Professional Documents
Culture Documents
AAFR by Sir Nasir Abbas BOOK
AAFR by Sir Nasir Abbas BOOK
AAFR by Sir Nasir Abbas BOOK
SCOPE
Exam notes:
For assets carried at revaluation model, following should be considered:
1. The only difference between “fair value” and “fair value less cost of disposal” is the direct
incremental costs attributable to the disposal of asset.
2. If cost of disposal is negligible then recoverable amount of asset must be equal to or greater than
fair value. Therefore, when both fair value and value in use are known, then asset is only revalued
to “fair value” and there is no need for impairment.
3. If cost of disposal is not negligible then “fair value less cost of disposal” is necessarily less than “fair
value”. Therefore, such asset is first revalued to “fair value” and then it is tested for impairment.
4. If fair value is not known and only value in use is known then asset is impaired if value in use is less
than carrying amount.
5. Although charging of impairment loss as per IAS 36 and revaluation loss as IAS 16/38 are same, but
accumulated depreciation is eliminated only at the time of revaluation as per IAS 16/38 and not at
the time of impairment as per IAS 36.
1. Carrying amount is the amount at which an asset is recognised after deducting any accumulated
depreciation (amortisation) and accumulated impairment losses thereon.
3. Impairment test is the comparison of “carrying amount [CA] determined as per relevant IAS” with
“recoverable amount [RA]”. An asset is impaired if its CA exceeds RA.
4. When an asset is tested for impairment, this may indicate that estimates of useful life, residual value
and depreciation method also need to be reviewed and adjusted even if asset is not impaired.
- For intangible assets not yet available for use - For all other assets
- For intangible assets with indefinite life
- For Goodwill acquired in business combination
Impairment is tested annually (at same time every An entity shall assess at the end of each reporting
year) period whether there is any indication that an
asset may be impaired. If any such indication
exists, the entity shall estimate the recoverable
amount of the asset.
Indications of impairment
1. It is not always necessary to determine both an asset’s fair value less costs of disposal and its value in
use. If either of these amounts exceeds the asset’s carrying amount, the asset is not impaired and it
is not necessary to estimate the other amount.
2. Sometimes it will not be possible to measure fair value less costs of disposal, In this case, the entity
may use the asset’s value in use as its recoverable amount.
3. If an asset’s value in use is not expected to exceed its fair value less costs of disposal, the asset’s fair
value less costs of disposal may be used as its recoverable amount. This will often be the case for an
asset that is held for disposal.
4. If recoverable amount cannot be determined for an individual asset because it does not generate cash
inflows that are largely independent of those from other assets or groups of assets, then recoverable
amount is determined for the cash‑generating unit to which the asset belongs unless either:
(a) the asset’s fair value less costs of disposal is higher than its carrying amount; or
(b) the asset’s value in use can be estimated to be close to its fair value less costs of disposal and fair
value less costs of disposal can be measured.
2. Costs of disposal are incremental costs directly attributable to the disposal of an asset or
cash‑generating unit, excluding finance costs and income tax expense.
3. Costs of disposal, other than those that have been recognized as liabilities, are deducted in
measuring fair value less costs of disposal.
Examples
legal costs, stamp duty and similar transaction taxes, costs of removing the asset, and direct
incremental costs to bring an asset into condition for its sale.
However, termination benefits (as defined in IAS 19) and costs associated with reducing or
reorganizing a business following the disposal of an asset are not direct incremental costs to dispose
of the asset.
Value in use
1. Value in use is the present value of the future cash flows expected to be derived from an asset or
cash‑generating unit.
2. Base cash flow projections on budgets/forecasts which shall cover a maximum period of five years,
unless a longer period can be justified. Extrapolate the projections based on the budgets/forecasts
using a steady or declining growth rate for subsequent years, unless an increasing rate can be justified.
5. Future cash flows shall be estimated for the asset in its current condition. Therefore, future cash flows
shall not include estimated future cash inflows or outflows that are expected to arise from:
(a) a future restructuring to which an entity is not yet committed; or
Once the entity is committed to the restructuring:
• its estimates of future cashflows reflect the cost savings and other benefits from the
restructuring; and
• its estimates of future cash outflows for the restructuring are included in a restructuring
provision in accordance with IAS 37.
7. Future cash flows are estimated in the currency in which they will be generated and then discounted
using a discount rate appropriate for that currency. An entity translates the present value using the
spot exchange rate at the date of the value in use calculation.
Discount rate
1. The discount rate (rates) shall be a pre‑tax rate (rates) that reflect(s) current market assessments of:
(a) the time value of money; and
(b) the risks specific to the asset for which the future cash flow estimates have not been adjusted.
2. A rate that reflects current market assessments of the time value of money and the risks specific to
the asset is the return that investors would require if they were to choose an investment that would
generate cash flows of amounts, timing and risk profile equivalent to those that the entity expects to
derive from the asset (e.g. weighted average cost of capital of a listed entity that has a single asset or
a portfolio of assets similar in terms of service potential and risks to the asset under review).
3. An entity normally uses a single discount rate. However, an entity may use separate discount rates
for different future periods.
Impairment loss shall be recognized in profit and Impairment loss shall be treated as a revaluation
loss immediately. decrease in accordance with relevant IAS (e.g. IAS
16, 38)
• After charging impairment loss, depreciation shall be charged on revised carrying amount over
remaining life.
• When impairment loss is greater than carrying amount (i.e. when recoverable amount is negative),
then entity shall recognize a liability if and only if required by another IAS.
A cash‑generating unit is the smallest identifiable group of assets that generates cash inflows that are
largely independent of the cash inflows from other assets or groups of assets.
Example
A mining entity owns a private railway to support its mining activities. The private railway could be sold
only for scrap value and it does not generate cash inflows that are largely independent of the cash
inflows from the other assets of the mine.
It is not possible to estimate the recoverable amount of the private railway because its value in use
cannot be determined and is probably different from scrap value. Therefore, the entity estimates the
recoverable amount of the cash‑generating unit to which the private railway belongs, ie the mine as a
whole.
Example
A bus company provides services under contract with a municipality that requires minimum service on
each of five separate routes. Assets devoted to each route and the cash flows from each route can be
identified separately. One of the routes operates at a significant loss.
Because the entity does not have the option to curtail any one bus route, the lowest level of identifiable
cash inflows that are largely independent of the cash inflows from other assets or groups of assets is
the cash inflows generated by the five routes together. The cash‑generating unit for each route is the
bus company as a whole.
2 In identifying whether cash inflows from an asset (or group of assets) are largely independent, an
entity considers various factors including how management monitors the entity’s operations (such as
by product lines, businesses, individual locations, districts or regional areas) or how management
makes decisions about continuing or disposing of the entity’s assets and operations.
3. If an active market exists for the output produced by an asset or group of assets, that asset or group
of assets shall be identified as a cash‑generating unit, even if some or all of the output is used
internally. If such cash inflows are affected by internal transfer pricing, an entity shall use
management’s best estimate of future price(s) that could be achieved in arm’s length transactions in
estimating:
(a) the future cash inflows of giving asset or CGU; and
(b) the future cash outflows of receiving asset or CGU.
1. Recoverable amount of a CGU is determined using the same guidance as studied earlier for a single
asset.
2. Carrying amount of a CGU shall be determined on a basis consistent with the way recoverable amount
is determined.
3. The carrying amount of CGU should include carrying amounts of only those assets that can be
attributed directly or allocated on a reasonable basis to that CGU and does not include the carrying
amount of any recognized liability unless recoverable amount of the CGU cannot be determined
without consideration of this liability (for example inclusion of provision for dismantling will reduce
the carrying amount CGU for fair comparison with recoverable amount).
4. For practical reasons, the recoverable amount of a CGU is sometimes determined after consideration
of assets that are not part of the CGU (for example, receivables or other financial assets) or liabilities
that have been recognised (for example, payables, pensions and other provisions). In such cases, the
carrying amount of the CGU shall also include such assets and liabilities only for calculating
impairment loss.
Example
A company operates a mine in a country where legislation requires that the owner must restore the
site on completion of its mining operations. A provision for the costs to replace the overburden was
recognised as soon as the overburden was removed. The carrying amount of the provision for
restoration costs is Rs. 500, which is equal to the present value of the restoration costs.
The entity is testing the mine (a CGU) for impairment. The entity has received various offers to buy the
mine at a price of around Rs. 800. This price reflects the fact that the buyer will assume the obligation
to restore the overburden. Disposal costs for the mine are negligible. The value in use of the mine is
approximately Rs. 1,200, excluding restoration costs. The carrying amount of the mine is Rs. 1,000.
The cash-generating unit’s fair value less costs of disposal is Rs. 800. This amount considers restoration
costs that have already been provided for. As a consequence, the value in use for the cash-generating
unit is determined after consideration of the restoration costs and is estimated to be Rs. 700 (i.e. Rs.
1,200 less Rs. 500). The carrying amount of the cash-generating unit is Rs. 500 (i.e. Rs. 1,000 less Rs.
500). Therefore, the recoverable amount of the cash-generating unit exceeds its carrying amount.
Goodwill
2. Goodwill sometimes cannot be allocated on a non-arbitrary basis to individual CGU, but only to groups
of CGUs.
2. A cash‑generating unit to which goodwill has been allocated shall be tested for impairment annually,
and whenever there is an indication that the unit may be impaired, by comparing the carrying amount
of the unit, including the goodwill, with the recoverable amount of the unit. If the recoverable amount
of the unit exceeds the carrying amount of the unit, the unit and the goodwill allocated to that unit
shall be regarded as not impaired.
Corporate assets
1. Corporate assets are assets other than goodwill that contribute to the future cash flows of both the
cash‑generating unit under review and other cash‑generating units.
2. Corporate assets include group or divisional assets such as the building of a headquarters or a division
of the entity, EDP equipment or a research centre. The distinctive characteristics of corporate assets
are that they do not generate cash inflows independently of other assets or groups of assets and their
carrying amount cannot be fully attributed to the cash‑generating unit under review.
3. In testing a cash‑generating unit for impairment, an entity shall identify all the corporate assets that
relate to the cash‑generating unit under review. If a portion of the carrying amount of a corporate
asset:
(a) can be allocated on a reasonable and consistent basis to that unit, the entity shall compare the
carrying amount of the unit, including the portion of the carrying amount of the corporate asset
allocated to the unit, with its recoverable amount and recognize any impairment loss.
(b) cannot be allocated on a reasonable and consistent basis to that unit, the entity shall:
(i) compare the carrying amount of the unit, excluding the corporate asset, with its recoverable
amount and recognize any impairment loss;
(ii) identify the smallest group of cash‑generating units that includes the cash‑generating unit
under review and to which a portion of the carrying amount of the corporate asset can be
allocated on a reasonable and consistent basis; and
(iii) compare the carrying amount of that group of cash‑generating units, including the portion of
the carrying amount of the corporate asset allocated to that group of units, with the
recoverable amount of the group of units and recognize any impairment loss.
Exam note
Recoverable amount of the group of CGUs should be given separately, however, if not given
separately then recoverable amounts of individual CGUs are added.
1. The impairment loss shall be allocated to reduce the carrying amount of the assets of the unit (group
of units) in the following order:
(a) first, to reduce the carrying amount of any goodwill allocated to the cash‑generating unit (group
of units); and
(b) then, to the other assets of the unit (group of units) pro rata on the basis of the carrying amount
of each asset in the unit (group of units).
2. These reductions in carrying amounts shall be treated as impairment losses on individual assets.
3. In allocating an impairment loss as above, an entity shall not reduce the carrying amount of an asset
below the highest of:
(a) its fair value less costs of disposal (if measurable);
(b) its value in use (if determinable); and
(c) zero.
The amount of the impairment loss that would otherwise have been allocated to the asset shall be
allocated pro rata to the other assets of the unit (group of units).
4. After allocating impairment loss as above, a liability shall be recognised for any remaining amount of
an impairment loss for a cash‑generating unit if, and only if, that is required by another IFRS.
1. An entity shall assess at the end of each reporting period whether there is any indication that an
impairment loss recognised in prior periods for an asset other than goodwill may no longer exist or
may have decreased. If any such indication exists, the entity shall estimate the recoverable amount
of that asset.
2. An impairment loss recognised in prior periods for an asset other than goodwill shall be reversed if,
and only if, there has been a change in the estimates used to determine the asset’s recoverable
amount since the last impairment loss was recognised.
3. An asset’s value in use may become greater than the asset’s carrying amount simply because the
present value of future cash inflows increases as they become closer. However, the service potential
of the asset has not increased. Therefore, an impairment loss is not reversed just because of the
passage of time (sometimes called the ‘unwinding’ of the discount), even if the recoverable amount
of the asset becomes higher than its carrying amount.
Impairment loss reversal shall be recognized in Impairment loss shall be treated as a revaluation
profit and loss immediately. increase in accordance with relevant IAS (e.g. IAS
16, 38)
Dr. Acc. depreciation & impairment loss Dr. Acc. depreciation & impairment loss
Cr. P&L Cr. P&L
Cr. Revaluation surplus
After reversing impairment loss, depreciation shall be charged on revised carrying amount over
remaining life.
1. A reversal of impairment loss for a CGU shall be allocated to the assets of the unit, except for goodwill,
pro rata with the carrying amounts of the assets
2. These increases in carrying amounts shall be treated as reversals of impairment losses for individual
assets, as studied above.
3. In allocating a reversal of impairment loss as above, an entity shall not increase the carrying amount
of an asset above the lowest of:
(a) its recoverable amount (if measurable); and
(b) the carrying amount that would have been determined (net of amortization or depreciation) had
no impairment loss been recognized for the asset in prior periods.
The amount of the reversal of impairment loss that would otherwise have been allocated to the asset
shall be allocated pro rata to the other assets of the unit (group of units), except for goodwill.
4. An impairment loss recognized for goodwill shall not be reversed in a subsequent period.
PRACTICE QUESTIONS
Question 1
Property, plant and equipment as disclosed in the draft financial statements of Apricot Pakistan Limited (APL)
for the year ended 30 June 2018 include a plant having a carrying value of Rs. 610 million. The performance of
the plant has been deteriorating since last year which is affecting APL’s sales.
Following information/estimates relate to the plant for the year ending 30 June 2019:
Rs. in million
Inflows from sale of product under existing condition of the plant 250
Operational cost other than depreciation 25
Depreciation 170
Expenses to be paid in respect of 30 June 2018 accruals 8
Cost of increasing the plant’s capacity 60
Additional inflows (net) expected from the upgrade 40
Interest on loan 30
Maintenance cost 15
Tax payment on profits 18
Cash flows from the plant are expected to decrease by 15% each year from 2020 and onward. The plant’s
residual value after its remaining useful life of 3 years is estimated at Rs. 100 million.
An offer has been received to buy the plant immediately for Rs. 570 million but APL has to incur the following
costs.
Rs. in million
Cost of delivery to the customer 45
Legal cost 10
Costs to re-organize the production process after disposal of plant 50
Required:
Calculate the amount of impairment loss (if any) on plant, for the year ended 30 June 2018. (07)
{FAR II Autumn 2018, Q # 6(b)}
Question No. 2
Identify cash generating unit in each of the following independent situations:
(a) Store X belongs to a retail store chain M. X makes all its retail purchases through M’s purchasing centre.
Pricing, marketing, advertising and human resources policies (except for hiring X’s cashiers and sales staff)
are decided by M. M also owns five other stores in the same city as X (although in different
neighbourhoods) and 20 other stores in other cities. All stores are managed in the same way as X.
(b) A significant raw material used for plant Y’s final production is an intermediate product bought from plant
X of the same entity. X’s products are sold to Y at a transfer price that passes all margins to X. Eighty per
cent of Y’s final production is sold to customers outside of the entity. Sixty per cent of X’s final production
is sold to Y and the remaining 40 per cent is sold to customers outside of the entity. X could sell the products
it sells to Y in an active market. Internal transfer prices are higher than market prices.
(c) A significant raw material used for plant Y’s final production is an intermediate product bought from plant
X of the same entity. X’s products are sold to Y at a transfer price that passes all margins to X. Eighty per
cent of Y’s final production is sold to customers outside of the entity. Sixty per cent of X’s final production
is sold to Y and the remaining 40 per cent is sold to customers outside of the entity. There is no active
market for the products X sells to Y.
(d) Entity M produces a single product and owns plants A, B and C. Each plant is located in a different
continent. A produces a component that is assembled in either B or C. The combined capacity of B and C
is not fully utilised. M’s products are sold worldwide from either B or C. For example, B’s production can
be sold in C’s continent if the products can be delivered faster from B than from C. Utilisation levels of B
and C depend on the allocation of sales between the two sites. There is an active market for A’s products.
(e) Entity M produces a single product and owns plants A, B and C. Each plant is located in a different
continent. A produces a component that is assembled in either B or C. The combined capacity of B and C
is not fully utilised. M’s products are sold worldwide from either B or C. For example, B’s production can
be sold in C’s continent if the products can be delivered faster from B than from C. Utilisation levels of B
and C depend on the allocation of sales between the two sites. There is no active market for A’s products.
(f) A publisher owns 150 magazine titles of which 70 were purchased and 80 were self-created. The price paid
for a purchased magazine title is recognised as an intangible asset. The costs of creating magazine titles
and maintaining the existing titles are recognised as an expense when incurred. Cash inflows from direct
sales and advertising are identifiable for each magazine title. Titles are managed by customer segments.
The level of advertising income for a magazine title depends on the range of titles in the customer segment
to which the magazine title relates. Management has a policy to abandon old titles before the end of their
economic lives and replace them immediately with new titles for the same customer segment.
(g) M is a manufacturing company. It owns a headquarters building that used to be fully occupied for internal
use. After down-sizing, half of the building is now used internally and half rented to third parties. The lease
agreement with the tenant is for five years.
Question No. 3
Engro Limited (EL) has various factory units, each of which is categorized as cash generating unit. Following
information relates one factory in respect of impairment test:
(i) EL follows cost model for all property, plant and equipment.
(ii) Carrying amount of assets in CGU as at June 30, 2017 are as follows:
Rs. in million
Land 150
Building 200
Plant and machinery 700
Equipment 180
Furniture and fixtures 120
Rs. in million
Net pre-tax cash flows:
Annual (for 5 years) 250
Year 6 180
Year 7 140
NASIR ABBAS FCA
IMPAIRMENT OF ASSETS (IAS-36) - QUESTIONS (3)
Year 8 110
(vi) Pre-tax discount rate of EL is 10% and post-tax discount rate is 7%. Tax rate applicable to EL is 30%.
Required:
Determine the carrying amount of each asset to be included in EL’s financial statements for the year ended
June 30, 2017.
Question 4
Carrying amounts of assets in a CGU as on June 30, 2020 are as follows:
Rs. in million
Land 1,000
Building 1,200
Plant and machinery 1,800
Software 300
Goodwill 100
Furniture and fixtures 500
Other information:
(i) Fair value less cost to sell of land is Rs. 950 million.
(ii) Recoverable amount of CGU is Rs. 4,100 million.
(iii) Software is outdated and management has decided to replace shortly. In this respect a party has offered
to purchase existing software for Rs. 100 million.
Required:
Calculate revised carrying amounts of assets after charging impairment loss.
Question 5
Carrying amounts of assets in a CGU as on June 30, 2020 are as follows:
Rs. in million
Land 900
Building 1,000
Plant and machinery 1,500
Equipment 400
Goodwill 100
Inventory 100
Other information:
(i) Fair value less cost to sell of land is Rs. 950 million.
(ii) Recoverable amount of CGU is Rs. 3,200 million.
(iii) An item of plant & machinery having book value of Rs. 120 million was severely damaged as result of
recent short circuit. It has been assessed as beyond repairs. It will be disposed off shortly.
(iv) Fair value less cost to sell of inventory (i.e. NRV) is Rs. 95 million.
Required:
Calculate revised carrying amounts of assets after charging impairment loss.
Question No. 6
BB Limited (BBL) produces a single product in two factories A and B. Factory A produces the required
components which are assembled in factory B. The finished product is then sent to distributors for sale.
(i) BBL uses cost model for subsequent measurement of property, plant and equipment.
(ii) The book value and fair value less cost to sell of BBL’s tangible assets as on 31 December 2016 were as
follows:
Required:
(a) Identify the cash generating unit for BB Limited. (02)
(b) Determine the carrying amount of each asset to be included in BBL’s financial statements for the year
ended 31 December 2016 in accordance with International Financial Reporting Standards. (Ignore tax
implications) 10)
{Spring 2017, Q#3}
Question No. 7
Dream Limited (DL) is a manufacturing concern engaged in export sales. Following information relating to its
assets as on June 30, 2020:
Carrying Remaining
amounts useful life
CGUs: Rs. million (years)
CGU 1 1,200 5
CGU 2 2,500 10
CGU 3 300 4
Corporate assets:
Vehicles 100 10
Head office building 300 20
Equipment 150 15
Other details:
• Following cashflows are estimated to determine value in use as on June 30, 2020:
Required:
Carrying amounts of assets after charging impairment loss, if corporate assets can be allocated to each CGU on a
reasonable basis.
Question No. 8
A plant was purchased and installed on July 1, 2015 at a total cost of Rs. 40 million. Initial estimate of useful
life was made at 8 years. It was tested for impairment as follows:
During 2018, estimate of useful life was reduced by 2 years. Accounting year ends on June 30th.
Required:
Journal entries to record both impairment tests. (depreciation entries are not required)
Question No. 9
31-12-18
Entity ABC tested its plant for impairment which had a carrying amount of Rs. 3,000 million and remaining life
of 10 years. Following cash flows (Rs. million) were estimated as follows:
2019 2020 2021 2022 2023 2024 2025 2026 2027 2028
300 280 420 520 350 420 480 480 460 400
Management has decided that plant will be restructured at an estimated cost of Rs 100 million at end of 2021.
However, no constructive obligation arose as it was not announced. Above cashflows do not include the effect
of restructuring. The restructuring would result in following additional benefits (Rs. million):
Discount rate appropriate for calculation of value in use is 14% (pre-tax) or 10% (post-tax).
31-12-19
No need to determine recoverable amount is felt.
31-12-20
ABC became committed to the restructuring and a provision for restructuring cost has been recognized. Cash
flow estimates are still the same as were on 31-12-18.
31-12-21
Restructuring actually took place and Rs. 120 million was incurred on restructuring cost. No need to determine
recoverable amount is felt.
Required:
All possible journal entries upto December 31, 2021.
Question No. 10
Decent Limited (DL) acquired a machine on July 1, 2016 at a cost of Rs. 24 million. Useful life of machine was
estimated at 10 years. Management of DL decided to follow revaluation model for this machine. Following
values were determined for impairment testing in respect of this machine:
It is DL’s policy to transfer required amount from revaluation surplus to retained earnings.
Required:
Journalize all the transactions upto June 30, 2020.
Question 11
Carrying amounts of assets in a CGU as on June 30, 2018 were as follows:
Recoverable amount of CGU was Rs. 4,100 million on June 30, 2018. On June 30, 2020, Recoverable amount of
CGU moved to Rs. 3,850 million whereas recoverable amount of Software was Rs. 130 million.
Required:
Calculate revised carrying amounts of assets after each impairment testing.
SOLUTIONS
Solution No. 1
Value in use
2019 2020 2021
----------- Rs. million ---------
Net operating cash flow (W-1) [LY x 0.85] 210.00 178.50 151.73
RV - - 100.00
210.00 178.50 251.73
factor @ 9% 0.917 0.841 0.772
192.57 150.12 194.33
Solution No. 2
(a)
All M’s stores are in different neighbourhoods and probably have different customer bases. So, although X is
managed at a corporate level, X generates cash inflows that are largely independent of those of M’s other
stores. Therefore, it is likely that X is a cash-generating unit.
(b)
X could sell its products in an active market and, so, generate cash inflows that would be largely independent
of the cash inflows from Y. Therefore, it is likely that X is a separate cash-generating unit, although part of its
production is used by Y. It is likely that Y is also a separate cash-generating unit. Y sells 80 per cent of its
products to customers outside of the entity. Therefore, its cash inflows can be regarded as largely independent.
Internal transfer prices do not reflect market prices for X’s output. Therefore, in determining value in use of
both X and Y, the entity adjusts financial budgets/forecasts to reflect management’s best estimate of future
prices that could be achieved in arm’s length transactions for those of X’s products that are used internally.
(c)
It is likely that the recoverable amount of each plant cannot be assessed independently of the recoverable
amount of the other plant because:
(a) the majority of X’s production is used internally and could not be sold in an active market. So, cash inflows
of X depend on demand for Y’s products. Therefore, X cannot be considered to generate cash inflows that
are largely independent of those of Y.
(b) the two plants are managed together.
As a consequence, it is likely that X and Y together are the smallest group of assets that generates cash inflows
that are largely independent.
(d)
It is likely that A is a separate cash-generating unit because there is an active market for its products. Although
there is an active market for the products assembled by B and C, cash inflows for B and C depend on the
allocation of production across the two sites. It is unlikely that the future cash inflows for B and C can be
determined individually. Therefore, it is likely that B and C together are the smallest identifiable group of assets
that generates cash inflows that are largely independent.
(e)
It is likely that the recoverable amount of each plant cannot be assessed independently because:
(a) there is no active market for A’s products. Therefore, A’s cash inflows depend on sales of the final product
by B and C.
(b) although there is an active market for the products assembled by B and C, cash inflows for B and C depend
on the allocation of production across the two sites. It is unlikely that the future cash inflows for B and C
can be determined individually.
As a consequence, it is likely that A, B and C together (ie M as a whole) are the smallest identifiable group of
assets that generates cash inflows that are largely independent.
(f)
It is likely that the recoverable amount of an individual magazine title can be assessed. Even though the level
of advertising income for a title is influenced, to a certain extent, by the other titles in the customer segment,
cash inflows from direct sales and advertising are identifiable for each title. In addition, although titles are
managed by customer segments, decisions to abandon titles are made on an individual title basis. Therefore,
it is likely that individual magazine titles generate cash inflows that are largely independent of each other and
that each magazine title is a separate cash-generating unit.
(g)
The primary purpose of the building is to serve as a corporate asset, supporting M’s manufacturing activities.
Therefore, the building as a whole cannot be considered to generate cash inflows that are largely independent
of the cash inflows from the entity as a whole. So, it is likely that the cash-generating unit for the building is M
as a whole. The building is not held as an investment. Therefore, it would not be appropriate to determine the
value in use of the building based on projections of future market related rents.
Solution No. 3
Existing carrying amount of each asset:
Rs. in million
Land 150
Building 200
Plant & machinery 700
Equipment 180
Furniture and fixtures 120
Goodwill 50
1,400 [A]
W-1
Since fair value less cost to sell of land exceeds carrying amount therefore impairment loss is not
allocated to land
Solution No. 4
Revised
Carrying Impairment
Assets carrying
amount loss (W-1)
amount
---------- Rs. million --------
Land 1,000 50 950
Building 1,200 154 1,046
P&M 1,800 231 1,569
Software 300 200 100
Goodwill 100 100 -
Furniture & fittings 500 64 436
4,900 800 4,100
Recoverable amount 4,100
Impairment loss 800
Solution No. 5
Revised
Carrying Adjusted Impairment
Assets Adjustments carrying
amount NBV loss (W-1)
amount
----------------------------- Rs. million -------------------------
Land 900 900 - 900
Building 1,000 1,000 207 793
P&M 1,500 (120) 1,380 285 1,095
Equipment 400 400 83 317
Goodwill 100 100 100 -
Inventory 100 (5) 95 - 95
4,000 3,875 675 3,200
Recoverable amount 3,200
Impairment loss 675
Solution No. 6
(a)
Financial statements for year ending June 30, 2015
A cash generating unit is the smallest identifiable group of assets that generates cash flows that are largely
independent of other assets or groups. Since both factories are engaged in production of single product,
therefore, both factories of BBL is a cash generating unit.
(b)
Carrying amount of each asset:
A B Total
--------------- Rs. million --------------
Building 1,850 3,600 5,450
Plant 1,125 2,700 3,825
Equipment 690 1,350 2,040
Other assets 240 510 750
Goodwill - - 100
12,165 [A]
W-1
Since fair values less cost to sell of following assets exceed carrying amounts therefore impairment
loss is not allocated to them:
NBV Fair value
Plant A 1,125 1,300
Building B 3,600 4,200
Equipment B 1,350 1,480
Solution No. 7
Carrying ----------- Loss --------- Revised
Assets
amount CGU1 CGU2 NBV
----------------------- Rs. million ---------------------
CGU assets 4,000.00 30.89 338.07 3,631.04
Vehicles 100.00 0.48 10.50 89.02
Building 300.00 1.44 31.50 267.06
Equipment 150.00 0.72 15.75 133.33
4,550.00 33.52 395.82 4,120.66
WORKINGS
W-1 Impairment loss allocation
Loss Loss
NBV NBV
CGU1 allocation CGU2 allocation
-------- Rs. million ------- ------ Rs. million -------
CGU assets 1,200.00 30.89 CGU assets 2,500.00 338.07
Vehicles 18.63 0.48 Vehicles 77.64 10.50
Building 55.90 1.44 Building 232.92 31.50
Equipment 27.95 0.72 Equipment 116.46 15.75
1,302.48 33.52 2,927.02 395.82
(W-2) (W-2)
Solution No. 8
------- Rs. million ------
30-06-17 Impairment loss [P&L] 6.00
Acc. Depreciation & impairment loss 6.00
[Impairment loss charged]
Workings
NBV Loss
01-07-15 Cost 40.00 -
30-06-16 Dep. [40/8] (5.00) -
35.00 -
30-06-17 Dep. (5.00) -
30.00 -
30-06-17 Impairment loss (6.00) (6.00)
24.00 (6.00)
30-06-18 Dep. [24/4] [6/4] (6.00) 1.50
18.00 (4.50)
30-06-19 Dep. (6.00) 1.50
12.00 (3.00)
30-06-19 Impairment loss reversal* 3.00 3.00
15.00 -
* Although recoverable amount is much higher but only Rs. 3 million loss can be reversed
Solution No. 9
------- Rs. million ------
W-1.1
Value in use: Cashflows D.F. at 14% PV
2019 300.00 0.877 263.10
2020 280.00 0.769 215.32
2021 420.00 0.675 283.50
2022 520.00 0.592 307.84
2023 350.00 0.519 181.65
2024 420.00 0.455 191.10
2025 480.00 0.399 191.52
2026 480.00 0.350 168.00
NASIR ABBAS FCA
IMPAIRMENT OF ASSETS (IAS-36) - SOLUTIONS (10)
W-1.2
Value in use: Cashflows D.F. at 14% PV
2021 420.00 0.877 368.34
2022 [520 + 50] 570.00 0.769 438.33
2023 [350 + 30] 380.00 0.675 256.50
2024 [420 + 30] 450.00 0.592 266.40
2025 [480 + 30] 510.00 0.519 264.69
2026 [480 + 30] 510.00 0.455 232.05
2027 [460 + 20] 480.00 0.399 191.52
2028 [400 + 10] 410.00 0.350 143.50
2,161.33
Solution No. 10
------- Rs. million ------
Impairment
Working NBV Surplus loss
-------------- Rs. million ------------
01-07-16 Cost 24.000 - -
30-06-17 Dep. [20/10] (2.400) - -
21.600 - -
30-06-18 Dep. (2.400) - -
19.200 - -
30-06-18 Revaluation (1.700) - (1.700)
17.500 - (1.700)
30-06-18 Impairment loss * (1.100) - (1.100)
16.400 - (2.800)
30-06-19 Dep. [16.50/8] [2.80/8] (2.050) - 0.350
14.350 - (2.450)
30-06-20 Dep. (2.050) - 0.350
12.300 - (2.100)
30-06-20 Impairment loss reversal** 0.825 - 0.825
13.125 - (1.275)
* Impairment loss:
Value in use 15.00
FV less cost to sell [17.50 - 1.1] 16.40
Recoverable amount (higher) 16.40
** Only impairment loss upto Rs. [i.e. Rs. 1.1m - Rs. 1.1 x 2/8] can be reversed
Solution No. 11
Impairment testing on June 30, 2018
Impairment
Assets NBV Revised NBV
loss (W-1)
---------- Rs. million --------
Land 1,000.00 145.83 854.17
Building 1,200.00 175.00 1,025.00
P&M 1,800.00 262.50 1,537.50
Software 300.00 43.75 256.25
Goodwill 100.00 100.00 -
Equipment 500.00 72.92 427.08
4,900.00 800.00 4,100.00
Recoverable amount 4,100.00
Impairment loss 800.00
Building [1,025 x 13/15] 888.33 1,040.00 [1,200 x 13/15] 151.67 135.16 1,023.49
P&M [1,537.50 x 8/10] 1,230.00 1,440.00 [1,800 x 8/10] 210.00 187.14 1,417.14
Software [256.25 x 2/4] 128.13 130.00 Recoverable amount 1.88 1.88 130.00
Goodwill - - - - -
Equipment [427.08 x 3/5] 256.25 300.00 [500 x 3/5] 43.75 38.99 295.24
Allocation of remaining reversal after limit of software [i.e. 18.82 - 1.88 = 16.95]
Loss
Assets Carrying amount
reversal
------ Rs. million -----
Land 854.17 4.48
Building 888.33 4.66
P&M 1,230.00 6.46
Equipment 256.25 1.34
3,228.75 16.95
WORKINGS
W-1 Impairment loss allocation
Maximum Loss allocation
NBV Limit (W-1.1)
loss (W-1.2)
Green
----------------------- Rs. million ----------------------
Buses 225.00 197.60 27.40 27.40
Other assets 400.00 - 400.00 160.60
Goodwill 5.69 - 5.69 5.69
Building 56.95 - 56.95 22.87
Computer 31.32 26.20 5.13 5.13
Equipment 25.63 34.17 - -
744.59 221.69
Buses 225.00 68.14 Exceeding limit Buses 150.00 32.10 Exceeding limit
Other assets 400.00 121.13 Other assets 350.00 74.90
Building 56.95 17.25 Building 34.17 7.31
Computer 31.32 9.48 Exceeding limit Computer 18.79 4.02 Exceeding limit
713.27 216.00 552.96 118.34
SCOPE
The measurement provisions of this standard shall not apply to the assets, covered in following IFRS,
either as individual assets or as a part of a disposal group:
(a) deferred tax assets (IAS 12);
(b) assets arising from employee benefits (IAS 19);
(c) financial assets (IFRS 9);
(d) investment property measured at fair value (IAS 40);
(e) biological assets measured at fair value less costs to sell (IAS 41);
(f) groups of contracts within the scope of IFRS 17; and
However, classification and presentation requirements of this IFRS apply to above assets as well if these
are part of a disposal group.
Disposal group:
- It is a group of assets to be disposed of, by sale or otherwise, together as a group in a single
transaction, and liabilities directly associated with those assets that will be transferred in the
transaction. The group includes goodwill acquired in a business combination if the group is a
cash‑generating unit to which goodwill has been allocated.
- If a non-current asset, which falls within the scope of measurement requirements of this IFRS (e.g.
PPE), is a part of a disposal group, the measurement requirements of this IFRS apply to the disposal
group as a whole (i.e. not applied to that individual non-current asset).
MEASUREMENT
2. A non-current asset (or disposal group) classified as held for distribution to owners shall be measured
at the lower of:
▪ Carrying amount; and
▪ Fair value less cost to distribute
Important:
• When the sale is expected to occur beyond one year, the entity shall measure the costs to sell at
their present value. Any increase in the present value of the costs to sell that arises from the passage
of time shall be presented in profit or loss as a financing cost.
• Immediately before the initial classification of the asset (or disposal group) as held for sale, the
carrying amounts of the asset (or all the assets and liabilities in the group) shall be measured in
accordance with applicable IFRSs.
• On subsequent remeasurement of a disposal group, the carrying amounts of any assets and
liabilities that are not within the scope of the measurement requirements of this IFRS, but are
included in a disposal group classified as held for sale, shall be remeasured in accordance with
applicable IFRSs before the fair value less costs to sell of the disposal group is remeasured.
Impairment loss reversal (i.e. gain) = Fair value less cost to sell – Carrying amount
For individual asset:
1. An impairment loss shall be recognized in P&L for initial or subsequent write-down to fair value less
cost to sell.
2. If subsequently fair value less cost to sell increases, a gain shall be recognized in P&L ONLY to the
extent to reverse the cumulative impairment loss previously recognized either as per this IFRS or as
per IAS 36.
2. If subsequently fair value less cost to sell increases, a gain shall be recognized ONLY to the extent to
reverse the cumulative impairment loss previously recognized on the assets that are within the scope
of measurement requirements of this IFRS, either as per this IFRS or as per IAS 36.
3. The impairment loss recognized for the group shall be allocated to all non-current assets in the group
that are within the scope of the measurement requirements of this IFRS, in following order:
• first, to reduce the carrying amount of any goodwill allocated to the group; and
• then, to the other assets of the group pro rata on the basis of the carrying amount of each asset
in the group.
Any subsequent gain (i.e. loss reversal) shall be allocated to other assets of the group, except for
goodwill, pro rata on the basis of the carrying amount of each asset in the group.
Exam note:
This loss allocation is same as studied in IAS 36 for loss allocation in CGU except here “maximum
limit for loss allocation as per IAS 36” is not applicable.
▪ Interest and other expenses attributable to the liabilities of a disposal group classified as held for
sale or held for distribution to owners shall however continue to be recognized.
1. If the criteria for “held for sale” or “held for distribution to owners” classification are no longer met,
then entity shall cease to classify the asset (or disposal group) as “held for sale” or “held for
distribution to owners”.
Change between classes:
If an entity reclassifies an asset (or disposal group) directly from “held for sale” to “held for
distribution to owners” or vice verse, then this change is not considered as a change in plan,
therefore, it will be measured as per respective guidance studied earlier.
2. If an asset (or disposal group) ceases to be classified as “held for sale” or “held for distribution to
owners”, then it shall be measured at lower of:
▪ Its carrying amount before classification, adjusted for any depreciation, amortization or
revaluations that would have been recognized had the asset (or disposal group) not been
classified as “held for sale” or “held for distribution to owners”; and
▪ Its recoverable amount at the date of subsequent decision not to sell or distribute.
3. The required adjustment in carrying amount shall be immediately recognized in profit and loss from
continuing operations in the same caption as used to present earlier gain or loss.
4. If an entity removes an individual asset or liability an individual asset or liability from a disposal group
classified as “held for sale” or “held for distribution to owners”:
Discontinued operations
A discontinued operation is a component (e.g. a cash generating unit or group of cash generating units)
of an entity that either has been disposed of, or is classified as held for sale, and
(a) represents a separate major line of business or geographical area of operations,
(b) is part of a single co‑ordinated plan to dispose of a separate major line of business or geographical
area of operations or
(c) is a subsidiary acquired exclusively with a view to resale.
Disclosures:
An entity shall disclose:
(a) a single amount in the statement of comprehensive income comprising the total of:
(i) the post‑tax profit or loss of discontinued operations and
(ii) the post‑tax gain or loss recognised on the measurement to fair value less costs to sell or on the
disposal of the assets or disposal group(s) constituting the discontinued operation.
The analysis may be presented in the notes or in the statement of comprehensive income. If it is
presented in the statement of comprehensive income it shall be presented in a section identified as
relating to discontinued operations, i.e. separately from continuing operations.
(c) the net cash flows attributable to the operating, investing and financing activities of discontinued
operations. These disclosures may be presented either in the notes or in the financial statements.
Comparative figures:
▪ An entity shall re-present above disclosures for prior period presented in the financial statements
so that the disclosures relate to all operations that have been discontinued by the end of current
period.
▪ If an entity ceases to classify a component as held for sale, the results of operations of the
component previously presented in discontinued operations shall be reclassified and included in
income from continuing operations for all periods presented.
This restatement/reclassification of comparative figures is relevant for SOCI only. Disclosure of non-
current asset or disposal group held for sale under current assets (SOFP) shall not be
represented/reclassified.
2. An entity shall present a non‑current asset classified as held for sale and the assets of a disposal group
classified as held for sale separately from other assets in the statement of financial position. The
liabilities of a disposal group classified as held for sale shall be presented separately from other
liabilities in the statement of financial position. Those assets and liabilities shall not be offset and
presented as a single amount.
3. An entity shall present separately any cumulative income or expense recognised in other
comprehensive income relating to a non‑current asset (or disposal group) classified as held for sale.
PRACTICE QUESTIONS
Question 1
On 1 December 2020, a company became committed to a plan to sell a manufacturing facility and has already
found a potential buyer. The company does not intend to discontinue the operations currently carried out in
the facility. At 31 December 2020 there is a backlog of uncompleted customer orders. The company will not
be able to transfer the facility to the buyer until after it ceases to operate the facility and has eliminated the
backlog of uncompleted customer orders. This is not expected to occur until spring 2021.
Required
Can the manufacturing facility be classified as 'held for sale' at 31 December 2020?
Question No. 2
On 20 October 2019 the directors of a company made a public announcement of plans to close a steel works.
The closure means that the company will no longer carry out this type of operation, which until recently has
represented about 10% of its total turnover. The works will be gradually shut down over a period of several
months, with complete closure expected in July 2020. At 31 December output had been significantly reduced
and some redundancies had already taken place. The cash flows, revenues and expenses relating to the steel
works can be clearly distinguished from those of the subsidiary's other operations.
Required
How should the closure be treated in the financial statements for the year ended 31 December 2019?
Question No. 3
An entity is committed to a plan to sell its headquarters building and has initiated actions to locate a buyer.
The entity will continue to use the building until construction of a new headquarters building is completed. The
entity does not intend to transfer the existing building to a buyer until after construction of the new building
is completed (and it vacates the existing building).
Required:
Can the building be classified as ‘held for sale’?
Question No. 4
An entity is committed to a plan to sell a manufacturing facility in its present condition and classifies the facility
as held for sale at that date. After a firm purchase commitment is obtained, the buyer’s inspection of the
property identifies environmental damage not previously existed. The entity is required by the buyer to make
good the damage, which will extend the period required to complete the sale beyond one year. However, the
entity has initiated actions to make good the damage, and satisfactory rectification of the damage is highly
probable.
Required:
Can the facility be classified as ‘held for sale’?
Question No. 5
An entity is committed to a plan to sell a non-current asset and classifies the asset as held for sale at that date.
(a) During the initial one-year period, the market conditions that existed at the date, the asset was classified
initially as held for sale, deteriorate and, as a result, the asset is not sold by the end of that period. During
that period, the entity actively solicited but did not receive any reasonable offers to purchase the asset
and, in response, reduced the price. The asset continues to be actively marketed at a price that is
reasonable given the change in market conditions.
(b) During the following one-year period, market conditions deteriorate further, and the asset is not sold by
the end of that period. The entity believes that the market conditions will improve and has not further
reduced the price of the asset. The asset continues to be held for sale, but at a price in excess of its current
fair value.
Required:
Discuss whether the non-current asset meets the criteria for classification as held for sale in each year.
Question No. 6
On 1 January 2017, AB acquires a building for Rs. 2,000,000 with an expected life of 50 years. On 31 December
2020 AB puts the building up for immediate sale. Costs to sell the building are estimated at Rs. 100,000.
Required
Outline the accounting treatment of the above if the building had a fair value at 31 December 2020 of:
(a) Rs. 2,200,000
(b) Rs. 1,100,000
Question No. 7
Nash purchased a building for its own use on 1 January 2017 for Rs. 10 million and attributed it a 50 year useful
economic life. Nash uses the revaluation model to account for buildings.
On 31 December 2018, this building was revalued to Rs. 12 million.
On 31 December 2019, the building met the criteria to be classified as held for sale. Its fair value was deemed
to be Rs. 11 million and the costs necessary to sell the building were estimated to be Rs. 500,000.
Required:
Journalize above transactions/adjustments till 31 December 2019.
Question No. 8
An entity plans to dispose of a group of its assets. The information regarding the assets forming the disposal
group as on June 30, 2020 is as follows:
Carrying amount Fair values immediately before
(Rs. million) classification as held for sale
(Rs. million)
Goodwill 150 -
Property, plant & equipment 460 400
(carried at revaluation model)
Property, plant & equipment 570 -
(carried at cost model)
Inventory 240 220
Financial assets (equity investment) 180 150
On June 30, 2020 the entity measured the fair value less cost to sell of the group at Rs. 1,300 million.
Required:
Calculate revised carrying amounts as on June 30, 2020.
Question No. 9
A building was purchased on July 1, 2015 at a cost of Rs. 40 million. Initial estimate of useful life was made at
8 years. On June 30, 2017 the building was classified as held for sale. Its fair value less cost to sell was
determined as follows:
Date Fair value less cost
to sell
June 30, 2017 Rs. 27 million
June 30, 2018 Rs. 29 million
On June 30, 2019 the plan to sell the building was changed. Recoverable amount on that date was determined
at Rs. 24 million.
Required:
All journal entries till June 30, 2019.
SOLUTIONS
Solution No. 1
The facility will not be transferred until the backlog of orders is completed; this demonstrates that the facility
is not available for immediate sale in its present condition. The facility cannot be classified as 'held for sale' at
31 December 2020. It must be treated in the same way as other items of property, plant and equipment: it
should continue to be depreciated and should not be separately disclosed.
Solution No. 2
Because the steel works is being closed, rather than sold, it cannot be classified as 'held for sale'. In addition,
the steel works is not a discontinued operation. Although at 31 December 2019 the group was firmly
committed to the closure, this has not yet taken place and therefore the steel works must be included in
continuing operations. Information about the planned closure could be disclosed in the notes to the financial
statements.
Solution No. 3
The delay in the timing of the transfer of the existing building imposed by the entity (seller) demonstrates that
the building is not available for immediate sale. The criteria can not be met until the construction of the new
building in completed. Therefore, the building is not classified as held for sale.
Solution No. 4
Since the delay is due to circumstances beyond entity’s control therefore this delay qualifies for exception to
one-year condition. Hence the facility shall be classified as held for sale.
Solution No. 5
(a) Since the delay is due to circumstances beyond entity’s control therefore this delay qualifies for exception
to one-year condition. Hence the facility shall be classified as held for sale. At the end of the initial one-
year period, the asset would continue to be classified as held for sale.
(b) In that situation, the absence of a price reduction demonstrates that the asset is not available for
immediate sale. Moreover, an asset must be marketed at a price that is reasonable in relation to its current
fair value. Therefore, the conditions for an exception to the one-year requirement would not be met. The
asset would be reclassified.
Solution No. 6
Until 31 December 2020 the building is a normal non-current asset and its accounting treatment is prescribed
by IAS 16. The annual depreciation charge was Rs. 40,000 (Rs. 2,000,000/50). As such, the carrying amount at
31 December 2020, prior to reclassification, was Rs. 1,840,000 [i.e. Rs. 2,000,000 – (4 × Rs. 40,000)].
(a) On 31 December 2020 the building is classified as a non-current asset held for sale. It is measured at the
lower of carrying amount (i.e. Rs. 1,840,000) and fair value less costs to sell (i.e. Rs. 2,200,000 – Rs. 100,000
= Rs. 2,100,000). This means that the building will continue to be measured at Rs. 1,840,000.
(b) On 31 December 2020 the building is classified as a non-current asset held for sale. It is measured at the
lower of carrying amount (i.e. Rs. 1,840,000) and fair value less costs to sell (i.e. Rs. 1,100,000 – Rs. 100,000
= Rs. 1,000,000). The building will therefore be measured at Rs. 1,000,000 as at 31 December 2020. An
impairment loss of Rs. 840,000 will be charged to the statement of profit or loss.
Solution No. 7
---- Rs. million ----
01-01-17 Building 10.00
Cash 10.00
[Purchase of building]
9.80 -
31-12-18 Dep. (0.20) -
9.60 -
31-12-18 Revaluation 2.40 2.40
12.00 2.40
31-12-19 Dep. [12/48] [2.40/48] (0.25) (0.05)
11.75 2.35
31-12-19 Revaluation (0.75) (0.75)
11.00 1.60
Solution No. 8
Remeasurement
NBV just
adjustment Impairment NBV after
NBV before initial
before initial loss (W-1) classification
classification
classification
-------------------------------------- Rs. million -------------------------------------
Goodwill 150.00 - 150.00 (150.00) -
PPE (revaluation model) 460.00 (60.00) 400.00 (16.49) 383.51
PPE (cost model) 570.00 - 570.00 (23.51) 546.49
Inventory 240.00 (20.00) 220.00 - 220.00
Financial assets 180.00 (30.00) 150.00 - 150.00
1,600.00 1,490.00 (190.00) 1,300.00
Solution No. 9
---- Rs. million ----
01-07-15 Building 40.00
Cash 40.00
[Purchase of building]
2020 2019
SOFP - Extracts ------- Rs. million ------
2020 2019
SOCI - Extracts ------- Rs. million ------
2020 2019
SOFP - Extracts ------- Rs. million ------
Current assets
Disposal group held for sale 155 165
2020 2019
SOCI - Extracts ------- Rs. million ------
W-1
PBT 120 80
Loss as per IFRS 5 [165 - 155] [180 - 165] (10) (15)
110 65
Tax [20%] (22) (13)
88 52
31-12-2020 155
2020 2019
SOFP - Extracts ------- Rs. million ------
Current assets
Disposal group held for sale 155 -
2020 2019
(reclassified)
SOCI - Extracts ------- Rs. million ------
W-1
PBT 120 80
Loss as per IFRS 5 [170 - 155] (15) -
105 80
Tax [20%] (21) (16)
84 64
Scenario IV - Division A was classified as held for sale in 2019 but ceased in 2020
31-12-2019 165
2020 2019
SOFP - Extracts ------- Rs. million ------
Current assets
Disposal group held for sale - 165
2020 2019
(reclassified)
SOCI - Extracts ------- Rs. million ------
W-1
Operating expenses 170 130
Loss as per IFRS 5 [180 - 165] - 15
Loss reversal as per IFRS 5 [170 - 165] (5) -
165 145
IAS 19 – Class notes
SCOPE
This standard shall be applied in accounting for all employee benefits, except those to which IFRS 2
applies.
EMPLOYEE BENEFITS
Employee benefits are all forms of consideration given by an entity in exchange for service rendered by
employees or for the termination of employment. Employee benefits include:
Prepayment or accrual
If payment is different from the amount of benefits, an entity shall recognize the difference as an
accrued expense (if amount of benefits exceeds payment) or prepayment (if payment exceeds the
amount of benefits).
3. An obligation arises as employees render service that increases their entitlement to future paid
absences. An entity shall measure the obligation at the expected cost of accumulating paid absences
as the additional amount that the entity expects to pay as a result of the unused entitlement that has
accumulated at the end of the reporting period.
Non-vesting:
The obligation exists, and is recognised, even if the paid absences are non‑vesting, although the
possibility that employees may leave before they use an accumulated non‑vesting entitlement
affects the measurement of that obligation.
A present obligation exists when, and only when, the entity has no realistic alternative but to make
the payments.
2. Under some profit‑sharing plans, employees receive a share of the profit only if they remain with the
entity for a specified period. Such plans create a constructive obligation as employees render service
that increases the amount to be paid if they remain in service until the end of the specified period.
The measurement of such constructive obligations reflects the possibility that some employees may
leave without receiving profit‑sharing payments.
3. An entity can make a reliable estimate of its legal or constructive obligation under a profit‑sharing or
bonus plan when, and only when:
(a) the formal terms of the plan contain a formula for determining the amount of the benefit;
(b) the entity determines the amounts to be paid before the financial statements are authorised for
issue; or
(c) past practice gives clear evidence of the amount of the entity’s constructive obligation.
POST-EMPLOYMENT BENEFITS
Arrangements whereby an entity provides post-employment benefits are post-employment benefit plans.
Disclosures
The entity shall disclose the amount recognized as expense for defined contribution plans.
Note:
PV of defined benefit obligation XXX
Fair value of plan assets (XXX)
Net defined benefit liability / (asset)* XXX
* All these costs are shown as a single line item “salaries & wages”
** All these items are shown as a single line item “Remeasurement gain/loss”
2. An entity shall use projected unit credit method to determine the present value of defined
obligation and related service cost. This method sees each period of service as giving rise to an
additional unit of benefit entitlement and measures each unit separately to build up the final
obligation. An entity shall attribute benefits of service under the plan’s benefit formula to periods
in which the obligation to provide post-employment benefit arises.
Example:
A lumpsum benefit equal to 1% of final salary multiplied by number of years of service will be paid
on retirement. Annual salary in year 1 is expected to be Rs. 25,000 and it is assumed to increase
8% per year. Appropriate discount rate is 10%. Assuming that employee will remain employed for
5 years, following is the calculation of defined benefit obligation and its related costs:
3. Employee service gives rise to an obligation under a defined benefit plan even if the benefits:
- are conditional on future employment (in other words they are not yet vested); or
- become payable only if a specified event occurs when an employee is no longer employed
(e.g. medical support).
In measuring its defined benefit obligation, an entity considers the probability that some
employees may not satisfy any vesting requirements or the specified event will not occur.
Examples:
1. A plan pays a benefit of Rs. 100 for each year of service. The benefits vest after ten years
of service.
A benefit of Rs. 100 is attributed to each year. In each of the first ten years, the current
service cost and the present value of the obligation reflect the probability that the employee
may not complete ten years of service.
2. A plan pays a benefit of Rs. 100 for each year of service, excluding service before the age
of 25. The benefits vest immediately.
No benefit is attributed to service before the age of 25 because service before that date does
not lead to benefits (conditional or unconditional). A benefit of Rs. 100 is attributed to each
subsequent year.
4. If further service of an employee will lead to no material amount of further benefits, then all
benefit is attributed to the service periods ending on or before that date.
Examples:
1. A plan pays a lumpsum of Rs. 1,000 that vests after 10 years of service. The plan provides
no further benefit for subsequent service.
A benefit of Rs. 100 (i.e. Rs. 1,000 divided by ten) is attributed to each of the first ten years.
In each of the first ten years, the current service cost and the present value of the obligation
reflect the probability that the employee may not complete ten years of service. No benefit
is attributed to subsequent years.
2. A plan pays a lumpsum retirement benefit of Rs. 2,000 to all employees who are still
employed at the age of 55 or above and completed twenty years of service, OR who are
still employed at the age of 65 or above, regardless of their length of service.
For employees who join before the age of 35, service first leads to benefits under the plan
at the age of 35 (an employee could leave at the age of 30 and return at the age of 33, with
no effect on the amount or timing of benefits). Those benefits are conditional on further
service. Also, service beyond the age of 55 will lead to no material amount of further
benefits. For these employees, the entity attributes benefit of Rs. 100 (Rs. 2,000 divided by
twenty) to each year from the age of 35 to the age of 55.
For employees who join between the ages of 35 and 45, service beyond twenty years will
lead to no material amount of further benefits. For these employees, the entity attributes
benefit of Rs. 100 (Rs. 2,000 divided by twenty) to each of the first twenty years.
For an employee who joins at the age of 55, service beyond ten years will lead to no material
amount of further benefits. For this employee, the entity attributes benefit of Rs. 200 (Rs.
2,000 divided by ten) to each of the first ten years.
For all employees, the current service cost and the present value of the obligation reflect the
probability that the employee may not complete the necessary period of service.
5. If an employee’s service in later years will lead to a materially higher level of benefit than in earlier
years, an entity shall attribute benefit on a straight‑line basis from:
(a) the date when service by the employee first leads to benefits under the plan (whether or not
the benefits are conditional on further service) until
(b) the date when further service by the employee will lead to no material amount of further
benefits under the plan, other than from further salary increases.
That is because the employee’s service throughout the entire period will ultimately lead to a
benefit at that higher level.
Example:
A post-employment medical plan reimburses 10% of an employee’s post-employment
medical costs if the employee leaves after more than ten and less than twenty years of service
and 50% of those costs if the employee leaves after twenty or more years of service.
Service in later years will lead to a materially higher level of benefit than in earlier years.
Therefore, for employees expected to leave after twenty or more years, the entity attributes
benefit on a straight-line basis. Service beyond twenty years will lead to no material amount of
further benefits. Therefore, the benefit attributed to each of the first twenty years is 2.5 per cent
of the present value of the expected medical costs (50 per cent divided by twenty).
For employees expected to leave between ten and twenty years, the benefit attributed to each
of the first ten years is 1 per cent of the present value of the expected medical costs. For these
employees, no benefit is attributed to service between the end of the tenth year and the
estimated date of leaving.
For employees expected to leave within ten years, no benefit is attributed.
6. Estimates for defined benefit obligation and related service cost are based on actuarial
assumptions. Such assumptions shall be unbiased (i.e. neither imprudent nor excessively
conservative) and mutually compatible (i.e. reflect economic relationship between factors such
as inflation, rates of salary increase and discount rate). These assumptions are entity’s best
estimates of the variables that will determine the ultimate cost of providing post-employment
benefits. Actuarial assumptions comprise of:
(a) Demographic assumptions that deal with matters such as:
- Mortality
- Rate of employee turnover, disability and early retirement
- The proportion of plan members with dependents who will be eligible for benefits
- The proportion of plan members who will select each form of payment option available
under the plan terms
- Claim rates under medical plans
(b) Financial assumptions that deal with items such as:
- The discount rate (It shall be determined in nominal terms by reference to market yield
at end of reporting period on high quality corporate bonds.)
- Benefits levels and future salary
- In case of medical benefits, future medical costs, claim handling costs
- Tax payable by the plan on contributions relating to service
Financial assumptions shall be based on market expectations at the end of the reporting
period, for the period over which the obligations are to be settled.
7. Some defined benefit plans require employees or third parties to contribute to the cost of the
plan. It is explained in application guidance of IAS as follows:
2. Past service cost may be either positive or negative. An entity shall recognize past service cost as
an expense at the earliest of:
(a) When the plan amendment or curtailment occurs; and
(b) When the entity recognises related restructuring costs or termination benefits
3) Settlement
1. Settlement is a transaction that eliminates all further legal or constructive obligations for part or
all of the benefits provided under a defined benefits plan, other than a payment of benefits to
employees that set out in the terms of plan and included in the actuarial assumptions. For
example: one off transfer of significant employer obligations under the plan to an insurance
company through purchase of an insurance policy.
2. An entity shall recognize a gain or loss on settlement of a defined benefit plan when the
settlement occurs. The gain or loss on settlement is calculated as the difference between:
(a) The present value of the defined benefit obligation being settled, as determined on the date
of settlement; and
(b) The settlement price, including any plan assets transferred and any payments made directly
by the entity in connection with the settlement.
4) Interest cost
1. Interest cost is the change during the period in the present value of defined benefit obligation
that arises from the passage of time.
2. It is calculated by applying discount rate (determined at end of last year) to year start present
value of defined benefit obligation.
Exam note:
Generally other movements in PV of defined benefit obligation are assumed to occur at year
end. However, interest calculation will be made on time proportionate basis to accommodate
the effect of changes (e.g. benefits paid) made during the year.
2. Fair value of plan assets is determined at end of every year and it is deducted from present value
of defined benefit obligation in determining net defined benefit obligation/(asset).
3. For disclosures in notes, fair value of plan assets is disaggregated into classes such as cash & cash
equivalents, equity instruments, debt instruments, real estate etc.
4. Plan assets:
(a) Exclude unpaid contributions due from the reporting entity to the fund.
(b) Are reduced by accrued liabilities of the fund that do not relate to employee benefits.
6) Interest income
Interest income is calculated by applying discount rate (determined at end of last year) to year start
fair value of plan assets.
Exam note:
Generally other movements in fair value of plan assets are assumed to occur at year end. However,
interest calculation will be made on time proportionate basis to accommodate the effect of changes
(e.g. benefits paid, contributions) made during the year.
7) Contributions to fund
Necessary and timely contributions are made to fund.
8) Benefits paid
Post-employment benefits are paid to retiring employees out of plan assets.
9) Remeasurement
1. Actuarial gain/loss is the change during the period in the present value of defined benefit
obligation because of changes in actuarial assumptions and experience adjustments. Such
gain/loss is recognized in other comprehensive income.
OR
2. Return on plan assets is interest, dividend and other income derived from the plan assets net of
the costs of managing the plan assets. It is determined as a balancing figure in movement in fair
value of plan assets. This return is recognized in other comprehensive income.
OR
3. Any adjustment for asset ceiling test (other than interest as discussed in IFRIC 14) shall be
recognized in other comprehensive income.
Reclassification to P&L:
All above remeasurements recognized in other comprehensive income shall not be reclassified to
P&L in a subsequent period. However, an entity may transfer those amounts within equity.
Multi-employer plans
1. Multi-employer plans are defined contribution plans or defined benefit plans that pool the assets
contributed by various entities that are not under common control and use those assets to provide
benefits to employees of more than one entity on the basis that contribution and benefit levels are
determined without regard to the identity of the entity that employs the employees.
2. An entity shall classify a multi-employer plan as a defined contribution plan or a defined benefit plan
under the terms of the plan.
3. If multi-employer plan is a defined benefit plan then entity shall account for its proportionate share
of the defined benefit obligation, plan assets and related costs as studied earlier. When sufficient
information is not available for defined benefit plan accounting, then entity shall account for the plan
as defined contribution plan.
Group plans
Defined benefit plans that share risks between group entities e.g. parent and subsidiary, are not multi-
employer plans.
State plans
An entity shall account for state plan in the same way as for a multi-employer plan.
Examples:
- Long-term paid absences
- Jubilee
- Long-term disability benefits
- Profit sharing and bonuses
- Deferred remuneration
TERMINATION BENEFITS
Termination benefits result from either an entity’s decision to terminate the employment or an
employee’s decision to accept an entity’s offer of benefits in exchange for termination of employment.
Recognition
An entity shall recognize a liability and expense for termination benefits at the earlier of the following
dates:
(a) When the entity can no longer withdraw the offer of those benefits; and
(b) When the entity recognizes cost for a restructuring that is within the scope of IAS 37 and involves the
payment of termination benefits.
Measurement
If termination benefits are expected to be settled wholly before twelve months after the end of the year
in which the termination benefit is recognized, then entity shall account for these benefits same as short-
term benefits.
If termination benefits are not expected to be settled wholly before twelve months after the end of the
year in which the termination benefit is recognized, then entity shall account for these benefits same as
other long-term benefits.
Example
Background
As a result of a recent acquisition, an entity plans to close a factory in ten months and, at that time,
terminate the employment of all of the remaining employees at the factory. Because the entity needs
the expertise of the employees at the factory to complete some contracts, it announces a plan of
termination as follows.
Each employee who stays and renders service until the closure of the factory will receive on the
termination date a cash payment of RS. 30,000. Employees leaving before closure of the factory will
receive RS. 10,000.
There are 120 employees at the factory. At the time of announcing the plan, the entity expects 20 of
them to leave before closure. Therefore, the total expected cash outflows under the plan are RS.
3,200,000 (ie 20 × RS. 10,000 + 100 × RS. 30,000). The entity accounts for benefits provided in exchange
for termination of employment as termination benefits and accounts for benefits provided in exchange
for services as short-term employee benefits.
Termination benefits
The benefit provided in exchange for termination of employment is RS. 10,000. This is the amount that
an entity would have to pay for terminating the employment regardless of whether the employees stay
and render service until closure of the factory or they leave before closure. Even though the employees
can leave before closure, the termination of all employees’ employment is a result of the entity’s
decision to close the factory and terminate their employment (ie all employees will leave employment
when the factory closes). Therefore the entity recognises a liability of RS. 1,200,000 (ie 120 × RS. 10,000)
for the termination benefits provided in accordance with the employee benefit plan at the earlier of
when the plan of termination is announced and when the entity recognizes the restructuring costs
associated with the closure of the factory.
PRACTICE QUESTIONS
Question 1
Employees of Alpha Limited (AL) are entitled to 10 paid leaves for each year. Unused leaves are entitled to cash
payment on leaving the entity. Average salary of employees for the year 2020 is Rs. 30,000 per month (2019:
Rs. 25,000 per month). As on June 30, 2019 there were 115 employees and their cumulative unused
compensated absences were 540 days.
During 2020, 15 employees resigned who cashed their unused leaves of 75 days. Of remaining employees 40%
employees availed 6 leaves each and 60% employees availed 9 leaves each.
Required:
Assuming 300 working days in a year, calculate the amount of compensated absence obligation at June 30,
2020 and related expense for the year 2020.
Question 2
Employees of Beta Limited (BL) are entitled to 5 paid leaves for each year. Unused leaves may be carried
forward for one calendar year (i.e. non-vesting). Leaves are allowed on LIFO basis therefore leave is taken first
out of the current year’s entitlement and then out any balance brought forward from the previous year.
Average salary of employees for the year 2020 is Rs. 1,000 per day (2019: Rs. 800 per day). As on June 30, 2019
there were 100 employees and their carried forward unused compensated absences were 240 days.
During 2020, on an average each employee availed 3 leaves. It is expected that during 2021, 70 employees will
avail 5 leaves or less, whereas 30 employees will avail 7 leaves.
Required:
Calculate the amount of compensated absence obligation at June 30, 2020 and related expense for the year
2020.
Question 3
Gamma Limited (GL) has offered its employees (including 5 directors) following profit share for their service
for the year:
o 10% of the profit in excess of target profit will be distributed to 5 directors, but each director can get a
maximum share equal to 20% of that profit share.
o 25% of the remaining excess profit (i.e. after deducting 10% share dedicated to directors) will be
distributed to all employees other than directors.
However, this profit share will be distributed to only those employees (including directors) who remain
employed till June 30th next year. Target profit for the year ending December 31, 2019 was set at Rs. 8,000,000.
However actual profit for the year 2019 was Rs. 10,500,000. Financial statements for the year ended December
31, 2019 are being finalized. It is estimated that one director will leave before June 30, 2020. Moreover, other
employees are also expected to leave as a result of which distribution of remaining excess profit to other
employees will reduce to 21%.
Required:
Journal entry to record profit share distribution for the year ending December 31, 2019.
Question 4
An annual pension equal to 2.5% of final salary multiplied by number of years of service will be paid from
retirement till death. Annual salary in year 1 is expected to be Rs. 40,000 and it is assumed to increase 6% per
year. Appropriate discount rate is 10%.
Required:
Assuming that employee will remain employed for 5 years and will live for 4 years after retirement, show yearly
calculations for service period of 5 years relating to defined benefit obligation and related costs.
Question 5
A company is operating two post-employment benefits plans (funded), the details of which are as follows:
Plan A
The terms of the plan are as follows.
(i) Employees contribute 6% of their salaries to the plan.
(ii) Employer contributes, currently, the same amount to the plan for the benefit of the employees.
(iii) On retirement, employees are guaranteed a pension which is based upon the number of years service with
the company and their final salary.
The following details relate to the plan in the year to December 31, 2019:
Rs. million
Present value of obligation at January 1, 2019 200
Present value of obligation at December 31, 2019 240
Fair value of plan assets at January 1, 2019 190
Fair value of plan assets at December 31, 2019 225
Current service cost 20
Pension benefits paid 19
Total contributions paid to the scheme for year to December 31, 2019 17
The interest rate on high quality corporate bonds for the two plans are:
January 1, 2019 5%
December 31, 2019 6%
Plan B
Under the terms of the plan, the company does not guarantee any return on the contributions paid into the
fund. The company's legal and constructive obligation is limited to the amount that is contributed to the fund.
The following details relate to this scheme:
Rs. million
Fair value of plan assets at December 31, 2019 21
Contributions paid by company for year to December 31, 2019 10
Contributions paid by employees for year to December 31, 2019 10
Required:
(a) Discuss the nature of and differences between above two plans.
(b) Prepare extracts of SOFP, SOCI and notes for the year 2019 in respect of Plan A only.
Question 6
Savage, a public limited company, operates a funded defined benefit plan for its employees. The plan provides
a pension of 1% of the final salary for each year of service. The cost for the year is determined using the
projected unit credit method. This reflects service rendered to the dates of valuation of the plan and
incorporates actuarial assumptions primarily regarding discount rates, which are based on the market yields
of high quality corporate bonds.
The directors have provided the following information about the defined benefit plan for the current year (year
ended June 30, 2020).
(a) The actuarial cost of providing benefits in respect of employees' service for the year to June 30, 2020 was
Rs. 40 million. This is the present value of the pension benefits earned by the employees in the year.
(b) The pension benefits paid to former employees in the year were Rs. 42 million.
(c) Savage should have paid contributions to the fund of Rs. 28 million. Because of cash flow problems Rs. 8
million of this amount had not been paid at the financial year end of June 30, 2020.
(d) The present value of the obligation to provide benefits to current and former employees was Rs. 3,000
million at June 30, 2019 and Rs. 3,375 million at June 30, 2020.
(e) The fair value of the plan assets was Rs. 2,900 million at June 30, 2019 and Rs. 3,170 million (including the
contributions owed by Savage) at June 30, 2020.
With effect from July 1, 2019, the company had amended the plan so that the employees were now provided
with an increased pension entitlement. The actuaries computed that the present value of the cost of these
benefits at July 1, 2019 was Rs. 125 million. The interest rate on high quality corporate bonds was as follows
from the following dates:
June 30,2019 6%
June 30, 2020 7%
Required:
Prepare extracts of SOFP, SOCI and notes for the year 2020.
SOLUTIONS
Solution No. 1
Days Rate* Amount
(Rs.) (Rs.)
Balance as on 01-07-19 540 1,000 540,000
Leave encashment (75) 1,000 (75,000)
Expense for the year (balancing) 357,000
Balance as on 30-06-20 **685 1,200 822,000
Solution No. 2
Since brought forward leaves balance could not be availed in 2020 and hence expired, therefore, opening
obligation must be reversed.
At 30-06-20 average unused leaves balance is 2 days for 100 employees but only 30 employees are expected
to utilize this balance in 2021 and unused leaves of 70 employees will lapse. Therefore, obligation will be
recorded for 60 days (30 x 2 days) as follows:
Solution No. 3
Rs.
Excess profit [10,500,000 - 8,000,000] 2,500,000
Solution No. 4
Solution No. 5
(a)
With defined contribution plans, the employer (and possibly, as here, current employees too) pay regular
contributions into the plan of a given or 'defined' amount each year. The contributions are invested, and the
size of the post-employment benefits paid to former employees depends on how well or how badly the plan's
investments perform. If the investments perform well, the plan will be able to afford higher benefits than if
the investments performed less well. The B scheme is a defined contribution plan. The employer's liability is
limited to the contributions paid.
With defined benefit plans, the size of the post-employment benefits is determined in advance, i.e. the
benefits are 'defined'. The employer (and possibly, as here, current employees too) pay contributions into the
plan, and the contributions are invested. The size of the contributions is set at an amount that is expected to
earn enough investment returns to meet the obligation to pay the post-employment benefits. If, however, it
becomes apparent that the assets in the fund are insufficient, the employer will be required to make additional
contributions into the plan to make up the expected shortfall. On the other hand, if the fund's assets appear
to be larger than they need to be, and in excess of what is required to pay the post-employment benefits, the
employer may be allowed to take a 'contribution holiday' (ie stop paying in contributions for a while).
The main difference between the two types of plans lies in who bears the risk: if the employer bears the risk,
even in a small way by guaranteeing or specifying the return, the plan is a defined benefit plan. A defined
contribution scheme must give a benefit formula based solely on the amount of the contributions.
A defined benefit scheme may be created even if there is no legal obligation, if an employer has a practice of
guaranteeing the benefits payable. The A scheme is a defined benefit scheme. The employer, guarantees a
pension based on the service lives of the employees in the scheme. The company's liability is not limited to the
amount of the contributions. This means that the employer bears the investment risk: if the return on the
investment is not sufficient to meet the liabilities, the company will need to make good the difference.
(b)
Plan A
Extracts - SOFP
Rs. million
Non-current liabilities
Net defined benefit liability 15
Extracts – SOCI
Rs. million
Employee cost (20.50)
Other comprehensive income:
Remeasurement loss (1.50)
Extracts – Notes
Amounts recognized in SOFP
Rs. million
PV of defined benefit obligation 240
Fair value of plan assets (225)
Net defined benefit liability 15
Solution No. 6
Extracts - SOFP
Rs. million
Non-current liabilities
Net defined benefit liability 213
Extracts – SOCI
Rs. million
Employee cost (179)
Other comprehensive income:
Remeasurement gain 46
Extracts – Notes
Amounts recognized in SOFP
Rs. million
PV of defined benefit obligation 3,375
Fair value of plan assets [3,170 – 8] (3,162)
Net defined benefit liability 213
Question 5 [Jun-11]
Galaxy Textiles Limited (GTL) operates a funded gratuity scheme for all its employees. Contributions to the
scheme are made on the basis of annual actuarial valuation. The following relevant information has been
extracted from the actuarial report pertaining to the year ended March 31, 2011.
Rs. million
Present value of defined benefit obligation:
- April 1, 2010 133
- March 31, 2011 166
Fair value of plan assets:
- April 1, 2010 114
- March 31, 2011 120
Benefits paid by the plan to employees 6
Current service cost 15
Interest cost on DBO 16
Interest income on plan assets 14
Required:
Prepare a note on retirement benefits for presentation in the financial statements for the year ended March
31, 2011 in accordance with International Financial Reporting Standards. (14)
Question 5 [Dec-12]
Lion Engineering Limited (LEL) operates an approved pension scheme (defined benefit plan) for all its
permanent employees who have completed one year’s service. The details for the year ended 30 June 2012
relating to the pension scheme are as follows:
Rs. million
Present value of pension scheme obligation at June 30, 2011 100
Fair value of scheme’s assets at June 30, 2011 70
Current service cost 29
Contributions made during the year 30
Benefits paid during the year 45
Present value of pension scheme obligation at June 30, 2012 110
Fair value of scheme’s assets at June 30, 2012 80
Additional information:
(i) With effect from 1 July 2011, LEL had amended the scheme whereby the employees’ pension entitlement
had been increased. The benefits would become vested after three years. According to actuarial valuation
the present value of the cost of additional benefits at 1 July 2011 was Rs. 15 million.
(ii) The relevant discount rate was 13%.
(iii) LEL was required to pay Rs. 40 million to the scheme, during the year ended 30 June 2012. Because of cash
flow constraints, LEL was able to contribute Rs. 30 million only.
Required:
Prepare the relevant extracts from the statement of financial position and the related notes to the financial
statements for the year ended 30 June 2012. Show all necessary workings.
(Accounting policy note is not required. Deferred tax may be ignored) (18)
2014 2013
Discount rate 9% 8%
-------- Rs. million ------
Present value of obligation at year end 2,040 2,300
Fair value of plan assets at year end 1,784 2,150
Current service cost 125 143
Benefits paid during the year 99 110
Contributions made during the year 105 118
Additional information:
• Present value of pension obligation and fair value of plan assets as on 1 January 2013 were Rs. 2,050 million
and Rs. 1,995 million respectively.
• During the year 2013, TL amended the scheme whereby the benefits available under the plan had been
increased. It resulted in an increase in the present value of the defined benefit pension obligation by Rs.
13 million.
• On 31 December 2014, TL sold a business segment to Sachai Limited (SL). Accordingly, TL transferred the
relevant component of its pension fund to SL. The present value of the defined benefit pension obligation
transferred was Rs. 280 million and the fair value of plan assets transferred was Rs. 240 million. TL also
made a cash payment of Rs. 20 million to SL in respect of the plan.
Required:
(a) Prepare relevant extracts to be reflected in the statement of financial position, statement of
comprehensive income and notes to the financial statements for the year ended 31 December 2014 in
accordance with International Financial Reporting Standards. (Show comparative figures) (11)
(b) Prepare entries to record the pension obligation:
- on sale of business segment to SL
- at the year-end. (03)
Question 2 [Jun-16]
Mehran Industries Limited (MIL) operates a funded gratuity scheme for all employees. The following relevant
information has been extracted from the actuarial reports/records for the year ended 31 December 2015:
2015 2014
Discount rate 9% 8%
-------- Rs. million ------
Present value of obligation at year end 482 438
Fair value of plan assets at year end 491 449
Current service cost 19 15
Benefits paid during the year 23 16
Contributions made during the year 37 21
Additional information:
(i) Present value of defined benefit obligations and fair value of plan assets as on 1 January 2014 were Rs. 380
million and Rs. 351 million respectively.
(ii) On 28 December 2014, MIL sold one of its divisions and transferred the relevant portion of defined benefit
plan to the buyer. The present value of defined benefit obligation and plan assets transferred was Rs. 21
million and Rs. 19 million respectively.
(iii) On 1 January 2015, MIL changed the terms of the scheme for employees who had completed 4 years of
service. As a result, present value of defined benefit obligation increased by Rs. 30 million.
(iv) Based on the advice received from the actuary, the contribution for the year 2016 will be Rs. 23 million.
(v) The plan assets comprise of 65% debt securities (2014: 66%), 15% mutual fund units (2014: 10%), 10%
equity (2014: 14%) and the balance in bank deposits.
Required:
Prepare relevant extracts to be reflected in the statement of financial position, statement of comprehensive
income and notes to the financial statements for the year ended 31 December 2015 in accordance with
International Financial Reporting Standards. (Show comparative figures) (11)
Extracts – Notes
5 – Defined benefit liability
5.1 Amounts recognized in SOFP
Rs. million
PV of defined benefit obligation 110
Extracts – SOCI
2014 2013
Rs. million
Employee cost (118) (160)
Extracts – Notes
5 – Defined benefit liability
5.1 Amounts recognized in SOFP
2014 2013
Rs. million
PV of defined benefit obligation 2,040 2,300
Fair value of plan assets 1,784 2,150
Net defined benefit liability 256 150
5.7 Settlement
During 2014, the company sells one of its business segments and transfers the relevant part of the pension
plan to the purchaser. This is a settlement. The overall gain on settlement is calculated as follows:
Rs. million
PV of benefit obligation 280
FV of plan assets (240)
Cash (20)
Gain on settlement 20
Extracts – SOFP
2015 2014
Rs. million
Non-current assets:
Net defined benefit asset (Note – 5) 9 11
Extracts – SOCI
2015 2014
Rs. million
Employee cost 50.71 15.23
Other comprehensive income:
Remeasurement gain [24.12 – 12.41] [83.92 – 49.60] 11.71 34.32
Extracts – Notes
5 – Defined benefit asset
5.1 Amounts recognized in SOFP
2015 2014
Rs. million
PV of defined benefit obligation 482 438
Fair value of plan assets 491 449
Net defined benefit asset 9 11
SCOPE
IMPORTANT DEFINITIONS
Investment property is property (land or a building or part of a building or both) held (by the owner or by
the lessee as a right-of-use asset) to earn rentals or for capital appreciation or both, rather than for:
(a) use in the production or supply of goods or services or for administrative purposes; or
(b) sale in the ordinary course of business.
Owner‑occupied property is property held (by the owner or by the lessee as a right-of-use asset) for use
in the production or supply of goods or services or for administrative purposes.
Important difference:
Investment property is held to earn rentals or for capital appreciation or both. Therefore, an investment
property generates cash flows largely independently of the other assets held by an entity. This
distinguishes investment property from owner‑occupied property. The production or supply of goods
or services (or the use of property for administrative purposes) generates cash flows that are
attributable not only to property, but also to other assets used in the production or supply process.
CLASSIFICATION OF PROPERTY
(b) land held for a currently undetermined future use. (If an entity has not determined that it will use the
land as owner‑occupied property or for short‑term sale in the ordinary course of business, the land is
regarded as held for capital appreciation.)
(c) a building owned by the entity (or a right-of-use asset relating to a building held by the entity) and
leased out under one or more operating leases.
(d) a building that is vacant but is held to be leased out under one or more operating leases.
(e) property that is being constructed or developed for future use as investment property.
(d) property held for future development and subsequent use as owner‑occupied property
(e) property occupied by employees (whether or not the employees pay rent at market rates)
Composite properties
1. If a property comprises of two portions; one is held to earn rentals or for capital appreciation and
other is held as owner occupied:
Portions can be sold or leased out under a Portions cannot be sold or leased out under a
finance lease separately: finance lease:
If services are insignificant to the arrangement If services are significant to the arrangement as
as a whole: a whole:
Subjectivity involved:
It may be difficult to determine whether ancillary services are so significant that a property does
not qualify as investment property. For example, the owner of a hotel sometimes transfers some
responsibilities to third parties under a management contract. The terms of such contracts vary
widely. At one end of the spectrum, the owner’s position may, in substance, be that of a passive
investor (i.e. investment property). At the other end of the spectrum, the owner may simply have
outsourced day‑to‑day functions while retaining significant exposure to variation in the cash flows
generated by the operations of the hotel (i.e. owner-occupied property).
RECOGNITION
An owned investment property shall be recognised as an asset when, and only when:
(a) it is probable that the future economic benefits that are associated with the investment property will
flow to the entity; and
(b) the cost of the investment property can be measured reliably.
MEASUREMENT – Initial
An owned investment property shall be measured initially at its cost. Transaction costs shall be included
in the initial measurement.
[Components of cost are same as earlier studied for property, plant and equipment IAS 16]
MEASUREMENT – Subsequent
An entity shall choose as its accounting policy either the fair value model or cost model and shall apply
that policy to all of its investment properties.
2. When a lessee uses the fair value model to measure an investment property that is held as right-of-
use asset, it shall measure the right-of-use asset, and not the underlying property, at fair value.
3. Any gain or loss from change in fair value shall be recognized in profit or loss for the period. No
depreciation is charged.
4. In determining the carrying amount of investment property under the fair value model, an entity does
not double‑count assets or liabilities that are recognised as separate assets or liabilities. For example:
(a) equipment such as lifts or air‑conditioning is often an integral part of a building and is generally
included in the fair value of the investment property, rather than recognised separately as
property, plant and equipment.
(b) if an office is leased on a furnished basis, the fair value of the office generally includes the fair
value of the furniture, because the rental income relates to the furnished office. When furniture
is included in the fair value of investment property, an entity does not recognise that furniture as
a separate asset.
(c) the fair value of investment property excludes prepaid or accrued operating lease income,
because the entity recognises it as a separate liability or asset.
(d) the fair value of investment property held by a lessee as a right-of-use asset reflects expected
cash flows (including variable lease payments that are expected to become payable). Accordingly,
if a valuation obtained for a property is net of all payments expected to be made, it will be
necessary to add back any recognised lease liability, to arrive at the carrying amount of the
investment property using the fair value model.
Exception:
• If there is clear evidence at initial recognition of investment property, that the fair value of an
investment property is not reliably measurable on a continuing basis, the entity shall measure that
investment property using cost model and continue to apply cost model until disposal of the
property. The residual value shall be assumed to be zero.
• If any entity determines that the fair value of an investment property under construction is not
reliably measurable but expects the fair value to be reliably measurable when construction is
complete, it shall measure that property under construction at cost until the earlier of:
When its fair value becomes reliably measurable; or
When its construction is completed.
Cost model
It is same as studied in IAS 16, IFRS 5 or IFRS 16 whichever is applicable.
TRANSFERS
An entity shall transfer a property to, or from, investment property when, and only when, there is a change
in use. A change in use occurs when the property meets, or ceases to meet, the definition of investment
property and there is evidence of the change in use.
In isolation, a change in management’s intentions for the use of a property does not provide evidence of
a change in use.
(b) commencement of development with a view to sale [transfer from investment property to
inventories];
(c) end of owner‑occupation [transfer from owner‑occupied property to investment property]; and
(d) inception of an operating lease to another party [transfer from inventories to investment property].
