BSA 2nd Trimester

Conceptual Framework & Accounting Standards 2 (CFAS 2)

Module 1:

PAS 41: Agriculture

Objective of PAS 41
To establish standards of accounting for agricultural activity – the management of the
biological transformation of biological assets (living plants and animals) into agricultural
produce (harvested product of the entity’s biological assets).

Definition of terms
Biological assets are living animals and living plants

Agricultural produce is the harvested product of an entity’s biological assets.

Harvest is the detachment of produce from a biological asset by the cessation of biological
asset’s life processes.

Examples:
Biological asset: Sheep
Agricultural produce: Wool
Product after harvest: Yarn, carpet

Biological asset: Pigs

Agricultural produce: Carcass
Product after harvest: Sausage, cured ham

Agricultural activity
Management by an entity of the biological transformation and harvest of biological assets for
sale or for conversion into agricultural produce or into additional biological assets.

Examples: raising livestock, annual cropping, floriculture, aquaculture

Biological transformation
This comprises processes of growth, degeneration, production and procreation that cause
qualitative or quantitative changes in a biological asset.

Scope
• IAS 41 applies to biological assets with the exception of bearer plants, agricultural
produce at the point of harvest, and government grants related to these biological assets.

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 • It does not apply to land related to agricultural activity, intangible assets related to
agricultural activity, government grants related to bearer plants, and bearer plants.
However, it does apply to produce growing on bearer plants.

Initial recognition
• An entity recognizes a biological asset or agriculture produce only when the entity
controls the asset as a result of past events, it is probable that future economic benefits
will flow to the entity, and the fair value or cost of the asset can be measured reliably

Measurement
• Biological assets within the scope of PAS 41 are measured on initial recognition and at
the end of each reporting period at fair value less estimated costs to sell, unless fair value
cannot be reliably measured.

• Agricultural produce is measured at fair value less estimated costs to sell at the point of
harvest. Because harvested produce is a marketable commodity, there is no
'measurement reliability' exception for produce.

• The gain on initial recognition of biological assets at fair value less costs to sell, and
changes in fair value less costs to sell of biological assets during a period, are included in
profit or loss.

• Agricultural produce growing on bearer plant is measured at fair value less cost of
disposal.

• A gain on initial recognition (e.g. as a result of harvesting) of agricultural produce at fair

value less costs to sell are included in profit or loss for the period in which it arises.

• All costs related to biological assets that are measured at fair value are recognized as
expenses when incurred, other than costs to purchase biological assets.

Fair value of biological asset

• There is a presumption that fair value can be measured reliably for a biological asset. However
the presumption can be rebutted only on initial recognition for a biological asset for which
market determined prices are not available or estimates of fair value are determined to be
clearly unreliable.

• In such a case, the biological asset shall be measured at cost less accumulated depreciation and
any accumulated impairment loss.

• Once the fair value of such biological asset becomes clearly measurable, the entity shall
measure the biological asset at fair value less cost of disposal.

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Fair value of agricultural produce
• In all cases, an entity shall measure agricultural produce at the point of harvest at fair value less
cost of disposal.

• The fair value measurement of agricultural produce stops at the point of harvest. After that,
PAS 2 on inventories shall apply.

• The harvested product is recorded by debiting inventory and crediting gain from change in fair
value of agricultural produce.

Gain and loss

• A gain or loss arising on initial recognition of a biological asset at fair value less cost of
disposal and any subsequent changes in fair value less cost of disposal shall be included in profit
or loss.

• A loss may arise on initial recognition of a biological asset because cost of disposal of a
biological asset.

• A gain or loss may arise on initial recognition of agricultural produce as a result of harvesting
which shall also be included in profit or loss.

• An entity shall disclose the aggregate gain or loss arising on the initial recognition of biological
asset and agricultural produce and from the change in fair value less cost of disposal of
biological asset.

Other issues
• The change in fair value of biological assets is part physical change (growth, etc) and part
unit price change. Separate disclosure of the two components is encouraged, not required.

• Agricultural produce is measured at fair value less costs to sell at harvest, and this
measurement is considered the cost of the produce at that time (for the purposes of IAS 2
Inventories or any other applicable standard).

• Agricultural land is accounted for under PAS 16 Property, Plant and Equipment.
However, biological assets (other than bearer plants) that are physically attached to land
are measured as biological assets separate from the land.

• In some cases, the determination of the fair value less costs to sell of the biological asset
can be based on the fair value of the combined asset (land, improvements and biological
assets).

• Intangible assets relating to agricultural activity (for example, milk quotas) are accounted
for under PAS 38 Intangible Assets.

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Agricultural Land
• Agricultural land is nor deemed biological asset
• Under PAS 16 PPE

Bearer Plants
• Should be accounted for as PPE
• The agricultural produce of bearer plants are under PAS 41
• Definition
a. Used in the production or supply of agricultural produce.
b. Expected to bear produce for more than one period
c. Has a remote likelihood of being sold as agricultural produce, except for incidental scrap
sales.
• Not considered bearer plants:
- Trees grown to be harvested and sold as log or lumber
- Annual crops which do not bear produce for more than one period and are held solely to be
harvested as agricultural produce such as corn and rice.

Plant with dual use

• Reported as biological asset not as bearer plant
• A plant may have a dual use, namely
a. The plant itself is being sold either as a living plant or an agricultural produce.

Measurement – immature bearer plants

• Immature bearer plants are similar to an item of PPE being constructed before intended use.
Thus, it is to be measured at accumulated cost in the same manner as self-constructed item of
PPE.

• There is no specific guidance when a bearer plant reaches maturity

Bearer animals
 Explicitly excluded from IASB amendment involving bearer plants and will continue to
be accounted for under IAS 41.

Animal-related recreational activities

• The natural breeding that takes place in a zoo is not a managed activity and is incidental only to

the main activity of providing a recreational facility.

• Shall be accounted for under PAS 16 PPE.

Government grants
• Unconditional government grants received in respect of biological assets measured at fair
value less costs to sell are recognized in profit or loss when the grant becomes receivable.

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 • If such a grant is conditional (including where the grant requires an entity not to engage
in certain agricultural activity), the entity recognizes the grant in profit or loss only when
the conditions have been met

Disclosure requirements
• aggregate gain or loss from the initial recognition of biological assets and agricultural
produce and the change in fair value less costs to sell during the period.

• description of an entity's biological assets, by broad group.

• description of the nature of an entity's activities with each group of biological assets and
non-financial measures or estimates of physical quantities of output during the period and
assets on hand at the end of the period.

• information about biological assets whose title is restricted or that are pledged as security

• commitments for development or acquisition of biological assets.

• financial risk management strategies.

PAS 38: Intangible Assets

An intangible asset is simply defined as an identifiable nonmonetary asset without physical
substance.

Essential criteria:
1. Identifiability
2. Control
3. Future economic benefits

Objective of PAS 28
To prescribe the accounting treatment for intangible assets that are not dealt with
specifically in another PFRS.

It requires an entity to recognize an intangible asset if, and only if, certain criteria are met.

It also specifies how to measure the carrying amount of intangible assets and requires certain
disclosures regarding intangible assets.

Scope
• PAS 38 applies to all intangible assets other than
• financial assets (see PAS 32 Financial Instruments: Presentation)

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 • exploration and evaluation assets (see PFRS 6 Exploration for and Evaluation of Mineral
Resources)
• expenditure on the development and extraction of minerals, oil, natural gas, and similar
resources
• intangible assets arising from insurance contracts issued by insurance companies
•  intangible assets covered by another PFRS, such as intangibles held for sale
(PFRS 5 Non-current Assets Held for Sale and Discontinued Operations), deferred tax
assets (PAS 12 Income Taxes), lease assets (PAS 17 Leases), assets arising from
employee benefits (PAS 19 Employee Benefits (2011)), and goodwill (PFRS 3 Business
Combinations).

