BABCOCK UNIVERSITY

COURSE GUIDE

COURSE CODE: ACCT 462

COURSE TITLE: FINANCIAL REPORTING & ACCOUNTING

ETHICS

Course Developer/Writer: Nwaobia, Appolos Nwabuisi, PhD, MSc, FCA, ACTI.

INTRODUCTION

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This is the course guide for ACCT 462 - Financial Reporting & Accounting Ethics. The
course guide gives you the structure of the course material you are expected to study in
Financial Reporting & Accounting Ethics as part of the requirements for a B.Sc. Accounting
degree of Babcock University. It promises to be of immense help to all those who in addition
to the B.Sc. degree in accounting have the target of writing the professional level of the
Institute of Chartered Accountants of Nigeria (ICAN) examinations as well as the ACCA
international examinations.

WHAT YOU WILL LEARN IN THIS COURSE

This course advanced the basic principles and concepts of Financial Accounting discussed in
ACCT 201 and 202- Financial Accounting I & II and ACCT 301 & 302 – Financial
Accounting I & II. It takes a more practical approach to address the current challenges faced
by the Accounting profession as a result of spates of corporate failures in which non-
transparent financial reporting is being implicated. Thus in addition to addressing the timeless
accounting principles and practices, this course will focus broadly on the regulatory
environment, rules of professional conduct and ethical considerations; strict adherence to
standards in corporate reporting; contemporary response of the accounting profession to the
demands to report beyond financial performance; the requirement to present integrated
reports as well as social and environmental accounting.

COURSE AIM

The aim of this course is to expose the students to the practical approach to financial reporting and
guide them in the acquisition of appropriate skills and competences in preparing and reporting both
financial and non-financial performance of entities. The course is also designed to keep students
aware of developments in the world of business, the accounting profession and the expectations of the
accountants’ stakeholders.

COURSE OBJECTIVES

By the end of this course, you should be able to:

 acquire good knowledge of current issues in the regulatory framework for financial
reporting as well as identify key ethical issues in accounting and financial reporting.
 formulate accounting and reporting policies for single entities and groups.
 prepare and present extracts from the single entity and consolidated financial
statements for entities undertaking a wide range of accounting transactions in
conformity with International Financial Reporting Standards (IFRS) and accounting
policies.
 Understand the relevant ethical and professional standards relating to the accounting
profession as well as apply professional ethical considerations in the practice of
financial reporting.
 Understand and apply the various provisions of IFRS in the preparation and
presentation of financial reports.
 develop ethical sensitivity in the recognition of ethical threats or issues, awareness of
alternative courses of action leading to ethical solution and the effect on stakeholders.

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  apply basic ethical principles to the relevant functional roles such as financial
accounting, management accounting, auditing and assurance, taxation and other
functional areas.

TEXTBOOKS AND REFERENCES

Main Texts

1. Alexander, D., Britton, A. and Jorrissen, A. (latest edition). International Financial

Reporting and Analysis, 4th Edition. Hampshire: Cengage Learning.

2. ICAN (2019). Study text on Corporate Reporting. UK: Emile Woolf International.

3. ACCA (latest edition): Study Pack on Corporate Reporting. London: BPP Learning
Media Ltd

4. Idekwuli, C. (2014). Teach yourself IFRS. Lagos: Piccas Global Concept

5. Ghillyer, A. (2008). Business Ethics – A real world approach. New York: Mcgraw-
hill/Irwin

6. Enahoro, J. A. (2012). Accounting for the Environmental and Natural Resources.

Ilishan-Remo: Babcock University Press.

Other Texts/Materials

1. Accounting: A Book of Readings, edited by Emeni, F., Asaolu, T.O., Ajibolade, and
Arowoshegbe, A.O. Lagos: Diamond Prints and Design Limited

2. FGN, Companies and Allied Matters Act, cap C20 LFN 2020

3. Financial Reporting Council of Nigeria, Act no.6, 2011

4. International Financial Reporting Standards as they are issued and/or amended..

5. Professional Accounting Journals of the following bodies: ICAN, AICPA, IIA, AAA,
ACCA etc

6. Siyanbola, T. T., (2021). Advanced Financial Accounting (IFRS Compliant), 2 nd

Edition, Lagos, Gastos Publications

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COURSE DESCRIPTION

This course applies the basic principles of accounting and ethics in reporting entity
performance. It takes a more practical approach to address the current challenges faced by the
Accounting profession as a result of spates of corporate failures arising from fraudulent
financial reporting. Topics such as the financial reporting framework, the professional and
ethical duties of the accountant, financial statements analysis/appraisal of financial
performance and position of entities, application of different accounting standards to the
preparation and presentation of financial statements, ethical decision making models,
environmental and social issues in accounting are covered in this course.

COURSE PRE-REQUISITE

A good knowledge of accounting concepts and principles and the preparation and
presentation of financial statements is essential. In this regard, students should have passed
Financial Accounting 1 & 2 (ACCT 201 and 202) as well as Advanced Financial Accounting
1 & 2 (ACCT 301 302).

CONTENT MODULES AND UNITS:

Module 1 Regulatory Framework and Analysis of financial Statements

Unit 1 Regulatory Framework
Unit 2 Accounting and Reporting Concepts
Unit 3 Analysis of financial statements I
Unit 4 Analysis of financial statements II
Module 2 Accounting Standards and Reporting Standards I
Unit 1 IASB Structure and Due Process
Unit 2 Accounting policies, changes in accounting estimates and errors (IAS 8)
Unit 3 First Time Adoption of IFRS (IFRS 1)
Unit 4 Interim Financial Reporting (ISA 34)

Module 3 Accounting and Reporting Standards II

Unit 1 Property, Plant & Equipment and Related standards (IASs 16, 20, 23, 36 &
40)
Unit 2 Intangible assets, Operating Segments and Accounting for Non-current
assets held for sale and Discontinued Operations (IAS 38, IFRS 8 & IFRS 5)
Unit 3 Inventory, Agriculture and Revenue Standards (IAS 2, 41 and IFRS 15)
Unit 4 Earnings per share (IAS 33)

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Module 4 Contemporary Issues in Financial Reporting
Unit 1 Integrated Reporting
Unit 2 Management Commentaries and Accounting Disclosures
Unit 3 Corporate Social Responsibilities
Unit 4 Social and Environmental accounting

Module 5 Accounting Ethics

Unit 1 Introduction to Ethics
Unit 2 Ethical theories
Unit 3 Framework for ethical decision making
Unit 4 Ethical standards and professional responsibilities

MODULE OVERVIEW:

Each module deals with a sub-theme of the course and contains four units. Each unit
discusses some topics in relation to the sub-theme. In each of the units, you will find:

Self-assessment Exercises

Each unit of the course has self-assessment exercise(s). You are expected to attempt them to
help you assess your understanding of the content of the unit.

In-text Questions and Answers

These are provided by the facilitator to guide and encourage you as you explore the contents. It will
help if you attempt the questions before checking out the provided answers.

Tutor marked assignments/questions

The Tutor Marked Assignments (TMAs) at the end of each module are designed to test your
understanding and application of the content/ concepts learned. Also note that you need to do your
examinable TMAs as they fall due, as they are an integral part of the total score for the course.

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Module 1 REGULATORY FRAMEWORK AND ANALYSIS OF FINANCIAL
STATEMENTS

IMAGE SOURCE: https://www.allbusinessschools.com/accounting/job-description/

Introduction
This module gives a highlight of the regulatory frameworks of financial reporting – legal and
conceptual and the need for such regulation. It goes further to give an indepth discussion on
the analysis of financial statements as a guide to useful economic and investment decisions.

General Objectives
By the end of this module, you should be able to:
1. Discuss the need for the frameworks in financial reporting.
2. Mention the sources of regulation.
3. Describe the forms and contents of financial report.
4. Discuss the conceptual framework for financial reporting.
5. analyse and interpret financial statements and other financial information and draw
appropriate conclusions.

Unit 1 REGULATORY FRAMEWORK

Introduction
In this unit, we discuss the need for framework in financial reporting and the sources of such
regulation. The accounting requirements of Companies and Allied Matters Act (CAMA) Cap
C20, LFN 2004(as amended) and are highlighted as well as the prescribed form and content
of annual financial reports. The unit closes with the requirement of CAMA for small
companies to present modified financial statements.

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Specific Objectives:
By the end of this unit, you should be able to:
1. Discuss the specific need for having financial reporting framework;
2. Describe the other reasons for the framework.
3. Describe the three sources of financial reporting regulations in Nigeria
4. Explain the accounting requirements specified by CAMA 2004(as amended)
5. Discuss the form and contents of annual financial report

1.1 Need for Framework

The primary purpose of regulation of accounting information is to ensure that users of
financial statements obtain minimum information that will enable them take meaningful
economic and investment decisions regarding their interests in a reporting entity.

Other reasons include:

 to ensure that entities adopt similar accounting treatments for similar items and
account for similar transactions in the same way over time. This makes inter-firm
comparison possible as well as comparison of an entity’s performance over time.
 to ensure that management does not deliberately mislead users of the financial
statements by adopting whichever accounting treatment that would present its results
and position in the best possible light.

1.2 Sources of Regulation

1. Company law: In Nigeria, the CAMA, 2020 gives the legal provisions for the
preparation, presentation and audit of financial statements of reporting entities.

Sections 374 – 384 deals with financial statements and audit of accounting records;
Sections 385 – 392 give guidance on the directors’ duties to keep such accounts,
penalties for non-compliance; sections 393 – 397 give instruction on filing of modified
financial statements while 398 – 399 give guidance on publication of financial
statements. Sections 401 – 416 deal with audit and auditors; sects. 417 – 425 deals with
Annual returns while 426 to 433 give guidance on the treatment of dividends and profits.
In addition to CAMA, there are other industry-specific regulatory statutes such as ISA,
BOFIA, CBN Act, Insurance Act, Money Laundering Act 2011(as amended) etc that
regulate financial reporting in the different sectors.
2. Accounting Standards: The bulk of the regulatory framework is contained in the
Accounting standards. Accounting standards give authoritative guidelines on how
specific items (events and transactions) are to be treated in the financial statements.
3. Capital Market Authorities’ (SEC, NSE) Rules: set out the information (including
accounting information) which companies must provide to be listed and remain listed in
the market.

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1.3 CAMA 2020 – Accounting Requirements

Section 374 provides as follows:

Sub-sect. 1 Every company shall cause accounting records to be kept.

Sub-sect. 2 The accounting records are sufficient to show and explain the transactions of the
company and are to:

a. disclose with reasonable accuracy, at any time, the financial position of the company
and;

b. enable the directors to ensure that financial statements prepared comply with the
requirements of the Act with regard to form and content.

Sub-sect.3 The accounting records shall in particular contain –

a. entries from day-to-day of all sums of money received and expended by the company,
and the matters in respect of which the receipts and expenditure take place; and

b. a record of assets and liabilities of the company.

Sub-sect. 4 If the business of the company involves dealing in goods, the accounting records
shall contain:


statements of stock held by the company at the end of each accounting year of
the company;
 all statements of stock takings from which any such statement of stock has
been or is to be prepared; and
 except in the case of goods sold by way of ordinary retail trade, statement of
all goods sold and purchased, showing the goods and the buyers and sellers in
sufficient detail to enable all these to be identified.
Sub-section 5 requires each public limited company to keep its audited accounts displayed
on its website.

1.4 Form and content of annual financial reports

By the provisions of S.377(2) and sched.1 of CAMA, 2020 the annual financial statements
should include the following:

1. Statement of Accounting policies

2. Balance sheet (Statement of Financial position)
3. Profit and Loss account (Statement of comprehensive Income) or Income and
Expenditure Account.
4. Notes on the Accounts

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5. The Auditors’ report
6. The directors’ report
7. Statement of Sources and Application of Funds ( now Statement of cash flows)
8. Statement of changes in equity
9. A value- added statement for the year
10. A Five-year financial summary
11. In the case of a holding company, the group financial statements; and
12. Such other matters as are required in accordance with the applicable accounting
standards

Sect. 377(3) The financial statements of private companies NEED NOT include:
i. Statement of Accounting Policies
ii. Statement of cash flows
iii. Statement of changes in equity
iv. A Value- added statement

Financial statements are to show corresponding figures for the preceding year. In addition to
complying with the requirements of CAMA, all financial statements are to comply, in respect
of their form and content, with all relevant statement of accounting standards issued by
NASB (FRCN), in so far that such standards do not conflict with the provisions of CAMA.

IFRS REQUIREMENTS
IFRS financial statements comprise:
1. A Statement of financial position (Balance Sheet)
2. A Statement of Comprehensive Income (Income statement)
3. A statement of changes in Equity (SOCE)
4. A cash flow statement
5. Notes, including a summary of the significant accounting policies.

Note: Based on the requirements of Sox Act 2002 and FRCN Act 2011, the content of
financial statements for public interest entities today also includes a Statement of Directors’
Responsibilities and a statement of Certification of the financial statements by the CEO and
CFO pursuant to S.60(2) of ISA Act No.29 of 2007

It is pertinent to note that current performance reporting goes beyond these basic
requirements to include other non-mandatory disclosures that are discussed in module 5, unit
2.

1.5 Small Companies Modified Financial Statements

A small company, in whichever year, it so qualifies, can deliver to the CAC, modified
financial statements that are not strictly in line with sect, 377 (2) and sch.1, of CAMA 2020.

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By section 394(1) a company qualifies as small in relation to its first financial year if the
qualifying conditions are met in that year.
SS.(2) – A company qualifies as small in relation to a subsequent financial year if the
qualifying conditions are –
a. met in that year and the preceding financial year
b. met in that year and the company qualified as small in relation to preceding financial year;
or
c. were mat in the preceding financial year and the company qualified as small in relation to
that year.

Sect.394(3) state that the qualifying conditions are met by a company in a year in which it
satisfies the following requirements –
a. It is a private company
b. its turnover is not more than =N=120 million or such amount as may be fixed by the
commission from time to time.
c. its net assets value is not more than =N=60million or such amount as may be fixed by
Commission from time to time
d. None of its members is an alien
e. None of its members is a govt., govt. corporation or agency or its nominee; and
a. In the case of a company having share capital, the directors between themselves, hold
at least 51% of the equity capital.
Where the financial year under consideration is less than 12 months, the turnover figure shall
be adjusted appropriately.

By sect.395, a holding company may present modified group fin. Statements if it is a private
company and the consolidated figures for turnover and net assets so qualify the group as a
small company.

IN-TEXT QUESTIONS (ITQ’s)

1. The primary purpose of regulation of accounting information is to ensure that users of

financial statements obtain minimum information that will enable them take
meaningful _________

2. _________ are possible when entities adopt similar accounting treatments for similar
items and account for similar transactions in the same way over time.
3. Three major sources of financial reporting framework in Nigeria are: company law,
accounting standard and _________
4. The financial statement of private companies need not include: statement of
accounting policy, statement of cash flow, value added statement and-------------

IN-TEXT ANSWERS (ITA’s)

1. economic and investment decisions

2. Inter-firm comparisons 10
3. Capital Market Authority (SEC, NSE) rules
4. 5 years financial summary
Unit 2 Accounting and Reporting Concepts
Introduction
Presented in this unit is the conceptual framework which identifies and defines the
accounting and reporting concepts that underlie the preparation and presentation of financial
statements. The 2010 framework is presented together with the 2018 framework for reason
that many subsisting standards still use the terminology and definitions of the elements of
financial statements as given in the 2010 framework.

Specific Objectives
At the end of this unit, students should be able to:
1. Define ´Generally Accepted Accounting Principles.’
2. Explain the purpose and status of the conceptual framework.
3. State the objectives of general purpose financial reporting
4. Explain the qualitative characteristics of useful financial statements
5. Discuss the elements of financial statements
6. Establish when an element of financial statement is to be recognised
7. Identify the different measurement bases of elements of financial statement;
8. Explain the concept of capital maintenance and profit determination
9. Explain fair presentation in line with IAS 1.

2.1 Conceptual Framework for Financial Reporting

History

Originally approved by the IASC in April 1989, the Conceptual Framework for Financial
Reporting was adopted by the IASB in April 2001.

In 2005 the IASB started working with the US FASB, (the Norwalk Agreement) to develop
a common Framework. This led to the IASB issuing a revised Framework in 2010 that
included two chapters that were also issued by the FASB (Chapter 1: The objective of general
purpose financial reporting and Chapter 3 Qualitative characteristics of useful financial
information).

In 2018 the IASB issued a revised Framework which came into effect immediately. Five of
the chapters are new, or have been revised substantially: Financial statements and the
reporting entity; the elements of financial statements; recognition and derecognition;

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Measurement; and Presentation and disclosure. It also reintroduces the terms stewardship and
prudence.

The Framework adopted by the IASB in 2001 and the Framework issued in 2010 are still
referred to by some Standards, so remain in effect alongside the new 2018 Framework.

2.2 Generally Accepted Accounting Principles (GAAP)

Generally Accepted Accounting Principles or GAAP refers to all the concepts, principles,
conventions, laws, rules and regulations that are used to prepare and present financial
statements.

Generally accepted accounting principles vary from country to country, because each country
has its own legal and regulatory system. The way in which businesses operate also differs
from country to country.

2.3 Purpose and status of the Conceptual Framework

The framework defines the concepts and principles that underpin the preparation and
presentation of financial statements.

By the provisions of the 2010 framework, the major reasons for providing the framework are
to:

 assist IASB in promoting harmonization of regulations, accounting standards and

procedures relating to the presentation of financial statements by providing a basis for
reducing the number of alternative treatments permitted by the standards.
 Identify the essential concepts underlying the preparation and presentation of financial
statements.

 Guide standard setters in developing new accounting standards and reviewing existing
ones.
 Assist the preparers of financial statements in applying the standards (IFRSs) and in
dealing with topics that are yet to form the subject of any IFRS.
 Assist auditors in forming an opinion on whether financial statements comply with
standards (IFRSs)
 Assist users of financial statements in interpreting the information contained in a set
of financial statements prepared in conformity with the standards.

Note: The conceptual framework only sets guidelines and thus when there is a conflict
between it and an IFRS, the standard prevails.

2.4 Scope of the 2010 Framework

The IASC (predecessor of IASB) issued the Framework on the preparation and presentation
of financial statements in 1989. This was adopted by the IASB in 2001. However the joint
project between FASB (US) and IASB (Norwalk Agreement) resulted in the issue of a new
framework, Conceptual framework for financial reporting, in 2010.

The scope of the framework covers:

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 the objective of general purpose financial reporting
the qualitative characteristics of useful financial information
the definition, recognition and measurement of elements from which financial
statements are constructed and
concepts of capital and capital maintenance
2.4.1 The objective of general purpose financial reporting

The objective of general purpose financial reporting is to “provide financial information

about the reporting entity that is useful to existing and potential investors, lenders and other
creditors in making decisions about providing resources to the entity. Those decisions involve
buying, selling or holding equity and debt instruments and providing or settling loans and
other forms of credit’.

Note:

(1) Existing and potential investors, lenders and other creditors are identified as primary users
of general purpose financial reports. Other parties, e.g. regulators and members of the public,
may make use of the reports but the information included therein is not primarily directed to
them.

(2) Information is considered ‘useful’ if it helps the primary users of financial reports to
assess the prospects of future net cash inflows to an entity; such an assessment enables the
primary users to estimate the return that they can expect from transacting with the entity.

(3) To assess an entity’s prospect for future net cash inflows, the primary users need
information regarding (i) the resources of the entity and claims against the entity and (ii) how
efficiently and effectively the entity’s management has discharged its responsibilities.

2.4.2 Qualitative Characteristics of Useful Financial Statements

Qualitative characteristics are the attributes that make the information provided in financial
statements useful to users. The framework puts these attributes into two categories, namely:
A. Fundamental qualitative characteristics.

1. Relevance: Financial information is relevant when it is ‘capable of making a

difference in the decisions made by users”. Information is capable of making a
difference in a decision making process if it has predictive value, confirmatory (i.e it
provides feedback about previous evaluations) or both.
The nature and materiality of the information are critical factors in determining
whether or not information is relevant to the needs of users. Information is material if
its omission or misstatement could influence the economic decisions of users taken on
the basis of the financial statements

2. Faithful representation: Relevant information must be faithfully represented to be

useful. A faithful representation is one that is complete, neutral and free from error to
the extent possible.

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 a. A depiction is ‘complete’ if it includes all of the information that a user needs to
understand what is being reported, including all necessary descriptions and
explanations.
b. A depiction is ‘neutral if it is without bias in the selection or presentation of
financial information (not weighted or manipulated to increase the probability that
the financial information will be received favourably or unfavourably by users.
c. A depiction is ‘free from error’ if there are no errors or omissions in the
information provided and the process used to produce the reported information
has been selected and applied with no errors in the process.

B Enhancing Qualitative Characteristics.

1. Comparability

Users should be able to compare the financial statements of an entity over a period of
time to identify trends in its financial position and performance. Also, users should be
to compare the financial statements of different entities to determine their relative
financial position, performance and changes in financial positions.

2. Verifiability: this implies that different knowledgeable and independent observers

could reach a consensus, though not necessarily complete agreement, that the
financial statements are fairly presented or faithfully represented.

3. Timeliness: This means having information available to decision makers in time to be

capable of influencing their decisions. Generally, the older the information is, the less
useful it is.

4. Understandability

Information provided in financial statements should be readily understandable by

users who have a reasonable knowledge of business, economic activities and
accounting and a willingness to study the information with reasonable diligence.
However, information about complex matters relevant to economic decision-making
should not be excluded from the financial statements merely because they may be too
difficult for certain users to understand.

2.4.3 Elements of Financial Statements

The financial position of an enterprise is primarily provided in the Statement of Financial

Position. The elements include:

1. Asset: An asset is a resource controlled by the enterprise as a result of past events, and
from which future economic benefits are expected to flow to the enterprise.

2. Liability: A liability is a present obligation of the enterprise arising from the past events,
the settlement of which is expected to result in an outflow from the enterprise' resources, i.e.,
assets.
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3. Equity: Equity is the residual interest in the assets of the enterprise after deducting all the
liabilities. Equity is also known as owner's equity.

The financial performance of an enterprise is primarily provided in an income statement or

profit or loss statement. The elements of an income statement or the elements that measure
the financial performance are as follows:

4. Revenues: increases in economic benefit during an accounting period in the form of

inflows or enhancements of assets, or decrease of liabilities that result in increases in equity.
However, it does not include the contributions made by the equity participants, i.e.,
proprietor, partners and shareholders.

5. Expenses: decreases in economic benefits during an accounting period in the form of

outflows, or depletions of assets or incurrences of liabilities that result in decreases in equity.

2.4.4 Recognition of elements of financial statements

An item is recognized in the financial statements when it meets the definition of an element
of financial statement and:

 it is probable future economic benefit associated with the item will flow to or from an
entity and
 the item has a cost or value that can be measured with reliability.

There is no precise point that can be identified at which an event is assessed as being
probable. An entity is required to make an assessment based on the facts at the time of the
preparation of the financial statements.
Many items in financial statements are products of estimates because their values are not
known with certainty. Thus the use of estimates is an essential part of preparing financial
statements. So long the estimates are reasonable and conform to industry practice, it is
appropriate to recognise items in the financial statements on the basis of estimated values.
Recognition stages

Recognition of assets and liabilities fall under three stages –

i. Initial recognition – occurs when an item first meets the definition of an asset or
liability eg on acquisition of an asset.

ii. Subsequent re-measurement – when the value of an asset or liability is changed

from its initial recognition value eg revaluation of an asset.

iii. De-recognition – occurs when an item no longer meets the definition of an asset or
liability e.g an asset is sold or completely destroyed of a liability is waived.

2.4.5 Measurement of the Elements of Financial Statements

Definition of Concept: Measurement is the process of determining the monetary amounts at

which the elements of the financial statements are to be recognised and carried in the balance

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sheet and income statement. This involves the selection of the particular basis of
measurement.

Measurement Bases: A number of different measurement bases are employed to different

degrees and in varying combinations in financial statements. They include the following:

(a) Historical cost. Assets are recorded at the amount of cash or cash equivalents paid or the
fair value of the consideration given to acquire them at the time of their acquisition.
Liabilities are recorded at the amount of proceeds received in exchange for the obligation, or
in some circumstances (for example, income taxes), at the amounts of cash or cash
equivalents expected to be paid to satisfy the liability in the normal course of business.

(b) Current cost. Assets are carried at the amount of cash or cash equivalents that would
have to be paid if the same or an equivalent asset was acquired currently. Liabilities are
carried at the undiscounted amount of cash or cash equivalents that would be required to
settle the obligation currently.

(c) Realisable (settlement) value. Assets are carried at the amount of cash or cash
equivalents that could currently be obtained by selling the asset in an orderly disposal.
Liabilities are carried at their settlement values; that is, the undiscounted amounts of cash or
cash equivalents expected to be paid to satisfy the liabilities in the normal course of business.

(d) Present value. Assets are carried at the present discounted value of the future net cash
inflows that the item is expected to generate in the normal course of business. Liabilities are
carried at the present discounted value of the future net cash outflows that are expected to be
required to settle the liabilities in the normal course of business.

Broadly these measurement bases can be classified as cost-based, cash flow-based and
market price-based and they produce different results. However, the measurement basis most
commonly adopted by entities in preparing their financial statements is historical cost. This is
usually combined with other measurement bases. For example, inventories are usually carried
at the lower of cost and net realisable value, marketable securities may be carried at market
value and pension liabilities are carried at their present value. Furthermore, some entities use
the current cost basis as a response to the inability of the historical cost accounting model to
deal with the effects of changing prices of non-monetary assets.

2.4.6 Concepts of Capital and Capital Maintenance

Concepts of Capital

1. Financial Concept: A financial concept of capital is adopted by most entities in preparing

their financial statements. Under a financial concept of capital, such as invested money or
invested purchasing power, capital is synonymous with the net assets or equity of the entity.

2. Physical Concept: Under a physical concept of capital, such as operating capability,

capital is regarded as the productive capacity of the entity based on, for example, units of
output per day.

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The selection of the appropriate concept of capital by an entity should be based on the needs
of the users of its financial statements. Thus, a financial concept of capital should be adopted
if the users of financial statements are primarily concerned with the maintenance of nominal
invested capital or the purchasing power of invested capital. If, however, the main concern of
users is with the operating capability of the entity, a physical concept of capital should be
used. The concept chosen indicates the goal to be attained in determining profit, even though
there may be some measurement difficulties in making the concept operational.

Capital Maintenance and the Determination of Profit

The concepts of capital give rise to the following concepts of capital maintenance:

(a) Financial capital maintenance. Under this concept a profit is earned only if the financial
(or money) amount of the net assets at the end of the period exceeds the financial (or money)
amount of net assets at the beginning of the period, after excluding any distributions to, and
contributions from, owners during the period.

(b) Physical capital maintenance. Under this concept a profit is earned only if the physical
productive capacity (or operating capability) of the entity (or the resources or funds needed to
achieve that capacity) at the end of the period exceeds the physical productive capacity at the
beginning of the period, after excluding any distributions to, and contributions from, owners
during the period.

Note: 1. Only inflows of assets in excess of amounts needed to maintain capital may be
regarded as profit and therefore as a return on capital. Hence, profit is the residual amount
that remains after expenses (including capital maintenance adjustments, where appropriate)
have been deducted from income. If expenses exceed income the residual amount is a loss.

2. The physical capital maintenance concept requires the adoption of the current cost basis of
measurement. The financial capital maintenance concept, however, does not require the use
of a particular basis of measurement. Selection of the basis under this concept is dependent
on the type of financial capital that the entity is seeking to maintain.

2.5 2018 Framework on Financial Reporting

Overview

The framework describes the objective of, and the concepts for, general purpose financial
reporting

Purpose and status

Assists:

i. the IASB to develop Standards that are based on consistent concepts;

ii. preparers to develop consistent accounting policies when no Standard applies to a
particular transaction or other event, or when a Standard allows a choice of
accounting policy; and

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 iii. all parties to understand and interpret the Standards.

As indicted earlier (ref. 2010 framework), it is not a Standard and sits outside of IFRS
Standards. Nothing in the Framework overrides any Standard or any requirement in a
Standard.

The Objective of General Purpose Financial Reporting

The objective of general purpose financial reporting is to provide financial information about
the reporting entity that is useful to existing and potential investors, lenders and other
creditors in making decisions relating to providing resources to the entity. Those decisions
include buying, selling or holding equity and debt instruments, providing or settling loans and
other forms of credit, exercising rights to vote on, or otherwise influence, management.

General purpose financial reports provide information about the resources of, and claims
against, an entity and the effects of transactions and other events on those resources and
claims.

Qualitative Characteristics of Useful Financial Information

For financial information to be useful, it needs to meet the qualitative characteristics set out
in the Framework. The fundamental qualitative characteristics are relevance and faithful
representation.

Financial reports represent economic phenomena in words and numbers. To be useful,

financial information must not only represent relevant phenomena, but it must also faithfully
represent the substance of the phenomena that it purports to represent.

Faithful representation means the information must be complete, neutral and free from error.
Neutrality is supported by exercising caution when making judgements under conditions of
uncertainty, which is referred to in the Framework as prudence. Such prudence does not
imply a need for asymmetry, for example, a systematic need for more persuasive evidence to
support the recognition of assets or income than the recognition of liabilities or expenses.
Such asymmetry is not a qualitative characteristic of useful financial information. Financial
information is also more useful if it is comparable, verifiable, timely and understandable.

Financial Statements and the Reporting Entity

Financial statements are prepared from the perspective of an entity as a whole, rather than
from the perspective of any particular group of investors, lenders or other creditors (the entity
perspective). Financial statements are prepared on the assumption that the reporting entity is a
going concern and will continue in operation for the foreseeable future. A reporting entity is
an entity that chooses, or is required, to prepare financial statements. Obvious examples
include a single legal structure, such as an incorporated company, and a group comprising a
parent and its subsidiaries. A reporting entity need not be a legal entity, although this makes it
more difficult to establish clear boundaries when it is not a legal entity, or a parent-subsidiary
group. When a reporting entity is not a legal entity, the boundary should be set by focusing

18
on the information needs of the primary users. A reporting entity could also be a portion of a
legal entity, such as a branch or the activities within a defined region. The Framework
acknowledges combined financial statements. These are financial statements prepared by a
reporting entity comprising two or more entities that are not linked by a parent-subsidiary
relationship. However, the Framework does not discuss when or how to prepare them.

The Elements of Financial Statements

An asset is a present economic resource controlled by the entity as a result of past events. An
economic resource is a set of rights – the right to use, sell, or pledge the object, as well as
other undefined rights. In principle, each right could be a separate asset. However, related
rights will most commonly be viewed collectively as a single asset that forms a single unit of
account. Control links a right to an entity and is the present ability to direct how a resource is
used so as to obtain the economic benefits from that resource (power and benefits). An
economic resource can be controlled by only one party at any point in time.

A liability is a present obligation of the entity to transfer an economic resource as a result of

past events. An obligation is a duty or responsibility that an entity has no practical ability to
avoid.

An entity may have no practical ability to avoid a transfer if any action that it could take to
avoid the transfer would have economic consequences significantly more adverse than the
transfer itself. The going-concern basis implies that an entity has no practical ability to avoid
a transfer that could be avoided only by liquidating the entity or by ceasing to trade.

Equity is the residual interest in the assets of the entity after deducting all its liabilities.

Income is increases in assets, or decreases in liabilities, that result in increases in equity,

other than those relating to contributions from holders of equity claims.

Expenses are decreases in assets, or increases in liabilities, that result in decreases in equity,
other than those relating to distributions to holders of equity claims.

Recognition and De-recognition

Recognition is the process of capturing for inclusion in the statement of financial position or
the statement(s) of financial performance an item that meets the definition of one of the
elements of financial statements – an asset, a liability, equity, income or expenses.

The Framework requires recognition when this provides users of financial statements with
relevant information and a faithful representation of the underlying transaction.

The recognition criteria do not include a probability or a reliable measurement threshold.

Uncertainties about the existence of an asset or liability or a low probability of a flow of
economic benefits are circumstances when recognition of a particular asset or liability might
not provide relevant information. .

19
De-recognition is the removal of all or part of a recognised asset or liability from an entity’s
statement of financial position and normally occurs when that item no longer meets the
definition of an asset or of a liability. The de-recognition principles aim to represent faithfully
any assets and liabilities retained, and any changes in the entity’s assets and liabilities, as a
result of that transaction. Sometimes an entity will dispose of only part of an asset or a
liability, or retain some exposure. The Framework sets out the factors that the IASB should
consider when assessing whether full de-recognition is achieved, when de-recognition
supported by disclosure is necessary and when it might be necessary for an entity to continue
to recognise the transferred component.

Measurement

The framework describes two measurement bases: historical cost and current value. It asserts
that both bases can provide predictive and confirmatory value to users but one basis might
provide more useful information than the other under different circumstances.

Historical cost reflects the price of the transaction or other event that gave rise to the related
asset, liability, income or expense.

A current value measurement reflects conditions at the measurement date. Current value
includes fair value, value in use (for assets) and fulfilment value (for liabilities), and current
cost.

Presentation and Disclosure

The Framework presumes that all income and expenses are presented in profit or loss. Only
in exceptional circumstances will the IASB decide to exclude an item of income or expense
from profit or loss and include it in OCI (other comprehensive income), and only for income
or expenses that arise from a change in the current value of an asset or liability. The
Framework also presumes that items presented in OCI will eventually be reclassified from
OCI to profit or loss, but reclassification must provide more relevant information than not
reclassifying the amounts.

Concepts of Capital and Capital Maintenance

Sets out some high-level concepts of physical and financial capital. This chapter has been
carried forward unchanged from the 2010 Framework (which, in turn, was carried forward
from the 1989 Framework).

2.6 Fair Presentation

The IASB does not deal directly with this matter. However, IAS 1 does state that, “fair
presentation requires the faithful representation of the effects of transactions, other events and
conditions in accordance with the definitions and recognition criteria for assets, liabilities,
income and expenses set out in the IASB Framework.”
Fair presentation implies that:

20
  Transactions and events are accounted for, in such a way that reflects their substance
and economic reality rather than their legal form;
 The amounts in the financial statements are classified and presented, and disclosures
made in such a way that important information is not obscured and users are not
misled.
 Financial statements comply fully with all relevant accounting standards
issued/effective to end of reporting period.

IAS 1 states that a fair presentation requires an entity:

i. to select and apply accounting policies in accordance with IAS 8.
ii. to present information in a manner that provides relevant, reliable, comparable and
understandable information; and
iii. to provide additional disclosures where these are necessary to enable users to
understand the impact of particular transactions and other events on the entity’s
financial performance and financial position.

In extreme rare cases, compliance with a standard or an interpretation may produce financial
statements that do not give a fair presentation. In such cases, an entity can depart from the
requirements of the standard or interpretation. The entity then must disclose:

 that management has concluded that the financial statements present fairly the entity’s
financial position, performance and cash flows;
 that it has complied with applicable standards and interpretations, except that it has
departed from a particular requirement to achieve a fair presentation;
 the title of the standard or interpretation from which the entity has departed, the nature
of the departure, including the required treatment by the standard or interpretation, the
reason why that treatment would be misleading, and the treatment adopted; and
 for each period presented, the financial impact of the departure on each item in the
financial statements that would have been reported in complying with the
requirement.

IN-TEXT QUESTIONS

1. All the concepts, principles, conventions, laws, rules and regulations that are used to prepare
and present financial statements are known as ------------------------------------

2. Resources controlled by an entity as a result of past events are called -------------------

3. The 2018 Framework on Financial Reporting gives 2 broad measurement bases for the
elements of financial statements. These are ---------------- and -------------------------

4. The conceptual framework enjoys the same status as the accounting standards. True/False

IN-TEXT ANSWERS
21
1. Generally Accepted Accounting Principles (GAAP)

2. Assets
TUTOR-MARKED ASSIGNMENT (TMA)
i. Discuss the major reasons for providing the conceptual framework for financial reporting.

ii. Information provided in financial statements are useful to users when they possess certain
attributes. These required attributes are referred to as the qualitative characteristics of
financial information.

Required:

Discuss two fundamental and any four enhancing qualitative characteristics of financial
information.

iii. In the measurement of elements of financial statements, a number of different

measurement bases are employed to different degrees and in varying combinations in
financial statements. Discuss any four bases adopted in the measurement of elements of
financial statements.

iv(a). Explain the concept of “Fair Presentation.”

(b). Where fair presentation conflicts with the requirements of an accounting standard
or interpretation, an entity is permitted to depart from the requirements of such
standard or interpretation.

Discuss the disclosure requirements when there is such a departure.

22
Unit 3 ANALYSIS OF FINANCIAL STATEMENTS I

Introduction
Financial statements are analysed using different techniques. In our study we employed the
most widely used technique in analysis, that is, the ratio. For the purpose of our study, we
have categorised these financial ratios into four namely, long-term solvency and stability
ratios, short term solvency and liquidity ratios, efficiency and profitability ratios and potential
and actual growth ratios.

This unit discusses long term solvency and stability ratios and short term solvency and
liquidity ratios. The last two are discusses in unit 4 of this module.

Specific Objectives
By the end of this unit, students should be able to:
1. Identify the three techniques of analysing financial statements;
2. Describe the basic steps in analysing financial statements,
3. Identify and discuss long-term solvency and stability ratios
4. Identify and explain short term solvency and liquidity ratios
5. Apply these ratios in economic/investment decision making

3.1 Techniques of analysing financial statements

Financial statements are analyzed using three basic techniques:

1. Straightforward criticism/Analytical Review: Here, the analyst studies the

relationship between elements in the financial statements and compares them with
comparable information for a period or periods, and with information relating to
similar entities.
2. Movement of Funds Statement: This assists the analyst in appreciating an entity’s
basis of generating and utilizing funds within a period. It highlights the gap (if any)
between internally generated sources of funds and the planned use of fund and the
volume of such gap.
3. Ratio Analysis: The most popular and widely used analytical tool is the ratio. A ratio
is one number expressed in terms of another number, to show the relationship
between the two numbers. It is expressed in terms of a common base, which could be
1, 10, or 100 (known as percentage). The type and nature of the analytical
tool/technique used depends on the target of the analyst and the magnitude of the

23
 decision sought. Using ratios, trends analysis, cross sectional comparison/analysis;
peer group analysis etc. could be done.

3.1.1 Basic Steps in Financial Statements Analysis

The analysis of financial statements demands:

 A thorough and clear appreciation of the need or purpose to be served by the

analysis;
 A good understanding of the conceptual framework of accounting and the
peculiarity of the practical principles;
 An appreciation of the significance of the relationship between figures in the
financial statements;
 Ability to select from a myriad of ratios, the best representative ones that serve
the need of the individual or organisation requesting for the analysis. Each
ratio is common as well as unique information;
 Ability to look beyond the results obtained from ratios and make use of other
sources of information in drawing conclusions regarding the state of the
organisation being studied, and
 A good skill in the preparation of reports, and summarising the deductions that
have been made.

3.1.2 Classes of financial ratios

For the purpose of our study, we shall group ratios into the following categories:

1. Long-term solvency and Stability ratios

2. Short-term solvency and liquidity ratios
3. Efficiency and Profitability ratios
4. Potential and Actual Growth ratios

3.2 Long-term Solvency and Stability Ratios

Of all the factors germane to a firm’s survival, solvency is the most important. It relates to the
ability of the firm to meet its debts as they fall due, whether in the short term or long term.

On the other hand, financial stability is a measure of how safe a company is from failure
because of its inability to meet its obligations. A company could meet its obligations in the
short term, but still face long-term solvency problem, if there are not enough resources to
meet long-term debts.

Important ratios to be considered under this category and their interpretations include:

A. Fixed Interest Cover

EBIT (Earnings before interest & tax)

Fixed interest

24
This ratio indicates how many times interest paid on borrowed funds is covered by net
earnings (profits) before charging the interest and tax.

The higher this ratio is the better. A low cover (ratio) can make a business vulnerable to
fluctuations in interest rates. Also, low cover has implications concerning the ability of an
enterprise to finance other areas of its business from retained profit and its ability to repay its
debts from profits.

Also, a low cover limits the company’s ability to borrow, especially during periods of violent
fluctuations in profits or periods of recession. The inability of an enterprise to meet its fixed
interest commitment (for instance, Secured Debenture interest) can lead to the initiation of
winding up proceedings.

B. Total Debt to Shareholders’ Funds (Debt/Equity Ratio)

This is a test of financial stability and indicates the extent of cover available to external
liabilities. It is defined as:

Total External liabilities (short & long term)

Shareholders’ funds (or net worth)

This ratio complements the gearing or leverage ratio (see (c) below). It reveals when, apart
from borrowed money, a firm is relying heavily on its customers to finance its turnover. The
interest of the analyst should be on the trend shown by this ratio. Is it rising or falling? A
steeply rising trend in this ratio can indicate that a company is under-capitalized and could be
vulnerable if external liabilities are reduced due to factors beyond its control, for instance, if
creditors reduce terms of trade.

C Gearing or Leverage (Debt/Networth) Ratio

Broadly speaking, this ratio is expressed as

Fixed Interest Loans + Preference capital

Shareholders’ funds or net worth or capital employed.
This is borrowed funds expressed as a ratio of shareholders’ funds or capital employed.

Note: The formula for this ratio will change if the entity’s policy is to treat Preference shares
as equity (e.g. irredeemable and cumulative preference shares) in accordance with IFRS 32.
In that case preference shares form part of shareholders’ fund and no longer as part of the
numerator.

There are variants of this ratio depending on the information the analyst intends to portray.
Thus we can compute:

i Capital gearing adjusted for Directors Loans

The computation of this ratio depends on the analyst’s judgment and the stability of the
loans. If the loans have been stable over a reasonable number of years, say a five-year

25
period, it would seem appropriate to regard the loans as supplementing shareholders’ funds
and as such can be included in the net worth.

ii Capital gearing adjusted for “hidden Reserve”

This brings in the fixed Assets (non-current assets) at their current valuation in the
computation of net worth. Again, everything depends on the Analysts’ judgment and needs.

iii. Capital gearing adjusted for contingent liabilities

Contingent liabilities are potential liabilities whose materialization depends on the happening
of a certain event. For example, a contracting company fails to execute a contract for which a
bank has given an advance payment guarantee or a performance bond. The Bank will be
required to pay to the owner of the job the amount advanced or value of the performance
bond as the case may be.

When this happens, the liability is said to have “crystallised” and is now an actual liability.
Thus, the inclusion of contingent liabilities in the computation of capital gearing will depend
on the assessed probability of its crystallisation.

iv. Potential Capital Gearing: An analyst may need to consider the gearing position of a
company assuming full utilization of whatever levels of credit that are available to the
company. That is, computing full potential gearing in order to assess total exposure to net
worth.

It should be noted that the results obtained from these different ways of computation could
vary considerably. Thus before considering whether a ratio points to a problem, the analyst
must be fully aware of what is (or is not) included in the computation of the ratio.

There is no simple mathematical formula to give a satisfactory gearing level. However the
analyst should be more comfortable with a highly geared situation (borrowed funds are much
higher than equity) if the company has a long and profitable track record than if it is a new
business or an old company with a poor recent history of profit performance. High debt ratio
implies high payouts in form of interest loan service. Thus the higher the gearing ratio, the
more need there is to be cautious, as the business could be vulnerable to fluctuations in its
fortunes.

The type of business is also crucial when assessing gearing levels. Generally, distributive
business is better able to maintain and manage higher gearing levels than a manufacturing
company whose assets are tied up in manufacturing plant and machinery.

d. Long-term debt to shareholders’ funds

This ratio provides a relationship between a company’s long-term funds provided by creditors
and those provided by the enterprise’s owners. It is expressed as:

Long-term Debt
Shareholders’ funds

26
This ratio highlights the extent of cover for fixed liabilities, for instance loans, debentures,
and warns about the volume of additional loans to be extended to the company. This ratio is
better compared with the industry average

e. Proprietary Ratio

This is shown as

Shareholders’ funds (share capital + reserves)

Total tangible Assets

This ratio indicates the degree to which unsecured creditors are protected in the event of
liquidation. How much per naira of their investment will they be able to get, should the
business go under? It gives an indication of the credit worthiness and financial risks of the
company: how much of the total assets are financed by the shareholders.

3.3 SHORT-TERM SOLVENCY AND LIQUIDITY RATIOS

These ratios establish the relationship between short-term resources owned and external
obligations, which have to be met in the near future. Liquidity refers to a company’s ability to
pay bills as they arise. Though shareholders bear the ultimate risk of losing their capital in the
event of insolvency, unsecured creditors likewise run the risk of financial losses. When the
financial fortune of an enterprise is deteriorating, the long-term secured creditors may attempt
to realise their security. In the case of unsecured short-term creditors, they have nothing to
fall back on, and thus, it is dangerous for this class of creditors to allow credit to a firm that is
running into financial difficulties.

Some of the ratios that measure short-term solvency and liquidity include:

a. Stock (or inventory) Turnover)

This is expressed as

COST OF SALES
AVERAGE STOCK

Average stock is opening stock plus closing stock divided by two. Where opening stock is not
available, this ratio is computed using the formula:

TURNOVER (OR SALES)

INVENTORY (CLOSING STOCK),

which gives a rough measure of how many times per year the inventory level is replaced.
This ratio, in essence, gives the rapidity with which a company’s investment in stock is
turned over into Receivables or Cash through sales.

Ideally, a rapid turnover is beneficial in the sense that cash is tied up in inventory for a
shorter period. However, the optimum period of inventory turnover will depend on the nature
of the stock and the type of business being considered.

27
Trends are important issues to consider in assessing this ratio. A lengthening of the stock
holding period may indicate obsolete/slow moving items or damaged stocks that may
ultimately be unsellable, or overstocking or stiffer competition leading to low sales.

Note: Stock/inventory Holding Period (Days) = 360 or 365 days or Av. Stock X 365 days
Rate of Stock turn COGS

b. CURRENT RATIO

This ratio is computed as follows:

Current Assets
Current Liabilities

This ratio is a broad indicator of a company’s short-term financial position, as it presents a

measure of the ability of a business to meet its short-term liabilities from funds generated
from current assets. It relates a firm’s pending need for cash to pay short-term liabilities to its
present cash and near-cash position.

Again, it is important to examine the trend. A falling trend in the current ratio, besides
indicating a reducing ability to meet payments for current liabilities from current assets, may
indicate reducing profit margin or losses.

Also, a reducing current ratio may arise from investment of liquid (short-term) funds in fixed
assets, for example, borrowing on overdraft to finance fixed asset purchases (regarded as
funds mismatched). Generally, a surplus of current assets over current liabilities (a ratio of
more than 1) is a sign of good business, but an unusually large ratio such as 4:1 or more may
indicate excess stockholding or slow paying debtors or excess holding of cash and cash
equivalents that may be more profitably invested.

c. QUICK OR ACID TEST RATIO

The quick ratio assumes that stocks and prepayments are not readily converted into cash and
as such are excluded from current assets. The ratio thus concentrates on cash, Marketable
Securities and Receivables in relation to current obligations and thus provides a more realistic
measure of liquidity than does the current ratio. The ratio is given as:

Current Assets –Inventories – Prepayments

Current Liabilities
The higher the quick ratio, the more liquid the firm’s position is. Again, trend analysis is
important here. Generally, the current and quick ratios should move in line. A static or
increasing current ratio together with a falling quick ratio would indicate an increasing
amount of money tied up in inventory. A quick ratio greater than 1 is normally considered
desirable, although for many large retail organizations, a ratio of less than 1 may be tolerable.

d. WORKING CAPITAL TURNOVER

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Working capital (or Net Current Assets –NCA) is defined as Current Assets less Current
Liabilities. This ratio determines the relationship between Sales and Working Capital, and is
expressed as:

SALES
NCAs (or working capital)

A rising trend in this ratio may indicate overtrading – a situation whereby sales are increasing
without the necessary additional working capital. In the short term, overtrading could be
managed by good control over stock, debts and creditors, but in the long run, overtrading
could bring about increasing pressure on liquidity and overdraft facilities, if any.

As the ratio provides an indication of the working capital needed to finance a given level of
sales, it could be used to calculate the approximate level of working capital needed to finance
a projected increase in the level of sales.

For example, assume Current Sales is ₦1.3M and Sales is projected to increase by 24%.
Assume also Net Current Assets (Working Capital) to be ₦207,000. Then, NCA/Sales is
approximately 16%. Thus, this capital measure equates approximately 16% of sales. Since
sales is projected to increase by 24% x ₦1.3M = ₦312,000, the projected extra capital (fund)
requirement is thus 16% x ₦312,000 or N49,920.

e. DEBTORS TURNOVER (Sales/Trade Debtors)

This ratio shows the number of times debtors pay for credit sales. The ratio gives an
indication of the way the credit policy of the company may have stimulated sales.

Note: Dividing 365 days by the Debtors turnover ratio gives the average collection period.

f. DEBTOR COLLECTION (RECOVERY) PERIOD (DEBTORS’TURNOVER

PERIOD)

This is defined as

DEBTORS x 365 days

CREDIT SALES

The ratio gives the number of days (months or weeks) taken to collect payment for sales on
credit. It is generally referred to as the average collection period, and gives an indication of a
company’s credit control policy. The average collection period should be considered in the
light of a firm’s terms of trade and the industry average. The quicker the debt recovery rate,
the better, as long as this has a beneficial impact on the cash flow. More important than the
absolute values revealed by this ratio is the trend disclosed. A lengthening of the Debtors
Turnover period (average collection period) could indicate –

1. Lax control by the company’s invoicing department

29
 2. Market competition forcing the company to extend its terms of trade in order to
maintain its clientele and sales volume.
3. Slow paying and potential bad debts that may be included in the company’s debtor
book

A shortening of the average collection period is good but may be detrimental in certain
circumstances. While a rapid recovery rate may have a positive cash impact, it may have
been attained by excessive pressure on customers because of cashflow problems. This could
lead to loss of future sales.

g. CREDITORS PAYMENT PERIOD

This ratio is expressed as

Creditors X 365 Days (or 12 months or 52 weeks)

Credit purchases

This index measures the credit period taken from suppliers - the number of days or months or
weeks taken to pay suppliers (creditors). This ratio should be considered in the light of the
terms of trade enjoyed from suppliers. Again, trend analysis is important. While lengthening
the period (ratio) may improve cashflow, it can lead to loss of credibility and goodwill. On
the other hand, a shortening of the period may indicate concern on the part of suppliers or a
change in terms of trade from them.

h. CASHFLOW TO DEBT

Cashflow in this case is defined as funds generated from operations during the year- PBT
(Profit Before Tax) adjusted for depreciation. It is a measure of a company’s ability to service
its debts from its annual cashflow. The ratio is expressed as:

ANNUAL CASHFLOW (PBT + DEPRECIATION)

TOTAL LIABILITIES
This ratio is useful in assessing the credit worthiness of a company seeking additional
external funding, such as a bank loan. The analyst should view this ratio in relation to the
volume of the additional funding required as well as with the existing debt structure of the
company.

i. CASH RATIO

For the purpose of this ratio, cash is defined as physical cash holdings of the company and its
readily encashable assets such as Marketable Securities. The essence of cash ratio is to
narrow down the waiting time within which current liabilities can be settled and regular
business of the enterprise continued without hindrance. The cash ratio is expressed as:

CASH RATIO = CASH + MARKETABLE SECURITIES(Cash equivalents)

CURRENT LIABILITIES

30
 The ratio gives a firm’s most liquid position as number of times its cash holding can meet
current liabilities. It measures the ability of the entity to settle current (short term) obligations
as at the Balance sheet date. A very low ratio signals some level of illiquidity, while a very
high level gives an indication of poor cash management as an unusually large volume of cash,
that otherwise should have been invested is being kept idle.

If more cash than is needed for the ordinary course of the firm’s business is retained, this is a
sign of inefficiency, as cash earns the lowest rate of return among all asset classes.

IN-TEXT QUESTIONS (ITQ’s)

1 Three techniques of analyzing financial information are accounting ratio, fund flow
statement and _________
2 Financial ratios are classified into --------- major categories.
3 -------------indicates the degree to which unsecured creditors are protected in the
event of liquidation

4 _________ are potential liabilities whose materialization depends on the happening

of a certain event.
5 ……………is another name for liquidity ratio.

6 _________ is also regarded as overtrading.

7

IN-TEXT ANSWERS (ITA’s)

1 Analytical review

2 Four

3. Proprietary ratio

4. Contingent liability

5. Acid test ratio or quick ratio

6. Under-capitalisation

31
Unit 4 FINANCIAL ANALYSIS II

Introduction

In this unit, we examine the ratios under efficiency and profitability category as well as the
investment ratios. Limitations of ratios as decision making tools are also highlighted. Finally,
there is a worked comprehensive example to illustrate the application of the ratios in making
economic decisions.

Specific Objectives
At the end of this unit, students should be able to:
1. Differentiate between efficiency and profitability;
2. Describe the different methods of calculating ROCE.
3. Discuss the limitation of ratio analysis as a decision making tool;
4. Compute specified ratios and discuss their implications for strategic and routine
management decisions
5. Identify the reason why the growth ratios are regarded as investors’ ratios;
6. Evaluate the performance of entities in terms of financial stability, profitability,
liquidity and growth using ratio analysis

4.1 Efficiency and Profitability Ratios

Efficiency ratios attempt to assess the financial performance of an enterprise by reference to

its ability to generate income and increase the wealth of shareholders. Profitability refers to
the relationship between profit and the resources employed in earning it. Thus, profitability
ratios measure the degree of returns generated by reference to some other magnitude, that is,
assets and other resources employed to generate the profit. It is not enough to report that the
firm has made profit; the efficiency of the process must be assessed, to show how well the
managers are utilizing resources at their disposal.

Some of the efficiency and profitability ratios of interest to the analyst include:

a. GROSS PROFIT RATIO

This ratio is expressed as

Gross profit x 100

32
Sales

Gross profit is the excess of Sales/Turnover/Gross Earnings over cost of sales.

It should be noted that this ratio will vary from business to business. Trends in the Gross
Profit margin should be noted, if possible, the underlying reasons explained and ascertained.

