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13. BPP - Alexandra

(relevant standard: IAS 1, IAS 10)

a) IT IS ASSUMED THAT THE FIRST WAIVER WAS OBTAINED BEFORE 30/4/X1.

According to IAS 1 “Presentation of financial statements”, when a long-term liability has become repayable on
demand due to a breach of the loan contract (in this case the entity was in default of an interest payment), the loan
should be classified as current as at the year-end.

This can only be avoided, if the entity manages to obtain a waiver from the lender before the year end, which
extends the loan repayment for more than 12 months from the year-end (i.e. the entity possesses at the year-end an
unconditional right to defer the settlement for more than 12 months).

Even though the first waiver is obtained before the year-end (ASSUMED ABOVE), still, this is only for 1 month after
the year-end and not for 12 months, plus it is only for the interest element (not for the full loan balance).

The second waiver is obtained after the year-end (on 17/5/x1), therefore it cannot enable the classification of the
loan as non-current. Moreover, the second waiver is not for 12 months but for only another 5 weeks to 5/7/20x1.

Consequently, the loan should be classified as current. If the second waiver is considered important for the entity,
then it can be disclosed as a non-adjusting subsequent event, under IAS 10).

Moreover, the fact that the entity obtained 2 consecutive waivers, may indicate that the entity is facing liquidity
problems, hence there may be concerns as to the entity’s ability to continue as a going concern.

Per IAS 1, when such concerns exist, the entity’s management should disclose these in the financial statements.

If the entity’s management decides, within the subsequent event period, that the entity is not a going concern, then
this is an adjusting subsequent event, hence the financial statements should be prepared on a different basis.

b) IAS 24 “Related party disclosures” requires an entity to disclose any transactions and balances with an entity’s key
management personnel (KMP).

KMP is defined as a person that has the authority and responsibility to plan, direct and control an entity’s activities,
and includes both executive and non-executive directors.

There is no requirement to disclose the remuneration of KMP per person (so the entity’s directors are right not to
provide such an analysis), however, the remuneration should not be provided in total but analysed per type of
employee benefit (per IAS 19) i.e. short-term benefits, post-employment benefits, termination benefits and other
long-term benefits and remuneration received under share based payments, per IFRS 2.

There are 2 such kinds of remuneration, being short-term benefits (salary and bonus) and share based payments.

An information is material when its omission or misstatement can affect the decisions to be taken by the users in
investing resources in the entity. Per the Practice Statement on Materiality, it is explained that materiality is an
entity-specific aspect of relevance, based on the magnitude and/or nature of the financial statement items involved.
Materiality should not only be considered from a quantitative perspective (i.e. consider as material whatever
amount exceeds a certain threshold), but also qualitative factors should be taken into account, which have to do
with the nature of the item involved and its relevance to the specific entity’s users.

Considering the nature of related party transactions, it is highly unlikely to justify that transactions of this nature are
not material. This is because disclosures about related parties are important to the users, due to the possibility that
the entity’s financial position and performance may be affected by the existence of such transactions.

Moreover, taking into account that Alexandra is a public entity, which is facing liquidity problems, the investors
would be interested to see the levels and nature of director’s remuneration (i.e. this disclosure is relevant to the
specific entity’s users). Especially, when the directors are receiving a bonus and share-based payments despite the

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entity’s bad performance would not be justifiable, hence through the disclosure, the directors are becoming
accountable to shareholders for receiving such excessive remuneration.

The directors view that when a disclosure is determined to relate to information which is not material, then even
through such a disclosure is required under IFRS, it may not be provided, is correct. This is because such a practice (a
checklist approach) would result in information overload and would obscure information presented in the financial
statements which is more important.

14. Caplan 22 - Hudson

(a)

Termination benefits are employee benefits payable as a result of an entity’s decision to terminate an employee’s
employment before the normal retirement date.

The first package, being a pension enhancement that was offered for all staff who leave before the final closure of
division Wye is a termination benefit.

Under IAS 19 “Employee benefits” an entity should recognize termination benefits as a liability and an expense in PL
at the earlier of the following dates:

• when it can no longer withdraw the offer of those benefits – as both 2 packages were offered before the year
end and there is nothing to indicate that the offer can be withdrawn, then a liability, together with the related
cost should be recognized before the year-end.

