CIMA F2

LONG TERM FINANCE (Chaps 1 & 2) (15%)

CHAPTER 1

 Equity Finance
 Long-term Finance
 Debt Finance

Sources of long term finance

If company does not have cash surplus then it might raise funds from (equity/debt):

 Capital Markets
o New Shares
o Rights Issues
o Marketable debt
 Bank Borrowings (long term/short term inc. revolving (RCFs))
 Government and similar sources

EQUITY

Share: fix identifiable unit of capital with (normally) fixed nominal value.

Ordinary Shares or equity shares. Pay dividends at the discretion of entity’s directors. Ordinary shareholders are
the owners of the company and they have the right to attend meetings and vote. They are subordinated to all
other finance providers.

Preference shares: pay fix dividend before ordinary share dividends. Preference shareholders are subordinated to
all other debt holders and creditors sauf ordinary. Typically do not have voting rights. More comparable to bonds
but as paid out of post-tax profits does not have tax benefit. Also company might be given permission to avoid
paying dividends in case of insufficient profit. Appealed to risk averse investors looking for a reliable income
stream. Might be redeemable (holders will be repaid capital, usually at par). There are 4 types:

1. Cumulative preference shares. Dividends are roll forward in case of inability to pay. Pay year 2, year 1&2
dividends.
2. Non-Cumulative preference shares. Not roll forward of dividends
3. Participating Preference Shares. Give holders fixed dividends plus extra earnings on certain conditions
4. Convertible preference shares. Can be exchanged for a specified number of ordinary shares on some given
future date. Attractive to investors who want to participate in the rise of growth companies while being
insulated from a drop in the price if they do not live up to expectations.

Shares are listed in CAPITAL MARKETS, which are driven by supply and demand forces.

Capital Markets. Two functions.

 Primary: enable companies to raise new finance (equity or debt). In UK must be PLC.
 Secondary Function: enable investors to sell their investments to other investors. Listed companies
are more attractive.
 Private vs Public. Public companies means shares can be offered to the public (listed or not). Public Cos have
more strict disclosure requirements.

Limited. Both Public or Private. Liability of shareholders to creditors is limited to the capital originally invested.

When entity obtains listing it is called floatation or IPO.

Advantages of exchange listing.

 More accurate valuation

 Mechanism for buying and selling at will
 Raise profile of entity
 Raise capital for future investment
 Makes employee share schemes more accessible.

Disadvantages:

 Costly for small entity

 Loss of some control
 Report requirement more onerous
 Stock exchange rules can be stringent

The roles of advisors on a share issue: investment banks, stockbrokers, institutional investors, registrars to an
issue, public and investor relations, reporting accountants, underwriters (page 8)

Methods of issuing new shares.

 IPO (1st time only). Transfer of (some or all) private share to the public. The offer could be made
through Fixed Price or Tender Offer (investors suggest price).
 A placing (further financing). Shares are place with certain investors on a prearranged basis.
 A rights issue (further financing). Shares are offered to existing shareholders in a proportion to the size
of their shareholding (called “pre-emption rights” & are protected by law). Shares are usually issued at
a discount to market price (aprox 20%). Not too low however to avoid price of share falling to this
level and diluting EPS (eg. 1 to 4). Typically price fall after announcement because of uncertainty and
after actual issue because of the increase number of shares at a lower price. Shareholders can sell
their rights. From the company viewpoint, a rights issue is usually successful.

DEBT Finance

Loan of funds to a business without conferring ownership rights. Interest is paid out of pre-tax profits as an
expense. It carries a risk of default if interest and principal are not met. Thus, lender will normally require a form
of security. There are two types of securities to be offered

 Fixed Charged or specific asset (preferred)

 Floating charge. Underlying assets are subject to changes in quantity or value (not so strong).

Covenants. Means of limiting the risk to the lender by limiting the actions of directors through covenants. Eg:
dividend restrictions, financial ratios specifications, financial reports requirements, issue of further debt
restrictions.

Money Market: short term borrowing/lending market.

Revolving credit: borrower may use or withdraw funds up to a pre approved credit limit. Borrower may repar over
time or infull at any time. Flexible debt financing option that enable to minimize interest payment as you borrow
only as much as you need.

Bonds. Is a debt type security that satisfy long term funding requirements. Issuers owe principal and obliged to
pay interest (coupon) at a fixed interval. Can be traded in capital markets. They do not confer ownership and have
a maturity after which the bond is redeemed. The underwriter (generally a IB) can place it with specific investors
(bond placement) or use a medium term note (MTN) program to issue debt securities on a regular/ continuous
basis.

OTHER SOURCES of finance

Retained earnings/existing cash balances. Retained earnings =/= cash in hand. Only if cash in hand.

Sale and leaseback. Specially for retail w high street property.

Grants. By local/national governments

Debt with warrants attached. Warrant is an option to buy shares at a specified point in the future for a specified
price. Often issued with bonds as a sweetener to encourage investors to buy the bonds. Holder can sell the
warrant.

Convertible debt. Similar to warrant sauf that the option cannot be detached and trade. If the investors choses
not to exercise the option (price too low), can hold until maturity.

Venture Capital & Business Angels (focused more on small business difficult to monitor).
CHAPTER 2. Cost of Capital

WACC (weighted average cost of capital) = measures the average cost of an entity’s finance.

Average of cost of equity (Ke) and cost of debt (Kd)

Cost of Equity: rate of return expected by shareholders. Main method of calculation is Dividend Valuation Model
(with constant or growing dividends). Market price of a share is assumed to be the present value of that future
income stream.

Ke=d/Po Po= market price of share

Ke=d(1+g)/ Po + g  Growth dividend (- could be average (historical) or – profit retention rate)

Assumptions on Growth model based on retention rate

- Entity must be equity financed

- Retained profits are the only source of additional investments
- Constant proportion of each year’s earnings is retained for reinvestment
- Project financed from retained earnings earn a constant rate of return

Cost of debt: rate of return that debt providers require on the funds. Value of debt is assumed to be the present
value of its future cash flows. Debt is tax deductible.

Kd for bank borrowings = r ( 1 – t)

r = annual interest rate in %

T= corporate tax rate

Kd for irredeemable, undated bonds = I ( 1 – T) / Po

I= interest paid each year per $100 of bond

Po= market price of bond after coupon

IRR= discount rate which gives a zero NPV

When Can WACC be used as a discount rate?

When using NPV or IRR calculations but only if these conditions are met:

1. Capital structure is constant; if it changes, the weightings in the WACC will also change
2. The new investment does not carry a different business risk profile to existing operations
3. The new investment is marginal to the entity. If it is a small investment, then Kd, Ke and WACC will not
change materially. Otherwise, it will cause these values to change.

Yield to Maturity = effective average annual percentage return to the investor relative to the current market
value of the bond. Tax is not deducted from any interest received within YTM calculation.
CHAPTER 3: Financial Instruments

IAS 32 Financial Instruments: presentation provides the rules on classifying financial instruments as liabilities or
equity.