A falling trend could indicate one or a combination of the following:

1. The business is becoming unprofitable as a result of reduction in pricing policy

necessitated by rising competition in the market.
2. There is an increase in costs of one or more of the components of Cost Goods Sold,
which the firm cannot, due to competition, pass on to its customers.
3. A deliberate policy by the management of the enterprise to reduce prices to increase
sales volume.
4. Different sales mix.

b. NET PROFIT MARGIN

This expresses the Net Operating profits as a percentage of Sales, that is

Profit before tax x 100%

Sales

Note: Profit after tax could be used; in that case management is held responsible for tax
planning to reduce the impact of tax expense on profits.

This ratio represents the premium gained by a firm for its net profit over its production costs.
The absolute value of this ratio will vary from industry to industry. Variations in net profit
margin ratio from one year to another will be accounted for by variations in gross profit and
the overhead expenses. Thus, this ratio will reveal the level of cost control of the firm.

Note: EBIT (Earnings or Profit before Interest and Tax) could be used in the calculation of
this ratio. In this case, the cost of borrowed funds (interest) is treated in the same platform as
Preference or Equity Dividend (that is, as an appropriation of profit.)

C. SALES TO TOTAL ASSETS RATIO

This is an efficiency ratio that measures management’s efficiency in the utilisation of assets
(all resources) in generating revenue and enhancing the value of the firm. It is expressed as:

SALES
TOTAL ASSETS
A declining trend in this ratio implies under-utilisation or under-employment of assets.

NOTE: In employing any asset-based ratio in comparing firms, care must be taken to ensure
that the assets of the companies are valued on the same basis - either historical cost and/or
current market value basis.

33
C(i) Return on Total Assets(ROTA): PBT or PAT
Total assets
This ratio measures management’s efficiency in the utilization of all assets in generating
profits and increasing cashflow and shareholders’ funds.

d. SALES TO CAPITAL EMPLOYED

Capital employed in this case is net capital employed, that is, the fixed assets plus net current
assets.

The ratio is expressed as:

Sales
capital employed

Like the ratio in (c) above, this is an activity ratio and it shows how efficiently the firm is
managing its assets. In general, high ratios are associated with good asset management.

e. RETURN ON CAPITAL EMPLOYED

This is a primary ratio that measures the overall profitability of the business. It is expressed
as follow:

Sales x Net Profit

Capital Employed Sales

Cancelling out, we have

Net Profit
Capital Employed

Opinions differ on what constitutes capital employed and profit in this regard. Depending on
the interest group being served by the analysis, any of the following could be applied:

ROCE CAPITAL EMPLOYED PROFIT

1 Shareholders’ fund +long-term loans + Profit before Interest and Tax

Current liabilities

2 Shareholders’ funds + long-term loans Profit before loan interest but after
overdraft interest

3 Shareholders’ fund PAT but bef. preference dividend

4 Equity holders’ fund Profit bef. tax and preference dividend

34
Option 2 gives a broader view of both earnings and capital employed. ROCE indicates the
earning power of the enterprise. It highlights the utilization of assets as well as profitability
on sales. An improvement in the earning power of the firm will result if there is an increase in
turnover on existing assets, an increase in the net margin, or both. Trend monitoring is very
important

4.2 Potential and Actual Growth Ratios (Investors’ ratios)

These are capitalization or investment ratios employed primarily in determining the share
value of the enterprise. They give an indication of the current worth of the company and its
projected future worth/growth.

a. EARNINGS PER SHARE (EPS)

This is defined as

Profit available for equity holders

Equity Shares in issue and ranking for dividend
It is expressed in kobo per share.

EPS is a good measure of a company’s performance and is of particular importance in

comparing the results over time. A company must be able to maintain its earnings in order to
pay dividends and reinvest in the business so as to achieve future growth. Trend analysis is
equally important here.

b. DIVIDEND PER SHARE (DPS)

This is defined as:

Total Dividends
No. of Ordinary Shares

DPS indicates the dividend and retention policy of the company. It is a major component of
the payout ratio (defined as DPS/EPS), which is important to shareholders as it has an impact
on their share value. To the analyst, it is an indication of profitability, good management and
liquidity.

DIVIDEND COVER

Indicates how many times current period’s net earnings can pay current level of dividends. A
measure of company’s ability to pay dividends out of profits generated.

It is expressed as: Profit after tax

Dividends declared/paid

C. PRICE/EARNINGS (P/E) RATIO

This is a good yardstick for assessing the relative worth of a share. It is defined as:

35
Market price (ex.div.) per ordinary share
EPS
Or

Total market value of equity

Total Earnings (attributable to ordinary shareholders)

This ratio is equal to the number of years’ earnings needed to cover the current market price
of the share. The P/E ratio reflects the market’s appraisal of the shareholders’ future
prospects. To the investor, it reflects two key considerations, viz:

1. The market price of a share

2. Its earning capacity.

To the lender, a higher P/E ratio might indicate that a firm is in a more secure industry or that
its earnings are expected to increase faster above the average rate. It predicts a firm’s future
performance.

d. EARNINGS YIELD

This gives an indication of the potential yield on the investment.

It is given as:

Gross earnings/share x 100%

Market price per share

The earnings yield highlights the amount earned on the shares relative to the market price. It
enables an investor to compare the returns from the shares/company with interest yields from
loan stock and gilts.

E. Dividend Yield

Dividend yield gives an indication of current return on investment. It is given as:

Dividend Per share x 100%

Market price per share

Like earnings yield, it affords a comparison between the investment and other available
investments elsewhere and assists an investor decide on where to invest.

Generally, ratios indicating growth are referred to as Stock Market Ratios, as they are
difficult to employ in assessing unquoted organizations.

4.3 Limitations of Ratio Analysis

36
The limitations of ratios as a decision making tool include:

1. Ratios are quantifiable data. They do not provide non-quantifiable information like
competence of management and staff, changes in the operating environment etc
2. The value of ratios may be eroded by inflation. Financial statements from which the
figures are derived are prepared on historical basis, and offers little value in assessing
future prospects of a company.
3. Managers start creative accounting when they sense things are going wrong. This
makes ratios computed from such accounting figures very unreliable.
4. Some of the ratios do not have universally accepted uniform parameters.
5. When carrying out inter-firm comparison, different accounting policies adopted by the
companies could distort ratios computed.
6. Some of the financial statements (especially the statement of financial position) are
static in nature while the business environment itself is dynamic.
7. They are not useful for budget preparation where predictions and forecasts are
required.
8. Unless ratios are calculated on a uniform basis, from a uniform data, comparisons can
be misleading.
9. A few simple ratios do not provide automatic means of running a company. Business
problems usually involve complex patterns which cannot be solved solely by the use of
ratios.

WORKED EXAMPLE
Angel Michael is a publicly listed company that assembles domestic electrical goods which
it then sells to both wholesale and retail customers. Angel Michael’s management were
disappointed in the company’s results for the year ended 31 December 2018. In an attempt to
improve performance the following measures were taken early in the year ended 31
December 2019:
i. a national advertising campaign was undertaken
ii. rebates to all wholesale customers purchasing goods above set quantity levels
were introduced,
iii. the assembly of certain lines ceased and was replaced by bought in completed
products. This allowed Angel Michael to dispose of surplus plant.

Angel Michael’s summarized financial statements for the year ended 31 December 2019 are
set out below

Statement of Comprehensive Income for the year ended

=N=million
Revenue (25% cash sales) 8,000
Cost of sales (6,900)
Gross profit 1,100
Operating expenses (740)
Profit on disposal of plant (note (i)) 80
Finance charges (40)

37
Profit before tax 400
Income tax expense (100)
Profit for the period 300

Statement of Financial Position =N=million

Non-Current Assets:
Property, plant and equipment (note (i)) 1,100

Current Assets
Inventory 500
Trade receivables 720
1,220
Total Assets 2,320

Equity and Liabilities

Equity shares of 25 kobo each 200
Retained earnings 760 960

Non-current liabilities
8% loan Notes 400
Current liabilities
Bank overdraft 20
Trade payables 860
Current tax payable 80 960
Total equity and liabilities 2,320

Below are ratios calculated for the year ended 31 December 2018:

Return on year end capital employed (profit before interest & tax over total assets less current
liabilities) 28.1%
Net assets (equal to capital employed) turnover 4 times
Net profit (before tax) margin 6.3%
Current ratio 1.6:1
Closing inventory holding period 46 days
Trade receivables’ collection period 45 days
Trade payables’ payment period 55 days
Dividend yield 3.75%
Dividend cover 2 times

Notes:
(i) Angel Michael received N240 million from the sale of plant that had a carrying
amount of N160 million at the date of its sale.
(ii) The market price of Angel Michael’s shares throughout the year averaged N3.75

38
 each.
(iii) There were no issues or redemption of shares or loans during the year.
(iv) Dividends paid during the year ended 31 December 2019 amounted to N180
million, maintaining the same dividend paid in the year ended 31 December 2018.
Required:
(a) Calculate ratios for the year ended 31 December 2019 for Angel Michael equivalent
to those provided above.
(b) Comment on the profitability and liquidity positions of Angel Michael for the year
ended 31 December 2019 compared to the previous year.

Suggested Solution

ANGEL MICHAEL PLC

a. Note: figures in the calculations are in =N=million

i. Return on year end Capital Employed: 440 / (2,320 – 960) x 100 = 32.3 %

ii. Net asset turnover: 8,000/1,360 = 5.9 times

iii. Net profit (before tax) margin: (400/8,000) x 100 = 5.0 %

iv. Current ratio: 1,220: 960 = 1.3 :1

v. Closing inventory holding period: 500/6,900 x 365days = 26 days

vi. Trade receivables’ collection period: 720/(8,000 – 2,000) x 365 = 44 days

vii. Trade payables’ payment period (based on cost of sales):

(860/6,900) x 365 = 45 days
viii. Dividend yield: DPS = 180,000/800,000 = 22.5k
Dividend yield =DPS/MPS = 22.5/375 x 100% = 6.0%

x. Dividend cover: 300/180 = 1.67 times

39
(b) Analysis of the comparative profitability and liquidity positions of Angel Michael
for the years ended 31 December 2019 and 2018.

Profitability

S/N. Ratio 2019 2018 % Change

1. ROCE 32.3% 28.1% 15%

2. Net Asset Turnover 5.9 times 4 times 48%

3. Net profit (before tax) 5.0% 6.3% -21%

margin

The measures taken by management appear to have been successful as the overall ROCE
(considered as a primary measure of performance) has improved by 15% (32.3 -28.1)/28.1).
Looking in more detail at the composition of the ROCE, the reason for the improved
profitability is due to increased efficiency in the use of the company’s assets (asset turnover),
increasing from 4 to 5.9 times (an improvement of 48%). The improvement in the asset
turnover has been offset by lower profit margin (a fall of about 21%). On the surface, this
performance appears to be due both to the company’s strategy of offering rebates to
wholesale customers if they achieve a set level of orders and also the beneficial impact on
sales revenue of the advertising campaign. The rebate would lead to lower gross profit
margin, and the cost of the advertising has reduced the net profit margin (presumably
management expected an increase in sales volume as a compensating factor). The decision to
buy complete products rather than assemble them in house has enabled the disposal of some
plant which has reduced the asset base. Thus possible increased sales and a lower asset base
are the cause of the improvement in the asset turnover which in turn, as stated above, is
responsible for the improvement in the ROCE.

The effect of the disposal needs careful consideration. The profit (before tax) includes a profit
of N80 million from the disposal. As this is a ‘one-off’ profit, recalculating the ROCE
without its inclusion gives a figure of only 23.7% (360m/(2,320 - 960m + 160m (the 160m is
the carrying amount of plant)) and the fall in the net profit percentage (before tax) would be
down even more to only 4.0% (320m/8,000m). On this basis the current year performance is
worse than that of the previous year and the reported figures do not truly reflect the
company’s underlying performance.

Liquidity

S/N. Ratio 2019 2018 % Change

40
 1. Current ratio 1.3: 1 1.6 : 1 (18.75%)

2. Closing Inventory Holding 26 days 46 days 43.5%

Period

3. Receivables Collection Period 44 days 45 days 2. 22%

4. Trade Payable Payment period 45 days 55 days (18.18%)

The company’s liquidity position has deteriorated during the period. A fairly acceptable
current ratio of 1.6 has fallen to a worrying 1.3. With the trade receivables period at virtually
a constant (45/44 days), the change in liquidity appears to be due to the levels of inventory
and trade payables. These give a contradictory picture. The closing inventory holding period
has decreased markedly (from 46 to 26 days) indicating more efficient inventory holding.
This is perhaps due to short lead times when ordering bought in products. The change in this
ratio has reduced the current ratio. However the trade payables payment period has decreased
from 55 to 45 days which has increased the current ratio. This may be due to different terms
offered by suppliers of bought in products.

The effect of the plant disposal on the liquidity position should be noted. The disposal has
generated a cash inflow of N240 million, and without this the company’s liquidity would
look far worse.

IN-TEXT QUESTIONS (ITQ’s)

1. ------------measures management’s efficiency in the utilization of all assets in

generating profits and increasing cashflow and shareholders’ funds .

2…………………attempts to assess the financial performance of an enterprise by

reference to its ability to generate income and increase the wealth of shareholders.

3. ……………. indicates the dividend and retention policy of the company.

4. …………… highlights the amount earned on the shares relative to the market price

IN-TEXT ANSWERS (ITA’s)

1. Return on Total Assets (ROTA)

2. Efficiency ratio

3. DPS

4. Earning Yield

41
TUTOR- MARKED ASSIGNMENT (TMA)
The following relates to the business of Gilt-Edge Digitals Ltd for the year ended 31 December 2018:
Rate of inventory turnover (calculated using average inventory) 20 days
Gross margin 50%
Net Margin 15%
Dividend paid as percentage of profit for year 25%
Payables payment period 32 days
Receivables collection period 28 days
Current ratio 3:1
Other information given include:
Issued share capital of 500,000 ordinary shares of 50k each
Retained earnings as at January 1 was N73,424.
Inventories as at 31 December 2018 was valued at N14,000.
Inventories as at January 1, 2018 was valued at N10,000.
READprice
The market MORE: of anhttp://www.ddegjust.ac.in/studymaterial/bba/bba-204.pd
ordinary share in Gilt-Edge Digitals at 31 December 2018 was N0.80.
The following performance ratios have been prepared by an analyst. They relate to similar businesses’
performance ratios in the same industry and environment as Gilt-Edge Digitals Ltd.
Dividend yield 5.6%
Dividend cover 3 times
Dividend per share 10.7 kobo
Earnings per share 32 kobo
Price earnings ratio 5.9
Required:
a. Prepare the Statement of Profit or Loss and Other comprehensive Income for the year ended 31
December 2018 in as much detail as possible. (3 marks)
b. Prepare the Statement of Financial position in as much detail as possible (Non-current assets and
cash and cash equivalents are balancing figures). (3 marks)
c. calculate similar ratios for Gilt-Edge Digitals as the industry ratios given above. (5 marks)
d. Explain what any THREE of the performance ratios indicate. (3 marks)
e. Comment on the calculated ratios in relation to the industry average. (4 marks)
(Total: 18 marks)

42
SELF-ASSESSMENT QUESTIONS

1(a) Explain the terms “profitability” and “financial stability”. (3 marks).

(b) The figures below relate to a medium sized firm.
=N=
For the year ended 31 December 2018:
Gross profit 797,000
Net profit 255,000
Turnover (Sales) 2,743,000

As at 31 December 2018:
Shareholders’ funds 1,335,000
Total tangible assets 2,008,000
Total current assets 32,000
Total current liabilities 25,000
Long-term loans 648,000
Non-liquid current assets 19,000

Required:
(i) From the above figures, compute three profitability ratios and three financial stability/liquidity
ratios. (6 marks)
(ii) Explain what each of the computed ratios indicates. (6 marks)
(Total 15 marks)

2(a). Section 377(2) and sched.1 of the Companies and Allied Matters Act, 2020 detail the form and
content of annual financial statements.

Required
State the required contents of annual financial statements as stipulated by the Act. (9 marks)

b. Discuss three reasons for having a regulatory framework for financial reporting.
(6 marks)
(Total 15 marks)

43
MODULE 2 ACCOUNTING AND REPORTING STANDARDS I

Image source: https://www.capitalbusiness.net/resources/accounting-nonprofit-

organizations-work/

Introduction
This module examines the IFRS Foundation/IASB structure and organs involved in the
standard setting process. It also discusses the due process and goes further to look at the role
of the Financial Reporting Council in financial reporting in Nigeria. The module finally looks
at two standards that are foundational in financial reporting, that is, IAS 8 and IFRS 1.

General Objectives
By the end of this module, students should be able to:
1. Identify and explain the organs involved in the standard setting process and their
respective roles.
2. Describe the required accounting process for first time adoption of IFRS.

3. Distinguish between change in accounting policy and change in estimates

4.account for changes in accounting policies, changes in estimates and prior period
errors.

Unit 1 IASB STRUCTURE AND DUE PROCESS

Introduction

In this unit, we examine the history of IASB, its structure, the organs involved in setting
accounting standards and the roles of these organs in the process. It also examines the pros

44
and cons of harmonisation. The unit finally presented the stages involved in setting
accounting standards – the due process.

Specific Objectives
By the end of this unit, students should be able to:

1. Explain the relationship between the local standard and international standards.
2. Trace the history of IASB
3. Explain the reason for converging to IFRS and the pros and cons of the move
4. Discuss the IASB structure;
5. Discuss the standard setting processes.

1.1 Preamble

The CAMA 2020 gives general provisions for the preparation and presentation of financial
statements. It does not give guidelines on the treatment/presentation of items subject to
alternative treatments in the financial statements. Therefore, to ensure uniformity in the
presentation of financial statements and to enhance comparability of the financial statements
of entities within the same industry and between periods, the accounting standards become
relevant, provided such standards do not conflict with the provisions of the Companies Act.
The application of the standards also helps to ensure that minimum financial information is
provided to users of financial statements to enable them make reasonable economic
decisions.

All IAS and IFRS adopted by FRCN, where relevant and appropriate need be applied by
reporting entities in Nigeria in the preparation and presentation of their financial statements.

Accounting standards are rules/principles that govern the manner in which specific
items/business transactions of entities are reported to users of financial information.

1.2 Brief History of IASB

The International Accounting Standards Committee (IASC) was set up in 1973 as an

independent, private sector body to set Accounting standards to be used by preparers of
financial statements around the world. The membership consisted of representatives from
accountancy bodies from various parts of the world – 152 organizations from 112 countries
by 2000.

In 1997, a strategy working party was formed to re-examine the IASC’s structure and
strategy. In 1999, the Working Party recommended replacing the part-time IASC with a full-
time International Accounting Standards Board, strengthened due process, greater resources
and complete independence. By July 1 2000, a new IASC constitution took effect. On April

45
1, 2001, the IASB assumed accounting standard-setting responsibilities. On 1 July 2001, the
IASC foundation was re-named the IFRS Foundation.

1.3 Objectives of IASB

The objectives of IASB are:

1. To develop in the public interest, a single set of high quality, understandable and
enforceable global accounting standards that require high quality, transparent and
comparable information in financial statements and other financial reporting to help
participants in the world’s capital markets and other users make economic decisions.
2. To promote the use and rigorous application of those standards
3. To take account of the special needs of small and medium sizes entities and emerging
economies; and
4. To bring about convergence of national accounting standards and international
financial reporting standards of high quality.

1.4 Convergence of accounting standards

Convergence of accounting standards refers to the goal of establishing a single set of

accounting standards that will be used internationally. This is also described as the
international harmonisation of accounting standards. Harmonisation of accounting would
result in all companies anywhere in the world reporting financial position and financial
performance in the same way with the belief being that this would lead to greater market
efficiency through the quality of the information and should make raising finance cheaper
and easier.

Advantages and disadvantages of harmonisation

There are some strong arguments in favour of the harmonisation of accounting standards in
all countries of the world, and in particular for the convergence of US GAAP and IFRSs.
There are also some arguments against harmonisation - even though these are probably not as
strong as the arguments in favour.

Advantages of harmonisation

1. Investors and analysts of financial statements can make better comparisons between the
financial position, financial performance and financial prospects of entities in different
countries. This is very important, in view of the rapid growth in international investment by
institutional investors.

2 For international groups, harmonisation will simplify the preparation of group accounts. If
all entities in the group share the same accounting framework, there should be no need to
make adjustments for consolidation purposes.

46
3 If all entities are using the same framework for financial reporting, management should find
it easier to monitor performance within their group.

4 Global harmonisation of accounting framework may encourage growth in cross-border

trading, because entities will find it easier to assess the financial position of customers and
suppliers in other countries.

5 Access to international finance should be easier, because banks and investors in the
international financial markets will find it easier to understand the financial information
presented to them by entities wishing to raise finance.

6 Harmonisation could also lead to a reduction in cost of capital as a result of 4 and 5 above.

Disadvantages of harmonisation

1. National legal requirements may conflict with the requirements of IFRSs. Some countries
may have strict legal rules about preparing financial statements, as the statements are
prepared mainly for tax purposes. Consequently, laws may need re-writing to permit the
accounting policies required by IFRSs.

2. Some countries may believe that their framework is satisfactory or even superior to IFRSs.
This has been a problem with the US, although currently is not as much of an issue as in the
past.

3. Cultural differences across the world may mean that one set of accounting standards will
not be flexible enough to meet the needs of all users

1.5 IASB Structure

The principal body within the IFRS Foundation is the IASB, which has the sole responsibility
for establishing IFRS. Other components of the structure are the Trustees, the Monitoring
Board of capital market regulatory authorities that oversees the Foundation, the IFRS
interpretations committee and the IFRS Advisory Council.

47
 MONITORING BOARD
Approve and oversee Trustees

IFRS FOUNDATION
22 TRUSTEES Appoint, oversee
Review Effectiveness, Funding

BOARD 16 (max. 3 part-time)

Set technical agenda, Approve standards,
Exposure Drafts and Interpretations

IFRS Advisory Council IFRS INTERPRETATION C’TTEE14 members

SMEImplementation Grp 21 Members
Approx. 40 members

Working Groups Appoints

For major Agenda
Advises
projects
Reports to

1.5.1 IFRS FOUNDATION

The governance of the IFRS Foundation rests with its 22 members drawn from Asia/Oceania
(6), Europe (6), North America (6) and 4 from any area (subject to maintaining geographical
balance).
The IFRS Foundation’ constitution requires an appropriate balance of professional
backgrounds, including auditors, preparers, users, academics and other officials serving the
public interest.
1.5.2 MONITORING BOARD
This serves as a mechanism for formal interaction between capital markets authorities and the
IFRS Foundation. The objective is to facilitate capital market authorities that allow or require

48
the use of IFRSs in their jurisdictions to discharge effectively their mandate relating to
investor protection, market integrity and capital formation.
The responsibilities of the Monitoring board include:
1. Participating in the process of appointing trustees and approving the appointment of
Trustees according to guidelines set out in the IFRS Foundation constitution.
2. Reviewing and providing advice to the trustees on their fulfillment of the
responsibilities set out in the constitution
3. Referring matters of broad public interest related to financial reporting to the IASB
through the IFRS Foundation.
1.5.3 THE IASB
The IASB is responsible for establishing IFRSs. Membership is 16: 13 will serve full time, 3
part time. The Board’s principal responsibilities are to:
 Develop and issue IFRSs in accordance with established due process; and
 Approve interpretations developed by IFRIC.
Key qualification for Board membership is professional competence and practical experience.
1.5.4 IFRS ADVISORY COUNCIL
The Advisory council provides a forum for organizations and individuals with an interest in
international financial reporting and having diverse geographical and functional backgrounds
to participate in the standard-setting process with the objectives of:
 Advising the board on agenda decisions and priorities in the Board’s work;
 Informing the board of the views of organizations and individuals on the Council on
major standard-setting projects; and
 Giving advice on other matters to the board and to the Trustees.
1.5.5 IFRS INTERPRETATION COMMITTEE
The interpretations Committee (formerly called IFRIC) has 14 voting members appointed by
the Trustees for terms of 3 years. Members are required to have technical expertise, possess
diversity of international business and market experience, be experienced in practical
application of IFRSs and analysis of financial statements prepared in accordance with IFRSs.
Members are not paid salaries but their expenses are reimbursed.
The committee’s responsibilities are to:
1. Interpret the application of IFRSs and provide timely guidance on financial reporting
issues not specifically addressed in IFRSs in the context of the IASB’s Conceptual
Framework for Financial Reporting in accordance with established due process and
undertake other tasks at the request of the Board.
2. Report to the Board and obtain Board approval for final interpretation.

The Local Standard Board (NASB now replaced by FRCN)

History

49
The NASB was formally inaugurated on September 9, 1982 with an initial membership of 8
organizations/establishments namely: CBN; FMF; NATA; NACCIMA; NBA; NSE; SEC and
ICAN.
The status (and the composition) of the Board was changed by CAMA Cap C20 LFN 2004.
Sect. 335(1) of CAMA requires that every financial statement comply with the Accounting
Standards laid down in the Statements of Accounting Standard issued from time to time by
the NASB. S.356 states that the Minister after consultation with NASB may alter accounting
requirements for the preparation and presentation of financial statements.
The Board was consequently expanded to 13 establishments and later to 14 following the
provisions of NASB Act 2003. The members up to June, 2011 were: ICAN; ANAN; FMC;
CBN; FMF; CAC; FIRS; NDIC; SEC; Auditor-General for the Federation; Accountant-
General of the Federation; CITN; NAA and NACCIMA
The NASB Act was repealed and replaced by The Financial Reporting council of Nigeria
Act, No.6, 2011, which took over the functions of the Board

Financial Reporting Council Act No.6, 2011.

This Act was enacted to take over the Standard setting and oversight functions of the
Nigerian Accounting Standards Board(NASB) but with enhanced functions. The council has
7 Directorates with functions, some of which impact directly accounting and auditing
practices. The Directorates are:

a). Directorate of Accounting Standards – Private Sector, with the responsibility of

developing accounting and financial reporting standards to be observed in the preparation of
financial statements in the private sector and SMEs.

b). Directorate of Accounting Standards – Public Sector: develops accounting and financial
reporting standards for the public sector.

c). Directorate of Auditing practices Standards: develops or liaise with relevant professional
bodies on auditing and ethical standards set by it.

d). Directorate of Actuarial Standards: develops an appropriate conceptual framework to

guide the setting of relevant actuarial standards.

e). Directorate of Inspection and Monitoring: Monitors compliance with auditing, accounting,
actuarial and valuation standards and guidelines reviewed and adopted by the council as well
as recommend sanctions to council and implement sanctions and fines approved by council.

f). Directorate of Valuation Standards: develops an appropriate conceptual framework to

guide the setting of relevant actuarial standards.

g). Directorate of Corporate Governance: Develops principles and practices of Corporate

Governance as well as promote the highest standards of corporate Governance.

See ss.24 -29, 50 for detailed and specific functions of these directorates

50
Membership of FRC comprises: CBN; CAC; FIRS; FMC; FMF; NAA; NACCIMA; NDIC;
SEC; ICAN; Auditor-General for the Federation; Accountant-General of the Federation;
ANAN; CITN; NSE; NAICOM; PENCOM; CIS and NIESV.

STANDARD SETTING PROCESS (DUE PROCESS)

Six Stages are involved namely:

1. Setting the agenda

The IASB evaluates the merits of adding a potential item to its agenda, also known as the
work plan, mainly by reference to the needs of investors.

The IASB considers:

 the relevance to users of the information and the reliability of information that could
be provided;
 whether existing guidance is available;
 the possibility of increasing convergence;
 the quality of the standard to be developed; and
 resource constraints.

Issues that may form the subject matter of a new standard may come from:

i. IASB’s technical staff: To help the IASB in considering its future agenda, its staff are
asked to identify, review and raise issues that might warrant the IASB’s attention.

ii. A change in the IASB’s Conceptual Framework a change in the IASB’s Conceptual
Framework.

iii. Comments from other standard-setters and other interested parties, the IFRS Advisory
Council and the IFRS Interpretations Committee, and staff research and other
recommendations. The IASB receives requests from constituents to interpret, review or
amend existing publications. The staff consider all such requests, summarise major or
common issues raised, and present them to the IASB from time to time as candidates for
when the IASB is next considering its agenda

2. Planning the project

When adding an item to its active agenda, the IASB also decides whether to:

 conduct the project alone; or

 jointly with another standard-setter.

Similar due process is followed under both approaches.

51
After considering the nature of the issues and the level of interest among constituents, the
IASB may establish a Consultative group at this stage.

A team is selected for the project by the two most senior members of the technical staff:

 The Director of Technical Activities; and

 The Director of Research.

The project manager draws up a project plan under the supervision of those Directors. The
team may also include members of staff from other accounting standard-setters, as deemed
appropriate.

3. Development and publication of a Discussion Paper

Although a Discussion Paper is not mandatory, the IASB normally publishes it as its first
publication on any major new topic to explain the issue and solicit early comment from
constituents.

If the IASB decides to omit this step, it will state why.

Typically, a Discussion Paper includes:

 a comprehensive overview of the issue;

 possible approaches in addressing the issue;
 the preliminary views of its authors or the IASB; and
 an invitation to comment.

This approach may differ if another accounting standard-setter develops the research paper.

Discussion Papers may result either from:

 a research project being conducted by another accounting standard-setter; or

 as the first stage of an active agenda project carried out by the IASB.

In the first case, the Discussion Paper is drafted by another standard-setter and published by
the IASB. Issues related to the Discussion Paper are discussed in IASB meetings, and
publication of such a paper requires a simple majority vote by the IASB.

If the Discussion Paper includes the preliminary views of other authors, the IASB reviews the
draft Discussion Paper to ensure that its analysis is an appropriate basis on which to invite
public comments.

All discussions of technical issues related to the draft paper take place in public session.

4. Development and publication of an Exposure Draft

Publication of an Exposure Draft is a mandatory step in due process.

Irrespective of whether the IASB has published a Discussion Paper, an Exposure Draft is the
IASB’s main vehicle for consulting the public.
52
Unlike a Discussion Paper, an Exposure Draft sets out a specific proposal in the form of a
proposed Standard (or amendment to an existing Standard).

The development of an Exposure Draft begins with the IASB considering:

 issues on the basis of staff research and recommendations;

 comments received on any Discussion Paper; and
 suggestions made by the IFRS Advisory Council, Consultative groups and accounting
standard-setters, and arising from public education sessions.

After resolving issues at its meetings, the IASB instructs the staff to draft the Exposure Draft.

When the draft has been completed, and the IASB has balloted on it, the IASB publishes it
for public comment.

5. Development and publication of an IFRS

After resolving issues arising from comments received on the Exposure Draft, the IASB
considers whether it should expose its revised proposals for public comment, for example by
publishing a second Exposure Draft.

In considering the need for re-exposure, the IASB:

 identifies substantial issues that emerged during the comment period on the Exposure
Draft that it had not previously considered;
 assesses the evidence that it has considered;
 evaluates whether it has sufficiently understood the issues and actively sought the
views of constituents; and
 considers whether the various viewpoints were aired in the Exposure Draft and
adequately discussed and reviewed in the basis for conclusions.

Drafting the IFRS

If the IASB decides that re-exposure is necessary, the due process to be followed is the same
as for the first Exposure Draft. When the IASB is satisfied that it has reached a conclusion on
the issues arising from the Exposure Draft, it instructs the staff to draft the IFRS.

Pre-ballot draft

A pre-ballot draft is usually subject to external review, normally by the IFRIC. Shortly before
the IASB ballots the Standard, a near-final draft is posted on eIFRS.

Finally, after the due process is completed, all outstanding issues are resolved, and the IASB
members have balloted in favour of publication, the IFRS is issued.

53
 6. Procedures after an IFRS is issued

After an IFRS is issued, the staff and the IASB members hold regular meetings with
interested parties, including other standard-setting bodies, to help understand unanticipated
issues related to the practical implementation and potential impact of its proposals.

The IFRS Foundation also fosters educational activities to ensure consistency in the
application of IFRSs.

After a suitable time, the IASB may consider initiating studies in the light of:

 its review of the IFRS’s application;

 changes in the financial reporting environment and regulatory requirements; and
 comments by the IFRS Advisory Council, the IFRS Interpretations Committee,
standard-setters and constituents about the quality of the IFRS.

Those studies may result in items being added to the IASB’s work plan.

IN-TEXT QUESTIONS (ITQ’s)

1. Convergence to IFRS by a nation can be through harmonization, adoption or adaptation.

Which strategy was used by Nigeria?
2. ________ is the erstwhile standard setting body before the advent of IASB.

IN-TEXT ANSWERS (ITA’s)

1. Adoption
2. IASC

54
Unit 2 IAS 8: Accounting Policies, changes in accounting estimates and
errors.
Introduction

This unit presents matters that are foundational to fair presentation of financial statements –
accounting policies, estimates and errors. It gives guidance on how to choose accounting
policies, factors that may warrant a change in policies and how to account for such changes in
the accounts. A distinction is made between change in policy and a change in estimate and
the importance of proper accounting of estimates is highlighted. Finally, the unit discusses
how to deal with errors, especially prior period errors.

Specific Objectives
At the end of this unit, students should be able to:

1. Explain the process involved in selecting accounting policy;

2. Explain the circumstances that may necessitate a change in accounting policy
3. Discuss when retrospective application of a change in policy is permissible;
4. Raise adjusting entries to reflect changes in accounting policies.
5. Discuss the disclosure requirements on accounting policy;
6. Explain how changes in accounting estimates are treated in the accounting records
7. Make adjustment entries to correct accounting errors discovered in the books

Preamble
The conceptual framework for financial reporting identified comparability as one of the
qualitative characteristics of financial statements. To enhance comparability, it is essential
that:
 different entities take account of the same types of income and expenditure in arriving
at the profit or loss for the period and measure and present them using constrained
alternatives;
 information is available about the accounting policies adopted by different entities;
 different entities treat changes in accounting policies or estimates and the accounting
for errors in the same way; and
 the scope for accounting policy changes is constrained.
IAS 8 is set out to give guidance in this direction. Thus, the standard aims at enhancing the
relevance and reliability of an entity’s financial statements and the comparability of those
statements over time and with the financial statements of similar entities. To achieve this
objective, the standard generally gives guidance on the criteria for selecting accounting
policies and the accounting treatment of changes in accounting policies, accounting estimates
and errors.

55
There have been revisions to this standard. The section in the earlier version that gave
guidance on the presentation requirements for the net profit or loss has been moved to IAS 1
while the area that deals with the selection and application of accounting policies was
transferred into IAS 8 from IAS 1.
2.1 Definition: IAS 8: 5 defines Accounting policies as “the specific principles, bases, rules
and practices applied by an entity in preparing and presenting financial statements.”

2.1.1 Selection of accounting policies

1. When an IFRS specifically applies to a transaction, other event or condition, the

accounting policy or policies applied to that item are determined by applying the
IFRS.
2. It is not necessary to apply these policies if the effect of applying them is immaterial.
But this does not mean that immaterial departures from IFRSs can be made or left
uncorrected, in order to achieve a particular presentation of an entity’s financial
position, performance or cash flows.
3. If there is no IFRS that specifically applies to a transaction, event or condition under
consideration, judgement is required by management in developing and applying an
accounting policy that results in information that is:
 Relevant to the economic decision-making needs of the users; and
 Reliable, in that the financial statements:
i. represent faithfully the financial position, financial performance and
cash flows of the entity;
ii. reflect the economic substance of transactions, other events and
conditions, and not merely the legal form;
iii. are neutral (i.e. free from bias);
iv. are prudent; and
v. are complete in all material respects.
4. In forming a judgement about a suitable accounting policy, management should refer
to , and consider the applicability of:
 requirements in IFRSs dealing with similar and related issues; and
 the definitions, recognition criteria and measurement concepts for assets,
liabilities, income and expenses in the Conceptual Framework.
 the most recent pronouncements of other standard-setting bodies that use
similar conceptual framework to develop standards, accounting literature and
accepted industry practices, provided they do not conflict with the first two
sources above.
5. Accounting policies should be applied consistently for similar transactions, unless an
IFRS specifically requires or permits categorization of items for which different
policies may be appropriate. In such a case, an appropriate accounting policy should
be selected and applied consistently to each category.
Note: By the provisions of IFRS 10 Consolidated Financial Statements, entities are required
to prepare consolidated financial statements using uniform accounting policies for like
transactions.

56
2.1.2 Changes in Accounting Policy

Accounting policy changes are permitted if the change:

a. is required by standard (an IFRS); or

b. is required by a new statute or law; or
c. results in the financial statements providing reliable and more relevant information
about the effects of transactions, other events or conditions on the entity’s financial
position, financial performance or cash flows.
Note: 1. The following do not constitute change in accounting policy viz.:

 the application of an accounting policy to a transaction, other event or condition that

differs in substance from those previously occurring in an entity;
 the application of a new accounting policy to a transaction, event or condition that had
not previously occurred in an entity ( or was previously immaterial).
2. A change in method of depreciating assets for reasons other than changes in pattern of
consumption, constitutes a change in accounting policy.
Example: a. Company A vacates an owner-occupier building classified as PPE and accounted
for under the cost model and leases it out to a third party. Company A’s accounting policy for
investment property under IAS 40 is to use fair value model. The change in accounting
treatment from cost model to fair value model in respect of the lease transaction (investment
property) is not a change in accounting policy as the transactions differ in substance, arising
from change in circumstance.

b. Company A becomes a subsidiary of company B. Subsequently the accounting policies

within company A will be harmonized with the accounting policies of company B – a change
in policies.

2.1.3 Applying Changes in Accounting Policy

IAS 8 addresses changes in accounting policy arising from 3 sources:

1. initial application (including early application) of a standard or interpretation

containing specific transition provisions
2. initial application of a standard or interpretation which does not contain specific
transition provisions
3. voluntary changes in accounting policy.
Policy changes under 1 above should be applied in accordance with the specific transition
provisions of that standard or interpretation, while changes in accounting policy under 2 or 3
should be applied retrospectively, unless it is impracticable to so do.

Retrospective Application of a change in Accounting Policy

Unless retrospective application is impracticable, retrospective application involves adjusting

both the opening balance of each affected component of equity for the earliest prior period
presented and the other comparative amounts disclosed for each prior period presented as if

57
the new accounting policy had always been applied. Usually the adjustment is made to
retained earnings but could be made to another component of equity, e.g. to comply with an
IFRS.

Historical summaries of financial data are also adjusted but when it is impracticable to restate
the earlier periods of any historical summaries in the financial statements, this should be
made clear and the affected periods identified.

Limitations on Retrospective Application (Impracticability of application)

Retrospective application of a new accounting policy or correcting a prior period error

requires distinguishing information that:

a. provides evidence of circumstances that existed on the date(s) as at which the

transaction, other event or condition occurred, and
b. would have been available when the financial statements for that prior period were
authorized for issue, from other information.
On the basis of this, IAS 8 notes that it is impracticable to apply a change in accounting
policy retrospectively or to make a retrospective restatement to correct an error if:

i. the effects of the retrospective application or retrospective restatement are not

determinable;
ii. the retrospective application or restatement requires assumptions about what
management’s intent would have been in that period; or
iii. the retrospective application or restatement requires significant estimates of amounts
and it is impossible to distinguish objectively information about those estimates that:-
 provides evidence of circumstances that existed on the date(s) as at which
those amounts are to be recognized, measured or disclosed; and
 would have been available when the financial statements for that prior period
were authorized for issue, from other information.
Note: Hindsight should not be used when applying a new accounting policy to, or correcting
amounts for, a prior period, either in making assumptions about what management’s intention
would have been in a prior period or estimating the amounts recognized, measured or
disclosed in a prior period.

2.1.4 Disclosure Requirements

For an initial application of an IFRS, the following should be disclosed:

 the title of the IFRS

 the nature of the change in accounting policy;
 when applicable, the description of the transition provisions applied in the change;
 for the current period and each prior period presented, to the extent possible, the
amount of the adjustment for each financial statement line item affected and
adjustments to basic and diluted EPS.

58
For voluntary change in accounting policy, the following should be disclosed:

 the nature of the change in accounting policy;

 the reasons why applying the new policy provides reliable and more relevant
information;
 for the current period and each prior period presented, to the extent possible, the
amount of the adjustment for each financial statement line item affected and
adjustments to basic and diluted EPS.

Example of typical Disclosure of Accounting Policies

Some of the Accounting policies that companies need to disclose and their effect on financial
statements include:

i. Depreciation Policy – Straight line depreciation compared with reducing balance

method. While reducing balance method will charge higher amount in the early
years of the asset’s life (reducing profits), straight line will charge equal amount
over the life of the asset (reporting lower profit in the later years than reducing
balance method).

ii. Revenue Recognition: The way in which revenue is recognized for sale of goods,
rendering of services, long term contracts etc is capable of affecting the net profit
for a period.

iii. Basis of Accounting: Accrual or cash basis will have an effect on net profit.

iv. Stock Valuation – The method applied in valuing stock (raw materials, spare
parts and finished goods) will affect reported profits e.g. FIFO will yield different
result from Weighted Average).

v. Research and Development Policy – The policy to expense R & D costs will
impact profit differently compared with expensing only research costs and
capitalizing Development costs.

vi. Fixed Assets Capitalization policy: While some companies may capitalize all capital
expenditure, others may have a minimum benchmark based on their set materiality
level. This will affect net profit differently.

Worked Example
Ikenga Ltd commenced trading two years ago, on 1 January 2016, and had recognized all
results in the financial statements providing reliable and more relevant information about the
effects of transactions, other events or conditions on the entity’s financial position, financial
performance or cash flows statements providing reliable and more relevant information about
the effects of transactions, other events or conditions on the entity’s financial position,
financial performance or cash flows borrowing costs in profit or loss. Its draft statement of

59
financial position at 31 December 2017, and its final statement of financial position for the
previous year are as follows:
2017 2016
₦’m ₦’m
Property, plant and equipment 284 241
Other assets 899 900
1,183 1,141

Share capital 100 100

Retained earnings 83 41
Liabilities 1,000 1,000
1,183 1,141

In each of the two years borrowing costs attributable to qualifying assets of ₦10 million have
been recognised in profit or loss.
Realising that IAS 23 requires borrowing costs attributable to qualifying assets to be
recognised as part of the cost of those assets, Ikenga Ltd has decided to apply the provisions
of the standard to its financial statements.
Required
Represent the financial statements to accommodate the intent of the standard.
Ignore tax implications of the change and its effect on depreciation.

Suggested Solution
The change from recognizing all borrowing costs in profit or loss to capitalizing borrowing
costs on qualifying assets is a change in accounting policy and should be applied
retrospectively. The line items PPE and retained earnings will be adjusted as shown below:

Ikenga Ltd.
Statement of financial position as at
Restated
2017 2016
₦’m ₦’m

Property, plant and equipment (W1) 304 251

Other assets 899 900
1,203 1,151

Share capital 100 100

Retained earnings (W2) 103 51
Liabilities 1,000 1,000
1,203 1,151

It should be observed that the effect of the change in accounting policy is an increase in asset
base of the entity by ₦20 million as at 2017.
Workings
2017 2016

60
 ₦’m ₦’m
1. Property, plant and equipment per accounts 284 241
Add: Capitalised interest (₦10m x 2) / ₦10m 20 10
304 251

2. Retained Earnings as given 83 41

Capitalised interest (₦10m x 2) / ₦10m 20 10
103 51
2.2 Changes in Accounting Estimates

IAS 8:5 defines a change in accounting estimate as “an adjustment in the carrying amount of
an asset or a liability or the amount of the periodic consumption of an asset that results from
the assessment of the present status of, and expected future benefits and obligations
associated with, assets and liabilities. Changes in accounting estimates result from new
information or new developments and accordingly, are not corrections of errors.”

Many items in financial statements cannot be measured with precision as a result of inherent
uncertainties in business activities. They can only be estimated. Estimates are formed using
judgements based on the latest available, reliable information. Examples of estimates in
financial statements include allowances for bad debts, allowances for inventory obsolescence,
the fair value of financial assets or financial liabilities, the useful lives of, or the expected
pattern of consumption of the future economic benefits embodied in depreciable assets,
warranty obligations etc.

An estimate may be revised if the circumstances on which the estimate was based change, or
if new information or experience is gained. The revision of an estimate does not relate to
prior periods and is not equivalent to the correction of an error.

Note: a) A change in the measurement basis applied to an item in the financial statements is a
change in accounting policy and not a change in accounting estimate.

b). In circumstances when it is difficult to distinguish between a change in an accounting

policy and a change in an accounting estimate, the change is treated as a change in an
accounting estimate.

2.2.1 Recognition of changes in accounting estimates

The effect of a change in an accounting estimate is recognized prospectively by including it

in profit or loss in the period of the change, if the change affects that period only (e.g. change
in bad debts provision) or in the period of the change and future periods, if the change affects
both e.g. revision of the estimated useful economic life of a depreciable asset.

Note: To the extent that a change in estimate gives rise to changes in assets, liabilities or
relates to an item of equity, it should be recognized by adjusting the carrying amount of the
related asset, liability or equity item in the period of the change.

2.2.2 Disclosure

61
 1. An entity should disclose the nature and amount of a change in an accounting estimate
that has an effect in the current period or is expected to have effect in future periods.
2. The disclosure of the effect on future periods is not required when it is impracticable
to estimate that effect.
3. If the amount of the effect in future periods is not disclosed because estimating it is
impracticable, the entity should disclose this fact. (IAS 8:40)

2.2.3 Worked Example

ABC plc acquired an articulated Vehicle on Jan.1, 2006 for =N=350 million. At the time of
recognition of the truck on 1 January 2006, the company estimated its useful life to be 15
years and expected it to fetch =N=50 million at the end of its useful life.
The company uses straight-line depreciation method for the Vehicle.
Regulatory changes introduced in November 2013 barred the company from operating this
truck after the end of 2015 following some design defects discovered. The management is
forced to sell it and acquire a new and an upgrade truck by the end of 2015. It revised the
useful life of the truck down to 10 years and increased its salvage value to N100 million.
Required
Indicate how the company will account for this development in the financial year ending 31
December 2014.
Suggested solution
Both the change in remaining useful life and the residual value of the Vehicle are changes in
estimate.
Annual depreciation charge based on old estimate:
=N=million
Cost 350
Residual Value 50
Useful life 15
Annual depreciation charge 300/15 = 20
Therefore, accumulated depreciation by the end of 2013: N20m x 8years = N160m.
Carrying amount as at 31 December 2013 = N350m – N160 = N190m
The regulatory changes forced the company to reduce useful life to 10 years. It means the
remaining useful life as at 1 January 2014 was 2 years.
Annual depreciation charge for 2014 = (N190 million – 100 million) ÷ 2 = N45million
Note:
The change in estimate is applied prospectively, that is, reflected only in periods subsequent
to the change. It doesn’t affect any of the historical depreciation charges or book values.

2.3 Errors

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Financial statements do not comply with IFRSs if they contain either material errors or
immaterial errors made intentionally in order to achieve a particular presentation of an
entity’s financial position, financial performance or cash flows.

Errors can occur in respect of the recognition, measurement, presentation or disclosure of

elements of the financial statements. (IAS 8:41)

2.3.1 Prior period errors are omissions from, and misstatements in, the entity’s financial
statements for one or more prior periods arising from a failure to use, or misuse of, reliable
information that:
(a) was available when financial statements for those periods were authorised for issue; and
(b) could reasonably be expected to have been obtained and taken into account in the
preparation and presentation of those financial statements.
Such errors include the effects of mathematical mistakes, mistakes in applying accounting
policies, oversights or misinterpretations of facts, and fraud.
Note: This replaces the definition of fundamental error as given in the earlier version of the
standard.
Material: Omissions or misstatements of items are material if they could, individually or
collectively, influence the economic decisions that users make on the basis of the financial
statements. Materiality depends on the size and nature of the omission or misstatement
judged in the surrounding circumstances. The size or nature of the item, or a combination of
both, could be the determining factor.
Recent guidance by the IASB states that information is material if omitting, misstating or
obscuring it could reasonably be expected to influence the decisions that the primary users of
general purpose financial statements make on the basis of those financial statements, which
provide information about a specific reporting entity.
Retrospective restatement is correcting the recognition, measurement and disclosure of
amounts of elements of financial statements as if a prior period error had never occurred.
2.3.2 Correction of errors

If a current period error is discovered before the financial statements are authorized for issue,
it is corrected in that period. But a prior period error is corrected retrospectively by:

 Restating the comparative amounts for the prior period(s) presented in which the error
occurred; or
 Restating the opening balances of assets, liabilities and equity for the earliest prior
period presented (if the error occurred before the earliest prior period presented).
Note: a) The correction of a prior period error is excluded from profit or loss in the period of
discovery. (IAS 8:46)

b). If it is impracticable to determine the period-specific effects of an error on comparative

information for one or more prior periods presented, the opening balances of assets, liabilities

63
and equity are restated for the earliest period for which retrospective restatement is
practicable. This may be the current period.

c). If it is impracticable to determine the cumulative effect on all prior periods of a prior
period error at the beginning of the current period, the comparative information is restated to
correct the error prospectively from the earliest date practicable.

2.3.3 Disclosure Requirements

When a material prior period error is corrected, the following should be disclosed:

 the nature of the prior period error;

 for each prior period presented, to the extent practicable, the amount of the correction
for each financial statement line item affected and for basic and diluted EPS.
 The amount of the correction at the beginning of the earliest prior period presented;
and
 If retrospective restatement is impracticable for a particular prior period, the
circumstances that led to the existence of that condition and a description of how and
from when the error has been corrected.
Note: Financial statements of subsequent periods need not repeat these disclosures. (IAS
8:49)

2.3.4 Worked Example

During 2018, Hitech Plc discovered that certain items had been included in inventory at 31
December 2017, valued at N8.4million. These items had been sold before the year end. The
following figures for 2017 and 2018 are available.

2018(draft) 2017
=N=’000 =N=’000
Sales 134,400 94,800
Cost of goods sold (111,600) (69,140)
Profit before tax 22.800 25,660
Income taxes (6,800) (7,760)
Net profit 16,000 17,900

Retained earnings as at January 1, 2017 were N26million. The cost of goods sold for 2018
includes the N8.4million error in opening inventory. The income tax rate for both years was
30%.
Required
Show the profit or loss and other comprehensive income for 2018 with the 2017 comparative
figures, and retained earnings.
Suggested solution

64
 HITECH PLC
Statement of Profit or Loss and Other Comprehensive Income
For The Period Ended 31 December

2018 2017
=N=’000 =N=’000

Sales 134,400 94,800

Cost of goods sold(W1) (103,200) (77,540)
Profit before tax 31,200 17,260
Income tax (W2) (9,320) (5,240)
Net profit 21,880 12,020

RETAINED EARNINGS
Balance brought forward 43,900 26,000
Correction of prior period error (N8,400 – 2,520) (5,880) -
As restated 38,020 26,000
Net profit for year 21,880 12,020
Retained carried forward 59,900 38,020

Workings
1. Cost of goods sold 2018 2017
=N=’000 =N=’000
Per question 111,600 69,140
Inventory adjustment ( 8,400) 8,400
103,200 77,540

2. Income tax
Per question 6,800 7,760
Inventory adjustment (8,400 x 30%) 2,520 (2,520)
9,320 5,240
Notes
1. The error occurred in 2017 but was discovered in 2018. Thus, the closing inventory in
2017 was overstated by N8.4m. The effect of this was reduction of cost of sales and increase
in (overstatement of) reported profit by N8.4m. This also led to increase in tax provision by
30% of N8.4m, i.e. N2.52m.
2. To correct the error in 1 above, we need to increase 2017 cost of sales by N8.4m and
reduce tax provision by N2.52m.
3. This error affected the opening inventory in 2018; thereby increasing the cost of sales by
the same amount, that is, N8.4m. This translated to reduction in reported profit by N8.4m and
tax liability by 30% of N8.4m, that is, N2.52m.
4. To correct this, we need to reduce cost of goods sold by N8.4m and increase taxation by
N2.52m.

65
 Notice that the adjustments in 2018 are the opposite (reversal) of 2017 adjustments.
5. The net effect of the error is overstatement of 2018 opening retained earnings by the value
of the error. Now that the error in income statement is corrected, the 2018 retained earnings is
adjusted by the value of the overstatement, net of tax, that is, N8.4m – N2.52m = (N5.88)
IN-TEXT QUESTIONS (ITQ’s)

1 ------------- is the specific principles, bases, rules and practices applied by an entity in
preparing and presenting financial statements..

2. A change in accounting policy is permissible if permitted by a new standard, a new law,

or-------

3. Items in financial statements that cannot be measured with precision as a result of inherent
uncertainties in business activities are expected to be -------------.

4. Changes in accounting estimates which result from new information are not regarded as-------

5. Omissions from, and misstatements in, the entity’s financial statements for one or more prior
periods are regarded as -------------.

3. Omissions or misstatements that influence the economic decisions are said to be-------

IN-TEXT ANSWERS (ITA’s)

1. Accounting policy

2. results in the financial statements providing reliable and more relevant information

3. Estimated

4. Correction of errors

5. Prior period errors

6. Material.

READ MORE: http://download.nos.org/srsec320newE/320EL16.pd

66
TUTOR-MARKED ASSIGNMENT (TMA)
Due to the complexity of International Financial Reporting Standards (IFRS), often judgments used at the
time of transition to IFRS have resulted in prior period adjustments and changes in estimates being
disclosed in financial statements. The selection of accounting policy and estimation techniques is intended
to aid comparability and consistency in financial statements. However, IFRS also place particular emphasis
on the need to take into account qualitative characteristics and the use of professional judgement when
preparing the financial statements. Although IFRS may appear prescriptive, the achievement of all the
objectives for a set of financial statements will rely on the skills of the preparer. Entities should follow the
requirements of IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors when selecting
or changing accounting policies, changing estimation techniques, and correcting errors.

However, the application of IAS 8 is additionally often dependent upon the application of materiality
analysis to identify issues and guide reporting. Entities also often consider the acceptability of the use of
hindsight in their reporting.

Required:

(i) Discuss how judgment and materiality play a significant part in the selection of an entity’s accounting
policies.
(ii) Discuss the circumstances where an entity may change its accounting policies, setting out how a
change of accounting policy is applied and the difficulties faced by entities where a change in accounting
policy is made.
(iii) Discuss why the current treatment of prior period errors could lead to earnings management by
companies, together with any further arguments against the current treatment.

