B.

Com in Accounting

Module: Financial Accounting 2A

Module Code: FNA 210

STUDY GUIDE
TABLE OF CONTENTS

Table of Contents
Module Information ............................................................................................................................... 3
STUDY UNIT 1: FRAMEWORK FOR THE PRESENTATION OF FINANCIAL STATEMENTS ............ 5
STUDY UNIT 2 PRESENTATION OF FINANCIAL STATEMENTS ..................................................... 13
STUDY UNIT 3: PROPERTY PLANT AND EQUIPMENT (IAS 16)...................................................... 18
STUDY UNIT 4: INTANGIBLE ASSETS (IAS 38)................................................................................. 26
STUDY UNIT 5: IMPAIRMENT OF ASSETS (IAS36) .......................................................................... 35
STUDY UNIT 6: INVESTMENT PROPERTY (IAS40) .......................................................................... 43
STUDY UNIT 7: INVENTORY (IAS 2) .................................................................................................. 53
STUDY UNIT 8: NON CURRENT ASSETS HELD FOR SALE AND DISCONT. OPERATIONS ........ 60
Module Information

Name of programme BCom Accounting/Information Management/Marketing and

Business Management
Type of programme Contact (Full-Time & Part Time)
NQF Level 5
Name of module Financial Accounting 2A
Credits 20
Notional hours 200
Module purpose The purpose of this module is to build on the knowledge gained
in accounting 1A and 1B with regards to the International
Financial Reporting Standards: ability to identify, recognize,
present and disclose financial transactions.
Learning Outcomes: Upon successful completion of this module the following
outcomes should be met:
• Explain the objectives of financial statements and the need
for a conceptual framework;
• Define and explain the underlying assumptions (Accrual
basis and Going concern) and apply these principles to case
studies;
• Define and explain the qualitative characteristics of financial
statements, and apply these to case studies;
• Define the elements of financial statements, and apply the
definitions to particular dilemmas in accounting;
• Define the recognition criteria of financial statement
elements, and apply the recognition criteria to particular
dilemmas in accounting;
• Explain the different ways in which financial statement
elements can be measured;
• Provide a brief explanation of the different concepts of
capital and capital maintenance.

Prescribed textbooks Griping GAAP,2018,C Service, Lexis Nexis

and other sources
Icons Additional information

Self-check activity

Reading in prescribed textbook

Bright ideas

Think point

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 Case Study

Study Group Discussion

Vocabulary

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STUDY UNIT 1: FRAMEWORK FOR THE PRESENTATION OF FINANCIAL
STATEMENTS

1.1 Introduction

The conceptual framework for financial reporting forms the foundation of all International
Financial Reporting Standards (IFRS).The International financial Reporting Standards (IFRS)
are the standards, interpretations and the framework adopted and developed by the
International Accounting Standards Board (IASB).The status of the conceptual framework is
that it is technically neither a standard nor an interpretation but rather the foundation for all
IFRS. The purpose of the conceptual framework is to set out the various concepts that
underpin the financial reporting in order to assist, the International Accounting Standards
Board (IASB) in developing new IFRSs. (Service: 2017)

The conceptual framework also assists the various national standard setters to develop
national standards. The preparers of financial statements are also assisted in interpreting and
applying difficult IFRSs, or in creating their own policies where IFRSs do not provide guidance
or do not cater for the topic. To assist auditors when assessing whether financial statements
comply with IFRSs. The framework also enables users in interpreting financial statements that
comply with IFRSs, and other parties interested in how the International Accounting Standards
Board develop IFRSs. (Service: 2017)

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

• Discuss and understand the brief history of accounting

• Understand GAAP VS IFRS
• Apply the conceptual framework for financial reporting
• Comprehend and apply Compliance with IFRS
• Differentiate between compliance and convergence
• Outline the objectives of general purpose financial statements
• Explain the qualitative characteristics and constraints
• Underlying assumptions of financial statements
• Discuss in detail the elements of financial statements.
• Outline the recognition and measurement of elements of financial statements.
• Evaluate the concepts of capital and capital maintenance

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1.2 The conceptual framework deals with the following

• The objectives of financial reporting

• Users of financial statements
• Underlying assumptions of financial reporting
• Qualitative characteristics of useful financial information
• Definition, recognition and measurement of financial statement elements
• The concepts of capital and capital maintenance.

1.3 The history and current status of the conceptual framework

The original framework was first published in 1989 by the IAS committee. In 2004 the IASB
and the FASB (the US body began working jointly to develop a new and improved common
framework. This project is referred to as the conceptual framework project, and its aim is to
update and refine the existing concepts to reflect the changes in the markets, business
practices, and the economic environment that have occurred in the two or more decades since
the concepts were first developed. (Service: 2017)

In South Africa companies have until recently prepared their financial statements in
accordance with IFRs in the case of large or listed companies and The South African Generally
Accepted Accounting Practice(SA GAAP) in the case of medium to smaller companies.
Therefore the SA GAAP was withdrawn with effect from 1 December 2012, and has been
replaced by IFRS for large and listed companies and IFRS for SMEs.

1.4 The Standard Setters consist of the following The Monitoring Board

The board consists of capital market authorities responsible for setting the form of financial
reporting. The Monitoring board provides a forma link between the trustees of the IFRS
Foundation and public authorities in order to enhance the public accountability of the IFRS
Foundation. The primary responsibilities of the monitoring board are to ensure that the trustees
discharge their duties in accordance with IFRS Foundation constitution and to approve the
appointment and re-appointment of the trustees. (Service: 2017)

1.5 The Trustees of the IFRS foundation

The Trustees are accountable to the monitoring board perform a governance and oversight
function, over the activities of the IFRS Foundation and IASB. The IFRS Foundation is an
independent, not for profit private sector organisation working in the public interest. The
principle objectives of the IFRS Foundation include, to develop, a single set of high quality,
understandable, enforceable and globally accepted IFRS through the IASB, to promote the
use and rigorous application of those standards, to take account of the financial reporting
needs of emerging economies, including small and medium sized entities(SMEs).and to
promote and facilitate the adoption of the IFRSs through the convergence of the national
accounting standards(International harmonisation). (Service: 2017)

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1.6 The International Accounting Standards board

The IASB is the independent, standard setting body of the IFRS Foundation. The IASB is
responsible for the development and publication of IFRSs and approving interpretations of
IFRS developed by the IFRS Interpretations committee.

1.7 The IFRS Advisory Council

The IFRS Advisory council is the formal advisory body of the IASB and the Trustees of the
IFRS Foundation. The council advises the IASB on a range of issues, including providing input
on single projects, the practical application of IFRS and implementation issues.

1.8 The IFRS Interpretations committee

The IFRS interpretations committee is the interpretative body of the IASB. The committee’s
objective is to review and provide timely authoritative guidance on issues arising from the
application and interpretation of IFRS. (Service: 2017)

1.9 Underlying assumptions of financial statements Accrual assumption

• This means that the expenses incurred are written off against income earned.
• Therefore transactions are recorded as they occur and not when the cash is
received, unless if the transactions are purely on a cash basis.
• Therefore the transactions are accounted for in the period in which they occur.
Income for that period is matched with the expenditure for that period.
• In essence the accrual concept or basis explains the nature of income and
expenses, and the timing of the expenses incurred and the income earned.

1.9.1 Going concern concept

• The financial statements of an entity are prepared on the assumption that the
business will continue to exist for the foreseeable future.
• Therefore it may be assumed that the business has no intention s for liquidation,
hence that assets are shown carrying amounts if there is no intention to liquidate.
• If the intention to liquidate is there then the assets have to be shown at the fair
values.
• It is thus important that the information shown in the financial statements must
comply with the qualitative characteristics.

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1.10 The measurement of element

1.10.1 Historical cost

This is the amount paid at the acquisition of the asset or other benefits in cash or cash
equivalents or the fair value of the consideration received. In the case of liabilities the historical
cost is the amount of the proceeds received in exchange for the obligation.

1.10.2 Current cost

This is the amount of cash or cash equivalents that the entity would have to pay if they were
to acquire the asset currently. For example if a motor vehicle was purchased five years ago
for R100000,and this time around in order to purchase the same asset its value is R120
000,then R120 000 is the current cost.. Current cost is used in cases where the assets are
donated. (Service: 2017).

1.10.3 Realisable value

The amount obtained when an asset is disposed in an orderly way is the realisable value. On
the other hand the net realisable value is the Expected proceeds from the disposal of the asset
less any costs to sell. For example if a motor vehicle which cost R500000 two years ago was
to be disposed at R300000 now then the R300 000 is the realisable value.

1.10.4 Settlement value

The full amount required to pay off or settle a debt is the settlement amount or value. The
settlement value is arrived at after deducting any applicable discounts or rebates.
If an obligation that was received 1 year ago for R80000, would now be settled at R78 000,
then R78 000 is the settlement amount.

1.10.5 Market value

Sometimes the market value is also known as the fair value. This is the value obtained in an
active market between willing buyers and willing sellers, in an arm’s length transaction.

1.10.6 The present value

The present value of the asset is the future discounted cash flows expected to be generated
from the asset in future. This s arrived at after applying the relevant interest rate which is
known as the discount factor.

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1.11 Assets

1.11.1 They can be classified into two

Non-current assets-these are expected to be used for a period greater than a year, meaning
that the economic benefits are expected to flow for a more than a year. Current assets-these
are expected to be owned for a short period of time usually less than a year

1.11.2 Examples of non-current assets among others include

Land and buildings machinery, equipment, vehicles, investments, fixed deposits, Intangible
assets such as franchise goodwill, copyrights and Trademarks

1.11.3 Examples of current assets include

Inventories include raw materials, work in process, trading stock and consumables on hand
such stationery packing material, trade and other receivables ,trade debtors ,accrued income
prepaid expenses SARS VAT receivable cash and cash equivalents. (Service: 2017)

1.11.4 Criteria for the recognition of assets

The following are the recognition criteria for the recognition of assets
It is probable that the future economic benefits will flow to the entity
The asset must have a cost or value that can be reliable measured.

1.11.5 Liabilities
They are the present obligations that the business has to people outside the businesses a
result of past events, and from which future economic outflows of cash are expected to flow
out of the entity. The settlement of liabilities is expected to result in decreases in equity

1.11.6 Criteria for the recognition of liabilities

It is probable that an outflow of resources embodying economic benefits will result from the
settlement of the present obligation. The amount at which the settlement will take place can
be reliably measured

1.11.7 Non-current liabilities

Expected to be settled over a period greater than a year and is long term in nature.

1.11.8 Current Liabilities

These are short term in nature, and are expected to repaid over a period less than a year
Examples Non-current liabilities include
Long term borrowings – Loans, debentures, mortgage loans

Examples current liabilities include

Trade creditors, Accrued expenses, Income received in advance, prepaid income

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1.12 Equity

Is the residual interest of assets over liabilities. It can also be referred to as the owners’ equity?
Equity increases when profits are made and the owner of the business contributes more
capital into the business, and decreases when losses and drawings are made. With regards
to the statement of comprehensive income, the elements include income and expenses.
(Service: 2017)

1.13 Recognition of income

The recognition of income is dependent upon the realisation concept. This means that income
must be earned before it can be recognised. Income is recognised if it meets the following
criteria.
• There must have been increase in future economic benefits, in the form of an
increase in assets or decrease in liabilities, both of which increase equity.
• The income can be reliably measured.

1.14 Revenue from the sale of goods.

In the case of the sale of goods the conclusion of the sales transaction is considered to be a
critical event for the recognition of revenue from the sale of goods. The following requirements
must be met for the recognition of revenue from the sale of goods.

• The significant rewards and risk associated with the ownership of the assets should
have been passed on from the seller to the buyer.
• It is possible to measure the amount of revenue reliably
• It is probable that the economic benefits associated with ownership of the sold
goods will definitely flow to the seller.
• It is possible to measure reliably any expenses associated with the conclusion of
the transaction.