Financial Instrument: Any contract that gives rise to a financial asset of one entity and a financial liability or equity
instrument of another entity (IAS 32, para 11)

Entity/ Financial Asset ----------------------------contract---------------------------Entity/Financial Liability/Equity

Financial Asset:

- Cash
- An equity instrument of another entity
- A contractual right to receive cash or another financial asset from another entity
- A contractual right to exchange financial instruments with another entity under conditions that are
potentially favorable

Financial Liability

- To deliver cash or another financial asset to another entity

- To exchange financial instruments with another entity under conditions that are potentially unfavorable

Equity: any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.
A financial instrument is only an equity instrument if there is no such a contract obligation.

Preference shares are classified as financial liabilities. Its dividends will be charged as a finance expense and go
through P/L. Standard shares go through Retained Earnings.

Offsetting a financial asset and a financial liability. May only be offset under very limited circumstances. Net
amount may only be reported when the entity:

- Has a legally enforceable right to set off the amounts

- Intends either to settle on a net basis or to realize the asset and settle the liability simultaneously (IAS 32,
para 42)

IFRS 9 provides guidance on when a financial instrument should be recognized and how they should measured.
They initially should be recognized at fair value. Subsequent measurement depends on classification.

Financial Liabilities (Bonds/loan stock/debentures)

Par value: headline value

Coupon rate: minimum interest repayment per annun based on par value
Discount: (only) if the cash amount received is less than par value
Redemption rate: date of repayment of capital interest of loan = maturity date
Premium: extra amount repayable at redemption date
Effective interest rate: rate of interest that spreads the total finance costs, including finance costs, premium,
coupon, across the life of the loan.

Initially recognized at fair value. Then:

  Fair value through profit or loss (FPVL)
o Applies to instruments:
 Held for trading
 Derivatives
 Record at Fair Value
 Expense Transaction costs
 Restate to fair Value at each reporting date
 Any gain and loss is taken to P/L
 Other Financial Liabilities (eg loan w the bank – held to maturity)
o Record at fair value less costs (fees related to issuance)
o Measured subsequently at amortized cost; ie from the value of a the liability via a finance charge
(effective interest) over the life up to its redemption amount.

Compound instrument. A financial instruments that has characteristics of both equity and liabilities. Eg.
Convertible bonds that are debt that can be converted into equity at certain point. For this priviledge the
bondholder normally have to accept a below-market interest. Upon initial recognition, IAS 32 requires it to be split
into their components parts:

 a financial libiality, measured at PV of future cash flows using a discount rate that equates to the interest
rate on similar instruments without conversion rights. Subsequently it is measured at amortized cost
 an equity instrument, calculated as the balancing figure. Subsequently, it remains unchanged.

Any transaction cost would be pro-rated between equity and libilitiy.

Financial Assets (equity or debt financial assets)

IFRS 9: asset should be initially recognized at fair value (cash paid/received). Subsequent measurement depends
upon classification.

Investments in equity

 Fair value through P/L – if held for trading ordinary shares

o Transaction cost through P/L
o Revalue to fair value after
o Gain/Losses through P/L
 Fair value though OCI
o Not-held for trading and irrevocable designated LT investment in ordinary shares
o Transaction costs added
o Revalue at fair value
o Gain and Losses through OCI

Debt financial asses

An entity will designate a debt financial asset as either FVOCI or amortized cost depending on two tests:

 Business model test. Keep financial assets? Sell them? Hold some and sell some?
 Contractual cash flow test. Contractual terms give rise to repayments of SOLELY Principal and Interests. If
cash flows relate to anything else (eg convertible bondscompensation for low interest in cash or
shares)FV through P/L

Investments in debt
  Business model: hold until redemption // Contractual: passed
o  Amortized cost
 Initial recognition at FV
 Transaction cost added
 Subsequent at Amortized Cost
 Business model: hold until redemption and sell before redemption // Contractual: passed
o FVOCI
 Transaction costs added
 Subsequent revalue to FV, gain/losses through OCI. Reclassified through P/L on disposal
 Does not pass the test (eg debt investments held for trading in short term)
o FVPL
 Initial recognition at FV
 Transaction cost through P/L
 Subsequent, revalue to FV
 Gain/Losses through P/L

Derivative Financial Instrument

IFRS 9: a derivative is an instrument that derives its value from the value of an underlying asset, price, rate or
index (equities, bonds, commodities, interest rates, exchange rates, stock market, other indices). Examples of
derivatives: futures, forward, options, interest rate and currency swaps.

Characteristics:

 Its value changes in response to changes in underlying asset

 Requires little or no investment
 Settle in future date

All derivatives are accounted at FV through PL and subsequently revalued through PL at each reporting date.

Types of derivatives: Forward, Forward rate agreement, future (standardized), swaps, options
CHAPTER 4: Earning Per Share (IAS 33)

EPS is widely regarded as the most important indicator of company’s performance.

EPS= Earnings / Number of shares

Earnings = net profit attributable to ordinary shareholders of the parent entity of the parent (group profit after tax,
less profit attributable to non-controlling and irredeemable preference share dividends). Number of shares
=Weighted number of ordinary shares on a time weighted basis.

Issues at full market price: Bring additional resources. Impact on earnings from the time of issue number of
shares are time apportioned.

Bonus Issue/Scrip issues. Issues of shares to current shareholders, based upon the shareholder’s current
shareholding (no cash raised, shareholder own the same proportion of shares before and after issuance). Bonus
shares are reflected for the full period (no time apportioned). Comparative figures are also restated to include
bonus shares.

Rights issues: Combine characteristics of full-market (raise capital, time apportioned) and Bonus issuance (priced
below market). To arrive to weighted average capital, must adjust by 1) bonus element 2) time apportioned.

Diluted EPS. Increase in the number of shares in issue without a proportionate increase in resources (exercise of
options, convertible bonds/shares). IAS 33 requires an entity to disclose DEPS as well as basic EPS with current
earnings and worse possible future dilution scenario.

Interest on bonds is tax deductible but preference dividends are not.

Options or warrants. Give the holder the right to buy shares at some time in the future at a predetermined price.
Cash received by co will be less than selling those shares at market price. Therefore the total number of shares
issue on the exercise of an option or warrant is split in two: 1) number of shares that would have been issue if cash
received had been used to buy shares at market price (using average price) 2) remainder, treated like a bonus and
added to the weighted number of shares issued when calculating DEPS.

CHAPTER 5: Leases (IFRS 16)

IFRS 16, appendix A

A lease is a contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period
of time in exchange for consideration.

The lessor is the entity that provides the right to use the underlying asset in exchange for consideration

The lessee is the entity that obtains the right to use an underlying asset in exchange for consideration

A right-to-use asset represents the lessee’s right to use an underlying asset in exchange for consideration

A right-of-use asset represents the lessee’s rights to use an underlying asset for the lease team.

