Chapter 3-5

Intermediate Financial Accounting-II (Acfn-3022) by Jundi M. (MSc).
@DDU, 2023
Chapter-Three
3. Investments
3.1. Nature and classification of investments
Corporations purchase investments in debt or stock securities generally for one of

three reasons. First, a corporation may have excess cash that it does not need for the
immediate purchase of operating assets. For example, many companies experience
seasonal fluctuations in sales. Thus, at the end of an operating cycle, many companies
may have cash on hand that is temporarily idle until the start of another operating
cycle. These companies may invest the excess funds to earn-through interest and
dividends a greater return than they would get by just holding the funds in the bank.
A second reason some companies such as banks purchase investments is to generate

earnings from investment income. Although banks make most of their earnings by
lending money, they also generate earnings by investing primarily in debt securities.
Banks purchase investment securities because loan demand varies both seasonally
and with changes in the economic climate. Thus, when loan demand is low, a bank
must find other uses for its cash. Some companies attempt to generate investment
income through speculative investments. That is, they are speculating that the
investment will increase in value and thus result in positive returns. Therefore, they
invest mostly in the common stock of other corporations.
Third, companies also invest for strategic reasons. A company may purchase a
non-controlling interest in another company in a related industry in which it wishes
to establish a presence. Or, a company can exercise some influence over one of its
customers or suppliers by purchasing a significant, but not controlling interest in
that company. Another option is for a corporation to purchase a controlling interest
in another company in order to enter a new industry without incurring the costs and
risks associated with starting from scratch. house
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Intermediate Financial Accounting-II (Acfn-3022) by Jundi M. (MSc). @DDU, 2023
3.2. Accounting for debt investments

Debt investments are investments in government and corporation bonds. In
accounting for debt investments, companies make entries to record (1) the acquisition,
(2) the interest revenue, and (3) the sale.
1. Recording Acquisition of Bonds
At acquisition, investments are recorded at cost. Cost includes all expenditures
necessary to acquire these investments, such as the price paid plus brokerage fees
(commissions), if any. Assume, for example, that Kuhl NV acquires 50 Doan SA 8%,
10-year, €1,000 bonds on January 1, 2017, at a cost of €50,000. The entry to record
the investment is:
Jan. 1 Debt Investments (50 × €1,000) 50,000
Cash 50,000
(To record purchase of 50 Doan SA bonds)
2. Recording Bond Interest

The Doan SA bonds pay interest of €4,000 annually on January 1 (€50,000 ×8%). If
Kuhl NV’s fiscal year ends on December 31, it accrues the interest of €4,000 earned
since January 1. The adjusting entry is:
Dec. 31 Interest Receivable 4,000
Interest Revenue 4,000
(To accrue interest on Doan SA bonds)
Kuhl reports Interest Receivable as a current asset in the statement of financial
position. It reports Interest Revenue under “Other income and expense” in the income
statement.
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Kuhl reports receipt of the interest on January 1 as follows.

Jan. 1 Cash 4,000
Interest Receivable 4,000
(To record receipt of accrued interest)
A credit to Interest Revenue at this time is incorrect because the company earned and
accrued interest revenue in the preceding accounting period.
3. Recording Sale of Bonds
When Kuhl NV sells the bonds, it credits the investment account for the cost of the
bonds. Kuhl records as a gain or loss any difference between the net proceeds from
the sale (sales price less brokerage fees) and the cost of the bonds.
Assume, for example, that Kuhl receives net proceeds of €54,000 on the sale of the
Doan SA bonds on January 1, 2018, after receiving the interest due. Since the
securities cost €50,000, the company realizes a gain of €4,000. It records the sale as:
Jan. 1 Cash 54,000
Debt Investments 50,000
Gain on Sale of Debt Investments 4,000
(To record sale of Doan SA bonds)
Kuhl reports any gains or losses on the sale of debt investments under “Other income
and expense” in the income statement.
3.3. Accounting for equity investments