1.15 Revenue from the rendering of services

The critical event from the rendering of services is the completion or conclusion of the
rendering of the service agreed upon.
In general the parties to the transaction agree on the following
• The enforceable rights of the party that renders the service and the party that
receives the service.
• The payment that will be made for the service to be rendered.
• The manner and conditions of payment
• The revenue can be reliably measured
• It is probable that the economic benefits will flow to the entity

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1.16 Expenses

These are costs that are incurred in the ordinary course of the business and they include any
losses suffered by the business .e.g. rent expense, salaries and wages, these result in an
outflow of cash and the depletion of assets such as cash, inventory and property plant and
equipment. (Service: 2017)

1.17 Qualitative Characteristics of financial statements

1.17.1 Relevance

This is associated with the timely presentation of the financial statements to the users in order
to enhance informed decision making, therefore the financial statements must be released in
a timely manner so that the information contained is current and fresh.

1.17.2 Reliability

Means that the information presented must be verifiable. This assures the users that the
information presented has been done so through faithful representation, and can be audited.
Trust is therefore created between the users of the financial statements and the entity.
(Service: 2017)

1.17.3 Comparability

The financial statements that are presented must be enabling the users to make decisions by
assessing the financial performance of the entity with that of other entities, or with other
alternative investments that the investor can be able to assess. (Service: 2017)

1.17.4 Understandability

The users of the financial statements must be able to comprehend or understand the
information presented in the financial statements. Strict adherence to the international
standards of financial reporting is important, in order to ensure that the financial statements
are standardised (Service: 2017)

1.18 Concepts of capital and capital maintenance

Financial capital maintenance deals with the fact that when profit is earned, capital increases.
This will result in the value of the net assets of the business at the end of the year to exceed
the value at the beginning of the year, of cause after excluding any distributions to and
contributions from the owners during the year.

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 Summary of the study unit

In this unit we looked at the conceptual framework for financial reporting and the
elements of financial statements. The conceptual framework for financial reporting is
mainly covered in the International Accounting Standard 1(IAS 1).

Self-assessment questions.

Question 1.1

The IFRS Foundation, is an independent, not for profit private sector organisation working in
the public interest. (IFRS website).
Required:
a) Describe the principal objectives of the IFRS Foundation.
b) Explain the role of the International Accounting Standards Board (IASB).
c) Explain the role of the IFRS Interpretations Committee.

Question 1.2

The financial accountant of Wondering Limited who is preparing its Annual Financial
statements for the year ended 31 December 2007 has come across a very detailed IFRS
compliance check list. He is scared that if he states that the annual financial statements
comply with IFRS, that he may actually missed certain onerous IFRS disclosure
requirements and that the financial do not actually comply with IFRS. He wants to know what
compliance with IFRS really means as t seems a big deal to him to include such a term in
Wondering Limited’s annual financial statements.

Required:

Respond to the financial accountant’s query above.

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STUDY UNIT 2 PRESENTATION OF FINANCIAL STATEMENTS

2.1 Introduction

The Objective of IAS 1(International Accounting Standard 1) is to set out the basis for the
preparation and presentation of general purpose financial statements to ensure comparability
with the entity’s prior period financial statements and the financial statements of other entities.
The objectives of financial statements is to provide information about the financial position,
performance and changes in the financial position of an entity. The information is useful to a
variety of users. The users can be internal which means within the organization or external
which means outside the organization (Service: 2017)

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

• Understand the Objectives of IAS 1 and Objective of Financial Statements.
• Analyse and discuss the Scope of IAS 1
• Construct a Complete set of financial statements.
• Comprehend the General features of financial Statements.
• Understand the Structure and content of financial statements in general.
• Draw up a Statement of financial Position
• Construct a Statement of Comprehensive income.
• Present the Statement of changes in Equity.
• Present the Statement of cashflows
• Formulate the Notes to the financial statements

2.2 Complete set of financial statements include

• The statement of financial position (Balance sheet)

• The Statement of profit and loss and other comprehensive income
• The Statement of changes in equity
• The Statement of Cash flows
• Notes, including significant accounting policies and other explanatory information
• Comparative information in respect of the preceding period

A Statement of financial position as at the beginning of the preceding period when an entity
applies an accounting policy retrospectively, or when it makes a retrospective restatement for
items in its financial statements or when it reclassifies the items in its financial statements.

2.3 Statement of profit and loss and other comprehensive Income

It basically consists of Total comprehensive income, profit and loss and other
comprehensive income. Total comprehensive income is defined as the change in equity,
during the period resulting from transactions and other events, other than those changes
resulting from transactions with owners.

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2.4 Other comprehensive income items

These can be defined as items of income and expense that are either not required or permitted
to be recognised in the profit and loss.

2.4.1 Components of other comprehensive income include

• Changes in revaluation surplus

• Re-measurements on defined
• Gains and losses arising from translating the financial statements of a foreign
operation
• Gains and losses from investments in equity instruments measured at fair value
through other comprehensive income
• The effective portion of gains and losses on hedging instruments in a cash flow
hedge
• For particular liabilities designated as at fair value through profit and loss, the
amount of the change in the fair value that is attributable to changes in the liability’s
credit risk

2.5 Statement of Changes in Equity

Equity is defined as the increase or decrease in the net assets of a business and these
changes are caused by transactions with owners and total comprehensive income.
Components of equity include, share capital, reserves and retained earnings.

2.6 Statement of Cash flows

The statement of cash flows helps to understand the overall net increase/decrease in the cash
flow of a business between two reporting periods.
It has three major headings namely
• Operating activities
• Investing Activities
• Financing activities

The cash flows from operating activities can be calculated using the direct and the indirect
methods

• Cash flow from investing activities-it shows the cash inflows and outflows from
acquisition and disposal of financial assets and non-current assets
• Cash flow from financing activities-Here we show the two main sources of finance
for the business and these are debt and equity. Therefore any changes in share
capital, loans and other long term borrowings are reflected in the financing section.

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2.7 Notes to the financial Statements

These include the explanation of the accounting policies, the property, plant and equipment
note (PPE), and any prior period errors that have been corrected. The notes to the financial
statements also explain the accounting treatment of certain specific balances and
compliance with International Financial Reporting Standards (IFRS).

Summary of the study unit

• In this unit we discussed the assumptions underlying the preparation of financial

statements
• We explained the qualitative characteristics of financial statements
• In this unit we identified the elements of financial statements
• The chapter also described the recognition of the elements of the financial statements
and the measurement of financial statements involves.

Self-assessment and reflection

Question 2.1

A financial accountant at Bistro Limited has highlighted the following paragraph in the
Conceptual Framework relating to measurement of the elements of financial statements.
‘Measurement is the process of determining the monetary amounts at which the elements of
the financial statements are to be recognised and carried in the balance sheet and the income
statement. This involves the selection of the particular basis of measurement.
The accountant is interested in knowing how effective the different measurement models are
in achieving the qualitative characteristics of financial statements.

Required:

Explain to the accountant how effective different measurement models are in achieving the
qualitative characteristics of financial statements.

Question 2.2

Foodie Limited is a large retail business that sells gourmet food ingredients to an upper middle
class target market that is health conscious. As part of its aggressive expansion strategy a
decision has been taken by the management team to open a new store in Ballito.
In order to gain market share e in Ballito and achieve a strong opening the company decided
to engage the services of a renowned advertising firm Sorrel & Draper Inc. On 30 September
2003 the company paid R750 000 to Sorrel & Draper Inc. for the design and production of a
large canvas banner to be displayed at a billboard in the Ballito town centre. The banner was
delivered on the same day. The banner will be on display from 1 October 2003 until 31 January
2004 at which point it will be taken down and will not be able to be used again, as it will be

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damaged from exposure to the weather.
In addition, Foodie Limited is required to pay a fee to the Ballito Municipality of R35 000 for
the renting of space on the advertising board. The fee was paid on 25 September 2003.

Required:

Discuss in terms of the Conceptual Framework, how these two payments should be accounted
for in the financial statements of Foodie Limited for the year ended 30 September 2003.

Question 2.3

The following is the trial balance of Eskimo Limited at 31 December 2008.

Debit(R) Credit(R)
Retained Earnings(1/1/2008) 145 000
Non –current liabilities: Loan from AB Bank 25 000
Revaluation surplus(1/1/2008) 20 000
Ordinary Share Capital 240 000
Revenue: Sales 580 000
Interest Income 12 500
Rent Income 23 000
Cost of Sales 300 000
Interest on bank overdraft 9 500
General expenses 113 000
Bad debt expense 20 000
Repairs and maintenance expense 30 000
Marketing expense 22 000
Fuel expense 40 000
Depreciation expense 25 000
Salaries 50 000
Investments in listed companies 50 000
Accounts receivable 250 000
Bank 23 000
Current tax payable 12 800
Inventories 120 000
Accounts payable 225 000
Land 200 000
Equipment: Cost 100 000
Equipment: Accumulated depreciation 40 000
Income tax expense 1 800
Dividends 15 000
1 346 000 1 346 000

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Additional Information

• Share capital constitutes 120 000 ordinary shares of no par value.20 000 shares were
issued for R40 000on the first day of the year.
• The interest and rental income are incidental to main business operations
• Eskimo Limited classifies expenses according to their function, Management
categorises the functions of the business into areas of sales, administration and
distribution. Salaries of R30 000 relate to the administrative function and R20 000 to
the distribution function. Depreciation of equipment of R10 000 relates to the
administrative function and R15 000 to the distribution function. The bad debts and
marketing expenses relate to the administration function. The repairs and maintenance
and fuel expenses relate to the distribution function.
• Dividends of R15 000 in respect of the year ended 31 December 2007 were declared
and paid during January 2008.Dividends of R20 000 in respect of the year ended 31
December 2008 were declared on 15 January 2009.
• There are no movements in other comprehensive income.

Required:

a) Prepare the statement of comprehensive income including earnings per

share(EPS) of Eskimo Limited for the financial year ending 31 December 2008 in
accordance with International Financial Reporting Standards
b) Prepare the statement of changes in equity of Eskimo Limited for the financial year
ended 31 December 2008 in accordance with International Financial Reporting
Standards (IFRS).
c) Prepare the statement of financial position of Eskimo Limited at 31 December 2008
in accordance with International Financial Reporting Standards (IFRS).
d) Prepare the profit before tax and dividends notes to the financial statements in
accordance with International Financial Reporting Standards

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STUDY UNIT 3: PROPERTY PLANT AND EQUIPMENT (IAS 16)

3.1 Introduction

This study unit deals with the vital component of most businesses, which are the physical
assets of the business. These have to be assets not held for investment purposes but rather
assets that are used in the production of Income. In terms of IAS 16, Property Plant and
Equipment (PPE) represent tangible assets that are held for use in the production or supply
of goods and services, held for rental to others, held for administrative purposes, and are
expected to be used for more than one period, for example buildings, machinery, office
equipment, furniture etc. (CL Service et al 2017). PPE can be used to assess the performance
of the entity such as how efficiently the business is utilizing its investment in PPE to generate
income and profits.

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

• Perform the recognition, initial measurement and subsequent measurement of PPE
(costs. (Including impairments)The cost model.
• Recognise the derecognition of PPE.(Cost model)
• Compute and comprehend the deferred tax consequences.(Cost model)
• Design the disclosure of PPE in the financial statements.
• Perform the recognition and measurement under the revaluation model.
• Compute and recognise the subsequent measurement –Revaluation model.
• Compute and recognise deferred tax consequences (Revaluation model).