Transfer out
Transfer in
DERECOGNITION
PRACTICE QUESTIONS
QUESTION NO. 1
Bilal Developers (BD) wishes to create a credible investment property portfolio with a view to determining if any property
may be considered surplus to the functional objectives. The following portfolio of property is owned by BD:
(a) BD owns several plots of land. Some of the land is owned by BD for capital appreciation and this may be sold at
any time in the future. Other plots of land have no current purpose as BD has not determined whether it will use
the land to provide services such as those provided by national parks or for short-term sale in the ordinary course
of operations.
(b) BD supplements it income by buying and selling properties. The housing department regularly sells part of its
housing inventory in the ordinary course of its operations as a result of changing demographics. Part of the
inventory, which is not held for sale, is to provide housing to low-income employees at below market rental. The
rent paid by employees covers the cost of maintenance of the property.
Required:
Discuss how above properties should be accounted for in financial statements of BD.
QUESTION NO. 2
Briefly discuss, with reasons, whether following properties may be classified as investment properties or not:
(a) An entity rents out a building it owns to independent third parties under operating leases.
(b) An entity owns a building it rents out to an independent third party (the lessee) under an operating lease. The
lessee operates a hotel from the building and provides a range of services commonly provided by such hotels.
The entity does not provide any services to the hotel guests and its rental income is unaffected by the number
of guests that occupy the hotel.
(c) An entity acquired a tract of land to divide it into smaller plots to be sold in the ordinary course of business at an
expected 40% profit margin. No rentals are expected to be generated from the land.
(d) An entity owns a building that it rents out to independent third parties under operating leases. The entity
provides cleaning, security and maintenance services for the lessees of the building. To do this, the entity’s
building administration and maintenance staff occupies a part of the building that measures less than 1% of the
floor area of the building.
(e) An entity owns a two-storey building. Floor 1 is rented out to independent third parties under operating leases.
Floor 2 is occupied by the entity’s administration and maintenance staff. The entity can measure reliably the fair
value of each floor of the building without undue cost or effort.
QUESTION NO. 3
Briefly discuss, with reasons, whether following properties may be classified as investment properties or not:
(i) An entity rents out a building it owns to independent third parties under operating leases. The entity provides
cleaning, security and maintenance services for the lessees of the building.
(ii) An entity acquired a tract of land as a long-term investment because it expects its value to increase over
time. No rentals are expected to be generated from the land in the foreseeable future.
(iii) An entity owns a building which it operates as a hotel (i.e. it rents out rooms to independent third parties in
return for payments). The entity provides hotel guests with a range of services commonly provided by hotels.
Some of the services are included in the room daily rate (e.g. breakfast and television); other services are charged
for separately (e.g. other meals, minibars, and guided tours of the surrounding area).
(iv) An entity owns a building it rents out to independent third parties under operating leases. The entity’s building
administration and maintenance staff occupies 25% of the building’s floor area.
QUESTION NO. 4
Alpha Limited (AL) owns following two properties:
Property X
An office building owned by AL was purchased on January 01, 2011 for Rs. 12 million. This building is mainly used for
administrative activities of AL. Total estimated useful life of building was 20 years. This building had a fair value of Rs. 8.8
million on January 1, 2015. On January 1, 2018 its fair value as determined at Rs. 8.32 million. There has been no change
in estimate of useful life.
Property Y
Another building owned by AL was purchased on July 1, 2017 for Rs. 8 million. This building was purchased for the
objective of earning rentals. However it could be rented out on July 1, 2018. It had a fair value of Rs. 8.5 million on
December 31, 2017 which was increased to Rs. 9.4 million on December 31, 2018. Estimated useful life of this building
was 15 years.
AL follows revaluation model for property, plant and equipment and fair value model for investment properties.
Required:
Prepare journal entries for the year ending December 31, 2018.
QUESTION NO. 5
Quality Limited (QL) owns following two properties:
Property A
An office building used by QL for administrative purposes has a depreciated historical cost of Rs.2 million. At July 1, 2018
it had a remaining life of 20 years. After a reorganisation on January 1, 2019, the property was let to a third party and
reclassified as an investment property applying QL’s policy of the fair value model. An independent valuer assessed the
property to have a fair value of Rs. 2.3 million at January 1, 2019, which had risen to Rs. 2.5 million at June 30, 2019.
Property B
Another office building has been rented out to a tenant. At June 30, 2018, it had a fair value of Rs. 1.5 million which had
risen to Rs. 1.65 million at June 30, 2019.
Required:
Prepare extracts of statement of comprehensive income and statement of financial position for the year ended June 30,
2019.
QUESTION NO. 6
Beta Limited (BL) is engaged in buying and selling of properties as well as renting out of properties. BL had many properties
classified as investment properties. It follows fair value model for its investment properties. On July 1, 2018 BL changed
use of following two properties:
Property M
Property M was purchased some years ago for Rs. 5 million with the intention of letting it out. It was given on rent for
many years. On December 31, 2017 it was updated to a fair value of Rs. 6.2 million. On July 1, 2018, the tenant vacated
the building and BL decided to sell it in ordinary course of business. The fair value of building on July 1, 2018 was Rs. 6.5
million.
Property N
Property N was purchased 5 years ago for Rs. 7 million. It was given on operating lease to a lessee since then. On July 1,
2018 it was vacated by the tenant and BL decided to use it as administration office. This building was updated to a fair
value of Rs. 5.5 million on December 31, 2017. On July 1, 2018 its fair value was Rs. 5.3 million.
Required:
Prepare journal entries for the transfers on July 1, 2018.
QUESTION NO. 7
Gee Investment Company Limited (GICL) acquires properties and develops them for diversified purposes, i.e. resale,
leasing and its own use. GICL applies the fair value model for investment properties and cost model for property, plant
and equipment. The details of the buildings owned are as follows:
Residual Fair value as on Dec. 31
Property Acquisition Life (years) Cost value 2020 2019
date --------------------------- Rs. million -------------------------
A 01-08-15 20 130 14 100 150
B 01-01-18 15 240 24 240 210
C 01-07-18 10 160 20 150 120
D 01-07-17 10 10 - N/A N/A
E 01-08-20 20 48 4 51 -
Rs. million
Purchase price 42.50
Agent’s commission 0.50
Registration fees and taxes 2.00
Administrative costs allocated 3.00
48.00
Required:
Prepare a note on investment property, for inclusion in GICL’s separate financial statements for the year ended 31
December 2020. (Ignore comparative figures)
SOLUTIONS
SOLUTION TO QUESTION NO.1
(a) The land that is owned by BD for capital appreciation which may be sold at any time in the future and
the land that has no current purpose are both considered to be investment property under IAS 40. If
the land has no current purpose, it is considered to be held for capital appreciation.
(b) BD supplements its income by buying and selling property, and the housing department regularly sells
part of its housing inventory. As these sales are in the ordinary course of its operations and are
routinely occurring, then the housing stock held for sale will be classified as inventory.
The part of the inventory held to provide housing to low-income employees at below market rental
will not be treated as investment property as the property is not held for capital appreciation and the
income just covers the cost of maintaining the properties and thus is not for profit. The property is
held to provide housing services rather than rentals. The rental revenue is incidental to the purposes
for which the property is held. This property will be accounted for under IAS 16 Property, Plant and
Equipment. The property is treated as owner occupied as set out above.
W-1
NBV Surplus P&L
01-01-11 Cost 12,000
31-12-11/14 Dep. [12m x 4/20] (2,400)
9,600 - -
01-01-15 Reval. (800) - (800)
8,800 - (800)
31-12-15/17 Dep. [8.8m x 3/16] (1,650) 150
7,150 - (650)
01-01-18 Reval. 1,170 520 650
8,320 520 -
31-12-18 Dep. [8.32m / 13] (640) (40) -
7,680 480 -
Property Y
Date Particulars Dr. (Rs.) Cr. (Rs.)
31-12-18 Investment property [9.4m – 8.5m] 900,000
P&L 900,000
[FV gain on investment property for 2018]
Extracts - SOCI
Rs.’000’
Depreciation [2m/20 x 6/12] 50.00
Fair value gain on investment property (W-1) 350.00
Other comprehensive income
Revaluation gain [2.3m – (2m – 0.05m)] 350.00
Extracts - SOFP
Rs.’000’
Non-current assets
Investment property [2.5m + 1.65m] 4,150.00
Equity
Revaluation surplus 350.00
W-1
Rs.’000’
FV gain on Property A [2.5m – 2.3m] 200.00
FV gain on Property B [1.65m – 1.5m] 150.00
350.00
Property M
Date Particulars Dr. (Rs.) Cr. (Rs.)
01-07-18 Investment property (M) [6.5m – 6.2m] 300,000
P&L 300,000
[Fair value gain at the date of transfer]
01-07-18 Inventory 6,500,000
Investment property (M) 6,500,000
[Investment property reclassified as inventory]
Property N
Date Particulars Dr. (Rs.) Cr. (Rs.)
01-07-18 P&L 200,000
Investment property (N) [5.5m – 5.3m] 200,000
[Fair value loss at the date of transfer]
01-07-18 Admin Building (PPE) 5,300,000
Investment property (N) 5,300,000
[Investment property reclassified as PPE]
5 - Investment property
5.1 Investment property carried at cost model
Rs. million
Cost
Balance as at 01-01-20 10.00
Addition -
Disposal -
Balance as at 31-12-20 10.00
Accumulated depreciation
Balance as at 01-01-20 (W-1) 2.50
Charge for the year (W-1) 1.00
Disposal
Balance as at 31-12-20 3.50
Property D is carried at cost because it is situated outside the main city and its fair value can
not be determined.
WORKINGS
W-1 Rs. million
Annual depreciation [10/10] 1.00
W-2
Property E
Total purchase cost 48.00
Allocated administrative costs (3.00)
Cost of property 45.00
W-3
Property A [120 - 100] (20.00)
Property C [150 - 120] 30.00
Property E [51 x 2/3 - 30] 4.00
14.00
Since Property B was transferred out of IAS 40, it is not included in investment property
BACKGROUND
IAS 19 limits the measurement of a net defined benefit asset to the lower of the surplus in the defined
benefit plan and the asset ceiling. Asset ceiling is defined as ‘the present value of any economic benefits
available in the form of refunds from the plan or reductions in future contributions to the plan’.
Questions have arisen about when refunds or reductions in future contributions should be regarded as
available, particularly when a Minimum Funding Requirement (MFR) exists. MFRs exist in many countries
to improve the security of the post-employment benefit promise made to members of an employee
benefit plan. Such requirements normally stipulate a minimum amount or level of contributions that must
be made to a plan over a given period. Therefore, an MFR may limit the ability of the entity to reduce
future contributions.
ISSUES
An entity shall determine the availability of a refund or a reduction in future contributions in accordance
with the terms and conditions of the plan and any statutory requirements in the jurisdiction of the plan.
An economic benefit, in the form of a refund or a reduction in future contributions, is available if the entity
can realize it at some point during the life of the plan or when the plan liabilities are settled. An entity
shall determine the maximum economic benefit that is available from refunds, reduction in future
contributions or a combination of both.
2. If the amount of a refund is determined as the full amount or a proportion of the surplus, rather than
a fixed amount, an entity shall make no adjustment for the time value of money, even if the refund is
realizable only at a future date.
If there is an MFR relating to future service, the economic benefit available as a reduction in future
contributions is the sum of:
(b) Estimated future service cost for each period over the shorter of the expected life of the plan and the
expected life of the entity less MFR contributions required for future service ignoring prepayment in
(a) above.
Limit for (b)
While discounting the amounts in (b), if the MFR contributions required for future service exceed
the future service cost in any year, then it will be taken as a negative for discounting purpose.
However, the total present value of (b) can never be less than zero.
If an entity has an obligation under an MFR to pay contributions to cover an existing shortfall on the
minimum funding basis in respect of past service, then:
(a) If MFR contributions payable will be available as a refund or reduction in future contributions after
payment
No liability shall be recognized. (in simple words no accounting needed for this obligation)
(b) If MFR contributions payable will NOT be available as a refund or reduction in future contributions
after payment
To the extent that the contributions payable will not be available after they are paid into the plan, the
entity shall recognize a liability when the obligation arises.
Exam note:
- If there is existing plan surplus
Find asset ceiling adjustment for existing surplus separately and determine liability for MFR
contribution separately. Then combine both adjustments to determine final net adjustment.
- If there is existing plan deficit
First find updated plan balance after making MFR contribution (only for the purpose of
working), then determine liability adjustment on that updated balance.
PRACTICE QUESTIONS
Question 1
ABC Limited operates a funded defined benefit plan for its employees. The plan provides a pension of 1% of
the final salary for each year of service. The cost for the year is determined using the projected unit credit
method. This reflects service rendered to the dates of valuation of the plan and incorporates actuarial
assumptions primarily regarding discount rates, which are based on the market yields of high quality corporate
bonds.
Following information is available in respect of the benefit plan:
2020 2019 2018
------------ Rs. million ------------
Fair value of plan assets 1,970 1,700 1,500
PV of defined benefit obligation 1,766 1,510 1,300
PV of economic benefits available (Asset ceiling) 220 180 170
Current service cost 280 250 210
Contributions 160 120 100
Benefits paid 190 150 140
Discount rate 10% 10% 10%
Required:
Prepare extracts of SOFP and SOCI for the year 2020 (also show comparative figures for 2019).
Question 2
XYZ Limited operates a funded defined benefit plan for its employees. As per the terms and conditions of the
plan, any surplus in plan can be refunded only after following deductions:
• 5% for professional costs.
• 3% local govt. tax
• 10% income tax
The present value of defined benefit plan and fair value of plan assets as determined at June 30, 2020 were Rs.
1,500 million and Rs. 1,700 million respectively.
Required:
Determine the amount of net defined liability/asset to be included in statement of financial position as at June
30, 2020.
Question 3
MNO Limited has a defined benefit plan. The MFR requires it to pay contributions to cover the future service
cost. The future service cost and related MFR contribution required as follows:
The present value of defined benefit plan and fair value of plan assets as determined at June 30, 2020 were Rs.
1,520 million and Rs. 1,600 million (including prepayment of Rs. 20 million in respect of above MFR
contributions) respectively. Any surplus in plan cannot be refunded to the entity under any circumstances but
can be used for reductions of future contributions.
Appropriate discount rate is 7%.
Required:
Determine the amount of net defined liability/asset to be included in statement of financial position as at June
30, 2020.
Question 4
AB Limited has a funding level on the MFR basis of 80% in a benefit plan. Under the MFR, it is required to
increase the funding level to 95% immediately. As a result, it has an obligation to contribute Rs. 50 million to
the plan to cover shortfall in respect of past service. The plan rules permit a full refund of any surplus to the
entity at the end of the life of the plan.
The present value of defined benefit plan and fair value of plan assets as determined at June 30, 2020 were Rs.
1,500 million and Rs. 1,600 million respectively.
Required:
Discussing the effect of MFR contribution required, determine the amount of net defined liability/asset to be
included in statement of financial position as at June 30, 2020.
Question 5
XY Limited has a funding level on the MFR basis of 75% in a benefit plan. Under the MFR, it is required to
increase the funding level to 100% immediately. As a result, it has an obligation to contribute Rs. 300 million
to the plan to cover shortfall in respect of past service. The plan rules permit a maximum refund of 70% of any
surplus to the entity at the end of the life of the plan.
The present value of defined benefit plan and fair value of plan assets as determined at June 30, 2020 were Rs.
1,500 million and Rs. 1,600 million respectively.
Required:
Discussing the effect of MFR contribution required, determine the amount of net defined liability/asset to be
included in statement of financial position as at June 30, 2020.
Question 6
MNO Limited has a funding level on the MFR basis of 77% in a benefit plan. Under the MFR, it is required to
increase the funding level to 100% immediately. As a result, it has an obligation to contribute Rs. 300 million
to the plan to cover shortfall in respect of past service. The plan rules permit a maximum refund of 60% of any
surplus to the entity at the end of the life of the plan.
The present value of defined benefit plan and fair value of plan assets as determined at June 30, 2020 were Rs.
1,600 million and Rs. 1,500 million respectively.
Required:
Discussing the effect of MFR contribution required, determine the amount of net defined liability/asset to be
included in statement of financial position as at June 30, 2020.
Question 7
PQR Limited has a funding level on the MFR basis of 95% in a benefit plan. Under the MFR, it is required to
increase the funding level to 100% over the next 3 years. The contributions are required to cover past service
as well as future service. The plan rules do not permit any refund of any surplus to the entity at the end of the
life of the plan however can be used for reductions of future contributions.
On June 30, 2020:
- The present value of MFR contributions required for past service is approximately Rs. 300 million.
- The present value of economic benefits available as a future contribution reduction (i.e. future service cost
net of MFR contributions required) is approximately Rs. 80 million.
- The present value of defined benefit plan is Rs. 1,200 million
- Fair value of plan assets is Rs. 1,300 million.
Required:
Discussing the effect of MFR contribution required, determine the amount of net defined liability/asset to be
included in statement of financial position as at June 30, 2020.
SOLUTIONS
Solution No. 1
2020 2019
Extracts - SOFP ------ Rs. million ------
Net defined benefit asset (W-1) 204 180
Extracts – SOCI
Employee cost (W-2) (W-3) (W-4) (262) (233)
[280 + 151 + 1 – 170] [250 + 130 + 3 – 150]
Other comprehensive income:
Remeasurement gain on benefit plan (W-5) 156 83
2020 2019
W-2 Reconciliation of PV of DBO ------ Rs. million ------
Opening balance 1,510 1,300
Interest 151 130
Current service cost 280 250
Benefits paid (190) (150)
Actuarial (gain)/loss 15 (20)
Closing balance 1,766 1,510
W-5 Remeasurement
Actuarial gain /(loss) (15) 20
Asset ceiling adjustment 11 23
Return on plan assets 130 80
126 123
Solution No. 2
Rs. million
Fair value of plan assets 1,700
PV of DBO 1,500
Surplus in plan 200
Solution No. 3
Rs. million
Fair value of plan assets 1,600.00
PV of defined benefit obligation 1,520.00
Surplus 80.00
W-1
Future MFR Contribution
Year
service cost contributions reduction
----------- Rs. million -----------
2021 15.00 17.00 (2.00)
2022 15.00 15.00 -
2023 15.00 12.00 3.00
2024 15.00 11.00 4.00
onwards
Rs. million
PV of future service cost less MFR 47.23
[-2 x 1.07-1 + 0 x 1.07-2 + 3 x 1.07-3 + 4 x 0.07-1 x 1.07-3]
Solution No. 4
IFRIC 14 requires the entity to recognize a liability to the extent that the contributions payable are not fully
available. Payment of the contributions of Rs. 50 million will increase the IAS 19 surplus from Rs. 100 million
to Rs. 150 million. Under the rules of the plan this amount will be fully refundable to the entity with no
associated costs. Therefore, no liability is recognized for the obligation to pay the contributions and the net
defined benefit asset will be presented in SOFP at Rs. 100 million.
Solution No. 5
The payment of Rs. 300 million would increase the IAS 19 surplus of Rs. 100 million to Rs. 400 million. Of this
Rs. 400, 70% (Rs. 280 million) is refundable. The remaining Rs. 120 million (30% of Rs. 400 million) of the
contributions paid is not available to the entity. IFRIC 14 requires the entity to recognize a liability to the extent
that the additional contributions payable are not available to it. Therefore, existing surplus of Rs. 100 million
will be reduced to its asset ceiling of Rs. 70 million and additional liability will be recorded for Rs. 90 million
(30% of Rs. 300 million). As a result the net defined benefit liability recognized in SOFP is Rs. 20 million. On
payment of MFR contribution of Rs. 300 million, it will be converted into net defined benefit asset of Rs. 280
million.
Summary:
Rs. million
Fair value of plan assets 1,600.00
PV of defined benefit obligation 1,500.00
Surplus 100.00
Asset ceiling adjustment(W-1) (120.00)
Net defined benefit liability (20.00)
W-1
Reduction of existing surplus [Rs. 100m x 30%] (30)
Additional liability for additional contributions (90)
(120)
Solution No. 6
The payment of Rs. 300 million would change the IAS 19 deficit of Rs. 100 to a surplus of Rs. 200 million. Of
this Rs. 200 million, 60% (Rs. 120 million) is refundable. The remaining Rs. 80 million (40% of Rs. 200 million)
of the contributions paid is not available to the entity. IFRIC 14 requires the entity to recognize a liability to the
extent that the additional contributions payable are not available to it. Therefore, the net defined benefit
liability is Rs. 180 million, comprising the deficit of Rs. 100 million plus the additional liability of Rs. 80 million.
On payment of MFR contribution of Rs. 300 million, it will be converted into net defined benefit asset of Rs.
120 million.
Summary:
Rs. million
Fair value of plan assets 1,500.00
PV of defined benefit obligation 1,600.00
Deficit (100.00)
Additional liability [200 x 40%] (80.00)
Net defined benefit liability (180.00)
Solution No. 7
Current surplus of Rs. 100 million can not be refunded however it can be used for future reduction in future
contributions. Only Rs. 80 million is available as economic benefit in form of reduction in future contributions,
thus it will be reduced by Rs. 20 million. Moreover, additional liability of Rs. 300 million will be recognized for
MFR in respect of past service as no refund is available.
Summary:
Rs. million
Fair value of plan assets 1,300.00
PV of defined benefit obligation 1,200.00
Surplus 100.00
W-1
Reduction of existing surplus [Rs. 100m - Rs. 80m] (20)
Additional liability for additional contributions (300)
(320)
SCOPE
1. This standard shall be applied in accounting for all share-based payment transactions, including:
(i) Equity-settled share-based payment transactions.
(ii) Cash-settled share-based payment transactions.
(iii) Transactions with options for settlement in cash or equity instruments.
Group entities:
This IFRS also applies when goods and services are received by one entity and another entity in
the same group has an obligation to settle a share-based payment transaction.
(b) equity instruments (including shares or share options) of the entity or another group entity,
(b) incurs an obligation to settle the transaction with the supplier in a share-based payment arrangement
when another group entity receives those goods or services.
RECOGNITION – General
When an entity obtains the goods or receive the services, it shall recognize the transaction:
Exam note:
IFRS 2 does not specifically mention which equity account is credited. It is better to use a separate
account e.g. “equity instruments granted” unless shares or share options are eventually issued.
Overview of measurement
An entity shall measure the goods or services received and the corresponding increase in equity at the
fair value of:
If fair value of goods or services received can be If fair value of goods or services cannot be
measured reliably: measured reliably (e.g. employee service)
Fair value
The amount for which an asset could be exchanged, a liability settled, or an equity instrument granted
could be exchanged, between knowledgeable, willing parties in an arm’s length transaction.
(It is different from IFRS 13)
Grant date
The date at which the entity and another party (including an employee) agree to a share-based
payment arrangement. If that agreement is subject to an approval process (for example, by
shareholders), grant date is the date when that approval is obtained.
received and no service conditions were imposed. Therefore, the identifiable consideration (nil) is less
than the fair value of the equity instruments granted (Rs. 100,000).
Application of requirements
Although the entity cannot identify the specific goods or services received, the circumstances indicate
that goods or services have been (or will be) received, and therefore IFRS 2 applies. In this situation,
because the entity cannot identify the specific goods or services received, the rebuttable presumption
in paragraph 13 of IFRS 2, that the fair value of the goods or services received can be estimated reliably,
does not apply. The entity should instead measure the goods or services received by reference to the
fair value of the equity instruments granted.
Case I – If the equity instruments granted vests immediately [i.e. no vesting conditions]
In the absence of evidence to the contrary, the entity shall presume that services rendered by the
counterparty as consideration for the equity instruments have been received. In this case, on grant date
the entity shall recognize the services received in full, with a corresponding increase in equity.
Performance condition
A vesting condition that requires:
(a) the counterparty to complete a specified period of service (ie a service condition); the service
requirement can be explicit or implicit; and
(b) specified performance target(s) to be met while the counterparty is rendering the service required
in (a) [e.g. share price growth or profits growth of the entity or its group member]. The period of
achieving such performance target shall not extend beyond the end of above service period in (a).
The entity shall presume that the services, to be rendered by the counterparty as consideration for those
equity instruments, will be received in the future, during the vesting period.
2. An entity shall estimate the length of the expected vesting period at the grant date, based on
most likely outcome of the performance condition. If performance condition:
Market condition
A performance condition, upon which the exercise price, vesting or exercisability of an equity
instrument depends, that is related to market price of the entity’s equity instruments (or of
group member). For example attaining a specified share price or a specified amount of intrinsic
value of share option or a specified % of total shareholders return.
Exam note:
Discussion about vesting period above can be summarized as follows:
In case of service condition:
Vesting period is the conditional service period agreed.
Measurement date:
It is the date at which fair value of the equity instrument granted is measured. Measurement date:
- If there are other performance conditions as - Instead, these conditions shall be taken into
well, then the entity shall recognize the goods account by adjusting the number of equity
or services when other vesting conditions are instruments included in the measurement of
met, irrespective of whether that market the transaction amount.
condition is satisfied.
- The entity shall recognize the amount of goods
[Treatment of non-vesting conditions are same as or services over the vesting period on the best
above.] available estimate of the number of equity
instruments expected to vest and shall revise
that estimate subsequently, if necessary, so
that ultimately the amount recognized for
goods and services shall be based on the
number of equity instruments that eventually
vest.
Exam note:
Amount is calculated at end of every year (till vesting date) on cumulative basis as follows:
= Best estimate of no. of equity instruments expected to eventually vest x fair value of instrument
granted at measurement date x period till reporting year end ÷ Total vesting period
Here, in case of employees, best estimate of no. of equity instruments can be further split into:
= Number of persons x number of instruments per person
Above calculated amount is considered as closing balance of respective equity account and any change
in balance is:
1. The entity shall measure the equity instruments (i.e. generally share options) initially at measurement
date at intrinsic value. This intrinsic value is remeasured subsequently on every year-end and finally
on the date of settlement (e.g. exercise, forfeiture, lapse). Any changes on this remeasurement are
recognized in P&L.
2. The entity shall recognize the goods or services received based on the number of instruments that are
expected to ultimately vest or ultimately be exercised. The entity shall revise that estimate, if
necessary, if subsequent information indicates that the number of instruments expected to vest
differs from previous estimates. [i.e. same as studied earlier in “treatment of other vesting
conditions”]
3. After vesting date, the entity shall reverse the amount recognized for goods or services received if
the share options are later forfeited, or lapse at the end of the share option’s life.
4. If an entity settles a grant, it shall account for it as an acceleration of vesting and shall therefore
recognize immediately the amount that would otherwise would have been recognized over the
remaining vesting period. Moreover, any payment made to counterparty on settlement of the grant
shall be accounted for:
- Upto the amount of fair value of equity instruments granted measured at cancellation date:
as the repurchase of equity (i.e. deduction from equity)
Modification to the terms and conditions of grant (including cancellations and settlements)
[For example, a downturn in the equity market may mean that the original option exercise price set is no
longer attractive, therefore, the exercise price is reduced (i.e. option is repriced)]
This guidance is relevant for share-based payment transactions with employees as well as transactions
with other parties that are measured at the fair value of the equity instruments granted. This guidance is
technically not necessary when equity instrument granted is measured at intrinsic value.
Examples – reduction in exercise price, increase in equity instruments granted, reduction in vesting
period, reduction in performance condition (other than market condition)
Application of modification:
1. Continue to recognize the original fair value of measurement date of the original equity instruments
granted over the original vesting period. (i.e. same as was done before modification)
2. Any increase in total fair value at the date of modification (either due to increase in fair value or due
to increase in number of equity instruments granted) shall be recognized:
If modification occurs during vesting period If modification occurs after vesting period
Over the remaining period from the Immediately
modification date until the date when the
modified equity instruments vest. OR
If fair value of equity instrument is increased (e.g. by reducing the exercise price)
Rs.
Fair value of instruments measured immediately after modification XXX
Less Fair value of instruments measured immediately before modification (XXX)
Total increase in fair value XXX
3. If the entity modifies the vesting conditions in a manner that is beneficial to the counterparty, the
entity shall consider the modified vesting conditions for “treatment of vesting conditions” as studied
earlier.
Examples – increase in exercise price, decrease in equity instruments granted, increase in vesting period,
addition in performance condition (other than market condition)
Application of modification:
1. If the modification decreases the fair value of equity instruments granted (e.g. due to increase in
exercise price), the entity shall not account for this decrease in fair value rather it shall continue to
recognize the original fair value of measurement date of the original equity instruments granted over
the original vesting period. (i.e. same as was done before modification)
2. If modification reduces the number of equity instruments granted, that reduction shall be accounted
for as a cancellation of that portion of grant, in accordance with Case III below.
3. If the entity modifies the vesting conditions in a manner that is not beneficial to the counterparty, the
entity shall not consider the modified vesting conditions for “treatment of vesting conditions” as
studied earlier.
2. Any payment made to counterparty on settlement of the grant shall be accounted for:
- Upto the amount of fair value of equity instruments granted measured at cancellation date:
as the repurchase of equity (i.e. deduction from equity)
3. If share-based payment arrangement included liability components, the entity shall remeasure
the fair value of the liability at the date of cancellation. Any payment made to settle the liability
component shall be accounted for as a repayment of the liability.
Examples – share appreciation rights, granting shares that are redeemable either mandatorily or at
employee’s option
Measurement
The entity shall measure the goods and services received and the related liability at the fair value of the
liability (i.e. determined using an appropriate valuation model). This fair value of liability is remeasured
subsequently on every year end and finally on the date of settlement. Any changes on this remeasurement
are recognized in P&L.
Recognition
Case I – If the counterparty’s right to receive cash vests immediately [i.e. no vesting conditions]
In the absence of evidence to the contrary, the entity shall presume that services rendered by the
counterparty have been received. In this case, the entity shall recognize the services received in full, with
a corresponding increase in liability.
The entity shall presume that the services to be rendered by the counterparty will be received in the
future, during the expected vesting period.
[Treatment of non-vesting conditions are same as - Instead these conditions shall be taken into
above.] account by adjusting the number of awards
included in the measurement of the
transaction amount.
(b) The liability for cash-settled transaction at modification date shall be derecognized.
(c) Any difference between (a) and (b) is recognized immediately in profit or loss.
If a result of the modification, the vesting period is extended or shortened, then application of (a)
reflects the modified vesting period.
2. If cash-settled transaction is cancelled and equity instruments are granted, which are identified as
replacement, then it shall also be accounted for as (1) above.
SHARE-BASED PAYMENT TRANSACTIONS WITH A NET SETTLEMENT FEATURE FOR WHT OBLIGATIONS
1. Tax laws or regulations may oblige an entity to withhold an amount for an employee’s tax obligation
associated with a share-based payment and transfer that amount, normally in cash, to the tax
authority on the employee’s behalf. To fulfil this obligation, the terms of the share-based payment
arrangement may permit or require the entity to withhold the number of equity instruments equal to
the monetary value of the employee’s tax obligation from the total number of equity instruments that
otherwise would have been issued to the employee upon exercise (or vesting) of the share-based
payment (i.e. the share-based payment arrangement has a ‘net settlement feature’).
2. Since this withholding of shares is to fund the payment to the tax authority in respect of employee’s
tax obligation associated with the transaction, therefore, the payment made shall be accounted for
same as studied in Case III (a) point 2 on page 9 above.
1. Total amounts of equity component and liability component are determined at grant date as follows:
Case II – If the fair value of goods or services cannot be measured [e.g. services of employees]
Rs.
Total value of goods or service [Fair value of share alternative] X
Liability component [Fair value of debt component] (X)
Equity (balancing) X
2. Once total amount is allocated, the “liability component” and “equity component” are accounted for
as studied earlier for “cash-settled share-based payment transactions” and “equity-settled share-
based payment transaction” respectively in relation to goods and service received.
3. At the settlement date, liability component shall be remeasured to its fair value with corresponding
increase/decrease in P&L.
4. If at settlement:
(a) Entity pays in cash rather than issuing equity instruments then:
- Payment is applied to settle the liability in full
- Equity component is transferred to any other reserve (e.g. retained earnings)
(b) Entity issues equity instruments rather than paying cash then:
- Liability shall be transferred to equity as the consideration of the equity instruments issued
PRACTICE QUESTIONS
Question 1 [IG Example 1A]
An entity grants 100 share options to each of its 500 employees. Each grant is conditional upon the employee
working for the entity over the next three years. The entity estimates that the fair value of each share option
is Rs. 15.
On the basis of a weighted average probability, the entity estimates that 20 % of employees will leave during
the three-year period and therefore forfeit their rights to the share options.
Required:
Prepare extracts of SOFP and SOCI for all 3 years and journal entry of issuing share options at end of 3rd year
if:
(a) If everything turns out exactly as expected.
(b) During year 1, 20 employees leave. The entity revises its estimate of total employee departures over the
three-year period from 20 % (100 employees) to 15 % (75 employees). During year 2, a further 22
employees leave. The entity revises its estimate of total employee departures over the three-year period
from 15 % to 12 % (60 employees). During year 3, a further 15 employees leave. Hence, a total of 57
employees forfeited their rights to the share options during the three-year period, and a total of 44,300
share options (443 employees × 100 options per employee) vested at the end of year 3.
By the end of year 1, the entity’s earnings have increased by 14 %, and 30 employees have left. The entity
expects that earnings will continue to increase at a similar rate in year 2, and therefore expects that the shares
will vest at the end of year 2. The entity expects, on the basis of a weighted average probability, that a further
30 employees will leave during year 2, and therefore expects that 440 employees will vest in 100 shares each
at the end of year 2.
By the end of year 2, the entity’s earnings have increased by only 10 % and therefore the shares do not vest at
the end of year 2. 28 employees have left during the year. The entity expects that a further 25 employees will
leave during year 3, and that the entity’s earnings will increase by at least 6 %, thereby achieving the average
of 10 % per year.
By the end of year 3, 23 employees have left and the entity’s earnings have increased by 8 %, resulting in an
average increase of 10.67 % per year. Therefore, 419 employees received 100 shares at the end of year 3.
Required:
Prepare extracts of SOFP and SOCI for all 3 years and journal entry of issue of shares at end of 3rd year (assuming
face value of each share Rs. 10).
15 % each year, each employee will receive 200 share options. If the volume of sales increases by an average
of 15 % or more, each employee will receive 300 share options.
On grant date, Entity A estimates that the share options have a fair value of Rs. 20 per option. Entity A also
estimates that the volume of sales of the product will increase by an average of between 10 % and 15 % per
year, and therefore expects that, for each employee who remains in service until the end of year 3, 200 share
options will vest. The entity also estimates, on the basis of a weighted average probability, that 20 % of
employees will leave before the end of year 3.
By the end of year 1, seven employees have left and the entity still expects that a total of 20 employees will
leave by the end of year 3. Hence, the entity expects that 80 employees will remain in service for the three-
year period. Product sales have increased by 12 % and the entity expects this rate of increase to continue over
the next 2 years.
By the end of year 2, a further five employees have left, bringing the total to 12 to date. The entity now expects
only three more employees will leave during year 3, and therefore expects a total of 15 employees will have
left during the three-year period, and hence 85 employees are expected to remain. Product sales have
increased by 18 %, resulting in an average of 15 % over the two years to date. The entity now expects that sales
will average 15 % or more over the three-year period, and hence expects each sales employee to receive 300
share options at the end of year 3.
By the end of year 3, a further two employees have left. Hence, 14 employees have left during the three-year
period, and 86 employees remain. The entity’s sales have increased by an average of 16 % over the three years.
Therefore, each of the 86 employees receives 300 share options.
Required:
Prepare extracts of SOFP and SOCI for all 3 years.
During year 1, the entity’s earnings increased by 12 %, and the entity expects that earnings will continue to
increase at this rate over the next two years. The entity therefore expects that the earnings target will be
achieved, and hence the share options will have an exercise price of Rs. 30.
During year 2, the entity’s earnings increased by 13 %, and the entity continues to expect that the earnings
target will be achieved.
During year 3, the entity’s earnings increased by only 3 %, and therefore the earnings target was not achieved.
The executive completes three years’ service, and therefore satisfies the service condition. Because the
earnings target was not achieved, the 10,000 vested share options have an exercise price of Rs. 40.
Required:
Prepare extracts of SOFP and SOCI for all 3 years.
of year 3. If the share price is above Rs. 65 at the end of year 3, the share options can be exercised at any time
during the next seven years, i.e. by the end of year 10.
The entity applies a binomial option pricing model, which takes into account the possibility that the share price
will exceed Rs. 65 at the end of year 3 (and hence the share options become exercisable) and the possibility
that the share price will not exceed Rs. 65 at the end of year 3 (and hence the options will be forfeited). It
estimates the fair value of the share options with this market condition to be Rs. 24 per option.
Required:
Prepare extracts of SOFP and SOCI for all 3 years.
6 90 5,000
7 96 9,000
8 105 8,000
9 108 5,000
10 115 2,000
Required:
(a) Journal entries for 1st four years
(b) Also compute following figures to be shown in SOFP (separately under following heads) and SOCI for all 10
years:
o Equity instruments granted
o Share options
o Share capital (assuming Face value of each share is Rs. 10 each)
o Share premium
Suppose that 40 employees leave during year 1. Also suppose that by the end of year 1, the entity’s share price
has dropped, and the entity reprices its share options, and that the repriced share options vest at the end of
year 3. The entity estimates that a further 70 employees will leave during years 2 and 3, and hence the total
expected employee departures over the three-year vesting period is 110 employees.
During year 2, a further 35 employees leave, and the entity estimates that a further 30 employees will leave
during year 3, to bring the total expected employee departures over the three-year vesting period to 105
employees.
During year 3, a total of 28 employees leave, and hence a total of 103 employees ceased employment during
the vesting period. For the remaining 397 employees, the share options vested at the end of year 3. The entity
estimates that, at the date of repricing, the fair value of each of the original share options granted (i.e. before
taking into account the repricing) is Rs. 5 and that the fair value of each repriced share option is Rs. 8.
Required:
Prepare extracts of SOFP and SOCI for all 3 years.
During 2019, 10 employees left and by the end of year, the entity still estimated that only 20 employees would
leave during the 4-year vesting period. During 2020, no employee left and the entity revised its estimate to a
total 15 employees leaving during 4-year vesting period. Financial year ends on every December 31st.
Required:
Prepare extracts of SOFP and SOCI for the years ending December 31, 2019 and 2020 in respect of each of the
following independent situations:
(a) On July 1, 2020 after share price collapsed, the entity reduced the exercise price to accommodate
employees. On the date of modification, fair value of each original share option granted was Rs. 10 and
fair value of each repriced share option granted was Rs. 14.
(b) On July 1, 2020 to further motivate, the entity granted additional 30 share options each without any change
in remaining vesting period. On the date of modification, fair value of each additional share option was Rs.
24.
(c) On July 1, 2020 the entity reduced to vesting period from 4 years to 3 years.
Required:
Show movement in liability for cash-settled share-based payment transaction for all 5 years.
Required:
Show movement in liability for cash-settled share-based payment transaction for all 5 years.
Required:
(a) Journal entries for all 4 years till December 31, 2020.
(b) Prepare extracts of SOFP and SOCI for all 4 years.
Required:
Journal entries for all years till December 31, 2024 (Assume face value of each share is Rs. 10).
Required:
Journalize all transactions over 3 years. (assuming face value of each share Rs. 10).
SOLUTIONS
Solution No. 1
(a)
Extracts – SOFP Year 1 Year 2 Year 3
------------------ Rs. ------------------
Equity 200,000 400,000 600,000
[50,000 x 80% x Rs. 15 x 1/3]
[50,000 x 80% x Rs. 15 x 2/3]
[50,000 x 80% x Rs. 15 x 3/3]
Rs. Rs.
Dr. Equity instrument granted 600,000
Cr. Share options 600,000
(b)
Extracts – SOFP Year 1 Year 2 Year 3
------------------ Rs. ------------------
Equity 212,500 440,000 664,500
[50,000 x 85% x Rs. 15 x 1/3]
[50,000 x 88%x Rs. 15 x 2/3]
[44,300 x Rs. 15 x 3/3]
Rs. Rs.
Dr. Equity instrument granted 664,500
Cr. Share options 664,500
Solution No. 2
Extracts – SOFP Year 1 Year 2 Year 3
------------------ Rs. ------------------
Equity 660,000 834,000 1,257,000
[44,000 x Rs. 30 x 1/2]
[41,700 x Rs. 30 x 2/3]
[41,900 x Rs. 30 x 3/3]
Rs. Rs.
Dr. Equity instrument granted 1,257,000
Cr. Share capital 419,000
Cr. Share premium 838,000
Solution No. 3
Extracts – SOFP Year 1 Year 2 Year 3
------------------ Rs. ------------------
Equity 106,667 340,000 516,000
[80 x 200 x Rs. 20 x 1/3]
[85 x 300 x Rs. 20 x 2/3]
[86 x 300 x Rs. 20 x 3/3]
Solution No. 4
Extracts – SOFP Year 1 Year 2 Year 3
------------------ Rs. ------------------
Equity 53,333 106,667 120,000
[10,000 x Rs. 16 x 1/3]
[10,000 x Rs. 16 x 2/3]
[10,000 x Rs. 12 x 3/3]
Solution No. 5
Extracts – SOFP Year 1 Year 2 Year 3
------------------ Rs. ------------------
Equity 80,000 160,000 240,000
[10,000 x Rs. 24 x 1/3]
[10,000 x Rs. 24 x 2/3]
[10,000 x Rs. 24 x 3/3]
Solution No. 6
Extracts – SOFP Year 1 Year 2 Year 3 Year 4 Year 5
----------------------------------- Rs. -------------------------------
Equity 400,000 800,000 1,200,000 1,600,000 1,750,000
[80,000 x Rs. 25 x 1/5]
[80,000 x Rs. 25 x 2/5]
[80,000 x Rs. 25 x 3/5]
[80,000 x Rs. 25 x 4/5]
[70,000 x Rs. 25 x 5/5]
Solution No. 7
(a)
Year - 1 Rs. Rs.
Dr. Employee cost (W-1) 40,000
Cr. Equity instruments granted 40,000
[Year 1 expense recorded]
Year - 2
Dr. Employee cost (W-1) 103,333
Cr. Equity instruments granted 103,333
[Year 2 expense recorded]
Year - 3
Dr. Employee cost (W-1) 501,667
Cr. Equity instruments granted 501,667
[Year 3 expense recorded]
(b)
------------------------ SOFP -------------------------
SOCI
Equity Share Share Share
Expense/
instrument options capital premium
(income)
granted (W-1) (W-2) (W-2)
----------------------------------- Rs. -------------------------------
Year – 1 40,000 - - 40,000
Year – 2 143,333 - - 103,333
Year – 3 - 645,000 - - 501,667
Year – 4 [6,000 shares issued] - 1,036,000 60,000 468,000 559,000
Year – 5 [8,000 shares issued] - 1,160,000 140,000 1,188,000 444,000
Year – 6 [5,000 shares issued] - 720,000 190,000 1,588,000 (290,000)
Year – 7 [9,000 shares issued] - 540,000 280,000 2,362,000 144,000
Year – 8 [8,000 shares issued] - 315,000 360,000 3,122,000 135,000
Year – 9 [5,000 shares issued] - 96,000 410,000 3,612,000 21,000
Year – 10 [2,000 shares issued] - - 430,000 3,822,000 14,000
Share Share
W-2 Share capital and Share premium capital premium
--------- Rs. -------
Issue [6,000 x 60 + 168,000 - 60,000] 60,000 468,000
Year 4
Balance 60,000 468,000
Issue [8,000 x 60 + 320,000 - 80,000] 80,000 720,000
Year 5
Balance 140,000 1,188,000
Issue [5,000 x 60 + 150,000 - 50,000] 50,000 400,000
Year 6
Balance 190,000 1,588,000
Issue [9,000 x 60 + 324,000 - 90,000] 90,000 774,000
Year 7
Balance 280,000 2,362,000
Issue [8,000 x 60 + 360,000 - 80,000] 80,000 760,000
Year 8
Balance 360,000 3,122,000
Issue [5,000 x 60 + 240,000 - 50,000] 50,000 490,000
Year 9
Balance 410,000 3,612,000
Issue [2,000 x 60 + 110,000 - 20,000] 20,000 210,000
Year 10
Balance 430,000 3,822,000
Solution No. 8
Extracts – SOFP Year 1 Year 2 Year 3
------------------ Rs. ------------------
Equity 195,000 454,250 714,600
[(500 – 110) x 100 x Rs. 15 x 1/3]
[(500 – 105) x 100 x (Rs. 15 x 2/3 + Rs. 3 x 1/2)]
[397 x 100 x (Rs. 15 + Rs. 3)]
Solution No. 9
(a)
(b)
(c)
Solution No. 10
IFRS requires, for a performance condition that is not a market condition, the entity to recognize the services
received during the vesting period based on the best available estimate of the number of equity instruments
expected to vest and to revise that estimate, if necessary, if subsequent information indicates that the number
of equity instruments expected to vest differs from previous estimates. On vesting date, the entity revises the
estimate to equal the number of equity instruments that ultimately vested.
If the entity modifies the vesting conditions in a manner that is not beneficial to the employee, the entity does
not take the modified vesting conditions into account when applying the requirements of the IFRS regarding
treatment of vesting conditions.
Therefore, because the modification to the performance condition made it less likely that the share options
will vest, which was not beneficial to the employee, the entity takes no account of the modified performance
condition when recognizing the services received. Instead, it continues to recognize the services received over
NASIR ABBAS FCA
SHARE BASED PAYMENTS (IFRS-2) - SOLUTIONS (7)
the three-year period based on the original vesting conditions. Hence, the entity ultimately recognizes
cumulative remuneration expense of Rs. 180,000 over the three-year period (12 employees × 1,000 options ×
Rs. 15).
Solution No. 11
Year - 2 Rs. Rs.
Dr. Equity instrument granted 20,000
Cr. Cash [10,000 x Rs. 2] 20,000
Workings
Balance -
Year 1
Expense (balancing) 40,000
Balance [10,000 x Rs. 12 x 1/3] 40,000
Year 2 Repurchase of equity [Rs. 2 x 10,000] (20,000)
Expense (balancing) 115,000
Balance [10,000 x Rs. 12 x 2/3 + 10,000 x Rs. 11* x 1/2] 135,000
Solution No. 12
Movement in liability Rs.
Balance -
Year 1 Settlement -
Expense (balancing) 194,400
Balance [(500 - 95) x 100 x Rs. 14.40 x 1/3] 194,400
Year 2 Settlement -
Expense (balancing) 218,933
Balance [(500 - 100) x 100 Rs. 15.50 x 2/3] 413,333
Year 3 Settlement [150 x 100 x Rs. 15] (225,000)
Expense (balancing) 272,127
Balance [(403 - 150) x 100 x Rs. 18.20] 460,460
Year 4 Settlement [140 x 100 x Rs. 20] (280,000)
Expense (balancing) 61,360
Balance [(403 - 290) x 100 x Rs. 21.40] 241,820
Year 5 Settlement [113 x 100 x Rs. 25] (282,500)
Expense (balancing) 40,680
Balance -
Solution No. 13
Movement in liability Rs.
Balance -
Year 1 Settlement -
Expense (balancing) -
Balance [0 x Rs. 14.40 x 1/3] -
Year 2 Settlement -
Expense (balancing) 516,667
Balance [500 x 100 Rs. 15.50 x 2/3] 516,667
Year 3 Settlement [150 x 100 x Rs. 15] (225,000)
Expense (balancing) 345,333
Balance [(500 - 150) x 100 x Rs. 18.20] 637,000
Year 4 Settlement [150 x 100 x Rs. 20] (300,000)
Expense (balancing) 91,000
Balance [(500 - 300) x 100 x Rs. 21.40] 428,000
Year 5 Settlement [200 x 100 x Rs. 25] (500,000)
Expense (balancing) 72,000
Balance -
Solution No. 14
(a)
Year - 1 Rs. Rs.
Dr. Employee cost 25,000
Cr. Liability [100,000 x 1/4] 25,000
Year - 2
Dr. Employee cost 35,000
Cr. Liability [120,000 x 2/4- 25,000] 35,000
Year - 3
Dr. Employee cost [132,000 x 3/4 - 66,000] 33,000
Cr. Equity instrument granted 33,000
Year - 4
Dr. Employee cost 33,000
Cr. Equity instrument granted 33,000
(b)
Extracts – SOFP 2017 2018 2019 2020
---------------------- Rs. -----------------------
Equity - 66,000 99,000 132,000
Liability 25,000 - - -
Solution No. 15
Year - 1 Rs. Rs.
Dr. Employee cost [100 x Rs. 50 x 1/4] 1,250
Cr. Equity instrument granted 1,250
Year - 2
Dr. Employee cost [100 x Rs. 50 x 1/4] 1,250
Cr. Equity instrument granted 1,250
Year - 3
Dr. Employee cost [100 x Rs. 50 x 1/4] 1,250
Cr. Equity instrument granted 1,250
Year - 4
Dr. Employee cost [100 x Rs. 50 x 1/4] 1,250
Cr. Equity instrument granted 1,250
Solution No. 16
Year - 1 Rs. Rs.
Dr. Employee cost [57,600(W-1) x 1/3] 19,200
Cr. Equity component [7,600(W-1) x 1/3] 2,533
Cr. Liability component [50,000(W-1) x 1/3] 16,667
[Initial recognition of transaction]
Year - 2
Dr. Employee cost 21,867
Cr. Equity component [7,600 x 2/3 - 2,533] 2,533
Cr. Liability component (W-2) 19,334
[Year end expenses and remeasurement]
Year - 3
Dr. Employee cost 25,867
Cr. Equity component [7,600 x 3/3 - 2,533 - 2,533] 2,533
Cr. Liability component (W-2) 23,333
[Year end expenses and remeasurement]
Settlement
Scenario I
Dr. Liability component (W-2) 60,000
Cr. Cash 60,000
[Cash settlement]
Scenario II
Dr. Equity component (W-1) 7,600
Dr. Liability component (W-2) 60,000
Cr. Share capital [1,200 x Rs. 10] 12,000
Cr. Share premium 55,600
[Issue of 1,200 shares]
Solution No. 17
Year - 1 Rs. Rs.
Dr. Employee cost [10,000 x Rs. 33 x 1/3] 110,000
Cr. Equity instrument granted 110,000
Year - 2
Dr. Employee cost [10,000 x Rs. 33 x 2/3 - 110,000] 110,000
Cr. Equity instrument granted 110,000
Year - 3
Dr. Employee cost 83,333
Cr. Liability [10,000 x Rs. 25 x 3/3 - 166,667] 83,333
W-1
Total expense [10,000 x Rs. 33] 330,000
Liability component [166,667 + 83,333] (250,000)
Equity component 80,000
Already recorded in equity component 53,333
[110,000 + 110,000 - 166,667]
26,667
31-12-16
Dr. Employee cost 4,953,334
Cr. Equity component 633,333
Cr. Liability component (W-2) 4,320,000
[Year end expenses and remeasurement]
31-12-17
Dr. Employee cost 5,513,333
Cr. Equity component 633,333
Cr. Liability component (W-2) 4,880,000
[Year end expenses and remeasurement]
Settlement
01-07-18
Dr. Employee cost 800,000
Cr. Liability component (W-2) 800,000
[Remeasurement on settlement]
Calculations:
Employees: Intrinsic values:
Total employees 600 30-06-10 [30 - 8] = 22
Opting for share options: 31-07-10 [34 - 8] = 26
[600 x 60%] 360 01-09-10 [40 - 8] = 32
[600 x 20%] 120
480
Opting for cash bonus 120
Journal entries
30-06-10 Rs. Rs.
Dr. Employee cost (balancing) 10,320,000
Cr. Share options [360 x 1,000 x 22] 7,920,000
Cr. Provision for bonus [240 x Rs. 10,000] 2,400,000
[Issue of share options to 60% employees]
31-07-10
Dr. Provision for bonus [120 x Rs. 10,000] 1,200,000
Dr. Employee cost (balancing) 1,920,000
Cr. Share options [120 x 1,000 x 26] 3,120,000
[Issued share options to 20% employees]
01-09-10
Dr. Employee cost 4,320,000
Cr. Share options [360 x 1,000 x (32 - 22) + 120 x 1,000 x (32 - 26)] 4,320,000
[Remeasurement of intrinsic value on settlement]
IMPORTANT CONCEPTS
Currencies
Foreign currency
It is a currency other than functional currency of the entity.
Presentation currency
It is the currency in which the financial statements are presented.
Functional currency
1. It is the currency of the primary economic environment in which the entity operates.
2. The primary economic environment in which an entity operates is normally the one in which it
primarily generates and expends cash. An entity considers the following factors in determining its
functional currency:
(a) the currency:
(i) that mainly influences sales prices for goods and services (this will often be the currency in
which sales prices for its goods and services are denominated and settled); and
(ii) of the country whose competitive forces and regulations mainly determine the sales prices of
its goods and services.
(b) the currency that mainly influences labour, material and other costs of providing goods or services
(this will often be the currency in which such costs are denominated and settled).
3. The following factors may also provide evidence of an entity’s functional currency:
(a) the currency in which funds from financing activities (i.e. issuing debt and equity instruments) are
generated.
(b) the currency in which receipts from operating activities are usually retained.
4. An entity’s functional currency reflects the underlying transactions, events and conditions that are
relevant to it. Accordingly, once determined, the functional currency is not changed unless there is a
change in those underlying transactions, events and conditions.
Monetary items
1. Monetary items are units of currency held and assets and liabilities to be received or paid in a fixed
or determinable number of units of currency.
2. The essential feature of a monetary item is a right to receive (or an obligation to deliver) a fixed or
determinable number of units of currency.
Examples
- pensions and other employee benefits to be paid in cash
- provisions that are to be settled in cash
- lease liabilities
- cash dividends that are recognised as a liability
- a contract to receive (or deliver) a variable number of the entity’s own equity instruments or a
variable amount of assets in which the fair value to be received (or delivered) equals a fixed or
determinable number of units of currency is a monetary item.
3. Conversely, the essential feature of a non‑monetary item is the absence of a right to receive (or an
obligation to deliver) a fixed or determinable number of units of currency.
Examples
- amounts prepaid for goods and services
- goodwill
- intangible assets
- inventories
- property, plant and equipment
- right‑of‑use assets
- provisions that are to be settled by the delivery of a non‑monetary asset.
2. A foreign currency transaction shall be recorded, on initial recognition in the functional currency, by
applying to the foreign currency amount the spot exchange rate between the functional currency and
the foreign currency at the date of the transaction.
- For practical reasons, a rate that approximates the actual rate at the date of the transaction is
often used, for example, an average rate for a week or a month might be used for all
transactions in each foreign currency occurring during that period. (Only use if asked in
question). However, if exchange rates fluctuate significantly, the use of the average rate for a
period is inappropriate.
Issue
This Interpretation addresses how to determine the date of the transaction for the purpose of
determining the exchange rate to use on initial recognition of the related asset, expense or income (or
part of it) on the derecognition of a non-monetary asset or non-monetary liability arising from the
payment or receipt of advance consideration in a foreign currency.
Consensus
The date of the transaction for the purpose of determining the exchange rate to use on initial recognition
of the related asset, expense or income (or part of it) is the date on which an entity initially recognises the
non-monetary asset or non-monetary liability arising from the payment or receipt of advance
consideration. If there are multiple payments or receipts in advance, the entity shall determine a date of
the transaction for each payment or receipt of advance consideration.
Exam note:
It is automatically done when valuation gain/loss
as per relevant IAS is calculated by comparing
values translated in functional currency at
valuation date.
PRACTICE QUESTIONS
Question No. 1
Determine the functional currency in each of the following cases:
(a) Company A manufactures a product for the domestic market in Pakistan. Its sales are denominated in Pak
rupee. The sale of its product in Pakistan is affected mainly by local supply and demand and regulations.
Its inputs are sources in Pakistan and the prices of inputs are denominated in Pak rupee and mainly
influenced by economic forces and regulations of Pakistan.
(b) Company B mines a product in Pakistan. Sales of the product in denominated in US dollars. The sale price
in USD is affected by global demand for the product. About 90% of company’s costs are for expatriate staff
salaries and for chemicals and specialized machinery imported from USA. These costs are denominated
and settled in US dollars. However its other costs are incurred and settled in Pak rupee.
Question No. 2
On December 21, 2018 40,000 units of a raw material were imported at $ 2 per unit on credit. Financial year
ends on December 31st. 60% of the payment was made on January 22, 2019 and 40% of the payment was made
on February 10, 2019. The spot exchange rates are as follows:
Question No. 3
On July 1, 2018 Alpha Limited (AL) purchased a building in UAE for Dhs. 500,000. After initial recognition,
management decided to measure this property using fair value model in accordance with IAS 40. AL’s financial
year ends on December 31st. The fair values and spot exchange rates are as follows:
Question No. 4
On January 1, 2017 Beta Limited (BL) purchased a building for administrative purposes for a liaison office in UK
for £ 100,000. Its useful life was initially estimated at 10 years. After initial recognition, management decided
to measure this property using revaluation model in accordance with IAS 16. BL’s financial year ends on
December 31st. The fair values and spot exchange rates are as follows:
Required:
Prepare extracts of statement of financial position and statement of comprehensive income for the years
ending December 31, 2017, 2018 and 2019.
Question No. 5
On September 1, 2018 purchase order was issued for import of a plant at an invoice price of $ 120,000. 20%
advance was paid alongwith purchase order. Plant was received on October 1, 2018 and installed accordingly.
30% of the invoice amount was paid at the time of delivery and remaining 50% was paid on February 28, 2019.
Plant has a useful life of 10 years. Financial year ends on every 31st December. The spot exchange rates are as
follows:
Question No. 6
Following transactions took place during the year ending June 30, 2019:
(a) On August 15, 2018 5,000 units of product “MN” were purchased for Dinars 5 per unit on credit. The
account was fully settled on September 30, 2018.
(b) On October 1, 2018 following equity investments were made:
On May 1, 2019 2000 shares of company A were sold at a price of $ 5.8 per share and 1000 shares of
company B were sold at a price of $ 10 per share. Market prices at June 30, 2019 of shares of company A
and B were $ 6 and $ 9.3 per share respectively.
(c) On January 1, 2019 3,000 units of product “MN were sold locally at a price of Rs. 750 per unit and remaining
2,000 units were exported at a price of € 6 per unit on credit. Sale proceeds from foreign customer were
realized on July 31, 2019.
(d) On April 1, 2019 a machine was imported from Japan for ¥ 2 million. 30% advance had been piad on March
1, 2019 and remaining balance was settled on July 31, 2019. Useful life of machine has been estimated at
10 years.
Following spot exchange rates in rupees are available:
Date Dinar 1 $1 €1 ¥1
15-08-18 100 - - -
30-09-18 102 - - -
01-10-18 - 110 - -
01-01-19 - - 140 -
01-03-19 - - - 2.50
01-04-19 - - - 3.00
01-05-19 - 118 - -
30-06-19 - 120 137 3.20
31-07-19 - - 132 3.50
Required:
Calculate “total profit or loss” and “other comprehensive income” for the year ending June 30, 2019.
Question No. 7
Copper Limited (CL) entered into following transactions during the year ended 30 June 2019:
(i) On 1 October 2018, CL imported a machine from China for USD 250,000 against 60% advance payment
which was made on 1 July 2018. The remaining payment was made on 1 April 2019.
(ii) On 1 January 2019, CL sold goods to a Dubai based company for USD 40,000 on credit. CL received 25%
amount on 1 April 2019, however, the remaining amount is still outstanding.
Required:
Prepare journal entries in CL’s books to record the above transactions for the year ended 30 June 2019.
SOLUTIONS
Solution No. 1
(a) Since market forces and regulations in Pakistan’s economy largely determines the selling price and costs
of entity’s inputs, therefore its functional currency is Pak rupee.
(b) Since market forces and regulations in USA’s economy largely determines the selling price and costs of
entity’s inputs, therefore its functional currency is US dollar.
Solution No. 2
Dr. Cr.
--------- Rs. ----------
21-12-18 Inventory 8,800,000
Creditors [40,000 x $ 2 x Rs. 110] 8,800,000
[Purchase of raw material]
Solution No. 3
Dr. Cr.
--------- Rs. ----------
01-07-18 Investment property 16,000,000
Bank 16,000,000
[Purchase of property]
W-1
Converted
Fair value Rate value Gain/(loss)
(Dhs) (Rs/Dhs) (Rs.) (Rs.)
01-07-18 500,000 32.00 16,000,000 -
31-12-18 515,000 30.00 15,450,000 (550,000)
31-12-19 505,000 40.00 20,200,000 4,750,000
Solution No. 4
2019 2018 2017
-------------------- Rs.'000 --------------------
Extracts – SOFP
Non-current assets
Building (W-1) 12,138 10,720 12,600
Equity
Revaluation surplus 2,338 - -
Extracts – SOCI
Depreciation (1,734) (1,340) (1,400)
Revaluation loss - (540) -
Revaluation loss reversal 480 - -
Other comprehensive income:
Revaluation gain / (loss) 2,672 - -
Solution No. 5
Dr. Cr.
--------- Rs. ----------
01-01-18 Advance to supplier 2,640,000
Bank [$120,000 x 20% x Rs. 110] 2,640,000
[20% advance paid to supplier]
Solution No. 6
(b)
Profit on sale of shares:
A [2000 x ($5.8 x Rs. 118 - $5 x Rs. 110)] - 268,800
B [1000 x ($10 x Rs. 118 - $9 x Rs. 110)] 190,000 -
Fair value gain at year end:
A [3000 x ($6 x Rs. 120 - $5 x Rs. 110)] - 510,000
B [7000 x ($9.3 x Rs. 120 - $9 x Rs. 110)] 882,000 -
(c)
Sales [3,000 x Rs. 750 + 2,000 x € 6 x Rs. 140] 3,930,000 -
Exchange loss on debtors [2,000 x € 6 x Rs. 3] (36,000) -
(d)
Depreciation [(¥ 2m x 30% x Rs. 2.50 + ¥ 2m x 70% x Rs. 3) / 10 x 3/12] (142,500) -
Exchange loss on creditors [¥ 2m x 70% x Rs. 0.2] (280,000) -
1,986,000 778,800
Solution No. 7
(i) Rs '000'
Date Debit Credit
1-Jul-18 Advance for PPE 18,150
Bank [250,000 x 60% x 121] 18,150
(ii)
1-Jan-19 Debtor 5,480
Sales [40,000 x 137] 5,480
RECOGNITION
An entity shall recognize a financial asset or a financial liability in its statement of financial position when
and only when the entity becomes party to the contractual provisions of the instrument. On initial
recognition the entity shall also classify financial asset or financial liability as per guidance discussed later
in this chapter.
Examples:
- Entity B transfers cash to Entity A as a collateral for a borrowing transaction. The cash is not legally
segregated from Entity A’s assets. Therefore, Entity A recognizes the cash as an asset and a payable
to Entity B, while Entity B derecognizes the cash and recognizes a receivable from Entity A.
- Assets to be acquired and liabilities to be incurred as a result of a firm commitment to purchase or
sell goods or services are generally not recognized until at least one of the parties has performed
under the agreement. For example, an entity that receives a firm order does not generally recognize
an asset (and the entity that places the order does not recognize a liability) at the time of the
commitment but, instead, delays recognition until the ordered goods or services have been shipped,
delivered or rendered.
- Planned future transactions, no matter how likely, are not assets and liabilities because the entity has
not become a party to a contract.
Financial assets which are debt instruments of other entity [e.g. investment in debentures]
1) Amortized cost
A financial asset shall be measured, except for 3(ii) below, at amortized cost if both of the following
conditions are met:
(i) the financial asset is held within a business model whose objective is to hold financial assets in order
to collect contractual cash flows and
(ii) the contractual terms of the financial asset give rise on specified dates to cash flows that are solely
payments of principal and interest on the principal amount outstanding.
Amortized cost
The amount at which the financial asset or financial liability is measured at initial recognition minus
the principal repayments, plus or minus the cumulative amortization using the effective interest
method of any difference between that initial amount and the maturity amount and, for financial
assets, adjusted for any loss allowance.
(ii) the contractual terms of the financial asset give rise on specified dates to cash flows that are solely
payments of principal and interest on the principal amount outstanding.
Business model
Any entity’s business model is determined at a level that reflects how groups of financial assets are
managed together to achieve a particular business objective. It does not depend on management’s
intentions for an individual instrument. However, an entity may have more than one business models
for managing its financial instruments. For example, an entity may hold a portfolio of investments that
it manages to collect contractual cash flows and another portfolio of investments that it manages in
order to trade to realize fair value changes.
This assessment is not performed on the basis of scenarios that the entity does not reasonably expect
to occur, such as so-called ‘worst case’ or ‘stress case’ scenarios. For example, if an entity expects that
it will sell a particular portfolio of financial assets only in a stress case scenario, that scenario would not
affect the entity’s assessment of the business model for those assets if the entity reasonably expects
that such a scenario will not occur.
Although the objective of an entity’s business model may be to hold financial assets in order to collect
contractual cash flows, the entity need not hold all of those instruments until maturity. Thus an entity’s
business model can be to hold financial assets to collect contractual cash flows even when sales of
financial assets occur or are expected to occur in the future.
Financial assets which are equity instruments of other entity [e.g. investment in shares]
An entity shall classify financial assets as subsequently measured at:
1) Fair value through other comprehensive income
2) Fair value through profit or loss
A financial asset shall be measured at fair value through P&L (default method) unless an entity has made
an irrevocable election, at initial recognition, for particular investments in equity instruments if these are
not held for trading to present subsequent changes in fair value in OCI.
An entity shall classify all financial liabilities as subsequently measured at amortized cost except for:
(a) Financial liabilities, including derivatives that are liabilities, measured at fair value through P&L
An entity may, at initial recognition, irrevocably designate a financial liability as measured at fair
value through P&L if either:
- It eliminates or significantly reduces an accounting mismatch; or
- A group of financial liabilities is managed and its performance is evaluated on a fair value basis
in accordance with a documented risk management or investment strategy.
(b) Financial liabilities that arise when a transfer of a financial asset does not qualify for derecognition or
when the continuing involvement approach applies.
(c) Financial guarantee contracts.
(d) Commitments to provide a loan at a below-market interest rate.
(e) Contingent consideration recognized by an acquirer in a business combination.
INITIAL MEASUREMENT
Financial assets
Financial liabilities
Transaction costs
Incremental costs that are directly attributable to the acquisition, issue or disposal of a financial asset
or financial liability. An incremental cost is one that would not have been incurred if the entity had not
acquired, issued or disposed of the financial instrument.
Financial assets
(ii) If asset is classified as - At each reporting date and on de-recognition, the asset shall be
measured at fair value measured at fair value with any gain or loss recognized in other
through OCI comprehensive income.
- Interest income using effective interest rate shall be recognized in
profit or loss (i.e. same as calculated in amortized cost).
- Any foreign exchange gain/loss on amortized cost measured in
foreign currency shall be recognized in P&L.
- Cumulative fair value gain or loss, previously recognized in OCI, shall
be reclassified to profit or loss on de-recognition of the asset.
(All amounts recognized in P&L would be the same which would have
been recognized had the asset been measured at amortized cost)
(iii) If asset is classified as - At each reporting date and on de-recognition, the asset shall be
measured at fair value measured at fair value with any gain or loss recognized in profit or
through profit or loss loss.
- It is a monetary item, therefore, as per IAS 21 its exchange gain or
loss shall be recognized in P&L.
- Actual interest received is recognized in profit or loss. (Need of
accrual concept is accounted for accordingly)
Financial liabilities
Types Treatment
(i) If liability is classified as - The liability shall be measured at amortized cost using effective
measured at amortized cost interest rate method.
(default measurement) - Interest expense using effective interest rate shall be recognized in
P&L.
- Any gain or loss on derecognition shall be recognized in P&L.
(ii) If liability is classified as - At each reporting date, the liability shall be measured at fair value.
measured at fair value - Any change in fair value attributable to change in own credit risk is
through profit or loss recognized in OCI [Amount presented in OCI shall not be
subsequently transferred to P&L, however, the entity may transfer
the cumulative gain or loss within equity e.g. retained earnings]. The
remaining amount of change in the fair value of the liability shall be
presented in P&L. However, if it creates or enlarges accounting
mismatch, then entire fair value gain or loss shall be recognized in
P&L.
- Actual interest paid is recognized in profit or loss. (Need for accrual
concept is accounted for accordingly)
Estimating change in fair value of liability attributable to change in own credit risk:
Multiple methods can be used to estimate the amount of change in fair value attributable to change in
own credit risk. If the only significant relevant changes in market conditions for a liability are changes
in an observed (benchmark) interest rate, the amount of change in fair value attributable to change in
own credit risk can be estimated in following steps:
1) First find “Instrument-specific component” of IRR of the liability as
= IRR of liability at start of period (i.e. a market rate of return which is calculated using fair value of
liability and the contractual cash flows at the start of the period) LESS observed benchmark interest
rate (e.g. KIBOR) at start of period
PRACTICE QUESTIONS
Question 1
Following independent situations relate to financial assets:
(1) A Limited (AL) holds investments to collect their contractual cash flows. The funding needs of AL are predictable and
the maturity of investments matches to estimated funding needs. However, AL would sell an investment in particular
circumstances, perhaps to fund unanticipated capital expenditure, or because the credit rating of the instrument falls
below that required by AL’s investment policy.
(2) B Limited (BL) purchases portfolios of financial assets such as loans. If payment on the loans is not made on a timely
basis, the entity attempts to realize the contractual cash flows through various follow-up measures. BL’s objective is
to collect the contractual cash flows and it does not manage any of the loans in this portfolio with an objective of
realizing cash by selling them.
(3) C Limited (CL) has a business model with the objective of originating loans to customers and subsequently selling
those loans to a securitisation vehicle. The securitisation vehicle issues instruments to investors. CL controls the
securitisation vehicle and thus consolidates it. The securitisation vehicle collects the contractual cash flows from the
loans and passes them on to its investors. It is assumed for the purposes of this example that the loans continue to
be recognised in the consolidated statement of financial position because they are not derecognised by the
securitisation vehicle.
(4) D Limited (DL) expects to pay a cash outflow in ten years to fund capital expenditure and invests excess cash in short-
term financial assets. When the investments mature, DL reinvests the cash in new short-term financial assets. DL
maintains this strategy until the funds are needed, at which time DL uses the proceeds from the maturing financial
assets to fund the capital expenditure. Only sales that are insignificant in value occur before maturity (unless there is
an increase in credit risk).
(5) E Limited (EL) expects to incur capital expenditure in a few years’ time. EL invests its excess cash in short and long-
term financial assets so that it can fund the expenditure when the need arises. Many of the financial assets have
contractual lives that exceed EL’s anticipated investment period. EL will hold financial assets to collect the contractual
cash flows and, when an opportunity arises, it will sell financial assets to re-invest the cash in financial assets with a
higher return.
(6) F Bank holds financial assets to meet its everyday liquidity needs. The bank actively manages the return on the
portfolio in order to minimize the costs of managing those liquidity needs. That return consists of collecting
contractual payments as well as gains and losses from the sale of financial assets. F Bank holds financial assets to
collect contractual cash flows and sells financial assets to reinvest in higher yielding financial assets or to better match
the duration of its liabilities. In the past, this strategy has resulted in frequent sales activity and such sales have been
significant in value. This activity is expected to continue in the future
Required:
Briefly discuss how each of the above assets should be classified?
Question 2
Following independent situations relate to financial assets (i.e. investments in bonds):
(1) Bond A has a stated maturity date. Payments of principal and interest on the principal amount outstanding are linked
to an inflation index of the currency in which the bond is issued.
(2) Bond B is a variable interest rate instrument with a stated maturity date that permits the borrower to choose the
market interest rate on an ongoing basis. For example, at each interest rate reset date, the borrower can choose to
pay three-month LIBOR for a three-month term or one-month LIBOR for a one-month term.
(3) Bond C has a stated maturity date and pays a variable market interest rate. That variable interest rate is capped.
(4) Bond D is a full recourse loan and is secured by collateral.
(5) Bond E is convertible into fixed number of equity instruments of the issuer.
(6) Bond F is a perpetual bond but the issuer may call the instrument at any point and pay the holder the par amount
plus accrued interest due. It pays a market interest rate but payment of interest cannot be made unless the issuer is
able to remain solvent immediately afterwards. Deferred interest does not accrue additional interest.
Required:
For each of the above assets, briefly discuss whether contractual cashflows solely comprise of principal and interest?
Question 3
On 1 January 2018 Abacus Co purchases a debt instrument for its fair value of Rs. 100,000. The debt instrument is due to
mature on 31 December 2022 at par. The instrument has a face value of Rs. 125,000 and the instrument carries fixed
interest at 4.72% that is paid annually. (The effective interest rate is 10%.)
Required:
Show extracts of Income statement and Balance sheet for each of the five years till December 31, 2022.
Question 4
On May 14, 2018 Zain Limited (ZL) acquired 5,000 shares of a listed company for Rs. 27.50 per share (including Rs. 1.50
per share as broker’s commission). On that date the fair value of share was Rs. 25 per share. ZL had purchased these
shares with the intention of holding in long term. Moreover, it made an irrevocable election for designation as fair value
through other comprehensive income. On June 30, 2018 (i.e. year-end) fair value of shares moved to Rs. 28 per share.
This price further increased to Rs. 33 per share on June 30, 2019. On August 1, 2019 ZL sold 3,000 shares for Rs. 31 per
share. On June 30, 2020 fair value moved to Rs. 37 per share.
Required:
Question 5
In January 1, 2018 Wolf Limited (WL) purchased 10 million shares of a listed company at a price of Rs. 25 per share
(whereas fair value was Rs. 25.50 per share). WL also paid transaction costs of Rs. 15 million. On November 30, 2018 WL
received a dividend of Rs. 4 per share. WL’s year end is December 31. At December 31, 2018, the shares were trading at
Rs. 28.
Required:
Show the financial statements extracts of WL at December 31, 2018 relating to the investment in shares if:
(i) The shares were bought for short term trading.
(ii) The shares were bought as a source of dividend income and were the subject of an irrevocable election at initial
recognition to recognize them at fair value through other comprehensive income.
Question 6
On January 1, 2018, Tokyo Limited (TL) bought Rs. 100,000 (nominal value) 5% bonds for Rs. 95,000 (fair value), incurring
transactions costs of Rs. 2,000. Interest is received at end of every year. The bonds will be redeemed at a premium of Rs.
5,960 over nominal value on December 31, 2020. The effective rate of interest is 8%. The fair value of the bond was as
follows:
Question 7
On January 1, 2018, Sialkot Limited (SL) bought 100 Euro-dollar bonds at a price of $ 50 each and incurred transaction
cost of $ 0.5 per bond. The bonds will be redeemed at a premium of 20% over face value of $ 40 each after four years.
Coupon rate is 10%. The effective rate of interest is 6.80%.
The exchange rates and fair value of the bond were as follows:
Required:
Journalize all transactions for the years ending December 31, 2018 and 2019 if:
(a) SL's business model is to hold bonds until the redemption date and collect contractual cash flows.
(b) SL's business model is to hold bonds until redemption but also to sell them if investments with higher returns become
available.
Question 8
Decent Limited (DL) issued following bonds on January 1, 2019:
1) Face value = Rs. 150,000
Issued at a discount of 5%
Coupon rate = 7%
Redemption after 4 years at a premium of 10%
Effective interest rate = 10.734%
2) Face value = Rs. 80,000
Issued at a premium of 10%
Issue costs = Rs. 2,000
Contractual cash flows:
31-12-19 – Rs. 9,500
31-12-20 – Rs. 41,500
31-12-21 – Rs. 52,700
Effective interest rate = 8.111%
3) Face value = Rs. 100,000
Coupon rate = zero
Issued at a discount of 25%
Redemption after 4 years at par
Effective interest rate = 7.457%
Required:
(a) Prepare complete schedules for amortized cost calculation for each bond.
(b) Journalize all the transactions for the year ending December 31, 2019.
(c) Show extracts of SOFP and SOCI for the year ending December 31, 2019.
Question 9
On January 1, 2018 Engro Limited (EL) issued debentures (nominal value Rs. 50,000) at a premium of 10%. Coupon rate is
10% payable at end of every year. A broker commission of 4% of nominal value was paid on issuance. These debentures
will be redeemed at a premium of 5% after 3 years.
Required:
(a) Calculate effective interest rate to be used for amortized cost calculation.
(b) Journalize all transactions for all three years.
Question 10
On January 1, 2018 Alpha Limited (AL) issued 9% debentures at nominal value of Rs. 80,000 to finance a certain investment
in assets. The management has decided to classify these debentures to be measured at fair value through profit and loss.
AL’s credit rating was also changed in subsequent years due to some factors. These debentures were revalued to fair
values as follows:
Required:
(a) Show extracts of Statement of comprehensive income and Statement of financial position for the years ending
December 31, 2018 and 2019.
(b) Journalize above transactions for the years ending December 31, 2018 and 2019.
Question 11
Beta Limited (BL) issued 8% debentures some years ago. These debentures will be redeemed at par (i.e. Rs. 100,000) on
December 31, 2023. On January 1, 2019 the fair value of debentures was Rs. 100,000 showing a market rate of return of
8% (i.e. IRR of fair value and contractual cashflows over remaining life). On that date KIBOR was 5%.
On December 31, 2019 KIBOR moved to 5.75% and fair value of BL’s debentures moved to Rs. 95,972 showing a market
rate of return of 9.25%.
On December 31, 2020 KIBOR moved to 5.50% and fair value of BL’s debentures moved to Rs. 95,026 showing a market
rate of return of 10%.
Required:
Calculate fair value gain/loss to be recognized in OCI and P&L for the years ending December 31, 2019 and 2020.
SOLUTIONS
Solution No. 1
(1) Although AL may consider, among other information, the financial assets' fair values from a liquidity perspective (i.e.
the cash amount that would be realised if AL needs to sell assets), AL’s objective is to hold the financial assets and
collect the contractual cash flows. Therefore, these assets shall be classified as measured at amortized cost.
(2) The objective of BL’s business model is to hold financial assets to collect contractual cash flows. Therefore, these
assets shall be classified as measured at amortized cost.
(3) The consolidated group originated the loans with the objective of holding them to collect the contractual cash flows.
However, CL has an objective of realising cash flows on the loan portfolio by selling the loans to the securitisation
vehicle, so for the purposes of its separate financial statements it would not be considered to be managing this
portfolio in order to collect the contractual cash flows and thus classified as measured at fair value through OCI.
(4) The objective of DL’s business model is to hold financial assets to collect contractual cash flows. Selling financial
assets is only incidental to DL’s business model. Therefore, these assets shall be classified as measured at amortized
cost.
(5) The objective of the business model is achieved by both collecting contractual cash flows and selling financial assets.
EL decides on an ongoing basis whether collecting contractual cash flows or selling financial assets will maximise the
return on the portfolio until the need arises for the invested cash. Therefore, these assets shall be measured at fair
value through other comprehensive income.
(6) The objective of the business model is to maximise the return on the portfolio to meet everyday liquidity needs and
F Bank achieves that objective by both collecting contractual cash flows and selling financial assets. In other words,
both collecting contractual cash flows and selling financial assets are integral to achieving the business model’s
objective. Therefore, these assets shall be measured at fair value through other comprehensive income.
Solution No. 2
(1) The contractual cash flows are solely payments of principal and interest on the principal amount outstanding. Linking
payments of principal and interest on the principal amount outstanding to an unleveraged inflation index resets the
time value of money to a current level. In other words, the interest rate on the instrument reflects ‘real’ interest.
Thus, the interest amounts are consideration for the time value of money on the principal amount outstanding.
However, if the interest payments were indexed to another variable such as the debtor’s performance (eg the
debtor’s net income) or an equity index, the contractual cash flows are not payments of principal and interest on the
principal amount outstanding.
(2) The contractual cash flows are solely payments of principal and interest on the principal amount outstanding as long
as the interest paid over the life of the instrument reflects consideration for the time value of money, for the credit
risk associated with the instrument and for other basic lending risks and costs, as well as a profit margin. The fact that
the LIBOR interest rate is reset during the life of the instrument does not in itself disqualify the instrument. However,
if the borrower is able to choose to pay a one-month interest rate that is reset every three months, the interest rate
is reset with a frequency that does not match the tenor of the interest rate. Consequently, the time value of money
element is modified. Similarly, if an instrument has a contractual interest rate that is based on a term that can exceed
the instrument’s remaining life (for example, if an instrument with a five-year maturity pays a variable rate that is
reset periodically but always reflects a five-year maturity), the time value of money element is modified. That is
because the interest payable in each period is disconnected from the interest period.
are payments of principal and interest on the principal amount outstanding as long as the interest reflects
consideration for the time value of money, for the credit risk associated with the instrument during the term of the
instrument and for other basic lending risks and costs, as well as a profit margin.
(4) The fact that a full recourse loan is collateralized does not in itself affect the analysis of whether the contractual cash
flows are solely payments of principal and interest on the principal amount outstanding.
(5) The holder would analyze the convertible bond in its entirety. The contractual cash flows are not payments of
principal and interest on principal amount outstanding because they reflect a return that is inconsistent with a basic
lending arrangement i.e. the return is linked to the value of the equity of the issuer.
(6) The contractual cashflows are not payments of principal and interest on the principal amount outstanding because
the issuer may be required to defer interest payments and additional interest does not accrue on those deferred
interest amounts. As a result, interest amounts are not consideration for the time value of money on the principal
amount outstanding.
Solution 3
2018 2019 2020 2021 2022
-------------------------------------- Rs. --------------------------------------
Income statement - extracts
Current assets
Investment - - - 119,028 -
W-1
Opening Closing
Date Interest Cashflow
balance balance
[A] [B = A x 10%] [C] [A + B - C]
Solution 4
Dr. Cr.
-------- Rs. -------
14-05-18 Investment [5,000 x (25 + 1.50)] 132,500
P&L [5,000 x (27.50 – 25 – 1.50)] 5,000
Cash [5,000 x 27.50] 137,500
[Initial recognition]
Solution 5
(i)
Rs. million
SOCI – extracts
Dividend income [10m x Rs. 4] 40.00
Gain on initial recognition [10m x Rs. 0.50] 5.00
Transaction cost (15.00)
Fair value gain [(Rs. 28 – Rs. 25.50) x 10m] 25.00
SOFP – extracts
Non-current assets
Investment [10m x Rs. 28] 280.00
(ii)
SOCI – extracts
Dividend income [10m x Rs. 4] 40.00
Gain on initial recognition 5.00
Other comprehensive income:
Fair value gain [(Rs. 28 x 10m - (Rs. 25.50 x 10m + Rs. 15m)] 10.00
SOFP – extracts
Equity
Fair value reserve 10.00
Non-current assets
Investment [10m x Rs. 28] 280.00
Solution 6
(a) Asset shall be measured at amortized cost
Dr. Cr.
-------- Rs. -------
01-01-18 Investment [95,000 + 2,000] 97,000
Cash 97,000
[Initial recognition]
W-1
Opening Closing Fair Fair value
Date Interest Cashflow OCI
balance balance value reserve
[A] [B = A x 8%] [C] [D = A + B - C] [E] [F = E - D] [Change in F]
Solution 7
(a) Measured at amortized cost Dr. Cr.