Share investments are investments in the shares of other corporations. The company
holds shares (and/or debt) of several different corporations, the group of securities is
identified as an investment portfolio. T8he accounting for investments in shares
depends on the extent of the investor’s influence over the operating and financial
affairs of the issuing corporation (the investee)
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1) Holdings of Less than 20%

In accounting for share investments of less than 20%, companies use the cost method.
Under the cost method, companies record the investment at cost and recognize
revenue only when cash dividends are received
A. Recording Acquisition of Shares
At acquisition, share investments are recorded at cost. For example, assume that on
July 1, 2020, Lee Ltd. acquires 1,000 shares (10% ownership) of Beal Ltd. Lee pays
HK$405 per share. The entry for the purchase is;
Cash 405,000
Share Investments 405,000
B. Recording Dividends
During the time Lee owns the shares, it makes entries for any cash dividends received.
If Lee receives a HK $20 per share dividend on December 31, the entry is:
Dec. 31
Cash (1,000 ×HK$20) 20,000
Dividend Revenue 20,000
(To record receipt of a cash dividend)
Lee reports Dividend Revenue under “Other income and expense” in the income
statement. Unlike interest on notes and bonds, dividends do not accrue. Therefore,
companies do not make adjusting entries to accrue dividends.
C. Recording Sale of Shares

When a company sells a share investment, it recognizes as a gain or a loss the
difference between the net proceeds from the sale (sales price less brokerage fees)
and the cost of the shares. Assume that Lee Ltd. receives net proceeds of HK$395,000
on the sale of its Beal shares on February 10, 2018. Because the shares cost
HK$405,000, Lee incurred a loss of HK$10,000. The entry to record the sale is:
Feb. 10
Cash 395,000
Loss on Sale of Share Investments 10,000
(To record sale of Beal shares)
Lee reports the loss under “Other income and expense” in the income statement.
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2) Holdings Between 20% and 50%

When an investor company owns only a small portion of the ordinary shares of
another company, the investor cannot exercise control over the investee. But, when an
investor owns between 20% and 50% of the ordinary shares of a corporation, it is
presumed that the investor has significant influence over the financial and operating
activities of the investee.
When an investor has significant infl uence but not control over an investee, it refers
to the investee as an associate. The investor probably has a representative on the
associate’s board of directors and, through that representative, may exercise some
control over the associate. The associate company in some sense becomes part of the
investor company.
Under the equity method, the investor records its share of the net income of the
associate in the year when it is earned. An alternative might be to delay recognizing
the investor’s share of net income until the associate declares a cash dividend. But,
that approach would ignore the fact that the investor and associate are, in some sense,
one company, making the investor better off by the associate’s earned income.
Under the equity method, the investor company initially records the investment in
ordinary shares of an associate at cost. After that, it adjuststhe investment account
annually to show the investor’s equity in the associate. Each year, the investor does
the following.
(1) It increases (debits) the investment account and increases (credits) revenue for its
share of the associate’s net income.
(2) The investor also decreases (credits) the investment account for the amount of
dividends received.
The investment account is reduced for dividends received because payment of a
dividend decreases the net assets of the associate.
i. Recording Acquisition of Share
Assume that Milar plc acquires 30% of the ordinary shares of Beck plc for
£120,000 on January 1, 2017. The entry to record this transaction is:
Jan. 1
Cash 120,000
(To record purchase of Beck ordinary shares)
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ii. Recording Revenue and Dividends