Credit will be given for relevant examples. (15 marks

67
UNIT 3 1FRS 1: FIRST TIME ADOPTION OF IFRS

Introduction

This unit presents the steps involved in preparing the first IFRS financial statement. In
addition, it lists the required exceptions and exemptions available to the entity preparing the
financial statements and finally gives the disclosure requirements.

Specific Objectives

By the end of this unit, you should be able to:

i. explain the concept of deemed cost

ii. outline the steps involved in preparing the first IFRS financial statements

iii. List 5 exceptions and 5 optional exemptions to retrospective application of other IFRS to
first IFRS financial statements.

3.1 Objective of the Standard: To ensure that an entity’s first-time IFRS financial
statements and interim financial statements contain high quality financial information that:

 is transparent for users and comparable over all periods presented;

 provides a suitable starting point for accounting under IFRS; and can be generated at a
cost that does not exceed the benefit to users.
3.1.1 Overview of the Standard

In the first-time adoption of IFRS, all IFRSs effective at the date of an entity’s first IFRS
financial statements should be applied retrospectively (that is, as if they have been the
framework for an entity’s accounting since inception) in the opening IFRS statement of
financial position, the comparative period and the first IFRS reporting period. This principle,
however is subject to certain ‘exceptions’ and ‘exemptions’.

The ‘exceptions’ to retrospective application (6 in number) are mandatory while the 19

‘exemption’ are optional – that is, a first-time adopter may choose whether and which
exemptions to apply.

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3.2 Definitions

1. Date of transition to IFRSs: This is the beginning of the earliest period for which an
entity presents full comparative information under IFRS in its first IFRS financial
statements. It is the date at which an entity prepares its opening IFRS statement of
financial position.
Applying IFRS for the first time
IFRS 1 - Limit retrospective application

Opening IFRS 31 Dec. 2012

Balance Sheet(SFP) 1st IFRS Annual
(1 January 2011) Report( + comparatives)
= Transition Date = Reporting date

2011 2012 2013

IFRS IFRS IFRS

Previous(local) GAAP reporting ends

IFRS effective at this date applied

retrospectively subject to
exceptions &exemptions)

2. Deemed Cost: An amount used as a surrogate for cost or depreciated cost at a given
date. Subsequent depreciation or amortization assumes that the entity had initially
recognised the asset or liability at the given date and that its cost was equal to the
deemed cost.
In most cases, fair value is used as the deemed cost. For entities applying IFRS 13,
fair value is defined as “the price that would be received to sell an asset or paid to
transfer a liability in orderly transaction between market participants at a
measurement date”.

3. First IFRS reporting Period: This is the first annual financial statements in which
an entity adopts IFRSs by an explicit and unreserved statement of compliance with
IFRSs.

4. International Financial Reporting standards (IFRSs): These are standards and

interpretations adopted by the IASB. They comprise:

 IFRSs
 IASs
 IFRS interpretations; and
 SIC interpretations.

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 5. Opening IFRS statement of financial position: An entity’s statement of financial
position at the date of transition to IFRSs.

6. Previous GAAP: The basis of accounting that a first-time adopter used immediately
before adopting IFRSs.
3.2.2 Steps required in preparing an entity’s first IFRS financial statements.
1. An opening SFP is prepared at the date of transition. The date of transition is the first
day of a one year comparative period. For example, if the reporting period is 31 Dec.
2012(as in the illustration above), the comparative period is 2011 and the transition
date is Jan.1, 2011.
2. In its first IFRS financial statements, the entity applies (subject to certain exceptions
and exemptions) the version of IFRSs effective at the end of its first IFRS reporting
period.
3. In the opening IFRS statement of financial position, the entity should:
 Recognise all assets and liabilities whose recognition is required by IFRS;
 De-recognise items as assets or liabilities if IFRSs do not permit such
recognition;
 Reclassify items recognised under previous GAAP as one type of asset,
liability or component of equity, but are a different asset, liability or
component of equity under IFRSs and
 Apply IFRSs in measuring all recognised assets and liabilities.
4. All adjustments (gains and losses) resulting from the application of IFRS to the
opening SFP are recognised in retained earnings at the date of transition, except for
reclassifications between goodwill and intangible assets.
5. Estimates made in accordance with IFRSs at the transition date must be consistent
with estimates made for the same date under previous GAAP, with limited exceptions.
E.g. estimates for market prices, interest rate or Forex rates should reflect market
conditions at the date of transition to IFRSs.
6. An entity’s first IFRS financial statements include the following:
 three SFP viz., at the transition date, at the end of the comparative period and
at the end of the reporting period;
 two statements of profit or loss and other comprehensive income, at the end of
the comparative period and at the end of the reporting period;
 two statements of cash flows, one for comparative period and one for the
reporting period; and
 two statements of changes in equity
All these statements must be in compliance with IFRSs.
7. Entities may present historical summaries of certain data for periods before the
transition date which do not comply with IFRS provided the information is labelled
as not being prepared in accordance with IFRS. Explanation of the main adjustments
that would be required to render the information compliant with IFRSs is needed.
8. A first time adopter is required to provide reconciliations between amounts reported
under previous GAAP and the equivalent measures under IFRSs. Any correction of
errors in respect of previous GAAP fin. Statements should be indicated.
Note: Accounting policies used in the opening SFP should be consistently applied to all first
IFRS financial statements.

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3.2.3 Exceptions and Exemptions to retrospective application of other IFRSs
Exceptions
IFRS 1 prohibits retrospective application of some aspects of other IFRSs relating to:
1. Estimates: shall be consistent with those made at the same date under previous
GAAP, unless there is objective evidence that those estimates were made in error.
2. De-recognition of financial assets and liabilities: These are applied prospectively.
Thus, financial assets and liabilities derecognised under previous GAAP are not
reinstated. However, all derivatives and other interests retained after de-recognition
and existing at the transition date must be recognised.
3. Hedge accounting: at the date of transition, all derivatives are measured at fair value
and all deferred gains or losses under derivatives recognised in SCI. Transaction
entered into before the transition date are not retrospectively designated as hedges.
4. Non-controlling interest: The following requirements in respect of IAS 27/(IFRS 10)
should be applied prospectively from the date of transition to IFRS:
 the requirement that total comprehensive income be attributed to the owners of
the parent and to non-controlling interests even if this results in the non-
controlling interests having a deficit balance;
 provisions regarding the accounting for changes in the parent’s ownership
interest in a subsidiary that do not result in a loss of control; and
 the requirements for accounting for a loss of control over a subsidiary and
related requirements of IFRS 5 Non- current Assets Held for Sale and
Discontinued Operations.
5. Classification and measurement of financial assets: A first time adopter applying
IFRS 9 should assess whether the financial asset meets the amortised cost criteria on
the basis of the facts and circumstances existing at the date of transition to IFRSs.
6. Embedded derivatives: A first time adopter applying IFRS 9 should assess whether an
embedded derivative should be separated from the host contract and accounted for as
a derivative on the basis of the conditions that existed at the later of the date it first
became a party to the contract and the date the a reassessment is required. Once it is
determined that an embedded derivative should be separated, the initial carrying
amounts of the embedded derivative and the host contract are determined based on the
circumstances at the date of such recognition.
Note: 5 & 6 apply only to entities that adopt IFRS 9 – Financial instruments - in their first
IFRS financial statements.
3.2.4 Optional Exemptions
A first time adopter may elect to use one or more of the following exemptions:
 Business combinations: Not necessary to restate business combinations that took
place before the transition date.
 Share-based payment transactions: May opt not to apply IFRS 2 to share-based
payments granted after 7 November 2002 that vested before the transition date to
IFRS.
 Insurance contracts: A first time adopter may apply the transitional provisions of
IFRS 4, which allows entities to continue to use their existing accounting policies.
 Deemed costs: fair value or revaluation may be used as deemed cost for PPE or
investment property accounted for under cost model as well as intangible assets that

71
 may be revalued in terms of IAS 38. The exemption is not available for any other
assets or liabilities.
 Leases: A first time adopter is allowed to determine whether an arrangement existing
at the date of transition contains a lease on the basis of the facts and circumstances
existing at that date.
 Employee benefits: A first time adopter may elect to recognise all cumulative
actuarial gains or losses in retained earnings at the date of initial transition to IFRS.
 Cumulative translation differences: A first time adopter need not comply with all
the requirements for Cumulative translation differences that existed on the date of
transition to IFRS. If the exemption is applied, the cumulative translation differences
for all foreign operations are deemed to be zero at the date of transition.
 Compound financial instruments: need not be separated into its equity and liability
components if at the transition date, the liability component is no longer outstanding.

 Investments in subsidiaries, associates and joint ventures

 Assets and liabilities of subsidiaries, associates and joint ventures
 Designation of previously recognised financial instruments
 Fair value measurement of financial assets or financial liabilities
 Decommissioning liabilities included in the cost of property, plant and equipment
 Financial assets or intangible assets accounted for in accordance with IFRIC 12 –
Service Concession Arrangements.
 Borrowing costs
 Transfers of assets from customers
 Extinguishing financial liabilities from equity instruments
 Severe hyperinflation
 Joint arrangements.

3.2.5 Presentation and Disclosure

1. An explicit statement to the effect that the financial statements are being prepared in
terms of IFRS for the first time.
2. Comparative information for the basic statements presented, namely, SFP, SCI, SCFs
and Statement of changes in equity and related notes.
3. Where the entity presents historical summaries or comparative information under
previous GAAP, the entity should:
Label the previous GAAP information prominently as not being prepared under
IFRSs; and disclose the nature of the main adjustments that would make it comply
with IFRSs.
4. The first IFRS financial statements to include
 Reconciliations of its equity reported under previous GAAP to its equity under
IFRSs as at the date of transition and at end of the latest period presented in
the entity’s most recent annual financial statements under previous GAAP;
 A reconciliation of total comprehensive income under IFRs to its latest net
income under previous GAAP.
5. If fair value is used as deemed cost in the opening statement of financial position,
there shall be disclosed, for each item in the opening SFP:
 The aggregate of those fair values; and the aggregate adjustment to the
carrying amounts reported under previous GAAP.

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 6. Impairment losses recognised or reversed for the first time when preparing the
opening SFP, should be disclosed as if the impairment loss or reversal took place in
the period beginning with the date of transition to IFRSs.

IN-TEXT QUESTIONS

1. An amount used as a surrogate for cost or depreciated cost at a specified date is called ----------

2. All adjustments (gains and losses) resulting from the application of IFRS to the opening SFP
are recognised in ------------- at the date of transition, except for reclassifications between
goodwill and intangible assets

IN-TEXT ANSWERS

1. Deemed cost

2. Retained earnings

UNIT 4 ISA 34: INTERIM FINANCIAL REPORTING

Introduction

In this unit, you will learn the meaning and need for interim reporting. The form and content
of interim financial statements are outlined as well as the recognition and measurement
principles for items appearing in interim reports. The use of estimates in the preparation of
the financial statements are also discussed.

Specific Objectives

By the end of this unit, you should be able to:

i. explain the reasons for interim reporting
ii. describe the form and content of interim financial statements
iii Discuss the use of estimates in the preparation and presentation of interim financial
statements

Preamble

IAS 34 gives guidance to entities that publish interim financial reporting but does not specify
the frequency of such reports. National regulations (particularly capital market regulators or
professional accountancy bodies) of different countries specify the time periods and/or
information contents. IAS 34 does not make the preparation of interim financial reports
mandatory but strongly recommends that companies whose securities are publicly traded
need to produce and publish half yearly reports. The reports should be filed with the
appropriate agencies no later than 60 days after the end of the interim period.

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In Nigeria, the Securities and Exchange Commission (SEC) requires that listed companies
and those wishing to be admitted to the official list of the Nigerian Stock Exchange produce
quarterly reports, prepared in accordance with IFRS. The report must be filed with the
commission and simultaneously with the relevant securities exchanges and the investing
public within 30 days of the end of the quarter. The report must be accompanied by a
certification letter signed by the chief executive officer and chief financial officer.

4.1 Definitions

Interim period is a financial reporting period shorter than a full financial year.

Interim financial report means a financial containing either a complete set of financial
statements (as described in IAS 1) or a set of condensed financial statements (as described in
this standard) for an interim period.

4.2 Form and content of interim financial statements

An interim financial report, as a minimum, should include:

i. a condensed statement of financial position, containing each of the major components
of Assets, liabilities and equity as were in the statement of financial position at the
end of the previous financial year.
ii. a condensed statement of profit or loss and other comprehensive income, presented
as either a condensed single statement or a condensed separate statement of profit or
loss followed by a condensed statement of other comprehensive income. This should
include each of the component items of income and expense as shown in the profit or
loss statement for the previous year, together with the EPS and diluted EPS.
iii. a condensed statement of changes in equity: The major components of equity as
reflected in the statement of changes in equity for the previous financial year should
be provided.
iv. a condensed statement of cash flows: The three major sub-totals of cash flow – cash
flows from operating activities, cash flows from investing activities and cash flow
from financing activities to be highlighted, and
v. selected explanatory notes to include the following:
a. a statement that the same accounting policies and methods of computation have
been used for the interim statements as were used for the most recent annual financial
statements. Where this is not the case, the nature of the difference and their financial
effect should be described.
b. comments on the seasonality and cyclicality of operations in the interim period.
c. the nature, size, incidence of unusual items during the interim period which has or
is affecting assets, liabilities, capital, net income or cash flows.
d. the effect of acquisition or disposal of subsidiaries during the interim period
e. the issue or repurchase of equity or debt securities
f. segments results for the business segments or geographical segments of the entity
g. nature and amounts of any changes in estimates of amounts reported in an earlier
interim report during the financial year or in prior financial years if those changes
materially affect the current interim period.
h. dividends paid (aggregate or per share) separately for ordinary shares and other
shares;
i. changes in contingent liabilities or contingent assets since the end of the last annual
reporting period

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 j. material events subsequent to the end of the interim period that have not been
reflected in the financial statements for the interim period.

IAS 34:17 gives examples of the kinds of disclosures that are required by the above
explanatory notes as including:
(a) the write-down of inventories to net realisable value and the reversal of such a write-
down;
(b) recognition of a loss from the impairment of property, plant and equipment, intangible
assets, or other assets, and the reversal of such an impairment loss;
(c) the reversal of any provisions for the costs of restructuring;
(d) acquisitions and disposals of items of property, plant and equipment;
(e) commitments for the purchase of property, plant and equipment;
(f) litigation settlements;
(g) corrections of prior period errors.
(h) any loan default or breach of a loan agreement that has not been remedied on or before the
end of the reporting period; and
(i) related party transactions

The interim statements provide updates on the performance and position of the entity.
Therefore, the focus is on new activities, events, and circumstances that have occurred since
the previous annual financial statements were issued; information that has already been
reported in the past should not duplicated.

4.3 Periods covered by interim financial statements

Interim reports must include the following financial statements (condensed or complete):

a. a statement of financial position at the end of the current interim period and a
comparative figures as at the end of the immediate preceding financial year.
b. statements of profit or loss and other comprehensive income for the current interim
period and cumulatively for the current financial year to date, with comparative
statements of profit or loss and other comprehensive income for the comparable
interim periods (current and year-to-date) of the immediately preceding financial year.
c. a statement of changes in equity for the current financial year to date, with a
comparative statement for the comparable year-to-date period in the previous year.
d. a statement of cash flows cumulatively for the current financial year to date, with a
comparative statement for the comparable year-to-date period in the previous year.

In Nigeria, all public companies must publish the signed quarterly statement of financial
position, statement of profit or loss and other comprehensive income and statement of cash
flows that comply with the content and periods stated in sub-sections 6.4 and 6.5, in at least
one national daily newspaper. However the accounting policy notes and other relevant
information must be posted on the company’s website the address of which must be disclosed
in the newspaper publication.
Half-yearly returns are also required of public companies which must be filed with the
Securities and Exchange Commission within 30 days of the end of the half year period either
in hard or electronic copy. The returns shall contain the following:
 general information;

75
  corporate governance issues;
 unclaimed dividends; and
 audit committee;
There should be an undertaking by the company secretary, chief internal auditor, financial
controller, managing director, board chairman and chairman of the audit committee certifying
the reliability of the information in the format provided.

4.4 Recognition and measurement principles

IAS 34 recognises that interim measurements rely to a greater extent on estimates than annual
financial data. Therefore, in deciding how to recognise, measure, classify, or disclose an item
for interim financial reporting purposes, materiality shall be assessed in relation to the interim
period financial data. The guiding principle is that an entity should use the same recognition
and measurement principles/accounting policies in the interim accounts that it uses in the
annual financial statements. Measurement for interim purposes should be made on a year-to-
date basis.
Where applying this principle results in re-measurement of amounts in a subsequent interim
period or at year- end, the nature and amount of any significant remeasurements should be
disclosed.
Appendix B to IAS 34 gives some guidance on applying the general recognition and
measurement rules from the IASB Conceptual Framework to the interim accounts. Some
examples given include:

Intangible Assets

An entity should follow the normal recognition criteria when accounting for intangible assets.
For example, development costs that have been incurred by the interim date but do not meet
the recognition criteria should be expensed. It is inappropriate to capitalise them as an
intangible asset in the expectation that the criteria will be met by the end of the annual
reporting period.
Interim income tax expense
Interim period income tax expense is accrued using the tax rate that would be applicable to
expected total annual earnings.
Revenues received occasionally, seasonally or cyclically
These should not be anticipated or deferred in interim financial statements, if they would not
be anticipated or deferred for the annual financial statements
Year-end bonus
This should not be provided for in an interim financial statement unless there is a constructive
obligation to pay a year-end bonus and the size of the bonus can be measured reliably.

4.5 Use of estimates.

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 The interim financial statements should be reliable, relevant and free from material error. But
the standard recognizes that accuracy and reliability could be sacrificed for the sake of
timeliness and cost-benefits. As earlier stated, IAS 34 therefore, recognises that the
preparation of interim financial reports will generally rely more heavily on estimates than the
annual financial statements.
Appendix B of IAS 34 provides examples of the use of estimates:
Inventories
A full count of inventory may not be necessary at each interim reporting date. Instead, it may
be sufficient to estimate inventory values based on sales margins.
Pensions
A company is not expected to obtain an actuarial valuation of its pension liabilities at the end
of each interim period. The most recent valuation could be rolled forward and used in the
interim accounts.

Provisions
The calculation of some provisions requires the assistance of an expert or a consultant. For
the interim accounts, this would not be cost and time effective. IAS 34 therefore permits that
the figure included in the annual financial statements for the immediately preceding year
should be updated without reference to an expert.

IN-TEXT QUESTIONS

1. A financial Statement containing either a complete set of financial statements or a set of

condensed financial statements for an interim period IS called----------------------------

2.An interim financial report contains four condensed statements, in addition to explanatory
notes, namely--------------; -------------------; -------------------- and -------------------------

IN-TEXT ANSWERS

1. Interim financial report

2. Condensed: statement of financial position; statement of profit or loss; statement of changes in

equity and statement of cash flows

SELF-ASSESSMENT QUESTION

You are the financial controller of Omega. Omega has subsidiaries located in a number of different
countries. Omega has a strategy of growth by acquisition
77 and regularly evaluates potential acquisition
targets from different countries and financial reporting regimes. Omega regularly seeks to raise capital on a
number of different markets to fund new acquisitions. All subsidiaries currently prepare financial
statements using applicable local accounting standards. The consolidated financial statements have been
TUTOR-MARKED ASSIGNMENT

Change Limited
The following financial statements relate to Change Ltd for period ended 31 December 2007.

Statement of Profit or Loss for the period ended 31 December 2007.

=N=’000
Revenue 110,800
Cost of sales (46,900)
Gross profit 63,900
Operating expenses (21,400)
Profit before tax 42,500
Income tax 30% (12,750)
Profit for the period 29,750

Statement of Change in equity for the year ended 31 December 2007.

Share share others Retained Total
Capital Premium earnings
N’000 N’000 N’000 N’000 N’000
Balance b/d 40,500 31,000 18,500 60,100 150,100
Profit for the period - - - 29,750 29,750
Dividends - - - 8,900 (8,900)
Issue of shares 8,500 4,500 - - 13,000
49,000 35,500 18,500 80,950 183,950

Statement of financial position as at 31 December 2007

=N=’000
Property, Plant and Equipment 108,690
Current Assets 78 169,310
Total assets 278,000

Equity and Liabilities

Share capital 49,000
MODULE 3 ACCOUNTING AND REPORTING STANDARDS II

Introduction

In this module, you will go through twelve accounting and reporting standards. Some of the
standards that are related have been grouped into one unit for ease of comprehension.
Property, plant and equipment (PPE), IAS 16, is in unit 1 with government grants and
assistance (IAS 20), borrowing costs (IAS 23), impairments of non-current assets (IAS 36)
and investment property (IAS 40). Standards such as inventories (IAS 2) and Agriculture
(IAS 41) that could impact on revenue are in a group with IFRS 15(Revenue from contract
with customers). Intangible assets (IAS 38), Non-current assets held for sale and discontinued
operations (IFRS 5) and IFRS 8 – operating segments are presented in unit 3 while the
mandatory reporting standard – earnings per share (IAS 33) is presented in unit 4.

General objectives

By the end of this module, you should be able to:

1. understand and demonstrate the accounting treatment of Property, Plant and
Equipment(PPE)
2. conduct an impairment review of non-current assets, including CPUs and demonstrate the
required accounting for impairment losses
3. evaluate the accounting treatment of government grants in the books of an entity
4. account for borrowing costs for the acquisition and construction of qualifying assets
5. understand how to account for investment property

UNIT 1 PROPERTY, PLANT AND EQUIPMENT (PPE) AND RELATED

STANDARDS

Introduction

In this unit, you will be acquainted with the definition, recognition and measurement criteria
of PPE, government grants, borrowing costs, impairment of non-current assets and
investment property. The unit, through illustrations and worked examples, gives the
accounting treatments and disclosure requirements of each of these line items in the financial
statements.

Specific objectives

By the end of this unit, you should be able to:

1. Identify the elements of cost of an acquired and self-constructed items of PPE;

79
 2. Demonstrate knowledge of accounting treatment of future costs of dismantling and
restoration of PPE after its useful life.
3. Discuss the accounting treatment of borrowing costs.
4. Recognise and measure borrowing costs in the financial statement of entities.
5. Explain the need for impairment reviews and the sources of impairment
6. Account for impairment losses in the books of an entity
7. Demonstrate the accounting treatment of investment property held under the cost
model and under the fair value model respectively
8. Give the accounting treatment of government grants in the books of an entity.

1.0 IAS16: PROPERTY, PLANT AND EQUIPMENT

Preamble

IAS 16 is applicable for accounting for PPE, defined as:

TANGIBLE items that:

 Are held for use in the production or supply of goods or services, for rentals to others
or for administrative purposes; and
 Are expected to be used during more than one period.

Note: IAS 16 is applied to all PPE except when another standard requires or permits different
accounting treatment e.g. IAS 17 LEASE, prescribes a different approach for the recognition
of assets held under leases.

The standard excludes from its scope the following:

1. PPE classified as held for sale and discontinued operations in IFRS 5.

2. Biological assets related to agricultural activity in IAS 41 and
3. Mineral rights and mineral reserves such as oil, natural gas and similar non-
regenerative resources.

Note:

 Though biological assets and mineral rights and reserves are excluded, IAS 16 applies
to PPE used to develop or maintain those assets e.g. it applies to agriculture and land
 Investment property, including property being constructed or developed for future use
as investment property, is within the scope of IAS 40, but when an entity chooses to
apply the COST MODEL to investment property under IAS 40, if standard use the
cost model as prescribed by IAS 16.

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1.1 RECOGNITION –
1. GENERAL RECOGNITION CRITERIA
An item of PPE is recognized as an asset if and only if ;

 It is probable that future economic benefits associated with the asset will flow to the
entity
 The cost of the asset to the entity can be measured reliably.

2. SPARE PARTS AND SERVICING EQUIPMENT

Usually carried as inventories and recognized as expense as they are consumed.

However, MAJOR Spare parts and stand-by equipment will qualify as PPE, when the
entity expects to use them during more than one period. Also, if the spare part and
servicing equipment can be used only in connection with a particular item of PPE,
they are accounted for as PPE.

3. ITEMS ACQUIRRED FOR SAFETY OR ENVIRONMENTAL REASONS.

So long they enable future economic benefits to be derived from related assets in
excess of what could otherwise have been derived, they qualify as PPE. The carrying
amount of such an asset and the related assets is reviewed for impairment in
accordance with IAS 36.
Example: A chemical Manufacturer is required to install certain new chemical
handling processes in order to comply with environmental requirements in relation to
the production and storage of dangerous chemical. Related plant enhancements are
recognized as an asset because without them, the entity will not produce and sell
chemicals.

4. AGGREGATION OF INDIVIDUALLY INSIGNIFICANT ITEM (e.g. tools moulds,

dies etc.)
Such insignificant items may be aggregated and the recognition criteria applied to the
aggregate value.

IAS 16:43 allows componentization for all significant components of PPE. That is,
each part of PPE with a cost that is significant in relation to the cost of the item should
be depreciated separately e.g. body and engine of an Aircraft.

5. SUBSEQUENT COST
A. Cost of repairs and maintenance (including small parts) are expensed.
B. Replacement parts that meet the recognition criteria are recognized in the carrying
amount of the affected item of PPE. However, once so recognized, the carrying
amount of the replaced part should be de-recognized to avoid carrying both the
replaced and replacement parts as assets. When it is not practical to determine the
carrying amount of the replaced part, the cost of the replacement may be used as

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 an indication of the cost of the replaced part at the time of acquisition or
construction (IAS 16:70).
C. Major inspections or overhauls – for items that require it e.g. ships, aircraft,
refining plants (TAM); such inspections or overhauls are capitalized, any
remaining amount of the previous inspections or overhauls is derecognized.
D. Substantial modifications – all costs that maintain existing service potential or
enhance future service potential of a PPE should be capitalized, provided that it is
probable that future economic benefit will flow to the entity. However, day to day
routine repairs and maintenance should be expensed as they are not sufficiently
certain to be recognized in the carrying amount of an asset under the general
recognition criteria.
Generally, subsequent costs on an item of PPE are capitalized when they –
- Significantly extend the useful life of the asset,
- Significantly reduce the operational costs and/or
- Significantly increase the quality and quantity of output

1.1.1 MEASUREMENT OF NON-CURRENT ASSETS

1. AT INITIAL RECOGNITION: At initial recognition, the item is measured at cost.

Cost is defined as the amount of cash or cash equivalents paid or the fair value of
considerations given to acquire an asset at the time of its acquisition or construction or
when applicable, the amount attributed to that asset when initially recognized under
specific requirements of other IFRSs e.g. IFRS 2 – share based payments.

Elements of Cost

For an acquired asset, cost comprises:

1. The purchases price, including import duties and non-refundable purchase taxes,
less trade discounts and rebates.
2. Any directly attributable costs of bringing the asset to the location and condition
necessary for it to operate in the manner intended by management. E.g. costs of
delivery and handling, site preparation, installation, testing, professional fees,
costs of employee benefits arising directly from the construction or acquisition of
the PPE.
3. The initial estimate of costs of dismantling and removing the items and restoring
the site on which it is located.

The following costs should be expensed –

 Costs of opening a new facility (pre-operation costs)

 Costs of introducing a new product or service, including advertising and promotions.
 Costs of conducting business in a new location or within a new class of customer
 Admin. and other general overhead costs.

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COST OF SELF-CONSTRUCTED ASSETS

1. The cost of self-constructed assets is determined using the same principles as for an
acquired asset.
2. Where the entity makes similar assets for sale in the normal cost of business, the cost
of the asset is the same as the cost of constructing the asset for sale.
3. Cost that can be incorporated in self - constructed assets includes;
 Direct materials
 Direct labour
 Unavoidable costs that are directly attributable to the construction activity
 Borrowing costs incurred during the period of production (IAS23)

Note: The following are eliminated from the cost of self-constructed assets

1. Any internal profits.

2. Costs of abnormal amounts of wasted material, labour or other resources.

EXCHANGE OF ASSETS

When an item of PPE is acquired in exchange for a non-monetary asset, or a combination of

monetary and non-monetary assets, the cost of that item is measured at fair value (even if the
entity cannot immediately recognize the asset given up) unless:

 The exchange lacks commercial substance; or

 The fair value of neither the asset received nor the asset given up is reliably
measurable.

Note:

1. If the acquired asset is not measured at fair value, its cost is measured at the carrying
amount of the asset given up.
2. To determine if an exchange has commercial substance, the entity considers the extent
to which the future cash flows are expected to change as a result of the transaction.
Thus, an exchange transaction has commercial substance if either:
 The configuration (risk, timing and amount) of the cash flows of the asset received
differs from the configuration of the cash flows of the asset transferred or,
 The entity-specific value (value in use) of the portion of the entity’s operations
affected by the transaction changes as a result of the exchange and
 The difference arising in either of the two circumstances above is significant relative
to the fair value of the assets exchanged.
E.g. A ship charterer owns land and buildings with a carrying amount of N10million
but which have a fair value of N15million. It exchanges the land and building for a
ship which has a fair value of N18million and pays additional N3million cash. The
transaction is believed to have commercial substance.

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Required: Give journal entries to reflect the effect of the exchange transaction in the books
of the company.

Suggested solution

1. Profit on disposal of land and buildings

N’000
Consideration received 18,000
Carrying amount of land and building disposed (10,000)
Cash paid (3,000)

Profit on disposal 5,000

Journal
DR CR
N’000 N’000
PPE (Ship) 18,000
PPE (land and building) 10,000
Cash 3,000
Profit or loss (profit on exchange of assets) 5,000
Effect: Being exchange transaction – land and building
for ship valued at fair value.

The fair value of an asset is reliably measurable if:

 The variability in the range of reasonable fair value measurement is not significant for
that asset or
 The possibilities of the various estimates within the range can be reasonably assessed
and used when measuring fair value.

Note: If the entity is able to measure reliably the fair values of either the asset received or the
asset given up, then the fair value of the asset given up is used to measure the cost of the asset
received, unless the fair value of the asset received is more evident (IAS 16:26)

Asset acquired as a part of business combination:

 Initial measurement of such assets is at FAIR VALUE for the purpose of inclusion in
the considered financial statements.
 This fair value is the cost of the asset for the purpose of subsequent accounting under
IAS 16.

1.1.2 ALTERNATIVES FOR MEASUREMENT AFTER RECOGNITION

Two different bases are permitted for the determination of carrying amount of PPE at the end
of subsequent reporting periods. These are;

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 1. Cost model
2. Revaluation model

COST MODEL

After initial recognition, the asset is carried at cost less any accumulated depreciation and
impairment losses. The cost of the assets remains unchanged (subjects to inclusion of
subsequent costs that meet capitalization criteria) until it is derecognized.

REVALUATION MODEL

After initial recognition, an entity that has chosen the revaluation model should carry its PPE
at a revalued amount being its fair value at the date of revaluation less any subsequent
accumulated depreciation and impairment losses.

NOTE:

1. Revaluation model can only be adjusted if the fair value of the PPE can be measured
reliably
2. Revaluations are to be carried out regularly to ensure that the carrying amount does
not differ materially from that which would be determined using fair value at the end
of each reporting period.

NOTE: Standard does not require annual revaluation. The frequency of revaluation will
depend on volatility/movement in the fair value of the asset, if items of PPE have
insignificant changes in fair value, the standard recommends revaluation every 3 or 5 years.

ACCUMULATED DEPRECIATION AT DATE OF REVALUATION

Dealt with in any of two ways;

1. Restated proportionately with the change in gross carrying amount of the asset so that
the carrying amount of the asset after revaluation equals its revalued amount (method
1). That is, the carrying amount is increased to the revalued amount by restating the
cost and depreciation proportionately. Used when an asset is revalued by means of
applying an index to determine its replacement cost.
2. Eliminated against the gross carrying amount of the asset and the resulting net amount
restated to the revalued amount of the asset (Method 2). The accumulated
depreciation is eliminated and any surplus is used to increase cost. This is the most
commonly used method.

DEPRECIATION

DEPRECIATION: is the systematic allocation of the depreciable amount of an asset (i.e. the
cost of the asset, or other amount substituted for cost, less residual value) over its useful life.

To comply with the requirements of IAS 16 relating to depreciation, there is need to identify:

a) The components (parts) of each item of PPE that are to be depreciated separately.

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 b) The cost or valuation of each separately depreciable component.
c) The estimated residual value of each component
d) Useful life of the component
e) The most appropriate depreciation method for each component

Note: Estimate of useful life

Useful life defined as:

i) The period over which an asset is expected to be available for use by an entity or
ii) The number of production or similar units expected to be obtained from the asset.

A. COMMENCEMENT AND CESSATION OF DEPRECIATION

1. Depreciation commences when the asset is available for use, that is, when it is in the
location and condition necessary for it to be capable of operating in the manner
intended by management.
2. Depreciation of an asset ceases at the earlier of:
i) The date that the asset is classified as held for sale or included in a disposal
group that is held for sale; and the date that the asset is derecognized.

Note: An asset or disposal group is classified as held for sale if its carrying amount will be
recovered principally through a sale rather than through continuing use (IFRS 5). Thus, the
asset or disposal group must be available for immediate sale in its present condition and its
sale must be highly probable.

B. Factors to consider in determining useful life:

a) Expected usage of the asset- assessed by reference to assets capacity or
physical output.
b) Expected physical wear and tear- frequency of use, maintenance programme,
care and maintenance of the asset while idle.
c) Technical or commercial obsolescence- arising from changes or improvements
in productions or from change in market demand for the product or service
output of the asset.
d) Legal or similar limits on the use of the asset. e.g. expiry dates of related
leases.

Note: Change in estimates of useful life is accounted for as a change in accounting estimate.

CHANGE IN DEPRECIATION METHOD

If there is a significant change in the expected pattern of consumption of benefits from an

asset, a change in depreciation method is permitted. The change is accounted for as a change
in estimate but NOT CHANGE IN ACCOUNTING POLICY.

Compensation for impairment or loss

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Any compensation for impairment or loss of an asset by 3 rd parties e.g. Government,
Insurance Company, and so on, should be included in Profit or loss.

DE-RECOGNITION: ON RETIREMENT AND DISPOSAL

Items of PPE are derecognized:

a) On disposal or
b) When no future economic benefits are expected from its use or disposal.

* Gain or loss on de-recognition should be included in profit or loss.

SALE OF PPE held for rental:

If an entity in the course of its ordinary activities sells items of PPE it has held for rental to
others, such assets are transferred to inventories when they cease to be rented and become
held for sale. Sale proceeds from such items are accounted for as REVENUE in line with
IFRS 15.

Note: when such items are transferred to inventory, IFRS 5 does not apply to them.

Depreciation methods:

1) Straight line
2) Reducing balance
3) Units of production
4) Sum of the years digits
5) Machine hour
6) Depletion method
7) Sinking fund etc

Depreciation of PPE with different components

Depreciate components separately if it can be established that their useful lives are
significantly different. e.g. land and building (with component parts such as lifts, fixtures etc)

Note: Land is non-depreciable.

1.1.3 Future cost of dismantling and restoration at the end of useful life

Where there is a requirement to dismantle an item of PPE and restore the site, provision is
usually made in the books for such future liability. The practice is to discount the estimated
cost with appropriate rate of discount and the resulting PV added to the cost of the asset.

Entries: DR Asset Account

CR Provision (liability) Account

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 (with the computed PV)

The adjusted depreciable amount of the asset is depreciated over its useful life. The periodic
unwinding of the discount (interest rate x PV) is recognized in profit or loss as a finance
charge.

DR Finance Cost

CR Provisions for dismantling and restoration (with the periodic unwinding cost)

1.1.4 Disclosure Requirements

1. General

In respect of each class of PPE, an entity is required to disclose:

 The measurement bases (Cost or valuation) used for determining the gross carrying
amount;
 The depreciation methods used;
 The useful lives or the depreciation rates used;
 The gross carrying amount and the accumulated depreciation (aggregated with
accumulated impairment losses) at the beginning and end of the period;
 A reconciliation of the carrying amount at the beginning and end of period showing:
 Additions
 Disposals
 Assets classified as held for sale or included as a disposal group
 Acquisitions through business combinations;
 Increases or decreases from revaluations and impairment losses
 Impairment losses recognized in profit or loss during the period;
 depreciation;
 Net exchange differences arising from foreign currency translations
 Other changes (movements);
 The existence and amounts of restrictions on title and PPE pledged as security for
liabilities;
 The amount of contractual commitments for the acquisition of PPE;
 The amount of expenditures recognized in the carrying amount of an item of PPE in
the course of its construction.
2. Items stated at revalued amounts

The following should be disclosed:

 The effective date of the revaluation;

 Whether an independent valuer was involved;
 The methods and significant assumptions applied in estimating the items’ fair value
(if the entity has not adopted IFRS 13);
 For each class of PPE, the carrying amount that would have been recognized had the
assets been carried under the cost model; and

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  The revaluation surplus, indicating the movement for the period and any restrictions
on the distribution of the balance to shareholders.

1.1.5 WORKED EXAMPLE

McKay Engineering completed construction of its production line on 30/12/10 at a total cost
of ₦700million. The useful life of the asset is estimated to be 15years. At the end of its life,
it is legally required that the plant be dismantled and the site restored to an acceptable
standard. The estimated cost of this exercise is ₦50million. The asset was put to use on Jan.
1, 2011. The cost of funds for the company is 18%

Calculate:
(a) Total cost of the plant
(b) The annual depreciation
(c) The finance (unwinding) cost for 2011
(d) The total provision for 2011.
(e) Carrying amount of the plant at 31/12/11
(f) Show extracts of statement of profit or loss and statement of financial position
at 31/12/11

Suggested Solution

(a) TOTAL COST OF PLANT

₦’000
Cost of Construction of Plant 700,000
PV of Dismantling and restoration:
(1.18)-15 x ₦50M 4,175

704,175

(ai) Annual depreciation charge

₦’000
704,175/15 = ₦16,945

(b) Unwinding Cost

18% x ₦4,175 = ₦751.5

(C) Total Provision for Dismantling and Restoration Cost 31/12/11

₦’000
PV of Dismantling cost 4,175
Unwinding cost 752
4,927

(d) Carrying amount of plant 31/12/11

₦’000
Cost 704,175
Depreciation (46,945)
657,230

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 (e) Extracts
Statement of Profit or Loss - 31/12/11
N’000

Depreciation 46,945
Finance (Unwinding) Cost 0.752

Statement of Financial Position - 31/12/11

Non-current Assets ₦’000
Production plant 657,230

Non-current Liability
Provision for dismantling and restoration 4,927

1.2.0 IAS 20: Accounting for Government Grants and Disclosure of Government
Assistance

1.2.1 Definitions
Government assistance is action by government designed to provide an economic benefit
specific to an entity or range of entities qualifying under certain criteria. It excludes benefits
provided only indirectly through action affecting general trading conditions, such as the
provision of infrastructure in development areas or the imposition of trading constraints on
competitors.

Government grants are assistance by government in the form of transfers of resources to an

entity in return for past or future compliance with certain conditions relating to the operating
activities of the entity.

Forgivable loans are loans which the lender undertakes to waive repayment of, under certain
prescribed conditions.

Grants related to assets are government grants whose primary condition is that an entity
qualifying for them should purchase, construct or otherwise acquire long-term assets.
Subsidiary conditions may also be attached restricting the type or location of the assets or the
periods during which they are to be acquired or held.

Grants related to income are government grants other than those related to assets.

Note: Government grants are sometimes called subsidies, subventions, or premiums.

1.2.2 Accounting Treatment

IAS 20 identifies two types of government grants namely

i. grants related to assets, or
ii. grants related to income

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Both types of grants should not be recognised until there is reasonable assurance that the
entity will comply with any conditions attaching to the grant, and the grant will be received.
Once these recognition criteria are met, the grants should be recognised in profit or loss (on a
systematic basis) over the periods necessary to match them with their related costs. They
should never be credited directly to shareholders’ interests in the statement of financial
position.
Grants related to income
For this type of grant IAS 20 recommends an ‘income approach’ that is, the grant should be
taken to income over the periods necessary to match the grant with the costs that the grant is
intended to compensate.

Two methods are allowed:

Method 1: Include the grant for the reporting period as ‘other income’ for inclusion on profit
or loss for the period
Method 2: Deduct the grant for the reporting period from the related expense.

Grants related to assets

IAS 20 also allows two methods of accounting for this
Method 1: Deduct the grant from the cost of the related asset. The asset is included in the
statement of financial position at cost minus the grant. Depreciate the net amount over the
useful life of the asset.
Method 2: Treat the grant as deferred income and recognise it as income on a systematic
basis over the useful life of the asset.

Illustrations

1. Grants related to Income

Avenso Ltd received a cash grant of ₦120,000 on 31 December 2014. The grant was towards
the cost of training young apprentices under the Apprentice training scheme. The training
programme was expected to last for 18 months from 1 January Year 2015. Actual costs of
the training were ₦120,000 in 2015 and ₦60,000 in 2016.
Required:
Show the accounting treatment of this grant in the financial statements of Avenso Ltd for the
relevant years.

Suggested solution
The grant would be accounted for as follows:
Method 1
At 31 December 2014: The grant would be recognised as a liability and presented in the
statement of financial position split between current and noncurrent amounts: ₦80,000 (12
months/18 months x ₦120,000) is current while the balance of ₦40,000 is non-current.
Dr Bank ₦120,000
Cr Deferred Income - Current ₦80,000
Non-current ₦40,000

At 31 December 2015: ₦80,000 would be recognised in profit or loss and the balance of
₦40,000 at the end of 2015 being the noncurrent balance at that year end, will be reclassified
as current in the statement of financial position.

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Dr Deferred Income –current ₦80,000
Cr Profit or loss ₦80,000

At 31 December 2016: ₦40,000 would be recognised in profit or loss – Dr Deferred Income

₦40,000; Cr Profit or loss ₦40,000.
Method 2
Entries in the statement of financial position are the same as in method 1. In statement of
profit or loss, training costs will be reported as ₦40,000 (i.e. ₦120,000 – 80,000) in 2015
while ₦20,000 (₦60,000 – 40,000) will be shown as training cost in 2016.

Extracts from the financial statements are as follows:

Statement of financial position (extracts)

31 December 31 December 31 December
2014 2015 2016
₦ ₦ ₦
Current liabilities
Deferred income 80,000 40,000 -

Non-current liabilities
Deferred income 40,000 - -

Statement of profit or loss (extracts)

31 December 31 December
2015 2016
₦ ₦
Method 1
Training costs (120,000) (60,000)
Government grant received 80,000 40,000

Method 2
Training costs (120,000 – 80,000) 40,000
Training costs (60,000 – 40,000) 20,000

2. Grants related to assets.

In 2016, a company receives a government grant of ₦400,000 towards the cost of an asset
with a cost of ₦1,000,000. The asset has an estimated useful life of 10 years and no residual
value.

Suggested Solution
The amounts could be reflected in the financial statements prepared at the end of 2016 in
accordance with IAS 20 in the following ways:
Method 1:
Statement of financial position (extract)
Property, plant and equipment ₦
Cost (1,000,000 – 400,000) 600,000

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Accumulated depreciation (60,000)
Carrying amount 540,000

Statement of profit or loss (extract) ₦

Depreciation charge (₦600,000/10 years) 60,000

Method 2:
Statement of financial position (extract)
Property, plant and equipment ₦
Cost 1,000,000
Accumulated depreciation (100,000)
Carrying amount 900,000

Current liabilities
Deferred income 40,000

Non-current liabilities
Deferred income 320,000

Note: At the end of 2016 there would be ₦360,000 of the grant left to recognise in profit in
the future at ₦40,000 per annum. ₦40,000 would be recognised in the next year and is
therefore current. The balance is non-current.

Statement of profit or loss (extract) ₦

Expense: Depreciation charge (₦1,000,000/10 years) (100,000)

Income: Government grant (₦400,000/10 years) 40,000

1.2.3 Disclosure requirements

IAS 20 requires the following disclosures in the notes to the financial statements:
i. the accounting policy adopted for government grants, including the method of
presentation in the financial statements
ii. the nature and extent of government grants recognised in the financial statements
and an indication of other forms of government assistance from which the entity has
directly benefitted.
iii. unfulfilled conditions and other contingencies attaching to government assistance (if
this assistance has been recognised in the financial statements).

SIC 10 Government assistance – no specific relation to operating activities

A company might receive a grant or other assistance that is not linked to operating activities.
The question arises as to whether such government assistance is "a government grant" within
the scope of IAS 20.

Consensus

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Such assistance meets the definition of government grants in IAS 20. Such grants should
therefore not be credited directly to shareholders' interests but should be accounted for, in
accordance with the requirements of IAS 20.

1.3.0 IAS 23 – BORROWING COSTS

Preamble

The construction, acquisition or production of non-current asset may be financed by loans.

The finance cost (borrowing cost) related to such borrowing may be capitalized or charged to
income when incurred. The core principle of IAS 23 is that borrowing costs directly
attributable to the acquisition, construction or production of a qualifying asset form part of
that asset, and thus should be capitalized. Other borrowing costs are recognized as an
expense.

1.3.1 Definitions

i. Borrowing costs are interest and other costs that an entity incurs in connection with the
borrowing of funds. These costs may include –

 interest expense calculated using the effective interest method;

 finance charges in respect of finance leases;
 exchange rate differences arising from foreign currency borrowings to the extent that
they are regarded as an adjustment to interest costs.

Notes

a. The effective interest rate is the rate that exactly discounts estimated future cash flows
(payments or receipts) through the expected life of a financial instrument or when
appropriate, a shorter period to the net carrying amount of the financial asset or financial
liability.

b. Qualifying interest costs denominated in the foreign currency, translated at the actual
exchange rate on the day in which the expense is incurred, should be classified as borrowing
costs.

ii. A qualifying asset is defined as an asset that necessarily takes a substantial period of time
to get ready for its intended use or sale. Depending on circumstances, any of the following
may be a qualifying asset:

 inventories;
 intangible assets;
 investment properties;
 manufacturing plants;

94
  power generating facilities.

The following are not qualifying assets:

 assets that are ready for their intended use or sale when acquired;
 financial assets; and
 inventories that are manufactured, or otherwise produced over a short period of time.

1.3.2 Recognition of borrowing costs

Only borrowing costs that are directly attributable to the construction, acquisition or
production of a qualifying asset are capitalized as part of the cost of the qualifying asset. But
an entity is not required to capitalize borrowing costs that are directly attributable to the
construction, acquisition or production of:

 a qualifying asset measured at fair value. This is because the measurement of such
assets is not affected by the amount of the borrowing costs incurred during their
construction or production period.
 Inventories that are manufactured or otherwise produced in large quantities on
repetitive basis, because there will be difficulty both in allocating the borrowing costs
to such inventories and monitoring those borrowing costs until the inventory is sold.

Note: The borrowing costs that are eligible for capitalization are those borrowing costs that
would have been avoided if the expenditure on the qualifying asset had not been made.

1.3.3 Specific and General borrowing costs

 If funds are specifically borrowed to obtain a particular asset, the amount of

borrowing costs to be capitalized is the actual costs incurred during the period, less
income earned on temporary investment of those borrowings.
 If a qualifying asset is funded from a pool of general borrowings, borrowing costs to
be capitalized should be determined by applying the weighted average of the
borrowing costs to the expenditure on that asset, that is,

Capitalization rate = Total general borrowing costs for the period

Weighted average total general borrowings.

Example:

An entity coordinates its financing activities through a treasury function, with borrowings
being raised to finance general requirements including the acquisition and development of
qualifying assets.

During the ended 31 Dec. 2012, the entity commenced a property development project and
incurred the following expenditure:

=N=

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1 June 5,000

1 October 10,000

1 November 10,000

The entity had total borrowings outstanding during the period, and incurred interest on those
borrowings as follows:

Balance O/standing Interest

=N= =N=
Long-term loans:
10 years at 10% 35,000 3,500
5 years at 8% 10,000 800
Short term loans 12,000 1,600
Bank overdraft 5,000 500
62,000 6,400
There was no movement on long-term loans in the period. The amounts disclosed for short
term loans and the bank overdraft represent the average amounts outstanding during the
period and the interest incurred at variable rates.
Determine the capitalization rate and the interest capitalized for the period.
Solution
Capitalization rate = Total borrowing costs for the period = 6400 = 10.32%
Weighted av. Borrowings 62,000

Interest capitalized is calculated as follows: =N=’000

N5million x7/12 x 10.32% 301
N10 million x 3/12 x 10.32% 258
N10 million x 2/12 x 10.32% 172
731

Note: In the capitalization of general borrowing costs, the amount of borrowing costs
capitalized should not exceed the actual borrowing costs incurred during that same period.

1.3.4 Period of capitalization: Borrowing costs should be capitalized from the

commencement date. That is, the date when all of the following conditions are first met:
 Expenditures for the asset are being incurred;
 Borrowing costs are being incurred;

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  Activities that are necessary to prepare the assets for its intended use or sale are being
undertaken.
Notes:
a. Capitalization should cease when substantially all the activities necessary to prepare the
qualifying asset for its intended use or sale are complete.

b. When a qualifying asset is constructed in stages, and each stage or part can be used or sold
individually while construction of the remaining development continues, capitalization of the
borrowing costs related to that part should cease when substantially all of the activities
necessary to prepare that part for its intended use or sale is completed.
c. When the carrying value of an asset, inclusive of capitalized interest, exceeds the net
realizable value, the asset should be written down to the net realizable value.

1.3 .5 Disclosure
Entities are required to disclose:
 the amount of borrowing costs capitalized during the period; and
 the capitalization rate used to determine the amount of borrowing costs eligible for
capitalization.

WORKED EXAMPLE

An entity coordinates its financing activities through a treasury function, with borrowings
being raised to finance general requirements including the acquisition and development of
qualifying assets.

During the ended 31 Dec. 2012, the entity commenced a property development project and
incurred the following expenditure:
=N=
1 June 5,000
1 October 10,000
1 November 10,000

The entity had total borrowings outstanding during the period, and incurred interest on those
borrowings as follows:

Balance O/standing Interest

=N= =N=
Long-term loans:
10 years at 10% 35,000 3,500
5 years at 8% 10,000 800
Short term loans 12,000 1,600
Bank overdraft 5,000 500
62,000 6,400

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There was no movement on long-term loans in the period. The amounts disclosed for short
term loans and the bank overdraft represent the average amounts outstanding during the
period and the interest incurred at variable rates.

Determine the capitalization rate and the interest capitalized for the period.
Solution

Capitalization rate = Total borrowing costs for the period = 6400 = 10.32%
Weighted av. Borrowings 62,000

Interest capitalized is calculated as follows: =N=’000

N5million x7/12 x 10.32% 301
N10 million x 3/12 x 10.32% 258
N10 million x 2/12 x 10.32% 172
731

Note: In the capitalization of general borrowing costs, the amount of borrowing costs
capitalized should not exceed the actual borrowing costs incurred during that same period.

1.4.0 IAS 36 – IMPAIRMENT OF ASSETS

1.4.1 Impairment Review

IAS 36 requires that review for impairment be carried out (for assets within its scope) if there
are indications that the carrying amount of the asset may not be recoverable. Thus, an
impairment review is the procedure required by IAS 36 to determine if and by how much an
asset may have been impaired. An asset is impaired if its carrying amount is greater than its
recoverable amount. The recoverable amount of an asset is the higher of its fair value less
costs of disposal and its value in use, calculated as the present values of the future net cash
flows the asset will generate. An impairment loss therefore is equal to carrying amount less
recoverable amount.
Pictorially:
New carrying Amount

Lower of :

Previous Carrying amount Recoverable Amount

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 Higher of:

Fair value less cost of Value in use (present

disposal value of future net cash
flows )

Recognising that assets rarely generate cash flows in isolation (most assets generate cash
flows in combination with other assets), IAS 36 introduces the concept of a cash generating
unit (CGU) which is the smallest identifiable group of assets that generate cash inflows that
are largely independent of other assets. Where an asset forms part of a CGU any impairment
review must be made on the group of assets as a whole. If impairment losses are then
identified, they must be allocated and/or apportioned to the assets of the CGU as prescribed
by IAS 36.

1.4.2 Scope

IAS 36 applies to many assets among which are Land and Building, Machinery and
Equipment, investment property carried at cost, biological assets carried at cost, intangible
assets, Goodwill, investments in subsidiaries, Associates and Joint Ventures other than those
accounted for in accordance with IAS 39/IFRS 9 and assets carried out revalued amounts
under IAS 16 and IAS 38.

IAS 36 does not apply to:

 Inventories (IAS 2)
 Assets arising from construction contracts (IAS 11)
 Deferred tax assets (IAS 12)
 Assets arising from employee benefits (IAS 19)
 Financial assets within the scope of IAS 39 (Financial instruments: Recognition and
measurement) and IFRS 9 (Financial instruments).
 Investment property measured at fair value (IAS 40)
 Biological assets related to agricultural activity that are measured at fair value less
cost to sell (IAS 41);
 Deferred acquisition costs and intangible assets, arising from an insurer’s contractual
rights under insurance contracts within the scope of IFRS 4; and
 Non-current assets (or disposal groups) classified as held for sale in accordance with
IFRS 5.

1.4.3 Definition of Concepts

Recoverable Amount for an asset or a cash-generating unit (CGU) is the higher of its fair
value less costs of disposal and its value in use.

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.

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Costs of disposal are incremental costs directly attributable to the disposal of an asset or
CGU, excluding finance costs and income tax expense.

Value in use is the present value of the future cash flows expected to be derived from an
asset of a CGU.

An impairment loss is the amount by which the carrying amount of an asset or CGU exceeds
its recoverable amount.

Carrying amount is the amount at which an asset is recognized in the statement of financial
position after deducting any accumulated depreciation (amortization) and accumulated
impairment losses.

A cash-generating unit (CGU) is the smallest identifiable group of assets that generates
cash flows that are largely independent of the cash flows from other assets or group of assets.

Corporate assets are assets other than goodwill that contribute to the future cash flows of
both the CGU under review and other CGUs.