IAS 16: paragraph 1 prescribes the treatment of property plant and equipment in order for
users to evaluate, information about an entity’s investment in Property, Plant and Equipment
and changes in such investment. IAS 16 does not apply to:

a) Assets classified as held for sale(IFRS5)

b) Biological assets related to agricultural activity(IAS 41)
c) Exploration and evaluation of assets(IRFS 6)
d) Mineral rights and mineral reserves such as oil, natural gas and similar non-
regenerative resources.
• is the loss in value of an asset over its useful life
• or the systematic allocation of the wear and tear of an asset over its useful life,
• or the systematic allocation of the depreciable amount of an asset over its
useful life
3.2 Depreciable amount is:

• The cost of an asset or its fair value, les the estimated residual value.
• The cost of an asset is the amount of cash ore cash equivalent paid or the fair
value of the consideration given at the time the asset was acquired or
constructed.
• Fair value is the price that would be received to sell the asset in an arm’s length

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 transaction

3.3 The carrying amount of an asset is:

• the cost less any accumulated wear and tear and depreciation of an asset less
accumulated impairment losses

3.4 Impairment loss is:

• The excess of the carrying amount over the recoverable amount.

• The recoverable amount is the greater of value in use and the fair value less
cost of disposal

3.5 Recoverable amount is:

• the higher of the fair value less costs of disposal,

• and its value in use.

3.6 Recognition criteria for PPE

In order to recognize an item as PPE,

a) The item must meet the definition of an asset
b) The asset must
c) Cause a flow of future economic benefits to the entity that is probable
d) And have a cost or fair value that can be reliably measured.

3.7 Initial measurement

The method of acquisition of an asset will affect the measurement of the cost. The initial cost
may be paid for in cash or on credit.
The initial cost of the asset is
a) The purchase price
b) Directly attributable costs
c) And certain future costs

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At a later stage in the asset‘s life further costs may be incurred, and these are
a) Repairs and maintenance
b) Replacement or renewal of parts
c) And major inspections

3.8 Exchange of assets

a) The cost of the new asset will be the fair value of the asset given up
b) The fair value of the asset received may be used instead if the, fair value of the asset
given up is not available, or the fair value of the asset received is clearly evident
c) An exchange of assets is deemed to have no commercial substance if the exchange
of the assets
d) Will not change any future cash flows in any way (risk, timing or amount)
e) Will not change the value of the operation that is to use the asset
f) Or the expected change in the cash flows or values insignificant relative to the fair
value of the asset exchanged

3.9 Recognition

The cost of an item of PPE is recognised if

• It is probable that the future economic benefits associated with the asset will
flow to the entity.
• The cost of the asset can be reliably measured.
These costs include the initial costs incurred to acquire or to construct PPE and subsequent
costs to add to, replace a part of, or service the PPE. If there are future dismantling costs that
will be incurred at the end of the useful life of the asset then the present value of the future
costs must be added to the asset.

NB: IAS 16 views land and buildings as separate assets which must be accounted for
separately, even though they might have been acquired together. Land has unlimited useful
life and therefore it is not depreciated, whilst buildings have a limited useful life and are a
depreciable asset.

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Self-Assessment Activities

Example 3.1

On 1 January 2015 Randburg Ltd, purchased a machine from a foreign supplier. The following
costs were incurred in the acquisition.
Purchase price R3 000 000
Import duties R250 000
Railage Inwards R30 000
Calibration devices (to adapt the machine to local conditions) R40 000
Installation devices R120 000
Advertising of new machine to customers R10 000

Required:

Calculate the cost of the machine at initial recognition.

Solution

Calculation of the Cost at Initial recognition

Purchase price R3 000 000
Import duties R250 000
Railage Inwards R30 000
Calibration devices R40 000
Installation devices R120 000
Cost at Initial recognition R3 440 000

Example 3.2

Exchange of assets were both fair values are known Don LTD gave up a machine for a vehicle
Machine:

Carrying amount (cost was R18000) R10 000

Fair value R11 000
Vehicle: Fair value R12 000

Required Show the journals for the exchange of assets.

Debit Credit
Vehicle: cost R11000
Machine: cost R18 000
Accumulated depreciation R8 000
Profit on exchange of assets(Balancing amount) R1 000

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Example 3.3

Exchange of assets were both fair values are known Don LTD gave up a machine for a
vehicle:
Machine: Carrying amount (cost was R18000) R10 000
Fair value R11 000
Vehicle: Fair value R15 000
Required Show the journals for the exchange of assets.

Debit Credit
Vehicle: cost R15000
Machine: cost R18 000
Accumulated depreciation R8 000
Profit on exchange of assets(Balancing amount) R5 000

Major inspections

When the asset requires Major inspections as part of its conditions for continued use, for
example an aircraft the cost thereof must be capitalized, which means the inspection will be
recognized as an asset The major inspection is depreciated over the period until the date of
the next inspection. If the cost of inspection is significant, it may be recognized as a separate
asset.

Example 3.4 (major inspection)

New legislation was introduced which made it compulsory for all public transport buses to
undergo regular inspections every 2 years. Vroom limited owns a bus that has a carrying
amount of R80000 as at 1 January 20.1. Assets are depreciated on a straight line basis to a
nil residual value. The useful life of the asset is 10 years from 1 January 2001. A major
inspection of the bus occurred on 1 October 20.1 at a cost of R 20 000.

Required:

a) Show the journal entries relating to this major inspection.

b) Disclose the asset in the Statement of Financial position.

Solution

Journal entries
Debit Credit
Bus major inspection: cost R20 000
Bank R20 000
Major inspection performed on 1 October 20.1
Depreciation-Bus R10 500
Accumulated depreciation-Bus(80000-0)/10 R8 000
inspection(20000/2*3/12) R2 500

Statement of financial position (Extract) as at 31 December 20.1

Assets R
Non-current assets
Bus (80000+20000-8000-2500) R89500

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Example of the format of the PPE Note.
Details 20.1 20.2
Carrying amount at the beginning of the year XXXX XXXX
Cost XXXX XXXX
Accumulated depreciation (XXXX) (XXXX)
Accumulated impairment losses (XXXX) (XXXX)
Fair value adjustments XXXX XXXX
Additions XXXX XXXX
Disposals (XXXX) (XXXX)
Depreciation for the year XXXX XXXX
Impairment loss for the year XXXX XXXX
Carrying amount at the end of the year XXXX XXXX
Cost XXXX XXXX
Accumulated depreciation XXXX XXXX
Accumulated impairment losses XXXX XXXX

3.10 Measurement after Recognition

An entity must choose either the cost model or the revaluation model as its accounting policy
to apply to its entire class of PPE.

3.11 Cost model

PPE is carried at cost less accumulated depreciation, less accumulated impairment losses.

3.12 Revaluation model

PPE is carried at the revalued amount (fair value) less any subsequent accumulated
depreciation and subsequent impairment losses.

3.13 The restatement and elimination methods can be used

IAS 16 paragraph 35 states that when PPE is revalued, any accumulated depreciation at the
revaluation date is either, restated proportionately, with the change in the gross carrying
amount, of the asset, (i.e. the net carrying amount after revaluation equals the revalued
amount) or eliminated against the gross carrying amount of the asset and the net amount
restated to the revalued amount of the asset.

3.14 Treatment of revaluation surplus

The revaluation surplus arises when the revaluation results in an increase in value, it should
be credited to other comprehensive income, and accumulated in equity. In subsequent periods
the accumulated revaluation surplus is transferred (realised) in retained earnings in the
statement of changes in equity, when either the asset is disposed of or over its remaining
useful life and as the asset is used by the entity

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Summary of the unit

The unit focused on the calculation of the cost of an asset, and the initial recognition criteria
for property, plant and equipment. The disclosure requirements related to the recognition an
asset, when to capitalize subsequent expenditure on an asset account, and when and how to
recognize a replacement or renewal as a separate asset. The presentation of PPE in the
financial statements of an entity.

Self-assessment and reflection

Example 3.5
Star Ltd acquired building on 1 January 2008 at a cost of R500000.The building was expected
to have a useful life of 25 years. On 1 January 2013, the buildings were revalued at R800000
(net replacement cost).The company has a 31 December year end. The policy of the company
is to realise revaluation surplus through use.
Show the journal entries to record the revaluation of the assets using
a) Elimination method
b) Proportionate restatement method

Elimination Method.

Historical cost R500 000

Accumulated depreciation(R500000x5/25) R100 000
Carrying value at 31 December 2012 R400 000
Revaluation Surplus(R800 000-R400 000) R400 000

Journal entries at 1 January 2013

Debit Credit
Accumulated Depreciation: Buildings R100 000
Buildings R100 000
Elimination of accumulated depreciation buildings
against cost before revaluation

Buildings R400 000

Revaluation Surplus R400 000
Revaluation on the net replacement cost of
buildings

Journal entries at 31 December 2013

Debit Credit
Depreciation R40 000
Accumulated Depreciation: Buildings R40 000

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 Being the deprecation on the revalued building

Revaluation surplus(400000x1/2 R20 000

Retained Earnings R20 000
Realisation of portion of revaluation surplus in
Retained earnings.

Proportionate Restatement Method.

Historical cost R500 000
Accumulated depreciation(500000x5/25) R100 000
Carrying value at 31 December 2012 R400 000

Revalued amount(Net replacement cost) R800 000

Gross replacement cost(800000x25/20) R1 000 000
Accumulated depreciation on replacement cost R200 000

Journal entries at 1 January 2013 Buildings

Debit Credit
Buildings (R1000000-R500000) R500 000
Accumulated depreciation(R200000-R100000) R100 000
Revaluation surplus R400 000
Revaluation and proportionate restatement of buildings
cost and accumulated depreciation

Journal entries at 31 December 2013

Depreciation R40 000
Accumulated depreciation: Buildings R40 000
Being the deprecation on the revalued building
Revaluation surplus(400000x1/2) R20 000
Retained earnings R20 000
Realisation of portion of revaluation surplus in retained
earnings

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STUDY UNIT 4: INTANGIBLE ASSETS (IAS 38)

4.1 Introduction

An asset is a resource that is controlled by the business as a result of past events and from
which future economic benefits are expected to flow to the entity. Intangible assets are defined
as assets that do not have a physical substance. In other words they do not have physical
form. This section basically deals with these types of assets, their cost and recognition in the
financial statements. An intangible asset is one that has no physical substance and is non-
monetary (CL Service 2014), must be identifiable and must not have physical form and must
be controlled by the entity. Examples of intangible assets include, manufacturing processes
and technical knowhow, licenses, patents and trademarks, market knowledge and customer
lists, and brand names and customer loyalty.

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

• Introduction, scope, recognition and measurement of intangible assets.

• Identify the recognition of subsequent expenditure.
• Compute and recognise the subsequent measurement(Cost model and Revaluation
model)
• Model the Derecognition of intangible assets
• Discuss and perform the disclosure of intangible assets
• Properly account for the treatment of Goodwill.

4.2 Definition of Intangible assets

Intangible asset: an identifiable non-monetary asset without physical substance. An asset is a

resource that is controlled by the entity as a result of past events (for example, purchase or
self-creation) and from which future economic benefits (inflows of cash or other assets) are
expected. [IAS 38.8] Thus, the three critical attributes of an intangible asset are:

a) Identifiability
b) Control (power to obtain benefits from the asset)
c) Future economic benefits (such as revenues or reduced future costs)

4.3 Identifiability and control

An intangible asset is identifiable when it: [IAS 38.12]

Is separable (capable of being separated and sold, transferred, licensed, rented, or
exchanged, either individually or together with a related contract) or arises from contractual or
other legal rights, regardless of whether those rights are transferable or separable from the
entity or from other rights and obligations. Completion and production-this is when commercial
production begins and the benefits are expected to flow to the entity

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4.4 Objective of IAS 38

To prescribe the accounting treatment for intangible assets that are not dealt with specifically
in another IFRS. The standard requires an entity to recognise an intangible asset if, and only
if, certain criteria are met. The standard also specifies how to measure the carrying amount of
intangible assets and requires certain disclosures regarding intangible assets. [ISA 38.1]

4.5 Scope

ISA 38 applies to all intangible assets other than: [ISA 38.2-3]

• Financial assets
• Exploration and evaluation assets (extractive industries)
• Expenditure on the development and extraction of minerals, oil, natural gas,
and similar resources
• Intangible assets arising from insurance contracts issued by insurance
companies’ Intangible assets covered by another IFRS, such as intangibles
held for sale, deferred tax assets, lease assets, assets arising from employee
benefits, and goodwill. Goodwill is covered by IFRS 3-Business Combinations

4.6 Examples of possible intangible assets include

Computer software ,Patents ,Copyrights ,Motion picture films ,Customer lists ,Mortgage
servicing rights ,Licenses ,Import quotas ,Franchises ,Customer and supplier relationships,
marketing rights and Royalties.