Identifiability
An asset is identifiable when:
a. It is separable
b. It arises from contractual or other legal rights

Control
Power of the entity to obtain the future economic benefits flowing from the intangible asset and
restrict the access of others to those benefits.

Future economic benefits

May include revenue from the sale of products and services, cost savings or other benefits
resulting from the use of the asset by the entity.

Intangible Asset
• an identifiable non-monetary asset without physical substance. An asset is a resource that
is controlled by the entity as a result of past events (for example, purchase or self-
creation) and from which future economic benefits (inflows of cash or other assets) are
expected. [PAS 38.8]

Thus, the three critical attributes of an intangible asset are:

• identifiability
• control (power to obtain benefits from the asset)
• future economic benefits (such as revenues or reduced future costs)

Identifiability: an intangible asset is identifiable when it:

• is separable (capable of being separated and sold, transferred, licensed, rented, or
exchanged, either individually or together with a related contract) or arises from
contractual or other legal rights, regardless of whether those rights are transferable or
separable from the entity or from other rights and obligations.

Examples of intangible assets

• patented technology, computer software, databases

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 • trade secrets trademarks, trade dress, newspaper mastheads,
• internet domains video and audiovisual material (e.g. motion pictures, television
programmes)
• customer lists
• mortgage servicing
• rights licensing, royalty and standstill agreements
• import quotas
• franchise agreements customer and supplier relationships (including customer lists)
marketing rights

Intangibles can be acquired:

- by separate purchase
- as part of a business combination
- by a government grant
- by exchange of assets
- by self-creation (internal generation)

Recognition Criteria
PAS38 requires an entity to recognize an intangible asset, whether purchased or self-created (at
cost) if, and only if:

• it is probable that the future economic benefits that are attributable to the asset will flow
to the entity; and the cost of the asset can be measured reliably.
• This requirement applies whether an intangible asset is acquired externally or generated
internally. PAS 38 includes additional recognition criteria for internally generated
intangible assets (see below).
• The probability of future economic benefits must be based on reasonable and supportable
assumptions about conditions that will exist over the life of the asset.
• The probability recognition criterion is always considered to be satisfied for intangible
assets that are acquired separately or in a business combination.

Recognition as an expense
1. An expenditure on an intangible item that does not meet the recognition criteria for an
intangible asset shall be expensed when incurred
2. Examples pf expenditures that are expensed when incurred include:
a. Start-up costs
b. Training costs
c. Advertising and promotional costs
d. Business relocation or reorganization costs

If recognition criteria not met

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 • If an intangible item does not meet both the definition of and the criteria for recognition
as an intangible asset, IAS 38 requires the expenditure on this item to be recognized as an
expense when it is incurred.

Business combinations
• There is a presumption that the fair value (and therefore the cost) of an intangible asset
acquired in a business combination can be measured reliably.
• An expenditure (included in the cost of acquisition) on an intangible item that does not
meet both the definition of and recognition criteria for an intangible asset should form
part of the amount attributed to the goodwill recognized at the acquisition date.

Reinstatement
• The Standard also prohibits an entity from subsequently reinstating as an intangible asset,
at a later date, an expenditure that was originally charged to expense. [PAS 38.71]

Initial recognition: research and development

• Charge all research cost to expense. [PAS 38.54] Development costs are capitalized only
after technical and commercial feasibility of the asset for sale or use have been
established.
• This means that the entity must intend and be able to complete the intangible asset and
either use it or sell it and be able to demonstrate how the asset will generate future
economic benefits. [PAS 38.57]
• If an entity cannot distinguish the research phase of an internal project to create an
intangible asset from the development phase, the entity treats the expenditure for that
project as if it were incurred in the research phase only.

Initial recognition: in-process research and development acquired in a

business combination
• A research and development project acquired in a business combination is recognized as
an asset at cost, even if a component is research.
• Subsequent expenditure on that project is accounted for as any other research and
development cost (expensed except to the extent that the expenditure satisfies the criteria
in PAS 38 for recognizing such expenditure as an intangible asset). [PAS 38.34]

Initial recognition: internally generated brands, mastheads, titles, lists

• Brands, mastheads, publishing titles, customer lists and items similar in substance that are
internally generated should not be recognized as assets. [PAS 38.63]

Initial recognition: computer software

• Purchased: capitalized
• Operating system for hardware: include in hardware cost Internally developed (whether
for use or sale): charge to expense until technological feasibility, probable future benefits,
intent and ability to use or sell the software, resources to complete the software, and
ability to measure cost.

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 • Amortization: over useful life, based on pattern of benefits (straight-line is the default).

Initial recognition: certain other defined types of costs

The ff. items must be charged to expense when incurred:
• internally generated goodwill [PAS 38.48]
• start-up, pre-opening, and pre-operating costs [PAS 38.69]
• training cost [PAS 38.69]
• advertising and promotional cost, including mail order catalogues [PAS 38.69]
• relocation costs [PAS 38.69]

Initial measurement
• Intangible assets are initially measured at cost
• PAS 38 provides that an intangible asset shall be measured initially at cost.

The cost of separately acquired intangible asset comprises

1. Purchase price
2. Import duties and nonrefundable purchase tax
3. Directly attributable costs of preparing the asset for the intended use. Directly attributable
costs
1. Cost of employee benefit arising directly from bringing the asset to its working condition
2. Professional fee arising directly from bringing the asset to its working condition.
3. Cost of testing whether the asset is functioning properly.

Measurement subsequent to acquisition: cost model and revaluation

models allowed
• An entity must choose either the cost model or the revaluation model for each class of
intangible asset. [PAS 38.72]

Cost model
• After initial recognition intangible assets should be carried at cost less accumulated
amortization and impairment losses. [PAS 38.74]

Revaluation model
• Intangible assets may be carried at a revalued amount (based on fair value) less any
subsequent amortization and impairment losses only if fair value can be determined by
reference to an active market. [PAS 38.75] Such active markets are expected to be
uncommon for intangible assets. [PAS 38.78] Examples where they might exist:

production quotas, fishing licenses, taxi licenses,

Classification of intangible assets based on useful life

• Indefinite life: no foreseeable limit to the period over which the asset is expected to
generate net cash inflows for the entity.
• Finite life: a limited period of benefit to the entity.
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Measurement subsequent to acquisition: intangible assets with finite
lives
• The cost less residual value of an intangible asset with a finite useful life should be
amortized on a systematic basis over that life:
• The amortization method should reflect the pattern of benefits. If the pattern cannot be
determined reliably, amortize by the straight-line method.
• The amortization charge is recognized in profit or loss unless another IFRS requires that
it be included in the cost of another asset.
• The amortization period should be reviewed at least annually.

Measurement subsequent to acquisition: intangible assets with indefinite

lives
• An intangible asset with an indefinite useful life should not be amortized.
• Its useful life should be reviewed each reporting period to determine whether events and
circumstances continue to support an indefinite useful life assessment for that asset. If
they do not, the change in the useful life assessment from indefinite to finite should be
accounted for as a change in an accounting estimate.
• The asset should also be assessed for impairment in accordance with PAS 36
(Impairment of assets).

Subsequent expenditure
• Due to the nature of intangible assets, subsequent expenditure will only rarely meet the
criteria for being recognized in the carrying amount of an asset.
• Subsequent expenditure on brands, mastheads, publishing titles, customer lists and
similar items must always be recognized in profit or loss as incurred.

