IPFMPSFR - Solutions 5 2023 Final - AA

5: Preparation of financial statements part 4
PUBLIC SECTOR FINANCIAL REPORTING
PREPARATION OF FINANCIAL
STATEMENTS PART 4
SOLUTIONS 5
Updated December 2022
Valid for exams from June 2023 to March 2024
1
Public Sector Financial Reporting
First published 2016
CIPFA
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London E1 8AN
+ 44 (0)20 75435600
Email: studentsupport@cipfa.org
Website: www.cipfa.org
Copyright © 2020 Chartered Institute of Public Finance and Accountancy

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2
Table of contents
Exercise Solution 5.1 ................................................................. 4
Exercise Solution 5.7 ............................................................... 10
Exercise Solution 5.10 ............................................................. 13
3
Exercise Solution 5.1
Operating losses
Future operating losses cannot be recognised as a provision. This is
because future operating losses cannot arise from a past event.
4

Loan guarantee
(a) At December 31 20X1
Analysis:
Present obligation as a result of a past obligating event – The
obligating event is the giving of the guarantee, which gives rise
to a legal obligation.
An outflow of resources embodying economic benefits or service
potential in settlement – No outflow of benefits is probable at 31
December 2009.
Conclusion:
No provision is recognised. The guarantee is disclosed as a
contingent liability unless the probability of any outflow is
regarded as remote.
(b) At 31 December 20X2
Analysis:
obligating event is the giving of the guarantee, which gives rise
potential in settlement – At 31 December 20X2, it is probable
that an outflow of resources embodying economic benefits or
service potential will be required to settle the obligation.
Conclusion:
A provision is recognised for the best estimate of the obligation.
Note: This example deals with a single guarantee. If an entity
has a portfolio of similar guarantees, it will assess that portfolio
as a whole in determining whether an outflow of resources
embodying economic benefits or service potential is probable.
Where an entity gives guarantees in exchange for a fee,
revenue is recognised under IPSAS 9 Revenue from exchange
transactions.
5

Provisions and contingent liabilities
(a) Do nothing = 3
(b) Disclose contingent liability = 2
(c) Recognise provision = 1
6

Expected value
(75% × nil) + (20% x £1m) + (5% × £4m) = £400 000
7

Expected value
Year 1
Gross expected value of the provision is £50 000
Discount rate is 96% calculated as 1/(1+0.022)2
Therefore provision on the statement of financial position needs to
be £50 000 × 96% = £48 000
Dr Operating expenses £48 000
Cr Provisions £48 000
Year 2:
1. The discount rate for the following year is 98% i.e.
1/(1=0.022)1.
The provision’s value should be £50 000 × 98% = £49 000.
This is an increase of £1 000.
2. Entries for NEXT year to unwind the discount:
Dr Finance costs £1 000
Cr Provisions £1 000
8

Changes in provisions
The first thing we need to do is establish what value the provision
should be brought forward as.
We currently have a provision on the statement of financial position
of £48 000 using the information above (i.e. £50 000 discounted to
2 years, i.e. × 96%). We now need to bring forward a provision
where the gross expected value is £40 000, discounted to 2 years.
Therefore:
£40 000 × 96% = £38 400
This represents a decrease in the required provision of £9 600. This
needs to be credited to operating expenses.
Dr Provisions £9 600
Cr Operating expenses £9 600
Having established the new brought forward value, we now need to
unwind the discount for the following year. We can either calculate
the 1 year discount factor (98%) or, as a short cut, simply take the
opening balance and multiply it by the discount rate as follows to
calculate the unwinding required:
£38 400 × 2.2% = £844
This will be charged as a finance cost.
Dr Finance costs £844
Cr Provisions £844
The closing provision in the statement of financial position is
therefore £38 400 + £844 = £39 244.
9

Onerous contract
Analysis:
obligating event is the signing of the lease contract, which gives rise
potential in settlement – When the lease becomes onerous, an
outflow of resources embodying economic benefits is probable.
Conclusion:
A provision is recognised for the best estimate of the unavoidable
lease payments.
10

Provision for restructuring costs
Yes, the raising of the valid expectation creates a constructive
obligation and a provision that must be recognised. However, if
there was no formal plan or if that plan had not been announced or
put in motion no obligating event would have occurred and no
provision would be necessary.
11

