PREFACE TO INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS)

Summary of Preface to International Financial Reporting Standards

Objective of the Preface to IFRS

The objective of the preface to IFRS is to set out IASB's mission and objectives, the scope of
International Financial Reporting Standards (IFRSs), due process for developing IFRSs and
Interpretations, and policies on effective dates, format, and language for IFRSs.

IASB's Objectives

Under the IFRS Foundation Constitution, the objectives of the IASB are:

• (a) to develop, in the public interest, a single set of high quality, understandable,
enforceable and globally accepted financial reporting standards based upon clearly
articulated principles. These standards should require high quality, transparent and
comparable information in financial statements and other financial reporting to help
investors, other participants in the world’s capital markets and other users of financial
information make economic decisions;

• (b) to promote the use and rigorous application of those standards;

• (c) in fulfilling the objectives associated with (a) and (b), to take account of, as
appropriate, the needs of a range of sizes and types of entities in diverse economic
settings; and

• (d) to promote and facilitate adoption of IFRSs, being the standards and interpretations
issued by the IASB, through the convergence of national accounting standards and
IFRSs.

Scope of IFRSs

• IASB Standards are known as International Financial Reporting Standards.

• All International Accounting Standards (IASs) and Interpretations issued by the former
IASC and SIC continue to be applicable unless and until they are amended or
withdrawn.

• IFRSs apply to the general purpose financial statements and other financial reporting by
profit-oriented entities – those engaged in commercial, industrial, financial, and similar
activities, regardless of their legal form.

• Entities other than profit-oriented business entities may also find IFRSs appropriate.

• General purpose financial statements are intended to meet the common needs of
shareholders, creditors, employees, and the public at large for information about an
entity's financial position, performance, and cash flows.

• Other financial reporting includes information provided outside financial statements that
assists in the interpretation of a complete set of financial statements or improves users'
ability to make efficient economic decisions.

• IFRS apply to individual company and consolidated financial statements.

• A complete set of financial statements includes a statement of financial position, a

 statement of comprehensive income, a statement of cash flows, a statement of changes
in equity, a summary of accounting policies, and explanatory notes. When a separate
income statement is presented in accordance with IAS 1(2007), it is part of that complete
set.

• In developing Standards, IASB intends not to permit choices in accounting treatment.

Further, IASB intends to reconsider the choices in existing IASs with a view to reducing
the number of those choices.

• IFRS will present fundamental principles in bold face type and other guidance in non-
bold type (the 'black-letter'/'grey-letter' distinction). Paragraphs of both types have equal
authority.

• The provision of IAS 1 Presentation of Financial Statements that conformity with IAS
requires compliance with every applicable IAS and Interpretation requires compliance
with all IFRSs as well.

Due Process for IFRS

• Due process steps for a Standard will normally include the following (* below means
required by IFRS Foundation's Constitution):

• staff work to identify and study the issues

• study of existing national standards and practices

• IASB consults with Trustees and the Advisory Council about the advisability of
adding the project to the IASB's agenda*

• IASB normally forms an advisory group

• IASB publishes a discussion document for comment

• IASB considers comments received on the discussion document

• IASB publishes an exposure draft with at least 9 affirmative votes if there are
fewer than 16 members, or 10 if there are 16 members* (the exposure draft will
include dissenting opinions and basis for conclusions)

• IASB considers comments received on the exposure draft*

• IASB considers the desirability of holding a public hearing and of conducting field
tests*

• IASB approves the final Standard with at least 9 affirmative votes if there are
fewer than 16 members, or 10 if there are 16 members* (the Standard will
include dissenting opinions and basis for conclusions)

• IASB publishes a standard with (i) a basis for conclusions, explaining, among
other things, the steps in the IASB's due process and how the IASB dealt with
public comments on the exposure draft, and (ii) the dissenting opinion of any
IASB member.*
 • IASB deliberates in meetings open to public observation.

Due Process for Interpretations

• Interpretations of IFRS will be developed by the IFRS Interpretations Committee for

approval by IASB

• Due process steps for an Interpretation will normally include (* below means required by
IFRS Foundation's Constitution):

• staff work to identify and study the issues and existing national standards and
practices

• The IFRS Interpretations Committee studies national standards and practices

• The IFRS Interpretations Committee publishes a draft Interpretation for comment

if no more than 4 Committee members have voted against the proposal*

• The IFRS Interpretations Committee considers comments received on the draft

Interpretation within a reasonable period of time

• The IFRS Interpretations Committee approves the final Interpretation if no more

than 4 Interpretations Committee members have voted against the proposal and
submits it to IASB*

• IASB approves the final Interpretation by at least 9 affirmative votes of IASB if

there are fewer than 16 members, or by 10 of its members if there are 16
members*

• The IFRS Interpretations Committee deliberates in meetings open to public observation

Effective Dates

• Each IFRS and Interpretation will set out its own effective date and transition provisions

Language

• English is the official language of IASB discussion documents, exposure drafts, IFRSs,
and Interpretations. IASB may approve translations if the process assures the quality of
the translation, and IASB may license other translations.

THE IASB FRAMEWORK

Purpose and status of the Framework
The IFRS Framework describes the basic concepts that underlie the preparation and
presentation of financial statements for external users. The IFRS Framework serves as a guide
to the Board in developing future IFRSs and as a guide to resolving accounting issues that are
not addressed directly in an International Accounting Standard or International Financial
Reporting Standard or Interpretation.

In the absence of a Standard or an Interpretation that specifically applies to a transaction,

management must use its judgement in developing and applying an accounting policy that
results in information that is relevant and reliable. In making that judgement, IAS 8.11 requires
management to consider the definitions, recognition criteria, and measurement concepts for
assets, liabilities, income, and expenses in the IFRS Framework. This elevation of the
importance of the [IFRS] Framework was added in the 2003 revisions to IAS 8.
Other uses of IFRS Framework
• Assist the Board of IASB in promoting and harmonisation of regulations, accounting
standards and procedures relating to the presentation of financial statements by providing a
basis for reducing the number of alternative accounting treatments permitted by IASs.
• Assist national standard- setting bodies in developing national standards
• Assist preparers of financial statements in applying IASs and in dealing with topics that have
yet to form the subject of an IAS.
• Assist auditors in forming an opinion as to whether financial statements conform with IASs
• Assist users of financial statements in interpreting the information contained in financial
statements prepared in conformity with IASs
• Provide those who are interested in the work of IASB with information about its approach to
the formulation of IASs (now IFRSs)

Scope
The IFRS Framework addresses:

• the objective of financial reporting

• the qualitative characteristics of useful financial information

• the reporting entity

• the definition, recognition and measurement of the elements from which financial
statements are constructed

• concepts of capital and capital maintenance

Chapter 1: The Objective of general purpose financial reporting

The primary users of general purpose financial reporting are present and potential investors,
lenders and other creditors, who use that information to make decisions about buying, selling or
holding equity or debt instruments and providing or settling loans or other forms of credit. [F
OB2]

The primary users need information about the resources of the entity not only to assess an
entity's prospects for future net cash inflows but also how effectively and efficiently management
has discharged their responsibilities to use the entity's existing resources (i.e., stewardship). [F
OB4]

The IFRS Framework notes that general purpose financial reports cannot provide all the
information that users may need to make economic decisions. They will need to consider
pertinent information from other sources as well. [F OB6]

The IFRS Framework notes that other parties, including prudential and market regulators, may
find general purpose financial reports useful. However, the Board considered that the objectives
of general purpose financial reporting and the objectives of financial regulation may not be
consistent. Hence, regulators are not considered a primary user and general purpose financial
reports are not primarily directed to regulators or other parties. [F OB10 and F BC1.20-BC 1.23]

Information about a reporting entity's economic resources, claims, and changes in

resources and claims

Economic resources and claims

Information about the nature and amounts of a reporting entity's economic resources and claims
assists users to assess that entity's financial strengths and weaknesses; to assess liquidity and
solvency, and its need and ability to obtain financing. Information about the claims and payment
requirements assists users to predict how future cash flows will be distributed among those with
a claim on the reporting entity. [F OB13]

A reporting entity's economic resources and claims are reported in the statement of financial
position. [See IAS 1.54-80A]

Changes in economic resources and claims

Changes in a reporting entity's economic resources and claims result from that entity's
performance and from other events or transactions such as issuing debt or equity instruments.
Users need to be able to distinguish between both of these changes. [F OB15]

Financial performance reflected by accrual accounting

Information about a reporting entity's financial performance during a period, representing

changes in economic resources and claims other than those obtained directly from investors
and creditors, is useful in assessing the entity's past and future ability to generate net cash
inflows. Such information may also indicate the extent to which general economic events have
changed the entity's ability to generate future cash inflows. [F OB18-OB19]

The changes in an entity's economic resources and claims are presented in the statement of
comprehensive income. [See IAS 1.81-105]

Financial performance reflected by past cash flows

Information about a reporting entity's cash flows during the reporting period also assists users to
assess the entity's ability to generate future net cash inflows. This information indicates how the
entity obtains and spends cash, including information about its borrowing and repayment of
debt, cash dividends to shareholders, etc. [F OB20]

The changes in the entity's cash flows are presented in the statement of cash flows. [See IAS 7]

Changes in economic resources and claims not resulting from financial performance

Information about changes in an entity's economic resources and claims resulting from events
and transactions other than financial performance, such as the issue of equity instruments or
distributions of cash or other assets to shareholders is necessary to complete the picture of the
total change in the entity's economic resources and claims. [F OB21]

The changes in an entity's economic resources and claims not resulting from financial
performance is presented in the statement of changes in equity. [See IAS 1.106-110]

Chapter 2: The Reporting entity

The chapter on the Reporting Entity will be inserted once the IASB has completed its re-deliberations
following the Exposure Draft ED/2010/2 issued in March 2010.
Chapter 3: Qualitative characteristics of useful financial information

The qualitative characteristics of useful financial reporting identify the types of information are
likely to be most useful to users in making decisions about the reporting entity on the basis of
information in its financial report. The qualitative characteristics apply equally to financial
information in general purpose financial reports as well as to financial information provided in
other ways. [F QC1, QC3]
Financial information is useful when it is relevant and represents faithfully what it purports to
represent. The usefulness of financial information is enhanced if it is comparable, verifiable,
timely and understandable. [F QC4]

Fundamental qualitative characteristics

Relevance and faithful representation are the fundamental qualitative characteristics of useful
financial information. [F QC5]

Relevance

Relevant financial information is capable of making a difference in the decisions made by users.
Financial information is capable of making a difference in decisions if it has predictive value,
confirmatory value, or both. The predictive value and confirmatory value of financial information
are interrelated. [F QC6-QC10]

Materiality is an entity-specific aspect of relevance based on the nature or magnitude (or both)
of the items to which the information relates in the context of an individual entity's financial
report. [F QC11]

Faithful representation

General purpose financial reports represent economic phenomena in words and numbers, To be
useful, financial information must not only be relevant, it must also represent faithfully the
phenomena it purports to represent. This fundamental characteristic seeks to maximise the
underlying characteristics of:

• completeness,

• neutrality and

• freedom from error. [F QC12]

Information must be both relevant and faithfully represented if it is to be useful. [F QC17]

Enhancing qualitative characteristics

Comparability, verifiability, timeliness and understandability are qualitative characteristics that

enhance the usefulness of information that is relevant and faithfully represented. [F QC19]

Comparability

Information about a reporting entity is more useful if it can be compared with a similar
information about other entities and with similar information about the same entity for another
period or another date. Comparability enables users to identify and understand similarities in,
and differences among, items. [F QC20-QC21]

Verifiability

Verifiability helps to assure users that information represents faithfully the economic phenomena
it purports to represent. Verifiability means that different knowledgeable and independent
observers could reach consensus, although not necessarily complete agreement, that a
particular depiction is a faithful representation. [F QC26]

Timeliness
Timeliness means that information is available to decision-makers in time to be capable of
influencing their decisions. [F QC29]

Understandability

Classifying, characterising and presenting information clearly and concisely makes it

understandable. While some phenomena are inherently complex and cannot be made easy to
understand, to exclude such information would make financial reports incomplete and potentially
misleading. Financial reports are prepared for users who have a reasonable knowledge of
business and economic activities and who review and analyse the information with diligence. [F
QC30-QC32]

Applying the enhancing qualitative characteristics

Enhancing qualitative characteristics should be maximised to the extent necessary. However,

enhancing qualitative characteristics (either individually or collectively) render information useful
if that information is irrelevant or not represented faithfully. [F QC33]

The cost constraint on useful financial reporting

Cost is a pervasive constraint on the information that can be provided by general purpose
financial reporting. Reporting such information imposes costs and those costs should be
justified by the benefits of reporting that information. The IASB assesses costs and benefits in
relation to financial reporting generally, and not solely in relation to individual reporting entities.
The IASB will consider whether different sizes of entities and other factors justify different
reporting requirements in certain situations. [F QC35-QC39]

Chapter 4: The Framework: the remaining text

Chapter 4 contains the remaining text of the Framework approved in 1989. As the project to revise the
Framework progresses, relevant paragraphs in Chapter 4 will be deleted and replaced by new Chapters in
the IFRS Framework. Until it is replaced, a paragraph in Chapter 4 has the same level of authority within
IFRSs as those in Chapters 1-3.
Underlying assumption

The IFRS Framework states that the going concern assumption is an underlying assumption.
Thus, the financial statements presume that an entity will continue in operation indefinitely or, if
that presumption is not valid, disclosure and a different basis of reporting are required. [F 4.1]

The elements of financial statements

Financial statements portray the financial effects of transactions and other events by grouping
them into broad classes according to their economic characteristics. These broad classes are
termed the elements of financial statements.

The elements directly related to financial position (balance sheet) are: [F 4.4]

• Assets

• Liabilities

• Equity

The elements directly related to performance (income statement) are: [F 4.25]

• Income
 • Expenses

The cash flow statement reflects both income statement elements and some changes in
balance sheet elements.
A process of sub-classification then takes place for presentation in the financial statements e.g.
assets are classified by their nature or function in the business to show information in the best
way for users to take economic decisions.

Definition of Elements of Financial Statements

The three terms listed under the statement of financial position are defined as follows:
.
Asset: A resource controlled by an entity as a result of past events and from which future
economic benefits are expected to flow to the entity.

Liability: A present obligation of the entity from past events, the settlement of which is expected
to result in an outflow from the entity of resources embodying economic benefits.

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

The details at the components of the definitions given above are:

Asset
(a) Future economic benefit: This is the potential to contribute, directly or indirectly, to the flow
of cash and cash equivalents to the entity. The potential may be a productive one that is part of
the operating activities of the entity. It may also take the form of convertibility into cash or cash
equivalents or a capability to reduce cash outflows, such as when an alternative manufacturing
process lowers the cost of production.
Assets are usually employed to produce goods or services for customers, customers will then
pay for these. Cash itself renders a service to the entity due to its command over other
resources.

(b) Control
The existence of an asset, particularly in terms of control, is not reliant on:
• physical form (hence patents and copyrights)
• legal rights (hence lease)

(c) Past event

Transactions or events in the past give rise to assets; those expected to occur in the future do
not in themselves give rise to assets. For example, an intention to purchase a non-current asset
does not in itself, meet the definition of asset

Liabilities
(a) Obligation
An essential characteristic of a liability is that the entity has a present obligation
Obligation: A duty or responsibility to act or perform in a certain way. Obligations may be
legally enforceable as a consequence of a binding contract or statutory requirement. Obligations
also arise, however, from normal business practice, custom and a desire to maintain good
business relations or act in an equitable manner.
It is important to distinguish between a present obligation and a future commitment. A
management decision to purchase assets in the future does not, in itself, give rise to a present
obligation.

(b) Settlement
Settlement of a present obligation will involve the entity giving up resources embodying
economic benefits in order to satisfy the claim of the other party. This may be done in various
ways, not just by payment of cash.

(c) Past event

Liabilities must arise from past transactions or events. In the case of, say, recognition of
future rebates to customers based on annual purchases, the sale of goods in the past is the
transaction that gives rise to the liability.
Provision: A present obligation which satisfies the rest of the definition of a liability, even if the
amount of the obligation has to be estimated.

Equity
Equity is defined above as a residual, but it may be sub-classified in the statement of financial
position. This will indicate legal or other restrictions on the ability of the entity to distribute or
otherwise apply its equity. Some resrves are required by statute or other law, eg. for the future
protection of the creditors. The amount shown for equity depends on the measurement of
assets and liabilities. It has nothing to do with the market value of the entity’s shares.

Performance
Profit is used as a measure of performance, or as a basis for other measures (e.g.EPS), it
depends directly on the measurement of income and expenses, which in turn depend (in part)
on the concepts of capital and capital maintenance adopted.
The elements of income and expense are therefore defined.

Income: Increases in economic benefits during the accounting period in the form of inflows or
enhancements of assets or decreases of liabilities that result in increase in equity, other than
those relating to contributions from equity participants.

Expenses: Decrease in economic benefits during the accounting period in the form of outflows
or depletions of assets or incurrences of liabilities that result in decrease in equity, other than
those relating to distributions to equity participants.

Income and expenses can be presented in different ways in the statement of comprehensive
income, to provide information relevant for economic decision-making. For example, distinguish
between income and expenses which relate to continuing operations and those which do not.
Items of income and expense can be distinguished from each other combined with each
other.
Income
The definition of income encompasses both revenue and gains. Revenue arises in the course
of the ordinary activities of an entity and is referred to by a variety of different names including
sales, fees, interest, dividends, royalties and rent. Gains represent other items that meet the
definition of income and may, or may not, arise in the course of the ordinary activities of an
entity. Gains represent increases in economic benefits and as such are no different in nature
from revenue. Hence, they are not regarded as constituting a separate element in the IFRS
Framework. [F 4.29 and F 4.30]

Expenses
The definition of expenses encompasses losses as well as those expenses that arise in the
course of the ordinary activities of the entity. Expenses that arise in the course of the ordinary
activities of the entity include, for example, cost of sales, wages and depreciation. They usually
take the form of an outflow or depletion of assets such as cash and cash equivalents, inventory,
property, plant and equipment. Losses represent other items that meet the definition of
expenses and may, or may not, arise in the course of the ordinary activities of the entity. Losses
represent decreases in economic benefits and as such they are no different in nature from other
expenses. Hence, they are not regarded as a separate element in this Framework. [F 4.33 and
F 4.34]

Recognition of the Elements of Financial Statements

Recognition: This is the process of incorporating in the statement of financial position or
statement of comprehensive income an item that meets the definition of an element and
satisfies the following criteria for recognition:
• it is probable that any future economic benefit associated with the item will flow to or
from the entity and
• the item has a cost or value that can be measured with reliability.

Probability of Future Economic Benefits

Probability here means the degree of uncertainty that the future economic benefits associated
with an item will flow to or from the entity. This must be judged on the basis of the
characteristics of the entity’s environment and the evidence available when the financial
statements are prepared.

Reliability of Measurement
The cost or value of an item, in many cases, must be estimated. The framework states,
however, that the use of reasonable estimates is an essential part of the preparation of financial
statements and does not undermine their reliability. When no reasonable estimate can be made,
the item should not be recognised, although its existence should be disclosed in the notes or
other explanatory material.
Items may still qualify for recognition at a later date due to changes in circumstances, or
subsequent events.
Based on these general criteria:

• An asset is recognised in the balance sheet when it is probable that the future economic
benefits will flow to the entity and the asset has a cost or value that can be measured
reliably. [F 4.44]

• A liability is recognised in the balance sheet when it is probable that an outflow of

resources embodying economic benefits will result from the settlement of a present
obligation and the amount at which the settlement will take place can be measured
reliably. [F 4.46]

• Income is recognised in the income statement when an increase in future economic

benefit related to an increase in an asset or a decrease of a liability has arisen that can
be measured reliably. This means, in effect, that recognition of income occurs
simultaneously with the recognition of increases in assets or decreases in liabilities (for
example, the net increase in assets arising on a sale of goods or services or the
decrease in liabilities arising from the waiver of a debt payable). [F 4.47]

• Expenses are recognised when a decrease in future economic benefits related to a

decrease in an asset or an increase of a liability has arisen that can be measured
reliably. This means, in effect, that recognition of expenses occurs simultaneously with
the recognition of an increase in liabilities or a decrease in assets (for example, the
accrual of employee entitlements or the depreciation of equipment). [F 4.49]
Measurement of the Elements of Financial Statements
Measurement involves assigning monetary amounts at which the elements of the financial
statements are to be recognised and reported. [F 4.54]
The IFRS Framework acknowledges that a variety of measurement bases are used today to
different degrees and in varying combinations in financial statements, including: [F 4.55]
 • Historical cost
• Current cost
• Realisable (settlement) value
• Present value of future cash flows

(a) Historical cost:

Thisis the measurement basis most commonly used today, but it is usually combined with other
measurement bases. [F. 4.56] The IFRS Framework does not include concepts or principles for
selecting which measurement basis should be used for particular elements of financial
statements or in particular circumstances. Individual standards and interpretations do provide
this guidance
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 amount 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:

• Realisable value. The amount of cash or cash equivalents that could currently be
obtained by selling an asset in an orderly disposal.
• Settlement value. 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: A current estimate of the present discounted value of the future net cash
flows in the normal course of business. For assets, the value to record is the discounted future
cash fllow resulting from future income to be realised from the use of the asset. For liabilities,
the value to record is the discounted future cash flow required to settle the liabilities.

Concepts of Capital and Capital Maintenance

Introduction
Profit is the differene between an entity’s capital at the beginning and the end of an accounting
period. But the capital could be ‘financial’ or ‘operating’

Concepts of capital
There are two traditional concepts of capital (a) financial concept and (b) physical concept
(a) Financial Concept
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. In other words, financial captial
is the aggregate of shares and reserves and is known as shareholders’ funds. The financial
concept of capital will 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.

(b) 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. In other words,
physical capital is the aggregation of non-current assets, inventories and monetary working
capital. The physical concept of capital will be adopted if the users of financial statements are
concerned with the operating capability of the entity.
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.

Concepts of Capital Maintenance and the Determination of Profit

The concepts of capital above 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.
Financial capital maintenance can be measured in either nominal monetary units or units of
constant purchasing power.
The objective of financial capital maintenance is to maintain shareholders’s wealth.

(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 of 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.
The objective of operating capital maintenance is to maintain operating capacity of the entity.
The concept of capital maintenance is concerned with how an entity defines the capital that it
seeks to maintain. It provides the linkage between the concepts of capital and the concepts of
profit because it provides the point of reference by which profit is measured. It is a prerequisite
for distinguishing between an entity’s return on capital and its return of capital; only inflows of
assets in excess of amounts needed to maintain capital may be regarded as profit and therefore
as a return on capital.
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.

REVIEW QUESTIONS
1. Two of the qualitative characteristics of information contained in the IASB’s Conceptual Framework for
Financial
Reporting are understandability and comparability.
Required:
Explain the meaning and purpose of the above characteristics in the context of financial reporting
and discuss the role of consistency within the characteristic of comparability in relation to
changes in accounting policy.
(6 marks) ACCA DECEMBER 2012

2. Your assistant has been reading the IASB’s Framework for the preparation and presentation of
financial
statements (Framework) and as part of the qualitative characteristics of financial statements under the
heading
of ‘relevance’ he notes that the predictive value of information is considered important. He is aware that
financial
statements are prepared historically (i.e. after transactions have occurred) and offers the view that the
predictive
value of financial statements would be enhanced if forward-looking information (e.g. forecasts) were
published
rather than backward-looking historical statements.
Required:
By the use of specific examples, provide an explanation to your assistant of how IFRS
presentation and
disclosure requirements can assist the predictive role of historically prepared financial
statements.
(6 marks) ACCA JUNE 2011

3. The Conceptual Framework for Financial Reporting identifies faithful representation as a fundamental
qualitative
characteristic of useful financial information.
Required:
Distinguish between fundamental and enhancing qualitative characteristics and explain why faithful
representation is important. (5 marks) ACCA DECEMBER 2013

4. The International Accounting Standards Board (IASB) has begun a joint project to revisit its conceptual
framework for financial accounting and reporting. The goals of the project are to build on the existing
frameworks and converge them into a common framework.
Required:
(a) Discuss why there is a need to develop an agreed international conceptual framework and the
extent to which an agreed international conceptual framework can be used to resolve practical
accounting issues.
(13 marks)
(b) Discuss the key issues which will need to be addressed in determining the basic components
of an
internationally agreed conceptual framework. (10 marks)
Appropriateness and quality of discussion. (2 marks)
(25 marks) ACCA CORPORATE REPORTING DECEMBER 2007

SUGGESTED SOLUTIONS
1 (a) The main objective of financial statements is to provide information that is useful to a wide range of
users for the purpose of making economic decisions. Therefore, it is important that the activities and
events of the entity, as expressed within the financial statements, are understood by users, meaning that
their usefulness and relevance is maximised. This can present management with a problem because
clearly not all users have the same (financial) abilities and knowledge. For the purpose of
understandability, management are allowed to assume users do have a reasonable knowledge of
accounting and business and are prepared to study the financial statements diligently. Importantly, this
characteristic cannot be used by management to avoid disclosing complex information that may be
relevant in user decision-making. However, management must recognise that too much or overly complex
disclosure can obscure the more important aspects of an entity’s performance, i.e. important information
should not be ‘buried’ in the detail of unfathomable information.
Comparability is the main tool by which users can assess the performance of an entity. This can be done
through trend analysis of the same entity’s financial statements over time (say five years), or by
comparing one entity with other (suitable) entities (or business sector averages) for the same time period.
This means that the measurement and disclosure (classification) of like transactions should be consistent
over time for the same entity, and (ideally) between different entities.
Consistency and comparability are facilitated by the existence and disclosure of accounting policies. The
above illustrates the close correlation between comparability and consistency. However, it is not always
possible for an entity to apply the same accounting policies every year; sometimes they have to change
(e.g. because of a new accounting standard or a change in legislation). Similarly, it is not practical for
accounting standards to require all entities to adopt the same accounting policies.
Thus, if an entity does change an accounting policy, this breaks the principle of consistency. In such
circumstances, IFRSs normally require that any reported comparatives (previous year’s financial
statements) are restated as if the new policy had been in force when those statements were originally
reported. In this way, although there has been a change of policy, comparability has been maintained.
It is more difficult to address the issue of consistency across entities; as already stated, accounting
standards cannot prescribe the use of the same policy for all entities (this would be uniformity). However,
accounting standards do prohibit certain accounting treatments (considered inappropriate or inferior) and
they do require entities to disclose their accounting policies, such that users become aware of differences
between entities and this may allow them to make value adjustments when comparing entities using
different policies.

2. Two important and interrelated aspects of relevance are its confirmatory and predictive roles. The
Framework specifically states that to have predictive value, information need not be in the form of an
explicit forecast. The serious drawback of forecast information is that it does not have (strong)
confirmatory value; essentially it will be an educated guess.
IFRS examples of enhancing the predictive value of historical financial statements are:
(i) The disclosure of continuing and discontinued operations. This allows users to focus on those areas of
an entity’s
operations that will generate its future results. Alternatively it could be thought of as identifying those
operations which
will not yield profits or, perhaps more importantly, losses in the future.
(ii) The separate disclosure of non-current assets held for sale. This informs users that these assets do
not form part of an entity’s long-term operating assets.
(iii) The separate disclosure of material items of income or expense (e.g. a gain on the disposal of a
property). These are often ‘one off’ items that may not be repeated in future periods. They are sometimes
called ‘exceptional’ items or
described in the Framework as ‘unusual, abnormal and infrequent’ items.
(iv) The presentation of comparative information (and the requirement for the consistency of its
presentation such as
retrospective application of changes in accounting policies) allows for a degree of trend analysis. Recent
trends may help predict future performance.
(v) The requirement to disclose diluted EPS is often described as a ‘warning’ to shareholders of what EPS
would have been if any potential (future) equity shares such as convertibles and options had already been
exercised.
(vi) The Framework’s definitions of assets (resources from which future economic benefits should flow)
and liabilities
(obligations which will result in a future outflow of economic benefits) are based on an entity’s future
prospects rather
than its past costs.

3. The Conceptual Framework for Financial Reporting implies that the two fundamental qualitative
characteristics (relevance and faithful representation) are vital as, without them, financial statements
would not be useful, in fact they may be misleading. As the name suggests, the four enhancing qualitative
characteristics (comparability, verifiability, timeliness and understandability) improve the usefulness of the
financial information. Thus financial information which is not relevant or does not give a faithful
representation is not useful (and worse, it may possibly be misleading); however, financial information
which does not possess the enhancing characteristics can still be useful, but not as useful as if it did
possess them.
In order for financial statements to be useful to users (such as investors or loan providers), they must
present financial
information faithfully, i.e. financial information must faithfully represent the economic phenomena which it
purports to
represent (e.g. in some cases it may be necessary to treat a sale and repurchase agreement as an in-
substance (secured) loan rather than as a sale and subsequent repurchase). Faithfully represented
information should be complete, neutral and free from error. Substance is not identified as a separate
characteristic because the IASB says it is implied in faithful representation such that faithful
representation is only possible if transactions and economic phenomena are accounted for according to
their substance and economic reality.
4 (a) The IASB wish their standards to be ‘principles-based’ and in order for this to be the case, the
standards must be based on fundamental concepts. These concepts need to constitute a framework
which is sound, comprehensive and internally consistent. Without agreement on a framework, standard
setting is based upon the personal conceptual frameworks of the individual standard setters which may
change as the membership of the body changes and results in standards that are not consistent with
each other. Such a framework is designed not only to assist standard setters, but also preparers of
financial statements, auditors and users.
A common goal of the IASB is to converge their standards with national standard setters. The IASB will
encounter difficulties converging their standards if decisions are based on different frameworks. The IASB
has been pursuing a number of projects that are aimed at achieving short term convergence on certain
issues with national standard setters as well as major projects with them. Convergence will be difficult if
there is no consistency in the underlying framework being used.
Frameworks differ in their authoritative status. The IASB’s Framework requires management to expressly
consider the
Framework if no standard or interpretation specifically applies or deals with a similar and related issue.
However, certain frameworks have a lower standing. For example, entities are not required to consider
the concepts embodied in certain national frameworks in preparing financial statements. Thus the
development of an agreed framework would eliminate differences in the authoritative standing of
conceptual frameworks and lead to greater consistency in financial statements internationally.
The existing concepts within most frameworks are quite similar. However, these concepts need revising to
reflect changes in markets, business practices and the economic environment since the concepts were
developed. The existing frameworks need developing to reflect these changes and to fill gaps in the
frameworks. For example, the IASB’s Framework does not contain a definition of the reporting entity. An
agreed international framework could deal with this problem, especially if priority was given to the issues
likely to give short-term standard setting benefits.
Many standard setting bodies attempted initially to resolve accounting and reporting problems by
developing accounting standards without an accepted theoretical frame of reference. The result has been
inconsistency in the development of standards both nationally and internationally. The frameworks were
developed when several of their current standards were in existence. In the absence of an agreed
conceptual framework the same theoretical issues are revisited on several occasions by standard setters.
The result is inconsistencies and incompatible concepts. Examples of this are substance over form and
matching versus prudence. Some standard setters such as the IASB permit two methods of accounting
for the same set of circumstances. An example is the accounting for joint ventures where the equity
method and proportionate consolidation are allowed.
Additionally there have been differences in the way that standard setters have practically used the
principles in the framework.
Some national standard setters have produced a large number of highly detailed accounting rules with
less emphasis on general principles. A robust framework might reduce the need for detailed rules
although some companies operate in a different legal and statutory context than other entities. It is
important that a framework must result in standards that account appropriately for actual business
practice.
An agreed framework will not solve all accounting issues, nor will it obviate the need for judgement to be
exercised in resolving accounting issues. It can provide a framework within which those judgements can
be made.
A framework provides standard setters with both a foundation for setting standards, and concepts to use
as tools for resolving accounting and reporting issues. A framework provides a basic reasoning on which
to consider the merits of alternatives. It does not provide all the answers, but narrows the range of
alternatives to be considered by eliminating some that areinconsistent with it. It, thereby, contributes to
greater efficiency in the standard setting process by avoiding the necessity of having to redebate
fundamental issues and facilitates any debate about specific technical issues. A framework should also
reduce political pressures in making accounting judgements. The use of a framework reduces the
influence of personal biases in accounting decisions.
However, concepts statements are by their nature very general and theoretical in their wording, which
leads to alternative conclusions being drawn. Whilst individual standards should be consistent with the
Framework, in the absence of a specific standard, it does not follow that concepts will provide practical
solutions. IAS8 ‘Accounting Policies, Changes in Accounting Estimates and Errors’ sets out a hierarchy of
authoritative guidance that should be considered in the absence of a standard.
In this case, management can use its judgement in developing and applying an accounting policy, albeit
by considering the IASB framework, but can also use accounting standards issued by other bodies. Thus
an international framework may not totally provide solutions to practical accounting problems.

(b) There are several issues which have to be addressed if an international conceptual framework is to be
successfully developed.
These are:
(i) Objectives
Agreement will be required as to whether financial statements are to be produced for shareholders or a
wide range of
users and whether decision usefulness is the key criteria or stewardship. Additionally there is the question
of whether
the objective is to provide information in making credit and investment decisions.
(ii) Qualitative Characteristics
The qualities to be sought in making decisions about financial reporting need to be determined. The
decision usefulness of financial reports is determined by these characteristics. There are issues
concerning the trade-offs between relevance and reliability. An example of this concerns the use of fair
values and historical costs. It has been argued that historical costs are more reliable although not as
relevant as fair values. Additionally there is a conflict between neutrality and the traditions of prudence or
conservatism. These characteristics are constrained by materiality and benefits that justify costs.
(iii) Definitions of the elements of financial statements
The principles behind the definition of the elements need agreement. There are issues concerning
whether ‘control’
should be included in the definition of an asset or become part of the recognition criteria. Also the
definition of ‘control’
is an issue particularly with financial instruments. For example, does the holder of a call option ‘control’
the underlying
asset? Some of the IASB’s standards contravene its own conceptual framework. IFRS3 requires the
capitalisation of
goodwill as an asset despite the fact that it can be argued that goodwill does not meet the definition of an
asset in the
Framework. IAS12 requires the recognition of deferred tax liabilities that do not meet the liability definition.
Similarly
equity and liabilities need to be capable of being clearly distinguished. Certain financial instruments could
either be
liabilities or equity. For example obligations settled in shares.
(iv) Recognition and De-recognition
The principles of recognition and de-recognition of assets and liabilities need reviewing. Most frameworks
have
recognition criteria, but there are issues over the timing of recognition. For example, should an asset be
recognised when a value can be placed on it or when a cost has been incurred? If an asset or liability
does not meet recognition criteria when acquired or incurred, what subsequent event causes the asset or
liability to be recognised? Most frameworks do not discuss de-recognition. (The IASB’s Framework does
not discuss the issue.) It can be argued that an item should be de-recognised when it does not meet the
recognition criteria, but financial instruments standards (IAS39) require other factors to occur before
financial assets can be de-recognised. Different attributes should be considered such as legal ownership,
control, risks or rewards.
(v) Measurement
More detailed discussion of the use of measurement concepts, such as historical cost, fair value, current
cost, etc are
required and also more guidance on measurement techniques. Measurement concepts should address
initial
measurement and subsequent measurement in the form of revaluations, impairment and depreciation
which in turn
gives rise to issues about classification of gains or losses in income or in equity.
(vi) Reporting entity
Issues have arisen over what sorts of entities should issue financial statements, and which entities should
be included
in consolidated financial statements. A question arises as to whether the legal entity or the economic unit
should be the reporting unit. Complex business arrangements raise issues over what entities should be
consolidated and the basis upon which entities are consolidated. For example, should the basis of
consolidation be ‘control’ and what does ‘control’ mean?
(vii) Presentation and disclosure
Financial reporting should provide information that enables users to assess the amounts, timing and
uncertainty of the
entity’s future cash flows, its assets, liabilities and equity. It should provide management explanations and
the limitations of the information in the reports. Discussions as to the boundaries of presentation and
disclosure are required.

THE IAS AND IFRS CURRENTLY IN ISSUE

Standard Title Date issued/Revised
IAS 1 Presentation of Financial Statements 2007
IAS 2 Inventories 2005
IAS 7 Statements of Cash Flows 1992
IAS 8 Accounting Policies, Changes in Accounting Estimates
and Errors 2003
IAS 10 Events After the Reporting Period 2003
IAS 11 Construction Contracts 1993
IAS 12 Income Taxes 1996
IAS 16 Properties, Plant and Equipment 2003
IAS 17 Leases 2003
IAS 18 Revenue 1993
IAS 19 Employee Benefits 2011
IAS 20 Accounting for Government Grants and Disclosure of
Government Assistances 1983
IAS 21 The Effects of Changes in Foreign Exchange Rates 2003
IAS 23 Borrowing Costs 2007
IAS 24 Related Party Disclosures 2009
IAS 26 Accounting and Reporting by Retirement Benefit Plans 1987
IAS 27 Separate Financial Statements 2011
IAS 28 Investments in Associates and Joint Ventures 2011
IAS 29 Financial Reporting in HyperInflationary Economies 1989
IAS 32 Financial Instruments: Presentation 2003
IAS 33 Earnings Per Share 2003
IAS 34 Interim Financial Reporting 1998
IAS 36 Impairment of Assets 2004
IAS 37 Provisions, Contingemt Liabilities and Contingent Assets 1998
IAS 38 Intangible Assets 2004
IAS 39 Financial Instruments: Recognition and Measurements 2003
(Superseded by IFRS 9 January 2018)
IAS 40 Investment Property 2003
IAS 41 Agriculture 2001
IFRS 1 First-time Adoption of International Financial Standards 2008
IFRS 2 Share Based Payment 2004
IFRS 3 Business Combinations 2008
IFRS 4 Insurance Contracts 2004
IFRS 5 Non – Current Assets Held for Sale and Discontinued
Operations 2004
IFRS 6 Exploration for and Evaluation of Mineral Assets 2004
IFRS 7 Financial Instruments: Disclosures 2005
IFRS 8 Operating Segments 2006
IFRS 9 Financial Instruments 2010
IFRS 10 Consolidated Financial Statements 2011
IFRS 11 Joint Arrangements 2011
IFRS 12 Disclosure of Interest in Other Entities 2011
IFRS 13 Fair Value Measurement 2011
IFRS 14 Regulatory Deferral Accounts 2014
IFRS 15 Revenue Recognition in Contracts with Customers 2014

IAS 1 PRESENTATION OF FINANCIAL STATEMENTS

The IASB issued IAS 1 revised in September 2007; the intention of the revision is to aggregate
information in the financial statements on the basis of shared characteristics and by this
improves the information provided to users.
Components of Financial Statements
A complete set of financial statements has the following components:
• A statement of financial position at the end of the reporting period
• A statement of comprehensive income for the period (or income statement and separate
statement showing other comprehensive income)
• A statement of change in equity for the period
• A statement of cash flows for the period
• Accounting policies note and other explanatory notes
• A statement of financial position at the beginning of the earliest comparative period when an
entity applies an accounting policy retrospectively or corrects an error retrospectively

Other reports and statements in the annual report, e.g. a financial review, an environmental
report, a social report etc, are outside the scope of IFRS

How items are disclosed

IAS 1 specifies disclosure of certain items in certain ways.
• Some items must appear on the face of the statement of financial position or statement of
comprehensive income.
• Other items can appear in a note to the financial statements instead
• Recommended formats are given which entities may or may not follow, depending on their
circumstances
Obviously, disclosures specified by other standards must also be made, which you are going
to meet as you study the disclosure requirements of the other standards.

Identification of financial statements

As a result of the above point, it is important that entities distinguish the financial statements
very clearly from any other information published with them. This is because IASs/IFRSs apply
only to the financial statements (i.e. the main statements and related notes), so readers of the
annual report must be able to differentiate the parts of the report which are prepared under
IFRS, and other parts which are not.
The entity should identify each financial statement and the notes very clearly. IAS 1 also
requires disclosure of the following information in a prominent position. If necessary it should be
repeated wherever it is felt to be of use to the reader in his understanding of the information
presented.
• Name of the reporting entity (or other means of identification)
• Whether the accounts cover the single entity only or a group of entities
• The date of the end of the reporting period or the period covered by the financial
statements (as appropriate)
• The presentation currency
• The level of rounding used in presenting amounts in the financial statements
Judgement must be used to determine the best method of presenting this information. In
particular, the standard suggests that the approach to this will be very different when the
financial statements are communicated electronically.
The level of rounding is important, as presenting figures in thousands or millions of units make
the figures more understandable. The level of rounding must be disclosed, however, and it
should not obscure necessary details or make the information less relevant.

Reporting period
It is normal for entities to present financial statements annually and IAS 1 states that they
should be prepared at least as often as this. If (unusually) the end of the entity’s reporting period
is changed, for whatever reason, the period for which the statements are presented will be less
or more than one year. In such cases the entity should also disclose:
• the reason(s) why a period other than one year is used; and
 • the fact that the comparative figures given are not in fact comparable
For practical purposes, some entities prefer to use a period which approximates to a year,
e.g.52 weeks, and the IAS allows this approach as it will produce statements not materially
different from those produced on an annual basis.

Timeliness
If the publication of financial statements is delayed too long after the reporting period, their
usefulness will be severely diminished. The standard states that entities should be able to
produce their financial statements within six months of the end of the reporting period. An
entity with consistently complex operations cannot use this as a reason for its failure to report on
a timely basis. Local legislation and market regulation imposes deadlines on certain entities.

Overall consideration- Accounting Concepts

A Going concern
Once management’s assessment is that there are no material uncertainties as to the ability of
an entity to continue for the foreseeable future, financial statements should be prepared on the
assumption that the entity will in fact continue, the going concern basis.

B Accrual basis of accounting

The accruals basis of accounting means that transactions and events are recognised when they
occur, not when cash is received or paid for them. IFRS in general, and IAS 1 in particular do
not approach things from a matching viewpoint.

C Consistency of presentation
The presentation and classification of items in the financial statements should be retained from
one period to the next unless:
• it is clear that a change will result in a more appropriate presentation
• a change is required by a Standard or an Interpretation

D Materiality and aggregation

An item is material if its omission or misstatement could influence the economic decisions of
users taken on the basis of the financial statements. Financial statements should therefore
show material items separately, but immaterial items may be aggregated with amounts of a
similar nature.

E Offsetting
Assets and liabilities, and income and expenses, should not be offset except when required or
permitted by a Standard or an Interpretation

F Comparative information
Comparative information for the previous period should be disclosed unless a Standard or an
Interpretation permits or requires otherwise.

G Compliance with IFRS

An entity whose financial statements comply with IFRS should make an explicit and unreserved
statement of such compliance in the notes.

Statement of financial position

The statement of financial position is largely the same as the balance sheet presented in the
previous IAS 1, with one exception
• Reserves other than share capital and retained earnings are now referred to as ‘other
components of equity’
Format of Statement of Financial Position
XYZ Group
Statement of financial position as at 31 December 2010
2010 2009
ASSETS N N N N
Non – current assets
Property, plant and Equipment XX XX
Goodwill XX XX
Other Intangible assets XX XX
Investment in Associates XX XX
Available for sale financial assets XX XX
XX XX
Current assets
Inventories XX XX
Trade receivables XX XX
Other current assets XX XX
Cash and cash equivalent XX XX
XX XX
Total assets (A) XX XX

Equity and liabilities

Ordinary share capital XX
XX
Retained earnings XX XX
Other components of equity XX XX
XX XX
Non-controlling interest XX XX
Total equity XX XX

Non-current liabilities:
Long-term borrowings XX XX
Deferred taxation XX XX
Long-term provisions XX XX
Total non-current liabilities XX XX

Current liabilities
Trade and other payable XX XX
Short-term borrowings XX XX
Current portion of long-term borrowings XX XX
Current tax payable XX XX
Short-term provisions XX XX
XX XX
Total equity and liabilities (B) XX XX

Items that must be disclosed on the face of the financial position

Items which must appear on the face of the financial statements of financial position as a
minimum disclosure are:
• Property, plant and equipment
• Investment property
• Intangible assets
• Financial assets (excluding the amounts shown under (e), (h), and (j)
• Investments accounted for using the equity method
• Biological assets
• Inventories
 • Trade and other receivables
• Cash and cash equivalent
• Assets classified as held for sale under IFRS 5
• Trade and other payables
• Provisions
• Financial liabilities (other than (j) and (k)
• Current tax liabilities and assets as in IAS 12
• Deferred tax liabilities and assets
• Liabilities included in disposal groups
• Non-controlling interests (minority interest)
• Issued capital and reserves
Any other line items, headings, or sub-totals should be shown on the face of the statement of
financial position when it is necessary for an understanding of the entity’s financial position.
The IAS however, does not prescribe the order or format in which the items listed should be
presented. It simply states that they must be presented separately because they are so
different in nature or function from each other.
Whether additional items are presented separately depends on the judgements based on the
assessment of the following factors:
• Nature and liquidity of assets and their materiality. Thus goodwill and assets arising
from development expenditure will be presented separately, as will monetary/non-
monetary assets and current/non-current assets.
• Function within the entity. Operating and financial assets, inventories, receivables and
cash and cash equivalents are therefore shown separately.
• Amounts, nature and timing of liabilities. Interest-bearing and non-interest bearing
liabilities and provisions will be shown separately, classified as current or non-current as
appropriate.
The standard also requires separate presentation where different measurement bases are
used for assts and liabilities which differ in nature or function. According to IAS 16, for example,
it is permitted to carry certain items of property, plant and equipment at cost or at a revalued
amount.

Information presented either on the face of the statement of financial position or by note
Further sub-classification of the line items above should be disclosed either on the face of the
statement of financial position or in the notes. The classification will depend upon the nature of
the entity’s operations. As well as each item being sub-classified by its nature, any amounts
payable or receivable from any group company or other related party should also be
disclosed separately.
The sub-classification details will in part depend on the requirements of IFRSs. The size, nature
and function of the amounts involved will also be important and the factors listed above should
be considered.
Disclosure will vary from item to item and IAS 1 gives the following examples.
• Property, plant and equipment are classified by class as described in IAS 16 on
Property, plant and equipment
• Receivables are analysed between amounts receivable from trade customers, other
members of the group, receivables from related parties, prepayments and other
amounts.
• Inventories are sub-classified in accordance with IAS 2 on Inventories, into
classifications such as merchandise, production supplies, materials, work in progress
and finished goods.
• Provisions are analysed showing separately provisions for employees benefit costs and
any other items classified in a manner appropriate to the entity’s operations.
• Equity capital and reserves are analysed showing separately the various classes of
paid in capital, share premium and reserves.
The standard then lists some specific disclosures which must be made, either on the face of
the statement of financial position or in the related notes.
(a) Share capital disclosure (for each class of share capital)
(i) Number of shares authorised
(ii) Number of shares issued and fully paid, and issued but not fully paid
(iii) Par value per share, or that the shares have no par value
(iv) Reconciliation of the number of shares outstanding at the beginning of the year and
at the end of the year
(v) Rights, preferences and restrictions attaching to that class including restrictions on
the distribution of dividends and the repayment of capital
(vi) Shares in the entity held by the entity itself or by related group companies
(vii) Shares reserved for issuance under options and sales contracts, including the
terms and amounts.

(b) Description of the nature and purpose of each reserve within owners’ equity

Some types of entity have no share capital e.g. partnerships. Such entities should disclose
information which is equivalent to that listed above. This means disclosing the movement during
the period in each category of equity interest and any rights, preference or restrictions attached
to each category of equity interest.

Statement of comprehensive income

Income and expenses to be presented either:
• in a single statement of comprehensive income (both ‘profit for the year’ combined with
‘other comprehensive income)
• in two statements: a separate income statement and statement of other comprehensive
income

Other comprehensive income includes:

(a) changes in revaluation surplus
(b) actuarial gains and losses on defined benefit plans recognised in accordance with IAS 19
Employees Benefits
(c) gains and losses arising from translating the financial statements of a foreign operation
(d) gains and losses on re-measuring available for sale financial assets
(e) the effective portion of gains and losses on hedging instruments in a cash flow hedge

IAS 1 allows a choice of two presentations of comprehensive income:

(1) A statement of comprehensive income showing all non-owner changes in equity (total
comprehensive income), or
(2) An income statement showing the income and expenses recognised in profit or loss PLUS a
statement showing income and expenses required to be recognised outside of profit or loss
(other comprehensive income.

Format one: Statement of Comprehensive Income

Comprehensive Income Statement format – Classification by function
XYZ Group
Statement of Comprehensive Income for the year ended 31 December 2010
2010 2009
N N
Revenue XX XX
Cost of sales XX XX
Gross profit XX XX
Other income XX XX
Distribution costs (XX) (XX)
Administrative expenses (XX) (XX)
Other expenses (XX) (XX)
XX XX
Finance costs (XX) (XX)
Share of profit of associates XX XX
Profit before tax XX XX
Income tax expense (XX) (XX)
Profit for the period XX XX
Other comprehensive income
Exchange difference on translating foreign operations XX XX
Available-for-sale financial assets XX XX
Cash flow hedges XX XX
Gain on property revaluation XX XX
Actuarial gains/(losses) on defined benefit pension plans XX (XX)
Share of other comprehensive income of associates XX XX
Income tax relating components of other Comprehensive Inc(XX) (XX)
Other comprehensive income for the year net of tax XX XX
Total comprehensive income for the year XX XX

Profit attributable to:

Owners of the parent XX XX
Non-Controlling interest XX XX
XX XX

Format two: separate income statement and statement showing other comprehensive
income
XYZ Group
Statement of Comprehensive Income for the year ended 31 December 2010
2010 2009
N N
Revenue XX XX
Cost of sales XX XX
Gross profit XX XX
Other income XX XX
Distribution costs (XX) (XX)
Administrative expenses (XX) (XX)
Other expenses (XX) (XX)
XX XX
Finance costs (XX) (XX)
Share of profit of associates XX XX
Profit before tax XX XX
Income tax expense (XX) (XX)
Profit for the period XX XX
Profit attributable to:
Owners of the parent XX XX
Non-Controlling interest XX XX
XX XX

XYZ Group
Statement of Comprehensive Income for the year ended 31 December 2010
2010 2009
N N
Profit for the year XX XX
Other comprehensive income
Exchange difference on translating foreign operations XX XX
Available-for-sale financial assets XX XX
Cash flow hedges XX XX
Gain on property revaluation XX XX
Actuarial gains/(losses) on defined benefit pension plans XX (XX)
Share of other comprehensive income of associates XX XX
Income tax relating components of other Comprehensive Inc(XX) (XX)
Other comprehensive income for the year net of tax XX XX
Total comprehensive income for the year XX XX

Profit attributable to:

Owners of the parent XX XX
Non-Controlling interest XX XX
XX XX
Other comprehensive income and related tax
IAS 1 requires an entry to disclose income tax expense relating to each component of other
comprehensive income.
This may be achieved by either:
• disclosing each component of other comprehensive income net of any related tax effect or
• disclosing other comprehensive income before related tax effects with one amount shown
for tax (as in the above example)
The purpose of this is to provide users with tax information relating to these components, as
they often have tax rates different from those applied to profit and loss

Income Statement format classification of expenses by nature

XYZ Group
Income Statement for the year ended 31 December 2010
2010 2009
N N
Revenue XX XX
Other income XX XX
Changes in inventories of finished goods and work in prog XX XX
Work performed by the enterprise and capitalized XX XX
Raw material and consumables used (XX) (XX)
Employee benefits expense (XX) (XX)
Depreciation and amortization expenses (XX) (XX)
Impairment of property, plant and equipment (XX) (XX)
Other operating expenses (XX) (XX)
XX XX
Finance costs (XX) (XX)
Share of profits of associates XX XX
Profit before tax XX XX
Income tax expense (XX) (XX)
Profit after tax XX XX
Attributable to:
Owners of the parent XX XX
Non-controlling interest XX XX
XX XX

Information provided in the statement of comprehensive income or separate income

statement
The standard lists the following as the minimum to be disclosed on the face of the income
statement.
• Revenue
 • Finance costs
• Share of profits and losses of associates and joint ventures accounted for using the
equity method
• Pre-tax gain or loss on the disposal of assets or settlement of liabilities attributable to
discontinued operations.
• Tax expense
• Profit or loss
The following items must be disclosed in the income statement as allocations of profit or loss for
the period:
• Profit or loss attributable to non-controlling interest
• Profit or loss attributable to owners of the parent
The allocated amounts must not be presented as items of income or expense.(These relate to
group accounts)

Income and expense items can only be offset when and only when:
• it is permitted or required by an IFRS, or
• Gains, losses, and related expenses arising from the same or similar transactions and
events are immaterial, in which case they can be aggregated.

Information presented either in the statement or in the notes

An analysis of expenses must be shown either in the income statement section (as above,
which is encouraged by the standard) or by note, using a classification based on either the
nature of the expenses or their function. This sub-classification of expenses indicates a range
of components of financial performance; these, may differ in terms of stability, potential for gain
or loss and predictability.

Nature of expense method

Expenses are not reallocated amongst various functions within the entity, but are aggregated in
the income statement according to their nature (e.g. purchase of materials, depreciation,
wages and salaries, transport costs). This is by far the easiest method, especially for smaller
entities.

Function of expense/cost of sales method

You are likely to be more familiar with this method. Expenses are classified according to their
function as part of cost of sales, distribution or administrative activities. This method often gives
more relevant information for users, but the allocation of expenses by function requires the
use of judgement and can be arbitrary. Consequently, perhaps, when this method is used,
entities should disclose additional information on the nature of expenses, including staff costs,
and depreciation and amortisation expense.

Which of the above methods is chosen by an entity will depend on historical and industry
factors, and also the nature of the organisation. Under each method, there should be given
an indication of costs which are likely to vary (directly or indirectly) with the level of sales or
production. The choice of method should fairly reflect the main elements of the entity
performance.

Dividends
IAS 1 also requires the disclosure of the amount of dividend per share for the period covered
by the financial statements. This may be shown in the income statement in the statement of
changes in equity.

Further points
The following disclosures are no longer required:
• The results of operating activities, as a line item in the Income statement ‘operating
 activities’ are not defined in the IAS 1
• Extraordinary items, as a line item in the income statement (disclosure of extraordinary
item is now prohibited)
• The number of entities employees

Statement of changes in equity

An entity shall present a statement of changes in equity showing on the face of the statement:
• profit or loss for the period
• each item of income and expense (other comprehensive income) for the period that, as
required by other standards is recognised directly in equity and the total of these items
• total income and expense for the period (calculated as the sum of (a) and (b), showing
separately the total amounts attributable to equity holders of the parent and to non-
controlling interest; and
• For each component of equity, the effects of changes in accounting polices and
correction of errors recognised in accordance with IAS 8

The format
Share Retained Available Revaluation Cash Total Non
Total
capital earnings for sale surplus flow Contr
f /assets hedges interest
N N N N N N N
Balance at 1 Jan 20X6 XX XX XX XX XX XX XX
XX
Changes in accounting
Policies - XX XX XX
XX
Restated balance XX XX XX XX XX XX XX
XX
Changes in equity
Dividends (XX) (XX)
(XX)
Total comprehensive income
For the year XX XX XX XX XX XX
XX
Balance at 31 Dec
20X6 XX XX XX XX XX XX XX
XX
Changes in equity for 20X7
Issue of share capital XX XX
XX
Dividends (XX) (XX)
(XX)
Total comprehensive
Income XX (XX) XX XX XX XX
XX

Transfer to retained
Earnings XX (XX)
Balance at 31 Dec
20X7 XX XX XX XX XX XX XX
XX
Notes to the financial statements
Contents of notes
The notes to the financial statements will amplify the information given in the statement of
financial position, statement of comprehensive income and statement of change in equity. To
some extent, the contents of the notes will be determined by the level of details shown on the
face of the statements.

Structure
The notes to the financial statements should perform the following functions:
• Provide the basis on which the financial statements were prepared and which
specific accounting policies were chosen and applied to significant
transactions/events
• Disclose any information, not shown elsewhere in the financial statements, which is
required by IFRSs
• Show any additional information that is relevant to understanding which is not shown
elsewhere In the financial statements
The way the notes are presented is important; they should be given in a systematic manner
and cross referenced back to the related figures(s) in the statements of comprehensive
income, financial position and cash flow.
Notes to the financial statements will amplify the information shown therein by giving the
following
• More detailed analysis or breakdowns of figures in the statements
• Narrative information explaining figures in the statements
• Additional information e.g. contingent liabilities and commitments

IAS 1 Suggests certain order for notes to the financial statements. This will assist users when
comparing the statements of different entities.
• Statement of compliance with IFRSs
• Statement of the measurement basis (bases) and accounting policies applied
• Supporting information for items presented in each financial statement in the same
order as each line item and each financial statement is presented
• Other disclosures, e.g.
• contingent liabilities
• non- financial disclosures

Presentation of accounting policies

The accounting policies section should describe the following
• The measurement basis (bases) used in preparing the financial statements
• The other accounting policies used, as required for a proper understanding of the
financial statements

The information may be shown in the notes or sometimes as a separate component of the
financial statements. The information on the measurement bases used is obviously fundamental
to an understanding of the financial statements. Where more than basis is used, it should be
stated to which assets or liabilities each basis has been applied.

Other disclosures
An entity must disclose in the notes:
• The amount of dividends proposed or declared before the financial statements were
authorised for issue but not recognised as a distribution to owners during the period, and
the amount per share
• The amount of any cumulative preference dividends not recognised
IAS 1 ends by listing some specific disclosures which will always be required if they are not
shown elsewhere in the financial statements
• The domicile and legal form of the entity, its country of incorporation and the address of
the registered office (or, if different, principal place of business)
• A description of the nature of the entity’s operations and its principal activities
• The nature of the parent entity and the ultimate parent entity of the group

REVIEW QUESTIONS
1 (a) The IASB’s Framework for the Preparation and Presentation of Financial Statements requires
financial statements to be prepared on the basis that they comply with certain accounting concepts,
underlying
assumptions and (qualitative) characteristics. Five of these are:
Matching/accruals
Substance over form
Prudence
Comparability
Materiality
Required:
Briefly explain the meaning of each of the above concepts/assumptions. (5 marks)

(b) For most entities, applying the appropriate concepts/assumptions in accounting for inventories is an
important
element in preparing their financial statements.
Required:
Illustrate with examples how each of the concepts/assumptions in (a) may be applied to
accounting for
inventory. (10 marks)
(15 marks) ACCA JUNE 2008 FINANCIAL REPORTING

2. The following trial balance relates to Clarion as at 31 March 2015:

N’000 N’000
Equity shares of N1 each (note (i)) 30,000
Retained earnings – 1 April 2014 8,600
Other component of equity – share premium (note (i)) 5,000
8% loan notes (note (ii)) 20,000
Plant and equipment at cost (note (iii)) 85,000
Accumulated depreciation plant and equipment – 1 April 2014 19,000
Investments through profit or loss – value at 1 April 2014 (note (iv)) 6,000
Inventory at 31 March 2015 11,700
Trade receivables 18,500
Bank 1,900
Deferred tax (note (vi)) 2,700
Trade payables 9,400
Environmental provision (note (iii)) 4,000
Finance lease obligation (note (iii)) 4,200
Revenue 132,000
Cost of sales 88,300
Operating lease payments (note (v)) 2,000
Administrative expenses 8,000
Distribution costs 7,400
Loan note interest paid 800
Suspense account (note (ii)) 5,800
Bank interest 300
Dividends paid 3,900
Investment income (note (iv)) 500
Current tax (note (vi)) 400
––––––––
––––––––
237,700 237,700
––––––––
––––––––
The following notes are also relevant:
(i) The equity shares and share premium balances in the trial balance above include a fully subscribed 1
for 5 rights
issue at N1·60 per share which was made by Clarion on 1 October 2014. The market value of Clarion’s
shares was N2·50 on 1 October 2014.
(ii) On 31 March 2015, one quarter of the 8% loan notes were redeemed at par and six months’
outstanding loan
interest was paid. The suspense account represents the double entry corresponding to the cash payment
for the
capital redemption and the outstanding interest.
(iii) Property, plant and equipment:
Included in property, plant and equipment are two major items of plant acquired on 1 April 2014:
Item 1 had a cash cost N14 million, however, the plant will cause environmental damage which will have
to be rectified when it is dismantled at the end of its five year life. The present value (discounting at 8%)
on 1 April 2014 of the rectification is N4 million. The environmental provision has been correctly
accounted for, however, no finance cost has yet been charged on the provision.
Item 2 was plant acquired with a fair value of N8 million under a five-year finance lease. This required an
initial deposit of N2·3 million and annual payments of N1·5 million on 31 March each year. The finance
lease obligation in the trial balance above represents the fair value of the plant less both the deposit and
the first annual payment. The lease has an implicit interest rate of 10% and the asset has been correctly
capitalised in plant and equipment.
No depreciation has yet been charged on plant and equipment which should be charged to cost of sales
on a
straight-line basis over a five-year life (including leased plant). No plant is more than four years old.
(iv) The investments through profit or loss are those held at 31 March 2015 (after the sale below). They
are carried
at their fair value as at 1 April 2014, however, they had a fair value of N6·5 million on 31 March 2015.
During the year an investment which had a carrying amount of N1·4 million was sold for N1·6 million.
Investment income in the trial balance above includes the profit on the sale of the investment and
dividends received during the year.
(v) Clarion renewed an operating lease on a property on 1 April 2014. The operating lease payments
represent an
annual payment (in advance) of N1 million and a lease premium of N1 million. The lease is for four years
and operating lease expenses should be included in cost of sales.
(vi) A provision for current tax for the year ended 31 March 2015 of N3·5 million is required. The balance
on current
tax in the trial balance above represents the under/over provision of the tax liability for the year ended 31
March
2014. At 31 March 2015, the tax base of Clarion’s net assets was N12 million less than their carrying
amounts.
The income tax rate of Clarion is 25%.
Required:
(a) Prepare the statement of profit or loss for Clarion for the year ended 31 March 2015.
(b) Prepare the statement of changes in equity for Clarion for the year ended 31 March 2015.
(c) Prepare the statement of financial position for Clarion as at 31 March 2015.
Notes to the financial statements are not required.
The following mark allocation is provided as guidance for these requirements:
(a) 10 marks
(b) 3 marks
(c) 10 marks
(23 marks)
(d) Calculate the basic earnings per share of Clarion for the year ended 31 March 2015. (3 marks)
(e) Prepare extracts from the statement of cash flows for Clarion for the year ended 31 March 2015
in respect
of cash flows from investing (ignore investment income) and financing activities. (4 marks)
(30 marks)

SUGGESTED SOLUTIONS
1 (a) The accruals basis requires transactions (or events) to be recognised when they occur (rather than
on a cash flow basis).
Revenue is recognised when it is earned (rather than when it is received) and expenses are recognised
when they are incurred (i.e. when the entity has received the benefit from them), rather than when they
are paid.
Recording the substance of transactions (and other events) requires them to be treated in accordance
with economic reality or their commercial intent rather than in accordance with the way they may be
legally constructed. This is an important element of faithful representation.
Prudence is used where there are elements of uncertainty surrounding transactions or events. Prudence
requires the exercise of a degree of caution when making judgements or estimates under conditions of
uncertainty. Thus when estimating the expected life of a newly acquired asset, if we have past experience
of the use of similar assets and they had had lives of (say) between five and eight years, it would be
prudent to use an estimated life of five years for the new asset.
Comparability is fundamental to assessing the performance of an entity by using its financial statements.
Assessing the performance of an entity over time (trend analysis) requires that the financial statements
used have been prepared on a comparable (consistent) basis. Generally this can be interpreted as using
consistent accounting policies (unless a change is required to show a fairer presentation). A similar
principle is relevant to comparing one entity with another; however it is more difficult to achieve consistent
accounting policies across entities.
Information is material if its omission or misstatement could influence (economic) decisions of users
based on the reported financial statements. Clearly an important aspect of materiality is the (monetary)
size of a transaction, but in addition the nature of the item can also determine that it is material. For
example the monetary results of a new activity may be small, but reporting them could be material to any
assessment of what it may achieve in the future. Materiality is considered to be a threshold quality,
meaning that information should only be reported if it is considered material. Too much detailed (and
implicitly immaterial) reporting of (small) items may confuse or distract users.

(b) Accounting for inventory, by adjusting purchases for opening and closing inventories is a classic
example of the application of the accruals principle whereby revenues earned are matched with costs
incurred. Closing inventory is by definition an example of goods that have been purchased, but not yet
consumed. In other words the entity has not yet had the ‘benefit’(i.e. the sales revenue they will generate)
from the closing inventory; therefore the cost of the closing inventory should not be charged to the current
year’s income statement.
Consignment inventory is where goods are supplied (usually by a manufacturer) to a retailer under terms
which mean the legal title to the goods remains with the supplier until a specified event (say payment in
three months time). Once the goods have been transferred to the retailer, normally the risks and rewards
relating to those goods then lie with the retailer. Where this is the case then (in substance) the
consignment inventory meets the definition of an asset and the goods should appear as such (inventory)
on the retailer’s statement of financial position (along with the associated liability to pay for them) rather
than on the statement of financial position of the manufacturer.
At the year end, the value of an entity’s closing inventory is, by its nature, uncertain. In the next
accounting period it may be sold at a profit or a loss. Accounting standards require inventory to be valued
at the lower of cost and net realisable value.
This is the application of prudence. If the inventory is expected to sell at a profit, the profit is deferred (by
valuing inventory at cost) until it is actually sold. However, if the goods are expected to sell for a (net) loss,
then that loss must be recognised immediately by valuing the inventory at its net realisable value.
There are many acceptable ways of valuing inventory (e.g. average cost or FIFO). In order to meet the
requirement of
comparability, an entity should decide on the most appropriate valuation method for its inventory and then
be consistent in the use of that method. Any change in the method of valuing (or accounting for) inventory
would break the principle of comparability.
For most businesses inventories are a material item. An error (omission or misstatement) in the value or
treatment of inventory has the potential to affect decisions users may make in relation to financial
statements. Therefore (correctly) accounting for inventory is a material event. Conversely there are
occasions where on the grounds of immateriality certain ‘inventories’ are not (strictly) accounted for
correctly. For example, at the year end a company may have an unused supply of stationery.
Technically this is inventory, but in most cases companies would charge this ‘inventory’ of stationery to the
income statement of the year in which it was purchased rather than show it as an asset.
Note: other suitable examples would be acceptable.

2. (a) Clarion – Statement of profit or loss for the year ended 31 March 2015
N’000
Revenue 132,000
Cost of sales (w (i)) (106,550)
––––––––
Gross profit 25,450
Distribution costs (7,400)
Administrative expenses (8,000)
Finance costs (w (ii)) (2,790)
Investment income (w (iii)) 1,000
––––––––
Profit before tax 8,260
Income tax expense (3,500 – 400 + 300 (w (iv))) (3,400)
––––––––
Profit for the year 4,860
––––––––

(b) Clarion – Statement of changes in equity for the year ended 31 March 2015
Share Share Retained Total
Capital premium earnings equity
N’000 N’000 N’000 N’000
Balance at 1 April 2014 25,000 2,000 8,600 35,600
Rights issue (see below) 5,000 3,000 8,000
Dividends paid (3,900) (3,900)
Profit for the year 4,860 4,860
––––––– –––––– –––––– –––––––
Balance at 31 March 2015 30,000 5,000 9,560 44,560
––––––– –––––– –––––– –––––––
Prior to the 1 for 5 rights issue there were 25 million (30,000 x 5/6) shares in issue. Therefore the rights
issue was 5 million shares at N1·60 each (N8 million), giving additional share capital of N5 million and
share premium of N3 million (5 million x 60 kobo).

(c) Clarion – Statement of financial position as at 31 March 2015

Assets N’000 N’000
Non-current assets
Property, plant and equipment (85,000 – 19,000 – 17,000) 49,000
Investments through profit or loss 6,500
Unamortised lease premium (1,000 – 250 (w (i)) – 250 current asset below) 500
–––––––
56,000
Current assets
Inventory 11,700
Trade receivables 18,500
Lease premium prepayment 250 30,450
––––––– –––––––
Total assets 86,450
–––––––
Equity and liabilities
Equity (see (b) above)
Equity shares of N1 each 30,000
Other equity component – share premium 5,000
Retained earnings 9,560
–––––––
44,560
Non-current liabilities
8% loan notes 15,000
Deferred tax (w (iv)) 3,000
Environmental provision (4,000 + 320 (w (ii))) 4,320
Finance lease obligation (w (v)) 3,747 26,067
–––––––
Current liabilities
Trade payables 9,400
Finance lease obligation (4,770 – 3,747 (w (v))) 1,023
Bank overdraft 1,900
Current tax payable 3,500 15,823
––––––– –––––––
Total equity and liabilities 86,450
–––––––

(d) Clarion – Basic earnings per share for the year ended 31 March 2015
Profit per statement of profit or loss N4·86 million
Weighted average number of shares (w (vi)) 28·3 million
Earnings per share 17·2 kobo

(e) Clarion – Extracts from the statement of cash flows for the year ended 31 March 2015
N’000
Cash flows from investing activities
Purchase of plant and equipment (14,000)
Sale of investments 1,600
Cash flows from financing activities
Issue of shares (see part (b)) 8,000
Redemption of loan notes (w (vii)) (5,000)
Repayment of finance lease (2,300 + (1,500 – 570)) (3,230)
Equity dividends paid (3,900)

Workings (figures in brackets in N’000)

(i) N’000
Cost of sales (per question) 88,300
Property rental (1,000 + (1,000/4 years) – see below) 1,250
Depreciation of plant and equipment (85,000 x 20%) 17,000
––––––––
 106,550
––––––––
The lease premium must be amortised, on a straight-line basis, over the length of the lease (four years).
(ii) Finance costs
8% loan notes (800 trial balance + 800 suspense account (w (vii))) 1,600
Finance lease (w (v)) 570
Bank interest 300
Environmental provision (4,000 x 8%) 320
––––––
2,790
––––––
(iii) Investment income
Dividends received (500 – 200 profit on sale) 300
Profit on sale 200
Gains on fair value (6,500 – 6,000) 500
––––––
1,000
––––––
(iv) Deferred tax
Provision required as at 31 March 2015 (12,000 x 25%) 3,000
Balance at 1 April 2014 (2,700)
––––––
Charge to profit or loss 300
––––––
(v) Leased plant/finance lease obligation
Fair value of plant/initial obligation (4,200 + 2,300 + 1,500) 8,000
Less deposit (2,300)
––––––
5,700
Interest at 10% to 31 March 2015 570
Less first annual payment (1,500)
––––––
Liability at 31 March 2015 4,770
Interest at 10% to 31 March 2016 477
Less second annual payment (1,500)
––––––
Liability at 31 March 2016 3,747
––––––
(vi) Theoretical ex-rights value
Shares N N
Holding (say) 100 2·50 250
Rights take up (1 for 5) 20 1·60 32
–––– ––––
120 282
–––– ––––
Theoretical ex-rights value 2·35 (N282/120)
–––––
Weighted average number of shares:
1 April 2014 to 30 September 2014 25 million x N2·50/N2·35 x 6/12 = 13·3 million
1 October 2014 to 31 March 2015 30 million x 6/12 = 15·0 million
–––––
Weighted average for year 28·3 million
–––––
(vii) Elimination of suspense account
 N’000
Cash cost of loan note redemption (20,000 x 25%) 5,000
Six months’ interest on loan note (20,000 x 8% x 6/12) 800
––––––
5,800
––––––

IAS 2: INVENTORIES
SCOPE
This Standard applies to all inventories other than
• Work in progress under construction contracts and directly related service contracts (IAS
11, Construction Contracts)
• Financial instruments
• Biological assets related to agricultural activity and agricultural produce at the point of
harvest (under IAS 41, Agriculture)
Certain inventories are exempt from the Standard’s measurement rules, ie those held by:
• Producers of agricultural and forest products
• Commodity – broker traders

DEFINITIONS OF KEY TERMS

Inventory. An asset
(a) Held for sale in the normal course of business;
(b) In the process of production for such sale; or
(c) In the form of materials or supplies to be used in the production process or in rendering of
services.
Net realizable value: The estimated selling price in the normal course of business less
estimated cost to complete and estimated cost to make a sale.
Fair value: The price to sell an asset or amount paid to transfer a liability in an oderly
transaction between market participants at the measurement date .

Inventories can include any of the following:

• Goods purchased and held for resale eg goods held for sale by a retailer, or land and
buildings held for sale
• Finished goods produced
• Work in progress being produced
• Materials and supplies awaiting use in the production process (raw material)

Measurement of Inventories
The Standard provided that inventories should be measured at the lower of cost and net
realisable value.

Cost of Inventories
The cost of inventories will consist of all costs of:
• Purchase
• Costs of conversion
• Other costs in bringing the inventories to their present location and condition

Costs of Purchase
The costs of purchase constitute all of
• The purchase price
• Import duties
• Transportation costs
• Handling costs directly pertaining to the acquisition of the goods
• Trade discounts and rebates are deducted when arriving at the cost of purchase of
inventory.

Costs of Conversion
Costs of conversion of inventories consist of two main parts
• Costs directly related to the units of production eg direct materials, direct labour
• Fixed and variable production overheads that are incurred in converting materials into
finished goods allocated on a systematic basis.
Fixed production overheads are those indirect costs of production that remain relatively constant
regardless of the volume of production, eg, the cost of factory management and administration.
Variable production overheads are those indirect costs of production that vary directly, or nearly
directly with the volume of production eg the indirect material and labour.
The Standard emphasized that fixed production overheads must be allocated to items of
inventory on the basis of the normal capacity of the production facilities.
(a) Normal capacity is expected achievable production on the average over several
periods/seasons under normal circumstances.
(b) The above figure should take account of the capacity lost through planned maintenance
(c) If it approximates to the normal level of activity, then the actual level of production can be
used.
(d) Low production or idle plant will not result in a higher fixed overhead allocation to each unit.
(e) Unallocated overheads must be recognised as an expense in the period in which they were
incurred.
(f) When production is abnormally high, the fixed overhead allocation to each unit will be
reduced, so avoiding inventories being stated at more than cost.
(g) The allocation of variable production overheads to each unit is based on the actual use of
production facilities.

Other Costs in Valuing Inventories

Other costs in valuing inventories include those costs that are incurred in bringing the
inventories to their present location and condition. An example of such “other costs” is costs of
designing products for specific customer needs.

Excluded Costs from Inventory Valuation

Certain costs are not included in valuing inventory. They are recognized as expenses during the
period they are incurred. Examples of such costs are:
(a) Abnormal amounts of wasted materials, labour, or other production costs
(b) Storage costs unless they are essential to the production process
(c) Administrative overheads that do not contribute to bringing inventories to their present
location and condition
(d) Selling costs
Illustration
Wayo Trading Plc purchases motor cycles from various countries and exports them to Europe.
Wayo Trading Plc has incurred these expenses during 2005:
(a) Cost of purchases (based on vendors’ invoices)
(b) Trade discounts on purchases
(c) Import duties
(d) Freight and insurance on purchases
(e) Other handling costs relating to imports
(f) Salaries of accounting department
(g) Brokerage commission payable to indenting agents for arranging imports
(h) Sales commission payable to sales agents
(i) After-sales warranty costs
Required
Wayo Trading Plc is seeking your advice on which costs are permitted under IAS 2 to be
included in cost of /inventory.

Solution
Items (a), (b), (c), (d), (e), and (g) are permitted to be included in cost of inventory under IAS 2.
Salaries of accounting department, sales commission, and after-sales warranty costs are not
considered cost of inventory under IAS 2 and thus are not allowed to be included in cost of
inventory.

Techniques for the Measurement of Cost

Two techniques are mentioned by the Standard, both of which produce results which
approximate to cost and so both of which may be used for convenience.
• Standard costs are set up to take account of normal production values, amount of raw
materials used, labour time etc. They are reviewed and revised on a regular basis.
• Retail method: this is often used in the retail industry where there is a large turnover of
inventory items, which nevertheless have similar profit margins. The only practical
method of inventory valuation may be to take selling price of inventories and deduct an
overall average profit margin, thus reducing the value to an approximation of cost. The
percentage will take account of reduced price lines. Sometimes different percentages
are applied on a departmental basis.

Cost Formulas
In cases of inventories that are not ordinarily interchangeable and goods or services produced
and segregated for specific projects, costs shall be assigned using the specific identification of
their individual costs.
In all other cases, the cost of inventories should be measured using either
• The FIFO (first-in, first-out) method; or
• The weighted-average cost method.
The FIFO method assumes that the inventories that are purchased first are sold first, with the
ending or remaining items in the inventory being valued based on prices of most recent
purchases.
However, using the weighted-average cost method, the cost of each item is determined from the
weighted-average of the cost of similar items at the beginning of a period and the cost of items
purchased or produced during the period.
Inventories having a similar nature and use to the entity should be valued using the same cost
formula. However, in case of inventories with different nature or use, different cost formulas may
be justified.

Illustration
First-in, First-out (FIFO) Method
XYZ Ltd is a newly established international trading company. It commenced its operation in
2005. XYZ Ltd imports goods from China and sells in the local market. It uses the FIFO method
to value its inventory.
Listed next are the purchases and sales made by the entity during the year 2005:
Purchases
January 2005 100,000 units @ N 25 each
March 2005 15,000 units @ N 30 each
September 2005 20,000 units @ N 35 each
Sales
May 2005 15,000 units
November 2005 20,000 units
Required
Based on the FIFO cost flow assumption, compute the value of inventory at May 31, 2005, September 30,
2005, and December 31, 2005.

Solution
(a) January 2005 Purchase + 10,000 units @ N25 = N250,000
March 2005 Purchase + 15,000 units @ N30 = N450,000
Total N700,000

(b) May 2005 Sales (15,000 units) – 10,000 units @ N25 = N(250,000)
– 5,000 units @ N30 = N(150,000)
N(400,000)
(c) Inventory valued on FIFO basis at May 31, 2005:
10,000 units @ N30 = N300,000
(d) September 2005 Purchase + 20,000 units @ N35 = N700,000

(e) Inventory valued on FIFO basis at September 30, 2005:

10,000 units @ N30 = N300,000
20,000 units @ N35 = N700,000
N1,000,000

(f) November 2005 Sales (20,000 units)– 10,000 units @ N30 = N(300,000)
– 10,000 units @ N35 = N(350,000)
N(650,000)
(g) Inventory valued on FIFO basis at December 31, 2005:
10,000 units @ N35 = N350,000

Example on Weighted-Average Cost Method

Best Practice Plc, a newly incorporated company, uses the latest version of a software package
(EXODUS) to cost and value its inventory. The software uses the weighted-average cost method to value
inventory. The following are the purchases and sales made by Best practice Plc during 2006 (as a newly
set up company, Best Practice Plc has no beginning inventory):

Purchases
January 100 units N250 per unit
March 150 units N300 per unit
September 200 units N350 per unit
Sales
March 150 units
December 170 units
Required
Best Practice Plc has approached you to compute the value of its inventory and the cost per unit of the
inventory at March 31, 2006, September 30, 2006, and December 31, 2006, under the weighted-average
cost method.

Suggested Solution
Month Purchases/Sales/Balance Rate per unit Amount Weightedaverage
Cost per unit Valuation
date
Jan 15 Purchases 100 units N250 N25,000
Jan 31 Balance 100 units
Mar 10 Purchases 150 units N300 45,000
Mar 10 Balance 250 units N280 70,000
Mar 15 Sales (150) units N280 (42,000)
Mar 31 Balance 100 units N28,000 N280.00 March
31, 2006
Sep 25 Purchases 200 units N350 70,000
Sep 30 Balance 300 units N98,000 N326.667
September 30, 2006
Dec 15 Sales (170) units N326.667 N(55,533)
Dec 31 Balance 130 units N42,467 N326.667
December 31, 2006

Net Realisable Value (NRV)

As a general rule, assets should not be carried at amounts greater than those expected to be
realised from their sale or use. In the case of inventories this amount could fall below cost when
items are damaged or become obsolete, or where the costs in completion have increased in
order to make the sale.
The principal situations in which NRV is likely to be less than cost, is where there has been:
• An increase in costs or a fall in selling price
• A physical deterioration in the condition of inventory
• Obsolescence of production
• A decision as part of the company’s marketing strategy to manufacture and sell products
at a loss
• Errors in production or purchasing

A write down of inventories would normally take place on an item by item basis, but similar or
related items may be grouped together. This grouping together is acceptable for, say, items in
the same product line, but is not acceptable to write down inventories based on a whole
classification (eg finished goods) of a whole business.
The assessment of NRV should take place at the same time as estimates are made of selling
price using the most reliable information available. Fluctuation of price or cost should be taken
into account if they relate directly to events after the reporting period, which confirm existing at
the end of the period.
The reason why inventory is held must also be taken into account. Some inventory may be held
to satisfy a firm contract and its NRV will therefore be the contract price. Any additional
inventory of the same type held at the period end will, in contrast , be assessed according to
general sales prices when NRV is estimated.
NRV must be reassessed at the end of each period and compared again with cost. If the NRV
has risen for inventories held over the end of more than one period, then the previous write
down must be reversed to the extent that the inventory is then valued at the lower of cost and
the new NRV. This is usually possible when selling prices have fallen in the past and then rise
again.
When a write down to NRV may be exceptionally high, then this must be disclosed separately.

Illustration
Moon Head Plc is a retailer of Italian furniture and has five major product lines: sofas, dining tables, beds,
closets, and lounge chairs. At December 31, 200X, quantity on hand, cost per unit, and net realizable
value (NRV) per unit of the product lines are as follows:
Product line Quantity on hand Cost per unit (N) NRVper unit (N)
Sofas 100 1,000 1,020
Dining tables 200 500 450
Beds 300 1,500 1,600
Closets 400 750 770
Lounge chairs 500 250 200
Required
Compute the valuation of the inventory of Moon Head Plc at December 31, 200X, under IAS 2 using the
“lower of cost and NRV” principle.

Suggested Solution
Product line Quantityon hand Costper unit (N)Inventoryat cost (N) NRVper unit (N)
Lower of cost and
NRV (N)
Sofas 100 1,000 100,000 1,020
100,000
Dining tables 200 500 100,000 450
90,000
Beds 300 1,500 450,000 1,600
450,000
Closets 400 750 300,000 770
300,000
Lounge chairs 500 250 125,000 200
100,000
N1,075,000
N1,040,000

Recognition as an Expense
The following treatment is required when inventories are sold:
• The carrying amount is recognised as an expense in the period in which the related
revenue is recognised
• The amount of any write- down of inventories to NRV and the losses of inventories are
recognised as an expense in the period the write- down or loss occurs
• The amount of any reversal of any write down of inventories, arising from an increase in
NRV, is recognised as a reduction in the amount of inventories recognised as an
expense in the period in which the reversal occurs

REVIEW QUESTIONS
1. You are the accountant at Jet Age Plc and you have been asked to calculate the valuation of
the company’s inventory at cost at its year end of 31 December 2007.
Jet Age Plc manufactures a range of pumps. The pumps are assembled from components
bought by Jet Age (the company does not manufacture any part).
The company does not use a standard costing system and work in progress and finished goods
are valued as follows:
• Material costs are determined upon the product specification which lists the components
required to make a pump
• The company produces a range of pumps. Employees record the hours spent on
assembling each type of pump, this information is input into the payroll system which
prints the total hours spent each week assembling each type of pump. All employees
assembling pumps are paid at the same rate and there is no overtime.
• Overheads are added to the inventory value in accordance with IAS 2 on Inventories.
The financial accounting records are used to determine the overhead cost, and this
 applied as a percentage based on the direct labour hour.
For direct labour costs, you have agreed that the labour expended for a unit in work in progress
is half that of a completed unit.
The draft accounts show the following materials and direct labour costs in inventory
Raw materials Work in progress Finished goods
Materials (N) 74,786 85.692 152,693
Direct labour (N) 13,062 46,584
The costs incurred in December as recorded in the financial accounting records, were as
follows:
N
Direct labour 61,320
Selling costs 43,550
Depreciation and finance costs of production machines 4,490
Distribution costs 6,570
Factory manager’s wage 2,560
Other production overheads 24,820
Purchasing an accounting costs relating to production 5,450
Other accounting costs 7,130
Other administrative overheads 24,770
For your calculations assume that all work in progress and finished goods were produced in
December 2007 and that the company was operating at a normal level of activity.
Required:
Calculate the value of overheads which should be added to work in progress and finished goods
in accordance with IAS 2 on Inventories.
You should include details and description of your workings and all figures should be calculated
to the nearest naira.

SUGGESTED SOLUTUON
1. Calculation of overheads for inventories
Production overheads are as follows N
Depreciation/finance costs 4,490
Factory manager’s wages 2,560
Other production overheads 24,820
Accounting/purchasing costs 5,450
37,320
Direct labour =N61,320
Therefore, production overhead rate = N37,320 = 60.86%
N61,320
Inventory valuation
Raw material WIP F/Goods Total
N N N N
Materials 74,786 85,692 152,693 313,171
Direct labour - 13,072 46,584 59,656
Production overhead
(at 60.86% of labour) - 7,956 29,351 36,307
74,786 106,720 227,628 409,134
IAS 7: STATEMENT OF CASH FLOW
Definition of Key Terms
Cash: Comprises cash on hand and demand deposits with banks.
Cash equivalents: Short-term, highly liquid investments that are readily convertible into known
amounts of cash and that are subject to an insignificant amount of risk of changes in value.
Operating activities: Principal revenue-producing activities of the entity and other activities that
are not investing or financing activities.
Investing activities: Activities of the entity that relate to acquisition and disposal of long-lived
assets and other non-current assets (including investments) other than those included in cash
equivalents.
Financing activities: Activities that result in changes in the size and composition of the equity
capital and borrowings of an entity.

Objective of the Standard

The aim of the standard is to provide information to users of financial statements about the
entity’s ability to generate cash and cash equivalents, as well as indicating the cash needs of
the entity. The statement of cash flow provides historical information about cash and cash
equivalents, classifying cash flows between operating, investing and financing.

Cash and Cash Equivalents

Cash equivalents are short – term, highly liquid investments that are readily convertible to
known amounts of cash and which are subject to a known insignificant risk of changes in value.
Ready conversion is normally taken to mean convertible into cash within three months after the
statement of financial position date.
In some countries bank overdrafts are repayable on demand and are treated as part of an
entity’s total cash management system. In these circumstances, an overdrawn balance will be
included in cash and cash equivalents. Such banking arrangements are characterised by a
balance which fluctuates between overdrawn and credit.

Presentation of a Statement of Cash Flow

IAS 7 requires statements of cash flows to report cash flows during the period by operating,
investing and financing activities.
Operating Activities
This is the key part of the statement of cash flows because it shows whether and to what extent
entities can generate cash from their operations. Examples of cash flow from operating activities
given by the Standard include:
• Cash receipts from the sale of goods and rendering of services
• Cash receipts from royalties, fees, commissions and other revenue
• Cash payments to suppliers for goods and services
• Cash payments to and on behalf of employees.

Investing Activities
The casf flows classified as investing show the extent of new investment in assets which will
generate future profits and cash flows. Examples given by the Standard includes:
• Cash payments to acquire property, plant and equipment, intangible and other non –
current assets
• Cash receipts from the sale of property, plant and equipment, intangible and other non –
current assets
• Cash payments to acquire shares, debentures of other entities
• Cash receipts from sale of shares and debentures of other entities
• Cash advances and loans made to other entities
• Cash receipt from the repayment of advances and loans made to other entities.

Financing Activities
This segment shows the cash of which the entity’s capital providers have advanced to or
claimed during the period, examples given by the Standard includes:
• Cash proceeds from issuing shares
• Cash payments to owners to acquire or redeem the entity’s shares
• Cash proceeds from issuing debentures, loans, notes, bonds, mortgages and other short
or long – term borrowings.
• Principal repayments of amounts borrowed under finance lease.

Reporting Cash Flows from Operating Activities

The Standard offers a choice of method for this part of the statement of cash flows.
(a) The direct method: This method discloses major classes of gross cash receipts and gross
cash payments.
(b) Indirect method: net profit or loss is adjusted for the effects of transactions of a non – cash
nature, any deferrals or accruals of past or future operating cash receipts or payments, and
items of income or expense associated with investing or financing cash flows.
The direct method is the preferred method because it discloses information, not available
elsewhere in the financial statements, which could be of use in estimating future cash flows.

Proforma Direct Method

Cash flows from Operating Activities N
Cash received from Customers XX
Cash paid to Suppliers (XX)
Cash paid for Operating Expenses and Employees (XX)
Cash flows from Operations XX
Income Taxes Paid (XX)
Net Cash Flow from Operating Activities XX

Proforma Indirect Method

Cash flows from Operating Activities
Profit Before Tax XX
Adjustments for:
Depreciation XX
Foreign Exchange Loss XX
Investment Income XX
Interest Expense XX
Increase in Trade & Other Receivables (XX)
Decrease in Inventories XX
Decrease in Trade Payables (XX)
Cash Generated from Operations XX
Interest Paid (XX)
Income Taxes Paid (XX)
Net Cash Flow from Operating Activities XX

Interests and Dividends

Cash flows from interest and dividends received and paid should each be disclosed separately.
Each should be classified in a consistent manner from period to period as operating, investing
or financing activities.
Dividends paid by the entity can be classifed in one of two ways
(a) As a financing cash flow, showing the cost of obtaining financial resources
(b) As a component of cash flows from operating activities so that users can access the entity’s
ability to pay dividends out of operating cash flows.

Taxes on Income
Cash flows arising from taxes on income should be separately disclosed and should be
classified as cash flows from operating activities unless they can be specifically identified with
financing and investing activities.

Components of Cash and Cash Equivalent

The components of cash and cash equivalents should be disclosed and a reconciliation should
be presented, showing the amounts in the statement of cash flows reconciled with the
equivalent items reported in the statement of financial position.
It is also necessary to disclose the accounting policy used in deciding the items included in cash
and cash equivalents, in accordance with IAS 1 Presentation of Financial Statements, and also
because of the wide range of cash management practices worldwide.

Non- Cash Transactions

The Standard requires that non- cash transactions relating to investing and financing activities
to be disclosed in separate notes to the financial statements. These items include:
• Conversion of debt to equity
• Issuance of share capital to acquire property, plant and equipment (non exchange of non
– monetary items)
• Acqusition of property, plant and equipement on credit
• Bonus share issues
• Debt refinancing

Other Disclosures
All entities should disclose, together with a commentary by management, any other information
likely to be of importance, for example:
(a) Restrictions on the use of or access to any part of cash equivalents
(b) The amount of undrawn borrowing facilities which are available
(c) Cash flows which increased operating capacity compared to cash flows which merely
maintained operating capacity
(d) Cash flows arising from each reported industry and geographical segment.

REVIEW QUESTIONS
1. Monty is a publicly listed company. Its financial statements for the year ended 31 March 2013 including
comparatives are shown below:
Statements of profit or loss and other comprehensive income for the year ended:
31 March 2013 31 March 2012
N’000 N’000
Revenue 31,000 25,000
Cost of sales (21,800) (18,600)
––––––– –––––––
Gross profit 9,200 6,400
Distribution costs (3,600) (2,400)
Administrative expenses (2,200) (1,600)
Finance costs – loan interest (150) (250)
– lease interest (250) (100)
––––––– –––––––
Profit before tax 3,000 2,050
Income tax expense (1,000) (750)
––––––– –––––––
Profit for the year 2,000 1,300
Other comprehensive income (note (i)) 1,350 nil
––––––– –––––––
3,350 1,300
––––––– –––––––
Statements of financial position as at:
31 March 2013 31 March 2012
N’000 N’000 N’000 N’000
Assets
Non-current assets
Property, plant and equipment 14,000 10,700
Deferred development expenditure 1,000 nil
––––––– –––––––
15,000 10,700
Current assets
Inventory 3,300 3,800
Trade receivables 2,950 2,200
Bank 50 6,300 1,300 7,300
–––––– ––––––– –––––– –––––––
Total assets 21,300 18,000
––––––– –––––––
Equity and liabilities
Equity
Equity shares of N1 each 8,000 8,000
Revaluation reserve 1,350 nil
Retained earnings 3,200 1,750
––––––– –––––––
12,550 9,750
Non-current liabilities
8% loan notes 1,400 3,125
Deferred tax 1,500 800
Finance lease obligation 1,200 4,100 900 4,825
–––––– ––––––
Current liabilities
Finance lease obligation 750 600
Trade payables 2,650 2,100
Current tax payable 1,250 4,650 725 3,425
–––––– ––––––– –––––– –––––––
Total equity and liabilities 21,300 18,000
––––––– –––––––

Notes:
(i) On 1 July 2012, Monty acquired additional plant under a finance lease that had a fair value of N1·5
million. On this date it also revalued its property upwards by N2 million and transferred N650,000 of the
resulting revaluation reserve this created to deferred tax. There were no disposals of non-current assets
during the period.
(ii) Depreciation of property, plant and equipment was N900,000 and amortisation of the deferred
development
expenditure was N200,000 for the year ended 31 March 2013.
Required:
(a) Prepare a statement of cash flows for Monty for the year ended 31 March 2013, in accordance
with IAS 7
Statement of Cash Flows, using the indirect method. (15 marks) ACCA FINANCIAL REPORTING
JUNE 2013

SUGGESTED SOLUTIONS
1. (a) Monty – Statement of cash flows for the year ended 31 March 2013:
(Note: Figures in brackets are in N000)
N’000 N’000
Cash flows from operating activities:
Profit before tax 3,000
Adjustments for:
depreciation of non-current assets 900
amortisation of non-current assets 200
finance costs 400
decrease in inventories (3,800 – 3,300) 500
increase in receivables (2,950 – 2,200) (750)
increase in payables (2,650 – 2,100) 550
––––––
Cash generated from operations 4,800
Finance costs paid (400)
Income tax paid (w (i)) (425)
––––––
Net cash from operating activities 3,975
Cash flows from investing activities:
Purchase of property, plant and equipment (w (ii)) (700)
Deferred development expenditure (1,000 + 200) (1,200)
––––––
Net cash used in investing activities (1,900)
Cash flows from financing activities:
Redemption of 8% loan notes (3,125 – 1,400) (1,725)
Repayment of finance lease obligations (w (iii)) (1,050)
Equity dividend paid (w (iv)) (550)
––––––
Net cash used in financing activities (3,325)
––––––
Net decrease in cash and cash equivalents (1,250)
Cash and cash equivalents at beginning of period 1,300
 ––––––
Cash and cash equivalents at end of period 50
––––––
Workings
N’000
(i) Income tax paid
Provision b/f – current (725)
– deferred (800)
Tax charge (1,000)
Transfer from revaluation reserve (650)
Provision c/f – current 1,250
– deferred 1,500
––––––
Balance – cash paid (425)
––––––
(ii) Property, plant and equipment
Balance b/f 10,700
Revaluation 2,000
New finance lease 1,500
Depreciation (900)
Balance c/f (14,000)
–––––––
Balance – cash purchases (700)
–––––––
(iii) Finance leases
Balances b/f – current (600)
– non-current (900)
New finance lease (1,500)
Balances c/f – current 750
– non-current 1,200
––––––
Balance cash repayment (1,050)
––––––
(iv) Equity dividend
N’000
Retained earnings b/f 1,750
Profit for the year 2,000
Retained earnings c/f (3,200)
––––––
Balance – dividend paid (550)

IAS 8 ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND

ERRORS
Accounting policies
These are the specific principles, bases, conventions, rules and practices applied by an entity in
preparing and presenting financial statements.

Selection and Application of Accounting Policy

When a Standard or an Interpretation specifically applies to a transaction, other event or
condition, the accounting policy or policies applied to that item shall be determined by applying
the Standard or Interpretation and considering any relevant Implementation Guidance issue by
the IASB for the Standard or Interpretation.
However, in the absence of a Standard or an Interpretation that specifically applies to a
transaction, other events or conditions, management shall use its judgement 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:
• represent faithfully the financial position, financial performance and cash flow
of the entity;
• reflect the economic substance of transactions, other events and conditions
and not merely the legal form;
• are neutral, i.e. free from bias;
• are prudent and
• are complete in all material respects.
In making the judgement, management shall refer to and consider the applicability of, the
following sources in descending order:
• the requirements and guidance in Standards and Interpretations dealing with similar and
related issues; and
• the definitions, recognition criteria and measurement concepts for assets, liabilities,
income and expenses in the ‘framework’

Consistency of Accounting Policies

An entity shall select and apply its accounting policies consistently for similar transactions, other
events and conditions, unless a Standard or an Interpretation specifically requires or permits
categorisation of items for which different policies may be appropriate. If a Standard or an
Interpretation requires or permits such categorisation, an appropriate accounting policy shall be
selected and applied consistently to each category.

Changes in Accounting Policies

An entity shall change an accounting policy only if the change:
• is required by a Standard or an Interpretation or
• 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.
The following are not changes in accounting policies:
• the application of an accounting policy for transactions, other events or conditions that
differ in substance from those previous occurring; and
• the application of a new accounting policy for transactions, other events and conditions
that did not occur previously or were immaterial.

Applying a Change in Accounting Policies

• an entity shall account for a change in accounting policy resulting, from the initial
application of a Standard or an Interpretation in accordance with the specific transitional
provisions, if any, in that Standard or Interpretation, and
• when an entity changes an accounting policy upon initial application of a Standard or an
Interpretation that does not include specific transitional provisions applying to that
change, or changes on accounting policy voluntarily, it shall apply the changes
retrospectively.

Retrospective Application of Changes in Accounting Policies

When a change in accounting policy is applied retrospectively in accordance with (a) or (b)
above, the entity shall adjust 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 the new accounting policy had always been applied.
Limitations of Retrospective Application
When retrospective application is required in applying a change in accounting policies (a)
and (b) above, a change in accounting policy shall be applied retrospectively except to the
extent that it is impracticable to determine either the period-specific effects or the cumulative
effect of the change.

When it is impracticable to determine the period-specific effects of a changing an accounting

policy, on comparative information for one or more prior periods presented, the entity shall apply
the new accounting policy to the carrying amounts of assets and liabilities as at the beginning of
the earliest period for which retrospective application is practicable, which may be the current
period, and shall make a corresponding adjustment to the opening balance of each affected
component of equity for that period.

When it is impracticable to determine the cumulative effects, at the beginning of the current
period, of applying a new accounting policy to all prior periods, the entity shall adjust the
comparative information to apply the new accounting policy prospectively from the earliest date
practicable.

Disclosure
1. When initial application of a Standard or an Interpretation has an effect on the current period
or any prior period, would have such an effect expect that it is impracticable to determine the
amount of the adjustment, or might have an effect on future periods, an entity shall disclose:
• the title of the Standard or Interpretation;
• when applicable, that the change in accounting policy is made in accordance with its
transitional provisions:
• the nature of the change in accounting policy;
• when applicable, a description of the transitional provisions;
• when applicable, the transitional provisions that might have an effect on future periods;
• for the current period and each prior period presented, to the extent practicable, the
amount of the adjustment:
• for each financial statement line item effected; and
• if IAS 33 Earnings per Share applies to the entity, for basic and diluted
earnings per share;
• the amount of the adjustment relating to periods before those presented, to the extent
practicable; and
• if retrospective application required on applying a change in accounting policies (a)
or (b) above is impracticable for a particular prior period, or for periods before those
presented, the circumstances that led to the existence of that condition and a description
of how and from when the change in accounting policy has been applied.

2. When a voluntary change in accounting policy has an effect on the current period or any prior
period, would have an effect on that period except that it is impracticable to determine the
amount of the adjustment, or might have an effect on future periods, an entity shall disclose:
• the nature of the change in accounting policy
• the reasons why applying the new accounting policy provides reliable and more relevant
information
• for the current period and each prior period presented, to the extent practicable, the
amount of the adjustment:
• for each financial statement line items affected; and
• if IAS 33 applies to the entity, for basic and diluted earnings per share
• the amount of the adjustment relating to periods before those presented, to the extent
practicable; and
• if retrospective application is impracticable for a particular prior period, or for the periods
before those presented, the circumstances that led to the existence of that condition and
 a description of how and from when the change in accounting policy has been applied.

3 When an entity has not applied a new Standard or Interpretation that has been issued but is
not yet effective, the entity shall disclose:
• this fact; and
• know or reasonably estimable information relevant to assessing the possible impact that
application of the new Standard or Interpretation will have on the entity’s financial
statements in the period of initial application

Changes in Accounting Estimates

Making estimates is an essential part of the preparation of financial statements. For example,
preparers may have to estimate allowances for receivables, inventory obsolescence or the
useful lives of non-current assets.
• A change in an accounting estimates is not a change in accounting policy
• The effect of a change in an accounting estimate must be recognised prospectively, by
including it in the statement of comprehensive income/income statement for the current
period and any future periods that are also affected.

Examples of changes in accounting estimates include:

• Bad debts
• Inventory obsolescence
• Fair value of financial assets and liabilities
• Useful lives of non – current assets
• Depreciation method
• Warranty provisions

The correction of prior period errors

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 reliable information that was available
when the financial statements were authorised for issue, and could reasonably be expected to
have been taken into account.
• They include mistakes in applying accounting policies, oversights and the effects of fraud
• Material prior period errors should be corrected retrospectively in the first set of financial
statements authorised for issue after their discovery. Opening balances of equity, and the
comparative figures, should be adjusted to correct the error.
• IAS 1 revised also requires that where a prior period error is corrected retrospectively, a
statement of financial position is provided at the beginning of the earliest comparative
period.

Illustration on Change in Accounting Policy with Retrospective Application

During 20X2, Gamma Co changed its accounting policy for the treatment of borrowing costs that
are directly attributable to the acquisition of a hydroelectric power under construction for use by
Gamma. In previous periods, Gamma had capitalised such costs. Gamma has now decided to
treat these costs as an expense, rather than capitalise them. Management judges that the new
policy is preferable because it results in a more transparent treatment of finance costs and is
consistent with local industry practice, making Gamma’s financial statements more comparable.
Gamma capitalised borrowing costs incurred of N2,600 during 20X1 and N5,200 in periods
before 20X1. All borrowing costs incurred in previous years in respect of the acquisition of the
power station were capitalised.
Gamma’s accounting records for 20X2 show profit before interest and income taxes of N30,000;
interest expense of N3,000 (which relates only to 20X2); and income taxes of N8,100
Gamma has not yet recognised any depreciation on the power station because it is not yet in
use.
In 20X1, Gamma reported:
 N
Profit before interest and income taxes 18,000
Interest expense -
Profit before income tax 18,000
Income tax 5,400
Profit 12,600
20X1 opening retained earnings was N20,000 and closing retained earnings was N32,600
Gamma’s tax rate was 30 per cent for 20X2, 20X1 and prior periods
Gamma had N10,000 of share capital throughout, and no other component of equity except for
retained earnings. Its shares are not publicly traded and it does not disclose earnings per share.

Gamma Co
Extract from the Income Statement
(restated)
20X2 20X1
N N
Profit before interest and income taxes 30,000 18,000
Interest expense (3,000) (2,600)
Profit before income tax 27,000 15,400
Income taxes (8,100) (4,620)
Profit 18,900 10,780

Gamma Co
Statement of Changes in Equity
(restated)
Share capital Retained earnings Total
N N N
Balance at 31 December 20X0 (prev. reported) 10,000 20,000 30,000
Change in accounting policy for the capitalisation of
Interest (net income tax of N1,560) (Note 1) (3,640) (3,640)
Balance at 32 December 20X0 as restated 10,000 16,360 26,360
Profit for the year ended 31 December 20X1 (restated) 10,780 10,780
Balance at 31 December 20X1 10,000 27,140 37,140
Profit for the year ended 31 December 20X2 18,900 18,900
Balance at 31 December 20X2 10,000 46,040 56,040

Extracts from the notes (Disclosure requirement)

1. During 20X2, Gamma changed its accounting policy for the treatment of borrowing costs
related to a hydro-electric power station under construction for use by Gamma. Previously,
Gamma capitalised such costs. They are now written off as expenses as incurred.
2. Management judges that this policy provides reliable and more relevant information because
it results in a more transparent treatment of finance costs and is consistent with local industry
practice, making Gamma’s financial statements more comparable.
3. This change in accounting policy has been accounted for retrospectively, and the comparative
statements from 20X1 have been restated. The effect of the change on 20X1 is tabulated below.
Opening retained earnings for 20X1 have been reduced by N3,640, which is the amount of the
adjustment relating to periods prior to 20X1.

Effect on 20X1 N
(Increase) in interest expense (2,600)
Decrease in income tax expense 780
(Decrease) in profit 1,820
Effect on periods prior to 20X1
(Decrease) in profit (N5,200 interest expense less tax of N1,560) (3,640)
(Decrease) in assets in the course of construction and in retained
earnings at 31 December 20X1 (5,460

Illustration on prospective application of a change in accounting policy when

retrospective application is not practicable
During 20X2, Delta Co changed its accounting policy for depreciating property, plant and
equipment, so as to apply much more fully a components approach, whilst at the same time
adopting the revaluation model.
In years before 20X2, Delta’s asset records were not sufficiently detailed to apply a components
approach fully. At the end of 20X1, management commissioned an engineering survey, which
provided information on the components held and their fair values, useful lives, estimated
residual values and depreciable amounts at the beginning of 20X2. However, the survey did not
provide a sufficient basis for reliably estimating the cost of those components that had not been
previously been accounted for separately, and the existing records before the survey did not
permit this information to be constructed.
Delta’s management considered how to account for each of the two aspects of the accounting
change. They determined that it was not practicable to account for the change to a fuller
component approach retrospectively, or to account for that change prospectively from any
earlier date than the start of 20X2.Also, the change from a cost model to a revaluation model is
required to be accounted for prospectively. Therefore, management concluded that it should
apply Delta’s new policy prospectively from the start of 20X2.

Additional information:
Delta’s tax rate is 30 per cent
N
Property, plant and equipment at the end of 20X1
Cost 25,000
Depreciation (14,000)
Net book value 11,000

Prospective depreciation expense for 20X2 (old basis)1,500

Some results of the engineering survey:

Valuation 17,000
Estimated residual value 3,000
Average remaining asset life (years) 7
Depreciation expense on existing property, plant and equipment for 20X2 (new basis) 2,000

Extracts from the notes

1. From the start of 20X2, Delta changed its accounting policy for depreciating property, plant
and equipment, so as to apply much more fully a components approach, whilst at the same time
adopting the revaluation model.
2. Management takes the view that this policy provides reliable and more relevant information
because it deals more accurately with the components of property, plant and equipment and is
based on up-to-date value.
3. The policy has been applied prospectively from the start of 20X2 because it was not
practicable to estimate the effects of applying the policy either retrospectively or prospectively
from any earlier date. Accordingly, the adoption of the new policy has no effect on prior years.
4. The effect on the current year is to increase the carrying amount property, plant and
equipment at the start of the year by N6,000; increase the opening deferred tax provision by
N1,800; create a revaluation surplus at the start of the year N4,200; increase depreciation
expense by N500; and reduce tax expense by N150

Illustration 3
(a) Future Hope Plc. changed its accounting policy in 2011 with respect to the valuation of
inventories. Up to 2010, inventories were valued using a weighted-average cost (WAC) method.
In 2011 the method was changed to first-in, first-out (FIFO), as it was considered to more
accurately reflect the usage and flow of inventories in the economic cycle. The impact on
inventory valuation was determined to be:
At December 31, 2009: an increase of N10,000
At December 31, 2010: an increase of N15,000
At December 31, 2011: an increase of N20,000

(b) The income statements prior to adjustment are

2011 2010
N N
Revenue 250,000 200,000
Cost of sales 100,000 80,000
Gross profit 150,000 120,000
Administration costs 60,000 50,000
Selling and distribution costs 25,000 15,000
Net profit 65,000 55,000
The retained earnings as at 31 December 2009 was N300,000
Required:
(a) Restate the financial statements for 2011 and 2010 on the basis of the new accounting
policy and show the restatement of statement of change in equity for all the prior years.(11
marks)
(b) Outline the requirements of IAS 8 where there is no accounting standard to guide the
management in the selection of accounting policy for a transaction (4 marks)
(c) Outline the disclosure requirements of IAS 8 where the management voluntarily changes its
accounting policies (5 mark)

Suggested Solution
The Income Statements after adjustment would be
Future Hope Plc
INCOME STATEMENT
For the Year Ended December 31, 2011
2011 2010 (restated)
N N
Revenue 250,000 200,000
Cost of sales 95,000 75,000
Gross profit 155,000 125,000
Administration costs 60,000 50,000
Selling and distribution costs 25,000 15,000
Net profit 70,000 60,000
Explanation
In the years 2010 and 2011, Cost of Sales will be reduced by N5,000 each, the net impact on
the opening and closing inventories of change in accounting policy. The effect on 2009 is
N10,000 which will be reflected in opening balance of retained earnings of 2010 in the
Statement of Change in Equity
The impact on the “retained earnings” included in the “statement of changes in equity” would be
as follows (the shaded figures represent the situation if there had been no change in accounting
policy).