And

• When it recognizes costs for a restructuring per IAS 37, which involve the payment of termination benefits –
below it is indicated that the criteria for a restructuring provision are also met before the year-end, hence a
restructuring provision should be recognized.

The criteria of IAS 37 for recognizing a restructuring provision are the following:

o The company has established a detailed formal plan for the restructuring (applies since the directors have
approved the restructuring in a formal directors’ meeting)

o The plan has started to be implemented before the year-end or its main features have been communicated to those
affected, in a way that has raised a valid expectation that implementation will take place right after the year end or as soon as possible
(applies since a number of redundancies were confirmed, termination packages were announced and staff was
reallocated)

Therefore, the full directly attributable cost of the restructuring (including all termination benefits - regardless of
when the employees will leave the company i.e. before or after the year end - should be recognized before the year-
end and the directors are wrong to support the view that only the cost for the staff left before the year-end should
be recognized.

In addition, the directors are wrong to suggest that this cost will be included in OCI, as only the following items are
recorded through other comprehensive income (OCI), and none of these apply in this case:

 Changes in actuarial assumptions, such as expected employee turnover and salary growth rates, including
the change in discount rate
 The return on plan assets
 The impairment of the DB asset down to the asset ceiling

Per IAS 19, termination benefits provided in the form of a pension enhancement, are accounted for in accordance
with the requirements of post-employment benefits. Therefore, as this is a termination cost is triggered by a
curtailment (i.e. as there is a reduction in the number of staff covered by the plan because of the closure of this
division). Therefore, it will appear in PL as a past service cost, with a credit in restructuring provision.
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The second package, which is offered for staff who will remain in employment until the final closure of the division,
represents a benefit provided in exchange for employee services to be offered until early 20x3 and not as a result of
termination of employment. Therefore, this will be accounted for as a short-term employee benefit under IAS 19,
which will be recognized in profit or loss over the period of the service, on an accrual basis (i.e. a part of the cost will
be recognized in the year 20x2 and a part in the year 20x3), undiscounted.

Other than the termination benefits, a restructuring provision may also include any penalties or other similar costs
for early termination of non-cancellable lease contracts (and other contracts). IAS 37 specifically excludes from a
restructuring provision the costs of marketing, relocating staff and investment in new systems and distribution
networks, as these are costs relating to the ongoing business activities of the company.

(b)

Per IAS 12 “Income taxes”, a deferred tax asset should only be recognized when it is probable that an entity will have
available future taxable profits, against which the deductible temporary differences will be utilized.

In the event where a deferred tax asset is recognized on unused tax losses, then this deferred tax asset can only be
recognized if there is convincing evidence as to the existence of future taxable profits.

This convincing evidence can be provided through the existence of budgets, which should be based on reasonable
and supportable assumptions.

Hudson operates under a tax jurisdiction which only allows losses to be carried forward for two years. Therefore, the
tax losses out of which the company can obtain a future tax benefit are the unused losses for the years 20X1 (we are
not aware of the amount, but expire at the end of 20x3) and 20X2 (the amount of losses is only $10m and it expires
at the end of 20x4).

It is clear therefore, that the main part of the Company’s tax losses expires in the year 20x3, which is the next year.
As the directors forecast profits of $80m in the year 20x3, increasing at a 20% rate thereafter, then it is clear that the
maximum amount of tax losses on which a deferred tax asset can be recognized, are $90m (i.e. $80m + $10m).

However, the director’s forecast does not appear to be supportable, as there is evidence that contradicts their
expectations. Apart from the recent history of trading losses for Hudson, there is little evidence that there will be an
improvement in trading results within the next couple of years. The market is depressed and sales orders for the first
quarter of 20X3 are below levels in any of the previous five years. Over and above that, it is also likely that Hudson
will incur various costs in relation to the restructuring (such as retraining and relocating costs) which would increase
losses into 20X3 and possibly 20X4.

Given that losses can only be carried forward for a maximum of two years, it is unlikely that any deferred tax asset
should be recognised.