The lessor must classify its leases as Finance (a lease that transfers all the risks and rewards of ownership. Title
may or may not be transferred) or Operating leases (other than finance leases)

Indications of a finance lease. Substance of the agreement should be considered. One or more should apply:
  Ownership is transferred to the lessee at the end of the lease
 The lease has the option to purchase the asset for a price substantially below the fair value of the asset
and it is reasonably certain the option will be exercised.
 The lease term is for the major part of the asset’s useful life.
 The present value of the minimum lease payments amounts to substantially all of the fair value of the
asset.
 The leased assets are of such a specialized nature that only the lessee can use them without major
modification
 The lessee bears losses arising from cancelling the lease
 Lessee has ability to continue the lease for a secondary period a rate below market rent.

Accounting treatment for an Operating lease

 Lease receipts are shown as income in the statement of P/L on a straight line basis over the term of the
lease, unless another systematic basis is more appropriate
 Any difference between amounts charged and amounts paid will be recognized as accrued income or
deferred income in the statement of financial position (SFP)

Finance leases

At the inception of a lease, lessors present assets held under a finance lease as a receivable

Net investments of the lease: The finance lease receivable is equal to the net investment of the lease. This is
calculated as the PV of all unreceived

 Fixed rental payments

 Variable rental payments
 Residual guarantees (amounts the lessee guarantees that the lease asset will be worth at the end of the
lease
 Unguaranteed residual values
 Termination penalties

Payments are discounted at the rate implicit in the lease. Record interest income in P/L

Subsequent the carrying amount of the lease is:

 Increased by the finance income

 Decrease by the cash receipts

CHAPTER 6: Revenue from contracts with customers (IFRS 15)

Revenue: Income arising in the course of an entity’s ordinary activities (IFRS, Appendix A)

Revenue does not include:

- Proceeds from sale of non-current assets

- Sales tax and other similar
 - Other amounts collected on behalf of others. Eg agency commission

Revenue recognition: 5 step process (COPAR acronym)

 Identify the Contract.

Contract is an agreement between two or more parties that creates rights and obligations (does not need to
be written). An entity can only account for revenue if the contract meets the following criteria:

- The parties to the contract have approved and are committed to fulfilling the contract
- Each party’s rights can be identified
- The payment terms can be identified
- The contract has commercial substance
- It is probable that the entity will be paid
 Identify the separate performance Obligations within the contract

Performance obligations are promises to transfer distinct goods or services to a customer. Some contracts
contain more than one performance obligation. For example: provide a course of 5 lectures as well as provide
a textbook the first day. Different performance obligations must be identified. An entity must decide if the
nature of a performance obligation is: to provide the specified goods or services itself or to arrange for
another party to provide those. If an entity is an agent, revenue is recognized in the form of commission.

 Determining the transaction Price

Price: Amount of consideration an entity expects in exchange for satisfying a performance obligation. The
following must be considered:
- Variable consideration: eg a bonus based on the delivery of the contract. It shall be included in the
transaction price if it is highly probably that a significant reversal in the amount of cumulative
revenue will not occur when the uncertainty is resolved (IFRS 15 p56). If a product is sold with a right
of return, then it is considered to be variable and the entity must estimate the likelihood of return
and record revenue below this figure (eg 96%)
- Significant financing components: The existence of a financing element to the sale can be indicated
by:
o A difference between the amount paid and the cash selling price
o An extended time period between the transfer of the goods/services and the payment date.

If there is a significant financing component, then the consideration receivable needs to be

discounted to present value using the rate at which the customer would borrow.

- Non-cash consideration: Customer may by using shares, options, or other assets. Any non-cash
consideration should be valued at fair value
- Consideration payable to a customer: Sometimes amounts are paid to customers as part of the
contract. These payments are often an incentive to encourage completion of the sale. If
consideration is paid to a customer in exchange for a distinct good or service (eg suppliers sell to
supermarkets but also pay them for shelf space) then it is essentially a purchase transaction and
should be accounted for in the same way as other purchasers from suppliers. If the consideration
paid to customer is not in exchange for a distinct good or service, an entity should account for it as a
reduction of the transaction price.
 Allocate the transaction price. Contracts can include a number of performance obligations. E.g. sales of
products including warranty periods. Prices should be allocated to each separate performance obligation
within a contract (in proportion to stand alone selling prices). The best evidence is the observable selling
 price of goods or services sold separately. If a stand-alone selling price is not observable, then the entity
estimates the stand-alone selling price. In relation to a bundle sale, any discount should generally be
allocated to a specific individual component of the transaction if that component is regularly sold separately
at a discount.
 Recognize revenue: revenue is recognized when the entity satisfies a performance obligation by transferring
a promised good or service to a customer (IFRS 15, para 31). For each performance obligation identified, an
entity must determine whether it satisfies the performance obligation:
a. At a point in time. Is satisfied when a customer obtains control of a promised asset. Control of an
asset refers to the ability to direct the use of, and obtain substantially all of, the remaining
benefits from the asset. Control includes the ability to prevent other entities from obtaining
benefits from an asset (i.e. an entity can restrict the assets use). The following are indicators of
control:
i. The entity has a present right to payment for the asset
ii. The customer has legal title to the asset
iii. The entity has transferred physical possession of the asset
iv. The customer has the significant risk and rewards of ownership of the asset
v. The customer has accepted the asset (IFRS, para 38)

Specific Applications:

- Consignment inventory. Inventory legally owned by one party but held by another party, on
terms which give the holder the right to sell the inventory in the normal course of business or,
at the holder’s option, to return it to the legal owner. Type of arrangement common in the
motor trade.
Inventory is legally owned by the manufacturer until 1) the dealer sells the inventory to a third
party or 2) the dealer’s right to return expires and the inventory is still not sold.
Particular attention should be paid to the need for the customer to hold the risks and rewards
of ownership. If the risk and rewards are transferred to the customer, the sale is recorded.
Otherwise, the opposite is true. If sale is not recorded at date of delivery, the manufacturer
continues to include goods in inventory and the dealer makes no entries on their books.
- Sale and repurchase agreements. A sale and repurchase agreement is where an entity sells an
asset but retains a right to repurchase the asset at some point in the future. Sale and
repurchase agreements are common in property developments and in maturing inventories
such as whisky or cheese. The asset has been legally sold but there is either a commitment or
an option to repurchase the asset at a later date. The point in time at which to recognize
revenue depends upon whether the control has transferred to the customer.

Factors to consider when determining who has control of the asset:

o Has the entity transferred the all of risks and benefits of the asset (and therefore
control)? Can the entity still use the asset? Does the entity bear costs associated with
the asset?
o Was the asset sold at a price different to market value?
o Is the entity obliged to repurchase the asset?
o If the entity has the option to repurchase the asset are they likely to exercise this
option?
o Is the sale is to a bank or financing company?
o Is repurchase at a fix price or market value?
 If asset has been sold, sale must be recorded. Otherwise it is recorded as a loan. (see case
study 4, page 154)

b. Satisfying a performance obligation over time. If one of the following criteria is met:
i. The customer simultaneously received and consumes the benefits provided by the entity’s
performance as the entity performs (i.e. the entity provides a services, classroom courses).
ii. The entity’s performance creates or enhances an asset (for example, work in progress)
that a customer controls as the asset is created or enhanced. (i.e construction work to
create a building on land owned by customer.
iii. The entity’s performance does not create an asset with an alternative use to the entity
and the entity has an enforceable right to payment for performance completed to date.
i.e. construction of highly specialized assets.