Future Hope Plc

 STATEMENT OF CHANGES IN EQUITY (Retained earnings columns only)
For the Year Ended December 31, 2011
Retained Retained
Retained earnings
N N
At January 1, 2010, as originally stated (say) 300,000
300,000
Change in accounting policy for valuation of inventory(2009)10,000
At January 1, 2010, as restated 310,000
Net Profit for the year as restated 60,000 55,000
At December 31, 2010 370,000
355,000
Net Profit for the year 2011 70,000
65,000
At December 31, 2011 440,000
420,000

Explanation
The cumulative impact at December 31, 2010, is an increase in retained earnings of N15,000
and at December, 31 2011, of N20,000
Tax is ignored, otherwise we would have removed 30% tax from N10,000 in 2009, and the
restated profits in 2010 and 2011 would have been after tax too.

REVIEW QUESTIONS
1. IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors contains guidance on the use
of accounting policies and accounting estimates.
Required:
Explain the basis on which the management of an entity must select its accounting policies and
distinguish,
with an example, between changes in accounting policies and changes in accounting estimates.
(5 marks)

(b) The directors of Tunshill are disappointed by the draft profi t for the year ended 30 September 2010.
The company’s assistant accountant has suggested two areas where she believes the reported profi t
may be improved:
(i) A major item of plant that cost N20 million to purchase and install on 1 October 2007 is being
depreciated on a straight-line basis over a fi ve-year period (assuming no residual value). The plant is
wearing well and at the beginning of the current year (1 October 2009) the production manager believed
that the plant was likely to last eight years in total (i.e. from the date of its purchase). The assistant
accountant has calculated that, based on an eight-year life (and no residual value) the accumulated
depreciation of the plant at 30 September 2010 would be N7·5 million (N20 million/8 years x 3). In the fi
nancial statements for the year ended 30 September 2009, the accumulated depreciation was N8 million
(N20 million/5 years x 2). Therefore, by adopting an eight-year life, Tunshill can avoid a depreciation
charge in the current year and instead credit N0·5 million (N8 million – N7·5 million) to the income
statement in the current year to improve the reported profit. (5 marks)

(ii) Most of Tunshill’s competitors value their inventory using the average cost (AVCO) basis, whereas
Tunshill uses the first in first out (FIFO) basis. The value of Tunshill’s inventory at 30 September 2010 (on
the FIFO basis) is N20 million, however on the AVCO basis it would be valued at N18 million. By adopting
the same method (AVCO) as its competitors, the assistant accountant says the company would improve
its profi t for the year ended 30 September 2010 by N2 million. Tunshill’s inventory at 30 September 2009
was reported as N15 million, however on the AVCO basis it would have been reported as N13·4 million.
(5 marks)
Required:
Comment on the acceptability of the assistant accountant’s suggestions and quantify how they
would affect
the fi nancial statements if they were implemented under IFRS. Ignore taxation.
(15 marks) ACCA DECEMBER 2010 FINANCIAL REPORTING

2. Lobden is a construction contract company involved in building commercial properties. Its current policy
for
determining the percentage of completion of its contracts is based on the proportion of cost incurred to
date
compared to the total expected cost of the contract.
One of Lobden’s contracts has an agreed price of N250 million and estimated total costs of N200 million.
The cumulative progress of this contract is:

Year ended: 30 September 2011 30 September 2012

Nmillion Nmillion
Costs incurred 80 145
Work certified and billed 75 160
Billings received 70 150
Based on the above, Lobden prepared and published its financial statements for the year ended 30
September
2011. Relevant extracts are:
Income statement
Nmillion
Revenue (balance) 100
Cost of sales (80)
––––
Profit (50 x 80/200) 20
––––
Statement of financial position
Nmillion
Current assets
Amounts due from customers
Contract costs to date 80
Profit recognised 20
––––
100
Progress billings (75)
––––
25
––––
Contract receivables (75 – 70) 5
Lobden has received some adverse publicity in the financial press for taking its profit too early in the
contract process, leading to disappointing profits in the later stages of contracts. Most of Lobden’s
competitors take profit based on the percentage of completion as determined by the work certified
compared to the contract price.
Required:
(i) Assuming Lobden changes its method of determining the percentage of completion of
contracts to that used by its competitors, and that this would represent a change in an accounting
estimate, calculate
equivalent extracts to the above for the year ended 30 September 2012; (7 marks)
(ii) Explain why the above represents a change in accounting estimate rather than a change in
accounting
policy. (2 marks) ACCA FINANCIAL REPORTING DECEMBER 2012
3. Due to the complexity of International Financial Reporting Standards (IFRS), often judgements 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 judgement 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)

(b) In 2013, Zack, a public limited company, commenced construction of a shopping centre. It considers
that in order to fairly recognise the costs of its property, plant and equipment, it needs to enhance its
accounting policies by capitalising borrowing costs incurred whilst the shopping centre is under
construction. A review of past transactions suggests that there has been one other project involving
assets with substantial construction periods where there would be a material misstatement of the asset
balance if borrowing costs were not capitalised. This project was completed in the year ended 30
November 2012. Previously, Zack had expensed the borrowing costs as they were incurred. The
borrowing costs which could be capitalised are N2 million for the 2012 asset and N3 million for the 2013
asset.
A review of the depreciation schedules of the larger plant and equipment not affected by the above has
resulted in Zack concluding that the basis on which these assets are depreciated would better reflect the
resources consumed if calculations were on a reducing balance basis, rather than a straight-line basis.
The revision would result in an increase in depreciation for the year to 30 November 2012 of N5 million,
an increase for the year end 30 November 2013 of N6 million and an estimated increase for the year
ending 30 November 2014 of N8 million.
Additionally, Zack has discovered that its accruals systems for year-end creditors for the financial year 30
November 2012 processed certain accruals twice in the ledger. This meant that expenditure services
were overstated in the financial statements by N2 million. However, Zack has since reviewed its final
accounts systems and processes and has made appropriate changes and introduced additional internal
controls to ensure that such estimation problems are unlikely to recur.
All of the above transactions are material to Zack.
Required:
Discuss how the above events should be shown in the financial statements of Zack for the year
ended
30 November 2013. (8 marks)
Professional marks will be awarded in question 4 for clarity and quality of presentation. (2 marks)
(25 marks) ACCA CORPORATE REPORTING DECEMBER 2013

SUGGESTED SOLUTIONS
1(a) Management’s choices of which accounting policies they may adopt are not as wide as generally
thought. Where an International Accounting Standard, IAS or IFRS (or an Interpretation) specifi cally
applies to a transaction or event the accounting policy used must be as prescribed in that Standard
(taking in to account any Implementation Guidance within the Standard). In the absence of a Standard, or
where a Standard contains a choice of policies, management must use its judgement in applying
accounting policies that result in information that is relevant and reliable given the circumstances of the
transactions and events. In making such judgements, management should refer to guidance in the
Standards related to similar issues and the defi nitions, recognition criteria and measurement concepts for
assets, liabilities, income and expenses in the IASB’s Framework for the preparation and presentation of
fi nancial statements. Management may also consider pronouncements of other standard-setting bodies
that use a similar conceptual framework to the IASB.
A change in an accounting policy usually relates to a change of principle, basis or rule being applied by an
entity. Accounting estimates are used to measure the carrying amounts of assets and liabilities, or related
expenses and income. A change in an accounting estimate is a reassessment of the expected future
benefits and obligations associated with an asset or a liability.
Thus, for example, a change from non-depreciation of a building to depreciating it over its estimated
useful life would be a change of accounting policy. To change the estimate of its useful life would be a
change in an accounting estimate.

(b) (i) The main issue here is the estimate of the useful life of a non-current asset. Such estimates form
an important part of the accounting estimate of the depreciation charge. Like most estimates, an annual
review of their appropriateness is required and it is not unusual, as in this case, to revise the estimate of
the remaining useful life of plant. It appears, from the information in the question, that the increase in the
estimated remaining useful life of the plant is based on a genuine reassessment by the production
manager. This appears to be an acceptable reason for a revision of the plant’s life, whereas it would be
unacceptable to increase the estimate simply to improve the company’s reported profit. That said, the
assistant accountant’s calculation of the fi nancial effect of the revised life is incorrect. Where there is an
increase (or decrease) in the estimated remaining life of a non-current asset, its carrying amount (at the
time of the revision) is allocated over the new remaining life (after allowing for any estimated residual
value). The carrying amount at 1 October 2009 is N12 million (N20 million – N8 million accumulated
depreciation) and this should be written off over the estimated remaining life of six years (eight years in
total less two already elapsed). Thus a charge for depreciation of N2 million would be required in the year
ended 30 September 2010 leaving a carrying amount of N10 million (N12 million – N2 million) in the
statement of financial position at that date. A depreciation charge for the current year cannot be avoided
and there will be no credit to the income statement as suggested by the assistant accountant. It should be
noted that the incremental effect of the revision to the estimated life of the plant would be to improve the
reported profi t by N2 million being the difference between the depreciation based on the old life (N4
million) and the new life (N2 million).

(ii) The appropriateness of the proposed change to the method of valuing inventory is more dubious than
the previous
example. Whilst both methods (FIFO and AVCO) are acceptable methods of valuing inventory under IAS
2 Inventories, changing an accounting policy to be consistent with that of competitors is not a convincing
reason. Generally changes in accounting policies should be avoided unless a change is required by a
new or revised accounting standard or the new policy provides more reliable and relevant information
regarding the entity’s position. In any event the assistant accountant’s calculations are again incorrect and
would not meet the intention of improving reported profit. The most obvious error is that changing from
FIFO to AVCO will cause a reduction in the value of the closing inventory at 30 September 2010
effectively reducing, rather than increasing, both the valuation of inventory and reported profit.
A change in accounting policy must be accounted for as if the new policy had always been in place
(retrospective
application). In this case, for the year ended 30 September 2010, both the opening and closing
inventories would need
to be measured at AVCO which would reduce reported profi t by N400,000 ((N20 million – N18 million) –
(N15 million –N13·4 million) – i.e. the movement in the values of the opening and closing inventories).
The other effect of the change will be on the retained earnings brought forward at 1 October 2009. These
will be restated (reduced) by the effect of the reduced inventory value at 30 September 2009 i.e. N1·6
million (N15 million – N13·4 million). This adjustment would be shown in the statement of changes in
equity.

2. Lobden’s income statement (extracts) for the year ended:

30 September 2012
Nmillion
Revenue (based on work certified) (160 – 100) 60
Cost of sales (balance) (48)
–––
Profit ((50 x 160/250) – 20) 12
–––
Statement of financial position (extracts) as at:
30 September 2012
Nmillion
Current assets:
Amounts due from customers
Contract costs to date 145
Profit recognised (cumulative 20 + 12) 32
––––
177
Progress billings (cumulative) (160)
––––
Amounts due from customers 17
––––
Contract receivables (160 – 150) 10
––––
(ii) The relevant issue here is what constitutes the accounting policy for construction contracts. Where
there is uncertainty in the outcome of a contract, the appropriate accounting policy would be the
completed contract basis (i.e. no profit is taken until the contract is completed). Similarly, any expected
losses should be recognised immediately. Where the outcome of a contract is reasonably foreseeable,
the appropriate accounting policy is to accrue profits by the percentage of completion method. If this is
accepted, it becomes clear that the different methods of determining the percentage of completion of
construction contracts are different accounting estimates. Thus the change made by Lobden in the year to
30 September 2012 represents a change of accounting estimate. This approach complies with the
guidance in IAS 11 Construction Contracts paras 30 and 38.

SUGGESTED SOLUTION
3 (a) (i) The selection of accounting policy and estimation techniques is intended to aid comparability and
consistency in financial statements. 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. An entity should determine the accounting policy to be applied to an item with direct reference to
IFRS but
accounting policies need not be applied if the effect of applying them would be immaterial. IAS 8 also
notes that it is
inappropriate to make or leave uncorrected immaterial departures from IFRS to achieve a particular
position. Where IFRS does not specifically apply to a transaction, judgement should be used in
developing or applying an accounting policy, which results in financial information which is relevant to the
decision-making and assessment needs of users. In making that judgement, entities must refer to
guidance in IFRS, which deals with similar issues and then subsequently to definitions, and criteria in the
Framework. Additionally, entities can refer to recent pronouncements of other standard setters who use
similar conceptual frameworks. Entities should select and apply their accounting policies consistently for
similar transactions. If IFRS specifically permits different accounting policies for categories of similar
items, an entity should apply an appropriate policy for each of the categories in question and apply these
accounting policies consistently for each category. For example, for different classes of property, plant
and equipment, some may be carried at fair value and some at historical cost.

(ii) A change in accounting policy should only be made if the change is required by IFRS, or it will result in
the financial statements providing reliable and more relevant financial information. Significant changes in
accounting policy other than those specified by IFRS should be relatively rare. IFRS specifies the
accounting policies for a high percentage of the typical transactions which are faced by entities. There are
therefore limited opportunities for an entity to choose an accounting policy, as opposed to a basis for
estimating figures which will satisfy such a policy.
IAS 8 states that the introduction of an accounting policy to account for transactions where circumstances
have changed is not a change in accounting policy. Similarly, an accounting policy for transactions which
did not occur previously or which were immaterial is not a change in accounting policy and therefore
would be applied prospectively.
For example, where an entity changes the use of a property from an administration building to a
residential space and
therefore an investment property, this would result in a different treatment of revaluation gains and losses.
However, this is not a change in accounting policy and so no restatement of comparative amounts should
be made.
A change in accounting policy is applied retrospectively unless there are transitional arrangements in
place. Transitional provisions are often included in new or revised standards and may not require full
retrospective application.
Sometimes it is difficult to achieve comparability of prior periods with the current period where, for
example, data might
not have been collected in the prior periods to allow retrospective application. Restating comparative
information for prior periods often requires complex and detailed estimation. This, in itself, does not
prevent reliable adjustments.
When making estimates for prior periods, the basis of estimation should reflect the circumstances which
existed at the
time and it becomes increasingly difficult to define those circumstances with the passage of time.
Estimates and
circumstances might be influenced by knowledge of events and circumstances which have arisen since
the prior period.
IAS 8 does not permit the use of hindsight when applying a new accounting policy, either in making
assumptions about what management’s intentions would have been in a prior period or in estimating
amounts to be recognised, measured or disclosed in a prior period.
When it is impracticable to determine the effect of a change in accounting policy on comparative
information, the entity
is required to apply the new accounting policy to the carrying amounts of the assets and liabilities as at
the beginning
of the earliest period for which retrospective application is practicable. This could actually be the current
period but the
entity should attempt to apply the policy from the earliest date possible.
(iii) IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors requires prior period errors
to be amended retrospectively by restating the comparatives as if the error had never occurred. Hence,
the impact of any prior period errors is shown through retained earnings rather than being included in the
current period’s profit or loss. Managers could use this treatment for prior period errors as a method for
manipulating current period earnings. Restatements due to errors and irregularities can be considered to
indicate poor earnings quality, and to threaten investor confidence, particularly if they occur frequently.
Thus, it might appear that the factors associated with earnings corrections could be linked to earnings
management.
Arguments against the approach in IAS 8 are:
– that the standard allows inappropriate use of hindsight;
– that the treatment renders errors less prominent to users; and
– that it allows amounts to be debited or credited to retained profits without ever being included in a
current period
profit or loss.
Managers have considerable discretion regarding the degree of attention drawn to such changes. The
information
content and prominence to users of disclosures regarding prior period errors are issues of significance,
with potential
economic and earnings quality implications. Expenses could be moved backward into a prior period, with
the result that managers are given a possible alternative strategy with which to manage earnings. It is
possible to misclassify liabilities, for example, as non-current rather than current, or even simply
miscalculate reported earnings per share. Under IAS 8, the prior period error can then be amended the
following year, with no lingering effects on the statement of financial position as a result of the
manipulation.

(b) IAS 23 Borrowing Costs states that such costs which are directly attributable to the acquisition,
construction or production of a qualifying asset form part of the cost of that asset and, therefore, should
be capitalised. Other borrowing costs are recognised as an expense. Thus the change in accounting
policy actually only brings Zack in line with IFRS, with the result that there is an accounting error which
will require a prior period adjustment. In applying the new accounting policy, Zack has identified that there
is another asset where there is a material impact if borrowing costs should have been capitalised during
the construction period. This contract was completed during 2012. Thus, the financial statements for the
year ended 30 November 2012 should be restated to apply the new policy to this asset. The effects of the
restatement are as follows: at 30 November 2012, the carrying amount of property, plant and equipment
is restated upwards by N2 million less depreciation for the period and this would result in an increase in
profit or loss for the period of the same amount. Disclosures relating to prior period errors include: 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 earnings per share, the
amount of the correction at the beginning of the earliest prior period presented. The disclosure would
include the nature of the prior period error.
The line items in the statement of profit or loss and other comprehensive income would also change. For
the current period, Zack would disclose the impact of the prior period error of N3 million. It can be
assumed that, because the asset is under construction, there will be no depreciation on the asset.
The change in the depreciation method is not a change in an accounting policy but a change in an
accounting estimate. For changes in accounting estimates, Zack should disclose the nature and the
amount of the change which affects the current period or which it is expected to have in future periods. It
should be noted that IAS 8 does permit an exception where it is impracticable to estimate the effect on
future periods. Where the effect on future periods is not disclosed because it is impracticable, that fact
should be disclosed. The revision results in an increase in depreciation for 2013 of N6m and the
disclosure of an estimated increase for 2014 of N8m.
The systems error has resulted in a prior period error. In order to correct this error, Zack should restate
the prior year
information for the year ended 30 November 2012 for the N2m in the statement of profit or loss and other
comprehensive income. Additionally, the trade creditors figure in the statement of financial position is
overstated by N2 million and should be restated. The movement in reserves note will also require
restating. This is not a correction of an accounting estimate.

IAS 10: EVENTS AFTER THE REPORTING PERIOD

Background and Introduction
The statement of financial position date is the pivotal date at which the financial position of an
entity is determined and reported. Thus, events that occur up to that date are critical in arriving
at an entity’s financial results and the financial position. However, sometimes events occurring
after the reporting period date may provide additional information about events that occurred
before and up to the statement of financial position date. This information may have an impact
on the financial results and the financial position of the entity. It is imperative that those post–
statement of financial position events up to a certain “cut-off date” (discussed later and referred
to as the authorization date) be taken into account in preparing the financial statements for the
year ended and as at the reporting period.
Additionally, certain events that occur after the reporting period date might not affect the figures
reported in the financial statements but may warrant disclosure in footnotes to the financial
statements. Informing users of financial statements about such post–reporting period date
events through footnote disclosures helps them make informed decisions with respect to the
entity, keeping in mind the impact these post–balance sheet events may have on the financial
position of the entity as at the reporting period.

Definition of Terms
Events after the reporting period: Those post–reporting period events, both favourable and
unfavourable, that occur between the statement of financial position date and the date when the
financial statements are authorized for issue.
Adjusting events after the reporting period: Those post–balance sheet events that provide
evidence of conditions that existed at the statement of financial position date.
Non-adjusting events after the statement of financial position date: Those post–statement
of financial position events that are indicative of conditions that arose after the reporting period.

Authorization Date
The authorization date is the date when the financial statements could be considered legally
authorized for issuance. The determination of the authorization date is critical to the concept of
events after the reporting period. The authorization date serves as the cut-off point after the
statement of financial position date up to which the post–balance sheet events are to be
examined in order to ascertain whether such events qualify for the treatment prescribed by IAS
10. This Standard explains the concept through the use of examples.
The general principles that need to be considered in determining the “authorization date” of the
financial statements are set out next.
• When an entity is required to submit its financial statements to its shareholders for
approval after they have already been issued, the authorization date in this case would
mean the date of original issuance and not the date when these are approved by the
shareholders; and
• When an entity is required to issue its financial statements to a supervisory board made
up wholly of non-executives, “authorization date” would mean the date on which
management authorizes them for issue to the supervisory board.

Ajusting and Non- Adjuting Events (after the reporting period)

Two kinds of events after the statement of financial position date are distinguished by the
Standard. These are, respectively, “adjusting events after the statement of financial position
date” and “non-adjusting events after the statement of financial position date.” Adjusting events
are those post-statement of financial position events that provide evidence of conditions that
actually existed at the statement of financial position date, albeit they were not known at the
time. Financial statements should be adjusted to reflect adjusting events after the reporting
period.
Typical examples of adjusting events are
• The bankruptcy of a customer after the statement of financial position date usually
suggests a loss of trade receivable at the reporting period.
• The sale of inventory at a price substantially lower than its cost after the reporting period
confirms its net realizable value at the reporting period.
• The sale of property, plant, and equipment for a net selling price that is lower than the
carrying amount is indicative of an impairment that took place at the reporting period.
• The determination of an incentive or bonus payment after the balance sheet when an
entity has a constructive obligation at the reporting period.
• A deterioration in the financial position (recurring losses) and operating results (working
capital deficiencies) of an entity that has a bearing on the entity’s continuance as a
“going concern” in the foreseeable future.

Example 1
During the year 2005, Top Tea Plc was sued by a competitor for N15 million for infringement of a
trademark. Based on the advice of the company’s legal counsel, Top Tea Plc. accrued the sum
of N10 million as a provision in its financial statements for the year ended December 31, 2005.
Subsequent to the balance sheet date, on February 15, 2006, the Supreme Court decided in
favour of the party alleging infringement of the trademark and ordered the defendant to pay the
aggrieved party a sum of N14 million.
The financial statements were prepared by the company’s management on January 31, 2006,
and approved by the board on February 20, 2006.
Required
Should Top Tea Plc adjust its financial statements for the year ended December 31, 2005?

Suggested Solution
Top Tea Plc should adjust the provision upward by N4 million to reflect the award decreed by the
Supreme Court (assumed to be the final appellate authority on the matter in this example) to be
paid by Top Tea Plc to its competitor.
Had the judgment of the Supreme Court been delivered on February 25, 2005, or later, this
post–reporting period event would have occurred after the cut-off point (i.e., the date the
financial statements were authorized for original issuance). If so, adjustment of financial
statements would not have been required.
Example 2
Shine Your Eyes Plc carries its inventory at the lower of cost and net realizable value. At
December 31, 2005, the cost of inventory, determined under the first-in, first-out (FIFO) method,
as reported in its financial statements for the year then ended, was N10 million. Due to severe
recession and other negative economic trends in the market, the inventory could not be sold
during the entire month of January 2006. On February 10, 2006, Shine Your Eyes plc entered
into an agreement to sell the entire inventory to a competitor for N6 million.
Required
Presuming the financial statements were authorized for issuance on February 15, 2006, should
Shine Your Eyes Plc recognize a write-down of N4 million in the financial statements for the year
ended December 31, 2005?

Suggested Solution
Yes, Shine Your Eyes Plc should recognize a write-down of N4 million in the financial
statements for the year ended December 31, 2005.

Examples of non-adjusting events include:

• Declaration of an equity dividend
• Decline in the market value of an investment after the reporting period
• Entering into major purchase commitments in the form of issuing guarantees after the
reporiting period
• Classification of assets as held for sale under IFRS 5 and the purchase, disposal, or
expropriation of assets after the reporting period
• Commencing a lawsuit relating to events that occurred after the reporting period

Example 3
The statutory audit of ABC Plc for year ended June 30, 2005, was completed on August 30,
2005. The financial statements were signed by the managing director on September 8, 2005,
and approved by the shareholders on October 10, 2005. The next events have occurred.
(1) On July 15, 2005, a customer owing N900,000 to ABC Plc filed for bankruptcy. The financial
statements include an allowance for doubtful debts pertaining to this customer only of N50,000.
(2) ABC Plc issued capital comprised 100,000 equity shares. The company announced a bonus
issue of 25,000 shares on August 1, 2005.
(3) Specialized equipment costing N545,000 purchased on March 1, 2005, was destroyed by
fire on June 13, 2005. On June 30, 2005, ABC Plc. has booked a receivable of N400,000 from
the insurance company pertaining to this claim. After the insurance company completed its
investigation, it was discovered that the fire took place due to negligence of the machine
operator. As a result, the insurer’s liability was zero on this claim by ABC Plc
Required
How should ABC Plc account for these three post–reporting period events?

Suggested Solution
(1) ABC Plc should increase its allowance for doubtful debts to N900,000 because the
customer’s bankruptcy is indicative of a financial condition that existed at the reporting period.
This is an “adjusting event.”

(2) IAS 33, Earnings Per Share, requires a disclosure of transactions as “stock splits” or “rights
issue,” which are of significant importance at the balance sheet. This is a non-adjusting event,
and only disclosure is needed.

(3) This is an adjusting event because it relates to an asset that was recognized at the balance
sheet date. However, as the insurance company’s liability is zero, ABC Plc must adjust its
receivable on the claim to zero.
Divends Proposed or Declared After the Reporting Period
Dividends on equity shares proposed or declared after the reporting period should not be
recognized as a liability at the statement of financial position date. Such declaration is a non-
adjusting subsequent event and footnote disclosure is required, unless immaterial.

Going Concern Consideration

Deterioration in an entity’s financial position after the statement of financial position date could
cast substantial doubts about an entity’s ability to continue as a going concern. IAS 10 requires
that an entity should not prepare its financial statements on a going concern basis if
management determines after the statement of financial position date either that it intends to
liquidate the entity or cease trading, or that it has no realistic alternative but to do so. IAS 10
notes that disclosures prescribed by IAS 1 under such circumstances should also be complied
with.

Disclosure Requirements
IAS 10 requires these three disclosures:
(1) The date when the financial statements were authorized for issue and who gave that
authorization. If the entity’s owners have the power to amend the financial statements after
issuance, this fact should be disclosed.

(2) If information is received after the statement of financial position date about conditions that
existed at the statement of financial position date, disclosures that relate to those conditions
should be updated in the light of the new information.

(3) Where non-adjusting events after the statement of financial position date are of such
significance that non-disclosure would affect the ability of the users of financial statements to
make proper evaluations and decisions, disclosure should be made for each such significant
category of non-adjusting event regarding the nature of the event and an estimate of its financial
effect or a statement that such an estimate cannot be made.

REVIEW QUESTIONS
1. The objective of IAS 10 Events after the Reporting Period is to prescribe the treatment of events that
occur after
an entity’s reporting period has ended.
Required:
Define the period to which IAS 10 relates and distinguish between adjusting and non-adjusting
events.
(5 marks)

(b) Waxwork’s current year end is 31 March 2009. Its financial statements were authorised for issue by its
directors
on 6 May 2009 and the AGM (annual general meeting) will be held on 3 June 2009. The following matters
have been brought to your attention:
(i) On 12 April 2009 a fire completely destroyed the company’s largest warehouse and the inventory it
contained. The carrying amounts of the warehouse and the inventory were N10 million and N6 million
respectively. It appears that the company has not updated the value of its insurance cover and only
expects to be able to recover a maximum of N9 million from its insurers. Waxwork’s trading operations
have been severely disrupted since the fire and it expects large trading losses for some time to come. (4
marks)

(ii) A single class of inventory held at another warehouse was valued at its cost of N460,000 at 31 March
2009. In April 2009 70% of this inventory was sold for N280,000 on which Waxworks’ sales staff earned a
commission of 15% of the selling price. (3 marks)
(iii) On 18 May 2009 the government announced tax changes which have the effect of increasing
Waxwork’s deferred tax liability by N650,000 as at 31 March 2009. (3 marks)
Required:
Explain the required treatment of the items (i) to (iii) by Waxwork in its financial statements for the
year ended 31 March 2009.
Note: assume all items are material and are independent of each other. (10 marks as indicated)
(15 marks) ACCA FINANCIAL REPORTING 2009 JUNE

SUGGESTED SOLUTION
1.(a) Events after the reporting period are defined by IAS 10 Events after the Reporting Period as those
events, both favourable and unfavourable, that occur between the end of the reporting period and the
date that the financial statements are authorised for issue (normally by the Board of directors).
An adjusting event is one that provides further evidence of conditions that existed at the end of the
reporting period, including an event that indicates that the going concern assumption in relation to the
whole or part of the entity is not appropriate.
Normally trading results occurring after the end of the reporting period are a matter for the next reporting
period, however, if there is an event which would normally be treated as non-adjusting that causes a
dramatic downturn in trading (and profitability) such that it is likely that the entity will no longer be a going
concern, this should be treated as an adjusting event.
A non-adjusting event is an event after the end of the reporting period that is indicative of a condition that
arose after the end of the reporting period and, subject to the exception noted above, the financial
statements would not be adjusted to reflect such events.
The outcome (and values) of many items in the financial statements have a degree of uncertainty at the
end of the reporting period. IAS 10 effectively says that where events occurring after the end of the
reporting period help to determine what those values were at the end of the reporting period, they should
be taken in account (i.e. adjusted for) in preparing the financial statements.
If non-adjusting events, whilst not affecting the financial statements of the current year, are of such
importance (i.e. material) that without disclosure of their nature and estimated financial effect, users’
ability to make proper evaluations and decisions about the future of the entity would be affected, then they
should be disclosed in the notes to the financial statements.

(b) (i) This is normally classified as a non-adjusting event as there was no reason to doubt that the value
of warehouse and the inventory it contained was worth less than its carrying amount at 31 March 2009
(the last day of the reporting period). The total loss suffered as a result of the fire is N16 million. The
company expects that N9 million of this loss will be recovered from an insurance policy. Recoveries from
third parties should be assessed separately from the related loss. As this event has caused serious
disruption to trading, IAS 10 would require the details of this non-adjusting event to be disclosed as a note
to the financial statements for the year ended 31 March 2009 as a total loss of N16 million and the effect
of the insurance recovery to be disclosed separately.
The severe disruption in Waxwork’s trading operations since the fire, together with the expectation of
large trading losses for some time to come, may call in to question the going concern status of the
company. If it is judged that Waxwork is no longer a going concern, then the fire and its consequences
become an adjusting event requiring the financial statements for the year ended 31 March 2009 to be
redrafted on the basis that the company is no longer a going concern (i.e. they would be prepared on a
liquidation basis).

(ii) 70% of the inventory amounts to N322,000 (460,000 x 70%) and this was sold for a net amount of
N238,000
(280,000 x 85%). Thus a large proportion of a class of inventory was sold at a loss after the reporting
period. This
would appear to give evidence of conditions that existed at 31 March 2009 i.e. that the net realisable
value of that class of inventory was below its cost. Inventory is required to be valued at the lower of cost
and net realisable value, thus this is an adjusting event. If it is assumed that the remaining inventory will
be sold at similar prices and terms as that already sold, the net realisable value of the whole of the class
of inventory would be calculated as:
N280,000/70% = N400,000, less commission of 15% = N340,000.
Thus the carrying amount of the inventory of N460,000 should be written down by N120,000 to its net
realisable value
of N340,000.
In the unlikely event that the fall in the value of the inventory could be attributed to a specific event that
occurred after
the date of the statement of financial position then this would be a non-adjusting event.

(iii) The date of the government announcement of the tax change is beyond the period of consideration in
IAS 10. Thus this would be neither an adjusting nor a non-adjusting event. The increase in the deferred
tax liability will be provided for in the year to 31 March 2010. Had the announcement been before 6 May
2009, it would have been treated as a non-adjusting event requiring disclosure of the nature of the event
and an estimate of its financial effect in the notes to the financial statements.

IAS 11: CONSTRUCTION CONTRACT

Defintion
Construction contract is a contract specifically negotiated for the construction of an asset or a
combination of assets that are closely interrelated or interdependent in terms of their design,
technology and function or their ultimate purpose or use.
The Standard differentiates between fixed price contract and cost plus contracts.
Fixed price contract: A contract in which the contractor agrees to a fixed contract price, or a
fixed rate per unit of output which in some cases is subjective to cost escalation clauses.
Cost plus contract: A construction contract in which the contractor is reimbursed for allowable
or otherwise defined costs plus a percentage of these costs or a fixed fee.
Construction contracts may involve the building of one asset, eg a bridge, or a series of
interrelated assets eg an oil refinery.

Combining and Segmenting Construction Contracts

The Standard lays out the factors which determine whether the construction of a series of
assets under one contract should be treated as several contracts.
• Separate proposals are submitted for each asset
• Separate negotiations are undertaken for each asset; the customer can accept or reject
each individually
• Identifiable costs and revenues can be separated for each asset

There are also circumstances where a group of contracts should be treated as one single
construction contract:
• The group of contracts are negotiated as a single package
• Contracts are closely interrelated, with an overall profit margin.
 • The contracts are performed concurrently or in a single sequence.

Contract Revenue
Contract revenue will be the amount specified in the contract, subject to variations in the
contract work, incentive payments and claims if these will probably give rise to revenue and if
they can be reliably measured. The result is that contract revenue is measured at the fair value
of received or receivable revenue.
The Standard enumerates on the types of uncertainty, which depend on the outcome of future
events, that affect the measurement of contract revenue:
• An agreed variation (increase/decrease)
• Cost escalation clauses in a fixed price contract (increase)
• Penalties imposed due to delays by the contractor (decrease)
• Number of units varies in a contract for fixed prices per unit (increase/decrease)
In the case of any variation, claim or incentive payment, two factors should be assessed to
determine whether contract revenue should be recognised.
• Whether it is probable that the customer will accept the variation/claim, or that the
contract is sufficiently advanced that the performance criteria will be met.
• Whether the amount of the revenue can be measured reliably.

Contract Expenses
Contract costs consist of:
• Costs relating directly to the contract
• Costs attributable to general contract activity which can be allocated to the contract,
such as insurance, cost of design and technical assistance not directly related to a
specific contract and construction overheads
• Any other costs which can be charged to the customer under the contract, which may
include general adminstrative costs and development costs.
Costs that relate directly to a specific contract include the following:
• Site labour costs, including site supervision
• Costs of materials used in construction
• Depreciation of plant and equipment used on the contract
• Costs of moving plant, equipment and materials to and from the contract site.
• Costs of hiring plant and equipment
• Costs of design and technical assistance that are directly related to the contract
• Estimated costs of rectification and guarantee work including expected warranty costs
• Claims from third parties (sub contracts)
General contract activity costs should be allocated systematically and rationally and all costs
with similar characteristics should be treated consistently. The allocation should be based on the
normal level of construction activity. Borrowing costs may be attributed in this way.

Costs That Cannot be Attributed to Contracts:

• General administrative costs unless reimbursement is specified in the contract
• Selling costs
• Research and development unless remibursement is specified in the contract
• Depreciation of idle plant and equipment not used on any particluar contract

Recogniion of Contract Revenue and Expenses

Revenue and costs associated with a contract should be recognised according to the stage of
completion of the contract at the end of the reporting period, but only when the outcome of the
activity can be estimated reliably. If a loss is predicted on a contract, then it should be
recognised immediately. This is often known as the percentage of completion method.
A reliable estimate of the outcome of a construction contract can only be made when certain
conditions have been met, and these conditions will be different for fixed price and cost plus
contract.
For Fixed Price Contracts:
• Probable that economc benefits of the contract will flow to the entity
• Total contract revenue can be reliably measured
• Stage of completion at the period end and costs to complete the contract can be reliably
measured
• Costs attributable to the contract can be identified clearly and be reliably measured.

For Cost Plus Contract:

• Probable that economic benefits of the contract will flow to the entity
• Costs attributable to the contract (whether or not rembursible) can be identified clearly
and be reliably measured.

The percentage of completion method is an application of the accruals assumption. Contract

revenue is matched to the contract costs incurred in reaching the stage of completion, so
revenue, costs and profits are attributed to the proportion of work completed.

When Can Reliable Estimates be Made?

The Standard only allows contract revenue and costs to be recognised when the outcome of the
contract can be predicted, ie when it is probable that the economc benefits attached to the
contract will flow to the entity. This can only be when a contract has been agreed which
establishes the following:
• The enforceable rights of each party of the asset to be constructed
• The consideration that is to be exchanged
• Terms and manner of settlement
In addition, the entity should have an effective financial budgeting and reporting system, in order
to review and revise the estimates of contract revenue and costs as the contract progresses.

Determining the Stage of Completion

The standard provides guidelines on deciding the stage of completion of a contract and the
methods are:
• Proportion of contract costs incurred for work carried out to date
• Surveys of work carried out
• Physical proportion of the contract work completed

Illustration on stage of completion

Cosmolitan Construction Plc has a fixed price contract to build a tower block. The initial amount
of revenue agreed is N220m. At the beginning of the contract on 1 January 2006 the initial
estimate of the contract costs is N200m. At the end of 2006 the estimate of the total costs has
risen to N202m.
During 2007 the customer agrees to a variation which increase expected revenue from the
contract by N5m and causes additonal costs of N3m. At the end of 2007 there are materials
stored on the site for use during the following period which cost N2.5m
The contract costs incurred at the end of each year were 2006; N52.52m, 2007; N154.2m
(including materials in stores), 2008; N205m
Required
Calculate the stage of completion for each year of the contract and show how revenues, costs
and profits will be recognised in each year, using the proportion of cost incurred to date bears to
the latest estimated total contract costs.

Suggested Solution
Summary of the financial data for each year end during the construction period:
 2006 2007 2008
N’000 N’000 N’000
Initial amount of revenue agreed in the contract 220,000 220,000 220,000
Variation - 5,000 5,000
Total contract revenue 220,000 225,000 225,000
Contract costs incurred to date 52,520 154,200 205,000
Contract costs to complete 149,480 50,800 ---- - -----
Total estimated contract costs 202,000 205,000 205,000
Estimated profit 18,000 20,000 20,000
Stage of completion 26% 74% 100%

The stage of completion has been calculated using the formula:

Contract costs incurred to date
Total estimated contract costs
Revenue, expenses and profit will be recognised in profit or loss as follows
Recognised in
Recognised in
To date Prior years current
year
N’000 N’000 N’000
2006 Revenue (N220m x 26%) 57,200
Costs (220m x 26%) 52,520
Profit 4,680

2007 Revenue (225m x 74%) 166,500 57,200 109,300

Costs (205m x 74%) 151,700 52,520 99,180
Profit 14,800 4,680 10,120

2008 Revenue (225m x 100%) 225,000 166,500 58,500

Costs (205m x 100%) 205,000 151,700 53,300
20,000 14,800 5,200

When the Outcome of Contract Cannot be Estimated Reliably

When the contract’s outcome cannot be reliably estimated the following treatment should be
followed:
• Only recognise revenue to the extent of contract costs incurred which are expected to be
recoverable
• Recognise contract costs as an expense in the perid they are incurred
This no profit nor loss approach reflects the situation near the beginning of a contract, ie the
outcome cannot be reliably estimated, but is likely that the cost will be recovered.
Contract costs which cannot be recovered should be recognised as an expense straight away.
IAS 11 lists the following situations where this might occur:
• The contract is not fully enforceable, ie its validity is seriously questioned
• The completion of the contract is subject to the outcome of pending litigation or
legislation
• The contract relates to properties which will probably be expropriated or condemned
• The customer is unable to meet its obligations under the contract
• The contractor cannot complete the contract or in any other way meet its obligations
under the contract.
Where these uncertainties cease to exist, contract revenue and costs should be recognised as
normal ie by reference to the stage of completion.

Recognition of Expected Losses

Any loss on a contract should be recognised as soon as it is foreseen. The loss will be the
amount by which total expected contract revenue is exceeded by total expected contract costs.
The loss amount is not affected by whether work has started on the contract, the stage of
completion of the work or profits on other contracts (unless they are related contracts treated as
a single contract).

Changes in Estimates
The effect of any change in the estimate of contract revenue or costs or the outcome of a
contract should be accounted for as a change in accounting estimate under IAS 8 on
Accounting Policies, Changes in Accounting Estimates and Errors.

Illustration on changes in estimates

Babylon Plc enters into three year contract, the estimated revenue is N20,000 while the
estimated cost is N16,000.
However, during the second year, management revises its estimates of total costs incurred and
thus the outcome of the contract. As a result, during the second year, a loss is recognised on
the contract for the year, even though the contract will still be profitable overall.
Year 1 Year 2 Year 3
N N N
Estimated revenue 20,000 20,000 20,000
Estimated total cost 16,000 18,000 18,000
Estimated total profit 4,000 2,000 2,000
Cost incurred to date 8,000 13,500 18,000
Percentage of completion 50% 75% 100%
Recognised profit/loss for year N2,000 (N500) N500
Cumulative recognised profit N2,000 N1,500 N2,000
Progress billings of N8,000, N8,000 and N4,000 are made on the last day of each year and are
received in the first month of the following year. The asset at the end of each year is:
Year 1 Year 2 Year 3
N N N
Costs incurred 8,000 13,500 18,000
Recognised profits 2,000 2,000 2,500
Recognised losses (500) (500)
Progress billings (8,000) (16,000) (20,000)
Amount recognised as an asset/(liability 2,000 (1,000) 0
In additon the entity recognises a trade receivable for the amount outstanding at the end of the
year of N8,000, N8,000 and N4,000 respectively.

Summary of Steps in Contract Accounting

Step 1: Compare the contract value and the total costs expected to be incurred on the contract.
If a loss is forseen, then it must be charged agianst profits. If a loss has already been charged in
previous years, then only the difference between the loss as previously and currently estimated
need be charged.

Step2: Using the percentage completed to date calculate sales revenue attributable to the
contract for the period, less revenue taken in in previous preriods.

Step 3: Calculate the cost of sale on the contract for the period N
Total contract costs x % completed XX
Less costs charged in previous periods (XX)
XX
Add: forseeable losses full not previously charged XX
Cost of sales on contract for the period XX

Step 4: Deduct the cost of sales as calculated in (3) above from the sales revenue calculated in
(2) to give profit or loss recognised for the period.

Step 5: Calculate amounts due to/from customer to be shown as inventory

N
Contract costs incurred to date XX
Recognised profits/(losses) to date XX
XX
Less Progress bills to date (XX)
Amount due from/to the customer XX
The progress bills to date received from customers would have entered the bank and the portion
not yet received presented as receivables in the statement of financial postion.

REVIEW QUESTIONS
1. Abuja Construction Co Ltd has an uncompleted contract at the end of 30 September 2005,
details of which are as follows:
Contract A
Date commenced 1 April 2003
Expected completion date 31 Dec 2005
N
Final contract price 290,000
Cost to 30 September 2005 210,450
Value of work certified to date 230,000
Progress bills to date 210,000
Cash received to date 194,000
Estimated costs completion at 30 September 2005 20.600
Required:
Prepare calculations showing the amount to be included in the statement of financial position at
30 September 2003 in respect of the above contract

Q2. One in Town Construction Co Ltd has two contracts work in progress, the details of which
are:
Road Construction Dam construction
(profitable) (loss making)
N’000 N’000
Total contract price 300 300
Costs incurred to date 90 150
Estimated cost to completion 135 225
Progress payments invoiced & received 116 116
Required
Show extracts from the statement of comprehensive income and the statement of financial
position for each contract, assuming they are both
40% complete and
36% complete

3. On 1 October 2009 Mocca entered into a construction contract that was expected to take 27 months
and therefore
be completed on 31 December 2011. Details of the contract are:
N’000
Agreed contract price 12,500
Estimated total cost of contract (excluding plant) 5,500
Plant for use on the contract was purchased on 1 January 2010 (three months into the contract as it was
not required
at the start) at a cost of N8 million. The plant has a four-year life and after two years, when the contract is
complete,
it will be transferred to another contract at its carrying amount. Annual depreciation is calculated using the
straight-line method (assuming a nil residual value) and charged to the contract on a monthly basis at
1/12 of the
annual charge.
The correctly reported income statement results for the contract for the year ended 31 March 2010 were:
N’000
Revenue recognised 3,500
Contract expenses recognised (2,660)
–––––––
Profit recognised 840
–––––––
Details of the progress of the contract at 31 March 2011 are:
N’000
Contract costs incurred to date (excluding depreciation) 4,800
Agreed value of work completed and billed to date 8,125
Total cash received to date (payments on account) 7,725
The percentage of completion is calculated as the agreed value of work completed as a percentage of the
agreed
contract price.
Required:
Calculate the amounts which would appear in the income statement and statement of financial
position of Mocca, including the disclosure note of amounts due to/from customers, for the year
ended/as at 31 March 2011 in respect of the above contract.
(10 marks) ACCA FINANCIAL REPORTING JUNE 2011

SUGGESTED SOLUTIONS
1. Abuja Construction Co N
Estimated final profit is:
Final contract price 290,000
Less: Cost to date (210,450)
Estimated future costs (20,600)
Estimated final profit 58,950
The attributable profit is found as follows:
Work certified x Estimated profit
Total contract price
= N230,000 x N58,950 = N46,753
N290,000

Figures for Statement of Financial Position

Long- term contract in progress N
Contract A
Costs to date 210,450
Attributable profit 46,753
257,203
Progress payments (210,000)
47,203
Trade receivables (N210,000 – N194,000) 16,000

2 One in Town Construction Co Ltd

2.(a) 40% complete
Road constuction N’000
Statement of comprehensive income
Revenue (N300 x 40%) 120
Cost of sales (N90 +135) x 40% (90)
Profit to date Wk 1) 30

Workings
1. Profit to date
Total contract price 300
Cost to date (90)
Cost to completion (135)
Total expected profit 75
Profit to date 40% x N75 30

Statement of financial position

Costs to date 90
Profits recognised to date 30
Progress billings (116)
Amount due from customer ie work in progress 4

Road construction N’000

(b) 36% complete
Statement of comprehensive income
Revenue (N300 x 36%) 108
Cost of sales (N90 + N135) x 36% (81)
Profit to date (36% x N75) 27

Statement of financial position extract

Costs to date 90
Profit recognised to date 27
Progress billings (116)
Amount due from customer ie WIP 1

Dam Contract
(a) 40% complete N’
Statement of comprehensive income
Revenue (N300 x 40%) 120
Cost of sales (wk ) (195)
Forseeable loss (75)

Workings
1. Total contract revenue 300
Costs to date (150)
Costs to complete (225)
Foreseeable loss 75

2. Costs to date
(150 + 225) x 40% 150
Foreseeable loss 60% x N75 45
195
40% of the foreseeable loss is included in cost to date

Statement of financial position extract

Cost to date 150
Foreseeable loss 75
Progress billings (116)
Amount due to customer (41)
(b) 36% complete N’000
Statement of comprehensive income
Revenue (N300 x 36%) 108
Cost of sales (wk 2) (183)
Foreseeabe loss (75)

Workings
1. Costs to date
(N150 + 225) x 36% 135
Forseeable loss 64% x N75 48
183

Statement of financial position extract

Costs to date 150
Foreseeable loss (75)
Progress billings (116)
Amount due to customer (41)

3. Mocca
Income statement year ended 31 March 2011
N’000
Revenue recognised ((65% (w (i)) x 12,500) – 3,500 in 2010) 4,625
Contract expenses recognised (balancing figure) (3,515)
––––––
Profit recognised ((65% (w (ii)) x 3,000) – 840 in 2010) 1,110
––––––
Statement of financial position as at 31 March 2011
Non-current assets
Plant (8,000 – 2,500 (w (iii))) 5,500
Current assets
Receivables (8,125 – 7,725) 400
Amounts due from customers – Note 1 1,125

Note 1
Amounts due from customers:
Contract costs incurred (w (iii)) 7,300
Recognised profits (3,000 x 65%) 1,950
––––––
9,250
Progress billings (8,125)
––––––
Amounts due from customers 1,125
––––––
Workings (in N’000)
(i) Percentage complete:
Agreed value of work completed at year end 8,125
–––––––
Contract price 12,500
Percentage completed (8,125/12,500 x 100) 65%

(ii) Estimated profit: N’000

Contract price 12,500
Plant depreciation (8,000 x 24/48 months) (4,000)
Other costs (5,500)
–––––––
Profit 3,000
–––––––
(iii) Contract costs incurred:
Plant depreciation (8,000 x 15/48 months) 2,500
Other costs 4,800
––––––
7,300
––––––

IAS 12 DEFERRED TAX

Deferred tax is an adjustment to the tax charge for a period to reflect the impact of temporary
timing
differences which are expected to reverse in the future

Current Tax
Current tax for the current and prior periods is recognised as a liability to the extent that it has
not yet been settled, and as an asset to the extent that the amounts already paid exceed the
amount due. [IAS 12.12] The benefit of a tax loss which can be carried back to recover current
tax of a prior period is recognised as an asset. [IAS 12.13] Current tax assets and liabilities are
measured at the amount expected to be paid to (recovered from) taxation authorities, using the
rates/laws that have been enacted or substantively enacted by the balance sheet date. [IAS
12.46]

Recognition of Deferred Tax Liabilities

The general principle in IAS 12 is that deferred tax liabilities should be recognised for all taxable
temporary differences. There are three exceptions to the requirement to recognise a deferred
tax liability, as follows: [IAS 12.15]

• liabilities arising from initial recognition of goodwill for which amortisation is not
deductible for tax purposes;

• liabilities arising from the initial recognition of an asset/liability other than in a business
combination which, at the time of the transaction, does not affect either the accounting or
the taxable profit; and

• liabilities arising from undistributed profits from investments where the entity is able to
control the timing of the reversal of the difference and it is probable that the reversal will
 not occur in the foreseeable future. [IAS 12.39]
Temporary Differences
Temporary differences arise where items are taxable or allowable in periods different from
those in which the matter is recognised for financial statement purposes.Sources of temporal
differences include:
• Short term differences because taxable profits are based on cash basis while accounting
profits are recognised on accrual basis (timing differences)
• Accelerated capital allowances that make taxable profits lower at the early stage and this
becomes lower when the capital allowances start getting lower
• Revaluation of property, plant and equipment. Surplus on revaluation is an indication
that profits will arise when eventually the assets are disposed of in the future, the future
tax liabilities on these profits have to be recognised now. The deferred tax has to be
computed even where an entity does not intend to sell the assets in the future. The
justification is that the profits will still be realised by the entity principally through use.
• Loss relief. A loss is reported in the financial statements and the related tax relief is only
available by carry forward against future profits.

• Permanent Differences
Permanent differences arise where items recognised in the Statement of Comprehensive
Income are either not taxable or not allowable. Examples of permanent differences incude,
government grants not taxable, and donations to political parties not tax allowable expense.

Alternative Bases for Calculation of Deferred Tax

(a) Nil Basis. This is also known as ‘flow through”, no deferred tax liability is recognised. Over
time all timing differences will reverse and taxes provided in the financial statements is based on
the taxable profit not accounting profits. This method is generally believed to be unsatisfactroy
hence the Standard does not recognise it as a basis of providing for deferred tax.

(b) Partial Provision Basis. Deferred tax is calculated on the net amount of temporary
differences which will reverse in the foreseable future.

(c) Full Provision Basis. This method requires all temporary differences to be provided for in
full.This is based on the principle that financial statements should recognise the tax effect of all
transactions in the period.IAS 12 requires the full provision basis to be adopted in the
computation of deferred taxes.

Alternative Methods of Computation of Deferred Tax

(a) Deferral Method. Calculate the tax effect of temporary differences using the tax rates which
apply when the differences arise with no adjustment for tax rate changes.

(b) Liability Method.Deferred tax balance is adjusted as tax rates change. This method
enables the deferred tax balance to be maintained as the actual liability which is expected to
arise. This method is further sub-classified into two (a) Statement of Comprehensive Income
liability method and (b) Statement of Financial Position liability method. The difference between
these two methods is largely conceptual. The deferred tax figure will be the same. The
Statement of Comprehensive liability method focuses on the difference between taxable profit
and accounting profit, while under the Statement of Financial Position method the calculation is
made by reference to difference between Statement of Financial Position values and tax values
of assets and liabilities.

Deferred Tax Assets and Accounting for Losses

Deferred tax asset arises as a result of deductible timing differences for example unused tax
losses. The implication is that an entity is incurring higher tax liabilities at present as against the
tax liabilities indicated by the accounting profits. Deferred tax asset will be recognised if it is
certain that the entity will recover the present high tax laibilites in the forseeable future.
Defrred tax asset can be offset against deferred tax liability if:
(a)the entity has a legally enforceable right to set-off current tax assets against current tax
liabilities and
(b) the deferred tax assets and deferred tax liabilities relate to taxes levied by the same tax
authority.

Deferred tax assets and liabilities should be classified in the Statement of Financial Position as
‘non-current’
Where an entity has unused tax losses to carry forward, a deferred tax asset should be
recognised to the extent that it is probable that future taxable profits will be available against
which the losses will be off-set.

Factors to Consider in Offsetting Tax Losses

• Will the entity has sufficient taxable temporary differences resulting in taxable amounts
against which the losses can be offset?
• Will the entity make sufficient taxable profits before the right to use the losses expire?
• Do the tax losses relate to identifiable causes which are unlikely to recur
• Are there tax planning opportunities available to create taxable profits?

Providing for Deferred Tax

Provision is made for deferred tax liability if in one period if the difference between accounting
profit and taxable profit is caused by a temporary difference. In this case, the actual tax payable
will be lower than what accounting profit is indicating, the deferred tax is recognised as an
expense in the statement of comprehensive income. Deferred tax asset will arise when the
actual tax payable in current period is higher than tax based on accounting profit. The deferred
tax is recognised as income in this case in the statement of comprehensive income.
Alternatively we say that deferred tax is calculated by reference to the tax base of an asset or
liability. The tax base is the amount attributed to the asset or liability for tax purposes. If the
carrying amount of an asset exceeds the tax base, deferred tax must be provided for, and the
temporary difference is said to be a taxable temporary difference (a liability). On the other hand,
if the carrying amount of an asset is lower than its tax base, a derred tax asset arises, or a
previous deferred tax liability has reversed. In the same vain, when the carrying amount of a
liability is less that its tax base, a deferred tax liability arises and when the reverse then a
deferred tax asset arises, or a previously recognised deferred tax liability has reversed.
Note that the carrying amount of an asset is the amount at which an asset is recorded in the
accounting records at a particular date net of accumulated depreciation, amortisation and
impairment loss.
Deferred tax will be computed at: tax rate x temporary difference.

Examples on Computation of Tax Base of Asset

1. Ikenga Ltd acquires an asset on 1 January 2013 for N10,000, depreciation for accounting
purpose is N1,000 per annum while capital allowance is N1,500 per annum. At the end of the
second year show the postion of this asset for deferred tax pourpose
Solution
Accounting Tax base
Carrying cost
N N
Asset at cost 10,000 10,000
Accumulated depreciaton/capital allowances (2,000) (3,000)
8,000 7,000
The temporary difference is N1,000 at the end of the second year giving rise to cumulative
deferred tax liability of N1,000 x 30% = N300
2. Ikenga Ltd has balance on accounts receivable of N40,000, the company has allowed for
doubtful debt provision of N2,000. What is the deferred tax provision on this?

Solution
The carrying cost of the receivable is N38,000 (net of doubtful debt provision), while its tax base
is N40,000. This is because the tax authority will not allow the doubtful debt provision for tax
purpose as an expense until it crystalises into actual bad debt.
Deferred tax asset = N40,000 – N38,000 x 30% =N600

Computation of Tax Base of Liabilities

1. Ikenga Ltd had accrued for interest on its loans at the end of a reporting period of N3,000.
What is the deferred tax implication?

Solution
The carrying cost of the liabilitiy is N3,000 but for tax purposes, the tax base is zero. This is
because the tax authorities allow expenses only on cash bases.
Therefore there is a deferred tax asset recognition of N3,000 x 30% =N900

Accounting entry for provision for deferred tax liability is:

Dr Statement of Comprehensive Income
Cr Provision for Deferred tax

Reversal of Deferred Tax

When the temporary difference reverses, at a future date, it simply means that the deferred tax
liability has crystalised into current tax. In this case the taxable profit will indicate higher tax
while accounting profit will indicate a lower tax. So the defered tax provision earlier made is
reversed thus:
Dr Provision for deferred tax
Cr Statement of Comprehensive Income (because defered tax has become current tax)

Illustration 1
Big Ltd purchased an asset on 1 January 2010 for N300,000. The asset has an estimated useful
life of ten years, and an estimated nil residual value
Capital allowances are available at the rate of 25% calculated on tax written down value. The
rate of tax is 30%.
The company’s annual operating profit before depreciation is N400,000.
Required, calculate Big Ltd’s Statement of Comprehensive Income and Statement of Financial
Position for the three years 2010, 2011 and 2012.

Solution
Statement of Comprehensive Income.
2010 2011 2012
N N N
Operating profit 400,000 400,000 400,000
Depreciation (30,000) (30,000) (30,000)
370,000 370,000 370,000
Taxation:
Current tax (Working 1) 97,500 103,125 107,344
Deferred tax (working 2) 13,500 7.875 3,656
Profit after tax 259,000 259,000 259,000

Accounting Profit Tax 111,000 111,000 111,000

(30% x N370,000)
Statement of Financial Position Extract
2010 2011 2012
N N N
Current Liability:
Income Tax 97,500 103,125 107,344

Non- Current Liability

Deferred tax 13,500 21,375 25,031

Workings
1. Current Tax
2010 2011 2012
N N N
Operating profit 400,000 400,000 400,000
Less Capital Allowance 75,000 56,250 42,188
Taxable profit 325,000 343,750 357,812
Tax at 30% 97,500 103,125 107,344

2. Deferred Tax Computation

Asset Tax Temporary Deferred
Carrying Base Difference Tax (30%)
Value
Cost of Asset 1 Jan 2010 300,000 300,000
Dep/Capital allowance 2010 30,000 75,000 45,000 13,500
Account NBV/ Tax WDV 2010 270,000 225,000 45,000 13,500
Dep/Capital allowance 2011 30,000 56,250 26,250 7,875
Account NBV/Tax WDV 2011 240,000 168,750 71,250 21,375
Dep/Capital allowance 2012 30,000 42,188 12,188 3,656
Account NBV/Tax WDV 2012 210,000 126,562 83,438 25,031

Illustration 2
An entity has the following assets and liabilities recorded in its balance sheet at December 31,
20X5:
Carrying value
N million
Property 10
Plant and equipment 5
Inventory 4
Trade receivables 3
Trade payables 6
Cash 2
The value for tax purposes of property and for plant and equipment are N7 million and N4
million respectively.
The entity has made a provision for inventory obsolescence of N2 million, which is not allowable
for tax purposes until the inventory is sold. Further, an impairment charge against trade
receivables of N1 million has been made. This charge does not relate to any specific trade
receivable but to the entity’s assessment of the overall collectibility of the amount. This charge
will not be allowed in the current year for tax purposes but will be allowed in the future. Income
tax paid is at 30%.
Required
Calculate the deferred tax provision at December 31, 20X5.

Solution
 Carrying value Taxbase Temporary
difference
Nm Nm Nm
Property 10 7 3
Plant and equipment 5 4 1
Inventory 4 6 (2)
Trade receivables 3 4 (1)
Trade payables 6 6 -
Cash 2 2 -
1
The deferred tax provision will be N1 million × 30%, or N300,000.
Because the provision against inventory and the impairment charge are not currently allowed,
the tax base will be higher than the carrying value by the respective amounts. Every asset or
liability is assumed to have a tax base. Normally this tax base will be the amount that is allowed
for tax purposes.
Some items of income and expenditure may not be taxable or tax deductible, and they will never
enter into the computation of taxable profit. These items sometimes are called permanent
differences.
Generally speaking, these items will have the same tax base as their carrying amount; that is,
no temporary difference will arise.
For example, if an entity has on its statement of financial position interest receivable of N2
million that is not taxable, then its tax base will be the same as its carrying value, or N2 million.
There is no temporary difference in this case. Therefore, no deferred taxation will arise.

Illustration 3: Deferral and Liability Method of Providing for Deferred Tax

Deferred and Liability Methods of Computing Deferred tax
A company acquired an asset on 1 January 2007 at a cost of N375, 000. The company’s
depreciation policy is to depreciate on a straight line basis over ten years. The assets rank for
capital allowance of 25% but no first year allowance. Assume that deferred tax is provided in
full, and the company income tax rate is 35% in 2007, 33% in 2008 and 34% in 2009. Calculate
the relevant amounts for the deferred tax under the two methods for the years 2007, 2008 and
2009
DEPRECIATION/ CAPITAL ALLOWANCE
CALCULATIONS
Account Tax
Carrying
Cost WDV
N N
Cost of asset 2007 375,000 375,000
Depreciation/capital allowance
2007 37,500 93,750
NBV/ WDV 31/12/2007 337,500 281,250
Depreciation/capital allowance
2008 37,500 70,313
NBV/WDV 31/12/2008 300,000 210,937
Depreciation/capital allowance
2009 37,500 52,734
NBV/WDV 31/12009 262,500 158,203

Deferred tax calculations

DEFERRED TAX ACCOUNT

 Timing diff Liability Method Deferred Method
N N N N N
Balance at 1-1-2007 - -
P or L 2007:
35% x (93,750 - 37,500) 56,250 19,688 19,688
Balance as at 31/12/1997 56,250 19,688 19,688

P or L 2008:
Tax rate adjustment:
2% x 56,250 (1,125) -
33% x (70,313 - 37,500) 32,813 10,828 9,703 10,828 10,828
Balance as at 31/12/2008 89,063 29,391 30,516

P or L 2009:
Tax rate adjustment
1% x 89,063 891 -
34% x (52,734 - 37,500) 15,234 5,180 6,071 5180 5,180
Balance as at 31/12/2009 104,297 35,462 35,696

Disclosure
In addition to the disclosures required by IAS 12, some disclosures relating to income taxes are
required by IAS 1, as follows:

• IAS 1 requires disclosures on the face of the statement of financial position about current
tax assets, current tax liabilities, deferred tax assets, and deferred tax liabilities [IAS
1.54(n) and (o)]

• IAS 1 requires disclosure of tax expense (tax income) on the face of the statement of
comprehensive income [IAS 1.82(d)].

• IAS 12 requires disclosure of tax expense (tax income) relating to ordinary activities on
the face of the statement of comprehensive income [IAS 12.77].

• IAS 12 requires that if an entity presents a statement of income, in addition to a

statement of comprehensive income, tax expense (income) from ordinary activities
should be presented in the statement of income. [IAS 12.77A]

IAS 12.80 requires the following disclosures:

• major components of tax expense (tax income) [IAS 12.79] Examples include:

• current tax expense (income)

• any adjustments of taxes of prior periods

• amount of deferred tax expense (income) relating to the origination and reversal
of temporary differences

• amount of deferred tax expense (income) relating to changes in tax rates or the
imposition of new taxes

• amount of the benefit arising from a previously unrecognised tax loss, tax credit
or temporary difference of a prior period
 • write down, or reversal of a previous write down, of a deferred tax asset

• amount of tax expense (income) relating to changes in accounting policies and

corrections of errors

IAS 12.81 requires the following disclosures:

• aggregate current and deferred tax relating to items reported directly in equity

• tax relating to each component of other comprehensive income

• explanation of the relationship between tax expense (income) and the tax that would be
expected by applying the current tax rate to accounting profit or loss (this can be
presented as a reconciliation of amounts of tax or a reconciliation of the rate of tax)

• changes in tax rates

• amounts and other details of deductible temporary differences, unused tax losses, and
unused tax credits

• temporary differences associated with investments in subsidiaries, associates, branches,

and joint ventures

• for each type of temporary difference and unused tax loss and credit, the amount of
deferred tax assets or liabilities recognised in the statement of financial position and the
amount of deferred tax income or expense recognised in the income statement

• tax relating to discontinued operations

• tax consequences of dividends declared after the end of the reporting period

Other required disclosures:

• details of deferred tax assets [IAS 12.82]

• tax consequences of future dividend payments [IAS 12.82A]

IAS 16: PROPERTY, PLANT AND EQUIPMENT
Scope
IAS 16, does not apply to the following:
• Biological assets related to agricultural activities
• Property plant and equipment classified as held for sale in accordance with IFRS 5
• Mineral rights and mineral reserves such as oil and gas and other non –regenerative
resources. However the Standard relates to property, plant and equipment used to
develop these assets.

Definitions
Property, plant, and equipment: Tangible assets that are held for use in production or supply
of goods and services, for rental to others, or for administrative purposes and are expected to
be used during more than one period.
Cost. The amount paid or fair value of other consideration given to acquire or construct an
asset.
Useful life: The period over which an asset is expected to be utilized or the number of
production units expected to be obtained from the use of the asset.
Residual value (of an asset): This is the net amount which the entity expects to obtain for an
asset at the end of its useful life after deducting the expected costs of disposal
Depreciable amount: The cost of an asset less its residual value.
Depreciation: The systematic allocation of the depreciable amount of an asset over its
expected useful life.
Fair value: The price to sell an asset or amount paid to transfer a liability in an orderly
transaction between market participants at measurement date.
Carrying amount: This is the amount which an asset is recognised in the statement of financial
position after deducting any accumulated depreciation and accumulated impairment losses.
An impairment loss: This is the amount by which the carrying amount of an asset exceeds its
recoverable amount.
Entity specific value: This is the present value of the cash flows an entity expects to derive
from the continuing use of an asset and from its disposal at the end of its useful life, or expects
to incur when settling a liability.

Recognition
This means the incorporation of the item in the entitiy’s accounts as a non – current asset. The
two recognition criteria are:
• It is probable that the future economic benefits associated with the asset will flow into the
entity.
• The cost of the asset to entity can be measured reliably.
These same recognition criteria also apply to subsequent expenditure, there are no longer any
separate criteria for recognising subsequent expenditure.

Illustration on subsequent expediture

Road Truckers Plc has acquired a heavy road transporter at a cost of N100,000 (with no
breakdown of the component parts). The estimated useful life is 10 years. At the end of the sixth
year, the power train requires replacement, as further maintenance is uneconomical due to the
off-road time required. The remainder of the vehicle is perfectly roadworthy and is expected to
last for the next four years. The cost of a new power train is N45,000.
Required
Can the cost of the new power train be recognized as an asset, and, if so, what treatment
should be used?

Suggest Solution
The new power train will produce economic benefits to Road Truckers Plc., and the cost is
measurable. Hence the item should be recognized as an asset. The original invoice for the
transporter did not specify the cost of the power train; however, the cost of the replacement—
N45,000—can be used as an indication (usually by discounting) of the likely cost, six years
previously. If an appropriate discount rate is 5% per annum, N45,000 discounted back six years
amounts to N33,500 [N45,000 / (1.05)]6, which would be written out of the asset records. The
cost of the new power train, N45,000, would be added to the asset record, resulting in a new
asset cost of N111,500 (N100,000 – N33,500 + N45,000).

Probable future economic benefits

The degree of certainty attached to the flow of future economic benefits must be assessed. This
should be based on the evidence available at the date of initial recognition usually the date of
purchase. The entity should thus be assured that it will receive the rewards attached to the
asset and it will incur the associated risks, which will only generally be the case when the
rewards and risks have actually passed to the entity.

Cost Measured Reliably

It is generally easy to measure the costs of an asset at the transfer amount on purchase, that is,
what was paid for it. Self – constructed assets can also be measured easily by adding together
the purchase price of all the constituent parts, (labour, material, overhead) paid to external
parties.

Separate Items
Most of the time assets will be identified individually, but this will not be the case for smaller
items, such as tools, dies and moulds, which are sometimes classified as inventory and written
off as an expense.
Major components or spare parts, however, should be recognised as property, plant and
equipment.
For very large and specialised items, an apparently single asset should be broken down into
its composite parts. This occurs where the different parts have different useful lives and different
depreciation rates are applied to each part, eg, an aircraft, where the body and engines are
separated as they have different useful lives.

Safety and Environmental Equipment

Such assets when acquired qualify for recognition where they enable the entity to obtain future
economic benefits from related assets in excess of those it would obtain otherwise. The
recognition will only be to the extent that the carrying amount of the asset and related assets
does not exceed the total recoverable amount of these assets.

Initial Measurement
An item pf property, plant and equipment that qualifies to be recognised as an asset has cost as
its initial recognition.
Component of costs
• Purchase price, less any trade discount or rebate
• Import duties and non – refundable purchase taxes
• Borrowing costs to the extent required by IAS 23 on Borrowing Costs
• Directly attributable costs of bringing the asset to working condition for its intended use,
eg
• The cost of site preparation
• Initial delivery and handling costs
• Installation costs
• Testing
• Professional fees (architects, engineering)
• Initial estimate of the unaviodable cost of dismantling and removing the asset and
restoring the site on which it is located
The revised Standard gave additional guidance on directly attributable costs included in the
cost of an item of property, plant and equipment.
(a) These costs bring the asset to the location and working conditions necessary for it to be
capable of operating in the manner intended by management, including those costs to test
whether the asset is functioning properly.
(b) They are determined after deducting the net proceeds from the selling any items produced
when bringing the asset to its location and condition.

Costs not Attributable to the Assets

The revision also states that income and related expenses of operations, that are incidential to
the construction or development of an item of property, plant and equipment should be
recognised in profit or loss.
The following costs will not be part of the cost of property, plant and equipment unless they can
be attributed directly to the asset’s acquisition, or bringing it into its working condition.
• Administrative and other general overhead costs
• Start – up and similar pre-production costs
• Initial operating losses before the asset reaches planned performance.
• Advertising and promotional costs
• Costs of introducing a new product or service
• Cosst of relocating,or reorganising part or all of the entity’s operations
• Training costs
All these costs will be recognised as expense rather than asset.

Illustration; this is concerned with directly attributable costs.

Extravagant Plc is installing a new plant at its production facility. It has incurred these costs:
1. Cost of the plant (cost per supplier’s invoice plus taxes) N2,500,000
2. Initial delivery and handling costs N200,000
3. Cost of site preparation N600,000
4. Consultants used for advice on the acquisition of the plant N700,000
5. Interest charges paid to supplier of plant for deferred credit N200,000
6. Estimated dismantling costs to be incurred after 7 years N300,000
7. Operating losses before commercial production N400,000
Required
Please advise Extravagant Plc on the costs that can be capitalized in accordance with IAS 16.

Suggested Solution
According to IAS 16, these costs can be capitalized: N
1. Cost of the plant 2,500,000
2. Initial delivery and handling costs 200,000
3. Cost of site preparation 600,000
4. Consultants’ fees 700,000
5. Estimated dismantling costs to be incurred after 7 years 300,000
4,300,000
Interest charges paid on “deferred credit terms” (see discussion under the “Measurement of
Cost” section) to the supplier of the plant (not a qualifying asset) of N200,000 and operating
losses before commercial production amounting to N400,000 are not regarded as directly
attributable costs and thus cannot be capitalized. They should be written off to the income
statement in the period they are incurred.

Self - Constucted Assets

In the case of self – constructed assets, the same principles are applied as for acquired assets.
If the entity makes similar assets during the normal course of business for sale externally, then
the cost of the asset will be the cost of its production under IAS 2 on Inventories. This also
means that abnormal costs (wasted material, labour or other resources) are excluded from the
cost of the asset. An example of a self – constructed asset is when a building company builds its
own head office.

Exchange of Assets
The revised Standard specifies that exchange of items of property, plant and equipment,
regardless of whether the assets are similar, are measured at fair value, unless the exchange
transaction lacks commercial substance or the fair value of neither of the assets exchanged
can be measured reliably. If the acquired item is not measured at fair value, its cost is
measured at the carrying amount of the asset given up.
Expenditure incurred in replacing or renewing a component of an item of property, plant and
equipment must be recognised in the carrying amount of the item. The carrying amount of the
replaced or renewed component must be derecognised. A similar approach is also applied when
a separate component item of property, plant and equipment is identified in respect of a major
component to enable the continued use of the item.

Measurement Subsequent to Initial Recognition

The Standard offers two possible treatments here, esentially a choice between keeping an asset
recorded at cost or revaluing it to fair value.
(a) Cost model: Carry the asset at its cost less depreciation and any accumulated impairment
loss.
(b) Revaluation model: Carry the asset at a revalued amount, being its fair value at the date of
the revaluation less any subsequent accumulated depreciation and subsequent accumulated
impairment losses. It is made clear by the Standard that the revaluation model is available only
if the fair value of the item can be measured reliably.

Revaluations
The market value of land and buildings usually represents fair value, assuming existing use and
line of business. Such valuations are usually carried out by professionally qualified valuers.
In the case of plant and equipment, fair value can also be taken as market value. Where a
market value is not available, however, depreciated replacement cost should be used. There
may be no market value where types of plant and equipment are sold only rarely or because of
their specialised nature (they would normally be sold as a part of an on-going business).
The frequency of revaluation depends on the volatility of the fair value of individual items of
property, plant and equipment. The more volatile the fair value, the more frequently revaluations
should be carried out. Where the current fair value is very different from the carrying value then
a revaluation should be carried out.
Most importantly, when an item of property, plant and equipment is revalued, the whole class of
assets to which it belongs, should be revalued.
All the items within a class should be revalued at the same time, to prevent selective
revaluation of certain assets and to avoid disclosing a mixture of costs and values from different
dates in the financial statements. A rolling basis of revaluation is allowed if the revaluations are
kept up to date and the revaluation of the whole class is completed in a short time.

Accounting Treatment of Revaluation

For increase in value, the debit will be reflected as increase in the statement of financial
position. For the credit, IAS 16 requires increase to be credited to a revaluation surplus (part of
owners equity), unless the increase is reversing a previous decrease which was recognised as
an expense. To the extent that this offset is made, the increase is recognised as income, any
excess is then taken to the revaluation surplus.

Illustration on revaluation
Big Ltd has an item of land carried at N13,000 in the books. Two years ago a slump in land
values led the company to reduce the carrying value from N15,000. This was taken as an
expense in the income statement. There has been a surge in land prices in the current year,
however, and the land it owned worth N20,000.
Account for the revaluation in the current year.

Suggested Solution
The double entry is:
Dr Asset value in SFP N7,000
Cr Income Statement N2,000
Cr Revaluation surplus N5,000
Note that the credit to the revaluation surplus will be shown under ‘other comprehensive
income’.
The case is similar for a decrease in value on revaluation, A decrease should be recognised as
an expense, except where it offsets a previous increase taken as a revaluation surplus in
‘owners equity’. Any decrease greater than the previous upwards increase in value must be
taken as an expense in the profit or loss.

Illustration on revaluation decrease

From the previous example, suppose the original cost was N15,000 revalued upwards to
N20,000 two years ago. The value has now fallen to N13,000.
Account for the decrease

Solution
Dr Revaluation surplus N5,000
Dr Income statement N2,000
Cr Asset value (SFP) N7,000

A further complication arises when a revalued asset is being depreciated. An upward revaluation
will mean that the depreciation charge will increase. Normally, a revaluation surplus is only
realised when the asset is sold, but when it is being depreciated, part of that surplus is being
realised as the asset is used. The amount of the surplus realised is the difference between
depreciation charged on the revalued amount and the depreciation which would have been
charged on the asset’s original cost. This amount can be transferred to retained earnings
(realised) but not through profit or loss.

Illustration on revaluation and depreciation

Smally Ltd bought an asset for N20,000 at the beginning of 2006. It had a useful life of five
years. On 1 January 2008 the asset was revalued to N24,000. The expected useful life has
remained unchanged ie three years.
Account for the revaluation and state the treatment for depreciation from 2008 onwards.

Suggested Solution
On 1 January 2008, the carrying value of the asset is N20,000 – (N20,000/5 x 2) =
N12,000
For the revaluation:
Dr Asset value N12,000
Cr Revaluation surplus N12,000
The depreciation for the next three years will be (N24,000/3), N8,000, compared to depreciation
on cost of N20,000/5 = N4,000. So each year, the extra N4,000 can be treated as part of the
surplus which has been realised.
Dr Revaluation surplus N4,000
Cr Retained earnings N4,000
This is a movement in owner’s equity not an item of the income statement.

Depreciation
• The depreciable amount of an item of property, plant and equipment should be allocated
on a systematic basis over its useful life.
• The depreciation method used should reflect the pattern in which the asset’s economic
benefits are consumed by the entity.
• The depreciation charge for each period should be recognised as an expense unless it is
included in the carrying amount of another asset.
Land and buildings are dealt with separately even when they are acquired together because
land normally has an unlimited life and is therefore not depreciated. In contrast buildings do
have life and must be depreciated. Any increase in the value of land on which a building is
standing will have no impact on the determination of the building’s useful life.
Depreciation is usually treated as an expense, but not where it is abosorbed by the entity in the
prices of producing other assets. For example, depreciation of plant and machinery can be
incurred in the production of goods for sale (inventory items). In such circumstances, the
depreciation is included in the cost of the new assets produced), in other words depreciation is
included in the cost of sales.

Review of Useful Life

A review of the useful life of property, plant and equipment should be carreid out at least at
each financial year and the depreciation charged for the current and future periods should be
adjusted if expectations have changed significantly from previous estimates. Changes are
changes in accounting estimates and are accounted for prospectively as adjustments to future
depreciation.

Illustration on review of useful life

Kwomi Na Allah acquired a non – current asset on 1 January 2008 for N160,000. It had no
residual value and a useful life of 10 years.
On 1 January 2011 the total useful life was reviewed and revised to seven years.
What will be the depreciation charge for 2011?

Suggested Solution N
Original cost 160,000
Depreciation 2008 to 2010 (160,000 x 3/10) 48,000
Carrying amount 31 December 2010 112,000
Remaining life (7 – 3) 4 years
Depreciation charge years 2011 2014 (112,000/4years 14,000

Review of Depreciation Method

The depreciation method should also be reviewed at least at each financial eyar end, if there
has been a significant change in the expected pattern of economic benefits from those assets,
the method should be changed to suit this changed pattern. When such a change in
depreciation method takes place, the change should be accounted for as a change in
accounting estimate and the depreciation charge for current and future periods should be
adjusted

Impairment of Asset Values

An impairment loss should be treated in the same was as a revaluation decrease, ie the
drecease should be recognised as an expense. However, a revaluation decrease (impairment
loss) should be charged directly against any related revaluation surplus to the extent that the
decrease does not exceed the amount held in the revaluation surplus in respect of that same
asset.
A reversal of an impairment loss should be treated in the same was as a revaluation increase, ie
a revaluation increase should be recognised as income to the extent that it reverses a
revaluation decrease or an impairment loss of the same asset previously recognised as an
expense.

Retirements and Disposals

When an asset is permanently withdrawn from use, or sold or scrapped, and no future economic
benefits are expected from its disposal, it should be withdrawn from the statement of financial
position.
Gains or losses are the difference between the estimated net disposal proceeds and the
carrying amount of the asset. They should be recognised as income or expense in profit or loss.

Derecognition
An entity is required to derecognise the carrying amount of an item of property, plant and
equipment that it disposes of on the date the criteria for sale of goods in IFRS 15 on Revenue
Recognition in Contrats with Customers would be met. This also applies to parts of an asset.

DEPRECIATION
Definition
This is result of systematic allocation of the depreciable amount of an asset over its estimated
useful life. Depreciation for the accounting period is charged to net profit or loss for the period
either directly or indirectly.
Depreciable assets are assets which:
• Are expected to be used during more than one accounting period
• Have a limited useful life
• Are held by an entity for use in the production or supply of goods and services, for rental
to others, or for administrative purposes.

Useful life is of two things:

• The period which a depreciable asset is expected to be used by the entity, or
 • The number of production or similar units expected to be obtained from the asset by the
entity.

Depreciable Amount
This is the historical cost or other amount substituted for cost in the financial statements, less
the estimated residual value.

Useful Life
The following factors should be considered when estimating the useful life of a depreciable
asset:
• Expected physical wear and tear
• Obsolescence
• Legal or other limits on the use of the assets.
Once decided, the useful life should be reviewed at least every financial year end and
depreciation rates adjusted for the current and future periods if expectations vary significantly
from the original estimates. The effect of the change should be disclosed in the accounting
period in which the change takes place.
The assessment of useful life requires judgement based on previous experience with similar
assets or classes of asset. When a completely new type of asset aqcuired it is still necessary to
estimate useful life, even though the exercise will be much more difficult.
The physical life of the asset might be longer than its useful life to the entity in question. One of
the main factors to be taken into consideration is the physical wear and tear the asset is likely to
endure. This will depend on various circumstances, including the number of shifts for which the
asset will be used, the entity’s repair and maintenance programme etc. Other factors to be
considered include obsolescence and legal restrictions, eg length of a related lease

Residual Value
In most cases the residual value of an asset is likely to be immaterial. It is likely to be of any
significant value, that value must be estimated at the date of purchase or any subsequent
revaluation. The amount of residual value should be estimated based on the current situation
with other similar assets, used in the same way, which are now at the end of their useful lives.
Any expected costs of disposal should be offset against the gross residual value.

Depreciation Method
Consistency is important. The depreciation method selected should be applied consistently from
period to period unless altered circumstances justify a change. When the method is changed,
the effect should be quantified and disclosed and the reason for the change should be stated.
Various methods of allocating depreciation to accounting periods are available, but whichever is
chosen must be applied consistently to ensure comparability from period to period. Change of
policy is not allowed simply because of the profitability situation of the entity.

Disclosure
An accounting policy note should disclose the valuation bases used for determining the
amounts at which depreciable assets are stated, along with the other accounting policies.
The Standard also requires the following to be disclosed for each major class of depreciable
assets:
• Depreciation method used
• Useful lives or the depreciation rates used
• Total depreciation allocated for the period
• Gross amount of depreciable assets and the related accumulated depreciation

What is Depreciation?
The need to depreciation non – current asset arises from the accruals assumption. If money is
expended in purchasing an asset then the amount expended must at some time be charged
against profits. If the asset is one which contributes to an entity’s revenue over a number of
accounting periods it would be inapprporiate to charge any single period with the whole of the
expenditure. Instead, some method must be found of spreading the cost of the asset over its
useful economic life.
This view of depreciation as a process of allocation of the cost of an asset over several
accounting periods is the view adopted by IAS 16. It is worth mentioning here two common
misconceptions about the purpose and effects of depreciation.
(a) It is sometimes thought that the net book value of an asset is equal to its net realisable value
and that the object of charging depreciation is to reflect the fall in value of an asset over its life.
This misconception is the basis of a common, but incorrect, arguement which says that freehold
property need not be depreciated in times when property values are rising. It is true that
historical cost statements of financial position often give a misleading impression when a
property’s NBV is much below its market value, but in such a case it is open to a business to
incorporate a revaluation into its books, or even to prepare its accounts based on current costs.
This is a separate problem from that of allocating the property’s cost over successive
accounting periods.
(b) Another misconception is that depreciation is provided so that an asset can be replaced at
the end of its useful life. This is not the case.
• If there is no intention of replacing the asset, it could then be argued that there is no
need provide for any depreciation at all.
• If prices are rising, the replacement cost of the asset will exceed the amount of
depreciation provided.

Illustration on depreciation methods

A lorry bought for a business cost N17,000. It is expected to last for five years and then be sold
for scrap for N2,000. Usage over the five years is expected to be:
Year 1 200 days
Year 2 100 days
Year 3 100 days
Year 4 150 days
Year 5 40 days
Required
Work out the depreciation to be charged each year under:
• The straight line method
• The reducing balance method (using a rate of 35%)
• The machine hour method
• The sum – of – the digits method

Suggested solution
(a) Under the straight line method, the depreciation for each of the five years is:
Annual depreciation = (N17,000 – N2,000)= N3,000
5

(b) Under the reducing balance method, depreciation for each of the five years is:
Year Depreciation
1 35% x N17,000 N5,950
2 35% x (N17,000 – N5,950) = 35% x N11,050 N3,868
3 35% x (N11,050 – N3,868) = 35% x N7,182 N2,514
4 35% x (7,182 – N2,514) =35% x N4,668 N1,634
5 balance to bring book value to N2,000 (N4,668 – N1,634 – N2,000) N1,034

(c) Under the machine hour method, depreciation for each of the five years is calculated as
follows:
Total usage (days) = 200 + 100 + 100 +150 + 40 = 590 days
Depreciation per day = N17,000 – N2,000 = N25.42
590
Year Usage (days) Depreciation (N25.42 x days)
N
1 200 5,074.00
2 100 2,542.00
3 100 2,542.00
4 150 3,813.00
5 40 1,016.80
14,997.80
(d) The sum – of – the digits method begins by adding up the years of expected life. In this
case, 5 + 4 + 3 + 2+ 1 =15
The depreciable amount of N15,000 will then be allocated as follows:
N
Year 1 15, 000 x 5/15 = 5,000
2 15,000 x 4/15 = 4,000
3 15,000 x 3/15 = 3,000
4 15,000 x 2/15 = 2,000
5 15,000 x 1/15 = 1,000

Ullustrative question on depreciation

• What are the purposes of providing for depreciation?
• In what circumstances is the reducing balance method more appropriate than the
straight line method? Give reasons for your answer.

Suggested Solution
(a) The accounts of a business try to recognise that the cost of a non – current asset is
gradually consumed as the asset wears out. This is done by gradually writing off the asset’s cost
to profit or loss over several accounting periods. This process is known as depreciation,and is
an example of the accruals assumptions. IAS 16 on Property, Plant and Equipment requires that
depreciation should be allocated on a systematic basis to each accounting period during the
useful life of the asset.
With regard to the accrual principle, it is fair that the profits should be reduced by the
depreciation charge, this is not an arbitrary exercise. Depreciation is not, as is sometimes
supposed, an attempt to set aside funds to purchase new non – current assets when required.
Depreciation is not generally provided on freehold land because it does not wear out (unless it is
held for mining).

(b) The reducing balance method of depreciation is used instead of the straight line method
when it is considered fair to allocate a greater proportion of the total depreciable amount to the
earlier years and a lower proportion to the later years on the assumption that the benefits
obtained by the business from using the asset decline over time.
In favour of this method it may be argued that it links the depreciation to the costs of maintaining
and running the asset. In the early years these costs are low and the depreciation charge is
high, while in later years this is reversed.

Illustrative question on purchase and disposal of property, pland and equipment

A company purchased two rivet – making machines on 1 January 2005 at a cost of N15,000.
Each had an estimated life of five years and a nil residual value. The straight line method of
depreciation is used.
Owing to an unforeseen slump in market demand for rivels, the business decided to reduce its
output of rivels, and switch to making other products instead. On 31 March 2007, one rivet
making machine was sold on credit to a buyer for N8,000.
Later, in the year, however, it was decided to abandon production of rivets altogether,and the
second machine was sold on 1 December 2007 for N2,500 cash.
Prepare the machinery account, provision for depreciation of machinery account and disposal of
machinery account for the accounting year to 31 December 2007.

Suggested Solution

MACHINERY ACCOUNT
2007 N 2007 N
1 Jan Balance b/f 30,000 31 Mar Machinery Disposal A/C 15,000
1 Dec Machinery Disposal A/C 15,000
30,000 30,000

ACCUMULATED DEPRECIATION - MACHINERY

2007 N 2007 N
31 Mar Machinery Disposal A/C (wk 1) 6,750 1 Jan Balance b/f 12,000
1 Dec Machinery Disposal A/C (wk 2) 8,750 31 Dec Income Statement (wk 3) 3,500
15,500 15,500

DISPOSAL OF MACHINERY ACCOUNT

2007 N 2007 N
31 Mar Machinery A/C 15,000 31 Mar Accounts Receivable A/C 8,000
1 Dec Machinery A/C 15,000 31 Mar Provision for Depciation 6,750
1 Dec Cash A/C 2,500
1 Dec Provision for Depciation 8,750
31 Dec Income Statement (loss) 4,000
30,000 30,000
Workings
1. Depreciation at the date of disposal = N6,000 + N750
2. Depreciation at date of disposal = N6,000+ N2,750
3. Depreciation charge for the year = N750 + N2,750
4. At January 1 2007, accumulated depreciation on the machines will be:
2 machines x 2 years x N15,000 machines per annum= N12,000 or N6,000 per
machine
5. Monthly depreciation is N3,000 = N250 per machine per month
12
6. The machines are disposed of in 2007
(a) On 31 March after three months depreciation of the year = 3 months x N250 = N750
(b) On 1 December after 11 months of the year depreciation 11 months x N250 = N2,750

Disclosure
• For each class of property, plant, and equipment, disclose: [IAS 16.73]
• Basis for measuring carrying amount
• depreciation method(s) used
• useful lives or depreciation rates
• gross carrying amount and accumulated depreciation and impairment losses
• reconciliation of the carrying amount at the beginning and the end of the period,
showing:
• additions
 • disposals
• acquisitions through business combinations
• revaluation increases or decreases
• impairment losses
• reversals of impairment losses
• depreciation
• net foreign exchange differences on translation
• other movements
Also disclose: [IAS 16.74]

• restrictions on title

• expenditures to construct property, plant, and equipment during the period

• contractual commitments to acquire property, plant, and equipment

• compensation from third parties for items of property, plant, and equipment that were
impaired, lost or given up that is included in profit or loss

If property, plant, and equipment is stated at revalued amounts, certain additional disclosures
are required: [IAS 16.77]

• the effective date of the revaluation

• whether an independent valuer was involved

• the methods and significant assumptions used in estimating fair values

• the extent to which fair values were determined directly by reference to observable
prices in an active market or recent market transactions on arm's length terms or were
estimated using other valuation techniques

• for each revalued class of property, the carrying amount that would have been
recognised had the assets been carried under the cost model

• the revaluation surplus, including changes during the period and any restrictions on the
distribution of the balance to shareholders
REVIEW QUESTIONS
1. (a) An assistant of yours has been criticised over a piece of assessed work that he produced for his
study course for giving the definition of a non-current asset as ‘a physical asset of substantial cost, owned
by the company, which
will last longer than one year’.
Required:
Provide an explanation to your assistant of the weaknesses in his definition of non-current assets
when
compared to the International Accounting Standards Board’s (IASB) view of assets. (4 marks)

(b) The same assistant has encountered the following matters during the preparation of the draft financial
statements
of Darby for the year ending 30 September 2009. He has given an explanation of his treatment of them.

(i) Darby spent N200,000 sending its staff on training courses during the year. This has already led to an
improvement in the company’s efficiency and resulted in cost savings. The organiser of the course has
stated that the benefits from the training should last for a minimum of four years. The assistant has
therefore treated the cost of the training as an intangible asset and charged six months’ amortisation
based on the average date during the year on which the training courses were completed. (3 marks)

(ii) During the year the company started research work with a view to the eventual development of a new
processor chip. By 30 September 2009 it had spent N1·6 million on this project. Darby has a past history
of being particularly successful in bringing similar projects to a profitable conclusion. As a consequence
the assistant has treated the expenditure to date on this project as an asset in the statement of financial
position. Darby was also commissioned by a customer to research and, if feasible, produce a computer
system to install in motor vehicles that can automatically stop the vehicle if it is about to be involved in a
collision. At 30 September 2009, Darby had spent N2·4 million on this project, but at this date it was
uncertain as to whether the project would be successful. As a consequence the assistant has treated the
N2·4 million as an expense in the income statement. (4 marks)

(iii) Darby signed a contract (for an initial three years) in August 2009 with a company called Media Today
to install a satellite dish and cabling system to a newly built group of residential apartments. Media Today
will provide telephone and television services to the residents of the apartments via the satellite system
and pay Darby N50,000 per annum commencing in December 2009. Work on the installation commenced
on 1 September 2009 and the expenditure to 30 September 2009 was N58,000. The installation is
expected to be completed by 31 October 2009. Previous experience with similar contracts indicates that
Darby will make a total profit of N40,000 over the three years on this initial contract. The assistant
correctly recorded the costs to 30 September 2009 of N58,000 as a non-current asset, but then wrote this
amount down to N40,000 (the expected total profit) because he believed the asset to be impaired.
The contract is not a finance lease. Ignore discounting. (4 marks)
Required:
For each of the above items (i) to (iii) comment on the assistant’s treatment of them in the
financial statements for the year ended 30 September 2009 and advise him how they should be
treated under
International Financial Reporting Standards. (15 marks) ACCA FINANCIAL REPORTING
DECEMBER 2009

2. (a) A director of Enca, a public listed company, has expressed concerns about the accounting
treatment of some of
the company’s items of property, plant and equipment which have increased in value. His main concern is
that the statement of financial position does not show the true value of assets which have increased in
value and that this ‘undervaluation’ is compounded by having to charge depreciation on these assets,
which also reduces reported profit. He argues that this does not make economic sense.
Required:
Respond to the director’s concerns by summarising the principal requirements of IAS 16 Property,
Plant and
Equipment in relation to the revaluation of property, plant and equipment, including its
subsequent treatment. (5 marks)

(b) The following details relate to two items of property, plant and equipment (A and B) owned by Delta
which are
depreciated on a straight-line basis with no estimated residual value:
Item A Item B
Estimated useful life at acquisition 8 years 6 years
N’000 N’000
Cost on 1 April 2010 240,000 120,000
Accumulated depreciation (two years) (60,000) (40,000)
–––––––– ––––––––
Carrying amount at 31 March 2012 180,000 80,000
–––––––– ––––––––
Revaluation on 1 April 2012:
Revalued amount 160,000 112,000
Revised estimated remaining useful life 5 years 5 years
Subsequent expenditure capitalised on 1 April 2013 nil 14,400
At 31 March 2014 item A was still in use, but item B was sold (on that date) for N70 million.
Note: Delta makes an annual transfer from its revaluation surplus to retained earnings in respect of
excess depreciation.
Required:
Prepare extracts from:
(i) Delta’s statements of profit or loss for the years ended 31 March 2013 and 2014 in respect of
charges
(expenses) related to property, plant and equipment;
(ii) Delta’s statements of financial position as at 31 March 2013 and 2014 for the carrying amount
of
property, plant and equipment and the revaluation surplus.
The following mark allocation is provided as guidance for this requirement:
(i) 5 marks
(ii) 5 marks (10 marks)
(15 marks) ACCA FINANCIAL REPORTING JUNE 2014

SUGGESTED SOLUTION
1(a) There are four elements to the assistant’s definition of a non-current asset and he is substantially
incorrect in respect of all of them.
The term non-current assets will normally include intangible assets and certain investments; the use of
the term ‘physical asset’ would be specific to tangible assets only.
Whilst it is usually the case that non-current assets are of relatively high value this is not a defining
aspect. A waste paper bin may exhibit the characteristics of a non-current asset, but on the grounds of
materiality it is unlikely to be treated as such.
Furthermore the past cost of an asset may be irrelevant; no matter how much an asset has cost, it is the
expectation of future economic benefits flowing from a resource (normally in the form of future cash
inflows) that defines an asset according to the IASB’s Framework for the preparation and presentation of
financial statements.
The concept of ownership is no longer a critical aspect of the definition of an asset. It is probably the case
that most noncurrent assets in an entity’s statement of financial position are owned by the entity; however,
it is the ability to ‘control’ assets (including preventing others from having access to them) that is now a
defining feature. For example: this is an important characteristic in treating a finance lease as an asset of
the lessee rather than the lessor.
It is also true that most non-current assets will be used by an entity for more than one year and a part of
the definition of property, plant and equipment in IAS 16 Property, plant and equipment refers to an
expectation of use in more than one period, but this is not necessarily always the case. It may be that a
non-current asset is acquired which proves unsuitable for the entity’s intended use or is damaged in an
accident. In these circumstances assets may not have been used for longer than a year, but nevertheless
they were reported as non-currents during the time they were in use. A non-current asset may be within a
year of the end of its useful life but (unless a sale agreement has been reached under IFRS 5 Non-current
assets held for sale and discontinued operations) would still be reported as a non-current asset if it was
still giving economic benefits. Another defining aspect of non-current assets is their intended use i.e. held
for continuing use in the production, supply of goods or services, for rental to others or for administrative
purposes.

(b) (i) The expenditure on the training courses may exhibit the characteristics of an asset in that they
have and will continue to bring future economic benefits by way of increased efficiency and cost savings
to Darby. However, the expenditure cannot be recognised as an asset on the statement of financial
position and must be charged as an expense as the cost is incurred. The main reason for this lies with the
issue of ’control’; it is Darby’s employees that have the ‘skills’ provided by the courses, but the employees
can leave the company and take their skills with them or, through accident or injury, may be deprived of
those skills. Also the capitalisation of staff training costs is specifically prohibited under International
Financial Reporting Standards (specifically IAS 38 Intangible assets).

(ii) The question specifically states that the costs incurred to date on the development of the new
processor chip are research costs. IAS 38 states that research costs must be expensed. This is mainly
because research is the relatively early stage of a new project and any future benefits are so far in the
future that they cannot be considered to meet the definition of an asset (probable future economic
benefits), despite the good record of success in the past with similar projects.
Although the work on the automatic vehicle braking system is still at the research stage, this is different in
nature from
the previous example as the work has been commissioned by a customer, As such, from the perspective
of Darby, it is work in progress (a current asset) and should not be written off as an expense. A note of
caution should be added here in that the question says that the success of the project is uncertain which
presumably means it may not be completed.
This does not mean that Darby will not receive payment for the work it has carried out, but it should be
checked to the
contract to ensure that the amount it has spent to date (N2·4 million) will be recoverable. In the event that
say, for
example, the contract stated that only N2 million would be allowed for research costs, this would place a
limit on how
much Darby could treat as work in progress. If this were the case then, for this example, Darby would
have to expense
N400,000 and treat only N2 million as work in progress.

(iii) The question suggests the correct treatment for this kind of contract is to treat the costs of the
installation as a
non-current asset and (presumably) depreciate it over its expected life of (at least) three years from when
it becomes
available for use. In this case the asset will not come into use until the next financial year/reporting period
and no
depreciation needs to be provided at 30 September 2009.
The capitalised costs to date of N58,000 should only be written down if there is evidence that the asset
has become
impaired. Impairment occurs where the recoverable amount of an asset is less than its carrying amount.
The assistant
appears to believe that the recoverable amount is the future profit, whereas (in this case) it is the future
(net) cash
inflows. Thus any impairment test at 30 September 2009 should compare the carrying amount of N58,000
with the
expected net cash flow from the system of N98,000 (N50,000 per annum for three years less future cash
outflows to
completion the installation of N52,000 (see note below)). As the future net cash flows are in excess of the
carrying
amount, the asset is not impaired and it should not be written down but shown as a non-current asset
(under
construction) at cost of N58,000.
Note: as the contract is expected to make a profit of N40,000 on income of N150,000, the total costs must
be
N110,000, with costs to date at N58,000 this leaves completion costs of N52,000.

2(a) The requirements of IAS 16 Property, Plant and Equipment may, in part, offer a solution to the
director’s concerns. IAS 16 allows (but does not require) entities to revalue their property, plant and
equipment to fair value; however, it imposes conditions where an entity chooses to do this. First, where an
item of property, plant and equipment is revalued under the revaluation model of IAS 16, the whole class
of assets to which it belongs must also be revalued. This is to prevent what is known as ‘cherry picking’
where an entity might only wish to revalue items which have increased in value and leave other items at
their (depreciated) cost. Second, where an item of property, plant and equipment has been revalued, its
valuation (fair value) must be kept up-to-date. In practice, this means that, where the carrying amount of
the asset differs significantly from its fair value, a (new) revaluation should be carried out. Even if there
are no significant changes, assets should still be subject to a revaluation every three to five years.
A revaluation surplus (gain) should be credited to a revaluation surplus (reserve), via other
comprehensive income, whereas a revaluation deficit (loss) should be expensed immediately (assuming,
in both cases, no previous revaluation of the asset has taken place). A surplus on one asset cannot be
used to offset a deficit on a different asset (even in the same class of asset).
Subsequent to a revaluation, the asset should be depreciated based on its revalued amount (less any
estimated residual value) over its estimated remaining useful life, which should be reviewed annually
irrespective of whether it has been revalued.
An entity may choose to transfer annually an amount of the revaluation surplus relating to a revalued
asset to retained
earnings corresponding to the ‘excess’ depreciation caused by an upwards revaluation. Alternatively, it
may transfer all of the relevant surplus at the time of the asset’s disposal.
The effect of this, on Enca’s financial statements, is that its statement of financial position will be
strengthened by reflecting the fair value of its property, plant and equipment. However, the downside
(from the director’s perspective) is that the depreciation charge will actually increase (as it will be based
on the higher fair value) and profits will be lower than using the cost model. Although the director may not
be happy with the higher depreciation, it is conceptually correct. The director has misunderstood the
purpose of depreciation; it is not meant to reflect the change (increase in this case) in the value of an
asset, but rather the cost of using up part of the asset’s remaining life.

(b) (i) Delta – Extracts from statement of profit or loss (see workings):
N’000
Year ended 31 March 2013
Plant impairment loss 20,000
Plant depreciation (32,000 + 22,400) 54,400
Year ended 31 March 2014
Loss on sale 8,000
Plant depreciation (32,000 + 26,000) 58,000

(ii) Delta – Extracts from statement of financial position (see workings):

N’000
As at 31 March 2013
Property, plant and equipment (128,000 + 89,600) 217,600
Revaluation surplus
Revaluation of item B (1 April 2012) 32,000
Transfer to retained earnings (32,000/5 years) (6,400)
––––––––
Balance at 31 March 2013 25,600
––––––––
As at 31 March 2014
Property, plant and equipment (item A only) 96,000
Revaluation surplus
Balance at 1 April 2013 25,600
Transfer to retained earnings (asset now sold) (25,600)
–––––––
Balance at 31 March 2014 nil
–––––––
Workings (figures in brackets in N'000)
Item A Item B
N’000 N’000
Carrying amounts at 31 March 2012 180,000 80,000
Balance = loss to statement of profit or loss (20,000)
––––––––
Balance = gain to revaluation surplus 32,000
––––––––
Revaluation on 1 April 2012 160,000 112,000
Depreciation year ended 31 March 2013 (160,000/5 years) (32,000) (22,400) (112,000/5
years)
–––––––– ––––––––
Carrying amount at 31 March 2013 128,000 89,600
Subsequent expenditure capitalised on 1 April 2013 nil 14,400
–––––––– ––––––––
104,000
Depreciation year ended 31 March 2014 (unchanged) (32,000) (26,000) (104,000/4
years)
–––––––– ––––––––
78,000
Sale proceeds on 31 March 2014 (70,000)
––––––––
Loss on sale (8,000)
––––––––
Carrying amount at 31 March 2014 96,000 nil
–––––––– ––––––––
IAS 17: LEASE
Definitions
Lease: An agreement whereby the lessor conveys to the lessee in return for payment the right
to use an asset for an agreed period of time.
Finance lease: A lease that transfers substantially all the risks and rewards of ownership of an
asset. Title need not necessarily be eventually transferred.
Operating lease: A lease that is not a finance lease.
Minimum lease payments: The payments over the lease term that are required to be
made.For a lessee, this includes any amounts guaranteed to be paid; for a lessor, this includes
any residual value guaranteed to the lessor.

Classification of Leases
The classification of a lease as either a finance lease or an operating lease is critical as
significantly different accounting treatments are required for the different types of lease. The
classification is based on the extent to which risks and rewards of ownership of the leased asset
are transferred to the lessee or remain with the lessor. Risks include technological
obsolescence, loss from idle capacity, and variations in return. Rewards include rights to sell the
asset and gain from its capital value.

Finance Lease
A lease is classified as a finance lease if it transfers substantially all the risks and rewards of
ownership to the lessee. If it does not, then it is an operating lease. When classifying a lease, it
is important to recognize the substance of the agreement and not just its legal form. The
commercial reality is important. Conditions in the lease may indicate that an entity has only a
limited exposure to the risks and benefits of the leased asset. However, the substance of the
agreement may indicate otherwise. Situations that, individually or in combination, would usually
lead to a lease being a finance lease include:
• Transfer of ownership to the lessee by the end of the lease term.
• The lessee has the option to purchase the asset at a price that is expected to be lower
than its fair value such that the option is likely to be exercised.
• The lease term is for a major part of the economic life of the asset, even if title to the
asset is not transferred.
• The present value of the minimum lease payments is equal to substantially all of the fair
value of the asset.
• The leased assets are of a specialized nature such that only the lessee can use them
without significant modification.

Situations that, individually or in combination, could lead to a lease being a finance lease
include:
• If the lessee can cancel the lease, and the lessor’s losses associated with cancellation
are borne by the lessee
• Gains or losses from changes in the fair value of the residual value of the asset accrue
to the lessee.
• The lessee has the option to continue the lease for a secondary term at substantially
below market rent.

Accounting for Lease in the Books of Lessee

Finance Lease
• Finance Lease recognises the asset at an amount which represents the lower of:
• present value of minimum lease payments, and
• fair value
• Depreciate over the shorter of:
• useful life
 • lease term
• Recognise the liability at the same value as the asset
• Calculate finance charges so as to give a constant rate on the balance outstanding
• Instalments are split between finance charges and capital element repayments

Operating Lease
• Operating lease recognises neither asset nor liability
• Rental payments expensed through Statement of Profit or Loss and Other
Comprehensive Income
as accrued.
• Unless another systematic basis is a better reflection of the lessee’s benefits obtained

Disclosure:
Leased assets
For each class of asset, disclose the net carrying amount at the Statement of Financial Position
date.
Finance lease liabilities
Finance lease liability should be separately disclosed, some within current liabilities, some
within long term liabilities.
Maturity analysis needed, subdividing amounts payable
≤ 12 months
> 12 months ≤ 5 years
> 5 years
Reconciliation between minimum lease payments and present value, shown either gross or net
Gross presentation example N
Payable within 12 months 3,000
> 12 months ≤ 5 years 12,000
> 5 years 3,000
18,000
Less: finance charges not yet accrued 4,935
13,065
Net presentation
Payable within 12 months 2,727
> 12 months ≤ 5 years 8,645
> 5 years 1,693
13,065

Operating leases disclose:

• future minimum lease payments with maturity analysis
≤ 12 months
> 12 months ≤ 5 years
> 5 years
• it is also common practice for entities to show as disclosure:
• depreciation charged on finance leased assets
• finance charges on finance leases

• Occasionally, in an operating lease, a lessor will offer an incentive to the prospective

lessee, to make it a more attractive deal. This incentive could be in the form of a “cash-
back” payment, or in the form of an initial rent-free period.
• The Standards Interpretation Committee has agreed that these incentives should be
treated as a reduction of the overall payments to be made under the operating lease,
and the benefit spread over the life of the lease.

