurance Contracts
IFRS 5* Non-current Assets Held for Sale and Discontinued Operations
IFRS 6 Exploration for and Evaluation of Mineral Resources
IFRS 7 Financial Instruments: Disclosures
IFRS 8 Operating Segments
IFRS 9 Financial Instruments
IFRS 10 Consolidated Financial Statements
IFRS 11 Joint Arrangements
IFRS 12 Disclosure of Interests in Other Entities
IFRS 13 Fair Value Measurement
IFRS 14 Regulatory Deferral Accounts
IFRS 15 Revenue from Contracts with Customers
IFRS 16 Leases
IFRS 17 Insurance Contracts
* These standards are covered in the Financial Accounting 2 module
The International Accounting Standards Board (IASB) has also issued two practice statements.
Practice Statement 1 Management Commentary

Practice Statement 2 Making Materiality Judgements
3.8 FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland
In July 2009, the International Accounting Standards Board (IASB) published the International Financial
Reporting Standard for Small- and Medium-Sized Enterprises (IFRS for SMEs) for application to all non-
listed reporting entities. It consists of approximately 200 pages, considerably less than the full IFRSs.
Because largely of legal difficulties within the European Union (EU), the UK and Republic of Ireland (ROI)
required a more tailored approach to ensure that the standard was acceptable to EU law and met the
specific needs of users in these islands. As a result there are considerable differences between the IFRS for
SMEs and the UK/Irish version FRS 102 The Financial Reporting Standard applicable in the UK and Republic
of Ireland.
FRS 102 standard replaces local accounting standards (i.e., SSAPs and FRSs) for accounting periods
commencing on or after 1st January 2015.
FRS 102 permits all non-listed companies to adopt the new standard but also permits smaller entities to
retain or apply the Financial Reporting Standard for Smaller Entities (FRSSE). It is possible that this may
only be a short term measure and over time the FRSSE may be abolished. Much will depend on the EU’s
current project on small companies which may result in a considerable reduction in reporting for those
entities passing the small entity criteria.
Three related standards were published:

FRS 100 Application of Financial Reporting Requirements
FRS 101 Reduced Disclosure Framework
FRS 102 The Financial Reporting Standard Applicable in the UK and Republic of Ireland

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3.8.1 FRS 100 Application of Financial Reporting Requirements
FRS 100 Application of Financial Reporting Requirements was issued in November 2012 and sets out the
financial reporting requirements for UK and Republic of Ireland entities. The standard is applicable to all
UK and Republic of Ireland companies with accounting periods beginning on or after 1 January 2015,
although early application is permitted subject to the provisions in FRS 101 (Reduced Disclosure
Framework) and FRS 102. Financial statements (whether consolidated financial statements or individual
financial statements) that are within the scope of this FRS must be prepared in accordance with the
following requirements:
(a) If the financial statements are those of an entity that is eligible to apply the Financial Reporting
Standard for Smaller Entities (FRSSE), they may be prepared in accordance with that standard.
(b) If the financial statements are those of an entity that is not eligible to apply the FRSSE, or of an entity
that is eligible to apply the FRSSE but chooses not to do so, they must be prepared in accordance with
FRS 102, EU-adopted IFRS or, if the financial statements are the individual financial statements of a
qualifying entity, FRS 101 sets out a reduced disclosure framework which addresses the financial
reporting requirements and disclosure exemptions for the individual financial statements of
subsidiaries and ultimate parents that otherwise apply the recognition, measurement and disclosure
requirements of EU-adopted IFRS.
(c) The consolidated financial statements of EU listed companies must follow full IFRSs. The individual
financial statements of the parent company and the subsidiaries have the option of applying FRS 102.
These requirements are summarised in Table 3.2:
Table 3.2: Financial reporting requirements for small entities, unlisted and listed companies
Reporting Entity Current Position New System

(a) Small Entity Option of FRSSE or full Option of FRSSE or FRS 102
FRSs/SSAPs
(b) Unlisted company FRSs/SSAPs
(c) Listed company Full IFRS Full IFRS (Consolidated financial statements)
(Consolidated Option of FRS 102 for non-consolidated
financial financial statements i.e., Reduced disclosure for
statements) individual financial statements of parent and
subsidiaries
Source: Adapted from Kirk (2013)
3.8.2 Reduced disclosures
FRS 102 provides for reduced disclosures in the financial statements of qualifying entities. These entities
are defined as:
A member of a group where the parent of that group prepares publicly available
consolidated financial statements which are intended to give a true and fair view (of
the assets, liabilities, financial position and profit or loss) and that member is included
in the consolidation.
Thus, subsidiaries are exempt from some disclosure requirements.
3.8.3 FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland
Table 3.3 summarises how the topics in the Financial Accounting 2 module are affected by FRS 102. While
there are differences between FRS 102 and international accounting standards, the differences generally
affect more advanced topics not covered in the Financial Accounting 2 syllabus.

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Table 3.3: Comparing international financial reporting regulations and FRS 102
Topic IFRSs (see Section 3.10) FRS 102

03 Conceptual framework Relevance  Understandability 
- Materiality  Relevance 
Faithful representation  Materiality 
Completeness  Reliability
Comparability  Substance over form
Verifiability  Prudence
Timeliness  Completeness 
Understandability  Comparability 
Accruals  Timeliness 
Offsetting  Accruals 
Offsetting 
05 Income statement  
06 Discontinued operations One line + note Separate column, and for every line item, on face of income statement.
07 Statement of financial position  
08 Statement of comprehensive  
income
09 Statement of changes in equity  
10 Earnings per share IFRS 33 Not applicable
11a Property, plant & equipment -  
Valuation
11b Property, plant & equipment –  
Depreciation
11c Property, plant & equipment –  
Revaluation
11d Property, plant & equipment – Grants accounted for using performance or accrual model. Performance model – grants
Government grants recognised when performance conditions are met (if none, recognise immediately). No longer
possible to deduct grants from carrying value of asset.
12 Inventories Term ‘net realisable value’ (NRV) is replaced with ‘estimated selling price less costs to complete
and sell’.
13 Provisions  
14 Contingent liabilities/assets  
15 Events after the balance sheet date Dividends proposed after year end may be presented as separate component retained earnings.
(Source: Deloitte, 2013)

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3.9 Users of financial reports
Financial accounting and reporting is only concerned with external users of the information.
Management accounting deals with internal users.
3.9.1 Nine groups of users
1. Equity investors – shareholders

2. Loan creditors
3. Employees
4. Analysts – advisors
5. Suppliers (trade creditors/payables)
6. Customers (trade debtors/receivables)
7. Competitors
8. Governments and regulators
9. Public and consumer groups
3.10 Characteristics of useful information
The qualitative characteristics of useful financial information identify the types of information
likely to be most useful to existing and potential investors, lenders and other creditors in making
decisions about the reporting entity on the basis of financial information in its financial report
(financial information). Financial reports provide information about the reporting entity’s
economic resources, claims against the reporting entity and the effects of transactions and other
events and conditions that change those resources and claims. Some financial reports also include
explanatory material about management’s expectations and strategies for the reporting entity, and
other types of forward-looking information.
The qualitative characteristics of useful financial information apply to financial information

provided in financial statements, as well as to financial information provided in other ways. Cost,
which is a pervasive constraint on the reporting entity’s ability to provide useful financial
information, applies similarly. However, the consideration in applying the qualitative
characteristics and the cost constraint may be different for different types of information. For
example, applying them to forward-looking information may be different from applying them to
information about existing economic resources and claims and to changes in those resources and
claims.
According to Chapter 3 of IASB’s (1989) Conceptual Framework for Financial Reporting, if financial
information is to be useful, it must be relevant and faithfully represent what it purports to
represent, including being complete, neutral and free from error. The usefulness of financial
information is enhanced if it is comparable, verifiable, timely and understandable.
Relevance
To be useful, information should be relevant to the decision making needs of users. Information
has the quality of relevance when it influences the economic decisions of the users by helping them
evaluate past, present and future events or confirming or correcting their past evaluation.
Materiality
The relevance of information is affected by its nature and materiality. In some cases, the nature
of information alone is sufficient to determine its relevance.
Omissions or misstatements of items are material if they could, individually or collectively,

influence the economic decisions of users taken on the basis of the financial statements.
Materiality depends on the size and nature of the omissions and misstatement judged in the
surrounding circumstances. The size or nature of the item, or a combination of both, could
be the determining factor. Users are assumed to have reasonable knowledge of business and

88
economic activities and accounting and a willingness to study the information with reasonable
diligence.
Until the global financial crisis, and questioning of the role of auditors in it, audit regulations have
changed. For listed companies to whom the UK Corporate Governance Code applies, auditors are
now required to disclose the level of materiality applied during the audit. CRH plc’s auditors now
disclose this quantitative amount as shown in Illustration 3.3.
CRH plc 2015 Q22: What is the level of materiality applied in the 2015 audit of CRH?
Illustration 3.3: CRH plc’s materiality levels applied in the audit

Our application of materiality
We apply the concept of materiality in planning and performing the audit, in evaluating
the effect of identified misstatements on the audit and in forming our audit opinion.
Materiality
We determined materiality for the Group to be €50 million (2014: €36 million), which is
approximately 5% (2014: 5%) of profit before tax. Profit before tax is a key performance
indicator for the Group and is also a key metric used by the Group in the assessment of
the performance of management. We therefore considered profit before tax to be the
most appropriate performance metric on which to base our materiality calculation as we
consider it to be the most relevant performance measure to the stakeholders of the
Group.
Performance materiality
On the basis of our risk assessments, together with our assessment of the Group’s overall
control environment, our judgement was that performance materiality should be set at
50% (2014: 50%) of our planning materiality, namely €25 million (2014: €18 million).
We have set performance materiality at this percentage due to our past experience of the
risk of misstatements, both corrected and uncorrected.
Audit work at component locations for the purpose of obtaining audit coverage over
significant financial statement accounts is undertaken based on a percentage of total
performance materiality. The performance materiality set for each component is based on
the relative scale and risk of the component to the Group as a whole and our assessment
of the risk of misstatement at that component. In the current year, the range of
performance materiality allocated to components was €4.1 million to €13 million (2014:
€3.6 million to €11 million).
Reporting threshold
We agreed with the Audit Committee that we would report to them all uncorrected audit
differences in excess of €2.1 million (2014: €1.8 million), which is set at approximately
5% of planning materiality, as well as differences below that threshold that, in our view,
warranted reporting on qualitative grounds.
We evaluate any uncorrected misstatements against both the quantitative measures of

materiality discussed above and in light of other relevant qualitative considerations in
forming our opinion.
Example 3.4 shows the materiality levels applied in the audits of a range of companies. CRH plc’s
and Marks & Spencer plc’s auditors based their calculate materiality as 5% of “adjusted” profit
before tax. Paddy Power plc’s and Ryanair plc’s auditors base their calculation of materiality on a
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“benchmark” of profit before tax. As the terms “adjusted” and “benchmark” are not defined, it is
hard for investors, even sophisticated investors to understand the materiality calculations.
CRH plc 2015 Q23: How does the level of materiality applied in the 2015 audit of CRH compare
with other companies?
Example 3.4: Materiality levels applied in the audit of a range of companies
Paddy Power Betfair plc 2015

Independent Auditor ’s Report to the Members of Paddy Power Betfair plc (extract)
3. Our application of materiality and an overview of the scope of our audit (extract)
The materiality for the Group financial statements as a whole was set at €9.0 million
(2014: €8.0 million).
(Source: Paddy Power Betfair plc, Annual Report 2013, p. 81)
CRH plc 2015

Independent Auditor’s Report (extract)
Materiality (extract)
We determined materiality for the Group to be €50 million (2014: €36 million), which is
approximately 5% (2014: 5%) of profit before tax. Profit before tax is a key performance
indicator for the Group and is also a key metric used by the Group in the assessment
(Source: CRH plc, Annual Report 2015, p. 129)
Marks and Spencer plc 2016

Independent Auditor’s Report (extract)
Our application of materiality (extract)
We determined materiality for the Group to be £30 million, based on a calculation of 5%
of profit before tax adjusted for certain non-underlying items due to the nature and
significance of these nonrecurring items.
(Source: Marks and Spencer plc, Annual Report 2016, p. 84)
Ryanair Holdings plc 2015

Independent Auditor’s Report to members of Ryanair Holdings plc (extract)
4 Our application of materiality and an overview of the scope of our audit (extract)
The materiality for the Group financial statements as a whole was set at €49.0 million
(2014: €29.5 million).
(Source: Ryanair plc, Annual Report 2015, p. 38)
Example 3.5 provides extracts from the financial statements of Anglo Irish Bank. The personal
borrowings of Mr Sean FitzPatrick, Chairman/former CEO of Anglo Irish Bank, were omitted from
the financial statements over a period of eight years. He and his friend, Mr Michael Fingleton, CEO
of Irish Nationwide Building Society, engaged in what is colloquially called “bed-and-breakfasting”
of Mr FitzPatrick’s personal borrowings from his own bank. Anglo Irish Bank’s year-end date was
30 September. Shortly before the year end, Mr Fingleton would lend Mr FitzPatrick sufficient funds
to repay his personal borrowings. Shortly after the year end, they would reverse the transaction.
Example 3.5 summarises the income statement amounts from the financial statements and Mr
FitzPatrick’s personal borrowings. The key question is whether Mr FitzPatrick’s personal
borrowings are material given the balance sheet amounts.

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Example 3.5: Materiality
2007 2006 2005 2004 2003 2002 2001

€m €m €m €m €m €m €m
Profit before tax 1,219 946 685 504 346 261 195
Chairman/CEO loans 122 48 27 24 15 4 5
Question
Are the Chairman/CEO loans material?
Solution
2007 2006 2005 2004 2003 2002 2001
€m €m €m €m €m €m €m
Profit before tax 1,219 946 685 504 346 261 195
Chairman/CEO loans (10.0%)122 (5.1%)48 (3.9%)27 (4.8%)24 (4.3%)15 (1.5%)4 (2.6%)5
IAS 1 provides guidance on what is material.

• Omissions or misstatements of items are material if they could, individually or collectively,
• Materiality depends on the size and nature of the omissions and misstatement judged in the
surrounding circumstances.
• The size or nature of the item, or a combination of both, could be the determining factor.
• Users are assumed to have reasonable knowledge of business and economic activities and
accounting and a willingness to study the information with reasonable diligence.
Sean FitzPatrick’s loans were material on grounds of their nature, not size. How do we know this to
be the case? Mr FitzPatrick hid his loans from shareholders – an indication that had they know about
his loans he believed it would have influenced their economic decisions.
(Sources: Anglo Irish Bank Annual Reports, Carswell, Simon (2009) Anglo Republic. Inside the Bank
that Broke Ireland, p. 246)
Faithful representation
Financial reports represent economic phenomena in words and numbers. To be useful, financial
information must not only represent relevant phenomena, but is must also faithfully represent the
phenomena that it purports to represent. To be a perfectly faithful representation, a depiction
would have three characteristics. It would be complete, neutral and free from error.
Example 3.6 illustrates how careful use of weasel words can mislead shareholders – in this case
the use of one letter – ‘s’ – the plural ‘defined benefit pension schemes’/‘members’ not singular
‘defined benefit pension scheme’/ ‘member’. I was alerted to the example by Tom Lyons’ and
Richard Curran’s book. The second part of Example 3.6 is taken from a note in the 2007 audited
financial statements of Irish Nationwide Building Society, one of Ireland’s most toxic financial
services organisations. Inclusion of the letter ‘s’ created the wholly misleading impression that
there were a number of pension schemes for a number of employees, when in fact there was only
one pension scheme of €27 million for one person, the CEO Mr Michael (‘Fingers’) Fingleton. As
this text comes from the audited financial statements, one wonders how the auditors allowed such
misleading material to get by them.

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Example 3.6: Faithful representation – not!
This figure [Michael Fingleton’s defined benefit pension pot of €27 million]
had been declared in the society’s annual report that year, but it was heavily
disguised. It was referred to as ‘one of the groups defined benefit pension
schemes’ that had not been settled for the ‘members of the scheme.’ This gave
the reader the false impression that the €27 million scheme was for more than
one person, when in fact it was for just one: Michael Fingleton.
(Source: Lyons and Curran, p. 193)
Notes to the financial statements (extract)

31. Pensions (extract)
The obligations under one of the groups [sic] defined benefit pension schemes,
operated by the Group, was settled on 12 January 2007 by transferring outside
the control of the Group the assets and obligations of the scheme to another
retirement benefit scheme. This represents full and final settlement of the
Groups [sic] pension obligations to the members of the scheme.
(Source: Irish Nationwide Building Society Annual Report & Accounts, 2007, p.
47)
Completeness
A complete depiction includes all information necessary for the user to understand the
phenomenon being depicted, including all necessary descriptions and explanations. Example 3.6
also illustrates breach of this quality characteristic.
Neutral
A neutral depiction is without bias in the selection or presentation of financial information. A

neutral depiction is not slanted, weighted, emphasised, de-emphasised or otherwise manipulated
to increase the probability that financial information will be received favourably or unfavourably
by users.
Free from error
Free from error means that there are no errors or omissions in the description of the phenomenon
and the process used to produce the reported information has been selected and applied with no
errors in the process. In this respect, free from error does not mean perfectly accurate in all
respects.
Enhancing qualitative characteristics
Comparability, verifiability, timeliness and understandability are qualitative

characteristics that e4nhance the usefulness of information that is relevant and faithfully
represented.
Comparability
Users must be able to compare the financial statements of an entity through time in order to
identify trends in its financial position and performance. Users must also be able to compare the
financial statements of different entities in order to evaluate their relative financial position,
performance and changes in financial position. Hence the measurement and display of the financial
effect of like transactions and other events must be carried out in a consistent way throughout an
entity and over time for that entity and in a consistent way for different entities.

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Verifiability
Verifiability means that different knowledgeable and independent observers could reach
consensus, although not necessarily complete agreement, that a particular depiction is a faithful
representation.
Timeliness
If there is undue delay in reporting financial information it may lose its relevance. Management
may need to balance the relative merits of timely reporting and the provision of reliable
information. To provide information in a timely basis it may be necessary to report before all
aspects of the transaction or other event are known, thus impairing reliability. Conversely, if
reporting is delayed until all aspects are known, the information may be highly reliable but of little
use to users who have had to make decisions in the interim. In achieving a balance between
relevance and reliability, the overriding consideration is how best to satisfy the economic decision-
making needs of users.
Illustration 3.4 shows the date on which the directors and auditors signed off on the financial
statements. The date is almost always the same for directors and auditors.
CRH plc 2015 Q24a: On what date, and how many days after the year end, did CRH directors adopt
the 2015 financial statements?
CRH plc 2015 Q24b: On what date, and how many days after the year end, did CRH plc’s auditors
sign off their audit report on CRH plc’s 2015 financial statements?
CRH plc 2015 Q24c: How many days after the year end did CRH present the 2015 financial
statements at the annual general meeting of shareholders?
Illustration 3.4: CRH plc’s signing off on the financial statements
On behalf of the Board,

N. Hartery, A. Manifold
Directors
2 March 2016
Breffni Maguire
for and on behalf of Ernst & Young
Dublin
2 March 2016
33. Board Approval

The Board of Directors approved and authorised for issue the financial statements on pages
132 to 209 in respect of the year ended 31 December 2015 on 2 March 2016.
Financial calendar
Announcement of final results for 2015 3 March 2016
Ex-dividend date 10 March 2016
Record date for dividend 11 March 2016
Latest date for receipt of scrip forms 20 April 2016
Annual General Meeting 28 May 2016
Dividend payment date and first day of dealing in scrip dividend shares 6 May 2016
(Source: CRH plc Annual Report 2015, p. 119, p. 131, p. 209, p. 222)

93
The Dublin department store, Arnotts, held its first annual general meeting on 31 August 1876, just
four days after the board of directors approved the financial statements on 26 August 1876. Very
timely reporting indeed! Note also in Illustration 3.5 the wording in the auditor’s report. All it says
is that the auditors found the accounts (i.e., financial statements) to be in agreement with the books
and records of the company. Very limited assurance indeed!
Illustration 3.5: Arnotts annual report, 1876
Arnott & Company, Dublin, Limited.
DIRECTORS’ REPORT, WITH STATEMENT OF ACCOUNTS,

To be presented to the Shareholders at the Eleventh Half-yearly General Meeting of the
Company, to be held at the Company’s Office, 12 Henry Street, in the City of Dublin, on
Thursday, the 31st day of August, 1876, at the hour of 12 o’clock, noon.
Directors:
Sir John Arnott, D.L. Orlando Beater, Esq.
Patrick Reid, Esq. William Freeman, Esq
James F. Lombard, Esq., J.P. Daniel J. Creedon, Esq.
In presenting the First Report since the Shares were put upon the Market, with the
Statement of Accounts for the Half-year ending 31st July, 1876, the Directors have
pleasure in stating that, notwithstanding the general depression of trade, the business
has been of a very profitable character, which is, no doubt, satisfactory, not alone to the
Shareholders, but also to those who have had the control and management of the
business.
The Profits earned in the Half-Year, after all outgoings, amount to £10,508 14s. 9d.
The Directors recommend that a Dividend be paid at the rate of 12 ½ per cent per annum
(free of Income Tax), being 5s. Per Share, which will permit of a Sum of £1,221 4s. 9d. being
placed to the credit of the next Half-Yearly Balance.
The Directors regret that they have to call attention to the death of their late much
esteemed and worthy friend, William McNaught, Esq. who had been a Director since the
formation of the Company, and was connected with the business since the opening of the
house in 1843.
Sir John Arnott, Patrick Reid, Esq., and Orlando Beater, Esq., retire from the Direction, but
offer themselves for re-election.
The Directors recommend that William Freeman, Esq., late Manager of the Company, and
Daniel Joesph Creedon, Esq., late Secretary of the Company, be appointed Directors. The
proposed change in the position of these gentlemen will not interfere in any way with the
duties they have heretofore so efficiently discharged, as it is intended to appoint them
Managing Directors.
By Order of the Board,
E. J. HUDSON, Secretary.

94
Illustration 3.5: Arnotts annual report, 1876 (continued)
DR. BALANCE SHEET MADE UP TO 31st JULY, 1876 CR.
CAPITAL AND LIABILITIES. PROPERTY AND ASSETS.

£ s. d. £ s. d.
To Capital Subscribed By Premises, Plant, Stock, Goodwill, &c, … 239,036 15 3
37,510 Shares of £5 each, £187,500 “ Sundry Debtors … … … … … … … … … … … 50,773 4 11
“Capital Paid up, 37,510 Shares of £4, Paid… 150,010 0 0 “ Cash on hand and Bills Receivable on Hands 9,783 14 6
“ Debentures … … … … … … … … … … … … … … 62,500 0 0 “ Investments … … … … … … … … … … … … … 1,609 11 11
“Sundry Cash and Trade Creditors and
73,064 11 10
Suspense Account … … … … … … … … … …
“Reserve Fund … … … … … … … … … … … … … 5,000 0 0
“Profit and Loss Account Amount to Credit … 10,598 14 9
£301,203 6 7 £301,203 6 7
DR. PROFIT AND LOSS ACCOUNT CR.

For the Half-year ending 31st July, 1876
£ s. d. £ s. d.
To Credit of Bad and Doubtful Debts 1,014 0 11 By Net Profits for Six Months, after
…… Payment of Charges, Expenses,
13,487 15 8
Freights, Interest on Deposits,
Repairs, Income Tax, &c … … …
“ Interest at 6% per annum on £2,500
1,875 0 0
Debentures for Six Months … … … …
“ Balance … … … … … … … … … … … 10,598 14 9
£13,487 15 8 £13,487 15 8
We have examined the above Accounts and Balance Sheet, and compared them with the Books, &c., and find them to agree.
CRAIG GARDNER & CO., Auditors
PATRICK REID, Chairman
Dublin, 26th August, 1876.
Understandability
An essential quality of information in financial statements is that it is readily understandable by

financial statement users. For this purpose, users are assumed to have a reasonable knowledge of
business and economic activities and accounting and a willingness to study the information with
reasonable diligence. Classifying, characterising and presenting information clearly and concisely
makes it understandable. The chairman of the UK Accounting Standards Board (1990-
2000)/International Accounting Standards Board (2001-2011), Sir David Tweedie, acknowledges
problems with understandability in the following quote.
“If you understand the accounting standard for financial instruments,

then you haven't read it properly”, Sir David Tweedie, Chairman,
Accounting Standards Board, quoted in Hughes, Jennifer, Flurry of
reports on their way as industry grapples with changes, Financial
Times, 13 December 2007, p. 21.

95
Figure 3.1 summarises the qualitative characteristics of financial information
3.11 Financial accounting conventions
A list of accounting conventions is shown in Table 3.4. Some of these taken-for-granted accounting
conventions are also covered in law and in IAS 1 Presentation of Financial Statements. The topic is
picked up again further on.

96
Table 3.4: Taken-for-granted accounting conventions
Implicit
1. Business entity The business is accounted for as a separate entity, separate from the
owners of the business
2. Duality – double entry All transactions are entered at least twice – a debit entry and a credit
entry
3. Monetary measurement All transactions must be capable of (reliable) measurement in
quantitative and money terms
4. Cost Most assets are recorded at their original cost, even if they have a value
greater (but not less) than original cost
IAS 1 Accounting conventions
5. Accounting Financial statements are prepared for a specific accounting
period/reporting period period/reporting period, usually one year
(IAS 1, para. 36)
6. Materiality (IAS 1, para. 29- The way in which transactions are disclosed in financial statements is
31) determined by their materiality, which crudely speaking refers to their
size.
7. Offsetting (IAS 1, para. 32) An entity shall not offset assets and liabilities or income and expenses,
unless required or permitted by an IFRS.
8. Continuity (going concern) Financial statements are prepared on the assumption the business will
(Law/IAS 1) (IAS 1, para. continue in operation for the foreseeable future. This is important for
25-26) asset valuation purposes. Asset values on a going concern basis of
accounting versus the break-up/liquidation basis of accounting are
materially different, with break-up/liquidation valuations generally
being much smaller.
9. Consistency (Law/IAS 1) Transactions are recorded using consistent accounting policies, and in
(IAS 1, para. 45-46) like manner, from accounting period to accounting period.
10. Accruals basis of accounting Expenses are matched against revenues, and accounted for in the
(Matching) (IAS 1, para. 27- accounting period to which they relate. Match against revenue the
28) expenses incurred in generating that revenue, whether paid for or not
(matching concept)
Law
11. Conservatism (prudence) All losses are recognised (this term has a particular meaning in
(Law) accounting, i.e., there is a double entry in the nominal ledger, a debit and
credit entry) as soon as they are identified; Revenues are not
anticipated. Accounting is therefore asymmetric, with losses being
recognised immediately while revenues are not anticipated.
12. Realisation of revenue Revenue is only recognised (this term has a particular meaning in
(Accruals) accounting, i.e., there is a double entry in the nominal ledger, a debit and
credit entry) in the financial statements when realised. Revenue is
realised when received in the form of cash or some other asset the
ultimate cash realisation of which is known with reasonable certainty.
Source: Alexander, Britton and Jorissen (2011, pp. 9-14) Adapted
3.11.1 Financial accounting conventions under FRS 102
Three financial accounting conventions were identified in Table 3.4 as featuring in FRS 102 The
Financial Reporting Standard applicable in the UK and Republic of Ireland but not featuring in IAS 1
Presentation of Financial Statements.
Reliability
The information provided in financial statements must be reliable. Information is reliable when it
is free from material error and bias and represents faithfully that which it either purports to
97
represent or could reasonably be expected to represent. Financial statements are not free from
bias (i.e., not neutral) if, by the selection or presentation of information, they are intended to
influence the making of a decision or judgement in order to achieve a predetermined result or
outcome. (Paragraph 2.7, FRS 102)
Substance over form

Transactions and other events and conditions should be accounted for and presented in
accordance with their substance and not merely their legal form. This enhances the reliability of
financial statements. (Paragraph 2.8, FRS 102)
Prudence
The uncertainties that inevitably surround many events and circumstances are acknowledged by
the disclosure of their nature and extent and by the exercise of prudence in the preparation of the
financial statements. Prudence is the inclusion of a degree of caution in the exercise of the
judgements needed in making the estimates required under conditions of uncertainty, such that
assets or income are not overstated and liabilities or expenses are not understated. However, the
exercise of prudence does not allow the deliberate understatement of assets or income, or the
deliberate overstatement of liabilities or expenses. In short, prudence does not permit bias.
(Paragraph 2.9, FRS 102)
3.12 Accounting terminology in different jurisdictions
Table 3.5 summarises some Irish / UK accounting terms that differ in the US and under
international accounting standards, including income statement items, balance sheet items and
other business accounting-related terms.
Table 3.5: Differences in terminology between jurisdictions
UK & Ireland US IASB

Turnover Sales (or revenue) Revenue
Profit & Loss account Income statement Income statement
Fixed Assets Non-current assets Non-current assets
Tangible fixed assets Property, plant and equipment
Stock Inventory Inventory
Debtors Receivables Receivables
Shareholders’ funds Equity
Shares Stock Shares
Creditors: Amounts falling due Current liabilities
within one year
Creditors: Amounts falling due Non-current liabilities
after more than one year
Long-term liabilities Non-current liabilities
Creditors Payables Payables
Acquisition Purchase Acquisition
Merger Pooling of interests Uniting of interests
Remuneration (Emoluments) Compensation Not applicable
CRH plc 2015 Q25: In relation to the terms in Table 3.5, which terms does CRH use in its 2015

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4. Content of annual reports
Section 4: Content of annual reports

4.1 Contents of annual reports
4.2 Introduction to group financial statements
4.2.1 Subsidiaries and associated companies
4.2.2 Group / consolidated financial statements
4.2.3 Accounting for subsidiaries and associated companies
4.2.4 Accounting for simple investments
4.3 Limitations of financial statements
4.3.1 Limitations in financial information
4.3.2 Accounting is a “work of art”
4.3.3 The human element and the temptation to manage earnings
4.3.4 Exploiting ambiguities in the rules
4.4 IAS 1 Presentation of Financial Statements
4.4.1 Introduction
4.4.2 Purpose of financial statements
4.4.3 Components of financial statements
4.4.4 Summary of IAS 1
4.1 Contents of annual reports
Irish annual report formats are fairly standard, with some limited variation in sequence of topics.
The same comment can be made about other countries, except that their annual report formats
may be different to those in Ireland. Typical annual report contents are summarised in Table 4.1.

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Table 4.1: Typical contents of an annual report
Annual reports – Unregulated sections (narratives)

Results in brief/financial highlights
Chairman’s statement
Chief executive’s report
Operating and financial review
Environmental report
Intellectual capital statement
Annual reports –Regulated sections

Report of the directors
Financial statements (most of)
Annual reports – Quasi-regulated sections

Directors and other corporate governance information
Financial statements – Regulated elements

[Auditor’s report]in brackets as not part of, rather report on, the financial statements
Group / Consolidated income statement/profit and loss account
Group / Consolidated statement of comprehensive income
Group / Consolidated Statement of changes in equity
Group / Consolidated balance sheet Two balance
Parent company balance sheet Sheets
Group / Consolidated cash flow statement
Accounting policies1
Notes to the financial statements1
Financial statements – Unregulated elements

Historical financial summary
Value added statement
Integrated report
1 Accounting policies are the specific principles, bases,

conventions, rules and practices applied by an entity to account
in preparing and presenting financial statements, Notes to the
financial statements provide additional explanatory
information and disclosures on items appearing in the financial
statements.
A considerable amount of the material at the start of annual reports is unregulated and provided
voluntarily by companies. Davison (2011) has called this the “paratext” or “surround” to the
financial statements. Examples of such material include:
• Results in brief/financial highlights
• Chairman’s statements
• Chief executives’ reports
Some material in annual reports is quasi-regulated. For example, the Stock Exchange’s Corporate
Governance Code is applicable on a comply-or-explain basis. Companies must comply with the
provisions of the Code or must explain non-compliance (thus the phrase ‘soft law’). Thus, non-
compliance with the Code is not a breach of the Code provided non-compliance is explained. Thus,
it is perfectly acceptable not to comply with elements of the Code, provided the board of directors
explains non-compliance. Consequently, the Code is a complete free-for-all; a smorgasbord of
choice. No company is ever in breach of it. There is little or no regulatory oversight or enforcement
of the comply-or-explain system, thus the Code is referred to as “self-regulatory”.

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Regulated material is often distinguished from earlier material by being on different quality paper.
It includes:
• Auditors’ reports
• Financial statements
Some material in financial statements is unregulated and produced voluntarily such as value added
statements and historical financial summaries.
Some material in financial statements is unregulated and produced voluntarily such as value added
statements and historical financial summaries. CRH plc provides on a voluntary basis a ten-year
financial summary (Illustration 4.1). CRH plc has completely free choice as to what to include in
this statement which is not audited (see Illustration 4.2 for the scope of auditors’ report, which
does not include the ten-year historical financial summary).
CRH plc 2015 Q26a: How many profit numbers does CRH plc show in its 10 year financial
summary?
CRH plc 2015 Q26b: How many of CRH plc’s financial summary profit numbers do not come from
the audited financial statements?

101
Illustration 4.1: CRH plc’s ten-year historical summary

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CRH plc 2015 Q27: Is CRH plc’s financial summary audited
The auditor’s report only applies to a limited part of the annual report. Illustration 4.2 shows how
narrow the scope is, with the audit confined to the financial statements and almost no other part
of the document.
Illustration 4.2: CRH plc’s audit of its ten-year historical summary
What we have audited

CRH plc’s financial statements comprise:
Group Company
Consolidated Income Statement for the year ended 31 December 2015 Balance Sheet as at 31 December 2015
Consolidated Statement of Comprehensive Income for the year then ended Statement of Changes in Equity for the year then ended
Consolidated Balance Sheet as at 31 December 2015 Statement of Cash Flows for the year then ended
Consolidated Statement of Changes in Equity for the year then ended Related notes 1 to 14 to the Company Financial Statements
Consolidated Statement of Cash Flows for the year then ended
Related notes 1 to 33 to the Consolidated Financial Statements
The auditors’ report is an important element of the financial statements. It reveals the identity of
the audit firm and the name of the individual partner in the firm responsible for that audit (see
Illustration 4.3). Mr Maguire is a graduate of UCD’s BComm and Master of Accounting programmes.
CRH plc 2015 Q28a: What firm is auditor to CRH plc?
CRH plc 2015 Q28b: Who is the audit (called ‘engagement’) partner in charge of CRH plc’s audit
Illustration 4.3: CRH plc’s audit engagement partner
Breffni Maguire
for and on behalf of Ernst & Young
Chartered Accountants and Statutory Audit Firm Dublin
2 March 2016
CRH plc 2015 Q29a: In relation to the 2015 annual report of CRH, what are its contents and how
do they compare with the description in Table 4.1 (in executing this requirement, please complete
Table 4.2)?
CRH plc 2015 Q29b: Complete a similar table in respect of the annual report you have selected for
the annual report examination.

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Table 4.2: Analysis of the contents of CRH plc’s annual report
CRH Company for

annual report
examination
Page Page
CRH plc Annual report
Unregulated sections
• Results in brief/financial highlights
• Chairman’s statement
• Chief executive’s report
• Operating and financial review
Regulated sections
• Directors and other information
• Report of the directors
Quasi regulated sections

• Corporate governance disclosures
CRH Financial statements

Regulated financial statements
• Auditors’ report
• Consolidated income statement
• Statement of comprehensive income
• Statement of changes in equity
• Consolidated balance sheet Two balance
• Parent company balance sheet sheets
• Consolidated cash flow statement
• Accounting policies
• Notes to the financial statements
Unregulated financial statements

• Historical financial summary
• Value added statement
• Environmental report
• Intellectual capital report
• Integrated report
Annual reports have been getting longer and longer. Note the length of Arnotts 1896 annual report
in Illustration 3.5 earlier! Example 4.1 contains some wry comments from the Lex column of the
Financial Times on this subject.

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Example 4.1: Annual reports: page inflation
‘‘First you take a drink, then the drink takes a drink, then the drink takes you.” F Scott
Fitzgerald’s words offer wisdom for bleary-eyed accountants returning to work to close
the year’s numbers and start the annual reports. As the headaches ease, the counters
need to remember that information, like a good drink, is best enjoyed in moderation.
Annual reports are still investors’ most important source, according to a survey by the
Association of Chartered Certified Accountants, and the reports are growing. The average
UK report is 65 per cent longer than 10 years ago and has more than doubled since 1996,
according to Deloitte. More information can help investors understand companies better
and complex businesses need room to explain but HSBC’s 598 page 2013 annual report is
too much to absorb.
Sarbanes-Oxley (2002) and Dodd-Frank (2010) require companies to disclose more.

More information on pay, complex financial instruments and off balance sheet items is
good information. The strategic report and enhanced disclosures for banks are very
useful — but it all adds up.
So what to do? The Financial Reporting Council’s lab (yes, really) recommends starting
with a clean sheet of paper and focusing on the audience — what do they want to know?
Cash flow and return on capital, maybe. Only include material information. Use tables and
summaries to make information clear. Go digital: link rather than repeat items and
publish non-essential information separately online. Short. Sweet. Santé.
Source: Lex (2015) Annual reports: page inflation - Essential sources for investors are
bigger, but are they better? Financial Times, 2 January 2015

105
4.2 Introduction to group/consolidated financial statements
If a company invests in another company, all that appears in the financial statements of the investor
company is the original cost of the investment which is shown in the balance sheet (Non-current
assets, Financial assets), and dividends received (if any) appear in the profit and loss account
(Other income). This provides very limited information about the investment. If the investee pays
no dividends, no information is available on the performance of the investment. If the investee is
increasing in value, this will not be reflected in the individual accounts of the investor as the
investment is generally shown at cost in the investor’s balance sheet.
Illustration 4.4 includes the parent company balance sheet of CRH plc.
CRH plc 2015 Q30: In relation to the 2015 annual report of CRH, where are CRH plc’s investments
at cost shown?
Illustration 4.4: CRH plc’s investments in the parent company’s balance sheet

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Group or consolidated financial statements show the financial position and results of a group of
companies as if the group were a single entity. A group consists of a parent company (also
referred to as a “holding” company, as in holding shares / investments in another company) and
its subsidiaries. It may also include investments in associated (‘related’) companies and other
investments such as joint ventures. Group financial statements are prepared by the holding
company (i.e., the company holding shares in other companies) in addition to its own individual
company financial statements. Finally, simple investment may also be included.
CRH plc 2015 Q31: In relation to the 2015 income statement (see page 24 of these notes) and
balance sheet (see page 20 of these notes) of CRH shown in Section 1 of these notes, what evidence
is there that those are consolidated financial statements?
4.2.1 Subsidiaries and associated companies
A subsidiary company is where the parent/holding company controls the company often
represented by the parent/holding company owning more than 50% of the share capital of the
subsidiary. An associated (‘related) company is where the parent/holding company exercises
significant influence over the company often represented by the parent/holding company owning
more than 20% but less than 50% of the share capital of the associated (‘related) company.
Group financial statements are prepared when one company controls another (>50%). Otherwise,
when a company owns shares in another company, it includes the investment in its balance sheet
at cost and includes dividend income in its income statement when received or receivable.
However, where a company has a substantial shareholding in another company without having a
controlling interest, including the investment at cost may not provide shareholders with useful or
sufficient information about the investment. Equity accounting was introduced to deal with such
situations. Investments where the holding company’s investment is substantial but not a
controlling interest, and where the holding company exercises significant influence are referred to
as ‘associated’ or ‘related’ companies (20%-50%). Finally, simple investments are ones where the
percentage held by the holding company is <20%.
4.2.2 Group / consolidated financial statements
In Ireland, company law requires parent or holding companies to include a parent company as well
as consolidated/group balance sheet. Parent/holding companies are exempt from including a
parent/holding company income statement in their annual reports, provided a note to the parent
company financial statements discloses the amount of the parent company profit dealt with in the
consolidated/group income statement.
Group financial statements normally comprise a consolidated balance sheet, a consolidated income
statement and usually a consolidated cash flow statement. Under United Kingdom (UK) and Irish
regulations, the annual report of a group will also include the individual balance sheet of the parent
company (Illustration 4.4), but not the individual profit and loss account – this does not have to be
shown provided the financial statements disclose separately the amount of the parent company’s
profit or loss that is included in the group consolidated income statement. As shown in Illustration
4.5, CRH plc discloses the parent company profit (€1.467 million) in a note to the parent company
balance sheet.

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CRH plc 2015 Q32: In relation to the 2015 annual report of CRH, where are the profits of the
parent/holding company disclosed?
Illustration 4.5: CRH plc’s disclosure of the parent company’s profit
9. Reserves
Revaluation reserve
The Company’s revaluation reserve arose on the revaluation of certain investments prior to the
transition to FRS 102.
In accordance with Section 304 of the Companies Act 2014, the Company is availing of the
exemption from presenting its individual profit and loss account to the Annual General
Meeting and from filing it with the Registrar of Companies. The profit for the financial year
dealt with in the Company Financial Statements amounted to €1,467 million (2014: €1,208
million).
4.2.3 Accounting for subsidiaries
The purpose of consolidated financial statements is to report the financial position and results of
a group controlled by the parent to its shareholders. In the consolidated balance sheet, the holding
company’s asset, Investment in subsidiaries, is replaced by the underlying (100%) assets and
liabilities of the subsidiaries. In the consolidated income statement, Income from financial assets in
subsidiaries, (i.e., investment income from subsidiaries) is replaced by the underlying (100%)
revenues and expenses of the subsidiaries. Where a subsidiary is not wholly owned (i.e., not 100%
owned), the non-controlling (‘minority’) interest is shown as a one-line adjustment in the balance
sheet and income statement.
Table 4.3 shows the group structure for a wholly owned subsidiary and for one with a 20% non-
controlling (i.e., minority) interest.
Table 4.3: Ownership of subsidiaries
Wholly owned Not wholly owned
H Limited H Limited
100% 80%
S Limited S Limited
Non-controlling
(minority) interest
20%
balance sheet (see page 20 of these notes) of CRH shown in Section 1 of these notes, does CRH have
non-controlling interests?

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4.2.4 Accounting for associated companies
Under equity accounting for associated (‘related’) companies, the group share of the net profit and
the group share of the net assets are included in the income statement and balance sheet.
balance sheet (see page 20 of these notes) of CRH shown in Section 1 of these notes, what evidence
is there that CRH has investments in associates?
4.2.5 Accounting for simple investments
Investments of less than 20% owned (i.e., not subsidiaries, not associates) by another company are
accounted for as simple investments. The cost of the investment is recorded in the balance sheet,
in non-current assets as investments in equity instruments (i.e., a financial asset). Dividend income
is recorded as ‘Other income’ in the income statement.
Table 4.4 draws together Section 4 into a concise summary of the accounting treatment for each
kind of investment.
Table 4.4: Summarising the accounting treatment of investments
Investment in Definition Method of account

Subsidiary >50% ownership • Consolidation
Parent company exercises • 100% Assets, Liabilities, Revenues,
control Expenses
• One-line adjustment for non-
controlling (minority) interest
Associate >20%<50% ownership • Equity method of accounting

Parent company exercises • Parent company share of net assets,
significant influence share of profits
Simple <20% ownership Investment at cost in balance sheet

investment Dividends received in income statement
Note 2 to the parent company balance sheet shows CRH plc’s investment in subsidiaries, a financial
fixed / non-current asset (see Illustration 4.6).
CRH plc 2015 Q35: In relation to the 2015 balance sheet of the CRH parent company (see page 106
of these notes), where are investments in subsidiaries, investments in associated companies,
simple investments disclosed?