For each performance obligation satisfied over time, an entity shall recognize the revenue over
time by measuring the progress towards complete satisfaction of that performance obligation
(IFRS, para 39). Methods for measuring performance include:

- Output methods (such as surveys of performance or time elapsed as a proportion of total

contract price/time).
- Input methods (such as costs incurred to date as a proportion of total expected costs)

This is typical in construction companies building an asset. As long as the construction company is
not able to use the asset and has a right to payment for work to date, revenue would be
recognized over time. In calculating the entries to be made for such contracts, the following 4-step
approach can be helpful:

1. Calculate overall profit or loss. If expected profitrevenue and cost should be

recognized according to progress of the contract. If expected lossthe whole loss
should be recognized immediately creating a provision as per IAS 37. If outcome is
unknown (early stages)revenue should be recognized only to the level of
recoverable costs incurred.
2. Determining the progress of a contract. Two acceptable methods: 1) Input based on
costs incurred/total costs=% complete 2) Output: based on performance completed
(work certified/contract price = % of complete.
3. Statement of profit or loss (from step 1)
4. Statement of financial position. Some contracts where performance obligations are
satisfied over time will be large scale projects and can span a number of years. Billing
is difficult to keep accurate as progress continues. As a result, the full amount of work
performed may not have been billed or amounts in excess of the work performed may
have been billed to the customer. At the year end, this discrepancy in billing will
create a contract asset or liability. IFRS is not prescriptive about this. As alternatives to
the term “contract asset”, IFRS also allow the terms receivable and work-in-progress
to be used. If revenue exceeds cash received, this could be included within trade
receivables. If cost to date exceed cost of sales, this could be included within
inventory as work in progress. If cash received exceeds the revenue recognized to
date, there will be a contract liability/provision (acting as deferred income). If contract
is loss making, there will be a provision recorded to recognize the full loss under the
onerous contract per IAS 37.
CHAPTER 7: Provisions, contingent liabilities and contingent assets (IAS 37)

Before IAS 37, provisions were a result of the intention to make an expenditure and not the obligation to do so.
With this, entities would smooth profits (reduce profits in good times, increase in bad), aggregate several
provisions as an exceptional item (“big bath”).

IAS 37 introduced a set of criteria that must be satisfied before a provision can be recognized.

A provision is a liability of uncertain timing or amount. A liability is a present obligation of the entity arising from
past events, the settlement of which is expected to result in an outflow from the entity fo resources embodying
economic benefits. (IAS 37, para 10).

Recognition criteria. Only when ALL of the following conditions are met (otherwise no):

- An entity has a present obligation (legal –contract, legislation, operation of law- or constructive –pattern
of past practice, published policy) as a result of a past event
- It is probable (more likely than not) that an outflow of resources embodying economic benefits will be
required to settle the obligation, and
- A reliable estimate can be made of the amount of the obligation. Estimate should be prudent and
discounted when it is material. Rare cases exist when these can’t be done.

Specific Applications

Future operating losses. The do not meet the definition of liability (are an expectation and not an obligation. A
provision cannot be made.

Onerous contracts. An onerous contract is a contract in which the unavoidable costs of meeting the obligation
under the contract exceed the economic benefits expected to be received under it. A provision is required for the
cheapest option of exiting the contract: cost of fulfilling the contract or any compensation/penalties payable for
failing to fulfill it

Restructuring. Program planned and controlled by management that materially changes the scope of business
undertaken or the way the business is conducted. A provision can be made if:

- The entity has a detailed formal plan AND

- has raised a valid expectation, in those affected that it will carry out the restructuring by starting to
implement it or announcing it.

A provision can then only be made for cost that are:

- Necessarily by the restructuring and

- Not associated with the ongoing activities of the entity. Cost specifically not allowed include:
retraining/relocation of existing staff, marketing and investment in new systems.

Provisions for dismantling/decommissioning costs. When a facility such as an oil well or mine is authorized by the
government, the license normally includes a legal obligation for the entity to decommission the facility at the end
of its useful life. IAS 37 requires a provision to be recognized for the decommissioning costs. These form part of
the cost of the asset and are therefore capitalized and expensed over the life of the asset (as part of the
depreciation charge). The provision is only recorded once damage has been incurred to the land upon which the
oil well or mine will be located. The obligation to incur the decommission costs is only created at the point
damage/changes to the land occurs.
Contingent liabilities and assets

A contingent liability is a possible obligation 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, or

A present obligation that arises from past events but is not recognized because:

- It is not probable that an outflow of resources embodying economic benefits will be required to settle the
obligation, OR
- The amount of the obligation cannot be measured with sufficient reliability (IAS 37, para 10)

Accounting for a contingent liability. According to IAS 37, it is not recognized AND should be disclosed in a note,
unless the possibility of outflow is remote.

A contingent asset is defined as 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 (IAS 37, para 10).

Accounting for contingent asset is not recognized and disclosed in a note, if an inflow is considered probable.

According to IAS 37 the following will be disclosed for contingent liabilities and assets:

- Description of contingent liability/asset

- An estimate of its financial effect
- An indication of uncertainties relating to amount or timing of outflow/inflow
- For contingent liabilities, the possibility of any reimbursement

Degree of probability of an Liability Asset

outflow/inflow
Virtually certain Recognize Recognize
Probable Provide No disclosure
Possible Disclosed by note No disclosure
Remote No disclosure No disclosure
CHAPTER 8: IAS 38 Intangible Assets

An intangible asset is an identifiable non-monetary asset without physical substance (IAS 38, para 8)

Intangible assets include items such as: licenses and quotas, intellectual property e.g. patents and copyrights,
grand names, trademarks

An asset is identifiable if it is both:

- separable (can be bought and sold separately) AND

- arrives from contractual or other legal rights (IAS 38,p12)

Goodwill arising from the acquisition of a business cannot be sold individually and is not accounted as intangible
asset.

Recognition of intangible assets

To be recognized in the financial statement, an intangible asset must meet

- the definition of intangible asset AND

- meet the recognition criteria of the framework IAS 38, para 18

INTANGIBLE ASSETS (recognition criteria)

- Internally generated. Cannot be capitalized as they cannot be identified separately from the cost
associated with running the business. Not capable of reliable measurement. Can never be recognized:
goodwill, brands, publishing titles, newspapers mastheads, customer lists, intellectual property. This
approach can greatly undervalue certain entities (creative design ind)
o Goodwill: should not be recognized, non identifiable and not capable of reliable measurement.
o Other: record at cost if recognition criteria met
- Purchased
o Separately: record at cost if recognition criteria met.
o As part of business combination. Record at FV assuming asset is identifiable and FV is reliable.
Otherwise included in goodwill

The cost comprises:

 Its price to purchase, included import duties, and non-refundable taxes on acquisition,
after deducting discounts and rebates.
 any directly attributable cost of preparing the assets for its intended use

Subsequent measurement of intangible assets:

- the cost model:

o Finite useful life: the intangible asset should be carried at cost less amortization and any
impairment losses. This model is more commonly used in practice. The intangible is amortized
over the useful life, normally straight-line, with the annual expense shown on P/L
o Indefinite useful life (no foreseeable limit to asset cash flow generation): should not be amortized
and be tested for impairment annually (and more often if there is indication).