For 2017, Beck reports net income of £100,000. It declares and pays a £40,000 cash
dividend. Milar records;
(1) Its share of Beck’s income, £30,000 (30% ×£100,000), and
(2) The reduction in the investment account for the dividends received, £12,000
(£40,000 ×30%). The entries are:
Dec 31.
Revenue from Share Investments 30,000
(To record 30% equity in Beck’s 2017 net income)
Cash 12,000
(To record dividends received)
After Milar posts the transactions for the year, its investment and revenue
accounts will show the following.
During the year, the investment account increased £18,000. This increase of £18,000
is explained as follows: (1) Milar records a £30,000 increase in revenue from its share
investment in Beck, and (2) Milar records a £12,000 decrease due to dividends
received from its share investment in Beck.
Note that the difference between reported revenue under the cost method and reported
revenue under the equity method can be significant. For example, Milar would report
only £12,000 (30% ×£40,000) of dividend revenue if it used the cost method.
3) Holdings of More than 50%

A company that owns more than 50% of the ordinary shares of another entity is
known as the parent company. The entity whose shares the parent company
owns is called the subsidiary (affiliated) company. Because of its share ownership, the
parent company has a controlling interestin the subsidiary.
When a company owns more than 50% of the ordinary shares of another
company, it usually prepares consolidated financial statements. These statements
present the total assets and liabilities controlled by the parent company.
They also present the total revenues and expenses of the subsidiary companies.
Companies prepare consolidated statements in addition tothe financial statements for
the parent and individual subsidiary companies.
Consolidated statements are useful to the shareholders, board of directors, and
managers of the parent company. These statements indicate the magnitude and scope
of operations of the companies under common control.
For example, regulators and the courts undoubtedly used the consolidated. Most of the
large corporations are holding companies that own other corporations. They therefore
prepare consolidated financial statements that combine the separate companies.
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Consolidated Statement of Financial Position

Companies prepare consolidated statements of financial position from the individual
statements of their affiliated companies. They do not prepare consolidated statements
from ledger accounts kept by the consolidated entity because only the separate legal
entities maintain accounting records.
All items in the individual statements of fi nancial position are included in the
consolidated statement except amounts that pertain to transactions between the
affiliated companies. Transactions between the affi liated companies are identified as
intercompany transactions. The process of excluding these transactions in preparing
consolidated statements is referred to as intercompany eliminations.
These eliminations are necessary to avoid overstating assets, liabilities, and equity in
the consolidated statement of financial position. For example, amounts owed by a
subsidiary to a parent company and the related receivable reported by the parent
company would be eliminated. The objective in a consolidated statement is to show
only obligations to and receivables from parties who are not part of the affi liated
group of companies.
To illustrate, assume that on January 1, 2017, Powers plc pays £150,000 in cash for
100% of Serto plc’s ordinary shares. Powers records the investment at cost.
Illustration 12A-1 presents the separate statements of financial position of the two
companies immediately after the purchase, together with combined and consolidated
data. Powers obtains the balances in the “combined” column by adding the items in
the separate statements of the affiliated companies. The combined totals do not
represent a consolidated statement of financial position because there has been a
double-counting of assets and equity in the amount of £150,000.
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3.4. Impairment of value

A company should evaluate every investment, at each reporting date, to determine if it
has suffered impairment—a loss in value that is other than temporary. For example,
if an investee experiences a bankruptcy or a significant liquidity crisis, the investor
may suffer a permanent loss. If the decline is judged to be other than temporary, a
company writes down the cost basis of the individual security to a new cost
basis. The company accounts for the write-down as a realized loss. Therefore, it
includes the amount in net income.
For debt securities, a company uses the impairment test to determine whether “it is
probable that the investor will be unable to collect all amounts due according to the
contractual terms.”
For equity securities, the guideline is less precise. Any time realizable value is lower
than the carrying amount of the investment, a company must consider an impairment.
Factors involved include the length of time and the extent to which the fair value has
been less than cost; the financial condition and near-term prospects of the issuer; and
the intent and ability of the investor company to retain its investment to allow for any
anticipated recovery in fair value.
To illustrate an impairment, assume that Strickler Company holds available-for sale
bond securities with a par value and amortized cost of $1 million. The fair value of
these securities is $800,000. Strickler has previously reported an unrealized loss on
these securities of $200,000 as part of other comprehensive income. In evaluating the
securities, Strickler now determines that it probably will not collect all amounts due.
In this case, it reports the unrealized loss of $200,000 as a loss on impairment of
$200,000. Strickler includes this amount in income, with the bonds stated at their new
cost basis. It records this impairment as follows.
Loss on Impairment 200,000
Available-for-Sale Securities 200,000
The new cost basis of the investment in debt securities is $800,000. Strickler includes
subsequent increases and decreases in the fair value of impaired available-for-sale
securities as other comprehensive income.
Companies’ base impairment for debt and equity securities on a fair value test. This
test differs slightly from the impairment test for loans.
3.5. Transfer between categories