(c)

There is evidence in the scenario that the Directors are intentionally adopting accounting treatments which are not
in compliance with IFRS “The directors are aware that the proposed treatment does not conform to IFRS Standards”.
This is against the ethical principle of integrity, according to which the professional accountants should be straight
forward and honest in the dealings with other parties.

Also, the objectivity of the directors, as to the preparation of the budgets to support the deferred tax asset
recognition, as well as deciding on the correct accounting treatment of employee benefits, is compromised, due to a

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self-interest threat, arising from the fact that their bonuses are linked to the entity’s EBITDA and the possible breach
of the debt-covenants.

More specifically, the proposed accounting treatment of:

1. Recording the redundancy costs within OCI (as remeasurements) rather than in profit or loss
2. Not recognizing a restructuring provision, as they have restricted the costs recognized to the redundancies
completed by the year-end

both result in an increase of EBITDA, which entitles them to a higher bonus.

Also, they achieve an increase in the entity’s net assets (from not recognizing a restructuring provision), thus
reducing the chances of breaching the debt covenant.

Moreover, the incorrect recognition of the deferred tax asset, does not have an impact on EBITDA (as it increases
profit after tax) but it increases the net assets. This departure from IFRS does not appear to be intentional, hence the
directors are in breach of the principle of professional competence and due care, as they do not appear to be fully
up to date with the provisions of IFRS.

Their position that the departure from the provisions of IFRS is done to support the best interests of the entity’s
shareholders is not correct, since in accordance with the ACCA code of ethics, the directors have a duty of care to
promote and preserve the public interest, which is the collective well-being of any person that would rely on their
work (e.g. the bank).

Moreover, per the Conceptual Framework, good stewardship exists when the entity’s resources are used efficiently
and effectively to produce a return for the shareholders and lenders and when the entity’s financial statements are
transparent, objective and in full compliance with IFRS.

Therefore, the Directors should have ensured that they are running the business properly, so as to safeguard the
company’s profitability and that the covenants are not breached. However, this should not be achieved through
manipulation.

Moreover, the shareholders will also be negatively impacted because of the departure from IFRS, as the directors
will receive a higher bonus that they would have been entitled, which is at the expense of the future dividends of the
shareholders.

Also, the fact that they are threatening the accountant that will be replaced, in case he does not agree with their
accounting treatment, is against the ethical principle of professionalism, as such actions are discrediting the
profession.

From the perspective of the accountant, his objectivity is also compromised, in view of the intimidation threat from
the directors. As a response to this threat, the accountant can communicate with the company’s non-executive
directors, audit committee, take legal advice or report this to ACCA or even resign.

15. BBP Aspire: 20b & d (Jun. 2014_2)

b) Relevant standards: IAS 21 / IAS 12

The property acquired represents a non-monetary asset. Such assets, when acquired in a currency other than the
functional, are translated at the functional currency using the exchange rate as at the date of the transaction or
equivalently, the rate existing at the date that they qualify for initial recognition, (historic rate) and never
retranslated.

Therefore, the property will be recorded on 1/5/20x3 at the amount of $1,2m (i.e. Dinars 6m / 5). The $1,20m will be
depreciated over the asset’s useful economic life of 12 years and thus give rise to a depreciation of $0,10 per annum
(=$1,20 / 12 years). Hence, the carrying amount (NBV) of the property at the year-end will be $1,10m.

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The fact that the tax allowable depreciation is at a higher rate than that for accounting purposes, means that the tax
benefits to be obtained in the first year, will be higher than the amount of depreciation, thus leaving less tax benefit
for the subsequent years (as the accounting cost and the tax base at the acquisition date are equal).

The above mismatch represents a taxable temporary difference, hence a deferred tax liability will be recognized at
the year-end, to reflect the reduced tax benefits of subsequent years. (Alternatively, as the tax base of an asset will
be lower than its carrying amount, then this will result to a taxable temporary difference).

As the taxable profits are determined in dinars (i.e. the tax computation of the foreign branch is made in Dinars), the
tax allowable depreciation will also be calculated in Dinars. Hence, for the first year, this will be equal to Dinars
0,75m (i.e. Dinars 6m / 8 years).