1.4.4 Requirement for impairment reviews

Entities are required to assess whether there is indication of impairment of an asset or CGU at
the end of each reporting period. If such an indication exists, the entity should estimate the
recoverable amount of the assets.

Example: An entity has a machine whose carrying amount as at 31 December 2012 was
N700,000. As at 31 December 2014, the directors became aware that a new technological
development means that demand for the output produced by the machine is likely to decline
significantly.
Under IAS 36, the directors are required to estimate the asset’s recoverable amount.

The following assets should be tested for impairment annually whether there is indication of
impairment or not:
 Intangible assets with an indefinite useful life;
 Intangible assets that are not yet available for use; and
 Goodwill acquired in a business combination.

1.4.5 Indications of impairment

Indications of impairment may come from internal or external sources.

Internal sources of information

1. Evidence of obsolescence or physical damage of the asset;

2. Significant changes with an adverse effect on the entity on the use or expected use of
the asset e.g. the possibility of the asset becoming idle, plans to discontinue or
restructure the operation to which the asset belongs, plans to dispose the asset before
previously expected date etc.

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 3. Evidence of poor economic performance of the asset below expectation. Such
evidence may include:
 Cash flow for acquiring the asset or subsequent cash needs for maintaining or
operating the asset significantly exceeds original budget;
 Actual net cash flows or operating profit or loss being generated by the are
significantly worse than budgeted;
 A significant decline in budgeted net cash flows or operating profit or a
significant increase in budgeted loss, flowing from the asset etc.

External sources of information

i. Significant decline in asset value more than would be expected as a result of passage
of time or normal use.
ii. Significant changes with an adverse effect on the entity, in the technological, market,
economic or legal environment in which the entity operates or in the market to which
the asset is dedicated e.g. A factory produces a product that is now judged armful to
the environment and the government bans the use of such equipment after a phased-
out period, the carrying amount of the factory and the associated equipment would
need to be assessed for impairment.
iii. The carrying amount of the net assets of the entity is more than its market
capitalization.
iv. Increase in market interest rates that may affect discount rates used in calculating
value in use.
v. Increase in interest rates that adversely affect the recoverable value of the asset.

1.4.6 Recoverable amount of the asset and value in use

The recoverable amount an asset is measured as the higher of

 its fair value less costs of disposal and
 its value in use.

Example: As at December 31, 2012, one of an entity’s machines has a carrying amount of
N4million. The machine generates largely independent cash inflows and therefore is tested
for impairment as a stand-alone asset. Due to changes in market condition, the entity
considers that the machine may be impaired. It is determined that the asset could be sold for
N2million (with costs of disposal at N200,000). The directors have estimated that the value in
use of the asset is N3.5million.
Required: Determine the impairment loss.

Fair value less costs of disposal = N2m – N0.2m = N1.8m

Value in use = N3.5m.
Therefore, the recoverable amount = N3.5m.
Impairment loss:
Carrying amount N4.0m
Less: recoverable value N3.5m
N0.5m

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For the purpose of impairment review, it is not always necessary to calculate both fair value
less costs of disposal and value in use.
a. If either fair value less costs of disposal or the value in use is higher than the carrying
amount, the asset is not impaired and there is no need to calculate the other amount.
b. If there is no basis for making a reliable estimate of fair value less costs of disposal,
recoverable amount is measured by reference to value in use alone.
c. The detailed calculations involved in measuring value in use may be avoided if a
simple estimate is sufficient to show either that value in use is higher than the
carrying amount or that it is lower than fair value less costs of disposal.

Calculation of Value in Use

Calculation of value in use takes four stages namely:
i. the determination of cash-generating unit. This stage is skipped if the recoverable
amount of an asset can be individually determined.
ii. the estimation of expected future cash flows;
iii. the determination of appropriate discount rate; and
iv. discounting and aggregating expected cash flows to arrive at value in use.

Cash flows to be included are:

 projected cash flows from the continuing use of the asset;
 projected cash outflows that are necessarily incurred to generate cash inflows from the
continuing use of the asset (e.g. maintenance and renewal costs); and
 net cash flows, if any, to be received (or paid) for the disposal of the asset at the end
of its useful life.

Illustration
Moabison Plc acquired an item of plant at a cost of N800,000 on 1 January 2011 that is used
to produce and package pharmaceutical pills. The plant had an estimated residual value of
N50,000 and an estimated life of five years, neither of which has changed. Moabison uses
straight-line depreciation. On 31 December 2012, Moabison was informed by a major
customer (who buys products produced by the plant) that it would no longer be placing orders
with Moabison. Even before this information was known, Moabison had been having
difficulty finding work for this plant. It now estimates that net cash inflows to be earned from
the plant for the next three years will be:
N’000
year ended: 31 December 2013 200
31 December 2014 150
31 December 2015 130
On 31 December 2015, the plant is still expected to be sold for its estimated realisable value.

Moabison has confirmed that there is no market in which to sell the plant at 31 December
2012. Moabison’s cost of capital is 10%.

Required:

a. Calculate the value in use of the asset at 31 December 2012.

b. Calculate the impairment loss.

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 c. Calculate the carrying amount of the Plant at 31 December 2012 after applying any
impairment losses.
Calculations should be to the nearest N1,000.

Suggested solution

a. Value in use:
Cash flow Discount factor Present value

N’000 at 10% N’000

year ended: 31 Dec. 2013 200 0·909 182

31 Dec. 2014 150 0·826 124

31 Dec. 2015 130 + 50 0·751 135

441

The value in use is N441,000. This is also the recoverable amount of the plant as it has no
market value at this date.

b. Impairment loss
Annual depreciation charge = 800,000 (cost) – 50,000 (residual value)/5 years =
N150,000.
Accumulated depreciation to 31/12/12 = N150,000 x 2 = N300,000.
Carrying amount before impairment review = N800,0000 – N300,000 = N500,000.
Less: Recoverable amount (= value in use) = N441,000
Impairment loss = N59,000
c. Carrying amount after impairment review
Cost = N800,000
Accumulated depreciation = (N300,000)
Impairment loss = (59,000)
Revised Carrying amount = N441,000

Note:
1. Where the asset or CGU generates uniform (or constant) annual cash flows, a
cumulative discount factor is determined and applied to the annual cash flow to arrive
-n
at the Value in use viz. Value in use = [1 – (1+r) ] x annual cash flows
r

For example: The expected cash flow from a depreciable asset is N100m per annum
for the next 5 years. If the discount rate is 10%,

Value in use = [1 – (1.1)-5] x N100m

0.1
= 3.791 x N100m

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 = N379.1m

2. An impaired asset will have its subsequent annual depreciation charge revised to
reflect the expected economic benefits from the asset for the remainder of its useful
economic life (UEL). Revised depreciation charge = recoverable value/remaining
UEL at the date of impairment.

1.4.7 Allocation of impairment loss to assets within a Cash-generating Unit (CGU)

Impairment loss is allocated to reduce the carrying amount of the assets of a CGU in the
following order:

a. any identified impairment loss on any specific asset is used to reduce the carrying
amount of that specific asset.
b. the remaining impairment loss is charged to goodwill allocated to the group till it is
reduced to zero.
c. the balance after charge to goodwill is allocated to other assets of the unit on pro-rata
basis based on the carrying amount of each asset in the unit.
Note: 1. In allocating impairment loss to individual assets within a CGU, the carrying amount
of an individual asset should not be reduced below the higher of its recoverable amount and
zero.

2. No allocation of impairment loss to monetary assets e.g. cash, trade receivables etc

Illustration

Maybros Plc owned a 100% subsidiary, Maylux, which is treated as a cash generating unit.
On 31 December 2012, there was an industrial accident (a gas explosion) that caused damage
to some of Maylux’s plant. The assets of Maylux immediately before the accident were:
N’000
Goodwill 1,800
Patent 1,200
Factory building 4,000
Plant 3,500
Receivables and cash 1,500
––––––
12,000

As a result of the accident, the recoverable amount of Maylux is N6·7 million. The
explosion destroyed (to the point of no further use) an item of plant that had a carrying
amount of N500,000.

Maylux has an open offer from a competitor of N1 million for its patent. The receivables and
cash are already stated at their fair values less costs of disposal.

Required:

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Calculate the carrying amounts of the CGU at 31 December 2012 after applying any
impairment losses.

Suggested solution

Maybros Plc
Impairment loss = carrying amount (after accident) – recoverable value
= N11,500,000 – 6,700,000 = N4,800,000.

Note: The destroyed plant with carrying value of N500,000 is de-recognised as it no longer
meets the definition of an asset.
After Impairment Allocation Revised carrying
Accident loss basis Amount
N’000 N’000 N’000
Goodwill 1,800 1,800 full write off 0
Patent 1,200 200 realisable value 1,000
Factory 4,000 1,600 pro rata (4/7 x 2,800) 2,400
Plant 3,000 1,200 pro rata (3/7 x 2,800) 1,800
Receivables and cash 1,500 0 realisable value 1,500
––––––– ––––––– ––––––
11,500 4,800 6,700
Note
1. Identified loss of N200,000 on the patent is first applied to the specific asset.
2. N1,800,000 of the balance of N4,600,000 is then applied to Goodwill.
3. The remaining amount of N2,800,000 of the impairment loss is allocated to factory
and plant on pro rata basis as shown above.
Accounting treatment of an impairment loss

a. Assets carried at historical cost.

Dr Statement of Profit or loss
Cr Asset account; (with the amount of the impairment loss)

By this treatment, the asset is reduced to its recoverable amount in the statement of financial
position.

b. Assets carried at Revalued amount (e.g. PPE revalued under IAS 16)
Dr Revaluation reserve (to the extent of the balance in the reserve a/c)
Cr Asset account

Any excess impairment loss (over the revaluation reserve balance) is charged to profit or loss.

Example

The impairment loss for Maylux (Subsidiary of Maybros) above will be accounted for as
follows:

Maylux

Journal

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 N’000 N’000

Dr Statement of Profit or loss 4,800

Cr Goodwill 1,800
Cr Patent 200
Factory 1,600
Plant 1,200
Being impairment loss for period ended 31/12/2012

1.4.8 Impairment reversal

If the recoverable amount of an asset or a CGU that was previous impaired becomes higher
than its current carrying amount, the impairment loss is reversed so as to reflect the new
value. A reversal of an impairment loss must reflect an increase in the estimated service
potential of an asset or CGU, either from use or sale.

Indications of reversals of impairment loss

Sources of information may be external or internal. External sources of information

indicating that an impairment loss previously recognized no longer exists or has decreased
include:

i. there are observable indications that the asset’s (CGU’s) value has increased significantly
during the period;

ii. significant changes with favourable effect on the entity have taken place during the period
or will take place in the near future, in the technological, market, economic or legal
environment in which the entity operates or in the market to which the asset (or CGU) is
dedicated; and

iii. Market interest rates or other market rates of return on investments have decreased during
the period, and those decreases are likely to affect the discount rate used in calculating the
asset’s (or CGU’s) value in use and increase the asset’s or CGU’s recoverable amount
materially.

Internal sources of information for impairment loss reversal include:

i. significant changes with favourable effect on the entity have taken place during the period
or are expected to take place in the near future, in the extent to which or the manner in which
the asset, (or CGU) is used or is expected to be used; and

ii. evidence is available from internal reporting that indicates that the economic performance
of the asset or CGU is, or will be, better than expected.

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 The procedure for impairment loss reversal is as follows:

1. An impairment loss on goodwill should not be reversed. This is because subsequent

increase in the recoverable amount of goodwill after impairment loss recognition is
likely to be an increase in internally generated goodwill, rather than a reversal of
impairment loss. Recognition of internally generated goodwill is prohibited by IAS 38
Intangible Assets. Reason: determination of its value is very subjective and cannot be
measured reliably.
2. The impairment loss reversal on assets other than goodwill should not exceed the
impairment loss previously recognized.
3. The carrying amount of the asset should be increased by the amount of the reversal to
the extent of what the carrying amount should have been had there been no
impairment in the first place. Any increase in excess of this amount would be a
revaluation and would be accounted for under IAS 16 – PPE.
4. The reversal of the impairment loss should be credited to statement of profit or loss (if
the loss was recognized as an expense). When an asset is carried at a revalued
amount, the reversal is considered a revaluation increase and treated as such.
5. After the reversal of an impairment loss, the depreciation charge for the asset is
adjusted in future periods to allocate the asset’s carrying amount, less its residual
value, on a systematic basis over its remaining useful life.
6. A reversal of impairment loss for a CGU should be allocated to increase the carrying
amounts of the assets (except goodwill), pro rata based on the carrying amount of
each asset in the unit.
1.4.9 Calculation of amount of impairment reversal

Impairment reversal = impairment loss x remaining UEL at the date of impairment reversal
Remaining UEL at the date of impairment loss.

Illustration

The following information is available on Plant 1:

1. Carrying amount before impairment reversal as at 31 December 2013 (date of

impairment reversal) N15.6m
2. Remaining Useful economic life (UEL) as at this date (i.e date of impairment
reversal) 3
years.
3. Impairment loss recognized N4m
4. Remaining UEL as at date of impairment loss 5 years
The market for the product produced by plant 1 has improved and the recoverable amount of
the plant is estimated at N20m.

Required:

a. Calculate the amount of the impairment reversal.

b. Show the accounting entries.

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Suggested Solution

a. Impairment reversal = 4m x 3
5
= N2.4m

Note: 1. If the increase in recoverable amount is lower than the impairment loss earlier
recognized, the increase in recoverable value will be used in place of impairment loss in the
calculation above.

2. The carrying amount of the asset should not be increased beyond what it should have been
if there was no impairment loss in the first place.

b. Accounting treatment:
Dr Asset account N2.4m
Cr statement of profit or loss N2.4m

1.4.10 Disclosures

1. The impairment losses recognized in profit or loss during the period and the line items
of the SCI in which the impairment losses were included;
2. Reversals of impairment losses recognized and the line items of the SCI in which the
impairment losses were included;
3. Impairment losses on revalued assets recognized in other comprehensive income
during the period;
4. Reversals of impairment losses on revalued assets recognized in other comprehensive
income during the period;
5. The events and circumstances that led to the recognition (reversal) of an impairment
loss;
6. For a CGU,
 a description of the CGU (product line, plant, reportable segment, business
operation? etc)
 the amount of the loss recognized (or reversed) by class of assets;
 any change in the aggregation of assets for identifying CGU since the previous
estimate of CGU’s recoverable amount and reasons for the change.
7. Whether the recoverable amount of the asset or CGU is its fair value less cost of
disposal or its value in use;
8. If the recoverable amount is fair value less cost of disposal, the basis used to measure
the fair value;
9. If the recoverable amount is value in use, the discount rate(s) used in the current
estimate and previous estimate, if any.
10. The amount of impairment losses recognized directly in equity, if any.

1.5.0 IAS 40: Investment Property

1.5.1 Definition

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An investment property is property (land or a building, part of a building or both) held to earn
rentals or for capital appreciation or both. Investment property includes the building whilst it
is under construction for eventual use as an investment property.

The property could be held by the owner; or the lessee under a finance lease or an operating
lease.

The following are examples of items that are not investment property:

a. property intended for sale in the ordinary course of business;

b. property being constructed or developed on behalf of third parties;

c. owner-occupied property including (among other things) property held for future use as
owner-occupied property, property held for future development and subsequent use as owner-
occupied property, property occupied by employees (whether or not the employees pay rent
at market rates) and owner-occupied property awaiting disposal;

d. property being leased to another entity under a finance lease.

Property held under an operating lease

A property interest that is held by a lessee under an operating lease may be classified and
accounted for as investment property if, and only if, the property would otherwise meet the
definition of an investment property and the lessee accounts for it using the IAS 40 fair value
model.

Note:

 This classification alternative is available on a property-by-property basis. This

means that a company might lease two properties from another under operating
leases;
 This classification alternative is not available for assets not accounted for using the
fair value model; and
 Once this classification alternative is selected for one property interest held under an
operating lease, all property classified as investment property must be accounted for
using the fair values model.

Example: Property held under an operating lease

A Plc rents two properties from B Plc under operating leases. A Plc sublets these properties
and they satisfy the IAS 40 definition of investment properties from A’s view.

A Plc has a choice of accounting treatment for its interests in these properties:

1. A Plc could use IAS 17 operating lessee accounting for both properties.

2. A Plc could use IAS 40 investment property accounting for both properties.

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 3. A Plc could use IAS 17 operating lessee accounting for one property and IAS 40
investment property accounting for the other.

If it applies IAS 40 it must apply the IAS 40 fair value model to the property and to all other
investment properties that it might hold.

Property leased within a group

In some cases, an entity owns property that is leased to, and occupied by, its parent or
another subsidiary.

i. The property could qualify as investment property from the perspective of the entity
that owns it (if it meets the IAS 40 definition). In that case the lessor must account
for the property as investment property in its individual financial statements.
ii. The property does not qualify as investment property in the consolidated financial
statements, because the property is owner-occupied from the perspective of the
group.

Partly occupied buildings

An entity might use part of a property for the production or supply of goods or services or for
administrative purposes and hold another part of the same property to earn rentals or for
capital appreciation. In other words, part of a property might be owner occupied and part held
as an investment.

If an insignificant portion is owner occupied, the property is accounted for as investment

property. Otherwise, the two parts are accounted for separately.

1.5.2 Accounting treatment of investment property

Recognition

An investment property should be recognised as an asset only when it is probable that future
economic benefits associated with the property will flow to the entity; and the cost of the
property can be measured reliably.

Measurement at recognition

Investment property should be measured initially at cost plus the transaction costs incurred to
acquire the property.

A property held under an operating lease may be classified as an investment property. The
initial cost of such a property is found by capitalising the operating lease as if it were a
finance lease according to IAS 17/IFRS 16 Leases.

Measurement after recognition

After initial recognition an entity may choose as its accounting policy:

110
  the fair value model; or
 the cost model.

The chosen policy must be applied to all the investment property of the entity. Once a policy
has been chosen it cannot be changed unless the change will result in a more appropriate
presentation.

Note: According to IAS 40, a change from the fair value model to the cost model is unlikely
to result in a more appropriate presentation.

Fair value model for investment property

Under the fair value model the entity should revalue all its investment property to ‘fair value’
(open market value) at the end of each financial year; and recognise any resulting gain or
loss in profit or loss for the period. The property would not be depreciated.

This is different to the revaluation model of IAS 16, where gains are reported as other
comprehensive income and accumulated as a revaluation surplus.

If it is not possible to arrive at a reliable fair value figure then the cost model should be
adopted for that property. This is an exception to the rule that all investment property must be
valued under either one model or the other.

Cost model for investment property

The cost model follows the provisions of IAS 16. The property is valued at cost and the non-
land element is depreciated.

Illustration

On 1 January Year 2015 Pacesetters Plc purchased a property for its investment potential.
The property cost ₦10 million with transaction costs of ₦1,000,000. The depreciable amount
of the building component of the property at this date was ₦3,000,000. The property has a
useful life of 50 years. At the end of Year 2015 the property’s fair value had risen to ₦13
million.
Required
Show the extracts of statement of financial position in respect of this transaction as at 31
December 2015 and the statement of profit or loss for the period ended on that date, under:
a. the cost model
b. the fair value mode

Suggested solution

a. Cost Model

PACESETTERS PLC

111
 Statement of Financial Position as at 31 December, 2015 (extract)

N’000

Investment Property - Cost (10,000,000 + 1,000,000) 11, 000

Accumulated depreciation (3,000,000 ÷ 50 years) (60)

Carrying Amount 10,940

Statement of Profit or loss, year ended 31 December 2015 (extract)

Depreciation ₦60,000

b. Fair Value Model

Statement of Financial Position as at 31 December, 2015 (extract)

N’000

Investment Property – Fair value 13,000

Statement of Profit or loss, year ended 31 December 2015

N’000
Fair value adjustment (gain) (₦13,000,000 – ₦11,000,000) 2,000

1.5.3 Transfers and disposals of investment property

If a property is transferred into or out of this category it must be reclassified as an investment

property or as no longer being an investment property. A transfer of investment property can
only be made where there is a change of use as illustrated below.

Circumstance Transfer to/from Deemed Transfer value

Commencement of Transfer from investment property Fair value at the date of change
Owner-occupation to owner-occupied property becomes the deemed cost for
future accounting purpose

End of owner-occupation Transfer from owner-occupied Where investment properties are

property to investment property measured at fair value, revalue in
accordance with IAS 16 prior to

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 the transfer

Commencement of Transfer from investment property Fair value at the date of change
development with a view to inventories of use becomes the deemed cost
to sale. for future accounting purposes

Commencement of an Transfer from inventories to Fair value at the date of the

operating lease to another investment property transfer, and any difference
party compared to previous carrying
amount is recognised in profit or
loss

1.5.4 Gain or loss on disposal

Gains or losses on disposals of investment properties are included in profit or loss in the
period in which the disposal occurs

Illustration

The investment property in the previous example was sold early in 2016 for ₦15,500,000,
Selling costs were ₦500,000.

Required

The amount that would be included in the statement of profit or loss for 2016 in respect of
this disposal under
a. the cost model
b. fair value model

Solution
a. Cost model ₦’000
Sale value 15,500
Selling costs (500)
Net disposal proceeds 15,000
Carrying amount (10,940)
Gain on disposal 4,060

Fair value model ₦’ 000

Sale value 15,500

Selling costs (500)

Net disposal proceeds 15,000

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Carrying amount (13,000)

Gain on disposal 2,000

1.5.5 Disclosure requirements

The following disclosures are required by IAS 40 in the notes to the accounts.

Disclosure requirements applicable to both the fair value model and the cost model

 whether the fair value model or the cost model is used

 the methods and assumptions applied in arriving at fair values
 the extent to which the fair value of investment property was based on a valuation by
a qualified, independent valuer with relevant, recent experience
 amounts recognised in income or expense in the statement of profit or loss for:
 rental income from investment property
 operating expenses in relation to investment property
 details of any restrictions on the ability to realise investment property or any
restrictions on the remittance of income or disposal proceeds
 the existence of any contractual obligation to purchase, construct or develop
investment property or for repairs, maintenance or enhancements.

Disclosure requirements applicable to the fair value model only

There must be a reconciliation, in a note to the financial statements, between opening and
closing values for investment property, showing:

 additions during the year

 assets classified as held for sale in accordance with IFRS 5
 net gains or losses from fair value adjustments
 acquisitions through business combinations

This reconciliation should show separately any amounts in respect of investment properties
included at cost because their fair values cannot be estimated reliably.

For investment properties included at cost because fair values cannot be estimated reliably,
the following should also be disclosed:

 a description of the property

 an explanation as to why fair values cannot be determined reliably
 if possible, the range within which the property’s fair value is likely to lie.

Disclosure requirements applicable to the cost model only

 the depreciation methods used

 the useful lives or depreciation rates used

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  gross carrying amounts and accumulated depreciation at the beginning and at the end
of the period
 A reconciliation between opening and closing values showing:
 additions
 depreciation
 assets classified as held for sale in accordance with IFRS 5
 acquisitions through business combinations
 impairment losses
 transfers.

When the cost model is used, the fair value of investment property should also be disclosed.
If the fair value cannot be estimated reliably, the same additional disclosures should be made
as under the fair value model.

IN-TEXT QUESTIONS (ITQ’s)

1 ……………… is the systematic allocation of the depreciable amount of an asset (i.e. the cost of
the asset, or other amount substituted for cost, less residual value) over its useful life.
2 Two different bases are permitted for the determination of carrying amount of PPE at the end of
subsequent reporting periods are………………….
3 ……………… are interest and other costs that an entity incurs in connection with the borrowing
of funds..
4 Borrowing costs are to be capitalized from ………………….
5 ……………… is the present value of the future cash flows expected to be derived from an asset
or a CGU .
6 ……………….is the amount by which the carrying amount of an asset or CGU exceeds its
recoverable amount
7 Investment property carried under the cost model is accounted for following the provisions of
-------

8. IAS 20 recommends the use of the ------------ approach in accounting for government grants.

IN-TEXT ANSWERS (ITA’s)

1. Depreciation

2. Cost and revaluation models

1. Borrowing cost
2. The commencement
3. Value in use
115
4. Impairment loss
5. IAS 16
6. Income
UNIT 2 INTANGIBLE ASSETS, OPERATING SEGMENTS AND
ACCOUNTING FOR NON-CURRENT ASSETS HELD FOR SALE
AND DISCONTINUED OPERATIONS (IAS 38, IFRS 8 & IFRS 5)

Introduction

This unit presents the recommended accounting procedures for intangible assets, non-current
assets held for sale and discontinued operations and operating segments. Students need to pay
attention to the definition, recognition and measurement criteria recommended by the
standards as well as the disclosure requirements.

Specific Objectives

At the end of this unit, students should be able to:

1. Identify classes of items that may be described as held for sale.

2. Correctly account for non-current assets held for sale
3. Recognise the disposal group;
4. Explain the disposal group that are held for distribution to owners;
5. Discuss the discontinued operations;
6. Define intangible assets in line with the standard;
7. Discuss the characteristics of items to be regarded as intangible assets;
8. Differentiate between development cost and research cost and how to measure them
in the financial statement.
9. Identify operating segments as well as prepare segment disclosure notes

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2.1 IAS 38: INTANGIBLE ASSETS
IAS 38 establishes the criteria for the recognition and measurement of intangible assets and
also prescribes disclosure requirements for intangible assets. The standard requires that
entities recognize intangible assets if, and only if specified criteria are met. The standard, like
IAS 16, gives guidance on measurement of intangible assets on first recognition as well as
after initial recognition. Acknowledging the difficulty in identifying intangible assets, the
standard gives broader guidance on how to do this and defines when to expense or capitalize
expenditure on intangible assets.
The standard applies to all intangible assets except leases that fall within the scope of IFRS
16, deferred tax assets (IAS 12), insurance contracts, assets arising from employee benefits
(IAS 19) etc.

2.1.1 Definition and explanation

An intangible asset is defined as an identifiable, non-monetary asset without physical
substance’
The key components of the definition are:
i. Identifiability and
ii. Asset

i. Identifiability: IAS 38: 12 gives some guidance. An asset is identifiable if either:

a) is separable, i.e. is capable of being separated or divided from the entity and sold,
transferred, licensed, rented or exchanged, either individually or together with a
related contract, identifiable asset or liability, regardless of whether the entity intends
to do so; or
b) arises from contractual or other legal rights, regardless of whether those rights are
transferable or separable from the entity or from other rights and obligations.

ii. Asset (control)

An entity controls an asset if the entity has the power to obtain the future economic benefits
flowing from the underlying resource and to restrict the access of others to those benefits.
Though not always a necessary condition, an enforceable legal right is an evidence of control
e.g. legal rights over the use of patents, trademarks or copyrights. The skills of employees
arising out of the benefits of training costs as well as market share and customer loyalty, do
not qualify as intangible assets as the entity may not be able to control the future actions of
either the employee or the customer. Market and technical knowledge may give rise to future
economic benefits, only to the extent that they are protected by legal rights.

Future economic benefits

These may include revenues and/or cost savings. Management judgement is needed in
assessing the degree of certainty attached to the flow of economic benefits to the entity.

2.1.2 Recognition and initial measurement

General principles

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If an item meets the definition of an intangible asset, it should be recognized in the financial
statements if, and only if, it is probable that future economic benefits attributable to the asset
will flow to the company and the cost of the asset can be measured reliably.
On initial recognition, intangible assets are measured at cost.

Subsequent expenditure
Most subsequent expenditure incurred on intangible assets is intended to maintain the
benefits expected from the asset. Many of such expenditure can be difficult to differentiate as
they are related to the business as a whole. Thus, it is rare to capitalize subsequent
expenditure on intangible assets. The standard specifically does not permit capitalization of
subsequent expenditure incurred on brands, mastheads, publishing titles as well as customer
lists.

Subsequent expenditure on in-process research and development project receives attention in

the standard. Such expenditure is:
 recognized as an expense if it is research expenditure;
 recognized as an expense if it is development expenditure that does not satisfy the
recognition criteria; but
 capitalized if it is development expenditure that satisfies the recognition criteria for
development expenditure.

Generally, all expenditure relating to an intangible asset that does not meet the criteria for
recognition either as an identifiable intangible asset or goodwill arising on acquisition should
be expensed as they are incurred. Examples of such expenditure given by IAS 38 include start
up costs, training costs, advertising costs, and business relocation costs.

Acquisition of intangible assets

Intangible assets be acquired through different ways namely:
 separate acquisition
 acquisition as part of a business combination;
 acquisition by way of a government grant.
 acquired in exchange for another asset;
 internally generated intangible assets

IAS 38 provides detailed rules on how the recognition and measurement criteria are to be
applied in each of the above circumstances.

Separate acquisition
Intangible assets separately acquired usually meets the recognition criteria future economic
benefits flowing to the entity and cost being able to be measured reliably. The anticipation of
future economic benefits is reflected in the price paid and the cash or other monetary assets
expended will normally give an indication of reliable measure of cost.

2.1.3 Measurement of cost

The cost of a separately acquired intangible asset, as in other assets, comprises:
 its purchase price, including any import duties and non-refundable purchase taxes,
after deducting any trade discounts and rebates; and
 any directly attributable expenditure on preparing the asset for its intended use.

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For example, personnel costs arising directly from bringing the asset to its working condition,
professional fees for legal services and costs of testing whether the asset is functioning
properly.
Deferred payments are recognised at the equivalent cash price and the difference between this
amount and the amount actually paid is treated as interest expense (unless capitalized in
accordance with IAS 23.

The recognition of costs in the carrying amount of an intangible asset ceases when the
intangible asset is in the condition necessary for it to be capable of operating in the manner
intended by management.

Acquisition as part of a business combination

The cost of any intangible asset acquired as part of a business combination is its fair value
which reflects the participant’s expectations at the acquisition date of future economic
benefits that will from the asset. Therefore, the probability recognition criterion is always
considered to be satisfied for intangible assets acquired in business combinations.
Intangible assets acquired in business combination (e.g. in-process R & D project of the
acquiree if the project meets the definition of an intangible asset) should be recognized
separately from goodwill.

Measuring fair value

If an asset acquired in a business combination is separable or arises from contractual or other
legal rights, sufficient information exists to measure reliably the fair value of the asset. Thus,
the reliable measurement criterion is always considered to be satisfied for intangible assets
acquired in a business combination.

The accounting implication here is that an intangible asset that is not recognized in a
subsidiary because it is an internally generated asset could be recognized in a consolidated
account as the consideration paid could have accommodated its acquisition.

Acquisition by way of a government grant

The government may grant an intangible asset to an entity free of charge or for a nominal
consideration, for example, import licences, broadcasting licences, quotas or other rights to
access restricted resources.
IAS 38: 44 directs that in such circumstances, an entity may either:
 Recognize both the grant and the intangible asset at fair value; or
 Recognize both the grant and the intangible asset at a nominal amount plus any
expenditure that is directly attributable to preparing the asset for its intended use.

Acquisition by exchange of assets

An intangible asset acquired in an exchange for a non-monetary asset or a combination of
monetary and non-monetary assets, is measured at fair value (even if the entity cannot
immediately derecognize the asset given up), unless either:
 The exchange transaction lacks commercial substance; or
 the fair value of neither the asset received nor the asset given up is reliably
measurable.

If the asset is not measured at fair value, it will be measured at the carrying amount of the
asset given up, the same rules as in tangible assets (refer to IAS 16).

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Internally generated intangible assets
Internally generated intangible assets are assets created by an entity through its own efforts.
IAS 38 prohibits the recognition of the following examples of internally generated intangible
assets:
 Goodwill
 Brands
 Mastheads
 Publishing titles
 Customer lists and
 Items similar in substance to any of these.
The internal costs of producing these items cannot be distinguished separately from the costs
of developing and operating the business as a whole but where any of these items are
acquired separately, it will be recognized in the books as an intangible asset.

2.1.4 Research and development

IAS 38 makes a distinction between two phases of generating intangible assets internally.
These are the research phase and the development phase. Capitalisation is only permitted
during the development phase.

Research is defined as an original and planned investigation undertaken with the prospect of
gaining new scientific or technical knowledge and understanding.
IAS 38:56 gives the following examples of research activities:
a) activities aimed at obtaining new knowledge;
b) the search for, evaluation and final selection of, applications of research findings or
other knowledge;
c) the search for alternatives for materials, devices, products, processes, systems or
services; and
d) the formulation, design, evaluation and final selection of possible alternatives for new
or improved materials, devices, products, processes, systems or services.

Costs incurred during research phase are required to be expensed.

Development, on the other hand, is the application of research findings or other knowledge to
a plan or design for the production of new or substantially improved materials, devices,
products, processes, systems or services before the start of commercial production or use.
Examples of development activities are:
(a) the design, construction and testing of pre-production or pre-use prototypes and models;
(b) the design of tools, jigs, moulds and dies involving new technology;
(c) the design, construction and operation of a pilot plant that is not of a scale economically
feasible for commercial production; and
(d) the design, construction and testing of a chosen alternative for new or improved materials,
devices, products, processes, systems or services

IAS 38:57 sets the conditions for recognizing development expenditure as an intangible asset:
“an intangible asset arising from development (or from the development phase of an internal
project) shall be recognised if, and only if, an entity can demonstrate all of the following:

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 a) the technical feasibility of completing the intangible asset so that it will be available
for use or sale.
b) its intention to complete the intangible asset and use or sell it.
c) its ability to use or sell the intangible asset.
d) how the intangible asset will generate probable future economic benefits.
e) the availability of adequate technical, financial and other resources to complete the
development and to use or sell the intangible asset.
f) its ability to measure reliably the expenditure attributable to the intangible asset
during its development.”
It is important to note that if an entity cannot distinguish the research phase of an internal
project to create an intangible asset from the development phase, the entity treats the
expenditure for that project as if it were incurred in the research phase only.

Illustration
During the period ended 31 December, 2017, Platinum Ltd spent ₦20 million on laboratory
and design works of a product. It is projected that it will take four years to develop and test
the design preparatory to production in the fifth year.
Within the year, ₦50 million was also spent on testing of a new production system which is
designed to reduce the cost of production by about 20%. The system will be in operation
during the following year.

Required
Explain how these costs will be treated in the financial statements of Platinum Ltd for the
period ended 31 December 2017.

Suggested solution

In compliance with IAS 38, the ₦20 million spent at the laboratory and design stage should
be expenses. At this stage, the probability of generating economic benefits from the potential
asset (the subject matter of the cost incurred) is not certain. The ₦50 million spent on testing
of a new production system should be capitalized as development cost since the new system
will soon be on stream and will generate economic benefits in the form of cost savings.

SIC 32: Intangible assets – Web site costs

This interpretation addresses the appropriate accounting treatment for internal expenditure to
develop, enhance and maintain a web site by an entity (whether for internal or external
access).

SIC-32:2 identifies the following stages of web site development:

i. Planning – feasibility studies, defining objectives and specifications, evaluating
alternatives and selecting preferences;
ii. Application and infrastructure development – obtaining a domain name, purchasing
and developing hardware and operating system, installing developed applications and
stress testing;
iii. Graphical design, including designing the appearance of web pages;
iv. Content development and
v. Operating – maintaining and enhancing the applications, infrastructure, graphical
design and content of the web site.
The interpretation (SIC-32: 7 & 8) states that:

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 i. A web site developed by an entity for its own use (for internal or external access) is
internally generated intangible asset that is subject to the requirements of IAS 38.
ii. Future economic benefits will be generated from a web site only when the website is
capable of generating revenue, for example, from enabling orders to be placed.
iii. If a web site is developed solely or primarily for promoting and advertising its own
products and services then an entity will not be able to demonstrate how it will
generate probable future economic benefits.

SIC- 32:9 concludes as follows:

a) The nature of each activity for which expenditure is incurred (e.g. training employees
and maintaining the web site) and the web site’s stage of development or post
development should be evaluated to determine the appropriate accounting treatment;
b) The planning stage of a web site development is similar to the research phase and
therefore, any expenditure incurred in this stage is recognised as an expense when it is
incurred;
c) The application and infrastructure stage, the graphical design and content
development stage, are similar in nature to the development phase. Therefore,
expenditure incurred at these stages is recognised as intangible asset if the expenditure
can be directly attributed and is necessary to creating, producing or preparing the web
site for operation in a manner intended by management.
d) Expenditure incurred in content development stage, to the extent that content is
developed to advertise and promote an entity’s own products and services is expensed
when incurred.
e) Expenditure incurred to maintain or enhance the web site after development has been
completed should be expensed unless it meets the recognition criteria prescribed by
the standard.

2.1.6 Measurement of intangible assets subsequent to initial recognition

As is the case with tangible assets, the initial recognition of intangible assets is at cost.
Subsequently, the entity has a choice of policy to carry the intangible assets in either of two
models namely cost model or revaluation model.
In applying the cost model, an intangible asset is carried out at cost, less any accumulated
amortisation and impairment losses.
For the revaluation model, the intangible asset is carried at a revalued amount, which is its
fair value at the date of revaluation, less any subsequent accumulated amortization and
subsequent accumulated impairment losses.
The standard requires that:

 the fair value be measured reliably with reference to an active market in that type of
assets. (An active market is a market in which the items traded in the market are
homogeneous, willing buyers and sellers can normally be found at any time; and
prices are available to the public).

 The entire class of intangible assets of that type must be revalued at the same time (to
prevent selective revaluations – “cherry picking”)

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  Where an active market ceases to exist for a class of revalued assets, the asset should
be carried at its revalued amount at the date of the last revaluation less any subsequent
accumulated amortisation and impairment losses and

 Revaluations should be made with such regularity that the carrying amount does not
differ materially from its fair value at the reporting date.

Note that the requirement that the rule to measure intangible assets at the fair value with
reference to an active market differs from the requirement in IAS 16 for the revaluation of
PPE.

Also finding an active market for intangible assets is very rare, if not impossible. Therefore it
may be rare for entities to use the revaluation model.

Accounting for the revaluation

The same principles that apply to IAS 16 Property, plant and equipment also apply to
intangible assets. Any surplus arising from an upward revaluation is credited to equity under
the heading of ‘revaluation surplus’ or revaluation reserve. A revaluation surplus could be
recognized in profit or loss, to the extent that it reverses a revaluation decrease of the same
asset previously recognized as expense.

However, a revaluation deficit is recognized as an expense in profit or loss. A revaluation

deficit should be recognized in other comprehensive income to the extent of any credit
balance existing in the revaluation surplus in respect of that same asset

Realisation of the revaluation surplus

The accounting treatment is also similar to the accounting under IAS 16. The revaluation
surplus could be moved to retained earnings when the intangible asset is derecognized or part
of the reserve may be transferred to retained earnings (as revaluation surplus realized) over
the period of use of the intangible asset by the entity. The amount transferred is the difference
in amortisation charge based on revalued carrying amount and the charge based on the assets
historical cost.

2.1.7 Amortisation of intangible assets and assessment of useful life

It is required that an entity should assess the useful life of an intangible asset which may be
finite or indefinite. An intangible asset has an indefinite useful life when there is no
foreseeable limit to the period over which the asset is expected to generate net cash inflows.

Factors such as expected usage, technical, technological, commercial and other types of
obsolescence, typical product life cycles, stability of the industry, legal or similar limits on
the use of the asset, the level of maintenance expenditure required etc are considered in
determining the useful life of intangible assets. The useful life of an intangible asset that
arises from contractual or other legal rights should not exceed the period of the rights.

Intangibles with a finite useful life – Amortisation method and period.

The depreciable amount of an intangible asset with a finite useful life is amortised on a
systematic basis over its useful life. Amortisation begins when the asset is available for use,
and ends at the earlier of the date that the asset is classified as held for sale in accordance

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with IFRS 5 and the date that the asset is derecognised. The amortisation method used must
reflect the pattern in which the asset's future economic benefits are expected to be consumed
by the entity. If that pattern cannot be determined reliably, the straight-line method must be
used. The amortization charge for each period is recognized in profit or loss.

The residual value of an intangible asset with a finite life is assumed to be zero unless there is
a commitment by a third party to buy the asset at the end of its useful life or there is an active
market for that type of asset and it is probable that such a market will exist at the end of the
asset's useful life.

The amortisation period and the amortisation method used for an intangible asset with a finite
life should be reviewed at each financial year-end. Where there is a change in the useful life,
the carrying amount of the asset at the date of change is written off over the (revised)
remaining useful life of the asset. A change in the amortistaion method used implies a
change in accounting estimate. A change of accounting estimate is applied prospectively
from the time of the change. The carrying amount of the asset at the date of the change is thus
written off over the remaining useful life of the asset.

Intangibles with an indefinite useful life

An intangible asset with an indefinite useful life is not amortised but is required to be tested
for impairment at least annually. The useful life of an intangible asset that is not being
amortised must be reviewed each period to determine whether it is still appropriate to assess
its useful life as indefinite. Where it is inappropriate and there is change in the useful life
assessment from indefinite to finite, that will imply a change in accounting estimate. The
carrying amount at the date of the change is amortised over the estimated useful life from that
date. Again, such a change is an indicator that the asset may be impaired and therefore it has
to be tested for impairment.

Disposals/retirement of intangible assets

The carrying amount of an intangible asset is derecognized on disposal or when no future

economic benefits are expected from its use or disposal. The gain or loss (that is, net disposal
proceeds minus carrying amount of the item) arising from the de-recognition of an intangible
asset is recognized in profit or loss.

2.1.8 Disclosures
In addition to the disclosure requirements for tangible non-current assets(IAS 16), most of
which are applicable to intangible assets, the following specific disclosures are required:
 whether the useful lives of the assets are finite or indefinite.
 If the useful lives are finite, the useful lives or amortisation rates used.
 If the useful lives are indefinite, the carrying amount of the asset and the reasons
supporting the assessment that the asset has an indefinite useful life.
For any intangible asset that is individually material to the financial statements, the following
disclosure is required:
 a description of the item
 its carrying amount
 the remaining amortisation period.

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 The total amount of research and development expenditure recognized as an expense during
the period must also be disclosed as well as the carrying amount of internally-generated
intangible assets.

2.1.9 WORKED EXAMPLE

On June30, 2018 Prospects Ltd acquired new technology that will revolutionise its current
manufacturing process. The costs are set out below:
₦
Original cost of the new technology 4,000,000
Discount provided 400,000
Staff training incurred in operating the new process 150,000
Testing of the new manufacturing process 110,000
Losses incurred whilst other parts of the plant stood idle 120,000

Required
Determine the carrying amount of the new technology (Intangible asset) at 31 December
2018.
Ignore any amortization charges.

Suggested Solution
Prospects Ltd
Carrying amount of the new technology – 31 December 2018.
₦
Cost 4,000,000
Less discount (400,000)
3,600,000
Plus testing of process 110,000
3,710,000

Staff training and the losses incurred should not form part of the cost of the intangible asset.
They should be expensed.

IN-TEXT QUESTIONS (ITQ’s)

1. An entity controls an asset if the entity has the power to obtain ………….
flowing from the underlying resource and to restrict the access of others to
those benefits.
2. The depreciable amount of an intangible asset with a finite useful life is

IN-TEXT ANSWERS (ITA’s)

1. Economic benefit
2. Amortised.

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2.2 IFRS 8 Operating Segments

2.2.1 Rationale
Many large companies, especially the multi-national companies, operate in different
jurisdictions/regions and produce and/or provide a wide range of products and services. Users
of financial statements will be better informed, and risks and returns associated with such
companies better assessed if they are provided with more detailed information on how the
overall results of the entities are made up from each of the products and services or the
geographical areas covered by the company’s operations.
IFRS 8 has as its primary target, entities whose debt or equity instruments are traded in a
public market and entities that file their financial statements with a regulator for the purpose
of issuing instruments in a public market. It requires such entities to disclose financial and
descriptive information about their operating segments. It is not mandatory for non-public
entities.
‘A public market’ is any domestic or foreign stock exchange or an over- the – counter market
including local and regional markets.
IFRS 8 replaced IAS 14 Segment reporting in November 2006.

2.2.2 Core principle

“An entity shall disclose information to enable users of its financial statements to evaluate the
nature and financial effects of the business activities in which it engages and the economic
environments in which it operates.” (IFRS 8:1)

2.2.3 Scope
This standard applies to the separate or individual financial statements of an entity and to the
consolidated financial statements of a group with a parent:
 Whose debt or equity instruments are traded in a public market; or
 that files or is in the process of filing, its (consolidated) financial statements with a
securities commission or other regulatory organization for the purpose of issuing any
class of instruments in a public market.
With regard to scope, it should be noted that
 When a single financial report includes both consolidated financial statements and
separate financial statements of a parent falling within the scope of IFRS 8,
segmental information need be presented on a consolidated basis only; (IFRS 8: 4)
and
 If an entity that is not required to comply with IFRS 8 (e.g. a private entity) chooses
to disclose information about segments that does not comply with the requirements of

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 that standard, the entity is not permitted to describe the information as segment
information’ IFRS 8:3.
Thus, the standard applies primarily to entities whose equity or debt instruments are
traded on a stock exchange. Only consolidated segmental information need be shown in
group accounts.

2.2.4 Definitions and explanations

Operating segment
IFRS 8 explains an operating segment as a component of an entity:
 That engages in business activities from which it may earn revenues and incur
expenses (including revenues and expenses relating to transactions with other
components of the same entity);
 Whose operating results are regularly reviewed by the entity’s chief operating
decision maker to make decisions about resources to be allocated to the segment and
assess its performance; and
 for which discrete financial information is available

Note that:
a. the standard does not define ‘component of an entity’. A component of an entity may be a
division, a subsidiary or a group of subsidiaries or even an interest in a joint venture or
associate.
b.“Not every part of an entity is necessarily an operating segment or part of an operating
segment. For example, a corporate headquarters or some functional departments may not earn
revenues or may earn revenues that are only incidental to the activities of the entity and
would not be operating segments. For the purposes of this IFRS, an entity’s post-employment
benefit plans are not operating segments.” (IFRS8:6)

2.2.5 Identification of operating segments

The standard takes a two-step approach in identifying an operating segment namely, the
entity’s operating segments are first identified and once this is done, the entity then
determines which operating segments are reportable, that is, whose information such as
revenue, profits or losses, assets and liabilities etc need to be disclosed to users.
Note that:
a. a component of an entity that sells primarily or exclusively to other operating
segments of the entity meets the definition of an operating segment, so long the entity
is structured and managed that way;
b. a component of an entity may not necessarily have external customers or earn revenue
before it can qualify as an operating segment.

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 Thus the standard recognizes that start-up operations will need to engage in business
activities for some time before earning revenues and at that pre-operating stage may be
classified as operating segments provided they meet other criteria.
It should be noted that the standard adopts ‘the management approach’ in identifying
operating segments. It is believed that this approach, “based on the structure of the entity’s
internal organization allows users to see an entity ‘through the eyes of management’, which
enhances a user’s ability to predict actions or reactions of management that can significantly
affect the entity’s prospects for future cash flows.” (Deliotte, 2012).

2.2.6 The chief operating decision maker

The chief operating decision maker, according to the standard, refers to a function – that of
assessing the performance of and allocating resources to operating segments. It does not
necessarily refer to a manager with a specific title. But often, the chief operating decision
maker may be the chief executive or chief operating officer, or a group of executive directors
or even a management committee. Thus, the chief operating decision maker is the individual
or function responsible for decisions about resource allocation and performance assessment
of each business unit or component of an entity.
If a management committee exists and the CEO has the ability to override the decision of
such a committee, there is an indication that the chief operating decision maker is the CEO
and not the management committee.

2.2.7 Aggregation criteria

IFRS 8 permits aggregation for homogeneous operations. IFRS 8:12 states that two or more
operating segments may be aggregated into a single operating segment if all of the following
criteria are met:
a. aggregation is consistent with the core principle of the standard;
b. the segments have similar economic characteristics; and
c. the segments are similar in each of the following aspects:
i. the nature of the products and services;
ii. the nature of the production services;
iii. the type or class of customer for their products and services;
iv. the methods used to distribute their products or provide their services; and
v. if applicable, the nature of the regulatory environment, for example, banking,
insurance or public utilities.

2.2.8 Determination of reportable segments – Quantitative threshold

The standard requires entities to report separately information about an operating segment if
it meets any of the following thresholds:
a. its reported revenue (internal and external) is 10% or more of combined revenue of all
operating segments;
b. the absolute amount of its reported profit is 10 per cent or more in absolute amount, of
the combined reported profit of all operating segments that did not report a loss or if

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 the segment’s loss is 10% or more of the combined reported loss of all operating
segments that reported a loss.
c. its assets are 10 per cent or more of the combined assets of all operating segments.
Illustration
Application of quantitative thresholds
Up-to- date Systems reports three business lines to its chief operating decision maker.
Summary of revenue, results and assets for period ended 31 December 2017 is given below.
Segment Segment segment Segment not Segment Segment
revenue result reporting a loss reporting a Assets
loss
N’000 N’000 N’000 N’000 N’000
Hardware 5,000 (500) 500 4,000
Software 25,000 2,000 2,000 3,000
Service 25,000 1,500 1,500
1,000
55,000 3,000 3,500 500 8,000

Note: Inter-segment sales during the period amounted to N5,000.

Suggested Solution

Segment Segment segment Segment not Segment Segment

revenue result reporting a loss reporting a Assets
loss
N’000 N’000 N’000 N’000 N’000
Hardware 5,000 (500) 500 4,000
Software 25,000 2,000 2,000 3,000
Service 25,000 1,500 1,500
1,000
55,000 3,000 3,500 500 8,000
Calculated
Threshold 10% N5,500 N350* N350* N800

* For the profit or loss threshold, the amount is the greater, in absolute value, of (i) the
combined profits of segments that did not report a loss and (ii) the combined loss of all
segments that reported a loss, that is, 10% of N3,500 > 10% of N500.

Considering each of the operating segments in turn:

1. The hardware segment exceeds the result threshold (N500 > N350) and the assets threshold
(N4,000 > N800).

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2. The Software segment exceeds the revenue threshold (N25,000 > N5,500), the result
threshold (N2,000 > N350) and the assets threshold (N3,000 > N800).

3. The Service segment exceeds the revenue threshold (N25,000 > N5,500), the result
threshold (N1,500 > N350) and the assets threshold (N1,000 > N800).

From the above all three segments meet at least one threshold. Therefore, they are all
reportable segments.

2.2.9 Operating segments below the quantitative threshold

Operating segments that do not meet any of the quantitative thresholds may be considered
reportable, and separately disclosed, if management believes that information about the
segment would be useful to users of the financial statements. Two or more operating
segments below the thresholds may be combined to produce a reportable segment if the
segments have similar economic characteristics and share a majority of the aggregation
criteria.
IFRS 8 requires that at least 75% of entity’s external revenue must be reported by operating
segments. When this is not the case, additional segments must be identified (even if they do
not meet the 10% threshold) until at least 75% of the entity’s revenue is included in
reportable segments.
Note: Information on other operating segments and business activities that are not reportable
should be combined and disclosed in a separate category captioned “all other segments”. The
sources of revenue included in the “all other segments” category should be described.

Illustration

Aristo Plc has noted that its reportable segments constitute 69% of consolidated revenue. All
remaining operating segments are of similar size and each contributes 8% to the total
revenue.
How should Aristo Plc give its segmental report?

Solution
Aristo Plc needs to meet the 75% minimum threshold. The standard does not specify which
of the remaining operating segments should be selected to achieve the 75% threshold. Since
the segments are similar in size, any one of them or a combination of them could be chosen.
Judgement is required in this case, and each situation will be based on individual facts and
circumstances.

2.2.10 Disclosure

Disclosure requirements are extensive and include:

 factors used to identify the entity’s reportable segments
 types of products and services from which each reportable segment derives its
revenue
 information about revenues, profit or loss, assets, liabilities and other material items
(a reconciliation of the material items to the entity’s reported figures is required)

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  Segment assets and liabilities and their bases of measurement
 External revenue by each product and service (if reported basis is not products and
services)
 Analysis of revenue and certain non-current assets including other material items by
geographical area
 Information about reliance on major customers (that is, those who represent more than
10% of total external revenue).

Note: Segment asset disclosure is not compulsory if it is not reported internally.

INTEXT QUESTIONS

1. Segment reporting is not mandatory for ----------------- entities

2. IFRS 8 requires that at least ………… of entity’s external revenue must be reported by
operating segments.

3. IFRS 8 requires entities to report separately information about an operating segment if it

meets any of 3 thresholds, one of which is its reported revenue (internal and external) being
-------------------- of combined revenue of all operating segments.

IN-TEXT ANSWERS
2.3 1. Non-public
IFRS 5: Non-current Assets held for sale and discontinued
operations
2. 75%

3. 10% or more
This standard replaced IAS 35 Discontinuing operations. It covers the measurement and
presentation of non-current assets and disposal groups held for sale in the statement of
financial statements. It also gives guidance on the presentation of discontinued operations in
the statement of profit or loss and other comprehensive income.
IFRS 5 identifies three classes of items that might be described as held for sale. These are:
 non-current assets;
 disposal groups; and
 discontinued operations.

2.3.1 Definitions

Non- current Assets

IFRS 5: Appendix A requires that an entity classifies an asset as current when:

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 a. it expects to realize the asset or intends to sell or consume it, in its normal operating
cycle;
b. it holds the asset primarily for the purpose of trading;
c. it expects to realize the asset within twelve months after the reporting period; or
d. the asset is cash or cash equivalent, unless the asset is restricted from being
exchanged or used to settle a liability for at least twelve months after the reporting
period.
Non-current assets are therefore, assets that do not meet the definition of a current asset.

Disposal group
This 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. A disposal group may be a group of cash-generating units, a single cash
generating unit, or part of a cash-generating unit.
A liability should be included in a disposal group only if it will be transferred with the assets
in the transaction.

2.3.2 Scoped- out non-current assets

IFRS 5 does not apply to certain assets covered by other accounting standards. These include
–
a. deferred tax assets (IAS 12).
b. assets arising from employee benefits (IAS 19).
c. financial assets (IAS 39)
d. Investment properties accounted for in accordance with the fair value model (IAS 40)
e. Agricultural and biological assets that are measured at fair value less estimated point-
of sale costs(IAS 41)
f. contractual rights under insurance contracts(IFRS 4)
These exclusions relate only to the measurement requirements of IFRS 5. The classification
and presentation rules of the standard apply to all non-current assets.