Amortization should start from the date is available for use. The method of amortizing should reflect
the pattern in which the economic benefits are expected to be consumed. If that is difficult, straight
line is acceptable. The residual value of the intangible should be zero unless there is a commitment
 from a third party to purchase the asset or the entity intends to sell and there is market. The useful life
and amortization method should be reviewed annually and change as soon as identified the need for
current and future periods.

- the revaluation model: intangible assets may be revalue to fair value. The fair value should be determined
by an active market. An active market exist if ALL the following: items traded in the market are
homogenous, willing buyers and sellers can be found at any time, prices are available to the public. The
markets are rare according to IAS 38. Certain licenses or quotas (e.g. taxi cab licenses and farm milk
quotas) may fit this model and could possibly be revalued, but most intangibles will not.

Derecognition of intangible assets: an intangible asset is derecognized on 1) on diposal; or 2) when no future

benefit are expected from it. A again or loss on disposal is recorded in P/L, being the difference between the
proceeds on disposal and the carrying amount. They are not part of revenue.

Research and development. R&D will extend to any industry (pharma, education, construction, etc) and
business operations (prod devel, recruitment, etc)

o Research: investigation undertaken to gain new knowledge and understanding. Its expenditure is
recognize as an expense when incurred.
o Development: Application of research findings or other knowledge to produce new or
substantially improved products. Consider criteria:
o intention to use/sell
o Intend to complete
o Reliable measurement of costs
o Technically feasible to complete project
o Adequate resources to complete the project exists
o Probable future benefits
 Criteria met? Yes  capitalized | Noexpense

Only expenditure incurred AFTER recognition criteria have been met, which should be
recognized as an asset. If an item of a plant is used in the development process, the
depreciation on the plant is added to the development costs in intangible assets during
the period that it meets the development criteria. That is because the economic benefits
from the plan is only realized when the development project is complete and production
under way. The depreciation will eventually take part of the amortization of the
development cost when the project is under way.

Development expenditure should be amortized over it useful life as soon as commercial

production begins.
CHAPTER 9: Income Taxes (IAS 12)

The income tax in the statement of P/L typically consist of:

- Current tax expense for the year: estimated amount of tax payable on the taxable profits of the enterprise
for the period
- Under or over provisions in relation to the tax expense of the previous period: Income tax for the period is
accrued in one financial period and then settled the next. The amount settled often differs from the
amount accrued in the previous year’s financial statements. The difference is recorded in the current
year’s income tax expense as an under or over provision.
- Deferred tax: the estimated tax consequences of transactions and events recognized in the financial
statements of the current and previous periods. Deferred tax is a basis of allocating tax charges to
particular accounting periods. It is an application of the accruals concept and aims to eliminate a mismatch
between:
o Accounting profit: the profit before tax figure in the statement of profit or loss
o Taxable profit: the figure on which the tax authorities base their calculations

The differences between accounting profit and taxable profit can be caused by:

 Permanent differences (e.g. expenses not allowed for tax purposes)

 Temporary differences (e.g. expenses allowed for tax purposes but in a later accounting period).
Differences between the carrying amount of an asset or liability in the SFP and its tax base (e.g.
certain types of income and expenditure that are taxed on a cash rather than accrual basis,
difference between depreciation charge and tax-allowance)

Only temporary differences are taken into account when calculating deferred tax.

Deferred tax is accounted for using a statement of financial position approach as follows:

1- Establish the temporary difference at the year-end= carrying amount of net assets less the tax base
2- Deferred tax balance (for SFP) = temporary difference x rate. This could be an asset or a liability depending
on whether the future tax consequence would increase or decrease the tax payable. It will be a deferred
tax liability if the carrying amount of the net assets is greater than the tax base. It would be a deferred tax
asset if the carrying amount of the net assets was lower than the tax base.
3- Deferred tax expense/credit (for SPL&OCI) = increase/decrease in deferred tax balance in year.

The cumulative deferred tax balance in the SFP would be presented as non-current item. The movement in the
deferred tax balance is usually recognized as an adjustment to the PL sauf if it related to an item that has been
recognized in the OCI. Any deferred tax credit/charge that related to an item that has been recognized in OCI
should also be recognized in OCI. E.g when an asset is revalued upwards, it increases the carrying amount of
the asset. This temporary difference gives rise to an additional deferred tax liability.
Year 1 Year 2 Year 3
Dr Income Tax Liabilit (SPL) 12 Dr Income Tax Liabilit (SPL) 3 Cr Income Tax Liabilit (SPL) 15
CR Defered tax liability (SFP) 12 CR Defered tax liability (SFP) 3 Dr Defered tax liability (SFP) 15

Deferred Tax on Losses. In accordance with IAS 12 Income taxes, a deferred tax asset is recognized on
unutilized losses carried forward (as there will be a future tax benefit when losses are offset against future
profits). However, the asset can only be recognized to the extent that it is probable that future profits will be
available against which the losses can be utilized.
CHAPTER 10: Foreign Currency  IAS 21: The effects of changes in foreign exchange rates

IAS 21 deals with:

1. The definition of functional and presentation currencies

2. Accounting for individual transactions in a foreign currency
3. Translating the financial statements of a foreign subsidiary

1) and 2) are considered as part of the “Explain relevant financial reporting standards” syllabus content. Only this
content is covered within this chapter. 3) is covered on chapter 16

Functional and Presentation Currencies: The functional currency is the currency of the primary economic
environment in which the entity operates (IAS 21, para 8). In most cases this will be the local currency. An entity
should consider the following when determining its functional currency:

 The currency that mainly influences sales prices for goods and services
 The currency of the country whose competitive forces and regulations mainly determine the sales prices
of goods and services
 The currency that mainly influences labor, material and other costs providing goods and services. (IAS 21,
para 9)

The following factors may also be considered:

 The currency in which funding from issuing debt and equity is generated
 The currency in which receipts from operating activities are usually retained (IAS 21, para 10)

The entity maintains its day-to-day financial records in its functional currency.

The presentation currency is the currency in which the entity presents its financial statements. This can be
different from the functional currency, particularly if the entity in question is a foreign owned subsidiary. It may
have to present its financial statements in the currency of its parent, even though that is different to its own
functional currency.

Translation of foreign currency translations: Where an entity enter into a transaction denominated in a currency
other than its functional currency, that transaction must be translated into the functional currency before it is
recorded. The transaction will initially be recorded by applying the spot exchange rate. i.e. the exchange rate at
the date of the transaction. When cash settlement occurs, for example payment by a receivable, the settled
amount should be translated using the spot exchange rate on the settlement date. If this amount differs from that
recorded when the transaction occurred, there will be an exchange difference which is taken to the statement of
profit or loss in the period in which it arises.