The tax base at the year-end is therefore Dinars 5,25m (i.e. 6 – 0,75). If this is translated at the closing rate of 6, gives
rise to a tax base in dollars of $0,875m.

Therefore, the deferred tax liability will equal: 20% * ($1,10m - $0,875) = $0,045m.

The 20% is used, because per IAS 12, this should be the tax rate expected to apply in the periods that the taxable
temporary differences will reverse (based on the tax rates enacted or substantially enacted by the year-end). As the
taxable profits will be taxed at the tax rate of the foreign branch, the 20% tax rate is used.

If the tax base of Dinars 5,25m was translated at the historic rate of 5, the tax base would have been $1,05 (i.e.
5,25 / 5), hence the deferred tax liability would be lower and would equal: 20% * ($1,12m - $1,05) = $0,014m.
MINOR POINT.

d) Relevant standards: IAS 21 / IFRS 9

The loan payable represents a financial liability at amortized cost.

At initial recognition, the financial liability will be recognized at the amount received (which represents its fair value),
less any transaction costs (if any).

As the loan is denominated in a currency other than the functional currency, it will be recorded at initial recognition
using the historic rate of 5 i.e. Dinars 5m / 5 = $1m.

The financial liability will increase by the finance cost using the effective interest rate, (this is 8% because this is also
the market rate for similar 2-year fixed interest loans) and will reduce by the interest paid at the year end, which is
also 8%.

As the finance cost is a profit or loss item, it will be retranslated using the average rate for the year, being 5.6.
Hence, the interest to be added to the financial liability will be Dinars 5m * 8% / 5.6 = $71,429.

The payment of interest takes place at the year-end, hence will be retranslated using the closing rate, being the rate
existing at the date of the transaction i.e. Dinars 5m * 8% / 6 = $66,667.

This will result to a carrying amount in dollars before retranslation of $1,004,762 (i.e. $1m + $71,429 - $66,667).

The closing balance in Dinars, will remain at Dinars 5m, as the finance cost is the same with interest paid (both
Dinars 5m * 8%). As the loan payable represents a monetary item, it will be retranslated at each year end at the
closing rate, with any exchange difference recorded through profit or loss. Hence, the Dinars 5m will be retranslated
to dollars using the closing rate of 6 i.e. Dinars 5m / 6 = $833,333.

Therefore, an exchange gain of $171,429 will be recorded in profit or loss.

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Dinars Rate USD

Initial recognition of loan payable 5,000,000 5 1,000,000

Dr: Finance cost (PL)

Interest expense @ 8% 400,000 5.6 71,429
/ Cr: FL

Payment of interest at year end -400,000 6 (66,667) Dr: FL / Cr: Bank

Loan balance at year end before
5,000,000 1,004,762
any retranslation

Exchange gain (PL) (171,429)

Retranslated at closing rate 5,000,000.00 6 833,333

16. Kiki (p. 431)

Relevant standard: IFRS 15

(i)

The question is answered on the assumption that the question would provide the following 2 additional
information:

 Total gift vouchers sold to customers during the year: 1,000

 Total gift vouchers exercised during the year: 400

Also, it is assumed that the exercise period is 2 years and not 1.

When an entity receives consideration that is attributable to a customer’s unexercised rights, the entity
recognises a contract liability equal to the full amount prepaid by the customer.
Therefore, Kiki will recognize a contract liability equal to $50,000 (i.e. 1,000 * $50).
When an entity expects that a % of its customers will not exercise their full rights (e.g. the 30% in the case
of Kiki), then the entity (seller) is entitled to the so-called “breakage amount”. The breakage amount is
equal to 30% of the transaction price i.e. 30% * $50,000 = $15,000.
The expected breakage represents a variable consideration and can only be recognised as revenue when it
is highly probable (if there is little chance that its recognition will cause a significant reversal in revenue in
the future).
Kiki’s expectation for a breakage entitlement, is based on a significant past experience with its customers,
hence this can be considered to support that the variable consideration is highly probably that will be
received.
The breakage amount is recognized as revenue as the entity fulfils a performance obligation i.e. it cannot
be recognized from the point that the customer prepays the company, even if this is highly probable that
will be received.
The breakage is recognized based on the proportion of rights exercised to date by the customer (i.e. 400),
compared to the total rights expected to be exercised i.e. 700 being 1,000 * (1-30%).
Therefore, the revenue to be recognized for the 400 gift vouchers exercised, will equal:

 The revenue that Kiki would have recognized assuming no breakage = 400 * $50 = $20,000
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plus
 The revenue corresponding to the breakage (variable consideration) = 400 / 700 * $15,000 =
$8,571.
Total revenue = $28,571.
The above is equivalent to recognizing $50/70% = $71.43 per voucher exercised (this is what you would
have used to answer numerically, if you were not given the extra information I gave you). Hence, 400 *
$71.43 = $28,571.
If Kiki did not have previous experience with the % of gift vouchers not exercised, then no revenue would
have been recognized in respect of the breakage, as it would not be probable that would be received.
Hence, Kiki would not recognize revenue in respect of breakage amount until the likelihood of the
customer exercising its right becames remote (which may even be the end of the exercise period i.e. upon
expiry).

TUTORIAL NOTE
Even though the guidance of IFRS 15 refers to breakage as a form of variable consideration, still, for
customer unexercised rights it is not accounted exactly as such, as it does not affect the transaction price.
Kiki will recognize the total revenue of $50,000 over the exercise period no matter what. So, it can be
argued that breakage is rather a revenue recognition concept, which only affects the timing of revenue
recognized and not the amount. To determine the timing of revenue recognition, an entity is using the
guidance on variable consideration.

(ii)

Per IFRS 15, an entity should only account for revenue from a contract with customer, when it meets all of
the following criteria:
1. The contract has been approved
2. Each party’s rights to the goods or services can be identified
3. Payment terms can be identified
4. There is commercial substance
5. It is probable that the seller will collect the consideration it is entitled under the contract
The above criteria are considered only at contact inception. In order for these to be reconsidered it takes a
significant change in facts and circumstances.
At contract inception, criteria 1-3 are met, since there is a signed contract between the 2 parties that
provides for all relevant terms and conditions.
Also, the contract has commercial substance since the contract is in line with the activity of Kiki.
Moreover, Colour had a strong credit rating, hence it is probable that Kiki will collect the consideration.
Consequently, as there is no significant change in facts and circumstances during 20x6, Kiki should
recognize revenue from the sales-based royalties in accordance with the volume of Comics books sold by
Colour.

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However, after July 20x7, Colour lost major customers and lost access to credit facilities. That represents a
significant change in facts and circumstances, hence Kiki needs to reassess whether the 5 criteria are still
met.
Clearly it is no longer probable that Kiki will collect the consideration, hence the revenue recognition
should be discontinued since July 20x7.
Moreover, the new facts and circumstances indicate that the level of Kiki’s credit risk arising from the
receivable from Colour have increased significantly. Therefore, Kiki should estimate the amount of
allowance for expected credit losses that should be recognized on any existing balances with Colour, which
will be reflected as an impairment loss in profit or loss.
If in a future year the circumstances change again, as it becomes again probable that the consideration will
be received, then Kiki will resume the revenue recognition and will also perform a catch-up adjustment in
order to capture the revenue from sale of goods not recognized for the period since July 20x7.

17. Kaplan 44A ZEDTECH (Mar. 2019_4b)

Relevant standard: IFRS 15

(b) (i)

According to step 2 of the IFRS 15 five-step model, an entity must identify the performance obligations (POs) in the
contract and decide which of these are separate POs.

A good or service to be delivered in a contract represents a separate (or distinct PO) when all of the following are
met:

 The customer can be benefited from that good or service on its own (or together with other resources that are
readily available to the customer), without the need to obtain an additional good or service offered in the
contract by the seller (the PO is “capable of being distinct”)

 The good or service is separately identifiable from other promises in the contract (the PO is “distinct within the
context of the contract”)

The following are indicators that a good or service is not separately identifiable:

• The entity provides a significant integrating service

• The good or service significantly modifies or customises another good or service in the contract

• The good or service is highly interdependent or interrelated with other goods or services in the contract.