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Illustration 4.6: CRH plc’s investments in its subsidiaries
4.3 Limitations of financial reporting
Financial reporting has a number of limitations. These arise because of inherent limitations in
financial information, because accounting is an art not a science and because financial reporting is
a human process.
4.3.1 Limitations in financial information
There are a number of inherent limitations in financial information. That company activities and
transactions are recorded as financial information introduces consequent inherent limitations:
• Items must be capable of measurement in money terms.
• Items must be capable of reliable measurement.
As a result, some items are either incapable of being measured in money terms or incapable of
being reliably measured. Examples include:
• Intellectual capital – many companies invest heavily (training etc) in their workforce, yet that
asset is never recorded in the financial statements. Firstly the asset cannot be reliably measured
in money terms. There is also an issue with ownership of the asset (staff may leave
organisations and move to other positions). Another example of an intellectual capital asset not
recorded in financial statements is customer loyalty developed over the years from company
investments in customer relations. There are many more such intangible assets not recorded
in financial statements.
• Internally generated goodwill is not recognised in financial statements, whereas externally
acquired goodwill is. Thus, the same kind of asset (goodwill) is inconsistently treated in
financial statements. If the goodwill has been paid for (externally acquired goodwill), it can be
reliably measured in money terms (at the amount paid for it) and can therefore be recorded.
Such reliable measurement is not possible with internally generated goodwill.
Financial statements are therefore missing some significant company assets. This explains why,
for listed companies, market values are so different from the book values of assets recorded in the
financial statements.

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Even where assets are capable of being recorded in money terms, they tend to be recorded at
historic cost, i.e., at the amount the asset originally cost. The original cost may bear no resemblance
to current asset values. One just has to consider the historic cost of an office building bought in
1970 compared with its value now, to get a sense of the inadequacy and inaccuracy of accounting
in the way in which it records such an asset.
Thus, financial statements have limited use for valuation purposes.
4.3.2 Accounting is a “work of art”
The precise numbers and amounts in profit and loss accounts and balance sheets suggest a
precision that does not exist. All transactions are measured in precise money amounts. Balance
sheets must balance. The reality is that financial reports are the product of multiple subjective
judgements by company directors. Accounting is an art, not a science!
All but the smallest businesses follow the accruals method of accounting in preparing their
financial reports. Company law requires this basis of accounting. Financial statements that do not
use the accruals basis of accounting will not show a “true and fair view”. Under the accruals method
of accounting, transactions are recorded by reference to when they occur rather than when cash is
received/paid. Using a somewhat extreme example, profit will be recorded in the construction
company’s financial statements throughout a long-term (say five-year) contract, reflecting the
work being done as the contract progresses, even if the cash from the customer is not received
until the end of year five when the contract is completed. The accruals method of accounting
(rather than cash accounting) is more suitable for giving a “true and fair view”, but introduces
subjectivity into accounting. As transactions are recorded under the accruals method of
accounting, estimates and judgements must be applied in deciding when to:
• Book revenue; and
• Record expenses.
The most common method of fraudulent financial reporting is recognising (i.e., recording as profit)
revenue too soon (Brennan and McGrath 2007), although famously the Worldcom scandal involved
not recognising expenses in time.
A case of fraudulent financial reporting – The Anglo Three
Example 4.2 summarises the case of the Anglo Three – three employees who engaged in fraudulent
financial reporting – who doctored the accounting records of Anglo Irish Bank to facilitate fraud in
the form of tax evasion by the CEO/Chairman of Anglo Irish Bank, Mr Sean FitzPatrick. None of the
three employees benefitted financially from the fraud. The key takeaway from this case is: If the
Boss asks you/pressurises you to do something wrong, don’t do it!
Action Point 4.1: In relation to Example 4.2 Please answer the following questions:
(i) Did the Boss stand by The Anglo Three during their trial for fraudulent financial reporting to
facilitate tax evasion by the Boss?
(ii) Did the Boss attend the trial to support The Anglo Three?
(iii) Did the Boss visit The Anglo Three in prison?
(iv) During the case, was the Boss on the golf course playing golf?

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Example 4.2: Financial accounting fraud – The Anglo Three
THEY are doing porridge but breakfast this Sunday morning for the Anglo Three will be dry cereal and bread in
a plastic bag, a small carton of milk to douse it with and plastic cutlery.
Tiarnan O'Mahoney (56), Bernard Daly (67) and Aoife Maguire (62), the first bankers to be jailed since the
financial crisis, will wake up this morning in a bleak environment a world away from life at the once high-flying
bank known for its sumptuous corporate entertainment. The three were sentenced on Friday in a case that has
had catastrophic consequences for all three. Bernard Daly and Tiarnan O'Mahoney could face the costs for their
legal fees for the lengthy trial.
Unlike Aoife Maguire, who was on legal aid, the two men's fees were covered by directors' and officers' liability
insurance which - depending on the policy - does not always pay out if directors are convicted of a criminal
offence.
The three were found guilty on all charges against them at the Dublin Circuit Criminal Court of trying to hide
accounts connected to the former chairman of Anglo Irish Bank, Sean FitzPatrick, from the Revenue
Commissioners.
After Friday's sentencing, the three prisoners were handcuffed and taken by prison transport to the Mountjoy
Prison complex in Dublin's north inner city to be admitted officially into the system. The new regime will
contrast with their previous lives. Mr O'Mahoney, a former chief operating officer at Anglo, left the bank with a
(EURO)250,000 pension top up and a pay-off of (EURO)3.65m. Brian Cowen, the former Taoiseach, appointed
him as chairman of the Irish Pensions Board, while just two years before his conviction, he joined a foreign
exchange company.
Bernard Daly, a former civil servant, was Anglo's director of treasury and later company secretary. During his
trial, he described himself as strait-laced and an outsider at the bank. He did parish work and volunteered with
the St Vincent de Paul.
Both men were introduced to life in Mountjoy on Friday in a prefab-cabin close to the reception entrance where
an officer filled out a form with their details including a physical description and any medical issues. Prison
officers would have asked whether they wanted to be put on special protection, a standard question for inmates
who may have enemies behind bars.
Then they were taken to the reception centre deep in the belly of the prison to a strip-lit room without any
natural light. O'Mahoney and Daly would have had to change into prison clothes, like any other prisoner, and
they would also have been offered the opportunity to take a shower. At this stage they were photographed and
assigned a prison number which will follow them through the system Their first nights in custody were spent
on the committal wing, where inmates are assessed by nursing staff. All new inmates are kept under close
watch - the so-called 'suicide watch' - for their first 24 hours behind bars.
As a female prisoner, Aoife Maguire was spared certain indignities. She was the most junior of those convicted.
She started out at Anglo as a dictaphone typist who worked her way up to assistant manager.
The sentencing hearing on Friday heard that she raised her daughter on her own and was a leading and
respected figure in her camogie club, the Good Counsel, in Drimnagh. Just over a year ago, she was voted Dublin
camogie 'Volunteer of the Year'.
On her arrival at the Dochas Centre, the women's section of the Mountjoy complex, she was not required to
wear prison-issue clothes but could hold on to her own. The accommodation is different as well, with most
prisoners sharing chalets as opposed to cells within the jail.
But because the prison is full to capacity, there is nowhere to segregate prisoners, which means the assistant
bank manager will have to mix with some notorious fellow inmates such as Catherine Nevin and the Scissor
Sisters, Charlotte and Linda Mulhall.
'They would have been asked if they wanted special protection'
Source: Sheehan, Maeve (2015) From dizzy heights to breakfast in a plastic bag; Anglo Three are embarking on
prison sentences in a bleak and alien regime, Sunday Independent, 2 August, 2015.

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4.3.3 The human element and the temptation to manage earnings
Accounting is a human process and, as a result, has weaknesses. Stock markets are excessively
focused on short-term quarterly / half yearly earnings announcements. This can pressurise some
managements into managing earnings. Earnings can be managed by exploiting ambiguities in
accounting rules.
There are two motivations to manage earnings:

1. Market expectations: Motivations to meet market earnings expectations may override common
sense business practices. Stock markets can be unforgiving of companies that fail to meet
earnings expectations (generally measured by financial analysts, as analyst forecasts)(Levitt,
1998)
2. Smooth earnings: Share prices are lower for companies with erratic earnings patterns as such
companies are perceived by the market to be riskier (Trueman and Titman, 1988). Managers
are motivated to manage earnings to achieve a smooth pattern for the purposes of a higher
share price. In good years, managers make overly prudent subjective judgements which have
the effect of lowering profits. In bad years managers are less prudent and can release previous
prudent provisions to the profit and loss account, thus increasing reported profits. Bad debt
provisions would be suitable for such management, especially in financial institutions where
the provisions are very large. A very small change in bad debt assumptions could have a
material effect on amounts of reported profits. Academic research has shown that such
practices are commonplace and have the effect of allowing companies to report profits which
are artificially smooth.
Both motivations to manage earnings are driven by management trying to operate in the best
interests of shareholders (by keeping their share price high). However, what starts as minor
accounting adjustments carried out in the best interest of shareholders, can end up as financial
statement fraud. At what stage does earnings management (legitimate activity practiced widely)
become earnings manipulation (financial statement fraud)? To what extent do earnings reports
reflect the wishes of management, rather than the real underlying financial performance of the
company? The widespread practice of managing earnings has lead to the erosion of, and has raised
questions concerning, the quality of reported earnings.
4.3.4 Exploiting ambiguities in the rules
Many accounting and auditing failures have arisen from companies exploiting ambiguities in
accounting rules. Companies may interpret accounting rules in very rigid or strict ways. This can
have the effect that transactions are, technically speaking, accounted for in accordance with the
rules. However, the substance of the transaction may not be properly accounted for. Companies
may deliberately enter into or structure transactions with the objective of achieving desired
financial accounting outcomes, which do not reflect the underlying substance of the transaction.
In the past, audit firms have earned considerable extra consulting revenue by devising clever
schemes to circumvent and exploit accounting rules. The same firm (but probably not the same
partner in the firm) is likely to be the company’s auditors. This begs the question: How can those
audit firms provide an independent opinion – when they are auditing themselves (i.e., their own
schemes to circumvent accounting rules)? US Securities and Exchange Commission chairman,
Arthur Levitt (2000), has referred to this exploitation of the accounting rules as a “culture of
gamesmanship”.
“I’ve referred to this mind-set as a ‘culture of

gamesmanship’. A mind-set that says ‘if a company is
testing the limits of appropriate conduct then so can I’. If a
rule doesn’t expressly prohibit it, then it’s fair game.”
(Levitt, 2000)

113
Such exploitation of accounting rules is harder under UK than under US Generally Accepted
Accounting Principles (GAAP). Financial Reporting Statement FRS 5 (applicable in Ireland and the
UK) is a principle-based (rather than rule-based) accounting standard and does not lay down
precise rules that can be exploited. However, it would be idealistic to believe that manipulation of
the rules is abolished completely by this accounting standard.
4.4 IAS 1 Presentation of Financial Statements
This section overviews the standard set of financial statements as set out in IAS 1. In further
sections of these notes, the rules surrounding specific Income Statement and Statement of
Financial Position items will be elaborated on. IAS 1 was originally issued in 1997. In December
2014 the IASB published the final Standard Disclosure Initiative (Amendments to IAS 1). These
amendments to IAS 1 address some of the concerns expressed about existing presentation and
disclosure requirements and ensure that entities are able to use judgement when applying IAS 1.
The narrow-focus amendments to IAS 1 clarify, rather than significantly change, existing IAS 1
requirements. In most cases the proposed amendments respond to overly prescriptive
interpretations of the wording in IAS 1. The final Standard Disclosure Initiative (Amendments to
IAS 1) is effective for annual periods beginning on or after 1 January 2016 with earlier application
permitted.
4.4.1 Objective of IAS 1
IAS 1 prescribes the basis for presentation of “general purpose” financial statements, to ensure
comparability both with the entity’s financial statements of previous periods and with the
financial statements of other entities.
General purpose financial statements are those intended to meet the needs of users who are not in
a position to require an entity to prepare reports tailored to their particular information needs.
For example, the financial statements of a pension fund would not be general purpose financial
statements.
It sets out overall requirements for the presentation of financial statements, guidelines for their
structure and minimum requirements for their content
4.4.2 Scope of IAS 1
• Preparing and presenting general purpose financial statements in accordance with IFRSs
• IAS 1 does not apply to interim financial statements prepared in accordance with IAS 34 Interim
Financial Reporting.
4.4.3 Purpose of financial statements (IAS 1, paragraph 9)
To provide information about the (i) financial position, (ii) performance and (iii) cash flows of an
enterprise that is useful to a wide range of users in making economic decisions.
Financial statements also show the results of management’s stewardship of the resources
entrusted to it.
Financial statements provide information about:
• Assets Balance sheet /

• Liabilities Statement of financial position
• Equity
• Revenues and expenses Income statement
• including gains and losses Statement of changes in equity
• Contributions by and Statement of changes in equity
distributions to owners
• Cash flows Cash flow statement

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Financial statements assist users in predicting the enterprise’s future cash flows –
timing, and certainty
4.4.4 Components of financial statements (IAS 1, paragraph 10-14)
• Statement of financial position (i.e., balance sheet)

• Income statement
• Statement of comprehensive income
• Statement of changes in equity
• Statement of cash flows
• Notes comprising
o significant accounting policies (the specific principles, bases, conventions, rules and
practices applied by an entity to account in preparing and presenting financial statements)
and
o other explanatory notes (provide additional explanatory information and disclosures on
items appearing in the financial statements.)
( to  = order of appearance in the financial statements in the annual report)
Companies are also encouraged to present a financial review which:
• Describes and explains main features of financial performance and financial position and
the principle uncertainties entity faces
• Reviews main factors and influences determining performance
♦ Changes in the operational environment
♦ Entity’s responses (and their effect) to changes in the operational environment
♦ Policy for investment to maintain and enhance performance, including dividend policy
• Sources of funding, policy on gearing (leverage, borrowing), risk management policies
• Resources not recognised (this term has a particular meaning in accounting, i.e., there is a
double entry in the nominal ledger, a debit and credit entry) in the statement of financial
position
Companies are also encouraged to present additional statements

• Environmental reports (especially where environmental issues are important)
• Value added statements (especially when employees are considered to be an important user
group)
In December 2010 the IASB issued the IFRS practice statement Management Commentary. The
practice statement provides a broad, non-binding framework for the presentation of management
commentary that relates to financial statements prepared in accordance with IFRS.
The practice statement is not an IFRS. Consequently, entities are not required to comply with the
practice statement, unless specifically required by their jurisdiction.
Management commentary is a narrative report that provides a context within which to interpret
the financial position, financial performance and cash flows of an entity. It also provides
management with an opportunity to explain its objectives and its strategies for achieving those
objectives. Management commentary encompasses reporting that jurisdictions may describe as
management’s discussion and analysis (MD&A)(as it is called in the US), operating and financial
review (OFR) (as it was called in the UK), or management’s report.

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4.5.5 Summary of IAS 1
A complete set of financial statements comprises a statement of financial position; an income
statement; a statement of comprehensive income (see Section 8 of these notes); a statement
of changes in equity (see Section 9 of these notes); a statement of cash flows; and notes,
comprising a summary of significant accounting policies and other explanatory notes.
• Financial statements present fairly the financial position, financial performance and cash flows
of an entity.
• Fair presentation requires faithful representation of the effects of transactions, events and
conditions in accordance with the definitions and recognition criteria for assets, liabilities,
income and expenses set out the Framework for the Preparation and Presentation of Financial
Statements.
• The application of IFRSs (i.e., Standards and Interpretations), with additional disclosure when
necessary, is presumed to result in financial statements that achieve a fair presentation.
• An entity makes an explicit and unreserved statement of compliance with IFRSs in the notes to
the financial statements (see Illustration 4.7).
• Such a statement is only made on compliance with all the requirement of IFRSs.
• A departure from IFRSs is acceptable only in the extremely rare circumstances in which
compliance with IFRSs conflicts with providing information useful to users in making economic
decisions.
• IAS 1 specifies the disclosures required when an entity departs from a requirement of an IFRS.
CRH plc 2015 Q36a: In relation to the 2015 annual report of CRH, what does its compliance
statement required by IAS 1 say?
CRH plc 2015 Q36b: What other statements of compliance does CRH include in its annual report?
CRH plc 2015 Q36c: To what regulations does CRH plc’s additional compliance statement refer?
Illustration 4.7: CRH plc’s compliance with international accounting standards
Accounting Policies
(including key accounting estimates and assumptions)
Basis of Preparation
The Consolidated Financial Statements of CRH plc have been prepared in accordance
with International Financial Reporting Standards (IFRSs) as adopted by the European
Union, which comprise standards and interpretations approved by the International
Accounting Standards Board (IASB). IFRS as adopted by the European Union differ in
certain respects from IFRS as issued by the IASB. However, the Consolidated Financial
Statements for the financial years presented would be no different had IFRS as issued
by the IASB been applied. The Consolidated Financial Statements are also prepared in
compliance with the Companies Act 2014 and Article 4 of the EU IAS Regulation.
CRH plc also reports on its compliance with its corporate governance requirements under the UK
Corporate Governance Code, as shown in Illustration 4.8, the UK Corporate Governance Code
operates on a comply-or-explain basis. Companies are allowed not to comply with the Code on
condition that they provide an explanation of non-compliance. While CRH plc says it complies with
the Code, the commentary on the clawback provisions not applying to the Performance Share Plan
hints at an explanation for non-compliance.

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Illustration 4.8: CRH plc’s compliance with UK Corporate Governance Code
Governance
CRH implements the 2014 UK Corporate Governance Code (the “2014 Code”) and
complied with its provisions in 2015. A copy of the 2014 Code can be obtained from
the Financial Reporting Council’s website, www.frc.org.uk.
The 2014 Code introduced a new requirement to include provisions in incentive

plans that would enable a company to recover sums paid or withhold the payment of
any sum. The Remuneration Committee has included clawback and malus provisions
in the Annual Bonus Plan (see page 82 in the Directors’ Remuneration Report). For
the 2014 Performance Share Plan, awards are subject to malus during the three-year
performance period and during the additional two-year holding period following
performance assessment. Given that malus provisions apply for the combined five-
year vesting period from the date of award, the Remuneration Committee considers
that an additional clawback provision for Performance Share Plan awards is not
necessary and is satisfied that the Company’s arrangements are appropriate and
balanced in the context of the intent of the 2014 Code. This position will,
nevertheless, be kept under review.
Generally Accepted Accounting Principles (GAAP) / Accounting Conventions
Companies Act 2014
Paragraph 7, Section A “General rules”, Part II “General Rules and Formats”, Schedule 3 “Accounting
Principles, Form and Content of Entity Financial Statements”, of the Companies Act 2014 does not
permit set off between assets/expenditure and liabilities/income.
Paragraph 12 – 17, Section A “Accounting Principles”, Part III “Accounting Principles and Valuation
Rules”, Schedule 3 “Accounting Principles, Form and Content of Entity Financial Statements”,
Companies Act 2014 addresses six accounting principles as follows:
• Going concern
• Accounting policies to be applied consistently from year to year.
• Prudence
(i.e., Include only realised (see glossary) profit. Realised profit is defined by the Act (Section
276) as those profits which fall to be treated as realised in accordance with generally accepted
accounting principles).
• All income/charges should be taken into account without regard to the date of receipt/payment
• Assets and liabilities should be determined separately
• Substance over form.
Paragraph 80, Part VI “Interpretation of Certain Expressions in Schedule”, Schedule 3 “Accounting

Principles, Form and Content of Entity Financial Statements”, of the Companies Act 2014 on
materiality states: “Amounts which in the particular context of any provision of this Schedule are
not material may be disregarded for the purposes of that provision.”
Section 290 (1) of the Companies Act 2014 requires the directors of a company to prepare entity
financial statements for the company in respect of each financial year of it.
Paragraph 5 of Schedule 3 of the Companies Act 2014 requires for every item shown in the
balance sheet, or profit and loss account, or notes thereto, of a company, the corresponding
amount for the financial year immediately preceding that to which the balance sheet or profit and
loss account relates shall also be shown. If that corresponding amount is not comparable with the
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amount to be shown for the item in question in respect of the financial year to which the balance
sheet or profit and loss account relates, the former amount may be adjusted, and particulars of
the adjustment and the reasons therefor shall be given in a note to the financial statements.
IAS 1 Presentation of Financial Statements
Due to abuses of the prudence principle, this accounting principle has been dropped / demoted in
IAS 1.
IAS 1 requires observance of seven accounting principles which are described below.
Seven accounting principles (refer back to Section 3.9 of these notes)
(Irish legislation: No netting off (i.e., no offsetting of one amount against another [‘apples against
oranges’][netting off is not transparent]), Going Concern, Consistency Prudence, Accruals,
Classes of assets and liabilities determined separately, substance over form)
 () Financial statements are prepared on a going concern basis unless management either intends
to liquidate the entity or to cease trading, or has no realistic alternative but to do so.
 () Financial statements, except for cash flow information, are prepared using the accrual basis of
accounting.
 () The presentation and classification of items in the financial statements are usually retained from
one period to the next.
 () Each material class of similar items is presented separately. Dissimilar items are presented
separately unless they are immaterial. Omissions or misstatements of items are material if they
could, individually or collectively, influence the economic decisions of users taken on the basis
of the financial statements.
 () Assets and liabilities, and income and expenses, are not offset unless required or permitted by
an IFRS.
 Comparative information is disclosed for all amounts reported in the financial statements,
unless an IFRS requires or permits otherwise (this is a requirement of Paragraph 5, Schedule 3,
Companies Act 2014)
 Financial statements are presented at least annually (this is a requirement of Section
288(1) & (2), Companies Act 2014).
(1) Both in Irish company law and IAS 1     / 

(2) IAS 1 only  [ elsewhere in Irish company law: the requirement for prior year
comparatives are contained in Paragraph 5, Schedule 3 of the Companies Act 2014; Section 290 of
the Companies Act 2014 requires annual financial statements]
(3) Irish company law only (Prudence is not referred to in IAS 1. This concept was demoted by
the International Accounting Standards Board arising from abuses of prudence in the form of ‘big
bath’ accounting (see Section 6.1.4). Prudence may come back into vogue post the banking crisis.
Prudence had the effect of making accounting counter-cyclical. Its absence (following demotion)
led to pro-cyclical accounting which exacerbated the 2008 banking crisis); substance over form.
IAS 1 specifies the minimum line item disclosures on the face of, or in the notes to, the statement
of financial position, the income statement, statement of comprehensive income (see Section 8 of
these notes) and the statement of changes in equity (see section 9 of these notes).
Current and non-current assets, and current and non-current liabilities are presented as separate
classifications on the face of the statement of financial position.
IAS 1 specifies disclosures about information to be presented in the financial statements, including
judgements (e.g., methods chosen to account for certain transactions; classification of assets;
substance of transactions), key sources of estimation uncertainty (e.g., rate of depreciation, bad
debt provisions, provisions for inventory write down to net realisable value), and accounting
policies (see Illustration 4.9).

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CRH plc 2015 Q37: What key sources of estimation uncertainty does CRH identify in its annual
report?
Illustration 4.9: CRH plc’s key sources of estimation uncertainty
Accounting Policies (extract)
Key Accounting Policies which involve Estimates, Assumptions and Judgements

The preparation of the Consolidated Financial Statements in accordance with IFRS requires
management to make certain estimates, assumptions and judgements that affect the
application of accounting policies and the reported amounts of assets, liabilities, income and
expenses. Management believes that the estimates, assumptions and judgements upon which it
relies are reasonable based on the information available to it at the time that those estimates,
assumptions and judgements are made. In some cases, the accounting treatment of a particular
transaction is specifically dictated by IFRS and does not require management’s judgement in
its application.
Management consider that their use of estimates, assumptions and judgements in the
application of the Group’s accounting policies are inter-related and therefore discuss them
together below. The critical accounting policies which involve significant estimates,
assumptions or judgements, the actual outcome of which could have a material impact on the
Group’s results and financial position outlined below, are as follows:
(Source: CRH plc Annual Report 2015, p.137-138)

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5. IAS 1 Presentation of Financial Statements – Income statement
Section 5: IAS 1 Presentation of Financial Statements – Income statement

5.1 Illustrative income statements MCQ 5.1-5.2
Q10 Face of
Q11 Right headings – income statement
5.1 Illustrative income statements
The following illustrations of the structure of income statements are taken from the guidance on
implementing IAS 1.
Two income statements are provided in IAS 1, to illustrate the alternative classifications of income
and expenses:
(i) By function (called “operational format” in Irish legislation (Format 1, Schedule 3, Companies
Act 2014). This is the most common format applied in practice.
(ii) By nature (called “type of expenditure format” in Irish legislation (Format 2, Schedule 3,
Companies Act 2014).
Students are required to be able to apply the “by function” format. The “by nature” format is shown
below for noting only. (Strikethrough text relates to items that will not be covered in Financial
Accounting 2).
Example 5.1 reproduces the example of an income statement “by function” from IAS 1.

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Example 5.1: IAS 1 exemplar Income statement (1)

(illustrating classification of expenses “by function” (operational format))
20X7 20X6
€000 €000
Revenue Face  X X
Cost of sales (X) (X)
Gross profit X X
Other income X X
Distribution costs (X) (X)
Administrative expenses (X) (X)
Other expenses (X) (X)
Finance costs Face  (X) (X)
Share of profit of associates* Face  X X
Profit before tax X X
Income tax expense Face  (X) (X)
Profit for the year from continuing operations X X
Loss for the year from discontinued operations Face (X)
 (see Section 6 of these notes)
Profit for the year Face  X X
Attributable to:
- Owners of the parent Face  X X
- Non-controlling interest 4 Face  X X
X X
 to  = 8 items that must be disclosed on the face of the income statement
(Paragraph 81-82 of IAS 1 Presentation of Financial Statements)
*This means the share of associates’ profit attributable to equity holders of the
associates, i.e., it is after tax and minority interests in the associates.
Items crossed out are not covered in Financial Accounting 2, except as per
Section 4.2 of these notes
The caption/heading “Other income” includes operating income and non-operating income.
Operating items of income and expenditure are those revenues and expenses from the company’s
own operations.
Examples of non-operating income/expenditures include dividend income from investments,

profit on sale of shares in other companies, losses on value of investments, foreign exchange losses,
write down of assets.
Operating earnings can be defined as revenue after cost of goods sold, distribution costs,
administrative expenses, other operating costs, before interest and before taxes. Net profit before
interest and taxes is sometimes abbreviated to EBIT. Operating profit is the profit from core
operations of the business. In 2002, Standard & Poor’s (S&P) attempted without success to get
4 Non-controlling (‘minority’) interest arises when a parent or holding company does not own
100% of the subsidiary’s share capital (i.e., where the subsidiary is not wholly owned). The
percentage of share capital not owned by the parent or holding company is referred to as the non-
controlling (minority) interest. The accounts of the parent company and the subsidiary are added
together (thus, 100% of the subsidiary is included in the consolidated financial statements, even
where the parent or holding company does not own 100% of the subsidiary). The non-controlling
(minority) interest in the profit for the year and in the net assets is shown as a one-line adjustment
in the income statement and balance sheet respectively.
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agreement on a common understanding of the definition of operating earnings.
Example 5.2 reproduces the example of an income statement “by type of expenditure” from IAS 1.
Example 5.2: IAS 1 exemplar income statement (2)

(illustrating classification of expenses “by nature” (type-of-expenditure format))
20X2 20X1
€000 €000
Revenue X X
Other income X X
Changes in inventories of finished goods and work-in-progress (X) X
Work performed by the entity and capitalised X X
Raw material and consumables used (X) (X)
Employee benefits expense (X) (X)
Depreciation and amortisation expense (X) (X)
Impairment of property, plant and equipment* (X) (X)
Finance costs (X) (X)
Share of profit of associates X X
Income tax expense (X) (X)
Profit for the period X X
Attributable to:
- Owners of the parent X X
- Non-controlling interest X X
X X
*In an income statement in which expenses are classified by nature, an impairment of
property, plant and equipment is shown as a separate line item. By contrast, if expenses are
classified by function, the impairment is included in the function(s) to which it relates.
How can “by function” (operational format) and “by nature” (type-of-expenditure format) income
statements be distinguished? Example 5.3 compares the headings in each. For example, if you see
“Cost of sales”, it is definitely a “by function” (operational format) income statement. If you see
“Raw material and consumables used”, it is definitely a “by nature” (type-of-expenditure format)
income statement. The evidence may be on the face of the income statement or in the explanatory
notes to the income statement
Example 5.3: Comparing “by function” (operational format) and “by nature” (type-
of-expenditure format) income statements
“by function” (operational format) “by nature” (type-of-expenditure format)

Cost of sales Changes in inventories of finished goods and
work-in-progress
Gross profit Work performed by the entity and capitalised
Other income Raw material and consumables used
Distribution costs Employee benefits expense
Administrative expenses Depreciation and amortisation expense
Impairment of property, plant and equipment*
Example 5.4 re-presents the draft income statement in Example 1.13 following the requirements

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of IAS 1 Presentation of Financial Statements, in a form suitable for publication using the “by
function” presentation.
Q03: Re-present the income statement of Example Limited shown in Example 1.13 of these notes,
in a format that complies with IAS 1 Presenting Financial Statements
Example 5.4: Income statement in a form suitable for publication
Example Limited
Income statement
for the year ending 31 December 20X1
20X1 20X0
€000 €000
Revenue 5,000
Cost of sales (4,000)
Gross profit 1,000
Other income 200
Total profit 1,200
Distribution costs (250)
Administrative expenses (370)
Operating profit 580
Finance costs (50)
Profit before tax 530
Taxation Nil
Profit after tax 530
Illustration 5.1 reproduces CRH plc’s income statement.

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CRH plc 2015 Q38: Which of the two income statement formats does CRH adopt in its 2015
CRH plc 2015 Q39: Identify the eight items that must be disclosed on the face of the income
statement on CRH plc’s income statement in its 2015 financial statements?
CRH plc 2015 Q40: Identify five differences between the IAS 1 illustrative income statements and
CRH plc’s income statement in its 2015 financial statements?
Illustration 5.1: CRH plc’s income statement format

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6. Reporting financial performance
Section 6: Reporting financial performance

6.1 Accounting abuses in the past, present and future MCQ 6.1-6.7
6.1.1 Reserve accounting Q12 Partway
6.1.2 Extraordinary items Q13 Mario
6.1.3 Earnings management
6.1.4 Big bath accounting
6.1.5 Anticipating income
6.1.6 Deferring costs
6.1.7 Pro forma earnings
6.2 Exceptional items
6.2.1 FRS 3 Reporting Financial Performance
6.2.2 IAS 1 Presentation of Financial Statements
6.2.3 Exceptional items
6.2.4 Definition of material
6.2.5 Accounting for material items of income and expenditure
6.3 Continuing and discontinued operations
6.3.1 Classification of operation as discontinued
6.3.2 Presentation of discontinued operations
6.3.3 Comparative amounts
6.3.4 Summarising the accounting treatment of discontinued operations
6.4 Examples of treatment of discontinued operations in the income statement
6.1 Accounting abuses in the past, present and future
In the past, accounting abuses which have required regulators to take step in relation to income
statements. The following abuses were common:
(1) Reserve accounting
(2) Extraordinary items
(3) Earnings management
(4) Big bath accounting
(5) Recognising income too early
(6) Deferring recognition of expenses/costs
(7) Pro forma earnings
6.1.1 Reserve accounting
The statement of comprehensive income and the statement of changes in equity (see Section 9
of these notes) were introduced to stop the practice of reserve accounting. Reserve accounting
involves excluding certain revenues and expenses from the income statement and reporting them
as reserve movements (usually buried deeply in the notes, if in the notes at all). Reserves are
balances in the equity section of the balance sheet, other than the share capital and share
premium accounts. The (self-serving!) argument for this treatment was that unusual and non-
recurring transactions should be excluded from the income statement as they would distort the
results. As a result of such distortion, investors would find it difficult to make predictions about
the future performance and trends of the company. Investors are interested in the financial
statement for what they can tell about the future. Assumptions and predictions about the future
will assist investors in decision making - for example, whether to buy more shares, hold their
shares, or sell their shares). This is one of the worse abuses of accounting which standard setters
have been working hard and successfully to eradicate.
Reserve accounting (the bad old way of accounting for some of these transactions – transactions
dealt with directly in reserves) is not always transparent. (i) IAS 1 requires all recognised gains
and losses to be shown in the income statement (comprehensive [“one-stop-shop”] income
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statement approach) (see Section 8 of these notes). (ii) IAS 1 requires changes in equity to be
explained/reconciled in a statement of changes in equity (see Section 9 of these notes).
6.1.2 Extraordinary and exceptional items
Reserve accounting was abolished by Statement of Standard Accounting Practice (SSAP) 6

Extraordinary Items and Prior Year Adjustments in 1974. SSAP 6 introduced two new concepts:
Extraordinary items and exceptional items.
Extraordinary items were defined as gains or losses that were material, non-recurring and
outside the normal course of business.
Exceptional items were defined as gains or losses that were material and non-recurring.
Both extraordinary and exceptional items were disclosed separately on the face of the income
statement. This allowed investors to exclude these items when predicting trends, etc.
Extraordinary items and exceptional items were treated differently in the calculating of earnings
per share. Extraordinary items were excluded from earnings per share; Exceptional items were
included in earnings per share. As a result, many once-off material losses were categorised as
extraordinary (and were thus excluded from earnings per share allowing a higher earnings per
share to be reported), and may once-off material profits were categorised as exceptional (and were
thus included in earnings per share also allowing a higher earnings per share to be reported).
In relation to the definition of extraordinary items, what does “outside the ordinary course of
business” mean? Very good question! Whatever you want it to mean? Thus, extraordinary items
no longer exist (see Section 6.2) because of the abuse by companies in the past, possibly arising
from the vagueness of the definition.
Former KPMG partner, UK Accounting Standard Board (ASB) chairman 1990-2000 and
International Accounting Standards Board (IASB) chairman 2001-2011, Sir David Tweedie, makes
some interesting observations on the application of accounting standards in practice in Example
6.1. Sir David is a Scots man. The Forth Bridge referred to in Example 6.1 is the longest bridge in
Scotland.
Example 6.1: A perspective on the application of accounting standards
"David Tweedie himself in his more candid moments confesses that his job is a bit like
painting the Forth Bridge. Once it is finished you start all over again. He realised that
whatever rules you put in place, smart people will find a way to express a distorted or
flattering picture of their performance".
(Source: Smith, Terry (1996) Accounting for Growth, Second Edition, Century Business, p.
10)

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6.1.3 Earnings management
Motives
Earnings may be managed to:

• Increase the share price before issuing more shares (to get maximum cash issuing minimum
number of shares)
• Decrease the share price before managers are awarded stock options (keep the option price as
low as possible)
• Increase the share price before managers exercise stock options (ensure managers are “in the
money” to the maximum possible extent)
• Meet market expectations / analysts’ forecasts about earnings
• Avoid reporting decreasing earnings from the prior year
• Avoid reporting a loss
• Project a smooth earnings pattern (income smoothing), portraying a smoother pattern of
profits, implying greater stability and less risk, resulting in higher share prices.
Under/overstate income
Profits reported in the income statement can be managed by recognising gains and losses early or
late, either bringing them into this year’s income statement, or pushing them forward into next
year. In a bank, for example, the subject estimated provision for bad debts can be robust
(recognising a lot of cost in the current financial statements) or less prudent (pushing out the cost
to future accounting periods). The widespread practice of earnings management has eroded the
quality of earnings.
Earnings management versus income manipulation
It is only a short step between earnings management (the legitimate exercise of judgement) and
earnings manipulation or fraudulent financial reporting.
A distinction is made in the academic literature between real earnings management versus
artificial earnings management. Real earnings management is executed using, for example, by
accelerating the timing of sales using price discounts. This would amount to earnings management.
Artificial (or opportunistic) earnings management, on the other hand, is executed using, for
example, discretionary accruals. Examples of discretionary accruals include inventory write-
downs, bad debt write-downs, bad debt provisions, other expense provisions. This would amount
to income manipulation.
6.1.4 Big bath accounting
Big bath accounting involves making huge provisions, resulting in large debits/charges to the
profit and loss account. If this happens, for example, on a change in CEO, the departing CEO can be
blamed for the hit. The excessive provision can be used as a war chest in the future by the incoming
CEO to smooth earnings and to meet analysts’ forecasts if the income is insufficient to do so. This
excessively prudent practice resulted in the demotion of the accounting concept of prudence by
the International Accounting Standards Board. Thus, nowadays, companies are constrained from
being overly prudent. The demotion of prudence resulted in banks not being able to make large
provisions for bad debts, As a result, accounting became pro-cyclical rather than counter-cyclical,
leading to a harder global financial crash than might otherwise have been. A countercyclical fiscal
policy refers to the opposite approach: reducing spending and raising taxes during a boom
economic cycle, and increasing spending/cutting taxes during a recession. This theme will be
revisited in Section 13 of the module notes when IAS 37 Provisions, Contingent Assets and
Contingent Liabilities will be discussed.

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6.1.5 Anticipating income
The most common form of fraudulent financial reporting is recognising income too soon, before
the income is earned (which is a subjective judgement in many cases). For this reason, IAS 18
Revenue Recognition provides guidance on when to recognise income (to be covered in Financial
Reporting 3).
6.1.6 Deferring costs/delaying recognition of costs/expenses in the income statement
Some companies (notably Worldcom) treat as assets in the statement of financial position
transactions that should be treated as expenses in the income statement. If assets with no value
are capitalised (i.e., recorded in the balance sheet) as assets, they are fictitious assets. The fiction
is that they have a future value when in fact they do not.
6.1.7 Pro forma earnings
Companies may prepare pro forma (notional) income statements, and report pro forma earnings.
These pro forma earnings are not audited, as they do not appear in the audited income statement.
This practice has been referred to as “earnings without the bad stuff” (Young, 2005).
Illustration 6.1 shows a pro forma or non-GAAP (Generally Accepted Accounting Principles)
earnings number disclosed by CRH plc. One earnings number disclosed is Earnings Before
Interest, Tax, Depreciation and Amortisation (EBITDA). From a CEO’s perspective, this number is
handy if things go wrong. If their compensation is based on EBITDA (“earnings without the bad
stuff” – Young (2005)), it won’t affect his [sic!] compensation. How many metrics on which CEO
compensation is based are non-GAAP “funny” numbers?
CRH plc 2015 Q41: Identify an unaudited performance number in CRH plc’s 2015 financial
statements?

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Illustration 6.1: CRH plc’s unaudited performance numbers
UK retailer, J Sainsbury plc, uses the term “underlying” over 200 times in its 2018 financial
statements, mainly in the unregulated management commentary sections of the annual report.
Readers must go to Note 3 on page 104 in the annual report to find out what this means. As a result,
Sainsbury reports two profit numbers: (i) the audited profit before tax amount of £409 million
appearing on the face of the income statement (p. 94) and (ii) the ‘underlying’ profit amount of
£589 million (p. 104 – see Illustration 6.2). This could be confusing for shareholders. The
underlying profit number is higher than the audited profit before tax number. Which number
should they rely on – the audited profit before tax or the ‘underlying’ profit number?

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Illustration 6.2: “Underlying” results
(Source: J Sainsbury plc Annual report 2018, p. 104)

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6.2 Exceptional and extraordinary items
Sections 6.1.1. and 6.1.2 describe the accounting treatment of once-off transactions by means of (i)
reserve accounting and (ii) as extraordinary items following Statement of Standard Accounting
Practice (SSAP) 6 Extraordinary Items and Prior Year Adjustments. This section continues the story,
showing how standard setters have tried to improve accounting for once-off items.
6.2.1 FRS 3 Reporting Financial Performance
The accounting treatment of exceptional and extraordinary items was tightened up in FRS 3
Reporting Financial Performance (UK/Irish Generally Accepted Accounting Principles (GAAP)).
Extraordinary items were defined out of existence. Items previously classified as extraordinary
items now required to be treated as exceptional items.
FRS 3 also restricts the exceptional items to be shown on the face of the profit and loss account as
separate items (restricted to three items) with the rest shown in notes to the financial statement,
unless so material as to justify separate disclosure on the face of the profit and loss account.
All realised 5 gains and losses to be shown in the income statement.
6.2.2 International Accounting Standard 1 (IAS 1) Presentation of Financial Statements
International Accounting Standard 1 (IAS 1) Presentation of Financial Statements requires full

disclosure of changes in equity (reserves) and divides that disclosure between the income
statement, statement of comprehensive income (see Section 8 of these notes) and the statement of
changes in equity (see Section 9 of these notes).
Specific rules are set out about what can or must be shown separately on the face of the income
statement and there are rules about income recognition.
The basic rule is that all revenue/expense and (recognised) gains/losses (whether realised or not)
go into the income statement or the statement of comprehensive income (see Section 8 of these
notes), unless a specific, stated rule in a standard places the item in the statement of changes in
equity. Example of exceptions to the basic rules include: Gains/losses foreign currency translation
differences; Gains/losses on Revaluations.
6.2.3 Material items of income and expenditure (Exceptional items)
Under IAS 1 Presentation of Financial Statements, material items of income and expenditure
[formerly called “exceptional items”] should be disclosed separately to aid the reader’s
comprehension of separate components of income and expenditure. This can be done (i) on the
face of the income statement or (ii) in the notes. If shown on the face of the income statement,
material items of income and expenditure (other than discontinued operations which has its own
accounting standard and unique accounting treatment) should be shown as separate one-line
items within operating profit, after distribution costs and administrative expenses, and before
finance costs.
The nature and amount of material items of income and expense should be disclosed. These are (in
effect) exceptional items although not called as such. Extraordinary items are prohibited in the
2003 revision of IAS 1.
5 Realised gains are those received in the form of cash, or another asset the ultimate cash
realisation of which is known with reasonable certainty, (e.g., trade receivables/debtors).
131
IAS 1 suggests that the following specific items (if material) may be shown on the face of the income
statement (i.e., exceptional items);
• Write-downs of inventories to net realisable value, as well as reversals of such write-downs

• Write-downs of property, plant and equipment to recoverable amount, as well as reversals of
such write-downs (Impairment of property, plant and equipment is covered in Section 11b)
• Restructuring of the activities of an entity and reversals of any provisions for the costs of
restructuring;
• Profits and losses on the disposals of items of property, plant and equipment
• Profits and losses on the disposals of investments
• Profit or loss on discontinued operations (see Section 6.3)
• Litigation settlements
• Other reversals of provisions.
6.2.4 Definition of material
IAS 1 provides guidance on what is material.