Accounting for Lease in the Books of the Lessor

Finance Lease
• Risks and rewards are transferred to the lessee therefore derecognise the asset from
Total Non – Current Asssets and intstead
• Recognise the receivable equal to the “net investment in the lease”. This “net
investment”is the aggregate of the present values of:
• minimum lease payments, and
• any un-guaranteed residual amount (see later)
• Recognise as finance income the instalment receipts net of the capital element (which
will be credited to the receivables account)

Operating Lease
• Risks and rewards remain with the lessor
• Keep the asset in lessor’s records within non – current assets
• Depreciate it over its estimated useful life
• Instalment income will be credited in full to the Statement of Profit or Loss and Other
Comprehensive Income on a straight line basis over the life of the lease (unless there is a
better basis)

Land and Buildings

Under IAS 17 the land and buildings elements of a lease of land and buildings are considered
separately for the purpose of lease classification.
A lease of land is normally treated as an operating lease, unless title is expected to pass at the
end of the lease terms. A lease of buildings will be treated as a finance lease if it satisfies the
requirments of finance lease. The minimum lease payments are allocated between the land and
building elements in proportion to the relative fair values of the leasehold interests in the land
and the buildings. If the value of the land is immaterial, classification will be according to the
buildings.
If payments cannot be reliably alocated, the entire lease is classified as a finance lease, unless
both elements are operating lease, in which case the entire lease is classifed as an operating
lease.

Illustration on Land and Building

A business has taken out a new lease on a factory building and surrounding land. The fair value
of the building is N5m and the fair value of the land is N3m. The lease is for 20 years with
annual payments in arrears of N500,000. Show the required treatment of this lease in the books
of the lessee.

Suggested Solution
The lease payments will be split in line with the fair values of the land and the building.
N187,500 (3/8 x N500,000) will be treated as payment on an operating lease for the land and
N312,500 will be treated as payment on a finance lease for the building, the building will be
capitalized and depreciated.

Guaranteed and Unguaranteed Residual Amounts

In a lease transaction, the lessor will have in mind the likely value of the asset at the end of the
lease. In the lease agreement the lessor will try to persuade the lessee to guarantee that
residual amount. Then, if the lessor cannot sell the asset for that amount, at least the lessee has
guaranteed any short fall. The lessee, on the other hand, will resist, and may finally agree to
guarantee only part of that estimated shortfall

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.
Accounting entries for the guaranteed residual value on expiration of the term of the lease:
Dr Obligation under finance lease
Cr Asset

Where the carrying cost of the asset on expirattion of the lease is lower than the guranteed
residual value, the lessee pays the difference in cash. Therefore the accounting entries will be:
Dr Obligation under finance lease
Cr Asset (carrying cost)
Cr Bank (shortfall to make up the residual value)

Sale and Leaseback Transactions

Finance Leases
Where an asset is sold and leased back under a finance lease, there is, in effect, no transfer of
risk and reward. In other words, there is no sales hany gain on sale (proceeds in excess of
carrying value) should be deferred, and benefits recognised over the finance lease term.
The required entries are:
Sale of the asset
Dr Bank (fair value of the asset)
Cr Asset (carrying cost)
Cr Deffered income on disposal

Lease of the asset and its liability

Dr Asse finance lease
Cr Obligation under F/lease

Derefered Income recogntion at each reporting period

Dr Defered income
Cr profit or loss

Operating Leases
If, however, the lease back is under an operating lease, then risks and rewards have been
transferred. A sale has been made, and a gain (or loss) may have resulted.

REVIEW QUESTIONS
Q1. An entity enters into a finance lease to lease a truck from another entity. The truck’s fair
value is N140,000. The lease rentals are payable monthly, and the lease term is five years. The
present value of the minimum lease payments at the inception of the lease is N132,000 and the
unguaranteed residual value of the truck is estimated at N20,000.
Required
At which amount will the lease liability be recorded in the financial accounts at the inception of
the lease?

2. An entity leases an asset from another entity. The fair value of the asset is N100,000, and the
lease rentals are N18,000, payable half yearly. The first payment is made on the delivery of the
asset. The unguaranteed residual value of the asset after the three-year lease period is N4,000.
The implicit interest rate in the lease is 9.3% (approximately), and the present value of the
minimum lease payment is N96,936.
Required
Show how this lease would be accounted for in the accounts of the lessee.

3.Voodoo Ltd as a lessor, enters into an agreement to lease an asset under the following terms:
Commencement date: 1 May, 2010
Lease period: 4 years
Rate implicit in the lease: 9%
Annual instalments payable 1 May, in advance: 4,000
Estimated residual value: 2,000
Guaranteed residual value: 1,600
Calculate the amount which Voodoo Ltd should show as his “net investment in the lease”,
clearly showing the guaranteed and the unguaranteed amounts.

Q4. On 1 January 2010 Biggs Ltd buys a small bottling and labelling machine from Seas Ltd
under a finance lease. The cash price of the machine is N7,710 while the amount to be paid
was N10,000. The agreement required the immediate payment of N2,000 deposit with the
balance being settled in four equal instalments commencing on 31 December 2010. The charge
of N2,290 represents interest of 15% per annum, 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 residual value of nil.

5. Fundo entered into a 20-year operating lease for a property on 1 October 2000 which has a remaining
life of
eight years at 1 October 2012. The rental payments are N2·3 million per annum.
Prior to 1 October 2012, Fundo obtained permission from the owner of the property to make some internal
alterations to the property so that it can be used for a new manufacturing process which Fundo is
undertaking. The cost of these
alterations was N7 million and they were completed on 1 October 2012 (the time taken to complete the
alterations
can be taken as being negligible). A condition of being granted permission was that Fundo would have to
restore the
property to its original condition before handing back the property at the end of the lease. The estimated
restoration
cost on 1 October 2012, discounted at 8% per annum to its present value, is N5 million.
Required:
(a) Explain how the lease, the alterations to the leased property and the restoration costs should
be treated in
the financial statements of Fundo for the year ended 30 September 2013. (4 marks)
(b) Prepare extracts from the financial statements of Fundo for the year ended 30 September 2013
reflecting
your answer to (a) above. (6 marks)
(10 marks) ACCA FINANCIAL REPORTING DECEMBER 2013

6. William is a public limited company and would like advice in relation to the following transactions.
William owned a building on which it raised finance. William sold the building for N5 million to a finance
company on 1 June 2011 when the carrying amount was N3·5 million. The same building was leased
back from the finance company for a period of 20 years, which was felt to be equivalent to the majority of
the asset’s economic life. The lease rentals for the period are N441,000 payable annually in arrears. The
interest rate implicit in the lease is 7%. The present value of the minimum lease payments is the same as
the sale proceeds.
William wishes to know how to account for the above transaction for the year ended 31 May 2012.
(7 marks) ACCA CORPORATE REPORTING JUNE 2012 ADAPTED

7. (a) Leasing is important to Holcombe, a public limited company as a method of financing the business.
The Directors feel that it is important that they provide users of financial statements with a complete and
understandable picture of the entity’s leasing activities. They believe that the current accounting model is
inadequate and does not meet the needs of users of fi nancial statements.
Holcombe has leased plant for a fixed term of six years and the useful life of the plant is 12 years. The
lease is non-cancellable, and there are no rights to extend the lease term or purchase the machine at the
end of the term.
There are no guarantees of its value at that point. The lessor does not have the right of access to the
plant until the end of the contract or unless permission is granted by Holcombe.
Fixed lease payments are due annually over the lease term after delivery of the plant, which is maintained
by
Holcombe. Holcombe accounts for the lease as an operating lease but the directors are unsure as to
whether the
accounting treatment of an operating lease is conceptually correct.
Required:
(i) Discuss the reasons why the current lease accounting standards may fail to meet the needs of
users and
could be said to be conceptually flawed; (7 marks)
(ii) Discuss whether the plant operating lease in the financial statements of Holcombe meets the
definition
of an asset and liability as set out in the ‘Framework for the Preparation and Presentation of
Financial
Statements.’ (7 marks)
Professional marks will be awarded in part (a) (i) and (ii) for clarity and quality of discussion. (2 marks)

(b) Holcombe also owns an office building with a remaining useful life of 30 years. The carrying amount of
the
building is N120 million and its fair value is N150 million. On 1 May 2009, Holcombe sells the building to
Brook, a public limited company, for its fair value and leases it back for five years at an annual rental
payable in arrears of N16 million on the last day of the financial year (30 April). This is a fair market rental.
Holcombe’s incremental borrowing rate is 8%.
On 1 May 2009, Holcombe has also entered into a short operating lease agreement to lease another
building. The lease will last for three years and is currently N5 million per annum. However an infl ation
adjustment will be made at the conclusion of leasing years 1 and 2. Currently inflation is 4% per annum.
The following discount factors are relevant (8%).
Single cash flow Annuity
Year 1 0·926 0·926
Year 2 0·857 1·783
Year 3 0·794 2·577
Year 4 0·735 3·312
Year 5 0·681 3·993
Required:
(i) Show the accounting entries in the year of the sale and lease back assuming that the operating
lease is
recognised as an asset in the statement of fi nancial position of Holcombe; (6 marks)
(ii) State how the inflation adjustment on the short term operating lease should be dealt with in the
financial
statements of Holcombe. (3 marks)
(25 marks) ACCA CORPORATE REPORTING JUNE 2010

SUGGESTED SOLUTIONS
1. The lease asset and liability will be recorded at N132,000, which is the present value of the
minimum lease payments. A lease liability should be recorded at the lower of the fair value of
the leased asset and the present value of the minimum lease payment. The difference between
the minimum lease payments and the fair value of N8,000 will represent the present value of the
unguaranteed residual value (N20,000).

2. The number of payments is six with a total value of N108,000. The use of the approximate
implicit interest rate will give a rounding error.
Payment Balance Finance Charge Payment Lease Liability
N N N N
1 96,936 0 (18,000) 78,936
2 78,936 3,670 (18,000) 64,606
3 64,606 3,004 (18,000) 49,610
4 49,610 2,306 (18,000) 33,916
5 33,916 1,577 (18,000) 17,493
6 17,493 507 (813 – 306) (18,000) 0

There is a rounding error of N306, which would be taken off the last finance charge to be taken
to the income statement.

3 Voodoo Ltd
DF
1.5.10 4,000 1 4,000 Deposit
1.5.11 4,000 .917 3,668 2nd instalment
1.5.12 4,000 .842 3,368 3rd instalment
1.5.13 4,000 .772 3,088 4th instalment
1.5.14 1,600 .708 1,132 Guaranteed residual amount
Present value of minimum lease payments 15,256
1.5.14 400 .708 283 Unguaranteed residual amount
Net investment in the lease 15,539

4.Interest is calcuated at 15% of the oustanding capital at the beginning of each year. The
outstanding capital balance reduces each year by the capital element comprised in each
instament. The oustanding capital balance at 1 January 2010 is N5,710, fair value of N7,710
less deposit of N2,000.
N
Balance 1 January 2010 5,710
Intereest at 15% 856
Instalement 31 December 2010 (2,000)
Balance outstanding 31 December 2010 4,566
Interest at 15% 685
Instalment 31 December 2011 (2,000)
Balance oustanding 31 December 2011 3,251
Interest at 15% 488
Instalment 31 December 2012 (2,000)
Balance oustanding 31 December 2012 1,739
Interest at 15% 261
Instalment 31 December 2013 (2,000
-

Disclosure of Lessee on the above lease transaction

Statement of Financial Position Extracts as at 31 December 2010
Non – Current Assets N N
Assets held under finance lease 7,710
Less accumulated depreciation 1,542 6,168

Non – current liabilities

Obligation under finance leases 3, 251
(N4,566 – N1,315))

Current .liabilities
Obligation under financel leases (2,000 – 685) 1,315
Statment of Comprehensive Income Extract
Finance cost
Interest on finance lease 856

Using the annuity formula to determine the rentals or the fair value
Where the rentals are paid in advance at the beginning of a period:
Present Value/ Fair value = a 1-(1+r)-t +1
r
Where a is the periodic rental
Where r is the interest rate implicit in the lease transaction
t is n -1 and n in this case refers to the duration of the lease

Where the rentals are paid at the end of a period:

Fair value = (1 – (1+r)-n
r
Where r is the interest rate
n is the duration of the lease

Determining the fair value

In this case the periodic rentals ‘a’,will be given you then make fair value the subject of the
formula.

5. (a) The alterations to the leased property do not affect the lease itself and this should continue to be
treated as an operating lease and charging profit or loss with the annual rental of N2·3 million.
The initial cost of the alterations should be capitalised and depreciated over the remaining life of the
lease. In addition to this, IAS 37 Provisions, Contingent Assets and Contingent Liabilities requires that the
cost of restoring the property to its original condition should be provided for on 1 October 2012 as this is
when the obligation to incur the restoration cost arises (as the time taken to do the alterations is
negligible). The present value of the restoration costs, given as N5 million, should be added to the initial
cost of the alterations and depreciated over the remaining life of the lease. A corresponding provision
should be created and a finance cost of 8% per annum should be charged to profit or loss and accrued on
this provision.

(b) Extracts from the financial statements of Fundo

N’000
Statement of profit or loss for the year ended 30 September 2013
Operating lease rental 2,300
Depreciation of alterations to leased property (12,000/8 years) 1,500
Finance cost (5,000 x 8%) 400

Statement of financial position as at 30 September 2013

Non-current assets
Alterations to leased property (7,000 + 5,000) 12,000
Accumulated depreciation (above) (1,500)
–––––––
Carrying amount 10,500
–––––––
Non-current liabilities
Provision for property restoration costs (5,000 + 400 above) 5,400
–––––––
6. A lease is classified as a finance lease if it transfers substantially the entire risks and rewards incident
to ownership. All other leases are classified as operating leases. Classification is made at the inception of
the lease. Whether a lease is a finance lease or an operating lease depends on the substance of the
transaction rather than the form. Situations that would normally lead to a lease being classified as a
finance lease include the following:
– the lease transfers ownership of the asset to the lessee by the end of the lease term;
– the lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than
fair value at
the date the option becomes exercisable that, at the inception of the lease, it is reasonably certain that the
option will
be exercised;
– the lease term is for the major part of the economic life of the asset, even if title is not transferred;
– 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 asset;
– the lease assets are of a specialised nature such that only the lessee can use them without major
modifications being made.
In this case the lease back of the building is for the major part of the building’s economic life and the
present value of the minimum lease payments amounts to all of the fair value of the leased asset.
Therefore the lease should be recorded as a finance lease.
The building is derecognised at its carrying amount and then reinstated at its fair value with any disposal
gain, in this instance N1·5 million (N5m – N3·5m) being deferred over the new lease term. The building is
depreciated over the shorter of the lease term and useful economic life, so 20 years. Finance lease
accounting results in a liability being created, finance charge accruing at the implicit rate within the lease,
in this case 7%, and the payment reducing the lease liability in arriving at the year-end balance. The
associated double entry for the lease is as follows:
N000 N000
Sale of building
Dr cash 5,000
Cr building 3,500
deferred income 1,500

Leased asset and liability

Dr asset – finance lease 5,000
Cr finance lease creditor 5,000

Deferred income release

Dr deferred income 75
Cr profit or loss 75

Depreciation of asset
Dr depreciation 250
Cr assets under finance lease 250

Rentals paid
Dr interest 350
finance lease creditor 91
Cr cash 441

SUGGESTED SOLUTION
7(a) (i) The existing accounting model for leases has been criticised for failing to meet the needs of users
of financial statements. It can be argued that operating leases give rise to assets and liabilities that should
be recognised in the fi nancial statements of lessees. Consequently, users may adjust the amounts
recognised in financial statements in an attempt to recognise those assets and liabilities and reflect the
effect of lease contracts in profi t or loss. The information available to users inthe notes to the financial
statements is often insufficient to make reliable adjustments to the financial statements.
The existence of two different accounting methods for finance leases and operating leases means that
similar transactions can be accounted for very differently. This affects the comparability of financial
statements. Also current accounting standards provide opportunities to structure transactions so as to
achieve a specifi c lease classifi cation. If the lease is classifi ed as an operating lease, the lessee obtains
a source of fi nancing that can be difficult for users to understand, as it is not recognised in the financial
statements.
Existing accounting methods have been criticised for their complexity. In particular, it has proved difficult
to define the
dividing line between the principles relating to finance and operating leases. As a result, standards use a
mixture of
subjective judgments and rule based criteria that can be difficult to apply.
The existing accounting model can be said to be conceptually fl awed. On entering an operating lease
contract, the lessee obtains a valuable right to use the leased item. This right meets the Framework’s
defnition of an asset. Additionally the lessee assumes an obligation to pay rentals that meet the
Framework’s definition of a liability. However, if the lessee classifies the lease as an operating lease, that
right and obligation are not recognised.
There are significant and growing differences between the accounting methods for leases and other
contractual
arrangements. This has led to inconsistent accounting for arrangements that meet the definition of a lease
and similar
arrangements that do not. For example leases are financial instruments but they are scoped out of IAS
32/39.

(ii) An asset is a resource controlled by the entity as a result of past events and from which future
economic benefits are expected to fl ow to the entity. Holcombe has the right to use the leased plant as
an economic resource because the entity can use it to generate cash infl ows or reduce cash outfl ows.
Similarly, Holcombe controls the right to use the leased item during the lease term because the lessor is
unable to recover or have access to the resource without the consent of the lessee or unless there is a
breach of contract. The control results from past events, which is the signing of the lease contract and the
receipt of the plant by the lessee. Holcombe also maintains the asset.
Unless the lessee breaches the contract, Holcombe has an unconditional right to use the leased item.
Future economic benefi ts will fl ow to the lessee from the use of the leased item during the lease term.
Thus it could be concluded that the lessee’s right to use a leased item for the lease term meets the defi
nitions of an asset in the Framework.
A liability is a present obligation of the entity arising from past events, the settlement of which is expected
to result in
an outflow from the entity of resources embodying economic benefi ts. The obligation to pay rentals is a
liability. Unless Holcombe breaches the contract, the lessor has no contractual right to take possession of
the item until the end of the lease term. Equally, the entity has no contractual right to terminate the lease
and avoid paying rentals. Therefore the lessee has an unconditional obligation to pay rentals. Thus the
entity has a present obligation to pay rentals, which arises out of a past event, which is the signing of the
lease contract and the receipt of the item by the lessee. Finally the obligation is expected to result in an
outfl ow of economic benefi ts in the form of cash.
Thus the entity’s obligation to pay rentals meets the defi nition of a liability in the Framework.

(b) (i) On sale of the building, Holcombe will recognise the following in the fi nancial statements to 30 April
2010:
Dr Cash N150m
Cr Office building N120m
Cr Deferred Income (SOFP) N30m

Recognition of gain on the sale of the building

Dr Deferred Income (SOFP) N6m
Cr Deferred Income (I/S) N6m
Release of the gain on sale of the building (N30m/5 years)
Dr Operating lease asset N63·89m
Cr Obligation to pay rentals N63·89m

Recognition of the leaseback at net present value of lease payments using 8% discount rate
In the first year of the leaseback, Holcombe will recognise the following:
Dr Lease obligation – rentals N16m
Cr Cash N16m

Recognition of payment of rentals

Dr Interest expense N5·11m
Cr Lease obligation N5·11m

Recognition of interest expense (N63·89m x 8%)

Dr Depreciation expense N12·78m
Cr Right-of-use asset N12·78m
Recognition of depreciation of operating lease asset over five years (N63·89m/5 years). The statement of
financial position will show a carrying value of N51·11m being cost of N63·89m less depreciation of
N12·78m.

(ii) Infl ation adjustments should be recognised in the period in which they are incurred as they are
effectively contingent rent and are not included in any minimum lease calculations. A contingent rent
according to IAS 17 is ‘that part of the rent 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.’ Thus in this case, Holcombe would recognise
operating rentals of N5 million in year 1, N5 million in year 2 plus the inflation adjustment at the beginning
of year 2, and N5 million in year 3 plus the infl ation adjustment at the beginning of year 2 plus infl ation
adjustment at the beginning of year 3. Based on current inflation, the rent will be N5·2 million in year 2
and N5·408 million in year 3.

Disclosure: lessees – operating leases [IAS 17.35]

• amounts of minimum lease payments at balance sheet date under noncancellable
operating leases for:

• the next year

• years 2 through 5 combined

• beyond five years

• total future minimum sublease income under noncancellable subleases

• lease and sublease payments recognised in income for the period

• contingent rent recognised as an expense

• general description of significant leasing arrangements, including contingent rent

provisions, renewal or purchase options, and restrictions imposed on dividends,
borrowings, or further leasing

Disclosure: lessors – finance leases [IAS 17.47]

• reconciliation between gross investment in the lease and the present value of minimum
lease payments;

• gross investment and present value of minimum lease payments receivable for:
 • the next year

• years 2 through 5 combined

• beyond five years

• unearned finance income

• unguaranteed residual values

• accumulated allowance for uncollectible lease payments receivable

• contingent rent recognised in income

• general description of significant leasing arrangements

Disclosure: lessors – operating leases [IAS 17.56]

• amounts of minimum lease payments at balance sheet date under noncancellable
operating leases in the aggregate and for:
• the next year
• years 2 through 5 combined
• beyond five years
• contingent rent recognised as in income
• general description of significant leasing arrangements
IAS 18: REVENUE
Revenue
• Revenue relates to both income and gains arising in the ordinary course of business
• It includes sales, services, interest, royalties and dividends
• It excludes trade discounts and VAT
• Should be measured at fair value of consideration received
• If consideration is deferred for fairly a long time,the liability should be discounted
• If sales financed by the seller, difference between apparent sale value and fair value
should be recognised as finance income like in the case of manufacturer type lease and
hire purchase sales

Sale of goods recognised when all criteria are met:

• If it transfers of significant risks and rewards
• No continuing managerial involvement nor effective control of goods sold
• Revenue can be reliably measured
• Probable inflow of related economic benefits
• Reliable measurement of transaction costs

Revenue from Services

Revenue from services is recognised according to the stage of completion. The following
conditions must be met:
• The revenue can be measured reliably
• The transaction’s economic benefits will probably flow to the provider
• The stage of completion at the reporting date can be measured reliably
• The costs incurred and the costs to complete can be measured reliably
If these conditions are not met, then revenue should be restricted to any recoverable costs
incurred.

Interests, Royalties and Dividends

Revenue from these sources should be recognised when the receipt is probable and the
revenues are measurable. Revenue should be recognised as follows:
• Interest is recognised on a time proportion basis, taking into account the effective yield on
the asset
• Royalties are accrued in accordance with the relevant contract
• Dividends are recognised when the shareholder’s right to receive payment is established

Guidance on Specific Situations

IAS 18 includes an Appendix which gives guidance on specific situations:

A Bill and Hold Arrangement

This is a contractor for the supply of goods, where the buyer accepts title to the goods but does
not take physical delivery of them until a later date. Provided the goods are available for
delivery, the buyer gives explicit instructions to delay delivery and there are no alterations to the
terms on which the seller normally trades with the buyer, revenue should be recognised when
the buyer accepts title.
B Payment for Goods in Advance (deposits)
Revenue should be recognised when delivery of the goods to the buyer takes place. Until then,
any payments in advance should be treated as liabilities.

C Payments for Goods by Instalments

Revenue is recognised when the significant risks and rewards of ownership have been
transferred, which is usually when delivery is made. If the effect of the time value of money is
material, the sale price should be discounted to its present value.

D Sale or Return
Sometimes goods are delivered to a customer but the customer can return them within a certain
time period. Revenue is normally recognised when the goods are delivered.
Revenue should then be reduced by an estimate of the returns. In most cases, a seller can
estimate returns from past experience. For example, retailer would know on average what
percentage of goods were returned after the year end and could adjust revenue by the amount
of expected returns.

E Presentation of Revenue as Principal or Agent

The principal supplies goods or services on its own account, whilst the agent receives a fee or
commission for arranging provision of goods or services by the principal. The principal is
exposed to the risks and rewards of the transaction and therefore records revenue as the gross
amount receivable. The agent only records the commission receivable on the transaction as
revenue. An example will be a cosmetics agent who earns commission on the number of
cosmetics sold. The agent owns no inventory, so is not exposed to obsolescence and therefore
could only record commission as its revenue. The cosmetics company is exposed to inventory
obsolescence and selling price changes, so would record the gross amount of the sale as
revenue.

F Separation and Linking of Contractual Arrangements

Sometimes businesses provide a number of different goods or services to customers as a
package. For example, customer might purchase software together with regular upgrades for
one year. The problem here is whether the sale is one transaction or two separate transactions.
A ‘package’ such as this can only be treated as more than one separate transaction if each
product or service is capable of being sold independently and if a reliable fair value can be
assigned to each separate component. Using the example above, if the support service is an
optional extra and the software can be operated without it, the sale is two (or more) separate
transactions. If the software cannot operate successfully without the upgrade, then the sale is
one transaction and the amount of revenue recognised depends on the extent to which the
seller has performed at the reporting date.

Disclosure Requirements
An entity should disclose:
• Its accounting policies for revenue including the methods adopted to determine the stage of
completion of service transactions.
• The amount of each significant category of revenue recognised during the period
• The amount of revenue arising from exchange of goods or services.

REVIEW QUESTION
1. It is argued that there is limited revenue recognition guidance available from IFRS with many
companies following the current provisions of US GAAP. The revenue recognition standard, IAS 18
Revenue, has been criticised because an entity applying the standards might recognise amounts in the
financial statements that do not faithfully represent the nature of the transactions. It has been further
argued that current standards are inconsistent with principles used in other accounting standards, and
further that the notion of the risks and rewards of ownership has also been
subjectively applied in sale transactions.
Required:
(a) (i) Discuss the main weaknesses in the current standard on revenue recognition; (11 marks)
(ii) Discuss the reasons why it might be relevant to take into account credit risk and the time value
of money
in assessing revenue recognition. (5 marks)
Professional marks will be awarded in part (a) for clarity and expression of your discussion. (2 marks)

(b) (i) Venue enters into a contract with a customer to provide computers at a value of N1 million. The
terms are that payment is due one month after the sale of the goods. On the basis of experience with
other contractors with similar characteristics, Venue considers that there is a 5% risk that the customer
will not pay the amount due after the goods have been delivered and the property transferred. Venue
subsequently felt that the financial condition of the customer has deteriorated and that the trade
receivable is further impaired by N100,000.

(ii) Venue has also sold a computer hardware system to a customer and, because of the current
difficulties in the market, Venue has agreed to defer receipt of the selling price of N2 million until two
years after the hardware has been transferred to the customer.
Venue has also been offering discounts to customers if products were sold with terms whereby payment
was due now but the transfer of the product was made in one year. A sale had been made under these
terms and payment of N3 million had been received. A discount rate of 4% should be used in any
calculations.
Required:
Discuss how both of the above transactions would be treated in subsequent financial statements
under
IAS 18 and also whether there would be difference in treatment if the collectability of the debt and
the time
value of money were taken into account. (7 marks)
(25 marks) ACCA CORPORATE REPORTING DECEMBER 2011

2. One of the hotels owned by Norman is a hotel complex which includes a theme park, a casino and a
golf course, as well as a hotel. The theme park, casino, and hotel were sold in the year ended 31 May
2008 to Conquest, a public limited company, for N200 million but the sale agreement stated that Norman
would continue to operate and manage the three businesses for their remaining useful life of 15 years.
The residual interest in the business reverts back to Norman after the 15 year period. Norman would
receive 75% of the net profit of the businesses as operator fees and Conquest would receive the
remaining 25%. Norman has guaranteed to Conquest that the net minimum profit paid to Conquest would
not be less than N15 million. (4 marks)

Norman has recently started issuing vouchers to customers when they stay in its hotels. The vouchers
entitle the
customers to a N30 discount on a subsequent room booking within three months of their stay. Historical
experience has shown that only one in five vouchers are redeemed by the customer. At the company’s
year end of 31 May 2008, it is estimated that there are vouchers worth N20 million which are eligible for
discount. The income from room sales for the year is N300 million and Norman is unsure how to report
the income from room sales in the financial statements. (4 marks)

Norman has obtained a significant amount of grant income for the development of hotels in Europe. The
grants
have been received from government bodies and relate to the size of the hotel which has been built by
the grant
assistance. The intention of the grant income was to create jobs in areas where there was significant
unemployment. The grants received of N70 million will have to be repaid if the cost of building the hotels
is less than N500 million. (4 marks)
Appropriateness and quality of discussion (2 marks)
Required:
Discuss how the above income would be treated in the financial statements of Norman for the
year ended
31 May 2008.(14 marks) ACCA CORPORATE REPORTING JUNE 2008

SUGGESTED SOLUTION
1.(a) (i) Revenue recognition standards have been criticised because an entity applying those standards
might recognise amounts in the financial statements that do not faithfully represent the nature of the
transactions. This can happen because revenue recognition for the sale of goods depends largely on the
transference of the risks and rewards of ownership to a customer. Thus an entity might still recognise
inventory because not all of the significant risks and rewards have passed to the customer even though
the customer has obtained substantial control of the good. This is inconsistent with the IASB’s definition of
an asset, which depends on control of the good, not the risks and rewards of owning the good.
The notion of risks and rewards in IAS 18 Revenue can also cause problems when a transaction involves
both the sale of goods and related services. An entity often considers the transaction as a whole in order
to determine when the risks and rewards of ownership are transferred. As a result, an entity can
recognise all of the revenue on delivery of a good, even though it has remaining contractual obligations
relating to services to be rendered, for example a warranty or maintenance agreement.
Thus the revenue recognised does not represent the pattern of the transfer to the customer of all of the
goods and
services in the contract. Additionally, an entity might recognise all of the profit in the contract before the
entity has
fulfilled all of its obligations, depending upon how the accruals for the services are measured.
Another deficiency in IFRSs relates to the lack of guidance for transactions involving the delivery of more
than one good or service, often called a multiple-element arrangement. IAS 18 states that in certain
circumstances, it is necessary to apply the revenue recognition criteria to the separately identifiable
components of a single transaction in order to reflect the substance of the transaction. IAS 18 does not
state clearly when or how an entity should separate a single transaction into components. Often, IAS 18 is
viewed as allowing the recognition of all the revenue for a multiple-element arrangement upon delivery of
the first element if all the elements are sold together. However, a different interpretation is often placed on
IAS 18 and revenue is deferred on all the elements until delivery of the final element.
Guidance on how to measure the elements in a multi-element arrangement is missing also, with entities
applying
different measurement approaches to similar transactions.
There is difficulty in distinguishing between goods and services. Some entities have been accounting for
construction
service contracts (sale of real estate), recognising revenue throughout the construction process, whilst
other entities were accounting for similar contracts as contracts for goods, recognising revenue when the
risks and rewards of owning the real estate were transferred to the customer. The lack of a clear
distinction between goods and services has reduced the comparability of revenue across different
entities.
There is inconsistency between standards. Under some standards, entities recognise revenue as the
activities take place even if the customer does not control and have the risks and rewards of ownership of
the item. In contrast, the principle of IAS 18 for the sale of goods is that revenue should be recognised
only when an entity transfers control and the risks and rewards of ownership of the goods to the
customer.

(ii) In most cases, the effect of a customer’s credit risk will not be material and the entity will measure the
transaction at the invoice amount. However, sometimes the customer defaults on payment for reasons
other than the non-performance by the entity. There may be situations where an entity enters into similar
transactions with customers and the entity expects some of those customers to default. In these cases it
may be prudent to take account of the fact that some of the revenue will not be received. It also would be
consistent with other standards to use a probability-weighted amount of consideration that will be
expected to be received. If the amount of consideration in these cases cannot be reasonably estimated, it
makes sense not to recognise revenue until the cash is collected or estimated with reasonable certainty.
Normally the time value of money will be immaterial. However in some contracts, the effect could be
material if payment is received significantly before or after the goods or services have been transferred. In
these cases, it may be more relevant for the entity to take into account the time value of money by
discounting the consideration using a rate, which reflects the time value of money and the credit risk.
Effectively it will be treated as a financing transaction. The use of discount rates is always quite a
subjective way of measuring transactions.

(b) (i) Under IAS 18, revenue would be recognised of N1 million and a trade receivable of the same
amount set up. The debt would be assessed periodically for impairment and, in this case, it would be
deemed to be impaired by N100,000. The 5% risk of not paying does not create a receivables expense as
it is the risk of not paying the entire balance and hence is insignificant. If the scenario had been that 5% of
the revenue was uncollectable in this instance a receivables expense of N50,000 would be required. This
impairment would be recognised as an expense rather than a reduction in revenue.
However, if credit risk were taken into account in assessing revenue to be recognised, the transaction
price would be
reduced to N950,000. Revenue and a receivable would be recognised of this amount. The impairment of
N100,000
would be recognised as an expense and not as a reduction in revenue.

(ii) Where payment is deferred, the substance of the arrangement is that there is both a sale and a
financing transaction.
Under IAS 18, it is already necessary to discount the consideration to present value in order to arrive at
fair value. In
this instance, the treatment is the same whether IAS 18 is being applied or the proposed accounting
treatment.
Venue would recognise revenue of N2 million/(1·04 x 1·04), i.e. N1·85 million. The interest would then be
unwound
over the period of the credit given and should be recognised as such. In many situations, entities will sell
the same type of goods on a cash or credit basis. In such cases, the cash price equivalent may normally
be the more readily
determinable indicator of fair value.
In terms of the cash payment in advance, under IAS 18, cash would be debited with N3 million and a
deferred income
liability set up in the financial statements of the same amount. No revenue is immediately recorded but
when delivery
has occurred in one year’s time, revenue is recognised of N3 million.
If the time value of money was taken into account, Venue would recognise a contract liability of N3 million
and cash of
N3 million. During the year to the date of the transfer of the product, an interest expense of (N3
million/1·04) –
N3 million, i.e. N120,000 would be recognised and the liability would be increased to N3·12 million. When
the product
is transferred to the customer, Venue would recognise revenue of N3·12 million.

2. Property is sometimes sold with a degree of continuing involvement by the seller so that the risks and
rewards of ownership have not been transferred. The nature and extent of the buyer’s involvement will
determine how the transaction is accounted for. The substance of the transaction is determined by looking
at the transaction as a whole and IAS18 ‘Revenue’ requires this by stating that where two or more
transactions are linked, they should be treated as a single transaction in order to understand the
commercial effect (IAS18 paragraph 13). In the case of the sale of the hotel, theme park and casino,
Norman should not recognise a sale as the company continues to enjoy substantially all of the risks and
rewards of the businesses, and still operates and manages them. Additionally the residual interest in the
business reverts back to Norman. Also Norman has guaranteed the income level for the purchaser as the
minimum payment to Conquest will be N15 million a year. The transaction is in substance a financing
arrangement and the proceeds should be treated as a loan and the payment of profits as interest.
The principles of IAS18 and IFRIC13 ‘Customer Loyalty Programmes’ require that revenue in respect of
each separate component of a transaction is measured at its fair value. Where vouchers are issued as
part of a sales transaction and are redeemable against future purchases, revenue should be reported at
the amount of the consideration received/receivable less the voucher’s fair value. In substance, the
customer is purchasing both goods or services and a voucher. The fair value of the voucher is determined
by reference to the value to the holder and not the cost to the issuer. Factors to be taken into account
when estimating the fair value, would be the discount the customer obtains, the percentage of vouchers
that would be redeemed, and the time value of money. As only one in five vouchers are redeemed, then
effectively the hotel has sold goods worth (N300 + N4) million, i.e. N304 million for a consideration of
N300 million. Thus allocating the discount between the two elements would mean that (300 ÷ 304 x
N300m) i.e. N296·1 million will be allocated to the room sales and the balance of N3·9 million to the
vouchers. The deferred portion of the proceeds is only recognised when the obligations are fulfilled.
The recognition of government grants is covered by IAS20 ‘Accounting for government grants and
disclosure of government assistance’. The accruals concept is used by the standard to match the grant
received with the related costs. The relationship between the grant and the related expenditure is the key
to establishing the accounting treatment. Grants should not be recognised until there is reasonable
assurance that the company can comply with the conditions relating to their receipt and the grant will be
received. Provision should be made if it appears that the grant may have to be repaid.
There may be difficulties of matching costs and revenues when the terms of the grant do not specify
precisely the expense towards which the grant contributes. In this case the grant appears to relate to both
the building of hotels and the creation of employment. However, if the grant was related to revenue
expenditure, then the terms would have been related to payroll or a fixed amount per job created. Hence
it would appear that the grant is capital based and should be matched against the depreciation of the
hotels by using a deferred income approach or deducting the grant from the carrying value of the asset
(IAS20). Additionally the grant is only to be repaid if the cost of the hotel is less than N500 million which
itself would seem to indicate that the grant is capital based. If the company feels that the cost will not
reach N500 million, a provision should be made for the estimated liability if the grant has been
recognised.
IAS 19: EMPLOYEES BENEFITS
Terminology used in the IAS
• Post - employment benefits are employee benefits which are payable after the
completion of employment.
• The present value of a is the present value, without deducting any plan
assets, of defined benefit obligation
expected future payments required to settle the
obligation
resulting from employee service in the current and
prior periods
• Current service cost is the increase in the present value of the defined
benefit
obligation resulting from employee service in the current
period.
In effect, the current service cost is the increase in
total
pensions payable as a result of continuing to employ your
staff for another year.
• Net interest cost is the increase during a period in the present value
of a defined benefit obligation which arises
because the benefits are one period closer
to settlement. The calculation of the net interest cost is
effected by
multiplying the net surplus /deficit in the plan at the
start of the year
by the blue-chip corporate bond rate of interest
• Plan assets are assets held in a legally separate trust in order
to be able to pay the
pensions in future.

Objective of the Standard

Objective of this Standard is to match benefits entities receive from staff (employee’s services)
in exchange for which the entity promises to pay the employees on the occasion of the
employee’s retirement.
This acknowledgement of liability should be stated on the face of the statement of financial
position and the increase in this obligation since last year (difference between last year and this
year provisions) to be recognised in the statement of comprehensive income.

Types of Benefits Paid to Employees

(a) Short Term Employees Benefits. The short term employees’ benefits include;
• Wages
• Car
• Maternity leave
• Accomodation and
• Bonuses etc
Short term employees’ benefits earnned by the employees not paid during the reporting period
should be expensed and accrued within the year’s financial statements.
Short term benefits may sometimes be carried forward into the next, or future, accounting
periods, the value of such carry-forward days should be calculated and accrued.
Death in Service Benefits
If insured, then the annual expense is the insurance premium, if not insured, then the employers
should accrue for the death benefits payable to the families of the employees that die during the
reporting period.

Long Term Employees Benefits

Pension Schemes
Pension schemes could either be (a) defined contributions or (b) defined benefits.

Defined Contributions
Defined contribution schemes involve the employer paying an agreed percentage of the
employee’s salary into a fund administered by trustees , the trustees will invest the fund and
(hopefully) make it grow. On retirement, the trustees will calculate how much is attributable to
that retiring employee. That amount is then used to pay a monthly pension to the retired staff
over their remaining useful life.

Defined Benefit Scheme

Defined benefit schemes involve the employer undertaking to pay a monthly pension based on
a percentage of the employee’s final salary, this percentage typically increases for each year of
service worked by the employee.
How much will be the employee’s final salary and how many years will the employees live after
retirement?
The final salary can be estimated but the estimated post employment life of the employee is
determined by an actuary. The actuary will advise the employer of the values of the plan assets,
the future obligations, and the amount to contribute into the fund.
In determining the value of future obligations to employees discount techniques are applied to
determine their present value. The appropriate discount rate to use should be related to the
‘market yield on blue – chip corporate bonds’.
As each year passes, the obligation increases in two ways:
• The unrolling of discount amount (unwinding the discount)
• The increased entitlement resulting from another year’s work of the employees (current
service cost)
At the same time the obligation is increasing, so also are the plan assets increasing either by:
• Earning a return from the investment of the asset or
• Being funded by a further injection of cash from the entity.

Problems Associated with Long Term Employes Benefit Scheme

• Blue – chip corporate bond rates change over time – so the rate used in discount factor
calculations needs to be regularly reviewed.
• Fair value of plan may fall as a result of adverse movements in the investments. May
need to ‘top up’ the assets by a one – off payment.
• Plan asset values may greatly exceed the present value of the future obligation.This may
result in the entity enjoying a ‘contribution holiday’.
• Retired employees may start to enjoy extended life expectancy so the actuary will need
regularly to re-assess the present value of future obligation.
• Possibility that the entity may change the rules of the scheme
• Such a rule change may probably give rise to additional expenses i.e past service costs
• These past service costs may relate to both current and former employees.
• These past service costs should be expensed in the year of the scheme change,
whether or not they relate to current employees.

Actuary Guidelines and Their Assumptions

The underlying guidelines that determine the actuary assumptions include:
• unbiased
• neither too optimistic nor too pessimistic
• compatible in that there should be a reasonable correlation between assumptions about
interest rates, market yields, salary increases, rates of return on investments

Illustration on short term employee benefits 1

Musa earns a bonus of 2% of net profit from his employers, Mutunchi Ltd. In September 2009,
Musa received a payment-in-anticipation of N3,000. On 31 December, 2009, the directors
estimated that net profits for the year would probably be N170,000.
What figure should be included in the Statement of Profit or Loss and Other Comprehensive
Income (SOCI) for the year ended 31 December, 2009 as an employee benefit, and how much
would be shown as a liability on the Statement of Financial Position?(SOFP)

Suggested solution N
Profits 170,000
2% 3,400 SOCI
Less paid in anticipation 3,000
400 SOFP

Illustration on short term employee benefits 2

Z Ltd employs 10 people at an average annual salary of N10,000, and allows them to carry
forward unused holidays from their paid-leave entitlement.
In 2009, she has calculated that the average number of these carry-forward days is 3½.
Calculate the accrual which Z Ltd should include within the financial statements for the year
ended 31 December, 2009.

Suggested solution
N10,000 × 10 × 31/2 . = N959
365

Illustration on present value of employees long – term benefits 3

Dimeji will become entitled to a pension in 5 years time from his former employers. This pension
will have an equivalent lump-sum value of N10,000. Today, 5 years before the obligation
becomes payable, it will have a present value of N10,000, discounted for 5 years, at a discount
rate of say 10%.
Calculate the present value of the obligation today.

Suggested solution
That is N6,209. N
(1.10)5
10,000 × .909 = 9,091
9,091 × .909 = 8,264
8,264 × .909 = 7,513
7,513 × .909 = 6,830
6,830 × .909 = 6,209
This is the same as:
10,000
(1.10)5
So today’s present value of N10,000 obligation is N6,209, One year later, the present value will
be N6,830, another year later, N7,513 etc (unwounding the discount)
So after five years, the obligation will be shown at N10,000, and then paid.

Accounting for Long Term Employee Benefits

The employees’ long- term benefits are calculated and accounted for annually in the financial
statements following the following steps:

Step 1: Actuarial Gain or Loss for the Period

Plan Obligations N
Actuary present value of Plan Obligation beginning of period XX
Interest cost XX
Current service cost XX
Past service costs XX
Benefits paid (XX)
Gain or Loss (balancing figure) XX
Actuary present value of Plan Obligation end of period XX
Gain will arise when the opening present value of obligations plus other entries are in excess of
the closing present value of the plan obligation by the actuary revaluation,(debit plan obligation
credit profit or loss). On the other hand, loss will arise when the opening present value of plan
obligation together with the other entries fall short of closing present value of plan obligation by
the actuary revaluation,(debit profit or loss and credit plan obligation)

Plan Assets
Actuary fair value of plan assets beginning of period XX
Expected return on plan assets XX
Contribution received XX
Benefits paid (XX)
Gain or Loss (balancing figure) XX
Actuary fair value of plan assets end of period XX
Gain arises when the opening fair values of plan assets together with the other entries are less
than the closing fair value of plan assets by the actuary revaluation, (debit plan assets and
credit profit or loss). Loss arises when the opening fair value of plan assets together with the
other enries are in excess of the closing fair value of plan assets by the actuary revaluation,
(debit profit or loss and credit plan assets).

Step 2: Calculate the liability being difference between plan obligation and plan assets each
year
Period
N
Present value of plan obligation XX
Fair value of plan assets (XX)
Amount recognised in SFP XX

Step 3: Calculate the charge to profit or loss for the period

Current service cost XX
Past service cost XX
Interest cost XX
Expected return on plan assets (XX)
Net actuarial gain/loss (being difference between actauarial
gain or loss on plan assets & gain or loss on actuarial on
actuarial plan liabilities) XX
Total charge XX

Comprehensive illustration on fair value of plan assets and present value of plan
obligations
The following information is given about a defined benefit plan of Fair Plus Transport Ltd. All
transactions are assumed to occur at the year end. The present value of the obligation and the
fair value of the plan assets were both N1,000 at january 1 2008.
 2008 2009 2010
Discount rate start of the year 10% 9% 8%
Expected rate of return on plan assets at
start of the year 12% 11.1% 10.3%
Current service cost N130 N220 N150
Benefits paid N150 N180 N190
Contributions received N90 N100 N110
PV of plan obligations 31 December N1,141 N1,197 N1,295
Fair value of plan assets 31 December N1,092 N1,109 N1,093
All actuary gains or losses are recognised immediately in profit or loss for the year.
Required:
Show the required treatment of the long term employee benefits in the financial statements of
Fair Plus Transport Ltd for all the years involved.

Suggested solution
Step 1:Actuarial gain or loss for the periods
2008 2009 2010
Plan Liabilities N N N
PV of plan obligations 1 January 1,000 1,141 1,197
Interest cost 100 103 96
Current service cost 130 220 150
Benefits paid (150) (180) (190)
Actuarial (gain)/loss –balancing figure 61 (87) 42
PV of plan obligation 31 December 1,141 1,197 1,295

Plan Assets
Fair value of plan assets 1 January 1,000 1,092 1,109
Expected return on plan assets 120 121 114
Contribution received 90 100 110
Benefits paid (150) (180) (190)
Actuarial gain/(loss)- balancing figure 32 (24) (50)
Fair value of plan assets 31 December 1,092 1,109 1,093

Step 2: Calculate the liability for each year

Present value of plan obligation 1,141 1,197 1,295
Fair value of plan assets (1,092) (1,109) (1,093)
Liability recognised in SFP 49 88 202

Step 3: Charge to profit or loss for each year

Current service cost 130 220 150
Interest cost 100 103 96
Expected return on plan assets (120) (121) (114)
Net actuarial (gain)/loss from plan assets &
plan liabilities) 29 (63) 92
Expenses recognised in profit or loss 139 139 224

Proof of movement in net liability recognised in SFP

2008 2009 2010
N N N
Opening net liability - 49 88
Expenses above 139 139 224
Contributions (90) (100) (110)
Closing net liability 49 88 202
Past Service Cost
This arises either when a new retirement benefit plan is introduced or where the benefit under
an existing plans are improved. Where a new plan is introduced, employees are often given
benefits rights for their years of service before the introduction of the plan.
If employees have the right to receive benefits under the plan immediately, the benefits are said
to be ‘vested’ and the cost must be recognised immediately.
If employees become entitled to benefits only at some later date, the benefits become vested at
that later date, and the cost may be spread on a straight line basis over the average period until
the vesting date.

Illustration on past service cost vesting at a later date

An entity operates a pension plan that provides a pension at 2% of final salary for each year of
service. The benefits become vested after five years of service. On January 1 2005 the entity
improves the pension to 2.5% of final salary for each year of service starting from January 1
2001. At the date of the improvement, the present value of the additional benefits of service
from January 1 2001 to January 2005 is as follows:
N’000
Employees with more than five years service at 1-1- 2005 150
Employees with less than five years service at 1-1-2005 120
(Average period until vesting: say 3 years) 270
How are the additonal benefits treated in the financial statements?

Suggested Solution
The entity recognises N150,000 immediately because those benefits are already vested. The
entity recognises N120,000 on a straight line basis over three years from January 1 2005.

Curtailment and Settlement

A curtailment occurs when an entity:
• is demonstratily committed to making a material reduction in the number of employees
covered by the plan or
• amends the term of a plan such that a material element of future service by current
employees will qualify for no or reduced benefits.
• Example is when an entity closes a plant and makes those employees redundant.
Settlement occurs when an entity enters into a transaction to eliminate the obligation for part or
all of the benefits under a plan. For example, an employee leaves the entity for a new job
elsewhere, and is paid a cheque by the retirement benefit to transfer out of that plan.
The gain or loss arising on a curtailment or settlement should be recognised when the
curtailment or settlement occurs.
The gain or loss comprises the difference between fair value of plan assets paid out and the
reduction of present value of the defined benefit obligation (together with relevant proportion of
any unrecognised actuarial gains or losses and past service costs in respect of the transaction.
The expected treatment is demonstrated below:

Liability in SFP N
PV of defined benefit obligation at reporting date XX
Add: any actuarial gain (less actuarial loses) not yet recognised XX
Less: any past service cost not yet recognised (XX)
Less: FV of plan assets at reporting date (XX)
XX
Illustration on curtailment and settlement
Enyimba Plc decides to close a business segment. The segment employees are made
redundant and will earn no further pension benefits. Their plan assets will remain in the scheme
so that the employees will be paid a reduced pension when they reach pensionable age (this is
a curtailment without settlement)
Before the curtailment the plan assets had fair value of N500,000 and the defined benefit
obligation had a present value of N600,000 and there were net cumulative unrecognised
actuarial gains of N30,000. The curtailment reduces the present value of the obligation by
N60,000 because the employees will not now receive the pay rises they would have been
awarded.
What is the gain or loss on the curtailment?

Suggested Solution
10% of the obligation is eliminated on the curtailment (being N60,000/N600,000) so we
recognise 10% of previous unrecognised actuarial gains (which are additional liability of the
plan).
Before On curtailment After
Curtailment
N’000 N’000 N’000
PV of plan obligation 600 (60) 540
FV of plan assets (500) - (500)
Unrecognised actuarial gain 30 (3) 27
Net liability SFP 130 (63) 67
Therefore, the net gain to be recognised in the profit or loss is N63,000

10% Corridor
Where actuarial gains and losses are carried forward in SFP (not recognised in one of the
performance statements) IAS 19 states that if the net cumulative unrecognised actuarial gains
and losses at the end of the previous year exceeds the greater of:
10% of PV of the plan obligation
10% of FV of plan assets
The excess must be recognised in profit or loss. The whole of gain or loss need not be
recognised immediately, it may be spread over the expected average remaining working lives of
employees.

Illustration on 10% corridor

An entity has the following information regarding its employees defined benefit:
Unrecognised actuarial gain N40m beginning of the year
Average remaining lives of employees is eight years
Plan asset b/f N300m
Plan liabilities b/f N320m
Calculate the limit of the corridor.

Suggested Solution
These are the greater:
10% of opening obligation 10% x N320m = N32m
10% of plan assets 10% x N300m =N30m
Some of the actuarial gain must be recognised as the N40m amount of unrecognised gain
brought forward is greater than N32m.
Therefore, the amount to recognise is N8 (N40 – N32)/8 years average remaining live = N1m

The Asset Ceiling

Sometimes the deduction of plan assets from the pension obligations results in negative
amounts (in an ideal situation the present value of plan obligation should be greater than the fair
value of plan assets), IAS 19 states that pension plan assets (surpluses) are measured at the
lower of:
(a) The amount calculated above; (a) plan assets less plan liabilities (the surplus(, (b)
unrecognised actuarial losses, (c) unrecognised past service costs and
(a) any cumulative unrecognised actuarial losses
(b) past service costs
(c) present value of any economic benefits available in form of refunds from the plan or
reductions in future contributions to the plan.
Applying the asset ceiling means that a surplus can only be recognised to the extent that it will
be recoverable in the form of refunds or reduced contributions in future.

Illustration on asset ceiling

A.B Y Ltd has the following details in relation to its pension defined benefit scheme:
N’000
Fair value of plan assets 950
Present value of plan obligations 800
Present value of future refunds and reductions in future contributions 70
Unrecognised actuarial losses 80
Unrecognised past service costs 50
What is the amount of the asset that is recognised in the financial statements?

Suggested Solution
Amount that can be recognised as pension assets is the lower of:
N’000
Present value of pension liabilities 800
Fair value of plan assets (950)
Surplus (150)
Unrecognised actuarial losses (80)
Unrecognised past service costs (50)
Surplus plan assets (280)
Unrecognised actuarial losses 80
Unrecognised past service costs 50
Present value of future refunds & reduction in future contributions 70
200
Therefore the amount of plan assets to be recognised is restricted to N200,000 (lower than
N280,000).
• Improved disclosures about matters such as:

• the characteristics of the company's defined benefit plans.

• the amounts recognised in the financial statements.

• risks arising from defined benefit plans.

• participation in multi-employer plans.

REVIEW QUESTIONS
1 Macaljoy, a public limited company, is a leading support services company which focuses on the
building industry.
The company would like advice on how to treat certain items under IAS19, ‘Employee Benefits’ and IAS
37 ‘Provisions,
Contingent Liabilities and Contingent Assets’. The company operates the Macaljoy (2006) Pension Plan
which
commenced on 1 November 2006 and the Macaljoy (1990) Pension Plan, which was closed to new
entrants from
31 October 2006, but which was open to future service accrual for the employees already in the scheme.
The assets
of the schemes are held separately from those of the company in funds under the control of trustees. The
following
information relates to the two schemes:
Macaljoy (1990) Pension Plan
The terms of the plan are as follows:
• employees contribute 6% of their salaries to the plan
(ii) Macaljoy contributes, currently, the same amount to the plan for the benefit of the employees
(iii) On retirement, employees are guaranteed a pension which is based upon the number of years
service with the company and their final salary
The following details relate to the plan in the year to 31 October 2007:
Nm
Present value of obligation at 1 November 2006 200
Present value of obligation at 31 October 2007 240
Fair value of plan assets at 1 November 2006 190
Fair value of plan assets at 31 October 2007 225
Current service cost 20
Pension benefits paid 19
Total contributions paid to the scheme for year to 31 October 2007 17
Actuarial gains and losses are recognised in the ‘statement of recognised income and expense’.

Macaljoy (2006) Pension Plan

Under the terms of the plan, Macaljoy does not guarantee any return on the contributions paid into the
fund. The
company’s legal and constructive obligation is limited to the amount that is contributed to the fund. The
following
details relate to this scheme:
Nm
Fair value of plan assets at 31 October 2007 21
Contributions paid by company for year to 31 October 2007 10
Contributions paid by employees for year to 31 October 2007 10
The discount rates and expected return on plan assets for the two plans are:
1 November 2006 31 October 2007
Discount rate 5% 6%
Expected return on plan assets 7% 8%
The company would like advice on how to treat the two pension plans, for the year ended 31 October
2007, together
with an explanation of the differences between a defined contribution plan and a defined benefit plan.

Required:
Draft a report suitable for presentation to the directors of Macaljoy which:
(a) (i) Discusses the nature of and differences between a defined contribution plan and a defined
benefit plan
with specific reference to the company’s two schemes. (7 marks)
(ii) Shows the accounting treatment for the two Macaljoy pension plans for the year ended 31
October 2007
under IAS19 ‘Employee Benefits’. (7 marks) ACCA CORPORATE REPORTING DECEMBER 2007

2. (a) Accounting for defined benefit pension schemes is a complex area of great importance. In some
cases, the net
pension liability even exceeds the market capitalisation of the company. The financial statements of a
company
must provide investors, analysts and companies with clear, reliable and comparable information on a
company’s
pension obligations, discount rates and expected returns on plan assets.
Required:
(i) Discuss the current requirements of IAS 19 ‘Employee Benefits’ as regards the accounting for
actuarial
gains and losses setting out the main criticisms of the approach taken and the advantages of
immediate
recognition of such gains and losses. (11 marks)
(ii) Discuss the implications of the current accounting practices in IAS 19 for dealing with the
setting of
discount rates for pension obligations and the expected returns on plan assets. (6 marks)
Professional marks will be awarded in part (a) for clarity and quality of discussion. (2 marks)

(b) Smith, a public limited company and Brown a public limited company utilise IAS 19 ‘Employee
Benefits’ to
account for their pension plans. The following information refers to the company pension plans for the
year to
30 April 2009:
(i) At 1 May 2008, plan assets of both companies were fair valued at N200 million and both had net
unrecognised actuarial gains of N6 million.
(ii) At 30 April 2009, the fair value of the plan assets of Smith was N219 million and that of Brown was
N276 million.
(iii) The contributions received were N70 million and benefits paid were N26 million for both companies.
These
amounts were paid and received on 1 November 2008.
(iv) The expected return on plan assets was 7% at 1 May 2008 and 8% on 30 April 2009.
(v) The present value of the defined benefit obligation was less than the fair value of the plan assets at
both 1 May 2008 and 30 April 2009.
(vi) Actuarial losses on the obligation for the year were negligible for both companies.
(vii) Both companies use the corridor approach to recognised actuarial gains and losses.
Required:
Show how the use of the expected return on assets can cause comparison issues for potential
investors using the above scenario for illustration. (6 marks)
(25 marks) ACCA CORPORATE REPORTING JUNE 2009

3. William operates a defined benefit scheme for its employees. At June 2011, the net pension liability
recognised
in the statement of financial position was N18 million, excluding an unrecognised actuarial gain of N15
million
which William wishes to spread over the remaining working lives of the employees. The scheme was
revised on
1 June 2011. This resulted in the benefits being enhanced for some members of the plan and because
benefits
do not vest for these members for five years, William wishes to spread the increased cost over that
period.
However, part of the scheme was to be closed, without any redundancy of employees.
William requires advice on how to account for the above scheme under IAS 19 Employee Benefits
including the
presentation and measurement of the pension expense. (7 marks) ACCA COPORATE REPORTING
DECEMBER 2012

SUGGESTED SOLUTIONS

1. Report to the Directors of Macaljoy plc

Terms of Reference
This report sets out the differences between a defined contribution and defined benefit plan, and the
accounting treatment of the company’s pension plans.
(a) Pension plans – IAS19
A defined contribution plan is a pension plan whereby an employer pays fixed contributions into a
separate fund and has no legal or constructive obligation to pay further contributions (IAS19 paragraph 7).
Payments or benefits provided to employees may be a simple distribution of total fund assets, or a third
party (an insurance company) may, for example, agree to provide an agreed level of payments or
benefits. Any actuarial and investment risks of defined contribution plans are assumed by the employee or
the third party. The employer is not required to make up any shortfall in assets and all plans that are not
defined contribution plans are deemed to be defined benefit plans.
Defined benefit, therefore, is the residual category whereby, if an employer cannot demonstrate that all
actuarial and
investment risk has been shifted to another party and its obligations limited to contributions made during
the period, then the plan is a defined benefit plan. Any benefit formula that is not solely based on the
amount of contributions, or that includes a guarantee from the entity or a specified return, means that
elements of risk remain with the employer and must be accounted for as a defined benefit plan. An
employer may create a defined benefit obligation where no legal obligation exists if it has a practice of
guaranteeing the benefits. An employer’s obligation under a defined benefit plan is to provide the agreed
amount of benefits to current and former employees. The differentiating factor between defined benefit
and defined contribution schemes is in determining where the risks lie.
In a defined benefit scheme it is the employer that underwrites the vast majority of costs so that if
investment returns are poor or costs increase the employer needs to either make adjustments to the
scheme or to increase levels of contribution.
Alternatively, if investment returns are good, then contribution levels could be reduced. In a defined
contribution scheme the contributions are paid at a fixed level and, therefore, it is the scheme member
who is shouldering these risks. If they fail to take action by increasing contribution rates when investment
returns are poor or costs increase, then their retirement benefits will be lower than they had planned for.
For defined contribution plans, the cost to be recognised in the period is the contribution payable in
exchange for service rendered by employees during the period. The accounting for a defined contribution
plan is straightforward because the employer’s obligation for each period is determined by the amount to
be contributed for that period. Often, contributions are based on a formula that uses employee
compensation in the period as its base. No actuarial assumptions are required to measure the obligation
or the expense, and there are no actuarial gains or losses.
The employer should account for the contribution payable at the end of each period based on employee
services rendered during that period, reduced by any payments made during the period. If the employer
has made payments in excess of those required, the excess is a prepaid expense to the extent that the
excess will lead to a reduction in future contributions or a cash refund.
For defined benefit plans, the amount recognised in the balance sheet should be the present value of the
defined benefit obligation (that is, the present value of expected future payments required to settle the
obligation resulting from employee service in the current and prior periods), as adjusted for unrecognised
actuarial gains and losses and unrecognised past service cost, and reduced by the fair value of plan
assets at the balance sheet date. If the balance is an asset, the amount recognised may be limited under
IAS19
In the case of Macaljoy, the 1990 plan is a defined benefit plan as the employer has the investment risk
as the company is guaranteeing a pension based on the service lives of the employees in the scheme.
The employer’s liability is not limited to the amount of the contributions. There is a risk that if the
investment returns fall short the employer will have to make good the shortfall in the scheme. The 2006
plan, however, is a defined contribution scheme because the employer’s liability is limited to the
contributions paid.
A curtailment occurs when an entity either (a) is demonstrably committed to making a material reduction
in the number of employees covered by a plan, or (b) amends the terms of a defined benefit plan.
An amendment would be such that a material element of future service by current employees will no
longer qualify for benefits or qualify for reduced benefits. Curtailments, by definition, have a material
impact on the entity’s financial statements. The fact that no new employees are to be admitted to the
1990 plan does not constitute a curtailment because future service qualifies for pension rights for those in
the scheme prior to 31 October 2006.
The accounting for the two plans is as follows. The company does not recognise any assets or liabilities
for the defined contribution scheme but charges the contributions payable for the period (N10 million) to
operating profit. The contributions paid by the employees will be part of the wages and salaries cost and
when paid will reduce cash. The accounting for the defined benefit plan results in a liability of N15 million
as at 31 October 2007, a charge in the statement of recognised income and expense of N5·3 million, and
an expense in the income statement of N16·7 million for the year (see Appendix 1).

Appendix 1
The accounting for the defined benefit plan is as follows:
31 October 2007 1 November 2006
Nm Nm
Present value of obligation 240 200
Fair value of plan assets (225) (190)
––––– –––––
Liability recognised in balance sheet 15 10
––––– –––––
Expense in Income Statement year ended 31 October 2007:
Nm
Current service cost 20
Interest cost 10
Expected return on assets (13·3)
–––––
Expense 16·7
–––––
Analysis of amount in Statement of Recognised Income and Expense:
Nm
Actuarial loss on obligation (w2) 29
Actuarial gain on plan assets (w2) (23·7)
–––––
Actuarial loss on obligation (net) 5·3
–––––
Working 1
Movement in net liability in balance sheet at 31 October 2007:
Nm
Opening liability 10
Expense 16·7
Contributions (17)
Actuarial loss 5·3
–––––
Closing liability 15
–––––

Working 2
Changes in the present value of the obligation and fair value of plan assets.
31 October 2007
Nm
Present value of obligation at 1 November 2006 200
Interest (5% of 200) 10
Current service cost 20
Benefits paid (19)
Actuarial loss on obligation 29
–––––
Present value of obligation at 31 October 2007 240
 –––––
Fair value of plan assets at 1 November 2006 190
Expected return on assets (7% of 190) 13·3
Contributions 17
Benefits paid (19)
Actuarial gain on plan assets 23·7
–––––
Fair value of plan assets at 31 October 2007 225
–––––

2 (a) (i) Accounting for post-employment benefits is an important financial reporting issue. It has been
suggested that many users of financial statements do not fully understand the information that entities
provide about post-employment benefits. Both users and preparers of financial statements have criticised
the accounting requirements for failing to provide high quality, transparent information about post-
employment benefit promises.
Delays in the recognition of gains and losses give rise to misleading figures in the statement of financial
position. Also,
multiple options for recognising gains and losses and lack of clarity in the definitions can lead to poor
comparability.
IAS 19 permits entities to recognise some changes in the value of plan assets and in the defined benefit
obligation in
periods after the period in which they occur. Specifically,
– It permits entities to leave unrecognised actuarial gains and losses within a ‘corridor’ (the greater of
10% of plan
assets and 10% of plan liabilities) and to defer recognition of actuarial gains and losses that exceed the
corridor.
Entities can recognise the gains and losses that exceed the corridor over the service lives of the
employees. IAS 19
also permits entities to adopt any systematic method that results in recognition of actuarial gains and
losses faster
than the minimum requirements.
– In addition, it permits immediate recognition of all gains and losses, either in
– profit or loss or
– in other comprehensive income.
The deferred recognition model in IAS 19 treats the recognition of changes in defined benefit obligations
and in plan
assets differently from changes in other assets and liabilities. The main criticisms of the deferred
recognition model are:
– An employer with a defined benefit plan is not required to recognise economic changes in the cost of
providing
post-employment benefits (the changes in plan assets and benefit obligations) as those changes take
place.
– An entity may recognise an asset when a plan is in deficit or a liability may be recognised when a plan is
in surplus.
– It relegates important information about post-retirement plans to the notes to the financial statements
– The resulting accounting has a level of complexity that makes it difficult for many users of financial
statements to
understand and
– adds to the cost of applying IAS 19 by requiring entities to keep complex records.

Advantages of immediate recognition

Immediate recognition would be consistent with the Framework and other IFRSs. The Framework
requires that ‘the
effects of transactions and other events are recognised when they occur … and they are recorded in the
accounting
records and reported in the financial statements of the periods to which they relate’. Immediate
recognition of actuarial
gains and losses is consistent with IAS 8 ‘Accounting Policies, Changes in Accounting Estimates and
Errors’. IAS 8
requires the effect of changes in accounting estimates to be included in the period of the change to the
extent that the
change gives rise to changes in assets and liabilities. IAS 37 requires changes in liabilities, including
changes in longterm liabilities (such as asset retirement obligations), to be recognised in the period they
occur.
Immediate recognition also has the following advantages:
– It represents faithfully the entity’s financial position. An entity will recognise an asset only when a plan is
in surplus
and a liability only when a plan has a deficit.
– It results in amounts in the statements of financial position and comprehensive income that are
transparent and
easy to understand.
– The approach generates income and expense items that provide information about changes in the post-
employment
benefit obligation and plan assets in that period.
– It improves comparability across entities by eliminating the options currently allowed by IAS 19.

(ii) IAS 19 states that the rate to be used to discount pension obligations should be determined by
reference to market yields at the balance sheet date on high quality corporate bonds of equivalent
currency and term to benefit obligations. The discount rate should reflect the time value of money, based
on the expected timing of the benefit payments. The discount rate does not reflect investment risk or
actuarial risk as other actuarial assumptions deal with these items. IAS 19 is not specific on what it
considers to be a high quality bond and therefore this can lead to variation in the discount rates used.
Also some countries may not have a market in high quality corporate bonds, in which case the market
yields on
government bonds of equivalent currency and term should be used. The result is that there is a measure
of subjectivity in the setting of discount rates which could lead to management of earnings and the
reduction of liabilities.
The return on plan assets is defined as interest, dividends and other revenue derived from plan assets,
together with
realised and unrealised gains or losses on plan assets, less any costs of administering the plan less any
tax payable by the plan itself. The amount recognised in the financial statements under IAS 19 is the
expected return on assets, and the difference between the expected return and actual return in the period
is an actuarial gain or loss. The expected return is based on market expectations at the beginning of the
period for returns over the entire life of the related obligation. The standard also requires an adjustment to
be made to the expected return for changes in the assets throughout the year. This return is a very
subjective assumption and an increase in the return can create income at the expense of actuarial losses
which may not be recognised because both companies use the ‘corridor approach’.

(b) In the case of Smith and Brown, the companies have experienced dramatically different investment
performance in the year.
The expected and actual return on plan assets was:
Smith (N) Brown (N)
Fair value of plan assets at 1 May 2008 200 200
Contribution 70 70
Benefits paid (26) (26)
Expected return (200 x 7% + (70 – 26) x 6/12 x 7%) 15·5 15·5
 –––––– ––––––
259·5 259·5
Actuarial gain/(loss) (40·5) 16·5
–––––– ––––––
Fair value of plan assets at 30 April 2009 219 276
–––––– ––––––
Unrecognised actuarial gain/(loss) at 1 May 2008 6 6
Actuarial gain/(loss) in the year (40·5) 16·5
–––––– ––––––
Unrecognised actuarial gain/(loss) (34·5) 22·5
–––––– ––––––
The difference between the expected return and the actual return represents an actuarial loss in the case
of Smith of
N40·5 million (being expected gain N15·5 becoming an actual loss N25) and an actuarial gain of N16·5
million in the case of Brown (being expected gain N15·5 becoming an actual gain of N32). Therefore the
cumulative net unrecognised gains and losses at the year ended 30 April 2009 of Smith and Brown are
N34·5 million loss and N22·5 million gain respectively.
In the year to 30 April 2009, there would not be any recognition of any of the above gains/losses as the
corridor approach is based upon opening scheme assets, liabilities and gains/losses. The opening
unrecognised gain is N6 million which is less than 10% of the plan assets (N20 million) which would be
used for these purposes as it is greater than the obligation at May 2008.
Despite very different performance, the amount shown as expected return on plan assets in the statement
of comprehensive income would be identical for both companies and the actuarial gains and losses would
not be recognised in the current period. The investment performance of Smith has been poor and Brown
has been good. However, this is not reflected in profit or loss. It can only be deduced from the disclosure
of the actuarial gains and losses. It is the ‘real’ return on plan assets which is important, and not the
expected return.Thus the use of the expected return on the plan assets can create comparison issues for
the potential investor especially if the complexities of IAS 19 are not fully understood.

3. Under IAS 19 Employee Benefits, the accounting procedures would be:

Recognition of actuarial gains and losses (remeasurements):
Actuarial gains and losses are renamed ‘remeasurements’ and will be recognised immediately in ‘other
comprehensive income’ (OCI). Actuarial gains and losses cannot be deferred or recognised in profit or
loss; this is likely to increase volatility in the statement of financial position and OCI. Remeasurements
recognised in OCI cannot be recycled through profit or loss in subsequent periods. Thus William will not
be able to spread these gains and losses over the remaining working life of the employees.

Recognition of past service cost:

Past-service costs are recognised in the period of a plan amendment; unvested benefits cannot be
spread over a future-service period. The plan benefits which were enhanced on 1 June 2011 would have
to be immediately recognised and the unvested benefits would not be spread over five years from that
date. A curtailment occurs only when an entity reduces significantly the number of employees. Curtailment
gains/losses are accounted for as past-service costs. Thus William will need to realise that any
curtailment is only recognised in these circumstances and will result in immediate recognition of any gain
or loss.

Measurement of pension expense:

Annual expense for a funded benefit plan will include net interest expense or income, calculated by
applying the discount rate to the net defined benefit asset or liability. The discount rate used is a high-
quality corporate bond rate where there is a deep market in such bonds, and a government bond rate in
other markets.
Presentation in the income statement:
The benefit cost will be split between (i) the cost of benefits accrued in the current period (service cost)
and benefit changes (past-service cost, settlements and curtailments); and (ii) finance expense or
income. This analysis can be in the income statement or in the notes.

IAS 20: GOVERNMENT GRANTS

Objective of IAS 20
The objective of IAS 20 is to prescribe the accounting for, and disclosure of, government grants
and other forms of government assistance.

Scope
IAS 20 applies to all government grants and other forms of government assistance. [IAS 20.1]
However, it does not cover government assistance that is provided in the form of benefits in
determining taxable income. It does not cover government grants covered by IAS 41
Agriculture, either. [IAS 20.2] The benefit of a government loan at a below-market rate of
interest is treated as a government grant. [IAS 20.10A]
Accounting treatment of government grants
There are two methods which could be used to account for government grants, and the
arguments for each are given in IAS 20, these are:
• Capital approach: credit the grant directly to shareholders’ interest
• Income approach: the grant is credited to the income statement over one or more
periods.
Arguments for capital approach
• The grants are a financing device, so should go through the statement of financial
position. In the statement of comprehensive income they would simply offset the
expenses which they are financing. No repayment is expected by the government, so
the grants should be credited directly to shareholders’ interest.
• Grants are not earned, they are incentives without related costs, so it would be wrong to
take them to profit or loss.
Arguments for income approach
• The grants are not received from shareholders so should not be credited directly to
shareholders’ interests.
• Grants are not given or received for nothing. They are earned by compliance with
conditions and by meeting obligations. There are therefore associated costs with which
the grant can be matched as these costs are being compensated by the grant.
• Grants are an extension of fiscal policies and so as income taxes and other taxes are
charged against income, so grants should be credited to income.
Accounting for grants
A government grant is recognised only when there is reasonable assurance that
(a) the entity will comply with any conditions attached to the grant and
(b) the grant will be received. [IAS 20.7]
The grant is recognised as income over the period necessary to match them with the related
costs, for which they are intended to compensate, on a systematic basis. [IAS 20.12]
Non-monetary grants, such as land or other resources, are usually accounted for at fair value,
although recording both the asset and the grant at a nominal amount is also permitted. [IAS
20.23]

Even if there are no conditions attached to the assistance specifically relating to the operating
activities of the entity (other than the requirement to operate in certain regions or industry
sectors), such grants should not be credited to equity. [SIC 10]

A grant receivable as compensation for costs already incurred or for immediate financial
support, with no future related costs, should be recognised as income in the period in which it is
receivable. [IAS 20.20]

A grant relating to assets may be presented in one of two ways: [IAS 20.24]

• as deferred income, or

• by deducting the grant from the asset's carrying amount.

Presentation of Grants Related to Income

A grant relating to income may be reported separately as 'other income' or deducted from the
related expense. [IAS 20.29]

When Grant becomes Repayable

If a grant becomes repayable, it should be treated as a change in estimate. Where the original
grant related to income, the repayment should be applied first against any related unamortised
deferred credit, and any excess should be dealt with as an expense. Where the original grant
related to an asset, the repayment should be treated as increasing the carrying amount of the
asset or reducing the deferred income balance. The cumulative depreciation which would have
been charged had the grant not been received should be charged as an expense. [IAS 20.32]

Disclosure of Government Grants

The following must be disclosed: [IAS 20.39]

• accounting policy adopted for grants, including method of balance sheet presentation

• nature and extent of grants recognised in the financial statements

• unfulfilled conditions and contingencies attaching to recognised grants

Government assistance
Government grants do not include government assistance whose value cannot be reasonably
measured, such as technical or marketing advice. [IAS 20.34] Disclosure of the benefits is
required. [IAS 20.39(b)]
Illustration
NNDC Limited receives a 20% grant towards the cost of a new item of machinery, which cost
N200,000. The machinery has an expected life of four years and a nil residual value. The
expected profits of the company before accounting for depreciation on he new machine or the
grant amounted to N80,000 per annum in each of the machinery’s useful life..
Present the Statement of Comprehensive Income and Statement of Financial Position extracts
under the (a) deferred income approach and (b) deducting the grant from carrying amount of the
asset approach.
Suggested solution
(a) Deferred Income Approach
Statement of Comprehensive Income
Year 1 Year2 Year3 Year4
Total
N N N N
N
Profits before grants & depreciation 80,000 80,000 80,000 80,000
320,000
Depreciation (N200,000 x 25%) (50,000) (50,000) (50,000) (50,000)
(200,000)
Grant (20% x N200,000)/4years 10,000 10,000 10,000 10,000
40,000
Profit before tax 40,000 40,000 40,000 40,000
160,000

Statement of Financial Postion Extracts

Non – Current Assets 200,000 200,000 200,000 200,000
Provision for Depreciation (50,000) (100,000) (150,000) (200,000)
Carrying cost 150,000 100,000 50,000 -

Non – Current Liabilities

Deferred Income (govt grants) 30,000 20,000 10,000 -
(b) Reducing the cost of the asset
Statement of Comprehensive Income
Year 1 Year 2 Year 3 Year 4
Total
N N N N
N
Profits before depreciation 80,000 80,000 80,000 80,000
320,000
Depreciation (200,000 -40,000)/4yrs (40,000) (40,000) (40,000) (40,000)
(160,000)
Profit before tax 40,000 40,000 40,000 40,000
160,000

Statement of Financial Position Extracts

Non – Current Assets 160,000 160,000 160,000 160,000
Provision for depreciation (40,000) (80,000) (120,000) (160000)
Carrying cost 120,000 80,000 40,000 -

IAS 21: EFFECT OF CHANGES IN FOREIGN EXCHANGE RATES

Objective
The purpose of IAS 21 is to set out how to account for transactions in foreign currencies and
foreign operations. The Standard also shows how to translate financial statements into a
presentation currency. The presentation currency is the currency in which the financial
statements are presented. The key issues are the exchange rate(s) that should be used and
where the effects of changes in exchange rates are reported in the financial statements.

Definition of Key Terms

Foreign currency: A currency other than the functional currency of the entity
Exchange difference: The difference resulting from translating a given number of units of one
currency into another currency at different exchange rates.
Foreign operation: A subsidiary, associate, joint venture, or branch whose activities are based
or conducted in a country or currency other than those of the reporting entity.
Exchange rate: The ration of exchange for two currencies
Functional currency: The currency of the primary economic environment in which the entity
operates.
Closing rate: The spot exchange rate at the year end date
Spot Echange rate: The exchange rate for immediate delivery.
Presentation currency: The currency that is used to present the financial statements.
Monetary item: Units of currency held and assets and liabilities to be recieved or paid in a fixed
or determinable number of units of currency.

Functional Currency
The functional currency should be determined by looking at several factors. This currency
should be the one in which the entity normally generates and spends cash and in which
transactions are normally denominated. All transactions in currencies other than the functional
currency are treated as transactions in foreign currencies. Five factors can be taken into
account in making this decision:
(1) The currency that mainly influences sales prices for goods and services
(2) The currency of the country whose competitive forces and regulations mainly determine the
sales prices of its goods and services
(3) The currency that mainly influences labour, material and other costs of providing goods or
services

Sometimes the functional currency of an entity is not immediately obvious. Management must
then exercise judgement and may also need to consider:
4. The curency in which funds from financing activities (raising loans and issuing equity) are
generated
5. The currency in which receipts from operating activities are usually retained.

Where a parent has a foreign operation a number of factors are considered:

1. Whether the activities of the foreign operations are carried out as an extension of the parent,
rather than being carried out with a significant degree of autonomy.
2. Whether transactions with the parent are a high or a low proportion of the foreign operation’s
activities.
3. Whether cash flows from the activities of the foreign operation directly affect the cash flows of
the parent and are readily available for remmitance to it.
4. Whether the activities of the foreign operation are financed from its own cash flows or by
borrowing from the parent.

Foreign Currency Translation

Foreign currency conversion is the process of expresing a foreign curency in terms of the local
currency, using an appropriate exchange rate. Entities do not need to have foreign operations
before they are involved in foreign currency conversion. Any entity that sells purchases in
foreign currencies or has some assets and liabilities designated in foreign currencies is involved
in foreign currency conversion.
Foreign currency translation is the process of restating the financial statements of foreign
operations into the presentation currency of the parent or head office where the head office or
parent has a different functional currency from those of the foreign operations.

Rules for Foreign Currency Translation

This starts with individual company stage and ends with consolidated financial statement stage.
Individual Company Stage
Each entity, whether it is an individual company, a parent of a group, or an operation within a
group such as a subsidiary or branch, should determine its functional currency and measures its
results and financial position in that currency.

Rules for Translation

1. Foreign currency transaction – initial recognition
The Standard states that a foreign currency transaction should be recorded, on initial
recognition in the functional currency, by applying the exchange rate between the reporting
currency and the foreign currency at the date of the transaction to the foreign currency
amount. An average rate for a period may be used if exchange rates do not fluctuate
significantly.

2. Reporting at Subsequent Year Ends

The following rules apply at each subsequent year end:
(a) Report foreign currency monetary items using the closing rate
(b) Report non – monetary items which are carried at historical cost in a foreign currency using
the exchange rate at the date of the transaction (historical rate)
(c) Report non – monetary items which are caried at fair value in a foreign currency using the
exchange rates that existed when the values were determined.

3. Recognition of Exchange Differences

Exchange differences arising on the settlement of monetary items or on translating an entity’s
monetary items at rates different from those at which they were translated initially, or reported in
previous financial statements, should be recognised in profit or loss in the period in which
they arise.
Where a monetary item has not been settled at the end of a period, it should be restated using
the closing exchange rate and any gain or loss taken to profit or loss.

Consolidated Financial Statement Stage

Definition of Key Terms
Foreign operations: A subsidiary, associate, joint venture or branch of a reporting entity, the
activities of which are based or conducted in a country or currency other than those of the
reporting entity.
Net investment in a foreign operation: The amount of the reporting entity’s interest in the net
assets of that operation.

Where Foreign Operations Have Same Functional Currency as Reporting Entity

In this situation, the foreign operation normally carries on its business as though it were an
extension of the reporting entity’s operations. Any movement in the exchange rate between the
reporting currency and the foreign operation’s currency will have an immediate impact on the
reporting entity’s cash flow from the foreign operations. In other words, changes in the
exchange rate affect the individual monetary items held by the foreign operation, not the
reporting entity’s net investment in that operation.
In this situation, where the presentation currency of the foreign operation differs from the
reporting entity’s functional currency, translation of the foreign entity’s financial statements
should be done using the rules discussed earlier on individual company stage.
Rules for Translation Where Foreign Operations Have Different Functional Currency
From Reporting Entity
In this situation, although the reporting entity may be able to exercise control, the foreign
operation normally operates in a semi – autonomous way. It accumulates cash and other
monetary items, generates income and incur expenses, and may also arrange borrowings, all in
its own local currency.
A change in the exchange rate will produce little or no direct effect on the present and future
cash flows from operations of either the foreign operation or the reporting entity. Rather, the
change in exchange rate affects the reporting entity’s net investmen in the foreign operation, not
the individual monetary and non – monetary items held by the foreign operation.
The financial statements of these foreign operations need to be translated before consolidation.
The rules of translation are:
(a) The assets and liabilities shown in the foreign operation’s statement of financial position are
translated at the closing rate at the year end, regardless of the date on which those items
originated. The balancing figure in the translated statement of financial position represents the
reporting entity’s net investment in the foreign operation.
(b) Amounts in the statement of profit or loss and other comprehensive income should be
translated at the rate ruling at the date of the transaction but an average rate will usually be
assumed to approximate the actual rate, except dividends.
(c) In all cases dividends should be translated at the rate ruling when the dividend was paid.
(d) For consolidation purposes calculations are simpler if a subsidiary’s share capital and pre-
acquisition reserves are translated at the historical rate (the rate when the investing company
acquired its interest) and post – acquisition reserves are found as a balancing figure.
(e) Exchange difference arising from the re-transalation at the end of each year of the parent’s
net investment should be recognised in other comprehensive income, not through the profit or
loss for the year, until the dispoal of the net investment. On disposal, the gains or losses
recognised to date will be reclassified to profit or loss.
(f) Goodwill on consolidation arising from the net investment in the foreign operations should be
determined first in the foreign currency, in subsequent period ends this is retranslated using the
closing rate and the exchange difference arising therein considered along with exchange
difference in (e)

Retranslation of Foreign Subsidiary’s Financial Statement Items in Currencies other Than

Its Functional Currency
A foreign subsidiary may have items in its financial statements in currencies other than its
functional currency, example loan from the Reporting Entity. Such items should be retranslated
using the closing rate and exchange gain or loss on retranslation recognised in the profit or loss
of the subsidiary.

Tax Effects of Exchange Differences

These must be accounted for using IAS 12 Income Taxes.

Disclosure
• The amount of exchange differences recognised in profit or loss (excluding differences
arising on financial instruments measured at fair value through profit or loss in
accordance with IAS 39) [IAS 21.52(a)]

• Net exchange differences recognised in other comprehensive income and accumulated

in a separate component of equity, and a reconciliation of the amount of such exchange
differences at the beginning and end of the period [IAS 21.52(b)]

• When the presentation currency is different from the functional currency, disclose that
 fact together with the functional currency and the reason for using a different
presentation currency [IAS 21.53]

• A change in the functional currency of either the reporting entity or a significant foreign
operation and the reason therefor [IAS 21.54]

When an entity presents its financial statements in a currency that is different from its functional
currency, it may describe those financial statements as complying with IFRS only if they comply
with all the requirements of each applicable Standard (including IAS 21) and each applicable
Interpretation. [IAS 21.55]

Convenience Translations
Sometimes, an entity displays its financial statements or other financial information in a currency
that is different from either its functional currency or its presentation currency simply by
translating all amounts at end-of-period exchange rates. This is sometimes called a
convenience translation. A result of making a convenience translation is that the resulting
financial information does not comply with all IFRS, particularly IAS 21. In this case, the
following disclosures are required: [IAS 21.57]

• Clearly identify the information as supplementary information to distinguish it from the

information that complies with IFRS

• Disclose the currency in which the supplementary information is displayed

• Disclose the entity's functional currency and the method of translation used to determine
the supplementary information

REVIEW QUESTIONS
1. Aspire, a public limited company, operates many of its activities overseas. The directors have asked for
advice on the correct accounting treatment of several aspects of Aspire’s overseas operations. Aspire’s
functional currency is the naira.
(a) Aspire has created a new subsidiary, which is incorporated in the same country as Aspire. The
subsidiary has
issued 2 million dinars of equity capital to Aspire, which paid for these shares in dinars. The subsidiary
has also
raised 100,000 dinars of equity capital from external sources and has deposited the whole of the capital
with a bank in an overseas country whose currency is the dinar. The capital is to be invested in dinar
denominated bonds. The subsidiary has a small number of staff and its operating expenses, which are
low, are incurred in naira. The profits are under the control of Aspire. Any income from the investment is
either passed on to Aspire in the form of a dividend or reinvested under instruction from Aspire. The
subsidiary does not make any decisions as to where to place the investments.
Aspire would like advice on how to determine the functional currency of the subsidiary. (7 marks)

(b) Aspire has a foreign branch which has the same functional currency as Aspire. The branch’s taxable
profits are
determined in dinars. On 1 May 2013, the branch acquired a property for 6 million dinars. The property
had an
expected useful life of 12 years with a zero residual value. The asset is written off for tax purposes over
eight years. The tax rate in Aspire’s jurisdiction is 30% and in the branch’s jurisdiction is 20%. The foreign
branch uses the cost model for valuing its property and measures the tax base at the exchange rate at
the reporting date.
Aspire would like an explanation (including a calculation) as to why a deferred tax charge relating to the
asset arises in the group financial statements for the year ended 30 April 2014 and the impact on the
financial statements if the tax base had been translated at the historical rate. (6 marks)

(c) On 1 May 2013, Aspire purchased 70% of a multi-national group whose functional currency was the
dinar. The
purchase consideration was N200 million. At acquisition, the net assets at cost were 1,000 million dinars.
The fair values of the net assets were 1,100 million dinars and the fair value of the non-controlling interest
was 250 million dinars. Aspire uses the full goodwill method.
Aspire wishes to know how to deal with goodwill arising on the above acquisition in the group financial
statements for the year ended 30 April 2014. (5 marks)

(d) Aspire took out a foreign currency loan of 5 million dinars at a fixed interest rate of 8% on 1 May 2013.
The interest is paid at the end of each year. The loan will be repaid after two years on 30 April 2015. The
interest rate is the current market rate for similar two-year fixed interest loans.
Aspire requires advice on how to account for the loan and interest in the financial statements for the year
ended 30 April 2014. (5 marks)
Aspire has a financial statement year end of 30 April 2014 and the average currency exchange rate for
the year is
not materially different from the actual rate.
Exchange rates N1 = dinars
1 May 2013 5
30 April 2014 6
Average exchange rate for year ended 30 April 2014 5·6
Required:
Advise the directors of Aspire on their various requests above, showing suitable calculations
where necessary.
Note: The mark allocation is shown against each of the four issues above.
Professional marks will be awarded in question 2 for clarity and quality of presentation. (2 marks)
(25 marks) ACCA CORPORATE REPORTING JUNE 2014

SUGGESTED SOLUTION
1.(a) The functional currency is the currency of the primary economic environment in which the entity
operates, which is normally the one in which it primarily generates and expends cash. An entity’s
management considers the following primary indicators in determining its functional currency:
(a) the currency which mainly influences sales prices for goods and services;
(b) the currency of the country whose competitive forces and regulations mainly determine the sales
prices of goods and services; and
(c) the currency which mainly influences labour, material and other costs of providing goods and services.
Further secondary indicators which may also provide evidence of an entity’s functional currency are the
currency in which funds from financing activities are generated and in which receipts from operating
activities are retained.
Additional factors are considered in determining the functional currency of a foreign operation and
whether its functional currency is the same as that of the reporting entity. These are:
(a) the autonomy of a foreign operation from the reporting entity;
(b) the level of transactions between the two;
(c) whether the foreign operation generates sufficient cash flows to meet its cash needs; and
(d) whether its cash flows directly affect those of the reporting entity.
When the functional currency is not obvious, management uses its judgement to determine the functional
currency which most faithfully represents the economic effects of the underlying transactions, events and
conditions.
In the case of Aspire, the subsidiary does not make any decisions as to the investment of funds, and
consideration of the currency which influences sales and costs is not relevant. Although the costs are
incurred in naira, they are not material to any decision as to the functional currency. Therefore it is
important to look at other factors to determine the functional currency. The subsidiary has issued 2 million
dinars of equity capital to Aspire, which is a different currency to that of Aspire, but the proceeds have
been invested in dinar denominated bonds at the request of Aspire. The subsidiary has also raised
100,000 dinars of equity capital from external sources but this amount is insignificant compared to the
equity issued to Aspire. The income from investments is either remitted to Aspire or reinvested on
instruction from Aspire. The subsidiary has a minimum number of staff and does not have any
independent management. The subsidiary is simply a vehicle for the parent entity to invest in dinar related
investments. Aspire may have set up the entity so that any exposure to the dinar/naira exchange rate will
be reported in other comprehensive income through the translation of the net investment in the subsidiary.
There does not seem to be any degree of autonomy as the subsidiary is merely an extension of Aspire’s
activities. Therefore the functional currency would appear to be the naira.
In contrast, the dinar represents the currency in which the economic activities of the subsidiary are
primarily carried out as is the case regarding the financing of operations and retention of any income not
remitted. However, the investment of funds could have been carried out directly by Aspire and therefore
the parent’s functional currency should determine that of the subsidiary.

(b) Where a foreign branch’s taxable profit is determined in a foreign currency, changes in exchange rates
may give rise to temporary differences. This can arise where the carrying amounts of the non-monetary
assets are translated at historical rates and the tax base of those assets are translated at the rate at the
reporting date. An entity may translate the tax base at the year-end rate as this rate gives the best
measure of the amount which will be deductible in future periods. The resulting deferred tax is charged or
credited to profit or loss.
Property Dinars (000) Exchange rate Naira (000)
Cost 6,000 5 1,200
Depreciation for year (500) (100)
–––––– ––––––
Net book amount 5,500 1,100
Tax base
Cost 6,000
Tax depreciation (750)
––––––
5,250 6 875
Temporary difference 225
Deferred tax at 20% 45

The deferred tax arising will be calculated using the tax rate in the overseas country. The deferred tax
arising is therefore N45,000, which will increase the tax charge in profit or loss. If the historical rate had
been used, the tax base would have been N1·05 million (5·25m/5) which would have led to a temporary
difference of N50,000 and a deferred tax liability of N10,000, which is significantly lower than when the
closing rate is used.

(c) The goodwill arising when a parent acquires a multinational operation with several currencies is
allocated to each level of functional currency. Goodwill arising on acquisition of foreign operations and
any fair value adjustments are both treated as the foreign operation’s assets and liabilities. They are
expressed in the foreign operation’s functional currency and translated at the closing rate. Exchange
differences arising on the retranslation of foreign entities’ financial statements are recognised in other
comprehensive income and accumulated as a separate component of equity
Exchange rate at 1 May 2013 N1= 5 dinars
Exchange rate at 30 April 2014 N1 =6 dinars
Net assets at fair value 1,100m dinars
Translated at 1 May 2013 N220m
Purchase consideration N200m
NCI (250m dinars/5) N50m
Goodwill N30m
Goodwill treated as foreign currency asset at 1 May 2013 (N30m x 5) 150m dinars
Goodwill translated at closing rate at 30 April 2014 (150m dinars/6) N25m
Translation adjustment for goodwill in equity (N5m)
An exchange loss of 70% of N5 million, i.e. N3·5 million, will be charged in other comprehensive income
together with any gain or loss on the retranslation of the net assets of the operations. The balance of the
exchange loss (30% of N5m) of N1·5 million will be charged against the NCI.

(d) The loan balance, as a monetary item, is translated at the spot exchange rate at the year-end date.
Interest is translated at the average rate because it approximates to the actual rate. Because the interest
is at a market rate for a similar two-year loan, Aspire measures the loan on initial recognition at the
transaction price translated into the functional currency. Because there are no transaction costs, the
effective interest rate is 8%.
On 1 May 2013, the loan is recorded on initial recognition as follows:
Dr Cash N1 million
Cr Loan payable – financial liability N1 million
Year ended 30 April 2014
Aspire records the interest expense as follows:
Dr Profit or loss – interest expense N71,429
Cr Loan payable – financial liability N71,429

To recognise interest payable for the year ended 30 April 2014 (0·4 million dinars/5·6).
On 30 April 2014 the interest is paid and the following entry is made:
Dr Loan payable – financial liability N66,666
Cr Cash N66,666
To recognise the payment of 2014 interest on financial liability (0·4 million dinars/6).
At 30 April 2014 the loan is recorded at 5 million dinars/6, i.e. N833,333, which gives rise to an exchange
gain of
N166,667. In addition to this, a further exchange gain of N4,763 arises on the translation of the interest
paid (N71,429 –
N66,666). The total exchange gain is therefore N171,430.
IAS 23: BORROWING COST
Definition
Borrowing cost is interest and other costs incurred by an enterprise in connection with the
borrowing of funds. Interest includes amortisation of discount/premium on debt. Other costs
include amortisation of debt issue costs and certain foreign exchange differences that are
regarded as an adjustment of interest cost.
Borrowing cost capitalization entails the extent to which interests on money borrowed to finance
the acquisition of certain assets are capitalized in other words forming part of the cost of the
asset.

Arguments for capitalizing borrowing costs

1. If it takes time to construct an asset or to bring it to the point at which it can begin to
generate income, borrowing costs incurred during that time to finance it are parts of the
cost of the asset
2. Capitalization of borrowing costs will give a better matching of revenue and expense,
because the interest is set off against the revenue generated from the asset. If interest is
not capitalized, current income is reduced because the assets are being acquired or
developed.
3. If an asset is purchased complete and ready for use, the seller’s price will include
interest costs incurred during the construction period. It is therefore logical to capitalize
interest incurred to provide finance during a construction period.

Arguments against capitalization of borrowing costs

1. There is no good reason to justify treating finance costs as part of the cost of
construction during the construction period, then charging them against revenue when
the construction is over.
2. It is often difficult to relate borrowing costs to a specific asset.
3. The final carrying cost of an asset will vary depending on the method of financing it.
4. The results of an enterprise are more comparative over time if borrowing costs are
always charged against income.

Benchmark Treatment (as revised)

IAS and IFRS now do not allow alternative treatments rather the benchmark treatment. As a
result, the revised treatment of borrowing costs is that these must be capitalised

The Interest Rate Considered

• If the borrowings are specifically made to acquire a particular asset, the borrowing costs,
which may be capitalized, are those actually incurred, less any investment income on
the temporary investment of the borrowings.
• If the funds come from general borrowings, the weighted average cost of general
borrowings is taken.

When Capitalization of Borrowing Cost Commences

(a) When expenditure for the asset is being incurred
(b) When borrowing costs are being incurred
(c) When activities that are necessary to prepare the asset for its intended use or sale are in
progress

When Capitalization of Borrowing Costs Should Cease

• When substantially all the activities necessary to prepare the qualifying asset for its
intended use or sale are in progress
• Capitalization of borrowing costs should be suspended during extended periods in which
active development is interrupted.

Disclosure Requirements
• The accounting policy adopted for borrowing costs
• The amount of borrowing costs capitalized during the period
• The capitalization rate used.

Illustration 1
On 1 January 2007, Richco Company Ltd secured a facility of ₦20million to finance the
production of two assets, both of which will be built within a year.
On 1 January 2009, Richco Company Ltd commenced draw-down of the facility and production
commenced immediately.
The draw-downs were utilised as follows:
ASSETS
A B
 ₦‟m ₦‟m
1 January 2009 3.33 6.67
1 July 2009 3.33 6.67
The loan interest rate was 19% per annum and Richco Company Ltd can invest any surplus
funds at 6%.
Required:
Calculate the borrowing costs which may be capitalised for each of the assets and consequently
the cost of each asset as at 31 December 2009. Ignore compound

Suggested Solution
ASSETS
A B
₦ ₦
BORROWING COSTS
To 30 June 2009 316,350 633,650
To 31 Dec 2009 632700 1,267,300
949,050 1,900,950
Less: Investment Income
To June 2009 99,900 200,100
849,150 1,700,850

Cost of Assets ₦ ₦
Expenditure Incurred 6,660,000 13,340,000
Cost of Borrowing 849,150 1,700,850
7,509,150 15,040,850
Workings
ASSETS
Borrowing Costs
To June 2009 A B
₦3.33m x 19% x 6/12 316,350
₦6.67m x 19% x 6/12 633,650

To Dec., 2009
₦6.66m x 19% x 6/12 632,700
₦13.34 x 19% x 6/12 1,267,300

Investment Income
₦3.33m x 6% x 6/12 99,900
₦6.67m x 6% x 6/12 200,100
849,150 1,700,850

Illustration 2
Roofco Ltd had the following loans in place at the beginning of the year 2012.
1 January 2012 31 December 2012
N’m N’m
10% Bank loan repayable 2014 120 120
9.5% Bank loan repayable 2015 80 80
8.9% Debenture repayable 2013 - 150
The 8.9% Debenture was issued to fund the construction of a qualifying asset (a piece of mining
equipment), construction of which began 1 July 2012.
On 1 January 2012, Roofco Ltd began construction of a qualifying asset, a piece of machinery
for hydro-electric plant, using existing borrowings. Expenditure drawn down for the constuction
was N30m on 1 January 2012, N20m on 1 October 2012.
Required:
Calculate the borowing costs that can be capitalized for the hydro-electric plant machine.

Suggested Solution
The capitalisation rate is the weighted average rate.
%
= 10% x N120 = 6.0
N120+ N80

9.5% x N80 3.8

N120+ N80 9.8%

Borrowing cost N’m

= 9.8% x N30m x 12/12 = 2.94
+ (9.8% x N20m x 3/12) = 0.49
3.43

REVIEW QUESTIONS
1. (a) Apex is a publicly listed supermarket chain. During the current year it started the building of a new
store. The directors are aware that in accordance with IAS 23 Borrowing costs certain borrowing costs
have to be capitalised.
Required:
Explain the circumstances when, and the amount at which, borrowing costs should be capitalised
in accordance with IAS 23. (5 marks)

(b) Details relating to construction of Apex’s new store:

Apex issued a N10 million unsecured loan with a coupon (nominal) interest rate of 6% on 1 April 2009.
The
loan is redeemable at a premium which means the loan has an effective fi nance cost of 7·5% per annum.
The
loan was specifi cally issued to finance the building of the new store which meets the definition of a
qualifying
asset in IAS 23. Construction of the store commenced on 1 May 2009 and it was completed and ready for
use on
28 February 2010, but did not open for trading until 1 April 2010. During the year trading at Apex’s other
stores
was below expectations so Apex suspended the construction of the new store for a two-month period
during
July and August 2009. The proceeds of the loan were temporarily invested for the month of April 2009 and
earned
interest of N40,000.
Required:
Calculate the net borrowing cost that should be capitalised as part of the cost of the new store
and the finance cost that should be reported in the income statement for the year ended 31 March
2010. (5 marks)
(10 marks) ACCA FINANCIAL REPORTING JUNE 2010

SUGGESTED SOLUTIONS
1(a) Where borrowing costs are directly incurred on a ‘qualifying asset’, they must be capitalised as part
of the cost of that asset.
A qualifying asset may be a tangible or an intangible asset that takes a substantial period of time to get
ready for its intended use or eventual sale. Property construction would be a typical example, but it can
also be applied to intangible assets during their development period. Borrowing costs include interest
based on its effective rate (which incorporates the amortisation of discounts, premiums and certain
expenses) on overdrafts, loans and (some) other fi nancial instruments and fi nance charges on finance
leased assets. They may be based on specifi cally borrowed funds or on the weighted average cost of a
pool of funds.
Any income earned from the temporary investment of specifically borrowed funds would normally be
deducted from the amount to be capitalised.
Capitalisation should commence when expenditure is being incurred on the asset, which is not
necessarily from the date funds are borrowed. Capitalisation should cease when the asset is ready for its
intended use, even though the funds may still be incurring borrowing costs. Also capitalisation should be
suspended if there is a suspension of active development of the asset.
Any borrowing costs that are not eligible for capitalisation must be expensed. Borrowing costs cannot be
capitalised for assets measured at fair value.

(b) The finance cost of the loan must be calculated using the effective rate of 7·5%, so the total finance
cost for the year ended 31 March 2010 is N750,000 (N10 million x 7·5%). As the loan relates to a
qualifying asset, the finance cost (or part of it in this case) can be capitalised under IAS 23.
The Standard says that capitalisation commences from when expenditure is being incurred (1 May 2009)
and must cease when the asset is ready for its intended use (28 February 2010); in this case a 10-month
period. However, interest cannot be capitalised during a period where development activity is suspended;
in this case the two months of July and August 2009. Thus only eight months of the year’s finance cost
can be capitalised = N500,000 (N750,000 x 8/12). The remaining four-months finance costs of N250,000
must be expensed. IAS 23 also says that interest earned from the temporary investment of specific loans
should be deducted from the amount of finance costs that can be capitalised. However, in this case, the
interest was earned during a period in which the finance costs were NOT being capitalised, thus the
interest received of N40,000 would be credited to the income statement and not to the capitalised finance
costs.
In summary:
N
Income statement for the year ended 31 March 2010:
Finance cost (debit) (250,000)
Investment income (credit) 40,000

Statement of financial position as at 31 March 2010:

Property, plant and equipment (finance cost element only) 500,000

IAS 24: RELATED PARTY DISCLOSURE

Need for Related Party Dislosure
• Entity results may be affected by related parties
 • Intra-group sales usually not at arm’s length
• Where a substantial proportion of an entity’s production is bought by another entity
within the same group. Particularly important if the producing entity has only a limited
outside market for its goods
• Where two entities are under common control such that the controller is in a position to
influence the activities of both entities.

Who are the Related Parties

• Most common is a controlling ( or controlled ) reporting entity
• Entities under common control of the reporting entity
• Entities with joint control over the reporting entity
• Associates
• Joint ventures
• Key management personnel, particularly directors
• Close family members of key management personnel
• Entities where directors and their families hold a substantial interest in voting power
• Post-employment benefit plans of the reporting entity

Who may not be Described as Related Parties?

• Two entities with a common director are not necessarily related
• To be classed as related it is necessary to show that the common director is able to
influence the activities of both entities

Related Party Transactions

Related party transactions include:-
• Purchase or sale of goods and components
• Purchase or sale of assets and property
• Provision and receipt of services
• Leasing – both operating and finance
• Transfer of research and development
• Transfers under licensing agreement
• Settlement of another’s liabilities

Related Parties Disclosures

• The existence of related parties, whether or not there have been any transactions
• Details of any transactions
• Details of any outstanding balances
• Details of any doubtful debt provisions on those balances
• Details of any amounts written off as bad debts
• separate disclosure required for:-
• Parent entity
• Entities with joint control or significant influence over the reporting entity
• Subsidiaries
• Associates
• Joint ventures where the reporting entity is a venturer
• Key management
• Other related parties disclosure

Exemptions from Related Party Classification

Exemptions to related party classification include:-
• Providers of finance
• Trade unions
• Utility providers like gas and electric suppliers
• Government departments like the revenue service
 • Customers and suppliers

Disclosure of Effects of Related Party Transactions

• Value of the related party transactions
• Value of any outstanding balances with related parties including any terms and
conditions as well as any guarantees
• The extent of any provision for doubtful debts relating to related party balances
• The extent of any expense recognised during the period in respect of related party
balances written off.

REVIEW QUESTIONS
On 1 April 2007, ADISA PLC owned 65% of the Equity Share Capital of DOTUN LTD and 70%
of the Equity Shares of TADE COY. LTD. On 1 April 2008, ADISA PLC purchased the remaining
35% of the Equity Shares of DOTUN LTD. In the two years ended 31 March 2008 and 31 March
2009, the following transactions occurred between the three companies.

(a) On 30 June 2007, ADISA PLC manufactured a machine for use by DOTUN LTD. The cost of
production was ₦2million. The machine was delivered to DOTUN LTD at an invoiced price of
₦2.5million. DOTUN LTD paid the invoice on 31 August 2007. DOTUN LTD depreciated the
machine over its anticipated useful life of 5 years, charging a full year‟s depreciation in the year
of purchase.

(b) On 30 September 2008, DOTUN LTD sold some goods to TADE COY. LTD at an invoiced
price of ₦1.5million. TADE COY. LTD settled the invoice on 30 November 2008. The goods had
cost DOTUN LTD ₦1.2million to manufacture. By 31 March 2009, TADE COY. LTD had sold all
the goods outside the group.

(c) For each of the years ended 31 March 2008 and 31 March 2009, ADISA PLC. provided
management services to DOTUN LTD and TADE COY. LTD. ADISA Plc did not charge for these
services in the year ended 31 March 2008 but in the year ended 31 March 2009, decided to
impose a charge of ₦1million per annum on TADE COY. LTD. The amount of ₦1million is due to
be paid by TADE COY. LTD on 31 May 2009.
Required:
Summarise the related party disclosures which will be required in respect of transactions in (a)
to (c) above, for both of the years ended 31 March 2008 and 31 March 2009 in the financial
statements of ADISA PLC., DOTUN LTD and TADE COY. LTD. (15 Marks)
Note: You may assume that ADISA PLC presented consolidated financial statements for both of
the years.

2. Zeeba Inc. is part of a major industrial group of companies and is known to accurately
disclose relatedparty transactions in its financial statements prepared under IFRS. With the
sweeping changes that were made to the various Standards under the International Accounting
Standards Board’s Improvements Project, the entity is seeking advice from IFRS specialists on
whether the following transactions need to be reported under IAS 24 and, if so, to what extent,
and how the related-party transactions footnote should be worded.
1. Remuneration and other payments made to the entity’s chief executive officer (CEO) during
the
year 20XX were
a. An annual salary of N2 million
b. Share options and other share-based payments valued at N1 million
c. Contributions to retirement benefit plan amounting to N1 million
d. Reimbursement of his travel expenses for business trips totaling N1.2 million

2. Sales made during the year 20XX to

a. Meifa, Inc., parent company: N35 million
b. Deifa, Inc., associate: N25 million

3. Trade debtors at December 31, 20XX, include

a. Due from Meifa, Inc.: Gross: N10 million, Net of provision: N7 million
b. Due from Deifa, Inc.: N15 million (these receivables are fully backed by corporate guarantees
from Deifa, Inc.)
Required
Please advise Zeeba, Inc. on related party transactions that need to be disclosed and draft a
sample related-party transactions footnote to guide the entity.

SUGGESTED SOLUTIONS
1. YEAR ENDED 31 MARCH 2008
RELATIONSHIP
ADISA PLC. has a 65% subsidiary (DOTUN LTD) and a 70% subsidiary (TADE Co. Ltd)
ADISA PLC. is a related party of DOTUN LTD and TADE COY. LTD and vice versa.
DOTUN LTD and TADE COY. LTD are also related parties because they are subject to “common
control”. Thus, any transactions between ADISA Plc. DOTUN LTD and TADE Co. Ltd need not
be disclosed in ADISA Plc consolidated accounts as they are eliminated.