Provisions
1. Yes, there is a legal obligation under the warranty and a
probable outflow would be required to settle it.
2. No, as long as Entity Y's financial condition is sound there is no
probable outflow required to settle the obligation. This would be
disclosed as a contingent liability. If Y's condition deteriorates
an outflow may become probable and provision would then be
required.
3. No, there is no legal or constructive obligation to repair the
assets. Therefore no provision is allowed.
12

Kole Town Council
(a) Criteria for recognising a provision:
To determine whether a provision should be recognised, we
must apply all 3 elements of the definition to the situation.
1. Present obligation (legal or constructive) as a result of a
past event – the past event was the dismissal of the
employee and the present obligation is the expected legal
obligation to pay compensation following the court case.
2. It is probable that a transfer of economic benefits will be
required to settle the obligation – to meet this it must be
more likely than not, i.e. more than 50% probable that we
will have to pay compensation. If our legal advisors believe
we will lose the case, then this second criterion has been
met.
3. A reliable estimate can be made of the obligation – the
third criterion has also been met as our legal advisors have
been able to estimate likely compensation based on similar
cases.
(b) Accounting entry
The accounting entry for making a provision will be:
Dr Operating expenses – statement of
financial performance £100 000
Cr Provisions for liabilities and
charges (liabilities) £100 000
(c) Accounting entry in the following year

In the following year Kole Town Council ends up paying out
compensation of £125 000, rather than the £100 000 previously
estimated by our legal advisors. In accordance with IPSAS 3,
this change to our accounting estimate must be recognised
within the current year and not treated as a prior year
adjustment. Therefore the accounting entry is:
Dr Operating expenses – statement of
Dr Provisions for liabilities and
Cr Cash £125 000
13
(d) Alternative accounting entry in the following year

In the following year the employee withdraws their claim, so the
provision is no longer needed. In accordance with IPSAS 3, this
change must be recognised within the current year and not
treated as a prior year adjustment. Therefore the following
accounting entry is required:
Dr Provisions for liabilities and
Cr Operating expenses – statement of
14

Discount
Option D is correct.
£85 000 = £100 000 – £10 000 – £5 000
15

Discount and deferral
Option D is correct.
1 / (1+0.1)1
1 / 1.1 =
90.9% × (£100 000 - £5 000) =
£86 364
16

Servicing fees (1)
IPSAS 9 states that if the outcome of a services contract cannot be
estimated reliably, revenue should be recognised to the extent that
expenses are recoverable. Therefore, £152 000 should be recognised
as revenue.
17

Servicing fees (2)
A selling price which includes an amount for after-sales support
should be split into two components: the support component (being
the cost of such support plus a reasonable profit margin) and the
sale of goods component (measured as the balance). The support
component should be recognised as revenue over the service period.
The support component is £180 000 (£120 000 plus 50%) of which
half (£90 000) should be recognised in the year ended 31 December
2010 along with the £620 000 (£800 000 – £180 000) sale of goods
component.
18

Recognising revenue from non-exchange transactions
The following receipts would constitute revenue for the year ended
December 20X1:
(d) – A donation from a local resident towards local services
The donation would constitute revenue; all the other receipts are
matched by liabilities or increases in owner’s equity.
The 20X2 property tax is an advance receipt.
The repayable receipt is probably a loan, except that a higher level
public sector funding body might designate it as an equity interest,
when it would be a contribution from owners.
The specific grant creates a present obligation and thus a liability.
19

Grant (1)
The university recognises the land as an asset in the statement of
financial position of the reporting period in which it obtains control of
that land. The land should be recognised at its fair value in
accordance with IPSAS 17. The restriction does not meet the
definition of a liability or satisfy the criteria for recognition as a
liability. Therefore, the university recognises revenue in respect of
the land in the statement of financial performance of the reporting
period in which the land is recognised as an asset.
20

Grant (2)
The provincial government recognises the grant money as an asset.
The provincial government also recognises a liability in respect of the
condition attached to the grant. As the province satisfies the
condition, that is, as it makes authorised expenditures, it reduces
the liability and recognises revenue in the statement of financial
performance of the reporting period in which the liability is
discharged.
21

Fine
The government (reporting entity) recognises a receivable and
revenue of £5 million in the financial statements of the reporting
period in which the fine is imposed.
22

Bequest
The public university does not recognise any asset or revenue in its
financial statements for the period in which the will is made. The
past event for a bequest is the death of the testator which has not
occurred.
23

Donations
The public hospital does not recognise any amount in its financial
statements in respect of the pledges. The entity does not control the
resources related to the pledge, because it cannot exclude or
regulate the access of the prospective transferors to the economic
benefits or service potential of the pledged resources; therefore it
cannot recognise the asset or the related revenue until the donation
is binding on the donor.
24