Disclosure
For each class of intangible asset, disclose:
• useful life or amortization rate
• amortization method
• gross carrying amount accumulated
• amortization and impairment losses

line items in the income statement in which amortisation is included

reconciliation of the carrying amount at the beginning and the end of the
period showing:
• additions (business combinations separately) assets held for sale retirements and other
disposals revaluations impairments reversals of impairments amortization, foreign
exchange differences other changes
• basis for determining that an intangible has an indefinite life
• description and carrying amount of individually material intangible assets
• certain special disclosures about intangible assets acquired by way of government grants

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 • information about intangible assets whose title is restricted
• contractual commitments to acquire intangible assets

Additional disclosures are required about:

• intangible assets carried at revalued amounts, the amount of research and development
expenditure recognized as an expense in the current period

Non-Capitalized costs
Examples:
1. Cost of introducing a new product or service, including cost of advertising and promotional
activity.
2. Cost of conducting business in a new location or with a new class of customer, including cost
of staff training.
3. Administration and other general overhead cost.
4. Cost incurred while an asset capable of operating in a manner intended by management has
yet to be brought into use.
5. Initial operating loss.

Internally generated intangible asset

The cost of internally generated intangible asset comprises all directly attributable costs
necessary to create, produce and prepare the asset to be capable of operating it in the manner
intended by the management.
PAS 38 explicitly provides that internally generated brand, masthead, publishing title, customer list and
other item similar in substance shall not be recognized as intangible asset. Instead such items are seen as
being component of internally generated goodwill.

Subsequent expenditure
As a rule, a subsequent expenditure on an intangible asset shall be recognized as expense.

However, the subsequent expenditure may be capitalized or added to the cost of the intangible
asset if the following recognition criteria are met:
a. It is probable that future economic benefits that are attributable specifically to the subsequent
expenditure will flow to the entity.
b. The subsequent expenditure can be measured reliably

Identifiable intangible assets

PAS 38 specifically pertains to identifiable intangible assets.

If the intangible asset is acquired through purchase, there is a transfer of legal right that would
make the asset identifiable. If the asset could be sold, transferred, licensed, rented or sold
separately, the intangible asset is identifiable.

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Unidentifiable intangible assets
An intangible asset is unidentifiable if it cannot be sold, transferred, licensed, rented or
exchanged separately.

The intangible asset is inherent in continuing business and can only be identified with the entity
as a whole.

The unidentifiable intangible asset squarely describes a goodwill.

Measurement after recognition

An entity shall choose whether the cost model or revaluation model as an accounting policy

Amortization of intangible assets

1. Intangible assets with limited useful life are amortized over their useful life.

2. Intangible assets with indefinite useful life are not amortized but are tested for
impairment at least annually and whenever there is an indication that the intangible asset
may be impaired.

Impairment of intangible assets

• Intangibles assets with finite useful life are tested for impairment whenever there is an
indication of impairment at the end of the reporting period.

• An impairment loss on an intangible asset is recognized if the recoverable amount is less than
the carrying amount.

Definition of amortization
• Amortization is the systematic allocation of the amortizable amount of an intangible asset over
the useful life.

• The amortization is recorded by debiting amortization expense and crediting the intangible
asset account

• Normally, the intangible asset account is credited directly for the periodic amortization but an
accumulated amortization account may be maintained.

Amortization period
• The amortizable amount of an intangible asset shall be amortized on a systematic basis over the
useful life.
• Amortization shall begin when the asset is available for use, meaning, when the asset is in the

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location and condition for the intended use.
• Amortization shall cease when the intangible asset is derecognized
Factors affecting useful life
• Technical, technological, commercial or other type of obsolescence
• Expected action by competitors or potential; competitors
• Expected usage of the asset by the entity
• Typical product life cycle for the asset
• Stability of the industry in which the asset operates
• Level of maintenance expenditure required to obtain the expected future economic benefits
from the asset
• The useful life of the asset may be dependent on the useful life of other assets of the entity/
• Period of control over the asset and legal or similar limits on the use of the asset, such as expiry
dates or related leases

Amortization method
• The method of amortization shall reflect the pattern in which the future economic benefits from
the asset are expected to be consumed by the entity.
• If such pattern cannot be determined reliably, the straight line method of amortization can be
used.

Residual value
The residual value of an intangible asset shall be presumed to be zero, except:
a. When a third party is committed to buy the intangible asset at the end of the useful life.
b. When there is an active market for the intangible asset

The residual value is reviewed every financial year-end. A change in it is treated as change in
accounting estimate.

Derecognition
An intangible asset shall be derecognized or eliminated from the statement of financial position:
a. On disposal of the asset
b. When no future economic benefits are expected from its use and disposal

Gain or loss arising from the derecognition of an intangible asset shall be determined as the
difference between the net disposal proceed and the carrying amount of the asset.

Research and development

PAS 38 Provides that to assess whether an internally generated intangible asset meets the criteria
for recognition, an entity classifieds the generation of the asset into a research phase and a
development phase.

• if an entity cannot distinguish the research phase from the development phase, the entity treats
the expenditure as if it were incurred in the research phase only.

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Definition of research
research is original in planned investigation undertaken with the prospect of gaining scientific or
technical knowledge and understanding.

a research activity is undertaken to discover new knowledge that will be useful in developing
new product.

Definition of development cost

Development is the application of research findings or other knowledge to a plan or design for
the production of new or substantially improved material, device, product, processcall ma system
or service, prior to the commencement of commercial production.

A development activity involves the application of research findings to develop a new product.

Examples of research activities

1. Laboratory research aimed at obtaining or discovering new knowledge.
2. Searching for application of research finding another knowledge.
3. Conceptual formulation and design of possible product or process alternative.
4. Testing in search for product or process alternative.

Examples of development activities

1. Design come up construction, and testing of pre-production prototype and
model.
2. Design of tools, jigs, molds and dies involving new technology.
3. Design, construction and operation of a pilot plant that is not of a scale economically feasible
to the entity for commercial production.
4. Design, construction and testing of a chosen alternative for new or improved product or
process.

Activities not considered research and development

• Research and development activities typically occur prior to the beginning of commercial
production and distribution of a product or process.
• Accordingly, activities that relate to commercial production do not result to research and
development costs.

Example of activities not considered research and development

• Engineering follow through in an early phase of commercial production.
• Quality control during commercial production including routine testing.
• Troubleshooting breakdown during production.
• Routine ongoing effort to refine, enrich or improve quality of an existing product.
• adaptation of an existing capability to a particular requirement or customer need.
• Periodic design changes to existing products.

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• Routine design of tools, jigs, molds and dies.
• Activity, including the cynan construction engineering related to construction, relocation,
rearrangement or startup of facilities and equipment.

Accounting for research cost

• PAS 38 provides that expenditure on research or on the research phase of an internal project
shall be recognized as expense when incurred. The reason is that the research phase of a project
an entity cannot be certain that future economic benefits would probably flow to the entity.

• At the research stage there is too much uncertainty about the likely success of the project. In
the research phase an entity cannot demonstrate that an intangible asset exists that will generate
probable future economic benefits.

Accounting for development cost

• In contrast with research cost, development cost is incurred at a later stage in a project and the
probability of success may be more apparent. Development costs may or may not be recognized
as an intangible asset depending on a very strict criteria.

Criteria for recognition

Development cost may qualify as intangible asset if and only if the entity can demonstrate all of
the following:

1. the technical feasibility of completing that intangible asset so that it will be available for use or
sale.
2. The intention to complete the intangible asset and use or sell it.
3. The ability to use or sell the intangible asset.
4. How the intangible asset will generate probable future economic benefits.
5. Availability of resources or funding to complete development and to use or sell assets
6. the ability to measure reliably the expenditure attributable to the intangible asset during its
development.

Capitalizable expenditures
Expenditures for research and development which have alternative future use, either in additional
research project or for productive purposes, can be capitalized. Subsequently the following
should be charged to research and development expense:

a. cost of materials used

b. depreciation of equipment used in research and development
c. Amortization of intangible asset used in research and development

Wasting Assets
Exploration and evaluation
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• Mineral resources include minerals, oil, natural gas and similar non regenerative resources.

• The term exploration and evaluation of mineral resources is defined as the as the search for the
mineral resources after the entity has obtained legal right to explore in a specific area as well as
the determination of the technical feasibility and commercial viability of extracting the mineral
resources.