2.3.3 Classification of assets (or disposal groups) as held for sale

The overall principle of this standard is that a non-current asset (or disposal group) must be
classified as held for sale if its carrying amount will be recovered principally through a sale
transaction rather than through continuing use.
The two general requirements for a non-current asset (or disposal group) to be so classified
are:
i. the asset (or disposal group) must be available for immediate sale in its present
condition subject only to terms that are usual and customary for sales of such assets
(or disposal groups); and
ii. the sale must be highly probable.
For the sale to be highly probable, the following must apply:

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 a) the appropriate level of management must be committed to a plan to sell the asset (or
disposal group);
b) an active programme to locate a buyer and complete the plan must have been
initiated;
c) the asset (or disposal group) must be actively marketed for sale at a price that is
reasonable in relation to its current fair value;
d) the sale must be expected to be completed within one year from the date of
classification) and actions required to complete the plan should indicate that it is
unlikely that significant changes to the plan will be made or that the plan will be
withdrawn.
The following should be noted:

i. If the held for sale criteria are not met for a non-current asset (or disposal group) until
after the reporting date but before the financial statements are authorised for issue,
that asset (or disposal group) should not be classified as held for sale as at the
reporting date. Rather the disclosures required by IFRS 5 should be made.
ii. An asset that is to be abandoned or is abandoned is not classified as held for sale as its
carrying amount can only be recovered through continuing use or the asset is closed.
However, if a disposal group that is to be abandoned meets the definition of a
discontinued operation, separate disclosure may be required.
iii. Where a disposal group is acquired (for example, a subsidiary) exclusively with a
view to its subsequent sale, such asset can be classified as held for sale only if the sale
is expected to take place within one year and it is highly probable that all the other
criteria will be met within a short time.
iv. An asset can still be classified as held for sale, even if the sale has not taken place
within one year provided that:
 the delay is caused by events or circumstances beyond the entity’s control; and
 there is sufficient evidence that the entity remains committed to its plan to sell
the asset (or disposal group).

Illustrations

Classification of asset as held for sale (Guidance on implementing IFRS 5[adapted])

Q1. An entity is committed to a plan to sell a manufacturing facility and has initiated
actions to locate a buyer. At the commitment date, there is a backlog of uncompleted
customer orders but the entity intends to sell the facility with its operations. Any
uncompleted orders at the sale date will be transferred to the buyer.

Can the facility be classified as held for sale?

Solution

The facility is available for immediate sale as the transfer of the uncompleted
customer orders will not affect the timing of the transfer of the facility. Therefore, the
facility can be classified as held for sale.

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Q2. On 1 December 2017, Onyeije Plc announced plans to close and sell one of its
manufacturing facilities. The company is required to perform major building and
equipment overhauls to be able to market the facility effectively. The facility was
closed from 31 January 2018 and the overhauls were completed on 28 February 2018.
Onyije Plc started to market the facility immediately after the completion of the
overhauls. On 30 April, 2018, the facility was sold.
Should the facility be classified as held for sale as at 31 December 2017?
Solution

It is inappropriate to classify the facility as held for sale in the company’s statement of
financial position as at December 31, 2017. At that date Onyeije Plc has not met the
condition of the standard which requires that the asset “must be available for
immediate sale in its present condition….” Assuming all other conditions are met, the
entity should classify the asset as held for sale on 28 February 2018, the date the
overhauls were completed and the company began to market the facility. Thus, as at
31December, 2017 the facility should be treated in the same way as other items of
property, plant and equipment: it should be depreciated and be subject to impairment
review (if there are indications of impairment) and should not be separately disclosed.

2.3.4 Measurement of non-current assets and disposal groups held for sale.
Non-current assets (or disposal groups) held for sale should be measured at the lower of
their carrying amount and fair value less costs to sell. Where fair value less costs to sell is
lower than the carrying amount, an impairment loss should be recognised in the statement of
profit or loss for the period. But if the asset has been carried at a previously recognised
revaluation surplus, the impairment loss is taken to other comprehensive income to the extent
that it is covered by the previously recognised surplus on that asset. Any excess amount is
recognised in the statement of profit or loss.
A non-current asset (or disposal group) ‘held for sale’ should not be depreciated (or
amortised) even if they are still being used by the entity.

The following points should be noted:

i. The separate presentation of non-current assets and disposal groups held for sale in
the statement of financial position has no retrospective application; they are presented
as such in the reporting period. Comparative amounts for prior year are not restated.
ii. If a non-current asset (or disposal group) is no longer classified as held for sale (for
example, because the criteria are no longer met), it is measured at the lower of :
a. the carrying amount before it was classified as held for sale, less any depreciation
that would have been charged had the asset not been held for sale, and
b. its recoverable amount at the date of the decision not to sell.
iii. Where the non-current asset (or disposal group) is subsequently re-measured(resulting
to decrease or increase in fair value), it might lead to:
 a further impairment loss - which should be recognised; or

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  a gain - which should be recognized, but not in excess of the cumulative
impairment loss recognized in accordance with IFRS 5 or previously in
accordance with IAS 36.
Note that an impairment loss on goodwill should not be reversed. This is because subsequent
increase in the recoverable amount of goodwill after impairment loss recognition is likely to
be an increase in internally generated goodwill, rather than a reversal of impairment loss.
Recognition of internally generated goodwill is prohibited by IAS 38 Intangible Assets.

2.3.5 A non-current asset (or disposal group) held for distribution to

owners
A non-current asset (or disposal group) is classified as held for distribution to owners when
the entity is committed to distribute the asset (or disposal group) to the owners. For this to be
the case, the assets must be available for immediate distribution in their present condition and
the distribution must be highly probable.
IFRS 5: Appendix A defines ‘highly probable’ as meaning ‘significantly more likely than
probable’ while ‘probable’ means ‘more likely than not.’
For the distribution to be highly probable,
 actions to complete the distribution must have been initiated and should be expected
to be completed within one year from the date of classification; and
 actions required to complete the distribution should indicate that it is unlikely that
significant changes to the distribution will be made or that the distribution will be
withdrawn.
The probability of shareholders’ approval (if required in the jurisdiction) should be
considered as part of the assessment of whether the distribution is highly probable.
Non-current assets (or disposal groups) held for distribution to owners should be measured at
the lower of their carrying amount and fair value less costs to distribute. Costs to distribute
are the incremental costs directly attributable to the distribution, excluding finance costs and
income tax expense.
Illustration

A Ltd acquired a machine on 1 January 2011 for ₦100,000. It had a useful life of 10 years
and no residual value. On 31 December 2015, the machine was classified as held for sale. On
this date the machine’s fair value was estimated at ₦53,000 and the costs to sell were
estimated at ₦6,000. The machine was sold for ₦44,500 on 30 June 2016.
Show the accounting entries in the books of A Ltd for years 2015 and 2016.

Solution

Assets held for sale are carried at the lower of carrying amount and fair value less costs to
sell.

2015: Carrying amount as at 31 December 2015. ₦

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 Cost 100,000
Accum. Depreciation to 31/12/2015: ₦100,000 x 5
10 (50,000)
₦50,000
Fair value 53,000
Les costs to sell 6,000
47,000
The machine is therefore written down to ₦47,000 and an impairment loss of ₦3,000
recognised in the statement of profit or loss.
Dr. Statement of Profit or loss ₦3,000
Cr. PPE ₦3,000

2016: The machine is sold ₦

Sales proceeds 44,500
Carrying amount 47,000
Loss on disposal 2,500
A loss of ₦2,500 is recognized in statement of profit or loss as at 31 December 2016.

Dr. Statement of Profit or loss ₦2,500

Bank ₦44,500
Cr. PPE ₦47,000

2.3.6 Discontinued operations

Reporting performance of entities to stakeholders entails giving relevant information about an
entity to users to enable them make reliable predictions about the future performance and
cash flows of the reporting entity. If some operations of an entity are closed down, the future
financial prospects of the entity will be affected. It is therefore appropriate that relevant
information about the discontinuation are provided to users of the financial statements.

Definition of a discontinued operation

A discontinued operation is a component 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
A component of an entity, according to the standard “comprises operations and cash flows
that can be clearly distinguished, operationally and for financial reporting purposes, from the
rest of the entity” (IFRS 5: 31).
Note: Routine disposal of asset groups that meet the definition of a component of an entity,
by certain entities, (e.g. real estate investment trusts) will not generally represent major line
of business or geographical area of operations. Therefore, such disposals should not be
classified as discontinued operations.

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If the criteria for classifying an operation as discontinued are met after the end of the
reporting period, such an operation is not classified as discontinued in the statement of
financial position.

2.3.7 Presentation and disclosure of discontinued operations

Presentation in the statement of profit or loss
IFRS 5:33(a) requires that a single amount be presented in the statement of profit or loss and
other comprehensive income comprising:
a) the post-tax profit or loss of discontinued operations; and
b) 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.
This single amount will need to be analysed, either in the notes or in the income statement
into:
1) the revenue, expenses and pre-tax profit or loss of discontinued operations;
2) the related income tax expense;
3) the 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; and
4) the related income tax expense.
If this analysis is presented on the face of the statement of profit or loss it must be presented
in a section identified as relating to discontinued operations. The analysis is not required for
disposal groups that are newly acquired subsidiaries that are classified as held for sale on
acquisition.
The net cash flows attributable to the operating, investing and financing activities of
discontinued operations must also be shown, either in the notes or on the face of the
statement of cash flows. These disclosures are also not required for disposal groups that are
newly acquired subsidiaries that are classified as held for sale on acquisition.
The standard also makes it clear that any gain or loss on remeasurement of a non-current
asset (or disposal group) classified as held for sale that does not meet the definition of a
discontinued operation should be included in profit or loss from continuing operations.

Entities are also required to disclose the amount of income from continuing operations and
from discontinued operations attributable to the owners of the parent.

Comparatives

The standard requires that comparative figures for prior periods be restated so that the
disclosures relate to all operations that have been discontinued by the reporting date for the
latest period presented.

Format

[Adapted from Guidance on implementing IFRS 5]

137
OKOROCHA PLC
Statement of profit or loss for the year ended 31 December
2017 2016
₦’000 ₦’000
Continuing operations
Revenue X X
Cost of sales (X) (X)
Gross profit X X
Other income X X
Distribution costs (X) (X)
Administrative expenses (X) (X)
Other expenses (X) (X)
Finance costs (X) (X)
Share of profit of associates X X
Profit before tax X X
Income tax expense (X) (X)
Profit for the period from continuing operations X X

Discontinued operations
Profit for the period (net of tax) from discontinued operations* X X

Profit for the period X X

Attributable to:
Owners of the parent –
Profit for the period from continuing operations X X
Profit for the period from discontinued operations X X
Profit for the period attributable to owners of the parent X X

Non-controlling interests –
Profit for the period from continuing operations X X
Profit for the period from discontinued operations X X
Profit for the period attributable to non-controlling interests X X

Profit for the period X X

* The required analysis would be given in the notes.

Presentation in the statement of financial position

Non-current assets held for sale should be disclosed separately from other assets in the
statement of financial position. In the same manner, assets and liabilities that are part of a
disposal group held for sale as well as assets and liabilities of a discontinued operation,
should be disclosed separately from other assets and liabilities in the statement of financial
position.

Note also that assets and liabilities held for sale should not be offset. Also, recall that in the
statement of financial position, the comparative figures for the previous year are not restated.

Illustration

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Presentation of discontinued operations in the statement of financial position

Global Plc is a multi-product company with 5 production lines. During the reporting period
ending 31 December 2018, operation in one of the production lines was discontinued.
Information relating to the discontinued operation are as follows:

₦’000
Property, plant and equipment 9,800
Liabilities directly associated with the discontinued product (1,400)

Given below is the statement of financial position for the period ended 31 December 2017,
presented by the trainee accountant who is not sure of how to deal with information relating
to the discontinued production line.

GLOBAL PLC
Statement of financial position as at 31 December 2018
₦’000
Assets
Non-current assets 40,000
Current assets 14,400
Total assets 54,400
Equity and liabilities

Share capital 20,000

Reserves 22,500
Total equity 42,500

Non-current liabilities 8,000

Current liabilities 3,900
Total liabilities 11,900

Total equity and liabilities 54,400

Required

Represent the statement of financial position to reflect the effect of the discontinued
operation.

Suggested Solution

Statement of financial position as at 31 December 2018

₦’000
Assets
Non-current assets 30,200
Current assets 14,400
Non-current assets relating to discontinued operations 9,800
Total assets 54,400

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Equity and liabilities

Share capital 20,000

Reserves 22,500
Total equity 42,500

Non-current liabilities 8,000

Current liabilities 2,500
Liabilities directly associated with non-current assets of
discontinued operations 1,400
Total liabilities 11,900

Total equity and liabilities 54,400

2.3.8 Adjustments to carrying amounts of discontinued operations

It may be necessary occasionally to adjust amounts previously presented in discontinued

operations that are directly related to the disposal of a discontinued operation in a prior
period. IFRS 5:35 gives examples of circumstances that may necessitate such adjustments as
including the resolution of uncertainties relating to:

 the disposal (e.g. purchase price adjustments and indemnification issues with the
purchaser;
 obligations retained by the seller (e.g. environmental and product warranty
obligations); and
 the settlement of employee benefit plan obligations if the settlement is directly
related to the disposal transaction.

Such adjustments are classified separately in discontinued operations and the nature and
amount of the adjustments are disclosed

Additional Disclosures

Additional disclosures about discontinued operations that should be included in the notes to
the financial statements include:

a) a description of the non-current asset or disposal group

b) a description of the facts and circumstances of the sale

in the case of discontinued operations and non-current assets ‘held for sale’, a description of
the facts and circumstances leading to the expected disposal and the expected manner and
timing of the disposal.

2.3.9 WORKED EXAMPLE

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Sincere Plc plans to dispose of a group of its assets (as an asset sale). The assets form a
disposal group. The carrying amounts as re-measured immediately before classification as
held for sale are as follows.
₦
Goodwill 15,000
Property, plant and equipment (carried at cost) 57,000
Property, plant and equipment (carried at revalued amount) 40,000
Inventory 22,000
Receivables 13,000
Investment in equity instruments 15,000
₦162,000

Sincere Plc measures the fair value less costs to sell at ₦ 131,000.

Required
Show how the impairment loss will be allocated to the non-current assets in the group and the
new carrying amount after impairment.

Solution

IFRS 5 requires that any recognised impairment loss for a disposal group, should be allocated
to reduce the carrying amounts of those non-current assets in the disposal group (that are
within the scope of the IFRS 5 measurement rules) in the following order:
First, Goodwill is written down to zero (or to the extent of the amount of the impairment
loss); and the balance, if any, is pro-rated among the other non-current assets on the basis of
their carrying values.

SINCERE PLC
Allocation of impairment loss
Amount before Alloc. of New carry
impairment loss imp. loss Amount
₦ ₦ ₦
Goodwill 15,000 (15,000) -
Property, plant and equipment (at cost) 57,000 (9,402) 47,598
Property, plant and equipment (revalued amount) 40,000 (6,598) 33,402
Inventory 22,000 - 22,000
Receivables 13,000 - 13,000
Investment in equity instruments 15,000 - 15,000
₦162,000 (31,000) 131,000

Workings
1. Impairment loss ₦
Carrying amount 162,000
Fair value less costs to sell (131,000)
₦31,000

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2. After allocating ₦15,000 to Goodwill, the balance of ₦16,000 is pro-rated between
the remaining non-current assets in the group based on their carrying amounts:

PPE (carried at cost) 57/97 x ₦16,000 = ₦9,402

PPE (carried at revaluation) 40/97 x ₦16,000 = ₦6,598

IN-TEXT QUESTIONS (ITQ’s)

1. Three classes of items that might be described as held for sale are non-current assets,
disposal group and………………...

2. ………………….is a group of assets to be disposed of, by sale or otherwise, together

as a group in a single transaction

IN-TEXT ANSWERS (ITA’s)

3. Discontinued operation
4. Disposal group

TUTOR MARKED ASSIGNMENT (TMA)

1. Savannah Limited was incorporated some years ago to process raw shea nuts into shea
butters for export as raw materials for the manufacture of cosmetics. So far a total of five
production lines have been identified as projects for Research and Development. An extract
of R&D account for the year ended 30 June 2010 was as follows:
Balance on Expenditure Balance on
1 July 2009 during the yr 30 June ‘10
Project N N N
1 46,500 -- 46,500
2 27,480 -- 27,480
3 36,000 4,000 40,000
4 18,950 21,050 40,000
5 -- 32,400 32,400
128,930 57,450 186,380
Additional information

Project 1 was completed in August 2009 and sales revenue was first generated on October 1,
2009;

Project 2 was completed on 1 July 2007 at a cost of N45,850 and is being amortised in
accordance with the company’s policy;

Project 3 was abandoned during the year ended 30 June 2010 because a competitor had
successfully launched a new product;

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Project 4 is still on-going and it meets the criteria for capitalization as per IAS 38. However,
sales of the product are yet to commence;

Project 5 was commenced in November 2009 and was completed in early June 2010 but sales
revenue is expected to begin on July 1 2010;

The company’s policy is to capitalize R&D expenditure meeting the company’s conditions
set out in IAS 38 and to amortise it over five years on a straight line basis beginning when
sales revenue is first generated from the development project;

Amortization is apportioned on a time proportion basis;

General research expenditure incurred during the year totaled N22,220.

Required:

i. State the criteria which must be met under IAS 38 for development expenditure to be
capitalized; (6 marks)
ii. Determine the amounts to be included in the Statement of Comprehensive Income for
R&D Expenditure for the year ended 30 June 2010 and in the Statement of Financial Position
for the Intangible Asset of Savannah Limited as at that date; (6 marks)

iii. Clearly distinguish between the cost and revaluation models of measuring Intangible
assets (3 marks)

(Total 15 marks)
2. Valuable Plc is a group with many companies and branches in many parts of the world.
The statement of profit or loss of the group for the period ended 31 December 2017 is as
follows:

₦’000
Revenue 1,901,640
Cost of sales (800,760)
Gross profit 1,100,880
Distribution cost (241,600)
Administrative expenses (216,600)
Finance costs (57,800)
Share of profit of associates 30,420
Profit before tax 615, 300
Income tax expense (205,200)
Profit for the period 410,100
Additional information
1. A branch of the company located in Ghana was sold during the year.
2. The operating results of the Ghana branch for the period ended 31 December 2017 are as
follows:

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 ₦’000
Revenue 56,000
Cost of sales 41,000
Distribution costs 2,000
Administrative expenses 4,000
Finance cost 1,000

3. Income tax rate 30%

4. Non-controlling interest on the average is 25% of the group.

Required
Redraft the statement of profit or loss in accordance with the requirements of IFRS 5.
(10 marks)

UNIT 3 REVENUE, INVENTORY AND AGRICULTURE (IFRS 15, IAS 2 &

IAS 41)

Intoduction

Specific Objectives
At the end of this unit, students should be able to:

1. Explain revenue from contracts with customers;

2. Discuss the core principles and the five step model for accounting for revenue.
3. give the accounting treatment for biological assets, agricultural produce at the point
of harvest and government grants for agriculture
4. evaluate the effect of the different inventory valuation methods on reported net
earnings.
5. Account for inventory using the different valuation methods.

3.0 IFRS 15 REVENUE FROM CONTRACTS WITH CUSTOMERS

The IASB issued IFRS 15 in May 2014. IFRS 15 is the product of a joint project between the
IASB and the US Financial Accounting Standards Board and replaces IAS 18, IAS 11, IFRIC
13, IFRIC 15, IFRIC 18 and SIC 31. This standard is effective for annual accounting periods
beginning on or after 1 January 2017 but earlier application is allowed.

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Summary

IFRS 15:

i. establishes a new control-based revenue recognition model;

ii. changes the basis for deciding whether revenue is recognised at a point in time or
over time;
iii. provides new and more detailed guidance on specific topics; and
iv. expands and improves disclosures about revenue.

3.1.1 Definition of concepts

Revenue is income arising in the course of an entity’s ordinary activities.

A customer is a party that has contracted with an entity to obtain goods or services that are
an output of the entity’s ordinary activities.

A contract is an agreement between two or more parties that creates enforceable rights and
obligations.

3.1.2 Core principle and the five-step model

IFRS 15 is based on a core principle that requires an entity to recognise revenue in a manner
that depicts the transfer of goods or services to customers and at an amount that reflects the
consideration the entity expects to be entitled to in exchange for those goods or services.

Applying this core principle involves following a five- step model as follows:

Step 1: Identify the contract(s) with the customer

Step 2: Identify the separate performance obligations

Step 3: Determine the transaction price

Step 4: Allocate the transaction price and

Step 5: Recognise revenue when or as an entity satisfies performance obligations.

Step 1: Identify the contract(s) with a customer

The first step in IFRS 15 is to identify the contract. This may be written, oral, or implied by
an entity’s customary business practices.

The general IFRS 15 model applies only when or if:

a. the parties have approved the contract;

b. the entity can identify each party’s rights;
c. the entity can identify the payment terms for the goods and services to be
transferred; and

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 d. the contract has commercial substance (i.e. the risk, timing or amount of the entity’s
future cash flows is expected to change as a result of the contract); and
e. it is probable the entity will collect the consideration.

If a customer contract does not meet these criteria, revenue is recognised only when either:

a. the entity’s performance is complete and substantially all of the consideration in the
arrangement has been collected and is non-refundable;
b. the contract has been terminated and the consideration received is nonrefundable. A
contract does not exist if each party has an enforceable right to terminate a wholly
unperformed contract without compensating the other party.

Combination of contracts

An entity must combine two or more contracts entered into at or near the same time with the
same customer (or related parties) and treat them as a single contract if one or more of the
following conditions are present:

i. the contracts are negotiated as a package with a single commercial objective;

ii. the amount of consideration to be paid in one contract depends on the price or
performance of the other contract; or
iii. the goods or services promised in the contracts (or some goods or services promised
in the contracts) are a single performance obligation

Contract modifications

A contract modification is any change in the scope and/or price of a contract approved by
both parties for example changes in design, quantity, timing or method of performance).

If a scope change is approved but the corresponding price change is not yet determined, these
requirements are applied when the entity has an expectation that the price modification will
be approved.

This requirement interacts with the guidance on determining the transaction price.

A contract modification must be accounted for as a separate contract when:

i. the scope of the contract increases because of the addition of promised goods or
services that are distinct; and
ii. 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
any appropriate adjustments to that price to reflect the circumstances of the particular
contract.

Step 2: Identify the separate performance obligations in the contract

A performance obligation is a promise in a contract with a customer to transfer to the

customer either a good or service (or a bundle of goods or services) that is distinct or a series

146
of distinct goods or services that are substantially the same and that have the same pattern of
transfer to the customer.

Performance obligations are normally specified in the contract but could also include
promises implied by an entity’s customary business practices, published policies or specific
statements that create a valid customer expectation that goods or services will be transferred
under the contract.

At the inception of a contract the entity must assess the goods or services promised in a
contract with a customer and must identify as a performance obligation each promise to
transfer to the customer either:

a. a good or service (or a bundle of goods or services) that is distinct; or

b. a series of distinct goods or services that are substantially the same and that have the
same pattern of transfer to the customer (described by reference to promises satisfied
over time, and progress to completion assessment)

A good or service is distinct if 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 and the
entity’s promise to transfer the good or service is separately identifiable from other promises
in the contract. If a good or service is regularly sold separately, this would indicate that
customers generally can benefit from the good/service on its own or in conjunction with other
available resources. If a promised good or service is not distinct, an entity must combine that
good or service with other promised goods or services until it identifies a bundle of goods or
services that is distinct.

Step 3: Determine the transaction price

The transaction price is the amount of consideration an entity expects to be entitled to in

exchange for the goods or services promised under a contract, excluding any amounts
collected on behalf of third parties (for example, VAT).

An entity must consider the terms of the contract and its customary practices in determining
the transaction price.

The transaction price assumes transfers to the customer as promised in accordance with the
existing contract and that the contract will not be cancelled, renewed or modified. The
transaction price is adjusted if the entity (e.g. based on its customary business practices) has
created a valid expectation that it will enforce its rights for only a portion of the contract
price.

An entity must consider the effects of all the following factors when determining the
transaction price:

a. variable consideration - An amount of consideration can vary because of discounts,

rebates, refunds, credits, price concessions, incentives, performance bonuses,
penalties or other similar items. The promised consideration can also vary if an

147
 entity’s entitlement to the consideration is contingent on the occurrence or non-
occurrence of a future event
b. the constraint on variable consideration;
c. time value of money;
d. non-cash consideration; and
e. consideration payable to the customer.

Step 4: Allocate the transaction price to the performance obligations

The entity allocates a contract’s transaction price to each separate performance obligation
within that contract on a relative stand-alone selling price basis at contract inception.

A stand-alone selling price is the price at which an entity would sell a promised good or
service separately to a customer.

The following three methods are suitable for estimating the stand-alone selling price:

i. adjusted market assessment approach: an entity could evaluate the market in which it
sells goods or services and estimate the price that a customer in that market would be
willing to pay for those goods or services. That approach might also include referring
to prices from the entity’s competitors for similar goods or services and adjusting
those prices as necessary to reflect the entity’s costs and margins.
ii. expected cost plus margin approach: an entity could forecast its expected costs of
satisfying a performance obligation and then add an appropriate margin for that good
or service.
iii. residual approach: an entity may estimate the stand-alone selling price by reference
to the total transaction price less the sum of the observable stand-alone selling prices
of other goods or services promised in the contract.

Note: A combination of methods may need to be used to estimate the stand-alone selling
prices of the goods or services promised in the contract if two or more of those goods or
services have highly variable or uncertain stand-alone selling prices.

Step 5: Recognise revenue when or as an entity satisfies performance obligations

Revenue is recognised when or as the promised goods or services are transferred to a

customer. A transfer occurs when the customer obtains control of the good or service.

A customer obtains control of an asset (good or service) when it can direct the use of and
obtain substantially all the remaining benefits from it. Control includes the ability to prevent
other entities from directing the use of and obtaining the benefits from an asset.

Indicators of control include:

 The entity has a present right to payment for the asset

 The customer has legal title
 The customer has physical possession (exceptions for bill and hold, consignment
sales)

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  The customer has the significant risks and rewards of ownership of the asset
 The customer has accepted the asset
 The benefits of an asset are the potential cash flows that can be obtained directly or
indirectly from the asset in many ways.

When goods or services are transferred continuously, a revenue recognition method that best
depicts the entity’s performance should be applied (updated as circumstances change).
Acceptable methods include:

 Output methods: Output methods recognise revenue on the basis of direct

measurements of the value to the customer of the goods or services transferred to
date relative to the remaining goods or services promised under the contract. Output
methods include units produced, units delivered, contract milestones or surveys of
work performed; or
 Input methods: Input methods recognise revenue on the basis of the entity’s efforts
or inputs to the satisfaction of a performance obligation (for example, resources
consumed, labour hours expended, costs incurred, time elapsed or machine hours
used) relative to the total expected inputs to the satisfaction of that performance
obligation. If the entity’s efforts or inputs are expended evenly throughout the
performance period, it may be appropriate for the entity to recognise revenue on a
straight-line basis.

3.1.3 Contract costs

Incremental costs of obtaining a contract

An entity shall recognise as an asset the incremental costs of obtaining a contract with a
customer if the entity expects to recover those costs.

The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a
contract with a customer that it would not have incurred if the contract had not been obtained
(for example, a sales commission).

Costs to obtain a contract that would have been incurred regardless of whether the contract
was obtained shall be recognised as an expense when incurred, unless those costs are
explicitly chargeable to the customer regardless of whether the contract is obtained. For
expediency, an entity may recognise the incremental costs of obtaining a contract as an
expense when incurred if the amortisation period of the asset that the entity otherwise would
have recognised is one year or less.

3.1.4 Costs to fulfill a contract

If the costs incurred in fulfilling a contract with a customer are not within the scope of
another Standard (for example, IAS 2 Inventories , IAS 16 Property, Plant and Equipment or
IAS 38 Intangible Assets ), an entity shall recognise an asset from the costs incurred to fulfil
a contract only if those costs meet all of the following criteria:

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(a) the costs relate directly to a contract (or to a specific anticipated contract)

(b) the costs generate or enhance resources of the entity that will be used in satisfying
performance obligations in the future; and

(c) the costs are expected to be recovered.

Costs that relate directly to a contract (or a specific anticipated contract) include any of the
following:

(a) direct labour (for example, salaries and wages of employees who provide the promised
services directly to the customer);

(b) direct materials (for example, supplies used in providing the promised services to a
customer);

(c) allocations of costs that relate directly to the contract or to contract activities (for example,
costs of contract management and supervision, insurance and depreciation of tools and
equipment used in fulfilling the contract);

(d) costs that are explicitly chargeable to the customer under the contract; and

(e) other costs that are incurred only because an entity entered into the contract (for example,
payments to subcontractors).

An entity shall recognise the following costs as expenses when incurred:

(a) general and administrative costs (unless those costs are explicitly chargeable to the
customer under the contract)

(b) costs of wasted materials, labour or other resources to fulfil the contract that were not
reflected in the price of the contract;

(c) costs that relate to satisfied performance obligations (or partially satisfied performance
obligations) in the contract (ie costs that relate to past performance); and

(d) costs for which an entity cannot distinguish whether the costs relate to unsatisfied
performance obligations or to satisfied performance obligations (or partially satisfied
performance obligations).

Amortisation and impairment

An asset recognised shall be amortised on a systematic basis that is consistent with the
transfer to the customer of the goods or services to which the asset relates. The asset may
relate to goods or services to be transferred under a specific anticipated contract

An entity shall update the amortisation to reflect a significant change in the entity’s expected
timing of transfer to the customer of the goods or services to which the asset relates.

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An impairment loss shall be recognised in profit or loss to the extent that the carrying amount
of the asset exceeds:

(a) the remaining amount of consideration that the entity expects to receive in exchange for
the goods or services to which the asset relates; less

(b) the costs that relate directly to providing those goods or services and that have not been
recognised as expenses.

3.1.5 Disclosure

An entity shall disclose qualitative and quantitative information about all of the following:
(a) its contracts with customers
(b) the significant judgements, and changes in the judgements, made in applying this
Standard to those contracts; and
(c) any assets recognised from the costs to obtain or fulfil a contract with a customer.

3.1.6 WORKED EXAMPLE

1a. IFRS 15 Revenue from contracts with customers stipulates that an entity shall
recognise an asset from the costs incurred to fulfill a contract only if those costs meet
all of certain criteria.

Required:

State the requisite criteria specified by the standard. (3 marks)

b. Ogunko Co. Ltd

Ogunko Co’s has as one of its major customers, the Mary Medical Centre (MMC), a
private hospital. In June 2015 a contract was entered into, under the terms of which
Ogunko Co would design a new radiotherapy machine for MMC. The machine is
based on a new innovation, and is being developed for the specific requirements of
MMC. It was estimated that the design and production of the machine would take 18
months with estimated installation in December 2016. As at 31 December 2015,
Ogunko Co had invested heavily in the contract, and design costs totalling
=N=3,500,000 have been recognised as work in progress in the draft statement of
financial position. Deferred income of =N=2,000,000 is also recognised as a current
liability, representing a payment made by MMC to finance part of the design costs.
No other accounting entries have been made in respect of the contract with MMC.
However, on January 2, 2016, Ogunko Co received a notice of cancellation of the
contract by MMC as it (MMC) is unable to pay for its completion. It appears that
MMC lost a significant amount of funding towards the end of 2015, impacting
significantly on the financial position of the company. The manager responsible for

151
 the MMC contract confirms that MMC contacted him about the company’s financial
difficulties in December 2015.
Note: Ogunko Co has the ownership right to the design work.
Required:

As the Accountant of Ogunko Co describe the accounting treatment necessary on the

cancellation of the contract assuming that:

i. the design work which has been undertaken to date can be used by Ogunko to
develop a new type of product for other customers. (3½ marks)
ii. the design work cannot find any other application as it was developed for the
specific requirements of MMC. (4 marks)

Suggested Solution

a. See section on “costs to fulfill a contract” above.

b(i). Design work can be used for other customers.

If the design work which has been undertaken to date can be used by Ogunko Co and
results in an ability to develop a new type of product for other customers, there is the
possibility that the costs could be capitalised in line with IAS 38 Intangible Assets. In
that case the debit of N3.5m to Work in Progress is appropriate and should be carried
as such in the books.

Deferred Income (Advance payment) of N2 million: Since MMC cancelled the

contract, it is unlikely that part or the entire amount is repayable. The amount should
therefore be released to the statement of profit or loss: Dr. Deferred Income a/c N2m;
Cr Profit or loss N2m.

(ii) Design work cannot find any other application.

If the costs cannot be capitalised, then there is a loss which needs to be recognised.
Assuming that the advance payment is non-refundable, the net position of the
development cost and the deferred income balances result in a loss of N1,500,000.

Accounting entries

Dr Deferred Income a/c N2m

Dr. Profit or loss N1.5m
Cr Work-in-Progress N3.5m

IFRS 16 LEASES

Definitions

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i. A lease is an agreement whereby the lessor conveys to the lessee in return for a
payment or series of payments the right to use an asset for an agreed period of time.

ii. A non-cancellable lease is a lease that is cancellable only:

(a) upon the occurrence of some remote contingency;
(b) with the permission of the lessor;
(c) if the lessee enters into a new lease for the same or an equivalent asset with the
same lessor; or
(d) upon payment by the lessee of an additional amount that, at inception of the
lease, continuation of the lease is reasonably certain.

iv. The inception of the lease is the earlier of the date of the lease agreement and the date
of commitment by the parties to the principal provisions of the lease.
.
v. The commencement of the lease term is the date from which the lessee is entitled to
exercise its right to use the leased asset. It is the date of initial recognition of the lease
(ie the recognition of the assets, liabilities, income or expenses resulting from the
lease, as appropriate).

vi. The lease term is the non-cancellable period for which the lessee has contracted to
lease the asset together with any further terms for which the lessee has the option to
continue to lease the asset, with or without further payment, when at the inception of
the lease it is reasonably certain that the lessee will exercise the option.

vii. Minimum lease payments are the payments over the lease term that the lessee is or can
be required to make, excluding contingent rent, costs for services and taxes to be paid
by and reimbursed to the lessor, together with:
(a) for a lessee, any amounts guaranteed by the lessee or by a party related to the
lessee; or
(b) for a lessor, any residual value guaranteed to the lessor by one of the
following:
(i) the lessee;
(ii) a party related to the lessee; or
(iii) a third party unrelated to the lessor that is financially capable of discharging
the obligations under the guarantee.

viii. Economic life is either:

(a) the period over which an asset is expected to be economically usable by one or
more users; or
(b) the number of production or similar units expected to be obtained from the
asset by one or more users.

ix. Useful life is the estimated remaining period, from the commencement of the lease
term, without limitation by the lease term, over which the economic benefits
embodied in the asset are expected to be consumed by the entity.

x. Guaranteed residual value is:

153
 (a) for a lessee, that part of the residual value that is guaranteed by the lessee or
by a party related to the lessee (the amount of the guarantee being the
maximum amount that could, in any event, become payable); and
(b) for a lessor, that part of the residual value that is guaranteed by the lessee or
by a third party unrelated to the lessor that is financially capable of
discharging the obligations under the guarantee.

xi. Unguaranteed residual value is that portion of the residual value of the leased asset,
the realisation of which by the lessor is not assured or is guaranteed solely by a party
related to the lessor.

xii. Initial direct costs are incremental costs that are directly attributable to negotiating
and arranging a lease, except for such costs incurred by manufacturer or dealer lessors
e.g commissions, legal fees etc

xiii. Gross investment in the lease is the minimum lease payments receivable by the lessor
under a finance lease plus any unguaranteed residual value accruing to the lessor.

xiv. Net investment in the lease is the gross investment in the lease discounted at the
interest rate implicit in the lease.

xv. Unearned finance income is the gross investment in the lease minus the net
investment in the lease.

xvi. The interest rate implicit in the lease is the discount rate that, at the inception of the
lease, causes the aggregate present value of the minimum lease payments and the
unguaranteed residual value to be equal to the sum of the fair value of the leased
asset and any initial direct costs of the lessor.

xvii. The lessee’s incremental borrowing rate of interest is the rate of interest the lessee
would have to pay on a similar lease or the rate that, at the inception of the lease, the
lessee would incur to borrow over a similar term, and with a similar security, the
funds necessary to purchase the asset.

xix. Contingent rent is that portion of the lease payments that is not fixed in amount but is
based on the future amount of a factor that changes other than with the passage of
time (eg percentage of future sales, amount of future use, future price indices, future
market rates of interest).

Forms of Lease: Two forms are recognized by the standard namely a Finance lease and an
operating lease.

A finance lease is a lease that transfers substantially all the risks and rewards incidental to
ownership of an asset. Title may or may not eventually be transferred.

Characteristics of a Finance Lease

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i. The lease term will consist of a primary period and a secondary period. The primary
period is non-cancellable or cancellable only under certain conditions e.g. payment of
a penalty/settlement sum by the lessee. The secondary period is cancellable at any
time at the lessee’s option.

ii. The rentals payable during the primary period will be sufficient to repay the lessor the
cost of the leased asset plus interest thereon.

iii. The rentals during the secondary period will be of a nominal amount.

iv. If the lessee wishes to terminate the lease during the secondary period, the asset will
be sold and substantially all the sale proceeds will go the lessee as a rebate of lease
rentals.

v. The lessee will be responsible for the maintenance and insurance of the leases asset
throughout the lease.

Classification as a Finance Lease

A lease is classified as a finance lease based on the substance of the transaction rather than
the legal 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 asset to the lessee by the end of the lease term;
(b) the lessee has the option to purchase the asset at a price that is expected to be
sufficiently lower than the fair value at the date the option becomes exercisable such
that, at the inception of the lease, it is reasonably certain that the option will be
exercised;
(c) the lease term is for the major part of the economic life of the asset even if title is not
transferred;
(d) at the inception of the lease the present value of the minimum lease payments
amounts to at least substantially all of the fair value of the leased; and
(e) the leased assets are of such a specialised nature that only the lessee can use them
without major modifications.

Indicators

Some 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 accrue to the
lessee (for example, in the form of a rent rebate equalling most of the sales 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.

Accounting treatment of Finance lease: In the books of the Lessee

155
1. The lease assets (at the lower of fair value and PV of the minimum lease rentals plus
initial direct costs) are recorded in the SOFP as non-current assets.

2. The amount due the lessor is shown as a liability, split between current and non-
current lease obligations, if the entity makes such distinction for other liabilities.

3. Minimum lease payments shall be apportioned between the finance charge and the
reduction of the outstanding liability. The finance charge shall be allocated to each
period during the lease term so as to produce a constant periodic rate of interest on the
remaining balance of the liability.

4. Contingent rents shall be charged as expenses in the periods in which they are
incurred.

5. The leased asset should be depreciated over the shorter of the lease term and its useful
life if there is no reasonable certainty that the lessee will obtain ownership by the end
of the lease term.

6. The depreciation policy should be consistent with similar non-leased assets.

Lessee’s disclosure for finance leases

Lessees shall, in addition to meeting the requirements of IFRS 7 Financial Instruments:
Disclosures, make the following disclosures for finance leases:
(a) for each class of asset, the net carrying amount at the end of the reporting period.
(b) a reconciliation between the total of future minimum lease payments at the end of the
reporting period, and their present value. In addition, an entity shall disclose the total
of future minimum lease payments at the end of the reporting period, and their present
value, for each of the following periods:
(i) not later than one year;
(ii) later than one year and not later than five years;
(iii) later than five years.
(c) contingent rents recognised as an expense in the period.
(d) the total of future minimum sublease payments expected to be received under non-
cancellable subleases at the end of the reporting period.
(e) a general description of the lessee’s material leasing arrangements including, but not
limited to, the following:
(i) the basis on which contingent rent payable is determined
(ii) the existence and terms of renewal or purchase options and escalation clauses;
and
(iii) restrictions imposed by lease arrangements, such as those concerning
dividends, additional debt, and further leasing.

Allocating finance charge

Two main ways namely:

 Actuarial method (before tax) – the best and most scientific;

 Sum of the digits method

156
The straight line method may be used if it is the company’s policy to do so, but not really
recommended.

Illustration

On January 1, 2010, Vicdech Ltd, wine merchants, bought a small bottling and labeling
machine from Granges ltd under a finance lease. The cash price of the machine was N7,710
while the amount to be paid was N10,000. The agreement required the immediate payment of
a N2,000 deposit with the balance being settled in 4 equal annual instalments commencing on
31 December 2010. The charge of N2,290 represents interest of 15% p.a, calculated on the
remaining balance of the liability during each accounting period. Depreciation on the plant is
to be provided for at the rate of 20% per annum on a straight line basis, assuming nil residual
value.

Required:

a. The breakdown of each instalment between interest and capital using:

 The Actuarial method;
 The sum of the digits method.
b. Show the extract of the financial statements for the relevant 4 years (for the actuarial
finance charge allocation method).
Suggested Solution

a(i) Actuarial Method

Lease Amortisation Table

Year Beginning bal. Finance cost at Instalment Capital Closing Bal.

(A) 15%(B=A x 15%) Paid (C) (D= C-B) (E = A + B – C)
=N= =N= =N= =N= =N=

2010 5,710 856 2,000 1,144 4,566

2011 4,566 685 2,000 1,315 3,251

2012 3,251 488 2,000 1,512 1,739

2013 1,739 261 2,000 1,739 -

Note:

1. At the beginning of the lease, the capital (opening bal.) is equal to the fair value (cash
price) of the asset less any initial deposit (i.e. N7,710 – 2000).

2. This amount reduces as each instalment is paid. Thus the interest (finance charge) is
greatest in the early part of the lease term, and gradually reduces as capital is repaid.

a(ii) Sum of the digits method

157
 Lease Amortisation Table

Year Alloc. of Beginning Finance cost Instalment Capital Closing Bal.

digits bal. C = A/10 x 2,290) Paid (D) (E= D-C) (F = B + C – D)
A (B) =N= =N= =N= =N=
=N=

2010 4 5,710 916 2,000 1,084 4,626

2011 3 4,626 687 2,000 1,313 3,313

2012 2 3,313 458 2,000 1,542 1,771

2013 1 1,771 229 2,000 1,771 -

1
0

b. VICDECH LIMITED

Statement of profit or loss (extract) for the periods ended 31 December

2010 2011 2012

2013

=N= =N= =N=

=N=

Operating Expenses

Depreciation (N7,710/5) 1,542 1,542 1,542

1,542

Finance cost

Lease interest 856 685 488

261

Statement of financial position (extract) as at 31 December

2010 2011 2012

2013

=N= =N= =N=

=N=

Non-current Assets

158
Leased plant at cost 7,710 7,710 7,710
7,710

Accum. Depreciation (1,542) (3,084) (4,626)

(6,168)

6,168 4,626 3,084

1,542

Non-current liabilities

Finance lease obligations 3,251 1,739 - -

Current liabilities

Finance lease obligation 1,315 1,512 1,739 -

Note:

i. The closing/outstanding balance for the following (next) year is the non-current
liability for the current year.
ii. Current year’s closing balance minus next year’s closing balance is the current
obligation for the current year.

Advance payment of lease rentals

Where the minimum lease payments are made at the beginning of the period (i.e. in advance),
the stream of rental payments is seen as an ordinary annuity due and the present value (PV) is
computed using the formular:
- n+1
PV = A[(1 – (1 + r) ) +1]
r

Illustration

On January 1, 2009, Topway Ltd entered into a lease contract for the acquisition of a
machine for the next five years. The cash price of the machine is N20 million. Under the
terms of the lease contract, Topway Ltd is to pay N5 million yearly in advance commencing
January 1, 2009. The rate of interest implicit in the lease is 12.6%. The machine has a useful
economic life of 5 years. Topway Ltd is required to insure the machine and cannot return it to
the lessor without severe penalties. Topway Ltd has 31 December as its reporting date.

159
Required

Show the extracts of the financial statements of Topway Ltd for the five years.

Suggested solution

Topway Ltd

Workings

1. Present Value of the Asset

- n+1
PV = A[(1 – (1 + r) ) +1]
r
Where A = N5,000

r = 12.6%

n = no. of lease payment periods.

PV = 5,000[(1 – (1.126)-5+1) + 1]

0.126

PV = 5,000[(1 – (1.126) – 4) +1]

0.126

PV = N5,000 x 3.9993

PV = N19,997

Since the difference between the PV of the minimum lease payments – N19,997– and the
cash price – N20,000 –is insignificant, we use N20,000 cash price as the value of the asset.

2. Lease Obligation Amortisation Table

Period Opening Balance Installment Outstanding Interest Closing

Charge at Balance
12.6%
=N=
=N= =N= =N= =N=

2009 20,000 5,000 15,000 1,890 16,890

2010 16,890 5,000 11,890 1,498 13,388

2011 13,388 5,000 8,388 1,057 9,445

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 2012 9,445 5,000 4,445 555* 5,000

2013 5,000 5,000 - - -

* Rounded up to take care of approximations.

Topway Limited

Statement of profit or loss (extract) for the periods ended 31 December

2009 2010 2011 2012

2013

=N= =N= =N= =N=

=N=

Operating Expenses

Depreciation (N20,000/5) 4,000 4,000 4,000 4,000

4,000

Finance cost

Lease interest 1,890 1,498 1,057 555 -

Statement of financial position (extract) as at 31 December

2009 2010 2011 2012

2013

=N= =N= =N=

=N=

Non-current Assets

Leased plant at cost 20,000 20,000 20,000 20,000

20,000

Accum. Depreciation (4,000) (8,000) (12,000) (16,000)

(20,000)

15,000 12,000 8,000 4,000 Nil

Non-current liabilities

Finance lease obligations 11,890 8,388 4,445 - -

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Current liabilities

Finance lease obligation* 1,890 1,498 1,057 555 -

Interest Principal 3,110 3,502 3,943 4,445 -

* To be paid as part of next period’s/year’s installment, hence its presentation as amount due
(current liability).

Sale and Lease Back

Under this transaction, a vendor sells an asset and still retains possession and the economic
benefits associated with the asset accrue to the vendor through a lease arrangement.

In a sale and lease back transaction that results in a finance lease, the apparent profit or loss
(i.e. the sale price minus the carrying amount) should not be recognized as income
immediately. The amount should be deferred and amortised over the lease term.

Note: In a sale and lease back that results in a finance lease, the substance of the transaction
is that no disposal of the asset has taken place and therefore no gain or loss on disposal
should be recognized. The transaction is merely a means by which the lessor provides finance
to the lessee with the asset as security.

Accounting Treatment

Two approaches could be adopted, namely:

 The ‘net’ presentation approach; and

 The ‘gross presentation approach.
The ‘Net’ Presentation approach

This is the most straightforward approach adopted in practice. The entity continues to
recognize the asset at its previous carrying amount and to account for the asset as if the sale
and leaseback transaction had not occurred. The proceeds from the sale transaction are
credited to a liability account representing the initial net obligation under the finance lease.

This presentation reflects the fact that the transaction has not resulted in a significant change
to the seller’s interest in the risks and rewards incidental to ownership. Consequently, there is
unlikely to be any change in the asset’s useful life or residual value, so far as the vendor is
concerned.

The ‘Gross presentation approach

Here the ‘sale’ is recognized and the apparent gain is deferred and amortised over the lease
term (IAS 17:59). The asset is recognized at its fair value at the date of sale and leaseback
transaction and this new carrying amount is the basis for subsequent depreciation.

162
Illustration 1

Delight ltd sold a vessel to Belzy Ltd on January 1, 2014 and at the same time entered into an
agreement with Belzy Ltd to lease the vessel back for five years. The lease is a finance lease.

The net present value of the lease payments and the fair value of the vessel is $8 million and
the carrying amount of the Vessel before the sale is $4 million. The residual value of the
Vessel is $2 million.

Required

Give journal entries to record this transaction under:

a. The net presentation approach; and

b. The gross presentation approach.
Suggested Solution

a. Net presentation
Delight Limited
Journal
N’000 N’000
Jan. 1. Cash/Bank 8,000
Lease Obligation 8,000
Being proceeds received
Dec.31. Profit or loss 400
Accum. Deprn 400
Being depreciation charge for year:
($4m - $2m)/5

b. Gross Presentation
Delight Limited
Journal
N’000 N’000

Jan. 1. Cash/Bank 8,000

Property, Plant & Equip’t 4,000

Deferred Gain 4,000
Being sale of PPE .

Jan.1. Property, Plant and Equip’t 8,000

Lease Obligation 8,000

Being Leaseback of PPE

Dec.31Profit or Loss 1,200

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 Accum. Deprn 1,200

Being Annual deprn charge ($8m-2)/5

Dec. 31Lease obligation 800

Profit or loss 800

Being amortization of deferred gain on

Leaseback transaction ($4 /5)

Illustration 2

Ocansey Ltd owned construction equipment on which it raised finance. Ocansey sold the
equipment for N50 million to a finance company on January 1, 2009 when the carrying
amount was N35 million. The same equipment was leased back from the finance company
for a period of 20 years, while the remaining useful life of the building is estimated at 25
years from January 1, 2009. The lease rentals for the period are N4.41million payable
annually in arrears. The interest rate implicit in the lease is 7%. The PV of the minimum lease
payment is the same as the sale proceeds.

Required

Show the financial statement extracts of Ocansey Ltd for the first five years of the transaction
(using the ‘gross’ presentation approach).

Suggested Solution

OCANSEY LIMITED

Statement of profit or loss (extract) for the periods ended 31 December

2009 2010 2011 2012

2013

=N=’000 =N=’000 =N=’000 =N=’000

=N=’000

Other Income

Deferred Income release(15m/20) 750 750 750 750 750

Operating Expenses

Depreciation (N50,000/25) 2,000 2,000 2,000 2,000

2,000

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Finance cost

Lease interest 3,500 3,436.3 3,368.14 3,217.18 -

Statement of financial position (extract) as at 31 December

2009 2010 2011 2012

2013

N’000 N’000 N’000 N’000

N’000

Non-current Assets

Leased Equip’t at cost 50,000 50,000 50,000 50,000

50,000

Accum. Depreciation (2,000) (4,000) (6,000) (8,000)

(10,000)

48,000 46,000 44,000 42,000

40,000

Non-current liabilities

Finance lease obligations 48,116.3 47,074.44 45,959.65 44,766.83

43,490.51

Deferred Income 13,500 12,750 12,000 11,250 10,500

Current liabilities

Finance lease obligation 973.70 1,041.86 1,114.79 1,192.82

1,276.32

Deferred Income 750 750 750 750 750

Lease Obligation Amortisation Table

Period Opening Balance Interest Cost Installment Closing

at 12.6% Balance

=N=’000 =N=’000
=N=’000 =N=’000

2009 50,000 3,500 4,410 49,090.00

2010 49,090 3,436.30 4,410 48,116.30

2011 48,116.30 3,368.14 4,410 47,074.44

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 2012 47,074.44 3,295.21 4,410 45,959.65

2013 45,959.65 3,217.18 4,410 44,766.83

2014 44,766.83 3,133.68 4,410 43,490.51

Leases of land and buildings

The usual treatment of the lease of land and building has been to treat the land element (based
on the fact that it has indefinite economic life) as an operating lease while the building
element where appropriate is classified as a finance lease. But with the 2009 amendment to
IAS 17, land held under a long lease may be classified as a finance lease, in particular, if at
the inception of the lease, the PV of the minimum lease payments amounts to substantially all
of the fair value of the leased asset. For proper accounting, the minimum lease payments
should be allocated in proportion to the relative fair values of the leased interests in the land
element and the buildings element at the inception of the lease (IAS 17:16). This implies that
the allocation of the minimum lease payments should reflect the extent to which they are
intended to compensate the lessor for the use of the separate elements. While the future
economic benefits of a building are likely to be consumed to some extent over the lease term,
land with an indefinite life maintains its value beyond the lease term.

If the lease payments cannot be allocated reliably between the land and the buildings
elements, the entire lease is classified as a finance lease unless there are indications that both
elements are operating leases.

Note that where title to the land is not expected to pass to the lessee at the end of the lease,
the lessee does not receive substantially all the risks and rewards of ownership of the land and
thus, any premium or deposit paid for such a leasehold is effectively a prepayment of lease
payments which should be amortised over the lease term.

Illustration

Question 8, p.111 (Teach yourself IFRS by Casmir Idekwulim).

Lessee’s Disclosure for finance leases

i. The net carrying amount at the year-end for each class of asset.
ii. A reconciliation between the total of minimum lease payments at the year end and
their present value.
iii. Contingent rents recognized as an expense for the period.
iv. Total of future minimum sublease payments expected to be received under non-
cancellable subleases at the year end.
v. A general description of the lessee’s significant leasing arrangements including
but not limited to the following:
 the basis on which contingent rent payments are determined

166
  the existence and terms of renewal of purchase options and escalation
clauses
 restrictions imposed by lease arrangements, such as those concerning
dividends, additional debt and further leasing.

Accounting for Finance Lease: In the books of the Lessor.

The amount due from the lessee under a finance lease is recorded in the SOFP of the lessor as
a receivable at the amount of the net investment in the lease, that is, the PV of the minimum
lease payments (MLPs) plus any unguaranteed residual value: the discount rate is the rate of
interest implicit in the lease. The MLPs are split into current asset element and non-current
asset element.

The initial direct costs (e.g. legal fees, commissions etc.) incurred by the lessor are included
in the initial measurement of the finance lease receivable.

The interest charges are recorded as finance income in the statement of profit or loss.

Note: The lessor recognizes finance income so as to reflect a constant periodic rate of return
on its net investment in the finance lease (IAS 17:39). This is achieved by allocating the
rentals received by the lessor between finance income to the lessor and repayment of the
debtor balance.

Illustration

Crystal Plc, which is not a manufacturer- dealer, leases a machine to Diamond Ltd for 25
years. The rents are $10 million per year. At inception, the fair value of the machine is
$120million. The carrying amount of the machine is $95 million. Crystal Plc incurred $5
million of initial direct costs relating to negotiating and arranging the lease. The machine also
has an unguaranteed residual value for Crystal plc; the PV of the unguaranteed residual value
is $10 million. The PV of the minimum lease payments is $115 million and the rate of
interest implicit in the lease is 7.15%.