Subsequent measurement – unsettled transactions: The treatment of any outstanding foreign currency balances
remaining in the statement of financial position at the year-end will depend on whether they are classified as
monetary or non-monetary.

 Monetary items: currency held and assets or liabilities to be received or paid in currency retranslate
using the closing rate (year-end exchange rate)
 Non-Monetary items: other items in the statement of financial position. (e.g. non current assets,
inventory, investments)  do not translate, leave at historic rate.

Any exchange difference arising on the translation of monetary items must be taken to the statement of P/L in
the period in which it arises.
CHAPTER 11: Group Accounts (subsidiaries)

A group will exist where one company (the parent) controls another (the subsidiary).

IFRS 10 Consolidated Financial Statements sets out a definition saying: “an investor controls an investee if and only
if the investor has all the following elements”:

 Power over the investee (power defined as “existing rights that give the current ability to direct the
relevant activities”
 Exposure or rights to variable returns from its involvement with the investee, and
 The ability to use its power over the investee to affect the amount of investor’s returns.
For examination purposes control is usually established based on ownership more than 50% of voting rights). The
method of consolidation applied is known as acquisition accounting.

Acquisition accounting
In accordance with IFRS 10 Consolidated Financial Statements, the following rules are applied:
 The parent and subsidiaries’ assets, liabilities, income and expenses are combined in full. This represents
the 100% control that the parent has over the subsidiary.
 Goodwill is recognized in accordance with IFRS 3 (revised) Business Combinations
 The share capital of the group is the share capital of the parent only
 Intra-group balances and transactions are eliminated in full (including profit/losses on intra-group
transactions still held in assets such as inventory and non-current assets – the PUP adjustment).
 Uniform accounting policies must be used.
 Non-controlling interests are presented within equity, separately from the equity of the owners of the
parent. Profit and the total comprehensive income are attributed to the owners of the parent and to the
non-controlling interests.

Exceptions from group accounts.

A parent need not present consolidated financial statements if it meets all the following conditions:
 It is a wholly owned subsidiary or a partially-owned subsidiary and its owners, including those not
otherwise entitled to vote, have been informed about, and do not object to, the parent not presenting
consolidated financial statements.
 Its debt or equity instruments are not traded in a public market
 It did not file its financial statements with a securities commission or other regulatory organization for
the purposes of issuing any class of instruments in a public market
 Its ultimate parent produces consolidated financial statements available for public use that comply
with IFRS standards (IFRS, para 4)

Non-Controlling interest and Goodwill

A subsidiary is controlled by another entity – the parent. Non-controlling interest (NCI) shareholders own the
shares in the subsidiary not owned by the parent entity. NCI shareholders are considered to be shareholder of the
group and thus their ownership interest in the subsidiary is reflected within equity.

When calculating goodwill at acquisition the value of the NCIs is added to the value of the parent’s investment in
the subsidiary so that the value of the subsidiary as a whole (100%) is compared against all its assets.

IFRS 3 Business combinations allows two methods to be used to value the NCI at the date of acquisition:
 - Fair Value: May be calculated using the market value of the subsidiary’s shares at the date of acquisition
or other valuation techniques if the subs’ shares are not traded in an active market. This method is
recognizing goodwill in full, in other words, goodwill attributable to both the parent and NCI is recognized.
- Proportionate share of the net assets method: the NCI is measured by calculating the share of the fair
value of the subs’ net assets at acquisition. This method results in only the goodwill attributable to the
parent shareholders being recognized in the consolidated accounts. This method was considered
inconsistent with the treatment of the other assets of the subsidiary. Since the group controls the assets
of the subsidiary, they are fully consolidated in the group accounts (i.e. 100% is added in line by line).

IFRS 3 permits groups to choose how to value NCI on an acquisition by acquisition basis; it is therefore possible
for a group to apply FV method for some acquisitions and the Proportionate Share for others.

Impairment of goodwill: IFRS 3 requires that goodwill is tested at each reporting date for impairment. This means
that goodwill is reviewed to ensure that its value is not overstated in the consolidated statement of financial
position. If an impairment exists, goodwill is written down and the loss is charged as an expense in the
consolidated statement of profit and loss. This charge against profits will result in a reduction in the equity section
of the CSFP. How the impairment loss is charged against equity in the CSFP will depend on the method adopted for
valuing NCI. Using FV method will impact both Parent Shareholders and NCI, while Proportionate method will only
impact the Parent Shareholders part.

Mid-year acquisition and the consolidated statement of financial position. The consolidated statement of
financial position (CSFP) reflects the position at the reporting date and, therefore, figures on the face of the CSFP
should never be time apportioned. However, it may be required to time apportion results, in order to calculate
reserves at acquisition. Add profits pre-acquisition or subtract profits post acquisition.

Intra-Group balances. Intra-group balances and transaction must be eliminated in full, as the group is treated as a
single entity and, therefore, cannot trade with or owe money to itself. Any profit still held within the group’s
assets from intra-group trading should also be eliminated (provision from unrealized profit adjustment PUP).

Provision from unrealized profit adjustment (PUP) in inventory. P and S may sell goods to each other, resulting in
a profit being recorded in the selling entity’s financial statements. If these goods are still held by the purchasing
entity at the year-end, the goods have not been sold outside the group. The profit therefore unrealized from the
group’s perspective should also be removed. The adjustment is also required to ensure that inventory is stated at
the cost of the group (cost at which they were first acquired by the group).

Provision from unrealized profit adjustment (PUP) in Non-current assets. P and S may sell non-current assets to
each other, resulting in a profit being recorded in the selling entity’s financial statements. If these non-current
assets are still held by the purchasing entity at the year-end, the profit is unrealized from the group’s perspective
and should be removed. The profit on disposal should be removed from the seller’s books (net assets working (at
reporting date) fi the sub is the seller, consolidated reserves working if the parent is the seller).

In addition to the profit, there is depreciation to consider.

Prior to the transfer, the asset is depreciated based on the original cost. After the transfer depreciation is
calculated on the transfer price, i.e. a higher value. Therefore depreciation is higher after the transfer and this
extra cost must be eliminated in the consolidated financial statements (profit needs to be increased).

Goodwill – further detail and fair values

The calculation of goodwill is governed by IFRS 3 Business Combinations.

Goodwill is a residual amount calculated by comparing, at acquisition, the value of the subsidiary as a whole and
the fair value of its identifiable net assets at this time. A residual amount may exist as a result of the subsidiary’s
positive reputation, loyal customer base, staff expertise, etc. Goodwill is capitalized as an intangible asset on the
consolidated statement of financial position (CSFP). It is subject to an annual impairment review to ensure its
value is not overstated on the CSFP.

Goodwill is calculated as:

- Fair Value of consideration transferred (by parent) X

- NCI at acquisition (FV or Proportionate Share of Net assets) X
- Fair Value of sub’s net assets at acquisition (X)
- Goodwill at acquisition X
- Impairment (X)
- Goodwill at reporting date X

**Fair value at date of acquisition.

Negative goodwill. Occasionally, the consideration paid for the subsidiary may be less than the fair value of
identifiable net assets at acquisition. This may arise when the previous shareholders have been forced to sell the
subsidiary and so are selling their holding at a bargain price. This situation rise to “negative goodwill” and
represents a credit balance. It is viewed as a gain on a “bargain purchase” (essentially a discount received) and is
credited directly to profits and so the group’s retained earnings.