Intangibles can be acquired

a) By separate purchase
b) As part of a business combination
c) By a government grant
d) By exchange of assets

.Recognition criteria for intangible assets

a) The treatment of intangible assets depends on whether the definition and
recognition criteria are met
b) The value of the asset must be reliably measured

4.7 Initial measurement

The costs that should be included in the cost of the asset are the purchase price and all directly
attributable costs (these are cost that are necessary to bring the asset into use)

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4.8 Internally generated assets Goodwill

It is expected to render future economic benefits but is not capitalized because it does not
meet the definition and recognition criteria which are
• It is not an identifiable resource which is separable and arises from a
contractual or legal right
• It may not be possible to control customer loyalty
• And it is impossible to measure the value.
• Therefore internally generated goodwill is always expensed and not
capitalised.

4.9 Purchased Goodwill

Conversely it is capitalized as it can be reliably measured as the excess of the purchase price
of an entity and the net assets acquired.

4.10 Other internally generated assets

The following internally generated intangible assets may never be capitalized but expensed
namely Goodwill, Brands, Mastheads, Publishing tittles and Customer lists. These normally
go through 3 phases namely:

Research-is an original and planned investigation undertaken with the prospect of gaining new
scientific or technical knowledge and understanding. Development- this is the application of
the research findings to a plan or design for the production of a new or highly improved
materials, devices, products, processes prior to the commencement of production.

The 6 criteria that must be met for the capitalisation of development costs. The following must
be proved

• The technical feasibility of completing the asset

• The intention to complete the asset and to sell or use it
• The ability to use the asset
• How the asset will generate future economic benefits by demonstrating that
there is a market for it
• The adequate availability of necessary resources to complete the
development and to sell or use the asset.
• The ability to reliably measure the cost of the asset.

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4.11 Recognition criteria

IAS 38 requires an entity to recognise an intangible asset, whether purchased or self- created
(at cost) if, and only if: [IAS 38.21]
a) is probable that the future economic benefits that are attributable to the asset will flow
to the entity; and
b) The cost of the asset can be measured reliably.
c) This requirement applies whether an intangible asset is acquired externally or
generated internally. IAS 38 includes additional recognition criteria for internally
generated intangible assets (see below).

The probability of future economic benefits must be based on reasonable and supportable
assumptions about conditions that will exist over the life of the asset. [IAS 38.22] The
probability recognition criterion is always considered to be satisfied for intangible assets that
are acquired separately or in a business combination. [IAS 38.33]

4.12 If recognition criteria not met

If an intangible item does not meet both the definition of and the criteria for recognition as an
intangible asset, IAS 38 requires the expenditure on this item to be recognised as an expense
when it is incurred. [IAS 38.68]

4.13 Business combinations

There is a presumption that the fair value (and therefore the cost) of an intangible asset
acquired in a business combination can be measured reliably. [IAS 38.35] An expenditure
(included in the cost of acquisition) on an intangible item that does not meet both the definition
of and recognition criteria for an intangible asset should form part of the amount attributed to
the goodwill recognised at the acquisition date.
Reinstatement. The Standard also prohibits an entity from subsequently reinstating as an
intangible asset, at a later date, an expenditure that was originally charged to expense. [IAS
38.71]

4.14 Initial recognition: research and development costs

Charge all research cost to expense. [IAS 38.54]

Development costs are capitalised only after technical and commercial feasibility of the asset
for sale or use have been established. This means that the entity must intend and be able to
complete the intangible asset and either use it or sell it and be able to demonstrate how the
asset will generate future economic benefits. [IAS 38.57]

If an entity cannot distinguish the research phase of an internal project to create an intangible
asset from the development phase, the entity treats the expenditure for that project as if it
were incurred in the research phase only.
Initial recognition: in-process research and development acquired in a business combination

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A research and development project acquired in a business combination is recognised as an
asset at cost, even if a component is research. Subsequent expenditure on that project is
accounted for as any other research and development cost (expensed except to the extent
that the expenditure satisfies the criteria in IAS 38 for recognising such expenditure as an
intangible asset). [IAS 38.34]

4.15 Initial recognition

Internally generated brands, mastheads, titles, lists

Brands, mastheads, publishing titles, customer lists and items similar in substance that are
internally generated should not be recognised as assets. [IAS 38.63]

Computer software, purchased must be capitalised, Operating system for hardware: include
in hardware cost .Internally developed (whether for use or sale),must be charged to expense
until technological feasibility, probable future benefits, intent and ability to use or sell the
software, resources to complete the software, and ability to measure cost.

For this purpose, 'when incurred' means when the entity receives the related goods or
services. If the entity has made a prepayment for the above items, that prepayment is
recognised as an asset until the entity receives the related goods or services. [IAS 38.70]

4.16 Initial measurement

Intangible assets are initially measured at cost. [IAS 38.24]

Measurement subsequent to acquisition: cost model and revaluation models allowed. An entity
must choose either the cost model or the revaluation model for each class of intangible asset.
[IAS 38.72]. Cost model. After initial recognition the benchmark treatment is that intangible
assets should be carried at cost less any amortisation and impairment losses. [IAS 38.74]

4.17 Revaluation model

Intangible assets may be carried at a revalued amount (based on fair value) less any
subsequent amortisation and impairment losses only if fair value can be determined by
reference to an active market. [IAS 38.75] Such active markets are expected to be uncommon
for intangible assets. [IAS 38.78] Examples where they might exist:
a) production quotas
b) fishing licences
c) taxi licences

Under the revaluation model, revaluation increases are credited directly to "revaluation
surplus" within equity except to the extent that it reverses a revaluation decrease previously
recognised in profit and loss. If the revalued intangible has a finite life and is, therefore,
being amortised (see below) the revalued amount is amortised. [IAS 38.85]

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4.18 Disclosure

For each class of intangible asset, disclose: [IAS 38.118 and 38.122]
a) useful life or amortisation rate
b) amortisation method
c) gross carrying amount
d) accumulated amortisation and impairment losses
e) line items in the income statement in which amortisation is included
f) reconciliation of the carrying amount at the beginning and the end of the period
showing:
g) additions (business combinations separately)
h) assets held for sale
i) retirements and other disposals
j) revaluations
k) impairments
l) reversals of impairments
m) amortisation
n) foreign exchange differences
o) other changes

NB it is important to note that development cost are either expensed or capitalized.

Example 4.1

(Research and development). A company started research and development incurring the
following costs evenly over each year
31 December 20.7 R120 000
31 December 20.8 R100 000
31 December 20.9 R100 000

On 1 September he recognition criteria for the capitalization of development costs were met
The recoverable amounts are as follows
31 December 20.7 R90 000
31 December 20.7 R90 000
31 December 2007 R90 000

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Required
Show all the journals related to the costs incurred for each of the years ended 31 December.

2007 Debit Credit

Research-Expense R40 000
Development Cost-Asset R40 000
Bank/Liability R120 000
Research and development costs incurred
(capitalization began on 1 September, and the costs
were expensed before this date
2008
Development; Cost R100 000
Bank/Liability R100 000
Impairment loss: development R30 000
Accumulated impairment loss: Development R30 000

Research and development costs

incurred(capitalization began on 1 September, and the
costs were expensed before this date
2009
Development; Cost R100 000
Bank/Liability R100 000
Development costs incurred.

Development: accumulated impairment loss R30 000

Impairment loss reversed: Development
R30 000

Example 4.2

Brighton Ltd acquired new software from a developer at a cost of R50000, on 1 January
2012.Although the software license has no time limit, and the company typically replaces its
software after every 5 years. The estimated residual value on the software is R5000. With the
current level of technological advancement, in the 2013 year, the software was now expected
to have a nil residual value.

Required:

Calculate the amortization expense for the 2012 and 2013 year. Show the adjusting journal
entries for 2012 and 2013.
2012 Year
Cost R50 000
Residual value 2012 R5 000
Depreciable amount R45 000
Useful life 5 years
Amortization for the year 2102 R9000

Journal Entries Debit Credit

Amortisation R9 000

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 Accumulated amortisation R9 000

2013 year
Cost R41 000
Residual value 2013 R0
Depreciable amount R41 000
Useful life 4 years
Amortization for the year 2102 R10 250

Journal Entries Debit Credit

Amortisation R10 250
Accumulated amortisation R10 250

Summary of the study unit

The fundamental principles for the, initial recognition, measurement and subsequent
recognition of intangible assets under IAS 38 were covered in this unit. The accounting
treatment of impairments relating to intangible assets was also discussed in detail.

Self-assessment and reflection

Question 4.1

a) State the definition of an intangible asset

b) Explain the concept ‘intangible’
c) Why can employees not be capitalised as an intangible asset?
d) A trademark purchased in a business combination can be recognised as an
intangible asset in the books of the acquirer even if it was not raised in the books of
the acquiree because the future economic benefits were not probable. True or false?
e) Can research and development expenditure be capitalised and if so, when?
f) Internally generated customer lists, brands and goodwill can never be capitalised.
True or false?
g) Explain the difference between finite and indefinite useful life intangible assets and
the measurement thereof
h) Compare the two measurement models
i) Why is the revaluation model usually impractical for intangible assets?
j) Impairment on goodwill can never be reversed. True or false

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Question 4.2

You are the auditor of a number of small companies and have been asked to advice Food
limited on how to deal with the following transaction:
Food limited is a fast food company. In order to facilitate expansions, Food limited purchased
100% of another successful food company. The purchase negotiations were settled during the
year as follows:
The total purchase price for the business amounted to R 40 000
The net tangible assets acquired were stipulate in the purchase R19 500
agreement at their fair value of

Although the purchase agreement stipulated that Food limited also acquires the legal rights to
a trademark for a period of 22 years, no value was attached thereto. The reason is that the
trademark was internally generated by the seller and was thus not recognised in the seller’s
financial statements, despite it having been a most profitable trademark for many years.
Initial Recognition: Food limited intends to record the purchased trademark in its financial
statements at R 20 500, calculated as follows:
Purchase price R 40 000
Less fair value of net tangible assets R 19 500
Trademark R 20 500

Amortization: Food limited is unsure whether or not to amortise the trademark since it
believes that the trademark is so profitable that it has an indefinite useful life.
Impairment testing and revaluing to fair values: Food limited intends to revalue the trademark
annually using the revaluation model.

Required:

Discuss the proposed accounting treatment of the trademark in the financial statements of
Food limited. Your discussion should be set out under the following sub headings:
• Definitions and recognition criteria relevant to the acquisition of the trademark
• Initial recognition
• Amortization
• Impairment testing and revaluing to fair values

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STUDY UNIT 5: IMPAIRMENT OF ASSETS (IAS36)

5.1 Introduction

Impairment of assets should occur to all assets except inventories, construction contacts
assets, deferred tax assets, employee benefit assets, financial assets, investment properties
measured at fair value, certain biological assets, insurance contracts, non-current assets
classified as held for sale. In simple terms the impairment of an asset must be processed if
the carrying amount is reflected at an amount that is too high.

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

• Introduction and indicator review.
• Compute and understand the recoverable amount.
• Perform calculations in recognising and measuring the impairment loss.
• Perform the Recognition of a reversal of previous impairment loss.
• Compute the Impairment of cash generating units.
• Conduct the disclosure of impairment in the financial statements

5.2 Impairment of Assets

The objective of this Standard is to prescribe the procedures that an entity applies to ensure
that its assets are carried at no more than their recoverable amount. An asset is carried at
more than its recoverable amount if its carrying amount exceeds the amount to be recovered
through use or sale of the asset. If this is the case, the asset is described as impaired and the
Standard requires the entity to recognise an impairment loss. The Standard also specifies
when an entity should reverse an impairment loss and prescribes disclosures.