-------- Rs. -------
01-01-18 Investment [(50 + 0.5) x 100 x Rs. 150] 757,500
Cash 757,500
[Initial recognition]
W-1
------------------------ $ Amortized cost ------------------------- Rupees
amortized
Date Opening Closing
Interest Cashflow cost
balance balance (translated)
[A] [B = A x 6.8%] [C] [D = A + B - C] [E]
31-12-18 5,050 343 400 4,993 758,936 [4,993 x 152]
31-12-19 4,993 340 400 4,933 754,749 [4,933 x 153]
W-2
------------------------ Translated values (ignoring FV change) -------------------------
Date Opening Exchange Closing
Interest Cashflow
balance gain/(loss) balance
(balancing figure)
--------------------------------------------- Rs. ------------------------------------------------
31-12-18 757,500 52,136 60,800 10,100 758,936
31-12-19 758,936 52,020 61,200 4,993 754,749
W-3
Amortized Fair value Fair value
Date OCI
cost (translated) reserve
[E] [F] [G = F – E] [Change in G]
--------------------------- Rs. -----------------------------------
31-12-18 758,936 775,200 16,264 16,264
[5,100 x 152]
31-12-19 754,749 734,400 (20,349) (36,613)
[4,800 x 153]
Solution 8
(a) ------------------------------- Rs. -----------------------------
Bond - 1
Opening Closing
Date Interest Cashflow
balance balance
[A] [B = A x 10.734%] [C] [A + B - C]
Bond - 3
Opening Closing
Date Interest Cashflow
balance balance
[A] [B = A x 7.457%] [C] [A + B - C]
Bond - 2
Bond - 3
Dr. Cr.
-------- Rs. -------
01-01-19 Cash [100,000 x 75%] 75,000
Bonds 75,000
[Initial recognition]
Solution No. 9
(a) ------ 5% ------ -------- 10% -------
Factor PV Factor PV
Initial recognition [50,000 x 1.1 - 50,000 x 4%] (53,000) 1.000 (53,000) 1.000 (53,000)
Year 1 payment [50,000 x 10%] 5,000 0.952 4,760 0.909 4,545
Year 2 payment [50,000 x 10%] 5,000 0.907 4,535 0.826 4,130
Year 3 payment [50,000 x 10% + 50,000 x 1.05] 57,500 0.864 49,680 0.751 43,183
5,975 (1,143)
(b)
Dr. Cr.
-------- Rs. -------
01-01-18 Cash 53,000
Debentures 53,000
[Initial recognition]
W-1
Date Opening balance Interest Cashflow Closing balance
Solution No. 10
(a) 2018 2019
-------------- Rs. ----------------
SOCI – extracts
Interest expense [80,000 x 9%] (7,200) (7,200)
Fair value gain / (loss) [W-1] (5,000) (1,000)
Other comprehensive income:
Fair value gain / (loss) (3,000) 7,000
SOFP - extracts
Equity
Fair value reserve (3,000) 4,000
Non-current liabilities
Debentures 88,000 82,000
(b)
Dr. Cr.
-------- Rs. -------
01-01-18 Cash 80,000
Debentures 80,000
[Initial recognition]
Solution No. 11
Calculation for 2019
01-01-19
Market rate for valuation 8%
Cashflows PV
(Rs.) (Rs.)
It is only shown for students
31-12-19 8,000 7,407
knowledge about calculation of
31-12-20 8,000 6,859
market value which is already
31-12-21 8,000 6,351 given in questions
31-12-22 8,000 5,880
31-12-23 108,000 73,503
Market value [A] 100,000
IRR 8.00%
KIBOR 5.00%
Instrument-specific component for 2019 3.00%
31-12-19
Market rate for valuation 9.25%
Cashflows PV
(Rs.) (Rs.) It is only shown for students
31-12-20 8,000 7,323 knowledge about calculation of
31-12-21 8,000 6,703 market value which is already
31-12-22 8,000 6,135 given in questions
31-12-23 108,000 75,812
Market value [B] 95,972
KIBOR 5.75%
Instrument-specific component 3.00%
Discount rate to find OCI portion 8.75%
Present value:
Rate to find OCI portion 8.75%
Cashflows PV
(Rs.) (Rs.)
31-12-20 8,000 7,356
31-12-21 8,000 6,764
31-12-22 8,000 6,220
31-12-23 108,000 77,216
[C] 97,557
IRR 9.25%
KIBOR 5.75%
Instrument-specific component for 2020 3.50%
31-12-20
KIBOR 5.50%
Instrument-specific component 3.50%
Discount rate to find OCI portion 9.00%
Present value:
Rate to find OCI portion 9.00%
Cashflows PV
(Rs.) (Rs.)
31-12-21 8,000 7,339
31-12-22 8,000 6,733
31-12-23 108,000 83,396
[C] 97,469
It is a purchase or sale of a financial asset under a contract whose terms require delivery of the asset
within the time frame established generally by regulation or convention in the marketplace concerned.
(e.g. Pakistan Stock Exchange)
Following two methods are allowed for accounting for regular way purchase or sale of financial assets:
1) Trade date accounting
2) Settlement date accounting
Trade date
The trade date is the date that an entity commits itself to purchase or sell an asset.
Settlement date
The settlement date is the date that an asset is delivered to or by an entity.
On trade date Financial asset is recognized at the amount as already studied earlier
depending upon the class of asset (i.e. initial measurement) and a
corresponding payable is recognized as payment has not yet been
made.
Fair value changes at year-end Gain/loss on changes in fair value of the financial asset is accounted for
(if it arrives between Trade as studied earlier depending upon the class of asset (i.e. as follows):
date and Settlement date) – Not applicable (for amortized cost class)
– Recognized in OCI (for FV through OCI class)
– Recognized in P&L (for FV through P&L class)
Dr. Payable
Cr. Cash
Dr. Receivable
Cr. Financial asset
Dr. / Cr. OCI (if it would be classified as measured at FV through OCI)
Dr./Cr. P&L (if it would be classified as measured at FV through P&L)
Fair value changes at year-end No entry as the financial asset is already derecognized.
(if it arrives between Trade
date and Settlement date)
Dr. Cash
Cr. Receivable
Fair value changes at year-end Though no investment has yet been recognized even then a gain/loss
(if it arrives between Trade on changes in fair value of the financial asset (except where it will be
date and Settlement date) classified as measured at amortized cost) is accounted for as follows (as
studied earlier depending upon the class of asset to be used):
Dr. Receivable
Cr. OCI (if it would be classified as measured at FV through OCI)
Cr. P&L (if it would be classified as measured at FV through P&L
On trade date Although the financial asset is not de-recognized but a gain or loss on
changes in fair value of the financial asset is accounted for as follows:
– Not applicable (for amortized cost class)
– Recognized in OCI (for FV through OCI class)
– Recognized in P&L (for FV through P&L class)
Fair value changes at year- No further gain/loss on fair value changes is recognized because the
end (if it arrives between entity’s right to changes in the fair value ceased on trade date.
Trade date and Settlement
date)
Following terms should be understood first to discuss the topic of impairment of financial assets:
Key terms
Credit loss
The difference between all contractual cash flows that are due to an entity in accordance with the
contract and all the cash flows that the entity expects to receive (i.e. all cash shortfalls), discounted at
the original effective interest rate (or credit-adjusted effective interest rate for purchased or
originated credit-impaired financial assets).
IAS 36 covers impairment of most of the non-current assets (except for financial assets) and it operates
an incurred loss model. This means that impairment is recognized only when an event has occurred which
has caused a fall in recoverable amount of asset. However, IFRS 9 operates an expected loss model. It is
no longer necessary for a credit event to have occurred before credit losses are recognized. Instead, an
entity always accounts for expected credit losses, and changes in those expected credit losses. The
amount of expected credit losses is updated at each reporting date to reflect changes in credit risk since
initial recognition and, consequently, more timely information is provided about expected credit losses.
2. An entity shall measure the allowance for expected credit losses at each reporting date:
If the credit risk on that financial instrument If the credit risk on that financial instrument
has increased significantly since initial has NOT increased significantly since initial
recognition: recognition:
Important
o Changes in credit risk can be assessed on an individual or collective basis considering all
reasonable and supportable information.
o When making the assessment of changes in credit risk, an entity shall use the change in the risk
of a default occurring over the expected life instead of the change in the amount of expected
credit losses.
o If reasonable and supportable forward-looking information is available without undue cost or
effort, an entity cannot rely solely on past due information when determining whether credit
risk has increased significantly since initial recognition.
o There is a rebuttable presumption that the credit risk on a financial asset has increased
significantly since initial recognition when contractual payments are more than 30 days past
due. However, ‘30 days past due’ is not a must for assessment of credit risk.
3. If previously a loss allowance has been recognized at lifetime expected credit losses but now the
change in credit risk is not significant since initial recognition, then entity shall measure the loss
allowance at 12-months expected credit losses at current reporting date.
4. Initial recognition of loss allowance as well as any change in the amount of allowance for expected
credit losses (or reversal) shall be recognized in profit or loss as an impairment gain or loss.
In case of financial asset measured at amortized cost:
Dr. Impairment loss (P&L)
Cr. Allowance for expected credit loss (it is a contra asset account)
This “allowance for expected credit loss” is deducted from gross carrying amount of financial asset
so that a net position is presented in statement of financial position.
In case of financial asset (which is a debt instrument of another entity) measured at FV through OCI
Dr. Impairment loss (P&L)
Cr. Allowance for expected credit loss [OCI]
Since loss is credited to OCI, hence no allowance is deducted from gross carrying amount of
financial asset.
Notes: Above entries are given for impairment loss. These should be reversed in case of impairment
gain.
(b) Simplified approach for trade receivables, contract assets (IFRS 15) and lease receivables
In case of Trade receivable and contract assets In case of Trade receivable and contract assets
which do not contain a significant financing which contain a significant financing component
component: and Lease receivables:
Simplified approach shall be followed Simplified approach may be followed if the entity
chooses this treatment as an accounting policy.
[Otherwise general approach will be used]
1. An allowance for expected credit losses on initial recognition as well as at each reporting date at an
amount equal to lifetime expected credit loss shall be recognized.
2. Any change in the amount of allowance for expected credit losses (or reversal) shall be recognized in
profit or loss as an impairment gain or loss.
This “allowance for expected credit loss” is deducted from gross carrying amount of financial asset
so that a net position is presented in statement of financial position.
Notes: Above entry is given for impairment loss. This should be reversed in case of impairment gain.
2) Credit-impaired asset
Evidence that a financial asset is credit-impaired include observable data about the following events:
(e) the disappearance of an active market for that financial asset because of financial difficulties; or
(f) the purchase or origination of a financial asset at a deep discount that reflects the incurred credit
losses.
It may not be possible to identify a single discrete event—instead, the combined effect of several events
may have caused financial assets to become credit-impaired.
1. Interest revenue shall be calculated by applying the normal effective interest rate to the amortized
cost of the financial asset
Interest income = (Gross carrying amount – Loss allowance) x normal effective interest rate
2. Measurement and accounting for subsequent allowance for impairment loss would be same as
studied earlier for general approach. However, an adjustment would be needed (otherwise amortized
cost table will not by applying effective interest rate to opening balance of loss allowance as follows:
Exam note:
1 and 2 above are easier to handle if accounted for in a compound entry.
3. If in subsequent reporting periods, the credit risk on the financial instrument improves so that the
financial asset is no longer credit-impaired (e.g. improvement in the borrower’s credit rating) then we
would revert to measuring the interest income by applying the effective interest rate to the gross
carrying amount as before.
1. In some cases, a financial asset is considered credit-impaired at initial recognition because the credit
risk is very high and in a case of purchase it is acquired at a deep discount. Credit-adjusted effective
interest rate is calculated using all contractual cashflows adjusted for initial estimate of the lifetime
expected credit losses.
2. Interest revenue shall be calculated by applying credit-adjusted effective interest rate to the
amortized cost (i.e. net carrying amount) of the financial asset from initial recognition.
3. An entity shall only recognize the cumulative changes in lifetime expected credit losses since initial
recognition as a loss allowance for purchased or originated credit-impaired financial assets. At each
reporting date, an entity shall recognize in profit or loss the amount of the change in lifetime expected
credit losses as an impairment gain or loss. An entity shall recognize favourable changes in lifetime
expected credit losses as an impairment gain, even if the lifetime expected credit losses are less than
the amount of expected credit losses that were included in the estimated cash flows on initial
recognition.
4. If expected credit losses are to be discounted then credit-adjusted effective interest rate determined
at initial recognition shall be used.
PRACTICE QUESTIONS
Question 1
On December 29, 2019 an entity commits itself to purchase a financial asset for Rs. 1,000, which is its fair value on
commitment (trade) date. On December 31, 2019 (i.e. year-end) and on January 4, 2020 (settlement date) the fair value
of the asset is Rs. 1,025 and Rs. 1,038 respectively.
Required:
Journal entries for the above transactions for each of the following cases:
Case – I Financial asset will be measured at amortized cost
Case – II Financial asset will be measured at fair value through OCI
Case – III Financial asset will be measured at fair value through P&L
Under following accounting policies:
(a) Trade date accounting
(b) Settlement date accounting
Question 2
On December 29, 2019 an entity commits itself to sell a financial asset for Rs. 1,010, which is its fair value on commitment
(trade) date. It had been purchased on January 1, 2019 and has a carrying amount of Rs. 1,000 on trade date. On December
31, 2019 (i.e. year-end) and on January 4, 2020 (settlement date) the fair value of the asset is Rs. 1,025 and Rs. 1,030
respectively.
Required:
Journal entries for the above transactions for each of the following cases:
Case – I Financial asset was measured at amortized cost
Case – II Financial asset was measured at fair value through OCI
Case – III Financial asset was measured at fair value through P&L
Under following accounting policies:
(c) Trade date accounting
(d) Settlement date accounting
Question 3
On December 29, 2019 an entity enters into a contract to sell Debenture A, which is measured at amortized cost, in
exchange for Bond B, which will be held for trading and thus will be measured at fair value through P&L. Debenture A had
a carrying amount of Rs. 10,000 on commitment date.
Fair values of both assets were as follows:
Debenture A Bond B
Trade date (i.e. 29-12-19) Rs. 10,100 Rs. 10,100
Year end (i.e. 31-12-19) Rs. 10,120 Rs. 10,090
Settlement date (i.e. 04-01-20) Rs. 10,130 Rs. 10,070
Entity follows settlement date accounting for assets measured at amortized cost and trade date accounting for assets
held for trading.
Required:
Journal entries for the above transactions.
Question 4
On January 1, 2018, Nobita Limited (NL) bought Rs. 200,000 (nominal value) 10% bonds, incurring transactions costs of
1% of purchase price. The bonds will be redeemed at a premium of Rs. 25% over nominal value on December 31, 2020.
The effective rate of interest is 16.6386%. The fair value of the bond was as follows:
The investment was not considered to be credit-impaired at any stage. The relevant expected credit losses, for use in
measuring the loss allowance were as follows:
Date Rs.
January 1, 2018 7,000
December 31, 2018 10,000
December 31, 2019 12,000
Required:
Journalize all above transactions over all relevant years if:
(a) NL's business model is to hold bonds until the redemption date and collect contractual cash flows.
(b) NL's business model is to hold bonds until redemption but also to sell them if investments with higher returns become
available.
Question 5
An entity purchased debentures of Rs. 450,000 on January 1, 2019, on which date they are not considered to be credit-
impaired. The financial asset is classified at amortized cost and has an effective interest rate of 10%. Coupon payment of
Rs. 30,000 was duly received on December 31, 2019 and December 31, 2020. The following additional information is also
available on December 31, 2019:
2019 2020
Lifetime expected credit loss if there is a default (i.e. LGD) 30% 35%
[% of gross carrying amount]
Probability of default occurring within 12-months 10% 11%
Probability of default occurring within lifetime 12% 15%
Required:
Extracts of SOFP and SOCI for the year ending December 31, 2019 and 2020 if risk assessment on each year end shows:
(a) There is no significant increase in credit risk since initial recognition
(b) There is a significant increase in credit risk since initial recognition
(c) The asset has become credit-impaired
Question 6
On January 1, 2019 Happy Limited (HL) invested in 5,000 debentures issued by Sad Limited (SL). Each debenture is
redeemable at par (i.e. Rs. 100) after 4 years. Coupon rate was 9% payable annually. Issue price was Rs. 98 per debenture
(i.e. equal to the fair value). Transaction costs incurred amount to Rs. 2,500. Effective rate of interest was 9.4678%.
HL classified this investment at amortized cost. The investment was not credit-impaired on initial recognition. On initial
recognition HL estimated the lifetime expected credit losses to be Rs. 15,000 and the 12-month expected credit losses to
be Rs. 3,125.
On December 31, 2019, due to high debt ratio and declining profit margins, SL issued a warning to its creditors that it is
undergoing a business restructuring process aimed at saving the business from bankruptcy. As a result, the directors of
HL determined that there was a significant increase in credit risk since the initial recognition. On that date, revised
estimates were as follows:
- The lifetime expected credit losses had increased to Rs. 17,500; and
- The 12-months expected credit loss had increased to Rs. 5,000
On December 31, 2020, the credit risk for the investment remained significantly higher than at initial recognition. On that
date, revised estimates were as follows:
- The lifetime expected credit losses had increased to Rs. 20,000; and
- The 12-months expected credit loss had increased to Rs. 8,000
Required:
Journal entries for the year ending December 31, 2019 and 2020 if risk assessment shows:
(a) The asset was not credit-impaired at either December 31, 2019 or December 31, 2020.
(b) The asset became credit-impaired at December 31, 2019 and remained so at December 31, 2020.
Question 7
On December 1, 2019 Good Limited (GL) entered into a contract with a customer for Rs. 500,000. All performance
obligations were satisfied on that date. There is no significant financing component in the contract.
At December 31, 2019 GL does not believe that the increase in credit risk since initial recognition is significant.
If default occurs, GL expects to lose 80% of the gross carrying amount of the receivable. The customer pays in full on
January 15, 2020.
01-12-19 31-12-19
Probability of default over the next 12-months 4% 5%
Probability of default over the lifetime 6% 7%
Required:
Journal entries of above transactions.
Question 8
On December 31, 2019 Mango Limited (ML) has a portfolio of receivables of Rs. 30 million. The trade receivables do not
have a significant financing component in accordance with IFRS 15.
ML has constructed following provision matrix to determine expected credit losses on the portfolio of receivables:
Required:
Journal entry to record impairment loss on December 31, 2019.
Question 9
On January 1, 2019 Almond Limited (AL) purchased 10% debentures (having nominal value of Rs. 60,000) at a price of Rs.
50,000. These bonds are redeemable at par on December 31, 2022. AL’s management had estimated at initial recognition
that only 85% of contractual cashflows would be recovered. As a result of which, the investment was considered as
purchased credit-impaired financial asset and credit-adjusted effective rate was estimated at 10.627%.
On December 31, 2019 Rs. 4,800 was received in respect of coupon payment of 2019 and AL’s revised its estimate of
expected default on contractual cashflows to 20%.
On December 31, 2020 Rs. 4,900 was received in respect of coupon payment of 2020 and AL’s revised its estimate of
expected default on contractual cashflows to 18%.
On December 31, 2021 Rs. 5,300 was received in respect of coupon payment of 2021 and AL’s revised its estimate of
expected default on contractual cashflows to 12%.
Finally on December 31, 2022 the debentures were redeemed at Rs. 58,000.
Required:
All journal entries till December 31, 2022.
SOLUTIONS
Solution No. 1
(a) Trade date accounting
Case – I Case – II Case – III
29-12-19
31-12-19
04-01-20
31-12-19
04-01-20
Solution No. 2
(a) Trade date accounting
Case – I Case – II Case – III
29-12-19
31-12-19
04-01-20
31-12-19
04-01-20
Solution 3
Dr. Cr.
-------- Rs. -------
29-12-19 Bond B 10,100
Payable 10,100
[initial recognition]
Solution 4
(a) Asset shall be measured at amortized cost Dr. Cr.
-------- Rs. -------
01-01-18 Investment [200,000 x 1.01] 202,000
Cash 202,000
[Initial recognition]
(b) Asset shall be measured at fair value through OCI Dr. Cr.
-------- Rs. -------
01-01-18 Investment [200,000 x 1.01] 202,000
Cash 202,000
[Initial recognition]
W-1
Opening Closing Fair Fair value
Date Interest Cashflow OCI
balance balance value reserve
[A] [B = A x 16.6386%] [C] [D = A + B - C] [E] [F = E - D] [Change in F]
Solution 5
(a) 2019 2020
----------- Rs. ----------
SOCI - extracts
Interest income (W-1) 45,000 46,500
Expected loss [Change in allowance(W-1)] (13,950) (4,588)
SOFP - extracts
Non-current assets
Investment (W-1) 451,050 462,962
(b)
SOCI - extracts
Interest income (W-1) 45,000 46,500
Expected loss [Change in allowance(W-1)] (16,740) (8,539)
SOFP - extracts
Non-current assets
Investment (W-1) 448,260 456,221
(c)
SOCI - extracts
Interest income (W-1) 45,000 44,826
Expected loss [Change in allowance(W-1)] [25,279 – 16,740 – 1,674] (16,740) (6,865)
SOFP - extracts
Non-current assets
Investment (W-1) 448,260 456,221
Loss allowance:
Impairment loss 13,950 16,740 16,740
Balance as at 31-12-19 13,950 16,740 16,740
[B x 30% x 10%] [B x 30% x 12%] [B x 30% x 12%]
[C] 451,050 448,260 448,260
Loss allowance:
Balance as at 01-01-20 13,950 16,740 16,740
Interest adjustment - - 1,674
Impairment loss 4,588 8,539 6,865
Balance as at 31-12-20 18,538 25,279 25,279
[D x 35% x 11%] [D x 35% x 15%] [D x 35% x 15%]
462,962 456,221 456,221
Solution 6
(a) Dr. Cr.
-------- Rs. -------
01-01-19 Investment [5,000 x 98 + 2,500] 492,500
Cash 492,500
[Initial recognition]
Loss allowance:
Initial amount 3,125 3,125
Impairment loss at year end 14,375 14,375
Balance as at 31-12-19 17,500 17,500
[C] 476,629 476,629
Loss allowance:
Balance as at 01-01-20 17,500 17,500
Interest adjustment - 1,657
Impairment loss 2,500 843
Balance as at 31-12-20 20,000 20,000
475,912 475,912
Solution 8
Dr. Cr.
-------- Rs. million -------
31-12-19 Impairment loss [P&L] 0.23
Loss allowance 0.23
[Impairment loss for 2019]
W-1
Gross
Default rate Allowance
amount
(Rs. million) (Rs. million)
Current 15.00 0.30% 0.05
1-30 days 7.50 1.60% 0.12
31-60 days 4.00 3.60% 0.14
61-90 days 2.50 6.60% 0.17
More than 90 days 1.00 10.60% 0.11
0.58
Opening balance 0.35
0.23
Solution 9
Dr. Cr.
-------- Rs. -------
01-01-19 Investment 50,000
Cash 50,000
[Initial recognition]
W-1 Rs.
Initial amount 50,000
Interest income [50,000 x 10.627%(W-2)] 5,314
Cashflow (W-2) (5,100)
Gross balance 31-12-19 50,214
Loss allowance:
Impairment loss 2,992
Balance 31-12-19 (W-2.1) 2,992
47,221
Loss allowance:
Balance 01-01-20 2,992
Interest adjustment 318
Impairment loss (1,451)
Balance 31-12-20 (W-.2.2) 1,859
48,590
Loss allowance:
Balance 01-01-21 1,859
Interest adjustment 198
Impairment loss (3,722)
Balance 31-12-21 (W-.2.2) (1,665)
52,376
Loss allowance:
Balance 01-01-22 (1,665)
Interest adjustment (177)
Impairment loss 1,842
Balance 31-12-22 -
-
W-2
Contractual Recovery Expected
Credit-adjusted effective rate cashflows expected cashflows
Transaction price (50,000) (50,000)
31-12-19 6,000 85% 5,100
31-12-20 6,000 85% 5,100
31-12-21 6,000 85% 5,100
31-12-22 66,000 85% 56,100
Credit-adjusted effective rate 10.627%
RE-CLASSIFICATION
Financial assets
1. When and only when an entity changes it business model for managing financial assets, it shall
reclassify all affected financial assets. Such changes are expected to be very infrequent. A change in
entity’s business model will occur only when an entity either begins or ceases to perform an activity
that is significant to its operations.
Examples:
- An entity has a portfolio of commercial loans that it holds to sell in the short term. The entity
acquires a company that manages commercial loans and has a business model that holds the loans
in order to collect the contractual cash flows. The portfolio of commercial loans is no longer for
sale, and the portfolio is now managed together with the acquired commercial loans and all are
held to collect the contractual cash flows.
- A financial services firm decides to shut down its retail mortgage business. That business no longer
accepts new business and the financial services firm is actively marketing its mortgage loan
portfolio for sale.
Exam note
Since reclassification is applied to “change in business model” only, therefore technically it is not
allowed for:
- Equity investments.
- Investments in debt instruments for which fair value through P&L class was elected irrevocably
on initial recognition.
3. The reclassification shall be applied prospectively from the reclassification date. The entity shall not
restate any previously recognized gains, losses (including impairment gains or losses) or interest.
Reclassification date
The first day of the first reporting period following the change in business model that results in an
entity reclassifying financial assets.
Fair value through OCI - The asset shall be measured at fair value on reclassification date.
- Any resulting fair value gain or loss shall be recognized in OCI.
- The effective interest rate and the measurement of expected credit
losses shall not be adjusted as a result of the reclassification.
Amortized cost - The asset shall be measured at fair value on reclassification date.
- Any resulting fair value gain or loss shall be recognized in P&L.
- The fair value at reclassification date becomes its new gross carrying
amount.
- The effective interest rate is calculated based on the fair value of the
asset at reclassification date.
- For the purpose of initial recognition of loss allowance,
reclassification date is treated as the date of initial recognition.
Amortized cost - The asset shall be measured at fair value on reclassification date.
- The cumulative gain or loss previously recognized in OCI shall be
removed from equity and adjusted against the asset.
Financial liabilities
If a part of a financial asset is transferred, then following de-recognition rules should be applied to the
part only if any one of the following conditions are met:
(i) The part comprises only specifically identified cash flows from an asset (e.g. when an entity enters
into an interest rate stirp whereby the counterparty obtains the right to the interest cash flows but
not the principal cash flows from a debt instrument, the de-recognition rules are applied to interest
cashflows);
(ii) The part comprises only a fully proportionate share of the cash flows from an asset (e.g. when an
entity enters into an arrangement whereby the counterparties obtain the rights to 90% share of all
cashflows of a debt instrument, the de-recognition rules are applied to 90% of those cashflows); OR
(iii) The part comprises only a fully proportionate share of specifically identified cashflows from an asset
(e.g. when an entity enters into an arrangement whereby the counterparties obtain the rights to
90% share of interest cashflows of a debt instrument, the de-recognition rules are applied to 90%
of those interest cashflows).
In all other cases de-recognition rules should be applied to the financial asset in its entirety.
In following guidance, term “financial asset” refers to either a part of a financial asset (as identified above)
or a financial asset in its entirety.
(b) if the entity retains substantially all the risks and rewards of ownership
The entity shall continue to recognize the financial asset and recognize a financial liability for the
consideration received. In subsequent periods, the entity shall recognize any income on the
transferred asset and any expense incurred on the liability.
Examples
(a) a sale and repurchase transaction where the repurchase price is a fixed price or the sale
price plus a lender’s return;
(b) a securities lending agreement;
(c) a sale of a financial asset together with a total return swap that transfers the market risk
exposure back to the entity;
(d) a sale of a financial asset together with a deep in-the-money put or call option; and
(e) a sale of short-term receivables in which the entity guarantees to compensate the
transferee for credit losses that are likely to occur.
(c) if the entity neither transfers nor retains substantially all the risks and rewards of ownership
[For example sale and repurchase transactions (i.e. repo transactions)]
The entity shall determine whether it has retained control of the financial asset.
(i) if the entity has not retained control (i.e. the transferee has the practical ability to sell the
financial asset), it shall derecognize the financial asset and recognize separately as assets or
liabilities any rights and obligations created or retained in the transfer.
(ii) if the entity has retained control (i.e. the transferee does not have the practical ability to sell
the financial asset), it shall continue to recognize the financial asset to the extent of its
continuing involvement in the financial asset. It also recognizes an associated liability.
5. On de-recognition of a part of an asset, the previous carrying amount of the larger financial asset shall
be allocated between the part that continues to be recognized and the part that is de-recognized, on
the basis of the relative fair values of parts on the date of transfer. The difference between:
(a) The carrying amount (measured at date of de-recognition) allocated to the part derecognized;
and
(b) The consideration received for the part derecognized (including any new asset obtained less any
new liability)
Shall be recognized in P&L.
If the asset, which is being partially de-recognized, has cumulative gain/loss in OCI, then the balance in
OCI will also be allocated based on the relative fair values of parts on the date of transfer.
Factoring
Factoring means sale of receivables to another party called “factor”. Factor provides debt collection
services and also provide a certain portion as advance. Factor service may be “with recourse” or
“without recourse”.
With recourse – Since bad debt risk is borne by the entity, therefore, any advance received is considered
as a loan and receivables are not derecognized.
Without recourse – Since bad debt risk is borne by the factor, therefore, receivables are derecognized.
Write-off
An entity shall directly reduce the gross carrying amount of a financial asset when the entity has no
reasonable expectations of recovering a financial asset in its entirety or a portion thereof. A write-off
constitutes a de-recognition event.
For example, an entity plans to enforce the collateral on a financial asset and expects to recover no
more than 30 per cent of the financial asset from the collateral. If the entity has no reasonable
prospects of recovering any further cash flows from the financial asset, it should write off the remaining
70 per cent of the financial asset.
1. An entity shall remove a financial liability (or a part of a financial liability) from its statement of
financial position when, and only when, it is extinguished—i.e. when the obligation specified in the
contract is discharged (e.g. payment) or cancelled or expires (i.e. legally released from primary
responsibility for the liability).
2. An exchange between an existing borrower and lender of debt instruments with substantially
different terms shall be accounted for as an extinguishment of the original financial liability and the
recognition of a new financial liability. Similarly, a substantial modification of the terms of an existing
financial liability or a part of it (whether or not attributable to the financial difficulty of the debtor)
shall be accounted for as an extinguishment of the original financial liability and the recognition of a
new financial liability.
Substantial change
The terms are substantially different if the discounted present value of the cash flows under the
new terms, including any fees paid net of any fees received (only fees paid or received between the
borrower and lender) and discounted using the original effective interest rate, is at least 10 per cent
different from the discounted present value of the remaining cash flows of the original financial
liability.
Scope
An entity shall not apply this Interpretation to transactions in situations where:
(a) the creditor is also a direct or indirect shareholder and is acting in its capacity as a direct or indirect
existing shareholder.
(b) the creditor and the entity are controlled by the same party or parties before and after the
transaction and the substance of the transaction includes an equity distribution by, or contribution
to, the entity.
(c) extinguishing the financial liability by issuing equity shares is in accordance with the original terms
of the financial liability. (e.g. convertibles)
Consensus
1. When equity instruments issued to a creditor as a consideration paid to extinguish all or part of a
financial liability are recognized initially, an entity shall measure them at:
(a) the fair value of the equity instruments issued, unless that fair value cannot be reliably
measured.
(b) If the fair value of the equity instruments issued cannot be reliably measured then the equity
instruments shall be measured to reflect the fair value of the financial liability extinguished.
3. If only a part of financial liability is extinguished and part of the consideration also relates to the
modification of the remaining portion, then the consideration paid shall be allocated between the
part extinguished and part retained.
1. An entity shall recalculate the gross carrying amount of the financial asset and shall recognize a
modification gain or loss in profit or loss.
2. The gross carrying amount of the financial asset shall be recalculated as the present value of the
renegotiated or modified contractual cash flows that are discounted at the financial asset’s original
effective interest rate (or credit-adjusted effective interest rate for purchased or originated credit-
impaired financial assets).
3. Any costs or fees incurred adjust the carrying amount of the modified financial asset and are
amortized over the remaining term of the modified financial asset.
4. An entity shall assess whether there has been a significant increase in the credit risk of the financial
instrument by comparing:
(a) the risk of a default occurring at the reporting date (based on the modified contractual terms);
and
(b) the risk of a default occurring at initial recognition (based on the original, unmodified contractual
terms).
5. If the contractual cash flows on a financial asset have been renegotiated or otherwise modified, but
the financial asset is not derecognized, that financial asset is not automatically considered to have
lower credit risk. An entity shall assess whether there has been a significant increase in credit risk
since initial recognition on the basis of all reasonable and supportable information that is available
without undue cost or effort.
1. The modified asset is considered a ‘new’ financial asset. Accordingly, the date of the modification shall
be treated as the date of initial recognition of that financial asset when applying the impairment
requirements to the modified financial asset. This typically means measuring the loss allowance at an
amount equal to 12-month expected credit losses until the credit risk is significantly increased
afterwards.
2. However, in some unusual circumstances following a modification that results in derecognition of the
original financial asset, there may be evidence that the modified financial asset is credit-impaired at
initial recognition, and thus, the financial asset should be recognized as an originated credit-impaired
financial asset.
PRACTICE QUESTIONS
Question 1
On January 1, 2017, Tokyo Limited (TL) invested Rs. 500,000 (i.e. equal to face value) in 8% debentures. These debentures
would be redeemed at a premium of 10%. The effective interest was 8.6687%.
Initially these debentures were classified as measured at amortized cost. However, on June 30, 2019 management of TL
changed its business model and decided to re-classify these bonds as measured at fair value through P&L.
The fair values of the debentures were as follows:
The debentures have never been credit-impaired and there have been no significant increase in credit risk since initial
recognition. The expected credit losses were determined as follows:
Required:
Journal entries for the years ending December 31, 2019 and 2020.
Question 2
Sigma Limited (SL) purchased bonds in a company some years ago. The bonds were classified at fair value through profit
or loss since they were held for trading. The bonds have a face value of Rs. 500,000 and coupon rate of 10% per annum.
The bonds would be redeemed at a premium of 20% on December 31, 2025.
On August 1, 2019, SL decided to change the classification from fair value through P&L to amortized cost.
The fair values of the bonds were as follows:
The debentures have never been credit-impaired and there have been no significant increase in credit risk since initial
recognition. The expected credit losses were determined as follows:
Required:
Journal entries for the years ending December 31, 2019 and 2020.
Question 3
Mango Limited (ML) purchased debentures of a company on January 1, 2018 for Rs. 147,408 (i.e. fair value). The face
value of debentures was Rs. 100,000 and coupon rate was 20% per annum. These would be redeemed at a premium of
23% on December 31, 2021. Effective interest rate was 10%.
On August 1, 2019, ML decided to change the classification from fair value through OCI to amortized cost.
The fair values of the debentures were as follows:
The debentures have never been credit-impaired and there have been no significant increase in credit risk since initial
recognition. The expected credit losses were determined as follows:
Required:
Journal entries for the years ending December 31, 2019 and 2020.
Question 4
On April 30, 2020 Alpha Limited (AL) sold 3,000 shares of a company at a price of Rs. 65 per share (fair value of share on
that date was Rs. 68). AL also incurred a transaction cost of Rs. 0.70 per share in sale transaction.
These shares had been purchased last year and were re-measured on December 31, 2019 to Rs. 62 per share.
Required:
Journal entries to record sale of shares on April 30, 2020 if AL measures its investments in shares at:
(a) Fair value through P&L
(b) Fair value through OCI
Question 5
On April 30, 2020 Beta Limited (BL) sold 2,000 debentures of a company at a price of Rs. 115 per debenture (fair value of
debenture on that date was Rs. 118). BL also incurred a transaction cost of Rs. 2.50 per debenture.
These debentures had been purchased on January 1, 2018 for Rs. 105 per debenture and also incurred transaction costs
of Rs. 6,000. The effective rate was 12% whereas annual coupon payment was Rs. 15 per debenture.
The fair values of the debentures were as follows:
Date Fair value (Rs.)
December 31, 2018 220,000
December 31, 2019 226,000
Required:
Journal entries to record sale of debentures on April 30, 2020 if BL measures its investments in debentures at:
(a) Amortized cost
(b) Fair value through OCI
Question 6
On January 1, 2020 an entity has a portfolio of loans whose coupon and effective interest rate is 10% and whose principal
amount and amortized cost is Rs. 10,000. On that date, it enters into a transaction in which, in return for a payment of Rs.
9,115, the transferee obtains the right to Rs. 9,000 of any collections of principal plus interest thereon at 9.5%. The entity
retains rights to Rs. 1,000 of any collections of principal plus interest thereon at 10%, plus the excess spread of 0.5% on
the remaining Rs. 9,000 of principal.
Collections are to be allocated between the entity and the transferee proportionately in the ratio of 1:9, but any defaults
are to be deducted from the entity’s interest of Rs. 1,000 until that interest is exhausted. The fair value of the loans at the
date of the transaction is Rs. 10,100 and the fair value of the excess spread of 0.5% is Rs. 40.
Required:
Explain the accounting treatment along with journal entry at the date of transfer.
Question 7
On January 1, 2019 Zee Limited (ZL) sold 2,000 debentures of a company at a price of Rs. 120 per debenture (equal to fair
value of debenture on that date) to Hexa Finance (HF) in a sale and repurchase agreement. Following terms were agreed
in repo agreement:
- ZL will purchase the debentures on December 31, 2020 at a price of Rs. 132 per debenture (irrespective of fair value)
- Coupon payments for 2019 and 2020 will be received by HF being legal owner of debentures
[It gives an effective rate of return of HF equal to 17.106%]
These debentures had been purchased on January 1, 2018 for Rs. 105 per debenture and ZL also incurred transaction
costs of Rs. 6,000. The effective rate was 12% whereas annual coupon payment was Rs. 15 per debenture.
Required:
Journal entries for the years ending December 31, 2019 and 2020.
Question 8
On December 1, 2019 Wee Limited (WL) sold its receivable to factors as follows:
- Receivables amounting to Rs. 800,000 were sold to Factor Aay and receives an advance of 70% immediately at an
interest of 1% per month. The factor also charged a fee of Rs. 8,000 for the service. Factor Aay will pay the balance
amount, after deducting interest and service fees, on debt settlement by customer (i.e. on December 31, 2019). The
debts are factored with recourse.
- Receivables amounting to Rs. 500,000 were sold to a Factor Bee for an immediate payment of Rs. 400,000 and
remaining Rs. 70,000 will be paid on December 31, 2019. The debts are factored without recourse.
Required:
Journal entries for above transactions assuming that debtors settled their accounts on December 31, 2019.
Question 9
Zalmi Limited (ZL) took a loan from Dolphin Bank amounting to Rs. 800,000 on January 1, 2017 at 10% interest payable
annually. Final maturity of loan is on December 31, 2021. ZL also paid processing and legal charges of Rs. 30,000. As a
result its effective interest rate was 11.015%.
During 2018, ZL faced certain financial difficulties and the bank agreed to modify the existing loan. On January 1, 2019,
new terms were agreed as follows:
o ZL will not pay interest for the years 2019 and 2020
o From 2021 onwards annual interest rate will be charged at 12% (i.e. market interest rate)
o Final maturity date will be extended to December 31, 2023
o Fair value of new loan on that date was Rs. 637,755 and effective interest rate was 12%.
ZL paid Rs. 25,000 on January 1, 2019 relating to modification of the loan contract.
Required:
Journal entries for the year ending December 31, 2019.
Question 10
Kings Limited (KL) took a loan from Sultan Bank amounting to Rs. 800,000 on January 1, 2017 at 10% interest payable
annually. Final maturity of loan is on December 31, 2021. ZL also paid processing and legal charges of Rs. 30,000. As a
result its effective interest rate was 11.015%.
During 2018, ZL faced certain financial difficulties and the bank agreed to modify the existing loan. On January 1, 2019,
new terms were agreed as follows:
o ZL will not pay interest for the years 2019 and 2020
o From 2021 onwards annual interest rate will be charged at 13% (i.e. market interest rate)
o Final maturity date will be extended to December 31, 2023
ZL paid Rs. 40,000 on January 1, 2019 relating to modification of the loan contract.
Required:
Journal entries for the year ending December 31, 2019.
Question 11
On January 1, 2017, Sidney Limited (SL) purchased 1 million 5 years debentures issued by Oval Limited (OL) at a premium
of Rs. 5 per debenture. SL also incurred transaction costs of Rs. 1.50 per debenture. Coupon rate was 6% payable annually.
The debentures would be redeemed at par value of Rs. 100 each on December 31, 2021. The effective interest rate was
4.5186%.
Due to certain financial and liquidity issues, OL re-structured the payment plan with effect from January 1, 2020 after due
consultation with debenture holders. Under the revised plan the maturity date was extended by one year. further the
coupon rate was increased to 6.25% for 2020 and 2021 and 6.50% for 2022.
Required:
Journal entries for the year ending December 31, 2020.
Question 12
On January 1, 2018, Mosco Limited (ML) issued 1 million debentures at par (i.e. Rs. 100 each) against purchase of a
building. Coupon rate was 12% per annum whereas effective interest was 14.5%.
On January 1, 2020 it was agreed with the creditor to settle the entire remaining liability by issue of ordinary shares of
ML (having face value of Rs. 10 each) and a result 1.8 million shares were issued. The market price of ML’s shares on
that date was Rs. 65 per share.
Required:
Journal entry to record the issue of shares.
SOLUTIONS
Solution No. 1
Dr. Cr.
------------ Rs. -----------
31-12-19 Investment (AC) 43,948
Interest income 43,948
[Investment income for 2019]
W-1
Opening Closing
Date Interest Payment
balance balance
[A] [B = A x 8.6687%] [C] [A + B - C]
31-12-17 500,000 43,344 40,000 503,344
31-12-18 503,344 43,633 40,000 506,977
31-12-19 506,977 43,948 40,000 510,925
W-2 Rs.
Gross carrying amount 510,925
Loss allowance (9,200)
501,725
Fair value 510,000
Fair value gain 8,275
Solution 2
Dr. Cr.
------------ Rs. -----------
31-12-19 Investment (FVPL) [590,000 - 545,000] 45,000
Fair value gain [P&L] 45,000
[Fair value gain for 2019]
Solution 3
Dr. Cr.
------------ Rs. -----------
31-12-19 Investment (FVOCI) (W-1) 14,215
Interest income 14,215
[Investment income for 2019]
W-1
Opening Closing Fair value
Date Interest Payment Fair value OCI
balance balance reserve
[A] [B = A x 10%] [C] [A + B - C] [E] [F = E - D] [Change in F]
31-12-18 147,408 14,741 20,000 142,149 145,350 3,201 3,201
31-12-19 142,149 14,215 20,000 136,364 148,850 12,486 9,285
31-12-20 136,364 13,636 20,000 130,000 - - -
Solution 4
Dr. Cr.
(a) ------------ Rs. -----------
30-04-20 Investment [3,000 x (68 – 62)] 18,000
Fair value gain [P&L] 18,000
[Remeasurement on the date of de-recognition]
Dr. Cr.
(b) ------------ Rs. -----------
30-04-20 Investment [3,000 x (68 – 62)] 18,000
Fair value reserve [OCI] 18,000
[Remeasurement on the date of de-recognition]
Solution 5
Dr. Cr.
(a) ------------ Rs. -----------
30-04-20 Investment (W-1) 8,294
Interest income 8,294
[Investment income for 4 months]
W-1
Opening Closing Fair value
Date Interest Payment Fair value OCI
balance balance reserve
[A] [B = A x 12%] [C] [A + B - C] [E] [F = E - D] [Change in F]
31-12-18 216,000 25,920 30,000 211,920 220,000 8,080 8,080
31-12-19 211,920 25,430 30,000 207,350 226,000 18,650 10,570
30-04-20 207,350 8,294 - 215,644 236,000 20,356 1,706
[207,350 x 12% x 4/12]
Solution 6
The entity calculates that Rs. 9,090 (90% × Rs. 10,100) of the consideration received of Rs. 9,115 represents the
consideration for a fully proportionate 90%. The remainder of the consideration received (Rs. 25) represents consideration
received for subordinating its retained interest to provide credit enhancement to the transferee for credit losses. In
addition, the excess spread of 0.5% represents consideration received for the credit enhancement. Accordingly, the total
consideration received for the credit enhancement is Rs. 65 (Rs. 25 + Rs. 40).
For allocation of carrying amount to portion of asset de-recognized and portion retained, it is assumed that fair values of
both portions also have a ratio of 1:9 as follows:
Allocation of carrying amount Fair value Portion Carrying amount
Rs. Rs.
Portion transferred 9,090 90% 9,000
Portion retained 1,010 10% 1,000
10,100 10,000
Dr. Cr.
-------- Rs. -------
01-01-20 Cash 9,115
Continuing involvement [1,000 + 40] 1,040
Liability [1,040 + 25] 1,065
Financial asset (W-1) 9,000
Profit on transfer (balancing) 90
[Recognition of transfer]
Solution 7
Dr. Cr.
------------ Rs. -----------
01-01-19 Cash [120 x 2,000] 240,000
Financial liability - repo 240,000
[sale of debentures]
W-1
Opening Closing
Date Interest Payment
balance balance
[A] [B = A x 12%] [C] [A + B - C]
31-12-18 216,000 25,920 30,000 211,920
31-12-19 211,920 25,430 30,000 207,350
31-12-20 207,350 24,882 30,000 202,232
Solution 8
Dr. Cr.
(a) Factor with recourse ------------ Rs. -----------
01-12-19 Cash [800,000 x 70%] 560,000
Financial liability (Factor) 560,000
[70% advance received]
Solution 9
Dr. Cr.
------------ Rs. -----------
01-01-19 Bank loan (existing) (W-1) 780,161
Gain on extinguishment 117,406
Cash 25,000
Bank loan (New) 637,755
[Restructuring of loan]
Solution 10
Dr. Cr.
------------ Rs. -----------
01-01-19 Bank loan (existing) (W-1) 40,000
Cash 40,000
[Restructuring cost of loan]
IRR = 9.0427%
Solution 11
Dr. Cr.
--------- Rs. million --------
01-01-20 Investment (W-2) 2.22
Modification gain [P&L] 2.22
[Modification gain recognized]
W-1
Opening Closing
Date Modification Interest Cashflow
balance balance
[A] [B] [C = (A + B) x 4.5186%] [D] [A + B + C - D]
Solution 12
Dr. Cr.
------------ Rs. million ----------
-
01-01-20 Debentures (W-1) 105.36
Loss on extinguishment 11.64
Share capital [1.8 x Rs. 10] 18.00
Share premium [1.8 x Rs. 55] 99.00
[Extinguishment of financial liability]
W-1
Opening Closing
Date Interest Payment
balance balance
[A] [B = A x 14.5%] [C] [A + B - C]
31-12-18 100.00 14.50 12.00 102.50
31-12-19 102.50 14.86 12.00 105.36
Loss allowance:
Initial amount 11,200
Impairment loss at year end -
Balance 31-12-15 11,200
1,469,650
Loss allowance:
Balance 01-01-16 11,200
Impairment loss 51,400
Balance 31-12-16 62,600
1,424,837
Loss allowance:
Balance 01-01-17 62,600
Impairment loss 8,300
Balance 31-12-17 70,900
1,423,954
Loss allowance:
Balance 01-01-17 70,900
Interest adjustment 8,933
Impairment loss (8,933)
Balance 31-12-18 70,900
1,432,306
IAS 32 – Class notes
DEFINITIONS
A financial instrument is any contract that gives rise to a financial asset of one entity and a financial
liability or equity instrument of another entity.
An equity instrument is any contract that evidences a residual interest in the assets of an entity after
deducting all of its liabilities.
PRESENTATION
1. The issuer of the financial instrument shall classify the instrument (or its component parts) on initial
recognition as a financial liability or an equity instrument in accordance with the substance of the
contractual agreement and the definitions.
2. A critical feature in differentiating a financial liability from an equity instrument is the existence of a
contractual obligation of one party to the financial instrument (the issuer) either to deliver cash or
another financial asset to the other party (the holder) or to exchange financial assets or financial
liabilities with the holder under conditions that are potentially unfavourable to the issuer. Although
the holder of an equity instrument may be entitled to receive a pro rata share of any dividends or
other distributions of equity, the issuer does not have a contractual obligation to make such
distributions because it cannot be required to deliver cash or another financial asset to another party.
3. A contract is not an equity instrument solely because it may result in the receipt or delivery of the
entity’s own equity instruments. Two examples are (a) a contract to deliver as many of the entity’s
own equity instruments as are equal in value to Rs. 100, and (b) a contract to deliver as many of the
entity’s own equity instruments as are equal in value to the value of 100 ounces of gold. Such a
contract is a financial liability of the entity even though the entity must or can settle it by delivering
its own equity instruments.
4. A financial instrument may require the entity to deliver cash or another financial asset, or otherwise
to settle it in such a way that it would be a financial liability, in the event of the occurrence or
non-occurrence of uncertain future events (or on the outcome of uncertain circumstances) that are
beyond the control of both the issuer and the holder of the instrument, such as a change in a stock
market index, consumer price index, interest rate or taxation requirements, or the issuer’s future
revenues, net income or debt-to-equity ratio. The issuer of such an instrument does not have the
unconditional right to avoid delivering cash or another financial asset (or otherwise to settle it in such
a way that it would be a financial liability). Therefore, it is a financial liability of the issuer.
For example, a bond or similar instrument convertible by the holder into a fixed number of ordinary
shares of the entity is a compound financial instrument. From the perspective of the entity, such an
instrument comprises two components: a financial liability (a contractual arrangement to deliver cash
or another financial asset) and an equity instrument (a call option granting the holder the right, for a
specified period of time, to convert it into a fixed number of ordinary shares of the entity). The
economic effect of issuing such an instrument is substantially the same as issuing simultaneously a
debt instrument with an early settlement provision and warrants to purchase ordinary shares, or
issuing a debt instrument with detachable share purchase warrants. Accordingly, in all cases, the
entity presents the liability and equity components separately in its statement of financial position.
2. Classification of the liability and equity components of a convertible instrument is not revised as a
result of a change in the likelihood that a conversion option will be exercised, even when exercise of
the option may appear to have become economically advantageous to some holders.
3. The initial carrying amount of a compound financial instrument is allocated to its equity and liability
components as follows:
Fair value of the instrument as a whole X
Less: Financial liability component [i.e. calculated as PV of contractual cashflows (X)
(ignoring conversion option) discounted at the market rate of interest on similar
debt instruments without conversion options]
Equity component X
4. Transaction costs that relate to the issue of compound financial instrument are allocated to the
liability and equity components of the instrument in proportion to above allocation.
Transaction cost relating to:
7. When an entity extinguishes a convertible instrument before maturity through an early redemption
or repurchase in which the original conversion privileges are unchanged:
(a) the entity allocates the consideration paid for the repurchase or redemption to the liability and
equity components of the instrument at the date of the transaction and account for as follows:
(b) Any transaction cost paid is allocated to liability component and equity component in ratio of [A]
and [B] above mentioned in point [7(a)]. This allocated transaction cost is then accounted for as
follows:
(c) Any remaining balance in equity component may be transferred to another line item in equity e.g.
retained earnings.
8. An entity may amend the terms of a convertible instrument to induce early conversion, for example
by offering a more favourable conversion ratio or paying other additional consideration in the event
of conversion before a specified date. The difference, at the date the terms are amended, between
the fair value of the consideration the holder receives on conversion of the instrument under the
revised terms and the fair value of the consideration the holder would have received under the
original terms is recognised as a loss in profit or loss.
Treasury shares
If an entity reacquires its own equity instruments, those instruments (‘treasury shares’) shall be deducted
from equity. No gain or loss shall be recognized in profit or loss on the purchase, sale, issue or cancellation
of an entity’s own equity instruments. Such treasury shares may be acquired and held by the entity or by
other members of the consolidated group.
However, when an entity holds its own equity on behalf of others, e.g. a financial institution holding its
own equity on behalf of a client, there is an agency relationship and as a result those holdings are not
included in the entity’s statement of financial position.
Interest, dividends, losses and gains relating to a financial instrument or a component that is a financial
liability shall be recognized as income or expense in profit or loss. Distributions to holders of an equity
instrument shall be recognized by the entity directly in equity. Transaction costs of an equity transaction
shall be accounted for as a deduction from equity.
1. A financial asset and a financial liability shall be offset and the net amount presented in the statement
of financial position when, and only when, an entity:
(a) currently has a legally enforceable right to set off the recognized amounts; and
(b) intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously.
2. An entity currently has a legally enforceable right of set‑off if the right of set‑off:
(a) is not contingent on a future event; and
(b) is legally enforceable in all of the following circumstances:
(i) the normal course of business;
(ii) the event of default; and
(iii) the event of insolvency or bankruptcy of the entity and all of the counterparties.
3. Offsetting a recognized financial asset and a recognized financial liability and presenting the net
amount differs from the derecognition of a financial asset or a financial liability. Although offsetting
does not give rise to recognition of a gain or loss, the derecognition of a financial instrument not only
results in the removal of the previously recognized item from the statement of financial position but
also may result in recognition of a gain or loss.
Preference shares
Preference shares may be issued with various rights. In determining whether a preference share is a
financial liability or an equity instrument, an issuer assesses the particular rights attaching to the share to
determine whether it exhibits the fundamental characteristic of a financial liability.
A summary of various terms relating to preference shares and the resulting accounting treatment is
outlined in the table below:
Preference shares Preference dividend Preference dividend
(Mandatory) (Discretionary)
Redeemable: It is considered as financial It is considered as compound
- Mandatory; OR liability instrument
- At the option of holder
Liability is initially measured at Liability is initially measured at
fair value i.e. present value of PV of the redemption amount
future contractual cashflows only.
Equity is initially measured as
residual.
PRACTICE QUESTIONS
Question 1
An entity issued 2,000 convertible bonds on January 1, 2020. The bonds have a three-year term, and are issued at par
with a face value of Rs. 1,000 per bond, giving total proceeds of Rs. 2,000,000 but the fair value was Rs. 1,980,000. Interest
is payable annually in arrears at a nominal annual interest rate of 6 per cent. Each bond is convertible at any time up to
maturity into 250 ordinary shares. When the bonds are issued, the prevailing market interest rate for similar debt without
conversion options is 9 per cent.
Required:
Journal entry at initial recognition of bonds.
Question 2
A Pakistani company issued 100 5% FCCBs at a nominal value of $ 5 each on January 1, 2019. These bonds can be redeemed
at par or converted into 25 ordinary shares per bond after 3 years. On the date of issuance, market rate of return for
similar bonds without conversion option was 9%. Exchange rates are as follows:
Date Rs./$
01-01-19 150
31-12-19 152
31-12-20 156
31-12-21 160
Required:
All journal entries till maturity if on maturity:
(a) Investor opts for cash redemption.
(b) Investor opts for conversion (Assume face value of each share is Rs. 10).
Question 3
An entity issued 1,000 convertible bonds on January 1, 2011. The bonds had a 10-year term, and were issued at par with
a face value of Rs. 1,000 per bond, giving total proceeds of Rs. 1,000,000. Interest is payable in arrears at a nominal annual
interest rate of 10% payable every 6-months. Each bond is convertible on maturity into ordinary shares at a conversion
price of Rs. 25 per share. When the bonds were issued, the prevailing market interest rate for similar debt without
conversion options was 11%.
On January 1, 2016 the entity repurchased the bonds at a price of Rs. 1,700 each. On that date market interest rate of
similar non-convertible bonds was 8%.
Required:
Journal entries to record repurchase of bonds.
Question 4
An entity issued 1,000 convertible bonds on January 1, 2011. The bonds had a 10-year term, and were issued at par with
a face value of Rs. 1,000 per bond, giving total proceeds of Rs. 1,000,000. Interest is payable in arrears at a nominal annual
interest rate of 10% payable every 6-months. Each bond is convertible on maturity into ordinary shares at a conversion
price of Rs. 25 per share. When the bonds were issued, the prevailing market interest rate for similar debt without
conversion options was 11%.
On January 1, 2012, to induce the holder to convert the convertible debenture, the entity reduced the conversion price
to Rs. 20. Assume the market price of entity’s ordinary shares on the date of amendment is Rs. 40 per share.
Required:
Journal entry on January 1, 2012 to record the effect of amendment.
Question 5
Following transactions relate to Aron Limited (AL):
(a) AL issued one million convertible bonds on January 1, 2018. The bonds had a term of three years and were issued
with a total fair value of Rs. 100 million which is also the par value. Interest is paid annually in arrears at a rate of 6%
per annum and bonds, without the conversion option, attracted an interest rate of 9% per annum on January 1, 2018.
The company incurred issue costs of Rs. 1 million. If the investor did not convert to shares they would have been
redeemed at par. At maturity all of the bonds were converted into 2.5 million ordinary shares of Rs. 10 each of AL.
No bonds could be converted before that date. The directors have been told that the impact of the issue costs is to
increase the effective interest rate to 9.38%.
(b) AL held a 3% holding of the shares in Smart, a public limited company, The investment was classified as an investment
in equity instruments and at December 31, 2020 had a carrying value of Rs. 5 million (brought forward from the
previous period). As permitted by IFRS 9 Financial instruments, AL had made an irrevocable election to recognize all
changes in fair value in other comprehensive income. The cumulative gain to December 31, 2019 recognized in other
comprehensive income relating to the investment was Rs. 400,000. On December 31, 2020, the whole of the share
capital of Smart was acquired by Given, a public limited company, and as a result, AL received shares in Given with a
fair value of Rs. 5.5 million in exchange for its holding in Smart.
(c) AL granted interest free loans to its employees on January 1, 2020 of Rs. 10 million. The loans will be paid back on
December 31, 2021 as a single payment by the employees. The market rate of interest for a two year loan on both of
the above dates is 6% per annum.
Required:
Journal entries for the year ending December 31, 2020.
SOLUTIONS
Solution No. 1 Dr. Cr.
------------ Rs. -----------
01-01-20 Cash 2,000,000
Gain on initial recognition [P&L] 20,000
Financial liability (W-1) 1,848,122
Equity component (W-1) 131,878
[Initial recognition of bonds]
W-1 Rs.
Total fair value of financial instrument 1,980,000
Liability component 1,848,122
[120,000 x annuity factor at 9% + 2,000,000 x discount factor at 9%]
Equity component 131,878
(a) Redemption
31-12-21 Financial liability [525(W-2) x 160] 84,000
Equity component 7,594
Retained earnings 7,594
Cash 84,000
[Redemption of bonds]
(b) Conversion
31-12-21 Financial liability [525(W-2) x 160] 84,000
Equity component 7,594
Share capital [100 x 25 x RS. 10] 25,000
Share premium (balancing) 66,594
[Conversion of bonds into ordinary shares]
W-1 $
Total fair value of financial instrument [$ 5 x 100] 500.00
Liability component [$500 x 5% x annuity factor at 9% + $500 x discount factor at 9%] 449.37
Equity component 50.63
W-2
------------------------ $ Amortized cost ------------------------- Rupees
amortized
Date Opening Closing
Interest Cashflow cost
balance balance (translated)
[A] [B = A x 9%] [C] [D = A + B - C] [E]
31-12-19 449.37 40.44 25.00 464.81 70,652 [464.81 x 152]
31-12-20 464.81 41.83 25.00 481.64 75,136 [481.64 x 153]
31-12-21 481.64 43.36 525.00 - -
W-1 Rs.
Initial measurement:
Total value of financial instrument 1,000,000
Liability component 940,248
[50,000 x annuity factor at 5.5%* + 1,000,000 x discount factor at 5.5%]
Equity component 59,752
* 11% x 6/12 = 5.5%
W-2
Loss on repurchase of liability:
PV of remaining contractual cashflows at 8% 1,081,109
[50,000 x annuity factor at 4% + 1,000,000 x discount factor at 4%]
Solution No. 4
Dr. Cr.
------------ Rs. -----------
01-01-12 Loss on amendment 400,000
Equity component (W-1) 400,000
[Loss on amendment of conversion ratio]
W-1 Rs.
Fair value of shares under amended terms [Rs. 1m ÷ Rs. 20 x Rs. 40] 2,000,000
Fair value of shares under original terms [Rs. 1m ÷ Rs. 25 x Rs. 40] 1,600,000
Loss on amendment 400,000
Solution No. 5
Dr. Cr.
------------ Rs. million ----------
(a) -
31-12-20 Interest expense (W-2) 9.11
Financial liability 9.11
[Interest expense for 2020]
(b)
31-12-20 Investment (Smart) [5.50 - 5] 0.50
FV reserve [OCI] 0.50
[Remeasurement gain on de-recognition]
(c)
01-01-20 Financial asset (Loan) [10m x 1.06-2] 8.90
Employee cost (balancing) 1.10
Cash 10.00
[Initial recognition of loan]
W-2
Opening Closing
Date Interest Payment
balance balance
[A] [B = A x 9.38%] [C] [A + B - C]
31-12-18 91.48 8.58 6.00 94.06
31-12-19 94.06 8.82 6.00 96.89
31-12-20 96.89 9.11 6.00 100.00
W-2
Initial measurement of liability component:
PV of interest cashflows:
2015 - 2019 [6m x 5-year annuity factor at 7% (i.e. KIBOR + 2%)] 24.60
2020 [3m x 1.07-6] 2.00
PV of principal payments:
2019 [50m x 1.07-5] 35.65
2020 [50m x 1.07-6] 33.32
95.57
W-3
Loss on repurchase of liability Rs. million
PV of interest cashflows:
2016 - 2019 [6m x 4-year annuity factor at 8% (i.e. KIBOR + 2%)] 19.87
2020 [3m x 1.08-5] 2.04
PV of principal payments:
2019 [50m x 1.08-4] 36.75
-5
2020 [50m x 1.08 ] 34.03
Fair value of liability component on 01-01-16 92.70
W-4
Allocation of transaction cost:
Financial liability component [0.2m x 9.27/10.50] 0.18
Equity component [0.2m x 1.23/10.50] 0.02
0.20
IFRS 9 (Hedging) – Class notes
DERIVATIVES
A financial instrument or other contract with all three of the following characteristics:
(a) its value changes in response to the change in a specified interest rate, financial instrument price,
commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other
variable (called the ‘underlying’).
(b) it requires no initial net investment or an initial net investment that is smaller than would be required
for other types of contracts that would be expected to have a similar response to changes in market
factors.
(c) it is settled at a future date.
Examples:
Forward – a forward contract is a binding contract to buy or sell a specified amount of a specified item
(e.g. currency, oil, gold etc.) on a specified date. Normally a commission is paid at the time of contract.
Future – a future contract is a contract to buy or sell standard amount of a particular item (e.g. currency,
copper, shares etc.) on a standard date at a price determined in market. Futures are traded in an organized
market where these contracts are mostly settled by closing out by taking opposite position (e.g. sell now
and buy later) and net gain/loss is settled.
Option – an option contract is a right to its holder to buy or sell a particular item (e.g. shares, currency, oil
etc.) at a specified price on a specified date. Holder is not obligated to exercise the option rather it may
exercise the option only when beneficial. A premium (i.e. charges for option) is paid at the time of contract
irrespective of whether the option is eventually exercised or not.
Swap – a swap is an agreement between parties to exchange a series of cashflow at an agreed rate. Most
commonly used type of swap arrangement is an interest rate swap where two parties agree to exchange
interest payments calculated on a notional principal. Sometimes a fee is also paid to a bank that arranges
the swap and the said fee is also generally agreed as a % of notional principal.
Use of derivatives:
- Speculation
- Hedging
Measurement:
If used for speculation, derivates are termed as “held for trading” and measured at fair value through P&L.
Embedded derivatives
An embedded derivative is a component of a hybrid contract that also includes non-derivative host—
with the effect that some of the cash flows of the combined instrument vary in a way similar to a
stand-alone derivative. An embedded derivative causes some or all of the cash flows that otherwise
would be required by the contract to be modified according to a specified interest rate, financial
instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit
index, or other variable, provided in the case of a non-financial variable that the variable is not specific
to a party to the contract.
If the host contract is not a financial asset as per IFRS 9, then an embedded derivative shall be separated
from the host and accounted for as a derivative (i.e. measured at fair value through P&L) [e.g. purchase
of convertible debenture].
However, if the host contract is a financial asset as per IFRS 9, then whole contract is accounted for as
per IFRS 9 and derivative is not separated. [e.g. purchase of a car with share warrant]
HEDGING
Hedging refers to an entity’s risk management activities that use financial instruments to manage
exposures arising from particular risks that could affect profit or loss or OCI.
Hedged item
A hedged item is a recognized asset or liability, an unrecognized firm commitment (e.g. purchase order),
highly probable forecast transaction or net investment in a foreign operation that (a) exposes the entity
to risk of changes in fair value or future cash flows and (b) is designated as being hedged.
Hedging instrument
A hedging instrument is a designated derivative or (for a hedge of the risk of changes in foreign currency
exchange rates only a designated non-derivative financial asset or non-derivative financial liability) whose
fair value or cash flows are expected to offset changes in the fair value or cash flows of a designated
hedged item.
Hedge effectiveness
Hedge effectiveness is the degree to which changes in the fair value or cash flows of the hedged item that
are attributable to a hedged risk are offset by changes in the fair value or cash flows of the hedging
instrument.
Hedge ratio
Hedge ratio is the relationship between the quantity of the hedging instrument and the quantity of the
hedged item in terms of their relative weighting.
HEDGING ACCOUNTING
A hedging relationship qualifies for hedge accounting only if all of the following criteria are met:
(a) the hedging relationship consists only of eligible hedging instruments and eligible hedged items.
(b) at the inception of the hedging relationship there is formal designation and documentation of the
hedging relationship and the entity’s risk management objective and strategy for undertaking the
hedge. That documentation shall include identification of the hedging instrument, the hedged item,
the nature of the risk being hedged and how the entity will assess whether the hedging relationship
meets the hedge effectiveness requirements (including its analysis of the sources of hedge
ineffectiveness and how it determines the hedge ratio).
(c) the hedging relationship meets all of the following hedge effectiveness requirements:
(i) there is an economic relationship between the hedged item and the hedging instrument (i.e. the
hedging instrument and the hedged item have values that generally move in the opposite
direction because of the same risk, which is the hedged risk).
(ii) the effect of credit risk does not dominate the value changes that result from that economic
relationship (i.e. the gain or loss from credit risk does not frustrate the effect of changes in the
underlying on the value of the hedged item or hedging instrument); and
(iii) the hedge ratio of the hedging relationship is the same as that resulting from the quantity of the
hedged item that the entity actually hedges and the quantity of the hedging instrument that the
entity actually uses to hedge that quantity of hedged item.
An entity shall discontinue hedge accounting prospectively only when the hedging relationship (or a part
of a hedging relationship) ceases to meet the qualifying criteria. This includes instances when the hedging
instrument expires or is sold, terminated or exercised.
There are three types of hedging relationships:
1) fair value hedge
2) cash flow hedge
3) hedge of a net investment in a foreign operation (IAS 21)
Exam tips for selecting between fair value hedge and cashflow hedge:
Examples of items Hedge
Fixed rate debt (asset/liability) Fair value hedge
Floating rate debt (asset/liability) Cashflow hedge
Highly probable forecast transaction Cashflow hedge
Foreign currency firm commitment Entity has choice of either of the two hedges
Foreign currency receivables/payables Cashflow hedge
Recognized assets whose value changes are a Fair value hedge
concern for entity (e.g. inventory, investment in
shares)
However, exam question may specify any hedge to be used different from above tips.
(b) the hedging gain or loss on the hedged item shall adjust the carrying amount of the hedged item. If
the measurement of hedged item involves amortized calculation, then this adjustment in carrying
amount is taken to P&L [as mentioned in (a) above] through revised effective interest rate.
When a hedged item is an unrecognized firm commitment, the cumulative change in the fair value of
the hedged item subsequent to its designation is recognized as a firm commitment asset or a firm
commitment liability. If this commitment was to acquire an asset or assume a liability, then such firm
commitment asset or firm commitment liability shall be closed against initial carrying amount of the
asset or liability on eventual recognition.
The cumulative gain or loss that has been accumulated in foreign currency translation reserve shall be
reclassified from equity to P&L as a reclassification adjustment on the disposal of the foreign operation.
PRACTICE QUESTIONS
Question 1
Journalize each of the following independent derivative transactions, entered into for speculation purposes:
(a) On May 1, 2020 A limited entered into a forward contract with Bank XYZ to purchase $ 50,000 on July 31, 2020 at an
agreed rate of Rs/$ 160. A forward commission of Rs. 0.1 per USD was paid at the time of contract. Following exchange
rates are available:
Date Forward rate (Rs/$) Spot rate (Rs/$)
01-05-20 160 (3-month forward) 158.20
30-06-20 (year-end) 162.25 (1 month forward) 161.30
31-07-20 - 163.50
(b) On June 1, 2020 B limited purchased 2000 call options on shares of ML, a listed company, on following terms:
Exercise price Rs. 45 per share
Exercise date August 31, 2020
Premium Rs. 2 per share (it is also considered as fair value of option on that date)
(c) On June 1, 2020 C limited bought 12 crude oil future contracts, with a contract size of 150 barrels, having 30 th
September maturity. Following are the future prices quoted in future market for 30th September crude oil futures:
Date Future price
(Rs/barrel)
01-06-20 10,000
30-06-20 (year-end) 9,800
30-09-20 9,450
(d) Company A has a loan of Rs. 2 million with a fixed rate of 10%. Company B has a loan of Rs. 2 million with a variable
rate of KIBOR which is revised annually. On January 1, 2019 both companies agreed to swap their interest rates for
three years. KIBOR was revised as follows:
Date KIBOR
01-01-19 10%
01-01-20 8%
01-01-21 13%
Journalize all transactions in books of Company A for three years.
Question 2
On December 1, 2019 A limited acquired 10,000 ounces of a Material XYZ, at a cost of Rs. 220 per ounce, which it held in
its inventories. A limited was concerned that the price of XYZ would fall, so on December 1, 2019 it sold 10,000 ounces in
future market at a price of Rs. 215 per ounce with a maturity date of March 31, 2020.
At December 31, 2019 (i.e. accounting year-end) the fair value of XYZ was Rs. 200 per ounce while the future price moved
to Rs. 198 per ounce. On March 1, 2020 A limited sold entire stock of XYZ at market price of Rs. 195 per ounce whereas
future price of 31st March XYZ future at date was Rs. 192.
Required:
All journal entries for above transactions.
Question 3
B limited has a firm commitment to buy a machine for $ 2 million on March 31, 2020. The directors are worried about
exchange rate fluctuations. On October 1, 2019, when exchange rate was Rs/$ 150, B limited entered into a future contract
to buy $ 2 million with a maturity date of March 31, 2020 at a price of Rs. 152 per $.
At December 31, 2019 (i.e. accounting year-end) spot exchange rate moved to Rs/$ 154.50. On that date future price of
31st March $ future moved to Rs. 157 per $. Finally on 31st March 2020 spot exchange rate moved to Rs./$ 160. Useful life
of machine is 10 years.
Required:
Journal entries in respect of above information for the years ending December 31, 2019 and 2020 if on October 1, 2019
the future contract was designated as a fair value hedge for the firm commitment of purchase of machine.
Question 4
OneAir is a successful international airline. A key factor affecting OneAir’s cashflows and profits is the price of jet fuel. On
October 1, 2019, OneAir entered into a forward contract to hedge its expected fuel requirements for the second quarter
of 2020 for delivery of 28m gallons of jet fuel on March 31, 2020 at a price of Rs. 204 per gallon. The spot price on October
1, 2029 of jet fuel was Rs. 190 per gallon.
The airline intended to settle the contract net in cash and purchase the actual required quantity of jet fuel in the open
market on March 31, 2020.
At the company’s year end (i.e. December 31, 2019) the forward price for delivery on March 31, 2020 had risen to Rs. 216
per gallon of
ereas spot price on that day was Rs. 200 per gallon.
All necessary documentation was set up at inception for the contract to be accounted for as a hedge. On March 31, 2020
the company settled the forward contract net in cash and purchased 30m gallons of jet fuel at the spot price on that day
of Rs. 219 per gallon.
Required:
Journal entries for above transactions.
Question 5
Beta limited has approved a capital budget in its board meeting on October 1, 2019 to purchase a machine on September
30, 2020 from Ceta limited for £8 million. Beta limited hedged this highly probable forecast transaction by entering into a
forward contract to buy £8 million at an agreed rate of Rs/£ 200. Spot and forward exchange rates were as follows:
On September 30, 2020 the machine was purchased as per plan and accordingly brought into use. Its useful life was
estimated at 10 years.
Required:
Journal entries for the years ending December 31, 2019 and 2020.
Question 6
Delta Limited (DL) planned to purchase an asset in July 2021. In this respect a quotation was received from a supplier in
US for $ 50,000. A forward contract was taken out to hedge currency fluctuation on March 1, 2021 with an expiry date of
August 31, 2021. On April 15, 2021 it accepted the quotation and issued purchase order for the asset to be delivered on
July 20, 2021. Full purchase amount to be settled on August 31, 2021.
40% of this asset was sold on September 27, 2021 and 60% was sold on October 31, 2021.
Required:
All relevant journal entries assuming that:
(a) Purchased asset was inventory.
(b) Purchased asset was an Investment.
SOLUTIONS
Solution No. 1
Dr. Cr.
(a) ------------ Rs. -----------
01-05-20 P&L [0.1 x $ 50,000] 5,000
Cash 5,000
[Transaction cost paid]
(b)
01-06-20 Financial asset [2 x 2000] 4,000
Cash 4,000
[Initial recognition of option contract]
(c)
01-06-20 No entry
W-1
30-06-20 Rs.
Buy 10,000
Sell 9,800
Loss (200)
Total loss [200 x 150 x 12] (360,000)
30-09-20 Rs.
Buy 10,000
Sell 9,450
Loss (550)
Total loss [550 x 150 x 12] (990,000)
Total loss previously recognized (360,000)
(630,000)
(d)
31-12-19 Finance cost [2m x 10%] 200,000
Bank 200,000
[Interest on loan for 2019]
W-1
2020 %
A receives from B 10%
A pays to B 8%
Net receipt 2%
2021 %
A receives from B 10%
A pays to B 13%
Net payment -3%
Solution No. 2
Dr. Cr.
------------ Rs. -----------
01-12-19 Inventory [10,000 x 220] 2,200,000
Cash 2,200,000
[Purchase of 10,000 ounces of XYZ]
W-1
31-12-19 Rs.
Sell 215
Buy 198
Gain 17
Total gain [17 x 10,000] 170,000
01-03-20 Rs.
Sell 215
Buy 192
Gain 23
Total gain [23 x 10,000] 230,000
Total gain previously recognized 170,000
60,000
Solution No. 3
Dr. Cr.
------------ Rs. -----------
01-10-19 No entry
W-1
31-12-19 Rs.
Buy 152
Sell 157
Gain 5
31-03-20 Rs.
Buy 152
Sell 160
Gain 8
Solution No. 4
Dr. Cr.
------------ Rs. million --------
01-10-19 No entry
W-1
31-12-19 Rs. million
Cumulative loss on hedged item [(200 - 190) x 28m] (280.00)
Cumulative gain on hedging instrument [(216 - 204) x 28m] 336.00
Cash flow hedge reserve [i.e. lower of above] 280.00
Solution No. 5
Dr. Cr.
------------ Rs. million --------
01-10-19 No entry
W-1
31-12-19 Rs. million
Cumulative loss on hedged item [(190 - 180) x £8m] (80.00)
Cumulative gain on hedging instrument [(214 - 200) x £8m] 112.00
Cash flow hedge reserve [i.e. lower of above] 80.00
W-2
30-09-20 Rs. million
Cumulative loss on hedged item [(222 - 180) x £8m] (336.00)
Cumulative gain on hedging instrument [(222 - 200) x £8m] 176.00
Cash flow hedge reserve [i.e. lower of above] 176.00
W-1
15-04-21 Rs. 000
Cumulative loss on hedged item [(153 - 150) x $50,000] (150.00)
Cumulative gain on hedging instrument [(160 - 158) x $50,000] 100.00
Cash flow hedge reserve [i.e. lower of above] 100.00
W-2
30-06-21 Rs. 000
Initial recognition in firm commitment 100.00
Revised value of commitment [(158 - 150) x $50,000] 400.00
Forex loss 300.00
W-1
30-06-15 Rs. million
Cumulative loss on hedged item [(105.38 - 103.20) x $6m] (13.08)
Cumulative gain on hedging instrument [(105.50 - 103.63) x $6m] 11.22
Cash flow hedge reserve [i.e. lower of above] 11.22
W-2
01-08-15 Rs. million
Cumulative loss on hedged item [(106 - 103.20) x $6m] (16.80)
Cumulative gain on hedging instrument [(106 - 103.63) x $6m] 14.22
Cash flow hedge reserve [i.e. lower of above] 14.22
SCOPE
An entity shall apply this standard to all leases, including leases of right-of-use assets in a sublease, except
for:
(a) Leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources;
(b) Leases of biological assets (IAS 41);
(c) Service concession arrangement (IFRIC 12);
(d) Licences of intellectual property granted by lessor within the scope of IFRS 15; and
(e) Rights held by a lessee under licencing agreements within the scope of IAS 38 for such items as motion
picture films, video recordings, plays, manuscripts, patents and copyrights.
[A lessee may, but is not required to, apply this standard to leases of intangible assets other than
those described above]
Lease
1. Lease is a contract, or part of a contract, that conveys the right to use an asset (the underlying asset)
for a period of time in exchange for consideration. A period of time may be described in terms of
the amount of use of an identified asset (for example, the number of production units that an item
of equipment will be used to produce.)
2. A contract conveys the right to control the use of an identified asset for a period of time if the
customer has, throughout the period, both of the following:
(a) The right to obtain substantially all of the economic benefits from use of the identified asset
(within the defined scope of a customer’s right to use the asset); and
(b) The right to direct the use of the identified asset
3. A customer has the right to direct how and for what purpose the asset is used if, within the scope
of its right of use defined in the contract, it can change how and for what purpose the asset is used
throughout the period of use.
4. A customer does not have the right to use an identifiable asset if the supplier has the substantive
right to substitute the asset throughout the period of use. A supplier’s right to substitute an asset
is substantive only if both of the following conditions exist:
(a) the supplier has the practical ability to substitute alternative assets throughout the period of
use (for example, the customer cannot prevent the supplier from substituting the asset and
alternative assets are readily available to the supplier or could be sourced by the supplier within
a reasonable period of time); and
(b) the supplier would benefit economically from the exercise of its right to substitute the asset
(i.e. the economic benefits associated with substituting the asset are expected to exceed the
costs associated with substituting the asset).
BOOKS OF LESSOR
Lessor
An entity that provides the right to use an underlying asset for a period of time in exchange for
consideration.
IMPORTANT TERMS
1. Types of leases
- A finance lease is a lease that transfers substantially all the risks and rewards incidental to
ownership of an underlying asset. [Title may or may not eventually be transferred]
- An operating lease is a lease that does not transfer substantially all the risks and rewards
incidental to ownership of an underlying asset.
2. The inception of the lease is the earlier of the date of a lease agreement and the date of commitment
by the parties to the principal terms and conditions of the lease.
3. The commencement date of lease is the date on which a lessor makes an underlying asset available
for use by a lessee.
4. The lease term is the non-cancellable period for which a lessee has the right to use an underlying
asset, together with both:
(a) periods covered by an option to extend the lease if the lessee is reasonably certain to exercise
that option; and
(b) periods covered by an option to terminate the lease if the lessee is reasonably certain NOT to
exercise that option.
5. Lease modification is a change in the scope of a lease, or the consideration for a lease that was not
part of the original terms and conditions of the lease (e.g. extending or shortening the contractual
lease term).
6. Lease payments [LP] are the payments made by a lessee to a lessor relating to the right to use an
underlying asset during the lease term, comprising the following:
(a) fixed payments (including in-substance fixed payments), less any lease incentives;
In-substance fixed payments exist, for example, if:
(a) payments are structured as variable lease payments, but there is no genuine variability in
those payments. Those payments contain variable clauses that do not have real economic
substance. Examples of those types of payments include:
(i) payments that must be made only if an asset is proven to be capable of operating during
the lease, or only if an event occurs that has no genuine possibility of not occurring; or
(ii) payments that are initially structured as variable lease payments linked to the use of
the underlying asset but for which the variability will be resolved at some point after
the commencement date so that the payments become fixed for the remainder of the
lease term. Those payments become in-substance fixed payments when the variability
is resolved.
(b) there is more than one set of payments that a lessee could make, but only one of those sets
of payments is realistic. In this case, an entity shall consider the realistic set of payments to
be lease payments.
(c) there is more than one realistic set of payments that a lessee could make, but it must make
at least one of those sets of payments. In this case, an entity shall consider the set of
payments that aggregates to the lowest amount (on a discounted basis) to be lease
payments.
Lease incentives are the payments made by a lessor to a lessee associated with a lease, or the
reimbursement or assumption by a lessor of costs of a lessee.
(b) variable lease payments that depend on an index (e.g. consumer index) or a rate (e.g. KIBOR);
(c) the exercise price of a purchase option if the lessee is reasonably certain to exercise that option;
and
(d) payments of penalties for terminating the lease, if the lease term reflects the lessee exercising an
option to terminate the lease.
Lease payments also include any residual value guarantees [GRV] provided to the lessor by the lessee,
a party related to the lessee or a third party unrelated to the lessor.
7. Residual value guarantee [GRV] is a guarantee made to a lessor by a party unrelated to the lessor
that the value (or part of the value) of an underlying asset at the end of a lease will be at least a
specified amount.
8. Unguaranteed residual value [UGRV] is that portion of the residual value of the underlying asset, the
realization of which by a lessor is not assured or is guaranteed solely by a party related to the lessor.
i.e. UGRV = Total expected RV – GRV
9. Initial direct costs [IDC] are Incremental costs of obtaining a lease that would not have been incurred
if the lease had not been obtained.
11. Net investment in lease [NIL] is the gross investment in the lease discounted at the interest rate
implicit in the lease.
13. The interest rate implicit in the lease is the rate of interest that causes
(a) the present value of the lease payments and the unguaranteed residual value
to equal the sum of;
(b) the fair value of the underlying asset and any initial direct cost of the lessor [Only for Financier
lessor].
Types of lessors:
For better understanding, following types of lessors can be described in case of finance lease:
Financier lessor Dealer / manufacturer lessor
A lessor who technically provides loan as it A lessor who provides asset out of its stock because
purchases asset from market for leasing e.g. it also sells such assets earning some selling profit.
banks, leasing companies e.g. a car dealer who sells cars on cash as well as on
lease.
CLASSIFICATION OF LEASES
1. A lessor shall classify each of its leases as either an operating lease or a finance lease. Whether lease
is a finance lease or an operating lease depends on the substance of the transaction rather than form
of the contract. Examples of situations that individually or in combination would normally lead to a
lease being classified as a finance lease are:
(a) The lease transfers ownership of the underlying asset to the lessee by the end of the lease term;
(b) The lessee has the option to purchase the underlying asset at a price that is expected to be
sufficiently lower than fair value at the date the option becomes exercisable for it to be reasonably
certain, at inception date, that the option will be exercised [called Bargain Purchase Option];
(c) The lease term is for the major part of the economic life of the underlying asset even if title is not
transferred. [Generally it is 75% of economic life or may be considered as 2/3 of economic life];
or
(d) At the inception of the lease, the present value of the lease payments amounts to at least
substantially all of the fair value of the underlying asset. [Here substantially means 90 % or more];
(e) The underlying asset is of such a specialized nature that only the lessee can use it without major
modifications.