Fair Value: (IFRS 13 Fair value measurement) “the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants and the measurement date”.

Fair value of parent’s consideration

The value of the consideration paid by the parent for its holding in the subsidiary can comprise of a number of
elements and, according to IFRS 3, each must be measured at its fair value at the date of acquisition. The parent
should already have reflected this amount on its individual SFP. Types of consideration that may be included are:

- cash (FV= amount paid)

- Shares issued by parent (FC= market price of shares issued)
- Deferred consideration (FC=present value)
- Contingent consideration (FC=probability weighted present value)

Exclusion from consideration: The following should never be recognized as part of consideration paid: legal and
professional fees (and other attributable costs of acquisition –they are not what the parent gives in rerun for the
shareholding in the sub) & provisions for future losses in subsidiary acquired. The latter are not part of the value of
the parent’s holding in the subsidiary). Future losses, may be recorded however in the parents’ individual financial
statement as a provisions according to IAS 37.

Deferred consideration: This is consideration, normally cash, which will be paid in the future. It is measured as its
present value at acquisition for inclusion within the goodwill calculation, i.e. the future cash flow is discounted.
Every year after acquisition, the liability will need to be increased to reflect unwinding the discount.

Contingent consideration: contingent consideration is consideration that may be paid in the future if certain future
events occur or conditions are met. For example, cash may be paid in the future if certain profit targets are met.
According to IFRS 3, contingent consideration is measured at its fair value at the date of acquisition. This will
typically be based on a probability weighted present value. Adjustments to the value of contingent consideration
arising from events after acquisition date, e.g. a profit target not being met, are normally charged/credited to
profits.

Fair value of subsidiary’s net assets: according to IFRS 3, at acquisition, the subsidiary’s net assets must be
measured at fair value for inclusion within the consolidated financial statements. The group must recognize the
fair value of the identifiable assets and liabilities of the subsidiary acquired.

 According to IAS 37 Provisions, contingent liabilities and contingent assets, and IFRS 3, an asset is
identifiable if it either:
 Is capable of being separated (sold separately, regardless of whether the subsidiary actually
intends to sell it), or
 Arises from contractual or other legal rights
An asset or liability may only be recognized if it meets the definition of an asset or liability as at the
acquisition date.
 For example, cost relating to restructuring the subsidiary that will arise after acquisition do not
meet the definition of a liability at the date of the acquisition and are not included in the
consolidation.
These requirements can create differences between the accounting of transactions in the individual
accounts of the subsidiary compared to the treatment within the consolidated accounts. For instance:
 Intangible assets: certain internally generated intangible assets such as brands names, patents and
client lists, are not recognized in the sub’s individual financial statements but may be recognized
on consolidation. These intangible are no longer internally generated as the parent has acquired
them as part of the acquisition of the sub. They are identifiable and should be included in the
consolidation of financial statements at their fair value.
 Contingent liabilities: they are not recognized in the sub’s individual financial statements (they are
disclosed by note in accordance with IAS 37). On consolidation however, a contingent liability will
be recognized as a liability if its fair value can be measured reliably (i.e. it is recognized even if it is
not probable).

Measuring fair value. IFRS provides the following guidance on measuring the fair value of certain assets and
liabilities.

ITEM VALUATION
PPE Market value. If there is no evidence of market value,
depreciated replacement cost should be used.
Intangible assets Market value. If non exist, an amount that reflects what
the acquirer would have paid otherwise.
Inventories  Finish goods should be valued at selling prices
less the sum of disposal costs and a reasonable
profit allowance.
 Work in Progress should be valued at the
ultimate selling prices less the sum of
completion costs, disposal costs and a
reasonable profit allowance.
 Raw materials should be valued at current
replacement costs.
Receivables, payables and loans Present value of future cash flows expected to be
received or paid. Discount is unlikely to be necessary for
short term receivables or payables.
Recording fair value adjustments: The fair value of the sub’s net assets at acquisition represents the cost of the
net assets to the group at the date of acquisition. Recording fair value adjustments is in accordance with the
historical cost concept. It also ensures an accurate measurement of goodwill. Assuming the fair value of the sub’s
net assets is higher than their carrying amount, goodwill would be overstated if the fair value adjustments were
not recognized.

To record fair value adjustments in the CSFP

 Adjust the net assets working at acquisition and the reporting date as appropriate:
o The fair value adjustment arises at acquisition so there should always be an adjustment to the net
assets at the date of acquisition.
o Reflect the reporting date adjustment on face of CSFP.

Impact on post-acquisition depreciation.

Fair value adjustments often involve adjustments to non-current asset values which, consequently, involve an
adjustment to depreciation.

Depreciation in the group accounts must be based on the carrying amount of the related non-current asset in the
group’s accounts. Therefore, if the non-current asset values are adjusted at acquisition then a depreciation
adjustment must be made in the post-acquisition period.

TO record depreciation adjustment in the CSFP:

 Adjust net assets working in the reporting date column to reflect the cumulative impact on depreciation of
the fair value adjustment.
 Also reflect adjustment on the face of CSFP.
 The extra depreciation will reduce the post-acquisition profits of the subsidiary included in consolidated
reserves and NCI calculations.

Treatment of investments as FVOCI. In the parent’s individual financial statements, an investment in a subsidiary
is likely to be classified as fair value through other comprehensive income (FVOCI), in accordance with IFRS 9. This
means that the investment will have been remeasured to fair value since the date of acquisition, with any gains
and losses arising being taken to other components of equity. Upon consolidation, these gains or losses should be
reverse back out so that the investment is restated to its fair value at the fate of acquisition (for inclusion in the
goodwill calculation).
CHAPTER 12: Group Accounts (subsidiaries - CSPLOCI)

Consolidated statement of profit or loss and other comprehensive income: The principles of consolidation per
IFRS 10 (Consolidated financial statements) are continued within the statement of profit or loss and other
comprehensive income (CSPLOCI).

A statement of profit or loss and other comprehensive income reflects the income and expenses generated by the
net assets shown on the statement of financial position. It incorporates two separate statements: the statement
of profit or loss and the statement of other comprehensive income.

Since the group controls the net assets of the subsidiary, the income and expenses of the subsidiary should be
fully included in the consolidated statement of comprehensive income i.e. add across 100% of the parent plus
100% of the subsidiary.

Consolidation adjustments and the consolidated statement of profit or loss and other comprehensive income
(CSOPLOCI).

Mid-year acquisitions: If the subsidiary was acquired mid-year the only the post-acquisition results should be
consolidated. Unless told otherwise, it is normal to assume that results should accrue evenly over the period and
therefore the results of the subsidiary should be time apportioned so that only the post-acquisition results are
consolidated.

Intra-group investment income: dividends paid by the subsidiary to the parent should be eliminated upon
consolidation from the parent’s investment income.