• Exploration and evaluation expenditures are expenditures incurred by an entity in connection

with the exploration and evaluation of mineral resources before the technical feasibility and
commercial viability of extracting a mineral resource. Exploration cost is the cost incurred in an
attempt to locate the natural resource that can economically be extracted.

Accordingly, exploration and evaluation expenditures do not include expenditures incurred:

a. before an entity has obtained the legal right to explore a specific area.
b. After the technical feasibility and commercial viability of extracting a mineral resource are
demonstrable . This birthday means to development expenditure.

Exploration and evaluation expenditures

• Acquisition of rights to explore.
• topographically, geological, Geo chemical engineer physical studies.
• Exploratory drilling
• Trenching
• Sampling
• activities in relation to evaluating the technical feasibility and commercial viability of
extracting a mineral resource.
• General and administrative costs directly attributable to exploration and evaluation activities.

Exploration and evaluation asset

• the exploration and evaluation expenditures may qualify as exploration and evaluation asset.

• an entity must develop its own accounting policy for the recognition of such assets IFRS 6
permits an entity to continue to apply its previous accounting policy provided that the resulting
information is relevant and reliable.

Measurement and classification

• Exploration and evaluation assets should be measured initially at cost
• After initial recognition, an entity shall apply either the cost model or the revaluation model.
• Exploration and evaluation asset is classified either as tangible asset or an intangible asset

Two methods of accounting for exploration costs

1. Successful effort method – exploration costs directly are really that the discovery of
commercially producible natural resource is capitalized as cause of the resource property.

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 The exploration costs related to dry holes or unsuccessful discovery is expensed in the
period incurred.

2. Full cost method – oil exploration costs, whether successful or unsuccessful, are
capitalized as cause of the successful resource discovery. This is on the theory that any
exploration cost is a wild goose chase and therefore necessary before any commercially
producible and profitable resource can be found.

Both methods are used in practice period most large and successful oil entities follow the
successful effort method. The full cost method is popular among small oil entities.

PAS 40: Investment Property

Investment Property
 property (land or a building or part of a building or both) held (by the owner or by
the lessee under a finance lease) to earn rentals or for capital appreciation or both.

Examples of Investment property

 land held for long-term capital appreciation
 land held for a currently undetermined future use
 building leased out under an operating lease
 vacant building held to be leased out under an operating lease
 property that is being constructed or developed for future use as investment property

The following are not investment property

 property held for use in the production or supply of goods or services or for
administrative purposes
 property held for sale in the ordinary course of business or in the process of construction
of development for such sale
 property being constructed or developed on behalf of third parties (PAS 11 Construction
Contracts)
 owner-occupied property (PAS 16 Property, Plant and Equipment), including property
held for future use as owner-occupied property, property held for future development and
subsequent use as owner-occupied property, property occupied by employees and owner-
occupied property awaiting disposal
 property leased to another entity under a finance lease

Other classification issues

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  Property held under an operating lease. A property interest that is held by a lessee
under an operating lease may be classified and accounted for as investment property
provided that:
 the rest of the definition of investment property is met
 the operating lease is accounted for as if it were a finance lease in accordance with PAS
17 Leases
 the lessee uses the fair value model set out in this Standard for the asset recognized
 An entity may make the foregoing classification on a property-by-property basis.

Partial own use

 If the owner uses part of the property for its own use, and part to earn rentals or for
capital appreciation, and the portions can be sold or leased out separately, they are
accounted for separately.

 Therefore, the part that is rented out is investment property. If the portions cannot be
sold or leased out separately, the property is investment property only if the owner-
occupied portion is insignificant

Ancillary Services
 If the entity provides ancillary services to the occupants of a property held by the entity,
the appropriateness of classification as investment property is determined by the
significance of the services provided.

 If those services are a relatively insignificant component of the arrangement as a whole

(for instance, the building owner supplies security and maintenance services to the
lessees), then the entity may treat the property as investment property.

 Where the services provided are more significant (such as in the case of an owner-
managed hotel), the property should be classified as owner-occupied

Intracompany rentals
 Property rented to a parent, subsidiary, or fellow subsidiary is not investment property in
consolidated financial statements that include both the lessor and the lessee, because the
property is owner-occupied from the perspective of the group.

 However, such property could qualify as investment property in the separate financial
statements of the lessor, if the definition of investment property is otherwise met

Recognition
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  Investment property should be recognized as an asset when it is probable that the future
economic benefits that are associated with the property will flow to the entity, and the
cost of the property can be reliably measured.

Initial measurement
 Investment property is initially measured at cost, including transaction costs. Such cost
should not include start-up costs, abnormal waste, or initial operating losses incurred
before the investment property achieves the planned level of occupancy

Measurement subsequent to initial recognition

 a fair value model, and a cost model.

 One method must be adopted for all of an entity's investment property. Change is
permitted only if this results in a more appropriate presentation. IAS 40 notes that this is
highly unlikely for a change from a fair value model to a cost model.

Fair Value Model

 Investment property is remeasured at fair value, which is the price that would be received
to sell an asset or paid to transfer a liability in an orderly transaction between market
participants at the measurement date.

 Gains or losses arising from changes in the fair value of investment property must be
included in net profit or loss for the period in which it arises

Cost Model
 After initial recognition, investment property is accounted for in accordance with the cost
model as set out in IAS 16 Property, Plant and Equipment – cost less accumulated
depreciation and less accumulated impairment losses.

Disposal
 An investment property should be derecognized on disposal or when the investment
property is permanently withdrawn from use and no future economic benefits are
expected from its disposal. The gain or loss on disposal should be calculated as the
difference between the net disposal proceeds and the carrying amount of the asset and
should be recognized as income or expense in the income statement.

 Compensation from third parties is recognized when it becomes receivable.

Disclosure (Fair value or cost model)

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  whether the fair value or the cost model is used
 if the fair value model is used, whether property interests held under operating leases are
classified and accounted for as investment property
 if classification is difficult, the criteria to distinguish investment property from owner-
occupied property and from property held for sale
 the extent to which the fair value of investment property is based on a valuation by a
qualified independent valuer; if there has been no such valuation, that fact must be
disclosed

Disclosures
 the amounts recognized in profit or loss for:
 rental income from investment property
 direct operating expenses (including repairs and maintenance) arising from investment
property that generated rental income during the period
 direct operating expenses (including repairs and maintenance) arising from investment
property that did not generate rental income during the period
 the cumulative change in fair value recognized in profit or loss on a sale from a pool of
assets in which the cost model is used into a pool in which the fair value model is used
 restrictions on the realizability of investment property or the remittance of income and
proceeds of disposal contractual obligations to purchase, construct, or develop investment
property or for repairs, maintenance or enhancements

Additional Disclosures for the Fair value model

 a reconciliation between the carrying amounts of investment property at the beginning
and end of the period, showing additions, disposals, fair value adjustments, net foreign
exchange differences, transfers to and from inventories and owner-occupied property, and
other changes
 significant adjustments to an outside valuation (if any)
 if an entity that otherwise uses the fair value model measures an item of investment
property using the cost model, certain additional disclosures are required

Additional Disclosures for the Cost Model

• the depreciation methods used
• the useful lives or the depreciation rates used
• the gross carrying amount and the accumulated depreciation (aggregated with accumulated
impairment losses) at the beginning and end of the period
• a reconciliation of the carrying amount of investment property at the beginning and end of the
period, showing additions, disposals, depreciation, impairment recognised or reversed, foreign
exchange differences, transfers to and from inventories and owner-occupied property, and other
changes
• the fair value of investment property. If the fair value of an item of investment property cannot
be measured reliably, additional disclosures are required, including, if possible, the range of
estimates within which fair value is highly likely to lie
Module 2:

20
Income Taxes
Introduction
Deferred tax accounting is applicable to all entities, whether public or non-public entities.