DISCLOSURES
ADISA PLC.
(a) Intra-group sale of machine for ₦2.5million at a profit of N500,000. No balance is
outstanding.
(b) Management services provided to DOTUN LTD (Nil Charge).
No disclosure is required in the group accounts of ADISA PLC. of these items as they are
eliminated.

DOTUN LTD.
(a) Parent (an ultimate controlling party) is ADISA PLC.
(b) Machine purchased from parent of ₦2.5million (original cost ₦2million) and depreciation
charge ₦500,000.
No amount is outstanding at year end.
(c) Purchase of management services from ADISA PLC. (Nil charge).
TADE COY. LTD.
(a) Parent ( an ultimate controlling party) is ADISA PLC.
(b) Purchase of management services from ADISA PLC. (Nil charge).
For all transactions, the nature of the related party relationship ( i.e parent, subsidiary, fellow
subsidiary), should be disclosed.

YEAR ENDED 31 MARCH 2009

RELATIONSHIP
ADISA PLC. has a 100% subsidiary (DOTUN LTD) and a 70% subsidiary (TADE COY.LTD)
ADISA PLC is a related party of DOTUN LTD. and TADE COY. LTD and vice versa.
DOTUN Ltd. and TADE COY. LTD are related because they remain under common control. Any
transactions between ADISA PLC., DOTUN LTD., and TADE COY. LTD need not be disclosed in
ADISA PLC consolidated accounts as they are eliminated.

DISCLOSURES
ADISA PLC.
(a) Management services provided to DOTUN (Nil charge) and
(b) TADE COY. LTD (₦1m outstanding).
No disclosure is required in the group account of ADISA PLC. of these items as they are
eliminated.
DOTUN LTD.
Parent (and ultimate controlling party) is ADISA PLC.
Disclosure of intragroup transactions is still required even though DOTUN LTD is a wholly
owned subsidiary.
(a) Sale of inventories to TADE COY. LTD for ₦1.5million (original cost ₦1.2million) all sold. No
amount outstanding at year end.
(b) Purchase of management services from ADISA PLC. (Nil charge).

TADE COY. LTD.

(a) Parent (an ultimate controlling party) is ADISA PLC.
(b) Purchase of inventories from DOTUN LTD. for ₦1.5million (original cost ₦1.2million) all sold,
no amount outstanding at year end.
(c) Purchase of management services from ADISA PLC. costing ₦1million are outstanding at
year end.
For all transactions, the nature of the related party relationship (i.e. parent, subsidiary, fellow
subsidiary) should be disclosed.

2. All the listed items are required to be disclosed in Zeeba, Inc.’s financial statements prepared
under IFRS. The only exception is the reimbursement of the travel expenses of the CEO
amounting to N1.2 million; as this sum is not “compensation,” it is not required to be disclosed
under IAS 24.

2. Footnote: Related Party Transactions

(a) Zeeba, Inc. enters into related party transactions in the normal course of business. During
the year 20XX, these related party transactions were entered into with related parties as defined
under IAS 24. The transactions resulted in balances due from those parties that, at December
31, 20XX, were
(1) With the parent company (Meifa, Inc.)
Sales N35 million
Included in trade debtors (due from parent company) N10 million
Provision for doubtful debts N 3 million

(2) With an “associate”

Sales N25 million
Included in trade debtors (due from an associate)* N15 million
*Amount due from an associate is secured by a corporate guarantee given by the associate.

b. For the year ended December 31, 20XX, Zeeba, Inc. made these payments to its CEO, part
of the “key management personnel”:
Short-term benefits (salary) N2 million
Postemployment benefits (retirement benefit plan contribution) N1 million
Share-based payments (stock options, etc.) N1 million
Total N4 million
IAS 26: ACCOUNTING AND REPORTING BY RETIREMENT BENEFIT PLANS
Introduction
IAS 26 deals with accounting and reporting to all participants of a retirement benefit plan as a
group, and not with reports that might be made to individuals about their particular retirement
benefits. The Standard sets out the form and content of the general-purpose financial reports of
retirement benefit plans. The Standard applies to
• Defined contribution plans: Where benefits are determined by contributions to the plan
together with investment earnings thereon.
• Defined benefit plans: Where benefits are determined by a formula based on employees’
earnings and/or years of service.

IAS 26 is sometimes confused with IAS 19, because both Standards address employee
benefits.But there is a difference: while IAS 26 addresses the financial reporting considerations
for the benefit plan itself, as the reporting entity, IAS 19 deals with employers’ accounting for the
cost of such benefits as they are earned by the employees. These Standards are thus
somewhat related, but there will not be any direct interrelationship between amounts reported in
benefit plan financial statements and amounts reported under IAS 19 by employers.

Scope
IAS 26 addresses the accounting and reporting by retirement benefit plans. It does not mandate
the presentation of an annual report for the plan. However, the terms of a retirement plan may
require that the plan present an annual report; in some jurisdictions this may be a statutory
requirement. If such annual reports are prepared by a retirement plan, then the requirements of
this Standard should be applied to them.
The retirement benefit plan is a separate entity, distinct from the employer of the plan’s
participants; the Standard treats it as such. The Standard also applies to retirement benefit
plans that have sponsors other than employer (e.g., trade associations or groups of employers).
Furthermore, this Standard deals with accounting and reporting by retirement benefit plans to all
participants as a group; it does not deal with reports to individual participants with respect to
their retirement benefit entitlements.

DEFINITIONS OF KEY TERMS (in accordance with IAS 26)

Actuarial present value of promised retirement benefits. The present value of the expected
future payments by a retirement benefit plan to existing and past employees, attributable to the
service already rendered.
Defined benefit plans. Retirement benefit plans whereby retirement benefits to be paid to plan
participants are determined by reference to a formula usually based on employees’ earnings
and/or years of service.
Defined contribution plans. Retirement benefit plans whereby retirement benefits to be paid to
plan participants are determined by contributions to a fund together with investment earnings
thereon.
Funding. The transfer of assets to a separate entity (distinct from the employer’s enterprise),
the “fund,” to meet future obligations for the payment of retirement benefits.
Net assets available for benefits. The assets of a retirement benefit plan less its liabilities
other than the actuarial present value of promised retirement benefits.
Participants. The members of a retirement benefit plan and others who are entitled to benefits
under the plan.
Retirement benefit plans. Formal or informal arrangements based on which an enterprise
provides benefits for its employees on or after termination of service, which usually are referred
to as termination benefits. These could take the form of annual pension payments or lump-sum
payments. Such benefits, or the employer’s contributions toward them, should however be
determinable or possible of estimation in advance of retirement from the provisions of a
document (i.e., based on a formal arrangement) or from the enterprise’s practices (which is
referred to as an informal arrangement).
Vested benefits. Entitlements, the rights to which, under the terms of a retirement benefit plan,
are not conditional on continued employment.

Defined Contribution Plans

Retirement benefit plans can either be defined contribution plans or defined benefit plans. When
the amount of the future benefits payable to the participants of the retirement benefit plan is
determined by the contributions made by the participants’ employer, the participants, or both,
together with investment earnings thereon, such plans are defined contribution plans. Defined
benefit plans guarantee certain defined benefits, often determined by a formula that takes into
consideration factors such as number of years of service of employees and their salary level at
the time of retirement, irrespective of whether the plan has sufficient assets; thus the ultimate
responsibility for payment (which may be guaranteed by an insurance company, the
government, or some other entity, depending on local law and custom) remains with the
employer. In rare cases, a retirement benefit plan may contain characteristics of both defined
contribution and defined benefit plans; for the purposes of this Standard, such a hybrid plan is
deemed to be a defined benefit plan.

According to IAS 26, the report of a defined contribution plan should contain a “Statement of the
Net Assets Available for Benefits” and a description of the funding policy. In preparing
thestatement of the net assets available for benefits, the plan investments should be carried at
“fair value,” which in the case of marketable securities would be their “market value.” If an
estimate of fair value is not possible, the entity must disclose why “fair value” has not been
used.

Example
An example of a statement of net assets available for plan benefits, for a defined contribution
plan,is presented next.

Benevolent Plc Defined Contribution Plan

STATEMENT OF NET ASSETS AVAILABLE FOR BENEFITS
December 31, 2006
N’000
Assets
Investments at fair value:
Nigeria government securities 10,000
Abuja. municipal bonds 13,000
Nigeria. equity securities 13,000
AU equity securities 13,000
Nigeria. debt securities 12,000
AU corporate bonds 12,000
Others 11,000
Total investments 84,000

Receivables:
Amounts due from stockbrokers on sale of securities 25,000
Accrued interest 15,000
Dividends receivable 12,000
Total receivables 52,000
Cash: 15,000
Total assets 151,000

Liabilities
Accounts payable
Amounts due to stockbrokers on purchase of securities 20,000
Benefits payable to participants—due and unpaid 21,000
Total accounts payable 41,000
Accrued expenses 21,000
Total liabilities 62,000
Net assets available for benefits 89,000

Defined Benefit Plans

Defined benefit plans are those plans where the benefits are guaranteed amounts and amounts
to be paid as retirement benefits are determined by reference to a formula, usually based on
employees’ earnings and/or number of years of service. The critical factors are thus the
retirement benefits that are fixed or determinable, without regard to the adequacy of assets that
may have been set aside for payment of the benefits. This clearly is different from the way
defined contribution plans work; they provide the employees, upon retirement, amounts that
have been set aside, plus or minus investment earnings or losses that have been accumulated
thereon, however great or small that amount may be.
IAS 26 requires that the report of a defined benefit plan should contain either
(1) A statement that shows
a] The net assets available for benefits;
b] The actuarial present value of promised retirement benefits, distinguishing between vested
and non-vested benefits; and
c] The resulting excess or deficit;
or

(2) A statement of net assets available for benefits including either

a] A note disclosing the actuarial present value of promised retirement benefits, distinguishing
between vested and nonvested benefits; or
b] A reference to this information in an accompanying actuarial report.

IAS 26 recommends, but does not mandate that in each of the three formats described above, a
report of the trustees in the nature of a management or directors’ report and an investment
report may also accompany the statements.

The Standard does not make it incumbent upon the plan to use annual actuarial valuations. If an
actuarial valuation has not been prepared on the date of the report, the most recent valuation
should be used as the basis for preparing the financial statement. The Standard does, however,
require that the date of the actuarial valuation used should be disclosed. Actuarial present
values of promised benefits should be based either on current or projected salary levels;
whichever basis is used should also be disclosed. Furthermore, the effect of any changes in
actuarial assumptions that had a material impact on the actuarial present value of promised
retirement benefits should also be disclosed. The report should explain the relationship between
actuarial present values of promised benefits, the net assets available for benefits, and the
policy for funding the promised benefits.

As in the case of defined contribution plans, investments of a defined benefit plan should be
carried at fair value, which for marketable securities would be “market values.”

Example
Examples of the alternative types of reports prescribed for a defined benefit plan follow.
Excellent Plc. Defined Benefit Plan
STATEMENT OF NET ASSETS AVAILABLE FOR BENEFITS, ACTUARIAL
PRESENT VALUE OF ACCUMULATED RETIREMENT
BENEFITS AND PLAN EXCESS OR DEFICIT
December 31, 2006
N’000
1. Statement of net assets available for benefits
Assets
Investments at fair value:
Nigeria. government securities 155,000
Abuja. municipal bonds 35,000
Nigeria. equity securities 35,000
Au equity securities 35,000
Nigeria. debt securities 25,000
AU corporate bonds 25,000
Others 15,000
Total investments 325,000

Receivables:
Amounts due from stockbrokers on sale of securities 155,000
Accrued interest 55,000
Dividends receivable 25,000
Total receivables 235,000
Cash: 55,000
Total assets 615,000

Liabilities
Accounts payable:
Amounts due to stockbrokers on purchase of securities 150,000
Benefits payable to participants–due and unpaid 150,000
Total accounts payable 300,000
Accrued expenses: 120,000
Total liabilities 420,000
Net assets available for benefits 195,000

2. Actuarial present value of accumulated plan benefits

Vested benefits 120,000
Non-vested benefits 30,000
Total 150,000

3. Excess of net assets available for benefits over actuarial

Present value of accumulated plan benefits 45,000
Excellent Inc. Defined Benefit Plan
STATEMENT OF CHANGES IN NET ASSETS AVAILABLE FOR BENEFITS
December 31, 2006
N’000
Investment income:
Interest income 45,000
Dividend income 15,000
Net appreciation (unrealized gain)
in fair value of investments 15,000
Total investment income 75,000

Plan contributions:
Employer contributions 55,000
Employee contributions 50,000
Total plan contributions 105,000
Total additions to net asset value 180,000
Plan benefit payments:
Pensions (annual) 25,000
Lump-sum payments on retirement 35,000
Severance pay 10,000
Commutation of superannuation benefits 15,000
Total plan benefit payments 85,000
Total deductions from net asset value 85,000
Net increase in asset value 95,000
Net assets available for benefits
Beginning of year 100,000
End of year 195,000

ADDITIONAL DISCLOSURES REQUIRED BY THE STANDARD

In case of both defined benefit plans and defined contribution plans, IAS 26 requires that the
reports of a retirement benefit plan should also contain this information:
• A statement of changes in net assets available for benefits
• A summary of significant accounting policies
• A description of the plan and the effect of any changes in the plan during the period

Reports provided by retirement benefits plans may include, if applicable

(1) A statement of net assets available for benefits disclosing
a] Assets at the end of the period suitably classified
b] The basis of valuation of assets
c] Details of any single investment exceeding either 5% of the net assets available for benefits
or 5% of any class or type of security
d] Details of any investment in the employer
e] Liabilities other than the actuarial present value of promised retirement benefits

(2) A statement of changes in net assets available for benefits showing

a] Employer contributions
b] Employee contributions
c] Investment income such as interest and dividends
d] Other income
e] Benefits paid or payable (analyzed, e.g., as retirement, death, and disability benefits, and
lump-sum payments)
f] Administrative expenses
g] Other expenses
h] Taxes on income
i] Profits and losses on disposal of investments and changes in value of investments
j] Transfers from and to other plans

(3) A description of the funding policy

(4) For defined benefit plans, the actuarial present value of promised retirement benefits
(which may distinguish between vested benefits and nonvested benefits) based on the benefits
promised under the terms of the plan, on service rendered to date and using either current
salary levels or projected salary levels. This information may be included in an accompanying
actuarial report to be read in conjunction with the related information.

(5) For defined benefit plans, a description of the significant actuarial assumptions made
and the method used to calculate the actuarial present value of promised retirement
benefits.

According to the Standard, since the report of a retirement benefit plan contains a description of
the plan, either as part of the financial information or in a separate report, it may contain
(1) The names of the employers and the employee groups covered
(2) The number of participants receiving benefits and the number of other participants, classified
as appropriate
(3) The type of plan—defined contribution or defined benefit
(4) A note as to whether participants contribute to the plan
(5) A description of the retirement benefits promised to participants
(6) A description of any plan termination terms
(7) Changes in items 1. through 6. during the period covered by the report

Furthermore, it is not uncommon to refer to other documents that are readily available to users
in which the plan is described, and to include in the report only information on subsequent
changes.

IAS 27 SEPARATE FINANCIAL STATEMENTS

Overview
IAS 27 Separate Financial Statements (as amended in 2011) outlines the accounting and
disclosure requirements for 'separate financial statements', which are financial statements
prepared by a parent, or an investor in a joint venture or associate, where those investments are
accounted for either at cost or in accordance with IAS 39 Financial Instruments: Recognition
and Measurement or IFRS 9 Financial Instruments. The Standard also outlines the accounting
requirements for dividends and contains numerous disclosure requirements.

IAS 27 was reissued in May 2011 and applies to annual periods beginning on or after 1 January
2013 and supersedes IAS 27 Consolidated and Separate Financial Statements from that date.

Summary of IAS 27 (as amended in 2011)

The summary below applies to IAS 27 Separate Financial Statements, issued in May 2011 and
applying to annual reporting periods beginning on or after 1 January 2013. For earlier reporting
periods, refer to our summary of IAS 27 Consolidated and Separate Financial Statements.

Objectives of IAS 27
IAS 27 has the objective of setting standards to be applied in accounting for investments in
subsidiaries, jointly ventures, and associates when an entity elects, or is required by local
regulations, to present separate (non-consolidated) financial statements.

Key definitions
[IAS 27(2011).4]
Consolidated Financial statements of a group in which the assets, liabilities, equity, income,
financial expenses and cash flows of the parent and its subsidiaries are presented as those of a
statements single economic entity
Financial statements presented by a parent (i.e. an investor with control of a
Separate financial subsidiary), an investor with joint control of, or significant influence over, an investee,
statements in which the investments are accounted for at cost or in accordance with IFRS 9
Financial Instruments

Preparation of Separate Financial Statements

Requirement for Separate Financial Statements

IAS 27 does not mandate which entities produce separate financial statements available for
public use. It applies when an entity prepares separate financial statements that comply with
International Financial Reporting Standards. [IAS 27(2011).3]

Financial statements in which the equity method is applied are not separate financial
statements. Similarly, the financial statements of an entity that does not have a subsidiary,
associate or joint venturer's interest in a joint venture are not separate financial statements. [IAS
27(2011).7]
An investment entity that is required, throughout the current period and all comparative periods
presented, to apply the exception to consolidation for all of its subsidiaries in accordance with of
IFRS 10 Consolidated Financial Statements presents separate financial statements as its only
financial statements. [IAS 27(2011).8A]

[Note: The investment entity consolidation exemption was introduced into IFRS 10 by
Investment Entities, issued on 31 October 2012 and effective for annual periods beginning on or
after 1 January 2014.]

Choice of Accounting Method

When an entity prepares separate financial statements, investments in subsidiaries, associates,

and jointly controlled entities are accounted for either: [IAS 27(2011).10]

• at cost, or

• in accordance with IFRS 9 Financial Instruments.

The entity applies the same accounting for each category of investments. Investments that are
accounted for at cost and classified as held for sale in accordance with IFRS 5 Non-current
Assets Held for Sale and Discontinued Operations are accounted for in accordance with that
IFRS. Investments carried at cost should be measured at the lower of their carrying amount and
fair value less costs to sell. The measurement of investments accounted for in accordance with
IFRS 9 is not changed in such circumstances.

If an entity elects, in accordance with IAS 28 (as amended in 2011), to measure its investments
in associates or joint ventures at fair value through profit or loss in accordance with IFRS 9, it
shall also account for those investments in the same way in its separate financial statements.
[IAS 27(2011).11]

Investment Entities

[Note: The investment entity consolidation exemption was introduced into IFRS 10 by
Investment Entities, issued on 31 October 2012 and effective for annual periods beginning on or
after 1 January 2014.]

If a parent investment entity is required, in accordance with IFRS 10, to measure its investment
in a subsidiary at fair value through profit or loss in accordance with IFRS 9 or IAS 39, it is
required to also account for its investment in a subsidiary in the same way in its separate
financial statements. [IAS 27(2011).11A]

When a parent ceases to be an investment entity, the entity can account for an investment in a
subsidiary at cost (based on fair value at the date of change or status) or in accordance with
IFRS 9. When an entity becomes an investment entity, it accounts for an investment in a
subsidiary at fair value through profit or loss in accordance with IFRS 9. [IAS 27(2011).11B]

Recognition of Dividends

An entity recognises a dividend from a subsidiary, joint venture or associate in profit or loss in its
separate financial statements when its right to receive the dividend in established. [IAS
27(2011).12]

(Accounting for dividends where the equity method is applied to investments in joint ventures
and associates is specified in IAS 28 Investments in Associates and Joint Ventures.)

Group Reorganisations

Specified accounting applies in separate financial statements when a parent reorganises the
structure of its group by establishing a new entity as its parent in a manner satisfying the
following criteria: [IAS 27(2011).13]

• the new parent obtains control of the original parent by issuing equity instruments in
exchange for existing equity instruments of the original parent

• the assets and liabilities of the new group and the original group are the same
immediately before and after the reorganisation, and

• the owners of the original parent before the reorganisation have the same absolute and
relative interests in the net assets of the original group and the new group immediately
before and after the reorganisation.

Where these criteria are met, and the new parent accounts for its investment in the original
parent at cost, the new parent measures the carrying amount of its share of the equity items
shown in the separate financial statements of the original parent at the date of the
reorganisation. [IAS 27(2011).13]

The above requirements:

• apply to the establishment of an intermediate parent within a group, as well as

establishment of a new ultimate parent of a group [IAS 27(2011).BC24]

• apply to an entity that is not a parent entity and establishes a parent in a manner that
satisfies the above criteria [IAS 27(2011).14]

• apply only where the criteria above are satisfied and do not apply to other types of
reorganisations or for common control transactions more broadly. [IAS 27(2011).BC27].

Disclosure
When a parent, in accordance with paragraph 4(a) of IFRS 10, elects not to prepare
consolidated financial statements and instead prepares separate financial statements, it shall
disclose in those separate financial statements: [IAS 27(2011).16]

• the fact that the financial statements are separate financial statements; that the
exemption from consolidation has been used; the name and principal place of business
(and country of incorporation if different) of the entity whose consolidated financial
statements that comply with IFRS have been produced for public use; and the address
where those consolidated financial statements are obtainable,

• a list of significant investments in subsidiaries, jointly controlled entities, and associates,

including the name, principal place of business (and country of incorporation if different),
proportion of ownership interest and, if different, proportion of voting rights, and

• a description of the method used to account for the foregoing investments.

When an investment entity that is a parent prepares separate financial statements as its only
financial statements, it shall disclose that fact. The investment entity shall also present the
disclosures relating to investment entities required by IFRS 12. [IAS 27(2011).16A]

[Note: The investment entity consolidation exemption was introduced into IFRS 10 by
Investment Entities, issued on 31 October 2012 and effective for annual periods beginning on or
after 1 January 2014.]

When a parent (other than a parent covered by the above circumstances) or an investor with
joint control of, or significant influence over, an investee prepares separate financial statements,
the parent or investor shall identify the financial statements prepared in accordance with
IFRS 10, IFRS 11 or IAS 28 (as amended in 2011) to which they relate. The parent or investor
shall also disclose in its separate financial statements: [IAS 27(2011).17]

• the fact that the statements are separate financial statements and the reasons why
those statements are prepared if not required by law,

• a list of significant investments in subsidiaries, jointly controlled entities, and associates,

including the name, principal place of business (and country of incorporation if different),
proportion of ownership interest and, if different, proportion of voting rights, and

• a description of the method used to account for the foregoing investments.

IAS 28: INVESTMENTS IN ASSOCIATES AND JOINT VENTURES
Overview
IAS 28 Investments in Associates and Joint Ventures (as amended in 2011) outlines how to
apply, with certain limited exceptions, the equity method to investments in associates and joint
ventures. The standard also defines an associate by reference to the concept of "significant
influence", which requires power to participate in financial and operating policy decisions of an
investee (but not joint control or control of those polices).

IAS 28 was reissued in May 2011 and applies to annual periods beginning on or after 1 January
2013.

Summary of IAS 28 (as amended in 2011)

The summary below applies to IAS 28 Investments in Associates and Joint Ventures, issued in
May 2011 and applying to annual reporting periods beginning on or after 1 January 2013. For
earlier reporting periods, refer to our summary of IAS 28 HYPERLINK
"http://www.iasplus.com/en/standards/standard27" HYPERLINK
"http://www.iasplus.com/en/standards/standard27" HYPERLINK
"http://www.iasplus.com/en/standards/standard27" HYPERLINK
"http://www.iasplus.com/en/standards/standard27" HYPERLINK
"http://www.iasplus.com/en/standards/standard27" HYPERLINK
"http://www.iasplus.com/en/standards/standard27" HYPERLINK
"http://www.iasplus.com/en/standards/standard27" HYPERLINK
"http://www.iasplus.com/en/standards/standard27" HYPERLINK
"http://www.iasplus.com/en/standards/standard27" HYPERLINK
"http://www.iasplus.com/en/standards/standard27" HYPERLINK
"http://www.iasplus.com/en/standards/standard27" HYPERLINK "http://www. Investments in
Associates.

Objective of IAS 28
The objective of IAS 28 (as amended in 2011) is to prescribe the accounting for investments in
associates and to set out the requirements for the application of the equity method when
accounting for investments in associates and joint ventures. [IAS 28(2011).1]

Scope of IAS 28
IAS 28 applies to all entities that are investors with joint control of, or significant influence over,
an investee (associate or joint venture). [IAS 28(2011).2]

Key definitions
[IAS 28.3]
Associate An entity over which the investor has significant influence
Significant The power to participate in the financial and operating policy decisions of the investee but is
influence not control or joint control of those policies
Joint
An arrangement of which two or more parties have joint control
arrangement
The contractually agreed sharing of control of an arrangement, which exists only when
Joint control decisions about the relevant activities require the unanimous consent of the parties sharing
control
A joint arrangement whereby the parties that have joint control of the arrangement have
Joint venture
rights to the net assets of the arrangement
Joint venturer A party to a joint venture that has joint control of that joint venture
A method of accounting whereby the investment is initially recognised at cost and adjusted
thereafter for the post-acquisition change in the investor's share of the investee's net
Equity method assets. The investor's profit or loss includes its share of the investee's profit or loss and the
investor's other comprehensive income includes its share of the investee's other
comprehensive income

Significant influence
Where an entity holds 20% or more of the voting power (directly or through subsidiaries) on an
investee, it will be presumed the investor has significant influence unless it can be clearly
demonstrated that this is not the case. If the holding is less than 20%, the entity will be
presumed not to have significant influence unless such influence can be clearly demonstrated. A
substantial or majority ownership by another investor does not necessarily preclude an entity
from having significant influence. [IAS 28(2011).5]

The existence of significant influence by an entity is usually evidenced in one or more of the
following ways: [IAS 28(2011).6]
• representation on the board of directors or equivalent governing body of the investee;

• participation in the policy-making process, including participation in decisions about

dividends or other distributions;

• material transactions between the entity and the investee;

• interchange of managerial personnel; or

• provision of essential technical information

The existence and effect of potential voting rights that are currently exercisable or convertible,
including potential voting rights held by other entities, are considered when assessing whether
an entity has significant influence. In assessing whether potential voting rights contribute to
significant influence, the entity examines all facts and circumstances that affect potential rights
[IAS 28(2011).7, IAS 28(2011).8]

An entity loses significant influence over an investee when it loses the power to participate in
the financial and operating policy decisions of that investee. The loss of significant influence can
occur with or without a change in absolute or relative ownership levels. [IAS 28(2011).9]

The Equity Method of Accounting

Basic principle. Under the equity method, on initial recognition the investment in an associate
or a joint venture is recognised at cost, and the carrying amount is increased or decreased to
recognise the investor's share of the profit or loss of the investee after the date of acquisition.
[IAS 28(2011).10]

Distributions and other adjustments to carrying amount. The investor's share of the
investee's profit or loss is recognised in the investor's profit or loss. Distributions received from
an investee reduce the carrying amount of the investment. Adjustments to the carrying amount
may also be necessary for changes in the investor's proportionate interest in the investee
arising from changes in the investee's other comprehensive income (e.g. to account for changes
arising from revaluations of property, plant and equipment and foreign currency translations.)
[IAS 28(2011).10]

Potential voting rights. An entity's interest in an associate or a joint venture is determined

solely on the basis of existing ownership interests and, generally, does not reflect the possible
exercise or conversion of potential voting rights and other derivative instruments. [IAS
28(2011).12]

Interaction with IFRS 9. IFRS 9 Financial Instruments does not apply to interests in associates
and joint ventures that are accounted for using the equity method. Instruments containing
potential voting rights in an associate or a joint venture are accounted for in accordance with
IFRS 9, unless they currently give access to the returns associated with an ownership interest in
an associate or a joint venture. [IAS 28(2011).14]

Classification as non-current asset. An investment in an associate or a joint venture is

generally classified as non-current asset, unless it is classified as held for sale in accordance
with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations. [IAS 28(2011).15]

Application of the Equity Method of Accounting

Basic principle. In its consolidated financial statements, an investor uses the equity method of
accounting for investments in associates and joint ventures. [IAS 28(2011).16] Many of the
procedures that are appropriate for the application of the equity method are similar to the
consolidation procedures described in IFRS 10. Furthermore, the concepts underlying the
procedures used in accounting for the acquisition of a subsidiary are also adopted in accounting
for the acquisition of an investment in an associate or a joint venture. [IAS 28.(2011).26]

Exemptions from Applying the Equity Method.

An entity is exempt from applying the equity method if the investment meets one of the following
conditions:

• The entity is a parent that is exempt from preparing consolidated financial statements
under IFRS 10 Consolidated Financial Statements or if all of the following four conditions
are met (in which case the entity need not apply the equity method): [IAS 28(2011).17]

• the entity is a wholly-owned subsidiary, or is a partially-owned subsidiary of

another entity and its other owners, including those not otherwise entitled to vote,
have been informed about, and do not object to, the investor not applying the
equity method

• the investor or joint venturer's debt or equity instruments are not traded in a
public market

• the entity did not file, nor is it in the process of filing, its financial statements with
a securities commission or other regulatory organisation for the purpose of
issuing any class of instruments in a public market, and

• the ultimate or any intermediate parent of the entity produces consolidated

financial statements available for public use that comply with International
Financial Reporting Standards.

• When an investment in an associate or a joint venture is held by, or is held indirectly

through, an entity that is a venture capital organisation, or a mutual fund, unit trust and
similar entities including investment-linked insurance funds, the entity may elect to
measure investments in those associates and joint ventures at fair value through profit or
loss in accordance with IFRS 9. [IAS 28(2011).18] When an entity has an investment in
an associate, a portion of which is held indirectly through a venture capital organisation,
or a mutual fund, unit trust and similar entities including investment-linked insurance
funds, the entity may elect to measure that portion of the investment in the associate at
 fair value through profit or loss in accordance with IFRS 9 regardless of whether the
venture capital organisation, or the mutual fund, unit trust and similar entities including
investment-linked insurance funds, has significant influence over that portion of the
investment. If the entity makes that election, the entity shall apply the equity method to
any remaining portion of its investment in an associate that is not held through a venture
capital organisation, or a mutual fund, unit trust and similar entities including investment-
linked insurance funds. [IAS 28(2011).19]

Classification as held for sale. When the investment, or portion of an investment, meets the
criteria to be classified as held for sale, the portion so classified is accounted for in accordance
with IFRS 5. Any remaining portion is accounted for using the equity method until the time of
disposal, at which time the retained investment is accounted under IFRS 9, unless the retained
interest continues to be an associate or joint venture. [IAS 28(2011).20]

Discontinuing the equity method. Use of the equity method should cease from the date that
significant influence or joint control ceases: [IAS 28(2011).22]

• If the investment becomes a subsidiary, the entity accounts for its investment in
accordance with IFRS 3 Business Combinations and IFRS 10

• If the retained interest is a financial asset, it is measured at fair value and subsequently
accounted for under IFRS 9

• Any amounts recognised in other comprehensive income in relation to the investment in

the associate or joint venture are accounted for on the same basis as if the investee had
directly disposed of the related assets or liabilities (which may require reclassification to
profit or loss)

• If an investment in an associate becomes an investment in a joint venture (or vice

versa), the entity continues to apply the equity method and does not remeasure the
retained interest. [IAS 28(2011).24]

Changes in ownership interests. If an entity's interest in an associate or joint venture is

reduced, but the equity method is continued to be applied, the entity reclassifies to profit or loss
the proportion of the gain or loss previously recognised in other comprehensive income relative
to that reduction in ownership interest. [IAS 28(2011).25]

Equity Method Procedures.

• Transactions with associates or joint ventures. Profits and losses resulting from
upstream (associate to investor, or joint venture to joint venturer) and downstream
(investor to associate, or joint venturer to joint venture) transactions are eliminated to the
extent of the investor's interest in the associate or joint venture. However, unrealised
losses are not eliminated to the extent that the transaction provides evidence of a
reduction in the net realisable value or in the recoverable amount of the assets
transferred. Contributions of non-monetary assets to an associate or joint venture in
exchange for an equity interest in the associate or joint venture are also accounted for in
accordance with these requirements. [IAS 28(2011).28-30]

• Date of financial statements. In applying the equity method, the investor or joint venturer
should use the financial statements of the associate or joint venture as of the same date
as the financial statements of the investor or joint venturer unless it is impracticable to do
so. If it is impracticable, the most recent available financial statements of the associate
 or joint venture should be used, with adjustments made for the effects of any significant
transactions or events occurring between the accounting period ends. However, the
difference between the reporting date of the associate and that of the investor cannot be
longer than three months. [IAS 28(2011).33, IAS 28(2011).34]

• Accounting policies. If the associate or joint venture uses accounting policies that differ
from those of the investor, the associate or joint venture's financial statements are
adjusted to reflect the investor's accounting policies for the purpose of applying the
equity method. [IAS 28(2011).35]

• Losses in excess of investment. If an investor's or joint venturer's share of losses of an

associate or joint venture equals or exceeds its interest in the associate or joint venture,
the investor or joint venturer discontinues recognising its share of further losses. The
interest in an associate or joint venture is the carrying amount of the investment in the
associate or joint venture under the equity method together with any long-term interests
that, in substance, form part of the investor or joint venturer's net investment in the
associate or joint venture. After the investor or joint venturer's interest is reduced to zero,
a liability is recognised only to the extent that the investor or joint venturer has incurred
legal or constructive obligations or made payments on behalf of the associate. If the
associate or joint venture subsequently reports profits, the investor or joint venturer
resumes recognising its share of those profits only after its share of the profits equals the
share of losses not recognised. [IAS 28(2011).38, IAS 28(2011).39]

Impairment. After application of the equity method an entity applies IAS 39 Financial
Instruments: Recognition and Measurement to determine whether it is necessary to recognise
any additional impairment loss with respect to its net investment in the associate or joint
venture. If impairment is indicated, the amount is calculated by reference to IAS 36 Impairment
of Assets. The entire carrying amount of the investment is tested for impairment as a single
asset, that is, goodwill is not tested separately. The recoverable amount of an investment in an
associate is assessed for each individual associate or joint venture, unless the associate or joint
venture does not generate cash flows independently. [IAS 28(2011).40, IAS 28(2011).42, IAS
28(2011).43]

Separate Financial Statements

An investment in an associate or a joint venture shall be accounted for in the entity's separate
financial statements in accordance with IAS 27 Separate Financial Statements (as amended in
2011).

Disclosure
There are no disclosures specified in IAS 28. Instead, IFRS 12 Disclosure of Interests in Other
Entities outlines the disclosures required for entities with joint control of, or significant influence
over, an investee.

IAS 29: FINANCIAL REPORTING IN HYPERINFALTIONARY ECONOMIES

Scope
This Standard deals with the measurement problems of entities that are reporting in the
currency of a hyperinflationary economy. In this situation, financial information reported in
historical terms would present a distorted picture of the entity’s performance and financial
position. This Standard sets out procedures for adjusting the financial information for the effects
of hyperinflation.

Definition of Hyperinflation
The Standard does not define hyperinflation but sets out the general characteristics of a
hyperinflationary economy.
These characteristics would include:
(1) Where the preference is to keep wealth in non-monetary assets or in a stable foreign
currency. Any local currency would be immediately invested in order to attempt to maintain its
purchasing power.
(2) Where prices are quoted in a stable foreign currency and the population regards monetary
amounts in that currency, as effectively a local currency
(3) Where transactions are priced at an amount that includes compensation for the future
expected loss of the purchasing power of the local currency. This characteristic would be taken
into account even if the credit period is quite short.
(4) Where prices, wages, and interest rates are closely linked to a price index
(5) Where cumulative inflation rates over a period of three years approaches or exceeds 100%

Although IAS 29 sets out the characteristics that may indicate a hyperinflationary economy, it
also states that judgment will have to be used in determining whether restatement of the
financial statements of the entity is required.

Ceasing to be Inflationary
Likewise, judgment will be required in determining whether an economy is no longer
hyperinflationary. The criteria used for this is whether the cumulative inflation rate drops below
100% in a three-year period.
When the economy ceases to have hyperinflation, then the entity should discontinue preparing
financial statements in accordance with IAS 29. If possible, all entities in that environment
should cease to apply the Standard from the same date.
The carrying amounts in subsequent financial statements will be taken as the amounts
expressed in the measuring unit current at the end of the previous year.

Restatement of Financial Statements – Statement of financial position

• IAS 29 requires the restatement of financial statements including the cash flow
statements and requires the use of a general price index.
• It is preferable that all entities in the same country use the same index.
• Monetary items are already stated in the measuring unit at the statement of financial
position dates and are therefore not restated.
• All non-monetary items are restated using the change in the general price index between
the date that those items were acquired and the current statement of financial position
date, unless they are carried at current values (e.g., net realizable value and market
value) at the statement of financial position date, in which case they are not restated.
• Any gain or loss on the restatement of non-monetary items is included in the income
statement. It is a requirement to disclose this net gain or loss separately.
• The index is applied from the dates on which accounting for hyperinflation was first
applicable to these items.
• Some non-monetary assets are carried at values determined at an earlier date than that
of the financial statements. Examples are the revaluation of property or equipment. In
this case, the carrying amounts are restated from the date the assets were revalued.
• The restated amounts are compared to (1) recoverable amounts in the case of non-
current assets, (2) net realizable value in the case of inventory, (3) market value in the
case of current investments, and reduced if they exceed the above values.
• An associate operating in the hyperinflationary economy should have its financial
 statements restated in accordance with IAS 29.
• Opening owners’ equity should be restated using the Standard, but retained earnings
and revaluation surplus should not be restated. Any revaluation surplus arising prior to
the application of the Standard is eliminated. Restated retained earnings are the
balancing figure in the restated statement of financial position.

Income Statement
The income statement is expressed in terms of the measuring unit at the statement of financial
position date. Therefore, amounts need to be restated from the dates they were initially
recorded.

Disclosure
This information has to be disclosed under IAS 29:
(a) That the financial statements and other corresponding period data have been restated for
changes in the general purchasing power of the reporting currency
(b) The basis on which the financial statements are prepared, that is, based on historical cost or
current cost approach
(c) The nature and level of the price index at the statement of financial position date and any
movements on this index in the current and previous reporting period

Illustration
Z operates in a hyperinflationary economy. Its statement of financial position at December 31,
20X5, follows:
N’m
Property, plant, and equipment 900
Inventory 2,700
Cash 350
Share capital (issued 20X1) 400
Retained earnings 2,350
Non-current liabilities 500
Current liabilities 700
The general price index had moved in this way:
December 31
20X1 100
20X2 130
20X3 150
20X4 240
20X5 300
The property, plant, and equipment was purchased on December 31, 20X3, and there is six
months’ inventory held. The non-current liabilities were a loan raised on March 31, 20X5.
Required
Show the statement of financial position of Z after adjusting for hyperinflation.

Suggested Solution
Statement of financial position as at 31 December 20X5
N’m
Property, plant, and equipment (900 × 300/150) 1,800
Inventory (300/270) × 2,700 3,000
Cash 350
5,150
Share capital (300/100 × 400) 1,200
Retained earnings (balance) 2,750
Non-current liabilities 500
Current liabilities 700
 5,150
The inventory had been restated assuming that the index has increased proportionately over
time. The loan is a monetary item and therefore is not restated. If the loan had been index
linked, then it would have been restated in accordance with the loan agreement.

IAS 32: FINANCIAL INSTRUMENTS: PRESENTATION

Definitions
Financial instrument is any contract that gives rise to both a financial asset of one enterprise
and financial liability or equity instrument of another enterprise.
A financial asset is any asset that is
• Cash:
• An equity instrument of another entity:
• A contractual right :
• to receive cash or another financial asset from another entity: or
• to exchange financial assets or financial liabilities with another entity
• under conditions that are potentially favourable to the entity.

A financial liability is any liability that is:

• a contractual obligation:
• to deliver cash or another asset to another entity: or
• to exchange financial assets or financial liabilities with another entity
• under conditions that are potentially unfavourable to the entity.

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

Types of Financial Instruments

Basically financial instruments can be classified into three when one considers the type of
returns accruing from them. The three classes are:
(a) Fixed interest Securities i.e. debentures
(b) Residual income securities e.g. ordinary shares and
(c) Hybrid securities that is securities that possess attributes of fixed interest securities and
residual income securities e.g. preference shares (participating pref shares).

Examples of Financial iInstruments are:

• Deposits, debtors, creditors, notes, loans, bonds and debentures to be settled in cash
 • Shares including ordinary shares, preference shares and deferred shares
• Unconditional lease obligations
• Obligations of an entity to issue or deliver its own shares, such as share option or
warrant
• Warrants or options to subscribe for shares of , or purchase shares from the issuing
entity
• Derivative financial instruments such as forward contracts futures, options, interest rates
and currency swaps
• Contingent liabilities that arise from contracts and, if they crystallize, will be settled in
cash. An example of this is financial guarantee

Examples of Non Financial Instruments are:

• Physical assets, such as stock, that is inventory, property, plant and equipment
• Intangible assets such as patents and trade marks
• Prepayments for goods and services since this will not be settled in cash or another
financial instrument
• Obligations to be settled by delivery of goods or the rendering of services warranty
obligations
• Income taxes, including deferred taxes since these are statutory rather than contractual
obligations
• Forwards, swaps, and options to be settled by delivery of goods or the rendering of
services
• Contingent items that do not arise from contracts
• The non – controlling interest that arises on consolidating a subsidiary that is not wholly
owned.

Presentation of Financial Instruments

A financial instrument gives rise to a financial asset of one entity, in simple terms a financial
instrument can be seen as a piece of paper or in a formal form a security representing a legal
claim to future cash payment. This is from the point of view of the investor, however from the
point of view of the issuer a financial liability or equity instrument is created.
As a result of this, the issuer has to take care as to give appropriate treatment in order to avoid
creative accounting which could occur where it shows an issue as equity rather than a debt.
The way and manner financial instruments are presented:

Liabilities and Equity

Financial instruments should be presented as either a liability or equity according to their
substance, not merely their legal form. To that extent, when a financial instrument gives rise to a
contractual obligation on the part of the issuer to deliver cash or another financial asset or to
exchange another financial instrument under conditions that are potentially unfavourable, it
should be presented as a financial liability. When no such contractual obligation exists, it is an
equity instrument.

Classification of Compound Instruments by the Issuer:

A compound instrument is one, which has both a liability and an equity component. It is a hybrid
of liability and equity elements. For instance the value of a convertible debt consists of liability
components (that is the actual worth of the debt) and an equity element (that is the value of the
right to convert the debt to equity shares in the future). IAS 32 stipulates that all such compound
instruments must be presented in balance sheet with the liability and equity elements separated.

Although IAS 32 doe not deal with measurement issues, it advocates two methods of separating
compound instruments into its liability and equity elements, and that are:
(a) Residual value of a component:- This involves calculating a value for the more easily
measurable component (usually the liability) and deducting this from the total value of
the instrument, leaving a residual value representing the equity elements
(b) Separate measurement:- This involves assigning values to the liabilities and equity
elements using some models and then allocate the total value of instrument on a pro
rata basis.

Interest, Dividends, Losses and Gains

The accounting treatment of interest, dividends, losses and gains depends on whether they
relate to financial liability or equity instrument. In other words, interest, dividends, losses, and
gains attributable to a financial liability must be reported in the income statements as either
income or expenses: whereas those relating to equity instrument are treated as movement to
equity.

Treasury Shares
The cost of an entity's own equity instruments that it has reacquired ('treasury shares') is
deducted from equity. Gain or loss is not recognised on the purchase, sale, issue, or
cancellation of treasury shares. Treasury shares may be acquired and held by the entity or by
other members of the consolidated group. Consideration paid or received is recognised directly
in equity.

Off Setting a Financial Asset and Financial Liability:-

Normally, a financial asset should not be used to set – off a financial liability, especially in the
following situations:
(a) When several different financial instruments are used to emulate the features of a single
financial instrument i.e. synthetic instrument
(b) When financial assets and financial liabilities arise from financial instruments having the
same primary risk exposure but involve different counter parties
(c) When financial assets are pledged as collateral for non – recourse financial liabilities
(d) When financial assets are set aside in trust by a debtor for the purpose of discharging an
obligation without those assets having been accepted by the creditor in settlement of the
obligation
(e) When obligations incurred as a result of events giving rise to losses are expected to be
recovered from a third party by virtue of a claim made under an insurance policy.

However, a financial asset and a financial liability may be set – off:

(a) only when an enterprise has a legally enforceable right to set off the amounts or
(b) intends either to settle on a net basis or
(c) to realize the asset and settle the liability at the same time.

Illustration on valuation of compound instruments

Omolowo Plc isssues 4,000 convertible bonds at the start of 2010. The bonds have a three year
term, and are issued at par with a face value of N2,000 per bond, giving total proceeds of
N8,000,000. Interest is payable annually in arrears at a nominal annual interest rate of 6%.
Each bond is convertible at any time up to maturity into 500 common shares.
When the bonds are issued, the prevailing market interest rate for similar debt without
conversion options is 9%. At the issue date, the market price of one common share is N3.00.
The dividends expected over the three years term of the bonds amount to 14 kobo per share at
the end of each year. The risk-free annual rate for a three year term is 5%.
Required: What is the value of the equity component in the bond?

Suggested solution
The liability component is valued first, and the difference between the proceeds of the bond
issue and the fair value of the liability is assigned to the equity. The present value of the liability
component is calculated using a discount rate of 9%, the market interest rate for similar
bonds having no conversion rights, as shown:
Year Cash flow DCF Present Value
N 9% N
1 480,000 0.9174 440,352
2 480,000 0.8417 404,016 6%x8m=480,000
3 8,480,000 0.7722 6,548,256
Total liability component 7,392,624
Equity component (balancing figure) 607,376
Proceeds of the bond 8,000,000

Disclosures
Financial instruments disclosures are in IFRS 7 Financial Instruments: Disclosures, and no
longer in IAS 32.

The disclosures relating to treasury shares are in IAS 1 Presentation of Financial Statements
and IAS 24 Related Parties for share repurchases from related parties. [IAS 32.34 and 39]
REVIEW QUESTION
1. (a) The difference between debt and equity in an entity’s statement of financial position is not easily
distinguishable
for preparers of financial statements. Some financial instruments may have both features, which can lead
to
inconsistency of reporting. The International Accounting Standards Board (IASB) has agreed that greater
clarity may be required in its definitions of assets and liabilities for debt instruments. It is thought that
defining the nature of liabilities would help the IASB’s thinking on the difference between financial
instruments classified as equity and liabilities.
Required:
(i) Discuss the key classification differences between debt and equity under International
Financial Reporting Standards.
Note: Examples should be given to illustrate your answer. (9 marks)
(ii) Explain why it is important for entities to understand the impact of the classification of a
financial
instrument as debt or equity in the financial statements. (5 marks)

(b) The directors of Avco, a public limited company, are reviewing the financial statements of two entities
which are
acquisition targets, Cavor and Lidan.They have asked for clarification on the treatment of the following
financial
instruments within the financial statements of the entities.
Cavor has two classes of shares: A and B shares. A shares are Cavor’s ordinary shares and are correctly
classed as equity. B shares are not mandatorily redeemable shares but contain a call option allowing
Cavor to repurchase them. Dividends are payable on the B shares if, and only if, dividends have been
paid on the A ordinary shares.
The terms of the B shares are such that dividends are payable at a rate equal to that of the A ordinary
shares.
Additionally, Cavor has also issued share options which give the counterparty rights to buy a fixed number
of its B shares for a fixed amount of N10 million. The contract can be settled only by the issuance of
shares for cash
by Cavor.
Lidan has in issue two classes of shares: A shares and B shares. A shares are correctly classified as
equity.
Two million B shares of nominal value of N1 each are in issue. The B shares are redeemable in two years’
time at the option of Lidan. Lidan has a choice as to the method of redemption of the B shares. It may
either redeem the B shares for cash at their nominal value or it may issue one million A shares in
settlement. A shares are currently valued at N10 per share. The lowest price for Lidan’s A shares since its
formation has been N5 pershare.
Required:
Discuss whether the above arrangements regarding the B shares of each of Cavor and Lidan
should be
treated as liabilities or equity in the financial statements of the respective issuing companies. (9
marks)
Professional marks will be awarded in question 4 for clarity and quality of presentation. (2 marks)
(25 marks) ACCA CORPORATE REPORTING JUNE 2014
SUGGESTED SOLUTION
1. (a) (i) IAS 32 Financial Instruments: Presentation establishes principles for presenting financial
instruments as liabilities orequity. To determine whether a financial instrument should be classified as debt
or equity, IAS 32 uses principles-baseddefinitions of a financial liability and of equity. In contrast to the
requirements of generally accepted accounting practicein many jurisdictions around the world, IAS 32
does not classify a financial instrument as equity or financial liability on the basis of its legal form. The key
feature of debt is that the issuer is obliged to deliver either cash or another financial asset to the holder.
The contractual obligation may arise from a requirement to repay principal or interest or dividends.
Such a contractual obligation may be established explicitly or indirectly through the terms of the
agreement. For example, a bond which requires the issuer to make interest payments and redeem the
bond for cash is classified as debt. In contrast, equity is any contract which evidences a residual interest
in the entity’s assets after deducting all of its liabilities. A financial instrument is an equity instrument only if
the instrument includes no contractual obligation to
deliver cash or another financial asset to another entity and if the instrument will or may be settled in the
issuer’s own
equity instruments. For example, ordinary shares, where all the payments are at the discretion of the
issuer, are classified as equity of the issuer. The classification is not quite as simple as it seems. For
example, preference shares required to be converted into a fixed number of ordinary shares on a fixed
date or on the occurrence of an event which is certain to occur, should be classified as equity.
A contract is not an equity instrument solely because it may result in the receipt or delivery of the entity’s
own equity
instruments. The classification of this type of contract is dependent on whether there is variability in either
the number
of equity shares delivered or variability in the amount of cash or financial assets received. A contract
which will be settled by the entity receiving or delivering a fixed number of its own equity instruments in
exchange for a fixed amount of cash or another financial asset is an equity instrument. However, if there
is any variability in the amount of cash or own equity instruments which will be delivered or received, then
such a contract is a financial asset or liability as applicable. For example, where a contract requires the
entity to deliver as many of the entity’s own equity instruments as are equal in value to a certain amount
of cash, the holder of the contract would be indifferent whether it received cash or shares to the value of
that amount. Thus this contract would be treated as debt.
Other factors, which may result in an instrument being classified as debt, are:
– redemption is at the option of the instrument holder
– there is a limited life to the instrument
– redemption is triggered by a future uncertain event which is beyond the control of both the holder and
issuer of the
instrument
– dividends are non-discretionary
Similarly, other factors, which may result in the instrument being classified as equity, are whether the
shares are
non-redeemable, whether there is no liquidation date or where the dividends are discretionary.

(ii) The classification of a financial instrument by the issuer as either debt or equity can have a significant
impact on the entity’s gearing ratio, reported earnings, and debt covenants. Equity classification can avoid
such impact but may be perceived negatively if it is seen as diluting existing equity interests. The
distinction between debt and equity is also
relevant where an entity issues financial instruments to raise funds to settle a business combination using
cash or as
part consideration in a business combination. Understanding the nature of the classification rules and
potential effects
is critical for management and must be borne in mind when evaluating alternative financing options.
Liability
classification normally results in any payments being treated as interest and charged to profit or loss,
which may affect
the entity’s ability to pay dividends on its equity shares.

(b) Cavor
An obligation must be established through the terms and conditions of the financial instrument. IAS 32
uses principles-based definitions of a financial liability and of equity. IAS 32 uses substance over form as
a principle to classify a financial instrument between equity and financial liability. IAS 32 restricts the role
of ‘substance’ to consideration of the contractual terms of an instrument. Anything outside the contractual
terms is not therefore relevant to the classification process under IAS 32. The B shares of Cavor should
be classified as equity as there is no contractual obligation to pay the dividends or to call the instrument.
Dividends can only be paid on the B shares if dividends have been declared on the A shares and they are
payable at the same rate as the A shares which will be variable. There is no contractual obligation to
declare A share dividends.
The classification of the B share options in Cavor is dependent on whether there is variability in either the
number of equity shares delivered or variability in the amount of cash or financial assets received. As
there is no variability and the contract will be settled by the entity issuing a fixed number of its own equity
instruments in exchange for a fixed amount of cash, then the share options are classified as an equity
instrument.

Lidan
The contractual obligation may arise from a requirement to repay principal or interest or dividends. Such a
contractual
obligation need not be explicit. It may instead be established indirectly through the terms and conditions
of the financial instrument and the liability classification is not avoided by a share settlement alternative
which is uneconomic in comparison to the cash obligation. The B shares of Lidan will be classified as a
liability. This is because the value of the own share settlement alternative substantially exceeds that of the
cash settlement option, meaning that the entity is implicitly obliged to redeem the option for a cash
amount of N1 per share. Additionally, IAS 32 also states that where a derivative contract has settlement
options, it is a financial asset or liability unless all of the settlement alternatives result in it being an equity
instrument. This would also lead to the conclusion that the B shares are a financial liability.

IAS 33: ON EARNINGS PER SHARE (EPS)

Definition
The profit in kobo attributable to each equity share, based on the (consolidated) profit of the
period after tax and after deducting non-controlling interest and preference dividends, divided by
the number of equity share in issue (and ranking for dividend in respect of the period).

Some Salient Points on Computation of EPS

1. Cumulative preference shares – The dividend on cumulative preference shares should be
deducted from earnings whether paid or not
2. Non-cumulative preference shares – The dividend can only be deducted from earnings if
paid at the end of the period, where this was not paid then it should be ignored as it can never
be paid again.
3. Participating preference shares – Dividend and the share of profit attributable to this class
of shareholders should be deducted from the earnings before determining the earnings
attributable to the ordinary shareholders.
4. Deferred taxation - the taxation charge deducted in arriving at earnings should include any
transfer to or from the deferred tax account.
5. Ordinary shares ranking for dividend – Only ordinary shares ranking for dividend should
be included in the computation of EPS; the ordinary shares not ranking for dividend will only be
useful in the computation of fully diluted EPS.
6. Treasury shares – These are the shares of an enterprise acquired by it for reissue. For
purpose of computing EPS, take away these shares from shares ranking for dividend using the
fraction part of the year that the shares were acquired.
7. Share exchange – Where an enterprise’s shares increased during the year due to share
exchange, assume that the share exchange was done at full market cash issue, assume the
date of issue as the date of acquisition.
8. Partly paid share capital – Where the ordinary share capital is partly paid, the number of
shares in issue will be the proportion of the paid amount expressed in terms of the nominal
value and having regard for the number of months the shares were in issue.
9. Exceptional items would be included in calculation of earnings
10. The net basis takes into account all elements of the tax, i.e. constant and variable including
adjustments for prior year under or over provision for tax. In other words, the constant and
variable elements refer to the tax charged to the income statement. This situation arises when
accounts of a company are prepared using a uniform basis for making provision for tax from
year to year with adjustments made in the succeeding year accounts for any under / over
provision. This practice is prevalent in foreign subsidiaries of overseas companies with tight
reporting deadlines. The IAS 33 recommends the net basis for purpose of computing an
enterprise’s earnings per share.
11. NIL bases – this basis taken into account the constant element of tax i.e. ignoring the
subsequent adjustments made after concluding the previous year’s tax assessment.
12. Loss per Share – Where an enterprise has negative earnings attributable to ordinary
shareholders, then Loss per Share (LPS) is computed.
13. Potential ordinary shares. This is a financial instrument or other contracts that may entitle
its holders to ordinary shares. IAS 33 identifies the following examples of financial instruments
and other contracts generating potential ordinary shares:
(a) Debt or equity instruments, including preference shares that are convertible into ordinary
shares
(b) Share warrants and options
(c) Employees plans that allow employees to receive ordinary shares as part of their
remuneration and other share purchase plans.
(d) Shares that would be issued upon the satisfaction of certain conditions resulting from
contractual arrangements, such as the purchase of a business or other assets.

Importance of Earnings Per Share

EPS is widely used by investors as a measure of a company’s performance and is of particular
importance in:
(a) Comparing the result of a company over a period of time,
(b) Comparing performance of one company’s equity shares against the performance of another
company’s equity.
(c) It is used in determining the market value of a company’s share (Market value = EPS X P/E
ratio). It suggests that earnings are a major determinant of an enterprise’s market value per
share. The P/E ratio measures the level of confidence of investors in an enterprise’s future
prospects, risks associated with it and its future earnings.
(d) It a useful tool in valuing the shares of unquoted companies. This is done by using the P/E
ratio of an enterprise of equal status but is quoted and is in the same industry.
(e) EPS, especially the diluted EPS assist investors to ascertain the degree of risk associated
with investment in an entity’s shares. A high diluted EPS is an indication of high risks with regard
to investment in that entity’s shares.
(f) EPS can be used to measure the level of managerial efficiency in generating earns for a
reporting period.

Limitations of EPS
EPS as a measure of performance and comparison with other entities performance has the
following limitations:
1. It cannot be used to predict the future earnings of an enterprise since the computation is
based on historical data. It only measures past performance; this also applies to diluted
earnings per share.
2. Different enterprises use different accounting policies, even companies in the same industry;
this makes comparison of the performance of one enterprise’s share performance with another
difficult.
3. It does not take into account the effect of inflation as the apparent growth in profits may not
represent the truth growth.
4. EPS is not the overall measure of an enterprise’s performance, other yardsticks for
measuring performance exists, and they include; statement of cash flow, gearing and working
capital.
5. Computation of EPS can be subjected to manipulation. This is possible especially where
management incentives are based on performance of the enterprise.
6. Revaluation and depreciation are often subjective and therefore their values have significant
effects on the computation of EPS.

New Issue of Shares and EPS

If a new issue of shares at full market price is made during the course of the year, the extra
profits earned from the capital raised will only apply to that part of the year from the time that the
share issue was made. It would therefore be unreasonable to calculate the EPS using the total
no of shares in issue, instead a weighted average total number of share in issue should be
used.

Example
30 September 2007 Y LTD made an issue at full market price 1,000,000 ordinary shares. The
company‘s account year runs from 1st January to 31st December.
Relevant information for 2006 & 2007 as follows:
2007 2006
N N
Shares in issue 31 December 9,000,000 8,000,000
Profit after tax & preference dividends 3,300,000 3,280,000
Calculate EPS 2007 & corresponding issue
2006.

Suggested solution
2007 2006
Weighted average no. of share in issue
12/12 months x 8m 8,000,000
3/12 months x 1m 250,000
8,250,000 8,000,000
EPS 40k 41k

Right Issue
Issue to existing shareholders at a price below the current market value always on basis of
shares currently held. To compute the EPS we need to calculate theoretical ex- rights price. This
is weighted average value per share, taking into consideration the price before the right issue
and the right issue price, and the total share holdings after the right issue.

Example
Suppose Moron Ltd has 10m shares in issue. It is now proposed to make a 1 for 4 right issue at
a price of N3 per share. The market value of the company’s shares on final day before the issue
is made is N3.50. (This is the ‘cum rights’ value) What is the theoretical ex rights price per
share?
N
Before issue 4 shares valued at N3.50 14, 00
Right issue 1 share valued at N 3 3.00
Theoretical value of shares 17.00

Theoretical ex rights price = N17 = N3.40 per share.

5
The procedures for calculating the EPS for the current year and a corresponding figure for the
previous year are now as follows:

(a) Previous year E.P.S

EPS for corresponding previous period should be adjusted by multiplying this by fraction of:
Theoretical ex rights price
Market price on last day of quotation (cumulative rights)
This adjustment is necessary because right issues at a price below the current market price
means that the issue involves some bonus elements (shares not paid for) and we always reflect
bonus issues retrospectively i.e as if the bonus issues were done in the previous accounting
period.

(b) To obtain EPS for the current year you should:

(i) Multiply the no. of share before rights issue by the fraction of the year before the date of
issue and by the fraction:
Market price on last day of quotation cumulative rights
Theoretical ex right price
The purpose of this adjustment is to bring out the bonus elements of the right issue.
ii. Multiply the number of shares after the right issue by the fraction of the year after the date of
issue and add to the figure in (i) above to determine the weighted average number of shares in
issue.
(iii) Earnings now divided by the weighted average number of share so calculated to arrive at
EPS for the current year.

Example
Highlanders Plc had 100,000 shares in issue but then makes a 1 for 5 rights issue on 1 st
October 2005 at a price of N1.00 The market value on last day of quotation cumulative rights
was N1.60.Calculate the EPS for 2005 and the corresponding figures for 2004 given total
earning of N50, 000 in 2005 and N40, 000 in 2004.

Suggested solution
Theoretical ex right price N
Before issue 5 shares valued at N 1.60 8
Right issue 1 share valued at N 1.00 1
6 9
Theoretical ex right price = N9 =N 1.50
6
EPS 2004
EPS before right issue 40k (40,000/100,000)
Adjusted EPS = N1.50 x 40k = 37.5k
N1.60
2005 EPS
No. share before right issue 100,000 and 20,000 new shares were issued:
Shares
Stage 1 – 100,000 x 9/12 x N1.60 = 80,000
N1.50
Stage 2 – 120,000 x 3/12 = 30,000
110,000

EPS = N50, 000 = 45.5 k

110,000 shares

Computation of EPS When there is Right Issue – Alternative Method

It has been established earlier on that right issue at a price below the current market indicates
that there are some bonus elements involved in the right issue. Where these bonus elements
are to be shown separately, then we may adopt this alternative method of computing the EPS.
Step 1 – Determine the Bonus Adjuster or Bonus Fraction. This will be determined as
follows:
Cum Right Price – Theoretical Ex Right Price
Theoretical Ex Right Price

Step 2 – Determine the Bonus Elements of the right issue. This is done by: Bonus Adjuster x
Shares in issue before right issue. Note that the bonus elements are expected to be in issue for
the whole year.
Step 3. – Determine the full market price share issue i.e. the number of the right issues at the
current market price. This is done by: Right issues – Bonus elements. Note that the number of
shares determined shall only be considered for the number of months the shares were in issue
before the reporting period end.

Previous year EPS – The previous year EPS is adjusted because of the bonus elements as
already shown in the previous illustration or alternatively recompute the previous year EPS
taking into account the bonus element as follow: Earnings of previous
year
Last year shares in issue + bonus elements

These steps can now be used to work out the EPS for 2005 and adjusted EPS for 2014 in the
previous illustration as follows:
1. Bonus adjuster = N1.60 – N1.50 x 100% = 6.667%
N1.5
2. Bonus elements of the right issue = 100,000 x 6.667% = 6,667 shares
3. Right issue at full market price 20,000 shares – 6,667 = 13,333 shares

Weighted Average Number of Shares in Issue

Date Details Shares Months in Issue Weighted Average
01/01/2005 Balance B/F 100.000 12/12 100,000
01/10/2005 Bonus element 6,667 12/12 6,667
01/10/2005 Full mkt price 13,333 3/12 3,333
110,000
EPS = N50, 000 = 45.5k
110,000 shares

Previous year EPS 2004 = N40, 000 = 37.5k

100,000 + 6,667
Bonus or Scrip Issue
A bonus issue is a capitalization of reserves and will have no effect on the earnings capacity of
the company because no new capital is raised. The earnings per share for the accounting
period in which the issue is made and for the corresponding period should be adjusted to take
into consideration the new issue. The corresponding period is adjusted because the reserve
now being capitalized as bonus issue has been in existence since that time, and this also
enables fair basis of comparison of EPS over time. Note that the bonus issue is assumed to
have come into existence for the whole year notwithstanding the date of the issue during the
year.

Example
Hallmark Plc had 400,000 shares in issue, until on 30 September 2007 it made a bonus issues
of 100, 000 shares. Calculate the EPS for 2007 and the corresponding figure for 2006 if total
earnings were N80, 000 in 2007and N75,000 in 2006. The company’s accounting year runs
from 1st January to 31st December
2007 2006
N N
Earnings 80,000 75,000
Shares at 1st January 400,000 400,000
Bonus issue 100,000 100,000 only adjusted
500,000 500,000

EPS 16k 15k

Note no. of shares for 2006 must also be adjusted if figures for EPS are to remain comparable.

Share Split and Share Consolidation

Share split takes place when the outstanding shares in a company are increased by reducing
the par value of each share. For purpose of EPS calculation in the previous year(s), the number
of shares ranking for dividend should be adjusted just as in bonus share issue. This is because
the paid up capital remains unchanged.
Share consolidation takes place when the outstanding shares in a company are decreased by
increasing the par value of each share. The previous year’s EPS should also be adjusted to the
number of shares in issue ranking for dividend used in computing the current year EPS

Fully Diluted EPS

At the end of a reporting period, an entity may have in issue some securities which do not (at
present) have any “claim” to a share of equity earnings but may give rise to such a claim in the
future. Those securities include:
(a) A separately class of equity shares which at present is not entitled to any dividend, but will
be entitled after some future date.
(b) Convertible loan stock or convertible preferred shares which give their holders the right at
some future date to exchange their securities for ordinary shares of the company, at a
predetermined conversion rate.
(c) Options or warrants
In such circumstances, the future number of shares ranking for dividend might increase, which
in turn results in a fall in other words a future increase in number of equity share will course a
dilution or ‘watering down’ of equity and it is possible to calculate a fully diluted EPS i.e. EPS
that would have been obtained during the financial period, if the dilution had already taken
place. This will indicate to investors the possible effects of a future dilution.
IAS 33 requires that the fully diluted EPS should be disclosed if this is material, this is material if
the effect is up to 5%.
Also the IAS 33 requires that any potential increase in ordinary shares that will result in anti-
dilution should not be considered in computing the fully diluted EPS
Example
Alheri Plc has 5,000, 000 ordinary shares of 25k each in issue, and also had in issue
N1,000,000 of 14% convertible loan stock, convertible in 3 years time at the rate of 2 shares per
N10 of stock.
N 2,000,000 of 10% convertible loan stock, convertible in 1 year time at the rate of 3 shares per
N5 of stock
Total earnings in 2007 N1, 750,000
Calculate EPS and fully diluted EPS assuming tax rate is at 30%

Suggested solution
EPS = N1, 750,000 =35k
5,000,000
On dilution the (maximum) number of shares in issue will be:
Shares
Current 5,000,000
On conversion 14% stock 200,000
On conversion 10% stock 1,200,000
6,400,000

Earnings N N
Current 1,750,000
Add interest saved on 14% Stock 140,000
Add interest saved on 10% Stock 200,000 340,000
Less tax payable on profit 30% 102,000 238,000
1,988,000

Fully Diluted EPS = N1, 988,000

6,400,000 = 31k

Further Discussions on Options and Warrants

An option is the right to deal in the security of an entity at a fixed price during a specific period of
time. An option can either be a call option or a put option. A call option is a right given by one
party to another to buy a security at a fixed price during a specific period of time. A put option
is a right given by one party to another to sell a security at a fixed price during a specific
period of time.
A warrant is a certificate by a company, which gives its holder the right to purchase its shares at
a fixed price within a specific period of time. Warrants are prohibited in Nigeria by S149 of
CAMA CAP C20 LFN 2004. It should always be assumed that options are exercised, where
they exist and that the proceeds would have accrued to the enterprise at a fair value this
being the average price of the shares during the period.
Two issues are involved in computing the Diluted EPS and they are:
1. Option to issue a given number of shares at their average fair value during the period. If this
is the case, there will be no effect on diluted EPS and should be ignored while computing the
diluted EPS, this is because the price is based on fair value which is neither dilutive or anti
dilutive in nature.
2. Option to issue the remaining number of shares at no consideration. This is dilutive in nature;
the share issue has not contributed to the company’s earnings and should therefore be
added to the number of shares used in computing the diluted EPS.
Shares are issued at no consideration when shares under option are to be issued at a price
below the average market price of a company’s shares. The shares issued at fair value is
determined by relating the option price to the average market price per share, this fraction is
applied on the total number of shares under option, the difference between the total number of
shares under option and those issued at fair value constitute shares issued at no consideration.
These shares issued at no consideration is dilutive, the figure is added to the existing shares in
issue to determine the revised shares in issue to be used in the computation of diluted EPS.

Example
AB Ltd has the following results for the year ended 31 December 2006
Net earnings for the year N4, 500,000
Weighted average number of shares outstanding during the year 1,875,000
Average market value of each ordinary share during the year N50
Weighted average number of shares under option during the year 375,000
Exercise price for shares under options during the year N37.50
Required, calculate both the basic and diluted EPS for the year

Suggested Solution
Basic EPS for the year: N4, 500,000 = 240 Kobo
1,875,000
Fully diluted EPS
Revised weighted average number of shares in issue No
Existing shares 1,875,000
No of shares under option 375,000
At fair value 375,000 X N37.5/N50.00 (281,250) 93,750
No of shares for diluted EPS 1,968,750
Fully Diluted EPS = N4, 500,000 =229Kobo
1,968,750
The 93,750 shares represent shares on option which would have been issued at no
consideration if the option price N37.50 is compared to the average market price per share for
the year of N50.00

Anti Dilution
An increase in earnings per share or a reduction in loss per share resulting from the assumption
that convertible instruments are converted, that options or warrants are exercised, or that
ordinary shares are issued upon the satisfaction of specified conditions.

Retrospective Adjustments
The calculation of basic and diluted EPS for all periods presented is adjusted retrospectively
when the number of ordinary or potential ordinary shares outstanding increases as a result of a
capitalisation, bonus issue, or share split, or decreases as a result of a reverse share split. If
such changes occur after the balance sheet date but before the financial statements are
authorised for issue, the EPS calculations for those and any prior period financial statements
presented are based on the new number of shares. Disclosure is required. [IAS 33.64]

Basic and diluted EPS are also adjusted for the effects of errors and adjustments resulting from
changes in accounting policies, accounted for retrospectively. [IAS 33.64]

Diluted EPS for prior periods should not be adjusted for changes in the assumptions used or for
the conversion of potential ordinary shares into ordinary shares outstanding. [IAS 33.65]

Disclosure
If EPS is presented, the following disclosures are required: [IAS 33.70]

• the amounts used as the numerators in calculating basic and diluted EPS, and a
reconciliation of those amounts to profit or loss attributable to the parent entity for the
 period

• the weighted average number of ordinary shares used as the denominator in calculating
basic and diluted EPS, and a reconciliation of these denominators to each other

• instruments (including contingently issuable shares) that could potentially dilute basic
EPS in the future, but were not included in the calculation of diluted EPS because they
are antidilutive for the period(s) presented

• a description of those ordinary share transactions or potential ordinary share

transactions that occur after the balance sheet date and that would have changed
significantly the number of ordinary shares or potential ordinary shares outstanding at
the end of the period if those transactions had occurred before the end of the reporting
period. Examples include issues and redemptions of ordinary shares issued for cash,
warrants and options, conversions, and exercises [IAS 34.71]

An entity is permitted to disclose amounts per share other than profit or loss from continuing
operations, discontinued operations, and net profit or loss earnings per share. Guidance for
calculating and presenting such amounts is included in IAS 33.73 and 73A.

REVIEW QUESTIONS
1. No Surrender Plc had the following capital structure:
N
Ordinary shares of 50k fully paid 10,000,000
Ordinary shares of 50k partly paid at 30k 3,000,000
10% N1 Preference shares 2,000,000
Additional information:
1. On 31st March 2010, the money on the partly paid shares were received
2. On 30 June 2010, the company made a 2 for 5 bonus shares
3. On 30 September 2010 the company made a right issue of 1 for 4 at 70k per share
4. The market price of the ordinary share on the last day of quotation cum rights was 105k
5. The profits after tax but before preference dividend in the last two years were:
Year ended 31 December 2009 N5, 500,000
Year ended 31 December 2010 N7, 100,000
Required:
Calculate the basic EPS for No Surrender Plc for the year ended 31 December 2010 and
adjusted basic EPS for the year ended 31 December 2009

2. Ojoro Plc has the following results for the year ended 31 December 2009.
Earnings: Net profit attributable to ordinary shareholders was N9, 000,000
Ordinary shares outstanding had been 1,500,000 shares of N1.00 each.
Average fair value of one ordinary share during the year was N75.00
Tax rate is 30%
The following were the potential ordinary shares in issue:
• Options: 800,000 with the exercise price of N60.00
• Convertible preference shares 1,500,000 0f N6.00 per share cumulative dividend, each
share is convertible to 2 ordinary shares.
• 5%convertible bond: Nominal amount is N60,000,000, each 1,000 bond is convertible to
20 ordinary shares and there is no amortization of premium or discount affecting the
determination of the interest expense
• N120, 000,000 9% loan stock: convertible in three years time at the rate of one share
per N120.00 stock.
Required:
Calculate the basic and diluted earnings per share for the year ended 31 December 2009.
3. (a) The following figures have been calculated from the financial statements (including comparatives) of
Barstead for the year ended 30 September 2009:
increase in profit after taxation 80%
increase in (basic) earnings per share 5%
increase in diluted earnings per share 2%
Required:
Explain why the three measures of earnings (profit) growth for the same company over the same
period can
give apparently differing impressions. (4 marks)

(b) The profit after tax for Barstead for the year ended 30 September 2009 was N15 million. At 1 October
2008 the
company had in issue 36 million equity shares and a N10 million 8% convertible loan note. The loan note
will mature in 2010 and will be redeemed at par or converted to equity shares on the basis of 25 shares
for each N100 of loan note at the loan-note holders’ option. On 1 January 2009 Barstead made a fully
subscribed rights issue of one new share for every four shares held at a price of N2·80 each. The market
price of the equity shares of Barstead immediately before the issue was N3·80. The earnings per share
(EPS) reported for the year ended 30 September 2008 was 35 kobo.
Barstead’s income tax rate is 25%.
Required:
Calculate the (basic) EPS figure for Barstead (including comparatives) and the diluted EPS
(comparatives not
required) that would be disclosed for the year ended 30 September 2009. (6 marks)
(10 marks) ACCA FINANCIAL REPORTING DECEMBER 2009

SUGGESTED SOLUTIONS
1. No Surrender Plc
. (a) Earnings per Share for the year ended 31 December 2010
N6, 900,000 = 15.04k
45,875,045 shares

(b) Adjusted Earnings per share for 2009

= N5, 500,000 – 200,000 = 17.5k
26,000,000 + 12,000,000 + 3,000,060 (bonus)

(c) Disclosure of EPS information in 2010 Published Accounts

2010 2009
(i) Basic EPS 15.04k 17.5k

(ii) The EPS for 2010 is based on weighted average number of ordinary shares in issue of 45,875,,045
and earnings of N6, 900,000. The 2009 earnings per share was adjusted as a result of the right issue
carried out in 2010 and bonus share issue also made in 2010.

(iii) The EPS of 2009 of 20.38k has been adjusted to 17.5k due to bonus issue of 12 million shares during
2010 and bonus issiue of 3,000,060 shares arising from right issue made during the year 2010.

Workings
1. Weighted Average Number of Shares in Issue
Date Details No of shares Months in issue Weighted Average
01/01/2010 Balance b/f 20,000,000 12/12 20,000,000
01/01/2010 Balance b/f 10,000,000 12/12 x 30k/50k 6,000,000
31/03/2010 Bank 9/12 x 20k/50k 3,000,000
30/06/2010 Bonus issue 12,000,000(30m/5 x2) 12/12 12,000,000
 42,000,000
30/09/2010 Right issue:
Bonus 3,000,060 (wk4) 12/12 3,000,060
Full mkt price 7,499,940 (wk5) 3/12 1,874,985
52,500,000 45,875,045

2. Theoretical Ex Right Price N

4 Shares @ N1.05 4.20
1 Right issue @ N0.70 0.70
5 4.90
Theoretical Ex Right price = N4.90 = N0.98
5 shares

3. Bonus adjuster = N1.05 – N0.98 = 7.143%

N0.98

4 Bonus elements = 7.143% x 36,400,000 (20m + 10m + 12 m) = 3,000,060 shares

5. Full market price issue Right issue – bonus elements = 42,000,000/4 = 10,500,000 – 3,000,060
=7,499,940 shares

6. Earnings to Ordinary shareholders = N7,100,000-200,000 (preference dividend) = N6, 900,000

2. Ojoro Plc
(a) Basic and diluted EPS
The basic EPS is the achieved EPS of an accounting period computed on the basis of the earnings
attributable to the ordinary shareholders and weighted average number of shares in issue ranking for
dividend. Diluted EPS is the watered down EPS that recognises the existence potential ordinary shares,
when thee are no potential ordinary shares, there will be no diluted EPS information.
Both IAS 33 and SAS 21 require the disclosure of diluted EPS, however, the SAS 21 only requires
disclosure only if the degree of dilution is material (5% and above)
Both basic and diluted EPS are indicators profitability, but the diluted EPS is also a measure of risk of
margin of safety. As a measure of risk, the diluted EPS is more useful in investment decision.

(b) Circumstances that require disclosure of fully diluted EPS in published accounts
(i) Where there are ordinary shares that do not rank for dividend now but may rank for dividend in the
future periods
(ii) Where there are convertible securities that may be converted into ordinary shares
(iii) Where there are options or warrants that will result in free shares. That is to say shares under option
at a price below the average market price resulting in some share issued at no consideration.

(c) Basic EPS for year 2010 N9, 000,000 = 600k

1,500,000 shares
Diluted EPS
(i) Options:
Incremental number of ordinary shares : No
Shares under option 800,000
Shares fully paid for: N60/N75 x 800,000 (640,000)
Shares not paid for i.e. incremental shares in issue 160,000
Incremental earnings Nil
Incremental EPS 0/160,000 shares
This alternative will lead to dilution since the incremental EPS does not show any anti dilution

(ii)Convertible preference shares:

Incremental number of shares 1,500,000 x 2 = 3,000,000 shares
Incremental earnings Savings in dividend of N6 per share = N6 x 1,500,000 =N9, 000,000
Incremental EPS N9, 000,000 = 300k
3,000,000 shares
There is dilution as the incremental EPS is below the basic EPS of 600k
(iii) 5% Convertible Bond:
Incremental ordinary shares in issue N60, 000,000 x 20 shares =1,200,000 shares
1,000
Incremental earnings (after tax) 5% x N60, 000,000 x 70% =N2, 100,000
Incremental EPS =N2, 100,000 = 175k
1,200,000 shares
The incremental EPS also shows dilution as it is below the basic EPS of 600k

(iv) N100, 000,000 9% convertible loan stock:

Incremental number of shares N120, 000,000 x 1 share = 1,000,000
shares
N120
Incremental earnings (after tax) 9% x N120, 000,000 x 70% = N7,560,000
Incremental EPS N7, 560,000 = 756k
1,000,000 shares
The incremental EPS shows anti dilution and in line with IAS 33, this shall not be included in computing
diluted EPS
Summary of Incremental earnings and shares:
Earnings Shares
N No
Option 0 160,000
Convertible preference shares 9,000,000 3,000,000
Convertible Bonds 2,100,000 1,200,000
11,100,000 4,360,000

Diluted EPS N9, 000,000 + N11,100,000 343k

1,500,000 + 4,360,000 shares
Degree of dilution = Basic EPS – Diluted EPS = 600k – 343k = 42.8%
Basic EPS 600k
Disclosure is required since the degree of dilution is more than 5%

3(a) Whilst profit after tax (and its growth) is a useful measure, it may not give a fair representation of the
true underlying earnings performance. In this example, users could interpret the large annual increase in
profit after tax of 80% as being indicative of an underlying improvement in profitability (rather than what it
really is: an increase in absolute profit). It is possible, even probable, that (some of) the profit growth has
been achieved through the acquisition of other companies (acquisitive growth).
Where companies are acquired from the proceeds of a new issue of shares, or where they have been
acquired through share exchanges, this will result in a greater number of equity shares of the acquiring
company being in issue. This is what appears to have happened in the case of Barstead as the
improvement indicated by its earnings per share (EPS) is only 5% per annum. This explains why the EPS
(and the trend of EPS) is considered a more reliable indicator of performance because the additional
profits which could be expected from the greater resources (proceeds from the shares issued) is matched
with the increase in the number of shares. Simply looking at the growth in a company’s profit after tax
does not take into account any increases in the resources used to earn them. Any increase in growth
financed by borrowings (debt) would not have the same impact on profit (as being financed by equity
shares) because the finance costs of the debt would act to reduce profit.
The calculation of a diluted EPS takes into account any potential equity shares in issue. Potential ordinary
shares arise from financial instruments (e.g. convertible loan notes and options) that may entitle their
holders to equity shares in the future.
The diluted EPS is useful as it alerts existing shareholders to the fact that future EPS may be reduced as
a result of share capital changes; in a sense it is a warning sign. In this case the lower increase in the
diluted EPS is evidence that the (higher) increase in the basic EPS has, in part, been achieved through
the increased use of diluting financial instruments. The finance cost of these instruments is less than the
earnings their proceeds have generated leading to an increase in current profits (and basic EPS);
however, in the future they will cause more shares to be issued. This causes a dilution where the finance
cost per potential new share is less than the basic EPS.

(b) (Basic) EPS for the year ended 30 September 2009 (N15 million/43·25 million x 100)
34·7 kobo
Comparative (basic) EPS (35 x 3·60/3·80) 33·2
kobo
Effect of rights issue (at below market price)
100 shares at N3·80 380
25 shares at N2·80 70
––– ––––
125 shares at N3·60 (calculated theoretical ex-rights value) 450
––– ––––
Weighted average number of shares
36 million x 3/12 x N3·80/N3·60
9·50 million
45 million x 9/12 33·75
million
––––––
43·25
million
––––––
Diluted EPS for the year ended 30 September 2009 (N15·6 million/45·75 million x 100) 34·1
kobo
Adjusted earnings
15 million + (10 million x 8% x 75%) N15·6
million
Adjusted number of shares
43·25 million + (10 million x 25/100) 45·75
million

IAS 34: INTERIM FINANCIAL REPORTING – DISCLOSURES

Where an entity is required by law or regulation to provide interim financial statements, it must
follow IAS 34 minimum contents:
• Abbreviated statement of financial position
• Abbreviated Statement of Profit or Loss
• Abbreviated Statement of Profit or Loss and Other Comprehensive Income for the period
• Abbreviated statement of changes in equity for the period
• Abbreviated statement of cash flows
• Basic and diluted earnings per share
• And selected notes ( see next )
• All the above should be shown together with comparatives

Selected notes
• Confirmation that accounting policies are consistent with those previously used or, if not,
an explanation for the change and the effect of the change
 • Explanation about seasonality
• Nature and amount of “unusual items”
• Nature and amount of material changes in accounting estimates
• Movements in share capital
• Dividends
• Segmental information in accordance with IFRS 8
• Material unadjusted events subsequent to the interim period end
• Material changes in the composition of the group, if the reporting enitiy is a parent
• Changes in the state of contingencies since the previous reporting date

IAS 36: IMPAIRMENT

Objective of the Standard
To ensure that assets are carried at no more than their recoverable amount, and to define how
recoverable amount is determined.

Exceptions
IAS 36 applies to all assets except: [IAS 36.2]
• inventories (see IAS 2)
• assets arising from construction contracts (see IAS 11)
• deferred tax assets (see IAS 12)
 • assets arising from employee benefits (see IAS 19)
• financial assets (see IAS 39)
• investment property carried at fair value (see IAS 40)
• agricultural assets carried at fair value (see IAS 41)
• insurance contract assets (see IFRS 4)
• non-current assets held for sale (see IFRS 5)
Therefore, IAS 36 applies to (among other assets):
• land
• buildings
• machinery and equipment
• investment property carried at cost
• intangible assets
• goodwill
• investments in subsidiaries, associates, and joint ventures carried at cost
• assets carried at revalued amounts under IAS 16 and IAS 38

Indication of Impairment
The recoverable amounts of the following types of intangible assets should be measured
annually whether or not there is any indication that it may be impaired:
• an intangible asset with an indefinite useful life
• an intangible asset not yet available for use
• goodwill acquired in a business combination

Indicators of Impairment External Sources:

• External Sources
• market value declines
• negative changes in technology, markets, economy, or laws having adverse effect on
assets
• increases in market interest rates increasing the discount factor rate and thereby
reducing the value in use of an asset.
• company stock price is below book value indicating that the assets are not geenrating
eniugh cash flows (value in use)

Internal Sources
• obsolescence or physical damage
• asset is part of a restructuring or held for disposal it implies that its value in use has
declined
• worse economic performance than expected, implying that the assets value in use is not
as expected.

Fair Value Less Costs to Sell

• If there is a binding sale agreement, use the price under that agreement less costs of
disposal. [IAS 36.25]

• If there is an active market for that type of asset, use market price less costs of disposal.
Market price means current bid price if available, otherwise the price in the most recent
transaction. [IAS 36.26]

• If there is no active market, use the best estimate of the asset's selling price less costs of
disposal. [IAS 36.27]

• Costs of disposal are the direct added costs only (not existing costs or overhead). [IAS
36.28]
Value in Use
The calculation of value in use should reflect the following elements: [IAS 36.30]

• an estimate of the future cash flows the entity expects to derive from the asset

• expectations about possible variations in the amount or timing of those future cash flows

• the time value of money, represented by the current market risk-free rate of interest

• the price for bearing the uncertainty inherent in the asset

• other factors, such as illiquidity, that market participants would reflect in pricing the future
cash flows the entity expects to derive from the asset

Cash flow projections should be based on reasonable and supportable assumptions, the most
recent budgets and forecasts, and extrapolation for periods beyond budgeted projections. [IAS
36.33] IAS 36 presumes that budgets and forecasts should not go beyond five years; for periods
after five years, extrapolate from the earlier budgets. [IAS 36.35] Management should assess
the reasonableness of its assumptions by examining the causes of differences between past
cash flow projections and actual cash flows. [IAS 36.34]

Cash flow projections should relate to the asset in its current condition – future restructurings to
which the entity is not committed and expenditures to improve or enhance the asset's
performance should not be anticipated. [IAS 36.44]

Estimates of future cash flows should not include cash inflows or outflows from financing
activities, or income tax receipts or payments. [IAS 36.50]

Discount Rate
In measuring value in use, the discount rate used should be the pre-tax rate that reflects current
market assessments of the time value of money and the risks specific to the asset. [IAS 36.55]

The discount rate should not reflect risks for which future cash flows have been adjusted and
should equal the rate of return that investors would require if they were to choose an investment
that would generate cash flows equivalent to those expected from the asset. [IAS 36.56]

For impairment of an individual asset or portfolio of assets, the discount rate is the rate the
entity would pay in a current market transaction to borrow money to buy that specific asset or
portfolio.

If a market-determined asset-specific rate is not available, a surrogate must be used that

reflects the time value of money over the asset's life as well as country risk, currency risk, price
risk, and cash flow risk. The following would normally be considered: [IAS 36.57]

• the entity's own weighted average cost of capital;

• the entity's incremental borrowing rate; and

• other market borrowing rates.

Recognition of an impairment loss

• An impairment loss should be recognised whenever recoverable amount is below
carrying amount. [IAS 36.59]
• The impairment loss is an expense in the income statement (unless it relates to a
revalued asset where the value changes are recognised directly in equity). [IAS 36.60]
 • Adjust depreciation for future periods. [IAS 36.63]

Cash-Generating Units (CGU)

• Recoverable amount should be determined for the individual asset, if possible. [IAS
36.66]
If it is not possible to determine the recoverable amount (fair value less cost to sell and value in
use) for the individual asset, then determine recoverable amount for the asset's cash-generating
unit (CGU). [IAS 36.66] The CGU is the smallest identifiable group of assets that generates
cash inflows that are largely independent of the cash inflows from other assets or groups of
assets. [IAS 36.6]

Impairment of Goodwill
Goodwill should be tested for impairment annually. [IAS 36.96]

To test for impairment, goodwill must be allocated to each of the acquirer's cash-generating
units, or groups of cash-generating units, that are expected to benefit from the synergies of the
combination, irrespective of whether other assets or liabilities of the acquiree are assigned to
those units or groups of units. Each unit or group of units to which the goodwill is so allocated
shall: [IAS 36.80]

• represent the lowest level within the entity at which the goodwill is monitored for internal
management purposes; and

• not be larger than an operating segment determined in accordance with IFRS 8

Operating Segments.

A cash-generating unit to which goodwill has been allocated shall be tested for impairment at
least annually by comparing the carrying amount of the unit, including the goodwill, with the
recoverable amount of the unit: [IAS 36.90]

• If the recoverable amount of the unit exceeds the carrying amount of the unit, the unit
and the goodwill allocated to that unit is not impaired.

• If the carrying amount of the unit exceeds the recoverable amount of the unit, the entity
must recognise an impairment loss.

The impairment loss is allocated to reduce the carrying amount of the assets of the unit (group
of units) in the following order: [IAS 36.104]

• first, reduce the carrying amount of any goodwill allocated to the cash-generating unit
(group of units); and

• then, reduce the carrying amounts of the other assets of the unit (group of units) pro rata
on the basis.

The carrying amount of an asset should not be reduced below the highest of: [IAS 36.105]

• its fair value less costs to sell (if determinable),

• its value in use (if determinable), and

• zero.

If the preceding rule is applied, further allocation of the impairment loss is made pro rata to the
other assets of the unit (group of units).

Reversal of an impairment loss

• Same approach as for the identification of impaired assets: assess at each balance
sheet date whether there is an indication that an impairment loss may have decreased. If
so, calculate recoverable amount. [IAS 36.110]
• No reversal for unwinding of discount. [IAS 36.116]
• The increased carrying amount due to reversal should not be more than what the
depreciated historical cost would have been if the impairment had not been recognised.
[IAS 36.117]
• Reversal of an impairment loss is recognised as income in the income statement. [IAS
36.119]
• Adjust depreciation for future periods. [IAS 36.121]
• Reversal of an impairment loss for goodwill is prohibited. [IAS 36.124]

Disclosure
Disclosure by class of assets: [IAS 36.126]

• impairment losses recognised in profit or loss

• impairment losses reversed in profit or loss

• which line item(s) of the statement of comprehensive income

• impairment losses on revalued assets recognised in other comprehensive income

• impairment losses on revalued assets reversed in other comprehensive income

Disclosure by reportable segment: [IAS 36.129]

• impairment losses recognised

• impairment losses reversed

Other disclosures:

If an individual impairment loss (reversal) is material disclose: [IAS 36.130]

• events and circumstances resulting in the impairment loss

• amount of the loss

• individual asset: nature and segment to which it relates

• cash generating unit: description, amount of impairment loss (reversal) by class of

assets and segment

• if recoverable amount is fair value less costs to sell, disclose the basis for determining
fair value

• if recoverable amount is value in use, disclose the discount rate

If impairment losses recognised (reversed) are material in aggregate to the financial statements
as a whole, disclose: [IAS 36.131]
 • main classes of assets affected

• main events and circumstances

Disclose detailed information about the estimates used to measure recoverable amounts of
cash generating units containing goodwill or intangible assets with indefinite useful lives. [IAS
36.134-35]
Illustration 1
On 1 January, 2005, a parent company acquires an 80% interest in a subsidiary for
₦1.28million, when the identifiable Net Assets of the subsidiary are ₦1.2million. The subsidiary
is a cash-generating unit. At 31 December 2005, the recoverable amount of the subsidiary was
₦800,000.
The carrying amount of the subsidiary‟s identifiable assets is ₦1.08million.
Calculate the impairment loss at 31 December 2005.

Suggested Solution
(b) At 31 December, 2005, the cash-generating unit consists of the Subsidiary‟sidentifiable Net
Assets (carrying amount ₦1.08million) and Goodwill of ₦320,000 (N1,280,000 - 8% x
₦1,2million). Goodwill is grossed up to reflect the 20% non - controlling interest.
Goodwill Net Assets Total
₦ ₦ ₦
Carrying amount 320 1080 1400
Unrecognised non – controlling interest 80 - 80
400 1080 1480
Recoverable amount ( 800)
Impairment loss 680

Illustration 2
A company that extracts natural gas and oil has a drilling platform in the Niger Delta Sea. It is
required by legislation of the country concerned to remove and dismantle the platform at the end
of its useful life. Accordingly, the company has included an amount in its accounts for removal
and dismantling costs, and is depreciating this amount over the platform’s expected life.
The company is carrying out an exercise to establish whether there has been an impairment of
the platform.
• Its carrying amount in the statement of financial position is N3m.
• The company has received an offer of N2.8m for the platform from another oil company.
The bidder would take over the responsibility (and costs) for dismantling and removing
the platforms at the end of its life.
• The present value of the estimated cash flows from the platforms’ continued use is
N3.3m (before adjusting for dismantling costs)
• The carrying amount in the statement of financial position for dismantling and removal is
currently N0.6m.
What should be the value of the drilling platform in the statement of financial position, and what,
if any is the impairment loss?

Suggested Solution
Fair value less costs to sell = N2.8m
Value in use = PV of cash flows from use less the carrying
amount of the provision/liability = N3.3m – N0.6m =
N2.7m
Recoverable amount = Higher of these two amounts i.e.N2.8m
Carrying amount = N3m
Impairment loss =N0.2m
The carrying amount should be reduced to N2.8m

Illustration 3
A company has acquired another business for N4.5m; tangible assets are valued at N4.0m and
goodwill at
N0.5m.
An asset with a carrying value of N1m is destroyed in a terrorist attack. The asset was not
insured. The loss
of the asset without insurance has prompted the company to assess whether there has been an
impairment
of assets in acquired business and what the amount of any such loss is.
The recoverable amount of the business ( a single cash generating unit) is measured at N3.1m

Suggested Solution
There has been an impairment loss of N1.4m (N4.5m – N3.1m)
The impairment loss will be recognised in profit or loss. The loss will be allocated between the
assets in the
cash generating unit as follows:
(a) A loss of N1m can be attributed directly to the uninsured asset that has been destroyed.
(b) The remaining loss of N0.4m will now be allocated to goodwill.
The carrying value of the assets will now be N3m for tangible assets and N0.1m for goodwill.

Illustration 4
Okurin Meta Plc has an item of plant and machinery that has a carrying cost of N52m
as at 31 December 2012. The fair value of this asset in its active market is N54m if
the entity wishes to sell this asset as at that
date, there will be advertisement cost of N0.8m, sales commission of N2.5m and
legal fees of N0.5m.The expected cash flows from the use of this asset for the next five years is
N13m each year and the asset
is expected to be sold for N1.2m at the end of the fifth year. The pre - tax risk free market
interest rate is 10 percent per annum.
Required: determine the impairment loss if any and show how the impairment loss is expected
to be treated in the absence of a revaluation
surplus for this asset.

Suggested Solution N’m N’m

Carrying cost 52.0
Recoverable value: higher of:
(a) Fair value and value in use:
Fair value 54.0
Less: Advert cost (0.8)
Sales commission (2.5)
Legal fees (0.5)
50.2

(b) Value in use

Year Cash Flow DCF PV
N’m 10% N’m
1–5 13.0 3.7907 49.28
5 1.2 0.6209 0.75
50.03
Recoverable value N50.2 being higher than N50.03 (50.2)
Impairment loss 1.80
In the absence of a revaluation surplus for this plant and machinery, the impairment
loss is charged as expense in the income statement (debit cost of sales or
admin expenses credit plant and machinery).

Illustration 5

A cash generating unit comprising a factory, plant and equipment etc and associated purchased
goodwill becomes impaired because the product it makes is overtaken by a technically more
advanced model produced by a competitor. The recoverable amount of the cash generating unit
falls to N60m, resulting in an impairment loss of N80m, allocated as follows:
Carrying amount Carrying amount
before impairment after impairment
N’m N’m
Goodwill 40 -
Patent (with no market value) 20 -
Tangible non – current assets (mkt value N60m 80 60
Total 140 60

After three years, the entity makes a technological breakthrough of its own, and the recoverable
amount of the cash generating unit increases to N90m. The carrying amount of the tangible non
– current assets had the impairment not ocurred would have been N70m.
Required: Calculate the reversal of the impairment loss.

Suggested Solution
The reversal of the impairment loss is recognised to the extent that it increases the carrying
amount of the tangible non – current assets to what it would have been had the impairment not
taken place, i.e a reversal of the impairment loss of N10m is recognised and the tangible non –
current assets written back to N70m.. Reversal of the impairment of goodwill and patent is not
recognised because the effect of the external event that caused the original impairment has not
reversed – the original product is still overtaken by a more advanced model.

REVIEW QUESTIONS
1. (a) The objective of IAS 36 Impairment of assets is to prescribe the procedures that an entity applies to
ensure thatits 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 an impairment or how impairment losses are
allocated against assets. (4 marks)

(b) (i) 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
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

(ii) Telepath owned a 100% subsidiary, Tilda, that is treated as a cash generating unit. On 31 March 2012,
there was an industrial accident (a gas explosion) that caused damage to some of Tilda’s plant. The
assets of Tilda 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 Tilda 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.
Tilda 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 to sell (net realisable values).

Required:
Calculate the carrying amounts of the assets in (i) and (ii) above at 31 March 2012 after applying
any impairment losses.
Calculations should be to the nearest N1,000.
The following mark allocation is provided as guidance for this requirement:
(i) 4 marks
(ii) 7 marks
(11 marks)
(15 marks) ACCA FINANCIAL REPORTING JUNE 2012

SUGGESTED SOLUTION
1.(a) An impairment review is the procedure required by IAS 36 Impairment of assets 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. In turn the recoverable amount of an asset is defined as the higher of its fair
value less costs to sell or its value in use, calculated as the present values of the future net cash flows the
asset will generate.
The problem in applying this definition is 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.

(b) (i) The carrying amount of the plant at 31 March 2012, before the impairment review, is N500,000
(800,000 – (150,000 x 2)) where N150,000 is the annual depreciation charge ((800,000 cost – 50,000
residual value)/5 years).
This needs to be compared with the recoverable amount of the plant which must be its value in use as it
has no market value at this date.
Value in use:
Cash flow Discount factor Present value
N’000 at 10% N’000
year ended: 31 March 2013 220 0·91 200
31 March 2014 180 0·83 149
31 March 2015 170 + 50 0·75 165
––––
514
––––
At 31 March 2012, the plant’s value in use of N514,000 is greater than its carrying amount of N500,000.
This means
the plant is not impaired and it should continue to be carried at N500,000.

(ii) Per question After plant After impairment

write off l osses
N’000 N’000 N’000
Goodwill 1,800 1,800 write off in full nil
Patent 1,200 1,200 at realisable value 1,000
Factory 4,000 4,000 pro rata loss of 40% 2,400
Plant 3,500 3,000 pro rata loss of 40% 1,800
Receivables and cash 1,500 1,500 realisable value 1,500
––––––– ––––––– ––––––
12,000 11,500 value in use 6,700
––––––– ––––––– ––––––
The plant with a carrying amount of N500,000 that has been damaged to the point of no further use
should be written off (it no longer meets the definition of an asset). The carrying amounts in the second
column above are after writing off this plant.
After this, firstly, goodwill is written off in full.
Secondly, any remaining impairment loss should write off the remaining assets pro rata to their carrying
amounts, except that no asset should be written down to less than its fair value less costs to sell (net
realisable value).
After writing off the damaged plant the remaining impairment loss is N4·8 million (11·5m – 6·7m) of which
N1·8 million is applied to the goodwill, N200,000 to the patent (taking it to its realisable value) and the
remaining N2·8 million is apportioned pro rata at 40% (2·8m/(4m + 3m)) to the factory and the remaining
plant.
The carrying amounts of the assets of Tilda, at 31 March 2012 after the accident, are as shown in the
third column above.
IAS 37: PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS
Justification for this Standard
This Standard is required for the following reasons:
• Inconsistency in the manner entities make provision for liabilities, provisions were used
for profit smoothing.
• It therefore makes comparability of one entity’s result with another not possible
• There is that need for harmonisation of financial reports globally
• Useful to global investors due to the harmonisation advantage
• Assist to prevent creative accounting (manipulation of financial statements to suit an
entity’s desire)
• Overall, it allows transaparency in the finanacial reporting processs.

Objective of the Standard

The objective of the Standard is to establish recognition criteria and measurement bases for
provisions, contingent liabilities and contingent assets and that sufficient information is disclosed
in the notes to the financial statements to enable users to understand their nature, timing and
amount.

Provisions
Definition: The Framework defines liability as a present obligation of the entity arising from past
events, the settlement of which is expected to result in an outflow of resources from the entity
embodying economic benfits. A provision is a liability of uncertain timing or amount.

Recognition Criteria
A provision should be recognised as a liability in the financial statements when:
• An entity has a present obligation (legal or constructive) as a result of past event.
• It is probable that an outflow of resources embodying economic benefits will be
required to settle the obligations
• A reliable estimate can be made out of the amount of the obligation.

Constructive Obligation
An obligation that derives from an entity’s actions where:
• By an established pattern of past practice, published policies, or a sufficiently specific
current statement the entity has indicated to other parties that it will accept certain
responsibilites; and
• As a result, the entity has created a valid expectation on the part of those other parties
that it will discharge those responsibilities.

Probable Transfer of Resources

A transfer of resources embodying economic benefits is regarded as ‘probable’ if the event is
more likely than not to occur. This seems to indicate a probability of more than 50%. However,
the Standard makes it clear that where there are a number of similar obligations the probability
should be based on considering the population as a whole, rather than one single item.
For instance, if an entity has entered into a warranty obligation then the probability of transfer of
resources embodying economic benefits may be small in respect of one specific item. However,
when considering the population as a whole, the probability of some transfer of resources is
quite likely to be much higher. If there is a greater than 50% probability of some transfer of
economic benefits then a provision should be made for the expected amount.

Case study 1
A Stockmanns has a policy of giving full refunds, no questions asked,on goods returned to
them.
Can you detemine if this transaction gives rise to a liability?

Suggested solution:
• Is there a present obilagtion legal or constructive?
• Is it as a result of past event?
• Will there be an outflow of economic resources? (ascertain the greater than 50%)
• Is it capable of objective measurement?

Case Study 2
As a result of Nigeria Government Act on cigaretee, it became unprofitable for foreign cigarette
manufacturers to continue to produce cigarrete in that country. The board of directors of a British
cigarrete manufacturing company made the decision to close the local factory.This will inolve
closure costs including redundancy.
Ascertain if there is need to make provision

Suggested solution
Use the same criteria in the last case study.

Measurement of Provisions
The amount recognised as a provision should be the best estimate of the expenditure required
to settle the present obligation at the end of the reporting period.
The estimate will be determined by the judgement of the entity’s management this
supplemented by the experience of similar transactions.
Allowance is made for uncertainty. Where the provision being measured invloves a large
population of items, the obligation is estimated by weighing all possible outcomes by their
associated probailities, i.e. expected value.
Where the provision involves a single item, such as the outcome a legal case, provision is made
in full for the most likely outcome.

Illustration
Best Automobiles Ltd sells goods with a warranty under which customers are covered for the
cost of repairs of any manufacturing defect that becomes apparent within the first six months of
purchase. The company’s past experience and future expectations indicate the following pattern
of likely repairs.

% of goods sold Defects cost of repairs if all items

suffer from these defects
N’m
60 None -
25 Minor 3.0
15 Major 6.0
Determine the provision required.

Suggested solution
Expected value (in probability) is used to determine the amount of provision to make thus:
 = (60% x Nil) + (25% x N3.0m) + (15% x N6.0m) = N1.65m

Present Value of Provision for Liabilities

Where the effect of the time value of money is material, the amount of a provision should be the
present value of the expenditure required to settle the obligation. An appropriate discount rate
should be used. The discount rate should be a pre – tax rate that reflects current market
assessments of the time value of money. The chosen discount rate should ignore risks which
future cash flows have been adjusted.

Illustration on present value of liabilities and unwinding the discount.

XY Ltd has made a provision for a known liability of N8m payable in six years time. The pre- tax
discount rate is 10%. Therefore, the provision to make now is the present value of N8m in six
years time thus:
N
N8m x (1/1.10)6 =(8x 0.5645) (6 years) 4,516,000

In two years from now the present value of the same N8m will be:
N8m x (1/1.10)4 = (8 x 0.6830) 5,464,000
It means that the present value has improved over two years by N948,000 this is grossed up to
the liability to reflect this at N5,464,000 and Income Statement charged as discount expenses.

Expected Gains on Disposal of Non - Current Assets

The expected gains on future disposal of non – current assets should never be taken into
account while making provision for liabilities.

Reimbursements
Somtimes expenditure needed to settle a liability may be recovered from a third pary, this
rembursement should only be recognised only when it is absolutely certain that the
rembursement will be received if the entity settles the obligation.
The reimbursement should be treated as a separate transaction, i.e. asset and the amount
recognised should not be greater than the provision.. The provision and the amount recognised
may be netted off the Statement of Comprehensive Income.

Review of Provisions
Provisions are expected to be reviewed at the end of each reporting period and adjusted to
reflect the current best estimate. Where it is no longer probable that a transfer of resources will
be required to settle the obligation, the provision should be reversed.
Note that all changes to provisions and any change at the time of settlement are changes in
estimates and should be accounted for in accordance with IAS 8.

Use of Provisions
A provision should be used only for expenditure for which the provision was originally
recognised. Setting expenditures against a provision that was originally recognised for another
purpose would conceal the impact of two different events.

Future Operating Losses

Provisions should not be recognised for future operating losses. They do not meet the definition
of a liability and the general recognition criteria set out in this Standard.

Onerous Contracts
An onerous contract is a contract entered into with another party which the unavoidable costs of
fulfilling the terms of the contract exceed any revenues expected to be received from the goods
or services supplied or purchased directly or indirectly under the contract and where the entity
would have to compensate the other party if it did not fulfil the terms of the contract.
If the entity has a contract that is onerous, the present obligation under the contract should be
recognised and measured as a provision. Example is vacant leasehold property; the entity is
under an obligation to maintain the property but is receiving no income from it.
Calculate how much the entity will lose if it goes on with the contract, calculate how much the
entity will lose of it breaks the terms of the contract, and provide for the lower of these two
figures as liablity.

Examples pf Provisions
(a) Warranties. These are argued to be genuine provisions as on past experience, it is
probable, i.e. more likely than not, that some claims will emerge. The provision must be
estimated, however, on the basis of the class as a whole and not on individual claims. There is a
clear legal obligation in this case.

(b) Major Repairs. In the past it has been popular for entities to provide for expenditure on a
major overhaul to be accrued gradually over the intervening years between overhauls. This is
no longer possible under IAS 37 because this is a mere intention to carry out repairs not an
obligation because the entity can always sell the asset in the meantime. The only remedy is to
treat major assets such as aircrafts and ships as a series of smaller assets where each part is
depreciated over shorter lives. Thus any major overhaul may be argued to be replacement and
therefore capital rather than revenue expenditire.

(c) Self Insurance. A number of companies have created a provision for self insurance based
on the expected cost of making good fire, damages, etc instead of paying premiums to an
insurance company. Under IAS 37 this is not justifiable, as there is no obligation until the fire or
damages occur.

(d) Environmental Contamination. If the company has an environmental policy such that other
parties would expect the company to clean up any contamination or if the company has broken
current environmental legislation then a provision for environmental damage must be done.

(e) Decommissioning or Abandonment Cost.Where an oil company initially purchases an

oilfield it is put under a legal obligation to decommission the site at the end of the its life. Prior to
IAS 37 most oil companies set up the provision gradually over the life of the field so that no one
year would be unduly burdened with this cost. However, IAS 37 insists that a legal obligation
exists on the initial expenditure on the field and therefore a liability exists immediately. All the
costs of decommissioning in this case may be capitalised.