Non-controlling interests: According to IFRS 10, the profit for the year and the total comprehensive income for
the year are analyzed between the amounts attributable to the owners of the parent and the amounts attributable
to the non-controlling interest. This analysis is presented at the bottom of the consolidated statement of profit or
loss and it is common for the NCI figures to be calculated with the amounts attributable to the owners of the
parent then being computed as a balancing figure.

Goodwill impairment: If the fair value method has been used to value the non-controlling interest at acquisition,
the NCI share of profit will be adjusted to reflect their share of any goodwill impairment loss.

Where the proportionate share of net assets method is used, all of the goodwill impairment is allocated to the
parent (as previously discussed) and therefore no adjustment is made to the NCI figure.

Intra-group balances: must be eliminated in full as the group is treated as single entity. Any profit still held from
intra-group trading should also be eliminated (PUP adjustment).

Impact on post –acquisition depreciation: fair value adjustments often involve adjustment to non-current asset
values, which consequently involve an adjustment to depreciation. Depreciation in the group’s accounts must be
based on the carrying amount of the related non-current asset in the group accounts. Therefore, if the non-
current asset values are adjusted at acquisition then a depreciation adjustment must be made in the post-
acquisition period. To record depreciation adjustments in the CSOPLOCI:

 An adjustment should be made to reflect the impact of the fair value adjustment on the current year’s
depreciation charge.
 As this depreciation charge relates to the subsidiary’s assets, the adjustment should be reflected in the
calculation of profit attributable to the NCI.
CHAPTER 13: Group Accounts – Associates and joint agreements

Investments in Associates: An associate is “an entity over which the investor has significant influence (IAS 28, para
3) and which is neither a subsidiary nor a joint venture of the investor.

 Significant influence is defined as “the power to participate in the financial and operating policy decisions
of the investee but not control or joint control of those policies (IAS 28, para 3). A holding of 20% or more
of the voting power is presumed to give significant influence unless it can be clearly demonstrated that his
is not the case. At the same time, a holding of 20% is assumed not give a significant influence unless such
influence can be clearly demonstrated”.
 IAS 28 explains that an investor probably has significant influence if:
o It is represented on the board of directors
o It participates in policy-making processes, including decisions about dividends or other
distributions.
o There are material transactions between the investor and the investee.
o There is intercharge of managerial personnel.
o There is provision of essential technical information (IAS 28, para 6)

Associates are accounted for using equity accounting in accordance with IAS 28. They are not
consolidated as the patent does not have control.

Consolidated statement of financial position

The CSFP will include a single line within non-current assets called “Investment in associate” calculated as:

Cost of Investment $

Add: share of post-acquisition reserves X

Less: Impairment losses (X)

Less: PUP (If A has inventory) (X)

Investment in Associate X

The share of post-acquisition reserves, impairment losses and PUP would also be recorded in consolidated
retained earnings.

Consolidated statement of profit or loss and other comprehensive income

The CSOPLOCI will include a single line before profit before tax called “share of profit of associate” calculated as:

Share of associate’s profit for the year X

Less: Impairment losses (X)

Less: PUP (if A is seller) (X)

If the associate has other comprehensive income, the investor’s share will also be recorded in the other
comprehensive income section of CSOPLOCI.

IAS 28 Investments in Associates and Joint Ventures

The equity method of accounting is normally used to account for associates and joint ventures in the consolidated
financial statements.

The equity method should not be used if:

 The investment is classified as held for sale in accordance with IFRS 5, or

 The parent is exempted from having to prepare consolidated accounts on the grounds that it is itself a
wholly, or partially, owned subsidiary of another company (IFRS 10).

Consolidation adjustments

Inter-group transactions & balances: Inter-group transaction (receivables, payables, sales and purchases)
between the group (whether with the parent or subsidiary) and the associate are not eliminated within the
CSOPLOCI or CSFP. This is because the associate is outside of the group. The transaction/balances are with third
party to the group and so may be reported within the group financial statements. The associate is not 100%
consolidated therefore no elimination of inter group transactions is needed. However, unrealized profit on
transactions must be eliminated on consolidation as the group takes a share of the transaction.

Provisions for unrealized profit (PUP): IAS 28 requires unrealized profits on transactions between the group and
the associate to be eliminated. Only the investor’s share of the profit is removed since the group financial
statements only reflect the investor’s share of the associate profits in the first place.

IFRS 11 Joint agreements: IFRS 11 Joints Agreements defines two types of arrangements in which there is joint
control – a joint venture and a joint operation – and sets out the accounting treatment of each.

A joint agreement is “an arrangement of which two or more parties have joint control” (IFRS 11, para 4)

Joint control is “the contractually agreed sharing of control of an arrangement, which exists only when decisions
about the relevant activities require the unanimous consent of the parties sharing control” (IFRS 11, para 7).

A joint venture is a “joint agreement whereby the parties that have joint control of the arrangement have rights to
the net assets of the arrangement” (IFRS 11, para 16)

Accounting treatment: Joint ventures are accounted for using the equity method of accounting in accordance with
IAS 28 Investments in Associates and Joint Ventures. Therefore, a joint venture is accounted for in the same way
as an associate.

Joints Operations: A joint operation is a “joint agreement whereby the parties that have joint control of the
arrangement have rights to the assets, and obligations for the liabilities, relating to the arrangements” (IFRS 11,
para 15). Under IFRS 11, a joint arrangement will either be a joint venture or a joint operation. A joint operation
will exist where the arrangement is not structured though a separate vehicle. A joint operator would account for
its shares of the assets, liabilities, revenues and expenses relating to its involvement with the joint operation in
accordance with the relevant IFRS.

IAS 27 Separate Financial Statements: outlines how parent companies should account for their investments in
subsidiaries, associates and joint ventures within the individual financial statement of the parent. The standard
outline that they are accounted for either: when an entity prepares separate financial statements, investments in
subsidiaries, associates, and jointly controlled entities are accounted for either:

At cost, or in accordance with IFRS 9 Financial Instruments or Using the equity method as described in IAS 28
Investment in Associates.
CHAPTER 12: Consolidated statements of changes in equity

Consolidated statements of changes in equity: they explain the movement in the equity section of the SFP from
the previous reporting date to the current reporting date. From a group perspective, the equity of the group
belongs partly to the parent shareholders and partly to the NCI shareholders. A consolidated statement of changes
in equity (CSOCIE) will be made of two columns reflecting:

 The changes in equity attributable to parent shareholders, made up of share capital, share premium,
retained earnings and any other reserves.
 The changes in equity attributable to NCI shareholders.

Parent Shareholders NCI Shareholders

$000 $000
Equity brought forward (b/f) X X
Comprehensive Income X X
Dividends
P’s dividend (X)
NCI% x S’s dividend (X)
Equity carried forward (c/f) X

Equity b/f

Parent shareholder: This is made up of share capital, share premium, retained earnings and any other reserves as
reported in the last year’s CSFP. Share capital and share premium is that of the parent company only. The retained
earnings and other reserves are consolidated and will need to be calculated using a working