Q30 Egin part (a) - pg43, pg176

The need for a conceptual framework

The financial reporting process is concerned with providing information that is useful in the
business and economic decision-making process. Therefore, a conceptual framework will form
the theoretical basis for determining which transactions should be accounted for, how they could
be measured and how they should be communicated to the users.

Although it is theoretical in nature, a conceptual framework for financial reporting has highly
practical final aims.

The danger of not having a conceptual framework is demonstrated in the way some countries’
standards have developed over recent years; standards tend to be produced in a haphazard and
fire-fighting approach. Where an agreed framework exists, the standard-setting body build the
accounting rules on the foundation of sound, agreed basic principles.

The lack of conceptual framework also means that fundamental principles are tackled more than
once in different standards, which can produce contradictions and inconsistencies in accounting
standards. This leads to ambiguity and it affects the true and fair concept of financial reporting.

Without a conceptual framework, there is a risk that a financial reporting environment becomes
governed by specific rules rather than general principles. A rules-based approach is much more
open to manipulation than a principles-based one. For example, a rule requiring an accounting
treatment based on a transaction reaching a percentage threshold, might encourage unscrupulous
directors to set up a transaction in such a way to deliberately to achieve a certain accounting
effect such as keep finance off the statement of financial position.

A conceptual framework can also bolster standard setters against political pressure from various
‘lobby groups’ and interested parties. Such pressure would only prevail if it was acceptable
under the conceptual framework.

Can it resolve practical accounting issues?

A framework cannot provide all the answers for standard setters. It can provide principles which
can be used when deciding between alternatives, and can narrow the range of alternatives that
can be considered. The IASB intends to use the principles laid out in the Conceptual Framework
as the basis for all future IFRSs, which should help to eliminate inconsistencies between
standards going forward.

However, a conceptual framework is unlikely, on past form, to provide all the answers to
practical accounting problems. There are a number of reasons for this:

i) Financial statements are intended for a variety of users, and it is not certain that a
single conceptual framework can be devised which will suit all users.
ii) Given the diversity of user requirements, there may be a need for a variety of
accounting standards, each produced for a different purpose and with different
concepts as a basis.
iii) It is no clear that a conceptual framework makes that task of preparing and then
implementing standards any easier than without a framework.

Q45 Skizer part (a) – pg61, pg225

The Conceptual Framework defines an asst as a present economic resource controlled by the
entity as a result of past events. An economic resource is a right that has the potential to produce
economic benefits. Assets should be recognized if they meet the Conceptual Framework
definition of an asset and such recognition provides users of financial statements with
information that is useful. For example, it is relevant and results in faithful representation. This is
subject to the criteria that the information provides must be sufficient to justify in the Conceptual
Framework allows for flexibility in how this criteria in the Conceptual Framework allows for
flexibility in how this criteria could be applied by the IASB in amending or developing
standards.

IAS38 Intangible Assets defines on intangible asset as an identifiable non-monetary asset

without physical substance. IAS38 retains the 2010 Conceptual Framework definition of a n
asset which specifies that future economic benefits are expected to flow to the entity.
Furthermore, IAS38 requires an entity to recognize an intangible asset, if, and only if:

a) It is probable that the expected future economic benefits that are attributable to the asset
will flow to the entity: and
b) The cost of the asset can be measured reliably.
This requirement applies whether an intangible asset is acquired externally or generated
internally. The probability of future economic benefits must be based on reasonable and
supportable assumptions about conditions which will exist over the life of the asset. The
probability recognition criteria is always considered to be satisfied for intangible assets which
are acquired separately or in a business combination. If the recognition criteria are not met,
IAS38 requires the expenditure to be expensed when it is incurred.

The Conceptual Framework does not prescribe a ‘probability criteria’, and thus does not prohibit
the recognition of asset or liabilities with a low probability of an inflow or outflow of economic
benefits. In terms of intangible assets, it is arguable that recognizing an intangible asset with a
low probability of economic benefits would not be useful to users given that the asset has no
physical substance.