Also, according to step 3 of the IFRS 15 five-step model, when an entity is willing to accept a lower price than that
stipulated in the contract with customer, either because:

 the entity’s customary past business practice or published statements have created a valid expectation to the
customer that the entity will reduce its price
or
 the entity wishes to develop or enhance a customer relationship.

then the entity is offering an implicit price concession.

When such implicit price concession is granted, then the consideration to be received is totally variable and
estimated using a probability weighted average approach.

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Also, the determination of whether it is probable that the consideration will be received (condition 5 of step 1) is
done by considering the likelihood to receive the variable consideration and not the price mentioned in the contract.

(ii)
Oinventory
The 3 elements of this software package are capable of being distinct, as the customer can be benefited from each of
these 3 elements, without the need to purchase any of the other 2. This is indicated by the following:
 Each element in the package can be purchased without affecting the performance of any other element and
 Zedtech regularly sells each service separately

In addition, the 3 elements are also distinct in the context of the contract, since Zedtech generally does not integrate
the goods and services into a single contract. Also, the fact that the performance of one element does not affect the
performance of another demonstrates that the elements are neither highly interdependent nor interrelated.

Thus, the hardware, professional services and hosting services (the 3 elements) should each be accounted for as 3
separate performance obligations. Thus, the total transaction price for the Oinventory package, will be allocated to
each Po based on their stand-alone selling prices.

Inventory X
The hardware element of the package should be combined with the hosting services, which together should
represent a separate PO (a bundle). This is because the customer cannot be benefited from the hardware on its own,
without purchasing the hosted software as well. Hence, these POs are not capable of being distinct (there is no need
to demonstrate that they are neither distinct in the context of the contract).

The professional services appear to represent a separate PO, since:

 It is explicitly mentioned that they are distinct, hence separately identifiable
 They can be sold on a stand-alone basis to a customer; hence the customer can obtain a benefit from these
services without the need to buy an additional good or service offered in the contract.

Sale to a new region

This is a case where Zedtech offers an implicit price concession. This arises because the facts and circumstances
indicate that the entity is willing to accept a lower price than the amount stated in the contract in an attempt to
develop or enhance a customer relationship.

Accordingly, Zedtech will conclude that the transaction price is not €3 million but only €2.4m i.e. 80% * €3m. The
transaction price of €2.4m represents a variable consideration which is estimated using a probability weighted
approach.

Zedtech will then consider whether the customer has the ability and intention to pay the amount of €2.4m. If it
concludes that the transaction price ($2.4m) is probable that it will be collected, then the 5th criterion of step 1 is
met and the entity can recognize revenue as or when it fulfils a PO.

18. Blackcutt (BPP)

1. Blackcutt (IFRS 16)

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Relevant standard: IFRS 16

For a contract to be accounted under the provisions of IFRS 16 “Leases” it has to meet the definition of a lease.

A lease is defined as a contract according to which the legal owner of the asset (lessor) conveys the right to control
the use of an identified asset (the underlying asset) to another person (lessee) for a specified period of time, in
exchange for a consideration.

In order for the lessee to have the right to control the use of the asset both of the following must be met:

 The lessee obtains substantially all of the economic benefits from the use of the asset, as these arise during the
lease period

 The lessee has the right to direct the use of the asset through either:
o Direct how and for what purpose the asset will be used over the lease period or
o The way of using the asset has been pre-determined at the inception of the lease and the lessor has no
right to intervene and amend the use/ operation of the asset

When the lessor has a substitution right, then the lessee does not have a right to control the use of a specified asset,
if this right is substantive. It is substantive when the lessor has the practical ability to replace the asset with an
alternative one throughout the period of the lease and by replacing the asset will obtain an economic benefit.

The definition of a lease appears to be met since:

 A contract exists and it is about specific vehicles, which are identifiable as these are painted in Blackcutt‘s name
and colour (hence there is a specified asset) – also refer to substitution right below*.

 Blackcutt pays an annual fee, which represents the consideration.

 The contract period is equal to nearly the useful economic life of the vehicles, which represents the lease-term.