Companies account for transfers between any of the categories at fair
value. Thus, if a company transfers available-for-sale securities to held-to-maturity
investments, it records the new investment (held-to-maturity) at the date of transfer
at fair value in the new category.
Similarly, if it transfers held-to-maturity investments to available- for-sale
investments, it records the new investments (available-for-sale) at fair value.
This fair value rule assures that a company cannot omit recognition of fair value
simply by transferring securities to the held-to-maturity category.
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Chapter Four
4. Leases
4.1. The leasing environment
4.1.1. Introduction to Lease
A lease is a contract between two parties for the temporary use of an asset in return
for payment. Businesses use many types of leases, tailoring them to include details
specific to each agreement. Leases can involve all kinds of assets, from property, such
as office buildings, to equipment, such as computers, cars, trucks and factory
machinery. A lease contract documents key terms for each lease and is signed by both
parties: the lessor and the lessee.
The lessor is the entity that owns the asset being leased. Lessors receive payment in
return for giving up their right to use the asset during the lease term, although they
maintain ownership. The lessee is the entity that pays the lessor for use and
day-to-day control over a leased asset during the lease term, in accordance with the
lease agreement. The lease agreement describes the obligations of both lessor and
lessee. Breaching these terms can cause early termination by either party. Typical
lessor and lessee obligations are compared below:
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A lease is a contractual agreement between a lessor and a lessee, that gives the lessee
the right to use specific property, owned by the lessor, for a specified period of time.
Largest group of leased equipment involves:
Information technology equipment
Transportation (trucks, aircraft, rail)
Construction, and
Agriculture
Among others the advantage of using lease financing are:- 100% financing at fixed
rates; Protection against obsolescence; Flexibility; Less costly financing; Tax
advantages and Off-balance-sheet financing.
The conceptual nature of a lease is to capitalize a lease that transfers substantially all
of the benefits and risks of property ownership, provided the lease is non-cancelable.
Leases that do not transfer substantially all the benefits and risks of ownership are
operating leases.
4.2. Classifications of lease
Classification of the lease is based of its substance. Whether a lease is a finance lease
or an operating lease depends on the substance of the transaction rather than the
form of the contract. Examples of situations that may indicate that a lease should be
classified as a finance lease include:
 ownership of the asset transfer to the lessee at the end of the lease term;
 the lease term covers substantially all of the asset’s economic life;
 the lessee will have the option to purchase the asset outright at
below-expected fair value or extend the lease term at below-market rent; and
 the present value of the minimum lease payments amounts to substantially

all of the fair value of the asset.
When a lease includes both land and building elements, each element should be
assessed and classified separately as a finance or an operating lease. In making this
assessment an important consideration is that land normally has an indefinite
economic life.
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IAS 17 classifies leases into two types:
1. a finance lease if the lease transfers substantially all the risks and rewards
incidental to ownership; and
2. an operating lease if the lease does not transfer substantially all the risks and
rewards incidental to ownership.
The following table summarizes the difference between finance and operating lease.
4.3. Accounting for leases by lessees