The recognition criteria and definition of an asset in IAS38 are different to those in the
Conceptual Framework. The criteria in IAS38 are more specific, but arguable do provide
information that is relevant and a faithful representation. When viewed in this way, the
requirements of IAS38 in terms of recognition appear to be consistent with the Conceptual
Framework.

Q47 Tang – pg63, pg232

Part (a) i

Criteria for a contract under IFRS15

The definition of what constitutes a contract for the purpose of applying IFRS15 is critical. A
contract exits when an agreement between two or more parties creates enforceable rights and
obligations between those parties. The agreement does not need to be in writing to be a contract
but the decision as to whether a contractual right or obligation is enforceable is considered within
the context of the relevant legal framework of a jurisdiction. Thus, whether a contract is
enforceable will vary across jurisdictions. The performance obligation could include promises
which result in a valid expectation that the entity will transfer goods or services to the customer
even though those promises are not legally enforceable.
An entity should only apply the revenue recognition model in IFRS15 to a contract with a
customer when all of the following five criteria have been met.

1. Contract approved and committed to perform obligations

The first criterion set out in IFRS15 is that the parties should have approved the contract and are
committed to perform their respective obligations. It would be questionable whether that contract
is enforceable if this were not the case. In the case of oral or implied contracts, this may be
difficult but all relevant facts and circumstances should be considered in assessing the parties’
commitment.

The parties need not always be committed to fulfilling all of the obligations under a contract.
IFRS15 gives the example where a customer is required to purchase a minimum quantity of
goods but past experience shows that the customer does not always do this and the other party
does not enforce their contract rights. The IFRS15 criterion would still be satisfied in this
example if there is evidence that the parties are substantially committed to the contract.

2. Entity can identify each party’s rights

It is essential that each party’s rights can be identified regarding the goods or services to be
transferred. Without this criterion, an entity would not be able to assess the transfer of goods or
services and therefore the point at which revenue should be recognized.

3. Entity can identify each party’s payment terms

It is essential that each party’s payment terms can be identified regarding the goods or services to
be transferred. This requirement is the key to determining the transaction price.

4. Contract has commercial substance

The contract must have commercial substance before revenue can be recognized, as without this
requirement, entities might artificially inflate their revenue and it would be questionable whether
the transaction has economic consequences.

The contract is deemed to have commercial substance when the risk, timing or amount of the
entity’s future cash flows is expected to change as a result of the contract.

5. Probable consideration
It should be probable that the entity will collect the consideration due under the contract. An
assessment of a customer credit risk is an important element in deciding whether a contract has
validity but customer credit risk does not affect the measurement or presentation of revenue.

The consideration may be different to the contract price because of discounts and bonus
offerings. The entity should assess the ability of the customer to pay and the customer’s intention
to pay the consideration.

Reassessment

If a contract with a customer does not meet these criteria, the entity can continually re-assess the
contract to determine whether it subsequently meets he criteria.

Combination of contracts

Two or more contracts which are entered into around the same time with the same customer may
be combined and accounted for as a single contract, if they meet the specified criteria.

Contract modification

The standard provides detailed requirements for contract modifications. A modification may be
accounted for as a separate contract or a modification of the original contract, depending upon
the circumstances of the case.

Q47 Tang – pg63, pg232

Part (b) - i

Existing printing machine

The contract contains a significant financing component because of the length of time between
when the customer pays for the asset and when Tang transfers the asset to the customer, as well
as prevailing interest rates in the market. This is a slightly unusual situation in which the
customer is paying Tang in advance (24 months before the finished machine is ready for use) but
the principles of the treatment of significant financing components prevail.

The contract should be separated into revenue component (for the notional cash sales price) and
a loan component. This makes the accounting treatment comparable to the accounting treatment
for a loan with the same features.
Tang uses the discount rate which would be reflected in a separate financing transaction between
the entity and its customer at contract inception. Tang should use a discount rete of 5%, which is
its incremental borrowing rate. As the customer is paying Tang in advance, in substance, Tang is
borrowing $240,000 from the customer which makes Tang’s incremental borrowing rate the
most appropriate rate to use.