2. Indicators of situations that individually or in combination could also lead to a lease being classified
as a finance lease are:
(a) If the lessee can cancel the lease, the lessor’s losses associated with the cancellation are borne by
the lessee;
(b) Gains or losses from the fluctuation in the fair value of the residual value accrue to the lessee (for
example proceeds at the end of the lease); and
(c) The lessee has the ability to continue the lease for a secondary period at a rent that is substantially
lower than market rent.
OPERATING LEASE
1. A lessor shall recognize lease payments from operating leases as income on either a straight-line basis
or another systematic basis. The lessor shall apply another systematic basis if that basis is more
representative of the pattern in which benefit from the use of the underlying asset is diminished.
2. A lessor shall add initial direct costs incurred in obtaining an operating lease to the carrying amount
of the underlying asset and recognize those costs as an expense over the lease term on the same basis
as the lease income.
3. The depreciation policy for depreciable underlying assets subject to operating leases shall be
consistent with the lessor’s normal depreciation policy for similar assets. [i.e. in accordance with IAS
16 and IAS 38]
4. A lessor shall account for a modification to an operating lease as a new lease from the effective date
of modification (i.e. date when both parties agree to modification). The original lease is considered
cancelled and any prepaid/accrued lease payments of the original lease shall be considered as part of
the lease payments for the new lease.
Disclosures
1. A lessor shall disclose lease income for the reporting period.
2. For items of PPE subject to an operating lease, a lessor shall apply the disclosure requirements of IAS
16.
3. A lessor shall disclose a maturity analysis of undiscounted lease payments to be received on an annual
basis for a minimum of each of the first five years and a total of the amounts for the remaining years.
FINANCE LEASE
Dr. Net investment in lease [NIL] Dr. Net investment in lease [NIL]
Cr. Cash Dr. Cost of sales [Cost or NBV – PV of UGRV]
Cr. Sales [NIL – PV of UGRV]
(If a lessor provides any of its PPE on finance Cr. Inventory [Cost/NBV]
lease then NBV of PPE is credited instead of
cash and a profit/loss on disposal is recorded)
Exam note:
NIL = PV of GIL discounted at implicit rate Exam note:
OR NIL = Fair value (i.e Sale price – trade discount)
NIL = fair value of asset + IDC OR
NIL = PV of GIL discounted at higher of market
interest rate or implicit rate
2) IDCs incurred by lessor are included in the
initial measurement of NIL. When NIL is 2) IDC type expenses incurred by lessor are
determined by discounting GIL at implicit rate recognized as expense at the commencement
then IDCs are automatically in the amount of of lease.
NIL therefore no need to add them separately.
IDCs reduce the finance income over the lease
term.
Subsequent measurement
1. A lessor shall recognize finance income over the lease term, based on a pattern reflecting a constant
periodic rate of return on the lessor’s NIL.
2. Finance income is calculated using a lease amortization schedule which starts from initial
measurement amount of net investment in lease.
Payment Opening Balance Interest Lease payment Closing Balance
date [A] [B = A x interest %] [C] [A + B – C]
X X X X
X X X X
3. A lessor shall review regularly estimated unguaranteed residual values used in computing the GIL. If
there has been a reduction, the lessor shall revise the income allocation over the lease term.
Lease modification
At the effective date of modification, a PPE is The lessor shall apply the modification
recognized with remaining balance in NIL: requirements of IFRS 9 which are as follows:
Dr. PPE (i.e. underlying asset) - lessor shall recalculate net investment in lease
Cr. Net investment in lease as PV of modified contractual cashflows that
are discounted at original implicit rate.
Onwards the lease shall be accounted for a new - Any modification gain/loss shall be recognized
operating lease. in P&L
Disclosures
1. A lessor shall disclose following amounts for the reporting period in a tabular format:
- Selling profit or loss
- Finance income on the net investment in lease
- Income relating to variable lease payments not included in the measurement of the net
investment in lease.
2. A lessor shall disclose a maturity analysis of undiscounted lease payments to be received on an annual
basis for a minimum of each of the first five years and a total of the amounts for the remaining years.
3. A lessor shall reconcile the undiscounted lease payments to the net investment in lease. The
reconciliation shall identify the unearned finance income relating to the lease payments receivable
and any undiscounted unguaranteed residual value.
1. When a lease includes both land and building elements, a lessor shall assess the classification of each
element as finance lease or operating lease.
2. Whenever necessary in order to classify and account for a lease of land and buildings, a lessor shall
allocate lease payments (including any lump-sum upfront payments) between the land and the
buildings elements in proportion to the relative fair values of the leasehold interests in the land
element and buildings element of the lease at the inception date.
3. If the lease payments cannot be allocated reliably between these two elements, the entire lease is
classified as a finance lease, unless it is clear that both elements are operating leases, in which case
the entire lease is classified as an operating lease.
4. For a lease of land and buildings in which the amount for the land element is immaterial to the lease,
a lessor may treat the land and buildings as a single unit for the purpose of lease classification and
classify it as a finance lease or an operating lease. In such a case, a lessor shall regard the economic
life of the buildings as the economic life of the entire underlying asset.
PRACTICE QUESTIONS
Question 1
On 1 January 2019, French Vanilla Leasing Limited (FVLL) purchased a machine costing Rs. 200 million having useful life
of 8 years. Residual value of the machine at end of its useful life is estimated at Rs. 16 million.
On 1 February 2019, FVLL entered into a lease agreement for this machine with Cotton Candy Limited (CCL) for a non-
cancellable period of 2.5 years with effect from 1 March 2019. Under the agreement, eight instalments of Rs. 12 million
are to be paid quarterly in arrears commencing from the end of 3rd quarter i.e. 30 November 2019.
FVLL has incorporated an implicit rate of 15% per annum which is not known to CCL. Incremental borrowing rate of CCL
is 16% per annum.
On 1 April 2019, CCL completed installation of the machine at a cost of Rs. 4 million and put it into use.
Both companies follow straight line method for charging depreciation.
Required:
Prepare journal entries for the year ended 31 December 2019 in the books of FVLL to record the above transactions.
(15)
[Spr-20, Q-5]
Question 2
Neptune Limited (NL) had established its business in December 2008 as a supplier of plant and machinery. During the year
ended December 31, 2009 the company sold two machines under lease arrangements. The details are as under:
A B
Date of commencement of lease January 1, 2009 January 1, 2009
Lease term 6 years 3 years
Lease installments payable annually in advance Rs. 2,000,000 Rs. 4,000,000
(to be reduced annually by 5%)
Cost of machine Rs. 6,963,448 Rs. 15,000,000
Economic life 6 years 6 years
NL sells machines on cash at cost plus 25%. It depreciates its assets under straight line method with no residual value. Fair
market annual interest rate is 15%.
Required:
(a) Prepare journal entries to record the above transactions.
(b) Prepare notes to the financial statements for the year ended December 31, 2009 in accordance with the
requirements of IFRS - 16 (Leases). (19)
(Ignore taxation and comparative figures) {Spring 2010, Q # 1}
Question 3
Galaxy Leasing Limited (GLL) has leased certain equipment to Dairy Products Limited on 1 July 2013. In this respect, the
following information is available:
Rs. in million
Cost of equipment 28.69
Amount received on 1 July 2013 3.00
Four annual installments payable in arrears on 30 June, each year 7.80
Guaranteed residual value on expiry of the lease 5.00
Useful life of the equipment is estimated at 5 years. Rate of interest implicit in the lease is 14%.
Required:
(a) Prepare accounting entries for the year ended 30 June 2014 in the books of GLL to record the transactions related
to the above lease arrangement in accordance with the requirements of International Financial Reporting
Standards. (07)
(b) Prepare a note for inclusion in GLL's financial statements for the year ended 30 June 2014, in accordance with
the requirements of International Financial Reporting Standards. (10)
{Autumn 2014, Q # 5}
Question 4
Quartz Auto Limited (QAL) is engaged in the business of manufacturing of trucks. Since a number of the prospective
customers do not have adequate funds to purchase the vehicles against full payment, QAL provides lease financing facility
to its customers. It expects to receive a return at the rate of 15% per annum on the amount of lease finance.
On 1 July 2010, QAL sold seven trucks to Emerald Goods Transport Company (EGTC) on lease. The terms of the lease and
related information are as follows:
(i) The lease period is 4 years, extendable up to the expected useful life of the trucks i.e. 5 years.
(ii) EGTC has guaranteed a residual value of Rs. 360,000 for each truck, till the end of the fourth year. However, the
guarantee would lapse if the lease term is extended to the fifth year. EGTC will return the truck at the end of the
lease term.
(iii) Lease rentals amount to Rs. 2,715,224 per annum and are payable in arrears i.e. on 30 June.
(iv) The cost of each truck is Rs. 900,000. Price in case of outright sale is Rs. 1,350,000 per truck.
(v) The expected residual value of each truck at the end of the 4th and 5th year is Rs. 150,000 and Rs. 100,000
respectively.
Required:
Assuming that QAL and EGTC intend to extend the lease for a period of five years, prepare:
(a) Journal entries to record the transactions for the year ended 30 June 2011. (08)
(b) A note for inclusion in the financial statements, for the year ended 30 June 2011, in accordance with the
requirements of IFRS-16 ‘Leases’. (07)
{Autumn 2011, Q # 4}
Question 5
Guava Leasing Limited (GLL), had leased a machinery to Honeyberry Limited (HL) on 1 July 2017 on the following terms:
(i) The non-cancellable lease period is 3.5 years. Each semi-annual lease instalment of Rs. 48 million is
receivable in arrears.
(ii) The useful life of machine is 6 years.
(iii) The lease contains an option to extend the lease term by 1.5 years. Each semiannual lease instalment
in the extended period will be of Rs. 15 million, receivable in arrears. It is reasonably certain that HL
will exercise this option.
(iv) The rate implicit in the lease is 10% p.a.
(v) The unguaranteed residual value at the end of lease term is estimated at Rs. 20 million.
GLL incurred a direct cost of Rs. 10 million and general overheads of Rs. 0.5 million to complete the transaction.
Required:
Prepare note(s) for inclusion in GLL’s financial statements, for the year ended 30 June 2018. (09)
{Autumn 2018, Q # 6(a)}
Question 6
Square Limited (SL) is a dealer of electronic items. SL acquires refrigerators of a particular model from a manufacturer at
a discount of 15% on the retail price of Rs. 300,000 per unit.
On 1 January 2018, SL sold 12 refrigerators to Cube Hotel at retail price on lease. The rate of interest implicit in the lease
was 10% per annum. The payment is to be made in three equal annual instalments payable in advance. Residual value at
the end of 3 years is nil.
Required:
Prepare journal entries in the books of SL in respect of above transaction for the year ended 31 December 2018. (07)
{Spring 2019, Q # 1(b)}
Question 7
On 1 January 2020, Bolan Leasing Company (BLC) leased a machine to Datsun Motors Limited (DML) to manufacture
components of a new model of vehicle, on the following terms:
(i) Non-cancellable lease period is 5 years,
(ii) The agreement contains an option for DML to extend the lease for further 3 years in which case, lease rentals for
further 3 years shall be 10% less than original rentals; and
(iii) Lease rentals are payable annually in advance.
Required:
In the books of BLC, for the year ended December 31, 2020:
(a) Prepare journal entries.
(b) Show extracts of SOFP and SOCI.
(c) Prepare a note on “net investment in lease”
Question 8
Lessor limited leased land and building to Lessee limited. The detail of which is as follows:
- Commencement date of lease is January 1, 2019
- Lease term is for 20 years
- Lease payments are Rs. 500,000 payable at end of every year.
At the inception of the lease the fair value of leasehold interest in land was Rs. 5,000,000 while the fair value of the
leasehold interest in the building was Rs. 2,240,832.
The building had been purchased for Rs. 3,000,000 and were being depreciated over its total estimated useful life of 30
years to a nil residual value. At inception of lease, the building had a remaining useful life of 22 years.
Land was purchased 10 years ago for Rs. 2,200,000 and was not depreciated.
After a careful assessment of all facts and circumstances, each of elements was correctly classified as follows:
- Lease over land was classified as operating lease
- Lease over building was classified as finance lease
Required:
Prepare accounting entries for the years ending December 31, 2019 and 2020.
SOLUTIONS
Solution No. 1
Books of FVLL
--------- Rs. million --------
01-01-19 Machine 200.00
Cash 200.00
[Purchase of machine]
Solution 2
(a)
Date Particulars Dr. Cr.
------------ Rs. '000 ----------
LEASE - A [FINANCE LEASE]
01-Jan-09 Lease receivable [W-1] 8,704
Cost of sales 6,963
Sales 8,704
Inventory 6,963
[Initial recognition of lease]
01-Jan-09 Bank 2,000
Lease receivable 2,000
[receipt of 1st rental]
31-Dec-09 Lease receivable 1,006
Finance income 1,006
[accrual of interest income for the year]
Since PV of LP is equal to FV and lease term covers whole life, therefore, lease A is a finance lease
W–2
Rent as per agreement: Rs,'000’
year 1 4,000
year 2 (95%) 3,800
year 3 (95%) 3,610
11,410
Income for the year 3,803
Receipt in 2009 4,000
Unearned income 197
Since LP is much lower than cost and lease term covers 50% life, therefore, lease B is an operating lease.
W - 3 Lease schedule
Date Open. Bal. Interest Payment Clos. Bal.
01-Jan-09 8,704 - 2,000 6,704
01-Jan-10 6,704 1,006 2,000 5,710
01-Jan-11 5,710 856 2,000 4,566
01-Jan-12 4,566 685 2,000 3,251
01-Jan-13 3,251 488 2,000 1,739
01-Jan-14 1,739 261 2,000 -
(b)
NOTES TO THE ACCOUNTS
1 - Net investment in lease
Lease term is 6 years. Rental is receivable at start of every year. Implicit rate is 15%.
Maturity analysis:
Rs.'000’
Lease payments receivable:
1 year 2,000
2 years 2,000
3 years 2,000
4 years 2,000
5 years 2,000
10,000
Reconciliation: Rs.'000’
Total lease payments receivable 10,000
Unguaranteed residual value -
Gross investment in lease 10,000
Less: Unearned finance income 2,290
Net investment in lease 7,710
2 - Operating lease
Maturity analysis:
Lease payments receivable:
1 year 3,800
2 years 3,610
7,410
Solution 3
(a)
Date Particulars Dr. Cr.
------------ Rs. '000’ ----------
01-Jul-13 Lease receivable 28,690
Bank 28,690
[Initial recognition of lease]
01-Jul-13 Bank 3,000
Lease receivable 3,000
[Receipt of down payment]
30-Jun-14 Bank 7,800
Finance income 3,597
Lease receivable 4,203
[receipt of 1st rental]
(b)
NOTES TO THE ACCOUNTS
5 - Net investment in lease
Lease term is 4 years and instalment is receivable at end of every year. Implicit rate is 14%.
Maturity analysis:
Rs.'000’
Lease payments receivable:
1 year 7,800
2 years 7,800
3 years 12,800
28,400
Reconciliation:
Rs.'000’
Total lease payments receivable 28,400
Unguaranteed residual value -
Gross investment in lease 28,400
Less: Unearned finance income 6,914
Net investment in lease 21,487
W – 1 Lease schedule
Date Open. Bal. Interest Payment Clos. Bal.
01-Jul-13 28,690 - 3,000 25,690
30-Jun-14 25,690 3,597 7,800 21,487
30-Jun-15 21,487 3,008 7,800 16,695
30-Jun-16 16,695 2,337 7,800 11,232
30-Jun-17 11,232 1,568 7,800 5,000
Solution 4
(a)
Date Particulars Dr. Cr.
------------ Rs. '000’ ----------
01-Jul-10 Lease receivable [1,350 x 7] 9,450
Cost of sales [900 x 7 – 348 (W-1)] 5,952
Sales [9,450 – 348 (W-1)] 9,102
Inventory [900 x 7] 6,300
[Initial recognition of lease]
30-Jun-11 Bank 2,715
Finance income 1,418
Lease receivable 1,297
[receipt of 1st rental]
(b)
NOTES TO THE ACCOUNTS
4 - Net investment in lease
Lease term is 4 years extendable upto 5 years. Rental is receivable at end of every year. Implicit rate is 15%.
Maturity analysis:
Rs.'000’
Lease payments receivable:
1 year 2,715
2 years 2,715
3 years 2,715
4 years 2,715
10,861
Reconciliation:
Total lease payments receivable 10,861
Unguaranteed residual value 700
Gross investment in lease 11,561
Less: Unearned finance income 3,409
Net investment in lease 8,152
W – 3 Lease schedule
Date Open. Bal. Interest Payment Clos. Bal.
30-Jun-11 9,450 1,418 2,715 8,152
30-Jun-12 8,152 1,223 2,715 6,660
30-Jun-13 6,660 999 2,715 4,944
30-Jun-14 4,944 742 2,715 2,970
30-Jun-15 2,970 445 2,715 700
Solution 5
Guava Leasing Limited
Notes to financial statements
for the year ended June 30, 2018
Maturity analysis:
Lease payments receivable as follows: Rs. million
1 year 96.00
2 years 96.00
3 years 63.00
4 years 30.00
285.00
W-2
Date Op. bal Interest Payment Cl. Bal
31-Dec-17 319.05 15.95 48.00 287.01
30-Jun-18 287.01 14.35 48.00 253.36
31-Dec-18 253.36 12.67 48.00 218.03
30-Jun-19 218.03 10.90 48.00 180.93
Solution 6
----- Rs. million ----
01-01-18 Lease receivable (W-2) 3.483
Cost of sales [3.60 x 85%] 3.060
Sales [W-2] 3.483
Inventory 3.060
[Initial recognition of lease]
W-1
Rental = [0.30m x 12] / (1 + annuity factor at 10%)
= 1.316
W-2
NIL = Sales = Lease receivable = 1.316 + 1.316 x annuity factor at 14%
= 3.483
Solution 7
Dr. Cr.
(a) ----------- Rs. million ----------
01-01-20 Lease receivable 206.10
Bank 206.10
[Initial measurement]
(b)
Extracts - SOCI Rs. million
Extracts - SOFP
Non-current assets
Lease receivable (W-2) 152.09
Current assets
Lease receivable [168.50 - 152.09 + 23.59] (W-2) 40.00
(c)
Notes
5 - Net investment in lease
Maturity analysis Rs. million
Lease payments are receivable as follows:
Year 1 40.00
Year 2 40.00
Year 3 40.00
Year 4 40.00
Year 5 36.00
More than 5 years [36 + 36 + 5] 77.00
273.00
Reconciliation
Lease payments 273.00
Un-guaranteed residual value 2.00
Gross investment in lease 275.00
Unearned finance income (82.91)
Net investment in lease 192.09
Workings
W-1 Rental calculation
Fair value = PV of lease payments + PV of UGRV
206.10m = R + R x 4-year A.F. at 14% + 0.9 R x 3-year A.F. at 14% x 4-year D.F. + 7m x 1.14-8 - 4m x 60%
Solution 8
------------ Rs. -----------
01-01-19 Lease receivable 2,240,832
Acc. dep - building [3,000,000 x 8/30] 800,000
Building 3,000,000
Profit on disposal 40,832
[Initial recognition of lease]
Current assets
Net investment in lease [9.60 - 5.07] (W-2) 4.53
Extracts - SOCI
for the year ending Dec 31, 2013 Rs. million
Sales (W-1) 16.64
Cost of sales [10 cars x Rs. 1.8m x 0.85] 15.30
Service revenue [Rs. 12,000 x 10 cars] 0.12
Service cost 0.11
Interest income (W-2) 1.64
WORKINGS
W-1 Initial measurement Rs. million
Lease receivable:
- Down payment [300,000 x 10 cars] 3.00
- Rentals [5.68m* x 3-year A.F. at 12%] 13.64
16.64
BOOKS OF LESSEE
Lessee
Lessee is an entity that obtains the right to use an underlying asset for a period of time in exchange for
consideration.
IMPORTANT TERMS
2. The lessee’s incremental borrowing rate of interest is the rate of interest that a lessee would have to
pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset
of a similar value to the right-of-use asset in a similar economic environment.
3. Right-of-use asset is an asset that represents a lessee’s right to use an underlying asset for the lease
term.
4. Short term lease is a lease that, at the commencement date, has a lease term of 12 months or less. A
lease that contains a purchase option is not a short-term lease.
For a contact that contains a lease component and one or more additional lease or non-lease components,
a lessee shall allocate the consideration in the contract to each lease component on the basis of the
relative stand-alone price of the lease component and the aggregate stand-alone price of the non-lease
components. [i.e. same concept as for allocation of transaction price to separate performance obligations
in IFRS-15]
Dr. Right-of-use
Cr. Lease liability
[Any lease payments made at or before the commencement date, less any lease incentives shall also
be included in the cost of right-of-use asset]
2. Any initial direct cost incurred by the lessee shall be included in the cost of right-of-use asset.
3. PV of estimated dismantling and site restoration shall be included in the cost of right-of-use asset if
lessee has an obligation in accordance with IAS 37.
4. If a lessee incurs costs relating to the construction or redesigning for use of underlying asset, the
lessee shall account for those costs in accordance with other applicable standards e.g. IAS 16.
Subsequent measurement
Right-of-use asset
1. A lessee shall measure the right-of-use asset using cost model, revaluation model or fair value model
(i.e. IAS 40) as per its selected policy.
If underlying asset will be retained by lessee after If underlying asset will be returned by lessee:
lease:
Depreciation shall be charged from the Depreciation shall be charged from the
commencement date to the end of useful life of commencement date to the earlier of:
the underlying asset. - the end of useful life of the right-of-use
asset.
- the end of lease term.
Exam tip:
Asset will be retained by lessee after lease if:
- ownership of the underlying asset will be transferred to lessee at end of lease term. OR
- If lease contains BPO.
Lease liability
1. A lessee shall recognize interest cost over the lease term, based on a pattern reflecting a constant
periodic rate of interest on remaining lease liability. Interest is calculated using a lease amortization
schedule.
2. Variable lease payments not included in the measurement of lease liability shall be recognized in P&L
in the period in which the event or condition that triggers those payments occurs.
Revised discount rate, There is a change in future lease payments resulting from a
reflecting the changes in change in rate (e.g. KIBOR) used to determine those payments.
interest rate, shall be used if: In this case revised lease payments shall be determined for the
remaining lease term based on revised contractual cashflows.
Lease modification
2. Adjustment for scope reduction (e.g. reduction in right of use, reduction in lease term) will be made
by decreasing the carrying amounts of lease liability and right of use. This adjustment will be made
before adjusting any other modification. The lessee shall recognize in profit or loss any gain or loss
relating to this scope reduction as follows:
W-1
Carrying amount of lease liability on the date of modification X
PV of lease payments after scope reduction discounted at original rate (X)
(ignoring any other modification)
X
Covid-19 pandemic
A lessee may elect not to assess whether a rent concession occurring as a direct consequence of the
covid-19 is a lease modification, only if all of the following conditions are met:
(a) the change in lease payments results in revised consideration for the lease that is substantially the
same as, or less than, the consideration for the lease immediately preceding the change;
(b) any reduction in lease payments affects only payments originally due on or before 30 June 2021
(for example, a rent concession would meet this condition if it results in reduced lease payments
on or before 30 June 2021 and increased lease payments that extend beyond 30 June 2021); and
(c) there is no substantive change to other terms and conditions of the lease.
Exceptional accounting:
The lessee shall recognize the lease payments associated with those leases as an expense on either a
straight-line basis over the lease term or another systematic basis. The lessee shall apply another
systematic basis if that basis is more representative of the pattern of the lessee’s benefit.
SUB-LEASE
A transaction for which an underlying asset is re-leased by a lessee (‘intermediate lessor’) to a third party,
and the lease (‘head lease’) between the head lessor and lessee remains in effect.
Classification of sublease:
In classifying a sublease, an intermediate lessor shall classify the sublease as a finance lease or an
operating lease as follows:
(a) if the head lease is a short-term lease that the entity, as a lessee, has followed exceptional accounting,
the sublease shall be classified as an operating lease.
(b) otherwise, the sublease shall be classified by reference to the right-of-use asset arising from the head
lease, rather than by reference to the underlying asset (for example, the item of property, plant or
equipment that is the subject of the lease).
During the term of the sublease, the intermediate lessor recognizes both finance income on the
sublease and interest expense on the head lease.
PRACTICE QUESTIONS
Question 1
On 1 January 2019, French Vanilla Leasing Limited (FVLL) purchased a machine costing Rs. 200 million having useful life
of 8 years. Residual value of the machine at end of its useful life is estimated at Rs. 16 million.
On 1 February 2019, FVLL entered into a lease agreement for this machine with Cotton Candy Limited (CCL) for a non-
cancellable period of 2.5 years with effect from 1 March 2019. Under the agreement, eight instalments of Rs. 12 million
are to be paid quarterly in arrears commencing from the end of 3rd quarter i.e. 30 November 2019.
FVLL has incorporated an implicit rate of 15% per annum which is not known to CCL. Incremental borrowing rate of CCL
is 16% per annum.
On 1 April 2019, CCL completed installation of the machine at a cost of Rs. 4 million and put it into use.
Both companies follow straight line method for charging depreciation.
Required:
Prepare journal entries for the year ended 31 December 2019 in the books of CCL to record the above transactions.
(15)
[Spr-20, Q-5]
Question 2
On 1 July 2010, Miracle Textile Limited (MTL) acquired a machine on lease, from a bank. Details of the lease are as follows:
(i) Fair value of machine is Rs. 20 million. It is also equal to present value of lease payments.
(ii) The lease term and useful life is 4 years and 10 years respectively.
(iii) Installment of Rs. 5.80 million is to be paid annually in advance on 1 July.
(iv) The interest rate implicit in the lease is 15.725879%.
(v) At the end of lease term, MTL has an option to purchase the machine on payment of Rs. 2 million. The fair value of
the machine at the end of lease term is expected to be Rs. 3 million.
MTL depreciates the machine on the straight line method to a nil residual value.
Required:
Prepare relevant extracts of the statement of financial position and related notes to the financial statements for the year
ended 30 June 2012 along with comparative figures. Ignore taxation (16)
{Autumn 2012, Q # 2}
Question 3
On 1 January 2020, Dettol Limited (DL) acquired a machine on lease from Lifebuoy Leasing Limited (LLL) for 3 years. The
first annual instalment amounting to Rs. 35 million was paid on 1 January 2020 and all subsequent annual instalments are
payable on 1 January subject to increase of 10% each year.
DL incurred initial direct cost of Rs. 5 million. As an incentive to DL for entering into the lease, LLL reimbursed Rs. 2 million.
LLL has incorporated an implicit rate of 11% per annum which is not known to DL.
The residual value of the machine at the end of 3 years is estimated at Rs. 30 million, out of which DL has guaranteed Rs.
20 million.
DL is also obliged to incur decommissioning cost of Rs. 4 million at the end of the lease term.
Discount rate of 12% may be assumed wherever required but not given.
Required:
Prepare relevant extracts from DL’s statement of profit or loss for the year ended 31 December 2020 and statement of
financial position as on that date.
(09)
[Spr-21, Q-5]
Question 4
On 1 July 2015, ABC acquired a machine on lease on following terms:
(i) Basic contract period is 5 years, however, ABC has an option to extend it by 2 more years.
(ii) Rental of Rs. 240,000 is payable at end of every year in first 5 years. During extension period, lease rental will reduce
to Rs. 180,000 per year.
Implicit rate was not readily determined, therefore, incremental borrowing rate of 8% was used at commencement to
account for lease. Initially ABC was uncertain about exercise of extension option.
On June 30, 2018 due to change in circumstances, ABC reassessed the possibility of exercise of extension option and
concluded it to be reasonably certain to be exercised. On that date the incremental borrowing rate was 10%.
Required:
Journal entries for the years ending June 30, 2018 and 2019.
Question 5
On 1 July 2016, XYZ acquired a machine on lease on following terms:
(i) Lease term 8 years.
(ii) Lease rental payable in advance on 1st July every year. It will be revised every two years on the basis of the increase
in CPI for the preceding 24 months. Rental applicable for first two years is Rs. 50,000 per year.
(iii) XYZ is also required to make a variable payment for each year of lease equal to 1% of sales generated from the
machine.
Implicit rate was not readily determined, therefore, incremental borrowing rate of 8% was used at commencement to
account for lease. Initial direct cost paid by XYZ was Rs. 4,000. CPI on the date of commencement was 125.
On July 1, 2018 i.e. start of third year of lease, CPI moved to 135. On that date the incremental borrowing rate was 10%.
XYZ made annual sales of Rs. 1,250,000 in 2018 and 2019.
Required:
Journal entries for the years ending June 30, 2018 and 2019 (excluding sales entry).
Question 6
On 1 July 2017, DEF acquired a property on lease on following terms:
(i) Basic contract period is 5 years.
(ii) Rental of Rs. 250,000 is payable at end of every year.
Implicit rate was not readily determined, therefore, incremental borrowing rate of 9% was used at commencement to
account for lease.
On July 1, 2019 lessee and lessor both agreed to amend the original lease by increasing the contractual lease period by
four years. Lease rentals were also revised to Rs. 290,000 payable at end of every year over remaining lease term. On that
date the incremental borrowing rate was 10%.
Required:
Journal entries for the years ending June 30, 2019 and 2020.
Question 7
On 1 July 2014, MNO acquired a 5,000 square metres of office space on lease on following terms:
(i) Contract period is 10 years.
(ii) Rental of Rs. 200,000 payable at end of every year.
Implicit rate was not readily determined, therefore, incremental borrowing rate of 9% was used at commencement to
account for lease.
On July 1, 2019 lessee and lessor both agreed to amend the original lease to reduce the office space by 2,500 square
metres only (i.e. 50% reduction) w.e.f. July 1, 2019. Lease payments were reduced to Rs. 120,000 per year. On that date
the incremental borrowing rate was 7%.
Required:
Journal entries for the years ending June 30, 2019 and 2020.
Question 8
On 1 July 2014, PQR acquired a 2,000 square metres of office space on lease on following terms:
(i) Contract period is 10 years.
(ii) Rental of Rs. 100,000 payable at end of every year.
Implicit rate was not readily determined, therefore, incremental borrowing rate of 6% was used at commencement to
account for lease.
On July 1, 2019 lessee and lessor both agreed to amend (w.e.f. July 1, 2019) the original lease to:
(a) include an additional 1,500 square metres of space in the same building
(b) reduce the lease term from 10 years to 8 years.
The annual rental for 3,500 square metres was revised to Rs. 150,000 per year. Since this increase in rental is not
consistent with the stand-alone price of additional office space, therefore, it can not be accounted for as a separate lease.
On that date the incremental borrowing rate was 7%.
Required:
Journal entries for the years ending June 30, 2019 and 2020.
SOLUTIONS
Solution No. 1
Books of CCL
--------- Rs. million --------
01-03-19 ROU asset (W-2) 74.70
Lease liability 74.70
[Initial recognition of lease]
Open. Lease
Date Interest Clos. Bal
Bal payment
31-05-19 74.70 2.99 - 77.69
31-08-19 77.69 3.11 - 80.79
30-11-19 80.79 3.23 (12.00) 72.02
29-02-20 72.02 2.88 (12.00) 62.91
Solution 2
Miracle Textile Limited
Balance sheet – Extracts 2012 2011
-------------- Rs.'000’ ----------
Non-Current assets
Right of use [Note - 1] 16,000 18,000
Non-Current liabilities
Lease liability [Note - 2] 6,505 10,633
Current liabilities
Lease liability [Note - 2] 5,800 5,800
Miracle Textile Limited
Notes - Extracts
1 - Property, plant and equipment
Cost
As at July 1 20,000 -
Additions - 20,000
Disposal - -
As at June 30 20,000 20,000
Depreciation
As at July 1 2,000 -
For the year 2,000 2,000
Disposal - -
As at June 30 4,000 2,000
NBV as at June 30 16,000 18,000
2 - Lease Liability
The Company has entered into a finance lease agreement with a bank in respect of a machine. The finance lease liability
bears interest at the rate of 15.725879% per annum. The company has the option to purchase the machine by paying
an amount of Rs. 2 million at the end of the lease term. The lease rentals are payable annually in advance
2012 2011
For the year: ---------- Rs.'000’ ----------
Depreciation 2,000 2,000
Finance charge 1,672 2,233
Total cash outflow for leases 5,800 5,800
Lease assets:
Carrying amount 16,000 18,000
Addition to right of use - 20,000
Solution 3
DL
Extracts - SOFP
as at Dec 31, 2020 Rs. million
Non-Current assets
Right of use asset (W-2.1) 72.66
Non-current liabilities
Provision for decommissioning (W-2.3) 3.19
Lease liability (W-2.2) 37.82
Current liabilities
Lease liability (W-2.2) [68.14 + 8.18 - 37.82] 38.50
Extracts - SOCI
for the year ending Dec 31, 2020 Rs. million
Depreciation (W-2.1) 36.33
Interest expense [8.18(W-2.2) + 0.34(W-2.3)] 8.52
WORKINGS
W-1 Initial measurement Rs. million
Lease liability:
- 1st payment [35 - 2 (i.e. lease incentive)] 33.00
-1
- 2nd payment [35 x 1.1 x 1.12 ] 34.38
2 -2
- 3rd payment [35 x 1.1 x 1.12 ] 33.76
- Expected payment under RV guarantee -
101.14
Initial direct cost 5.00
De-commissioning obligation [4 x 1.12-3] 2.85
ROU asset 108.98
Solution 4
------------ Rs. -----------
30-06-18 Depreciation [958,250(W-1)/5] 191,650
Acc. depreciation 191,650
[Depreciation for 2018]
Solution 6
------------ Rs. -----------
30-06-19 Depreciation [972,413(W-1)/5] 194,483
Acc. depreciation 194,483
[Depreciation for 2019]
Solution 7
------------ Rs. -----------
30-06-19 Depreciation [1,283,532(W-1)/10] 128,353
Acc. depreciation 128,353
[Depreciation for 2019]
Solution 8
------------ Rs. -----------
30-06-19 Depreciation [736,009(W-1)/10] 73,601
Acc. depreciation 73,601
[Depreciation for 2019]
Current assets
Net investment in lease [9.60 - 5.07] (W-2) 4.53
Extracts - SOCI
for the year ending Dec 31, 2013 Rs. million
Sales (W-1) 16.64
Cost of sales [10 cars x Rs. 1.8m x 0.85] 15.30
Service revenue [Rs. 12,000 x 10 cars] 0.12
Service cost 0.11
Interest income (W-2) 1.64
WORKINGS
W-1 Initial measurement Rs. million
Lease receivable:
- Down payment [300,000 x 10 cars] 3.00
- Rentals [5.68m* x 3-year A.F. at 12%] 13.64
16.64
If an entity (seller-lessee) transfers an asset to another entity (buyer-lessor) and leases that asset back,
this whole transaction (i.e. transfer and leaseback) is called sale and leaseback.
[Sale value is equal to the fair value of the asset and lease payments are at market rates]
Books of Seller-Lessee
De-recognition of transferred asset and recognition of lease:
W-1
NBV of transferred asset
ROU asset = PV of lease payments x Fair value of transferred asset
ROU asset and lease liability shall be measured subsequently using same guidance as already studied in
books of lessee.
Books of Buyer-Lessor
The buyer-lessor shall account for the purchase of the asset as per applicable standard (e.g. IAS 16). Lease
shall be accounted as already studied in books of lessor.
[Sale value > fair value of the asset or PV of lease payments > PV of lease payments at market rate]
Books of Seller-Lessee
De-recognition of transferred asset and recognition of lease:
W-1
NBV of transferred asset
ROU asset = [PV of cashflows – Above market terms(W-1.1)] x
Fair value of transferred asset
W-1.1
“Above market terms” shall be accounted for as additional financing. It is calculated as:
- ROU asset and lease liability shall be measured subsequently using same guidance as already studied
in books of lessee.
- Financial liability shall be measured subsequently as per IFRS 9
- Contractual cashflows will be split in ratio of “lease liability” and “financial liability” initially recognized
and applied against these separate liabilities accordingly.
Books of Buyer-Lessor
- The buyer-lessor shall account for the purchase of the asset as per applicable standard (e.g. IAS 16).
- Lease shall be accounted as already studied in books of lessor.
- Above market terms (W-1.1) shall be recognized as financial asset as per IFRS 9
- Split of cashflows (as done above for lessee) shall be accounted for “lease payments” and “contractual
cashflow of financial asset” accordingly.
[Sale value < fair value of the asset or PV of lease payments < PV of lease payments at market rate]
Books of Seller-Lessee
De-recognition of transferred asset and recognition of lease:
W-1
NBV of transferred asset
ROU asset = [PV of cashflows + Below market terms(W-1.1)] x
Fair value of transferred asset
W-1.1
“Below market terms” shall be accounted for as a prepayment of lease payments. It is calculated as:
ROU asset and lease liability shall be measured subsequently using same guidance as already studied in
books of lessee.
Books of Buyer-Lessor
The buyer-lessor shall account for the purchase of the asset as per applicable standard (e.g. IAS 16). Lease
shall be accounted as already studied in books of lessor.
Books of Seller-Lessee
- It shall continue to recognize the transferred asset as per relevant standard (e.g. IAS 16)
- It shall recognize a financial liability equal to the transfer proceeds as per IFRS 9.
Books of Buyer-Lessor
PRACTICE QUESTIONS
Question 1
Shoaib Limited (SL) were facing financial difficulties for some period. Finance director decided to use sale and lease
back as a source of finance. SL entered into following transactions during the year:
On July 1, 2012, SL sold an equipment, having net book value of Rs. 2.25 million, to ABC Finance for Rs. 2.5 million and
leased it back for remaining life of equipment i.e. 5 years. Lease rental of Rs. 693,524 is payable on every June 30th.
Implicit rate is 12%.
SL had a machine in use having book value of Rs. 1.5 million on December 31, 2012. On that date it sold the machine
for Rs. 1.675 million (equal to the fair value) and leased it back for 3 years. This sale can be assumed to meet criteria of
sale under IFRS 15. Agreed lease payments are as follows:
- December 31, 2013 : Rs. 150,000
- December 31, 2014 : Rs. 160,000
- December 31, 2015 : Rs. 200,000
Implicit rate is 10%.
Required:
(a) Journal entries for the year ending June 30, 2013
(b) Show the relevant extracts of Income statement and Balance sheet for the year ending June 30, 2013
(Disclosures in notes are not required)
Question 2
On July 1, 2019, Ess Limited sold an equipment, having net book value of Rs. 1.5 million, to XYZ Traders and leased it
back for 3 years. The fair market value at that date was Rs. 1,600,000. Implicit rate in lease was 10%.
Following are the terms of sale and lease back agreement:
Sale price Annual rent (arrears)
------------ Rs.------------
Scenario I 1,600,000 130,000
Scenario II 1,700,000 140,000
Scenario III 1,400,000 120,000
XYZ Traders classified this lease as operating lease and estimated the useful life to be 20 years.
Required:
Journal entries for the year ending June 30, 2020 for each scenario in books of both companies.
Question 3
On 1 January 2016 Maisum Limited (ML) entered into a sale and lease back agreement with Bachat Bank in respect of a
machine. The details of machine sold and leased back are as under:
Rs. in million
Carrying value 85
Sale price to the lessor 95
Fair market value 120
The transfer of machine by the seller-lessee satisfies the requirements of IFRS 15 to be accounted for as a sale.
Required:
(a) Prepare journal entry in the books of ML to record the above transaction on 1 January 2016. (07)
(b) Prepare relevant extracts from the statements of financial position and comprehensive income and related notes for
inclusion in ML’s financial statements, for the year ended 31 December 2016. (10)
{Spring 2017, Q # 4}
SOLUTIONS
Solution No. 1
(a)
Date Particulars Dr. Cr.
01-Jul-12 Bank 2,500,000
Financial liability 2,500,000
[Sale proceeds]
31-Dec-12 Bank 1,675,000
Right of use (W-2) 374,964
Machine 1,500,000
Lease liability (W-2) 418,710
Profit on disposal (balancing) 131,254
[Sale and recognition of lease]
30-Jun-13 Depreciation [2,250 / 5] 450,000
Accumulated depreciation 450,000
[Depreciation charge on equipment for the year]
30-Jun-13 Finance cost [418,710 x 10% x 6/12] 20,936
Lease liability 20,936
[Interest expense for the year]
30-Jun-13 Depreciation [374,964/3 x 6/12] 62,494
Accumulated depreciation 62,494
[Depreciation charge on right of use for the year]
30-Jun-13 Financial liability 393,524
Interest expense (W-1) 300,000
Bank 693,524
[Payment of 1st rental]
W - 1 Financial liability
Date Open. Bal. Payment Interest Principal Clos. Bal.
30-Jun-13 2,500,000 693,524 300,000 393,524 2,106,476
30-Jun-14 2,106,476 693,524 252,777 440,747 1,665,729
W - 2 PV of LP
Rental Discount factor Present value
150,000 0.909 136,350
160,000 0.826 132,160
200,000 0.751 150,200
418,710
W - 3 Lease liability
Date Open. Bal. Payment Interest Principal Clos. Bal.
31-Dec-13 418,710 150,000 41,871 108,129 310,581
(b)
INCOME STATEMENT - Extracts
Rs.
Finance charge on lease 20,936
Interest expense 300,000
Depreciation [450,000 + 62,494] 512,494
Profit on disposal 131,254
Non-Current assets
Machine [2,250,000 - 450,000] 1,800,000
Right of use [374,964 - 62,494] 312,470
Non-current liabilities
Lease liability 310,581
Financial liability 1,665,729
Current liabilities
Lease liability 129,065
Financial liability 440,747
Solution No. 2
BOOKS OF LESSEE
Scenario I
------------ Rs. -----------
01-07-19 Bank 1,600,000
Right-of-use (W-1) 303,085
Equipment 1,500,000
Lease liability (W-1) 323,291
Profit on disposal 79,794
[Initial recognition of lease]
Scenario II
------------ Rs. -----------
01-07-19 Bank 1,700,000
Right-of-use (W-1) 232,649
Equipment 1,500,000
Lease liability (W-1) 248,159
Financial liability (W-1) 100,000
Profit on disposal 84,490
[Initial recognition of lease]
Scenario III
------------ Rs. -----------
01-07-19 Bank 1,400,000
Right-of-use (W-1) 467,271
Equipment 1,500,000
Lease liability (W-1) 298,422
Profit on disposal 68,849
[Initial recognition of lease]
BOOKS OF LESSOR
Scenario I
------------ Rs. -----------
01-07-19 Equipment 1,600,000
Cash 1,600,000
[Purchase of equipment]
Scenario II
------------ Rs. -----------
01-07-19 Equipment 1,600,000
Financial asset 100,000
Cash 1,700,000
[Purchase of equipment]
Scenario III
------------ Rs. -----------
01-07-19 Equipment 1,600,000
Lease income 200,000
Cash 1,400,000
[Purchase of equipment]
W-1 Rs.
Lease income [(200,000 + 120,000 x 3)/3] 186,667
Solution No. 3
(a) Dr. Cr.
Journal entry -------- Rs. in million --------
01-01-16 Right-of-use asset 70.24
Bank 95.00
Machine 85.00
Lease liability 74.16
Current liabilities
Lease liability 21.00
Extracts of Notes
for the year ended December 31, 2016
Depreciation
Balance as at 01-01-16 -
Charge for the year 17.56
Disposal -
Balance as at 31-12-16 17.56
Net book value as 31-12-16 52.68
8 - Lease liability
ML has entered into a lease agreement of a machine. Lease term is 4 years. Implicit rate is 9%.
Lease asset:
Carrying amount 52.68
Addition to right of use 70.24
Maturity analysis:
Undiscounted lease payments are as follows
1 year 21.00
2 years 21.00
3 years 21.00
63.00
Non-current liabilities
Lease liabilities:
- Machine (W-2) 120.09
- Warehouse (W-4) 996.67
Current liabilities
Lease liabilities:
- Machine (W-2) 50.00
- Warehouse [1,060.06 + 58.30 - 996.67] 121.70
HPL
Extracts of SOCI
for the year ending December 31, 2019
Rs. million
Machines:
Depreciation [201.87(W-1) ÷ 5] 40.37
Interest expense(W-2) 18.22
Usage fees 3.00
Trucks:
Truck rent [10 x 9/6] 15.00
Fuel cost 1.20
Warehouse:
Depreciation - Owned[900 ÷ 18 x 6/12] 25.00
- ROU [696.04(W-3) ÷ 10 x 6/12] 34.80
SCOPE
An entity shall apply this standard to all contracts with customers except the following:
(a) Lease contracts [IFRS 16]
(b) Insurance contracts [IFRS 17]
(c) Financial instruments
(d) Non-monetary exchange between entities in the same line of business to facilitate sales to customers
or potential customers.
Revenue
Income arising in the course of an entity’s ordinary activities
Contract
An agreement between two or more parties that creates enforceable rights and obligations.
Customer
A party that has contracted with an entity to obtain goods or services that are an output of the entity’s
ordinary activities in exchange for consideration.
2. A contract does not exist if each party to the contract has the unilateral enforceable right to terminate
a wholly underperformed contract without compensating the other party.
Wholly underperformed contract
A contract is wholly underperformed if:
o the entity has not yet transferred any promised goods or services to the customer; and
o the entity has not yet received and is not yet entitled to receive any consideration.
3. If identification criteria as mentioned in point 1 above is not met, then any consideration received
from the customer shall be recognized as revenue only when either of the following events has
occurred:
(a) the entity has no remaining obligations to transfer goods or services to the customer and all, or
substantially all, of the consideration promised by the customer has been received by the entity
and is nonrefundable; or
(b) the contract has been terminated and the consideration received from the customer is non-
refundable.
Combination of contracts
An entity shall combine two or more contracts entered into at or near the same time with the same
customer (or related parties of the customer) and account for the contracts as a single contract if one
or more of the following criteria are met:
(a) the contracts are negotiated as a package with a single commercial objective;
(b) the amount of consideration to be paid in one contract depends on the price or performance of the
other contract; or
(c) the goods or services promised in the contracts (or some goods or services promised in each of the
contracts) are a single performance obligation.
Contract modification
A contract modification is a change in the scope or price (or both) of a contract that is approved by the
parties to the contract.
Case 1 – Modification is a separate contract
An entity shall account for a contract modification as a separate contract if both of the following
conditions are present:
(a) the scope of the contract increases because of the addition of promised goods or services that are
distinct; and
(b) the price of the contract increases by an amount of consideration that reflects the entity’s stand-alone
selling prices of the additional promised goods or services and appropriate adjustments to that price
to reflect the circumstances of the particular contract.
If the remaining goods o An entity shall account for the modification as if it were a termination of
or services are distinct existing contract and the creation of a new contracts.
from those already o Total amount of consideration to be allocated to remaining performance
transferred: obligation(s) = consideration promised (including already received) by
the customer that had not been recognized as revenue plus
consideration promised for modification.
If the remaining goods o An entity shall account for the modification as if it were a part of the
or services are not existing contract.
distinct o The effect of modification on transaction price and progress
measurement is recognized as an adjustment to revenue at modification
date. (i.e. cumulative catch-up basis)
2. A contract with a customer generally explicitly states the goods or services that an entity promises to
transfer to a customer. However, a contract with a customer may also include promises that are
implied by an entity’s customary business practices, published policies or specific statements if, at the
time of entering into the contract, those promises create a valid expectation of the customer that the
entity will transfer a good or service to the customer.
3. A good or service that is promised to a customer is distinct if both of the following criteria are met:
(a) the customer can benefit from the good or service either on its own or together with other
resources that are readily available to the customer (ie the good or service is capable of being
distinct).
Example – where customer can benefit from the good
The fact that the entity regularly sells a good or service separately would indicate that a
customer can benefit from the good or service on its own or with other readily available
resources
(b) the entity’s promise to transfer the good or service to the customer is separately identifiable from
other promises in the contract (ie the promise to transfer the good or service is distinct within the
context of the contract).
Examples – where two or more promises are NOT separately identifiable
o The entity is using the goods or services as inputs to produce or deliver the combined
output or outputs specified by the customer.
o One or more of the goods or services significantly modifies or customizes one or more of
the other goods or services promised in the contract.
o The goods or services are highly interdependent or highly interrelated.
2. When determining the transaction price, an entity shall consider the effects of the following:
(a) Variable consideration / (b) constraining estimates of variable consideration
An amount of consideration can vary because of discounts, rebates, refunds, credits, price
concessions, incentives, performance bonuses, penalties or other similar items. An entity shall
estimate an amount of variable using either (whichever better predicts the amount):
• Expected value (Ʃpx) of a range of possible consideration amounts (it is used when there are
large number of possible outcomes or large number of similar contracts).
• Mostly likely amount in a range of possible consideration amounts (it is used when a contract
has only two possible outcomes).
Transaction price shall include the amount of variable consideration only to the extent that it is
highly probable that a significant reversal in recognized revenue will not occur. Following are the
examples of factors that could increase the likelihood of revenue reversal:
o Amount of consideration is highly susceptible to factors outside entity’s influence
o Uncertainty is not expected to be resolved for a long period of time
o Entity’s experience with similar types of contracts is limited
o Entity has a practice of offering a broad range of price concessions
o Contract has a large number and broad range of possible consideration amounts
At end of every year, an entity shall update the estimated transaction price and any necessary
adjustment in the amount of revenue, already recognized, shall be recognized in the period of
change.
of those contributed goods or services. If so, the entity shall account for the contributed goods or
services as non-cash consideration received from the customer.
Revenue shall be recognized over time by measuring the progress towards complete
satisfaction. Following methods, provided the selected method faithfully depicts the entity’s
performance, may be used for measuring progress:
• Output methods (e.g. survey of performance, milestones achieved, time elapsed and units
produced/delivered)
• Input methods (e.g. resources consumed, cost incurred, machine/labor hours used)
Important for input methods:
An entity shall exclude while applying input method the effects of any inputs that do not
depict the entity’s performance in transferring control of goods or services. For instance,
when using a cost-based input method an adjustment may be required for a cost incurred
that is not proportionate to the progress in satisfying the performance obligation. In
those circumstances, the best depiction of the entity’s performance may be to adjust the
input method to recognize revenue only to the extent of that cost incurred if all of the
following conditions are met:
- The good transferred is not distinct;
- The customer is expected to obtain control of the good significantly before receiving
services related to the good;
- The cost of the transferred good is significant relative to the total expected costs;
- The entity procured the transferred good from a third party and is not significantly
involved in designing and manufacturing of good.
At end of every year, an entity shall remeasure its progress using updated estimates.
If progress cannot be measured reliably (i.e. in early stages of a contract), the entity shall
recognize revenue only to the extent of recoverable costs incurred.
CONTRACT COSTS
Costs of obtaining the o An entity shall recognize as an asset [i.e. “contract cost”] the incremental
contract: costs (e.g. sales commission) of obtaining a contract if it expects to
recover those costs. [Entity may recognize these incremental costs as
expense when incurred if amortization period, as discussed below in point
1, is one year or less].
o Costs to obtain a contract that would have been incurred regardless of
whether the contract was obtained or not shall be recognized as expense
when incurred unless those costs are explicitly chargeable to customer.
Costs to fulfill the o Costs incurred in fulfilling the contract (except for those covered under
contract: IAS 2, IAS 16 and IAS 38 which are accounted for as per aforementioned
standards accordingly) shall be recognized as an asset [i.e. “contract
cost”] only if those costs are directly related to the contract (e.g. direct
material, direct labor, directly attributable overheads).
o General and administrative costs, costs of wasted resources which were
not reflected in price of contract and costs related to past satisfied
performance shall be recognized as expense when incurred.
1. The “Contract cost” asset shall be amortized on a systematic basis that is consistent with the transfer
of the goods or services to the customer (i.e. consistent with revenue recognition).
2. An entity shall recognize an impairment loss in P&L to the extent the carrying amount of the asset
exceeds “remaining consideration entity expects to receive for goods or services to which the asset
relates less directly related costs not yet recognized as expense”.
PRESENTATION
Receivable
If an entity has unconditional to an amount of consideration, it is presented as a “receivable”. A right to
consideration is unconditional if only the passage of time is required before payment of that consideration
is due even though that amount may be subject to refund in future. Such receivable is measured as per
IFRS 9.
Contract asset
If an entity has transferred goods or services before the customer pays consideration or before the
payment is due, it shall present as a “contract asset”. This asset shall be assessed for impairment in
accordance with IFRS 9.
Contract liability
If a customer pays consideration, or an entity has a right to an amount of consideration that is
unconditional (i.e. a receivable), before the entity transfers a good or service to the customer, the entity
shall present the contract as a “contract liability” when the payment is made or the payment is due
(whichever is earlier). A contract liability is an entity’s obligation to transfer goods or services to a
customer for which the entity has received consideration (or an amount of consideration is due) from the
customer.
Warranty provides a ▪ It is generally the case when a customer does not have an option to purchase
customer with assurance a warranty separately.
that the product will ▪ It is not a separate performance obligation rather it is accounted for in
accordance with IAS 37.
function as intended:
Warranty provides the ▪ It is the case when a customer has an option to purchase a warranty
service to the customer in separately.
addition to the assurance ▪ It is considered as a separate performance obligation and a portion of
transaction price is allocated to that performance obligation.
of compliance as
intended:
Factors to be considered:
o If the entity is required by law to provide a warranty, then it is not a separate performance obligation.
o Longer warranty coverage period is more likely to be a separate performance obligation.
Example 44—Warranties
An entity, a manufacturer, provides its customer with a warranty with the purchase of a product. The warranty
provides assurance that the product complies with agreed-upon specifications and will operate as promised for one
year from the date of purchase. The contract also provides the customer with the right to receive up to 20 hours of
training services on how to operate the product at no additional cost.
The product and training services are each capable of being distinct because the customer can benefit from the
product on its own without the training services and can benefit from the training services together with the product
that already has been transferred by the entity. The entity regularly sells the product separately without the training
services.
The training services and product do not significantly modify or customize each other. The product and the training
services are not highly interdependent or highly interrelated. Consequently, the entity concludes that its promise to
transfer the product and its promise to provide training services are not inputs to a combined item, and, therefore,
give rise to two separate performance obligations.
Finally, the entity assesses the promise to provide a warranty and observes that the warranty provides the customer
with the assurance that the product will function as intended for one year. The entity, therefore, does not account
for it as a performance obligation rather it accounts for the assurance-type warranty in accordance with the
requirements in IAS 37. As a result, the entity allocates the transaction price to the two performance obligations
(the product and the training services) and recognizes revenue when (or as) those performance obligations are
satisfied.
Principal: ▪ An entity is a principal if it controls the specified good or service before that
good or service is transferred to a customer.
▪ When principal satisfies a performance obligation, then it recognizes revenue
in the gross amount of consideration.
the customer and the price charged by the supplier. The contract between the entity and the customer requires the
customer to seek remedies for defects in the equipment from the supplier under the supplier’s warranty. However,
the entity is responsible for any corrections to the equipment required resulting from errors in specifications.
The entity concludes that it has promised to provide the customer with specialized equipment designed by the entity.
Although the entity has subcontracted the manufacturing of the equipment to the supplier, the entity concludes
that the design and manufacturing of the equipment are not distinct, because they are not separately identifiable
(i.e. there is a single performance obligation). The entity is responsible for the overall management of the contract
(for example, by ensuring that the manufacturing service conforms to the specifications) and, thus, provides a
significant service of integrating those items into the combined output—the specialized equipment—for which the
customer has contracted. In addition, those activities are highly interrelated. If necessary, modifications to the
specifications are identified as the equipment is manufactured, the entity is responsible for developing and
communicating revisions to the supplier and for ensuring that any associated rework required conforms with the
revised specifications.
Thus, the entity concludes that it is a principal in the transaction. The entity recognizes revenue in the gross amount
of consideration to which it is entitled from the customer in exchange for the specialized equipment.
Example 46A—Promise to provide goods or services (entity is a principal)
An entity enters into a contract with a customer to provide office maintenance services. The entity and the customer
define and agree on the scope of the services and negotiate the price. The entity is responsible for ensuring that the
services are performed in accordance with the terms and conditions in the contract. The entity invoices the customer
for the agreed-upon price on a monthly basis with 10-day payment terms. The entity regularly engages third-party
service providers to provide office maintenance services to its customers. When the entity obtains a contract from
a customer, the entity enters into a contract with one of those service providers, directing the service provider to
perform office maintenance services for the customer. The payment terms in the contracts with the service providers
are generally aligned with the payment terms in the entity’s contracts with customers. However, the entity is obliged
to pay the service provider even if the customer fails to pay.
The customer does not have a right to direct the service provider to perform services that the entity has not agreed
to provide. Therefore, the right to office maintenance services obtained by the entity from the service provider is
not the specified good or service in its contract with the customer. The entity concludes that it controls the specified
services before they are provided to the customer. The entity obtains control of a right to office maintenance services
after entering into the contract with the customer but before those services are provided to the customer.
Thus, the entity is a principal in the transaction and recognizes revenue in the amount of consideration to which it
is entitled from the customer in exchange for the office maintenance services.
Example 47—Promise to provide goods or services (entity is a principal)
An entity negotiates with major airlines to purchase tickets at reduced rates compared with the price of tickets sold
directly by the airlines to the public. The entity agrees to buy a specific number of tickets and must pay for those
tickets regardless of whether it is able to resell them. The reduced rate paid by the entity for each ticket purchased
is negotiated and agreed in advance. The entity determines the prices at which the airline tickets will be sold to its
customers. The entity sells the tickets and collects the consideration from customers when the tickets are purchased.
The entity also assists the customers in resolving complaints with the service provided by the airlines. However, each
airline is responsible for fulfilling obligations associated with the ticket, including remedies to a customer for
dissatisfaction with the service.
The entity concludes that, with each ticket that it commits itself to purchase from the airline, it obtains control of a
right to fly on a specified flight (in the form of a ticket) that the entity then transfers to one of its customers.
The entity has inventory risk with respect to the ticket because the entity committed itself to obtain the ticket from
the airline before obtaining a contract with a customer to purchase the ticket. This is because the entity is obliged
to pay the airline for that right regardless of whether it is able to obtain a customer to resell the ticket to or whether
it can obtain a favourable price for the ticket. The entity also establishes the price that the customer will pay for the
specified ticket.
Thus, the entity concludes that it is a principal in the transactions with customers. The entity recognizes revenue in
the gross amount of consideration to which it is entitled in exchange for the tickets transferred to the customers.
Example 48—Arranging for the provision of goods or services (entity is an agent)
An entity sells vouchers that entitle customers to future meals at specified restaurants. The sales price of the voucher
provides the customer with a significant discount when compared with the normal selling prices of the meals (for
example, a customer pays Rs. 100 for a voucher that entitles the customer to a meal at a restaurant that would
otherwise cost Rs. 200). The entity does not purchase or commit itself to purchase vouchers in advance of the sale
of a voucher to a customer; instead, it purchases vouchers only as they are requested by the customers. The entity
sells the vouchers through its website and the vouchers are non-refundable. The entity and the restaurants jointly
determine the prices at which the vouchers will be sold to customers. Under the terms of its contracts with the
restaurants, the entity is entitled to 30% of the voucher price when it sells the voucher. The entity also assists the
customers in resolving complaints about the meals and has a buyer satisfaction programme. However, the
restaurant is responsible for fulfilling obligations associated with the voucher, including remedies to a customer for
dissatisfaction with the service.
A customer obtains a voucher for the restaurant that it selects. The entity does not engage the restaurants to provide
meals to customers on the entity’s behalf. The entity concludes that it does not control the voucher (right to a meal)
at any time.
Thus, the entity concludes that it is an agent with respect to the vouchers. The entity recognizes revenue in the net
amount of consideration to which the entity will be entitled in exchange for arranging for the restaurants to provide
vouchers to customers for the restaurants’ meals, which is the 30% commission it is entitled to upon the sale of each
voucher.
Example 48A—Entity is a principal and an agent in the same contract
An entity sells services to assist its customers in more effectively targeting potential recruits for open job positions.
The entity performs several services itself, such as interviewing candidates and performing background checks. As
part of the contract with a customer, the customer agrees to obtain a License to access a third party’s database of
information on potential recruits. The entity arranges for this License with the third party, but the customer contracts
directly with the database provider for the License. The entity collects payment on behalf of the third-party database
provider as part of the entity’s overall invoicing to the customer. The database provider sets the price charged to
the customer for the License, and is responsible for providing technical support and credits to which the customer
may be entitled for service down time or other technical issues.
For the purpose of this example, it is assumed that the entity concludes that its recruitment services and the
database access License are each distinct. Accordingly, there are two specified goods or services to be provided to
the customer—access to the third party’s database and recruitment services. The entity concludes that it does not
control the access to the database before it is provided to the customer. The entity does not at any time have the
ability to direct the use of the License because the customer contracts for the License directly with the database
provider. The entity does not control access to the provider’s database—it cannot, for example, grant access to the
database to a party other than the customer, or prevent the database provider from providing access to the
customer.
Thus, the entity concludes that it is an agent in relation to the third party’s database service. In contrast, the entity
concludes that it is the principal in relation to the recruitment services because the entity performs those services
itself and no other party is involved in providing those services to the customer.
If an entity grants a customer the option to acquire additional goods or services (e.g. sales incentive, credit points,
renewal options or other discounts), that option gives rise to a performance obligation in the contract only if the
option provides a material right to the customer that it would not receive without entering into that contract. If
the option provides a material right to the customer, the customer in effect pays the entity in advance for future
goods or services and related revenue is thus recognized when those future goods or services are transferred or
when the option expires. If the stand-alone selling price for a customer’s option to acquire additional goods or
services is not directly observable, an entity shall estimate it. That estimate shall reflect the discount that the
customer would obtain when exercising the option, adjusted for both of the following:
• any discount that the customer could receive without exercising the option; and
• the likelihood that the option will be exercised.
Example 49—Option that provides the customer with a material right (discount voucher)
An entity enters into a contract for the sale of Product A for Rs. 100. As part of the contract, the entity gives the customer
a 40 per cent discount voucher for any future purchases up to Rs. 100 in the next 30 days. The entity intends to offer a 10
per cent discount on all sales during the next 30 days as part of a seasonal promotion. The 10 per cent discount cannot be
used in addition to the 40 per cent discount voucher.
Because all customers will receive a 10 per cent discount on purchases during the next 30 days, the only discount that
provides the customer with a material right is the discount that is incremental to that 10 per cent (i.e. the additional 30
per cent discount). The entity accounts for the promise to provide the incremental discount as a performance obligation
in the contract for the sale of Product A. To estimate the stand-alone selling price of the discount voucher, the entity
estimates an 80 per cent likelihood that a customer will redeem the voucher and that a customer will, on average, purchase
Rs. 50 of additional products. Consequently, the entity’s estimated stand-alone selling price of the discount voucher is
Rs. 12 (Rs. 50 average purchase price of additional products × 30 per cent incremental discount × 80 per cent likelihood
of exercising the option). The stand-alone selling prices of Product A and the discount voucher and the resulting allocation of
the Rs. 100 transaction price are as follows:
The entity allocates Rs. 89 to Product A and recognizes revenue for Product A when control transfers. The entity allocates
Rs. 11 to the discount voucher and recognizes revenue for the voucher when the customer redeems it for goods or services
or when it expires.
Example 50—Option that does not provide the customer with a material right (additional goods or services)
An entity in the telecommunications industry enters into a contract with a customer to provide a handset and
monthly network service for two years. The network service includes up to 1,000 call minutes and 1,500 text
messages each month for a fixed monthly fee. The contract specifies the price for any additional call minutes or texts
that the customer may choose to purchase in any month. The prices for those services are equal to their stand-alone
selling prices. The entity determines that the promises to provide the handset and network service are each separate
performance obligations.
The prices of the additional call minutes and texts reflect the stand-alone selling prices for those services. Because
the option for additional call minutes and texts does not grant the customer a material right, the entity concludes it
is not a performance obligation in the contract. Consequently, the entity does not allocate any of the transaction
price to the option for additional call minutes or texts. The entity will recognize revenue for the additional call
minutes or texts if and when the entity provides those services.
Example 51—Option that provides the customer with a material right (renewal option)
An entity enters into 100 separate contracts with customers to provide one year of maintenance services for Rs.
1,000 per contract. The terms of the contracts specify that at the end of the year, each customer has the option to
renew the maintenance contract for a second year by paying an additional Rs. 1,000. Customers who renew for a
second year are also granted the option to renew for a third year for Rs. 1,000. The entity charges significantly higher
prices for maintenance services to customers that do not sign up for the maintenance services initially (i.e. when the
products are new). That is, the entity charges Rs. 3,000 in Year 2 and Rs. 5,000 in Year 3 for annual maintenance
services if a customer does not initially purchase the service or allows the service to lapse.
The entity concludes that the renewal option provides a material right to the customer that it would not receive
without entering into the contract, because the price for maintenance services are significantly higher if the
customer elects to purchase the services only in Year 2 or 3. Consequently, the entity concludes that the promise to
provide the option is a performance obligation. The renewal option is for a continuation of maintenance services
and those services are provided in accordance with the terms of the existing contract. Instead of determining the
stand-alone selling prices for the renewal options directly, the entity allocates the transaction price by determining
the consideration that it expects to receive in exchange for all the services that it expects to provide.
The entity expects 90 customers to renew at the end of Year 1 (90 per cent of contracts sold) and 81 customers to
renew at the end of Year 2 (90 per cent of the 90 customers that renewed at the end of Year 1 will also renew at the
end of Year 2, that is 81 per cent of contracts sold).
At contract inception, the entity determines the expected consideration for each contract is Rs. 2,710 [Rs. 1,000 +
(90 per cent × Rs. 1,000) + (81 per cent × Rs. 1,000)]. The entity also determines that recognizing maintenance service
revenue on the basis of costs incurred relative to the total expected costs depicts the transfer of services to the
customer. Estimated costs for a three-year contract are as follows:
Rs.
Year 1 600
Year 2 750
Year 3 1,000
Accordingly, the pattern of revenue recognition expected at contract inception for each contract is as follows:
Rs. Rs.
Year 1 600 (Rs. 600 × 100%) 780 [(Rs. 600 ÷ Rs. 2,085) x Rs. 2,710]
Year 2 675 (Rs. 750 × 90%) 877 [(Rs. 675 ÷ Rs. 2,085) x Rs. 2,710]
Year 3 810 (Rs. 1,000 × 81%) 1,053 [(Rs. 810 ÷ Rs. 2,085) x Rs. 2,710]
Total 2,085 2,710
Consequently, at contract inception, the entity allocates to the option to renew at the end of Year 1 Rs. 22,000 of
the consideration received to date [cash of Rs. 100,000 – maintenance service revenue to be recognized in Year 1 of
Rs. 78,000 (Rs. 780 × 100)].
Assuming there is no change in the entity’s expectations and the 90 customers renew as expected, at the end of the
first year, the entity has collected cash of Rs. 190,000 [(100 × Rs. 1,000) + (90 × Rs. 1,000)], has recognized revenue
of Rs. 78,000 (Rs. 780 × 100) and has recognized a contract liability of Rs. 112,000.
Consequently, upon renewal at the end of the first year, the entity allocates Rs. 24,300 to the option to renew at the
end of Year 2 [cumulative cash of Rs. 190,000 less cumulative revenue recognized in Year 1 and to be recognized in
Year 2 of Rs. 165,700 (Rs. 78,000 + Rs. 877 × 100)].
If the actual number of contract renewals was different than what the entity expected, the entity would update the
transaction price and the revenue recognized accordingly.
Example 52—Customer loyalty programme
An entity has a customer loyalty programme that rewards a customer with one customer loyalty point for every Rs. 10 of
purchases. Each point is redeemable for a Rs. 1 discount on any future purchases of the entity’s products. During a
reporting period, customers purchase products for Rs. 100,000 and earn 10,000 points that are redeemable for future
purchases. The consideration is fixed and the stand-alone selling price of the purchased products is Rs. 100,000. The entity
expects 9,500 points to be redeemed. The entity estimates a stand-alone selling price of Rs. 0.95 per point (totalling Rs.
9,500).
The points provide a material right to customers that they would not receive without entering into a contract.
Consequently, the entity concludes that the promise to provide points to the customer is a performance obligation. The
entity allocates the transaction price (Rs. 100,000) to the product and the points on a relative stand-alone selling price basis
as follows:
Rs.
Product 91,324 [Rs. 100,000 × (Rs. 100,000 stand-alone selling price ÷ Rs. 109,500)]
Points 8,676 [Rs. 100,000 × (Rs. 9,500 stand-alone selling price ÷ Rs. 109,500)]
Non-refundable upfront fee
An entity may charge a customer a non-refundable upfront fee at or near inception (e.g. joining fees in health
club). It does not result in the transfer of a promised good or service to the customer. Instead the upfront fee is
an advance payment for future goods or services and therefore would be recognized as revenue when those when
those future goods or services are provided.
An entity may charge a non-refundable fee in part as compensation for costs incurred in setting up a contract (or
other administrative tasks). If those setup activities do not satisfy a performance obligation, the entity shall
disregard those activities (and related costs) when measuring progress. That is because the costs of setup
activities do not depict the transfer of services to the customer.
Example 53—Non-refundable upfront fee
An entity enters into a contract with a customer for one year of transaction processing services. The entity’s
contracts have standard terms that are the same for all customers. The contract requires the customer to pay an
upfront fee to set up the customer on the entity’s systems and processes. The fee is a nominal amount and is non-
refundable. The customer can renew the contract each year without paying an additional fee.
The entity’s setup activities do not transfer a good or service to the customer and, therefore, do not give rise to a
performance obligation. The entity concludes that the renewal option does not provide a material right to the
customer that it would not receive without entering into that contract. The upfront fee is, in effect, an advance
payment for the future transaction processing services. Consequently, the entity determines the transaction price,
which includes the non-refundable upfront fee, and recognizes revenue for the transaction processing services as
those services are provided.
Licensing
A License establishes a customer’s rights to the intellectual property of an entity. Following are some examples
of such intellectual properties:
(a) software and technology;
(b) motion pictures, music and other forms of media and entertainment;
(c) franchises; and
(d) patents, trademarks and copyrights.
In addition to a promise to grant a License to a customer, an entity may also promise to transfer other goods or
services to the customer:
If the promise to grant a An entity shall account for the License and other services as a single performance
License is NOT distinct obligation. Examples of such Licenses are:
from other promised ▪ a License that forms a component of a tangible good and that is integral to the
goods or services: functionality of the good; and
▪ a License that the customer can benefit from only in conjunction with a related
service (such as an online service provided by the entity that enables, by
granting a License, the customer to access content)
Determination of whether the performance obligation is satisfied over time or at
a point in time is made as per guidance studied in IFRS 15.
If the promise to grant a An entity shall account for the License as a separate performance obligation.
License is distinct from Determination of whether the performance obligation is satisfied over time or at
other promised goods or a point in time is made as follows:
services: (a) performance obligation is satisfied over time:
If grant of License is a right to access the intellectual property as it exists
throughout the License period. It happens when all of the following criteria is
met:
▪ entity will undertake the activities that significantly affect the intellectual
property.
▪ the rights granted by the License directly expose the customer to any +/-
effects of aforementioned activities (e.g. the benefit derived from a brand is
often dependent on the entity’s ongoing activities that support or maintain the
value of property).
▪ these activities do not result in the transfer of a good or service to customer as
those activities occur.
(b) performance obligation is satisfied at a point in time
If grant of License is a right to access the intellectual property as it exists at the
point in time at which the License is granted. It happens when the intellectual
property, to which the customer has rights, has significant stand-alone
functionality and a substantial portion of the benefit of that intellectual property
is derived from that functionality. Consequently, the ability of the customer to
obtain benefit from that intellectual property would not be significantly affected
by the entity’s activities unless those activities significantly change its form or
functionality.
simultaneously receives and consumes the benefits of the entity’s performance as it occurs, the performance
obligation is satisfied over time.
Example 56—Identifying a distinct License
An entity, a pharmaceutical company, licenses to a customer its patent rights to an approved drug compound for 10
years and also promises to manufacture the drug for the customer. The drug is a mature product; therefore the
entity will not undertake any activities to support the drug, which is consistent with its customary business practices.
Case A—License is not distinct
In this case, no other entity can manufacture this drug because of the highly specialized nature of the manufacturing
process. As a result, the License cannot be purchased separately from the manufacturing services. The entity
determines that the customer cannot benefit from the License without the manufacturing service; therefore, the
License and the manufacturing service are not distinct and the entity accounts for the License and the manufacturing
service as a single performance obligation.
Case B—License is distinct
In this case, the manufacturing process used to produce the drug is not unique or specialized and several other
entities can also manufacture the drug for the customer. The entity concludes that its promises to grant the License
and to provide the manufacturing service are separately identifiable. In reaching this conclusion, the entity considers
that the customer could separately purchase the License without significantly affecting its ability to benefit from the
License. Neither the License, nor the manufacturing service, is significantly modified or customized by the other and
the entity is not providing a significant service of integrating those items into a combined output. Thus, although the
manufacturing service necessarily depends on the License in this contract (i.e. the entity would not provide the
manufacturing service without the customer having obtained the License), the License and the manufacturing
service do not significantly affect each other. Consequently, the entity concludes that its promises to grant the
License and to provide the manufacturing service are distinct and that there are two performance obligations.
The drug is a mature product (i.e. it has been approved, is currently being manufactured and has been sold
commercially for the last several years). For these types of mature products, the entity’s customary business
practices are not to undertake any activities to support the drug. The drug compound has significant stand-alone
functionality (i.e. its ability to produce a drug that treats a disease or condition). Consequently, the customer obtains
a substantial portion of the benefits of the drug compound from that functionality, rather than from the entity’s
ongoing activities. The nature of the entity’s promise in transferring the License is to provide a right to use the
entity’s intellectual property in the form and the functionality with which it exists at the point in time that it is
granted to the customer. Consequently, the entity accounts for the License as a performance obligation satisfied at
a point in time.
Example 57—Franchise rights
An entity enters into a contract with a customer and promises to grant a franchise License that provides the customer
with the right to use the entity’s trade name and sell the entity’s products for 10 years. In addition to the License,
the entity also promises to provide the equipment necessary to operate a franchise store. In exchange for granting
the License, the entity receives a sales-based royalty of 5% of the customer’s monthly sales. The fixed consideration
for the equipment is Rs. 150,000 payable when the equipment is delivered.
Identifying performance obligations
The entity observes that the entity, as a franchisor, has developed a customary business practice to undertake
activities such as analyzing consumers’ changing preferences and implementing product improvements, pricing
strategies, marketing campaigns and operational efficiencies to support the franchise name. However, the entity
concludes that these activities do not directly transfer goods or services to the customer because they are part of
the entity’s promise to grant a License.
The entity determines that it has two promises to transfer goods or services: a promise to grant a License and a
promise to transfer equipment. In addition, the entity concludes that the promise to grant the License and the
promise to transfer the equipment are each distinct. The customer can benefit from the License together with the
equipment that is delivered before the opening of the franchise and the equipment can be used in the franchise or
sold for an amount other than scrap value. The entity concludes that the License and the equipment are not inputs
to a combined item (i.e. they are not fulfilling what is, in effect, a single promise to the customer). In addition, the
License and the equipment are not highly interdependent or highly interrelated because the entity would be able to
fulfil each promise (i.e. to license the franchise or to transfer the equipment) independently of the other.
Consequently, the entity has two performance obligations; the franchise license and the equipment.
Allocating the transaction price
The entity determines that the transaction price includes fixed consideration of Rs. 150,000 and variable
consideration (5% of customer sales). The stand-alone selling price of the equipment is Rs. 150,000 and the entity
regularly licenses franchises in exchange for 5% of customer sales. In addition, the entity observes that allocating Rs.
150,000 to the equipment and the sales-based royalty to the franchise License would be consistent with an allocation
based on the entity’s relative stand-alone selling prices in similar contracts. Consequently, the entity concludes that
the variable consideration should be allocated entirely to the performance obligation to grant the franchise License.
Application guidance: licensing
The entity assesses the nature of the entity’s promise to grant the franchise License and concludes that it is to
provide access to the entity’s intellectual property in its current form throughout the license period because:
▪ entity will undertake the activities that significantly affect the intellectual property. In addition, the entity observes
that because part of its compensation is dependent on the success of the franchisee (as evidenced through the
sales-based royalty), the entity has a shared economic interest with the customer that indicates that the customer
will expect the entity to undertake those activities to maximize earnings.
▪ the rights granted by the License directly expose the customer to any +/- effects of aforementioned activities.
▪ these activities do not result in the transfer of a good or service to customer as those activities occur.
The entity concludes that the promise to transfer the License is a performance obligation satisfied over time. After
the transfer of the franchise License, the entity recognizes revenue as and when the customer’s sales occur because
the entity concludes that this reasonably depicts the entity’s progress towards complete satisfaction of the franchise
License performance obligation.
Example 58—Access to intellectual property
An entity, a creator of comic strips, licenses the use of the images and names of its comic strip characters in three of
its comic strips to a customer for a four-year term. There are main characters involved in each of the comic strips.
However, newly created characters appear regularly and the images of the characters evolve over time. The
customer, an operator of cruise ships, can use the entity’s characters in various ways, such as in shows or parades,
within reasonable guidelines. The contract requires the customer to use the latest images of the characters. In
exchange for granting the License, the entity receives a fixed payment of Rs. 1 million in each year of the four-year
term. The entity concludes that it has no other performance obligations other than the promise to grant a License.
That is, the additional activities associated with the License do not directly transfer a good or service to the customer
because they are part of the entity’s promise to grant a License.
The entity assesses the nature of the entity’s promise to grant the license and concludes that it is to provide access
to the entity’s intellectual property in its current form throughout the license period because:
▪ entity will undertake the activities that significantly affect the intellectual property. This is because the entity’s
activities (i.e. development of the characters) change the form of the intellectual property.
▪ the rights granted by the License directly expose the customer to any +/- effects of aforementioned activities
because the contract requires the customer to use the latest characters.
▪ these activities do not result in the transfer of a good or service to customer as those activities occur.
Consequently, the entity concludes that the nature of the entity’s promise to transfer the License is to provide the
customer with access to the entity’s intellectual property as it exists throughout the License period. The entity
accounts for the promised License as a performance obligation satisfied over time. Because the contract provides
the customer with unlimited use of the licensed characters for a fixed term, the entity determines that a time-based
method would be the most appropriate measure of progress towards complete satisfaction of the performance
obligation.
Example 59—Right to use intellectual property
An entity, a music record label, licenses to a customer a 1975 recording of a classical symphony by a noted orchestra.
The customer, a consumer products company, has the right to use the recorded symphony in all commercials,
including television, radio and online advertisements for two years in Country A. In exchange for providing the
License, the entity receives fixed consideration of Rs. 10,000 per month. The contract does not include any other
goods or services to be provided by the entity. The contract is non-cancellable. The entity concludes that its only
performance obligation is to grant the License. The entity determines that the term of the License (two years), its
geographical scope (the customer’s right to use the recording only in Country A), and the defined permitted use for
the recording (in commercials) are all attributes of the promised License in the contract. The entity does not have
any contractual or implied obligations to change the licensed recording. The licensed recording has significant stand-
alone functionality (i.e. the ability to be played) and, therefore, the ability of the customer to obtain the benefits of
the recording is not substantially derived from the entity’s ongoing activities. Consequently, the entity concludes
that the nature of its promise in transferring the License is to provide the customer with a right to use the entity’s
intellectual property as it exists at the point in time that it is granted. The entity recognizes all of the revenue at the
point in time when the customer can direct the use of, and obtain substantially all of the remaining benefits from,
the licensed intellectual property. Because of the length of time between the entity’s performance (i.e. at the
beginning of the period) and the customer’s monthly payments over two years (which are non-cancellable), the
entity must determine whether a significant financing component exists.
Example 60—Sales-based royalty for a License of intellectual property
An entity, a movie distribution company, licenses Movie XYZ to a customer. The customer, an operator of cinemas,
has the right to show the movie in its cinemas for six weeks. Additionally, the entity has agreed to (a) provide
memorabilia from the filming to the customer for display at the customer’s cinemas before the beginning of the six-
week screening period; and (b) sponsor radio advertisements for Movie XYZ on popular radio stations in the
customer’s geographical area throughout the six-week screening period. In exchange for providing the License and
the additional promotional goods and services, the entity will receive a portion of the operator’s ticket sales for
Movie XYZ (i.e. variable consideration in the form of a sales-based royalty). The entity concludes that the License to
show Movie XYZ is the predominant item to which the sales-based royalty relates because the entity has a
reasonable expectation that the customer would ascribe significantly more value to the License than to the related
promotional goods or services. If the License, the memorabilia and the advertising activities are separate
performance obligations, the entity would allocate the sales-based royalty to each performance obligation.
Example 61—Access to intellectual property
An entity, a well-known sports team, licenses the use of its name and logo to a customer. The customer, an apparel
designer, has the right to use the sports team’s name and logo on items including t-shirts, caps, mugs and towels for
one year. In exchange for providing the License, the entity will receive fixed consideration of Rs. 2 million and a
royalty of 5% of the sales price of any items using the team name or logo. The customer expects that the entity will
continue to play games and provide a competitive team. The entity concludes that its only performance obligation
is to transfer the License. The additional activities associated with the License (i.e. continuing to play games and
provide a competitive team) do not directly transfer a good or service to the customer because they are part of the
entity’s promise to grant the License.
The entity assesses the nature of the entity’s promise to grant the license and concludes that it is to provide access
to the entity’s intellectual property in its current form throughout the license period because:
▪ entity will undertake the activities that significantly affect the intellectual property. This is because the entity’s
activities (i.e. continuing to play) support and maintain the value of the name and logo. In addition, the entity
observes that because part of its compensation is dependent on the success of the customer (as evidenced
through the sales-based royalty), the entity has a shared economic interest with the customer that indicates that
the customer will expect the entity to undertake those activities to maximize earnings.
▪ the rights granted by the License directly expose the customer to any +/- effects of aforementioned activities.
▪ these activities do not result in the transfer of a good or service to customer as those activities occur.
The entity concludes that the entity’s promise to grant the License is to provide the customer with access to the
entity’s intellectual property as it exists throughout the License period. Consequently, the entity accounts for the
promised License as a performance obligation satisfied over time. The entity concludes that recognition of the Rs. 2
million fixed consideration as revenue rateably over time plus recognition of the royalty as revenue as and when the
customer’s sales of items using the team name or logo occur reasonably depicts the entity’s progress towards
complete satisfaction of the License performance obligation
Repurchase agreements
A repurchase agreement is a contract in which an entity sells an asset and also promises or has the option (either
in the same contract or in another contract) to repurchase the asset. The repurchased asset may be the asset that
was originally sold to the customer, an asset that is substantially the same as that asset, or another asset of which
the asset that was originally sold is a component. Repurchase agreements generally come in following forms:
A forward or a call If an entity an obligation to repurchase (i.e. forward) or a right to repurchase (i.e.
option: call option) the asset, a customer does not obtain control of the asset.
