ACCA Strategic Business

Reporting (SBR)

Achievement Ladder

Step 2 Questions and Answers

Strategic Business Reporting Achievement Ladder Step 2

Question 1
Question text
Johan, a public limited company, operates in the telecommunications industry. The industry is capital
intensive with heavy investment in licences and network infrastructure. Competition in the sector is
fierce and technological advances are a characteristic of the industry. Johan has responded to these
factors by offering incentives to customers and, in an attempt to acquire and retain them, Johan
purchased a telecom licence on 1 December 20X6 for $120 million. The licence has a term of six
years and cannot be used until the network assets and infrastructure are ready for use. The related
network assets and infrastructure became ready for use on 1 December 20X7. Johan could not
operate in the country without the licence and is not permitted to sell the licence. Johan expects its
subscriber base to grow over the period of the licence but is disappointed with its market share for the
year to 30 November 20X8. The licence agreement does not deal with the renewal of the licence but
there is an expectation that the regulator will grant a single renewal for the same period of time as
long as certain criteria regarding network build quality and service quality are met. Johan has no
experience of the charge that will be made by the regulator for the renewal but other licences have
been renewed at a nominal cost. The licence is currently stated at its original cost of $120 million in
the statement of financial position under non-current assets.
Required
Discuss the principles and practices which should be used in the financial year to 30 November 20X8
to account for the licences. (8 marks)
Feedback

Marking scheme

Marks
Intangible assets: Licence 2
Amortisation 2
Impairment 2
Renewal 2
8

(IAS 38: paras. 18, 21, 74, 75)

Licences
The relevant standard here is IAS 38 Intangible Assets. An intangible asset may be recognised if it
meets the identifiability criteria in IAS 38, if it is probable that future economic benefits attributable
to the asset will flow to the entity and if its fair value can be measured reliably. For an intangible
asset to be identifiable the asset must be separable or it must arise from contractual or other legal
rights. It appears that these criteria have been met. The licence has been acquired separately, and its
value can be measured reliably at $120 million (cost). It is also expected that future economic benefits
will flow to Johan. Therefore the licence will be recognised as an intangible asset at cost.
Regarding subsequent valuation, IAS 38 has two models: the cost model and the revaluation
model. The revaluation model can only be used if intangible assets are traded in an active market.
As Johan cannot sell the licence, this is not the case here, so Johan cannot use the revaluation
model.
Under the cost model, intangible assets must be carried at cost less amortisation and impairment
losses. The depreciable amount of an asset is cost less residual value; since the licence has no
residual value, the depreciable amount is the cost. However, an impairment review should have been
undertaken at 30 November 20X7, before amortisation commenced, and the licence written down, if
necessary to its recoverable amount.
The depreciable amount must be allocated over the useful life of the licence on a systematic
basis. The basis of allocation should reflect the pattern of consumption of the asset's benefit,
unless this cannot be reliably determined, in which case the straight line basis would be used. The
straight line basis is appropriate, in any case, for this licence, because the economic benefit is
Johan's ability to earn income from the licence which accrues on a time basis and is not affected by
wear and tear as some assets would be.
The amortisation starts on the day that the network is available for use, that is 1 December
20X7. Although the licence runs for six years from the date of purchase, 1 December 20X6, economic
benefits cannot flow to the entity before the network assets and infrastructure are ready for use.
Other licences have been renewed at a nominal cost. It could therefore be argued that the licence
should be amortised over two periods totalling eleven years: a period of five years from 1 December
20X7 to the renewal date, followed by six years from the renewal date. However, Johan does not
know for certain what charge the regulator will make on renewal, so it would be more appropriate to
amortise the licence over a five-year period, that is $24 million per annum.
For the purposes of any impairment review, the licence and network assets should be classified as a
single cash generating unit. They cannot be used separately from one another. There are indications
that the licence may be impaired: disappointing market share, fierce competition and difficulty in
retaining customers. Therefore the cash generating unit (licence and network assets) must be tested
for impairment.
Question 2
Question text
Kappa prepares financial statements to 30 September each year. During the year ended
30 September 20X5, Kappa entered into the following transactions:
(a) On 1 September 20X5, Kappa sold a machine to a customer. Kappa also agreed to service the
machine for a two-year period from 1 September 20X5 for no additional charge. The total amount
payable by the customer for this arrangement was agreed to be:
 $800,000, if the customer paid by 31 December 20X5
 $810,000, if the customer paid by 31 January 20X6
 $820,000, if the customer paid by 28 February 20X6
The directors of Kappa consider that it is highly probable the customer will pay for the products in
January 20X6. The stand-alone selling price of the machine was $700,000 and Kappa would
normally expect to receive $140,000 in consideration for providing two years' servicing of the
machine. The alternative amounts receivable are to be treated as variable consideration.
(7 marks)
(b) On 20 September 20X5, Kappa sold 100 identical items to a customer for $2,000 each. The
items cost Kappa $1,600 each to manufacture. The terms of sale are that the customer has the
right to return the goods for a full refund within three months. After the three-month period has
expired the customer can no longer return the goods and payment becomes immediately due.
Kappa has entered into transactions of this type with this customer previously and can reliably
estimate that 4% of the products are likely to be returned within the three-month period.
(4 marks)
Required
Explain, with calculations, how both these transactions should be reported in the financial statements
of Kappa for the year ended 30 September 20X5.
(Total = 11 marks)
Feedback