Tang would account for the contract as follows:

Recognise a contract liability for the $240,000 payment received on 1 December 20X4 at the
contract inception.

During the two years form contract inception (1 December 20X4) until the transfer of the
printing machine, Tang adjusts the amount of consideration and accretes the contract liability by
recognizing interest on $240,000 at 5% for two years.

This would result in interest of $12.000 ($240,000*5%) in the year ended 30 November 20X5.

Contract liability would stand at $252,000 (240,000+12,000) at 30 November 20X5. Therefore,

interest in the year ended 30 November 20X6 would be $126,000 (252,000*5%).

This would bring the contract liability up to $264,600.

Contract revenue would be recognized on the transfer of the printing machine to the customer on
30 November 20X6 by debiting (decreasing) the contract liability and crediting (increasing)
revenue with $264,600.

Q47 Tang – pg63, pg232

Part (b) – ii

Constructed printing machine

Tang accounts for the promised bundle of goods and services as a single performance obligation
satisfied over time in accordance with IFRS15. At the inception of the contract, Tang expects the
following:

Transaction price $1,500,000

Expected costs $800,000

Expected profit (46.7%) %700,000

The $100,000 bonus constitutes variable consideration under IFRS15. At contract inception,
Tang excludes the $100,000 bonus from the transaction price because it cannot conclude that it is
highly probable that a significant reversal in the amount of cumulative revenue recognized will
not occur. Completion of the printing machine is highly susceptible to factors outside the entity’s
influence.

This is a contract in which Tang satisfied its performance obligation over time. Therefore,
revenue should also be recognized over time by measuring the progress towards complete
satisfaction of that performance obligation. By the end of the first year, the entity has satisfied
65% of its performance obligation on the basis of costs incurred to date. Costs incurred to date
are therefore $520,000 ($800,000*65%) and Tang reassesses the variable consideration of
$100,000 and concludes that the amount is still constrained which means that it may not yet be
recognized. Therefore, at 30 November 20X5, only the portion of the fixed consideration of
$1,500,000 related to progress to date may be recognized as revenue. This results in revenue of
$975,000 ($1,500,000*65%). The following amounts would therefore be included in the
statement of profit or loss:

Revenue $975,000

Costs $520,000

Gross profit $455,000

However, on 4 December 20X5, the contract is modified. As a result, the fixed consideration and
expected costs increase by $110,000 and $60,000 respectively. This increases the fixed
consideration to $1,610,000 (1,500,000+110,000) and the expected costs to $860,000
($800,000+60,000).

The total potential consideration after the modification is $1,710,000 which is $1,616,000 fixed
consideration plus $100,000 completion bonus as Tang has concluded that receipt of the bonus is
highly probable and that including the bonus in the transaction price will not result in a
significant reversal in the amount of cumulative revenue recognized in accordance with IFRS15.
Tang also concludes that the contract remains a single performance obligation. Thus, Tang
accounts for the contract modification as if it were part of the original contract. Therefore, Tang
updates its estimates of costs and revenue as follows:

Tang has satisfied 60.5% of its performance obligation ($520,000 actual costs incurred compared
to $860,000 total expected costs). The entity recognizes additional revenue of $59,550 [(60.5%
of 1,710,000) – 975,000 revenue recognized to date) at the date of the modification as a
cumulative catch-up adjustment. As the contract amendment took place after the year end, the
additional revenue would not be treated as an adjusting event after the reporting period.
Therefore, it would be accounted for in the year ended 30 November 20X6 rather than as an
adjustment in the year ended 30 November 20X5.

Q47 Tang – pg63, pg232

Part (c)

Use of fair value in IFRSs

Treatment under IFRS

It is not entirely to say that IFRS implement a fair value model. While IFRSs use fair value (and
present value) it is not a complete fair system. IFRSs are often based on the business model of
the entity and on the probability of realizing the asset and liability-related cash flows through
operations or transfers.

