Adv. Fin Acc Volume 2 - CIS Study Pack

INSTITUTE OF CHARTERED
SECRETARIES AND
ADMINISTRATORS IN ZIMBABWE
ADVANCED ACCOUNTING AND FINANCIAL
REPORTING
(Volume 2)
By Patrick M. Paradza
ICSAZ – P.M. PARADZA II

BSc(Econ)
M.Acc
ACIS
RPAcc(Zim)
Published by Institute of Chartered Secretaries &

Administrators in Zimbabwe, (ICSAZ)
P. O. Box CY 172
Causeway,
Harare.
©: ICSAZ 2016
All rights reserved. No part of this publication may be reproduced, stored in a retrieval
system, or transmitted, in any form, or by any means, electronic, mechanical, photocopying,
recording or otherwise, without prior permission, in writing, from the publisher.
Typeset by Outline Electronic Publishing, Harare, Zimbabwe.
ISBN 978-0-7974-3370-0
ICSAZ – P.M. PARADZA III

The study material in this book has been compiled from International Accounting Standards,
International Financial Reporting Standards and International Financial Reporting
Interpretations published by the International Accounting Standards Board. Other sources
have been duly acknowledged.
ICSAZ – P.M. PARADZA IV

Contents
Unit
Page
1 Accounting Policies, Changes in Accounting Policies and Errors 1
2 Events after the Reporting Period 22
3 Borrowing Costs 31
4 Financial Instruments 37
5 Insurance Contracts 84
6 Provisions, Contingent Liabilities and Contingent Assets 97
7 Revenue from contracts with customers 110
8 Operating Segments 133

9 Interim Financial Reporting 152
10 Investment Property 164
11 Effects of Changes in Foreign Exchange Rates 177
12 Revenue 188
13 Inventories 205
14 Financial Reporting under Hyperinflationary Economies 218
15 Agriculture 236
16 Accounting for Government Grants and Disclosure of Government Assistance 247
17 Related Party Disclosures 261
18 Accounting and Reporting by Retirement Benefit Funds 272
Subject Index 280
ICSAZ – P.M. PARADZA V

ADVANCED ACCOUNTING & FINANCIAL REPORTING
Volume 2
COURSE OUTLINE
UNIT ONE
ACCOUNTING POLICIES, CHANGES IN ACCOUNTING POLICIES
AND ERRORS (IAS 8)
1.0 Introduction………………………………………………………..…………………. 1
1.1 Objectives…………………………………………………………………………….. 1
1.2 Key definitions……………………………………………………………………….. 1
1.3 Selection and application of accounting policies…………………………………….. 2
1.4. Changes in accounting estimates……………………………………………………. 11
1.4.1 Accounting for changes in accounting estimates…………………………............... 11
1.5. The nature of accounting errors……………………………………………............... 16
1.5.1 Treatment of accounting errors…………………………………………….............. 16
1.6 Disclosure of prior period errors……………………………………………............... 20
1.7 Summary……………………………………………………………………............... 21
1.8 References……………………………………………………………………………. 21
UNIT TWO
EVENTS AFTER THE REPORTING PERIOD (IAS 10)
2.0 Introduction…………………………………………………………………………… 22
2.1 Objectives…………………………………………………………………………….. 22
2.2 Key definitions……………………………………………………………………….. 22
2.3 Recognition and measurement issues………………………………………………… 22
2.4 Disclosure requirements……………………………………………………………… 23
2.5. Additional considerations……………………………………………………............. 26
2.5.1 Dividends…………………………………………………………………………… 26
2.5.2 Going concern status……………………………………………………………….. 27
2.6 Disclosure requirements……………………………………………………………… 27
2.7 Summary……………………………………………………………………………… 30
2.8 Reference……………………………………………………………………………... 30
UNIT THREE
BORROWING COSTS (IAS 23)
3.0 Introduction…………………………………………………………………………… 31
3.1 Objectives…………………………………………………………………………….. 31
3.2 Terminology and examples…………………………………………………………… 31
3.3.0 Identification of costs that are eligible for capitalisation…………………………… 32
ICSAZ – P.M. PARADZA VI

3.3.1 Capitalisation limits………………………………………………………………… 32
3.3.2 Suspension of capitalisation………………………………………………………...
33
3.3.3 Cessation of capitalisation………………………………………………………….. 33
3.4 Interest capitalization and foreign loans……………………………………………… 35
3.5 Summary……………………………………………………………………………… 36
3.6 References……………………………………………………………………………. 36
UNIT FOUR
FINANCIAL INSTRUMENTS (IFRS 9, IFRS 7, IAS 39, IAS 32)
4.0 Introduction…………………………………………………………………………… 37
4.1 Objectives…………………………………………………………………………….. 38
4.1.1 Timeline of IFRS 9…………………………………………………………………. 38
4.1.2 Transitional provisions…………………………………………………………....... 39
4.1.3 Transition disclosures………………………………………………………………. 39
4.1.4 Expected implementation challenges………………………………………………. 39
4.2 Terminology…………………………………………………………………….......... 40
4.2.1 Recognition, measurement and definitions that relate to recognition and
Measurement……………………………………………………………………….. 42
4.2.1.1 Definitions that relate to recognition and measurement………………………….. 42
4.2.1.2 Recognition………………………………………………………………….......... 43
4.2.1.2.1 Accounting treatment as regards recognition and measurement of a
financial asset at amortised cost………………………………………………… 50
4.2.1.2.2 Accounting treatment as regards recognition and measurement of
a financial asset at fair value through other comprehensive income………........ 51
4.2.1.2.3 Accounting treatment as regards recognition and measurement of a
financial asset at fair value through profit or loss…………………………........ 51
4.2.1.3 Derecognition of a financial asset ………………………………………….......... 51
4.2.1.3.1 Examples of when financial asset is derecognized……………………….......... 54
4.2.1.3.2 Examples of when financial asset is not derecognized……………………........ 54
4.2.1.4 Derecognition of a Financial Liability…………………………………………… 54
4.3. Initial and subsequent measurement……………………………………………......... 55
4.3.1 Initial Measurement of financial assets and liabilities……………………………… 55
4.3.2 Subsequent classification and measurement of financial assets………………......... 55
4.3.2.1 Financial assets at amortised cost………………………………………………… 56
4.3.2.1.1 Business model……………………………………………………………......... 56
4.3.1.2 Contractual cash flow model………………………………………………........... 56
4.3.2 Financial assets at fair value through profit or loss (FVTPL)………………............ 57
4.3.3 Financial assets at fair value through other comprehensive income
(FVTOCI)……………………………………………………………………............ 57
4.3.3.1 Equity instruments at FVTOCI…………………………………………………… 57
4.3.3.2 Debt Instruments at FVTOCI……………………………………………….......... 57
4.3.4 Subsequent classification and measurement of financial liabilities…………........... 57
4.3.4.1 Financial liabilities at amortised cost……………………………………….......... 57
4.3.4.1.1 Accounting treatment as regards recognition and measurement
ICSAZ – P.M. PARADZA VII

of a financial liability at amortised cost…………………………………………. 58
4.3.4.2 Financial liabilities at fair value through profit or loss…………………………… 58
4.3.4.2.1 Accounting treatment as regards recognition and measurement
of a financial liability at fair value through profit or loss………………….......... 58
4.3.5 IFRS 9`s specific guidance for financial guarantee contracts and
commitments to provide a loan at a below market interest rate……............... 59
4.3.6 IFRS 9`s specific guidance for financial liabilities resulting from the
transfer of a financial asset and not derecognised (continually involved)…............ 59
4.4 Scope exclusions……………………………………………………………............... 59
4.5 Classification of financial instruments………………………………………….......... 60
4.6 Split accounting…………………………………………………………………......... 62
4.7 Classification of interest, dividends, losses and gains (IAS 32)……………………… 63
4.8. Offsetting of financial assets and financial liabilities (IAS 32)……………………… 63
4.9 Acquisition of own equity instruments………………………………………….......... 64
4.10 Different ways of settling liabilities and other commitments…………………..........
64 4.10.1 Settlement in the Entity's Own Equity
Instruments………………………….......... 64
4.10.2 Settlement Options………………………………………………………………… 64
4.11 Impairment and uncollectibility of financial assets……………………..................... 65
4.11.1 Scope of IAS 39…………………………………………………………………… 65
4.11.2 Impairment of specific types of financial assets per IAS 39……………………… 65
4.11.2.1 Financial assets carried at amortised cost………………………………….......... 65
4.11.3 Scope of IFRS 9…………………………………………………………………… 67
4.11.3.1 Initial recognition……………………………………………………………….. 67
4.11.3.2 Subsequent measurement…………………………………………...................... 67
4.12 Expected credit loss method – Furthermore on the new
impairment model…………………………………………………………………… 68
4.12.1 Presentation………………………………………………………………….......... 68
4.12.2 Disclosure…………………………………………………………………………. 68
4.12.3 Period over which to estimate the expected credit loss…………………………… 69
4.13 Hedge accounting…………………………………………………………………… 71
4.13.1 Definitions Related to Hedge Accounting………………………………………… 71
4.13.2 Types of hedging relationships……………………………………………………. 72
4.13.3 Conditions for hedge accounting…………………………………………….......... 72
4.13.4 Fair Value Hedges………………………………………………………………… 74
4.13.4.1 Summary accounting treatment for a fair value hedge…………………….......... 74
4.13.4.2 Discontinuing Hedge Accounting – Fair value hedge (IAS 39)………………… 75
4.13.5 Cash Flow Hedges………………………………………………………………… 75
4.13.5.1 Summary accounting treatment for a cash flow hedge……………………......... 76
4.13.5.2 Discontinuing Hedge Accounting – Cash flow Hedge (IAS 39)……………….. 78
4.13.6 Hedges of a net investment……………………………………………………….. 79
4.14 General Disclosures…………………………………………………………………. 81
4.14.1 Risk disclosures…………………………………………………………………… 81
4.15 Summary……………………………………………………………......................... 83
4.16 References…………………………………………………………………………… 83
ICSAZ – P.M. PARADZA VIII

UNIT FIVE
INSURANCE CONTRACTS
5.0 Introduction…………………………………………………………………………… 84
5.1 Objectives……………………………………………………………………….......... 84
5.2 Highlights of IFRS 4 ………………………………………………………………… 84
5.3 Scope exclusions……………………………………………………........................... 85
5.4 Terminology………………………………………………………………………….. 85
5.5 The concept of significant insurance risk……………………………………….......... 87
5.6 Examples of insurance contracts……………………………………………………… 88
5.6.1 Examples of agreements that are not insurance contracts…………………….......... 88
5.7 Unbundling the components of an insurance contract……………………………….. 89
5.7.1 Reasons for unbundling the components of an insurance
contract………………… 90
5.7.2 Reasons against unbundling the components of an insurance
contract……….......... 90
5.7.3 The final
position…………………………………………………………………... 91
5.8 Liability adequacy………………………………………………………………......... 91
5.9 Discretionary participation features in insurance contracts…………………………... 91
5.9.1 Discretionary Participation Features in Financial Instruments…………………….. 92
5.10 Guidance on Accounting Policy Disclosures (Para 37a of IFRS 4;
Implementation Guidance 17 of IFRS 4)……………………………………............ 94
5.11 Summary……………………………………………………………………………. 96
5.12 References…………………………………………………………........................... 96
UNIT SIX
PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT

ASSETS (IAS 37)
6.0 Introduction…………………………………………………………………………… 97
6.1 Objectives………………………………………………………………...................... 97
6.2 Key terms………………………………………………………………....................... 97
6.3 Differences between provisions and other liabilities…………………………............. 98
6.4 Summary of the major characteristics of provisions, contingent liabilities and
contingent assets (Appendix A of IAS 37)……………………............. 99
6.5 Recognition issues……………………………………………………………………. 100
6.6 Measurement guidelines……………………………………………………………… 102
6.6.1 Risks and uncertainties……………………………………………………............... 102
6.6.2 Present value…………………………………………………………....................... 103
6.6.3 Future events…………………………………………………………....................... 103
6.7 Re-imbursements……………………………………………………………...............
104
6.8 Other recognition points to be noted…………………………………………………. 104
ICSAZ – P.M. PARADZA IX

6.9 Application of recognition and measurement rules…………………………...............
105
6.10 Disclosure requirements……………………………………………….. …............... 107
6.11 Summary………………………………………………………………...................... 109
6.12 References…………………………………………………………………................ 109
UNIT SEVEN
REVENUE FROM CONTRACTS WITH CUSTOMERS
7.0 Introduction…………………………………………………………………............... 110
7.1 Objectives…………………………………………………………………………….. 110
7.2 Terminology………………………………………………………………………….. 110
7.3 Definition of a customer……………………………………………………………… 111
7.3.1 Interaction with other standards………………………………………..................... 111
7.4.0 Relationship with IAS 8………………………………………………..................... 112
7.4.1 Methods of applying the standard………………………………………………….. 112
7.4.2 Practical considerations……………………………………………………………..
112
7.4.3 The essentials of a contract………………………………………………................. 112
7.5 Modifying the Contract……………………………………………………………….. 114
7.6 The Substance of a Contract……………………………………………...................... 114
7.7 Guidelines on Classification………………………………………………………….. 115
7.8 Performance Obligations in Contracts………………………………………………... 117
7.9 Determination of the Transaction Price……………………………………………….
119 7.10 Principal vs Agent
Considerations…………………………………………………... 121
7.11 Consignment Sales…………………………………………………………………... 122
7.12 Sale of products with a right of return……………………………………................. 122
7.13 Measuring Progress on the Performance Obligation………………………………... 124
7.14 Allocation of Discount………………………………………………………………. 125
7.15 Allocation of Variable Consideration……………………………………………….. 126
7.16 Treatment of contract costs………………………………………………………….. 127
7.16.1 Treatment of general and other costs………………………………........................ 128
7.17 Guidelines for specific contract outcomes………………………………................... 128
7.17.1 Amortisation and impairment………………………………………....................... 128
7.17.2 Presentation in the Statement of Financial Position………………………………. 129
7.18 Disclosure Requirements……………………………………………………………. 132
7.19 Summary………………………………………………………………...................... 132
7.20 References…………………………………………………………………………… 132
UNIT EIGHT
OPERATING SEGMENTS (IFRS 8)
8.0 Introduction…………………………………………………………………………… 133
8.1 Core principle………………………………………………………………………… 133
8.2 Scope……………………………………………………………………..................... 133
ICSAZ – P.M. PARADZA X

8.2 Objectives………………………………………………………………….................. 133
8.3 Definition……………………………………………………………………………... 135
8.3.1 Changes from previous requirements………………………………………………. 135
8.4 Disclosures……………………………………………………………………………. 135
8.5 Reportable segments……………………………………………………….................. 135
8.6.1 Restatement; previously reported information……………………………………… 136
8.6.2 Restatement of previously reported information…………………………………… 136
8.7 Entity-wide
disclosures…………………………………………………….................. 137 8.8
Products and services………………………………………………………………….
143 8.9 Geographical
areas……………………………………………………………………. 143 8.10
Revenue……………………………………………………………………………… 144
8.11 Assets……………………………………………………………………................... 144
8.14 Frequently asked questions relating to IFRS 8……………………………………… 145
8.15 Comprehensive example…………………………………………………………….. 146
8.12 Summary…………………………………………………………………………….. 150
8.13 References…………………………………………………………………………… 150
UNIT NINE
INTERIM FINANCIAL REPORTING (IAS 34)
9.0 Introduction…………………………………………………………………………… 152

9.1 Objectives………………………………………………………………….................. 152
9.2 Definitions…………………………………………………………………………….
152
9.3 Minimum contents of an interim financial report…………………………………….. 153
9.3.1 Form and content of interim financial statements……………………….................. 153
9.3.2 Significant events and transaction……………………………………….................. 153
9.4 Periods for which interim financial statements are required to
be presented………………………………………………………………................... 154
9.4.1 Approaches to identifying and measuring revenues, expenses, gains and losses of
an interim period and assets and liabilities at the interim date……………. 154
9.5 Materiality threshold………………………………………………………………….. 155
9.6 Recognition and measurement guidelines……………………………………………. 155
9.7 Implications of the IASB conceptual framework for interim financial
Reports………………………………………………………………………………... 155
9.8 Use of estimates………………………………………………………………………. 156
9.8.1 Examples of the use of estimates (Appendix C, IAS 34)…………………………... 156
9.8.1.1 Inventories………………………………………………………………………... 156
9.8.1.2 Classification of current and non-current assets and liabilities…………………... 156
9.8.1.3 Provisions………………………………………………………………………… 157
9.8.1.4
Pensions…………………………………………………………………………... 157
9.8.1.5 Income taxes……………………………………………………………………… 158
ICSAZ – P.M. PARADZA XI

9.8.1.6 Revaluation and fair value accounting…………………………………………… 158
9.8.1.7 Intercompany reconciliations………………………………………...................... 158
9.8.1.8 Specialised
industries………………………………………………...................... 158
9.9 Restatements of previously reported interim periods………………………………… 159
9.10 Summary………………………………………………………………...................... 163
9.11 References…………………………………………………………………………… 163
UNIT TEN
INVESTMENT PROPERTY (IAS 40)
10.0 Introduction…………………………………………………………………………. 164
10.1 Objectives…………………………………………………………………………… 164
10.2 Terminology………………………………………………………………………… 164
10.3 Examples of Investment Property…………………………………………………… 164
10.3.1 Special Case - Operating Leases……………………………………...................... 164
10.4 Scope exclusions……………………………………………………………………. 165
10.5. Accounting for Investment Property…………………………………...................... 165
10.5.1 Recognition…………………………………………………………….................. 165
10.5.2 Measurement at initial recognition………………………………………………... 165
10.6 Measurement after initial recognition…………………………………...................... 166
10.6.1 Determination of Fair Value………………………………………………………. 167
10.6.2 Inability to determine fair value reliably……………………………....................... 167
10.7 The cost model………………………………………………………………………. 168
10.8 The fair value model………………………………………………………………… 168
10.9 Transfers to or from investment property………………………………....................
169
10.10 Disposals……………………………………………………………….................... 171
10.11 Disclosure requirements……………………………………………………………. 176
10.11 Summary……………………………………………………………….................... 176
10.12 References…………………………………………………………………………. 176
UNIT ELEVEN
EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES (IAS 21)
11.0 Introduction…………………………………………………………………………. 177
11.1 Objectives…………………………………………………………………………… 177
11.2 Key definitions……………………………………………………………………… 177
11.3 Monetary items……………………………………………………………………… 178
11.4 Reporting foreign currency transactions in the functional currency……................... 179
11.4.1 Initial recognition……………………………………………………..................... 179
11.4.2 Reporting at the end of subsequent reporting periods………………….................. 179
11.4.3 Recognition of exchange differences…………………………………................... 180
ICSAZ – P.M. PARADZA XII

11.5 Translation of a foreign operation…………………………………………………... 185
11.6 Disposal of a foreign operation……………………………………………………… 186
11.7 Covered foreign currency transactions……………………………………………… 186
11.8 Disclosures………………………………………………………………...................
186
11.9 Summary……………………………………………………………………………..
187
11.10 References…………………………………………………………………………. 187
UNIT TWELVE
REVENUE (IAS 18)
12.0 Introduction…………………………………………………………………………. 188
12.1 Objectives…………………………………………………………………………… 188
12.2 Key terms……………………………………………………………………………. 189
12.3 Scope exclusions…………………………………………………………………….. 189
12.4 Measurement of revenue……………………………………………………………. 190
12.5 Recognition of revenue………………………………………………....................... 190
12.6 Rendering of services……………………………………………………..................
193
12.6.1 Revenue recognition for specific services rendered………………………………. 195
12.6.1.1 Installation fees………………………………………………………………….. 195
12.6.1.2 Servicing fees included in the price of the product………………....................... 195
12.6.1.3 Advertising commissions…………………………………………….................. 195
12.6.1.4 Insurance agency commissions…………………………………………………. 195
12.6.1.5 Financial service fees……………………………………………………………. 195
12.6.1.6 Admission fees………………………………………………………................... 198
12.6.1.7 Tuition
fees………………………………………………………........................ 198
12.6.1.8 Initiation, entrance and membership
fees……………………………………….. 198
12.6.1.9 Franchise fees…………………………………………………………………….
198
12.6.1.10 Fees from the development of customized software……………........................ 199
12.7 Revenue recognition for specific sales of goods…………………………………….. 199
12.7.1 Bill and hold sales………………………………………………………………….
199
12.7.2 Goods shipped subject to conditions……………………………………………….
199
12.7.3 Consignment sales………………………………………………………………….
200
12.7.4 Cash on delivery sales…………………………………………………...................
200
12.7.5 Lay-away sales……………………………………………………………………..
200
ICSAZ – P.M. PARADZA XIII

12.7.6 Orders when payment (or partial payment) is received in advance)….……………
200
12.7.7 Sale and repurchase agreements (other than swap transactions)…………………..
200
12.7.8 Sales to intermediate parties, such as distributors, dealers or
others for resale…………………………………………………………………… 200
12.7.9 Subscriptions to publications and similar items…………………………………... 201
12.7.10 Installment sales, under which the consideration is receivable
in installments……………………………………………………………………. 201
12.7.11 Real estate sales……………………………………………………...…………... 201
12.8 Interest, royalties and dividends………………………………………...…………... 201
12.9 Disclosure requirements………………………………………………….................. 202
12.10 Summary…………………………………………………………………………… 204
12.11 References…………………………………………………………………………. 204
UNIT THIRTEEN
INVENTORIES (IAS 2)
13.0 Introduction……………………………………………………………..…………… 205

13.1 Objectives……………………………………………………………………………. 205
13.2 Scope exclusions…………………………………………………………………….. 206
13.3 Terminology……………………………………………………………..................... 206
13.4 Measurement rules and guidelines……………………………………..……………. 206
13.4.1 Cost of inventories………………………………………………………………… 207
13.4.2 Inventory costs for service providers……………………………………………… 208
13.4.3 Techniques for measuring cost……………………………………………………. 208
13.4.4 Cost formulae……………………………………………………………………… 208
13.5 Implementation of the lower of cost or net realisable value rule……………………. 209
13.6 Recognition of inventory as an expense………………………………….................. 214
13.7 Disclosure requirements…………………………………………………................... 214
13.8 Summary…………………………………………………………………………….. 216
13.9 References…………………………………………………………………………… 217
UNIT FOURTEEN
FINANCIAL REPORTING IN HYPERINFLATIONARY ECONOMIES

(IAS 29)
14.0 Introduction……………………………………………………………..................... 218

14.1 Objectives……………………………………………………………….................... 218
14.2 Key terms………………………………………………………………..................... 219
14.3 The meaning of hyperinflation………………………………………………………
219
14.4 The need to restate historic-based financial statements…………………................... 219
14.5 Concepts of capital maintenance……………………………………………………. 220
ICSAZ – P.M. PARADZA XIV

14.6 Restatement of historical cost financial statements…………………………………. 222
14.6.1 Gain or loss on net monetary position………………………………….................. 223
14.6.2 Accounting treatment of the gain or loss on net monetary position……………… 224
14.7 Implementation of IAS 29……………………………………………..…………... 224
14.8 Current cost financial statements………………………………………................... 232
14.9 Common requirements for historical cost and current financial
statements………………………………………………………………………….. 233
14.10 Cessation of hyperinflationary conditions……………………………..................... 233
14.11 Disclosure requirements…………………………………………………………… 234
14.12 Summary…………………………………………………………………………… 235
14.13 References……………………………………………………………..…………… 235
UNIT FIFTEEN
AGRICULTURE (IAS 41)
15.0 Introduction……………………………………………………………………......... 236
15.1 Objectives…………………………………………………………………………… 236
15.2 Terminology………………………………………………………………………… 236
5.3 Recognition and measurement issues…………………………………….................... 237
15.4 Gains and losses in agricultural activity………………………………….................. 238
15.5 Inability to measure fair value reliably………………………………….................... 238
15.6 Accounting for government grants……………………………………….................. 243
15. 7.1 Illustrative presentation of the statement of financial position
for a Dairy Company………………………………………………........................ 245
15.7.2 Illustrative presentation of the statement of comprehensive
income for a Dairy Company………………………………..……………………. 245
15.7.3 Illustrative presentation of the statement of cash flows
for a Dairy Company……………………………………………………………… 245
15.8 Summary…………………………………………………………………………….. 246
15.9 References……………………………………………………………........................ 246
UNIT SIXTEEN
ACCOUNTING FOR GOVERNMENT GRANTS AND DISCLOSURE OF
GOVERNMENT ASSISTANCE (IAS 20)
16.0 Introduction…………………………………………………………………………. 247
16.1 Objectives…………………………………………………………………………… 248
16.2 Key terms……………………………………………………………...……………. 248
16.3 Recognition in financial statements…………………………………………………. 248
16.4 Basic accounting approaches……………………………………………................... 249
16.4.1 Accounting for specific types of grant……………………………………………. 250
16.5 Repayment of government grants……………………………………........................ 258
16.6 Other forms of government assistance………………………………........................ 259
ICSAZ – P.M. PARADZA XV

16.8 Summary………………………………………………………………..…………… 259
16.9 References……………………………………………………………….................... 260
UNIT SEVENTEEN
RELATED PARTY DISCLOSURES (IAS 24)
17.0 Introduction…………………………………………………………………………. 261
17.1 Objectives……………………………………………………………........................ 261
17.2 Terminology…………………………………………………………........................ 261
17.2.1 Related party………………………………………………………......................... 261
17.2.2 Related party transaction…………………………………………...……………… 262
17.2.3 Compensation……………………………………………………………………… 262
17.2.4 Control………………………………………………………………….................. 263
17.2.5 Key management personnel…………………………………………..…………… 263
17.3 Determination of related party relationships……………………………................... 263
17.5 Summary……………………………………………………………......................... 271
17.6 References……………………………………………………………….................... 271
UNIT EIGHTEEN
ACCOUNTING AND REPORTING BY RETIREMENT BENEFIT

FUNDS (IAS 26)
18.0 Introduction…………………………………………………………………………. 272

18.1 Objectives…………………………………………………………............................ 272
18.2. Key definitions……………………………………………………………………… 273
18.3 Difference between funding and accounting requirements…………………………. 274
18.4 Accounting by defined contribution plans………………………............................... 274
18.5 Accounting by defined benefit plans……………………………............................... 275
18.6 Valuation of plan assets……………………………………………………………... 276
18.7. Disclosure requirements……………………………………………………………. 277
18.8 Summary…………………………………………………………………………….. 278
18.9 References…………………………………………………………………………… 279
ICSAZ – P.M. PARADZA XVI

Examples and Activities
UNIT ONE
AND ERRORS (IAS 8)
Example 1………………………………………………………………………………… 3
Example 2………………………………………………………………………………… 6
Example 3………………………………………………………………………………… 8
Activity 1………………………………………………………………………………… 9
Example 4………………………………………………………………………………… 12
Example 5 – Retrospective correction of a prior period error………………….. 17
UNIT TWO
Example 1………………………………………………………………………………… 24
Example 2………………………………………………………………………………… 27
Activity 1………………………………………………………………………………… 29
Activity 2………………………………………………………………………………… 29
UNIT THREE
Example 1 – Weighted average rate……………………………………………. 33

Example 2 – Actual rate with investment………………………………………. 34
Example 3 – Weighted average expenditure…………………………………… 34
Activity…………………………………………………………………………………… 35
Example 4………………………………………………………………………………… 35
UNIT FOUR
ICSAZ – P.M. PARADZA XVII

Example – Effective interest rate method…………………………………….. 42
Example 1 – Trade date vs. settlement date (purchase of asset)………………... 44
Example 2 – Trade date vs. settlement date (sale of asset)……………………... 48
Activity – Recognition and derecognition………………………………….... 54
Example – IAS 32 classification…………………………………………….... 60
Example – Split accounting to compound financial instruments…………….. 62
Activity – Split accounting…………………………………………………... 62
Example – Assessment of impairment (IAS 39)……………………………... 66
Example – Impairment incurred versus expected loss……………………….. 69
Example – Expected loss……………………………………………………... 70
Activity – Expected loss model……………………………………………… 71
Example – Fair value hedges (IAS 39)……………………………………….. 74
Example 1 – Cash flow hedges………………………………………………… 77
Example 2 – Cash flow hedges (IAS 39)………………………………………. 79
UNIT FIVE
INSURANCE CONTRACTS
Activity 1………………………………………………………………………………… 89
Example – Unbundling a deposit component………………………………… 93
Example – Unbundling a deposit component………………………………… 93
UNIT SIX
ASSETS (IAS 37)
Example 1………………………………………………………………………………… 100
Example 2 – Contaminated land-Legislation virtually certain to
be enacted (IAS 37)………………………………………………. 102
Example 3………………………………………………………………………………… 103
Activity 1………………………………………………………………………………… 104
Activity 2………………………………………………………………………………… 107
Example 4………………………………………………………………………………… 108
UNIT SEVEN
Example – IFRS 15………………………………………………………….... 111
Example 15 – Consideration is not the stated price-Implicit price concession
(from IFRS)………………………………………………………. 113
Activity…………………………………………………………………………………… 114
Example 8 – Contract modification resulting in a cumulative catch-up
adjustment to revenue…………………………………………….. 116
Example 11 – Determining whether goods or services are distinct (IE49-IE58)... 118
ICSAZ – P.M. PARADZA XVIII

Example on allocation of transaction price………………………………………………. 126
Example on calculation of contract profit………………………………………………... 129
Example – T Ltd……………………………………………………………… 130
Activity…………………………………………………………………………………… 132
UNIT EIGHT
Example 1 – Frequently asked questions relating to IFRS 8…………………… 145
Example – Operating segments (Comprehensive)……………………………. 146
UNIT NINE

Example 1………………………………………………………………………………… 156
Example 2………………………………………………………………………………… 156
Example 3 – XY Ltd…………………………………………………………….. 159
UNIT TEN
Activity 1………………………………………………………………………………… 169
Example 1 – K Ltd ……………………………………………………………... 170
Example 2 – Transfer from investment property (IAS 40) to owner-occupied
property (IAS 16)………………………………………………… 171
Example 3 – Transfer from owner-occupied property to investment property)... 172
UNIT ELEVEN
Examples – Monetary items………………………………………………….... 178
Examples – Non-monetary items……………………………………………… 178
Activity 1 ………………………………………………………………………………... 179
Example 1 – Uncovered foreign currency transaction………………………….. 180
Example 2 – Uncovered foreign currency transaction………………………….. 181
Activity 2…………………………………………………………………………………. 184
Example – Foreign loan accessed by a subsidiary from parent......................... 185
Activity 3 – Disposal of a foreign operation…………………………………... 186
UNIT TWELVE
REVENUE (IAS 18)
Example – Recognized of revenue under deferred payment…………………. 191
Example – Revenue recognition under credit installment sales ……………... 192
ICSAZ – P.M. PARADZA XIX

Activity – Revenue recognition……………………………………………… 192
Example – Revenue recognition (rendering of services)……………………... 194
Example – Calculation of effective interest rate……………………………… 202
Activity – GIT Electronics…………………………………………………… 203
UNIT THIRTEEN
INVENTORIES (IAS 2)
Example 1 – GD Ltd. Manufacturers…………………………………………... 210

Example 2 – T Ltd……………………………………………………………… 211
Example 3 ………………………………………………………………………………... 215
Activity – D Ltd……………………………………………………………… 216
UNIT FOURTEEN

(IAS 29)
Example 1………………………………………………………………………………… 221

Example 2 – Restating revenue………………………………………………… 224
Example 3 – Restating cost of goods sold……………………………………… 225
Example 4 – Including calculation of net monetary position…………………... 226
Example – Arusha Ltd………………………………………………………... 229
Activity 1………………………………………………………………………………… 234
Activity 2………………………………………………………………………………… 234
UNIT FIFTEEN

Example 1………………………………………………………………………………… 239
Activity …………………………………………………………………………………... 245
UNIT SIXTEEN

Example 1 – J Ltd………………………………………………………………. 250
Example 2 – Asset based grant…………………………………………………. 252
Example 3 – Income based grant……………………………………………….. 254
Example 4 – Conditional repayment of government grant……………………... 257
Activity…………………………………………………………………………………… 258
UNIT SEVENTEEN
ICSAZ – P.M. PARADZA XX

Example – Symphony Limited……………………………………………….. 267
Activity – Mrs. Ruvimbo - CEO of H Ltd…………………………………… 271
UNIT EIGHTEEN

FUNDS (IAS 26)
Activity 1………………………………………………………………………………… 274

Activity 2 – Mini research exercise……………………………………………………… 278
ICSAZ – P.M. PARADZA XXI

UNIT ONE
AND ERRORS (IAS 8)
1.0 INTRODUCTION
In Volume 1 of this Module, it was pointed out that the quality of earnings has occupied the
minds of accounting researchers and practitioners for many centuries. What is referred to as
the bottom line is the net profit after tax and preference dividends and has proved to be very
controversial because it is this profit which is the source of dividends for ordinary
shareholders. It is true that these shareholders expect dividends, capital gains and the growth
of their investments. However, the payment of dividends is normally considered to be a sign
of the company's ability to take care of its shareholders' needs for cash as well as a pointer to
its future profitability.
Decisions concerning dividends are made by the directors and management of the company
based on the profits of a particular period, as well as the availability of cash flows. It should
be noted that companies are permitted to use retained earnings in order to meet dividend
commitments. In this context, the critical nature of accounting information, especially that
found in the statement of comprehensive income and the statement of changes in equity,
cannot be over emphasized. The situation is complicated by the fact that directors and
management are usually both referees and players in the wealth allocation game with
shareholders. These company insiders can therefore, use certain accounting policies and
changes in these policies to achieve certain objectives.
1.1 OBJECTIVES
By the end of this Unit, you should be able to:
• Define and distinguish between accounting policies and accounting estimates;
• Explain the major types of errors and adjustments which can affect the statement of comprehensive
income and the statement of financial position;
• Define and distinguish between retrospective application, retrospective restatement and prospective
application in the context of accounting policies and accounting estimates:
• Explain the selection and application of accounting policies according to IAS 8;
• Outline the disclosure requirements for accounting policies and accounting estimates according to
IAS 8.
1.2 KEY DEFINITIONS

Accounting policies are the specific principles, bases, conventions, rules and practices applied by
an entity in the preparation and presentation of financial statements.
Accounting estimates are used by a company whenever recognized financial items cannot be
measured with certainty. Examples of such estimates are inventory values, residual values of
non-current assets and future tax liabilities.
ICSAZ – P.M. PARADZA 1

A change in accounting estimate involves an adjustment of the carrying amount of a liability,
or the amount representing the periodic consumption of an asset. The standard explains that
such changes result from new information or new developments, and should not be classified
as corrections of 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, or misuse of, reliable information that:
i) was available when financial statements for those periods were authorised for issue, and
ii) could reasonably be expected to have been obtained and taken into account in the
preparation and presentation of those financial statements.
Omissions or misstatements of items are considered to be material if they could individually
or collectively influence the economic decisions of users based on the financial statements.
Materiality depends on the size and nature of the omission or misstatement in the relevant
context.
The sources of such errors include mathematical mistakes, mistakes in the application of accounting
policies, oversight or misinterpretation effects, as well as outright fraud.
Retrospective application refers to the use of a new accounting policy to transactions, other events
and conditions as if that policy had always been in existence.
Retrospective restatement involves correcting the recognition, measurement and disclosure of affected
elements of financial statements as if a prior period error had never occurred.
Prospective application of a change in accounting policy and of recognizing the effect of a change in
an accounting estimate refers to:
a) the application of a new accounting policy to transactions, other events and conditions
occurring after the date on which the policy is changed
b) the recognition of the effect of a change in an accounting estimate in the current and future
periods.
1.3 SELECTION AND APPLICATION OF ACCOUNTING POLICIES
IAS 8 states that when a standard or an interpretation specifically applies to a transaction,
other event or condition, the accounting policy or policies to be applied to that item should be
identified with reference to the relevant standard or interpretation, as well as any
implementation guidance which is available. An entity is not required to apply the identified
policies when their effect is immaterial.
However, the standard emphasizes that “… it is inappropriate to make, or leave uncorrected, immaterial
departures from IFRSs to achieve a particular presentation of an entity's financial position, financial
performance or cash flows”. It is generally inappropriate to window dress or aggressively account.
Where there is no relevant standard or interpretation, entities are allowed to use professional judgment
to ensure information that is:
i) relevant to the economic decision-making needs of stakeholders ii)
reliable, which means that the financial statements will

a) represent faithfully the financial position, financial performance and cash flows of the entity
b) reflect the economic substance of transactions, other events and conditions, and not merely
the legal form
c) are neutral, that is, free from bias
d) are prudent
e) are complete in all material respects
Entities are also permitted to take into account the most recent pronouncements of other
standard-setting bodies that base their accounting standards on similar conceptual
frameworks, other accounting literature and accepted industry practices.
EXAMPLE 1
The following financial statements relate to ABC Ltd.
Statement of comprehensive income for years-ended 31 March
20-6 20-7
$ $
Operating profit 3 430 000 4 730 680
Interest paid (49 720) (368 925)
Profit before tax 3 380 280 4 361 755
Tax expenses (1 195 828) (1 195 788)
Profit after tax 2 184 452 3 165 967
Earnings per share 273 cents 396 cents
Dividend per share 22 cents 31 cents
Statement of changes in equity for year 31 March 20-7
Retained Earnings
$
Balance b/d 1/04/2005 10 168 000
Profit for the year after tax 2 184 452
Dividends (175 000)
Balance on 31/03/20-6 12 177 452
Dividends (250 000)
Balance c/d 31/03/20-7 15 093 419 Additional
information
i) The company started constructing a new factory on 1 April 20-3. The project is
expected to be completed by 31 December 20-7, and the factory will be used from
that date.
ii) After the financial statements for the year-ended 31 March 20-7 had been drafted, the
company’s directors decided to change the accounting policy on borrowing costs and
use the mandatory treatment required by IAS 23, leading to the capitalization of
qualifying borrowing costs.

iii) The borrowing costs which were incurred and capitalized were as follows:
Years-ended 31 March
20-5 20-6 20- 7
$ $ $
Borrowing costs incurred 136 170 49 720 368 925
Borrowing costs to be capitalized 125 280 49 720 228 900
iv) The applicable company tax rate is 40%. The company makes a provision for
deferred tax in its financial statements.
v) The company's share capital consists of 800 000 ordinary shares of $1.25 each.
REQUIRED
Prepare the company's statement of comprehensive income and statement of changes in equity
(retained profits only) for the year-ended 31 March 20-7. Show accounting policy notes to the financial
statements.
SUGGESTED SOLUTION
ABC Ltd
Restated statement of comprehensive income or year ended 31 March
20-7 20-6
$ $
Interest Paid (368 925 -228 900) (49 720 - 49 720) 140 025 Nil
Tax expense (1 195 788 + 640 474) (1 195 828 + 176 172) (1 836 262) (1 372 000)
Profit after tax 2 754 393 2 058 000
Earnings per share (800 000 shares) 344 cents 257 cents Dividends per
share (800 000 shares) 31 cents 22 cents ABC Ltd
Restated statement of changes in equity for the year ended 31 March 2007
Retained profits
$
Balance b/d 1/04/05 10 168 000
Change in accounting policies (21 452)
Restated balance 10 146 548
Profit for the year (restated - 2006) 2 058 000
Dividends (175 000)
Balance c/d 31/03/06 12 029 548
Net profit for the year 754 393
Dividends (250 000)
Balance c/d 31/03/07 14 533 941
ABC Ltd
Notes to the financial statements for the year ended 31 March 2007

1. Accounting policy
Borrowing costs incurred with respect to qualifying assets are capitalised. This represents a change in
accounting policy.
2. Finance costs
2007 2006
$ $
Total interest paid 368 925 49 720
Capitalised portion 228 920 49 720
140 025 —
2007 2006
$ $
3. Company tax expense (w2) 1 836 262 1 372 000
4. Change in accounting policy
The company recently changed its policy in respect to borrowing costs. While borrowing costs
on qualifying assets were previously expensed, such costs are now added to the cost of
relevant assets. This change in policy has been accounted for retrospectively to show the
effect of the change. The effect is calculated as follows:
2007 2006
$ $
Decrease in finance charges 228 900 49 720
Increase in tax expense (w2) 640 474 176 172
Decrease in profit 411 574 126 452
Increase in property, plant and equipment 403 900 175 000

(125 280 + 49 720 + 125 280)
Decrease in deferred tax asset (161 560) (70 000)
Increase in equity 242 340 125 000
Adjustments against retained profit at beginning of 2006 21 452

WORKINGS
w1 Decrease/ Increase in Deferred tax

2007 2006
$ $
Increase in property, plant and equipment 403 900 175 000
Decrease in deferred tax asset 161 560 70 000
w2 Tax expense
2007 2006
$ $
Total 1 195 788 1 195 828
Increase in tax expense (note 4) 640 474 176 172
Current taxation 1 836 262 1 372 000
EXAMPLE 2
Using the same information as in EXAMPLE 1 except that item (iii) should read as follows
Year-ended 31 March
20-5 20-6 20- 7
$ $ $
Borrowing costs to be capitalized ? ? 228 900
The total borrowing costs to be capitalized in 2005 and 2006 amount to $175 000, but it is not practicably
possible to allocate this amount between the two years.
REQUIRED
Prepare the company's income statement and statement of changes in equity (retained profits
only) for the year -ended 31 March 20- 7. Show accounting policy notes related to the changes
in the accounting statements.
SUGGESTED SOLUTION
Statement of comprehensive income for years-ended 31 March
20-6 20- 7
$ $
Interest expense (49 720) (140 025)

Tax expense (40%) (1 352 112) (1 836 262) Net
profit after tax 2 028 168 2 754 393
Statement of changes in equity for year 31 March 20 – 7
Retained Earnings
$
Balance b/d 1/04/20-5 10 168 000
Net profit for the year 2 028 168
Dividends (175 000)
Balance on 31/03/20-6 12 021 168
Effects of change in accounting policy (169 234)*
Balance on 31/03/20-6 (restated) 11 851 934
Dividend on 31/03/20-7 (250 000)
Balance c/d 14 356 327
* 411 574 – 242 340 = 169 234 (calculation from the last example)
Notes for the year ended 31 March 20-7
The company recently changed its policy in respect of borrowing costs .While borrowing costs
on qualifying assets were previously expensed, such costs are now added to the cost of the
relevant assets. Due to insufficient information, it is not possible to fully account for this
change retrospectively in relation to the results of the years-ended 31 March 2006 and 2007.
The change has therefore been applied retrospectively from the beginning of the current
financial year, with an adjustment of $169 234 being effected on the opening balance of
retained profits. The effect of the change in accounting policy is calculated as follows:
2007
$
Decrease in finance charges 228 900
Increase in tax expense (640 474)
Decrease in profit 411 574
Increase in property, plant and equipment (175 000 + 228 900) 403 900
Decrease in deferred tax asset (161 560)
Increase in equity 242 340
Increase in earnings per share 73 cents
EXAMPLE 3
Using the same information as in EXAMPLE 1, except that item (iii) should read as follows:
Year -ended 3 1 March
20-5 20-6 20-7

$ $ $
Borrowing costs to be capitalized ? 49 720 228 900
Due to insufficient information, it is not practicably possible to determine the borrowing costs that
should have been capitalized in 20-5.
REQUIRED
(retained profits only) for the year-ended 31 March 20-7. Show also the note related to the
change in accounting policy.
SUGGESTED SOLUTION
Statement of comprehensive income for the year-ended 31 March
20-6 20-7
$ $
Interest expense Nil (140 035)
Tax-expense (40%) (1 372 000) (1 836 262)
Net profit after tax 2 058 000 2 754 393
Earnings per share (800 000 shares) 257 cents 344 cents
Retained earnings
$
Balance b/d 1/04/20-5 10 168 000
Dividends (175 000)
Balance on 31/03/20-6 12 051 000
Effects of change in accounting policy 2 754 393
Balance on 31/03/20-6 (restated) (250 000)
Balance on 31/03/20-7 14 555 393
Notes for the year ended 31 March 20-7

The company recently changed its policy in respect of borrowing costs. While borrowing
costs on qualifying assets were previously expensed, such costs are now added to the costs of
the relevant assets. Due to insufficient information, it is not possible to fully account for this
change retrospectively, since the company was unable to determine the cumulative effect of
the change at the beginning of the year-ended 31 March 20-7. As a result the change was
applied retrospectively from the beginning of the current financial year, without an adjustment
against the opening equity balance on 1 April 20- 6. The effect of the change in accounting
policy is calculated as follows:
2006 2007
$ $
Decrease in finance charges 49 720 228 900
Increase in tax expense (176 172) (640 474)
Decrease in profit 126 452 411 574
Increase in property, plant and equipment 49 720

(49 720 + 228 900) 278 620
Decrease in deferred tax asset (40%) (19 888) (111 448)
Increase in equity 29 832 167 172
Increase in earnings per share 47 cents 73 cents
ACTIVITY 1
The following financial statements relate to XYZ Ltd.
20–4 20–5
$ $
Interest expense (340 000) (750 000)
Tax-expense (1 674 200) (1 780 000)
Net profit after tax 2 777 800 4 120 000
Dividend per share 24.5 cents 35 cents
Retained Earnings
$
Balance b/d 1/1/20-4 14 325 000
Dividends (245 000)
Balance on 31/12/20-4 16 777 800
Dividends (350 000)
Balance on 31/12/20-5 20 547 800

Additional Information
i) The company commenced building a new factory on 1 January 20-3. The project is
expected to be completed by 31 December 20-5, and the factory will be used from
that date.
ii) After the financial statements for the year-ended 31 December 20-3 had been drafted,
the company's directors decide to change the accounting policy on borrowing costs
and use the mandatory treatment required by IAS 23, leading to the capitalization of
borrowing costs.
iii) The borrowing costs, which were incurred and capitalized were as follows:
Year-ended 31 December
20-3 20-4 20-5
$ $ $
Borrowing costs to be capitalized 230 000 340 000 500 000
iv) The applicable company tax rate is 35%. The company makes a provision for
deferred tax in its financial statements.
v) The company's share capital consists of 1 000 000 ordinary shares of $1 each.
REQUIRED
a) Prepare the company's statement of comprehensive income and statement of changes in equity (retained
profits only) for the year ended 31 March 20-5. Show accounting policy as well other relevant notes to the
financial statements.
b) Using the same information as in (a) above except that item (iii) should read as follows:
20-3 20-4 20-5

$ $ $
The total borrowing costs to be capitalized in 20-3 and 20-4 amount to $570 000, but it is not practicably
possible to allocate this amount between the 2 years.
REQUIRED
(retained profits only) for the year ended 31 December 20-5.Show also the note related to the
c) Using the same information as in (a) above except that item (iii) should read as follows:

20-3 20-4 20-5
$ $ $
Due to insufficient information, it is not practicably possible to determine the borrowing costs that
should have been capitalized in 20-3
REQUIRED
(retained profits only) for the year ended 31 December 20-5. Show also the note related to the
1.4. CHANGES IN ACCOUNTING ESTIMATES
Para 32 of the standard explains that due to uncertainties inherent in most business activities,
many items in financial statements cannot be measured with precision, but can only be
estimated. This estimation requires the use of informed judgments based on the latest
available, reliable and relevant information.
Examples of items that need to be estimated are:
a) irrecoverable debts
b) inventory obsolescence
c) the fair value of financial assets or financial liabilities
d) the useful lives of, or expected pattern of consumption of the future economic benefits embodied in
depreciable assets and
e) warranty obligations
The following important provisions for the standard should be noted:
1. An estimate may need to be revised if changes occur in the circumstances on which it

was based, or as a result of new information or more related experience. By its very
nature, the revision of any estimate does not relate to prior periods and does not
therefore constitute the correction of an error.
2. A change in the measurement basis applied to a transaction type is a change in an

accounting policy, not an accounting estimate. If it is difficult or impossible to
distinguish between a change in an accounting policy and a change in an accounting
estimate, such a change should be treated as a change in an accounting estimate.
1.4.1 Accounting for Changes in Accounting Estimates
The effect of a change in an accounting estimate should be recognized prospectively in the statement of
comprehensive income as follows:

i) in the period affected by the change, if the change affects the period.
ii) in the period of the change and future periods, if the change affect both periods.
This means that the change should be applied to transactions which occur in the current and
future periods. If a change in an accounting estimate affects the recognition and measurement
of assets and liabilities or relates to any item of equity, the change should be recognized by
adjusting the carrying amount of the related assets, liability or equity item in the period of
change.
EXAMPLE 4
The following information was summarized from the financial statement of TX Ltd. for 2 consecutive
years:
Statement of comprehensive income for year 31 December
20-8 20-9
$ $
Operating profit before tax 345 000 448 500
Company tax (138 000) (179 400)
Profit after tax 207 000 269 100
Statement of changes in equity for years ended 31 December
20-8 20-9
$ $
Balance b/d 233 250 490 000
Profit for the year 256 750 269 500
Balance c/d 490 000 759 500
Statement of financial position as at 31 December
20- 8 20-9 $
ASSETS $
1 331 050 1 873 790

2 159 050 2 536 190
Non-current assets 828 000 662 400
Net currents assets
EQUITY & LIABILITIES

Ordinary share capital 1 500 000 1 500 000
Retained earnings c/d 490 000 759 500
Deferred tax 169 050 276 690
2 159 050 2 536 190

i) The non-current assets were purchased on 1 January 20- 7 for $1 380 000 and they are
being depreciated at 20% p. a. on the straight line method, with no estimate for the residual
value. ii) The applicable rates for the special initial allowance on non-current assets are 1st
year 50 %, 2nd year 25 % and 3rd year 25 %.
iii) The company tax rate is 35%
On 31 December 20-9 the company estimated that the non-current assets would have a
maximum remaining useful life of 6 years with effect from 1 January 2009. The straight line
method would continue to be used.
REQUIRED
Redraft the financial statements taking into account the additional information.
SUGGESTED SOLUTION
$
i) Carrying amount of non-current asset 31 December 20-7
($1 380 000 x 80%) = 1 104 000
31 December 20-8
($1 380 000 x 60%) = 828 000
ii) Annual depreciation for 20-9 based on new rate ($828 000/6) = 138 000
iii) Annual depreciation for 20-9 based on old rates ($828 000/5) = 165 600
iv) Timing difference for 20-9

$
S.I.A 345 000
Depreciation (138 000)
Timing difference 207 000
Deferred tax for the year $207 000 * 35% = $72 450
v) Closing deferred tax balance

Balance as at 1/1/20-9 (828 000-345 000) * 35% 169 050
Add current year charge 72 450
241 500
vi) Carrying amounts of non-current assets as at 31/12/20-9 $

Balance before adjustment 662 400

Depreciation under old rate 165 600
Depreciation under new rate (138 000)
690 000
vii) Adjusted operating profit before tax

Net profit before adjustment = 448 500
Add back original depreciation = 165 600
Less new depreciation = (138 000)
476 100
viii) Taxable income for 19-9

Operating profit before tax = 476 100
Add back new depreciation = 138 000
Less accelerated wear and tear = (345 000)
269 100
Current tax @ 35% 94 185
TX LTD
Statement of comprehensive income for year-ended 31 December 20-9
Note $
Operating profit before tax 476 100
Company tax 2 (166 635)
309 465
Statement of changes in equity for the year ended 31 December 20-9
Retained Earnings
$
Balance as at 1/1/20-9 490 000
Profit for the year 309 465
Balance as at 31/12/20-9 799 465
Statement of financial position as at 31 December 20-9
ASSETS $
Non-current assets 690 000
Net-current assets 1 850 965
2 540 965

Share capital and reserves
Ordinary share capital 1 500 000
Retained earnings 799 465
Non-current liabilities

Deferred tax 241 500
2 540 965
DEFERRED TAX LEDGER A/C
20-7 $ 20-7 $
Dec 31 Balance c/d 144 900 Dec 31 SCI 144 900
20-8 20-8
Dec 31 Balance c/d 169 050 Jan 1 Balance b/d 144 900
Dec SCI 24 150
169 050 169 050
20-9 20-9
Dec 31 Balance c/d 241 500 Jan 1 Balance b/d 169 500
Dec 31 SCI 72 450
241 500 241 500
WORKINGS
Deferred Tax Calculations $
20-7
S I A (1 380000 * 50%) 690 000
Depreciation (1 380000* 20%) (276 000)
Deferred Tax 414000 * 35% 144 900
20-8
S I A (1 380 000 * 25%) 345 000
Depreciation (1 380 000 * 20%) (276 000)
Deferred Tax 69 000 * 35% 24 150
20-9
S I A (1 380 000 * 25%) 345 000
Depreciation (1 380 000 * 20%) (138 000)
Deferred Tax 207 000 * 35% 72 450

20-9
Before change in estimate –
S I A (1 380 000 * 25%) 345 000
Depreciation (1 380 000 * 20%) (165 600)
Deferred Tax 179 400 * 35% 62 790 Notes to the financial statements for year-
ended 31 December 20-9
1.1. Depreciation
Non-current assets are depreciated on a straight-line basis over 6 years, without any estimate for
residual value.
Deferred Taxation
It is provided for using the comprehensive liability method.
2. Taxation
The company tax figure in the income statement is made up as follows:

$
Current tax expense 94 185
Deferred tax expense 72 450
166 635
3. Change in accounting estimate
During the year-ended 31 December 20-9, the company changed the depreciation rate for non-
current assets from 20% straight line to a situation where the assets would depreciate over 6
years on a straight-line basis with effect from 1 January 20-9.
1.5. THE NATURE OF ACCOUNTING ERRORS
Para 41 of IAS 8 points out that errors can arise from the recognition, measurement,
presentation or disclosure of elements of financial statements. According to this para, financial
statements do not comply with IFRSs if they contain either material errors or immaterial
errors made intentionally to achieve a particular presentation of an entity’s financial
performance or cash flows.
1.5.1 Treatment of Accounting Errors
Potential current period errors discovered in that period should be corrected before the
financial statements are authorized for issue. Material errors which are not discovered until a
subsequent period should be corrected in the comparative information which is presented in
the financial statements for that period.

Another important provision of this section is that an entity should correct material prior
period errors prospectively in the first financial statements authorized for issue after their
discovery. This should be done by:
a) restating the comparative amounts for the prior period(s) presented in which the error
occurred or
b) if the error occurred before the earliest prior period presented, restating the opening
balances of assets, liabilities and equity for the earliest prior period presented.
Such errors should be corrected through retrospective restatement unless it is impracticable to

determine either the period-specific or the cumulative effect of the errors. When this is the
case, the entity should restate the opening balance of assets, liabilities and equity for the
earliest period in which retrospective restatement is practicable, which may be the current
period. If it is impracticable to determine the cumulative effect, at the beginning of the current
period, of an error on all prior periods, the entity should restate the comparative information to
correct the error prospectively from the earliest practicable date.
Important Note!!
The correction of an error should be distinguished from a change in an accounting estimate. Accounting
estimates by their nature are approximations that may need to be revised, as additional information becomes
known. For example the gain or loss recognized on the outcome of a contingency should note be classified
as the correction of an error.
EXAMPLE 5 (RETROSPECTIVE CORRECTION OF A PRIOR PERIOD ERROR)
P Ltd values all its inventory at the lower of cost or net realizable value based on the FIFO
method. The value of work- in-progress includes all direct overheads calculated on the normal
capacity. The closing inventory as 31 December 20-6, 20-7 and 20-8 was originally recorded
as follows:
Raw Mat W.I.P Finished Goods

$ $ $
20-6 185 040 251 300 809 500
20-7 215 880 269 850 450 000
20-8 192 750 262 140 784 900
An audit of the company's financial statements for the year-ended 31 December 20-8 showed errors
in the finished goods inventory for the 3 years. The figures were revised as follows:
$
20-6 1 125 000
20-7 540 000
20-8 1 200 000

The draft financial statements (before the discovery of the valuation errors) showed the following profit
before tax figures:
$
20-6 1 890 000
20-7 2 184 500
20-8 2 560 000
The company had made the following provisional tax payments for the 3 years:
$
20-6 629 700
20-7 764 800
20-8 932 400
The company tax rate has remained unchanged at 35% for the past 3 years. The company normally
pays a total dividend of $250 000 at the end of each financial year.
Other relevant information is as follows
Retained earnings at 1/01/20-7 3 740 000

Retained earnings at 1/01/20-8 4 950 000
Issued share capital (1 000 000 ordinary shares of $1.50 each) 1 500 000
REQUIRED
Disclose the above information in the company's income statement, statement of changes in
equity and statement of financial position for the year ended 31 December 20-8. Show all the
relevant notes.
SUGGESTED SOLUTION
Statement of comprehensive income for year 31 December 20-8
20-8 20-7
$ $
Tax expense (35%) 1 009 785 685 600
Profit after tax 1 875 315 1 273 400
Statement of changes in equity for year 31 December 20-8
Retained Earnings
$

Balance b/d 31/12/20-6 3 740 000
Adjustment for error in prior periods (WI) 205 075
Restated balance 3 945 075
Profit for the year restated 1 273 400
Dividends (250 000)
Balance on 31/12/20-7 4 968 475
Profit for the year 1 873 315
Dividends (250 000)
Balance c/d 31/12/08 6 591 790
Note 20-7 20-8

ASSETS $ $
Current Assets
Inventory 1 025 730 1 654 890

Share Capital and reserves
Share premium 500 000 500 000
Current Liabilities
Company tax 31 275 108 885
Notes for year-ended 31 December 20-8
2. Taxation
20-7 20-8
$ $
Current tax expense 685 600 1 009 785
3. Prior period error
There was an error arising from inaccuracies in the valuation of finished goods inventory. As
a result, the opening balance of equity at the beginning of 20-7 has been adjusted, while the
comparative amounts have been restated accordingly. The effects of the adjustment on the 207
results is as follows:
$
Increase in cost of goods sold (w1) (225 000)
Decrease in taxation expense (w1) 78 925
Decrease in profit 146 575
Increase in inventory 90 000

Increase in taxation due (31 500)
Increase in equity 58 500
Adjustment against retained profits at the beginning of 2007 (w1)

Decrease/increase in earnings per share [127-(2 184 500 x 65/1 000 000)] = 15 cents
4. Inventory
20-8 20-7
$ $
Raw materials 192 750 215 880
Work in progress 262 140 269 850
Finished goods 1 200 000 540 000
1 654 890 1 025 730
WORKINGS
w1 Error in Inventory
20-8 Effect on 20-7 Effect on 20-6
$ $ $ $ $
Original inventory value (784 900) (334 900) (450 000) (359 500) (809 500)
Restated inventory value 1 200 000 660 000 540 000 585 000 1 125 000
Difference 415 100 325 100 90 000 (225 000) 315 000
Taxation at 35% (145 285) (113 785) (31 500) 78 925 (110 425)
269 815 211 315 58 500 146 575 205 075
w2 Profit before tax

20-8
20-7 $
$
Original amount 2 560 000 2 184 500
Correction of error (w1) 325 100 (225 500)
2 885 100 1 959 000
w3 Current Taxation On profit before taxation before adjustment

2 560 000 x 35 % = 896 000
2 184500 x 35% = 764 575
Correction of error 13 785 78 925
1 009 785 685 650
w4 Overpayment to ZIMRA [896 000 (w3)-932 400] (36 400) 225

[764 575 (w3)-764 800]
Taxation due with regard to inventory: Prior to 20-6 110 425 110 425
20-7 (78 925) (78 925)
20-8 113 785 Nil
108 885 31 275
1.6 DISCLOSURE OF PRIOR PERIOD ERRORS

It was previously stated that an entity should correct material prior period errors
retrospectively in the first set of financial statements authorized for issue after their discovery.
In doing so, the entity should disclose:
i) the nature of the prior period error.

ii) for each prior period presented, to the extent practicable, the amount of the
correction
a) for each financial line item affected
b) if IAS 33 is applicable, for basic and diluted earnings per share
iii) the amount of the correction at the beginning of the earliest prior period presented iv) if
retrospective restatement is impracticable for a particular prior period, the reasons for the
existence of that condition, and how and from when the error has been corrected.
1.7 SUMMARY
This Unit explains the various ways in which accounting information can be made more
meaningful and intelligible to users through various adjustments of previous estimates and
corrections of errors as soon as they are discovered. Accounting policies play a pivotal role in
the interpretation of financial statements, and companies should draft their policies in the light
of the changing information needs of users. This Unit and IAS 8 should be read in conjunction
with the IASB Conceptual Framework and IAS 1 (Presentation of Financial Statements).
1.8 REFERENCES
VORSTER, Q. Descriptive Accounting

KOORNHOF, C. et al 15th Edition LexisNexis/Butterworths 2010
SHOKO, D. Advanced Financial Accounting & Reporting

Denmark Training Services CIS Study Pack
2008
IASB International Financial Reporting Standards

2012

UNIT TWO
2.0 INTRODUCTION
It is a well-known fact in Financial Accounting that financial statements are rarely if ever,
published on the last day of the period to which they relate. This poses a problem concerning
the treatment of transactions and other events, which occur between the reporting date and the
date on which they are authorised for issue by the directors. Economic transactions will occur
during the normal course of business regardless of administrative cut-offs for financial
reporting and tax purposes. The IASB saw the need to address the grey area between the two
dates and provide guidance to preparers and users of financial statements.
2.1 OBJECTIVES
• define and explain the key terms in IAS 10;
• distinguish between the date when financial statements are authorised for issue and other cut-off
dates as explained in IAS 10;
• explain the recognition and measurement issues in IAS 10.
2.2 KEY DEFINITIONS
Events after the reporting date are those events, both favourable and unfavourable to the
entity, that occur between the reporting date and the date when the financial statements are
authorised for issue. It is possible to identify 2 types of events:

a) those that provide evidence or additional information on conditions that existed at the reporting
date, referred to as adjusting events after the reporting date or period;
b) those that relate to conditions that arose after the reporting date, referred to as non- adjusting
events after the reporting date or period.
2.3 RECOGNITION AND MEASUREMENT ISSUES
An entity should adjust the amounts recognised in its financial statements to reflect adjusting events
after the reporting date. Examples of such events are as follows:
i) The settlement after the reporting date of a court case which confirms that the entity
had a present obligation at that date. The entity should adjust any previously
recognised provision related to the case according to the guidance in IAS 37
(Provisions, Contingent Liabilities and Contingent Assets) or recognise a new
provision altogether.
ii) The receipt of information after the reporting date indicating the impairment of an
asset on that date, or the need to adjust a previously recognised impairment loss for
that asset.
• The bankruptcy of a customer occurring after the reporting date usually confirms that
a loss existed at that date on a trade receivable, and that the entity should adjust the
carrying amount of this asset.
• The sale of inventories after the reporting date may provide evidence about their net
realizable value on that date.
iii) The determination after the reporting date of the cost of assets purchased, or the proceeds from
assets sold, before the reporting date;
iv) The determination after the reporting date of the amount of profit sharing or bonus payments, if
the entity had a present legal or constructive obligation on that date to make such payments
arising from transactions or events before that date;
v) The discovery of fraud or errors that show that the financial statements have significant
inaccuracies.
An entity should not adjust the amount recognized in its financial statements to reflect
nonadjusting events after the reporting date. An example of such an event is a reduction in the
market value of the entity's investments between the reporting date and the date on which the
financial statements are authorized for issue. The entity should disclose the following
information for each material category of non-adjusting event after the reporting date:
• the nature of the event
• an estimate of its financial effect or a statement that such an estimate cannot be made

2.4 DISCLOSURE REQUIREMENTS
The standard provides the following examples of non-adjusting events which should be disclosed in the
statement of financial position:
i) a major business combination after the reporting date or the disposal of a major subsidiary;
ii) the announcement of a plan to discontinue an operation;
iii) major purchases of assets, classification of assets as held for sale, other disposals of assets, or
expropriation of major assets by the government;
iv) the destruction of a major production plant by fire after the reporting date; v) announcing, or
commencing the implementation of a major restructuring; vi) major ordinary share
transactions and potential ordinary share transactions after the reporting date;
vii) abnormally large changes in asset prices or foreign exchange rates after the reporting date;
viii) changes in tax rates or tax laws enacted or announced after the reporting date that
have a significant effect on current and deferred tax assets and liabilities;
ix) entering into significant commitments or contingent liabilities e.g. by issuing significant
guarantees
x) commencing major litigation arising solely out of events that occurred after the reporting
date;
xi) a decline in the market price of investments between the end of the reporting period and the
date when the financial statements are authorised for issue.
EXAMPLE
The directors of X Ltd received its financial statements for authorization on 25 March 20-7.
The company's financial year-end is 31 December. The following events occurred after the
year-end.
1) The selling prices of some items in X Ltd's product range were reduced to take into
account the sales promotion of a major competitor. These reductions were effected on
10 February 20-7, and were expected to cause a 20% decrease in the company's gross
profit. As a result, the company estimated that its net profit before tax for the year
ended 31 December 20-7 would go down by $1 850 000.
2) On 10 February 20-7 there was a burglary at the premises and goods worth $250 000
disappeared without trace. The company was not insured for this type of risk.
3) On 20 February 20-7 a firm of chartered secretaries announced that one of its clients
was suspending business operations due to economic difficulties. Available
information showed that this client could only pay 40 cents in the dollar to all
creditors. X Ltd was owed $150 000, and this amount was included in debtors on 31
December 20-6.
4) There was an outstanding legal case involving a customer who sued X Ltd. for goods
damaged in transit. These goods were sold in 20-6, and the customer commenced legal
action on 1 February 20-7. X Ltd has been advised by its lawyers that it will probably
lose the case, which would require $350000 to settle.
5) In December 20-6, X Ltd.'s R&D department finalized the design of a new product
which was expected to make the company more competitive in its line of business.