Consequently, the entity shall account for the contract as either of the following:
▪ a lease in accordance with IFRS 16 if the entity can or must repurchase the
asset for an amount that is LESS than the original selling price of the asset.; OR
▪ a financial liability (e.g. loan) for consideration received if the entity can or
must repurchase the asset for an amount EQUAL to or MORE than the original
selling price of the asset. The asset shall remain recognized in books and the
difference between the consideration received for sale and consideration to be
paid for repurchase shall be recognized as interest. If option lapses
unexercised, an entity shall derecognize the liability and recognize revenue.
A put option: ▪ If an entity has an obligation to repurchase the asset at customer’s demand at
a price LOWER than the original selling price of the asset as well as than
expected market value of the asset at the date of repurchase, the entity shall
account for the agreement as a sale of a product with a right of return.
▪ If an entity has an obligation to repurchase the asset at customer’s demand at
a price LOWER than the original selling price of the asset but MORE than
expected market value of the asset at the date of repurchase, the entity shall
account for the agreement as a lease in accordance with IFRS 16.
▪ If an entity has an obligation to repurchase the asset at customer’s demand at
a price EQUAL to or MORE than the original selling price of the asset and MORE
than expected market value of the asset at the date of repurchase, the entity
shall account for the agreement as a financial liability as studied above for call
option.
▪ If an entity has an obligation to repurchase the asset at customer’s demand at
a price EQUAL to or MORE than the original selling price of the asset but EQUAL
to or LESS than expected market value of the asset at the date of repurchase,
the entity shall account for the agreement as a sale of a product with a right of
return.
When comparing repurchase price with the selling price, time value of money is to be considered.
When an entity delivers a product to another party (such as a dealer or a distributor) for sale to end customers,
the entity shall evaluate whether that other party has obtained control of the product at that point in time. A
product that has been delivered to another party may be held in a consignment arrangement if that other party
has not obtained control of the product. Accordingly, an entity shall not recognize revenue upon delivery of a
product to another party if the delivered product is held on consignment.
Indicators that an arrangement is a consignment arrangement include, but are not limited to, the following:
(a) the product is controlled by the entity until a specified event occurs, such as the sale of the product to a
customer of the dealer or until a specified period expires;
(b) the entity is able to require the return of the product or transfer the product to a third party (such as another
dealer); and
(c) the dealer does not have an unconditional obligation to pay for the product (although it might be required to
pay a deposit).
Bill-and-hold arrangements
A bill-and-hold arrangement is a contract under which an entity bills a customer for a product but the entity
retains physical possession of the product (i.e. entity provides custodial service) until it is transferred to the
customer at a point in time in the future.
The entity has satisfied its performance obligation to transfer a product when a customer obtains control of that
product. For a customer to have obtained control of a product in a bill-and-hold arrangement, all of the following
criteria must be met:
(d) the reason for the bill-and-hold arrangement must be substantive (for example, the customer has requested
the arrangement);
(e) the product must be identified separately as belonging to the customer;
(f) the product currently must be ready for physical transfer to the customer; and
(g) the entity cannot have the ability to use the product or to direct it to another customer.
Consequently, the contract modification does not meet the conditions to be accounted for as a separate contract.
Because the remaining products to be delivered are distinct from those already transferred, the entity accounts for
the modification as a termination of the original contract and the creation of a new contract.
Consequently, the amount recognized as revenue for each of the remaining products is a blended price of Rs. 93.33
{[(Rs. 100 × 60 products not yet transferred under the original contract) + (Rs. 80 × 30 products to be transferred
under the contract modification)] ÷ 90 remaining products}.
Example 6—Change in the transaction price after a contract modification
On 1 July 20X0, an entity promises to transfer two distinct products to a customer. Product X transfers to the
customer at contract inception and Product Y transfers on 31 March 20X1. The consideration promised by the
customer includes fixed consideration of Rs. 1,000 and variable consideration that is estimated to be Rs. 200. The
entity includes its estimate of variable consideration in the transaction price because it concludes that it is highly
probable that a significant reversal in cumulative revenue recognized will not occur when the uncertainty is resolved.
The transaction price of Rs. 1,200 is allocated equally to the performance obligation for Product X and the
performance obligation for Product Y (because both have same stand-alone price). When Product X transfers to the
customer at contract inception, the entity recognizes revenue of Rs. 600.
On 30 November 20X0, the scope of the contract is modified to include the promise to transfer Product Z (in addition
to the undelivered Product Y) to the customer on 30 June 20X1 and the price of the contract is increased by Rs. 300
(fixed consideration), which does not represent the stand-alone selling price of Product Z. The stand-alone selling
price of Product Z is the same as the stand-alone selling prices of Products X and Y.
The entity accounts for the modification as if it were the termination of the existing contract and the creation of a
new contract. This is because the remaining Products Y and Z are distinct from Product X, which had transferred to
the customer before the modification. Consequently, the consideration to be allocated to the remaining
performance obligations comprises the consideration that had been allocated to the performance obligation for
Product Y and the consideration promised in the modification. The transaction price for the modified contract is Rs.
900 and that amount is allocated equally to the performance obligation for Product Y and the performance obligation
for Product Z (i.e. Rs. 450 is allocated to each performance obligation).
After the modification but before the delivery of Products Y and Z, the entity revises its estimate of the amount of
variable consideration to which it expects to be entitled to Rs. 240. The entity concludes that the change in estimate
of the variable consideration can be included in the transaction price, because it is highly probable that a significant
reversal in cumulative revenue recognized will not occur when the uncertainty is resolved. Therefore, the change in
the transaction price is allocated to the performance obligations for Product X and Product Y on the same basis as
at contract inception. Consequently, the entity recognizes revenue of Rs. 20 for Product X in the period in which the
change in the transaction price occurs. Because Product Y had not transferred to the customer before the contract
modification, the change in the transaction price that is attributable to Product Y is allocated to the remaining
performance obligations at the time of the contract modification. Thus, the entity allocates the Rs. 20 increase in
the transaction price for the modified contract equally to the performance obligations for Product Y and Product Z.
Consequently, the amount of the transaction price allocated to the performance obligations for Product Y and
Product Z increases by Rs. 10 to Rs. 460 each.
On 31 March 20X1, Product Y is transferred to the customer and the entity recognizes revenue of Rs. 460. On 30
June 20X1, Product Z is transferred to the customer and the entity recognizes revenue of Rs. 460.
Example 7—Modification of a services contract
An entity enters into a three-year contract to clean a customer’s offices on a weekly basis. The customer promises
to pay Rs. 100,000 per year. The stand-alone selling price of the services at contract inception is Rs. 100,000 per
year. The entity recognizes revenue of Rs. 100,000 per year during the first two years of providing services. At the
end of the second year, the contract is modified and the fee for the third year is reduced to Rs. 80,000. In addition,
the customer agrees to extend the contract for three additional years for consideration of Rs. 200,000 payable in
three equal annual instalments of Rs. 66,667 at the beginning of years 4, 5 and 6. After the modification, the contract
has four years remaining in exchange for total consideration of Rs. 280,000. The stand-alone selling price of the
services at the beginning of the third year is Rs. 80,000 per year, therefore, total stand-alone price of remaining
services should be Rs. 320,000 (i.e. 4 years × Rs. 80,000 per year).
At contract inception, the entity accounts for the cleaning contract as a single performance obligation because the
weekly cleaning services are a series of distinct services that are substantially the same and have the same pattern
of transfer to the customer. At the date of the modification, the entity assesses the remaining services to be provided
and concludes that they are distinct. However, the amount of remaining consideration to be paid (Rs. 280,000) does
not reflect the stand-alone selling price of the services to be provided (Rs. 320,000).
Consequently, the entity accounts for the modification as a termination of the original contract and the creation of
a new contract with consideration of Rs. 280,000 for four years of cleaning service and recognizes revenue of Rs.
70,000 per year (Rs. 280,000 ÷ 4 years) as the services are provided over the remaining four years.
Example 8—Modification resulting in a cumulative catch-up adjustment to revenue
An entity, a construction company, enters into a contract to construct a commercial building for a customer on
customer-owned land for promised consideration of Rs. 1 million and a bonus of Rs. 200,000 if the building is
completed within 24 months. The entity accounts for the promised bundle of goods and services as a single
performance obligation satisfied over time. At the inception of the contract, the entity expects the following:
Rs.
Transaction price 1,000,000
Expected costs 700,000
Expected profit (30%) 300,000
At contract inception, the entity excludes the Rs. 200,000 bonus from the transaction price because it cannot
conclude that it is highly probable that a significant reversal in the amount of cumulative revenue recognized will
not occur.
By the end of the first year, the entity has satisfied 60% of its performance obligation on the basis of costs incurred
to date (Rs. 420,000) relative to total expected costs (Rs. 700,000). The entity reassesses the variable consideration
and concludes that the amount is still constrained. Consequently, the cumulative revenue and costs recognized for
the first year are as follows:
Rs.
Revenue 600,000
Costs 420,000
Gross profit 180,000
In the first quarter of the second year, the parties to the contract agree to modify the contract by changing the floor
plan of the building. As a result, the fixed consideration and expected costs increase by Rs. 150,000 and Rs. 120,000,
respectively. Total potential consideration after the modification is Rs. 1,350,000 (Rs. 1,150,000 fixed consideration
+ Rs. 200,000 completion bonus). In addition, the allowable time for achieving the Rs. 200,000 bonus is extended by
6 months to 30 months from the original contract inception date. At the date of the modification, on the basis of its
experience and the remaining work to be performed, which is primarily inside the building and not subject to
weather conditions, the entity concludes that it is highly probable that including the bonus in the transaction price
will not result in a significant reversal in the amount of cumulative revenue recognized and includes the Rs. 200,000
in the transaction price. In assessing the contract modification, the entity evaluates that the remaining goods and
services to be provided using the modified contract are not distinct from the goods and services transferred on or
before the date of contract modification; that is, the contract remains a single performance obligation.
Consequently, the entity accounts for the contract modification as if it were part of the original contract and updates
its measure of progress and estimates that it has satisfied 51.2 % of its performance obligation (Rs. 420,000 actual
costs incurred ÷ CU820,000 total expected costs). The entity recognizes additional revenue of Rs. 91,200 [(51.2 %
complete × CU1,350,000 modified transaction price) – Rs. 600,000 revenue recognized to date] at the date of the
modification as a cumulative catch-up adjustment.
the entity typically does not provide maintenance services and, therefore, the entity’s customary business practices,
published policies and specific statements at the time of entering into the contract have not created an implicit
promise to provide goods or services to its customers. The entity transfers control of the product to the distributor
and, therefore, the contract is completed. However, before the sale to the end customer, the entity makes an offer
to provide maintenance services to any party that purchases the product from the distributor for no additional
promised consideration. The promise of maintenance is not included in the contract between the entity and the
distributor at contract inception. Consequently, the entity does not identify the promise to provide maintenance
services as a performance obligation. Instead, the obligation to provide maintenance services is accounted for in
accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets. Although the maintenance services
are not a promised service in the current contract, in future contracts with customers the entity would assess
whether it has created a business practice resulting in an implied promise to provide maintenance services.
Performance obligations satisfied over time
Example 13—Customer simultaneously receives and consumes the benefits
An entity enters into a contract to provide monthly payroll processing services to a customer for one year. The
promised payroll processing services are accounted for as a single performance obligation. The performance
obligation is satisfied over time because the customer simultaneously receives and consumes the benefits of the entity’s
performance in processing each payroll transaction as and when each transaction is processed. The fact that another entity
would not need to re-perform payroll processing services for the service that the entity has provided to date also
demonstrates that the customer simultaneously receives and consumes the benefits of the entity’s performance as the
entity performs. The entity recognizes revenue over time by measuring its progress towards complete satisfaction of
that performance obligation in.
Example 14—Assessing alternative use and right to payment
An entity enters into a contract with a customer to provide a consulting service that results in the entity providing a
professional opinion to the customer. The professional opinion relates to facts and circumstances that are specific
to the customer. If the customer were to terminate the consulting contract for reasons other than the entity’s failure
to perform as promised, the contract requires the customer to compensate the entity for its costs incurred plus a
15% margin. The 15% margin approximates the profit margin that the entity earns from similar contracts.
If the entity were to be unable to satisfy its obligation and the customer hired another consulting firm to provide the
opinion, the other consulting firm would need to substantially re-perform the work that the entity had completed
to date, because the other consulting firm would not have the benefit of any work in progress performed by the
entity. However, the entity’s performance obligation is a performance obligation satisfied over time because of both
of the following factors:
(a) the development of the professional opinion does not create an asset with alternative use to the entity because
the professional opinion relates to facts and circumstances that are specific to the customer; and
(b) the entity has an enforceable right to payment for its performance completed to date for its costs plus a
reasonable margin, which approximates the profit margin in other contracts.
Example 15—Asset has no alternative use to the entity
An entity enters into a contract with a customer, a government agency, to build a specialized satellite. The entity
builds satellites for various customers, such as governments and commercial entities. The design and construction
of each satellite differ substantially, on the basis of each customer’s needs and the type of technology that is
incorporated into the satellite.
Although the contract does not preclude the entity from directing the completed satellite to another customer, the
entity would incur significant costs to rework the design and function of the satellite to direct that asset to another
customer. Consequently, the asset has no alternative use to the entity because the customer-specific design of the
satellite limits the entity’s practical ability to readily direct the satellite to another customer.
For the entity’s performance obligation to be satisfied over time when building the satellite, IFRS 15 also requires
the entity to have an enforceable right to payment for performance completed to date. This condition is not
illustrated in this example.
Example 16—Enforceable right to payment for performance completed to date
An entity enters into a contract with a customer to build an item of equipment. The payment schedule in the contract
specifies that the customer must make an advance payment at contract inception of 10% of the contract price,
regular payments throughout the construction period (amounting to 50% of the contract price) and a final payment
of 40% of the contract price after construction is completed and the equipment has passed the prescribed
performance tests. The payments are non-refundable unless the entity fails to perform as promised. If the customer
terminates the contract, the entity is entitled only to retain any progress payments received from the customer. The
entity has no further rights to compensation from the customer.
Even though the payments made by the customer are non-refundable, the cumulative amount of those payments is
not expected, at all times throughout the contract, to at least correspond to the amount that would be necessary to
compensate the entity for performance completed to date. This is because at various times during construction the
cumulative amount of consideration paid by the customer might be less than the selling price of the partially
completed item of equipment at that time. Consequently, the entity does not have a right to payment for
performance completed to date. Thus, the entity accounts for the construction of the equipment as a performance
obligation satisfied at a point in time.
Example 17—Assessing whether a performance obligation is satisfied at a point in time or over time
An entity is developing a multi-unit residential complex. A customer enters into a binding sales contract with the entity
for a specified unit that is under construction. Each unit has a similar floor plan and is of a similar size, but other
attributes of the units are different (for example, the location of the unit within the complex).
Case A—Entity does not have an enforceable right to payment for performance completed to date
The customer pays a deposit upon entering into the contract and the deposit is refundable only if the entity fails to
complete construction of the unit in accordance with the contract. The remainder of the contract price is payable on
completion of the contract when the customer obtains physical possession of the unit. If the customer defaults on the contract
before completion of the unit, the entity only has the right to retain the deposit.
The entity does not have an enforceable right to payment for performance completed to date because, until construction
of the unit is complete, the entity only has a right to the deposit paid by the customer. Because the entity does not have a
right to payment for work completed to date, the entity’s performance obligation is not a performance obligation satisfied
over time. Instead, the entity accounts for the sale of the unit as a performance obligation satisfied at a point in time.
Case B—Entity has an enforceable right to payment for performance completed to date
The customer pays a non-refundable deposit upon entering into the contract and will make progress payments during
construction of the unit. The contract has substantive terms that preclude the entity from being able to direct the unit to
another customer. In addition, the customer does not have the right to terminate the contract unless the entity fails
to perform as promised. If the customer defaults on its obligations by failing to make the promised progress payments as
and when they are due, the entity would have a right to all of the consideration promised in the contract if it completes the
construction of the unit. The courts have previously upheld similar rights that entitle developers to require the customer to
perform, subject to the entity meeting its obligations under the contract.
The entity also has a right to payment for performance completed to date. This is because if the customer were to
default on its obligations, the entity would have an enforceable right to all of the consideration promised under the
contract if it continues to perform as promised. Therefore, the terms of the contract and the practices in the legal
jurisdiction indicate that there is a right to payment for performance completed to date. Consequently, the entity has a
performance obligation that it satisfies over time.
Case C—Entity has an enforceable right to payment for performance completed to date
The same facts as in Case B apply to Case C, except that in the event of a default by the customer, either the entity can
require the customer to perform as required under the contract or the entity can cancel the contract in exchange for the
asset under construction and an entitlement to a penalty of a proportion of the contract price.
Notwithstanding that the entity could cancel the contract (in which case the customer’s obligation to the entity would
be limited to transferring control of the partially completed asset to the entity and paying the penalty prescribed), the
entity has a right to payment for performance completed to date because the entity could also choose to enforce its rights to
full payment under the contract. The fact that the entity may choose to cancel the contract in the event the customer
defaults on its obligations would not affect that assessment, provided that the entity’s rights to require the customer
to continue to perform as required under the contract (ie pay the promised consideration) are enforceable.
Measuring progress towards complete satisfaction of a performance obligation
Example 18—Measuring progress when making goods or services available
An entity, an owner and manager of health clubs, enters into a contract with a customer for one year of access to any of
its health clubs. The customer has unlimited use of the health clubs and promises to pay Rs. 100 per month.
The entity determines that its promise to the customer is to provide a service of making the health clubs available for the
customer to use as and when the customer wishes. This is because the extent to which the customer uses the health
clubs does not affect the amount of the remaining goods and services to which the customer is entitled. The entity
concludes that the customer simultaneously receives and consumes the benefits of the entity’s performance as it performs
by making the health clubs available. Consequently, the entity’s performance obligation is satisfied over time.
The entity also determines that the customer benefits from the entity’s service of making the health clubs available
evenly throughout the year. Consequently, the entity concludes that the best measure of progress towards complete
satisfaction of the performance obligation over time is a time-based measure and it recognizes revenue on a straight-
line basis throughout the year at Rs. 100 per month.
Example 19—Uninstalled materials
In November 20X2, an entity contracts with a customer to refurbish a 3-storey building and install new elevators for
total consideration of Rs. 5 million. The promised refurbishment service, including the installation of elevators, is a
single performance obligation satisfied over time. Total expected costs are Rs. 4 million, including Rs. 1.5 million for
the elevators. A summary of the transaction price and expected costs is as follows:
Rs.
Transaction price 5,000,000
Expected costs:
Elevators 1,500,000
Other costs 2,500,000
Total expected costs 4,000,000
The entity uses an input method based on costs incurred to measure its progress towards complete satisfaction of
the performance obligation. The customer obtains control of the elevators when they are delivered to the site in
December 20X2, although the elevators will not be installed until June 20X3. The costs to procure the elevators (Rs.
1.5 million) are significant relative to the total expected costs to completely satisfy the performance obligation (Rs.
4 million). The entity is not involved in designing or manufacturing the elevators.
The entity concludes that including the costs to procure the elevators in the measure of progress would overstate
the extent of the entity’s performance. Consequently, the entity adjusts its measure of progress to exclude the costs
to procure the elevators from the measure of costs incurred and from the transaction price. The entity recognizes
revenue for the transfer of the elevators in an amount equal to the costs to procure the elevators (i.e. at a zero
margin).
As of 31 December 20X2 the entity observes that:
(a) other costs incurred (excluding elevators) are Rs. 500,000; and
(b) performance is 20% complete (i.e. Rs. 500,000 ÷ Rs. 2,500,000).
An entity’s promise to stand ready to accept a returned product during the return period shall not be accounted
for as a performance obligation in addition to the obligation to provide a refund.
An entity shall update the measurement of the refund liability at the end of each reporting period for changes in
expectations about the amount of refunds. An entity shall recognise corresponding adjustments as revenue (or
reductions of revenue).
significant reversal in the amount of cumulative revenue recognized will not occur. Although the entity’s historical
price concessions have ranged from 20%–60%, market information currently suggests that a price concession of
15%–50% will be necessary. Consequently, the entity concludes that it is highly probable that a significant reversal
in the cumulative amount of revenue recognized will not occur if the entity includes Rs. 50,000 in the transaction
price (Rs. 100 sales price and a 50% price concession) and therefore, recognizes revenue at that amount and
reassesses the estimates of the transaction price at each reporting date until the uncertainty is resolved.
Example 24—Volume discount incentive
An entity enters into a contract with a customer on 1 January 20X8 to sell Product A for Rs. 100 per unit. If the customer
purchases more than 1,000 units of Product A in a calendar year, the contract specifies that the price per unit is
retrospectively reduced to Rs. 90 per unit. Consequently, the consideration in the contract is variable.
For the first quarter ended 31 March 20X8, the entity sells 75 units of Product A to the customer. The entity estimates that
the customer’s purchases will not exceed the 1,000-unit threshold required for the volume discount in the calendar
year. The entity concludes that it is highly probable that a significant reversal in the cumulative amount of revenue
recognized (i.e. Rs. 100 per unit) will not occur when the uncertainty is resolved (i.e. when the total amount of
purchases is known). Consequently, the entity recognizes revenue of Rs. 7,500 (75 units × Rs. 100 per unit) for the quarter
ended 31 March 20X8. In the second quarter ended 30 June 20X8 the entity sells an additional 500 units of Product A to the
customer. In the light of the new fact, the entity estimates that the customer’s purchases will exceed the 1,000-unit
threshold for the calendar year and therefore it will be required to retrospectively reduce the price per unit to Rs. 90.
Consequently, the entity recognizes revenue of Rs. 44,250 for the quarter ended 30 June 20X8. That amount is calculated
from Rs. 45,000 for the sale of 500 units (500 units × Rs. 90 per unit) less the change in transaction price of Rs. 750 (75
units × Rs. 10 price reduction) for the reduction of revenue relating to units sold for the quarter ended 31 March 20X8.
Example 25—Management fees subject to the constraint
On 1 January 20X8, an entity enters into a contract with a client to provide asset management services for five years.
The entity receives a 2% quarterly management fee based on the client’s assets under management at the end of
each quarter. In addition, the entity receives a performance-based incentive fee of 20% of the fund’s return in excess
of the return of an observable market index over the five-year period. Consequently, both the management fee and
the performance fee in the contract are variable consideration.
The entity accounts for the services as a single performance obligation, because it is providing a series of distinct
services that are substantially the same and have the same pattern of transfer. The entity observes that the promised
consideration is dependent on the market and thus is highly susceptible to factors outside the entity’s influence. In
addition, the incentive fee has a large number and a broad range of possible consideration amounts. The entity also
observes that although it has experience with similar contracts, that experience is of little predictive value in
determining the future performance of the market. Therefore, at contract inception, the entity cannot conclude that
it is highly probable that a significant reversal in the cumulative amount of revenue recognized would not occur if
the entity included its estimate of the management fee or the incentive fee in the transaction price.
At each reporting date, the entity updates its estimate of the transaction price. Consequently, at the end of each
quarter, the entity concludes that it can include in the transaction price the actual amount of the quarterly
management fee because the uncertainty is resolved. At 31 March 20X8, the client’s assets under management are
Rs. 100 million. Therefore, the resulting quarterly management fee and the transaction price is Rs. 2 million. At the
end of each quarter, the entity allocates the quarterly management fee to the distinct services provided during the
quarter. This is because the fee relates specifically to the entity’s efforts to transfer the services for that quarter,
which are distinct from the services provided in other quarters. Consequently, the entity recognizes Rs. 2 million as
revenue for the quarter ended 31 March 20X8.
The existence of a significant financing component in the contract
Example 26—Significant financing component and right of return
An entity sells a product to a customer for Rs. 121 that is payable 24 months after delivery. The customer obtains control of
the product at contract inception. The contract permits the customer to return the product within 90 days. The product
is new and the entity has no relevant historical evidence of product returns or other available market evidence. The
cash selling price of the product is Rs. 100 and entity’s cost of the product is Rs. 80.
The entity does not recognize revenue when control of the product transfers to the customer. This is because the existence
of the right of return and the lack of relevant historical evidence means that the entity cannot conclude that it is highly
probable that a significant reversal in the amount of cumulative revenue recognized will not occur. Consequently, revenue
is recognized after three months when the right of return lapses.
The contract includes a significant financing component which is evident from the difference between the amount of
promised consideration of Rs. 121 and the cash selling price of Rs. 100 at the date that the goods are transferred to the
customer. The following journal entries illustrate how the entity accounts for this contract:
(a) When the product is transferred to the customer:
Dr. Asset for right to recover product to be returned Rs. 80
Cr. Inventory Rs. 80
(b) During the three-month right of return period, no interest is recognised because no contract asset or receivable has
been recognized.
(c) When the right of return lapses (the product is not returned):
Dr. Receivable Rs. 100
Cr. Revenue Rs. 100
Case B—Contractual discount rate does not reflect the rate in a separate financing transaction
In evaluating the discount rate in the contract that contains a significant financing component, the entity observes
that the 5% contractual rate of interest is significantly lower than the 12% interest rate that would be used in a
separate financing transaction between the entity and its customer at contract inception (i.e. the contractual rate
of interest of 5% does not reflect the credit characteristics of the customer). This suggests that the cash selling price
is less than Rs. 1 million.
Thus, the entity determines the transaction price by adjusting the promised amount of consideration to reflect the
contractual payments using the 12% interest rate that reflects the credit characteristics of the customer.
Consequently, the entity determines that the transaction price is Rs. 848,357 (60 monthly payments of CU18,871
discounted at 12%). The entity recognizes revenue and a loan receivable for that amount. The entity accounts for
the loan receivable in accordance with IFRS 9.
Example 29—Advance payment and assessment of discount rate
An entity enters into a contract with a customer to sell an asset. Control of the asset will transfer to the customer in two
years (i.e. the performance obligation will be satisfied at a point in time). The contract includes two alternative
payment options: payment of Rs. 5,000 in two years when the customer obtains control of the asset or payment of Rs. 4,000
when the contract is signed. The customer elects to pay Rs. 4,000 when the contract is signed. The entity concludes
that the contract contains a significant financing component because of the length of time between when the customer
pays for the asset and when the entity transfers the asset to the customer.
The interest rate implicit in the transaction is 11.8%. However, the entity determines that the rate that should be used in
adjusting the promised consideration is 6%, which is the entity’s incremental borrowing rate as well as the prevailing market
interest rate. The following journal entries illustrate how the entity would account for the significant financing
component:
(a) recognize a contract liability for the Rs. 4,000 payment received at contract inception:
Dr. Cash Rs. 4,000
Cr. Contract liability Rs. 4,000
(b) during the two years from contract inception until the transfer of the asset, the entity adjusts the promised
amount of consideration and accretes the contract liability by recognizing interest on Rs. 4,000 at 6% for two years:
Finally, the entity would incur higher administration costs such as the costs related to administering renewals and
collection of monthly payments.
Thus, the entity determines that the payment terms were structured primarily for reasons other than the provision
of finance to the entity and concludes that there is not a significant financing component.
Non-cash consideration
Example 31—Entitlement to non-cash consideration
An entity enters into a contract with a customer to provide a weekly service for one year. In exchange for the service, the
customer promises 100 shares of its common stock per week of service (a total of 5,200 shares for the contract). The terms
in the contract require that the shares must be paid upon the successful completion of each week of service. The
entity measures its progress towards complete satisfaction of the performance obligation as each week of service is
complete. To determine the transaction price (and the amount of revenue to be recognized), the entity measures the
fair value of 100 shares that are received upon completion of each weekly service. The entity does not reflect any
subsequent changes in the fair value of the shares received (or receivable) in revenue.
Consideration payable to a customer
Example 32—Consideration payable to a customer
An entity that manufactures consumer goods enters into a one-year contract to sell goods to a customer that is a large
global chain of retail stores. The customer commits to buy at least Rs. 15 million of products during the year. The contract
also requires the entity to make a non-refundable payment of Rs. 1.5 million to the customer at the inception of the
contract. The Rs. 1.5 million payment will compensate the customer for the changes it needs to make to its shelving to
accommodate the entity’s products.
The entity concludes that the payment to the customer is not in exchange for a distinct good or service that transfers to
the entity. This is because the entity does not obtain control of any rights to the customer’s shelves. The entity concludes
that the consideration payable is accounted for as a reduction in the transaction price when the entity recognizes revenue
for the transfer of the goods. Consequently, as the entity transfers goods to the customer, the entity reduces the
transaction price for each good by 10% (Rs. 1.5 million ÷ Rs. 15 million). Therefore, in the first month in which the entity
transfers goods to the customer, the entity recognizes revenue of Rs. 1.8 million (Rs. 2.0 million invoiced amount less Rs. 0.2
million of consideration payable to the customer).
Allocating the transaction price to performance obligations
Example 33—Allocation methodology
An entity enters into a contract with a customer to sell Products A, B and C in exchange for Rs. 100. The entity will satisfy the
performance obligations for each of the products at different points in time. The entity regularly sells Product A separately
and therefore the stand-alone selling price is directly observable. The stand-alone selling prices of Products B and C are not
directly observable. Because the stand-alone selling prices for Products B and C are not directly observable, the entity
must estimate them. To estimate the stand-alone selling prices, the entity uses the adjusted market assessment approach for
Product B and the expected cost plus a margin approach for Product C. In making those estimates, the entity maximizes the
use of observable inputs. The entity estimates the stand-alone selling prices as follows:
entity’s customer has occurred, the performance obligation to which the royalty has been allocated has not been
satisfied.
Contract costs
Example 36—Incremental costs of obtaining a contract
An entity, a provider of consulting services, wins a competitive bid to provide consulting services to a new customer. The
entity incurred the following costs to obtain the contract:
Rs.
External legal fees for due diligence 15,000
Travel costs to deliver proposal 25,000
Commissions to sales employees 10,000
Total costs incurred 50,000
The entity recognizes an asset for the Rs. 10,000 incremental costs of obtaining the contract arising from the
commissions to sales employees because the entity expects to recover those costs through future fees for the consulting
services. The entity also pays discretionary annual bonuses to sales supervisors based on annual sales targets, overall
profitability of the entity and individual performance evaluations. However, the entity does not recognize an asset for the
bonuses paid to sales supervisors because the bonuses are not incremental to obtaining a contract. The amounts are
discretionary and are based on other factors, including the profitability of the entity and the individuals’
performance. The bonuses are not directly attributable to identifiable contracts. Also the external legal fees and travel
costs would have been incurred regardless of whether the contract was obtained. Therefore, those costs are recognized
as expenses when incurred.
Example 37—Costs that give rise to an asset
An entity enters into a service contract to manage a customer’s information technology data centre for five years.
The contract is renewable for subsequent one-year periods. The average customer term is seven years. The entity
pays an employee a Rs. 10,000 sales commission upon the customer signing the contract. Before providing the
services, the entity designs and builds a technology platform for the entity’s internal use that interfaces with the
customer’s systems. That platform is not transferred to the customer, but will be used to deliver services to the
customer.
Incremental costs of obtaining a contract
The entity recognizes an asset for the Rs. 10,000 incremental costs of obtaining the contract for the sales commission
because the entity expects to recover those costs through future fees for the services to be provided. The entity
amortizes the asset over seven years, because the asset relates to the services transferred to the customer during
the contract term of five years and the entity anticipates that the contract will be renewed for two subsequent one-
year periods.
Costs to fulfill a contract
The initial costs incurred to set up the technology platform are as follows:
Rs.
Design services 40,000
Hardware 120,000
Software 90,000
Migration and testing of data centre 100,000
Total costs 350,000
The initial setup costs relate primarily to activities to fulfil the contract but do not transfer goods or services to the
customer. The entity accounts for the initial setup costs as follows:
(a) hardware costs—accounted for in accordance with IAS 16 Property, Plant and Equipment.
(b) software costs—accounted for in accordance with IAS 38 Intangible Assets.
(c) costs of the design, migration and testing of the data centre—assessed to determine whether an asset can be
recognized for the costs to fulfil the contract. Any resulting asset would be amortized on a systematic basis over
the seven-year period that the entity expects to provide services related to the data centre.
In addition to the initial costs to set up the technology platform, the entity also assigns two employees who are
primarily responsible for providing the service to the customer. Although the costs for these two employees are
incurred as part of providing the service to the customer, the entity concludes that the costs cannot be recognized
as an asset rather the entity recognizes the payroll expense for these two employees when incurred.
Presentation
Example 38—Contract liability and receivable
Case A — Cancellable contract
On 1 January 20X9, an entity enters into a cancellable contract to transfer a product to a customer on 31 March 20X9. The
contract requires the customer to pay consideration of Rs. 1,000 in advance on 31 January 20X9. The customer pays the
consideration on 1 March 20X9. The entity transfers the product on 31 March 20X9. The following journal entries illustrate
how the entity accounts for the contract:
(a) The entity receives cash of Rs. 1,000 on 1 March 20X9 (cash is received in advance of performance):
Dr. Cash Rs. 1,000
Cr. Contract liability Rs. 1,000
(b) The entity satisfies the performance obligation on 31 March 20X9:
Dr. Contract liability Rs. 1,000
Cr. Revenue Rs. 1,000
Case B — Non-cancellable contract
The same facts as in Case A apply to Case B except that the contract is non-cancellable. The following journal entries
illustrate how the entity accounts for the contract:
(a) The amount of consideration is due on 31 January 20X9 (which is when the entity recognizes a receivable because it
has an unconditional right to consideration):
Dr. Receivable Rs. 1,000
Cr. Contract liability Rs. 1,000
(b) The entity receives the cash on 1 March 20X9:
Dr. Cash Rs. 1,000
Cr. Receivable Rs. 1,000
(c) The entity satisfies the performance obligation on 31 March 20X9:
Dr. Contract liability Rs. 1,000
Cr. Revenue Rs. 1,000
If the entity issued the invoice before 31 January 20X9 (the due date of the consideration), the entity would not
present the receivable and the contract liability on a gross basis in the statement of financial position because the entity
does not yet have a right to consideration that is unconditional.
Example 39—Contract asset recognized for the entity’s performance
On 1 January 20X8, an entity enters into a contract to transfer Products A and B to a customer in exchange for Rs. 1,000. The
contract requires Product A to be delivered first and states that payment for the delivery of Product A is conditional
on the delivery of Product B. In other words, the consideration of Rs. 1,000 is due only after the entity has transferred both
SOLUTIONS
SOLUTION TO QUESTION NO. 1
(ii)
Standalone Allocation of
Product price Rs. 104,000
--------------- Rs. -------------
E-1 30,000 24,000
[104,000 x 30/130]
E-3 100,000 80,000
[50,000 x 2] [104,000 x 100/130]
130,000 104,000
(i) The contract contains two distinct performance obligations i.e. selling the machine and providing the maintenance
services as:
• the customer can separately benefit from the machine without the maintenance services from GW (or GW
sells maintenance services separately) and
• the machine and maintenance services are separately identifiable in the contract.
Thus GW will allocate the transaction price between the two performance obligations as follows:
Revenue related to sale of machine would be recognized at a point in time i.e. upon delivery on 1 August 2018.
While revenue related to maintenance service would be recognized over time i.e. as the services are rendered.
Till 31 December 2018, revenue would be recognized in respect of:
• Sale of machine Rs. 1,530,000
• Maintenance service Rs. 112,500 (i.e Rs. 22,500 for 5 months)
Remaining amount of Rs. 157,500 would appear in liabilities as deferred revenue.
(ii) The contract contains two distinct performance obligations i.e. selling the machine and providing the maintenance
services.
The contract includes a significant financing component in respect of sale of machine which is evident from the
difference between the amount of promised consideration of Rs. 1.95 million and the cash selling price of Rs. 1.7
million.
Revenue related to machine would be recognized upon delivery on 1 October 2018. Revenue related to
maintenance service would be recognized as the services are rendered each month. The difference between
promised consideration and cash selling price of Rs. 250,000 would be recognized as interest revenue over two
years using the implicit rate of 7.1% [(1.95÷1.7) ½ –1].
Till 31 December 2018, revenue would be recognized in respect of:
- Sale of machine Rs. 1,700,000
- Maintenance service Rs. 75,000 i.e Rs. 25,000 for 3 months
- Interest revenue Rs. 30,175 (Rs. 1.7 million × 7.1% × 3/12)
Dr. Dr.
(ii) Rs. Rs.
1/6/18 Cash 100,000
Refund liability 100,000
(To record upfront cash received for goods delivered)
1/6/18
Asset for right to recover products 75,000
Inventory 75,000
(To record asset for right to recover products)
(c)
30-01-18 Refund liability 4,000
Sale return [2 x Rs. 500] 1,000
Cash [10 x Rs. 500] 5,000
[Refund actually made]
W-1
950,000
Present value of sale price = = Rs. 785,124
(1+10%)2
Product A Rs.
Up-front price 37,500
Year 1 Interest expense [37,500 x 6%] 2,250
39,750
Year 2 Interest expense [39,750 x 6%] 2,385
Year 2 Revenue for Product A 42,135
Product B
Up-front price 112,500
Year 1 Interest expense [112,500 x 6%] 6,750
119,250
Year 2 Interest expense [119,250 x 6%] 7,155
126,405
Year 3 Interest expense [126,405 x 6%] 7,584
133,989
Year 4 Interest expense [133,989 x 6%] 8,039
142,029
Year 5 Interest expense [142,029 x 6%] 8,522
Year 5 Revenue for Product B 150,550
W-1
[1−(1+12%)−3 ]
Present value of installments = 40,000 x
12%
W-2
Installment Interest Principal Balance
Date -------------------- Rs. ----------------------
96,073
31-Dec-18 40,000 11,529 28,471 67,602
31-Dec-19 40,000 8,112 31,888 35,714
31-Dec-20 40,000 4,286 35,714 0
W-2
Revenue Interest Principal Balance
Date -------------------- Rs. ----------------------
300,000
31-Dec-18 124,905 36,000 88,905 211,095
31-Dec-19 124,905 25,331 99,573 111,522
31-Dec-20 124,905 13,383 111,522 0
Allocation of price:
Boat [325 x 300/350] 278,571
Anchorage [325 x 50/350] 46,429
325,000
Allocation of price:
Boiler [400 x 360/420] 342,857
Services [400 x 60/420] 57,143
400,000
A 115,385
B 134,615
C 130,000
D 150,000
530,000
Allocation of price
Rs.
Stand-alone prices
Handset 500
Services 2,100
2,600
Allocation of price:
Handset [2,400 x 500/2,600] 462
Services [2,400 x 2,100/2,600] 1,938
2,400
(v) Recognise revenue when (or as) the entity satisfies a performance obligation, that is when the entity transfers
a promised good or service to a customer. This applies to each of the performance obligations:
(1) When TeleSouth gives a handset to Angelo, it needs to recognize the revenue of Rs. 462.
(2) When TeleSouth provides network services to Angelo, it needs to recognize the total revenue of
Rs. 1,938. It would be reasonable to recognized service revenue on monthly basis.
Journal entries
Dr. Cr.
--------- Rs. --------
01-01-18 Receivable 462
Revenue 462
[Revenue from sale of handset recognized]
Extracts – SOFP
Current assets
Contract asset [100 – 75] 2 marks 25
Receivable 1 mark 75
Extracts - SOCI
Rs. million
Revenue 154.00
Contract cost amortized 97.46
Extracts - SOFP
Non-current assets
PPE [320 - 16] 304.00
Current assets
Contract cost WIP (W-2) 3.54
Receivable 120.00
Contract asset 34.00
WORKINGS
W-1 Rs. million
Total estimated contract cost:
- Incurred to date (excluding dep) 85.00
- to be incurred (excluding dep) 310.00
- Plant dep [320 x 3/20] 48.00
443.00
Amortized [443 x 22%] 97.46
W-2
Cost incurred to date 101.00
Amortized (W-1) (97.46)
c/d balance 3.54
PRACTICE QUESTIONS
QUESTION NO. 1
On 1 January 2021, Covaxin Telecom (CT) announced a new annual promotional package for its customers. The package
comprises of a mobile phone, full year unlimited on-net calls and 1,000 minutes per month on other networks. Package
price is Rs. 11,550 per quarter payable in advance on the first day of each quarter. At the end of the contract, the phone
would not be returned to CT.
On the first day of the promotional announcement, CT sold 1,000 packages. Based on the data available with CT, it is
expected that each customer would utilize 10,000 minutes of other networks with quarterly break-up as under:
The mobile phone has a retail value of Rs. 34,000, if sold separately. A monthly subscription for unlimited on-net calls is
Rs. 500 while every call on other networks is charged at Rs. 1.5 per minute, if billed separately.
Required:
Compute the quarterly revenue to be recognised for the quarters ending 31 March 2021 and 30 June 2021. (08)
[Q-3, Spr-21]
QUESTION NO. 2
(a) Stupa Limited (SL) sells electrical products at following standalone prices:
Products Rupees
E-1 30,000
E-2 30,000
E-3 50,000
Required:
Calculate transaction price to be allocated to each product under each of the following independent situations:
(i) SL offered to sell one unit of each of the above products for Rs. 90,000. SL regularly sells one unit each of E-2 and
E-3 together for Rs. 70,000. (04)
(ii) SL offered to sell one unit of E-1 and two units of E-3 for Rs. 104,000. (02)
(b) On 1 October 2018, Kushan Construction Limited (KCL) entered into a contract to construct a commercial building for
a customer for Rs. 50 million and a bonus of Rs. 10 million if the building is completed on or before 31 December
2019.
Till 30 June 2019, KCL expected that the building will be completed within time at a total cost of Rs. 40 million.
However, due to bad weather and time involved in regulatory approvals, the building was completed on 28 February
2020 at a total cost of Rs. 42 million of which Rs. 26 million was incurred till 30 June 2019.
Required:
Compute profit to be recognized for the years ended 30 June 2019 and 2020, if:
(i) performance obligation under the contract is satisfied over time. (04)
(ii) performance obligation under the contract is satisfied at a point in time. (01)
(c) The nature, timing and amount of consideration promised by a customer affect the estimate of the transaction price.
Define the term ‘transaction price’ and list down the factors that may affect determination of the transaction price.
(04)
[Q-5, Autumn 2020]
QUESTION NO. 3
Financial statements of Trich Mir Limited (TML) for the year ended 31 December 2019 are under preparation. While
reviewing revenues from contract with customers, following matters have been identified:
(i) On 1 October 2019, TML sold Machine C to Chan Limited for Rs. 25 million. As per the contract, payment would be
made after 2 years. The accountant recognised sales revenue of Rs. 25 million upon delivery on 1 October 2019.
Further, commission paid to sales employees for winning the contract of Rs. 1.6 million was capitalised and is being
amortised over 2 years period. Applicable discount rate is 10% per annum.
(ii) TML entered into a contract to manufacture a specialised machine for Dhan Limited at a price of Rs. 30 million. The
contract meets the criteria of recognition of revenue over time. At the year end, the machine was 60% complete and
it was estimated that a further cost of Rs. 10 million would be incurred. Cost of Rs. 15 million incurred till year end
has been included in closing inventory and receipts of Rs. 11 million have been credited to revenues.
(iii) TML entered into a contract to sell one unit of Machine A and Machine B for a total price of Rs. 16 million. Machine
A was delivered in December 2019 to the customer while Machine B was delivered in January 2020. The consideration
of Rs. 16 million is due only after TML transfers both the machines to the customer. TML sells machines A and B at
standalone prices of Rs. 12 million and Rs. 8 million respectively. The accountant recognised receivable and revenue
of Rs. 12 million upon delivery of Machine A.
Required:
Prepare correcting entries for the year ended 31 December 2019 in accordance with IFRS 15. (14)
{Spring 2020, Q # 7}
QUESTION NO. 4
Thursday Enterprise (TE) is a supplier of product Zee and has provided you the following
information:
(a) On 1 August 2018, TE entered into a six months contract with customer Alpha for sale of Zee for Rs. 250 per unit,
under the following terms and conditions:
• if Alpha purchases more than 5,000 units during the contract period, the price per unit would be retrospectively
reduced to Rs. 215 per unit.
• TE’s unconditional right to receive consideration would be established upon:
- completion of quality control procedures by Alpha for the first order. The procedure would take a week after
receiving the goods.
- placement of order by Alpha for subsequent orders.
At the inception of the contract, TE concludes that Alpha’s purchases will not exceed the 5,000 units threshold for
the discount. Alpha placed the following orders:
(b) On 1 February 2019, TE entered into a six months contract with another customer Beta for sale of Zee for Rs. 250 per
unit, under the following terms and conditions:
• if the Beta purchases more than 15,000 units during the contract period, the price per unit would be
retrospectively reduced to Rs. 215 per unit.
• TE’s unconditional right to receive consideration would be established upon delivery of goods to Beta.
At the inception of the contract, TE concludes that Beta will meet 15,000 units threshold for the discount. Beta placed
the following orders:
Order date Units Delivery date Payment date
[Transfer of control]
14-02-2019 10,000 25-02-2019 20-03-2019
01-06-2019 8,000 15-07-2019 18-07-2019
Required:
In respect of the above contracts, prepare journal entries to be recorded in the books of TE for the years ended 31
December 2018 and 2019. (Entries without date will not be awarded any marks) (15)
{Autumn 2019, Q # 8}
QUESTION NO. 5
Guitar World (GW) normally sells Machine A13 for Rs. 1.7 million. Maintenance services for such type of machines are
provided separately at Rs. 25,000 per month. Details of two contracts for sale of Machine A13 are as follows:
(i) On 1 July 2018, GW signed a contract with Energene Limited to sell Machine A13 with one year free maintenance
services at a lumpsum payment of Rs. 1.8 million. The amount was received upon delivery of machine on 1 August
2018.
(ii) On 1 October 2018, GW sold Machine A13 to Vitalene Limited for Rs. 1.95 million. As per the contract, payment would
be made after 2 years. Maintenance services would also be provided for Rs. 25,000 per month for two years which
would be paid at the end of each month.
Required:
With reference to IFRS-15 ‘Revenue from Contracts with Customers’, explain how the above contracts should be recorded
in GW’s books for year ended 31 December 2018. (Show supporting calculations but entries are not required).
(11)
{Spring 2019, Q # 4(b)}
QUESTION NO. 6
On 1 June 2018 Ravi Limited (RL) delivered 500 units of one of its products to Bravo Limited (BL) at Rs. 200 per unit. BL
immediately paid the amount and obtained control upon delivery. BL is allowed to return unused units within 30 days and
receive a full refund. RL’s cost of the product is Rs. 150 per unit and it uses perpetual system for recording inventory
transactions.
On 30 June 2018, BL returned 20 units.
Required:
Prepare necessary journal entries in the books of RL on 1 June 2018 and 30 June 2018 under each of the following
independent situations:
(i) Based upon historical data, RL estimates that 5% units will be returned on expiry of 30 days. (05)
(ii) The product is new and RL has no relevant historical evidence of product returns or other available market evidence.
(04)
{Autumn 2018, Q # 3}
QUESTION NO. 7
On 1 October 2017, Galaxy Telecommunications (GT) entered into a contract with a bank for supplying 20 smart phones
to the bank staff with unlimited use of mobile network for one year. The contract price per smart phone is Rs. 34,650 and
the price is payable in full within 10 days from the date of contract. At the end of the contract, the phones will not be
returned to GT.
The entire amount received as per contract was credited by GT to advance from customers account. The smart phones
were delivered on 1 November 2017.
If sold separately, GT charges Rs. 18,000 for a smart phone and a monthly fee of Rs. 1,800 for unlimited use of mobile
network.
Required:
Prepare adjusting entry for the year ended 31 December 2017 in accordance with IFRS 15 ‘Revenue from Contracts with
Customers’. (04)
{Spring 2018, Q # 2 (b)}
QUESTION NO. 8
(a) Jupiter Limited (JL) entered into a two year contract on 1 January 2017, with a customer for the maintenance of
computer network. JL has offered the following payment options:
Option 1: Immediate payment of Rs. 200,000.
Option 2: Payment of Rs. 110,000 at the end of each year.
The applicable discount rate is 6.596%.
Required:
Prepare journal entries to be recorded in the books of JL under each option over the period of contract. (05)
(b) Pluto Limited (PL) sells industrial chemicals at following standalone prices:
Products Rupees
(per carton)
C-1 100,000
C-2 90,000
C-3 110,000
PL regularly sells a carton each of C-2 and C-3 together for Rs. 170,000.
Required:
Calculate the selling price to be allocated to each product, in case PL offers to sell one carton of each product for
a total price of Rs. 260,000. (05)
{Autumn 2017, Q # 6}
QUESTION NO. 9
Decent Constructions (DC) enters into a contract with a customer to build an asset for Rs. 20 million with a performance
bonus of Rs. 2 million that will be paid based on the timing of completion. The amount of the performance bonus
decreases by 10% per week for every week beyond the agreed-upon completion date. The contract requirements are
similar to contracts DC has performed previously, and management believes that such experience is predictive for this
contract. DC concludes that the expected value method is most predictive in this case.
DC estimates that there is a 60% probability that the contract will be completed by the agreed-upon completion date, a
30% probability that it will be completed one week late, and a 10% probability that it will be completed two weeks late.
Required
How should DC determine the transaction price?
QUESTION NO. 10
United Constructions (UC) enters into a contract to construct a manufacturing facility for a customer. The contract price
was agreed at Rs. 250 million plus a Rs. 25 million bonus only if the facility is completed by a specified date. The contract
is expected to take three years to complete. UC has a long history of constructing similar facilities. UC will receive no
bonus if the facility is not completed by the specified date. UC believes, based on its experience, that it is 95% likely that
the contract will be completed successfully and in advance of the target date.
Required:
How should UC determine the transaction price?
QUESTION NO. 11
Newage Constructions (NC) enters into a contract to construct a manufacturing facility for a customer. The contract price
was agreed at Rs. 100 million and a stipulated time period of 2 years was also agreed. To ensure timely completion, a
penalty of Rs. 10 million was agreed which would be deducted from contract price if work is not completed within 2 years.
NC believes, based on its experience, that it is 80% likely that the contract will be completed successfully and in advance
of the target date.
Required:
How should NC determine the transaction price?
QUESTION NO. 12
Alpha Consultants (AC) entered into a 1-year contract for book keeping services with a customer. Total contract price was
agreed at Rs. 5 million. It was also agreed that AC will be entitled to an extra Rs. 500,000 if number of mistakes found in
audit are less than 10. AC has experience of providing such services and it is highly probable that mistakes will not exceed
the acceptable limit.
Required:
How should AC determine the transaction price?
QUESTION NO. 13
Beta Traders (BT) enters into 100 contracts with customers on January 1, 2018. Each contract includes the sale of one
product for Rs. 500. The cost to BT of each product is Rs. 300. Cash is received upfront and control of the product transfers
on delivery. Customers can return the product within 30 days to receive a full refund. BT can sell the returned products
at a profit.
BT has significant experience in estimating returns for this product. It estimates that 92 products will not be returned.
Required:
How the above transactions should be accounted for if after 30 days:
(a) no refunds are claimed
(b) 5 products are refunded
(c) 10 products are refunded
QUESTION NO. 14
Gamma Traders (GT) enters into a 1-year contract with a customer to supply standard capacity UPS for office use. The
contract states that price per UPS will be adjusted retroactively once customer reaches certain sale volume as follows:
Based on past experience and knowledge of customer, GT estimates that sales volume for the year will be 610 UPS. At
the end of first month, customer purchased 130 UPS at a price of Rs. 5,000 per UPS.
Required:
Journal entry to record first month sale.
QUESTION NO. 15
Using the same situation as in Question 14, at the end of 2nd month customer purchased 300 units at a price of Rs. 5,000
per UPS. Now GT estimates that cumulative sale volume for the year will be 850 UPS.
Required:
Journal entry to record 2nd month sale.
QUESTION NO. 16
On January 1, 2018 Gallant Limited (GL) sold a machine to a customer. Control was transferred at the time of delivery.
However customer requested for a special credit of 2 years. Therefore a special price of Rs. 950,000 was charged.
Prevailing market interest rate on that date was 10%. Financial year of GL ends every December 31st. Cost of machine to
GL was Rs. 400,000. Cash equivalent price of machine was Rs. 750,000.
Required:
All journal entries for above transaction.
QUESTION NO. 17
On January 1, 2018 Prudent Limited (PL) agreed to sell an equipment to a customer. The customer demanded its delivery
after 2 years. PL will manufacture the equipment at the time of delivery. PL gave two options to customer:
Option I – 100% advance payment of Rs. 800,000 at the time of agreement
Option II – Payment of Rs. 1,000,000 at the time of delivery
Prevailing market interest rate at the date of agreement was 9%.
Required:
All journal entries for above transaction if customer opts for:
(a) Option I
(b) Option II
(c)
QUESTION NO. 18
Honest Traders (HT) entered into a contract with a customer to deliver Product A and Product B for Rs. 150,000 payable
up-front. Product A will be delivered in two years and Product B will be delivered in five years.
HT has determined that contract contains two performance obligations; Product A and Product B. Total price of Rs.
150,000 has been allocated, on the basis of stand-alone prices, to Product A and B at Rs. 37,500 and Rs. 112,500
respectively. HT also concludes that transaction contains significant financing component and interest rate of 6% is
appropriate.
Required:
Calculate annual interest expense till final delivery and amount of revenue recognized for each product.
QUESTION NO. 19
Finance House (FH) sold an equipment, costing Rs. 60,000, to a customer on installment sale basis on January 1, 2018.
Each installment of Rs. 40,000 will be received on every December 31 st for 3 years. Controlled was transferred on delivery.
Applicable market interest rate is 12%. FH prepares its financial statements on 31 st December every year.
Required:
All journal entries for above transaction.
QUESTION NO. 20
Modern Engineering (ME) entered into a contract for 3-year maintenance services with a manufacturing concern. Same
service will be rendered over 3-year period. Contract required 100% upfront fees of Rs. 300,000 payable at the time of
agreement on January 1, 2018. Prevailing market interest rate for ME is 12%. ME prepares its financial statements on 31st
December every year.
Required:
All journal entries for above transaction.
QUESTION NO. 21
Manufacture Co enters into a contract with Technology Co to build a machine. Technology Co pays Manufacture Co Rs. 1
million and contributes materials to be used in the development of the machine. The materials have a fair value of Rs.
500,000. Technology Co will deliver the materials to Manufacture Co approximately three months after development of
the machine begins. Manufacture Co concludes that it obtains control of the materials upon delivery by Technology Co
and could elect to use the materials for other projects.
Required:
How should Manufacture Co determine the transaction price?
QUESTION NO. 22
Golden Gate enters into a contract with a major chain of retail stores. The customer commits to buy at least Rs. 20m of
products over the next 12 months. The terms of the contract require Golden Gate to make a payment of Rs. 1m to
compensate the customer for changes that it will need to make to its retail stores to accommodate the products. By the
31 December 2018, Golden Gate has transferred products with a sales value of Rs. 4m to the customer.
Required
How much revenue should be recognised by Golden Gate in the year ended 31 December 2018?
QUESTION NO. 23
Mobile Co sells 1,000 phones to Retailer for Rs. 100,000. The contract includes an advertising arrangement that requires
Mobile Co to pay Rs. 10,000 toward a specific advertising promotion that Retailer will provide. Retailer will provide the
advertising on strategically located billboards and in local advertisements. Mobile Co could have elected to engage a third
party to provide similar advertising services at a cost of Rs. 10,000.
Required:
How should Mobile Co determine the transaction price?
QUESTION NO. 24
Marine sells boats and provides mooring facilities for its customers. Marine sells the boats for Rs. 300,000 each and
provides anchorage facilities for Rs. 50,000 per year. Marine concludes that the goods and services are distinct and
accounts for them as separate performance obligations. Marine enters into a contract to sell a boat and one year of
anchorage services to a customer for Rs. 325,000.
Required:
How should Marine allocate the transaction price of Rs. 325,000 to the performance obligations?
QUESTION NO. 25
Alpha Traders (AT) sells industrial boilers and also provides maintenance services. On January 1, 2018 AT sold a boiler
along with one year maintenance service at a package price of Rs. 400,000 to a customer. The contract involves two
performance obligations. Boilers are normally sold at a price of Rs. 360,000 and maintenance services are sold at cost plus
20%. Estimated cost of services in this contract will be Rs. 50,000.
Required:
Allocate transaction price to the performance obligations.
QUESTION NO. 26
Seller enters into a contract with a customer to sell Products A, B, and C for a total transaction price of Rs. 100,000. Seller
regularly sells Product A for Rs. 25,000 and Product B for Rs. 45,000 on a standalone basis. Product C is a new product
that has not been sold previously, has no established price, and is not sold by competitors in the market. Products A and
B are not regularly sold together at a discounted price. Product C is delivered on March 1, and Products A and B are
delivered on April 1.
Required:
How should Seller determine the standalone selling price of Product C?
NASIR ABBAS FCA
REVENUE (IFRS-15) - QUESTIONS (7)
QUESTION NO. 27
A seller sold four products A, B, C and D (all qualify for separate performance obligation) to a customer at a package price
of Rs. 500,000. It also sells such products on individual basis at following prices:
Products Stand-alone price
(Rs.)
A 120,000
B 140,000
C 130,000
D 150,000
Some customers also normally purchase products A and B at a package price of Rs. 250,000.
Required:
Allocate transaction price of Rs. 500,000 to four performance obligations.
QUESTION NO. 28
Telecom sells wireless mobile phone and other telecom service plans from a retail store. Sales agents employed at the
store signed 120 customers to two-year service contracts in a particular month. Telecom pays its sales agents commissions
for the sale of service contracts in addition to their salaries. Salaries paid to sales agents during the month were Rs.
120,000, and commissions paid were Rs. 24,000. The retail store also incurred Rs. 20,000 in advertising costs during the
month.
Required:
How should Telecom account for the costs?
QUESTION NO. 29
TechCo enters into a contract with a customer to track and monitor payment activities for a five-year period. A
prepayment is required from the customer at contract inception. TechCo incurs costs at the outset of the contract
consisting of uploading data and payment information from existing systems. The ongoing tracking and monitoring is
automated after customer set up. There are no refund rights in the contract.
Required:
How should TechCo account for the set-up costs?
QUESTION NO. 30
On 1 January 2018, Angelo enters into a twelve-month ‘pay monthly’ contract for a mobile phone. The contract is with
TeleSouth, and terms of the plan are:
(a) Angelo receives a free handset on 1 January 2018
(b) Angelo pays a monthly fee of Rs. 200, which includes unlimited free minutes. Angelo is billed on the last day of
the month
Customers may purchase the same handset from TeleSouth for Rs. 500 without the payment plan. They may also enter
into the payment plan without the handset, in which case the plan costs them Rs. 175 per month.
Required:
Show how TeleSouth should recognise revenue from this plan in accordance with IFRS 15 Revenue from contracts with
customers. Your answer should also give journal entries:
(a) On 1 January 2018
(b) On 31 January 2018
QUESTION NO. 31
Hassan Builders (HB) entered into a construction contract for construction of a building on January 1, 2017. Total contract
price was agreed at Rs. 500 million. Following information relates to the year ending December 31, 2017:
Rs. million
Contract cost incurred to date 80
Estimated further cost to complete the contract 320
Invoice issued on December 1, 2017 75
(HB has an unconditional right to receive payment against this invoice)
It has been determined that construction of building is single performance obligation and it will be satisfied over time. It
is HB’s policy to measure progress using proportion of cost incurred to date method.
Required:
Prepare extracts of statement of financial position and statement of comprehensive income for the year ending December
31, 2017.
QUESTION NO. 32
Kamran Builders (KB) signed a contract for construction of an office building for a customer in 3 years. Total contract price
was agreed at Rs. 700 million. Construction was commenced on January 1, 2021 and following information relates the
year ended December 31, 2021:
- A plant was purchased on January 1, 2021 for Rs. 320 million. Its total useful life is estimated to be 20 years. It would
be used throughout the contract period.
- Total costs incurred during the year (excluding plant depreciation) amounted to Rs. 85 million.
- As per contract, 1st invoice was raised on December 31, 2021 for Rs. 120 million which will be received on January 31,
2022.
- At year end, additional total cost (excluding plant depreciation) to be incurred for completion of contract is estimated
at Rs. 310 million.
- Using an appropriate method, progress is estimated at 22% till year end.
Required:
Journal entries, extracts of SOFP and SOCI for the year ending December 31, 2021.
QWL
Extracts - SOFP 2016 2015
------- Rs. million -------
Non-current assets
Retention money receivable 120.00 67.50
[2014: 3,000 x 80% x 5%][2013: 3,000 x 45% x 5%]
Current assets
Contract cost (W-1) 233.00 323.00
Receivable [2014: 100 x 85%][2013: 75 x 85%] 85.00 63.75
Current liabilities
Contract liability [2014: 3,000 x 20% x 10%][2013: 3,000 x 55% x 10%] 60.00 165.00
WORKINGS
W-1 Contract cost [i.e. Contract WIP] 2014 2013
------- Rs. million -------
b/d 323.00 -
Cost incurred [2014: 2,560 - 7 - 1,493] [2013: 1,500 - 7] 1,060.00 1,493.00
Amortized [2014: 2,900 x 80% - 1,170][2013: 2,600 x 45%] (1,150.00) (1,170.00)
c/d balance 233.00 323.00
Solution [Q-4 Jun-17]
Note
1) Entire contract amount received in advance is assumed to be a financing arrangement.
2) To avoid complicated calculations, financing arrangement is assumed to relate to building only.
Non-current liabilities
Contract liability [2016: 35.10 - 7.80] [2015: 39 - 3.90] 27.30 35.10
Current liabilities
Contract liability [2015: 257.24(W-1) + 3.90] 7.80 261.14
WORKINGS
W-1 Transaction price allocation Rs. million
Advance received 275.00
Cash for maintenance [6m x 1.3 x 5] (39.00)
Cash for sale of building (i.e. residual value basis) 236.00
Building
01-01-15 Advance 236.00
31-12-15 Interest [236 x 9%] 21.24
257.24
30-06-16 Interest [257.24 x 9% x 6/12] 11.58
268.82
IAS 12 – Class notes
Tax expense (tax income) is the aggregate amount included in the determination of profit or loss for the
period in respect of current tax and deferred tax.
CURRENT TAX
IMPORTANT TERMS
1. Accounting profit is profit or loss for a period before deducting tax expense (i.e. PBT).
2. Taxable profit (tax loss) is the profit (loss) for a period, determined in accordance with the rules
established by the taxation authorities, upon which income taxes are payable (recoverable).
3. Current tax is the amount of income taxes payable (recoverable) in respect of the taxable profit (tax
loss) for a period.
RECOGNITION
1. Current tax for current and prior periods shall, to the extent unpaid, be recognized as a liability. If the
amount already paid in respect of current and prior periods exceeds the amount due for those
periods, the excess shall be recognized as an asset.
Tax arising from a transaction Current tax shall also be recognized in OCI
or event which is recognized in
OCI (e.g. equity investment
measured at FV through OCI):
Tax arising from a transaction Current tax shall also be recognized directly in equity.
or event which is recognized [Tax relating to share based payments is discussed in detail later]
directly in equity (e.g.
adjustment in RE as per IAS 8):
MEASUREMENT
Current tax liabilities (assets) for the current and prior periods shall be measured at the amount expected
to be paid to (recovered from) the taxation authorities, using the tax rates (and tax laws) that have been
enacted or substantively enacted by the end of the reporting period.
(2) Current tax for prior year [Accounted for after assessment order for any prior year is received]
Dr. Tax expense [Under estimate]
Cr. Tax payable
OR
Dr. Tax payable
Cr. Tax expense [Over estimate]
Following assumptions are used for calculation of current tax for current year:
1. Incomes and expenses are taxable / deductible on accrual basis unless specifically mentioned otherwise.
2. Fines and penalties are not deductible for tax purposes.
3. Tax deduction is not allowed for doubtful debts, rather, it is allowed for bad debts actually written off.
4. Tax deduction is not allowed for provision of expenses (e.g. warranty provision), however, it is allowed when
expenditure is actually incurred.
5. Tax deduction is not allowed for employee cost (under post-employment benefit) for the year, rather, it is
allowed for benefits actually paid or contributions made (as instructed in question) during the year.
6. Any fair value gain/loss, revaluation gain/loss or impairment recognized in P&L is not allowed for tax
purposes.
7. In case of lease (books of lessee) tax deduction is not allowed for finance charge and depreciation on ROU
asset, rather full tax deduction is allowed for lease payments.
8. Borrowing cost is capitalized in accordance with IAS 23, however, it is allowed as tax deduction when incurred.
For tax purposes, actual borrowing cost incurred (e.g. contractual coupon payment) is allowed rather than
interest cost using effective interest rate method.
9. Dismantling cost is allowed for tax purposes in full when actually incurred, therefore, finance cost on provision
of dismantling is not allowed for tax purposes.
10. Tax depreciation (also called capital allowance) is calculated on full year basis. Tax depreciation is calculated
on cost of asset for tax purposes (i.e. excluding borrowing cost capitalized and dismantling cost capitalized.)
DEFERRED TAX
IMPORTANT TERMS
1. Deferred tax liabilities [DTL] are the amounts of income taxes payable in future periods in respect of
taxable temporary differences.
2. Deferred tax assets [DTA] are the amounts of income taxes recoverable in future periods in respect
of:
(a) deductible temporary differences;
(b) the carry forward of unused tax losses; and
(c) the carry forward of unused tax credits.
3. Temporary differences are differences between the carrying amount [CA] of an asset or liability in the
statement of financial position and its tax base [TB]. Temporary differences may be either:
(a) taxable temporary differences [TTD], which are temporary differences that will result in taxable
amounts in determining taxable profit (tax loss) of future periods when the carrying amount of
the asset or liability is recovered or settled; or
(b) deductible temporary differences [DTD], which are temporary differences that will result in
amounts that are deductible in determining taxable profit (tax loss) of future periods when the
carrying amount of the asset or liability is recovered or settled.
Exam note:
Students can identify the differences as taxable or deductible with the help of following guidance:
For Assets For Liabilities
Taxable difference If CA > TB If TB > CA
Deductible difference If TB > CA If CA > TB
4. The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes.
Examples
(a) A machine cost 100. For tax purposes, depreciation of 30 has already been deducted in the current
and prior periods and the remaining cost will be deductible in future periods, either as depreciation
or through a deduction on disposal. Revenue generated by using the machine is taxable, any gain
on disposal of the machine will be taxable and any loss on disposal will be deductible for tax
purposes. The tax base of the machine is 70.
(b) Interest receivable has a carrying amount of 100. The related interest revenue will be taxed on a
cash basis. The tax base of the interest receivable is nil.
(c) Trade receivables have a carrying amount of 100. The related revenue has already been included in
taxable profit (tax loss). The tax base of the trade receivables is 100.
(d) Dividends receivable from a subsidiary have a carrying amount of 100. The dividends are not
taxable. In substance, the entire carrying amount of the asset is deductible against the economic
benefits. Consequently, the tax base of the dividends receivable is 100.
(e) A loan receivable has a carrying amount of 100. The repayment of the loan will have no tax
consequences. The tax base of the loan is 100.
TB = carrying amount less any amount of the TB = carrying amount less any amount that will be
revenue that will not be taxable in future deductible for tax purposes in respect of that
periods liability in future periods
Examples
(a) Current liabilities include accrued expenses with a carrying amount of 100. The related expense will
be deducted for tax purposes on a cash basis. The tax base of the accrued expenses is nil.
(b) Current liabilities include interest revenue received in advance, with a carrying amount of 100. The
related interest revenue was taxed on a cash basis. The tax base of the interest received in advance
is nil.
(c) Current liabilities include accrued expenses with a carrying amount of 100. The related expense has
already been deducted for tax purposes. The tax base of the accrued expenses is 100.
(d) Current liabilities include accrued fines and penalties with a carrying amount of 100. Fines and
penalties are not deductible for tax purposes. The tax base of the accrued fines and penalties is 100.
(e) A loan payable has a carrying amount of 100. The repayment of the loan will have no tax
consequences. The tax base of the loan is 100.
Some items have a tax base but are not recognized as assets and liabilities in the statement of financial
position. For example, research costs are recognized as an expense in determining accounting profit in
the period in which they are incurred but may not be permitted as a deduction in determining taxable
profit (tax loss) until a later period.
RECOGNITION
to the extent that it is probable that future taxable profits will be available against which such deductible
differences, unused tax losses and unused tax credits can be utilized. To the extent that it is not probable
that taxable profits will be available, the deferred tax asset is not recognized. However, at end of each
reporting period, an entity reassesses unrecognized deferred tax assets. The entity recognizes a previously
unrecognized deferred tax asset to the extent that it has become probable that future taxable profit will
allow the deferred tax asset to be recovered.
Tax arising from a transaction or Deferred tax shall also be recognized directly in equity.
event which is recognized directly
in equity (e.g. equity component of
convertible debt):
MEASUREMENT
1. Deferred tax assets and liabilities shall be measured at the tax rates that are expected to apply to the
period when the asset is realized or the liability is settled, based on tax rates (and tax laws) that have
been enacted or substantively enacted by the end of the reporting period. [If future rates are not yet
announced, then year end rates are used].
2. When different tax rates apply to different levels of taxable income, deferred tax assets and liabilities
are measured using the average rates that are expected to apply to the taxable profit (tax loss) of the
periods in which the temporary differences are expected to reverse.
3. The measurement of deferred tax liabilities and deferred tax assets shall reflect the tax consequences
that would follow from the manner in which the entity expects, at the end of the reporting period, to
recover or settle the carrying amount of its assets and liabilities.
The entity recognizes a deferred tax liability of 8 (40 at 20%) if it expects to sell the item without further
use and a deferred tax liability of 12 (40 at 30%) if it expects to retain the item and recover its carrying
amount through use.
Example 2
An item or property, plant and equipment with a cost of 100 and a carrying amount of 80 is revalued
to 150. No equivalent adjustment is made for tax purposes. Cumulative depreciation for tax purposes
is 30 and the tax rate is 30%. If the item is sold for more than cost, the cumulative tax depreciation of
30 will be included in taxable income but sale proceeds in excess of cost will not be taxable.
The tax base of the item is 70 and there is a taxable temporary difference of 80. If the entity expects to
recover the carrying amount by using the item, it must generate taxable income of 150, but will only be
able to deduct depreciation of 70. On this basis, there is a deferred tax liability of 24 (80 at 30%). If the
entity expects to recover the carrying amount by selling the item immediately for proceeds of 150, the
deferred tax liability is computed as follows:
Example 3
The facts are as in example 2, except that if the item is sold for more than cost, the cumulative tax
depreciation will be included in taxable income (taxed at 30%) and the sale proceeds will be taxed at
40%, after deducting an inflation‑adjusted cost of 110.
If the entity expects to recover the carrying amount by using the item, it must generate taxable income
of 150, but will only be able to deduct depreciation of 70. On this basis, the tax base is 70, there is a
taxable temporary difference of 80 and there is a deferred tax liability of 24 (80 at 30%), as in example
2.
If the entity expects to recover the carrying amount by selling the item immediately for proceeds of 150,
the entity will be able to deduct the indexed cost of 110. The net proceeds of 40 will be taxed at 40%. In
addition, the cumulative tax depreciation of 30 will be included in taxable income and taxed at 30%. On
this basis, the tax base is 80 (110 less 30), there is a taxable temporary difference of 70 and there is a
deferred tax liability of 25 (40 at 40% plus 30 at 30%).
Example 4
An investment property has a cost of 100 and fair value of 150. It is measured using the fair value model
in IAS 40. It comprises land with a cost of 40 and fair value of 60 and a building with a cost of 60 and
fair value of 90. The land has an unlimited useful life. Cumulative depreciation of the building for tax
purposes is 30. Unrealized changes in the fair value of the investment property do not affect taxable
profit. If the investment property is sold for more than cost, the reversal of the cumulative tax
depreciation of 30 will be included in taxable profit and taxed at an ordinary tax rate of 30%. For sales
proceeds in excess of cost, tax law specifies tax rates of 25% for assets held for less than two years and
20% for assets held for two years or more.
Because the investment property is measured using the fair value model in IAS 40, there is a rebuttable
presumption that the entity will recover the carrying amount of the investment property entirely
through sale. If that presumption is not rebutted, the deferred tax reflects the tax consequences of
recovering the carrying amount entirely through sale, even if the entity expects to earn rental income
from the property before sale.
The tax base of the land if it is sold is 40 and there is a taxable temporary difference of 20 (60 – 40). The
tax base of the building if it is sold is 30 (60 – 30) and there is a taxable temporary difference of 60 (90
– 30). As a result, the total taxable temporary difference relating to the investment property is 80 (20 +
60).
The tax rate is the rate expected to apply to the period when the investment property is realized. Thus,
the resulting deferred tax liability is computed as follows, if the entity expects to sell the property after
holding it for more than two years:
TTD Tax% DTL
Cumulative tax depreciation 30 30% 9
Proceeds in excess of cost 50 20% 10
Total 80 19
If the entity expects to sell the property after holding it for less than two years, the above computation
would be amended to apply a tax rate of 25%, rather than 20%, to the proceeds in excess of cost. If,
instead, the entity holds the building within a business model whose objective is to consume
substantially all of the economic benefits embodied in the building over time, rather than through sale,
this presumption would be rebutted for the building.
However, the land is not depreciable. Therefore, the presumption of recovery through sale would not be
rebutted for the land. It follows that the deferred tax liability would reflect the tax consequences of
recovering the carrying amount of the building through use and the carrying amount of the land through
sale. The tax base of the building if it is used is 30 (60 – 30) and there is a taxable temporary difference
of 60 (90 – 30), resulting in a deferred tax liability of 18 (60 at 30%).
The tax base of the land if it is sold is 40 and there is a taxable temporary difference of 20 (60 – 40),
resulting in a deferred tax liability of 4 (20 at 20%). As a result, if the presumption of recovery through
sale is rebutted for the building, the deferred tax liability relating to the investment property is 22 (18 +
4).
Example 5
The following example deals with the measurement of current and deferred tax assets and liabilities
for an entity in a jurisdiction where income taxes are payable at a higher rate on undistributed profits
(50%) with an amount being refundable when profits are distributed. The tax rate on distributed profits
is 35%. At the end of the reporting period, 31 December 20X1, the entity does not recognize a liability
for dividends proposed or declared after the reporting period. As a result, no dividends are recognized
in the year 20X1. Taxable income for 20X1 is 100,000. The net taxable temporary difference for the year
20X1 is 40,000.
The entity recognizes a current tax liability and a current income tax expense of 50,000. No asset is
recognized for the amount potentially recoverable as a result of future dividends. The entity also
recognizes a deferred tax liability and deferred tax expense of 20,000 (40,000 at 50%) representing the
income taxes that the entity will pay when it recovers or settles the carrying amounts of its assets and
liabilities based on the tax rate applicable to undistributed profits.
Subsequently, on 15 March 20X2 the entity recognizes dividends of 10,000 from previous operating
profits as a liability.
On 15 March 20X2, the entity recognizes the recovery of income taxes of 1,500 (15% of the dividends
recognized as a liability) as a current tax asset and as a reduction of current income tax expense for
20X2.
When inter-company URP eliminations take place in consolidated SOFP, then temporary difference
arises because no corresponding adjustment is made in tax base. As a result, deferred tax is recognized
using buyer’s tax rate.
As a result of a business combination, the probability of realizing a pre‑acquisition deferred tax asset of
the acquirer could change. An acquirer may consider it probable that it will recover its own deferred
tax asset that was not recognized before the business combination. For example, the acquirer may be
able to utilize the benefit of its unused tax losses against the future taxable profit of the acquiree.
Alternatively, as a result of the business combination it might no longer be probable that future taxable
profit will allow the deferred tax asset to be recovered. In such cases, the acquirer recognizes a change
in the deferred tax asset in the period of the business combination, but does not include it as part of
the accounting for the business combination. Therefore, the acquirer does not take it into account in
measuring the goodwill or bargain purchase gain it recognizes in the business combination.
As already discussed above, if related fair value gain/loss is recognized in OCI then its related deferred
tax is also recognized in OCI. If an entity transfers required amount from revaluation surplus to retained
earnings, such transfer shall be a net of deferred tax amount.
For example
A building having carrying amount of Rs. 400 is revalued to Rs. 500. Ignoring tax, Rs. 30 out of this gain
is to be credited to P&L (loss reversal) and remaining Rs. 70 is to be credited to Revaluation surplus
(OCI). Remaining useful life is 10 years. If tax rate is 20% then revaluation entries will be:
Year end:
Dr. Revaluation surplus 5.60
Cr. Retained earnings 5.60
Goodwill
If goodwill is allowed as a deduction for tax purposes, then any resulting deferred tax liability/asset shall
be recognized. However, if no reduction in goodwill is allowed as deduction for tax purposes, then
taxable temporary difference arises on initial recognition of goodwill. No deferred tax liability shall be
recognized on such difference (neither initial nor subsequent).
Convertible debt
In accordance with IAS 32, the issuer of a compound financial instrument (for example, a convertible
bond) classifies the instrument’s liability component as a liability and the equity component as equity.
In some jurisdictions, the tax base of the liability component on initial recognition is equal to the initial
carrying amount of the sum of the liability and equity components. The resulting taxable temporary
difference arises from the initial recognition of the equity component separately from the liability
component.
Consequently, an entity recognizes the resulting deferred tax liability and the deferred tax is charged
directly to the carrying amount of the equity component. Any subsequent changes in the deferred tax
liability are recognized in profit or loss as deferred tax expense (income).
For example, in some jurisdictions, an entity may recognize an expense for the consumption of
employee services received as consideration for share options granted as per IFRS 2, and not receive a
tax deduction until the share options are exercised, with the measurement of the tax deduction based
on the entity’s share price at the date of exercise.
The difference between the tax base of the employee services received to date (being the amount the
taxation authorities will permit as a deduction in future periods in respect of services rendered to date),
and the carrying amount of nil, is a deductible temporary difference that results in a deferred tax asset.
If the amount the taxation authorities will permit as a deduction in future periods is not known at the
end of the period, it shall be estimated, based on information available at the end of the period.
Liabilities
xxxxx X X X X% X
xxxxx X X X X% X
xxxxx X X X X% X
Tips:
- for assets, difference = CA – TB
- for liabilities, difference = TB – CA
- Do not include assets/liabilities which are covered under exception, in above calculation.
Calculation of deferred tax expense for the year in a comprehensive exam question:
Deferred tax [DTL / DTA]
b/d [Opening DTA] X b/d [Opening DTL] X
Tax on OCI (e.g. revaluation downwards) X Tax on OCI (e.g. revaluation upwards) X
Effect of tax rate change on OCI item X Effect of tax rate change on OCI item X
Tax directly credited in equity X Tax directly debited in equity X
Tax expense (– ve expense) (bal.) X Tax expense (+ ve expense) (bal.) X
c/d [Closing DTL] X c/d [Closing DTA] X
DISCLOSURES
5 – Deferred tax Opening -------- Recognized during the year ------- Closing
Balance Equity OCI P&L Balance
Deferred tax comprises of: ------------------------------------ Rs. million -------------------------------------
Deferred tax liability
PPE X X
Investments X X
Deferred tax asset
Defined benefit obligation (X) (X)
Share options (X) (X)
Doubtful debts (X) (X)
c/f loss (X) (X)
X X
** It does not include those expenses for whom deferred tax has been recognized e.g. impairment loss
PRACTICE QUESTIONS
Question No. 1
Given below is the statement of comprehensive income of Shakir Industries for the year ended December 31, 2008:
2008
Rs. in million
Sales 143.00
Cost of goods sold (96.60)
Gross profit 46.40
Operating expenses (28.70)
Operating profit 17.70
Other income 3.40
Profit before interest and tax 21.10
Financial charges (5.30)
Profit before tax 15.80
Following information is available:
(i) Operating expenses include an amount of Rs. 0.7 million paid as penalty to SECP on non-compliance of certain
requirements of the Companies Act.
(ii) During the year, the company made a provision of Rs. 2.4 million for gratuity. The actual payment on account of
gratuity to outgoing members was Rs. 1.6 million.
(iii) Lease payments made during the year amounted to Rs. 0.65 million which include financial charges of Rs. 0.15
million. As at December 31, 2008, Lease liability stood at Rs. 1.2 million. The movement in right-of-use assets is
as follows:
Rs. in million
Opening balance – 01/01/2008 2.50
Depreciation for the year (0.7)
Closing balance – 31/12/2008 1.80
(iv) The details of owned fixed assets are as follows:
Accounting Tax
Rs. in million
Opening balance – 01/01/2008 12.50 10.20
Purchased during the year 5.30 5.30
Depreciation for the year (1.10) (1.65)
Closing balance – 31/12/2008 16.70 13.85
(v) Capital work-in-progress as on December 31, 2008 include financial charges of Rs. 2.3 million which have been
capitalized in accordance with IAS-23 “Borrowing Costs”. However, the entire financial charges are admissible,
under the Income Tax Ordinance, 2001.
(vi) Deferred tax liability and provision for gratuity as at January 1, 2008 was Rs. 0.55 million and Rs. 0.7 million
respectively.
(vii) As at December 31, 2008, the company had assessed brought forward tax losses of Rs. 3.5 million.
(viii) Applicable income tax rate is 35%.
Required:
Based on the available information, compute the current and deferred tax expenses for the year ended December 31,
2008. (15)
{Spring 2009, Q # 5}
Question No. 2
Following information relates to Dynamic Limited for the year ended June 30, 2019:
(i) Property plant and equipment has a net book value at year end of Rs. 24.5 million. During the year equipment having
carrying amount of Rs. 3.5 million was sold at a loss of Rs. 0.1. Tax gain on this sale was Rs. 0.3 million. There was no
other disposal during the year. Additions during the year amount to Rs. 6 million. Tax written down value of property
plant and equipment at start of year was Rs. 19.5 million. Accounting depreciation for the year was Rs.4.75 million
whereas capital allowance for the year was Rs. 7 million.
(ii) Provision for gratuity at start of year was Rs. 8.25 million. During the year a further provision for Rs. 1.5 million was
recognized. Gratuity payments during the year amount to Rs. 5 million.
(iii) During the year Rs. 0.45 million were spent on advertisement. As per tax rules such expenses are allowed over 3
years on straight line basis.
(iv) Bad debts written off during the year were Rs. 0.1 million whereas bad debt expense charged to profit and loss
during the year was Rs. 0.175 million. Provision for doubtful debts at start of year was Rs. 0.35 million.
(v) Profit before tax for the year amounts to Rs. 6.5 million. It includes an income of Rs. 0.05 million received during the
year which is exempt from tax.
(vi) Corporation tax rate is 35%.
Required:
Calculate current tax expense and deferred tax expense for the year ended June 30, 2019. (15)
Question No. 3
Following are the relevant extracts from the financial statements of Floor & Tiles Limited (FTL) for the year ended 31
December 2015:
Rs. in million
Profit before tax 80
Provision for gratuity for the year 12
Bad debt expense for the year 10
Capital gain (exempt from tax) 5
The following information is also available:
(i) Opening balances of deferred tax liability, provision for bad debts and provision for gratuity were Rs. 5.28 million,
Rs. 2 million and Rs. 13 million respectively.
(ii) The cost and other details related to buildings (owned) included in property, plant and equipment are as follows:
Rs. in million
Opening balance (purchased on January 1, 2013) 350
Cost of a building sold on April 30, 2015 (for Rs. 35 million) 30
Purchased on July 1, 2015 40
(iii) Accounting depreciation on buildings is calculated @ 5% per annum on straight line basis whereas tax depreciation
is calculated @ 10% on reducing balance method. Accounting depreciation of all other owned assets included in
property, plant and equipment is same as tax depreciation.