A public entity is an entity:

a. Whose equity and debt securities are traded in a stock exchange or over the counter market.
b. Whose equity or debt securities are registered with SEC in preparation for sale of the
securities.

Accounting income
 Accounting Income or financial income is the net income for the period before deducting
income tax expense.
 This is the income appearing on the traditional income statement and computed in
accordance with accounting standards.

Taxable Income
 Taxable income is the income for the period determined in accordance with the rules
established by the taxation authorities upon which income taxes are payable or
recoverable.
 Taxable income may be defined also as the excess of taxable revenue over tax deductible
expense and exemptions for the period as defined by the BIR.

Differences between accounting and taxable income

 Permanent Differences
 Temporary Differences

Permanent Differences
 Items of revenue and expense which are included in either accounting income or taxable
income but will never be included in the other.
 Examples:
1. Interest income on deposits
2. Dividends received
3. Life insurance premium
4. Tax penalties, surcharges and fines are nondeductible

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Temporary Differences
 Items of income and expenses which are included in both accounting income and taxable
income but at difference time periods.
 Temporary differences give rise either to a deferred tax liability or deferred tax asset.

Deferred tax liability

PAS 12, paragraph 15, provides that a deferred tax liability shall be recognized for all taxable
temporary differences.
 Deferred tax liability is the amount of income tax payable in future periods with respect
to a taxable temporary difference.
 Taxable temporary difference is the temporary difference that will result in future taxable
amount in determining taxable income of future periods.
 A deferred tax liability arises when accounting income is higher than taxable income
because of future taxable amount.

Accounting Income higher than taxable income

Temporary differences that result in accounting income higher
than taxable income include the following:
1. Revenue and gains are include in accounting income at the time of sale and included in
taxable income when cash is collected in future periods.
2. Expenses and losses are deductible for tax purposes in the current period but deductible
for accounting purposes in future periods.

Deferred tax asset

PAS 12 provides that a deferred tax asset shall be recognized for all deductible temporary
differences and operating loss carryforward when it is probable that taxable income will be
available against which the deferred tax asset can be used.
 Operating loss carryforward is an excess of tax deductions over gross income in a
year that may be carried forward to reduce taxable income in a future year.
 A deferred tax asset is the deferred tax consequence attributable to a future
deductible amount and operating loss carryforward.
 A deferred tax asset arises when taxable income is higher than accounting income
because of future deductible amount.

Taxable income higher than accounting income

Temporary differences that will result to taxable income higher than
accounting income because of temporary deductible differences include the
following:
1. Revenue and gains are included in taxable income of current period but are included in
accounting income of future periods.
2. Expenses and losses are deducted from accounting income but are deductible for tax
purposes in future periods.

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Current tax liability and current tax asset
 A current tax liability is the current tax expense or the amount if income tax
actually payable. This is classified as current liability
 If the amount of tax already paid for the current period exceeds the amount
actually payable for the period, the excess is recognized as current tax asset (a
prepaid income tax and to be classified as current asset)
 A current tax liability or current tax expense shall be measured using the tax rate that
has been enacted and effective at the end of the reporting period.

Measurement of deferred tax asset/liability

 A deferred tax liability or deferred tax asset shall be measured using the tax
rate that has been enacted by the end of the reporting period and expected
to apply to the period when the asset is realized or the liability is settled.
 Example: the tax rate of 30% is applicable to the taxable year 2019. By
12/31/2019, a new tax law has been enacted imposing a 25% tax rate
effective 2020. The current tax liability is measured at 30% but the deferred
tax liability is measured at 25%.
 Deferred tax liability – noncurrent liability; Deferred tax asset – noncurrent asset
 Deferred tax asset shall not be discounted.

Provision, Contingent Liability and

Asset

Provision
A provision is an existing liability of uncertain timing or uncertain amount.

The uncertainty that distinguishes provision from other liabilities.

Recognition of Provision
PAS 37 provides that a provision shall be recognized as a liability in the financial statements
under the following conditions:
 The entity has a present obligation, legal or constructive, as a result of a past event.
 It is probable that an outflow of resources embodying economic benefits would be
required to settle the obligation.
 The amount of the obligation can be measured reliably.

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Measurement of Provision
The amount recognized as a provision should be the best estimate of the expenditure required to
settle the present obligation at the end of the reporting period.
 Single obligation being measured – the individual most likely outcome adjusted for the effect of
other possible outcomes may be the best estimate.
 Continuous range of possible outcomes and each point in that range is as likely as any other –
midpoint of range is used.

Measurement considerations
1. Risks and uncertainties
2. Present value of the obligation
3. Future events
4. Expected disposal of assets
5. Reimbursements
6. Changes in provision
7. Use of provision
8. Future operating losses
9. Onerous contract.

Examples of provision
1. Warranties
2. Environmental contamination
3. Decommissioning or abandonment costs
4. Court case
5. Guarantee

Contingent Liability
PAS 37 defines contingent liability in two ways:
1. A contingent liability is a possible obligation that arises from past event and whose
existence will be confirmed only by the occurrence or nonoccurrence of one or more
uncertain future events not wholly within the control of the entity.
2. A contingent liability is a present obligation that arises from past event but it 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 reliably.

Contingent Liability and Provision

 The present obligation is either probable or measurable but not both to be considered a
contingent liability.
 If the present obligation is probable and the amount can be measured reliably, the
obligation is not contingent liability but shall be recognized as a provision.

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Treatment of contingent liability
A contingent liability shall not be recognized in the financial statements but shall be disclosed
only. The required disclosures are:
a. Brief description of the nature of the contingent liability.
b. An estimate of its financial effects
c. An indication of the uncertainties that exist
d. Possibility of any reimbursement

If a contingent liability is remote, no disclosure is necessary.

Contingent asset
PAS 37 defines contingent asset as a possible asset that arises from past event and whose
existence will be confirmed only by the occurrence or nonoccurrence of one or more uncertain
future events not wholly within the control of the entity.

A contingent asset shall not be recognized because this may result to recognition of income that
may never be realized.

However, when the realization of income is virtually certain, the related asset is no longer
contingent asset and its recognition is appropriate. It is only disclosed when probable.

If a contingent asset is only possible or remote, no disclosure is required.

Employee Benefits
 Employee benefits are all forms of consideration given by an entity in exchange
for services rendered by employees or for the termination of employment.
 The employee benefits include:
a. Short-term employee benefits
b. Postemployment benefits
c. Other long-term employee benefits
d. Termination benefits

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Short-term employee benefits
 These are employee benefits other than termination benefits which are expected to
be settled wholly within twelve months after the end of annual reporting period in which
the employees render the related service.
 It includes the following:
a. Salaries, wages and social security contributions
b. Short-term compensated or paid absences
c. Profit sharing and bonuses payable within twelve months
d. Nonmonetary benefits, such as medical care, housing, car and free or subsidized
goods.

Recognition and measurement

 Accounting for short-term employee benefits is fairly straightforward because there are
no actuarial assumptions
 There is no requirement to discount future benefits because such benefits are all, by
definition, payable no later than twelve months after the end of the current reporting
period.
 There is no possibility of actuarial gain or loss because short-term employee
benefits are measured on an undiscounted basis.

Accounting procedures
The rules of short-term employee benefits are essentially an application of basic accounting
principles and practice.
a. Unpaid short-term employee benefits at the end of the accounting period shall be
recognized as accrued expense.
b. Any short-term benefits paid in advance shall be recognized as a prepayment.

Short-term compensated or paid absences

An entity may pay employees for absences for various reasons such as vacation, sickness
and short-term disability, maternity or paternity and military service.

Entitlement to paid absences falls into two categories namely accumulating and non-
accumulating absences.

Accumulating paid absences are carried forward and can be used in future periods if the
current period’s entitlement is not used in full.