Required:

a. An amortization table to show the split of the annual rental between finance income
and finance lease receivable repayment.
b. Journal entries to record the events/transactions of the first two years in the books of
Crystal Plc.

Suggested solution

Workings

167
i. Finance Lease Receivable (net investment in the lease) at inception of lease.

PV of minimum lease payments $115m

PV of unguaranteed residual value 10m
125m
Which should be equal to:

Fair value of machine $120 million plus

Initial direct costs 5 million
125 million

ii. Profit on disposal

Since Crystal plc is not a manufacturer-dealer, the profit on disposal to be credited to
Profit or loss is computed as follows:

Net investment in the lease $125m

Less: Carrying value of machine $95m
Initial direct costs 5m 100m
25m
a. Finance Lease Amortisation Table
Year Opening Finance Income Rental Lease Rec. Closing
Bal. @7.15% Payment Repayment Balance
**(A) (B = A x (C) *(D = C- B) (E = A – D)
$’000 0.0715) $’000 $’000 $’000
$’000

1 125,000 8,938 10,000 1,062 123,938

2 123,938 8,862 10,000 1,138 122,800

3 122,800 8,780 10,000 1,220 121,580

4 121,580 8,693 10,000 1,307 120,273

5 120,273 8,600 10,000 1400 118,875

* Reported as current asset in SOFP, if outstanding.

** Reported as Non-current asset in SOFP.

Finance income is credited to Statement of Profit or loss.

b. Crystal Plc
Journal
$’000 $’000

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Jan. 1. Finance Receivable 125,000

Property, Plant & Equip’t 95,000

Cash: Initial direct costs 5,000
Profit or loss 25,000
Being sale of PPE & recognition of finance
Lease receivable .

Dec.31 Cash 10,000

Profit or loss: Finance Income 8,938

Finance lease receivable 1,062

Being receipt of rental payment/recognition of

finance income
Dec.31 Cash 10,000

Profit or loss: Finance Income 8,862

Finance lease receivable 1,138

Being receipt of rental income/recognition of

finance income

Manufacturer/dealer lessors

1. When a manufacturer or dealer offers leasing as an option in addition to normal

selling terms, two types of income will arise:
i. the profit or loss (i.e. an amount equivalent to the profit or loss arising on an
outright sale of the asset at normal selling price); and
ii. the finance income over the period of the lease.

2. The selling profit or loss is recognized at the commencement of the lease. The sales
revenue recognized is the lower of the fair value of the asset and the PV of minimum
lease payments, at a market rate of interest.
3. If artificially low rates of interest are charged, the amount of the selling profit is
restricted to the profit that would have been earned if a commercial rate of interest
had been charged over the lease term.
4. The costs of negotiating and arranging a finance lease are recognized as an expense
when the selling profit is recognized.

Finance lease disclosure requirements for lessors

i. A reconciliation between the gross investment in the lease at the end of the
reporting period, and the PV of the MLPs receivable;
ii. Unearned finance income;
iii. The unguaranteed residual value accruing to the benefit of the lessor;

169
 iv. The accumulated allowance for uncollectible MLPs receivable;
v. Contingent rents included in income in the period; and a general description of the
lessor’s material leasing arrangements.

Operating Lease

An operating lease is a lease other than a finance lease. That is, the lessor retains
substantially all the risks and rewards of ownership of the asset.

Characteristics of Operating lease

i. The lessor retains substantially all the risks and rewards of ownership of the asset.
ii. The lessor retains ownership of asset at the end of the lease term.
iii. No provision for bargain purchase option
iv. The lease period forms an insignificant part of the useful life of the leased asset.
v. The fair value of the leased asset is substantially greater than the PV of the MPLs
vi. It is a cancellable lease agreement; it can be cancelled by either party with or
without significant penalty.

Accounting for Operating Lease

Accounting in the books of the Lessee

The lessee recognizes the annual lease rent payments as expense in the statement of Profit or
loss of the related period. Any advance payment of rent is treated as a prepaid expense and
disclosed in the SOFP as a current asset. Any unpaid rent is reported as an accrued expense in
the SOFP.

Book keeping entries.

a. Lease rent paid to lessor

Dr lease rent expense a/c
Cr Bank/cash.

b. Year end transfer of lease expense incurred for period

Dr Profit or loss a/c
Cr Lease rent expense a/c

c. Lease rent due but unpaid

Dr Lease rent expense a/c or profit or loss a/c
Cr accrued rent a/c

When Lessee is offered Incentive e.g. rent-free period or cash-back incentive

170
This is dealt with in SIC 15. Such incentive may take the form of up-front cash payment to
the lessee or re-imbursement (cash-back) or rent-free or reduced rent period at the beginning
of the lease. Whichever form it takes, it is equivalent to receiving a discount from the lessor.
The aggregate benefit of incentives should be recognized as a reduction of rental expense
over the lease term on a straight line basis while the net amount payable (that is, gross
amount minus amount of discount within free period) is spread over the lease term.

Illustration

The total payments under an operating lease are as follows:

Years 1 to 5 N2,000 per year

Years 6 to 20 N1,000 per year

In addition, the lessor provides a lease incentive with a value of N5000. The lessee’s benefit
under the lease arises on a straight-line basis over the full lease term.

Required:

Detremine the net lease expense to be recognized in the statement of profit or loss per year.

Suggested Solution

Total lease rent payments: (N2,000 x 5) + (N1,000 x 15) = N25,000

Length of lease 20 years

Lease expense recognized each year: N1,250.

Applying SIC-15 to the incentive:

Reduction/incentive per year 5000/20 years = N250

Net lease expense recognized each year: N1,250 – 250 = N1,000. (to be charged to profit
or loss a/c each year).

Accounting in the books of the Lessee

The leased asset is treated as a non-current asset and appropriately depreciated and subjected
to impairment review. Rent income from the lessee is credited to profit or loss a/c.

Book keeping entries

a. Lease rental income received from Lessee

Dr Cash/bank

Cr Lease rent income a/c

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 b. Lease rent earned (year end)
Dr Lease rent income a/c
Cr Statement of Profit or loss a/c

Operating lease disclosure requirements for lessees

1. The total of future minimum lease payments;

2. The total of future minimum sublease payments to be received at the end of the
reporting period;
3. Lease and sublease payments recognised as expense in the period, with separate
amounts for minimum lease payments, contingent rents and sublease payments; and
4. A general description of the lessee’s leasing arrangements

Operating lease disclosure requirements for lessors

1. The future minimum lease payments;

2. Total contingent rents recognized in income for the period; and
3. A general description of the lessor’s leasing arrangements.

3.2 IAS 2 Inventories

IAS 2 prescribes accounting treatment for inventories and gives guidance for determining the
cost of inventories and for recognizing an expense, including write-downs to net realizable
value. The standard also gives guidance on the cost formulae that are used to assign costs to
inventories.

3.2.1 Definitions and Scope

i. Inventories are defined as assets:

 held for sale in the ordinary course of business, (this may include inventories held by
retailers and finished goods of a manufacturer); or
 In the process of production for sale; (this may include work in progress of a
manufacturing entity and labour costs of a service provider); or
 In the form of materials or supplies to be consumed in the production process or in the
rendering of services (generally referred to as raw materials).

172
ii. Net realisable value is the estimated selling price in the ordinary course of business less
the estimated costs of completion and the estimated costs necessary to make the sale.
iii. Fair value is the amount for which an asset could be exchanged, or a liability settled,
between knowledgeable, willing parties in an arm’s length transaction.

IAS 2 applies to all inventories except work in progress under construction contracts,
financial instruments and biological assets.

3.2.2 Measurement of inventories

How inventory values are measured and determined is important to performance reporting as
the inventory figure affects both reported profits and total asset values.

IAS 2 requires that inventories be measured at the lower of cost and net realisable value.
Net realizable value may be lower that cost as a result of declining selling prices, damage to
inventories and obsolescence. When this occurs, the items involved are written down to their
realizable by debiting cost of sales and crediting inventory.
A reversal of a write- down of inventory is permitted, for example, if the item of inventory
written down is still unsold and the price of the item has risen above cost.

Illustration
The following data relate to Crystal Ltd for the period ended 31 December 2017.
Inventory types A B C D
₦ ₦ ₦ ₦
Cost per unit 35 40 60 45
Selling price per unit 65 62.50 70 60
Marketing cost per unit 15 20 12.50 10
Other selling expenses per unit - 5 7.50 2.50
Units of inventory held 250 200 400 300

Required

Calculate the value of closing inventory for purpose of reporting for the period ended 31
December 2017.

Suggested solution

Inventory value per unit

Crystal Ltd
Inventory types A B C D
₦ ₦ ₦ ₦
Cost per unit 35 40 60 45

Net Realisable value per unit

Selling price per unit 65 62.50 70 60
Marketing cost per unit (15) (20) (12.50) (10)
Other selling expenses per unit - (5) (7.50) (2.50)
50* 37.50 50 47.50*

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*The inventory values per unit for items A and D are their cost prices as they are lower than
their net realizable values. The net realizable values for B and C are lower than their cost
prices and are used for closing inventory valuation purpose.

Calculation of ending inventory value

Inventory type Value per unit Quantity Value
₦ ₦
A 35 250 8,750
B 37.50 200 7,500
C 50 400 20,000
D 45 300 13,500
49,750

Cost of inventories
This comprises all costs of purchase, costs of conversion and other costs incurred in bringing
the inventories to their present location and condition.

Purchase cost
The purchase cost of inventory consists of the purchase price, import duties and other non-
recoverable taxes including transport, handling and other costs directly attributable to the
purchase. The purchase price is arrived at, after deduction of trade discounts and other
rebates.

Illustration
Excel Ltd recently imported 2,000 sheets of 10m x 3m x 20mm steel plates. The quoted price
of the plates was ₦50,000 per plate. Considering the size of the order, the suppliers offered
Excel Ltd a trade discount of 5%. The terms of supply included a cash discount of 2% if
payment is made within 45 days. Excel Ltd. intends to take advantage of this offer. Import
duties of ₦150 per sheet was paid before custom release. The transportation cost to deliver
the goods from the wharf to Excel’s workshop was ₦25,000.

Required
Determine the purchase cost of this consignment.

Suggested Solution
Excel Ltd
Computation of Purchase Cost
₦’000 ₦’000
Purchase price (2,000 x ₦50,000) 100,000
Less trade discount 5% 5,000 95,000
Import duties (2,000 x ₦150) 300
Delivery cost 25
Cost of inventory 95,325

Conversion cost
These are costs that are attributable to converting raw materials into finished goods and work
in progress. Conversion costs consist of costs directly related to units of production, such as

174
costs of direct labour, fixed and variable production overheads that are allocated/absorbed to
costs of items produced and closing inventories on the basis of the normal production
capacity in the period and other costs incurred in bringing the inventories to their present
location and condition.

Illustration
Garland Ltd manufactures high quality product called ‘Kleen’ which is sold in overseas
markets.
The following information is available in respect of the production of one unit of the product
for the month of June 2018:
Dept. A Dept. B Dept. C
Materials consumed ₦4,000 ₦1,000 ₦1,500

Direct labour:
Wage rate per hour ₦3 ₦4 ₦5
Direct labour hours 300 200 400
Fixed production overheads are absorbed into production at ₦5 per direct labour hour.
Administration costs for the month amounted to ₦100,000.

Required
Determine the cost of each unit of the product.

Suggested solution
Garland Ltd
Calculation of Production cost of one unit of Kleen
₦ ₦
Direct materials: Dept. A 4,000
B 1,000
C 1,500
6,500
Direct labour: Dept. A (₦3 x 300hrs) 900
B (₦4 x 200hrs) 800
C (₦5 x 400hrs) 2,000
3,700
Fixed production overhead (₦5 x 900 hrs) 4,500
Total production cost 14,700

Note: The administrative costs do not form part of inventory.

Other costs
Other costs are included in the cost of inventories only to the extent that they are incurred in
bringing the inventories to their present location and condition. For example, it may be
appropriate to include non-production overheads or the costs of designing products for
specific customers in the cost of inventories. Borrowing costs for inventories purchased on
deferred settlement terms as well as those that took a substantial period of time to produce
may be included in the cost of inventories.

Cost of inventories of a service provider

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Where service providers have inventories, they are measured at the costs of their production.
These costs consist primarily of the labour and other costs of personnel directly engaged in
providing the service, including supervisory personnel, and attributable overheads. Labour
and other costs relating to sales and general administrative personnel are not included. Non-
attributable overheads that are often factored into prices charged by service providers are also
not included.

Cost of agricultural produce harvested from biological assets

In line with IAS 41, inventories comprising agricultural produce that an entity has harvested
from its biological assets are measured on initial recognition at their fair value less costs to
sell at the point of harvest. This is the cost of the inventories at that date for application of
this Standard.
3.2.3 Cost formulae

The requirement of IAS 2:23 is that the cost of inventory items that are not ordinarily
interchangeable, and of goods or services produced or segregated for specific projects, should
be assigned by using specific identification of their individual costs. This method is only
appropriate when items of inventory are produced for specific projects or when other items of
inventory held could not be substituted for those items e.g. works of art.

When the use of specific identification is inappropriate (for example, for the routine
production of inventories that are ordinarily interchangeable), the cost of inventory is usually
measured by one of the following methods:
i. First in, first out (FIFO)
ii. Weighted average cost (AVCO)

IAS 2: IN13 prohibits the use of last in, first out (LIFO).

First-in, first-out method (FIFO)

This method assumes that inventory items that were bought or produced first are sold first.
Thus, at the end of the period, the unsold items of inventory are valued using the prices for
the most recent purchases. Using this method requires tracking the date, price and number of
units of inventory received into and issued out of the store.

Weighted average cost (WAVCO) method

This method assigns a value to each item of inventory based on the weighted average of
items of inventories outstanding and the weighted average of new items purchased or
produced. Using the perpetual basis, a new average cost is calculated whenever more items
are purchased and received into store. The weighted average cost is calculated as:

Cost of inventory currently in store + Cost of new items received = New weighted average
Number of units currently in store + Number of new units received

Below is a simple illustration of these measurement methods and how they affect reported
inventory values and profit.

176
Illustration
Pathlight Ltd maintains a perpetual inventory system. Stores data for part 10G for the month
of October 2018 are given below:
Date Receipts Purchase price Issues
Per unit (₦)
1/10/18 150 units 400
5/10/18 100 units 450
6/10/18 80 units
12/10/18 100 units
20/10/18 90 units 480
24/10/18 80 units

Required
Determine the value of the closing inventory using
i. FIFO method
ii. Weighted Average Method
iii. Given that the company had opening stock of ₦50,000 as at the end of September,
made purchases of ₦690,000 within the month of October and reported sales figure of
₦1,000,000, show the profit impact of the two valuation methods for the month of
October.

Suggested Solution
Pathlight Ltd

i. Stores Ledger Account using FIFO Method

Receipt GRN Qty. Unit Total Issue details Stock balance
date No. Price
₦ ₦ Req. Qty Price Total Qty Price Total
No. ₦ ₦ ₦ ₦

1/10/18 150 400 60,000 150 400 60,000

5/10/18 100 450 45,000 150 400
100 450 105,000
6/10/18 80 400 32,000 70 400
100 450 73,000
12/10/1 70 400
8 30 450 41,500 70 450 31,500
20/01/1 90 480 43,200 70 450
8 90 480 74,700
24/10/1 70 450
8 10 480 36,300 80 480 38,400

ii. Stores Ledger Account using Weighted Average Cost(WAVCO) Method

GRN Qty Unit Total Issue details Stock balance
Receipt No. . Price
date ₦ ₦ Req. Qty Price Total Qty Price Total
No. ₦ ₦ ₦ ₦

177
 1/10/18 150 400 60,000 150 400 60,000
5/10/18 100 450 45,000 250 420 105,000

6/10/18 80 420 33,600 170 420 71,400

12/10/18 100 420 42,000 70 420 29,400

20/01/18 90 480 43,200 160 453.75 72,600
24/10/18 80 453.75 36,300 80 453.75 36,300

Pathlight Ltd
Statement of profit or loss for the period ended 31 October 2018
FIFO WAVCO
₦ ₦
Sales 1,000,000 1,000,000

Cost of sales:
Stock, Oct.1 50,000 50,000
Purchases 690,000 690,000
740,000 740,000
Closing Stock (38,400) (36,300)
701,600 703,700

Gross profit ₦298,400 ₦296,300

The difference in the reported profit is accounted for by the difference in inventory values
resulting from the two different valuation methods.

3.2.4 Presentation and Disclosures

IAS 1:54 requires that the total carrying amount of inventories (other than those in disposal
groups that are classified as held for sale) should be presented as a separate item in the
statement of financial position.

IAS 2 requires the following disclosures:

i. The accounting policies adopted in measuring inventories, including the cost formula
used;
ii. The total carrying amount of inventories together with an analysis of the carrying
amount in a manner appropriate to the entity ((For a manufacturer, appropriate
classifications will be raw materials, work-in-progress and finished goods);
iii. The amount of inventories carried at realizable value less costs to sell.
iv. The amount of inventories recognized as expense during the period.
v. The amount of any write-down of inventories to net realizable value recognized as an
expense during the period
vi. The amount of any reversal of any write-down recognized as a reduction in the
inventories expense for the period and the circumstances or events that led to any
recognized reversal of a write-down of inventories; and

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vii. The carrying amount of inventories pledged as security for liabilities.

3.3 IAS 41: Agriculture

3.3.1 Scope
IAS 41 prescribes the accounting treatment and disclosures related to agricultural activity in
the following areas:
 biological assets, except for bearer plants.
 agricultural produce at the point of harvest; and
 government grants for agriculture (unconditional and conditional grants).
Outside the scope of IAS 41 are:
 the harvested agricultural products – These are accounted under IAS 2 Inventory ;
 land relating to the agricultural activity – The accounting for this falls under IAS 16
or IAS 40;
 bearer plants related to agricultural activity- The reader should recall that during our
discussion on PPE, it was mentioned that the 2014 amendment to the standard moved
bearer plants within the scope of IAS 16. However, IAS 41 does apply to the produce
on those bearer plants; and
 intangible assets related to agricultural activity to which IAS 38 Intangible assets
applies.
This Standard applies to agricultural produce, which is the harvested product of the entity’s
biological assets, only at the point of harvest. Thereafter, IAS 2 Inventories or another
applicable standard is applied. The Standard therefore does not deal with the processing of
agricultural produce after harvest.

3.3.2 Definitions
Agriculture-related definitions
i. Agricultural activity is the management by an entity of the biological transformation and
harvest of biological assets for sale or for conversion into agricultural produce or into
additional biological assets.
ii. Agricultural produce is the harvested product of the entity’s biological assets.
iii. A biological asset is a living animal or plant, for example, cows, goats, wheat, fruit trees
etc.
iv. Biological transformation comprises the processes of growth, degeneration, production,
and procreation that cause qualitative or quantitative changes in a biological asset.
v. Costs to sell are the incremental costs directly attributable to the disposal of an asset,
excluding finance costs and income taxes.
vi. A group of biological assets is an aggregation of similar living animals or plants.
vii. Harvest is the detachment of produce from a biological asset or the cessation of a
biological asset’s life processes.

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IAS 41:4 provides examples of biological assets, agricultural produce, and products that are
the result of processing after harvest. The details are given in the table below:

Biological assets Agricultural produce Products that are the result

of processing after harvest
Wool
Sheep Yarn, carpet

Trees in a plantation forest Felled trees Logs, lumber

Cotton Plant Cotton Thread, clothing

Sugar cane Harvested cane Sugar

Dairy cattle Milk Cheese

Pigs Carcass Sausages, cured hams

Tea bushes Picked leaf Tea

Tobacco plants picked leave cured tobacco

Vines Grapes Wine

Fruit trees Picked fruit Processed fruit

Oil palm Picked fruit Palm oil

Rubber trees Harvested latex Rubber products

3.3.3 Accounting treatment (Recognition and measurement)

Recognition of a biological asset or agricultural produce
IAS 41:10 gives guidance in this regard. According to the standard, an entity should
recognise a biological asset or agricultural produce when, and only when:
 the entity controls the asset as a result of past events;
 it is probable that future benefits will flow from the asset to the entity; and
 the fair value or cost of the asset can be measured reliably.
In agricultural activity, control may be evidenced by, for example, legal ownership of an
animal e.g. cow and the branding or otherwise marking of the animal on acquisition, birth, or
weaning. According to the standard, the future benefits are normally assessed by measuring
the significant physical attributes.
When future agricultural produce (e.g. fruit) is attached to a biological asset (e.g fruit trees),
it should not be recognized separately before harvest. Until harvest, that future agricultural

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produce remains part of the total biological asset and the asset should be measured as a
whole.
Illustration
A Ltd owns a palm plantation. The palm trees are mature and their fair value (excluding fruit)
has not increased during the reporting period. The fair value less costs to sell of the fruits on
the trees is ₦150,000 immediately before harvest.
Required
Show Journal entries to reflect the recognition and harvesting of the palm fruits.

Suggested solution
A Ltd
Journal
₦ ₦
Palm trees 150,000
Gain on biological assets 150,000
Being recognition of the increase in fair value due
Fruits growing on them (to the point of harvest)
Inventories 150,000
Gain on harvest of palm fruits 150,000
Being recognition fair value of palm fruits at harvest
Loss on biological assets 150,000
Palm trees 150,000
Being recognition of the decrease in fair value of
Palm trees following harvest of fruits

3.3.4 Measurement
A biological asset should be measured on recognition and at the end of each reporting period
at its fair value less costs to sell (unless the fair value cannot be measured reliably). The gain
or loss arising on initial recognition and subsequent revaluation should be included in profit
or loss for the period in which it arises.
Agricultural produce harvested from an entity’s biological assets is measured at its fair value
minus estimated ultimate selling costs. The gain or loss on initial recognition is included in
the profit or loss for that period.
Ultimate selling costs (costs to sell) include commissions to brokers and dealers, levies to
regulators, transfer taxes and duties.
Fair value is the quoted price in an active market. The determination of fair value for a
biological asset or agricultural produce may be facilitated by grouping biological assets or
agricultural produce according to significant attributes; for example, by age or quality. An
entity selects the attributes corresponding to the attributes used in the market as a basis for
pricing. Where an active market exists for a biological asset or agricultural produce in its

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present location and condition, the quoted price in that market is the appropriate basis for
determining the fair value of that asset.
If an active market does not exist, reference should be made to the following market-based
measures in order to arrive at the most reliable estimate:
 The most recent market price for that type of asset, provided that there has not been a
significant change in economic circumstances between the date of that transaction and
the end of the reporting period;
 Market prices for similar assets appropriately adjusted to reflect differences; and
 sector benchmarks such as the value of cattle expressed per kg of meat.
If market-determined prices or values are not available for a biological asset in its present
condition, an entity should use the present value of expected net cash flows from the asset
discounted at a current market-determined rate in determining fair value.
Cost may sometimes approximate fair value, particularly when:
(a) little biological transformation has taken place since initial cost incurrence (for example,
for fruit tree seedlings planted immediately prior to the end of a reporting period); or
(b) the impact of the biological transformation on price is not expected to be material (for
example, for the initial growth in a 30-year pine plantation production cycle).
There is a presumption that fair value can be measured reliably for a biological asset. Where
this presumption is rebutted, the biological asset should be measured at its cost minus any
accumulated depreciation or impairment.
3.3.5 Government grants
Farms and other Agricultural entities, from time to time may benefit from government grant.
Where such grant is unconditional and the biological asset is being measured at its fair value,
the entity should recognize the grant in profit or loss when, and only when, it becomes
receivable.
If a government grant related to a biological asset measured at its fair value is conditional,
including when a government grant requires an entity not to engage in specified agricultural
activity, an entity shall recognise the government grant in profit or loss when, and only when,
the conditions attaching to the government grant are met.
If a government grant relates to a biological asset measured at its cost less any accumulated
depreciation and impairment losses, IAS 20 is applied in its accounting.

3.3.6 Presentation and disclosure

Presentation
The carrying amount of biological assets (other than those included in disposal groups)
should be presented separately in the statement of financial position, sub-classified under:
 class of animal or plant
 nature of activities
 mature or immature for intended purpose

Agricultural produce classified as inventory in the statement of financial position .

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Disclosure
An entity should disclose the following:
 a description of each group of biological assets;
 the aggregate gain or loss arising on the initial recognition of biological assets and
agricultural produce, and from the change in fair value less costs to sell of biological
assets;
 a reconciliation of the changes in carrying amount of biological assets between the
beginning and end of the accounting period;
 where an entity has not adopted IFRS 13, it should disclose the methods and
significant assumptions used in determining fair value of each group of agricultural
produce and biological assets as well as fair value less costs to sell of agricultural
produce harvested during the year;
 the existence and carrying amounts of biological assets whose title is restricted, and
the carrying amounts of biological assets pledged as security for liabilities;
 the amount of commitments for the development or acquisition of biological assets;
financial risk management strategies in relation to its agricultural activities
If biological assets are measured at cost less accumulated depreciation and impairment losses,
the following should be disclosed:
 a description of the biological assets;
 an explanation as to why fair value cannot be determined reliably;
 the range of estimates within which fair value is highly likely to lie, if possible;
 the depreciation method used;
 the useful lives or depreciation rates used; and
 the gross carrying amount and the accumulated depreciation and impairment losses at
the beginning and end of period.
For government grants relating to agricultural activity, the following disclosures are required:
 the nature and extent of government grant recognized;
 unfulfilled conditions and other contingencies attaching to grants; and
 significant decreases expected in the level of government grants.

INTEXT QUESTIONS

1. ………………is any change in the scope and/or price of a contract approved by

both parties for example changes in design, quantity, timing or method of
performance).

2. ------ is the price an entity would sell a promised good or service separately to a
customer

3. IAS 2 requires that inventories be measured at the …………………..

4. IAS 2 recommends that the cost of inventory be measured by any one of two
methods namely……………………… and ……………..

5. Using either LIFO or WAVCO to value inventory will always report the same profit
figure. True/False
6. A biological asset should be measured on recognition and at the end of each
reporting period at --------------------------

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 IN-TEXT ANSWERS (ITA’s)

1. Contract modification

2. Stand -alone price

3. lower of cost and net realisable value.

4. First in, first out (FIFO) and Weighted average cost (WAVCO)

5. False
6. its fair value less costs to sell

UNIT 4 IAS 33: Earnings per Share (EPS)

Introduction
This unit takes you through the calculation and presentation of earnings per share – an
important performance index, mandatorily required to be disclosed by every public interest
entity. The procedures for computation of EPS when dilutive and anti-dilutive instruments
are introduced should be noted by the student.

Specific Objectives
At the end of this unit, students should be able to:

1. Define EPS in line with the standard;

2. Differentiate between basic EPS and diluted EPS;
3. Calculate both basic and diluted EPS under different scenarios of dilution

Earnings per Share (EPS) is a good measure of a company’s performance and is of particular
importance in comparing the results over time. A company must be able to maintain its
earnings in order to pay dividends and reinvest in the business so as to achieve future growth.
It is a measure of earnings within a period that is attributable to each ordinary share of the
entity.

Related to EPS is the price/earnings ratio, another key investment/stock market ratio. This is
a good yardstick for assessing the relative worth of a share and it is a measure of the current
market price of a company’s share in relation to the EPS, that is,

P/E ratio = Market price (ex.div.) per ordinary share

EPS
Or
Total market value of equity
Total Earnings (attributable to ordinary shareholders)

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The P/E ratio reflects the market’s appraisal of the shareholders’ future prospects. Therefore,
to the investor, it reflects two key considerations, viz: the market price of a share of an entity
and its earning capacity. To the lender, a higher P/E ratio might indicate that a firm is in a
more secure industry or that its earnings are expected to increase faster above the average
rate. It predicts a firm’s future performance.

Investors are interested in the trend exhibited by a company’s EPS over time as well as in the
size of EPS relative to the current market price of an entity’s shares.

4.1.1 Objective of IAS 33

The importance of EPS and its relationship with the P/E ratio makes it necessary that its
computation and presentation are standardized for application by and across entities.
Therefore, the objective of IAS 33 is to set out principles for the calculation of EPS and its
presentation in the financial statements to enhance comparison of the performance of
different entities in the same reporting period; and the trend of performance of an entity for
different reporting periods over time.

4.1.2 Definitions
Ordinary share: an equity instrument that is subordinate to all other classes of equity
instruments.

Potential ordinary share: a financial instrument or other contract that may entitle its holder
to ordinary shares at some time in the future.

Share Options and Warrants: These are financial instruments that give the holder right to
purchase ordinary shares.

Convertible instruments: These are instruments that give the holder the right to convert or
exchange their security into ordinary shares.

Contingently issuable ordinary shares are ordinary shares issuable for little or no cash or
other consideration upon the satisfaction of certain conditions in a contingent share
arrangement.

Contingent share arrangement: This is an agreement to issue shares that is dependent on

the satisfaction of specified conditions.

Dilution: A reduction in EPS or an increase in loss per share resulting from assumption that
convertible instruments are converted, that options or warrants are exercised, or that ordinary
shares are issued upon the satisfaction of certain conditions.

Anti-dilution: An increase in EPS or a reduction in loss per share resulting from assumption
that convertible instruments are converted, that options or warrants are exercised, or that
ordinary shares are issued upon the satisfaction of certain conditions.

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Scope of IAS 33
IAS 33 applies only to listed entities or those which are about to be listed. For a group, EPS
is computed and presented on the basis of consolidated figures and not those of the parent.
Non-listed companies that choose to present EPS should do so in accordance with the
guidance given by IAS 33.

4.2 Computation of Earnings per share

IAS 33 gives guidance to entities on the computation of two types of EPS on their continuing
operations namely:
a. Basic earnings per share; and
b. Diluted earnings per share.
Basic EPS will differ from diluted EPS whenever there are potential ordinary shares. This
will be discussed as we deal with the calculation of diluted earnings per share.

Basic Earnings per share

Generally, basic EPS is computed as profit/(loss) after tax and preference dividend divided by
weighted average number of ordinary shares in issue and ranking for dividend, that is,

EPS = Profit available for equity holders

Weighted average no. of equity Shares in issue and ranking for dividend

The following points are noteworthy:

i. The earnings are defined as profit or loss less tax and preference dividends. Relevant
earnings are earnings from continued operations and for group entities, only earnings
relating to the group are considered. EPS for discontinued operations is computed and
disclosed separately.
ii. Preference dividends to be deducted is the sum of preference dividends on non-
cumulative preference shares declared in the reporting period and preference
dividends on cumulative preference shares required for the period, whether or not
declared.
iii. Where an entity purchases its own shares for more than the carrying amount, the
excess is regarded as return to the preference shareholders and should be deducted
from the profit attributable to ordinary shareholders.
iv. In line with IAS 32, preference shares can be classified as equity or debt (liability). If
it is classified as debt, the borrowing cost would have been deducted before arriving
at the net profit and so need not be further backed out from the reported profit.
v. Changes in the number of shares within the year necessitate the use of weighted
average number of shares as the denominator. These changes can arise from –
 Issue and redemption of shares at full market price
 Bonus issues
 Rights issues/Bonus element in rights issues
 Share split
 Reverse share split
 Issue of contingently issuable shares etc.
Time- weighting factor is usually applied in the computation of weighted average number of
shares and this is the number of days/months the shares were outstanding in relation to the

186
total number of days in the period. Inclusion of shares in the weighted average number of
shares will generally need a consideration of the specific terms attached to their issue but in
many cases it will be the date consideration is receivable, that is, the date of issue.

Illustrations

On 31 December 2017, Maybros Plc. had in issue 10,000,000 ordinary shares of ₦1 each and
5,000,000 10% Preference shares. During the period ended 31 December 2017, the company
made a profit after tax of ₦5.5million, ₦500,000 of which is from discontinued operations.
The preference dividend for the period was duly paid.

Required

a. Calculate the basic EPS if preference shares are classified as liability (debt) in accordance
with IAS 32.

b. Calculate the EPS if preference shares are classified as equity in accordance with IAS 32.

Suggested Solution

a. Maybros Plc

Calculation of basic EPS (Preference shares classified as liability)

EPS = Net profit (or loss) attributable to ordinary shareholders during a period
Weighted average number of shares in issue during the period
= ₦5,000,000
₦10,000,000

= 50 kobo

Note:

1. The relevant profit figure for the purpose of this computation is the profit from
continuing operations, that is, ₦5,500,000 - ₦500,000.

2. Since Preference shares are classified as liability, the 10% dividend rate attaching to
the instrument is treated as cost of borrowing and is expected to have been charged to
income before arriving at the profit after tax.

Maybros Plc

b. Calculation of basic EPS (Preference shares classified as equity)

EPS = Net profit (or loss) attributable to ordinary shareholders during a period
Weighted average number of shares in issue during the period

= ₦5,000,000 – 500,000
₦10,000,000

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 = 45 kobo

Changes in the number of shares during a period

i. Issue of new shares at full market price

Where there has been more than one capital change in the period, time-weighting factor is
applied in determining the weighted average number of shares for the period.

Illustration

On 1 January 2016 Ugoeze Plc had 6,500,000 ordinary shares in issue. On 1 April, 1,000,000
new shares were issued at full market price. On 1 August a further 300,000 shares were
issued to the public, also at full market price. On 1 October 4,000,000 more shares were
issued at market price. In the period, the company made profit after tax of ₦2,750,000.

Required

Calculate Ugoeze Plc’s EPS for the year 2016..

Date Number of shares Time factor Weightedaverage

number

1 January to 31 March 6,500,000 x 3/12 1,625,000

New issue on the 1 April 1,000,000
1 April to 31 July 7,500,000 x 4/12 2,500,000
New issue on the 1 August 300,000
1 August to 30 September 7,800,000 x 2/12 1,300,000
New issue on the 1 October 4,000,000
1 October to 31 December 11,800,000 x 3/12 2,950,000
8,375,000

EPS = Net profit (or loss) attributable to equity holders during a period
Weighted average number of shares in issue during the period

= 2,750,000
8,375,000

= 32.83 kobo

The time factor is the period between the existing shares and issuing of new shares. For
example, the time lag between January 1 and 1 April when additional shares were issued is
three months, out of the 12 months in a year, that is, 3/12 etc.

Alternatively, the weighted average number of shares could be calculated using the following
approach:

Weighted number

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Jan.1 Existing no. of shares used for 12 months (6,500,000 x 12/12) 6,500,000
April 1: New shares issued, used for 9 months (1,000,000 x 9/12) 750,000
Aug. 1: New issue of shares, used for 5months (300,000 x 5/12) 125,000
Oct. 1: Additional share issue, used for 3 months (4,000,000 x 3/12) 1,000,000
8,375,000
Partly paid shares

Partly paid shares are included in the weighted number of outstanding shares on the basis of
equivalent units, that is, the partly paid shares are included as fully paid shares to the extent
of the proportion paid up.

Illustration

On January 1, 2017 Goldie Plc had in issue 9 million ordinary shares of N1 each, inclusive of
2 million shares paid up to 80% of their value. On May 1, payment was received for the
remaining 20% of the partly paid shares. Total earnings for ordinary shareholders in 2017
were ₦6,200,000. Compute the EPS for the year.

Suggested solution
Number of shares Time factor WAnumber
Jan1 to 30 April 2017 9,000,000 x 4/12 3,000,000
May1 Receipt of outstanding
20%( 2,000,000 shares) 400,000
May 1 to 31 December 2017 9,400,000 x 8/12 6,266,667
9,266,667

EPS = 6, 200,000
9,266,667
= 66.90 kobo

ii. Bonus issues

Bonus issue of shares involves capitalization of reserves which are issued to existing
shareholders in proportion to their existing shareholding at no cost to them. Since no cash is
raised from a bonus issue, it does not improve earnings and therefore are treated as if they
have always been in issue.
After bonus issue, the new number of shares is arrived at by multiplying existing number of
shares by the ‘bonus fraction’. The bonus fraction is computed as the number of
shareholding after the bonus issue divided by the number of shareholding before the bonus
issue. For example, a bonus issue of 1 for 2 implies that a holder of 2 shares will thereafter
have 3 shares. Thus, the bonus fraction is 3/2.

Restatement of preceding year EPS

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For effective comparison, and considering the fact that bonus issues do not boost earnings,
the comparative figure of EPS is restated after a bonus issue. This is achieved by multiplying
the computed preceding year’s EPS by the inverse of the bonus fraction.

Illustration
On January 1, 2017 Zindam Plc had ₦1 million ordinary shares of 25 kobo. On October 1,
2017 there was a 1 for 4 bonus issue of 1 million shares. Reported profits for years 2017 and
2016 were ₦400,000 and ₦350,000 respectively. The company’s year-end is 31 December.

Required
Calculate the EPS for 2017 and the comparative figure for 2016.

Suggested solution

Zindam Plc

Calculation of EPs (on issue of bonus shares)

Weighted average
number
Existing no. of shares (1,000,000/0.25 x 12/12) 4,000,000
Bonus issue (Oct.1) (1,000,000 x 12/12) 1,000,000
5,000,000

2017 EPS = 400,000

5,000,000
= 8 kobo

2016 EPS = 350,000

4, 000,000
= 8.75 kobo

Restatement of 2016 EPS = Computed EPS x inverse of bonus fraction

8.75 k x 4/5

7 Kobo

Note that this straight forward system of calculating weighted number of shares is appropriate
only when the bonus issue is the only capital change within the year. If there is more than
one, applying time-weighting and multiplying the preceding number of shares by the bonus
fraction is more appropriate. This is done to avoid time apportionment of the new shares
issued.

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Alternatively then, the weighted average number of shares in the above example could be
computed as demonstrated under.

Number of shares Time factor Bonus fraction Weighted

average
number
Jan. 1 to sept. 30 4,000,000 x 9/12 x 5/4 3,750,000
Oct.1 Bonus issue 1,000,000
Oct.1 to Dec.31 5,000,000 x 3/12 1,250,000
5,000,000

Rights Issue
A right issue is usually offered first to members of the company for less than the market price
and in proportion to their holding. There is therefore a bonus element in every rights issue
which has to be factored into the calculation of weighted average number of shares.

The rights issue bonus fraction is calculated as actual cum rights price divided by theoretical
ex-rights price. The theoretical ex-rights price is the expected share price after the right issue
and is computed as a weighted average price of the shares before the rights issue and the
price of the new shares in the rights issue.

For example, a company did a 1 for 3 rights issue at a price of ₦20 per share. The market
price of the shares before the rights issue was ₦25. The theoretical ex-rights price will be
computed as: ₦

3 existing shares at cum rights price of ₦25 gives a value of 75

1 new share at ₦20 ex-rights 20
Weighted average value 95

Theoretical ex-rights price (₦95/4 ) ₦23.75

As in bonus issues, the comparative figures of EPS should be restated by multiplying them by
the inverse of the rights issue bonus fraction, that is, theoretical ex-rights price divided by the
actual cum rights price.

Illustration

On January 1, 2017 Midland Plc had in issue 300,000 ordinary shares of ₦1 each. The
company made a rights issue of 2 for every 5 shares at a price of ₦1.5 on July 1, 2017. The
actual market price just before the issue was ₦2.50.

The reported EPS for the year ended 31 December 2016 was 70 kobo. The company reported
profit after tax of ₦250,000 for the period ended 31 December 2017.

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Required

Calculate the EPS for the year ended 31 December 2017 and the restated EPS for 2016.

Suggested Solution

Midland Plc

Weighted average number of shares

Date Number of shares Time factor Rightsfraction Weighted

average
number

Jan.1 to 30 June 300,000 x 6/12 2.5/2.21 169,683

Jul. 1 New shares 120,000
Jul.1 to 31 December 420,000 x 6/12 210,000
379,683

EPS (2017) = PAT/Weighted Av. No. of shares

= 250,000/379,683

= 65.84 kobo

Restated EPS (2016) = 70k x 2.21/2.5

= 61.88 kobo

Working

i. Theoretical Ex-rights Price

Cum rights value: 5 shares x ₦2.50 ₦12.50
Ex- rights value: 2 shares x ₦1.50 3.00
15.50

Theoretical Price 15.5/7

₦2.21

ii. Number of rights shares issued:

300,000 x 2/5 120,000

4.3 Diluted Earnings per share

Where a company has potential ordinary shares that are dilutive( that is, that can reduce EPS
or increase EPS due to increase in number of shares), IAS 33 requires such company to
present diluted EPS in addition to the basic EPS, notwithstanding that such dilutive shares do

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not at present have any share of equity earnings. A comparative diluted EPS for the preceding
year should also be presented.

To calculate diluted EPS, earnings and number of shares figures used in calculating the basic
EPS calculation are adjusted to remove the post- tax effect of dividends or interest that have
been recognised during the year for the potential ordinary shares. Any other income or
expense that would change (e.g. reduction in interest expense related to the potential ordinary
shares) as a result of the conversion of the potential ordinary shares into actual ordinary
shares is also adjusted.

For convertible preference shares, the total earnings will be increased by the dividend saved
(which is the dividend paid for the year) and for convertible bonds, total profit is increased by
the interest cost saved less tax. In both cases, the weighted average number of shares is
increased, by the maximum number of new shares that would be created by the conversion of
potential ordinary shares into actual ordinary shares. The additional number of shares is
assumed to be in issue at the beginning of the year.

Dilutive instruments/securities include convertible preference shares and convertible bonds,

options and warrants and Employee share options.

Illustrations

Convertible preference shares and convertible bonds

In 2017, Diamond Plc reported earnings for equity holders of ₦210,000. 200,000 ordinary
shares of ₦1 each were in issue. It also had in issue ₦80,000 15% convertible loan stock,
convertible in 2 years’ time at the rate of 8 ordinary shares for every ₦10 stock. The rate of
tax is 30%.

Required

Calculate the basic EPS and the diluted EPS for 2017.

Suggested Solution

Diamond Plc

Basic EPS = Earnings

No. of shares

= 210,000
200,000

= 105 kobo

Diluted EPS = Adjusted Earnings (W1)

Adjusted No. of shares (W2)
= 218,400
264,000

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 = 82.72 Kobo

The dilution in earnings per share as a result of the presence of the potential ordinary shares
is 22.28 Kobo, that is, 105 kobo – 82.72 kobo.

Workings
1. Adjusted Earnings
₦ ₦
Earnings for basic EPS 210,000
Add: Interest on conv. Loan – 15% x ₦80,000 12,000
Less Tax 30% x ₦12,000 3,600 8,400
218,400

2. Adjusted Weighted average no. of shares

No. of shares for basic EPS 200,000

Additional shares on conversion of stock: 80,000/10 x 8 shares 64,000
264,000

IAS 33:44 directs that only dilutive potential ordinary shares should be included in the
computation of diluted EPS. In determining whether potential ordinary shares are dilutive or
antidilutive, each issue or series of potential ordinary shares is considered separately rather
than in aggregate.

The test for dilution is given by the formula:

Incremental EPS on convertible stock = Interest savings net of tax on convertible stock
No. of shares exchangeable for the convertible
stock
c. New issue of convertible securities in the year

If, during the course of the year new convertible securities are issued, the additional number
of shares and the earnings adjustment are included in the computation of diluted EPS from
the date of issue of the new securities.

On January 1, 2018 Singeobi Plc had 5,000,000 ordinary shares in issue. The company
issued ₦1,000,000 convertible 6% bonds on 1 July 2018. These are convertible into ordinary
shares at the following rates:
On 30 June 2023 25 shares for every ₦10 of bonds
On 31 June 2024 20 shares for every ₦10 of bonds
In the period ended 31 December 2018, total earnings for equity holders were ₦20,435,000.

Tax is at the rate of 30%.

Required
Calculate the 2018 basic EPS and diluted EPS.

Suggested Solution

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Singeobi Plc

Basic EPS = Equity Earnings

No. of ordinary shares
= 20,435,000
5,000,000

= ₦4.087

Diluted EPS = Adjusted Earnings (W1)

Adjusted No. of shares (W2)
= 20,458,000
6,250,000
= ₦3.27

Workings
1. Adjusted earnings

₦ ₦
Earnings for basic EPS 20,435,000
Add: Interest on conv. Loan – 6% x ₦1,000,000 x 6/12 30,000
Less Tax 30% x ₦30,000 9,000 23,000
20,458,000

2. Adjusted Weighted average no. of shares

No. of shares for basic EPS 5,000,000

Additional shares on conversion of stock: 1,000,000/10 x 25 x 6/12 1,250,000
6,250,000

Note: The number of potential shares is calculated using the conversion rate of 25 shares for
every ₦10 of bonds, because this rate produces more new shares than the other conversion
rate of 20 shares for every ₦10 of bonds.

2. Options and warrants

Options and warrants permit the holder of the option to buy shares of a company at some
time in the future at a pre-agreed price. On the exercise of the option right for the agreed
number of shares, the holder of the right pays cash to the company at the pre-agreed price
which is expected to boost its earnings.

For the purpose of computing the diluted earnings per share, the amount received on exercise
of the options is used to determine the number of shares it would have bought were the shares
sold at full market price. The difference between the number of shares given out on exercise
of the right and this calculated number is taken to be free shares given to the option holders
and are considered to be dilutive. They are added to the existing number of shares in issue, to
obtain the total shares for calculating the diluted EPS.

Example

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On January 1, 2018 Booster Plc had 3,000,000 ordinary shares in issue. There are
outstanding share options on 200,000 shares, which can be exercised at a future date, at an
exercise price of ₦20 per share. At 31 December 2018, total equity earnings stood at
₦15,000,000. The average market price of Booster Plc’s shares during year was ₦25.
Required
Calculate the diluted EPS for 2018.

Suggested Solution
Booster Plc
Diluted EPS = Equity Earnings
Adjusted no. of equity shares (W1)
= 15,000,000
3,040,000
= ₦4.93

Notice that the total earnings are not adjusted as it is not possible to do so. Though the cash
received from the exercise of the option rights may boost earnings for the company, it is
impossible to predict how total earnings will be affected by the cash received.

Workings

1. Adjusted number of shares.

₦ No. of
Shares
Cash received from exercise of option - ₦20 x 200,000 4,000,000
At full market price of ₦25, this will procure 4,000,000/25 shares 160,000
Number of shares issued on exercise of the option 200,000
Shares issued for free (dilutive) 40,000
Basic EPS number of shares 3,000,000
Adjusted number of shares 3,040,000

3. Employee share options

The treatment of employee share options that have vested follow the same procedure as any
other option. For unvested options the expense recognised over the vesting period for the
employees’ future service, in accordance with IFRS 2, is added to the cash received on the
exercise of the option to get the total future benefit. This figure is divided by the average

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share price within the period to get the number of shares assumed to be issued at full market
price. The difference between this figure and the number of shares issued on exercise of the
option represents the number of shares issued for free. This is then added to the existing
number of shares to get the adjusted number of shares for the purpose of calculating the
diluted EPS.

Example

Sincere Plc has 5,000,000 ordinary shares in issue. The company reported total earnings of
₦20,000,000 during 2018. There are unvested employee share options on 300,000 shares,
which can be exercised at a future date, at an exercise price of ₦150 per share. The future
expense that the company expects to recognise in respect of these options up to the vesting
date is ₦10,000,000. The average market price of shares in Sincere Plc during 2018 was
₦250.

Required

Calculate the diluted earnings per share.

Suggested Solution
Sincere Plc

Diluted EPS = Equity Earnings

Adjusted no. of equity shares (W1)
= 20,000,000
5,080,000
= ₦3.94

Working

1. Adjusted number of shares.

₦ No. of Shares
Cash received from exercise of option - ₦150 x 300,000 45,000,000
Employees’ future service 10,000,000
Total future benefit 55,000,000

At full market price of ₦250, this will give 55,000,000/250 shares 220,000
Number of shares issued on exercise of the option 300,000
Shares issued for free (dilutive) 80,000
Basic EPS number of shares 5,000,000
Adjusted number of shares 5,080,000

4. Contingently Issuable shares

IAS 33: 52 – 57 deal with contingently issuable shares. Such shares are issuable only on the
occurrence of some future event and thus have no effect on the basic EPS calculation until the
condition is actually met. They affect the diluted EPS only if the conditions leading to their
issue have been satisfied. The conditions may be attainment of specified future earnings and

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future prices of the ordinary shares. In such cases, the number of ordinary shares included in
the diluted earnings per share calculation is based on both conditions (ie earnings to date and
the current market price at the end of the reporting period). Contingently issuable ordinary
shares are not included in the diluted earnings per share calculation unless both conditions are
met.
For this purpose the reporting date is treated as the end of the contingency period.
Contingently issuable shares are included in the diluted EPS calculation from the later of the
beginning of the period or the date of the contingently issuable share agreement.

Illustration

Emerald Co. has 8,000,000 ordinary shares in issue as at 31 December 2017. Emerald Co.
acquired a new business during period ended 31 December 2016. As part of the purchase
agreement Emerald Co. would issue a further 500,000 shares to the vendor on 30 June 2018 if
the share price was ₦300 at that date. The share price was ₦400 on 31 December 2017.
Earnings for the year to 31 December 2017 were ₦40,000,000

Required

Calculate basic and diluted EPS for 2017.

Suggested Solution

The condition for the issuance of the shares was satisfied by December 2017 and thus the
shares will be included in computing diluted EPS.

Basic EPS = Equity earnings

No. of ordinary shares
= ₦40,000,000
8,000,000
= ₦5.00
Diluted EPS = Equity earnings
Basic no. of shares + dilutive shares
= 40,000,000
8,000,000 + 500,000
= ₦4.70

4.4 Presentation and Disclosure

An entity should present in the statement of profit or loss the basic EPS and the diluted EPS
for the profit or loss from continuing operations attributable to the ordinary equity holders.
For consolidated accounts, this is the EPS and diluted EPS attributable to the owners of the
parent company. An entity shall present basic and diluted earnings per share with equal

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prominence for all periods presented. If diluted earnings per share is reported for at least one
period, it shall be reported for all periods presented, even if it equals basic earnings per share.
These figures are presented at the end of the statement of profit or loss. If the entity presents
a separate statement of profit or loss the EPS and diluted EPS should be shown in this
statement, and not in the statement of comprehensive income.

If there is a discontinued operation, the basic EPS and diluted EPS from discontinued
operation should be shown either on the face of the statement of profit or loss or in a note to
the financial statements, even if the amounts are negative (i.e. a loss per share)

IAS 33:70 also requires disclosure in a note to the financial statements of the following:

(a) the amounts used as the numerators in calculating basic and diluted earnings per share,
and a reconciliation of those amounts to profit or loss attributable to equity holders for the
period. The reconciliation shall include the individual effect of each class of instruments that
affects earnings per share.

(b) the weighted average number of ordinary shares used as the denominator in calculating
basic and diluted earnings per share, and a reconciliation of these denominators to each other.
The reconciliation shall include the individual effect of each class of instruments that affects
earnings per share.

4.5 WORKED EXAMPLE

In 2017, AntiDilution Plc had in issue 10 million ordinary shares of 50 kobo each and:

a. ₦2,000,000 14% convertible loan stock, convertible in 3 years’ time at the rate of 4 shares
per ₦20 of stock; and

b. ₦4,000,000 10% convertible loan stock in one year’s time at the rate of 6 shares per ₦10
of stock.
Earnings for ordinary shares for the year ended 31 December 2017 was ₦3,500,000 and
corporate tax rate was 35%.

Required
Calculate the basic EPS and the diluted EPS.

Suggested Solution

AntiDilution Plc

Basic EPS = Earnings

Weighted Av. No. of shares
= 3,500,000
10,000,000

= 35 kobo

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To calculate the diluted EPS, it is necessary to test for the dilutive potentials of the two
convertible securities, one after the other. Thus, incremental EPS of each of the convertible
loan stocks is calculated. If any of them is more than the basic EPS, it is considered anti-
dilutive and will not be included in the computation of the diluted EPS.

Incremental EPS on convertible stock = Interest savings net of tax on convertible stock
No. of shares exchangeable for the convertible
stock

For the 14% loan stock, Incremental EPS = (14% x 2,000,000) x (100% - 35%)
2,000,000/20 x 4
= 182,000
400,000
= 45.5 kobo > 35 kobo (basic EPS)

This implies that the 14% convertible loan stock is not dilutive and will not be factored into
the computation of diluted EPS.

For the 10% loan stock, incremental EPS = (10% x 4,000,000) x (100% - 35%)
4,000,000/10 x 6
= 260,000
2,400,000

= 10.83 kobo < 35 kobo (basic EPS)

The 10% stock is dilutive and will be included in the computation of diluted EPS. Therefore,

Diluted EPS = Earning for basic EPS + post tax int. savings on 10% loan stock)
No. of shares for basic EPS + 2,400,000 shares exchanged for 10% loan stock

= 3,500,000 + 260,000
10,000,000 + 2,400,000

= 30.32 kobo

INTEXT QUESTIONS

1. -----------are financial instruments that give the holder right to purchase ordinary
shares.

2. …………is an agreement to issue shares that is dependent on the satisfaction of

specified conditions

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 IN-TEXT ANSWERS (ITA’s)

5. Options and warrants

6. Contingent shares arrangement

TUTOR MARKED ASSIGNMENT (TMA)

1. As at 31 December, 2017 Erehwon Plc had the following capital structure:
1,000,000 ordinary shares of 50 kobo each fully paid;
200,000 12% irredeemable preference shares of ₦1 each fully paid;
150, 000 10% redeemable preference shares of ₦1 each fully paid; and
350,000 8% non-convertible, redeemable debenture

On 1 January 2018, the directors made a new issue of 400,000 ordinary shares at ₦2 per
share and a further ₦300,000 4% convertible loan stocks on 1 September 2018. The terms of
the issue provide for conversion into ordinary shares as stated below:

On 31 December No. of Ordinary shares per ₦100 of loan stock.

2019 118
2020 125
2021 122

The ordinary shares would rank for dividend in the current year.
The following information are available for current year’s operations:
i. Profit before interest and taxes ₦425,000
ii. Company tax rate 30%
iii. Basic EPS for 2016 24 kobo

Required:
Calculate for the year ended 31 December 2017
a. Basic earnings per share
b. Diluted Earnings per share.
(10 marks)

2. Kappa prepares financial statements to 30 September each year. During the year ended 30
September 2015, Kappa entered into the following transactions –

(i) On 1 September 2015, Kappa sold a machine to a customer. Kappa also agreed to
service the machine for a 2-year period from 1 September 2015 for no additional charge. The
total amount payable by the customer for this arrangement was agreed to be:

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  N800,000, if the customer paid by 31 December 2015.
 N810,000, if the customer paid by 31 January 2016
 N820,000, if the customer paid by 28 February 2016.