5.3 Identifying an asset that may be impaired

An entity shall assess at the end of each reporting period whether there is any indication that
an asset may be impaired. If any such indication exists, the entity shall estimate the
recoverable amount of the asset.

Irrespective of whether there is any indication of impairment, an entity shall also:

Test an intangible asset with an indefinite useful life or an intangible asset not yet available for
use for impairment annually by comparing its carrying amount with its recoverable amount.
This impairment test may be performed at any time during an annual period, provided it is
performed at the same time every year. Different intangible assets may be tested for
impairment at different times. However, if such an intangible asset was initially recognised
during the current annual period, that intangible asset shall be tested for impairment before
the end of the current annual period.

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5.4 Measuring recoverable amount

The recoverable amount of an asset or a cash-generating unit is the higher of its fair value
less costs of disposal and its value in use .It is not always necessary to determine both an
asset’s fair value less costs of disposal and its value in use. If either of these amounts exceeds
the asset’s carrying amount, the asset is not impaired and it is not necessary to Estimate the
other amount.

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. Costs of
disposal are incremental costs directly attributable to the disposal of an asset or cash-
generating unit, excluding finance costs and income tax. Value in use is the present value of
the future cash flows expected to be derived from an asset or cash generating unit.

The following elements shall be reflected in the calculation of an asset’s value in use
An estimate of the future cash flows the entity expects to derive from the asset; expectations
about possible variations in the amount or timing of those future cash flows
The time value of money, represented by the current market risk-free rate of interest.
The price for bearing the uncertainty inherent in the asset; and other factors, such as illiquidity,
that market participants would reflect in pricing the future cash flows the entity expects to
derive from the asset.

5.5 Estimates of future cash flows shall include:

Projections of cash inflows from the continuing use of the asset. Projections of cash outflows
that are necessarily incurred to generate the cash inflows from continuing use of the asset
(including cash outflows to prepare the asset for use) and can be directly attributed, or
allocated on a reasonable and consistent basis, to the asset; and net cash flows, if any, to be
received (or paid) for the disposal of the asset at the end of its useful life. Future cash flows
shall be estimated for the asset in its current condition. Estimates of future cash flows shall
not include estimated future cash inflows or outflows that are expected to arise from. A future
restructuring to which an entity is not yet committed; or Improving or enhancing the asset’s
performance.

Estimates of future cash flows shall not include

a) Cash inflows or outflows from financing activities; or
b) Income tax receipts or payments.

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5.6 Recognising and measuring an impairment loss

If, and only if, the recoverable amount of an asset is less than its carrying amount, the carrying
amount of the asset shall be reduced to its recoverable amount. That reduction is an
impairment loss.
An impairment loss shall be recognised immediately in profit or loss, unless the asset is carried
at re-valued amount in accordance with another Standard (for example, in accordance with
the revaluation model in IAS 16

5.7 Goodwill

For the purpose of impairment testing, goodwill acquired in a business combination shall, from
the acquisition date, be allocated to each of the acquirer’s cash-generating units, or groups of
cash-generating units, that is expected to benefit from the synergies of the combination,
irrespective of whether other assets or liabilities of the acquire are assigned to those units or
groups of units.

The annual impairment test for a cash-generating unit to which goodwill has been allocated
may be performed at any time during an annual period, provided the test is performed at the
same time every year. Different cash generating units may be tested for impairment at different
times. However, if some or all of the goodwill allocated to a cash-generating unit was acquired
in a business combination during the current annual period, that unit shall be tested for
impairment before the end of the current annual period

The Standard permits the most recent detailed calculation made in a preceding period of the
recoverable amount of a cash-generating unit (group of units) to which goodwill has been
allocated to be used in the impairment test for that unit (group of units) in the current period,
provided specified criteria are met.An entity shall assess at the end of each reporting period
whether there is any indication that an impairment loss recognised in prior periods for an asset
other than goodwill may no longer exist or may have decreased. If any such indication exists,
the entity shall estimate the recoverable amount of that asset.

An impairment loss recognised in prior periods for an asset other than goodwill shall be
reversed if, and only if, there has been a change in the estimates used to determine the asset’s
recoverable amount since the last impairment loss was recognised. A reversal of an
impairment loss for a cash-generating unit shall be allocated to the assets of the unit, except
for goodwill, pro rata with the carrying amounts of those assets. The increased carrying
amount of an asset other than goodwill attributable to a reversal of an impairment loss shall
not exceed the carrying amount that would have been determined (net of amortisation or
depreciation) had no impairment loss been recognised for the asset in prior years.

A reversal of an impairment loss for an asset other than goodwill shall be recognised
immediately in profit or loss, unless the asset is carried at re-valued amount in accordance
with another IFRS (for example, there valuation model in IAS 16 Property, Plant and
Equipment). Any reversal of an impairment loss of a re-valued asset shall be treated as a
revaluation increase in accordance with that other IFRS. An impairment loss recognised for
goodwill shall not be reversed in a subsequent period

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5.8 Impairments and the cost model

The carrying amount of an asset which is the excess of the cost over the accumulated
depreciation and the accumulated impairment losses, should reflect the future economic
benefits that the entity expects for the asset

The recoverable amount is a calculation of these estimated future economic benefits that the
entity expects from the asset.

Therefore if the carrying amount exceeds the recoverable amount it must be adjusted
downwards, so that it shows a more reasonable reflection of the future economic benefits of
the asset.

This downward adjustment is known as the impairment loss.

An entity is therefore required to perform an indicator review at the end of the reporting period.

Example 5.1 Research and development

A company started research and development incurring the following costs evenly over each
year.
2007 R120 000
2008 R100 000
2009 R100 000

On 1 September the recognition criteria for the capitalisation of development costs were met
the recoverable amounts are as follows:
31 December 2007 R90 000
31 December 2008 R90 000
31 December 2009 R90 000

Required

Show all the journals related to the costs incurred for each of the years ended 31 December.
2007 2008 2009
Opening balance(1 January) 0 20.8 20.9
Current year costs that are capitalized 40000 100000 110000
(20.7:R120000*4/12 when all 6 criteria are
met) 40000 100000 110000
Subtotal
Compared with recoverable amount given 90000 110000 250000
Impairment loss/impairment loss reversed n/a (30000) 30000
Closing balance(31 December) 40000 110000 240000

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 2007 Debit Credit
Research-Expense R80 000
Development; cost (asset) R40 000
Bank/Liability R120 000
Research and development costs incurred
(capitalization began on 1 September, and the costs
were expensed before this date
20.8
Development; Cost R100 000
Bank/Liability R100 000
Impairment loss: development 30000

Recoverable amount is the higher of the:

a) Value in use (future economic benefits expected from the use of the asset)
b) Fair value less costs of disposal. (future economic benefits expected from the
sale of the asset)

5.9 Example on the fair value

A company owns a machine with a carrying value of R200 000 at 30 June 2013.The fair value
of the machine in an active market is R220000.Selling costs would be brokerage fees of R5000
and dismantling and removal costs of R3500.Additional costs of R2000 were to be incurred in
servicing the machine before determining the recoverable amount. Therefore the fair value
less costs to sell =R220000-R5000-R2000-R3500=R209500.

The indicator review should take into consideration the following factors namely
a) External information
b) Internal information
c) Materiality
d) Reassessment of the variables of depreciation.

5.10 Impairments and the revaluation model

In order to process an impairment loss for an asset that is measured using the revaluation
model, the carrying amount of the asset must be credited in order to reduce it and the
impairment loss expenses account is debited. This will remove any revaluation surplus
balance.

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Example 5.1

Bloo Ltd is a manufacturing company and owns various items of machinery. At the end of the
year one item of machinery was damaged, but it is still in working order. The machine was
acquired on 1 January 2002 at a cost of R900 000. Depreciation was calculated on the straight-
line method over the expected useful life of 10 years. Due to the damage the useful life of the
machine was reviewed, and management estimated that the remaining life of the machine is
now only 3 years from 31 December 2004.
Management determined the fair value (realizable value) less costs to sell to be R530 000.

Required:

Calculate the impairment loss to be recognized by Bloo Ltd for the year ended 31 December
2004 in accordance with IAS 36.
Determination of impairment of machine:
Carrying amount (W1) R540 000
Less: Recoverable amount (R530 000)
Impairment loss R10 000

Workings.
Carrying amount:
Cost R900 000
Less: Accumulated depreciation i.e. 2002 - 2003 (R180 000)
[(R900 000 ÷ 10) x 2]
Carrying amount by 2002 - 2003 R720 000
Depreciation i.e. 2004 (180 000)
(720 000 ÷ 4)
Years remaining at 1 January 2004 4 years
Carrying amount by 2004 R540 000

Summary of the study unit

The unit covered the fundamental concepts relating to the impairment of assets and the
calculation of impairment losses and reversal of losses.

Self-assessment and reflection

Question 5.1

On 15 August 2002, Tartan Ltd purchased land in a remote area of the Eastern Cape at a cost
of R 150 000. The land is held for future development as a resort when transport links to the
area are made available.
At each reporting date, the directors estimated the net selling price of the land as well as
estimated the value in use of the land to the business if kept for future development. These
estimates are as follows:

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 Reporting date Net selling price Value in use
31/12/02 165 000 195 000
31/12/03 135 000 180 000
31/12/04 120 000 135 000
31/12/05 180 000 165 000

On 31 March 2006 the government cancelled all plans to provide transport to the area. There
is no prospect of selling the land. The cost of Tartam Ltd of developing transport exceeds the
present value of operating the resort.

Required:

a) State the amount at which the land should be recorded in the statement of financial
position at each reporting date
b) Prepare any journal entries that are needed in relation to the land at each of the above
reporting dates
c) Describe giving reasons, how should Tartan Ltd account for cancellation of the transport
plans on 31 March 2006

Question 5.2

Whale Limited is based in the United States but owns a plant in South Africa. Whale limited
expects to use the plant for a further two years after which it will be sold. The expectation is
reflected in the following forecast of the net cash flows from this plant over these remaining
two years:
2001 2002 2003
Net cash inflows from usage
R 150 000 R 80 000
Net cash inflow from disposal - R 10 000

Expected average spot rates R 8.0: $1 R 9.0: $1

Expected closing spot rates R 8.2: $1 R 9.0: $1

Actual closing spot rates R 8.5: $1

The relevant post tax discount rate for South Africa based on risks in South Africa is 7%(pre-
tax discount rate: 10%) whereas the relevant post tax discount rate for the United States based
on the risk in the United States is 8% (pre –tax discount rate: 9%)

Required:

Calculate the plants value in use to Whale Limited as at 31 December 2001

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Question 5.3

Elna limited has a division that is considered to be a cash generating unit for purpose of IAS
36 impairment of assets. The recoverable amount of this cash generating unit is R 130 000 at
31 December 2007
This carrying amount of the cash generating unit is R 181 000 at 31 December 2007,
constituted by the following individual carrying amount as at this date:
• Goodwill (purchased goodwill):R 20 000
• Equipment (measures under the cost model): R 60 000
• Investment property (measures under the cost model): R 81 000
• Inventory: R 20 000
The recoverable amounts at 31 December 2007 for the goodwill and investment property could
not be estimated on an individual basis, but the recoverable amount for equipment was
estimated to be R 40 000. In accordance with IAS 2 the net realisable value of the inventory
was R 15 000.

Required:

Calculate weather the cash generating unit is impaired and process the impairment loss
journal/s if relevant

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STUDY UNIT 6: INVESTMENT PROPERTY (IAS40)

6.1 Introduction

This is land and buildings that a company holds for two main purposes, and that is for capital
appreciation and the earning of rental income. IAS 40 which deals with investment property
requires that the company differentiates between investment properties and other properties
(CL Service 2012).IAS 40 paragraph 5 states that investment property, is land and or buildings
or part of a building held to earn rentals or for capital appreciation or both rather than for use
in the production of goods and services or for administrative purposes and sale in the ordinary
course of business.