Accumulating paid absences may be either:

a. Vesting – meaning, employees are entitled to a cash payment for unused entitlement on
leaving the entity. Vested benefits are employee benefits that are conditional on future
employment.
b. Non-vesting – meaning, employees are entitled to a cash payment for unused
entitlement on leaving the entity.

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Non-accumulating paid absences are not carried forward.
Post-employment benefits
Post-employment benefits, other than termination benefits and short-term employee benefits,
which are payable after completion of employment. It includes:
a. Retirement benefits such as pensions and lump-sum payment on retirement.
b. Postemployment life insurance
c. Postemployment medical care

Defined contribution plan

 A defined contribution plan is a postemployment benefit plan under which an entity
pays fixed contributions into a separate entity known as the fund.
 Simply stated, the entity makes a specific or definite amount of contribution to a
separate fund without specifying the retirement benefit to be received by the
employee.
 The contribution is definite but the benefit is indefinite.
 Once the defined contribution is paid, the employer has no more obligation under the
plan.

Accounting for defined contribution plan

 Accounting for defined contribution plan is straightforward because the obligation
of the entity is determined by the amount contributed by each period.
 There are no actuarial assumption to measure the contribution and there is no possibility
of any actuarial gain or loss.
 The obligations are measured in an undiscounted basis, except when they are not
expected to be settled wholly within twelve months after the end of the period.

Accounting procedures
 The contribution shall be recognized as expense in the period it is payable.
 Any unpaid contribution at the end of the period shall be recognized as accrued
expense.
 Any excess contribution shall be recognized as prepaid expense but only to the extent
that the prepayment will lead to a reduction in future payments or a cash refund.

Insured benefits
 When an insurance policy is in the name of a specified plan participant or a group of
participants or a group of participants and the entity does not have any legal or
constructive obligation to cover any loss on the policy, the entity has no obligation
to pay benefits and the insurer has sole responsibility for paying the benefits.
 The payment of fixed premiums under the insurance contract is in substance the
settlement of the employee benefit obligation.
 The entity shall treat such insurance payment as contribution to a defined benefit plan.

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Current service cost
 Current service cost is the increase in the present value of the defined benefit
obligation resulting from employee service in the current period.
 Current service cost is the cost to an entity under a defined benefit plan for service
rendered by employee in the current year.
 This component of benefit expense understandably increase expense and defined benefit
obligation

Net interest
 Net interest on defined benefit liability or asset is the change in the defined
benefit obligation, plan assets and asset ceiling as a result of the passage of time.
 Three elements:
a. Interest expense on deferred benefit obligation
b. Interest income on plan assets
c. Interest expense on effect of asset ceiling.
 The net interest expense or net interest income is the difference between the interest
expense on the defined benefit obligation, interest expense on the effect of asset
ceiling and interest income on the plan assets.

Past service cost

 Past service cost is the change in the present value of defined benefit obligation for
employee service in prior periods resulting from a plan amendment or curtailment.
 Past service cost is the cost to an entity under a defined benefit plan for services
rendered by employees in prior periods resulting from the introduction of a defined
benefit plan or amendment of an existing plan or curtailment of an existing plan.
 Plan amendment includes introduction of defined benefit plan or changes to an existing
defined benefit plan.
 Plan curtailment is a significant reduction by the entity in the number of
employees covered by the defined benefit plan.

Recognition of past service cost

 PAS 19 provides that an entity shall recognize past service cost as an expense
when the plan amendment or curtailment occurs.
 All past service costs, whether vested or unvested, shall be recognized as an expense
immediately.

Plan assets
 Plan assets comprise assets held by a long-term benefit fund and qualifying insurance
policy. The conditions for assets held by a long-term benefit fund are:
a. The assets are held by an entity, the fund itself, that is legally separate from the reporting
entity.
b. The assets are available to pay only employee benefits.
c. The assets are not available to the reporting entity’s own creditors even in bankruptcy.

28
 d. The assets cannot be returned to the reporting entity if the remaining assets of the
fund are sufficient to meet all employee benefit obligations or the assets are returned
to the reporting entity to reimburse it for employee benefits already paid.

Qualifying insurance policy

 A qualifying insurance policy is an insurance policy issued by an insurer that is
not a related party of the reporting entity.
 The proceeds of the policy can be used only to pay employee benefits and are
not available to the reporting entity’s own creditors even in bankruptcy.
 The proceeds of the policy cannot be paid to the reporting entity, except:
a. When the proceeds represent surplus assets not needed for the policy to pay
employee benefits.
b. When the proceeds are returned to the reporting entity to reimburse it for employee
benefits already paid.
 When an insurance policy held by an entity is not a qualifying insurance policy,
that insurance policy is not a plan asset.

Actual return on plan assets

 The components of actual return on plan assets include the following:
a. Interest, dividend and other income derived from the plan assets.
b. Realized and unrealized gains and losses on the plan assets.

Remeasurement of plan assets

The measurement of plan assets is the difference between actual return on plan assets and
interest income on plan assets.
a. If the actual return is higher than interest income, the difference is a remeasurement gain.
b. If the actual return is less than the interest income, the difference is a remeasurement loss.

Remeasurement of projected benefit obligation

 The remeasurement of defined benefit obligation is the recognition of actuarial gain and
actuarial loss.
 Actuarial gain and actuarial loss are changes in the present value of the projected benefit
obligation resulting from experience adjustments and the effects of changes in actuarial
assumptions.
 Experience adjustments are adjustments from the differences between the previous
actuarial assumptions and what has actually occurred.

Determination of actuarial gain or loss

a. If the actual benefit obligation is higher than the estimated amount, there is an actuarial
loss.
b. If the actual benefit obligation is lower than the estimated amount, there is an actuarial
gain.

29
Basic accounting considerations
The information contained in the memorandum records of the benefit plan contains the
following:
a. Fair value of plan assets (FVPA)
b. Projected benefit obligation (PBO)

Other long-term employee benefits

Other long-term employee benefits are all employee benefits other than short-term employee
benefits, postemployment benefits and termination benefits.

Termination benefits
Termination benefits are employee benefits provided in exchange for the termination of an
employee’s employment as a result of either
a. An entity’s decision to terminate an employee’s employment before the normal
retirement date
b. An employee’s decision to accept an offer of benefits in exchange for the termination of
employment.

Leases
 A lease is defines as a contract or part of a contract that conveys the right to use the
underlying asset for a period of time in exchange for consideration.
 The underlying asset is the subject of a lease from which the right to use that asset has
been provided by the lessor to the lessee
 The lessee is the entity that obtains the right to use an underlying asset for a period of
time in exchange for consideration
 The lessor is the entity that provides the right to use an underlying asset for a period of
time in exchange for consideration.

Finance lease model for lessee

 IFRS 16 provides that at the commencement date, a lessee shall recognize a right of use
asset and lease liability.
 All leases shall be accounted for by the lessee as a finance lease under the new lease
standard.

Operating lease model for lessee

 IFRS 16 provides that a lessee is permitted to make an accounting policy election to
apply the operating lease accounting and not recognize an asset and lease liability in two
optional exemptions.
a. Short-term lease
b. Low value lease
 A lessee may or may not apply the operating lease accounting if the lease is short-term or
if the underlying asset is of low value.

30
Short-term lease
 A short-term lease as a lease is defined that has a term of 12 months or less at the
commencement date of the lease.
 A lease that contains a purchase option is not a short-term lease.

Low value lease

 The new lease standard does not provide for a quantitative threshold for low value asset.
It is a matter of professional judgment.
 A lease of an underlying asset does not qualify as a low value lease if the nature of the
asset is such that the asset is typically not of low value when new.
 Typically low value underlying assets include personal computer, office furniture and
equipment.

Accounting for operating lease - lessee

 If the lessee elects to apply the operating lease accounting the lessee shall
recognize the lease payments as rent expense in either a straight line basis over
the lease term or another systematic basis.
 Under the operating lease model, the periodic rental is simply recognized as
rent expense on the part of the lessee.