In fact the IASB favours a mixed measurement system, with some items being measured of fair
value and others at historical cost.

Definition of fair value

IFRS13 has brought consistency to the definition and application of fair value, and this
consistency is applied across other IFRS, which one generally required to measure fair value ‘in
accordance with IFRS13’. This does not mean, however, that IFRS requires all assets and
liabilities to be measured at fair value. On cost, a notable exception being in the case of business
combinations, where assets and liabilities are recorded at fair value at the acquisition date. In
other cases, the use of fair value is restricted.

Examples of use of fair values in IFRS

Examples include:

 IAS16 Property, Plant and Equipment allows revaluation through other comprehensive
income, provided it is carried out regularly.
 While IAS40 Investment Property allows the option of measuring investment properties
at fair value with corresponding changes in profit or loss, and this arguably reflects the
business model of some property companies, many companies still use historical cost.
 IAS38 Intangible Assets permits the measurement of intangible assets at fair value with
corresponding changes in equity, but only if the assets can be measured reliably through
the existence of an active market for them.
 IFRS9 Financial Instruments requires some financial assets and liabilities to be measured
basis is largely determined by the business model for that financial instrument. For
financial instruments measured at fair value, depending on the category and the
circumstances, gains or losses are recognized either in profit or loss or in other
comprehensive income.

Financial value of an entity

While IFRS makes some use of fair values in the measurement of assets and liabilities, financial
statements prepared under IFRS are not, as is sometimes believed, intended to reflect the
aggregate value of a n entity. The Conceptual Framework specifically states that general purpose
financial reports are not designed to show the value of a reporting entity. Such an attempt would
be incomplete, since IFRS disallows the recognition of certain internally generated intangibles.
Rather, the objective of general purpose financial reports is to provide financial information
about the reporting entity which is useful to existing and potential investors, leaders and other
creditors in making decisions about providing resources to the entity.

It is only when an entity is acquired by another entity and consolidated in group accounts that an
entity’s net assets are reported at market value.

Q33 Verge – pg46, pg186

Part (a) Maintenance contract

Recognition of revenue from the maintenance contract

Under IFRS15, an entity must adjust the promised amount of consideration for the effects of the
time value of money if the contract contains a significant financing component. A significant
financing component exists even if the financing is only implied by the payment terms.

In effect Verge is providing interest-free credit to the government body. IFRS15 requires the use
of the discount rate which would be reflected in a separate financing transaction between the
Verge and its customer (the government agency), here 6%. This 6% must be used to calculate the
discounted amount of the revenue, and the difference between this and the cash eventually
received recognized as interest income.

The government agency simultaneously receives and consumes the benefits as the performance
takes place so this contract contains a performance obligation satisfied over time. Verge must
therefore recognize revenue from the contract as the services are provided that is as work is
performed throughout the contract’s life, and not as the cash is received. The invoices sent by
Verge reflect the work performed in each year, but the amounts must be discounted in order to
report the revenue at fair value. The exception is the $1m paid at the beginning of the contract.
This is paid in advance and therefore not discounted, but it is invoiced and recognized in the year
ended 31 March 20X2. The remainder of the amount invoiced in the year ended 31 March 20X2
(2.8m-1m=1.8m) is discounted at 6% for two years.

In the year ended 31 March 20X3. The invoiced amount of 102m will be discounted rate at 6%
for only one year. There will be also interest income of $96,000, which is unwinding of the
discount in 20X2.

Reccognised in year ended 31 March 20X2

Initial payment (not discounted) 1m

Remainder invoiced at 31 March 20X2 [1.8*(1/1.06^2)] 1.6m

Revenue recognised 2.6m

Revenue recognized

Recognised in year ended 31 March 20X3

Revenue [1.2m* (1/1.06)] = 1.3m

Unwinding of the discount on revenue recognized in 20X2 $1.6m*6% = 96,000

Correction of prior period error

The accounting treatment previously used by Verge was incorrect because it did not comply with
IFRS15. Consequently, the change to the new, correct policy is the correction of an error under
IAS8 Accounting Policies, Changes in Accounting Estimates and Errors.