REQUIRED
a) State in each of the above cases whether an adjusting or non-adjusting event occurred.
b) Explain the effect of the events on the company's financial statements on 31 December 206.
c) Show an extract of the financial statements on 31 December 20-6, taking into account the additional
information.
SUGGESTED SOLUTION
1st case
(a) The information provided indicates a non-adjusting event.
(b) The reduction of selling prices is expected to reduce net profit before tax for the next period.
This information may be disclosed in the directors' report for the current period.
(c) Note disclosure in the Directors' report for year-ended 31 December 20-6 (extract)
The selling prices of some items in the company's product range were reduced to take into
account the sales promotion of a major competitor. As a result, the net profit before tax is
likely to go down by $ 1 850 000.
2nd case
(a) The information provided indicates a non-adjusting event.
(b) Although the company was not insured for this type of risk on 31 December 20-6, the loss should not be
incorporated in the financial statements for the year ended on that date. This is because the event giving
rise to the loss only occurred on 10 February 20-7.
However, the loss should be disclosed in the financial statements.
(c) Note disclosure under notes to the financial statements for year-ended 31 December 20-6
In February 20-7, a burglary at the premises resulted in a loss of goods worth $250 000 at cost.
3rd case
(a) The information provided indicates an adjusting event.
(b) Because the debtor has properly documented its position and notified all concerned parties, it is
unlikely that legal action will result in improved recovery. Therefore the loss should be written off.
Debtors should be reduced by $90 000, that is, $150 000*60%. Assuming a tax rate of 40% the
statement of comprehensive income and the statement of financial position will be adjusted by $36 000
with respect to tax.
(c) Face disclosure
Statement of comprehensive income for the year ended 31 December 20-6
$
Turnover xxx
Profit before tax (xxx-90 000) xxx
Company tax (xxx-36 000) xxx
Profit after tax (xxx-54 000) xxx

ASSETS
Current assets
Trade receivables (xxx-90 000) xxx
EQUITY AND LIABILITIES

Distributable reserves
Retained profits (xxx-54 000) xxx
Current liabilities
4th case
(a) The information provided indicates an adjusting event
(b) This case meets the requirements of IAS 37 for a present obligation arising from a past obligating
event which is defined as "-- an event that creates a legal or constructive obligation that results in an
entity having no realistic alternative to settling that obligation.” This case is an example of a contingent
loss which should be provided for in the statement of comprehensive income.
(c) i. Face disclosure
Statement of comprehensive income for the year-ended 31 December 20-6
$
Turnover xxx
Profit before tax (xxx-350 000) xxx
Profit after tax (xxx-210 000) xxx
Note $
Distributable reserve
Retained profits (xxx-210 000) xxx
Current liabilities 13
Provisions (xxx+350000) xxx
Company tax (xxx-36000) xxx
C ii. Note disclosure
Notes to the financial statements for the year ended 31 December 2006
13. Provisions
Carrying amount 31/12/20-5 xxx

Additional provision (xxx+350 000) xxx
Carrying amount 31/12/20-6 xxx

On 31 December 20-6, there was an outstanding legal case involving a customer who sued the
company for goods damaged in transit. Indications are that the company will lose the case,
which would require $350 000 to settle.
5th case
(a)The information provided shows that there was no event after the reporting date. (b)
Since no transaction has occurred, there is no effect on reporting for events after the reporting
date. However, this development may be mentioned in the Directors' report for the benefit of
shareholders.
(c) Disclosure - No specific disclosure is required.
2.5. ADDITIONAL CONSIDERATIONS
2.5.1 Dividends
IAS 10 states that if an entity declares dividends after the reporting date but before the
authorization of financial statements for issue, these dividends should not be treated as a
liability at that date. The declaration of dividends means that they have been authorized at an
appropriate level of authority and they are no longer subject to the entity's discretion. It should
be noted that such dividends do not meet the criterion of a present obligation according to IAS
37. The correct treatment is therefore not to recognize them in the statement of changes in
equity and the statement of financial position but rather to disclose them in the notes.
According to Von Well & Wingard (2004), an entity's past practice of paying dividends does
not give rise to a constructive obligation and therefore does not create the need to recognize a
liability.
2.5.2 Going Concern Status
An entity's financial statements should not be prepared on a going concern basis if

management decides after the reporting date to liquidate the entity or suspend trading or
determines that there is no realistic alternative. IAS 10 explains that a deterioration in an
entity's operating results and/or financial position after the reporting date will often indicate a
need to reconsider the entity's going concern status. IF THIS IS NO LONGER
APPROPRIATE, THE
STANDARD REQUIRES A FUNDAMENTAL CHANGE IN THE BASIS OF
ACCOUNTING, RATHER THAN A ONCE-OFF ADJUSTMENT TO THE AMOUNTS
RECOGNISED IN THE FINANCIAL STATEMENTS. The going concern disclosures
required under IAS 1 will be applicable even if the related events or conditions arose after the
reporting date.
The disclosure requirements for events arising after the reporting period are stipulated as follows:
1. The date when the financial statements were authorized for issue;
2. Who gave the authorisation;
3. If any other party has the power to amend the statements after issue, this fact should be disclosed. In
addition, if the entity receives information after the reporting date about conditions that existed on that

date, it should update the related disclosures in the notes to the financial statements. This is required even
if the information has no effect on the amounts that have been recognised in the financial statements.
Examples have already been given of non-adjusting events after the reporting dates that are
normally required to be disclosed. IAS 10 notes that if such events are material, failure to
disclose them could influence economic decisions of users of the financial statements. Thus,
the entity should disclose the following information for each type of non-adjusting event that
occurs after the reporting date:
i) the nature of the event; .
ii) an estimate of its financial effect( s), or a statement that such an estimate cannot be
made.
EXAMPLE 2
The financial statements of M Ltd. (a motor vehicle manufacturer) for the year ended 30 June
20-7 were presented to the board of directors for authorization and issue on 30 September 207.
The following events took place after the financial year-end:
i) It was discovered that a credit sale transaction which occurred in March 20-7 had
been recorded as $260 000 instead of $2 600 000.
ii) On 31 July 20-7 M Ltd received information that N Ltd had declared an ordinary
dividend of 15%. M Ltd owns 300 000 of N Ltd's authorized and issued shares which
have a nominal value of $5 each.
iii) On 28 August 20-7 a major defect was discovered in one of the company's motor
vehicle models, resulting in the recall of 100 units. Production of the model had
started in the current financial year and the following cost estimates have been made
to have the problem rectified:
$
Cost to repair vehicles in stock 4 375 000
Cost to repair vehicles already sold
To tow to the premises 670 000
To repair 234 000
Costs related to vehicles manufactured between 1/07/2007
and 30/09/2007 1 645 000
Additional information
a) The company tax rate is 35%.

b) All amounts are material and the company's going concern status is not in doubt
REQUIRED
i) Explain how the events outlined will affect M Ltd's financial statements ii)
Show relevant extracts in the financial statements of M Ltd to comply with

SUGGESTED SOLUTION
i Explanation
This is an example of an event after the reporting date providing additional information on the
value of an asset at this date. The error which was made should be corrected by adjusting the
SFP
ASSETS $
Current assets xxx
Receivables (xxx + 2 340 000) xxx
SCI
Turnover xxx
Profit before tax xxx (xxx + 2 340 000) xxx
Company tax (xxx + 819 000) xxx
ii Explanation
This is an example of an event after the reporting date providing additional evidence on an asset -
the right to which accrued up to that date. This dividend income meets the criteria for benefits
which will flow to the entity, the amount can be measured reliably, and the right of M Ltd to
receive payment can be quantified.
Disclosure
SCI for the year-ended 30 June 20-7
$
Turnover xxx
Profit before tax (xxx + 225 000) xxx
SFP as at 30 June 20-7
ASSETS
Current assets
Receivables (xxx + 225 000) xxx
iii. Explanation
This is an example of an event after the reporting date providing additional evidence of
conditions existing on that date. There is proof that the asset of stock has been impaired. The
required accounting treatment is as follows:
a) The cost to repair vehicles in stock should be adjusted for in the financial statements. The
adjusted cost of closing stock should compared with its net realisable value, with this stock
being recorded at the lower of cost and net realisable value.

b) The cost to tow and repair the vehicles already sold should be shown as a provision in the
year ended 30 June 20-7.
c) Costs related to vehicles manufactured after 30 June 20-7 should not be adjusted for in the
year ended 30 June 20-7. However, this information can be disclosed as a note if failure to do
so would mislead the readers of the financial statements.
d) Event after the reporting date

The costs to rectify a material defect in vehicles manufactured by the company in the year ended -
30 June 20-8 amounted to 1 645 000. This will reduce profit after tax.
ACTIVITY 1
a) Define the term event after the reporting date.

b) Identify and give examples of 2 such types of events.
ACTIVITY 2
P Ltd is a manufacturer of brick-moulding equipment with a 30 September year end. The

company’s financial statements for the year-ended 30 September 20-8 were presented to the
board of directors for authorisation and issue on 30 November 20-8. On 25 October a material
defect was discovered in the design of the equipment. Production of the equipment had
commenced in the current financial year and the following cost estimates have been made to
have the problem rectified.
$
Costs to rectify closing inventory units 12 375 000
Costs to recover defective units sold 4 229 500
Costs to repair defective units sold 7 238 000
Costs to recover and repair defective units manufactured during
the year-ended 30 September 20-9 1 063 700
a) The company tax rate is 32.5%
b) All amounts are material and the company’s overall financial position is sound.
REQUIRED
i) Explain how the information provided will affect P Ltd’s financial statements.
ii) Show relevant extracts in the company’s financial statements to comply with the requirements
of IAS 10.
2.7 SUMMARY
IAS 10 is a standard which deals with the accounting treatment of post-reporting date events.
The standard is based on the fact there is usually a delay between a reporting entity’s formal
year -end and the date on which the financial statements approved for publication and issue.
Shareholders and other stakeholders require the maximum possible disclosure of information
related to the entity, as long as such information is not harmful to the entity’s interests. This

observation applies even if some transactions did not occur during the financial year under
review.
2.8 REFERENCES
KOPPESCHAAR, Z.R.; STURDY J. et al Descriptive accounting, IFRS Focus, 18th

Edition, LexisNexis, 2013
IASB IFRS Consolidated without early

application, Part B, 2015
UNIT THREE
3.0 INTRODUCTION
Most business activities are financed through the use of external funds, often referred to as
other people’s money on a short, medium or long term-basis. A company which relies on its
own sources of funds usually fails to undertake desired or meaningful expansion plans
because such funds may be tied up in non-current assets or working capital. On the other
hand, the advantages of borrowing are well documented in Corporate Finance, since the
judicious use of equity and debt is associated with a lower weighted average cost of capital.
The matching principle in Financial Accounting states that the income earned by a business
should be matched with the expenses which were incurred to earn it during the period in
question. This principle is related to the accruals concept, which necessitates the identification
of periods under which transactions should be correctly accounted for. The importance of
these core concepts is also recognised in Corporate Finance, where it is argued that short-term
needs should be financed with short-term sources. The major purpose of the matching
principle in this context is to relate the maturity of the sources of funds to the length of time
over which the funds are required. From the Financial Accounting view-point, when a
company incurs borrowing costs in relation to the acquisition or construction of certain

assets, such costs are considered to be an integral part of the assets’ total costs. The
requirements for borrowing costs are explained in IAS 23.
3.1 OBJECTIVES
• Define borrowing costs and give examples of expenses which meet this definition in the
context of IAS 23;
• Explain how borrowing costs eligible for capitalisation can be identified;
3.2 TERMINOLOGY AND EXAMPLES
The following key terms are defined in standard:
Borrowing costs are interest and other costs which are incurred by an entity in connection with
the borrowing of funds.
A qualifying asset is an asset that necessarily takes a substantial period of time before it is ready
for its intended use and purpose.
According to the standard borrowing costs may include
i) interest expense calculated using the effective interest method;
ii) finance charges in respect of finance leases recognised in accordance to IAS 17 (Leases);
iii) exchange differences arising from foreign currency borrowing to the extent that they are
regarded as adjustment to interest costs.
3.3.0 IDENTIFICATION OF COSTS THAT ARE ELIGIBLE FOR

CAPITALISATION
The most direct test of eligibility for the capitalisation of borrowing costs in relation to a
qualifying asset is if such costs could have been avoided if the expenditure on the asset had
not been incurred. A clear example of this situation is when an entity borrows funds
specifically for the purpose of acquiring, constructing or producing a particular qualifying
asset. However, difficulties can arise in trying to determine the borrowing that could
otherwise have been avoided. Examples of such circumstances are as follows:
a) The financing activity is co-ordinated centrally i.e. in a group situation, a qualifying

asset obtained by a company is financed through interest-free borrowing from its
holding company
b) The group uses a range of debt instruments to borrow funds at different interest rates,
and lends funds to individual companies in the group.

c) A qualifying asset is financed by the group or the company through a loan
denominated in or linked to a foreign currency, and the business is operating in a
highly inflationary environment or suffering from fluctuations in exchange rates.
The determination of capitalised borrowing costs should be before tax, as using the after tax figure
would understate the value at which the asset is initially stated.
3.3.1 Capitalisation Limits
The following important limits to the capitalisation of borrowed funds set out in the standard should
be noted:
Para 12 To the extent that funds are borrowed specifically for the purpose of obtaining a
qualifying asset, the amount of borrowing costs eligible for capitalisation on that asset should
be determined as the actual borrowing costs incurred on the borrowings during the period less
any investment of those borrowings.
Para 14 To the extent that funds are borrowed generally and used for the purpose of obtaining
a qualifying asset, the amount of borrowing costs eligible for capitalisation shall be
determined by applying a capitalisation rate on that asset. The capitalisation rate shall be the
weighted average of the borrowing costs applicable to the borrowings of the entity that are
outstanding during the period, other than borrowings made specifically for the purpose of
obtaining a qualifying asset. The amount of borrowing costs capitalised during a period shall
not exceed the amount of borrowings incurred during that period.
3.3.2 SUSPENSION OF CAPITALISATION
Capitalisation of borrowing costs should be suspended during extended periods when there is
no active development on the asset. Borrowing costs incurred during such periods are
considered to be costs of holding partially completed assets and do not qualify for
capitalisation. However, the following exceptions to this general rule should be noted
i. Capitalisation is not suspended when substantial technical and administrative work is
being carried out on the asset.
ii. Capitalisation is not suspended when a temporary delay is a necessary part of getting the
asset ready for its intended use or sale.
3.3.3 Cessation of Capitalisation
Capitalisation of borrowing costs should cease when all the activities necessary to prepare the
qualifying asset for its intended use or sale are substantially complete. If the asset's
construction is being completed in parts and each part can be used while construction
continues on the other parts, the capitalisation of borrowing costs should cease when all the
activities necessary to prepare that part for its intended use or sale are substantially complete.
EXAMPLE 1 (WEIGHTED AVERAGE RATE)
During 20-8 a company with a 31 December year end had average outstanding borrowings of $
7 920 000, while total interest paid amounted to $1 188 000.

Expenditure on qualifying assets was incurred as follows.
$
1/01/20-8 937 500
1/04/20-8 1 640 700
1/07/20-8 2 343 750
1/10/20-8 5 000 000
9 921 950
The qualifying assets were still under construction on 31 December 20-8.
REQUIRED
Calculate the interest to be capitalized on the assets based on the weighted average rate for
the period.
SUGGESTED SOLUTION
Average interest rate = $1 188 000/7 920 000 = 15%

Application of rate to actual borrowings:
937 500 * 15% * 12/12 140 625

1 640 700 * 15% * 9/12 184 588
2 343 750 * 15% * 6/12 175 781 5
000 000 * 15% * 3/12 187 500
688 494
Alternative calculation
Average expenditure during the period

9 37500 * 12/12 937 500
1 640 700 * 9/12 1 230 525
2 343 750 * 6/12 1 171 875
5 000 000 * 3/12 1 250 000
Total average expenditure 4 589 900
Application of rate to actual borrowings 15%

Interest to be capitalized in 20-8 $4 589 900 * 15% $ 688 484
EXAMPLE 2 (ACTUAL RATE WITH INVESTMENT)
A company spent $3 000 000 evenly throughout the initial year of a particular project. Total
project costs are expected to be $5 500 000. A loan of $5 500 000 was raised at the
commencement of the period. The interest rate on the loan is 20% while surplus funds can be
invested at 15% p.a.
REQUIRED

Calculate the borrowing costs to be capitalized.
SUGGESTED SOLUTION
$
Total borrowing costs $3 000 000 * 20% 600 000
Interest income on surplus funds 15% (375 000) (5 500
000 - 3 000 000) *15%
Interest to be capitalized 225 000
EXAMPLE 3-WEIGHTED AVERAGE EXPENDITURE
Assume the same data as for Example 1, except that the expenditure in January 20-8 was incurred
evenly over the 3-month period to 31 March 20-8.
REQUIRED
Calculate the interest to be capitalized on the assets based on the weighted average expenditure
for the year.
SUGGESTED SOLUTION
In this case it is necessary to average the expenditure to obtain a weighted average amount which
can be used in the calculation of interest.
Weighted average expenditure $

937 500 * ½ (incurred evenly) * 3/12 (Jan - Mar) 117 188
1 640 700* 9/12 1 230 525
2 343 750* 6/12 1 171 875 5 000 000* 3/12
1 250 000
Total weighted average expenditure 3 769 588 Interest
to be capitalized $3 769 588*15% $565 438
ACTIVITY
a) T Ltd obtained an 18% p.a. loan of $ 10 000 000 1 July 20-8 to finance a qualifying
project. The company has a 30 June financial year-end. Actual expenditures on the project
were as follows:
$
1/07/20-8 3 630 000
1/09/20-8 1 650 000 1/02/20-9 825 000
Total expenditure 7 205 000
The project was still under construction on 30 June 20-9.
REQUIRED
Calculate the interest to be capitalized for the year-ended 30 June 20-9, based on the weighted
average expenditure

b) Assume that the expenditure in (a) above was incurred evenly as follows:
$
1/07/20-8 to 31/08/20-8 3 630 000
1/0 9/20-8 to 31/01/20-9 1 650 000
1/02/20-9 to 31/05/20-9 1 100 000
1/06/20-9 to 30/06/20-9 825 000
Total expenditure 7 205 000
The project was still under construction on 30 June 20-9.
REQUIRED
Calculate the interest to be capitalized for the year- ended 30 June 20-9, based on the weighted
average expenditure.
3.4 INTEREST CAPITALIZATION AND FOREIGN LOANS
The capitalization of interest with a foreign component and whose rate is subject to fluctuation
is illustrated as follows:
EXAMPLE 4
On 1 April 20-7, before the commencement of the multi-currency system in Zimbabwe, B Ltd
started the construction of a coke oven at an estimated cost of $350 000 000. Work was
expected to be completed in 2 years. The expenditure on the project for the first year was as
follows:
$
1/04/20-7 72 400 000
1/07/20-7 85 600 000
1/10/20-7 66 300 000 1/01/20-8 75 700 000
On 1 April 20-7, the company raised a 2-year US$ denominated loan of $100 000 at 15% p.a. specifically
to finance this project. Interest on this loan is payable on 31 March each year.
The company arranged a 3-month forward exchange contract for the loan repayment on 1
January 20- 9 at a cover rate of US$1= ZS5 000. The exchange rate moved as follows during the
relevant period.
US$=Z
1/04/20-8 4 500
1/01/20-9 4 800
31/03/20-9 6 500
Surplus funds were temporarily invested, earning $22 500 000 for the company.
REQUIRED

Calculate the borrowing costs to be capitalized for the year- ended 31 March 20-9.
SUGGESSTED SOLUTION
Z$
Loan amount at year-end 100 000 x 6500 650 000 000
Loan amount at the beginning of year 100 000 * 4500 450 000 000
Exchange loss 200 000 000
Forward exchange contract gain 100 000 x (6 500-5 000) 150 000 000
50 000 000
Interest expense 100 000 * 15% * 5000 75 000 000
125 000 000
Less interest earned 22 500 000
Amount to be capitalised 102 500 000
3.5 SUMMARY
This Unit explains the theoretical background of and accounting requirements for the
treatment of borrowing costs based on IAS 23. This standard explains various circumstances
in which it is necessary to determine the amounts of borrowing costs to be capitalized to the
costs of qualifying assets. When the carrying amount or the expected final cost of a qualifying
asset exceeds its recoverable amount or net book value, the carrying amount should be written
down or written off according to the requirements of relevant standards e. g. IAS 36
(Impairment of assets).
3.6 REFERENCES
IASB International Financial Reporting Standards 2015

UNIT FOUR
4.0 INTRODUCTION
Financial instruments present you with some kind of a moving target which however, with the
three phase project of IFRS 9 - Financial Instruments being bought to finality in 2014 it is all
now left to adoption or implementation by preparers of financial statements with effect from I
January 2018. IFRS 9 had long since 2009 been earmarked to replace all the other accounting
standards on financial instruments by the time the revision project ends. This entails that you
should make it a point to make a trail up to date of changes that would have been effected by
the IASB over time on this important and inevitable subject area in our world financial
markets and any organisation`s day to day operations. You should see if what was intended
has been achieved and if not, stay on course on what else still needs to be done after
completion of certain milestones in projects or completion of the projects in their fullness.
You should borrow from Project Management studies and recognise that a project is basically
an activity with a specified start date and end date. IAS 32 (Financial Instruments -
Presentation) and IAS 39 (Financial Instruments - Recognition and measurement) have
traditionally been the reference points for quite some time followed by the introduction of

IFRS 7 (Financial Instruments – Disclosures). IFRS 7 simplified some parts of IAS 32. IFRS
9 then came into the picture with 3 project phases that were aimed at replacing IAS 39. The
view that has been taken in this Unit is similar to that of pwc, especially that in essence,
financial assets and financial liabilities that are accounted for under IAS 39 are in IFRS 9`s
scope (Item 6.10.21, pwc, IFRS 2015, Vol 1)
The reason why financial instruments have become popular is that local, regional and
international financial markets have seen new levels of sophistication, arising partly from the
need on the part of various players to be more innovative in order to be competitive and stay
afloat. With this, financial instruments have come with own challenges especially the fact that
they are a very specialized area of trade, they tend to be generic which makes operating or
dealer's margins to be low from one financial institution to another and that derivatives trade
has potential of posing significant financial risks yet requiring little to no initial outlay as is
usually the case with conventional investment transactions. One top manager, used the
following statement to emphasise why the potential of operating or dealer`s margins can be
low due to the generic nature of trade in Financial Instruments:
"In the main, our competitors are acquainted with the same fundamental concepts and
techniques and approaches that we follow, and they are as free to pursue them as we are. More
often than not, the difference between their level of success and ours lies in the relative
thoroughness and discipline with which we develop and execute our strategies for the future."
The long and short of it is that success or failure in business lies in the application of widely
available strategies, and the challenge of competition is particularly severe in financial
services markets. As a result, commercial banks have had to diversify from traditional areas
like retail banking into non-traditional areas like international trade finance, options and
futures. This Unit will explore these newer areas from a Financial Accounting point of view.
4.1 OBJECTIVES
By the end of this Unit, you will be able to:
• Classify financial instruments according to the guidelines in IFRS 9.

• Understand the use of the business model and the contractual cash flow model in subsequent
measurement of financial assets.
• Distinguish between the removed incurred loss model and expected credit loss model that has
replaced it.
• Explain the nature and accounting treatment of compound financial instruments.
• Identify financial instruments, define and account for derivatives and distinguish between
financial assets and financial liabilities.
• Understand the accounting treatment of fair value and cash flow hedges and hedges of a net
investment in a foreign operation.
• Outline the disclosure requirements for financial instruments including significant risks faced
by the trading entity.
4.1.1 TIMELINE OF IFRS 9

Below is BDO International`s summary of the tracked development of the IFRS. Little changes
have been made to BDO`s content:
a) November 2009 – IFRS 9 (2009) was issued by the IASB. This was the first milestone
in the three phase project to replace IAS 39. Through it financial assets where to be
classified and measured only as financial assets at amortized cost or financial assets at
fair value through profit or loss (“FVPL”).
b) October 2010 – an updated IFRS 9 (2010) was issued by the IASB. It included
guidance on financial liabilities and derecognition of financial instruments, and in
particular the requirement to present changes in own credit risk on liabilities at fair
value in other comprehensive income (“OCI”).
c) March 2013 – an exposure draft on limited amendments to IFRS 9 (2010) in order to
address specific application questions was issued. It would also reduce differences
with the FASB. However the FASB still decided not to pursue a classification and
measurement model similar to that of the IASB. The end result is that, the FASB’s
classification and measurement project may result in few changes to current US
GAAP.
d) November 2013 – the IASB published the final hedging requirements excluding macro
hedging.
e) July 2014 – new and complete version of IFRS 9. In it are the new hedge accounting,
impairment (the expected credit loss model for earlier recognition of losses) and
classification and measurement requirements (for instance use of the business
valuation model and the contractual cash flow model or the introduction of a fair value
through other comprehensive income category for certain debt instruments). pwc states
that it replaces most of the guidance in IAS 39.
4.1.3 TRANSITIONAL PROVISIONS
IFRS 9 will be effective for annual periods beginning on or after January 1, 2018, subject to
approval in certain territories, for example the European Union. It is interesting to note how
the EU or the USA, in selected cases, have objectively sought to contribute to the refinement
of IFRS by taking a cautious approach to their adoption, for example, on IFRS 9 and IFRS 8 –
Operating segments/IAS14 – Segment reporting.
A report by the pwc indicated that IFRS 9 (2014) allows earlier adoption by entities with no
more early adoption of previous versions of IFRS 9 (that is, IFRS 9 – 2009 and 2010) after
February 1, 2015. If management elects to early apply the standard after such date, it is
required to apply all the provisions in the standard, including classification and measurement,
hedge accounting and own credit risk. Retrospective application is advised though restatement
of comparatives is not required. Only the opening balance of retained earnings is adjusted in
order to recognise financial effects of applying the standard in the year of initial application.
However, the choice to restate comparatives is there where no hindsight is used by
management.
The date when an entity first applies the requirements of the standard must be the beginning of
a reporting period after the standard is issued.
4.1.4 TRANSITION DISCLOSURES

pwc advices that the transitional disclosure is that of information which permits the
reconciliation of the closing impairment allowances in accordance with IAS 39 or IAS 37 to
the opening loss allowances determined in accordance with IFRS 9. For financial assets, this
disclosure should be provided by the related financial assets’ measurement categories in
accordance with IAS 39 and IFRS 9, and should show separately the effect of the changes in
the measurement category on the loss allowance at the date the entity first applied the
requirements of IFRS 9.
4.1.5 EXPECTED IMPLEMENTATION CHALLENGES
These are:
i) With financial institutions being involved in financial services markets more than any
other organisations they will obviously face challenges in applying the IFRS`s
requirements.
ii) Significant changes will have to be made by entities to their current credit and
information systems if they are to meet the IFRS`s requirements.
iii) New models to establish both the 12-month and lifetime expected credit loss will have
to be developed by entities using complex professional judgments in for instance,
defining default, defining low credit risk and behavioural life of revolving credit
facilities. This will take time and cost entities money to set up or bring the financial
information systems up to date. However, given that IFRS 9 takes effect in 2018, it is
possible to say there is fairly ample time.
4.2 TERMINOLOGY
A financial instrument is any contract that results in a financial asset of one entity and a financial
liability or equity instrument of another entity.
A financial asset is any asset that consists of
a) cash or the equity instrument of another entity;
b) a contractual right to receive cash or another financial asset or to exchange financial assets or
financial liabilities with another entity under conditions that are potentially favourable to the entity;
c) a contract that will or may be settled in the entity's own equity instruments and is:
i) a non-derivative for which the entity is or may be obliged to receive a variable
number of the entity's own equity instruments or
ii) a derivative that will or may be settled other than by the exchange of a fixed
amount of cash or another financial asset for a fixed number of the entity's own
equity instruments.
Examples of assets that meet the definition of a financial asset as above are cash, investment
in shares, trade receivables, loans to other entities, investments in bonds and, derivative
financial assets.
A financial liability is any liability that is
a) a contractual obligation
i) to deliver cash or another financial asset to another entity or

ii) to exchange financial assets or financial liabilities with another entity under
contractual conditions that are potentially unfavourable to the entity or
b) a contract that will or may be settled in the entity's own equity instruments and is:
i) a non-derivative for which the entity is or may be obliged to deliver a variable number
of the entity's own equity instruments or;
ii) a derivative that will or may be settled other than by the exchange of a fixed amount of
cash or another financial asset for a fixed number of the entity's own equity
instruments An equity instrument is any contract, that provides evidence of a residual
interest in the assets of an entity after deducting all of its liabilities.
Examples of liabilities that meet the definition of a financial liability as above are trade
payables, loans from other entities, redeemable preference shares, issued bonds and other
debt instruments issued by the entity, forward contracts standing at a loss, and derivative
financial liabilities.
A contract refers to an agreement between two or more parties that involves clear economic
consequences which the parties have little, if any, discretion to avoid, usually because the
agreement is legally enforceable.
An equity instrument is any contract that gives evidence of a residual interest in the assets of an
entity after all of its liabilities have been deducted.
A derivative is a financial instrument or other contract which has the following characteristics:
a) its value changes in response to the change in a specified interest rate, financial
instrument price, commodity price, foreign exchange rate, index of prices or rates,
credit rating or credit index, or other variable, provided in the case of a non-financial
variable, that variable is not specific to a party to the underlying contract.
b) it requires no initial net investment or an initial net investment that is smaller than
would be required for other types of contracts that would be expected to have a similar
response to changes in market factors and
c) it is settled at a future date
Examples of derivatives are forward contracts (non-standardised, traded over the counter),
futures contracts (standardised, traded on an exchange), interest rate swaps and currency
swaps)
An embedded derivative is a component of a hybrid (combined) instrument that also includes
a non-derivative host contract, in such a way that some of the combined instrument's cash
flows will behave like those of a stand-alone derivative. An embedded derivative causes some
or all of the cash flows that otherwise would be required under the contract to be modified
according to a specified interest rate, financial instrument price, commodity price, foreign
exchange rate, index or prices or rates, credit rating or credit index or other variable, provided
that in the case of a non-financial variable that variable is not specific to one of the parties to
the contract.
Excluded and exempted from embedded derivatives are:
i) Non-financial variables that are specific to a party to the contract;

ii) A derivative, attached to a financial instrument that is contractually transferable
independently of that instrument, or, has a different counterparty from that instrument;
instead, this is a separate financial instrument
A derivative that is attached to a financial instrument but is contractually transferable
independently of that instrument, or has a different counter party from that instrument, is not
an embedded derivative, but a separate financial instrument.
Examples of a non-derivative host contract include a lease, a debt or equity instrument, an insurance
contract, a sale or purchase contract and a construction contract
N.B. An update by BDO, 2015, states that IFRS 9 removes the requirement to separate
embedded derivatives from financial asset host contracts (it instead requires a hybrid contract
to be classified in its entirety at either amortised cost or fair value.) Separation of embedded
derivatives has been retained for financial liabilities (subject to criteria below being met).
The criteria to separate an embedded derivative is as follows:
1) Economic characteristics of the embedded derivative and host are not closely related
2) An identical instrument (with the same terms) would meet the definition of a derivative,
and
3) The entire (hybrid) contract is not measured at fair value through profit or loss.
Once embedded derivative is separated the (non-financial asset) host contract is accounted for in
accordance with the appropriate IFRS.
Puttable instrument is a financial instrument that gives the holder the right to put the
instrument back to the issuer for cash or another financial asset or is automatically put back to
the issuer on occurrence of an uncertain future event or the death or retirement of the
instrument holder (IAS 32).
4.2.1 Recognition, measurement and definitions that relate to recognition and measurement
4.2.1.1 Definitions that relate to recognition and measurement
The amortized cost of a financial asset or a financial liability is the amount at which the
financial asset or liability is measured at initial recognition minus principal repayment, plus or
minus the cumulative amortization using the effective interest method of any difference
between that initial amount and the maturity amount, and minus any reduction (directly or
through the use of an allowance account) for impairment or uncollectability.
The effective interest method is a method of calculating the amortized cost of a financial asset
or a financial liability and of allocating the interest income or interest expense over the
relevant period.
The effective interest rate is the rate that exactly discounts estimated future cash payments or
receipts through the expected life of the financial instrument or, when appropriate, a shorter
period to the net carrying amount of the financial asset or financial liability. When calculating
the effective interest rate, an entity should estimate cash flows considering all contractual
terms of the financial instrument.

Here is how you can locate where to use or apply effective interest rate and amortised cost:
Amortisation schedule (using effective interest rate method)
Year Amortized cost Profit or loss Interest received Amortized

cost
at beginning (interest income during year at end
of year for year (@ 8%) (cash-inflow) of year
20-9 xxx xxx*1 xxx*2 xxx*3
*1 = amortised cost at beginning of the year x effective interest rate
*2 = fixed annual interest rate, that is, coupon rate x principal

*3 = A + B - C
EXAMPLE – EFFECTIVE INTEREST RATE METHOD
A debt security has a stated principal amount of $5 000. This will be repaid in 5 years at an
interest rate of 6% per year, payable annually at the end of each year. The company purchased
the security on 1 January 20-4, at a discount, for $4 670. The company classifies the debt
security as a financial asset at amortized cost (a held to maturity investment). The effective
interest rate of the investment in the debt security is approximately 7.65%.
REQUIRED
The relevant journal entry at end of 20-4.
SUGGESTED SOLUTION
Year (a) Start of (b) Interest cash (c) Interest income (d) Amortisation (e) End of
period inflows (a) x 7.65% of debt period
amortized at 6% (c) – (b) amortized
(a+d)
(SFP amount)
$ $ $ $ $
20-4 4 670 300 357 57 4 727
20-5 4 727 300 362 62 4 789
20-6 4 789 300 366 66 4 855
20-7 4 855 300 371 71 4 926
20-8 4 926 300 374 (rounded) 74 5 000
(Cash received)
Relevant journal entry
31 December 20-4 $ $
DEBIT Bank 300
DEBIT Debt security 57 CREDIT
Interest income (P/L) 357
Being recognition of interest income.

Derecognition is the removal of a previously recognized financial asset or financial liability from
an entity's statement of financial position.
A regular way purchase or sale is a purchase or sale of a financial asset under a contract
whose terms require delivery of the asset within the time frame established generally by
regulation or convention in the relevant market place.
Transaction costs are incremental costs that are directly attributable to the acquisition, issue or
disposal of a financial asset or financial liability. An incremental cost is one that would not
have been incurred if the entity had not acquired, issued or disposed of the financial instrument.
4.2.1.2 Recognition
An entity should only recognize a financial asset or a financial liability, derivatives included,
on its statement of financial position when it becomes a party to the contractual provisions of
the instrument. For example, a contractual obligation to deliver cash or another financial asset
to a counter party will be recognized when the entity becomes a party to the agreement, and
the agreement is irrevocable. According to paragraph 38 of IAS 39, conventional or regular
way transactions in financial assets should be recognized and derecognized using trade date
accounting or settlement date accounting. The method chosen should be applied consistently
for all purchases and sales of financial assets that belong to the same category.
The trade date is the date on which an entity commits itself to purchase or sell an asset. Trade date
accounting involves:
a) the recognition of an asset to be received and the liability to pay for it on the trade date
and;
b) derecognition of an asset that is sold, recognition of any gain or loss on disposal and
recognition of a receivable from the buyer for payment on the trade date.
The settlement date is the date on which an asset is delivered to or by an entity under the terms
of a contract.
Settlement date accounting involves
a) the recognition of an asset on the date it is received by the entity and;
b) derecognition of an asset and recognition of any gain or loss on disposal on the date it is
delivered by the entity.
When settlement date accounting is used, the entity should account for any change in the fair
value of the asset to be received between the trade date and the settlement date as it would
account for an acquired asset. This means that the change in value should not be recognized
for assets carried amortized cost, but rather:
i) it is recognized in profit or loss for assets classified as financial assets at fair value through
profit or loss;
ii) it is recognized in other comprehensive income for investments in equity instruments.
EXAMPLE 1 – TRADE DATE VS. SETTLEMENT DATE (PURCHASE OF ASSET)

On 28 September 20-7, an entity committed itself to purchase a financial asset for $5 600
which was the asset's fair value on the trade date. The transaction costs were immaterial. On
30 September 20-7 (the financial year end) and 5 October 20-7 (the settlement date), the fair
value of the asset was $7 000 and $8 200 respectively.
REQUIRED
Show alternative ways of accounting for the asset, assuming that it is classified as
1) a financial asset measured at amortised cost;
2) a financial asset measured at fair value with changes presented in other comprehensive income;
3) a financial asset measured at fair value through profit or loss.
SUGGESTED SOLUTION
The amounts at which the asset will be recorded depend on how it is classified, and whether
trade date or settlement date accounting is used, as shown below. However, what we now call
Financial Asset at Fair Value through OCI (FVTOCI) was then called Available for Sale
Financial Asset (AFSFA). Fair value gains/losses for AVFSA (or financial asset at FVTOCI)
would, per IAS 39 be accumulated to equity, through OCI, and only transferred to P/L, from
OCI, at date of derecognition of the financial asset. In other words at the date of
derecognition, the equity reserve account that would have carried the cumulative gains or
losses all along ceased to exist.
Per IFRS 9 we now talk only of “FVTOCI” and “gains/losses on FVTOCI” also presented as
“gains/losses on investment in equity instruments”. Such OCI gains or losses are no longer
reclassified from OCI to PL section of the statement of comprehensive income at date of
derecognition:
What you need to remember is that the IASB published an amendment to IAS 1 called
Presentation of items of other comprehensive income, in 2011, that changed the presentation
of items contained in the Other Comprehensive Income (OCI) section and their classification
within that section as follows.
Other comprehensive income (A + B) xxx
Items that will not be reclassified to profit or loss:

Gains on property revaluation xxx
Gains on investment in equity instruments (Financial assets at FVTOCI) xxx
Actuarial gains (losses) on defined benefit pension plans xxx
Share of gain (loss) on investment in associate`s property revaluation xxx
Income tax relating to items that will not be reclassified (xxx) – A
Items that may be reclassified subsequently to profit or loss:

Gains on translating foreign operations xxx
Gains on cash flow hedges (for example, forward exchange contracts) xxx
Income tax relating to items that may be reclassified (xxx) – B

Though in the example below the cumulative fair value gains or losses on a financial asset at
FVTOCI (formerly AFSFA) have been shown as re-classifiable, which was the IAS 39
treatment, today they are no longer re-classifiable per IFRS 9. The same emphasis above was
given in Unit 4 of Volume 1 under 4.5.7. You should therefore, be able to re-perform the same
journal entries, at trade date and at settlement date, in class, applying requirements of IFRS 9
and see what changes. Take note that guidance from IFRS 9 (2014) on accounting treatment to
a financial asset at amortised cost, at fair value through other comprehensive income and at
fair value through profit or loss, is given after the solution to the second example below:
TRADE DATE ACCOUNTING
1. Financial asset at amortized cost

N.B. a financial asset held to maturity such as a debenture, loan note, bond and trade or
loan receivable.
28/09/20-7
Debit Financial asset at amortized cost 5 600 000
Credit Payables 5 600 000
30/09/20-7 No entry
05/10/20-7
Debit Payables 5 600 000
Credit Bank 5 600 000
2. Financial asset at FVTOCI

N.B. This category is as a result of an election by management to classify the financial
asset as such. Election is only available for investment in equity instruments at their
initial recognition and is irrevocable once opted. You should remember that IAS 39
used to treat this as either a default category or out of election. Now IFRS 9 states out
of election only.
28/09/20-7
Debit Financial asset at FVTOCI 5 600 000
Credit Payables 5 600
000
30/09/20-7
Credit Other Comprehensive Income 1 400
000
05/10/20-7
Credit Other Comprehensive Income 1 200
000
05/10/20-7

Credit Bank 5 600
000
3. Financial Asset at Fair Value through P/L

N.B. a financial asset held for trading or short term profit taking or derivative contracts
which are held by the entity for the purpose of trading.
28/09/20-7
Debit Financial Asset at Fair Value through P/L 5 600 000
30/09/20-7
Credit P/L 1 400 000
05/10/20-7
05/10/20-7
SETTLEMENT DATE ACCOUNTING
28/09/20-7 No entry
30/09/20-7 No entry
05/10/20-7
28/09/20-7 No entry
30/09/20-7
Debit Receivables 1 400 000
Credit Other Comprehensive Income 1 400 000
05/10/20-7

Credit Other Comprehensive Income 1 200 000
05/10/20-7
Credit Receivables 2 600 000
28/09/20-7 No entry
30/09/20-7
05/10/20-7
05/10/20-7
EXAMPLE 2 – TRADE DATE VS. SETTLEMENT DATE (SALE OF ASSET)

On 27 March 2-12 (trade date) an entity entered into a contract to sell a financial asset for its
current fair value of $7 500. The asset had been purchased one year earlier for $6 000 and its
amortised cost is at the same amount. On 31 March 2-12(the financial year-end) and 4 April
212 (the settlement date) the fair values of the asset were $7 900 and $8 400 respectively.
REQUIRED
Show alternative ways of accounting for the asset, assuming that it is classified as
1) a financial asset measured at amortised cost;
2) a financial asset measured at fair value with changes presented in other comprehensive income;
3) a financial asset measured at fair value through profit or loss.
SUGGESTED SOLUTION
The amounts at which the sale will be recorded depends on how the asset is classified, and whether
trade date or settlement date accounting is used, as shown below:
TRADE DATE ACCOUNTING

One year earlier
27/03/2-12
Credit Financial asset at amortized cost 6 000 000
31/03/2-12 No entry
04/04/2-12
Debit Bank 7 500 000
2. Financial assets at FVTOCI
One year earlier

27/03/2-12
Credit OCI 1 500 000
Credit Financial asset at FVTOCI 6 000 000
31/03/2-12 No entry
04/04/2-12
04/04/2-12
Debit OCI 1 500 000
Being reclassification (narration only given here to remind you this is where reclassification comes in)
One year earlier

Debit Financial asset at FVTPL 6 000 000
27/03/2-12

Credit Financial asset at FVTPL 6 000 000
31/03/2-12 No entry
04/04/2-12
SETTLEMENT DATE ACCOUNTING
One year earlier

27/03/2-12
31/03/2-12 No entry
04/04/2-12
Credit Financial asset at amortized cost 6 000 000
One year earlier

27/03/2-12
Credit OCI 1 500 000
31/03/2-12 No entry
04/04/2-12
Credit Financial asset at FVTOCI 7 500 000
04/04/2-12
Debit OCI 1 500 000
Being reclassification

One year earlier

27/03/2-12
31/03/2-12 No entry
04/04/2-12
Credit Financial asset at FVTPL 7 500 000
4.2.1.2.1 Accounting treatment as regards recognition and measurement*1 of a financial asset

at amortised cost
The financial assets which are classified under the amortized cost category are measured as follows:
i) These are initially measured at purchase price
ii) Any related transaction cost (such as commission or brokerage) will be included in the
value of instrument
iii) At each reporting date, these are measured at amortized cost using effective interest rate and
change in value will be charged to the statement of profit or loss
iv) Any interest income received relating to these investments will be charged to the statement
of profit or loss.
at fair value through other comprehensive income
The financial assets in the form of investment in equity instruments for which entity has taken an
election to recognize the relating changes in fair value in the other comprehensive income, will
be measured as follows:
a) These are initially measured at purchase price including transaction cost.
b) At each reporting date, these are re-measured at their fair value on reporting date and
change in fair value (fair value increase or decrease) will be reported to other
comprehensive income, and it will be accumulated in statement of changes in equity in a
separate column; it will remain there till the disposal of related investment. When such
investment will be sold in future, any previous fair value gain or loss held in the separate
column in the statement of changes in equity may be transferred to other reserves or
alternatively it may retain in the equity
c) However, any dividend income received and disposal gain or loss upon disposal relating
to these investments will be charged to statement of profit or loss

at fair value through profit or loss
The financial assets which are measured at fair value through profit or loss will be measured as
follows:
1) These are initially measured at purchase price (fair value);
2) Any related transaction cost (such as commission or brokerage) will be charged to the
statement of profit or loss;
3) At each reporting date, these are re-measured at their fair value on reporting date and any
change in fair value (fair value increase or decrease) will be charged to the statement of profit
or loss
4) Any interest or dividend income received relating to these financial assets will be charged to
profit or loss;
5) The disposal gain or loss upon the disposal of these investments will be charged to profit or
loss.
*1 Measurement ended up being alluded to here, it is touched on in the next section, 4.3. It
should be clearer now when you go to that section. Otherwise this section 4.2 was supposed to
be for Recognition aspects only.
4.2.1.3 Derecognition of a financial asset

To derecognise a financial asset means to remove it from the statement of financial position. This
can be done partially or in its entirety.
An entity should derecognize a financial asset when:
a) the contractual rights to the cash flows from the asset expire;
b) the entity is transferred and this transfer qualifies for derecognition;
c) the entity retains no control over the financial asset after transfer.
The transfer of a financial asset occurs when:
a) the entity gives up the contractual rights to receive the cash flows from the asset or
b) retains the contractual rights to receive the cash flows from the asset, but assumes a
contractual obligation to pay the cash flows from the asset to one or more recipients;
such a transaction should only be treated as a transfer if all the following conditions
are met;
i) the entity has no obligation to pay amounts to the eventual recipients unless it
collects equivalent amounts from the original asset; however, short-term advances by
the entity with the right of full recovery of the amount lent plus interest do not violate
the condition;
ii) the entity is prohibited by the terms of the transfer contract from selling or
pledging the original asset, other than as security to the identified recipients for the
obligation to pay them cash flows;

iii) the entity has an obligation to remit any cash flows it collected on behalf of the
identified recipients without significant delay; in addition, the entity can only reinvest
such cash flows in cash or cash equivalents for a short settlement period, and interest
earned on the investments should be passed on the recipients.
When an entity transfers a financial asset, it should ascertain the extent to which it is retaining the
risks and rewards of ownership.
a) if the entity has transferred substantially all the risks and rewards of ownership, it should
derecognize the asset and recognize separately as assets and obligations any rights and
obligations created or retained in the transfer.
b) if the entity has retained substantially all the risks and rewards of ownership, it should continue
to recognize the financial asset.
c) if the entity neither transfers nor retains substantially all the risks and rewards of ownership, it
should determine whether it has retained control of the asset; in this case.
i) if the entity has not retained control, it should derecognise the financial asset and
recognize separately as assets or liabilities any rights and obligations created or
retained as a result of the transfer;
ii) if the entity has retained control, it should continue to recognize the asset to the
extent of its continuing involvement in the asset.
The transfer of risks and rewards is evaluated by comparing the entity’s exposure, before and
after transfer, with the variability in the amounts and timing of the net cash flows from the
transferred asset. The entity’s continuing involvement in a transferred asset is shown by the
extent to which it is exposed to changes in the asset’s value. Examples of such assessments
are:
a) when the entity guarantees a transferred asset, the extent of continuing involvement is the
lower of
i) the amount of the asset and
ii) the maximum amount of the consideration received that the entity could be required
to repay.
b) When the entity takes out a written and/or purchased option, the extent of continuing
involvement is the amount of the transferred asset that the entity may purchase;
however, if a written put option is taken on an asset that is measured at fair value, the
extent of continuing involvement is limited to the lower of the fair value of the
transferred asset and the option's exercise price.
c) When the entity takes out a cash-settled option on the transferred asset, the extent of
continuing involvement is measured in the same way as for non-cash settled options.
If an entity continues to recognise a transferred asset to the extent of its continuing
involvement, it should also recognise any related liability. Both the asset and the liability
should be measured on a basis that reflects the rights and obligations that have been retained
by the entity. The entity should ensure that the net carrying amount of the asset and the
liability is:

a) the amortised cost of the rights and obligations retained by the entity, if the asset has
been measured at amortised cost;
b) equal to the fair value of the rights and obligations retained by the entity when measured
on a stand-alone basis, if the asset is measured at fair value
The entity should continue to recognise any income from the transferred asset to the extent of its
continuing involvement, and also recognise any expense incurred on the associated liability.
Important note!!
Before evaluating the extent to which it is appropriate to derecognise a financial asset, an
entity should determine whether the proposed derecognition applies to the whole asset or part
of it. The above guidelines would only apply to part of a derecognised asset if it meets one of
the following conditions:
i) The part consists of only specifically identified cash flows from a financial asset or
a group of similar financial assets. For example, if the counter party is entitled to
interest income but not the principal cash flows from a debt instrument (an interest
rate strip) the guidelines will apply only to the interest income.
ii) The part consists of only a fully proportionate share of the cash flows from a
financial asset or a group of similar financial assets. For example, if the counter
party obtains the right to 90% of all cash flows from a debt instrument, the
guidelines will apply only to that share of the cash flows.
iii) The part consists of only a fully proportionate share of specifically identified cash
flows from a financial asset or a group of similar financial assets. For example, if
the counterparty obtains the right to 90% of all interest cash flows from a financial
asset, the guidelines will apply to that share of the interest cash flows.
4.2.1.3.1 Examples of when financial asset is derecognized
a) An unconditional sale of financial asset;
b) A sale of financial asset with a contract to buy back on some certain future date at its current
fair value;
c) Non-recourse factoring of trade receivables (that is, sale of account customer invoices to a
factor (credit insurer) along with the risks (irrecoverable debts) and rewards that attach to
them).
4.2.1.3.2 Examples of when financial asset is not derecognized
a) Sale of financial asset with a contract to buy back on some certain future date at a fair value plus
interest;
b) Factoring of receivable on recourse;
c) Sale of financial asset with a total return swap.
ACTIVITY – RECOGNITION AND DERECOGNITION

Discuss the recognition and derecognition of financial assets under the following headings: a) Initial
recognition
b) Subsequent derecognition
c) Transfer of financial assets
4.2.1.4 Derecognition of a Financial Liability
An entity should remove a financial liability or part of it from its statement of financial
position when it is extinguished, that is, the obligation specified in the contract is discharged,
is cancelled or expires.
The exchange between an existing borrower or lender of debt instruments with substantially
different terms should be accounted for as an extinguishment of the original financial liability
and the recognition of a new one. The same applies to a substantial modification of the terms
of an existing financial liability or a part of it.
Paragraph 3.3.3 of IFRS 9 (2010) states that the difference between the carrying amount of a
financial liability or part of it extinguished or transferred to another party and the
consideration paid, including any non-cash assets transferred or liabilities assumed, should be
recognised in profit or loss.
If an entity repurchases part of a financial liability, it should allocate the previous carrying
amount of the liability between the part that will continue to be recognised and the part that is
being derecognised based on the relative fair values of those parts on the date of the
repurchase transaction. The difference between:
a) the carrying amount allocated to the derecognised part and,
b) the consideration paid, including any non-cash transfers or liabilities assumed for the derecognised
part, should be recognised in profit or loss.
To put emphasis, according to IFRS 9 (2014), extinguishment means 1 liability is paid or
settled or expires and 2 liability is exchanged. With exchange the lender of finance either re-
terms or modifies the terms of original liability. The following is the accounting treatment:
i) If the reduction in the value of original liability is material, that is, more than 10% of
original liability, it will be treated as exchange of original liability for a new liability.
The entity will de-recognize the old liability and recognize new liability and the
difference is charged to the statement of profit or loss
ii) If the reduction in the value original liability is immaterial, that is, less than 10% of
original liability, the entity will continue to recognize the old liability and treat it as
simple reduction in the value of original liability and such reduction in the value of
original liability will be charged to the statement of profit or loss
The entity will determine the reduction as the difference between the present value of liability
considering original cash out flow using original effective interest rate and the present value
of liability considering revised cash out flow using original effective interest rate
4.3. INITIAL AND SUBSEQUENT MEASUREMENT
4.3.1 Initial Measurement of financial assets and liabilities

Financial assets and liabilities at fair value through profit or loss are initially measured at fair
value. For those financial assets and liabilities not classified at fair value through profit or
loss, directly attributable transaction costs must be taken into account. Fair value is the price
that would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date. Transaction costs have been defined
under 4.2.1.1 above.
4.3.2 Subsequent classification and measurement of financial assets IAS
39 required the following classification of financial assets:
a) Financial asset at fair value through profit or loss which was measured at fair value
with fair value gains or losses being taken to the profit or loss section of the statement
of comprehensive income.
b) Available for sale financial asset which was measured at fair value with gains or losses
being taken to other comprehensive income section of the statement of comprehensive
income.
c) Held to maturity financial asset measured at amortised cost with gains or loss being
taken to profit or loss section of the statement of comprehensive income.
d) Loans and receivables which were measured at amortised cost with gains or losses
being taken to profit or loss section of the statement of comprehensive income.
IFR9 now requires the following classification of financial assets:
i) At amortised cost,
ii) At fair value through profit or loss,
iii) At fair value through other comprehensive income
4.3.2.1 Financial assets at amortised cost
IFRS 9 gives the category classification criteria whose two approaches namely the business model
objective and contractual cash flow characteristics must be met.
A financial asset is classified as measured at amortised cost, which make use of the effective interest
rate method, where:
i) The objective of the business model within which the asset is held is to hold assets in
order to collect contractual cash flows and
ii) The contractual terms of the financial asset give rise on specified dates to cash flows that
are solely payments of principal and interest on the principal outstanding.
4.3.2.1.1 Business model
It is a model that is based on the overall business, not instrument-by-instrument. It centres on
whether financial assets are held to collect contractual cash flows. This requires a look at the
following:
i) how the entity is run

ii) the objective of the business model as determined by key management personnel as
defined by IAS 24 – Related Party Disclosures.
iii) if an entity has more than one business model for managing its financial assets and the
classification need not be determined at the reporting entity level. Classification is
rather carried at the portfolio level.
iv) the entity does not need to hold all its financial assets meant to collect contractual cash
flows, until maturity. Therefore, even when sales of financial assets occur an entity’s
business model can still remain as that of holding financial assets in order to collect
contractual cash flows.
BDO advises that, per IFRS 9, the financial assets do not have to be held to contractual
maturity in order to be deemed to be held to collect contractual cash flows, but the overall
approach must be consistent with ‘hold to collect’.
4.3.1.2 Contractual cash flow model
It uses the instrument-by-instrument approach. It considers financial assets with cash flows
that are solely payments of principal and interest (SPPI) on the principal amount outstanding
with the interest component being consideration for the time-value of money and credit risk.
When it comes to forex financial assets the assessment is made in the denomination currency.
Movements in foreign exchange are not taken into account.
Student Note/Tutorial Note:

Ensure to go through examples of instruments that pass the business model test and contractual
cash flows test, guidance of which is provided by the IFRS itself or any other reliable sources.
4.3.2 Financial assets at fair value through profit or loss (FVTPL)
This classification applies to financial assets that do not meet the amortised cost criteria. They
get this designation right at initial recognition. The option to designate the assets as financial
assets at fair value through profit or loss is available if doing so eliminates, or significantly
reduces, a measurement or recognition inconsistency that is, an ‘accounting mismatch’. Once
selected the option to designate them as such is irrevocable.
The fair value gains and losses are subsequently measured and recognised in the profit or loss section
of the statement of comprehensive income.
4.3.3 Financial assets at fair value through other comprehensive income (FVTOCI) This
category classification has the following two branches:
4.3.3.1 Equity instruments at FVTOCI

This classification is available only for investments in equity instruments (within the scope of
IFRS 9) that are not held for trading. The option to designate as such is available at initial
recognition is optional and irrevocable.
The subsequent fair value gains and losses are recognised in other comprehensive income and
are not subsequently recycled to profit and loss. The dividend income is however, recognised
in profit or loss.
4.3.3.2 Debt Instruments at FVTOCI