Lessees do NOT classify the leases as finance or operating anymore. Instead, lessees
account for all the leases in the same way.
4.3.1. Initial recognition
At lease commencement, a lessee accounts for two elements:
1. Right-of-use asset: - Initially, a right-of-use asset is measured in the amount
of the lease liability and initial direct costs. Then it is adjusted by the lease
payments made before or on the commencement date, lease incentives
received, and any estimate of dismantling and restoration costs (remember
IAS 37).
2. Lease liability: - The lease liability is in fact all payments not paid at the
commencement date discounted to present value using the interest rate
implicit in the lease (or incremental borrowing rate if the previous one cannot
be set). These payments may include fixed payments, variable payments,
payments under residual value guarantees, purchase price if the purchase
option will be exercised, etc.
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The journal entries are listed as follows:

I. When Lessee takes an asset under the lease
Debit-Right-of-use asset
Credit -Lease liability (in the amount of the lease liability)
II. Lessee pays the legal fees for negotiating the contract:
Credit-Suppliers (Bank account, Cash, whatever is applicable)
III. The estimated cost of removal, discounted to present value (lessee will need to
remove an asset and restore the site after the end of the lease term):
Credit-Provision for asset removal (under IAS 37)
4.3.2. Subsequent measurement
After commencement date, lessee needs to take care about both elements recognized
initially:
a) Right-of-use asset
Normally, a lessee needs to measure the right-of-use asset using a cost model under
IAS 16 Property, Plant and Equipment. It basically means to depreciate the asset over
the lease term:
Debit Profit or loss – Depreciation charge
Credit Accumulated depreciation of right-of-use asset
However, the lessee can apply also IAS 40 Investment Property (if the right-of –use
asset is an investment property and fair value model is applied), or using revaluation
model under IAS 16 (if right-of-use asset relates to the class of PPE accounted for by
revaluation model).
b) Lease liability
A lessee needs to recognize an interest on the lease liability:
Debit-Profit or loss – Interest expense
Credit-Lease liability
Also, the lease payments are recognized as a reduction of the lease liability:
Debit-Lease liability
Credit-Bank account (cash)
If there is a change in the lease term, lease payments, discount rate or anything else,
then the lease liability must be re-measured to reflect all the changes.
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IFRS 16 permits two exemptions (IFRS 16, par. 5 and following):

1) Leases with the lease term of 12 months or less with no purchase option
(applied to the whole class of assets)
2) Leases where underlying asset has a low value when new (applied on
one-by-one basis)
So, if you enter into the contract for the lease of PC, or you rent a car for 4 months,
then you don’t need to bother with accounting for the right-of-use asset and the lease
liability. You can simply account for all payments made directly in profit or loss on a
straight-line (or other systematic) basis.
4.4. Accounting for lease by lessors

4.4.1. Accounting for finance lease by lessors
4.4.1.1. Initial Recognition
At the commencement of the lease term, lessor should recognize lease receivable in
his statement of financial position. The amount of the receivable should be equal to
the net investment in the lease. Net investment in the lease equals to the payments not
paid at the commencement date discounted to present value (exactly the same as
described in lessee’s accounting) plus the initial direct costs.
The journal entry is as follows:
Debit Lease receivable
Credit PPE (underlying asset)
4.4.1.2. Subsequent Measurement
The lessor should recognize:

1) A finance income on the lease receivable:
Debit Lease receivable
Credit Profit or loss – Finance income
2) A reduction of the lease receivable by the cash received:
Debit Bank account (Cash)
Credit Lease receivable
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Finance income shall be recognized based on a pattern reflecting constant periodic

rate of return on the lessor’s net investment in the lease.
IFRS 16 then also specifies accounting for manufacturer or dealer lessors.
4.4.2. Accounting for operating lease by lessors