• Omissions or misstatements of items are material if they could, individually or collectively,
• Materiality depends on the size and nature of the omissions and misstatement judged in the
surrounding circumstances.
• The size or nature of the item, or a combination of both, could be the determining factor.
• Users are assumed to have reasonable knowledge of business and economic activities and
accounting and a willingness to study the information with reasonable diligence.
Illustration 6.3 (see also Illustration 3.3) reveals the quantitative amount applied by way of
materiality in the audit of CRH (See also Example 3.4 and Example 3.5 for insights on materiality).
CRH plc 2015 Q42: What is the level of materiality applied in the audit of CRH plc’s financial statements?

132
Illustration 6.3: CRH plc’s materiality levels applied in the audit

Our application of materiality
We apply the concept of materiality in planning and performing the audit, in evaluating
the effect of identified misstatements on the audit and in forming our audit opinion.
Materiality
We determined materiality for the Group to be €50 million (2014: €36 million), which
is approximately 5% (2014: 5%) of profit before tax. Profit before tax is a key
performance indicator for the Group and is also a key metric used by the Group in the
assessment of the performance of management. We therefore considered profit before
tax to be the most appropriate performance metric on which to base our materiality
calculation as we consider it to be the most relevant performance measure to the
stakeholders of the Group.
Performance materiality
On the basis of our risk assessments, together with our assessment of the Group’s overall
control environment, our judgement was that performance materiality should be set at
50% (2014: 50%) of our planning materiality, namely €25 million (2014: €18 million).
We have set performance materiality at this percentage due to our past experience of the
risk of misstatements, both corrected and uncorrected.
Audit work at component locations for the purpose of obtaining audit coverage over
significant financial statement accounts is undertaken based on a percentage of total
performance materiality. The performance materiality set for each component is based
on the relative scale and risk of the component to the Group as a whole and our
assessment of the risk of misstatement at that component. In the current year, the range
of performance materiality allocated to components was €4.1 million to €13 million
(2014: €3.6 million to €11 million).
Reporting threshold
We agreed with the Audit Committee that we would report to them all uncorrected audit
differences in excess of €2.1 million (2014: €1.8 million), which is set at approximately
5% of planning materiality, as well as differences below that threshold that, in our view,
warranted reporting on qualitative grounds.
We evaluate any uncorrected misstatements against both the quantitative measures of

materiality discussed above and in light of other relevant qualitative considerations in
forming our opinion.
6.2.5 Accounting for material items of income and expenditure
Material items of income and expenditure (i.e., exceptional items) are accounted for as follows:
• Shown on a separate line
• On the face of the income statement
• After Distribution Costs and Administrative Expenses, before Finance costs
• See CRH plc income statement for an example of a material item of income and expenditure
(i.e., exceptional item)(Section 5.1)
• Except for the material item of income and expenditure (i.e., exceptional item), Discontinued
Operations, which are accounted for as set out in Section 6.3.

133
6.3 Continuing and discontinued operations
It is important for investors to be informed of discontinued operations. For this reason, separate
disclosure is required of discontinued operations in the income statement and in the notes to the
financial statements. The income statement must clearly distinguish between continuing
operations and discontinued operations.
Large companies usually consist of a number of subsidiary operations or divisions. Companies

often buy, sell or close these down, as the needs of their strategy dictate. Discontinued operations
are operations which an entity has disposed of or contracted to dispose of, at the balance sheet
date. It is desirable to separate these from continuing activities in the income statement as the
continuing activities show the future profit potential of the entity, while the discontinued are no
longer relevant. IFRS 5 Non-current assets held for sale and discontinued operations requires that a
separate, net figure is shown for the results of discontinued operations. An individual income
statement should be shown separately for the discontinued operations, either on the face of the
income statement or in the notes.
6.3.1 Classification of operation as discontinued
Activities are treated as discontinued, only if arrangements for discontinuance (e.g., disposal) have
begun before the year end. This is not something that can occur after the year end.
6.3.2 Presentation of discontinued operations
In circumstances where there are discontinued operations, under IFRS 5 Non-current assets held
for sale and discontinued operations certain disclosures must be shown in the income statement as
illustrated in Example 6.2.

134
Example 6.2: Income statement including a discontinued operation
Continuing operations
Revenue
Cost of sales
Gross profit
Other income
Distribution costs
Finance costs
Share of income/ loss of joint ventures and associates
Profit before taxation
Income tax expense
Profit after tax
Discontinued operations
Post tax profit/ loss of discontinued operations and disposal profits/ losses
of the discontinued operation
Profit or loss
Division of profit or loss between the parent company shareholders and minority
shareholders.
Earnings per share data with comparatives (see section further on dealing with this
topic).
 + A note to the financial statements containing the detailed income statement for the
discontinued operations (the total in this note has to match amount in income statement
for discontinued operations).
Key:
=Heading distinguishing continuing operations
=Heading distinguishing discontinuing operations
=One line “material item of income or expenditure” (i.e., exceptional item)
=Cross reference to a note in the financial statements
=Note in the financial statements to the one line “material item of income or
expenditure”
6.3.3 Comparative amounts
Comparative figures are adjusted for the operations being disposed of THIS year. Items are
reclassified in the income statement every year in the light of disposals made or being made this
year. Thus, the comparative amounts will in total match the amounts disclosed in the previous
year’s financial statements, their categorisation between continuing operations and discontinued
operations will change.
Example 6.3 shows how comparative amounts are affected by discontinued operations.

135
Example 6.3: Categorisation of continuing and discontinued operations
Holding company (i.r, Parent) and Subsidiary H plc S Ltd Income statement 20X5
€m €m €m
Revenue 1,000 100 1,100
Cost of sales (600) (60) (660)
Gross profit 400 40 440
Other income 20 2 22
Distribution costs (100) (10) (110)
Administrative expenses (150) (15) (165)
Profit before taxation 170 17 187
Income tax expense (30) (3) (33)
Profit after taxation 140 14 154
S Ltd was sold in 20X6.
Question
You are required to show the comparative amounts that would appear for 20X5 in the 20X6
financial statements of H plc
Solution
20X6 20X5
Continuing operations €m €m
Revenue X 1,000
Cost of sales (X) (600)
Gross profit X 400
Other income X 20
Distribution costs (X) (100)
Administrative expenses (X) (150)
Profit before taxation X 170
Income tax expense (X) (30)
Profit after taxation X 140
Operating result and profit/loss on disposal of Note X X 14
discontinued operations
Profit for period attributable to equity holders X 154
Note X: Operating result and loss on disposal of discontinued operations

20X6 20X5
Operating result €m €m
Revenue X 100
Cost of sales (X) (60)
Gross profit X 40
Other income X 2
Distribution costs (X) (10)
Administrative expenses (X) (15)
Profit before taxation X 17
Income tax expense (X) (3)
Profit after taxation X 14
Profit after taxation X 14
Profit on disposal of discontinued operations X Nil
X 14
Key:  to = Six steps in recording a discontinued operation, as summarised in Section 6.3.4
 &  = Components of the one line dealing with discontinued operations

136
In relation to Example 6.3:
1. How many material items of income and expenditure (i.e., exceptional items) are shown in the income
statement?
2. What was the profit from continuing operations for 20X5 as shown in the 20X6 financial statements?
3. What was the profit from discontinued operations for 20X5 as shown in the 20X6 financial statements?
4. What are the amounts for the two components of discontinued operations for 20X5?
5. What was the total profit for 20X5?
6.3.4 Summarising the accounting treatment of discontinued operations
 Identify continuing operations in the income statement

 Identify discontinued operations in the income statement
 Show discontinued operations in the income statement at one amount comprising
 Post tax profit/ loss of discontinued operations and disposal profits/losses of the discontinued
operation
 Include a note to the financial statements providing the breakdown of  above
 Re-calculate the comparatives.
6.4 Examples of treatment of discontinued operations in the income statement
In Example 6.4, the discontinued operation is shown as a single line item in the income statement,
with full details of the discontinued operation in a note to the financial statements.

137
Example 6.4: Presentation and disclosure of continuing and

discontinued operations
ALF plc
Income statement for year ended 31 December 20X5
20X5 20X4
€m €m
Continuing operations
Revenue 650 550
Cost of sales (460) (445)
Gross profit 190 105
Distribution costs (50) (40)
Administrative expenses (54) (43)
Profit on disposal of properties in continuing operations 9 6
Profit before interest and taxation 95 28
Finance costs (18) (15)
Profit before taxation 77 13
Income tax expense (14) (4)
Profit after taxation 63 9
Operating result and loss on disposal of (17) (20)
discontinued operations (Note 27) 
Profit 46 (11)
Attributable to:
Owners of the parent 38 (9)
Non-controlling (minority) interest 6 8 (2)
46 (11)
Basic earnings per share 3c (1)c
Note 27 Operating result and loss on disposal of discontinued operations

20X5 20X4
Operating result from discontinued operations €m €m
Revenue 150 142
Cost of sales (140) (130)
Gross profit 10 12
Distribution costs (31) (20)
Administrative expenses (21) (20)
Finance revenues 2 3
(Loss) before taxation (39) (25)
Income tax saving 12 5
(Loss) after taxation  (27) (20)
Profit on disposal of discontinued operations  10 -
(17) (20)
Basic earnings per share - discontinued operations (2)c (2)c

Key:
 to = Six steps in recording a discontinued operation, as summarised in
Section 6.3.4
 &  = Components of the one line dealing with discontinued operations
6 Non-controlling (i.e., minority) interest arises when a parent or holding company does not own
138
In relation to Example 6.4 above:
1. How many material items of income and expenditure (i.e., exceptional items) are shown in the income
statement?
2. What was the profit/loss from continuing operations for 20X5?
3. What was the amount for discontinued operations for 20X5?
4. What are the amounts for the two components of discontinued operations for 20X5?
5. What was the total profit for 20X5?
6. Was the decision to discontinue operations in ALF plc commercially wise?
6.5 Comparing accounting treatment of discontinued operations and other material items
of income and expenditure
Table 6.1 compares the accounting treatment of discontinued operations with that for other
material items of income and expenditure.
Table 6.1: Discontinued operations and other material items of income and expenditure
“Normal” Discontinued
exceptional operations
items
Separate line in income statement  
After: Distribution costs, Administrative Expenses 
After: Profit after taxation 
139
7. IAS 1 Presentation of Financial Statements – Statement of financial position
Section 7: IAS 1 Presentation of Financial Statements – Statement of financial position and notes to the
financial statements

7.1 Illustrative statement of financial position MCQ 7.1-7.5
7.2 Notes to the financial statements Q14 Right headings – statement of financial position
7.3 Disclosure of accounting policies Q15 Hose Tab plc
7.3.1 Key sources of estimation uncertainty Q16 Golding plc
7.3.2 Other disclosures
7.1 Illustrative statement of financial position
The (edited) illustrative statement of financial position shows one way in which a balance sheet
distinguishing between current and non-current items may be presented. Other formats may be
equally appropriate, provided the distinction is clear. (Strikethrough text relates to items that will
not be covered in Financial Accounting 2).
Example 7.1 reproduces the example of a statement of financial position from IAS 1.
Note that trade receivables are a separate line item from other current assets. Conversely, trade
and other payables are combined into one-line item.
Note that there are 13 captions (headings) in the balance sheet (items in bold capitals and in bold).
“Equity instruments” (in non-current assets) are equity/ordinary shares. “Short term borrowings”
(in current liabilities) refer to bank overdrafts. The “current portion of long-term borrowings”
refer to the amount of the borrowings repayable within one year (e.g., three-year loan: one-third
goes into current liabilities and two-thirds is classified as long-term liabilities). Current tax payable
refers to the company’s own tax, i.e., its corporate tax. Taxes collected by the company from other
tax payers, such as pay-as-you-earn (PAYE) from employees or value added tax (VAT) from
customers is classified as “other payables”.

140
Example 7.1: Statement of financial position in form suitable for publication
Statement of financial position as at 31 December 20X7

20X7 20X6
€000 €000
ASSETS
Non-current assets
Property, plant and equipment X X
Goodwill X X
Other intangible assets X X
Investments in associates X X
Investments in equity instruments (i.e., financial assets) X X
X X
Current assets
Inventories X X
Trade receivables X X
Other current assets X X
Cash and cash equivalents X X
X X
Total assets X X
Equity attributable to owners of the parent
Share capital X X
Retained earnings X X
Other components of equity X X
Total equity X X
Long-term borrowings X X
Deferred tax X X
Long-term provisions X X
Total non-current liabilities X X
Current liabilities
Trade and other payables X X
Short-term borrowings X X
Current portion of long-term borrowings X X
Current tax payable X X
Short-term provisions X X
Total current liabilities X X
Total liabilities X X
Total equity and liabilities X X
Example 7.2 re-presents the draft balance sheet in Example 1.11 in a form suitable for publication
following the requirements of IAS 1 Presentation of Financial Statements.
Q04: Re-present the balance sheet of Example Limited shown in Example 1.11 in these notes, in a
format that complies with IAS 1 Presenting Financial Statements

141
Example 7.2: Balance sheet in a form suitable for publication
Example Limited
Statement of financial position at 31 December 20X1
20X1 20X0
€000 €000
ASSETS
Non-current assets
Property, Plant and Equipment 4,375 3,950
Current Assets
Inventories 1,000 500
Trade receivables 1,230 1,200
Bank and cash 340 890
2,570 2,590
Total assets 6,945 6,540
Equity attributable to equity holders of the parent
Equity share capital 3,000 3,000
Retained earnings 995 1,090
Total equity 3,995 4,090
Bank term loan 1,000 1,000
Total non-current liabilities 1,000 1,000
Current liabilities
Trade payables 850 780
Current income tax liabilities 500 670
Bank overdraft 600 -
Total current liabilities 1,950 1,450
Total equity and liabilities 6,945 6,540
Illustration 7.1 reproduces CRH plc’s balance sheet.
CRH plc 2015 Q43: Identify five differences between the IAS 1 illustrative balance sheet and CRH
plc’s balance sheet in its 2015 financial statements?

142
Illustration 7.1: CRH plc’s balance sheet and IAS 1 Presentation of Financial Statements

143
IAS 1 requires the following items to be presented on the face of the statement of financial
position ( = included /  = not included in IAS 1 illustrative statement of financial position).
(Strikethrough text relates to items that will not be covered in Financial Accounting 2).
1. Property plant and equipment
2. Investment property
3. Intangible assets
4. Investments in equity instruments (i.e., Financial assets) 
5. Investments under equity method of accounting (see Section 4.2 of these notes)
6. Biological assets
7. Inventories
8. Trade and other receivables
9. Cash and cash equivalents
10. Assets classified as held for sale and included in disposal groups
11. Trade and other payables
12. Provisions
13. Financial liabilities
14. Liabilities and assets for current tax
15. Deferred tax liabilities and assets
16. Liabilities included in disposal groups classified as held for sale
17. Non-controlling interest (i.e., Minority interest) 7
18. Issued capital and reserves
Key: Items with a strike through are not covered in Financial Accounting 2, other than as per
Section 4.2 of these notes.
7.2 Notes to the financial statements
The notes shall:

(a) present information about the basis of preparation of the financial statements (see
Illustration 7.2)
(b) the specific accounting policies used [Accounting policies are the specific principles, bases,
conventions, rules and practices applied by an entity to account in preparing and presenting
financial statements];
(c) disclose the information required by IFRSs that is not presented on the face of the statement
of financial position, income statement, statement of changes in equity (see section 9 of these
notes) or cash flow statement; and
(d) provide additional information that is not presented on the face of the statement of financial
position, income statement, statement of changes in equity (see section 9 of these notes) or
cash flow statement, but is relevant to an understanding of any of them. [Notes to the financial
statements provide additional explanatory information and disclosures on items appearing
in the financial statements].
CRH plc 2015 Q44: What is the basis of preparation of CRH plc’s 2015 financial statements?
7 Non-controlling or minority interest arises when a parent or holding company does not own
controlling (minority)interest. The accounts of the parent company and the subsidiary are added
144
Illustration 7.2: CRH plc’s basis of preparation
Accounting Policies
The Consolidated Financial Statements of CRH plc have been prepared in accordance
with International Financial Reporting Standards (IFRSs) as adopted by the
European Union, which comprise standards and interpretations approved by the
International Accounting Standards Board (IASB). IFRS as adopted by the European
Union differ in certain respects from IFRS as issued by the IASB. However, the
Consolidated Financial Statements for the financial years presented would be no
different had IFRS as issued by the IASB been applied. The Consolidated Financial
Statements are also prepared in compliance with the Companies Act 2014 and
Article 4 of the EU IAS Regulation.
Notes shall, as far as practicable, be presented in a systematic manner. Each item on the face of the
statement of financial position, income statement, statement of changes in equity (see Section 9 of
these notes) and cash flow statement shall be cross-referenced to any related information in the
notes.
Notes are normally presented in the following order, which assists users in understanding the
financial statements and comparing them with financial statements of other entities:
(a) a statement of compliance with IFRSs (see Illustration 7.3)
(b) a summary of significant accounting policies applied;
(c) supporting information for items presented on the face of the statement of financial position,
income statement, statement of changes in equity (see section 9 of these notes) and cash flow
statement, in the order in which each statement and each line item is presented; and
(d) other disclosures, including:
(i) contingent liabilities 8 (see IAS 37 Provisions, Contingent Liabilities and Contingent Assets
in sections 12, 13 and 14 of these notes) (see Illustration 7.4) and “unrecognised” 9
contractual commitments (see Illustration 7.5); and
(ii) non-financial disclosures (see Illustration 7.6), e.g., the entity’s financial risk
management objectives and policies (see IAS 32).
CRH plc 2015 Q45: What does CRH plc’s 2015 statement of compliance say?
8 Contingent liabilities are those that are dependent on the outcome of some future event, e.g.,
outcome of a court case, guarantor for a loan (only called up if borrower defaults on loan).
9 “Unrecognised” means not recorded in the nominal ledger accounts by means of double entry,
i.e., not recorded in the income statement or balance sheet.

145
Illustration 7.3: CRH plc’s Statement of compliance
Accounting Policies
The Consolidated Financial Statements of CRH plc have been prepared in accordance with
International Financial Reporting Standards (IFRSs) as adopted by the European Union, which
comprise standards and interpretations approved by the International Accounting Standards Board
(IASB). IFRS as adopted by the European Union differ in certain respects from IFRS as issued by the
IASB. However, the Consolidated Financial Statements for the financial years presented would be no
different had IFRS as issued by the IASB been applied. The Consolidated Financial Statements are
also prepared in compliance with the Companies Act 2014 and Article 4 of the EU IAS Regulation.
CRH plc 2014 Q46: What does CRH disclose in its 2014 financial statements for contingent
liabilities?
Following Illustration 7.4, relating to the Competition Commission in Switzerland fining CRH plc
for breaches of competition law, in July 2015 the Swiss Commission ultimately announced fines of
CHF 34 million (approximately €32 million) on CRH plc.
Illustration 7.4: CRH plc’s contingent liabilities
32. Contingent Liabilities

On 30 May 2014 CRH announced that the secretariat of the Competition Commission in Switzerland had
invited CRH plc’s Swiss subsidiaries BR Bauhandel AG, Gétaz-Miauton SA and Regusci Reco SA, to comment
on a proposal to impose sanctions on the Association of Swiss Wholesalers of the Sanitary Industry and all
other major Swiss wholesalers, including CRH plc’s subsidiaries, regarding the pending investigation into
the sanitary (bathroom fixtures and fittings) industry in Switzerland. The secretariat alleges competition
law infringements and proposes a total fine of approximately CHF 283 million on all parties, of which
approximately CHF 119 million (€99 million) is attributable to CRH plc’s Swiss subsidiaries, based on Swiss
turnover.
CRH believes that the position of the secretariat is fundamentally ill-founded and views the proposed fine as
unjustified. The Group has made submissions to this effect to the Competition Commission. Any decision of
the Competition Commission on this matter is not expected before April 2015. Any decision finding an
infringement can be appealed to the Federal Administrative Tribunal, and ultimately to the Federal Supreme
Court. No provision has been made in respect of this proposed fine in the 2014 Consolidated Financial
Statements.
Swiss Competition Commission Investigation

In July 2015, the Swiss Competition Commission (“ComCo”) announced its decision to impose fines of
approximately CHF 80 million on the Association of Swiss Wholesalers of the Sanitary Industry (the
“Association”) and on major Swiss wholesalers including certain subsidiaries of CRH in Switzerland. The full
decision of ComCo, setting out the basis of its findings, is expected to be available in March 2016 at which
time CRH has the option to appeal the decision to the Federal Administrative Tribunal, and ultimately to the
Federal Supreme Court. While the Group is of the view that the position of ComCo is fundamentally ill-
founded and that the fine imposed on CRH is unjustified, a provision of €32 million (CHF 34 million),
representing the full amount of the fine attributed to the Group’s subsidiaries, has been recorded in the
2015 Consolidated Financial Statements.

146
CRH plc 2015 Q47: What does CRH disclose in its 2015 financial statements for “unrecognised”
contractual commitments?
Illustration 7.5: CRH plc’s unrecognised contractual commitments
13. Property, Plant and Equipment (extract)
CRH plc 2015 Q48: What does CRH disclose in its 2015 financial statements for non-financial
disclosures, e.g., the entity’s financial risk management objectives and policies?
Illustration 7.6: CRH plc’s non-financial disclosures
Principal Risks and Uncertainties

Under Section 327(1)(b) of the Companies Act 2014 and Regulation 5(4)(c)(ii) of the
Transparency (Directive 2004/109/EC) Regulations 2007, the Group is required to give a
description of the principal risks and uncertainties which it faces. These risks and
uncertainties reflect the international scope of the Group’s operations and the Group’s
decentralised structure.
Et cetera
In scoping out their audit coverage precisely, CRH plcs’ auditors conveniently identify the
number of notes to CRH plc’s financial statements in Illustration 7.7. The topics for each of CRH
plcs’ notes are summarised in Table 7.1.
CRH plc 2015 Q49a: How many notes to its financial statements does CRH disclose in its 2015
CRH plc 2015 Q49b: What are the notes to CRH plc’s 2015 financial statements?
Illustration 7.7: CRH plc’s notes to the financial statements
What we have audited

CRH plc’s financial statements comprise:
Group Company
Consolidated Income Statement for the year ended 31 December 2015 Balance Sheet as at 31 December 2015
Consolidated Statement of Comprehensive Income for the year then ended Statement of Changes in Equity for the year then ended
Consolidated Balance Sheet as at 31 December 2015 Statement of Cash Flows for the year then ended
Consolidated Statement of Changes in Equity for the year then ended Related notes 1 to 14 to the Company Financial Statements
Consolidated Statement of Cash Flows for the year then ended
Related notes 1 to 33 to the Consolidated Financial Statements

147
Table 7.1: Notes to CRH plc’s 2015 financial statements
Notes Note to the financial statements

1 Segment information
2 Costs analysis
3 Operating profit disclosures
4 Business and non-current asset disposals
5 Employment
6 Directors’ emoluments and interest
7 Share-based payment expense
8 Finance costs and finance revenue
9 Share of equity accounted investments’ profits
10 Income tax expense
11 Dividends
12 Earnings per ordinary share
13 Property plant and equipment
14 Intangible assets
15 Financial assets
16 Inventories
17 Trade and other receivables
18 Trade and other payables
19 Movements in working capital and provisions for liabilities
20 Analysis of net debt
21 Capital and financial risk management
22 Cash and cash equivalents
23 Interest-bearing loans and borrowings
24 Derivative financial instruments
25 Provision for liabilities
26 Deferred income tax
27 Retirement benefit obligations
28 Share capital and Reserves
29 Commitments under operating and finance leases
30 Business combinations
31 Non-controlling interests
32 Related party transactions
33 Board approval

148
7.3 Disclosure of accounting policies
An entity shall disclose in the summary of significant accounting policies:

(a) the measurement basis (or bases) used in preparing the financial statements; and
(b) the other accounting policies used that are relevant to an understanding of the financial
statements.
It is important for users to be informed of the measurement basis or bases used in the financial
statements (for example, historical cost, current cost, net realisable value, fair value or recoverable
amount) because the basis on which the financial statements are prepared significantly affects
their analysis. When more than one measurement basis is used in the financial statements, for
example when particular classes of assets are revalued, it is sufficient to provide an indication of
the categories of assets and liabilities to which each measurement basis is applied.
An entity shall disclose, in the summary of significant accounting policies or other notes, the
judgements, apart from those involving estimations management has made in the process of
applying the entity’s accounting policies that have the most significant effect on the amounts
recognised in the financial statements.
An accounting policy may be significant for some companies but not others. For example, the bad
debt accounting policy is not significant for most companies and is therefore usually not disclosed
in the list of significant accounting policies. An exception is financial institutions, were bad debts
are one of their largest costs.
The topics for each of CRH plc’s accounting policies are summarised in Table 7.2.

149
CRH plc 2015 Q50a: How many accounting policies does CRH disclose in its 2015 financial
statements?
CRH plc 2015 Q50b: What are the accounting policies in CRH plc’s 2014 financial statements?
Table 7.2: Accounting policy notes to CRH plc’s 2015 financial statements
Notes Accounting policy notes

1 Basis of preparation
2 Adoption of IFRSs and Adoption of IFRS and International Financial Reporting
Interpretations Committee (IFRIC) interpretations
3 Key Accounting Policies which involve Estimates, Assumptions and Judgements
4 Impairment of long-lived assets and goodwill
5 Retirement benefit obligations
6 Provision for liabilities
7 Taxation – Current and deferred
8 Property, plant and equipment
Other Significant Accounting Policies
9 Basis of consolidation
10 Revenue recognition
11 Segment reporting
12 Assets and liabilities held for sale
13 Share-based payments
14 Business combinations
15 Goodwill
16 Intangible assets (other than goodwill) arising on business combinations
17 Leases
18 Other financial assets
19 Inventories and construction contracts
20 Trade and other receivables
21 Cash and cash equivalents
22 Interest bearing loans and borrowings
23 Derivative financial instruments and hedging practices
24 Fair value hierarchy
25 Share capital and dividends
26 Emission rights
27 Foreign currency translation

150
7.3.1 Key sources of estimation uncertainty
An entity shall disclose in the notes information about the key assumptions concerning the future,
and other key sources of estimation uncertainty (see Illustration 7.8) at the balance sheet date, that
have a significant risk of causing a material adjustment to the carrying amounts of assets and
liabilities within the next financial year. In respect of those assets and liabilities, the notes shall
include details of:
(a) their nature; and
(b) their carrying amount as at the balance sheet date.
CRH plc 2015 Q51: Identify five estimation uncertainty disclosures in the accounting policies of
CRH in its 2015 financial statements?
Illustration 7.8: CRH plc’s key sources of estimation uncertainty

Key Accounting Policies which involve Estimates, Assumptions and Judgements
The preparation of the Consolidated Financial Statements in accordance with IFRS requires
management to make certain estimates, assumptions and judgements that affect the
application of accounting policies and the reported amounts of assets, liabilities, income and
expenses. Management believes that the estimates, assumptions and judgements upon which it
relies are reasonable based on the information available to it at the time that those estimates,
assumptions and judgements are made. In some cases, the accounting treatment of a particular
transaction is specifically dictated by IFRS and does not require management’s judgement in
its application.
Management consider that their use of estimates, assumptions and judgements in the
application of the Group’s accounting policies are inter-related and therefore discuss them
together below. The critical accounting policies which involve significant estimates,
assumptions or judgements, the actual outcome of which could have a material impact on the
Group’s results and financial position outlined below, are as follows:
(Source: CRH plc Annual Report 2015, p.137-38)
7.3.2 Other disclosures
IAS 1 Presentation of Financial Statements requires an entity to disclose in the notes:

(a) the amount of dividends proposed 10 or declared before the financial statements were
authorised for issue but not recognised as a distribution to equity holders during the period,
and the related amount per share (see Illustration 7.9); and
(b) the amount of any cumulative preference dividends not recognised.
An entity shall disclose the following, if not disclosed elsewhere in information published with the
financial statements:
(a) the domicile and legal form of the entity, its country of incorporation (see Illustration 7.10) and
the address of its registered office (or principal place of business, if different from the registered
office) (see Illustration 7.11);
(b) a description of the nature of the entity’s operations and its principal activities (see Illustration
7.12); and
(c) the name of the parent and the ultimate parent of the group (see Illustration 7.13).
10 Under international accounting standards, proposed dividends do not meet the definition of a
liability and are therefore not recognised (i.e., not included in the income statement and balance
sheet following a double entry) in the financial statements. Theoretically, shareholders at the
annual general meeting could turn down the directors’ proposals re proposed dividends, thus they
are not an obligation of the company until they are ratified by shareholders at the annual general
meeting. Instead, the proposed dividends are disclosed as a memorandum note to the financial
statements.
151
CRH plc 2015 Q52: What does CRH disclose in respect of proposed dividends in its 2015 financial
statements?
Illustration 7.9: CRH plc’s memorandum disclosure on dividends proposed
11. Dividends
(Source: CRH plc Annual Report 2015, p.162)
CRH plc 2015 Q53: What does CRH disclose in respect of its parent company, legal form, country
of incorporation and domicile in its 2015 financial statements?
Illustration 7.10: CRH plc’s disclosure of legal form, country of incorporation, domicile
Accounting Policies (Extract)

Basis of Preparation (Extract)
CRH plc, the Parent Company, is a publicly traded limited company incorporated and
domiciled in the Republic of Ireland.
CRH plc 2015 Q54: What does CRH disclose in respect of its registered office in its 2015 financial
statements?

152
Illustration 7.11: CRH plc’s disclosure of registered office
The International
Building Materials Group
CRH plc
Belgard Castle
Clondalkin
Dublin 22
Ireland
Telephone: +353 1 404 1000
Fax: +353 1 404 1007
E-mail: mail@crh.com
Website: www.crh.com
Registered Office
42 Fitzwilliam Square
Dublin 2
Ireland
Telephone: +353 1 634 4340
Fax: +353 1 676 5013
E-mail: crh42@crh.com
(Source: CRH plc Annual Report 2015, p. inside back cover)
CRH plc 2015 Q55: What does CRH disclose in respect of a description of the nature of the entity’s
operations and its principal activities?

153
Illustration 7.12: CRH plc’s disclosure of nature of its activities
Our business
CRH creates value by maintaining a balanced portfolio. Our product mix spans the breadth of
building materials demand and sectoral end-use, thereby minimising exposure to any one
single demand driver. In addition, the Group offsets cyclical economic risk by maintaining a
geographically diversified portfolio across its key regions of North America and Europe, as
well as in the emerging regions of Asia and South America.
CRH at a glance
CRH plc is a leading global diversified building materials group, employing 89,000 people at
over 3,900 operating locations in 31 countries worldwide.
CRH is a top two building materials company globally and the largest in North America. The
Group has leadership positions in Europe as well as established strategic positions in the
emerging economic regions of Asia and South America.
CRH is committed to improving the built environment through the delivery of superior
materials and products for the construction and maintenance of infrastructure, residential and
commercial projects.
A Fortune 500 company, CRH is listed in London and Dublin and is a constituent member of
the FTSE100 and the ISEQ 20 indices. CRH’s American Depositary Shares are listed on the New
York Stock Exchange. CRH’s market capitalisation at 31 December 2015 was approximately
€22 billion.
(Source: CRH plc Annual Report 2015, inside front cover, p. 1)
CRH plc 2015 Q56: What does CRH disclose in respect of its ultimate parent in its 2015 financial
statements?
Table 7.3 shows a group structure diagrammatically. H (for Holding company) Limited is the
parent company of S (for Subsidiary) Limited. S Limited is the parent company of SS (for Sub-
Subsidiary) Limited. However, H Limited is the ultimate parent company of SS Limited. Thus, S
Limited is SS Limited’s immediate parent, CRH plc is its ultimate parent.
Table 7.3: Parent companies and ultimate parent companies
H Limited Parent company of S Limited

Ultimate parent company of SS Limited
S Limited Parent company of SS Limited
SS Limited
As shown in Illustration 7.13, CRH plc is disclosed as the ultimate parent company in the group.

154
Illustration 7.13: CRH plc’s disclosure of ultimate parent
32. Related Party Transactions (Extract)

Subsidiaries, joint ventures and associates
The Consolidated Financial Statements include the financial statements of the Company (CRH
plc, the ultimate parent) and its subsidiaries, joint ventures and associates as documented in the
accounting policies on pages 137 to 147. The Group’s principal subsidiaries, joint ventures and
associates are disclosed on pages 224 to 231.

155
8. IAS 1 Presentation of Financial Statements – Statement of comprehensive income
Section 8: IAS 1 Presentation of Financial Statements –

Statement of comprehensive income

8.1 IAS 1 Presentation of Financial Statements – Statement of comprehensive income MCQ 8.1
8.1 IAS 1 – Statement of comprehensive income (IAS 1, paragraph 81-105)
Entities shall present all items of income and expenditure recognised in period
• In a single statement of comprehensive income
• In two statements
o Separate income statement (All realised 11 gains and losses are shown in the income
statement) and
o statement of comprehensive income which commences with profit or loss for the year
(from separate income statement ) and which displays the components of “other
comprehensive income” (“other” meaning other than the realised income in the income
statement)
• The latter is the approach following in the Financial Accounting 2 module
Statement of comprehensive income (edited) is to include  an income statement (this has already
been covered in Section 5 of these notes)(Strikethrough text relates to items that will not be
covered in Financial Accounting 2):
11 Realised gains are those received in the form of cash, or another asset the ultimate cash
realisation of which is known with reasonable certainty, (e.g., trade receivables/debtors).
156
 Example 8.1: IAS 1 exemplar Income statement (1)
20X7 20X6
€000 €000
Revenue Face  X X
Cost of sales (X) (X)
Gross profit X X
Other income X X
Distribution costs (X) (X)
Administrative expenses (X) (X)
Finance costs Face  (X) (X)
Share of profit of associates* Face  X X
Income tax expense Face  (X) (X)
Profit for the year from continuing operations X X
Loss for the year from discontinued operations Face (X)
 (see Section 6 of these notes)
Profit for the year Face  X X
Attributable to:
- Owners of the parent Face  X X
- Non-controlling interest 12 Face  X X
X X
 to  = 8 items that must be disclosed on the face of the income statement
(Paragraph 81-82 of IAS 1 Presentation of Financial Statements)
Statement of comprehensive income

• Profit or loss (from income statement)
• Each component of “other” (“other” meaning other than the realised income in the income
statement) comprehensive income classified by nature (e.g., exchange differences on
translating foreign subsidiaries [Note: foreign currency transaction differences are not the
12 Non-controlling (‘minority’) interest arises when a parent or holding company does not own
157
same as foreign currency translation differences 13]; gains [not losses as these would be
recorded in the income statement 14] on property revaluations)
• [Share of comprehensive income of associates and joint ventures accounted for using the equity
method]
• Total comprehensive income
• [Total comprehensive income attributable to non-controlling interests] (consolidated financial
statements only)
• Total comprehensive income attributable to owners of the parent
 Example 8.2: Statement of comprehensive income for the year ended 31 December
20X7
20X7 20X6
€000 €000
Profit for the year X X
Other comprehensive income
Exchange differences in translating foreign operations (X) (X)
Investments in equity instruments (X) X
Cash flow hedges X (X)
Gains on property revaluations X X
Actuarial gains (losses) on defined pension plans X (X)
Share of other comprehensive income of associates X (X)
Income tax relating to components of other comprehensive income X (X)
Other comprehensive income for the year, net of tax X X
TOTAL COMPREHENSIVE INCOME FOR THE YEAR X X
Key: Items with a strike through are not covered in Financial Accounting 2.
13 ° Foreign currency transaction gains and losses are recorded in the income statement as they
are considered to be realised
° For example, company sells €100m goods when US$/€ exchange rate was 1:1. Customer pays for
the goods one month later, when US$/€ exchange rate was US$1:€0.9/€1.1, i.e., for €111m (gain
€11m)/€91m (loss €9m). The gain or loss, which is realised, is recorded in the income statement.
° Foreign currency translation gains and losses arise when the accounts of subsidiary companies
in a currency not the same as the parent company’s reporting currency are translated into the
parent company’s reporting currency for the purposes of consolidation. Resulting gains and losses
are not realised and therefore are recorded in the statement of comprehensive income
° For example, subsidiary net assets $100m 20X1 when US$/€ exchange rate was 1:1. Therefore
net assets of subsidiary are included in consolidated financial statements for 20X1 at €100m. At
the end of 20X2, US$/€ exchange rate was US$1:€0.9/€1.1. Subsidiary is included in 20X2
consolidated financial statements at €111m (gain €11m)/€91m (loss €9m). The gain or loss,
which is unrealised, is recorded in the statement of comprehensive income.
14 Accounting is asymmetric – gains and losses are not treated in a similar manner. Losses are
recognised as soon as they become known (although this is less so nowadays with IASB’s demotion
of the prudence concept). Conversely, gains are not anticipated. Unrealised losses are generally
recorded in the income statement whereas unrealised gains are always recorded in the statement
of comprehensive income – other comprehensive income. CRH plc’s statement of comprehensive
income is reproduced in Illustration 8.1.

158
IAS 1 requires all recognised gains and losses to be shown in the income statement (comprehensive
[“one-stop-shop”] income statement approach).
This ensures that all transactions (including any unusual /exceptional items) must hit the “bottom
line” in the comprehensive income statement. Reserve accounting (the bad old way of accounting
for some of these transactions – transactions dealt with directly in reserves) is not always
transparent. The purpose of the statement of comprehensive income and the statement of changes
in equity is to enhance transparency by ensuring that full disclosure is recognised of all gains and
losses made in the period which have not gone through the income statement.
CRH plc 2015 Q57: What is included in CRH plc’s statement of comprehensive income in its 2015
Illustration 8.1: CRH plc’s statement of comprehensive income

159
Table 8.1 compares how realised and unrealised gains (+) and losses (-) are recognised in the
Table 8.1: Comparing realised and recognised gains and losses
Items Statement Example

Realised + Recognised Income statement Revenues (e.g., Sales), Expenses (e.g.,
purchases), etc
Unrealised + Recognised Statement of Gains (e.g., Gain on revaluation, gain on
comprehensive foreign currency translation), Losses (e.g.,
income loss on foreign currency translation)
Unrealised + Unrecognised  • Asset values not reflected in financial
statements (e.g., increase in value of site
beside factory)
• Assets not reflected in financial
statements (e.g., intellectual capital,
internally generated goodwill)
• Proposed dividends
Realised: Income/revenue/profit that has been realised in the form of cash or some other
asset the ultimate cash realisation of which is reasonably certain.
Recognised: The process of incorporating an item/transaction in the income

statement/balance sheet in the form of a double entry. Items not recognised may
be disclosed in a note to the financial statements, e.g., dividends proposed.