Financial assets are classified under this category if they meet the SPPI contractual cash flow
characteristics test and if the entity holds the instrument to collect contractual cash flows and
to sell the financial assets
Subsequently fair value gains and losses are recognised in other comprehensive income and changes
in fair value are not subsequently recycled to profit or loss.
4.3.4 Subsequent classification and measurement of financial liabilities IFRS
9 requires that financial liabilities are classified as either:
a) at amortised cost, or
b) at fair value through profit or loss.
Additionally, specific guidance exists for:
i) financial guarantee contracts,
ii) commitments to provide a loan at a below market interest rate, and
iii) financial liabilities that arise when the transfer of a financial asset either does not qualify for
derecognition or where there is continuing involvement.
4.3.4.1 Financial liabilities at amortised cost
It is the category for all financial liabilities, except those that meet the criteria of item b) above
at initial recognition.
Subsequently financial liabilities are measured at amortised cost using the effective interest method.
4.3.4.1.1 Accounting treatment as regards recognition and measurement of a financial liability at
amortised cost
Examples of liabilities held by the entity to maturity date that are classified under this
category are trade payables, bank loan payables and issue of debt instruments (loan notes,
debentures and redeemable preference shares).
The accounting treatment is as follows:
a) These are initially measured at net cash inflow;
b) Any transaction cost relating the liability will be deducted from the value of liability;
c) At reporting date these are measured at amortized cost using the effective interest rate method and
change in value will be charged to profit or loss;
d) Any interest expense will be charged to profit or loss.
4.3.4.2 Financial liabilities at fair value through profit or loss
Just as how it was required by IAS 39, a financial liability is classified at fair value through profit or
loss under IFRS 9 if:
i) it is held for trading, or

ii) upon initial recognition it is designated at fair value through profit or loss. This
option is available only if doing so eliminates, or significantly reduces, a
measurement or recognition inconsistency, that is, ‘accounting mismatch’, or if a
group of financial liabilities (or financial assets and financial liabilities) is
managed, and evaluated, on a fair value basis, in accordance with a documented
risk management or investment strategy, and information about the group is
provided internally to key management personnel as defined by IAS 24.
As for derivative financial liabilities, they are always measured at fair value through profit or loss.
All subsequent fair value gains and losses are measurement and recognised in profit or loss.
4.3.4.2.1 Accounting treatment as regards recognition and measurement of a financial liability at
fair value through profit or loss
Examples of financial liabilities that fit into this category are derivatives held by the entity for
trading purposes and a financial liability designated under this category to eliminate an
accounting mismatch, though the election is irrevocable.
The following is the accounting treatment:
i) These are initially measured at fair value
ii) At each reporting date, these will be re-measured at fair value and any change in fair value
will be charged to profit and loss
iii) However, in the case of designated financial liabilities, the change in value at reporting date
will be analyzed into two portions as follows:
a) The change in fair value due to entity’s own credit risk (deterioration in the
financial position of the entity) will be reported to other comprehensive income
and
b) The change in fair value due to other factors (market factors) is charged to
profit or loss account.
4.3.5 IFRS 9`s specific guidance for financial guarantee contracts and commitments to provide
a loan at a below market interest rate
They are subsequently measured at the higher of either the amount determined in accordance
with IAS 37 – Provisions, contingent liabilities and contingent assets or the amount initially
recognised, less (when appropriate) cumulative amortisation recognised in accordance with
IAS 18 – Revenue (now replaced by IFRS 15).
4.3.6 IFRS 9`s specific guidance for financial liabilities resulting from the transfer of a
financial asset and not derecognised (continually involved)
The financial liability for the consideration received is recognised as a financial liability in the
statement of financial position. Subsequently the net carrying amount of the transferred asset
and associated liability is measured either as:
i) Amortised cost of the rights and obligations retained, if the transferred asset is measured
at amortised cost, or

ii) The fair value of the rights and obligations retained by the entity when measured on a
stand-alone basis, if the transferred asset is measured at fair value.
4.4 SCOPE EXCLUSIONS
Financial instruments presentation is per the provisions of IFRS 7. The following areas are not
covered by the provisions of IFRS 7:
a) interests in subsidiaries, associates and joint ventures that are accounted for in accordance with
IAS 27 and IAS 28, or IFRS 11;
b) employers' rights and obligations under' employee benefit plans, to which IAS 19 applies;
c) insurance contracts as defined in IFRS 4;
However, IFRS 7 applies to derivatives that are embedded in insurance contracts if IAS 39
requires the entity to account for them separately.
d) financial instruments that are within the scope of IFRS 4 because they contain a discretionary
participation feature;
e) financial instruments, contracts and obligations under share-based payment transactions to which
IFRS 2 applies with the exception of paragraphs 8 – l0, 34 of IAS
32;
f) rights and obligations arising under:
i) an insurance contract (other than an issuer's rights and obligations in terms of a financial
guarantee contract; or
ii) a contract that is within the scope of IFRS 4 because it contains a discretionary participation
future.
g) contracts between an acquirer and a vendor in a business combination to buy or sell an
acquirer at a future date;
h) loan commitments except those designated as financial liabilities at fair value through
profit or loss, or those that can be settled net in cash or by delivering or issuing another
financial instrument, or those that are intended to provide funds at a below-market interest
rate;
i) financial instruments, contracts and obligations under share-based payment transactions
to which IFRS 2 applies (except paragraph 5 - 7 of IAS 39)
j) rights to payments to reimburse the entity for expenditure it is required to make to settle
a liability that it recognizes as a provision in accordance with IAS 37.
4.5 CLASSIFICATION OF FINANCIAL INSTRUMENTS
According to IAS 32, the issuer of a financial instrument should classify the instrument or its
components on initial recognition as a financial liability, a financial asset or an equity
instrument depending on the substance of the contractual arrangement. In other words a
substance over form model is applied to debt/equity classification. The essentials of an equity
instrument are as follows:
a) It includes no contractual obligation

i) to deliver cash or another financial asset to another entity or
ii) to exchange financial assets or financial liabilities with another entity involving conditions that
are potentially unfavourable to the issuer
b) If the instrument will or may be settled in the issuer's own equity instruments, it is
i) a non-derivative that includes no contractual obligation for the issuer to deliver a variable
number of its own equity instruments;
ii) a derivative that will be settled only by the issuer exchanging a fixed amount of cash or
another financial asset for a fixed number of its own equity instruments.
EXAMPLE – IAS 32 CLASSIFICATION
On 1 July 20-9, a company entered into a contract to deliver as many of its equity instruments as
are equal in value to $1 500 000.
REQUIRED
State with reasons if this contract represents a liability or equity.
SUGGESTED SOLUTION
This contract is a liability for the issuing company, even though the settlement will be through
equity instruments. The contract is not itself an equity instrument since the company will issue
a variable number of its own shares. Therefore there is no evidence that the contract represents
a residual interest in the company's assets after deducting all its liabilities. This contract would
only qualify as an equity instrument, if it would require the company to issue a specific number
of its own equity instruments in return for a specific amount of cash or another financial asset.
Other important guidelines on the classification of financial instruments are as follows:
1. The substance of a financial instrument, rather than its legal form, should govern its
classification on the entity's statements of financial position. Some financial instruments, for
example, preference shares may have the legal form of equity, while they are liabilities in
substance. On the other hand, some instruments may combine features of both equity and
liabilities.
2. If an entity does not have an unconditional right to avoid delivering cash or another
financial asset to settle a contractual obligation, this obligation will meet the definition of a
financial liability. This means that a restriction on an entity's ability to satisfy a contractual
obligation, for example, lack of access to foreign currency, does not affect the other party's
claim to receive payment. In addition, a contractual obligation that depends on the other party
actually exercising its right to redeem value is also a financial liability because the entity has
not been absolved from the obligation to deliver cash or another financial asset. A financial
instrument that does not explicitly establish a contractual obligation to deliver cash or another
financial asset may do so indirectly through its terms and conditions. Examples of this are:
a) if the entity can avoid a transfer of cash or another financial asset only by settling a
non-financial liability.

b) a financial instrument will meet the definition of a financial liability if it provides that
on settlement the entity will deliver either i) cash or another financial asset or;
ii) its own shares whose value is determined to exceed substantially the value of the cash
or other financial asset.
3. An entity should recognize separately the components of a financial instrument which
incorporates both a financial liability of the entity and an option to the holder of the
instrument to convert it into an equity instrument of the entity. According to paragraph 29, the
economic effect of issuing such an instrument is identical to issuing simultaneously a debt
instrument with an early settlement provision and warrants to purchase ordinary shares, or
issuing a debt instrument with detachable share purchase warrants. Any change in the
likelihood that a conversion option will be exercised should not affect the classification of a
convertible instrument between liability and equity. Therefore, the entity's contractual
obligation to make future payments in cash or kind remains outstanding until it is discharged
through conversion, the instrument's maturity or another transaction.
4.6 SPLIT ACCOUNTING

Studies by Mirza et al, 2008, indicated that sometimes issued non-derivative financial
instruments contain both liability and equity elements. A component of the instrument meets
the definition of a financial liability at the same time another component of the same
instrument meets the definition of an equity instrument. We refer to such instruments as
compound instruments. IAS 32 provides for this principle of split accounting of compound
financial instruments. It is the presentation of the liability and equity elements separately. The
equity component is calculated as a residual value after deducting the value of the liability
component from the fair value of the financial instrument. Discounted cash flow techniques
such as present valuation as appropriate are used to determine the present value of the liability
component. The balance of the instrument's total value is taken as the equity component.
EXAMPLE – SPLIT ACCOUNTING TO COMPOUND FINANCIAL INSTRUMENTS
On 1 January 20-5, a company issued 200 convertible bonds at par with a nominal value of
$15 000 each. These bonds were issued with a 3 year term, and interest was payable at 10%
p.a. in arrears. Each bond could be convertible at any time up to maturity based on the agreed
conversion ratio of 1 bond as to 300 ordinary shares.
At the time of issue, the current market rate of interest for similar bonds without conversion rights
was 18%. On the same date, the market value of the company's ordinary shares was $5.
REQUIRED
Calculate the value of the equity component in the bond issue. Use only relevant information.
SUGGESTED SOLUTION
$
Present value of principal [$3 000 000 x 0.6086(PVIF3, 18%)] 1 825 800
Present value of interest [$300 000 x 2.1743(PVIFA3, 18%)] 652 290
Total liability component 2 478 090 Equity
component (balancing figure) 521 910

Total bond value 3 000 000
ACTIVITY – SPLIT ACCOUNTING
On 1 July 20-6, a company issued 500 convertible bonds at par with a nominal value of $20
000 each. These bonds were issued with a 4-year term, and interest was payable at 15% p.a. in
arrears.
Each bond could be converted at any time up to maturity based on the agreed conversion ratio of
1 bond : 100 ordinary shares.
At the time of issue, the current market rate for similar bonds without conversion rights was 20%
p.a. On the same date, the market value of the company's ordinary shares was $10.
REQUIRED
Calculate the value of the equity component in the bond issue, using only relevant information.
4.7 CLASSIFICATION OF INTEREST, DIVIDENDS, LOSSES AND GAINS (IAS 32)
Interest, dividends, losses and gains relating to a financial instrument or a component that
represents a financial liability should be recognized as income or expense in profit or loss. In
this regard, the following points should be noted:
i) distributions to the holders of an equity instrument should be debited directly to equity,
net of any related tax benefit;
ii) dividend payments on preferred shares classified as liabilities (redeemable preference
shares) are treated as expenses;
iii) transaction costs arising from an equity transaction should be accounted for as a
deduction from equity net of any related tax benefit. This should be done only if they are
incremental costs directly attributable to the equity transaction. On the other hand, the
costs of an equity transaction that is abandoned should be treated as an expense.
Changes in the fair value of an equity instrument should not be recognized in the financial statements as
long as it remains issued.
4.8. OFFSETTING OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES (IAS
32)
An entity can only offset a financial asset and a financial liability and show the net amount in the
statement of financial position if:
a) it currently has a legally enforceable right to set off the recognized amounts and;
b) it intends either to settle on a net basis, or to realize the asset and settle the liability concurrently.
If a financial asset that does not qualify for derecognition is transferred, the entity should not
effect an offset between the asset and the related liability. In addition to the legal right of
setoff, such a course of action is justified if the entity intends to exercise the right to settle
simultaneously. This is because presentation of the asset and the liability on a net basis would

reflect more appropriately the amounts and timing of the expected future cash flows, as well
as the related risks.
The following are the conditions under which offsetting is considered to be inappropriate:
i) several different financial instruments are used to simulate the features of a single
financial instrument (referred to as a synthetic instrument)
ii) the financial assets and financial liabilities arise from financial instruments which have
the same primary risk exposure but involve different counter parties
iii) financial or other assets are pledged as collateral for non-recourse financial liabilities
iv) a debtor sets aside financial assets to discharge an obligation, although the creditor has
not accepted the assets in settlement of the obligation.
v) obligations incurred as a result of certain losses are expected to be recovered from a
third party based on a claim made under an insurance contract.
4.9 ACQUISITION OF OWN EQUITY INSTRUMENTS
If an entity reacquires its own equity instruments (treasury shares) the value of such shares
should be deducted from equity. No gain or loss can be recognized in profit or loss on the
purchase, sale, issue or cancellation of such shares. The shares may be acquired and held by
the entity or by other members of its group. Any consideration paid or received should be
recognized directly in equity.
4.10 DIFFERENT WAYS OF SETTLING LIABILITIES AND OTHER
COMMITMENTS
4.10.1 Settlement in the Entity's Own Equity Instruments
A contract is not an equity instrument simply because it may result in the receipt or delivery of
the entity's own equity instruments. Such a contractual right or obligation may be for a fixed
amount or an amount that fluctuates partly or in full due to changes in a variable other than the
market price of the entity's own equity instruments, for example, an interest rate, a commodity
price or a financial instrument price. An example of this is a contract to deliver as many of the
entity's own equity instruments as are equal in value to $2 500 000. Such a contract is not an
equity instrument because it requires the entity to effect settlement based on a variable number
of its own equity instruments. Therefore, the contract does not show evidence of a residual
interest in the entity's assets after deducting all its liabilities. On the other hand, a contract that
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.
A contract that includes an obligation for an entity to purchase its own equity instruments for
cash or another financial asset will result in a financial liability for the present value of the
redemption amount e.g. the present value of the forward repurchase price, option exercise
price or other redemption amount even if the contract itself is an equity instrument. This is the
case even if the obligation to purchase depends on the counter party exercising the right to
redeem.
4.10.2 Settlement Options

When a derivative financial instrument gives one party a choice over how it will be settled
(for example, net in cash or by exchanging shares for cash), it should be considered as a
financial asset or a financial liability unless all of the settlement alternatives would result in it
being an equity instrument. For example, some contracts to buy or sell a non-financial item
for the entity's own equity instruments can be settled either by delivery of the non-financial
asset or net in cash or another financial instrument. Such contracts are financial assets or
financial liabilities and not equity instruments.
4.11 IMPAIRMENT AND UNCOLLECTIBILITY OF FINANCIAL ASSETS

4.11.1 Scope of IAS 39
In line with the requirements of IAS 36 – Impairment of assets, an entity would assess at each
reporting date whether there was any objective evidence that a financial asset or group of
financial assets was impaired. This assessment was based on a consideration of one or more
events that occurred after the initial recognition of the asset, with an adverse impact on the
future cash flows of the asset or group of assets. IAS 39 does not permit the recognition of
losses that are expected from future events, thereby favouring a delayed approach. The
following loss events were usually taken to constitute objective evidence that an asset or
group of assets was impaired.
i) significant financial difficulties being faced by a borrower;
ii) a breach of contract, for example failure to meet principal or interest payments; iii)
the lender, for economic or legal reasons relating to the borrower's financial
condition granting the borrower a concession that the lender would not normally
consider;
iv) a probability that the borrower will enter bankruptcy or other financial
reorganization;
v) the disappearance of an active market for the financial asset due to economic difficulties;
vi) indications that there is a measurable decrease in the estimated future cash flows from a group
of financial assets since their initial recognition, even if the decrease cannot yet be identified
with individual assets in the group.
4.11.2 Impairment of specific types of financial assets per IAS 39
4.11.2.1 Financial assets carried at amortised cost
If there was objective evidence that an impairment loss on loans and receivables or held-to-
maturity investments carried at amortised cost has been incurred, the loss was measured as the
difference between the asset's amount and the present value of the estimated future cash flows
discounted at the asset's original effective interest rate determined at initial recognition

(incurred loss model). The asset's carrying amount was then reduced either directly or through
an allowance account and recognised in profit or loss.
If subsequently the amount of the impairment loss decreased and the decrease could be
identified with an event/s occurring after the initial recognition of impairment, the previously
recognised loss is reversed either directly or by adjusting an allowance account, and
recognised in profit or loss. However, the reversal is not supposed to result in a carrying
amount of the asset that exceeded what the amortised cost would have been if the impairment
loss had not been recognised.
Tom Clendon pointed out that the incurred loss approach had the advantage of being fairly
objective – there had to be a past event – for example, an actual default or a breach of a debt
covenant. This objectivity reduced the risk of profit smoothing by companies given that they
were unable to estimate anticipated future losses. However, the incurred loss model still
attracted criticism because it resulted in the overstatement of both assets and profits. It also
could be argued that the incurred loss approach was a contributory factor in the credit crunch
suffered in Europe with effects being suffered throughout the world.
EXAMPLE – ASSESSMENT OF IMPAIRMENT IAS 39

Because of Customer B's financial difficulties, Entity A is concerned that Customer B will not
be able to make all principal and interest payments due in a timely manner. The two parties
negotiate a restructuring of the loan. Entity A expects that Customer B will be able to meet its
obligations under the restructured terms.
REQUIRED
State, with reasons, whether Entity A should recognise an impairment loss under the following
separate cases:
a) Customer B will pay the full principal amount of the original loan 5 years after the
original due date, but none of the interest due under the original terms.
b) Customer B will pay the full principal amount of the original loan on the original due
date, but none of the interest due under the original terms.
c) Customer B will pay the full principal amount of the original loan on the original date
with interest only at a lower rate than that in the original loan.
d) Customer B will pay the full principal amount of the original loan 5 years after the
original due date and all interest accrued during the original loan term, but no interest for the
extended term.
e) Customer B will pay the full principal amount of the original loan 5 years after the
original due date and all interest, including interest for both the original due date and all interest,
including interest for both the original and extended terms of the loan.
SUGGESTED SOLUTION
The amount of the impairment loss for a loan measured at amortised cost is the difference
between the loan's carrying amount and the present value of future principal and interest
payments discounted at the loan's original effective interest rate.

For cases (a - d), the present value of the future principal and interest payments discounted at
the loan's original effective interest rate will be lower than the loan's carrying amount.
Therefore; an impairment loss should be recognised in those cases.
In case (e), although the timing of payments has changed, the lender will receive interest on
interest. The present value of the future principal and interest payments discounted at the
loan's effective interest rate will equal the loan's carrying amount. Therefore, there is no
impairment loss.
4.11.3 Scope of IFRS 9
With IFRS 9 the impairment requirements are applied to:
i) Financial assets measured at amortised cost including trade receivables; ii)
Financial assets measured at FVTOCI;
iii) Loan commitments and financial guarantee contracts where losses are currently
accounted for under IAS 37 – Provisions, contingent liabilities and contingent assets.
These are all loan commitments not measured at fair value through profit or loss; iv)
Lease receivables. These are lease receivables that are within the scope of IAS 17, Leases,
and trade receivables or contract assets within the scope of IFRS 15 that give rise to an
unconditional right to consideration.
The IFRS 9 expected credit loss impairment model follows a three-stage approach based on changes
in expected credit losses of a financial instrument that determine:
a) the recognition of impairment, and
b) the recognition of interest revenue
4.11.3.1 Initial recognition
At initial recognition of the financial asset an entity recognises a loss allowance equal to 12
months expected credit losses which consist of expected credit losses from default events
possible within 12 months from the entity’s reporting date. An exception is purchased or
originated credit impaired financial assets.
4.11.3.2 Subsequent measurement A

three-stage approach applies:
STAGE 1
12 month expected credit losses (gross interest)
BDO report states that:
i) This is applicable when there is no significant increase in credit risk. ii) Entities
continue to recognise 12 month expected losses that are updated at each reporting
date.
iii) Interest is presented on a gross basis
STAGE 2

Lifetime expected credit losses (gross interest) BDO
report states that:
i) This is applicable in case of significant increase in credit risk

ii) Lifetime expected losses are recognised iii) Interest is
presented on a gross basis
STAGE 3
Lifetime expected credit losses (net interest) BDO
report states that:
i) This is applicable in case of credit impairment

ii) Lifetime expected losses are recognised iii)
Interest is presented on a net basis
4.12 EXPECTED CREDIT LOSS METHOD – FURTHERMORE ON THE NEW IMPAIRMENT

MODEL
Tom Clendon pointed out the expected loss approach is likely to result in earlier recognition
of credit losses, by recognizing not only losses that have already been incurred but also
expected future losses. It arguably is relatively more prudent as both assets and profits will be
reduced. It is however, open to the criticism especially that allowing professional judgment of
what future losses might be incurred it allows some companies to engage in profit smoothing.
Expected credit losses are defined as the expected shortfall in contractual cash flows. The
estimation of expected credit losses should consider past events, current conditions and
reasonable and supportable forecasts. PwC made an observation that the expected credit loss
model relies on a relative assessment of credit risk
4.12.1 Presentation pwc took note that per IFRS 9 (2014) management interest revenue is
presented in the statement of comprehensive income as a separate line item. Similarly,
impairment losses (including reversals of impairment losses or impairment gains) should also
be presented as a separate line item in the statement of comprehensive income.
An entity should recognize the expected credit loss in the statement of financial position as:
i) a loss allowance for financial assets measured at amortized cost and lease receivables;
and
ii) a provision (that is, a liability) for loan commitments and financial guarantee contracts.
For financial assets that are mandatorily measured at fair value through other comprehensive
income, the accumulated impairment amount is not separately presented in the statement of
financial position. However, an entity should disclose the loss allowance in the notes to the
4.12.2 Disclosure

Extensive disclosures are required to identify and explain the amounts in the financial
statements that arise from the expected credit loss and the effect of deterioration and
improvement in credit risk.
4.12.3 Period over which to estimate the expected credit loss

For loan commitments, the maximum period over which the expected credit loss should be measured is
the maximum contractual period over which the entity is exposed to credit risk.
For those financial instruments that include both a loan and an undrawn commitment
component, such as revolving credit facilities, management should measure the expected
credit loss over the period that the entity is exposed to credit risk and the expected credit loss
would not be mitigated by credit risk management actions, even if that period extends beyond
the maximum contractual period.
Take note that in such cases, the contractual ability to demand repayment and cancel the
undrawn commitment does not necessarily limit the exposure to credit losses beyond the
contractual period. The factors for consideration when determining the period over which to
estimate the expected credit loss are:
i) the period over which the entity was exposed to credit risk on similar instruments; ii)
the length of time for related defaults to occur on similar financial instruments following
an increase in credit risk; and
iii) the credit risk management actions that an entity expects to take once the credit risk on
the financial instrument has increased, such as the reduction or removal of undrawn
limits.
EXAMPLE – IMPAIRMENT INCURRED VERSUS EXPECTED LOSS
ACCA June 2011 past examination question
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 $5 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
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)

SUGGESTED SOLUTION
Amortisation schedule – Incurred loss model (IAS 39)
Date Loan asset Interest Cash flow Loss (C) Loan asset Return
(A) at 16% (B) (B-C)/A%
$000 $000 $000 $000 $000
y/e 30/04/11 5,000 800 (800) 0 5,000 16%
y/e 30/04/12 5,000 800 (800) 0 5,000 16%
y/e 30/04/13 5,000 800 (728) 522 4,550 5·56%
being 800 x 91%
Amortisation schedule – Expected loss model (IFRS 9)
Date Loan asset Interest Cash flow Loan asset Return

(A) at 9·07% (B) B/A%
$000 $000 $000 $000
y/e 30/04/11 5,000 453·5 (800) 4,653·5 9·07%

y/e 30/04/12 4,653·5 422·1 (800) 4,275·6 9·07%
y/e 30/04/13 4,275·6 387·8 (728) 3,935·4 9·07%
being 800 x 91%
EXAMPLE - EXPECTED LOSS

Harurwa Ltd is a manufacturer of cellphones for the local market. The cellphones are sold to
client organizations and individuals on credit on 90 day credit terms. Discount is offered on a
2,5%, 60 net 90 basis. The entity has tracked historical loss experience for its trade
receivables over the past five years and calculated the following historical loss experience:
$
a) 0.9 percent for receivables that are current 500 000
b) 5 percent for receivables that are 1–30 days past due 2 500 000
c) 15 percent for receivables that are 31–60 days past due 3 300 000
d) 30 percent for receivables that are 61–90 days past due 650 000
e) 45 percent for receivables that are more than 90 days past due. 1 710 000
8 660 000
It is Harurwa Ltd`s belief that the historical losses experienced are consistent with what shall
be experienced for the financial assets held at the reporting date. The composition of the
receivables at this reporting date has remained similar to that which was used in development
of the historical statistics. In other words there has not been any significant changes in the risk
features of client organizations and individual customers. The economic climate in which the

historical statistics were determined generally are consistent with the economic conditions
which are expected over the remaining lives of the trade receivables.
REQUIRED
At the reporting date, develop the provision matrix for Harurwa Ltd to estimate current expected credit
losses.
SUGGESTED SOLUTION
Age of receivables Carrying amount Loss rate Expected

credit loss
$
Current 500 000 0.9% 4 500
1 – 30 2 500 000 5% 125 000
31 – 60 3 300 000 15% 495 000
61 – 90 650 000 30% 195 000
+90 days 1 710 000 45% 769 500
1 589 000
N.B. An editor made the following contributions towards the expected loss model during the finalization
of IFRS 9 (2014):
i) the use of a provision matrix may not differ significantly from an entity’s current
methods for determining the allowance for irrecoverable accounts. ii) an entity is required
to consider whether expected credit losses should be recognized for trade receivables that
are considered “current”.
iii) when using historical loss rates in a provision matrix, an entity would be required to
consider whether and, if so, how the historical loss rates differ from what is currently
expected over the life of the trade receivables.
ACTIVITY – EXPECTED LOSS MODEL

Discuss briefly the issues related to considering the effects of expected losses in dealing with impairment
of financial assets. (6 marks)
4.13 HEDGE ACCOUNTING

4.13.1 Definitions Related to Hedge Accounting
A firm commitment is a binding agreement for the exchange of a specified quantity of resources
at a specific price on a specified future date or dates.
A forecast transaction is an uncommitted but anticipated future transaction.
A hedging instrument is a designated derivative or a designated non-derivative financial asset
or non- derivative financial liability whose fair value or cash flows are expected to offset
changes in the fair value or cash flows of a designated hedged item.
A hedged item is an asset, liability, firm commitment, highly probable forecast transaction or net
investment in a foreign operation that:

a) exposes the entity to risk of changes in fair value or future cash flows, and
b) is designated as being hedged.
Hedge effectiveness is the degree to which changes in the fair value or cash flows of the
hedged item that are attributable to a hedged risk are offset by changes in the fair value or
cash flows of the hedging instrument.
An exchange rate is the rate at which one nation's currency can be traded in exchange for another
nation's currency.
The spot rate is the exchange rate currently offered on a particular currency for immediate delivery at
the transaction/contract date.
A forward rate is an exchange rate set now for currencies to be exchanged at a future date
A forward exchange contract is a contract made now for the purchase or sale of a quantity of
currency in exchange for another currency, for settlement at a future date, and at a rate of
exchange that is fixed in the contract.
A forward rate agreement is used to hedge risk by fixing the interest rate on future short-term borrowings.
4.13.2 Types of hedging relationships
IFRS 9 states that there are three types of hedging relationships:
i) Fair value hedge which refers to a hedge of the exposure to changes in the fair value of
a recognised asset, or liability, or an unrecognised firm commitment, or an identified
portion of such an asset, liability or firm commitment, that is attributable to a particular
risk and could affect the entity's profit or loss.
ii) Cash flow hedge which refers to a hedge of the exposure to variability in cash flows
that:
(a) is attributable to a particular risk related to a recognised asset or liability, for example,
future interest payments on variable rate debt or a highly probable forecast transaction
and;
(b) could affect profit or loss.
iii) Hedge of a net investment in a foreign operation as defined in IAS 21.
4.13.3 Conditions for hedge accounting
According to IAS 39 a hedging relationship will qualify for hedge accounting if the following conditions
are met:
a) At the commencement of the hedge there is formal designation and documentation of
the relationship, and the entity's risk management objective and strategy for
undertaking the hedge. The documentation should include identification of the
relationship, the hedged item or transaction, the nature of the risk being hedged, and
how the entity will assess the hedging instrument's effectiveness in offsetting the
exposure to changes in the hedged item's fair value or cash flows attributable to the
hedged risk

b) The hedge is expected to be highly effective in achieving offsetting changes in fair
value or cash flows attributable to the hedged risk, consistently with the originally
documented risk management strategy for that particular hedging relationship. (80% to
125% window of effectiveness). Any percentage outside the range below 80% or
above 125% is indicative of ineffectiveness.
Tutorial Note:
You should see if the proposed amendments by the 2010 Exposure Draft on Hedge accounting, brought
about changes to the principle`s application, together with the rest of the changes by the IASB that were
incorporated into a draft IFRS 9 in 2012. If so, explain the effects thereof to the students:
The 80% to 125% principle had received criticism for being a purely quantitative test and therefore narrow
and arbitrary. Hence proposals were made to replace it by an objective-based assessment
c) For cash flow hedges, a forecast transaction that is the subject of the hedge must be
highly probable, and must present an exposure to variations in cash flows that could
ultimately affect profit or loss.
d) The effectiveness of the hedge can be reliably measured, that is, the fair value of cash
flows of the hedged item that are attributable to the hedged risk and the fair value of
the hedging instrument can be reliably measured.
e) The hedge is assessed on an ongoing basis and determined actually to have been
highly effective throughout the financial reporting periods for which the hedge as
designated.
According to IFRS 9 (2014) the criteria to apply hedge accounting is as follows and all criteria
must be met:
A hedging relationship must consist of:
i) eligible hedging instruments ii)
eligible hedged items.
Designation and documentation must be formalised at the inception of the hedging relationship:
i) the hedging relationship
ii) risk management strategy and

objective for undertaking the
hedge iii) The hedged item and
hedging instrument iv) how hedge
effectiveness will be assessed.
All the three hedge effectiveness requirements must be met, that is,

a) An economic relationship exists between the hedged item and hedging instrument
b) Credit risk does not dominate changes in value
c) The hedge ratio is the same for both the:
i) hedging relationship
ii) quantity of the hedged item actually hedged, and the quantity of the hedging instrument
used to hedge it.
4.13.4 Fair Value Hedges
If a fair value hedge meets the above conditions during the period, it should be accounted for as
follows:
a) the gain or loss from re-measuring the hedging instrument at fair value (for a
derivative hedging instrument) or the foreign currency component of its carrying
amount (for a non- derivative hedging instrument) should be recognised in profit or
loss.
b) The gain or loss on the hedged item attributable to the hedged risk should be used to
adjust the carrying amount of the hedged item and be recognized in profit or loss. This
applies if the hedged item is otherwise measured at cost. (If the hedged item is an
equity instrument measured at fair value through OCI, then recognised in OCI).
EXAMPLE – FAIR VALUE HEDGES (IAS 39)
On 1 January 20-5, an entity purchased an investment for $250 000, that is classified as a
financial asset at fair value through other comprehensive income. On 31 December 20-5, the
fair value was $275 000. On the same date, the entity entered into a hedge by acquiring a
derivative. On 31 December 20-6, the derivative showed a gain of $15 000, while the
investment's value had gone down by the same amount.
REQUIRED
Show the entries related to the above transaction in the entity's books.
SUGGESTED SOLUTION
20-5 $ $
Jan 1 DR Investment 250 000
Jan 1 CR Bank 250 000
Being entry to record purchase of investment
Dec 31 DR Investment 25 000

Dec 31 CR SCI 25 000
Being entry to show increase in fair value of the investment
20-6
Dec 31 DR Derivative asset 15 000

Dec 31 CR SCI 15 000
Being entry to show increase in fair value of the derivative
20-6
Dec 31 DR SCI 15 000
Dec 31 CR Investment 15 000
Being entry to show decrease in the fair value of the investment.
4.13.4.1 Summary accounting treatment for a fair value hedge
Save for the exceptional instance above, in italics, under the fair value hedge accounting the
hedge item and hedging instrument both will be measured at fair value and change in fair
value at reporting date will be charged to profit or loss.
4.13.4.2 Discontinuing Hedge Accounting – Fair value hedge (IAS 39)
An entity should discontinue hedge accounting under the fair value model if:
a) the hedging instrument expires or is sold, terminated or exercised; however, the replacement or
rollover of a hedging instrument into another hedging instrument is not an expiration or termination
if such action is part of the entity's documented hedging strategy.
b) the hedge no longer meets the criteria for hedge accounting
c) the entity revokes the designation
4.13.5 Cash Flow Hedges
According to IAS 39, if a cash flow hedge meets the qualifying conditions, it should be accounted for as
follows:
(i) The portion of the gain or loss on the hedging instrument that is determined to be an effective
hedge should be recognized in other comprehensive income.
(ii) The ineffective portion of the gain or loss on the hedging instrument should be recognised in
profit or loss
The specific requirements for cash flow hedge accounting are as follows:
a) A hedging reserve (part of the statement of changes in equity) is adjusted to the lesser of:
i) the cumulative gain or loss on the hedging instrument from the inception of the hedge;
ii) the cumulative change in fair value of the expected future cash flows on the hedged
item from inception of the hedge.
b) Any remaining gain or loss on the hedging instrument or designated component that is
not an effective hedge is recognised in profit or loss.
c) If an entity's documented risk management strategy for a particular hedging relationship
excludes from the assessment of hedge effectiveness a specific component of the gain or
loss or related cash flow on the hedging instrument, that excluded component or gain is
recognized in accordance with the provisions for IFRS 9 (2010).

If a hedge of a forecast transaction subsequently results in the recognition of a financial asset
or a financial liability, the associated gains or losses that were recognized in other
comprehensive income should be reclassified from equity into profit or loss in the same
period or periods during which the hedged forecast cash flows affect profit or loss, for
example, in the period that interest income or interest expense is recognized. However, if an
entity expects that all or portion of a loss recognized in other comprehensive income will be
recovered in one or more future periods, it should reclassify into profit or loss the amount that
is not expected to be recovered.
If a hedge of a forecast transaction subsequently results in the recognition of a non-financial
asset or a non-financial liability or a forecast transaction for a non-financial liability becomes
a firm commitment for which fair value hedge accounting is applicable, the entity should
i) reclassify the associated gains and losses that were recognized in other comprehensive
income to profit or loss in same period or periods during which the asset acquired or
liability assumed affects profit or loss e.g. in the period that depreciation expense or
cost of goods sold is recognized. However, if all or part of a loss recognized in other
comprehensive income is not expected to be recovered in a future period, it should be
reclassified into profit or loss or
ii) remove the associated gains and losses that were recognized in other comprehensive
income and include them in the initial carrying cost or other carrying amount of the
asset or liability.
For any other cash flow hedges, amounts that had been recognized in other comprehensive
income should be recognized in profit or loss in the same period or periods during which the
hedged forecast transaction affects profit or loss e.g. when a forecast sale occurs.
According to IFRS 9 (2014) a cash flow hedge is a hedge of exposure to cash flow variability
in cash attributable to a particular risk associated with an asset, liability, or highly probable
forecast transaction (or part thereof, that is, component).
a) The hedge effectiveness is recognised in OCI and the hedge ineffectiveness in the profit
or loss section of the statement of comprehensive income.
b) The lower of the cumulative gain or loss on the hedging instrument or fair value in the
hedged item is recognised separately within equity (cash flow hedge reserve – CFHR).
c) For forecast transactions resulting in a non-financial asset/liability, the amount
recognised in CFHR is removed and included in the initial cost of the non-financial
asset/liability. This is not accounted for as a reclassification.
d) For all other forecast transactions, the amount recognised in CFHR is reclassified to
profit or loss in the periods when the cash flows are expected to affect profit or loss.
4.13.5.1 Summary accounting treatment for a cash flow hedge
Under cash flow hedging the hedged item has no treatment. Still the hedging instrument is
measured at fair value and its change in fair value at reporting date is analysed into two
portions, the effective portion and ineffective portion.
The effective portion will be initially reported to other comprehensive income and ineffective portion
is charged to the statement of profit or loss

The effective portion held initially in the other comprehensive income will be reclassified to
the statement of profit or loss in future when hedge item will affect the statement of profit or
loss.
As for the effective portion, the gain or loss on the hedge instrument up to the extent of gain
or loss on the hedged item will be effective portion. Any excess will be treated as ineffective
portion.
EXAMPLE 1 – CASH FLOW HEDGES
Kahle Corporation is a dairy milk producer and exporter headquartered in Bulawayo,
Zimbabwe. It entered into a firm contract on 1 September 2-15 to acquire a state of the art
milk processing machine at 1 September 2-16 from Russia. The purchase cost is €25 000.
Kahle Corporation uses the USD as its presentation currency given that Zimbabwe has since
20-9 adopted the use of multiple foreign currencies. To cushion itself from foreign exchange
fluctuations Kahle Corporation took up a cash flow hedge (forward exchange contract) to
purchase €25 000 on 1 September 2-16 at $1 : €2.2. The company has a 31 December year
end.
Spot rate Forward rate
for delivery at
1 September 2-16
At 1 September 2-15 $1 = €2.13 $1 = €2.2

At 31 December 2-15 $1 = €1.80 $1 = €1.86
At 1 September 2-16 $1 = €1.50 $1 = €1.50
REQUIRED
Relevant journal entries for the above transaction. Assume the machine has a 10 year useful life
and is depreciated on a straight line basis.
SUGGESTED SOLUTION
You should take note that this is a forward exchange contract taken out in anticipation of
a transaction.
1 September 2-15
Nil entry
You can only disclose risks emanating from the contractual engagement, given that a firm
commitment towards the acquisition of production machinery is generally, a fairly material
transaction. Do not mind the amount used in this case example or the size of Kahle
Corporation.
31 December 2-15
$
Calculation of gain or loss on FEC Contract
At 31 December 2-15 (€25 000/1.86) 13 441
At 1 September 2-15 (€25 000/2.20) (11 364)

Gain 2 077
Calculation of gain or loss on cost of machine

At 31 December 2-15 (€25 000/1.80) 13 889
At 1 September 2-15 (€25 000/2.13) (11 737)
Loss due to increase in cost of machinery 2 152
Comment
At 103.61% that is 2152/2077 x 100%, the hedge can be considered fully effective at this point, therefore,
$ $
DEBIT FEC Asset 2 077
CREDIT Hedge Reserve 2 077
1 September 2-16
Calculation of gain or loss on FEC Contract
At 1 September 2-16 (€25 000/1.50) 16 667
At 31 December 2-15 (€25 000/1.86) (13 441)
Gain 3 226
Calculation of gain or loss on cost of machine

At 1 September 2-16 (€25 000/1.50) 16 667
At 31 December 2-15 (€25 000/1.80) (13 889)
Loss due to increase in cost of machinery 2 778
Comment
At 86.11% that is 2778/3226 x 100%, the hedge still falls within the 80 to 125% window.
Therefore,
$ $
DEBIT FEC Asset 3 226
CREDIT Hedge Reserve 3 226
CREDIT Profit or loss 448
DEBIT Machinery (25 000/1.5) 16 667

CREDI Bank 16 667
Being acquisition of equipment
DEBIT Bank (3 226 + 2 077) 5 303

CREDIT FEC Asset 5 303
Being settlement of the forward exchange contract
DEBIT Depreciation expense (P/L) (4/12 x 16 667/10) 556

CREDIT Accumulated depreciation 556
Being depreciation charge for the year ended 31 December 2-16
DEBIT Hedge Reserve [4/12 x (2 778 + 2 077)/10] 162

CREDIT Profit or loss 162

4.13.5.2 Discontinuing Hedge Accounting – Cash flow Hedge (IAS 39)
An entity should discontinue hedge accounting under the cash flow model if:
(a) The hedging instrument expires or is sold, terminated .or exercised. In this case, the
cumulative gain or loss on the hedging instrument that remains recognised directly in
equity from the period when the hedge was effective should remain separately
recognised in equity until the forecast transaction occurs.
(b) The hedge no longer meets the criteria for hedge accounting. In this case, the
cumulative gain or less on the hedging instrument that remains recognised directly in
equity from the period when the hedge was effective should remain separately
recognised in equity until the forecast transaction occurs
(c) The forecast transaction is no longer expected to occur, in which case any related
cumulative gain or loss on the hedging instrument that remains recognized directly in
equity from the period when the hedge was effective should be recognised in profit or
loss. Note that a forecast transaction that is no longer highly probable may still be
expected to occur.
(d) The entity revokes the designation. Hedges of a forecast transaction are treated
similarly to the situation in (b) above.
4.13.6 Hedges of a net investment
According to IAS 39 hedges of a net investment in a foreign operation, including the hedge of
a monetary item that is accounted for as part of the net investment should be accounted for
similarly to cash flow hedges as follows:
(i) The portion of the gain or loss on the hedging instrument that is determined to be an
effective hedge should be recognised directly in equity through the statement of changes
in equity.
(ii) The ineffective portion should be recognised in profit or loss.
(iii)The gain or loss on the hedging instrument relating to the effective portion of the
hedge that has been recognised directly in equity should be recognised in profit or loss
on disposal of the foreign operation.
According to IFRS 9 (2014) for hedges of a net investment in a foreign operation or specifically
hedge of an entity’s interest in the net assets of a foreign operation:
a) The hedge effectiveness is recognised in OCI
b) Hedge ineffectiveness is recognised in profit or loss
c) Upon disposal of the foreign operation, accumulated amounts in equity are reclassified to profit or
loss.
EXAMPLE 2 – CASH FLOW HEDGES (IAS 39)
On 1 April 20-4, A Ltd. anticipated that it would need to purchase inventory amounting to
US$50 000. On that date, the company entered into a 6-month forward exchange contract
(FEC) to purchase the required foreign currency. The supplier shipped the goods FOB on 31

May 20-4, with payment being due on 30 September 20-4. A Ltd's financial year end is 30
April, and the hedge meets all relevant criteria for a cash flow hedge.
30% of the inventory was sold by 30 April 20-5. A Ltd. includes amounts that emanate from
cash flow hedges of forecast transactions in the initial measurement of the related asset. The
following exchange rates were applicable.
Spot Rate Forward Rate

1 US$ = Z$ 1 US$ = Z$
01/04/20-4 121.5 145
30/04/20-4 122 148
31/05/20-4 125 150
30/09/20-4 130 –
REQUIRED
Prepare the relevant journal entries.
SUGGESTED SOLUTION
You should take note that this is a forward exchange contract taken out in anticipation
of a transaction.
Dr Cr
Z$ Z$
30/04/04
Debit FEC Asset (148-145) x 50 000 150 000
Credit Hedge Reserve (122-121.5) x 50 000 25 000
Credit SCI (Foreign Exchange Gain) 125 000
31/05/04
Debit Inventory (50 000 x 125) 6 250 000
31/05/04
Debit FEC Asset (150-148) x 50 000 100 000
Debit SCI (Foreign Exchange Loss) 50 000
Credit Hedge Reserve (125-122) x 50 000 150 000
31/05/04
Debit Hedge Reserve (25 000 + 150 000) 175 000
Credit Inventory 175 000
30/09/04
Debit SCI (Foreign Exchange Loss) 1 250 000

Credit Bank (50 000 x 145) 7 250 000
Credit FEC Asset (150 000 + 100 000) 250 000
30/04/05
Debit SCI (Cost of Sales) (6 250 000 -175 000) x 30% 1 822 500
Credit Inventory 1 822 500
Tutorial Note:
More scenarios should be attempted in class, for example,
i) A forward exchange contract taken out after a transaction has taken place
ii) Accounting treatment for a forward exchange contract taken out in anticipation of a transaction but the
hedging instrument being ineffective, iii) A forward exchange contract taken on the transaction date
4.14 General Disclosures

IFRS 7 requires entities to provide disclosures in their financial statements which would enable
users to evaluate:
a) the significance of financial instruments for the entity’s financial position and
performance (in other words SCI and SFP disclosures); and
b) the nature and extent of risks (namely credit, currency, interest rate, liquidity, market
and other price risk) arising from financial instruments to which the entity is exposed
during the period and at the end of the reporting period, and how the entity managed
those risks (in other words, risk management procedures).
4.14.1 Risk disclosures
Below are some of the risk types that need disclosure per IFRS 9:
1. Credit risk (Maximum credit risk)
Para 36 (a) requires disclosures of the amount that best represents the entity`s
maximum exposure to credit risk. For a financial asset, this is typically the gross
carrying amount, net of:
a) any amounts offset in accordance with IAS 32
b) any impairment losses recognised in accordance with this IFRS (that is through the
use of the expected credit loss model)
You should take note that the standard (IFRS 9) gives examples of activities that give rise
to credit risk and associated maximum exposure to credit risk.
2. Liquidity risk (Quantitative liquidity risk)

Para 34 (a) requires the entity to disclose summarised quantitative data about its
exposure to liquidity risk on the basis of the information provided internally to key
management personnel.
N.B. IFRS 9 does not specify who the key management personnel is/are but you can start
with the board of directors or those charged with governance.
You should also take note that the other factors that an entity might consider in
providing the disclosures required are cited by IFRS 9 para 39 (c). You are advised to
go through it.
3. Market risk
Para 40 (a) requires a sensitivity analysis for each type of market risk to which the
entity is exposed. The example on how to aggregate the information is given by the
standard as follows:
a) an entity that trades financial instruments might disclose this information
separately for financial instruments held for trading and those not held for trading.
b) an entity would nor aggregate its exposure to market risks from areas of
hyperinflation with its exposure to the same market risks from areas of very low
inflation.
4. Interest rate risk
It arises on interest bearing financial instruments recognised in the statement of
financial position (for example, loans and receivables) and on some financial
instruments not recognised in the statement of financial position (for example, some
other commitments)
5. Currency risk
It arises on financial instruments that are denominated in a foreign currency. N.B.
IAS 21 defines foreign currency.
Currency risk does not arise from financial instruments that are non-monetary items or
from instruments denominated in the functional currency.
6. Other price risk
IFRS 9 requires disclosure of other price risk. It arises on financial instruments because
of changes in commodity prices or equity prices.
Finally, take note that initially the disclosures on financial instruments were per IAS 32 before
the adoption of IFRS 7 in 2009. The principles for recognising and measuring financial assets
and financial liabilities were in IFRS 9 (2009/2010) whereas the principles for disclosing
information about financial instruments were in IFRS 7. You should now go on and observe
what the amendments to IFRS 7 disclosures have been brought up by the adoption of IFRS 9
(2014). What is important is background awareness of IFRS 7 before these recent
amendments.
Transition disclosures have been stated in brief above, in section 4.4 of this Unit, the same with
the need for credit risk related disclosures in section 4.12.2.

4.15 SUMMARY
This Unit explains the accounting and disclosure requirements for financial instruments, and it
is based on IAS 32, IAS 39 and IFRS 7, and IFRS 9 (2009/2010) and IFRS 9 (2014). This is a
complex area in Financial Accounting, as shown by the fact that it was not possible to cover
all the material in one standard. The examples given in the Unit are additional to those in the
standards.
4.16 REFERENCES
BDO INTERNATIONAL Financial instruments July 2015
MIRZA, A. A.; ORRELL, M.; HOLT. G. J. Wiley IFRS Practical
Implementation and Guide
Workbook, 2nd Edition, Hoboken,
New Jersey, 2008
Pwc An in depth look at current

financial reporting issues, 2014
VONWELL,R & WINGARD, C GAAP Handbook 2005
LexisNexis/Butterworths
VORSTER, Q.; KOORNHOF, C et al Descriptive Accounting, 15th
Edition LexisNexis/Butterworths
2010

UNIT FIVE
INSURANCE CONTRACTS
5.0 INTRODUCTION
Insurance business mainly involves the provision for and recognition of current and long-term
assets, which are intended to cover future liabilities of a counterparty. An entity which
provides insurance services is known as an insurer, while the client is referred to as the
insured. Insurance contracts have been an integral part of industry and commerce for
centuries, although it is only now that the IASB and other accounting regulators are striving to
throw more light on the amounts, timing and uncertainty of future cash flows related to
insurance business. IFRS 4 is an interim standard that seeks to identify and explain the
amounts in an insurer's financial statements arising from insurance contracts. The standard
also deals with the accounting requirements of business-to-business insurance arrangements,
which cover the risk of insurers and are commonly referred to as reinsurance.
5.1 OBJECTIVES
• identify and explain the various aspects of an insurance contract;
• distinguish between insurance risk and other types of risks;

• explain the concept of liability adequacy and how it is used in practice;
• give examples of agreements that meet the definition of 'insurance contract’;
• give examples of agreements that do not meet the definition of ‘insurance contract’.
5.2 HIGHLIGHTS OF IFRS 4
The main features of this standard are as follows:
i) it explains that an insurer does not need to account for an embedded derivative
separately at fair value if the derivative meets the definition of an insurance contract. ii) it
requires the insurer to account separately for deposit components of some insurance
contracts, to avoid the omission of some assets and liabilities from the statement of
financial position.
iii) it explains the concept of liability adequacy and how it is used in practice.
iv) it permits an expanded presentation for insurance contracts that are included in a business
combination or portfolio transfer.

v) it explains some aspects of discretionary participation features that are contained in insurance
contracts or financial instruments.

The provisions of IFRS 4 should not be applied to:
a) product warranties issued directly by a manufacturer, dealer or retailer.
b) employers' assets and liabilities under employee benefit plans and retirement benefit
obligations of defined benefit retirement plans.
c) contractual rights or contractual obligations that depend on the future use of, or right to use,
a non-financial item (e.g. royalties and contingent lease payments), as well as a lessee's
residual value guarantee embedded in a finance lease.
d) financial guarantee contracts unless the issuer has previously stated explicitly that it regards
such agreements as insurance contracts, and has used accounting provisions applicable to
insurance contracts.
e) contingent consideration payable or receivable in a business combination.
f) direct insurance contracts that the entity holds i.e. contracts in which the entity is the policy
holder.
The standard explains that a reinsurance contract is an example of an insurance contract.
Therefore, all references in the standard to insurance contract also apply to reinsurance
contracts.
5.4 TERMINOLOGY
The following are some important terms that are defined in the standard:
Insurance contract
This is an agreement 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. The
standard explains that uncertainty or risk is the essence of an insurance contract. At least one
of the following should be uncertain at the commencement of such a contract:
i) whether the insured event will occur ii)
when it will occur
iii) how much the insurer will need to pay if it occurs

It should be noted that an insurance contract can cover events that have already occurred, but
whose financial effect is still uncertain. An example of this is a reinsurance contract that
protects the direct insurer against adverse development of claims already reported by
policyholders. In such contracts, the insured event is the discovery of the ultimate cost of
those claims.

Cedant
This term refers to the policyholder in a reinsurance contract.
Deposit component
A contractual component that is not accounted for as a derivative under IFRS 9, but would be within
the scope of this standard if it were a separate instrument.
Direct insurance contract
An insurance contract that is not a reinsurance contract.
Discretionary participation feature
A contractual right to receive, as a supplement to guaranteed benefits, additional benefits:
a) that are likely to be a significant portion of the total contractual benefits;
b) whose amount or timing is contractually at the discretion of the issuer; and
c) that are contractually based on:
i) the performance of a specified pool of contracts or a specified type of contract; ii)
realised and/or unrealised investment returns on a specified pool of assets held by the
issuer; or
iii) the profit or loss of the company, fund or other entity that issues the contract
Fair value
The price that would be received from selling an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date.
Financial guarantee contract
A contract that requires the issuer to make specified payments to reimburse the holder for a
loss it incurs because a specified debtor fails to make payment when due in accordance with
the original or modified terms of a debt instrument.
Financial risk
The risk of a possible future change in one or more of a specified interest rate, index of prices
or rates, credit rating or credit index or other variable, provided that in the case of a
nonfinancial variable that the variable is not specific to a party to the contract.
Guaranteed benefits
Payments or other benefits to which a particular policyholder or investor has an unconditional right
that is not subject to the contractual discretion of the issuer.
Guaranteed element
An obligation to pay guaranteed benefits, included in a contract that contains a discretionary participation
feature.

Insurance asset
An insurer’s net contractual obligations under an insurance contract.

Insurance risk
An uncertain future event that is covered by an insurance contract to compensate a policyholder
if the insured event occurs.
Liability adequacy test
An assessment of whether the carrying amount of an insurance liability needs to be increased
(or the carrying amount of related intangible assets decreased), based on a review of future
cash flows.
Policyholder
A party that has a right to compensation under an insurance contract if an insured event occurs.
Reinsurance contract
An insurance contract issued by one insurer (the reinsurer) to compensate another insurer (the cedant)
for losses on one or more contracts issued by the cedant.
Reinsurer
The party that has an obligation under a reinsurance contract to compensate a cedant if an insured
event occurs.
Unbundle
To account for the components of a contract as if they were separate contracts.
An insurer should assess the significance of insurance risk contract by contract, not by
reference to materiality to the financial statements. This means that insurance risk may be
significant even if there is a minimal probability of material losses for a whole book of
contracts.
5.5 THE CONCEPT OF SIGNIFICANT INSURANCE RISK
The standard explains that insurance risk is significant only if an insured event could cause an
insurer to pay significant additional benefits in any scenario, .unless the scenario lacks
commercial substance. This condition applies even if the insured event is extremely unlikely,
or the expected present value of contingent cash flows is a small proportion of the expected
present value of all the remaining contractual cash flows. The term 'additional benefits' refers
to amounts exceeding those that would be payable if no insured event had occurred. The
additional amounts include claims handling and claims assessment costs, but exclude
i) the loss of the ability to charge the policyholder for future services e.g. in an
investment- linked life insurance contract, the death of the policyholder would
mean that the insurer can no longer perform investment management services and
be paid for doing so.

ii) waiver on death of charges that would be made on cancellation of surrender of the
policy; because the contract gave rise to those charges, waiving them would not
compensate the policyholder for a pre-existing risk; therefore the charges should
not be considered when assessing how much insurance risk is transferred by a
contract. iii) a payment conditional on an event that does not cause a significant loss
to the policyholder.
5.6 EXAMPLES OF INSURANCE CONTRACTS

The standard gives the following examples of contracts that are classified as insurance contracts, if the
transfer of insurance risk is significant:
i) insurance against theft or damage to property.
ii) insurance against product liability, professional liability, civil liability or legal expenses.
iii) life insurance and prepaid funeral plans.
iv) life-contingent annuities and pensions i.e. contracts that provide compensation for uncertain
future events e.g. the survival of the annuitant or pensioner.
v) disability and medical cover.
vi) surety bonds, fidelity bonds, performance bonds and bid bonds i.e. contracts that provide
compensation if another party fails to perform a contractual obligation. vii) credit insurance
that provides for specified payments to be made to reimburse the holder for a loss incurred
because a specified debtor fails to make payment under the original or modified terms of a
debt instrument.
viii) product warranties issued by another party for goods sold by a manufacturer, dealer
or retailer, except those which are covered by IAS 18 or IAS 37. ix) title insurance i.e.
insurance against the discovery of defects in title to land or other property that were not
apparent when the contract was entered into.
x) travel assistance i.e compensation in cash or kind to policyholders for losses

suffered while they are travelling.
xi) catastrophic bonds that provide for reduced payments of principal, interest or both if
a specified event adversely affects the issuer.
xii) insurance swaps and other contracts that require a payment based on changes in
climatic, geological or other physical variables that are specific to one of the
contracting parties.
xiii) reinsurance contracts.
5.6.1 Examples of agreements that are not insurance contracts
The standard gives the following examples of agreements that do not meet the definition of an
insurance contract
i) investment contracts that have the legal form of an insurance contract, but do not
expose the insurer to significant insurance risk

ii) contracts that have the legal form of insurance, but pass all significant insurance
risk back to the policyholder through non-cancellable and enforceable mechanisms
iii) self-insurance i.e. retaining a risk that could have been covered by insurance iv)
contracts e.g. gambling contracts that require payment if a specified uncertain future
event occurs, but do not require, as a contractual precondition for payment, that the
event adversely affects the policyholder
v) derivatives that expose one party to financial risk but not insurance risk; such
agreements require the party to make payment based solely on changes in one or
more of a specified interest rate, financial instrument price, commodity price,
foreign exchange rate etc, as long as in the case of a non-financial variable, that
variable is not specific to one of the contracting parties
vi) a credit-related guarantee (or letter of credit, credit derivative, default contract or
credit insurance contract) that requires payment, even if the holder has not incurred
a loss on the failure of the debtor to make payments when due
vii) contracts that require a payment based on a climatic, geological or other physical
variable that is not specific to one of the contracting parties
viii) catastrophic bonds that provide for reduced payments of principal, interest or both
based on a climatic, geological or other physical variable that is not specific to one
of the contracting parties.
ACTIVITY 1
a) Explain the concept of significant insurance risk in the context of IFRS 4.
b) Give 13 examples of contracts that are classified as insurance contracts, if transfer of insurance risk is
significant.
5.7 UNBUNDLING THE COMPONENTS OF AN INSURANCE CONTRACT

It is important to distinguish insurance contracts within the scope of IFRS 4 from investments
and deposits which are covered by IAS 39. This is because most insurance contracts have an
implicit or explicit deposit component, as the policyholder is generally required to pay
premiums before any pay-outs can be expected, a process which is sometimes referred to as
establishing the policy. The standard refers to the separation of the insurance and deposit
components of an insurance contract as 'unbundling.' The consequences of unbundling are as
follows:
i) The insurance component is measured as an insurance contract.
ii) The deposit component is measured according to the provisions of IAS 39 at either
amortised cost or fair value. This may be different from the basis used for insurance
contracts.
iii) Premium receipts for the deposit component are recognised not as revenue, but rather
as changes in the deposit liability. However, premium receipts for the insurance
element are normally recognised as revenue.
iv) A portion of the transaction costs incurred at the commencement of the contract should
be allocated to the deposit component, if this allocation would have a material effect.

5.7.1 Reasons for Unbundling the Components of an Insurance Contract
a) An entity should account in the same way for the deposit component of an insurance
contract as for any other financial contract that does not transfer significant insurance risk.
b) The similarity of products offered by banks, insurers and fund managers suggests that
they should account for the deposit component of insurance contracts in a similar way.
c) Many entities sell products which range from pure investments to pure insurance, with
variations in between. Unbundling would avoid major differences in accounting for a product
that transfers just enough insurance risk to be an insurance contract, and another product that
falls marginally on the other side.
d) Financial statements should make a clear distinction between premium revenue
derived from products that transfer significant insurance risk and premium receipts that are in
essence, investments or deposits.
5.7.2 Reasons against Unbundling the Components of an Insurance Contract
A 1999 issues paper on insurance proposed that the deposit component should be unbundled if
it is either disclosed explicitly to the policyholder, or clearly identifiable from the terms of the
contract. However, some respondents to the paper were against unbundling for the following
reasons:
a) The components of an insurance contract are closely related, and the value of the
bundled product is not necessarily equal to the sum of the individual values of the
components.
b) Unbundling would require significant and costly systems changes; contracts of this
kind represent a single product, regulated as insurance business, and should therefore
be treated in a similar way for financial reporting purposes.
c) Some users of financial statements would prefer that either all products are unbundled
or no products are unbundled at all, because such users regard information about gross
premium inflows as important.
d) Insurance contracts are, in general, designed, priced and managed as packages of
benefits. In addition, the insurer cannot unilaterally terminate the agreement or sell
parts of it. This means that any unbundling undertaken solely for accounting purposes
would be artificial.
e) There would be no need to require unbundling if the Board strengthened the liability
adequate test, defined significant insurance risk more narrowly and confirmed that
contracts that are combined artificially are separate contracts.
f) Because Exposure Draft No.5 did not propose recognition criteria, insurers would have
to use local accounting standards to assess whether any assets or liabilities were
omitted, which would defeat the stated reason for unbundling.
g) Unbundling could affect the presentation of revenue more than it affects liability
recognition. Therefore, unbundling should also be required if it would have a
significant effect on reported revenue and is easy to perform.
5.7.3 The final position

The IASB retained the approach advocated in ED 5. This requires unbundling if it is needed to
ensure the recognition of rights and obligations related to the deposit component and those
that can be measured separately. If only the separate measurement condition is met, IFRS 4
permits unbundling, but does not require it.
5.8 LIABILITY ADEQUACY
This is a critical measure of an insurer's ability to meet its commitments to policyholders.
IFRS 4 notes that many accounting models involve tests to confirm that insurance liabilities
are not understated, and that related amounts recognised as assets e.g. deferred acquisition
costs, are not overstated. The credibility of IFRSs could be adversely affected if an insurer
claims to comply with these standards, but does not recognise material and reasonably
foreseeable losses arising from existing contractual obligations.
An insurer should assess at each reporting date whether its recognised insurance liabilities are adequate,
using current estimates of future cash flows under its insurance contracts.
If the assessment shows that the carrying amount of its insurance liabilities (less related
deferred acquisition costs and related intangible assets) is inadequate in the light of the
estimated future cash flows, the full deficiency should be recognised in the income statement.
The minimum requirements for liability adequacy are as follows:
a) The test takes into account current estimates of all contractual cash flows, and of
related cash flows (e.g. claims handling costs), as well as cash flows resulting from embedded
options and guarantees .
b) If the test shows that the liability is inadequate, the entire deficiency should be
recognised in the income statement.
If the carrying amount of an insurer's insurance liabilities is less than the carrying amount that would
be required if the relevant liabilities were within the scope of IAS 37, the insurer should
i) recognise the full difference in profit or loss and
ii) decrease the carrying amount of the deferred acquisition costs or related intangible assets, or
increase the carrying amount of the relevant insurance liabilities.
If an insurer's liability adequacy test meets the minimum requirements, the test should be
applied at the level of aggregation which has been specified. If the minimum requirements are
not met, the comparison should be based on a portfolio of contracts that are subject to broadly
similar risks and managed together as a single portifolio.
5.9 DISCRETIONARY PARTICIPATION FEATURES IN INSURANCE CONTRACTS

As explained earlier, an insurance contract may give the policyholder a contractual right to
receive additional benefits depending on the fulfilment of certain conditions. IFRS 4 states
that the issuer of such a contract
a) may but is not required to, recognise the guaranteed element separately from the
discretionary participation feature; if this feature is not recognised separately, the
whole contract should be classified as a liability.

b) should, if it recognises the discretionary participation feature separately from the
guaranteed portion, classify that feature as either a liability or a separate component of
equity; it is not permitted to classify the feature as an intermediate category that is
neither a liability nor part of equity.
c) may recognise all premiums received as revenue without separating any portion that
relates to the equity component; the resulting changes in the guaranteed element and in
the portion of the discretionary participation feature that has been classified as a
liability should be recognised in profit or loss.
d) should continue its existing accounting policies, unless the policies are changed in a
way that complies with relevant paragraphs of this IFRS.
5.9.1 Discretionary Participation Features in Financial Instruments
In addition to the provisions outlined in 5.9.0 above, the following provisions should be applied
to financial instruments that include discretionary participation features.
a) If the whole discretionary participation feature is classified as a liability, the issuer
should apply the liability adequacy test to the whole contract according to the requirements of
IFRS 4. The issuer is not required to determine the amount that would otherwise result from
applying IAS 39 to the guaranteed element.
b) If part or all of the discretionary participation feature is classified as a separate
component of equity, the liability recognised for the whole contract should not be less than the
amount that would result from applying IAS 39 to the guaranteed element. That amount
should include the intrinsic value of an option to surrender the contract, but is not required to
include its time value if the option is exempted from measurement at fair value.
c) Although these contracts are financial instruments, the issuer may continue to
recognise the premiums for those contracts as revenue, and recognise as an expense the
resulting increase in the carrying amount of the liability.
d) Although these contracts are financial instruments, an issuer applying IFRS 7 to
contracts with a discretionary participation feature should disclose the total interest expense
recognised in profit or loss, but is not required to calculate the expense using the effective
interest method.
EXAMPLE-UNBUNDLING A DEPOSIT COMPONENT

A reinsurance contract has the following features
i) The cedant (original insurer) pays premiums of $1 500 000 every year for 5 years. ii)
An experience account is established, equal to 90% of cumulative premiums.
iii) If the balance in the experience account is negative (i.e. cumulative claims exceed
cumulative premiums), the cedant is required to pay an additional premium equal to the
experience account balance divided by the number of years remaining on the contract. iv)
At the end of the contract, if the experience account balance is positive (i.e. cumulative

premiums exceed cumulative claims), it is refunded to the cedant; if the balance is
negative, the cedant pays this balance to the reinsurer as an additional premium.
v) Neither party can cancel the contract before maturity.
vi) The maximum loss that the reinsurer is required to meet in any period is $5 000 000.
REQUIRED
Show a schedule of the movements in the loan component of the contract, in the books of the reinsurer.
Assume the following different scenarios:
a) There are no claims by the cedant for the whole duration of the contract
b) There is a claim of $4 200 000 by the cedant in Year 1. An appropriate discount rate is 10%
p.a., and the insurance cover is equal each year.
SUGGESTED SOLUTION
This contract is an insurance contract because it transfers significant insurance risk to the
reinsurer. If the reinsurer is required or elects to unbundle the contract, this can be done as
follows. Each payment by the cedant has 2 components i.e. a loan (deposit component) and a
payment for insurance cover (insurance component). According to 1AS 39, the deposit
component should be measured initially at fair value. This can be done by discounting the
expected cash flows from this component.
Since the insurance cover is equal each year, the nominal payment for this cover is also equal.
This means that the annual payment of $1 500 000 is made up of a loan portion as shown below:
EXAMPLE - UNBUNDLING A DEPOSIT COMPONENT
A reinsurance contract has the following features
a) The cedant (original insurer) pays premiums of $1 500 every year for 5 years.
b) An experience account is established, equal to 90% of cumulative premiums.
c) If the balance in the experience account is negative (i.e. cumulative claims exceed cumulative
premiums), the cedant is required to pay an additional premium equal to the experience account
balance divided by the number of years remaining on the contract.
d) At the end of the contract, if the experience account balance is positive (i.e. cumulative premiums
exceed cumulative claims), it is refunded to the cedant; if the balance is negative, the cedant pays
this balance to the reinsurer as an additional premium.
e) Neither party can cancel the contract before maturity.
f) The maximum loss that the reinsurer is required to meet in any period is $30 000.
REQUIRED
Show a schedule of the movements in the loan component of the contract, in the books of the reinsurer.
Assume that there are no claims by the cedant for the whole duration of the contract.
SUGGESTED SOLUTION

This contract is an insurance contract because it transfers significant insurance risk to the
reinsurer. If the reinsurer is required or elects to unbundle the contract, this can be done as
follows. Each payment by the cedant has 2 components i.e. a loan (deposit component) and a
payment for insurance cover (insurance component). According to IAS 39, the deposit
component should be measured initially at fair value. This can be done by discounting the
expected cash flows from this component. Since the insurance cover is equal each year, the
nominal payment for this cover is also equal. This means that the annual payment of $1 500 is
made up of a loan portion of $1 005 as shown below and an insurance premium of $495.
Year Opening Balance Interest at Loan Advance Closing
10% p.a (repayment) Balance
$ $ $ $
0 0 0 1 005.00 1 005.00
1 1 005.00 100.50 1 005.00 2 110.50
2 2 110.50 211.05 1 005.00 3 326.55
3 3 326.55 332.66 1 005.00 4 664.21
4 4 664.21 466.42 1 005.00 6 136.36
5 6 135.63 614.56 (6 750) 00.00
1 725.00 (1 725.00)
5.10 GUIDANCE ON ACCOUNTING POLICY DISCLOSURES (PARA 37A OF IFRS 4;

IMPLEMENTATION GUIDANCE 17 OF IFRS 4)
Based on IAS 1, an insurer should consider the inclusion of the following aspects in its accounting policy
disclosures.
i) premiums (including the treatment of unearned premiums,
renewals and lapses, premiums collected by agents and
brokers but not yet received, taxes on premiums etc)
ii) fees or other charges made to policy holders. iii)
acquisition costs (including a description of their nature).
iv) claims incurred (both reported and not reported), claims handling costs, liability handling
tests (including the treatment of embedded options and guarantees in those tests).
v) information on whether insurance liabilities are disclosed and, if so, an explanation of the
methodology used.
vi) the objective of methods used to adjust insurance liabilities for risk and uncertainty, the
nature of the models and the source of information used
vii) embedded options and guarantees, including a description of whether:
a. the measurement of insurance liabilities reflects the intrinsic value and time value of
these items.
b. their measurement is consistent with observed current market prices.
viii) discretionary participation features, including a clear statement on how the features
are classified as liabilities or components of equity

ix) salvage, subrogation or other recoveries from third parties
x) reinsurance contracts held

xi) underwriting pools, coinsurance and guarantee fund arrangements xii) insurance contracts
acquired through business combinations and portfolio transfers, and the treatment of related
intangible assets
xiii) judgements, apart from those involving estimates that have been made by
management in applying the policies with the most significant effect on the amounts
recognised in the financial statements.
IAS 1 also requires disclosure, either in the statement of financial position or in the notes, of
sub-classifications of the line items presented. Appropriate sub-classifications of insurance
liabilities include:
a) unearned premiums
b) claims reported by policyholders
c) claims incurred but not reported
d) provisions arising from liability adequacy tests
e) provisions for future non-participating benefits
f) liabilities or components of equity relating to discretionary participation features
g) receivables and payables related to insurance contracts
h) non- assurance assets acquired by exercising rights to recoveries
Additional disclosure requirements can be found in 1G34-1G70p B481 of IFRS4 Implementation Guidance
2012.
5.11 SUMMARY
The IASB decided to promulgate a standard on insurance contracts because there was little or
no guidance for companies involved in insurance or reinsurance business. It was considered
that standards on provisions, financial instruments and intangible assets were largely
inapplicable to this type of business. In addition, accounting practices for insurance contracts
were diverse and often differed from practices in other economic sectors. IFRS 4 applies to all
insurance and reinsurance contracts that an entity issues or holds unless such contracts are
covered by other standards. The complexity of IFRS 4 is shown by a lengthy basis for
conclusions and a detailed implementation guidance. The standard provides extensive
disclosure guidelines for entities affected by its requirements.
5.12 REFERENCES
IASB International Financial Reporting Standards 2015.