Restructuring Costs
IAS 37 defines a restructuring as
A programme that is planned and is controlled by management and materially changes one of
two things:
• The scope of a business undertaken by an entity
• The manner in which that business is conducted
The Standard gave the following examples of restructuring:
• The sale or termination of a line of business
• The closure of business location in a country or region or the relocation of business
activities from one country region to another
• Changes in management structure, for example, the elimination of a layer of
management
• Fundamental reorganisations that have a material effect on the nature and focus of the
entity’s operations

Criteria to Recognise Restructuring Obligation

• An entity must have a detailed plan for the restructuring
 • It must have raised a valid expectation in those affected that it will carry out the
restructuring by starting to implement that plan or announcing its main features to those
affected by it.
A mere decision by management will not warrant a provision to be made since the final approval
may be subjected to employees representative negotiation and other interested parties.
Where the restructuring involves the sale of an operation, no obligation arises until the entity
has entered into a binding sale agreement. This is because until this occurs the entity will be
able to change its mind and withdraw from the sale even if its intentions have been announced
publicly.

Costs to be Included Within Restructuring Provisions

The Standard states that a restructuring provision should include the direct expenditure arising
from the restructuring, which are those that are both:
• Necessarily entailed by the restructuring and
• Not associated with the ongoing activities of the entity.

Costs Excluded
• Retraining or relocating existing staff
• Marketing
• Investment in new systems and distribution networks.

Disclosures on Provisions
• Disclosure of details of the changes in carrying value of a provision from the beginning to
the end of the year (balance b/f, increase/decrease and balance c/f)
• Disclosure of the background to the making of the provision and the uncertainties
affecting its outcome (narrative).

Contingent Liabilities and Contingent Assets

An entity should not recognise a contigent asset or liability, but they should be disclosed.

Definition of Contingent Liability

A possible obligation that arises from past events and whose existence will be confirmed only by
the occurence or non – occurence of one or more uncertain future events not wholly within the
control of the entity or
A present obligation that arises from past event but is not recognised because:
• It is not probable that an outflow of resources embodying economic benefits will be
required to settle the obligation or
• The amount of the obligation cannot be measured with sufficient reliability

Disclosure of Contingent Liabilities

Contingent liabilities are not recognised in financial statements rather only dislosure is required:
• A brief description of the nature of the contingent liability
• An estimate of its financial effect
• An indication of the uncertainties that exist
• The possibility of any reimbursement

Contingent Assets
Defintion
IAS 37 define contingent asset as :
A possible asset that arises from past event and whose existence will be confirmed by the
occurence or non – occurence of one or more uncertain events not wholly within control of the
entity.
A continengent asset must not be recognised
Disclosure of Contingent Assets
Contingent assets must only be disclosed in the notes if they are probable. In that case a brief
description of the contingent asset should be provided along with an estimate of its likely
financial effect.

‘Let out’
IAS 37 permits a reporting entity to avoid disclosure requirments to provisions, contingent
liabilities and contingent assets if they would be expected to seriously prejudice the position of
the entity in dispute with other parties. However, this should only be employed in extremely rare
cases. Details of the general nature of the provision /contingencies must still be provided,
together with an explanation of why it has not been disclosed.

Disclosures
Reconciliation for each class of provision: [IAS 37.84]

• opening balance

• additions

• used (amounts charged against the provision)

• unused amounts reversed

• unwinding of the discount, or changes in discount rate

• closing balance

A prior year reconciliation is not required. [IAS 37.84]

For each class of provision, a brief description of: [IAS 37.85]

• nature

• timing

• uncertainties

• assumptions

• reimbursement, if any

Further illustration on recognition of liabilities

1. During 2012, Smart Plc gives a guarantee of certain borrowings of Hand Ltd, whose financial
condition at that time is sound. During 2013, the financial condition of Hand Ltd deteriotrates
and at 30 June of that year Hand Ltd files for protection from its creditors.
What accounting treatments are required in 2012 and 2013?

Suggested solution
In 2012
There is a present obligation as a result of past obligating event. The obligating event is the
giving of the guarantee, which gives rise to a legal obligation. However, at 31 December 2012
no trasfer of resources is probable in settlement of the obligation. No provision is recognised,
the guarantee is disclosed as a contingent liability unless the probability of any transfer is
regarded as remote.
At 31 December 2013
As above, there is a present obligation as a result of a past obligating event, namely the giving
of the guarantee. At 31 December, 2013 it is probable that a transfer of resources will be
required to settle the obligation; therefore, a provision is recognised in the best estimate of the
obligation.

Illustration on warranties
Adisco Ltd gives warranties at the time of sale to its customers. Under the terms of the
warranty, the manufacturer undertakes to make good, the repair or replacement of
manufacturing defects that become apparent within a period of three years from the date of
sale. Should a provision be recognised?

Suggested solution
Adisco Ltd cannot avoid the cost of repairing or replacing all items of products that manifest
manufacturing defects in respect of which warranties are given before the end of the reporting
period, and a provision for the cost of this should therefore be made.
Where Adisco is obliged to repair or replace items that fail within the entire warranty period.
Therefore, in respect of this year’s sales, the obligation provided for at the end of reporting
period should be the cost of making good items for which defects have been notified but not yet
processed, plus an estimate of costs in respect of the other items sold for which there is
sufficient evidence that the manufacturing defects will manifest themselves during their
remaining periods of warranty cover.

REVIEW QUESTIONS
1. After a wedding in 2011 ten people died, possibly as a result of food poisoning from products
sold by Careful Plc. Legal proceedings are started seeking damages from Careful Plc but it
disputes liability. Up to the date of approval of the financial statements for the year to 31
December 2011, Careful’s lawyers advise that it is probable that it will not be found liable.
However, when Careful Plc prepares the financial statements for the year ended 31 December
2012 its lawyers advice that, owing to developments in the case, it is probable that it would be
found liable.
What is the required accounting treatment for 2011 and 2012?

2. Excellent Plc is an oil entity that is exploring oil off the shores of Excessoil Islands. It has
employed oil exploration experts from around the globe. Despite all efforts, there is a major oil
spill that has grabbed the attention of the media. Environmentalists are protesting and the entity
has engaged lawyers to advise it about legal repercussions. In the past, other oil entities have
had to settle with the environmentalists, paying huge amounts in out-of-court settlements. The
legal counsel of Excellent Inc. has advised it that there is no law that would require it to pay
anything for the oil spill; the parliament of Excessoil Islands is currently considering such
legislation, but that legislation would probably take another year to be finalized as of the date of
the oil spill. However, in its television advertisements and promotional brochures, Excellent Plc
often has clearly stated that it is very conscious of its responsibilities toward the environment
and will make good any losses that may result from its exploration. This policy has been widely
publicized, and the chief executive officer has acknowledged this policy in official meetings
when members of the public raised questions to him on this issue.
Required
Does the above give rise to an obligating event that requires Excellent Plc to make a provision
for the cost of making good the oil spill?

3.Macaljoy has the following information regarding Warranties

The company manufactures and sells building equipment on which it gives a standard one year warranty
to all customers. The company has extended the warranty to two years for certain major customers and
has insured against the cost of the second year of the warranty. The warranty has been extended at nil
cost to the customer. The claims made under the extended warranty are made in the first instance against
Macaljoy and then Macaljoy in turn makes a counter claim against the insurance company. Past
experience has shown that 80% of the building equipment will not be subject to warranty claims in the first
year, 15% will have minor defects and 5% will require major repair. Macaljoy estimates that in the second
year of the warranty, 20% of the items sold will have minor defects and 10% will require major repair.

In the year to 31 October 2007, the following information is relevant:

Standard warranty Extended warranty Selling price per unit
(units) (units) (both)(N)
Sales 2,000 5,000 1,000
Major repair Minor defect
N N
Cost of repair (average) 500 100
Assume that sales of equipment are on 31 October 2007 and any warranty claims are made on 31
October in the year of the claim. Assume a risk adjusted discount rate of 4%.
Required:
(i) Discusses the principles involved in accounting for claims made under the above warranty
provision.
(6 marks)
(ii) Shows the accounting treatment for the above warranty provision under IAS37 ‘Provisions,
Contingent
Liabilities and Contingent Assets’ for the year ended 31 October 2007. (3 marks)
ACCA CORPORATE REPORTING DECEMBER 2007

4. (a) The definition of a liability forms an important element of the International Accounting Standards
Board’s
Framework for the Preparation and Presentation of Financial Statements which, in turn, forms the basis
for
IAS 37 Provisions, Contingent Liabilities and Contingent Assets.
Required:
Define a liability and describe the circumstances under which provisions should be recognised.
Give two
examples of how the definition of liabilities enhances the reliability of financial statements. (5
marks)

(b) On 1 October 2007, Promoil acquired a newly constructed oil platform at a cost of N30 million together
with the
right to extract oil from an offshore oilfield under a government licence. The terms of the licence are that
Promoil
will have to remove the platform (which will then have no value) and restore the sea bed to an
environmentally
satisfactory condition in 10 years’ time when the oil reserves have been exhausted. The estimated cost of
this
on 30 September 2017 will be N15 million. The present value of N1 receivable in 10 years at the
appropriate
discount rate for Promoil of 8% is N0·46.
Required:
(i) Explain and quantify how the oil platform should be treated in the financial statements of
Promoil for
the year ended 30 September 2008; (7 marks)
(ii) Describe how your answer to (b)(i) would change if the government licence did not require an
environmental clean up. (3 marks)
(15 marks) ACCA FINANCIAL REPORTING DECEMBER 2008
5. (a) IAS 37 Provisions, contingent liabilities and contingent assets prescribes the accounting and
disclosure for those
items named in its title.
Required:
Define provisions and contingent liabilities and briefly explain how IAS 37 improves consistency
in financial
reporting. (6 marks)

(b) The following items have arisen during the preparation of Borough’s draft financial statements for the
year ended
30 September 2011:
(i) On 1 October 2010, Borough commenced the extraction of crude oil from a new well on the seabed.
The cost of a 10-year licence to extract the oil was N50 million. At the end of the extraction, although not
legally bound to do so, Borough intends to make good the damage the extraction has caused to the
seabed environment. This intention has been communicated to parties external to Borough. The cost of
this will be in two parts: a fixed amount of N20 million and a variable amount of 2 cents per barrel
extracted. Both of these amounts are based on their present values as at 1 October 2010 (discounted at
8%) of the estimated costs in 10 years’ time. In the year to 30 September 2011 Borough extracted 150
million barrels of oil.

(ii) Borough owns the whole of the equity share capital of its subsidiary Hamlet. Hamlet’s statement of
financial
position includes a loan of N25 million that is repayable in five years’ time. N15 million of this loan is
secured on Hamlet’s property and the remaining N10 million is guaranteed by Borough in the event of a
default by Hamlet. The economy in which Hamlet operates is currently experiencing a deep recession, the
effects of which are that the current value of its property is estimated at N12 million and there are
concerns over whether Hamlet can survive the recession and therefore repay the loan.
Required:
Describe, and quantify where possible, how items (i) and (ii) above should be treated in Borough’s
statement
of financial position for the year ended 30 September 2011.
In the case of item (ii) only, distinguish between Borough’s entity and consolidated financial
statements and
refer to any disclosure notes. Your answer should only refer to the treatment of the loan and
should not
consider any impairment of Hamlet’s property or Borough’s investment in Hamlet.
Note: the treatment in the income statement is NOT required for any of the items.
The following mark allocation is provided as guidance for this requirement:
(i) 5 marks
(ii) 4 marks
(9 marks)
(15 marks) ACCA FINANCIAL REPORTING DECEMBER 2011

SUGGESTED SOLUTIONS
1. Careful Plc
2011
On the basis of the evidence available when the financial statements were approved, there is no
obligation as a result of past event so no provision is recognised. This event is only disclosed as
a contingent liability unless the probability of any transfer of resources is regarded as remote

2012
On the basis of the evidence available, there is a present obligation, a transfer of resources in
settlement is probable. A provision is recognised in the best estimate of the amount needed to
settle the present obligation.
2.(a) Present obligation as a result of a past obligating event. The obligating event is the oil spill.
Because there is no legislation in place yet that would make cleanup mandatory for any entity
operating in Excessoil Islands, there is no legal obligation. However, the circumstances
surrounding the issue clearly indicate that there is a constructive obligation since the company,
with its advertised policy and public statements, has created an expectation in the minds of the
public at large that it will honour its environmental obligations.
(b) An outflow of resources embodying economic benefits in settlement. Probable.
(c) Conclusion. A provision should be recognized for the best estimate of the cost to clean up
the oil spill.

(3) 1. Provisions – IAS37

An entity must recognise a provision under IAS37 if, and only if:
(a) a present obligation (legal or constructive) has arisen as a result of a past event (the obligating event)
(b) it is probable (‘more likely than not’), that an outflow of resources embodying economic benefits will be
required to settle the obligation
(c) the amount can be estimated reliably
An obligating event is an event that creates a legal or constructive obligation and, therefore, results in an
enterprise having no realistic alternative but to settle the obligation. A constructive obligation arises if past
practice creates a valid expectation on the part of a third party. If it is more likely than not that no present
obligation exists, the enterprise should disclose a contingent liability, unless the possibility of an outflow of
resources is remote.
The amount recognised as a provision should be the best estimate of the expenditure required to settle
the present obligation at the balance sheet date, that is, the amount that an enterprise would rationally
pay to settle the obligation at the balance sheet date or to transfer it to a third party. This means
provisions for large populations of events such as warranties, are measured at a probability weighted
expected value. In reaching its best estimate, the entity should take into account the risks and
uncertainties that surround the underlying events.
Expected cash outflows should be discounted to their present values, where the effect of the time value of
money is material using a risk adjusted rate (it should not reflect risks for which future cash flows have
been adjusted). If some or all of the expenditure required to settle a provision is expected to be
reimbursed by another party, the reimbursement should be recognised as a separate asset when, and
only when, it is virtually certain that reimbursement will be received if the entity settles the obligation. The
amount recognised should not exceed the amount of the provision. In measuring a provision future events
should be considered. The provision for the warranty claim will be determined by using the expected
value method.
The past event which causes the obligation is the initial sale of the product with the warranty given at that
time. It would be appropriate for the company to make a provision for the Year 1 warranty of N280,000
and Year 2 warranty of N350,000, which represents the best estimate of the obligation (see Appendix 2).
Only if the insurance company have validated the counter claim will Macaljoy be able to recognise the
asset and income. Recovery has to be virtually certain. If it is virtually certain, then Macaljoy may be able
to recognise the asset. Generally contingent assets are never recognised, but disclosed where an inflow
of economic benefits is probable.
The company could discount the provision if it was considered that the time value of money was material.
The majority of provisions will reverse in the short term (within two years) and, therefore, the effects of
discounting are likely to be immaterial.
In this case, using the risk adjusted rate (IAS37), the provision would be reduced to N269,000 in Year 1
and N323,000 in Year 2. The company will have to determine whether this is material.

Appendix 1
Year 1 warranty
Expected value Discounted
expected value (4%)
 N000 N000
80% x Nil 0
15% x 7,000 x N100 105
5% x 7,000 x N500 175
––––– –––––
280 269
––––– –––––
Year 2 extended warranty
Expected value Discounted
expected value (4%)

N000 N000
70% x Nil 0
20% x 5,000 x N100 100
10% x 5,000 x N500 250
––––– –––––
350 323
––––– –––––

4. (a) A liability is a present obligation of an entity arising from past events, the settlement of which is
expected to result in an outflow of economic benefits (normally cash). Provisions are defined as liabilities
of uncertain timing or amount, i.e. they are normally estimates. In essence provisions should be
recognised if they meet the definition of a liability. Equally they should not be recognised if they do not
meet the definition. A statement of financial position would not give a ‘fair representation’ if it did not
include all of an entity’s liabilities (or if it did include, as liabilities, items that were not liabilities). These
definitions benefit the reliability of financial statements by preventing profits from being ‘smoothed’ by
making a provision to reduce profit in years when they are high and releasing those provisions to increase
profit in years when they are low. It also means that the statement of financial position cannot avoid the
immediate recognition of long-term liabilities (such as environmental provisions) on the basis that those
liabilities have not matured.
(b) (i) Future costs associated with the acquisition/construction and use of non-current assets, such as
the environmental costs in this case, should be treated as a liability as soon as they become unavoidable.
For Promoil this would be at the same time as the platform is acquired and brought into use. The
provision is for the present value of the expected costs and this same amount is treated as part of the
cost of the asset. The provision is ‘unwound’ by charging a finance cost to the income statement each
year and increasing the provision by the finance cost. Annual depreciation of the asset effectively
allocates the (discounted) environmental costs over the life of the asset.

Income statement for the year ended 30 September 2008 N’000

Depreciation (see below) 3,690
Finance costs (N6·9 million x 8%) 552

Statement of financial position as at 30 September 2008

Non-current assets
Cost (N30 million + N6·9 million (N15 million x 0·46)) 36,900
Depreciation (over 10 years) (3,690)
–––––––
33,210
–––––––
Non-current liabilities
Environmental provision (N6·9 million x 1·08) 7,452

(ii) If there was no legal requirement to incur the environmental costs, then Promoil should not provide for
them as they do not meet the definition of a liability. Thus the oil platform would be recorded at N30
million with N3 million depreciation and there would be no finance costs.
However, if Promoil has a published policy that it will voluntarily incur environmental clean up costs of this
type (or if
this may be implied by its past practice), then this would be evidence of a ‘constructive’ obligation under
IAS 37 and
the required treatment of the costs would be the same as in part (i) above.

5. (a) IAS 37 Provisions, contingent liabilities and contingent assets defines provisions as liabilities of
uncertain timing or amount that should be recognised where there is a present obligation (as a result of
past events), it is probable (assumed to be more than a 50% chance) that there will be an outflow of
economic benefits (to settle the obligation) and the amounts can be estimated reliably. The obligation may
be legal or constructive.
A contingent liability has more uncertainty in that it is a possible obligation (assumed to be less than a
50% chance) whose existence will be confirmed only by one or more future uncertain events that are not
wholly within the control of the entity.
An existing obligation where the amount cannot be reliably measured is also treated as a contingent
liability.
The Standard seeks to improve consistency in the reporting of provisions. In the past some entities
created ‘general’ (rather than specific) provisions for liabilities that did not really exist (known as ‘big bath’
provisions); equally many entities did not recognise provisions where there was a present obligation. The
latter often related to deferred liabilities such as future environmental costs. The effect of such
inconsistencies was that comparability was weakened and profit was frequentlymanipulated.

(b) (i) Although the information in the question says the environmental provision is not a legal obligation, it
implies that it is a constructive obligation (Borough has created an expectation that it will pay the
environmental costs) and therefore these costs should be provided for. The obligation for the fixed
element of the cost arose as soon as the extraction commenced, whereas the variable element accrues in
line with the extraction of oil. The present value of the environmental cost is shown as a non-current
liability (credit) with the debit added to the cost of the licence and (effectively) charged to income as part
of the annual amortisation charge.
The relevant extracts from Borough’s statement of financial position as at 30 September 2011 are:
N’000
Non-current asset
Licence for oil extraction (50,000 + 20,000) 70,000
Amortisation (10 years) (7,000)
–––––––
Carrying amount 63,000
–––––––
Non-current liability
Environmental provision ((20,000 + (150,000 x 0·02 cents)) x 1·08 finance cost) 24,840
–––––––
(ii) From Borough’s perspective, as a separate entity, the guarantee for Hamlet’s loan is a contingent
liability of N10 million. As Hamlet is a separate entity, Borough has no liability for the secured amount of
N15 million, not even for the potential shortfall for the security of N3 million. The N10 million contingent
liability would normally be described and disclosed in the notes to Borough’s entity financial statements.
In Borough’s consolidated financial statements, the full liability of N25 million would be included in the
statement of
financial position as part of the group’s consolidated non-current liabilities – there would be no contingent
liability
disclosed.
The concerns over the potential survival of Hamlet due to the effects of the recession may change the
disclosure in
Borough’s entity financial statements. If Borough deems it probable that Hamlet is not a going concern the
N10 million
loan, which was previously a contingent liability, would become an actual liability and should be provided
for on
Borough’s entity statement of financial position and disclosed as a current (not a non-current) liability.

IAS 38: INTANGIBLE ASSETS

Objectives of the Standard
• To establish the criteria for recognition of intangible assets
• To specify how intangible assets should be measured
• To specify the disclosure requirements for intangible assets

Definition of an Intangible Asset

An intangible asset is an identifiable non – monetary asset without physical substance. The
asset must be
• Controlled by the entity as a result of events in the past and
• Something from which the entity expects future economic benefits to flow.

Features of Intangible Assets

(a) Identifiability
An intangible asset must be identifiable in order to distinguish it from goodwill. An intangible
asset meets the identifiability criterion when:
• Is capable of being separated from the entity and sold, transferred, licensed or rented
either individually or in a combination with a related contract, or asset or liability
• Arises from a contractual or legal rights, regardless of whether those rights are
transferable or separable from the entity or other rights or obligations.

(b) Control by the Entity

The entity by this feature must be able to enjoy the future economic benefits from the asset, and
prevent the access of others to those benefits. A legally enforceable right is evidence of such
control, but is not always a necessary condition.
• Control over technical knowledge or know how only exists if it is protected by a legal
right.
• The skill of employees arising, out the benefits of training costs, are most unlikely to be
recognisable as an intangible asset, because an entity does not control the future
actions of the staff
• Similarly, market share and customer loyalty cannot normally be intangible assets, since,
an entity cannot control the actions of its customers.

(c) Expected Future Benefits

Economic benefits may come from the sale of products or services, or from a reduction in
expenditures (cost savings).

Recognition and Measurement

An item may be recognised as an intangibe asset when it meets the defintion of intangible asset
and meets the following recognition criteria:
• It is probable that the future economic benefits that are attributable to the asset will flow
to the entity and
• The cost of the asset can be measured reliably
Initial Measurement
The initial measurement of intangible assets will depend on the means by which they are
acquired. The means of acquiring intangible assets are as follows:
(a) Purchased separately
(b) Acquired in business combination
(c) By way of government grant
(d) Exchange of assets
(e) Internally generated

(a) Purchased Separately

Initially, intangible assets shall be measured at cost. The cost of separately acquired intangible
assets comprises:
• Purchase price, including any import duties and non-refundable purchase taxes, less
discounts
and rebates; and
• Directly attributable costs of preparing the asset for use.
Directly attributable costs can include employee benefits, professional fees, and costs of testing.

Costs that cannot be included are:

• Costs of introducing new products or services, such as advertising
• Costs of conducting new business
• Administration costs
• Costs incurred while an asset that is ready for use is awaiting deployment
• Costs of redeployment of an asset
• Initial operating losses incurred from operation
If payment for an intangible asset is deferred beyond normal credit terms, then the cost is the
cash price and the balance is treated as a finance charge over the period of the finance.

(b) Acquired in Business Combination

If intangible assets are acquired as part of a business combination, as defined in IFRS 3, their
cost is their fair value at the acquisition date. The probability of future economic benefit is
reflected in the fair value, and, therefore, the probability of future economic benefit required for
recognition is presumed. In a business combination, such intangible assets are to be recognised
separately from goodwill.
Quoted market price in an active market provide, the most reliable estimate of the fair value of
an intangible asset. If no active market exists for an intangible asset, its fair value is the amount
that the entity would have paid for the asset, at the acquisition date, in an arm’s length
transaction between knowledgeable and willing parties, on the basis of the best information
available. In determinning this amount, an entity should consider the outcome of recent
transactions for similar assets. There are techniques for estimating the fair values of unique
intangible assets) such as brand names) and these may be used to measure an intangible asset
acquired in business combination.

(c) By Way of Government Grant

In accordance with IAS 20, intangible assets acquired by way of government grant and the grant
itself may be recorded initially either at cost (which may be zero) or fair value.

(d) Exchange of Assets

If an intangible asset is acquired in exchange for another asset, then the acquired asset is
measured at its fair value unless the exchange lacks commercial substance or the fair value
cannot be reliably measured, in which case the acquired asset should be measured at the
carrying amount of the asset given up, where carrying amount is equal to cost less accumulated
depreciation and impairment losses. For impairment losses, reference should be made to IAS
36. In this context, any compensation received for impairment or loss of an asset shall be
included in the income statement.

Illustration on costs capitalized as intangible asset

Brilliant Plc acquires copyrights to the original recordings of a famous singer. The agreement
with the singer allows the company to record and rerecord the singer for a period of five years.
During the initial six-month period of the agreement, the singer is very sick and consequently
cannot record. The studio time that was blocked by the company had to be paid even during the
period the singer could not sing.
These costs were incurred by the company: N
(a) Legal cost of acquiring the copyrights 10 million
(b) Operational loss (studio time lost, etc.) during start-up period 2 million
(c) Massive advertising campaign to launch the artist 1 million
Required
Which of the above items is a cost that is eligible for capitalization as an intangible asset?

Suggested solution
(a) The legal cost of acquiring the copyright can be capitalized.
(b) “Operational costs” during the start-up period are not allowed to be capitalized.
(c) Massive advertising campaign to launch the artist is not allowed to be capitalized.

(e) Internally Generated Intangible Assets

With internally generated intangible assets, problems arise in identifying whether there is an
identifiable asset that will generate future economic benefit and in reliably determining its cost.
Internally generated intangible assets include the following:
• Goodwill
• Brands
• Mastheads
• Publishing titles
• Customer lists
• Researc & development cost

Goodwill
The Standard proscribes the recognition of internally generated goodwill as an asset. The
rationale behind this is that any expenditure incurred does not result in an asset that is an
identifiable resource— it is not separable, nor does it arise from a contractual or other legal
rights—or that is controlled by the entity. In addition, any costs incurred are unlikely to be
specifically identifiable as generating the goodwill. The position that the difference between a
valuation of a business and the carrying amount of its individual assets and liabilities may be
capitalized as goodwill falls down insofar as that difference cannot be categorized as the cost
and therefore cannot be recognized as an asset.

Research and Development Costs

Research
Research activities by definition do not meet the criteria under IAS 38. This is because, at the
research stage of a project, it cannot be certain that future economic benefits will probably flow
to the entity from the project. There is too much uncertainty about the likely success or
otherwise of the project. Research costs should be written off as an expense as they are
incurred.

Examples of research costs:

• Activities aimed at obtaining new knowledge
• The search for, evaluation, and selection of applications of research findings or
knowledge
 • The search for alternatives for materials, devices, products, systems, or processes
• The formulation, design, evaluation, and selection of possible alternatives for new or
improved materials, devices, products, systems, or processes

Development Costs
Development costs may be capitaziled as intangible assets if the following conditions are met:
• The technical feasibility of completing the asset so that it will be available for use or sale
• The intention to complete the asset and use or sell it
• The ability to use or sell the asset
• How the asset will generate probable future economic benefit, including demonstrating a
market for the asset’s output, or for the asset itself, or the asset’s usefulness
• The availability of sufficient technical, financial, and other resources to complete the
development and to use or sell the asset
• The ability to reliably measure the expenditure attributable to the asset during its development

Examples of activities that may be recognized as intangible assets include:

• The design, construction, and testing of preuse prototypes or models
• The design of tools and jigs involving new technology
• The design, construction, and operation of a pilot plant that is not capable of commercial
production
• The design, construction, and testing of a chosen alternative for new or improved
materials, devices, products, systems, or processes

Other Internally Generated Intangible Assets

The Standard prohibits the recognition of internally generated brands, mastheads, publishing
titles and customers lists and similar items as intangible assets. These all fail to meet one or
more definition and recognition criteria and in some cases are probably indistinguishable from
internally generated goodwill.

Cost of an Internally Generated Intangible Asset

The costs allocated to an internally generated intangible asset should be only costs that can be
directly attributed or allocated on a reasonable and consistent basis to creating, producing or
preparing the asset for its intended use. The principles underlying the costs which may or may
not be included are similar to those for other non – current assets and inventory.
The cost of an internally generated intangible asset is the sum of the expenditure incurred from
the date when the intangible asset first meets the recognition criteria. If, as often happens,
considerable costs have already been recognised as expenses before management could
demonstrate that the criteria have been met, this earlier expenditure should not be
retrospectively recognised at a later date as part of the cost of an intangible asset.

Disclosure
For each class of intangible asset, disclose: [IAS 38.118 and 38.122]

• useful life or amortisation rate

• amortisation method

• gross carrying amount

• accumulated amortisation and impairment losses

• line items in the income statement in which amortisation is included

 • reconciliation of the carrying amount at the beginning and the end of the period showing:

• additions (business combinations separately)

• assets held for sale

• retirements and other disposals

• revaluations

• impairments

• reversals of impairments

• amortisation

• foreign exchange differences

• other changes

• basis for determining that an intangible has an indefinite life

• description and carrying amount of individually material intangible assets

• certain special disclosures about intangible assets acquired by way of government

grants

• information about intangible assets whose title is restricted

• contractual commitments to acquire intangible assets

Additional disclosures are required about:

• intangible assets carried at revalued amounts [IAS 38.124]

• the amount of research and development expenditure recognised as an expense in the

current period [IAS 38.126]

Illustration on costs to be recognised as intangible asset generated internally

Extreme Plc is a newly established enterprise. It was set up by an entrepreneur who is generally
interested in the business of providing engineering and operational support services to aircraft
manufacturers. Extreme Plc., through the contacts of its owner, received a confirmed order from
a well known aircraft manufacturer to develop new designs for ducting the air conditioning of
their aircraft. For this project, Extreme Plc needed funds aggregating to N1 million. It was able to
convince venture capitalists and was able to obtain funding of N1 million from two Silicon Valley
venture capitalists.
The expenditures Extreme Plc incurred in pursuance of its research and development project
follow, in chronological order:
• January 15, 20X5: Paid N175,000 toward salaries of the technicians (engineers and
consultants)
• March 31, 20X5: Incurred N250,000 toward cost of developing the duct and producing the test
model
• June 15, 20X5: Paid an additional N300,000 for revising the ducting process to ensure that
product could be introduced in the market
• August 15, 20X5: Developed, at a cost of N80,000, the first model (prototype) and tested it with
the air conditioners to ensure its compatibility
• October 30, 20X5: A focus group of other engineering providers was invited to a conference for
the introduction of this new product. Cost of the conference aggregated to N50,000.
• December 15, 20X5: The development phase was completed and a cash flow budget was
prepared. Net profit for the year 20X5 was estimated to equal N900,000.
Required
What is the proper accounting treatment for the various costs incurred during 20X5?

Suggested solution
Treatment of various costs incurred during 20X5 depends on whether these costs can be
capitalized or expensed as per IAS 38. Although IAS 38 is clear that expenses incurred during
the research phase should be expensed, it is important to note that not all development costs
can be capitalized. In order to be able to capitalize costs, strict criteria established by IAS 38
should be met. Based on the criteria prescribed by IAS 38, these conclusions can be drawn:
(1) It could be argued that the technical feasibility criterion was established at the end of August
20X5, when the first prototype was produced.
(2) The intention to sell or use criterion was met at the end of August 20X5, when the sample
was tested with the air-conditioning component to ensure it functions. But it was not until
October 20X5 that the product’s marketability was established. The reason is attributable to the
fact that the entity had doubts about the new models being compatible with the air conditioners
and that the sample would need further testing, had it not functioned.
(3) In October 20X5, the existence of a market was clearly established.
(4) The financial feasibility and funding criterion was also clearly met because Extreme Plc. Has
obtained a loan from venture capitalists and it had the necessary raw materials.
(5) Extreme Plc was able to measure its cost reliably, although this point was not addressed
thoroughly in the question. Extreme Plc can easily allocate labor, material, and overhead costs
reliably.
Therefore, the costs that were incurred before October 20X5 should be expensed. The total
costs that should be expensed = N175,000 + N250,000 + N300,000 + N80,000 = N805,000.
The costs eligible for capitalization are those incurred after October 20X5. However, conference
costs of N50,000 would need to be expensed because they are independent from the
development process.
Thus there are no total costs to be capitalized in terms of IAS 38.

Illustration 2 on internally generated intangible asset

Boom Plc is developing a new production process. During 2003, exxpenditure incurred was
N100,000, of which N90,000 was incurred before 1 October 2003 and N10,000 between 1
December 2003 and 31 December 2003. Boom Plc can demonstrate that, at 1 December 2003,
the production process met the criteria for recognition as an intangible asset. The recoverable
amount of the know how embodied in the process is estimated to be N50,000.
How should the expenditure be treated?

Suggested solution
At the end of 2003, the production process is recognised as intangible asset at a cost of
N10,000. This is the expenditure incurred since the date when the recognition criteria were met,
that is, 1 December 2003. The N90,000 expenditure incurred 1 December 2003 is expensed,
because the recognition criteria were not met. It will never form part of the cost of the production
process recognised in the statement of financial position.

Recognition of an Expense
All expenditure related to an intangible asset which does not meet the criteria fo recognition
either as an identifiable intangible asset or as goodwill arising on an acquistion should be
expensed as incurred. The IAS gives examples of such expenditure:
• Start up costs
• Training costs
 • Advertising costs
• Business relocation costs
Prepaid costs for services, for example, advertising or marketing costs for campaigns that have
been prepaid but not launched, can still be recognised as a prepayment.

Case study
Costs generally incurred by a newly established entity include
(a) Preopening costs of a business facility
(b) Recipes, secret formulas, models and designs, prototype
(c) Training, customer loyalty, and market share
(d) An in-house–generated accounting software
(e) The design of a pilot plan
(f) Licensing, royalty, and stand-still agreements
(g) Operating and broadcast rights
(h) Goodwill purchased in a business combination
(i) A company-developed patented drug approved for medical use
(j) A license to manufacture a steroid by means of a government grant
(k) Cost of courses taken by management in quality engineering management
(l) A television advertisement that will stimulate the sales in the technology industry

Required
Which of the above-mentioned costs are eligible for capitalization according to IAS 38, and
which of them should be expensed when they are incurred?

Suggested solution
Costs that are eligible for capitalization include items (b), (e), (f), (g), and (h); for item (j), after
initial recognition at cost, both the asset and the grant can be recognized at fair value.
These costs are eligible for capitalization under IAS 38 because
• They meet the criteria of “identifiability” (i.e., they are separable or they arise from
contractual
rights).
• It is probable that future economic benefits will flow to the entity.
• These costs can be measured reliably.
Costs that should be expensed because they do not meet the criteria under IAS 38 include
items (a), (c), and (d). Item (i) is a case of an internally generated intangible asset that can be
capitalized only provided it meets the development criterion. The main issue with item (k) is that
the entity does not have “control” over its workforce. Despite the obvious benefit of item (l) to the
business, such expenditure on advertisement does not meet the criterion of “control.”

Measurement of Intangible Assets Subsequent to Initial Recognition

The two recognised measurement basis subsequent to initial recognition are:
• Cost model and
• Revaluation model.
Cost model: In applying the cost model, an intangibe asset should be carried at its cost, less
any accumulated amortisation and less any accumulated impairment losses.

Revaluatiom model: This model allows an intangible asset to be carried at a revalued amount,
which is its fair value at the date of revaluation, less any subsequent accumulated amortisation
and any subsequent accumulated inpairment losses.
• The fair value must be able to be measured reliably with reference to an active market in
that type of asset
• The entire class carried of intangible assets of that type must be revalued at the same
time
• If an intangible asset in a class of revalued intangible assets cannot be revalued
 because there is no active market for that asset, the asset should be armortised at its
cost less any accumulated amortisation and impairment losses.
• Revaluation should be made with such regularity that the carrying amount does not differ
from that which would be determined using fair value at the end of the reporting period.
Where an intangible asset is revalued upwards to a fair value, the amount of the revaluation
should be credited directly to equity under the heading of a revaulation surplus.
However, if a revaluation surplus is a reversal of a revaluation decrease that was previously
charged against income, the increase can be recognised as income.
Where the carrying amount of an intangible asset is revalued downwards, the amount of the
downward revaluation should be charged as an xpense against income, unless the asset has
previously revaluation surplus in respect of that asset.

Illustration on revaluation of intangible assets

An intangible asset is measured by a company at fair value. The asset was revalued by N400 in
2003, and there is a revaluation surplus of N400 in the statement of financial position. At the end
of 2004, the asset is valued again, and a downward valuation of N500 is required.
Required:
State the accounting treatment for the downward revaluation.

Suggested solution
In this example, the downward revaluation of N500 can first be set against the revaluation
surplus of N400. The revaluation surplus will be reduced to zero and a charge of N100 made as
an expense in 2004.

Realisation of Revaluation Surplus

When the revaluation model is used, and an intangible asset is revalued upwards, the
cumulative revaluation surplus may be transferred to retained earnings when the surplus is
eventually realised through disposal. However, the surplus may aslo be realised over time as
the asset is used by the entity. The amount of the surplus realised each year is the difference
between the amortisation charge for the asset based on the revalued amount of the asset, and
the amortisation that would be charged on the basis of the asset’s historical cost. The realised
surplus in such case should be transferred from revaluation surplus directly to retained
earnings, and should not be taken through profit or loss.

Useful Life of Intangible Asset

An entity should assess the useful life of an intangible asset, which may be finite or indefinite.
An tangible
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 for the entity.
Many factors are considered in determining the useful life of an intangible asset, including,
expected usage, typical product life cycles, technical, technological, commercial or other types
of obsolescence, the stability of the industry, expected actions by competitors; the level of
maintenance expenditure required; and legal or similar limits on the use of the asset, such as
the expiry dates of related leases. Computer software and many other intangible assets
normally have short lives because they are susceptible to technological obsolescence.
However, unceratinty does not justify choosing a life that is unrealistically short.
The useful life of an intangible asset that arises from contractual or other legal rights should not
exceed the period of the rights, but may be shorter depending on the period over which the
entity expects to use the asset.

Amortisation Period and Amortisation Method

An intangible asset with a finite useful life should be amortised over its expected useful life
• Amortisation should start when the asset is available for use
• Amortisation should cease at the earlier of the date that the asset is classified for sale in
 accordance with IFRS 5 on Non Cuurent Assets Held for Sale and Discontinued
Operations and the date that the asset is derecognised.
• The amortisation method used should reflect the pattern in which the asset’s future
economic beenfits are consumed. If such a pattern cannot be predicted reliably, the
straight line method should be used.
• The amortisation charge for each period should normally be recognised in profit or loss.
The residual value of an intangible asset with a finite useful life is assumed to be zero
unless a third party is committed to buying the intangible asset at the end of its useful life or
unless there is an active market for that type of asset and it is probable that there will be a
market for the asset at the end of its useful life.
The amortisation period and the amortisation method used for an intangible assset with a
finite useful life should be reviewed at each financial year end.

Intangible Assets with Indefinite Useful Life

An intangible asset with an indefinte useful life should not be amortised, but it should be
subjected for impairment test at least annualy in accordance with IAS 36 on Impairment
Loss.
The useful life of an intangible asset that is not being amortised should be reviewed each
year to determine whether it is still appropriate to assess its useful life as indefinite.
Reassessing the useful life of an intangible asset as finite rather than indefinite is an
indicator that the asset may be impaired and therefore it should be tested for impairment.

Illustration on useful life of intangible assets

It may be difficult to establish the useful life of an intangible asset, and judgement will be
needed.
Consider how to determine the useful life of a purchased brand name.

Suggested solution
The factor to consider will include the following:
• Legal protection of the brand name and the control of the entity over the (illegal) use
by others of the brand name (control over pirating)
• Age of the brand name
• Status or position of the brand in its particular market
• Ability of the management of the entity to manage the brand name and to measure
activities that support the brand name
• Stability and geographical spread of the market in which the branded products are
sold
• Patterns of benefits that the brand name is expected to generate over time
• Intention of the entity to use and promote the brand over time

Disposal/ Retirement of Intangible Asset

An intangible asset should be eliminated from the statement of financial position when it is
disposed of or when there is no futher expected economic benefit from its future use. On
disposal the gain or loss arising from the difference between the net disposal proceeds and the
carrying amount of the asset should be taken to profit or loss as a gain on disposal (treated as
income or expense).

IAS 39: RECOGNITION AND MEASUREMENT OF FINANCIAL INSTRUMENTS

Initial Recognition
An enterprise should recognise a financial asset or a financial liablity on its statement of
financial position when the enterprise becomes a party to that contract that constitutes the
financial instrument. This recognition criterion departs from the recognition criteria of other
assets and liabilities (probable future economic benefits accrue to or out of the entity, the item
has cost that can be measured reliably). This is why a financial asset or liability can be
recognised even with zero value.

De-recognition
De-recognition is the removal of a previously recognized financial instrument from an entity’s
statement of financal position.

Derecognition of financial assets

An entity should de-recognize a financial asset when:
• The contractual rights to the cash flows from the financial asset expires or
• It transfers substantially all the risks and rewards of ownership of the financial asset to
another party.
• The financial asset is transferred, substantially all of the risks and rewards of ownership
are neither transferred nor retained but control of the asset has been lost.
On de-recognition, the difference between the carrying value of the instrument and the sales
proceeds (including price adjustment to fair value reported in equity) should be taken to the
income statement.

Derecognition of financial liability

A financial liability or part of a financial liability is derecognised when, and only when it is
extinguished.
This is when the obligation specified in the contract is discharged (settled) or cancelled or
expires.

Measurement of Financial Instruments

(1) Initial measurement and (2) Subsequent Measurement
Initial measurement
All financial instruments should initially be measured at cost, which is the fair value of the
consideration given or recieved, i.e. costs plus in most cases transaction costs that are directly
attributable to the acquistion or issue of the financial instrument.
Transaction costs may be incurred on initial recognition of financial instruments. The accounting
treatment of these costs depends on the subsequent accounting treatment of a financial asset
or a financial liability. Transaction costs are expensed immediately in profit or loss if the
subsequent measurement of financial instruments is at fair value. If the subsequent
measurement basis is other wise, the transaction costs are recognised in the carrying cost at
the initial measurement. Transaction cost relating to financial liabilites is deducted from the
financial liability while transaction cost relating to financia assets is added to that asset.

Categories of Financial Instruments

Financial Assets Categories
Financial assets may be categorised into four as follows:
(a) Financial assets at fair value through profit or loss. This includes financial assets held
for trading. Marked to market i.e short term investment, measured through fair value.
(b) Held to maturity investments. These are financial assets with fixed payments and a fixed
maturity that the entity intends to hold until their maturity, example, is bonds acquired from other
entities. Measured at amortized cost.
(c) Loans and Receivables. These are assets with fixed payments but are not quoted in an
active market, examples are bank loans and trade receivables. Measured at amortized cost.
(d) Available for Sale Financial Assets. These are other financial assets that do not fall into
any of the three categories above. An entity can also designate a financial asset as available for
sale when it is first recognised. Disposal of ASFA - the gain should be recognized in the profit or
loss and previously recognized which have been recorded under equity reserve should also be.
ASFA was acquired at N5m 3 years ago, at the time it was to be diposed off, the carrying cost
become N8m and it was diposed off at N10m.

Financial Liabilities Categories

Financial liabilities may fall into any of the two categories below.
(a) Financial liabilities at fair value through profit or loss.
(b) Financial liabilities measured at armotised cost. This category is for all other financial
liabilities other than those measured at fair value through profit or loss.

(2) Subsequent Measurement

After initial recognition, financial instruments may be measured either at fair value or amortised
cost depending on the category the financial instrument belongs to. The subsequent
measurement basis of the different categories of financial instruments is outlined below:

Financial Assets
(a) Financial assets at fair value through profit or loss. These are subsequently measured at fair
value and the gains or losses recognised in the profit or loss account. They are said to be
marked to market.
(b) Held to maturity investments. The subsequent measurement basis is amortised cost.
(c) Loans and receivables. The subsequent measurement basis is amortised cost.
(d) Available for sale financial assets. The subsequent measurement basis is fair value. Unlike
financial assets at fair value, the gains and losses on this category of financial assets are
recognised in other comprehensive income not profit or loss account. Such gains or losses are
accumulated in a separate equity reserve until the disposal of the financial assets when such
reserves are transferred to profit or loss.

Financial Liabilities
(a) Liabilities at fair value through profit or loss. The subsequent measurement basis is fair
value. The gains or losses are recognised in the profit or loss account.
(b) Liabilities measured at amortised cost. The subsequent measurement basis is amortised
cost.

Measurement of Financial Instruments at Amortised Cost

Amortised cost of a financial asset or financial liability: This is the amount at which the
financial asset or liability is measured at initial recognition minus principal repayments, plus or
minus the cumulative amortization of any difference between the initial amount and the maturity
amount, and minus any write down for impairment or uncertainty.
The effective interest method: This is a method of calculating the amortised cost of a financial
instrument and of allocating the interest income or interest expense over the relevant periods.
The effective interest rate is the rate that exactly discounts estimated future payments or
receipts through the expected life of the financial instrument to the net carrying amount.
In summary measurement of financial assets at amortised cost entails:
• Initial cost of investment (fair value) plus;
• Interest income recognised using effective rate less;
• Interest actually recieved in cash.
Measurement of financial liabilities at amotised cost entails:
• Initial cost plus
• Interest expense recognised using effective rate less
• Interest actually paid in cash.

Impairment of Financial Assets

All financial assets should be reviewed for impairment at each statement of financial position
date. If there is any objective evidence that a financial asset is impaired, it should be written
down to its estimated recoverable value. Note that this rule only applies to financial assets
measured at amortised cost and those measured at fair value through other comprehensive
income. Financial assets measured at fair value through profit or loss by implication has already
complied with impairment test.
The impairment loss of financial assets is determined by comparing the carrying cost of the
assets with their recoverable values. Recoverable values are determined discounting the future
cash flows from the asset using the effective rate as the discount rate.

Embedded Derivatives
An embedded derivative is known as hybrid contract because it contains the host contract and
an embedded derivative. For example, a loan might have interest or principal repayments linked
to oil prices. This implies that there is an oil derivative embedded in the loan.

Separation of Hybrid from Host Contract in Embedded Derivatives

The hybrid contract is separated from the host contract in embedded derivatives if the following
rules are met:
(a) when the hybrid is not measured at fair value with changes to profit or loss
(b) a separate instrument with similar terms will be a derivative and
(c) the economic characteristics and risks are not closely related to those of the host
Embedded derivatives measured at fair value need no separation as the separation will still lead
to measurement at fair value.

Hedging
This is the process of entering into a transaction to minimise risk. In most cases derivatives are
used by entities as hedging instrument, such that gains or losses from holding such derivatives
can offset gains or losses on items being hedged.
Hedge accounting entails that a gain on a hedging instrument which must have been reported in
the profit or loss should be used to offset a loss from a transaction or other event being hedged.
This could be the other way round that is, loss from a hedging instrument reported in profit or
loss used to offset a gain from a transaction or other event being hedged.

Conditions for Hedge Accounting by IAS 39

(a) Hedge of net items cannot qualify for hedge accounting, for example, an entity cannot carry
out a hedge on a net asset, being deduction of liability from an asset and hedging the net
amount.
(b) An entity can only hedge risk components not ‘total risk’ hedge. For example, an entity in
Nigeria invests in a foreign interest yielding bond, each risk component must be hedged
separately, and these include, credit risk, inerest rate risk and foreign currency risk.
(c) Hedge accounting is only allowed for hedges involving derivatives external to the entity, the
use of non- derivatives be it financial asset or financial liability is not allowed except for hedges
of foreign exchange risk.

Hedge Effectiveness
This is the degree to which changes in the fair value or cash flows of the hedged item that are
attributable to a hedged risk are offset by changes the fair value or cash flows of the hedging
instrument.

The Rules of Hedge Accounting

The Standard provides basic rules that should be applicable in the process of matching the
gains or losses on the derivative instruments with the gains or losses on hedged items. These
rules or principles are:
(a) The derivative must be designated as a hedging instrument
(b) The hedge must be expected to be highly effective (almost offsetting all of the risk)
(c) The hedge must be regularly assessed and found to be highly effective (change in value
ranges between 80% to 125%)
(d) Formal documentation prepared disclosing the following:
• The hedging instrument
• The hedged item
• The hedged risk
• The method of testing effectiveness
• The type of hedge

Fair Value Models (hedging relationship)

Three fair value models are identified:
• Fair value hedges (change in fair value of asset or liability); the gain or loss on the
hedging instrument recognised in profit or loss; the carrying amount of the hedged item
adjusted for such gain or loss and the corresponding entry in profit or loss
• Cash flow hedges (risk of changes in cash flows of asset or liability); the gain or loss
classified into effective and inneffective applying 80% to 125% rule. The effective
amount recognised in other comprehensive income and the ineffective amount
recognised in the profit or loss.
• Hedges of net investment in a foreign entity; net investments in foreign subsidiaries
translated at every reporting period and exchange gain or loss on translation recognised
in other comprehensive income.

Example on measurement of financial asset at amortised cost

On 1 January 2011 AB Ltd purchases a debt instrument for its fair value of N1,000. The debt
instrument is due to mature on 31 December 2015. The instrument has a principal amount of
N1,250 and the instrument carries fixed interest at 4.72% that is paid annually.
How should AB Ltd account for the debt instrument over its five year term if the subsequent
measuement basis is at amortised cost?

Suggested solution
AB Ltd will receive interest of N59 being N1,250 x 4.72% each year and N1,250 when the
instrument matures. AB Ltd must allocate the discount of N250 and the interest receivable over
the five year term at a constant rate on the carrying amount of the debt (this gives 5% per
annum). To do this effective interest rate 10% must applied (4.72% + 5%). This rate is usually
given in the examination questions.

The following table shows the allocation over the years

Year Amortised cost Income Statement Interest Amortised cost
Interest income
at beginning of int. effective rate received at end of year
during the
year for year 10% year 4.72% bal c/f
bal b/f (cash inflow)
N N N N
2011 1,000 100 (59) 1,041
2012 1,041 104 (59) 1,086
2013 1,086 109 (59) 1,136
2014 1,136 113 (59) 1,190
2015 1,190 119 (1,250+59) -

Workings
The carrying amount of the financial asset is increased each year by the interest income of 10%
and decreased by the actual interest received annually of N59.

The accounting entries are as follows

Year 1
Dr Bank N59
Dr Financial Asset (N100 – N59) N41
Cr Finance income - Profit or Loss N100

Year 2
Dr Bank N59
Dr Financial Asset (N104 – N59) N45
Cr Finance income - Profit or Loss N104

Year 3
Dr Bank N59
Dr Financial Asset (N109 – N59) N50
Cr Finance income - Profit or Loss N109

Year 4
Dr Bank N59
Dr Financial Asset (N113 – N59) N54
Cr Finance income - Profit or Loss N113

Year 5
Dr Bank N59
Dr Financial Asset (N119 – N59) N60
Cr Finance income - Profit or Loss N119

On redemption in year 5
Dr Bank N1,250
Cr Financial Asset N1,250

Example 2 Financial liability measured at amortised cost

Global Investments Ltd issues a bond for N503,778 on 1 January 2012. No interest is payable
on the bond, but it will be held to maturity and redeemed on 31 December 2014. For N600,000.
The bond has not been designated as at fair through profit and loss and is therefore measured
at amortised cost
Required:
Calculate the charge to the Income Statement of Global Investment Ltd for the year ended 31
December 2012 and the balance outstanding at 31 December 2012.

Suggested solution
The bond is a financial liability of Global Investment It is measured at amortised cost. Although
there is no interest as such, the difference between the initial cost of the bond and the price at
which it will be redeemed is a financial cost. This must be allocated over the term of the bond at
a constant rate on the carrying amount.
To calculate amortised cost we need to calculate the effective interest rate of the bond:
N600,000 = = 1.06 per annum
N503,778
Therefore the effective interest rate is 6%
The charge to Income Statement is N30,226 (N503,778 x 6%)
The balance outstanding at 31 December 2012 is N534,004 (N503,778 + N30,226)

The schedule of the periodic carring value of the Bond is as below:

Year Carrying value Interest at Carrying value
B/F effective rate 6% C/F
N N N
1 503,778 30,226 534,004
2 534,004 32,040 566,044
3 566,044 33,956 (appr) 600,000 (settlement date)

The accounting entries like the financial assets will be:

Year 1
Dr Finance cost - Profit or Loss N30,226
Cr Financial liability (Bond) N30,226

Year 2
Dr Finance cost - Profit or Loss N32,040
Cr Financial Liability (Bond) N32,040

Year 3
Dr Finance cost - Profit or Loss N33,956
Cr Financial Liability (Bond) N33,956

On redemption at the end of year 3

Dr Financial Liability (Bond) N600,000
Cr Bank N600,000

Disclosure Requirements
The disclosure requrements on recognition and messurement of financial instruments are done
by IFRS 7

REVIEW QUESTIONS
1. Bertrand issued N10 million convertible loan notes on 1 October 2010 that carry a nominal interest
(coupon) rate of
5% per annum. They are redeemable on 30 September 2013 at par for cash or can be exchanged for
equity shares
in Bertrand on the basis of 20 shares for each N100 of loan. A similar loan note, without the conversion
option, would
have required Bertrand to pay an interest rate of 8%.
When preparing the draft financial statements for the year ended 30 September 2011, the directors are
proposing to
show the loan note within equity in the statement of financial position, as they believe all the loan note
holders will
choose the equity option when the loan note is due for redemption. They further intend to charge a
finance cost of
N500,000 (N10 million x 5%) in the income statement for each year up to the date of redemption.
The present value of N1 receivable at the end of each year, based on discount rates of 5% and 8%, can
be taken as:
5% 8%
End of year 1 0·95 0·93
2 0·91 0·86
3 0·86 0·79
Required:
(a) (i) Explain why the nominal interest rate on the convertible loan notes is 5%, but for non-
convertible loan
notes it would be 8%. (2 marks)
(ii) Briefly comment on the impact of the directors’ proposed treatment of the loan notes on the
financial statements and the acceptability of this treatment. (3 marks)

(b) Prepare extracts to show how the loan notes and the finance charge should be treated by
Bertrand in its
financial statements for the year ended 30 September 2011. (5 marks)
(10 marks) ACCA FINANCIAL REPORTING DECEMBER 2011

2. The directors of Aron, a public limited company, are worried about the challenging market conditions
which the
company is facing. The markets are volatile and illiquid. The central government is injecting liquidity into
the economy.
The directors are concerned about the significant shift towards the use of fair values in financial
statements. IAS 39
‘Financial Instruments: recognition and measurement’ defines fair value and requires the initial
measurement of
financial instruments to be at fair value. The directors are uncertain of the relevance of fair value
measurements in
these current market conditions.
Required:
(a) Briefly discuss how the fair value of financial instruments is determined, commenting on the
relevance of fair value measurements for financial instruments where markets are volatile and
illiquid. (4 marks)

(b) Further they would like advice on accounting for the following transactions within the financial
statements for the
year ended 31 May 2009:
(i) Aron issued one million convertible bonds on 1 June 2006. The bonds had a term of three years and
were issued with a total fair value of N100 million which is also the par value. Interest is paid annually in
arrears at a rate of 6% per annum and bonds, without the conversion option, attracted an interest rate of
9% per annum on 1 June 2006. The company incurred issue costs of N1 million. If the investor did not
convert to shares they would have been redeemed at par. At maturity all of the bonds were converted into
25 million ordinary shares of N1 of Aron. No bonds could be converted before that date. The directors are
uncertain how the bonds should have been accounted for up to the date of the conversion on 31 May
2009 and have been told that the impact of the issue costs is to increase the effective interest rate to
9·38%. (6 marks)

(ii) Aron held 3% holding of the shares in Smart, a public limited company. The investment was classified
as available-for-sale and at 31 May 2009 was fair valued at N5 million. The cumulative gain recognised in
equity relating to the available-for-sale investment was N400,000. On the same day, the whole of the
share capital of Smart was acquired by Given, a public limited company, and as a result, Aron received
shares in Given with a fair value of N5·5 million in exchange for its holding in Smart. The company wishes
to know how the exchange of shares in Smart for the shares in Given should be accounted for in its
financial records. (4 marks)

(iii) The functional and presentation currency of Aron is the naira (N). Aron has a wholly owned foreign
subsidiary, Gao, whose functional currency is the zloti. Gao owns a debt instrument which is held for
trading. In Gao’s financial statements for the year ended 31 May 2008, the debt instrument was carried at
its fair value of 10 million zloti.
At 31 May 2009, the fair value of the debt instrument had increased to 12 million zloti. The exchange
rates
were:
Zloti to N1
31 May 2008 3
31 May 2009 2
Average rate for year to 31 May 2009 2·5
The company wishes to know how to account for this instrument in Gao’s entity financial statements and
the consolidated financial statements of the group. (5 marks)

(iv) Aron granted interest free loans to its employees on 1 June 2008 of N10 million. The loans will be paid
back on 31 May 2010 as a single payment by the employees. The market rate of interest for a two-year
loan on both of the above dates is 6% per annum. The company is unsure how to account for the loan but
wishes to classify the loans as ‘loans and receivables’ under IAS 39 ‘Financial Instruments: recognition
and measurement’. (4 marks)
Required:
Discuss, with relevant computations, how the above financial instruments should be accounted
for in the
financial statements for the year ended 31 May 2009.
Note. The mark allocation is shown against each of the transactions above.
Note. The following discount and annuity factors may be of use
Discount factors Annuity factors
6% 9% 9·38% 6% 9% 9·38%
1 year 0·9434 0·9174 0·9142 0·9434 0·9174 0·9174
2 years 0·8900 0·8417 0·8358 1·8334 1·7591 1·7500
3 years 0·8396 0·7722 0·7642 2·6730 2·5313 2·5142
Professional marks will be awarded in question 2 for clarity and quality of discussion. (2 marks)
(25 marks) ACCA CORPORATE REPORTING JUNE 2009

SUGGESTED SOLUTIONS
1. (a) (i) The interest rate (5%) for the convertible loan notes is lower because of the potential value of the
conversion option. The cost of equivalent loan notes without the option is 8%, the difference is mainly due
to the market expectation of the higher worth of Bertrand’s equity shares (compared to the cash
alternative) when the loan notes are due for redemption. From the entity’s viewpoint, the conversion
option means lower payments of interest (to help cash flow), but it will eventually cause a dilution of
earnings.

(ii) If the directors’ treatment were acceptable, the use of the conversion option (compared to issuing non-
convertible loans) would improve profit and earnings per share because of lower interest rates (and hence
interest charges) and the company’s gearing would be lower as the loan notes would not be shown as
debt. However, this proposed treatment is not acceptable. A convertible loan note is a complex (hybrid)
financial instrument and IFRS requires that the proceeds of the issue should be allocated between equity
(the value of the option) and debt and the finance charge should be based on that of an equivalent non-
convertible loan (8% in this case).

(b) Extracts from the financial statements of Bertrand

Income statement for the year ended 30 September 2011
N’000
Finance costs (9,190 x 8%) 735 rounded

Statement of financial position as at 30 September 2011

Equity
Equity option 810
Non-current liabilities
8% convertible loan notes ((9,190 x 1·08) – 500) 9,425
rounded
Working
Year ended Cash flow Discount rate Discounted cash flows
30 September N’000 at 8% N’000
2011 500 0·93 465
2012 500 0·86 430
2013 10,500 0·79 8,295
–––––––
value of debt component 9,190
value of equity option component (= balance) 810
–––––––
total proceeds 10,000
–––––––

2. (a) Discussion of fair value and its relevance

The fair value of an asset is the amount at which that asset could be bought or sold in a current
transaction between willing parties, other than in a liquidation. The fair value of a liability is the amount at
which that liability could be incurred or settled in a current transaction between willing parties, other than
in a liquidation. If available, a quoted market price in an active market is the best evidence of fair value
and should be used as the basis for the measurement. If a quoted market price is not available, preparers
should make an estimate of fair value using the best information available in the circumstances. This may
include discounting future cash flows or using pricing models such as Black-Scholes. However these
methods all use an element of estimation which in itself can create discrepancies in the values that result.
In an efficient market these differences should be immaterial.
The IASB has concluded that fair value is the most relevant measure for most financial instruments. Fair
value measurements provide more transparency than historical cost based measurements. Reliability is
as important as relevance because relevant information that is not reliable is of no use to an investor. Fair
value measurements should be reliable and computed in a manner that is faithful to the underlying
economics of the transaction. Measuring financial instruments at fair value should not necessarily mean
abandoning historical cost information.
However, market conditions will affect fair value measurements. In many circumstances, quoted market
prices are
unavailable. As a result, difficulties occur when making estimates of fair value. It is difficult to apply fair
value measures in illiquid markets and to decide how and when models should be used for fair valuation.
Fair value information can provide a value at the point in time that it is measured but its relevance will
depend on the volatility of the market inputs and whether the instruments are actively traded or are held
for the long term. Fair value provides an important indicator of risk profile and exposure but to fully
understand this and to put it into context, the entity must disclose sufficient information.

(b) (i) Convertible bond

Some compound instruments have both a liability and an equity component from the issuer’s perspective.
In this case,
IAS32 ‘Financial Instruments: Presentation’ requires that the component parts be accounted for and
presented separately according to their substance based on the definitions of liabilities and equity. The
split is made at issuance and not revised for subsequent changes in market interest rates, share prices,
or other events that changes the likelihood that the conversion option will be exercised. (IAS32.28)
A convertible bond contains two components. One is a financial liability, namely the issuer’s contractual
obligation to
pay cash in the form of interest or capital, and the other is an equity instrument, which is the holder’s
option to convert
into shares. When the initial carrying amount of a compound financial instrument is required to be
allocated to its equity and liability components, the equity component is assigned the residual amount
after deducting from the fair value of the instrument as a whole the amount separately determined for the
liability component. (IAS32.31)
In the case of the bond, the liability element will be determined by discounting the future stream of cash
flows which
will be the interest to be paid and the final capital balance assuming no conversion. The discount rate
used will be 9%
which is the market rate for similar bonds without the conversion right. The difference between cash
received and the
liability component is the value of the option.
N’000
Present value of interest at end of:
Year 1 (31 May 2007) (N100m x 6%) ÷ 1·09 5,505
Year 2 (31 May 2008) (N100m x 6%) ÷ 1·092 5,050
Year 3 (31 May 2009) (N100m + (N100m x 6%))÷ 1·093 81,852
––––––––
Total liability component 92,407
Total equity element 7,593
––––––––
Proceeds of issue 100,000
––––––––
The issue cost will have to be allocated between the liability and equity components in proportion to the
above proceeds.
N’000 N’000 N’000
Liability Equity Total
Proceeds 92,407 7,593 100,000
Issue cost (924) (76) (1,000)
––––––– –––––– ––––––––
91,483 7,517 99,000
––––––– –––––– ––––––––
The credit to equity of N7,517 would not be re-measured. The liability component of N91,483 would be
measured at
amortised cost using the effective interest rate of 9·38%, as this spreads the issue costs over the term of
the bond. The interest payments will reduce the liability in getting to the year end. The initial entries would
have been:
N000 N000
Dr Cash 100,000 Cr Cash 1,000
Cr Liability 92,407 Dr Liability 924
Cr Equity 7,593 Dr Equity 76
The liability component balance on 31 May 2009 becomes N100,000 as a result of the effective interest
rate of 9·38%
being applied and cashflows at 6% based on nominal value.
B/f Effective Interest 9·38% Cashflow 6% C/f
N’000 N’000 N’000 N’000
91,483 8,581 6,000 94,064
94,064 8,823 6,000 96,887
96,887 9,088 6,000 ~100,000
On conversion of the bond on 31 May 2009, Aron would issue 25 million ordinary shares of N1 and the
original equity
component together with the balance on the liability will become the consideration.
N’000
Share capital – 25 million at N1 25,000
Share premium 82,517
––––––––
Equity and liability components (100,000 + 7,593 – 76) 107,517
––––––––
(ii) Shares in Smart
In this situation Aron has to determine if the transfer of shares in Smart qualifies for derecognition. The
criteria are firstly to determine that the asset has been transferred, and then to determine whether or not
the entity has transferred
substantially all of the risks and rewards of ownership of the asset. If substantially all the risks and
rewards have been
transferred, the asset is derecognised. If substantially all the risks and rewards have been retained,
derecognition of the asset is precluded. (IAS39.20)
In this case the transfer of shares qualifies for derecognition as Aron no longer retains any risks and
rewards of
ownership. In addition Aron obtains a new financial asset which is the shares in Given which should be
recognised at
fair value. The transaction will be accounted for as follows:
N’m
Proceeds 5·5
Carrying amount of shares in Smart 5
––––
Gain on recognition 0·5
Gain in equity reclassified 0·4
––––
Gain to profit/loss 0·9
––––
The gain on disposal will be N900,000. The accounting entries would be:
N’m N’m
Dr Shares in Given 5·5 Cr Gain on sale 0·4
Cr Shares in Smart 5 Dr Equity 0·4
Cr Gain on sale 0·5
Gain on sale Transfer of accrued gain in equity

(iii) Foreign Subsidiary

In this situation, IAS 39 will apply to the debt instrument in the foreign subsidiary’s financial statements
and IAS 21, ‘The Effects of Changes in Foreign Exchange Rates’, will apply in translating the financial
statements of the subsidiary. Under IAS 21, all exchange differences resulting from translation are
recognised in equity until disposal of the subsidiary. This includes exchange differences on financial
instruments carried at fair value through profit or loss and financial assets classified as available-for-sale.
As the debt instrument is held for trading it will be carried at fair value through profit or loss in Gao’s
financial statements.
Thus at 31 May 2009, there will be a fair value gain of 2 million zloti which will be credited to the income
statement
of Gao. In the consolidated financial statements, the carrying value of the debt at 1 June 2008 would have
been
N3·3 million (10 million zloti ÷ 3). At the year end this carrying value will have increased to N6 million (12
million zloti
÷ 2). Aron will translate the income statement of Gao using the average rate of 2·5 zloti to the naira.
Although the fair
value of the debt instrument has increased by N2·7 million, Aron will only recognise 2 million zloti ÷ 2·5,
i.e. N800,000
of this in the consolidated income statement with the remaining increase in value of (N2·7 – N0·8) million,
i.e.
N1,900,000 being classified as equity until the disposal of the foreign subsidiary.
N’m
Opening balance at 1 December 2008 3·3
Increase in year 2·7
–––
Closing balance at 30 November 2009 6·0
–––
Dr Debt instrument 2·7
Cr Consolidated income statement 0·8
Cr Equity 1·9
(iii) Interest Free Loans
When a financial asset is recognised initially, IAS 39 requires it to be measured at fair value, plus
transaction costs in
certain situations. Normally the fair value is the fair value of the consideration given. However, the fair
value of an
interest free loan may not necessarily be its face amount. The instrument’s fair value may be evidenced
by comparison with other market transactions in the same instrument. In this case, the fair value may be
estimated as the discounted present value of future receipts using the market interest rate. The difference
between the fair value of the loan and the face value of the loan will be treated as employee remuneration
under IAS19, ‘Employee Benefits’.
N’m
Fair value of loan at 1 June 2008 (10/(1·062)) 8·9
Employee compensation 1·1
–––––
10
–––––
The employee compensation would be charged to the income statement over the two-year period. As the
company
wishes to classify the asset as loans and receivables, it will be measured at 31 May 2009, at amortised
cost using the
effective interest method. In this case the effective interest rate will be 6% and the value of the loan in the
statement of
financial position will be (N8·9 million x 1·06) i.e. N9·43 million. Interest of N0·53 million will be credited to
the income
statement.

At 1 June 2008
N’m
Dr Loan 8·9
Dr Employee compensation 1·1
Cr Cash 10
At 31 May 2009
Dr Loan 0·53
Cr Income statement – interest 0·53

IAS 40: INVESTMENT PROPERTY

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

Examples of investment property:

• land held for long-term capital appreciation

• land held for undetermined future use

• building leased out under an operating lease

• vacant land held to be leased out under an operating lease

• property that is being constructed or developed for future use as investment property
Items That Are Not Investment Property
• property held for use in the production or supply of goods or services or for
administrative purposes

• property held for sale in the ordinary course of business or in the process of construction
of development for such sale (IAS 2 Inventories)

• property being constructed or developed on behalf of third parties (IAS 11 Construction

Contracts)

• owner-occupied property (IAS 16 Property, Plant and Equipment), including property

held for future use as owner-occupied property, property held for future development and
subsequent use as owner-occupied property, property occupied by employees and
owner-occupied property awaiting disposal

• property leased to another entity under a finance lease

Partial own use
If the owner uses part of the property for its own use, and part to earn rentals or for capital
appreciation, and the portions can be sold or leased out separately, they are accounted for
separately. Therefore the part that is rented out is investment property. If the portions cannot be
sold or leased out separately, the property is investment property only if the owner-occupied
portion is insignificant. [IAS 40.10]

Ancillary services.
If the entity provides ancillary services to the occupants of a property held by the entity, the
appropriateness of classification as investment property is determined by the significance of the
services provided. If those services are a relatively insignificant component of the arrangement
as a whole (for instance, the building owner supplies security and maintenance services to the
lessees), then the entity may treat the property as investment property. Where the services
provided are more significant (such as in the case of an owner-managed hotel), the property
should be classified as owner-occupied. [IAS 40.13]

Intracompany rentals.
Property rented to a parent, subsidiary, or fellow subsidiary is not investment property in
consolidated financial statements that include both the lessor and the lessee, because the
property is owner-occupied from the perspective of the group. However, such property could
qualify as investment property in the separate financial statements of the lessor, if the definition
of investment property is otherwise met. [IAS 40.15]

Recognition
• If its is probable that the future economic benfits will flow to the entity
• If the cost can be measured reliably

Measurement
Initial Measurement
Investment property is initially measured at cost, including transaction costs. Such cost should
not include start-up costs, abnormal waste, or initial operating losses incurred before the
investment property achieves the planned level of occupancy.
Measurement Subsequen to Intial Recognition
Entities should value investment property under the:
• Cost model, or
• Fair value model
• Whichever model is chosen should then be applied to all investment property
Cost Model
Under cost model investment property will be carried at historic cost less accumulated
depreciation

Fair Value Model

Under fair value model:-
• Initial recognition is at cost
• Subsequent measurement is at fair value
• Gains and losses on subsequent measurement go through the Statement of Profit or
Loss and Other Comprehensive Income
• Fair value is normally open-market price with no adjustment for transaction costs (see
next)
• Profits and losses on disposal are proceeds less carrying value

Fair value determination:

• Normally by reference to current prices on an active market for similar properties in a
similar location in a similar condition
• If no active market exists then consider:-
• Current prices on an active market for properties of a different nature, location or
condition making adjustments to take account of the differences
• Recent prices in a less active market
• Present values of associated future cash flows capable of reliable measurement
• if not possible to arrive at a fair value, the cost model should be applied
• A lessee under an operating lease may treat leased property as investment property,
but must then also treat the lease as a finance lease, and must adopt the fair value
model

Changes in classification
A change in classification to or from investment property can only be effected where there is a
change in the use of the property as follows:
• Investment property now being owner occupied: use fair value at date of change and
then follow IAS 16
• Investment property now ready for sale:use fair value at date of transfer and then follow
IAS 2
• Owner occupied now classed as investment property: carry at fair value if using fair
value model.It will previously have been depreciated under IAS 16, so a change to
investment property will normally result in an increase in valuation, that increase should
be credited to a revaluation reserve. If it’s a decrease, then recognise in full in the
Statement of Profit or Loss and Other Comprehensive Income
• Transferring from inventory to investment property: Carry at fair value if using fair value
model. Difference between fair value and inventory value recognised in the Statement of
Profit or Loss and Other Comprehensive Income.
When an entity decides to sell an investment property without development, the property is not
reclassified as investment property but is dealt with as investment property until it is disposed of.
[IAS 40.58]

When an entity uses the cost model for investment property, transfers between categories do
not change the carrying amount of the property transferred, and they do not change the cost of
the property for measurement or disclosure purposes.

Disposal
An investment property should be derecognised on disposal or when the investment property is
permanently withdrawn from use and no future economic benefits are expected from its
disposal. The gain or loss on disposal should be calculated as the difference between the net
disposal proceeds and the carrying amount of the asset and should be recognised as income or
expense in the income statement. [IAS 40.66 and 40.69] Compensation from third parties is
recognised when it becomes receivable. [IAS 40.72]

Disclosure
• Whichever model is being used, disclose:
• Rental income
• Investment property operating expenses
• Any restrictions on sale or remittance of income or sale proceeds
• Any obligations to purchase, construct or develop properties

• if using cost model, also disclose:

• Depreciation method
• Useful lives or depreciation rates
• Movements in the year for cost and depreciation
• Investment property fair value, or an explanation of why this cannot be determined

• if using fair value model, also disclose:

• Method and assumptions used in determining fair values
• Identity and qualifications of any professional valuers used
• Additions and disposals during the period
• Net gains/losses arising from fair value adjustments
• Transfers to and from investment property

Illustration
Kaduna Investment Coy Plc, incorporated in Nigeria ventured into construction of a mega
shopping mall in south Asia, which is rated as the largest shopping mall of Asia. The company’s
board of directors after market research decided that instead of selling the shopping mall to a
local investor, who had approached them several times during the construction period with
excellent offers which he progressively increased during the year of construction, the company
would hold this property for the purposes of earning rentals by letting out space in the shopping
mall to tenants. For this purpose it used the services of a real estate company to find an anchor
tenant (a major international retail chain) that then attracted other important retailers locally to
rent space in the mega shopping mall, and within months of the completion of the construction
the shopping mall was fully let out.

The construction of the shopping mall was completed and the property was placed in service at
the end of 20X1. According to the company’s engineering department the computed total cost of
the construction of the shopping mall was N100 million. An independent valuation expert was
used by the company to fair value the shopping mall on an annual basis. According to the fair
valuation expert the fair values of the shopping mall at the end of 20X1 and at each subsequent
year-end thereafter were
20X1 N100 million
20X2 N120 million
20X3 N125 million
20X4 N115 million
The independent valuation expert was of the opinion that the useful life of the shopping mall
was 10 years and its residual value was N10 million.
Required
What would be the impact on the profit and loss account of the company if it decides to treat the
shopping mall as an investment property under IAS 40
(a) Using the “fair value model”; and
(b) Using the “cost model.”
(Since the rental income for the shopping mall would be the same under both the options, for
the purposes of this exercise do not take into consideration the impact of the rental income from
the shopping mall on the net profit or loss for the period).

Suggested Solution
(a) Fair value model
If the company chooses to measure the investment property under the fair value model it will
have to recognize in net profit or loss for each period changes in fair value from year to year.
Thus the impact on the profit and loss account for the various years would be:
Year Cost(N millions) Fair value(N millions) Profit or Loss
a/c(Nmillions)
20X1 100 100 0
20X2 120 20
20X3 125 5
20X4 115 (10)

(b) Cost model

If the company decided to measure the investment property under the cost model it would have
to account for it under IAS 16 using the cost model prescribed under that standard (which
requires that the asset should be carried at its cost less accumulated depreciation and any
accumulated impairment losses). Therefore, when investment property is measured under the
cost model, the fluctuations in the fair value of the investment property from year to year would
have no effect on the profit and loss account of the entity. Instead, the annual depreciation
which is computed based on the acquisition cost of the investment property will be the only
charge to the net profit or loss for each period (unless there is impairment which will also be a
charge to the net profit or loss for the year).
Based on the acquisition cost of N10 million (assuming there is no subsequent expenditure that
would be capitalized), a residual value of N10 million, a useful life of 10 years, and using the
straight-line method of depreciation, the annual impact of depreciation on the net profit or
loss for each year would be:
20X1 N (100 – 10)/10 years =N9 million
20X2 N (100 – 10)/10 years = N9 million
20X3 N (100 – 10)/10 years =N9 million
20X4 N (100 – 10)/10 years = N9 million

REVIEW QUESTION
1. (a) The accounting treatment of investment properties is prescribed by IAS 40 Investment Property.
Required:
(i) Define investment property under IAS 40 and explain why its accounting treatment is different
from that of owner-occupied property;
(ii) Explain how the treatment of an investment property carried under the fair value model differs
from an
owner-occupied property carried under the revaluation model.
The following mark allocation is provided as guidance for this requirement:
(i) 3 marks
(ii) 2 marks
(5 marks)

(b) Speculate owns the following properties at 1 April 2012:

Property A: An office building used by Speculate for administrative purposes with a depreciated historical
cost of
N2 million. At 1 April 2012 it had a remaining life of 20 years. After a reorganisation on 1 October 2012,
the
property was let to a third party and reclassified as an investment property applying Speculate’s policy of
the fair
value model. An independent valuer assessed the property to have a fair value of N2·3 million at 1
October 2012,
which had risen to N2·34 million at 31 March 2013.

Property B: Another office building sub-let to a subsidiary of Speculate. At 1 April 2012, it had a fair value
of N1·5 million which had risen to N1·65 million at 31 March 2013.
Required:
Prepare extracts from Speculate’s entity statement of profit or loss and other comprehensive
income and
statement of financial position for the year ended 31 March 2013 in respect of the above
properties. In the
case of property B only, state how it would be classified in Speculate’s consolidated statement of
financial
position.
Note: Ignore deferred tax. (5 marks)
(10 marks) ACCA FINANCIAL REPORTING JUNE 2013

SUGGESTED SOLUTION
1. (a) (i) An investment property is land or buildings (or a part thereof) held by the owner to generate
rental income or for capital appreciation (or both) rather than for production or administrative use. It would
also include property held under a finance lease and may include property under an operating lease, if
used for the same purpose as other investment properties. Generally, non-investment properties generate
cash flows in combination with other assets, whereas a property that meets the definition of an investment
property means that it will generate cash flows that are largely independent of the other assets held by an
entity and, in that sense, such properties do not form part of the entity’s normal operations.

(ii) Superficially, the revaluation model and fair value sound very similar; both require properties to be
valued at their fair value which is usually a market-based assessment (often by an independent valuer).
However, any gain (or loss) over a previous valuation is taken to profit or loss if it relates to an investment
property, whereas for an owner-occupied property, any gain is taken to a revaluation reserve (via other
comprehensive income and the statement of changes in equity). A loss on the revaluation of an owner-
occupied property is charged to profit or loss unless it has a previous surplus in the revaluation reserve
which can be used to offset the loss until it is exhausted. A further difference is that owner-occupied
property continues to be depreciated after revaluation, whereas investment properties are not
depreciated.

(b) Extracts from Speculate’s financial statements for the year ended 31 March 2013
(workings in brackets in N’000)
N’000
Statement of profit or loss and other comprehensive income
Depreciation of office building (A) (2,000/20 years x 6/12) (50)
Gain on investment properties: A (2,340 – 2,300) 40
B (1,650 – 1,500) 150
Other comprehensive income (A see below) 350

Statement of financial position

Non-current assets
Investment properties (A and B) (2,340 + 1,650) 3,990
Equity
Revaluation reserve (A) (2,300 – (2,000 – 50)) 350

In Speculate’s consolidated financial statements property B would be accounted for under IAS 16
Property, Plant and
Equipment and be classified as owner-occupied. Further information is required to determine the
depreciation charge.

IAS 41: AGRICULTURE

Definition of Terms
Biological assets: Living plants and animals.
Agricultural produce: The harvested product of the entity’s biological assets, for example, milk
and coffee beans.
Biological transformation: Relates to the processes of growth, degeneration, and production
that can cause changes of quantitative or qualitative nature in a biological asset.
Active market: One where these conditions exist: The items traded in the market are
homogenous; willing buyers and sellers normally can be found at any time; and prices are
available to the public.
Fair value: The amount for which an asset can be exchanged or a liability settled in an arm’s
length transaction between knowledgeable and willing parties. The fair value of an asset is
based on its present location and condition.
Government grants: Those as defined in IAS 20, Accounting for Government Grants and
Disclosure of Government Assistance.
Costs to sell – incremental costs directly attributable to the disposal of an asset excluding
finance costs and taxation

Background and Introduction

The main objective of IAS 41 is to establish accounting standards for agricultural activity. This
Standard applies to biological assets, agricultural produce at the point of harvest, and
government grants. The Standard does not apply to land related to agricultural activity, which is
covered by IAS 16, Property, Plant, and Equipment, and IAS 40, Investment Property, or to
intangible assets related to agricultural activity, which are covered by IAS 38, Intangible Assets.

initial recognition
An entity should recognise a biological asset or agricultural produce only when the entity:
• Controls the asset
• -As a result of past events
• It is probable that future economic inflows will result
• The asset and inflows are capable of reliable measurement

Measurement
Biological Assets
On initial recognition and on subsequent reporting dates, biological assets should be measured
at fair value less estimated costs to sell, unless fair value cannot be reliably measured (see
below)

Agricultural Produce
• Agricultural produce should be measured at fair value less estimated costs to sell at the
point of harvest because harvested produce is a marketable commodity, there is no
exception for measurement unreliability
• Any gain on initial recognition of biological assets at fair value less costs to sell, and any
changes during a period in fair valueless costs to sell of biological assets are reported in
 the statement of profit or loss
• Similarly, any gain on initial recognition of agricultural produce at fair value less costs to
sell should be included in the statement of profit or loss for the period in which it arises
• All costs related to biological assets measured at fair value are recognised as expenses
in the period in which they are incurred with the exception of the purchase cost of those
assets
• From above, there remains a problem with measurement of a biological asset for which
fair value cannot be reliably measured it is conceivable that, at initial measurement,
there is no quoted price in an active market for the biological asse and nalternative
appropriate and workable method exists:
• in this case, the asset should be measured at cost less accumulated
depreciation and impairment losses
• but the entity must still measure all of its other biological assets at fair value
less costs to sell
• and if circumstances change and fair value becomes reliably measurable, a
switch to fair value less costs tsell is required

Guidance on the Measurement of Fair Value

• Best measure is “quoted market price in an active market”
• If inactive market, a market based price such as the most recent market price for that
type (or similar) asset
• If market based prices not available, the net present value of related cash flows from
that asset, discounted at the entity’s current cost of capital
• In rare circumstances, cost may be taken as fair value where there has been little or no
change to the biological asset since acquisition or where such change is not likely to
have a material affect on value
• The fair value of a biological asset is based on current prices and is not reflective of
actual prices agreed in binding sales contracts requiring delivery at some time in the
future

Sundry points
• Change in fair value of biological assets is part due to physical change
• (asset is one year older) and part due to market price change
• Separate disclosure of the elements is encouraged but not required
• Fair value measurement stops at harvest. After that, IAS on inventory applies
• Agricultural land is accounted for under IAS 16 on Property, Plant & Equipment
• But agricultural assets attached tthe land (for example fruit trees) are measured
separately from the land
• Intangible agricultural assets (for example milk quotas) are accounted for under IAS 38
on Intangible Assets
• Government grants unconditionally received in respect of biological assets measured at
fair value less costs tsell are accounted for as income in the period when the grant is
receivable • but if the grant is conditional, it shall be recognised as income only when the
conditions have been met,this includes grants receivable where an entity is required
NOT to engage in agricultural activities

Disclosure
Disclosure requirements in IAS 41 include:

• carrying amount of biological assets [IAS 41.39]

• description of an entity's biological assets, by broad group [IAS 41.41]

 • change in fair value less costs to sell during the period [IAS 41.40]

• fair value less costs to sell of agricultural produce harvested during the period [IAS
41.48]

• description of the nature of an entity's activities with each group of biological assets and
non-financial measures or estimates of physical quantities of output during the period
and assets on hand at the end of the period [IAS 41.46]

• information about biological assets whose title is restricted or that are pledged as
security [IAS 41.49]

• commitments for development or acquisition of biological assets [IAS 41.49]

• financial risk management strategies [IAS 41.49]

• methods and assumptions for determining fair value [IAS 41.47]

• reconciliation of changes in the carrying amount of biological assets, showing separately

changes in value, purchases, sales, harvesting, business combinations, and foreign
exchange differences [IAS 41.50]

Disclosure of a quantified description of each group of biological assets, distinguishing between

consumable and bearer assets or between mature and immature assets, is encouraged but not
required. [IAS 41.43]

If fair value cannot be measured reliably, additional required disclosures include: [IAS 41.54]

• description of the assets

• an explanation of the circumstances

• if possible, a range within which fair value is highly likely to lie

• depreciation method

• useful lives or depreciation rates

• gross carrying amount and the accumulated depreciation, beginning and ending

If the fair value of biological assets previously measured at cost now becomes available, certain
additional disclosures are required. [IAS 41.56]

Disclosures relating to government grants include the nature and extent of grants, unfulfilled
conditions, and significant decreases expected in the level of grants. [IAS 41.58]

Example 1
An entity on adoption of IAS 41 has reclassified certain assets as biological assets. The total
value of the group’s forest assets is N2,000 million comprising
Nm
Freestanding trees 1,700
Land under trees 200
Roads in forests 100
2,000
Required
Show how the forests would be classified in the financial statements.
Suggested Solution
The forests would be classified as
Nm
Biological assets 1,700
Noncurrent assets—land 200
Noncurrent assets—other tangible assets 100
2,000

Example 2
An entity has these balances in its financial records:
Nm
Value of biological asset at cost 12/31/X1 600
Fair valuation surplus on initial recognition at fair value 12/31/X1 700
Change in fair value to 12/31/X2 due to growth and price fluctuations 100
Decrease in fair value due to harvest 90
Required
Show how these values would be incorporated into the financial statements at December 31,
20X2.

Suggested Solution
Statement of Financial Position as at December 31, 20X2:
Nm
Biological assets— 600
Fair valuation (included in profit or loss year ended 12/31/01) 700
Carrying value 1/1/20X2 1,300
Change in fair value 100
Decrease due to harvest (90)
Carrying value at December 31, 20X2 1,310

Income statement for year ended December 31, 20X2:

Biological assets change in fair value 100
Decrease due to harvest (90)
Net gain 10

IFRS1: FIRST TIME ADOPTION OF IFRS

Objective
IFRS 1 First-time Adoption of International Financial Reporting Standards sets out the
procedures that an entity must follow when it adopts IFRSs for the first time as the basis for
preparing its general purpose financial statements.

Definition of first-time adoption

A first-time adopter is an entity that, for the first time, makes an explicit and unreserved
statement that its general purpose financial statements comply with IFRSs. [IFRS 1.3]

An entity may be a first-time adopter if, in the preceding year, it prepared IFRS financial
statements for internal management use, as long as those IFRS financial statements were not
made available to owners or external parties such as investors or creditors. If a set of IFRS
financial statements was, for any reason, made available to owners or external parties in the
preceding year, then the entity will already be considered to be on IFRSs, and IFRS 1 does not
apply. [IFRS 1.3]
An entity can also be a first-time adopter if, in the preceding year, its financial statements: [IFRS
1.3]

• asserted compliance with some but not all IFRSs, or

• included only a reconciliation of selected figures from previous GAAP to IFRSs.

(Previous GAAP means the GAAP that an entity followed immediately before adopting to
IFRSs.)

However, an entity is not a first-time adopter if, in the preceding year, its financial statements
asserted:

• Compliance with IFRSs even if the auditor's report contained a qualification with respect
to conformity with IFRSs.

• Compliance with both previous GAAP and IFRSs.

Overview for an entity that adopts IFRSs for the first time in its annual financial
statements for the year ended 31 December 2009
Accounting policies

Select accounting policies based on IFRSs effective at 31 December 2009.

IFRS reporting periods

Prepare at least 2009 and 2008 financial statements and the opening balance sheet (as of 1 January 2008
or beginning of the first period for which full comparative financial statements are presented, if earlier) by
applying the IFRSs effective at 31 December 2009. [IFRS 1.7]

• Since IAS 1 requires that at least one year of comparative prior period financial information be
presented, the opening balance sheet will be 1 January 2008 if not earlier. This would mean that an
entity's first financial statements should include at least: [IFRS 1.21]

• three balance sheets (statements of financial position)

• two statements of comprehensive income

• two separate income statements (if presented)

• two statements of cash flows

• two statements of changes in equity and

• related notes, including comparative information

• If a 31 December 2009 adopter reports selected financial data (but not full financial statements) on
an IFRS basis for periods prior to 2008, in addition to full financial statements for 2008 and 2009,
that does not change the fact that its opening IFRS balance sheet is as of 1 January 2008.

Adjustments required to move from previous GAAP to IFRSs at the time of first-time
adoption
Derecognition of some previous GAAP assets and liabilities

The entity should eliminate previous-GAAP assets and liabilities from the opening balance sheet
if they do not qualify for recognition under IFRSs. [IFRS 1.10(b)] For example:
 • IAS 38 does not permit recognition of expenditure on any of the following as an
intangible asset:

• research

• start-up, pre-operating, and pre-opening costs

• training

• advertising and promotion

• moving and relocation

If the entity's previous GAAP had recognised these as assets, they are eliminated in the
opening IFRS balance sheet
• If the entity's previous GAAP had allowed accrual of liabilities for "general reserves",
restructurings, future operating losses, or major overhauls that do not meet the
conditions for recognition as a provision under IAS 37, these are eliminated in the
opening IFRS balance sheet

• If the entity's previous GAAP had allowed recognition of contingent assets as defined in
IAS 37.10, these are eliminated in the opening IFRS balance sheet

Recognition of some assets and liabilities not recognised under previous GAAP

Conversely, the entity should recognise all assets and liabilities that are required to be
recognised by IFRS even if they were never recognised under previous GAAP. [IFRS 1.10(a)]
For example:

• IAS 39 requires recognition of all derivative financial assets and liabilities, including
embedded derivatives. These were not recognised under many local GAAPs.

• IAS 19 requires an employer to recognise a liability when an employee has provided

service in exchange for benefits to be paid in the future. These are not just post-
employment benefits (eg, pension plans) but also obligations for medical and life
insurance, vacations, termination benefits, and deferred compensation. In the case of
'over-funded' defined benefit plans, this would be a plan asset.

• IAS 37 requires recognition of provisions as liabilities. Examples could include an entity's

obligations for restructurings, onerous contracts, decommissioning, remediation, site
restoration, warranties, guarantees, and litigation.

• Deferred tax assets and liabilities would be recognised in conformity with IAS 12.

Reclassification

The entity should reclassify previous-GAAP opening balance sheet items into the appropriate
IFRS classification. [IFRS 1.10(c)] Examples:

• IAS 10 does not permit classifying dividends declared or proposed after the balance
sheet date as a liability at the balance sheet date. If such liability was recognised under
previous GAAP it would be reversed in the opening IFRS balance sheet.

• If the entity's previous GAAP had allowed treasury stock (an entity's own shares that it
had purchased) to be reported as an asset, it would be reclassified as a component of
equity under IFRS.
 • Items classified as identifiable intangible assets in a business combination accounted for
under the previous GAAP may be required to be reclassified as goodwill under IFRS 3
because they do not meet the definition of an intangible asset under IAS 38. The
converse may also be true in some cases.

• IAS 32 has principles for classifying items as financial liabilities or equity. Thus
mandatorily redeemable preferred shares that may have been classified as equity under
previous GAAP would be reclassified as liabilities in the opening IFRS balance sheet.
Note that IFRS 1 makes an exception from the "split-accounting" provisions of IAS 32. If
the liability component of a compound financial instrument is no longer outstanding at
the date of the opening IFRS balance sheet, the entity is not required to reclassify out of
retained earnings and into other equity the original equity component of the compound
instrument.

• The reclassification principle would apply for the purpose of defining reportable
segments under IFRS 8.

• The scope of consolidation might change depending on the consistency of the previous
GAAP requirements to those in IAS 27. In some cases, IFRS will require consolidated
financial statements where they were not required before.

• Some offsetting (netting) of assets and liabilities or of income and expense items that
had been acceptable under previous GAAP may no longer be acceptable under IFRS.

Measurement

The general measurement principle – there are several significant exceptions noted below – is
to apply effective IFRSs in measuring all recognised assets and liabilities. [IFRS 1.10(d)]

How to recognise adjustments required to move from previous GAAP to IFRSs

Adjustments required to move from previous GAAP to IFRSs at the time of first-time adoption
should be recognised directly in retained earnings or, if appropriate, another category of equity
at the date of transition to IFRSs. [IFRS 1.11]

Estimates
In preparing IFRS estimates at the date of transition to IFRSs retrospectively, the entity must
use the inputs and assumptions that had been used to determine previous GAAP estimates as
of that date (after adjustments to reflect any differences in accounting policies). The entity is not
permitted to use information that became available only after the previous GAAP estimates
were made except to correct an error. [IFRS 1.14]

Changes to disclosures
For many entities, new areas of disclosure will be added that were not requirements under the
previous GAAP (perhaps segment information, earnings per share, discontinuing operations,
contingencies and fair values of all financial instruments) and disclosures that had been
required under previous GAAP will be broadened (perhaps related party disclosures).

Disclosure of selected financial data for periods before the first IFRS balance sheet
If a first-time adopter wants to disclose selected financial information for periods before the date
of the opening IFRS balance sheet, it is not required to conform that information to IFRS.
Conforming that earlier selected financial information to IFRSs is optional.[IFRS 1.22]
If the entity elects to present the earlier selected financial information based on its previous
GAAP rather than IFRS, it must prominently label that earlier information as not complying with
IFRS and, further, it must disclose the nature of the main adjustments that would make that
information comply with IFRS. This latter disclosure is narrative and not necessarily quantified.
[IFRS 1.22]

Disclosures in the financial statements of a first-time adopter

IFRS 1 requires disclosures that explain how the transition from previous GAAP to IFRS
affected the entity's reported financial position, financial performance and cash flows. [IFRS
1.23] This includes:

• Reconciliations of equity reported under previous GAAP to equity under IFRS both (a) at
the date of the opening IFRS balance sheet and (b) the end of the last annual period
reported under the previous GAAP. [IFRS 1.24(a)] (For an entity adopting IFRSs for the
first time in its 31 December 2009 financial statements, the reconciliations would be as
of 1 January 2008 and 31 December 2008.)

• Reconciliations of total comprehensive income for the last annual period reported under
the previous GAAP to total comprehensive income under IFRSs for the same period
[IFRS 1.24(b)]

• explanation of material adjustments that were made, in adopting IFRSs for the first time,
to the balance sheet, income statement and cash flow statement [IFRS 1.25]

• If errors in previous GAAP financial statements were discovered in the course of

transition to IFRSs, those must be separately disclosed [IFRS 1.26]

• If the entity recognised or reversed any impairment losses in preparing its opening IFRS
balance sheet, these must be disclosed [IFRS 1.24(c)]

• Appropriate explanations if the entity has elected to apply any of the specific recognition
and measurement exemptions permitted under IFRS 1 – for instance, if it used fair
values as deemed cost.

Disclosures in interim financial reports

If an entity is going to adopt IFRSs for the first time in its annual financial statements for the year
ended 31 December 2009, certain disclosure are required in its interim financial statements
prior to the 31 December 2009 statements, but only if those interim financial statements purport
to comply with IAS 34 Interim Financial Reporting. Explanatory information and reconciliation
are required in the interim report that immediately precedes the first set of IFRS annual financial
statements. The information includes reconciliations between IFRS and previous GAAP. [IFRS
1.32]

Exceptions to the retrospective application of other IFRSs

Prior to 1 January 2010, there were three exceptions to the general principle of retrospective
application. On 23 July 2009, IFRS 1 was amended, effective 1 January 2010, to add two
additional exceptions with the goal of further simplifying the transition to IFRSs for first-time
adopters. The five exceptions are: [IFRS 1.Appendix B]

IAS 39 – Derecognition of financial instruments

A first-time adopter shall apply the derecognition requirements in IAS 39 prospectively for
transactions occurring on or after 1 January 2004. However, the entity may apply the
derecognition requirements retrospectively provided that the needed information was obtained
at the time of initially accounting for those transactions. [IFRS 1.B2-3]

IAS 39 – Hedge accounting

The general rule is that the entity shall not reflect in its opening IFRS balance sheet (statement
of financial position) a hedging relationship of a type that does not qualify for hedge accounting
in accordance with IAS 39. However, if an entity designated a net position as a hedged item in
accordance with previous GAAP, it may designate an individual item within that net position as a
hedged item in accordance with IFRS, provided that it does so no later than the date of
transition to IFRSs. [IFRS 1.B5]

IAS 27 – Non-controlling interest

IFRS 1.B7 lists specific requirements of IAS 27(2008) that shall be applied prospectively.

Full-cost oil and gas assets.

Entities using the full cost method may elect exemption from retrospective application of IFRSs
for oil and gas assets. Entities electing this exemption will use the carrying amount under its old
GAAP as the deemed cost of its oil and gas assets at the date of first-time adoption of IFRSs.

Determining whether an arrangement contains a lease

If a first-time adopter with a leasing contract made the same type of determination of whether an
arrangement contained a lease in accordance with previous GAAP as that required by IFRIC 4
Determining whether an Arrangement Contains a Lease, but at a date other than that required
by IFRIC 4, the amendments exempt the entity from having to apply IFRIC 4 when it adopts
IFRSs.

Optional exemptions from the basic measurement principle in IFRS 1

There are some further optional exemptions to the general restatement and measurement
principles set out above. The following exceptions are individually optional. They relate to:

• business combinations [IFRS 1.Appendix C]

• and a number of others [IFRS 1.Appendix D]:

• share-based payment transactions

• insurance contracts

• fair value or revaluation as deemed cost

• leases

• employee benefits

• cumulative translation differences

• investments in subsidiaries, jointly controlled entities, associates and joint

ventures
 • assets and liabilities of subsidiaries, associated and joint ventures

• compound financial instruments

• designation of previously recognised financial instruments

• fair value measurement of financial assets or financial liabilities at initial

recognition

• 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 with equity instruments

• severe hyperinflation

• joint arrangements

Some, but not all, of them are described below.

Business combinations that occurred before opening balance sheet date

IFRS 1 includes Appendix C explaining how a first-time adopter should account for business
combinations that occurred prior to transition to IFRS.

An entity may keep the original previous GAAP accounting, that is, not restate:

• previous mergers or goodwill written-off from reserves

• the carrying amounts of assets and liabilities recognised at the date of acquisition or
merger or

• how goodwill was initially determined (do not adjust the purchase price allocation on
acquisition)

However, should it wish to do so, an entity can elect to restate all business combinations
starting from a date it selects prior to the opening balance sheet date.

In all cases, the entity must make an initial IAS 36 impairment test of any remaining goodwill in
the opening IFRS balance sheet, after reclassifying, as appropriate, previous GAAP intangibles
to goodwill.

The exemption for business combinations also applies to acquisitions of investments in

associates and of interests in joint ventures.

Fair value or revaluation as deemed cost

Assets carried at cost (e.g. property, plant and equipment) may be measured at their fair value
at the opening IFRS balance sheet date. Fair value becomes the 'deemed cost' going forward
under the IFRS cost model. Deemed cost is an amount used as a surrogate for cost or
depreciated cost at a given date. [IFRS 1.D6]
If, before the date of its first IFRS balance sheet, the entity had revalued any of these assets
under its previous GAAP either to fair value or to a price-index-adjusted cost, that previous
GAAP revalued amount at the date of the revaluation can become the deemed cost of the asset
under IFRS. [IFRS 1.D6]

If, before the date of its first IFRS balance sheet, the entity had made a one-time revaluation of
assets or liabilities to fair value because of a privatisation or initial public offering, and the
revalued amount became deemed cost under the previous GAAP, that amount would continue
to be deemed cost after the initial adoption of IFRS. [IFRS 1.D8]

This option applies to intangible assets only if an active market exists. [IFRS 1.D7]

IAS 19 – Employee benefits: actuarial gains and losses

An entity may elect to recognise all cumulative actuarial gains and losses for all defined benefit
plans at the opening IFRS balance sheet date (that is, reset any corridor recognised under
previous GAAP to zero), even if it elects to use the IAS 19 corridor approach for actuarial gains
and losses that arise after first-time adoption of IFRS. If a first-time adopter uses this exemption,
it shall apply it to all plans. [IFRS 1.D10]

IAS 21 – Accumulated translation reserves

An entity may elect to recognise all translation adjustments arising on the translation of the
financial statements of foreign entities in accumulated profits or losses at the opening IFRS
balance sheet date (that is, reset the translation reserve included in equity under previous
GAAP to zero). If the entity elects this exemption, the gain or loss on subsequent disposal of the
foreign entity will be adjusted only by those accumulated translation adjustments arising after
the opening IFRS balance sheet date. [IFRS 1.D13]

IAS 27 – Investments in separate financial statements

In May 2008, the IASB amended the standard to change the way the cost of an investment in
the separate financial statements is measured on first-time adoption of IFRSs. The amendments
to IFRS 1:

• allow first-time adopters to use a 'deemed cost' of either fair value or the carrying
amount under previous accounting practice to measure the initial cost of investments in
subsidiaries, jointly controlled entities and associates in the separate financial
statements

• remove the definition of the cost method from IAS 27 and add a requirement to present
dividends as income in the separate financial statements of the investor

• require that, when a new parent is formed in a reorganisation, the new parent must
measure the cost of its investment in the previous parent at the carrying amount of its
share of the equity items of the previous parent at the date of the reorganisation

Assets and liabilities of subsidiaries, associates and joint ventures: different IFRS
adoption dates of investor and investee

If a subsidiary becomes a first-time adopter later than its parent, IFRS 1 permits a choice
between two measurement bases in the subsidiary's separate financial statements. In this case,
a subsidiary should measure its assets and liabilities as either: [IFRS 1.D16]

• the carrying amount that would be included in the parent's consolidated financial
statements, based on the parent's date of transition to IFRSs, if no adjustments were
 made for consolidation procedures and for the effects of the business combination in
which the parent acquired the subsidiary or

• the carrying amounts required by IFRS 1 based on the subsidiary's date of transition to
IFRSs

A similar election is available to an associate or joint venture that becomes a first-time adopter
later than an entity that has significant influence or joint control over it. [IFRS 1.D16]

If a parent becomes a first-time adopter later than its subsidiary, the parent should in its
consolidated financial statements, measure the assets and liabilities of the subsidiary at the
same carrying amount as in the separate financial statements of the subsidiary, after adjusting
for consolidation adjustments and for the effects of the business combination in which the
parent acquired the subsidiary. The same approach applies in the case of associates and joint
ventures. [IFRS 1.D17]
REVIEW QUESTIONS
1. First Timer Plc
Statement of Financial Position as at 31 December
2010 2009
N N
Assets
Non-Current Assets 800 700
Current assets
Investments (note 1) 180 180
Others 198 160
378 340
Less: Current liabilities
Proposed dividends (note 2) 150 120
Others 73 89
155 131
955 831
Long term liabilities:
Convertible debt (note 3) (200) (200)
Provision for deferred tax (note 4) (95) (81)
Net assets 660 550

Capital and Reserves

Ordinary share capital 250 250
Retained profit 290 180
540 430
Preference shares (note 5) 120 120
660 550

First Timer Plc

Statement of Income for the year ended 31, December 2010
N N
Operating profit 358
Interest paid 20
Profit before tax 338
Taxation
Current tax 50
Deferred tax 14
64
Profit after tax 274
Preference Note 5) 14
Equity dividend (note 2) 150
Retained profit for the year 110
Retained profit brought forward 180
Retained profit carried forward 290

Notes
1. Investments
These are equity securities held for trading. They are shown at cost under previous GAAP. IAS
39 requires that they be shown at fair value with any gain or loss during the year reported in the
Statement of Income. Fair values at December 2009 and 2010 respectively were N150 and
N170.
2. Proposed dividend
Under previous GAAP dividends declared after the year end were provided as a liability. IAS 10
requires that only dividends proposed before the year end should provided for. Under IFRS,
dividends are recognised in Statement of Change in Equity when they are paid. During 2010,
the 2009 proposed dividend was paid.
3. Convertible debt
Under previous GAAP, any convertible debt is recognised as a liability until converted or repaid.
Under IAS 32, this type of compound instrument should be split into the separate components of
equity and liability. The relevant split is:
Equity N16, Liability N184
4. Deferred tax
First Timer Plc has discounted its deferred liabilities. IAS 12 does not allow discounting of this
type of liability. The undiscounted amounts would be:
2009 N90
2010 N108
5 Preference shares and dividends
Previous GAAP requires all preference shares to be classified as part of Capital and Reserves
and dividends as an appropriation of profits. IAS 32 requires these preference shares to be
classified as liablities, and dividends to be charged to Statement of Income as a finance charge.
Prepare the financial statements for First Timer Plc in accordance with IFRS1

2. The transition to International Financial Reporting Standards (IFRSs) involves major change for
companies as IFRSs introduce significant changes in accounting practices that were often not required by
national generally accepted accounting practice. It is important that the interpretation and application of
IFRSs is consistent from country to country. IFRSs are partly based on rules, and partly on principles and
management’s judgement. Judgement is more likely to be better used when it is based on experience of
IFRSs within a sound financial reporting infrastructure. It is hoped that national differences in accounting
will be eliminated and financial statements will be consistent and
comparable worldwide.
Required:
(a) Discuss how the changes in accounting practices on transition to IFRSs and choice in the
application of
individual IFRSs could lead to inconsistency between the financial statements of companies. (17
marks)
(b) Discuss how management’s judgement and the financial reporting infrastructure of a country
can have a
significant impact on financial statements prepared under IFRS. (6 marks)
Appropriateness and quality of discussion. (2 marks)
(25 marks) ACCA CORPORATE REPORTING JUNE 2008

SUGGESTED SOLUTIONS
FIRST TIMER PLC
STATEMENT OF FINANCIAL POSITION AS AT
2010 2009
N N N N
ASSETS
Non Current Assets 800 700
Current Assets:
Investments 170 150
Others 198 160
368 310
1,168 1.010
Equity & Liabilities
Equity
Ordinary share capital 250
250
Other components of equity 16 16
Retained earnings 417 261
683 527
Non-Current liabilities:
Convertible debt 184 184
Preference shares 120 120
Deffred tax 108 90
412 394
Current liabilities 73 89
1,168 1,101

First Timer Plc

Statement of Income for the year ended 31 December, 2010 N N
Operating Profit 358
Increase in value of investment 20
378
Finance costs
Preference dividend 14
Interest paid 20
34
Profit before tax 344
Taxation
Current tax 50
Deferred tax 18
68
Profit after tax 276

Statement of Change in Equity

Equity Other Retained Total
Shares Equity earnings
N N N N
January 1, 2010 as reported 250 180 430
IFRS adjustments
Reclassified debt 16 16
Investment decrease (30) (30)
Deferred tax increase (9) (9)
Add back dvidend proposed 120 120
January 1, 2010 restated 250 16 261 527
Profit for 2010 276 276
Dividend paid (120) (120)
 250 16 417 683

Reconciliation of Equity as at
1.1.2010 31.12.2010
N N
As previously reported 430 540
Debt reclassification 16 16
Investment valuation change (30) (10)
Increase in deferred tax (9) (13)
Add back equity dividend 120 150
As retated for IFRS 527 683

Reconciliation of of 2010 Profit N

Profit after tax as reported 274
Investment valuation increase 20
Deferred tax increase (4)
Preference dividend charge (14)
As restated for IFRS 276

Workings
Investment Account
N N
31 Dec 2009 Balance b/d 180 31 Dec 2009 R/Earnings 30
31 Dec.2009 Balance c/d 150
180 180
1 Jan 2010 Balance b/d 150 31 Dec 2010 Balance c/d 170
31 Dec 2010 Profit or Loss 20
170 170

2. Deferred Tax Account

N N
31 Dec 2009 Balance c/d 90 31 Dec 2009 Balance b/d 81
31 Dec 2009 R/Earnings 9
90 90
31 Dec 2010 Balance c/d 108 1 Jan 2010 Balance b/d 90
31 Dec 2010 Profit or Loss 14
31 Dec 2010 R/Earnings 4
108 108

3 Dividend proposed in 2009

Dr Proposed dividend (current liability)
Cr Retained eanings b/f

4. Dividend proposed in 2010 is only a reconciling item as the IFRS becomes applicable in that
year

2. (a) The transition to International Financial Reporting Standards (IFRS) involves major change for
companies as IFRS introduces significant changes in accounting practices that often were not required by
national GAAPs. For example financial instruments and share-based payment plans in many instances
have appeared on the statements of financial position of companies for the first time. As a result IFRS
financial statements are often significantly more complex than financial statements based on national
GAAP. This complexity is caused by the more extensive recognition and measurement rules in IFRS and
a greater number of disclosure requirements. Because of this complexity, it can be difficult for users of
financial statements which have been produced using IFRS to understand and interpret them, and thus
can lead to inconsistency of interpretation of those financial statements.
The form and presentation of financial statements is dealt with by IAS1 ‘Presentation of Financial
Statements’. This standard sets out alternative forms or presentations of financial statements. Additionally
local legislation often requires supplementary information to be disclosed in financial statements, and best
practice as to the form or presentation of financial statements has yet to emerge internationally. As a
result companies moving to IFRS have tended to adopt IFRS in a way which minimises the change in the
form of financial reporting that was applied under national GAAP. For example UK companies have
tended to present a statement of recognised income and expense, and a separate statement of changes
in equity whilst French companies tend to present a single statement of changes in equity.
It is possible to interpret standards in different ways and in some standards there is insufficient guidance.
For example there are different acceptable methods of classifying financial assets under IAS39 ‘Financial
Instruments: Recognition and Measurement’ in the statement of financial position as at fair value through
profit or loss (subject to certain conditions) or available for sale.
IFRSs are not based on a consistent set of principles, and there are conceptual inconsistencies within
and between standards. Certain standards allow alternative accounting treatments, and this is a further
source of inconsistency amongst financial statements. IAS31 ‘Interests in Joint Ventures’ allows interests
in jointly controlled entities to be accounted for using the equity method or proportionate consolidation.
Companies may tend to use the method which was used under national GAAP.
Another example of choice in accounting methods under IFRS is IAS16 ‘Property, Plant and equipment’
where the cost or revaluation model can be used for a class of property, plant and equipment. Also there
is very little industry related accounting guidance in IFRS. As a result judgement plays an important role in
the selection of accounting policies. In certain specific areas this can lead to a degree of inconsistency
and lack of comparability.
IFRS1, ‘First time Adoption of International Financial Reporting Standards’, allows companies to use a
number of exemptions from the requirements of IFRS. These exemptions can affect financial statements
for several years. For example, companies can elect to recognise all cumulative actuarial gains and
losses relating to post-employment benefits at the date of transition to IFRS but use the ‘corridor’
approach thereafter. Thus the effect of being able to use a ‘one off write off’ of any actuarial losses could
benefit future financial statements significantly, and affect comparability. Additionally after utilising the
above exemption, companies can elect to recognise subsequent gains and losses outside profit or loss in
‘other comprehensive income’ in the period in which they occur and not use the ‘corridor’ approach thus
affecting comparability further.
Additionally IAS18 ‘Revenue’ allows variations in the way revenue is recognised. There is no specific
guidance in IFRS on revenue arrangements with multiple deliverables. Transactions have to be analysed
in accordance with their economic substance but there is often no more guidance than this in IFRS. The
identification of the functional currency under IAS21,‘The effects of changes in foreign exchange rates’,
can be subjective. For example the functional currency can be determined by the currency in which the
commodities that a company produces are commonly traded, or the currency which influences its
operating costs, and both can be different.
Another source of inconsistency is the adoption of new standards and interpretations earlier than the due
date of application of the standard. With the IASB currently preparing to issue standards with an adoption
date of 1 January 2009, early adoption or lack of it could affect comparability although IAS8 ‘Accounting
Policies, Changes in Accounting Estimates and Errors’ requires a company to disclose the possible
impact of a new standard on its initial application. Many companies make very little reference to the future
impact of new standards.