(iv) On 1 January 2015, a machine was acquired on lease. Some of the relevant information is as follows:
The lease term as well as the useful life is 5 years.
Annual lease rentals amounting to Rs. 30 million are payable in advance.
The interest rate implicit in the lease is 12.59%.
This right of use would be depreciated over its useful life on straight line method.
(v) On 1 June 2015, an amount of Rs. 1 million was paid as penalty to the provincial government due to non-compliance
of environmental laws.
(vi) The amount of gratuity paid to outgoing members was Rs. 10 million.
(vii) During the year, entertainment expenses and repair expenses amounting to Rs. 6 million and Rs. 8 million
respectively, pertaining to year ended 31 December 2013 were disallowed. FTL has decided to file appeal only
against the decision regarding repair expenses.
(viii) Applicable tax rate is 32%.
Required:
Prepare a note on taxation (expense) for inclusion in FTL’s financial statements for the year ended 31 December 2015
giving appropriate disclosures relating to current and deferred tax expenses including a reconciliation to explain the
relationship between tax expense and accounting profit. (17)
{Spring 2016, Q 4}
Question No. 4
Rose Limited (RL) is finalizing its financial statements for the year ended 31 December 2017. In this respect, the following
information has been gathered:
(i) Applicable tax rate is 30% except stated otherwise.
(ii) During the year RL incurred advertising cost of Rs. 15 million.
This cost is to be allowed as tax deduction over 5 years from 2017 to 2021.
(iii) Trade and other payables amounted to Rs. 40 million as on 31 December 2017 which include unearned
commission of Rs. 10 million.
Commission is taxable when it is earned by the company. Tax base of remaining trade and other payables is Rs.
25 million.
NASIR ABBAS FCA
INCOME TAXES (IAS-12) – QUESTIONS (3)
(iv) Other receivables amounted to Rs. 17 million as on 31 December 2017 which include dividend receivable of Rs.
8 million.
Dividend income was taxable on receipt basis at 20% in 2017. However, with effect from 1 January 2018, dividend
received is exempt from tax. Tax base of remaining other receivables is Rs. 6 million.
(v) On 1 April 2017, RL invested Rs. 40 million in a fixed deposit account for one year at 10% per annum. Interest will
be received on maturity.
Interest was taxable on receipt basis at 10% in 2017. However, with effect from 1 January 2018, interest received
is taxable at 15%.
(vi) On 1 January 2016, a machine was acquired on lease for a period of 4 years at annual lease rental of Rs. 28
million, payable in advance. Interest rate implicit in the lease is 10%.
Under the tax laws, all lease related payments are allowed in the year of payment.
(vii) Details of fixed assets are as follows:
• On 1 January 2017 RL acquired a plant at a cost of Rs. 250 million. It has been depreciated on straight
line basis over a useful life of six years. RL is also obliged to incur decommissioning cost of Rs. 50 million
at the end of useful life of the plant. Applicable discount rate is 8%.
• On 1 July 2017 RL sold one of its four buildings for Rs. 60 million. These buildings were acquired on 1
January 2013 at a cost of Rs. 100 million each having useful life of 30 years.
The dismantling costs will be allowed for tax purposes when paid. Tax depreciation rate for all owned fixed assets
is 10% on reducing balance method. Further, full year’s tax depreciation is allowed in year of purchase while no
depreciation is allowed in year of disposal.
Required:
Compute the deferred tax liability/asset to be recognised in RL’s statement of financial position as on 31 December 2017.
(16)
(Q-6, Spr-18)
Question No. 5
Orange Limited (OL) is in the process of finalizing its financial statements for the year ended 30 June 2018. The following
information has been gathered for preparing the disclosures related to taxation:
(i) Profit before tax for the year ended 30 June 2018 was Rs. 508 million.
(ii) Accounting depreciation for the year exceeds tax deprecation by Rs. 45 million.
(iii) During the year, OL sold a machine whose accounting WDV exceeded tax WDV by Rs. 15 million.
(iv) OL carries trademark of Rs. 90 million having indefinite useful life which was acquired on 1 July 2015. Tax
authorities allow its amortization over 10 years on straight line basis.
(v) OL sells goods with a 1-year warranty and it is estimated that warranty expenses are 2% of annual sales. Actual
payments during the year related to warranty claims were Rs. 54 million. Of these, Rs. 38 million pertain to goods
sold during the previous year. Sales for the year ended 30 June 2018 was Rs. 1,750 million. Under the tax laws,
these expenses are allowed on payment basis.
(vi) During the year, OL expensed out payments of Rs. 17.5 million related to restructuring of one of its business
segments. As per tax laws, these expenses are to be allowed as tax expense over a period of 5 years from 2018
to 2022.
(vii) Expenses include:
• accruals of Rs. 26 million which will be allowed for tax purpose on payment basis.
• cash donations of Rs. 5 million which are not allowed as tax expense.
(viii) Other income includes:
• commission receivable of Rs. 12 million.
• dividend receivable of Rs. 35 million.
Both incomes were taxable on receipt basis at 30% up to 30 June 2018. With effect from 1 July 2018 commission
income is exempt from tax whereas dividend income is taxable at 10% on receipt basis.
(ix) On 30 June 2018, OL received advance rent of Rs. 16 million. Rent income is taxable on receipt basis.
(x) Net deferred tax liability as on 1 July 2017 arose on account of:
Rs. in million
Property, plant and equipment 34.5
Trademark 5.40
Provision for warranty (14.70)
25.20
(xi) Applicable tax rate is 30% except stated otherwise.
Required:
(a) Prepare a note on taxation for inclusion in OL's financial statements for the year ended 30 June 2018
including a reconciliation to explain the relationship between tax expense and accounting profit. (11)
(b) Compute the deferred tax liability/asset in respect of each temporary difference. (07)
(Comparative figures are not required)
{Autumn 2018, Q # 1}
Question No. 6
Following information relates to Akmal Limited for the year ended December 31, 2019:
(i) Owned property plant and equipment has a net book value of Rs. 28.5 million at December 31, 2019. Tax base of
property, plant and equipment on December 31, 2018 was Rs. 24 million. On January 1, 2019, an owned machine
was sold at fair value of Rs. 9 million (i.e. Rs. 1.8 million higher than its carrying amount). Accumulated accounting
depreciation of the machine at the time of sale was Rs. 3.6 million whereas its accumulated capital allowance at
that date was Rs. 5 million. On the same date, a similar machine was obtained on a lease for four years. Lease
rental was agreed at Rs. 2.019 million payable at end of every year with an effective interest rate of 10%.
Additions to owned property, plant and equipment during the year amount to Rs. 3.5 million. Accounting
depreciation for the year on owned assets was Rs. 2.3 million whereas capital allowance for the year was Rs. 5.2
million.
(ii) During the year Rs. 3 million was incurred on research. Due to deficiency in supporting documents, only Rs. 2.4
million can be claimed as deduction for tax purposes. Such expenses are allowed on straight line basis over 3
years.
(iii) Rent income (i.e. operating lease) is taxed on receipt basis. Rent income recognized during the year was Rs. 0.25
million. Unearned rent income at start and end of year was Rs. 0.1 million and Rs. 0.15 million respectively.
(iv) During the year a pending appeal in respect of tax year 2017 was settled. As a result, tax return was revised and
a tax refund of Rs. 0.3 million was approved. No adjustment in books has been made so far in this respect.
(vi) Profit before tax for the year amounts to Rs. 18.2 million.
(vii) Corporation tax rate is 35%.
Required:
Prepare “Deferred tax” and “Taxation” notes to the financial statements for the year ending December 31, 2019.
(Comparative information is not required) (22)
Question No. 7
Mercury Water Limited (MWL) is a listed company and is engaged in the business of purifying and marketing of bottled
water.
MWL purchased a bottling plant on 1 July 2006 at a cost of Rs. 90 million. The plant has a useful life of ten years with no
residual value. Depreciation is provided on straight-line method over the plant’s useful life. MWL revalues its plant at the
end of every two years.
The revalued amounts determined by Jet Valuers, an independent firm of valuers, are as follows:
(i) On 30 June 2008: Rs. 64 million
(ii) On 30 June 2010: Rs. 60 million
However, there was no change in the expected useful life and residual value of the plant.
Profit before tax for the years ended 30 June 2011 and 2010 was Rs. 80 million and Rs. 60 million respectively. The tax
authorities allow tax depreciation at 20% on reducing balance method. There are no temporary or permanent differences
other than those apparent from the above information. The tax rate applicable on MWL is 40%.
Required:
(a) Prepare journal entries to record the effect of revaluation and deferred tax, at the end of each year, up to 30
June 2011. (14)
(b) Prepare a note on taxation for the year ended 30 June 2011 in accordance with International Financial Reporting
Standards. (Comparative figures are required. Accounting policies are not required.) (07)
{Autumn 2011, Q # 5}
Question No. 8
Following information has been gathered for preparing the disclosures related to taxation of Lux Limited (LL) for the year
ended 31 December 2020:
(i) Accounting profit before tax for the year amounted to Rs. 1,270 million.
(ii) Accounting depreciation exceeds tax depreciation by Rs. 100 million (2019: Rs. 150 million). Accounting
depreciation also includes incremental depreciation of Rs. 40 million (2019: Rs. 60 million). As on 1 January 2019,
carrying value of property, plant and equipment exceeded their tax base by Rs. 500 million.
Other information:
1) Land is carried at revaluation model. It was revalued to Rs. 18 million in 2017. Its fair value at December 31, 2019
is Rs. 18.5 million. However, no adjustment has been made for this revaluation. The revaluation surplus in balance
sheet relates to this land. Effect of rate change has not yet been accounted for.
2) Building was purchased on January 1, 2016. Total useful life of building was 20 years. Tax department allows
depreciation on building @ 10% on straight line basis.
3) Plant is depreciated on straight line basis over a life of 10 years. Plant was purchased on January 1, 2014. Tax
department allows depreciation on plant @ 25% reducing balance basis.
4) During the year Rs. 3 million were incurred on Research cost. Supporting documents relating to Rs. 0.45 million
are not available therefore will not be allowed as deduction by Tax deptt. As it allows only verifiable research
expenses on straight-line basis over three years.
5) Total lease rentals are allowed as deduction when paid. Total payments made during the year include Rs. 425,000
in respect of principal.
6) Gratuity expense for the year amounts to Rs. 0.35 million. Provision for gratuity balance at start of 2019 was Rs.
0.7 million.
8) Depreciation on leased vehicles during the year is Rs. 550,000.
9) Brought forward tax loss amounts to Rs. 850,000.
10) A penalty of Rs. 60,000 was charged during the year. No deduction is available for tax purposes.
11) Profit includes an income of Rs. 40,000 which is exempt from tax.
12) Profit before tax for the year is Rs. 4,200,000.
13) An expense claim has been rejected during 2019 as a result of assessment of 2015. BL will pay tax amounting to
Rs. 45,000 on this expense in 1st quarter of 2020.
14) Tax rate at end of 2018 was 30% and at end of 2019 is 35%.
Required:
Prepare "Tax expense" note for the year ended December 31, 2019. (comparatives not required)
Question No. 10
Following information relates to Irfan Limited (IL) as at December 31, 2018:
Carrying
Tax base
amount
---------- Rs. million --------
Building 180.00 128.00
Plant & machinery 80.00 70.00
Provision for doubtful debts 9.00 -
Provision for gratuity 13.00 -
Other information:
(1) Building was purchased on January 1, 2017. Its useful life was estimated at 20 years. It was revalued on January
1, 2019 to Rs. 216 million. Revaluation will not affect tax depreciation.
(2) Tax depreciation is charged on all fixed assets at 20% reducing balance basis. Accounting depreciation on plant
& machinery for 2019 amounts to Rs. 10 million.
(3) Provision for gratuity and provision for doubtful debt as at December 31, 2019 amounts to Rs. 20 million and
Rs. 13 million respectively.
(4) Tax rate applicable to IL is 30%.
(5) Carried forward assessed tax losses as at December 31, 2018 were Rs. 20 million.
(6) Tax profit, before adjustment of brought forward losses, for the year 2019 amounts to Rs. 11 million.
Required:
Prepare note on "deferred tax" for inclusion in financial statements for the year ending December 31, 2019.
Question No. 11
A company issued 5% convertible bonds for a nominal amount of Rs. 50,000 on January 1, 2017. On that date prevailing
market interest rates for comparable bonds without conversion option was 9%. These bonds will be redeemed at par or
converted into 5 ordinary shares per bond after 3 years. Tax rate is 30%.
Required:
Journal entries for all 3 years assuming that investors eventually chose cash redemption.
Question No. 12
A company granted 100 share options each to its 500 employees on January 1, 2016. Options involved a vesting period of
3 years. 40,000 options were eventually exercised on December 31, 2020. Tax deduction for such options was allowed for
intrinsic value on actual exercise of options.
Following detail relates to expense recognized as per IFRS 2 and intrinsic value at each year end:
Date Employee service expense Number of options Intrinsic value per option
(Rs.) (Rs.)
31-12-16 188,000 50,000 5
31-12-17 185,000 45,000 8
31-12-18 190,000 40,000 13
31-12-19 40,000 17
31-12-20 40,000 20
SOLUTIONS
Solution No. 1
Shakir Industries
(W-1)
CA TB Diff
---------------- Rs. million ---------------
PPE 16.70 13.85 2.85
ROU asset 1.80 - 1.80
Capital WIP 2.30 - 2.30
Provision for gratuity [0.7 + 2.4 - 1.6] 1.50 - (1.50)
Lease liability 1.20 - (1.20)
4.25
Solution No. 2
Current tax expense for the year
Rs.'000
Accounting profit 6,500
Accounting depreciation 4,750
Capital allowance (7,000)
Loss on disposal 100
Tax gain on disposal 300
Gratuity expense 1,500
Gratuity paid (5,000)
Advertisement [450 - 150] 300
NASIR ABBAS FCA
INCOME TAXES (IAS-12) – SOLUTIONS (2)
W-1 PPE CA TB
------ Rs.'000 -------
Year start balance 26,750 19,500
Addition 6,000 6,000
Disposal [3,500 - 100 - 300] (3,500) (3,100)
Depreciation (4,750) (7,000)
Year end balance 24,500 15,400
Solution No. 3
Notes:
No adjustment is needed for tax on repairs disallowed unless decision on appeal is finalized.
Floors & Tiles Limited
Extracts from notes to the financial statements
For the year ended December 31, 2015
TAXATION
Rs. in million
Current tax:
- for current year (W-1) 26.60
- for prior year [6 x 32%] 1.92
Deferred tax (W-4) (2.28)
Tax expenses 26.24
(W-5)
PV of lease payments = 30 + 30 x annuity factor = Rs. 120 million
Solution No. 4
Note
It is assumed that change in taxation for dividend and interest for 2018 was enacted or substantively enacted at
year end.
W-2 Plant
CA TB
Initial cost:
Purchase cost 250.00 250.00
Dismantling (W-2.1) 31.51 -
281.51 250.00
Depreciation (46.92) (25.00)
234.59 225.00
W-2.1
Initial [50 x (1 + 8%)-6] 31.51
Interest 2017 [31.51 x 8%] 2.52
34.03
Solution No. 5
(a)
Notes:
- It is assumed that restructuring relates to current year only and no provision was recognized last year
- It is assumed that change in taxation of dividend and commission is based on tax laws enacted.
Orange Limited
Extracts – Notes
4 – Taxation Rs. million
Current tax (W-1) 162.90
Deferred tax (W-2) (19.60)
143.30
4.1 - Relationship between tax expense and accounting profit
Accounting profit 508.00
Tax [508 x 30%] 152.40
Tax on dividend income [35 x 20%] (7.00)
Tax on exempt income [12 x 30%] (3.60)
Tax on inadmissible donation [5 x 30%] 1.50
143.30
-
Solution No. 6
Notes to the financial statements Rs.'000
1 - Deferred tax
Deferred tax liability comprises of:
Deferred tax liability
PPE 4,200
2 – Taxation
Current tax:
- for current year (W-4) 6,710
- for prior year (300)
W - 2 PPE CA TB
-------- Rs.'000 ---------
Year start balance 34,500 24,000
Addition 3,500 3,500
Disposal [9,000 - 1,800] [7,200 + 3,600 - 5,000] (7,200) (5,800)
NASIR ABBAS FCA
INCOME TAXES (IAS-12) – SOLUTIONS (8)
W - 3 Lease liability
Date Open. bal. Rental Interest Principal Clos. bal.
31-12-19 6,400 2,019 640 1,379 5,021
[2,019 x annuity factor]
Solution No. 7
(a)
Mercury Water Limited
Journal entries
Date Particulars Dr. Cr.
Rs.'000 Rs.'000
30-Jun-07 Tax expense (W-2) 3,600
Deferred tax 3,600
(Deferred tax expense for the year)
(b)
Taxation 2011 2010
Rs. '000 Rs. '000
Solution No. 8
(a)
Lux Limited
Notes
For the year ending December 31, 2020
Taxation Rs. million
Current tax (W-1) 427.50
Deferred tax (W-2) (67.00)
360.50
Relationship between tax expense and accounting profit
Accounting profit 1,270.00
Tax [1,270 x 30%] 381.00
Tax on extra donation [50 x 30%] (15.00)
Lower tax rate on interest [55 x 10%] (5.50)
360.50
Tax recognized in OCI:
Deferred tax 19.50
-
W-1 Current tax
Accounting profit 1,270.00
Excess accounting depreciation 100.00
Liability treated as income for the year [100 - 70] 30.00
Commission receipt [80 - 15] 65.00
Interest income (55.00)
Extra allowance for donation (50.00)
NRV write-down disallowed 35.00
1,395.00
Normal tax [1,395 x 30%] 418.50
Tax on interest received [45* x 20%] 9.00
427.50
* Interest received = 30 + 55 - 40 = 45
(b)
Deferred tax liability/(asset) as at 31-Dec-19
CA TB Diff Tax rate DTL/((DTA)
-------------------------------- Rs. million --------------------------------------
PPE (W-3) 350.00 30% 105.00
Interest receivable 30.00 - 30.00 20% 6.00
Long outstanding liabilities 100.00 30.00 (70.00) 30% (21.00)
Unearned commission 15.00 - (15.00) 30% (4.50)
85.50
Solution No. 9
Tax expense Rs.'000
Current tax:
- for current year (W-1) 2,240
- for prior year 45
2,285
Deferred:
Effect of rate change [6,465 x 5/30 - 250 (W-2)] 827
Relating to differences during the year (605)
(W-2) 222
2,507
DTL
Rs.,000 Rs.'000
b/d 6,465
OCI (rate change) 250
[3,500 x 5/70] OR [1,500 x 5/30]
OCI [500 x 0.35] 175
c/d 7,112 Tax expense (bal.) 222
7,112 7,112
Solution No. 10
Deferred tax
Deferred tax liability comprises of:
Rs. million
Deferred tax liability
Depreciation [30.48 + 4.20 (W-2)] 34.68
Solution No. 11
---------- Rs. --------
01-01-17 Cash 50,000
Financial liability (W-1) 44,937
Equity component (W-1) [5,063 x 70%] 3,544
Deferred tax (W-2) 1,519
[Initial recognition]
Solution No. 12
2016
Deferred tax:
CA TB Difference (DTA)
--------------------- Rs. -------------------------
Employee cost - 83,333 (83,333) (33,333)
[50,000 x Rs. 5 x 1/3]
Opening DTA -
Deferred tax income charged to P&L (bal.) (33,333)
Deferred tax income charged to equity -
Deferred tax for the year (33,333)
Deferred tax income is charged to P&L because future tax deduction is less than accounting expense.
2017
Deferred tax:
CA TB Difference (DTA)
--------------------- Rs. -------------------------
Employee cost - 240,000 (240,000) (96,000)
[45,000 x Rs. 8 x 2/3]
Deferred tax income is charged to P&L because cumulative future tax deduction is less than
cumulative accounting expense of Rs. 373,000.
2018
Deferred tax:
CA TB Difference (DTA)
--------------------- Rs. -------------------------
Employee cost - 520,000 (520,000) (208,000)
[40,000 x Rs. 13 x 3/3]
Deferred tax income is charged to P&L because cumulative future tax deduction is less than
cumulative accounting expense of Rs. 563,000.
2019
Deferred tax:
CA TB Difference (DTA)
--------------------- Rs. -------------------------
Employee cost - 680,000 (680,000) (272,000)
[40,000 x Rs. 17 x 3/3]
2020
Deferred tax:
CA TB Difference (DTA)
--------------------- Rs. -------------------------
Employee cost - - - -
Current tax:
Current tax income for the year [40,000 x 20 x 40%] (320,000)
Current tax income to be recognized in P&L [563,000 x 40%] (225,200)
Current tax to be recognized in equity (bal.) (94,800)
WORKINGS
W-1 Deferred tax CA TB Diff (75%) DTL/(DTA)
W-1.1 year 2014 ---------------------- Rs. million -----------------------
PPE 1,800.00 1,050.00 562.50 180.00
Exchange translation - - 108.75 34.80
Share options [600,000 x 140 x 1/3] - 28.00 (21.00) (6.72)
Prov. for DD 60.00 - (45.00) (14.40)
Other liab. 3.00 - (2.25) (0.72)
c/f tax loss (35.00) (11.20)
568.00 181.76
CA TB Diff DTL/(DTA)
W-1.2 year 2015 ---------------------- Rs. million -----------------------
PPE 1,950.00 1,120.00 622.50 199.20
Exchange translation - - 39.75 12.72
Share options [600,000 x 110 x 2/3] - 44.00 (33.00) (10.56)
Prov. for DD 110.00 - (82.50) (26.40)
Other liab. 7.00 - (5.25) (1.68)
c/f tax loss (40.00) (12.80)
501.50 160.48
Q-3 Dec-16
(a) ---------- Rs. million --------
01-07-14 Cash 600.00
Financial liability (W-1) 600.00
[Initial recognition]
Brief explanation
Property was sold but TL has an option to repurchase (i.e. call option). Total consideration paid in
form of rentals and repurchase price is higher (considering time value of money at 10%) * than the
original sale price, therefore, it will be treated as financing.
(b)
30-06-16 Interest expense 63.69
Financial liability (W-1) 63.69
[Interest for 2016]
2016
Closing DTA [Since both Property and loan are derecognized] -
Opening DTA (105.69)
Deferred tax expense for 2016 105.69
Q-4 Jun-14
Moonlight Limited
Extracts - Notes
4 - Taxation Rs. million
Current tax:
- For current year (W-1) 230.00
- For prior year 4.20
234.20
Deferred tax (40.25)
193.95
4.1 - Relationship between tax expense and accounting profit
Accounting profit 553.00
Tax [553 x 35%] 193.55
Tax for prior year 4.20
Tax on inadmissible expense [35 x 35%] 12.25
Tax on dividend income [25 x 25%] (6.25)
Tax on exempt income [28 x 35%] (9.80)
193.95
-
8 - Deferred tax 2013 Recognized 2014
Balance Equity OCI P&L Balance
Deferred tax comprises of: ------------------------------------ Rs. million -------------------------------------
Deferred tax liability
PPE 17.50 - - (28.00) (10.50)
Deferred tax asset
Provision for D.D. (31.50) - - (12.25) (43.75)
PV of DBO (49.00) 21.00 - - (28.00)
(63.00) 21.00 - (40.25) (82.25)
WORKINGS
W-1 Current tax Rs. million
PBT [500 + 28 + 25] 553.00
Exempt capital gain (28.00)
Dividend income (25.00)
Inadmissible expense 35.00
Bad debt expense [125 + 25 - 90] 60.00
Bad debt written off (25.00)
Excess accounting depreciation [(1,880 - 1,750) - (1,850 - 1,800)] 80.00
650.00
Normal tax [650 x 35%] 227.50
Tax on dividend [25 x 10%] 2.50
Current tax 230.00
CA TB Diff DTL/(DTA)
W-2.2 year 2014 ---------------------- Rs. million -----------------------
PPE 1,850.00 1,880.00 (30.00) (10.50)
Provision for D.D. 125.00 - (125.00) (43.75)
PV of DBO 80.00 - (80.00) (28.00)
(235.00) (82.25)
Q-5 Jun-16
---- Rs. million ----
31-12-15 Depreciation (W-1) 887.74
Accumulated depreciation 887.74
[Depreciation for 2015]
WORKINGS
W-1 Deferred tax CA TB Diff DTL/(DTA)
W-1.1 year 2011 ---------------------- Rs. million -----------------------
PPE 2,000.00 1,600.00 400.00 140.00
Provision for D.D. / PV of DBO 50.00 - (50.00) (17.50)
Other liab. 8.00 8.00 - -
350.00 122.50
CA TB Diff DTL/(DTA)
W-1.2 year 2012 ---------------------- Rs. million -----------------------
PPE 2,700.00 2,400.00 300.00 105.00
Provision for D.D. / PV of DBO [50 - 5 + 6] 51.00 - (51.00) (17.85)
Other liab. [8 - 2 - 3] 3.00 - (3.00) (1.05)
246.00 86.10
BASIC CONSOLIDATION [SOFP WITH ONE SUBSIDIARY] – Class notes
Consideration transferred for acquisition of controlling interest is mostly different from value of S’s
identifiable net assets at acquisition date. This difference is called “goodwill” (if +ve) and “negative goodwill
or bargain purchase gain” (if –ve).
(i) NCI valued at proportionate share (ii) NCI valued at Fair value
(i) P’s share in S’s post acquisition profits are ADDED to P’s RE to make it Group RE
(ii) P’s share in S’s post acquisition other reserves (e.g. revaluation reserve) are ADDED to P’s other
reserves in Group reserves
If in question, such costs are included in cost of investment appearing in P’s SOFP, then:
DEDUCT from Investment in “Goodwill” working
DEDUCT from P’s RE as an expense in “Group RE” working
It is shown as a part of equity in Group SOFP and represents portion of S’s net assets that are not owned by P
(a) NCI valued at proportionate share (b) NCI valued at Fair value
“S’s reserves” include revaluation reserve raised for group revaluation policy application
1. IMPAIRMENT LOSS
Goodwill on acquisition is tested for impairment annually as a part of CGU. Generally whole “S” is a CGU and
therefore when it is tested for impairment, the impairment loss is allocated to goodwill and other assets of S as
per IAS 36. In questions, impairment loss of goodwill may be:
- Given OR
- Determined by impairment testing of CGU (i.e. S) as follows:
Calculations at impairment testing date: X
Recoverable amount of whole S
Less: Carrying amounts of:
Identifiable net assets of S (i.e. after making all fair value adjustments as well) X
Full goodwill on acquisition (Note) X (X)
Total impairment loss X
[This loss is now allocated as per IAS 36 i.e. first to full goodwill and then other assets]
Note:
If NCI is valued at fair value method, then Goodwill calculated at acquisition already reflects “Full
goodwill”.
If NCI is valued at proportionate share method, then goodwill on acquisition represents only the portion of
goodwill attributable to P whereas recoverable amount reflects contribution of total goodwill towards
cashflows of S. Therefore, only for the purpose of calculation of impairment loss, Goodwill is grossed up by
P’s% share to find “Full goodwill”.
Consolidation adjustment:
(a) NCI valued at proportionate share method (b) NCI valued at Fair value method
Memorandum entry:
Dr. Group RE Dr. Group RE (P’s share)
Cr. Goodwill Dr. NCI (NCI share)
Cr. Goodwill (Total)
Examples:
- Debtor and creditor [due to inter-company trading]
- Loan (asset) and loan (liability) [due to inter-company loan]
- Inter-company current account
- P’s investment (asset) in S’s debentures (liability)
- Inter-company finance lease
Memorandum entry:
Dr. Payable (Agreed / adjusted balance)
Cr. Receivable
URP is the profit included in the amount of inventory out of inter-company sale. Inventory value may be given
in question or mentioned as a proportion of intercompany sale.
Calculation of URP:
URP = Inventory x GP margin %
OR
Inventory x GP markup / (100 + GP markup)
OR
Total profit earned in the inter-company sale x % goods held in stock
Consolidation adjustment:
P to S sale S to P sale
Memorandum entry:
Dr. Group RE Dr. Group RE
Cr. Inventory Dr. NCI
Cr. Inventory
URP adjustment on goods which have been written down to NRV by buyer:
URP adjustment will be made at “URP – NRV write down already recorded”. If NRV write down is more than
URP, then no adjustment for URP is needed.
IFRS 3 requires recognition of identifiable net assets of S at their acquisition-date fair values. Therefore, certain
fair value adjustments are needed. Information about fair value adjustments at acquisition date may be available
as:
- Difference between fair values and book values is given (e.g. building was overvalued by Rs. 50,000) OR
- Both Fair values and book values of S assets and liabilities are given (i.e. net assets)
Consolidation adjustment:
Asset/Liability still exists in books of S Asset/Liability was sold / settled after acquisition
For asset: For asset:
FV adjustment (increase) is ADDED to: FV adjustment (increase) is:
(i) S’ net assets in “Goodwill working” (i) ADDED to S’s net assets in “Goodwill working”
(ii) Relevant asset’s NBV in Group SOFP (ii) DEDUCTED from S' RE in Group RE working
Memorandum entry:
Dr. Relevant Asset Dr. Group RE
Cr. Goodwill Dr. NCI
Cr. NCI Cr. Goodwill
Cr. Relevant liability Cr. NCI
Notes:
- In case of FV adjustment (decrease) to S’s net assets, above adjustments will be reversed
- If subsequently S has accounted for any such fair value adjustment in its books, then reverse it.
It is calculated using same depreciation basis as of S in its books. This adjustment is not applicable if related
asset has been sold / realized after acquisition date.
Consolidation adjustment:
Memorandum entry:
Dr. Group RE
Dr. NCI
Cr. PPE
In case of negative adjustment to S’s net assets, above adjustments will be reversed
5. (a) PROFIT ON INTER-COMPANY SALE OF NON-CURRENT ASSET
Profit in inter-company sale of non-current asset is unrealized unless the asset is fully depreciated by buyer.
Calculation of Profit:
Profit = Sale value of Asset x margin %
OR
Sale value of Asset x markup / (100 + markup)
Consolidation adjustment:
P to S sale S to P sale
Memorandum entry:
Dr. Group RE Dr. Group RE
Cr. Relevant asset Dr. NCI
Cr. Relevant asset
As asset is depreciated, a portion of seller’s profit is realized. Therefore excess depreciation on profit is
deducted from seller’s profit on this sale OR added back to seller’s RE.
Calculation of Accumulated excess depreciation:
= Profit x depreciation % x years since sale of asset
[It is calculated using same depreciation basis as of buyer company in its books]
Consolidation adjustment:
P to S sale S to P sale
Excess accumulated depreciation is ADDED to: Excess accumulated depreciation is ADDED to:
(i) Relevant Asset in Group SOFP (i) Relevant Asset in Group SOFP
(ii) P’ RE in Group RE working (i.e. seller) (ii) S' RE in Group RE working (i.e. seller)
Memorandum entry:
Dr. Relevant asset Dr. Relevant asset
Cr. Group RE Cr. Group RE
Cr. NCI
Consolidation adjustment:
P to S sale S to P sale
Memorandum entry:
Dr. Group RE Dr. Group RE
Cr. Relevant asset Dr. NCI
Cr. Relevant asset
Consolidation adjustment:
IFRS 3 allows to recognize some items (e.g. brand, customer relationship) as intangible asset in Group
SOFP even if its recognition was not allowed to S in accordance with IAS 38. Treat this just like a fair value
adjustment of an asset which had “zero” carrying amount in S’s books.
A contingent asset (as defined in IAS 37) shall not be recognized at the acquisition date.
Fair value at acquisition date is:
(i) ADDED to Intangible assets in Group SOFP
(ii) ADDED to S’s net assets in “Goodwill working”
Memorandum entry:
Dr. Intangible assets
Cr. Goodwill
Cr. NCI
Consolidation adjustment:
IFRS 3 allows the recognition of a contingent liability of S if it is a present obligation (i.e. not a possible
obligation) that arises from past events and its fair value can be reliably measured.
Initial measurement
Fair value at acquisition date is:
(i) ADDED to liabilities in Group SOFP
(ii) DEDUCTED from S’s net assets in “Goodwill working”
Memorandum entry:
Dr. Goodwill
Dr. NCI
Cr. Liability
Subsequent measurement
After initial recognition and until the liability is settled, cancelled or expires, the liability shall be
measured at the higher of:
(i) the amount initially recognized
(ii) the amount that would be recognized in accordance with IAS 37
[In other words, subsequent measurement is only needed if initially recognized amount is to be
increased]
Memorandum entry:
Dr. Group RE
Dr. NCI
Cr. Liability
Note – If S has subsequently accounted for this obligation in its books, then reverse the treatment done by S
If P has already accounted for this issue, then no adjustment required in non-current liabilities
In case of consideration only in form of share exchange, if fair value of P’s shares is not reliably
measurable then fair value of S’s shares is used to find cost of investment.
If P has already accounted for this issue, then no adjustment required in share capital and premium.
[If shares were acquired from “S” instead of its former owners and the asset transferred as
consideration remains with S, then “cost of investment” includes carrying amount of that asset and no
derecognition is required.]
If P has recorded investment in S as per IFRS 9, then do not forget to reverse any fair value gain/loss recorded
Consolidation adjustment:
Only effect is on the calculation of Pre and Post acquisition reserves as follows:
Pre acq. reserves = S’s reserves at SOFP date – income for the year x n/12
(n = no. of months from acquisition to year end)
Post acq. reserves= S’s reserves at SOFP date – pre acquisition reserves
OR
Income for the year x n/12
(i) Additional Deferred tax asset/liability shall be recognized on fair value adjustments in S net assets at
acquisition date and INCLUDED in:
- S net assets in goodwill working
- DTA/DTL in Group SOFP
(ii) Additional Deferred tax shall be calculated for all consolidation adjustments in P as well as S net assets
after acquisition and:
- CHARGED in respective RE column in Group RE working
- ADDED to or DEDUCTED from DTA/DTL in Group SOFP
Group member should follow uniform accounting policies. However, if S follows different accounting
policies, then adjustments are made while consolidation to convert figures from S financial position in
accordance with group policies.
Inter-company Eliminate:
operating lease “ROU asset” and “Lease liability” and adjust difference of both in lessee’s RE.
[If underlying asset was property, then lessor must have been following IAS 40. But
from group point of view its PPE rather than Investment property, therefore, IAS 40
accounting shall be reversed and IAS 16 accounting shall be followed.]
Inter-company sale of In case of inter-company sale of property, if buyer rents out the property and follows
investment property fair value model for investment property, then no adjustment for URP shall be made.
Provisional amounts In 1st year of acquisition, if values are not yet finalized at year end then consolidation
will be made using provisional amounts. Next year, when provisional amounts are
revised, these adjustments shall be made retrospectively from acquisition date.
Un-realized loss on Calculation of unrealized loss is same as studied for URP but the treatment is with
inter-company sale of inverse signs. However, if losses indicate an impairment, then no adjustment is needed
goods/PPE for URL.
Types of dividends:
Pre acq. dividend: Dividend paid / payable (after acquisition) out of pre-acquisition profits
Post acq. dividend: Dividend paid / payable out of post-acquisition profits
PPE XXX
(P’s + S’s + FV adj. at acquisition – Acc. extra dep. on FV adj. – URP on asset sale + revaluation
policy application +/- any other adjustment)
Goodwill (W – 1) XXX
Investment XXX
(P’s + S’s – P’s investment in S eliminated)
CURRENT ASSETS:
Inventory XXX
(P’s + S’s – URP [P to S / S to P] + Goods in transit)
Receivables XXX
(P’s + S’s +/- correction of error– cash in transit – intercompany balance + any other asset recognized at acquisition)
XXX
Rs.
CAPITAL AND RESERVES:
NON-CURRENT LIABILITIES:
CURRENT LIABILITIES:
Payables XXX
(P’s + S’s + goods in transit +/- correction of error – intercompany balance + contingent liab. recognized)
XXX
WORKINGS
(W – 1) Goodwill
Consideration transferred:
Cash paid XXX
Loan notes issued XXX
Share exchange XXX
Any other non-cash asset transferred XXX
Deferred consideration XXX
Contingent consideration XXX XXX
Proportionate value of NCI [S’s net assets at acquisition x NCI%] XXX
XXX
Less: S’s net assets at acquisition:
S’s Capital XXX
Add: S’s Premium XXX
Add: S’s Pre-acquisition other reserves XXX
Add: S’s Pre-acquisition RE XXX
Add/Less: Fair value adjustment XXX
Less: Liabilities recognized (XXX)
Add: Assets recognized at acquisition XXX
(XXX)
Goodwill at acquisition XXX
Less: Accumulated impairment loss (Total) (XXX)
Carrying amount of goodwill XXX
(W – 2) Other reserves
Rs. Rs.
P’s other reserves XXX
Add: S’s Other reserves XXX
Less: S’s other reserves at acquisition date (XXX)
XXX
Group share @ (% share in ordinary shares) XXX
XXX
(W – 3) Retained earnings
Rs. Rs.
P’s RE XXX
Less: Accumulated impairment loss of goodwill [Note 2] (XXX)
Less: URP on goods [ P to S ] (XXX)
Less: URP on asset sale [ P to S ] (XXX)
Less: Finance cost on deferred consideration (XXX)
Less: change in fair value of contingent consideration (XXX)
Add / Less: correction of error XXX
Add: negative goodwill (total) XXX
Add: Unrecorded income (including dividend from S) XXX
XXX
Add: S’s RE XXX
Less: Pre-acquisition RE (XXX)
Less: Acc. Impairment loss of goodwill [Note 2] (XXX)
Less: URP on goods [ S to P ] (XXX)
Less: URP on asset sale [ S to P ] (XXX)
Less: FV adjustment of asset sold after acquisition (XXX)
Less/Add: Extra depreciation on FV adjustment (XXX)
Nasir Abbas FCA Page 13 | 15
BASIC CONSOLIDATION [SOFP WITH ONE SUBSIDIARY] – Class notes
Note 2:
NCI is valued at fair value: Impairment loss of goodwill is deducted from S RE
NCI is valued at proportionate basis: Impairment loss of goodwill is deducted from P RE
(W – 4) Non-controlling interest
1-Recorded by both 2-Recorded by both 3-Not recorded by (P) 4-Not recorded by (S) 5-Not recorded by both
P S P S P S P S P S
Cash 80 R.E. 100 D.R. 80 R.E. 100 R.E. 100 D.R. 80
Income 80 Cash 100 Income 80 D.P. 100 D.P. 100 Income 80
No adjustment required. Eliminate Inter company (i). Add P’s share in S’s (i). Deduct S’s total dividend (i). Add P’s share in S’s
balance of 80 dividend to P’s RE in “Group from S’s post acquisition dividend to P’s RE in “Group
RE working” profits RE working”
Dividend Payable 80
Dividend Receivable 80 Dividend Receivable 80 Group RE 80 Dividend Receivable 80
Group RE 80 NCI 20 Group RE 80
Dividend Payable 100
(ii). Then eliminate inter (ii). Deduct S’s total dividend
company balance of 80 (ii). Then eliminate inter from S’s post acquisition
company balance of 80 profits
Dividend Payable 80 Group RE 80
Dividend Receivable 80 Dividend Payable 80 NCI 20
Dividend Receivable 80 Dividend Payable 100
Dividend Payable 80
Dividend Receivable 80
PRACTICE QUESTIONS
Question No. 1
Equity
Share capital (Rs. 10 per share) 45,000 32,000
Share premium 5,000 3,000
Other reserves 14,000 7,000
Retained earnings 61,000 53,000
Non-current liabilities
- - -
Current liabilities
Creditors 21,000 22,000
146,000 117,000
Required:
Prepare consolidated balance sheet as at June 30, 2019.
Question No. 2
Current assets
Inventories 10,000 12,000
Debtors 12,000 10,000
Cash & bank 4,000 7,000
126,000 89,000
P S
Equity ---------- Rs.--------
Share capital (Rs. 10 per share) 45,000 24,000
Share premium 4,500 2,400
Other reserves 9,000 6,000
Retained earnings 49,500 25,600
Non-current liabilities
Debentures - 20,000
Current liabilities
Creditors 18,000 11,000
126,000 89,000
Required:
Prepare consolidated balance sheet as at June 30, 2019.
Question No. 3
Following are the balance sheets as at June 30, 2019:
P S
---------- Rs. ----------
Non-current assets
Property, plant & equipment 65,000 60,000
Investments 30,000 5,000
Current assets
Inventories 9,000 10,000
S current account 5,000 -
Debtors 11,000 10,000
Cash & bank 5,000 8,000
125,000 93,000
Equity
Share capital (Rs. 10 per share) 40,000 30,000
Share premium 4,000 3,000
Other reserves 13,000 -
Retained earnings 52,000 22,000
Non-current liabilities
Bank loan - 20,000
Current liabilities
Creditors 16,000 11,000
P current account - 7,000
125,000 93,000
Required:
Prepare consolidated balance sheet as at June 30, 2019.
Question No. 4
Following are the balance sheets as at June 30, 2019:
P S
----------- Rs.-----------
Non-current assets
Property, plant & equipment 90,000 64,000
Investments 80,000 5,000
Current assets
Inventories 11,000 10,000
S current account 8,000 -
Debtors 10,000 11,000
Cash & bank 5,000 8,000
204,000 98,000
Equity
Share capital (Rs. 10 per share) 80,000 40,000
Share premium 5,000 4,000
Other reserves 9,000 6,000
Retained earnings 94,000 25,000
Non-current liabilities
- - -
Current liabilities
Creditors 16,000 18,000
P current account - 5,000
204,000 98,000
Following further information is available:
(i) P acquired 3600 shares of S last year for Rs. 75,000 when other reserves were 6,000 and retained
earnings were Rs. 28,000.
(ii) At acquisition date, fair value of land of S was Rs. 2,000 higher than its carrying amount. Fair values of
other nets assets were approximately equal to their carrying amounts.
(iii) At year end, recoverable amount attributable to goodwill is Rs. 1,200.
(iv) During the year P sold goods, costing Rs. 9,000, to S for Rs. 12,000. 40% of these goods are still held in
stock of S at year end.
(v) P provides certain management services to S in respect of which intercompany current account is
maintained. The difference in current account balances at year end is due to an invoice for such services
amounting to Rs. 3,000 sent and recorded by P but not received and recorded by S.
Required:
Prepare consolidated balance sheet as at June 30, 2019.
Question No. 5
Current assets
Inventories 12,000 10,000
Debtors 10,000 12,000
Cash & bank 5,000 5,000
158,000 97,000
Equity
Share capital (Rs. 10 per share) 60,000 40,000
Share premium 6,000 4,000
Other reserves - -
Retained earnings 71,000 37,000
Non-current liabilities
- - -
Current liabilities
Creditors 21,000 16,000
158,000 97,000
Following further information is available:
(i) P acquired 60% shares of S some years ago when retained earnings were Rs. 11,000.
(ii) At acquisition date, land of S was undervalued by Rs. 2,000. This land was sold last year. Fair values of other
nets assets were approximately equal to their carrying amounts at acquisition date.
(iii) Fair value of non-controlling interest at acquisition date was Rs. 25,600.
(iv) At year end, impairment loss of goodwill is Rs. 1,600.
(v) During the year S sold goods to P for Rs. 5,000 at a profit markup of 25% on credit. By year end, these goods
were not received by P and therefore not recorded in its books.
Required:
Prepare consolidated balance sheet as at June 30, 2019.
Question No. 6
Following are the balance sheets as at June 30, 2019:
P S
------------ Rs.----------
Non-current assets
Property, plant & equipment 60,000 70,000
Investment 38,000 -
Current assets
Inventories 12,000 15,000
Debtors 21,000 13,000
Cash & bank 5,000 7,000
136,000 105,000
Equity P S
---------- Rs.--------
Share capital (Rs. 10 per share) 54,000 36,000
Share premium 5,000 -
Other reserves - 5,000
Retained earnings 63,000 47,000
Current liabilities
Creditors 14,000 17,000
136,000 105,000
Books of S:
Goods purchased from P Rs. 32,000
Payable to P (included in creditors) Rs. 8,000
Some goods were dispatched by P on June 29th. These goods were not received and therefore not recorded by
S b year end. Any remaining difference in intercompany balance, after adjusting for goods in transit, is due to
double recording by P in respect of a receipt from S.
Required:
Prepare consolidated balance sheet as at June 30, 2019.
Question No. 7
Following are the balance sheets as at June 30, 2019:
P S
---------- Rs.----------
Non-current assets
Property, plant & equipment 75,000 75,000
Investment 42,500 -
Loan to S 15,000
Current assets
Inventories 16,000 15,000
Debtors 11,000 18,000
Cash & bank 5,000 3,000
164,500 111,000
P S
Equity ---------- Rs.--------
Share capital (Rs. 10 per share) 50,000 35,000
Share premium 4,000 3,500
Other reserves 11,000 6,000
Retained earnings 78,500 39,500
Non-current liabilities
Loan from P - 12,000
Current liabilities
Creditors 21,000 15,000
164,500 111,000
Required:
Prepare consolidated balance sheet as at June 30, 2019.
Question No. 8
Following are the balance sheets as at June 30, 2019:
P S
---------- Rs.--------
Non-current assets
Property, plant & equipment 80,000 60,000
Investments 60,000 10,000
Current assets
Inventories 16,000 10,000
Debtors 11,000 6,000
Cash & bank 5,000 2,000
172,000 88,000
Equity
Share capital (Rs. 10 per share) 50,000 30,000
Share premium 5,000 3,000
Other reserves 12,000 5,000
Retained earnings 88,000 39,000
Non-current liabilities
- - -
Current liabilities
Creditors 17,000 11,000
172,000 88,000
Question No. 9
Following are the balance sheets as at June 30, 2019:
P S
---------- Rs.--------
Non-current assets
Property, plant & equipment 80,000 57,000
Investment 16,000 -
Current assets
Inventories 8,000 5,000
Debtors 9,000 12,000
Cash & bank 7,000 6,000
120,000 80,000
Equity
Share capital (Rs. 10 per share) 45,000 40,000
Share premium 5,000 4,000
Other reserves 3,000 1,000
Retained earnings 41,500 23,400
Non-current liabilities
Loan notes 16,000 -
Current liabilities
Creditors 9,500 11,600
120,000 80,000
Following further information is available:
(i) P acquired 80% shares of S on July 1, 2018. The purchase consideration consisted of two elements: a share
exchange of three shares in P for every five acquired shares in S and the issue of Rs. 100 8% loan note for every
20 shares acquired. The share issue has not yet been recorded by P but the issue of the loan notes has been
recorded. At acquisition date, shares in P had a market value of Rs. 18 each and the shares in S had a market
value of Rs. 14 each.
(ii) At acquisition date, the fair value of property of S was Rs. 4,000 below its carrying amount. This would lead to
a reduction of depreciation charge of Rs. 400 in 2019. Fair values of other nets assets were approximately equal
to their carrying amounts.
(iii) It is group’s policy to value non controlling interest at fair value.
(iv) At year end, impairment loss of goodwill is Rs. 1,000.
(v) During the year S sold goods to P for Rs. 5,000 at a profit markup of 25%. By year end, half of these goods were
held in P’s stock.
(vi) Net profit for the year 2019 earned by S was Rs. .9,000. There has been no increase in other reserves from last
year.
Required:
Prepare consolidated balance sheet as at June 30, 2019.
Question No. 10
Current assets
Inventories 16,000 9,000
Debtors 11,000 11,000
Cash & bank 5,000 4,500
167,000 97,500
Equity
Share capital (Rs. 10 per share) 50,000 40,000
Share premium 5,000 4,000
Other reserves 15,000 3,000
Retained earnings 75,000 38,500
Non-current liabilities
- - -
Current liabilities
Creditors 22,000 12,000
167,000 97,500
Required:
Prepare consolidated balance sheet as at June 30, 2019.
Question No. 11
Following are the balance sheets as at June 30, 2019:
P S
---------- Rs.--------
Non-current assets
Property, plant & equipment 70,000 60,000
Investments 60,000 5,000
Current assets
Inventories 16,000 10,000
Debtors 11,000 9,000
Cash & bank 5,000 6,000
162,000 90,000
Equity
Share capital (Rs. 10 per share) 60,000 30,000
Share premium 6,000 3,000
Other reserves 12,000 -
Retained earnings 67,000 43,000
Non-current liabilities
- - -
Current liabilities
Creditors 17,000 14,000
162,000 90,000
Question No. 12
Following are the balance sheets as at June 30, 2019:
P S
---------- Rs.--------
Non-current assets
Property, plant & equipment 90,000 80,000
Investments 50,000 5,000
Current assets
Inventories 12,000 11,000
Debtors 11,000 12,000
Cash & bank 7,000 8,000
170,000 116,000
Equity P S
---------- Rs.--------
Share capital (Rs. 10 per share) 50,000 50,000
Share premium 5,000 5,000
Other reserves 15,000 7,000
Retained earnings 81,000 42,000
Non-current liabilities
- - -
Current liabilities
Creditors 14,500 12,000
Dividend payable 4,500 -
170,000 116,000
Question No. 13
Following are the balance sheets as at June 30, 2019:
P S
---------- Rs.--------
Non-current assets
Property, plant & equipment 100,000 70,000
Investments 50,000 10,000
Current assets
Inventories 9,000 7,000
Debtors 10,000 8,000
Cash & bank 4,000 5,000
173,000 100,000
Equity
Share capital (Rs. 10 per share) 60,000 50,000
Share premium 6,000 5,000
Revaluation surplus 8,000 -
Retained earnings 84,500 35,500
Non-current liabilities
- - -
Current liabilities
Creditors 14,500 9,500
173,000 100,000
(iii) At acquisition date, fair value of land of S had a fair value higher than book value by Rs. 3,000. Since acquisition
this fair value has further increased by Rs. 4,000.
(iv) S follows cost model for all of its fixed assets whereas group’s policy is to carry land at revaluation model.
(v) On June 30, 2019 P and S both declared a dividend of Re. 1 per share. Neither P nor S has recorded any dividend.
(vi) At year end, goodwill is impaired by Rs. 500.
Required:
Prepare consolidated balance sheet as at June 30, 2019.
Question No. 14
The following summarized statements of financial position pertain to Alpha Limited (AL) and its subsidiary Delta Limited
(DL) as at 30 June 2014.
AL DL
----------- Rs. in million --------
Property plant and equipment 460 200
Investment (2 million shares of DL) 340 -
Long term loan granted to DL 30 -
Current assets 595 400
1,425 600
(iii) Inter-company sales of goods are invoiced at a mark-up of 20%. The relevant details are as under:
Rs. in million
AL’s inventory includes goods purchased from DL 27
DL’s inventory includes goods purchased from AL 24
Receivable from DL on June 30, 2014 as per AL’s books 19
Payable to AL on June 30, 2014 as per DL’s books 19
(iv) Long term loan was granted to DL on 1 July 2013. It is repayable after five years and carries interest at 12% per
annum, payable on 30 June and 31 December, each year.
(v) AL values non-controlling interest at the acquisition date at its fair value which was Rs. 80 million.
Required:
Prepare a consolidated statement of financial position as at 30 June 2014 in accordance with the requirements of
International Financial Reporting Standards. (15)
(Autumn 2014,Q#6)
Question No. 15
On 1 July 2014, Galaxy Limited (GL) acquired controlling interest in Beta Limited (BL). The following information has been
extracted from the financial statements of GL and BL for the year ended 30 June 2015:
GL BL
----------- Rs. in million --------
Share capital (Rs. 100 each) 100 50
Retained earnings – 1 July 2014 40 18
Profit for the year ended 30 June 2015 20 6
Shareholders’ equity / Net assets 160 74
Required:
Compute the amounts of goodwill, consolidated retained earnings and non-controlling interest as they would appear in
GL's consolidated statement of financial position as at 30 June 2015. (15)
(Autumn 2015,Q#6)
Question No. 16
Following information has been extracted from the financial statements of Yasir Limited (YL) and Bilal Limited (BL) for the
year ended 30 June 2016.
YL BL YL BL
Assets Equity & Liabilities
Rs. in million Rs. in million
Fixed assets 250 540 Share capital (Rs. 10 each) 750 500
Accumulated depreciation (70) (70) Retained earnings 340 258
180 470 1,090 758
Investment in BL – at cost 675 - Loan from YL - 12
Loan to BL 16 - Creditors & other liabilities 75 51
Stock in trade 160 150
Other current assets 71 50
Cash and bank 63 151
1,165 821 1,165 821
Additional information:
(i) On 1 July 2014, YL acquired 75% shares of BL at Rs. 18 per share. On the acquisition date, fair value of BL’s net
assets was equal to its book value except for an office building whose fair value exceeded its carrying value by
Rs. 12 million. Both companies provide depreciation on building at 5% on straight line basis.
(ii) Year-wise net profit of both companies are given below:
2016 2015
-------- Rs. in million ------
YL 219 105
BL 11 168
(iii) The following inter-company sales were made during the year ended 30 June 2016:
Question No. 17
The draft summarized statements of financial position of Golden Limited (GL) and its subsidiary Silver Limited (SL) as at
31 December 2016 are as follows: GL SL
GL SL
------------ Rs. in million ----------
Building 1,600 500
Plant & machinery 1,465 690
Investment in SL 327 -
Current assets 2,068 780
5,460 1,970
The market value of each share of GL and SL on acquisition date was Rs. 25 and Rs. 11 respectively. At acquisition
date, retained earnings of SL were Rs. 100 million.
(ii) The following table sets out those items whose fair value on the acquisition date was different from their book
value. These values have not been incorporated in SL’s books of account.
Book value Fair value
------------ Rs. in million ----------
Building 250 170
Inventory 112 62
Provision for bad debts (15) (24)
(iii) Upon acquisition of SL, a contract for management services was also signed under which GL would provide
various management services to SL at an annual fee of Rs. 50 million from the date of acquisition. The payment
would be made in two equal instalments payable in arrears on 1 April and 1 October.
(iv) On 30 September 2016, GL acquired a plant from SL in exchange of a building which was currently not in use of
GL. The details of plant and building are as follows:
Cost Accumulated *Exchange
depreciation price
----------------- Rs. in million ----------------
Building 240 130 120
Plant 200 80 120
* Equivalent to fair value
Both companies follow cost model for subsequent measurement of property, plant and equipment and charge
depreciation on building and plant at 5% and 20% respectively on cost.
(v) SL paid an interim cash dividend of 10% on 31 July 2016.
(vi) GL values non-controlling interest at the acquisition date at its fair value.
Required:
Prepare a consolidated statement of financial position as at 31 December 2016 in accordance with the requirements of
International Financial Reporting Standards. (17)
(Spring 2017, Q#5)
Question No. 18
Following are the draft statement of financial position of Jasmine Limited (JL) and its subsidiary, Sunflower Limited (SL) as
on 31 December 2017:
JL SL
------ Rs. in million ------
Property, plant and equipment 880 330
Intangible assets 40 50
Investment in SL 520 -
Loan to JL - 120
Current assets 640 345
2,080 845
Additional information:
(i) JL acquired 75% shares of SL on 1 January 2017. Cost of investment in JL’s books consists of:
• 10 million JL's ordinary shares issued at Rs. 24 per share; and
• cash payment of Rs. 280 million (including professional fee of Rs. 10 million for advice on acquisition of SL)
(ii) On acquisition date, carrying value of SL's net assets was equal to fair value except an intangible asset (brand)
whose fair value was Rs. 40 million as against carrying value of Rs. 25 million. The remaining useful life of the
brand is estimated at 5 years. The recoverable amount of the brand at 31 December 2017 was estimated at
Rs. 28 million.
(iii) JL values non-controlling interest at fair value. The market price of SL's shares was Rs. 36 at the date of
acquisition, which has increased to Rs. 40 as of 31 December 2017.
(iv) JL and SL showed a net profit of Rs. 200 million and Rs. 60 million respectively for the year ended
31 December 2017.
(v) The loan was granted on 1 July 2017 and carries mark-up of 10% per annum. A cheque of Rs. 30 million including
interest was dispatched by JL on 31 December 2017 but was received by SL after the year end. No interest has
been accrued by SL in its financial statements.
(vi) On 1 May 2017 SL sold a machine to JL for Rs. 52 million at a gain of Rs. 12 million. However, no payment has yet
been made by JL. The remaining useful life of the machine at the time of disposal was 2 years.
(vii) During the year, JL made sales of Rs. 250 million to SL at 20% above cost. 60% of these goods are included in SL’s
closing stock.
(viii) SL declared interim cash dividend of 10% in November 2017 which was paid on 2 January 2018. The dividend has
correctly been recorded by both companies.
Required:
Prepare JL's consolidated statement of financial position as at 31 December 2017. (15)
(Spring 2018, Q#3)
90% 40,050
101,050
Solution No. 2
P Group
Consolidated statement of financial position
as at June 30, 2019
Rs.
Non-current assets
PPE [60 + 60] 120,000
Investments [40 - 31 - 4] 5,000
Goodwill [W-1] 1,800
Current assets
Inventories [10 + 12 - 0.9] 21,100
Debtors [12 + 10 - 7] 15,000
Cash and bank [4 + 7 + 0.5] 11,500
174,400
Equity
Share
capital 45,000
Share premium 4,500
Other reserves [W-2] 11,250
Retained earnings [W-3] 60,650
Non-controlling interest [W-4] 14,500
Non-current liabilities
Debentures [20 - 4] 16,000
Current liabilities
Creditors [18 + 11 + 0.5 - 7] 22,500
174,400
Workings
W-1 Goodwill Rs. Rs.
Investment 31,000
Value of NCI [37,600 x 25%] 9,400
Less: net assets at acq.:
Share capital 24,000
Share premium 2,400
Other reserves 3,000
Pre-acq RE 8,200
(37,600)
Goodwill at acquisition 2,800
Impairment loss (1,000)
1,800
Solution No. 3
P Group
Consolidated statement of financial position
as at June 30, 2019
Non current assets Rs.
PPE [65 + 60] 125,000
Investments [30 - 21 + 5] 14,000
Current assets
Inventories [9 + 10 - 0.5] 18,500
Current account [5 + 2 - 7] -
Debtors [11 + 10] 21,000
Cash and bank [5 + 8 - 2] 11,000
189,500
Equity
Share capital 40,000
Share premium 4,000
Other reserves 13,000
Retained earnings [W-2] 74,700
Non-controlling interest [W-3] 10,800
Non current liabilities
Bank loan 20,000
Current liabilities
Creditors [16 + 11] 27,000
Current account [7 - 7] -
189,500
Workings
W-1 Goodwill Rs. Rs.
Investment 21,000
Fair value of NCI [600 x 9.5] 5,700
Less: net assets at acq.:
Share capital 30,000
Share premium 3,000
Pre-acq RE (4,000) (29,000)
(2,300)
Solution No. 4
P Group
Consolidated statement of financial position
as at June 30, 2019
Rs.
Non current assets
PPE [90 + 64 + 2] 156,000
Investments [80 - 75 +5] 10,000
Goodwill [W-1] 1,200
Current assets
Inventories [11 + 10 - 1.2] 19,800
Current account [8 - 8] -
Debtors [10 + 11] 21,000
Cash and bank [5 + 8] 13,000
221,000
Equity
Share capital 80,000
Share premium 5,000
Other reserves [W-2] 9,000
Retained earnings [W-3] 85,600
Non-controlling interest [W-4] 7,400
Current liabilities
Creditors [16 + 18] 34,000
Current account [5 + 3 - 8] -
221,000
-
Workings
W-1 Goodwill Rs. Rs.
Investment 75,000
Value of NCI [80,000 x 10%] 8,000
Less: net assets at acq.:
Share capital 40,000
Share premium 4,000
Other reserves 6,000
Pre-acq RE 28,000
Fair value adj. 2,000
(80,000)
Goodwill at acquisition 3,000
Impairment loss (1,800)
1,200
221,000
Equity
Share capital 60,000
Share premium 6,000
Retained earnings [W-2] 83,840
Non-controlling interest [W-3] 34,160
Current liabilities
Creditors [21 + 16 + 5 - 5] 37,000
221,000
Workings
W-1 Goodwill Rs. Rs.
Investment 41,000
Fair value of NCI 25,600
Less: net assets at acq:
Share capital 40,000
Share premium 4,000
Pre-acq RE 11,000
Fair value adj. 2,000 (57,000)
Goodwill at acquisition 9,600
Impairment loss (1,600)
8,000
Solution No. 6
P Group
Consolidated statement of financial position
as at June 30, 2019
Rs.
Non current assets
PPE [60 + 70 + 4 - 1.6] 132,400
Goodwill [W-1] 5,160
Current assets
Inventories [12 + 15 + 3 - 0.5] 29,500
Debtors [21 + 13 + 4 - 11] 27,000
Cash and bank [5 + 7 - 4] 8,000
202,060
Equity
Share capital 54,000
Share premium 5,000
Other reserves [W-2] 1,650
Retained earnings [W-3] 76,470
Non-controlling interest [W-4] 41,940
Current liabilities
Creditors [14 + 17 + 3 - 11] 23,000
202,060
Workings
W-1 Goodwill Rs. Rs.
Investment 38,000
Fair value of NCI [1620 x 18] 29,160
Less: net assets at acq.:
Share capital 36,000
Other reserves 2,000
Pre-acq RE 18,000
FV adjustment - P&M 4,000 (60,000)
Goodwill at acquisition 7,160
Impairment loss (2,000)
5,160
Solution No. 7
P Group
Consolidated statement of financial position
as at June 30, 2019
Rs.
Non current assets
PPE [75 + 75 - 3 + 1.2 - 2 + 0.2] 146,400
Goodwill [W-1] 5,000
Loan to S [15 - 3 - 12] -
Current assets
Inventories [16 + 15] 31,000
Debtors [11 + 18] 29,000
Cash and bank [5 + 3 + 4.5] 12,500
223,900
Equity Rs.
Share capital 50,000
Share premium 4,000
Other reserves [W-2] 13,450
Retained earnings [W-3] 95,790
Non-controlling interest [W-4] 24,660
Non-current liabilities
Loan from P [12 - 12] -
Current liabilities
Creditors [21 + 15] 36,000
223,900
Workings
Solution No. 8
P Group
Consolidated statement of financial position
as at June 30, 2019
Rs.
Non current assets
PPE [80 + 60] 140,000
Brand [5 - 1.5] 3,500
Investments [60 - 54 + 10] 16,000
Goodwill [W-1] 3,420
Current assets
Inventories [16 + 10 - 2.4] 23,600
Debtors [11 + 6] 17,000
Cash and bank [5 + 2] 7,000
210,520
Equity
Share capital 50,000
Share premium 5,000
Other reserves [W-2] 15,600
Retained earnings [W-3] 104,038
Non-controlling interest [W-4] 7,882
Current liabilities
Creditors [17 + 11] 28,000
210,520
Workings
W-1 Goodwill Rs. Rs.
Investment 54,000
Fair value of NCI 5,700
Less: net assets at acq.:
Share capital 30,000
Share premium 3,000
Other reserves 1,000
Pre-acq RE 15,000
Brand 5,000 (54,000)
Goodwill at acquisition 5,700
Impairment loss (2,280)
3,420
W-2 Other reserves
P Other reserves 12,000
Add: S Other reserves 5,000
Less: Pre-acq (1,000)
4,000
[2700 / 3000] 90% 3,600
15,600
Solution No. 10
P Group
Consolidated statement of financial position
as at June 30, 2019
Rs.
Non current assets
PPE [75 + 65] 140,000
Investments [60 - 58 + 8] 10,000
Brand 4,500
Current assets
Inventories [16 + 9 - 1] 24,000
Debtors [11 + 11] 22,000
Cash and bank [5 + 4.5] 9,500
210,000
Equity
Share capital 50,000
Share premium 5,000
Other reserves [W-2] 15,000
Retained earnings [W-3] 83,750
Non-controlling interest [W-4] 22,250
Current liabilities
Creditors [22 + 12] 34,000
210,000
-
W-1 Goodwill Rs. Rs.
Investment 58,000
Value of NCI [81,000 x 25%] 20,250
Solution No. 11
P Group
Consolidated statement of financial position
as at June 30, 2019
Rs.
Non current assets
PPE [70 + 60 - 4 + 0.4] 126,400
Investment 5,000
Brand [6 - 0.8] 5,200
Goodwill [W-1] 6,400
Current assets
Inventories [16 + 10] 26,000
Debtors [11 + 9] 20,000
Cash and bank [5 + 6] 11,000
200,000
Equity Rs.
Share capital 60,000
Share premium 6,000
200,000
-
Workings
W-1 Goodwill Rs. Rs.
Investment [2,400 x 25] 60,000
Fair value of NCI [600 x 24] 14,400
Less: net assets at acq.:
Share capital 30,000
Share premium 3,000
Pre-acq RE [43 - 21 x 8/12] 29,000
Brand 6,000 (68,000)
6,400
241,200
Equity Rs.
Share capital 50,000
Share premium 5,000
NASIR ABBAS FCA
BASIC CONSOLIDATION [SOFP WITH ONE SUBSIDIARY] - Solutions (15)
241,200
Workings
W-1 Goodwill Rs. Rs.
Investment [3,000 x 15] 45,000
Value of NCI [66,000 x 40%] 26,400
Less: net assets at acq.:
Share capital 50,000
Share premium 5,000
Other reserves 4,000
Pre-acq RE 11,000
FV adj. - P&M (4,000)
(66,000)
5,400
Less: Impairment loss (2,000)
3,400
Solution No. 13
P Group
Consolidated statement of financial position
as at June 30, 2019
Rs.
Non current assets
PPE [100 + 70 + 3 + 4] 177,000
Investments 10,000
Goodwill [W-1] 2,500
Current assets
Inventories [9 + 7] 16,000
Debtors [10 + 8] 18,000
Cash and bank [4 + 5] 9,000
232,500
Equity
Share capital 60,000
Share premium 6,000
Revaluation surplus [W-2] 10,800
Retained earnings [W-3] 96,000
Non-controlling interest [W-4] 28,200
Current liabilities
Creditors [14.5 + 9.5] 24,000
Dividend payable [6 + 1.5] 7,500
232,500
-
Workings
W-1 Goodwill Rs. Rs.
Investment 50,000
Fair value of NCI [1,500 x 14] 21,000
Less: net assets at acq.:
Share capital 50,000
Share premium 5,000
Pre-acq RE 10,000
FV adj. - land 3,000 (68,000)
Goodwill at acquisition 3,000
Impairment loss (500)
2,500
W-4 NCI
Fair value 80.00
Share in RE [55.5 x 20%] 11.10
91.10
Solution 15
Galaxy Group
as at June 30, 2015
Rs. in million Rs. in million
Goodwill
Investment 50.00
Fair value of NCI 35.00
Less: net assets
Capital 50.00
Retained earnings 18.00
Impairment of plant (10.00)
Fair value adj. – land 20.00 (78.00)
7.00
Less: Impairment loss [10%] (0.70)
6.30
NCI
Fair value of NCI 35.00
NCI share in post acq. Profits [13.8 x 40%] 5.52
40.52
Solution No. 16
Notes:
- Depreciation rate of 5% must be used for remaining life of building after acquisition
- Final dividend of 20% for 2016 was declared during 2017, therefore, not accounted for in 2016
Yasir Limited
Consolidated statement of financial position
as at June 30, 2016
Rs.
(million)
Non current assets
Fixed assets [180 + 470 + 12 - 1.2] 660.80
Goodwill [W-1] 190.35
Current assets
Stock in trade [160 + 150 - 4.62 - 4.8] 300.58
Other current assets [71 + 50] 121.00
Cash and bank [63 + 151 + 5.92] 219.92
1,492.65
Equity
Share capital 750.00
Retained earnings [W-3] 406.19
Non-controlling interest [W-4] 210.46
Current liabilities
Creditors [75 + 51] 126.00
1,492.65
Workings
Rs. Rs.
W-1 Goodwill (million) (million)
Investment 675.00
Fair value of NCI [50 x 25% x 15] 187.50
Less: net assets at acq.:
Share capital 500.00
Pre-acq RE [W-2] 139.00
FV adj. (building) 12.00 (651.00)
Goodwill at acquisition 211.50
Impairment loss (10%) (21.15)
190.35
W-4 NCI
FV of NCI 187.50
Share in post acq RE [91.85 x 25%] 22.96
210.46
Solution No. 17
Notes:
- Remaining life should have been given for depreciation on fair value adjustment on building. However,
in absence of remaining life, same 5% rate has been used for extra depreciation.
- It is assumed that assets requiring fair value adjustments still exist at year end. Therefore, effect of value
adjustment has been taken to balance sheet instead of SL's retained earnings.
- It is assumed that accrual in respect of management fees receivable on April 1, 2017 has been made.
Golden Limited
Consolidated statement of financial position
as at December 31, 2016
Rs. (million)
Non-current assets
Building [1,600 + 500 - 80 - 10 + 0.13 + 3] 2,013.13
Plant [1,465 + 690] 2,155.00
Goodwill [W-1] 209.00
Current assets
Current assets [2,068 + 780 - 50 - 9 - 50 x 3/12] 2,776.50
7,153.63
Equity
Share capital 980.00
Share premium [730 + 20 x 13] 990.00
Retained earnings [W-2] 3,192.93
Non-controlling interest [W-3] 243.20
Current liabilities
Current liabilities [600 + 1,160 - 50 x 3/12] 1,747.50
7,153.63
Workings
Rs. Rs.
W-1 Goodwill (million) (million)
Investment:
Cash [87 - 15] 72.00
Shares [20 x 25] 500.00 572.00
Fair value of NCI [45 x 40% x 11] 198.00
Less: net assets at acq.:
Share capital 450.00
Share premium 150.00
Pre-acq RE 100.00
FV adj. (building) (80.00)
FV adj. (stock) (50.00)
FV adj. (debtors) (9.00) (561.00)
Goodwill at acquisition 209.00
Rs. Rs.
W-2 Retained earnings (million) (million)
GL RE 3,150.00
Less: acquisition expenses (15.00)
Less: Profit on sale of building [120 - (240 - 130)] (10.00)
Add: Excess dep. on profit [10 x 5% x 3/12] 0.13
Add: SL RE 210.00
Less: Pre-acq [W-2] (100.00)
Add: Extra dep. on FV adj. [80 x 5% x 9/12] 3.00
Less: Profit on plant [120 - (200 - 80)] -
113.00
60% 67.80
3,192.93
W-3 NCI
FV of NCI 198.00
Share in post acq RE [113 x 40%] 45.20
243.20
Solution No. 18
Jasmine Limited
Consolidated statement of financial position
as at December 31, 2017
Current assets
Current assets [640 + 345 + 30 - 52 - 25 - 20 x 75%] 923.00
2,328.00
Equity
Share capital 700.00
Share premium 240.00
Retained earnings [W-2] 708.25
Non-controlling interest [W-4] 187.75
Current liabilities
Current liabilities [324 + 235 - 52 - 20 x 75%] 492.00
2,328.00
-
Workings
W-1 Goodwill ----- Rs. (million) ----
Investment:
Cash [280 - 10] 270.00
Shares [10 x 24] 240.00 510.00
W-4 NCI
FV of NCI 180.00
Share in post acq RE [31 x 25%] 7.75
187.75
Pulp Group
Consolidated statement of financial position
as at June 30, 2020
Rs.
Non current assets
PPE [125 + 120 - 8 + 3 - 1.2 - 7.6 - 7.8] 223,400
Intangible asset [12 - 4.8] 7,200
Goodwill [W-1] -
Current assets
Inventories [18 + 14 + 4 - 1.8 - 2] 32,200
Debtors [22 + 24 - 13] 33,000
Other receivables [11 + 8 - 2.8] 16,200
Cash and bank [9 + 9] 18,000
330,000
Equity
Share capital [70 + 2.8 x 2/5 x 10] 81,200
Share premium [10 + 2.8 x 2/5 x 22] 34,640
Other reserves [W-2] 10,750
Retained earnings [W-3] 71,844
Non-controlling interest [W-4] 35,610
Non-current liabilities
Deferred consideration [7,650 x 1.12] 9,256
Deferred tax (W-5) 26,100
Current liabilities
Contingent consideration [2,800 x 3] 8,400
Creditors [16 + 15 + 4 - 13] 22,000
Other payables [14 + 19 - 2.8] 30,200
330,000
-
Workings
W-1 Goodwill Rs. Rs.
Consideration transferred:
- Cash [7 x 2,800] 19,600
- Share exchange [2,800 x 2/5 x 32] 35,840
- Deferred consideration [2,800 x 4 x 1.1-4] 7,650
- Contingent consideration [2,800 x 1.25] 3,500
- Land 10,000
Value of NCI [84,500 x 30%] 25,950
Less: net assets at acquisition:
Share capital 40,000
Share premium 20,000
Other reserves 4,500
RE 14,000
FV adj. - Land 2,000
FV adj. - Plant 3,000
Brand 12,000
Contingent liability (7,000)
DTL [(3,000 + 12,000 - 7,000) x 25%] (2,000) (86,500)
Goodwill at acquisition 16,040
Impairment loss [22,914(W-3.1) x 70%] (16,040)
-
71,844
W-3.1 Impairment loss Rs.
Carrying amount as per question:
PPE 120,000
Fair value adjustment of Plant [3,000 - 1,200] 1,800
Goodwill [16,040 ÷ 0.7] 22,914
144,714
Recoverable amount 114,000
Impairment loss 30,714
Question
Following are the balance sheets as at June 30, 2020:
Pulp Seed
-------------- Rs.--------------
Non-current assets
Property, plant & equipment 125,000 120,000
Investment in Seed 21,000 -
Current assets
Inventories 18,000 14,000
Debtors 22,000 24,000
Other receivables 11,000 8,000
Cash & bank 9,000 9,000
206,000 175,000
Pulp Seed
Equity ------------- Rs.-----------
Share capital (Rs. 10 per share) 70,000 40,000
Share premium 10,000 20,000
Other reserves 9,000 7,000
Retained earnings 74,000 58,000
Non-current liabilities
Deferred tax 13,000 16,000
Current liabilities
Creditors 16,000 15,000
Other payables 14,000 19,000
206,000 175,000
Pulp only recorded immediate cash payment plus commission paid to investment banker as cost of investment.
Land transferred as consideration is still appearing in Pulp’s books. Fair value of contingent consideration at
the date of acquisition was Rs. 1.25 per share. Pulp’s cost of capital is 10%.
(2) At acquisition date, carrying amounts of all assets and liabilities of Seed were equal to fair values except
following:
Book value Fair value
----------- Rs. ----------
Land 15,000 17,000
Plant 24,000 27,000
Remaining useful life of Plant at acquisition date was 5 years. The land was sold by Seed during 2020 for Rs.
19,500.
(3) At acquisition date there was an internally generated brand of Seed, however, its fair value could not be
estimated reliably at that date due to insufficient information. Though its remaining life was estimated to be 5
years. The financial consultant provided with reliable estimate of fair value at Rs. 12,000 on receipt of sufficient
information 4 months later.
(4) At acquisition date there was a pending court case against Seed for which no provision was recognized in its
books as outflow of economic resources was not probable. At that date fair value of the contingent liability
was determined at Rs. 7,000. In respect of this claim, on June 30, 2019 Seed recognized a provision for Rs.
9,000 as outflow of economic resources became probable. The claim was finally settled during 2020 for Rs.
10,000.
(5) It is PL’s policy to value non-controlling interest at proportionate share in identifiable net assets.
(6) There was no need for impairment test in 2019, however, recoverable amount of CGU of Seed (i.e. comprising
of PPE and Goodwill) on June 30, 2020 was Rs. 114,000.
(7) The following intercompany sales were made during the year 2020:
In respect of above intercompany sales, Seed’s books show a net balance owed to Pulp is Rs. 9,000. However,
it differs from balance as per Pulp’s books due to goods sold by Pulp for Rs. 4,000 on June 28, 2020 but were
received and recorded by Seed on July 3, 2020.
(8) On January 1, 2020 Seed sold a machine to Pulp for Rs. 38,000 at a profit of Rs. 8,000. Pulp charged depreciation
on that machine for Rs. 1,900.
(9) During June 2020, Pulp and Seed declared ordinary dividend of 5% and 10% respectively which would be
payable in next month. Both companies have duly recorded the dividends.
(10) Deferred tax liabilities are calculated on all temporary differences at a tax rate of 25%. Gain on sale of land is
not taxable. No tax deduction will be allowed on deferred consideration and contingent consideration.
Required:
Prepare consolidated statement of financial position as at June 30, 2020.
BASIC PRESENTATION
After line by line addition till Total comprehensive income, “Profit after tax” and “Total comprehensive
income” is attributed to:
- Shareholders of “P”
- NCI
We have already studied consolidation adjustments in sufficient detail in “Consolidation of SOFP”. In this chapter will
discuss the effect of those adjustments in Consolidated SOCI for the year as follows:
Note – If P has recorded investment in S as per IFRS 9, then do not forget to reverse any fair value gain/loss recorded.
Consolidation adjustment:
(1) Impairment loss for the current year attributable to other assets shall be:
- ADDED to “Admin expenses/Cost of sales”
- DEDUCTED from “S’s PAT” in NCI working
(a) NCI valued at proportionate share (b) NCI valued at Fair value
In case of first year of acquisition, acquisition related costs which were capitalized by P in its cost of
investment, shall be adjusted as follows:
Consolidation adjustment:
Acquisition related transactions costs (except for the issue costs relating to debt or equity
securities issued as consideration, in which case such costs are accounted for as IAS 32 and IFRS 9)
shall ADDED to “Finance cost” OR “Admin expenses”
Either sales are from “P to S” or “S to P”, these transactions are adjusted in the same manner
Consolidation adjustment:
P or S may provide management services to other and charge certain fees. This fee is an inter-company
transaction and must be eliminated.
Consolidation adjustment:
URP is the profit included in the amount of inventory out of inter-company sale. Inventory value may be given
in question or mentioned as a proportion of intercompany sale.
Calculation of URP:
URP = Inventory x GP margin %
OR
Inventory x GP markup / (100 + GP markup)
OR
URP = Total profit in the inter company sale x % goods held in stock
Consolidation adjustment:
P to S sale S to P sale
Consolidation adjustment:
In case of negative adjustment to S’s net assets, above adjustments will be reversed
Note – If subsequently S has accounted for any such fair value adjustment in its books, then its effect in current year
SOCI must be reversed.
Calculation of Profit:
Profit = Sale value of asset x margin %
OR
Sale value of asset x markup / (100 + markup)
Consolidation adjustment:
In case of S to P sale, also DEDUCT the profit on sale from S’s PAT in NCI working
P to S sale S to P sale
When asset is depreciated, seller’s profit is realized, therefore, this adjustment is made in seller’s profits. It is
calculated using same depreciation basis as of buyer company in its books
Consolidation adjustment:
P to S sale S to P sale
First ensure whether both entities have recorded the interest / dividend as per accrual concept. If not
properly recorded, then accordingly account for it.
First ensure whether both entities have recorded the dividend as per relevant IAS. If not properly recorded,
then accordingly account for it.
Consolidation adjustment:
It is recognized as income and generally shown as a separate line item of income on Group statement of
comprehensive income ONLY in the year of acquisition.
Consolidation adjustment:
Amortization for the year, if any, is ADDED to “admin expenses” and DEDUCTED from S’s PAT in NCI
working.
Consolidation adjustment:
1) Any increase for the year in contingent liability value recognized only for consolidated SOFP, is
ADDED to “Admin expenses” and DEDUCTED from S PAT in NCI working.
2) Reverse any treatment if accounted for by S in its SOCI in respect of this obligation on the
face of consolidated SOCI as well as in S PAT in NCI working.
OR
Finance cost on deferred consideration for the year will be ADDED to the finance cost for the year in
Group SOCI.
Fair value change on contingent consideration for the year will be RECOGNIZED to the Admin expenses
for the year in Group SOCI.
In first year of acquisition, profit/loss on transfer of non-cash asset shall be recognized in Group SOCI. If
the asset was depreciable then reverse any depreciation, for the period after acquisition, charged in P
books.
If sufficient data is available to prepare separate SOCI of S for post-acquisition period then use this specific
period SOCI for consolidation purposes. However generally in questions such data is not available ,therefore,
all incomes and expenses of S are assumed to occur evenly throughout the year unless any specific expense
or income is mentioned to be exceptional and specifically relates to a particular period. In which case
following adjustments are made:
Consolidation adjustment:
Note:
Generally all expenses and incomes of S are assumed to occur evenly throughout the year therefore all these items are
time apportioned according to post acquisition months. However there may be certain expenses and incomes which are
mentioned to be exceptional and they specifically relate to pre or post acquisition period.
Example:
P acquired controlling interest in S on August 1, 2013. S’s PAT for the year is Rs. 74,000. Its other income for the year
includes Rs. 2,000 which specifically relates to December 2013. Now S’s PAT in NCI working will be as [(74,000 - 2,000) x
5/12 + 2,000 = 32,000]
Tax effect of consolidation adjustments for the year shall be accounted in deferred tax expense for the year.
Consolidation adjustment:
Sale XXX
(P’s + S’s x n/12 – Inter-company transaction)
Cost of sales (XXX)
(P’s + S’s x n/12 – Inter-company transaction + URP on goods [P or S] + Extra depreciation
on Fair value adjustment – Excess depreciation on asset sale)
Gross profit (Cast down) XXX
Distribution cost (XXX)
(P’s + S’s x n/12)
Administrative expenses (XXX)
(P’s + S’s x n/12 + unrecorded expense – Inter-company transaction – Excess depreciation
on asset sale + Extra depreciation on fair value adjustment + Amortization on asset
recognized at acquisition + total impairment loss of goodwill for the year + value increase
of contingent liability of S + fair value change in contingent consideration)
Finance cost (XXX)
(P’s + S’s x n/12 – Intercompany finance cost + finance cost on deferred consideration)
Other income XXX
(P’s + S’s x n/12 – Intercompany interest / dividend – Profit [P or S] on asset sale during
the year + unrecorded income)
Profit before tax (Cast down) XXX
Tax (XXX)
(P’s + S’s x n/12 + tax on consolidation adjustments)
Profit after tax (Cast down) XXX
Other comprehensive income:
Revaluation gain / (loss) XXX
(P’s + S’s)
Fair value gain / (loss) XXX
(P’s + S’s)
Total comprehensive income for the year XXX
Profit for the year attributable to:
Shareholders of Parent XXX
Non-controlling interest (W – 1) XXX
XXX
Total comprehensive income attributable to:
Shareholders of Parent XXX
Non-controlling interest XXX
(“Answer of W – 1” + NCI % x S’s other comprehensive income)
XXX
WORKINGS
Notes:
1. Intercompany eliminations have nothing to do with NCI working
2. Also see note on page no. 5
“n” means number of months from acquisition date to year end, in case of acquisition during the year.