Debt forgiveness
When it receives the letter and documentation from the national
government, which communicates this decision, the local
government derecognises the liability for the loan and recognises
revenue in the statement of financial performance of the reporting
period in which the liability is derecognised.
25

The Oil Agency
(a) IPSAS 19 defines a provision as a liability of uncertain timing or
amount. A liability is a present obligation of the entity arising
from past events, the settlement of which is expected to result
in an outflow of economic benefits.
A provision should be recognised when, and only when,
(a) an entity has an obligation, either legal or constructive,
arising from past events
(b) it is probable (i.e. more likely than not) that an outflow of
resources will be required to settle the obligation, and
(c) a reliable estimate can be made of the obligation.
Provisions should not be recognised if the entity can avoid the
transfer of economic benefits by its future actions.
A contingent liability is defined as a possible obligation that
arises from past events and whose existence will be confirmed
by the occurrence or non-occurrence of one or more uncertain
future events not wholly within the control of the entity.
A contingent liability should not be recognised, but should be
disclosed unless the possibility of a transfer of economic
benefits is remote.
(b) (i) There is a present obligation to pay the rentals; a past
event, the signing of the lease and transfer of benefits,
cash payments. The unavoidable costs of meeting the
obligation exceeds the economic benefits expected to be
received under the lease. The agency does not expect to
receive any benefit yet they are unable to cancel the lease,
so they must continue to pay the annual lease payment of
£15 million and yet get no benefit. This can be defined as
an onerous contract under IPSAS 19, the full amount
payable (2 years at £15 million) should be provided for in
full, discounted if the difference is material.
(b) (ii) As the tanker captain’s fault cannot be established, the
agency may not have a legal obligation to pay for the
clean-up. However due to their stated environmental
policies there is almost certainly a constructive obligation
to pay for the clean-up. A provision should be made for the
full cost of £50 million.
(b) (iii) No provision is allowed by IPSAS 19. Although the Board of
26
Directors has made a decision, they have not informed

anyone, therefore they could change their minds. There is
therefore no obligation either contractual or constructive,
so there is no requirement to make any provision.
(b) (iv) The expense will have to be incurred, once the oil rig is put
in place and drilling starts, the legal obligation exists to
remove it at the end. Therefore the full cost of the £150
million should be provided for in the year to 31 March
20X5. The £150 million should be discounted if it is
material, which it probably will be over a 20 year period.
27

Learnmore School
(a) Item 5: Adult education fees
 The fees have been received in payment for the provision

of education courses. This is therefore an exchange
transaction and so the relevant accounting standard is
IPSAS 9 Revenue from Exchange Transactions.
 Under IPSAS 9, tuition fees have to be recognised over the

period of instruction. Therefore, only the £106 000 fees
relating to course provided in 20X6 should be recognised
and the amounts received in advance for 20X7 should be
deferred until the following financial year.
 Therefore, £99 000 of the tuition fees must be excluded

from tuition fee income and included within ‘Income in
advance’ under current liabilities in the statement of
financial position as at 31 December 20X6. In the 20X7
financial year, once the tuition has been provided, they can
be released from the deferred revenue liability and
recognised in income.
Item 6: Grant from National Languages Agency
 Unlike the adult education fees, which were received in

direct exchanged for a service, this grant was not received
in direct exchange for an asset or service of the same
value. It is therefore a non-exchange transaction and
therefore the relevant accounting standard is IPSAS 23
Revenue from Non-Exchange Transactions (Taxes and
Transfers).
 Upon receipt, the school would have recognised the entire

grant as a liability as it has conditions attached. As the
school satisfies the condition, that is, as it makes
authorised expenditures, it reduces the liability and
recognises revenue in the statement of financial
performance of the reporting period in which the liability is
discharged. Therefore, £8 000 of the grant can be
recognised in revenue for the year to 31 December 20X6
and the rest (£21 000) will be included in current liabilities.
As all of the grant is currently included within grant
income, grant income will need to be reduced by £21 000.
In the following financial year, assuming that the teacher
remains in employment providing the services stipulated by the grant, the
28
remainder of the grant income can be recognised.