Lessor keeps recognizing the leased asset in his statement of financial position. Lease income
from operating leases shall be recognized as an income on a straight-line basis over the lease
term, unless another systematic basis is more appropriate.
Here you can see that the accounting for operating leases is asymmetrical: both lessees and
lessors recognize an asset in their financial statements (it’s a bit controversial and there were
huge debates around).
4.4.3. Sale and Leaseback transactions
A sale and leaseback transaction involves the sale of an asset and the leasing the
same asset back. In this situation, a seller becomes a lessee and a buyer becomes a
lessor.
This is illustrated in the following scheme:
Accounting treatment of sale and leaseback transactions depends on the whether the
transfer of an asset is a sale under IFRS 15 Revenue from contracts with
customers.
a) If a transfer is a sale:
The seller (lessee) accounts for the right-of-use asset at the proportion of the
previous carrying amount related to the right-of-use retained. Gain or loss is
recognized only to the extend related to the rights transferred. (IFRS 16, par.100). The
buyer (lessor) accounts for a purchase of an asset under applicable standards and for
the lease under IFRS 16.
b) If a transfer is NOT a sale:
The seller (lessee) keeps recognizing transferred asset and accounts for the cash
received as for a financial liability under IFRS 9 Financial Instruments. The buyer
recognizes a financial asset under IFRS 9 amounting to the cash paid.
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4.5. Special Lease Accounting Problems
1. Initial Direct Costs

Initial direct costs incurred by the lessee are included in the cost of the right-of-use
asset but are not recorded as part of the lease liability. Lessor accounting for initial
direct costs depends on the type of lease
 For operating leases, a lessor defers the initial direct costs and
amortizes them as expenses over the term of the lease.
 For sales-type leases, the lessor expenses initial direct costs at
lease commencement (in the period in which it recognizes the
profit on the sale)
2. Bargain Purchase Option
Allows the lessee to purchase the leased property for a future price that is
substantially lower than the asset’s expected future fair value. If a bargain purchase
option exists, the lessee must increase the present value of the lease payments by the
present value of the option price.
3. Short-Term Leases
A lease that, at the commencement date, has a lease term of 12 months or less. Rather
than recording a right-of-use asset and lease liability, lessees may elect to expense the
lease payments as incurred. Renewal or termination options that are reasonably
certain of exercise by the lessee are included in the lease term
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CHAPTER-5
5 REVENUE RECOGNITION
5.1 Revenue Recognition Framework
5.1.1 Introduction
IAS 18 addresses when to recognize and how to measure revenue. Revenue is the
gross inflow of economic benefits during the period arising from the course of the
ordinary activities of an entity when those inflows result in increases in equity, other
than increases relating to contributions from equity participants.
5.1.2 Measurement of revenue
Revenue should be measured at the fair value of the consideration received or
receivable. An exchange for goods or services of a similar nature and value is not
regarded as a transaction that generates revenue. However, exchanges for dissimilar
items are regarded as generating revenue.
If the inflow of cash or cash equivalents is deferred, the fair value of the consideration
receivable is less than the nominal amount of cash and cash equivalents to be received,
and discounting is appropriate. This would occur, for instance, if the seller is
providing interest-free credit to the buyer or is charging a below-market rate of
interest. Interest must be imputed based on market rates. Revenue is measured at the
fair value of the consideration received or receivable
5.1.3 Recognition of revenue
Recognition, as defined in the IASB Framework, means incorporating an item that
meets the definition of revenue (above) in the income statement when it meets the
following criteria:
 It is probable that any future economic benefit associated with the item of
revenue will flow to the entity, and
 The amount of revenue can be measured with reliability
IAS 18 provides guidance for recognizing the following specific categories of
revenue:
a. Sale of goods
Revenue arising from the sale of goods should be recognized when all of the
following criteria have been satisfied:
a) The seller has transferred to the buyer the significant risks and rewards of
ownership
b) The seller 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 seller, and the costs incurred or to be incurred in respect of the
transaction can be measured reliably.
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b. Rendering of services
For revenue arising from the rendering of services, provided that all of the following
criteria are met, revenue should be recognized by reference to the stage of completion
of the transaction at the balance sheet date (the percentage-of-completion method):
the amount of revenue can be measured reliably; it is probable that the economic
benefits will flow to the seller; the stage of completion at the balance sheet date can
be measured reliably; and the costs incurred, or to be incurred, in respect of the
transaction can be measured reliably.
When the above criteria are not met, revenue arising from the rendering of services
should be recognized only to the extent of the expenses recognized that are
recoverable (a "cost-recovery approach".
c. Interest, royalties, and dividends
For interest, royalties, and dividends, provided that it is probable that the economic
benefits will flow to the enterprise and the amount of revenue can be measured
reliably, revenue should be recognized as follows:
Interest: using the effective interest method as set out in IAS 39
Royalties: on an accrual’s basis in accordance with the substance of the relevant
agreement
Dividends: when the shareholder's right to receive payment is established
5.2 Long-Term Construction Contracts
Long-term contracts are contracts for the building, installation, construction, or
manufacturing in which the contract is completed in a later tax year than when it was
started. However, a manufacturing contract only qualifies if it is for the manufacture
of a unique item for a particular customer or is an item that ordinarily takes more than
1 year to manufacture. Long-term contracts frequently provide that the seller (builder)
may bill the purchaser at intervals, as it reaches various points in the project.
Examples of long-term contracts are construction-type contracts, the development of
military and commercial aircraft, weapons-delivery systems, and space exploration
hardware. When the project consists of separable units, such as a group of buildings
or miles of roadway, contract provisions may provide for delivery in installments. In
that case, the seller would bill the buyer and transfer title at stated stages of
completion, such as the completion of each building unit or every 10 miles of road.
The accounting records should record sales when installments are "delivered."
A company satisfies a performance obligation and recognizes revenue over time if at
least one of the following three criteria is met:
The customer simultaneously receives and consumes the benefits of the
seller's performance as the seller performs.
The company's performance creates or enhances an asset (for example, work
in process) that the customer controls as the asset is created or enhanced.
The company's performance does not create an asset with an alternative use.
For example, the asset cannot be used by another customer.
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In addition to this alternative use element, at least one of the following criteria must
be met:
(a) Another company would not need to substantially re-perform the work the
company has completed to date if that other company were to fulfill the
remaining obligation to the customer.
(b) The company has a right to payment for its performance completed to
date, and it expects to fulfill the contract as promised.
5.2.1 Overview of the Ethiopian construction sector