(b) Management judgement may have a greater impact under IFRS than generally was the case under
national GAAP. IFRS utilises fair values extensively. Management have to use their judgement in
selecting valuation methods and formulating assumptions when dealing with such areas as onerous
contracts, share-based payments, pensions, intangible assets acquired in business combinations and
impairment of assets. Differences in methods or assumptions can have a major impact on amounts
recognised in financial statements. IAS1 expects companies to disclose the sensitivity of carrying
amounts to the methods, assumptions and estimates underpinning their calculation where there is a
significant risk of material adjustment to their carrying amounts within the next financial year. Often
management’s judgement is that there is no ‘significant risk’ and they often fail to disclose the degree of
estimation or uncertainty and thus comparability is affected.
In addition to the IFRSs themselves, a sound financial reporting infrastructure is required. This implies
effective corporate governance practices, high quality auditing standards and practices, and an effective
enforcement or oversight mechanism. Therefore, consistency and comparability of IFRS financial
statements will also depend on the robust nature of the other elements of the financial reporting
infrastructure.
Many preparers of financial statements will have been trained in national GAAP and may not have been
trained in the
principles underlying IFRS and this can lead to unintended inconsistencies when implementing IFRS
especially where the accounting profession does not have a CPD requirement. Additionally where the
regulatory system of a country is not well developed, there may not be sufficient market information to
utilise fair value measurements and thus this could lead to hypothetical markets being created or the use
of mathematical modelling which again can lead to inconsistencies because of lack of experience in those
countries of utilising these techniques. This problem applies to other assessments or estimates relating to
such things as actuarial valuations, investment property valuations, impairment testing, etc.
The transition to IFRS can bring significant improvement to the quality of financial performance and
improve comparability worldwide. However, there are issues still remaining which can lead to
inconsistency and lack of comparability with those financial statements.

IFRS 2: SHARE BASED PAYMENT

Definition
A share based payment is a transaction in which the entity receives or acquires goods or
services either as consideration for its equity instruments (equity settled) or by incurring
liabilities for amounts based on the price of the entity’s shares or other equity instruments of the
entity (cash settled). In other words, equity settled refers to situations where an obligation is
settled by the issue of shares and cash settled is a situation where share values are used to
determine the amount of a liability payable.

Scope of the Standard

IFRS 2 applies where goods or services are received in exchange for equity – based payment,
but does not apply to:
• Shares issued in a business combination
• Financial instrument contracts for the purchase of goods
• Purchase of treasury shares
• A right issue where some of the shareholders are also employees

IFRS 2 thus apply to:

• Call options
• Share appreciation rights
• Share ownership schemes
• Payments to external consultants where the amount paid is dependent upon the share
price

Requirements of IFRS 2
The Standard requires the recognition of the following:
• The expense for the purchase of goods and service
• The liability (cash settled)
• Equity increased (equity settled)
Period to Recognise the Expenses
• If in respect of goods received, then recognise the expense immediately.
• If in respect of services, recognition depends on the vesting terms:
• If shares vest immediately, then recognise immediately
• If shares vest in the future, then spread over the vesting period.
• Equity settled transactions with the directors and employees:
Expense at fair value as at the date of the grant, where fair value is the market value (if
the shares are traded), if not traded, use a valuation model and if fair value cannot be
reliably determined, use intrinsic value which will be given for purpose of examination.

What is the Purpose of Expensing Off?

The purpose of expensing off share based transactions is to spread the costs over the period
during which the service is rendered.
For example, where options are granted to employees, but only vest if the employee is still
employed at the end of the grant period, then:
(a) calculate fair value as at the date of the grant
(b) charge equally over the vesting period, with annual adjustments to reflect best estimates,
and
(c) increase equity by the amount of the Statement of Comprehensive Income charge
If the options are not exercised, no adjustment is made to the Statement of Comprehensive
Income
On early settlement, charge the balance which would otherwise have been charged over the
remaining period.

Limitations of Share Based Payment

1. Some commentators suggest that its is neither practicable nor desirable
2. No particluar method is defined for the fair value of equity shares which are not traded
3. Option pricing models are generally difficult to apply.
4. It may probably have adverse consequences for financially weak entities which try to attract
prospective employees by the promise of share options.
5. Consequently, such a struggling company in (4) above will find it has an additional expense in
the Statement of Comprehensive Income; ironically this is a situation the company is trying to
avoid.

Measurement of Equity Settled Transactions

An entity should adopt the direct method of valuing equity settled share based payment. That is,
the fair value of goods or services received.
Where the goods or services themselves cannot be reliably measured, then the indirect
method is appropriate.This indirect method is simply the fair value of the equity shares
issued.

Illustration 1
An entity acquires a property which has an open market value of N3m, and settles the amount
due by the issue of 500,000 N1 equity shares.
Show how this transaction will be recorded in the entity’s books.

Suggested Solution
Since the fair value of the property is known, the direct method will be most appropriate:
Dr Property, plant & equipemnt 3 m
Cr Share capital 0.5m
Cr Share premium 2.5m

Illustration 2
Suppose the same entity employs a consultant for a particular project, and agrees consultancy
fees in the form of 30,000 N1 equity shares, with a market value of N2.50 per share.Since the
fair value of the consultancy fees is not known the indirect method is used to value the liability,
ie. Fair value of equity issued.

Dr Professional fees (30,000 x N2.50) N75,000

Cr Share capital N30,000
Cr Share premium N45,000

Measurement of Cash Settled Obligations

Obligations should be measured at fair value and at each operating date, fair value must be
reviewed until the obligation is settled.
Any movement in fair value between two reporting periods is recognised through the Statement
of Comprehensive Income.

Illustration 1
Space Plc buys inventory on 20 September 2010, agreeing to settle the debt in cash. The
amount to be paid shall be the market value of 20,000 N1.00 equity shares in Space Plc as at
the settlement date. Space Plc eventually paid cash on 24 December the same year, by which
date the market value of one N1.00 equity share had risen from its September value of N2.80 to
N3.20.
How will Space Plc reflect this transaction in its books of accounts?

Suggested Solution
On September 2010
Dr Purchases (20,000 x N2.80) N56,000
Cr Accounts Payable N56,000

On 24 December, 2010
Dr Accounts Payable N56,000
Dr Statement of Comprehensive Income (expenses) N3.20 – N2.80) N 8,000
Cr Bank N64,000

Expected Complication Employee Share - Based Payment

A complication arises where the issue of shares agreement is reached today, but the issue is
dependent upon an employee continuing to work for the entity for a further period of time. In
such a situation, the total cost of the transaction should be spread over the period of further
work.
Illustration 1– Recognition of employee share option grant

Company grants a total of 100 share options to 10 members of its executive management team
(10 options each) on 1 January 20X5. These options vest at the end of a three-year period. The
company has determined that each option has a fair value at the date of grant equal to 15. The
company expects that all 100 options will vest and therefore records the following entry at 30
June 20X5 - the end of its first six-month interim reporting period.
Dr. Share Option Expense N250
Cr. Equity N250
[(100 × 15) ÷ 6 periods] = 250 per period
If all 100 shares vest, the above entry would be made at the end of each 6-month reporting
period. However, if one member of the executive management team leaves during the second
half of 20X6, therefore forfeiting the entire amount of 10 options, the following entry at 31
December 20X6 would be made:
Dr. Share Option Expense 150
Cr. Equity 150
[(90 × 15) ÷ 6 periods = 225 per period. [225 × 4] – [250+250+250] = 150

Illustration 2
AB Plc grants to each of its 1,000 employees, options to purchase 3,000 shares on condition
that they remain in its employment for the next four years. A generally accepted option model
has valued each option at N15.
On average, AB Plc forecast that 5% of its employees will leave in each of the next four years,
and will thus lose their option rights.
Show how AB Plc should reflect the above grant for each of the next four years.

Suggested Solution
1000 x 3000 shares x N15 x80% =N36,000,000
The annual expense will therefore be N36,000,000/4years = N9000,000.
Statement of Comprehensive Income will be:
Year 1 Year 2 Year 3 Year 4
N N N N
Contract costs 9,000,000 9,000,000 9,000,000 9,000,000

Statement of Financial Position 9,000,000 9,000,000 9,000,000 9,000,000

Summary of Measurement guidance

Depending on the type of share-based payment, fair value may be determined by the value of
the shares or rights to shares given up, or by the value of the goods or services received:

• General fair value measurement principle. In principle, transactions in which goods or

services are received as consideration for equity instruments of the entity should be
measured at the fair value of the goods or services received. Only if the fair value of the
goods or services cannot be measured reliably would the fair value of the equity
instruments granted be used.

• Measuring employee share options. For transactions with employees and others
providing similar services, the entity is required to measure the fair value of the equity
instruments granted, because it is typically not possible to estimate reliably the fair value
of employee services received.

• When to measure fair value - options. For transactions measured at the fair value of
the equity instruments granted (such as transactions with employees), fair value should
be estimated at grant date.

• When to measure fair value - goods and services. For transactions measured at the
fair value of the goods or services received, fair value should be estimated at the date of
receipt of those goods or services.

• Measurement guidance. For goods or services measured by reference to the fair value
of the equity instruments granted, IFRS 2 specifies that, in general, vesting conditions
are not taken into account when estimating the fair value of the shares or options at the
relevant measurement date (as specified above). Instead, vesting conditions are taken
into account by adjusting the number of equity instruments included in the measurement
of the transaction amount so that, ultimately, the amount recognised for goods or
services received as consideration for the equity instruments granted is based on the
number of equity instruments that eventually vest.
 • More measurement guidance. IFRS 2 requires the fair value of equity instruments
granted to be based on market prices, if available, and to take into account the terms
and conditions upon which those equity instruments were granted. In the absence of
market prices, fair value is estimated using a valuation technique to estimate what the
price of those equity instruments would have been on the measurement date in an arm's
length transaction between knowledgeable, willing parties. The standard does not
specify which particular model should be used.

• If fair value cannot be reliably measured. IFRS 2 requires the share-based payment
transaction to be measured at fair value for both listed and unlisted entities. IFRS 2
permits the use of intrinsic value (that is, fair value of the shares less exercise price) in
those "rare cases" in which the fair value of the equity instruments cannot be reliably
measured. However this is not simply measured at the date of grant. An entity would
have to remeasure intrinsic value at each reporting date until final settlement.

• Performance conditions. IFRS 2 makes a distinction between the handling of market

based performance features from non-market features. Market conditions are those
related to the market price of an entity's equity, such as achieving a specified share price
or a specified target based on a comparison of the entity's share price with an index of
share prices of other entities. Market based performance features should be included in
the grant-date fair value measurement. However, the fair value of the equity instruments
should not be reduced to take into consideration non-market based performance
features or other vesting features.
Deferred Tax Implications of Share Based Payments
• Where tax deductions are allowed by a local jusridction on share based payments, these
taxes will be based on intinsic values, that is, the difference between the fair value and
exercise price.
• Therefore, a deferred tax asset will arise based on the difference between the value of
the service received to date and the cash price.

Disclosure
Required disclosures include:
• the nature and extent of share-based payment arrangements that existed during the
period;
• how the fair value of the goods or services received, or the fair value of the equity
instruments granted, during the period was determined; and
• the effect of share-based payment transactions on the entity's profit or loss for the period
and on its financial position.

REVIEW QUESTIONS
1. A company has options dated 1 September 2010 for the purchase inventory which was
eventually sold in December 2010.
The value of the goods 1 September 2010 N3m
Sales proceeds N6m
Shares have a market value of N4.5m
Required, show how this will be dealt with in the financial statements for the year ended
December 2010.

2. 2,000 share options were granted to each of the 3 directors on 1 January 2011 subject to
them being still employed as at 31 December, 2013 the date of vesting,
The fair value of each option on 1 Jaunary 2011 was N10.00
Option will vest when the share price reaches N14.00
The share price as at 31 December 2011 was N8.00 and is not anticipated to rise in the next
two years.
As at 31 December 2011, it is anticipated that only two directors will still be with the company as
at 31 December 2013.
Required, what is the appropriate treatment in the financial statements for the year ended 31
December,
2011.

3. 300 shares appreciation rights granted to 500 employees on 31 July 2010.

As at 31 July 2010, it is believed that 80% will vest on 31 July 2012.
Fair value at 31 July 2010 is N15.
What is the fair value of the liability to be recognised as at 31 July 2011?

4. Margie, a public limited company, has entered into several share related transactions during the period
and wishes to obtain advice on how to account for the transactions.
(a) Margie has entered into a contract with a producer to purchase 350 tonnes of wheat. The purchase
price will be
settled in cash at an amount equal to the value of 2,500 of Margie’s shares. Margie may settle the
contract at any time by paying the producer an amount equal to the current market value of 2,500 of
Margie shares, less the market value of 350 tonnes of wheat. Margie has entered into the contract as part
of its hedging strategy and has no intention of taking physical delivery of the wheat. Margie wishes to treat
this transaction as a share based payment transaction under IFRS 2 ‘Share-based Payment’. (7 marks)

(b) Margie has acquired 100% of the share capital of Antalya in a business combination on 1 December
2009. Antalya had previously granted a share-based payment to its employees with a four-year vesting
period. Its employees have rendered the required service for the award at the acquisition date but have
not yet exercised their options. The fair value of the award at 1 December 2009 is N20 million and Margie
is obliged to replace the share-based payment awards of Antalya with awards of its own.
Margie issues a replacement award that does not require post-combination services. The fair value of the
replacement award at the acquisition date is N22 million. Margie does not know how to account for the
award on the acquisition of Antalya. (6 marks)

(c) Margie issued shares during the financial year. Some of those shares were subscribed for by
employees who were
existing shareholders, and some were issued to an entity, Grief, which owned 5% of Margie’s share
capital. Before the shares were issued, Margie offered to buy a building from Grief and agreed that the
purchase price would be settled by the issue of shares. Margie wondered whether these transactions
should be accounted for under IFRS 2. (4 marks)

(d) Margie granted 100 options to each of its 4,000 employees at a fair value of N10 each on 1 December
2007.
The options vest upon the company’s share price reaching N15, provided the employee has remained in
the
company’s service until that time. The terms and conditions of the options are that the market condition
can be met in either year 3, 4 or 5 of the employee’s service.
At the grant date, Margie estimated that the expected vesting period would be four years which is
consistent with the assumptions used in estimating the fair value of the options granted. The company’s
share price reached N15 on 30 November 2010. (6 marks)
Required:
Discuss, with suitable computations where applicable, how the above transactions would be dealt
with in the
financial statements of Margie for the year ending 30 November 2010.
Professional marks will be awarded in question 2 for the clarity and quality of discussion. (2 marks)
(25 marks) ACCA CORPORATE REPORTING DECEMBER 2010

5. William is a public limited company and would like advice in relation to the following transaction On 1
June 2009, William granted 500 share appreciation rights to each of its 20 managers. All of the rights vest
after two years service and they can be exercised during the following two years up to 31 May 2013. The
fair value of the right at the grant date was N20. It was thought that three managers would leave over the
initial two-year period and they did so. The fair value of each right was as follows:
Year Fair value at year end N
31 May 2010 23
31 May 2011 14
31 May 2012 24
On 31 May 2012, seven managers exercised their rights when the intrinsic value of the right was N21.
William wishes to know what the liability and expense will be at 31 May 2012. (5 marks)
ACCA CORPORATE REPORTING JUNE 20102 ADAPTED

SUGGESTED SOLUTIONS
1. You have to value the share option for goods at fair value of the goods at the date the option
was granted except that fair value cannot be measured reliably.So:
Dr Purchases (inventory) N3m
Cr Equity N3m (separated into nominal value and share premium)

2. Please ignore the rise in the share price, but adhere strictly to the conditions.
2,000 shares x 2 directors x N10/3 years = N13,333
Dr Statement of Comprehensive Income (yr ended 2009) N13,333
Cr Equity. (Separated into share capital & premium yr ended 2009) N13,333

3. 300 shares x 500 employees x N15x 80% /2years =N900,000.

Comprehensive Income are either not taxable or not allowable

4. (a) The arrangement is not within the scope of IFRS 2 ‘Share-based payment’ because the contract
may be settled net and has not been entered into in order to satisfy Margie’s expected purchase, sale or
usage requirements. Margie has not purchased the wheat but has entered into a financial contract to pay
or receive a cash amount. The arrangement should be dealt with in accordance with IAS 39 ‘Financial
Instruments: Recognition and measurement’.
Contracts to buy or sell non-financial items are within the scope of IAS 39 if they can be settled net in
cash or another financial asset and are not entered into and held for the purpose of the receipt or delivery
of a non-financial item in accordance with the entity's expected purchase, sale, or usage requirements.
Contracts to buy or sell non-financial items are inside the scope if net settlement occurs. The following
situations constitute net settlement:
(a) the terms of the contract permit either counterparty to settle net;
(b) there is a past practice of net settling similar contracts;
(c) there is a past practice, for similar contracts, of taking delivery of the underlying and selling it within a
short period after delivery to generate a profit from short-term fluctuations in price, or from a dealer’s
margin; or
(d) the non-financial item is readily convertible to cash.
The contract will be accounted for as a derivative and should be valued at fair value (asset or liability at
fair value). Initially the contract should be valued at nil as under the terms of a commercial contract the
value of 2,500 shares should equate to the value of 350 tonnes of wheat. At each period end the contract
would be revalued and it would be expected that differences will arise between the values of wheat and
Margie shares as their respective market values will be dependent on a number of differing factors. The
net difference should be taken to profit or loss.
As Margie has no intention of taking delivery of the wheat this does not appear to be a hedging contract
as no firm
commitment exists to purchase neither is this a highly probable forecast transaction.

(b) Share-based payment awards exchanged for awards held by the acquiree’s employees are measured
in accordance with IFRS 2 ‘Share-based payment’. If the acquirer is obliged to replace the awards, some
or all of the fair value of the replacement awards must be included in the consideration. The amount not
included in the consideration will be recognised as a compensation expense. If the acquirer is not obliged
to exchange the acquiree’s awards, the acquirer does not adjust the consideration even if the acquirer
does replace the awards. A portion of the fair value of the award granted by Margie is accounted for under
IFRS 3 and a portion under IFRS 2, even though no post-combination services are required. The amount
included in the cost of the business combination is the fair value of Antalya’s award at the acquisition date
(N20 million).
Any additional amount, which in this case is N2 million, is accounted for as a post-combination expense
under IFRS 2. This amount is recognised immediately as a post-combination expense because no post-
combination services are required.

(c) The shares issued to the employees were issued in their capacity as shareholders and not in
exchange for their services. The employees were not required to complete a period of service in
exchange for the shares. Thus the transaction is outside the scope of IFRS 2.
As regards the purchase of the building, Grief did not act in its capacity as a shareholder as Margie
approached the company with the proposal to buy the building. Grief was a supplier of a building and as
such the transaction comes under IFRS 2.
The building is valued at fair value with equity being credited with the same amount.

(d) Where the vesting period is linked to a market performance condition, an entity should estimate the
expected vesting period. If the actual vesting period is shorter than estimated, the charge should be
accelerated in the period that the entity delivers the cash or equity instruments to the counterparty. When
the vesting period is longer, the expense is recognised over the originally estimated vesting period. The
effect of a vesting condition may be to change the length of the vesting period. In this case, paragraph 15
of IFRS 2 ‘Share based payment’ requires the entity to presume that the services to be rendered by the
employees as consideration for the equity instruments granted will be received in the future, over the
expected vesting period.
Hence, the entity will have to estimate the length of the expected vesting period at grant date, based on
the most likely
outcome of the performance condition. If the performance condition is a market condition, the estimate of
the length of the expected vesting period must be consistent with the assumptions used in estimating the
fair value of the share options granted and is not subsequently revised.
Margie expects the market condition to be met in 2011 and thus anticipates that it will charge N1 million
per annum until that date (100 x 4,000 x N10 divided by 4 years). As the market condition has been met in
the year to 30 November 2010, the expense charged in the year would be N2 million (N4 million – N2
million already charged) as the remaining expense should be accelerated and charged in the year.

5. Expenses in respect of cash-settled share-based payment transactions should be recognised over the
period during which goods are received or services are rendered, and measured at the fair value of the
liability. The fair value of the liability should be remeasured at each reporting date until settled. Changes in
fair value are recognised in the statement of comprehensive income.
The credit entry in respect of a cash-settled share-based payment transaction is presented as a liability.
The fair value of each share appreciation right (SAR) is made up of an intrinsic value and its time value.
The time value reflects the fact that the holders of each SAR have the right to participate in future gains.
At 31 May 2012, the expense will comprise any increase in the liability plus the cash paid based on the
intrinsic value of the SAR.
Liability 31 May 2012 (10 x 500 x N24) N120,000
Liability 31 May 2011 (17 x 500 x N14) (N119,000)
Cash paid (7 x 500 x N21) N73,500
Expense year ending 31 May 2012 N74,500
Therefore the expense for the year is N74,500 and the liability at the year end is N120,000.
IFRS: 3 BUSINESS COMBINATION
Overview
IFRS 3 Business Combinations outlines the accounting when an acquirer obtains control of a
business (e.g. an acquisition or merger). Such business combinations are accounted for using
the 'acquisition method', which generally requires assets acquired and liabilities assumed to be
measured at their fair values at the acquisition date.

A revised version of IFRS 3 was issued in January 2008 and applies to business combinations
occurring in an entity's first annual period beginning on or after 1 July 2009.

Summary of IFRS 3

Scope
Definition of a business combination. A business combination is a transaction or event in
which an acquirer obtains control of one or more businesses. A business is defined as an
integrated set of activities and assets that is capable of being conducted and managed for the
purpose of providing a return directly to investors or other owners, members or participants.
[IFRS 3.Appendix A]

Acquirer must be identified. Under IFRS 3, an acquirer must be identified for all business
combinations. [IFRS 3.6]

Scope changes from IFRS 3 (2004). IFRS 3(2008) applies to combinations of mutual entities
and combinations without consideration (dual listed shares). These are excluded from IFRS
3(2004).

Scope exclusions. IFRS 3 does not apply to the formation of a joint venture, combinations of
entities or businesses under common control. The IASB added to its agenda a separate agenda
project on Common Control Transactions in December 2007. Also, IFRS 3 does not apply to the
acquisition of an asset or a group of assets that do not constitute a business. [IFRS 3.2]

Method of accounting for business combinations

Acquisition method. The acquisition method (called the 'purchase method' in the 2004 version
of IFRS 3) is used for all business combinations. [IFRS 3.4]

Steps in applying the acquisition method are: [IFRS 3.5]

• Identification of the 'acquirer' – the combining entity that obtains control of the acquiree
[IFRS 3.7]

• Determination of the 'acquisition date' – the date on which the acquirer obtains control of
the acquiree [IFRS 3.8]

• Recognition and measurement of the identifiable assets acquired, the liabilities assumed
and any non-controlling interest (NCI, formerly called minority interest) in the acquiree

• Recognition and measurement of goodwill or a gain from a bargain purchase

Measurement of acquired assets and liabilities. Assets and liabilities are measured at their
acquisition-date fair value (with a limited number of specified exceptions). [IFRS 3.18]
Measurement of NCI. IFRS 3 allows an accounting policy choice, available on a transaction by
transaction basis, to measure NCI either at:

• fair value (sometimes called the full goodwill method), or

• the NCI's proportionate share of net assets of the acquiree (option is available on a
transaction by transaction basis).
Example: P pays 800 to purchase 80% of the shares of S. Fair value of 100% of S's identifiable net
assets is 600. If P elects to measure non-controlling interests as their proportionate interest in the net
assets of S of 120 (20% x 600), the consolidated financial statements show goodwill of 320 (800
+120 - 600). If P elects to measure non-controlling interests at fair value and determines that fair
value to be 185, then goodwill of 385 is recognised (800 + 185 - 600). The fair value of the 20% non-
controlling interest in S will not necessarily be proportionate to the price paid by P for its 80%,
primarily due to control premium or discount as explained in paragraph B45 of IFRS 3. [IFRS 3.19]
Acquired intangible assets. Must always be recognised and measured at fair value. There is
no 'reliable measurement' exception.

Goodwill
Goodwill is measured as the difference between:

• the aggregate of (i) the acquisition-date fair value of the consideration transferred, (ii) the
amount of any NCI, and (iii) in a business combination achieved in stages (see Below),
the acquisition-date fair value of the acquirer's previously-held equity interest in the
acquiree; and

• the net of the acquisition-date amounts of the identifiable assets acquired and the
liabilities assumed (measured in accordance with IFRS 3). [IFRS 3.32]

If the difference above is negative, the resulting gain is recognised as a bargain purchase in
profit or loss. [IFRS 3.34]

Business combination achieved in stages (step acquisitions)

Prior to control being obtained, the investment is accounted for under IAS 28, or IAS 39, as
appropriate. On the date that control is obtained, the fair values of the acquired entity's assets
and liabilities, including goodwill, are measured (with the option to measure full goodwill or only
the acquirer's percentage of goodwill). Any resulting adjustments to previously recognised
assets and liabilities are recognised in profit or loss. Thus, attaining control triggers
remeasurement. [IFRS 3.41-42]

Provisional accounting
If the initial accounting for a business combination can be determined only provisionally by the
end of the first reporting period, account for the combination using provisional values.
Adjustments to provisional values within one year relating to facts and circumstances that
existed at the acquisition date. [IFRS 3.45] No adjustments after one year except to correct an
error in accordance with IAS 8. [IFRS 3.50]

Cost of an acquisition
Measurement. Consideration for the acquisition includes the acquisition-date fair value of
contingent consideration. Changes to contingent consideration resulting from events after the
acquisition date must be recognised in profit or loss. [IFRS 3.58]
Acquisition costs. Costs of issuing debt or equity instruments are accounted for under IAS 32
and IAS 39. All other costs associated with the acquisition must be expensed, including
reimbursements to the acquiree for bearing some of the acquisition costs. Examples of costs to
be expensed include finder's fees; advisory, legal, accounting, valuation and other professional
or consulting fees; and general administrative costs, including the costs of maintaining an
internal acquisitions department. [IFRS 3.53]

Contingent consideration. Contingent consideration must be measured at fair value at the

time of the business combination. If the amount of contingent consideration changes as a result
of a post-acquisition event (such as meeting an earnings target), accounting for the change in
consideration depends on whether the additional consideration is an equity instrument or cash
or other assets paid or owed. If it is equity, the original amount is not remeasured. If the
additional consideration is cash or other assets paid or owed, the changed amount is
recognised in profit or loss. If the amount of consideration changes because of new information
about the fair value of the amount of consideration at acquisition date (rather than because of a
post-acquisition event) then retrospective restatement is required. [IFRS 3.58]

Pre-existing relationships and reacquired rights

If the acquirer and acquiree were parties to a pre-existing relationship (for instance, the acquirer
had granted the acquiree a right to use its intellectual property), this must be accounted for
separately from the business combination. In most cases, this will lead to the recognition of a
gain or loss for the amount of the consideration transferred to the vendor which effectively
represents a 'settlement' of the pre-existing relationship. The amount of the gain or loss is
measured as follows:

• for pre-existing non-contractual relationships (for example, a lawsuit): by reference to fair

value

• for pre-existing contractual relationships: at the lesser of (a) the favourable/unfavourable

contract position and (b) any stated settlement provisions in the contract available to the
counterparty to whom the contract is unfavourable. [IFRS 3.B51-53]

However, where the transaction effectively represents a reacquired right, an intangible asset is
recognised and measured on the basis of the remaining contractual term of the related contract
excluding any renewals. The asset is then subsequently amortised over the remaining
contractual term, again excluding any renewals. [IFRS 3.55]

Reversal acquisition (or takeover)

This is where Company A acquires ownership of Company B through a share exchange. (For
example, a private entity may arrange to have itself ‘acquired’ by a smaller public entity as a
means of obtaining a stock exchange listing). The number of shares issued by Company A as
consideration to the shareholders of Company B is so great that control of the combined entity
after the transaction is with the shareholders of Company B.

In legal terms company A may be regarded as the parent of continuity entity, but IFRS 3 states
that it is the Company B shareholders who control the combined entity. Company B should be
treated as the acquirer. Company B should apply the acquistion method to the assets and
liabilities of Company B.(IFRS 3.B19)

Other issues
In addition, IFRS 3 provides guidance on some specific aspects of business combinations
including:
 • business combinations achieved without the transfer of consideration [IFRS 3.43-44]

• identifying intangible assets acquired [IFRS 3.B31-34]

• the reassessment of the acquiree's contractual arrangements at the acquisition date

[IFRS 3.15]

Parent's disposal of investment or acquisition of additional investment in subsidiary

Partial disposal of an investment in a subsidiary while control is retained. This is
accounted for as an equity transaction with owners, and gain or loss is not recognised.

Partial disposal of an investment in a subsidiary that results in loss of control. Loss of

control triggers remeasurement of the residual holding to fair value. Any difference between fair
value and carrying amount is a gain or loss on the disposal, recognised in profit or loss.
Thereafter, apply IAS 28, or IAS 39, as appropriate, to the remaining holding.

Acquiring additional shares in the subsidiary after control was obtained. This is accounted
for as an equity transaction with owners (like acquisition of 'treasury shares'). Goodwill is not
remeasured.

Disclosure
Disclosure of information about current business combinations

The acquirer shall disclose information that enables users of its financial statements to evaluate
the nature and financial effect of a business combination that occurs either during the current
reporting period or after the end of the period but before the financial statements are authorised
for issue. [IFRS 3.59]

Among the disclosures required to meet the foregoing objective are the following: [IFRS 3.B64-
66]

• name and a description of the acquiree

• acquisition date

• percentage of voting equity interests acquired

• primary reasons for the business combination and a description of how the acquirer
obtained control of the acquiree. description of the factors that make up the goodwill
recognised

• qualitative description of the factors that make up the goodwill recognised, such as
expected synergies from combining operations, intangible assets that do not qualify for
separate recognition

• acquisition-date fair value of the total consideration transferred and the acquisition-date
fair value of each major class of consideration

• details of contingent consideration arrangements and indemnification assets

• details of acquired receivables

• the amounts recognised as of the acquisition date for each major class of assets
acquired and liabilities assumed
 • details of contingent liabilities recognised

• total amount of goodwill that is expected to be deductible for tax purposes

• details of any transactions that are recognised separately from the acquisition of assets
and assumption of liabilities in the business combination

• information about a bargain purchase ('negative goodwill')

• for each business combination in which the acquirer holds less than 100 per cent of the
equity interests in the acquiree at the acquisition date, various disclosures are required

• details about a business combination achieved in stages

• information about the acquiree's revenue and profit or loss

• information about a business combination whose acquisition date is after the end of the
reporting period but before the financial statements are authorised for issue

Disclosure of information about adjustments of past business combinations

The acquirer shall disclose information that enables users of its financial statements to evaluate
the financial effects of adjustments recognised in the current reporting period that relate to
business combinations that occurred in the period or previous reporting periods. [IFRS 3.61]

Among the disclosures required to meet the foregoing objective are the following: [IFRS 3.B67]

• details when the initial accounting for a business combination is incomplete for particular
assets, liabilities, non-controlling interests or items of consideration (and the amounts
recognised in the financial statements for the business combination thus have been
determined only provisionally)

• follow-up information on contingent consideration

• follow-up information about contingent liabilities recognised in a business combination

• a reconciliation of the carrying amount of goodwill at the beginning and end of the
reporting period, with various details shown separately

• the amount and an explanation of any gain or loss recognised in the current reporting
period that both:

• (i) relates to the identifiable assets acquired or liabilities assumed in a business

combination that was effected in the current or previous reporting period, and

• (ii) is of such a size, nature or incidence that disclosure is relevant to

understanding the combined entity's financial statements.
IFRS 4: INSURANCE CONTRACT
Background and Introduction
IFRS 4 is the first Standard from the International Accounting Standards Board (IASB) on
insurance contracts. The extent of guidance in IFRS 4 is quite modest in comparison with the
more comprehensive overhaul of insurance accounting that is envisaged by the IASB in the
future. IFRS 4 was introduced in time for insurance companies to comply with the adoption of
International Financial Reporting Standards (IFRS) in Europe and elsewhere in 2005. The
Standard is designed to make limited improvements to accounting practices and to provide
users with an insight into the key areas that relate to accounting for insurance contracts.
All entities that issue policies that meet the definition of an insurance contract in IFRS 4 have to
apply the Standard. Additionally, the Standard applies to financial instruments with so called
discretionary participation features. The Standard does not apply to other assets and liabilities
of the insurance companies, such as financial assets and financial liabilities, which fall within the
scope of IAS 39. Similarly, it does not address the accounting required by policyholders.
Additionally, IFRS 4 sets out new disclosure requirements for contracts that qualify as
insurance, including details about future cash flows.

Definition of Key Terms (in accordance with IFRS 4)

Insurance contract: A contract under which one party (the insurer) accepts significant
insurance risk from another party (the policyholder) by agreeing to compensate the policyholder
if a specified uncertain future event (the insured event) adversely affects the policyholder.

Scope
IFRS 4 covers most motor, travel, life, and property insurance contracts as well as most
reinsurance contracts. However, some policies that transfer no significant insurance risk, such
as savings and pension plans, are covered by IAS 39 and accounted for as financial
instruments irrespective of their legal form.
IAS 39 also applies to those contracts that principally transfer financial risk, such as credit
derivatives and some financial reinsurance contracts. IFRS 4 does not apply to: product
warranties, which are covered by IAS 18 and IAS 37; employers’ assets and liabilities under
employee benefits plans, which are covered by IAS 19 and IFRS 2; and contingent
consideration payable or receivable in a business combination, which is covered by IFRS 3,
Business Combinations.

Financial guarantee contracts are outside the scope of IFRS 4 unless the issuer elects to apply
IFRS 4 to such contracts. An issuer may make such an election only if it has previously asserted
explicitly that it regards such contracts as insurance contracts and has used accounting
applicable to insurance contracts.

First Phase
Insurance contracts continue to be covered by existing accounting practices during this first
phase of the development of a comprehensive set of standards on insurance. The IFRS actually
exempts an insurer temporarily from some requirements of other Standards, including the
requirement to consider the IASB’s Framework in determining accounting policies.

IFRS 4 makes limited improvements to accounting policies for insurance contracts in order to
bring them more into line with IFRS. The Standard
(a) Prohibits provisions for possible claims under contracts that are not in existence at the
balance sheet date. This includes catastrophe provisions and equalization provisions.
(b) Sets out a minimum liability adequacy test that requires insurers to compare their recognized
insurance liabilities against estimates of future cash flows. Additionally, there is a requirement to
carry out an impairment test for reinsurance assets.

There is a requirement for an insurer to keep insurance liabilities in its balance sheet until they
are discharged. The IFRS also prohibits offsetting insurance liabilities against related
reinsurance assets.

Changes in Accounnting Policies

Insurers are permitted to modify their existing accounting policies for insurance contracts as
long as any changes meet the IASB’s criteria for improving the relevance of their financial
statements without making them less reliable. An insurer cannot introduce any of these
practices, although it can continue using accounting policies that involve any of them:
 • Measuring insurance liabilities on a non discounted basis
• Measuring contractual rights to future investment management fees at an amount that
exceeds their fair value
• Using non-uniform accounting policies for the insurance liabilities of a subsidiary

Insurers can use current market interest rates to value liabilities, thus bringing them more into
line with movements in associated assets that are interest-sensitive. This measure does not
need to be applied consistently across all insurance liabilities. However, insurers will need to
designate the liabilities that will be measured using market rates.

An insurer does not need to change its accounting policies on insurance contracts in order to
eliminate excessive prudence. However, an insurer that already measures its insurance
contracts with sufficient prudence should not introduce additional prudence.
An insurer need not change its accounting policies for insurance contracts to eliminate future
investment margins. However, entities cannot change to an accounting policy that adjusts their
liabilities to reflect future investment margins unless, for example, this is part of a wider switch to
a comprehensive investor-based accounting system.

The IASB would require proof that this switch improves the relevance and reliability of the
financial statements to such an extent that it outweighs the disadvantage caused by the
inclusion of future investment margins.

Concessions in IFRS 4
There is a concession to insurers regarding the accounting on a business combination. Insurers
can recognize an intangible asset that is the difference between the fair value and book value of
the insurance liabilities taken on board. Such an asset is excluded from the scope of IAS 36,
Impairment of Assets, and IAS 38, Intangible Assets.

Entities can continue to value insurance and investment contracts that have discretionary
participation in profit features using their existing accounting policies. Any fixed guaranteed
amount should be regarded as the minimum liability with the rest of the contract classified as an
additional liability or included in equity, or evenly split between equity and liabilities. If the
contract is not split in this way, the issuer of the contract should classify the whole contract as a
liability. These requirements also apply to any financial instruments that contain a discretionary
participation future.

Accounting Under IFRS 4

Certain derivative features in a contract, such as an index-linked option, may need to be
separated at fair value. IAS 39 applies to derivatives that are embedded in an insurance
contract unless the embedded derivative is itself an insurance contract. An insurer need not
account for an embedded derivative separately at fair value if the embedded derivative meets
the definition of an insurance contract.

IFRS 4 requires an insurer to account separately for the deposit components of some insurance
contracts in order to avoid the omission of assets and liabilities from the balance sheet. An
insurance contract can contain both deposit and insurance components.

An example might be a profit-sharing reinsurance contract where the cedent is given a

guarantee as to the minimum repayment of the premium. As with embedded derivatives,
insurers need to identify any policies that may require unbundling. Generally speaking, any
deposit component is subject to IAS 39 and any insurance feature is subject to existing
accounting policies.

IFRS 4 also clarifies the applicability of a practice that is often called shadow accounting. This
practice allows insurers to adjust their liabilities for any changes that have arisen if any
unrealized gains and losses on assets have been realized. An insurer is permitted to change its
accounting policies such that recognized, but unrealized gains or losses, also adjust their
liabilities. Any movements in the liability may be recognized in equity only if unrealized gains or
losses are recognized directly in equity.
Information that helps users understand the amount, timing, and uncertainty of future cash flows
is required. The terms and conditions of insurance contracts that have a material affect on the
amount, timing, and uncertainty of the insurer’s future cash flows also have to be disclosed.

Information about the actual claims as compared with previous estimates needs disclosure, and
information about interest rate risk and credit rate risk that IAS 32 would require should be
shown.

Information about exposures to interest rate risk or market risk under embedded derivatives
contained in a host insurance contract should be shown if the insurer does not show the
embeddedderivatives at fair value. However, insurers do not need to disclose the fair value of
their insurance contracts at present but need to disclose the gains and losses from purchasing
reinsurance contracts.

Disclosures
The standard requires disclosure of:

• information that helps users understand the amounts in the insurer's financial statements
that arise from insurance contracts: [IFRS 4.36-37]

• accounting policies for insurance contracts and related assets, liabilities, income,
and expense

• the recognised assets, liabilities, income, expense, and cash flows arising from
insurance contracts

• if the insurer is a cedant, certain additional disclosures are required

• information about the assumptions that have the greatest effect on the
measurement of assets, liabilities, income, and expense including, if practicable,
quantified disclosure of those assumptions

• the effect of changes in assumptions

• reconciliations of changes in insurance liabilities, reinsurance assets, and, if any,

related deferred acquisition costs

• Information that helps users to evaluate the nature and extent of risks arising from
insurance contracts: [IFRS 4.38-39]

• risk management objectives and policies

• those terms and conditions of insurance contracts that have a material effect on
the amount, timing, and uncertainty of the insurer's future cash flows

• information about insurance risk (both before and after risk mitigation by
reinsurance), including information about:

• the sensitivity to insurance risk

 • concentrations of insurance risk

• actual claims compared with previous estimates

• the information about credit risk, liquidity risk and market risk that IFRS 7 would
require if the insurance contracts were within the scope of IFRS 7

• information about exposures to market risk arising from embedded derivatives

contained in a host insurance contract if the insurer is not required to, and does
not, measure the embedded derivatives at fair value
Case study 1
Entity A has a reinsurance contract that has these elements to it: A policyholder under a
reinsurance contract pays premiums of N200 every year for 10 years. The entity sets up an
experience account equal to 80% of the cumulative premiums less 80% of the cumulative
claims under the policy. If the balance in the experience account ever becomes negative, the
policyholder has to pay an additional premium based on the balance on the experience account
divided by the number of years the policy has left to run. At the end of the contract, if the
balance on the experience account is positive, it is refunded to the policyholder. If the balance is
negative, the policyholder has to pay the amount as an additional premium. The policy is not
able to be cancelled before the end of the contract, and the maximum loss that the policyholder
is required to pay in any year is N300.
Required
Discuss how the reinsurance contract should be accounted for in the financial statements of the
insurer.

Suggested Solution
The contract is an insurance contract because it transfers a significant insurance risk to the
reinsurer. Where there are no claims on the contract, the policyholder will receive N1,600 at the
end of year 10, which is 80% of the cumulative premiums of N2,000. IFRS 4 basically says that
the policyholder has made a loan that the reinsurer will repay in one instalment in year 10. If
current policies of the reinsurer are that it should recognize a liability under the contract, then
unbundling is permitted but not required.
However, if the reinsurer does not have such policies, then IFRS 4 would require the reinsurer
to unbundle the contract. If the contract is unbundled, each payment by the policyholder has two
components: a loan advance payment and a payment for insurance cover. IAS 39 will be used
to value the deposit element— the loan—and it will be measured initially at fair value. The fair
value of the deposit element would be calculated by discounting back the future loan repayment
in year 10 using an annuity method. If the policyholder makes a claim, then this in itself will be
unbundled into a claim of NX and a loan of NY, which will be repaid in installments over the life
of the policy.

Case study 2
Entity A writes a single policy for a N1,000 premium and expects claims to be made of N600 in
year 4. At the time of writing the policy, there are commission costs paid of N200. Assume a
discount rate of 3% risk-free. The entity says that if a provision for risk and uncertainty were to
be made, it would amount to N250, and that this risk would expire evenly over years 2, 3, and 4.
Under existing policies, the entity would spread the net premiums, the claims expense, and the
commissioning costs over the first two years of the policy. Investment returns in years 1 and 2
are N20 and N40 respectively.
Required
Show the treatment of this policy using a deferral and matching approach in years 1 and 2 that
would be acceptable under IFRS 4.
How would the treatment differ if a “fair value” approach were used?
Suggested Solution
Deferral and Matching (IFRS 4):
Year 1 Year 2
N N
Premium earned 500 500
Claims expense (300) (300)
Commission costs (100) (100)
Underwriting profit 100 100
Investment return 20 40
Profit 120 140
If a fair value approach were used, the whole of the premium earned would be credited in year
1. The expected claims would be provided for on a discounted basis and then unwound over the
period to year 4. The provision for risk and uncertainty would be made in year 1 and unwound
over the following three years. Commission costs would all be charged in year 1 also. The
investment returns would be treated in the same way as in the deferral approach.

IFRS 5: NON – CURRENT ASSET HELD FOR SALE AND DISCONTINUED

OPERATIONS
Non – Current Assets Held for Sale
Definition of Terms
Held for sale: The carrying amount of a non - current asset will be recovered mainly through
selling the asset rather than through usage.
Disposal group: A group of assets and possibly some liabilities that an entity intends to
dispose of in a single transaction.

Objective of the Standard

The aim of the IFRS is to specify the accounting treatment of non-current assets held for sale as
distinct from those which are held for continuing use or for their investment potential
An asset should be classified as asset held for sale if the asset’s carrying value will be
recovered primarily through sale rather than through continuing use

Coditions for Classification of Asset As Held For Sale

• The asset is available for immediate sale
• The sale is highly probable, within 12 months of classification as held for sale
• Managment is actively marketing the asset
• Management committed to a plan to sell the asset
• It is unlikely that planned sale will be changed or withdrawn
• The asset is being actively marketed for sale at sales price reasonable in relation to its
fair value

Where an asset has been purchased solely with a view of selling it, it may be classed as asset
held for sale on acquisition
• The asset must be held for sale rather than merely being closed down or abandoned
• If it has already been closed down or abandoned it may well require disclosure as a
“discontinued operation” ( see next )
• The IFRS applies to groups of assets (Disposal Group) as well as to individual assets

Measurement
The following principles apply:
At the time of classification as held for sale: Immediately before the initial classification of
the asset as held for sale, the carrying amount of the asset will be measured in accordance with
applicable IFRSs (IAS 16, IAS 36, IAS 38 and IAS 39). Resulting adjustments are also
recognised in accordance with applicable IFRSs. Any impairment loss is recognised in profit or
loss unless the asset had been measured at revalued amount under IAS 16 or IAS 38, in which
case the impairment is treated as a revaluation decrease.

After classification as held for sale: Non – current assets or disposal groups that are
classified as held for sale are measured at the lower of carrying amount and fair value less
costs to sell. Calculate any impairment loss based on the difference between the adjusted
carrying amounts of the asse/disposal group and fair value less costs to sell. Any impairment
loss that arises by using the measurement principles of IFRS 5 must be recognised in profit or
loss even if assets previously carried at revalued amounts.

• once classified as held for sale, the asset should no longer be depreciated
• anticipated tax charge arising on disposal should not be included as a selling cost

Assets no longer classified as held for sale: is measured at the lower of:
(a) its carrying amount before it was classified as held for sale, adjusted for any depreciation
that would have been charged had the asset not been held for sale
(b) its recoverable amount at the date of the decision not to sell

Presentation
Non–Current asset held for sale should be shown separately on statement of financial position

Disclosure
• Description of the asset or group of assets
• Description of the sale or expected sale
• Impairment losses ( or reversals ) recognised in the year
• If applicable, the segment in which the asset is held

Case study 1
An entity is planning to sell part of its business that is deemed to be a disposal group. The entity
is in a business environment that is heavily regulated, and any sale requires government
approval. This means that the sale time is difficult to determine. Government approval cannot be
obtained until a buyer is found and known for the disposal group and a firm purchase contract
has been signed. However, it is likely that the entity will be able to sell the disposal group within
one year.
Required
Would the disposal group be classified as held for sale?

Suggested Solution
The disposal group would be classified as held for sale because the delay is caused by events
or circumstances beyond the entity’s control and there is evidence that the entity is committed to
selling the disposal group.

Case study 2
An entity has an asset that has been designated as held for sale in the financial year to
December 31,20X5. During the financial year to December 31, 20X6, the asset still remains
unsold, but the market conditions for the asset have deteriorated significantly. The entity
believes that market conditions will improve and has not reduced the price of the asset, which
continues to be classified as held for sale. The fair value of the asset is N5 million, and the asset
is being marketed at N7 million.
Required
Should the asset be classified as held for sale in the financial statements for the year ending
December 31, 20X6?

Suggested Solution
Because the price is in excess of the current fair value, the asset is not available for immediate
sale and should not be classified as held for sale.

Case study 3
An entity is reorganizing its business activities. In one location, it is stopping the usage of certain
equipment because the demand for the product produced by that equipment has reduced
significantly. The equipment is to be maintained in good working order, and it is expected that it
will be brought back into use if the demand increases. Additionally, the entity intends to close
three out of five manufacturing units. The manufacturing units constitute a major activity of the
entity. All the work within the three units will end during the current year, and as of the year-end
all work will have ceased.
Required
How will the piece of equipment and the closure of the manufacturing units be treated in the
financial statements for the current year?

Suggested Solution
The equipment will not be treated as abandoned as it will subsequently be brought back into
usage. The manufacturing units will be treated as discontinued operations.

Case study 4
Lagoon Plc, a parent entity, approved on June 30, 20X5, a plan to sell its subsidiary, Pinnacle
Ltd. The sale is expected to be completed on September 1, 20X5. The year-end of Lagoon Plc
is July 31, 20X5, and the financial statements were approved on August 16, 20X5. The
subsidiary had net assets of N15 million (including goodwill of N2 million) at carrying value at
year-end. Pinnacle Ltd made a loss of N3 million from August 1 to August 16, 20X5, and is
expected to make a further loss of N2 million up to the date of sale. At the date of approval of
the financial statements, Lagoon Plc was in negotiation for the sale of Pinnacle, but no contract
had been signed. Lagoon Plc expects to sell Pinnacle Ltd for N9 million and to incur costs of
selling of N1 million. The value in use of Pinnacle Ltd at August 16, 20X5, was estimated at N8
million.
Lagoon Plc had approved the relocation of the administrative headquarters of the group.
Lagoon Plc does not intend to sell the property until it has renovated it. The renovations were
completed on June 30, 20X5.However, on July 30, 20X5, environmental contamination was
found within the headquarters that necessitated the transfer of the staff to temporary premises.
The hazard was removed at a cost of N50,000 and the building declared safe on November 1,
20X5. At July 31, 20X5, the carrying value of the building was N3 million and its market value
(assuming no contamination) was N4 million before estimated selling costs of N500,000.

The administrative headquarters were moved on December 1, 20X5, and the property was
offered for sale at a price of N4 million. The market for such property was in decline, and a
buyer had not been found by July 31, 20X6. The market price at that date was around N3.5
million, but the entity refused to reduce the sale price of the property. On September 1, 20X6, a
bid of N3.3 million was accepted for the property and costs of N600,000 were incurred in its
sale. The carrying value of the property at cost was N2.8 million as of July 31, 20X6.
Lagoon Plc also has equipment that it recently had leased to third parties. At July 31, 20X5,
there was N5 million (carrying value) of this equipment, and at July 31, 20X6, there was an
additional N8 million (carrying value) of this equipment. The leases had expired at the
respective dates but no decision had been made as to whether to refurbish and sell the
equipment or to abandon it. The entity subsequently refurbished both sets of equipment and
sold them on December 1, 20X5, for N10 million and on December 15, 20X6, for N16 million.
The refurbishment costs were N2 million and N3 million respectively for the two sets of assets.
Required
Discuss the treatment of the above elements in the financial statements as of July 31, 20X5,
and July 31, 20X6.

Suggested Solution
Deal with the disposal of the subsidiary, then the administrative headquarters and finally the
equipment on lease.

Disposal of the Subsidiary

Under IFRS 5, an entity should classify a disposal group, which Pinnacle Ltd is, as held for sale
if its carrying amount will be recovered principally through a sales transaction rather than
through continuing use. The basic criteria to be met are that: there must be a commitment to a
plan to sell the asset, an active program to locate a buyer and complete the plan must have
been initiated, the asset must be actively marketed at a reasonable price in relation to its fair
value, the sale should be expected to occur within one year, and it would appear that significant
changes to the plan are unlikely. In this situation, the entity has approved the plan prior to the
year-end and the sale is expected to be completed within 12 months, on September 1, 20X5. By
the time the financial statements were approved, the entity was in negotiation for the sale of
Pinnacle Ltd, so it would appear that the entity is actively trying to find a buyer and that the sale
is highly probable. Additionally, if the entity is in negotiation for the sale, then the asset would
appear to be actively marketed. Finally, there does not appear to be any intention to change the
plan of sale significantly; therefore, the disposal group would appear as if it is held for sale.
Measurement Before Classification as Held for Sale: Before classification of the item as held
for sale, an impairment review will have to be undertaken. In this case, there is indication of
possible impairment in any event because the subsidiary is making a loss in the post-acquisition
period. Any loss arising on the impairment review will be charged to profit or loss. An item that is
held for sale should be reported at the lower of carrying value and fair value less costs to sell.
An impairment calculation will have to be carried out as of July 31, 20X5, before Pinnacle Ltd
can be measured in the statement of financial position. The value in use of Pinnacle Ltd at
August 16, 20X5, is estimated at N8 million. The loss up to that date is N3 million. Therefore, the
value in use at July 31 will be N8 million plus N3 million, or N11 million. The net realizable value
of Pinnacle Ltd will be N9 million less the costs of selling it of N1 million, or N8 million. The
recoverable amount is the higher of the net realizable value and the value in use. Therefore, in
any impairment test at year-end, the value in use of N11 million would be used. Before
classification for sale, the impairment loss is N15 million less N11 million which is N4 million.

On Classification as Held for Sale: However, because the disposal group has been classified
as held for sale, any impairment loss will be calculated by reference to different criteria. That is,
any disposal group that is classified as held for sale should be measured at the lower of carrying
amount, in this case N11 million and fair value less costs to sell, and in this case N8 million.. On
classification as held for sale, another impairment loss of N3 million arises (N11 million minus
N8 million). A total impairment loss of N7 million before reclasification as held for sale (N4
million) and after reclasifiaction for sale (N3 million) arises.
Administrative Headquarter
Regarding the administrative headquarters, the non-current assets will qualify as held for sale if
they are available for immediate sale in their present condition subject to the usual selling terms.
However, as of July 31, 20X5, the administrative building could not be sold because of the
environmental contamination. Therefore, it would simply be shown at carrying value within the
financial statements. The entity has the intent and the ability to sell the asset, but it would be
unlikely to find a buyer while this contamination was present. It does not appear there is any
impairment of the carrying value of the building due to the contamination; the building’s carrying
value is N3 million and the market value was N4 million before estimated selling costs of
N500,000. In rectifying the environmental contamination, the cost was only N50,000, and
therefore it does not seem that the value of the building is impaired.
In the year to July 31, 20X6, the property has been offered for sale at a price of N4 million. The
market is in decline, and by year-end a buyer had not been found. The market price at that date
was much less than the offer price, and the entity has refused to reduce the selling price of the
property. The property has been vacated; therefore, it is available for sale, but because the price
is not reasonable in relation to its current fair value—N4 million as opposed to N3.5 million—
then the entity’s intention to sell the asset might appear be questionable. The property fails the
test in IFRS 5 regarding the reasonableness of price and, therefore, should not be classified as
held for sale. If the property had been classified as held for sale at July 31, 20X6, then it would
have had to be carried at the lower of the carrying value and fair value less costs to sell. This
would have meant that the carrying value of N2.8 million would have been compared with the
fair value of N3.3 million less the costs of N600,000, or N2.7 million, and there would have been
the need to write down the value of the asset by N100,000. To qualify for classification as held
for sale, the sale of a non-current asset must be highly probable and the sale of the asset must
be expected to qualify for recognition as a completed sale within one year.
In the case of the equipment that had recently been leased, at July 31, 20X5, and July 31,
20X6, there was a significant amount of this equipment in the balance sheet. The leases had
expired but no decision had been made as to whether to refurbish and sell the equipment or to
abandon it. Therefore, these assets will not qualify as held-for-sale assets at either date. They
should be shown as non-current assets and depreciated. Held-for-sale assets are not
depreciated. It would appear also that the fair value less costs to
sell is significantly higher than the carrying value.
The selling prices of the two sets of assets are N10 million and N16 million respectively, and the
refurbishment costs are N2 million and N3 million respectively. Therefore, even taking into
account the refurbishment costs, the expectation is that they will recover significantly more
revenue than the carrying value. Thus, the assets are not impaired at July 31, 20X5, or July 31,
20X6.

Discontinued Operations
Discontinued Operation is a component of an entity which
• has been disposed of, or
• has been classified as asset held for sale

Discontinued Operation must:

• Represent a separate, major line of business or geographical area of operations, or
• Be part of a single, coordinated plan to dispose of a separate major line of business or
geographical area of operations, or
• Be a subsidiary acquired exclusively with a view of resale

Statement of Profit or Loss and Other Comprehensive Income presentation

• Disclose a single amount, calculated as the total post-tax profit ( or loss ) of the
Diacontinued Operation together with the post-tax gain ( or loss ) on the measurement of
fair value, less costs to sell or dispose of the Discontinued Operation
• (and in the Notes) an analysis of the above single line entry, showing:
• Revenue
• Expenses
• Pre-tax profit ( or loss )
• Related taxation
• Gain ( or loss ) on remeasurement
• Related taxation

Statement of Cash Flows presentation

Disclose the net cash flows for operating, investing and financing for the Discontinued
Operations, either on the face of the Statement of Cash Flows, or by way of Note.
Disclosures:

In addition to the income statement and cash flow statement presentations noted above, the
following disclosures are required:

• adjustments made in the current period to amounts disclosed as a discontinued

operation in prior periods must be separately disclosed. [IFRS 5.35]

• if an entity ceases to classify a component as held for sale, the results of that component
previously presented in discontinued operations must be reclassified and included in
income from continuing operations for all periods presented. [IFRS 5.36
REVIEW QUESTIONS
1. Z plans to dispose of a group of net assets that form a disposal group. The net assets at
December 31, 20X5, are
Carrying value at
December 31, 20X5
Nm
Goodwill 6
Property, plant, and equipment 18
Inventory 10
Financial assets (profit of N2 million recognized in equity) 7
Financial liabilities (4)
37
On moving to accounting under IFRS, some of the assets had been transferred at deemed cost
and had not been remeasured under IFRS. These assets were property, plant, and equipment,
and inventory. Under IFRS, property, plant, and equipment would be stated at N16 million and
inventory stated at N9 million. The fair value less costs to sell of the disposal group is N25
million. Assume that the disposal group qualifies as held for sale. Therefore, under IAS 36, any
impairment loss will be allocated to goodwill and PPE.
Required
Describe how the disposal group would be shown in the financial statements for the year ended
December 31, 20X5.

2. Ghorse, a public limited company, operates in the fashion sector and had undertaken a group re-
organisation during the current financial year to 31 October 2007. As a result the following events
occurred:
(a) Ghorse identified two manufacturing units, Cee and Gee, which it had decided to dispose of in a single
transaction. These units comprised non-current assets only. One of the units, Cee, had been impaired
prior to the financial year end on 30 September 2007 and it had been written down to its recoverable
amount of N35 million.
The criteria in IFRS5, ‘Non-current Assets Held for Sale and Discontinued Operations’, for classification
as held for sale, had been met for Cee and Gee at 30 September 2007. The following information related
to the assets of the cash generating units at 30 September 2007:
Depreciated Fair value less Carrying value
Historical cost costs to sell under IFRS
and recoverable
amount
Nm Nm Nm
Cee 50 35 35
Gee 70 90 70
–––– –––– ––––
120 125 105
 –––– –––– ––––
The fair value less costs to sell had risen at the year end to N40 million for Cee and N95 million for Gee.
The increase in the fair value less costs to sell had not been taken into account by Ghorse. (7 marks)

(b) As a consequence of the re-organisation, and a change in government legislation, the tax authorities
have allowed
a revaluation of the non-current assets of the holding company for tax purposes to market value at 31
October 2007. There has been no change in the carrying values of the non-current assets in the financial
statements.
The tax base and the carrying values after the revaluation are as follows:
Carrying amount Tax base at Tax base at
at 31 October 31 October 2007 31 October 2007
2007 after revaluation before revaluation
Nm Nm Nm
Property 50 65 48
Vehicles 30 35 28
Other taxable temporary differences amounted to N5 million at 31 October 2007. Assume income tax is
paid at
30%. The deferred tax provision at 31 October 2007 had been calculated using the tax values before
revaluation.
(6 marks)

(c) A subsidiary company had purchased computerised equipment for N4 million on 31 October 2006 to
improve the manufacturing process. Whilst re-organising the group, Ghorse had discovered that the
manufacturer of the
computerised equipment was now selling the same system for $2·5 million. The projected cash flows from
the
equipment are:
Year ended 31 October Cash flows
Nm
2008 1·3
2009 2·2
2010 2·3
The residual value of the equipment is assumed to be zero. The company uses a discount rate of 10%.
The directors think that the fair value less costs to sell of the equipment is N2 million. The directors of
Ghorse propose to write down the non-current asset to the new selling price of N2·5 million. The
company’s policy is to depreciate its computer equipment by 25% per annum on the straight line basis. (5
marks)
(d) The manufacturing property of the group, other than the head office, was held on an operating lease
over 8 years. On re-organisation on 31 October 2007, the lease has been renegotiated and is held for 12
years at a rent of N5 million per annum paid in arrears. The fair value of the property is N35 million and its
remaining economic life is 13 years. The lease relates to the buildings and not the land. The factor to be
used for an annuity at 10% for 12 years is 6·8137. (5 marks)
The directors are worried about the impact that the above changes will have on the value of its non-
current assets
and its key performance indicator which is ‘Return on Capital Employed’ (ROCE). ROCE is defined as
operating profit
before interest and tax divided by share capital, other reserves and retained earnings. The directors have
calculated
ROCE as N30 million divided by N220 million, i.e. 13·6% before any adjustments required by the above.
Formation of opinion on impact on ROCE. (2 marks)
Required:
Discuss the accounting treatment of the above transactions and the impact that the resulting
adjustments to the financial statements would have on ROCE.
Note: your answer should include appropriate calculations where necessary and a discussion of the
accounting
principles involved.
(25 marks) ACCA CORPORATE REPORTING DECEMBER 2007

3. (a) The objective of IFRS 5 Non-current Assets Held for Sale and Discontinued Operations specifies,
amongst other
things, accounting for and presentation and disclosure of discontinued operations.
Required:
Define a discontinued operation and explain why the disclosure of such information is important
to users of
financial statements. (5 marks)

(b) Radar’s sole activity is the operation of hotels all over the world. After a period of declining profitability,
Radar’s
directors made the following decisions during the year ended 31 March 2013:
– it disposed of all of its hotels in country A;
– it refurbished all of its hotels in country B in order to target the holiday and tourism market. The previous
target market in country B had been aimed at business clients.
Required:
Treating the two decisions separately, explain whether they meet the criteria for being classified
as
discontinued operations in the financial statements for the year ended 31 March 2013. (4 marks)

(c) At a board meeting on 1 July 2012, Pulsar’s directors made the decision to close down one of its
factories on
31 March 2013. The factory and its related plant would then be sold.
A formal plan was formulated and the factory’s 250 employees were given three months’ notice of
redundancy
on 1 January 2013. Customers and suppliers were also informed of the closure at this date.
The directors of Pulsar have provided the following information:
Fifty of the employees would be retrained and deployed to other subsidiaries within the group at a cost of
N125,000; the remainder will accept redundancy and be paid an average of N5,000 each.
Factory plant has a carrying amount of N2·2 million, but is only expected to sell for N500,000 incurring
N50,000 of selling costs; however, the factory itself is expected to sell for a profit of N1·2 million.
The company rents a number of machines under operating leases which have an average of three years
to run
after 31 March 2013. The present value of these future lease payments (rentals) at 31 March 2013 was
N1 million; however, the lessor has said they will accept N850,000 which would be due for payment on 30
April 2013 for their cancellation as at 31 March 2013.
Penalty payments due to non-completion of supply contracts are estimated at N200,000.
Required:
Explain and quantify how the closure of the factory should be treated in Pulsar’s financial
statements for the
year ended 31 March 2013.
Note: The closure of the factory does not meet the criteria of a discontinued operation. (6 marks)
(15 marks) ACCA FINANCIAL REPORTING JUNE 2013

SUGGESTED SOLUTIONS
1 Z
Carryingvalue Remeasured Impairment Carrying
amount
after impairment
Nm Nm Nm Nm
Goodwill 6 6 (6) -
Property, plant, and equipment 18 16 (3) 13
Inventory 10 9 9
Financial assets 7 7 7
Financial liabilities (4) (4) (4)
37 34 (9) 25
IFRS 5 requires that, immediately before the initial classification of the disposal group as held
for sale, the carrying amounts of the disposal group be measured in accordance with applicable
IFRS and any profit or loss dealt with under those IFRS. The reduction in the carrying amount of
property, plant, and equipment will be dealt with in accordance with IAS 16; the inventory will be
dealt with in accordance with IAS 2.
After the remeasurement, the entity will recognize an impairment loss of N9 million. This loss is
allocated in accordance with IAS 36. Thus goodwill will be reduced to zero and property, plant,
and equipment to N13 million. The loss will be charged against profit or loss. If not separately
presented on the face of the income statement, the caption in the income statement that
includes the loss should be disclosed.
The major classes of assets and liabilities classified as held for sale should be separately
disclosed on the face of the balance sheet or in the notes. In this case there would be separate
disclosure of the disposal group:
Nm
Assets
Non-current assets
Current assets
Non-current and current assets classified as held for sale 29
Total assets
Equity and liabilities
Equity attributable to parent
Amounts recognized directly in equity relating to
Noncurrent assets held for sale (18-16) 2
Non - Controlling interest
Total equity
Noncurrent liabilities:
Current liabilities
Liabilities directory associated with noncurrent assets
classified as held for sale 4
Total liabilities
Total equity and liabilities
Assets classified as held for sale at the balance sheet date are not reported retrospectively;
therefore, comparative balance sheets are not restated.

2. The company should account for the events as follows:

(a) The two manufacturing units meet the criteria for classification as held for sale and are, therefore,
deemed to be a disposal group under IFRS5 ‘Non-current Assets Held for Sale and Discontinued
Operations’ as the assets are to be disposed of in a single transaction.
The measurement basis required for non-current assets held for sale is applied to the group as a whole
and any impairment loss will reduce the carrying amount of the non-current assets in the disposal group
in the order of allocation required by IAS36 ‘Impairment of Assets’ (IFRS5 paragraph 4). Before
classification as held for sale, evidence of impairment will be tested on an individual cash generating unit
basis, but after classification it will be done on a disposal group basis.
Immediately before the initial classification of the asset as held for sale, the carrying amount of the asset
will be measured in accordance with applicable IFRSs.
On classification as held for sale, disposal groups that are classified as held for sale are measured at the
lower of carrying amount and fair value less costs to sell. Impairment must be considered both at the time
of classification as held for sale and subsequently. Immediately prior to classifying a disposal group as
held for sale, it must measure and recognise impairment in accordance with the applicable IFRSs. Any
impairment loss is recognised in profit or loss unless the asset had been measured at a revalued amount
under IAS16 ‘Property, Plant and Equipment’ or IAS38 ‘Intangible Assets’, in which case the impairment is
treated as a revaluation decrease. On classification as held for sale, any impairment loss will be based on
the difference between the adjusted carrying amounts of the disposal group and fair value less costs to
sell. Any impairment loss that arises by using the measurement principles in IFRS5 must be recognised in
profit or loss (IFRS5 paragraph 20).
Thus Ghorse should not increase the value of the disposal group above N105 million at 30 September
2007 as this is the carrying amount of the assets measured in accordance with applicable IFRS
immediately before being classified as held for sale (IAS36 and IAS16). After classification as held for
sale, the disposal group will remain at this value as this is the lower of the carrying value and fair value
less costs to sell, and there is no impairment recorded as the recoverable amount of the disposal group is
in excess of the carrying value. At a subsequent reporting date following initial classification as held for
sale the disposal group should be measured at fair value less costs to sell. However, IFRS5 (paragraphs
21–22) allows any subsequent increase in fair value less costs to sell to be recognised in profit or loss to
the extent that it is not in excess of any impairment loss recognised in accordance with IFRS5 or
previously with IAS36. Thus any increase in the fair value less costs to sell can be recognised as follows
at 31 October 2007:
Nm
Fair value less costs to sell – Cee 40
Fair value less costs to sell – Gee 95
––––
135
Carrying value (105)
––––
Increase 30
––––
Impairment recognised in Cee (50 – 35) 15
––––
Therefore, the carrying value of the disposal group can increase by N15 million and profit or loss can be
increased by the same amount, where the fair value rises. Thus the value of the disposal group will be
N120 million. These adjustments will affect ‘Return on Capital Employed’ (ROCE).

(b) The differences between the IFRS carrying amounts for the non-current assets and tax bases will
represent temporary differences.
The general principle in IAS12 ‘Income Taxes’ is that deferred tax liabilities should be recognised for all
taxable temporary differences. A deferred tax asset should be recognised for deductible temporary
differences, unused tax losses and unused tax credits to the extent that it is probable that taxable profit
will be available against which the deductible temporary differences can be utilised.
A deferred tax asset cannot be recognised where it arises from negative goodwill or the initial recognition
of an asset/liability other than in a business combination. The carrying amount of deferred tax assets
should be reviewed at each balance sheet date and reduced to the extent that it is no longer probable that
sufficient taxable profit will be available to allow the benefit of part or all of that deferred tax asset to be
utilised. Any such reduction should be subsequently reversed to the extent that it becomes probable that
sufficient taxable profit will be available (IAS12 paragraph 37)
The recognition of deferred tax assets will result in the recognition of income, in the income statement.
This amount cannot be reported in equity as IAS12 only allows deferred tax to be recognised in equity if
the corresponding entry is recognised in equity. This is not the case in this situation as the revaluation
was not recognised for IFRS purposes.
Carrying Tax Temporary
Amount Base Difference
Nm Nm Nm
Property 50 65 15
Vehicles 30 35 5
Other taxable temporary differences (5)
–––
15
–––
The deferred tax asset would be N15 million x 30%, i.e. N4·5 million subject to there being sufficient
taxable profit. The deferred tax provision relating to these assets would have been:
Carrying Tax Temporary
Amount Base Difference
Nm Nm Nm
Property 50 48 2
Vehicles 30 28 2
–––
4
Other taxable temporary differences 5
–––
9
–––
N9 million at 30%, i.e. N2·7 million
The impact on the income statement would be significant as the deferred tax provision of N2·7 million
would be released and a deferred tax asset of N4·5 million credited to it. These adjustments will not affect
profit before interest and tax. However an asset of N4·5 million will be created in the balance sheet which
will affect ROCE.

(c) At each balance sheet date, Ghorse should review all assets to look for any indication that an asset
may be impaired, i.e. where the asset’s carrying amount (N3 million) is in excess of the greater of its net
selling price and its value in use. IAS36 has a list of external and internal indicators of impairment. If there
is an indication that an asset may be impaired, then the asset’s recoverable amount must be calculated
(IAS36 paragraph 9).
The recoverable amount is the higher of an asset’s fair value less costs to sell (sometimes called net
selling price) and its value in use which is the discounted present value of estimated future cash flows
expected to arise from:
(i) the continuing use of an asset, and from
(ii) its disposal at the end of its useful life
If the manufacturer has reduced the selling price, it does not mean necessarily that the asset is impaired.
One indicator of impairment is where the asset’s market value has declined significantly more than
expected in the period as a result of the passage of time or normal usage. The value-in-use of the
equipment will be N4·7 million.
Year ended Cash Discounted
31 October flows (10%)
Nm Nm
2008 1·3 1·2
2009 2·2 1·8
2010 2·3 1·7
––––
Value in use – 4·7
––––
The fair value less costs to sell of the asset is estimated at N2 million. Therefore, the recoverable amount
is N4·7 million which is higher than the carrying value of N3 million and, therefore, the equipment is not
impaired with no effect on ROCE.

(d) Under IAS17, ‘Leases’, operating lease payments should be recognised as an expense in the income
statement over the lease term on a straight line basis, unless another systematic basis is more
representative of the time pattern of the user’s benefit.
The provisions of the lease have changed significantly and would need to be reassessed.
The lease term is now for the major part of the economic life of the assets, and at the inception of the
lease, the present value of the minimum lease payments is substantially all of the fair value of the leased
asset. (Fair value N35 million, NPV of lease payments N34·1 million) Even if title is not transferred at the
end of the lease the lease can still be a finance lease. Any change in the estimate of the length of life of a
lease would not change its classification but where the provisions of the lease have changed, re-
assessment of its classification takes place. Thus it would appear that the lease is now a finance lease,
and it would be shown in the balance sheet at the present value of the lease payments as this is lower
than the fair value. This change in classification will not affect ROCE as it will increase non-current assets
by N34·1 million and liabilities by the same amount.

Effect on ROCE
Nm
Profit before tax and interest 30
add increase in value of disposal group 15
–––––
45
–––––
Capital employed 220
add increase in value of disposal group 15
Deferred tax asset (4·5 + 2·7) 7·2
–––––
242·2
–––––
ROCE will rise from 13·6% to 18·6% (45/242·2) and thus the directors’ fears that ROCE would be
adversely affected are unfounded.

3. (a) A discontinued operation is a component (see below) of an entity that has either already been
disposed of or is classified as held for sale that represents a separate major line of business or
geographical area of business operations (or is part of a co-ordinated plan to dispose of such). It also
applies to a subsidiary that is acquired specifically with a view to resale.
A component of an entity has operations and cash flows that are clearly distinguished for reporting
purposes from those of the rest of an entity. It would normally be a cash generating unit (or a group of
cash generating units) or a subsidiary.
This information is important to users of financial statements when they are forming an assessment of the
likely future
performance of an entity. For example, if a group made a large profit from one of its subsidiaries that it
has recently sold (or will soon sell), this will have a material effect on any forecast of the group’s future
profit. This is because the profits from the subsidiary disposed of will no longer contribute to future group
profit (though the re-investment of any sale proceeds from the disposal could). Also, the converse would
be true where the disposal or closure of a loss-making subsidiary could improvefuture profitability.

(b) IFRS 5 Non-current Assets Held for Sale and Discontinued Operations has been criticised for the use
of the term ‘a separate major line of business or geographical area of business operations’ to identify a
discontinued operation as it may mean different things to different people and lead to inconsistency (and
thus a lack of comparability). Despite this, the disposal of hotels in country A would seem to represent a
separate geographical location and should be treated as a discontinued operation, even though the group
will continue to operate hotels in other countries. The example of country B is less conclusive. Some
might argue that a change in the target market (to holiday and tourism) does represent a different ‘line of
business operations’ that has a different pricing structure, operating costs (such as providing ‘all-inclusive’
holidays) and profit margins than that of business clients. Also, the refurbishment of the hotels would
seem to indicate catering to a different market. Others may argue that this is simply adapting a product
(as all companies have to do) and does not represent a change to a separate line of business.

(c) On its own, a board decision to close the factory is not sufficient to justify the creation of a provision
under IAS 37 Provisions, Contingent Liabilities and Contingent Assets. However, by formulating a plan
and informing interested parties (employees, customers and suppliers), this is likely to constitute a
constructive obligation for a restructuring provision by raising a valid expectation of the closure.
The amounts that should be provided for at 31 March 2013 are:
(workings in brackets are in N’000)
N’000
– redundancy (200 employees x 5) 1,000
– impairment loss on plant (2,200 – (500 – 50)) 1,750 (may be shown as a separate provision)
– onerous contract (lower amount) 850
– penalty payments 200
––––––
3,800
––––––
The N3·8 million should be charged to the statement of profit or loss for the year ended 31 March 2013
and the same amount reported in the statement of financial position as at 31 March 2013 as a current
liability/plant impairment (assuming all parts of the factory closure will be completed within the next 12
months).
The factory and the plant would be disclosed in the statement of financial position as non-current assets
held for sale at the lower of their carrying amount (the factory) or fair value less cost to sell (the plant).
The N125,000 retraining costs cannot be provided for as they are part of future activities and the
anticipated $1·2 million profit on the disposal of the factory cannot be recognised until it is realised.

IFRS 6: EXPLORATION FOR AND EVALUATION OF MINERAL RESOURCES

Introduction
IFRS 6 addresses the financial reporting for the exploration for and evaluation of mineral
resources, including minerals, oil, natural gas, and similar nonregenerative resources. The
Standard is intended to provide some limited, initial guidance about the accounting for such
activities until the International Accounting Standards Board (IASB) has made a more
comprehensive review of the accounting for extractive industries. In particular, the Standard
modifies the requirements of other Standards so as to minimize disruption to entities in the
extractive industries applying International Financial Reporting Standards (IFRS) for the first
time.

More specifically, IFRS 6:

• Identifies expenditures to be included in and excluded from exploration and evaluation
assets;
• Provides an exemption for exploration and evaluation assets from part of the hierarchy in
IAS 8, Accounting Policies, Changes in Accounting Estimates, and Errors, of criteria that
an entity should use to develop an accounting policy if no IFRS applies specifically to an
item;
• Requires an entity that recognizes exploration and evaluation assets to assess such
assets for impairment in accordance with IFRS 6 and to measure such impairment in
accordance with IAS 36, Impairment of Assets;
 • Requires disclosures that identify and explain financial statement amounts that arise
from evaluation for and exploration of mineral resources, including
• The entity’s accounting policies for exploration and evaluation expenditures; and
• The amounts of assets, liabilities, income, and expense and operating and
investing cash flows arising from the exploration for and evaluation of mineral
resources.

IFRS 6 is effective for annual periods beginning on or after January 1, 2006. Earlier application
is encouraged.

Scope
IFRS 6 applies to expenditures incurred in the exploration and evaluation of mineral resources.
It does not apply to expenditures incurred:
(a) Before an entity has obtained the legal rights to explore a specific area (i.e., pre-acquisition
or preexploration expenditures), or
(b) After the technical feasibility and commercial viability of extracting a mineral resource are
demonstrable (i.e., development expenditure).

Definition of KeyTerms(in accordance with IFRS 6)

Exploration and evaluation expenditures: Expenditures incurred by an entity in connection
with the exploration for and evaluation of mineral resources before the technical feasibility and
commercial viability of extracting a mineral resource are demonstrated. Mineral resources
include minerals, oil, natural gas, and similar nonregenerative resources.
Exploration for and evaluation of mineral resources:The search for mineral resources after
the entity has obtained legal rights to explore in a specific area as well as the determination of
the technical feasibility and commercial viability of extracting the mineral resources.
Exploration and evaluation assets: Exploration and evaluation expenditures that are
recognized as assets in accordance with the entity’s accounting policy under IFRS 6. Such
assets are scoped out of IAS 16, Property, Plant, and Equipment, and IAS 38, Intangible Assets.

IAS 8 specifies a hierarchy of criteria that an entity ordinarily should use to develop an
accounting policy if no IFRS applies specifically to an item. When developing accounting
policies for exploration and evaluation assets, however, IFRS 6 exempts an entity from part of
the hierarchy in IAS 8. In the absence of such an exemption, the hierarchy in IAS 8 would have
required an entity to refer to, and consider the applicability of, these sources of authoritative
requirements and guidance in developing and applying an accounting policy for exploration and
evaluation assets:
(a) The requirements and guidance in Standards and Interpretations dealing with similar and
related issues; and
(b) The definitions, recognition criteria, and measurement concepts for assets, liabilities, income
and expenses in the Framework.
The reason for the exemption is that the IASB wanted to minimize disruption on first-time
adoption of IFRS both for users (e.g., due to lack of continuity of trend data) and for preparers
(e.g., due to the need to do costly system changes) until the IASB has made a comprehensive
review of accounting for extractive industries.

The requirement in IAS 8 for management to use its judgment in developing and applying an
accounting policy that results in information that is relevant and reliable applies to exploration
and evaluation assets. This means, for instance, that information that results from the entity’s
accounting policy needs to be complete in all material respects, reflect economic substance (not
merely legal form), and be neutral.(Two common methods in Oil Industry is the Full cost and
suceessful effort methods).

Changes in Accounting Policies

Once an entity has established accounting policies for exploration and evaluation expenditures,
it is permitted to change those policies only if the change makes the financial statements more
relevant to the economic decision-making needs of users and no less reliable, or more reliable
and no less relevant to those needs. The concepts of relevance and reliability are found in IAS
8.

Measurement
Initial Measurement
If an entity’s accounting policy results in the recognition of an exploration and evaluation asset,
IFRS 6 requires the entity to measure the asset initially at cost.
An entity is required to determine a policy that specifies which expenditures are recognized as
part of the cost of exploration and evaluation assets. That policy should consider the degree to
which the expenditure can be associated with finding specific mineral resources.

Examples
Expenditures that according to an entity’s policy might be recognized as exploration and
evaluation assets include expenditures for
• Acquisition of rights to explore
• Topographical, geological, geochemical, and geophysical studies
• Exploratory drilling
• Trenching
• Sampling
• Activities in relation to evaluating the technical feasibility and commercial viability of
extracting a mineral resource
In some cases, general and administrative and overhead costs directly attributable to
exploration and evaluation activities might also qualify for recognition as exploration and
evaluation assets.

Expenditures related to the development of mineral resources (i.e., preparations for commercial
production, such as building roads and tunnels) cannot be recognized as an exploration and
evaluation asset. Property, plant, and equipment used to develop or maintain exploration or
evaluation assets also cannot be recognized as an exploration and evaluation asset.

Classification
An entity classifies an exploration or evaluation asset as either a tangible asset or an intangible
asset according to the nature of the asset.

Examples
Vehicles and drilling rigs would be classified as tangible assets. Drilling rights would be
classified as intangible assets.

Subsequent Measurement
After initial recognition, an entity applies one of two measurement models to exploration and
evaluation assets:
(1) The cost model
(2) The revaluation model
Exploration and evaluation assets that are classified as tangible assets are measured in
accordance with IAS 16. Those that are classified as intangible assets are measured in
accordance with IAS 38.

Impairment
Because of the difficulties in obtaining the information necessary to estimate future cash flows of
exploration and evaluation assets, IFRS 6 modifies the requirements of IAS 36 regarding the
circumstances in which exploration and evaluation assets are required to be assessed for
impairment.

IFRS 6 requires exploration and evaluation assets to be assessed for impairment when facts
and circumstances suggest that the carrying amount of an exploration and evaluation asset may
exceed its recoverable amount. Facts or circumstances that may indicate that impairment
testing is required include:
• The period for which the entity has the right to explore in the specific area has expired or
is expected to expire in the near future, unless the right is expected to be renewed.
• Substantive expenditure on further exploration and evaluation activities in the specific
area is neither budgeted nor planned.
• Exploration and evaluation activities in the specific area have not led to the discovery of
commercially viable quantities of mineral resources, and the entity has decided to
discontinue such activities in the specific area.
• Although a development in the specific area is likely to proceed, there is sufficient data
to indicate that the carrying amount of the exploration and evaluation asset is unlikely to
be recovered in full from successful development or by sale.

If such facts or circumstances exist, the entity is required to perform an impairment test in
accordance with IAS 36, subject to special requirements with respect to the level at which
impairment is assessed: In assessing evaluation and exploration assets for impairment, an
entity allocates the assets either to cash-generating units or to groups of cash-generating units.
Cash-generating units are the smallest identifiable group of assets that generate cash inflows
that are largely independent of the cash inflows from other assets or groups of assets (e.g., an
oilfield). IFRS 6 requires
an entity to determine an accounting policy for its allocations. In no case would an entity assess
impairment at a level larger than a segment.

Disclosure
IFRS 6 requires an entity to disclose information that identifies and explains the amounts
recognised in its financial statements arising from the exploration for and evaluation of mineral
resources.
Such disclosures include:
• Accounting policies for exploration and evaluation expenditures, including the
recognition of exploration and evaluation assets
• The amounts of assets, liabilities, income, and expense, and operating and investing
cash flows arising from the exploration for and evaluation of mineral resources

In addition, an entity is required to make the disclosures required by IAS 16 or IAS 38 consistent
with an asset’s classification as either tangible or intangible.
IFRS 7: DISCLOSURE OF FINANCIAL INSTRUMENTS
Objective of the Standard
The main objective of IAS 32 is to provide full and useful disclosures relating to financial
instruments. IFRS 7 revises, enhances and replaces the disclosures in IAS 32. IAS 32 will only
deal with presentation matters.

Overview of IFRS 7
• adds certain new disclosures about financial instruments to those currently required by
IAS 32;

• replaces the disclosures previously required by IAS 32; and

• puts all of those financial instruments disclosures together in a new standard on

Financial Instruments: Disclosures. The remaining parts of IAS 32 deal only with
financial instruments presentation matters.

Disclosure requirements of IFRS 7

IFRS requires certain disclosures to be presented by category of instrument based on the IAS
39 measurement categories. Certain other disclosures are required by class of financial
instrument. For those disclosures an entity must group its financial instruments into classes of
similar instruments as appropriate to the nature of the information presented. [IFRS 7.6]

The two main categories of disclosures required by IFRS 7 are:

• information about the significance of financial instruments.

• information about the nature and extent of risks arising from financial instruments

Information about the significance of financial instruments

Balance sheet

• Disclose the significance of financial instruments for an entity's financial position and
performance. [IFRS 7.7] This includes disclosures for each of the following categories:
[IFRS 7.8]

• financial assets measured at fair value through profit and loss, showing
separately those held for trading and those designated at initial recognition

• held-to-maturity investments

• loans and receivables

• available-for-sale assets

• financial liabilities at fair value through profit and loss, showing separately those
held for trading and those designated at initial recognition

• financial liabilities measured at amortised cost

• Other balance sheet-related disclosures:

 • special disclosures about financial assets and financial liabilities designated to be
measured at fair value through profit and loss, including disclosures about credit
risk and market risk, changes in fair values attributable to these risks and the
methods of measurement.[IFRS 7.9-11]

• reclassifications of financial instruments from one category to another (e.g. from

fair value to amortised cost or vice versa) [IFRS 7.12-12A]

• information about financial assets pledged as collateral and about financial or

non-financial assets held as collateral [IFRS 7.14-15]

• reconciliation of the allowance account for credit losses (bad debts) by class of
financial assets[IFRS 7.16]

• information about compound financial instruments with multiple embedded

derivatives [IFRS 7.17]

• breaches of terms of loan agreements [IFRS 7.18-19]

Income Statement and Equity

• Items of income, expense, gains, and losses, with separate disclosure of gains and
losses from: [IFRS 7.20(a)]

• financial assets measured at fair value through profit and loss, showing
separately those held for trading and those designated at initial recognition.

• held-to-maturity investments.

• loans and receivables.

• available-for-sale assets.

• financial liabilities measured at fair value through profit and loss, showing
separately those held for trading and those designated at initial recognition.

• financial liabilities measured at amortised cost.

• Other income statement-related disclosures:

• total interest income and total interest expense for those financial instruments
that are not measured at fair value through profit and loss [IFRS 7.20(b)]

• fee income and expense [IFRS 7.20(c)]

• amount of impairment losses by class of financial assets [IFRS 7.20(e)]

• interest income on impaired financial assets [IFRS 7.20(d)]

Other disclosures

• accounting policies for financial instruments [IFRS 7.21]

• information about hedge accounting, including: [IFRS 7.22]

• description of each hedge, hedging instrument, and fair values of those

instruments, and nature of risks being hedged
 • for cash flow hedges, the periods in which the cash flows are expected to occur,
when they are expected to enter into the determination of profit or loss, and a
description of any forecast transaction for which hedge accounting had
previously been used but which is no longer expected to occur

• if a gain or loss on a hedging instrument in a cash flow hedge has been

recognised in other comprehensive income, an entity should disclose the
following: [IAS 7.23]

• the amount that was so recognised in other comprehensive income during the
period

• the amount that was removed from equity and included in profit or loss for the
period

• the amount that was removed from equity during the period and included in the
initial measurement of the acquisition cost or other carrying amount of a non-
financial asset or non- financial liability in a hedged highly probable forecast
transaction

• for fair value hedges, information about the fair value changes of the hedging instrument
and the hedged item [IFRS 7.24(a)]

• hedge ineffectiveness recognised in profit and loss (separately for cash flow hedges and
hedges of a net investment in a foreign operation) [IFRS 7.24(b-c)]

• information about the fair values of each class of financial asset and financial liability,
along with: [IFRS 7.25-30]

• comparable carrying amounts

• description of how fair value was determined

• the level of inputs used in determining fair value

• reconciliations of movements between levels of fair value measurement

hierarchy additional disclosures for financial instruments whose fair value is
determined using level 3 inputs including impacts on profit and loss, other
comprehensive income and sensitivity analysis

• information if fair value cannot be reliably measured

The fair value hierarchy introduces 3 levels of inputs based on the lowest level of input
significant to the overall fair value (IFRS 7.27A-27B):

• Level 1 – quoted prices for similar instruments

• Level 2 – directly observable market inputs other than Level 1 inputs

• Level 3 – inputs not based on observable market data

Note that disclosure of fair values is not required when the carrying amount is a reasonable
approximation of fair value, such as short-term trade receivables and payables, or for
instruments whose fair value cannot be measured reliably. [IFRS 7.29(a)]

Nature and extent of exposure to risks arising from financial instruments

Qualitative disclosures [IFRS 7.33]

• The qualitative disclosures describe:

• risk exposures for each type of financial instrument

• management's objectives, policies, and processes for managing those risks

• changes from the prior period

Quantitative disclosures

• The quantitative disclosures provide information about the extent to which the entity is
exposed to risk, based on information provided internally to the entity's key management
personnel. These disclosures include: [IFRS 7.34]

• summary quantitative data about exposure to each risk at the reporting date

• disclosures about credit risk, liquidity risk, and market risk and how these risks
are managed as further described below

• concentrations of risk

Credit Risk

• Credit risk is the risk that one party to a financial instrument will cause a loss for the
other party by failing to pay for its obligation. [IFRS 7. Appendix A]

• Disclosures about credit risk include: [IFRS 7.36-38]

• maximum amount of exposure (before deducting the value of collateral),

description of collateral, information about credit quality of financial assets that
are neither past due nor impaired, and information about credit quality of financial
assets whose terms have been renegotiated [IFRS 7.36]

• for financial assets that are past due or impaired, analytical disclosures are
required [IFRS 7.37]

• information about collateral or other credit enhancements obtained or called

[IFRS 7.38]

Liquidity Risk

• Liquidity risk is the risk that an entity will have difficulties in paying its financial liabilities.
[IFRS 7. Appendix A]

• Disclosures about liquidity risk include: [IFRS 7.39]

• a maturity analysis of financial liabilities

• description of approach to risk management

Market Risk [IFRS 7.40-42]

• Market risk is the risk that the fair value or cash flows of a financial instrument will
fluctuate due to changes in market prices. Market risk reflects interest rate risk, currency
risk and other price risks. [IFRS 7. Appendix A]
 • Disclosures about market risk include:

• a sensitivity analysis of each type of market risk to which the entity is exposed

• additional information if the sensitivity analysis is not representative of the entity's

risk exposure (for example because exposures during the year were different to
exposures at year-end).

• IFRS 7 provides that if an entity prepares a sensitivity analysis such as value-at-

risk for management purposes that reflects interdependencies of more than one
component of market risk (for instance, interest risk and foreign currency risk
combined), it may disclose that analysis instead of a separate sensitivity analysis
for each type of market risk

Transfers of financial assets [IFRS 7.42A-H]

An entity shall disclose information that enables users of its financial statements:

a. to understand the relationship between transferred financial assets that are not
derecognised in their entirety and the associated liabilities; and

b. to evaluate the nature of, and risks associated with, the entity's continuing involvement in
derecognised financial assets. [IFRS 7 42B]

Transferred financial assets that are not derecognised in their entirety

• Required disclosures include description of the nature of the transferred assets, nature
of risk and rewards as well as description of the nature and quantitative disclosure
depicting relationship between transferred financial assets and the associated liabilities.
[IFRS 7.42D]

Transferred financial assets that are derecognised in their entirety

• Required disclosures include the carrying amount of the assets and liabilities
recognised, fair value of the assets and liabilities that represent continuing involvement,
maximum exposure to loss from the continuing involvement as well as maturity analysis
of the undiscounted cash flows to repurchase the derecognised financial assets. [IFRS
7.42E]

• Additional disclosures are required for any gain or loss recognised at the date of transfer
of the assets, income or expenses recognise from the entity's continuing involvement in
the derecognised financial assets as well as details of uneven distribution of proceed
from transfer activity throughout the reporting period. [IFRS 7.42G]
IFRS 8: OPERATING SEGMENTS
Definition
Operating segment is defined as a component of an entity which engages in business
activities•from which it may earn revenues and incur expenses (including revenues and
expenses from other components within the entity) whose operating results are regularly
reviewed by the Chief Operating Decision Maker (CODM) when making decisions about
resource allocation and performance assessment, and for which discrete information is
available

Salient Points
• Operating segments are identified on the basis of internal information given to CODM
• Operating segments may be components selling exclusively within the entity
• Reportable segment information is to be the same as that given to CODM
• The IFRS fails to define revenue, expense, results, assets or liabilities but does require
an explanation of how segment profit has been arrived at

The reasons or purposes for segment reporting include:

(a To understand better the past performance of an enterprise
(b) To assess better the risks and returns of an enterprise
(c) To gain more informed judgments about an enterprise as a whole
(d) To be aware of the impact that changes in significant components of a business may
have on the business as a whole

Reportable Segments
Information must be disclosed about any operating segment that meets any of the following
qualitative thresholds:-
• Reported revenue ( internal and external ) ≥ 10% of total entity revenue
• Reported profit or loss ≥ 10% of the greater of aggregate profits ( without netting off
losses )or aggregate losses ( without netting off profits )
• Assets are ≥ 10% of combined assets of the entity
• If reported segmental revenue is less than 75% of the entity’s revenue then additional
segments shall be reported until at least 75% revenue has been reported

Problems of Segment Reporting

(a) Identifying and definition of a segment is not an easy task
(b) Analyzing segments based on risks and returns may be misleading, a component with a
higher risk may yield a higher return
(c) Allocation of common costs on a reasonable basis may be subjective.
(d) To analyze the sales revenue into external and internal, including the method of transfer
pricing used for inter-segmental sale is not an easy task.
(e) Finance is normally raised centrally, and so interest received and paid is normally treated as
an unallocated item. However, if the enterprise had a banking division, then the related finance
costs would be treated as part of the segment result of the division or segment.

example of a primary reporting format is shown below:

Segmen
t Segment Segment Eliminations Total
1 2 3
N'000 N'000 N'000 N'000 N'000
REVENUE
External sales 500 400 600
Inter-segment sales 70 80 50 (200)
Total sales 570 480 650 (200) 1,500

RESULT
Segment Result 120 140 90 350
Unallocated expenses 110
Operating profit 240
Interest expenses 60
Income tax 45
Profit after tax 135

OTHER INFORMATION
Segment assets 350 220 430 1,000
Unallocated assets 200
Total assets 1,200

Segment liabilities 120 80 200 400

Unallocated liabilities 300
Total liabilities 700

Capital expenditure 95 55 70 220

Depreciation 80 40 80 200
Other non cash expenses 4 6 - 10

Disclosure
General information
IFRS 8 requires disclosure of the following:
• Factors used to identify the entity’s reportable segments, including the basis of organisation
e.g whether segments are based on products or service, geographical areas or a
combination of these
• The types of products and services from which each reportable segment derives revenues

Information about profit or loss and other segment items

For each reportable segment an entity should report:
• A measure of profit or loss
• A measure of total assets
• A measure of totals liabilities
IFRS 8 does not define segment revenue, segment result (profit or loss) or segment assets,
therefore the following amounts must be disclosed if they are included in segment profit or loss:
• revenues from external customers
• revenues from inter-segment transactions
• interest revenue
• interest expense
• depreciation and amortisation
• material items of income and expense (exceptional items)
• interests in the profit or loss of associates and joint ventures accounted for by the equity
method
• income tax expense
• material non-cash items other than depreciation or amortisation

Entity’s Wide Disclosure

• Core principle of disclosure is that entities should disclose sufficient information to
enable users to evaluate the nature and financial effects of the types of business
activities and the economic environments in which the entity operates
• Information to be disclosed about how operating segments are identified as well as the
types of products or services from which each segment derives its revenues
• Interest revenue and interest expense to be reported separately for each segment if they
are included within the results reported to CODM
• Information about the reported results including specified revenues and expenses,
segment assets and liabilities and the basis of measurement
• Reconciliations between the entity financial statement figures and the reported segment
information
• Information about each product or service
• Analyses of revenues and certain non-current assets by geographical area unless this
information is too expensive to obtain, in which case a statement is required that it “is too
expensive”
• Required to disclose information about transactions with major customers where
revenue ≥ 10% of total revenues
• A Cash Generating Unit (CGU) for impairment considerations shall not exceed a
reporting segment

REVIEW QUESTIONS
1. TORITEL Limited manufactures a wide variety of pharmaceuticals, medical instruments, and
other related medical supplies. Eighteen months ago the company developed and began to
market a new product line of antihistamine drugs under various trade names. Sales and
profitability of this product line during the current
fiscal year greatly exceeded management‟s expectations. The new product line will account for
10% of the company‟s total sales and 12% of the company‟s operating income for the fiscal
year ended June 30, 2009. Management believes sales and profits will be significant for several
years.
Toritel is concerned that its maket share and competitive position may suffer if it discloses the
volume and profitability of its new product line in its annual financial statements. Management is
not sure of how IFRS 8 applies in this case.
Required:
(a) State THREE purposes of requiring segment information in financial statements (3 Marks)
(b) Identify SIX factors that should be considered when attempting to decide on how products
should be grouped to determine a single business segment.
(c) What options, if any, does Toritel Ltd. have with the disclosure of its new antihistamine
product line? Explain your answer.
2. (a) Norman, a public limited company, has three business segments which are currently reported in its
financial
statements. Norman is an international hotel group which reports to management on the basis of region. It
does not currently report segmental information under IFRS8 ‘Operating Segments’. The results of the
regional segments for the year ended 31 May 2008 are as follows:
Region Revenue Segment results Segment Segment
External Internal profit/(loss) assets liabilities
Nm Nm Nm Nm Nm
European 200 3 (10) 300 200
South East Asia 300 2 60 800 300
Other regions 500 5 105 2,000 1,400
There were no significant inter company balances in the segment assets and liabilities. The hotels are
located in
capital cities in the various regions, and the company sets individual performance indicators for each hotel
based
on its city location.
Required:
Discuss the principles in IFRS8 ‘Operating Segments’ for the determination of a company’s
reportable
operating segments and how these principles would be applied for Norman plc using the
information given
above. (11 marks) ACCA CORPORATE REPORTING JUNE 2008

SUGGESTED SOLUTIONS
1. (a) Purpose of segment information in financial statements.
(i) It provides effective analysis and comparison of entities whose operation cuts across different
classes of business and geographical boundaries.
(ii) It provides better understanding of the entity‟s past performances.
(iii) It provides better assessment of the entity‟s risks and returns.
iv) It provides more informed judgements about the entity as a whole.

(b) The factors to be considered in grouping segment information include:

(i) Information about products and services.
(ii) Information about the geographical areas.
(iii) Information about major customers.
(iv) Existing profit centres.
(v) Nature of the product or service.
(vi) The nature of the production processes.
(vii) Market and marketing methods.
(viii) The nature of their regulatory environments, e.g. for Banks, Insurance, Oil and Gas, public
utilities etc.

(c) Concern is sometimes expressed that disclosing information about segmentsmay weaken an
entity‟s competitive position because more information is made available to competitors,
customers, suppliers and others as rightly observed by Toritel Ltd. For this reason, some
consider it appropriate to withhold certain information where disclosures are deemed to be
detrimental to their entity; the required disclosure about segments are no more detailed or
specific than the disclosures typically provided by an entity that operates a single entity. The
only information that Toritel Ltd. Can disclose is that which is intended primarily to permit users
of Financial Statements to make better assessment of the past performance and future
prospects of the Company.

2. (a) Upon adoption of IFRS8,‘Operating Segments’, the identification of Norman’s segments may or may
not change depending on how segments were identified previously. IFRS8 requires operating segments
to be identified on the basis of internal reports about the components of the entity that are regularly
reviewed by the chief operating decision maker in order to allocate resources to the segment and to
assess its performance. Formerly companies identified business and geographical segments using a risks
and rates of return approach with one set of segments being classed as primary and the other as
secondary.
IFRS8 states that a component of an entity that sells primarily or exclusively to other operating segments
of the entity meets the definition of an operating segment if the entity is managed that way. IFRS8 does
not define segment revenue, segment expense, segment result, segment assets, and segment liabilities
but does require an explanation of how segment profit or loss, segment assets, and segment liabilities are
measured for each segment. This will give entities some discretion in determining what is included in
segment profit or loss but this will be limited by their internal reporting practices. The core principle is that
the entity should disclose information to enable users to evaluate the nature and financial effects of the
types of business activities in which it engages and the economic environments in which it operates.
IFRS8 ‘Operating Segments’ defines an operating segment as follows. An operating segment is 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 reviewed regularly by the entity’s chief operating decision makers to make
decisions about resources to be allocated to the segment and assess its performance; and for which
discrete financial information is available IFRS8 requires an entity to report financial and descriptive
information about its reportable segments. Reportable segments are operating segments that meet
specified criteria:
– the reported revenue, from both external customers and intersegment sales or transfers, is 10% or
more of the combined revenue, internal and external, of all operating segments; or
– the absolute measure of its reported profit or loss is 10% or more of the greater, in absolute amount, of
(i) the combined reported profit of all operating segments that did not report a loss, and (ii) the combined
reported loss of all operating segments that reported a loss; or
– its assets are 10% or more of the combined assets of all operating segments.
If the total external revenue reported by operating segments constitutes less than 75% of the entity’s
revenue, additional operating segments must be identified as reportable segments (even if they do not
meet the quantitative thresholds set out above) until at least 75% of the entity’s revenue is included in
reportable segments. There is no precise limit to the number of segments that can be disclosed.
As the key performance indicators are set on a city by city basis, there may be information within the
internal reports about the components of the entity which has been disaggregated further. Also the
company is likely to make decisions about the allocation of resources and about the nature of
performance on a city basis because of the individual key performance indicators.
In the case of the existing segments, the European segment meets the criteria for a segment as its
reported revenue from external and inter segment sales (N203 million) is more than 10% of the combined
revenue (N1,010 million). However, it fails the profit/loss and assets tests. Its results are a loss of N10
million which is less than 10% of the greater of the reported profit or reported loss which is N165 million.
Similarly its segment assets of N300 million are less than 10% of the combined segment assets (N3,100
million). The South East Asia segment passes all of the threshold tests. If the company changes its
business segments then the above tests will have to be reperformed. A further issue is that the current
reported segments constitute less than 75% of the company’s external revenue (50%), thus additional
operating segments must be identified until 75% of the entity’s revenue is included in reportable
segments.
Norman may have to change the basis of reporting its operating segments. Although the group reports to
management on the basis of three geographical regions, it is likely that management will have information
which has been further disaggregated in order to make business decisions. Therefore, the internal reports
of Norman will need to be examined before it is possible to determine the nature of the operating
segments.
IFRS 9: FINANCIAL INSTRUMENTS
Introduction
IFRS 9 on Financial Instruments is to replace IAS 39 on Recognition and Measurement of
Financial Instruments by January 2018.
A brief summary of comparability between these two Standards:
• No change in scope
• No change in recognition criteria
• No change on derecognition criteria
• No change on measurement on initial recognition (fair value of consideration paid)
• New rules on classification of financial assets in IFRS 9 different from those of IAS 39
• No change on classification of financial liabilities
• There is no need to separate embedded derivatives in financial assets because the
derivative will cause the host contract to be measured at fair value through profit or loss
• There are new rules on impairment of financial assets – expected loss model
• There are new rules on hedge accounting.

Initial Recognition of Financial Instruments

This remains the same as in IAS 39, fair value of consideration paid or received subject to or no
adjustment of transaction costs.

Financial Assets (can be either debt instrument or equity instrument)

Subsequent Measurement of Financial Assets
The Standard divides financial assets that are currently in the scope of IAS 39 into the following
classifications for the purpose of subsequent measurement:
• Amortised cost
• Fair value through profit or loss (FVTPL)
• Fair value through other comprehensive inomcme (FVTOCI)

(A) Debt Instruments

A debt asset may only be valued at amortised cost if it satisfies both of two tests:
(a) Business model test – the asset is held with the intention of realising its cash flows rather
than being held for early sale, and
(b) Cash flow characteristics test – the asset terms are such that cash flows will arise on
specific dates in the future representing interest payments and repayments of principal.

All other debt instruments that do not meet these tests must be measured at fair value through
profit or loss (FVTPL).
Fair value option – Even if a debt instrument meets the two amortised cost tests, IFRS 9
contains an option to designate a financial asset as measured at FVTPL if doing so eliminates
or significantly reduces a measurement or recognition inconsistency (sometimes referred to as
an ‘accounting mismatch’) that would otherwise arise from measuring assets or liabilities or
recognising the gains or losses on them on different bases.

(B) Equity Instruments

All equity investments in scope of IFRS 9 are to be measured at fair value (FVTPL) in the
statement of financial position, with value changes recognised in profit or loss except for those
equity investments for which the entity has elected to report value changes in ‘other
comprehensive income’ (FVTOCI).