(b) Statement of financial performance for Learnmore School
for the year-ended 31 December 20X6
Workings £
Operating revenue:
Funding grants 1 010 000 – 21 000 (a) 989 000
Rental income 89 000
Tuition fees 205 000 – 99 000 (a) 106 000
Other revenue 345 000
Total operating revenue 1 529 000
Operating expenses:
Wages, salaries and
employee benefits (847 040)
Depreciation 10 106+63 400(W2) (73 506)
Legal claims 7 000 + 460 000 (W3) (467 000)
Other operating expenses 255 000+9 000 (W4) (264 000)
Total operating expenses (1 651 546)
Surplus/(deficit) from
operating activities (122 546)
Finance costs (2 250)
Surplus (deficit) for
(124 796)
the year
29
Statement of financial position for Learn more School

as at 31 December 20X6
Working £
Non-current assets:
Land W1 230 000
Buildings W1 464 894
Equipment W1 253 600
948 494
Current assets:
Receivables 38 460
Short term investments 30 000
Cash 173 400 – 45 000 128 400
196 860
Total assets 1 145 354
Capital:
Capital contributed by
government 275 000
Revaluation reserve 95 000+30 000
+55 000 (W1) 180 000
Accumulated
surpluses/(deficits) 39 000 – 124 796 (85 796)
369 204
Non-current liabilities:
Bank loan 112 000
Provision for legal claim W3 460 000
572 000
Current liabilities:
Payables 75 150
Accrued expenses W4 9 000
99 000+21 000
Income in advance (a) 120 000
204 150
Total capital and liabilities 1 145 354
30
Working 1: Property, plant and equipment

Land Buildings F,F & Eqt
£ £ £
Cost or valuation
b/f 200 000 450 000 567 000
Revaluation (balancing figure) 30 000 25 000 –
c/f 230 000 475 000 567 000
Accumulated depreciation
c/f 30 000 250 000
Revaluation (30 000)
Charge for the year (W2) 10 106 63 400
c/f – 10 106 313 400
Carrying value at year-end 230 000 464 894 253 600
Revaluation of building: Before After Movement

£ £ £
Gross cost 450 000 475 000 25 000
Accumulated depreciation (30 000) – 30 000
Net carrying value 420 000 475 000 55 000
– to
revaluation
reserve
Working 2: Depreciation £000

Buildings: 475/47 = 10 106
Equipment: (567-250) × 20% 63 400
73 506
Working 3: Provisions
Note 3: Provision no longer required. Excess amount paid
(45 – 38 = 7) to operating expenses for the year.
Note 4: Meets IPSAS 19 criteria for provision. Needs to be
discounted at 3% for 3 years:
Discount factor = 1/(1 + .03)3 = 92%
Therefore provision required 92% × £500 000 = £460 000
Working 4: Operating lease
Spread total cost of lease straight line and recognise 6 out of
24 months for 20X6
Total cost of lease (18 months × £2 000) = £36 000
£36 000 × 6 months / 24 months benefit to allocate to 20X6 =
£9 000 (Accruals)
31
77 Mansell Street
London E1 8AN
+ 44 (0)20 75435600
Email: studentsupport@cipfa.org
Website: www.cipfa.org
32

IPFMPSFR - Solutions 5 2023 Final - AA

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5: Preparation of financial statements part 4

PUBLIC SECTOR FINANCIAL REPORTING

Updated December 2022

Valid for exams from June 2023 to March 2024

First published 2016

Copyright © 2020 Chartered Institute of Public Finance and Accountancy

Exercise Solution 5.1

Exercise Solution 5.2

Exercise Solution 5.3

Exercise Solution 5.4

Exercise Solution 5.5

Exercise Solution 5.6

Exercise Solution 5.7

Exercise Solution 5.8

Exercise Solution 5.9

Exercise Solution 5.10

(c) Accounting entry in the following year

(d) Alternative accounting entry in the following year

Exercise Solution 5.11

Exercise Solution 5.12

Exercise Solution 5.13

Exercise Solution 5.14

Exercise Solution 5.15

Exercise Solution 5.16

Exercise Solution 5.17

Exercise Solution 5.18

Exercise Solution 5.19

Exercise Solution 5.20

Exercise Solution 5.21

Exercise Solution 5.22

Directors has made a decision, they have not informed

Exercise Solution 5.23

 The fees have been received in payment for the provision

 Under IPSAS 9, tuition fees have to be recognised over the

 Therefore, £99 000 of the tuition fees must be excluded

 Unlike the adult education fees, which were received in

 Upon receipt, the school would have recognised the entire

remainder of the grant income can be recognised.

Statement of financial position for Learn more School

Working 1: Property, plant and equipment

Revaluation of building: Before After Movement

Working 2: Depreciation £000

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