Ethiopia's construction industry and infrastructure development include transport
infrastructure, road construction, railway and energy projects, real estate, and
industrial parks. Small and medium construction companies operate in the informal
market and local and foreign companies operate in the formal market. The
construction industry in Ethiopia has been developing tremendously since 2001.
Recent studies indicated that the GDP contribution of the industry has been raised to
5.6% there for this paper examines the contribution of construction sector output
(growth) to that of the Ethiopian GDP. Development Bank of Ethiopia extends short,
medium, and long-term loans for development projects, including industrial and
agricultural projects.
5.2.2 Basic Terminologies in construction contracts
A construction contract is a contract specifically negotiated for the construction of
an asset or a group of interrelated assets. Under IAS 11, if a contract covers two or
more assets, the construction of each asset should be accounted for separately if (a)
separate proposals were submitted for each asset, (b) portions of the contract relating
to each asset were negotiated separately, and (c) costs and revenues of each asset can
be measured. Otherwise, the contract should be accounted for in its entirety. Two or
more contracts should be accounted for as a single contract if they were negotiated
together and the work is interrelated.
If a contract gives the customer an option to order one or more additional assets,
construction of each additional asset should be accounted for as a separate contract if
either (a) the additional asset differs significantly from the original asset(s) or (b) the
price of the additional asset is separately negotiated.
5.2.3 Revenue Recognition: Long-Term Projects
For long-term projects, companies have some flexibility with respect to revenue
recognition. There are 2 primary methods of accounting to determine when revenue
is recognized for long-term contracts:
1) Completed contract method (CCM)
2) Percentage of completion method (PCM)
1. Completed Contract Method
Rarely used in the United States and prohibited by the IFRS, this method allows
revenue recognition only once the entire project has been completed. Using the
completed contract method, the taxpayer does not recognize revenue until the contract
is completed and accepted by the customer.
18
Except for home construction contracts, CCM can only be used by small contractors
for contracts with an estimated life that does not exceed 2 years. There should be no
terms in the contract with the only purpose of deferring tax. The CCM is required for
home construction contracts that are for the construction of residential buildings
with 4 or fewer dwelling units, where at least 80% of the estimated cost is for the
dwelling units and related land improvements, even if the contract is for longer than 2
years or the contractor is a large contractor. Other types of construction contracts
qualify for the completed contract method if they satisfy the general CCM
requirements.
2. Percentage of completion Method
Revenues are recognized on the basis of the percentage of total work completed
during the accounting period. Except for home construction contracts, large
contractors must use the percentage of completion method for long-term contracts.
PCM must also be used to determine liability under the alternative minimum tax
(AMT) system. Under the PCM, the amount of progress on the project is determined
by the total costs actually incurred as compared to the total estimated cost. Hence,
revenue in any given year is determined by the actual contract costs incurred for that
year divided by the total estimated cost multiplied by the total contract price:
If there is a dispute in regards to the contract price, and the amount of the dispute is
small in relation to the total amount of the contract, then reportable income is
determined by subtracting the contract price by the amount in dispute. The disputed
amount will be recognized when the dispute is resolved. Any additional costs incurred
in completing the performance of the contract are deductible against the recognized
disputed revenue.
The revenue reported for the last year = the total revenue received minus the total
reported revenue. Because the total cost of the contract is estimated, there may be an
underpayment of taxes if costs were overestimated or an overpayment of taxes if costs
were underestimated. The revenue that was actually reported may differ from the
revenue that should have been reported based on actual costs. Therefore, upon
completion of each contract, the revenue that should have been reported for each tax
year must be calculated and compared to the revenue that was reported for those
previous tax years
Reportable Income = Contract Price x Annual Contract Cost/Estimated Total
Cost
19