The formal definition of investment property is that it land and buildings that held by the owner
or by a lessee under a finance lease to earn rentals or for capital appreciation. It is not PPE;
however property held under an operating lease can be classified as investment property.

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

• Introduction and the classification of investment property.
• Identify the recognition of an investment property.
• Perform measurement of Investment property (using the cost model and the fair
value model).
• Calculate and present the transfers from PPE to Investment property and from
Investment property to PPE.
• Identify the de-recognition, deferred tax, current tax, disclosure relating to investment
property.

6.2 Initial recognition

Investment property must be initially measured at cost; thereafter the cost model and or the
fair value model can be used.
Examples of property classified as investment property
• Property held for long term capital appreciation
• A building that is leased out under an operating lease
• A vacant building that is held with the intention of leasing it out under an
operating lease.
• A property being constructed for future use as investment property
• A property that is being redeveloped for future use as an investment property
• Land whose use is undecided (assumed with the intention for capital
appreciation.

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6.3 Examples of property is not classified as investment property

• Owner occupied property (PPE)

• Property that is leased out to someone under a finance lease
• Property held for sale in the ordinary course of the business.
• Property that is in the process of being developed for third parties

6.4 Change in use

Certain transfers in and out of investment property are however allowed when the use of the
property is changed from owner occupied to investment property and the other way around.
IAS 40 Investment Property applies to the accounting for property (land and/or buildings) held
to earn rentals or for capital appreciation (or both). Investment properties are initially measured
at cost and, with some exceptions may be subsequently measured using a cost model or fair
value model, with changes in the fair value under the fair value model being recognised in
profit or loss.
IAS 40 was reissued in December 2003 and applies to annual periods beginning on or after 1
January 2005.

6.5 Summary of IAS 40

Definition of investment property

Investment property is property (land or a building or part of a building or both) held (by the
owner or by the lessee under a finance lease) to earn rentals or for capital appreciation or
both. [IAS 40.5]

Examples of investment property: [IAS 40.8]

• land held for long-term capital appreciation
• land held for undetermined future use
• building leased out under an operating lease
• vacant building held to be leased out under an operating lease
• property that is being constructed or developed for future use as investment
property

The following are not investment property and, therefore, are outside the scope of IAS 40: [IAS
40.5 and 40.9]

• property held for use in the production or supply of goods or services or for
administrative purposes
• property held for sale in the ordinary course of business or in the process of
construction of development for such sale (IAS 2 Inventories)
• property being constructed or developed on behalf of third parties (IAS 11
Construction Contracts)
• owner-occupied property (IAS 16 Property, Plant and Equipment), including
property held for future use as owner-occupied property, property held for
future development and subsequent use as owner-occupied property,

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 property occupied by employees and owner-occupied property awaiting
disposal
• property leased to another entity under a finance lease

In May 2008, the IASB expanded the scope of IAS 40 to include property under construction
or development for future use as an investment property. Such property previously fell within
the scope of IAS 16.
Other classification issues
Property held under an operating lease. A property interest that is held by a lessee under an
operating lease may be classified and accounted for as investment property provided that:
[IAS 40.6]
• the rest of the definition of investment property is met
• the operating lease is accounted for as if it were a finance lease in accordance
with IAS 17 Leases
• the lessee uses the fair value model set out in this Standard for the asset
recognised

An entity may make the foregoing classification on a property-by-property basis.

Partial own use. If the owner uses part of the property for its own use, and part to earn rentals
or for capital appreciation, and the portions can be sold or leased out separately, they are
accounted for separately. Therefore the part that is rented out is investment property. If the
portions cannot be sold or leased out separately, the property is investment property only if
the owner-occupied portion is insignificant. [IAS 40.10]

6.5.1 Ancillary services.

If the entity provides ancillary services to the occupants of a property held by the entity, the
appropriateness of classification as investment property is determined by the significance of
the services provided. If those services are a relatively insignificant component of the
arrangement as a whole (for instance, the building owner supplies security and maintenance
services to the lessees), then the entity may treat the property as investment property. Where
the services provided are more significant (such as in the case of an owner-managed hotel),
the property should be classified as owner-occupied. [IAS 40.13]

Intercompany rentals. Property rented to a parent, subsidiary, or fellow subsidiary is not

investment property in consolidated financial statements that include both the lessor and the
lessee, because the property is owner-occupied from the perspective of the group. However,
such property could qualify as investment property in the separate financial statements of the
lessor, if the definition of investment property is otherwise met. [IAS 40.15]

6.5.2 Recognition

Investment property should be recognised as an asset when it is probable that the future
economic benefits that are associated with the property will flow to the entity, and the cost of
the property can be reliably measured. [IAS 40.16]
Initial measurement
Investment property is initially measured at cost, including transaction costs. Such cost should

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not include start-up costs, abnormal waste, or initial operating losses incurred before the
investment property achieves the planned level of occupancy. [IAS 40.20 and 40.23]

6.6 Measurement subsequent to initial recognition

IAS 40 permits entities to choose between: [IAS 40.30]

• A fair value model, and
• A cost model.

One method must be adopted for all of an entity's investment property. Change is permitted
only if this results in a more appropriate presentation. IAS 40 notes that this is highly unlikely
for a change from a fair value model to a cost model.

6.6.1 Fair value model

Investment property is re-measured at fair value, which is the amount for which the property
could be exchanged between knowledgeable, willing parties in an arm's length transaction.
[IAS 40.5] Gains or losses arising from changes in the fair value of investment property must
be included in net profit or loss for the period in which it arises. [IAS 40.35]

Fair value should reflect the actual market state and circumstances as of the balance sheet
date. [IAS 40.38] The best evidence of fair value is normally given by current prices on an
active market for similar property in the same location and condition and subject to similar
lease and other contracts. [IAS 40.45] In the absence of such information, the entity may
consider current prices for properties of a different nature or subject to different conditions,
recent prices on less active markets with adjustments to reflect changes in economic
conditions, and discounted cash flow projections based on reliable estimates of future cash
flows. [IAS 40.46]
There is a rebuttable presumption that the entity will be able to determine the fair value of an
investment property reliably on a continuing basis. However: [IAS 40.53]

If an entity determines that the fair value of an investment property under construction is not
reliably determinable but expects the fair value of the property to be reliably determinable
when construction is complete, it measures that investment property under construction at
cost until either its fair value becomes reliably determinable or construction is completed.

If an entity determines that the fair value of an investment property (other than an investment
property under construction) is not reliably determinable on a continuing basis, the entity shall
measure that investment property using the cost model in IAS 16. The residual value of the
investment property shall be assumed to be zero. The entity shall apply IAS 16 until disposal
of the investment property.

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Where a property has previously been measured at fair value, it should continue to be
measured at fair value until disposal, even if comparable market transactions become less
frequent or market prices become less readily available. [IAS 40.55]

6.6.2 Cost model

After initial recognition, investment property is accounted for in accordance with the cost model
as set out in IAS 16Property, Plant and Equipment – cost less accumulated depreciation and
less accumulated impairment losses. [IAS 40.56]

Transfers to or from investment property classification

Transfers to, or from, investment property should only be made when there is a change in use,
evidenced by one or more of the following: [IAS 40.57]
• commencement of owner-occupation (transfer from investment property to owner-
occupied property)
• commencement of development with a view to sale (transfer from investment
property to inventories)
• end of owner-occupation (transfer from owner-occupied property to investment
property)
• commencement of an operating lease to another party (transfer from inventories to
investment property)
• end of construction or development (transfer from property in the course of
construction/development to investment property

When an entity decides to sell an investment property without development, the property is
not reclassified as investment property but is dealt with as investment property until it is
disposed of. [IAS 40.58]
The following rules apply for accounting for transfers between categories:
• for a transfer from investment property carried at fair value to owner-occupied
property or inventories, the fair value at the change of use is the 'cost' of the
property under its new classification [IAS 40.60]
• For a transfer from owner-occupied property to investment property carried at fair
value, IAS 16 should be applied up to the date of reclassification. Any difference
arising between the carrying amount under IAS 16 at that date and the fair value
is dealt with as a revaluation under IAS 16 [IAS 40.61]
• for a transfer from inventories to investment property at fair value, any difference
between the fair value at the date of transfer and it previous carrying amount
should be recognised in profit or loss [IAS 40.63]
• when an entity completes construction/development of an investment property
that will be carried at fair value, any difference between the fair value at the date
of transfer and the previous carrying amount should be recognised in profit or
loss. [IAS 40.65]

When an entity uses the cost model for investment property, transfers between categories do
not change the carrying amount of the property transferred, and they do not change the cost
of the property for measurement or disclosure purposes

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6.6.3 Disposal

An investment property should be de-recognised on disposal or when the investment property

is permanently withdrawn from use and no future economic benefits are expected from its
disposal. The gain or loss on disposal should be calculated as the difference between the net
disposal proceeds and the carrying amount of the asset and should be recognised as income
or expense in the income statement. [IAS 40.66 and 40.69] Compensation from third parties
is recognised when it becomes receivable. [IAS 40.72]

6.6.4 Disclosure

Both Fair Value Model and Cost Model [IAS 40.75]

• whether the fair value or the cost model is used
• if the fair value model is used, whether property interests held under operating
leases are classified and accounted for as investment property
• if classification is difficult, the criteria to distinguish investment property from
owner- occupied property and from property held for sale
• the methods and significant assumptions applied in determining the fair value
of investment property
• the extent to which the fair value of investment property is based on a valuation
by a qualified independent valuer; if there has been no such valuation, that fact
must be disclosed
• the amounts recognised in profit or loss for:
• rental income from investment property
• direct operating expenses (including repairs and maintenance) arising from
investment property that generated rental income during the period
• direct operating expenses (including repairs and maintenance) arising from
investment property that did not generate rental income during the period
• the cumulative change in fair value recognised in profit or loss on a sale from
a pool of assets in which the cost model is used into a pool in which the fair
value model is used

6.6.7 Additional Disclosures for the Fair Value Model [IAS 40.76]

• a reconciliation between the carrying amounts of investment property at the

beginning and end of the period, showing additions, disposals, fair value
adjustments, net foreign exchange differences, transfers to and from inventories
and owner-occupied property, and other changes [IAS 40.76]
• significant adjustments to an outside valuation (if any) [IAS 40.77]
• if an entity that otherwise uses the fair value model measures an item of
investment property using the cost model, certain additional disclosures are
required [IAS 40.78]

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6.6.8 Additional Disclosures for the Cost Model [IAS 40.79]

• the depreciation methods used

• the useful lives or the depreciation rates used
• the gross carrying amount and the accumulated depreciation (aggregated with
accumulated impairment losses) at the beginning and end of the period
• a reconciliation of the carrying amount of investment property at the beginning
and end of the period, showing additions, disposals, depreciation, impairment
recognised or reversed, foreign exchange differences, transfers to and from
inventories and owner- occupied property, and other changes
• the fair value of investment property. If the fair value of an item of investment
property cannot be measured reliably, additional disclosures are required,
including, if possible, the range of estimates within which fair value is highly
likely to lie

Example 6.1 [Change from owner occupied to investment property]

Fantastic ltd had its head office located in De rust South Africa. During a landslide, a building
which it owned and was renting to Sadly Limited was destroyed. Fantastic ltd then decide to
move its head office to another under-utilized building nearby, which was currently being
used for administration purposes and to lease its original head office building to Sadly limited
as a replacement.