 Blackcutt has a right to control the use of the asset since:

o the vans are used exclusively for Blackcutt‘s waste collection during the lease-term. Hence, Blackcutt obtains
substantially all of the economic benefits from the use of the asset during the period of the lease. [the fact
that the period of the lease represents nearly all of the asset’s UEL is irrelevant]

o the use of the asset is predetermined (only for waste collection) and there is no evidence that Waste and Co
can change this use. Hence, Blackcutt directs their use.

*: Finally, even though the lessor has a substitution right, this is not substantive, since Waste and Co can only replace
the vans only when they break down (hence does not have the practical ability to replace the asset throughout the
period of the lease). Even if it did, replacing the underlying asset is clearly not at its benefit, as the vehicles need to
be equipped and painted with the name and colour of Blackcutt.

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In view of the above, Blackcutt should recognise a right of use asset and a lease liability equal to the present value of
the annual lease payments.

However, before doing so, the service component included in the annual payments (i.e. for the waste collection
service) is separated from the non-lease component, using their stand-alone selling prices. [A lessee may apply a
practical expedient offered by IFRS 16, by class of underlying asset, and ignore the requirement to separate the lease
from the non-lease component].

19. Carsoon – BPP

Relevant standards: IFRS 16 / IAS 7 / IAS 2

Per IFRS 16 “Leases”, a lessor should determine, at the inception of the lease, whether the lease will be classified as
operating or finance lease.

When the lease contract transfers substantially all the risks and rewards of ownership in the underlying asset (from
the lessor/owner to the lessee/user), then the lease is classified as a finance lease. All other leases are classified as
operating leases. This is an application of substance over form (i.e. the person that will eventually recognise the
underlying asset on its statement of financial position (SOFP), is not necessarily the legal owner).

If classified as a finance lease, the lessor derecognises the asset from its SOFP and instead recognises a receivable
equal to the net investment in the lease, which is defined as the present value of lease payments plus the present
value of the unguaranteed residual value.

If classified as an operating lease, the lessor will not derecognise the leased asset from its SOFP and keep it as
property, plant and equipment (PPE) under IAS 16 (it is IAS 16 because it is an asset held to earn rentals which is not
a property).

The lease contract of Carsoon appears that should be classified as an operating lease by the lessor, as all factors
indicate to this direction. Specifically,

1. the lessor is responsible for the maintenance of the asset => operating lease

2. even though there is an option for transfer of ownership, still, the transfer is unlikely to take place at the end of
the three-year contract, as the exercise price in which the customer can purchase the vehicle is expected to be
above the market value of the vehicle => operating lease

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The present value of lease payments does not appear to be higher or substantially equal to the fair value of the
leased asset, due to the fact that the lease payments will only be for 3 years => operating lease

3. The lease period of 3 years does not appear to represent a substantial part of the asset’s useful economic life
(“UEL”), as the UEL of a vehicle is approximately 10 years => operating lease

4. The underlying asset is a vehicle, hence it is not of a specialised nature. Hence, anyone can use it without major
modifications => operating lease

5. The fact that there are contractual limitations e.g. the maximum mileage is only 10,000 miles per year or the fact
that the vehicle cannot be modified in any way, demonstrates that the rewards from the use of the asset have
not been substantially transferred to the lessee => operating lease

Consequently, the vehicle will remain in the financial statements of the lessor as a PPE under IAS 16 and depreciated
over its estimated useful economic life. Moreover, the rental income will be recognised in the profit or loss on a
straight-line basis over the lease-term.

At the end of lease term, when the asset is held for sale in the ordinary course of business (through the Company’s
retail outlets), this should be classified as inventory. The adopted cost of the asset as an inventory, will be the
carrying amount (NBV) of the lease asset, at the point of reclassification from PPE to inventory.

When such asset is sold, the proceeds from sale will be recognised as revenue, in accordance with IFRS 15 “Revenue
from contracts with customers”. This is because the proceeds from the sale will represent a transaction with a
customer in the ordinary course of business (Carsoon manufactures and retails motor vehicles).

Consequently, the presentation of the disposal proceeds of such a vehicle in the statement of cash flows (per IAS 7)
will not appear in the investing activities (as a sale of PPE) but rather captured in operating activities (which includes
the principal revenue-producing activities of an entity), as part of the profit before tax. If any part of this revenue is
not received, then this will be captured under the movement in debtors (working capital charges).