CHAUDHRY A; et al Wiley, Interpretation and application of IFRS, PKF,
2015
UNIT SIX
ASSETS (IAS 37)
6.0 INTRODUCTION
Historical financial statements are mostly based on transactions, that is, facts with economic
substance, which are compiled in a systematic manner to provide a meaningful basis for
decision making by the users of the statements. However, the accounting model is made
complex by the need to account for future uncertain events, which may result in expenses,
income, liabilities or assets. Accounting would be straight-forward if it only involved the
recording of cash or credit transactions between entities or between entities and individuals.
There are many cases in which an entity needs to recognise non-cash expenses, for example,
depreciation of non-current assets, or an increase in future tax liabilities. Over the life of a
particular non-current asset, the related tax liabilities will begin to reverse at some point,

giving rise to tax assets. What all this means is that the earning of income, the incurring of
expenses and the creation of assets and liabilities is not limited to the current accounting
period. The overriding true and fair view which preparers of financial statements are required
to comply with requires them to take into account all relevant information which comes to
light before the statements are authorised for issue. As explained in IAS 10, actual recognition
or disclosure of this information in the statements will depend on whether the related events or
conditions are considered to be probable or remote.
6.1 OBJECTIVES
• Distinguish between a legal obligation and a constructive obligation
Explain the relationship between provisions and contingent
liabilities
• Explain the treatment of risks and uncertainties in the context of IAS

37.
6.2 KEY TERMS
A liability is a present obligation of the entity arising from past events, the settlement of which
is expected to result in an outflow of resources embodying economic benefits from the entity.
A provision is a liability which has an uncertain timing or amount.
An obligating event is an event that creates a legal or constructive obligation, resulting in the entity
having no realistic alternative to settling that obligation.
A legal obligation is one that derives from:
i) a contract (through its explicit or implicit terms); ii)
legislation; iii) other operation of the law.
A constructive obligation is one that derives from an entity's actions whereby:

i) through 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 responsibilities; and
ii) as a result, the entity has created a valid expectation on the part of those parties
that it will discharge those responsibilities.
A contingent liability is:
a) a possible obligation that arises from past events and whose existence will only be
confirmed by the occurrence or non-occurrence of one or more uncertain future events
not wholly within the entity's control.
b) a present obligation that arises from past events but is not recognised because:

i) it is not probable that an outflow of economic resources will be required to
settle the obligation; and
ii) the amount of the obligation cannot be measured with sufficient reliability
In other words it is a possible liability which has an uncertain timing and
amount.
A contingent asset is a possible asset that arises from past events, and whose existence will
only be confirmed by the occurrence or non-occurrence of one or more uncertain future events
not wholly within the entity's control.
An onerous contract is one in which the unavoidable costs of meeting the obligations under the
contract would exceed the economic benefits expected from it.
A restructuring is a programme that is planned and controlled by management, and changes to
a material extent
a) the scope of a business undertaken by an entity; or
b) the manner in which that business is conducted.
6.3 DIFFERENCES BETWEEN PROVISIONS AND OTHER LIABILITIES
A major feature of a provision is the uncertainty that is linked to the timing or amount of the
future expenditure required to settle the obligation. Other liabilities can be distinguished as
follows:
a) Trade payables (creditors) are liabilities to pay for goods or services that have been
received and have been invoiced or formally agreed with the supplier.
b) Accruals are liabilities to pay for goods or services that have been received but not yet
paid for, invoiced or formally agreed with the supplier including amounts due to employees. It
is noted that the uncertainty related to accruals is generally less than that for provisions. IAS
37 uses the term 'contingent liability' to refer to liabilities that do not meet recognition criteria.
The standard makes a distinction between:
i) provisions, which are recognised as liabilities (assuming that a reliable estimate can be
made because they are present obligations, and an outflow of economic resources will be
required to settle them; and
ii) present obligations that do not meet the recognition criteria set out in the standard, for
example, the need to make a sufficiently reliable estimate of the obligation.
According to Vorster and Koornhof (2004), the fundamental difference between provisions
and contingent liabilities is in the degree of fulfilment of the requirements of specific
identification of a transaction with a particular time period.
6.4 SUMMARY OF THE MAJOR CHARACTERISTICS OF PROVISIONS,
CONTINGENT LIABILITIES AND CONTINGENT ASSETS (APPENDIX A OF IAS
37)
PROVISIONS AND CONTIGENT LIABILITIES

Where as a result of past events, there may be an outflow of resources embodying future
economic benefits in settlement of:
a) a present obligation or;
b) a possible obligation whose existence will only be confirmed by the occurrence or
non-occurrence of one or more uncertain future events not wholly within the control
of the entity
There is a present There is a possible There is a possible
obligation that obligation or a present obligation or a present
probably requires an obligation that may, but obligation where the
outflow of resources probably will not, require likelihood of an outflow
an outflow of resources is remote.
A provision is No provision is No provision is recognised

recognised recognised
Disclosures are Disclosures are required No disclosure is required

required for the for the contingent liability
provision
The standard requires the disclosure of a contingent liability that cannot be recognised
because it cannot be measured reliably.
CONTINGENT ASSETS
Where, as a result of past events, there is a possible asset whose existence will only be
confirmed by the occurrence or non-occurrence future events not wholly within the control of
the entity.
The inflow of The inflow of economic The inflow is not

Benefits is benefits is probable, but not
Virtually certain. virtually certain
The asset is not No asset is recognised. No asset is recognised.

contingent Disclosure is required. No disclosure is required.
EXAMPLE 1
Y Ltd has a 31 December financial year-end. On 25 October 2-11, it was sued for $1 500 for
one of its products which was alleged to be defective by a customer who had taken delivery of
a consignment and paid for it. The issue had not yet been resolved on 31 December 2-11.
REQUIRED
State the accounting treatment of this matter based on the following assumptions: a)
The company will probably lose the case
b) It is unlikely that the company will lose the case.

SUGGESTED SOLUTION
a) There is a present obligation arising from a past obligating event. There is a probability of
an outflow of economic resources in the future. Therefore, the company should recognise a
provision amounting to $1 500.
b) Based on the facts presented, a present obligation does not exist.
Therefore, a provision should not be recognised. However, the company should disclose a contingent
liability amounting to $1 500.
6.5 RECOGNITION ISSUES
The requirements for recognition are outlined in Section 6.3 above. As explained earlier, an obligating
event is a past event that results in a present obligation. This can only occur when:
i) the settlement of the obligation can be enforced by law;
ii) there is a constructive obligation, whereby the entity's actions lead other parties to believe
that it will discharge the obligation.
The standard states that no provision should be recognised for costs that an entity will need to
incur in order for it to operate in the future. The only liabilities recognised in the statement of
financial position are those that exist on the reporting date.
Examples of such obligations are as follows:
a) penalties or clean-up costs for unlawful environmental damage;
b) the decommissioning costs of an oil installation or a nuclear power station to the extent
that the entity is required to rectify damage already caused.
Note that where details of a proposed new law have not yet been finalised, an obligation will only
arise if the legislation is virtually certain to be enacted as drafted.
Sometimes an entity has a number of similar obligations for example, product warranties or
guarantees. In such cases the probability that an outflow will be required in settlement should
be determined by taking into account the class of obligations as a whole. This overall

consideration of probability will then lead to the recognition of a provision if the other criteria
for recognition are met.
The standard states that the use of estimates is an essential part of the preparation of financial
statements and does not undermine their reliability (and credibility, if the estimates are done
properly). Provisions are by their very nature more uncertain than most other statement of
financial position items. However, in most cases an entity will be able to determine a range of
possible outcomes and make an estimate of its obligation(s) that can be used as a basis for
recognising a provision.
The recognition rules for contingent liabilities and contingent assets are as follows:
i) An entity should not recognise a contingent liability. Such a liability should be disclosed,
unless the possibility of an outflow of economic resources is remote
• If the entity is jointly and severally liable for an obligation the part of the
obligation that it expects to be met by the other parties should be treated as a
contingent liability.
• Contingent liabilities may develop in a way which was not initially expected.
They should therefore be assessed continually to determine whether an
outflow of economic resources has become probable. If this is the case, the
entity should recognise a provision in the period in which the change in
probability has occurred, unless it is not possible to make a reliable estimate of
the provision.
ii) An entity should not recognise a contingent asset. Such assets usually arise from unplanned
or other unexpected events with uncertain outcomes.
• Contingent assets are not recognised in the financial statements, since this will
lead to the recognition of income that may never be realised;
• If the realisation of income is virtually certain, the related asset ceases to be

contingent, and may be recognised;
• A contingent asset should be disclosed where an inflow of economic benefits
is probable;
• Contingent assets should be assessed continually to ensure that any
developments are appropriately reflected in the financial statements.
EXAMPLE 2 (CONTAMINATED LAND-LEGISLATION VIRTUALLY CERTAIN TO
BE ENACTED (IAS 37)
An entity in the oil industry causes contamination, but cleans up only when required to do so
under the laws of the particular country in which it operates. One country in which the entity
operates has had no legislation requiring cleaning up, and the contamination has been going
on for several years. At 31 December 2-11 it is virtually certain that a draft law requiring a
cleanup of land already contaminated will be enacted shortly after the year end.
REQUIRED
State with reasons, the accounting treatment of this issue in the entity's financial statements.

SUGGESTED SOLUTION
i) There is a present obligation as a result of a past obligating event. The event is the
contamination of land, which the entity now has to rectify since relevant legislation is
virtually certain to be enacted. ii) There is a probability that the entity will suffer an
outflow of resources embodying economic benefits to settle the case.
iii) The entity should recognise a provision based on the best estimate of the cleaning up
costs.
6.6 MEASUREMENT GUIDELINES
Paragraph 36 of the standard states that 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.
6.6.1 Risks and Uncertainties
The standard emphasizes that risks and uncertainties that are associated with many events and
circumstances should be considered in arriving at the best estimate of a provision. The term
'risk' refers to the variability of a future outcome particularly when this outcome can be
measured. Uncertainty is a more general description of the concept of risk.
A risk adjustment may have the effect of increasing the amount at which a liability is
measured. Judgements which are made under conditions of uncertainty should be exercised
carefully, to ensure that income or assets are not overstated and expenses or liabilities are not
understated. However, uncertainty should not be used to justify the creation of excessive
provisions or a deliberate overstatement of liabilities. It is also important to avoid duplicating
adjustments for risk and uncertainty, leading to the overstatement of provisions.
6.6.2 Present Value

Where the effect of the time value of money is material, the amount of a provision should be
measured as the present value of the expenditures expected to settle the obligation. The
discount rate should be a pre-tax rate that reflects current market assessments of the time
value of money and the risks specific to the liability. The rate should not reflect risks for
which future cash flow estimates have been adjusted.
6.6.3 Future Events
Future events that may affect the amount required to settle an obligation should be reflected in
the amount of a provision where there is sufficient objective evidence that they will occur. For
example, an entity may have reason to believe that the cost of cleaning up a site at the end of a
project's useful life will be reduced by future changes in technology. In this case, the amount
recognised should reflect the reasonable expectations of technically qualified and objective
observers, taking into account all available evidence on the technology that will obtain at the
time of the clean-up. Factors to be considered include:
a) expected cost reductions associated with increased experience in applying existing
technology;

b) the expected cost of applying existing technology to a larger or more complex clean-
up operation than was previously undertaken. The effects of possible new legislation
should be taken into account when measuring an existing obligation if sufficient
objective evidence exists that the legislation is virtually certain to be enacted.
Evidence is required both on what the legislation will require, and if its enactment and
implementation are virtually certain.
EXAMPLE 3
Legal Requirement to fit smoke filters (IAS 37 Appendix C).
Under new legislation, an entity with a 31 December financial year-end is required to fit smoke
filters to its factories by 30 June 2-11.
The entity has not fitted the filters.
REQUIRED
Outline the accounting treatment of this issue on a)
31 December 2-10; and
b) 31 December 2-11
SUGGESTED SOLUTION
a) On 31 December 2-10, there is no present obligation as a result of a past obligating
event. Due to the absence of legislation, an obligating event does not exist either for the cost
of fitting smoke filters or for fines under the legislation. Therefore, no provision should be
recognised for the cost of fitting the filters
b) On 31 December 2-11, there is still no obligation for the cost of fitting smoke filters,
since no obligating event has occurred. However, an obligation may arise to pay fines or
penalties, under the legislation. The entity's assessment of the probability of incurring fines
and penalties through non-compliance with the law will depend on the details of the
legislation and the extent of enforcement. Therefore, no provision should be recognised for
the cost of fitting the filters. However, a provision is required for the best estimate of any fines
and penalties that are more likely than not to be imposed under the new legislation.
ACTIVITY 1
The following provisions have been included in the financial statements of Q Ltd as at
31December, 2-12:
$
a) Provision for repair costs under warranty 850 000
b) Provision for repairs and maintenance of plant and machinery 340 000
c) Provision for premium payable on the redemption of debentures
on 31 December 2-15 50 000
d) Provision for expected operating losses to be incurred in a
trade show scheduled for April 2-13 160 000
REQUIRED

Outline the accounting treatment of the above items in the financial statements of Q Ltd. on 31 December
2-12
6.7 RE-IMBURSEMENTS
Where some or all of the expenditure required to settle a provision is expected to be
reimbursed by another party, the re-imbursement should only be recognised when it is
virtually certain that the amount will be received if the entity settles the obligation. The
reimbursement should be treated as a separate asset, with the amount recognized for the
reimbursement not exceeding the amount of the provision. In the SCI the expense relating to
a provision may be presented net of the amount recognized for a reimbursement.
Statement of profit or loss and Statement of comprehensive income.
The legal position with regard to reimbursements is that the entity will remain liable for the
full amount of a provision, so that it would have to settle this amount if the third party fails to
pay for any reason. This is why the provision should be recognised for the full amount of the
liability, with a separate asset being recognised for the expected reimbursement.
6.8 OTHER RECOGNITION POINTS TO BE NOTED
i) Provisions should be reviewed at each reporting date and adjusted to reflect the current
best estimate. If it is no longer probable that an outflow of economic resources will be
required to settle the obligation, the provision should be reversed. If discounting is
being used, the carrying amount of a provision should increase in each period to reflect
the passage of time. This increase should be recognised as a borrowing cost
ii) A provision should only be used for expenditures for which the provision was
originally recognised. Only expenditures which relate to the original provision can be
offset against it.
6.9 APPLICATION OF RECOGNITION AND MEASUREMENT RULES
Provisions should not be recognised for future operating losses. This is because such losses do
not satisfy the definition of liabilities and the general recognition criteria for provisions. An
expectation of future operating losses indicates that certain assets of the entity may be
impaired. Such assets should be tested for impairment according to IAS 36-Impairment of
assets.
If an entity has a contract that is onerous, the present obligation under the contract should be
recognised and measured as a provision. The unavoidable costs under a contract represent the
least net cost of bailing out of the contract, which is the lower of the cost of fulfilling it and
any compensation or penalties arising from the failure to fulfil it. The entity should recognise
any impairment loss that has occurred on assets dedicated to an onerous contract before a
separate provision for the contract is set up.
Student Note:
Give at least two practical examples in which an onerous contract situation may prevail.
Examples of events that meet the definition of a restructuring (as defined earlier) are as follows:
a) sale or termination of a line of business;

b) the closure of business locations in a country or region;
c) the relocation of business activities from one country or region to another;
d) changes in management structure, for example, eliminating a layer of management; and,
e) fundamental reorganisations that have a material effect on the nature and focus of the entity's
operations.
The recognition rules and guidelines for restructuring are as follows:
A constructive obligation to restructure only arises when an entity:
i) has a detailed formal plan for the restructuring identifying at least:
• the business or part of the business;
• the principal locations affected;
• the location, function and approximate number of employees who will be compensated
for terminating their services;
• the expenditures that will be undertaken; when the plan will be implemented.
ii) has 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.
If an entity starts to implement a restructuring plan, or announces its main features to those
concerned, only after the reporting date, disclosure will be required according to IAS 10-
Events after the reporting period. However, this is only the case if the restructuring plan is
material, and non-disclosure could affect the economic decisions of the users of the entity's
It should be noted that negotiations with employee representatives (for example; works
committee, trade unions, for termination payments, or with purchasers for the sale of an
operating segment, may have been concluded subject only to board approval. As soon as that
approval has been obtained and communicated to the interested parties, the entity will have a
constructive obligation to restructure, if the conditions in (a) and (b) above are met.
No obligation will arise for the sale of an operation until the entity is committed to the sale i.e.
there is a binding sale agreement.
This is because, in the absence of such an agreement, the entity will be able to change its mind
and take a different course of action if a purchaser cannot be found on acceptable terms.
A restructuring provision should include only the direct expenditures arising from the restructuring, that is;
those that are:
i) necessarily related to the restructuring and, ii)
not related to the entity's ongoing activities
The provision should exclude costs related to the retraining or relocation of continuing staff,
marketing activities or investments in new systems and distribution networks. The reason for

this is that such costs relate to the future conduct of the business, and not liabilities for
restructuring at the statement of financial position date. Other important exclusions are as
follows:
a) identifiable future operating losses up to the date of a restructuring, unless they relate to
an onerous contract;
b) gains on the expected disposal of assets, even if the sale of assets is envisaged as a part
of the restructuring.
You should take note that;
Where the proposed sale of an operation is part of a restructuring, the operation's assets should
be reviewed for impairment according to IAS 36.
ACTIVITY 2
X Ltd is a company which manufactures a brand-name product under licence. All the items
are sold with a 1 year warranty. On 31 December 20-7 the following information related to
warranties.
$
Warranty provision 31/12/20-6 2 250 000
Repairs done to defective items under warranty in 20-6 (1 800 000)
Warranty provision for 20-7 4 050 000
Warranty provision 31/12/20-7 4 500 000
The company's accountant calculated warranty provisions as follows:
Based on expected value of cost of repairs where 20 of items

sold will be returned with defects 2 250 000
Based on expected value of cost of repairs where 80 of items
sold will be returned with defects 4 050 000
From past experience, approximately 20 of items sold are returned with defects. However, the
accountant decided to be prudent and make a provision based on 80 of items sold being
returned with defects. Hence, he made a provision for expected repair costs amounting to $4
050 000 as has been indicated above.
By the end of 20-7, the warranties for all items sold in 20-6 had expired, and no further costs were
expected to be incurred in respect of those sales. Assume that all the amounts are material.
REQUIRED
a) Discuss for the year-ended 31 December 20-7 the accountant's decision to make a
provision based on 80 sale of returns, 80 items and recommend a suitable provision.

b) Disclose all relevant information in respect of the recommended provision in the notes to
the financial statements for the year ended 31 December 2007.
i) For each class of provisions, an entity should disclose:
a) the carrying amount at the beginning and end of the period;

b) additional provisions made in the period, including increases to existing provisions;
c) amounts used (that is, incurred and charged against the provision) during the period;
d) unused amounts reversed during the period;
e) the increase during the period in the discounted amount arising from the passage of time, and the
effect of any change in the exchange rate.
ii) For each class of provisions, an entity should disclose
a) a brief description of the nature of the obligation and the expected timing of any resulting
outflows of economic benefits;
b) an indication of the uncertainties about the amount or timing of those outflows;
c) where necessary to provide adequate information, the entity should disclose the major
assumptions concerning future events;
d) the amount of any expected reimbursement, stating the amount of any asset has been recognized
for that reimbursement.
iii) Unless the possibility of any outflow of economic resources in settlement is remote, an
entity should disclose for each class of contingent liability at the end of the reporting
period a brief description of the liability, and where practicable:
a) an estimate of its financial effect;

b) an indication of the uncertainties relating to the amount or timing of any outflow; and
c) the possibility of any reimbursement.
iv) Where a provision and a contingent liability arise from the same circumstances, an
entity should make the disclosures required in (i) to (iii) above, in a way that shows the
link between the provision and the contingent liability,
v) Where an inflow of economic benefits is probable, an entity should disclose a brief

description of the nature of the contingent assets at the end of the reporting period and
where practicable, and an estimate of their financial effect, measured on the same basis as
for provision.
vi) Disclosure of some or all of the information normally required by the standard may be
expected to prejudice seriously the entity's position in a dispute with other parties. In such
cases, the entity is not required to disclose the information but only the general nature of
the dispute, together with the fact that, and reason why, the information has not been
disclosed.

EXAMPLE 4
Disclosure Exemption (Appendix D, IAS 37)
An entity is involved in a dispute with a competitor, who is alleging that the entity has
infringed patents and is seeking damages of $10 million. The entity recognises a provision for
its best estimate of the obligation, but does not need to disclose any of the information
required by paragraphs 84 and 85 of the standard.
The following information is what is disclosed by way of a note;
Litigation is in process against the company relating to a dispute with a competitor who
alleges that the company has infringed patents and is seeking damages of $10 million. The
information usually required by IAS 37 (Provisions, Contingent Liabilities and Contingent
Assets) is not disclosed on the grounds that it can be expected to prejudice seriously the
outcome of the litigation. The directors are of the opinion that the claim can be successfully
resisted by the company.
6.11 SUMMARY
This Unit explains the requirements of IAS 37, which prescribes the accounting procedures and
disclosures for all provisions, contingent liabilities and contingent assets, except:
a) those resulting from financial instruments that are carried at fair value;
b) those resulting from executory contracts, unless the contract is onerous (an executory contract is one
under which neither party has performed any of its obligations, or both parties have partly performed their
obligations to an equal extent);
c) those arising in insurance entities from contracts with policyholders;
d) those covered by another IFRS.
The standard sets out the accounting treatment for provisions, contingent liabilities and
contingent assets, particularly in relation to recognition and measurement issues, including the
estimation of an entity's future obligations.
6.12 REFERENCES
OPPERMANN, H.R.B. Accounting Standaco. Ltd
BOOYSEN, S.F. et al 14th Edition Juta & Ltd 2011
VORSTER, Q Descriptive Accounting

KOORNHOF, C. et al 15th Edition, LexisNexis/Butterworths
2010

UNIT SEVEN
7.0 INTRODUCTION
According to the IASB Conceptual Framework for Financial Reporting, the term ‘income’
relates to increases in economic benefits that arise during an accounting period in the form of
immediate and deferred cash inflows. The framework states that income includes both
revenue from the ordinary and continuing activities of an entity and gains from other sources
of income e.g. a once-off sale of non-current assets. The old IAS 18 (Revenue) gave a detailed
explanation of revenue which may be referred to by various names depending on the nature of
the entity’s business e.g. fees, interest, dividends, royalties and rent. According to the old IAS
11 (Construction Contracts), the major issue in accounting for construction work is performed.
A closer look at IAS 11 shows that the issues that it addresses are really issues of revenue and
the identification of related costs and expenses. IFRS 15 is a new standard which combines
these 2 standards (IAS 18 and IAS 11) because of the similarities between them.
7.1 OBJECTIVES

• Identify the point at which revenue is recognised in the accounting cycle;
• Explain the measurement of revenue in the context of IFRS 15;
• List the criteria for recognising revenue from the sale of goods, rendering of services; Explain the
recognition of contract revenue and expenses in the financial statements.
• Outline the 5-step model for revenue recognition under IFRS 15.
7.2 TERMINOLOGY

IFRS 15 defines some key terms as follows:
A contract is an agreement between two or more parties that creates enforceable rights and obligations.
Revenue refers to income which arises in the course of an entity’s ordinary activities.
Income refers to economic benefits accruing to an entity during an accounting period in the
form of inflows or enhancements of assets or decreases of liabilities that result in an increase
in equity, other than those relating to contributing from equity participants.
A contract asset is an entity’ right to financial or other consideration in exchange for goods or
services that the entity has transferred to a customer, when that right is conditional on
something other than the passage of time e.g. the entity’s future performance.
A contract liability is an entity’s obligation to transfer goods or services to a customer for which
the entity has received financial or other consideration from the customer.
Performance obligation refers to a contract with a customer to transfer to the customer either:
(a) A good or service or a bundle of goods or services that is distinct; or

(b) A series of distinct goods or services that are substantially the same and that have the same
pattern of transfer to the customer.
CORE PRINCIPLE
The core principle of this standard is that an entity should recognise revenue to depict the
transfer of promised goods or services to customers. The amount should reflect the
consideration to which the entity expects to be entitled in exchange for those goods or services.
For all reporting periods presented before the date of initial application, an entity need not
disclose the amount of the transaction price allocated to the remaining performance
obligations, and an explanation of when the entity expects to recognise that amount as
revenue.
7.3. DEFINITION OF A CUSTOMER

IFRS 15 defines a customer as
“……a party that has contracted with an entity to obtain goods or services that are an output of
the entity`s is ordinary activities in exchange for consideration.’’
It should be noted that some transactions may involve multiple parties, in which case not all the
parties may meet the definition of a customer, depending on the facts and circumstances.
In certain collaborative arrangements, a party may not be a customer in the normal sense, but
more of a partner who shares in the risks amd benefits of developing a product to be marketed
e.g. pharmaceuticals.

7.3.1 Interaction with other standards
IFRS 15 explains the accounting requirements when a contract with a customer is partially within its
scope, and partially within the scope of other standards.
(i) If the other standards provide guidance on how to separate and/or initially measure
one or more parts of the contract, the entity should first use the guidance in those
standards.
(ii) If the other standards do not provide guidance on how to separate and/or initially
measure one or more parts of the contract, the entity should use the guidance in
this standard.
EXAMPLE
IFRS 15 outlines the accounting requirements for certain costs e.g. the incremental costs of
following a contract and the costs of undertaking a contract. However, the standard states
clearly that these requirements will apply only if there are no applicable requirements in other
IFRSs.
7.4 RELATIONSHIP WITH IAS 8 – ACCOUNTING POLICIES, CHANGES IN

ACCOUNTING POLICIES AND ERRORS
The transition to IFRS 15 should take into account the following provisions of IAS 8:
(a) An entity should account for a change in accounting policy resulting from the initial
application of an IFRS in accordance with the specific transitional provisions, if any,
in that IFRS; and
(b) When an entity changes an accounting policy upon initial application of an IFRS that
does not include specific transitional provisions applying to that change or changes in
the accounting policy voluntarily, it should apply the change retrospectively.
When an entity applies a new accounting policy retrospectively, it should apply the new accounting
policy to comparative information for prior periods as far back as a possible.
7.4.1 Methods of applying the standard
An entity should apply the standard using one of the two methods:
(i) Retrospectively to each prior reporting period presented in accordance with IAS 8;
(ii) Retrospectively with the cumulative effect of initially applying the standard recognised at the
date of initial application
7.4.2 Practical considerations
The standard gives the following concessions on accounting requirements when they are applied
retrospectively:
(a) For completed contracts, an entity need not restate contracts that begin and end within
the same annual reporting period;

(b) For completed contracts that have variable consideration, an entity may use the
transaction price on the date the contract was completed, rather than estimating
variable consideration amounts in the comparative reporting periods;
(c) For all reporting periods presented before the date of initial application, an entity need
not disclose the remaining performance obligations, and an explanation of when the
entity expects to recognise that amount as revenue.
7.4.3 The essentials of a contract
According to IFRS 15, an entity should only account for a contract with a customer when all of
the following criteria are met:
(a) The parties to the contract have approved (i.e.in writing, orally or in accordance with
other customary business practices) and are committed to perform their respective
obligations; (b) The entity can identify each party’s rights regarding the goods or services
to be transferred;
(c) The entity can identify the payment terms for the goods or services to be transferred;
(d) The contract has commercial substance (i.e. the risk, timing or amount of the entity’s future
cash flows) is expected to change as a result of the contract;
(e) It is probable that the entity will collect the consideration to which it will be entitled in
exchange for the goods or services that will be transferred to the customer.
THE COLLECTABILITY CRITERION
EXAMPLE FROM IFRS 15- CONSIDERATION IS NOT THE STATED PRICE- IMPLICIT
PRICE CONCESSION.
An entity sells 1000 units of a prescription drug to a customer for a promised consideration of
CU 1 million. This is the entity’s first sale to a customer in a new region, which is
experiencing significant economic difficulty. Thus, the entity expects that it will not be able to
collect the full amount of the promised consideration from the customer. Despite the
possibility of not collecting the full amount, the entity expects the region’s economy to
recover over the next two to three years, and determines that a relationship with the customer
could help it to forge relationships with other potential customers in the region.
When assessing whether the criterion in para 9 (e) of IFRS 15 is met, the entity should also
consider paragraphs 47 and 52(b) of IFRS 15. Based on the assessment of facts and
circumstances, the entity will determine that it will have to provide a price concession and
accept a lower amount of consideration from the customer. Accordingly, the entity concludes
that the transaction price is not CU 1 million and therefore, the promised consideration is
variable. The entity estimates the variable consideration and determines that it expects to be
entitled to CU400 000.
The entity considers the customer’s ability and intention to pay the consideration and
concludes that even though the region is experiencing economic difficulty, it is probable that
it will collect CU 400 000 from the customer.
Consequently, the entity concludes that the criterion in para 9(e) of IFRS 15 is met based on
an estimate of variable consideration of CU 400 000. In addition, on the basis of an evaluation
of the contract terms and other facts and circumstances, the entity concludes that the other
criteria in para 9 of IFRS are also met. Consequently, the entity accounts for the contract with
the customer in accordance with the requirements in IFRS 15.

Word of Caution!
Ernest & Young believes that the assessment related to the collectability criterion will
require significant judgement. For example, it may be difficult to determine whether a
partial payment is:
(a) a contract with an implied price concession;
(b) an impairment loss;
(c) An arrangement lacking sufficient substance to which the model in the standard
applies.
Source: Applying IFRS: IFRS 15 Revenue from contracts with customers p25 (2014) ACTIVITY
(a) State the core principle in IFRS 15
(b) (i) Explain the general provisions of IFRS 15 with other international financial
reporting standards;
(ii)Explain the relationship between IFRS with IAS 8 (Accounting policies, changes
in accounting policies and errors).
THE FIVE-STEP MODEL FOR REVENUE RECOGNITION

IFRS 15 explains in detail the 5-step model for revenue recognition shown in the following diagram:
Step 1. Identify the contract
Step 2. Identify the performance obligations within the contract
Step 3. Determine the transaction price

Step 4. Allocate the transaction price to performance obligation within the contract
Step 5. Recognise revenue when (or as) the entity satisfies a performance obligation
7.5 MODIFYING THE CONTRACT

The standard states that an entity should account for revenue from a contract with a customer only
when all the following conditions are met:
(a) the parties to the contract have approved it (in writing, orally or in accordance with
other customary business practices) and are committed to perform their respective
obligations; (b) the entity can identify each party’s rights regarding the goods or services
to be transferred;
(c) the entity can identify the payment terms for the goods or services to be transferred;
(d) the contract has commercial substance (i.e. the risk, timing or amount of the entity’s future cash
flows is expected to change as a result of the contract); and
(e) it is probable that the entity will collect the consideration to which it be entitled in exchange for
the goods or services that will be transferred to the customer.
7.6 THE SUBSTANCE OF A CONTRACT
The enforceability of the rights and obligations in a contract is a matter of law. Contracts
can be written, oral or implied by the parties’ customary business practices. These
practices and the related processes may vary across legal jurisdictions, industries and
entities. Within an entity itself, they may depend on the class of customer, or the nature of

promised goods or services. An entity should always consider these practices and
processes when determining whether and when an agreement with a customer creates
enforceable rights and obligations:
• A contract does not exist if each or either party to the agreement has the
enforceable right to terminate a wholly unperformed contract without
compensating the other party.
• The parties to an arrangement may agree to change the price, scope or both of
their contract. In that case, an entity should determine whether the
modification;
(i) creates a new contract or
(ii) whether it should be accounted for as part of the existing contract.
7.7 GUIDELINES ON CLASSIFICATION
An entity should account for a contract modification as a separate contract if both of the following
conditions are met:
(i) The scope of the contract increases because of the addition of promised goods or
services that are distinct.
(ii) The price of the contract increases by an amount of consideration that reflects the
entity’s stand-alone selling prices of the additional promised goods or services and
any appropriate adjustments to that price to reflect the circumstances of the
particular contract.
If a contract modification is not accounted for as a separate contract, the entity should account
for the promised goods or services/not yet transferred at the date of the contract modification
in whichever of the following ways is applicable.
(i) The entity should account for the contract modification as if it were a termination
of the existing contract and the creation of a new contract. This applies if the
remaining goods or services transferred on or before the date of the contract
modification. The amount of consideration to be allocated to the remaining
performance obligations is the sum of:
(a) The consideration promised by the customer (including amounts already
received) that was included in the estimate of the transaction price and that had
not been recognised as revenue, and;
(b) The consideration promised as part of the contract modification
(ii) An entity should account for the contract modification as if it were a part of the
existing contract if the remaining goods or services are not distinct i.e. they form
part of a single performance obligation which is partly satisfied at the date of the
contract modification. The increase or decrease in revenue at the date of this
modification should be made on a cumulative catch-up basis.
(iii) If the remaining goods or services are a combination of (i) and (ii), the entity
should account for the effects of the modification on the unsatisfied performance
obligations in the modified contract in a way that is consistent with the objectives
of para 21 of the standard.

Example on contract modification resulting in a cumulative catch-up adjustment to revenue.
Extract from IFRS 15
Example 8-Modification resulting in a cumulative catch-up adjustment to revenue (IFRS 15.IE37-IE41)
An entity, a construction company, enters into a contract to construct a commercial building for a
customer on customer-owned land for promised consideration of CU 1 million and bonus of CU 200 000
if the building is completed within 24 months. The entity accounts for the promised bundle of goods and
services as a single performance obligation satisfied over time in accordance with paragraph 35(b) of
IFRS 15 because the customer controls the building during construction. At the inception of the contract,
the entity expects the following:
CU
Transaction price 1000 000
Expected costs 700 000
Expected profit (30%) 300 000
At contract inception, the entity excludes the CU 200 000 bonus from the transaction price because it
cannot conclude that it is highly probable that a significant reversal in the amount of cumulative revenue
recognised will not occur. Completion of the building is highly susceptible to factors outside the entity’s
influence, including weather and regulatory approvals. In addition, the entity has limited experience with
similar types of contracts.
The entity determines that the input measure, on the basis of costs incurred, provides an appropriate
measure of progress towards complete satisfaction of the performance obligation. By the end of the first
year, the entity has satisfied 60 percent of its performance on the basis of costs incurred to date (CU 420
000) relative to total expected costs (CU 700 000). The entity reassesses the variable consideration and
concludes that the amount is still constrained in accordance with paragraphs 56-58 of IFRS 15.
Consequently, the cumulative revenue and costs recognised for the first year are as follows:
CU
Revenue 600 000
Costs 420 000
Gross profit 180 000
In the first quarter of the second year, the parties to the contract agree to modify the contract by changing
the floor plan of the building. As a result, the fixed consideration and expected costs increase by CU 150
000 and CU 120 000, respectively. Total potential consideration after the modification is CU 1 350 000
(CU 1 150 000 fixed consideration + CU 200 000 bonus is extended by 6 months to 30 months from the
original contract inception date.
At the date of the modification, on the basis of its experience and the remaining work to be performed,
which is primarily inside the building and not subject to weather conditions, the entity concludes that it is
highly probable that including the bonus in the transaction price will not result in a significant reversal in
the amount of cumulative revenue recognised in accordance with paragraph 56 IFRS 15 and includes the
CU200 000 in the transaction price.
In assessing the contract modification, the entity evaluates paragraph 27(b) of IFRS 15 and concludes
(on the basis of the factors in paragraph 29 of IFRS 15) that the remaining goods and services to be
provided using the modified contract modification; that is, the contract remains a single performance
obligation.
Consequently, the entity accounts for the contract modification as if it were part of the original contract (in
accordance with paragraph 21(b) of IFRS 15). The entity updates its measure of progress and estimates
that it has satisfied 51.2 percent of its performance obligation (CU 420 000 actual costs incurred divided
by CU 820 000 total expected costs). The entity recognises additional revenue of CU 91 200 [(51.2
percent complete multiplied by CU 1 350 000 modified transaction price) – C U600 000 revenue
recognised to date] at the date of the modification as a cumulative catch-up adjustment.

Arrangements that do not meet the definition of a contract under the standard
If an arrangement does not meet the criteria to be considered a contract under the standard, it must
be accounted for as follows:
15. When a contract with a customer does not meet the criteria in paragraph 9 and an entity receives
consideration from the customer, the entity shall recognise the consideration received as revenue only
when either of the following events has occurred:
a) The entity has no remaining obligations to transfer goods or services to the customer and all, or
substantially all, of the consideration promised by the customer has been received by the entity
and is non-refundable; or
b) The contract has been terminated and the consideration received from the customer is
nonrefundable.
16. An entity shall recognise the consideration received from a customer as a liability until one of the
events in paragraph 15 occurs or until the criteria in paragraph 9 are subsequently met (see paragraph
14). Depending on the facts and circumstances relating to the contract, the liability recognised represents
the entity’s obligation to either transfer goods or services in the future or refund the consideration
received.
In either case, the liability shall be measured at the amount of consideration received from the customer.
7.8 PERFORMANCE OBLIGATIONS IN CONTRACTS

At the inception of a contract, an entity should assess the goods or services promised in a
contract with a customer and identity as a performance obligation each promise to transfer to
the customer either:
(a) a good or service (or a bundle of goods or services) that is/are distinct;
(b) a series of distinct goods or services that are substantially the same and that have the same
pattern of transfer to the customer
Examples of distinct goods or services are as follows
(i) Sale of goods produced by an entity e.g. the inventory of a manufacturer; (ii)
Resale of goods purchased by an entity e.g. the merchandise of a retailer;
(iii) Resale of rights to goods or services purchased by an entity;
(iv) Performing a contractually agreed upon task(s) for a customer;
(v) Providing a service of standing ready to provide goods or services available basis;
alternatively, making goods or services available for a customer to use as and when the
customer decides.
(vi) Providing a service of arranging for another party to transfer goods or services to a customer
e.g. acting as an agent of another party;
(vii) Granting rights to goods or services to be provided in the future that a customer can resell to
its customer.

The examples below illustrate how an entity applies the two-step process for determining whether
promised goods or services in an arrangement are distinct.

EXAMPLE 11 – DETERMINING WHETHER GOODS OR SERVICES ARE
DISTINCT (IFRS 15.IE49-IE58)
Case A-Distinct goods or services
An entity, a software developer, enters into a contract with a customer to transfer a software licence,
perform an installation service and provide unspecified software updates and technical support (online
and telephone) for a two-year period. The entity sells the licence, installation service and technical
support separately. The installation services includes changing the web screen for each type of user (for
example, marketing, inventory management and information technology). The installation service is
routinely performed by other entities and does not significantly modify the software. The software
remains functional without the updates and the technical support.
The entity assesses the goods and services promised to the customer to determine which goods and
services promised to the customer to determine which goods and services are distinct in accordance with
paragraph 27 of IFRS 15. The entity observes that the software is delivered before the other goods and
services and remains functional without the update and the technical support. Thus, the entity concludes
that the customer can benefit from each of the goods and services either on their own or together with
other goods and services that are readily available and the criterion in paragraph 27(a) of IFRS 15 is met.
The entity also considered the factors in paragraph 29 of IFRS 15 and determines that the promise to
transfer each good and service to the customer is separately identifiable from each of the other promises
(thus the criterion in paragraph 27(b) of IFRS 115 is met). In particular, the entity observes that the
installation service does not significantly modify or customise the software itself and, as such, the
software and the installation services are separate outputs promised by the entity instead of inputs used
to produce a combined output.
On the basis of this assessment, the entity identifies four performance obligations in the contract for the
following goods or services:
(a) The software licence;
(b) An installation service;
(c) Software updates, and;
(d) Technical support.
The entity applies paragraphs 31-38 of IFRS 15 to determine whether each of the performance
obligations for the installation service, software updates and technical support are satisfied at point in
time or over time. The entity also assesses the nature of the entity’s promise to transfer the software
licence in accordance with paragraph B58 of IFRS 15 (see Example 54 in paragraphs IE276-IE277).
Case B-Significant customization
The promised goods and services are the same as in Case A, except that the contract specifies that, as
part of the installation service, the software is to be substantially customised to add significant new
functionality to enable the software to interface with other customised software applications used by the
customer. The customised installation service can be provided by other entities.
The entity assesses the goods and services promised to the customer to determine which goods and
services are distinct in accordance with paragraph 27 of IFRS 15. The entity observes that the terms of
the contract result in a promise to provide a significant service of integrating the licenced software into
the existing software system by performing a customised installation service as inputs to produce the
combined output (i.e. a functional and integrated software system) specified in the contract (see

paragraph 29(a) of IFRS 15). In addition, the software is significantly modified and customised by the
service (see paragraph 29(b) of IFRS 15). Although, the customised installation service can be provided
by other entities, the entity determines that within the context of the contract, the promise to transfer the
transfer
the licence is not separately identifiable from the customised installation service and, therefore, the
criterion in paragraph 27(b) of IFRS 15 (on the basis of the factors in paragraph 29 of IFRS 15) is not
met. Thus, the software licence and the customised installation service are not distinct.
As in Case A, the entity concludes that the software updates and technical support are distinct from the
other promises in the contract. This is because the customer can benefit from the updates and technical
support either on their own or together with the other goods and services that are readily available and
because the promise to transfer the software updates and the technical support to the customer are
separately identifiable from each of the other promises.
On the basis of the assessment, the entity identifies three performance obligations in the contract for the
following goods or services:
(a) customised installation service (that includes the software licence);
(b) software updates, and; (c) technical support.
The entity applies paragraphs 31-38 of IFRS 15 to determine whether each performance obligation is
satisfied at a point in time or over time.
It is important to note that the assessment of whether a good or service is distinct must
consider the specific contract with a customer. That is, an entity cannot assume that a
particular good or service is distinct (or not distinct) in all instances. The manner in which
promised goods and services are bundled within a contract can affect the conclusion of
whether a good or service is distinct. We anticipate that the entities may treat the same goods
and services differently, depending on how those goods and services are bundled within a
contract.
7.9 DETERMINATION OF THE TRANSACTION PRICE
An entity should always consider the terms of the contract and its customary business
practices to determine the transaction price. This is the amount of consideration which the
entity expects to be entitled to in exchange for transferring promised goods or services to a
customer. However, this excludes any amounts collected on behalf of third parties e.g. value-
added tax. The consideration promised by a customer may include fixed amounts, variable
amounts, or both.
The estimate or determination of the transaction price is affected primarily by the nature,
timing amount of the consideration promised by the customer. The entity should take into
account all of the following:
(a) variable consideration
- The consideration can vary because of discounts, rebates, refunds, credits, price
concessions, incentives, penalties etc. A variation can also occur if the entity’s
entitlement to the consideration is contingent on the occurrence or non-occurrence of
an event.
(b) constraining estimates of variable consideration

- The whole or part of an amount of variable consideration should only be included in
the transaction price if it is highly probable that a significant reversal in the amount
of cumulative revenue recognised will not occur when the uncertainty associated
with the variable consideration is substantially resolved.
(c) the existence of a significant financing component in the contract.

- If the contract provides that the customer will pay in arrears the entity is effectively
providing financing to the customer. On the other hand, if the customer will pay in
advance, the entity is effectively receiving financing from the customer. A
significant financing component in a contract may exist regardless of whether the
promise of financing is explicitly stated in the contract or implied by the agreed
payment terms.
Factors which are considered when assessing the existence of a significant financing component in a
contract include the following:
(i) The difference, if any, between the amount of promised consideration and the cash
selling price of the promised goods or services, and;
(ii) The combined effects of both of the following:
• The expected length of time between when the entity transfers the promised
goods or services to the customer and when the customer pays for those goods
or services
• The prevailing interest rates in the relevant market
(d) any non-cash consideration
- The consideration paid or promised by a customer may be in the form of goods,

services or other non-cash considerations. When an entity receives or expects to
receive non-cash consideration the fair value of this consideration should be
included in the transaction price.
consideration payable to the customer
(e) - An entity may make payments to its customer(s) if it also purchases goods or
services which satisfies its own needs. The entity may also give incentives to the
customer(s) to encourage them to continue purchasing its goods or services if the
consideration payable to a customer is accounted for as a reduction of the revenue
when/or as the latter of the following events occurs.
(i) The entity recognises revenue for the transfer of the related goods or
services to the customer, and;
(ii) The entity pays or promises to pay the consideration, even if the payment
is conditional on a future event.

Consideration paid to customer can take many different forms. Therefore, entities will have to
carefully evaluate each transaction to determine the appropriate treatment of such amounts.
Some common examples of consideration paid to a customer include:
• Slotting fees- Manufacturers of consumer products commonly pay retailers fees to

have their goods displayed prominently in the store) or virtual (i.e. they represent
space in an internet reseller’s online catalogue). Generally, such fees do not provide a
distinct good or service to the manufacturer and are treated as a reduction of the
transaction price.
• Co-operative advertising arrangements- In some arrangements, a vendor agrees to
reimburse a reseller for a portion of costs incurred by the reseller to advertise the
vendor’s products. The determination of whether the payment from the vendor is in
exchange for a distinct good or service at fair value will depend on a careful analysis
of the facts and circumstances of the arrangement.
• Price protection- A vendor may agree to reimburse a retailer up to a specified amount
for shortfalls in the sales price received by the retailer for the vendor’s products over a
specified period of time. Normally such fees do not provide a distinct good or service
to the manufacturer and are treated as a reduction of the transaction price.
• ‘Pay-to-play’ arrangements- In some arrangements, a vendor pays an upfront fee to
the customer in order to obtain a new contract. In most cases, these payments are not
associated with any distinct good or service to be received from the customer and are
treated as a reduction of the transaction price.
• Purchase of goods or services- Entities often enter into supplier-vendor arrangements
with their customers in which the customer in which the customers provides them with
a distinct good or service. For example, a software entity may buy its office supplies
from one of its software customers. In such situations, the entity has to carefully
determine whether the payment made to the customer is solely for the goods and
services received, or whether part of the payment is actually a reduction of the
transaction price for the goods and services the entity is transferring to the customer.
CONSIDER THESE POTENTIAL SOURCES OF REVENUE REVERSAL.
(i) The amount of consideration is highly susceptible to factors outside the entity’s
influence, e.g. market volatility, weather conditions, and obsolescence of goods or
services.
(ii) The uncertainty about the amount of consideration is not expected to be resolved for
a long period of time.
(iii) The entity’s experience (or other evidence) with similar types of contracts is limited,
or has limited predictive value.
(iv) The entity has a practice of either offering a broad range of price concessions, or
changing the payment terms and conditions of similar contracts
(v) The contract has a large number and broad range of possible consideration amounts.

7.10 PRINCIPAL VS AGENT CONSIDERATIONS
There are some contracts which result in an entity’s customer receiving goods or services
from another entity that is not a direct party to the contract with the customer. IFRS 15 states
that when other parties are involved in providing goods or services to an entity’s customers,
the entity should determine whether its performance obligation is to provide the goods or
services itself i.e. the entity is a principal: or to arrange for another party to provide the goods
or services i.e. the entity is an agent.
• When the entity is the principal, the revenue it recognises is the gross amount it
experts to be entitled to;
• When the entity is the agent, the revenue it recognises is the net amount it is entitled to
retain for its services as the agent.
The measure issue which affects the entity’s revenue recognition is whether it takes control of the
goods/services or not before transferring them to the customer.
According to the standard, the indicators that an entity is an agent rather than a principal, include the
following:
(a) Another party is primarily 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 return;
(c) The entity does not have discretion in establishing prices for the other party’s goods or services
(d) The entity’s consideration is in the form of a commission;
(e) The entity is not exposed to credit risk for the amount receivable from a customer in exchange
for the other party’s goods or services.
By extension, the absence of the above indicators would show that the entity is a principal rather
than an agent.
7.11 CONSIGNMENT SALES
Entities sometimes deliver inventory on a consignment basis to other parties who may be
distributors or dealers. However, this is done without selling the goods/services to the
consignee.
According to IFRS 15, the indicators that a transaction is a consignment rather than an outright
sale include:
(i) The product is controlled by the consignor until a specified event occurs e..g. the sale to
a customer of the consignee, or until a specified period expires;
(ii) The consignor is able to require the return of the product or transfer it to a third party,
e.g. another dealer;
(iii) The consignee does not have an unconditional obligation to pay for the product,
although it may be required to pay a deposit.
Due to the nature of consignment sales the consignor will not generally recognise revenue
when the goods/services are delivered to the consignee. This is because the performance
obligation to deliver goods/services to the customer has not yet been satisfied.
7.12 SALE OF PRODUCTS WITH A RIGHT OF RETURN

An entity may provide its customer with the right to return some goods/services which have already
been sold.
Such a right may be:
(a) Contractual;
(b) An implicit right that exists due to the entity’s customary business practices, or;
(c) A combination of both e.g. the entity has a staled return period, but generally accepts returns over a
longer period.
A customer who has returned goods/services may be reimbursed in a number of ways e.g. a full
or partial refund, a reduction of the amount received, or a different product in exchange.
AN ENTITY SHOULD NOT RECOGNISE REVENUE FOR SALES THAT ARE
EXPECTED TO FAIL IF CUSTOMERS EXERCISE THEIR RIGHT OF RETURN. THE
ENTITY SHOULD CONSIDER THE POTENTIAL FOR CUSTOMER RETURNS WHEN
IT DETERMINES THE TRANSACTION PRICE.
IMPORTANT NOTE!!
TWO METHODS OF SATISFYING PERFORMANCE OBLIGATIONS
Performance obligation satisfied over time
An entity is said to transfer control of a good or service over time and therefore, satisfies a
performance obligation and recognises revenue over time, if one of the following is met:
(a) The customer simultaneously receives and consumes the benefits provided by the
entity’s performance as the entity performs;
(b) The entity’s performance creates or enhances an asset e.g. work-in-progress that the
customer controls as the asset is created or enhanced;
(c) 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.
 An asset created by an entity’s performance does not have an alternative use to an

entity if the entity is either restricted contractually from readily directing the asset the
asset for another use during the creation or enhancement of that asset or limited
practically from practically from readily directing the asset in its completed state for
another use.
Performance obligation satisfied at a point in time
If a performance obligation is not satisfied over time, this means that the obligation will be
satisfied at a point in time. This occurs when the customer obtains control of the promised
asset, and the entity satisfies the performance obligation. Examples of transfer of control
include:
(i) The entity has a present right to payment for the asset;
(ii) The customer has legal title to the asset;
(iii) The entity has transferred physical possession of the asset;
(iv) The customer has the significant risks and rewards of ownership of the asset; (v) The
customer has accepted the asset.

7.13 MEASURING PROGRESS ON THE PERFORMANCE OBLIGATION
When an entity has determined that a performance obligation will be satisfied over time, the
IFRS 15 requires the entity to select a single revenue recognition method related to the
fulfilment of its performance obligation on the contract.
An entity should determine the stand-alone selling prices at contract inception of the distinct
good or service underlying each performance obligation in the contract, and allocate the
transaction price in proportion to those stand-alone selling prices. If these prices are not
readily available, the entity should estimate them.

A suitable framework for such estimates is as follows:
The est imate is based on the prices of

Adjusted market assessment similar products in the market and
adjusted for the entity’s cost and
margin structure
The estimate is based on the expected

Expected costs plus a margin costs of satisfying a performance
obligation plus an appropriate margin
An entity may estimate the stand alone

selling price by reference to the total
transaction price less the sum of the
observable stand -alone selling prices of
other goods or services promised in the
Residual contract. It may use this approac h only
if one of the following criteria are met.
The entity sells the same good

or service to different
customers for a broad range of
amounts; or
The entity has not yet
established a price for that
good or service, and that good
or service has not previously
been sold on a stand-alone
basis
Source: Descriptive Accounting – IFRS Focus 19th Edition p340

7.14 ALLOCATION OF DISCOUNT
The total discount on a transaction arises if the sum of the stand-alone selling prices of
promised goods or services in the contract exceeds the promised consideration. Unless this
discount relates to only one or more, but not all performance obligations, the entity should
allocate the discount proportionately to all the performance obligations. This is achieved by

allocating the total transaction price to each performance obligation on the basis of the relative
stand-alone selling prices of the underlying distinct goods or services.
An entity should allocate discount to one or more, but not all, performance obligations in the contract
if all the following criteria are met:
(a) The entity regularly sells each distinct good or service or each bundle of distinct goods
or services in the contract on a stand-alone basis.
(b) The entity regularly sells on a stand-alone basis a bundle or bundles of some of those
distinct goods or services at a discount to the stand-alone selling prices of the goods or
services in each in each bundle.
(c) The discount attributable to each bundle of goods or services is substantially the same
as the discount in the contract as a whole; there is observable evidence of the
performance obligation to which the discount relates.
7.15 ALLOCATION OF VARIABLE CONSIDERATION
The standard states that variable consideration that is promised in a contract may be attributable
to the entire contract or to a specific part of the contract e.g.
(i) One or more, but not all, performance obligations in the contract (e.g. a bonus may
be contingent on an entity transferring a promised good or service within a
specified period);
(ii) One or more, but not all, distinct goods or services promised in a series of distinct
goods or services that forms part of a single performance obligation e.g. the
consideration promised for the second part year of a two-year cleaning service
contract will increase on the basis of movements in a specified inflation index.
An entity should allocate a variable amount and any subsequent changes to the amount
entirely to a performance obligation or to a distinct good or service that forms part of a single
performance obligation if both of the following criteria are met:
(i) The terms of a variable payment relate specifically to the entity’s efforts to satisfy
the performance obligation or transfer the distinct good or service;
(ii) Allocating the variable amount of consideration entirely to the performance
obligation or the distinct good or service is consistent with the allocation objective
related to the performance objective and payment terms in the contract.
EXAMPLE ON ALLOCATION OF TRANSACTION PRICE
MM Motors (Pvt) Ltd entered into an agreement with a customer for the sale of a motor
vehicle with 3 years of service for a total sum of $30 000. It is also possible for a customer to
purchase a motor vehicle from the vehicle without a service plan for a stand-alone price of
$27 000. The company regularly sells 3-year service plans to customers on a stand-alone basis
for $2 300.

REQUIRED
Show the allocation of the transaction price between the components of the contract.
SUGGESTED SOLUTION
Tutorial Note
(i) MM Ltd has two performance obligations i.e. the delivery of a motor vehicle and
the delivery of the service plan which are accounted for separately for revenue
purposes.
(ii) The total consideration from the customer is allocated to the two performance
obligations, based on the best estimate of the stand-alone selling prices.
(iii) Revenue is only recognised for these two performance obligations when they have
been satisfied.
Allocation
Stand-alone Ratio Allocation of
Selling price transaction price
$ % $
Motor vehicle 27 000 92.15 27 645
3-year service plan 2 300 7.85 2 355
29 300 100.00 30 000
7.16 TREATMENT OF CONTRACT COSTS

IFRS 15 identifies 2 major types of costs related to contracts which should be recognized as assets
i.e. capitalized:
a) The incremental costs of obtaining a contract with a customer if the entity expects to
recover these costs; these are costs which the entity would not have incurred if the
contract had not been obtained e.g. sales commission.
b) The costs incurred in fulfilling the contract, if these costs are not within the scope of
another standard e.g. IAS 16 (Property, Plant and Equipment). However, capitalization
of such costs is only permitted if:
(i) the costs relate directly to a contract or an anticipated contract which the entity
can specifically identify e.g. costs related to services associated with the
renewal of an existing contract;
(ii) the costs generate or enhance resources of the entity which will be used to
satisfy performance obligations in the future; (iii) the costs are expected to be
recovered.
Costs which relate directly to a contract include:

a) direct labour e.g. salaries and wages of employees who provide the promised products or
services to the customer;
b) direct materials e.g. supplies used to provide the promised products or services to the customer;
c) allocations of costs which relate directly to the contract or to contract activities e.g. contract
management and supervision;
d) costs which are explicitly chargeable to the customer under the contract;
e) other costs which are incurred only because the entity entered into the contract e.g. payments to
sub-contractors.
7.16.1 Treatment of general and other costs
According to IFRS 15, an entity should recognize the following costs as expenses when incurred:
i) general and administrative costs, unless they are explicitly chargeable to the customer
under the contract;
ii) costs of wasted materials, labour or other resources to fulfil the contract that were not
included in the contract price;
iii) costs which relate to satisfied or partly satisfied performance obligations in the contract;
iv) costs for which the entity cannot distinguish whether they relate to satisfied performance
obligations or unsatisfied performance obligations.
7.17 GUIDELINES FOR SPECIFIC CONTRACT OUTCOMES
If revenue from a contract with a customer is being recognized over time, the following guidelines can
be used to determine profit or loss on the contract:
• If the expected outcome is a profit, revenue and costs should be recognized according to
the progress of the contract.
• If the expected outcome is a loss, the whole loss should be recognized immediately, with
a provision being recorded arising from an onerous contract.
• If the expected outcome or stage of progress is unknown (usually because the contract is
in a very early stage:
(a) revenue should be recognized up to the recoverable costs

(b) contract costs should be recognized as an expense in the period in which they are incurred.
Source: Kaplan Publishing – ACCA Financial Reporting 2015 – 2016 p 258
7.17.1 Amortisation and impairment
An asset which is recognized in terms of Section above should be amortised on a systematic
basis consistent with the transfer to the customer of the goods or services to which the asset
relates. The amortization should be updated to reflect any significant change in the entity’s
expected timing of such a transfer.
An entity should recognize an impairment loss in profit or loss to the extent that the carrying amount
of a recognized asset exceeds:
a) the remaining amount of consideration which the entity expects to receive in exchange
for the goods or services to which the asset relates.

b) the costs which relate directly to providing the goods or services and which have not been
recognized as expenses.
Example on calculation of contract profit
The following information relates to a construction contract:
$
Estimated contract revenue 320 000
Costs to date 128 000
Estimated costs to complete 112 000
Estimated stage of completion 70%
REQUIRED
(a) Calculate the amounts of revenue, costs and profit which should be recognized in the
company’s financial statements.
(b) The company is not able to estimate reliably the outcome of the contract, although
there is evidence that all costs incurred will be recoverable from the customer.
Calculate the amounts of revenue, costs and profit which should be recognized in the
company’s financial statements.
SUGGESTED SOLUTION
(a) $
Revenue (320 000 x 70%) 224 000
Costs (128 000 + 112 000) x 70% (168 000)
Profit 56 000
(b) Revenue(same as costs to date) 128 000

Costs to date (128 000)
-
7.17.2 Presentation in the Statement of Financial Position
On the reporting entity’s reporting date, the contract should be presented in the statement of financial
position as a contract asset or a contract liability.
A contract liability is an entity’s obligation to transfer goods or services to a customer for which
the entity has received consideration from the customer.
A contract asset is an entity’s right to consideration in exchange for goods or services which the
entity has transferred to the customer.
A receivable is an entity’s unconditional right to consideration A right is unconditional if only the

passage of time is required before payment of the consideration is due.