Only including 1m of revenue in the financial instruments for the year ended 31 March 20X2 is
clearly a mistake on the part of Verge. As a prior period error, it must be corrected
retrospectively. This involves restating the comparative figures in the financial statemen for
20X3 (For example, the 20X2 figures) and restating the opening balances for 20X3 so that the
financial statements are presented as if the error had never occurred.

Q33 Verge – pg46, pg186

Part (b) Legal claim

A provision is defined by IAS37 Provisions, Contingent Liabilities and Contingent Assets as a

liability of uncertain timing or amount. IAS37 states that a provision should only be recognized
if:

 There is a present obligation as the result of a past event

 An outflow of resources embodying economic benefits is probable:
 A reliable estimate of the amount can be made.

If these conditions apply, a provision must be recognized.

The past event that gives rise, under IAS37, to a present obligation, is known as the obligating
event. The obligation may be legal, or it may be constructive (as when put practice creates a
valid expectation on the part of a third party). The entity must have no realistic alternative but to
settle the obligation.

Year ended 31 March 20X2

In this case, the obligating even is the damage to the building, and it took place in the year ended
31 March 20X2. As at that date, no legal proceedings had been started, and the damage appeared
to be superficial. While Verge should recognize an obligation to pay damages, at 31 March 20X2
the amount of any provision would be immaterial. It would a best estimate of the amount
required to settle obligation at that date, taking into account all relevant risks and uncertainties,
and at the year end the amount does not look as if it will be substantial.

Year ended 31 March 20X3

IAS37 requires that provisions should be reviewed at the end of each accounting period for any
material changes to the best estimate previously made. The legal action will cause such a
material change, and Verge will be required to reassess the estimate at likely damages. While the
local company is claiming damages of 1.2m, Verge is not obligated to make a provision for this
amount, but rather should base its estimate on the legal advice it has received and the opinion of
the expert, both of which put the value of the building at 800,000. This amount should be
provided for as follows.

Debit Profit or loss for the year 800,000

Credit Provision for damages 800,000

Some or all of the expenditure needed to settle a provision may be expected recovered form a
third party, in this case the insurance company. If so, the reimbursement should be recognized
only when it is virtually certain that reimbursement will be received if the entity settles the
obligation.

 The reimbursement should be treated as a separate asset, and the amount recognized
should not be greater than the provision itself.
 The provision and the amount recognized for reimbursement may be netted off in profit
or loss for the year.

There is no reason to believe that the insurance company will not settle the claim for the first
200,000 of damages, and so the company should accrue for the reimbursement as follows.

Debit Receivables 200,000

Credit Profit or loss for the year 200,000

Verge lost the court case and is required to pay 300,000. This was after the financial statements
were authorized, however, and so it is not an adjusting event per IAS10 Events After the
Reporting Period. Accordingly the amount of the provision as at 31 March 20X3 does not need
to be adjusted.

Q33 Verge – pg46, pg186

Part (c) Gift of building

The application standards here are IAS16 Property, Plant and Equipment, and IAS20 Accounting
for Government Grants and Disclosure of Government Assistance, within the framework of
IAS1 Presentation of Financial Statements. IAS1 requires that all items of income and expense
recognized in a period should be included in profit or loss for the period unless a standard or
interpretation requires or permits a different treatment.

IAS16: Recognition of building

IAS16 states that the cost of an item of property, plant and equipment should be recognized
when two conditions have been fulfilled:

 It is probable that future economic benefits associated with the item will flow to the
entity.
 The cost of the item can be measured reliably.

These conditions are normally fulfilled when the risks and rewards have transferred to the entity,
and they may be assumed to transfer when the contract is unconditional and irrevocable. As at 31
March 20X2, the condition of use has not been compiled with and Verge has not taken
possession of the building.