The directors of Kappa consider that it is highly probable the customer will pay for the
product in January 2016. The stand-alone selling price of the machine was N700,000 and
Kappa would normally expect to receive N140,000 in consideration for providing two years’
servicing of the machine. The alternative amounts receivable are to be treated as variable
consideration.

(ii) On 20 September 2015, Kappa sold 100 identical items of its product to a customer for
N2,000 each. The item cost N1,600 each to manufacture. The terms of sale are that the
customer has the right to return the goods for a full refund within three months. After a 3-
month period has expired the customer can no longer return the goods and payment becomes
immediately due. Kappa has entered into transactions of this type with this customer
previously and can reliably estimate that 4% of the products are likely to be returned within
the 3- month period.

Required

Explain and show how these two transactions would be reported in the books of Kappa for
the year ended 30 September 2015.

3a. The objective of IAS 36 Impairment of assets is to prescribe the procedures that an
entity applies to ensure that its assets are not impaired.

Required:

Explain what is meant by an impairment review. Your answer should include

reference to assets that may form a cash generating unit.

Note: you are NOT required to describe the indicators of impairment or how
impairment losses are allocated against assets. (5 marks)

b. Telepath acquired an item of plant at a cost of N800,000 on 1 April 2010 that is used
to produce and package pharmaceutical pills. The plant had an estimated residual
value of N50,000 and an estimated life of five years, neither of which has changed.
Telepath uses straight-line depreciation. On 31 March 2012, Telepath was informed
by a major customer (who buys products produced by the plant) that it would no
longer be placing orders with Telepath. Even before this information was known,
Telepath had been having difficulty finding work for this plant. It now estimates that
net cash inflows earned from the plant for the next three years will be:
N’000
year ended: 31 March 2013 220
31 March 2014 180
31 March 2015 170

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 On 31 March 2015, the plant is still expected to be sold for its estimated realisable
value.

Telepath has confirmed that there is no market in which to sell the plant at 31 March
2012. Telepath’s cost of capital is 10% and the following values should be used:

value of N1 at: N
end of year 1 0·91
end of year 2 0·83
end of year 3 0·75

Required:

Calculate the carrying amount of the Plant at 31 March 2012 after applying any impairment
losses. Calculations should be to the nearest N1,000.
(10 marks)

(Total: 15 marks)

SELF-ASSESSMENT QUESTIONS
1. Okeorji Plc had the following loans in place at the beginning and end of 2006:
01/01/06 31/12/06
=N=’000 =N=’000
10% bank loan repayable 2009. 38,200 38,200
8% bank loan repayable 2011 10,800 10,800
5% loan notes repayable 2010 20,000 20,000
15% Debenture repayable 2009 - 25,500

On April 1, 2006 the directors of Okeorji Plc issued 15% debenture to fund the construction
of a qualifying asset (a piece of mining equipment). The construction of the mining
equipment began on 1 July 2006.
On 1 January 2006, the company began the construction of a qualifying asset, a piece of
machinery for a hydro-electric plant, using existing borrowings. Expenditure drawdown for
the construction was: =N=20 million on 1 January 2006 and =N=15 million on 1 September
2006.

Required
(i) What are the borrowing costs to be capitalized for the mining equipment at 31
December 2006?
(ii) What are the borrowing costs to be capitalized for the hydro-electric plant
machine at 31 December 2006?

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 (10 marks)

2. The directors are preparing the published accounts of Dorman Plc for the year to 31
October 2015. The following information is provided for certain of the items which are to be
included in the final accounts:

(i) Plant and machinery: An item of plant was shown in the 2014 accounts at a net book
value of N90,000 (N160,000 less accumulated depreciation of N70,000). The plant
was purchased on 1 November, 2012 and has been depreciated at 25% reducing
balance. The directors now consider the straight line basis to be more appropriate:
they have estimated that at 1 November 2014 the plant had a remaining useful life of
six years and will possess zero residual value at the end of that period.

(ii) Freehold Property: The company purchases a freehold property for N250,000 eleven
years ago, and it is estimated that the land element was worth N50,000 at that date.
The company has never charged depreciation on the property but the directors now
feel that it should have done so; the building is expected to have a total useful life of
40 years.

Required

Explain how each of the above items should be dealt with in the published financial
statements of Dorman Plc (10 marks)s

Module 4 CONTEMPORARY ISSUES IN FINANCIAL REPORTING

Image source: https://evergreensmallbusiness.com/payroll-accounting-rules-for-s-

corporation-shareholder-health-insurance/

Introduction

General Objectives
At the end of this unit, students should be able to:

1. Appraise the need for integrated reporting.

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 2. Discuss the principles governing integrated reporting;
3. Understand the usefulness of management commentaries.
4. Evaluate the reasons for mandatory and voluntary disclosures;
5. Assess the importance of corporate social responsibilities in financial reporting
6. Evaluate the need and techniques of social and environmental accounting.

Unit 1 Integrated Reporting

Introduction

The need to account for every activity of entities that affect and are affected by its significant
public and stakeholders has led to global call for companies to report not only its financial
activities but to include the environmental, social and governance activities in one report to
stakeholders. This unit presents integrated reporting, its fundamental concepts, guiding
pinciples, content elements and benefits.

Specific Objectives
At the end of this unit, students should be able to:

1. Define and explain integrated reporting.

2. Trace the history of integrated reporting as a better option to the traditional annual
report;
3. Discuss the guiding principles that underpin the preparation and presentation of
integrated reporting
4. Mention and explain the content elements of integrated reporting

1.1 Definition

IIRC 2013: An integrated report is a concise communication about how an organization’s

strategy, governance, performance and prospects, in the context of its external environment,
lead to the creation of value over the short, medium and long term. Integrated reporting
brings together material information about an organization’s strategy, governance,
performance and prospects in a way that reflects the commercial, social and environmental
context within which it operates
Eccles and Krzus (2010): A single report that combines the financial and narrative
information found in a company’s annual report with the non-financial, such as
environmental, social and governance (ESG) issues and narrative information found in a
company’s Corporate Social Responsibility or sustainability report.

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King Code for Governance Principles for South Africa (King III)- 2009: describes
integrated reporting as a holistic and integrated representation of the company’s performance
in terms of its finance and sustainability.
Drunkman, (2012): A market-led initiative, driven by business and investor needs to gain
greater insights into how a company’s strategy creates value over the short, medium and
long-term.

Integrated reporting is situated at the interception between strategy, financial performance,

governance, social, environmental and economic pillars so that stakeholders can have a
complete picture of the organization’s financial and non-financial performance.

1.2 Objectives of Integrated Reporting (IR).

The primary purpose of an integrated report is to explain to providers of financial capital how
an organization creates value over time.

Integrated Reporting therefore aims to:

 Improve the quality of information available to providers of financial capital to enable

a more efficient and productive allocation of capital;
 Promote a more cohesive and efficient approach to corporate reporting that draws on
different reporting strands and communicates the full range of factors that materially
affect the ability of an organization to create value over time;
 Enhance accountability and stewardship for the broad base of capitals (financial,
manufactured, intellectual, human, social and relationship, and natural) and promote
understanding of their interdependencies; and
 Support integrated thinking, decision-making and actions that focus on the creation
of value over the short, medium and long term.

Note: Integrated thinking takes into account the connectivity and interdependencies between
the range of factors that affect an organization’s ability to create value over time, including:
 The capitals that the organization uses or affects, and the critical interdependencies,
including tradeoffs, between them;
 The capacity of the organization to respond to key stakeholders’ legitimate needs and
interests;
 How the organization tailors its business model and strategy to respond to its external
environment and the risks and opportunities it faces;
 The organization’s activities, performance (financial and other) and outcomes in
terms of the capitals –past, present and future.

Motivation for IR

In current reporting practice:

 Only providers of capital and managers assume relevant;
 Financial information are available but not coherent and properly linked with
environmental, social and governance (ESG) issues all of which are necessary in
creating value for the stakeholders;

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  More focused approach needed that identifies the issues that affect performance and
value and the actions that are being taken to address them;
 Only through the integration of ESG factors can connection between strategic
direction, financial performance and sustainability impacts be made clear.

1.3 Emergence and Evolution of IR

A Danish company Novozymes, is generally considered the first company to issue an

integrated report in 2002. Other early adopters include:
 Novo Nordisk- also a Danish company in Diabetes care business (2004);
 Natura – a Brazilian company in cosmetics business (2008);
 Philips – a Dutch company in health care and lighting business (2008).
 United Technologies- American company in diversified manufacturing business
(2008)
 American Electric power (power generation), PepsiCo (Soft drink) and South West
Airline (Airline business) all joined in 2009.

The King Report on Governance for South Africa in 2009 (King 111)- Committee lead by
Professor Mervyn King, University of South Africa- recommended that organizations
produce integrated reports connecting material financial and sustainability information.
From March 1, 2010, submission of SIR became a requirement for South African companies
listed on the Johannesburg Securities Exchange.

1.4 The International Integrated Reporting Council (IIRC) and the IR Framework

The International Integrated Reporting Council (IIRC) was previously (the International
Integrated Reporting Committee) which began late 2009 as a coalition of organizations
including the Global Reporting Initiative (GRI), The Prince’s Accounting for Sustainability
Project (A4S), International Federation of Accountants (IFAC,) International Accounting
Standards Board (IASB,) Financial Accounting Standards Board(FASB), United Nations
Environmental Programme Finance Initiative, UN Global Compact, Carbon Disclosure
Standards Board (CDSB), International Organization of Securities Commissions (IOSC), and
the World Business Council for Sustainable Development (WBCSD). This coalition shares
the view that communication about value creation should be the next step in the evolution of
corporate reporting.
In July 2010, this Committee became the IIRC.

The Mission of IIRC

“To create a globally accepted integrated reporting framework which brings together
financial, environmental, social and governance information in a clear, concise, consistent
and comparable format. The aim is to help with the development of more comprehensive and
comprehensible information about organisations, prospective as well as retrospective, to meet
the needs of a more sustainable, global economy.”

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The principal role of the IIRC is to:

1. reach a consensus among governments, listing authorities, business, investors,

accounting bodies and standard setters for the best way to tackle the challenges of
Integrated Reporting
2. identify priority areas where additional work is needed and provide a plan for
development
3. develop an overarching Integrated Reporting framework, which sets out the scope and
key components of Integrated Reporting
4. consider whether standards in this area should be voluntary or mandatory
5. promote the adoption of Integrated Reporting by relevant regulators and report
preparers.

The IIRC Framework

The Framework was issued by IIRC on 8 December 2013.

Purpose:

(i) to establish Guiding Principles and Content Elements that govern the overall
content of an integrated report and
(ii) to explain the fundamental concepts that underpin them.

Thus, the framework:

 Identifies information to be included in an integrated report

 Is written primarily in the context of private sector, for-profit companies of any size;
but
 could also be applied, adapted as necessary, by public sector and not-for-profit
organizations.

Structure of the Framework

The Framework adopts a principles-based approach - tries to strike an appropriate balance

between flexibility and prescription without sacrificing comparability. Specific key
performance indicators, measurement methods, or the disclosure of individual matters are not
prescribed. Thus, an IR may be prepared in response to existing compliance requirements and
may be either a standalone report or be included as a distinguishable, prominent and
accessible part of another report or communication.

Framework falls into three categories:

1. Fundamental Concepts

The framework highlights three concepts that are fundamental in every Integrated report.
These are:

 Value creation
 The capitals
 The value creation process.

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Value Creation

The process that results in increases, decreases or transformations of the capitals caused by
the organization’s business activities, interactions, relationships and outputs.

The capitals

Stocks of value on which all organizations depend for their success as inputs to their business
model, and which are increased, decreased or transformed through the organization’s
business activities and outputs. For example, an organization’s financial capital is increased
when it makes a profit, and the quality of its human capital is improved when employees
become better trained. The capitals may equally be seen as the resources and the relationships
used and affected by the organization

The capitals are categorized into:

1. Financial capital – The pool of funds that is available to an organization for use in the
production of goods or the provision of services. They may be obtained through
financing, such as debt, equity or grants, or generated through operations or
investments.
2. Manufactured capital – Manufactured physical objects (as distinct from natural
physical objects) that are available to an organization for use in the production of
goods or the provision of services, including buildings, equipment, infrastructure e.g.
roads, ports, bridges etc
3. Intellectual capital – Organizational, knowledge-based intangibles, including
intellectual property, such as patents, copyrights, software, rights and licences as well
as “organizational capital” such as tacit knowledge, systems, procedures and
protocols.

4. Human capital – People’s competencies, capabilities and experience, and their

motivations to innovate, including their:
 alignment with and support for an organization’s governance framework, risk
management approach, and ethical values;
 ability to understand, develop and implement an organization’s strategy;
 loyalties and motivations for improving processes, goods and services, including
their ability to lead, manage and collaborate.
5. Social and relationship capital – The institutions and the relationships within and
between communities, groups of stakeholders and other networks, and the ability to
share information to enhance individual and collective well-being. Social and
relationship capital includes:
 shared norms, and common values and behaviours;
 key stakeholder relationships, and the trust and willingness to engage that an
organization has developed and strives to build and protect with external
stakeholders
 intangibles associated with the brand and reputation that an organization has
developed;
 an organization’s social licence to operate
6. Natural capital – All renewable and nonrenewable environmental resources and
processes that provide goods or services that support the past, current or future
prosperity of an organization. It includes air, water, land, minerals and forests as well
as biodiversity and eco-system health.
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An integrated report may not cover all capitals – the focus is on capitals that are relevant to
the entity. This would depend on the industry and size of the entity. Again, Capitals are
interrelated and tradeoffs are likely to occur and some types of capitals are more important
than others. An analysis of the correlation between capitals and stakeholder impacts
(dependencies) helps to set boundaries for IR

The Value Creation Process

Three factors drive the value creation process: the entity’s business model, the external
environment and the governance (oversight) structure.

At the core of the value creation process is an entity’s business model. Business model is an
organization’s system of transforming inputs through its business activities into outputs and
outcomes that aims to fulfill the organization’s strategic purposes and create value. The
model draws on various capitals and other business activities to create outputs (products,
services, by-products, waste) over the short, medium and long term. Also affecting the value
creation process are the external environment (economic conditions, technological change,
societal issues and environmental challenges) and appropriate oversight structure created by
those charged with governance to support the entity’s ability to create value.

2. Guiding Principles

The framework defines the under-listed guiding principles which underpin the preparation
and presentation of an integrated report:

 Strategic Focus and Future Orientation

An IR should provide information into the organization's strategy and how it relates
to the company's ability to create value in the short, medium, and long term and to its
use of and effects on the capitals.

Adopting a strategic focus and future orientation includes:

 clearly articulating how the continued availability, quality and affordability
of significant capitals contribute to the organization’s ability to achieve
its strategic objectives in the future and create value.
 Highlighting significant risks, opportunities and dependencies flowing from
the organization’s market position and business model.

 Connectivity of Information
A holistic picture should be shown of the combination, interrelatedness, and
dependencies between the factors that affect the organization's ability to create value
over time e.g. linking the organization’s strategy and business model with changes in
its external environment, such as increases or decreases in the pace of technological
change, evolving societal expectations, and resource shortages.

 Stakeholder Relationships

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 An integrated report should provide insight into the nature and quality of the
organization’s relationships with its key stakeholders, including how and to what
extent the organization understands, takes into account and responds to their
legitimate needs and interests. For example, the capitals are provided by either inside
stakeholders or outsiders, and accountability and stewardship impose the
responsibility on an organization to care for, or use responsibly, the capitals that its
activities and outputs affect.
 Materiality
Information should be disclosed about matters that substantively affect the
organization's ability to create value over the short, medium, and long term. Material
matters to be disclosed encompass both positive and negative matters, including risks
and opportunities and favourable and unfavourable performance or prospects,
financial and non- information.

 Conciseness
The report should be concise

 Reliability and Completeness

All positive and negative matters should be included in a balanced way and without
error.
The reliability of information is affected by its balance and freedom from material
error. Reliability (often called faithful representation) is enhanced by robust internal
control and reporting systems, stakeholder engagement, internal audit or similar
functions, and independent, external assurance.

 Consistency and Comparability

Information should be presented
(a) on a consistent basis over time and
(b) in a way that it can be compared with other organizations to the extent it is
material to the organization’s own ability to create value over time.

3. Content Elements

Eight content elements- fundamentally linked to each other and not mutually exclusive.
1) Organizational Overview and External Environment: Information on what the
organization does and the circumstances under which it operates.

2) Governance: Information on how the organization’s governance structure supports

its ability to create value.

3) Business model: Information on an organization’s system of transforming inputs

through its business activities into outputs and outcomes that aims to fulfill the
organization’s strategic purposes and create value over the short, medium and long
term.

4) Risks and opportunities: Information on the specific risks and opportunities that
affect the organization’s ability to create value and how the organization is dealing
with them.

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 5) Strategy and Resource Allocation: A description of where the organization wants to
go and how it intends to get there.

6) Performance: Information on the extent the organization has achieved its strategic
objectives for the period and its outcomes in terms of effects on the capitals.

7) Outlook: Information on the challenges and uncertainties the organization is likely to

encounter in pursuing its strategy and the potential implications for its business model
and future performance.

8) Basis of preparation and Presentation: How the organization determines what

matters to include in the integrated report and how such matters are quantified or
evaluated.

General Benefits of IR

1. More efficient capital allocation

2. Streamlined reporting processes
3. Reduced reporting costs and
4. Enhanced organizational clarity in terms of business strategy and the business model
5. Better organization reputation

General Reporting Guidance

The following general reporting matters are relevant to various Content Elements:

Disclosure of material matters:

 Key information, such as an explanation of the matter and its effect on the
organization’s strategy, business model or the capitals need be disclosed.
 If there is uncertainty surrounding a matter, disclosures about the uncertainty, such as
an explanation of the uncertainty; the range of possible outcomes, associated
assumptions, and how the information could change if the assumptions do not occur
as described, the volatility, certainty range or confidence interval associated with the
information provided
 If key information about the matter is considered indeterminable, disclosure of that
fact and the reason for it.
 If significant loss of competitive advantage would result, disclosures of a general
nature
about the matter, rather than specific details.

Disclosures about the capitals: Disclosures about the capitals, or a component of a capital:
 Are determined by their effects on the organization’s ability to create value over
time, rather than whether or not they are owned by the organization.
 Include the factors that affect their availability, quality and affordability and the
organization’s expectations of its ability to produce flows from them to meet future
demand. This is particularly relevant with respect to capitals that are in limited
supply, are non-renewable, and can affect the long term viability of an organization’s
business model.

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When it is not practicable or meaningful to quantify significant movements in the capitals,
qualitative disclosures are made to explain changes in the availability, quality or affordability
of capitals as business inputs and how the organization increases, decreases or transforms
them. It is not, however, necessary to quantify or describe the movements between each of
the capitals for every matter disclosed.

1.5 Time frames for short, medium and long term:

The future time dimension to be considered in preparing and presenting an integrated report
will typically be longer than for some other forms of reporting. The length of each time frame
for short, medium and long term is decided by the organization with reference to its business
and investment cycles, its strategies, and its key stakeholders’ legitimate needs and interests.
There is, therefore, no set answer for establishing the length for each term.

Time frames differ by:

 Industry or sector (e.g., strategic objectives in the automobile industry typically cover
two model-cycle terms, spanning between eight and ten years, whereas within the
technology industry, time frames might be significantly shorter).
 The nature of outcomes (e.g., some issues affecting natural or social and relationship
capitals can be very long term in nature).

Note: The length of each reporting time frame and the reason for such length might affect the
nature of information disclosed in an integrated report. For example, because longer term
matters are more likely to be more affected by uncertainty, information about them may be
more likely to be qualitative in nature, whereas information about shorter term matters may
be better suited to quantification, or even monetization.

1.6 Aggregation and disaggregation

Each organization determines the level of aggregation (e.g., by country, subsidiary, division,
or site) at which to present information that is appropriate to its circumstances. This includes
balancing the effort required to disaggregate (or aggregate) information against any added
meaningfulness of information reported on a disaggregated (or aggregated) basis.

In some circumstances, aggregation of information can result in a significant loss of meaning

and can also fail to highlight particularly strong or poor performance in specific areas. On the
other hand, unnecessary disaggregation can result in clutter that adversely affects the ease of
understanding the information.

The organization disaggregates (or aggregates) information to an appropriate level

considering, in particular, how senior management and those charged with governance
manage and oversee the organization and its operations. This commonly results in presenting
information based on the business or geographical segments used for financial reporting
purposes.

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IN-TEXT QUESTIONS (ITQ’s)

3. Three factors drive the value creation process: the entity’s business model, the
external environment and………………….
4. The IIRC framework highlights three concepts of value creation, capital
and……….

IN-TEXT ANSWERS (ITA’s)

7. the governance (oversight) structure

8. the value creation process.

UNIT 2 MANAGEMENT COMMENTARIES AND ACCOUNTING

DISCLOSURES

Specific Objectives
At the end of this unit, students should be able to:

1. Define and explain what management commentaries.

2. Discuss the information content of management commentaries
3. Explain the difference between mandatory and voluntary disclosures;
4. State the motivations for making voluntary disclosures by entities;

MANAGEMENT COMMENTARIES

2.1 Definition and Purpose of Management Commentaries

‘Management commentary’ is additional information about an entity that complements the
information provided in the financial statements of an entity.
Two important features of management commentary are that:
 it is provided by management, and expresses the view of the management of the
entity;
 it is a commentary; therefore much of it is in a narrative form.

Definitions:
The Canadian Accounting Standards Board defined Management Commentary as a narrative
explanation, through the eyes of management, of how your company performed during the
period covered by the financial statements and of your company’s financial condition and
future prospects.

Management commentary is defined by the IFRS Practice Statement (PS) as a narrative

report accompanying financial statements prepared in accordance with IFRSs that provides
users with historical and prospective commentary on the entity’s financial position, financial
performance and cash flows and a basis for understanding management’s objectives and
strategies for achieving those objectives.

2.2 IFRS Practice Statement on Management commentary

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IFRS Practice Statement is a non-mandatory document that sets out guidelines to be followed
by companies who wish to or are required to produce a management commentary in
accordance with IFRS. The guidance is intended to provide a basis for the development of
good management commentary. It offers a non-binding framework which could be adapted to
the legal and economic circumstances of individual jurisdictions.

The PS prescribes a framework for the preparation and presentation of management

commentary to assist management in preparing decision-useful management commentary to
accompany financial statements prepared in accordance with IFRS. Management
commentary may help users to understand:

 the entity’s risk exposures, its strategies for managing risks and the effectiveness of
those strategies
 how resources that are not presented in the financial statements could affect the
entity’s operations
 how non-financial factors have influenced the information presented in the financial
statements.

Management commentary should:

 provide management’s view of the entity’s performance, position and development

 supplement and complement information presented in the financial statements; and
 be orientated to the future.

2.3 The main focus of Management commentaries, that is, the information
content/elements of management commentary are:

(i) the nature of business The knowledge of the business in which a company/ entity
engages in and the external environment a business operates will enable the users to have
further information about an entity and how it works.

(ii) Objectives & strategies

It provides readers of commentaries in financial statements opportunity to assess the
strategies adopted by the entity and the likelihood that those strategies will be successful in
meeting management’s stated objectives.

(iii) Resources, risks & relationships

This is a basis for determining the resources available to the entity as well as obligations to
transfer resources to others. The ability of the entity to generate long term sustainable net
inflow of resources and the risks to which those resources generating activities are exposed,
both in the near and in the long-term will be of benefit to the users.

(iv) Results and prospect

Users of financial statements would also need to understand whether an entity has delivered
in line with expectations and, implicitly, how well management has understood the entity’s
market, executed its strategy and managed the entity’s resources, risks and relationships.

(v) Performance & measures

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Users should be able to focus on critical performance measures and indicators that
management uses in assessing and managing the entity’s performance against stated
objectives & strategies.

2.4 Mandatory and Voluntary Disclosures

Disclosures may be a mandatory requirement of the law or other regulations, or they may be
provided as voluntary disclosures by a company. In practice, the disclosures by a company
are likely to be a mixture of mandatory and voluntary disclosures.

The nature and amount of mandatory disclosures depends on the laws and regulations of the
country. Some disclosures are required by law. For example, companies are required to
prepare an annual report and accounts, and present these to the shareholders. Company law
specifies what the directors’ report and the accounts must contain, and in addition other
regulations about content apply such as the requirements of financial reporting standards.

Some other disclosures are required by stock market rules. For example, the SEC rules
require listed companies to provide information relating to corporate governance and a
chairman’s report in their annual report and accounts. There are also stock market rules about
other announcements by the company, such as profit warnings and announcements of
proposed takeovers.

Voluntary Disclosures
In addition to the mandatory disclosures required by law or regulation, many companies
provide additional information, as part of their normal reporting cycle. Typically, these
include
 an operating and financial review;
 a social and environmental report;
 corporate social responsibility report;
 financial summaries;
 details of key performance indicators (KPIs).

Reasons Why Companies make voluntary disclosures

A company might make voluntary disclosures for such reasons as:

 Providing information as a public relations or marketing exercise, to present ‘good
news’ about the company to investors and other users of the company’s published
reports.
 providing information on a voluntary basis might persuade the government or
financial service regulator that compulsory disclosures and regulation are not
necessary.
 companies might publish social and environmental reports out of a genuine ethical
and cultural belief in the responsibilities of the company to society and the
environment. If a company believes that it has social and environmental
responsibilities, publishing a report on these issues is a way of making itself
accountable.
 a company might use voluntary disclosures as a way of improving communications
with its shareholders. By giving more disclosures to shareholders, companies might

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 encourage shareholders to respond, and enter into a dialogue with the company about
its strategies and plans for the future.

The main limitations of information provided on a voluntary basis are that:

 the company can decide what to include in the report and what to leave out;
 The information is often presented in a very positive form, as public relations for
investors, and might not be entirely reliable.

IN-TEXT QUESTIONS (ITQ’s)

5. ……………is a narrative explanation, through the eyes of management, of how

your company performed during the period covered by the financial statements
and of your company’s financial condition and future prospects.

6. ……………is information reflected in the financial statement of an entity in

line with the requirements of accounting standards and law of the nation.

IN-TEXT ANSWERS (ITA’s)

9. Management Commentaries
10. Mandatory disclosure.

TUTOR MARKED ASSIGNMENT

1(a) There has been a growing acceptance that using traditional financial reporting as the sole
measure of a company’s performance and financial standing is a flawed approach. Financial
reports are historical in nature, providing little information on the future potential of a company.
Corporate sustainability reports help to fill this gap, but are not often linked to a company’s
strategy or financial performance, and provide insufficient information on value creation.
Businesses need a reporting environment that allows them to explain how their strategy drives
performance and leads to the creation of value over time.

In the light of this the International Integrated Reporting Council (IIRC) has developed and
published The International <IR> Framework to provide a foundation for the development of
integrated reports.

Required:
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i). With reference to the framework, explain an integrated report. (5 marks)

ii) Briefly discuss the content elements of an integrated report. (12 marks)
UNIT 3 CORPORATE SOCIAL RESPONSIBILITIES

Introduction
This unit explores the corporate social responsibility (CSR) debate, theories underpinning
CSR and the reasons why companies should assume responsibility for their actions and
activities in the environment.

Specific Objectives
At the end of this unit, students should be able to:

1. Define and explain the difference between CSR and ethics;

2. Explain the responsibilities of entities to the society they serve;
3. Discuss the relevant theories that support CSR;

Preamble

This is variously referred to as Corporate Citizenship, corporate responsibility or

corporate social performance. It functions as a self-regulating mechanism, inbuilt in a
business model, under which the business monitors and ensures that it complies with
laws, international norms and best practices as well as ethical prescriptions. Within the
corporate citizenship framework, a business avoids harmful activities as well as assumes
responsibility for the impact of its activities on the environment, employees, consumers,
communities and other stakeholders and members of the public.

CSR and Ethics

Both concepts are related in that part of the concern of business ethics is dealing with the
challenge of being socially or morally responsible, either as an organization or an
individual in an organization.

Rights, Obligations and Responsibilities

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 Every ‘right’ has an opposing or corresponding ‘obligation’ either on the one that enjoys
the right or on the one upon whom the right is exercised. For example, a right by a
community to enjoy an unpolluted environment imposes an obligation on companies
within the area to avoid environmental pollution. In this regard, the factories have the
responsibility to maintain an unpolluted environment for the interest of the community.

Responsibilities could be direct or indirect.

a. Direct Responsibilities

Direct responsibilities are either internal direct responsibilities or external direct

responsibilities.

i. Internal Direct Responsibility

This encompasses an organization’s responsibility to create, maintain and control

such working environments that will enhance its mission, corporate culture and
objectives as well as the well-being of employees. Internal direct responsibilities
include providing a safe working environment, fair working practices, good
compensation and staff development schemes, individual autonomy within the
organization etc.

ii. External Direct Responsibility

These are responsibilities organizations owe to their consumers and the local
community. These include safe and variety of products as well as information about
the products (origin and composition of the products) that will enable buyers make
informed decisions and choices. Companies should have the obligation to withdraw
from circulation, contaminated and expired products or even inform consumers about
such. To the community they have the obligation to ensure safe and unpolluted
environment and other environmental degradation and hazards as well as paying
compensation for environmental damage in the community.

b. Indirect Responsibilities

These are social responsibilities companies assume outside the main sphere of the
companies’ control/activities. It may include assisting in cleaning up environmental
pollution not caused by the company just for the interest of the community or even
lobbying and influence government to provide facilities and social services to local
communities where they are located.

Corporate Social Responsibility and Moral Responsibility

CSR refers to the responsibilities companies assume for the impact of their activities
on various stakeholders such as customer, suppliers, employees, shareholders,
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communities as well as the environment and society at large. Socially responsible
organizations strive to maximize the positive effects of their activities on its
stakeholders while minimizing the negative effects.

CSR thus is defined generically as the integration by companies of social and

environmental concerns in their business operations and in the interaction with their
stakeholders on a voluntary basis (The European Commission)

Moral Responsibility connotes acceptance of the outcomes of one’s intentional acts.

This implies that one was not forced to act but rather acted based on one’s choice.

The Corporate Social Responsibility Debate

The Shareholder Theory

This theory posits that the central concern of business organizations is the investors
(the shareholders) whose interests and property rights must be protected. Thus, it
tends to imply that shareholders are the only legal stakeholders of any organization as
a result of their investments. The proponents of this theory and their views are
highlighted below:

Adolph A. Berle: Organizations exist for the purpose of creating benefits for the
shareholders. Thus all powers granted to a company are exercisable for the ratable
benefits of all shareholders based on their interests (quantum of investments).

Friedman Milton supports this view and argued that companies should pursue their
economic self-interest. For Milton, companies have only one social responsibility and
that is to use all its resources to engage in economic activities geared towards
maximizing profits for the shareholders. He argued further that it will amount to
moral wrong if companies attempt to pursue CSR, since this falls to the jurisdiction of
government.

Frederick Hayek is of the view that organizations are the private properties of the
shareholders. Thus every business organization must aim at maximizing profits to
enhance shareholder value. He believes that efficient economic activities and
outcomes are attained when organizations pursue their self-interest.

Central to the Shareholders theory is the idea that managers have a fiduciary duty to
act in the interest of shareholders to maximize the return on their investment without
any direct concern to the well-being of society. According to the proponents,
(foremost among whom was Adam Smith), it is only when businesses are profitable
and stable that they can provide good and satisfying service to consumers through
which societal well-being will indirectly be more positively impacted than when a
visible hand(government intervention) try to force enterprises to bring about social

220
benefits to the society. Business can achieve same result if they pursue their self-
interest without the intent to benefit the society. This is the idea behind Adam Smith’s
‘invisible hand’.

The Stakeholder Theory

This theory suggests that there multiple groups that have interest/stake in the
operation of any organization. The needs of all these groups should be met by the firm
and thus management ought to consider their interests in decision making. This
implies redefining the purpose of the firm to include promoting the overall interest
and welfare of all stakeholders. Thus, stakeholder theory attempts to justify the
provision of social information and benefits in order to gain stakeholder support and
thus minimize the costs of dealing with complaints and actions that might negatively
affect firms.

Some of the proponents of Stakeholder theory and their views include:

Merric Dodd: Dodd believes that a firm, though an economic institution, has both
social service and profit making functions. The focus and purpose of firms and their
managers should be more job security and better conditions of service for employees,
better quality products for customers and contributions to the well-being of the
community as a whole.
John Mackey: Argued that every enlightened organization should strive to create
value for all its constituencies which include customers, employees, suppliers,
shareholders and the community. Each of these stakeholders deserves different forms
of valid and legitimate benefits in their relationship with the firm.
Werhane and Freeman (1997): Are of the view that companies may be accountable
to any person or organization affected by their activities or otherwise having a right to
information about them. Stakeholder rights in this regard can be considered in terms
of three different ‘logics’ or moral view-points. These view-points are interest-based,
rights-based and duty-based.
An interest-based analysis assesses the consequences of actions and policies solely in
relation to parties with direct interest in those actions. It thus encompasses self-
interest, group interest and the concept of utilitarianism. The central theme of ‘rights-
based’ analysis is that rights protection should supersede interest satisfaction and that
the most rights to be protected are the rights of fair distribution of opportunities and
wealth and rights to basic freedom or liberties. The third logic in stakeholder theory,
the duty-based analysis, is governed by the ethical concept of duty or responsibility
to communities rather than individuals. It is thus concerned with the ideals of fidelity
and loyalty.
Caroll Archie (1979): Archie attempted to “embrace businesses’ legitimate economic
or profit making function with responsibilities that extend beyond the basic economic
role of the firm”. Along this line of thinking, she proposed her ‘four part model of
corporate social responsibility’, highlighting that firms have four responsibilities to
fulfill to the society and these are legal, ethical, economic and discretionary(or
philanthropic).

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 Legal responsibility – Corporate bodies are expected to obey the laws and
regulations of government which are intended to set minimum standards for
responsible behavior. These include laws against unfair competition and pricing
practices, laws protecting the consumer and the environment as well as health and
safety of stakeholders etc.
The ethical dimension–refers to behaviours and activities that are expected or
prohibited by members of the organization, the local community and society, even
though there may not be laws requiring these behaviours.
The economic dimension- relates to distribution of resources within the system. The
investors naturally have a primary influence on management decisions since
maximization of returns on their investment is a primary objective.
Philanthropic responsibility–this relates to giving back to society part of the benefits
the organization have derived from it. Businesses are expected to contribute to the
quality of life and welfare of society and the local community.
Archie believes that both profit maximization and social concerns should be the focus
of businesses.
The stakeholder theory has been acclaimed to be a balanced theory that should guide
the relationship of corporate bodies with its significant public. The provision of
benefits to, as well as information and communication with, all stakeholders is
important to organizations as they help to address problems before they become
insoluble.

Why Firms have responsibilities

i. Companies activities have social impacts, whether through the provision of products
and services, the employment of workers and suppliers etc. These impacts may be
positive or negative and companies cannot escape responsibility for them.

ii. Companies rely on the contributions of wider stakeholders beyond just

shareholders and hence have a duty to take into account the interest and goals of these
wider stakeholders in their decision making and operations.

iii. Companies cause social problems, e.g. pollutions, environmental degradation etc
and thus have responsibility to solve the problems they cause or prevent such social
problems from arising.

iv. Many companies are powerful social actors, with substantial resources, and thus
have moral/ethical responsibility to use their power and resources responsibly in
society.

IN-TEXT QUESTIONS (ITQ’s)

7. ……………is a self-regulating mechanism, inbuilt in a business model, under

which the business monitors and ensures that it complies with laws,
international norms and best222
practices as well as ethical prescriptions.

8. …………… believes that organizations exist for the purpose of creating

benefits for the shareholders.
 IN-TEXT ANSWERS (ITA’s)

11. Corporate Social Responsibilities

12. Adolph A. Berle

UNIT 4 SOCIAL AND ENVIRONMENTAL ACCOUNTING

Introduction

In this unit, you will be put through on the concept of social and environmental accounting
and its proponents. The unit goes further to explore the underlying theories of social and
environmental accounting. Some of the concepts of environmental management accounting
are examined and the differences between environmental management accounting and cost
accounting are highlighted. It is advisable to pay attention to the illustrations given in the
unit.

Specific Objectives
At the end of this unit, students should be able to:

1. Define and explain what social accounting.

2. Explain the theories relating to social and environmental accounting;
3. Explain environmental management accounting.
4. Explain the corporate social audit;
5. State the differences between environmental management accounting and cost
accounting;

4.1 Social Accounting

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Social Accounting and reporting is concerned with the voluntary identification and disclosure
of information about the relationship of an organization with its employees, its local
community and society in general. It is also called social and environmental accounting or
sustainability accounting.

Gray, Owen and Maunders (1987) defined corporate social reporting as the process of
communicating the social and environmental effects of organizations’ economic actions to
particular interest groups within society and to society at large. It involves extending the
accountability of organizations beyond the traditional role of providing financial accounts to
owners of capital.

Crowther (2000)defines social accounting as an approach to reporting a firm’s activities

which stresses the need for the identification of socially relevant behavior, the determination
of those to whom the company is accountable for its social performance and the development
of appropriate measures and reporting techniques.

Social accounting broadens the scope of conventional accounting by:

a. dealing with more than only economic issues;

b. not being solely expressed in financial terms;
c. being accountable to a broader collection of stakeholders; and
d. broadening its purpose beyond reporting financial success.

Theories of Social and Environmental Accounting

The concept of accountability requires that organizations be accountable for the often
unintended and unacknowledged moral, social and environmental consequences of their
pursuit of economic objectives. In this regard, some theories have come up to explain why
companies are engaging in the provision of social information. These are stakeholder theory,
legitimacy theory and political economy theory.

Stakeholder Theory

As highlighted in section 1.2 (CSR debate) above, any organization has multiple interest
groups and the success of an organization depends on its ability to balance the conflicting
demands of its various stakeholders. These stakeholders not only want to be part of the
distribution of resources but also demand to have information on the activities of the
company that impact on them in one way or the other. In response to this theory, there is
pressure on companies to adopt the triple bottom line reporting in order to capture, for the
benefit of stakeholders, the economic(financial), social and environmental performance of the
companies. The intention is to demonstrate to the stakeholders that the business is adopting
sustainable business practices.

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Legitimacy theory

This is based on the notion of a social contract, express or implied, between an organization
and the community. The view of this theory is that companies are created by corporation law
enacted by the representatives of the public in parliament, and thus there is an indirect social
contract between a company and the general public. Therefore, organizational legitimacy
derives and depends on social and political support and the survival and growth of companies
depend on their delivering some socially desirable ends. It is expected that companies will
deliver benefits to the groups from which they derive their power and that their activities will
not be socially harmful. For example, companies do form associations with highly respected
community and charitable organizations and/or through sponsorship of events and sporting
activities.

To legitimize their operations therefore, companies need to provide information on their

social effects and adopt a broader concept of accounting and accountability.

Political Economy theory

The political economy of accounting argues that the economic domain cannot be considered
in isolation from the environment within which economic transaction are undertaken. Thus,
accounting reports should be seen as social, political and economic documents.

4.2 Environmental Management Accounting

Some of the techniques used by companies to determine the social and environmental impact
of their activities include:

a. Full Cost Accounting: The cost of production is added to social and environmental
management costs and the total divided by the number of units produced to get the unit cost
(cost per unit).

Illustration

Adax Petroleum produced 3 million barrels of crude oil in 2012. The cost of production
amounted to US$10.5 million. However the company incurred the following expenditure in
social and environmental matters:

Community affairs $30,000

Scholarship awards $25,000
Oil spill clean- up $105,000
Sponsorship of sporting activities $20,000.

Required:
Determine the Full cost per barrel of crude produced by the company in 2012.

Ans: $3.56 per barrel

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b. Eco-Accounting(Total Cost Assessment, TCA): All related environmental impact costs
are put together and divided into the units produced or service rendered. The smaller the cost
per unit, the more eco-efficient the effort of the company is in handling environmental
impact.

Note: Eco-efficiency refers to the reduction of resource and energy utilization and waste
production per unit of product or service.

c. Life Cycle Costing (LCC): LCC is a systematic approach for estimating the
environmental consequences, energy and resource usage associated with a project, process or
operation throughout all usages of the life cycle. This technique seeks to optimize the use of
cost and works on the logic of cost minimization. All costs, including environmental
management costs, are identified and summed up. The estimated useful lives of fixed assets
to be bought and the cost of capital are determined. The costs are discounted and the project
with the least discounted cost is regarded as more economical.

Illustration

Two Process Plants, A & B, are being considered, one of which is to be chosen. Plant ‘A’
will cost N25million while Plant ‘B’ will cost N20million. The estimated lives of the Plants
are 3 years each. The annual maintenance costs of the Plants are:

A B

N’000 N’000

Fuel and lubricants 7,000 12,500

Salaries and wages 5,000 10,000
Environmental expenses 4,000 6, 000

16,000 28,500

Required:

Assuming 20% cost of capital, determine which project to be chosen

Suggested Solution

Project A.

Year Cashflows Disc. Factor PV

N’000 N’000
0 (25,000) 1.0000 (25,000)
1–3 (16,000) 2.1064 (33,702)
(58,702)

Project B

Year Cashflows Disc. Factor PV

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 N’000 N’000

0 (20,000) 1.0000 (20,000)

1–3 (28,500) 2.1064 (60,032)

(80,032)

Project A is recommended since it has the lower cost.

Matthews (1993) posited 3 broad methods of Social and environmental accounting. These are

a. Total impact accounting – refers to attempts to measure in monetary terms, the total cost
of running an organization in its existing form. The total costs may be divided between
private(internal costs) e.g raw materials, labour costs and overheads, and public
costs(external costs or externalities) e.g costs of health problems caused by emissions from
industrial processes. According to Matthews, the difficulty in implementing total impact
accounting relates to the identification, measurement and valuation of externalities to enable
their disclosure in the financial statements.

b. Socio-economic accounting: This is more suitable to the public sector and can be related
to the concept of cost-benefit analysis. It concerns itself with the micro-approach to the
problems of project selection, operation, control and evaluation. The method is used in
making decisions about the effectiveness and efficiency of public funded activities in the
absence of market prices for outputs. The main limitation of this method is that inputs may be
measured in financial and nonfinancial terms, but outputs will often be limited to
nonfinancial values such as employable school leavers, discharged patients, university
graduates etc.

and

c. Social indicators accounting: can be applied at macro level, where the objectives of a
social system are to have , for example, a healthier, wealthier and better educated population
and where progress towards the objective can be measured. Performance indicators are
developed in relation to the objectives to be achieved, and performance measured against
them.

4.2.1 Environmental Management Accounting and Environmental Cost Accounting

Environmental Management Accounting (EMA)

Bartolomeo (2000):EMA is the generation, analysis and use of financial and related non-
financial information to support management within a company or business. It involves the
production, analysis and appropriate application of costing, financial and statistical data in
proactively managing a company’s environmental issues.

Environmental Cost Accounting (ECC)

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ECC targets at attaching costs to their specific causes. Thus, the technique directly allocates
every environmental cost to its immediate cause or source e.g Oil spill or pollution. ECC
helps to eliminate or reduce the arbitrary allocation of environmental overhead, to enable the
true cost of products or service to be ascertained.

Minimizing the threats of Social costs and Liabilities

The following measures have been suggested to minimize threats of social costs and
liabilities:

i. Introduction and consolidation of principles and practice of good corporate governance that
embraces CSR and maximization of stakeholders’ interests.

ii. Optimising production processes and costs in such a way that environmental costs will be
minimized.

iii. As good corporate citizens, companies should observe laws on environmental

management and collaborate with relevant agencies in preserving the environment.

iv. Industrial wastes and discharges should be minimized and properly managed.

v. Companies should have teams for assessing environmental impacts and costs.

4.2.3 Corporate Social Audits

A social audit is a process of measuring the socially responsible activities of an organization

to determine their impact on the wider community. Social audits thus monitors, measures and
appraises socially responsible performance.

Canadian ethics audits have 6 components: Values-based standard setting, Document review,
Benchmarking, Environmental scan, Multi-stakeholder surveys, action-enabling
recommendation.

Values-based Standard setting – reviews whether the corporation has taken into account the
values and interests of all stakeholders in its corporate policy – employees, host community,
shareholders, retirees, industry institutions, human rights organizations etc

Document Review – Review of the administration manual, corporate code of ethics, board
minutes and corporate policies, policies regarding business practices, conflict of interest etc
to see the extent to which CSR principles are incorporated and practiced.

Benchmarking: Looks at the extent to which the company’s behaviour and practices
compare to industry norms and best practices.

Environmental Scan: Looks at the macro-changes in social climate, nationalism,

technology, international trade policies etc that can transform the organization of the business
or agency under study. The scan helps companies to adjust their policies and practices to
align with best practice.

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Multi-stakeholder surveys: Seek public opinion on the perception of significant
stakeholders on the policies and actions of the firm.

Action-enabling Recommendation: that ensures that the findings of the audit form a strong
basis form change and improvement in the company.

IN-TEXT QUESTIONS (ITQ’s)

1.________ requires entities to be held responsible for their moral, social and
environmental consequences of their pursuit of economic objectives

2.…………..is based on the notion of a social contract, express or implied, between an

organization and the community

3. ………is a process of measuring the socially responsible activities of an organization

to determine their impact on the wider community

4. ________ refers to the reduction of resource and energy utilization and waste
production per unit of product or service.

IN-TEXT ANSWERS (ITA’s)

1. Accountability

2. Legitimacy theory.

3. Social audit

4. Eco-efficiency

TUTOR MARKED ASSIGNMENT (TMA)

Some shareholders in Nigeria are becoming increasingly interested in the
environmental policies, impacts and practices of business entities given the
activities of some oil and gas and telecommunication companies. However financial
statements have not traditionally provided this information. As a result, there is
early indication that some listed companies in Nigeria are beginning to publish
sustainability report complying with the Global Reporting Initiative (“GRI”), an

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 organisation set up in 1997, to develop a sustainability reporting framework for
businesses. The GRI Sustainability Reporting Guidelines give guidance to entities
on how to measure and report on managements‟ approach to the economic,
environmental and social aspects that impact on their businesses

Required:

a. Identify and explain the principal arguments against voluntary disclosure by

business entities of their environmental policies, impacts and practices. (8 Marks)

b. Explain the nature of the information that could be disclosed by entities in their
external reports in respect of the economic, environmental and social aspects, in order
to comply with the GRI guidelines. (7 marks)
(Total 15 marks)

SELF-ASSESSMENT QUESTION

In the Corporate Social responsibility (CSR) debate, some opponents have argued that the
central concern of business organizations is the investors (the shareholders) whose interests and
property rights must be protected. They further posit that efficient economic activities and
outcomes are attained when organizations pursue their self-interest. It will thus amount to moral
wrong if companies attempt to pursue CSR, since this falls within the jurisdiction of
government.

Required:

a. Discuss four reasons why companies should have social responsibility. (4 marks)

b. Explain three methods/techniques of accounting for social and environmental costs. (6 marks)

(Total: 10 marks)

Module 5 ACCOUNTING ETHICS

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Image source: https://evergreensmallbusiness.com/payroll-accounting-rules-for-s-
corporation-shareholder-health-insurance/

Introduction
This module exposes the student to ethical considerations in corporate reporting and the
demand of the stakeholders for entities to be responsible to the environment and the society
which their operations affect. The module goes further to consider wholistic reporting beyond
financial performance. The public demands that entities report their environmental, social and
governance performance, to which the accounting profession has responded through guidance
on integrated reporting (one report). These contemporary matters are captured in this module.

General Objectives
At the end of this module, students should be able to:

1 Differentiate between business ethics and professional ethics;

2 Apply the relevant ethical theories in accounting practice
3 Apply the ethical principles in accounting and financial reporting in the work place
4 Make right ethical decisions based on given scenario
5 Understand the ethical principles and be aware of threats to these principles

UNIT 1 INTRODUCTION TO ACCOUNTING ETHICS

Introduction

This unit is an introduction to ethics in accounting. Some definitions of ethics are given and a
distinction is made between business ethics and professional ethics

Specific Objectives
At the end of this unit, students should be able to:

1, Define and explain what ethics is in accounting.

3. Differentiate between business ethics and professional ethics.
Ethics
Definitions

1. The moral principles that control or influence a person’s behaviour (Oxford Advanced
Learners Dictionary).
2. Ethics is about how we meet the challenge of doing the right thing when that will cost
more than we want to pay – The Josephson Institute of Ethics.

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3. Whittington and Pany (2004) – The study of moral principles and values that govern the
actions, inactions and decisions of an individual or group of individuals.
4. Chambers Dictionary (2003) – The science of moral; that branch of philosophy which is
concerned with human character and conduct; a system of morals or rules of behaviour; a
treatise or morals.

Ethics is a normative science; it is concerned with norms and standard of human conduct.
The primary focus is with “what ought to be the case rather than what is the case.” It could
be seen from two perspectives namely:

 Rules of appropriate behaviour for an individual based on moral standards he

develops for himself and which impact his life on a daily basis in the choices and
decisions he makes.
 Rules of appropriate behaviour for a community or society made up of
individuals that share both similar and different value systems and moral
standards. Thus, establishing an ethical ideal for a community or society allows
that group to live with confidence and knowledge that they share a common
standard e.g. ICAN Code of Professional Conduct and Guide for Members.

Business Ethics
 Business ethics describes the moral principles and values that guide how people and
institutions behave in the world of business.
 It considers how the pursuit of self-interest/profit affects other parties through the
actions of individuals or firms.
 When embodied in formal corporate code of ethics, it provides a reference point for
employees and other stakeholders‟ behavior within business organisations.
 The business ethics of a business organisation will apply to all its employees.

Professional Ethics
 Professional ethics describes the moral principles and values that govern behaviour in
the context of specific professions such as the legal profession, architecture and
accountancy.
 Professional ethics are usually specified in the professional code of conduct that all
members and students professing or aspiring to be part of specific professions must
abide by.
 Adherence to ethical codes of specific professions is usually a requirement for
membership of a professional body

IN-TEXT QUESTIONS (ITQ’s)

1________ refers to the moral principles and values that guide how people and institutions
behave in the world of business.

2………….define ethics as the study of moral principles and values that govern the
actions, inactions and decisions of an individual or group of individuals
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 IN-TEXT ANSWERS (ITA’s)

1. Business ethics

2. Whittington and Pany

UNIT 2 ETHICAL THEORIES

Introduction
In this unit, the student is taken through the broad categorisation of ethical theories. Case
studies are presented to drive home the application of these theories in making decisions in
the work place.

Specific Objectives
At the end of this unit, students should be able to:

1. Discuss the relevant ethical theories based on their broad categories

2. Explain ethical conducts and ethical dilemma faced by Accountants;
3. Apply these theories in practice of accounting in the work place

Broad classification of ethical theories:

a. Descriptive or comparative ethics – Study about people’s beliefs about morality.

What are people’s beliefs about values, right or wrong actions; which characters of
moral agents are virtuous? It involves factual description and explanation of moral
behaviour and beliefs.

b. Prescriptive or normative Ethics- Attempt to arrive at practical moral standards that

distinguish between right and wrong and how to live moral lives. It provides a
principle on how we ought to behave irrespective of current social norms and
practices. Thus, it deals with norms, standards or principles of human behaviour.

TRADITIONAL CLASSIFICATION

a. Meta- Ethics - Metaphysical issues (nature of existence, physical and nonphysical)

Psychological issues – Psychological basis of our moral judgment and conducts.

b. Normative Ethics – Teleology, Deontology, ontology, utilitarianism, ethical egoism

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c. Applied Ethics- Bio-ethics, Business ethics, Environmental ethics etc.

NORMATIVE THEORIES

Normative theories of ethics could be viewed from two dimensions:

A. (i) Consequential theories: define ‘good’ in terms of consequences: e.g.

Utilitarianism.

(ii) Non-consequential theories: define ‘good’ by its intrinsic value rather than its
consequences or outcome. An act or a decision is right because it is the right thing to
do, e.g. rights and justice theories.

B. (i) Ethics of conduct, also divided into Teleology (Ethical egoism and Utilitarianism)
and Deontology (Kantianism).

(ii) Ethics of character: Examines the character of the decision maker- good actions
come from good people) e.g. Aristotlelianism (Virtue Ethics)

ETHICS OF CONDUCT

1. TELEOLOGICAL Theories determine the ethics of an act by looking at the probable

outcome (end or aim) or consequences of the act or decision. Teleologism gives priority to
the good over the right and evaluates actions by the goal or non-moral consequences that they
attain. Right actions are those that produce the most good or optimise the consequences of
one’s choices. That is, actions have no intrinsic value but merely serve as means to attain that
which has value.
2. ETHICAL EGOISM: A subset of teleologism, ethical egoism provides rationale for
evaluating judgements based on one’s self interest. According to Ayn Rand (1961), “the
achievement of his own happiness is man’s moral purpose”. An action is right if it maximises
one’s own personal good. John Hospers- “one’s sole duty is to promote his own interests
exclusively”. For Spinello, Richard A. (2005), Egoism is a deficient moral theory since it is
predicated on the vice of selfishness. An egoist considers the interest of others when it is in
his own interest to do so (i.e. if it benefits him). He will further the interest of others if it is
believed that reciprocity will advance his self-interest.
3. UTILITARIANISM: another subset of Teleologism. The most popular version of
consequentialism. Formulated by Jeremy Bentham and John Stuart Mill. An action is good if
it created the greatest good for the greatest number of people affected by the action or
decision. An action is right if it maximises the net benefit or produces the lowest costs to the
community.
Setbacks:

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i. May impair objectivity in decision making e.g outsourcing jobs to cut costs and maximise
profits for company or bear high, uncompetitive production costs and avoid lay-offs and
family hardships.

ii. No intrinsically unjust or immoral acts. Moral rightness depends completely on the context
and on achieving the optimal proportion of benefits to harm.

iii. It is insensitive to basic human rights and justice.