EXAMPLE
T Ltd. is undertaking a contract to build townhouses for a client. The company is entitled to
receive payments related to the progress on the work, so it should recognize revenue over
time. The contract price is $5 000 000 and the work is expected to be completed on 31
December 20-6. Details of the contract to 31 March 20-5 (the company’s financial year-end)
were as follows:
Commencement date 1 July 20-4

$
Contract costs
Architect’s and surveyor’s fees 62 500

Materials delivered to site 350 000
Direct labour costs 437 500
Overheads are apportioned at 40% of
direct labour costs of the contract to 31/03/20-5
Estimated cost to complete (excluding depreciation) 1 850 000
Plant and machinery being used on the contract cost $450 000 on 1 July 20-4 is expected to be
transferred to another contract at a value of $75 000. Depreciation on the plant and machinery
is calculated on a time basis. The client made a progress payment of $1 600 000 on 31 March
20-5.
Additional information on the contract on 31 March 20-5 was as follows:

$
Contract costs to date excluding depreciation 2 550 000
Estimated costs to complete excluding depreciation 825 000
The client made a further progress payment of $2 025 000 on 31 March 20-6. The company
calculates profit on its construction contracts using the percentage of completion basis, as
measured by the percentage of the contract costs to date compared to the total estimated
contract costs.
REQUIRED
Show extracts from the financial statements of T Ltd. in relation to the contract for the years ended
31 March 20-5 and 31 March 20-6.
SUGGESTED SOLUTION

(i) Overall contract Year-ended 31 March
20-5 20-6
$ $
Contract price 5 000 000 5 000 000
Costs to date (2 550 000)
Architect’s and surveyor’s fees ( 62 600)
Materials delivered to site ( 350 0000)
Direct labour ( 437 500)
Overheads (437 500 x 40%) ( 175 000)
Depreciation of plant & machinery
(450 000-75 000) x 9 months

30 months
Costs to complete
Excluding depreciation (1 850 000) ( 825 000)
Depreciation of plant & machinery
(450 000-75 000) x 21 months ( 262 500) ( 112 500)
30 months Profit 1 750 000 1 250 000
(ii) Progress
Based on costs to date/total costs:
Year-ended 31/03/20-5 1 137 500 = 35%
3 250 000
Year-ended 31/03/20-6 1 812 500 = 75%

3 750 000
(iii) Statement of profit or loss

& other comprehensive income Year-ended 31 March
20-5 20-6
$ $
Revenue (5 000 000 x 35%) 1 750 000
[(5 000 000 x 75%) – 1 750 000] 2 000 000
Cost of sales (3 250 000 x 35%) (1 137 500) (1 675 000)

(2 812 500 – 1 137 500)
Contract profit 612 500 325 000
(iv) Statement of financial position

Year-ended 31/03/20-5 $
Non-current assets
Property, plant & equipment (450 000-112 500) 337 500
Contract asset (trade receivable) 150 000
(1 750 000-1 600 000 received

Year-ended 31/03/20-6
Non-current assets
Property, plant & equipment (450 000-262 500) 187 500
Contract asset (trade receivable) 125 000
(1 750 000 +2 000 000) = 3 750 000
Less total cash received (1 600 000 + 2 025 000)
= 3 625 000
ACTIVITY
(a) What are the major components of a contract?

(b) List the costs that may relate directly to a specific contract.
(c) List the costs which may be attributable to contract activity in general and can be allocated to
specific contracts.
Base your answer on IFRS 15
The objective of IFRS 15 in this regard is to ensure that reporting entities disclose sufficient
information to enable users of their financial statements to understate the nature, amount,
timing and uncertainty of revenue and cash flows arising from contracts with customers.
Entities should disclose qualitative and quantitative information about the following:
(a) Its contracts with customers.

(b) The significant judgements, and changes in the judgements, made in applying the standard to those
contracts.
(c) Any assets recognized from the costs to obtain or fulfil contracts with customers.
The detailed disclosure requirements of the standard are outlined in paras 111 to 128.
7.19 SUMMARY
IFRS 15 is the standard which establishes principles and gives guidance on the reporting of
useful information to users of financial information concerning the characteristics of revenue
and cash flows arising from entities’ contracts with customers. The standard sets out
recognition criteria based on 5 steps. A specific requirement of the standard is the treatment of
assets recognized from the costs incurred in obtaining or fulfilling contracts with customers.
7.20 REFERENCES
KOPPESCHAAR, Z.R. Descriptive Accounting – IFRS Focus

ROSSOUW, J. & 19th Edition LexisNexis 2014
DEYSEL, D. J. et al
KAPLAN PUBLISHING Financial Reporting Module 2015 – 2016
IASB International Financial Reporting

Standards 2015
UNIT EIGHT
8.0 INTRODUCTION
IFRS 8 Operating Segments sets requirements for disclosure of information about an entity’s products
and services, the geographical areas in which it operates and its major customers.
For entities that operate in a variety of classes of business, geographical locations, regulatory
or economic environments or markets, the availability of segmental information is essential
for good management. Such information is vital if management is to be able to monitor
performance within its specific business and geographical regions and to decide how best to
allocate resources to segments. With good segment information, management is better placed
to devise strategies and focus actions towards countering adverse trends or exploiting
opportunities in specific business lines, geographical areas or market places. Segment
information not only serves as an internal management tool but has an important role in
external reporting to investors and to the market, the factors that contribute to the results for
the year.
8.1 OBJECTIVES
• give the reasons for reporting financial information by segment;
• explain how segment reporting facilitates decision making at organisational/ corporate level;
• identify reportable segments based on the criteria in IFRS 8;
• list the factors used to identify operating segments;
• outline the disclosure requirements for operating segments.
8.2 SCOPE
IFRS 8 applies to:
A. The separate or individual financial statements of an entity:
i) whose debt or equity securities are traded in a public market (that is, a
domestic or foreign stock exchange or an over-the-counter market, including
local or regional markets); or
ii) that files, or is 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.
B. The consolidated financial statements of a group with a parent:

i) whose debt or equity securities are traded in a public market (that is a domestic
or foreign stock exchange or an over-the-counter market, including local or
regional markets); or
ii) that files, or is in the process of filing, the consolidated financial statements
with a securities commission or other regulatory organisation for the purpose
of issuing any class of instruments in a public market. [IFRS 8 para 2] C.
i) if an entity that is not required to apply IFRS 8 voluntarily discloses
information about segments, but that information does not comply with the
IFRS, the entity should not describe the information as segment information.
(IFRS 8 para 3). For example, if such an entity disclosed information about
segments, but that information was not the information reported to the CODM,
it should not be described as segment information. Similarly, if such an entity
voluntarily disclosed only part of the information required by the standard,
such as sales information for segments, but did not disclose segment profit or
loss or the other information required by the standard, it should not describe
the sales information as segment information. [IFRS 8 para BC 22]
ii) where a parent’s separate financial statements that are required to comply with
IFRS 8 are included in a financial report with the consolidated financial
statements of the parent and its subsidiaries, segment information need only be
given for the consolidated financial statements. [ IFRS 8 para 4]
iii) a subsidiary company whose debt or equity securities are traded in a public
market or who is in the process of filing its financial statements with a
securities commission or regulatory authority for the purpose of issuing its
securities in a public market is required to present segment information. The
subsidiary would need to analyse its segments separately from the parent’s
analysis. This would include identifying its own CODM (see further para
10.31.3), determining its own operating segments based on its CODM’s review
and disclosure of its reportable segments in accordance with IFRS 8. iv)
where a subsidiary has listed securities but the parent does not, whether the
consolidated financial statements are required to comply with IFRS 8 will
depend on whether the consolidated financial statements are required to be
filed with a regulator irrespective of the filing requirements of the subsidiary,
the consolidated financial statements must comply with IFRS 8.
v) IFRS 8 may apply to entities that issue instruments on a public market where
those instruments can only be redeemed by ‘putting them back’ to the issuer.
For example, an entity that is a fund issues a public prospectus whereby
members of the public can subscribe for units. Investors can only redeem their
units by selling them back to the fund. Since the entity was required to file its
financial statements, as part of the public prospectus, for purposes of issuing
the instruments and subsequently issued instruments to members of the public,
IFRS 8 would apply.
vi) in contrast however, a regulatory requirements to file financial statements is
not always linked to the process of issuing instruments to a public market.
Therefore, entities that file financial statements will not always be within IFRS
8’s scope. Where an entity does not file financial statements but not for the
purpose of issuing instruments to the public, such an entity would not be
required to comply with IFRS 8.

vii) an entity that is not within the scope of IFRS 8 may still be required to identify
its operating segments in accordance with this standard. IAS 36 states that a
cash generating unit to which goodwill acquired in a business combination is
allocated for the purpose of impairment testing cannot be larger than an
operating segment. [IAS 36 para 80(b)].
Therefore, although the entity does not need to comply with the disclosure of
IFRS 8, it will need to comply with this standard’s requirements for
determining its operating segments.
8.3 DEFINITION
An operating segment is a component of an entity:
a) 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.)
b) whose operating results are regularly reviewed by the entity’s Chief Operating
Decision Maker to make decisions about resources to be allocated to the segment and
assess its performance and;
c) For which discrete financial information is available.
8.4 CORE PRINCIPLE

The core principle of IFRS 8 is to require an entity to disclose information that enables users
of the financial statements to evaluate the nature and financial effects of the business activities
in which the entity engages and the economic environments in which it operates.
8.5 CHANGES FROM PREVIOUS REQUIREMENTS.

The IFRS replaces IAS 14 Segment Reporting.
The main changes from IAS 14 are described below:
a) Identification of segments.
IFRS 8 requires identification of operating segments on the basis of internal reports
that are regularly reviewed by the Chief Operating Decision Maker in order to allocate
resources to the segment and assess its performance. IAS 14 identification was based
on:
i) Related products and services, and; ii)

Geographical areas.
A component of an entity that sells primarily and exclusively to other operating segments of the
entity is included in the IFRS8’s definition of an operating segment.
IAS 14 limited reportable segments to those that earn a majority of their revenue from
sales to external customers and therefore did not require the different stages of
vertically integrated operations to be identified as separate segments.

b) Measurement of segment information.
The IFRS requires the amount reported for each operating segment item to be the
measure reported to the Chief Operating Decision Maker for the purpose of allocating
resources to the segment and assessing its performance. IAS 14 required segment
information to be prepared in conformity with the accounting policies adopted for
preparing and presenting the financial statements of the consolidated group or entity.
IAS 14 defined segment revenue, segment expenses, segment results, segment assets
and segment liabilities. The IFRS does not define these terms, but requires an
explanation of how segment profit or loss, segment assets and segment liabilities are
measured for each reportable segment.
8.6 REPORTABLE SEGMENTS

Reportable segments may comprise some operating segments or an aggregation of operating
segments, that meet certain quantitative thresholds set out in the standard. Reportable
segments are those operating segments or aggregation of operating segments for which
segment information must be separately reported.
Aggregation of segments must satisfy the principal condition that the operating segments
should have similar economic characteristics and that the segments are similar in all the
following aspects:
(i) the nature of products and services
(ii) the nature of the production processes
(iii) the type of class of customers for their products and services
(iv) the methods used to distribute their products or services
(v) the nature of the regulatory environment; for example banking, insurance or public utilities.
Information must be reported for each aggregated operating segment that:
(i) contributes 10% or more of the entity’s total sales (combining internal and intersegment
sales.)
(ii) earns 10% or more of the combined reported profit of all operating segments that did not
report a loss (or 10% or more of the combined reported loss of all operating segments that
reported a loss or;
(iii) has 10% or more of the combined assets of all operating segments.
After the aggregation process described above, if the total external revenue reported by operating
segments constitutes less than 75% of the entity’s revenue, additional operating segments must be
identified until at least 75% of the entity’s revenue is included in reportable segments. Once reportable
segments account for at least 75% of consolidated revenue, the remaining segments may be grouped
under all other segments’.
8.7 IDENTIFICATION OF OPERATING SEGMENTS
Appendix

The following chart is reproduced from the Guidance on Implementing IFRS 8
8.7.1 Steps to identification

As notes to flow chart above
Step 1- Identify the Chief Operating Decision Maker:-
The function of the Chief Operating Decision Maker could be an individual such as the Chief
Executive Officer or Chief Operating Officer, or could be a group of executives; either the
board of directors or the management committee.

Step 2- Can the component generate revenue and incur expenses from its own business activities?
:-
A start-up operation that has not earned revenue may be an operating segment as a component
of an entity that sells primarily or exclusively to other components of the same entity.
Step 3- Are the components’ operating results regularly reviewed by the Chief Operating
Decision Maker as a basis for resource allocation and performance assessment? :-
In practice, a key issue in identifying operating segments is the extent to which operating
results of business units are aggregated for the purpose of review by the Chief Operating
Decision Maker. The Chief Operating Decision Maker may review one type of result based on
product lines and another type based on geographical area. In such situations, operating
segments should be determined based on the accountability or performance of managers who
report directly to the Chief Operating Decision Maker.
Step 4- Is discrete financial information available for the component? :-
For a component to be an operating segment the financial information about the operating results of
the component should be sufficiently detailed to enable the Chief Operating Decision
Maker to make decisions about resources to be allocated and assess its performance.
8.7.2 Aggregating segments

Step 5
Do some operating
segments meet all the
aggregation criteria? No
Step 6
No
Aggregate operating
segments if desired
Step 7
Yes Do some operating

segments meet all the
aggregation criteria?
No
Step 8
Combine
operating Do the reportable
segments if segments identified
desired account for 75% of Yes
consolidated revenue? Aggregate remaining
These are
reportable segments and other
No activities into ‘all
segments to
be disclosed other segments’
Identify additional category
operating segments
(and if appropriate,
aggregate with other
reportable segments)
until external revenue
of all segments >75% of
consolidated returns
8.7.3 Summarised aggregation guide.

The following chart is reproduced from the Guidance on Implementing IFRS

Identify operating segments based on
management reporting system
(Paragraphs; 5-10)
Do some operating Yes Aggregate

segments meet all segments if
aggregation criteria? desired.
No
Do some operating
Yes segments meet all
(paragraph 12)
No
Aggregate
segments Do some remaining
if desired operating segments meet
a majority of the
No
Do identified reportable
segments account for Yes
75% of the entity’s
revenue?
No
Report additional segment if external

revenue of all segments is less than 75%
of entity’s revenue (paragraph 15)
These are reportable

segments to be disclosed Aggregate remaining segments
into “all other segments” category
(paragraph 16)
8.7.4 Detailed disclosure requirements IFRS

requires the following disclosures:
1. General information: The factor used to identify the entity’s reportable segments,
discussion of how the entity is organised and whether operating segments have been

aggregated. The types of products and services from which each reportable segment
receives its revenues.
2. For each reportable segment information about profit or loss assets and liabilities
including:
• A measure of profit or loss
• A measure of total assets
• A measure of total liabilities if such an amount is regularly provided to the
CODM
• The amount of any of the following items that are either included in the measure of segment
profit or loss reviewed by the CODM or otherwise regularly provided to the CODM:
• Revenues from external customers
• Revenues from transactions with other operating segments within the entity
• Interest revenue and expense (interest revenue and expense may only be CODM relies
primarily on net interest revenue to assess the performance of the segment and make
decisions about resources to be allocated to the segment)
• Depreciation and amortisation
• Material items of income and expense disclosed in accordance with paragraph 86 of IAS 1
Presentation of Financial Statements
• The entity’s interest in profit or loss of associates and joint ventures accounted for by the
equity method
• Income tax expense or income.
• Material non-cash items other than depreciation and amortisation
3. Any of the following items that are either included in the measure of segment assets
reviewed by or otherwise regularly provided to the CODM:
• The investment in equity-accounted associates and joint ventures
• Total additions to non-current assets other than financial instruments, deferred
tax assets, post –employment benefits and rights arising under insurance
contracts (i.e. property, plant and equipment; and intangible assets and
investments, for the most part)
4. An explanation of the measurement basis of segment information, including: the basis of

accounting for intersegment transactions.
• If not apparent from the reconciliation’s described below, the nature of any differences
between the measurement of the following items in the entity’s financial statements in
accordance with IFRS:
• Profit or loss before income tax and discontinued operations
• Assets
• Liabilities
5. As well as accounting policy differences, measurement differences might include
policies for allocating central costs or jointly used or shared assets and liabilities to
individual segments:
• The nature of any changes from prior periods in the measurement methods used
to determine segment profit or loss and the effect, if any;
• The nature and effect of any asymmetrical allocations to reportable segments
(e.g. an allocation of depreciation expense when the related depreciable assets
are not allocated the same segment)

6. Reconciliations of: The total of the reportable segments’ revenues to the entity’s
revenue. The total of the reportable segments’ profit or loss to the entity’s profit or
loss before income tax and discontinued operations (or, if items such as income tax are
allocated to segments, to profit or loss after tax)
• The total of the reportable segments’ liabilities to the entity’s liabilities
• The total of the segment’s amounts for every other material item information
disclosed to the corresponding amount for the entity.
7. All material reconciling items must be separately identified and described
8. Entity-wide disclosures, to the extent that this information is not provided as part of the
reportable segment information:
• External revenues on an IFRS basis attributed to (1) the entity’s country of domicile
and (2) all foreign countries, if material; the entity must disclose the basis on which
revenues have been attributed to different countries.
• Non-current assets on an IFRS basis other than financial instruments, deferred tax
assets, post-employment benefit assets, and rights arising under insurance contracts
(i.e. property, plant and equipment, intangible assets and investments, for the most
part):
• Located in the entity’s country of domicile
• Located in all foreign countries
9. Separate disclosure of assets in an individual foreign country must be made if the assets
are material
10. Where any of the entity-wide information required to be disclosed is not available, and
the cost to develop it would be excessive, an entity must disclose that fact.
11. If revenues from a single external customer (for which purpose entities under common
control of a particular government are in each case considered to be a single customer)
amounts to 10% or more of an entity’s revenues, the total revenues from the customer
concerned and the identity of the segment(s) reporting the revenues must be disclosed.
Disclosure of the name of the customer(s) is not required.
12. If an entity changes the structure of its internal organisation in a manner that causes the
composition of its reportable segments to change, the corresponding information for
earlier periods must be restated unless the information is not available and the cost to
develop would be excessive in which case segment information for the year in which the
change occurs must be disclosed on both the old basis and the new basis of segmentation
(unless the necessary information is not available and the cost to develop it would be
excessive)
13. Many of the disclosures required by IFRS 8 should come from readily available
information within the entity so that a minimal amount of time and effort should be
required to prepare them. More effort may be required, however, in preparing the
reconciliations of the segment information to the relevant IFRS amounts appearing in the
financial statements and the associated explanations. Prior to the adoption of IFRS 8 an
entity should assess its systems and processes to ensure that the required information can
be prepared.
8.8 RESTATEMENT OF PREVIOUSLY REPORTED INFORMATION.
If an entity changes the structure of its internal organisation such that the composition of its
reportable segments changes, the corresponding information for earlier periods including

interim periods, shall be restated unless the information is not available and the cost to
develop, it would be excessive. The determination of whether the information is not available
or cost excessive shall be made for each individual item of disclosure following a change in
the composition of its reportable segments, an entity shall disclose whether it has restated the
corresponding items or segments for either periods.
Following the change in composition of reportable segments and failure to restate earlier
results, the entity shall disclose in the year in which the change occurs. Segment information
for the current period on both the old bases and the new basis of segmentation unless the
necessary information is not available and the cast to develop it would be excessive.
8.9 ENTITY-WIDE DISCLOSURES
The standard requires all entities that report in accordance with IFRS 8 to make certain
entitywide disclosures, that is disclosures for the entity as a whole rather than the segment.
This requirement applies even to those entities with one reportable segment. The reason for
this requirement is that some entities’ business activities are not organised on the basis of
differences in products and services or differences in geographical areas of operations.
Entity-wide disclosures are based mainly on information about the entity’s products and services and
information on the entity’s geographical areas of operation.
8.10 PRODUCTS AND SERVICES

Entities that report revenue from different products and services are required to disclose
revenue from external customers for each product and services or each group of products and
services.
8.11 GEOGRAPHICAL AREAS
IFRS 8 paragraph 33 lists the geographical information to be disclosed being the same
information that is used to produce the entity’s financial statements. The standard does not
prescribe how revenue should be allocated to geographic areas. An entity may choose to
allocate revenue on the basis of either the customer’s location or the location in which the sale
originated. An entity must disclose the basis it has selected for attributing revenue to
geographic areas.

8.12 REVENUE
The standard does not define the term “material” for the purpose of determining whether an
individual country’s revenue should be separately disclosed. The entity should consider
materiality from the quantitative and qualitative perspectives. 10% or more threshold should
be a guide in determining the separate report ability of a country’s revenue.
8.13 ASSETS
Non-current assets for the purpose of disclosure include tangible and intangible assets.
Information about major customers. If revenues from transactions with a single customer amount to
10% or more of an entity’s revenue the entity should disclose:
(i) the fact that revenue from a customer exceeds 10% or more of the entity’s revenues (if
this applies to more than one customer, the number of customers should be given.)
(ii) the total amount of revenue from each such customer
(iii)the identity of the segment or segments that report the revenues. There is no need to
disclose the identity of the customer or customers or amount of revenues that each
segment reports from that customer or customers. A group of entities under a common
control should be considered to be a single customer e.g. government departments or
subsidiaries of one parent company.
Segment disclosures required or encouraged by other standards-IFRS 5 requires disclosure

where applicable, if the reportable segment in which non-current asset (or disposal group) is
presented in accordance with IFRS 8.
IFRS 7 requires disclosure of information about the entity’s exposure to credit risk in so far as
they are material to the entity or are reported internally to the entity’s key management
personnel.
IAS 7 encourages disclosure of the amount of cash flows arising from operating investing and financing
activities of each reportable segment IAS 7 para 50 (d) as revised by IFRS 8.
IAS 34 requires segmental disclosures in interim financial statements. The disclosure
requirements in respect of segmental information for interim accounts are listed in paragraph
16A (g) of IAS 34.
IAS 36 requires that where an entity applies the IFRS, it should disclose:
(i) The amount of impairment losses recognized in profit or loss and comprehensive income
during the period.
(ii) The amount of reversals of impairment losses recognized in profit or loss and comprehensive
income during the period.
Additional voluntary disclosures:

(i) Sales conditions
(ii) Research and development
(iii)Environmental expenditure, health and safety

8.14 FREQUENTLY ASKED QUESTIONS RELATING TO IFRS 8
EXAMPLE 1
1. Scope.
(a) Are there any scope exclusions: Yes. IFRS 8 applies only to entries whose
securities are traded in a public market.
(b) Does IFRS 8 apply to entities that are not required to prepare consolidated
financial statements? Yes IFRS 8 applies to individual financial statements. For
an entity that produce both consolidated financial statements and the parent’s
financial statements segment information is required in the consolidated financial
statements.
2. (a) Reportable operating segments.
In aggregating operating segments, must all aggregation criteria be satisfied? For
segments that meet the 10% quantitative threshold for a reportable segment all
criteria all criteria must be satisfied. Segments that do not meet any of the
quantitative thresholds, may be combined if they exhibit similar economic
characteristics and satisfy a majority of the aggregation criteria (rather than all of
the criteria) IFRS 8; 12 and 14.
(b) Definition of terms: Segment profit/loss segment assets and segment liabilities are
not defined by IFRS 8. IFRS 8 requires an entity to explain the composition/ build-up
of the items and to reconcile the total segment amounts to that reported in the entity’s
IFRS financial statements.
3. If the measurement bases of the information provided to Chief Decision Maker differ
from the measurement bases of IFRS financial statement; the what needs to happen?
Reconciliations are required that separately identify and describe each adjustment
needed to reconcile the total of all reportable segments profits or losses to the
consolidated profit or loss.
4. Disclosures. Is there any upper limit on the number of reportable segments that an
entity should disclose? IFRS 8 does not impose a limit. However, it does advise that if
the number of reportable segments exceeds 10, an entity should consider whether a
practical limit has been reached. Does an entity have to disclose segment information
that may be competitively harmful? Yes IFRS does not grant any exemptions from
disclosing segment information on the grounds that it may be competitively harmful
(IFRS 8 BC109-111).
5. Impairment: Is it possible that the exemption of IFRS 8 will impact the allocation of
Goodwill for impairment testing under IAS 36-Impairement of assets? Yes. IAS 36
requires Goodwill to be allocated to each Cash Generating Unit or to groups of Cash
Generating Units. Differences will arise where Cash Generating Units under IFRS 8
are different from those under IAS 14. It is possible that this reallocation of Goodwill
could expose Cash Generating Units for which the carrying amount, including the
allocated Goodwill exceeds the recoverable amount, thereby giving rise to an
impairment loss.
6. Transition- Is there any exemption from restating comparatives if an entity early adopts
IFRS 8?
No, there is not exemption from restating comparatives (IFRSs 8 and 36)
8.15 COMPREHENSIVE EXAMPLE – OPERATING SEGMENTS

Global investments (Pvt) Ltd is a diversified entity that operates in Southern Africa, Europe
and the Far East. The entity`s main operating branches are tobacco processing, clothing and
motor trade. The entity identified these three operating branches as the only three reportable
segments. The entity has a 30 June year-end.
Information about each of the entity`s main operating branches is reported to the Chief
Operating Decision Maker (CODM) on a quarterly basis for the purposes of decision making
about allocating resources to the branches and assessing their performance. The CODM is of
the opinion that the results (profit or loss) of the operating branches should be calculated on a
case basis, with the exception of depreciation, for decision making purposes. The following is
a summary of the information presented to the CODM for the year ended 30 June 2-13.
External customers (3 750 000) (1 500 000) 1 125 000

Other segments Nil (1 000 000) Nil
Results Motor Trade Tobacco Clothing Branch assets
Processing (125
$ $ $ 000)
(375 000)
Revenue 3 750 000 2 500 000 1(75
125000)
000 T
o
bacco processing assets
- allocated (500 000)
(50 000)
Expenses (including expenses

paid to other segments) (2 000 000) (937 500) (312 500)
Depreciation 550 000 (125 000) (450 000)

Net results for the year 1 200 000 1 437 500 362 500
Financial position
Assets 1 650 000 1 875 000 1 100 000
Liabilities (562 500) (900 000) (387 500)
The following is an extract from the trial balance of Global investments (Pvt) Ltd for the year ended
30 June 2-13.
Revenue 6 062
500
Cash from external customers 6 375 000
Income received in advance for tobacco processing (625 000)
Income receivable for goods delivered (cash to be
received early in the next financial period) 312 500
Cost of sales (3 000 000)

Cash paid to external parties 2 750 000
Operating expenses 2 250
Overhead cost incurred by head office 000
Accrued expenses 500 250
000 000
Other expenses (1 525 000)
Depreciation
Impairment loss on plant (motor trade)
-reported to CODM (1 125 000)
Profit before tax (sub-total) 1 537
500 (400 000)
Income tax expense (543 750)
Profit for the year 993 750
Assets 1 650 000 8 687 500
Motor trade – Plant 1 100 000
Clothing – Equipment 1 875 000
Tobacco processing – Equipment 3 750 000
Building – Head office 312 500
Accrued income
Liabilities 2 475
000
Interest bearing loans 1 850 000
Income received in advance 625 000

REQUIRED
Disclose segment information as per IFRS 8 requirements.
SUGGESTED SOLUTION
8.15.1. Operating segments
8.15.2 Identifying operating segments
The entity identified three reportable operating segments based on the nature of the
products and services delivered by each segment. Each segment is a strategic business unit
(S.B.U) exposed to risks which are unique to the S.B.U and each S.B.U is separately
managed.
The products or services provided by each segment to generate revenue are as follows:
Motor trade Buying and selling of second-hand vehicles in Southern Africa and the Far East.
Tobacco processing Buying and selling of tobacco to Europe and the Far East.
Clothing Manufacturing clothing in Europe and distribution in Europe and Southern Africa
8.15.3 Segment information
The segment income, segment expenses and segment profit or loss are calculated on a cash basis,
except for depreciation.
Segment results Motor Trade Tobacco Clothing Total

Processing
$ $ $ $
Segment income 3 750 000 2 500 000 1 125 000 7 375 000
External customers 3 750 1 500 1 125 6 375
Other segments 000 000 000 000
Nil 1 000 Nil 1 000
Segment expenses 000 000 (2 550 000) (1
062 500) 500) (3 250 (762 500) (4
375 000) 000)
Cash expenses (550 000) (125 000) (450 (1 125 (2 000 000)
(937 500) 000) 000) (312
Depreciation

Segment profit 1 200 000 1 437 500 362 500 3 000 000
Non-cash items (not included

in segment result)
Impairment loss (400 000) Nil Nil (400 000)
Segment assets 1 650 000 1 875 000 1 100 000 4 625 000
Segment liabilities (562 500) (900 000) 387 500 (1850 000)
Reconciliation between segment information and line items in the financial statements.
$
Revenue
Total segment 7 375 000
Revenue received from other segments (1 000 000)
Revenue received in advance (625 000)
Accrued revenue 312 500
Revenue as per statement of profit or . loss
and other comprehensive income 6 062 500
Expenses
Total segment expenses 4 375 000
Expenses paid to other segments 1 000 000
Impairment loss (non-cash items) (400 000) Head
office – overhead expenses (500 000)
Expenses as per statement of profit or .
Loss and other comprehensive income 4 525 000
Assets
Total segment assets 4 625 000
Accrued revenue 312 500
Head office building 3 750 000
Assets as per statement of financial position 8 687 500
Liabilities
Total segment liabilities 1 850 000
Revenue received in advance 625 000
Liabilities as per statement of financial position 2 475 000
8.15.4 Entity-wide information *1
8.15.5 Geographical information

China 750 000
India 500 000
Japan 250 000
Great Britain 375 000
France 375 000
250 000
Revenue Non-current G
assets 625 000 e
$ $ 750 000 r
South Africa 3 562 500 4 937 500 500 000 m
Other countries 2 500 000 3 750 000 625 000 a
875 000 n
y 375 000
8.15.6 Customers
The entity received $1 062 500 from a single customer. This revenue is included in the Tobacco
Processing segment.
*1 Assume the information in this note, since detai was not provided in the information concerning these
numbers. This note is prepared simply for the sake of completeness of disclosure.
Comment:
IFRS 8 does not prescribe the measurement basis for the amounts in the segment report. The amount of each
segment item reported shall be the measure used for internal reporting to the CODM. On this example, the
cash basis is used for this purpose. It follows that a reconciliation is needed from the segment information
(cash basis) to the entity`s financial statements prepared in accordance with IFRSs.
8.16 SUMMARY
This unit provides information about the requirements of IFRS 8 on Operating Segments
highlighting the differences between this standard and IAS 14 which it is replacing. The unit
explains the procedures followed in identifying segments of a reporting entity and the core
principle of IFRS 8 i.e. to require an entity to disclose information that enables users of
financial statements to evaluate the nature and financial effects of the business activities in
which the entity engages and the economic environments in which it operates. The unit also
gives benefits and advantages to both users and management by adopting the standard.
8.17 REFERENCES
pwc MANUAL OF ACCOUNTING, IFRS 2015- volume 1

Ernst & Young IFRS 8 OPERATING SEGMENTS
SHOKO D. ADVANCED FINANCIAL ACCOUNTING & REPORTING
VOLUME 1, Denmark Training Services CIS Study Pack 2006
PARADZA P. FINANCIAL ACCOUNTING 3
IAC Study pack 2004
IASB International Financial Reporting Standards, 2015
UNIT NINE

9.0 INTRODUCTION
Lack of timeliness has been recognized as one of the major weaknesses of historical financial
reporting. In Volume 1 of this study guide, it was noted that quality is an attribute with many
components. However, to many people what comes to mind in this context is usefulness for
decision-making purposes. Investors and other stakeholders who need financial accounting
use it to, inter alia,
i) decide when to buy, hold or sell investments; ii) assess the

stewardship or accountability of the entity's management;
iii) assess the entity's ability to pay adequate remuneration and provide other benefits to its
employees;
iv) assess the adequacy of security for amounts lent to the entity;
v) estimate distributable profits and dividends that can be expected from the entity;
Decision-making based on historical financial statements is made difficult by the fact that
such statements are produced periodically, while their users face decision-making situations
continually. To address this constant need for financial information, many entities are now
providing their reports more frequently in between annual reporting dates.
9.1 OBJECTIVES
• Outline the minimum contents of an interim financial report
• Outline the minimum information that should be disclosed in the notes to an interim financial report
• Identify the periods for which interim financial periods are required to be presented
• Explain the recognition and measurement issues related to interim financial report
9.2 DEFINITIONS
An interim period is a financial reporting period that is shorter than a full financial year.
According to IAS 1 – Presentation of financial statements, a full financial year is a twelve
month long period.
An interim financial report is one containing either a complete set of financial statements or a set
of condensed financial statements for an interim period.
9.3 MINIMUM CONTENTS OF AN INTERIM FINANCIAL REPORT
The major purpose of an interim financial report is to provide an update of the latest complete
set of annual financial statements. Accordingly, the report focuses on new activities, events

and circumstances and should not duplicate previously reported information. The minimum
contents of the report are as follows:
a) Condensed statement of financial position;

b) Condensed statement of comprehensive income;
c) Condensed statement of the changes in equity;
d) Condensed statement of cash flows;
e) Selected explanatory notes.
9.3.1 Form and content of interim financial statements
If an entity publishes a complete set of financial statements in its interim financial reports, the
form and content of those statements should comply with the requirements of IAS 1 for a
complete set of financial statements.
If an entity publishes a set of condensed financial statements in its interim financial reports,
those condensed statements should include as a minimum each of the headings and sub-totals
that were included in its most recent financial statements and the selected explanatory notes
required by IAS 34.
Additional line items or notes should be included if their omission would make the condensed statements
misleading.
Basic and diluted earnings per share should be presented on the face of the interim statement of
comprehensive income, whether it is condensed or not.
9.3.2 Significant events and transaction
An entity should include in its interim financial report explanations of events and transactions
that are significant for an understanding of the changes in financial position and performance
of the entity since the end of the last annual reporting period. This information should update
the relevant information presented in the most recent annual financial report.
Examples of events and transactions for which disclosures are required if they are significant are
as follows:
a) the write-down of inventories to net realisable value and the reversal of such a writedown;
b) recognition of a loss from the impairment of property, plant and equipment, intangible assets, or
other assets and the reversal of such a loss;
c) the reversal of any provisions for the cost of restructuring
d) acquisitions and disposals of items of property, plant and equipment;
e) commitments for the purchase of property, plant and equipment;
f) litigation settlements;
g) corrections of prior period errors;
h) any loan default or breach of a loan agreement that has not been remedied on or before the end of
the reporting period.

i) Changes in the business or economic circumstances that affect the fair value of the entity`s financial
assets and financial liabilities, whether those assets or liabilities are recognised at fair value or
amortised cost.
j) Related party transactions
k) Transfers between levels of the fair value hierarchy used in measuring the fair value of the financial
instruments.
l) Changes in the classification of financial assets as a results of a change in the purpose or use of those
assets; and
m) Changes in contingent liabilities or contingent assets.
9.4 PERIODS FOR WHICH INTERIM FINANCIAL STATEMENTS ARE

REQUIRED TO BE PRESENTED
Interim reports should include interim financial statements (condensed or complete) for the following
periods:
i) Statement of financial position at the end of the current interim period and a
comparative statement of financial position;
ii) SCIs for the current interim period and cumulatively for the current financial year to
date, with comparative SCIs for the comparable interim periods (current and year-
todate) of the immediately preceding financial year;
iii) Statement showing changes in equity cumulatively for the current financial year-
todate, with a comparative statement for the comparable year-to-date period of the
immediately preceding financial year and
iv) Statement of cash flows cumulative for the current financial year-to-date, with a
comparative.
9.4.1 Approaches to identifying and measuring revenues, expenses, gains and losses of an
interim period and assets and liabilities at the interim date
There are two approaches that can be used namely:
a) The integral approach whereby the interim period is viewed as an integral part of the
entire financial year and bases measurements of interim period revenues and expenses
on full year estimates. According to this view, the interim financial data should
primarily be predictive and explanatory of financial data for the full current financial
year.
b) The discrete approach whereby the interim period is viewed as a discrete “stand alone”
reporting period (the year to date approach). Interim results are determined in
essentially the same way annual financial results are.
The discrete approach is endorsed by IAS 24 as the primary approach.
9.5 MATERIALITY THRESHOLD

In deciding how to recognise, measure, classify or disclose an item for the purpose of interim
financial reporting, materiality should be assessed in relation to the interim period financial
data. In making such assessments, it should be noted that interim measurements may rely on
estimates to a greater extent than annual measurements.
9.6 RECOGNITION AND MEASUREMENT GUIDELINES
An entity should apply the same accounting policies in its interim financial statements as
those applicable to its annual financial statements, except for accounting policy changes made
after the date of the most recent annual financial statements that are to be reflected in the next
set of annual financial statements. However, the frequency of an entity's reporting cycle (that
is, annual, half-yearly or quarterly) should not affect the measurement of its annual results. In
order to achieve this objective, measurements for interim reporting purposes should be made
on a year-to-date basis. IAS 34 acknowledges that an interim period is part of a longer
financial year. Year-to-date measurements may involve changes in estimates of amounts
reported in prior interim periods of the current year. However, the principles for recognising
assets, liabilities, income and expenses for interim periods should be the same as for annual
• For assets, the same tests of future economic benefits apply at interim dates and at the
end of an entity's financial year; and
• Similarly, a liability at an interim reporting date should represent an existing

obligation at that date, just as it would at an annual reporting date.
9.7 IMPLICATIONS OF THE IASB CONCEPTUAL FRAMEWORK FOR INTERIM

FINANCIAL REPORTS
In measuring the assets, liabilities, income, expenses and cash flows reported in its financial
statements, an entity that reports annually can take into account information that become
available throughout the year. The accounting measurements of such an entity are therefore
effective on a year-to-date basis. An entity that reports on a 6-monthly basis uses information
that is available by mid-year or shortly thereafter in making the measurements for the first
6monthly period and information available by year-end or shortly thereafter for the 12-month
period. The 12-month measurements will reflect possible changes in estimates of amounts
reported for the first 6-month period, although these amounts should not be retrospectively
adjusted. The standard states that the nature and amount of any significant changes in
estimates should be disclosed.
An entity that reports more frequently than at 6-monthly intervals should measure income and
expenses on a year-to-date basis for each interim period, using information that is available
when each set of financial statements is being prepared. The amounts of income and expenses
reported in the current interim period will reflect any changes in estimates of amounts
reported in prior interim periods of the financial year, which should not be retrospectively
adjusted. The standard states that the nature and amount of any significant changes in
estimates should be disclosed.

Revenues that are received seasonally, cyclically, or occasionally within a financial year
should only be anticipated or deferred on an interim date if it is appropriate to do so.
Examples of such revenues are dividends, royalties and government grants. An example of
seasonal revenue is that of retailers. Costs that are incurred unevenly should be recognised
when they occur. Such costs should only be anticipated or deferred for interim reporting
purposes if it is also appropriate to anticipate or defer that type of cost at the end of the
financial year.
9.8 USE OF ESTIMATES
IAS 1 states that the proper use of estimates does not reduce the validity and credibility of
final statements. With regard to interim financial reports, an entity should design measurement
procedures to ensure that all material financial information that is relevant to understanding
financial position or performance is appropriately disclosed. Measurements for both annual
and interim financial reports are usually based on reasonable estimates. However, the
preparation of interim financial reports will normally require a greater use of estimation
methods than is the case with annual financial reports.
EXAMPLE 1
C Ltd. usually earns most of its revenue in the 3rd and 4th quarters of the year. Analysis of previous
year`s results showed the following revenue pattern:
1st quarter 14 %
2nd quarter 11 %
3rd quarter 30 %
4th quarter 45 %
During the 1st quarter of the current year, total revenue amounted to $2 800 000. Due to the
sensitivity of the reported results management intends to report 1/4 of the projected annual revenue
in its 1st quarter interim report. This would amount to $5 000 000.
REQUIRED
Comment on the proposed treatment of the 1st quarter revenue. What is the correct treatment according
to IAS 34?
SUGGESTED SOLUTION
According to IAS 34, some entities consistently earn more revenues in certain interim periods
of a financial year than in other interim periods, for example, Christmas sales of retailers. The
standard states that such revenues should be recognized when they occur. The company
should therefore report revenue of $2 800 000 in the 1st quarter, not $5 000 000 which would
represent average quarterly revenue.
EXAMPLE 2

D Ltd. which produces interim financial statements on a 6 monthly basis had equipment with
a historical cost of $13 450 000 at the end of the previous financial year (30 June 20-6). This
equipment is depreciated at 10 p.a. on the straight-line method. The company intends to
acquire new equipment costing $6 555 000 at the beginning of the second interim period of
the current year. The accountant would like to calculate depreciation for the first interim
period taking into account the planned capital expenditure. According to this method,
depreciation for this period would amount to: 6/12 x [13 450 000+ (1/2 x 6 550 000)] x 10 =
$836 250
REQUIRED
Comment on the proposed treatment of the depreciation charge.
SUGGESTED SOLUTION
According to para B24 of IAS 34, depreciation and amortisation of non-current assets should
be based only on assets owned during the relevant interim period. The calculation of such
expenses should not take into account asset acquisitions or disposals planned for a later part of
the year. Depreciation for the first interim period should therefore be calculated as follows:
6
/12 x (13 450 000) x 10% = $672 500.
Depreciation for the year (coinciding with the end of the second interim period) will be
calculated as follows: 836 250 + [6/12 x (6 550 000)] x 10% = $1 163 750. This is if
depreciation is provided on a full year`s basis without pro rating.
9.8.1 Examples of the use of estimates
9.8.1.1 Inventories
Full inventory count and valuation procedures may not be required for inventories on interim
dates, although they may be done at year-end. On interim dates it may be sufficient to make
estimates based on sales margins (C1, IAS 34).
9.8.1.2 Classification of current and non-current assets and liabilities

Entities may need a more thorough investigation for classifying assets and liabilities as current
and non-current on annual reporting dates than on interim dates (C2, IAS 34).
9.8.1.3 Provisions
Determination of the appropriate amount of a provision (for example, provisions for

warranties, environmental costs and site restoration costs) may be complex, costly and time
consuming. Making estimates on interim dates may require updating the prior year provisions
rather than doing a completely new calculation (C3, IAS 34).
9.8.1.4 Pensions
IAS 19 requires that an entity should determine the present value of defined benefit
obligations and the market value of plan assets on each statement of financial position date.
Entities are encouraged to engage professionally qualified actuaries to measure the

obligations. However, for interim reporting purposes, reliable measurement can often be
obtained by extrapolation of the most recent actuarial valuation (C4, IAS 34).
9.8.1.5 Income taxes
Entities may calculate income tax expense and deferred tax liabilities on annual dates by
applying the tax rates for each individual jurisdiction to the relevant measures of income.
However, para 14B of IAS34 states that this degree of precision may not always be achieved,
and indicates that a weighted average of rates across jurisdictions or income categories maybe
quite acceptable (C5, IAS 34).
Suppose that a company, Reckitt Ltd, earns pre-tax income in the first quarter of the year of
$500,000, but expects to make a loss of $180,000 in each of the next three quarters, with the
net loss before tax for the year being $40 000. Given a tax rate of 25%, excluding aids levy,
it would be inappropriate to anticipate the losses, meaning that the tax charge should be $125
000 for the first quarter. It becomes a negative tax charge of $45,000 for each of the next
three quarters, should actual losses turn out the same as anticipated.
From another angle, suppose that in a particular jurisdiction, the rate of tax on company
profits is 17.5%, excluding aids levy, on the first amount of profit if 35% of sales are export
sales and 15% on the next set of profits if 50% or more of those sales are export sales, in a bid
to incentivise exportation. Supposing that in the first half of the year Mutirikwi Ltd makes a
profit of $1 000 000 and $1 500 000 is expected in the second half of the year. The rate of tax
to be applied in the interim financial report should be the expected average rate of tax for the
year as a whole 16.25%, not 17.5%.
9.8.1.6 Revaluation and fair value accounting
IAS 16 allows an entity to choose as its accounting policy the revaluation model whereby
items of property, plant equipment are revalued to fair value. Similarly IAS 40 requires an
entity to determine the fair value of investment property. For those measurements the entity
may rely on professionally qualified independent valuers on annual reporting dates not on
interim reporting dates (C7, IAS 34).
9.8.1.7 Intercompany reconciliations

Some intercompany balances that are reconciled in great detail when preparing consolidated
financial statements at financial year end may be reconciled in less detail when preparing the
same statements for an interim date (C8, IAS 34).
9.8.1.8 Specialised industries
Due to complexity, costliness and time, interim period reports in specialised industries may be
less precise than at financial year-end. An example of this would be calculation of financial
reserves by an insurance company (C9, IAS 34).
9.8.1.7 Contingencies

Opinions of legal experts or other advisors are involved, the same with use of independent
views from experts. Such opinions come on litigation, assessment of claims, and other
contingencies and uncertainties may not also be needed at interim dates (C6, IAS 34).
9.9 RESTATEMENTS OF PREVIOUSLY REPORTED INTERIM PERIODS
A change in accounting policy, other than one for which the transition is specified by a new standard
or specification should be reflected by:
a) restating the financial statements of prior interim periods of the current financial year
and the comparable interim periods of any prior financial years that will be restated in
the annual financial statements in accordance with IAS 8; or
b) when it is impracticable to determine the cumulative effect at the beginning of the

financial year of applying a new accounting policy to all prior periods, adjusting the
financial statements of prior interim periods of the current financial year, and
comparable interim periods of prior financial years to apply the new accounting policy
prospectively from the earliest practicable date, this means that within the current
financial year any change in accounting policy should be applied either retrospectively
or if that is not practicable, prospectively from no later than the beginning of the year.
The standard notes that to allow accounting policy changes to be reflected on an
interim date within the financial year would mean that 2 different policies are applied
to a particular class of transactions in a single year. This would result in interim
allocation difficulties, obscured operating results and complicated analysis of interim
period information.
EXAMPLE 3
XY Ltd manufactures and sells rubber stamps. The company publishes interim reports
biannually and has a 30 June financial year-end. The trial balances for the two quarters ending
31 December 2-08 were as follows:
1st QUARTER 2nd QUARTER

DR/(CR) $ $
Revenue (15,600,000) (22,400,000)
Distribution costs 581,200 1,825,200
Administration expenses 2,872,000 2,872,000
Other expenses 150,000 208,000
Finance charges 146,800 146,800
Insurance expenses 2,184,000 1,260,000
Maintenance costs 1,312,000 1,560,000
Depreciation 390,000 390,000
Costs of goods sold 7,800,000 12,090,000
Property, plant & equipment 5,120,000 5,432,000
Accumulated depreciation (1,560,000) (2,656,000)
Inventory 5,440,000 2,550,000

Trade payables (5,470,000) (3,900,000)
Trade receivables 1,800,000 1,570,000
Listed investments (costs) 2,560,000
Bank balance 1,204,000 2,536,000
Long term loans (1,000,000)
Ordinary share capital (2,000,000) (2,000,000)
Retained earnings 1/07/2-08 (3,120,000) (1,794,000)
General Reserve 30/06/2-08 (1,250,000) (1,250,000)
Nil Nil
1. The company's revenue is normally earned evenly throughout the year, but sales during
the second quarter are higher than for other quarters because of the Christmas festivities.
2. The insurance costs incurred in the first quarter relate to the period 1 July 20-8 to 30 June
20-9. The insurance costs incurred in the second quarter relate to only that period.
3. Plant and equipment are serviced during the Christmas break, leading to higher
maintenance costs during the second quarter.
4. Depreciation charges for the 2 quarters are based on the property, plant and equipment (at
cost) at the beginning of the year. On 1 December 20-8, a new machine was acquired for
$600,000 and put to use immediately. Depreciation on machinery is written off at 20% p.a. on the
straight-line basis
5. In the second quarter obsolete inventory amounting to $110,000 was written off. This
amount is included in the other expenses in the trial balance but the inventory has not been
adjusted.
6. The average effective tax rate for the year is estimated to be 32.5% of the pre-tax profit
for the year.
7. The listed investment had a market value of $2,400,000 on 31 December 20-8, but this
decrease in value is considered to be temporary. This is an available for sale financial asset.
8. The issued share capital has not changed during the year. An interim ordinary dividend of
15% was declared on 22 December 20-8, but has not yet been recorded in the financial
statements.
9. On 20 January 20-9, a machine operator intentionally destroyed a machine with a carrying

amount of $625,000. The insurance company has declined to settle the claim and XY Ltd has
initiated a court case to recover the damages.
REQUIRED

Draw up condensed financial statements (excluding the cash flow statement) together with
accompanying notes for the first interim period ending 31 December 20-8. Comparative
figures are not required.
SUGGESTED SOLUTION
XY LTD
Condensed statement of comprehensive income for 6 months ending 31/12/2-08

$
Revenue (15,600,000 + 22,400,000) 38 000 000
Costs of goods sold (7,800,000+12,090,000) (19 890 000)
Gross Profit 18 110 000
Distribution costs (1,581,200+ 1,825,200) (3 406 400)
Admin Expenses (2, 872, 000 +2, 872, 000) (5 744 000)
Insurance Expenses (2 352 000) (i)
Maintenance Costs (1,312,000 + 1,560,000) (2 872 000)
Depreciation (390,000 + 390,000) + 10000 (ii) (790 000)
Other expenses (150,000 + 208,000 + 160,000) (iii) (518 000)
Operating Profit 2 427 600
Finance charges (146,800 + 146,800) (293 600)
Profit before tax 2 134 000
Company tax (32.5%) (693 550)
Profit after tax 1 440 450
Basic earnings per share (2,000,000 shares) 72c
WORKINGS
$
(i) Total amount paid 1st quarter 2 184 000
Deferred for future economic benefits (straight line basis) (1 092 000)
Recognised in statement of comprehensive 1 092 000
Total Amount paid in 2nd quarter 1 260 000
2 352 000
(ii) Cost of machine purchased on 1/12/2-08 600 000

Depreciation for 1 month (600,000 x 20% x 1/12) 10 000
(iii) Listed investment at cost 2 560 000

Market value on 31/12/2-08 2 400 000

Decline in value 160 000
Condensed statement of changes in equity for 6 months ending 31/12/2-08
Retained Earnings
$
Balance b/d 1/07/2-08 3 120 000
4 560 450
Proposed ordinary dividend (300 000)
4 260 450
Condensed statement of financial position as at 31/12/2-08
ASSETS $
Non-current assets
Property, plant & equipment at cost 6 032 000
Accumulated depreciation (2 666 000)
3 366 000
Listed investments 2 400 000
Current assets
Inventory 2 440 000
Trade receivables 1 570 000
Pre-paid insurance 1 092 000
Cash at bank 2 536 000
7 638 000
13 404 000

Capital and reserves
Ordinary share capital 2 000 000
Retained earnings 4 260 450
General reserves 1 250 000
7 150 450
Long term loans 1 000 000
Current liabilities
Trade payables 3 900 000
Company tax 693 550
Proposed ordinary dividend 300 000
4 893 550
13 404 000
Notes to the financial statements for the 6 months ending 31 December 2-08
1. Accounting policies

1.1 The interim financial report was prepared in accordance with the requirements of IAS 34. The
accounting policies are consistent with those used for the most recent annual financial statements
1.2 Seasonal fluctuations
The revenue of the first interim period includes sales for the busy Christmas period and is
normally higher than that of the second interim period. Essential maintenance of plant and
equipment is also carried out during the Christmas shut down towards the end of the second
interim period.
2. Separately disclosable items
2.1 Included in other expenses is an amount of $110,000 relating to the write down of obsolete
inventory.
2.2 An interim dividend of 15% was declared on 22 December 2-11
2.3 A machine with a carrying amount of $625,000 was intentionally destroyed by a machine operator
on 20 January 2-11. The insurance company has declined to settle the claim, and XY Ltd has
initiated a court case to recover the damage.
9.10 SUMMARY
This Unit explains the minimum requirements of interim financial reports as set out in IAS 34.
The standard prescribes the recognition and measurement rules to be applied in complete or
condensed financial statements for interim periods. The standard notes that timely and reliable
interim financial reporting improves the ability of the investors, creditors and other users of
financial statements to have a better appreciation of the reporting entity's capacity to generate
earnings and cash flows, as well as its financial position.
9.11 REFERENCES

UNIT TEN
10.0 INTRODUCTION
An investment is any asset held by an entity or an individual for the purpose of creating
wealth through interest, royalties, dividends and rentals, for capital appreciation, or for other
benefits e.g. those obtained through trading relationships. A distinction is usually made
between real assets (those which have physical properties like buildings) and financial assets
e.g. shares and debentures issued by companies. IAS 40 focuses on one type of investment,
referred to as ‘investment property.’
10.1 OBJECTIVES
• Distinguish between investment property and other types of property;

• Give examples of items that do not meet the definition of investment property;
• Calculate the carrying amounts of investment property;
• Explain and apply the fair value and cost models relating to investment property.
10.2 TERMINOLOGY
Investment property is property (land and buildings - 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, rather than for:
a) use in the production or supply of goods or services or for administrative purposes;
b) sale in the ordinary course of business.
Owner-occupied property is property held (by the owner or by the lessee under a finance lease)
for use in the production or supply of goods or services or for administrative purposes.
10.3 EXAMPLES OF INVESTMENT PROPERTY
a) Land held for long-term capital appreciation rather than for short-term sale in the ordinary
course of business;

b) Land held for a currently undetermined future use, if the land has not been designated as
owner-occupied property or for sale in the ordinary course of business, it can be assumed
that it is held for capital appreciation;
c) A building owned by the entity (or held by the entity under a finance lease) and leased out
under one or more operating leases;
d) A building that is vacant but is held to be leased out under one or more operating leases.
10.3.1 Special Case - Operating Leases
Para 6 of IAS 40 states that a property interest held by a lessee under an operating lease can
only be classified and accounted for as investment property if the property would otherwise
meet the definition of an investment property, and it is accounted for under the fair value
model. This classification should be carried out on a property-by-property basis. However,
once this method is selected for a property held under an operating lease, all property that is
classified as investment property should be accounted for using the fair value model.
The following items are specifically excluded from the definition of investment property:
i. Property intended for sale in the ordinary course of business or in the process of
construction or development for such sale e.g. property acquired exclusively with a
view to subsequent disposal in the near future or for development and resale;
ii. Property being constructed or developed on behalf of third parties;
iii. Owner-occupied property, 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 (whether or not they pay rent at market
rates) and owner- occupied property awaiting disposal;
iv. Property that is being constructed or developed for future use as investment property.
IAS 16 should be applied to such property until construction or development is
complete, at which time it is reclassified as investment property;
v. Property that is leased to another entity under a finance lease.
10.5 ACCOUNTING FOR INVESTMENT PROPERTY
10.5.1 Recognition
Investment property should only be recognised as an asset when;
a) it is probable that the future economic benefits associated with the property will flow to
the entity;
b) the cost of the investment property can be measured reliably.
10.5.2 Measurement at initial recognition
An investment property should initially be measured at cost. Transaction costs are included in
this measurement. The following points should be noted in relation to initial and related costs:
i) The cost of a purchased investment property consists of its purchase price and any
directly attributable expenditure e.g. legal fees, property transfer taxes and other
transaction costs. Excluded from cost are:

a) abnormal amounts of wasted material, labour or other resources incurred in constructing or
developing the property;
b) start-up costs (however, depending with the extent to which they are directly related to the
investment property);
c) operating losses before attainment of a planned occupancy level.
ii) if payment for an investment property is deferred, its cost is the cash price equivalent;
the difference between this amount and the total payments should be recognised as
interest expense over the credit period.
iii) The initial cost of a property held under a lease and classified as an investment
property is the lower of the property's fair value and the present value of the minimum
lease payments. The entity should recognise an equivalent amount as a liability in
accordance with para 20 of IAS 17 – Leases.
iv) If a property interest held under a lease is classified as an investment property, the
item to be accounted for at fair value is that interest and not the underlying property.
v) One or more investment properties may be acquired in exchange for a non- monetary
asset or assets, or a combination of monetary and non-monetary assets. The costs of
such a property should be measured at fair value unless:
a) the exchange transaction lacks commercial substance or;

b) the fair value of the asset received or the asset given up cannot be measured reliably.
The acquired asset is measured in this way even if the entity cannot immediately derecognise
the asset given up. If the acquired asset cannot be measured at fair value, its cost should be
measured at the carrying amount of the asset given up. An exchange transaction is considered
to have commercial substance if:
a) the configuration (i.e. the risk, timing and amounts) of the cash flows of the asset received
differs from the configuration of the cash flows of the transferred asset;
b) the entity-specific value of the portion of the entity's operations affected by the transaction
changes as a result of the exchange; this value should reflect after-tax cash flows;
c) the difference in (a) or (b) is significant relative to the fair value of the exchanged assets
If comparable market transactions are not available to indicate the fair value of an asset, this value
can be estimated reliably when the following conditions exist:
i. the variability in the range of reasonable fair value estimates is not significant for that
asset;
ii. the probabilities of the various estimates within the range can be reasonably assessed and
used in estimating fair value.
10.6 MEASUREMENT AFTER INITIAL RECOGNITION
Entities are encouraged to determine the fair value of investment property by engaging an
independent valuer who holds a recognised and relevant professional qualification, and has
recent experience in the location and category of the investment property. Once such a
valuation has been undertaken, an entity may choose either;

a) the fair value model or the cost model for all investment property used as security for
liabilities that pay a return linked directly to the fair value of, or returns from,
specified assets including that investment property;
b) the fair value model or the cost model for all other investment property, regardless of
the choice made in (a)
In other words, investment property is subsequently measured at fair value or at cost less
accumulated depreciation and accumulated impairment losses. This is the cost model in the
same IAS 16-Property, Plant and Equipment sense.
If the entity chooses different models for the 2 categories described above, any sales of
investment property between groups of assets should be recognised at fair value, while the
cumulative change in fair value is recognised in profit or loss. For example, an investment
property may be sold from a disposal group in which the fair value model is used into a group
in which the cost model is used; the property's fair value at the date of the sale will be its
deemed cost.
IFRS 5-Non-current-assets held for sale and discontinued operations defines a disposal group
10.6.1 Determination of Fair Value

The standard states that the definition of fair value refers to arm's length transactions i.e. those
that occur between parties without any special relationships. IFRS 13-Fair value measurement
defines value fair value holistically. The best indication of fair value is given by current prices
in an active market for similar property in the same location and condition, and subject to
similar lease and other contracts. In the absence of such prices, fair value may be based on:
a) current prices in an active market for properties of different nature, location or
condition, adjusted to reflect those differences
b) recent prices of similar prices on less active markets, with adjustments to reflect any
changes in economic conditions since the dates of the transactions that occurred at those prices
c) discounted cash flow projections based on reliable estimates of future cash flows, supported
by the terms of any existing lease and other contracts, as well as external evidence e. g. current
market rates for similar properties in the same location and condition; the discount rates should
reflect current market assessments of the uncertainty in the amount and timing of the cash
flows
It should be noted that the fair value of an investment property is different from its value in use
• Fair value reflects the knowledge of and estimates made by knowledgeable, willing
buyers and sellers
• Value in use reflects the entity's own estimates, including the effects of factors that may
be specific to it. IAS 36 – Impairment of assets defines value in use.
Fair value will generally not reflect any of the following factors:

i. additional value derived from the creation of a portfolio of properties in different location
legal rights or legal restrictions that are specific to the current owner;
ii. tax benefits or tax liabilities that are specific to the current owner
10.6.2 Inability to determine fair value reliably
In some cases, there is evidence that when an entity first acquires an investment property, the
fair value of the property cannot be reliably determined on a continuing basis. The same
valuation problem may occur when an existing property first becomes investment property
following the completion of construction or development, or after a change in use. This
usually occurs when comparable market transactions are infrequent and alternative reliable
estimates of fair value (e.g. those based on discounted cash flow projections, that is, present
value basis per the IASB conceptual framework) are not available. In such cases, the standard
makes the following provisions:
The entity should measure the investment property using the cost model in IAS 16;
The residual value of the property should be assumed to be zero.
The entity should apply IAS 16 until the property is disposed of
If an entity has previously measured an investment property at fair value, it should continue to
use this basis until disposal or,
i. Until the property becomes owner-occupied or;
ii. Until the entity begins to develop the property for subsequent sale in the ordinary
course of business. These provisions will apply even if comparable market
transactions become less frequent or market prices become less readily available.
10.7 THE COST MODEL
After initial recognition, an entity that chooses the cost model should measure all its
investment property in accordance with IAS 16's requirements for that model. IAS 16 states
that after initial recognition as an asset, an item of property, plant and equipment should be
carried at its cost less any accumulated depreciation and any accumulated impairment losses.
The exceptions to this rule are investment properties that meet the criteria to be classified as
held for sale in accordance with IFRS 5. Such properties should be measured according to the
requirements of that standard.
10.8 THE FAIR VALUE MODEL
After initial recognition, an entity that chooses the fair value model should measure all its
investment property at fair value, except in the cases explained in Section 10.6.2 above.
However, when a property interest held by a lessee under an operating lease is classified as an
investment property, use of the fair value model is mandatory. The following points should be
noted with regard to the use of this model:
i) A gain or loss arising from a change in the fair value of investment property should
be recognised in the period in which it arises
ii) The fair value of investment property should reflect market conditions at the
STATEMENT OF FINANCIAL POSITION date. The definition of this value
assumes simultaneous exchange and completion of the contract. Because market
conditions may change, fair value is time-specific as of a given date.