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Chapter 3-5

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Intermediate Financial Accounting-II (Acfn-3022) by Jundi M. (MSc).

3.1. Nature and classification of investments

Corporations purchase investments in debt or stock securities generally for one of

A second reason some companies such as banks purchase investments is to generate

3.2. Accounting for debt investments

2. Recording Bond Interest

Kuhl reports receipt of the interest on January 1 as follows.

3.3. Accounting for equity investments

1) Holdings of Less than 20%

C. Recording Sale of Shares

2) Holdings Between 20% and 50%

ii. Recording Revenue and Dividends

3) Holdings of More than 50%

Consolidated Statement of Financial Position

3.4. Impairment of value

3.5. Transfer between categories

4.1. The leasing environment

4.1.1. Introduction to Lease

Information technology equipment

Transportation (trucks, aircraft, rail)

4.2. Classifications of lease

 the present value of the minimum lease payments amounts to substantially

IAS 17 classifies leases into two types:

4.3. Accounting for leases by lessees

The journal entries are listed as follows:

IFRS 16 permits two exemptions (IFRS 16, par. 5 and following):

4.4. Accounting for lease by lessors

4.4.1.1. Initial Recognition

The lessor should recognize:

Finance income shall be recognized based on a pattern reflecting constant periodic

4.4.2. Accounting for operating lease by lessors

4.4.3. Sale and Leaseback transactions

4.5. Special Lease Accounting Problems

1. Initial Direct Costs

2. Bargain Purchase Option

5.2.1 Overview of the Ethiopian construction sector

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