Marking scheme

Marks
Machine and service agreement 7
Sale with right of return 4
11

(a) Kappa has two performance obligations – to provide the machine and to provide the servicing.
The total transaction price consists of a fixed element of $800,000 and a variable element of
$10,000 or $20,000.
The variable element should be included in the transaction price based on the probability of its
occurrence. Therefore a variable element of $10,000 should be included and the total transaction
price will be $810,000.
The transaction price should be allocated to the performance obligations based on their stand-
alone fair values. In this case, these are $700,000:$140,000 or 5:1.
Therefore $675,000 ($810,000  5/6) should be allocated to the obligation to supply the machine
and $135,000 ($810,000  1/6) to the obligation to provide two years' servicing of the machine.
The obligation to supply the machine is satisfied fully in the year ended 30 September 20X5 and
so revenue of $675,000 in respect of this supply should be recognised.
Only 1/24 of the obligation to provide the servicing is satisfied in the year ended 30 September
20X5 and so revenue of $5,625 ($135,000  1/24) in respect of this supply should be recognised.
On 30 September 20X5, Kappa will recognise a receivable of $810,000 based on the expected
transaction price. This should be reported as a current asset.
On 30 September 20X5, Kappa will recognise deferred income of $129,375 ($810,000 –
$675,000 – $5,625). $67,500 ($129,375  12/23) of this amount will be shown as a current
liability. The balance of $61,875 ($129,375 – $67,500) will be non-current.
(b) When the customer has a right to return products, the transaction price contains a variable
element.
Since this can be reliably measured, it is taken account of in measuring the revenue and the total
revenue will be $192,000 (96  $2,000).
$200,000 (100  $2,000) will be recognised as a trade receivable.
$8,000 ($200,000 – $192,000) will be recognised as a refund liability. This should be shown as a
current liability.
The total cost of the goods sold is $160,000) (100  $1,600). Of this amount, only $153,600 (96 
$1,600) should be shown as a cost of sale. The other $6,400 ($160,000 – $153,600) should be
shown as a right of return asset under current assets.
Question 3
Question text
Greenie, a public limited company, builds, develops and operates airports. During the financial year to
30 November 20X0, a section of an airport collapsed and as a result several people were hurt. The
accident resulted in the closure of the terminal and legal action against Greenie. When the financial
statements for the year ended 30 November 20X0 were being prepared, the investigation into the
accident and the reconstruction of the section of the airport damaged were still in progress and no
legal action had yet been brought in connection with the accident. The expert report that was to be
presented to the civil courts in order to determine the cause of the accident and to assess the
respective responsibilities of the various parties involved, was expected in 20X1.
Financial damages arising related to the additional costs and operating losses relating to the
unavailability of the building. The nature and extent of the damages, and the details of any
compensation payments had yet to be established. The directors of Greenie felt that at present, there
was no requirement to record the impact of the accident in the financial statements.
Compensation agreements had been arranged with the victims, and these claims were all covered by
Greenie's insurance policy. In each case, compensation paid by the insurance company was subject
to a waiver of any judicial proceedings against Greenie and its insurers. If any compensation is
eventually payable to third parties, this is expected to be covered by the insurance policies.
The directors of Greenie felt that the conditions for recognising a provision or disclosing a contingent
liability had not been met. Therefore, Greenie did not recognise a provision in respect of the accident
nor did it disclose any related contingent liability or a note setting out the nature of the accident and
potential claims in its financial statements for the year ended 30 November 20X0.
Required
Discuss how the above financial transactions should be dealt with in the financial statements of
Greenie for the year ended 30 November 20X0. (6 marks)
Feedback

Marking scheme

Marks
Provision discussion 3
Contingent liability discussion 3
6

(IAS 37: paras. 10, 14)

Provision or contingent liability?
A provision is defined by IAS 37 Provisions, Contingent Liabilities and Contingent Assets as a
liability of uncertain timing or amount. IAS 37 states that a provision should only be recognised if:
 There is a present obligation as the result of a past event
 An outflow of resources embodying economic benefits is probable, and
 A reliable estimate of the amount can be made
If these conditions apply, a provision must be recognised.
The past event that gives rise, under IAS 37, to a present obligation, is known as the obligating
event. The obligation may be legal, or it may be constructive (as when past practice creates a valid
expectation on the part of a third party). The entity must have no realistic alternative but to settle the
obligation.
As at 30 November 20X0, Greenie has no legal obligation to pay compensation to third parties. No
legal action has been brought in respect of the accident. Nor can Greenie be said to have a
constructive obligation at the year end, because the investigation has not been concluded, and the
expert report will not be presented to the civil courts until 20X1. Therefore under IAS 37 Provisions,
Contingent Liabilities and Contingent Assets no provision would be recognised for this amount.
However, the possible payment does fall within the IAS 37 definition of a contingent liability, which
is:
 A possible obligation depending on whether some uncertain future event occurs, or
 A present obligation but payment is not probable or the amount cannot be measured reliably
There is uncertainty as to the outcome of the investigation and findings of the report, and the extent of
the damages and any compensation arising remain to be confirmed. However, the uncertainty over
these details is not so great that the possibility of an outflow of economic benefits is remote.
Therefore as a contingent liability the details and, if possible an estimate of the amount payable,
would be disclosed in the notes to the financial statements.
The question arises as to whether the possible recovery of the compensation costs from the
insurance company constitutes a contingent asset under IAS 37. A contingent asset is a possible
asset that arises from past events, and whose existence will be confirmed only by the occurrence or
non-occurrence of one or more uncertain future events not wholly within the control of the entity.
Because any insurance claim will only be made after the courts have determined compensation, and
will then need to be assessed on its merits, any payout is one step removed from the potential
payment of compensation. In other words it is merely possible rather than probable, and disclosure
of a contingent asset would not be appropriate.