CASE STUDY

COOKING UP A VENTURE

Vincent is desperate to secure an additional loan to fend off insistent creditors. Vincent
believes he can secure a loan from the bank so long as he can support his claims with a
positive financial report. Vincent asked his public accountant, Jane, to ‘cook the books’ so
that the financial statements appear more favourable than they really are. Vincent asked Jane
to do whatever she could to make the reports appear as favourable as possible. Vincent
emphasised, ‘whatever it takes’. When Jane questioned his motives, Vincent became
apprehensive and threatened to withdraw Jane’s services unless she complied with his
request.

Jane was left contemplating her choices; she may either accept or reject Vincent’s request.
What should Jane do, based on utilitarian theory?

Utilitarianism

According to the utilitarianism principle, the ethical solution is the course of action that
produces the greatest net benefit to the greatest number of stakeholders. We begin our
utilitarian analysis by listing the possible consequences and stakeholders affected for each
alternative course of action:

IF JANE COMPLIES WITH VINCENT’S DEMAND

POSITIVE CONSEQUENCES NEGATIVE CONSEQUENCES

 The probability of Vincent receiving  Jane’s integrity as a professional

a loan will be enhanced.
 Vincent and bank will benefit
financially if the loan is used to
improve the profitability of the
business.
 Jane will retain Vincent as a client
accountant will suffer.
 Based on the revised financial
reports, the loan carries an unknown
risk. Vincent and the bank will be
financially poorer if Vincent defaults
on the loan.

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 and her billings will not diminish.

IF JANE REJECTS VINCENT’S DEMAND

 Jane’s integrity and her reputation  Jane may lose Vincent as a client
remain intact. (this could also be a positive
outcome) and reduce her billings.
 The bank is protected from an  Based on the existing financial
investment that carries an unknown reports, Vincent is unlikely to raise
risk. the loan. He must find alternative
 Vincent will avoid further financial methods to fend off the creditors.
stress from servicing an additional
loan.
 Vincent may avoid further financial
losses if the loan does not improve
the profitability of the business.

Choosing an ethical alternative based on the consequences will often depend on the
probability of the outcomes occurring. Unfortunately, the uncertainty or the lack of
predictability of outcomes is a major problem with utilitarian analysis. In this dilemma, we
must consider the likelihood of the loan improving the profitability of the business. If the
subsequent outlay from obtaining the loan is successful, the majority of stakeholders
(Vincent, the bank, creditors, employees and Jane) will be better off. If the subsequent outlay
is unsuccessful, the majority of stakeholders will be financially poorer. The success of the
investment is difficult to determine from the facts stated above; however, the probability of a
successful return on investment must be questioned when the acquisition of the loan relies on
questionable financial reports. On the basis that an adequate return on investment is unlikely,
the majority of stakeholders will be worse off if Jane complies with Vincent’s demand to
‘cook the books’. Therefore, Jane should reject Vincent’s request.

Rights

Individuals have a right to the truth. In accounting, this means users of financial statements
have a right to receive true and accurate financial reports and accountants have a
corresponding duty to prepare the financial reports accordingly. To do otherwise is unethical.
Therefore, Jane should refuse Vincent’s request to cook the books as she has an ethical
obligation to prepare the financial statements in accordance with the applicable accounting
regulation to ensure as far as practicable the truthfulness of the reports.

Justice

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Jane must identify the benefits and burdens that are likely to result from her decision and
assess the fairness of the distribution of such benefits and burdens to the various stakeholders.
In this case, Vincent will benefit from the acquisition of the loan that may not have otherwise
acquired. On the other hand, the bank must shoulder the burden of an investment that is
riskier than the financial reports indicate. This is clearly unfair, as one party, Vincent,
receives the benefits, and a different party, the bank, is shouldering the burden. Jane must,
once again, refuse Vincent’s request.

2. DEONTOLOGISM: This is a theory of duty or obligation. The ethics of an act is

determined through the process of the decision (the means). What makes an act right is not
the sum of its consequences but the fact that it conforms to the moral laws. The emphasis is
on having a sense of duty or moral obligation to act honestly or truthfully.

KANTIANISM (ETHICS OF DUTY):

Immanuel Kant (1724-1804)- For Kant, the Moral point of view is best expressed by the
discernment and carrying out of one’s moral duty. Actions only have moral worth when they
are done for the sake of duty. The consequences of one’s action are immaterial. e.g. taking
care of your sick parents out of a sense of duty as opposed to taking care of them with the
hope that they will increase your inheritance. The later action has no moral worth, even
though the consequences of both actions are the same -sick parents are cared for.

For Kant, to be moral one must consciously act according to rules previously calculated by
‘reason’ to be right or just and the incentive for observing those rules must be respected for
duty alone.

Kant developed a guide to what ought to be our commitment to duty by developing a

framework of principles he called “categorical imperative”. These are universal principles
that are seen to apply to everyone, everywhere at all times. e.g. there is no exception to the
principle that murder and lying are immoral. Moral acts therefore are seen to be those acts
which are necessary to further the permissible ends of others.

(ii) ETHICS OF CHARACTER/VIRTUE ETHICS/ARISTOTLELISM:

This is a concept of living your life according to a commitment to the achievement of a clear
ideal- “what sort of person would I like to become and how do I go about becoming that
person?” Propounded by Aristotle, this theory looks at the character of the decision maker or
action, and holds that good actions come from good people. Aristotle believed that before one
can begin to inquire into the nature of the good, one must first have received proper
upbringing in moral character. In line with this thinking, Crane Andrew & Matthew Dirk
stated that virtue ethic contends that morally correct actions are those undertaken by actors
with virtuous characters. Therefore, the formation of a virtuous character is the first step
towards morally correct behaviour. Aristotle believed that the disposition towards virtuous

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character is nurtured overtime, preferably from childhood and does not depend on mechanical
application of universal principle as Kant or Mill asserted.

ETHICAL DILEMMA

Ones ethical principles are tested when faced with a situation where there is no obvious right
or wrong decision, but rather a right or right answer, such a situation is referred to as ethical
dilemma. It is a situation in which all available courses of action appear to include morally
undesirable as well as morally desirable aspects. Ethical dilemma tends towards uncertainty.
The decision you make in a dilemma requires you to make a right choice knowing fully well
that you are:

a) Leaving an equally right choice undone.

b) Likely to suffer something bad as a result of that choice.
c) Contradicting a personal ethical principle in making that choice.
d) Abandoning an ethical value of your community or society in making that
choice.

Worked Example
As an internal auditor, you are not comfortable with the outcome of sales promo done twice
yearly by your company as it makes little or no impact on the company’s turnover and the
bottom line. To worsen the situation, it is known that the MD’s wife is one of the distributors
of the company’s products, and collects 30% trade discount. Would you inform the external
Auditor about this?

Suggested solution

The Dilemma: Loyalty to the company through the MD and the need to uphold
utilitarianism- the spirit of trying to maximise right/good or wrong/bad.

The two positions are in conflict and pose a dilemma

IN-TEXT QUESTIONS (ITQ’s)

9. ________ is described as a theory of duty or obligation.

10. ………….is a principle that believes that ethical solution is the course of action
that produces the greatest net benefit to the greatest number of stakeholders.

IN-TEXT ANSWERS (ITA’s)

13. Deontologism
14. Utilitarianism
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UNIT 3 FRAMEWORK FOR ETHICAL DECISION MAKING

Introduction
This unit introduces the student to four ethical frameworks that can help the accountant
resolve some ethical dilemma. These are the framework by Markkula centre for applied
ethics, Chris Macdonald’s framework, Tucker’s five question model and Kohlberg’s theory
of moral reasoning. Some illustrations (scenario based) are given to guide the student’s
understanding of these theories and their application.

Specific Objectives
At the end of this unit, students should be able to:

1, Explain the frameworks propounded by various authors.

2. Discuss and explain Tucker’s five-question model;

3 Make use of the various frameworks in their day to day practices;

3.1 Markkula Centre for Applied Ethics

Markkula Centre for Applied Ethics has suggested a framework for ethical decision making
that can be useful in exploring ethical dilemmas and identifying ethical courses of action.

The framework/guide is as given below:

1. Recognize an ethical issue

 Is there something wrong personally, interpersonally, or socially? Could the conflict,

be it a situation or a decision, be damaging to people or to the community?
 Does the issue go beyond legal or institutional concerns? What does it do to people,
who have dignity, rights and hopes for a better life together?

2. Get the facts

 What are the relevant facts of the case? What facts are unknown?
 Do individuals and groups have an important stake in the outcome? Do some
individuals or groups have a greater stake because they have a special need or because
we have special obligations to them?

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  What are the options for acting? Have all the relevant persons and groups been
consulted? If you showed your list of options to someone you respect, as better
experienced, what would that person say?

3. Evaluate alternative actions from various ethical perspectives

Which option will produce the best and do the least harm? Test, using different ethical
approaches.

 Utilitarian approach: the ethical action is the one that will produce the greatest
balance of benefits over harms
 Right approach: Is the option I am taking fairly guaranteeing the rights of all
stakeholders? The ethical action is the one that most dutifully respects the rights of all
affected.
 Fairness or justice approach: Which option is fair to all stakeholders? The ethical
action is the one that treats people equally, fairly and justly.
 Common good approach: Which option would help all to participate more fully in the
life we share as a family, community or society? The ethical action is the one that
contributes most to the achievement of a qualitative common life.
 Virtue ethics: would you want to become the sort of person who acts this way (e.g., a
person of courage or compassion)? The ethical action is the one that embodies the
habits and values of humans at their best.

4. Make a decision and test it:

 Considering all the perspectives listed under (iii) above, which of the options is the
right or best thing to do?
 If you were to tell someone you respect as more knowledgeable and experienced why
you chose this option, what would that person say? If you had to explain your
decision in public, would you be comfortable doing so?

5. Act, and then reflect on the decision later: Implement your decision and reflect on how it
turned out for all concerned? If you had to do it over again, what would you do differently?

The practical implications that can be drawn from the above for a Chartered Accountant is
that when the Accountant is faced with ethical problems, the framework for ethical decision
should act as a guide in resolving them to the benefit of all. As an ethical leader he operates
with high ethical standards and pursues the good for the benefit of the society. An ethical
leader is equitable and just, honest and trustworthy and possesses integrity. He will, therefore
seek to uphold the social contract that guides the co-existence of all citizens.

However, where a difficult ethical problem that cannot be easily resolved through a rigid
application of an ethical decision making framework arises, he may need to rely on outcome
of discussions and dialogue with other professional colleagues about the dilemma. A careful
exploration of the problem, aided by the insight and different perspectives of other more

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experienced professional colleagues can facilitate good ethical choices in cases of difficult
ethical problems.

3.2 A GUIDE TO MORAL DECISION MAKING BY CHRIS MACDONALD

According to Macdonald, the guide presented below does not guarantee good decision but
serves as an aid to taking good decision. The order of the steps may vary from one situation
to the other.

1. Recognize the Moral Dimension: First recognize the decision as one that has moral
importance. Conflicts between two or more values or ideals may serve as a clue.

2. Who are the interested parties and what are their relationships? Identify the parties
that have stake in the decision. Evaluate the relationship of the parties with each other,
with yourself and with relevant institutions. Do those relationships bring special
obligations or expectations?

3. What values are involved? Determine the shared values that are at stake in making the
decision. Is there a question of trust, personal autonomy or fairness? Is anyone to be
harmed of helped by the decision?

4. Weigh the Benefits and the burdens: what physical, emotional, financial or social
benefits will the decision produce for the various parties. Are there preferences to be
satisfied?

Burdens might include causing physical and emotional pain to various parties,
imposing financial costs, and ignoring relevant values.

5. Look for analogous cases: can you think of other similar decisions? What course of
action was taken? Was it a good decision? How is the present case like that one? How
is it different?

6. Discuss with relevant persons: the merits of discussion should not be underestimated.
Time permitting; discuss your decision with as many persons as have a stake in it.
Gather opinions and ask for the reasons behind those opinions. Remember that your
ability to discuss others may be limited by the people’s expectations of
confidentiality.

7. Does this decision accord with legal and organizational rules? Some decisions are
appropriately made based on legal considerations. If one option is illegal, we should
at least think very seriously before taking that option.

Decisions may also be affected by rules set by organizations of which we are

members. For example, most professional organizations have codes of ethics which
are intended to guide individual decision making. Institutions (hospitals, banks,
corporations) may also have policies which limit the options available to us.

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 Sometimes there are bad laws, or bad rules, and sometimes those should be broken.
But usually it is ethically important to pay attention to laws and rules.

8. Am I comfortable with the decision? Sometimes your ‘gut reaction’ will you if you
have missed something.

Questions to be asked in this regard might include:

 If I carry out this decision, would I be comfortable telling my family about it? My
clergyman? My mentors?
 Would I want children to take my behavior as an example?
 Is this decision one which a wise, informed, virtuous person would make?
 Can I live with this decision?

3.3 Tucker’s five-question model

Tucker’s five-question model for ethical decision-making in business holds that the purpose
of decision-making in business is to ensure that profit is made in an ethical way. The model
identifies five questions to be asked before making an ethical business decision. If the
answers to all five questions are ”Yes‟, the decision is ethically sound. The five questions to
be asked are:

a) Is it profitable?
b) Is it legal?
c) Is it fair?
d) Is it right?
e) Is it sustainable or environmentally sound?

Applying Tucker’s model, however, requires a little more thought. This is because three of
the five questions (profitable, fair, and right) can only be answered by referring to other
things. So when the model asks, ‘is it profitable?’, it is reasonable to ask, ‘compared to
what?’ ‘Similarly, whether an option is ‘fair’ depends on whose perspective is being adopted.
This might involve a consideration of the stakeholders involved in the decision and the
effects on them. Whether an option is ‘right’ depends on the ethical position adopted. A
deontological perspective may well arrive at a different answer than a teleological
perspective, for example.

Illustration (Adopted from ACCA global SBL resources)

The two decision scenarios herein will help us understand how this model works in practice.

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Tucker: Scenario 1

Big Company is planning to build a new factory in a developing country. Analysis shows
that the new factory investment will be more profitable than alternatives because of the
cheaper labour and land costs. The government of the developing country has helped the
company with its legal compliance, which is now fully complete, and the local population is
anxiously waiting for the jobs which will, in turn, bring much needed economic growth to the
developing country. The factory is to be built on reclaimed ‘brownfield’ land and will
produce a lower unit rate of environmental emissions than a previous technology.

Is it profitable?
Yes. The investment will enable the company to make a superior return than the alternatives.
The case explains that these are ‘because of the cheaper labour and land costs’.

Is it legal?
Yes. The government of the developing country, presumably very keen to attract the
investment, has helped the company with its legal issues.

Is it fair?
As far as we can tell, yes. The only stakeholder mentioned in the scenario is the workforce of
the developing country who, we are told, is ‘anxiously waiting’ for the jobs. The scenario
does not mention any stakeholders adversely affected by the investment.

Is it right?
Yes. The scenario explains that the factory will help the developing country with ‘much
needed economic growth’, and no counter - arguments are given.

Is it sustainable or environmentally sound?

Yes. The scenario specifically mentions an environmental advantage from the investment.

So in this especially simplified case, the decision is clear as it passes each decision criteria in
the 5-question model. In more complex situations, it is likely to be a much more finely
balanced decision.

Tucker: Scenario 2
Some more information has emerged about Big Company’s new factory in the developing
country. The ‘brownfield’ land that the factory is to be built on has been forcefully
requisitioned from a community (the ‘Poor Community’) considered as ‘second class
citizens’ by the government of the developing country. The Poor Community occupied the
land as a slum and now has nowhere to live.

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Is it profitable?

Yes. The same arguments apply as before.

Is it legal?
It appears that the government of the developing country has no effective laws to prevent the
forced displacement of the Poor Community and may be complicit in the forced removal.
While the investment may not be technically illegal, it appears that the legal structures in the
host country are not particularly robust and are capable of what amounts to the oppression of
the Poor Community.

Is it fair?
While the issue of the much needed employment remains important, it must be borne in mind
that the jobs are provided at the cost of the Poor Community’s homes. This apparent
unfairness to the Poor Community is a relevant factor in this question. The answer to ‘is it
fair?’ will depend on the decision maker’s views of the conflicting rights of the parties
involved.

Is it right?
The new information invites the decision maker to make an ethical assessment of the rights of
the Poor Community against the economic benefits of the investment. Other information
might be sought to help to make this assessment including, for example, the legality of the
Poor Community’s occupation of the site, and options for rehousing them once construction
on the site has begun.

Is it sustainable or environmentally sound?

Yes. The same arguments apply as before.

3.4 ETHICAL REASONING- KOHLBERG’S THEORY OF COGNITIVE MORAL

REASONING AND DEVELOPMENT (1969)

In attempting to resolve an ethical dilemma, a process of ethical reasoning is followed. One

looks at the information available to him/her and draws conclusions based on that
information in relation to one’s ethical standards.

Lawrence Kohlberg developed a framework, distinguishing 3 levels of moral development:

pre-conventional, conventional and post-conventional. Each level has two distinct stages.

LEVEL I: PRECONVENTIONAL

This is a level of moral reasoning that is exclusively self-centred. Individuals are concerned
about consequences that result from their behaviour rather than the intrinsic value of the

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behaviour. The driving force behind personal decisions is the minimization of personal harm
(stage I) or the maximization of personal gain (stage II).

STAGE 1- OBEDIENCE AND PUNISHMENT ORIENTATION

At this stage a person is focused on avoidance of punishment and deference to power and
authority. The motivation for behaviour is governed by the desire to avoid penalty. In general
terms, people are likely to act ethically simply to avoid the consequences of wrong
behaviour/punishment but are likely to do a wrong thing they believe they can get away with
it.

STAGE 2: INDIVIDUALISM, INSTRUMENTALISM & EXCHANGE

At this stage, people are viewed as independent agents motivated to pursue their own self-
interest. Here a course of action is ethical if the benefits to the decision maker exceed the
costs. Stage 2 people will occasionally consider the interests of others, in so far as there is
mutual advantage in exchange and deals.

LEVEL II: CONVENTIONAL

At this stage, a person is becoming aware of influences outside of the family. Individuals take
a ‘member of society’ perspective and exhibit loyalty to the immediate group, and its norms
by living up to the expectations of their families, peer groups and society.

STAGE 3: INTERPERSONAL RELATIONS (‘good boy’/ ‘nice girl’ orientation)

The focus here is living up to roles and social expectations, most especially as persons to
count on. Good behaviour is that which pleases or helps the members of the group.
Stereotypical majority behaviour is recognised and conformity to that behaviour develops,
especially in the absence of identifiable group norms.

STAGE IV: LAW & ORDER/ MAINTAINING SOCIAL ORDER ORIENTATION

Here, people are concerned with loyalty to their larger nation rather than their immediate
group. A person is increasingly aware of his or her membership in a society and the existence
of codes of behavior - that is, something is right or wrong because codes of legal, religious,
professional or social behaviour detect it.

LEVEL 3: POST CONVENTIONAL

At this level, moral reasoning shifts from strict compliance with established rules to reliance
on personally held principles as a means for making moral choices. At this level, people think
beyond society’s laws to make decisions based on universal moral principles.

STAGE V: SOCIAL CONTRACT AND INDIVIDUAL RIGHTS ORIENTATION

Right actions, at this level, are defined in the realm of general individual rights and standards
which have survived the scrutiny of society. Individuals at this stage will respect laws but
will evaluate, question and seek to change laws if they are inconsistent with the principles of

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justice and welfare. E.g. Accountants at this stage are primarily concerned with protecting
and serving the public interest. Thus, the accountant may not comply with an accounting
standard, if strict compliance will not result in fair presentation of the financial statements.

STAGE VI: UNIVERSAL ETHICAL PRINCIPLE ORIENTATION

At this stage, a person is focused on self-chosen ethical principles that are found to be
comprehensive and consistent. That is, something is right or wrong because it reflects that
person’s value system and the conscious choices he makes in life. At this stage, moral
decisions are made based entirely on ethical principles without influence from authority,
rules, consequences or group.

SUMMARY OF THE SIX STAGES OF MORAL REASONING

LEVEL FOCUS STAGE ORIENTATION

Pre-conventional Self-centred 1 Obedience & punishment,

2 Individualism & exchange

Conventional Community 3 Good boy/nice girl

4 Law and order (rule follower)

Post conventional Universal principles 5 Social contract

6 Principled conscience (self

chosen ethical principles).

CASE STUDY 2

WHO’S CONTROLLING HELEN?

Suppose Helen, a young audit assistant, is given the task of evaluating the internal control
structure of a client’s accounting information system. She discovers several significant
weaknesses in the system. John, Helen’s supervisor, is fearful of the client’s reactions to an
adverse report, so he instructs Helen to modify the report. John feels that management may
appoint a new auditor if the client receives the report in its current form. John is eager to
impress his seniors and wants to maintain this client as a continuing engagement.

What is Helen’s likely response at each stage of Kohlberg’s theory of moral development?

STAGE 1 (Avoiding punishment/harm)

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Helen’s decision to modify the report will be determined by her aversion to harm. If Helen
feels threatened by her supervisor and believes that he will act on his threats, she will
probably abide by his wishes and modify the report. However, if Helen believes that a higher
authority such as a partner will discipline her for modifying the report, then she is unlikely to
modify the report.

STAGE 2: Individualism & Exchange

Helen will modify the report if she believes it is in her best interests to do so. The perceived
benefits may come from exhibiting a sense of loyalty to her supervisor and the firm that
might one day reward her.

STAGE 3: Good boy/Nice girl Orientation

Helen may modify the report in order to win the approval of her colleagues, particularly her
supervisor. Alternatively, she may comply with her professional responsibilities simply
because this is what is expected of her as a professional accountant.

STAGE 4; Law & Order- Rule follower

The need to abide by the rules of the profession will oblige her to report truthfully and fairly.
Despite personal risk, the interests of the client and the firm take precedence.

STAGE 5: Social Contract

Helen will resist pressure from her superior to modify the report and uphold the principles of
professional conduct. In this way she is acting in a manner consistent with the authority
bestowed her as a professional accountant- to act in the public interest.

STAGE 6: Principled Conscience

Helen will resolve the dilemma by exercising fundamental principles such as honesty, which
do not rest on particular needs. She will not modify the report.

A stage of moral development implies that Helen will respond similarly in different
circumstances. However, you should be cautious when predicting behaviour based solely on a
person’s stage of moral development. Consistency of action should not be defined by the
behaviour itself but in terms of the person’s rationale. At stage 1, Helen may act
appropriately on one occasion, but not on another. In both situations, however, the reasoning
will be consistent- to avoid penalty. Behavioural predictions become clearer in the latter
stages of moral development. In Helen’s case, she may or may not modify the report in the
first three stages of moral development. But in stages 4 to 6, her decision becomes more
predictable. Since unethical behaviour is difficult to reconcile with properly developed rules

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and regulations and post-conventional considerations, Helen is more likely to adopt the
ethical course of action at the higher stages of moral reasoning.

CRITICISMS OF KOHLBERG’S THEORY

1. Moral reasoning does not necessarily lead to moral behaviour. Knowing what
should be done differs from actual actions.
2. The theory appears to over-emphasise the idea of justice when considering moral
choices. Other issues such as caring, compassion & other interpersonal dispositions
play a role in moral reasoning.
3. Individualistic cultures (as in advanced economies) tend to emphasise personal
rights as against collectivistic cultures which emphasise the importance of
community and society.

IN-TEXT QUESTIONS (ITQ’s)

1. ________ is a level of moral reasoning that is exclusively self-centred.

IN-TEXT11. The approach

ANSWERS (ITA’s) being adopted when the ethical action is the one that will produce
the greatest balance of benefits over harms is ………….
15. Pre-conventional
16. Utilitarian approach

UNIT 4 ETHICAL STANDARDS AND PROFESSIONAL RESPONSIBILITIES

Introduction
This unit examines the provisions of the accountants’ code of ethics – the fundamental
principles and the statements. Threats to these ethical principles and possible safeguards are
also highlighted. Furthermore, the accountant’s stakeholders and their expectations are
discussed as well as the fiduciary roles of the accountant.

Specific Objectives
At the end of this unit, students should be able to:

1. Define and explain the code of professional ethics by IFAC and ICAN.
2. Explain the rule based and principle based approaches to ethical conducts;
3. Identify the consequences of infractions of the ethical standards;
4. Identify the accountant’s stakeholders and potential threats to independence they
constitute
5. discuss the fiduciary duties of the accountant

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4.1 Code of professional conduct

The standards as contained in both the IFAC and ICAN codes are in two categories namely:

1. Fundamental Principles and

2. Statements.

1. Fundamental Principles.
These are drawn from the duties owed by all members of the profession, whether in practice
or not. They constitute basic advice on professional behavior.

A professional accountant shall comply with the following fundamental principles:

(1) Integrity: The principle of integrity imposes an obligation on all professional accountants
to be straightforward and honest in all professional and business relationships. Integrity also
implies fair dealing and truthfulness.
A professional accountant shall not knowingly be associated with reports, returns,
communications or other information where the professional accountant believes that the
information:
(a) Contains a materially false or misleading statement;
(b) Contains statements or information furnished recklessly; or
(c) Omits or obscures information required to be included where such omission or obscurity
would be misleading.
Where such issues as above have arisen, a professional accountant shall take steps to be
disassociated from that information and is advised to issue a modified report..

(2) Objectivity –A professional Accountant not allow bias, conflict of interest or undue
influence of others to override professional or business judgments. A professional accountant
may be exposed to situations that may impair objectivity. A professional accountant shall not
perform a professional service if a circumstance or relationship biases or unduly influences
the accountant’s professional judgment with respect to that service

(3) Professional Competence and Due Care – The Accountant has the obligation to maintain
professional knowledge and skill at the level required to ensure that a client or employer
receives competent professional services based on current developments in practice,
legislation and techniques and act diligently and in accordance with applicable technical and
professional standards.
Competent professional service requires the exercise of sound judgment in applying
professional knowledge and skill in the performance of such service. Professional
competence may be divided into two separate phases:
(a) Attainment of professional competence; and
(b) Maintenance of professional competence.
The maintenance of professional competence requires a continuing awareness and an
understanding of relevant technical, professional and business developments. Continuing

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professional development enables a professional accountant to develop and maintain the
capabilities to perform competently within the professional environment.
Diligence encompasses the responsibility to act in accordance with the requirements of an
assignment, carefully, thoroughly and on a timely basis.

(4) Confidentiality – The Accountant has the obligation to respect the confidentiality of
information acquired as a result of professional and business relationships. He should
therefore, neither disclose any such information to third parties without proper and specific
authority, unless there is a legal or professional right or duty to disclose, nor use the
information for his personal advantage or that of third parties.
The need to comply with the principle of confidentiality continues even after the end of
relationships between a professional accountant and a client or employer. However, when a
professional accountant changes employment or acquires a new client, the professional
accountant is entitled to use prior experience.

A professional accountant shall maintain confidentiality, including in a social environment,

being alert to the possibility of inadvertent disclosure, particularly to a close business
associate or a close or immediate family member.
A professional accountant shall maintain confidentiality of information disclosed by a
prospective client or employer.
A professional accountant shall maintain confidentiality of information within the firm or
employing organization.
A professional accountant shall take reasonable steps to ensure that staff under the
professional accountant’s control and persons from whom advice and assistance is obtained
respect the professional accountant’s duty of confidentiality. The professional accountant
shall not, however, use or disclose any confidential information either acquired or received as
a result of a professional or business relationship.

Circumstances where professional accountants may disclose Confidential Information

The following are circumstances where professional accountants are or may be required to
disclose confidential information or when such disclosure may be appropriate:
(a) Disclosure is permitted by law and is authorized by the client or the employer;
(b) Disclosure is required by law, for example:
(i) Production of documents or other provision of evidence in the course of legal proceedings;
or
(ii) Disclosure to the appropriate public authorities of infringements of the law that come to
light; and
(c) There is a professional duty or right to disclose, when not prohibited by law:
(i) To comply with the quality review of a member body or professional body;
(ii) To respond to an inquiry or investigation by a member body or regulatory body;
(iii) To protect the professional interests of a professional accountant in legal proceedings; or
(iv) To comply with technical standards and ethics requirements.

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In deciding whether to disclose confidential information, relevant factors to consider include:
(a) Whether the interests of all parties, including third parties whose interests may be
affected, could be harmed if the client or employer consents to the disclosure of information
by the professional accountant;
(b) Whether all the relevant information is known and substantiated, to the extent it is
practicable; when the situation involves unsubstantiated facts, incomplete information or
unsubstantiated conclusions, professional judgment shall be used in determining the type of
disclosure to be made, if any;
(c) The type of communication that is expected and to whom it is addressed; and
(d) Whether the parties to whom the communication is addressed are appropriate recipients.

(5) Professional Behavior: The principle of professional behavior imposes an obligation on

all professional accountants to comply with relevant laws and regulations and avoid any
action that the professional accountant knows or should know may discredit the profession.
This includes actions that a reasonable and informed third party, weighing all the specific
facts and circumstances available to the professional accountant at that time, would be likely
to conclude adversely affects the good reputation of the profession.
In marketing and promoting themselves and their work, professional accountants shall not
bring the profession into disrepute. Professional accountants shall be honest and truthful and
not:
(a) Make exaggerated claims for the services they are able to offer, the qualifications they
possess, or experience they have gained; or
(b) Make disparaging references or unsubstantiated comparisons to the work of others.

4.2 Statements
Statements provide more elaborate discussions on what is expected of members in certain
circumstances. Most of the statements are relevant to members in practice and where
appropriate, to employees of practicing firms but not to other members.

The statements as stated in ICAN code are as given in the table below:

ANALYSIS OF THE STATEMENTS OF ETHICAL STANDARDS

S/NO SUBJECT MATTER THOSE TO WHOM APPLICABLE

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1. Integrity, Objectivity and Independence

Preface – integrity, objectivity,

framework, etc.
All Members

Introduction – Safeguarding Objectivity

Section A – Objectivity and All Members, Practicing Members, Affiliates

Independence and the Audit. and employees of practicing Firms.

Section B – Objectivity and Practicing Members, affiliates and employee

independence in financial reporting and of practicing firms.
similar non-audit roles.

Section C – Objectivity and Practicing Members, Affiliates and employees

independence in professional roles other of Practicing firms.
than covered in sections A& B.

Section D – Definitions All Members

2. Conflicts of Interest Practicing Members, Affiliates and

Employees of practicing firms.

3. Confidentiality All members

4. Changes in a professional appointment Practicing Members, Affiliates and

Employees of practicing firms.

5. Consultancy Practicing Members, Affiliates and

Employees of practicing firms.

6. Associations with non-members Practicing Members, Affiliates and

Employees of practicing firms.

7. Fees Practicing Members, Affiliates and

Employees of practicing firms.

8. Obtaining Professional work Practicing Members, Affiliates and

Employees of practicing firms.

9. Names and Letterheads of practicing Practicing Members, Affiliates and

firms Employees of practicing firms.

10. Second and other opinions All members

11. Members in business Members in business

12. Enforcement of ethical standards. All members.

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4.3 RULES-BASED AND PRINCIPLES-BASED APPROACHES TO ETHICAL
CONDUCT.
From the above, it can be seen that the codes are designed to serve as ‘pillars of guidance’ to
safeguard the integrity of the accountancy profession. They can thus be seen as Rules-based
and principles-based guidelines. The Statements more or less highlight ‘rules’ for ethical
conduct, and the section of the code on enforcement of ethical standards and enforcement
procedures define the powers of the Institute in ensuring compliance to the rules.
The said section states:
1. The power of the Institute to enforce ethical standards is derived from the ICAN Act
1965 and this power is conferred on the Disciplinary Tribunal, which is independent
of the Council.
2. The investigating panel considers complaints against the conduct of members and
initiates disciplinary action by referring appropriate cases to the Disciplinary
Tribunal.
3. Where the complaint is against a member of a firm having more than one partner, all
partners in the firm as at the time of complaint will be jointly and severally held.
4. Where a complaint of misconduct is brought against a member, such a member is
required to furnish his defence to the Investigating panel within 14 days of
notification by the panel.
5. Where the members fails to respond within this specified time, a first reminder is sent
requesting that he sends his defence or reaction within 7 days from the date of receipt
of the reminder.
6. If the member fails to respond after the first reminder, a formal charge of contempt
will be preferred against the member before the Disciplinary tribunal.
7. If the members address cannot be readily obtained, the Panel shall publish the
invitation on a National Newspaper after which if there is no response within a
reasonable time, it shall be treated as contempt of the Institute and is sanctionable by
the Disciplinary Tribunal.
8. The Disciplinary Tribunal is the only body that can determine, subject to the right of
appeal, if a complaint of misconduct is proved.

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 9. From the Accountants’ Disciplinary Tribunal, a member has a right of appeal to the
Court of Appeal.
10. If a member of the Institute has been declared guilty of professional misconduct by
the Tribunal, the member shall not be eligible to serve on the Institute’s council or any
of the Institute’s committees for a period of 5 years from the date of re-admission into
membership or studentship.

4.4 CONSEQUENCES OF UNETHICAL BEHAVIOUR

Unethical behavior of the professional Accountant refers to failure to comply with the
expected normal moral standards of a profession. It is in other words, termed professional
misconduct.

As stated above, the power of ICAN to enforce ethical standards is conferred on the
Accountants Disciplinary Tribunal, with powers equivalent to those of a High Court. Any
appeal against its verdict goes to the Appeal court. The investigating panel considers
complaints against the conduct of members and is empowered to initiate disciplinary action
by referring appropriate cases to the Disciplinary Tribunal for adjudication.

Sanctions commonly imposed for professional misconduct include:

1. Reprimand
2. Payment of costs
3. Fine
4. Withdrawal of practicing rights
5. Suspension from membership for a period of time
6. Expulsion from membership.

4.5 Accountant’s Independence

Independence of the Accountant adds credibility to his report on which users of the financial
information depend to make economic decisions about a company. Thus, Accountant/auditor
independence is one of the basic requirements to keep public confidence in the reliability of
the audit report. The benefits of safeguarding the independence of the auditor therefore
extend so far as to the overall efficiency of the capital market.
Independence is described by the IFAC (2011) Code as:
 Having a position to take an unbiased view point in the performance of audit tests,
analysis of results and attestation in the audit report;
 Independent in fact: accountant’s ability to maintain an unbiased attitude throughout
the audit, so being objective and impartial;
 Independent in appearance: the result of others’ interpretations of this independence.
In this regard, the IFAC ethics guideline states that independence requires:
i. Independence of mind: The state of mind that permits the provision of an opinion
without being affected by influences that compromise professional judgment,

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 allowing an individual to act with integrity, and exercise objectivity and profession
skepticism.
ii. Independence in appearance: The avoidance of facts and circumstances that are so
significant that a reasonable and informed third party, having knowledge of all
relevant information, including safeguards applied, would reasonably conclude a
firm’s or a member of the assurance team’s integrity, objectivity and professional
skepticism had been compromised.

4.6 POTENTIAL THREATS TO INDEPENDENCE AND SAFEGUARDS

There are five general sources of potential threats to independence identified by the revised
Code.

(a) Self-interest threat (for example, having a financial interest in a client):

This is the threat that “a financial or other interest will inappropriately influence the
professional accountant’s judgment,” conduct or behaviour.

According to The Code (2009), examples which create self interest threats for a professional
accountant in public practice include:
(i) A firm entering into a contingent fee arrangement (i.e. fees are contingent upon the
findings or results of services) that relates to an assurance engagement;
(ii) A firm which is concerned about the chance happening of losing a significant client;
(iii) A member of the audit team entering into employment deals with the audit client;
(iv) A firm having undue dependence on total fees receivable from a client;
(v) A member of the assurance team having a direct financial interest (e.g. ownership of
client equities or financial instruments) in the assurance client; and
(vi) A member of the assurance team having a significant close business relationship with an
assurance client.

(b) Self-review threat (for example, auditing financial statements prepared by the firm).
The threat that a professional accountant will not appropriately evaluate the results of a
previous judgment made or service performed by the professional accountant, or by another
individual within the professional accountant’s firm or employing organization, on which the
accountant will rely when forming a judgment as part of providing a current service.
Examples of circumstances which create self-review threat for a professional accountant in
public practice include:
i). A firm issuing an assurance report on the effectiveness of the operation of a financial
system after designing or implementing it.
ii). A firm, having prepared the original data used to generate records that are the subject
matter of the assurance engagement.
iii). A member of the assurance team being or having recently been a director or officer of the
client.

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iv). A member of the assurance team being or having recently been employed in a position to
exert significant influence over the subject matter of the engagement.
v). The firm performing a service for a client that directly affects the subject matter
information of the assurance engagement.

(a) Advocacy threat (for example, promoting the client’s position by dealing in its shares).
This threat says that a professional accountant will promote the position of a client or
employer to the stage that the professional accountant’s objectivity is compromised. When
the auditor takes a strongly proactive stance on the client’s behalf, the special objectivity that
audit requires is impaired.
Examples of circumstances which create advocacy threats for a professional accountant who
is in public practice include:
(i) When the firm is promoting shares in an audit client (selling, underwriting or otherwise
dealing in financial securities or shares of the client); and
(ii) When a professional accountant is acting as an advocate on behalf of an audit client in
litigation or disputes with third parties.

(b) Familiarity threat (for example, an audit team member having his/her family member as
an officer of the client).
This is the threat that due to a long or close relationship with a client or employer, a
professional accountant will be too sympathetic to their interests or too accepting of their
work.
Examples of circumstances which may create familiarity threats include:
i). a member of the assurance team having a close or immediate family member who is a
director or officer of the assurance client;
ii). a member of the assurance team having a close or immediate family member who is an
employee of the client and in a position to significantly influence the subject matter of the
assurance engagement;
iii). A former partner of the firm being a director, officer of the assurance client or an
employee in a position of significant influence;
iv). Acceptance of gifts or hospitality, unless the value is clearly insignificant, from the client,
its directors or employees; and
v). long association of a senior member of the assurance team with the assurance client.

(c) Intimidation threat (for example, threats of replacement due to disagreement).

This is the threat that a professional accountant will be prevented from performing his work
objectively in view of actual or perceived pressure which includes attempts to exert undue
influence over him.

Examples of circumstances which may create intimidation threats for a professional

accountant who is in public service include:
(i) A firm being threatened with dismissal from a client engagement;
(ii) A firm being threatened with litigation by the client;

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(iii) A firm being pressurized to reduce inappropriately the extent of work performed so as to
reduce fees;
(iv) An audit client indicating that it will not award a planned non-assurance contract to the
firm if the firm continues to disagree with the client’s accounting treatment for a particular
transaction;
and
(v) A professional accountant being informed by a partner of the firm that a planned
promotion will not take place except the accountant agrees with an audit client’s
inappropriate accounting
treatment.

4.7 Safeguards
There are two general categories of safeguard identified by the Code:
(i) Safeguards created by the profession, legislation or regulation
(ii) Safeguards within the work environment

Examples of safeguards created by the profession, legislation or regulation:

(i) Educational training and experience requirements for entry into the profession;
(ii) Continuing professional development requirements;
(iii) Corporate governance regulations;
(iv) Professional standards;
(v) Professional or regulatory monitoring and disciplinary procedures;
and
(vi( External review by a legally empowered third party of the reports, returns,
communication or information produced by a professional accountant.

Examples of safeguards in the work environment (that is, within the Audit firm):
(i) Involving an additional professional accountant to review the work done or otherwise
advise as necessary;
(ii) Consulting an independent third party, such as a committee of independent auditors, a
professional regulatory body or another professional accountant;
(iii) Rotating senior personnel;
(iv) Discussing ethical issues with those in charge of client governance;
(v) Disclosing to those charged with governance (through the audit committee) the nature of
services provided and extent of fees charged.
(vi) Involving another firm to perform or re-perform part of the engagement.
vii) leadership stressing the importance of independence, having written independence
policies and designating a member of senior management to oversee the adequate functioning
of the safeguarding system.

Hayes, Dassen, Schilder and Wallage posit a third category of safeguard, that is, safeguard
within the Assurance Client.
Examples of such safeguard include:

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i). Ratification by the audit committee of the appointment of the audit firm ( the trend is
towards appointment of the auditor by the Audit committee);
ii). Competent personnel in the employment of client;
iii). Client is committed to fair financial reporting;
iv). The client has internal procedures that ensure objective choices in commissioning non-
assurance engagements;
v). client has a corporate governance structure such as audit committee, that provides
oversight of the audit firm’s services.

4.8 ETHICS AND THE ACCOUNTING PROFESSION

A profession is a vocation or occupation that requires a specialized area of training, skills

acquisition and knowledge attainment which makes a person an expert in his area. The
training goes with moral values that could positively influence every stakeholder of the
professional, that is, those who are impacted by his services and actions. Thus, possession of
moral/ethical values is the fulcrum on which every profession revolves.

The characteristics of a profession which highlight its ethical base include:

1. Undergoing an educational and training process where discrete and edifying body of
knowledge is acquired.
2. The need to be a member of a professional association and be licenced to practice.
3. The profession must have a code of ethics that guide the conduct of members and a
set of technical standards.
4. The profession owes the significant public – the larger society- a lot of social and
moral obligations.

4.9 The Foundation of the Accounting Profession

The accounting profession is founded on trust. The Accountant holds a fiduciary position and
performs fiduciary duties while acting as an agent of his employer or client. A fiduciary duty
is a legal obligation based on trust that one party would act in the best interest of another. The
accountant has a legal or ethical obligation to act in the best interest of his stakeholders (e.g.
the general public, investors and potential investors, donor agencies, etc), who rely on his
report to make huge investment and financial commitments.

The accountant performs fiduciary services in the areas of:

a. auditing of financial statements

b. taxation: tax returns and advisory services
c. insolvency services- executorship, trusteeship, receivership and liquidation
d. financial planning and advisory services

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e. Management control – advice and design of management information systems
f. debt management and recovery
g. corporate restructuring and re-engineering
h. Treasury management
i. Payroll services etc
In all these, the accountant must maintain high ethical standard for him to continue to enjoy
the confidence and trust of the stakeholders. It follows therefore that the value of the
accounting profession can only be maintained through adherence to ethical principles by the
practitioners.

4.10 Accountants and their Stakeholders

A stakeholder is a person who is affected by the action or inaction of another person or the
impacts of another person’s activities. The stakeholders of the accountant are the users of the
information he generates and which the users rely on to make decisions.

The accountant’s stakeholders and their interest areas are:

1. Existing and Potential investors: Existing investors need to read from the financial
statements how the funds they invested have been utilized and the returns accruing
from their investments. This enables them to decide whether to divest or retain their
investment in the organization. Potential investors are interested on the
stability/viability, profitability and liquidity of an organization. Key performance
indicators provided by the accounting information assist them in deciding where to
channel their investments.
2. Lenders and suppliers: Lenders do not commit funds to poorly performing entities and
suppliers cannot continue to supply to entities that cannot honour payment
obligations. Accounting information reveal adverse performance indices.
3. Governments use accounting information as a score sheet for stewardship, decision
making, taxing function and performance control.
4. Employees are interested in the continuity and growth of the company to confirm
stability of employment, promotion prospects and assurance of good life after
retirement. Accounting information give indications about profitability, solvency and
liquidity of the organization.
5. Employers and management are interested in accounting figures to ascertain current
performance, compare with past performance/observe trends and take decisions on the
scale of operations.
6. Donor agencies are interested in proper utilization of funds (Value for money) and
impact of the project on the environment and standard of living.
7. Financial analyst and statistician– The financial analyst/statistician is interested in
evaluating the firm’s present performance so as to be able to project into the future

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 based on the financial data provided. Through the financial statements he assesses the
enterprise’s risk level and its growth potentials. They store accounting data from
which international agencies and the public seek information.
8. Other interest groups– These include:
i. Customers, who are interested in ability of the company to remain in business
(long-term solvency and stability), as well as its pricing policy in relation to
other companies in the same industry.
ii. Local Community – interested in the employment generating capacity of the
company (again, solvency and stability), the social and welfare impact of the
firm’s activities as well as its economic linkage effects.
9. Companies within the same industry are interested in comparing the performance of
firms so as to draw average ratios as bench marks. Accounting information in the
audited financial statements provide the needed data.

4.11 STAKEHOLDERS’ CONFLICTING INTERESTS

Stakeholders’ interests are varied and divergent and often conflict with one another. Areas of
conflict of interests usually include:

1. Employees versus Employers: Employees expect the best conditions of service –

very high remuneration and allowances, good working environment and excellent
retirement benefit conditions. Employers on the other hand will want to implement
basic rules of equity and justice in the distribution of the wealth created by the
company and often do not meet the expectations of the employees.

2. Workers versus Government: Workers will want to pay little or no tax, especially
with the general notion that governments in Nigeria do not wisely apply the proceeds
of taxation in the provision of social amenities – hospitals, good roads, security,
education etc. Thus, they resent tax deductions made by the company from their
payrolls. But governments will want to levy reasonable taxes on the premise that
governance attracts heavy expenditure, sources of which include the levying of taxes.
3. Shareholders versus Management: Management sometimes pursue goals and
interests that run counter to the wealth maximizing expectations of shareholders.
Some managers do unethically award contracts to themselves through non-existing
companies.

4. Suppliers/Creditors versus the company: Suppliers and creditors have the

expectation that the vendee company will faithfully implement agreed payment terms.
But companies could face down turns and such insolvent companies might
accumulate a lot of unpaid debts and resort to unethical treatment of their
financiers/suppliers.
5. Customers versus the company: Customers’ interests and expectations include fair
pricing of the company’s products, provision of high quality products that will ensure

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 value for money, innovative and variety of products and services, clear and accurate
information about the products and good service.
The company on its part will appreciate enduring and faithful customers with
guaranteed long-term relationships. These expectations are hardly met.

6. Local Community versus the company: The local community’s interest usually
centres on the company discharging its responsibilities as a good corporate citizen.
The community expects the company to care for the wellbeing of the community,
protect and safeguard the environment, offer social welfare and employment
opportunities and provide high quality products and services.
The company on its part expects the local community to protect the organization’s
interests and assets, contribute to the work force and help the government in providing
conducive environment for the operation of the business. Often each party’s interests
do conflict with the other party’s and each fail to meet the expectations of the other.

4.12 INFLUENCE OF SOME STAKEHOLDERS ON THE PROFESSIONAL

BEHAVIOR OF THE ACCOUNTANT

Some stakeholders directly influence the professional behavior of accountants and the
accountant needs to develop ethical courage to resist the pressure that often comes from these
stakeholders.

Some of these stakeholders include:

The Management: As the direct employer of the accountant, management sometimes take
decisions and give directives that may not be unethical and the accountant is expected to
carry out such directives and instructions. Where the accountant is part of the management,
he may have some opportunity to argue his view and put up a little resistance. An accountant
at the lower rung of the administrative ladder may face greater difficulty in situations of this
nature.

The Board: Board members often times are equally shareholders and members of
management. In such dual capacity they exercise a lot of influence on the behavior of the
accountant. As shareholders they desire capital appreciation of their investments and as
management, they wish to declare excellent results so as to attain such performance targets
that will guarantee end of year bonus and enhanced executive compensation for the executive
directors. The board and management might be under pressure to achieve these parameters
and thus may require an unethical conduct from the accountant.

Major/powerful shareholders: These are only concerned with growth and maximization of
their share values. They can have significant influence on the professional behaviour of the
accountant as he is pressurized to achieve a predetermined result.

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4.13 Virtue Ethics Theory and Value-Based Education

Virtue Ethics theory

This is a concept of living a life based on a commitment to the achievement of a clear ideal.
Thus, a virtuous person is one who manages his opportunities well.This theory looks at the
character of the decision maker or action, and holds that good actions come from good
people. Aristotle believed that before one can begin to inquire into the nature of the good, one
must first have received proper upbringing in moral character. He believes that being virtuous
connotes acting with excellence. Virtue ethic contends that morally correct actions are those
undertaken by actors with virtuous characters. Therefore, the formation of a virtuous
character is the first step towards morally correct behaviour. Aristotle believed that the
disposition towards virtuous character is nurtured overtime, preferably from childhood and
does not depend on mechanical application of universal principle.

Extending this theory, Aristotle was of the view that everything on earth has its own virtue,
provided it performs the way nature has structured it to perform. This implies that virtue is
not reserved for human beings; it does involve inanimate objects.

Value-based Education

Values are beliefs people have of what is right and wrong, which ultimately control their
behavior and actions. Values are the basic convictions which people have as regards ‘right’
and ‘wrong’, ‘good’ and ‘bad’. Value-based education seeks to impart values that should
shape recipients’ personality as well as their spiritual and moral powers. An educational
system is expected to lay enduring foundation of sound values that will enable the products of
the system always act correctly and be able to choose between what is right and wrong, true
and untrue.

Car and Wellenberg posit that education, practical and theoretical, on what constitutes ‘value’
can be imparted by the teacher through:

1. Assisting students to acquire an understanding of the importance of values which

society appreciates as worthwhile;
2. Assisting students to sustain and utilize positive values when faced with ethical
challenges;
3. Teaching that people should be good examples (models);
4. Showing students how to reach conclusions/generalizations on issues of every day
experience, by means of evaluations and expression of desirable personal values; and
5. Helping young people to assess the situations of conflict so as to develop constructive
values and attitudes.

The level of ethical principles an accountant has imbibed through his education and training
ultimately determines his professional values; this emphasizes the importance of value-based
education in the training of the accountant.

The Accountant as an Ethical Leader

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A leader is someone who influences people to strive willingly and enthusiastically towards
the achievement of group goals. He charts the direction in which an organization will move
and detects the moral tone of the group/organization.

An ethical leader is a virtuous leader; he operates with high ethical standards and pursues the
good for the benefit of the society. An ethical leader is equitable and just, honest and
trustworthy and possesses integrity. An ethical leader seeks to uphold the social contract that
guides the co-existence of all citizens. Thus, he ensures satisfaction of the needs and realistic
expectations of other people in the society since his own needs and realistic expectations are
satisfied thereby.

Accountants assume reasonable position of authority and can influence people ethically.
There is, therefore, the need for every accountant to avoid every form of unethical practice.

IN-TEXT QUESTIONS (ITQ’s)

1.________ is a person who is affected by the action or inaction of another person or

the impacts of another person’s activities

2. …………. is a concept of living a life based on a commitment to the achievement

of a clear ideal

IN-TEXT ANSWERS (ITA’s)

1. Stakeholder

2. Virtue Ethics theory

TUTOR- MARKED ASSIGNMENT (TMA)

1. Adeola is member of ICAN working as a unit accountant. He is a member of a bonus
scheme under which, staff receive a bonus of 10% of their annual salary if profit for the year
exceeds a trigger level.

Adeola has been reviewing working papers prepared to support this year’s financial
statements. He has found a logic error in a spreadsheet used as a measurement tool for
provisions. Correction of this error would lead to an increase in provisions. This would
decrease profit below the trigger level for the bonus.

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 (3 marks)

Ojemba is a chartered accountant recruited on a short-term contract to assist the finance

director, Ademola (who is not a chartered accountant) in finalising the draft financial
statements of Onyeogaziri Plc. The decision on whether to employ Ojemba on a permanent
basis rests with Ademola.

Ojemba has been instructed to prepare information on leases to be included in the financial
statements. He has identified a number of large leases which are being accounted for as
operating leases even though the terms of the contract contain clear indicators that the risks
and benefits have passed to the company. Changing the accounting treatment for the leases
would have a material impact on asset and liability figures.

Ojemba has explained this to Ademola. Ademola responded that Ojemba should ignore this
information as the company needs to maintain a certain ratio between the assets and liabilities
in the statement of financial position.
(5 marks)

Aguda Ltd, an SME, is currently experiencing some operating and liquidity problems and
needs significant injection of capital to enable it modernise its plant and equipment. The
company has been promised new orders if it can produce goods to international standard.

The CEO, Hellen Onyeocha, has just discussed with the company’s bankers on the possibility
of securing a loan to meet the impending need. While the bank is sympathetic, its lending
policy requires that borrowers provide current and projected cash flows, as well as a level of
profitability that can evidence the company’s ability to make repayments from its operations.

The business has not been performing at its optimum in recent times and as such the figures
will not satisfy the bank’s requirements.

However, the CEO informs you, the CFO, that she had told the bank that the company is
excellent in shape; that she believed that its financial results will meet the bank’s criteria. She
had told the bank that the CFO will deliver the company’s financial report to the bank at the
beginning of the following week. She then adds, “it is up to you to decide on the contents of
the report.”

As you were about leaving, she mentioned that the company would have no option but to
retrench if the company fails to secure the bank loan required to modernize the Plant and
equipment. You have just purchased a new house, with a significant mortgage yet to be
settled and you are afraid of being retrenched. (7 marks)

Required:

Discuss the ethical and professional issues involved in each of the above cases, including the
right ethical and professional actions that should be taken.

(Total 15 marks)

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SELF-ASSESSMENT QUESTION

An indigenous company wants to set up a retail mega store in the city of Ibadan. The city was
chosen because of its population density that promises a vast market for the company’s
products. Besides, it was discovered that in Ibadan, overhead cost (which includes salaries, rent,
transportation and power supply) would just be about half of what it would be in Lagos. For
instance, there is usually a minimum of 20-hour daily supply of electricity in Ibadan compared
with the barely 10-hour daily supply in Lagos. Were the store to be located in Lagos, it would
have to spend double the amount of money required in Ibadan to generate electricity. Invariably,
the store would, everything being equal, record a higher profit in Ibadan than in Lagos. Also, its
operations in Ibadan would be more environmentally friendly than in Lagos as it would be
emitting less carbon dioxide into the atmosphere because it would use less of its diesel operated
power generating set. Furthermore, the taxes the store would be paying would enhance the
revenue generation of the state government.

The government has already approved the building of the new mega store and the local
population is anxiously awaiting the commencement of construction. This would provide
immediate jobs for a good number of people in the city apart from those that would be employed
when the store becomes fully operational

Required:
Employ Tucker’s five-question model for ethical decision-making in business to determine if
the decision to build the mega store in Ibadan and not Lagos is ethical. (15 Marks)

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