ACTIVITY 1
Explain the requirements of IAS 40 with regard to investment property under the following
headings:
a) Examples of investment property.
b) Recognition, initial and subsequent measurement of investment property.
10.9 TRANSFERS TO OR FROM INVESTMENT PROPERTY

Transfers between investment property and other categories of property should only be made when
there is a change in use. Such a change is shown by:
a) Commencement of owner-occupation, for a transfer from investment property to owner-
occupied property;
b) Commencement of development with a view to sale, for a transfer from investment property to
inventories;
c) End of owner-occupation, for a transfer from owner-occupied property to investment property;
d) Commencement of an operating lease to another party, for a transfer from inventories to
investment property or;
e) End of construction or development, for a transfer from property in the course of construction
or development to investment property
When an entity uses the cost model, transfers between investment property, owner- occupied
property and inventories will not change the carrying amount of the property transferred. In
addition, such transfers will not change the cost of that property for measurement or
disclosure purposes.
For a transfer from investment property carried at fair value to owner-occupied property or
inventories, the property's deemed cost for subsequent accounting periods in accordance with
IAS 16-Property, plant and equipment or IAS 2-Inventories should be its fair value at the date
of change in use.
If an owner-occupied property becomes an investment property that will be carried at fair
value, an entity should apply IAS 16 up to the date of change in use. The entity should treat
any difference at that date between the carrying amount of the property in accordance with
IAS 16 and its fair value as a revaluation as explained in that standard, which states that:
i. any resulting decrease in the carrying amount of the property is recognised in profit or
loss. However, to the extent that an amount is included in a revaluation surplus for
that property, the decrease should be charged against the surplus;

ii. any resulting increase in the carrying amount is treated as follows:
a) to the extent that the increase reverses a previous impairment loss or that
property, the increase is recognised in profit or loss; the amount recognised
should not exceed the amount needed to restore the property's carrying amount
to that which would been determined (net of depreciation) if an impairment
loss had not been recognised;
b) any remaining part of the increase should be credited directly to equity as part
of the revaluation surplus; on subsequent disposal of the property, the
revaluation surplus may be transferred to retained profits; however, such a
transfer should not be made through the income statement
For a transfer from inventories to investment property that will be carried at fair value, any
difference between the fair value of the property at that date and its previous carrying amount
should be recognised in the income statement. This treatment is consistent with that used for
sales of inventories.
When an entity completes the construction or development of a self-constructed investment
property that will be carried at fair value, any difference between the fair value of the property
at that date and its previous carrying amount should be recognised in profit or loss.
EXAMPLE 1– K Ltd
On 1 January 20-7, K Ltd leased land with a fair value of $17 800 000 from L Ltd for a period
of 3 years at an annual rental of $2 800 000 payable in arrears. K Ltd sub-leased the land to M
Ltd for the same period at $4 000 000 p.a also payable in arrears. K Ltd accounts for this
property interest as an investment property based on an interest rate of 12% p.a.
REQUIRED
Outline the accounting treatment for this property in the books of K Ltd.
SUGGESTED SOLUTION
Finance charges and non-current liability
$
PVIFA
Present value of rental payments (2 800 000 x 2.4018 ) 6 725 040
Present value of investment property (re-measurement) (4 000 000 x 2.4018PVIFA) 9 607 200
Re-measurement gain (9 607 200 - 6 725 040) 2 882 160
$
Components of rental payment
Finance charge (6 725 040 x 12%) – interest portion 807 005
principal portion
Reduction in liability (6 725 040 - 807 005) – 5 918 035
6 725 040
N.B. At year end the non-current liability in K Ltd` books is reduced by only the principal portion out
of the annual rental of $6 725 000.
Finance income and non-current asset

$
Fair value adjustment on 31/12/20-7

Present value of rental income over a 2-year period (4 000 000 x 1.6901) 6 760 400
Present value or rental income at the beginning of the year (9 607 200)
Loss on re-measurement 2 846 800
N.B. Only rental income that the property is earning is due from the sub-leasing. The
noncurrent asset status of the property is that it is an investment property as has been alluded
to in the question requirement. You should take note that, although K Ltd. is leasing the
property from another entity, it can account for this property, since according to IAS 40 the
property would otherwise meet the definition of an investment property in this specific case.
10.10 DISPOSALS
An investment property should be derecognised on disposal or when it is permanently
withdrawn from use, and no future economic benefits are expected from its disposal. The
disposal may be effected through an outright sale, a finance lease, or a sale and leaseback
transaction.
Gains or losses arising from the retirement or disposal of investment property should be
determined as the difference between the net disposal proceeds and the carrying amount of the
asset. Such gains or losses should be recognised in profit or loss in the period of retirement or
disposal, except for sale and leaseback transactions, which may be treated differently in
accordance with IAS 17. If payment for an investment property being disposed of is deferred,
the consideration to be received should be recognised initially at the cash price equivalent.
The difference between the nominal amount of the consideration and the cash price equivalent
should be recognised as interest revenue using the effective interest rate method (IAS 18).
Any compensation from third parties for investment property that was impaired, lost or given
up, should be recognised in profit or loss when the compensation becomes receivable. The
cost of assets restored, purchased or constructed as replacements should be determined in
accordance with the rules for measurement at initial recognition (paras 20-29 of IAS 40).
EXAMPLE 2– TRANSFER FROM INVESTMENT PROPERTY (IAS 40) TO OWNEROCCUPIED
PROPERTY (IAS 16)
On 1 July 2-10, P Ltd acquired land and buildings for its manufacturing operations at a cost of
$5 112 000. The property was leased immediately to Q Ltd at an annual rental of $900 000 in
terms of an operating lease. On 30 September 2-11 P Ltd. gave Q Ltd. notice to vacate the
premises on 31 December 2-11, as they were required for its own operations. P Ltd. does not
depreciate land, but depreciates buildings on a straight-line basis over 30 years, using the fair
value model for investment properties. On 30 June 2-11, the property's fair value was $6 300
000. On 31 December 2-11 the property's fair value amounted to $2 250 000 land and $5 760
000 buildings.
REQUIRED
Outline the accounting treatment for the property in the books of P Ltd.
SUGGESTED SOLUTION
1 July 2-10

The property meets the definition of an investment property, at a cost of $5 112 000. Therefore,
it is initially measured at that cost.
30 June 2-11 $
Fair value adjustment
Fair value of investment property 6 300 000
Fair value of investment property (1 July 2-10) (5 112 000)
Re-measurement gain 1 188 000
N.B. subsequent measurement is at fair value. In other words, as has been indicated in the
question, the fair value model has been elected for re-measurement at each subsequent
reporting date.
31 December 2-11
Fair value adjustment
Fair value of investment property 8 010
000 (6 300 000)
Fair value of investment property (1 July 2-10) 1 710 000
Re-measurement gain
Subsequent to 31 December 2-11

Transfer to property plant and equipment at a deemed cost
Land 2 250 000
Buildings 5 760 000
8 010 000
Depreciation over the remainder of their useful life as at 31 December 2-11

Buildings` remaining useful life (30 – 1 ½ years) 28 ½ years
Current year depreciation charge on buildings, from 31 Dec 2-11 to 30 June 2-12
(5 760 000/28.5 x 6/12) 101 053
Example 3 (Transfer from Owner-occupied Property to Investment Property)

G Ltd. acquired land and buildings for its manufacturing operations at a cost of $15 000
000 (land $4 000 000 and buildings $11 000 000) on 1 October 2-09. On 1 January 2-11 the
company moved into new remises and decided to lease the old premises to D Ltd. at an annual
rental of $3 000 000 in terms of an operating lease.
C Ltd depreciates its buildings on a straight-line basis over 20 years, and uses the fair value
model for investment properties. On 1 January 2-11, the fair value of the property amounted
to $19 000 000 (land $15 000 000 and buildings $14 000 000) and to $24 000 000 on 30
September 2-11).
REQUIRED
Outline the accounting treatment for the property in the books of C Ltd

SUGGESTED SOLUTION
1st financial period – 1 Oct 2-09 to 30 Sep 2-10
1 October 2-09
Property, plant and equipment $
Land 4 000 000
Buildings 11 000 000
15 000 000
30 September 2-10
4 000 000
Depreciation on buildings ( /20years) 550 000
Being full year depreciation charge.
2nd financial period – 1 Oct 2-10 to 30 Sep 2-11
Depreciation on buildings (1 Oct to 31 Dec 2-10) 137 500

Being depreciation in the first 3 months that the property is owner-occupied.
1 Jan 2-11 to 30 Sep
1 January 2-11 - Land and buildings are re-measured to Fair Value

Land (5 000 000 - 4 000 000) 1 000 000
Buildings [14 000 000 - (11 000 000 - 550 000 - 137 500)] 3 687 500
Revaluation surplus 4 687 500
1 January 2-11
Fair value
Land 5 000 000
Buildings 14 000 000
19 000 000
30 September 2-11 – Fair value adjustment on re-measurement
Land and buildings at 1 Jan 2-11 19 000 000
Land and buildings at 30 Sep 2-11 24 000 000
Fair value gain 5 000 000
Being Fair value gain on re-measurement at period-end (N.B. the Fair value model on the investment
property is now applicable).

Fair Value Model and Cost Model An
entity should disclose:

a) whether it applies the fair value model or the cost model if it applies the fair value
model, whether, and in what circumstances, property interests held under operating
leases are classified and accounted for as investment property;
b) when classification is difficult, the criteria it uses to distinguish investment property

from owner-occupied property and from property held for sale in the ordinary course
of business;
c) the methods and significant assumptions applied in determining the fair value of
investment property, including a statement whether the fair value was supported by
market evidence or was more heavily based on other factors (which the entity should
disclose) because of the nature of the property and lack of comparable market data;
d) The extent to which the fair value of investment property (as measured or disclosed in
the financial statements) is based on a valuation by an independent valuer who holds a
recognised and relevant professional qualification and has recent experience in the
location arid category of the investment property being valued. If there has been no
such valuation, that fact should be disclosed;
e) The amounts recognised in profit or loss:

i. rental income from investment property;
ii. direct operating expenses (including repairs and maintenance) arising from investment
property that generated rental income during the period;
iii. direct operating expenses (including repairs and maintenance) arising from investment
property that did not generate rental income during the period;
iv. the cumulative change in fair value recognized in profit or loss on a sale of investment
property from a pool of assets in which the cost model is used into a pool in which the
fair value model is used;
v. the existence and amounts or restrictions on the realisability of investment property or
the remittance of income and proceeds of disposal;
vi. contractual obligations to purchase, construct or develop investment property or for
repairs, maintenance or enhancements.
Fair Value Model
In addition to the disclosures required above, an entity that applies the fair value model should
disclose a reconciliation between the carrying amounts of investment property at the
beginning and end of the period, showing the following:
a) additions, disclosing separately those additions resulting from acquisitions and those resulting from
subsequent expenditure recognised in the carrying amount of an asset;
b) additions resulting from acquisitions through business combinations;
c) assets classified as held for sale or included in a disposal group classified as held for sale in
accordance with IFRS 5 and other disposals;
d) net gains or losses from fair value adjustments;

e) the net exchange differences arising on the translation of the financial statements into a different
presentation currency, and on translation of a foreign operation into the presentation currency of the
reporting entity;
f) transfers to and from inventories and owner-occupied property

g) other changes.
When a valuation obtained for investment property is adjusted significantly for the purpose of
the financial statements, e.g. to avoid double-counting of assets or liabilities that are
recognised as separate assets and liabilities (para 50 of the standard) the entity should disclose
a reconciliation between the valuation obtained and the adjusted valuation included in the
financial statements. This reconciliation should show separately the aggregate amount of any
recognised Iease obligations that have been added back, and any other significant adjustments.
When an entity measures investment property using the cost model in IAS 16, the
reconciliation should disclose amounts relating to that investment property separately from
amounts relating to other investment property. In addition, the entity should disclose:
a) a description of the investment property;
b) an explanation of why fair value cannot be determined reliably;
c) if possible, the range of estimates within which fair value is highly likely to lie;
d) on disposal of investment property not carried at fair value;
e) the fact that the entity has disposed of investment property
i) not carried at fair value; ii) the carrying amount of that investment
property at the time of sale; and, iii) the amount of gain or loss recognised.
Cost Model
In addition to the disclosures indicated above, an entity that applies the cost model should disclose:
a) the depreciation methods used;
b) the useful lives or the depreciation rates used;
c) the gross carrying amount and the accumulated depreciation (aggregated with accumulated
impairment losses) at the beginning and end of the period;
d) a reconciliation of the carrying amount of investment property at the beginning and end of the
period, showing the following:
i. additions, disclosing separately those additions resulting from acquisitions, and
those resulting from subsequent expenditure recognised as an asset;
ii. additions resulting from acquisitions through business combinations;
iii. assets classified as held for sale or included in a disposal group classified as held for
sale in accordance with IFRS 5 and other disposals;
iv. depreciation;
v. the amount of impairment losses recognised, and the amount of impairment losses
reversed, during the period in accordance with IAS 36;
vi. the net exchange differences arising on the translation of the financial statements
into a different presentation currency, and on translation of a foreign operation into
the presentation currency of the reporting entity;

vii. transfers to and from inventories and owner-occupied property and; viii. other
changes.
When an entity cannot determine the fair value of investment property reliably (para 53 of the standard),
it should disclose:
i. a description of the investment property;
ii. an explanation of why fair value cannot be determined reliably;
iii. if possible, the range of estimates within which fair value is highly likely to lie.
Transitional Provisions for the Fair Value Model
An entity that previously applied IAS 40 (2000) which elects for the first time to classify and
account for some or all eligible property interests held under operating leases as investment
property should recognise the effect of that election as an adjustment to the opening balance
or retained profits for the period in which the election is made. In addition:
a) if the entity has previously disclosed publicly the fair value of those property interests in
earlier periods, it is encouraged, but not required;
b) to adjust the opening balance of retained profit for the earliest period presented for
which such fair value was disclosed publicly.
(i) to restate comparative information for those periods
c) if the entity has not previously disclosed publicly the information described in (a), it should
not restate comparative information, but should disclose that fact.
10.11 SUMMARY
This Unit explains the accounting treatment and disclosure requirements for investment
property, which is an alternative classification of property, plant and equipment. The Unit is
based on IAS 40, a standard which was revised recently to include the measurement in a
lessee's financial statements of investment property held under a finance lease or an operating
lease.
10.12 REFERENCES
VaN WELL, R. GAAP 2005
WINGARD, C. et al LexisNexis/Butterworths 2004 pwc
Manual of Accounting, IFRS 2015, Vol 2
IFRS Consolidated without early application, Part A, 2015

UNIT ELEVEN
11.0 INTRODUCTION
IAS 21 provides guidelines on which exchange rates to use when accounting for transactions
which involve foreign currencies. The standard also explains the way in which changes in
exchange rates should be treated in the financial statements of reporting entities. Specific
applications which are explained in the standard include accounting for transactions and
balances in foreign currencies, and the translation of an entity's results and financial position
into the currency of its major user(s). You should take note that translation of a foreign
operation’s annual financial results for consolidation purposes is dealt with towards the end of
Unit 5 of Volume 1. Importantly, the standard sets out requirements which would enable the
resulting financial statements to be described as complying with international financial
reporting standards. The major challenge in this area arises from fluctuations in exchange
rates which normally occur to a greater or lesser extent between countries with trading
relationships and other transactions requiring settlement in foreign currency.
11.1 OBJECTIVES
• Explain the accounting and disclosure requirements of IAS 21;
• Distinguish between monetary and non-monetary items, and explain how they are accounted for
under IAS 21;
• Explain the rules relating to the recognition of exchange differences; Account for uncovered
foreign currency transactions.
11.2 KEY DEFINITIONS

Exchange rate is the rate of exchange for two currencies, that is, the number of units of
another currency which can be purchased using one unit of a given currency. For example,
USD1 = ZAR15.00, where ZAR stands for South African Rand.
Exchange difference is the difference in an entity's financial statements resulting from
translating a given number of units of one currency into another currency at different
exchange rates.
Closing rate is the spot exchange rate, that is, the rate at which a transaction is or could be undertaken at
the end of the reporting period.
Spot rate is the exchange rate for immediate delivery.
Functional currency is the currency of the primary economic environment in which an entity operates.
Presentation currency is the currency in which an entity's financial statements are reported.

Foreign currency is a currency other than the functional currency of the entity.
Monetary items are units of currency held and assets and liabilities to be received or paid in a fixed
or determinable number of units of currency.
A foreign operation is 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. [Refer
to Unit 5, Volume 1 for accounting treatment]
Net investment in a foreign operation is the amount of the reporting entity's interest in the assets
of that operation.
A forward rate is an exchange rate set now for currencies to be exchanged at a future date.
A forward exchange contract (FEC) is a contract made now for the purchase or sale of a quantity of currency
in exchange for another currency, for settlement at a future date, and at a rate of exchange that is fixed in the
contract.
[Refer to Unit 4 of this volume for Hedge Accounting aspects where FECs are considered]
11.3 MONETARY ITEMS
Examples of monetary items (as defined in 11.2 above) are:
• pensions and other employee benefits to be paid in cash;
• provisions that are to be settled in cash;

• cash dividends that are recognized as a liability;
• a contract to receive or deliver a variable number of the entity's own equity instruments;
• a contract to receive or deliver a variable amount of assets in which the fair value involved equals a
fixed or determinable number of currency units;
• convertible preference shares and debentures, into debentures or redeemable preference shares.
Examples-of non-monetary items (as defined in 11.2 above by implication) are:
• amounts prepaid for goods and services;
• goodwill and other intangible assets;
• inventories, property, plant and equipment;
• provisions that are to be settled by the delivery of a non-monetary asset; convertible preference
shares and debentures, into ordinary shares.
11.4 REPORTING FOREIGN CURRENCY TRANSACTIONS IN THE FUNCTIONAL

CURRENCY

11.4.1 Initial Recognition
A foreign currency transaction is one that is denominated or requires settlement in a foreign currency.
Such transactions occur when an entity:
a) buys or sells goods or services whose prices are denominated in a foreign currency;
b) borrows or lends funds when the amounts payable or receivable are denominated in a foreign
currency;
c) otherwise acquires or disposes of assets, or incurs or settles liabilities denominated in a
foreign currency.
A foreign currency transaction should be recorded, on initial recognition in the functional
currency, by applying to the foreign currency amount, the spot exchange rate between the
functional currency and the foreign currency at the date of the transaction. The standard
permits the use of a rate that approximates the actual rate at the date of the transaction, for
example, an average rate for the week or month if the exchange rate does not fluctuate widely.
11.4.2 Reporting at the end of subsequent reporting periods
At each reporting date
i) foreign currency monetary items should be translated using the closing rate; ii) non-
monetary items that are measured in terms of historical cost in a foreign currency should
be translated using the exchange rate at the date of the transaction; iii) non-monetary items
that are measured at fair value in a foreign currency should be translated using the
exchange rates at the date when the fair value was determined.
When several exchange rates are available, the entity should use the rate at which the future
cash flows represented by the transaction or balance could have been settled if these cash
flows had occurred at the measurement date.
ACTIVITY 1
Briefly explain the terms/phrases below:
Multiple exchange rates
Suspension of rates
When should a purchase of inventory transaction be recorded if the goods are shipped under the terms
below?
F.O.B – Free on board
C.I.F – Cost insurance and freight
11.4.3 RECOGNITION OF EXCHANGE DIFFERENCES
Exchange differences arising on monetary items are reported in profit or loss in the period, with
one exception.
However, there are two situations that arise:

i) If the transaction is settled in the same period as that in which it occurred the whole of
the exchange difference is recognised in that period.
ii) If the transaction is settled in a subsequent accounting period, the exchange difference
recognised in each intervening period up to the period of settlement is determined by
the change in exchange rates during that period. In other words, where a monetary
item has not been settled at the period-end, it has to be restated using the closing
exchange rate with any gain or loss being taken to the profit or loss section of the
statement of comprehensive income (see EXAMPLE 1).
The only exception is that exchange differences arising on monetary items that form part of
the reporting entity’s net investment in a foreign operation are recognized in the group
financial statements within a separate component of equity. They are recognized in profit or
loss on disposal of the net investment.
If a gain or loss on a non-monetary item is recognized in equity (for example, property, plant,
and equipment revalued under IAS 16), any foreign exchange gain or loss element is also
recognized in equity.
EXAMPLE 1 – UNCOVERED FOREIGN CURRENCY TRANSACTION (N.B. In your
Corporate Finance module, such a transaction faces what is known as transaction risk. Transaction risk is a component of
foreign exchange risk as a result of exchange rate fluctuations over a period of time. It is such fluctuations that result in
foreign exchange gains or losses touched in this Unit. You shall fully grasp this aspect when you get to Professional
Programme II level).
Harvey Corporation, a horticultural firm based in Zimbabwe, acquired from a foreign

manufacturer of agro-processing equipment, a combined harvester worth ZAR 12m on credit.
The transaction date was 30 September 2-14. The spot rate at that date was USD 1 = ZAR 3.
Under the same year, Harvey Corporation exported agro produce on credit for ZAR 2m on 31 October
2-14. The exchange rate had remained stable at USD 1 = ZAR 3.
At the reporting date the transactions had not yet been paid for. The functional currency used
by Harvey is mainly the USD due to the adoption of the use of multiple foreign currencies in
Zimbabwe. At 31 November 2-14, the year-end date, the exchange rate was USD 1 = ZAR
2.5.
REQUIRED
Calculate the exchange differences that would be recorded in profit or loss for the period ending
May 31, 20X6.
SUGGESTED SOLUTION
Acquisition of a combined harvester
At the transaction date, 30 September 2-14 the entity recognises a non-current asset, the
combined harvester at USD 4m and an equivalent corresponding liability. The spot rate at that
date is what you use, that is ZAR 12m/3 = USD 4m. A lesser USD equivalent is the result
given that the USD is the stronger currency among the two. At 31 November 2-14 a foreign
exchange loss of USD 0.8m is recognised that is (ZAR 12m/2.5 less ZAR 12m/3). The

combined harvester is credited by that amount and the profit or loss section of the statement of
comprehensive income debited with the foreign exchange loss.
Export sales of agro produce
At the transaction date, 31 October 2-14, a receivable of USD0.67m (that is, ZAR 2m/3) and an
equivalent credit sale entry is recognised.
At the year-end, 31 November 2-14 the receivable will be standing at USD 0.80m (that is,
ZAR 2m/2.5). An exchange gain of USD 0.13m is the result. This is reported in the profit or
loss section of the statement of comprehensive income.
EXAMPLE 2 – UNCOVERED FOREIGN CURRENCY TRANSACTION (N.B. such a transaction faces
transaction risk, a component of foreign exchange risk)
B Ltd, a manufacturing company in Zimbabwe, obtained a foreign loan in US$ on 1 January 20-2.
The details of the agreement were as follows:
1. The amount of the loan was US$1 500 000.
2. Interest at a rate of 12% is payable annually in advance, commencing on 1 January 20-2.
3. The capital amount is repayable at US$150 000 p.a. commencing on 1 January 20-3. No forward cover
was taken out.
4 The relevant exchange rate were as follows: 1 US$ =ZW$
1 January 20-2 100
31 December 20-2 97
1 January 20-3 97.5
31 December 20-3 97.3
1 January 20-4 97.3
31 January 20-4 96
1 January 20-5 95
31 December 20-5 92
For all the years the operating profit before foreign exchange transactions and tax amounted to
$45 000 000. The company tax rate was 35% throughout the 4 year period.
Key: ZW$ - stands for Zimbabwe dollar
REQUIRED
Draw up journal entries in the books of B Ltd for the 4years ending 31 December 20-5. Narrations are
required. Show all workings.
SUGGESTED SOLUTION
Journal Entries
(i) 20-2 DR CR

$ $ Jan
1 Bank 150 000 000
'' 1 Long term loan 150 000 000
Being entry to show the amount of a term loan expressed in local currency.
Jan 1 Interest expense 18 000 000

'' 1 Bank 18 000 000
Being entry to show interest for the year ended 31 December20-2, paid in advance.
Dec 31 Long term loan 4 500 000

" 31 Foreign exchange 4 500 000
Being entry to show a gain made as a result of an improvement in the US$ exchange rate from
ZW$ 100 to ZW$ 97.
Dec 31 Company tax 11 025 000 " 31

ZIMRA 11 025 000
Being entry to show company tax payable estimate for the year.
(ii) 20-3
" 1 Bank 15 795 000
Being entry to show interest for the year ended 31 December 20-3 paid in advance.
Dec 31 Long term loan 270 000

" 31 Foreign exchange difference 270 000
Being entry to show effective reduction in long term loan through an exchange rate gain.
Dec 31 Company tax 10 053 750 " 31

ZIMRA 10 053 750
Dec 31 Foreign exchange difference 750 000

" 31 Long-term loan 13 875 000
" 31 Bank 14 625 000
Being entry to show reduction in the long-term loan (payment made on 1 January 20-3).
(iii) 20-4
Jan 1 Long-term loan 14 595 000
" 1 Bank 14 595 000
Being entry to show reduction in the long-term loan.

" 1 Bank 14 011 200
Being entry to show interest for the year-ended 31 December 20-4, paid in advance.
Dec 31 Long-term loan 1 560 000

" 31 Foreign exchange difference 1 560 000

Being entry to show effective reduction in long-term loan through an exchange rate gain.
Dec 31 Company tax 11 392 080

" 31 ZIMRA 11 392 080
(iv) 20-5
" 1 Bank 14 250 000
Being entry to show reduction in the long-term loan.

" 1 Foreign exchange difference 4 350 000
Being entry to show effective reduction in long-term loan through an exchange rate gain.
Dec 31 Company tax 13 083 000 " 31

ZIMRA 13 083 000
WORKINGS (it is acceptable if you work through a different approach and still come up with the same results)
1. Long-term loan US$ Rate ZW$

1 January 20-2 1 500 000 100 150 000 000
31 December 20-2 – exchange difference-(gain) – (4 500 000)
Balance 31 December 20-2 1 500 000 97 145 500 000
31 December 20-3- Exchange difference – (loss) 750 000
1 January 20-3 – payment (150 000) 97.5 (14 625 000)
Balance 1 January 20-3 (after payment) 1 350 000 131 625 000
31 December 20-3 – exchange difference-(gain) – (270 000)
Balance 31 December 20-3 1 350 000 97.3 131 355 000
1 January 20-4 – payment (150 000) 97.3 (14 595 000)
31 December 20-4 – exchange difference-(gain) – (1 560 000)
1 January 20-5 – payment (150 000) 95 (14 250 000)
31 December 20-5 – difference-(gain) – (4 350 000)
2. Interest paid
1 January 20-2 18 000 000 (i)
1 January 20-3 15 795 000 (ii)
1 January 20-4 14 011 200 (iii)

1 January 20-5 11 970 000 (iv)
(i) ($1 500 000 x 12) x 100 = $18 000 000

(ii) ($1 350 000 x 12 x 97.5) = $15 795 000
(iii) ($1 200 000 x 12 x 97.3) = $14 011 200
(iv) ($1 050 000 x 12 x 95) = $11 970 000
3. Current tax
20-2 20-3 20-4 20-5
$ $ $ $
Operating profit 45 000 000 45 000 000 45 000 000 45 000 000
Interest paid (18 000 000) (15 795 000) (14 011 200) (11 970 000)
Exchange gain 4 500 000 (480 000)(v) 1 560 000 4 350 000
31 500 000 28 725 000 32 548 800 37 380 000 Tax
at @ 35% 11 025 000 10 053 750 11 392 080 13 083 000
(v) $750 000 loss – 270 000 gain = $480 000 net loss.
ACTIVITY 2
C Ltd., a listed mining company, received a foreign loan in South African Rand on 1 January 20-3.
The details of the agreement were as follows:
1. The amount of the loan was ZAR5 000 000.
2. Interest at a rate of 20% p.a. is payable annually in arrears, commencing on 31 December 20-3.
3. The capital amount is repayable in annual instalments at ZAR500 000 p.a. commencing on 31 December
20-3. No forward cover was taken out.
The relevant exchange rate were as follows:
1 ZAR= Z$
1 January 20-3 30
31 December 20-3 26
31 December 20-4 28.5
31 December 20-5 27
31 December 20-6 25
31 December 20-7 26.2
For all the years, the operating profit before foreign exchange transactions and tax amounted to
$65 800 000. The company tax rate was 40% throughout the 5-year period.

REQUIRED
Draw up journal entries in the books of C Ltd. for the 5 years-ending 31 December 20-7. Narrations
are required. Show all workings.
11.5 TRANSLATION OF A FOREIGN OPERATION (N.B. such a transaction faces translation risk, which
is another component of foreign exchange risk)
Though covered by IAS 21, this area has been dealt with under the Consolidated Financial
Statements Unit in volume 1. However, you should tackle the example below in addition to
what you have already covered in Unit 5 of Volume 1.
EXAMPLE – FOREIGN LOAN ACCESSED BY A SUBSIDIARY FROM PARENT
Mhondoro Diamond Ltd has a foreign subsidiary, Gaborone Mining Ltd whose functional
currency is the Botswana Pula (BP). On 1 January 2-10, when the exchange rate was US$ 1 =
BP 4.5 Mhondoro Diamond Ltd lent Gaborone Mining Ltd US$900 000. At 31 December
210, the exchange rate (spot/closing) was US$1 = BP 6 and the average annual rate of US$ 1
= BP 5.25. The amount had not been repaid by 31 December 2-10 and is regarded as part of
the net investment in the foreign subsidiary. This is because of the fact that its settlement is
not highly likely in the foreseeable future.
REQUIRED
Advise Mhondoro Diamond Ltd management on the group accounting treatment for the US$900 000
loan.
SUGGESTED SOLUTION
The loan has been made in US$ the presentation currency for Mhondoro Diamond Ltd therefore, no
foreign exchange difference arises in its separate books.
In Gaborone Mining Ltd`s books the loan is translated into the functional currency, the BP, as follows:
1 Jan 2-10 DR CR
BP BP
Bank (USD$900 000 x 4.5) 4 050 000
Long term loan 4 050 000
31 Dec 2-10
Foreign exchange loss [$900 000 x (6-4.5)] 1 350 000
Long term loan 1 350 000
In the group`s books the same exchange loss will be translated at the average rate for the year,
BP1 350 000
that is, /5.25 = US$257 143
The exchange loss is recognisable in equity.
There will however, be a further exchange difference (a gain) that arises between the amount included
in Gaborone Mining Ltd`s statement of comprehensive income at the average rate and at the closing

1 350 000
rate (US$257 143 – /6), that is 32 143. The net exchange loss is therefore, US$225 000.
Alternatively, the exchange loss is deduced as follows:
BP4 050 000

/4.5 – BP 4 050 000/6, that is, US$900 000 – US$675 000 = US$225 000 (Loss).
11.6 DISPOSAL OF A FOREIGN OPERATION

When a foreign operation is disposed of, the cumulative amount of the exchange differences
in equity relating to that foreign operation shall be recognized in profit or loss when the gain
or loss on disposal is recognized.
ACTIVITY 3 – DISPOSAL OF A FOREIGN OPERATION (make use of this activity for further
practise on this aspect which comes as second last item under group accounting, Unit 5 in Volume 1)
Alberta Ltd wholly owns a foreign subsidiary, that is carried at an original cost of USD 8 500
000. The foreign subsidiary is sold 30 September, 2-12, for M40 000 000. The balance of the
exchange reserve at 30 September was USD 1 500 000 credit. The functional currency of the
entity is the US dollar. The exchange rate on 30 September 2-12 was USD1 = M16. The net
asset value of the subsidiary at the date of disposal was USD2 250 000.
REQUIRED
Lay out the accounting treatment of the disposal of the foreign subsidiary showing clearly the following:
i) the gain/loss in Alberta Ltd books,
ii) the gain or loss in consolidated financial statements; and iii) the
cumulative exchange gain/loss in consolidated financial statements.
Student Note:
You need to be aware of accounting treatment of a partial disposal of a foreign operation. Ensure you
use a reliable source/reference text
11.7 COVERED FOREIGN CURRENCY TRANSACTIONS

This area is the preserve of IFRS 9 – Financial Instruments. Simply ensure that you go
through hedge accounting for foreign currency transactions, especially accounting treatment
of both cash flow and fair value hedges.
11.8 DISCLOSURES
The following are the disclosures:
i) The amount of exchange differences recognised in profit or loss except for those
arising on financial instruments measured at fair value through profit or loss in
accordance with IFRS 9.
ii) 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. iii) The fact that the presentation

currency is different from the functional currency and the reason for use of a different
presentation currency.
iv) The fact and the reason for a change in the functional currency of either the reporting entity
or a significant foreign operation.
v) Description of the financial statements in terms of compliance with this IFRS (IAS 29) and
the translation method set out in it, in those circumstances where an entity presents its
financial statements in a curremcy that is different from its functional currency.
vi) Supplementary information as set out in para 57 (a) to (c) of IAS 21.
11.9 SUMMARY
This Unit explains the accounting requirements and procedures for transactions which involve
a reporting entity and entities which use other currencies. IAS 21 distinguishes between an
entity's functional currency, that is, the one in which it conducts most of its transactions and a
presentation currency, in which the entity may choose to show its financial statements. There
are special requirements for entities whose primary operations are carried out in
hyperinflationary economies.
11.10 REFERENCES
KOPPESCHAAR, Z.R. et al Descriptive Accounting, IFRS Focus, 18th
Edition, 2013
pwc MANUAL OF ACCOUNTING, IFRS 2015
VORSTER, Q.; KOORNHOF, C. et al Descriptive accounting, 14th Edition
LexisNexis/Butterworths 2011
VON WELL, R. & WINGARD, C. GAAP Handbook 2012 LexisNexis
Butterworths
IASB International Financial Reporting Standards,
2015
UNIT TWELVE
REVENUE (IAS 18)
12.0 INTRODUCTION

IAS 18 should be read in conjunction with the new IFRS 15 - Revenue from contracts with
customers which is effective for annual periods beginning on or after 1 January 2018, though
earlier adoption is allowed. The introduction of IFRS 15 has sought to, among other issues,
align the provisions of the old IAS 11 – Construction contracts with those of this IAS 18 for
more clarity.
According to the IASB Conceptual Framework for Financial Reporting, the term 'income'
relates to increases in economic benefits that arise during an accounting period in the form of
intermediate or deferred cash inflows. Other sources of income are enhancements of assets or
decreases of liabilities that are related to increases in equity, apart from those that come from
equity participants. The Framework states that income includes both revenue from the
ordinary (and continuing) activities of an entity and gains from other sources of income for
example, a once-off sale of non- current assets. IAS 18 gave a detailed explanation of revenue,
which may be referred to by various names depending on the nature of the entity's business,
for example, sales, fees, interest, dividends, royalties and rent. It should be clear that, in any
type of business setting, the importance of revenue cannot be overstated. For an entity that is a
going concern, most if not all of its expenses and other costs will be met from revenue. Failure
to meet financial obligations may lead to foreclosure by long-term and short-term creditors, or
even liquidation. A clear understanding of revenue is, therefore, critical for any serious
student of accounting at this level.
12.1 OBJECTIVES
• Distinguish between revenue and other sources of income, at the same time comparing these to the
new IFRS 15`s provisions.
N.B.1 Unit 7 of this study guide is IFRS - 15 Revenue from contracts with customers. That
can be your starting point.
• Identify the point at which revenue is recognized in the accounting cycle;
• Explain the measurement of revenue in the context of IAS 18;
• List the criteria for recognizing revenue from the sale of goods;
• List the criteria for recognizing revenue from the rendering of services;
• Give examples clarifying the recognition of revenue in respect of sales of goods and rendering of
services;
• To trace and notice the changes that have been effected with the adoption of IFRS 15 - Revenue from
contracts with customers.
12.2 KEY TERMS
IAS 18 defined key terms as follows:

Revenue: the gross inflow of economic benefits during the period arising in the course of the
ordinary activities of an entity when those inflows result in increases in equity, that exclude
increases as a result of contributions from equity participants. This definition is in line with
the IASB Conceptual Framework.
N.B.2 you should go through IFRS 15`s definition of revenue and notice changes if any.
Fair value refers to 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 (IFRS 13).
N.B.3 you should notice newer key definitions that IFRS 15 has brought about in addition.
IAS 18 provided guidance in accounting for revenue that arises from the sale of goods, the
rendering of services, and the use by others of the entity`s assets resulting in the accrual of
income in the form of interest, royalties and dividends.
The standard did not deal with issues discussed in other standards such as finance income
from lease agreements, dividends arising from investments which are accounted for under the
equity method; premiums, unearned premiums and fees on insurance contracts; changes in the
fair value of financial assets and financial liabilities or their disposal; changes in the values of
other current assets; initial recognition of and changes in the fair value of biological assets
related to agricultural activity; and initial recognition of agricultural produce and the
extraction of mineral ores.
The term 'revenue' excluded amounts collected by an entity on behalf of third parties, for
example, value-added output tax and other taxes on goods and services collected on behalf of
ZIMRA. Similarly, in an agency relationship only commission accruing to the agent can be
considered to be revenue, since all other amounts will be passed on to the principal.
Guidance was given by the standard on determination of whether or not the reporting entity is acting
as an agent or principal as follows:
a) An entity will be the principal if it is exposed to the significant risks and rewards
associated with the sale of goods or rendering of services. The features that indicate
this position are:
i) primary responsibility for providing goods or services to the customer or for fulfilling
the order.
ii) inventory risk pre or post placement of the customer order, during shipping or on return.
iii) discretion in pegging prices.
iv) customer's credit risk for the amount receivable being borne by the entity.
b) An entity will be the agent if it is not exposed to the significant risks and rewards
associated with the sale of goods or rendering of services. This is indicated chiefly by

the amount that the entity earns being predetermined either as a fixed fee per
transaction or percentage of amount billed to the customer.
12.4 MEASUREMENT OF REVENUE
The amount of revenue from a transaction was arrived at by agreement between the seller and
the buyer. This revenue was measured at the fair value of the consideration received or
receivable, taking into account any trade discounts and volume rebates. If the inflow of cash
or cash equivalents is deferred, the fair value of the consideration may be less than the
nominal amount of cash received or receivable. This was because the seller may provide
interest-free credit to the buyer, or accept a note receivable with an interest rate that is below
the market rate. When the agreement effectively constitutes a financing transaction, the fair
value of the consideration should be determined by discounting all the expected future
receipts using an imputed interest rate. This rate was the one that can be more clearly
determined between:
a) the prevailing rate for a similar instrument of an issuer with a similar credit rating;
b) a rate that discounts the nominal amount of the instrument to the current cash sales
price of the goods or services. The difference between the fair value and the nominal
amount of the consideration should be recognized as interest revenue.
N.B.4 check if this has changed with IFRS 15 and note the changes if any.
12.5 RECOGNITION OF REVENUE
If goods or services were exchanged for goods or services of a similar nature and value, the
exchange does not constitute revenue. Revenue only arose if the goods or services exchanged
are dissimilar. In that case, the revenue was measured at the fair value of the goods or services
received, adjusted by the amount of any cash or cash equivalents transferred. However, if this
value could not be measured reliably, the revenue was measured at the fair value of the goods
or services given up, adjusted by the amount of any cash or cash equivalents transferred.
The recognition criteria for revenue were generally applied separately to each transaction.
Where necessary the criteria would be applied to the separately identifiable components of a
single transaction in order to better reflect the substance of the transaction. For example, if the
selling price of a product included a specific amount for after-sales service, this amount would
be deferred and recognized as revenue during the period over which the service is performed.
On the other hand, the recognition criteria would be applied to several transactions when their
commercial effect could only be properly understood if combined.
Revenue from the sale of goods was recognizable if all the following conditions were satisfied:
i) the entity has transferred to the buyer the significant risks and rewards of ownership
related to the goods.
ii) the entity does not retain continuing managerial involvement or effective control over the
goods.
iii) the amount of revenue can be measured reliably.

iv) it is probable that the economic benefit associated with the transaction will follow to the
entity.
v) the costs incurred or to be incurred in respect of the transaction can be measured reliably.
Although the transfer of the risks and rewards of ownership is usually associated with the transfer of
legal title or the passing of possession to the buyer, this is not always the case.
If the entity retained significant risks of ownership, the transaction would not be a sale and revenue
was not to be recognized. The entity retained such risks in the following ways:
a) retention of an obligation for unsatisfactory performance not covered by normal warranty

provisions.
b) receipt of revenue from a particular sale is contingent on the buyer deriving revenue from
selling the goods.
c) goods shipped subject to installation, and the installation is a significant part of the contract
which the entity has not yet completed.
d) the buyer having the right to rescind the purchase for a reason specified in the sales contract,
and the entity is uncertain about the probability of return.
If any uncertainty arose about the collectability of an amount already in revenue, the
uncollectible amount or the amount whose recovery is no longer considered probable, for
example, an irrecoverable trade debt, would be recognized as an expense, rather than an
adjustment of the originally recognized amount.
Because revenue and expenses that relate to the same transaction were required to be
recognized simultaneously, revenue on any transaction was not be recognized if the related
expenses could not be measured reliably. In such cases, any consideration that had already
been received would be recognized as a liability.
EXAMPLE - RECOGNITION OF REVENUE UNDER DEFERRED PAYMENT
Xeron Ltd sold a product for $1 322 500 and granted the customer a 2 year payment holiday. Interest
on such loans is normally charged at 15% p.a on outstanding amounts in arrears.
REQUIRED
Determine the amounts to be recognized as the cash selling price and revenue in the books of Xeron
Ltd.
SUGGESTED SOLUTION
$
Year 0 (commencement of agreement) 1 000 000

Year 1 Interest receivable (1000 000 x 15%) 150 000
Year 2 Interest receivable (1000 000 + 150000) x 15% 172 500
Amounts to be recognized
Cash selling price at commencement of agreement 1 000 000
Revenue for year 1 150 000
Revenue for year 2 172 500
N.B.6 The cash selling price is calculated as the difference between the total selling price at
the commencement of the agreement and total revenue, that is, ($1 322 500 – 150 000 – 172
500 = 1 000 000) or $1 322 500/(1 + 0.15)2 = 1 000 000
EXAMPLE - REVENUE RECOGNITION UNDER CREDIT INSTALLMENT SALES
Yelrone Ltd sold a product for $2 500 000 under a credit installment agreement requiring 6
monthly payments. The interest rate was not specifically stated, but the rate on similar
transactions is 24% p.a. compounded monthly.
REQUIRED
Determine the amounts to be recognized as revenue and finance income over the period of the agreement.
SUGGESTED SOLUTION
$
Revenue $2 500 000/(1+0.02)6 2 219 928
Finance income 280 072
Total selling price 2 500 000
N.B.7 The revenue is calculated as the net present value of the total selling price, based on a monthly
interest rate of 24%/12 = 2% over 6 monthly periods.
ACTIVITY – REVENUE RECOGNITION
Explain IAS 18`s recognition criteria for the sale of goods under the following headings:
a) Specific conditions under which the sale of goods should be recognized;

b) Situations when an entity may retain significant risks and rewards of ownership related to goods which
have been sold;
c) The accounting procedure required when there is uncertainty about the collectability of an amount already
recognized in revenue.
12.6 RENDERING OF SERVICES

According to IAS 18, revenue from a service transaction was accounted for by reference to the
transaction's stage of completion at the statement of financial position date. The outcome of a
transaction was capable of reliable measurement when all the following conditions were met:
a) the amount of revenue can be measured reliably;
b) it is probable that the economic benefits associated with the transaction will flow to the entity;
c) the stage of completion of the transaction at the statement of financial position date can be measured
reliably;
d) the costs incurred for the transaction and the costs to complete the transaction can be measured
reliably.
Reliable estimates are normally made by parties to a transaction after they have agreed on the following:
i) each party's enforceable rights regarding the service to be provided;
ii) the consideration to be paid or received;
iii) the manner and terms of settlement.
The entity which is rendering a service should review and when necessary, revise the estimates
of revenue as the service is being performed.
To facilitate accounting procedures, a service may be considered to be rendered uniformly

over a period if this is appropriate. In this case, the stage of completion of the service being
performed may be determined by reference to the effluxion of time. Revenue is then
recognized on a straight-line basis unless another method better represents the stage of
completion. The following points should be carefully noted:
a) Only costs that are related to services already performed should be included in costs incurred
to date;
b) Only costs that are related to services already performed or to be performed should be
included in the total costs estimated for the transaction;
c) Progress payments and advances received from customers do not necessarily reflect the
extent of services performed to date.
IAS 18 states that when the outcome of a transaction involving the rendering of services
cannot be estimated reliably, revenue should only be recognized to the extent that the
recognized expenses are recoverable. This is often the case during the early stages of a
transaction, when sufficient information to project future revenues and costs is not available.
Under these circumstances, an entity should not recognize any profit.
When the outcome of a transaction cannot be estimated reliably, and it is not probable that the
costs incurred will be recovered, revenue is not recognized at all, and the costs incurred

should be written off. However, if the uncertainty that prevented the outcome of the contract
being estimated reliably no longer exist, revenue should be recognized.
EXAMPLE – REVENUE RECOGNITION (RENDERING OF SERVICES)
Broadlaws Ltd a company with a 31 December financial year-end, entered into 3 contracts which
involved the rendering of services to different clients.
Contract 1
By year-end, the work had just started, and it was not possible to determine the outcome of the
contract reliably. The contract price was $1 000 000, while expenses amounting to $145 000
had been incurred to date. The company considered these expenses to be recoverable.
Contract 2
The contract started off well, and the company spent $213 000 on the preliminary stages of,
the work. The total value of the contract was $1 500 000. The contractee is facing financial
problems, and has indicated that the contract may have to be cancelled.
Contract 3
A lot of work has been done on this contract, which has a total value of $2 500 000. Total
costs incurred to date amount to $1 500 000, while the total cost of completing the work is
expected to be $2 000 000. These amounts have been measured reliably.
REQUIRED
Determine the revenue to be recognized in the above unrelated cases.
SUGGESTED SOLUTION
Contract 1
Para 26 of IAS 18 states that, under the circumstances described, revenue should only be
recognized to the extent that the recognized expenses are recoverable. In this case the
company should recognize $145 000 as revenue, that is, the amount of expenses which are
expected to be recovered from the client. However, the company should not recognize any
profit. This is because it was not possible to determine the outcome of the contract reliably at
the reporting date.
Contract 2

Para 27 of IAS 18 states that, under the circumstances described, revenue should not be
recognized and the costs incurred should be expensed. This means that the company should
not recognize any revenue, and the $213 000 spent so far should be written off.
Contract 3
Para 20 of IAS 18 states that, under the circumstances described, revenue should be
recognized by reference to the transaction's stage of completion at the statement of financial
position date. Application of the stage of completion method means that revenue of $2 500
000 x 1 500 000/2 000 000 = $1 875 000 should be recognized at the year end.
12.6.1 Revenue recognition for specific services rendered
N.B.9 of all the items 1 to 11 below cautiously take note by cross checking with IFRS 15 the changes
if any
12.6.1.1 Installation fees
Installation fees are recognized as revenue by reference to the stage of completion of the
installation, unless they are incidental to the sale of a product, in which case they are
recognized when the goods are sold.
12.6.1.2 Servicing fees included in the price of the product
When the selling price of a product includes an identifiable amount for subsequent servicing
(for example, after sales support and product enhancement on the sale of software), that
amount is deferred and recognized as revenue over the period during which the service is
performed. The amount deferred is that which will cover the expected costs of the services
under the agreement, together with a reasonable profit on those services.
12.6.1.3 Advertising commissions
Media commissions are recognized when the related advertisement or commercial appears
before the public. Production commissions are recognized by reference to the stage of
completion of the project.
12.6.1.4 Insurance agency commissions
Insurance agency commissions received or receivable which do not require the agent to render
further services are recognized as revenue by the agent on the effective commencement or
renewal dates of the related policies. However, when it is probable that the agent will be
required to render further services during the life of the policy, the commission, or part
thereof, is deferred and recognized as revenue over the period during which the policy is in
force.

12.6.1.5 Financial service fees
The recognition of revenue for financial service fees depends on the purposes for which the
fees are assessed, and the basis of accounting for any associated financial instrument. The
description of fees for financial services may not be indicative of the nature and substance of
the services provided. Therefore, it is necessary to distinguish between fees that are an integral
part of the effective interest rate of a financial instrument, fees that are earned as services are
provided, and fees that are earned on the execution of a significant act.
a) Fees that are an integral part of the effective interest rate of a financial instrument
Such fees are generally treated as an adjustment to the effective interest rate. However,
when the financial instrument is measured at fair value with the change in fair value
recognized in profit or loss, the fees are recognized as revenue when the instrument is
initially recognized.
i) Origination fees received by the entity relating to the creation or acquisition of a

financial asset other than one that under IAS 39 (you should take note that, the
standard can still be referred to as long as the IASB phases to replace it are not yet
complete as is presently the case) is classified as a financial asset at fair value
through profit or loss. Such fees may include compensation for activities such as
evaluating the borrower's financial condition, evaluating and recording
guarantees, collateral and other security arrangements, negotiating the terms of the
instrument, preparing and processing documents and closing the transaction.
These fees are an integral part of generating an involvement with the resulting
financial instrument and, together with the related direct costs, are deferred and
recognized as an adjustment to the effective interest rate.
ii) Commitment fees received by the entity to originate a loan when the loan
commitment is outside the scope of IAS 39. If it is probable that the entity will
enter into a specific lending arrangement and the loan commitment is not within
the scope of IAS 39, the commitment fee received is regarded as compensation for
an ongoing involvement with the acquisition of a financial instrument and
together with the related direct costs, is deferred and recognized as an adjustment
to the effective interest rate. If the commitment expires without the entity making
the loan, the fee is recognized as revenue on expiry. Loan commitments that are
within the scope of IAS 39 are accounted for as derivatives and measured at fair
value.
iii) Origination fees received on issuing financial liabilities measured at amortized

cost. These fees are an integral part of generating an involvement with a financial
liability. When a financial liability is not classified as 'at fair value through profit
or loss,' the origination fees received are included, with the related transaction
costs incurred, in the initial carrying amount of the financial liability and
recognized as an adjustment to the effective interest rate. An entity should
distinguish fees and costs that are an integral part of the effective interest rate for

the financial liability from origination fees and transaction costs relating to the
right to provide services, such as investment management services.
b) Fees earned as services are provided
These include:
i) Fees charged for servicing a loan
Fees charged by an entity for servicing a loan are recognized as revenue as the services
are provided.
ii) Commitment fees to originate a loan when the loan commitment is outside the
scope of IAS 39
If it is unlikely that a specific lending arrangement will be entered into and the
loan commitment is outside the scope of IAS 39, the commitment fee is
recognized as revenue on a time proportion basis over the commitment period.
Loan commitments that are within the scope of IAS 39 are accounted for as
derivatives and measured at fair value.
iii) Investment management fees
Fees charged for managing investments are recognized as revenue as the

services are provided. Incremental costs that are directly attributable to
securing an investment contract are recognized as an asset if they can be
identified separately and measured reliably and if it is probable that they will
be recovered. As in IAS 39, an incremental cost is one that would not have
been incurred if the entity had not secured the investment management
contract. The asset represents the entity's contractual right to benefit from
providing investment management services, and is amortized as the entity
recognizes the related revenue. If the entity has a portfolio of investment
management contracts, it may assess their recoverability, on a portfolio basis.
c) Fees that are earned on the execution of a significant act
The fees are recognized as revenue when the significant act has been completed, as explained in
the following examples.
i) Commission on the allotment of shares to a client. The commission is recognized

as revenue when the shares have been allotted.
ii) Placement fees for arranging a loan between a borrower and an investor. The fee
is recognized as revenue when the loan has been arranged.
iii) Loan syndication fees. Syndication fees received by an entity that arranges a loan
and retains no part of the loan package for itself (or retains a part at the same
effective interest rate for comparable risk as other participants) are compensation

for the service of syndication. Such fees are recognized as revenue when the
syndication has been completed.
12.6.1.6 Admission fees
Revenue from artistic performances, banquets and other special events is recognized when the
event takes place. When a subscription to a number of events is sold, the fee is allocated to
each event on a basis which reflects the extent to which services are performed at each event.
12.6.1.7 Tuition fees
Revenue is recognized over the period of instruction.
12.6.1.8 Initiation, entrance and membership fees
Revenue recognition depends on the nature of the services provided. If the fee permits only
membership, and all other services or products are paid for separately, or if there is a separate
annual subscription, the fee is recognized as revenue when no significant uncertainty as to its
uncollectibilty exists. If the fee entitles the member to services or publications to be provided
during the membership period, or to purchase goods or services at prices lower than those
charged to non-members, it is recognized on a basis that reflects the timing, nature and value
of the benefits provided.
12.6.1.9 Franchise fees
Franchise fees may cover the supply of initial and subsequent services, equipment and other
tangible assets, and know-how. Accordingly, franchise fees are recognized as revenue on a
basis that reflects the purpose for which the fees were charged. The following methods of
franchise fee recognition are permitted by IAS 18:
a) Supplies of equipment and other tangible assets.
The amount, based on the fair value of the assets sold, is recognized as revenue when the
items are delivered or title passes to the franchisee.
b) Supplies of initial and subsequent services
Fees for the provision of continuing services, whether part of the initial fee or a
separate fee, are recognized as revenue as the services are rendered. When the separate
fee does not cover the cost of continuing services together with a reasonable profit,
part of the initial fee, sufficient to cover the costs of continuing services and to provide
a reasonable profit on those services, is deferred and recognized as revenue as the
services are rendered.
The initial services and other obligations under an area franchise agreement may
depend on the number of individual outlets established in the area. In this case, the
fees attributable to the initial services are recognized as revenue in proportion to the
number of outlets for which the initial services have been substantially completed.