PRACTICE QUESTIONS
Question No. 1
Following are the statements of comprehensive income for the year ending June 30, 2019:
P S
---------- Rs.--------
Sales 120,000 100,000
Cost of sales (75,000) (65,000)
Gross profit 45,000 35,000
Distribution cost (12,000) (8,000)
Admin expenses (10,000) (6,000)
Finance cost (3,000) (2,000)
Other income 1,500 500
Profit before tax 21,500 19,500
Tax (7,000) (5,500)
Profit after tax 14,500 14,000
Other comprehensive income:
Revaluation gain - 1,200
Total comprehensive income 14,500 15,200
Question No. 2
Following are the statements of comprehensive income for the year ending June 30, 2019:
P S
---------- Rs.--------
Sales 125,000 90,000
Cost of sales (82,000) (57,000)
Gross profit 43,000 33,000
Distribution cost (13,000) (9,000)
Admin expenses (12,000) (14,000)
Finance cost (4,000) (1,000)
Other income 6,000 -
Profit before tax 20,000 9,000
Tax (7,500) (3,200)
Profit after tax 12,500 5,800
Other comprehensive income:
Revaluation gain - -
Total comprehensive income 12,500 5,800
Required:
Prepare consolidated statement of comprehensive income for the year ending June 30, 2019.
Question No. 3
Following are the statements of comprehensive income for the year ending June 30, 2019:
P S
---------- Rs.--------
Sales 90,000 80,000
Cost of sales (54,000) (42,000)
Gross profit 36,000 38,000
Distribution cost (8,000) (9,000)
Admin expenses (7,000) (7,800)
Finance cost (3,000) (1,200)
Other income 1,000 800
Profit before tax 19,000 20,800
Tax (6,000) (7,200)
Profit after tax 13,000 13,600
Other comprehensive income:
Revaluation gain 1,500 2,000
Total comprehensive income 14,500 15,600
Question No. 4
Following are the statements of comprehensive income for the year ending June 30, 2019:
P S
---------- Rs.--------
Sales 110,000 95,000
Cost of sales (82,000) (62,000)
Gross profit 28,000 33,000
Distribution cost (6,400) (8,000)
Admin expenses (4,200) (7,100)
Finance cost (2,000) (1,500)
Other income 1,600 700
Profit before tax 17,000 17,100
Tax (6,000) (6,050)
Profit after tax 11,000 11,050
Other comprehensive income:
Revaluation gain / (loss) 1,000 (300)
Total comprehensive income 12,000 10,750
(ii) Impairment loss of goodwill for the year was Rs. 1,000.
(iii) Non controlling interest is valued at proportionate share.
(iv) During the year P sold goods to S for Rs. 8,000 at a markup of 25%. One-fourth of these goods are
still held in S’s stock.
Required:
Prepare consolidated statement of comprehensive income for the year ending June 30, 2019.
Question No. 5
Following are the statements of comprehensive income for the year ending June 30, 2019:
P S
---------- Rs.--------
Sales 150,000 120,000
Cost of sales (96,000) (74,000)
Gross profit 54,000 46,000
Distribution cost (12,000) (9,500)
Admin expenses (10,000) (7,000)
Finance cost (4,000) (3,000)
Other income 1,000 4,200
Profit before tax 29,000 30,700
Tax (7,500) (7,000)
Profit after tax 21,500 23,700
Other comprehensive income:
Revaluation gain (500) 200
Total comprehensive income 21,000 23,900
Question No. 6
Following are the statements of comprehensive income for the year ending June 30, 2019:
P S
---------- Rs.--------
Sales 140,000 120,000
Cost of sales (85,000) (70,000)
Gross profit 55,000 50,000
Distribution cost (11,000) (9,000)
Admin expenses (13,000) (11,400)
Finance cost (5,000) (6,300)
Other income 4,500 1,000
Profit before tax 30,500 24,300
Tax (8,500) (7,000)
Profit after tax 22,000 17,300
Other comprehensive income:
Revaluation gain 200 400
Total comprehensive income 22,200 17,700
Question No. 7
Following are the statements of comprehensive income for the year ending June 30, 2019:
P S
---------- Rs.--------
Sales 100,000 90,000
Cost of sales (70,000) (58,000)
Gross profit 30,000 32,000
Distribution cost (9,500) (9,000)
Admin expenses (8,000) (10,000)
Finance cost (3,000) (2,000)
Other income 2,000 2,800
Profit before tax 11,500 13,800
Tax (4,200) (6,000)
Profit after tax 7,300 7,800
Other comprehensive income:
Revaluation gain 100 300
Total comprehensive income 7,400 8,100
Question No. 8
Following are the statements of comprehensive income for the year ending June 30, 2019:
P S
---------- Rs.--------
Sales 140,000 120,000
Cost of sales (75,000) (84,000)
Gross profit 65,000 36,000
Distribution cost (13,500) (9,000)
Admin expenses (7,200) (12,000)
Finance cost (3,000) (6,000)
Other income 1,500 3,600
Profit before tax 42,800 12,600
Tax (11,200) (3,000)
Profit after tax 31,600 9,600
Question No. 9
Following are the statements of comprehensive income for the year ending June 30, 2019:
P S
---------- Rs.--------
Sales 150,000 120,000
Cost of sales (80,000) (72,000)
Gross profit 70,000 48,000
Distribution cost (12,000) (9,600)
Admin expenses (11,000) (10,800)
Finance cost (3,000) (3,800)
Other income 4,600 1,800
Profit before tax 48,600 25,600
Tax (13,500) (9,000)
Profit after tax 35,100 16,600
Other comprehensive income:
- - -
Total comprehensive income 35,100 16,600
Question No. 10
The following summarized Trial Balances pertain to Rivera Limited (RL) and its subsidiary Chenab Limited (CL) for the year
ended 31 December 2014:
RL CL
Dr. Cr. Dr. Cr.
-------------- Rs. in million -----------
Sales - 285 - 320
Cost of sales 186 - 240 -
Selling and distribution expenses 27 - 25 -
Administration expenses 17 - 15 -
Finance charges 8 - 10 -
Tax expense 19 - 12 -
Share capital (Rs. 100 each) - 350 - 200
Retained earnings – 1 January 2014 - 50 - 36
Property, plant and equipment 190 - 263 -
Current assets 23 - 35 -
Investment in CL (1.6 million shares) 250 - - -
Current liabilities - 35 - 44
720 720 600 600
Question No. 11
The summarized trial balances of Oscar Limited (OL) and United Limited (UL) as at 31 December 2015 are as follows:
OL UL
Dr. Cr. Dr. Cr.
-------------- Rs. in million -----------
Sales - 835 - 645
Cost of sales 525 - 396 -
Operating expenses 115 - 102 -
Tax expense 65 - 48 -
Share capital (Rs. 10 each) - 600 - 250
Share premium - 150 - 60
Additional information:
(i) On 1 May 2015, OL acquired 80% shares of UL. UL has not recognized the value of brand in its books of account.
At the date of acquisition, the fair value of brand was assessed at Rs. 45 million. The remaining useful life of the
brand was estimated as 15 years.
(ii) OL charged Rs. 2.5 million monthly to UL for management services provided from the date of acquisition and has
credited it to operating expenses.
(iii) On 1 October 2015, UL sold a machine to OL for Rs. 24 million. The machine had been purchased on 1 October
2013 for Rs. 26 million. On the date of purchase of machine, it was assessed as having a useful life of ten years
and that estimate has not changed. Gain on disposal was erroneously credited to sales account.
(iv) Other inter-company transactions during the year 2015 were as follows:
Included in buyer’s
Sales closing stock Profit %
------------ Rs. in million ---------
OL to UL 60 20 25% of cost
UL to OL 30 5 20% of sales
UL settled the inter-company balance as on 31 December 2015 by issuing a cheque of Rs. 30 million. However,
the cheque was received by OL on 1 January 2016.
(v) The non-controlling interest is measured at the proportionate share of UL’s identifiable net assets.
It may be assumed that profits of both companies had accrued evenly during the year.
Required:
Prepare consolidated statement of comprehensive income for the year ended 31 December 2015 and consolidated
statement of financial position as at 31 December 2015. (18)
[Spring 2016, Q#1]
Question No. 12
The following balances are extracted from the records of Present Limited (PL) and Future Limited (FL) for the year ended
30 June 2017:
PL FL
Debit Credit Debit Credit
--------------- Rs. in million ---------------
Sales 2,060 1,524
Cost of sales 1,300 846
Selling and administrative expenses 350 225
Investment income 190 50
Gain on disposal of fixed assets – net 35
Taxation 80 60
Share capital (Rs. 10 each) 3,500 2,600
Retained earnings as on 30 June 2017 1,996 704
Additional information:
(i) PL acquired 65% shares of FL on 1 September 2016 against the following consideration:
▪ Cash payment of Rs. 900 million.
▪ Issuance of shares having nominal value of Rs. 1,000 million.
The fair value of each share of PL and FL on acquisition date was Rs. 16 and Rs. 12 respectively. Retained earnings
of PL and FL on the acquisition date were Rs. 1,671 million and Rs. 506.5 million respectively.
At acquisition date, fair value of FL’s net assets was equal to their book value except a brand which had not been
recognised by FL. The fair value of the brand is assessed at Rs. 90 million. PL estimates that benefit would be
obtained from the brand for the next 10 years.
(ii) The incomes and expenses of FL had accrued evenly during the year except investment income. The investment
income is exempt from tax and had been recognised in August 2016 and received in September 2016.
(i) On 1 January 2017 PL sold a manufacturing plant having carrying value of Rs. 42 million to FL against cash
consideration of Rs. 30 million. The plant had a remaining useful life of 6 years on the date of disposal.
(ii) On 1 February 2017 FL delivered goods having sale price of Rs. 100 million to PL on ‘sale or return basis’. 40% of
these goods were returned on 1 May 2017 and the remaining were accepted by PL. 20% of the goods accepted
were included in the closing inventory of PL. FL earned a profit of 33.33% on cost.
(iii) Both companies paid interim cash dividend at the rate of 5% in May 2017.
(iv) An impairment test carried out at year end has indicated that goodwill of FL has been impaired by 10%.
(v) PL measures the non-controlling interest at its fair value.
Required:
(a) Prepare consolidated statement of profit or loss for the year ended 30 June 2017. (13)
(b) Compute the amounts of consolidated retained earnings and non-controlling interest as would appear in the
consolidated statement of financial position as at 30 June 2017. (04)
[Autumn 2017, Q#4]
Question No. 13
The following summarized trial balances pertain to Arrow Limited (AL) and its subsidiary Box Limited (BL) for the year
ended 31 December 2018:
AL BL
Debit Credit Debit Credit
--------------- Rs. in million ---------------
Sales - 5,177 - 3,996
Cost of sales 3,255 - 2,448 -
Operating expenses 713 - 636 -
Other income - 350 - 18
Tax expense 403 - 288 -
Share capital (Rs. 10 each) - 3,720 - 1,600
Share premium - 1,430 - 322
Retained earnings as at January 1, 2018 - 2,293 - 516
Current liabilities - 713 - 651
Property, plant and equipment 5,418 - 1,934 -
Investments 1,600 - - -
Loan to BL’s director 10 - - -
Current assets 2,284 - 1,797 -
13,683 13,683 7,103 7,103
Additional information:
(i) AL acquired 96 million shares of BL on 1 May 2018 at following consideration:
• Cash payment of Rs. 450 million
• Issuance of 40 million shares of AL at Rs. 25 each
(ii) On acquisition date, carrying values of BL's net assets were equal to fair value except the following:
• A building whose fair values and value-in-use were Rs. 390 million and Rs. 520 million respectively as against
carrying value of Rs. 480 million. The group follows cost model for subsequent measurement of property,
plant and equipment. The remaining life of building on acquisition date was 20 years. Fair value of the
building has increased to Rs. 440 million at 31 December 2018.
• A brand which had not been recognized by BL. The fair value of the brand was assessed at Rs. 162 million. It
is estimated that benefit would be obtained from the brand for the next 6 years.
(iii) AL measures the non-controlling interest at fair value. On the date of acquisition, the market price of BL's shares
was Rs. 14 per share.
(iv) On 1 July 2018 AL sold an equipment to BL for Rs. 250 million at a gain of Rs. 20 million. BL has charged
depreciation of Rs. 12.5 million on this equipment.
(v) In each month of 2018, BL sold goods costing Rs. 40 million to AL at cost plus 20%. At year end, 75% of the goods
purchased in December were included in stock of AL.
(vi) BL's credit balance of Rs. 38 million in AL’s books does not agree with BL's books due to Rs. 7 million charged by
AL for management service on 26 December 2018. Total management fee charged by AL to BL since acquisition
amounted to Rs. 16 million.
(vii) BL declared interim cash dividend of Re. 0.50 per share in December 2018. AL has correctly recorded the dividend
in its books. However, BL has not yet accounted for the dividend.
(viii) The incomes and expenses of BL may be assumed to have accrued evenly during the year.
Required:
Prepare the following:
• consolidated statement of profit or loss for the year ended 31 December 2018. (15)
• consolidated statement of financial position as at 31 December 2018. (10)
[Spring 2019, Q#2]
W-1 NCI
S PAT 14,000
Less: Impairment loss (3,000)
11,000
30.00% 3,300
Solution No. 2
P Group
Consolidated statement of comprehensive income
for the year ended June 30, 2019
Rs.
Sales [125 + 90 - 8.2] 206,800
Cost of sales [82 + 57 - 8.2] (130,800)
Gross profit 76,000
Distribution cost [13 + 9] (22,000)
Admin expenses [12 + 14 - 3.5] (22,500)
Rs.
Finance cost [4 + 1] (5,000)
Other income [6 - 3.5] 2,500
Profit before tax 29,000
Tax [7.5 + 3.2] (10,700)
Profit after tax 18,300
Solution No. 3
P Group
Consolidated statement of comprehensive income
for the year ended June 30, 2019
Rs.
Sales [90 + 80 - 7] 163,000
Cost of sales [54 + 42 - 7 + 0.42] (89,420)
Gross profit 73,580
Distribution cost [8 + 9] (17,000)
Admin expenses [7 + 7.8 + 2] (16,800)
Finance cost [3 + 1.2] (4,200)
Other income [1 + 0.8] 1,800
Profit before tax 37,380
Tax [6 + 7.2] (13,200)
Profit after tax 24,180
Other comprehensive income:
Revaluation gain [1.5 + 2] 3,500
Total comprehensive income 27,680
Solution No. 4
P Group
Consolidated statement of comprehensive income
for the year ended June 30, 2019
Rs.
W-1 NCI
S PAT 11,050
Less: Extra dep on FV adj. [3 / 10] (300)
10,750
10.00% 1,075
Solution No. 5
P Group
Consolidated statement of comprehensive income
for the year ended June 30, 2019
Rs.
W-1 NCI
S PAT 23,700
Less: Profit on PPE (2,500)
Add: Extra dep on FV adj. [15 / 10] 1,500
Less: Impairment loss (1,200)
Add: Excess dep on PPE sale 500
22,000
15.00% 3,300
Solution No. 6
P Group
Consolidated statement of comprehensive income
for the year ended June 30, 2019
Rs.
W-1 NCI
S PAT 17,300
Less: URP of goods [20 x 30% x 1/5] (1,200)
16,100
37.50% 6,038
Solution No. 7
P Group
Consolidated statement of comprehensive income
for the year ended June 30, 2019
Rs.
W-1 NCI
S PAT 7,800
Less: Amortization of brand [5 x 1/5] (1,000)
6,800
20.00% 1,360
W-2 Negative goodwill
Investment 30,800
Fair value of net assets [40 x 80%] (32,000)
(1,200)
Solution No. 8
P Group
Consolidated statement of comprehensive income
for the year ended June 30, 2019
Rs.
Sales [140 + 120 x 8/12 - 8] 212,000
Cost of sales [75 + 84 x 8/12 - 8 + 1] (124,000)
Gross profit 88,000
Distribution cost [13.5 + 9 x 8/12 + 1] (20,500)
Admin expenses [7.2 + 12 x 8/12] (15,200)
Finance cost [3 + 6 x 8/12] (7,000)
Other income [1.5 + 3.6 x 8/12] 3,900
Profit before tax 49,200
Tax [11.2 + 3 x 8/12] (13,200)
Profit after tax 36,000
Solution No. 9
P Group
Consolidated statement of comprehensive income
for the year ended June 30, 2019
Rs.
Sales [150 + 120 x 10/12 - 10] 240,000
Cost of sales [80 + 72 x 10/12 - 10 + 0.9] (130,900)
Gross profit 109,100
Distribution cost [12 + 9.6 x 10/12] (20,000)
Admin expenses [11 + 10.8 x 10/12 + 0.4] (20,400)
Finance cost [3 + (3.8 - 2) x 10/12 + 2 - 2] (4,500)
Other income [4.6 + (1.8 - 0.3) x 10/12 - 2] 3,850
Profit before tax 68,050
Tax [13.5 + 9 x 10/12] (21,000)
Profit after tax 47,050
W-1 NCI
S PAT [(16.6 - 0.3 + 2) x 10/12 - 2] 13,250
Less: Extra dep on FV adj. (400)
Less: URP on goods (900)
11,950
40.00% 4,780
Solution No. 10
Rivera Group
Consolidated statement of comprehensive income
for the year ending December 31, 2014
Rs. in million
Sales [285 + 320 - 60 - 48] 497.00
Cost of sales [186 + 240 - 60 - 48 + 2.8 (W-2) + 1.6 (W-2)] (322.40)
Gross profit 174.60
Selling and distribution expense [27 + 25] (52.00)
Administration expenses [17 + 15 + 1.2 (W-3) + 4.68 (W-1)] (37.88)
Finance cost [8 + 10] (18.00)
Profit before tax 66.72
Tax [19 + 12] (31.00)
Profit after tax 35.72
Profit attributable to:
Shareholders of RL 32.92
Non-controlling interest (W-4) 2.80
35.72
Rivera Group
Consolidated statement of financial position
as at December 31, 2014
Non current assets
PPE [190 + 263 + 18 - 1.2] 469.80
Goodwill [W-1] 42.12
W - 4 NCI (SCI)
PAT (W-6) 18.00
Less: Extra depreciation [18/15] (1.20)
Less: URP on goods [16.8 x 20/120] (2.80)
14.00
20% 2.80
W-5 NCI
NCI share in net assets acquired [254 (W-1) x 20%] 50.80
NCI share in post acq. Profits [14 (W-3) x 20%] 2.80
53.60
Notes:
- It is assumed that inter-company sales given are for full year.
- It is assumed that depreciation on machine is included in operating expenses.
- Elimination of inter company management services is ignored as it would have a net effect of zero.
Oscar Group
Consolidated statement of financial position
as at December 31, 2015
Non current assets Rs. in million
PPE [390 + 350 - 3.2 (W-4) + 0.1 (W-4)] 736.90
Intangible asset [45 – 2 (W-5)] 43.00
Goodwill (W-1) 46.40
Current assets
Stock in trade [125 + 115 - 4 - 1] 235.00
Trade receivables [140 + 125 - 30] 235.00
Cash and bank [105 + 103 + 30] 238.00
1,534.30
Capital and reserves
Share capital 600.00
Share premium 150.00
Retained earnings (W-2) 438.92
NCI (W-3) 125.38
Current liabilities
Current liabilities [115 + 105] 220.00
1,534.30
Oscar Group
Rs. in million
Sales [835 + 645 x 8/12 - 60 x 8/12 - 30 x 8/12 - 3.2(W-4)] 1,201.80
Cost of sales [525 + 396 x 8/12 - 60 x 8/12 - 30 x 8/12 + 4(W-2) + 1(W-5)] (734.00)
Gross profit 467.80
Operating expenses [115 + 102 x 8/12 + 2(W-5) - 0.1 (W-4)] (184.90)
Profit before tax 282.90
Tax [65 + 48 x 8/12] (97.00)
Profit after tax 185.90
Workings:
W - 1 Goodwill ----- Rs in million -----
Investment 500.00
Less: net assets acquired:
Share capital 250.00
Share premium 60.00
Retained earnings
[179 + 99 (W-2.1) – 66 (W-5)] 212.00
Brand 45.00
567.00
80% (453.60)
46.40
W - 2 Retained earnings
OL RE [265 + 130] 395.00
Less: URP on goods [20 x 25/125] (4.00)
Add: Share in post acq RE of UL [59.9(W-5) x 80%] 47.92
438.92
Alternatively:
OL opening RE 265.00
Add: Profit attributable to shareholders of OL 173.92
438.92
W - 3 NCI (SOFP)
Share in net assets acquired [ 567(W-1) x 20%] 113.40
Share in post acq. RE 11.98
125.38
W - 5 NCI (SCI)
Post acq. PAT [99(W-2.1) x 8/12] 66.00
Less: Profit on machine (W-4) (3.20)
Add: Excess depreciation (W-4) 0.10
Less: URP on goods [5 x 20%] (1.00)
Less: Amortization of brand [45/15 x 8/12] (2.00)
59.90
20% 11.98
Solution No. 12
Assumptions
- Dividend relates to post acquisition profits only.
- Retained earnings given are after including current year profits
- Loss on plant was only due to inter company price agreement and no impairment on plant is required
(a)
PL Group
Consolidated Income Statement
for the year ended June 30, 2017
------------ Rs in million ------------
Non-controlling interest
as at June 30, 2017
Fair value at acq. Date [260 x 35% x Rs. 12] 1,092.00
Share in FL post RE [147.45 x 35%] 51.61
1,143.61
WORKING
W-1 URP on goods ------------ Rs in million ------------
[100 x 60% x 20% x 33.33/133.33] 3.00
Solution No. 13
AL Group
Consolidated balance sheet
as at December 31, 2018
Rs. million
Non current assets
PPE [5,418 + 1,934 - 90 + 3 - 19 (W-9)] 7,246.00
Investments [1,600 - 1,450] 150.00
Brand [162 - 18] 144.00
Loan to BL's director 10.00
Attributable to shareholders of P
Non-
Share Other Retained controlling Total
Share capital Total
premium reserves earnings interest
------------------------------------------- Rs. ------------------------------------------------
Balance as on 01-07-19 X X X X X X X
Dividend * - - (X) (X) (X) (X)
Issue of shares ** X X - - X X X
Total comprehensive income for the year *** - - X X X X X
Transfers - - (X) X - - -
Balance as on 30-06-20 X X X X X X X
* In retained earnings column only P's declared dividend is shown whereas in NCI column only NCI's % in S's declared dividend is shown.
** In Share capital and Share premium only those shares are shown which are issued by P during the year whereas in NCI column only NCI's% in
those shares which are issued by S during the year.
*** Total comprehensive income is:
Other reserves column :- TCI attributable to shareholders of P LESS Profit attributable to shareholders of P
Retained earnings column :- Profit attributable to shareholders of P
NCI column :- TCI attributable to NCI
Master question SOCI & SOCIE [Basic]
Question
Following are the statements of comprehensive income for the year ending June 30, 2020:
Pulp Seed
---------- Rs.--------
Sales 140,000 141,000
Cost of sales (80,000) (82,000)
Gross profit 60,000 59,000
Distribution cost (12,000) (10,000)
Admin expenses (11,000) (13,000)
Finance cost (4,000) (5,000)
Other income 9,000 13,000
Profit before tax 42,000 44,000
Tax (15,000) (18,000)
Profit after tax 27,000 26,000
Other comprehensive income:
Revaluation gain 1,800 1,500
Total comprehensive income 28,800 27,500
Pulp only recorded immediate cash payment plus commission paid to investment banker as cost of investment.
Land transferred as consideration is still appearing in Pulp’s books. Fair value of contingent consideration at
the date of acquisition was Rs. 1.25 per share. It did not change on June 30, 2019. Pulp’s cost of capital is 10%.
(2) At acquisition date, carrying amounts of all assets and liabilities of Seed were equal to fair values except
following:
Book value Fair value
----------- Rs. ----------
Land 15,000 17,000
Plant 24,000 27,000
Remaining useful life of Plant at acquisition date was 5 years. The land was sold by Seed during 2020 for Rs.
19,500.
(3) At acquisition date there was an internally generated brand of Seed, however, its fair value could not be
estimated reliably at that date due to insufficient information. Though its remaining life was estimated to be 5
years. The financial consultant provided with reliable estimate of fair value at Rs. 12,000 on receipt of sufficient
information 4 months later.
(4) At acquisition date there was a pending court case against Seed for which no provision was recognized in its
books as outflow of economic resources was not probable. At that date fair value of the contingent liability
was determined at Rs. 7,000. In respect of this claim, on June 30, 2019 Seed recognized a provision for Rs.
9,000 as outflow of economic resources became probable. The claim was finally settled during 2020 for Rs.
10,000.
(5) It is PL’s policy to value non-controlling interest at proportionate share in identifiable net assets.
(6) There was no need for impairment test in 2019, however, recoverable amount of CGU of Seed (i.e. comprising
of PPE and Goodwill) on June 30, 2020 was Rs. 114,000.
(7) The following intercompany sales were made during the year 2020:
In respect of above intercompany sales, Seed’s books show a net balance owed to Pulp is Rs. 9,000. However,
it differs from balance as per Pulp’s books due to goods sold by Pulp for Rs. 4,000 on June 28, 2020 but were
received and recorded by Seed on July 3, 2020.
(8) On January 1, 2020 Seed sold a machine to Pulp for Rs. 38,000 at a profit of Rs. 8,000. Pulp charged depreciation
on that machine for Rs. 1,900. Both companies include the depreciation on plant and machinery in cost of
sales.
(9) During June 2020, Pulp and Seed declared ordinary dividend of 5% and 10% respectively which would be
payable in next month. Both companies have duly recorded the dividends.
(10) Deferred tax liabilities are calculated on all temporary differences at a tax rate of 25%. Gain on sale of land is
not taxable. No tax deduction will be allowed on deferred consideration and contingent consideration.
Required:
Prepare consolidated statement of comprehensive income and consolidated statement of changes in equity for the
year ending June 30, 2020.
Pulp Group
Consolidated statement of comprehensive income
for the year ended June 30, 2020
Rs.
Sales [140 + 141 - 20 - 36] 225,000
Cost of sales (W-1) (110,000)
Gross profit 115,000
Distribution cost [12 + 10] (22,000)
Admin expenses (W-2) (55,140)
Finance cost (W-3) (9,842)
Other income (W-4) 9,200
Profit before tax 37,219
Tax (W-7) (27,450)
Profit after tax 9,769
Other comprehensive income:
Revaluation gain [1.8 + 1.5] 3,300
Total comprehensive income 13,069
W-7 Tax
Pulp 15,000
Seed 18,000
Tax on P's adjustments [URP on goods i.e. 1,800 x 25%] (450)
Tax on S's adjustments (W-6) (5,100)
27,450
Solution
Workings
W-1 Goodwill Rs. Rs.
Consideration transferred:
- Cash [7 x 2,800] 19,600
- Share exchange [2,800 x 2/5 x 32] 35,840
- Deferred consideration [2,800 x 4 x 1.1-4] 7,650
- Contingent consideration [2,800 x 1.25] 3,500
- Land 10,000
Value of NCI [84,500 x 30%] 25,950
Less: net assets acquired:
Share capital 40,000
Share premium 20,000
Other reserves 4,500
RE 14,000
FV adj. - Land 2,000
FV adj. - Plant 3,000
Brand 12,000
Contingent liability (7,000)
DTL [(3,000 + 12,000 - 7,000) x 25%] (2,000) (86,500)
Goodwill at acquisition 16,040
68,185
W-4 NCI Rs.
Value of NCI (W-1) 25,950
Other reserves [1,000 x 30%] 300
RE [25,000 x 30%] 7,500
33,750
Reverse acquisitions
A reverse acquisition occurs when the entity that issues securities (the legal acquirer) is identified as the acquiree
for accounting purposes. The entity whose equity interests are acquired (the legal acquiree) must be the acquirer
for accounting purposes for the transaction to be considered a reverse acquisition. For example, reverse acquisitions
sometimes occur when a private operating entity wants to become a public entity but does not want to register its
equity shares. To accomplish that, the private entity will arrange for a public entity to acquire its equity interests in
exchange for the equity interests of the public entity. In this example, the public entity is the legal acquirer because
it issued its equity interests, and the private entity is the legal acquiree because its equity interests were acquired.
However, in substance:
(a) the public entity as the acquiree for accounting purposes (the accounting acquiree); and
(b) the private entity as the acquirer for accounting purposes (the accounting acquirer).
Example:
Entity B, the legal subsidiary, acquires Entity A, the entity issuing equity instruments and therefore the legal
parent, in a reverse acquisition on 30 September 20X6. This example ignores the accounting for any income tax
effects. The statements of financial position of Entity A and Entity B immediately before the business combination
are:
Entity A Entity B
Rs. Rs.
Non-current assets 1,300 3,000
Current assets 500 700
1,800 3,700
Issued equity [100 shares] [60 shares] 300 600
Retained earnings 800 1,400
As a result of Entity A (legal parent, accounting acquiree) issuing 150 ordinary shares, Entity B’s shareholders own
60% of the issued shares of the combined entity (i.e. 150 of 250 issued shares). The remaining 40% are owned by
Entity A’s shareholders. If the business combination had taken the form of Entity B issuing additional ordinary
shares to Entity A’s shareholders in exchange for their ordinary shares in Entity A, Entity B would have had to issue
40 shares for the ratio of ownership interest in the combined entity to be the same. Entity B’s shareholders would
then own 60 of the 100 issued shares of Entity B—60% of the combined entity. As a result, the fair value of the
consideration effectively transferred by Entity B and the group’s interest in Entity A is Rs. 1,600 (40 shares with a
fair value per share of Rs. 40).
The fair value of the consideration effectively transferred should be based on the most reliable measure. In this
example, the quoted price of Entity A’s shares in the principal (or most advantageous) market for the shares
provides a more reliable basis for measuring the consideration effectively transferred than the fair value of the
shares in Entity B, and the consideration is measured using the market price of Entity A’s shares—100 shares with
a fair value per share of Rs. 16.
The amount recognised as issued equity interests in the consolidated financial statements (Rs. 2,200) is
determined by adding the issued equity of the legal subsidiary immediately before the business combination (Rs.
600) and the fair value of the consideration effectively transferred (Rs. 1,600). However, the equity structure
appearing in the consolidated financial statements (i.e. the number and type of equity interests issued) must
reflect the equity structure of the legal parent, including the equity interests issued by the legal parent to effect
the combination.
Replacement awards
An acquirer may exchange its share-based payment awards (i.e. replacement awards) for awards held by employees
of the acquiree. If acquirer replaces the acquiree awards, either all or a portion of the market-based measure (i.e.
the amount determined as per IFRS 2) of the acquirer’s replacement awards shall be included in measuring the
consideration transferred in the business combination.
Steps:
1. Calculate market-based measures of both acquirer’s awards and acquiree’s awards.
2. Now calculate the amount to be included in consideration transferred (i.e. pre-combination service) as follows:
Example 1
Acquiree awards – Vesting period completed before the business combination
Replacement awards – Additional employee services are not required after the acquisition date
Discussion
AC issues replacement awards of Rs. 110 (market-based measure) at the acquisition date for TC awards of Rs. 100
(market-based measure) at the acquisition date. No post-combination services are required for the replacement
awards and TC’s employees had rendered all of the required service for the acquiree awards as of the acquisition
date.
The amount attributable to pre-combination service is the market-based measure of TC’s awards (Rs. 100) at the
acquisition date; that amount is included in the consideration transferred in the business combination. The amount
attributable to post-combination service is Rs. 10, which is the difference between the total value of the replacement
awards (Rs. 110) and the portion attributable to pre-combination service (Rs. 100). Because no post-combination
service is required for the replacement awards, AC immediately recognizes Rs. 10 as remuneration cost in its post-
combination financial statements.
Example 2
Acquiree awards – Vesting period completed before the business combination
Replacement awards – Additional employee services are required after the acquisition date
Discussion
AC exchanges replacement awards that require one year of post-combination service for share-based payment
awards of TC, for which employees had completed the vesting period before the business combination. The market-
based measure of both awards is Rs. 100 at the acquisition date. When originally granted, TC’s awards had a vesting
period of four years. As of the acquisition date, the TC employees holding unexercised awards had rendered a total
of seven years of service since the grant date.
Even though TC employees had already rendered all of the service, AC attributes a portion of the replacement award
to post-combination remuneration cost in accordance with paragraph B59 of IFRS 3, because the replacement
awards require one year of post-combination service. The total vesting period is five years—the vesting period for
the original acquiree award completed before the acquisition date (four years) plus the vesting period for the
replacement award (one year).
The portion attributable to pre-combination services equals the market-based measure of the acquiree award (Rs.
100) multiplied by the ratio of the pre-combination vesting period (four years) to the total vesting period (five years).
Thus, Rs. 80 (Rs. 100 × 4/5 years) is attributed to the pre-combination vesting period and therefore included in the
consideration transferred in the business combination. The remaining Rs. 20 is attributed to the post-combination
vesting period and is therefore recognized as remuneration cost in AC’s post-combination financial statements in
accordance with IFRS 2.
Example 3
Acquiree awards – Vesting period not completed before the business combination
Replacement awards – Additional employee services are required after the acquisition date
Discussion
AC exchanges replacement awards that require one year of post-combination service for share-based payment
awards of TC, for which employees had not yet rendered all of the service as of the acquisition date. The market-
based measure of both awards is Rs. 100 at the acquisition date. When originally granted, the awards of TC had a
vesting period of four years. As of the acquisition date, the TC employees had rendered two years’ service, and they
would have been required to render two additional years of service after the acquisition date for their awards to
vest. Accordingly, only a portion of the TC awards is attributable to pre-combination service.
The replacement awards require only one year of post-combination service. Because employees have already
rendered two years of service, the total vesting period is three years. The portion attributable to pre-combination
services equals the market-based measure of the acquiree award (Rs. 100) multiplied by the ratio of the pre-
combination vesting period (two years) to the greater of the total vesting period (three years) or the original vesting
period of TC’s award (four years). Thus, Rs. 50 (Rs. 100 × 2/4 years) is attributable to pre-combination service and
therefore included in the consideration transferred for the acquiree.
The remaining Rs. 50 is attributable to post-combination service and therefore recognised as remuneration cost in
AC’s post-combination financial statements.
Example 4
Acquiree awards – Vesting period not completed before the business combination
Replacement awards – Additional employee services are not required after the acquisition date
Discussion
Assume the same facts as in Example 3 above, except that AC exchanges replacement awards that require no post-
combination service for share-based payment awards of TC for which employees had not yet rendered all of the
service as of the acquisition date. The terms of the replaced TC awards did not eliminate any remaining vesting
period upon a change in control. (If the TC awards had included a provision that eliminated any remaining vesting
period upon a change in control, the guidance in Example 1 would apply.) The market-based measure of both awards
is Rs. 100. Because employees have already rendered two years of service and the replacement awards do not
require any post-combination service, the total vesting period is two years.
The portion of the market-based measure of the replacement awards attributable to pre-combination services
equals the market-based measure of the acquiree award (Rs. 100) multiplied by the ratio of the pre-combination
vesting period (two years) to the greater of the total vesting period (two years) or the original vesting period of TC’s
award (four years). Thus, Rs. 50 (Rs. 100 × 2/4 years) is attributable to pre-combination service and therefore
included in the consideration transferred for the acquiree. The remaining Rs. 50 is attributable to post-combination
service. Because no post-combination service is required to vest in the replacement award, AC recognises the entire
Rs. 50 immediately as remuneration cost in the post-combination financial statements.
* Employee cost is an exception to measurement rules of IFRS 3 which is not measured at fair value.
** PAL might have reversed its deferred tax as its share options are replaced by LG's share options, hence
LG is now accounting for deferred tax asset for the replacement awards
Here a subsidiary [S] of the parent [P] holds controlling interest in another entity (often called sub-
subsidiary [SS]). As a result P controls S as well as SS.
Example:
SS
In addition to S shareholding in SS, P also has a direct holding in SS (which is less than 50%). In this case it
is not necessary that S must hold controlling interest in SS rather P controls SS if combined share of P and
S in SS forms a controlling interest (i.e. more than 50%) even if S holds less than 50% in SS.
P P
SS SS
If “A” has a subsidiary then it is not considered as a sub-subsidiary for the group
EFFECTIVE SHAREHOLDING %
For calculation of Group and NCI shares in equity items of SS, the effective shareholding % are used. It is
explained with the help of following example:
Example
P holds 60% in S and 10% in SS whereas S holds 80% in SS. Effective shareholding % are calculated as follows:
%
P’s direct holding in SS 10
P’s indirect holding through S [60% x 80%] 48
Effective Group shareholding % 58
Effective NCI% [i.e. 100 – Effective group shareholding] 42
Effective shareholding % are used only for calculation and are NOT used for determining the “control” e.g.
effective group shareholding % in SS may be less than 50%.
GOODWILL IN SS
Goodwill on SS is calculated on acquisition date using following working and added with goodwill in S and
presented as total goodwill on SOFP.
Rs.
P’s prior direct investment in SS (Note) XXX
Investment through S [S’s investment in SS x P’s % in S] XXX
Value of NCI [i.e. Value of effective NCI] XXX
Less: SS’s net assets at acquisition (XXX)
Goodwill at acquisition XXX
Less: Impairment loss (XXX)
Carrying amount of Goodwill XXX
Note – In case of P’s prior direct investment in SS, this investment will be included at its fair value on date of
acquisition of SS in above working. Any resulting change is recognized in P’s profits.
NCI in S NCI in SS
Value of NCI at acquisition XXX XXX
Add: Other reserves XXX XXX
[Other reserves x NCI%] [Other reserves x effective NCI%]
Add: Retained earnings XXX XXX
[Retained earnings x NCI%] [Retained earnings x effective NCI%]
Less. Investment in SS (XXX) -
[S’s investment in SS x NCI%]
XXX XXX
Sub associate/JV
A group’s share in an associate or a joint venture is the aggregate of the holdings in that associate or joint
venture by the parent and its subsidiaries (i.e. there is no need for any effective shareholding as used for SS).
The holdings of the group’s other associates or joint ventures are ignored for this purpose.
When an associate or a joint venture has subsidiaries, associates or joint ventures, the profit or loss, other
comprehensive income and net assets taken into account in applying the equity method are those
recognised in the associate’s or joint venture’s financial statements (including the associate’s or joint
venture’s share of the profit or loss, other comprehensive income and net assets of its associates and joint
ventures), after any adjustments necessary to give effect to uniform accounting policies.
Current assets
Inventories [18 + 14 + 10 - 1.4 - 1.5 - 0.6] 38,500
Debtors [22 + 24 + 18 - 5 - 3] 56,000
Cash and bank [9 + 9 + 9] 27,000
344,450
Equity
Share capital 70,000
Share premium 10,000
Other reserves [W-2] 15,900
Retained earnings [W-3] 138,382
Non-controlling interest [W-4] 67,168
Current liabilities
Creditors [14 + 19 + 18 - 5 - 3] 43,000
344,450
-
Pure Group
Consolidated statement of comprehensive income
for the year ended June 30, 2020
Rs.
Sales [140 + 141 + 120 - 40 - 30 - 10] 321,000
Cost of sales (W-5) (156,000)
Gross profit 165,000
Distribution cost [12 + 10 + 8] (30,000)
Admin expenses [11 + 13 + 9 + 2.5 + 0.2] (35,700)
Finance cost [4 + 5 + 3] (12,000)
Other income (W-6) 24,300
Profit before tax 111,600
Tax [10 + 9 + 8] (27,000)
Profit after tax 84,600
Other comprehensive income:
Revaluation gain [1.8 + 1.5 + 1] 4,300
Total comprehensive income 88,900
Workings
Sure Cure
W-1 Goodwill ---------- Rs. -----------
Consideration transferred:
- Direct [Cure: 350 x 20] 64,000 7,000
- Indirect [Cure: 44,000 x 80%] - 35,200
Value of NCI [74,000 x 20%] [65,000 x 42%(W-1.1)] 14,800 27,300
Less: net assets at acquisition:
Share capital 40,000 35,000
Share premium 20,000 12,000
Other reserves 2,000 3,000
RE 10,000 11,000
FV adj. - Building 2,000 -
FV adj. - Plant - 4,000
74,000 65,000
Goodwill at acquisition 4,800 4,500
Impairment loss (1,000) (1,500)
3,800 3,000 6,800
Sure Cure
W-7 NCI [SOCI] -------- Rs. --------
PAT 35,000 34,000
Less: Dividend [35,000 x 20% x 60%] (4,200) -
Less: URP on goods (1,500) (600)
Less: Extra depreciation [2,000/10][4,000/8] (200) (500)
29,100 32,900
20% 42%
5,820 13,818 19,638
Master question – complex group [SOFP & SOCI]
Question
Following are the financial statements of group companies for the year ended June 30, 2020:
Equity
Share capital (Rs. 10 each) 70,000 40,000 35,000
Share premium 10,000 20,000 12,000
Other reserves 9,000 7,000 8,000
Retained earnings 74,000 58,000 64,000
Current liabilities
Creditors 14,000 19,000 18,000
177,000 144,000 137,000
(2) On July 1, 2018 Sure acquired 60% shares of Cure when its other reserves were Rs. 3,000 and retained earnings
were Rs. 11,000. At that date, carrying amounts of all assets and liabilities of Sure were equal to fair values
except for a plant whose fair value was higher than carrying amount by Rs. 4,000. Its remaining life was 8 years.
Fair value of Cure’s shares on that date was Rs. 20 per share.
(4) It is Pure’s policy to value non-controlling interest at proportionate share in identifiable net assets.
(5) There was no need for impairment test in 2019, however, on June 30, 2020 goodwill in Sure was impaired by
Rs. 1,000 and goodwill in Cure was impaired by Rs. 1,500.
(6) The following intercompany sales were made during the year 2020:
Required:
Prepare consolidated statement of financial position and consolidated statement of comprehensive income for the
year ended June 30, 2020.
DL Group
Consolidated statement of financial position
as at December 31, 2013
Rs. million
Non current assets
PPE [10,000 + 6,100 + 5,400] 21,500.00
Goodwill (W-1) 352.50
Current assets
Current assets [6,325 + 7,100 + 3,100] 16,525.00
38,377.50
Equity
Share capital 9,000.00
Retained earnings [W-2] 7,381.44
Equity component (W-2.1) 12.01
Non-controlling interest [W-3] 3,882.50
Non-current liabilities
Non-current liabilities [6,000 + 3,000 + 1,000 - 250(W-2.1) + 241.55(W-2.1)] 9,991.55
Current liabilities
Current liabilities [3,500 + 3,210 + 1,400] 8,110.00
38,377.50
-
Workings
GL SL
W-1 Goodwill ----- Rs. million -----
Consideration transferred:
- Direct [SL: 9 x 200] 7,500.00 1,800.00
- Indirect [SL: 2,800 x 75%(W-1.1)] - 2,100.00
Value of NCI [9,530 x 25%] [6,010 x 35%(W-1.2)] 2,382.50 2,103.50
Less: net assets at acquisition:
Share capital 7,000.00 3,000.00
RE 2,500.00 3,010.00
FV adj. - Land 30.00 -
9,530.00 6,010.00
Goodwill at acquisition 352.50 (6.50)
W-1.1 % holding in GL
52.50m shares / 70m shares = 75.00%
W-1.2 Effective holding in SL
7,381.44
W-3 NCI GL SL
--------- Rs. million --------
Value at acquisition (W-1) 2,382.50 2,103.50
RE [GL: 260 x 25%] [SL: 90 x 35%(W-1.1)] 65.00 31.50
Share in investment in CL [2,800 x 25%] (700.00) -
1,747.50 2,135.00 3,882.50
BASIC CONSOLIDATION [SOFP & SOCI WITH ONE SUBSIDIARY AND ONE ASSOCIATE] – Class notes
Memorandum entry:
Dr. Investment in A
Cr. Group RE (Group’s share in A’s post acquisition profits)
Cr. Group other reserves (Group’s share in A’s post acquisition other reserves)
Note:
In case of losses, “investment in A” will not be taken below zero.
Consolidation adjustment:
Memorandum entry:
Dr. Group RE
Cr. Investment in A
No elimination:
Since there is no consolidation of receivables and payables of A, therefore, there is no need to eliminate any
intercompany balance
Calculation of URP:
URP = Inventory x GP margin %
OR
Inventory x GP markup / (100 + GP markup)
OR
URP = Total profit earned in the inter-company sale x % goods held in stock
Consolidation adjustment:
P to A sale A to P sale
P’s share of URP is DEDUCTED from: P’s share of URP is DEDUCTED from:
(i) “Investment in A” working (i) Inventory in Group SOFP
(ii) P’ RE in Group RE working (ii) P’ RE in Group RE working
Memorandum entry:
Dr. Group RE Dr. Group RE
Cr. Investment in A Cr. Inventory
Information about fair value adjustments at acquisition date may be given as follows:
- Difference between fair values and book values is given (e.g. building was overvalued by Rs. 50,000) OR
- Both Fair values and book values of A’s assets and liabilities are given (i.e. net assets)
Consolidation adjustment:
No adjustment for fair values is accounted for in Group SOFP as no consolidation of assets is being made.
However, these are considered for calculation of goodwill and adjustment of “extra depreciation”.
Consolidation adjustment:
Extra Accumulated depreciation is DEDUCTED from A’s RE in “Group RE working”
Memorandum entry:
Dr. Group RE
Cr. Investment in A
In case of negative adjustment to A’s net assets, above adjustments will be reversed
Unrealized profit is the profit included in carrying amount of a non-current asset sold in an inter-company
transaction.
Calculation of URP:
URP = NBV of asset x margin %
OR
NBV of asset x markup / (100 + GP markup)
OR
Consolidation adjustment:
P to A sale A to P sale
P’s% share of URP is DEDUCTED from: P’s% share of URP is DEDUCTED from:
(i) Investment in A (i) Relevant asset in Group SOFP
(ii) P’s RE in Group RE working (ii) P’s RE in Group RE working
Memorandum entry:
Dr. Group RE Dr. Group RE
Cr. Investment in A Cr. PPE
7. NEGATIVE GOODWILL
Do calculate goodwill just like it is done in case of subsidiary where NCI is valued on proportionate basis. If the
answer is positive then leave it there but if answer is negative then make following adjustment:
Consolidation adjustment:
Negative goodwill is ADDED to:
(i) P’s RE in Group RE working
(ii) Investment in A
Memorandum entry:
Dr. Investment in A
Cr. Group RE
Consolidation adjustment:
Only effect is on the calculation of Pre and Post acquisition reserves as follows:
Pre acq. reserves = A’s reserves at balance sheet date – income for the year x n/12
(n = no. of months from acquisition to year end)
Post acq. reserves= A’s reserves at balance sheet date – pre acquisition reserves
OR
Income for the year x n/12
In questions, impairment loss for the year on investment in associate may be:
- Given OR
- Determined by deducting “recoverable amount of current year” from “recoverable amount of previous year”
of investment.
Consolidation adjustment:
Impairment loss for the year is DEDUCTED from share of profit from associate in “Share of profit from associate
working” (W – 1)
2. INTER COMPANY SALES / INTER COMPANY MANAGEMENT SERVICES / INTET COMPANY INTEREST
No elimination:
Since there is no consolidation of incomes and expenses of A, therefore, there is no need to eliminate any
intercompany transaction.
Calculation of URP:
URP = Inventory x GP margin %
OR
Inventory x GP markup / (100 + GP markup)
OR
Total profit earned in the inter-company sale x % goods held in stock
Consolidation adjustment:
P to A sale A to P sale
P’s % share of URP is ADDED to “Cost of sales” P’s % share of URP is DEDUCTED in “Share of profit from
associate” working (W – 1)
Consolidation adjustment:
Extra depreciation for the year is DEDUCTED from A’s PAT in “Share of profit from associate working”
In case of negative adjustment to A’s net assets, above adjustments will be reversed
Following adjustment is required only in case of sale of non-current asset during the current year:
Calculation of URP:
URP = NBV of asset x margin %
OR
NBV of asset x markup / (100 + GP markup)
OR
Consolidation adjustment:
P to A sale A to P sale
P’s % share of URP is DEDUCTED from “Other P’s % share of URP is DEDUCTED in “Share of profit from
income” associate” working
[If P accounted for this sale as a “sale of goods”,
then adjustment number 3 will be followed]
6. NEGATIVE GOODWILL
Adjustment for negative goodwill is only made in 1st year of purchase of investment in A.
Consolidation adjustment:
Negative goodwill is ADDED to “share of profits from associate working”
P’s share in A’s dividend recorded by P is DEDUCTED from P’s other income as share in total profit of associate is
separately included as a separate line item.
Consolidation adjustment:
A’s PAT in “share of profit from associate working” is time apportioned as per number of months after
acquisition.
PPE XXX
[Same as studied earlier – P’s % share x URP on PPE (A to P)]
Goodwill XXX
(Same as studied earlier)
Investment XXX
(Same as studied earlier)
CURRENT ASSETS:
Inventory XXX
(Same as studied earlier – P’s% share x URP (A to P))
Receivables XXX
(Same as studied earlier)
Rs.
CAPITAL AND RESERVES:
NON-CURRENT LIABILITIES:
Payables XXX
(Same as studied earlier)
XXX
WORKINGS
(W – 1) Investment in associates
Rs.
(W – 2) Retained earnings
Rs. Rs.
Parent’s RE XXX
------ same adjustments as studied earlier ----- |
|
XXX
Add: S’s RE XXX
------ same adjustments as studied earlier ----- |
|
XXX
Group share @ (% share in ordinary shares) XXX
PRACTICE QUESTIONS
Question No. 1
Following are the balance sheets as at June 30, 2019:
P S
---------- Rs.--------
Non-current assets
Property, plant & equipment 70,000 35,000
Investment in Alpha 11,000 -
Current assets
Inventories 12,000 19,000
Debtors 15,000 13,000
Cash & bank 1,500 1,000
109,500 68,000
Equity
Share capital (Rs. 10 per share) 50,000 20,000
Retained earnings – at July 1, 2018 20,000 18,000
– for the year ended June 30, 2019 18,000 8,000
Non-current liabilities
8% Loan notes 5,000 -
Current liabilities
Creditors 16,500 22,000
109,500 68,000
Following further information is available:
(i) On April 1, 2019 P acquired 75% shares of S by means of a share exchange of two shares in P for every three
shares of S acquired. On that date, further consideration was also issued to the shareholders of S in the form of
four Rs. 100 8% loan notes for every 100 shares acquired in S. None of the purchase consideration, nor the
outstanding interest on these loan notes at June 30, 2019, has yet been recorded by P. At the date of acquisition,
the share price of P and S is Rs. 30 and Rs. 22 respectively.
(ii) At the date of acquisition, the fair values of S’s assets were equal to their carrying amounts. However, S operates
a mine which requires to be decommissioned in five years’ time. No provision has been made for these
decommissioning costs by S. The present value (discounted at 8%) of the decommissioning is estimated at Rs.
4,000 and will be paid five years from the date of acquisition (i.e. the end of the mine’s life).
(iii) It is group’s policy to value non-controlling interest at fair value.
(iv) The inventory of S includes goods bought from P for Rs. 2,100. P applies a consistent mark-up on cost of 40%
when arriving at its selling prices. On June 28, 2019, P dispatched goods to S with a selling price of Rs. 700. These
were not received by S until after the year end and so have not been included in the above inventory at June
30, 2019.
At June 30, 2019, P’s records showed a receivable due from S of Rs. 5,000, this differed to the equivalent payable
in S’s records due to the goods in transit.
(v) The investment in Alpha represents 30% of its voting share capital acquired on July 1, 2018 and P uses equity
accounting to account for this investment. Alpha’s profit for the year ended June 30, 2019 was Rs. 6,000 and
Alpha paid total dividends during the year ended June 30, 2019 of Rs. 2,000. P has recorded its share of the
dividend received from Alpha in investment income (and cash).
(vi) All profits and losses accrued evenly throughout the year.
(vii) At June 30, 2019, investment in Alpha is impaired by Rs. 200.
Required:
Prepare consolidated balance sheet as at June 30, 2019.
Question No. 2
Following are the balance sheets as at June 30, 2019:
P S A
---------------------- Rs.--------------------
Non-current assets
Property, plant & equipment 80,000 50,000 40,000
Intangible assets 8,000 - -
Investments:
- in S 43,200 - -
- in A 10,000 - -
- other 5,000 - 2,000
Current assets
Inventories 12,000 8,000 10,000
Debtors 9,000 11,000 5,000
Cash & bank 4,000 6,000 4,000
171,200 75,000 61,000
Equity
Share capital (Rs. 10 per share) 70,000 20,000 10,000
Retained earnings – at July 1, 2018 36,000 19,000 21,000
– for the year ended June 30, 2019 18,000 12,000 9,000
Non-current liabilities
Loan notes 25,000 15,000 5,000
Current liabilities
Creditors 22,200 9,000 16,000
171,200 75,000 61,000
Following further information is available:
(i) On July 1, 2018 P acquired 1,600 shares of S in consideration of a cash payment of Rs. 27 per share. At the date
of acquisition, the share price of S was Rs. 25 per share.
(ii) At the date of acquisition, the fair values of S’s property, plant and equipment were equal to their carrying
amounts except for a plant which had a fair value of Rs. 4,000 above its carrying amount. At that date, the plant
had a remaining life of four years. S uses straight-line depreciation for plant assuming a nil residual value.
Also at the date of acquisition, P valued S’s customer relationships as a customer base intangible asset at fair
value of Rs. 3,000. S has not accounted for this asset. Trading relationships with S’s customers last on average
for six years.
(iii) It is group’s policy to value non-controlling interest at fair value.
(iv) Following information is relevant to inter-company transactions and balances:
P’s records: S A
Purchases from Rs. 40,000 Rs. 12,000
Year-end payable to Rs. 4,000 Rs. 3,000
Year-end stock held out inter-company purchase Rs. 7,000 Rs. 6,000
Profit margin earned by seller 20% 25%
(v) The investment in A represents 25% of its voting share capital purchased on January 1, 2019. P uses equity
accounting to account for this investment.
(vi) All profits and losses accrued evenly throughout the year.
(vii) At June 30, consolidated goodwill has been impaired by Rs. 1,200 and investment in A has been impaired by Rs.
200.
(viiI)P’s other investments are equity investments measured at fair value through profit and loss. At June 30, 2019
fair value of these investments has moved to Rs. 6,000 but no entry has been made in books by P.
Required:
Prepare consolidated balance sheet as at June 30, 2019.
Question No. 3
Following are the balance sheets as at June 30, 2019:
P S A
---------------------- Rs.--------------------
Non-current assets
Property, plant & equipment 40,000 25,000 22,000
Investments 40,000 - -
Current assets
Inventories 10,000 8,000 5,000
Debtors 7,000 2,000 3,000
Cash & bank 2,000 4,000 1,000
99,000 39,000 31,000
Equity
Share capital (Rs. 10 per share) 20,000 10,000 8,000
Share premium 10,000 - -
Retained earnings – at July 1, 2018 26,000 8,000 7,000
– for the year ended June 30, 2019 18,000 6,000 3,000
Non-current liabilities
Loan notes 15,000 - 5,000
Current liabilities
Creditors 10,000 15,000 8,000
99,000 39,000 31,000
Following further information is available:
(i) On July 1, 2018 P acquired 75% shares of S in a share exchange of two shares in P for every three shares acquired
in S. At the date of acquisition, the market prices of P’s and S’s shares were Rs. 30 and Rs. 18 respectively.
(ii) At the date of acquisition, the fair values of S’s property, plant and equipment were equal to their carrying
amounts except for a plant which had a fair value of Rs. 2,000 below its carrying amount. As a result, the
differential amount of depreciation would be Rs. 100 per year.
Also at the date of acquisition, S had a software costing Rs. 500 in its statement of financial position. P’s directors
believed the software to have no recoverable value at the date of acquisition and S wrote it off shortly after its
acquisition.
(iii) It is group’s policy to value non-controlling interest at fair value.
(iv) On January 1, 2019 P acquired 40% of the equity shares of A paying a cash of Rs. 17 per share and issuing at par
one Rs. 100 loan note for every 20 shares acquired in A. The consideration has been correctly accounted for by
P.
(v) Following information is relevant to inter-company transactions and balances:
P’s records: S A
Sales to Rs. 20,000 Rs. 10,000
Year-end receivable from Rs. 2,000 Rs. 1,000
Year-end stock out of inter-company sale held with Rs. 3,000 Rs. 2,000
Profit margin earned by P 30% 25%
(vi) All profits and losses accrued evenly throughout the year.
(vii) At June 30, consolidated goodwill has been impaired by 20%.
Required:
Prepare consolidated balance sheet as at June 30, 2019.
Question No. 4
Following are the summarized statements of financial position of Pistachio Limited (PL), Mint Limited (ML) and Jalapeno
Limited (JL) as on 31 December 2019:
PL ML JL
------------------ Rs. million ---------------
Property, plant & equipment 850 750 500
Investment in ML at cost 900 - -
Investment in JL at cost 170 - -
Inventories 300 340 200
Debtors 240 200 150
Cash & bank 60 170 50
2,520 1,460 900
Question No. 5
Following are the statements of comprehensive income for the year ending June 30, 2019:
P S
---------- Rs.--------
Sales 180,000 150,000
Cost of sales (120,000) (80,000)
Gross profit 60,000 70,000
Distribution cost (18,000) (20,000)
Admin expenses (12,000) (16,000)
Finance cost (2,000) (3,000)
Other income 5,000 2,000
Profit before tax 33,000 33,000
Tax (15,000) (18,000)
Profit after tax 18,000 15,000
Other comprehensive income:
Revaluation (loss)/gain on land (2,200) 3,000
Total comprehensive income 15,800 18,000
Question No. 6
Following are the statements of comprehensive income for the year ending September 30, 2019:
P S
---------- Rs.--------
Sales 90,000 80,000
Cost of sales (50,000) (60,000)
Gross profit 40,000 20,000
Distribution cost (9,000) (4,000)
Admin expenses (11,000) (6,000)
Finance cost (500) (800)
Other income 1,200 1,600
Profit before tax 20,700 10,800
Tax (7,000) (4,000)
Profit after tax 13,700 6,800
Question No. 7
The following balances are extracted from the records of Golden Limited (GL), Silver Limited (SL) and Bronze Limited (BL)
for the year ended 30 June 2019:
GL SL BL
----------------- Rs. in million ------------
Sales 2,500 2,050 1,000
Cost of sales 1,550 1,150 590
Operating expenses 810 520 288
Other income 350 180 50
Finance cost 90 60 35
Surplus arising on revaluation of property, plant and 60 - 20
equipment during the year
Investment in SL – at cost 1,400 - -
Investment in BL – at cost 2,500 - -
Retained earnings as at June 30, 2019 8,000 3,500 2,200
Additional information:
(i) Details of GL’s investments are as follows:
On the date of investment, the market price of shares of GL and SL were Rs. 20 and Rs. 17 respectively. Applicable
discount rate is 12%.
(iv) At the date of acquisition of SL, carrying values of its net assets were equal to fair value except the following:
• an internally developed software by SL which had a fair value of Rs. 150 million. The cost of Rs. 120 million
incurred by SL on development had been expensed out by SL since the software did not meet the criteria for
capitalization during development. At acquisition date, the software had a remaining useful life of 5 years.
• a contingent liability of Rs. 90 million as disclosed in financial statements of SL which had an estimated fair
value of Rs. 60 million. Subsequent to acquisition, the liability has been recognised by SL in its books at Rs.
40 million.
(v) Following inter-company sales at cost plus 15% were made during the year ended 30 June 2019:
Sales Included in buyer’s
closing stock
-------------- Rs. in million -------------
SL to GL 506 138
GL to BL 161 69
(vi) On 1 January 2019, GL granted loans of Rs. 150 million and Rs. 130 million to SL and BL respectively, at interest
rate of 12% per annum.
(vii) GL and BL follow revaluation model whereas SL follows cost model for subsequent measurement of property,
plant and equipment. If SL had adopted the revaluation model, SL would have recorded revaluation surplus of
Rs. 35 million for the year ended 30 June 2019.
(viii) GL measures non-controlling interest at the acquisition date at its fair value.
Required:
(a) Prepare GL’s consolidated ‘statement of profit or loss and other comprehensive income’ for the year ended 30
June 2019. (17)
(b) Compute the amount of investment in associate as would appear in GL’s consolidated statement of financial
position as at 30 June 2019. (03)
{Autumn 2019, Q#6}
Question No. 8
The following amounts are extracted from the records of Manzil Limited (ML), Himmat Limited (HL) and Koshish Limited
(KL) for the year ended 31 December 2019:
ML HL KL
-------------- Rs. in million -------------
Sales 800 315 132
Cost of sales (540) (180) (97)
Operating expenses (114) (60) (6)
Other income 41 - 8
Finance cost (20) (12) (5)
Retained earnings as at December 31, 2019 3,600 322 200
Additional information:
(i) Details of ML’s investments are as follows:
Required:
Prepare ML’s consolidated statement of profit or loss and other comprehensive income for the year ended 31 December
2019. (19)
[Q-5, Aut-20]
Current assets
Inventories [12 + 19 + 0.7 - 0.8 (W-3)] 30,900
Debtors [15 + 13 - 5] 23,000
Cash and bank [1.5 + 1] 2,500
180,200
Equity
Share capital [50 + 1.5 x 2/3 x Rs. 10] 60,000
Share premium [1.5 x 2/3 x Rs. 20] 20,000
Retained earnings [W-3] 39,370
Non-controlling interest [W-4] 11,430
Current liabilities
Accrued interest (W-3) 120
Creditors [16.5 + 22 + 0.7 - 5] 34,200
180,200
-
Workings
W-1 Goodwill Rs. Rs.
Investment:
Shares [1,500 x 2/3 x Rs. 30] 30,000
Loan notes [1,500 x 4/100 x Rs. 100] 6,000
Fair value of NCI [500 x Rs. 22] 11,000
Less: net assets acquired:
Share capital 20,000
RE [18 + 8 x 9/12] 24,000
FV adj. - Mine 4,000
FV adj. - dismantling prov. (4,000) (44,000)
3,000
W-4 NCI
FV of NCI 11,000
RE [1.72 x 25%] 430
11,430
Solution No. 2
P Group
Consolidated statement of financial position
as at June 30, 2019
Rs.
Non current assets
PPE [80 + 50 + 4 - 1] 133,000
Intangibles [8 + 3 - 0.5] 10,500
Goodwill [W-1] 6,000
Investment in A [W-2] 10,925
Other equity investment 6,000
Current assets
Inventories [12 + 8 – 1.4 – 0.375] 18,225
Debtors [9 + 11 - 4] 16,000
Cash and bank [4 + 6] 10,000
210,650
Equity
Share capital 70,000
Retained earnings [W-3] 61,870
Non-controlling interest [W-4] 11,580
W-2 Investment in A
Investment at cost 10,000
Share in profits (W-5) 925
10,925
W-4 NCI
FV of NCI 10,000
RE [7.9 x 20%] 1,580
11,580
W-5 Share in A
Year end RE 30,000
Pre-acquisition RE [21 + 9 x 6/12] (25,500)
4,500
Share of P 25% 1,125
Less: Impairment loss (200)
925
Solution No. 3
P Group
Consolidated statement of financial position
as at June 30, 2019
Rs.
Non current assets
PPE [40 + 25 - 2 + 0.1] 63,100
Goodwill [W-1] 3,200
Investment in A [W-2] 7,440
Other investment [40 - 15 - 7.04] 17,960
Current assets
Inventories [10 + 8 - 0.9] 17,100
Debtors [7 + 2 - 2] 7,000
Cash and bank [2 + 4] 6,000
121,800
Equity
Share capital 20,000
Premium 10,000
Retained earnings [W-3] 47,850
Non-controlling interest [W-4] 5,950
Current liabilities
Creditors [10 + 15 - 2] 23,000
121,800
-
Workings
W-1 Goodwill Rs.
Investment [750 x 2/3 x Rs. 30] 15,000
Fair value of NCI [250 x Rs. 18] 4,500
Less: net assets acquired:
Share capital 10,000
RE 8,000
FV adj. - Plant (2,000)
Software writen off (500) (15,500)
4,000
Less: Impairment loss (800)
3,200
W-2 Investment in A
Investment at cost:
Cash [320 x Rs. 17] 5,440
Loan notes [320 x 1/20 x Rs. 100] 1,600
7,040
URP on P to A sale [2 x 25% x 40%] (200)
Share in profits (W-3) 600
7,440
W-4 NCI
FV of NCI 4,500
RE [5.8 x 25%] 1,450
5,950
Solution No. 4
PL Group
Consolidated balance sheet
as at December 31, 2019
Rs. million
Non current assets
PPE [850 + 750 - 88 - 9(W-2)] 1,503.00
Goodwill (W-1) 108.00
Investment in associates (W-4) 203.80
Current assets
Inventories [300 + 340 + 50 x 20%] 650.00
Trade receivables [240 + 200] 440.00
Cash & bank [60 + 170] 230.00
3,134.80
Equity
Share capital 1,400.00
Retained earnings [W-2] 836.00
Non controlling interest [W-3] 263.80
Current liabilities:
Contingent consideration 115.00
Other liabilities [340 + 180] 520.00
3,134.80
-
NASIR ABBAS FCA
BASIC CONSOLIDATION [SOFP & SOCI WITH ONE SUBSIDIARY AND ONE ASSOCIATE] - Solutions (6)
W-3 NCI
FV of NCI 252.00
Post-acq RE [59 x 20%] 11.80
263.80
W-4 Investment in JL
Investment as per books 170.00
Share in JL's RE (W-2) 35.00
URP on goods (W-2) (1.20)
203.80
Solution No. 5
(a)
Goodwill Rs. Rs.
Investment:
Shares [1,800 x 1/3 x Rs. 42] 25,200
Cash [1,800 x Rs. 10] 18,000
Fair value of NCI [1,200 x Rs. 22] 26,400
Less: net assets acquired:
Share capital 30,000
RE [21 + 15 x 6/12] 28,500
FV adj. – land 2,000
FV adj. – plant 3,000
Customer relationship 2,000 (65,500)
4,100
(b)
P Group
Consolidated statement of comprehensive income
for the year ended June 30, 2019
Rs.
W-3 NCI
S PAT [15 x 6/12] 7,500
Less: Extra depreciation (750)
Less: Amort. of customer relationship (200)
6,550
40.00% 2,620
Solution No. 6
(a) Goodwill Rs. Rs.
Investment:
Shares [1,800 x 2/3 x Rs. 30] 36,000
Cash [1,800 x Rs. 8] 14,400
Fair value of NCI [200 x Rs. 26] 5,200
Less: net assets acquired:
Share capital 20,000
RE [22 + 6.8 x 3/12] 23,700
FV adj. - plant 3,000
Contingent liability (500) (46,200)
9,400
(b) P Group
Consolidated statement of comprehensive income
for the year ended September 30, 2019
Sales [90 + 80 x 9/12 - 18 x 9/12] 136,500
Cost of sales (W-1) (83,600)
Gross profit 52,900
Distribution cost [9 + 4 x 9/12] (12,000)
Admin expenses [11 + 6 x 9/12 + 2] (17,500)
Finance cost [0.5 + 0.8 x 9/12] (1,100)
Other income [1.6 x 9/12] 1,200
Share of profit from associate (W-2) 3,520
Profit before tax 27,020
Tax [7 + 4 x 9/12] (10,000)
Profit after tax 17,020
Profit/TCI attributable to:
Shareholders of P 16,920
NCI [W-3] 100
17,020
W-1 Cost of sales
P's cost of sales 50,000
S's cost of sales [60 x 9/12] 45,000
Inter company purchase [18 x 9/12] (13,500)
NASIR ABBAS FCA
BASIC CONSOLIDATION [SOFP & SOCI WITH ONE SUBSIDIARY AND ONE ASSOCIATE] - Solutions (9)
Solution No. 7
(a)
- Inter-company interest income and interest expense have been accrued by all companies in their books.
- Surplus arising on revaluation relates to current year only and thus shown in OCI for the year.
GL Group
Consolidated Statement of comprehensive income
for the year ended June 30, 2019 Rs. million
Sales [2,500 + 2,050 - 506] 4,044.00
Cost of Sales [1,550 + 1,150 - 506 + 18(W-1) + 3.15(part b)] (2,215.15)
Gross Profit 1,828.85
Operating expenses [810 + 520 + 20 + 30(W-1) - 40] (1,340.00)
Other income [350 + 180 + 438.22 (W-2) - 9(W-3)] 959.22
Finance cost [90 + 60 + 711.78(W-2) x 12% - 9(W-3)] (226.41)
Share of profit from Associate (W-4) 47.95
Profit for the year 1,269.61
Other Comprehensive income:
Revaluation gain [60 + 35] 95.00
Share of OCI from Associate [20 x 35%] 7.00
Total Comprehensive income 1,371.61
Profit Attributable to :
Group 1,122.01
NCI (W-1) 147.60
1,269.61
Total Comprehensive income attributable to :
Group 1,213.51
NCI [147.60 + 35 x 30%] 158.10
1,371.61
(W-3)
Inter company interest = 150 x 12% x 6/12 = 9.00
(W-4)
Profit for the year of BL
Sales 1,000.00
Cost of Sales (590.00)
Operating expenses (288.00)
Other income 50.00
Finance Cost (35.00)
137.00
35% 47.95
(b)
Investment in Associate as on 30th June 2019:
Rs. million
Cost 2,500.00
Post acquisition RE [(2,200 - 1,800) x 35%] 140.00
URP on goods [69 x 15/115 x 35%] (3.15)
Share in revaluation surplus [20 x 35%] 7.00
2,643.85
Solution No. 8
HL's dividend relate to 1st half of 2019 which consist of both pre and post acquisition periods. But we
can not distinguish between both, therefore, it is not deducted from investment in GW working.
ML Group
Consolidated Statement of comprehensive income
for the year ended December 31, 2019 Rs. million
Sales [800 + 315 x 8/12] 1,010.00
Cost of Sales [540 + 180 x 8/12 + 5(W-1)] (665.00)
Gross Profit 345.00
Operating expenses [114 + 60 x 8/12 + 12.4(W-2)] (166.40)
Other income (W-3) 94.00
Finance cost [20 + 12 x 8/12] (28.00)
Share of profit from Associate (W-4) 6.20
Profit for the year 250.80
Other Comprehensive income:
Fair value loss on equity investment (W-5) (9.00)
Share of OCI from Associate (W-5) (1.50)
Total Comprehensive income 240.30
Profit Attributable to :
Shareholders of ML 236.00
NCI (W-1) 14.80
250.80
Total Comprehensive income attributable to :
Shareholders of ML 229.10
NCI [14.80 - 9 x 40%] 11.20
240.30
* Dividend = 600 x 5% = 30
(W-3)
ML's other income 41.00
Building transferred as consideration [226 - 150] 76.00
Dividend from HL [30 x 60%] (18.00)
Dividend from KL [400 x 5% x 25%] (5.00)
94.00
(W-4)
Profit for the year of KL
Sales 132.00
Cost of Sales (97.00)
Operating expenses (6.00)
Other income 8.00
Finance Cost (5.00)
URP on machine [8 - 8/5 x 6/12] (7.20)
24.80
25% 6.20
(W-5)
Fair value loss of HL [(150 x 1.02 - 138) x 0.6] 9.00
Share in Fair value loss of KL [(150 x 1.02 - 138) x 0.4 x 25%] 1.50
Joint arrangement
An arrangement of which two or more parties have joint control. A joint arrangement has following
characteristics:
(a) The parties are bound by a contractual arrangement
(b) The contractual arrangement gives two or more of those parties joint control of the arrangement.
A joint arrangement is either a:
(i) Joint Operation
(ii) Joint Venture
It is a joint arrangement whereby the parties that It is a joint arrangement whereby the parties that
have joint control of the arrangement have rights have joint control of the arrangement have rights
to the assets, and obligations for the liabilities, to the net assets of the arrangement.
relating to the arrangement.
A party to a joint operation that has joint control A party to a joint venture that has a joint control
of that operation is called a Joint Operator of that venture is called a Joint Venturer
A joint arrangement that is not structured through A joint arrangement in which the assets and
a separate vehicle is a joint operation. liabilities relating to the arrangement are held in a
separate vehicle can either be a joint operation or
a joint venture.
Joint control
The contractually agreed sharing of control of an arrangement, which exists only when decisions about
the relevant activities require the unanimous consent of the parties sharing control.
In a joint arrangement, no single party controls the arrangement on its own. A party with joint control
of an arrangement can prevent any of the other parties from controlling the arrangement. An
arrangement can be a joint arrangement even though not all of its parties have joint control of the
arrangement.
Separate vehicle
A separately identifiable financial structure, including separate legal entities or entities recognized by
statute, regardless of whether those entities have a legal personality.
Joint Operations
Contract terms
Y carries out all maintenance work on the pipeline but maintenance expenses are shared between X and
Y in the ratio 40%: 60%.
Both entities use the pipeline for their own operations and share any income from third parties 50%: 50%.
Sales to third parties are invoiced by Y.
The full interest on the loan is initially paid by X but the expense is to be shared equally.
When an entity acquires an interest in joint operation, it shall apply, to the extent of its share (as studied
above) all the principles on business combinations accounting in IFRS 3. It is summarized as follows:
- Fair values of identifiable assets and liabilities (other than exceptions as per IFRS 3) will be used for
accounting for its share.
- Recognize DTA/DTL that arise from initial recognition of assets or liabilities.
- Goodwill will be calculated and accounted for by comparing consideration transferred and net assets
acquired.
- Recognize acquisition related costs as expense.
- All intercompany eliminations are made proportionately.
This guidance is applicable to acquisition of both the initial interest and additional interests in joint
operations. However, in case of additional interest, the previously held interests are not remeasured.
Joint Ventures
A joint venturer shall recognize its interest in a joint venture as an investment and shall account for that
investment using the equity method in accordance with IAS 28 Investments in Associates and Joint
Ventures unless the entity is exempted from applying the equity method as specified in that standard.
A party that participates in, but does not have joint control of, a joint venture shall account for its interest
in the arrangement in accordance with IFRS 9 Financial Instruments, unless it has significant influence over
the joint venture, in which case it shall account for it in accordance with IAS 28
Current assets
Stock in trade [20 + 17 - 0.4] 36.60
Trade and other receivables [25 + 5] 30.00
Cash and bank [3 + 1] 4.00
281.20
Equity
Share capital 50.00
Retained earnings [W-2] 94.20
Non-controlling interest [W-4] 7.00
Current liabilities
Current liabilities [25 + 18] 43.00
281.20
PL Group -
Consolidated Income Statement
for the year ended December 31, 2009
Rs. million
Sales [1,267 + 276 - 10] 1,533.00
Cost of sales (W-5) (1,081.80)
Gross profit 451.20
Selling expenses [174 + 68] (242.00)
Administrative expenses [88 + 30 + 1] (119.00)
Other income 10.00
Financial charges [12 + 4] (16.00)
Share of profit from JV [(18 -2) x 50%] 8.00
Profit before tax 92.20
Tax [26 + 5] (31.00)
Profit for the year 61.20
RL Group
Consolidated statement of financial position
as at December 31, 2018
Rs. million
Non current assets
PPE [7,450 + 3,000 - 300 + 70 + 180 - 24] 10,376.00
Goodwill [W-1] 375.49
Investment in YL (W-5) 1,128.00
Current assets
Current assets [650 + 500 - 15 - 37.50] 1,097.50
12,976.99
Equity
Share capital 4,000.00
Share premium 1,100.00
Retained earnings [W-2] 2,989.33
Non-controlling interest [W-3] 469.62
Non-current liabilities
Bank loan [1,700 + 800 + 182.87(W-1.1)] 2,682.87
Deferred tax [244.75 + 145.42](W-4) 390.17
Current liabilities
Current liabilities [950 + 355 + 40] 1,345.00
12,976.99
-
Workings
W-1 Goodwill ----- Rs. million -----
Consideration transferred:
- Cash 1,300.00
- Land 450.00
- Bank loan (W-1.1) 179.89
Value of NCI [1,943 x 20%] 388.60
Less: net assets at acquisition:
Share capital 800.00
Share premium 225.00
RE 750.00
FV adj. - Land 70.00
FV adj. - Building 180.00
Contingent liability (40.00)
DTL [(180 - 40) x 30%] (42.00) (1,943.00)
Goodwill at acquisition 375.49
W-1.1 Bank loan Rs. million
Value at 01-01-18:
Interest [Rs. 24m x 5-year annuity factor at 15%] 80.45
Redemption [Rs. 200m x 5-year discount factor at 15%] 99.44
Initial recognition 179.89
Interest expense [179.89 x 15%] 26.98
Cashflow (24.00)
Closing balance 182.87
2,989.33
SITUATIONS
1. Equity investment to S
2. A/JV to S
3. Further investment in S
Subsequent purchase of shares under each of the above situation is discussed in detail as follows:
(i) Full consolidation of assets and liabilities will be made at year end.
(ii) Goodwill working:
Fair value of 1st investment at acquisition date X
Additional investment X
Value of NCI X
Less: Net assets of S at acquisition date (X)
Goodwill at acquisition X
Less: Impairment loss (X)
Goodwill carrying amount X
(iii) “Other reserves” working will be made as studied earlier.
(iv) “Retained earnings” working will be made as studied earlier except that a gain/(loss) on derecognition of
earlier investment is recognized in P’s column calculated as follows:
SOCI is better understood if we assume 2nd investment made during the current year (i.e. control achieved
during the current year).
(i) Time proportionate consolidation of incomes and expenses will be made for the year.
(ii) Profit on de-recognition of earlier investment is recognized in “Other income” (if classified as FV through
P&L) or “Other comprehensive income (if classified as FV through OCI).
(iii) NCI working is made on time proportionate basis as studied earlier in basic consolidation.
2) A/JV to Subsidiary
1st investment was accounted for as per equity method. Control is obtained on 2nd investment, therefore,
acquisition date is the date of 2nd investment. Treatment after 2nd investment is discussed separately for SOFP
and SOCI.
STATEMENT OF FINANCIAL POSITION
(i) Full consolidation of assets and liabilities will be made at year end.
(i) Full consolidation of assets and liabilities will be made at year end.
(ii) Goodwill is calculated at the date of 1st investment and it is not recalculated on 2nd investment.
SOCI is better understood if we assume subsequent acquisition during the current year.
(i) Full consolidation of incomes and expenses will be made for the year.
(ii) NCI working is made on time proportionate basis in following two components:
S’s PAT [from year start to 2nd investment date x old NCI %] X
S’s PAT [from 2nd investment date to year end x new NCI %] X
X
Question
Following statements of financial positions relate to Peru and Solid as at June 30, 2020:
Peru Solid
--------------- Rs. ----------
PPE 87,000 89,000
Investments (at cost) 60,000 10,000
Current assets 20,000 25,000
167,000 124,000
Shar capital (Rs. 10 each) 70,000 40,000
Other reserves 9,000 7,000
Retained earnings 74,000 58,000
Current liabilities 14,000 19,000
167,000 124,000
Peru made investments in Solid twice; fist on July 1, 2015 and second on July 1, 2017. Following
information relates to Solid on these dates:
01-07-15 01-07-17
Market price of Solid’s shares Rs. 14 Rs. 16
Other reserves Rs. 1,500 Rs. 4,500
Retained earnings Rs. 3,200 Rs. 8,000
At June 30, 2020 impairment review shows that goodwill is impaired by 10%. It is Peru’s policy to follow
full goodwill method.
Required:
Prepare group SOFP as at June 30, 2020 under each of the following situations:
(a) Peru acquired 10% shares on July 1, 2015 at market price and 70% shares on July 1, 2017 at a price of
Rs. 17 per share.
(b) Peru acquired 25% shares on July 1, 2015 at market price and 55% shares on July 1, 2017 at a price of
Rs. 17 per share.
(c) Peru acquired 70% shares on July 1, 2015 at a price of Rs. 15 per share and 10% shares on July 1, 2017
at market price.
Question
Following statements of comprehensive income relate to Blue and Green for the year June 30, 2020:
Blue Green
--------------- Rs. ----------
Sales 140,000 120,000
Cost of sales (105,000) (90,000)
Gross profit 35,000 30,000
Operating expenses (14,000) (12,000)
Other income 4,000 6,000
Profit before tax 25,000 24,000
Tax (8,000) (9,000)
Profit after tax 17,000 15,000
Blue made investments in Green twice; fist on July 1, 2018 and second on October 1, 2019. Following
information relates to Green on these dates:
01-07-18 01-10-19
Market price of Green’s shares Rs. 25 Rs. 30
Fair value adjustment on building Rs. 4,800 Rs. 4,400
Remaining useful life of building 4 years 2.75 years
Share capital (Rs. 10 each) Rs. 40,000 Rs. 40,000
Green earned profit after tax of Rs. 12,000 in the year 2019. During the year 2020, Green sold goods for
Rs. 1,000 every month to Blue. Out of intercompany sale, unrealized profit included in Blue’s stock at June
30, 2020 amounts to Rs. 500.
Required:
Prepare group SOCI for the year ended June 30, 2020 under each of the following situations:
(a) Blue acquired 10% shares on July 1, 2018 at market price and 70% shares on October 1, 2019 at a
price of Rs. 32 per share.
(b) Blue acquired 30% shares on July 1, 2018 at market price and 50% shares on October 1, 2019 at a
price of Rs. 32 per share.
(c) Blue acquired 70% shares on July 1, 2018 at a price of Rs. 27 per share and 10% shares on October 1,
2019 at market price.
SITUATIONS
Disposal of S
Control is lost
1. Full disposal [i.e. S to 0]
2. Part disposal [S to Equity investment]
3. Part disposal [S to A/JV]
Control is retained
4. Decrease in ownership interest [S to S]
Disposal of A/JV
5. Full disposal [A/JV to zero]
6. Part disposal [A/JV to Equity investment
Following discussions are made in respect of the “subsidiary sold” / “A or JV sold” in consolidated financial
statements because there are other subsidiaries as well for which consolidated financial statements are
prepared.
(ii) “Other reserves” working will include share in post-acquisition other reserves till the date of disposal.
Consideration received X
Less: Share of net assets derecognized:
Carrying amount of net assets at the date of disposal X
Consolidation adjustments in assets & liabilities X
Carrying amount of goodwill X
X
Less: NCI derecognized:
Value at acquisition X
Other reserves [Post-acq. till disposal x NCI%] X
RE [Post-acq. till disposal x NCI%] X
(X)
(X)
Gain / (loss) on disposal X
(iv) No NCI working will be made as there is no consolidation.
(ii) “Other reserves” working will include share in post-acquisition other reserves till the date of disposal.
Consideration received X
Fair value of investment retained at disposal date X
Less: Share of net assets derecognized:
Carrying amount of net assets at the date of disposal X
Consolidation adjustments in assets & liabilities X
Carrying amount of goodwill X
X
Less: NCI derecognized:
Value at acquisition X
Other reserves [Post-acq. till disposal x NCI%] X
RE [Post-acq. till disposal x NCI%] X
(X)
(X)
Gain / (loss) on disposal X
(iv) Account for any fair value gain/loss on application of IFRS 9 at year end on investment retained (if not
already done by P).
Consideration received X
Fair value of investment retained at disposal date X
Less: Share of net assets derecognized:
Carrying amount of net assets at the date of disposal X
Consolidation adjustments in assets & liabilities X
Carrying amount of goodwill X
X
Less: NCI derecognized:
Value at acquisition X
Other reserves [(ii) (1) x NCI%] X
RE [(iii) (1) x NCI%] X
(X)
(X)
Gain / (loss) on disposal X
(iv) No NCI working will be made as there is no consolidation.
(v) Investment retained will be accounted for as per equity method as follows:
(i) Full consolidation of assets and liabilities will be made at year end.