160
9. IAS 1 Presentation of Financial Statements – Statement of changes in equity
Section 9: IAS 1 Presentation of Financial Statements –

Statement of changes in equity

9.1 Components of equity MCQ 9.1-9.8
9.2 Requirements of IAS 1 concerning statement of changes in equity Q 17 Goodhead plc
9.3 Examples Q18 Cougar plc
Q19 Ash Limited
9.1 Components of equity
Capital/Equity/Shareholders’ Funds can be expressed in a number of ways:

• Equity = Share capital and Reserves
• Equity = Share capital, Capital reserves (i.e., non-distributable, unrealised gains/losses) and
Retained earnings/Revenue reserves (i.e., distributable, realised gains/losses)
• Equity = Share capital, Share premium 15 (called ‘undenominated capital’ under the Companies
Act 2014) (a capital reserve), Revaluation reserves (a capital reserve), Foreign currency
translation reserves (a capital reserve) and Retained earnings (a revenue reserve)
9.2 Requirements of IAS 1 concerning statement of changes in equity (IAS 1, paragraphs 106-110)
International Accounting Standard 1 (IAS 1) Presentation of Financial Statements requires full

disclosure of changes in equity:
• Total comprehensive income (identifying separately amounts attributable to owners of the

parent and to non-controlling interests)
• For each component of equity, a reconciliation between the carrying amount at the beginning
and the end (A reconciliation is an explanation of changes in balances expressed in numerical
terms of why one balance (often the opening balance) changed into another balance (often the
closing balance))
• Disclosing separately
♦ the profit or loss,
♦ other comprehensive income,
♦ transactions with owners in their capacity as owners, showing separately (i) contributions
by owners (i.e., new share capital into the company), (ii) contributions to owners (i.e., share
buy-backs by the company) and (ii) distributions to owners (i.e., dividends).
To summarise:
• Most changes in equity are disclosed in the Income Statement
• Some additional other comprehensive income items are included in the statement of
comprehensive income
• Some changes in equity are only included in the Statement of Changes in Equity.
• Dividends are not shown in the Income Statement, but instead are shown in the Statement of
Changes in Equity.
• Equity balances brought down/brought forward (i.e., opening balances) and carried
down/carried forward (i.e., closing balances) are not shown on the face of the income statement
(as might have been done in the past), but instead are shown in the Statement of Changes in
Equity.
15Amount at which shares are issued by the company in excess of their nominal or par value
(shares cannot be issued at a discount).
161
© Prof Niamh Brennan, University College Dublin

The statement of changes in equity shows separately the components of shareholders’ equity, such
as:
• Share capital
• Share premium account
• Retained earnings
• Foreign currency translation reserves [Note: foreign currency transaction differences are not
the same as foreign currency translation differences – see footnote 9 earlier]; and revaluation
reserves
• Revaluation gain (which is recorded in the Revaluation reserve account)
• Non-controlling interests
• Total equity
The statement of changes in equity starts by showing the balances on the components of
shareholders’ equity at the beginning of the accounting period. Then the changes in each balance
are itemised. Finally the statement finishes with the closing balances. Shareholders’ equity is thus
reconciled from one balance sheet to the next. Full comparatives are provided..
Except for changes resulting from transactions with equity holders acting in their capacity as
equity holders (such as equity contributions, re-acquisitions of the entity’s own equity instruments
and dividends) and transaction costs directly related to such transactions, the overall change in
equity during a period represents the total amount of income and expenses, including gains and
losses, generated by the entity’s activities during that period (whether those items of income and
expenses are recognised in the income statement or in the comprehensive income statement).
Thus, equity changes for three broad reasons:

1. The entity generates net realised profit/losses, which increases/decreases equity (income
statement  statement of comprehensive income/statement of changes in equity)
2. The entity has net recognised but unrealised gains/losses, which increases/ decreases equity
(statement of comprehensive income  statement of changes in equity)
3. The shareholders contribute more/less capital, or receive dividends (statement of changes in
equity)
To summarise the steps required to prepare a statement of changes in equity:
Step 1: Identify the number of components of equity and draw up a table with a column for each
component of equity, and a total column
Step 2: Record the opening balances for each component of equity (which may be given in the question
or may have to be derived by working backwards from the closing balance in Step 5)
Step 3: Record transactions directly with shareholders – (i) issue of share capital (in Share capital and
Share premium columns); (ii) dividends paid (a deduction in the Retained earnings column)
Step 4: Record Total comprehensive income for the year from the Statement of comprehensive income.
Put the elements of Total comprehensive income into the correct column ((i) Profit for year in
Retained earnings; (ii) Translation differences in Foreign currency translation reserve and (iii)
Revaluation gains in the Revaluation reserve)
Step 5: Record the closing balances for each component of equity (which may be given in the question
or may have to be derived)
IAS 1 requires the format in Example 9.1 to be applied to the statement of changes in equity.
CRH plc’s statement of changes in equity is shown in Illustration 9.1.
162

Example 9.1: Statement of changes in equity for the year ended 31 December 20X7 (adapted from the example in IAS 1)
(in thousands of currency units)
Share Retained Translation Revaluation Total

capital earnings of foreign reserve
Note 1 operations
 Balance at 1 January 20X6 X X (X) X X
Changes in equity for 20X6
Dividends (X) (X)
Total comprehensive income for the year Note 2X Note 2X Note 2X X
Balance at 31 December 20X6 X X (X) X X
Issue of share capital X X Closing balance 20X6
Dividends (X) (X) is the opening balance
Total comprehensive income for the year Note 2X Note 2X Note 2X X 2007, thus the dotted
Transfer to retained earnings Note 3 Note 3X Note 3(X) line
Balance at 31 December 20X7 X X (X) X X
Note 1: There is no share premium account, so the shares must have been issued at nominal value/par.
Note 2: The X in retained earnings is the net profit for the year, from the Income Statement; the X in the Translation of foreign
operations column is from the Statement of Comprehensive Income and represents the foreign currency differences on
translating the financial statements of the subsidiaries for the purposes of consolidation; the X in the Revaluation reserve
column represents the gain on revaluation of property plant and equipment recognised during the year and is taken
from the Statement of Comprehensive Income.
Note 3: When an asset which has previously been revalued is sold, the revaluation gain is realised. The revaluation gain is
therefore distributable. To reflect this, revaluation gain is moved out of the revaluation reserve account which is a anon-
distributable capital reserve, into the distributable retained earnings. Over, equity remains unchanged. The transfer is
merely a re-classification of the revaluation gain from non-distributable to distributable.
 = Five steps described on previous page
163

CRH plc 2015 Q58a: What is included in CRH plc’s Statement of Changes in Equity in its 2015
CRH plc 2015 Q58b: How much is CRH plc’s opening equity?
CRH plc 2015 Q58c: What are the components of CRH plc’s equity and what are they?
CRH plc 2015 Q58d: How much is CRH plc’s closing equity?
CRH plc 2015 Q58e: What are the three largest items that explain the changes in CRH plc’s equity
in 2015?
CRH plc 2015 Q58f: How does the format of CRH plc’s statement of changes in equity differ from
the model statement of changes in equity in IAS 1
Illustration 9.1: CRH plc’s statement of changes in equity
164

9.3 Examples
Example 9.2 traces the amounts in the statement of comprehensive income to the statement of
changes in equity using arrows and black numbers by way of cross-reference.
Example 9.2: Statement of changes in equity
ALF plc Statement of comprehensive income for the year ended 31st December 20X5
20X5 20X4
€m €m
Profit / (loss) for the period 36 (11)
Exchange differences on translation of foreign operations (52) 16
Gain on property revaluation  14 -
Other comprehensive income for the year (38) 16
TOTAL COMPREHENSIVE INCOME FOR THE YEAR  (2)  5
ALF plc Statement of changes in equity for the year ended 31st December 20X5
Share Retained Foreign Revaluation Total
Capital earnings currency Reserve
translation
reserve
€m €m €m €m €m
Balance at 1st January 20X4 45 94 25 10 174
Issue of shares at par 16 5 5
Dividends paid (20) (20)
Total comprehensive income for the year (11) 16 5
Balance at 31st December 20X4 50 63 41 10 164
Issue of shares at par 20 20
Dividends paid (20) (20)
Total comprehensive income for the year 36 (52) 14 (2)
Balance at 31st December 20X5 70 79 (11) 24 162
 = These symbols trace the journey of the statement of comprehensive income items into
the statement of changes in equity

1. What was the profit for 20X4 and 20X5?
2. How many transactions/items are dealt with in the statement of comprehensive income? What are they?
3. How much is the comprehensive income in total in 20X4 and 20X5?
4. How much are opening equity/shareholders’ funds for 20X4 and 20X5?
5. How many transactions were there with shareholders in 20X4 and 20X5 and what are they?
6. What was the retained profit for 20X5?
7. How are statement of comprehensive income items treated in the statement of changes in equity?
8. How much is closing equity/shareholders’ funds in 20X4 and 20X5?
9. What is the main reason for the fall in equity from 1.1.20X4 to 31.12.20X5?
16 Issuing shares at par means at their nominal value; there is no share premium on the issue of the
shares.
165

Example 9.3 traces the amounts in the statement of comprehensive income to the statement of
changes in equity using black numbers by way of cross-reference.
Example 9.3: Statement of changes in equity – reconciliation of opening and closing balances
Statement of comprehensive income for the year ended 31 December 20X8

€000
Profit for the period 22,414
Exchange differences on translation of foreign operations 2,875
Gain on property revaluation 2,600
Other comprehensive income for the year 5,475
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 27,889
Statement of changes in equity for the year ended 31 December 20X8

Share Share Retained Foreign Revaluation Total
Capital premium earnings exchange reserve
translation
reserve
€000 €000 €000 €000 €000 €000
Balance at 1 January 20X8 30,000 10,424 61,391 1,300 5,210 103,912

Issue of share capital 15,000 5,000 20,000
Dividends paid (15,736) (15,736)
Total comprehensive income for the year 22,414 2,875 2,600 27,889
Balance at 31 December 20X8 45,000 15,424 68,069 4,175 7,810 140,478
 = These symbols trace the journey of the statement of comprehensive income items into the
statement of changes in equity

1. What was the profit for 20X8?
2. How many transactions/items are dealt with directly in the statement of comprehensive income ? What are
they?
3. How much is the comprehensive income in total for 20X8?
4. How much are opening equity/shareholders’ funds for 20X8?
5. How many transactions were there with shareholders in 20X8 and what are they?
6. What was the retained profit for 20X8 and 20X7?
7. How much is closing equity/shareholders’ funds in 20X8?
166

Example 9.4 is a simple example, illustrating the mechanics of preparing a statement of changes
in equity based on some basic data.
Example 9.4: Preparation of a statement of changes in equity (1)
At 1 January 20X5 a company had two components of shareholders’ equity:

• Share capital of €4 million
• Retained earnings of €6 million.
During the year profits were €2 million, dividends of €3 million were paid, and land was revalued
from €4 million to €5 million.
Question
Prepare (i) the statement of comprehensive income and (ii) the statement of changes in equity,
based on the above information.
Statement of comprehensive income for the year ended 31 December 20X5 €m

Profit for the period 2
Gain on property revaluation 1
Other comprehensive income for the year 1
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 3

 Share Retained Revaluation Total
capital earnings reserve
€m €m €m €m
Opening balance at 1/1/20X5 Q4 Q6 DerivedNil 10
Dividends paid (3) (3)
Total comprehensive income for the year 2 1 3
Closing balance at 31/12/20X5 4 5 1 10
Steps in preparing the statement of changes in equity

Step  Identify the number of components of equity and draw up a table with a column for each
component of equity, and a total column
Step  Record the opening balances for each component of equity (which may be given in the
question or may have to be derived by working backwards from the closing balance in
Step 5)
Step  Record transactions directly with shareholders – (i) issue of share capital (in Share
capital and Share premium columns); (ii) Buy-back of shares; (iii) dividends paid (a
deduction in the Retained earnings column)
Step  Record Total comprehensive income for the year from the Statement of comprehensive
income. Put the elements of Total comprehensive income into the correct column ((i)
Profit for year in Retained earnings; (ii) Translation differences in Foreign currency
translation reserve and (iii) Revaluation gains in the Revaluation reserve)
Step  Record the closing balances for each component of equity (which may be given in the
question or may have to be derived)
167


2. How many transactions/items are dealt with directly in the statement of comprehensive
income ? What are they?
3. How much is the comprehensive income in total?
5. How many transactions were there with shareholders? What are they?
7. How much is closing equity/shareholders’ funds?
Example 9.5 provides some basic facts from which a statement of comprehensive income and statement of
changes in equity are to be prepared.
168

Example 9.5: Preparation of a statement of changes in equity (2)
At 1 January 20X5 GH plc had four components of shareholders’ equity:

• Equity / ordinary share capital of €10,000
• Share premium account €90,000
• Revaluation reserve €20,000
• Retained earnings of €690,000
During the year

• Profits were €94,775
• Land (Site A) (original cost €10,000) carried at revaluation of €15,000 was sold during the year
for €15,000
• Land (Site B) was revalued at the end of the year creating an additional gain of €10,000
• Dividends paid during the year of €49,000
• 120,000 new €1 ordinary shares were issued at a premium of €2 per share
Question
Prepare (i) the statement of comprehensive income and
(ii) the statement of changes in equity, based on the above information.
Solution
Statement of comprehensive income for the year ended 31 December 20X5 €

Profit for the period 94,775
Gain on property revaluation 10,000
Other comprehensive income for the year 10,000
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 104,775

 Share Share Retained Revaluation Total
capital premium earnings reserve
€ € € € €
Opening balance at 1/1/20X5 Q10,000 Q90,000 Q690,000 Q20,000 810,000
Issue of share capital 120,000 240,000 360,000
Dividends paid (49,000) (49,000)
Total comprehensive income for the year 94,775 10,000 104,775
(Site A unrealised gain now realised and ∴distributable) 5,000 (5,000) 0
Closing balance at 31/12/20X5 130,000 330,000 740,775 25,000 1,225,775

2. How many transactions/items are dealt with directly in the statement of comprehensive income ? What are they?
3. How much is the comprehensive income in total?
5. How many transactions were there with shareholders? What are they?
7. How much is closing equity/shareholders’ funds?
8. Where is the €5,000 revaluation surplus on Site A at 1 January 20X5?
169

10. IAS 33 Earnings per share
Section 10: IAS 33 Earnings per share

10.1 Background MCQ 10.1-MCQ 10.14
10.1.1 Importance of earnings per share Q20 Ray plc
10.1.2 Problems with earnings per share Q21 Cauldwell plc
10.1.3 Important points Q22 Chasewater plc
10.2 IAS 33 Basic earnings per share
10.2.3 Measurement of earnings per share
10.2.4 Non-controlling (minority) interest
10.2.5 Discontinued operations
10.2.6 Issue of new ordinary shares at full market price
10.2.7 Issue of shares for free – Bonus shares and share splits
10.3 IAS 33 Diluted earnings per share
10.3.1 Objective of diluted earnings per share
10.3.2 Principle of diluted earnings per share
10.3.3 Calculation of diluted earnings per share
10.4 IAS 33 Presentation and disclosure of earnings per share
10.4.1 Presentation of earnings per share
10.4.2 Disclosure of earnings per share
10.1 Background
There are three different ways of measuring return to shareholders, which is often expressed on a
per share basis:
• Dividend per share – this is uncontroversial and easy to calculate
• Cash flow per share – this measure is not much used or understood (although CRH plc prepares
such a measure)
• Earnings per share – this is the standard measure of return
10.1.1 Importance of earnings per share
Price earnings (p/e) ratio tells investors how well the market assesses a share’s performance. It
consists of the share price divided by the earnings per share. Earnings per share is the profit each
ordinary share earns (in cents).
Stock analysts and institutional investors are the largest and most powerful group of users of
financial statements. They sometimes do not fully read annual reports. Instead they concentrate
on the “bottom line”, i.e., profit after taxation. They need some indication of return with which to
compare companies and to decide on how much to pay for shares. Because they buy shares, they
want profit expressed on a per share basis. The p/e ratio allows for a “same size” / “common size”
analysis. Company information on profits and earnings per share is not comparable. However, p/e
ratios can be compared company-by-company.
P/E ratio = Market price per share in cents

Earnings per share in cents
P/E ratio is used by investors to get an idea of how an enterprise is valued. For example, an
enterprise with a p/e ratio of 20 (e.g., Microsoft, Ryanair) is more highly valued than one with a
P/E ratio of 4 or 5 (Donegal Creameries). The p/e ratio represents the multiple/number of times
future earnings investors are willing to pay for the company now/today.
170

Example 10.1 summarises the price earning rations of some of Ireland’s best known financial institutions
during the boom, after the bust and since then.
Q05: Complete Example 10.1 for the most recent data for Bank of Ireland and AIB
Example 10.1: Boom-to-bust price earnings ratios
2005/06 Bank of Ireland: AIB Anglo Irish Bank

€million €million €million
• Profitability: €1,296 million €1,433 million €491 million
• Earnings per share: 136 cent 151 cent 73 cent
• P/E ratio: 12.9 14.1 18.5

• Profitability: €1,704 million €2,066 million €1,008 million
• P/E ratio: 0.7 1.2 0.99

• Profitability: €34 million €885 million €664 million
• P/E ratio: 45.9 3.0 1Not applicable
2010/11 Bank of Ireland: AIB 1AngloIrish Bank

• Profitability: €(1,469) million €(2,334) million €(12,708) million
• Earnings per share: (169) cent (215) cent 1Not applicable
• P/E ratio: Share price 0.585 2 0.00 Share price 0.37 20.00 1Not applicable
2014/15 Bank of Ireland: AIB 1Anglo Irish Bank

• Profitability: €786 €915 1 Not applicable
• Earnings per share: 2.0c 0.2c 1Not applicable
• P/E ratio: 2.49 10.40 1Not applicable

1 Anglo Irish Bank was nationalised in 2009. Following merger with Irish
Nationwide Building Society, it was renamed Irish Bank Resolution Corporation

(IBRC) in July 2011. IBRC was put into liquidation by the Government in February
2013.
2 It is not possible to calculate a price earnings ratio when there is a loss per share
Earnings per share are calculated by the enterprise and disclosed in annual financial statements.
A number of alternative ways exist to calculate EPS, either using different measures of profit, or
different numbers of shares as a denominator – e.g., using share numbers at the year end, using
share numbers at the reporting date or using a weighted average; IAS 33 exists to regulate which
of these are chosen.
171

10.1.2 Problems with earnings per share
Abuses by reporting entities: Numerator (earnings number)

• Excluding “exceptional” (pre SSAP 6 Extraordinary Items and Prior Year Adjustments in 1974)
profits and losses, side-stepping the income statement by treating gains and losses as reserve
movements (side-stepping the income statement)
• Excluding “extraordinary” (pre FRS 3 in 1990) profits and losses from the earnings per share
calculation
Abuses by reporting entities: Denominator (number of shares)

• Hiding potential “dilution” of EPS by share options
• Using unclear bases to calculate the shares in issue
Abuses by analysts and brokers

• Calculating a “house” EPS
• Recalculating EPS on different bases to suit whatever recommendation they wanted to make
Generally
• No clear basis for EPS – so figures were not reliable or comparable
• Some companies used year-end number of shares, others used averages to calculate EPS
10.1.3 Important points
EPS is calculated on the earnings (profit) available to ordinary shareholders only – claims by
other holders are excluded from earnings for the calculation
 It is the entity itself which calculates and presents EPS, and not the marketplace
 The rules about the numbers of shares make a clear distinction between shares issued for
value and those issued for free
10.2 IAS 33 Basic earnings per share
IAS 33 is almost identical to the UK/Irish equivalent accounting standard. Unquoted companies do
not have to follow the standard.
10.2.1 Objective of IAS 33 (para. 1, IAS 33)
“…to prescribe principles for the determination and presentation of earnings per share, so as to
improve performance comparisons between different entities in the same reporting period and
between different reporting periods for the same entity. Even though earnings per share data have
limitations because of the different accounting policies that may be used for determining
'earnings', a consistently determined denominator enhances financial reporting.”
10.2.2 Scope of IAS 33 (para. 2,3,4 IAS 33)
• Entities whose ordinary, or potential ordinary shares are publicly traded, or who are going to
issue shares to the public;
• Where consolidated financial statements are presented, to present earnings per share based on
consolidated information only.
• Focus of the standard is on the denominator i.e., the number of shares, other standards deal
with how earnings are calculated.
(See for comparison, scope of IAS 1 Presentation of financial statements in Section 4.5.2 of these
notes)
172

10.2.3 Measurement of earnings per share (IAS 33, paragraph 10)
EPS = Net profit/loss for the period attributable to ordinary shareholders

(numerator)
Weighted average no. ordinary shares outstanding for the period
(denominator)
Profit attributable to ordinary shareholders based on:

 Consolidated profit after tax;
 After: non-controlling (minority) interest
 After: Preference dividends
Divided by
 Weighted average number of ordinary shares outstanding during the period
(Weighted average = time weighted)
10.2.4 Non-controlling (minority) interest (see also Section 4.3 of these notes)
An investment is classified as an investment in a subsidiary if (crudely speaking) the parent

company owns more than 50% of the share capital of the subsidiary. In order for there to be a non-
controlling (minority) interest, the subsidiary must not be wholly owned by the parent company.
When a group prepares consolidated financial statements, all of the turnover, net assets and profits
of subsidiaries are included in the financial statements, whether the group owns the whole of each
subsidiary or not. This means that any non-controlling (minority) shareholders in the subsidiaries
are entitled to a share of the profits, but these profits have been included as being those of the
group.
To deal with this, the appropriate proportion of the profit of subsidiaries owned by the minority
shareholders is deducted as a one-line adjustment from profit on the face of the income statement.
Because this proportion of profit is not available to the owners of the parent company, this amount
is deducted in arriving at profit for earnings per share purposes.
Example 10.2 is the first of “Niamh’s example”, showing the calculation of basic earnings per share.
173

Example 10.2: Basic earnings per share – Niamh’s example (1)
20X5 20X4
Income Statement (extract) €000 €000
Profit after tax 650 550
Non-controlling (minority) interest in profit after tax for year 100 100
Statement of Financial Position (extract) €000 €000
EQUITY
Share capital
– 4 million ordinary shares of 25 cent each 1,000 1,000
– 500,000 10% preference shares of €1 500 500
Share premium 250 250
Retained earnings 1,500 1,000
3,250 2,750
Question
What are the basic earnings per share for this company for 20X5 and 20X4?
Solution
Basic earnings per share 20X5 20X4
Numerator – Profit attributable to ordinary shareholders €000 €000
Profit for the period 650 550
Non-controlling (minority) interest (100) (100)
Preference dividends (10% €500,000Preference shares) (50) (50)
Earnings attributable to ordinary shareholders 500 400
000s 000s
Denominator – Number of shares 4,000 4,000
Earnings per share attributable to ordinary shareholders

20X5; 500/4,000 | 20X4: 400/4,000 12.5 cent 10 cent
174

10.2.5 Discontinued operations
Example 10.3 is the second of “Niamh’s example”, showing the calculation of basic earnings per
share in the event of a discontinued operation during the year. A separate EPS figure is to be
calculated for continuing and discontinued operations.
Example 10.3: Basic earnings per share – continuing and discontinued operations
– Niamh’s example (2)
20X5 20X4
€000 €000
Income Statement (extract)
Profit after tax (including discontinued operations) 650 550
Profit on discontinued operations after tax 150 75
Non-controlling (minority)interests in profit of continuing operations 100 100

EQUITY
Share capital
– 4 million ordinary shares of 25 cent each 1,000 1,000
3,250 2,750
Question
What are the basic earnings per share for continuing & discontinued operations for this
company for 20X5 and 20X4?
Solution
Preference dividends (50) (50)
500 400
Discontinued operations after tax (150) (75)
Earnings (continuing) attributable to ordinary shareholders 350 325
000s 000s

– continuing operations (350[325]Continuing earnings/4,000No. shares) 8.75 c 8.125 c
– discontinued operations (150[75]Discontinued earnings/4,000No. shares) 3.75 c 1.875 c
Earnings per share (500[400]Total earnings/4,000No. shares) 12.5 cent 10 cent
175

Illustration 10.1 shows the earnings per share of NTR plc for 2014, a year when there were
discontinued operations. The discontinued operations are shown as one line after profit after
taxation (i.e., as an exceptional item). The income statement relating to the discontinued
operations is included in Note 3 to the financial statements. The earnings per share are shown in
total, distinguishing between continuing operations and discontinued operations.
Illustration 10.1: NTR plc’s earnings per share continuing/ discontinued operations
(Source: NTR plc Annual Report 2014, p. 32)
176

Illustration 10.2 reproduces CRH plc’s income statement, including earnings per share disclosed
on the face of the income statement. Illustration 10.3 discloses the note in the financial statements
to the earning per share amounts on the face of the income statement.
CRH plc 2015 Q59a: How many earnings per share calculations are disclosed (a) on the face of the
income statement and (b) in the notes in CRH plc’s 2015 financial statements?
CRH plc 2015 Q59b: What are the amounts for the numerator and denominator in CRH plc’s
calculation of the three earnings per share disclosed in its 2015 financial statements?
CRH plc 2015 Q59c: What are the effects of non-controlling (minority) interest on the calculation
of earnings per share disclosed in CRH plc’s 2015 financial statements?
CRH plc 2015 Q59d: What are the effects of preference shares the calculation of earnings per share
disclosed in CRH plc’s 2015 financial statements?
Illustration 10.2: CRH plc’s earnings per share in the income statement
177

Illustration 10.3: CRH plc’s earnings per share in the notes to the financial statements
(CRH plc Annual Report 2015, p. 163)
10.2.6 Issue of new ordinary shares at full market price (Para. 19-29 IAS 33)
Earnings are divided by the weighted average number of ordinary shares outstanding:
• No. ordinary shares outstanding at beginning of period;
• Adjusted by no. ordinary shares issued (bought back) multiplied by a time-weighted factor (no. days/total
no. days in period or reasonable approximation);
• Timing of inclusion of ordinary shares is from the date the consideration receivable - determined by specific
terms and conditions (see para. 21 IAS 33 for details);
There are two approaches to the calculation of weighted average, each giving the same answer:
(1) Based on the absolute number of shares at each date when there is a change during the year, weighted by
the number of months for which there were that absolute number of shares
(2) Taking the opening number of shares outstanding (i.e., in issue) weighted for the whole year (i.e.,
12months/12months), and increasing that number by the time weighted new shares issued during the year (i.e.,
178

by the time the company had those shares), and reducing it by the time weighted shares bought back during
the year (i.e., by the time the company did not have those shares).
Example 10.4 reproduces an example from IAS 33 showing the calculation of basic earnings per
share when there has been a movement in shares during the year requiring a weighted average
number of shares to be calculated.
Example 10.4: Calculating weighted average number of shares – IAS 33 example
Movements in a company’s share capital are shown below:

Shares issued Own shares Shares outstanding
acquired
01/01/20X5 Bal. b/d 2,000 (300) 1,700
31/05/20X5 New shares issued 800 (-) 2,500
01/12/20X5 Redeem (buy back) shares - (250) 2,250
31/12/20X5 Bal. b/f 2,800 (550) 2,250
Question
Calculate the (denominator) weighted average number of shares in computing basic earnings per
share
Solution
Denominator – Weighted average number of shares (two approaches to the calculation):
 (1,700Balance at 1/1/X5 x 5/12Jan-May) + (2,500 Balance at 1/6/X5 x 6/12June-Nov) + (2,250 Balance at 1/12/X5 x 1/12Dec)
= 2,146
OR
 (1,700Opening balance x 12/12Jan-Dec) + (800New shares x 7/12June-Dec) - (250Buy back x 1/12Dec) = 2,146
 Number of shares Absolute Weighting Weighted

number average
No. No.
01/01/20X5 Bal. b/d 1,700 1,700
31/05/20X5 New shares issued 800 7/12 467
01/12/20X5 Redeem (buy back) shares (250) 1/12 (21)
31/12/20X5 Bal. b/f 2,250 2,146
 = three different approaches to calculating the weighted average number of shares
Example 10.5 is the third of “Niamh’s example”, showing the calculation of basic earnings per share
where there were movement in shares during the year such that a weighted average number of
shares has to be calculated.
179

Example 10.5: Equity / ordinary share capital changes – Niamh’s example (3)
20X5 20X4
Non-controlling (minority) interest in profit 100 100
EQUITY
Share capital
– 5 million (4 millionprior year) ordinary shares of 25 cent each
1,250 1,000
3,250 2,750
On 1/10/20X5 1 million ordinary shares were issued at full market price.
Question
What are the basic earnings per share for this company for 20X4 and 20X5?
Solution
Profit after taxation and Non-controlling (minority) interest 650 550
Denominator – Weighted average share capital:

 (4,000Opening balance x 9/12) + (5,000Balance at 1/10/20X5 x 3/12)
OR 4,250 4,000
 (4,000 Opening balance x 12/12) + (1,000New shares x 3/12)
 Number of shares Absolute Weighting Weighted
number average
No. No.
01/01/20X4 & 20X5 Bal. b/d 4,000 4,000 4,000
01/10/20X5 New shares issued 1,000 3/12 250
31/12/20X5 Bal. c/d 5,000 4,250
Earnings per share 11.8 cent 10 cent

 = three different approaches to calculating the weighted average number
of shares
180

10.2.7 Issue of shares for free – Bonus shares and share splits
Bonus issues (shares issued for free), sometimes called a “capitalisation issue” (as reserves are
capitalised as share capital), or a “scrip issue”, takes place when reserves (often capital (non-
distributable) reserves such as the share premium account) are re-designated (“capitalised”) as
share capital.
Motives for bonus issues
(1) Bonus issues are made when a company has sufficient reserves which it cannot use in the
future.
(2) A bonus issue can rectify a large disparity between share capital and total equity arising from
large reserves.
(3) Bonus issues will reduce the appearance of large dividends arising from large profits within
the company. This could attract competitors to the sector.
(4) Bonus issues will reduce the appearance of large dividends arising from large profits within
the company. This could breed resentment amongst employees.
The following points should be noted
(i) Bonus shares will increase the Share Capital of a company. Ideally, there should be sufficient
profits to enable the company to pay the same rate of dividend.
(ii) The company’s constitution should provide for sufficient number of unissued shares for
allotment as bonus shares.
(iii) If there is insufficient unissued shares, a resolution altering the Memorandum and Articles of
Association will have to be passed to enable the company to increase the authorised capital of the
company.
Bonus Shares are issued to all the existing shareholders in their shareholding proportion.
Under IAS 33 (paragraph 26) “The weighted average number of ordinary shares outstanding
during the period and for all periods presented shall be adjusted for events, other than the
conversion of potential ordinary shares, that have changed the number of ordinary shares
outstanding without a corresponding change in resources.”
A bonus issue changes the number of shares issued without changing the resources available to
the enterprise – it is thus treated differently than an issue of shares for cash. The approach is to
treat the bonus issue as though it had been in place from the beginning of the period and for the
whole of the comparative period. Thus if an entity has a 1,000 shares and issues another 1,000
free halfway through the year then the entity calculates EPS with a denominator of 2,000 shares
through the whole period, and for the previous year.
A share split also changes the number of shares issued without changing the resources available
to the enterprise. However, in the case of a stock split the shares are divided in two. Thus, a bonus
issue involves free additional shares; stock splits involve shares split in two.
A complication is introduced by IAS 33, paragraph 64: “If the number of ordinary or potential
ordinary shares outstanding increases as a result of a capitalisation, bonus issue or share split, or
decreases as a result of a reverse share split, the calculation of basic and diluted earnings per
share for all periods presented shall be adjusted retrospectively.”
Paragraph 64 of IAS 33 requires that the calculation of basic and diluted earnings per share for all
periods presented should be adjusted retrospectively for increases in the number of ordinary or
181

potential ordinary shares arising from capitalisation, bonus issue or share split, or decreases as a
result of a reverse share split, which take place after the balance sheet date but before the financial
statements are authorised for issue. This fact must be disclosed.
Under paragraph 28 of IAS 33, the number of ordinary shares outstanding before the bonus issue
is adjusted for the proportionate change in the number of ordinary shares outstanding as if the
event had occurred at the beginning of the earliest period presented.
There is a rule of thumb to calculate the prior year bonus adjusted earnings per share, illustrated
in Example 10.6 and Example 10.7. The rule of thumb is that the previously computed prior year
earnings per share is multiplied by the number of shares held before the bonus issue, divided by
the number of shares held after the bonus issue. Thus, the adjusted comparative earnings per
share after the bonus issue is lower than the previously computed earnings per share. If the rule
of thumb is applied below the line (i.e., to the number of shares), it is inverted, such that the bonus-
adjusted number of shares after the bonus issue is larger (and the earnings per share after the
bonus issue is therefore lower).
The rule of thumb is a neat way of adjusting for the proportionate change in the number of
ordinary shares outstanding.
Example 10.6 reproduces an example from IAS 33 showing the calculation of basic earnings per
share when there has been a bonus issue during the year.
182

Example 10.6: Bonus share issue (1) IAS 33 example
20X1 20X0
Profit attributable to ordinary owners of the parent 225 180

EQUITY
Share capital (1,800 (20X0 - 600) ordinary shares of €1 each 1,800 600
Share premium (converted to bonus shares in 20X1) - 1,200
Retained income 1,180 1,000
1,980 2,800
On 1/10/20X1 bonus ordinary shares were issued at a rate of 2 bonus shares

for each ordinary share outstanding at 30 September 20X1
Question
What are the basic earnings per share for this company
(i) In the 20X0 financial statements?
(ii) In the 20X1 financial statements including comparatives?
Solution
Workings
Opening share capital: 600 shares
Bonus issue 2New shares for 1Existing share: 600 Existing shares/1 x 2 = 1,200
Shares after bonus issue: 600Opening + 1,200Bonus issue =1,800Closing
Source of bonus issue – share premium: 1,200Opening share premium  0Closing share premium
(i) Basic earnings per share 20X0 20X0

€000
Numerator – Profit attributable to ordinary shareholders 180
000s
Denominator – Weighted average share capital: 600
Earnings per share (180Earnings /600Shares) 30c
(ii) Basic earnings per share 20X1

Because the bonus issue was without consideration, it is treated as if it had
occurred before the beginning of 20X4, the earliest period presented.
20X1 20X0
€000 €000
Numerator – Profit attributable to ordinary shareholders 225 180
000s 000s
Denominator – Weighted average share capital: 1,800 1,800
(600Existing + 1,200Bonus shares)
20X1 Earnings per share (225Earnings /1,800Shares) 12.5c
20X0 Earnings per share (180Earnings /1,800Shares) (no time
weighting, treat as if the bonus issue was always in place in order to compare like with like) 10c
Basic earnings per share – comparatives for 20X0

Rule of thumb: Previously reported earnings per share 30 cent x 1no. shares before
the bonus issue / 3 no. shares after the bonus issue = 10 cent
Example 10.7 is the fourth of “Niamh’s example”, showing the calculation of basic earnings per
share involving a bonus issue.
183

Example 10.7: Bonus share issue (2) Niamh’s example (4)
20X5 20X4
€000 €000
Non-controlling (minority)interest in profit after tax for year 100 100
EQUITY
Share capital
– 5 million (4 millionprior year) ordinary shares of 25 cent each 1, 250 1,000
Share premium - 250
3,250 2,750
On 1/10/20X5 a bonus issue was made (out of the share premium account) of
1 new ordinary share for every 4 existing shares held.
Question
What are the basic earnings per share for this company
(i) In the 20X4 financial statements?
(ii) In the 20X5 financial statements including comparatives?
Solution
Profit after taxation 650 550
Non-controlling (minority) interest in profit (100) (100)
Denominator – Weighted average share capital 000s 000s

Share in issue: 1/1/20X5/1/1/20X4 4,000 4,000
Bonus issue (no time weighting, treat as if the bonus issue was always in place in order 1,000 1,000
to compare like with like)
5,000 5,000
(i) Earnings per share 20X4
(400Earnings/4,000Existing shares) 10c
(ii) Earnings per share 20X5 

20X5: (500Earnings/4,000Existing shares+1,000Bonus shares) 10c
20X4: (400Earnings/4,000Existing shares+1,000Bonus shares) 8c
Rule of thumb: Previously reported earnings per share
10cent Original EPS in 20X0 financial statements x 4No.shares before bonus issue/5No. shares after bonus 8c
issue
184

10.3 Diluted Earnings per Share
10.3.1 Objective of diluted earnings per share
“The objective of diluted earnings per share is consistent with that of basic earnings per share—to
provide a measure of the interest of each ordinary share in the performance of an entity—while
giving effect to all dilutive potential ordinary shares outstanding during the period” (IAS 33,
paragraph 31).
This is important where a company has granted rights to instrument holders which enable them
to convert the instrument into ordinary shares and so dilute the existing shareholders’ share of the
profits. Examples of potential ordinary shares outstanding include convertible debentures,
convertible loan stock, convertible preference shares (all convertible into ordinary shares)
and options/warrants to subscribe in the future for equity shares.
The approach of IAS 33 is to require presentation of the diluted EPS for all EPS disclosures with
equal prominence, and to require reconciliations to be disclosed in notes to the financial
statements which make explicit the effect of each dilutive instrument. This protects shareholders
from management actions in which the dilutive effect of contracts may be hidden, or whose
implications they may not have fully grasped.
Options
Share or stock options are used to remunerate senior management. Share/stock options give
managers the right to buy shares in the company at a predetermined price, the exercise price. The
idea is that share/stock options align the interests of managers and shareholders. Shareholders
are interested in the share price. Managers holding share/stock options also become interested in
the share price. If the market price of the share exceeds the option price, managers will exercise
their options (they are “in-the-money”). If the market price of the share is less than the option
price, the options are “out-of-the-money” and will not be exercised.
Warrants
Companies may issue loan stock which in itself is not convertible into equity, but which gives the
holder the right to subscribe at fixed future dates for ordinary shares at a predetermined price.
The subscription rights, called ‘warrants’, entitle the bond holder to obtain a specified number of
the company’s ordinary shares at an agreed price. With convertible loan stock, the loan stock is
given up if the conversion right is exercised. With a warrant, the bond holder keeps the original
loan stock, and have the choice of using the warrant to obtain ordinary shares in addition. The
advantage of this approach to financing a company is that the loan stock is maintained until
redemption, and the warrants also enable the company to raise new capital. There is no need to
substitute one form of capital for another as in the case of convertible loan stock. The exercise price
is usually greater than the share price at the date the warrants are issued, in the expectation that
the share price will be higher than the warrant price at the date of exercise of the warrants.
10.3.2 Principle of diluted earnings per share
“For the purpose of calculating diluted earnings per share, an entity shall adjust profit or loss
attributable to ordinary owners of the parent entity, and the weighted average number of shares
outstanding, for the effects of all dilutive potential ordinary shares” (IAS 33, paragraph 30).
10.3.3 Calculation of diluted earnings per share
(a) “profit or loss attributable to ordinary owners of the parent entity is increased by the after-tax
amount of dividends and interest recognised in the period in respect of the dilutive potential
ordinary shares and is adjusted for any other changes in income or expense that would result from
the conversion of the dilutive potential ordinary shares, e.g., a €1,000,000 10% convertible bond
185

is convertible to Ordinary shares on a €1 for 1 ordinary share basis; the €100,000 interest cost
does not have to be paid on conversion  add it back to profit (assuming no tax effect)
and
(b) the weighted average number of ordinary shares outstanding is increased by the weighted
average number of additional ordinary shares that would have been outstanding assuming the
conversion of all dilutive potential ordinary shares” (IAS 33, paragraph 31).
Earnings available to ordinary shareholders

(after adjustment for conversion)________________________
No. shares outstanding + those not yet outstanding (i.e., that could be outstanding)
i.e., potential ordinary shares
A potential ordinary share is any instrument which can be converted into an ordinary share. For the
purposes of the diluted earnings per share calculations, they are measured in terms of the number of
ordinary shares into which they can be converted – so a single debenture which can be converted into
1,000 ordinary shares is 1,000 potential ordinary shares.
Example 10.8 reproduces an example from IAS 33 showing the calculation of diluted earnings per
share.
Example 10.8: Diluted earnings per share (1) IAS 33 example
• Net profit €1,000

• Ordinary shares outstanding 10,000
• Convertible bonds €1,000.
• Each block of 10 bonds is convertible into 15 ordinary shares
• Interest expense relating to convertible bonds €100
• Deferred tax related to interest expense €40
Question
What are the (i) basic and (ii) diluted earnings per share for this company?
Solution
(i) Basic earnings per share
€1,000 profit /10,000 ordinary shares = 10 cent
(ii) Diluted earnings per share

Adjusted net profit (1,000Net profit +100Bond interest ‘saved’ – 40Tax on bond interest) = €1,060
No. ordinary shares (10,000Ordinary shares + 1,500Issued were bonds converted)
Diluted EPS €1,060Earnings/11,500Shares= 9.2c
Conclusion: Dilution of 0.8 cent per share would be suffered by ordinary

shareholders were bonds converted
Example 10.9 reproduces another example from IAS 33 showing the calculation of diluted earnings
per share.
186

Example 10.9: Diluted earnings per share (2) IAS 33 example
• Net profit €1,000 after preference dividend

• Ordinary shares outstanding 2,000
• 1,000 Convertible preference shares
• Convertible into 1,000 ordinary shares
• Preference dividend €1,000
Question
What are the (i) basic and (ii) diluted earnings per share for this company?
Solution
(i) Basic earnings per share
€1,000 profit after preference dividend/2,000 ordinary shares = 50 cent
(ii) Diluted earnings per share

€1,000 profit after preference dividend + 1,000 preference dividend /2,000
ordinary shares + 1,000 ordinary shares on conversion of preference shares = 67
cent
Conclusion: Unusually, the preference shares are anti-dilutive. Diluted earnings

per share are 0.17cent higher than the basic earnings per share.
Example 10.10 is based on “Niamh’s example”, showing the calculation of diluted earnings per share as a
result of the preference shares being convertible into ordinary shares at some time in the future.
instruments that could potentially dilute basic earnings per share in the future, but are anti-dilutive are
not included in the calculation of diluted earnings per share.
187

Example 10.10: Diluted earnings per share (3) – Niamh’s example (5)
20X5 20X4
€000 €000
Non-controlling (minority) interest in profit after tax for year 100 100
EQUITY
Share capital
– 4 million ordinary shares of 25 cent each 1, 000 1,000
– 500,000 10% convertible preference shares of €1 500 500
3,250 2,750
The preference shares are convertible into ordinary shares on a one-for-one basis
Question
What are the basic and diluted earnings per share for this company for 20X5 and 20X4?
Solution
Non-controlling (minority)interests (100) (100)
000s 000s

20X5: 500/4,000 | 20X4: 400/4,000 12.5 cent 10 cent
Diluted earnings per share 20X5 20X4

000s 000s
Denominator – Number shares (4,000Ordinary shares+500Potential ordinary shares) 4,500 4,500

20X5; 550/4,500 | 20X4: 450/4,500 12.2 cent 10 cent
Example 10.11 brings together Niamh’s five examples, comparing the five calculations.
188

Example 10.11: Niamh’s five examples
Solution
Continuing
Basic Discontinued New shares Bonus issue Diluted
EG 10.2 EG 10.3 EG 10.5 EG 10.7 EG 10.10
Basic earnings per share 20X5 20X5 20X5 20X5 20X5
Numerator
Profit attributable to ordinary shareholders €000 €000 €000 €000 €000
Profit after taxation 650 650 650 650 650
Non-controlling (minority) interest in profit (100) (100) (100) (100) (100)
Preference dividends (50) (50) (50) (50) (50)
Earnings attributable to ordinary shareholders 500 500 500 500 550
Discontinued operations (150)
Continuing operations 350
Denominator 000s 000s 000s 000s 000s

Weighted average share capital 4,000 4,000 4,250 5,000 5,500
Earnings per share

Continuing 8.75c
Discontinued 3.75c
Earnings per share 12.5c 12.50c 11.8c 10.0c 12.2c
Illustration 10.4 shows the calculation of CRH plc’s basic and diluted earnings per share.
CRH plc 2015 Q60a: Does CRH disclose a diluted earnings per share in its 2015 financial
statements?
CRH plc 2015 Q60b: Is CRH plc’s diluted earnings per share in its 2015 financial statements lower
than the basic earnings per share?
CRH plc 2015 Q60c: What are the dilutive instruments in CRH plc’s diluted earnings per share
calculation in its 2015 financial statements?
189

Illustration 10.4: CRH plc’s Basic and diluted earnings per share
190

10.4 IAS 33 Presentation and disclosure of earnings per share
10.4.1 Presentation of earnings per share
“An entity shall present on the face of the income statement

• basic and diluted earnings per share for profit or loss from continuing operations attributable to the
ordinary owners of the parent entity
• and for profit or loss attributable to the ordinary owners of the parent entity for the period for each
class of ordinary shares that has a different right to share in profit for the period.
• An entity shall present basic and diluted earnings per share with equal prominence for all periods
presented” (IAS 33, paragraph 66).
“An entity that reports a discontinued operation shall disclose the basic and diluted amounts per share for
the discontinued operation either on the face of the income statement or in the notes to the financial
statements” (IAS 33. paragraph 68).
“An entity shall present basic and diluted earnings per share, even if the amounts are negative (i.e., a loss
per share)” (IAS 33, paragraph 69).
Example 10.12 shows how earnings per share should be disclosed on the income statement and in
the notes to the financial statements.
Example 10.12: Presentation of earnings per share in the income statement
Income Statement for the year ended 31st

December 20X5 20X5 20X4
€000 €000
Earnings per share
Attributable to equity shareholders
Continuing operations – basic 8.75 cent 8.125 cent
– diluted 6.67 cent 6.111 cent
Note 27 to the Financial Statements –

Discontinued Operations
Earnings per share

Attributable to equity shareholders
Discontinued operations – basic 3.75 cent 1.875 cent
– diluted 3.33 cent 1.667 cent
191

10.4.2 Disclosure of earnings per share
An entity shall disclose the following (six disclosure items identified by  to ):
(1) the amounts used as the numerators in calculating (1a) basic and (2a) diluted earnings per share,
and
(2) a reconciliation of those amounts to profit or loss attributable to the parent entity for the period.
The reconciliation shall include the individual effect of each class of instruments that affects earnings
per share.
(3) the weighted average number of ordinary shares used as the denominator in calculating (3a) basic
and (3b) diluted earnings per share, and
(4) a reconciliation of these denominators to each other. The reconciliation shall include the individual
effect of each class of instruments that affects earnings per share.
(5) instruments (including contingently issuable shares) that could potentially dilute basic earnings per
share in the future, but were not included in the calculation of diluted earnings per share because they
are anti-dilutivefor the period(s) presented.
(6) a description of ordinary share transactions or potential ordinary share transactions, other than those
accounted for in accordance with paragraph 64, that occur after the balance sheet date and that
would have changed significantly the number of ordinary shares or potential ordinary shares
outstanding at the end of the period if those transactions had occurred before the end of the reporting
period” (IAS 33, paragraph 70).
Detailed disclosures of the make-up of CRH plc’s earning per share are included in Illustration 10.5.
CRH plc 2015 Q61: Summarise CRH plc’s presentation of earnings per share in its 2015 financial
statements?
CRH plc 2015 Q62: What amounts does CRH disclose in respect of the above items in its earnings
per share in its 2015 financial statements?
192

Illustration 10.5: CRH plc’s presentation of earnings per share
193

Illustration 10.6: CRH plc’s disclosures on earnings per share
194

11. Accounting valuation issues – Non-Current Assets: 11a: Property Plant and Equipment
Section 11: Accounting Valuation Issues – Non-Current Assets (IAS 16, 20)
Section 11a: Property, Plant and Equipment

11a.1 Problem areas in accounting for fixed assets MCQ 11a.1-MCQ 11a.2
11a.1.1 Revenue and capital expenditure
11a.1.2 Problem areas to be addressed
11a.2 IAS 16 Property, Plant and Equipment
11a.2.1 Objective of IAS 16
11a.2.2 Definitions in IAS 16
11a.2.3 Scope of IAS 16
11a.2.4 Recognition of property, plant and equipment
11a.2.5 Initial measurement of property, plant and equipment
11a.1 Problem areas in accounting for fixed assets
11a.1.1 Revenue and capital expenditure
It is important to distinguish between revenue and capital expenditure.
Expenditure is normally included as expenses in the Income Statement. This is called ‘Revenue expenditure’.
Expenditure that clearly and demonstrably improves a fixed asset can be ‘capitalised’ as part of Property
plant and equipment in the balance sheet. This is called ‘Capital expenditure’ (use of the word ‘capital’ in
this context has nothing to do with capital as in equity/capital or with the share capital of a company).
Fixed assets / property plant and equipment are deferred costs, held in the balance sheet until
transferred as an expense (as depreciation) in the income statement, to be matched against the
related revenue generated by the use of the fixed assets / property plant and equipment. (Please
revisit Section 1.10 of these notes).
11a.1.2 Problem areas to be addressed
• When should fixed assets initially be recognised?