‘Other Comprehensive Income’ Option

If an equity investment is not held for trading, an entity can make an irrevocable election at initial
recognition to measure it at fair value through other comprehensive income (FVTOCI) as stated
in the preceding paragraph.
It is to be noted that such an election cannot be changed – it is irrevocable.So, if the election is
made, only the dividend income from the investment will be recognised.within the Statement of
Profit or Loss.
Note that if the investment was made with the intention of trading those shares, then it is not
possible to elect to classify the investment as at FVTOCI.
On Disposal
Gains and losses previously recognized through statement of other comprehensive income
cannot be recycled through the Statement of Profit or Loss, instead, on disposal, previously
recognized gains and losses will be transferred to retained earnings through the statement of
changes in equity. It is only on disposal of debt instruments that can have the previuos gains or
loses recognised in other equity reserve transferred to profit or loss (new rule in IFRS 9).

Subsequent Measurement of Financial Liabilities

IFRS 9 does not change the basic accounting model for financial liabilities under IAS 39.
Financial liabilities held for trading will continue to be measured at fair value through profit
or loss (FVTPL) while all other financial liabilities are measured at amortised cost unless fair
value option is applied.

Fair value option

IFRS 9 allows all other financial liabilities which would have been measured at amortised cost to
exercise the fair value option if doing so:
(a) eliminates or significantly reduces a measurement or recognition inconsistency (sometimes
referred to as an ‘accounting mismatch’) that would otherwise arise from measuring assets or
liabilities or recognising the gains and losses on them on different bases, or
(b) this will allow the entity to reflect a documented risk management strategy.
Like the financial assets any such designation is irrevocable. Reclasification of financial
liabilities after intial recognition is not allowed.

Illustration on financial liability at amortised cost

An entity raises finance by issuing N600,000 4% debentures, redeemable in 3 years’ time at a
premium of N33,367. You are told that the effective rate of interest is 7%.
No election has been made to treat the liability at FVTPL so it will be accounted for on an
amortised cost basis. Issue costs of N20,000 were incurred

Suggested Solution
On issue, the double entry will be:
Dr Cash with the net receipts N580,000
Cr Liabilities – debenture N580,000
• in order to calculate the annual finance charge it is advisable to set out a table as follows:
Brought Effective Interest Carried
Forward interest 7% paid 4% Forward
N N N N
Year 1 580,000 40,600 24,000 596,600
Year 2 596,600 41,762 24,000 614,362
Year 3 614,362 43,005 24,000 633,367

Note, if the interest rate / coupon rate had been zero, then no amount of interest would be paid.
The only payment would have been the amount paid on maturity at the end of the 3 years. But
the annual finance charge using the effective interest rate would be shown
• In the unusual situation that a financial liability is classified as at FVTPL, it is initially
measured at fair value but any related transaction costs are expensed immediately
through Statement of Profit or Loss as before, the liability will be annually adjusted by
the difference between effective rate and nominal rate
 • But this is then further affected by the adjusted value compared with the “new fair value”
• The new fair value is measured as the market value or, if this is not known, then by the
present value of its future associated cash flows using the current market interest rate
• And the current market interest rate is then used to calculate the future finance charges
until the next revaluation takes place

Compound / Mixed Instruments

• These are financial instruments which have both a debt element and an equity element
• classically, a convertible debenture
• you will not be asked in an exam to calculate the effective rate of interest on any
financial instrument if it’s relevant, it will be stated in the question
• in the situation of a compound instrument being issued, the issuing entity will need to
value separately the debt element and, by default, the equity element
• in valuing the debt element, discounted cash flow techniques are applied to the future
cash flows attributable to the debt by deducting the total present value of the debt
element from the face value of the compound instrument, we are left with the equity
element

Illustration – on compound instruments

A N400,000 4% debenture was issued, redeemable at par in 3 years’ time. We are told that the
effective rate of interest is 7%. In this illustration, there are no transaction costs but, if there had
been, these would have been proportionally allocated between the debt and the equity elements
The debenture can be repaid in cash or the lender can opt to convert the debt into equity shares
on agreed terms of, say, 750 N1 equity shares for each N1,000 debenture

We need a table to calculate the present value of the cash flows related to the debt element
Cash Flow discount factor @ 7% present value
N N
Year 1 16,000 . 0.9346 14,954
Year 2 16,000 . 0 8734 13,974
Year 3 416,000 . 0 8163 339,580
368,508
The double entry to record the issue of convertible debenture would be:
Dr Cash N400,000
Cr Other Components of equity 31,492
Cr Financial Liability Debenture 368,508

To calculate the amounts to be included within the financial statements, it is advisable to set
up a table as follows:
brought effective interest 7% interest paid 4% Carried
forward
forward
N N N N
Year 1 368,508 25,796 16,000 378,304
Year 2 378,304 26,481 16,000 388,785
Year 3 388,785 27,215 16,000 400,000

In year 1 there will be a charge to the Statement of Profit or Loss of N25,796 even though
only N16,000 is actually paid. The difference of N9,796 is added to the financial liability in the
statement of financial position
Similarly, in year 2 the finance charge in the Statement of Profit or Loss will be N26,481 and the
liability will be increased by N10,481 ie N26,481 - N16,000 paid
At the end of year 3, the liability now stands at N400,000 and will be either repaid in cash or, if
the lender chooses, it could be settled by the issue of 300,000 N1 equity shares in which case
the double entry would be:
Dr 4% Debenture 400,000
Cr Share capital 300,000
Cr Share premium 100,000

Impairment of Financial Instruments

IFRS 9 suggests that only assets held at amortised cost should be subjected to annual
impairment review but it is proposed that an “expected loss” model be introduced so investors
holding financial assets will be required to determine and account for expected losses when the
asset is acquired rather than wait until the investee entity defaults.
This will be achieved by making allowance for the expected losses over the life of the asset by
acknowledging a potential reduction in the income stream from that asset.

Illustration 1
The accounting treatment on the disposal of an equity investment classified as at
FVTOCI
-(a) Some shares were acquired some years ago for, say, N6,000 an election was made on
acquisition to classify as at FVTOCI
(b) Throughout the period of ownership, the investment has been annually re-measured with
increases and decreases reflected in other comprehensive income and credited to “Other
components of Equity”
(c) At the last year end, the fair value had risen to N9,600 and, at the date of disposal during this
year, it had risen further to N9,800
(d) Only N200 will be recognized through this year’s Statement of Profit or Loss. The previous
gains of N3,600 will be transferred from “Other componnents of equity” to ‘Retained earnings”
through the Statements of Change in Equity. (note for debt instruments previously recognised
gain or loss on fair value changes recognised in other components of equity will be transferred
to profit or loss)

Illustration 2: How the “Expected Loss Model” Works on Impairment of Financial Assets
A portfolio of debt instruments has been acquired and recognised at its cost of N40,000.
The assets satisfy both the business model test and the cash flow characteristics test and have
been accounted for at amortised cost.
The actual and effective rate of return is 6% but there is an element of doubt about the
continuing viability of the investee entities and, although there has been no default this year, it is
considered likely that the actual rate of return in the long run will be only 4%
Required: Show how the expected loss model will be used to identify impairment loss on this
asset.

Suggested Solution
In applying the expected loss model, only 4% return on the portfolio will be recognised in the
Statement of Profit or Loss. The amount to be recognised before the expected loss review was
6% × N40,000 ie N2,400 but the expected loss restricts the amount to be recognised to just 4%
× N40,000 ie N1,600
The “missing” 2% ie N800 will be credited to the asset account reducing the value of the
portfolio to N40,000 – N800 ie N39,200

The double entry will therefore be:-

Dr Cash N2,400
Cr Income N1,600
Cr Asset N800
Derecognition of Financial Instruments

Derognition of financial asset or financial liability is the removal of these instruments previouly
recognised from an entity’s financial statements. The criteria for derecognition of financial assets
and financial liabilites under IFRS 9 have not changed from those stipulated in IAS 39.

Derivatives

All derivatives, including those linked to unquoted equity investments, are measured at fair
value. Value changes are recognised in profit or loss unless the entity has elected to treat the
derivative as a hedging instrument in accordance with IAS 39, in which case the requirements of
IAS 39 apply.

Embedded derivatives

The treatment of embedded derivatives depends on whether the hybrid contract contains a host
that is an asset within the scope of IFRS 9.

Hybrids contains a host contract within the scope of IFRS 9

If the host contract is an asset within the scope of IFRS 9 the normal rules of classification and
accounting apply. The contractual cash flows from the financial asset is assessed in their
entirety, and the asset as a whole is measured at fair value through profit or loss (FVTPL)
provided none of its cash flows represent payments of principal and interest.

Hybrid contains a host contract outside the scope of IFRS 9

If a hybrid contract contains a host that is an asset outside the scope of IFRS 9 , an embedded
derivative must be separated from the host and accounted for as a derivative subject to the
same rules as in IAS 39.

Hedge Accounting

The Hedging rules in IAS 39 has been criticized, they were rather rule based rather than being
principle based hence the need to develop new rules in IFRS 9.

Objective of Hedge Accounting

The Standard states that the objective of hedge accounting is to represent the effect of an
entity’s risk management activities that use financial instruments to manage exposures arising
from particular risks that could affect profit or loss or other comprehensive income.

This pronouncement links the accounting rules to the risk management objective resulting in a
principle based approach

Summary of the Changes Made on IAS 39 Hedge Accounting Changed by IFRS 9

1. The quantitative effectiveness test hurdle of 80% - 125% in IAS 39 has been removed.

2. Under IAS 39 only foreign exchange risk that can be hedged with non derivative financial
instrument, under IFRS 9, non derivative financial instruments can be used as hedging
instruments as long as they are at fair vaue through profit or loss (FVTPL).

3. IAS 39 allows hedging of component parts of financial assets or financial liabilities but not
components of non financial items IFRS 9 has removed this distinction; therefore components of
non financial items now qualify for hedge accounting.
4. IAS 39 does not allow hedging of net positions ie net assets IFRS 9 now allows this, provided
certain criteria are met.

Reclassification

For financial assets, reclassification is required between FVTPL and amortised cost, or vice
versa, if and only if the entity's business model objective for its financial assets changes so its
previous model assessment would no longer apply. [IFRS 9, paragraph 4.4.1]

If reclassification is appropriate, it must be done prospectively from the reclassification date. An

entity does not restate any previously recognised gains, losses, or interest.

IFRS 9 does not allow reclassification where:

• the 'other comprehensive income' option has been exercised for a financial asset, or

• the fair value option has been exercised in any circumstance for a financial assets or
financial liability.

Disclosures

IFRS 9 amends some of the requirements of IFRS 7 Financial Instruments: Disclosures

including added disclosures about investments in equity instruments designated as at FVTOCI.
REVIEW QUESTION
1. The publication of IFRS 9, Financial Instruments, represents the completion of the first stage of a three-
part project
to replace IAS 39 Financial Instruments: Recognition and Measurement with a new standard. The new
standard
purports to enhance the ability of investors and other users of financial information to understand the
accounting of
financial assets and reduces complexity.
Required:
(a) (i) Discuss the approach taken by IFRS 9 in measuring and classifying financial assets and the
main effect
that IFRS 9 will have on accounting for financial assets. (11 marks)

(ii) Grainger, a public limited company, has decided to adopt IFRS 9 prior to January 2012 and has
decided to restate comparative information under IAS 8 Accounting Policies, Changes in Accounting
Estimates and Errors. The entity has an investment in a financial asset which was carried at amortised
cost under IAS 39 but will be valued at fair value through profit and loss (FVTPL) under IFRS 9. The
carrying value of the assets was N105,000 on 30 April 2010 and N110,400 on 30 April 2011. The fair
value of the asset was N106,500 on 30 April 2010 and N111,000 on 30 April 2011. Grainger has
determined that the asset will be valued at FVTPL at 30 April 2011.
Required:
Discuss how the financial asset will be accounted for in the financial statements of Grainger in the
year
ended 30 April 2011. (4 marks)

(b) Recently, criticisms have been made against the current IFRS impairment model for financial assets
(the incurred
loss model). The issue with the incurred loss model is that impairment losses (and resulting write-downs
in the
reported value of financial assets) can only be recognised when there is evidence that they exist and
have been
incurred. Reporting entities are not allowed currently to consider the effects of expected losses. There is a
view
that earlier recognition of loan losses could potentially reduce the problems incurred in a credit crisis.
Grainger has a portfolio of loans of N5 million which was initially recognised on 1 May 2010. The loans
mature in 10 years and carry an interest rate of 16%. Grainger estimates that no loans will default in the
first two years, but from the third year onwards, loans will default at an annual rate of about 9%. If the
loans default as expected, the rate of return from the portfolio will be approximately 9·07%. The number
of loans are fixed without any new lending or any other impairment provisions.
Required:
(i) Discuss briefly the issues related to considering the effects of expected losses in dealing with
impairment
of financial assets. (4 marks)
(ii) Calculate the impact on the financial statements up to the year ended 30 April 2013 if Grainger
anticipated the expected losses on the loan portfolio in year three. (4 marks)
Professional marks will be awarded in question 4 for clarity and quality of discussion. (2 marks)
(25 marks) ACCA CORPORATE REPORTING JUNE 2011

SUGGESTED SOLUTION
1. (a) (i) IFRS 9 Financial instruments retains a mixed measurement model with some assets measured
at amortised cost and others at fair value. The distinction between the two models is based on the
business model of each entity and a requirement to assess whether the cash flows of the instrument are
only principal and interest. The business model approach is fundamental to the standard and is an
attempt to align the accounting with the way in which management uses its assets in its business whilst
also looking at the characteristics of the business. A debt instrument generally must be measured at
amortised cost if both the ‘business model test’ and the ‘contractual cash flow characteristics test’ are
satisfied. The business model test is whether the objective of the entity’s business model is to hold the
financial asset to collect the contractual cash flows rather than have the objective to sell the instrument
prior to its contractual maturity to realise its fair value changes.
The contractual cash flow characteristics test is whether the contractual terms of the financial asset give
rise, on specified dates, to cash flows that are solely payments of principal and interest on the principal
amount outstanding.
All recognised financial assets that are currently in the scope of IAS 39 will be measured at either
amortised cost or fair value. The standard contains only the two primary measurement categories for
financial assets unlike IAS 39 where there were multiple measurement categories. Thus the existing IAS
39 categories of held to maturity, loans and
receivables and available-for-sale are eliminated along with the tainting provisions of the standard.
A debt instrument (e.g. loan receivable) that is held within a business model whose objective is to collect
the contractual cash flows and has contractual cash flows that are solely payments of principal and
interest generally must be measured at amortised cost. All other debt instruments must be measured at
fair value through profit or loss (FVTPL). An investment in a convertible loan note would not qualify for
measurement at amortised cost because of the inclusion of the conversion option, which is not deemed to
represent payments of principal and interest. This criterion will permit amortised cost measurement when
the cash flows on a loan are entirely fixed such as a fixed interest rate loan or where interest is floating or
a combination of fixed and floating interest rates.
IFRS 9 contains an option to classify financial assets that meet the amortised cost criteria as at FVTPL if
doing so
eliminates or reduces an accounting mismatch. An example of this may be where an entity holds a fixed
rate loan
receivable that it hedges with an interest rate swap that swaps the fixed rates for floating rates. Measuring
the loan asset at amortised cost would create a measurement mismatch, as the interest rate swap would
be held at FVTPL. In this case the loan receivable could be designated at FVTPL under the fair value
option to reduce the accounting mismatch that arises from measuring the loan at amortised cost.
All equity investments within the scope of IFRS 9 are to be measured in the statement of financial position
at fair value
with the default recognition of gains and losses in profit or loss. Only if the equity investment is not held
for trading can
an irrevocable election be made at initial recognition to measure it at fair value through other
comprehensive income
(FVTOCI) with only dividend income recognised in profit or loss. The amounts recognised in OCI are not
recycled to profit or loss on disposal of the investment although they may be reclassified in equity.
The standard eliminates the exemption allowing some unquoted equity instruments and related derivative
assets to be
measured at cost. However, it includes guidance on the rare circumstances where the cost of such an
instrument may
be appropriate estimate of fair value.
The classification of an instrument is determined on initial recognition and reclassifications are only
permitted on the
change of an entity’s business model and are expected to occur only infrequently. An example of where
reclassification from amortised cost to fair value might be required would be when an entity decides to
close its mortgage business, no longer accepting new business, and is actively marketing its mortgage
portfolio for sale. When a reclassification is
required it is applied from the first day of the first reporting period following the change in business model.
All derivatives within the scope of IFRS 9 are required to be measured at fair value. IFRS 9 does not
retain IAS 39’s
approach to accounting for embedded derivatives. Consequently, embedded derivatives that would have
been separately accounted for at FVTPL under IAS 39 because they were not closely related to the
financial asset host will no longer be separated. Instead, the contractual cash flows of the financial asset
are assessed as a whole and are measured at FVTPL if any of its cash flows do not represent payments
of principal and interest.
One of the most significant changes will be the ability to measure some debt instruments, for example
investments in
government and corporate bonds at amortised cost. Many available-for-sale debt instruments currently
measured at fair value will qualify for amortised cost accounting.
Many loans and receivables and held-to-maturity investments will continue to be measured at amortised
cost but some will have to be measured instead at FVTPL. For example some instruments, such as cash-
collateralised debt obligations, that may under IAS 39 have been measured entirely at amortised cost or
as available-for-sale will more likely be measured at FVTPL. Some financial assets that are currently
disaggregated into host financial assets that are not at FVTPL will instead by measured at FVTPL in their
entirety.
IFRS 9 may result in more financial assets being measured at fair value. It will depend on the
circumstances of each
entity in terms of the way it manages the instruments it holds, the nature of those instruments and the
classification
elections it makes.
Assets that are currently classified as held-to-maturity are likely to continue to be measured at amortised
cost as they
are held to collect the contractual cash flows and often give rise to only payments of principal and interest.
IFRS 9 does not directly address impairment. However, as IFRS 9 eliminates the available-for-sale (AFS)
category, it also eliminates the AFS impairment rules. Under IAS 39 measuring impairment losses on debt
securities in illiquid markets based on fair value often led to reporting an impairment loss that exceeded
the credit loss that management expected.
Additionally, impairment losses on AFS equity investments cannot be reversed within the income
statement section of
the statement of comprehensive income under IAS 39 if the fair value of the investment increases. Under
IFRS 9, debt
securities that qualify for the amortised cost model are measured under that model and declines in equity
investments
measured at FVTPL are recognised in profit or loss and reversed through profit or loss if the fair value
increases.

(ii) Under the general rules of retrospective application of IAS 8, the financial statements for the year
ended 30 April 2011 would have an opening adjustment to equity of N1,500 credit as at 1 May 2010
(N106,500 minus N105,000). The fair value of the asset was N106,500 on 30 April 2010 and N111,000 on
30 April 2011 and therefore N4,500 will
be credited to profit or loss for the year ended 30 April 2011.

(b) (i) The expected loss model is more subjective in nature compared to the incurred loss model, since it
relies significantly on the cash flow estimates prepared by the reporting entity which are inherently
subjective. Therefore safeguards are needed to be built into the process such as disclosures of methods
applied. The expected loss model would involve significant operational challenges notably it is onerous in
data collection since data needs to be collected for the whole portfolio of financial assets measured at
amortised cost held by a reporting entity. This means that data is not only required for impaired financial
assets but it also requires having historical loss data for all financial assets held at amortised cost. Entities
do not always have historical loss data for financial assets, particularly for some types of financial asset or
some types of markets. The historical loss data often does not reflect the losses to maturity or the
historical data are not relevant due to significant changes in circumstances.

(ii) Incurred loss model per IAS 39

Date Loan asset Interest Cash flow Loss (C) Loan asset Return
(A) at 16% (B) (B – C)/A
%
N000 N000 N000 N000 N000
y/e 30 April 11 5,000 800 (800) 0 5,000 16%
y/e 30 April 12 5,000 800 (800) 0 5,000 16%
y/e 30 April 13 5,000 800 (728) 522 4,550 5·56%
being 800 x 91%
Expected loss model
Date Loan asset Interest Cash flow Loan asset Return
A at 9·07% (B) B/A%
N000 N000 N000 N000
y/e 30 April 11 5,000 453·5 (800) 4,653·5 9·07%
y/e 30 April 12 4,653·5 422·1 (800) 4,275·6 9·07%
y/e 30 April 13 4,275·6 387·8 (728) 3,935·4 9·07%
being 800 x 91%

The expected loss model matches the credit loss on the same basis as interest revenue recognised from
the financial
asset. Under an expected loss model revenue is set aside to cover expected future credit losses. The
expected loss model has the effect of smoothing the reported income for cash flows that are not expected
to accrue evenly over the life of the portfolio as impairment is recognised earlier. The IAS 39 model is
based on the perspective of matching a credit loss to the period in which that loss was incurred. This
results in loan loss expenses being recognised later in the life of the instrument. Interest income is
recognised in full without considering expected credit losses until they have actually been incurred. This
model is therefore characterised by higher revenues due to the period immediately after initial recognition,
followed by lower net income if credit losses are incurred.
IFRS 10: CONSOLIDATED FINANCIAL STATEMENTS
Overview

IFRS 10 Consolidated Financial Statements outlines the requirements for the preparation and
presentation of consolidated financial statements, requiring entities to consolidate entities it
controls. Control requires exposure or rights to variable returns and the ability to affect those
returns through power over an investee.

IFRS 10 was issued in May 2011 and applies to annual periods beginning on or after 1 January
2013.

Summary of IFRS 10

Objective

The objective of IFRS 10 is to establish principles for the presentation and preparation of
consolidated financial statements when an entity controls one or more other entities. [IFRS 10:1]

The Standard: [IFRS 10:1]

• requires a parent entity (an entity that controls one or more other entities) to present
 consolidated financial statements

• defines the principle of control, and establishes control as the basis for consolidation

• set out how to apply the principle of control to identify whether an investor controls an
investee and therefore must consolidate the investee

• sets out the accounting requirements for the preparation of consolidated financial
statements

• defines an investment entity and sets out an exception to consolidating particular

subsidiaries of an investment entity*.

* Added by Investment Entities amendments, effective 1 January 2014.

Key definitions

[IFRS 10:Appendix A]
The financial statements of a group in which the assets, liabilities, equity, income,
Consolidated
expenses and cash flows of the parent and its subsidiaries are presented as those of
financial statements
a single economic entity
An investor controls an investee when the investor is exposed, or has rights, to
Control of an
variable returns from its involvement with the investee and has the ability to affect
investee
those returns through its power over the investee
An entity that:
• obtains funds from one or more investors for the purpose of providing those
investor(s) with investment management services

Investment entity* • commits to its investor(s) that its business purpose is to invest funds solely for
returns from capital appreciation, investment income, or both, and

• measures and evaluates the performance of substantially all of its investments

on a fair value basis.
Parent An entity that controls one or more entities
Power Existing rights that give the current ability to direct the relevant activities
Rights designed to protect the interest of the party holding those rights without giving
Protective rights
that party power over the entity to which those rights relate
Relevant activities Activities of the investee that significantly affect the investee's returns
* Added by Investment Entities amendments, effective 1 January 2014.

Control

An investor determines whether it is a parent by assessing whether it controls one or more

investees. An investor considers all relevant facts and circumstances when assessing whether it
controls an investee. An investor controls an investee when it is exposed, or has rights, to
variable returns from its involvement with the investee and has the ability to affect those returns
through its power over the investee. [IFRS 10:5-6; IFRS 10:8]

An investor controls an investee if and only if the investor has all of the following elements:
[IFRS 10:7]

• power over the investee, i.e. the investor has existing rights that give it the ability to
direct the relevant activities (the activities that significantly affect the investee's returns)
 • exposure, or rights, to variable returns from its involvement with the investee

• the ability to use its power over the investee to affect the amount of the investor's
returns.

Power arises from rights. Such rights can be straightforward (e.g. through voting rights) or be
complex (e.g. embedded in contractual arrangements). An investor that holds only protective
rights cannot have power over an investee and so cannot control an investee [IFRS 10:11, IFRS
10:14].

An investor must be exposed, or have rights, to variable returns from its involvement with an
investee to control the investee. Such returns must have the potential to vary as a result of the
investee's performance and can be positive, negative, or both. [IFRS 10:15]

A parent must not only have power over an investee and exposure or rights to variable returns
from its involvement with the investee, a parent must also have the ability to use its power over
the investee to affect its returns from its involvement with the investee. [IFRS 10:17].

When assessing whether an investor controls an investee an investor with decision-making

rights determines whether it acts as principal or as an agent of other parties. A number of factors
are considered in making this assessment. For instance, the remuneration of the decision-
maker is considered in determining whether it is an agent. [IFRS 10:B58, IFRS 10:B60]

Accounting requirements

Preparation of consolidated financial statements

A parent prepares consolidated financial statements using uniform accounting policies for like
transactions and other events in similar circumstances. [IFRS 10:19]

However, a parent need not present consolidated financial statements if it meets all of the
following conditions: [IFRS 10:4(a)]

• it is a wholly-owned subsidiary or is a partially-owned subsidiary of another entity and its

other owners, including those not otherwise entitled to vote, have been informed about,
and do not object to, the parent not presenting consolidated financial statements

• its debt or equity instruments are not traded in a public market (a domestic or foreign
stock exchange or an over-the-counter market, including local and regional markets)

• it did not file, nor is it in the process of filing, its financial statements with a securities
commission or other regulatory organisation for the purpose of issuing any class of
instruments in a public market, and

• its ultimate or any intermediate parent of the parent produces consolidated financial
statements available for public use that comply with IFRSs.

Investment entities are prohibited from consolidating particular subsidiaries (see further
information below).
Furthermore, post-employment benefit plans or other long-term employee benefit plans to which
IAS 19 Employee Benefits applies are not required to apply the requirements of IFRS 10. [IFRS
10:4(b)]
Consolidation procedures

Consolidated financial statements: [IFRS 10:B86]

 • combine like items of assets, liabilities, equity, income, expenses and cash flows of the
parent with those of its subsidiaries

• offset (eliminate) the carrying amount of the parent's investment in each subsidiary and
the parent's portion of equity of each subsidiary (IFRS 3 Business Combinations
explains how to account for any related goodwill)

• eliminate in full intragroup assets and liabilities, equity, income, expenses and cash flows
relating to transactions between entities of the group (profits or losses resulting from
intragroup transactions that are recognised in assets, such as inventory and fixed
assets, are eliminated in full).

A reporting entity includes the income and expenses of a subsidiary in the consolidated financial
statements from the date it gains control until the date when the reporting entity ceases to
control the subsidiary. Income and expenses of the subsidiary are based on the amounts of the
assets and liabilities recognised in the consolidated financial statements at the acquisition date.
[IFRS 10:B88]

The parent and subsidiaries are required to have the same reporting dates, or consolidation
based on additional financial information prepared by subsidiary, unless impracticable. Where
impracticable, the most recent financial statements of the subsidiary are used, adjusted for the
effects of significant transactions or events between the reporting dates of the subsidiary and
consolidated financial statements. The difference between the date of the subsidiary's financial
statements and that of the consolidated financial statements shall be no more than three
months [IFRS 10:B92, IFRS 10:B93]

Non-controlling interests (NCIs)

A parent presents non-controlling interests in its consolidated statement of financial position

within equity, separately from the equity of the owners of the parent. [IFRS 10:22]

A reporting entity attributes the profit or loss and each component of other comprehensive
income to the owners of the parent and to the non-controlling interests. The proportion allocated
to the parent and non-controlling interests are determined on the basis of present ownership
interests. [IFRS 10:B94, IFRS 10:B89]

The reporting entity also attributes total comprehensive income to the owners of the parent and
to the non-controlling interests even if this results in the non-controlling interests having a deficit
balance. [IFRS 10:B94]

Changes in ownership interests

Changes in a parent's ownership interest in a subsidiary that do not result in the parent losing
control of the subsidiary are equity transactions (i.e. transactions with owners in their capacity
as owners). When the proportion of the equity held by non-controlling interests changes, the
carrying amounts of the controlling and non-controlling interests area adjusted to reflect the
changes in their relative interests in the subsidiary. Any difference between the amount by which
the non-controlling interests are adjusted and the fair value of the consideration paid or received
is recognised directly in equity and attributed to the owners of the parent.[IFRS 10:23, IFRS
10:B96]

If a parent loses control of a subsidiary, the parent [IFRS 10:25]:

• derecognises the assets and liabilities of the former subsidiary from the consolidated
statement of financial position
 • recognises any investment retained in the former subsidiary at its fair value when control
is lost and subsequently accounts for it and for any amounts owed by or to the former
subsidiary in accordance with relevant IFRSs. That fair value is regarded as the fair
value on initial recognition of a financial asset in accordance with IFRS 9 Financial
Instruments or, when appropriate, the cost on initial recognition of an investment in an
associate or joint venture

• recognises the gain or loss associated with the loss of control attributable to the former
controlling interest.

Investment entities consolidation exemption

[Note: The investment entity consolidation exemption was introduced by Investment Entities,
issued on 31 October 2012 and effective for annual periods beginning on or after 1 January
2014.]

IFRS 10 contains special accounting requirements for investment entities. Where an entity
meets the definition of an 'investment entity' (see above), it does not consolidate its subsidiaries,
or apply IFRS 3 Business Combinations when it obtains control of another entity. [IFRS 10:31]

An entity is required to consider all facts and circumstances when assessing whether it is an
investment entity, including its purpose and design. IFRS 10 provides that an investment entity
should have the following typical characteristics [IFRS 10:28]:

• it has more than one investment

• it has more than one investor

• it has investors that are not related parties of the entity

• it has ownership interests in the form of equity or similar interests.

The absence of any of these typical characteristics does not necessarily disqualify an entity
from being classified as an investment entity.

An investment entity is required to measure an investment in a subsidiary at fair value through

profit or loss in accordance with IFRS 9 Financial Instruments or IAS 39 Financial Instruments:
Recognition and Measurement. However, an investment entity is still required to consolidate a
subsidiary where that subsidiary provides services that relate to the investment entity’s
investment activities. [IFRS 10:31-32]

Because an investment entity is not required to consolidate its subsidiaries, intragroup related
party transactions and outstanding balances are not eliminated [IAS 24.4, IAS 39.80].

Special requirements apply where an entity becomes, or ceases to be, an investment entity.
[IFRS 10:B100-B101]

The exemption from consolidation only applies to the investment entity itself. Accordingly, a
parent of an investment entity is required to consolidate all entities that it controls, including
those controlled through an investment entity subsidiary, unless the parent itself is an
investment entity. [IFRS 10:33]

Disclosure

There are no disclosures specified in IFRS 10. Instead, IFRS 12 Disclosure of Interests in Other
Entities outlines the disclosures required.
Applicability and early adoption

Note: This section has been updated to reflect the amendments to IFRS 10 made in June 2012
and October 2012.

IFRS 10 is applicable to annual reporting periods beginning on or after 1 January 2013 [IFRS
10:C1].

Retrospective application is generally required in accordance with IAS 8 Accounting Policies,

Changes in Accounting Estimates and Errors [IFRS 10:C2]. However, an entity is not required to
make adjustments to the accounting for its involvement with entities that were previously
consolidated and continue to be consolidated, or entities that were previously unconsolidated
and continue not to be consolidated at the date of initial application of the IFRS [IFRS 10:C3].

Furthermore, an entity is not required to present the quantitative information required by

paragraph 28(f) of IAS 8 for the annual period immediately preceding the date of initial
application of the standard (the beginning of the annual reporting period for which IFRS 10 is
first applied) [IFRS 10:C2A-C2B]. However, an entity may choose to present adjusted
comparative information for earlier reporting periods, any must clearly identify any unadjusted
comparative information and explain the basis on which the comparative information has been
prepared [IFRS 10.C6A-C6B].

IFRS 10 prescribes modified accounting on its first application in the following circumstances:

• an entity consolidates an entity not previously consolidated [IFRS 10:C4-C4C]

• an entity no longer consolidates an entity that was previously consolidated [IFRS 10:C5-
C5A]

• in relation to certain amendments to IAS 27 made in 2008 that have been carried
forward into IFRS 10 [IFRS 10:C6].

An entity may apply IFRS 10 to an earlier accounting period, but if doing so it must disclose the
fact that is has early adopted the standard and also apply:

• IFRS 11 Joint Arrangements

• IFRS 12 Disclosure of Interests in Other Entities

• IAS 27 Separate Financial Statements (as amended in 2011)

• IAS 28 Investments in Associates and Joint Ventures (as amended in 2011).

The amendments made by Investment Entities are applicable to annual reporting periods
beginning on or after 1 January 2014 [IFRS 10:C1B]. At the date of initial application of the
amendments, an entity assesses whether it is an investment entity on the basis of the facts and
circumstances that exist at that date and additional transitional provisions apply [IFRS 10:C3B–
C3F].
IFRS 11: JOINT ARRANGEMENTS
Overview

IFRS 11 Joint Arrangements outlines the accounting by entities that jointly control an
arrangement. Joint control involves the contractual agreed sharing of control and arrangements
subject to joint control are classified as either a joint venture (representing a share of net assets
and equity accounted) or a joint operation (representing rights to assets and obligations for
liabilities, accounted for accordingly).

IFRS 11 was issued in May 2011 and applies to annual reporting periods beginning on or after 1
January 2013.

Summary of IFRS 11

Core principle
The core principle of IFRS 11 is that a party to a joint arrangement determines the type of joint
arrangement in which it
is involved by assessing its rights and obligations and accounts for those rights and obligations
in accordance with
that type of joint arrangement. [IFRS 11:1-2]

Key definitions
[IFRS 11:Appendix A]
Joint arrangement An arrangement of which two or more parties have joint control
The contractually agreed sharing of control of an arrangement, which exists only when
Joint control decisions about the relevant activities require the unanimous consent of the parties
sharing control
A joint arrangement whereby the parties that have joint control of the arrangement
Joint operation
have rights to the assets, and obligations for the liabilities, relating to the arrangement
A joint arrangement whereby the parties that have joint control of the arrangement
Joint venture
have rights to the net assets of the arrangement
Joint venturer A party to a joint venture that has joint control of that joint venture
Party to a joint An entity that participates in a joint arrangement, regardless of whether that entity has
arrangement joint control of the arrangement
 A separately identifiable financial structure, including separate legal entities or entities
Separate vehicle
recognised by statute, regardless of whether those entities have a legal personality

Joint arrangements
A joint arrangement is an arrangement of which two or more parties have joint control.
[IFRS 11:4]

A joint arrangement has the following characteristics: [IFRS 11:5]

• the parties are bound by a contractual arrangement, and

• the contractual arrangement gives two or more of those parties joint control of the
arrangement.

A joint arrangement is either a joint operation or a joint venture. [IFRS 11:6]

Joint control

Joint control is the contractually agreed sharing of control of an arrangement, which exists only
when decisions about the relevant activities require the unanimous consent of the parties
sharing control. [IFRS 11:7]

Before assessing whether an entity has joint control over an arrangement, an entity first
assesses whether the parties, or a group of the parties, control the arrangement (in accordance
with the definition of control in IFRS 10 Consolidated Financial Statements). [IFRS 11:B5]

After concluding that all the parties, or a group of the parties, control the arrangement
collectively, an entity shall assess whether it has joint control of the arrangement. Joint control
exists only when decisions about the relevant activities require the unanimous consent of the
parties that collectively control the arrangement. [IFRS 11:B6]

The requirement for unanimous consent means that any party with joint control of the
arrangement can prevent any of the other parties, or a group of the parties, from making
unilateral decisions (about the relevant activities) without its consent. [IFRS 11:B9]

Types of joint arrangements

Joint arrangements are either joint operations or joint ventures:
• A joint operation is a joint arrangement whereby the parties that have joint control of
the arrangement have rights to the assets, and obligations for the liabilities, relating to
the arrangement. Those parties are called joint operators. [IFRS 11:15]

• A joint venture is a joint arrangement whereby the parties that have joint control of the
arrangement have rights to the net assets of the arrangement. Those parties are called
joint venturers. [IFRS 11:16]

Classifying joint arrangements

The classification of a joint arrangement as a joint operation or a joint venture depends upon the
rights and obligations of the parties to the arrangement. An entity determines the type of joint
arrangement in which it is involved by considering the structure and form of the arrangement,
the terms agreed by the parties in the contractual arrangement and other facts and
circumstances. [IFRS 11:6, IFRS 11:14, IFRS 11:17]

Regardless of the purpose, structure or form of the arrangement, the classification of joint
arrangements depends upon the parties' rights and obligations arising from the arrangement.
[IFRS 11:B14; IFRS 11:B15]

A joint arrangement in which the assets and liabilities relating to the arrangement are held in a
separate vehicle can be either a joint venture or a joint operation. [IFRS 11:B19]

A joint arrangement that is not structured through a separate vehicle is a joint operation. In such
cases, the contractual arrangement establishes the parties' rights to the assets, and obligations
for the liabilities, relating to the arrangement, and the parties' rights to the corresponding
revenues and obligations for the corresponding expenses. [IFRS 11:B16]

Financial statements of parties to a joint arrangement

Joint operations

A joint operator recognises in relation to its interest in a joint operation: [IFRS 11:20]

• its assets, including its share of any assets held jointly;

• its liabilities, including its share of any liabilities incurred jointly;

• its revenue from the sale of its share of the output of the joint operation;

• its share of the revenue from the sale of the output by the joint operation; and

• its expenses, including its share of any expenses incurred jointly.

A joint operator accounts for the assets, liabilities, revenues and expenses relating to its
involvement in a joint operation in accordance with the relevant IFRSs. [IFRS 11:21]

A party that participates in, but does not have joint control of, a joint operation shall also account
for its interest in the arrangement in accordance with the above if that party has rights to the
assets, and obligations for the liabilities, relating to the joint operation. [IFRS 11:23]

Joint ventures

A joint venturer recognises its interest in a joint venture as an investment and shall account for
that investment using the equity method in accordance with IAS 28 Investments in Associates
and Joint Ventures unless the entity is exempted from applying the equity method as specified
in that standard. [IFRS 11:24]

A party that participates in, but does not have joint control of, a joint venture accounts for its
interest in the arrangement in accordance with IFRS 9 Financial Instruments unless it has
significant influence over the joint venture, in which case it accounts for it in accordance with
IAS 28 (as amended in 2011). [IFRS 11:25]

Separate Financial Statements

The accounting for joint arrangements in an entity's separate financial statements depends on
the involvement of the
entity in that joint arrangement and the type of the joint arrangement:
• If the entity is a joint operator or joint venturer it shall account for its interest in

• a joint operation in accordance with paragraphs 20-22;

• a joint venture in accordance with paragraph 10 of IAS 27 Separate Financial

Statements. [IFRS 11:26]
 • If the entity is a party that participates in, but does not have joint control of, a joint
arrangement shall account for its interest in:

• a joint operation in accordance with paragraphs 23;

• a joint venture in accordance with IFRS 9, unless the entity has significant
influence over the joint venture, in which case it shall apply paragraph 10 of IAS
27 (as amended in 2011). [IFRS 11:27]

Disclosure
There are no disclosures specified in IFRS 11. Instead, IFRS 12 Disclosure of Interests in Other
Entities outlines the
disclosures required.

Applicability and early adoption

Note: This section has been updated to reflect the amendments to IFRS 11 made in June 2012.
IFRS 11 is applicable to annual reporting periods beginning on or after 1 January 2013.
[IFRS 11:Appendix C1]
When IFRS 11 is first applied, an entity need only present the quantitative information required
by paragraph 28(f) of IAS 8 for the annual period immediately preceding the first annual
period for which the standard is applied [IFRS 11:C1B]
Special transitional provisions are included for: [IFRS 11.Appendix C2-C13]

• transition from proportionate consolidation to the equity method for joint ventures

• transition from the equity method to accounting for assets and liabilities for joint
operations

• transition in an entity's separate financial statements for a joint operation previously

accounted for as an investment at cost.

In general terms, the special transitional adjustments are required to be applied at the beginning
of the immediately preceding period (rather than the beginning of the earliest period presented).
However, an entity may choose to present adjusted comparative information for earlier reporting
periods, and must clearly identify any unadjusted comparative information and explain the basis
on which the comparative information has been prepared [IFRS 11.C12A-C12B].
IFRS 12: DISCLOSURE OF INTERESTS IN OTHER ENTITIES
Overview
IFRS 12 Disclosure of Interests in Other Entities is a consolidated disclosure standard requiring
a wide range of disclosures about an entity's interests in subsidiaries, joint arrangements,
associates and unconsolidated 'structured entities'. Disclosures are presented as a series of
objectives, with detailed guidance on satisfying those objectives.

IFRS 12 was issued in May 2011 and applies to annual periods beginning on or after 1 January
2013.
Effective for annual periods
12 May 2011 IFRS 12 Disclosure of Interests in Other Entities published beginning on or after 1
January 2013
28 June 2012 Amended by Consolidated Financial Statements, Joint Effective for annual periods
Arrangements and Disclosure of Interests in Other Entities: beginning on or after 1
 Transition Guidance (project history) January 2013

Summary of IFRS 12

Objective and scope

The objective of IFRS 12 is to require the disclosure of information that enables users of
financial statements to evaluate: [IFRS 12:1]

• the nature of, and risks associated with, its interests in other entities

• the effects of those interests on its financial position, financial performance and cash
flows.

Where the disclosures required by IFRS 12, together with the disclosures required by other
IFRSs, do not meet the above objective, an entity is required to disclose whatever additional
information is necessary to meet the objective. [IFRS 12:3]

IFRS 12 is required to be applied by an entity that has an interest in any of the following: [IFRS
12:5]

• subsidiaries

• joint arrangements (joint operations or joint ventures)

• associates

• unconsolidated structured entities

IFRS 12 does not apply to certain employee benefit plans, separate financial statements to
which IAS 27 Separate Financial Statements applies (except in relation to unconsolidated
structured entities and investment entities in some cases), certain interests in joint ventures held
by an entity that does not share in joint control, and the majority of interests in another entity
accounted for in accordance with IFRS 9 Financial Instruments. [IFRS 12:6]

Key definitions
[IFRS 12:Appendix A]
Refers to contractual and non-contractual involvement that exposes an entity to variability of
returns from the performance of the other entity. An interest in another entity can be
evidenced by, but is not limited to, the holding of equity or debt instruments as well as other
Interest in
forms of involvement such as the provision of funding, liquidity support, credit enhancement
another entity
and guarantees. It includes the means by which an entity has control or joint control of, or
significant influence over, another entity. An entity does not necessarily have an interest in
another entity solely because of a typical customer supplier relationship.
An entity that has been designed so that voting or similar rights are not the dominant factor
Structured
in deciding who controls the entity, such as when any voting rights relate to administrative
entity
tasks only and the relevant activities are directed by means of contractual arrangements.

Disclosures required
Important note: The summary of disclosures that follows is a high-level summary of the main requirements
of IFRS 12. It does not list every specific disclosure required by the standard, but instead highlights the
broad objectives, categories and nature of the disclosures required. IFRS 12 lists specific examples and
additional disclosures which further expand upon the disclosure objectives, and includes other guidance on
the disclosures required. Accordingly, readers should not consider this to be a comprehensive or complete
listing of the disclosure requirements of IFRS 12.

Significant judgements and assumptions

An entity discloses information about significant judgements and assumptions it has made (and
changes in those judgements and assumptions) in determining: [IFRS 12:7]

• that it controls another entity

• that it has joint control of an arrangement or significant influence over another entity

• the type of joint arrangement (i.e. joint operation or joint venture) when the arrangement
has been structured through a separate vehicle.

Interests in subsidiaries

An entity shall disclose information that enables users of its consolidated financial statements
to: [IFRS 12:10]

• understand the composition of the group

• understand the interest that non-controlling interests have in the group's activities and
cash flows

• evaluate the nature and extent of significant restrictions on its ability to access or use
assets, and settle liabilities, of the group

• evaluate the nature of, and changes in, the risks associated with its interests in
consolidated structured entities

• evaluate the consequences of changes in its ownership interest in a subsidiary that do

not result in a loss of control

• evaluate the consequences of losing control of a subsidiary during the reporting period.

Interests in unconsolidated subsidiaries

[Note: The investment entity consolidation exemption referred to in this section was introduced
by Investment Entities, issued on 31 October 2012 and effective for annual periods beginning
on or after 1 January 2014.]

In accordance with IFRS 10 Consolidated Financial Statements, an investment entity is required

to apply the exception to consolidation and instead account for its investment in a subsidiary at
fair value through profit or loss. [IFRS 10:31].

Where an entity is an investment entity, IFRS 12 requires additional disclosure, including:

• the fact the entity is an investment entity [IFRS 12:19A]

• information about significant judgements and assumptions it has made in determining

that it is an investment entity, and specifically where the entity does not have one or
more of the 'typical characteristics' of an investment entity [IFRS 12:9A]

• details of subsidiaries that have not been consolidated (name, place of business,
ownership interests held) [IFRS 12:19B]
 • details of the relationship and certain transactions between the investment entity and the
subsidiary (e.g. restrictions on transfer of funds, commitments, support arrangements,
contractual arrangements) [IFRS 12: 19D-19G]

• information where an entity becomes, or ceases to be, an investment entity [IFRS 12:9B]
An entity making these disclosures are not required to provide various other disclosures
required by IFRS 12 [IFRS 12:21A, IFRS 12:25A].
Interests in joint arrangements and associates

An entity shall disclose information that enables users of its financial statements to evaluate:
[IFRS 12:20]

• the nature, extent and financial effects of its interests in joint arrangements and
associates, including the nature and effects of its contractual relationship with the other
investors with joint control of, or significant influence over, joint arrangements and
associates

• the nature of, and changes in, the risks associated with its interests in joint ventures and
associates.

Interests in unconsolidated structured entities

An entity shall disclose information that enables users of its financial statements to: [IFRS
12:24]

• understand the nature and extent of its interests in unconsolidated structured entities

• evaluate the nature of, and changes in, the risks associated with its interests in
unconsolidated structured entities.

IFRS 13: FAIR VALUE MEASUREMENT

Introduction
Some Standards have made reference to fair value, its definition, the initial and subsequent
measurement recommended by some Standards at fair value. This Standard has therefore
harmonised the concept of ‘fair value’, its definition and measurement procedures.

Objective of the Standard

• To define fair value
• To set out in a single Standard a framework for measuring fair value
• To require disclosure about fair value measurement.

Definition of Terms Used in the Standard

Fair value: 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.
Active market: A market in which transactions for the asset or liability take place with sufficient
frequency and volume to provide pricing information on an ongoing basis.
Exit price: The price that would be received to sell an asset or paid to transfer a liability
Highest and best use: The use of a non – financial asset by market participants that would
maximise the value of the asset or the group of assets and liabilities (e.g. a business) within
which the asset would be used.
Most advantageous market: The market that maximises the amount that would be received or
sell the asset or minimises the amount that would be paid to transfer the liability, after taking into
account tranactions costs and transport costs
Principal market: The market with the greatest volume and level of activity for the asset or
liability
Oderly transaction: A transaction that assumes exposure to the market for a period before the
measurement date to allow for marketing activities that are usual and customary for transactions
involving such assets or liabilities; it is not a forced transaction (eg liquidation or distress sale).
Market participants: Buyers and sellers in the principal ( or most advantageous) market for the
asset or liability that have all of the following characteristics:
(a) They are independent of each other, i.e they are not related parties as defined by IAS 24,
although the price in a related party transaction may be used as an input to a fair value
measurement if the entity has evidenced that the transaction was entered into at market terms.
(b) They are knowledgeable, having reasonable understanding about the asset or liability and
the transaction using all available information, including information that might be obtained
through the dilligence efforts that are usual and customary.
(c) They are able to enter into a transaction for the asset or liability
(d) They are willing to enter into a transaction for the asset or liability, ie they are motivated but
not forced or otherwise compelled to do so.

Transaction and Transport Costs

Transaction costs: The costs to sell an asset or transfer a liability in the principal (or most
advantageous) market for the asset or liability that are directly attributable to the disposal of the
asset or the transfer of the liability and meet both of the following criteria:
(a) They result directly from and are essential to that transaction
(b) They would not have been incurred by the entity had the decision to sell the asset or transfer
the liability not been made
Transort costs: The cost that would be incurred to transport an asset from its current location
to its principal (or most advantageous) market.
Both costs affect determination of the fair value of an asset or liability. When determining the
principal (or most advantageous) market in which an asset may be sold, the level of transaction
costs will be considered. In general, lower transaction costs will indicate a more advantageous
market. The determination of the most advantageous market will then affect the measurement of
the fair value. However, the price used to measure the fair value of an asset or liability will not
be adjusted for these costs. The reason for this is that these costs are not considered to be a
characteristic of the asset or liability. Instead they are specific to a transaction and will change
from transaction to transaction.

Illustration on transaction costs and transport costs

An entity sells Asset ‘B’ in a number of markets including market ABC. In market ABC the price
that would be received is N26; transaction costs are N2 and the costs to transport asset ‘B” to
market ABC are N1.
Both transaction costs and transport costs are used to determine that market ABC is the most
advantageous market in that both are used to determine the net amount to be received by the
entity – in this case N23. This net amount is compared with that receivable in other markets to
determine the most advantageous market.
Having determined that market ABC is the principal market, the fair value of asset ‘B’ is
measured at N25 i.e being N26 less transport costs of N1.The measurement of fair value is then
adjusted for transport cost but not for transaction costs.

Application to Non – Financial Assets

Financial assets include cash, shares in other entities and rights to receive cash from other
entities, non- financial assets include property, plant and equipment and intangible assets.
The application guidance of the Standard indicated four steps involved in fair value
measurement:
1. The particular asset or liability that is the subject of the measurement
2. For non – financial asset, the valuation premise that is appropriate for the measurement
consistence with the highest and best use
3. The principal (or the most advantageous) market for the asset or liability
4. The valuation technique appropriate for the measurement, considering the availability of data
with which to develop inputs that represent the assumptions that market participants would use
when pricing the asset or liability and the level of the fair value hierarchy within the inputs are
categorised.

1. The particular asset that is the subject of measurement

The entity is interested in the fair value of a particular asset, therefore it should be able to take
into account its charactersitics, and these include:
(a) The location of the asset: the location of the asset may be different from the market and the
asset has to be transported to the market, transport costs will then be incurred. If there are
difficulties in transporting the asset, as well as time constraints, these factors may affect the fair
value of the asset.
(b) The condition of the asset: Many of the factors that are considered in depreciating the asset
will be of relevance here, such as remaining useful life, physical condition, expected usage, and
technical or commercial obsolescence.
(c) Restrictions on sale or use of the asset: There may be legal limits on the use of the asset (eg
patents, licenses)
(d) Stand- alone assets or a group of assets: Where a fair value is being calculated for
impairment purposes, the asset being valued may be a cash generating unit as defined in IAS
36. Similarly, if the fair value relates to a business, the definition of a business in IFRS 3 would
need to be considered.

2. The valuation premise appropriate for measurement of fair value

The fair value of an asset is determined by considering what a market participant would pay to
buy the asset. The market participant will determine this by considering the potential cash flows
from the asset, whether from sale or use of the asset. Fair value is measured by considering the
highest and best use of the asset. These uses may be:
• Phsyically possible, taking into account the phsyical characeristics of the asset
• Legally permissible, considering any legal restriction
• Financially feasible, in that the use of the asset must result in the market participant
obtaining an appropriate return from the asset

Illustration on determining best use and valuation premise

An entity acquired a research and development (R & D) project in a business combination. The
entity does not intend to complete the project. If completed, the project would compete with one
of its own R & D projects. Instead, the entity intends to hold the project to prevent its
competitors from obtaining access to the technology. The project is expected to provide
defensive value, principally by improving the prospects for the entity’s own competing
technology.
Under IFRS 3, the acquiring entity is required to measure the R & D asset acquired at fair value.
To measure the fair value at initial recognition, it is necessary to determine the highest and best
use of the project by the market participants and the valuation premise.
Required: determine the highest and best use and their related premises

Suggested Solution
Some possible uses and their related valuation premises are:
(a) The highest and best use of the R & D project may be where the market participants would
continue to develop the R & D project to maximise its use within their own operations. The
relevant valuation premise is the in-combination valuation premise. The fair value of the R & D
project would be determined on the basis of the price that the reporting entity would receive on
selling the R & D project to the market participants, assuming that these market participants
would use the R & D asset in conjuction with their other assets as a group and that these assets
are available to the market participants.
(b) The highest and best use may be for the market participants to cease development of the
project. This might occur if the project is not expected to provide a market rate of return if
completed. The relevant valuation premise is the stand-alone valuation premise as the asset will
exist as a stand-alone asset and not be used in conjunction with other assets. The fair value of
the R & D would be determined on the basis of the price that would be received on sale of the
project by itself to market participants. The fair value may be zero

Illustration 2 on best use and valuation premise

In a business combination, an entity acquires land on which a factory stands. The land is
currently developed for industrial use. Nearby sites have recently been developed for resdiential
use as sites for high-rise apartment buildings. Recent zoning changes have meant that the land
could now be used for residential purposes.
Required determine the highest and best use and premise for valuation

Suggested Solution
The highest and best use of the land would be determined by comparing the results from the
following possible uses:
• The land could continue to be used as currently used, namely as a site for the factory,
and the factory would continue to operate. The valuation premise in this scenario is the
in- combination valuation premise, as the fair value of both the land and the factory
would be based on selling these assets to market participants who would also use these
assets for industrial purposes in conjunction with their other assets.
• The land could be made into a vacant site for residential purposes. The valuation
premise is then stand-alone valuation premise as the land is sold as a stand-alone
asset. Use of the land for residential purpose would mean that the factory would need to
be demolished. The fair value of the land would then be calculated net of the cost of
demolition of the factory and other costs of conversion to a vacant site.
In this situation, the fair value of the factory may be linked to the fair value of the land on which it
is situated. The fair value of the factory may be zero if the land has an alternative use, such as
for resdiential purposes, and the factory is demolished.

3. Principal (or most advantageous) Market for the Asset

The Standard states that a fair value measurement assumes that the transaction to sell or
transfer a liability takes place in either (a) in the principal market for the asset or liability or (b) in
the absence of a principal market, in the most advantageous market for the asset or liability.
Principal market is defined by the Standard as the market with the greatest volume and level of
activity for the asset or liability. The principal market is then the largest market for the non –
financial assets. Unless evidence to the contrary exists, the market in which the entity enters to
sell this type of asset is presumed to be the principal market.
Where there is no principal market, the entity needs to determine the most advantageous
market. This is the market that maximises the amount that would be received to sell the asset or
miminise the amount that would be paid to transfer the liability, after considering transaction
costs and transport costs. Thus by comparison, the most advantageous market is the one that
offers the highest returns.

Illustration on most advantageous market

Asset “A” is sold in two different active markets.
In market XYZ, the price that would be received is N27, transaction costs are N2 and the cost to
transport the asset to market XYZ are N3.
In market ABC the price that would be received is N26, transaction costs are N2 and the cost to
transport the asset to market ABC are N1.
Required, which of the market is the most advantageous market and the fair value of the asset?

Suggested Solution
The fair value of the asset is measured using the price in the most advantageous market. The
most advantageous market is the one that maximises the amount that would be received to sell
the asset after considering transaction costs and transportation costs.
In market XYZ the net amount received by the entity is N22 that is N27 –N2-N3
In market ABC the net amount received by the entity is N23 that is, N26-N2-N1
Market ABC is then the most advantageous market. The fair value of the asset is N25 being the
amount received net of transportation costs.

A scenario may exist where at the measurement date, the price receivable in the principal
market is less than a more advantageous price receivable in another market. In this case, the
price used to measure fair value is that receivable in the principal market.

4. Valuation Techniques Appropriate for the Measurement

The objective of using a valuation technique is to estimate the price at which the asset will be
transfered in an orderly transaction between market participants. The possible valuation
techniques are:
• The market approach
• The cost approach and
• The income approach
The market approach: This is defined as a valuation technique that uses prices and other
relevant information generated by market transactions involving identical or comparable (similar)
assets or liabilities or a group of assets and liabilities, such as business. The prices are obtained
directly from information gathered from the activities in market.

The cost approach: A valuation technique that reflects the amount that would be required
currently to replace the service capacity of an asset (often referred to as current replacement
cost). It is the amount a market participant would pay to acquire or construct an asset that has
the same quantities as the asset being valued. This may involve the consideration of the
amount to be paid for a new asset, with this amount then adjusted for both physical deterioration
and technological obsolescence.

The Income approach: Valuation techniques that cover future amounts (eg cash flows or
income and expenses) to a single current (ie discounted) amount. The fair value measurement
is determined on the basis of the value indicated by current market expectations about those
future amounts. The approach does not then rely on information generated by observation of
prices generated in a market place. The fair value is based upon market expectations about
future cash flows or income and expenses associated with that asset. The fair value of the asset
is generated by discounting the expected earnings from the use of the asset by a market
participant

Choice of Techniques
The Standard does not propose a hierarchy of valuation techniques. Some valuation techniques
are better in some circumstances than others; judgement is required in selecting the appropriate
valuation technique for the situation. However, some guidance in the choice of technique is
provided by the Standard:
• The technique must be appropriate to the circumstances
• There must be sufficient data available to apply the technique
• The technique must maximise the use observable inputs and minimise the use of
unobservable inputs
• In some cases, multiple techniques are used with the results being weighed and
evaluated
 • Valuation techniques used to measure fair value must be consistently applied except
when there is need for a change because new markets develop or new information
becomes available.

Inputs to Valuation Techniques

Inputs are defined as the assumptions that market participants would use when pricing the
asset or liability, including assumptions about risk, such as the following:
• The risk inherent in a particular valuation technique used to measure fair value
(such as pricing model) and
• The risk inherent in the inputs to the valuation technique.
Inputs may be observable or unobservable.
Observable inputs are inputs that are developed using market data, such as publicly available
information about actual events or transactions, and reflect the assumptionss that market
participants would use when pricing an asset or liability.
Unobservable inputs are inputs for which market data is not available and are developed using
the best information available about the assumptions that market participants would use when
pricing the asset or liability.

Fair Value Hierarchy – Prioritising Inputs

To achieve consistency and comparability in the measurement of fair values, the Standard
provides a hierarchy of inputs showing which inputs are considered to be given higher priority in
determining fair value measurement.
1. The inputs are prioritised into three levels level 1, level 2 and level 3.
2. The fair value hierarchy gives the highest priority to quoted market prices in active markets
for identical assets and liabilities and the lowest priority to unobservable inputs
3. When observable inputs are used, they must be relevant observable inputs.
4. The availability of inputs and their relative subjectivity potentially affects the selection of the
valuation technique, however, the fair value hierarchy prioritises the inputs to the valuation
techniques not the techniques themselves.
5. Having selected the inputs and applied a valuation technique(s), a fair value measure is
made. The fair value measure is then categorised. It is categorised in its entirety at the same
level of the fair value hierarchy as the lowest level input that is significant to the entire
measurement. Hence a valuation technique that relies solely on level 1 inputs produces a level
1 valuation measurement. However, if the measurement also uses some level 3 inputs that are
significant to the fair value measure, then that fair value measure is classified as level 3
valuation measure.

Level 1 Inputs
Level 1 inputs are defined as quoted prices (unadjusted) in active market for identical assets or
liabilities that the entity can access at the measurement date.
Markets such as for vehicles, property and equity instruments on a security exchange would
generally be regarded as active markets. It would be expected that active markets would not
exist for intangible assets such as patent and trademarks. A market will not be considered active
if:
• There has been a significant decrease in the volume and level of activity for the asset or
liability when compared with normal market activity
• There are few recent transactions
• Price quotations are not based on current information
• Price quotations vary substantially over time or among market-makers
Level 1 input must also be prices for identical items, for vehicle and buildings the items may
similar but not identical; new vehicles may be identical but it is unlikely for used vehicles would
be identical. Shares and other financial instruments, both financial assets, are examples of
assets which are identical and trade in active markets.
Level 2 Inputs
Level 2 inputs are defined as inputs other than quoted prices included within level 1 that are
observable for the asset or liability, either directly or indirectly. Level 2 inputs are said to include:
• Quoted prices for similar assets or liabilities in active markets
• Quoted prices for identical or similar assets or liabilities in markets that are not active
• Inputs other than quoted prices that are observable for the asset or liability, such as
interest rates and yield curves, volatilities, repayment speeds and credit risks
• Inputs that are derived from or corroborated by observable market data by correlation or
other means.
It may be necessary to make adjustments to level 2 inputs for example for possible condition of
the asset or the location of the asset. Making these adjustments may make lead to fair value
being categorised as level 3 rather than level 2 inputs.

Level 3 Inputs
Level 3 inputs are defined as unobservable inputs for the asset or liability.
Whereas Level 1 and Level 2 inputs are based on observable market data, with Level 3 inputs,
the inputs are unobservable. The data used may be that of the entity itself, which may be
adjusted for factors that market participants may build into the valuation or to eliminate the
effects of variables that are specific to the entity but not relevant to other market participants.
Examples of Level 3 inputs include:
• Cash – generating unit: A Level 3 input would include a financial forecast of cash flows
or earnings based on the entity’s data
• Trademarks: A Level 3 input would be to measure the expected royalty rate that could
be obtained by allowing other entities to use the trademark to produce the products
covered by the trademark
• Accounts receivables: A Level 3 input would be to measure the asset based upon the
amount expected to be recovered based upon the entity’s historical record of
recoverability of accounts receivable
In all cases the fair value measure is based upon inputs that are not observable in a market

Illustration on different valuation techniques to measure the fair value of assets with
consideration of level of inputs
An entity acquired a machine in a business combination that is held and used in its operations.
The machine was initially acquired from a supplier and was then customised by the entity for
use in its own operations.
What are the valuation premise and valuation techniques of this asset?

Suggested Solution
The highest and best use of the machine is its use in combination with other assets as a group.
The valuation premise is then ‘in-combination’.
Two valuation techniques that could be applied are the market approach and the cost approach.
The income approach is not applicable as the machine by itself does not generate cash flows or
earnings; the earnings are generated by its use in combination with other assets, within a cash-
generating unit.
Market approach
This would be applied by determining quoted prices from similar machines adjusted for
differences between the machine, it’s customised, and other machines and taking into accounts
the effects of location and condition of the asset. The inputs here are Level 2 inputs as they
arise from observable market prices, being quoted prices for similar machines.
Cost approach
The entity would estimate the amount that would currently be required to construct a substitute
(customised) machine of comparable utility. Again adjustments would be necessary for the
effects of location and condition of the asset acquired. The inputs applied here are Level 2
inputs as they are based on observable market data, namely the cost of construction.
Both prices obtained are effectively current replacement costs. The entity would need to
evaluate the results of applying both valuation approaches. It needs to consider the subjectivity
of the information used in the valuations, the range of values supplied by the valuation
approach, the ability of an approach to be able to adjust for the condition of the machine, for
example, there may be a second hand market for used machines whereas it is impossible to
construct a used machine. The level of customisation may also affect the decision as extensive
customisation would lend more weight to the use of the cost approach as current market prices
would not be available for customised machines.
If the fair value were based on the application of both approaches, then as Level 2 inputs are
used under both approaches, the fair value measure would be classified as a Level 2 valuation.

Application to Liabilities
Prior to this Standard, the measurement of a liability was commonly based on the amount
required to settle the present obligation, by definition of IFRS 13, fair value is the amount paid
to transfer the liability. Therefore, the fair value measurement assumes that the liability is
transferred to another market participant at the measurement date.
There are three steps involved in the measurement of fair value of liabilities, these include:
1. the particular liability that is the subject of the measurement
2. the principal (or most advantageous) market for the liability
3. the valuation technique(s) appropriate for the measuremnt.

For some liabilities, such as financial liabilities, an observable market may exist and a quoted
price may be obtained to measure the fair value of the liability. Where this is not available,
valuation techniques must be used. The objective of fair value measurement of liability, when
using a valuation technique, is to estimate the price that would be paid to transfer the liability
between market participants at the measurement data under current market conditions. In all
cases, an entity must maximise the use of relevant observable inputs and minimise the use of
unobservable inputs.
In most cirmustances, a liability will be held as an asset by another entity for example, a loan is
recognised as a payable by one entity, the recipient of the loan, and a receivable by another
entity, the lender. In such cases the Standard requires that the measurement of the fair value of
the liability be calculated from the perspective of a market participant that holds the identical
item as an asset at measurement date. From the Standard’s perspective, the fair value of a
liability equals the fair value of a properly defined corresponding asset.
The Standard states that the measurement of the corresponding asset should be in the
following descending order of preference:
• The quoted price of the asset in active market
• The quoted price of the asset in a market that is not active
• A valuation under a technique such as;
• An income approach: present value techniques could be used using the expected future
cash flows as market participant would expect to receive from holding the liability as an
asset
• A market approach: the measure would be based on quoted prices for similar liabilities
held by other parties as assets.

Illistration on the use of market approach valuation technique of liability

On 1 January, 2013, Kangaroo Ltd issues at par N2million Bond traded 5 year fixed rate debt
instruments with an annual 10% interest coupon.
On 31 December 2013, the instrument is trading as an asset in an active market at N929 per
N1,000 of par value after payment of accrued interest. Kangaroo Ltd uses the quoted price of
the asset in an active market as its input into fair value measurement of its liability. This
measure is N1,858,000, being N929/N1000 x N2,000,000.
Suggested Solution
In determining whether the price of the asset can be used to measure the liability, Kangaroo Ltd
needs to assess whether the price of the assets includes any factors that would not be included
in the price of the liability – such as the effect of third-party credit enhancements. If there are
none then the liability can be measured at a fair value of N1,858,000.

Using Present Value Techniques to Determine Fair Value of Liabilities

Where a corresponding asset is not held by another entity, such as in the case of an entity that
must decommission an oil platform when drilling ceases, the entity measuring the fair value of a
liability must use a valuation technique from the perspective of a market participant that owes
the liability. In such cases a present value technique could be applied.
The following elements are to be captured when using present value technique for this purpose:
• An estimate of future cash flows
• Expectations about variations in the amount and timing of the cash flows representing
the uncertainty inherent in the cash flows.
• The time value of money , represented by risk-free interest rate
• A risk premium being the price for bearing the uncertainty inherent in the cash flows
• Other factors that market participants would take ino account
• Non-performance risk.

Illustration on use of present value technique to a simple debt obligation

On 1 January 2013, Kaduna Ltd issued at par in a private placement 42 milion bond
redeemable in 4 years fixed rate debt instrument with an annual 10% interest coupon rate.
At 31 December 2013, Kaduna Ltd’s market conditions, including interest rates and liquidity,
remain unchanged from the date of issue of the debt instrument. However, Kaduna Ltd credit
spread had deteriorated because of a change in its risk of non – perfomance. If the instruments
were issued on 31 December 2013, the instrument would need to have an interest rate of 10.5%
Determine the fair value of the debt instrument using a present value technique.

Suggested Solution N
N2,000,000 x 0.670735 (present value of a single sum at end of year 4 at 10.5%)
1,341,470
N2,000,000 x 3.1359 (present vaue of an annuity for 4 years at 10%) interest
627,180
Fair value
1,968,650

Illustration on present value technique for fair value of non financial liability
On 1 January 2013, Emu Ltd assumed a decommissioning liability in a business combination,
useful life, which is estimated to be 10 years.
If Emu Ltd were contractually allowed to transfer its decommissioning liability to a market
participant, Emu Ltd considers that the market participant would need to take into account the
following inputs:
• Labour costs N131,250 – these would be developed on the basis of current market
place wages, adjusted for expected wage increases with the final amount to be
determined on a probability weighted basis
• Allocation of overhead costs N105,000
• Contractor’s profit margin at 20% of total cost
• Compensation for undertaking the activity including profit and a premium for
undertaking the risk involved.
• Effects of inflation at 4% for ten years
• Time value of money, represented by the risk free rate
• Non – performance risk relating to the risk that Emu Ltd will to fulfil the obligation,
including Emu Ltd’s own credit risk
The risk free rate of interest for a 10 year maturity at January 1 2013 is 5%. Emu Ltd adjusts
that rate by 3.5 % to reflect its risk of non-performance including its credit risk. Hence the
interest rate used in the preset value calculation is 8.5%

Suggested Solution
The present value calculation is determined as follows: N
Expected labour costs 131,250
Allocated overhead and equipment costs 105,000
Contractors’ profit margin (20% of total cost) 47,250
Expected cash flow before inflation adjustment 283,500
Inflation factor (4% for 10 years) 136,137
Expected cash flows adjusted for inflation 419,637
Market risk premium (0.05% x N419,637) 20,982
Expected cash flows adjusted for risk market risk 440,619
Expected present value using a discount rate of 8.5% for 10 years N194,879.
Therefore, the fair value of the decommisioning liability at 1 January 2013 determined using the
present value technique is N194,879.

Non- Performing Risks

The fair value of a liability will reflect the effect of non-perfomance risk, this being defined as the
risk that an entity will not fulfil an obligation and this includes the entity’s own credit risk.

Illustration of liabilities and non – performance risk

ABC Ltd and XYZ Ltd entered into contractual obligation to pay cash of N500 to Big Ltd in five
years’ time. ABC Ltd has a high credit rating and can borrow at 6%, while XYZ has a lower
credit rating and can borrow at 12%
Required; determine the fair value of the debts taking into consideration non- performance risk

Suggested Solution
ABC Ltd would measure its liability at a fair value of N374, being the present value of N500 in 5
years time at 6% p.a. XYZ Ltd will measure its liability at a fair value of N284, being the present
value of N500 in 5 years time at 12%

Application to Measurement of Equity Instruments

Measurement of equity instruments may be needed in such circumstances where an entity
undertakes a business combination and issues its own equity instruments in exchange for a
business. In general the principles set out for liabilities also apply to equity instruments. The fair
value measure assumes that an entity’s own equity instruments are transferred to a market
participant at measurement date.
In measuring an equity instrument at fair value, as with assets and liabilities, the objective is to
estimate an exit price at measurement date from the perspective of market participant who
holds the instrument as an asset. If a company is the issuer of an equity instrument such as an
ordinary share, then in order to exit from the instrument, the company must either cancel the
share or repurchase the share. The company must then measure the fair value of the equity
instrument from the perspective of a market participant who holds the instrument as an asset.

Example of Disclosure Requirement of the Standard

Fair value measurement at the end of reporting period
using
Quoted prices significant Significant total
In active other unobservable gains/
Market for observable inputs (losses)
Identical assets inputs
Description 31/12/09(Level 1) (Level 2) (Level 3)
Recurring fair value measurements
Trading equity securities
Real estate industry 93 70 23
Oil & gas industry 45 45
Others 15 15
Total trading equities 153 130 23
Other equity securities
Financial services industry 150 150
Health care industry 163 110 53
Energy industry 32 32
Private equity fund invest 25 25
Other 15 15
Total other equity securities 385 275 110
Debt securities:
Residenial mortgage back sec149 24 125
Comm. Morgaged back sec 50 50
Collateral debt obligations 35 35
Risk-free govt securities 85 85
Corporate bonds 93 9 84
Total debt securities 412 94 108 210
Hedge fund investments:
Equity long/short 55 55
Global opportunities 35 35
High – yield debt securities 90 90
Total hedge fund investment 180 90 90
Derivatives:
Interest rate contract 57 57
Foreign exc contracts 43 43
Credit contracts 38 38
Comm future contracts 78 78
Comm forward contracts 20 20
Total derivatives 236 78 20 38
Investment properties:
Commercial Nigeria 31 31
Commercial Africa 27 27
Total investment properties 58 58
Total recurring fair value
Measurement 1,424 577 341 506

Non recurring fair value measurments

Assets held for sale 26 26 (15)
Total non recurring fair value
Measurement 26 26 (15)

(a) on the basis of its analysis of the nature, characteristics and risks of the securities, the entity
has determined that presenting them by industry is appropriate
(b) on the basis of its analysis of the nature, characteristics and risks of the investments, the
entity has determined that presenting them as a single class is appropriate
(c) In accordance with IFRS 5 assets held for sale with a carrying amount of N35 million were
written down to their fair value of N25 million, less costs to sell of N6 million resulting in a loss of
N15 million, which was included in profit or loss for the period.

REVIEW QUESTION
1. (a) The International Accounting Standards Board has recently completed a joint project with the
Financial
Accounting Standards Board (FASB) on fair value measurement by issuing IFRS 13 Fair Value
Measurement.
IFRS 13 defines fair value, establishes a framework for measuring fair value and requires significant
disclosures
relating to fair value measurement.
The IASB wanted to enhance the guidance available for assessing fair value in order that users could
better gauge the valuation techniques and inputs used to measure fair value. There are no new
requirements as to when fair value accounting is required, but the IFRS gives guidance regarding fair
value measurements in existingstandards. Fair value measurements are categorised into a three-level
hierarchy, based on the type of inputs to the valuation techniques used. However, the guidance in IFRS
13 does not apply to transactions dealt with by certain specific standards.
Required:
(i) Discuss the main principles of fair value measurement as set out in IFRS 13. (7 marks)
(ii) Describe the three-level hierarchy for fair value measurements used in IFRS 13. (6 marks)
(b) Jayach, a public limited company, is reviewing the fair valuation of certain assets and liabilities in light
of the
introduction of IFRS 13.
It carries an asset that is traded in different markets and is uncertain as to which valuation to use. The
asset has to be valued at fair value under International Financial Reporting Standards. Jayach currently
only buys and sells the asset in the Australasian market. The data relating to the asset are set out below:
Year to 30 November 2012 Asian European Australasian
Market Market Market
Volume of market – units 4 million 2 million 1 million
Price N19 N16 N22
Costs of entering the market N2 N2 N3
Transaction costs N1 N2 N2
Additionally, Jayach had acquired an entity on 30 November 2012 and is required to fair value a
decommissioning liability. The entity has to decommission a mine at the end of its useful life, which is in
three years’ time. Jayach has determined that it will use a valuation technique to measure the fair value of
the liability.
If Jayach were allowed to transfer the liability to another market participant, then the following data would
be used.
Input Amount
Labour and material cost N2 million
Overhead 30% of labour and material cost
Third party mark-up – industry average 20%
Annual inflation rate 5%
Risk adjustment – uncertainty relating to cash flows 6%
Risk-free rate of government bonds 4%
Entity’s non-performance risk 2%
Jayach needs advice on how to fair value the liability.
Required:
Discuss, with relevant computations, how Jayach should fair value the above asset and liability
under IFRS 13. (10 marks)
Professional marks will be awarded in question 4 for the clarity and quality of the presentation and
discussion.
(2 marks) (25 marks) ACCA CORPORATE REPORTING DECEMBER 2012

2.(a) Mehran, a public limited company, has just acquired a company, which comprises a farming and
mining business. Mehran wishes advice on how to fair value some of the assets acquired. One such
asset is a piece of land, which is currently used for farming. The fair value of the land if used for farming is
N5 million. If the land is used for farming purposes, a tax credit currently arises annually, which is based
upon the lower of 15% of the fair market value of land or N500,000 at the current tax rate. The current tax
rate in the jurisdiction is 20%. Mehran has determined that market participants would consider that the
land could have an alternative use for residential purposes. The fair value of the land for residential
purposes before associated costs is thought to be N7·4 million. In order to transform the land from
farming to residential use, there would be legal costs of N200,000, a viability analysis cost of N300,000
and costs of demolition of the farm buildings of N100,000.
Additionally, permission for residential use has not been formally given by the legal authority and because
of this, market participants have indicated that the fair value of the land, after the above costs, would be
discounted by 20% because of the risk of not obtaining planning permission.
In addition, Mehran has acquired the brand name associated with the produce from the farm. Mehran has
decided to discontinue the brand on the assumption that it will gain increased revenues from its own
brands. Mehran has determined that if it ceases to use the brand, then the indirect benefits will be N20
million. If it continues to use the brand, then the direct benefit will be N17 million. (8 marks)

(b) Mehran wishes to fair value the inventory of the entity acquired. There are three different markets for
the produce, which are mainly vegetables. The first is the local domestic market where Mehran can sell
direct to retailers of he produce. The second domestic market is one where Mehran sells directly to
manufacturers of canned vegetables. There are no restrictions on the sale of produce in either of the
domestic markets other than the demand of the retailers and manufacturers. The final market is the
export market but the government limits the amount of produce which can be exported. Mehran needs a
licence from the government to export its produce. Farmers tend to sell all of the produce that they can in
the export market and, when they do not have any further authorisation to export, they sell the remaining
produce in the two domestic markets.
It is difficult to obtain information on the volume of trade in the domestic market where the produce is sold
locally direct to retailers but Mehran feels that the market is at least as large as the domestic market –
direct to manufacturers. The volumes of sales quoted below have been taken from trade journals.
Domestic market – Domestic market – Export market
direct to retailers direct to
manufacturers
Volume – annual Unknown 20,000 tonnes 10,000 tonnes
Mehran – sales per month 10 tonnes 4 tonnes 60 tonnes
Price per tonne N1,000 N800 N1,200
Transport costs per tonne N50 N70 N100
Selling agents’ fees per tonne – N4 N6 (9 marks)
(c) Mehran owns a non-controlling equity interest in Erham, a private company, and wishes to fair value it
as at its financial year end of 31 March 2016. Mehran acquired the ordinary share interest in Erham on 1
April 2014.
During the current financial year, Erham has issued further equity capital through the issue of preferred
shares to a venture capital fund.
As a result of the preferred share issue, the venture capital fund now holds a controlling interest in Erham.
The terms of the preferred shares, including the voting rights, are similar to those of the ordinary shares,
except that the preferred shares have a cumulative fixed dividend entitlement for a period of four years
and the preferred shares rank ahead of the ordinary shares upon the liquidation of Erham. The
transaction price for the preferred
shares was N15 per share.
Mehran wishes to know the factors which should be taken into account in measuring the fair value of their
holding in the ordinary shares of Erham at 31 March 2016 using a market-based approach. (6 marks)
Required:
Discuss the way in which Mehran should fair value the above assets with reference to the
principles of IFRS 13 Fair Value Measurement.
Professional marks will be awarded in question 2 for clarity and quality of presentation. (2marks) TOTAL
(25 marks)
ACCA CORPORATE REPORTING DECEMBER 2015

SUGGESTED SOLUTION
1. (a) (i) Fair value has had a different meaning depending on the context and usage. The IASB’s
definition 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. Basically it is an exit price. Fair value
is focused on the assumptions of the market place and is not entity specific. It therefore takes into
account any assumptions about risk. Fair value is measured using the same assumptions and taking into
account the same characteristics of the asset or liability as market participants would. Such conditions
would include the condition and location of the asset and any restrictions on its sale or use. Further, it is
not relevant if the entity insists that prices are too low relative to its own valuation of the asset and that it
would be unwilling to sell at low prices. Prices to be used are those in ‘an orderly transaction’. An orderly
transaction is one that assumes exposure to the market for a period before the date of measurement to
allow for normal marketing activities and to ensure that it is not a forced transaction. If the transaction is
not ‘orderly’, then there will not have been enough time to create competition and potential buyers may
reduce the price that they are willing to pay. Similarly, if a seller is forced to accept a price in a short
period of time, the price may not be representative. It does not follow that a market in which there are few
transactions is not orderly. If there has been competitive tension, sufficient time and information about the
asset, then this may result in a fair value for the asset.
IFRS 13 does not specify the unit of account for measuring fair value. This means that it is left to the
individual standard to determine the unit of account for fair value measurement. A unit of account is the
single asset or liability or group of assets or liabilities. The characteristic of an asset or liability must be
distinguished from a characteristic arising from the holding of an asset or liability by an entity. An example
of this is that if an entity sold a large block of shares, it may have to do so at a discount to the market
price. This is a characteristic of holding the asset rather than of the asset itself and should not be taken
into account when fair valuing the asset.
Fair value measurement assumes that the transaction to sell the asset or transfer the liability takes place
in the principal market for the asset or liability or, in the absence of a principal market, in the most
advantageous market for the asset or liability. The principal market is the one with the greatest volume
and level of activity for the asset or liability that can be accessed by the entity.
The most advantageous market is the one which maximises the amount that would be received for the
asset or minimises the amount that would be paid to transfer the liability after transport and transaction
costs.
An entity does not have to carry out an exhaustive search to identify either market but should take into
account all
available information. Although transaction costs are taken into account when identifying the most
advantageous market, the fair value is not after adjustment for transaction costs because these costs are
characteristics of the transaction and not the asset or liability. If location is a factor, then the market price
is adjusted for the costs incurred to transport the asset to that market. Market participants must be
independent of each other and knowledgeable, and able and willing to enter into transactions.
IFRS 13 sets out a valuation approach, which refers to a broad range of techniques, which can be used.
These
techniques are threefold. The market, income and cost approaches.

(ii) When measuring fair value, the entity is required to maximise the use of observable inputs and
minimise the use of
unobservable inputs. To this end, the standard introduces a fair value hierarchy, which prioritises the
inputs into the fair value measurement process.
Level 1 inputs are quoted prices (unadjusted) in active markets for items identical to the asset or liability
being
measured. As with current IFRS, if there is a quoted price in an active market, an entity uses that price
without
adjustment when measuring fair value. An example of this would be prices quoted on a stock exchange.
The entity needs to be able to access the market at the measurement date. Active markets are ones
where transactions take place with sufficient frequency and volume for pricing information to be provided.
An alternative method may be used where it is expedient. The standard sets out certain criteria where this
may be applicable. For example, where the price quoted in an active market does not represent fair value
at the measurement date. An example of this may be where a significant event takes place after the close
of the market such as a business reorganisation or combination.
The determination of whether a fair value measurement is level 2 or level 3 inputs depends on whether
the inputs are
observable inputs or unobservable inputs and their significance.
Level 2 inputs are inputs other than the quoted prices in level 1 that are directly or indirectly observable
for that asset
or liability. They are quoted assets or liabilities for similar items in active markets or supported by market
data. For
example, interest rates, credit spreads or yield curves. Adjustments may be needed to level 2 inputs and if
this adjustment is significant, then it may require the fair value to be classified as level 3.
Level 3 inputs are unobservable inputs. The use of these inputs should be kept to a minimum. However,
situations may occur where relevant inputs are not observable and therefore these inputs must be
developed to reflect the assumptions that market participants would use when determining an appropriate
price for the asset or liability. The entity should maximise the use of relevant observable inputs and
minimise the use of unobservable inputs. The general principle of using an exit price remains and IFRS
13 does not preclude an entity from using its own data. For example, cash flow forecasts may be used to
value an entity that is not listed. Each fair value measurement is categorised based on the lowest level
input that is significant to it.

(b) Year to 31 December 2012 Asian Market European Market Australasian Market
Volume of market – units 4 million 2 million 1 million
Price N19 N16 N22
Costs of entering the market (N2) (N2) (n/a) see note
Potential fair value N17 N14 N22
Transaction costs (N1) (N2) (N2)
Net profit N16 N12 N20
Note: As Jayach buys and sells in Australasia, the costs of entering the market are not relevant as these
would not be incurred.Further transaction costs are not considered as these are not included as part of
the valuation.
The principal market for the asset is the Asian market because of the fact that it has the highest level of
activity due to the highest volume of units sold. The most advantageous market is the Australasian market
because it returns the best profit per unit. If the information about the markets is reasonably available,
then Jayach should base its fair value on prices in the Asian market due to it being the principal market,
assuming that Jayach can access the market. The pricing is taken from this market even though the entity
does not currently transact in the market and is not the most advantageous. The fair value ould be N17,
as transport costs would be taken into account but not transaction costs.
If the entity cannot access the Asian or European market, or reliable information about the markets is not
available, Jayach would use the data from the Australasian market and the fair value would be N22. The
principal market is not always the market in which the entity transacts. Market participants must be
independent of each other and knowledgeable, and able and willing to enter into transactions.
Input Amount (N 000)
Labour and material cost 2,000
Overhead (30%) 600
Third party mark-up – industry average (20% of 2,600) 520
––––––
Total 3,120
Annual inflation rate (3,120 x 5% compounded for three years) 492
––––––
Total 3,612
Risk adjustment – 6% 217
––––––
Total 3,829
––––––
Discounted at risk free rate of government bonds plus entity’s non-performance risk – 6% 3,215
The fair value of a liability assumes that it is transferred to a market participant at the measurement date.
In many cases there is no observable market to provide pricing information. In this case, the fair value is
based on the perspective of a market participant who holds the identical instrument as an asset. If there is
no corresponding asset, then a valuation technique is used. This would be the case with the
decommissioning activity. The fair value of a liability reflects any compensation for risk and profit margin
that a market participant might require to undertake the activity plus the non-performance risk based on
the entity’s own credit standing. Thus the fair value of the decommissioning liability would be N3,215,000.

2 (a) IFRS 13 requires the fair value of a non-financial asset to be measured based on its highest and
best use from a market participant’s perspective. This requirement does not apply to financial
instruments, liabilities or equity. The highest and best use takes into account the use of the asset which is
physically possible, legally permissible and financially feasible. The highest and best use of a non-
financial asset is determined by reference to its use and not its classification and is determined from the
perspective of market participants. It does not matter whether the entity intends to use the asset
differently. IFRS 13 allows management to presume that the current use of an asset is the highest and
best use unless market or other factors uggest otherwise.
In this case, the agricultural land appears to have an alternative use as market participants have
considered its alternative use for residential purposes. If the land zoned for agricultural use is currently
used for farming, the fair value should reflect the cost structure to continue operating the land for farming,
including any tax credits which could be realised by market participants. Thus the fair value of the land if
used for farming would be N(5 + (20% of 0·5)) million, i.e. N5·1 million.
If used for residential purposes, the value should include all costs associated with changing the land to
the market participant’s intended use. In addition, demolition and other costs associated with preparing
the land for a different use should be included in the valuation. These costs would include the uncertainty
related to whether the approval needed for changing the usage would be obtained, because market
participants would take that into account when pricing value of the land if it had a different use. Thus the
fair value of the land if used for residential purposes would be N(7·4 – 0·2 – 0·3 – 0·1) million x 80%, i.e.
N5·44 million. Therefore the value of the land would be N5·44 million on the highest and best use basis.
In this situation, the presumption that the current use is the highest and best use of the land has been
overridden by the market factors which indicate that residential development is the highest and best use.
A use of an asset need not be legal at the measurement date, but it must not be legally prohibited in the
jurisdiction.
In the absence of any evidence to the contrary, Mehran should value the brand on the basis of the highest
and best use. The fair value is determined from the perspective of a market participant and is not
influenced by the Mehran’s decision to discontinue the brand. Therefore the fair value of the brand is N17
million.

(b) IFRS 13 sets out the concepts of principal market and most advantageous market. Transactions take
place in either the principal market, which is the market with the greatest volume and level of activity for
the inventory, or in the absence of a principal market, the most advantageous market. The most
advantageous market is the market which maximises the amount which would be received to sell the
inventory, after taking into account transaction costs and transportation costs. The price used to measure
the inventory’s fair value is not adjusted for transaction costs although it is adjusted for transport cost. The
principal market is not necessarily the market with the greatest volume of activity for the particular
reporting entity. The principle is based upon the importance of the market from the participant’s
perspective. However, the principal market is presumed to be the market in which the reporting entity
transacts, unless there is evidence to the contrary. In evaluating the principal or most advantageous
markets, IFRS 13 restricts the eligible markets to only those which can be accessed at the measurement
date. If there is a principal market for the asset or liability, IFRS 13 states that fair value should be based
on the price in that market, even if the price in a different market is higher. It is only in the absence of the
principal market that the most advantageous market should be used. An entity does not have to
undertake an exhaustive search of all possible markets in order to identify the principal or most
advantageous market. It should take into account all information which is readily available.
There is a presumption in the standard that the market in which the entity normally transacts to sell the
asset or transfer the liability is the principal or most advantageous market unless there is evidence to the
contrary.
In this case, the greatest volume of transactions is conducted in the domestic market – direct to
manufacturers. There is no problem with obtaining data from trade journals but the problem for Mehran is
that there is no data to substantiate the volume of activity in the domestic market – direct to retailers even
though Mehran feels that it is at least 20,000 tonnes per annum.
The most advantageous market is the export market where after transport and transaction costs the price
per tonne is N1,094.
Domestic market – Domestic market – Export market
direct to retailers direct to manufacturers
Price per tonne N1,000 N800 N1,200
Transport costs N50 N70 N100
Selling agents’ fees – N4 N6
–––––– ––––– –––––
Net price per tonne N950 N726 N1,094
–––––– ––––– ––––––
It is difficult to determine a principal market because of the lack of information. It could be argued that the
domestic market – direct to manufacturers has the highest volume for the produce, and is therefore the
principal market by which Mehran should determine fair value of N730 (N800 – N70). However, because
of the lack of information surrounding the domestic market – direct to retailers, the principal or most
advantageous market will be presumed to be the market in which Mehran would normally enter into
transactions which would be the export market. Therefore the fair value would be N1,100 (N1,200 –N100)
per tonne.

(c) Measuring the fair value of individual unquoted equity instruments which constitute a non-controlling
interest in a private company falls within the scope of IFRS 9 Financial Instruments in accordance with the
principles set out in IFRS 13. There is a range of commonly used valuation techniques for measuring the
fair value of unquoted equity instruments within the market and income approaches as well as the
adjusted net asset method. IFRS 13 states that fair value is a market-based measurement, although it
acknowledges that in some cases observable market transactions or other market information might not
be available. IFRS 13 does not contain a hierarchy of valuation techniques nor does it prescribe the use
of a specific valuation technique for meeting the objective of a fair value measurement. However, IFRS 13
acknowledges that, given specific circumstances, one valuation technique might be more appropriate
than another. The market approach takes a transaction price paid for an identical or a similar instrument
in an investee and adjusts the resultant valuation. The transaction price paid recently for an investment in
an equity instrument in an investee which is similar, but not identical, to an investor’s unquoted equity
instrument in the same investee would be a reasonable starting point for estimating the fair value of the
unquoted equity instrument.
Mehran would take the transaction price for the preferred shares and adjust it to reflect certain differences
between the preferred shares and the ordinary shares. There would be an adjustment to reflect the
priority of the preferred shares upon liquidation.
Mehran should acknowledge the benefit associated with control. This adjustment relates to the fact that
Mehran’s individual ordinary shares represent a non-controlling interest whereas the preferred shares
issued reflect a controlling interest.There will be an adjustment for the lack of liquidity of the investment
which reflects the lesser ability of the ordinary shareholder to initiate a sale of Erham relative to the
preferred shareholder. Further, there will be an adjustment for the cumulative dividend entitlement of the
preferred shares. This would be calculated as the present value of the expected future dividend receipts
on the preferred shares, less the present value of any expected dividend receipts on the ordinary shares.
The discount rate used should be consistent with the uncertainties associated with the relevant dividend
streams.
Mehran should review the circumstances of the issue of the preferred shares to ensure that its price was
a valid benchmark.Mehran must, however, use all information about the performance and operations of
Erham which becomes reasonably available to it after the date of initial recognition of the ordinary shares
up to the measurement date. Such information can have an effect on the fair value of the unquoted equity
instrument at 31 March 2016. In addition, Mehran should consider the existence of factors such as
whether the environment in which Erham operates is dynamic, or whether there have beenchanges in
market conditions between the issue of the preferred shares and the easurement date.

IFRS 14: REGULATORY DEFERRAL ACCOUNTS

Overview

IFRS 14 Regulatory Deferral Accounts permits an entity which is a first-time adopter of

International Financial Reporting Standards to continue to account, with some limited changes,
for 'regulatory deferral account balances' in accordance with its previous GAAP, both on initial
adoption of IFRS and in subsequent financial statements. Regulatory deferral account balances,
and movements in them, are presented separately in the statement of financial position and
statement of profit or loss and other comprehensive income, and specific disclosures are
required.

IFRS 14 was originally issued in January 2014 and applies to an entity's first annual IFRS
financial statements for a period beginning on or after 1 January 2016.

Summary of IFRS 14

Objective

The objective of IFRS 14 is to specify the financial reporting requirements for 'regulatory deferral
account balances' that arise when an entity provides good or services to customers at a price or
rate that is subject to rate regulation. [IFRS 14:1]

IFRS 14 is designed as a limited scope Standard to provide an interim, short-term solution for
rate-regulated entities that have not yet adopted International Financial Reporting Standards
(IFRS). Its purpose is to allow rate-regulated entities adopting IFRS for the first-time to avoid
changes in accounting policies in respect of regulatory deferral accounts until such time as the
International Accounting Standards Board (IASB) can complete its comprehensive project on
rate regulated activities.

Scope

IFRS 14 is permitted, but not required, to be applied where an entity conducts rate-regulated
activities and has recognised amounts in its previous GAAP financial statements that meet the
definition of 'regulatory deferral account balances' (sometimes referred to 'regulatory assets' and
'regulatory liabilities'). [IFRS 14.5]

Entities which are eligible to apply IFRS 14 are not required to do so, and so can chose to apply
only the requirements of IFRS 1 First-time Adoption of International Financial Reporting
Standards when first applying IFRSs. The election to adopt IFRS 14 is only available on the
initial adoption of IFRSs, meaning an entity cannot apply IFRS 14 for the first time in financial
statements subsequent to those prepared on the initial adoption of IFRSs. However, an entity
that elects to apply IFRS 14 in its first IFRS financial statements must continue to apply it in
subsequent financial statements. [IFRS 14.6]

When applied, the requirements of IFRS 14 must be applied to all regulatory deferral account
balances arising from an entity's rate-regulated activities. [IFRS 14.8]

Key definitions
[IFRS 14:Appendix A]
A framework for establishing the prices that can be charged to customers for goods and
Rate regulation
services and that framework is subject to oversight and/or approval by a rate-regulator
An authorised body that is empowered by statute or regulation to establish the rate or
range of rates that bind an entity. The rate regulator may be a third-party body or a
Rate regulator related party of the entity, including the entity's own governing board, if that body is
required by statute or regulation to set rates both in the interest of customers and to
ensure the overall financial viability of the entity
The balance of any expense (or income) account that would not be recognised as an
Regulatory
asset or a liability in accordance with other Standards, but that qualifies for deferral
deferral account
because it is included, or is expected to be included, by the rate regulator in establishing
balance
the rate(s) that can be charged to customers
Accounting policies for regulatory deferral account balances

IFRS 14 provides an exemption from paragraph 11 of IAS 8 Accounting Policies, Changes in

Accounting Estimates and Errors when an entity determines its accounting policies for
regulatory deferral account balances. [IFRS 14.9] Paragraph 11 of IAS 8 requires an entity to
consider the requirements of IFRSs dealing with similar matters and the requirements of the
Conceptual Framework when setting its accounting policies.

The effect of the exemption is that eligible entities can continue to apply the accounting policies
used for regulatory deferral account balances under the basis of accounting used immediately
before adopting IFRS ('previous GAAP') when applying IFRSs, subject to the presentation
requirements of IFRS 14 [IFRS 14.11].

Entities are permitted to change their accounting policies for regulatory deferral account
balances in accordance with IAS 8, but only if the change makes the financial statements more
relevant and no less reliable, or more reliable and not less relevant, to the economic decision-
making needs of users of the entity's financial statements. However, an entity is not permitted to
change accounting policies to start to recognise regulatory deferral account balances. [IFRS
14.13]

Interaction with other Standards

The requirements of other IFRSs are required to be applied to regulatory deferral account
balances, subject to specific exceptions, exemptions and additional requirements contained in
IFRS 14 [IFRS 14.16]. These are briefly summarised below: [IFRS 14.B7-B28]
IFRS Requirements
The requirements of IAS 10 are applied when determining which events
IAS 10 Events After the
after the end of the reporting period should be taken into account in the
Reporting Period
recognition and measurement of regulatory deferral account balances
Deferred tax assets and liabilities arising from regulatory deferral account
balances are presented separately from total deferred tax amounts and
IAS 12 Income Taxes
movements in those deferred tax balances are presented separately from
tax expense (income)
Entities applying IFRS 14 are required to present an additional basic and
IAS 33 Earnings Per Share diluted earnings per share that excludes the impacts of the net movement
in regulatory deferral account balances
Regulatory deferral account balances are included in the carrying amount
IAS 36 Impairment of Assets of any relevant cash-generating unit (CGU) and are treated in the same
way as other assets and liabilities where an impairment loss arises
IFRS 3 Business Combinations The entity's accounting policies for regulatory deferral account balances
 are used in applying the acquisition method, which can result in the
recognition of regulatory deferral account balances in respect of an
acquiree, regardless of whether the acquiree itself recognised such
balances
The measurement requirements of IFRS 5 do not apply to regulatory
IFRS 5 Non-current Assets Held
deferral account balances, and modifications are made to the
for Sale and Discontinued
presentation of information about discontinued operations and disposal
Operations
groups in relation to such balances
The entity's accounting policies in respect of regulatory deferral account
IFRS 10 Consolidated Financial balances are required to be applied in an entity's consolidated financial
Statements and IAS 28 statements or in the determination of equity accounted information of
Investments in Associates and associates or joint ventures, notwithstanding that the entity's investees
Joint Ventures (2011) may not have recognised regulatory deferral account balances in their
financial statements
Separate disclosure of regulatory deferral account balances and net
IFRS 12 Disclosure of Interests
movements in those balances recognised in profit or loss or other
in Other Entities
comprehensive income are required for various IFRS 12 disclosures
Presentation in financial statements

The impact of regulatory deferral account balances are separately presented in an entity's
financial statements. This requirements applies regardless of the entity's previous presentation
policies in respect of regulatory deferral balance accounts under its previous GAAP.
Accordingly:

• Separate line items are presented in the statement of financial position for the total of all
regulatory deferral account debit balances, and all regulatory deferral account credit
balances [IFRS 14.20]

• Regulatory deferral account balances are not classified between current and non-
current, but are separately disclosed using subtotals [IFRS 14.21]

• The net movement in regulatory deferral account balances are separately presented in
the statement of profit or loss and other comprehensive income using subtotals [IFRS
14.22-23]

The Illustrative examples accompanying IFRS 14 set out an illustrative presentation of financial
statements by an entity applying the Standard. This is presented below:
Statement of financial position N
Assets
Non – Current Assets XX
Current Assets XX
Total Asstes XX
Regulatory Defferal Account Debit & Related Deferred Tax Assets XX
Total Assets & Regulatory Defferal Debit Balances
Equity and Liabilities
Equity XX
Non – Current Liabilities XX
Current Liabilities XX
Total Equity and Liabilities XX
Regulatory Defferal Credit Balances XX
Total Equity, Liabilities & Reguatory Defferal Balances

Statement of Profit or Loss and Other Comprehensive Income N

Profit before tax XX
Tax expenses XX
Profit for the year before net movement in Regulatory Defferal Account
Balances XX
Net Movement in Regulatory Defferal Account Balances XX
Profit for the year & net movement in Regulatory Defferal Account XX
Other Comprehensive Income
Net movement in Regulatory Defferal Account Balances to Other
Comprehensive Income XX
Total Comprehensive Income & net movement in Regulatory Defferal A/c XX

Profit & net movement in Regulatory Defferal Account Balances Attributable to:
Owners of the Parent XX
Non – Controlling Interest XX
XX
Total Comprehensive Income Attributable to :
Owners of the Parent XX
Non – Controlling Interest XX
XX
EPS
Basic and Diluted XX Kobo
Basic and Diluted including net movement in Regulatory Defferal Account
Balances XX Kobo
Disclosures

IFRS 14 sets out disclosure objectives to allow users to assess: [IFRS 14.27]

• the nature of, and risks associated with, the rate regulation that establishes the price(s)
the entity can charge customers for the goods or services it provides - including
information about the entity's rate-regulated activities and the rate-setting process, the
identity of the rate regulator(s), and the impacts of risks and uncertainties on the
recovery or reversal of regulatory deferral balance accounts

• the effects of rate regulation on the entity's financial statements - including the basis on
which regulatory deferral account balances are recognised, how they are assessed for
recovery, a reconciliation of the carrying amount at the beginning and end of the
reporting period, discount rates applicable, income tax impacts and details of balances
that are no longer considered recoverable or reversible.

Effective date

Where an entity elects to apply it, IFRS 14 is effective for an entity's first annual IFRS financial
statements that are for a period beginning on or after 1 January 2016. The standard can be
applied earlier, but the entity must disclose when it has done so. [IFRS 14.C1]
IFRS 15: REVENUE RECOGNITION IN CONTRACTS WITH CUSTOMERS
Overview

IFRS 15 specifies how and when an IFRS reporter will recognise revenue as well as requiring
such entities to provide users of financial statements with more informative, relevant
disclosures. The standard provides a single, principles based five-step model to be applied to all
contracts with customers.

IFRS 15 was issued in May 2014 and applies to an annual reporting period beginning on or after
1 January 2017.

Superseded Standards

IFRS 15 replaces the following standards and interpretations:

• IAS 11 Construction contracts

• IAS 18 Revenue

• IFRIC 13 Customer Loyalty Programmes

• IFRIC 15 Agreements for the Construction of Real Estate

• IFRIC 18 Transfers of Assets from Customers

• SIC-31 Revenue - Barter Transactions Involving Advertising Services

Summary of IFRS 15

Objective

The objective of IFRS 15 is to establish the principles that an entity shall apply to report useful
information to users of financial statements about the nature, amount, timing, and uncertainty of
revenue and cash flows arising from a contract with a customer. [IFRS 15:1] Application of the
standard is mandatory for annual reporting periods starting from 1 January 2017 onwards.
Earlier application is permitted.

Scope
IFRS 15 Revenue from Contracts with Customers applies to all contracts with customers except
for: leases within the scope of IAS 17 Leases; financial instruments and other contractual rights
or obligations within the scope of IFRS 9 Financial Instruments, IFRS 10 Consolidated Financial
Statements, IFRS 11 Joint Arrangements, IAS 27 Separate Financial Statements and IAS 28
Investments in Associates and Joint Ventures; insurance contracts within the scope of IFRS 4
Insurance Contracts; and non-monetary exchanges between entities in the same line of
business to facilitate sales to customers or potential customers. [IFRS 15:5]

A contract with a customer may be partially within the scope of IFRS 15 and partially within the
scope of another standard. In that scenario: [IFRS 15:7]

• if other standards specify how to separate and/or initially measure one or more parts of
the contract, then those separation and measurement requirements are applied first. The
transaction price is then reduced by the amounts that are initially measured under other
standards;

• if no other standard provides guidance on how to separate and/or initially measure one
or more parts of the contract, then IFRS 15 will be applied.

Key definitions

[IFRS 15: Appendix A]

An agreement between two or more parties that creates enforceable rights and
Contract
obligations.
A party that has contracted with an entity to obtain goods or services that are an output of
Customer
the entity’s ordinary activities in exchange for consideration.
Increases in economic benefits during the accounting period in the form of inflows or
Income enhancements of assets or decreases of liabilities that result in an increase in equity,
other than those relating to contributions from equity participants.
A promise in a contract with a customer to transfer to the customer either:

Performance • a good or service (or a bundle of goods or services) that is distinct; or

obligation • a series of distinct goods or services that are substantially the same and that have
the same pattern of transfer to the customer.
Revenue Income arising in the course of an entity’s ordinary activities.
The amount of consideration to which an entity expects to be entitled in exchange for
Transaction
transferring promised goods or services to a customer, excluding amounts collected on
price
behalf of third parties.
Accounting requirements for revenue

The five-step model framework

The core principle of IFRS 15 is that an entity will recognise revenue to depict the transfer of
promised goods or services to customers in an amount that reflects the consideration to which
the entity expects to be entitled in exchange for those goods or services. This core principle is
delivered in a five-step model framework: [IFRS 15:IN7]

• Identify the contract(s) with a customer

• Identify the performance obligations in the contract

• Determine the transaction price

 • Allocate the transaction price to the performance obligations in the contract

• Recognise revenue when (or as) the entity satisfies a performance obligation.

Application of this guidance will depend on the facts and circumstances present in a contract
with a customer and will require the exercise of judgment.

Step 1: Identify the contract with the customer

A contract with a customer will be within the scope of IFRS 15 if all the following conditions are
met: [IFRS 15:9]

• the contract has been approved by the parties to the contract;

• each party’s rights in relation to the goods or services to be transferred can be identified;

• the payment terms for the goods or services to be transferred can be identified;

• the contract has commercial substance; and

• it is probable that the consideration to which the entity is entitled to in exchange for the
goods or services will be collected.

If a contract with a customer does not yet meet all of the above criteria, the entity will continue to
re-assess the contract going forward to determine whether it subsequently meets the above
criteria. From that point, the entity will apply IFRS 15 to the contract. [IFRS 15:14]

The standard provides detailed guidance on how to account for approved contract
modifications. If certain conditions are met, a contract modification will be accounted for as a
separate contract with the customer. If not, it will be accounted for by modifying the accounting
for the current contract with the customer. Whether the latter type of modification is accounted
for prospectively or retrospectively depends on whether the remaining goods or services to be
delivered after the modification are distinct from those delivered prior to the modification. Further
details on accounting for contract modifications can be found in the Standard. [IFRS 15:18-21].

Step 2: Identify the performance obligations in the contract

At the inception of the contract, the entity should assess the goods or services that have been
promised to the customer, and identify as a performance obligation: [IFRS 15.22]

• a good or service (or bundle of goods or services) that is distinct; or

• a series of distinct goods or services that are substantially the same and that have the
same pattern of transfer to the customer.

A series of distinct goods or services is transferred to the customer in the same pattern if both of
the following criteria are met: [IFRS 15:23]

• each distinct good or service in the series that the entity promises to transfer
consecutively to the customer would be a performance obligation that is satisfied over
time (see below); and

• a single method of measuring progress would be used to measure the entity’s progress
towards complete satisfaction of the performance obligation to transfer each distinct
good or service in the series to the customer.

A good or service is distinct if both of the following criteria are met: [IFRS 15:27]
 • the customer can benefit from the good or services on its own or in conjunction with
other readily available resources; and

• the entity’s promise to transfer the good or service to the customer is separately
idenitifable from other promises in the contract.

Factors for consideration as to whether a promise to transfer the good or service to the
customer is separately identifiable include, but are not limited to: [IFRS 15:29]

• the entity does not provide a significant service of integrating the good or service with
other goods or services promised in the contract.

• the good or service does not significantly modify or customise another good or service
promised in the contract.

• the good or service is not highly interrelated with or highly dependent on other goods or
services promised in the contract.

Step 3: Determine the transaction price

The transaction price is the amount to which an entity expects to be entitled in exchange for the
transfer of goods and services. When making this determination, an entity will consider past
customary business practices. [IFRS 15:47]

Where a contract contains elements of variable consideration, the entity will estimate the
amount of variable consideration to which it will be entitled under the contract. [IFRS 15:50]
Variable consideration can arise, for example, as a result of discounts, rebates, refunds, credits,
price concessions, incentives, performance bonuses, penalties or other similar items. Variable
consideration is also present if an entity’s right to consideration is contingent on the occurrence
of a future event. [IFRS 15:51]

The standard deals with the uncertainty relating to variable consideration by limiting the amount
of variable consideration that can be recognised. Specifically, variable consideration is only
included in the transaction price if, and to the extent that, it is highly probable that its inclusion
will not result in a significant revenue reversal in the future when the uncertainty has been
subsequently resolved. [IFRS 15:56]

However, a different, more restrictive approach is applied in respect of sales or usage-based

royalty revenue arising from licences of intellectual property. Such revenue is recognised only
when the underlying sales or usage occur. [IFRS 15:B63]

Step 4: Allocate the transaction price to the performance obligations in the contracts

Where a contract has multiple performance obligations, an entity will allocate the transaction
price to the performance obligations in the contract by reference to their relative standalone
selling prices. [IFRS 15:74] If a standalone selling price is not directly observable, the entity will
need to estimate it. IFRS 15 suggests various methods that might be used, including: [IFRS
15:79]

• Adjusted market assessment approach

• Expected cost plus a margin approach

• Residual approach (only permissible in limited circumstances).