Additional information.
The head office was purchased on 1 January 2005 for R500 000, with a useful life of 5 years.
The fair value of the head office building was R520000 on 30 June 2005 and R 490 000 on 31
December 2005. Fantastic limited uses the cost model to measure the Property Plant and
equipment and the revaluation model to measure the investment properties.
Provide all related journals for Fantastic Limited for the year ended 31 December 2005

Journal Entries Debit Credit

PPE-Office building Bank/Liability R500 000
Being the recording of head office building (owner R500 000
occupied)
Depreciation expense R50 000
Property plant and Equipment: Office building R50 000
Being the depreciation expense to date of the
change in use. R70 000
Office building :Carrying amount(PPE)
Revaluation surplus(520 000-(500000-50000) R70 000
Being the head office in change in fair value on
date of change in use.
Office building(Investment property) Office building: R520 000
Carrying amount(PPE) R520 000
Transfer of building from PPE to Investment
property
Fair value adjustment on investment R30 000
property(expense) Office building: Fair value R30 000
investment property

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Example 6.2
A company owns a piece of land with hotel building thereon. This property is leased out to a
well-known hotel group under an operating lease.
Required
Discuss fully whether the directors of the company shall account for the land and hotel building
as an investment property or as property, plant and equipment in accordance with IAS 40.

Solution
Investment property is defined as property held (by the owner or by a lessee under a finance
lease) to earn rentals and or for capital appreciation, rather than for:
• Use in the production or supply of goods or services or for administrative
purposes or
• Sale in the ordinary course of the business.
Property, plant and equipment is property held (by the owner or by a lessee under a finance
lease) for use in the production or supply of goods or services or for administrative purposes.
Judgment is needed to determine whether a hotel qualifies as an investment property or
Property, plant and equipment. In conclusion the property referred to in the question is,
however, not owner occupied, but rented out to a tenant that provides rental income and hence
should be considered as investment property.

Summary of the study unit

The unit covered the important distinction between property plant and equipment as well as
investment property. The initial recognition, measurement and subsequent disclosure of
investment property was also covered...

Self-assessment and reflection

Answer the questions in this unit and in your textbook to check whether you have achieved
all the set outcomes

Question 6.1

Green Tea limited acquired a property on 1 January 2008 at a cost of R 4.2 million. It was
immediately leased out as an investment property for a period of 1 ½ years until 30 June 2009.
On 1 July 2009 the company tool occupation of the property as its administrative headquarters.

The fair values of the property were determined as follows:

• On 31/12/2008: R 4 500 000
• On 31/07/2009: R 5 200 000
• On 31/12/2009: R 5 300 000
The accounting policy of the company is to depreciate buildings at 4% per annum on the
straight line basis. The company adopts the cost model for property plant and equipment and
fair value model for investment properties.

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Required:

a) Prepare an extract from the notes to the financial statement showing the statement
of compliance and basis of preparation notes as well as the accounting policy notes
for property, plant and equipment and for investment property
b) Prepare an extract from the profit before tax note for the year ended 31 December
2009
c) Prepare an extract from the statement of financial position at 3 December 2009.

Question 6.2

Angazi Limited owns an office park that it developed during the current reporting period. It is
also a lessee in a number of properties held under lease agreements

Angazi Limited’s head office is situated in the office park in a stand-alone building. The balance
of the office park, containing two stand-alone properties, is let to tenants under non-
cancellable operating leases.
The Chief Executive Officer of Angazi Limited has insisted that the accountant measures all
their properties using the cost model per IAS 16 property, plant and equipment since he
believes this model is the cheapest measurement model to implement (as fair values will not
be required) and would have the least impact on the financial statements.

Required:

Prepare a letter to the accountant of Angazi Limited explaining how these properties should
be recognised and measured. Also indicate whether the Chief Executive Officers assumptions
are correct.

Question 6.3

Wealth Wizard Limited is involved in property development. One of the properties that it owns
is a beachfront flat which is still under construction during 2005. This beachfront flat will be
used to rent out as a holiday accommodation.
Details of the construction are as follows:
• Construction costs incurred during the year ended 31 December 2004:
R 500 000.
• Construction costs incurred during 2005 to talled R 300 000.
• Construction was completed on 30 June 2005.
• All construction costs were paid as they were incurred.
The directors have estimated that the building once completed will have a residual value of R
300 000 and a useful life of 10 years.
Wealth Wizard Limited measures property, plant and equipment using the cost model and
investment property using the fair value model. Depreciation is provided on the straight line
basis unless another method is clearly more appropriate.

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Required:

Ignoring tax show all journals relating to the beachfront flat in Wealth Wizards general journal
for the year ended 31 December 2004 and 31 December 2005 assuming that:
a) The fair value of the property could not be measured whilst it was under construction
and that when completed on 30 June 2005, fair values were not expected to be
determinable on a continuing basis
b) The fair value of property could not be measured whilst it was under construction but
that when completed on 30 June 2005, he fair value was R 900 000 and was R 950
000 on 31 December 2005
c) The fair value of the property could not be measured whilst it was under construction
and that when completed on 30 June 2005, the fair value was to determinable on a
continuing basis. An unexpected property boom occurred in the area from
September 2005 with the results that the fair value was now considered
determinable on a continuing basis. The fair value was determined to be R 950 000
on 31 December 2005.
d) The fair value of the property could be measured whist it was under construction:
• 31 December 2004: R 550 000
• 31 December 2005: R 950 000

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STUDY UNIT 7: INVENTORY (IAS 2)

7.1 Introduction

There are different types of inventories that a company can hold as part of its assets.
Inventories are assets that are held for the sale in the ordinary course of the business, or in
the process of production, for such sale and in the form of materials or supplies to be
consumed in the production process or in the rendering of services. Inventories are assets of
the business as they are controlled by the business due to past events, and from which future
economic benefits are expected to flow to the entity.IAS 2 para 1 sets out to provide guidance
on the following.

a) The determination of the cost of the inventories

b) The subsequent recognition as an expense ,including any write off down to net
realisable value
c) Cost formulas used to assign costs to inventories

IAS 2 applies to all inventories except

a) Work in progress arising under construction contracts(IAS 11)
b) Financial instruments(IAS 32,39 and IFRS 9)
c) Biological assets related to agricultural activity and produce at the point of
harvest(IAS 41)

These are assets that are held in the ordinary course of the business, in the process of
production for such sale, and in the form of materials or supplies to be consumed in the
production process or in the rendering of services

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

• Introduction, recognition and classification of inventories.
• Compute the initial measurement at cost.
• Perform the recording of inventory movements (Periodic and perpetual
inventory systems).
• Compute the subsequent measurement: Inventory movements (Cost
formulae) overview.
• Identify and calculate the subsequent measurement year end.
Identify and present the disclosure, of inventory in the financial statements

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7.2 Net realisable value

Estimated selling price in the ordinary course of the business less estimated cost of completion
necessary to make the sale.

7.3 Fair value

The price that would be received to sell the asset or paid to transfer a liability in an orderly
transaction between market participants at the measured date.

7.4 There are two systems of inventory management

7.4.1 Perpetual Inventory System

Perpetual inventory valuation-where every time a sale or purchase is made the inventory
records automatically update, to the new levels. This system uses two accounts, which are

• An inventory account
• Cost of sales account.

7.4.2 Periodic Inventory System

Periodic inventory valuation-in this case the inventory is valued on a regular basis, i.e. annual
or monthly inventory count. There are 3 accounts that are maintained and these are

• Purchases account
• Inventory account
• Trading account

7.4.3 Valuation and measurement of inventory

Inventory is measured at cost or net realizable value whichever is lower.

The net realizable value is the expected selling price less all costs incurred to bring the
inventories into a saleable condition. Cost is the purchase price less settlement discount
received; add any other costs incurred to bring the inventory into a saleable condition and to
its present location, e.g. transport costs (inwards, import duties, and other direct costs)

7.4.4 Cost formulas for inventory movements

There are 3 different cost formulae that are used when measuring movements and these are

a) First in first out Method (FIFOM)

b) Weighted average cost method (WAM)
c) Specific identification method.(SIM)

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IAS 2 Inventories contains the requirements on how to account for most types of inventory.
The standard requires inventories to be measured at the lower of cost and net realisable value
(NRV) and outlines acceptable methods of determining cost, including specific identification
(in some cases), first-in first-out (FIFO) and weighted average cost. A revised version of IAS
2 was issued in December 1993 and applies to annual periods beginning on or after 1 January
2005.

The objective of IAS 2 is to prescribe the accounting treatment for inventories. It provides
guidance for determining the cost of inventories and for subsequently recognising an expense,
including any write-down to net realisable value. It also provides guidance on the cost formulas
that are used to assign costs to inventories.

7.5 Scope

Inventories include assets held for sale in the ordinary course of business (finished goods),
assets in the production process for sale in the ordinary course of business (work in process),
and materials and supplies that are consumed in production (raw materials). [IAS 2.6]

7.6 Measurement of inventories

Cost should include all: [IAS 2.10]

Costs of purchase (including taxes, transport, and handling) net of trade discounts received,
costs of conversion (including fixed and variable manufacturing overheads) and, other costs
incurred in bringing the inventories to their present location and condition.
IAS 23 Borrowing Costs identifies some limited circumstances where borrowing costs
(interest) can be included in cost of inventories that meet the definition of a qualifying asset.
[IAS 2.17 and IAS 23.4]

Inventory cost should not include: [IAS 2.16 and 2.18]

• abnormal waste
• storage costs
• administrative overheads unrelated to production
• selling costs
• foreign exchange differences arising directly on the recent acquisition of
inventories invoiced in a foreign currency
• Interest cost when inventories are purchased with deferred settlement terms.

Study Guide Page 55 of 77 Damelin ©

7.7 Write-down to net realisable value

NRV is the estimated selling price in the ordinary course of business, less the estimated cost
of completion and the estimated costs necessary to make the sale. [IAS 2.6] Any write-down
to NRV should be recognised as an expense in the period in which the write-down occurs.
Any reversal should be recognised in the income statement in the period in which the reversal
occurs. [IAS 2.34]

7.8 Expense recognition

IAS 18 Revenue addresses revenue recognition for the sale of goods. When inventories are
sold and revenue is recognised, the carrying amount of those inventories is recognised as an
expense (often called cost-of-goods-sold). Any write-down to NRV and any inventory losses
are also recognised as an expense when they occur. [IAS 2.34]

7.9 Disclosure

Required disclosures: [IAS 2.36]

• accounting policy for inventories
• Carrying amount, generally classified as merchandise, supplies, materials, work
in progress, and finished goods. The classifications depend on what is
appropriate for the entity
• carrying amount of any inventories carried at fair value less costs to sell
• amount of any write-down of inventories recognised as an expense in the period
• amount of any reversal of a write-down to NRV and the circumstances that led
to such reversal
• carrying amount of inventories pledged as security for liabilities
• Cost of inventories recognised as expense (cost of goods sold). IAS 2
acknowledges that some enterprises classify income statement expenses by
nature (materials, labour, and so on) rather than by function (cost of goods sold,
selling expense, and so on). Accordingly, as an alternative to disclosing cost of
goods sold expense, IAS 2 allows an entity to disclose operating costs
recognised during the period by nature of the cost (raw materials and
consumables, labour costs, other operating costs) and the amount of the net
change in inventories for the period). [IAS 2.39] This is consistent with IAS 1
Presentation of Financial Statements, which allows presentation of expenses by
function or nature.

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Example 7.1

Unique Limited entered into the following inventory transactions during April 2015 April.
Date Details
1 April Inventory on hand:
14 units at R1.80 each
6 units at R2.00 each
5 April Purchased 60 units at R3.00 each
Purchased 35 units at R4.00 each
15 April Purchased 40 units at R5.00 each
19 April Sold 50 units
22 April Purchased 100 units at R4.00 each
30 April Sold 60 units

All units are sold at a selling price of R6.00 each. Unique ltd uses the perpetual inventory
system.

Required
Calculate the cost of closing inventory on hand at 30 April 2015 using each of the following
methods.
a) FIFO-First In First Out.
b) Weighted Average Cost Method.
c) Calculate the gross profit under each method.