• How should cost be measured?
• How should they be depreciated?
• When should they be regarded as not fully recoverable?
• What are the implications of revaluation?
• How should capital grants be treated?
11a.2 IAS 16 Property, Plant and Equipment
IAS 16 addresses four areas:

• When to recognise Property, Plant and Equipment (Section 11a)
• Initial measurement - uniform principles (Section 11a)
• Depreciation - all depreciable assets to be depreciated (Section 11b)
• Valuations - valuations kept up to date (Section 11c)
195

11a.2.1 Objective of IAS 16
• Consistent principles applied to initial measurement;

• Valuation of tangible fixed assets on a consistent basis, kept up-to-date and gains/losses
recognised on a consistent basis;
• Depreciation calculated in a consistent manner;
• Sufficient information disclosed.
11a.2.2 Definitions in IAS 16
Tangible fixed assets
Assets that have physical substance and are held for use in the production or supply of goods
or services, for rental to others, or for administrative purposes on a continuing basis in the
reporting entity’s activities.
[“on a continuing basis” generally means for use over more than one year]
Illustration 11a.1 shows the property, plant and equipment in CRH plc’s balance sheet.
CRH plc 2015 Q63a: What amounts does CRH disclose for Property, Plant and Equipment in its
CRH plc 2015 Q63b: How much of its disclosures does CRH disclose on the face of the balance sheet
for Property, Plant and Equipment in its 2015 financial statements?
CRH plc 2015 Q63c: What categories does CRH disclose for Property, Plant and Equipment in its
CRH plc 2015 Q63d: What movements does CRH disclose for Property, Plant and Equipment in its
196

Illustration 11a.1: CRH plc’s property, plant and equipment
197

11a.2.3 Scope of IAS 16
• Financial statements intended to give a true and fair view

• Applies to all tangible fixed assets except Investment Properties (IAS 40)
(See for comparison, scope of IAS 1 Presentation of financial statements in Section 4.4.2 and scope
of IAS 33 Earnings per share in Section 10.2.2 of these notes)
11a.2.4 Recognition of property plant and equipment
Recognise cost of an item of property plant and equipment if and only if:
 It is probable that there will be future economic benefits
 Cost can be measured reliably
CRH plc’s accounting policy for recognition and measurement of property, plant and equipment is shown in
Illustration 11a.2.
CRH plc 2015 Q64: How are IAS 16’s recognition and initial measurement principles reflected in
CRH plc’s financial statements?
Illustration 11a.2: CRH plc’s recognition and measurement principles for property, plant
and equipment

Property, plant and equipment – Note 13 (extract)
Repair and maintenance expenditure is included in an asset’s carrying amount or recognised
as a separate asset, as appropriate, only when it is probable that future economic benefits
associated with the item will flow to the Group and the cost of the item can be measured
reliably. All other repair and maintenance expenditure is charged to the Consolidated Income
Statement during the financial period in which it is incurred.
11a.2.5 Initial measurement of property plant and equipment
• Initially measure at cost.

• Cost is the fair value of the consideration for purchase
• Elements of cost comprise:
♦ Purchase price (including import duties and non-refundable purchase taxes (i.e., Value Added Tax
VAT), after deducting trade discounts and rebates) and
♦ Any costs directly attributable to bringing the asset to the location and condition necessary for it to
be capable of operating in a manner intended by management.
♦ The initial estimate of costs of dismantling and removing the item and restoring the site on which it
is located, the obligation for which an entity incurs either when the item is acquired or as a
consequence of having used the items during a particular period for purposes other than to produce
inventories during that period. (Note: Costs of dismantling and removal would normally be
immaterial and therefore assumed to be €nil. Exceptions would be large items of property plant and
equipment such as nuclear plants or oil rigs).
1. Examples of directly attributable costs (i.e., incremental avoidable costs)

♦ Costs of employee benefits (i.e., labour costs) of own employees
♦ Costs of site preparation and clearance
♦ Initial delivery and handling costs
♦ Installation and assembly costs
♦ Acquisition costs (stamp duties, import duties, non-refundable purchase taxes)
198

♦ Professional fees
♦ Dismantling and removal costs
♦ Commissioning and start-up costs – costs of testing whether the asset is functioning properly, after
deducting the net proceeds from selling any items produced while bringing the asset to that location
and condition.
NOT:
♦ Costs of opening a new facility
♦ Costs of introducing a new product or service
♦ Costs of conducting business in a new location or with a new class of customer
♦ Administration and other general overhead costs
♦ Employee costs not related to a specific asset
NOT:
♦ Abnormal costs, e.g.,
o Design errors
o Industrial disputes
o Idle capacity
o Wasted materials
o Production delays
o Operating losses due to suspension of activity during construction.
Cease capitalisation (i.e., including costs in a balance sheet item such as Property, plant and equipment,
instead record the costs in the [default normal] income statement) when asset is substantially in a location
and condition necessary for it to be capable of operating in the manner intended by management.
DO NOT INCLUDE:
♦ Costs incurred while an item capable of operating in the manner intended by management has yet
to be brought into use or is operated at less than full capacity
♦ Initial operating losses, such as those that are incurred while demand for the entity’s output builds
up
♦ Costs of relocating or reorganising part or all of the entity’s operations.
Table 11a.1 summarises what can and cannot be included (i.e., capitalised) in property, plant and
equipment.
199

Table 11a.1: Summarising the rules of capitalisation of costs in property, plant, equipment
Capitalise Do not capitalise

1. Purchase price (+import duties, +non- 12. Costs of opening a new facility
refundable purchase taxes, - trade discounts and 13. Costs of introducing a new product or service
rebates) 14. Costs of conducting business in a new
2. Any costs directly attributable to bringing the location or with a new class of customer
asset to the location and condition necessary for 15. Administration and other general overhead
it to be capable of operating in a manner costs
intended by management. 16. Employee costs not related to a specific asset
3. Dismantling and removal costs, if material. 17. Abnormal costs, e.g., Design errors, Industrial
4. Costs of employee benefits (i.e., labour costs) of disputes, Idle capacity, Wasted materials,
own employees Production delays, Operating losses due to
5. Costs of site preparation and clearance suspension of activity during construction.
6. Initial delivery and handling costs 18. Costs incurred while an item capable of
7. Installation and assembly costs operating in the manner intended by
8. Acquisition costs (stamp duties, import duties, management has yet to be brought into use
non-refundable purchase taxes) or is operated at less than full capacity
9. Professional fees 19. Initial operating losses, such as those that are
10. Dismantling and removal costs incurred while demand for the entity’s
11. Commissioning and start-up costs – costs of output builds up
testing whether the asset is functioning 20. Costs of relocating or reorganising part or all
properly, after deducting the net proceeds from of the entity’s operations.
selling any items produced while bringing the
asset to that location and condition.
IAS 16 does not deal with the issue of whether borrowing costs associated with the financing of a
constructed asset can be regarded as a directly attributable cost of construction. IAS 23 Borrowing
Costs requires the inclusion of borrowing costs of qualifying assets as part of the cost of
constructing the asset. “A qualifying asset is an asset that takes a substantial period of time to get
ready for its intended use”.
Illustration 11a.3 reproduces CRH plc’s accounting policy for initial measurement of property, plant and
equipment.
CRH plc 2015 Q65: How does IAS 23 affect CRH plc’s initial measurement principles as reflected in
CRH plc’s financial statements?
Illustration 11a.3: CRH plc’s initial measurement of property, plant and equipment

Borrowing costs incurred in the construction of major assets which take a substantial period
of time to complete are capitalised in the financial period in which they are incurred.
200

11. Accounting valuation issues – Non-Current Assets: 11b: Depreciation
Section 11: Accounting Valuation Issues – Non-Current Assets

Section 11b: Depreciation and impairment

11b.1 Arguments against depreciation MCQ 11b.1-MCQ 11b.9
11b.2 IAS 16 Property, Plant and Equipment
11b.2.1 Definition of depreciation
11b.2.2 Other definitions
11b.2.3 Objective of IAS 16
11b.2.4 Standard accounting practice
11b.2.5 Assessment of economic useful life
11b.2.6 Methods of depreciation
11b.2.7 No depreciation charge
11b.2.8 Change in method
11b.2.9 Useful economic life
11b.2.10 Residual value
11b.3 IAS 36 Impairment of Assets
11b.3.2 Scope of IAS 36
11b.3.3 Summary of IAS 36
11b.3.4 Recoverable amount
11b.3.5 Accounting for impairment
11b.3.6 Comparing depreciation charges and impairment charges
11b.1 Arguments against depreciation
In the past, many companies did not depreciate buildings:

• Not material
• Life of asset infinite
• Level of maintenance: The argument that no depreciation should be charged where companies
invest in maintenance of their assets was eloquently rebutted by the experience of the UK post-
privitised water companies in the late 1990s. Maintenance and renewal of underground assets
(sewers and water mains) was argued to be so significant that this justified these underground
assets not being depreciated. Shaoul (1998: 33-34) concluded that “Far from maintaining the
infrastructure, the underground network is deteriorating faster than it is being renovated.”
• Value exceeds cost (No sense in charging depreciation on an asset that is not declining in value
[view that depreciation is a valuation technique rather than measure of consumption])
In relation to depreciation, there is often confusion between allocation and valuation objectives.
The definition clarifies this as follows:
• Measure of consumption (not a measure of loss in value)
• Method of allocation of cost
• Not a means of valuation
• Does not provide for replacement of the asset
As a method of cost allocation, involves taking the cost of property, plant and equipment out of the
balance sheet and charging it as an expense (called ‘depreciation’) in the income statement.
The double entry is:

Dr Depreciation (expense in income statement) X
Cr Aggregate Depreciation X
(keep in separate account and subtract from related property, plant and equipment
category leading to net book value amount in the balance sheet)
201

The depreciation expense is included in the caption/heading in the income statement to which the
asset most relates. For example, depreciation of the factory buildings, or plant and machinery would
be included in cost of goods sold, depreciation on the warehouse and on delivery vehicles would be
included in distribution costs, depreciation on the office, or on computers would be included in
administrative expenses.
11b.2 IAS 16 Property, Plant and Equipment
11b.2.1 Definition of depreciation
Depreciation
Systematic allocation of the depreciable amount of an asset over its useful life.
11b.2.2 Other definitions
Depreciable amount
The cost of a tangible fixed asset, or other amount substituted for its cost, (i.e., or, where an asset
is revalued, the revalued amount) less its residual value
Useful life
The useful life is:
(a) The period over which the entity expects to derive economic benefit from that asset.
(b) The number of production units or similar units expected to be obtained from the asset by the
entity (e.g., airplane – flying hours during the accounting period; mine – weight of minerals
extracted during the accounting period: oil well – number of barrels of oil removed during the
accounting period)
Residual value
The net realisable value of an asset at the end of its useful economic life. Residual values are based
on prices prevailing at the date of the acquisition (or revaluation) of the asset and do not take
account of expected price changes. Ryanair assigns a value of its aircraft at the end of their useful
life as shown in Illustration 11b.1
Illustration 11b.1: Ryanair’s aircraft depreciation policy
The Company’s estimate of the recoverable amount of aircraft residual values is 15% of current
market value of new aircraft, determined periodically, based on independent valuations and
actual aircraft disposals during prior periods. Aircraft are depreciated over a useful life of 23
years from the date of manufacture to residual value.
(Source: Ryanair Holdings plc annual report 2015, p. 99)
Illustration 11b.2 highlights the subjective judgement and estimation involved in calculating
depreciation.
CRH plc 2015 Q66: How does CRH reflect the uncertainty concerning the calculation of
depreciation in its 2015 financial statements?
202

Illustration 11b.2: CRH plc’s uncertainty and depreciation calculations

• To reflect in operating profit the cost of using the assets (i.e., amount consumed) that generate
the revenue of the period.
• This requires a charge in the profit and loss account even if asset has risen in value.
• Where asset has been revalued, charge in current year profit and loss account should be based
on revalued amount.
Depreciation should be based on revalued amount
11b.2.4 Standard accounting practice
• Depreciable amount should be allocated on a systematic basis over its useful economic life
• Depreciation method should reflect the pattern the asset’s economic benefits are consumed
(Note: If the pattern is even during the useful life of the assets, straight-line depreciation
(depreciation is the same amount each year) is suggested; if the pattern goes from high to low
consumption of economic benefits during the useful life of the assets, reducing-balance
depreciation (depreciation is gets smaller each year) is suggested.
• Depreciation charge should be recognised as an expense in the income statement (e.g., in cost of
sales, distribution costs, administrative expenses, depending on the nature of the asset) unless
it is permitted to be capitalised by including it in the carrying value of another asset (e.g.,
development costs).
11b.2.5 Assessment of economic useful life
Guidance is provided in IAS 16. Take into account:

 Expected use of the asset.
 Expected physical wear and tear, which depends on both operational factors and the care and
maintenance of the asset while idle.
 Technical or commercial obsolescence arising from changes or improvements, or a change in
the market demand
 Legal or similar limits on the use of the asset, such as the expiry dates of related leases.
11b.2.6 Methods of depreciation
A variety of methods of depreciation permissible:

• Straight-line method
• Reducing-balance method
• Other methods
Use straight-line method where pattern of consumption uncertain.
CRH plc’s accounting policy for depreciation is shown in Illustration 11b.3.
203

CRH plc 2015 Q67: What method of depreciation does CRH apply to its tangible fixed assets in its
CRH plc 2015 Q68: What useful lives does CRH expect in relation to its tangible fixed assets in its
Illustration 11b.3: CRH plc’s depreciation accounting policies

Land and buildings: The book value of mineral-bearing land, less an estimate of its residual
value, is depleted over the period of the mineral extraction in the proportion which production
for the year bears to the latest estimates of proven and probable mineral reserves. Land other
than mineral-bearing land is not depreciated. In general, buildings are depreciated at 2.5% per
annum (“p.a.”).
Plant and machinery: These are depreciated at rates ranging from 3.3% p.a. to 20% p.a.
depending on the type of asset. Plant and machinery includes transport which is, on average,
depreciated at 20% p.a.
11b.2.7 No depreciation charge
Permitted in two circumstances:

• Charge would be immaterial (an item is material if it could reasonably influence the decisions
of users of the financial statements); Immaterial should be considered in aggregate as well as
for each tangible fixed asset. An item of property plant and equipment may be immaterial due
to very long useful economic lives or to a high residual value or to both.
• Expected remaining useful economic life of the tangible fixed asset exceeds 50 years
Illustration 11b.4 is an accounting policy where no depreciation is charged on the grounds that the
depreciation would be immaterial.
Illustration 11b.4: No depreciation charge
ACCOUNTING POLICIES
FIXED ASSETS (extract)
Residual value is based on prices prevailing at the date of acquisition or subsequent valuation.
Where, because of high estimated residual value, depreciation is immaterial, no depreciation is
charged but an annual review for impairment is performed. Both residual values and useful
lives are reviewed and adjusted, if appropriate, at each financial year end.
(Source: Daniel Twaithes plc Annual Report and Accounts 2014, p. 28)
In both circumstances (no depreciation because (i) immaterial charge, (ii) economic life exceeds 50
years), impairment reviews must be carried out at the end of each reporting period (see further on
in this section for a discussion of impairment)
204

11b.2.8 Change in method
• Only permitted if results in fairer presentation of results/financial position

• Net book value at date of change depreciated prospectively (i.e., from now on, into the future)
under new method
• Disclose (i) effect of change in method in year of change, if material and (ii) reason for change
11b.2.9 Useful economic life
• (Must be) Review annually

• If expectations significantly different from previously - change should be accounted for
prospectively (i.e., from now on, into the future) over remaining useful life i.e., net book amount
should be written off over the remaining useful life.
Example 11b.1 shows the effect on calculating depreciation when the useful life of the asset is
revised.
Example 11b.1: Revision of expected useful life
On 1.1.20X1
• A company bought a machine for €100,000
• Its useful economic life was expected to be 10 years
• Its residual value was assumed to be zero
• The company uses straight-line depreciation
On 1.1.20X5
• The remaining useful life of the machine was expected to be 3 years.
Question
Calculate the depreciation charge (i) for 20X1 to 20X4 and (ii) for 20X5 to 20X7
Solution
Depreciation expense
(i) 20X1 – 20X4 (100,000Cost x 1/10Useful life) €10,000 pa
(ii) 20X5 – 20X7 (100,000Cost – 40,000Agg depr 20X1-20X4=60,000NBV x 1/ 3Revised useful life) €20,000 pa
11b.2.10 Residual value
• Where material, review annually

• Change in estimate is accounted for prospectively (i.e., from now on, into the future)
Example 11b.2 shows the effect on calculating depreciation when the useful life of the asset and the
residual value is revised.
205

Example 11b.2: Revision of expected useful life and estimated residual value
1.1.20X1
• Plant cost €220,000
• Expected useful life 5 years
• Estimated residual value €20,000
1.1.20X2
• Estimated residual value €12,000
Question
Calculate the depreciation charge (i) for 20X1 and (ii) for 20X2 to 20X4
Solution
(i) 20X1 €000
Depreciation (220Cost-20Residual value = 200Depreciable amount x 1/5Useful life) 40
Net book value (220Cost-40Aggregate depreciation) 180
(ii) 20X2, 20X3, 20X4

Depreciation (180Net book value [220cost – 40Aggregate depreciation] - 12Revised residual value =
168Depreciable amount x 1/3Revised useful life) 56
CRH plc’s accounting policy for depreciation in Illustration 11b.5 explains how changes in the accounting
policy are handled.
CRH plc 2015 Q70: How are changes in depreciation methods and/or useful economic lives
reflected in CRH plc’s accounting policies?
Illustration 11b.5: CRH plc’s changes in depreciation accounting policies

Depreciation methods, useful lives and residual values are reviewed at each financial year-end.
Changes in the expected useful life or the expected pattern of consumption of future economic
benefits embodied in the asset are accounted for by changing the depreciation period or
method as appropriate on a prospective basis. For the Group’s accounting policy on
impairment of property, plant and equipment please see impairment of long-lived assets and
goodwill.
206

11b.3 IAS 36 Impairment of Assets
IAS 36 Impairment of Assets explains how an entity reviews the carrying amount of its assets, how
it determines the recoverable amount and when it recognises or reverses the recognition of an
impairment loss.
11b.3.1 Objective
To prescribe procedures to ensure that assets are carried at no more than their recoverable
amount. If the carrying amount of an asset exceeds its recoverable amount, the asset is described
as “impaired”. The standard also prescribes when an entity should reverse an impairment loss and
prescribes disclosures.
11b.3.2 Scope of IAS 36
Applies to the impairment of all assets, other than

• Inventory
• Etc.
11b.3.3 Summary of IAS 36
• Impairment reviews must be carried out at the end of each reporting period in accordance with
IAS 36 Impairment of Assets
• Assets should be carried at no more than their recoverable amount
• If the carrying amount [i.e., net book value] of an item of property plant and equipment is greater
than its recoverable amount Impairment charge
• Any resulting impairment is measured and recognised on a consistent basis (see Section 11c
for more details on accounting for impairment charges)
• Users of financial statements should be aware of the impact of impairment on the financial
position and performance
11b.3.4 Recoverable amount
Higher of an asset’s net selling price and its value in use.
Example 11b.3 shows the effect on calculating depreciation when the recoverable amount of an
asset is reduced.
207

Example 11b.3: Reduction in recoverable amount
As for Example 11b.2 above, but assume recoverable amount was €165,000 at 31.12.20X1.
1.1.20X1
• Plant cost €220,000;
• Estimated residual value €20,000.
• 31.12.20X1 Estimated net selling price is €160,000 and the value in use is €165,000
1.1.20X2
• Estimated residual value €12,000.
Question
Calculate (i) for 20X1 and (ii) for 20X2 to 20X4 (a) the depreciation and (b) the impairment
charge
Solution
(i) 20X1 €000
(a) Depreciation 220Cost-20Residual value = 200Depreciable amount x 1/5Useful life 40
(b) Write down to recoverable amount: Income statement 15
(220Cost-40Depreciation-165Recoverable amount)
Net book value (220Cost-40Depreciation-15Impairment write off) 165
(ii) 20X2, 20X3, 20X4

Depreciation (165Net book value -12Revised residual value = 153Depreciable amount x 1/3Revised useful life) 51
Double entry
(i)(a) Dr Depreciation charge (income statement, cost of sales) 40
Cr Accumulated depreciation 40
(i)(b) Dr Impairment losses (income statement, cost of salesAssume not material) 15
Cr Provision for impairment losses (Accumulated impairment) 15
(ii)(a) Dr Depreciation charge (income statement, cost of sales) 51
Cr Accumulated depreciation 51
208

11b.3.5 Accounting for impairment
Under IAS 1 Presentation of Financial Statements, material items of income and expenditure
[formerly called “exceptional items”] should be shown separately (i) on the face of the income
statement or (ii) in the notes to aid the reader’s comprehension of separate components of income
and expenditure. If shown on the face of the income statement, material items of income and
expenditure (other than discontinued operations which has its own accounting standard and
unique accounting treatment) should be shown as separate one-line items within operating profit,
after distribution costs and administrative expenses, and before finance costs.
IAS 1 suggests that certain specific items (if material) may be shown on the face of the income
statement (i.e., exceptional items):
• Write-downs of property, plant and equipment to recoverable amount, as well as reversals of
such write-downs (see Section 6 of these notes)
Material items of income and expenditure (i.e., exceptional items) are accounted for as follows:
• Shown on a separate line
• On the face of the income statement
• After Distribution Costs and Administrative Expenses, before Finance costs
• Except for the material item of income and expenditure (i.e., exceptional item), Discontinued
Operations, which are accounted for as set out in Section 6.3 of these notes.
11b.3.6 Comparing depreciation charges and impairment charges
Depreciation is a systematic allocation of cost.
Impairment is once-off, occasional arising from annual impairment reviews, which on occasion
reveal recoverable amounts lower than carrying amounts, which results in an impairment charge.
209

11. Accounting valuation issues – Non-Current Assets: 11c: Revaluation

Section 11c: Revaluation

11c.1 Revaluation MCQ11c.1-MCQ11c.7
11c.2 Measurement after recognition Q23 A Company
11c.2.1 Cost model Q24 Components Limited
11c.2.2 Revaluation model Q25 Juniper plc
11c.3 Treatment of gains/losses on revaluation
11c.3.1 IAS 16 Revaluation gains
11c.3.2 IAS 16 Revaluation losses
11c.3.3 IAS 36 Impairment losses
11c.4 Profits/losses on disposal
11c.5 Comprehensive examples of revaluations
11c.1 Revaluation
Unusually for an accounting standard, IAS 16 allows a choice of accounting treatment. After initial
measurement (at cost – see Section 11a.2.5), companies may choose to continue to value property,
plant and equipment at cost, or may choose to revalue their property, plant and equipment.
11c.2 Measurement after recognition (IAS 16, paragraph 29-42)
An entity shall choose as its accounting policy, and shall apply that policy to an entire class of
property, plant and equipment, either
• Cost model or
• Revaluation model
11c.2.1 Cost model (IAS 16, paragraph 30)
After recognition as an asset, initially measured at cost, an item of property, plant and equipment
shall be carried at its:
cost less any accumulated depreciation [IAS 16] and any accumulated impairment losses /
provisions for impairment [IAS 36].
11c.2.2 Revaluation model (IAS 16, paragraph 31-42)
After recognition as an asset, an item of property, plant and equipment whose fair value can be
measured reliably shall be carried at a revalued amount, being:
Fair value at the date of the revaluation less Any subsequent accumulated depreciation [IAS
16] and Subsequent accumulated impairment losses / provisions for impairment [IAS 36].
[Devaluations or impairments must be recognised; the choice is only available in respect of
revaluations].
CRH plc’s accounting policy for property, plant and equipment is shown in Illustration 11c.1.
CRH plc 2015 Q71a: Does CRH disclose any Property, Plant and Equipment at valuation rather than
cost in its 2015/2008 financial statements?
CRH plc 2015 Q71b: What evidence is there that CRH records Property, Plant and Equipment at
valuation rather than cost in its 2015/2008 financial statements?
210

Illustration 11c.1: CRH plc’s valuation of property, plant and equipment

The Group’s accounting policy for property, plant and equipment is considered critical because
the carrying value of €13,062 million at 31 December 2015 represents a significant portion
(41%) of total assets at that date. Property, plant and equipment are stated at cost less any
accumulated depreciation and any accumulated impairments except for certain items that had
been revalued to fair value prior to the date of transition to IFRS (1 January 2004).
Accounting Policies continued

Property, plant and equipment
With the exception of the one-time revaluation of land and buildings noted below, items of
property, plant and equipment are stated at historical cost less any accumulated depreciation
and any accumulated impairments.
(Source: CRH plc Annual Report 2015, p.140; CRH plc Annual Report 2008, p.66, 84)
11c.2.3 Entries to record revaluations
When an item of property, plant and equipment is revalued, any accumulated depreciation at the
date of the revaluation is treated in one of the following ways:
• Proportionate method: Restate accumulated depreciation proportionately with the change in
the gross carrying amount of the asset so that the carrying amount of the asset after
revaluation equals its revalued amount. This method is often used when an asset is revalued
by means of applying an index to its depreciated replacement cost
• Elimination method: Eliminate accumulated depreciation against the gross carrying amount of
the asset and restate the net amount to the revalued amount of the asset. This method is often
used for buildings. This is the method used in Financial Accounting 2 module.
The elimination method involves five steps as follows:
Step  Change amount of asset to revalued amount

Step  Eliminate aggregate depreciation balance (i.e., set the clock back to zero)
Step  Calculate gain or loss on revaluation
Step  Deal with gain on revaluation (see further on in these notes); Deal with loss on
devaluation (see further on in these notes)
Step  Depreciate revalued asset prospectively (i.e., from now on, into the future) over
remaining useful life
Example 11c.1 compares the proportionate approach to recording an asset revaluation compared
with the elimination approach.
211

Example 11c.1: Proportionate versus elimination approaches to revaluation
1 January 20X1
• A machine cost €100 million
• Depreciation is to be charged over five years on a straight-line basis
1 January 20X3
• The machine was revalued
• Replacement cost of a new machine is €210 million
Question
(i) What is the current valuation of the machine?
(ii) What is the revaluation gain/loss?
(iii) How should the revaluation be reflected in the financial statements under
(a) the proportionate method and
(b) the elimination method?
(iv) Show the five steps for recording the revaluation using the elimination method
(v) Show the statement of comprehensive income
(vi) Show the statement of changes in equity
(vii) Show the statement of financial position
Solution
(i) Current value
 €210 million is the replacement cost of a brand new machine with a useful life of 5 years
 Our machine has only 3 years useful life left
 The equivalent replacement cost value of our machine is therefore only €210 million x
3Years left/5Useful life
 = €126 million
(ii) Revaluation gain

Gain or loss on revaluation
€126New valuation – €60Net book value [€100Cost-40Aggregate depreciation]
= €66 million
(iii)(a) Proportionate change in replacement cost

 Value of machine €126 million (from (i) above)
 Restate gross plant and accumulated depreciation by proportionate change in
replacement cost
 i.e., gross up cost, gross up accumulated depreciation
 €210 million – 84 [210 x 2years depreciation/5Useful life] = €126 million
 Asset now in books at €210 million gross valuation and €84 million aggregate
depreciation = €126 million NBV
(iii)(b) Elimination of aggregate depreciation

 Value of machine €126 million (from (i) above)
 Asset to be included in financial statements at revalued amount of €126 million and nil
aggregate depreciation
Comparison of the two approaches

(a) €210 Gross amount - €84Aggregate depreciation = 126NBV
(b) €126 Gross amount - €NilAggregate depreciation = 126NBV
212

Example 11c.1: Proportionate versus elimination approaches to revaluation (contd)
Solution (continued)
(iv)(b) Steps in recording elimination of aggregate depreciation method

Step  Change amount of asset to revalued amount (€100€126 million)
Step  Eliminate aggregate depreciation balance (€40€nil)
Step  Calculate gain or loss on revaluation (€126 – 60 [€100-40] = €66 million)
Double entry to record gain/loss on revaluation:

Dr Property plant and equipment (Step )(100Cost  €126Valuation) 26
Dr Property plant and equipment aggregate depreciation (Step ) 40
(€40Aggregate depreciation  0)
Cr Revaluation reserve (Step ) 66
Step  Deal with gain on revaluation (statement of comprehensive income, statement

of changes in equity, revaluation reserve in the balance sheet)
Step  Depreciate revalued asset prospectively (i.e., from now on, into the future) over
remaining useful life (€126 x 1/3Remaining useful life = €42 million per annum)
(v) Statement of comprehensive income

Statement of comprehensive income for the year ended 31 December 20X3
20X3 20X2
€m €m
Profit for the year X X
Exchange differences in translating foreign operations (X) (X)
Gains on property revaluations 66 X
Other comprehensive income for the year, net of tax X X
TOTAL COMPREHENSIVE INCOME FOR THE YEAR X X

Share Retained Translation Revaluation Total
capital earnings of foreign gain
operations
€m €m €m €m €m
Balance at 1 January 20X3 X X (X) - X
Issue of share capital X X
Dividends (X) (X)
Total comprehensive income for the year X X 66 X
Balance at 31 December 20X3 X X X 66 X
Statement of financial position at 31 December 20X3 (Extract)

EQUITY €m
Share capital X
Retained earnings X
Translation of foreign operations X
Revaluation reserve 66
X
213

11c.3 Treatment of gains/losses on revaluation

(Not applicable to insurance companies)
11c.3.1 IAS 16 Revaluation gains
• Under IAS 16, revaluation gains should be recognised via statement of comprehensive income,
statement of changes in equity, revaluation reserve in the statement of financial position.
• Except those that reverse previous losses on the same asset previously recognised in the income statement,
in which case the revaluation gain should also be recognised in the income statement (any balance of gain
being treated as above).
• Such gain is reduced by depreciation that would have been charged had the loss not be recognised in the
first place.
The double entries to record a revaluation gain are as follows:

Dr Property plant and equipment (Step ) X
Dr Property plant and equipment aggregate depreciation (Step ) X
Cr Revaluation reserve [with gain on revaluation] (Step ) X
OR
Dr Property plant and equipment (Step ) X
Cr Income statement [with amount of gain reversing previous revaluation losses] (Step )
Cr Revaluation reserve [with remaining gain on revaluation] (Step ) X
Illustration 11c.2 shows how Harvey Nash plc accounts for the effects of reversal of impairments.
Illustration 11c.2: Devaluations/impairment reversals
2. Accounting policies (continued)

Where an impairment subsequently reverses, the carrying amount of the asset is increased to
the revised estimate of its recoverable amount, but so that the increased carrying amount does
not exceed the original carrying value prior to any impairment charges. A reversal of an
impairment charge is recognised in the income statement immediately, unless the relevant
asset is carried at a revalued amount, in which case the reversal of impairment loss is treated
as a revaluation reserve adjustment.
(Source: Harvey Nash Group plc Annual Report 2015, p. 43)
In Illustration 11c.3, the reversal of impairment losses (a credit in the income statement) is shown on a
separate line in the income statement of Kingdom Holding Company, thereby treating the reversal as a
material item of income or expense (i.e., exceptional item).
214

Illustration 11c.3: Disclosing reversal of impairment loss
(Source: Kingdom Holding Company Annual Report 2011, p. 25)
Example 11c.2 shows how a revaluation gain is accounted for.
215

Example 11c.2: Revaluation gains
1.1.20X1: Land cost €100,000

1.1.20X5: Following an impairment review, land was devalued to €80,000
1.1.20X8: Land revalued to €150,000
Question
How should the devaluation / impairment / revaluation be recognised in the
Solution
1.1.20X5
Dr Impairment charge - Income statement (maybe as a material item of 20,000
expenditure – recorded on its own separate line in the income statement)
Cr Accumulated impairment losses 20,000
1.1.20X8
Dr Accumulated impairment losses (80Net book value  100Cost) 20,000
Dr Land (100Cost 150Valuation) 50,000
Cr Reversal of impairment charge (Income statement) 20,000
Cr Revaluation reserves 50,000
Via Statement of comprehensive income and
Statement of changes in equity
Statement of financial position
11c.3.2 IAS 16 Revaluation losses
• Revaluation /devaluation/impairment losses should be recognised in the income statement

• Except if asset is carried at a revalued amount: revaluation losses that reverse previous
revaluation gains on that asset which were recognised via statement of comprehensive
income, statement of changes in equity, revaluation reserve in the Equity section of the
statement of financial position
• In which case the loss should also be recognised via statement of comprehensive income,
statement of changes in equity, revaluation reserve in the statement of financial position.
The double entries to record a devaluation are as follows:

Dr Income statement [revaluation loss/devaluation loss/impairment loss] (Step ) X
Cr Property plant and equipment (Step ) X
OR
Dr Revaluation reserve [with amount of loss reversing previous revaluation gains] (Step ) X
Dr Income statement [with balance of loss on revaluation] (Step ) X
Cr Property plant and equipment (Step ) X
11c.3.3 IAS 36 Impairment losses
• An impairment loss should be recognised immediately in the income statement

• Under IAS 1 Presentation of financial statements, write-downs of property plant and equipment
to recoverable amount (as well as reversals of such write-downs), if material, would be
“material items of income or expenditure” i.e., exceptional items – see IAS 1 list of exceptional
items in Section 6.2.3) and therefore shown on their own separate line in the income statement
after distribution costs and administrative expenses.
216

• Except if impairment loss reverses previous revaluation gains  an impairment loss on a revalued asset
should be treated as a “revaluation decrease”, i.e., impairment loss  statement of comprehensive
income, statement of changes in shareholders’ equity,  statement of financial position.
Example 11c.3 shows how a revaluation (devaluation) loss is accounted for.
Example 11c.3: Revaluation losses
1.1.20X1: Land cost €100,000

1.1.20X5: Land revalued to €130,000
1.1.20X8: Following an impairment review, land devalued to €80,000
Question
How should the revaluations be recognised in the financial statements?
Solution
1.1.20X5
Dr Land 30,000
Cr Revaluation reserve (via Statement of comprehensive Income 30,000
Statement of change in equity Statement of financial position)
1.1.20X8
Dr Revaluation reservesReversal of revaluation gain (via Statement of 30,000
comprehensive Income Statement of change in equity Statement of financial
position)
Dr Income statement – Balance of impairment charge 20,000
(130,00020X5 Value-80,00020X8 Value = €50,000Impairment-
30,000Reversal of revaluation gain) = €20,000Remaining impairment
charge
Cr Land (130,000Valuation 100,000Cost) 30,000
Cr Accumulated impairment losses (100,000Cost80,000Devaluation) 20,000
Illustration 11c.4 shows the statement of comprehensive income which includes revaluation gains on
property, plant and equipment, where they exist.
217

CRH plc 2015 Q72: Does CRH have any valuation gains in relation to the value of its property plant
and equipment in its 2015 financial statements?
Illustration 11c.4: CRH plc’s revaluation gains
218

11c.4 Profit/loss on disposal of a revalued asset
Disposal proceeds – carrying amount = profit/loss in the income statement in the period of disposal
Example 11c.4 shows the wrong way and the right way to calculate the profit/loss on disposal of a
(previously) revalued asset.
Example 11c.4: Two ways of calculating profit/loss on disposal of revalued asset
20X1 An asset (land) was purchased costing €100m

20X5 The land was revalued to €130m
20X8 The land was sold for €145m
Question
(a) What is (i) the incorrect and (ii) correct method of calculating the profit or loss on disposal
of the land?
(b) What adjustment is required in the statement of changes in equity?
Solution
(a)(i) Incorrect calculation €m
Treat the asset as having never been revalued (i.e., roll back
the revaluation) which results in higher profit on disposal
Proceeds 145Proceeds - 100Original cost pre-revaluation 45
(a)(ii) Correct calculation €m

Once an asset is revalued, that value become the basis for
calculating profit/loss on disposal
Proceeds 145 Proceeds - 130Revalued amount / net book value / carrying amount 15
(b) Adjustment in statement of changes in equity

Share Retained Revaluation Total
Balance at 1 January 20X5 X X X X
Dividends paid (X)
Statement of comprehensive income X X
Transfer Revaluation Reserves to Retained earnings 30 (30) 0
See Note below
Balance at 1 December 20X5 X X X X
Note: Unrealised gains recognised in the financial statements are recorded in a capital, or
non-distributable reserve. Only realised gains can be recognised in the income statement.
Only realised gains can be distributed to shareholders. When the revaluation reserve is
realised on sale of the asset it can be distributed. This is shown by transferring the non-
distributable unrealised revaluation reserve to the realised distributable income statement.
CRH plc’s statement of changes in equity is shown in Illustration 11c.5. If revaluation gains are realised on
disposal of fixed assets, this would appear in the statement of changes in equity. The revaluation gains
would move from a non-distributable to a distributable reserve, showing that the revaluation gain now
realised can be paid out in dividends to shareholders.
219

CRH plc 2009 Q73: Did CRH dispose of any revalued tangible fixed assets in its 2009 financial
statements?
(2009 was the last year CRH separately identified the revaluation reserve in its note on the
movements in shareholder’ funds [which is now called the statement of changes in equity]). It is
likely the revaluation reserve is no longer considered to be sufficiently material to justify separate
disclosure. However, materiality is set at €36m / €25m according to the external auditor’s reports
for 2015 and 2013 respectively, which raises questions as to whether these disclosures are
immaterial (see Illustration 3.3 and Illustration 3.6).
Illustration 11c.5: CRH plc’s realisation of revaluation gains
(Source: CRH plc Annual Report 2009. p. 119)
220

11c.5 Comprehensive examples of revaluations
Example 11c.5 is a comprehensive exemplar involving revaluation of fixed assets.
Example 11c.5: Accounting for revaluation gains/losses
1.1.20X1: Cost €100,000; Useful life 10 years; Residual value €Nil

1.1.20X5: Assume asset revalued at (a) €125,000 (b) €80,000
Remaining useful life reduced to 5 years; Residual value €Nil
Question
How should the revaluations be recognised in the financial statements?
Solution
Recording/accounting for revaluations:
Step  Change amount of asset to revalued amount
Step  Eliminate aggregate depreciation balance
Step  Calculate gain or loss on revaluation
Step  Deal with gain or loss on revaluation as indicated above
Step  Depreciate revalued asset prospectively (i.e., from now on, into the future) o
remaining useful life
(a) (b)
(W1) Workings €000 €000
1 January 20X5: Cost 100 100
Aggregate depreciation 4 years (40) (40)
Net book value 60 60
Valuation 125 80
Gain 65 20
Double entries
Debit
Fixed assets at €100Cost  €125Valuation (Step 25
)
Aggregate depreciation (Step ) 40 40
Income statement
Credit
Revaluation reserve (Statement of W165 W120
comprehensive income Statement of changes
in shareholders’ equity Balance sheet –
Equity – Revaluation reserves)( Step /)
Fixed assets at €100Cost  €80Valuation (Step ) 20
Where the useful life of an asset is changed, the net book value of the asset at the
date of change must be written off over the remaining useful life. Step .
Therefore the depreciation expense for 20X5 is:
(a) €25,000 (€125,000New value x 1/5New useful life) = €25,000
(b) €16,000 (€80,000New value x 1/5New useful life) = €16,000
Example 11c.6 shows how to calculate the profit or loss on disposal of an asset that has been
previously revalued.
221

Example 11c.6: Profit and loss on disposal of revalued asset
1.1.20X1 Cost €100,000; Useful Life 10 years; Residual value €Nil

1.1.20X5 Valuation €75,000: Remaining life reduced to 5 years
1.1.20X7 Sold €50,000
Question
How should the disposal be recognised in the financial statements for 20X7
Solution
(W1) Workings €
Cost 1 January 20X1 100,000
Aggregate depreciation (100 x 4/10) (40,000)
Net book value 1 January 20X5 60,000
Valuation 1 January 20X5 75,000
Gain on revaluation (Statement of comprehensive income 15,000
Statement of changes in shareholders’ equity Balance
sheet – Equity – Revaluation reserve)
Valuation 1 January 20X5 75,000
Aggregate depreciation 2 years 20X6, 20X7 (75 x 2/5) (30,000)
Net book value 1 January 20X7 45,000
Disposal proceeds 1 January 20X7 50,000
Gain (to income statement) 5,000

Share Retained Revaluation Total
Balance at 1 January 20X7 X X X X
Dividends paid (X)
Statement of comprehensive income X X
Transfer Revaluation Reserves to Retained W115 W1(15) 0
earnings See Note below
Balance at 1 December 20X7 X X X X
Note: Unrealised gains recognised in the financial statements are recorded in a capital, or
non-distributable reserve. Only realised gains can be recognised in the income statement.
Only realised gains can be distributed to shareholders. When the revaluation reserve is
realised on sale of the asset it can be distributed. This is shown by transferring the non-
distributable unrealised revaluation reserve to the realised distributable profit and loss
account.
222

11. Accounting valuation issues – Non-Current Assets: 11d: Government grants

Section 11d: Government grants

11d.1 Possible accounting treatments for government grants MCQ 11d.1-MCQ 11d.3
11d.2 IAS 20 Accounting for Government Grants and Disclosure of Government Assistance Q26 Newtrade Limited
11d.2.1 Definitions in IAS 20 Q27 Mane Limited
11d.2.2 Underlying principles of IAS 20
11d.2.3 Methods of accounting for capital grants
11d.2.4 When to recognise grant
11d.2.5 Rules for matching grant and related expenditure
11d.2.6 Disclosure
11d.3 Examples of accounting treatments for government grants
11d.1 Possible accounting treatments for government grants
Double entry
Dr Bank/Receivable
Cr Government grant (where should this credit balance been recorded?)
 Credit to income statement immediately