Any overall discount compared to the aggregate of standalone selling prices is allocated
between performance obligations on a relative standalone selling price basis. In certain
circumstances, it may be appropriate to allocate such a discount to some but not all of the
performance obligations. [IFRS 15:81]

Where consideration is paid in advance or in arrears, the entity will need to consider whether
the contract includes a significant financing arrangement and, if so, adjust for the time value of
money. [IFRS 15:60] A practical expedient is available where the interval between transfer of the
promised goods or services and payment by the customer is expected to be less than 12
months. [IFRS 15:63]

Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation

Revenue is recognised as control is passed, either over time or at a point in time. [IFRS 15:32]

Control of an asset is defined as the ability to direct the use of and obtain substantially all of the
remaining benefits from the asset. This includes the ability to prevent others from directing the
use of and obtaining the benefits from the asset. The benefits related to the asset are the
potential cash flows that may be obtained directly or indirectly. These include, but are not limited
to: [IFRS 15:31-33]

• using the asset to produce goods or provide services;

• using the asset to enhance the value of other assets;

• using the asset to settle liabilities or to reduce expenses;

• selling or exchanging the asset;

• pledging the asset to secure a loan; and

• holding the asset.

An entity recognises revenue over time if one of the following criteria is met: [IFRS 15:35]

• the customer simultaneously receives and consumes all of the benefits provided by the
entity as the entity performs;

• the entity’s performance creates or enhances an asset that the customer controls as the
asset is created; or

• the entity’s performance does not create an asset with an alternative use to the entity
and the entity has an enforceable right to payment for performance completed to date.

If an entity does not satisfy its performance obligation over time, it satisfies it at a point in time.
Revenue will therefore be recognised when control is passed at a certain point in time. Factors
that may indicate the point in time at which control passes include, but are not limited to: [IFRS
15:38]

• the entity has a present right to payment for the asset;

• the customer has legal title to the asset;

• the entity has transferred physical possession of the asset;

• the customer has the significant risks and rewards related to the ownership of the asset;
and
 • the customer has accepted the asset.
Illustration on idenifying separae peformance obligation
Optimum Solution Ltd has developed a personnel payroll software package called PaySoft.
Optimum Solution Ltd has entered into a contract with Brght Future Ltd to supply the following:
(a) Licence to use PaySoft
(b) Installation service. This may require an upgrade to the computer operating system, but the
software package does not need to be customized
(c) Technical support for three years
(d) Three years of update for PaySoft
Optimum Solution us not the only company that can install, and the technical support can also
be provided by other companies. The software can function without the updates and technical
support.
Required:
Explain whether the goods and services provided to Bright Futures Ltd are distinct in
sccordance with IFRS 15 on Revenue Recognition in Contracts with Customers.
Suggested Solution

PaySoft was delivered before the other goods or services and remain functional without the
updates and the technical support. It may be concluded that Bright Future Ltd can benefit from
each of the goods and services either on their own or or together with the other goods and
services that are readily available.

The promise to transfer each good and service to the customer are separately indentifiable. In
particular, the installation service does not significantly modify the software itself, and as such,
the software and the installation service are separate outputs prmised by Optimum Solution Ltd
rather than inputs used to produce a combined output.
In conclusion, the goods and services are distinct and amount to four performance obligations in
the contract under IFRS 15.

Illustration on determininig the transaction price

Refer to the review question one and the suggested solution

Contract costs
The incremental costs of obtaining a contract must be recognised as an asset if the entity
expects to recover those costs. However, those incremental costs are limited to the costs that
the entity would not have incurred if the contract had not been successfully obtained (e.g.
‘success fees’ paid to agents). A practical expedient is available, allowing the incremental costs
of obtaining a contract to be expensed if the associated amortisation period would be 12 months
or less. [IFRS 15:91-94]
Costs incurred to fulfil a contract are recognised as an asset if and only if all of the following
criteria are met: [IFRS 15:95]

• the costs relate directly to a contract (or a specific anticipated contract);

• the costs generate or enhance resources of the entity that will be used in satisfying
performance obligations in the future; and

• the costs are expected to be recovered.

These include costs such as direct labour, direct materials, and the allocation of overheads that
relate directly to the contract. [IFRS 15:97]

The asset recognised in respect of the costs to obtain or fulfil a contract is amortised on a
systematic basis that is consistent with the pattern of transfer of the goods or services to which
the asset relates. [IFRS 15:99]
Contracts - Performance Obligations Satisfied Over Time
A peformance obligation satisfied over time meets the criteria in step 5 of the Standard, and if it
enters into more than one accounting period, would previously have been described as a long-
term contract.
In this type of contract, an entity has an enforcable right to payment for performance completed
to date. The Standard describes this as an amount that approximates the selling price of the
goods or services transferred to date.

The methods of measuring the amount of performance completed to date include output
methods and input methods.

Output Methods. This method recognises revenue on the basis of the value to the customer of
the goods and services transferred. These may include inventory of performance completed,
appraisal of units produced or delivered.

Input Methods. This method recognises revenue on the basis of the entity’s inputs, such as
labour hours, resources consumed, and costs incurred. If cost based method is used, the costs
incurred must contribute to the entity’s progres in satisfying the performance obligation.
Illustration on contract where performance obligations are satisfied over time
Note that the requirements of this Standard on contract where performance obligstion is satisied
over time is not different from IAS 11 requirements.
Suppose that a contract was started on 1 January 20X7, when an estimated completion date of
31 December 20X8. The final contract price is N1,500,000. In the first year to 31 December
20X7:
(a) Costs incurred amounted to N600,000
(b) Half the work on the contract is completed
(c) Certificate on work completed has been issued, to the value of N750,000
(d) It is estimated with reasonable certainty that further costs to completion in 20X8 will be
N600,000.
What is the contract profit in 20X7, and what entries will be made in the contract as at 31
December 20X7?

Solution
This is a contract in which performance obligation is satisfied over time. The entity is carrying
out the work for the benefit of the customer rather than creating an asset for its own use and it
has an enforceable right to payment for work completed to date. This is evidenced by the fact
that certificate of work completed has been issued.
IFRS 15 states that the amount of payment the entity is entitled to corresponds to the amount of
performance completed to date, which approximates to the costs incurred in satisfying the
performance obligation plus a reasonable profit margin.
In this case the contract certified is 50% complete. At 31 December 20X7 the entity will
recognise revenue of N750,000 and cost of sales of N600,000, leaving profit of N150,000. The
contract asset will be the cost to date plus the profit – N750,000. No evidence that any of this
amount has yet been invoiced, so no amount is deducted for receivables.

Summary of Accounting Treatment Contract Performance Obligation Satisfied Over Time

Statement of Profit or Loss
(a) Revenue and costs
- sales revenue and associated costs should be recorded in profit or loss s the contract
activity progresses
- include an appropriate proportion of total contract value as sales revenue in the profit
 or loss
The costs incurred in completing that amount of performance obligation are matched
with this sales revenue, resulting in the reporting of results which can be attributed to the
proportion of work completed.
• Sales revenue is the value of work caried out to date.

(b) Profit recognized in the contract

- It must reflect the proportion of work carried out
- it should take into account any known inequalities in profitabilty in the various stages of
a contract.
Statement of Financial Position
(a) Contract assets presented separately uder current assets
N
Costs to date XX
Add Profits recogised XX
XX
Less Any recognised losses (XX)
Less receivables (amounts invoiced) (XX)
Contract Assets (amount due from customer not yet invoced) XX

(b) Receivables
Invoices not yet settled by customer XX

(c) Contract liability

Where in (a) above the amount shows amount due to customer, this amount should be inckuded
as contract liability presented separately under current liabilities.

Comprehensive illustration
Stevo Plc has the following construction contrat (performance obligations satisfied over time) in
progress.
N’m
Total contract price 750
Costs incured to date 225
Estimated costs to completion 340
Progress payments invoiced and received 290

Required: Calculate the amounts to be recognized for the contract in the statement of profit or
loss and statement of financial position assuming the amount of performance obligation satisfied
is calculated using the prorportion of cost incurred method.

Suggested Solution
1. Estimated profit N’m
Total contract price 750
Less costs incurred to date (225)
Less estimated costs to completion (340)
Estimated profit 185

2. Percentage of performance obligation completed

Costs to date/total estimated cost = 22/225+340 x100% = 40%

3. Statement of Profit or Loss N’m

Revenue (40% x N750) 300
Cost of sales 40% x (225 +340) (226)
Profit (40% x N185) 74
4. Statement of financial position N’m
Costs incurred to date 225
Recognised profits 74
Less receivable (290)
Contract asset 9

Loss Making Contract

Assuming in the illustration above the contract price is reduced to N550million.
1. Estimated Loss N’m
Total contract price 550
Less costs incurred to date (225)
Less estimated costs to completion (340)
Estimated loss (15)
2. Percentage of completion
Costs to date/Total estimated costs = 225/225+340 X 100% 40%

3. Statement of profit or loss N’m

Revenue (40% x N550) 220
Cost of sales (balancing figure) (235)
Loss (15)

4. Statement of financial position N’m

Costs incurred to date 225
Recogized loss (15)
Less Receivable (290)
Contract liability (80)

Illustration applying the IFRS five – step model

On 1 January 20X8, Abike enters into a twelve-month ‘pay monthly’ mobile phone. The contract
is with Excellent GSM, and the terms of the plan are:
(a) Abike receives a free handset on 1 January 20X8
(b) Abike pays a monthly fee of N200, which includes unlimited free minutes. Abike is billed on
the last day of the month.
Customers may purchase the same handset from Excellent GSM for N500 without the payment
plan. They may also enter into the payment plan without the handset, in which case the plan
costs them N175 per month.
The company’s year end is 31 July 20X8
Required
Show how Excellent GSM should recognise revenue from this plan in accodance with IFRS 15
Revenue from Contract with Customers. Your answer should give journal entries.
• On 1 January 20X8
• On 31 January 20X8
Suggested Solution
IFRS 5 requires application of its five – step model
(a) Identify the contract with a customer. A contract can be written, oral or implied by
customary business practices.
(b) Identify the separate performance obligations in the contract. If a promised good or
service is not distinct, it can be combined with others
(c) Determine the transaction price. This is the amount to which the entity expects to be
entitled. For variable consideration, the probability – weighted expected amount is used. The
effect of any credit losses shown as a separate line item.
(d) Allocation the transaction price to the separate performance obligations in the
contract. For multiple deliverables, the transaction price is allocated to each separate
performance obligation in proportion to the stand-alone selling price at contract inception of
each performance obligation.
(e) Recognise revenue when (or as) the entity satisfies a performance obligation, that is when
the entity transfers a promised good or service to a customer. The good or service is only
considered as transferred when the customer obtains control of it.

Application of the five step model to Excellent GSM

(a) Identify the contract with the customer: This is clear Excellent GSM has twelve month
contract with Abike.
(b) Identify the separate performance obligation in the contract; Tehre are two distinct
performance obligation in this contract:
(i) the obligation to deliver a handset
(ii) the obligation to provide network services for twelve months
(c) determine the transaction price; This is straightforward it is N2,400 (N200 x 12 months)
(d) allocate the transaction cost to the separate performance obligation in the contract:
The transaction price is allocated to each separate performance obligation in proportion to
stand-alone selling price at contract inception of each performance obligation, that is, the
stand alone price of the hand set (N500 and the stand alone price of the network services (N175
x 12= N2,100)
Performance Obligation Stand Alone % of Total Revenue (=Relative
Selling
Selling Price Price (=N2,400 x %)
N N
Handset 500 19.2% 460.8
Network Services 2,100 80.8% 1,939.2
Total 2,600 100.0 2,400.0

(e) Recognise revenue when (or as) the entity satisfies a performance obligation; That is,
when the entity transfers a promised good or service to a customer. This applies to each of the
performance obligation.
(i) When Excellent GSM gives a handset o Abike it needs to recognize revenue of N460.8
(ii) When Excellent GSM provides network services to Abike, it needs to recognize total revenue
of N1,939.2. Its practical to do it once per month as the biling happens.

Journal Entries
On 1 January 20X8
The entries in the books of Excellent GSM will be:
Dr Receivable (unbilled revenue) N460.8
Cr Revenue N460.8
Being revenue recognised for the sale of hand set

On 31 January 20X8
The monthly payment from Abike is split bwteen amounts owing for the network services and
amounts owing for the handset
Dr Receivable (Abike) N200.0
Cr Revenue (N1,939.2/12) N161.6
Cr Receivable (unbilled revenue) N460.8/12 N38.4
Being recognition of revenue for monthly provision of network services and repayment of hand
set

Further useful implementation guidance in relation to applying IFRS 15

These topics include:
Sale with a right of return: When goods are sold with a right of return, an entity should not
recognise revenue for goods it expects to be returned. It can calculate the level of return using
the expected value method (the probalility weighted sum of amounts) or simply estimate the
most lilely amount. This will be accounted for as a reduction or refund of liability of the customer
and a reduction in revenue.
The entity also recognises an asset (adjusted against cost of sales) for its right to recover
products from customers on settlement of the refund or reduced liability.

Warranties: If a customer has the option to purchase a warranty separately from the product to
which it relates, it constitutes a distinct service and is accounted for as a separate perfomance
obligation. This would apply to a warranty which provides the customer with a service in addition
to the assurance that the product complies with agreed upon specifications.

If the customer does not have the option to purchase the warranty separately,for instance if
warranty is required by law, that does not give rise to performance obligation and the warranty is
accounted for under IAS 37 on Provisions, Contingent Assets and Contingent Liabilities.

Principal versus agent considerations: An entity must establish in every transaction whether
it is acting as principal or agent. The entity is a principla if it controls the promised good or
service before it is transferred to the customer. Wehn the perfomance obligation is satisfied, the
entity recognises reveue in the gross amount of the consideration for those goods or services.

An entiry is acting as an agent if its performance obligation is to arrange for the provision of
goods or services by another party. Satisfaction of this performance obligation will give rise to
the recognition of revenue in the amount of any fee or commission to which it expects to be
entitled in exchange for arranging for the other party to provide its goods or services.

Indicators that an entity is an agent rather than a principal includes:

(a) Another party is primariy responsible for fulfilling the contract

(b) The entity does not have inventory risk before or after the goods have been ordered by a
customer, during shipping or on return.

(c) The entity does not have discretion in establishing prices for the other party’s goods or
services, and, therefore, the benefit that the entity can receive from those goods or services is
limited.

(d) The entity’s consideration is in the form of a commision

(e) The entity is not exposed to credit risk for the amount receivable from the customer in
exchange for the other party’s goods or services.
Illustration on principal versus agent
An entity operates a website that enables customers to purchase goods from a range of
customers. The suppliers deliver directly to the customers, who have paid in advance, and the
entity receives a a commission of 10% of the sales price.
The entity’s website also processes payments from the customers to the suppliers at prices set
by the supplier. The entity has no further obligation to the customers after arranging for the
products to be supplied.
Is the entity a principal or an agent?

Solution
The following points are relevant:
• Goods are supplied directly from the supplier to the customer, so the entity does not
obtain control of the goods
• The supplier is primarily responsible for fulfilling the contract
 • The entity’s consideration is in the form of commission
• The entity does not establish prices and bears no credit risk
The entity would therefore conclude that it is acting as an agent and that the only revenue to
recognise is the amounts received as commission.
Customer’s options for additional goods or services: If an option in the contract grants the
customer the right to acquire additional goods or services at a discount which can only be
obtained by entering into the contract, that options gives rise to a performance obligation.

Revenue is recognised when the additional future goods or services are transferred, taking
account of the discount.

If the option granted to the customer does not offer a discount, it is treated as a marketing offer
and no contract exists until the customer exercises the option to purchase.

Customers’ unexercised rights: When a customer pays in advance for goods or services the
prepayment gives rise to contract liability, which is derecognised when the performance
obligation is satisfied.

If, having made a non- refundable prepayment, the customer does not exercise the right to
receive the good or service, the unexercised right is often refered to as breakage. A breakage
amount can be recognised as reveue if the pattern of rights exercised by the customer gives
rise to the expectation that the entity will be entitled to a breakage amount. If this does not
apply, it can be recognised as revenue when the likelihood of the customer exercising its rights
become remote.

Non-refundable upfront fees: A non-refundable upfront fees is often charged at the beginning
of a contract, such as joining fees in health club membership contracts.

In many cases upfront fees do nit rekate to the transfer of any promised good or service but are
simply advance payments for future goods or services. In this case revenue is recognised
when the future goods or services are provided.

If the fee relates to a good or service the entity should evaluate whether or not it amounts to a
separate performance obligation. This deoends on whether it results in the transfer of an asset
to the customer. The fees may relate to costs incurred in setting up a contract, but these setup
activities may not result in the transfer of services to the customer.

Licensing: A licence establishes a customer’s rights to the intellectual property of an entity.

Intellectual property can include software, music, franchises, patents, trademarks and
copyrights.

The promise to grant a licence may be accompanied by the promise to transfer other goods or
services to the customer. If the promise to grant the licence is not distinct from the promised
goods or services, this is treated as a single performance obligation.

If the promise to grant the licence is distinct, it will constitute a separate performance obligaton.
The entity must establish whether the performance obligation is satisfied ‘at a point in time’ or
‘over time’

In this respect the entity should consider whether the nature of the entity’s promise in granting
the licence to a customer is to provide the customer with either:

(a) a right to access the entity’s intellectual property as it exists throughout the licence period
or
(b) a right to use the entity’s intellectual property as it exists at a point in time at which the
licence is granted.

A right to access exists where the entity can make changes to the intellectual property
throuhout the licence period, the customer us exposed to the effects of these changes and the
changes do not constitute the transfer of a good or service to the customer. In this case the
promise to grant a licence is treated as a performance obligation satisfied over time and the
entity recognises revenue over time by measuring the progress towards complete satisfaction of
that performance obligation.

Where this does not apply, the nature of the entity’s promise is the right to use its intellectual
property as it exists at the point in time at which the licence is granted. This means that the
customer can direct the use of, and obtain substantially all the remaining benefits from, the
licence at the point at which it is transferred. The point at which revenue can be recognised may
be later than the date on which the licence is granted if the customer does not have immediate
access to the intellectual property,

When royalties, based on sale or on usage are promised by the customer in exhange for a
licence of intellectual property, revenue can be recognised at the later of the following
occurences:

• The sale or usage occurs and

• The performance obligation to which the royalty has been allocated has been
satisfied.

Repurchase arrangements: Under a repurchase agreement an entity sells an asset, and

promises or has the option to repurchse it. Repurchase agreements generally come in three
forms:

(a) An entity has the obligation to repurchase the asset (a forward contract)

(b) An entity has the right to repurchase the asset (call option)

(c) An entity must repurchase the asset if requested to do so by the customer (put option)

In the case of forward or call option the customer does not obtain control of the asset, even if it
has physical possesion. The entity will account for the contract as:

(a) A lease in accordance with IAS 17 now IFRS 16 if the repurchsse price is below the original
selling price.

(b) A financing arrangement if the repurchsse price is equal to or greater than the original selling
price. In this case the entiry will recognise both the asset and a corresponding liability.

If the entity is obliged to repurchase the asset at the request of the customer (put option), it must
consider whether or not the customer is likely to exercise that option.

If the repurchase price is lower than the original selling price and it is considered that the
customer does not therefore have significant economic incentive to exercise the option, the
contract should be accounted for as an outright sale, with a right of return.

If the repurchase price is greater than or equal to the original selling price and is above the
expected market value of the option, the contract is treated as a financing arrangement.
Illustration on a contract with a call option
An entity enters into a contract with a customer for the sale of a tangibke asset on 1 January
20X7 for N1 million. The contract includes a call option that gives the entity the right to
repurchase the asset for N1.1million on or before 31 Decemebr 20X7.
This means that the customer does not obtain control of the asset, because the repurchase
option means that it is limited in its abiity to use and obtain benefits from the asset.

Solution
As control has not been transferred, the entity accounts for the transaction as a financing
arrangement, becasue the exercise price is above the original selling price. The entity
continues to recognise the asset and recognise the cash received as a financial liability. The
difference of N0.1 million is recognised as interest expense.
If by 31 December 20X7 the option lapses unexercised, the customer now obtains comtrol of
the asset. The entity will derecognise the asset and recognise revenue of N1.1 million (N1
million already received and 0.1 million charged to interest)

Illustration on contract with put option

The same contract as above, included instead a put option that obliges the entity to repuchase
the asset at the customer’s request for N900,000 on or before 31 December 20X7, at which
time the market vakue is expected to be N750,000.

Solution
In this case the customer has significant economic incentive to exercise the put option because
the repurchase price exceeds the market value at the repurchase date. This means that control
does not pass to the customer.Since the customer will be exercising the put option, this limits its
ability to use or obtain benefit from the asset.
In this situation the entity accounts for the transaction as a lease in accordance with Ias 17 now
IFRS 16 on lease. The asset has ben leased to the customer for the period up to the repurchse
and the difference of N100,000 will be accounted for as payments received under operating
lease.
Consignment arrangements: When a product is delivered to a customer under a consignment
arrangement, the customer (dealer) does not obtain control of the product at that point in time,
so no revenue is recognised upon delivery.

Indicators of consignment arrangement include:

(a) The product is controled by the entity until a specified event occurs, such as the product is
sold on, or a specfied period expires.

(b) The entity can require the return of the product, or transfer it to another party.

(c) The customer (dealer) does not have an unconditional obligation to pay for the product.

Bill-and-hold arrangements: Under a bill-and-hold arrangement goods are sold but remain in
the posseion of the seller for a specified period, perhaps because the customer lacks storage
facilities.

An entity will need to determine at what point the customer obtains control of the product. For
some contracts, conrol will not be transferred until the goods are delivered to the customer. For
others, a customer may obtain control even though the products remain in the entity’s physical
possesion. In this case the entity will be providing custodial services to the customer over the
customer’s assets.

For a customer to have obtained control of a product in a bill- and- hold arrangement, the
following criteria must be met:
(a) The reason for the bill-and-hold must be substantive, for example, request by the customer.

(b) The product must be separately identified as belonging to the customer

(c) The product must be ready for physical transfer to the customer

(d) The entity cannot have the ability to use the product or to transfer it to another customer.
Illustration on bill-and-hold arrangement
An entity enters into a contract with a customer on 1 January 20X8 for sale of machine and
spare parts. It takes two years to manufacture these and on 31 December 20X9 the customer
pays for both the machine and spare parts but only takes physical posseion of the machine. The
customer inspects and accepts the spare parts but requests that they continue to stored at the
entity;s warehouse.

Solution
There are now three performance obligations – transfer of the machine, transfer of the spare
parts and the custodial services. The transaction price is allocated to the three performance
obligations and revenue is recognised when (or as) control passes to the customer.
The machine and the spare parts are both performance obligations satisfied at a point in time,
and for both of them that point in time is 31 December 20X9. In the case of the spare parts, the
customer has paid for them, the customer has legal title to them and the customer has control of
them as they can remove them from storage at any time.
The custodial services are performance obligation satisfied over time, so revenue will be
recognised over the period during which the spare parts were stored.
Presentation in financial statements
Contracts with customers will be presented in an entity’s statement of financial position as a
contract liability, a contract asset, or a receivable, depending on the relationship between the
entity’s performance and the customer’s payment. [IFRS 15:105]
A contract liability is presented in the statement of financial position where a customer has paid
an amount of consideration prior to the entity performing by transferring the related good or
service to the customer. [IFRS 15:106]

Where the entity has performed by transferring a good or service to the customer and the
customer has not yet paid the related consideration, a contract asset or a receivable is
presented in the statement of financial position, depending on the nature of the entity’s right to
consideration. A contract asset is recognised when the entity’s right to consideration is
conditional on something other than the passage of time, for example future performance of the
entity. A receivable is recognised when the entity’s right to consideration is unconditional except
for the passage of time.

Contract assets and receivables shall be accounted for in accordance with IFRS 9. Any
impairment relating to contracts with customers should be measured, presented and disclosed
in accordance with IFRS 9. Any difference between the initial recognition of a receivable and the
corresponding amount of revenue recognised should also be presented as an expense, for
example, an impairment loss. [IFRS 15:107-108]
Disclosures
The disclosure objective stated in IFRS 15 is for an entity to disclose sufficient information to
enable users of financial statements to understand the nature, amount, timing and uncertainty of
revenue and cash flows arising from contracts with customers. Therefore, an entity should
disclose qualitative and quantitative information about all of the following: [IFRS 15:110]
• its contracts with customers;
 • the significant judgments, and changes in the judgments, made in applying the guidance
to those contracts; and

• any assets recognised from the costs to obtain or fulfil a contract with a customer.

Entities will need to consider the level of detail necessary to satisfy the disclosure objective and
how much emphasis to place on each of the requirements. An entity should aggregate or
disaggregate disclosures to ensure that useful information is not obscured. [IFRS 15:111]

In order to achieve the disclosure objective stated above, the Standard introduces a number of
new disclosure requirements. Further detail about these specific requirements can be found at
IFRS 15:113-129.

Effective date and transition

The standard should be applied in an entity’s IFRS financial statements for annual reporting
periods beginning on or after 1 January 2018. Earlier application is permitted. An entity that
chooses to apply IFRS 15 earlier than 1 January 2017 should disclose this fact in its relevant
financial statements. [IFRS 15:C1]

When first applying IFRS 15, entities should apply the standard in full for the current period,
including retrospective application to all contracts that were not yet complete at the beginning of
that period. In respect of prior periods, the transition guidance allows entities an option to either:
[IFRS 15:C3]

• apply IFRS 15 in full to prior periods (with certain limited practical expedients being
available); or

• retain prior period figures as reported under the previous standards, recognising the
cumulative effect of applying IFRS 15 as an adjustment to the opening balance of equity
as at the date of initial application (beginning of current reporting period).
REVIEW QUESTIONS
1. There has been significant divergence in practice over recognition of revenue mainly because
International FinancialReporting Standards (IFRS) have contained limited guidance in certain areas. The
International Accounting StandardsBoard (IASB) as a result of the joint project with the US Financial
Accounting Standards Board (FASB) has issuedIFRS 15 Revenue from Contracts with Customers. IFRS
15 sets out a five-step model, which applies to revenueearned from a contract with a customer with
limited exceptions, regardless of the type of revenue transaction or the industry. Step one in the five-step
model requires the identification of the contract with the customer and is critical for the purpose of
applying the standard. The remaining four steps in the standard’s revenue recognition model are
irrelevant if the contract does not fall within the scope of IFRS 15.
Required:
(a) (i) Discuss the criteria which must be met for a contract with a customer to fall within the
scope of IFRS 15. (5 marks)

(ii) Discuss the four remaining steps which lead to revenue recognition after a contract has been
identified as falling within the scope of IFRS 15. (8 marks)

(b) (i) Tang enters into a contract with a customer to sell an existing printing machine such that control of
the printing machine vests with the customer in two years’ time. The contract has two payment options.
The customer can pay N240,000 when the contract is signed or N300,000 in two years’ time when the
customer gains control of the printing machine. The interest rate implicit in the contract is 11·8% in order
to adjust for the risk involved in the delay in payment. However, Tang’s incremental borrowing rate is 5%.
The customer paid N240,000 on 1 December 2014 when the contract was signed. (4 marks)
(ii) Tang enters into a contract on 1 December 2014 to construct a printing machine on a customer’s
premises for a promised consideration of N1,500,000 with a bonus of N100,000 if the machine is
completed within 24 months. At the inception of the contract, Tang correctly accounts for the promised
bundle of goods and services as a single performance obligation in accordance with IFRS 15. At the
inception of the contract, Tang expects the costs to be N800,000 and concludes that it is highly probable
that a significant reversal in the amount of cumulative revenue recognised will occur. Completion of the
printing machine is highly
susceptible to factors outside of Tang’s influence, mainly issues with the supply of components.
At 30 November 2015, Tang has satisfied 65% of its performance obligation on the basis of costs incurred
to date and concludes that the variable consideration is still constrained in accordance with IFRS 15.
However, on 4 December 2015, the contract is modified with the result that the fixed consideration and
expected costs increase by N110,000 and N60,000 respectively. The time allowable for achieving the
bonus is extended by six months with the result that Tang concludes that it is highly probable that the
bonus will be achieved and that the contract still remains a single performance obligation. Tang has an
accounting year end of 30 November. (6 marks)
Required:
Discuss how the above two contracts should be accounted for under IFRS 15. (In the case of (b)(i),
the discussion should include the accounting treatment up to 30 November 2016 and in the case
of (b)(ii), the accounting treatment up to 4 December 2015.)
Note: The mark allocation is shown against each of the items above.
Professional marks will be awarded in question 4 for clarity and quality of presentation. (2marks) TOTAL
(25 marks)
ACCA COPORATE REPORTING JUNE 2016

SUGGESTED SOLUTIONS
1. (a) (i) The definition of what constitutes a contract for the purpose of applying the standard is critical.
The definition of contract is based on the definition of a contract in the USA and is similar to that in IAS 32
Financial Instruments: Presentation. A contract exists when an agreement between two or more parties
creates enforceable rights and obligations between those parties. The agreement does not need to be in
writing to be a contract but the decision as to whether a contractual right or obligation is enforceable is
considered within the context of the relevant legal framework of a jurisdiction. Thus, whether a contract is
enforceable will vary across jurisdictions. The performance obligation could include promises which result
in a valid expectation that the entity will transfer goods or services to the customer even though those
promises are not legally enforceable.
The first criteria set out in IFRS 15 is that the parties should have approved the contract and are
committed to perform their respective obligations. It would be questionable whether that contract is
enforceable if this were not the case. In the case of oral or implied contracts, this may be difficult but all
relevant facts and circumstances should be considered in assessing the parties’ commitment. The parties
need not always be committed to fulfilling all of the obligations under a contract. IFRS 15 gives the
example where a customer is required to purchase a minimum quantity of goods but past experience
shows that the customer does not always do this and the other party does not enforce their contract
rights. However, there needs to be evidence that the parties are substantially committed to the contract.
It is essential that each party’s rights and the payment terms can be identified regarding the goods or
services to be transferred. This latter requirement is the key to determining the transaction price.
The contract must have commercial substance before revenue can be recognised, as without this
requirement, entities might artificially inflate their revenue and it would be questionable whether the
transaction has economic consequences.
Further, it should be probable that the entity will collect the consideration due under the contract. An
assessment of a customer’s credit risk is an important element in deciding whether a contract has validity
but customer credit risk does not affect the measurement or presentation of revenue. The consideration
may be different to the contract price because of discounts and bonus offerings. The entity should assess
the ability of the customer to pay and the customer’s intention to pay the consideration. If a contract with a
customer does not meet these criteria, the entity can continually re-assess the contract to determine
whether it subsequently meets the criteria.
Two or more contracts which are entered into around the same time with the same customer may be
combined and accounted for as a single contract, if they meet the specified criteria. The standard
provides detailed requirements for contract modifications. A modification may be accounted for as a
separate contract or a modification of the original contract, depending upon the circumstances of the
case.

(ii) Step one in the five-step model requires the identification of the contract with the customer. After a
contract has been determined to fall under IFRS 15, the following steps are required before revenue can
be recognised.
Step two requires the identification of the separate performance obligations in the contract. This is often
referred to as’unbundling’, and is done at the beginning of a contract. The key factor in identifying a
separate performance obligation is the distinctiveness of the good or service, or a bundle of goods or
services. A good or service is distinct if the customer can benefit from the good or service on its own or
together with other readily available resources and is separately identifiable from other elements of the
contract. IFRS 15 requires a series of distinct goods or services which are substantially the same with the
same pattern of transfer, to be regarded as a single performance obligation. A good or service, which has
been delivered, may not be distinct if it cannot be used without another good or service which has not yet
been delivered. Similarly, goods or services which are not distinct should be combined with other goods
or services until the entity identifies a bundle of goods or services which is distinct. IFRS 15 provides
indicators rather than criteria to determine when a good or service is distinct within the context of the
contract. This allows management to apply judgement to determine the separate performance obligations
which best reflect the economic substance of a transaction.
Step three requires the entity to determine the transaction price, which is the amount of consideration
which an entity expects to be entitled to in exchange for the promised goods or services. This amount
excludes amounts collected on behalf of a third party, for example, government taxes. An entity must
determine the amount of consideration to which it expects to be entitled in order to recognise revenue.
The transaction price might include variable or contingent consideration. Variable consideration should be
estimated as either the expected value or the most likely amount. Management should use the approach
which it expects will best predict the amount of consideration and should be applied consistently
throughout the contract. An entity can only include variable consideration in the transaction price to the
extent that it is highly probable that a subsequent change in the estimated variable consideration will not
result in a significant revenue reversal. If it is not appropriate to include all of the variable consideration in
the transaction price, the entity should assess whether it should include part of the variable consideration.
However, this latter amount still has to pass the ’revenue reversal’ test.
Additionally, an entity should estimate the transaction price taking into account non-cash consideration,
consideration payable to the customer and the time value of money if a significant financing component is
present. The latter is not required if the time period between the transfer of goods or services and
payment is less than one year. If an entity
anticipates that it may ultimately accept an amount lower than that initially promised in the contract due to,
for example, past experience of discounts given, then revenue would be estimated at the lower amount
with the collectability of that lower amount being assessed. Subsequently, if revenue already recognised
is not collectable, impairment losses should be taken to profit or loss.
Step four requires the allocation of the transaction price to the separate performance obligations. The
allocation is based on the relative standalone selling prices of the goods or services promised and is
made at inception of the contract. It is not adjusted to reflect subsequent changes in the standalone
selling prices of those goods or services. The best evidence of standalone selling price is the observable
price of a good or service when the entity sells that good or service separately. If that is not available, an
estimate is made by using an approach which maximises the use of observable inputs. For example,
expected cost plus an appropriate margin or the assessment of market prices for similar goods or
services adjusted for entity-specific costs and margins or in limited circumstances a residual approach.
When a contract contains more than one distinct performance obligation, an entity allocates the
transaction price to each distinct performance obligation on the basis of the standalone selling price.
Where the transaction price includes a variable amount and discounts, consideration needs to be given
as to whether these amounts relate to all or only some of the performance obligations in the contract.
Discounts and variable consideration will typically be allocated proportionately to all of the performance
obligations in the contract. However, if certain conditions are met, they can be allocated to one or more
separate performance obligations.
Step five requires revenue to be recognised as each performance obligation is satisfied. An entity
satisfies a performance obligation by transferring control of a promised good or service to the customer,
which could occur over time or at a point in time. The definition of control includes the ability to prevent
others from directing the use of and obtaining the benefits from the asset. A performance obligation is
satisfied at a point in time unless it meets one of three criteria set out in IFRS 15. Revenue is recognised
in line with the pattern of transfer.
If an entity does not satisfy its performance obligation over time, it satisfies it at a point in time and
revenue will be recognised when control is passed at that point in time. Factors which may indicate the
passing of control include the present right to payment for the asset or the customer has legal title to the
asset or the entity has transferred physical
possession of the asset.
(b) (i) The contract contains a significant financing component because of the length of time between
when the customer pays for the asset and when Tang transfers the asset to the customer, as well as the
prevailing interest rates in the market. A contract with a customer which has a significant financing
component should be separated into a revenue component
(for the notional cash sales price) and a loan component. Consequently, the accounting for a sale arising
from a contract which has a significant financing component should be comparable to the accounting for a
loan with the same features.
An entity should use the discount rate which would be reflected in a separate financing transaction
between the entity and its customer at contract inception. The interest rate implicit in the transaction may
be different from the rate to be used to discount the cash flows, which should be the entity’s incremental
borrowing rate. IFRS 15 would therefore
dictate that the rate which should be used in adjusting the promised consideration is 5%, which is the
entity’s incremental borrowing rate, and not 11·8%.
Tang would account for the significant financing component as follows:
Recognise a contract liability for the N240,000 payment received on 1 December 2014 at the contract
inception:
Dr Cash N240,000
Cr Contract liability N240,000
During the two years from contract inception (1 December 2014) until the transfer of the printing machine,
Tang adjusts the amount of consideration and accretes the contract liability by recognising interest on
N240,000 at 5% for two years.

Year to 30 November 2015

Dr Interest expense N12,000
Cr Contract liability N12,000
Contract liability would stand at N252,000 at 30 November 2015.

Year to 30 November 2016

Dr Interest expense N12,600
Cr Contract liability N12,600
Recognition of contract revenue on transfer of printing machine at 30 November 2016 of N264,600 by
debiting contract liability and crediting revenue with this amount.

(ii) Tang accounts for the promised bundle of goods and services as a single performance obligation
satisfied over time in accordance with IFRS 15. At the inception of the contract, Tang expects the
following:
Transaction price N1,500,000
Expected costs N800,000
Expected profit (46·7%) N700,000
At contract inception, Tang excludes the N100,000 bonus from the transaction price because it cannot
conclude that it is highly probable that a significant reversal in the amount of cumulative revenue
recognised will not occur. Completion of the printing machine is highly susceptible to factors outside the
entity’s influence. By the end of the first year, the entity has satisfied 65% of its performance obligation on
the basis of costs incurred to date. Costs incurred to date are therefore N520,000 and Tang reassesses
the variable consideration and concludes that the amount is still constrained.
Therefore at 30 November 2015, the following would be recognised:
Revenue N975,000
Costs N520,000
Gross profit N455,000
However, on 4 December 2015, the contract is modified. As a result, the fixed consideration and expected
costs increase by N110,000 and N60,000, respectively. The total potential consideration after the
modification is N1,710,000 which is N1,610,000 fixed consideration + N100,000 completion bonus. In
addition, the allowable time for achieving the bonus is extended by six months with the result that Tang
concludes that it is highly probable that including the bonus in the transaction price will not result in a
significant reversal in the amount of cumulative revenue recognised in accordance with IFRS 15.
Therefore the bonus of N100,000 can be included in the transaction price. Tang also concludes that the
contract remains a single performance obligation. Thus,Tang accounts for the contract modification
as if it were part of the original contract. Therefore, Tang updates its estimates of costs and revenue as
follows:
Tang has satisfied 60·5% of its performance obligation (N520,000 actual costs incurred compared to
N860,000 total expected costs). The entity recognises additional revenue of N59,550 [(60·5% of
N1,710,000) – N975,000 revenue recognised to date] at the date of the modification as a cumulative
catch-up adjustment. As the contract amendment took place after the year end, the additional revenue
would not be treated as an adjusting event.

IFRS 16: LEASES

Objective

IFRS 16 establishes principles for the recognition, measurement, presentation and disclosure of
leases, with the objective of ensuring that lessees and lessors provide relevant information that
faithfully represents those transactions. [IFRS 16:1]

Scope

IFRS 16 Leases applies to all leases, including subleases, except for: [IFRS 16:3]

• leases to explore for or use minerals, oil, natural gas and similar non-regenerative
resources;

• leases of biological assets held by a lessee (see IAS 41 Agriculture);

• service concession arrangements (see IFRIC 12 Service Concession Arrangements);

• licences of intellectual property granted by a lessor (see IFRS 15 Revenue from

Contracts with Customers); and

• rights held by a lessee under licensing agreements for items such as films, videos,
plays, manuscripts, patents and copyrights within the scope of IAS 38 Intangible Assets

A lessee can elect to apply IFRS 16 to leases of intangible assets, other than those items listed
above. [IFRS 16:4]
Recognition exemptions

Instead of applying the recognition requirements of IFRS 16 described below, a lessee may
elect to account for lease payments as an expense on a straight-line basis over the lease term
or another systematic basis for the following two types of leases:

i) leases with a lease term of 12 months or less and containing no purchase options – this
election is made by class of underlying asset; and

ii) leases where the underlying asset has a low value when new (such as personal computers or
small items of office furniture) – this election can be made on a lease-by-lease basis.

[IFRS 16:5, 6 & 8]

Identifying a lease

A contract is, or contains, a lease if it conveys the right to control the use of an identified asset
for a period of time in exchange for consideration. [IFRS 16:9]

Control is conveyed where the customer has both the right to direct the identified asset’s use
and to obtain substantially all the economic benefits from that use. [IFRS 16:B9]

An asset is typically identified by being explicitly specified in a contract, but an asset can also be
identified by being implicitly specified at the time it is made available for use by the customer.

However, where a supplier has a substantive right of substitution throughout the period of use, a
customer does not have a right to use an identified asset. A supplier’s right of substitution is only
considered substantive if the supplier has both the practical ability to substitute alternative
assets throughout the period of use and they would economically benefit from substitution.
[IFRS 16:B13-14]

A capacity portion of an asset is still an identified asset if it is physically distinct (e.g. a floor of a
building). A capacity or other portion of an asset that is not physically distinct (e.g. a capacity
portion of a fibre optic cable) is not an identified asset, unless it represents substantially all the
capacity such that the customer obtains substantially all the economic benefits from using the
asset. [IFRS 16:B20]

Separating components of a contract

For a contract that contains a lease component and additional lease and non-lease
components, such as the lease of an asset and the provision of a maintenance service, lessees
shall allocate the consideration payable on the basis of the relative stand-alone prices, which
shall be estimated if observable prices are not readily available.

As a practical expedient, a lessee may elect, by class of underlying asset, not to separate non-
lease components from lease components and instead account for all components as a lease.
[IFRS 16:13-15]

Lessors shall allocate consideration in accordance with IFRS 15 Revenue from Contracts with
Customers.

Key definitions

[IFRS 16: Appendix A]

Interest rate implicit in the lease

The interest rate that yields a present value of (a) the lease payments and (b) the unguaranteed
residual value equal to the sum of (i) the fair value of the underlying asset and (ii) any initial
direct costs of the lessor.

Lease term

The non-cancellable period for which a lessee has the right to use an underlying asset, plus:

a) periods covered by an extension option if exercise of that option by the lessee is reasonably
certain; and

b) periods covered by a termination option if the lessee is reasonably certain not to exercise that
option

Lessee’s incremental borrowing rate

The rate of interest that a lessee would have to pay to borrow over a similar term, and with a
similar security, the funds necessary to obtain an asset of a similar value to the right-of-use
asset in a similar economic environment.

Accounting by lessees

Upon lease commencement a lessee recognises a right-of-use asset and a lease liability. [IFRS
16:22]

The right-of-use asset is initially measured at the amount of the lease liability plus any initial
direct costs incurred by the lessee. Adjustments may also be required for lease incentives,
payments at or prior to commencement and restoration obligations or similar. [IFRS 16:24]

After lease commencement, a lessee shall measure the right-of-use asset using a cost model,
unless: [IFRS 16:29, 34, 35]

i) the right-of-use asset is an investment property and the lessee fair values its investment
property under IAS 40; or

ii) the right-of-use asset relates to a class of PPE to which the lessee applies IAS 16’s
revaluation model, in which case all right-of-use assets relating to that class of PPE can be
revalued.

Under the cost model a right-of-use asset is measured at cost less accumulated depreciation
and accumulated impairment. [IFRS 16:30(a)]

The lease liability is initially measured at the present value of the lease payments payable over
the lease term, discounted at the rate implicit in the lease if that can be readily determined. If
that rate cannot be readily determined, the lessee shall use their incremental borrowing rate.
[IFRS 16:26]

Variable lease payments that depend on an index or a rate are included in the initial
measurement of the lease liability and are initially measured using the index or rate as at the
commencement date. Amounts expected to be payable by the lessee under residual value
guarantees are also included. [IFRS 16:27(b),(c)]

Variable lease payments that are not included in the measurement of the lease liability are
recognised in profit or loss in the period in which the event or condition that triggers payment
occurs, unless the costs are included in the carrying amount of another asset under another
Standard. [IFRS 16:38(b)
The lease liability is subsequently remeasured to reflect changes in: [IFRS 16:36]

• the lease term (using a revised discount rate);

• the assessment of a purchase option (using a revised discount rate);

• the amounts expected to be payable under residual value guarantees (using an

unchanged discount rate); or

• future lease payments resulting from a change in an index or a rate used to determine
those payments (using an unchanged discount rate).

The remeasurements are treated as adjustments to the right-of-use asset. [IFRS 16:39]

Lease modifications may also prompt remeasurement of the lease liability unless they are to be
treated as separate leases. [IFRS 16:36(c)]

Accounting by lessors

Lessors shall classify each lease as an operating lease or a finance lease. [IFRS 16:61]

A lease is classified as a finance lease if it transfers substantially all the risks and rewards
incidental to ownership of an underlying asset. Otherwise a lease is classified as an operating
lease. [IFRS 16:62]

Examples of situations that individually or in combination would normally lead to a lease being
classified as a finance lease are: [IFRS 16:63]

• the lease transfers ownership of the asset to the lessee by the end of the lease term

• the lessee has the option to purchase the asset at a price which is expected to be
sufficiently lower than fair value at the date the option becomes exercisable that, at the
inception of the lease, it is reasonably certain that the option will be exercised

• the lease term is for the major part of the economic life of the asset, even if title is not
transferred

• 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 asset

• the leased assets are of a specialised nature such that only the lessee can use them
without major modifications being made

Upon lease commencement, a lessor shall recognise assets held under a finance lease as a
receivable at an amount equal to the net investment in the lease. [IFRS 16:67]

A lessor recognises finance income over the lease term of a finance lease, based on a pattern
reflecting a constant periodic rate of return on the net investment. [IFRS 16:75]

At the commencement date, a manufacturer or dealer lessor recognises selling profit or loss in
accordance with its policy for outright sales to which IFRS 15 applies. [IFRS 16:71c)]

A lessor recognises operating lease payments as income on a straight-line basis or, if more
representative of the pattern in which benefit from use of the underlying asset is diminished,
another systematic basis. [IFRS 16:81]

Sale and leaseback transactions

To determine whether the transfer of an asset is accounted for as a sale an entity applies the
requirements of IFRS 15 for determining when a performance obligation is satisfied. [IFRS
16:99]

If an asset transfer satisfies IFRS 15’s requirements to be accounted for as a sale the seller
measures the right-of-use asset at the proportion of the previous carrying amount that relates to
the right of use retained. Accordingly, the seller only recognises the amount of gain or loss that
relates to the rights transferred to the buyer. [IFRS 16:100a)]

If the fair value of the sale consideration does not equal the asset’s fair value, or if the lease
payments are not market rates, the sales proceeds are adjusted to fair value, either by
accounting for prepayments or additional financing. [IFRS 16:101]

Disclosure

The objective of IFRS 16’s disclosures is for information to be provided in the notes that,
together with information provided in the statement of financial position, statement of profit or
loss and statement of cash flows, gives a basis for users to assess the effect that leases have.
Paragraphs 52 to 60 of IFRS 16 set out detailed requirements for lessees to meet this objective
and paragraphs 90 to 97 set out the detailed requirements for lessors. [IFRS 16:51, 89]

Effective date and transition

An entity applies IFRS 16 for annual reporting periods beginning on or after 1 January 2019.
Earlier application is permitted if IFRS 15 Revenue from Contracts with Customers has also
been applied. [IFRS 16:C1]

As a practical expedient, an entity is not required to reassess whether a contract is, or contains,
a lease at the date of initial application. [IFRS 16:C3]

A lessee shall either apply IFRS 16 with full retrospective effect or alternatively not restate
comparative information but recognise the cumulative effect of initially applying IFRS 16 as an
adjustment to opening equity at the date of initial application. [IFRS 16:C5, C7]

IFRS FOR SME

Introduction
The IFRs for Small and Medium Sized Entities (SMEs) was published in 2009. It is only 230
pages and has simplications that reflect the needs of users of SMEs’s financial statements and
cost benefit considerations. It is designed to facilitate financial reporting by small and medium
sized entities in a number of ways:
(a) It provides sigificantly less guidance than full IFRS
(b) Many of the principles for recognising and measurement of assets, liabilities, income and
expenses in full IFRS are simplified
(c) Where full IFRSs allow accounting policy choices, the IFRS for SMEs allows only the easier
option.
(d) Topics not relevant to SMEs are omitted
(e) Significantly fewer disclosures are required
(f) The standard has been written in clear language that can easily be translated

Scope
The IFRS is suitable for all enties except those whose securities are publicly traded and
financial institutiuons such as banks amd insurance companies. It is the first set of international
accounting requirements developed specifically for small and medium sized entities. Although it
has been prepared on a similar basis to IFRSs, it is a stand-alone product and will be updated
on its own timescale.
The IFRS will be revised only once every three years. It is hoped that this will further reduce the
reporting burden on SMEs.
There are no quantitative thresholds for qualification as a SME; instead, the scope of the IFRS
is determined by a test of public accountability. As with full IFRS, it is up to legislative and
regulatory authorities and standard setters in individual jurisdictions to decide who is permitted
or required to use the IFRS for SMEs.

Effective Date
The IFRS for SMEs does not contain an effective date, this is determined in each jurisdiction.

Accounting Policies
For situations where the IFRS for SME does not provide specific guidance, it provides a
hierarchy for determining a suitable accounting policy. An SME must consider, in descending
order:
• The guidance in the IFRS for SME on similar and related issues
• The definitions, recognition criteria and measurement concepts in Section 2 Concepts
and pervasive Principles of the standards.
The entity also has the option of considering the requirements and guidance in full IFRS with
similar topics. However, it is under no obligation to do this, or to consider the pronouncements of
other standard setters.

Overlap with Full IFRS

In the following areas, the recognition and measurement guidance in the IFRS for SMEs is like
that in the full IFRS.
• Provisions and contingencies
• Hyperinflation accounting
• Events after the end of the reporting period

Omitted Topics
The IFRS for SMEs does not address the following topics that are covered in full IFRS
• Earnings per share
• Interim financial reporting
• Segment reporting
• Classification for non-current assets (or disposal groups) as held for sale

Examples of options in full IFRS not included in the IFRS for SMEs
• Revaluation model for intangible assets and property, plant and equipment
• Choice between cost and fair value models for investment property (measurement
depends on the circumstances)
• Options for government grants
Principal recognition and measurent simplifications
(a) Financial instruments
Financial instruments meeting specified criteria are measured at cost or amortised cost. All
others are measured at fair value through profit or loss. The procedure for derecognition has
been simplified as have hedge accounting requirements.

(b) Goodwill and other indefinite life intangibles

These are always amortised over their estimated useful life (or ten years if it cannot be
estimated)

(c) Investments in associates and joint ventures

These can be measured at cost, but fair value must be used if there is a published price
quotation.

(d) Research and development costs and borrowing costs

These costs must be expensed.

(e) Property, plant and equipment and intagibles

There is no need to review residual value, useful life and depreciation method unless there is an
indication that they have changed since the most recent reporting date.

(f) Defined benefit plans

All actuarial gains and losses are to be recognised immediately (in profit or loss or other
conprehensive income). All past service costs are to be recognised immediately in profit or loss.
To measure the defined benefit obligation, the projected unit credit method must be used.

(g) Income tax

When published, the IFRS for SMEs said to follow the ED Income Tax, which simplified IAS 12.
This ED has been withdrawn, but it is likely that the treatment of income tax will be simpler in
the IFRS for SMEs when this is replaced.

(h) Available for sale assets

There is no separate available – for - sale classification, holding an asset or group of assets for
sale is an indicator of impairment.

(i) Biological assets

SMEs are to use the cost-depreciation-impairment model unless the fair value is readily
determinable, in which case the fair value through profit or loss model is required.
(j) Equity-settled share-based payment
If observable market prices are not available to measure the fair value of the equity-settled
share-based payment, the directors’best estimate is used.

Advantages of the IFRS for SMEs

(a) It is virtually a ‘one stop shop’
(b) It is structured according to topics, which should make it practical to use
(c) It is written in an accessible language
(d) There is considerable reduction in disclosure requirements
(e) Guidance not relevant to private entities is excluded

Disadvantages
(a) It does not focus on the smallest companies
(b) The scope extends to ‘non-publicly accountable’ entities. Potentially, the scope is too wide
(c) The standard will be onerous for small companies
(d) Further simplications could be made. These might include:
(i) Amortisation for goodwill and intangibles
(ii) No requirement to value intangibles separately from goodwill on a business
combination
(iii) No recognition of deferred tax
(iv) No measurement rules for equity settled share-based payment
(v) No requirement for consolidated accounts
(vi) All leases accounted for as operating leases with enhanced disclosures
(vii) Fair value measurement when readily determinable without undue cost or effort

The Quantitative Threshhold for SMEs in Nigeria

An entity is regarded as an SME in Nigeria if all the following conditions are met:
(a) The entity is not publicly quoted (in Nigeria Stock exchange or other recognised stock
market)
(b) The entity owes no fiduciary dutie to the public (not in insurance or banking business)
(c) Its issued share capital is not less than N500 million
(d) Its total assets is not less than N200 million
(e) Non of the members is an alien
(f) Non of the members is government or government agency
(g) The directors must hold not less than 51% of the issued share capital of the entity (to show
it is really private)

THE IFRS STANDARD FOR SMEs

Summary of the IFRS for SMEs

Contents of the IFRS for SMEs

Section

• Preface

• 1 Small and Medium-sized Entities

• 2 Concepts and Pervasive Principles

• 3 Financial Statement Presentation

• 4 Statement of Financial Position

• 5 Statement of Comprehensive Income and Income Statement

• 6 Statement of Changes in Equity and Statement of Comprehensive Income and

Retained Earnings

• 7 Statement of Cash Flows

• 8 Notes to the Financial Statements

• 9 Consolidated and Separate Financial Statements

• 10 Accounting Policies, Estimates and Errors

• 11 Basic Financial Instruments

 • 12 Additional Financial Instruments Issues

• 13 Inventories

• 14 Investments in Associates

• 15 Investments in Joint Ventures

• 16 Investment Property

• 17 Property, Plant and Equipment

• 18 Intangible Assets other than Goodwill

• 19 Business Combinations and Goodwill

• 20 Leases

• 21 Provisions and Contingencies

• 22 Liabilities and Equity

• 23 Revenue

• 24 Government Grants

• 25 Borrowing Costs

• 26 Share-based Payment

• 27 Impairment of Assets

• 28 Employee Benefits

• 29 Income Tax

• 30 Foreign Currency Translation

• 31 Hyperinflation

• 32 Events after the End of the Reporting Period

• 33 Related Party Disclosures

• 34 Specialised Activities

• 35 Transition to the IFRS for SMEs

• Glossary

• Derivation Table

Separate Booklets

• Basis for Conclusions

• Illustrative Financial Statements and Presentation and Disclosure Checklist

Section-by-Section Summary of the IFRS for SMEs
Preface

• The IFRS for Small and Medium-sized Entities is organised by topic, with each topic
presented in a separate section. All of the paragraphs in the standard have equal
authority.

• The standard is appropriate for general purpose financial statements and other financial
reporting of all profit-oriented entities. General purpose financial statements are directed
towards the common information needs of a wide range of users, for example,
shareholders, creditors, employees and the public at large.

• The IASB intends to issue a comprehensively reviewed standard after two year's
implementation, to address issues identified and also, if appropriate, recent changes to
full IFRSs. Thereafter, an omnibus proposal of amendments will be issued, if necessary,
once every three years.

Section 1 Small and Medium-sized Entities

• Defines SME as used by IASB:

Small and medium-sized entities are entities that:

• (a) do not have public accountability, and

• (b) publish general purpose financial statements for external users. Examples of
external users include owners who are not involved in managing the business,
existing and potential creditors, and credit rating agencies. General purpose
financial statements are those that present fairly financial position, operating
results, and cash flows for external capital providers and others.

An entity has public accountability if:

• (a) its debt or equity instruments are traded in a public market or it is in the
process of issuing such instruments for trading in a public market (a domestic or
foreign stock exchange or an over-the-counter market, including local and
regional markets), or

• (b) it holds assets in a fiduciary capacity for a broad group of outsiders as one of
its primary businesses. This is typically the case for banks, credit unions,
insurance companies, securities brokers/dealers, mutual funds and investment
banks. If an entity holds assets in a fiduciary capacity as an incidental part of its
business, that does not make it publicly accountable. Entities that fall into this
category may include public utilities, travel and real estate agents, schools, and
charities.

• The standard does not contain a limit on the size of an entity that may use the IFRS for
SMEs provided that it does not have public accountability

• Nor is there a restriction on its use by a public utility, not-for-profit entity, or public sector
entity

• A subsidiary whose parent or group uses full IFRSs may use the IFRS for SMEs if the
subsidiary itself does not have public accountability

• The standard does not require any special approval by the owners of an SME for it to be
 eligible to use the IFRS for SME

• Listed companies, no matter how small, may not use the IFRS for SMEs

• Q&A 2011/01 (published June 2011) states that a parent entity assesses its eligibility to
use the IFRS for SMEs in its separate financial statements on the basis of its own public
accountability without considering whether other group entities have, or the group as a
whole has, public accountability.

Section 2 Concepts and Pervasive Principles

• Objective of SMEs' financial statements: To provide information about financial position,

performance, cash flows

• Also shows results of stewardship of management over resources

• Qualitative characteristics (understandability, relevance, materiality, reliability, substance

over form, prudence, completeness, comparability, timeliness, balance between benefit
and cost)

• Definitions:

• Asset: Resource with future economic benefits

• Liability: Present obligation arising from past events, result in outflow of

resources

• Income: Inflows of resources that increase equity, other than owner investments

• Expenses: Outflows of resources that decrease equity, other than owner

withdrawals

• Financial position: the relationship of assets and liabilities at a specific date

• Performance: the relationship of income and expenses during a reporting period

• Total comprehensive income: arithmetic difference between income and expenses

• Profit or loss: arithmetic difference between income and expenses other than those
items of income or expense that are classified as 'other comprehensive income'.

• There are only 3 items of other comprehensive income (OCI) in the IFRS for SMEs:

• Some foreign exchange gains and losses relating to a net investment in a foreign
operation (see Section 30)

• Some changes in fair values of hedging instruments – in a hedge of variable

interest rate risk of a recognised financial instrument, foreign exchange risk or
commodity price risk in a firm commitment or highly probable forecast
transaction, or a net investment in a foreign operation (see Section 12) (Note that
hedge accounting is optional)

• Some actuarial gains and losses (see Section 28) (Note that reporting actuarial
gains and losses in OCI is optional)

• Basic recognition concept – An item that meets the definition of an asset, liability,
income, or expense is recognised in the financial statements if:
 • it is probable that future benefits associated with the item will flow to or from the
entity, and

• the item has a cost or value that can be measured reliably

• Basic measurement concepts

• Historical cost and fair value are described

• Basic financial assets and liabilities are generally measured at amortised cost

• Other financial assets and liabilities are generally measured at fair value through
profit or loss

• Non-financial assets are generally measured using a cost-based measure

• Non-financial liabilities are generally measured at settlement amount

• Section 2 includes pervasive recognition and measurement principles

• Source of guidance if a specific issue is not addressed in the IFRS for SMEs (see
Section 10)

• Concepts of profit or loss and total comprehensive income

• Offsetting of assets and liabilities or of income and expenses is prohibited unless

expressly required or permitted

Section 3 Financial Statement Presentation

• Fair presentation: presumed to result if the IFRS for SMEs is followed (may be a need
for supplemental disclosures)

• State compliance with IFRS for SMEs only if the financial statements comply in full

• Does include 'true and fair override' but this should be 'extremely rare'

• IFRS for SMEs presumes the reporting entity is a going concern

• SMEs shall present a complete set of financial statements at least annually

• At least one year comparative prior period financial statements and note data

• Presentation and classification of items should be consistent from one period to the next

• Must justify and disclose any change in presentation or classification of items in

financial statements

• Materiality: an omission or misstatement is material if it could influence economic

• Complete set of financial statements:

• Statement of financial position

• Either a single statement of comprehensive income, or two statements: an

income statement and a statement of comprehensive income

• Statement of changes in equity

 • Statement of cash flows

• Notes

• If the only changes to equity arise from profit or loss, payment of dividends, corrections
of errors, and changes in accounting policy, an entity may present a single (combined)
statement of income and retained earnings instead of the separate statements of
comprehensive income and of changes in equity (see Section 6)

• An entity may present only an income statement (no statement of comprehensive

income) if it has no items of other comprehensive income (OCI)

• The only OCI items under the IFRS for SMEs are:

• Some foreign exchange gains and losses relating to a net investment in a foreign
operation (see Section 30)

• Some changes in fair values of hedging instruments – in a hedge of variable

interest rate risk of a recognised financial instrument, foreign exchange risk or
commodity price risk in a firm commitment or highly probable forecast
transaction, or a net investment in a foreign operation (see Section 12)

• Some actuarial gains and losses (see Section 28)

Section 4 Statement of Financial Position

• May still be called 'balance sheet'

• Current/non-current split is not required if the entity concludes that a liquidity approach
produces more relevant information

• Some minimum line items required. These include:

• Cash and equivalents

• Receivables

• Financial assets

• Inventories

• Property, plant, and equipment

• Investment property at fair value

• Intangible assets

• Biological assets at cost

• Biological assets at fair value

• Investment in associates

• Investment in joint ventures

• Payables

• Financial liabilities
 • Current tax assets and liabilities

• Deferred tax assets and liabilities

• Provisions

• Non-controlling interest

• Equity of owners of parent

• And some required items may be presented in the statement or in the notes

• Categories of property, plant, and equipment

• Info about assets with binding sale agreements

• Categories of receivables

• Categories of inventories

• Categories of payables

• Employee benefit obligations

• Classes of equity, including OCI and reserves

• Details about share capital

• Sequencing, format, and titles are not mandated

Section 5 Statement of Comprehensive Income and Income Statement

• One-statement or two-statement approach – either a single statement of comprehensive

income, or two statements: an income statement and a statement of comprehensive
income

• Must segregate discontinued operations

• Must present 'profit or loss' subtotal if the entity has any items of other comprehensive
income

• Bottom line ('profit or loss' in the income statement and 'total comprehensive income' in
the statement of comprehensive income) is before allocating those amounts to non-
controlling interest and owners of the parent

• No item may be labelled 'extraordinary'

• But unusual items can be separately presented

• Expenses may be presented by nature (depreciation, purchases of materials,

transport costs, employee benefits, etc) or by function (cost of sales, distribution
costs, administrative costs, etc) either on face of the statement of comprehensive
income (or income statement) or in the notes
Single statement of comprehensive income:
• Revenue
 • Expenses, showing separately:

• finance costs

• profit or loss from associates and jointly controlled entities

• tax expense

• discontinued operations)

• Profit or loss (may omit if no OCI)

• Items of other comprehensive income

• Total comprehensive income (may label Profit or Loss if no OCI)

Separate statements of income and comprehensive income:

Income Statement:

• Bottom line is profit or loss (as above)

Statement of Comprehensive Income:

• Begins with profit or loss

• Shows each item of other comprehensive income

• Bottom line is Total Comprehensive Income

Section 6 Statement of Changes in Equity and Statement of Comprehensive Income and

Retained Earnings

• Shows all changes to equity including

• total comprehensive income

• owners' investments

• dividends

• owners' withdrawals of capital

• treasury share transactions

• Can omit the statement of changes in equity if the entity has no owner investments or
withdrawals other than dividends and elects to present a combined statement of
comprehensive income and retained earnings

Section 7 Statement of Cash Flows

• Presents information about an entity's changes in cash and cash equivalents for a period

• Cash equivalents are short-term, highly liquid investments (expected to be

converted to cash in three months) held to meet short-term cash needs rather
than for investment or other purposes
 • Cash flows are classified as operating, investing, and financing cash flows

• Option to use the indirect method or the direct method to present operating cash flows

• Interest paid and interest and dividends received may be operating, investing, or
financing

• Dividends paid may be operating or investing

• Income tax cash flows are operating unless specifically identified with investing or
financing activities

• Separate disclosure is required of some non-cash investing and financing transactions

(for example, acquisition of assets by issue of debt)

• Reconciliation of components of cash

Section 8 Notes to the Financial Statements

• Notes are normally in this sequence:

• Basis of preparation (ie IFRS for SMEs)

• Summary of significant accounting policies, including

• Information about judgements

• Information about key sources of estimation uncertainty

• Supporting information for items in financial statements

• Other disclosures

• Comparative prior period amounts are required by Section 3 (unless another section
allows omission of prior period amounts)

Section 9 Consolidated and Separate Financial Statements

• Consolidated financial statements are required when a parent company controls another
entity (a subsidiary).

• Control: Power to govern financial and operating policies to obtain benefits

• More than 50% of voting power: control presumed

• Control exists when entity owns less than 50% but has power to govern by agreement or
statute, or power to appoint majority of the board, or power to cast majority of votes at
board meetings

• Control can be achieved by currently exercisable options that, if exercised, would result
in control

• A subsidiary is not excluded from consolidation because:

• Investor is a venture capital organisation

• Subsidiary's business activities are dissimilar to those of parent or other subs

 • Subsidiary operates in a jurisdiction that imposes restrictions on transferring cash
or other assets out of the jurisdiction

• However, consolidated financial statements are not required, even if a parent-subsidiary

relationship exists if:

• Subsidiary was acquired with intent to dispose within one year

• Parent itself is a subsidiary and its parent or ultimate parent uses IFRSs or IFRS
for SMEs

• Must consolidate all controlled special-purpose entities (SPEs)

• Consolidation procedures:

• Eliminate intracompany transactions and balances

• Uniform reporting date unless impracticable

• Uniform accounting policies

• Non-controlling interest is presented as part of equity

• Losses are allocated to a subsidiary even if non-controlling interest goes

negative

• Guidance on separate financial statements (but they are not required).

• In a parent's separate financial statements, it may account for subsidiaries,

associates, and joint ventures that are not held for sale at cost or fair value
through profit and loss.

• Guidance on combined financial statements (but they are not required)

• If investor loses control but continues to hold some investment:

• If the subsidiary becomes an associate, follow Section 14

• If the subsidiary becomes a jointly controlled entity, follow Section 15

• If investment does not qualify as an associate or jointly controlled entity, treat it

as a financial asset under Sections 11 and 12

Section 10 Accounting Policies, Estimates and Errors

• If the IFRS for SMEs addresses an issue, the entity must follow the IFRS for SMEs

• If the IFRS for SMEs does not address an issue:

• Choose policy that results in the most relevant and reliable information

• Try to analogise from standards in the IFRS for SMEs

• Or use the concepts and pervasive principles in Section 2

• Entity may look to guidance in full IFRSs (but not required)

• Change in accounting policy:

 • If mandated, follow the transition guidance as mandated

• If voluntary, retrospective

• Change in accounting estimate: prospective

• Correction of prior period error: restate prior periods if practicable

Section 11 Basic Financial Instruments

• IFRS for SMEs has two sections on financial instruments:

• Section 11 on Basic Financial Instruments

• Section 12 on Other FI Transactions

• Option to follow IAS 39 instead of sections 11 and 12

• Even if IAS 39 is followed, make Section 11 and 12 disclosures (not IFRS 7 disclosures)

• Essentially, Section 11 is an amortised historical cost model

• Except for equity investments with quoted price or readily determinable fair value.
These are measured at fair value through profit or loss.

• Scope of Section 11 includes:

• Cash

• Demand and fixed deposits

• Commercial paper and bills

• Accounts and notes receivable and payable

• Debt instruments where returns to the holder are fixed or referenced to an

observable rate

• Investments in nonconvertible and non-puttable ordinary and preference shares

• Most commitments to receive a loan

• Initial measurement:

• Basic financial assets and financial liabilities are initially measured at the
transaction price (including transaction costs except in the initial measurement of
financial assets and liabilities that are measured at fair value through profit or
loss) unless the arrangement constitutes, in effect, a financing transaction. A
financing transaction may be indicated in relation to the sale of goods or
services, for example, if payment is deferred beyond normal business terms or is
financed at a rate of interest that is not a market rate. If the arrangement
constitutes a financing transaction, measure the financial asset or financial
liability at the present value of the future payments discounted at a market rate of
interest for a similar debt instrument.

• Measurement subsequent to initial recognition:

 • Debt instruments at amortised cost using the effective interest method

• Debt instruments that are classified as current assets or current liabilities are
measured at the undiscounted amount of the cash or other consideration
expected to be paid or received (ie net of impairment) unless the arrangement
constitutes, in effect, a financing transaction. If the arrangement constitutes a
financing transaction, the entity shall measure the debt instrument at the present
value of the future payments discounted at a market rate of interest for a similar
debt instrument.

• Investments in non-convertible preference shares and non-puttable ordinary or

preference shares:

• if the shares are publicly traded or their fair value can otherwise be
measured reliably, measure at fair value with changes in fair value
recognised in profit or loss

• measure all other such investments at cost less impairment

• Must test all amortised cost instruments for impairment or uncollectibility

• Previously recognised impairment is reversed if an event occurring after the impairment

was first recognised causes the original impairment loss to decrease

• Guidance is provided on determining fair values of financial instruments

• The most reliable is a quoted price in an active market

• When a quoted price is not available the most recent transaction price provides
evidence of fair value

• If there is no active market or recent market transactions, a valuation technique

may be used

• Guidance is provided on the effective interest method

• Derecognise a financial asset when:

• the contractual rights to the cash flows from the financial asset expire or are
settled;

• the entity transfers to another party all of the significant risks and rewards relating
to the financial asset; or

• the entity, despite having retained some significant risks and rewards relating to
the financial asset, has transferred the ability to sell the asset in its entirety to an
unrelated third party who is able to exercise that ability unilaterally and without
needing to impose additional restrictions on the transfer.

• Derecognise a financial liability when the obligation is discharged, cancelled, or expires

• Disclosures:

• Categories of financial instruments

• Details of debt and other instruments

 • Details of derecognitions

• Collateral

• Defaults and breaches on loans payable

• Items of income and expense

Section 12 Additional Financial Instruments Issues

• Financial instruments not covered by Section 11 (and, therefore, are within Section 12)
are measured at fair value through profit or loss. This includes:

• Investments in convertible and puttable ordinary and preference shares

• Options, forwards, swaps, and other derivatives

• Financial assets that would otherwise be in Section 11 but that have 'exotic'
provisions that could cause gain/loss to the holder or issuer

• Hedge accounting involves matching the gains and losses on a hedging instrument and
hedged item.

• It is allowed only for the following kinds of risks:

• interest rate risk of a debt instrument measured at amortised cost

• foreign exchange or interest rate risk in a firm commitment or a highly

probable forecast transaction

• price risk of a commodity that it holds or in a firm commitment or highly

probable forecast transaction to purchase or sell a commodity

• foreign exchange risk in a net investment in a foreign operation.

• Section 12 defines the type of hedging instrument required for hedge accounting.

• Hedges must be documented up front to qualify for hedge accounting

• Section 12 provides guidance for measuring assessing effectiveness

• Special disclosures are required

Section 13 Inventories

• Inventories include assets for sale in the ordinary course of business, being produced for
sale, or to be consumed in production

• Measured at the lower cost and estimated selling price less costs to complete and sell

• Cost is determined using:

• specific identification is required for large items

• option to choose FIFO or weighted average for others

• LIFO is not permitted

 • Inventory cost includes costs to purchase, costs of conversion, and costs to bring the
asset to present location and condition

• Inventory cost excludes abnormal waste and storage, administrative, and selling costs

• If a production process creates joint products and/or by-products, the costs are allocated
on a consistent and rational basis

• A manufacturer allocates fixed production overheads to inventories based on normal

capacity

• Standard costing, retail method, and most recent purchase price may be used only if the
result approximates actual cost

• Impairment – write down to net realisable value (selling price less costs to complete and
sell – see Section 27)

Section 14 Investments in Associates

• Associates are investments where significant influence exists. Significant influence is

defined as the power to participate in the financial and operating policy decisions of the
associate but where there is neither control nor joint control over those policies.
Presumption that significant influence exists if investor owns 20% or more of the voting
shares.

• Option to use:

• Cost-impairment model (except if there is a published quotation – then must use

fair value through profit or loss)

• Equity method (investor recognises its share of profit or loss of the associate –
detailed guidance is provided)

• Fair value through profit or loss

• Investments in associates are always classified as non-current assets

Section 15 Investments in Joint Ventures

• For investments in jointly controlled entities, there is an option for the venturer to use:

• Cost model (except if there is a published quotation – then must use fair value
through profit or loss)

• Equity method (using the guidance in Section 14)

• Fair value through profit or loss

• Proportionate consolidation is prohibited

• For jointly controlled operations, the venturer should recognise assets that it controls and
liabilities it incurs as well as its share of income earned and expenses that are incurred

• For jointly controlled assets, the venturer should recognise its share of the assets and
liabilities it incurs as well as income it earns and expenses that are incurred

Section 16 Investment Property

 • Investment property is investments in land, buildings (or part of a building), and some
property interests in finance leases held to earn rentals or for capital appreciation or both

• Property interests that are held under an operating lease may be classified as an
investment property provided the property would otherwise have met the definition of an
investment property

• Mixed use property must be separated between investment and operating property

• If fair value can be measured reliably without undue cost or effort, use the fair value
through profit or loss model

• Otherwise, an entity must treat investment property as property, plant and equipment
using Section 17

Section 17 Property, Plant and Equipment

• Historical cost-depreciation-impairment model only

• The revaluation model (as in IAS 16) is not permitted

• Section 17 applies to most investment property as well (but if fair value of investment
property can be measured reliably without undue cost or effort then the fair value model
in Section 16 applies)

• Section 17 applies to property held for sale – there is no special section on assets held
for sale. Holding for sale is an indicator of possible impairment.

• Measurement is initially at cost, including costs to get the property ready for its intended
use Subsequent to acquisition, the entity uses the cost-depreciation-impairment model,
which recognises depreciation and impairment of the carrying amount

• The carrying amount of an asset, less estimated residual value, is depreciated over the
asset's anticipated useful life. The method of depreciation shall be the method that best
reflects the consumption of the asset's benefits over its life. Separate significant
components should be depreciated separately.

• Component depreciation only if major parts of an item of PP&E have 'significantly

different patterns of consumption of economic benefits'

• Review useful life, residual value, depreciation rate only if there is a significant change in
the asset or how it is used. Any adjustment is a change in estimate (prospective).

• Impairment testing and reversal – follow Section 27

Section 18 Intangible Assets other than Goodwill

• No recognition of internally generated intangible assets. Therefore:

• Charge all research and development costs to expense

• Charge the following items to expense when incurred: Costs of internally

generated brands, logos, and masthead, start-up costs, training costs,
advertising, and relocating of a division or entity

• Amortisation model for intangibles that are purchased separately, acquired in a business
combination, acquired by grant, and acquired by exchange of other assets
 • Amortise over useful life. If the entity is unable to estimate useful life, then use 10 years.
Review useful life, residual value, depreciation rate only if there is a significant change in
the asset or how it is used. Any adjustment is a change in estimate (prospective)

• Impairment testing – follow Section 27

• Any revaluation of intangible assets is prohibited

Section 19 Business Combinations and Goodwill

• Section does not apply to combinations of entities under common control

• Acquisition (purchase) method. Under this method:

• An acquirer must always be identified

• The cost of the business combination is measured. Cost is the fair value of
assets given, liabilities incurred or assumed, and equity instruments issued, plus
costs directly attributable to the combination

• At the acquisition date, the cost is allocated to the assets acquired and liabilities
and provisions for contingent liabilities assumed. The identifiable assets acquired
and liabilities and provisions for contingent liabilities assumed are measured at
their fair values. Any difference between cost and amounts allocated to
identifiable assets and liabilities (including provisions) is recognised as goodwill
or so-called 'negative goodwill'.

• All goodwill must be amortised. If the entity is unable to estimate useful life, then use 10
years.

• 'Negative goodwill' – first reassess original accounting. If that is ok, then immediate
credit to profit or loss

• Impairment testing of goodwill – follow Section 27

• Reversal of goodwill impairment is not permitted

Section 20 Leases

• Scope includes arrangements that contain a lease [IFRIC 4]

• Leases are classified as either finance leases or operating leases.

• Finance leases result in substantially all the risks and rewards incidental to
ownership being transferred between the parties, while operating leases do not.

• Substantially all risks and rewards of ownership are presumed transferred if:

• the lease transfers ownership of the asset to the lessee by the end of the
lease term

• the lessee has a 'bargain purchase option'

• the lease term is for the major part of the economic life of the asset even
if title is not transferred

• 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 asset

• the leased assets are of such a specialised nature that only the lessee
can use them without major modifications

• the lessee bears the lessor losses if cancelled

• a secondary rental period at below market rates

• the residual value risk is borne by the lessee.

• Lessees – finance leases:

• The rights and obligations are to be recognised as assets and liabilities at fair
value, or, if lower, the present value of the minimum lease payments. Any direct
costs of the lessee are added to the asset amount recognised. Subsequently,
payments are to be spilt between a finance charge and reduction of the liability.
The asset should be depreciated either over the useful life or the lease term.

• Lessees – operating leases:

• Payments are to be recognised as an expense on the straight line basis, unless

payments are structured to increase in line with expected general inflation or
another systematic basis is better representative of the time pattern of the user's
benefit.

• Lessors – finance leases:

• The rights are to be recognised as assets held, i.e. as a receivable at an amount

equal to the net investment in the lease. The net investment in a lease is the
lessor's gross investment in the lease (including unguaranteed residual value)
discounted at the interest rate implicit in the lease.

• For finance leases other than those involving manufacturer or dealer lessors,
initial direct costs are included in the initial measurement of the finance lease
receivable and reduce the amount of income recognised over the lease term.

• If there is an indication that the estimated unguaranteed residual value used in

computing the lessor's gross investment in the lease has changed significantly,
the income allocation over the lease term is revised, and any reduction in respect
of amounts accrued is recognised immediately in profit or loss.

• Lessors – finance leases by a manufacturer or dealer:

• A finance lease of an asset by a manufacturer or dealer lessor gives rise to two

types of income:

• profit or loss equivalent to the profit or loss resulting from an outright sale
of the asset being leased, at normal selling prices, reflecting any
applicable volume or trade discounts; and

• finance income over the lease term.

• The sales revenue recognised at the commencement of the lease term by a

manufacturer or dealer lessor is the fair value of the asset or, if lower, the present
 value of the minimum lease payments accruing to the lessor, computed at a
market rate of interest.

• The cost of sale recognised at the commencement of the lease term is the cost,
or carrying amount if different, of the leased property less the present value of
the unguaranteed residual value. The difference between the sales revenue and
the cost of sale is the selling profit, which is recognised in accordance with the
entity's policy for outright sales.

• If artificially low rates of interest are quoted, selling profit shall be restricted to
that which would apply if a market rate of interest were charged. Costs incurred
by manufacturer or dealer lessors in connection with negotiating and arranging a
lease shall be recognised as an expense when the selling profit is recognised.

• Lessors – operating leases:

• Lessors retain the assets on their balance sheet and payments are to be
recognised as income on the straight line basis, unless payments are structured
to increase in line with expected general inflation or another systematic basis is
better representative of the time pattern of the user's benefit.

• Sale and leaseback:

• If a sale and leaseback results in a finance lease, the seller should not recognise
any excess as a profit, but recognise the excess over the lease term

• If a sale and leaseback results in an operating lease, and the transaction was at
fair value, the seller shall recognise any profits immediately.

Section 21 Provisions and Contingencies

• Provisions:

• Provisions are recognised only when (a) there is a present obligation as a result
of a past event, (b) it is probable that the entity will be required to transfer
economic benefits, and (c) the amount can be estimated reliably

• The obligation may arise due to contract or law or when there is a constructive
obligation due to valid expectations having been created from past events.
However, these do not include any future actions that may create an expectation.
Nor can expected future losses be recognised as provisions.

• Initially recognised at the best possible estimate at the reporting date. This value
should take into any time value of money if this is considered material. When all
or part of a provision may be reimbursed by a third party, the reimbursement is to
be recognised separately only when it is virtually certain payment will be
received.

• Subsequently, provisions are to be reviewed at each reporting date and adjusted

to meet the best current estimate. Any adjustments are recognised in profit and
loss while any unwinding of discounts is to be treated as a finance cost.

• Must accrue provisions for (examples):

• Onerous contracts
 • Warranties

• Restructuring if legal or constructive obligation to restructure

• Sales refunds

• May NOT accrue provisions for (example):

• Future operating losses, no matter how probable

• Possible future restructuring (plan but not yet a legal or constructive obligation)

• Contingent liabilities:

• These are not recognised as liabilities

• Unless remote, disclose an estimate of the financial effect, indications of the

uncertainties relating to timing or amount, and the possibility of reimbursement

• Contingent assets:

• These are not recognised as assets.

• Disclose a description of the nature and the financial effect.

Section 22 Liabilities and Equity

• Guidance on classifying an instrument as liability or equity

• An instrument is a liability if the issuer could be required to pay cash

• Puttable financial instruments are only recognised as equity if it has all of the following
features:

• The holder is entitled to a pro rata share of the entity's net assets in the event of
liquidation.

• The instrument is the most subordinate class.

• All financial instruments in the most subordinate class have identical features.

• Apart from the puttable features the instrument includes no other financial
instrument features.

• The total expected cash flows attributable to the instrument over the life of the
instrument are based substantially on the change in the value of the entity.

• Members' shares in co-operative entities and similar instruments are only classified as
equity if the entity has an unconditional right to refuse redemption of the members'
shares or the redemption is unconditionally prohibited by local law, regulation or the
entity's governing charter. If the entity could not refuse redemption, the members' shares
are classified as liabilities.

• Covers some material not covered by full IFRSs, including:

• original issuance of shares and other equity instruments. Shares are only
recognised as equity when another party is obliged to provide cash or other
 resources in exchange for the instruments. The instruments are measured at the
fair value of cash or resources received, net of direct costs of issuing the equity
instruments, unless the time value of money is significant in which case initial
measurement is at the present value amount. When shares are issued before the
cash or other resources are received, the amount receivable is presented as an
offset to equity in the statement of financial position and not as an asset. Any
shares subscribed for which no cash is received are not recognised as equity
before the shares are issued.

• sales of options, rights and warrants

• stock dividends and stock splits – these do not result in changes to total equity
but, rather, reclassification of amounts within equity.

• 'Split accounting' is required to account for issuance of convertible instruments

• Proceeds on issue of convertible and other compound financial instruments are

split between liability component and equity component. The liability is measured
at its fair value, and the residual amount is the equity component. The liability is
subsequently measured using the effective interest rate, with the original issue
discount amortised as added interest expense.

• A comprehensive example of split accounting is included

• Treasury shares (an entity's own shares that are reacquired) are measured at the fair
value of the consideration paid and are deducted from the equity. No gain or loss is
recognised on subsequent resale of treasury shares.

• Minority interest changes that do not affect control do not result in a gain or loss being
recognised in profit and loss. They are equity transactions between the entity and its
owners.

• Dividends paid in the form of distribution of assets other than cash are recognised when
the entity has an obligation to distribute the non-cash assets. The dividend liability is
measured at the fair value of the assets to be distributed.

Section 23 Revenue

• Revenue results from the sale of goods, services being rendered, construction contracts
income by the contractor and the use by others of your assets

• Some types of revenue are excluded from this section and dealt with elsewhere:

• leases (section 20)

• dividends from equity accounted entities (section 14 and 15)

• changes in fair value of financial instruments (section 11 and 12)

• initial recognition and subsequent re-measurement of biological assets (section

34) and initial recognition of agricultural produce (section 34)

• Principle for measurement of revenue is the fair value of the consideration received or
receivable, taking into account any possible trade discounts or rebates, including volume
rebates and prompt settlement discounts
 • If payment is deferred beyond normal payment terms, there is a financing component to
the transaction. In that case, revenue is measured at the present value of all future
receipts. The difference is recognised as interest revenue.

• Recognition – sale of goods: An entity shall recognise revenue from the sale of goods
when all the following conditions are satisfied:

• (a) the entity has transferred to the buyer the significant risks and rewards of
ownership of the goods.

• (b) the entity retains neither continuing managerial involvement to the degree
usually associated with ownership nor effective control over the goods sold.

• (c) the amount of revenue can be measured reliably.

• (d) it is probable that the economic benefits associated with the transaction will
flow to the entity.

• (e) the costs incurred or to be incurred in respect of the transaction can be

measured reliably.

• Recognition – sale of services: Use the percentage of completion method if the outcome
of the transaction can be estimated reliably. Otherwise use the cost-recovery method.

• Recognition – construction contracts: Use the percentage of completion method if the

outcome of the contract can be estimated reliably. Otherwise use the cost-recovery
method.

• Recognition – interest: Interest shall be recognised using the effective interest method
as described in Section 11

• Recognition – royalties: Royalties shall be recognised on an accrual basis in accordance

with the substance of the relevant agreement.

• Recognition – dividends: Dividends shall be recognised when the shareholder's right to

receive payment is established.

• Appendix of examples of revenue recognition under the principles in Section 23

• Award credits or other customer loyalty plan awards need to be accounted for
separately. The fair value of such awards reduces the amount of revenue initially
recognised and, instead, is recognised when awards are redeemed.

Section 24 Government Grants

• This section does not apply to any 'grants' in the form of income tax benefits

• All grants are measured at the fair value of the asset received or receivable

• Recognition as income:

• Grants without future performance conditions are recognised in profit or loss

when proceeds are receivable

• If there are performance conditions, the grant is recognised in profit or loss only
when the conditions are met
Section 25 Borrowing Costs

• Borrowing costs are interest and other costs arising on an entity's financial liabilities and
finance lease obligations

• All borrowing costs are charged to expense when incurred – none are capitalised

Section 26 Share-based Payment

• Basic principle: all share-based payment must be recognised

• Equity-settled:

• Transactions with other than employees are recorded at the fair value of the
goods and services received, if these can be estimated reliably

• Transactions with employees or where the fair value of goods and services
received cannot be reliably measured are measured with reference to the fair
value of the equity instruments granted

• Cash-settled:

• Liability is measured at fair value on grant date and at each reporting date and
settlement date, with each adjustment through profit or loss.

• For employees where shares only vest after a specific period of service has been
completed, recognise the expense as the service is rendered.

• Share-based payment with cash alternatives:

• Account for all such transactions as cash settled, unless the entity has a past
practice of settling by issuing equity instruments or the option has no commercial
substance because the cash settlement amount bears no relationship to, and is
likely to be lower in value than, the fair value of the equity instrument.

• Fair value of equity instruments granted:

• (a) Observable market price if available

• (b) If no observable price, use entity-specific market data such as a recent share
transaction or valuation of the entity

• (c) If (a) and (b) are impracticable, directors must use their judgement to estimate
fair value

• Certain government-mandated plans provide for equity investors (such as employees) to

acquire equity without providing goods or services that can be specifically identified (or
by providing goods or services that are clearly less than the fair value of the equity
instruments granted). These are equity-settled share-based payment transactions within
the scope of this section.

Section 27 Impairment of Assets

• Inventories – write down, in profit or loss, to lower of cost and selling price less costs to
complete and sell, if below carrying amount. When the circumstances that led to the
impairment no longer exist, the impairment is reversed through profit or loss.
 • Other assets – write down, in profit or loss, to recoverable amount, if below carrying
amount. When the circumstances that led to the impairment no longer exist, the
impairment is reversed through profit or loss.

• Recoverable amount is the greater of fair value less costs to sell and value in use

• If recoverable amount of an individual asset cannot be determined, measure recoverable

amount of that asset's cash generating unit

• If an impairment indicator exists, the entity should review the useful life and the
depreciation methods even though an impairment may not be recognised

• Simplified guidance on computing impairment of goodwill when goodwill cannot be

allocated to cash generating units

Section 28 Employee Benefits

• Short-term benefits:

• Measured at an undiscounted rate and recognised as the services are rendered.

• Other costs such as annual leave are recognised as a liability as services are
rendered and expensed when the leave is taken or used.

• Bonus payments are only recognised when an obligation exists and the amount
can be reliably estimated.

• Post-Employment Benefits – Defined Contribution Plans:

• Contributions are recognised as a liability or an expense when the contributions

are made or due.

• Post-Employment Benefits – Defined benefit plans

• Recognise a liability based on the net of present value of defined benefit

obligations less the fair value of any plan assets at balance sheet date.

• The projected unit credit method is only used when it could be applied without
undue cost or effort.

• Otherwise, en entity can simplify its calculation:

• Ignore estimated future salary increases

• Ignore future service of current employees (assume closure of plan)

• Ignore possible future in-service mortality

• Plan introductions, changes, curtailments, settlements: Immediate recognition

(no deferrals)

• For group plans, consolidated amount may be allocated to parent and

subsidiaries on a reasonable basis

• Actuarial gains and losses may be recognised in profit or loss or as an item of

other comprehensive income – but...
 • No deferral of actuarial gains or losses, including no corridor approach

• All past service cost is recognised immediately in profit or loss

• Other Long-Term benefits:

• The entity shall recognise a liability at the present value of the benefit obligation
less any fair value of plan assets.

• Termination benefits:

• These are recognised in profit and loss immediately as there are no future
economic benefits to the entity.

Section 29 Income Tax

• Requires a temporary difference approach, similar to IAS 12

• Current tax:

• Recognise a current tax liability if the current tax payable exceeds the current tax
paid at that point in time. Recognise a current tax asset when current tax paid
exceeds current tax payable or the entity has carried a loss forward from the prior
year and this can be used to recover current tax in the current year.

• Current tax assets and liabilities for current and prior periods are measured at the
actual amount that is owed or the entity owes using the applicable tax rates
enacted or substantively enacted at the reporting date. The measurement must
include the effect of the possible outcomes of a review by the tax authorities.

• Deferred tax:

• If an asset or liability is expected to affect taxable profit if it recovered or settled

for its carrying amount, then a deferred tax asset or liability is recognised

• If the entity expects to recover an asset through sale, and capital gains tax is
zero, then no deferred tax is recognised, because recovery is not expected to
affect taxable profit

• Temporary difference arises if the tax basis of such assets or liabilities is different
from carrying amount

• Tax basis assumes recovery by sale. Exception: No deferred tax on unremitted

earnings of foreign subsidiaries and jointly controlled entities

• Recognise deferred tax assets in full, with a valuation allowance

• Criterion is that realisation is probable (more likely than not)

• Take uncertainty into account in measuring all current and deferred taxes –
assume tax authorities will examine reported amounts and have full knowledge of
all relevant information

• Deferred taxes are all presented as non-current

• Recognition of changes in current or deferred tax must be allocated to the related

components of profit or loss, other comprehensive income and equity.
Section 30 Foreign Currency Translation

• Functional currency approach similar to that in IAS 21

• An entity's functional currency, is the currency of the primary economic environment in

which it operates

• It is a matter of fact, not an accounting policy choice

• A change in functional currency is applied prospectively from the date of the

change

• To record a foreign currency transaction in an entity's functional currency:

• On initial recognition, record the transaction by applying the spot rate at the date
of the transaction. An average rate may be used, unless there are significant
fluctuations in the rate.

• At reporting date, translate foreign currency monetary items using the closing
rate. For non-monetary items measured at historical cost, use the exchange at
the date of the transaction. For non-monetary items measured at fair value, use
the exchange at the date when the fair value was determined.

• For monetary and non-monetary item translations, gains or losses are

recognised where they were initially recognised – either in profit or loss,
comprehensive income, or equity

• Exchange differences arising from a monetary item that forms part of the net investment
in a foreign operation are recognised in equity and are not 'recycled' through profit or
loss on disposal of the investment

• Goodwill arising on acquisition of a foreign operation is deemed to be an asset of the

subsidiary, and translated at the closing rate at year end

• An entity may present its financial statements in a currency different from its functional
currency (a 'presentation currency'). If the entity's functional currency is not
hyperinflationary, translation of assets, liabilities, income, and expense from functional
currency into presentation currency is done as follows:

• Assets and liabilities for each statement of financial position presented are
translated at the closing rate at the date of that statement of financial position

• Income and expenses are translated at exchange rates at the dates of the
transactions

• All resulting exchange differences are recognised in other comprehensive

income.

Section 31 Hyperinflation

• An entity must prepare general price-level adjusted financial statements when its
functional currency is hyperinflationary

• IFRS for SMEs provides indicators of hyperinflation but not an absolute rate. One
indicator is where cumulative inflation approaches or exceeds 100% over a 3 year
period.
 • In price-level adjusted financial statements, all amounts are stated in terms of the
(hyperinflationary) presentation currency at the end of the reporting period. Comparative
information and any information presented in respect of earlier periods must also be
restated in the presentation currency.

• All assets and liabilities not recorded at the presentation currency at the end of the
reporting period must be restated by applying the general price index (generally an index
published by the government).

• All amounts in the statement of comprehensive income and statement of cash flows
must also be recorded at the presentation currency at the end of the reporting period.
These amounts are restated by applying the general price index from the dates when
they were recorded.

• The gain or loss on translating the net monetary position is included in profit or loss.
However, that gain or loss is adjusted for those assets and liabilities linked by agreement
to changes in prices.

Section 32 Events after the End of the Reporting Period

• Adjust financial statements to reflect adjusting events – events after the balance sheet
date that provide further evidence of conditions that existed at the end of the reporting
period.

• Do not adjust for non-adjusting events – events or conditions that arose after the end of
the reporting period. For these, the entity must disclose the nature of event and an
estimate of its financial effect.

• If an entity declares dividends after the reporting period, the entity shall not recognise
those dividends as a liability at the end of the reporting period. That is a non-adjusting
event.

Section 33 Related Party Disclosures

• Disclose parent-subsidiary relationships, including the name of the parent and (if any)
the ultimate controlling party.

• Disclose key management personnel compensation in total for all key management.
Compensation includes salaries, short-term benefits, post-employment benefits, other
long-term benefits, termination benefits and share-based payments. Key management
personnel are persons responsible for planning, directing and controlling the activities of
an entity, and include executive and non-executive directors.

• Disclose the following for transactions between related parties:

• Nature of the relationship

• Information about the transactions and outstanding balances necessary to

understand the potential impact on the financial statements

• Amount of the transaction

• Provisions for uncollectible receivables

• Any expense recognised during the period in respect of an amount owed by a

related party
 • Government departments and agencies are not related parties simply by virtue of their
normal dealings with an entity

Section 34 Specialised Activities

Agriculture:

• If the fair value of a class of biological asset is readily determinable without undue cost
or effort, use the fair value through profit or loss model.

• If the fair value is not readily determinable, or is determinable only with undue cost or
effort, measure the biological assets at cost less and accumulated depreciation and
impairment.

• At harvest, agricultural produce is be measured at fair value less estimated costs to sell.
Thereafter it is accounted for an inventory.

Extractive industries:

• Not required to charge exploration costs to expense, but must test for impairment

• Expenditure on tangible or intangible assets used in extractive activities is accounted for

under Section 17 Property, Plant and Equipment and Section 18 Intangible Assets other
than Goodwill

• An obligation to dismantle or remove items or restore sites is accounted for using

Section 17 and Section 21 Provisions and Contingencies.

Service concession arrangements:

• Guidance is provided on how the operator accounts for a service concession

arrangement. The operator either recognises a financial asset or an intangible asset
depending on whether the grantor (government) has provided an unconditional
guarantee of payment or not.

• A financial asset is recognised to the extent that the operator has an unconditional
contractual right to receive cash or another financial asset from or at the direction of the
grantor for the construction services.

• An intangible asset is recognised to the extent that the operator receives a right or
license to charge users for the public service.

Section 35 Transition to the IFRS for SMEs

• First-time adoption is the first set of financial statements in which the entity makes an
explicit and unreserved statement of compliance with the IFRS for SMEs: '...in
conformity with the International Financial Reporting Standard for Small and Medium-
sized Entities'.

• Can be switching from:

• National GAAP

• Full IFRSs

• Or never published General Purpose Financial Statements in the past

 • Date of transition is beginning of earliest period presented

• Select accounting policies based on IFRS for SMEs at end of reporting period of first-
time adoption

• Many accounting policy decisions depend on circumstances – not 'free choice'

• But some are pure 'free choice'

• Prepare current year and one prior year's financial statements using the IFRS for SMEs

• But there are many exceptions from restating specific items

• Some exceptions are optional

• Some exceptions are mandatory

• And a general exemption for impracticability

• All of the special exemptions in IFRS 1 are included in the IFRS for SMEs

Significant judgements and assumptions

An entity discloses information about significant judgements and assumptions it has made (and
changes in those judgements and assumptions) in determining: [IFRS 12:7]

• that it controls another entity

• that it has joint control of an arrangement or significant influence over another entity

• the type of joint arrangement (i.e. joint operation or joint venture) when the arrangement
has been structured through a separate vehicle.

Interests in subsidiaries

An entity shall disclose information that enables users of its consolidated financial statements
to: [IFRS 12:10]

• understand the composition of the group

• understand the interest that non-controlling interests have in the group's activities and
cash flows

• evaluate the nature and extent of significant restrictions on its ability to access or use
assets, and settle liabilities, of the group

• evaluate the nature of, and changes in, the risks associated with its interests in
consolidated structured entities

• evaluate the consequences of changes in its ownership interest in a subsidiary that do

not result in a loss of control

• evaluate the consequences of losing control of a subsidiary during the reporting period.

Interests in unconsolidated subsidiaries

[Note: The investment entity consolidation exemption referred to in this section was introduced
by Investment Entities, issued on 31 October 2012 and effective for annual periods beginning
on or after 1 January 2014.]

In accordance with IFRS 10 Consolidated Financial Statements, an investment entity is required

to apply the exception to consolidation and instead account for its investment in a subsidiary at
fair value through profit or loss. [IFRS 10:31].

Where an entity is an investment entity, IFRS 12 requires additional disclosure, including:

• the fact the entity is an investment entity [IFRS 12:19A]

• information about significant judgements and assumptions it has made in determining

that it is an investment entity, and specifically where the entity does not have one or
more of the 'typical characteristics' of an investment entity [IFRS 12:9A]

• details of subsidiaries that have not been consolidated (name, place of business,
ownership interests held) [IFRS 12:19B]

• details of the relationship and certain transactions between the investment entity and the
subsidiary (e.g. restrictions on transfer of funds, commitments, support arrangements,
contractual arrangements) [IFRS 12: 19D-19G]

• information where an entity becomes, or ceases to be, an investment entity [IFRS 12:9B]
An entity making these disclosures are not required to provide various other disclosures
required by IFRS 12 [IFRS 12:21A, IFRS 12:25A].
Interests in joint arrangements and associates

An entity shall disclose information that enables users of its financial statements to evaluate:
[IFRS 12:20]

• the nature, extent and financial effects of its interests in joint arrangements and
associates, including the nature and effects of its contractual relationship with the other
investors with joint control of, or significant influence over, joint arrangements and
associates

• the nature of, and changes in, the risks associated with its interests in joint ventures and
associates.

Interests in unconsolidated structured entities

An entity shall disclose information that enables users of its financial statements to: [IFRS
12:24]

• understand the nature and extent of its interests in unconsolidated structured entities

• evaluate the nature of, and changes in, the risks associated with its interests in
unconsolidated structured entities.
REVIEW QUESTIONS

REVIEW QUESTIONS

1. (a) The principal aim when developing accounting standards for small to medium-sized enterprises
(SMEs) is to
provide a framework that generates relevant, reliable, and useful information which should provide a high
quality and understandable set of accounting standards suitable for SMEs. There is no universally agreed
definition of an SME and it is difficult for a single definition to capture all the dimensions of a small or
medium-sized business.
The main argument for separate SME accounting standards is the undue cost burden of reporting, which
is
proportionately heavier for smaller firms.
Required:
(i) Comment on the different approaches which could have been taken by the International
Accounting
Standards Board (IASB) in developing the ‘IFRS for Small and Medium-sized Entities’ (IFRS for
SMEs),
explaining the approach finally taken by the IASB. (6 marks)
(ii) Discuss the main differences and modifications to IFRS which the IASB made to reduce the
burden of
reporting for SME’s, giving specific examples where possible and include in your discussion how
the Board has dealt with the problem of defining an SME. (8 marks)
Professional marks will be awarded in part (a) for clarity and quality of discussion. (2 marks)

(b) Whitebirk has met the definition of a SME in its jurisdiction and wishes to comply with the ‘IFRS for
Small and
Medium-sized Entities’. The entity wishes to seek advice on how it will deal with the following accounting
issues in its financial statements for the year ended 30 November 2010.The entity already prepares its
financial statements under full IFRS.
(i) Defined benefit obligation
30 November
2009 (Nm) 2010 (Nm)
Present value of defined benefit obligation 1·5 2·0
Fair value of plan assets 1·2 1·65
Unrecognised actuarial losses 0·19 0·21
Average working lives of employees 12 years
The entity currently uses the ‘corridor approach’ to recognise actuarial gains and losses.

(ii) Whitebirk purchased 90% of Close, a SME, on 1 December 2009. The purchase consideration was
N5·7 million and the value of Close’s identifiable assets was N6 million. The value of the non-controlling
interest at 1 December 2009 was estimated at N0·7 million. Whitebirk has used the full goodwill method
to account for business combinations and the estimated life of goodwill cannot be estimated with any
accuracy. Whitebirk wishes to know how to account for goodwill under the IFRS for SMEs.

(iii) Whitebirk has incurred N1 million of research expenditure to develop a new product in the year to 30
November 2010. Additionally, it incurred N500,000 of development expenditure to bring another product
to a stage where it is ready to be marketed and sold.
Required:
Discuss how the above transactions should be dealt with in the financial statements of Whitebirk,
with
reference to the ‘IFRS for Small and Medium-sized Entities’. (9 marks)
(25 marks) ACCA CORPORATE REPORTING DECEMBER 2010

SUGGESTED SOLUTION TO REVIEW QUESTION

1. (a) (i) There were several approaches, which could have been taken in developing standards for
SMEs. One course of action would have been for GAAP for SMEs to be developed on a national basis,
with IFRS focusing on accounting for listed company activities. The main issue would have been that the
practices developed for SMEs may not have been consistent and may have lacked comparability across
national boundaries. Additionally, if a SME had wished to list its shares on a capital market, the transition
to IFRS would have been more difficult.
Another approach would have been to detail the exemptions given to smaller entities in the mainstream
IFRS. In this
case, an appendix would have been included within the standard detailing the exemptions given to
smaller enterprises.
A third approach would have been to introduce a separate set of standards comprising all the issues
addressed in IFRS, which are relevant to SMEs.
However, the IFRS for SMEs is a self-contained set of accounting principles that are based on full IFRSs,
which have
been simplified so that they are suitable for SMEs. The Standard is organised by topic with the intention
that the standard would be helpful to preparers and users of SME financial statements. The IFRS for
SMEs and full IFRSs are separate and distinct frameworks. Entities that are eligible to apply the IFRS for
SMEs, and that choose to do so, must apply that Standard in full and cannot choose the most suitable
accounting policy from full IFRS or IFRS for SMEs.
However, the IFRS for SMEs is naturally a modified version of the full standards, and not an
independently developed
set of standards. It is based on recognised concepts and principles which should allow easier transition to
full IFRS if
the SME decides to become a public listed entity.

(ii) In deciding on the modifications to make to IFRS, the needs of the users have been taken into
account, as well as the costs and other burdens imposed upon SMEs by IFRS. Relaxation of some of the
measurement and recognition criteria in IFRS have been made in order to achieve the reduction in these
costs and burdens. Some disclosure requirements in full IFRS are intended to meet the needs of listed
entities, or to assist users in making forecasts of the future. Users of financial statements of SMEs often
do not need such detailed information. Small companies have different strategies, with survival and
stability rather than profit maximisation being their goals. The stewardship function is often absent in small
companies thus there are a number of accounting practices and disclosures which may not provide
relevant information for the users of SME financial statements. As a result the standard does not address
the following topics:
(i) earnings per share;
(ii) interim financial reporting;
(iii) segment reporting;
(iv) insurance (because entities that issue insurance contracts are not eligible to use the standard); and
(v) assets held for sale.
In addition there are certain accounting treatments, which are not allowable under the standard.
Examples of these
disallowable treatments are the revaluation model for property, plant and equipment and intangible
assets, and
proportionate consolidation for investments in jointly controlled entities. Generally there are simpler and
more cost
effective methods of accounting available to SMEs than those accounting practices, which have been
disallowed.
Additionally the Standard eliminates the ‘available-for-sale’ and ‘held-to maturity’ classifications of IAS 39,
‘Financial
Instruments: Recognition and measurement’. All financial instruments are measured at amortised cost
using the effective interest method except that investments in non-convertible and non-puttable ordinary
and preference shares that are publicly traded or whose fair value can otherwise be measured reliably are
measured at fair value through profit or loss.
All amortised cost instruments must be tested for impairment. At the same time the Standard simplifies
the hedge
accounting and de-recognition requirements. However, SMEs can choose to apply IAS 39 in full if they so
wish.
Additionally the IFRS for SMEs makes numerous simplifications to the recognition, measurement and
disclosure
requirements in full IFRSs. Examples of these simplifications are:
(i) goodwill and other indefinite-life intangibles are amortised over their useful lives, but if useful life cannot
be reliably
estimated, then the useful life is presumed to be 10 years

(ii) a simplified calculation is allowed if measurement of defined benefit pension plan obligations (under
the projected
unit credit method) involves undue cost or effort

(iii) the cost model is permitted for investments in associates and joint ventures.
As a result of the above, SMEs do not have to comply with over 90% of the volume of accounting
requirements
applicable to listed companies. If an entity opts to use the IFRS for SMEs, it must follow the standard in its
entirety and
it cannot cherry pick between the requirements of the IFRS for SMEs and those of full IFRSs.
There is no universally agreed definition of a SME and a single definition cannot capture all the
dimensions of a SME,
or cannot be expected to reflect the differences between firms, sectors, or countries at different levels of
development.
Most definitions based on size use measures such as number of employees, net asset total, or annual
turnover. However, none of these measures apply well across national borders. The IFRS for SMEs is
intended for use by entities that have no public accountability (i.e. its debt or equity instruments are not
publicly traded).
The decision regarding which entities should use the IFRS for SMEs remains with national regulatory
authorities and
standard-setters. These bodies often specify more detailed eligibility criteria.

(b) (i) Defined benefit scheme

The IFRS states that an entity is required to recognise all actuarial gains and losses in the period in which
they occur.
The entity shall:
(a) recognise all actuarial gains and losses in profit or loss, or
(b) recognise all actuarial gains and losses in other comprehensive income as an accounting policy
election. The entity shall apply its chosen accounting policy consistently to all of its defined benefit plans
and all of its actuarial gains
and losses. Actuarial gains and losses recognised in other comprehensive income shall be presented in
the
statement of comprehensive income.
Thus the corridor approach should not be used but rather the unrecognised losses of N0·21 million should
be recognised in profit or loss or other comprehensive income.

(ii) Business combination

The IFRS states that the acquirer shall, at the acquisition date:
(a) recognise goodwill acquired in a business combination as an asset, and
(b) initially measure that goodwill at its cost, being the excess of the cost of the business combination
over the acquirer’s interest in the net fair value of the identifiable assets, liabilities and contingent
liabilities.
After initial recognition, the acquirer shall measure goodwill acquired in a business combination at cost
less accumulated amortisation and accumulated impairment losses. If an entity is unable to make a
reliable estimate of the useful life of goodwill, the life is presumed to be ten years. There is no choice of
accounting method for non controlling interests and therefore the partial goodwill method would be used.
Goodwill will be N5·7 million less 90% of N6 million i.e. N0·3 million. This will then be amortised over ten
years at a
value of N30,000 per annum.
(iii) Research and development expenditure
The IFRS states that an entity shall recognise expenditure incurred internally on an intangible item,
including all
expenditure for both research and development activities, as an expense when it is incurred unless it
forms part of the
cost of another asset that meets the recognition criteria in this IFRS. Thus the expenditure of N1·5 million
on research
and development should all be written off to profit or loss.