Finance lease – lessee

 A finance lease is defined as a lease that transfers substantially all of the risks and
rewards incidental to ownership of an underlying asset.
 At the commencement date, the lessee shall recognize a tight of use asset and lease
liability.

Initial measurement of right of use asset

 A right of use asset is defined as an asset that represents the right of a lessee to use an
underlying asset over the lease term in a finance lease.
 The cost of right of use asset comprises:
a. The present value of lease payments
b. Lease payments made to lessor such as lease bonus, less any lease incentive received.
c. Initial direct costs incurred by the lessee
d. Estimate of cost of dismantling and restoring the underlying asset for which the lessee
has a present obligation
 Lease incentive is payment by the lessor to the lessee associated with a lease or the
reimbursement or assumption by the lessor of the cost of the lessee
 The lease incentive should be deducted from the cost of the right of use asset.
 Initial direct cost is incremental cost of obtaining a lease that would not have been
incurred if the lease had not been obtained.
 Leasehold improvement is not initial direct cost and not included in the cost of the right
of use asset.
 Any security deposit refundable upon the lease expiration is accounted for as an asset by
the lessee.

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Subsequent measurement
 The lessee shall measure the right of use asset applying the cost model.
 To apply the cost model, the lessee shall measure the right of use asset at cost less any
accumulated depreciation and impairment loss.

Presentation of right of use asset

 The lessee shall present the right of use asset as a separate line item as noncurrent asset in
the statement of financial position.
 As an alternative, the lessee may include the right of use asset in the appropriate line item
within which the corresponding underlying asset would be presented if owned.

Depreciation of right of use asset

 The lessee shall apply normal depreciation policy for right of use asset.
 IFRS 16 provides that the lessee shall depreciate the right of use assert over the useful life
of the underlying asset under the following conditions:
a. The lease transfers ownership of the underlying asset to the lessee at the end of lease term.
b. The lessee is reasonably certain to exercise a purchase option.
 If there is no transfer of ownership to the lessee or if the purchase option is not
reasonably certain to be exercised the lessee shall depreciate the right of use asset over
the shorter between the useful life of the asset and the lease term

Measurement of lease liability

 the lessee shall measure the lease liability at the present value of lease payments.
 The lease payments shall be discounted using the interest rate implicit in the lease
desired by the lessor.
 If the implicit interest rate cannot be readily determined the increment borrowing rate of
the lessee is used.

Components of lease payments

a. Fixed lease payments or periodic rental
b. Variable lease payments
c. Exercise price of a purchase option if the lessee is reasonably certain to exercise option.
d. Amount expected to be payable by the lessee under a residual value guarantee
e. Termination penalties if the lease term reflects the exercise of a termination option
 Residual value guarantee – made by the lessor by a party unrelated to the lessor
that the value of an underlying asset at the end of the lease term will be at least a
specified amount.
 Unguaranteed residual value – portion of the residual value of the underlying
asset, the realization of which by the lessor is not assured or is guaranteed solely
by a party related to the lessor.
 Executory costs – ownership expenses such as maintenance taxes and insurance
for the underlying asset. Such executory costs are expensed immediately when
incurred.

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Lessor accounting
 IFRS 16 provides that a lessor shall classify leases as either an operating lease or a
finance lease.
 An operating lease is a lease that does not transfer substantially all the risks and rewards
incidental to ownership of underlying asset.
 A finance lease is a lease that transfers substantially all the risks and rewards incidental to
ownership of an underlying asset.

When is a lease classified as finance lease

 Whether a lease is a finance lease or an operating lease depends on the substance of the
transaction rather than the form of the contract.
 Under IFRS 16, any of the following situations would normally lead to a lease being
classified as a finance lease.
a. The lease transfers ownership of the underlying asset to the lessee at the end of the lease
term.
b. The lessee has an option to purchase the asset at a price which is expected to be sufficiently
lower than the fair value at the date the option becomes exercisable.
c. The lease term is for the major part of the economic life of the underlying asset even if title is
not transferred.
d. The present value of the lease payment amounts to substantially all of the fair value of the
underlying asset at the inception of the lease.

Operating lease – Lessor

 IFRS 16 provides that a lessor shall recognize lease payments from operating lease as
income either on a straight line basis or another systematic basis.
 A lessor shall present an underlying asset subject to operating lease in the statement of
financial position according to the nature of the asset.
 The underlying asset remains as an asset of the lessor. However, the lessor may pass on
to the lessee the payment for taxes, insurance and maintenance cost.
 Initial direct cost incurred by the lessor in an operating lease shall be added to the
carrying amount of the underlying asset and recognized as an expense over the lease term
on the same basis and the lease income.
 Any security deposit refundable upon the lease expiration shall be accounted for as
liability by the lessor.
 Any lease bonus received by the lessor from the lessee is recognized as unearned rent
income to be amortized over the lease term.

Finance lease classification – lessor

 On the part of the lessor, a finance lease is either:
a. Direct financing lease
b. Sales type lease
 The main distinction between the two us the presence or absence of a manufacturer or
dealer profit or loss.

33
  A direct financing lease recognizes only interest income
 A sales type lease recognizes interest income and gross profit on sale.

34
Module 3

Financial Instruments – Presentation

Financial Instrument
• PAS 32 defines a financial instrument as any contract that gives rise to both a
financial asset of one entity and a financial liability or equity instrument of another
entity.
• Characteristics:
a. There must be a contract
b. There are at lease two parties to the contract
c. The contract shall give rise to a financial asset of one party and financial liability or equity
instrument of another party.
Examples:
a. Cash in the form of notes and coins
b. Cash in the form of checks
c. Cash in bank
d. Trade accounts
e. Note an loan
f. Debt security
g. Equity security

Financial assets
Financial assets representing a contractual right to receive cash in the future include:
a. Trade accounts receivable
b. Notes receivable
c. Loans receivable
d. Bonds receivable

In case of exchanges of financial instruments with another entity , conditions are potentially
favorable when such exchanges will result to gain or additional cash inflow to the entity.
Conversely, conditions are unfavorable when such exchanges will result to loss or additional
cash outflow to the entity.

Investments in shares or other equity instruments issued by other entities, for example,
trading securities, can be classified as financial assets.

Non-financial assets
a. Physical assets
b. Intangible assets
c. Prepaid expenses
d. Right of use asset or leased asset

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Financial liability
A financial liability is any liability that is contractual obligation
a. To deliver cash or other financial asset to another entity
b. To exchange financial instruments with another entity under conditions that are
potentially unfavorable.

Examples:
• Trade accounts payable
• Notes payable
• Loans payable
• Bonds payable

Non-financial liabilities
a. Deferred revenue and warranty obligations are not financial liabilities because
the outflow of economic benefits is the delivery of goods and services rather than
a contractual obligation to pay cash
b. Income tax payable is not a financial liability because it is imposed by law and
non-contractual
c. Constructive obligations are not financial liabilities because the obligations do
not rise from contract.

Equity instrument
An equity instrument is any contract that evidences a residual interest in the assets of an
entity after deducting all of the liabilities.

When liability and when equity

PAS 32 provides that the issuer of a financial instruments shall classify the instruments as
a financial liability or equity instruments in accordance with the substance of the contractual
arrangement and the definition of a financial liability, financial asset and equity instrument.

It further provides that to determine whether a financial instruments is an equity instruments

rather than a financial liability, the instruments is an equity instruments if the instrument includes
no contractual obligation to deliver cash or another financial asset.

Redeemable preference share

a. A preference share that provides for mandatory redemption by the issuer for a
fixed or determinable amount at a future date is a financial liability of the issuer
because the issuer has a contractual obligation to pay cash at some future time.
b. A preference share that gives the holder the right to require the issuer to redeem
the instrument at a particular date for a fixed or determinable amount is also a
financial liability because the issuer has a contractual obligation to pay cash at
some future time.