If the initial fee is collectible over an extended period and there is a significant
uncertainty that it will be collected in full, the fee is recognized as cash installments
are received.
c) Continuing franchise fees
Fees charged for the use of continuing rights granted by the agreement, or for other
services provided during the period of the agreement, are recognized as revenue as the
services are provided or the rights used.
d) Agency transactions
Transactions may take place between the franchisor and the franchisee which, in
substance, involve the franchisor acting as agent for the franchisee. For example, the
franchisor may order supplies and arrange for their delivery to the franchisee at no
profit. Such transactions do not constitute revenue to the franchisor.
12.6.1.10 Fees from the development of customized software
Fees from the development of customized software are recognized as revenue by reference to
the stage of completion of the development, including completion of services provided for
postdelivery service support.
12.7 REVENUE RECOGNITION FOR SPECIFIC SALES OF GOODS
N.B.10 of all the items 1 to 11 below cautiously take note by cross checking with IFRS 15 the changes
if any.
12.7.1 Bill and hold sales in which delivery is delayed at the buyer's request, but the buyer takes
title and accepts billing.
Revenue is recognized when the buyer takes title provided:
a) it is probable that delivery will be made;
b) the item is on hand, identified and ready for delivery to the buyer at the time the sale is recognized;
c) the buyer specifically acknowledges the deferred delivery instructions and
d) the usual payment terms apply.
Revenue is not recognized when there is simply an intention to acquire or manufacture the goods in
time for delivery.
12.7.2 Goods shipped subject to conditions such as
a) Installation and inspection

Revenue is normally recognized when the buyer accepts delivery, and installation and
inspection are complete. However, revenue is recognized immediately upon the
buyer's acceptance of delivery when:
i) the installation process is simple in nature, e.g. the installation of a factory

tested television receiver which only requires unpacking and connection of
power and antennae or
ii) the inspection is performed only for purposes of final determination of contract
prices, for example, shipments of iron ore, sugar or soya beans
b) When the buyer has negotiated a limited right of return
If there is uncertainty about the possibility of return, revenue is recognized when the
shipment has been formally accepted by the buyer or the goods have been delivered
and die time period for rejection has passed.
12.7.3 Consignment sales under which the recipient (buyer) undertakes to sell the goods on behalf on the
shipper (seller)
Revenue is recognized by the shipper when the goods are sold by the recipient to a third party.
12.7.4 Cash on delivery sales
Revenue is recognized when delivery is made and cash is received by the seller or its agent.
12.7.5 Lay-away sales under which the goods are delivered only when the buyer makes the final payment
in a series of installments
Revenue from such sales is recognized when the goods are delivered. However, when
experience indicates that post such sales are consummated, revenue may be recognized when
a significant deposit is received, provided the goods are on hand, identified and ready for
delivery to the buyer.
12.7.6 Orders when payment (or partial payment) is received in advance of delivery for goods not
presently held in inventory, for example, the goods are still to be manufactured or will be delivered
directly to the customer from a third party
Revenue is recognized when the goods are delivered to the buyer.
12.7.7 Sale and repurchase agreements (other than swap transactions) under which the seller
concurrently agrees to repurchase the same goods at a later date, or when the seller has a call option
to repurchase, or the buyer has a put option to require the repurchase, by the seller of the goods
For a sale and repurchase agreement on an asset other than a financial asset, the terms of the
agreement need to be analyzed to ascertain whether, in substance, the seller has transferred the
risks and rewards of ownership to the buyer and hence revenue is recognized. When the seller
has retained the risks and rewards of ownership, even though legal title has been transferred,

the transaction is a financing arrangement and does not give rise to revenue. For a sale and
repurchase agreement on a financial asset, the provisions of IAS 39 should be applied.
12.7.8 Sales to intermediate parties, such as distributors, dealers or others for resale
Revenue from such sales is generally recognized when the risks and rewards of ownership
have passed. However, when the buyer is acting, in substance, as an agent, the sale is treated
as a consignment sale.
12.7.9 Subscriptions to publications and similar items
When the items involved are of a similar nature in each time period, revenue is recognized on a
straight-line basis over the period in which the items are dispatched. When the items vary in
value from period to period, revenue is recognized on the basis of the sales value of the items
dispatched in relation to the total estimated sales value of all items covered by the subscription.
12.7.10 Installment sales, under which the consideration is receivable in installments
Revenue attributable to the sales price, exclusive of interest, is recognized at the date of sale.
The sale price is the present value of the consideration, determined by discounting the
installments receivable at the imputed rate of interest. The interest element is recognized as
revenue as it is earned, using the effective interest method.
12.7.11 Real estate sales
Revenue is normally recognized when legal title passes to the buyer. However, in some
jurisdictions the equitable interest in a property may vest in the buyer before legal title passes,
and therefore the risks and rewards of ownership have been transferred at that stage. In such
cases, provided that the seller has no further substantial acts to complete under the contract, it
may be appropriate to recognize revenue. In either case, if the seller is obliged to perform any
significant acts after the transfer of the equitable and/or legal title, revenue is recognized as
the acts are performed. An example is a building or other facility on which construction has
not been completed.
A seller should consider the means of payment and evidence of the buyer's commitment to
complete payment. For example, when the aggregate of the payments received, including the
buyer's initial down payment, or continuing payments by the buyer, provide insufficient
evidence of the buyer's commitment to complete payment, revenue should only be recognized
to the extent that cash is received.
12.8 INTEREST, ROYALTIES AND DIVIDENDS
N.B.11 of all the items a) to c) below cautiously take note by cross checking with IFRS 15 the changes
if any.
Revenue from sundry sources of income like interest, royalties and dividends should be recognized
according to the following guidelines:

a) Interest is recognized based on the effective interest method explained in IAS 39 /IFRS 9;
b) Royalties are recognized on an accrual basis, taking into account the substance of the relevant agreement;
c) Dividends are recognized when the shareholder's right to receive them is established.
Revenue from the use by others of the entity's assets yielding these types of income should only be
recognized when:
i) it is probable that the economic benefits related to the transaction will flow to the entity;
ii) the amount of the revenue can be measured reliably.
EXAMPLE - CALCULATION OF EFFECTIVE INTEREST RATE
Three different financial institutions offer 30% p.a, interest to depositors. Institution X
compounds its interest semi-annually, Institution Y compounds its interest quarterly, while
Institution Z compounds its interest monthly.
REQUIRED
Calculate the effective interest rates offered by the institutions.
SUGGESTED SOLUTION
The annual effective interest rate (EIR) is calculated as follows:
EIR = (1 + r/n) n - 1
Where r = nominal interest rate per period n =

number of compounding periods a year
Institution X
EIR = (1 + 30%/2)2 - 1
(1 + 0.15)2 - 1
= 32.25%
Institution Y
EIR = (1 + 30%/4)4 - 1
= (1 +0.075)4 - 1
= 33.55%
Institution Z
EIR = (1 + 30%/12)12 - 1
= (1 + 0.025)12 - 1
= 34.49%

N.B. Institution Z offers the highest effective interest rate on the investment, because it compounds its
interest more frequently than the other institutions.
N.B.12 compare and contrast the new IFRS 15`s disclosure requirements.
Entities should disclose the following:
i) The accounting policies adopted for the recognition of revenue, including the
methods used to determine the stage of completion of transactions involving the
rendering of services.
ii) The amount of each significant category of revenue recognized during the period,
including revenue from the sale of goods, the rendering of services, interest,
royalties and dividends.
iii) The amount of revenue arising from exchanges of goods or services included in
each significant category of revenue.
iv) Contingent liabilities and contingent assets in accordance with IAS 37; such
liabilities and assets may arise from warranty costs, claims, penalties or possible
losses.
ACTIVITY – GIT ELECTRONICS
a) What are the three main categories of revenue dealt with in IAS 18?
b) In terms of IAS 18, what information should an enterprise disclose in respect of income in its
financial statements?
c) GIT Electronics is an electronics company which sells, repairs and installs electrical, electronic and
telecommunications goods, equipment and systems.
GIT Electronics Ltd. enters into maintenance contracts with its customers whereby it
maintains, during the period of the contract, the computer hardware it sells. GIT Electronics
Ltd. receives royalties for a patented television component which is manufactured under
license by another company.
GIT Electronics also runs repair technician training courses which are offered to the public. The
following transactions and other details relate to the year-ended 31 March 20-1:
$
Sales of equipment 226 000
Repair services 167 200
Royalties received in cash 7 260
Royalties payable by the manufacturer in terms of the contract amounted to 9 680

Installation fees received 81 400
Included in installation fees received is:
- Installation fees received in advance on 31/03/20-1 300 -
Installation fees received from a customer who was not
satisfied with the installation, which was to be redone 770
Sales of equipment by GIT Electronics Ltd on behalf of JIT

Electronics Ltd, with GIT Electronics Ltd
receiving a commission of 15% on the sales 147 400
Contract fees received during the year-ended 31/03/20-1 211 200

Prepaid contract fees: At 1/4/20-0 30 800
At 31/3/20-1 26 400
Training fees received 21 120

Outstanding training course fees at 31/3/20-1 5 280
(the amount is considered collectible)
REQUIRED
Calculate the amount of revenue that should be shown in the financial statements of GIT
Electronics Ltd. for the year-ended 31 March 20-1, in respect of the above transactions, so as
to comply with the requirements of IAS 18.
Source: ICSAZ May 2001 past examination question
12.10 SUMMARY
The provision of services to clients and sale of goods to customers is critical to the existence
of all business entities. Revenue from these activities has a big influence on the profitability
and viability of these entities. It therefore, remains of paramount importance that you
understand the nature of revenue and the circumstances under which it can be considered to
have arisen. Transactions involving revenue should be properly identified, reported and
disclosed in the financial statements. Therefore, a cautious approach is advised in identifying
the changes made to this standard by the newly introduced IFRS 15.
12.11 REFERENCES
VORSTER, Q. KOORNHOF, C. et a1 Descriptive Accounting, IFRS

Focus, 14th Edition,
LexisNexis/Butterworths 2011

Standards 2011

UNIT THIRTEEN
INVENTORIES (IAS 2)
13.0 INTRODUCTION
Also known as stocks, inventories form an important part of the assets of most manufacturing,
wholesale and retail organizations. Inventories are so important to the operations of these
organizations that inadequate levels can adversely affect their profitability, viability and cash
flows. On the other hand, excessive levels will increase holding costs which can be classified
into two categories, that is, those which increase as inventory increases, and those which
decrease as inventory increases. Costs that increase with inventory are referred to as carrying
costs and include the costs of financing, storage, servicing interest and the risk of loss of value.
Storage costs include rent on premises (or alternatively the opportunity cost of the entity's own
premises), insurance and utilities, for example, electricity. Servicing costs include labour for
handling the inventory, clerical and accounting costs. A decline in value may occur due to
pilferage, fire, physical deterioration, obsolescence, or a fall in market value. Some of these
risks can be insured, in which case the cost of insurance becomes a component of carrying
cost.
Costs that decrease as inventories increase include ordering costs, unit purchase costs, unit
production costs, and the opportunity costs of lost sales. Ordering costs are usually a fixed
amount per order placed regardless of the value of the order. (Remember C o – cost of ordering
in your Cost and Management Accounting module). By ordering less frequently in large
quantities total ordering costs are reduced, but average inventories are increased. In other
words, holding costs increase (Ch). Unit costs of materials purchased may be decreased if
quantity discounts can be obtained by buying in larger quantities. With bigger inventories of
raw materials, and work-in-progress, longer production runs can be made with fewer set-ups,
lower total set up costs and fewer delays. In addition, higher finished goods inventories will
reduce stock outs and lost contributions from sales. Inventory management is a key aspect of
working capital management, a subject area you shall come across in you Corporate Finance
module. This Unit explains principles and procedures for dealing with inventories from an
accounting point of view. The Unit is based on IAS 2 – Inventories.
13.1 OBJECTIVES
• Identify and explain the costs associated with holding inventories
• Identify and explain the core principle on which the measurement of inventories should be based
• Identify and explain the components of inventory costs

• Explain the circumstances in which inventories will constitute an expense
• Outline the disclosure requirements for inventories
IAS 2 applies to all inventories except:
i) work-in-progress related to construction contracts, including directly-related service

contracts. Construction contracts are now covered by IFRS 15.
ii) financial instruments for instance financial assets held for trading, that is at fair value
through profit or loss (IFRS 9).
iii) biological assets related to agricultural activities and agricultural produce at the point of
harvest (IAS 41)
iv) agricultural forest products, agricultural produce after harvest, minerals and mineral
products to the extent that they are measured at net realisable value
v) inventories of commodity broker-traders that are measured at fair value less costs
to sell
13.3 TERMINOLOGY
The following terms are defined in the standard as follows:
Inventories are assets that are:
a) held for sale in the ordinary course of business (e.g finished goods);
b) in the process of production for sale (e.g work in progress);
c) in the form of materials or supplies to be consumed in the production process or in the rendering of
services (e.g raw materials).
Net realisable value is the estimated selling price in the ordinary course of business less the estimated
costs of completion and the estimated costs necessary to make the sale.
Fair value is defined in the same way as in other International Accounting Standards and International
Financial Reporting Standards.
13.4 MEASUREMENT RULES AND GUIDELINES
All inventories which fall under the scope of this standard should be measured at the lower of
cost and net realisable value. This is the core principle of inventory valuation - an accounting
procedure that influences the value at which an entity's assets are reported as well as all
measures of profit. The principle is based on the fact that the cost of inventories may not be
recoverable if they are damaged, they have become wholly or partially obsolete, or their
selling prices have declined. The same reduction in earning potential will occur if the
estimated costs of completion or the estimated costs to be incurred to dispose of the
inventories have increased. Writing down inventories below cost to net realisable value is

consistent with the view that assets should never be carried at amounts in excess of those
expected to be realised from their sale or use. This observation is a restatement of the
prudence concept.
13.4.1 Cost of inventories
The standard states that the cost of inventories consists of all costs of purchase, costs
conversion and other costs incurred in bringing the inventories to their present location and
condition.
Cost of purchase comprise the purchase price, import duties and other irrecoverable taxes,
transport, handling and other costs directly attributable to the acquisition of finished goods,
materials and services. Trade discounts, rebates and similar items are deducted in arriving at
the final purchase cost. Remember that from your earlier levels of accounting, trade discounts
are not part of the double entry bookkeeping process as they are netted off on capturing sales
or purchase amounts into the books of original entry. However, cash discount is not deducted
because it is conditional on the purchaser's ability to meet specified settlement terms. Cash
discounts allowed or received constitute part of the double entry bookkeeping.
Conversion cost includes costs that are directly related to the units of production, for example,
direct labour. This cost also includes fixed and variable production overheads that are incurred
in converting materials into finished goods. Fixed production overheads are those indirect
production costs that remain relatively constant regardless of production volume, for example,
depreciation and maintenance of factory buildings and factory administration costs. On the
other hand, variable production overheads will vary directly or almost directly with the
production volume, for example, indirect materials and indirect labour.
The allocation of fixed production overheads to conversion costs should be based on the
normal capacity of the production facilities. Normal capacity is the production level that is
expected to be achieved on average over a number of periods under normal circumstances,
taking into account the loss of capacity resulting from planned maintenance. However, the
actual production level may be used if it is approximately equal to normal capacity. The
amount of fixed overheads allocated to each production unit (known as the fixed overhead
absorption/recovery rate per unit in your Cost and Management Accounting module) should
not be increased due to low production or idle plant. Unallocated overheads are recognised as
an expense in the period in which they are incurred. During periods of abnormally high
production, the fixed overhead absorption rate is decreased to ensure that inventories will not
be measured above cost. The variable overhead absorption rate is constant, although total
variable overheads will increase with production volume.
A production process may result in more than one product being produced simultaneously, for
example, when the process produces joint products or when there is a main product and a
byproduct. If the conversion costs of each product are not separately identifiable, they should
be allocated between the products on a rational and systematic basis. The allocation may be
based on the relative sales volume of each product:

(a) at the stage in the production process when the products become separately identifiable or (b)
at the completion of production.
The value of most by-products is usually immaterial and they are normally measured at net realisable
value, with this value being deducted from the cost of the main product.
Other costs should only be included in inventory costs if they are incurred in bringing the
inventories to the desired location and condition. An example of this is the inclusion of non-
productive overheads or design costs in inventory costs. Costs which should be excluded from
inventory costs and expensed in the relevant period include:
a) abnormal amounts of wasted materials, labour and other production costs

b) storage costs, unless these costs are necessarily incurred in the production process before a further
production stage
c) administrative overheads that do not contribute to bringing inventories to their present location
and condition
d) selling costs inventory costs for service providers
13.4.2 Inventory costs for service providers
Service providers should measure their inventories at the costs of production. These costs
consist mainly of the labour and other costs of personnel directly engaged in providing the
service, including supervisory personnel, as well as attributable overheads. Labour and other
costs related to sales and general administrative personnel are not included, but recognised as
expenses in the period during which they are incurred. Inventory costs for service providers
should exclude profit margins on non- attributable overheads that are often included in selling
prices.
13.4.3 Techniques for measuring cost
There are various techniques for measuring inventory costs, for example, the standard cost
method or the retail method. Standard costs take into account normal levels of materials and
supplies, labour, efficiency and capacity utilisation. Such costs should be frequently reviewed,
and if necessary, revised in the light of current conditions.
The retail method is usually used by retail establishments to measure inventories of large
numbers of rapidly changing items with similar margins, for which it is impracticable to use
other costing methods. The inventory cost is determined by the appropriate percentage gross
margin. The percentage used for any inventory category should take into account inventory
that has been marked down to below its original selling price.
13.4.4 Cost formulae
The cost of inventories for items that are not normally interchangeable and goods or services
produced and segregated for specific projects should be determined by using specific
identification of their individual costs. This means that specific costs are attributed to
identified items of inventory. The method is not appropriate for large numbers of inventory

items that are ordinarily interchangeable. This is because the selection of items that remain in
inventory can be done in such a way as to obtain predetermined levels of profit or loss.
Inventory costs, apart from those determined through specific identification, should be
assigned by using the first-in-first-out (FIFO) or weighted average cost formula. An entity
should use the same formula for all inventories having similar nature and use to the entity. For
other types of inventory, different cost formulae may be justified. The average may be
calculated on a periodic basis, or as each additional consignment is received, depending on the
entity's circumstances.
13.5 IMPLEMENTATION OF THE LOWER OF COST OR NET REALISABLE

VALUE RULE
i) Inventories are usually written down to net realisable value item by item.
However, in some cases it may be appropriate to group similar or related items.
This may apply to inventory items related to the same product line that have
similar purposes or end use, are produced and marketed in the same geographical
area, and cannot practicably be evaluated separately from other items in that
product line. Service providers generally accumulate costs in respect of each
service for which a separate selling price is charged.
ii) Estimates of net realisable value are based on the most reliable evidence available
at the time the estimates are made, of the amount the inventories are expected to
realise. These estimates should take into account price or cost fluctuations directly
related to events occurring after the end of the period, to the extent that such events
confirm conditions that existed at the end of the period (IAS 10).
iii) Estimates of net realisable value should also take into account the purpose for
which the inventory is held. For example, the net realisable value of inventory held
to satisfy sales or service contracts is based on the contract price. If the contract
selling prices are less than the value of inventory held, the net realisable value of
the excess is based on general selling prices. Any provisions that have to be made
in respect of firm sales contracts in excess of inventory quantities held or from
firm purchase contracts should be accounted for in terms of IAS 37.
iv) Materials and other supplies held for use in the production of inventory should not
be written down below cost if the finished products in which they will be used are
expected to be sold at or above cost. However, when a decline in the price of
materials indicates that the cost of the finished products exceeds net realisable
value, the materials should be written down to net realisable value. In such cases,
the replacement cost of the materials may be the best available measure of their net
realisable value.
v) A new assessment of the net realisable value of inventories should be made in each
subsequent period. Sometimes the circumstances that previously caused
inventories to be written down below cost will no longer exist, or there may be
clear evidence of an increase in net realisable value due to changed economic
circumstances. In such cases, the amount of the write-down should be reversed, so
that the new carrying amount is the lower of the cost and the net realisable value.

However, the reversal is limited to the amount of the original write- down. An
example of this is when an inventory item that is carried at net realisable value
because its selling price has decreased, is still on hand in a subsequent period and
its selling price has increased.
EXAMPLE 1
GD Ltd. manufactures sports shoes. The normal capacity the factory is 300 000 pairs of shoes
per year. During the year-ended 30 June 2012, 350 000 pairs were produced to meet higher
demand.
On 1 July 20-1 there were 25 000 pairs on hand, and 338 000 pairs were sold during the ensuing
year. The company does not keep inventories of raw materials.
The following information applies to the year-ended 30 June 20-2:
$ $
Opening inventory (finished goods) 500 000
Raw material purchased 1 750 000
Auditors' remuneration 170 000
Directors' remuneration 250 000
Advertising 348 000
Telephone 183 000
Depreciation:
Plant. 228 000
Office equipment 167 000
Motor vehicles (admin. & delivery) 195 000
Furniture 116 000 706 000
Electricity & water (plant) 210 000
Repairs & maintenance: Plant (75 % fixed) 270 000
Motor vehicles (admin & delivery) 315 000
Consumable inventory used in production 230 000
Factory direct wages' 3 600 000
Factory salaries 495 000
Pension fund contributions 180 000
Medical aid contributions 200 000
It is estimated that 65% of salaries, pension fund contributions and medical aid contributions
are attributable to the management and supervision of the manufacturing activities. On 30
June the estimated net realizable value of the finished goods inventory exceeded its 2013
REQUIRED
Calculate the value of the closing inventory on 30 June 20-2 to comply with IAS 2.

SUGGESTED SOLUTION
Closing inventory (in pairs of shoes) as at 30 June 20-2 $
Opening inventory 1/07/20-1 25 000

Manufactured during the year 350 000
Sold during the year (338 000)
37 000
Allocation of fixed production overheads $

Depreciation of plant 228 000
Repairs & maintenance of plant (270 000 x 75%) 202 500
Factory salaries (495 000 x 65%) 321 750
Pension fund cont. (180 000 x 65%) 117 000 Medical
aid cont. (200 000 x 65%) 130 000
Total fixed production overheads 999 250
Allocation of variable production overheads $

Electricity & water 210 000
Repairs & maintenance of plant (270 000 x 25%) 67 500
Consumable inventory 230 000
Total variable production overheads 507 500
Calculation of the unit cost of finished goods

Raw materials (1 750 000/350 000) 5.0
Direct wages (3 600 000/350 000) 10.29
Fixed production O/Hs (999 250/350 000) 2.86
Variable production O/Hs (507 500/350 000) 1.45
$19.60
Alternative calculation $
Raw materials 1 750 000
Direct wages 3 600 000
Fixed production O/Hs 999 250 Variable
production O/Hs 507 500
Total cost of finished goods 6 856 750
Unit cost of finished goods (6 856 750/350 000) $19.60
Value of closing inventory 37 000 pairs x $19.60 $725 200

N.B. When production is above normal capacity as in this case, IAS 2 requires the fixed
production overheads allocated to each unit of production to be reduced so that inventory is
not measured above cost. Therefore, the fixed overheads have been allocated on the basis of
350 000 pairs, not the normal capacity of 300 000 pairs.
EXAMPLE 2
T Ltd. is a manufacturer of cement bricks. The following information relates to the year- ended
30 September 20-2:
$ $
Sales 8 500 000
Opening inventory: Finished goods 580 000
Work-in-progress 225 000
Raw materials 450 000 1 255 000
Purchase of raw materials 1 740 000
Variable production costs: Direct labour and overheads 900 000
Fixed production costs 750 000
i) $120 000 must be written off the opening inventory of raw materials due to
physical damage.
ii) Fixed production overheads are allocated at $15 per unit based on a normal capacity
of 250 000 units. Actual production for the year-ended 30 September 202 was 235
000 units.
iii) Closing inventory on 30 September 20-2 was as follows:
Cost NRV
$ $
Raw materials 280 000 280 000
Work-in-progress 375 000 300 000
Finished goods 360 000 458 000
iv) Other items on hand on 30 September 2012 were as follows:
Cost
$
Stationery 75 000
Packaging materials 112 500
The company uses the FIFO method to value inventory. The bricks which are currently being manufactured
are expected to be sold at or above cost.

REQUIRED
Disclose inventory in the statement of comprehensive income and statement of financial position
of T Ltd. to comply with IAS 2. Notes to the financial statements are also required. Show all
workings.
SUGGESTED SOLUTION
T Ltd
Income statement for year ended 30 September 20-2 (extract)
Note $
Sales 8 500 000
(d)
Cost of sales (6 705 000) Gross
profit 1 795 000
T Ltd
Statement of financial position as at 30 September 20-2 (extract)
Note $
ASSETS
Current assets
Inventory 2 1 202 500
T Ltd
Notes to the financial statements for year-ended 30 September 20-2
1.1 Inventory
Inventory is valued at the lower of cost or net realizable value on the FIFO basis.
2. Inventory $
Raw materials 280 000
Work-in-progress 375 000
Finished goods 360 000
Consumables 187 500
1 202 500
N.B. Raw materials, W.I.P and other supplies held for use in the production of inventories are
not written down below cost if the finished products in which they will be incorporated are
expected to be sold at or above cost.

WORKINGS
a) Raw materials $
Opening inventory 450 000
Purchase 1 740 000
Closing inventory (280 000)
Transferred to W.I.P 1 790 000
b) Work-in-progress $ Opening
inventory 225 000
Raw materials (a) 1 790 000
Variable production costs 900 000
Fixed production costs (235 000 x $15) 3 525 000
Transferred to finished goods 6 140 000
c) Finished goods $
Opening inventory 580 000
Completed during the year 6 140 000
Transferred to cost of inventory 6 360 000
d) Cost of inventory $
Cost of finished goods sold 6 360 000
Opening inventory written off 120 000
Under-recovery of production overheads (250000 - 235 000) x $15 225 000
Transferred to statement of comprehensive income 6 705 000
13.6 RECOGNITION OF INVENTORY AS AN EXPENSE
When inventories are sold, the carrying amount of those inventories should be recognized as
an expense in the period in which the related revenue is recognized .The amount of any write
down of inventories to net realizable value and losses of inventories should be recognized as
an expense in the period the write down or losses occurs. The amount of any reversal of any
write-down of inventories arising from an increase in net realizable value, should be
recognized in the period in which the reversal occurs. Inventories that are allocated to other
asset accounts e.g inventory used as a component of self-constructed property, plant or
equipment should be recognized as an expense during the useful life of the assets.
The following information should be disclosed in the financial statements.
i) The accounting policies used in measuring inventories, including the cost formula used.
ii) The total carrying amount of inventories and the carrying amount in classifications
appropriate to the entity

iii) The carrying amount of inventories carried at fair value less costs to sell iv) The
amount of inventories recognized as an expense during the period
v) The amount of any write-down of inventories recognized as an expense in the period vi)
The amount of any reversal of a write-down that is recognized as a reduction in the amount
of inventories recognized as an expense in the period
vii) The circumstances or events that led to the reversal of a write-down of inventories
viii) The carrying amount of any inventories pledged as security for liabilities
Para 99 of IAS 1 – Presentation of financial statements states that an entity should present an
analysis of expenses using a classification based on either the nature of expenses or their
function within the entity, whichever provides information that is reliable or more relevant.
The following example shows the application of these two methods with emphasis on accounting for
inventories:
EXAMPLE 3
The following information relates to Y Ltd. for the year-ended 31 December 20-2:
$
Sales 10 500 000
Opening inventory of finished goods 198 000
Closing inventory of finished goods 276 500
Raw materials used 1 274 000
Labour costs 1 680 000
Variable production O/Hs allocated 1 230 000
Fixed production O/Hs allocated 1 183 000
Packaging materials 445 000
Selling & administration expenses 2 429 000
Write-down of raw materials to net realizable value 35 000
Over-recovery of fixed production O/Hs 57 400
Abnormal loss of raw materials 22 700
REQUIRED
Draw up the statement of comprehensive income for the year-ended 31 December 20-2 using a)
classification of expenses by nature
b) classification of expenses by function.
SUGGESTED SOLUTION
Y Ltd
Statement of comprehensive income for the Y/E 31 December 20-2 (nature of expense)
$
Sales 10 500 000
Changes in inventories 78 500
Materials used (1 274 000 + 445 000 + 35 000 + 22 700) (1 776 700)
Labour costs (1 680 000)

Other expenses
Variable production O/Hs (1 230 000)
Fixed production O/Rs (1 183 000 - 57 400) (1 125 600)
Selling & administrative expenses (2 429 000)
Y Ltd
Statement of comprehensive income for the Y/E 31 December 20-2 (by function)
$
Sales 10 500 000
Cost of sales
(1 274 000 + 1 680 000 + 1 230 000 + 1 183 000 - 57 400 + 445 000 + 35 000 + 22 700 +198 000 - 276 500) (5 733 800)
Gross profit 4 766 200
Selling & administrative expenses (2 429 000)
ACTIVITY
The following information relates to D Ltd. for the year-ended 31 March 20-2
Opening Closing Closing inventory inventory inventory

(at historical cost) (at historical cost) (at NRV)
$ $ $
Raw materials 296 000 326 750 315 200
Work-in-progress 275 000 430 000 388 450
Finished goods 338 000 273 400 260 000
Packaging materials 125 800 142 600 135 300
A summary of transactions for the year revealed the following:

$
Sales 3 750 000
Administrative expenses 633 750
Raw materials purchased 760 500
Transport cost (raw materials) 77 400
Variable production O/Hs 442 800
Fixed production O/Hs 350 000
Selling & distribution expenses 283 600

The company values raw materials and work-in-progress using the FIFO method. Finished
goods and consumables (packaging materials and stationery) are valued on the weighted
average cost method. Fixed production overheads are recovered at $300 per unit based on a
normal capacity of 900 000 units.
REQUIRED
Disclose inventory in the income statement and statement of financial position of D Ltd. to comply
with IAS 2. Notes to the financial statements are required. Show all workings.
13.8 SUMMARY
This Unit explains the accounting and disclosure requirements for inventories, and is based on
IAS 2. The major types of inventory are raw materials, work in-progress and finished goods.
Inventories of consumables should also be accounted for appropriately. The standard states
that inventories should not be written down below cost according to the net realizable value
rule if the finished goods in which they are incorporated are expected to be sold at or above
cost.
13.9 REFERENCES
VORSTER, Q; KOORNHOF, C. et al Descriptive Accounting - IFRS Focus
OPPERMAN, H.R.B. 16th Edition LexisNexis, Butterworth
2012
BOOYSEN, S.P. et aI Accounting Standards 14th Edition Juta
& Co 2011

Standards 2015

UNIT FOURTEEN

(IAS 29)
14.0 INTRODUCTION
Profit may be defined as the increase in an entity's wealth during a period, or the maximum
amount that may be distributed without adversely affecting the amount of wealth at the
beginning of the period. Profit is calculated as the excess of revenue over related expenses,
which necessitates the matching of revenue and expenses according to the accruals concept.
On the face of it, this calculation is straightforward, but in practice it is fraught with
distortions arising from the fact that monetary amounts of different purchasing power are
summed up to produce totals which are, at best, difficult to interpret and at worst, useless for
decision-making purposes. Although this problem is particularly severe during periods of
inflation and hyperinflation, some accounting scholars consider it to be inherent in all sets of
financial statements. According to one critique of historic-based accounts:
"In a profit and loss account, out of date historical costs are deducted from current revenues to
produce a profit figure that may not be useful. In addition, the prudence concept requires the
application of an asymmetric test in determining whether or not profits or losses are to be
recognized. Profits are recognized only when they have been realized, but provision is made
for all foreseeable losses. This has the result that the profit for a year includes certain gains
which relate to earlier periods but have been realized during this year, while it excludes
certain gains which relate to the current year but have not been realized at the end of the year.
Conversely, such a profit is reduced by all foreseeable losses, whether or not they have been
realized in the current period".
Source:Financial Training Courses 1990
The issues raised in the above quotation are at the core of the proper interpretation of financial
statements. It is clear that when the general price level is rising, an entity which distributes the

profit shown by its historic-based accounts would not be able to replace its assets without
raising additional capital.
14.1 OBJECTIVES
• List the economic characteristics indicating that a country is experiencing hyperinflation;
• List the major aspects of historic-based financial statements;
• Explain the principles which should be applied in the restatement of financial statements;
• Apply the practical rules which are used in the restatement of financial statements.
14.2 KEY TERMS
Monetary items are assets and liabilities whose amounts are fixed by contract and whose
values do not change with the general price level. Examples of such items are cash, accounts
receivable, long and short-term loans, and preference share capital. A common feature of
monetary assets is that their purchasing power decreases during (hyper) inflationary periods,
resulting in losses to their owners. On the other hand, holders of monetary liabilities
experience gains during (hyper) inflationary periods, because the amounts they owe will not
be adjusted to take into account the decline in their purchasing power.
Non-monetary items are assets and liabilities whose values are affected by price changes over
a certain period. Examples of such items are non-current assets, inventories, and investments
in the securities of other companies. The values of some non-current assets tend to increase
rapidly during (hyper) inflationary periods, while the increase in inventories tends to be less
pronounced because they are held for relatively short periods of time.
Certain inflation adjustment models consider ordinary share capital to be a liability that is neither
monetary nor non-monetary.
14.3 THE MEANING OF HYPERINFLATION
IAS 29 defines hyperinflation as 'the loss of purchasing power of money at such a rate that
comparison of amounts from transactions and other events that have occurred at different
times, even within the same accounting period is misleading.' According to this standard, the
existence of hyperinflation in a country is indicated by the following:
i) The general population prefers to keep its wealth in non-monetary assets or in a

relatively stable foreign currency. Amounts of local currency held above transaction
balances are immediately invested to maintain purchasing power.
ii) The general population regards monetary amounts not in terms of the local currency
but in terms of a relatively stable foreign currency.

iii) Sales and purchases on credit take place at prices that compensate for the expected loss
of purchasing power during the period, even if the period is short.
iv) Interest rates, wages and prices are linked to a price index
v) The cumulative inflation rate over three years is approaching or exceeds 100.
14.4 THE NEED TO RESTATE HISTORIC-BASED FINANCIAL STATEMENTS
One of the basic accounting conventions is that economic transactions are initially measured
at historical cost, although adjustments may be made later. This is a measurement basis
according to which assets are recorded at the amount of cash or cash equivalents paid or the
fair value of the consideration given to acquire them. Liabilities are recorded at the amount of
proceeds received in exchange for the obligation, or at the amounts of cash or cash equivalents
expected to be paid to satisfy the liability during the normal course of business. As an
accounting basis, historical cost has stood the test of time. However, it only works well in
countries which have no inflation or insignificant rates of inflation. D Shoko (2006) has listed
the following disadvantages of historical cost accounting in hyper-inflationary environments:
a) Assets are grossly undervalued:
This is particularly the case where entities do not revalue their assets in line with inflation
trends.
b) Depreciation is grossly understated:
This is because the depreciation is calculated on the unadjusted cost of non-current

assets. The specific effects of understating depreciation is that profit will be
overstated, while the carrying amount of non-current assets is understated.
c) Outdated costs are matched with current revenue, resulting in unrealistically high profit
figures.
d) There is no attempt to separate holding against real gains and losses. This distinction is
significant during periods of hyperinflation. Holding gains and losses arise from having
monetary liabilities and monetary assets respectively during periods of hyperinflation.
e) Higher taxes may result from the use of historical cost financial statements, if the FIFO
method has been used.
f) Because of the overstatement of capital dividends may be paid out of capital. In most cases,
this is due to the failure to take into account the replacement cost of inventories and other
assets.
g) The comparison of financial statements for several periods becomes difficult or unrealistic.
14.5 CONCEPTS OF CAPITAL MAINTENANCE

In measuring a corporate entity's capital, two methods can be used:
a) The operating capital maintenance concept whereby profit is measured after provision has
been made to maintain the entity's operating capital, that is, its ability to produce a certain
volume of output (goods and services).
b) The financial capital maintenance concept, which can be sub-divided into:
i) Money financial capital maintenance, that is, the maintenance of capital in nominal terms
ii) Real financial capital maintenance, according to which profit is measured after the general
purchasing power of opening shareholders' equity has been maintained.
EXAMPLE 1
X Ltd. is financed by ordinary share capital. Its net assets on 1 January 2-13 and 31 December 2-
13 are $10 000 000 and $25 000 000 respectively. There was no change in the share capital during
the year.
The general rate of inflation, as measured by the consumer price index, is 100. The specific rate of
price increase applicable to the company is 80.
REQUIRED
Calculate the company's profits using different concepts of capital maintenance.
SUGGESTED SOLUTION
The company's profits under different concepts of capital maintenance can be presented in tabular
form as follows:
Operating Capital Money Financial Real Financial

Maintenance Maintenance Maintenance
$ $ $
Net assets 31/12/2-13 25 000 000 25 000 000 25 000 000
Net assets required
to maintain capital
as at 1/01/2-13
Operating capital (18 000 000)
(10m x 180%)
Money financial capital (10 000 000)
Real financial capital (20 000 000)
(10m x 20%) . . .
Profit 7 000 000 15 000 000 5 000 000

Notes
i) Using operating capital maintenance, $18 000 000 is required at the year-end to
buy the same goods and/or services that the company could have bought on 1
January 2-13. This leaves a profit of $7 000 000.
ii) Using money financial maintenance, the company is as well off at the year-end as
it was on 1 January 2-13 with $10 000 000. This leaves a profit of $15 000 000.
iii) Using real capital maintenance, it is clear that there has been a decrease in the
general purchasing power of money. As a result, $20 000 000 is required at the
year-end to purchase the same goods and/or services in general as could-be bought
for $10 000 000 on 1 January 2- 13. This leaves a profit of $5 000 000.
N.B. the least sophisticated approach, that is, the money financial capital maintenance results
in the highest profit, which is clearly in nominal terms. In practice, the difference between the
profits reported according to the operating capital maintenance concept and the real financial
capital maintenance concept depends on the relationship between the price changes of specific
assets which the company purchases and the change in the general price level.
14.6 RESTATEMENT OF HISTORICAL COST FINANCIAL STATEMENTS
The standard provides the following guidelines for the restatement of historical cost statements
of financial position:
i) Amounts not already expressed in terms of the measuring unit current at the reporting
date are restated by applying a general price index.
ii) Monetary items are not restated because they are already expressed in terms of the
monetary unit current at the reporting date.
iii) Assets and liabilities linked by agreement to changes in prices e.g. index-linked bonds
and loans, are adjusted according to the agreement in order to ascertain the amount
outstanding at the reporting date. These items are carried at the adjusted amounts in
the restated statement of financial position.
iv) All other assets and liabilities are non-monetary. Such items which are already carried
at current amounts at the reporting date, for example, net realizable value and market
value, do not need to be restated. Any other non-monetary-items should be restated.
v) Most non-monetary items are carried at cost (or cost less accumulated depreciation),
that is, at amounts current at their acquisition dates. The restated cost or cost less
accumulated depreciation of each item is determined by applying to its historical cost
and accumulated depreciation the change in a general price index from the acquisition
date to the reporting date The following items should be restated from the dates of
purchase:
• property, plant and equipment

• goodwill
• purchased finished goods (merchandise)
• raw materials
• patents and trademarks
iv) Some non-monetary items are carried at amounts current at dates other than of
acquisition or that of the statement of financial position, for example, property,
plant and equipment that has been revalued at an earlier date. In such cases, the
carrying amounts should be restated from the re-valuation date.
v) The restated amount of a non-monetary item is reduced when it exceeds the

amount recoverable from its future use through or other means of disposal (see
IAS 36).
vi) The statement of comprehensive income and statement of financial position of an

investee company that is accounted for under the equity method and that reports in
the currency of a hyperinflationary economy are restated in order to calculate the
investor's share of its net assets and results of operations. If the restated financial
statements of the investee are expressed in a foreign currency they should be
translated at closing rates.
vii) When capital expenditure is financed by borrowing, the part of borrowing costs
that compensates for inflation should be restated and recognized as an expense in
the period in which the costs are incurred.
viii) An entity may acquire assets under an arrangement that permits it to defer payment
without incurring an explicit interest charge. If it is impracticable to impute the
amount of interest, such assets should be restated from the payment date and not
the date of purchase.
ix) At the beginning of the first period of applying IAS 29, the components of owners'
equity, except retained earnings and any revaluation surplus, are restated by
applying a general price index from the dates these components were contributed.
Any revaluation surplus that arose from previous periods should be eliminated.
Restated retained earnings are derived from all the other amounts in the restated
statement of financial position as a balancing figure.
x) At the end of the first period and in subsequent periods of applying IAS 29, all
components of owners' equity are restated by applying a general price index from
the beginning of the period or the date of contribution, if later. The movements for
the period in owners' equity should be disclosed in accordance with IAS 1.
IAS 29 provides the following guidelines for the restatement of historical cost statement of comprehensive
income:

i) All items in the statement of comprehensive income should be expressed in terms
of the measuring unit at the reporting date.
ii) All amounts are restated by applying the change in the general price index from
the dates when the items of income and expense were initially recorded in the
14.6.1 Gain or loss on net monetary position
During a period of hyperinflation, an entity holding an excess of monetary assets over

monetary liabilities loses purchasing power. On the other hand, an entity with an excess of
monetary liabilities over monetary assets gains purchasing power if the assets and liabilities
are not linked to a price index. The gain or loss on the net monetary position can be calculated
as the difference resulting from the restatement of non-monetary assets, owners' equity and
statement of comprehensive income items and the adjustment of index linked assets and
liabilities. The gain or loss may be estimated by applying the change in a general price index
to the weighted average for the period of the difference between monetary assets and
monetary liabilities.
14.13.2 Accounting treatment of the gain or loss on net monetary position
i) The gain or loss on the net monetary position should be included in the calculation of net
income.
ii) The adjustment to assets and liabilities that are linked by agreement to changes in prices
should be offset against the gain or loss on net monetary position.
iii) Other statement of comprehensive income items, for example, interest income, interest
expense and foreign exchange differences related to invested or borrowed funds are
separately disclosed, but they may be presented together with the gain or loss on net
monetary position.
14.14 IMPLEMENTATION OF IAS 29
Vorster, Koomhof et al (2006) have identified the following steps which can be used to restate
financial statements in accordance with IAS 29.
a) Select the general price index

b) Segregate monetary and non-monetary items
c) Restate non-monetary items
d) Restate the statement of comprehensive income
e) Restate the owners' equity
f) Restate comparative figures
g) Calculate the gain or loss on the net monetary position
h) Prepare the inflation-adjusted cash flow statement
The most important characteristics of a reliable price index are as follows:

i) A wide range of goods or services must be included in the index, in order to accurately reflect varying
price fluctuations
ii) The index must be obtained from a reputable source, which uses accurate data to prepare the
information
iii) The index should be available for a number of years, since IAS 29 is applicable to prior
periods
iv) The index should be updated regularly, preferably monthly, in order to facilitate accurate
calculations.
EXAMPLE 2 (RESTATING REVENUE)
The revenue of P Ltd. for the year-ended 30 June 2-13 amounted to $11 620 000. Monthly revenue
figures and the related price indices were as follows:
$
2-12 July 325 000 125
August 520 000 130
September 780 000 133
October 1 200 000 140
November 1 340 000 148
December 1 480 000 155
2-13 January 1 440 000 171
February 950 000 182
March 950 000 185
April 1 050 000 190
May 865 000 194
June 720 000 198
11 620 000
REQUIRED
Calculate the revenue that should be included in the restated statement of comprehensive income for
the year-ended 30 June 2-13 to comply with IAS 29.
SUGGESTED SOLUTION
The restatement calculations are as follows:
$
198
2-12 July (325 000 x /125) 514 800
198
August (520 000 x /130) 792 000 Sept.
198
(780 000 x /133) 1 161 203 October (1
198
200 000 x /140) 1 697 143 November (1 340
198
000 x /148) 1 792 703
198
December (1 480 000 x /155) 1 890 581

198
2-13 January (1 440 000 x /171) 1 667 368
198
February (950 000) x /182) 1 033 516
198
March (950 000 x /185) 1 016 758 April
198
(1 050 000) x /190) 1 094 211
198
May (865 000 x /194) 882 835
198
June (720 000 x /198) 720 000
14 263 118
EXAMPLE 3 (RESTATING COST OF GOODS SOLD)
On 1 July 2-12, Q Ltd. had inventory of $556 000 which had been purchased on the same date.
During the following year, inventory costing $1 670 000 was purchased. On 30 June 20-13
inventory costing $780 000 was still on hand. The company uses the FIFO method and all
inventory on 30 June 20-13 was purchased on that date. The following indices are applicable:
Index
1/07/2-12 145
30/06/2-13 220
Average for the year 184
REQUIRED
Calculate the cost of goods sold figure that should be included in the restated income statement
for the year-ended 30 June 2-13 to comply with IAS 29.
SUGGESTED SOLUTION
The restatement calculations are as follows:

220 843 586
Opening inventory (556 000 x /145)
220 1 996 739
Purchases (1 670 000 x /184)
220 (780 000)
Closing inventory (780 000 x /220)
Restated cost of goods sold 2 060 625
N.B.
i) The average index for a year is not always the simple average of the indices on the
opening date and the closing date.
ii) A more accurate restated cost of goods sold figure can be obtained if monthly
purchases figures and monthly indices are available. In this example average figures
have been used.
EXAMPLE 4 (INCLUDING CALCULATION OF NET MONETARY POSITION)

Part of the historical cost statement of comprehensive income for the year-ended 30 September 2-
13 for Cherish Ltd was as follows:
$
Sales 9 375 000
Cost of goods sold (6 419 500)
The historical cost statement of financial positions for the 2-years-ended 30 September 2-13 were
as follows:
Statement of financial positions as at 30 September
2-12 2-13
$ $
ASSETS
Non-current assets
Property, plant & equipment 3 750 000 3 750 000
Accumulated depreciation (937 500) (1 406 250)
2 812 500 2 343 750
Current assets
Inventory 890 000 3 265 000
Trade receivables 797 500 Nil
Cash at bank 196 700 Nil
4 696 700 5 608 750
Retained profits Nil 1 500 000
Long-term loan (15%) 2 000 000 Nil Current
liabilities
Bank overdraft 137 800 434 300
Trade payables 58 900 1 174 450
4 696 700 5 608 750 Additional
information
i) Opening inventory and purchases for the year-ended 30 September 2-13 were $890
000 and $8 794 500 respectively. ii) Depreciation and loan interest for the year-ended
30 September 2-13 were $468 750 and $300 000 respectively. Sundry expenses
amounted to $127 400.
iii) The consumer price index (CPI) figures from the Central Statistics Office were as follows:
1 October 2-11 75
1 October 2-12 100
30 September 2-13 270
Average for the year-ended 30/09/2-13 190 iv)
The ordinary share capital was issued on 1 October 2-11.

v) The non-current assets are depreciated using the straight-line method. Other
transactions occurred evenly during the year.
vi) The closing inventory was all purchased on 1 September 2-13 when the CPI was 265.
REQUIRED
Prepare the inflation-adjusted income statement for the year-ended 30 September 2-13 and the
restated statement of financial position as at that date to comply with IAS 29.
Cherish Ltd
Inflation-adjusted statement of comprehensive income for Y/E 30/09/2-13
$ $
Sales (9 375 000 x 270/190) 13 322 368 Cost
of goods sold
Opening inventory (890 000 x 270/100) 2 403 000
270
Purchases (8 794 500 x /190) 12 497 447
14 900 447
270
Closing inventory (3 265 000 x /265) (3 326 604) (11 573 843)
Trading Expenses
Depreciation (3 750 000 x 270/75)/8 1 687 500
270
Loan interest (300 000 x /190) 426 316
270 181 042 (2 294 858)
Sundry expenses (127 400 x /190)
Loss before monetary gain (546 333)
Net monetary gain 1 701 687
* Also the retained profits figure on 30 September 2-13 since the retained profits figure on 30 September
2-12 was nil:
Calculation of net monetary position on 30/09/2-13

$
Adjusted opening monetary assets
Trade receivables at 30/09/2-12 (797 500 x 270/100) 2 153 250
Cash at hand at 30/09/2-12 (196 700 x 270/100) 531 090
(2 684 340)
Adjusted opening monetary liabilities
Long-term loan (2 000 000 x 270/100) 5 400 000 Trade
payables at 30/09/2-12 (137 800 x 270/100) 372 060
Bank overdraft at 30/09/2-12(58 900 x 270/100) 159 030
5 931 090
Net opening monetary liabilities (5 931 090 – 2 684 340) 3 246 750
Adjusted net receipts

Sales 13 322 368
Expenditure:

Purchases 12 497 447
Interest 426 316
Sundry expenses 181 042
13 104 805
Adjusted net receipts (13 322 368 – 13 104 805) 217 563
Closing monetary assets

Trade receivables at 30/09/2-13 Nil
Cash at hand at 30/09/2-13 Nil
Closing monetary liabilities

Bank overdraft at 30/09/2-13 1 174 450 Trade
payables at 30/09/2-13 434 300
1 608 750
Net closing monetary liabilities 1 608 750
N.B. Even if they were not at nil value, closing monetary assets are already expressed at
current prices, therefore they do not need to be adjusted. The same is the case with closing
monetary liabilities.
$
Net monetary position
Adjusted opening net monetary liabilities 3 246 750
Adjusted net receipts 217 563
3 464 313
Holding loss (balancing figure) (1 855 563)
Adjusted closing net monetary liabilities 1 608 750 Cherish Ltd
Inflation-adjusted statement of financial position as at 30/09/2-13
$
ASSETS
Non-current assets
Property, plant & equipment 13 500 000
Accumulated depreciation (1 687 500 x 3) (5 062 500)
8 437 500
Current assets
Inventories 3 326 604
Trade receivables Nil
Cash Nil
3 326 604
11 764 104
Share capital and reserves
270 9 000 000
Ordinary share capital (2 500 000 x /75)
Retained earnings (balancing figure) 1 155 354
10 155 354

Non-current liabilities Nil
Current liabilities
Bank overdraft 1 174 450
Trade payables 434 300
1 608 750
11 764 104
Calculation of gain/loss on net monetary position

Net assets at reporting date/Closing equity (11 764 104 - 1 608 750) 10 155 354
270 9 000 000
Net assets at beginning of year/Opening equity (2 500 000 x /75)
Inflation adjusted profit for the year (10 155 354 – 9 000 000) 1 155 354
Loss before monetary gain (546 333)
Gain 1 701 687
EXAMPLE – ARUSHA LTD
The following information pertains to Arusha TP Ltd, a company which operates in Zambia.
Abridged statement of profit or loss and other comprehensive income for the year
ended 30 June 2-12
Kwacha
Revenue 28 800 000
Cost of sales (16 800 000)
Depreciation on machinery (600 000 x 20%) (120 000)
Interest paid on loan (at 30 June 2-12) (2400 000)
Other expenses (at 31 Dec 2-11) (5 700 000)
Income tax expense (assuming it is correct for restatement) (1 380 000)
Other comprehensive income net of tax Nil
Total comprehensive income 2 400 000
Statement of changes in equity for the year ended 30 June 2-12
Share Capital Retained Earnings Total

Kwacha Kwacha Kwacha
Bal at 1 July 2-11 600 000 6 600 000 7 200 000
Dividend paid at 30 June 2-12 (450 000) (450 000)

Total comprehensive income 2 400 000 2 400 000
Bal at 30 June 2-12 600 000 8 550 000 9 150 000
Statement of financial position as at 30 June 2-12
ASSETS Kwacha

Non-current assets
Property, plant and equipment on 2 July 2-07 for K4 500 000,
valuation at 2 July 2-10 7 500 000
Machinery at cost at 2 July 2-09 1 200 000
Accumulated depreciation (720 000) 480 000
7 980 000
Current assets
Inventory (average acquisition date at 1 April 2-12) 6 330 000
Trade receivables 5 100 000
Cash at bank 900 000 12 330 000
20 310 000

Share capital & Reserves
Share capital (1 200 000 ordinary shares issued at 2 July 2-07 at K0.50 each) 600 000
Retained earnings 8 550 000
9 150 000
Bank term loan 7 800 000
Monetary current liabilities 3 360 000
11 160 000
20 310 000
Assuming the consumer price index in Zambia has been as follows since 2-07:
2 July 2-07 100

2 July 2-09 125
2 July 2-11 185
31Dec 2-11 210
1 Apr 2-12 260
30 June 2-12 300 You may use the index at 30
June 2-12 to adjust the statement of profit or loss and other comprehensive income items. The inflation
adjusted retained earnings on 1 July 2-11 was K7 068 000.
Deferred tax aspects are not applicable.
REQUIRED
a) Inflation adjusted statement of profit or loss and other comprehensive income for the year ended 30
June 2-12.
b) Inflation adjusted statement of changes in equity for the year ended 30 June 2-12.
c) Inflation adjusted statement of financial position as at 30 June 2-12.
SUGGESTED SOLUTION
a)
ARUSHA TP LTD

Inflation adjusted statement of profit or loss and other comprehensive income for the
year ended 30 June 2-12
Kwacha
Revenue (28 800 000 x 300/210) 41 142 857
Cost of sales 16 800 000 x 300/210 (24 000 000)
Depreciation on machinery (120 000 x 300/185) (194 595)
Interest paid on loan (2 400 000)
Other expenses (5 700 000 x 300/210) (8 142 857)
6 405 405
Net monetary loss on restatement*4 (1 041 181)
Income tax expense (1 380 000)
*4 Net monetary gain or loss on restatement

see SOCIE
Restated total comprehensive income (profit after tax for the year) 3 984 224
Profit after tax before monetary gain/loss (6 405 405 – 1 380 000) (5 025 405)
Loss (1 041 181)
b)
ARUSHA TP LTD
Inflation adjusted statement of changes in equity for the year ended 30 June 2-12
Share Capital Retained Earnings Total

Kwacha Kwacha Kwacha
Bal at 1 July 2-11 1 110 000 7 068 000 8 178 000
(600 000 x 185/100)
(7 068 000 x 300/185) – 7 068 000 4 393 622 4 393 622
(600 000 x 300/100) – 1 110 000 690 000 690 000
1 800 000 11 461 622 13 261 622
Dividend paid at 30 June 2-12 (450 000) (450 000)
Total comprehensive income (bal. figure) 3 984 224 3 984 224
Bal at 30 June 2-12 1 800 000 14 995 846 16 795 846*3

*3 = Closing net assets (equity)
c)
ARUSHA TP LTD
Statement of financial position as at 30June 2-12
Kwacha
ASSETS
Non-current assets
Property (4 500 000 x 300/100) 13 500 000
Machinery: Cost (1 200 000 x 300/125) 2 880 000
Acc. depreciation (720 000 x 300/125) (1 728 000) 1 152 000
14 652 000
Current assets
Inventory (6 330 000 x 300/260) 7 303 846
Receivables (monetary item) 5 100 000
Cash at bank (monetary item) 900 000
27 955 846

Share capital & reserves
Share capital (600 000 x 300/100) 1 800 000 Retained
earnings (Balancing figure*2) 14 995 846
16 795 846*1
Bank term loan (monetary item) 7 800 000
Monetary current liabilities 3 360 000
27 955 846
14.15 CURRENT COST FINANCIAL STATEMENTS
IAS 29 gives the following guidelines for the restatement of current cost financial statements:
i) With regard to the statement of financial position items stated at current cost do not
need to be restated because they are already expressed in terms of the measuring unit
current at the reporting date. Other items should be restated as explained earlier for
historical cost financial statements.
ii) With regard to the statement of comprehensive income, it should be noted that the
current cost statement of comprehensive income (before restatement) generally reports
costs which were current when the underlying transactions or events occurred. For
example, cost of goods sold and depreciation are recorded at current costs at the time
of consumption, while sales and other expenses are recorded at their amounts when
they occurred. Therefore all amounts should be restated into the measuring unit current
at the reporting date by applying a general price index.
iii) The gain or loss on net monetary position should be accounted for as explained earlier
for historical cost financial statements.

iv) The restatement of financial statements may result in differences between the carrying
amounts of individual assets and liabilities in the statement of financial position and
their tax bases. These differences should be accounted for as explained in IAS 12.
v) All items in the cash flow statement should be expressed in terms of the measuring
unit current at the reporting date. The basic principles for preparing the cash flow
statement are unchanged.
14.16 COMMON REQUIREMENTS FOR HISTORICAL COST AND CURRENT COST

FINANCIAL STATEMENTS
Corresponding figures for the previous reporting period, whether they were based on a
historical cost approach or a current cost approach, should be restated by applying a general
price index so that the comparative financial statements are presented in terms of the
measuring unit current at the end of the reporting period. Information that is disclosed in
reports of earlier periods should also be expressed in terms of the measuring unit current at the
end of the reporting period.
14.17 CESSATION OF HYPERINFLATIONARY CONDITIONS
When an economy ceases to be hyperinflationary and an entity discontinues the preparation

and presentation of financial statements according to IAS 29, the entity should treat the
amounts expressed in the measuring unit current at the end of the previous reporting period as
the basis for the carrying amounts in its subsequent financial statements. It is important to take
note of the distinction made by IAS 29 between measurement principles at inception and at
cessation.
At the onset of hyper-inflation accounting, items are measured as if the entity had always applied the
standard, as if the economy was not hyperinflationary in the past.
On cessation of hyperinflation the financial statements will still include the effect of the
previous application of the standard, as the closing IAS 29 balance becomes the starting point
for further measurement.
IAS 29 requires the following disclosures in financial statements:
a) The fact that the financial statements and the corresponding figures for previous periods
have been restated to reflect changes in the general purchasing power of the functional
currency, and as a result are stated in terms of the measuring unit current at the reporting
date;
b) Whether the original financial statements are based on a historical cost approach or a
current cost approach;

c) The identity and level of the price index at the reporting date and the movement in the
index during the current and the previous reporting period.
ACTIVITY 1
a) List the guidelines which are found in IAS 29 for the restatement of historical cost financial statements.
b) What do you understand by the term ‘gain or loss on net monetary position’?
ACTIVITY 2
Some authorities argue that in a period of rising prices, the historical cost as a basis for accounting reporting
has inherent defects.
You are required to discuss the defects of historical cost as a basis for accounting reporting, and to suggest
remedies or solutions that could possibly be applied to remedy these problems.
(Further Education Examinations Board – Zimbabwe)
14.11 SUMMARY
This Unit is an introduction to inflation-adjusted financial statements and expounds on the

principles explained in IAS 29. However, it should be noted that this standard is quite brief
and does not shed a lot of light on many key issues e.g. the selection of an appropriate general
level price index. The major advantage of the standard is that it attempts to simplify
considerably the adjustments which were required for the earlier inflation reporting methods
i.e. current purchasing power accounting and current cost accounting.
14.19 REFERENCES
KOPPESCHAAR, Z.R; et al Descriptive Accounting, 19th Edition,

IFRS Focus, LexisNexis/Butterworths
2014
BOOYSEN, S.F. et al 14 Edition, Juta & Co 2011
FINANCIAL TRAINING Advanced Financial Accounting Courses

(UK.) CIMA Study Pack 1990

Standards 2015

UNIT FIFTEEN
15.0 INTRODUCTION
The major purpose of IAS 41 is to prescribe the accounting treatment and disclosures related to
agricultural activities. The need for a specific standard on such activities was highlighted by
the fact that they are associated with a lot of uncertainty when traditional accounting models
are used. This is because the critical events related to biological transformation (i.e. growth,
degeneration, production and procreation) that alter the substance of biological assets are not
easy to capture in an accounting model based on historical cost and realization of profit or loss.

This standard requires measurement of agricultural produce at fair value less estimated pointof
sale costs from initial recognition of biological assets up to the point of harvest, unless fair
value cannot be measured reliably on initial recognition. However, the standard does not deal
with the processing of agricultural produce after harvest, since this processing is considered to
be more related to manufacturing than to agriculture.
15.1 OBJECTIVES
• Distinguish between agriculture and agriculture-related manufacturing activities;

• Identify and explain the recognition and measurement criteria for biological assets or
agricultural produce;
• Explain the application of fair value principles to agricultural activity Account for government
grants as they relate to agricultural activity.
15.2 TERMINOLOGY
The standard defines the following terms related to agricultural activity:
Agricultural activity is or for conversion he management by an entity of the biological
transformation and harvest of biological assets for sale into agricultural produce or into
additional biological assets.
Agricultural produce is the harvested product of the entity's biological assets.
A biological asset is a living animal or plant that is controlled by an entity as a result of past events,
and from which future economic benefits are expected to flow to the entity.
Biological transformation comprises the processes of growth degradation production and procreation
that cause qualitative or quantitative changes in a biological asset.
Harvest is the detachment of produce from a biological asset or the cessation of a biological asset:
is life processes.
As in other accounting situations, the fair value of an asset depends on its present location and
condition. For example, the fair value of cattle at a farm is the price of the cattle in the
relevant market less the transport and other costs of getting the cattle to that market.
15.3 RECOGNITION AND MEASUREMENT ISSUES

IAS 41 provides the following guidelines for the recognition and measurement of agricultural assets:
i. An entity should only recognize a biological asset or agricultural produce when:
a) the entity controls the asset as a result of past events;
b) it is probable that future economic benefits associated with the asset will flow to
the entity;
c) the fair value or cost of the asset can be measured reliably. ii. A biological asset
should be measured on initial recognition and at each reporting date at its fair
value less estimated point-of-sale costs, unless the fair value cannot be
determined reliably;

iii. Agricultural produce harvested from an entity's biological assets should be measured
at its fair value less estimated point-of-sale costs at the point of harvest. This cost is
based on the application of IAS 2 – Inventories;
iv. The determination of fair value for a biological asset or agricultural produce may be
facilitated by grouping the assets or produce based on significant attributes e.g. age
or quality, commonly known as ‘grading’. An entity should select the attributes
according to those used in the relevant market for pricing purposes;
v. Entities often enter into contracts to sell their assets or produce at a future date.
Contract prices should not be used to determine fair value, since this reflects the
current market in which a willing buyer and seller would enter into a transaction.
This means that the fair value of an asset or produce should not be adjusted due to the
existence of a contract. It should also be noted that an agreement for the sale of an
asset or produce may be an onerous contract, as explained in IAS 37 – Provisions,
Contingent Liabilities and Contingent Assets;
vi. If an active market exists for a biological asset or agricultural produce, the quoted
price in that market is the appropriate basis for determining fair value. If an entity has
access to different active markets, the entity should use the most relevant one i.e, the
market which is more likely to-be used to dispose of the asset or produce;
vii. If an active market does not exist, an entity should use one or more of the following
sources of information if available:
a) the most recent market transaction price, provided that there has not been a significant
change in economic circumstances between the date of that transaction and the
balance sheet date;
b) market prices for similar assets with adjustments to reflect differences;
c) sector benchmarks such as the value of an orchard expressed per export tray, bushel,
or hectare, and the value of cattle per kilogram of meat.
viii. An entity should consider all available information including location and condition,
in determining an appropriate discount rate to be used in the calculation of present
value of agricultural assets or produce.
In any present value calculation, the entity should incorporate expectations about possible
variations in cash flow into either the expected cash flows, the discount rate or a combination
of the two. However, cash flows related to financing the assets, taxation or re-establishing
biological assets after harvest should be excluded.
ix. Cost may approximate fair value in the following circumstances:
a) Little biological transformation has taken place since the cost initially occurred
(e.g. fruit tree seedlings planted just before the STATEMENT OF FINANCIAL
POSITION date);
b) The impact of the biological transformation on price is not expected to be material.
x. Biological assets are often physically attached to land (e.g. trees in a plantation
forest). Although there may be no separate market for biological assets that are
attached to the land, an active market may exist for the combined asset i.e. for the
biological assets, land and improvements as a package. An entity may use
information on the combined assets to determine fair value for the biological assets.
This may be done by deducting the fair value of land and land improvements from
the fair value of the combined assets.
15.4 GAINS AND LOSSES IN AGRICULTURAL ACTIVITY

A gain or loss arising on initial recognition of a biological asset at fair value less estimated
point-of-sale costs and from a change in fair value less estimated point-of-sale costs of a
biological asset should be included in the profit or loss for the period in which it arises.
A gain may arise when a calf is born.
A loss may arise through the deduction of point- of-sale costs when determining the fair value of
a steer.
A gain or loss arising on initial recognition of agricultural produce fair value less estimated point-of-sale
costs should be included or the period in which it arises.
A gain or loss may arise on initial recognition of agricultural produce as a result of harvesting.
15.5 INABILITY TO MEASURE FAIR VALUE RELIABLY
There is normally a presumption that fair value can be measured reliably for a biological asset.
However, this presumption may not hold on initial recognition for a biological asset for which
market- determined prices or values are not available. In addition, an entity may determine
that alternative estimates of fair value are clearly unreliable. In such cases, the asset should be
measured at its cost less any accumulated depreciation and any accumulated impairment
losses. Once the fair value of such an asset becomes reliably measurable, the entity should
measure it at its fair value less estimated point- of-sale costs. If a non- current biological asset
meets the criteria to be classified as held for sale (or is included in a disposal group that is
classified as held for sale) in accordance with IFRS 5, it is presumed that fair value can be
measured reliably. In determining cost, accumulated depreciation and accumulated
impairment losses, an entity should follow the guidelines in IAS 2, IAS 16 and IAS 36.
EXAMPLE 1
The livestock inventory of CC Cattle Company on 1 January 2-11 was as follows:
Age Number
1 year 15
2 years 32
3 years 35
4 years 0
5 years 28
During the year-ended 31 December 2-11 there were 26 live births. Average prices per kg of live
weight for that year were as follows:

AGE PRICE PER KG
1/01/2-11 31/12/2-11
1 year 0.9 1.35
2 years 1.8 2.25
3 years 2.7 3.20
4 years 5.5 6.85
5 years 7.4 8.90
The average weight per animal for the different age groups was as follows:
AGE WEIGHT (KG)
Newborn 23
1 year 85
2 years 150
3 years 320
4- years 540 5 years
670
REQUIRED:
Show relevant extracts from the financial statements of CC Cattle Company
SUGGESTED SOLUTION
Value of livestock on 31/12/2-11
Type of No. of Average Total Rate per Total
Animals Animals weight (kgs) kg
weight kgs $ $ New Born 26
23 598 1 350 807 300
1 years 15 85 1 275 2 250 2 868 750
2 years 32 150 4 800 3 200 15 360 000
3 years 35 320 11 200 4 000 44 800 000
5 years 28 670 18 760 8 900 166 964 000
230 800 050
Value of livestock on 1/01/2-11

Type of No. of Average Total Rate per Total
Animals Animals weight (kgs) kg
weight kgs $ $ 1 year
15 85 1 275 1 800 2 295 000
2 years 32 150 4 800 2 700 12 960 000
3 years 35 320 11 200 3 600 40 320 000
5 years 28 670 18 760 7 400 138 824 000
194 399 000
SCI (EXTRACT) FOR Y/E 31/12/1-11

Increase in value of livestock $
230 800.50 -194 399.000 36 401.050
STATEMENT OF FINANCIAL POSITION 2-11
(EXTRACT) AS AT 31/12/2-11 $
Valued of livestock 230 800 050
Example 2
T Ltd, a farming company with a 30 June financial year-end, had an inventory of 12 (twelve)
2-years old cattle on July 2-11. 2 animals aged 1.5 years were purchased 21 January 2-11 $72
000 each, and 5 live births were recorded on 31 March 2-12. There were no sales or other
disposal of animals is during the year. Per- unit fair values less estimated point-of sale cost
were as follows:
$
2-year old animal on 1/07/2-11 95 000
New-born animal on 1/04/2-12 58 000
1.5 - year old animal on 1/01/2-12 72 000
New-born animal on 30/06/2-12 65 000
1.5 -year old animal 30/06/2-12 115 000
2-year old animal on 30/06/2-12 120 000
3-month old animal on 30/06/2-12 75 000 3-year
old animal on 30/06/2-12 150 000
REQUIRED:
Show relevant extracts from the financial statements of T Ltd, for the ended 30 June 2-12. In
your answer you should distinguish between changes in fair value to price changes and those due
to physical change.