20. Kaplan 51a(ii) - Carsoon

Relevant standard: IFRS 15

Penalties and additional costs

Per IFRS 15 “Revenue from contracts with customers” the costs of fulfilling a contract are capitalised as an asset
(provided that these are not governed by another standard) if the following criteria are m/et:

1. The costs are incremental

2. The costs relate directly to an identifiable contract
3. The costs create or enhance resources to be used in fulfilling a contract in the future
4. The costs are expected to be recovered

If capitalised, these are subsequently amortised in the profit or loss on a systematic basis, which is consistent with
the transfer to customer of goods and services to which the costs relate.

General and administrative costs and costs of wasted materials

The general and administrative costs are clearly not incremental, as these would have incurred anyway, regardless of
undertaking the particular customer contract. Also they do not relate directly to an identifiable contract, as they are
overheads.

The costs of wated material do not create or enhance resources to be used in fulfilling a contract in the future.

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In view of the above, both costs totalling $15m should be expensed in profit or loss.

Moreover, IFRS 15 specifically mentions that administrative costs and costs of wasted materials are expensed in the
profit or loss as incurred.

Therefore, the suggested treatment by the directors of recognising these costs as a contract asset is not correct. A
contract asset arises when a company partly fulfils a performance obligation, for which revenue should be
recognised, however, no invoice has been issued.

Penalties

A penalty represents a form of variable consideration. Therefore, the Company would only deduct the penalty from
the transaction price, only when it is highly probable that the penalty will be paid.

If it is highly probable, then the penalty will be deducted from the transaction price (this is also supported by the
guidance on consideration payable to client) and this will reduce proportionally the rev+enue to be recognised from
the construction contract in the future.

If it is not highly probable, then it will not be deducted from the transaction price and it is thus possible for the client
to disclose this as a contingent liability [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]. Past event is the delay and the uncertain future event is the outcome of the legal case –
assuming this will end up in court.

Construction of storage facility

[It can be argued that this represents a contract modification, as there is a change both in price (plus $7m) and in scope, being the construction
of storage facility.

Under IFRS 15, an entity needs to determine whether the modification will be accounted for as a separate revenue contract. For this to be the
case, the following criteria must be met:

 The modification involves the transfer of an additional good (being the storage facility) which is distinct
 The addition to the transaction price of $7m must represent the stand-alone selling price of such a building

Assuming that the second criterion is also met, then the construction of storage facility will be accounted for as a separate revenue contract,
with transaction price the $7m.]

Tutorial note 1: this part of the question would make more sense if the construction was completed during next
year. So, we are making the assumption that:

 the % of completion was 75% as at the year-end

 $4m of costs were incurred during the year, and another $1m was anticipated to be required for full
completion (total: $5m).

The construction of a building on a customer’s land meets the criteria of a performance obligation satisfied over
time, as it creates an asset that the customer controls, hence revenue will be recognised in accordance with the % of
completion method. As this is 75%, then revenue equal to $5,25m will be recognised.

The contraction cost of $4m is a cost of fulfilling the contract, which will be capitalised since:

 it is incremental (arising because of the contraction of the storage facility)

 it relates to an identifiable contract
 the cost creates an asset to be delivered to customer as part of the contract
 the cost is also directly recoverable, since there is a $2m profit on the contract.

Tutorial note 2: per IFRS 15, for costs of fulfilling a contract, we first consider any other applicable standard (e.g. IAS
2, IAS 16 or IAS 38). If costs incurred in fulfilling a contract are within the scope of another standard, an entity
accounts for those costs in accordance with those other standards (in this case the costs are within the scope of IAS

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2 and would have been capitalised as inventories). If the costs incurred to fulfil a contract were not within the scope
of another standard, then an entity would consider the above 4 criteria to determine if these would be capitalised.

Hence, the $4m will be capitalised and transferred to cost of sales on a systematic basis, in accordance with the % of
completion of the construction. The amortisation of contract costs will be ($4m+$1m) * 75% = $3.75m, which will be
recognised as cost of sales. The other $0.25m ($4m - $3.75m) incurred but not transferred to PL, will remain as
inventory.

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