FIFO
Date Purchases Issues Balance
Qty Units Amount Qty Units Amount Qty Units Amount

1 14 1.80 25.20
6 2.00 12.00
5 60 3.00 180.00 14 1.80 25.20
6 2.00 12.00
60 3.00 180.00
10 35 4.00 140.00 14 1.80 25.20
6 2.00 12.00
60 3.00 180.00
35 4.00 140.00
11 14 (1.80) (25.20) 50 3.00 150.00
6 (2.00) (12.00) 35 4.00 140.00
10 (3.00) (30.00)
15 40 5.00 200.00 50 3.00 150.00
35 4.00 140.00
40 5.00 200.00
19 50 (3.00) (150) 35 4.00 140.00
40 5.00 200.00
22 100 4.00 400.00 35 4.00 140.00
40 5.00 200.00
100 4.00 400.00
30 35 (4.00) (140) 15 5.00 75.00
25 (5.00) (125) 100 4.00 400.00

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Weighted Average Cost Method.
Date Purchases Issues Balance
Qty Units Amount Qty Units Amount Qty Units Amount

1 20 1.86 37.20
5 60 3.00 180.00 80 2.715 217.20
10 35 4.00 140.00 115 3.106 357.21
11 30 (3.402) (102.06) 85 3.106 264.01
15 40 5.00 200.00 125 3.712 464.00
19 50 (3.958) (197.90) 75 3.712 284.40
22 100 4.00 400.00 175 3.876 678.30
30 60 (3.983) (238.98) 115 3.876 445.74

Unique Ltd
Trading Account for the Month ended 30 April 2006
Details FIFO FIFO WAC WAC
Sales (140 x 6.00) R840.00 R840.00
Cost of Sales (R482.20) (R511.46)
Opening Inventory
R37.20 R37.20
Purchases R920.00 R920.00
Less: Closing Inventory (R475.00) (R445.74)
R357.80 R386.54

Summary of the study unit

The main issues regarding the treatment of inventories such as definition, measurement and
recognition have been covered in this unit in line with IAS 2.

Self-assessment and reflection

Question 7.1

Wall Cleaning services provides wall cleaning and painting services to Harbour House in
central Durban. The accountant does not believe that IAS 2 inventories applies to this business
since it does not hold any physical stock in order to provide these services

A contract for services during the year ended 31 December 2004 was concluded at a contract
price of R 100 000. The contract required that the office walls on ten floors would be washed
and repainted and that this would cost R 80 000. By 31 December 2004, the walls of six floors
had been completed and costs of R 50 000 had been incurred.

Required:
Discuss whether or not the contract above would involve IAS 2 inventories, providing journals
where possible

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Question 7.2

Foam Limited was incorporated on 1 July 2001. The bookkeeper has provided you with the
following information regarding its factory: A supervisor has been hired to manage all
administration at the factory. Hs annual salary is R 96 000
• The plant cost R 480 000 and is depreciated on a straight line basis to a nil
residual value.
• There are no other fixed manufacturing costs
Production during the first period (10 months) of operations was as follows:
Budgeted (10 months) Actual (10 months)
Production (units) 24 000 units 14 400 units
Sales (units) 18 000 units 12 000 units

Required:
Calculate the following for the year ended 30 April 2002:

a) The application rate to be used when allocating fixed manufacturing costs

inventory at year end;
b) The amount of fixed manufacturing costs included in the closing balance of
inventory on 30 April 2002,and
c) the total amount of fixed manufacturing costs expensed during the period ended
30April 2002

Question 7.3

Cupcake International produces long life cupcakes for export and local consumption. At its
financial year ended 31 December 2004, it had raw materials of R 400 00 on hand. It is
expected that the cost to convert the raw materials into finished cupcakes is R 100 000.

Required:
Calculate the net realisable value of the raw materials and journalise any write – down
assuming that, once converted into the finished cup – cakes, these finished cupcakes would:

a) be saleable at R 600 000 and would incur selling cost of R 50 000

b) be saleable at R 500 000 and would incur selling cost of R 50 000

Study Guide Page 59 of 77 Damelin ©

STUDY UNIT 8: NON CURRENT ASSETS HELD FOR SALE AND DISCONTINUED
OPERATIONS

8.1 Introduction

This unit covers the classification; measurement presentation and disclosure of, Non-current
assets held for sale and discontinued operations. Non-current assets held for sale are assets
whose carrying amount will be recovered mainly through a sale transaction rather than through
continuing use.

IFRS 5 sets out specific measurement requirements for non-current assets and disposal
groups that are classified as held for sale. Held for sale classification is not an accounting
policy choice; it is mandatory when certain conditions apply, namely if the asset(s) in question
is (are) available for immediate sale and the sale is highly probable. Very often, a planned sale
involves a group of assets (and possibly liabilities). IFRS 5 introduces the concept of a disposal
group to address this situation.

Typically, this definition captures individual assets that the entity seeks to dispose of in a sale
transaction, such as:

a) Property, plant and equipment;

b) Intangible assets;
c) Investment property,
d) Biological assets; and
e) Non-current financial investments such as interests in associates, or other financial
instruments.
Assets that are to be abandoned or scrapped (rather than sold) are not classified as assets
held for sale (IFRS 5.13-14). Assets that will be derecognised due to an exchange of non-
current assets with a third party are covered by IFRS 5 unless the exchange lacks commercial
substance. Sale and leaseback transactions are outside the scope of IFRS 5 and are covered
by IAS 17 Leases. Sales of machinery, vehicles and other equipment, which have been
replaced by new items and sales of surplus property are very common examples of
transactions where IFRS 5 applies even where the disposed assets do not form a disposal
group.

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

• Overview scope and classification as assets held for sale and discontinued
operations.
• Present the measurement: Individual non-current assets held for sale.
• Compute the disposal groups held for sale.
• Presentation and disclosure: non-current assets (or disposal groups) held for sale
and distribution.
• Summarise the key or fundamental accounting treatment of NCAHFS

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8.2 A disposal group is defined as:

A group of assets to be disposed of, by sale or otherwise, together as a group in a single

transaction, and liabilities directly associated with those assets that will be transferred in the
transaction. The group includes goodwill acquired in a business combination if the group is a
cash-generating unit to which goodwill has been allocated in accordance with the
requirements of paragraphs 80& 87 of IAS 36

(IFRS 5.A).
Examples of a disposal group include a subsidiary or an operating segment or a cash
generating unit (CGU). A disposal group is sometimes but not always a discontinued operation

8.3 Initial classification requirements

IFRS 5 specifies two main requirements to initially classify asset(s) as held for sale. Firstly,
the asset(s) must be available for immediate sale in its (their) present condition. Secondly, the
sale must be highly probable.

8.4 Available for immediate sale

The term available for immediate sale requires some interpretation. An asset is available for
immediate sale if there is no significant reason why the sale could not take place immediately.
Terms that are usual and customary for similar sales and are not likely to cause a material
delay do not preclude held for sale classification.

The Implementation Guidance to IFRS 5 sets out a number of examples to illustrate these
concepts. Assets are not available for immediate sale if they continue to be needed for the
entity's on-going operations (IFRS 5.IG examples 1b and 2b) or are being refurbished to
enhance their value. Held for sale classification is then delayed until the assets under review
are available for immediate sale.

Example 8.1

Property used as headquarters by the entity itself needs to be vacated before it can be sold.
If the property is expected to be vacated in the usual course of the sales plan, then a held for
sale classification may be appropriate in accordance with the standard. If however the property
can be vacated only after a replacement is available (e.g. a new building under construction
or one that still needs to be vacated by its former tenants/owners), then this may indicate that
the property is not available for immediate sale, but only after the replacement becomes
available.

An entity intends to sell a manufacturing facility. If the entity needs the facility to clear a backlog
of uncompleted orders, then this may indicate that the facility is not available for immediate
sale. If the entity however seeks to sell the manufacturing facility including the backlog of
uncompleted orders, its availability for immediate sale may be assumed.

An entity plans to renovate some of its property to increase its value prior to selling it to a

Study Guide Page 61 of 77 Damelin ©

third party. The entity is already searching for a buyer at current market values.
Nevertheless, due to the plans to renovate the property prior to sale, the property may not be
available for immediate sale.

8.5 Discontinued operations

[IFRS 5 also addresses the concept of discontinued operations. This concept is not the same
as the held for sale classification, although the concepts are linked. Discontinued operations
give rise to specific presentation requirements rather than re-measurements. Discontinued
operations are presented separately in an entity s statement of comprehensive income and
also require preparers to compute and disclose additional measures of earnings per share
(EPS). Mandatory disclosures are provided to further explain the underlying event or
transaction.
This section explains the conditions that trigger the presentation of a discontinued operation.
The interaction with the held for sale classification is also addressed.

8.6 Definitions

IFRS 5 applies to a variety of situations in which an entity ceases separately identifiable

activities IFRS 5 defines a discontinued operation as:
A component of an entity that either has been disposed of or is classified as held for sale and:
a) Represents a separate major line of business or geographical area of operations,
b) Is part of a single co-ordinated plan to dispose of a separate major line of business
or geographical area of operations or
c) Is a subsidiary acquired exclusively with a view to resale (IFRS 5.A).

8.7 A component of an entity is defined as:

Operations and cash flows that can be clearly distinguished, operationally and for financial
reporting purposes, from the rest of the entity (IFRS.5.A)
Judgement is sometimes necessary in deciding whether a disposal represents a discontinued
operation. Depending on the facts and circumstances of each transaction, it may not be
appropriate to present every ceased activity of the reporting entity as a discontinued operation.
Rather the entity should focus on significant elements of its operations.

Summary of the study unit

In this chapter we have explained, the meaning of non-current assets held for sale, in
addition the classification and recognition of non-current assets. The measurement of non-
current assets we also discussed the disposal of entities previously considered as going
concerns.

Study Guide Page 62 of 77 Damelin ©

Self-assessment and reflection

Question 8.1

Out here Limited owns only one item of property, plant and equipment being plant, which has
always carried under the cost model, details of which:
Cost (1 January 2001) R 500 000
Recoverable amount (31 December 2002) R 210 000
Depreciation is charged at 20% per annum, straight line with a nil residual value.

On 1 April 2003, the company decided to sell the plant. All the criteria necessary for
reclassification as a non-current asset held for sale were met on this date. The following
information was relevant on this date:
Value in use R200 000
Fair value R200 000
Cost of sell R10 000

At 31 December 2003 (the company’s year-end) the following information was relevant:
Fair value R180 000
Cost to sell R10 000

All impairments and/or impairment reversals are considered material.

Required:

Part A:
Ignore tax effects
a) Show all journal entries relevant to the above information
b) Disclose the effect on the statement of financial position, related notes and profit
before tax note for the year ended 31 December 2003
Note: Accounting policy notes are not required

Part B:
Assume the following information regarding tax:
• The tax authorities allow a wear and tear deduction of 25% of cost (not
apportioned)
• The normal income tax rate is 30%
c) Show all journal entries relevant to the above information
d) Disclose the effect on the statement of financial position, related notes and profit
before tax note for the year ended 31 December 2003
Note: Accounting policy notes are not required

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Question 8.2

Jovial Limited owns only one item of property, plant and equipment being a machine. Jovial
purchased this machine at a cost of R 250 000 on 1 January 2005. It has always carried this
machine under the cost model. On 1 April 2007, the company decided to sell the machine and
all necessary criteria to reclassify the machine as a non-current asset held for sale were met.

The machine is expected to have a useful life of 5 years

The tax authority allows the machine to be deducted over 4 years (not apportioned) the
machine had the following values:

31 December 2006: recoverable amount R105 000

1 April 2007: fair value less costs to sell (value in use:90 000) R95 000
31 December 2007:fair value less costs to sell(value in use: 105 000) R 145 000

The normal income tax rate is 30%

All impairments and/or impairment reversals are considered material required:

Required:

a) Show all journal entries relevant to the above information.

b) Disclose the effect on the statement of financial position, related notes and profit before
tax note for the year ended 31 December 2007
Note: Accounting policy notes are not required

Study Guide Page 64 of 77 Damelin ©

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