SUGGESTED SOLUTION
WORKINGS
$ $
Fair value less estimated point of sales costs of
Herd on 1/07/2-11($95 000 x12) 1 140 000

Purchased on 1/01/2-12 ($72 000 x 2) 144 000
Increase fair value less estimated
Point of sale costs due to price change
($ 120 000- 95 000 x 12) 300 000
($115 000 72 000) x 2 86 000
($65 000-58 000) x 5 35 000 421 000
Increase in fair value less estimated
Point of sale costs due to physical change
($150 000- 120 000) x 12 360 000

($ 120 000- 115 000) x 2 10 000
($75-000-65 000) x 5 50 000
$58 000 x 5 290 000 710 000
2 415 000
Fair value less estimated point-of-sale

Cost of herd on 31/06/2-12
($150 000x 12) 1 800 000
($120 000x 2) 240 000
($ 75 000x 5) 375 000 2 415 000
SCI (EXTRACT) FOR Y/E 30/06/2-12

$
Increase in fair value of livestock less
estimated point-of-sale costs due to
price change 421 000
Increase in fair value of livestock less
estimated point-of-sale costs due to physical change 710 000
STATEMENT OF FINANCIAL POSITION (EXTRACTION) FOR Y/E 30/06/2-12

$
Value of livestock 2 415 000
15.6 ACCOUNTING FOR GOVERNMENT GRANTS

IAS 41 gives the following guidelines for the recognition of government grants:
i. An unconditional government grant related to a biological asset ensured at its fair
value less estimated point-of-sale costs should only be recognized in profit or loss
when the grant becomes receivable;
ii. If the grant referred to in; (i) above is conditional e,g. where the entity is required not
to engage in specified agricultural activity, the entity should recognise the grant in
profit or loss only when the conditions related to it have been met.
If the government allows part of the grant to be retained based on the passage of time, the entity
may recognise the grant as income on a time proportion basis.
The following disclosure requirements are outlined in IAS 41:
i. An entity should disclose the aggregate gain or loss arising during the current period on
initial recognition of biological assets and agricultural produce, and from the change in fair
value less estimated point-of-sale costs of biological assets;
ii. An entity should provide a description of each group of biological assets. This description
may be in narrative or quantified form;

iii. If not disclosed elsewhere in information published with the financial statements, an entity
should describe:
a) the nature of its activities involving each group of biological assets;
b) non-financial measures or estimates of the physical quantities of each group of
the entity's biological assets at the end of the period output of agricultural
produce during the period.
iv. An entity should disclose the methods and significant assumptions applied in determining the
fair value of each group of agricultural produce at the point of harvest and each group of
biological assets.
v. An entity should disclose the fair value less estimated point-of-sale costs of agricultural
produce harvested during the period, determined at the point of harvest;
vi. An entity should disclose;
a) the existence and carrying amounts of biological assets whose title is restricted,
and the carrying amounts of biological assets pledged as security for liabilities; b)
the amount of commitments for the development or acquisition of biological
assets;
c) financial risk management strategies related to agricultural activity; vii. An
entity should present a reconciliation of changes in the carrying amount of biological assets
between the beginning and the end of the current period. This reconciliation should include:
a) the gain or loss arising from changes in fair value less estimated point-of-sale costs;
b) increases due to purchases;
c) decreases attributable to sales and biological assets classified as held for sale, or
included in a disposal group that is classified as held for sale in accordance with
IFRS 5;
d) decreases due to harvest;
e) increases resulting from business combinations;
f) net exchange differences arising on the translation of financial statements into a
different presentation currency, and on the translation of a foreign operation into the
presentation currency of the reporting entity.
Additional Disclosures for Biological Assets where Fair Value Cannot be Measured reliably:
i. If an entity measures biological assets at their cost less any accumulated depreciation
and any accumulated impairment losses at the end of the period, the following should
be disclosed for such assets:
a) a description of the assets;
b) an explanation of why fair value cannot be measured reliably;
c) if possible, the range of estimates within which fair value is likely to be;
d) the depreciation method used;
e) the useful lives of the assets or the depreciation rates used and;
f) the gross carrying amount and the accumulated depreciation (aggregated with accumulated
impairment losses) at the beginning and end of the period.
ii. If during the current period, an entity measures biological assets as in (i) above, it
shall disclose any gain or loss recognised on disposal of such assets. The
reconciliation required by para 50 of the standard should disclose amounts related to
the assets separately. In addition, the reconciliation should include the following
amounts included in profit or loss related to the assets:
a) impairment losses;
b) reversals of impairment losses;

c) depreciation. iii. If the fair value of biological assets previously measured at their cost less
any accumulated depreciation and any impairment losses becomes reliably measurable during
the current period, an entity should disclose for those assets:
a) a description of the assets;
b) an explanation of why fair value has become reliably measurable;
c) the effect of the change
Government Grants
An entity should disclose the following information related to agricultural activity:
i. the nature and extent of government grants recognised in the financial statements;
ii. unfulfilled conditions and other contingencies attached to government grants;
iii. significant decreases expected in the level of government grants.
ACTIVITY
A herd of 10 2-year old animals was held on 1 January 2-11.One animal aged 2.5 years was
purchased on 1 July 2-11 324 and one animal was born on the same date. No animals were
sold or otherwise disposed of during the following period.
Per-unit fair values less estimated point-of-sale costs were as follows:
$
2- year old animal at 1/01/2-11 300
New born animal at 01/07/2-11 210
2.5 year old at 1/07/2-11 324
New born animal at 31/12/2-11 216
0.5 year old at 31/12/2-11 240
2-year old animal at 31/12/2-11 315 2.5 year
old animal at 31/12/2-11 333
REQUIRED:
Show relevant extracts from the financial statements. [Workings are required.]
15. 7.1 Illustrative presentation (face disclosure) of the statement of financial position for
a Dairy Company.
Mombe Breeders & Milk Dairies
Extract statement of financial position as at
Note 31 Dec 31 Dec

20-1 20-0

ASSETS $ $
Non-current assets
Dairy livestock – immature xx xx
– mature xx xx
3 xx xx
Property, plant and equipment 4 xx xx
xx xx
15.7.2 Illustrative presentation (face disclosure) of the statement of comprehensive

income for a Dairy Company

Extract statement of comprehensive income for the year ended
Note 31 Dec 31 Dec

20-1 20-0
$ $
Fair value of milk produced xx xx
Gains or losses arising from changes in fair
value less costs to sell of dairy livestock 3 xx xx
xx xx
Inventories used (xx) (xx)
Staff costs (xx) (xx)
Depreciation expense (xx) (xx)
Other operating expenses (xx) (xx)
Profit from operations xx xx
15.7.3 Illustrative presentation (face disclosure) of the statement of cash flows for a Dairy
Company

Extract statement of cash flows for the year ended
Note 31 Dec 31 Dec

20-1 20-0
$ $
1. Cash flow from operating activities
Cash receipts from – sales of milk xx xx
– sales of livestock xx xx
Cash paid for purchases of livestock (xx) (xx)
xx xx
Income taxes paid (xx) (xx)
Net cash inflow/outflow from operating activities xx xx

15.8 SUMMARY
IAS 41 prescribes the accounting treatment, financial statement presentation and disclosures
related to agricultural activity, to the extent that these issues are not covered by other
standards. A key point noted in this standard is that any change in physical attributes of
biological assets or agricultural produce owned by an entity will directly increase or decrease
its economic benefits. The major aspect of the accounting model required by the standard is
that it recognises and measures biological growth using fair values, and enables the entity to
ascertain changes in these values which occur throughout an accounting period.
15.9 REFERENCES
IASB IFRS Consolidated without early application, Part B, 2015
UNIT SIXTEEN
16.0 INTRODUCTION
In most countries, the government has a substantial involvement in the production and
distribution of goods and services. This involvement in not limited to social goods like
education, health, and defence, but extends to areas which market forces may be expected to
ensure the most efficient allocation of the goods and services e.g. food and housing. There is
now a realisation that the market mechanism alone cannot perform all economic functions, but
needs public policy to guide it, correct it and complement it. A number of reasons have been
identified for the increasing participation of various levels of government in the economy i. e.
i) The contractual arrangements and exchanges needed for the market operations cannot
exist without the protection and enforcement of governmentally provided legal
structures.
ii) The belief that the market mechanism leads to efficient allocation is based on the
existence of competitive factor and product markets, which means that there must not
be obstacles to free entry, and that there must be full market knowledge by consumers

and producers. Government regulation and other measures are required to ensure
these conditions.
iii) Even if all barriers to competition were removed, the production or consumption
characteristics of certain goods are such that they cannot be provided privately. There
are problems of prioritisation, referred to as externalities, which give rise to market
failure and are better dealt with by the public sector.
iv) The rate of discount used in valuing future relative to present consumption may differ
when seen from public and private view-points. The market system does not
necessarily achieve national priorities e.g. high production levels, high employment,
price level stability, and balanced development in the country's urban and rural areas.
In summary, the major aims of government involvement in the economy of a country like
Zimbabwe may be to encourage growth in rural areas, to decentralize economic activity from
the main urban centres and to take essential services to the people, the great majority of whom
reside in the rural and farming areas. The government uses fiscal policy to make decisions on
the necessary allocations. Accounting for such allocations provides an interface between
financial accounting and public sector accounting.
16.1 OBJECTIVES
• Distinguish between government grants and benefits that are determined on the basis of
tax liability;
• Distinguish between and explain the two main approaches to the accounting treatment of
government grants;
• Give examples of government assistance which is not accounted for in accordance with
IAS 20;
• Outline disclosure requirements for government grants.
16.2 KEY TERMS
IAS 20 defines key terms related to government grants as follows:
Government assistance refers to action by government designed to provide an economic
benefit to an entity or entities, which meet certain criteria. Such assistance does not include
benefits that are provided indirectly through action affecting general trading conditions e.g.
the provisions of infrastructure in underdeveloped areas or the imposition of trading
constraints on competitors.
Government grants refer to assistance by government in the form of direct transfers of
resources to an entity in return for past or future compliance with certain conditions relating to
the operating activities of the entity. Such grants exclude forms of government assistance that

cannot reasonably have value placed on them. Transactions with the government that cannot
be distinguished from the normal trading transactions of the entity are also excluded.
Grants related to assets are government grants whose primary condition is that an entity
qualifying for them should purchase, construct or otherwise acquire long term assets.
Subsidiary conditions may also be attached restricting the type or location of the assets or the
periods during which they are to be acquired or held.
Grants related to income are government grants other than those related to assets.
Forgivable loans are loans, which the lender undertakes to waive repayment of under certain prescribed
conditions.
16.3 RECOGNITION IN FINANCIAL STATEMENTS
The standard states that government grants, including non-monetary grants at fair value, should
not be recognised until there is reasonable assurance that
a) the entity will comply with the conditions attaching to them
b) the grants will be received
The following important points should be noted:
• Receipt of a grant does not itself provide conclusive evidence that the related conditions
have been or will be fulfilled;
• The manner in which a grant is received does not affect the accounting method to be used
for the grant;
• A forgivable loan from the government is treated as a government grant when there is
reasonable assurance that the entity will meet the terms for forgiveness of the loan once a
government grant is recognised, any related contingent liability or contingent asset is
treated in accordance with IAS 37 – Provisions, contingent liabilities and contingent assets.
16.4 BASIC ACCOUNTING APPROACHES
The standard identifies two broad approaches that can be used in the accounting treatment of
government grants. Under the capital approach, a grant is credited directly to shareholders
interests. The main arguments for this approach are as follows:
i. Government grants are financing devices and should be dealt with as such in the
STATEMENT OF FINANCIAL POSITION rather than passed through the income
statement to offset the expense items that they finance. Since no repayment is
expected, such grants should be credited directly to shareholders' interests;
ii. It is inappropriate to recognize government grants in the income statement, since they
are not earned, but represent an incentive provided by the government without any
related costs.
Under the income approach, a grant is credited to income over one or more periods. The main arguments
for this approach are as follows:
i. Since government grants are receipts from a source other than shareholders, they
should not be credited directly to shareholders' interests, but should be recognised as
income in appropriate periods;

ii. Government grants are not really free, since the entity earns them through compliance
with their conditions and meeting the envisaged obligations. Such grants should
therefore, be recognised as income and matched with the associated costs which the
grant is intended to compensate;
iii. As income and other taxes are charges against income, it is logical to include
government grants, which are extension of fiscal policies, in the income statement.
The standard requires the use of the income approach. This means that the government grants
should be included in income over the correct periods to match them with the related costs on
a systematic basis. The following points should be noted with respect to the implementation of
this rule:
• Income recognition of government grants on a receipt basis violates the accrual

accounting assumption. However, this method would be acceptable if there is no basis
for allocating a grant to periods other than the one in which it was received.
• Grants related to depreciable assets are usually recognised as income over the periods
and in proportion to the amounts charged for depreciation.
Grants related to non-depreciable assets may require the fulfilment of certain obligations. In such
cases, the grants should be recognised as income over the periods which bear the cost of meeting
the obligation. An example of this is that a grant of land may be conditional on the erection of a
certain building on the site.
A government grant that becomes receivable as compensation for expenses or losses already
incurred, or for the purpose of giving immediate financial support to the entity with no future
related costs should be included in income in the period in which it becomes receivable.
16.4.1 Accounting for specific types of grant
Government grants related to assets, including non-monetary grants at fair value, should be
presented appropriately in the STATEMENT OF FINANCIAL POSITION. There are two
alternative methods of presenting such grants in the financial statements:
i. Set up the grant as deferred income, which is then recognised as income on a systematic
and rational basis over the asset's useful life; or
ii. Deduct the grant in determining the carrying amount of the asset. The grant is recognised
as income over the life of a depreciable asset by way of a reduced
Grants related to assets should be shown be shown at their gross amounts in the cash flow
statement of cash flows. This is a requirement even if the grant is deducted from the related
asset for the purpose of meet presentation.
EXAMPLE 1
J Ltd. has responded to an offer of assistance by the government. The company manufactures
industrial filters and has set up a new plant in Makombe Industrial Park. The agreement
between the company and the Ministry of Industry and International trade provides for the
following grants:
i. Industrial land with a market value of 10 000 000. The grant is conditional upon the erection of a
factory building with a minimum value of $ 50 000 000 in not more than

5 years; ii. $7 000 000 as a contribution towards the expenditure on plant and
equipment whose total cost is expected to be $75 000 000. The plant will be depreciated on
a straight line basis over the 5 years;
iii. 25% of the interest paid by J Ltd. on loans obtained for the erection of a factory
building and acquisition of plant and equipment. The average loan values for these
items for the first 5 years are expected to be $12 000 000 (at 10%.p.a.) and $10 000
000 (at 15% p.a) respectively;
iv. A training allowance amounting to 35% of wages paid to factory workers who are
originally from the Harare Metropolitan Province. The total wages payable to such
workers for the first five years are expected to be:
Year 1 $6 000 000
Year 2 $10 000 000
Year 3 $15 000 000 Year
4 $18 000 000
Year 5 $20 1000 000
v. An allowance of 50% on all freight charges on raw materials purchased. For the first 5
years, these charges are expected to be:
Year 1 $1 500 000
Year 2 $2 100 000
Year 3 $3 000 000 Year 4
$4 400 000
Year 5 $5 600 000
REQUIRED:
Draw up journal entries with narrations in the books of J Ltd to comply with the requirements
of IAS 20. Only entries for the first year are required. Assume that the company will satisfy
all the stipulated conditions. Ignore the effects of inflation on costs and income.
SUGGESTED SOLUTION
Journal Entries for Year 1 $ $
i. Dr Lands 10 000 000
Cr Deferred Income 10 000 000
Being fair value of land received from the government through a grant.
ii. Dr Deferred Income 2 000 000

Cr SCI 2 000 000
Being portion of deferred income that is recognized on a straight line basis over the
period that will bear the cost of meeting the obligation to erect a factory building i.e.
$10 000 000
/5 =$2 000 000
iii. Dr Ministry of Industry and International Trade 7 000 000

Cr Deferred Income 7 000 000
Being contribution received from the government towards the purchase of plant and equipment
Dr Deferred Income 1 400 000
Cr SCI 1400 000

Being portion of deferred income (plant and equipment) that is recognized on a straight
line basis in proportion to the depreciation charge.
iv. Dr Ministry of Industry and International Trade 675 000

Cr Interest Expense (factory building) 300 000
Cr Interest Expense (plant and equipment) 375 000 Being
entries to show subvention of finance costs as per agreement
Factory building $12 000 000 x10% x 25% = 300 000
Plant & Equipment $ 10 000 000 x 15% x 25% = 375 000
N.B. These entries are made when the amounts become receivable.
v. Dr SCI 15 000 000
Cr Provision for Depreciation 15 000 000
Being entries to show depreciation on plant & equipment for the first year
vi. Dr Ministry of Industry and International Trade 2 100 000

Cr Factory Wages 2 100 000
Being entry to show refund of factory wages to be received from the Ministry as per agreement
i.e. $6 000 000 x 35% = 2 100 000
vii. Dr Ministry of Industry and International Trade 750 000

Cr Freight charges (raw materials) 750 000
Being entry to show refund of freight charges on raw materials to be received from the
ministry as per agreement i.e. $1 500 000 x 50% = $750 000
N.B. This entry is made when the refund becomes receivable
EXAMPLE 2 (ASSET BASED GRANT)
K Ltd. purchased a printing machine for $150 000 and qualified for a cash grant of $30
000.The machine is being depreciated over 4 years on a straight-line basis with, no expected
residual value. The machine is being written off over 3 years for tax purposes, while the grant
is fully taxable in the first year. The company tax rate is 30%.
REQUIRED:
a) Show calculations related to deferred tax and normal tax in the books of K Ltd.
assuming that The grant is accounted for as deferred income;
b) The grant is deducted from the cost of the asset.
SUGGESTED SOLUTION
a) Year 1 Year 2 Year 3 Year 4
Equipment (printing machine) $ $ $ $
Cost 150 000 150 000 150 000 150 000
Accumulated Depreciation 37 500 75 000 112 500 150 000
112 500 75 000 37 500 Nil
Deferred Income
Deferred tax calculations

Year 1 Carrying Tax Base Temporary Deferred
amount Difference Tax
CA TB TD
DT $ $ $
$
Equipment 112 500 100 000 12 500 3 750
Grant (22 500) – (22 500) (6 750)
90 000 100 000 10 000 3 000
Year 2
Equipment 75 000 50 000 25 000 7 500
Grant (15 000) – (15 000) (4 500)
60 000 50 000 10 000 3 000
Year 3
Equipment 37 500 – 37 500 11 250
Grant (7 500) – (7 500) (2 250)
30 000 – 30 000 9 000
Year 4
Equipment – – – –
Grant – – – –
N.B. The tax base of income received in advance is the carrying amount not taxable in future
years. Since the full amount of the grant has been taxed in the first year, no amount will be
taxable in the future.
Normal Tax calculations
Year 1 Year 2 Year 3 Year 4
$ $ $ $
Net Profit before tax xxx xxx xxx xxx
Temporary differences
Depreciation (25%) 37 500 000 37 500 000 37 500 000 37 500 000
Income recognized (7 500 000) (7 500 000) (7 500 000) (7 500 000)
Wear and Tear (33,33%) (50 000 000) (50 000 000) (50 000 000) –
Grant 30 000 000 – – –
10 000 000 (20 000 000) (20 000 000) 30 000 000
Income Statement extracts

$ $ $ $
Depreciation 37 000 37 500 37 500 37 500
Deferred income (Grant) amortised (7 500) (7 500) (7 500) (7 500)

Net expense 30 000 30 000 30 000 30 000 b)

$ $ $ $
Equipment (printing machine) 120 000 120 000 120 000 120 000
Cost less grant 120 000 120 000 120 000 120 000
Accumulated depreciation (30 000) (60 000) 90 000 Nil
90 000 60 000 30 000 30 000
Depreciation expense in P/L 30 000 30 000 30 000 30 000
Deferred Tax Cal Carrying Amount Tax Base Temp Diff Deffered Tax
Year 1 $ $ $ $
Equipment 90 000 100 000 (10 000) (3 000)
Historic (112 500) (100 000) (12 500) (3 750)
Grant (22 500) (22 500) (6 750)
Year 2 $ $ $ $
Equipment 60 000 50 000 10 000 3 000
Historic (75 000) (50 000) (25 000) (7 500)
Grant (15 000) – (15 000) (4 500)
Year 3 $ $ $ $
Equipment 30 000 – 30 000 3 000
Historic (37 500) – (37 500) (7 500)
Grant (7 500) – (7 500) (2 250)
Year 4 $ $ $ $
Equipment – – – –
Historic – – – –
Grant Nil Nil Nil Nil
Normal Tax Calculations
$ $ $ $
Net profit before tax xxx xxx xxx xxx
Temporary difference
Depreciation (25%) 30 000 30 000 30 000 30 000
Wear and Tear (33,33%) (50 000) (50 000) (50 000) ( – )
Grant 30 000 – – –
Taxable income xxx xxx xxx xxx
Income Statement extracts


$ $ $ $
120 000
Depreciation ( /4) 30 000 30 000 30 000 30 000
EXAMPLE 3 (INCOME BASED GRANT)

M Ltd. was awarded a general grant of $8 500 000 by the government. The grant was
receivable in 3 instalments and the first one amounting to $3 000 000 was received on. 31
December 212.The remaining amount was received as follows 31 December 2-1 $3 000 000
and 31 December 2-12 $2 500 000. As a condition for receiving the grant, M Ltd. was
required to create 20 new jobs with effect from 1 January 2-12 and maintain them for at least
3 years. 20 new employees were recruited as per agreement at a total cost of $3 360 000 and
their total salaries for the year ended 31 December 2-12 amounted to $11 120 000. These
salaries were increasing by 15% p.a.
It is M Ltd's policy to show income-related government grants as other income in the financial
statements. The grant is fully taxable and the company tax rate is 35%. The company's net
profit before tax for the year-ended 31 December 2-12 (before taking into account the above
information) was $38 000 000
REQUIRED:
a) Disclose the above information in the financial statements of M Ltd. for the year
ended
31 December 2-12;
b) Disclose the above information in the financial statements of M Ltd. for the year
ended 31 December 2-12, using the alternative approach for recognising income
related government grants.
[Show all workings.]

SUGGESTED SOLUTION
INCOME STATEMENT FOR Y/E 31/12/2-12
$
Revenue xxx
Cost of goods sold (xxx)
Gross profit xxx
Other operating income (xxx)
Distribution costs (14 560 000)
Administration costs (xxx)
Other operating costs (xxx)
Net profit before tax xxx
Company Tax (9 229 122)
Net profit after tax xxx
STATEMENT OF FINANCIAL POSITION AS AT 31/12/20-6 (extracts)
ASSETS $
Non-current assets Deferred
tax 24 818

Prepaid government grants 2-14 2 979 788
Current liabilities
Prepaid government grants 2-13 2 591 120
WORKINGS
Cumulative salaries and related costs $
2-12 Hiring costs 3 360 000
2012 Salaries 11 200 000
14 560 000
2-13 Salaries (11 200 000*115%) 12 880 000
2-14 Salaries (12 880 000*115%) 14 812 000
Total employment costs over 3 years 42 252 000
Apportionment of grant (proportionately to total employment costs over the life of the grant)
$ 2-12 $8
145 600
500 000 * = 2 929 092
422 520
128 800
2-13 $8 500 000 * = 2 591120
422 520
148 120
2-14 $8 500 000 * = 2 979 788
422 520
Calculation of taxable income $

Net profit before tax 38 000 000
+ Government grant 3 000 000
41 000 000
Less Salaries related costs (14 560 000)
Taxable income 26 440 000 Company
tax (35%) 9 254 000
Calculation of deferred tax $
Government grant income 2 929 092
Government grant received (3 000 000)
Deferred amount 70 908
Deferred tax (35%) 24 818
NOTES TO THE FINANCIAL STATEMENTS FOR YEAR ENDING 31 DECEMBER
2-12

1 Accounting Policy
1.1 Government grants
Income related grants are treated as deferred income in the STATEMENT OF FINANCIAL
POSITION and are matched on a systematic basis with the employment costs to which they
relate. The amortised portion of the grants are shown as other income in the SCI.
2 Other Income
Other income consists of government grants as follows:
Current portion of government grant 2 929 092
3 Taxation 9 254 000
Current 24 818
Deferred 9 229 182
EXAMPLE 4 (CONDITIONAL REPAYMENT OF GOVERNMENT GRANT)

On 1 January, 2-13 D Ltd purchased construction equipment at a cost $650 000 with an
estimated useful life of 10 years and a residual value of $50 000 at the end of that period.
Depreciation on the equipment is written off on a straight-line basis. The Ministry of Local
Government made a cash grant of $200 000 relating to the equipment, on condition that the
company would erect 100 core houses of a specific size and standard in the following 3 years.
The Ministry would then purchase the houses at an agreed price representing the reasonable
market value on completion.
The following conditions attached to the agreement:
a) If the 100 houses had not been completed at the end of 3 years, D Ltd would repay an amount
equal to the percentage of units still to be erected.
On 31 December 2-15 D Ltd. had completed 75 houses and it repaid the required amount to the
Ministry. However, the company completed the remaining houses in 20-8.
REQUIRED
Show how the above information will be accounted for in the books of D Ltd. if the grant is considered
as i) deferred income and ii) is deducted from the cost of the equipment.
SUGGESTED SOLUTION
a)
GRANT ACCOUNTED FOR AS DEFFERED INCOME
2-13 2-14 2-15
$ $ $
Equipment at cost 650 000 650 000 650 000
Accumulated Depreciation 60 000 120 000 180 000
(based on 650 000- 50 000)/10
590 000 530 000 470 000

Deferred income
Grant received from Ministry 200 000 200 000 200 000
Amortised to income (20 000) (40 000) (60 000)
Grant repaid to Ministry (200 000*25/100) (50 000) Adjustment
of excess amortisation
(60 000*25/100) (15 000)
180 000 160 000 75 000
Depreciation 60 000 60 000 60 000

Grant amortised (20 000) (20 000) (15 000)
40 000 40 000 45 000
N.B. The adjustment for the excessive amount previously amortised should be treated as a
change in estimate, not as a prior-year adjustment. b)
GRANT DEDUCTED FROM THE COST OF EQUIPMENT

2-13 2-14 2-15
$ $ $
Equipment at cost 650 000 650 000 650 000
Grant received from Ministry (200 000) (200 000) (200 000)
450 000 450 000 450 000
Grant partly repaid – – (50 000)
450 000 450 000 400 000
Accumulated depreciation 40 000* 80 000 135 000
410 000 370 000 265 000
Depreciation 40 000 40 000 45 000
*(450 000-50 000)/10 = 40 000 (first year)
Explanatory Notes.
i) In 2-15, the amount of depreciation represents the old depreciation charge of $40 000 plus
$5 000 under provided for the 3 years. This excess may be shown in the income
SCI; ii) If an income-based grant must be repaid, the unamortised balance is reduced
by the amount repaid. Should the repayment exceed the unamortised balance-the
difference should immediately be debited in the SCI.
ACTIVITY
C Ltd. purchased a lathe machine for $120 000 and qualified for a cash grant of $20 000 from
the government. The machine is being depreciated over 5 years on a straight-line basis, with
no expected residual value. The machine is being written off over 4 years for tax purposes,
while the grant is fully taxable in the first year. The company tax rate is 35%.
REQUIRED
Show calculations related to deferred tax and normal tax in the books of C Ltd., assuming that;
a) The grant is accounted for as deferred income;
b) The grant is deducted from the cost of the asset.

16.5 REPAYMENT OF GOVERNMENT GRANTS
A government grant-that becomes repayable should be accounted for as a revision to an
accounting estimate in accordance with IAS 8. The repayment of a grant related to income
should be applied first against any unamortised deferred credit set up in respect of the grant.
To the extent that the repayment exceeds any such deferred credit, or where no deferred credit
exist, the repayment should be recognised immediately as an expense. The repayment of a
grant related to an asset should be recorded by increasing the carrying amount of the asset, or
reducing the deferred income balance by the amount repayable. The cumulative additional
depreciation that would have been recognised to date in the absence of the grant should be
recognized immediately as an expense.
See Example 4 above.
16.6 OTHER FORMS OF GOVERNMENT ASSISTANCE
The standard notes that there are certain types of government assistance that cannot
reasonably have a value placed on them, and transactions with government that cannot be
distinguished from an entity's normal trading transactions. Examples of such assistance are
free technical or marketing advice and the provision of guarantees, as well as a government
procurement policy that is responsible for part of the entity's sales. These types of assistance
are excluded from the definition of government grants. However it may be necessary to
disclose the nature, extent and duration of the assistance to ensure that the entity's financial
statements are not misleading. The standard does not require the calculation or imputation of
interest in respect of low interest loans from the government.
The standard requires disclosure of the following information:
i) The accounting policy adopted for government grants, including the method of
presentation used in the financial statements;
ii) The nature and extent of government grants recognised in the financial statements, and an
indication of other forms of government assistance from which the entity has directly
benefited;
iii) Unfulfilled conditions and other contingencies attaching to government assistance that
has been recognised.
16.8 SUMMARY
This Unit explains the accounting requirements for and disclosure of government grants and
other forms of government assistance. The Unit is based on IAS 20, which distinguishes
between direct forms of assistance that have to be recognised in the financial statements and
indirect forms in respect of which disclosure is considered sufficient. Government grants are
normally conditional on the beneficiary carrying out or desisting from carrying out certain
actions. The standard sets out the accounting procedures which are required if a grant has to
be repaid, most probably due to the beneficiary's failure to satisfy stipulated conditions.

16.9 REFERENCES
VON WELLR, GAAP Handbook 2005
WINGARD, C Juta & Co Ltd
VORSTER, Q Descriptive Accounting
KOORNHOF, C, et al 15th Ed. Lexis/Butterworths 2011
SHOKO, D Advanced Financial Accounting & Reporting

Vol 1, CIS Study Pack 2008 Denmark
Training Services
IASB International Financial Reporting Standards
2015.

UNIT SEVENTEEN
17.0 INTRODUCTION
Regardless of their shareholding or other specific ownership structure, business entities are
assumed to have a separate legal identity which confers on them the power to undertake
transactions and deploy available resources in their best interests. In pursuit of the overriding
business objective of maximising owners' wealth, managers with requisite qualifications,
experience and other attributes are appointed to run these entities. These managers usually
wield considerable power because they run the entities on a day-day basis, and have access to
privileged information on issues like share prices and proposed mergers and acquisitions. An
agency problem is therefore, likely to arise from the fact that at times management actions
will not necessarily be in the interest of the shareholders. The potential conflict of interest is
an example of what may happen if a party is related to the entity.
A key premise of financial accounting and reporting is that transactions are assumed to have
been undertaken by parties who were independently pursuing their best interests. Since
transactions are the basis of financial statements, lack of independence by parties to a wide
range of transactions will adversely affect the proper interpretation of these statements by
shareholders and other stakeholders, particularly if the relationships between the parties are
not disclosed. The issue of related parties is very important in the work of auditors. It is
possible for a related party relationship to have a financial effect on the profit or loss and
financial position of an entity. It also possible for related parties to enter into transactions that
unrelated parties would not, at comparably lesser amounts or costs.
17.1 OBJECTIVES
• Define the term-related party and give examples of transactions involving related parties;
• Distinguish between intra-group related party transactions and other types of related party
transactions;
• Explain the purpose of related party disclosures;
• Outline the disclosure requirements of related party situations.
17.2 TERMINOLOGY
IAS 24 defines key terms as follows:
17.2.1 Related party
A party/entity is related to the reporting entity if directly or indirectly through one or more
intermediaries, the reporting entity controls or is controlled by or is under common control (in
a similar group) with the entity, or

A party/entity is related to the reporting entity if directly or indirectly through one or more
intermediaries the reporting entity has an interest in the entity that gives influence over the
entity, or
• If it has joint control over the party/entity or the party/entity is controlled or jointly controlled by
a close member to a related party (a person or entity).
• If it is an associate.
• If it is a joint venture in which the reporting entity is a venturer.
• If both entities are joint ventures of the same third party
• If one of them is a joint venture of a third entity and the other entity is an associate of the third
entity
• If one of them is an associate or joint venture of the other entity
• If the party/entity is a post-employment benefit plan for the benefit of employees of either the
reporting entity or an entity related to the reporting entity.
• If the entity, or any member of a group of which it is a part, provides key management personnel
services to the reporting entity or to the parent of the reporting entity.
17.2.2 Related party transaction
It is a transfer of resources, services or obligations between a reporting entity and related
parties regardless of whether a price is charged. Close members of the family of an individual
are those family members who may be expected to influence, or be influenced by, that
individual in their dealings with the entity. Such members may include:
i) that person`s spouse or domestic partner (a living in partner).
ii) children of that person`s spouse or domestic partner.
iii) dependants of that person or that person's spouse or domestic partner.
17.2.3 Compensation
This includes all employee benefits as defined in IAS 19, including those benefits to which
IFRS 2 applies. Employee benefits are all forms of consideration paid, payable or provided by
the entity, or on behalf of the entity in exchange for services rendered to the entity, on behalf
of the entity, in exchange for services rendered to the entity. Such considerations include
amounts paid on or behalf of a parent of the entity in respect of the entity. The following are
specifically included in the term 'compensation':
i) short-term employee benefits, for example, wages, salaries and social security
contributions, paid annual leave and paid sick leave, profit sharing and bonuses (if
payable within 12 months from the end of the period) and non-monetary benefits, for
example, medical care, housing, cars and free or subsidized goods or services for current
employees;
ii) post-employment benefits such as pension, other retirement benefits, post- employment
life assurance and post-employment medical care;

iii) other long-term employee benefits, including long service leave or sabbatical leave,
jubilee and other long service benefits, long-term disability benefits and if they are not
payable within 12 months after the end of the period, profit sharing, bonuses and deferred
compensation
iv) termination benefits
v) share-based payment
17.2.4 Control
It is the power to govern the financial and operating policies of an entity so as to obtain
benefits from its activities. According to IFRS 10, an investor can exercise control over an
entity even if the shareholding is 50% or less of the entity's voting power represented by
equity shares. This is possible if any or all the following conditions are met:
a) power over the investee

b) exposure or rights to variable returns from the involvement with the investee
c) ability to use that power over the investee to effect the amount of the investee`s returns.
IFRS 10 defines how power arises in para 10-14. IAS 27 (2008) had explained power as set out
below:
i) The parent entity having power over more than half of the voting rights by virtue of an
agreement with other investors;
ii) The parent entity having power to govern the financial and operating policies of the entity in
terms of a statutory provision or agreement;
iii) The parent entity having power to appoint or remove the majority of the members of the
entity`s board of directors.
iv) Power to cast the majority of votes at meetings of the entity`s board of directors.
17.2.5 Key management personnel
These are those persons having authority and responsibility for planning, directing and
controlling the activities of an entity, directly or indirectly, including any executive and
nonexecutive directors of the entity.
17.3 DETERMINATION OF RELATED PARTY RELATIONSHIPS

The standard states that when considering each related party relationship, it is important to
take into account the economic substance of the relationship, and not merely its legal form.
From an auditing point of view, Meigs, Whittington et al (1998) have commented that:
"Since transactions with related parties are not conducted at arm's length, the auditors should
be aware that the economic substance of these transactions may differ from their form. For

example, a long-term interest free loan to an officer includes in substance an element of
executive compensation equal to a realistic interest charge."
The following diagram shows the related parties of a reporting entity A Ltd. Related parties are
identified by the asterisk *:

Z Ltd. Parent*
Y Ltd* Fellow Subsidiary A Ltd subsidiary
Control Joint control Significant influence

W Ltd* D Ltd* X Ltd* B Ltd* C Ltd*
Subsidiary Subsidiary Subsidiary Jointly controlled Associate
Entity
E Ltd* F Ltd*
Subsidiary Associate
K Ltd* L Ltd*
Susidiary Associate
Significant interest Mr Z*
Shareholder
Mr X* A Ltd*
Executive Director Key Management
Member
Mrs X*
Family member
T Ltd*
Significant Interest

The main purpose of disclosing related party relationships and transactions is to enable users
of financial statements to obtain the information provided in its proper context. Failure to
disclose material information usually leads to wrong decisions on the part of information
users. The standard sets out the following disclosure requirements:
i) Relationships between parents and subsidiaries should be disclosed regardless of
whether there have been transactions between them. An entity should disclose the name of
its parent and if different, the ultimate controlling party. If neither the entity's parent nor
ultimate controlling party produces financial statements for public use, the name of the
next most senior parent that does so should be disclosed. The identification of related
party relationship between parents and subsidiaries is in addition to the disclosure
requirements in IAS 27, IAS 28, and IFRS 11 which require a listing and description of
significant investments in subsidiaries, associates and jointly controlled activities. ii) An
entity should disclose the compensation of key management personnel in total and for
each of the following categories: a. Short-term employee benefits;
b. Post-employment benefits ;
c. Other long-term benefits ;
d. Termination benefits ; and
e. Share-based payment.
iii) If there have been transactions between related parties, an entity should disclose the
nature of the relationship, as well as information about the transactions and
outstanding balances necessary for an understanding of the potential effect of the
relationship on the financial statements. The minimum disclosures are as follows:
a) the amount of the transactions;

b) the amount of the outstanding balances including commitments and:
• their terms and conditions, including whether they are secured, and the nature of
the consideration to be provided in settlement; and
• details of any guarantees given and received;
c) provisions for doubtful debts related to the amount of outstanding balances; and
d) the expense recognised during the period in respect of bad or doubtful debts due
from related parties.
These disclosures should be made separately for each of the following categories:
1) the parent;
2) entities with joint control or significant influence over the entity;
3) subsidiaries;
4) associates;
5) joint ventures in which the entity is a venturer;
6) key management personnel of the entity or its parent; and
7) other related parties.

iv) Transactions that should be disclosed if they are with a related party include
a. purchases or sales of finished or unfinished goods
b. purchases or sales of property and other assets
c. rendering or receiving services
d. leases
e. transfers of research and development
f. transfers under license agreements
g. transfers under finance agreements
h. provision of guarantees or collateral
i. settlement of liabilities on behalf of the entity or by the entity on behalf of another party
A disclosure that related party transactions were made on terms equivalent to arm's length
transactions should only be made if this can be demonstrated
EXAMPLE
The executives of Symphony Limited for the whole of the financial year-ended 30 June 20-6
Directors: Albeniz - Chairman

Bartock - Managing Director
Copeland - Alternate with Erb
Delius - Alternate with Mohler
Secretary: Mohler
Sales Manager: Erb
Production Manager: Delius
Erb was appointed alternate director on 2 January 20-6. Alternate directors do not receive directors'
fees.
In 2003 the company purchased 80% of the shares in Concerts Limited. The executives in that
subsidiary during the year ended 30 June 20-6 were as follows:
Directors Bartok - Chairperson

Copeland - Managing Director
Delius appointed 1/10/20-5
Company Secretary Vaughan
The fees, allowances, salaries and other payments to which they were entitled for the year ended
30 June 2006 were as follows:
Symphony Concerts
Limited Limited
$ $
Chairman - fees per annum 15 000 13 000
Directors (other than the alternates)

$ $
Fees per annum 12 000 6 000
Managing director
Salary per annum 120 000 100 000
Entertainment allowance p.a, 12 000 6 000
Company secretary salary per annum 100 000 80 000
Sales manager - salary per annum 70 000
Production manager - salary per annum 90 000
The sales manager is paid a non-pensionable commission of 1% of the annual profits after
allowing for this commission. The amount is paid in a lump sum at the end of the financial
year. The members of the board of directors, the company secretary and the sales manager
each have the free use of a motor vehicle, including fuel. This benefit is considered to be
worth $3 000 000 per year. 20% of it is to the sales manager alone.
The members of the board of directors and all employees of both companies are members of
the Overture Pension Fund. They contribute on a 5% basis of their salaries and companies
contribute on a $ for $ basis.
Shostakovich, a former managing director of Symphony limited, drew a pension of $3 000

000 per month from the pension fund during the year ended 30 June 20-6. Due to inflation,
this had become inadequate and was supplemented with payments made by Symphony
Limited amounting to $30 000 000 during the year.
The profit of Symphony Limited for the year ended 30 June 2006, before allowing for the
sales manager's commission, was $35 000 000. The company's profit is earned evenly
throughout the year.
REQUIRED
Give the information regarding directors' emoluments required to be disclosed in terms of IAS 24
in the financial statements of Symphony Limited.
ICSAZ Nov. 1986 examination question paper - adapted

SUGGESTED SOLUTION
SYMPHONY LIMITED
Extract notes to financial statements for the year ended 20-6 (Typical presentation)
5. Related parties
These are parties considered to be related if one party has the ability to control the other or
exercise significant influence over the other party in making financial or operating decisions.
The following are the related party relationships and transactions during the current financial
period.
5.1.1 Relations between parents and subsidiaries
The following represents a list of all significant subsidiaries of the group:
Concert Ltd 80% ownership interest
5.1.2 Transactions with related parties other than key management personnel
Sales of goods to Concert Ltd xx

Purchase of goods from Concert Ltd xx
Amounts owed by Concert Ltd xx
Amounts owed to Concert Ltd xx
5.1.3 Transactions with key management personnel
The group`s key management personnel and persons connected with them are also considered
to be related parties for disclosure purposes. Key management personnel are those persons
having authority and responsibility for planning and controlling activities of Symphony Ltd
and its subsidiaries, directly or indirectly. They comprise the directors of Symphony Ltd and
its subsidiaries, former directors, management and heads of major business units.
5.1.4 Remuneration of directors and other key management personnel
Amounts included in remuneration, in aggregate, are as follows:
Concert Total
Symphony
$ $ $
5.1.4.1 Short-term benefits
5.1.4.1.1 Directors and company secretary
Chairperson`s fees per annum 15 13 000 28

000 000

Director`s fees per annum 12 6 000 18
000 000
Managing director`s salary per annum 120 100 000 220
000 000
Entertainment allowance-managing director 12 6 000 18
000 000
Company secretary 100 80 000 180
000 000
Motoring benefits (3 000 000 x 80%) 2 400 000
Salaries and other short term benefits 259 205 000 2 864 000
000
5.1.4.1.2 Managers
Sales manager`s salary excl. commission 70 000
Sales manager`s vehicle use (motoring benefit) 600 000
Commission (1% x 30 000 000) 300 000
Production manager`s salary per annum 90 000
Salaries and other short term benefits 1 060 000
5.1.4.2 Post-employment benefits
5.1.4.2.1 Directors and company secretary

Pension costs 40 000
Employees` contribution (5% x 220 000 + 5% x 20 000
180 000)
Employers` contribution 20 000
80 000
5.1.4.2.2 Managers
Pension costs 16 000

Employees` contribution (5% x 70 000 + 5% x 90 8 000
000)
Employers` contribution 8 000
32 000

5.1.4.3 Other long-term benefits xx
5.1.4.4 Terminal benefits

Former directors` pension paid (3 000 x 12 + 30 66 000
000)
5.1.4.5 Share based payments xx
5.1.4.6 Contracts with directors (and their connected persons) and managers
The aggregate outstanding under transactions, arrangements and agreements were:
Number of Number of Amount

directors or connected
managers persons
$ $ $
5.1.4.6.1 Directors
- Loans xx xx xx
- Quasi loans xx xx xx
xx xx xx
5.1.4.6.2 Managers
- Loans xx xx xx
- Quasi loans xx xx xx
xx xx xx
ACTIVITY
Mrs. Ruvimbo, whilst CEO of H Ltd. purchased a factory property in Harare from H Ltd. at a
consideration of $10 million, paid in cash, which was allegedly way below the market price of
$100m. Mrs. Ruvimbo was subsequently fired.
REQUIRED
Assuming that H Ltd. complies with IFRSs:
a) Show what disclosure we may have expected to see in the financial statements of H Ltd.
with respect to the transactions.
b) Explain why we would expect to see this disclosure.
c) Briefly discuss whether or not you believe Mrs. Ruvimbo should have been fired for this transaction.
ICSAZ November 2005 question paper

17.5 SUMMARY
Disclosure of information on related parties is part of the worldwide trend towards fuller
access to accounting and related information by shareholders and other investors. In line with
other securities regulators, the Zimbabwe Stock Exchange has stated that it is convinced that
the public disclosure of the fullest possible information about corporate activities is in the best
interest of all companies and their stakeholders. The importance of disclosure is also
emphasized by the Companies' Act (Chapter 23:04) rules on declaration of interests by
directors.
17.6 REFERENCES
MEIGS, W.B. Principles of Auditing Revised 8th Ed Irwin 1998
KOPPESCHAAR Z. R. et al Descriptive Accounting, IFRS Focus, 18th Edition,

LewisNexis
IASB International Financial Reporting Standards, 2015,

Consolidated without early application
UNIT EIGHTEEN

FUNDS (IAS 26)
18.0 INTRODUCTION
Many business organisations have a commitment to pay certain amounts of money to their
employees when they retire from service. These arrangements, commonly known as 'pensions'
in this country can take various forms, but one of the most important aspects is the way the
pension scheme is financed to ensure that the money due to the employees is available when
required. Such pensions are very helpful to the working population, especially in countries
which do not have a comprehensive social security scheme. A company may manage its own
pension scheme or entrust the funds to another organisation e.g. an insurance company. These
funds are usually invested in various financial instruments so that they can generate income
for the scheme before they are finally paid out to the employees.
Accounting for pensions is a difficult area, and practice differs from country to country. In the
U.K, employers are required to take into account all relevant costs of providing retirement

benefits on a systematic and rational basis. In the U.S.A, accounting for pensions is outlined
in Financial Accounting Standards Board (FASB) Statement No. 87 (Employers' Accounting
for Pensions) and Statement No. 88 (Employers' Accounting for Settlements and Curtailment
of Defined Benefit Pension Plans and for Termination Benefits). An important aspect of these
statements is the net periodic pension cost, defined as the amount recognised in an employer's
financial statements as the cost of a pension plan for a period.
The IASB has produced two complementary statements on pensions i.e. IASB 19 (Employee
Benefits) and IAS 26 (Accounting and Reporting by Retirement Benefit Plans). IAS 19 is
discussed in Volume 1 of this book. This Unit focuses on accounting and reporting
requirements of organisations that provide pensions and other retirement services.
18.1 OBJECTIVES
• Identify the major types of retirement benefit plans;
• Explain the recognition and measurement rules for retirement benefits plans;
• Explain the alternative methods of calculating the present value of expected payments
• Explain the valuation of plan assets by retirement benefit plans
• Outline the disclosure requirements for retirement benefit plans
18.2. KEY DEFINITIONS
Retirement benefit plans are arrangements whereby an entity provides benefits for other
entities' employees on or after termination of service (either in the form of an annual income
or as a lump sum) when such benefits, or the contribution towards them, can be determined or
estimated at or before retirement from the provisions of a document or from the entity's
practices.
Defined contribution plans are retirement benefit plans under which amounts to be paid as
retirement benefits are determined by contributions to a fund together with investment
earnings on these contributions.
Defined benefit plans are retirement benefit plans under which amounts to be paid as
retirement benefits are determined by reference to a formula usually based on employees'
earnings and/or years of service.
Funding is the transfer of assets to an entity (i.e. the fund) separate from the employer to meet future
obligations for the payment of retirement benefits.

Participants are the members of a retirement benefit plan and others who are entitled to benefits
under the plan.
Net assets available for benefits are the assets of a plan less liabilities other than the actuarial present
value of promised retirement benefits.
Actuarial present value of promised retirement benefits is the present value of the expected
payments by a retirement benefit plan to existing and past employees, attributable to the
service already rendered.
Vested benefits are benefits, the rights to which, under the conditions of a retirement benefit plan,
are not conditional on continued employment.
The following terms are not defined in IAS 19 or IAS 26, but are defined here to provide a greater
understanding of the issues to be discussed later in the Unit.
A final pay plan is a defined benefit plan that promises benefits based on an employee's
remuneration at or near retirement. The remuneration may be that of the final year or based on
an average number of years specified in the plan.
Actuarial valuation is the process used by an actuary to estimate the present value of benefits to
be paid under a retirement benefit.
Accrued benefit valuation methods are actuarial valuation methods that reflect retirement
benefits based on service rendered by employees to the date of valuation. Such methods may
incorporate assumptions regarding projected salary levels to the retirement date.
Projected benefit valuation methods are actuarial valuation methods that reflect retirement benefits
based on service both rendered and to be rendered by employees as at the date of actuarial valuation,
and may incorporate assumptions regarding projected salary levels to the retirement date.
Past service cost is the actuarially-determined cost arising on the introduction of a retirement
benefit plan, or on the completion of minimum service requirements for eligibility in such a
plan, all of which give employees credit for service prior to the occurrence of one or more
such events. (Compare this with the definition given in Volume 1, Unit 21).
18.3 DIFFERENCE BETWEEN FUNDING AND ACCOUNTING REQUIREMENTS
The aim of funding a retirement benefit plan is to make available amounts to meet future
obligations for the payment of employee benefits. Funding is a financing procedure, and in
determining the periodic amounts to be paid, the employer may be influenced by such factors
as the availability of money and tax considerations. On the other hand, the aim of accounting
for the cost of a retirement benefit plan is to ensure that the cost of required benefits is
allocated to accounting periods on a systematic basis related to the services being rendered by
the employees.
Other Considerations:

i) When a retirement benefit plan is amended resulting in additional benefits for retired
employees, the cost of these benefits should be estimated and accounted for. ii) When
supplementary benefits are added to an existing plan with an effect on retired employees,
the present value of the cost of these benefits should be charged against income at the time
that the change is made.
iii) When a plan is to be terminated or when it is probable that it will be terminated, the
cost of any unfulfilled obligations should be accrued and charged against income
immediately, unless the remaining obligation is transferred to another plan.
ACTIVITY 1
Define and explain the following terms: a)

Retirement benefit plan
b) Net assets available for benefits
c) Actuarial valuation
18.4 ACCOUNTING BY DEFINED CONTRIBUTION PLANS
The financial statements of a defined contribution plan should contain a statement of net
assets available for benefits and a description of the funding policy. Under such a plan, the
amount of a participant's future benefits is determined by the contributions paid by the
employer, the participant or both, as well as the operating efficiency and investment earnings
of the fund. An employer's obligation is usually discharged by contributions to the fund. This
means that the employer entity will have no legal or constructive obligation to pay further
contributions if the fund does not have sufficient assets to pay all accrued employee benefits.
The participants of a defined contribution plan are interested in its activities because they
directly affect the level of their future benefits. The participants will thus want to know
whether contributions have been received, and proper control has been exercised to protect
their interests. Employers are interested in the efficient and fair operation of the plan because
these aspects will affect their rights and obligations as well as the investment in the welfare of
their employees.
The accounting requirements of a defined contribution plan are normally met by providing financial
statements which include the following:
i) A description of significant activities for the period and the effect of any changes relating
to the plan, its membership, terms and conditions
ii) Statements reporting on the transactions and investment performance for the period, and
the financial position of the plan at the end of the period
iii) A description of the investment policies
18.5 ACCOUNTING BY DEFINED BENEFIT PLANS
The financial statements of a defined benefit 'plan should contain either:
a) A statement that shows

i) the net assets available for benefits

ii) the actuarial present value of promised retirement benefits, distinguishing between vested
benefits and non-vested benefits
iii) the resulting excess or deficit OR
b) A statement of net assets available for benefits including either

i) a note disclosing the actuarial present value of promised retirement benefits.
distinguishing between vested benefits and non-vested benefits.
ii) a reference to this information in an accompanying actuarial-report
If an actuarial valuation has not been prepared at the date of the financial statements, the most recent
valuation should be used as a base, and the date of the valuation disclosed.
The actuarial present value of promised retirement benefits should be based on the benefits
promised under the terms of the plan on service rendered to date using either current salary
levels or projected salary levels, with disclosure of the basis used. The effect of any changes
in actuarial assumptions that have had a significant effect on this present value should also be
disclosed.
The financial statements should explain the relationship between the actuarial present value of
promised retirement benefits and the net assets available for benefits, as well as the policy for
funding promised benefits. A defined benefit plan requires the periodic advice of an actuary to
assess its financial future contribution levels. The objective of reporting by a defined benefit
plan is to periodically provide information about its financial resources that is useful in
assessing the relationship between the accumulation of resources and plan benefits over time.
This objective is normally achieved by providing financial statements that include:
a) A description of significant activities for the period, and the effect of any changes relating to the
plan, its membership, terms and conditions.
b) Statements reporting on the transactions and investment performance for the period, and the
financial position of the plan at the end of the period
c) Actuarial information either as part of the statements, or by way of a separate report
d) A description of the investment policies
18.6 Determination of the Actuarial Present Value of Promised Retirement Benefits
According to IAS 19, actuarial assumptions are an entity's best estimate of the variables that
will affect the final cost of providing post-employment benefits. Major examples of such
assumptions are:
a) Demographic assumptions about the future characteristics of current and former

employees and their dependants who are entitled to benefits from the entity. The
assumptions require estimates for:
i) mortality both during and after employment ii) rates of

employee turnover, disability and early retirement
iii) the proportion of plan participants with dependants who will be eligible for benefits
b) Financial assumptions, which require estimates for:

i) the discount rates ii) future salary
and benefit levels
iii) in the case of medical benefits, future medical costs including, where material, the cost
of administering claims and benefit payments
iv) the expected rate of return on plan assets
Financial assumptions should be based on market expectations at the statement of financial position
date, for the period over which the obligations are expected to be settled.
The present value of the expected payments by a retirement benefit plan can be calculated and
reported based on 2 methods:
Current Salary Approach
The arguments for this approach are as follows:
i) The actuarial present value of promised retirement benefits, being the sum of the
amounts presently attributable to each participant in the plan, can be calculated
more objectively than with projected salary levels because it involves fewer
assumptions
ii) Increases in benefits attributable to a salary increase become a plan obligation at
the time of the increase.
iii) The amount of the actuarial present value of promised retirement benefits using
current salary levels is generally more closely related to the amount payable in the
event of termination or discontinuance of the plan.
Projected Salary Approach
The arguments for this approach are as follows:

i) Financial information should be prepared on a going concern basis, irrespective of
the assumptions and estimates that must be made.
ii) Under final pay plans, benefits are determined by reference to salaries at or near
retirement date; hence salaries, contribution levels and rates of return must be
projected.
iii) Failure to incorporate salary projections, when most funding is based on such
projections, may result in the reporting of an apparent over-funding when this is
not the case, or in reporting adequate funding when the plan is under-funded.
N.B.1
The actuarial present value of promised retirement benefits based on current salaries should be disclosed in
the financial statements of a plan to indicate the obligation for benefits earned to the date of the financial
statements.
N.B.2

The actuarial present value of promised retirement benefits based on projected salaries should be disclosed
in the financial statements to indicate the magnitude of the potential obligation on a going concern basis,
which is normally the basis for funding.
18.7 VALUATION OF PLAN ASSETS (BOTH TYPES OF PLANS)
The investments made by retirement benefit plans should be carried at fair value, which in the
case of marketable securities is equivalent to market value. If an estimate of fair value is not
possible, the entity should disclose why fair value was not used. Securities with a fixed
redemption value which have been acquired to match plan obligations or specific parts thereof
may be carried at amounts based on their ultimate redemption value, assuming a constant rate
of return to maturity. If investments are carried at amounts other than market value or fair
value, this value should also be disclosed. Assets that are used in the fund's operations should
be accounted for in accordance with applicable standards.
18.8. DISCLOSURE REQUIREMENTS (BOTH TYPES OF PLANS)
In addition to the disclosures indicated earlier, the financial statements of a retirement benefit plan
should also contain the following information:
a) A statement of changes in net assets available for benefits
a) A summary of significant accounting policies
c) A description of the plan and the effect of any changes in it during the period
The following detailed information should be provided under the above headings:
Statement of net assets available for benefits:
i) assets at the end of the period suitably classified ii) the

basis of valuation of assets
iii) details of any single investment exceeding either 5 of net assets available for benefits or 5 of any
class or type of security
iv) details of any investment by the plan in the employer
v) liabilities other than the actuarial present value of promised retirement benefits Statement of
changes in net assets available for benefits:
i) employer and employee contributions ii) investment income such as interest and
dividends, and any other income iii) benefits paid or payable (classified, for example,
as retirement, death and disability benefits, and lump sum payments)
iv) administrative and other expenses v)
taxes on income
vi) profits and losses on disposal of investments and changes in the value of investments
vii) transfers to and from other plans
A description of the funding policy
For defined benefit plans, the actuarial present value of promised retirement benefits, a
description of the significant actuarial assumptions made, as well as the method used to
calculate the actuarial present value of promised retirement benefits

Description of the plan:
i) the names of the employers and the employee groups covered

ii) the number of participants receiving the benefits and the number of other
participants, classified as appropriate
iii) the type of plan i.e. defined contribution or defined benefit iv) a note as to whether participants
contribute to the plan
v) a description of the retirement benefits promised to participants vi)
a description of any plan termination terms and
vii) changes in items (i) to (vi) during the period covered by the report
ACTIVITY 2 (Project)
Obtain the annual report of a pension fund or retirement benefit fund and make sure that you understand all
its provisions. You should practice familiarise with it, be able to formulate and write its contents, in case the
examiner asks an examination question that relate to it.
18.9 SUMMARY
This Unit explains the accounting procedures and disclosure requirements for retirement
benefit plans, which are also known as pension schemes, superannuation schemes or
retirement benefit schemes. It should be noted that IAS 26 deals with accounting and
reporting by a plan to all participants as a group. The standard does not cover reports to
individual participants about their retirement benefits rights. This standard must be read in
conjunction with IAS 19, which is concerned with the determination of the cost of retirement
benefits in the financial statements of employers having such plans.
18.10 REFERENCES
FINANCIAL TRAINING Advanced Financial Accounting Courses

(U.K.) CIMA Study Pack 2008
SHOKO,D. Advanced Financial Accounting &

Reporting Denmark Training Services
CIS Study Pack 2008

Standards 2015

SUBJECT INDEX
Accounting & reporting by retirement funds 272, 273

Accounting by defined benefit plans 275
Accounting errors 16
Accounting estimates 11
Accounting for investment property 165
Accounting policies 1
Aggregation of segments 136, 139, 140

Agriculture 236
B
Biological transformation 236
Bottom line 1
C
Capital approach (accounting for government grants) 249
Cedant 85
Closing rate 177
Concepts of capital maintenance 220
Contingent liability 98
Contract asset 110
Contract liability 110
Contractual cash flow model 38, 56
Control in relation to related parties 263
Conversion costs for inventories 207
Core principle 135
Criteria for recognising revenue from the rendering of services 193
Criteria for recognising revenue from the sale of goods 190
Current cost financial statements 232
Current salary approach 276 D
Defined benefit plans 273, 275
Defined contribution plans 273, 274
Definition of agricultural activity 236
Deposit component 86
Determination of fair value (investment property) 167
Determination of functional currency 179
Determination of related party relationships 263
Disclosure requirements for events after the reporting date 23
Disclosure requirements for related parties 266
Disposal of foreign operations 186

E
Economic characteristics indicating hyperinflation 219
Effect of changes in Forex Rates 177
Embedded derivative 41
Entity-wide disclosures 142, 143
Equity instrument 40
Events after reporting date 22
F
Fair value measurement in agriculture 238
Fair value model and cost model (investment) 173
Financial assets at fair value 38
Financial guarantee contract 86
Financial instrument 37
Forgivable loans 248
Form and content interim financial statements 153
G
Gain or loss on net monetary position 223
Gains and losses in agricultural activity 238
Going concern-impact on events after the reporting date 27 Government assistance
248
Government grants 248
Government grants in agriculture 243
H
Hedge accounting 38, 71, 75
Hyperinflationary economies 218
I
Implementation of IAS 29 229
Income approach (accounting for government grants) 249
Insurance contract 85, 87
Interim financial reporting 152

Inventories 205
Inventory costs for service providers 208
Investment property 164
L
Legal obligation 97
Lower of cost or net realisable value rule 209
M
Market mechanism 247
Measurement of investment property 165, 166
Measurement rates and guidelines for inventories 206
Minimum contents of an interim financial report 153
Monetary items 178
N
Net investment in a foreign operation 178
Non-monetary items 219
O
Obligating event 97
Onerous contract 98
Operating segments 136, 139, 140 Owner-occupied property 164, 165, 168, 169
P
Performance obligation 111, 117
Project management 37
Projected salary approach 276
Prospective restatement 2
R
Recognition and measurement guidelines for interim financial report 155
Recognition and measurement issues for events after the reporting date 22
Recognition and measurement issues in agriculture 237
Recognition measurement of revenue under deferred payment 191
Recognition of exchange differences 180

Recognition of inventory as an expense 214
Recognition of investment property 166
Related party definition 261
Repayment of government grants 25
Restatement of historic-based financial statements 219, 222

Restatements of previously reported interim periods 159
Restrospective application 2
Revenue 188
Revenue from interest, royalties and dividends 201
Revenue recognition for specific sales of goods 199
Revenue under instalment credit sales 192, 201
S
Slotting fees 120
T
Transaction of foreign operations 185
Transactions with key management personnel 269
Transfers to or from investment property 169
Transition disclosures 39
Types of retirement benefit plans 277
U
Unbundling of an insurance contract 87, 89, 90, 93
Uncovered foreign currency transactions 181
Use of estimates for interim financial reports 156
V
Valuation of plan assets by retirement benefit plans 277


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INSTITUTE OF CHARTERED

ADVANCED ACCOUNTING AND FINANCIAL

ICSAZ – P.M. PARADZA II

Published by Institute of Chartered Secretaries &

Typeset by Outline Electronic Publishing, Harare, Zimbabwe.

ICSAZ – P.M. PARADZA III

ICSAZ – P.M. PARADZA IV

7 Revenue from contracts with customers 110

8 Operating Segments 133

ICSAZ – P.M. PARADZA V

EVENTS AFTER THE REPORTING PERIOD (IAS 10)

BORROWING COSTS (IAS 23)

ICSAZ – P.M. PARADZA VI

ICSAZ – P.M. PARADZA VII

ICSAZ – P.M. PARADZA VIII

PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT

ICSAZ – P.M. PARADZA IX

ICSAZ – P.M. PARADZA X

INTERIM FINANCIAL REPORTING (IAS 34)

9.0 Introduction…………………………………………………………………………… 152

ICSAZ – P.M. PARADZA XI

ICSAZ – P.M. PARADZA XII

ICSAZ – P.M. PARADZA XIII

13.0 Introduction……………………………………………………………..…………… 205

FINANCIAL REPORTING IN HYPERINFLATIONARY ECONOMIES

14.0 Introduction……………………………………………………………..................... 218

ICSAZ – P.M. PARADZA XIV

ICSAZ – P.M. PARADZA XV

ACCOUNTING AND REPORTING BY RETIREMENT BENEFIT

18.0 Introduction…………………………………………………………………………. 272

ICSAZ – P.M. PARADZA XVI

EVENTS AFTER THE REPORTING PERIOD (IAS 10)

BORROWING COSTS (IAS 23)

Example 1 – Weighted average rate……………………………………………. 33

ICSAZ – P.M. PARADZA XVII

ICSAZ – P.M. PARADZA XVIII

INTERIM FINANCIAL REPORTING (IAS 34)

ICSAZ – P.M. PARADZA XIX

Example 1 – GD Ltd. Manufacturers…………………………………………... 210

FINANCIAL REPORTING IN HYPERINFLATIONARY ECONOMIES

Example 1………………………………………………………………………………… 221

AGRICULTURE (IAS 41)

ACCOUNTING FOR GOVERNMENT GRANTS AND DISCLOSURE OF

ICSAZ – P.M. PARADZA XX

ACCOUNTING AND REPORTING BY RETIREMENT BENEFIT

Activity 1………………………………………………………………………………… 274

ICSAZ – P.M. PARADZA XXI

• Define and distinguish between accounting policies and accounting estimates;

• Explain the selection and application of accounting policies according to IAS 8;

1.2 KEY DEFINITIONS

ICSAZ – P.M. PARADZA 1

ICSAZ – P.M. PARADZA 2

Statement of changes in equity for year 31 March 20-7

ICSAZ – P.M. PARADZA 3

ICSAZ – P.M. PARADZA 4

4. Change in accounting policy

Increase in property, plant and equipment 403 900 175 000

Adjustments against retained profit at beginning of 2006 21 452

ICSAZ – P.M. PARADZA 5

w1 Decrease/ Increase in Deferred tax

Statement of comprehensive income for years-ended 31 March

ICSAZ – P.M. PARADZA 6

Statement of changes in equity for year 31 March 20 – 7

Notes for the year ended 31 March 20-7