The building may, however, be recognized in the year ended 31 March 20X3, as the conditions
of donation were met in February 20X3. The fair value of the building of 105m must be
recognized as income in profit or loss for the year, as it was a gift. The refurbishment and
adaptation cost must also be included as part of the cost of the asset in the statement of financial
position, because, according to IAS16, the cost includes directly attributable costs of bringing the
asset to the location and condition necessary for it to be capable of operating in a manner
intended by management. The transactions should be recorded as follows.
Debit PPE 2.5m

Credit Profit or loss for the year 1.5m

Credit Cash/ Payables 1m

In addition, the building would be depreciated in accordance with the entity’s accounting policy,
which could (depending on the policy) involve time-apportioning over one or two months
(February and March 20X3), depending on when in February the building came into use as a
museum.

IAS20: Government grant

The principle behind IAS20 is that at accruals or matching: the grant received must be matched
with the related costs on a systematic basis. Grants receivable as compensation for costs already
incurred, or for immediate financial support with no future related costs, should be recognized as
income in the period in which they are receivables.

Government grants are assistance by government in the form of transfers of resources to ana
entity in return for past or future compliance with certain conditions relating to the operating
activities of the entity,

There are two main types of grants:

i) Grants related to assets: grant whose primary condition is that an entity qualifying for
them should purchase, construct or otherwise acquire long-term assets.
ii) Grant related to income: These are government grants other than grants related to
assets.

It is not always easy to match costs and revenues, but in this case the terms of the grant are
explicit about the expense to which the grant is meant to contribute. Part of the grant relates to
the creation of jobs and this amount (20*5,000 = 100,000) should be taken to income.

The rest of the grant (250,000 – 100,000 = 150,000) should be recognized as capital-based grant
(grant relating to assets). IAS20 would two possible approaches for the capital-based portion of
the grant.

i) Match against the depreciation of the building using a deferred income approach.
 ii) Deduct from the carrying amount of the building, resulting in a reduced depreciation
charge.

The double entry would be:

Debit Cash 250,000

Credit Profit or loss 100,000

Credit Deferred income/ PPE (depending on the accounting policy) 150,000

If a deferred income approach is adopted, the deferred income would be released over the life of
the building and matched against depreciation. Depending on the policy, both may be time-
apportioned because conditions were only met in February 20X3.

Q33 Verge – pg46, pg186

Part (d)

The amendments proposed in ED 2018/1 are intended to facilitate voluntary changes in

accounting policies that result from agenda decisions published by the IFRS Interpretations
Committee. The IASB believes this will improve consistency in application of IFRSs.

Agenda decisions are not authoritative so entities are not required to change their accounting
policies in response, but can do so voluntarily. To encourage this, the IASB proposes to amend
IAS8 so that these changes can be applied prospectively, rather than retrospectively as currently
required by IAS8, subject to a cost-benefit analysis.

Verge’s accounting policies

At present, this is an exposure draft and not an IFRS, so Verge cannot apply these provisions
now. In fact, there has generally been a negative response to the ED as many stakeholders
believe that this does not address the fundamental issues which is that agenda decisions are not
mandatory and have no effective date, yet are treated as such by securities regulators. So it is
doubtful whether the amendments will go ahead.

If the amendments did go ahead, then only changes in accounting policy resulting from agenda
decisions will be affected. All other changes in accounting policy will still need to be applied
retrospectively.
It is concerning that the finance director thinks some of Verge’s accounting policies are
‘outdated’. If she means the policies do not comply with IFRS, then this should be addressed and
corrected as soon as possible. The professional competence of the finance director would be
under question if this was the case.

If by outdated, the finance director means that a different policy would provide more useful
information for primary users of the financial statements, then the question needs to be asked as
to why the change has not been made when IAS8 permits a change in accounting policy if the
change results in reliable and more relevant information. Further investigation is required.