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Compound financial instrument
PAS 32 defines a compound financial instrument as a “financial instrument that contains
both a liability and an equity element from the perspective of the issuer. Common examples of
compound financial instrument are:
a. Bonds payable issued with share warrants
b. Convertible bonds payable

Accounting for compound financial instrument

• If the financial instrument contains both a liability and equity component, PAS 32
mandates that such components shall be accounted for separately. This approach is
known as “split accounting”.

Bonds payable issued with share warrants

• When the bonds are sold with share warrants, the bondholders are given the right to
acquire shares of the issuer at a specified price at some future time.
• Share warrants attached to a bond may be detachable or non-detachable. Detachable
warrants can be traded separately from the bond and non-detachable warrants cannot be
traded separately.

Convertible bonds
• Convertible bonds give the holders the right to convert their bondholdings into share
capital of the issuing entity within a specified period of time. They are conceived as
compound financial instrument.

Financial Instruments (PFRS 9)

Initial measurement
• PFRS 9 provides that at initial recognition, an entity shall measure a financial asset at fair
value plus, in the case if financial asset not at fair value through profit or loss, transaction
costs that are directly attributable to the acquisition of the financial asset.
• As a rule, transaction costs that are directly attributable to the acquisition of the financial
asset shall be capitalized as cost of the financial asset.
• If the financial asset is held for trading or if the financial asset is measured at fair value
through profit or loss, transaction costs are expensed outright.

Subsequent measurement
PFRS 9 provides that after initial recognition, an entity shall measure a financial asset at:
a. Far value through profit or loss (FVPL)
b. Fair value through other comprehensive income (FVOCI)
c. Amortized cost

The measurement depends on the business model of managing financial asset which may be to
realize fair value changes and to collect contractual cash flows.

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Financial assets at fair value through profit or loss
The following financial assets shall be measured at fair value through profit or loss
1. Financial assets held for trading or popularly known as “trading securities”.
2. All other investments in quoted equity instruments
3. Debt investments that are irrevocably designated on initial recognition as at fair value
through profit or loss
4. All debt investments that do not satisfy the requirements from measurement at amortized
cost and at fair value through other comprehensive income.

Financial assets held for trading

PFRS 9 provides that a financial asset is held for trading if:
a. It is acquired principally for the purpose of selling or repurchasing it in the near term.
b. On initial recognition, it is part of a portfolio of identified financial assets that are
managed together and for which there is evidence of a recent actual pattern of short-term
profit-taking.
c. It is a derivative, except for a derivative that is a financial guarantee contract or a
designated and an effective hedging instrument.

Trading securities are debt and equity securities that are purchased with the intent of selling them
in the “near term” or very soon.

What is an equity security?

The term equity security encompasses any instrument representing ownership shares and right,
warrants or options to acquire or dispose of ownership shares at a fixed or determinable price.

Equity securities represent an ownership interest in an entity.

Ownership shares include ordinary shares, preference shares and rights or options to acquire
ownership shares.

What is debt security?

A debt security is any security that represents a creditor relationship with an entity. A debt
security has a maturity date and a maturity value.

Financial asset at FVOCI

At initial recognition, PFRS 9 provides that an entity may make an irrevocable election to
present in other comprehensive income or OCI subsequent changes in fair value of an investment
in equity instrument that is not held for trading.
 Thus, irrevocable approach is designed to impose discipline in accounting for non-trading equity
investment.
 The amount recognized in other comprehensive income is not reclassified to profit or loss under
any circumstances.
However, on derecognition, the amount may be transferred to retained earnings. If the
investment in equity instrument is held for trading, subsequent changes in fair value are
always included in profit or loss or reported in the income statement.

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Debt investment at amortized cost
PFRS 9 provides that a financial asset shall be measured at amortized cost if both of the
following conditions are met:
a. The business model is to hold the financial asset in order to collect contractual cash flows
on specified date.
b. The contractual cash flows are solely payments of principal and interest on the principal
amount outstanding.
In other words, the business model is to collect contractual cash flows if the contractual cash
flows are solely payments of principal and interest. In such case, the financial asset shall be
measured at amortized cost.

Debt investment at fair value through OCI

PFRS 9 provides that a financial asset shall be measured at fair value through OCI if both of the
following conditions are met:
a. The business model is achieved both by collecting contractual cash flows and by selling
the financial asset.
b. The contractual cash flows are solely payment of principal and interest on the principal
outstanding.

On derecognition, the cumulative gain and loss recognized in the OCI shall be reclassified to
profit or loss.

The measurement of debt investment at amortized cost or at fair value through OCI is discussed
extensively in an intermediate accounting course

Summary of measurement rules

Measurement of equity investments:
1. Held for trading – at fair value through profit or loss
2. Not held for trading – as a rule, at fair value through profit or loss
3. Not held for trading – at fair value through other comprehensive income by irrevocable
election
4. All other investments in quoted equity instruments – at fair value through profit or loss
5. Investments in unquoted equity instruments – at fair value through profit or loss.
6. Investments of 20% to 50% - equity method of accounting
7. Investments of more than 50% - consolidation method to be taken up in an advanced
accounting course.

Measurement of debt investments:

1. Held for trading – at fair value through profit or loss
2. Held for collection of contractual cash flows at amortized cost
3. Held for collection of contractual cash flows – at fair value through profit or loss by
irrevocable designation or fair value option.
4. Held for collection of contractual cash flows and for sale of the financial asset – at fair
value through other comprehensive income

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 5. Held for collection of contractual cash flows and for sale of the financial asset – at fair
value through profit or loss by irrevocable designation or fair value option.

Non-current assets held for sale

PFRS 5
PFRS 5 provides that a noncurrent asset or disposal group is classified as held for
sale if the carrying amount will be recovered principally through a sale transaction rather than
through continuing use.

Conditions for classification as held for sale

1. The asset or disposal group is available for immediate sale in the present condition.
2. The sale must be highly probable.

Definition of highly probable

a. Management must be committed to a plan to sell the asset or disposal group.
b. An active program, to locate buyer and complete the plan must has been initiated.
c. The sale is expected to be a completed sale within one year from the date of classification
as held for sale.
d. The asset or disposal group must be actively marketed for sale at a sale price that is
reasonable in relation to the fair value.
e. Actions required to complete the plan indicate that it is unlikely that the plan will be
significantly changed or withdrawn

Measurement of asset held for sale

PFRS 5 provides than an entity shall measure a noncurrent asset or disposal group
classified as held for sale at the lower carrying amount or fair value less cost of disposal.

It further provides that a noncurrent asset classified as held for sale shall not be
depreciated.

Write-down to fair value less cost of disposal

 If the fair value less cost of disposal is lower than carrying amount if the asset or
disposal group, the write-down to fair value less cost of disposal is treated as an
impairment loss.
 If the noncurrent asset is a disposal group, the impairment loss is apportioned across
the assets based on carrying amount.

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Abandoned noncurrent asset
PFRS 5 provides that an entity shall not classify as held for sale a noncurrent
asset or disposal group that is to be abandoned.

This is because the carrying amount will be recovered principally through continuing use or
the noncurrent asset is to be used until the end of its economic life.

Temporarily abandoned
PFRS 5 provides that an entity shall not account for non-current asset that has been
temporarily taken out of use as if it had been abandoned.

The plant is maintained in workable condition and it is expected that it will be brought back into
use if demand picks up. In this case, the plant is not regarded as abandoned.

Presentation of asset classified as held for sale

PFRS 5 provides that assets classified as noncurrent in accordance with PAS1 shall
not be reclassified as current assets until they meet the criteria to be classified as held for sale.

PFRS 5 provides that if the noncurrent asset is a disposal group classified as held for
sale, the assets and liabilities of the group shall be presented separately and cannot be
offset as a single amount.

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