 Credit to income statement over life of related asset
 Take straight to reserves, by-passing the income statement
Example 11d.1 is an example showing the three alternative methods of accounting for government
grants above.
223

Example 11d.1: Choices in accounting for a capital grant
On 1 January 20X4, Pastra Ltd. purchased a machine for €60,000 and received a
grant of €20,000 towards its purchase. The machine has a useful life of four years.
Question
• How could the grant be recognised in (i) the income statement and (ii) the
balance sheet in 20X4, assuming:
(a) Credit grant to income statement immediately
(b) Credit grant to income statement over life of related asset
(c) Take straight to reserves, by-passing the income statement
• Show the double entries for each scenario
Solution
(a) (b) (c)
DEBIT €000 €000 €000
Bank 20 20 20
CREDIT
(i) Income statement
Government grant 20 Year 15 Nil
(ii) Balance sheet

Equity
Government grant reserve 20
Current liabilities
Deferred credit - Govt grant €20k x ¼ Year 25
Deferred credit - Govt grant €20k x 2/4 Year 3&410
Double entries
(a) Dr Bank 20
Cr Government grants (income statement) 20
(b) Dr Bank 20
Cr Government grants (deferred credit B/S) 20
Year 1 Dr Government grants (deferred credit B/S) 5
(c) Dr Bank 20
Cr Government grants (Capital reserve B/S) 20
224

(a) Credit to the profit and loss account immediately
This breaches the matching principle.
(b) Credit to the profit and loss account over useful life of asset
This is the correct approach, as it implements the matching principle. The grant is matched against
cost of the related asset (i.e., the annual depreciation on the asset) by amortising it, or releasing it,
to the income statement over the useful life of the related asset.
(c) Credit to reserves
This is reserve accounting which, as described in section 6.1.1. is an accounting abuse of the past,
no longer permitted by accounting standards.
11d.2 IAS 20 Accounting for Government Grants and Disclosure of Government Assistance
IAS 20 deals with both capital and revenue grants which are accounted for differently.
Capital grants relate to “capital expenditure” which is expenditure that is “capitalised”, i.e., recorded on the
balance sheet. This was explained in Section 11a.2. Thus, capital grants relate to property, plant and
equipment recorded on the balance sheet.
Revenue grants, on the other hand, relate to “revenue expenditure” which is expenditure recorded/charged
in the income statement.
11d.2.1 Definitions in IAS 20
Government grants
Government grants are assistance by government in the form of cash or transfers of assets to an
enterprise in return for past or future compliance with certain conditions relating to the operating
activities of the enterprise.
Example 11d.2 shows what happens when the conditions for a government grant are not met. In
this instance, it was a condition of obtaining a grant that the machinery be new. Complex
transactions were entered into to make it appear that the machinery had been bought new when
it was second hand.
225

Example 11d.2: Conditions for receipt of government grants: Case of Tipperary

Anthracite, Flair Resources (Ireland) and Powerscreen International plc
Mr Conor Crowley, a senior partner with accountants Stokes Kennedy Crowley, said
yesterday that his only involvement with the Ballingarry anthracite mines in Co. Tipperary
was as a financial consultant acting at the request of an American Investor in the mines,
Mr Bill Kilkenny, chairman of the Hyster Corporation.
The Fraud Squad has been investigating the circumstances of an application for IDA grant-
aid for equipment to be used in the mining operation.
The mine was operated by a company called Tipperary Anthracite, a subsidiary of Flair
Resources (Ireland) which in turn was a subsidiary of Flair Resources (Canada). Mr
Crowley’s signature appeared on a Tipperary Anthracite cheque for £400,000 in favour of
Powerscreen, which supplied equipment for the mining operation.
Mr Crowley said yesterday that the Hyster chairman, Mr Kilkenny, had been approached
in 1983 by the main shareholders in Flair Resources (Canada) and later put £300,000 into
Flair Resources (Ireland).
Mr Kilkenny asked him, Mr Crowley, to act as a financial consultant to assess the viability
of the mines. Mr Crowley was also authorised by Flair Resources (Canada) to counter-sign
cheques because they wanted him to have sight of any large cheques which Tipperary
Anthracite might be issuing, he said.
It was in this capacity that his signature had appeared on £400,000 cheque, he said. The
cheque referred to equipment which Powerscreen had agreed to defer payment for five
years, without charging interest, he said, an arrangement which he discovered after his
appointment.
In order to make sure that this transaction was accounted for in the books, Powerscreen
and Tipperary Anthracite exchanged cheques for £400,000, Mr Crowley said, adding that
this procedure is not an abnormal one. He had informed the IDA in a letter that
Powerscreen was making a £400,000 loan to Tipperary Anthracite.
He had come to the conclusion that the mine needed a long-term investment of £2 million
to £3 million to make it viable but the banks would not put up the money, he said.
He did not know, even at this stage, if there had been a fraud in connection with any aspect
of the operation of the mining business and his involvement had been purely as a financial
consultant acting at Mr Kilkenny’s request, he said. Mr Kilkenny had lost the £300,000 he
invested in Flair Resources (Ireland) as well as what he had paid for shares in Flair
Resources (Canada), Mr Crowley said.
(Source: Anonymous, (1986) Accountant outlines Ballingarry role, Irish Times 17 March
1986)
Grants related to assets (i.e., capital grants)
Government grants whose primary condition is that an entity qualifying for them should purchase,
construct or otherwise acquire long-term assets. Subsidiary conditions may also be attached
restricting the type or location of the assets or the periods during which they are to be acquired or
held.
226

Grants related to income (i.e., revenue grants)
Government grants other than those related to assets.
11d.2.2 Underlying principles of IAS 20
Matching principle (determines accounting treatment of grant – see Section 11d.2.3)

Prudence concept (determines recognition of grant – see Section 11d.2.5)
11d.2.3 Methods of accounting for capital grants
Two methods of accounting for capital grants and applying matching principle:
1. Net grant off cost of fixed asset and depreciate net amount
2. Carry grant in balance sheet as deferred credit and release it (‘amortise’ it) over useful life of
related asset
Thus, IAS 20 allows an option, but strongly favours deferred credit approach for three reasons:
• Conflict with Paragraph 7 Schedule 3, Companies Act 2014 requirement not to net-off items –
fixed assets not shown at cost
• Amount for fixed assets is disclosed at its original cost (more transparent)
• Amount of credit for grants in the profit and loss account can be disclosed separately under
deferred credit approach (more transparent)
• If grants become repayable (see Section 11d.2.4), the netting approach involves more complex
adjustments to balance sheet.
The grant should be amortised in the income statement, in the same place as the depreciation is
charged on the related property, plant and equipment, i.e., cost of sales, distribution costs,
administrative expenses, depending on the nature of the property, plant and equipment.
11d.2.4 When to recognise grant
Government grants, including non-monetary grants at fair value, should not be recognised in the
profit and loss account until conditions for its receipt have been complied with and there is
reasonable assurance the grant will be received [prudence principle].
If the conditions for receipt of a government grant are breached, the government grant becomes
repayable to the government. In such circumstances, provide for repayment of grants only if
repayment probable (if repayment is possible, then treat it as a contingent liability) (see Section
7.2 and Footnote 5 for definition of Contingent liability; see Table 14.2 on how to account for
contingent liabilities).
Example 11d.3 shows the political ramifications when a multinational withdraws from Ireland
having received taxpayers’ money in the form of a government grant. The news item refers to the
grant becoming repayable consequent on closure of the factory in Clonmel.
227

Example 11d.3: A case of repayment of a government grant
A small town was last night in shock after the bombshell closure of the area's biggest
employer.
More than 1,400 high-tech jobs have gone in Clonmel - a town of just 15,000 people.
The news comes just a week after managers at Seagate said that the company's future
was looking bright.
And just two years after the high-tech company opened.
The demise of the Tipperary plant has also cast doubt on Seagate's promise to create
1,000 more jobs in the south of Ireland next year. Tanaiste Mary Harney, who visited the
workforce yesterday, revealed that the government would now be reluctant to provide
grants and tax relief to the company.
The multi-national giant may be forced to repay a IR£16 million government grant it
received when its Clonmel factory opened to provide jobs for the next century.
(Source: 'I've never seen so many people cry' special investigation: Town in despair after
firm's shock collapse, 12 December 1997
http://www.thefreelibrary.com/'I'VE+NEVER+SEEN+SO+MANY+PEOPLE+CRY'+SPECIA
L+INVESTIGATION%3A+Town+in...-a061049799 – Accessed 4 November 2014)
Repayment should be accounted for by  first setting it against the unamortised deferred credit
relating to the grant in the balance sheet,  with the excess being charged to the profit and loss
account.
Double entry for repayment of a government grant
Dr Government grant (Deferred credit in B/S) X

Dr Government grant (Balance in income statement) X
Cr Bank X
Example 11d.4 shows how to account for a grant in the event it becomes repayable to the state
resulting from breach of conditions for the grant.
228

Example 11d.4: How to account for repayment of a capital grant
On 1 January 20X4, Pastra Ltd. purchased a machine for €60,000 and received a grant of
€20,000 towards its purchase. The machine has a useful life of four years. On 31 December
20X5, conditions of the grant were breached and grant had to be repaid.
Question
• How should (a) the grant and (b) the repayment of the grant be recognised in: (i) the
income statement and (ii) the balance sheet in 20X4 and 20X5, assuming the grant is
credited to the income statement over life of related asset (i.e., assuming the deferred
credit method is adopted)?
• Show the double entries for the repayment of the grant on 31 December 20X5
Solution
20X4 20X5
€000 €000
DEBIT
Bank 20
CREDIT
(a) Amortisation of government grant (€20k ÷ 4years) 5 5
(include in the same expense heading as depreciation
on the related asset)
(b) Repayment of government grant (10) 
(20Grant-520X4-520X5-20Repayment)
(ii) Balance sheet

Current liabilities
(a)+(b) Deferred credit - Govt grant €20k x ¼ Year 25 Nil 5Opening balance P/L 20X5
(a)+(b) Deferred credit - Govt grant €20k x 2/4 Year 3&410 Nil (10O.Bal-10Repayment)
20
Double entry for repayment of grant

Dr Government grants (deferred credit balance sheet ) 10
Dr Government grants (income statement ) 10
Cr Bank 20
11d.2.5 Rules for matching grant and related expenditure
• Recognise grant in the income statement so as to match it with expenditure to which it is to

contribute
• Assume it contributes to whatever expenditure is the basis for its receipt
Capital grant
• If grant contributes to fixed assets, recognise over useful economic lives of related assets
Capital grant
Revenue grant
• If grant is to give immediate financial support/to reimburse costs already incurred, recognise
in the profit and loss account when it becomes receivable Revenue grant
• If grant relates to a specific period recognise it in the period in which it is paid Revenue grant
229

11d.2.6 Disclosure
1. Accounting policy for government grants

2. Effect of government grants on results for period
3. Effects of government grants on financial position should be shown
4. Potential liability to repay grants
Illustration 11d.1 reproduces CRH plc’s accounting policy on government grants. The accounting
policy dates back to 2009 and is no longer included in the financial statements, presumably
because the amounts for government grants are immaterial. Only significant accounting policies
are included in company financial statements. The balance sheet amounts for capital grants in 2009
are shown in Illustration 11d.2. They amounted to €12 million, which in the context of the other
numbers in the CRH plc financial statements appears small/immaterial. The note (Note 29) to the
balance sheet on capital grants is shown in Illustration 11d.3
CRH plc 2009 Q74: What is CRH plc’s accounting policy for government grants?
Illustration 11d.1: CRH plc’s government grants accounting policy

Government grants
Capital grants are recognised at their fair value where there is reasonable assurance that the
grant will be received and all attaching conditions have been complied with. When the grant
relates to an expense item, it is recognised as income over the periods necessary to match the
grant on a systematic basis to the costs that it is intended to compensate. Where the grant
relates to an asset, the fair value is treated as a deferred credit and is released to the
Consolidated Income Statement over the expected useful life of the relevant asset through
equal annual instalments.
CRH plc 2009 Q75: Where does CRH plc’s disclose government grants (i) in its income statement;
(ii) in its consolidated balance sheet?
Illustration 11d.2: CRH plc’s government grants in the balance sheet
230

CRH plc 2008 Q76: What does CRH disclose in its financial statements concerning government
grants?
Illustration 11d.3: CRH plc’s government grants disclosures
11d.3 Examples of accounting treatments for government grants
Example 11d.5 is a comprehensive exemplar of the accounting treatment of a government grant

over the useful life of the related asset.
231

Example 11d.5: Comprehensive cradle-to-grave example of accounting for a capital

grant under IAS 20
On 1 January 20X4, Pastra Ltd. purchased a machine for €60,000 and received a grant of
€20,000 towards its purchase. The machine has a useful life of four years.
Question
How should the fixed asset and the grant be recognised (i) in the income statement and (ii)
in the balance sheet in the four years 20X4 to 20X7?
Solution
The fixed assets should be capitalised and depreciated. The grant should be treated as a
deferred credit in the balance sheet, and should be amortised over the useful life of the asset
to which it relates.
20X4 20X5 20X6 20X7
€000 €000 €000 €000
Depreciation of plant (25% x €60,000) (15) (15) (15) (15)
Amortisation of government grant (25% x Year 15 Year 25 Year 35 Year 45
€20,000) (include in the same expense heading as

depreciation on the related asset)
(ii) Balance sheet

Property plant and equipment
Plant 60 60 60 60
Aggregate depreciation (15) (30) (45) (60)
Net book value 45 30 15 Nil
Current liabilities
Deferred credit - Government grant €20k x ¼ Year 2(5) Year 3(5) Year 4(5)
Deferred credit - Government grant €20k x 2/4; x 1/4 Year 3&4(10) Year 4(5)
Double entry for grant €000 €000

Dr Bank (grant received) 20
Cr Government grants (deferred credit in liabilities in balance sheet) 20
(Being receipt of grant)
Dr Government grants (deferred credit in liabilities in balance sheet) 5

Cr Amortisation of government grant (income statement) 5
(Being amortisation of government grant)
Example 11d.6 addresses how to account for a revenue grant.
232

Example 11d.6: When to recognise a revenue grant
• Astra Ltd. incurred €100,000 on training costs in October 20X7

• A grant of 60% of total costs incurred is due from the government
• The grant formalities were completed by the company’s year end of 31.12.20X7
• The actual payment of the grant is not expected until February 20X8.
Question
(a) When should the grant be recognised – 20X7 or 20X8?
(b) How should the fixed asset and the grant be recognised (i) in the income
statement and (ii) in the balance sheet for the calendar year 20X7/20X8
(depending on your answer to (a))?
Solution
(a) When should the grant be recognised?
Government grants should not be recognised in the profit and loss account until
conditions for its receipt have been complied with and there is reasonable
assurance the grant will be received [prudence principle]. As the grant formalities
were completed by the company’s year end and payment of the grant is expected
in February 20X8, the grant should be treated as receivable and included in the
balance sheet as an asset and should be credited to the profit and loss account for
the year ended 31 December 20X7 in order to match it against the related training
costs.
(b) How should the fixed asset and the grant be recognised?
20X7 Income statement €000
Training costsNote 1 (100)
Government grant (60%) Note 1 60
20X7 Balance sheet

Current assets
Other current assets (Government grant receivable) 60
Double entry for grant

Dr Grant receivable (cash not yet received – Due February 20X8) 60
Cr Government grant - Income statement 60
Note 1 Include in income statement caption/heading to which the training cost relates (e.g., training factory workers – cost of
sales; training office workers – cost administrative expenses;
233

12. Accounting Valuation Issues – IAS 2 Inventories
Section 12: Accounting Valuation Issues – IAS 2 Inventories

12.1 Conceptual and practical measurement issues in valuing inventories
12.2 IAS 2 Inventories MCQ 12a.1 – MCQ 12a.6
12.2.1 Objectives of IAS 2 Q28 Beta plc
12.2.2 Scope of IAS 2 Q29 Lintel plc
12.2.3 Definitions in IAS 2 Q30 Rickatt plc
12.2.4 Measurement of inventories
12.2.5 Accounting treatment MCQ 12b.1 – MCQ 12b.3
12.2.6 Disclosure
12.2.7 Example wording accounting policy note for inventory
12.3 Valuing inventory at cost
12.1 Conceptual and practical measurement issues in valuing inventory
• Closing inventory, similar to property plant and equipment, is a deferred cost held in the
balance sheet until its transfer as an expense (as opening inventory) in the income statement,
to be matched against the related revenue when the inventory is sold. (Please revisit Example
1.15 in Section 1 of these notes.)
• Valuing inventory involves the exercise of subjective judgement

• The amount of the valuation has a direct impact on profit – for 2 years!
Example 12.1 shows the sensitivity of inventory valuation and the direct effect inventory valuation
can have on profit.
Example 12.1: Direct impact of inventory valuation on profit
M plc had sales of €100 during 20X6. The opening inventory was €20, purchases were €120
and closing inventory was (a) €40; (b) €50; (c) €30.
Question
(i) What is the profit for 20X6?;
(ii) What effects do changes in closing inventory have on profits?
Solution
(i) Profit for 20X6 (a) (b) (c)
Sales 100 100 100
Cost of sales
Opening stock 20 20 20
Purchases 120 120 120
Closing stock (40) +10(50) -10 (30)
100 90 110
Gross profit Nil +1010 -10 (10)
(ii) Effects of changes in closing inventory on profits

(b) This year (Year 1): The higher the closing stock the higher the profit
Next year (Year 2): The higher the closing stock in Year 1 the lower the profit in Year 2
(c) This year (Year 1): The lower the closing stock the lower the profit
Next year (Year 2): The lower the closing stock in Year 1 the higher the profit in Year 2
234

Example 12.2 describes how one business man understood the importance of having high levels of
inventory. Of course, this scam only lasts one year. The high closing stock that boosted this year’s
profits will crucify next year’s profits.
Example 12.2: The great salad oil swindle
One of the most famous scams in modern finance occurred in 1960, when Tino De
Angelis, CEO of a very large salad oil company, borrowed $200 million that was secured
by large tanks of salad oil. But unbeknown to the creditors, the company had significantly
overstated its oil inventory using three methods:
(1) 40-foot tanks were filled with 37 feet of seawater, which left 3-feet of oil
floating on top for all the foolish creditors to admire.
(2) Tino listed more tanks on the inventory records than actually existed. Then he
had his men quickly repaint the numbers on the tanks after the creditors had
examined them, thus causing the foolish creditors to count the same tanks
twice.
(3) Tino built underground pipes that could rapidly transfer oil from one tank to
another, causing the same salad oil to be counted twice by the foolish creditors.
In the end, the foolish creditors were left out in the cold looking for their $200 million
and Tino was put in the slammer for 7 years.
(Source: Wells, Joseph T. (2001) Ghost goods: How to spot phantom inventory. Journal of
Accountancy, 191(6): 33-38)
See also:
http://archive.pixelettestudios.com/hallofinfamy/inductees.php?action=detail&artist=ti
no_deangelis
Objectives of inventory measurement

• Proper determination of income through matching costs with related revenue
• Inventory costs are period costs (and are charged in the income statement as part of
purchases/manufacturing costs in the cost of goods sold amount in the trading account) except
for cost of unconsumed inventories (which are carried forward as deferred costs in  Balance
sheet  Current assets  Inventory)
• Cost of unconsumed inventory in the balance sheet
• Represents deferred costs (to be matched against future revenue when the inventory is sold)
• Inventory is valued at cost
• Except for prudence override – which requires a write-down of inventory to Net Realisable
Value (NRV)[this is similar to the requirement to charge impairment under IAS 36 Impairment
of Assets when the book value of property plant and equipment is higher than its recoverable
amount]
Two considerations affect the calculations:

 Cost flow assumptions: Is it necessary to make cost flow assumptions where identical
(fungible) items are purchased at different costs. Assumptions must be made in deciding
which costs to apply to valuing the inventory at cost. Examples of cost flow assumptions are:
o First in, First out (FIFO): The cost of closing stock is computed, assuming that the goods
purchased (goods in) first are sold (goods out) first, leaving closing stock at the most
recent cost
o Last in, First out (LIFO): The cost of closing stock is computed, assuming that the goods
purchased (goods in) last are sold (goods out) first, leaving closing stock at the oldest
cost
235

o Weighted average: Unit cost is computed as an average cost of identical units purchased
at different costs by reference to the total purchase cost divided by the number of units
purchased
o Current cost: current cost is what is would cost now to replace the closing stock
o Base cost: This assumes that a business cannot operate without a base lower amount /
minimum level of stock which is valued at it cost at the start, with the remaining identical
items valued at their assumed cost flow basis.
Example 12.3 shows the effect on stock valuation of the different assumptions discussed
above.
Example 12.3: Cost flow assumptions: associating costs with units in inventory
• In its first year of trading (i.e., no opening stock), A plc purchased 170 units of
inventory during September 20X6 at various and increasing prices/costs
• On 30th September 20X6, 80 units remained in inventory
• The replacement price/cost was €1.60 per unit.
• A plc cannot operate without a minimum level of stock of 40 units
• The following table summarises inventory movements and related costs of purchases:
Date Purchases Unit Total purchases Date Sales

Cost at cost
Units € € Units
01.09.20X6 100 1.00 100 08.09.20X6 60
11.09.20X6 50 1.20 60 15.09.20X6 20
21.09.20X6 20 1.50 30 24.09.20X6 10
___ 30.09.20X6 Bal. c/d 80
170 €190 170
01.10.20X6 80
Question
Value the remaining 80 units of inventory at cost, making the following assumptions with
respect to cost flows:
(1) FIFO
(2) LIFO
(3) Weighted average
(4) Current cost
(5) Base inventory (assuming 40 units of base inventory)
(5A) Base inventory and FIF0
(5B) Base inventory and weighted average
Solution
Each assumption gives different amounts for closing inventories.
1. FIFO:
Assume units acquired first, are used first. Month end inventory, therefore, comes from:
€
10 units (1001st purchase 1.9.X6 – [601st sale 8.9.X6 + 202nd sale 15.9.X6 + 103rd sale 24.9.X6) @ €1.00 10
50 units (2nd purchase 11.9.X6) @ €1.20 60
20 units (3rd purchase 21.9.X6) @ €1.50 30
80 units Cost of closing inventory 100
236

Example 12.3 (continued): Association of costs with units in inventory
2. LIFO:
Assume units used come from most recently acquired. Month end inventory, therefore, is
based on a comparison of outputs with most recent inputs:
€
40 units (1001st purchase 1.9.X6 – 601st sale 8.9.X6) @ €1.00 40
30 units (502nd purchase 11.9.X6 – 202nd sale 15.9.X6) @ €1.20 36
10 units (203rd purchase 21.9.X6 – 103rd sale 24.9.X6) @ €1.50 15
3. Weighted average:
Average cost per unit is €1.12 (€190Total purchases at cost ÷ 170Units purchased)
80 units @ €1.12 = Cost of closing inventory €89.60
4. Current cost:
Replacement cost at period end
80 units x €1.60 = Cost of closing inventory €128
5. Base (cost) inventory:

A fixed unit cost would be attached to a predetermined number of units in inventory to
reflect the minimum inventory level anticipated over the long term. Any excess over this
minimum would be valued using weighted average, FIFO, or LIFO. For example, assuming
40 units will be the minimum inventory, these units will be consistently valued at €1 each:
5A. Base (cost) inventory and FIFO €

40 units (Base inventory) @ €1 40
0 units ([1001st purchase 1.9.X6 – 40 Base inventory –601st sale 8.9.X6] @€1
20 units ( [502nd purchase 11.9.X6 – 202nd sale 15.9.X6 – 103rd sale 24.9.X6] @€1.20 24
20 units (3rd purchase 21.9.X6) @ €1.50 30
5B. Base (cost) inventory and weighted average €

40 units (Base inventory) @ €1Original cost 40.00
40 units (Balance) @ €1.15Weighted average (€190Purchases-€40Base stock ÷ 46.00
80 130Units 170Units purchased-40Base stock)
Cost of closing inventory 86.00
Summary
1.FIFO 2.LIFO 3.WAv 4.CC 5A.BC+FIFO 5B.BC+WAv
Cost of closing inventory 100 91 89.60 128 94 86
Source: Brennan, Niamh and Pierce, Aileen (1996) Irish Company Accounts: Regulation and
Reporting, Oak Tree Press, Dublin, p. 279
CRH plc’s accounting policy for inventories (Illustration 12.1) discloses the cost flow assumptions
applied in valuing inventory.
237

CRH plc 2015 Q77: What cost flow assumptions does CRH disclose in relation to inventory in its
Illustration 12.1: CRH plc’s inventory cost flow assumptions

Inventories and construction contracts – Note 16
Inventories are stated at the lower of cost and net realisable value. Cost is based on the first-in,
first-out principle (and weighted average, where appropriate) and includes all expenditure
incurred in acquiring the inventories and bringing them to their present location and
condition. Raw materials are valued on the basis of purchase cost on a first-in, first-out basis.
In the case of finished goods and work-in-progress, cost includes direct materials, direct
labour and attributable overheads based on normal operating capacity and excludes
borrowing costs.
 Direct costing vs. full absorption costing? Direct costing (see manufacturing accounts, Section
2.2 of these notes) assumes that only direct costs are included in inventory valuation, whereas
full absorption costing is based on the assumption that full (variable and fixed)
production/factory overheads are absorbed into inventory valuation.
12.2 IAS 2 Inventories
12.2.1 Objectives of IAS 2
• Prescribe the accounting treatment for inventories.

• Guidance on the determination of cost and its subsequent recognition as an expense, including
any write-down to net realisable value.
• Guidance on the “cost formulas” (i.e., cost flow assumptions) used to assign costs to
inventories.
Applies to all inventories except:
• Work-in-progress arising under construction contracts, directly related service contracts (IAS
11, Construction Contracts);
• Financial instruments;
• Biological assets related to agricultural activity (IAS 41 Agriculture);
Does not apply to the measurement of inventories held by

• Producers of agricultural and forest products, agricultural produce after harvest, mineral ores
and agricultural produce to the extent that they are measured at net realisable
valueChanges in net realisable value are recognised in the profit and loss account in the
period of change
• Commodity broker traders who measure their inventories at fair value less costs to sell
Changes in fair value are recognised in the profit and loss account in the period of change.
238

12.2.3 Definitions in IAS 2
Inventories
Assets:
• Held for sale in the ordinary course of business (i.e., finished goods stock)
• In the process of production for such sale (i.e., work-in-progress stock) or
• In the form of materials or supplies to be consumed in the production process or in the
rendering of services (i.e., raw material stock) (See Section 2 of these notes on manufacturing
accounts)
Includes:
• Goods purchased and held for resale Retail
• Merchandise purchased by a retailer and held for resale business
• Land and other property held for resale
• Finished goods produced Manufacturing
• Work-in-progress, include materials and supplies awaiting use in the production Business
process
Net realisable value
Estimated selling price in the ordinary course of business less the estimated costs of
completion (only applies to incomplete goods such as raw materials and work in progress and not
to finished goods) and the estimated costs necessary to make the sale. Example 12.4 shows how
net realisable should be calculated.
Example 12.4: Calculating net realisable value
Hug Hess plc manufactures Rooks. Rooks sell at a recommended retail price of €100 each,
to wholesalers who receive a 25% discount on the recommended retail price. A further
discount of 5% is given to customers who pay cash. Estimated marketing selling and
distribution costs are €10 per Rook
Required
You are required to calculate the net realisable value per unit of Rook
Solution
Unit cost
€
Recommended (i.e., list) retail price 100
Wholesalers discount (25%) (25)
Estimated selling price 75
Estimated marketing selling and distribution costs (10)
Total net realisable value per unit 65
The further discount for paying cash (or discount for paying on time) is not a
manufacturing / production cost, and therefore is not an element in the net realisable
value calculation.
CRH plc’s accounting policy note (Illustration 12.2) discloses how it computes net realisable value.
CRH plc 2015 Q78: How does CRH calculate net realisable value as disclosed in the accounting
policy note for inventory disclosed in its 2015 financial statements?
239

Illustration 12.2: CRH plc’s calculating net realisable value

Inventories and construction contracts – Note 16 (extract)
Net realisable value is the estimated proceeds of sale less all further costs to completion, and
less all costs to be incurred in marketing, selling and distribution. Estimates of net realisable
value are based on the most reliable evidence available at the time the estimates are made,
taking into consideration fluctuations of price or cost directly relating to events occurring after
the end of the period, the likelihood of short-term changes in buyer preferences, product
obsolescence or perishability (all of which are generally low given the nature of the Group’s
products) and the purpose for which the inventory is held. Materials and other supplies held
for use in the production of inventories are not written down below cost if the finished goods,
in which they will be incorporated, are expected to be sold at or above cost.
12.2.4 Measurement of inventories
Inventories should be measured at the lower of cost and net realisable value.
This is shown by CRH plc in Illustration 12.3 – the accounting policy on inventory valuation.
CRH plc 2015 Q79: What does CRH disclose in its accounting policy for inventory in its 2015
Illustration 12.3: CRH plc’s inventory valuation accounting policy

borrowing costs.
240

Net realisable value is computed by reference to separate items (or categories of similar items) of
stock and not by reference to stock as a whole. This is exemplified in Example 12.5.
Example 12.5: Lower of cost and net realisable value of separate items
You are given the following information about inventory, of which there is
two categories (A & B)
Net realisable
Cost value
€ €
Item A 100 110
Item B 200 195
300 305
Required
Based on the above, information, at what value should inventory be included
in the published financial statements
Solution
Value each separate category of inventory at the lower of cost and net
realisable value
€
Item A (€100Cost lower than €110NRV) 100
Item B (€€195NRV lower than €200Cost) 195
295
Stocks should be included in the financial statements at €295, not at €300, or
at €305.
Source: Brennan, N. and Pierce, A. (1996) Irish Company Accounts: Regulation

and Reporting, p. 280
Cost of inventories
The cost of inventories should comprise all costs of purchase (e.g., raw materials, transport in,
etc.), costs of conversion (conversion costs are costs incurred to convert raw materials into
finished goods and broadly speaking comprise direct labour and factory overheads) and other
costs incurred in bringing the inventories to their present location and condition. (i.e., full
absorption costing (see Section 2.2 and page 238) – for example, as used in Example 12.6 where
cost comprises Purchase cost + Production overheads).
Costs of purchase
• Purchase price, import duties and other taxes, transport, handling and other costs directly
attributable to the acquisition of finished goods, materials and services.
• Less: Trade discounts (not pay-on-time discounts, which are dealt with in the profit and loss
account [back office] rather than the trading account), rebates and other similar items are
deducted in determining the costs of purchase.
241

Costs of conversion
• Costs directly related to the units of production, such as direct labour.

• Valuing inventory involves the systematic allocation of fixed and variable production
overheads, that are incurred in converting raw materials into finished goods, to units
produced.
• Fixed production overheads are those indirect costs of production that remain relatively
constant regardless of the volume of production, e.g., depreciation and maintenance of factory
buildings, cost of factory management and administration (see Section 2 on manufacturing
accounts)
• Variable production overheads are those indirect costs of production that vary directly, or
nearly directly, with the volume of production, e.g., indirect materials and indirect labour (see
Section 2 on manufacturing accounts)
The valuation of inventory at cost and the initial measurement of property plant and equipment at
cost have commonalities, as illustrated in Table 12.1.
242

Table 12.1: Comparing valuation of property plant and equipment (IAS 16) and inventory at cost (IAS 2)
Property plant and equipment at cost Inventory at cost
• Cost is the fair value of the consideration for • The cost of inventories should comprise all costs of
purchase purchase (e.g., raw materials, transport in, etc), costs
of conversion (conversion costs are costs incurred to
convert raw materials into finished goods and
broadly speaking comprise direct labour and factory
overheads)
• Elements of cost comprise: Costs of purchase
♦ Purchase price (including import duties and non- ♦ Purchase price, import duties and other taxes,
refundable purchase taxes (i.e., Value Added Tax transport, handling and other costs directly
VAT), after deducting trade discounts and attributable to the acquisition of finished goods,
rebates) materials and services.
♦ Less: Trade discounts (not pay-on-time
discounts, which are dealt with in the profit and
loss account [back office] rather than the
trading account), rebates and other similar
items are deducted in determining the costs of
purchase.
Costs of conversion
♦ Any costs directly attributable ♦ Costs directly related to the units of production,
such as direct labour.
♦ to bringing the asset to the location and condition ♦ and other costs incurred in bringing the
necessary for it to be capable of operating in a inventories to their present location and
manner intended by management. condition.
♦ The initial estimate of costs of dismantling and
removing the item and restoring the site on
which it is located, the obligation for which an
entity incurs either when the item is acquired or
as a consequence of having used the items during
a particular period for purposes other than to
produce inventories during that period. (Note:
Costs of dismantling and removal would normally
be immaterial and therefore assumed to be €nil.
Exceptions would be large items of property
plant and equipment such as nuclear plants or oil
rigs).
• Valuing inventory involves the systematic
allocation of fixed and variable production
overheads, that are incurred in converting raw
materials into finished goods, to units produced.
• Fixed production overheads are those indirect
costs of production that remain relatively constant
regardless of the volume of production, e.g.,
depreciation and maintenance of factory buildings,
cost of factory management and administration
• Variable production overheads are those indirect
costs of production that vary directly, or nearly
directly, with the volume of production, e.g.,
indirect materials and indirect labour
243

Table 12.1: Comparing valuation of property plant and equipment and inventory at cost (continued)
Property plant and equipment at cost Inventory at cost

21. Examples of directly attributable costs (i.e.,
incremental avoidable costs)
♦ Costs of employee benefits (i.e., labour costs) of
own employees;
♦ Costs of site preparation and clearance;
♦ Initial delivery and handling costs;
♦ Installation and assembly costs;
♦ Acquisition costs (stamp duties, import duties,
non-refundable purchase taxes)
♦ Professional fees
♦ Dismantling and removal costs
♦ Commissioning and start-up costs – costs of
testing whether the asset is functioning
properly, after deducting the net proceeds from
selling any items produced while bringing the
asset to that location and condition.
NOT:
♦ Costs of opening a new facility
♦ Costs of introducing a new product or service
♦ Costs of conducting business in a new location
or with a new class of customer
♦ Administration and other general overhead
costs;
♦ Employee costs not related to a specific asset
NOT:
♦ Abnormal costs, e.g., Design errors, Industrial
disputes, Idle capacity, Wasted materials,
Production delays, Operating losses due to
suspension of activity during construction.
Cease capitalisation when asset is substantially in a
location and condition necessary for it to be capable of
operating in the manner intended by management.
DO NOT INCLUDE:
♦ Costs incurred while an item capable of
operating in the manner intended by
management has yet to be brought into use or is
operated at less than full capacity
♦ Initial operating losses, such as those that are
incurred while demand for the entity’s output
builds up
♦ Costs of relocating or reorganising part or all of
the entity’s operations.
Example 12.6 involves calculating cost and net realisable value for three categories of stock items and
computing the final stock valuation, depending on whether cost or net realisable value is lower.
244

Example 12.6: Valuing stock at the lower of cost and net realisable value
The following information relates to the closing inventory of El. Iod plc
Item Raw material Production Distribution costs Estimated
cost overheads to be incurred sales price
€000 €000 €000 €000
Nore 800 100 120 850
Gore 500 150 200 700
Core 200 50 100 400
1,500 300 420 1,950
Required
You are required to calculate the value of closing stock for El Iod plc
Solution
€000
Nore (900Cost 800+100 versus 730NRV 850-120) NRV730
Gore (650Cost 500+150 versus 500NRV 700-200) NRV 500
Core (250Cost 200+50 versus 300NRV 400-100) Cost250
Total inventory at lower of cost or net realisable value 1,480
NOT Total (1,800Cost 1,500Raw Materials +300Production overheads 1,530

versus 1,530NRV 1,950Estimated sales price -420 Distribution costs)
Allocation of overheads to units of production
• The allocation of fixed production overheads to the costs of conversion is based on the normal
capacity of the production facilities.
• Normal capacity is production expected to be achieved on average over a number of periods
or seasons under normal circumstances, taking into account the loss of capacity resulting from
planned maintenance.
• Actual level of production may be used if it approximates normal capacity (see Example 12.7a)
• Amount of fixed overhead allocated to each unit of production is not increased as a
consequence of low production or idle plant. (see Example 12.7b)
• Unallocated overheads are recognised as an expense in period in which incurred (see Example
12.7b)
• In periods of abnormally high production, the amount of fixed overhead allocated to each unit
of production is decreased so that inventories are not measured above cost. (see Example
12.7c)
• Variable production overheads are allocated to each unit of production on the basis of the
actual use of the production facilities.
CRH plc’s accounting policy on inventory in Illustration 12.4 details the basis on which overheads
are allocated to inventory.
CRH plc 2015 Q80: on what basis does CRH allocate overheads to its inventory in its 2015 financial
statements?
245

Illustration 12.4: CRH plc’s basis of allocating overheads in inventory valuation

borrowing costs.
(Note: As discussed in Section 2, factory overheads are often allocated or apportioned to units of
production on different bases, the basis being related to the overhead cost to be allocated. The
simplest basis of allocation is on a per-unit basis, treading all units of product as if they were the
same and dividing the factory overhead over the number of units. This simple approach might not
be suitable, for example, between standard and deluxe units of product. A more accurate approach
might be, for example, to allocate (say) rent of property between cost of sales (i.e., production),
distribution and administration based on square footage; cost of the restaurant may be based on
number of employees in the factory (cost of sales), warehouse (distribution costs) or office
(administrative expenses) etc.)
Example 12.7a: Allocating overheads to units of production – normal capacity
A manufacturing company produced 100,000 units of finished goods. Each unit required
raw materials costing €5 and direct labour costing €3. In addition, fixed manufacturing
overheads were incurred amounting to €100,000. The normal capacity is 100,000 units
per annum.
Required
You are required to calculate a unit cost for the units of production
Solution
Unit cost
€
Raw materials 5
Direct labour 3
Factory overhead (€100,000Factory overhead/100,000 Normal capacity/level of activity) 1
Total cost per unit 9
246

Example 12.7b: Allocating overheads – abnormal level of activity (1)

Underproduction
A strike occurred in a manufacturing company and as a result it only produced 60,000

units of finished goods. Each unit required raw materials costing €5 and direct labour
costing €3. In addition, fixed manufacturing overheads were incurred amounting to
€100,000. The normal capacity is 100,000 units per annum.
Required
Solution
Unit cost
€
Raw materials 5
Direct labour 3
Factory overhead (€100,000Factory overhead/100,000Normal capacity/level of activity) 1
Total cost per unit 9
Note: Thus, fixed factory overhead of only 60,000 units x €1 = €60,000 is allocated to
production.
The unallocated overhead of €40,000 [€100,000Factory overheads-€60,000Factory overheads allocated

to production] is written off in the income statement as a period cost (as a material item of
income/expenditure i.e., exceptional item if material), rather than being carried forward
as part of the cost of production, some of which will end up in the inventory asset.
Example 12.7c: Allocating overheads – abnormal level of activity (2)

Overproduction
Due to abnormal demand, a manufacturing company produced 200,000 units of finished

goods. Each unit required raw materials costing €5 and direct labour costing €3. In
addition, fixed manufacturing overheads were incurred amounting to €100,000. The
normal capacity is 100,000 units per annum.
Required
Solution
Unit cost
€
Raw materials 5.00
Direct labour 3.00
Factory overhead (€100,000Factory overhead/200,000Actual level of activity) 0.50
Total cost per unit 8.50
Note: Fixed factory overhead should not be allocated to production/inventory assets
beyond or higher than the actual fixed factory overhead incurred. Thus, in periods of
overproduction, the allocation of fixed factory overheads is based on the higher actual
amount of production, rather than on the normal capacity.
247

Example 12.8: Sensitivity in valuing inventory: Waterford Glass Case
As forecast in the board's announcement of January 24, these results are significantly worse than previously been
expected as a result of serious problems in the Waterford Manufacturing Operation.
In that announcement the board also advised that it had instructed Peat Marwick McLintock to investigate the reasons
for the shortfall in the performance of the Waterford Manufacturing Operation and to determine why the company's
information systems had failed to identify these problems.
This report is now complete and its conclusions have been accepted by the board -- these are:
(i) the board was correct in identifying the need for the restructuring at Waterford in order to secure the future of the
operation in the face of escalating labor cost and the declining U.S. dollar;
(ii) the restructuring was, however, inadequately planned and there were significant shortcomings in its subsequent
management and control;
(iii) when progress fell short of the budgeted level, stocks were over-valued and costs deferred with the results that
misleading information was presented to the board; and that
(iv) although there is an improving trend at Waterford, management's ability to reach realistic long-term agreements
with the workforce will not only be critical to Waterford's future, but will be a key factor in the timing of the operation's
return to profitability.
…
In December 1988, an internal review indicated that actual progress on the restructuring was significantly slower than
had been indicated in reports to the board.
As a result, Peat Marwick McLintock were instructed to investigate the reasons for the shortfall in the performance of
the Waterford Manufacturing Operation and to determine why the company's information systems had failed to identify
the problems.
This report is now complete and its recommendations have been accepted by the board.
Whilst financial and operating disciplines have already been strengthened and controls have been reinforced, further
systems developments and improvements in the planning process are essential.
It will, however, take both time and additional resources to implement fully the recommendations.
The report confirms that the board was correct in identifying the need for the restructuring. However, it concludes that
the projections, on which the plan had been based, significantly underestimated the potential cost and the time required
for the benefits of the new technology and reduced labor force to be reflected in the operating results.
In addition to inadequacies in its planning, there were significant shortcomings in the subsequent management and
control of the restructuring plan.
When progress fell short of the budgeted level, stocks were over-valued and costs deferred, resulting in misleading
information being presented to the board, and consequently, the taking of corrective action was delayed.
By December, the management accounts overstated profits by some IR 15 million pounds of which the over-valuation of
stocks accounted for IR 8 million pounds and cost deferrals the majority of the balance.
It is clear that statements made at the half year, having been based on misleading information from January 1988
onwards, were incorrect.
There was an improving trend during the year and the Waterford Crystal Division incurred an operating loss of IR 12.3
million pounds in the first half and a loss of IR 8.2 million pounds in the second half.
In the light of the information now available, restructuring costs of IR 6.1 million pounds separately identified in the half
year results have no longer been treated as exceptional and this has been reflected in the results above.
(Source: Waterford Glass Group plc makes announcement, Press release, 10 April 1989)
248

Waterford Glass’s stock valuation problems in Example 12.8 arose because stock valuation was not
reduced when production was abnormally low and fell below normal levels of activity (item (iii)
in the example). Unallocated overheads in such circumstances should be written off in the income
statement not carried as part of the stock valuation. The incorrect valuation mislead the board of
directors who did not respond quickly enough to the company’s problems as a result.
I hope the finance director was not one of my former students!
Other costs
Other costs included only to the extent that they are incurred in bringing the inventories to their
present location and condition. For example, it may be appropriate in certain circumstances to
include non-production overheads, or costs of designing products for specific customers.
Costs excluded from the cost of inventories:

• Abnormal wasted materials, labour, or other production costs;
• Storage costs, unless necessary in the production (e.g., maturing whiskey stocks)
• Administrative overheads do not contribute to bringing inventories to their present location
and condition
• Selling costs, e.g., advertising costs.
IAS 2 cross-references to IAS 23 Borrowing Costs. Under IAS 23 Borrowing Costs, limited
circumstances are identified where borrowing costs should be included in cost of inventories
(Inventories that require a substantial period of time to bring them to a saleable condition).
Illustration 12.5 reveals the accounting treatment of borrowing costs in relation to inventory
valuation.
CRH plc 2015 Q81: What costs does CRH include in its inventory valuation disclosed in its 2015
Illustration 12.5: CRH plc’s costs included in inventory valuation

borrowing costs.
Example 12.9 is a more challenging exemplar of calculating the cost of stock.
249

Example 12.9: Valuing inventory at cost
The following details were taken from the production records of a manufacturing company concerning closing
inventory.
€
Raw materials at cost 8,520
Less: Trade discount (426)
Net cost of raw materials 8,094
Import duty 852
8,946
Direct labour costs 7,100
Fixed overheads 2,840
Storage costs since completion 225
Advertising costs _317
19,428
• You discover that one-third of the raw materials above were incurred due to wastage arising from a faulty
machine.
• The normal capacity/level of activity is 2,840 units. Fixed overhead was allocated to production based on
normal capacity.
• Actual production is 2,840 units.
Required
(a) Compute the cost of closing inventory for inclusion in the published financial statements of the company.
(b) How would your answer in (a) change, if you were told that actual production was abnormally low at 2,020
units.
(c) How would your answer in (a) change, if you were told that actual production was abnormally high at 5,680
units.
Solution – Normal / Abnormally low / Abnormally high production

(a) (b) (c)
Normal capacity Abnormally Abnormally high
2,840 units low 2,020 units 5,680 units
Cost of purchase € € €
Raw materials at cost 8,520
Less: Trade discount (426)
Net cost of raw materials 8,094
Import duty 852
Total cost of raw materials 8,946
(a) Cost of raw materials in production (€8,946 x 2/3rd - exclude 1/3rd abnormal wastage) 5,964
(b) Cost of raw materials in production (€5,964 x 2,020 units/2,840 units) 4,242
(c) Cost of raw materials in production (€5,964 x 5,680 units /2,840 units) 11,928
Conversion costs
(a) Direct labour costs (€7,100/2,840 units = €2.50/unit) 7,100
(b) Direct labour costs (€7,100 x 2,020 units/2,840 units OR 2,020 units @ €2.50/unit) 5,050
(c) Direct labour costs (€7,100 x 5,680 units/2,840 units OR 5,680 units @ €2.50/unit) 14,200
Allocation of fixed overheads
(a) based on normal capacity (@€1 per unit €2,840/2,840 units) 2,840
(b) based on abnormally low activity (@€1 per unit €2,840/2,840 units) 2,020
(c) based on abnormally high activity (€0.50 per unit €2,840/5,680 units) ________ ________ 2,840
Total cost of production 15,904 11,310 28,968
Period cost – Unallocated factory overheads written off 820
Note:
• The one-third raw material wastage are not product costs and are expensed immediately in the income
statement
• Storage costs are not product costs, unless necessary in the production (e.g., maturing whiskey stocks).
Include in Distribution Costs in the income statement
• Advertising costs are not product costs and are included in Distribution Costs in the income statement
• Amount of fixed overhead allocated to each unit of production is not increased as a consequence of low
production. This results in unallocated overheads of €820 (2,840Overheads-2,020Overheads allocated) which are
expensed immediately in the income statement.
250

12.2.5 Accounting treatment
Cost
• Cost of inventories should be assigned by using the first-in, first-out (FIFO) or weighted average
cost formulas.
• Use same cost formula for all inventories having similar nature and use to the entity
• For inventories with different nature or use, different cost formulas may be justified
• Assets should not be carried in excess of amounts expected to be realised from their sale or
use.
• Usually written down to net realisable value on an item-by-item basis (see Example 12.5,
Example 12.6).
• May be appropriate to group similar or related items.
Calculating net realisable value
• Estimates of net realisable value based on the most reliable evidence available at the time the
estimates are made.
• Take into consideration fluctuations of price or cost after end of reporting period.
• To extent that such events confirm conditions existing at the end of the period (see Section 15
Events after the balance sheet date)
• Estimates take into consideration the purpose for which the inventory is held e.g., Inventory
held to satisfy firm sales or service contracts.
• A new assessment is made of net realisable value in each subsequent period.
• If circumstances no longer exist, the amount of the write-down is reversed.
When to recognise inventory as an expense
• When inventories are sold the carrying amount should be recognised an as expense in the
period in which the related revenue is recognised.
• Amount of any write-down of inventories to net realisable value and all losses of inventories
shall be recognised as an expense in the period the write-down or loss occurs (possibly as a
material items of income / expenditures (i.e., an exceptional item) – see Section 6.2.3 in these
notes).
• Reversal of any write-down of inventories shall be recognised as a reduction in the amount of
inventories recognised as an expense in the period in which the reversal occurs.
• Some inventories may be allocated to other asset accounts recognised as an expense during
the useful life of that asset.
12.2.6 Disclosure
Disclose:
 Accounting policies in measuring inventories including the cost formula used

 Total carrying amount of inventories in classifications appropriate
 Carrying amount of inventories at net realisable value
 Amount of any reversal of any write-down recognised as income in the period
 Circumstances or events that led to the reversal of a write-down
 Carrying amount of inventories pledged as security for liabilities.
Common classifications of inventories are:

• Merchandise
• Production supplies
• Materials
251

• Work-in-progress
• Finished goods.
CRH plc’s Note 16 (Illustration 12.6) to the balance sheet shows how inventory is classified.
CRH plc 2015 Q82: What categories of inventory does CRH disclose in its 2015 financial
statements?
Illustration 12.6: CRH plc’s inventory categories
12.2.7 Example wording accounting policy note for inventory
 Inventory is valued at the lower of cost and net realisable value,

Cost
on a first in, first out basis (or weighted average).
Cost comprises direct material and labour costs together with an allocation of relevant factory
overheads incurred in
bringing the goods to their present location and condition, calculated on the basis of
normal capacity/normal activity levels.
Net realisable value is based on the estimated selling costs less all further costs to completion
and
all costs to be incurred in marketing, selling and distribution.
Provision is made for obsolete, slow-moving and defective items where appropriate.
The above wording can be applied to analyse CRH plc’s inventory accounting policy in Illustration
12.7.
CRH plc 2015 Q83a: What wording does CRH adopt in relation to valuing its inventory in its 2015
CRH plc 2015 Q83b: How does CRH plc’s inventory accounting policy in relation to valuing its
inventory in its 2015 financial statements compare with the eight items listed above?
252

Illustration 12.7: CRH plc’s inventory valuation accounting policy note

borrowing costs.
12.3 Valuing inventory at cost
 Count and record units of stock (i.e., Opening stockUnits + Purchases/ProductionUnits – SalesUnits =
Closing stockUnits);
 Calculate their direct costs (direct material, labour and other direct costs);
 Make appropriate assumption on cost flows (this is relevant where identical items are
purchased at different costs – mainly FIFO or weighted average)
 to associate different costs at different times with units actually in stock; and
 Calculate the proportion of total production overhead costs (excluding abnormal costs)
attributable to / allocated to units of stock (i.e., based on normal capacity/normal level of
activity – reduce normal level of activity where there is abnormally high production, but not
where production is abnormally low).
253

Example 12.10 shows how the above five steps can be applied to a stock valuation problem.
Example 12.10: Valuing stock at lower of cost and net realisable value
The following information is available concerning C. Old Limited’s production for 20X8:
Units
Opening inventory 2,500
Units produced evenly over year 12,000
(not deemed to be abnormally high level of production)
Units sold 11,500
Closing inventory 3,000
Normal capacity 11,000
• C. Old Limited adopts the FIFO cost flow assumption

• Raw materials cost €1.35 per unit for the first six months of the year, and €1.40 thereafter.
• Labour cost €1.55 for the first 10 months of the year, and €1.60 thereafter.
• Variable production overheads cost €0.35 per unit for the first six months of the year, and €0.40
thereafter.
• Fixed production overheads were €17,325.
Required
Value the finished goods inventory at cost.
Solution
 Count inventory units
2,500Opening inventory + 12,000Produced– 11,500Sales = 3,000Closing inventory (i.e., 3 months’ worth)
 Calculate actual direct costs
€
Raw material (3,000 units @ €1.40Raw material actual cost in Oct, Nov. Dec 20X8 ) 4,200
Direct labour (2,000 units @€1.60DL actual cost in Nov,Dec 20X8 +1,000 units @€1.55DL actual cost in Oct 20X8) 4,750
Variable overhead (3,000 units @ €0.40Variable Overhead actual cost in Oct, Nov. Dec 20X8) 1,200
10,150
 Fixed overhead (€17,325Fixed overhead/11,000Normal capacity = 1.575/unit @ 3,000 units) 4,725
14,875
254

13. Accounting Valuation Issues – IAS 37 – Provisions
Section 13: Accounting Valuation Issues – IAS 37 – Provisions

13.1 Categories of liabilities MCQ 13.1 – MCQ 13.3
13.2 IAS 37 Provisions, Contingent Liabilities and Contingent Assets
13.2.2 Definition of provision
13.2.3 Recognition of provision
13.2.4 Measurement of provision
13.2.5 Disclosure
13.1 Categories of liabilities
Three terms require to be defined in connection with this section of the notes:
Liability
 Entity has a present obligation (to transfer resources)
(As discussed in Footnote 8 in Section 7.3.2, under international accounting standards, proposed
dividends do not meet the definition of a liability and are therefore not recognised (i.e., not
included in the income statement and balance sheet following a double entry) in the financial
statements. Theoretically, shareholders at the annual general meeting could turn down the
directors’ proposals re proposed dividends, thus they are not an obligation of the company until
they are ratified by shareholders at the annual general meeting. Instead, the proposed dividends
are disclosed as a memorandum note to the financial statements.)
Certainty re amount and timing

 Known liability, amount certain, timing certain (e.g., Trade creditor)
 Known liability, amount reasonably certain, timing certain (e.g., Accrual [of an expense])
 Known liability (“obligation”), amount uncertain, timing uncertain (e.g., Provision)
 Unknown liability, amount uncertain, timing uncertain (e.g., contingent liability)
Broadly-speaking, there are two types of provisions:

 Provisions to write down assets are asset valuation issues
o Provision for depreciation (i.e., aggregate/accumulated depreciation) – balance is
subtracted from the related property plant and equipment in the balance sheet
o Provision for impairment (i.e., accumulated impairment) of property, plant and
equipment – balance is subtracted from the related property plant and equipment in the
balance sheet
o Provision for bad debts – balance is subtracted from debtors in the balance sheet
o Provision for obsolete inventory – balance is subtracted from inventory in the balance
sheet
o Provision for future losses/liabilities – liability in liability sections of the balance sheet;
usually long-term/non-current liabilities.
13.2 IAS 37 Provisions, Contingent Liabilities and Contingent Assets
Sets out conditions to be fulfilled before a provision may be recognised.
Scope
Applies to all financial statements intended to give a true and fair view
255

To ensure appropriate recognition criteria and measurement bases are applied to provisions and
contingencies and that sufficient information is disclosed to enable users to understand their
nature, timing and amount.
Outlaws one of the most prevalent ways of manipulating company profits - ‘big bath’ accounting –
whereby companies make huge provisions for future reorganisations, which are fed back into
income over subsequent years (See also Section 6.1.4 in these notes).
13.2.2 Definition of provision (IAS 37)
Provision
A liability of uncertain timing or amount
13.2.3 Recognition of provision (IAS 37)
Conditions: Provision should be recognised (i.e., debit/credit double entry in the nominal ledger)
only when the following conditions are met:
 Entity has a present obligation as a result of a past event
 Probable transfer of economic benefits will be required
 Reliable estimate can be made of the amount of the obligation
Recognition of provision:
 Debit loss/charge to income statement
 Credit in balance sheet in creditors [or against related asset]
Example 13.1, taken from IAS 37, applies the three conditions to judge whether a provision should
be made.
Example 13.1: Provision – fire
A company suffered a fire in the factory on 19 January 20X6 and lost all its inventory
which was uninsured. The company’s year end is 31 December 20X5.
Question
Should there be a provision at 31 December 20X5?
Solution
 Present obligation as a result of a past event:

There has been no past event – the fire took place after the year end. Therefore there is no
“present obligation” (Condition ) in 20X5.
Conclusion:
No provision is recognised
 Transfer of economic benefits

Not applicable given  above

Not applicable given  above
256

Example 13.2, taken from IAS 37, is another exemplar of applying the three conditions to judge
whether a provision should be made.
Example 13.2: Provision – faulty goods
A company sold goods on 1 January 20X6. It was discovered on 19 January 20X6 that the
goods were faulty. No customer suffered damages as a result of faulty goods. The goods
were recalled by the company and were destroyed. The company’s year end is 31
December 20X5
Question
Solution
 Present obligation as a result of a past event:

The past event is the manufacture of faulty inventory which was in stock at the year
end. The present obligation relates to the impairment in value of the stock which has a
net realisable value of zero (i.e., it had to be scrapped) from its value in the books at
cost.
 Transfer of economic benefits

There will be a loss of economic benefits in that the stock is not saleable and had to be
destroyed.
Conclusion:
A provision is recognised

The amount of the obligation is the value at which the stock has been included in the
balance sheet (generally the cost of the inventory) which now needs to be provide
against in full.
Double entry
Dr Cost of manufacturing faulty goods (Income statement) (possibly as a “material item
of income and expenditure”, separate one-line disclosure on the face of the income
statement”)
Cr Inventory
257

Example 13.3: Provision – contaminated land
An enterprise in the oil industry causes contamination but cleans up only when required
to do so under the laws of the particular country in which it operates. The enterprise has
been contaminating land in a number of countries for several years. Country A in which
the oil industry enterprise operates has enacted legislation requiring cleaning up during
20X5.
Question
Solution
 Present obligation as a result of a past event
The past event is contamination of the land. Because of the new legislation requiring
cleaning up there is a present obligation.
 Transfer of economic benefits in settlement:

Probable
Conclusion:
 Measurement:
Best estimate of the costs of the clean-up.
Double entry
Dr Clean-up costs (Income statement) (possibly in cost of sales or possibly as a
“material item of income and expenditure”, separate one-line disclosure on the face of
the income statement”)
Cr Provision for clean-up costs (balance sheet, non-current liabilities)
258

Example 13.4: Provision – refunds policy
A retail store (e.g., Marks and Spencer) has a policy of refunding purchases by
dissatisfied customers, even though it is under no legal obligation to do so. Its policy of
making refunds is generally known. The company’s experience is that customers
generally return 10% of goods sold in the following month.
Question
Solution
 Present obligation as a result of a past obligating event:

The obligating event is the sale of the product, which gives rise to a constructive
obligation because the conduct of the store has created a valid expectation on the part of
its customers that the store will refund purchases. The obligation will be included in the
financial statements as a provision for refunds, which will probably be charged against
sales in the income statement.
Transfer of economic benefits in settlement:

Probable, as a proportion of goods are returned for refund.
Conclusion:
 Measurement:
Best estimate of the costs of refunds – i.e., 10% of the previous month’s sales.
Double entry
Dr Sales/Sales returns/Sales refunds (Income statement)
Cr Provision for sales returns/sales refunds (balance sheet, Current liabilities)
13.2.4 Measurement of provision (IAS 37)
• Best estimate of expenditure to settle present obligation

• Risks and uncertainties should be taken into account in reaching best estimate
• Amount of provision should be the present value
• The discount rate should be the pre-tax rate reflecting current market assessment of the time
value of money and the risks specific to the liability.
• Future event affecting amount of provision should be reflected where there is sufficiently
objective evidence that they will occur
• Gains from expected (i.e., probable) disposal of assets should not be taken into account (i.e.,
should not be recognised). The non-recognition of the probable inflow of economic benefits is
taken up again in Section 14.2.4)
• Reimbursement from a third party should only be recognised where virtually certain. Show
provision in the profit and loss account net of reimbursement
• Review provisions at each balance sheet date
• Reverse (i.e., release) provision if it is no longer probable that a transfer of economic benefits
will occur
• Provision should only be used for expenditures for which the provision was originally
recognised – provisions released (i.e., unmaking a provision/ reversing a provision)should be
matched against the expenditure when the expenditure provided for now is actual incurred in
the future.
259

13.2.5 Disclosure
For each class of provision

 Opening and closing balances
 Additional provisions during period
 Amounts used (i.e., incurred and charged against the provision) during the period
 Unused amounts reversed during the period
 Increase during the period in discounted amount arising from time or change in the discount rate
(Comparative information is not required)
For each class of provision

 Nature of obligation and likely timing of payment
 Uncertainties about the amount or timing - including major assumptions made
 Amount of any expected reimbursement
Where any information required to be disclosed is not disclosed because it is not practicable, that
fact should be stated, as is exemplified in Illustration 13.1.
Illustration 13.1: Disclosure not practicable
(Source: HSBC annual report, 2009, p. 468)
Example 13.5 reproduces the balance sheet/statement of financial position from IAS 1, which
shows where provisions are disclosed.
Q06: Where are provisions (other than those relating to assets) shown in the IAS 1 Presentation of
Financial Statements example balance sheet?
260

Example 13.5: Statement of financial position in form suitable for publication
The statement of financial position as at 31 December 20X7

20X7 20X6
€000 €000
ASSETS
Non-current assets
Property, plant and equipment X X
Goodwill X X
Other intangible assets X X
Investments in associates X X
Investments in equity instruments (i.e., financial assets) X X
X X
Current assets
Inventories X X
Trade receivables X X
Other current assets X X
Cash and cash equivalents X X
X X
Total assets X X
Equity attributable to owners of the parent
Share capital X X
Retained earnings X X
Other components of equity X X
Total equity X X
Long-term borrowings X X
Deferred tax X X
Long-term provisions X X
Total non-current liabilities X X
Current liabilities
Trade and other payables X X
Short-term borrowings X X
Current portion of long-term borrowings X X
Current tax payable X X
Short-term provisions X X
Total current liabilities X X
Total liabilities X X
Total equity and liabilities X X
Provisions are disclosed in CRH plc’s balance sheet, as shown in Illustration 13.2.
CRH plc 2015 Q84: How much are CRH plc’s provisions (other than those relating to assets) in its
CRH plc 2015 Q85: What does CRH disclose in its accounting policies in respect of provisions in the
Illustration 13.2 shows CRH plc’s provisions in its balance sheet. CRH plc has an accounting policy
for provisions as shown in Illustration 13.3. Completing the trilogy, Illustration 13.4 shows the
note to the balance sheet with detailed disclosures of the provisions.
261

CRH plc 2015 Q86a: How many provisions does CRH disclose in its 2015 financial statements?
CRH plc 2015 Q86b: In relation to each provision balance, what does CRH disclose in its 2015
CRH plc 2015 Q86c: How are amounts for provisions calculated?
Illustration 13.2: CRH plc’s Provisions in the balance sheet
262

Illustration 13.3: CRH plc’s Accounting policy for provisions

Provisions for liabilities – Note 25
A provision is recognised when the Group has a present obligation (either legal or constructive) as a result of a past
event, it is probable that a transfer of economic benefits will be required to settle the obligation and a reliable
estimate can be made of the amount of the obligation. Where the Group anticipates that a provision will be
reimbursed, the reimbursement is recognised as a separate asset only when it is virtually certain that the
reimbursement will arise. The expense relating to any provision is presented in the Consolidated Income Statement
net of any reimbursement. Provisions are measured at the present value of the expenditures expected to be
required to settle the obligation. The increase in the provision due to passage of time is recognised as an interest
expense. Contingent liabilities arising on business combinations are recognised as provisions if the contingent
liability can be reliably measured at its acquisition-date fair value. Provisions are not recognised for future
operating losses.
Rationalisation and redundancy provisions

Provisions for rationalisation and redundancy are established when a detailed restructuring plan has been drawn
up, resolved upon by the responsible decision making level of management and communicated to the employees who
are affected by the plan. These provisions are recognised at the present value of future disbursements and cover only
expenses that arise directly from restructuring measures and are necessary for restructuring; these provisions
exclude costs related to future business operations. Restructuring measures may include the sale or termination of
business units, site closures and relocation of business activities, changes in management structure or a fundamental
reorganisation of departments or business units.
Environmental and remediation provisions

The measurement of environmental and remediation provisions is based on an evaluation of currently available
facts with respect to each individual site and considers factors such as existing technology, currently enacted laws
and regulations and prior experience in remediation of sites. Inherent uncertainties exist in such evaluations
primarily due to unknown conditions, changing governmental regulations and legal standards regarding liability,
the protracted length of the clean-up periods and evolving technologies. The environmental and remediation
liabilities provided for in the Consolidated Financial Statements reflect the information available to management at
the time of determination of the liability and are adjusted periodically as remediation efforts progress or as
additional technical or legal information becomes available. Due to the inherent uncertainties described above,
many of which are not under management’s control, the accounting for such items could result in different amounts
if management used different assumptions or if different conditions occur in future accounting periods.
Legal contingencies
The status of each significant claim and legal proceeding in which the Group is involved is reviewed by
management on a periodic basis and the Group’s potential financial exposure is assessed. If the potential loss from
any claim or legal proceeding is considered probable, and the amount can be estimated, a liability is recognised for
the estimated loss. Because of the uncertainties inherent in such matters, the related provisions are based on the
best information available at the time; the issues taken into account by management and factored into the
assessment of legal contingencies include, as applicable, the status of settlement negotiations, interpretations of
contractual obligations, prior experience with similar contingencies/ claims, the availability of insurance to protect
against the downside exposure and advice obtained from legal counsel and other third parties. As additional
information becomes available on pending claims, the potential liability is reassessed and revisions are made to the
amounts accrued where appropriate. Such revisions in the estimates of the potential liabilities could have a
material impact on the results of operations and financial position of the Group.
263

Illustration 13.4: CRH plc’s disclosure of provisions
264

14. Accounting Valuation Issues – IAS 37 – Contingent Liabilities and Contingent Assets
Section 14: Accounting Valuation Issues – IAS 37 – Contingent Liabilities and

Contingent Assets

14.1 What is a contingency? MCQ 14.1-MCq14.2
14.2 Standard accounting practice
14.2.1 Definitions in IAS 37
14.2.3 Accounting for contingencies
14.2.4 Disclosure
14.1 What is a contingency?
A contingency is a condition that exists at the balance sheet date whose outcome will be confirmed on the
occurrence or non-occurrence of one or more uncertain future events (Source: Statement of Standard
Accounting Practice (SSAP) 18 Accounting for Contingencies)
(This is referred to in Condition  IAS 37 as “past event”. Also see Section 12.2.5 where the phrase
“conditions existing at the end of the period” was used in connection with the calculation of net realisable
value which should take into account events which confirm “conditions existing at the end of the period”.)
14.2 Standard accounting practice
14.2.1 Definitions (IAS 37)
Contingent liability
(a) a possible obligation that arises from past events and whose existence will be confirmed only by the
occurrence of one or more uncertain future events not wholly within the entity’s control; and
(b) a present obligation that arises from past events but is not recognised because:
(i) it is not probable that a transfer of economic benefits will be required to settle the obligation (i.e.,
IAS 37 Condition ); or
(ii) the amount of the obligation cannot be measured with sufficient reliability (i.e., IAS 37 Condition
).
A liability / loss (i.e., provision) should only be recognised where:

• there is sufficient evidence to indicate that there is an obligation to transfer economic benefits as a
result of past events (i.e., IAS 37 Condition )
• a reasonable estimate of the loss can be made (i.e., IAS 37 Condition )
Contingent asset
A possible asset that arises from past events and whose existence will be confirmed only by the occurrence
of one or more uncertain future events not wholly within the entity’s control.
14.2.2 Scope
Applies to all financial statements intended to give a true and fair view
265

14.2.3 Accounting for contingencies (IAS 37)
An entity should not recognise (i.e., no debit (charge) or credit entry) a contingent asset or liability.
Example 14.1 applies the three conditions of IAS 37 in deciding whether to provide or disclose an item as
a contingent liability.
Example 14.1: Contingent liabilities
In December 20X5, a customer tripped and suffered serious injuries on the company’s
premises. The customer had sued the company for €1.5 million. The company’s health
and safety procedures were found to be flawed and it has been advised by its lawyer that
the customer is likely to be awarded damages of €1 million. The company’s year end is
31 December 20X5.
Question
How would you account for the above?
Solution
(i) The company needs to provide for the probable liability to the injured customer
 Present obligation as a result of a past event
The past event is the injury to the customer. The company has an obligation / liability to
the customer because of its negligence concerning health and safety.
Transfer of economic benefits in settlement:

Probable economic transfer as per lawyer’s advice
Conclusion:
 Measurement:
Best estimate of the liability to the customer on legal advice is €1 million.
Double entry
Dr Customer damages (Income statement) (possibly as a “material item of income and
expenditure”, separate one-line disclosure on the face of the income statement”) €1m
Cr Provision for legal settlement (balance sheet, non-current liabilities) €1m
(ii) The company needs to disclose a contingent liability for the possible liability to the
injured customer
Although the company’s lawyer has indicated that the likely damages are €1 million, it is
possible the company will be found liable for the whole amount of the customer’s claim
of €1.5 million. Accordingly, in addition to the provision, the company needs to disclose
a contingent liability of €0.5 million
266

14.2.4 Disclosure (IAS 37)
• For each class of contingent liabilities:

♦ Estimate of financial effect
♦ Indication of uncertainties re amount or timing of outflow
♦ Possibility (sic – I think this should be “virtually certain”) of any reimbursement
• Where an inflow of economic benefits is probable, disclose brief description of contingent assets and
estimate of financial effect (see Provisions – Section 13.2.4 of these notes – Gains from expected
disposal of assets should not be taken into account)
• If disclosure is not practical, that fact should be stated
Where any information required to be disclosed is not disclosed because it is not practicable, that
fact should be stated. In Illustration 14.1, HSBC Holdings plc takes advantage of this exemption in
relation to litigation.
Illustration 14.1: Non-disclosure due to impracticability
Other litigation
These actions apart, HSBC is party to legal actions in a number of jurisdictions including
the UK, Hong Kong and the US arising out of its normal business operations. HSBC
considers that none of the actions is material, and none is expected to result in a
significant adverse effect on the financial position of HSBC, either individually or in the
aggregate. Management believes that adequate provisions have been made in respect of
the litigation arising out of its normal business operations. HSBC has not disclosed any
contingent liability associated with these legal actions because it is not practical to do so.
(Source: HSBC Holdings plc Interim report 13 August 2010)
In extremely rare cases, where disclosure can be expected to prejudice seriously the position of
the entity in a dispute, disclosure need not be made (unless disclosure is required by law). Disclose
the general nature of the dispute, the fact that and reason why the information has not been
disclosed. Illustration 14.2 concerns this exemption.
Illustration 14.2: Non-disclosure due to seriously prejudicial
(Source: Synarbor PLC Annual Report and Financial Statements 2013)
Illustration 14.3 shows how CRH plc discloses contingent liabilities (these illustrations have
already been shown in Section 7.2 and Section 11d.2.6 of these notes).
CRH plc 2008/2014/2015 Q87a: Identify contingent liabilities in CRH’s 2008/2014/2015

CRH plc 2008/2014/2015 Q87b: What is the contingency in each case?
267

CRH plc 2008/2014/2015 Q87c: In relation to each contingency, what does CRH disclose in its
2008/2014/2015 financial statements?
Illustration 14.3: CRH plc’s Disclosure of contingencies

On 30 May 2014 CRH announced that the secretariat of the Competition Commission in Switzerland had
invited CRH plc’s Swiss subsidiaries BR Bauhandel AG, Gétaz-Miauton SA and Regusci Reco SA, to
comment on a proposal to impose sanctions on the Association of Swiss Wholesalers of the Sanitary
Industry and all other major Swiss wholesalers, including CRH plc’s subsidiaries, regarding the pending
investigation into the sanitary (bathroom fixtures and fittings) industry in Switzerland. The secretariat
alleges competition law infringements and proposes a total fine of approximately CHF 283 million on all
parties, of which approximately CHF 119 million (€99 million) is attributable to CRH plc’s Swiss
subsidiaries, based on Swiss turnover.
CRH believes that the position of the secretariat is fundamentally ill-founded and views the proposed
fine as unjustified. The Group has made submissions to this effect to the Competition Commission. Any
decision of the Competition Commission on this matter is not expected before April 2015. Any decision
finding an infringement can be appealed to the Federal Administrative Tribunal, and ultimately to the
Federal Supreme Court. No provision has been made in respect of this proposed fine in the 2014
Consolidated Financial Statements.
Swiss Competition Commission Investigation

In July 2015, the Swiss Competition Commission (“ComCo”) announced its decision to impose fines of
approximately CHF 80 million on the Association of Swiss Wholesalers of the Sanitary Industry (the
“Association”) and on major Swiss wholesalers including certain subsidiaries of CRH in Switzerland. The
full decision of ComCo, setting out the basis of its findings, is expected to be available in March 2016 at
which time CRH has the option to appeal the decision to the Federal Administrative Tribunal, and
ultimately to the Federal Supreme Court. While the Group is of the view that the position of ComCo is
fundamentally ill-founded and that the fine imposed on CRH is unjustified, a provision of €32 million (CHF
34 million), representing the full amount of the fine attributed to the Group’s subsidiaries, has been
recorded in the 2015 Consolidated Financial Statements.
268

Illustration 14.3: CRH plc’s Disclosure of contingencies (continuedP
24. Interest-bearing Loans and Borrowings (Extract)

Guarantees
The Company has given letters of guarantee to secure obligations of subsidiary undertakings as follows:
€8.9 billion in respect of loans, bank advances, derivative obligations and future lease obligations (2014:
€5.8 billion), €308 million in respect of letters of credit (2014: €288 million) and €10 million in respect
of other obligations (2014: €5 million).
Pursuant to the provisions of Section 357(1)(b) of the Companies Act 2014, the Company has guaranteed
all amounts shown as liabilities in the statutory financial statements of its wholly-owned subsidiary
undertakings and the Oldcastle Finance Company general partnership in the Republic of Ireland for the
financial year ended 31 December 2015 and as a result, such subsidiary undertakings and the general
partnership have been exempted from the filing provisions of Sections 347 and 348 of the Companies Act
2014 and Regulation 20 of the European Communities (Accounts) Regulations, 1993 respectively.
I include Illustration 14.4 as it relates to a highly colourful event in Irish corporate history (you
wouldn’t believe it if you read it in a novel!). I encourage you to look up the incident on the
internet (for example, see: https://www.theguardian.com/law/2010/nov/18/naked-
sleepwalker-record-libel-payout [accessed 17 November 2017].
Illustration 14.4: Kenmare Resource plc’s disclosure of contingencies

On 17 November 2010, a High Court jury delivered a verdict of damages of €10 million in a defamation
case taken by a former Company Director. The Company submitted an appeal to the Supreme Court with
a view to setting aside both the verdict and the amount, with the intention of securing a retrial. The High
Court granted a stay on the award subject to the payment of €0.5 million until the hearing of the appeal.
The Company’s legal team strongly advise that the award will be set aside on appeal and therefore no
provision has been made in these financial statements for the award as the Company do not consider
that there is any future probable loss. The Company has provided US$1.4 million for the costs associated
with the defamation case appeal and retrial and further actions taken by the former Director, as detailed
in Note 25.
25. Provisions (extract)

On 17 November 2010, a High Court jury delivered a verdict of damages of €10 million in a defamation
case taken by a former Company Director. The Company submitted an appeal to the Supreme Court with
a view to setting aside both the verdict and the amount, with the intention of securing a retrial. The High
Court granted a stay on the award subject to the payment of €0.5 million until the hearing of the appeal.
The Company’s legal team strongly advise that the award will be set aside on appeal. The same former
Director has also served notice that he intends to pursue a number of non-defamation actions against the
Company.
(Source: Kenmare Resources plc Annual Report 2016, p. 163, p. 159)
Table 14.1 compares and contrasts the accounting treatment of provisions, contingent assets and
contingent liabilities. This demonstrates the asymmetric treatment of losses versus gains,
influenced by the prudence principle. Losses are recognised when they are discovered (provide
they meet the three conditions of IAS 37); gains are not anticipated. The phrase “virtually certain”
has already been used in Section 13.2.4 in connection with measurement of provisions
(reimbursement from a third party should only be recognised where virtually certain).
269

Table 14.1: Comparing treatment of provisions, contingent liabilities and contingent assets
Degree of probability Obligation Inflow of economic benefits

Liability/Payable/Loss Asset/Receivable/Gain
 Virtually certain Recognise Recognise
 More likely than not to arise Recognise Note
(expected/probable)
 Less likely than not to arise (possible) Note Ignore
 Remote Ignore Ignore
The summary in Table 14.1 is developed in more detail in Table 14.2 by reference to the
requirements of IAS 37.
Table 14.2: Accounting for gains/losses: Contingent and otherwise
Degree of probability Accuracy of measurement Accounting treatment
A. Payable/Receivable Losses Gains

 Known liability of (reasonably) certain Measurable Dr Income stat Dr Balance sheet
timing/amount (e.g., trade creditors, accruals) Cr Balance sheet Cr Income stat
Known asset (virtually certain) (e.g., trade
debtors)
B. Provision Losses Gains
 Known liability of uncertain timing/amount Measurable Dr Income stat Disclose by note
More likely than not to arise Cr Balance sheet
(expected/probable)
C. Contingent liability Losses
(b) Known liability of uncertain timing/amount Not measurable Disclose by note
More likely than not to arise
(expected/probable)
(a) Unknown liability of uncertain timing/amount Measurable/Not measurable Disclose by note
Less likely than not to arise (possible)
D. Contingent asset Gains
 Reasonably certain/More likely than not to arise Measurable/Not measurable Disclose by note
 (expected/probable)
 Less likely than not to arise Measurable/Not measurable Ignore
(possible)
E. Do nothing Losses Gains
 Remote Measurable/Not measurable Ignore Ignore
IAS 37 definition of contingent liability:

(a) a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence of
one or more uncertain future events not wholly within the entity’s control; and
(b) a present obligation that arises from past events but is not recognised because:
(i) it is not probable that a transfer of economic benefits will be required to settle the obligation; or
(ii) the amount of the obligation cannot be measured with sufficient reliability
270

15. Accounting valuation issues – IAS 10 Events after the Balance Sheet Date
Section 15: Accounting Valuation Issues – IAS 10 Events after the Reporting Period

15.1 International accounting practice MCQ 15.1- MCQ 15.9
15.1.1 Objectives of IAS 10 Q31 Classify Each plc
15.1.2 Definitions in IAS 10 Q32 Tobacco plc
15.1.3 Recognition and measurement – adjusting events Q33 Not Just Toys Limited
15.1.4 Criteria indicating events requiring adjustment
15.1.5 Going concern
15.1.6 Non-adjusting events
15.1.7 Dividends
15.1.8 Disclosure requirements
15.1.9 ‘Window dressing’
15.1 International accounting practice
IAS 10 Events after the reporting period
15.1.1 Objectives of standard
To prescribe:
 When to adjust financial statements for events after balance sheet date
 Disclosures about date when financial statements authorised for issue and about events
after balance sheet date
Financial statements should not be prepared on going concern basis, if events after balance sheet
date indicate that the going concern assumption not appropriate (see Section 3.11 and 4.5.5 for
definition of going concern).
15.1.2 Definition
Events after the reporting period
Those events, both favourable and unfavourable, that occur between the end of the reporting
period and the date when the financial statements are authorised for issue. Two types of events
can be identified:
(a) those that provide evidence of conditions that existed at the end of the reporting period
(b) those that are indicative of conditions that arose after the reporting period
Financial statements are authorised for issue on the date of original issuance, not on date when
shareholders approve financial statements (i.e., the date of the board meeting at which directors
approve the financial statements for issuance, not the date of the Annual General Meeting (AGM)
at which shareholders adopt the financial statements).
271

Example 15.1: Date on which financial statements are authorised for issue
Year end 31 December 20X1

Draft financial statements completed 28 February 20X2
At its board meeting, the board of directors adopts the financial statements on 18 March 20X2
Financial statements made available to shareholders on 1 April 20X2
Shareholders approve financial statements at the annual general meeting on 15 May 20X2
Financial statements filed with the Companies Office 17 May 20X2
Question
What is the date of authorisation for issue of the financial statements?
Solution
the date of authorisation for issue of the financial statements is the date of the board meeting at
which the directors adopted the financial statements, i.e., 18 March 20X2
(Source: IAS 10 Example)
15.1.3 Recognition and measurement - Adjusting events
An entity adjusts the amounts recognised in the financial statements to reflect adjusting events
after the balance sheet date. Adjusting events are those that provide evidence of conditions that
existed at the balance sheet date.
Table 15.1 includes examples of adjusting events after the balance sheet date from IAS 10 that
require an entity to adjust the amounts recognised in its financial statements, or to recognise items
that were not previously recognised, together with identification of the adjustment to be made and
the related double entry.
272

Table 15.1: Recognition & measurement of adjusting events, together with adjustment and related double entry
Adjusting event Adjustment Double entry

(a) the settlement after the balance The entity adjusts (upwards or Dr Expense (caption depends on
sheet date of a court case that confirms downwards) any previously recognised nature of court case)
that the entity had a present obligation provision related to this court case in Cr Provision for litigation costs
at the balance sheet date. accordance with IAS 37 Provisions, (adjust upwards for
Contingent Liabilities and Contingent new/increase in provision)
Assets or recognises a new provision. OR
The entity does not merely disclose a Dr Provision for litigation costs
contingent liability because the (adjust downwards)
settlement provides additional evidence Cr Expense (caption depends on
that would be considered in accordance nature of court case)
with IAS 37.
(b) the receipt of information after the Requires enterprise to Dr Expense (caption depends on
balance sheet date indicating that an (i) adjust [upwards or downwards] a nature of asset impaired)
asset was impaired at the balance sheet provision for impairment (Accumulated Cr Provision for impairment
date, or that the amount of a previously impairment) of property plant and (Accumulated impairment)
recognised impairment loss for that equipment already recognised, or (ii) to (adjust upwards for
asset needs to be adjusted. recognise a new provision for new/increase in provision)
impairment (Accumulated impairment) OR
Dr Provision for impairment
(Accumulated impairment)
(adjust downwards)
Cr Expense (caption depends on
nature of asset impaired)
(b)(i) bankruptcy of a customer that Usually confirms that a loss existed at Dr Bad debt expense (Income
occurs after the balance sheet date. the balance sheet date on a trade statement)
receivable and that the entity needs to Cr Trade receivables/debtors
adjust the carrying amount of the trade (Balance sheet)
receivable
(b)(ii) sale of inventories after the Requires enterprise to (i) adjust Dr Cost of sales
balance sheet date may give evidence [upwards or downwards] a provision Cr Provision for impairment of
about their net realisable value at the for impairment of inventory already inventory (adjust upwards for
balance sheet date. (See also Section recognised, or (ii) to recognise a new new/increase in provision)
12.2.5) provision for impairment of inventory OR
Dr Provision for impairment of
inventory (adjust downwards)
Cr Cost of sales
(c) the determination after the balance Requires enterprise to adjust cost of (i) Dr Property, plant, equipment
sheet date of (i) the cost of assets asset or to record proceeds on disposal Cr Trade and other payables
purchased, or (ii) the proceeds from in the disposal account OR
assets sold, before the balance sheet (ii) Dr Other current assets (proceeds not
date. received (∴ are receivable) at balance sheet date
Cr Disposal account
(d) the determination after the balance Requires enterprise to prepare draft Dr Administrative expenses
sheet date of the amount of profit- income statement, to calculate the Cr Trade and other payables
sharing or bonus payments, if the entity bonus due and to record a provision for
had a present legal or constructive the bonus
obligation at the balance sheet date to
make such payments as a result of
events before that date (see IAS 19
Employee Benefits).
(e) the discovery of fraud or errors that Requires enterprise to adjust for the Not possible to note the double
show that the financial statements are fraud entry without more information on
incorrect. precise details of nature of the fraud
(Source: Paragraph 9, IAS 10)
273

15.1.4 Criteria indicating events requiring adjustment
The criteria distinguishing adjusting post balance sheet events are summarised as follows:
• Culmination of conditions existing at the balance sheet date (i.e., past event) (see Example 13.2)
• Prudence indicates adjustment needed for events affecting realisation of assets or changes in
estimated liabilities
• Prudence indicates that adjustments should not be made so that profit is recognised before
realisation
• Events that bring into question the going concern concept may need to be adjusted for
• Some post balance sheet events are recognised because of statutory requirements or customary
accounting practice e.g., transfers to reserves, effects of changes in taxation, arising for example
from the receipt of information regarding rates of taxes, dividends receivable from
subsidiaries/associates
15.1.5 Going concern
Financial statements are not prepared on a going concern basis if management determines after
the balance sheet date either (i) that it intends to liquidate the entity or to cease trading, or (ii) that
it has no realistic alternative but to do so. Deterioration in operating results and financial position
after balance sheet date may indicate a need to consider whether going concern assumption is still
appropriate. If going concern is no longer considered to be appropriate, and the effect is pervasive,
is comprises a fundamental change in basis of accounting. Indicators of deterioration might include
withdrawal of facilities by the bank, or the withdrawal of custom by a large customer or losing a
large customer through bankruptcy.
(Asset values on a going concern basis of accounting versus the break-up/liquidation basis of
accounting are materially different, with break-up/liquidation valuations generally being much
smaller. In Section 11b.2.11 we saw that property plant and equipment had to be written down to
recoverable amount if it is lower than cost. Recoverable amount is the higher of value in use and
the asset’s selling price. Value in use is almost always higher than the asset’s selling price. Value in
use is not a valuation under the break-up/liquidation basis of accounting).
15.1.6 Non-adjusting events
An entity does not adjust the amounts recognised in the financial statements to reflect non-
adjusting events after the balance sheet date.
Non-adjusting events are those that are indicative of conditions that arose after the balance sheet
date (e.g., a decline in the market value of investments between the balance sheet date and the date
when the financial statements are authorised for issue. For example, that could have arisen in
financial statements for the year ended 31 August 2001. Share prices plummeted when the
airplanes crashed into the twin towers in New York on re 11 September 2001 (colloquially referred
to as “9/11”). The drop in share prices did not relate to conditions existing at the balance sheet
date of 31/8/2001).
The following are ten examples of non-adjusting events after the reporting period taken from IAS
10 that would generally result in disclosure:
(a) a major business combination after the balance sheet date (IFRS 3 Business Combinations
requires specific disclosures in such cases) or disposing of a major subsidiary
(b) announcing a plan to discontinue an operation
(c) major purchases of assets, classification of assets as held for sale in accordance with IFRS 5
Non-current Assets Held for Sale and Discontinued Operations, other disposals of assets and
disposals of assets, or expropriation of major assets by government;
(d) the destruction of a major production plant by a fire after the balance sheet date (see Example
13.1);
(e) announcing, or commencing the implementation of, a major restructuring (see IAS 37);
(f) major ordinary share transactions and potential ordinary share (potential ordinary shares are
financial instruments that could in the future be converted into ordinary shares – see Section
274