(ii) “Other reserves” working will include share from Associate/JV in post-acquisition other reserves till the
date of disposal.
Consideration received X
Less: Carrying amount of investment derecognized:
Cost of investment X
Share in Other reserves [as per (ii) above] X
Share in RE [as per (b) above] X
(X)
Gain / (loss) on disposal X
(ii) “Other reserves” working will include share from Associate/JV in post-acquisition other reserves till the
date of disposal.
Consideration received X
Fair value of investment retained at disposal date X
Less: Carrying amount of investment derecognized:
Cost of investment X
Share in Other reserves [as per (ii) above] X
Share in RE [as per (b) above] X
(X)
Gain / (loss) on disposal X
(iv) Account for any fair value gain/loss on application of IFRS 9 at year end on investment retained (if not
already done by P).
(i) Time proportionate (i.e. year start till disposal) consolidation of incomes and expenses will be made for
the year.
(ii) Profit on sale of shares already recognized in SOCI of P shall be reversed.
(iii) “Gain/(loss) on disposal of S” shall be recognized in Group SOCI.
(iv) NCI working is made on time proportionate basis (i.e. year start till disposal)
(i) Time proportionate (i.e. year start till disposal) consolidation of incomes and expenses will be made for
the year.
(ii) Profit on sale of shares already recognized in SOCI of P shall be reversed.
(iii) “Gain/(loss) on disposal of S” shall be recognized in Group SOCI.
(iv) Recognize fair value gain/(loss) as per IFRS 9 in SOCI on equity investment retained.
(v) NCI working is made on time proportionate basis (i.e. year start till disposal).
(i) Time proportionate (i.e. year start till disposal) consolidation of incomes and expenses will be made for
the year.
(ii) Profit on sale of shares already recognized in SOCI of P shall be reversed.
(iii) “Gain/(loss) on disposal of S” shall be recognized in Group SOCI.
(iv) “Share of profit/OCI from associate/JV” shall be calculated on S’s PAT/OCI between disposal date and year
end.
(v) NCI working is made on time proportionate basis (i.e. year start till disposal).
(i) Full consolidation of incomes and expenses will be made for the year.
(ii) Profit on sale of shares already recognized in SOCI of P shall be reversed.
(iii) NCI working is made on time proportionate basis in following two components:
(i) “Share of profit/OCI from associate/JV” shall be calculated on A/JV’s PAT/OCI between year start and
disposal date.
(ii) Profit on sale of shares already recognized in SOCI of P shall be reversed.
(iii) “Gain/(loss) on disposal of Associate/JV” shall be recognized in Group SOCI.
(i) “Share of profit/OCI from associate/JV” shall be calculated on A/JV’s PAT/OCI between year start and
disposal date.
(ii) Profit on sale of shares already recognized in SOCI of P shall be reversed.
(iii) “Gain/(loss) on disposal of Associate/JV” shall be recognized in Group SOCI.
(iv) Account for any fair value gain/loss on application of IFRS 9 at year end on investment retained (if not
already done by P).
(i) No line by line consolidation of incomes and expenses of disposed subsidiary will be made for the year.
(ii) Profit on sale of shares already recognized in SOCI of P shall be reversed.
(iii) A separate line item “Profit from discontinued operations” will be shown which is calculated as follows:
Profit from discontinued operations:
S PAT (time proportionate basis) X
Gain/(loss) on disposal of subsidiary X
X
(iv) NCI working is made on time proportionate basis (i.e. year start till disposal)
(v) Profit/TCI attributable to shareholders of P and NCI is split into:
- Profit/TCI from continuing operations
- Profit/TCI from discontinued operations
(i) No line-by-line consolidation of incomes and expenses of disposed subsidiary will be made for the year.
(ii) Profit on sale of shares already recognized in SOCI of P shall be reversed.
(iii) A separate line item “Profit from discontinued operations” will be shown.
(iv) Recognize fair value gain/(loss) as per IFRS 9 in SOCI on equity investment retained (if not already done).
(v) NCI working is made on time proportionate basis (i.e. year start till disposal).
(vi) Profit/TCI attributable to shareholders of P and NCI is split into:
- Profit/TCI from continuing operations
- Profit/TCI from discontinued operations
(i) No line by line consolidation of incomes and expenses of disposed subsidiary will be made for the year.
(ii) Profit on sale of shares already recognized in SOCI of P shall be reversed.
(iii)A separate line item “Profit from discontinued operations” will be shown.
(iv) “Share of profit/OCI from associate” shall be calculated on S’s PAT/OCI between disposal date and year
end.
(v) NCI working is made on time proportionate basis (i.e. year start till disposal).
(vi) Profit/TCI attributable to shareholders P and NCI is split into:
- Profit/TCI from continuing operations
- Profit/TCI from discontinued operations
No difference in 4, 5 and 6.
Charlie earned Profit after tax of Rs. 12,000 for the year ending June 30, 2019.
Alpha acquired 60% shares in Bravo on July 1, 2017. There were no fair value adjustments necessary at
acquisition.
Alpha acquired 80% shares in Charlie on July 1, 2018 for Rs. 80,000 when its retained earnings were Rs.
48,000 and share capital was Rs. 40,000 (Rs. 10 each).
Fair values relating to office building of Charlie were higher than book values as follows:
01-07-18 by Rs. 4,800
(remaining life 4 years)
01-01-20 by Rs. 4,000
(remaining life 2.5 years)
Required:
Prepare group SOCI for the year ending June 30, 2020 under each of the following situations:
(a) Alpha sold its entire shareholding in Charlie for Rs. 35 per share on January 1, 2020.
(b) Alpha sold 70% shares of Charlie for Rs. 35 per share on January 1, 2020. Market price of remaining
shares of Charlie on that date was Rs. 34. Moreover this market price moved to Rs. 36 per share on
June 30, 2020.
(c) Alpha sold 50% shares of Charlie for Rs. 35 per share on January 1, 2020. Market price of remaining
shares of Charlie on that date was Rs. 34.
(d) Alpha sold 10% shares of Charlie for Rs. 34 per share on January 1, 2020 (i.e. market price at that
date).
Question
Following statements of financial positions relate to Solid, Liquid and Gas as at June 30, 2020:
Gas earned Profit after tax of Rs. 12,000 and no other comprehensive income for the year ending June 30,
2020.
Solid acquired 80% shares in Liquid on July 1, 2017 for Rs. 48,000 [Fair value of NCI at that date was Rs.
11,200] and 70% shares in Gas on July 1, 2018 for Rs. 33,600 [Fair value of NCI at that date was Rs. 13,500].
Fair values relating to office buildings were higher than book values as follows:
Liquid Gas
01-07-17 by Rs. 3,000 -
(remaining life 8 years)
01-07-18 - by Rs. 2,000
(remaining life 8 years)
01-01-20 - by Rs. 1,300
(remaining life 6.5 years)
Goodwill of each company was impaired by 10% on June 30, 2019. It is Solid’s policy to follow full goodwill
method.
Required:
Prepare group SOFP as at June 30, 2020 under each of the following situations:
(a) Solid sold its entire shareholding in Gas for Rs. 28 per share on January 1, 2020.
(b) Solid sold 60% shares of Gas for Rs. 28 per share on January 1, 2020. Market price of remaining shares
of Gas on that date was Rs. 27. Moreover this market price moved to Rs. 29 per share on June 30,
2020.
(c) Solid sold 40% shares of Gas for Rs. 27 per share on January 1, 2020 (i.e. market price at that date).
(d) Solid sold 10% shares of Gas for Rs. 27 per share on January 1, 2020 (i.e. market price at that date).
Attributable to shareholders of P
Non-
Share Other Retained controlling Total
Share capital Total
premium reserves earnings interest
------------------------------------------- Rs. ------------------------------------------------
Balance as on 01-07-19 X X X X X X X
Dividend - - (X) (X) (X) (X)
Issue of shares X X - - X X X
Purchase of subsidiary * - - X - - X X
Sale of subsidiary ** - - X - - (X) (X)
Total comprehensive income for the year - - X X X X X
Transfers - - (X) X - - -
Balance as on 30-06-20 X X X X X X X
Current assets
Stock in trade [24,100 + 1,700 - 2.56] 25,797.44
Trade and other receivables [16,400 + 2,900 - 12] 19,288.00
Cash and bank [800 + 700] 1,500.00
126,609.61
Equity
Share capital 44,300.00
Retained earnings [W-2] 16,821.87
Non-controlling interest [W-5] 399.74
Non-current liabilities
Long term loan 36,400.00
Current liabilities
Trade and other payables [24,600 + 4,100 - 12] 28,688.00
126,609.61
-
Workings
CL TL
W-1 Goodwill ----- Rs. million -----
Consideration transferred 3,900.00 1,200.00
Value of NCI [3,143 x 10%] [1,100 x 20%] 314.30 220.00
Less: net assets at acquisition:
Share capital 2,800.00 1,000.00
RE 350.00 100.00
Contingent liability (7.00) -
3,143.00 1,100.00
Goodwill at acquisition 1,071.30 320.00
Less: Impairment loss [1,071.30 x 10%] (107.13) -
964.17 320.00
W-2 Retained earnings BL CL
--------- Rs. million ---------
RE 15,800.00 1,200.00
Less: Pre-acq - (350.00)
Add: Gain on sale of TL (W-3) 850.00 -
Less: Reversal of profit on disposal TL [2,000 - 1,200 x 75%] (1,100.00) -
Add: Contingent liability settled - 7.00
Less: Impariment of goodwill (W-1) (107.13) -
Less: URP on goods [32 x 40% x 25/125] - (2.56)
854.44
16,821.87
3,105.03 431.93
(b)
ICL Group
Consolidated Statement of changes in equity
for the year ended December 31, 2020
- Attributable to shareholders of ICL -
Retained Share NCI
Share capital
earnings options
--------------------- Rs. million -------------------
Balance as at 01-01-19 700.00 1,013.00 - 310.00
Purchase of subsidiary [950 x 20%] - - - 190.00
Bonus dividend [700 x 20%] 140.00 (140.00) - -
Profit for the year - restated (W-1) - 287.73 - 50.00
Balance as at 31-12-19 restated 840.00 1,160.73 - 550.00
Final dividend [840 x 15%] - (126.00) - -
Interim dividend [500 x 20% x 20%] - - - (20.00)
Disposal of subsidiary (W-1.3) - - - (128.00)
Modification of SAR (W-1.2) - - 32.00 -
Profit for the year (W-1) - 304.36 - 60.00
Balance as at 31-12-20 840.00 1,339.09 32.00 462.00
Workings
W-1 Correction in profits 2020 2019
------- Rs. million ------
Given 440.00 312.00
Lease (i)
Reversal of depreciation (W-1.1) 138.99 138.99
Reversal of interest expense (W-1.1) 55.12 66.74
Rent expense (i.e. short term lease) (180.00) (180.00)
Share appreciation rights (ii)
Expense for cash-settled transaction (W-1.2) (17.25) -
Loss on modification (W-1.2) (3.50) -
Disposal of subsidiary (iii)
Loss on disposal of TL (W-1.3) (69.00) -
Adjusted profit 364.36 337.73
Attributable to NCI 60.00 50.00
Attributable to shareholders of ICL 304.36 287.73
ROU
Cost 694.96
Depreciation:
- 2019 [694.96 / 5) (138.99)
- 2020 (138.99)
416.97
Liability
Date Op. bal Interest Cashflow Cl. Bal
30-06-19 694.96 34.75 90.00 639.71
31-12-19 639.71 31.99 90.00 581.69
66.74 180.00
30-06-20 581.69 29.08 90.00 520.78
31-12-20 520.78 26.04 90.00 456.82
55.12 180.00
Modification:
Equity-settled granted [32,000 x 10 x 200 x 2/4] 32.00
Cash-settled cancelled 28.50
Loss on modification 3.50
Question No. 1
The following information has been extracted from the draft financial statements of Alpha Limited for the year ended
31 December 2015.
Question No. 2
Following are the extracts from the financial statements of Universal Limited (UL) for the year ended 30 June 2017:
Statement of financial position as on 30 June 2017
2017 2 2016 2017 2016
Assets Equity & liabilities
Rs. in ‘000 Rs. in ‘000
Property, plant and equipment 158,500 120,000 Share capital (Rs. 10 each) 175,000 150,000
Retained earnings 54,434 21,500
Deferred tax asset 8,500 - Revaluation surplus 10,000 -
Stock in trade 58,000 45,000 Debentures (Rs. 100 each) 18,000 20,000
Trade receivables 68,000 56,000 Deferred tax liability - 6,000
Cash 39,434 48,000 Interest payable 1,000 2,500
Trade payables 42,000 39,000
Accrued liabilities 20,000 18,000
Unearned maintenance 2,000 4,000
Provision for taxation 10,000 8,000
332,434 269,000 332,434 269,000
Rs. in '000’
Sales 273,000
Cost of sales (187,500)
Gross profit 85,500
Operating expenses (46,766)
Other income 11,200
Profit before interest and tax 49,934
Interest expense (2,000)
Profit before tax 47,934
Tax expense (15,000)
Profit after tax 32,934
Additional information:
(i) 60% of sales were made on credit.
(ii) UL maintains a provision for doubtful receivables at 6%. During the year, trade receivables of Rs. 7 million
were written off.
(iii) Depreciation expense for the year was Rs. 22.5 million. 70% of the depreciation was charged to cost of
sales.
(iv) Other income comprises of:
▪ gain of Rs. 3 million on disposal of vehicles for Rs. 12 million;
▪ maintenance income of Rs. 8 million; and
▪ discount of Rs. 10 per debenture which were redeemed during the year.
Required:
Prepare UL’s statement of cash flows for the year ended 30 June 2017 using direct method. (15)
(Q1, Autumn 2017)
Solution No. 1
Alpha Limited
Statement of cash flows
For the year ended December 31, 2015
Rs in million
Cash flows from operating activities
Profit before tax (114 – 53 + 17) 78.00
Adjustments for:
Interest expense (40 × 0.13 × 5 ÷ 12) 2.17
Depreciation (W-1) 17.00
Gain on sale of building (20 – 18) (2.00)
Bad debts expense (W-2) 5.63
Provision for gratuity (6 + 6.5 – 3) 9.50
32.30
Operating profit before working capital changes 110.30
Workings:
W-1: Computation of depreciation
Rs. in million
Property, plant & equipment – Opening WDV 193
Purchases during the year 65
NBV of assets disposed off during the year (18)
Property, plant & equipment – Closing WDV (223)
Depreciation expense for the year 17
Solution No. 2
Universal Limited
Cash flow statement
for the year ended June 30, 2017
W-1 Customers
Rs.'000 Rs.'000
b/d 59,574 Receipts (bal.) 253,234
Sales 273,000 Write off 7,000
c/d 72,340
332,574 332,574
W-2 Suppliers
Rs.'000 Rs.'000
Payments (bal.) 181,750 b/d 39,000
c/d 42,000 Purchases 184,750
223,750 223,750
Inventory
Rs.'000 Rs.'000
b/d 45,000 COS [187.5 - 22.5 x 70%] 171,750
Purchases (bal.) 184,750 c/d 58,000
229,750 229,750
W-3.1
Cash expenses = Operating exp - Dep - Bad debts [W-3.2]
= 32,250
W-4 Tax
Rs.'000 Rs.'000
Payments (bal.) 27,500 b/d [6 + 8] 14,000
c/d 10,000 Expense 15,000
c/d 8,500
37,500 37,500
W-5 PPE
Rs.'000 Rs.'000
b/d 120,000 Disposal [12 - 3] 9,000
Revaluation 10,000 Depreciation 22,500
Addition (bal.) 60,000 c/d 158,500
190,000 190,000
W-6 Rs.'000
Other income 11,200
Gain on vehicle (3,000)
Maintenance income (8,000)
Discount on redemption [A] 200
Total redemption payment [A x 90/10] 1,800
W-7 RE
Rs.'000 Rs.'000
Dividends (bal.) - b/d 21,500
c/d 54,434 PAT 32,934
54,434 54,434
[Indirect method]
Company name
Statement of cash flows
For the year ended -----------------
Rs.’000 Rs.’000
Cash flow from operating activities:
Profit before tax (W-1) XXX
Add: Depreciation (W-8) / Amortization (W-9) XXX
Loss on disposal of asset (W-8, W-9) XXX
Impairment loss (W-8, W-9) XXX
Interest expense / Finance cost (W-2) XXX
Bad debt expense (W-3) XXX
Retirement benefits cost (e.g. gratuity) (W-4) XXX
Fair value loss [P&L] (W-12, W-14) XXX
Less: Interest income / Investment income (W-5) (XXX)
Dividend income (W-6) (XXX)
Fair value gain [P&L] (W-12, W-14) (XXX)
Grant income (W-13) (XXX)
Profit on sale of asset (W-8, W-9) (XXX)
Operating profit before working capital changes: XXX
(Increase) / Decrease in debtors (Note-1) (XXX) / XXX
(Increase) / Decrease in stocks (XXX) / XXX
(Increase) / Decrease in advances (XXX) / XXX
(Note-2)
(Increase) / Decrease in prepayments (XXX) / XXX
Increase / (Decrease) in creditors XXX / (XXX)
Increase / (Decrease) in accruals XXX / (XXX)
Increase / (Decrease) in short term provisions XXX / (XXX)
Cash generated from operations XXX
Tax paid / Tax refund (W-7) (XXX) / XXX
Retirement benefits paid (W-4) (XXX)
Interest / Finance cost paid (W-2) (XXX)
Cash inflow / (Outflow) from operating activities (A) XXX
EXAM NOTES:
1. Increase / decrease in debtors can be determined in following two ways:
(a) Movement in gross debtors (as done in above format)
= closing gross debtors + bad debt written off during the year – opening gross debtors
(b) Movement in net debtors
= closing debtors (net of provision) – opening debtors (net of provision)
Tips:
• If (b) is used then bad debt expense line will not appear in adjustments to profit before tax
• (a) is more practically used treatment however (b) is also acceptable in exams
2. Changes in all current assets and current liabilities are shown in this section except for followings:
(i) cash and cash equivalents
(ii) tax assets and liabilities
(iii) Dividend payable and receivable
(iv) Interest payable and receivable
(v) Any other asset or liability which is shown under investing or financing activities e.g. short-term finance,
investment, payable for purchase of a PPE and current portion of loan etc.
These items may be hidden in other current assets or liabilities (e.g. interest payable may be hidden in “accrued
expenses”). In this case exclude above items first while calculating working capital changes.
WORKINGS
W–1 Profit before tax
Retained earnings
W–7 Tax
Tax
Examples of non-cash additions – Trade in allowance, provision for dismantling, and credit purchase.
PPE Disposal
Note – While working for PPE, do not forget to prepare accounts for “Lease liability”, “Capital WIP” and “Revaluation
surplus”
Disposal
W – 10 Dividend payable
Dividend payable
Note – Even if there is no information regarding dividend paid / declared in other information do not forget to prepare
“Retained earnings” account as it may give cash dividend declared as a balancing figure on debit side.
W – 11 Capital WIP
Capital WIP
Govt. grant
W –14 Investments
Investment
Share capital
Share premium
Note – Bonus issue is by default made out of retained earnings (i.e. bonus dividend)
W –16 Loans
Loans
Loan repaid (principal only) XXX Opening balance (Non current) XXX
Closing balance (non current) XXX Opening balance (current) XXX
Closing balance (current) XXX New loan XXX
Lease liability
Lease payments (principal only) XXX Opening balance (Non current) XXX
Closing balance (non current) XXX Opening balance (current portion) XXX
Closing balance (current portion) XXX Asset leased during the year (W – 8) XXX
[Direct method]
Company name
Statement of cash flows
For the year ended -----------------
Rs.’000 Rs.’000
Cash flow from operating activities:
Receipts from customers (W-1) XXX
Other receipts (e.g. rent received) XXX
Payments to suppliers (W-2) (XXX)
Payment for other operating expenses (W-3) (XXX)
Cash generated from operations XXX
``
``
Remaining format after “cash generated from operations” is exactly
same as Indirect method
``
``
Note – If accrued interest is included, then exclude it first before using here.
Opening advances & prepayments (Note-1) XXX Opening accrued expenses (Note-2) XXX
Payments (balancing) XXX Operating expenses (Note-3) XXX
Closing accrued expenses (Note-2) XXX Closing advances & prepayments (Note-1) XXX
Notes:
1. If advance income tax is included, then exclude it first before using here.
2. If accrued interest is included, then exclude it first before using here.
3. Operating expenses = Admin expenses + Distribution cost + Other expenses – Depreciation – Amortization
– Bad debt expense – Impairment loss – retirement benefit expense – loss on disposal of
asset – fair value loss – exchange loss
[Indirect method]
Group name
Consolidated Statement of cash flows
For the year ended -----------------
Rs.’000 Rs.’000
Cash flow from operating activities:
Profit before tax XXX
Add: Depreciation / Amortization XXX
Loss on disposal of asset XXX
Loss on disposal of subsidiary/associate XXX
Impairment loss XXX
Impairment loss of goodwill (W-1) XXX
Total interest expense / Finance cost XXX
Bad debt expense XXX
Retirement benefits cost (e.g. gratuity) XXX
Fair value loss [P&L] XXX
Less: Interest income / Investment income (XXX)
Dividend income (XXX)
Fair value gain [P&L] (XXX)
Grant income (XXX)
Share or profit from associate [Share of PAT – URP (P to A)] (W-2) (XXX)
Profit on derecognition of earlier investment [i.e. direct investment in SS] (XXX)
Gain on disposal of subsidiary/associate (XXX)
Negative goodwill on subsidiary (XXX)
Profit on sale of asset (XXX)
Operating profit before working capital changes: XXX
(Increase) / Decrease in debtors (XXX) / XXX
(Increase) / Decrease in stocks (XXX) / XXX
(Increase) / Decrease in advances (XXX) / XXX
(Note-2)
(Increase) / Decrease in prepayments (XXX) / XXX
Increase / (Decrease) in creditors XXX / (XXX)
Increase / (Decrease) in accruals XXX / (XXX)
Increase / (Decrease) in short term provisions XXX / (XXX)
Cash generated from operations XXX
Tax paid / Tax refund (XXX) / XXX
Retirement benefits paid (XXX)
Interest / Finance cost paid (XXX)
Cash inflow / (Outflow) from operating activities (A) XXX
3. In all other workings we studied in revision, put values at acquisition date and values at disposal date of
assets/liabilities arising on purchase of subsidiary and disposal of subsidiary respectively during the year in relevant
accounts as non-cash items. For example:
PPE at NBV
WORKINGS
W–1 Impairment loss of goodwill
Goodwill
New investment in associate made during XXX Carrying amount of investment in associate XXX
the year derecognized during the year
Purchase of subsidiary = Cash consideration paid – Cash & cash equivalents of S at acquisition date
Sale of subsidiary = Cash consideration received – Cash & cash equivalents of S at disposal date
[Direct method]
Group name
Consolidated Statement of cash flows
For the year ended -----------------
Rs.’000 Rs.’000
Cash flow from operating activities:
Receipts from customers (W-1) XXX
Other receipts (e.g. rent received) XXX
Payments to suppliers (W-2) (XXX)
Payment for other operating expenses (W-3) (XXX)
Cash generated from operations XXX
``
``
Remaining format after “cash generated from operations” is exactly
same as Indirect method
``
``
W–1 Receipts from customers
Debtors
Inventory
Notes – Operating expenses = Admin expenses + Distribution cost + Other expenses – Depreciation – Amortization
– Bad debt expense – Impairment loss – retirement benefit expense – loss on disposal of
asset/subsidiary – fair value loss – exchange loss
DISCLOSURES
1. When subsidiary is purchased or disposed during the year, following shall be disclosed:
- Total consideration paid or received
- Portion of consideration consisting of cash and cash equivalents
- Amount of cash and cash equivalents in subsidiaries purchased or disposed
- Amount of assets and liabilities other than cash and cash equivalents in subsidiaries purchased or
disposed
2. Non-cash transactions in investing and financing activities such as:
- Acquisition of assets assuming directly related liabilities (e.g. loan)
- Leases
- Acquisition of an entity by an equity issue
- Conversion of debt to equity
3. Components of cash and cash equivalents.
Notes to accounts
1 - Property, plant and equipment
During the year property, plant and equipment amounting to Rs. 250 million was acquired against
a long term loan
W-2.1 Inventory
Opening balance 4,280.00
Purchases (balancing) 61,450.00
Cost of sales [59,110 - 140 + 8.40*] (58,978.40)
Closing balance [6,760 - 8.40] 6,751.60
* URP on goods = 140 x 25/125 x 30% = 8.40
W-5 PPE
Opening balance 900.00
Addition (balancing) 40.00
Loan 250.00
Depreciation [75 + 15] (90.00)
Closing balance 1,100.00
W-4 NCI
Opening balance 120.00
TCI attributable to NCI 300.00
Dividend paid (balancing) (185.00)
Closing balance 235.00
Solution [Q-4 Dec-10] Difference in ICAP solution:
- Short term deposit was considered as cash equivalent
- Use of proceeds of loan to purchase PPE was considered non-cash
KGL - Slight differences in notes
Consolidated cashflow statement
for the year ended June 30, 2010
-------- Rs. million -------
Cashflow from operating activities
Profit before tax 180.00
Depreciation 70.00
Finance cost 14.00
Impairment loss of trademark [6 x 50%] 3.00
Loss on exchange of machine [(7 - 1) - 6.50] 0.50
Share of profit from associate (5.00)
Operating profit 262.50
Working capital changes: (W-2)
Increase in inventories (51.00)
Increase in trade and other receivables (10.00)
Increase in short term deposits (10.00)
Decrease in trade and other payables (42.00)
Cash generated from operations 149.50
Finance cost paid [5 + 14 - 8] (11.00)
Tax paid [50 + 65 - 60] (55.00)
Cash inflow from operating activities 83.50
WORKINGS
W-1 Intangible assets Rs. million
Opening balance 25.00
Goodwill on acquisition (W-1.1) 8.00
Impairment of trademark (3.00)
Impairment loss of goodwill (balancing) -
Closing balance 30.00
W-3 PPE
Opening balance 500.00
Acquisition of AEWL 20.50
Addition (balancing) 60.00
Trade in allowance [7 - 1] 6.00
Depreciation (70.00)
Disposal (6.50)
Closing balance 510.00
W-4 Investment in associate
Opening balance 10.00
Share of profit 5.00
Dividend (3.00)
Closing balance 12.00
W-5 NCI
Opening balance 10.00
TCI attributable to NCI 15.00
Acquisition of AEWL 5.50
Dividend paid (balancing) (2.50)
Closing balance 28.00
FOREIGN OPERATION [SOFP & SOCI] – Class notes
FOREIGN OPERATION
Foreign operation is an entity that is a subsidiary, associate, joint arrangement or a branch of a reporting entity,
the activities of which are based or conducted in a country or currency other than those of the reporting entity.
2) Also incorporate fair value adjustments at acquisition date and post-acquisition effects of these
adjustments (except for goodwill and its impairment) in FS’s SOFP in foreign currency.
3) Now translate FS’s adjusted SOFP (as per 2 above) into functional currency of P as follows:
(a) All assets and liabilities at closing rate
(b) Share capital and pre-acquisition reserves at acquisition date rate
(c) Post-acquisition profits/OCI at actual or average rate of each year separately
(d) Post-acquisition dividends at actual rates of the respective dates
(e) Any balancing figure in such translated SOFP will be an equity reserve named “Exchange
reserve/Translation reserve”
4) Calculate goodwill and its impairment loss in foreign currency. Then translate impairment loss of each year
at average rate or closing rate for that year and translate closing carrying amount of goodwill at end of
every year at closing rate. Any resulting balancing figure is the exchange gain/loss on goodwill for each
year. Such exchange gain/loss is also taken to Exchange reserve as discussed below in 5.
6) Now consolidate P’s SOFP (as per 1) and FS’s translated SOFP (as per 3) normally as studied earlier. In this
respect following is important:
(i) Fair value adjustments have already made in 2 above therefore no need to perform such adjustments
again, however, inter-company eliminations will be performed.
(ii) URP will be calculated at actual rate of transaction date.
(iii) Exchange reserve (as per 5) shall be shown in equity.
(iv) Any exchange gain/(loss) on investment in foreign operation for the year already recognized in P’s RE
shall be reversed.
(v) NCI will also include:
- Its share in Exchange gain/(loss) on translation of FS’s SOFP [as per 3(e)].
- Its share in Exchange gain/(loss) of goodwill (as per 5) ONLY if NCI is valued at fair value.
2) Associate/JV]
Same rules are used for translation of foreign operations as studied above for application of equity method.
2) Also incorporate post-acquisition effects of fair value adjustments (except for goodwill and its impairment)
in FS’s SOCI in foreign currency.
3) Now translate FS’s adjusted SOCI (as per 2 above) into functional currency of P by applying actual or
average rate to all incomes and expenses and OCI items.
4) Now consolidate P’s SOCI (as per 1) and FS’s translated SOCI (as per 3) normally as studied earlier. In this
respect following is important:
(i) Fair value adjustments have already made in 2 above therefore no need to perform such adjustments
again, however, inter-company eliminations will be performed.
(ii) URP will be calculated at actual rate of transaction date.
(iii) Any exchange gain/(loss) on investment in foreign operation for the year already recognized in P’s SOCI
shall be reversed.
(iv) “Exchange gain or loss/Translation gain or loss on foreign operation” for the year shall be recognized
in OCI which is calculated as follows:
PAT/OCI for the year translated at actual rate or average rate (X)
2) Associate/JV]
Same rules are used for translation of foreign operations as studied above for application of equity method.
Question
Following are the financial statements of group companies for the year ended June 30, 2020:
Equity
Share capital 25,000 100
Retained earnings 26,200 120
Current liabilities
Creditors 9,800 50
61,000 270
(2) FS paid ordinary dividend of 10% and 20% on January 1, 2019 and January 1, 2020 respectively.
(3) Goodwill was not impaired in 2019 however, it was impaired by $ 5 million at June 30, 2020.
(4) On January 1, 2020 LP sold goods to FS for Rs. 12,500 million invoiced in PKR at a profit margin of 30%. Half of
the amount is still owed by FS on June 30, 2020. Moreover, 40% of these goods are held in FS inventory at year
end. In this respect FS has not yet recorded exchange gain/loss on this foreign currency payable at year end.
(5) FS earned a net profit of $ 40 million for the year ending June 30, 2019.
Rs. per $
01-07-18 100
01-01-19 112
30-06-19 120
Average for 2019 116
01-01-20 125
30-06-20 130
Average for 2020 128
Required:
Prepare consolidated statement of financial position and consolidated statement of comprehensive income for the
year ended June 30, 2020.
Current assets
Current assets [11,550 + 2,160(W-2.1) - 2 x 2] 13,706.00
33,216.00
Equity
Share capital 6,000.00
Exchange reserves [W-2] 414.70
Reserves [W-3] 6,988.60
Non-controlling interest [W-4] 2,997.20
Liabilities
Deferred consideration [121 x 1.1-2 + 7.50(W-3)] 107.50
Other liabilities [13,360 + 40 + 3,312(W-2.1) - 2 x 2] 16,708.00
33,216.00
-
Workings
W-1 Goodwill Rs. million
As per question 350.00
Goodwill on FD (W-1.1) 804.00
Increase in GW on LB due to recording of contingent liability [40 x 60%] 24.00
Increase in GW on LC due to recording of deferred consideration [121 x 1.1 -2 - 60] 40.00
1,218.00
Rs. million
* Profit on equipment [70 x 40/140] 20.00
Less: excess depreciation [20 ÷ 5 x 6/12] (2.00)
18.00
SCOPE
MEASUREMENT
1. Fair value 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.
Level 1 Quoted prices (unadjusted) in active markets for identical assets or liabilities that the
entity can access at the measurement date. For example, share prices quoted on PSE.
Level 2 Inputs other than quoted prices included within Level 1 that are observable for the asset
or liability, either directly or indirectly. For example, quoted prices for similar assets in
active markets or for identical or similar assets in non-active markets or use of quoted
interest rates for valuation purposes.
Level 3 Unobservable inputs for the asset or liability. For example, discounting of estimated
future cashflows.
3. Fair value is the price on measurement date under current market conditions (i.e. an exit price)
regardless of whether that price is directly observable or estimated using another valuation
technique.
Exit price
The price that would be received to sell an asset or paid to transfer a liability.
Entry price
The price paid to acquire an asset or received to assume a liability in an exchange transaction.
4. Fair value measurements are based on an asset’s or a liability’s unit of account which is specified by
each IFRS where a fair value measurement is required. For most assets and liabilities, the unit of
account is the individual asset or liability, but in some instances may be a group of assets or liabilities.
5. Since fair value measurement is for a particular asset or liability, therefore, an entity shall take into
account the characteristics of the asset or liability if market participants would take those
characteristics into account when pricing the asset or liability at the measurement date. Such
characteristics include, for example, the following:
(a) The condition and location of the asset; and
(b) Restrictions, if any, on the sale or use of the asset.
6. A fair value measurement assumes that the transaction to sell the asset or transfer the liability takes
place either:
(a) in the principal market for the asset or liability; or
Principal market
The market with the greatest volume and level of activity for the asset or liability.
(b) in the absence of a principal market, in the most advantageous market for the asset or liability.
Most advantageous market
The market that maximizes the amount that would be received to sell the asset or minimizes
the amount that would be paid to transfer the liability, after taking into account transaction
costs and transport costs.
An entity need not undertake an exhaustive search of all possible markets to identify the principal
market or, in the absence of a principal market, the most advantageous market, but it shall take into
account all information that is reasonably available. In the absence of evidence to the contrary, the
market in which the entity would normally enter into a transaction to sell the asset or to transfer the
liability is presumed to be the principal market or, in the absence of a principal market, the most
advantageous market.
7. For fair value measurement of non-financial asset or liability, the fair value should be from the highest
and best use or by selling it to another market participant that would use the asset in its highest and
best use. The highest and best use of a non-financial asset takes into account the use of the asset that
is physically possible, legally permissible and financially feasible.
8. A fair value measurement assumes that A liability would remain outstanding and the market
participant transferee would be required to fulfil the obligation. The liability would not be settled with
the counterparty or otherwise extinguished on the measurement date. The fair value of liability also
reflects the effect of non-performance risk (i.e. the risk that an entity will not fulfill an obligation).
PRACTICE QUESTIONS
Question 1 [IG Example 1A]
Following information relates to an asset of AB Limited which can be sold in following possible markets:
Market A Market B Market C
Sale volume – annual 30,000 units 15,000 units 10,000 units
Sale price per unit Rs. 1,000 Rs. 800 Rs. 1,200
Transport cost per unit Rs. 50 Rs. 70 Rs. 100
Selling agents’ fee per unit Rs. 20 Rs. 10 Rs. 25
Required:
(a) Identify principal market and most advantageous market.
(b) Calculate fair value of the asset in principal market and most advantageous market.
Question 2
B Limited acquired a plot of land developed for industrial use as a factory. A factory with similar facilities in Karachi and
access has recently been sold for Rs. 80 million.
The plot is located on the outskirts of Clifton in Karachi.
Similar sites nearby have recently been developed for residential use as sites for high-rise apartment buildings.
B Limited determines that the land could be developed as a site for residential use at a cost of Rs. 15 million (to cover
demolition of the factory and legal costs associated with the change of use). The plot of land would then be worth Rs. 98
million.
Required:
Fair value of land.
Question 3
Sigma Power Limited (SPL) has just acquired an entity and is required to fair value a decommissioning liability. The
entity has to decommission a mine at the end of its useful life, which is in three years’ time. SPL has determined that it
will use a valuation technique to measure the fair value of the liability. If SPL were allowed to transfer the liability to
another market participant, then the following data would be used.
Labor, material and overheads (based on current prices) Rs. 2.60 million
Third party contractors markup (industry average) 20%
Annual inflation rate 5%
Risk adjustment – uncertainty relating to cash flows 6%
Risk free rate on government securities 5%
Entity’s non-performance risk 3%
Required:
Fair value of decommissioning liability at acquisition date.
SOLUTIONS
Solution No. 1
(a)
Principal market is Market A because it has highest volume of transactions.
Most advantageous market is Market C as follows:
A B C
------------------ Rs. ------------------
Sale price 1,000 800 1,200
Transport cost (50) (70) (100)
950 730 1,100
Transaction cost (20) (10) (25)
930 720 1,075
(b)
Fair values:
[Market A] = Rs. 950
[Market C] = Rs. 1,100
Solution No. 2
The fair value of land is Rs. 83 million (i.e. 98 – 15) as this is its highest and best use because market
participants would take into account the site’s development potential when pricing the land.
Solution No. 3
Rs. 000
Decommissioning cost 2,600
Third party markup [2,600 x 20%] 520
3,120
Rs. million
Assets
Property and equipment 5,600
Right of use assets 890
Intangible assets 800
Investments
- Equity securities 4,100
- Government securities 1,100
- Debt securities 3,400
- Term deposits 1,500
Insurance/reinsurance receivables 430
Other loans and receivables 140
Prepayments 90
Cash and bank 160
18,210
Equity
Share capital 1,500
Share premium 750
Revaluation surplus 900
Retained earnings 3,030
6,180
Liabilities
Insurance liabilities 9,800
Borrowings 1,000
Lease liabilities 760
Premium received in advance 85
Tax liability 360
Other payables 25
12,030
18,210
Rs. million
Premium revenue 9,430
Premium ceded to reinsurers (2,035)
Net premium revenue 7,395
Rs. million
Gross premium
Regular premium individual policies
- First year 1,200
- Second year renewal 1,400
- Subsequent year renewal 2,600
5,200
Rs. million
Gross claims
Claims under individual policies
- by death 650
- by insured event other than death 130
- by maturity 400
- by surrender 200
1,380
Claims under group policies
- by death 110
- by insured event other than death 40
- by maturity 900
- by surrender 150
1,200
Total gross claims 2,580
MUTUAL FUNDS
A mutual fund is a type of financial vehicle made up of a pool of money collected from many investors
to invest in securities like stocks, bonds, money market instruments, and other assets. Mutual funds are
operated by professional money managers, who allocate the fund's assets and attempt to produce
capital gains or income for the fund's investors.
Mutual funds give small or individual investors access to professionally managed portfolios of equities,
bonds, and other securities. They invest in shares/units of mutual fund and therefore participate
proportionally in the gains or losses of the fund. That's why the price of a mutual fund unit/share is
referred to as the net asset value (NAV) per share which is calculated as follows:
Rs. million
Incomes:
Markup/Interest income 700
Dividend income 500
Gain/(loss) on sale of investments 250
Other income 150
1,600
Expenses:
Remuneration to management company 410
Remuneration to trustees 50
Fees to SECP 20
Brokerage commission and fees 130
Selling and marketing expenses 70
Administrative and general expenses 40
Other expenses 10
(730)
Net income for the year before tax 870
Taxation (120)
Net income for the year after tax [A] 750
Element of income paid on redemption of units [B] (70)
Net income available for distribution [C] 680
Rs. million
Assets:
Cash & bank balances 2,450
Investments 3,845
Receivables 700
Other assets 300
7,295
Liabilities:
Payable to Management company 120
Payable to Trustees 30
Payable to SECP 10
Other payables 80
(240)
Net assets [F] 7,055
Rs.
NAV per unit [F ÷ G] 66.74
Rs.
NAV per unit at start of year 46.68
NAV per unit at end of year 66.74
Rs. million
Assets
Property and equipment 4,400
Right of use assets 540
Intangible assets 600
Investments
- Equity securities 6,420
- Debt securities 4,200
- Term deposits 980
Insurance/reinsurance receivables 460
Reinsurance recoveries against outstanding claims 1,240
Other loans and receivables 310
Salvage recoveries accrued 200
Deferred commission expense 290
Prepayments 430
Cash and bank 460
20,530
Equity
Share capital 3,500
Share premium 700
Revaluation surplus 455
Retained earnings 9,400
14,055
Liabilities
Underwriting provisions:
- Outstanding claims including IBNR 1,300
- Unearned premium reserve 720
- Unearned reinsurance commission 160
Borrowings 3,100
Lease liabilities 325
Premium received in advance 105
Tax liability 540
Other payables 225
6,475
20,530
Rs. million
Net insurance premium 2,195
Rs. million
Written gross premium 4,600
Unearned premium reserve - opening 450
Unearned premium reserve - closing (720)
Premium earned 4,330
Rs. million
Claims paid 1,100
Outstanding claims including IBNR - closing 1,300
Outstanding claims including IBNR - opening (940)
Claims expense 1,460
Rs. million
Commission paid or payable 740
Deferred commission expense - opening 210
Deferred commission expense - closing (290)
Net commission 660
Rs. million
Assets:
Investments 7,500
Receivables 700
Cash & bank balances 300
8,500
Liabilities:
Payable to outgoing members 100
Accrued expenses 20
(120)
Net assets 8,380
Rs. million
Contributions to fund during the year [Employers’ and employees’] 3,500
Benefits paid/payable to outgoing members (1,600)
Incomes:
Investment income 7,500
Other income 300
8,500
Expenses:
Administrative expenses 140
Investment loss 30
Other expenses 20
(190)
Net assets generated during the year 2,210
Net assets available for benefits at start of the year 6,020
Net assets available for benefits at end of the year 8,230
----------------------------------(Rupees in '000)------------------------------
ASSETS
LIABILITIES
REPRESENTED BY
The annexed notes 1 to 48 and annexures I to III form an integral part of these unconsolidated financial statements.
President & Chief Executive Officer Chief Financial Officer Director Director Director
President & Chief Executive Officer Chief Financial Officer Director Director Director
---------(Rupees in '000)---------
--------------Rupees--------------
The annexed notes 1 to 48 and annexures I to III form an integral part of these unconsolidated financial statements.
President
President & Chief&Executive
Chief Executive
OfficerOfficer ChiefChief Financial
Financial Officer DirectorDirector
Officer Director
Director Director
Director
228
Unconsolidated Statement of BANK ALFALAH LIMITED
Comprehensive Income UNCONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
FOR THE YEAR ENDED DECEMBER 31, 2020
For the year ended December 31, 2020
2020 2019
---------(Rupees in '000)---------
Items that may be reclassified to profit and loss account in subsequent periods:
Effect of translation of net investment in foreign branches 586,512 1,720,854
Movement in (deficit) / surplus on revaluation of investments - net of tax (781,967) 4,001,228
(195,455) 5,722,082
Items that will not be reclassified to profit and loss account in subsequent periods:
Remeasurement (loss) / gain on defined benefit obligations - net of tax (212,406) 62,104
Movement in (deficit) / surplus on revaluation of operating fixed assets - net of tax (75,839) (95,097)
Movement in (deficit) / surplus on revaluation of non-banking assets - net of tax (361) 77,923
(288,606) 44,930
Total comprehensive income 9,990,849 18,462,529
The annexed notes 1 to 48 and annexures I to III form an integral part of these unconsolidated financial statements.
President
President & Chief&Executive
Chief Executive
Officer Officer ChiefChief Financial
Financial Officer DirectorDirector
Officer Director
Director Director
Director
In hand
Local currency 5.1 18,110,657 15,799,677
Foreign currency 5.2 3,641,949 2,418,292
21,752,606 18,217,969
With State Bank of Pakistan in
Local currency current accounts 5.3 36,654,027 44,854,841
Foreign currency current account 5.4 5,367,302 5,551,990
Foreign currency deposit account 5.5 22,810,448 14,084,512
64,831,777 64,491,343
With other central banks in
Foreign currency current account 5.6 8,253,771 8,529,825
Foreign currency deposit account 5.7 681,448 659,039
8,935,219 9,188,864
With National Bank of Pakistan in local currency current account 3,242,108 8,469,281
Prize bonds 586,487 364,416
99,348,197 100,731,873
5.1 This includes cash in transit amounting to Rs. 2,354.106 million (2019: Rs. 3,465.118 million).
5.2 This includes cash in transit amounting to Rs. 314.391 million (2019: Rs. 219.079 million).
5.3 This includes statutory liquidity reserves maintained with the SBP under Section 22 of the Banking Companies Ordinance, 1962.
5.4 This includes cash reserve of 5% maintained with the State Bank of Pakistan held under the New Foreign Currency Accounts
Scheme (FE-25 deposits), as per BSD Circular no. 9 dated Dec 3, 2007.
5.5 This includes special cash reserve of 10% maintained with the State Bank of Pakistan on FE-25 deposits as specified in BSD Circular
No. 14 dated June 21, 2008. Profit rates on these deposits are fixed by SBP on a monthly basis. These deposits carry interest rate
ranging from 0.00% to 0.76 % per annum (2019: 0.70% to 1.5% per annum).
5.6 These represent deposits with other central banks to meet their minimum cash reserves and capital requirements pertaining to the
overseas operations of the Bank.
5.7 These represent deposits with other central banks pertaining to the overseas operations of the Bank, in accordance with their
regulatory requirements and carry interest 0.19% to 0.42% (2019: 0.71 % to 3.67%).
Outside Pakistan
In current account 6.1 5,642,659 3,535,371
In deposit account 6.2 590,030 600,262
6,232,689 4,135,633
6,234,299 4,709,968
6.2 This includes placement of funds generated through foreign currency deposits scheme (FE-25) and non-contractual deposits at
interest rates ranging from 2.00% to 3.00% per annum (2019: 2.00% to 9.75% per annum).
7.1 These represent lendings to financial institutions at markup rates ranging from 0.05% to 9.70% per annum (2019: 2.35% to 12.00%
per annum) having maturities upto June 2021 (2019: March 2020).
7.2 These represent short term lending to financial institutions against investment securities. These carry markup rates ranging from
6.20% to 7.12% per annum (2019: 2.04% to 13.37% per annum) with maturities upto January 2021 (2019: January 2020).
7.3 These represent Bai Muajjal agreements entered into with SBP and other commercial banks. These carry markup rate of 6.85% to
6.95% per annum (2019: 9.70% to 13.40% per annum), and these are due to mature by April 2021 (2019: February 2022).
2020 2019
---------------------------------------(Rupees in '000)------------------------------------
244
8 INVESTMENTS Note 2020 2019
Cost / Cost /
Provision for Surplus / Carrying Provision for Surplus / Carrying
8.1 Investments by type: Amortised Amortised
diminution (Deficit) Value diminution (Deficit) Value
cost cost
--------------------------------------------------(Rupees in '000)--------------------------------------------------
Held-for-trading securities
Federal Government Securities
Market Treasury Bills 56,821,307 - (9,388) 56,811,919 20,533,478 - (14,058) 20,519,420
Pakistan Investment Bonds 7,510,169 - 30,229 7,540,398 5,148,051 - (12,795) 5,135,256
Shares
Ordinary shares / units - Listed 477,729 - 13,547 491,276 449,778 - 4,858 454,636
Foreign Securities
Overseas Bonds - Sovereign 6,142,136 - 56,800 6,198,936 915,694 - 2,043 917,737
70,951,341 - 91,188 71,042,529 27,047,001 - (19,952) 27,027,049
Available-for-sale securities
Federal Government Securities
Market Treasury Bills 145,099,588 - 102,559 145,202,147 72,573,764 - (14,777) 72,558,987
Pakistan Investment Bonds 187,006,839 - 2,381,275 189,388,114 92,232,030 - 3,220,117 95,452,147
Government of Pakistan Sukuks 24,322,881 - (439) 24,322,442 4,212,347 - 86,367 4,298,714
Government of Pakistan Euro Bonds 1,956,045 - 147,772 2,103,817 1,925,652 - 40,577 1,966,229
Naya Pakistan Certificates 466,435 - - 466,435 - - - -
Shares
Ordinary shares - Listed 3,390,701 (423,497) 2,313,639 5,280,843 5,605,847 (1,029,285) 2,506,441 7,083,003
Ordinary shares - Unlisted 1,201,285 (59,661) - 1,141,624 1,151,285 (59,661) - 1,091,624
Preference Shares - Listed 108,835 (108,835) - - 108,835 (108,835) - -
Preference Shares - Unlisted 25,000 (25,000) - - 25,000 (25,000) - -
Non Government Debt Securities
Term Finance Certificates 1,596,910 (452,530) (11,209) 1,133,171 1,753,977 (409,577) (22,887) 1,321,513
Sukuks 18,250,653 (96,511) 113,865 18,268,007 4,817,886 (96,510) 170,457 4,891,833
Foreign Securities
Overseas Bonds - Sovereign 16,552,071 - 813,215 17,365,286 10,206,335 - 144,151 10,350,486
Overseas Bonds - Others 17,326,311 - 716,255 18,042,566 19,409,473 - 330,542 19,740,015
Redeemable Participating Certificates 8.1.1 2,904,675 - - 2,904,675 2,727,165 - - 2,727,165
420,208,229 (1,166,034) 6,576,932 425,619,127 216,749,596 (1,728,868) 6,460,988 221,481,716
Held-to-maturity securities
Federal Government Securities
Pakistan Investment Bonds 20,003,717 - - 20,003,717 25,968,179 - - 25,968,179
Other Federal Government Securities 7,216,366 - - 7,216,366 7,216,366 - - 7,216,366
Non Government Debt Securities -
Term Finance Certificates 398,013 (24,680) - 373,333 714,266 (524,266) - 190,000
Sukuks 1,136,216 (94,545) - 1,041,671 1,255,831 (120,898) - 1,134,933
Foreign Securities
Overseas Bonds - Sovereign 19,629,502 - - 19,629,502 13,901,861 - - 13,901,861
Overseas Bonds - Others 798,356 - - 798,356 771,808 - - 771,808
49,182,170 (119,225) - 49,062,945 49,828,311 (645,164) - 49,183,147
Total Investments 541,819,346 (1,397,534) 6,668,120 547,089,932 295,102,514 (2,445,435) 6,441,036 299,098,115
8.1.1 The adoption of IFRS 9 at Bahrain Operations of the Bank has resulted in investments in Redeemable Participating Certificates held abroad, being
mandatorily measured at Value through Profit and Loss However, based on the clarification received from the State Bank of Pakistan (SBP)
vide their letter No. BPRD/RPD/2018-16203 dated July 26, 2018, such investments have been reported and measured under for investments
in these unconsolidated financial statements.
Alfalah CLSA Securities (Private) Limited (formerly: Alfalah Securities (Private) Limited)
246
2020 2019
Cost / Cost /
Provision for Surplus / Carrying Provision for Surplus / Carrying
Amortised Amortised
diminution (Deficit) Value diminution (Deficit) Value
8.2 Investments by segments: cost cost
-----------------------------------------------------------(Rupees in '000)-----------------------------------------------------------
Federal Government Securities:
Listed Companies 3,977,265 (532,332) 2,327,186 5,772,119 6,164,460 (1,138,120) 2,511,299 7,537,639
Unlisted Companies 1,226,285 (84,661) - 1,141,624 1,176,285 (84,661) - 1,091,624
5,203,550 (616,993) 2,327,186 6,913,743 7,340,745 (1,222,781) 2,511,299 8,629,263
Non Government Debt Securities
Associates
Subsidiaries
Alfalah Securities (Private) Limited 300,000 (42,981) - 257,019 300,000 (42,981) - 257,019
Total Investments 541,819,346 (1,397,534) 6,668,120 547,089,932 295,102,514 (2,445,435) 6,441,036 299,098,115
The market value of securities given as collateral is Rs. 181,215.233 million (2019: Rs. 30,746.266 million).
Charge / reversals
Charge for the year 1,042,001 1,589,125
Reversals for the year (26,352) (49,130)
Reversal on disposals (1,564,459) (522,107)
(548,810) 1,017,888
Written off 8.3.2 (499,586) -
Closing Balance 1,397,534 2,445,435
8.3.2 As allowed by the SBP circular no. 06 of 2007 dated June 05, 2007, the bank during the year has written off Rs. 499.586 million in respect Term Finance Certificate of Agritech Limited
as part of the balance sheet cleanup exercise. The Bank holds enforceable colleratal in the event of recovery through litigation.
Domestic
Loss 8.3.2 668,266 668,266 1,151,251 1,151,251
Overseas - - - -
Details regarding quality of Available for Sale (AFS) securities are as follows:
Note 2020 2019
Cost
-------(Rupees in '000)-------
8.4.1 Federal Government Securities - Government guaranteed
Market Treasury Bills 145,099,588 72,573,764
Pakistan Investment Bonds 187,006,839 92,232,030
Government of Pakistan Sukuks 24,322,881 4,212,347
Government of Pakistan Euro Bonds 1,956,045 1,925,652
Naya Pakistan Certificates 8.4.1.1 466,435 -
358,851,788 170,943,793
8.4.1.1 This represents intial investment made for the establishment of the modarba pools in Naya Pakistan Company limited in accordance
with S.R.O 964 (I) / 2020 dated October 05, 2020.
Ordinary Shares
Automobile Parts & Accessories 119,848 -
Cement 254,111 452,244
Chemicals 109,420 17,909
Commercial Banks 1,312,929 1,433,176
Engineering 28,953 110,496
Fertilizer 488,153 430,828
Investment Banks 15,000 15,000
Oil and Gas Exploration Companies 436,504 1,666,312
Oil and Gas Marketing Companies 174,951 347,886
Pharmaceuticals 51,216 102,392
Power Generation & Distribution 62,826 602,191
Real Estate Investment Trust 336,790 372,093
Textile Composite - 55,320
3,390,701 5,605,847
Preference Shares
Fertilizer 108,835 108,835
3,499,536 5,714,682
248
2020 2019
8.4.2.2 Unlisted Companies Break up value Cost Breakup value Cost Breakup value
as at ----------------------(Rupees in '000)----------------------
Ordinary Shares
Al-Hamara Avenue (Private) Limited June 30, 2010 50,000 47,600 50,000 47,600
Pakistan Export Finance Guarantee
Agency Limited June 30, 2010 5,725 286 5,725 286
Pakistan Mobile Communication Limited Dec 31, 2019 22,235 80,303 22,235 71,986
Pakistan Mortgage Refinance Company Limited Dec 31, 2019 300,000 385,098 300,000 304,476
Society for worldwide Interbank Financial
Telecommunication Dec 31, 2016 4,095 11,754 4,095 11,754
TriconBoston Consulting Corporation (Private)
Limited June 30, 2020 769,230 1,389,619 769,230 941,130
1 Link (Private) Limited June 30, 2020 50,000 230,837 - -
1,201,285 2,145,497 1,151,285 1,377,232
Preference Shares
Trust Investment Bank Limited Dec 31, 2017 25,000 27,784 25,000 27,784
2020 2019
Cost
8.4.3 Non Government Debt Securities -------(Rupees in '000)-------
8.4.3.1 Listed
Unlisted
8.6 The market value of securities classified as held-to-maturity as at December 31, 2020 amounted to Rs. 50,506.972 million (December
31, 2019 : Rs. 49,648.885 million).
250
9 ADVANCES
---------------------------------------------------(Rupees in '000)---------------------------------------------------
Loans, cash credits, running finances, etc. 9.1 458,635,232 403,040,273 20,822,483 20,686,613 479,457,715 423,726,886
Islamic financing and related assets 9.2 101,747,490 87,309,952 3,927,311 1,532,279 105,674,801 88,842,231
Bills discounted and purchased 14,657,070 17,203,494 1,109,786 198,336 15,766,856 17,401,830
Advances - gross 575,039,792 507,553,719 25,859,580 22,417,228 600,899,372 529,970,947
2020 2019
------------------------------------------------------(Rupees in '000)------------------------------------------------------
Lease rentals receivable 405,674 2,995,404 38,109 3,439,187 430,979 2,864,065 52,356 3,347,400
Residual value 292,660 738,799 8,598 1,040,057 222,973 718,226 11,353 952,552
Minimum lease payments 698,334 3,734,203 46,707 4,479,244 653,952 3,582,291 63,709 4,299,952
Financial charges for future
periods (51,927) (333,409) (10,371) (395,707) (17,117) (537,608) (19,354) (574,079)
9.1.1 Advances include an amount of Rs. 137.815 million (2019: Rs. 147.568 million), being Employee Loan facilities allowed to Citibank, N.A, employees, which
were either taken over by the Bank, or were granted afresh, under a specific arrangement executed between the Bank and Citibank, N.A, Pakistan. The said
arrangement is subject to certain relaxations as specified vide SBP Letter BPRD/BRD/Citi/2017/21089 dated September 11, 2017.
The said arrangement covers only existing employees of Citibank, N.A, Pakistan, and the relaxations allowed by the SBP are on continual basis, but subject to
review by BID and OSED departments. These loans carry mark-up at the rates ranging from 9.46% to 24.42% (December 31, 2019: 9.46% to 24.46%) with
maturities up to December 2039 (December 31, 2019: December 2039).
9.2 These represents financing and related assets placed under shariah permissible modes and presented in Annexure-II.
2020 2019
9.3 Particulars of advances (Gross) -------(Rupees in '000)-------
2020 2019
Note Specific General Total Specific General Total
----------------------------------------------------(Rupees in '000)----------------------------------------------------
9.5.2 The additional profit arising from availing the forced sales value (FSV) benefit - net of tax at December 31, 2020 which is not available for distribution as either
cash or stock dividend to shareholders/ bonus to employees amounted to Rs. 72.557 million (2019: Rs. 38.426 million).
9.5.3 During the year, non performing loans and provisions were reduced by Rs. 1,049.600 million (2019: Rs. 222.278 million) due to debt property swap with two non
performing clients.
9.5.5 Although the Bank has made provision against its non-performing portfolio as per the category of classification of the loan, the Bank holds enforceable collateral
in the event of recovery through litigation. These securities comprise of charge against various tangible assets of the borrower including land, building and
machinery, stock in trade etc.
252
Note 2020 2019
9.6.3 As allowed by the SBP circular no. 06 of 2007 dated June 05, 2007 , the bank during the year has written off Rs. 2,784.442 million as part of the balance
sheet cleanup exercise. The Bank holds enforceable colleratal in the event of recovery through litigation.
In terms of sub-section (3) of Section 33A of the Banking Companies Ordinance, 1962 the statement in respect of written-off loans or any other financial relief of rupees
five hundred thousand or above allowed to a person(s) during the year ended December 31, 2020 is given in Annexure-I.
At January 1, 2020
Cost / Revalued amount 6,151,946 3,086,200 1,655,333 3,174,993 5,881,693 2,095,553 13,250,977 367,004 35,663,699
Accumulated depreciation - - (47,325) (93,186) (4,021,878) (1,741,943) (10,230,292) (272,727) (16,407,351)
Net book value 6,151,946 3,086,200 1,608,008 3,081,807 1,859,815 353,610 3,020,685 94,277 19,256,348
Building on
Leasehold Building on Lease hold Furniture and Office
Freehold land Leasehold Vehicles Total
land Freehold land improvement fixture equipment
land
--------------------------------------------------------(Rupees in '000)-----------------------------------------------------------
At January 1, 2019
Cost / Revalued amount 6,150,446 3,278,701 1,440,029 3,038,083 5,272,656 1,996,822 11,520,228 349,844 33,046,809
Accumulated depreciation - - - - (3,695,795) (1,654,117) (9,361,666) (238,355) (14,949,933)
Net book value 6,150,446 3,278,701 1,440,029 3,038,083 1,576,861 342,705 2,158,562 111,489 18,096,876
10.2.1 Land and buildings were last revalued on December 31, 2018 on the basis of market values, determined by independent valuer M/s Akbani & Javed Associates, M/s
Harvester Service (Private) Limited and M/s Hamid Mukhtar & Co. (Private) Limited. Had there been no revaluation, the carrying amount of the revalued assets at
December 31, 2020 would have been Rs. 5,807.270 million (2019: Rs. 5,549.644 million).
2020 2019
Net book Net book Net book Net book
value at Cost value at value at Cost value at
Revalued Revalued
amount amount
----------------------------(Rupees in '000)----------------------------
10.2.2 Included in cost of building and equipment are fully depreciated items still in use having cost of Rs. 12,661.556 million (2019: Rs. 11,740.137 million).
10.2.3 Carrying amount of idle and held for sale properties. 10.2.3.1 - 42,000
10.2.3.1 During the year, properties having book value of Rs. 355.735 million were transfered from non banking assets aquired under satisfaction of claims to operating fixed
assets. Furthermore, the Bank has transferred 'idle and held for sale properties' having book value of Rs. 42.000 million to 'owned properties' (land and building).
10.2.4 Sale of fixed assets to related parties are disclosed in Annexure III to these unconsolidated financial statements.
254
Note 2020 2019
-------(Rupees in '000)-------
10.3 Right-of-use assets
At January 1
At December 31
11 INTANGIBLE ASSETS
11.1 At January 1
At December 31
11.2 Included in cost of intangible assets are fully amortized items still in use having cost of Rs. 2,420.016 million (2019: Rs. 1,925.272 million).
12.1 Market value of Non-banking assets acquired in satisfaction of claims - properties only 1,536,100 987,862
The Non-banking assets (properties) of the Bank have been revalued by independent professional valuers as at December 31, 2020.
The revaluation was carried out by M/s. Josheph Lobo (Pvt) Ltd, M/s. FairWater Property & Surveys (Pvt) Ltd and M/s. Hamid
Mukhtar & Co. (Pvt) Ltd on the basis of professional assessment of present market values which resulted in an increase in surplus
by Rs. 32.506 million (2019: Rs. 89.447 million).
256
12.2 This represents fraud and forgery amount receivable from the insurance company and other sources. Provision has been held
against non-recoverable amount.
Note 2020 2019
-------(Rupees in '000)-------
12.3 Provision held against other assets
13 BILLS PAYABLE
Secured
Borrowings from State Bank of Pakistan
Export Refinance Scheme 14.1 45,178,774 31,680,935
Long-Term Finance Facility 14.2 24,532,476 15,947,561
Financing Facility for Renewable Energy Projects 14.3 4,551,837 1,945,374
Financing Facility for Storage of Agriculture Produce (FFSAP) 14.4 490,748 325,330
Refinance for Wages & Salaries 14.5 29,170,716 -
Other refinance schemes 14.6 1,581,880 -
Repurchase agreement borrowings 14.7 93,965,252 5,000,000
199,471,683 54,899,200
Unsecured
Call borrowings 14.11 14,032,513 10,126,463
Overdrawn nostro accounts 14.12 1,532,864 939,151
Bai Muajjal 14.13 8,766,071 -
Others
- Pakistan Mortgage Refinance Company 14.14 1,388,140 494,646
- Karandaaz Risk Participation 14.15 650,087 502,375
- Other financial institutions 14.16 2,742,233 623,335
Total unsecured 29,111,908 12,685,970
314,960,186 102,842,330
14.2 This facility is secured against a demand promissory note executed in favour of the State Bank of Pakistan. The mark-up rate on
this facility ranges from 2.00% to 5.00% per annum (2019: 2.00% to 5.00% per annum) payable on a quarterly basis.
14.3 This facility is secured against a demand promissory note executed in favour of the State Bank of Pakistan. The mark-up rate on
this facility is 2.00% to 3.00% per annum (2019: 2.00% to 3.00% per annum) payable on a quarterly basis.
14.4 This facility is secured against a demand promissory note executed in favour of the State Bank of Pakistan. The mark-up rate on
this facility is 2.00% to 3.50% per annum (2019: 6.00% per annum) payable on a quarterly basis.
14.5 This facility is secured against a demand promissory note executed in favour of the State Bank of Pakistan. This is new scheme as
part of COVID-19 relief to finance entities against payroll. The mark-up rate on this facility is 0% to 2.00% per annum (2019: nil)
payable on a quarterly basis.
14.6 This facility is secured against a demand promissory note executed in favour of the State Bank of Pakistan. The mark-up rate on
this facility is 0% to 3.00% per annum (2019: nil) payable on a quarterly basis.
14.7 This represents repurchase agreement borrowing from SBP at the rate 7.1% per annum (2019: 13.32% per annum) having maturity
in January 2021 (2019: March 2020).
14.8 This represents repurchase agreement borrowing from other banks at the rate of ranging from 7.00% to 7.02% per annum (2019:
2.04% to 13.32% per annum) having maturities upto January 2021 (2019: January 2020).
14.9 This represents borrowings from financial institutions at mark-up rates ranging from 8.38% to 8.48% per annum (2019: 10.85% to
13.25%) having maturities upto July 2025 (2019: October 2020).
14.10 This represents pre-IPO proceeds received in respect of first tranche of the Rated, Secured, Listed, Redeemable Fixed Rate Term
Finance Certificates ("TFCs")-Series A which has been assigned a rating of by PACRA. The primary purpose for this TFC
issuance is to hedge the Bank's fixed rate assets. This issue has a maturity of three years and carries a markup of 9.03%. This
instrument is secured against the government securities. Subsequent to the year end, the Bank conducted IPO of TFC-Series A
through which subscription proceeds amounting to Rs. 2,000 million were retained by the Bank.
14.11 This represents borrowings from financial institutions at mark-up rates ranging from 1.00% to 7.12% per annum (2019: 0.40% to
3.15%) having maturities upto March 2021 (2019: November 2020).
14.12 This represents book overdrawn balances appearing under certain nostro accounts which are due for settlement and the balance
exist only due to timing differences. These do not carry any interest.
14.13 This represents borrowings from financial institutions at mark-up rates ranging from 6.85% to 7.06% per annum (2019: nil) having
maturities upto May 2021 (2019: nil).
14.14 This includes borrowing from Pakistan Mortgage Refinance Company Limited (PMRC) to extend housing finance facilities to the
Bank's customers on the agreed terms and conditions. This borrowing carries mark-up rate ranging 7.77% to 10.79% per annum
(2019: 10% to 11%).
14.15 This includes borrowing from Karandaaz Pakistan Limited in lieu of Risk Participation Agreement to support venture into
SME segments. The participation carries a mark-up rates ranging from 8.54% to 21.69% per annum. (2019: 13.84% to 25.24%).
14.16 This represents borrowing from other financial institutions at the rate ranging between 0% to 3.17% per annum (2019: 3.15% per
annum) having maturity upto July 2022 (2019: December 2020).
2020 2019
-------(Rupees in '000)-------
258
15 DEPOSITS AND OTHER ACCOUNTS
2020 2019
In Local In Foreign In Local In Foreign
Total Total
Currency currencies Currency currencies
----------------------------------------------(Rupees in '000)----------------------------------------------
Customers
Financial Institutions
2020 2019
-------(Rupees in '000)-------
15.2 Deposits include eligible deposits of Rs. 493,322.428 million (2019: Rs. 417,047.985 million) protected under Depositors Protection
Mechanism introduced by the State Bank of Pakistan.
15.3 Current deposits include amount related to prepaid cards Rs. 42.164 million (2019: 53.876).
- A related party relationship could have an effect on the profit or loss and financial position of an
entity. For example, an entity that sells goods to its parent at cost might not sell on those terms to
another customer.
- The profit or loss and financial position of an entity may be affected by a related party relationship
even if related party transactions do not occur. For example, a subsidiary may terminate relations
with a trading partner on acquisition by the parent of a fellow subsidiary engaged in the same activity
as the former trading partner.
- One party may refrain from acting because of the significant influence of another—for example, a
subsidiary may be instructed by its parent not to engage in research and development.
For these reasons, knowledge of an entity’s transactions, outstanding balances, including commitments,
and relationships with related parties may affect assessments of its operations by users of financial
statements, including assessments of the risks and opportunities facing the entity.
DEFINITIONS
A related party is a person or entity that is related to the entity that is preparing its financial statements
(in this Standard referred to as the ‘reporting entity’).
(a) A person or a close member of that person’s family is related to a reporting entity if that person:
(i) has control or joint control of the reporting entity;
(ii) has significant influence over the reporting entity; or
(iii) is a member of the key management personnel of the reporting entity or of a parent of the
reporting entity.
(b) An entity is related to a reporting entity if any of the following conditions applies:
(i) The entity and the reporting entity are members of the same group (which means that each
parent, subsidiary and fellow subsidiary is related to the others).
(ii) One entity is an associate or joint venture of the other entity (or an associate or joint venture
of a member of a group of which the other entity is a member).
(iii) Both entities are joint ventures of the same third party.
(iv) One entity is a joint venture of a third entity and the other entity is an associate of the third
entity.
(v) The entity is a post-employment benefit plan for the benefit of employees of either the
reporting entity or an entity related to the reporting entity. If the reporting entity is itself such
a plan, the sponsoring employers are also related to the reporting entity.
(vi) The entity is controlled or jointly controlled by a person identified in (a).
(vii) A person identified in (a)(i) has significant influence over the entity or is a member of the key
management personnel of the entity (or of a parent of the entity).
(viii) The entity, or any member of a group of which it is a part, provides key management personnel
services to the reporting entity or to the parent of the reporting entity.
Important
In the context of this Standard, the following are not related parties:
(a) two entities simply because they have a director or other member of key management
personnel in common or because a member of key management personnel of one entity has
significant influence over the other entity.
(b) two joint venturers simply because they share joint control of a joint venture.
(c)
(i) providers of finance,
(ii) trade unions,
(iii) public utilities, and
(iv) departments and agencies of a government that does not control, jointly control or
significant influence the reporting entity, simply by virtue of their normal dealings with an
entity (even though they may affect the freedom of action of an entity or participate in its
decision‑making process).
(d) a customer, supplier, franchisor, distributor or general agent with whom an entity transacts a
significant volume of business, simply by virtue of the resulting economic dependence.
A related party transaction is a transfer of resources, services or obligations between a reporting entity
and a related party, regardless of whether a price is charged.
Close members of the family of a person are those family members who may be expected to influence,
or be influenced by, that person in their dealings with the entity and include:
(a) that person’s children and spouse or domestic partner;
(b) children of that person’s spouse or domestic partner; and
(c) dependants of that person or that person’s spouse or domestic partner.
Key management personnel are those persons having authority and responsibility for planning, directing
and controlling the activities of the entity, directly or indirectly, including any director (whether executive
or otherwise) of that entity.
DISCLOSURES
1. Relationships between a parent and its subsidiaries shall be disclosed irrespective of whether there
have been transactions between them. An entity shall disclose the name of its parent and, if different,
the ultimate controlling party. If neither the entity’s parent nor the ultimate controlling party
produces consolidated financial statements available for public use, the name of the next most senior
parent that does so shall also be disclosed.
2. An entity shall disclose key management personnel compensation in total and for each of the
following categories:
(a) short‑term employee benefits;
(b) post‑employment benefits;
(c) other long‑term benefits;
(d) termination benefits; and
(e) share‑based payment.
3. If an entity has had related party transactions during the periods covered by the financial statements,
it shall disclose, at a minimum:
(a) the amount of the transactions;
(b) the amount of outstanding balances, including commitments, and their terms and conditions,
including whether they are secured, and the nature of the consideration to be provided in
settlement and details of any guarantees given or received;
(c) provisions for doubtful debts related to the amount of outstanding balances; and
(d) the expense recognised during the period in respect of bad or doubtful debts due from related
parties.
Above disclosures shall be made separately for each of the categories of related parties.
PRACTICE QUESTIONS
QUESTION NO. 1
During the year ended 30 June 2013, Uzair Limited (UL), a listed company, undertook the following transactions:
(i) All the raw materials were supplied by Hamid Limited for Rs. 180 million.
(ii) Goods costing Rs. 15 million were sold by UL for Rs. 18 million to its subsidiary Tania (Pvt.) Limited as against its
normal policy of adding 30% margin on cost. At the year end, the amount receivable in respect of this sale was Rs.
5.5 million.
(iii) A machine costing Rs. 20 million was purchased from Perveen Limited, one of whose executive director is a director
in UL.
(iv) UL’s approved gratuity fund is administered by the trustees appointed by the company. During the year, contribution
made to the approved gratuity fund amounted to Rs. 3.2 million.
(v) During the year, UL sold goods amounting to Rs. 12 million to Gohar Limited, which is controlled by the uncle of Mr.
Haris, a key shareholder and a member of UL’s board of directors.
(vi) An interest free loan of Rs. 4 million was granted to the Chief Financial Officer (CFO) of the company under the terms
of employment. During the year, Rs. 0.5 million were repaid by the CFO.
Required:
In the light of International Financial Reporting Standards:
(a) Comment as to whether or not the above entities are related parties of Uzair Limited. (06)
(b) Prepare a note on related party transactions for inclusion in Uzair Limited’s financial statements for the year ended 30
June 2013. (Ignore corresponding figures) (07)
{Autumn 2013, Q # 1}
QUESTION NO. 2
On 1 July 2009, Metal Limited (ML) acquired 80% shareholdings in Copper Limited (CL), 90% shareholdings in Zinc Limited
(ZL) and 55% shareholdings in Steel Limited (SL). The following transactions took place among these companies, during
the period up to 30 June 2011:
(i) On 1 May 2010, ML sold a machine to CL at 20% above the carrying amount of Rs. 16 million. CL paid the entire
amount on 15 July 2010. The useful life of the machine is 10 years.
(ii) On 1 July 2010, ZL awarded a contract of Rs. 15 million to Iron Builders and Developers (IBD) for the extension of
its existing factory. One of the directors of ML is also a partner in IBD.
(iii) Since the date of acquisition, ML has been providing management services to CL and ZL. ML did not charge
management fee for its services during the first year. However, with effect from 1 July 2010, management fee
has been charged from each company at the rate of Rs. 0.5 million per month. Payment is made on the 10th day
of the next month.
(iv) On 1 January 2011, ML sold goods amounting to Rs.10 million to Gold Limited (GL). The wife of chief financial
officer of ZL is a major shareholder in GL.
Required:
Prepare a note on related party disclosure including comparative figures, for inclusion in the individual financial
statements of ML, CL, ZL and SL, for the year ended 30 June 2011. (18)
{Autumn 2011, Q # 3}
QUESTION NO. 3
The following related party transactions were carried out by Golden Limited (GL) during the first year of its operation i.e.
year ended December 31, 2009.
(i) Inventory costing Rs. 15 million was sold for Rs. 18 million to Platinum Limited (PL) which owns 60% shares in GL.
It is GL’s policy to add 30% margin on cost. Outstanding liability at year end, in respect of these purchases was
Rs. 6.5 million.
(ii) PL provided administrative services to GL. The cost of these services, if billed in the open market, would have
amounted to Rs. 350,000. No entries were made to record these transactions, as it was agreed that the services
would be provided free of charge.
(iii) A property was sold to Silver Limited (SL), an associated company, at its fair market value of Rs. 10 million. 50%
of the amount was settled prior to year end. GL reimbursed Rs. 500,000 to SL on account of transfer and other
incidental charges related to this property.
(iv) An interest free loan of Rs. 2 million was granted to an executive director of the company under the terms of
employment. During the year, Rs. 200,000 were repaid by the executive director.
(v) On July 1, 2009 GL obtained a short term loan of Rs. 25 million from one of its major shareholder, at the prevailing
annual interest rate of 12%. The principal as well as the accrued mark-up were outstanding at the close of the
year.
NASIR ABBAS FCA
IAS 24 – QUESTIONS (2)
Required:
Prepare a note on related party transactions for inclusion in GL’s financial statements for the year ended December 31,
2009 showing disclosures as required under IAS - 24 (Related Party Disclosures). (15)
{Spring 2010, Q # 2}
QUESTION NO. 4
During the year ended June 30, 2008, Baber Limited (BL) has carried out several transactions with the following individuals
/ entities:
(i) AK Associates provides information technology services to BL. One of the directors of BL is also the partner in AK
Associates.
(ii) SS Bank Limited is the main lender. By virtue of an agreement it has appointed a nominee director on the Board
of BL.
(iii) Mr. Zee who supplies raw materials to BL, is the brother of the Chief Executive Officer of the company.
(iv) JB Limited is the distributor of BL’s products and have exclusive distribution rights for the province of Punjab.
(v) Mr. Tee is the General Manager-Marketing of BL and is responsible for all major decisions made in respect of
sales prices and discounts.
(vi) BL’s gratuity fund is administered by the Trustees appointed by the company.
(vii) MM Limited is the leading supplier of BL and supplies 60% of BL’s raw materials.
(viii) Ms. Vee who conducted various training programmes for the employees of the company, is the wife of BL’s Chief
Executive Officer.
Required:
Comment as to whether the above individuals/entities are ‘related parties’ of the company or not. Support your
arguments with references from International Accounting Standards. (15)
{Autumn 2008, Q # 4}
QUESTION NO. 5
Fazal Limited is engaged in the manufacturing of specialized spare parts for automobile assemblers. During the year 2007,
the company has undertaken the following transactions with its related parties:
(i) Sales of Rs. 500 million were made to its only subsidiary M/s Sami Motors Limited (SML). Being the subsidiary, a
special discount of Rs. 25 million was allowed to SML.
(ii) SML returned spare parts worth Rs. 5.5 million.
(iii) Raw materials of Rs. 5 million were purchased from Jalal Enterprises, which is owned by the wife of the CFO of
Fazal Limited.
(iv) Equipment worth Rs. 3 million was purchased from Khan Limited (KL). The wife of the Production Director of the
company is a director in KL.
(v) The company awarded a contract for supply of two machines amounting to Rs. 7 million per machine to an
associated company.
(vi) In 2005, an advance of Rs. 2 million was given to the Chief Executive of the company. During the year 2007, he
repaid Rs. 0.3 million. The balance outstanding as on December 31, 2007 was Rs. 1,100,000.
Required:
In accordance with the requirement of IAS-24 “Related Party Disclosures”, prepare a note to the financial statements, for
inclusion in the company’s financial statements. (12)
{Spring 2008, Q # 4}
QUESTION NO. 6
Following transactions were carried out by Yellow Limited during the year ended June 30, 2006.
(i) Mr. Sharp, a well-known management consultant was hired, to conduct a three weeks workshop on time
management for the staff of the company at a fee of Rs. 0.5 million. Mr. Sharp is the son of the Chief Executive
Officer.
(ii) A loan of Rs. 30 million was obtained from Blue Bank Limited. The loan was negotiated by Mr. Slim, General
Manager Finance of Yellow Limited, who was formerly a senior executive of the Bank.
(iii) Three used delivery trucks of the company were sold to Red Supplies Limited, which supplies approximately 60%
of the total raw material used by the company.
(iv) Granted interest bearing loan to its Chief Executive Officer for construction of house in accordance with the
company’s policy relating to employees’ benefit.
(v) Paid mobilization advance of Rs. 9 million against a construction contract to Orange Limited which is owned by
Mr. Clear, a member of a reputed business family. Two influential directors of the company are nephews of Mr.
Clear.
(vi) The company awarded a contract for plant maintenance services to its subsidiary Brown (Pvt.) Limited effective
August 01, 2007.
Required:
For each case, discuss the requirement of IAS 24 (Related Party Disclosures) as regards the following disclosures in the
financial statements for the year ended June 30, 2006:
(a) Related party relationship; and
(b) Related party transactions. (14)
{Spring 2007, Q # 6}
SOLUTIONS
SOLUTION TO QUESTION NO.1
(a)
(i) UL and Hamid Limited are not related parties. According to IFRS, significant volume of transactions between two
parties even it results in economic dependence does not create related party relationship.
(ii) Tania (Private) Limited is a related party of UL because both the companies have parent-subsidiary relationship.
(iii) They are not related parties. According to IFRS, having common director does not necessarily create a related party
relationship.
(iv) A post-employment benefit plan for the benefits of employees is treated as related party.
(v) The uncle of Mr. Haris is not related party of UL because an uncle is not considered as a close member of a person's
family.
(vi) CFO is a related party as he is the key management personnel of the company.
(b)
(ii) Additionally, management services were provided by Metal Limited during the year as follows:
Rs. In million
Fee for services 6.0
Less: Paid 5.5
Outstanding balance 0.5
In the previous year, services were given without any charges.
Others:
(a) Iron Builders and Developers:
Rs. In million
Contract awarded for extension of building 15
Note: Iron Builders and Developers is a related party of Metal Limited, not of Zinc Limited.
B) Associate company:
Nature of relationship: Silver Limited (SL) is an associate company of Golden limited (GL).
A property was sold to SL at Rs. 10 millions. Additionally, transfer and other incidental charges were
paid by GL amounting to Rs. 0.5 million. Movement of the account is as under:
Total amount receivable 10 millions
Amount settled prior to year end 5 millions
Amount receivable at year end 5 millions
C) Key management personal:
Nature of relationship: Executive director is a related party to Golden Limited (GL).
An interest free loan was granted to executive director under the terms of employment. Movement of
the account is as under:
Amount of loan 2 millions
Amount repaid by director 0.2 million
Amount outstanding 1.8 millions
D) Others:
Nature of relationship: Related party is a major shareholder of Golden Limited (GL).
GL obtained a short term loan @ 12% rate of interest from this related party on 01.07.09. Movement of
the account is as under:
Amount of loan obtained 25 millions
Mark-up payable (25 x 12% x 6 / 12) 1.5 millions
Total amount payable 26.5 millions
Note: Assuming that major shareholder is having significant influence in the entity.
(i) AK associates are related party to BL because director of BL has joint control over AK associates.
(ii) SS Bank ltd. is not a related party to BL due to the reason that two entities simply because they have a director
or other member of key management personnel in common.
(iii) As Mr. Zee is the brother of CEO of the company and brother does not fall under close members of the family of
an individual and include only those family members who may be expected to influence, or be influenced by,
that individual in their dealings with the entity so Mr. Zee is not a related party to BL.
(iv) JB is only a distributor of BL’s products and according to IAS-24 a customer, supplier, franchisor, distributor
with whom an entity transacts a significant volume of business, merely by virtue of the resulting economic
dependence are not related party.
(v) Mr. Tee is a related party to BL as he has a key management personnel which include those persons having
authority and responsibility for planning, directing and controlling the activities of the entity, directly or
indirectly.
(vi) A party is related to an entity if the party is a post-employment benefit plan for the benefit of employees of the
entity. So, gratuity fund is a related party to BL.
(vii) MM is only a major supplier and according to IAS-24, a customer, supplier or distributor with whom an entity
transacts a significant volume of business by virtue of the resulting economic dependence are not related parties.
(viii) Ms. Vee is a related party as she is a close family member of an individual which includes only those family
members who may be expected to influence or be influenced by that C.E.O of BL in their dealings with the entity.
A) SUBSIDIARIES:
Nature of Relationship: Sami Motors Limited (SML) is a subsidiary of Fazal Limited.
Sales of Rs. 500 million were made to SML after allowing a special discount of Rs. 25 million.
Amount outstanding 500 millions
Provision of balance Nil
SML returned spare parts worth Rs. 5.5 million.
B) ASSOCIATES:
Nature of relationship: It is an associate of the Fazal Limited.
NASIR ABBAS FCA
IAS – 24 - SOLUTIONS (4)
A contract for the supply of two machines amounting to RS. 7 million per machine was awarded to this
subsidiary.
C) KEY MANAGEMENT PERSONNEL:
Nature of Relationship: Chief Executive is a related party to Fazal Limited.
Advance of Rs 2 million was given to him during 2005.
Amount of transaction: 2.0 millions
Amount outstanding at start: 1.4 millions
Amount repaid during 2007: 0.3millions
Amount outstanding at end: 1.1 millions
Provision: Nil
Guarantee: Nil
D) OTHERS:
(i) Nature of Relationship: Jalal Enterprises is owned by the wife of CFO of Fazal Limited.
Raw mateials worth Rs 5 million were purchased from Jalal Enterprises.
Amount of transaction: 5 millions
Amount outstanding: 5 millions
Provision: Nil
Guarantee: Nil
(ii) Nature of Relationship: Equipment purchased from Khan limited whose director is the wife of
Production Director of Fazal Limited.