10.3.1) transactions after the balance sheet date (IAS 33 Earnings per Share requires an entity
to disclose a description of such transactions, other than when such transactions involve
capitalisation or bonus issues, share splits or reverse share splits all of which are required to
be adjusted under IAS 33);
(g) abnormally large changes after the balance sheet date in asset prices or foreign exchange rates;
(h) changes in tax rates or tax laws enacted or announced after the balance sheet date that have a
significant effect on current and deferred tax assets and liabilities (see IAS 12 Income Taxes);
(i) entering into significant commitments or contingent liabilities, for example, by issuing
significant guarantees; and
(j) commencing major litigation arising solely out of events that occurred after the balance sheet
date.
15.1.7 Dividends
Dividends declared after the reporting period are not recognised as a liability at the end of the
reporting period, because no obligation exists at the end of the reporting period. Such dividends
are disclosed in the notes to the financial statements in accordance with IAS 1 Presentation of
CRH plc 2015 Q88: What does CRH disclose in respect of proposed dividends in its 2015 financial
statements?
Illustration 15.1: CRH plc’s memorandum disclosure on dividends proposed
11. Dividends
15.1.8 Disclosure requirements
1. Date on which financial statements are authorised for issue.
2. Update disclosure about conditions at the balance sheet date

o If entity receives information after balance sheet date about conditions that existed at
balance sheet date, update disclosures.
o Evidence about a contingent liability
• [Adjusting events: No separate disclosure]
3. Material non-adjusting events: If non-adjusting events are of such importance that non-
disclosure would affect ability of users of financial statements to make proper evaluations and
decisions
Disclose the following information (where necessary for a proper understanding of the
financial position):
o Nature of the event
o Financial effect or statement if not practical
o Tax implications of financial effect - only where necessary for a proper understanding of the
financial position
275

CRH plc 2015 & 2014 Q88a: How many post balance sheet events does CRH disclose in its 2015 &
CRH plc 2015 & 2014 Q88b: In relation to each post balance sheet events, what does CRH disclose
in its 2015 & 2014 financial statements?
CRH plc 2015 Q88c: In considering post balance sheet events, what period after the year end did
CRH consider?
Illustration 15.2: CRH plc’s events after the balance sheet date
There have been no acquisitions completed subsequent to the balance sheet date which would be individually material to
the Group, thereby requiring disclosure under either IFRS 3 or IAS 10 Events after the Balance Sheet Date. Development
updates, giving details of acquisitions which do not require separate disclosure on the grounds of materiality, are typically
published in January and July each year.
33. Events after the Balance Sheet Date

On 1 February 2015, CRH announced that it had made a binding irrevocable offer to acquire certain of the businesses and
assets of Lafarge S.A. (‘Lafarge’) and Holcim Limited (‘Holcim’ and together with Lafarge the ‘Sellers’) comprising a global
portfolio of assets in the building materials industry (which are complementary to CRH plc’s footprint) for an enterprise
value of €6.5 billion (based on exchange rates at 30 January 2015). The consideration will be paid in a combination of euro,
Sterling and Canadian Dollars.
The proposed acquisition constitutes a Class 1 transaction under the UKLA Listing Rules and therefore requires the
approval of a simple majority of CRH plc’s shareholders. An Extraordinary General Meeting (‘EGM’) will be held on 19
March 2015 to seek shareholder approval of the acquisition. If the acquisition is not approved by CRH plc’s shareholders at
the EGM, a termination fee of approximately €158 million in total will be payable by CRH to the Sellers. A termination fee
of approximately €158 million will be payable by the Sellers to CRH in either of the following circumstances: 1) if the
Sellers do not accept CRH plc’s offer; or 2) if the proposed merger of Lafarge and Holcim (the ‘Merger’) does not proceed to
successful completion.
The acquisition is also conditional upon: 1) the successful completion of the Merger; and 2) the completion of certain local
reorganisations that need to take place before completion of the acquisition. In addition, CRH has committed to the Sellers
that it will take all steps and do all things necessary to obtain regulatory approvals required in relation to the acquisition.
The long stop date for completion of the acquisition is the earlier of: 1) three months following completion of the Merger;
or 2) 31 December 2015, but in any case no earlier than 31 August 2015.
In connection with the proposed acquisition, CRH completed a placing of 74,039,915 new ordinary shares raising gross
proceeds of approximately €1.6 billion, and representing approximately 9.99% of CRH plc’s issued ordinary share capital
before the placing. Closing of the placing and admission of the placing shares to the official lists and to trading on the main
markets of the London Stock Exchange and Irish Stock Exchange took place on 5 February 2015.
On 1 February 2015, CRH agreed a €6.5 billion senior unsecured bridge loan facility which has subsequently been reduced
by €1.6 billion to reflect the proceeds of the placing and by a further €2.0 billion to reflect other cash balances which are
intended to fund the acquisition. The remaining €2.9 billion of the loan facilities are available to be used to complete the
debt-funded portion of the proposed acquisition. Subject to certain carveouts, the facilities contain provisions requiring
mandatory prepayment from disposal proceeds and the proceeds of capital market transactions. Other terms and
conditions are otherwise substantially similar to CRH plc’s existing €2.5 billion revolving credit facility dated 11 June 2014.
33. Board Approval

The Board of Directors approved and authorised for issue the financial statements on pages 132 to 209 in respect of the
year ended 31 December 2015 on 2 March 2016.
276

15.1.9 ‘Window dressing’
The term “window dressing” was introduced in Section 1.6 of these notes, as follows:
The balance sheet / statement of financial position is a snapshot picture of a

company's financial position at a certain date. The choice of date will affect the
picture portrayed by the balance sheet. Thus the phrase “managing the snapshot”
came up during the Anglo Irish Bank trial in April 2016. The practice of entering
into transactions over the year end to artificially misrepresent the financial
position of a company, known as “window dressing”, can also be described
euphemistically as “balance sheet management”, “managing the snapshot”, “the
calendar effect”, and “putting on your best suit for the photograph” (Brennan,
2016). I call it “fraud”/“fraudulent financial reporting”!
The precursor to IAS 10, Statement of Standard Accounting Practice (SSAP) 17 Post balance sheet
events, first published in 1980, provided specifically for the disclosure of:
“the reversal or maturity after the year end of a transaction entered into
before the year end, the substance of which was primarily to alter the
appearance of the company’s balance sheet”.
This practice is known colloquially as ‘window dressing’.
The word “substance”, brings to mind the fundamental accounting principle (see Section 3.11.1)
“Substance over form”: Transactions and other events and conditions should be accounted for and
presented in accordance with their substance and not merely their legal form. This enhances the
reliability of financial statements. (Paragraph 2.8, FRS 102)
Unusually, the 30 September 2008 (the exact date of the Irish Government bank guarantee 17), the
financial statements of Anglo Irish Bank disclose two incidents of ‘window dressing’ perpetrated
in the 30 September 2007 financial statements:
(i) Refinancing of loans (Illustration 15.4, Illustration 15.5) by Anglo Irish Bank to the Chairman of
the bank, Mr Sean FitzPatrick, and to another non-executive director, Mr Lar Bradshaw, to make
it look as if their personal borrowings from the bank were less than they actually were; and
(ii) Deposits by Irish Life and Permanent plc to Anglo Irish Bank to make the Bank’s balance sheet
look healthier than it actually was (Example 15.3 and Illustration 15.6).
The board of Anglo Irish Bank originally authorised the 2008 financial statements for issue on 2
December 2008. However, when the Anglo directors’ loan issue and the ILP “circular” transaction
came to light on 18 December 2008 and 10 February 2009 respectively, the financial statements
were withdrawn and reissued by the board approximately two months later, as explained in
Illustration 5.2.
17 For details of the Irish bank guarantee see http://www.thejournal.ie/bank-guarantee-oral-

history-30-september-2008-1103254-Dec2014/
277

Illustration 15.3: Date Anglo Irish Bank’s 2008 financial statements authorised for
issue
55. Approval of financial statements

In order to provide additional information in respect of the events described in note 53,
the Group has made amendments to certain disclosure notes contained in the financial
statements originally approved on 2 December 2008. The revised Group financial
statements were authorised for issue by the Board of Directors on 19 February 2009.
(Source: Anglo Irish Bank plc annual report 2008, p. 159)
❶ Disclosure re Window-dressing: Refinancing directors’ personal borrowings
Illustration 15.4 reproduces the related party transaction disclosures. Related parties to a
company include its directors. Note 51(2) in Illustration 15.4 refers to refinancing of €122 million
personal borrowings “shortly before the year end” and that the amounts “were subsequently
redrawn in October 2007”. The repayment/refinancing (and subsequent) re-drawing of loans was
achieved using a mixture of directors’ deposits (Illustration 15.5 – last paragraph) and borrowing
from Irish Nationwide Building Society (Mr Michael Fingleton, CEO) in a process known
colloquially as “bed-and-breakfasting”. Mr Fingleton provided Mr FitzPatrick with a loan to repay
the borrowings as at the year end of 30 September 2007 such that the closing balance showed no
personal borrowings by Mr FitzPatrick. A few days after the year end the transaction was reversed,
and Mr FitzPatrick’s personal borrowings were reinstated.
The scam was discovered in December 2008 before the financial statements for 2008 had been
finalised. Thus, Mr FitzPatrick’s personal borrowings are included in the 30 September 2008
balance sheet (when previously they had been omitted from the balance sheet thanks to the bed-
and-breakfasting arrangement with Mr Michael Fingleton/Irish Nationwide Building Society).
278

Illustration 15.4: Anglo Irish Bank disclosures re directors’ loans
(Source: Anglo Irish Bank Annual Report 2008, p. 148)
279

Illustration 15.5: Anglo Irish Bank disclosures re directors’ deposit accounts
280

❷ Disclosure re Window-dressing: Irish Life & Permanent plc support to Anglo Irish Bank
In September 2008, Anglo Irish Bank suffered huge withdrawals by customers who had become
worried about the credit worthiness of the Bank. Irish Life & Permanent (IL&P) placed €6-7 billion
worth of deposits with Anglo Irish Bank in September 2008 coming up to Anglo Irish Bank’s year
end. On its year-end date, 30 September 2008, in a highly irregular “circular” transaction, Anglo
Irish Bank lent €4bn to Irish Life & Permanent (IL&P) for one day by way of inter-bank loan, and a
subsidiary of Irish Life placed a deposit of a similar amount with Anglo. Further, Anglo Irish Bank
to categorised the deposit as a customer or corporate deposit rather than a short-term inter-bank
deposit, making the asset side of Anglo Irish Bank’s balance sheet look healthier than it really was.
The story is summarised in Example 15.2.
Example 15.2: Anglo Irish Bank – Irish Life and Permanent circular transactions
Irish Life & Permanent confirms "exceptional support" to Anglo Irish Bank during
September 2008; IL&P removed from S&P's CreditWatch Negative list
By Finfacts Team
Feb 11, 2009 - 6:42:02 AM
Irish Life & Permanent plc confirmed on Tuesday that it provided "exceptional support"
to Anglo Irish Bank during September 2008 and in particular on September 30, 2008
following the introduction of the Government Guarantee Scheme. The Irish Financial
Regulator is investigating a deposit of €4 billion, made at the end of September, which
was also the end of Anglo Irish Bank's financial year. Also on Tuesday, Standard & Poor’s
announced that it has removed Irish Life & Permanent plc from CreditWatch Negative
and affirmed its current ratings.
IL&P said on Tuesday:

"During a period of unprecedented turmoil in global financial markets there was an
acceptance that financial institutions would seek to provide each other with appropriate
support where possible.
The transactions were fully and appropriately accounted for in the books and records of
Irish Life & Permanent and in our regular reports and returns to the Financial
Regulator."
It is reported that deposits placed by ILP with Anglo during September amounted to
between €6-€7 billion. The €4 billion that was lodged with Anglo Irish on September
30th, hours after the State’s bank guarantee was announced, was withdrawn by ILP a
week to 10 days later.
The deposit improved Anglo's position, as it had suffered withdrawals of €4 billion

before the State’s bank guarantee was announced, a move that helped to attract other
deposits to the bank.
Illustration 15.6 shows disclosures concerning the ILP circular transaction in the financial
statements for 2008, which were (re)issued after the year-end window-dressing transactions had
been discovered.
281

Illustration 15.6: Anglo Irish Bank disclosures re Irish Life

and Permanent circular transactions
282

Glossary
Term Explanation
Accelerated depreciation Depreciation that is either at a faster rate than would be

suggested by an asset’s expected life or using methods that
charge proportionately more depreciation in earlier years.
Account A record of all the double entries relating to a particular

item. For example, the wages account would record all the
payments of wages. An account in the double-entry system
has a debit side (left) and a credit side (right).
‘Accounts’ may also mean ‘financial statements’ (the

preferred term under modern-day accounting standards),
such as balance sheets and income statements.
Accounting concepts The assumptions underlying the preparation of financial

statements. The basic assumptions of going concern,
accruals, consistency and prudence are included in this
glossary.
Accounting conventions Accounting conventions are fundamental taken-for-granted

assumptions underlying the preparation of financial
statements
Accounting period The period for which financial statements are prepared,
usually one year.
Accounting policies Accounting policies are the specific principles, bases,

conventions, rules and practices applied by an entity in
preparing and presenting financial statements, i.e., that
specify how the effects of transactions and other events are
to be reflected in its financial statements. Frequently there is
more than one acceptable method of accounting for a
particular accounting transaction. Only those accounting
policies that are “material” are disclosed.
Accounting principles In the United States, accounting principles refer to

conventions of practice, but in the United Kingdom/Ireland
they refer to something more fundamental and theoretical.
Thus, the US Generally Accepted Accounting Principles
(GAAP) encompass a wide range of broad and detailed
accounting rules of practice. In the United Kingdom, the
detailed rules are often called practices, policies or bases;
with broader matters such as accruals or conservatism were
traditionally referred to as concepts or conventions. So, in
the United Kingdom/Ireland, GAAP may mean ‘generally
accepted accounting practices’.
283

Glossary
Term Explanation
Accounting standards Technical accounting rules of recognition,

measurement and presentation/disclosure set by
committees of accountants. The exact title of
accounting standards varies from country to country.
The practical use of the words seems to originate
officially with the Accounting Standards Steering
Committee (later the Accounting Standards
Committee) in the United Kingdom in 1970.
Accounts payable Alternative expression for creditors i.e., amounts

owing by a business to suppliers of goods and services.
Accounts receivable Alternative expression for debtors i.e., amounts owing

to a business by customers who have not yet paid for
goods or services received.
Accrual principle The accounting concept which requires that revenues

and expenses are recognised in the accounting period
in which they are earned or incurred rather than in the
period in which they are received or paid.
Accrual An accrual occurs when expenses of one accounting

period are paid in a later accounting period.
Expense incurred but not yet paid for
Accumulated depreciation The total amount by which the accounting value of a

fixed asset has so far been reduced to take account of
the fact that it is wearing out or becoming obsolete
(see depreciation).
Acid test Name sometimes given to a ratio of some of a

business’s liquid assets to some of its short-term debts.
It is thus one test of the likelihood of liquidity
problems. It is also called the quick ratio.
Amortisation Alternative expression for depreciation, particularly

that due mainly to the passage of time. A word used, to
refer to depreciation of intangible assets.
Annual report A report sent annually to the shareholders of a

company. It contains the financial statements and
explanatory notes, the report of the auditors, the
chairman’s statement and the directors’ report.
284

Glossary
Term Explanation
Asset Any property or rights owned or controlled by a

company that have expected future economic benefits.
Associated company A company over which another company or group of

companies has a significant influence. An associated
company is essentially the same as a related company.
A company will normally be assumed to be an
associated/related company if between 20% and 50%
of its ordinary share capital is owned by another
company or group of companies.
Authorised share capital The maximum amount of a particular type of share in a

particular company that may be issued. It may be
interesting information to shareholders as it puts a
limit on the number of co-owners.
Bad debt An amount owing from debtors which is not expected

to be received.
Balance sheet A snapshot of the accounting records of assets,

liabilities and equity of a business at a particular
moment, most obviously the accounting year end.
Bills of exchange A written order directing that a specified sum of money

(payable/receivable) be paid to a specified person on a specified date.
Bonus issues Bonus issues (shares issued for free), sometimes called a
“capitalisation issue” (as reserves are capitalised as share
capital), or a “scrip issue”, takes place when reserves (ofte
capital (non-distributable) reserves such as the share
premium account) are re-designated (“capitalised”) as sh
capital.
Business combinations Acquisitions or mergers involving two or more

companies.
Capital allowances A system of depreciation used in the determination of

taxable income that is unique to the British Isles. This
tends to be more generous than the depreciation that
accountants charge for financial accounting purposes.
Capital employed Usually refers to the total of the funds invested by

shareholders plus the long-term debt.
285

Glossary
Term Explanation
Capital expenditure Expenditure that is recorded on the balance sheet (i.e.,

usually property plant and equipment).
Capital lease US term for finance lease.
Capitalisation This term most often means the inclusion of an item in

a balance sheet. It generally refers to costs. By
capitalising costs, they are not recorded in the income
statement. As a results profits are higher.
Capitalisation is a term also used in relation to

recording reserves as share capital – also called a bonus
issue or scrip issue.
Carried down (c/d)/ carried forward To denote the closing/opening balance

(c/f); Brought down (b/d)/brought
forward (c/f)
Cash flow The receipts of cash by, and payment of cash from, a
business.
Cash flow statement A financial statement that reports the cash receipts and
cash payments of an accounting period. International
Accounting Standard 7 Cash Flow Statements requires
all companies to publish a cash flow statement.
Close company A UK company which is controlled by not more than

five shareholders or their families or partners.
Common stock US term for the ordinary shares in a corporation.

Normally a majority of the ownership capital will
comprise issues of common stock, though
preference/preferred shares are also issued.
Consistency The accounting concept that a company should use the

same accounting policies over time.
Consolidated financial statements A set of financial statements which combine the

accounts of a parent company and its subsidiaries as if
they were a single entity.
286

Glossary
Term Explanation
Contingencies Conditions (usually liabilities) that are known at the

date of balance sheet, but of which the future outcome
(i.e., the amount of the liability) is not known for
certain.
Contingent liabilities Possible future obligations or present obligations that

are remote or unquantifiable. They are not accounted
for, in the sense of adjusting the financial statements,
but are explained in the notes to the balance sheet.
Corporation tax The tax that is payable by companies.
Costs of conversion Conversion costs are costs incurred to convert raw

materials into finished goods and broadly speaking
comprise direct labour and factory overheads.
Cost of sales/cost of goods sold The costs of making the products that have been sold
in a period (usually consists of raw material, labour
and production overhead).
Creditors Amounts owing by a business to suppliers of goods and

services. The US expression is accounts payable.
Current assets Assets which are already in the form of cash or are
expected to be converted into cash within one year
from the date of the balance sheet.
Current cost accounting A system of accounting which adjusts for changing

prices.
Current liabilities Amounts which a company owes which are expected to

be paid within one year from the date of the balance
sheet. (Also referred to as ‘Creditors: amounts falling
due within one year’.)
Current rate method The US term for a method of foreign currency

translation. The UK term is closing rate method,
although this implies some greater flexibility in the
choice of rates.
Current ratio The current assets divided by the current liabilities of

an entity at a particular date.
287

Glossary
Term Explanation
Debentures A certificate acknowledging a debt
Long-term loans which are usually secured on the

assets of a company. The word ‘debenture’ refers to the
legal agreements concerning the loans.
Debtors Amounts owing to a business from customers. The US

terminology is accounts receivable.
Deferred asset A receivable/amount owed to a company that is not

expected to be received within one year from the date
of the balance sheet. This is common when a business
is sold and the consideration for the sale is deferred, to
ensure the business delivers to the purchaser as
promised by the vendor.
Deferred credit Deferred credits are credit balances not recognised in

the current income statement but are held in the
balance sheet for recognition in a future income
statement (thus the word “deferred”). The deferred
credit held is in the balance sheet until it is transferred
to the income statement. Government grants are
deferred credits in the liabilities section of the balance
sheet.
Deferred taxation An estimate of the tax liability payable at some future

date that is due to timing differences in the accounting
treatment and the taxation treatment of some types of
income and expenditure. For example, the depreciation
allowed for tax purposes (capital allowances) may be
greater than the depreciation used for accounting
purposes in the early years of an asset’s life, but the
situation will be reversed in later years.
Depreciation A charge against the profit of an accounting period to

represent the estimated proportion of the cost of a
fixed asset which has been consumed (whether
through use, obsolescence or the passage of time)
during that period.
288

Glossary
Term Explanation
Discount allowed/received Discount allowed is when the seller of goods or

services grants a discount (lower price for
goods/services) to a buyer. Discount received is when
the purchaser of goods or services receives a discount
(lower price for goods/services) from a vendor/seller.
This discount is often allowed/received for paying an

amount due on credit sales on time, or for paying cash
up front, or for buying in high volume, or for buying
during a promotion period when goods or services are
offered at reduced prices.
Dividend The amount distributed to shareholders out of the

profits of a company. Large companies will normally
pay an interim dividend part way through the financial
year, with a final dividend paid after the end of the
financial year when it has been approved by the
shareholders.
Earnings A technical accounting term, meaning the amount of

profit (normally for a year) available to the ordinary
shareholders (UK)/common stockholders (US). That is,
it is the profit after all operating expenses, interest
charges, taxes and dividends on preferred/preference
stock.
Earnings per share (EPS) The most recent year’s total earnings divided by the
average number of ordinary/common shares
outstanding in the year.
Equity An element of the balance sheet showing the owners’

interests. It is equal to the total assets minus the total
liabilities.
Equity method A method of accounting for investments in associated

companies.
Equity share capital An alternative expression for the normal type of

ownership finance, i.e., Ordinary shares. It is defined as
any issued share capital (called ‘company capital’
under the Companies Act 2014) which has unlimited
rights to participate in either the distribution of
dividends or capital.
289

Glossary
Term Explanation
Exceptional items Items shown separately in the income statement that

arise within the ordinary course of business, but are
once-off in terms of unusual size (i.e., material) and
incidence (do not happen often).
Extraordinary items Items of income and expenditure which are significant

in amount and which are outside the normal activities
of a business. They do not form part of the earnings
per share calculations. These have been banned by
standard setters.
Exposure drafts Documents that precede the issue of accounting

standards. They are intended to attract response from
companies, auditors, academics, investment analysts,
financial institutions, etc.
Fair value The amount that willing buyers and sellers would
exchange something for in a market at arm’s length.
For example, assets and liabilities of new subsidiaries
are brought into consolidated financial statements at
fair values rather than book values. This is designed to
be an estimate of their cost to the group at the date of
acquisition of a subsidiary.
FIFO (first-in, first out) A common assumption for accounting purposes about
the flow of items of raw materials or other inventories.
It need not be expected to correspond with physical
reality buy may be used for accounting purposes. The
assumption is that the first units to be received as part
of inventories are the first ones to be used up or sold.
This means that the most recent units are deemed to
be those left at the period end.
Finance lease A contract that transfers the majority of risks and

rewards of an asset to the lessee.
Fiscal year US expression for the period for which companies

prepare their annual financial statements. The
majority of US companies use 31 December as the
fiscal year end, which corresponds with the year end
for tax purposes. In the United Kingdom, the
expression ‘fiscal year’ means tax year.
Fixed assets Assets such as land, buildings and machines which are
intended for use on a continuing basis by the business
rather than for sale.
290

Glossary
Term Explanation
Free cash flow (1) Cash flow after interest, tax, dividends, and capital
expenditure, but before acquisitions and share buy-
backs.
Free cash flow (2) Cash flow available to providers of capital after re-
investment in the existing business (i.e., Operating cash
flow less taxation, less capital expenditure and
acquisitions and disposals).
Generally accepted accounting A widely accepted set of rules, conventions, standards

principles (GAAP) and procedures for reporting financial information, as
established standard setters such as the Accounting
Standards Board (UK), the Financial Accounting
Standards Board (US), the Accounting Standards Board
(International).
A technical term in accounting that encompasses the

conventions, rules and procedures necessary to define
accepted accounting practice at a particular time
Gearing (leverage, borrowing) The proportion of the capital employed of a company

that is financed by lenders rather than shareholders.
Going concern An accounting concept which assumes that a business

will continue in operation for the foreseeable future.
Goodwill The amount paid for a business which exceeds the fair
value of the assets acquired.
Gross profit The difference between the value of sales and the cost
of sales.
Group financial statements The financial statements of a group of companies.

These are usually presented in the form of
consolidated financial statements. UK expression for
consolidated financial statements.
Historical cost accounting The conventional system of accounting under which

assets are recorded at the original cost of acquiring or
producing them.
291

Glossary
Term Explanation
Holding company A company which owns or controls other companies.

(Control can occur through the ownership of 50 per
cent of the voting rights or through the exercise of a
dominant influence.)
Impairment If the carrying amount of an asset exceeds its

recoverable amount, the asset is described as
“impaired”.
Income statement The statement of revenues and expenses of a particular

period, leading to the circulation of net income or net
profit. The format of the income statement is either
‘vertical’/’statement’ form or ‘horizontal’/’two-
sided’/’account’ form. The equivalent UK statement is
the profit and loss account.
Inflation accounting A system of accounting which, unlike historical cost

accounting, takes account of changing prices.
Insolvency This occurs when a business is unable to pay debts as

they fall due.
Intangible assets Assets such as goodwill, patents, trademarks, etc.

which have no physical or tangible form.
Interim dividend Dividend payment bases on all the profits of less than a
full accounting period.
Interim report A half-yearly or quarterly report issued by a company

to its shareholders. Listed companies are required to
publish an interim report.
International Accounting Standards The standard setting body set up in 2001 by the
Board (IASB) International Accounting Standards Committee
Foundation, a private sector trust.
Issued share capital The amount of the share capital of a company that has
been issued to shareholders.
Inventories Raw materials, work-in-progress and goods ready for

sale. In the United Kingdom, the word ‘stocks’ is
generally used instead.
292

Glossary
Term Explanation
Investment properties Properties held by a business for investment or rental

income, rather than for owner-occupation.
Joint venture An entity in which the reporting company holds an

interest on a long-term basis and which is jointly
controlled by the reporting company and one or more
other ventures under a contractual arrangement.
Liabilities The amounts owing by a company. Present obligations

of an enterprise, arising from past events, the
settlement of which is expected to result in an outflow
of resources (usually cash). Most liabilities are of
known amount and date. They include long-term loans,
bank overdrafts and amounts owed to suppliers. There
are current and non-current liabilities. The former are
expected to be paid within a year from the date of the
balance sheet on which they appear. Most measures of
liquidity include the total of current liabilities. Net
current assets is the difference between the current
assets and the current liabilities. Liabilities are valued
at the amounts expected to be paid at the expected
maturity date. In some cases, amounts that are not
quite certain will be included as liabilities (provisions);
they will be valued at the best estimate available.
LIFO (last-in, first-out) One of the methods available under US rules for the
calculation of the cost of inventories, in those frequent
cases where the assets are fungible., i.e.,
indistinguishable from one another (e.g., widgets) . As
a result, it is difficult or impossible to determine
exactly which items remain or have been used. Under
LIFO, it is assumed the last units purchased are the
first to be used. This, in turn, determines the cost to
apply in valuing the closing inventory.
Liquidity The ability of a company to meet its immediate

liabilities.
Listed company A public company listed or quoted on a stock exchange.
Listed investments Investments which are listed or quoted on a stock

exchange.
Loan capital Alternative name for debt capital, i.e., the amounts
borrowed by a company as a long-term source of
finance.
293

Glossary
Term Explanation
Matching A convention that the expenses and revenues

measured in order to calculate the profit for a period
should be those that can be related together for that
period.
Materiality An accounting concept which states that the normal

rules of accounting concerning valuation or disclosure
need only be applied to amounts that are significant or
important.
Minority (non-controlling) interests The share capital of a subsidiary company that is not
held by the parent company. When consolidated
financial statements are prepared, 100 per cent of the
assets, liabilities, revenues and expenses of all
subsidiaries are normally included. However, not all
subsidiaries are 100 per cent owned and in such cases
a minority of the shares will be left in the ownership of
what are known as minority shareholders. The
interests of these minority shareholders in the capital
of the group (i.e., the minority interest) are shown
separately in the consolidated balance sheet.
Net assets The total of all the assets less liabilities (i.e., obligations
of the company to outsiders). This is equal to the
shareholders’ funds/capital/equity i.e., obligations of
the company to its owners).
Net current assets An alternative name for working capital, i.e., the
current assets less current liabilities of a company.
Net income US / international accounting standards expression for

net profit in UK terminology.
Net profit Normal UK expression for the excess of all the

revenues over all the business for a period. The profit
and loss account of a business will show the net profit
before tax and the net profit after tax. The profit is then
available for distribution as dividends (assuming there
is sufficient cash) or for transfer to various reserves.
After any dividends on preference shares have been
deducted, the figure may be called earnings.
Net realisable value The amount at which an asset could be sold less the
costs incurred in its sale.
294

Glossary
Term Explanation
Nominal value Most shares have a nominal or par value. This is little
more than a label to distinguish a share from any of a
different value issued by the same company. Normally,
the shares will be exchanged/traded at above the
nominal value, and the company will consequently
issue any new shares at approximately the market rate.
Dividends may be expressed as a percentage of
nominal value. Share capital is recorded at nominal
value, any excess being recorded as share premium.
Notes to the financial statements Notes to the financial statements provide additional
explanatory information and disclosures on items
appearing in the financial statements.
Off balance sheet financing Financing operations in such a way that some or all of
the finance /liability does not appear as a balance
sheet item.
Operating profit Profit before the deduction of interest and tax.
Ordinary shares Shares which entitle the owners to share in the profits
remaining after deducting loan interest, taxation and
preference share dividends.
Own shares Shares in a company bought back by the company from

its shareholders. In the United States, own shares are
called treasury stock.
Parent company (holding company) A company which owns, or has effective control over,
the activities of another company (its subsidiary).
Post When accountants make entries to the nominal ledger,

they call this “posting”. Posting is the process of
recording amounts as credits (right side), and amounts
as debits (left side), in the nominal ledger.
Post balance sheet events Events occurring after the date of the balance sheet but
before the financial statements are issued. These can
be events that require adjustment of the financial
statement (‘adjusting events’) and events that require
disclosure but do not require adjustment to the
financial statements (‘non-adjusting events’).
295

Glossary
Term Explanation
Preference shares Shares which normally have preference over ordinary

shares for payment of dividends, and for repayment of
capital if a company is wound up. Preference shares are
usually entitled to a fixed rate of dividend.
Prepayment A prepayment occurs when expenses of one accounting

period are paid in advance of that accounting period.
Expense paid for but not yet incurred
Private company A company that is not allowed to issue shares or loan

stock to the public.
Profit The excess of the revenues earned in a period over the

costs incurred in earning them.
Profit and Loss Account The UK expression for the financial statement that
summarises the difference between the revenues and
expenses of a period. Such statements may be drawn up
frequently for the managers of a business, but a full
audited statement is normally only published for each
accounting year. The equivalent US expression is income
statement; and generally, the IASB also uses this term.
Provision An amount charged against profit to provide for an

expected liability or loss even though the amount or date
of the liability or loss is uncertain.
Prudence An accounting concept which requires that provisions be

made for all known liabilities or losses when calculating
profit but that any gains or revenues should only be
included when realised in cash or near cash (e.g.,
debtors).
Prudence is the inclusion of a degree of caution in the

exercise of the judgements needed in making the
estimates required under conditions of uncertainty such
that gains and assets are not overstated and losses and
liabilities are not understated. (IASB Conceptual
Framework 1989, para. 37-38)
Reference to prudence was removed by the IASB in

2010: “Chapter 3 does not include prudence or
conservatism as an aspect of faithful representation
because including either would be inconsistent with
neutrality. (IASB Conceptual Framework 1989, para. BC
3.27)
296

Glossary
Term Explanation
Public company A company whose shares and loan stock may be

publicly traded. A public company must have ‘public
limited company’ (or plc) as part of its name.
Realisation convention A well-established principle of conventional

accounting, that gains or profits should only be
recognised when they have been objectively realised
by some transaction or event. For example, a gain on
revaluation is only realised when the asset is disposed
of for cash.
Realised income/revenue/profit Realised profit is defined by the Companies Act, 1963

(The Schedule Part VII para. 72) as those profits which
fall to be treated as realised in accordance with
generally accepted accounting principles.
Realised income/revenue/profit is that income /

revenue / profit that has been realised in the form of
cash or some other asset the ultimate cash realisation
of which is reasonably certain.
Receivables The IASB and US expression for amounts of money due

to a business; often know as accounts receivable. The
UK term is debtors.
Recognition The process of incorporating an item/transaction in

the income statement/balance sheet in the form of a
double entry. Items not recognised may be disclosed in
a note to the financial statements, e.g., dividends
proposed.
Reconciliation A reconciliation is an explanation of changes in

balances expressed in numerical terms of why one
balance (often the opening balance) changed into
another balance (often the closing balance)
Reducing-balance depreciation A technique of calculating the depreciation charge,

usually for machines, whereby the annual charge
reduces over the years of an asset’s life. A fixed
percentage depreciation is charged each year on the
cost (first year) or the un-depreciated cost
(subsequent years).
297

Glossary
Term Explanation
Registrar of companies A government official who is responsible for collecting

and arranging public access to the annual reports of all
companies.
Related companies The Companies Act term for what are essentially
associated companies.
Replacement cost accounting A system of accounting in which assets (and related

expenses such as depreciation) are valued at what it
would cost to replace them.
Reserves Reserves consist of the accumulated profits that have

been retained by a company, plus any gains from the
revaluation of assets, plus any share premium.
Reserves belong to shareholders and are part of
shareholders’ funds.
Retained profits Profits that have not been paid out as dividends to
shareholders, but retained for further investment by
the company.
Revaluation Conventional accounting uses historical COST as the

basis for the valuation of ASSETS. However, under
IASB and some other rules, it is acceptable to revalue
fixed assets annually.
Revaluation reserve The gain or loss arising from the revaluation of assets.
Revenue expenditure Expenditure on items expensed in the profit and loss

account. Revenue expenditure is the opposite of capital
expenditure.
Rights issue The issue of new shares by a company to existing

shareholders. The ‘rights’ to buy the new shares are
usually fixed at a price below the current market price.
Sales The figure for sales recorded in the financial

statements for a period, including all those sales
agreed or delivered in the period, rather than those
that are paid for in cash. The sales figure will be shown
net of sales taxes (VAT, etc). In the United Kingdom the
word turnover is used in the financial statements,
although ‘sales’ is generally used in the books of
account.
298

Glossary
Term Explanation
Segment reporting The disclosure of sales, profit or assets by line of

business or by geographical area.
Share capital The aggregate amount of the nominal value of the

shares that have been issued by a company.
Share premium (‘undenominated The amount received by a company for its issued
capital’ under the Companies Act shares that is in excess of their nominal value.
2014)
Shareholders’ funds The total of the shareholders’ interest in a company. It

consists of share capital plus reserves and is equal to
the net assets of the company.
Short-term debt A type of current liability. A loan that is repayable

within one year from the date of the balance sheet.
Solvency The ability to pay debts as they become due.
Statement of changes in equity Statement of all changes in equity during the period,
comprising changes in equity from (i) changes in
profit/loss during the period, (ii) together with
changes in items of income and expense not
recognised in profit/loss for the period as required or
permitted by IASs/IFRSs and (iii) changes in equity
resulting from transactions with owners (in their
capacity as owners)
Statement of comprehensive income Statement of all components of profit/loss for the

period together with items of income and expense not
recognised in profit/loss for the period as required or
permitted by IASs/IFRSs
Stock US term for securities of various kinds; for example,

common stock or preferred stock (equivalent to
ordinary and preference shares in UK terminology).
Stocks and work-in-progress This consists of items purchased for resale and
includes raw materials required for production,
partially completed products (work-in-progress) and
finished products.
299

Glossary
Term Explanation
Straight-line depreciation A system calculating the annual depreciation expense

of a fixed asset. This method is based on the cost of
the asset and charges equal annual instalments
against profit over the useful life of the asset.
Subsidiary A company that is controlled by another company (a

parent company). Control can occur because either
more than 50 per cent of the voting rights are owned
by another company or because a ‘dominant
influence’ is exercised by another company.
Substance over form The presentation in financial statements of the

underlying economic or commercial substance of a
particular transaction, rather than the superficial,
strictly legal or technical form of it.
Tangible assets Normally applied to those fixed assets that have a

physical existence, such as land and buildings, plant
and machinery.
Total assets The total of the fixed assets and current assets of a
company.
Treasury stock US expression for a company’s shares that have been

bought back by the company and not cancelled. The
shares are held ‘in the corporate treasury’. They
received no dividends and carry no votes at company
meetings. The UK equivalent term is ‘own shares’.
True and fair view The overriding legal requirement for the presentation
of financial statements of companies in the United
Kingdom, most of the (British) Commonwealth and
the European Union. The nearest US equivalent is ‘fair
presentation’.
Turnover The sales revenue of an accounting period.
Undenominated capital (Companies The amount received by a company for its issued
Act 2014)(i.e., share premium) shares that is in excess of their nominal value.
Unlisted investments Investments which are not listed on a stock exchange.
300

Glossary
Term Explanation
Window dressing Manipulation of amounts in the balance sheet in order

(“managing the snapshot”, “the to give a misleading or unrepresentative impression
calendar effect”, “putting on your best of the financial position of the company.
suit for the photograph”)
Working capital An alternative name for net current assets, i.e., the
current assets less current liabilities of a company.
Written down value The value of assets in the books of a company. This is
usually the historical cost less the cumulative amount
of depreciation written off at the balance sheet date.
Sources: This glossary is based on glossaries published in Pendlebury and Groves (2001) and
Alexander and Nobes (2004)
301

References
Aisbitt, Sally and Nobes, Christopher (2001) The true and fair view requirement in recent national
implementations. Accounting and Business Research 31(2): 83-90.
Alexander, David, Britton Anne and Jorissen, Ann (2011) International Financial Reporting and
Analysis, fifth edition, South Western Cengage Learning, Andover, Hampshire.
Alexander, David and Nobes, Chris (2004) Financial Accounting: An International Introduction.
Second edition, Financial Times Prentice Hall, London.
Brennan, Michael (2016), 'Window dressing' a known practice in banking, trial told, Irish Independent,
8 April 2016.
Brennan, Niamh M. and McGrath, Mary (2007) Financial statement fraud: incidents, methods and
motives, Australian Accounting Review, 17(2)(42)(July): 49-61.
Brennan, Niamh, O’Brien, Francis J. and Pierce, Aileen (1992) European Financial Reporting:
Ireland, Routledge, London.
Brennan, Niamh and Pierce, Aileen (1996) Irish Company Accounts: Regulation and Reporting, Oak
Tree Press, Dublin.
Chandra, U., Ettredge, M. and Stone, M.S. (2006) ‘Enron-era disclosure of off-balance sheet entities’.
Accounting Horizons, 20, 231-252.
Davison, Jane (2011) Paratextual framing of the annual report: luminal literary conventions and
visual devices, Critical Perspectives on Accounting, 22 (2): 118–134.
Deloitte (2013) 2015 Irish GAAP in your Pocket: a Guide to FRS 102, Deloitte, Dublin.
International Accounting Standards Board (2013) A Review of the Conceptual Framework for
Financial Reporting, DP/2013/1, London: International Accounting Standards Board.
Kirk, Robert (2013) A New Era for Irish & UK GAAP - A quick reference guide to FRS 102. Institute
of Certified Public Accountants in Ireland, Dublin.
Levitt, Arthur (2000) Remarks at the Economic Club of Washington, US Securities and Exchange
Commission, New York, 6 April 2000.
Pendlebury, Maurice W. and Groves, Roger (2001) Company Accounts: Analysis, Interpretation and
Understanding, Thomson Learning, London.
Raynor, Michael E. (2013) Dangerous digits: Focusing on numbers is not the way to make them.
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Corporate Accounting and Finance, 13, 101-103.
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303

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Financial Accounting 2 – Lecture notes

©Prof Niamh Brennan

Happily, they never reproduce and all of them finally go to hell”

©Prof Niamh Brennan

How should profit be calculated?

How should assets be valued?

Example 0.1: Illustrating the big questions in accounting

(b) (i) What do you understand by the term “value”?

©Prof Niamh Brennan

Section 1: Principles of double entry bookkeeping and year-end adjusting entries

Notes Problem questions

©Prof Niamh Brennan

Fra Luca Bartolomeo de Pacioli, the father of Accounting 1:

1.1 Types of business organisations

1.1.1 Sole trader

Table 1.1: Types of registered company

Included in name of company

1.1.4 Charities, Societies, State Bodies

1.2 Double entry bookkeeping

1.2.1 Books of prime entry

Thus, books of prime entry have three purposes:

1. Cash receipts book/journal;

©Prof Niamh Brennan

Example 1.1: A book of prime entry – Cheque payments book

Monthly postings to the nominal ledger

Example 1.2: Recording journal entries

Dr Depreciation Expense (profit and loss account) X

1.2.2 Nominal ledger

©Prof Niamh Brennan

1.2.3 Debits (Dr) and credits (Cr)

There are three rules of double entry;.

Rule ① The duality rule

Rule ② The “when to debit, when to credit” rule

Table 1.2 summarised Rule ② of double entry.

Table 1.2: Summary of the rules of double entry

• Asset Debit balance (Dr)

Balance sheet items

©Prof Niamh Brennan

Five steps to apply in recording a double entry

 Identify the two accounts affected by the transaction

Assets, liabilities, capital, revenues, expenses

Recording double entries

©Prof Niamh Brennan

Example 1.3: Recording transactions as double entries

A company has five transactions as follows:

Transaction 1: Receive €100,000 cash from debtors/receivables

Transaction 2: Pay €200,000 cash to creditors/payables

Transaction 3: Buy plant and machinery on credit for €300,000

Transaction 4: Make cash sales of €400,000

©Prof Niamh Brennan

Example 1.3: Recording transactions as double entries (continued)

Transaction 5: Make purchases of €500,000 on credit

1.2.4 Nominal ledger accounts

Example 1.4: ‘T’ account

©Prof Niamh Brennan

Asset (or Expense) (these are debits) account

Increases go on this side Decreases go on this side

Liability (or Capital) (or Revenue) (these are credits) account

Decreases go on this side Increases go on this side

Example 1.7 shows five transactions recorded in ‘T’ accounts.

©Prof Niamh Brennan

Example 1.7: Recording double entries in nominal ledger ‘T’ accounts

A company has five transactions as follows: